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Getty Images (GYI)

Q2 2006 Earnings Conference Call

July 25, 2006 5:00 pm ET

Executives

Mark Getty – Co Founder and Chairman

Jonathan Klein – Co Founder and Chief Executive Officer

Tom Oberdorf – Senior Vice President and Chief Financial Officer

Alan Pickerill – Investor Relations

Analysts

Peter Appert – Goldman Sachs

Matthew Troy – Citigroup

Troy Mastin – William Blair

Christa Sober Quarles – Thomas Weisel.

Jeetil Patel – Duetsche Bank.

Steve Ashley – Robert Baird

Operator

Good day and welcome to the Getty Images Second Quarter Earnings Release for 2006 Conference Call. [Operator Instructions] Later we will conduct a question and answer session.

Presentation

Allen Pickerill

[Audio gap] If you have additional questions we're happy to follow up with you after the call. Joining us we have Jonathan Klein, Getty Images Co Founder and Chief Executive Officer and Tom Oberdorf the Company's Chief Financial Officer. I'll now turn the call over to Jonathan Klein.

Jonathan Klein, Getty Images, Inc.

Thanks Allen. Good afternoon everyone and thank you for joining us on the call today. Before I begin I would like to introduce and also welcome our new CFO Tom Oberdorf. Tom joined us about a month ago and I'm very pleased to have him on board. 2006 will be a very good year indeed for Getty Images. The business is strong. We have an outstanding business model and are in an enviable position's. It's sad to say that most companies in any business, including imagery would happily exchange their coquetted disposition for ours. In absolute terms the results for Q1 and Q2 are extremely good. However, they are not as strong as we had hoped or anticipated when we entered the year. At the beginning of the year we set ourselves high expectations for 2006 and these stretch goals are not being achieved largely due to an under performance in one area of our business.

I'm going to begin by talking about what worked well in the quarter. The shortest way to describe what worked well is to say everything did well, in fact did very well with one exception and of course I'll get to the exception later. Revenue grew almost 13% on a currency neutral basis to just under $205 million. Once again, this is a record revenue quarter for Getty Images and record revenues are pleasing, should be celebrated and we never take them for granted. Our cost of revenue was a record low, exactly what you want at 24.8% of revenue. G&A came in as anticipated and will decline over the coming quarters. Excluding stock-based compensation and the charge for the New York lease loss operating income was $62.2 million or an operating margin of 30.4% of revenue. As you're aware, we have a very high margin business, also highly cash generative. Cash flow from operations was $65.4 million for the quarter.

I'm going to highlight just a handful of the many achievements during the second quarter. Firstly, a key component of our record total revenue was the performance of Created Skills. This part of the business accounted for about 80% of our total revenue in the quarter. Created Skills revenues grew over 10% on a currency neutral basis. Rights-Managed grew 8% to $83.7 million in the quarter and Royalty Free grew over 12% to $78.2 million in the second quarter.

Touching on cost of sales, improvements in our cost of sales line was largely driven by the acquisition about a year ago of Digital Vision and much more recently of stockbyte. One of the primary reasons for these acquisitions was to improve our margins by eliminating significant royalty payments to what were our largest image partners at the time of acquisition. This has already been demonstrated in the short time since we acquired stockbyte, all of whose content is wholly ours. In the quarter we generated healthy revenue growth in every region and every product line.

I hate to point to this one region but it would be remiss of me not to draw attention to Asia, which was the standout performer with revenue growth of more than 30% currency neutral during the quarter. In fact in Japan, we had revenue growth of over 50%. The growth numbers in China are even higher albeit on a smaller base. As you know, in countries where we do not have a company owned office we operate through delegates and they are doing very well indeed. In the quarter delegates grew more than 25% on a currency neutral basis and this success provides further evidence of strong progress in one of our key initiatives this year, which is to grow our business in non-English speaking markets.

Moving away from creative imagery for a moment to the other significant part of our business and that is editorial imagery. To remind you, that's the wide news, sport, and entertainment product as well as our archives. In editorial imagery we had significant year-over-year currency neutral growth of 23% with once again strong growth in every region

I'd like to just point a moment to entertainment imagery where growth was 65%. The relatively short period of time we've clearly become a force to be reckoned with in the entertainment imagery market. Some of you may have noticed that we managed to not only shoot, but also distribute, what many described as the photographic tool of the century and that was the baby pictures from Angelina Jolie and Brad Pitt. I should stress that no revenue or profit was generated for Getty Images as we and the couple agreed that all proceeds should go to charitable causes. We were very pleased to be able to participate in this groundbreaking event. Overall, to summarize, our entertainment imagery is exploding. We've been the leading in sports imagery for sometime and believe that this lead continues to increase with once again stellar execution at major events like the Olympic games and the World Cup.

Our news product, although less than five years old, continues to be a force and also goes from strength to strength. Look at any major magazine, newspaper, or Website and you will see the evidence. Importantly we believe that there is much more growth in all areas of editorial imagery as we expand even more aggressively internationally.

Channel sales is not something we've spoken about much in the past. Channel sales represents our imagery being sold through third party distributors. Channel sales during the quarter grew over 50% on a currency neutral basis. These distributors operate all over the world as well as in the U.S. and in the U.K. and as so many of them are outside of those countries once again it is another strategy to enable us to deliver on the key initiatives of growing sales outside the English-speaking world.

As you're used to now, we make acquisitions and during the quarter we closed the acquisitions of stockbyte and Laura Ronchi. As you know, stockbyte was our largest image partner at the time of acquisition and includes, or has, a 100% wholly owned imagery. We told you that we were going to continue to carry the cost of stockbyte, stock and related expenses for the whole of the second quarter and that's exactly what we did. We also told you that we would completely integrate the business at the end of the second quarter and I'm pleased to report that this transition is now complete and we are no longer carrying those costs. We discussed the acquisition in a fair amount of detail during our last call. So in an interest of time I'll move straight on.

Laura Ronchi was our largest delegate in the space in the country that just won the World Cup. If you don’t know which country that is I suggest you go on-line. The acquisition in Italy is an example of how the delegate relationship and our efforts in a particular country can evolve over time. We've been doing this for many years. Early on the delegate relationship worked very well as a local company had strong knowledge of the local industry and developed successful relationships as they distribute our products and begin to grow revenue in the region. It's successful and over time we can, and often do, purchase these delegates and when we do so we take the revenues in that country to a much higher level. It also means that these acquisitions provide a very straightforward and seamless integration. Laura Ronchi was our largest delegate and is clearly a very good example of this strategy.

So we have very many positive things on which to focus when evaluating our results for the second quarter and the list I've touched on is far from comprehensive. If I had more time I would go into the strength we're seeing in assignment photography, a terrific momentum in celebrity portraits and our exclusive products both in our asset management business, Media Manager, our strong business in Germany, accomplishments in China and many others. But let's move on.

As with any business, we also have challenges. The most important of these is the matter that we shared with you last quarter and this concerns royalty-free volumes in the United States. Before we dive into the details I'd like to frame the conversation with a fact or two. It's important for us to remember that we did just announce the quarter with record revenues for our royalty-free business and growth of over 12%. In the first quarter we told you that royalty-free volumes was down 6% in the U.S. versus the prior year. I'm pleased to tell you that the second quarter was much better. Volumes were essentially flat compared to last year and we saw volume growth of about 11% sequentially over the first quarter of this year. So it is quite clear that we have already seen an improvement. However, as I pointed out when we last spoke, it would take a few quarters to turn around the volume decline and we would not be satisfied until we saw meaningful and sustained growth. I also pointed to a number of issues, which were causing the decline in the first quarter and. as I pointed out, essentially flat volumes in the second quarter.

Let me just touch on them very briefly. The reorganization of our U.S. sales force is now beginning to meet our expectations. We continue to make sure that we have the right people and processes in place so that our sales force is aligned with our customers by product. Progress is being made and we have significantly higher levels of customer contact and customer touches than ever before and this is increasing every week. It has also been backed up by significant amounts of very effective marketing. As you would expect, there are many sales and marketing initiatives and I'm pleased to report that even though it is relatively early days they are beginning to work. Our alignment with customers is good. We're increasing our interaction in ways that are meaningful to them. Our creative team is interacting much more with our customers than ever before and we are making meaningful investments, many of whom we can measure or track, in a variety of new marketing initiatives. Now some of the more cool innovative industry-changing stuff is in the future, not least, our new Website.

Last quarter I spent some time talking about the competition. I've since read much more market research, started more and more focus groups, looked at empirical data from the competition, gathered a lot of anecdotal evidence and data and it's fair to say that while the world free market in the U.S. is more competitive than last year I would remind you that we have had competition in the past and will continue to have competition in the future. We're embolden and feel strong as a result of the quality of our imagery, the breadth and depth of our industry leading collection, the quality of our service, the unrivaled strength of our technology and our ability to help customers find and purchase just the imagery that they need. This is how we got to where we are today. We also have an unrivaled track record in our industry of tireless and unrelenting innovations and improvements, which have continued to create this lead and, in our views, we continue to maintain and, in certain places, expand this lead.

Let's talk about the other part of the equation, revenues. You normally need a little volume or a lot and you need to charge something. So let's talk about price. There's been a lot of talk about price over the last several months and Tom will review the numbers in more detail but I want to steal Tom's thunder but in short there were no significant changes in our average price for image in this quarter in either rights-managed or royalty-free. As many of you know, price has no impact in our industry on the margin percentage. Price remains a secondary or even tertiary consideration for the majority of customers. Of course, if you ask a customer whether they would welcome a price range you know before you even ask what the answer will be. At least I know what my answer would be. But historically our price increases have always come along with increasing service, increasing breadth and depth of our collections, higher quality imagery and enhanced tools for finding the right imagery. All are areas where we lead the industry. Also it's worth pointing out that a little bit of research has shown us that we are not the highest priced provider in the market, far from it.

The other thing we talked about last quarter, and I think this is very important, is the impact on our industry of alternative licensing models. One of these is micro payment, a model invented by iStockPhoto, a company we acquired in February of this year. I can tell you that iStockPhoto is continuing to have tremendous success and is by far and away the clear leader in the marketplace. The sheer volume of images licensed by iStockPhoto in this new model is impressive. I can tell you this, the license model and the opportunity that the iStockPhoto community has brought to Getty Images are here to stay and we're only just beginning to explore them. Nobody can tell you, least of all me, with any precision how big iStockPhoto can get but we are well positioned. We have more knowledge and information about this area than anybody else and we know that we will be able to grow it over time.

Now of course many of you are wondering, as am I, about what the impact on royalty-free will be from this new license model. As I've said right from the start, it has and will continue to impact some portion of our business as well, dare I say it, some portion of everybody else's business in our industry. I also told you that we did some analysis and when we acquired the business we noticed that the customer overlap, that is the percentage of iStock's customer's who are also Getty Image's customers was about 8%. Let's make myself very clear; when we made the acquisition 8% of iStock's customers were also Getty image's customers. Well we're just done the work again and, believe it or not, the figure has not changed at all. Now of course we will keep you informed of this and what we're learning and all of the new innovations around this new model; but the most important thing to stress is that we remain very excited about it and the fact that we are early and are leaders in this growing segment of our industry.

I should also take a moment to remind you that when royalty-free was introduced more than ten years ago most of my time was spent answering questions about the impact of royalty-free or rights-managed and whether rights-managed would disappear as a licensing model. As you know, rights-managed is thriving and continues to be an important part of the industry and of our business. So over time it is clear that there will be some movement to micro stock but it is also clear that it will not be some sort of tsunami that tweeds away the other licensing model. It will have its place in the market as will royalty-free, subscription, and rights-managed. Not to mention, the yet to be launched, but already invented by us, new licensing model.

Now that I've had a chance to talk to you about my thoughts on the quarter let's shift our focus briefly to the remainder of the year. First, as I just pointed out, we have not yet turned around royalty-free volume to our satisfaction in the U.S. As I pointed out, we did make progress Q2 but we've also consistently stressing that it would take some time. To cut a long story short we expect that RS volumes for the rest of the year will be lower than we had previously anticipated. I would like to remind you as well that this is not the first time listing volume declined in our business. We've seen it before and we've always been able to formulate and execute on good plans, which over time have always turned the volumes around.

Tom will walk you through the guidance in a few moments but of course the numbers are in a press release that you have already seen. At the beginning of the year we told you about our key initiatives in 2006. They are designed to help drive our business to the next level. I measure our performance, my performance, and the Company's performance against these key initiatives. So I'd like to spend a few minutes updating you on the progress we are making. Very briefly, as a reminder, our key initiatives for 2006 are as follows in no particular order, but first to accelerate non-English speaking market growth both in editorial imagery and creative imagery. We are delivering on this exactly as we had hoped. In addition to making an acquisition like our Italian delegate Laura Ronchi, we are seeing strong growth in Asia-Pacific and Japan. We had a very successful World Cup coverage and that has significantly enhanced our editorial business in Germany. We have ongoing efforts and promising early results in China. We are investing more in creative content in China, Japan, and South America. We also have a number of aspects of functionality of the new Website, which is specifically designed for international markets.

The second key initiative was to continue to build a world-class organization. The first thing we had to do was to structure the organization right along customer lines and we have completed the sales force reorganization in the U.S. having done this in the past in other countries. We have significantly increasing safe time and touches between our creative organization and customers. There's been a large increase in regional marketing efforts and we have launched many innovative marketing programs like The Next Big Idea for Film and Ten Ways; and our philanthropic program to elevate the power of imagery, which we call Change Me.

Thirdly, the third key initiative was to innovate new product, services, platforms and markets. As far as the models are concerned I've spoke already in some depth about the micro payment model and we continue to invest and develop that model through iStockPhoto. We are far along in our ongoing efforts to simplify existing licensing models, invent new ones and serve all customers at all price points. That is our stated strategy and has been for some time. We continue to expand in new businesses like entertainment where we have landed a large number of high value shoots and we are still having ongoing success in our photo assignment products.

We plan to launch www.gettyimages.com the fourth key initiative for this year. Alpha testing is complete. We are receiving significant positive feedback from these customers. Over 400 customers have given us input to our site. We are loading images to the new system and we move soon to the beta testing phase. Beta users will be using our site in the late summer and early fall and we're looking to launch parts of the Web Vision, which is what we call our new site, towards the end of the year. I’m delighted with the progress with the site.

So we're making great progress on these initiatives and we'll continue to do so as we move forward this year and I'm as confident as ever that we are focused on the right thing. We focus most on what's going well as well as what is not. In closing, it is clear to me that this is a fundamentally great business with strong financial results by most objective measures. Our growth is still solid. Our margins are very strong and we are by far and away the clear visual content provider of choice to creators and publishing professionals. We have proved quarter in and quarter out and once again in the quarter that just ended that this is a scalable business that leverages its infrastructure, drives profitability, while generating significant cash flow. We know this business inside out and we're focused on what we need to do to continue to grow it.

With that, it gives me great pleasure to turn over the call to our new CFO, Tom Oberdorf.

Tom Oberdorf – Getty Images, Inc.

Thanks Jonathan. I'd like to start how excited I am to have joined Getty Images. This is a great business model and I'm energized by the opportunity that is in front of us as a Company. Now let me walk you through the results for the quarter.

For the second quarter we reported revenue of $204.8 million up 10.5% over the second quarter of 2005. Currency neutral growth was 12.8%. Consistent with the first quarter this year about 80% of our revenue in the second quarter came from creative fields in which rights-managed imagery represented 52%. This compared to 53% a year ago. Rights-managed revenue increased 6.2% compared to the prior year or 8.4% on a currency neutral basis. During the quarter we saw an increase in volume offset by slightly lower average prices. The average price per single image was $571, which was down 2% from a year ago and down about 1% from the first quarter. The year-over-year change in price per image for rights-managed imagery was primarily due to currency. The remaining creative fields revenue came from royalty-free imagery. Total royalty-free revenue improved 10.8% year-over-year, 12.4% currency neutral.

Single image royalty-free revenue, which represents 84% of total royalty-free revenue, grew 4.2% year-over-year or almost 6% on a currency neutral basis. Global buy ins for royalty-free was essentially flat. The average price per single royalty-free image was $241 up almost 3% from the second quarter of 2005 primarily due to the price and mix partially offset by currency. The average price was down about 5% from the first quarter primarily to mix.

Revenues from, what we call, other royalty-free, which includes CDs and virtual CD licenses, subscription revenue, and micro payment revenue showed strong growth and represented 16% of total royalty-free revenue compared to 11% last year.

Editorial imagery comprised of news, sports, entertainment and title imagery grew 20% and 23% on a currency neutral basis. Editorial represented about 12% of second quarter revenue. Film comprised about 5% of total revenues and grew 8% from the second quarter of 2005 of 9% on a currency neutral basis.

For Getty Images overall about 47% of the sales were in Americas, 4% in Ameia and 9% in the Asia-Pacific.

As promised, we will continue to provide average royalty rates by portfolio. The average royalty rate for rights-managed imagery was 34% compared to 33% a year ago. For royalty-free imagery it was 15%, a major improvement from 21% a year ago as a result of the acquisitions of Digital Vision last year and stockbyte this quarter, as well as additional investments made by us in wholly owned imagery.

For editorial imagery the royalty rate increased to 25% compared to 19% in the prior year primarily as the result of the launch of our exclusive offering, which has lower margins.

For film the average royalty rate improved to 25% from 28% a year ago. Selling, general and administrative expenses for the quarter were $77.9 million, which included $3.9 million of stock-based compensation expense. Excluding stock-based compensation SG&A of $74 million increased about $9 million over the second quarter of 2005. As a percentage of revenue this increased to 36% compared to 35% a year ago. Most of the increase in SG&A relates to expenses associated with acquired businesses. In 2006 we have acquired iStockPhoto, opened an office in Dublin and we acquired our delegate in Italy. We also acquired stockbyte and carry their expenses until the end of the quarter.

In addition to the acquisitions, we also had significant expenses in the quarter for our intellectual property migration project, which we talked to you about before.

Lastly, we have increased our marketing spend this year and in the second quarter in accordance with the plans that we've already shared with you. Because of the nature of some of these expenses we expect SG&A to decrease on a dollar basis as well as a percentage of revenue in the third and fourth quarters.

Depreciations was $13.3 million for the quarter compared to $12.3 million last year. The increase in depreciation is primarily due to depreciation associated with wholly owned imagery that we recently acquired. Amortization of tangible assets was $5.2 million increasing form $2.5 million last year. This increase is due to the amortization of intangible assets associated with our recent acquisitions.

In the second quarter we reported operating income of $39.7 million compared to $55.5 million in the second quarter of 2005. Remember that this year we had $3.9 million of stock-base compensation and a loss on the access space in New York of $18.6 million. Excluding these two charges operating income $62.2 million, which was $6.3 million higher than the operating income last year. On this basis the operating income margin was 30.4% up from 30.1% last year. Excluding stock-based compensation expense, the loss of the New York facility and the loss on the sale of short-term investments, net income was $40.2 million or $0.64 per diluted share. Excluding $0.05 per share for the accelerated debt amortization earnings per share in the second quarter of 2005 were $0.58. On this basis, current quarter EPS grew 10% from the prior year and almost 14% on a currency neutral basis. As a quick reminder, we announced the lease loss on the New York facility and the loss of the sale of short-term investments on May 23rd.

Cash reported from operations for the second quarter was $55.4 million. As we've mentioned, we became a U.S. Federal cash tax paper in 2006 and paid total cash costs of $37 million in the second quarter. This had a significant impact on our operating cash flows when compared to prior years. For the second quarter we generated $34.9 million of free cash flow, which is defined as cash provided by operating activities minus capital expenditures.

Looking at share repurchases; to date we have purchased 2.7 million shares of our stock for a total of 175 million representing just over 4% of our outstanding shares. The detail of the share repurchases will be outlined in our 10-Q.

Capital expenditures for the quarter were $20.5 million, which is high on a run rate basis, which is a bit higher than our planned rate of expenditure as a result of an opportunistic acquisition of an image collection during the quarter. In addition we're at the heart of our Web Vision project, which contributed to the capitalized spending this quarter. We now expect capital expenditures for the year to be $60-65 million and we expect to generate approximately $190 million of pre-cash flow from operations in 2006. Note that we expect to pay over $70 million in cash taxes this year.

Before I discuss our guidance for the third quarter and full year I want to remind you that these forward-looking statements reflect our expectations as of July 25, 2006 and they are subject to change and to risks as mentioned by Allen at the beginning of the call.

For Q3 we expect revenues to be between $205 and $210 million and diluted earnings per share between $0.64 and $0.66 for the third quarter. Note that EPS excludes stock-based compensation expense of approximately $0.04 for the quarter. For 2006 we are lowering our revenue guidance for the range of $820 million to $830 million and lowering the range of expected diluted earnings per share to between $2.63 and $2.70. Full year EPS guidance excludes stock-based compensation expense of approximately $0.16 for the year. It also excludes the charges we itemized in the press release, including the loss of sublease property in New York and the losses of the sale of short-term investments. This guidance implies an operating margin of approximately 31% for the year, excluding stock-based compensation and the New York lease loss.

The guidance also assumes fully diluted shares of 60.7 million shares for the third quarter and 61.7 million shares for the full year.

With that, I'd like to turn it to Jonathan to wrap up.

Jonathan Klein, Getty Images, Inc.

Thanks so much Tom. I'd very much like to leave time for questions so I'm just going to cover one or two more thoughts. I celebrated ten years as the CEO of a publicly traded Getty Images just a few weeks ago at the beginning of July. Of course, over ten years or 40 quarters we've had many successes and all kinds of quarters. We've also had challenges and I think it's fair to say that we have got most things right and a couple of things wrong; but when all is said and done I remain more optimistic about our industry, the growth prospects for imagery and our place in the industry than every before. I'm also yet to find anyone who disputes the simple assertion that the world will continue to consume more and more imagery in more and more places delivered as well as sourced in more and more ways. And I've also found no on one to dispute the fact that no business is in an affective potion to provide this imagery than us, not even close. So we are positioned well. I'd like you to stay tuned the next several months for a number of exciting announcements, which will provide a point tip of the direction of the industry and, of course, of our industry leading position. I'm as excited as ever about what we can do to grow this business and with that I'd like to turn it over to the operator so we can take as many questions as possible.

Question-and-Answer Session

Operator

(Operator Instructions) We'll have our first question with Peter Appert with Goldman Sachs.

Peter Appert – Goldman Sachs

Thanks. Jonathan I'm wondering in the context of scales of these current operations and somewhat more difficult operating condition on a short-term basis if you've given any thought to resetting the bar in terms of your longer-term growth expectations? Specifically you talked about 15% top line, 25% bottom-line growth. These seem like a bit of a stretch to me. How do you think about that?

Jonathan Klein, Getty Images, Inc.

At this point we are not specifically outlining growth expectations for 2007 and beyond but it would be naïve of me to forget that those are still attainable in the short-term and if you look at the guidance you'll see that the EPS guidance for this year assumes currency neutral EPS growth of between 18 and 21%. That's for the full year and there's no question that we have not achieved the 25% EPS growth that we had aimed for currency neutral in 2006. At the end of 2004 we hoped to achieve 25% per annum. Last year EPS grew 33% and this year, I just pointed out where we would be if the guidance came through. I think it's also fair to say that for this year the objective that we had of currency neutral organic growth of 12-14% will also not be achieved. So I think the reality is that, as you said, conditions have got a little more difficult in one area in particular. Business is extremely strong but those very ambitious goals will take us a little longer to achieve but we don't wish to put out our numbers now for 2007 or thereafter.

Peter Appert – Goldman Sachs

Okay, great. This is a related question so it falls under the one question rule. The royalty rate in royalty-free imagery was down 15%, an all time low. Is that the steady state or is this going to get lower?

Jonathan Klein, Getty Images, Inc.

Can I answer a different or similar but related question? If I look at the overall cost of sales for the Company or to put it the other way around the gross margin we still think we can do better. Bear in mind that the cost of revenue percentage, the cost of sales percentage, which was at a record low at 24.8% in the quarter benefited yes from a full year of Digital Vision but not even from a full quarter of stockbyte. stockbyte is wholly owned imagery. In addition to that we've significantly increased the amount of investment that we're putting into wholly owned imagery and of course that takes time. You have to spend the money, shoot the imagery and then get it into the system. So I'm extremely bullish about our business in relation to that metrics, the cost of revenue, as you said, was at a record low in the quarter. Royalty-free yes, I mean the royalty-free you'll see benefits both in royalty-free as well as in other parts of the business because the wholly owned content, which we're shooting is not going into royalty-free.

Peter Appert – Goldman Sachs

I'm wondering if this is at 15% should be royalty-free? Should we just analyze that as the new run rate, which would actually then imply that the gross margin might be better than previously thought?

Jonathan Klein, Getty Images, Inc.

Well I think you have to be slightly cautious because if you look at the whole Company there's a whole new set of image partners and the image partners are at different percentages and so that's the one piece of it. The second piece of it is that there are a couple of businesses, which are growing extremely well, which are inherently lower margins than I think I referred to our exclusive offering, celebrity [unintelligible at 37:36]. So I wouldn't want anyone to get carried away but if one's looking for trend lines as opposed to what's going to happen in Q3 and Q4 I think the trend line is as we've indicated Peter.

Peter Appert – Goldman Sachs

Okay, great. Thank you.

Operator

We'll have our next question from Matt Troy with Citigroup.

Matthew Troy – Citigroup

Good afternoon guys. I had a question with respect to the portfolio images, specifically if you could help me just directionally. If I think about what you've got today how much of your revenue is generated by images that have been taken, let's say, in the last 12 months versus some of the older legacy content? I'm just trying to get a directional foot. How do you think about that? And two, if you could just help me understand trends in your incremental return on sales for new image added. How that's trending over time? Some context around those two points would be very helpful. Thank you.

Jonathan Klein, Getty Images, Inc.

Well those are big industry questions. Let's make it simple. 80% of our business comes from contemporary, and I stress the word contemporary, stock photography either royalty-free or rights-managed. What tends to happen is that an image typically in that segment, contemporary stock photography, has on average a six-year life. Now it varies but we're very comfortable in our basis support in a four-year life, sometimes a five-year life. Let's say four to five years to make it simple.

Matthew Troy – Citigroup

Sure.

Jonathan Klein, Getty Images, Inc.

Now an image tends to sell extremely well in the early stages and then tapers off over time. A key factor there is the Website. In the last 12 months we've increased the number of images we've had on our Website by more than 50% and as a result of that images, which come to the Website most recently as well as the way our search engine works are the ones that appear on the first pages of the search results and therefore sell more. As an image gets older it appears less frequently high up on the searches because the more recent images appear first. So what one needs to do is one need to continue to provide fresh content but knowing full well that images are selling for a significant period of times. So I wouldn't want to put a percentage, you know, in the last we put in, in the last 12 months are the images, which are generating X percent. Suffice to say that the images that come in the last 12 months are a quickly low percentage of overall revenue of Getty Images. There have been periods in the past where we've only put in say 30,000 new rights-managed and royalty-free images in a year and notwithstanding that the growth has been very significant. So it's a mix between the two.

Now in terms of you asked in the second part of your question was about return. Well the return on an image varies enormously. There are some images that are provided to us completely free by the image partner. We have 70 different collections on the site. Image partner business is a very significant part of our business and the image partners bear absolutely all the cost of generating the image. They provide the image to us. We do some quality check both technical and otherwise. We keyword the image and put it on the site and we generate the sale. Then there are images with photography issues and we have very little touch points with the photographer; and then there are images at the other end of the scale, which we finance and shoot entirely ourselves. So it's very difficult to say what's the average return on an image is; but what we do know is we have a very high collection of efficiency, which means we look at an entire collection, whether it's Image Bank, or Photonica, or Stone or Photo Disk, about 75% of the images that we bring into the collection will sell at least one in the first 12 months and over their life the collection rate is probably higher than 75%. So I think it's not the number that you were after but I hope that gives you some color.

Matthew Troy – Citigroup

Directionally very much so, thank you.

Jonathan Klein, Getty Images, Inc.

You're quite welcome.

Operator

We'll have our next question from Troy Mastin with William Blair.

Troy Mastin – William Blair

Thank you. Good afternoon. I wanted to clarify a statement that I heard Tom make. Did global royalty-free volume last in the quarter? Is that what I heard?

Tom Oberdorf – Getty Images, Inc.

Yes, Troy.

Troy Mastin – William Blair

I guess that would imply flat royalty-free volumes outside of the U.S. as well. I don't think that's been the case in the past. Should we read anything into that?

Jonathan Klein, Getty Images, Inc.

Tom, you go first.

Tom Oberdorf – Getty Images, Inc.

Yeah, I don't think it screams but I think we've had APAC show an increase that Jonathan mentioned and we're seeing significant growth in the APAC and EBA was basically flat. Obviously there are countries that are up and down within those and Jonathan may want to just touch on that as far as what affect did the world have or have not on that but I'll let Jonathan add some color on that.

Jonathan Klein, Getty Images, Inc.

Yeah, I think it's a very important point. In having a look at our revenues for the second quarter two things should be borne in mind. The second quarter is seasonally the trickier quarter anyway and to achieve record revenue in the second quarter certainly pleased us. Our business in Europe was certainly affected in a fairly significant way by the World Cup. It's fair to say that business virtually came to a standstill in certain countries and it's not just us that felt that. Any business you talked to operating in Europe will tell you that June was a month for watching television not for working; and when we look at what happened in Europe whether it's royalty-free or rights-managed we know there was a big June impact of the World Cup and just to amplify slightly on what Tom said you need to remember that our royalty-free business in Europe is at very different stages in different countries. The net net when you put the countries together and you took the June affect of the World Cup volumes in Europe were flat, strongly up in Asia.

Troy Mastin – William Blair

Can you provide some additional insight into RS as I guess it relates to acquisitions? Can you give us some indication of how much acquisitions contributed to the overall revenue and given the nature the three that are meaningful I would assume almost all of that revenue was in RS and it appears how that impacts volumes, particularly with more recent acquisitions such as stockbyte?

Jonathan Klein, Getty Images, Inc.

Well we've now got a full year since we've owned larger royalty-free acquisitions. In fact, our largest acquisition in six years and that was Digital Vision. So there's no impact there. You're looking at a life for life period at Digital Vision. stockbyte we had for a part of the quarter. Bear in mind that we already had their imagery on the site and also bear in mind that the also had distribution relationships with some other parties who are no longer distributing the product. So you wouldn't see an enormous amount of incremental revenue from stockbyte on a year-over-year basis because of the facts that I just outlined and Digital Vision is a life for life period. So I think it would be wrong to assume that there was an enormous amount of growth in the royalty-free volume segment as a result of those acquisitions. There was some but not enormous.

Troy Mastin – William Blair

Can you share with us roughly what the acquisition contribution was in the quarter overall?

Jonathan Klein, Getty Images, Inc.

Are you asking what we estimate was the organic growth for the whole business during the quarter or royalty-free volumes or I'm not quite sure where you want me to go Troy?

Troy Mastin – William Blair

I'm trying to get to organic revenue growth so you can give me acquisitions, revenue contribution or you can give me organic revenue growth.

Jonathan Klein, Getty Images, Inc.

Tom, do you want to take this one?

Tom Oberdorf – Getty Images, Inc.

Sure. Troy your question goes pretty deep when you talk about contributions so I'm going to stick with revenue because first of all it's very difficult to discuss the acquisitions. We look at it from a revenue basis and it's very hard to flow all the way down the P&L. We take some of these collections. We put them into our collections and, you know, they start getting fuzzy; but certainly we're looking at organic revenue growth for the year around the 9-10% area.

Troy Mastin – William Blair

Do you mean organic in the second quarter year-over-year was 9-10%?

Tom Oberdorf – Getty Images, Inc.

I'm not saying in the second quarter. I'm saying for the year we're looking at it from between 9 and 10%.

Troy Mastin – William Blair

I'm asking for the quarter.

Tom Oberdorf – Getty Images, Inc.

I don’t have a second quarter number but – I don't have an exact second quarter number but again this gets very difficult for us to look at the organic revenue growth but we guesstimate it for the year and we think it's between 9 and 10%.

Troy Mastin – William Blair

Okay, I'll follow up later.

Jonathan Klein, Getty Images, Inc.

Just remember that the way we run the business because of the degree of integration, because of the fact that we change the distribution of some of the businesses that we acquire there are a lot of ins and outs even on the revenue side. So we care about organic revenue growth but we're not obsessed to figure out exactly what the number is given the acquisition environment.

Operator

We'll have our next question from Christa Sober Quarles, Thomas Weisel.

Christa Sober Quarles – Thomas Weisel

Hi. Just two quick questions; first could you describe, I guess, the percentage of revenue that come through the Website on a self-service basis? Obviously the entire, a big chunk of the iStock, or all of the iStock is coming that way but I'm just trying to understand both how the Website redesign as well as the sales force redesign had an impact. And then just Jonathan you indicated that the percentage of alternative didn't change as well as you're not seeing any different competitive forces. So is the weakness in RS to your estimation a macro issue?

Jonathan Klein, Getty Images, Inc.

We'll start with the first question. About 80% of the royalty-free revenue is not assisted by a salesperson, about 80% but 20% is. On the rights-managed side, which is still our biggest business, the overwhelming majority of sales are touched by a salesperson. In addition to that, we do not see our business as different products or [unintelligible at 48:33]. We see it as different customers. It would be very rare indeed, close to unheard of, to have an important customer who doesn't buy both. So in that case even though the customer may be buying royalty-free in an unassisted way through the Website because we set them up to do that there is still the sales and customer relationship. So I know where you're going and I think it's sensible to look at it that way but to answer the question, which I think you were asking is the sales force reorganization and the marketing that we're doing is very important for both sides of the creative business. You shouldn't be fooled because of this high unassist league that in royalty free it doesn't matter. The frequency of new customer touches, the new products, the new services, the new licensing models, the different pieces of marketing using our creative team and photography people as customer interface has an enormous impact even though that customer may then purchase more royalty-free on-line.

Now what the new Website does – it does a lot of things but one of the physical challenges all of us are having in any industry, which uses the web is around how do you make it easier for your customer to find what they want as there is more and more and more content? What the new Website does is we can set up preferences and we can customize the site for each customer and as a result of that a customer will be able to go to the site, set up their preferences either alone or with a salesperson and get exactly the imagery they want, as well as have on the site all of the licensing agreements that they have, any price deals that have relationship to volume; all in one place. Then they're a whole number of outside English-speaking markets fix that the site is able to do for customers all over the world in multiple languages. So the site is important but the frequency of the purchases is also important and having said that once you've set customers up on the new site and once they get all their preferences all set up there's less customer interaction going- forward in terms of the transaction. It's more about the relationship.

Your second question was…

Christa Sober Quarles – Thomas Weisel

It related to what you think is really going on the RS business. I mean you indicated that the percentage of revenue related to alternatives didn't really change and that the competitive forces haven't really changed. So is it a macro economic issue or what's really causing the contraction?

Jonathan Klein, Getty Images, Inc.

Well a couple of things. First let's remember that revenue from, what we call, other royalty-free, which is CDs, virtual CDs, our subscription offering and micro payments this time last year was 11% of total royalty-free revenue and now it's 16%. Even for us the amount of other royalty-free revenue has significantly increased over last year and that combination of the micro payment growth and subscription growth. So basically the other models are having an impact. Thankfully, we were ahead of the curve and have by far the leader in micro payment. So I think the other model impact is certainly part of it.

The second piece of it is that we, and I said this on the first quarter conference call and not everyone was pleased but I'll say it again. We have been very deliberate and intentional and strategic around changing how we interact with the customers from a sales perspective and how we market towards them. As I've told people on prior calls, we're spending significantly more money marketing this year than last year. Not that we didn't have the money last year. It's that we have a lot more smart measurable strategies to touch customers and we are much more present now in front of customers than we were in the first quarter. So I do not feel that there is something of a macro basis going on. People are using more and more images and there are now more models under which they can get the images. So before there was no subscription people would to have gotten and RS image. Micro payment is another alternative although it's such a different part of the market and it's such a different price point that it doesn’t really compete in that way. As I said, the overlap between iStock customers and Getty Image customers was 8% in April and it's still 8% now; but in short it's not a macro issue around demand for imagery.

Christa Sober Quarles – Thomas Weisel

Okay, thanks.

Jonathan Klein, Getty Images, Inc.

Sure.

Operator

We'll have our next question from Jeetil Patel, Duetsche Bank.

Jeetil Patel – Deutsche Bank

Hi. This is actually Herman Lee for Jeetil Patel. A question on the competition side I guess. You talked a little bit about how that alternative licensing model has impacted the business slightly. In last quarter you're seeing a little bit more competitive noise. I was wondering if you still see some of that additional competitive noise and second of all on the 8% overlap of the micro payment business where do you see that percentage trending over time given the fact that the model certainly evolved over the like the past 18-24 months? The second question is on the sales and marketing expense you guys have increased about roughly $7 million in the quarter. I was wondering if you guys can give us an update on monetization on that additional expense? Thanks.

Jonathan Klein, Getty Images, Inc.

Well, that's three questions; competition, micro payments, percentages and marketing expense. Okay competition. I think the best way to stress this is that the amount of noise in the market has not changed significantly from the first quarter. However, we are much more active. What we've also found, as I said, we have seen so much more market research and so many more focus groups and touch points with customers. We've also seen empirical data from the competition, lots of anecdotal evidence and it's perfectly clear to us that in the pure RS market our lead is remaining. So I don't see us having a big issue through that. It would be wrong of me to say that micro payments is not an issue and it would be naïve to suggest that the 8% would not increase slightly over time; but we also feel very strongly that there's room for all of these different models. I always point to the history of royalty-free largely because it was our history and it changed the industry and if you think about what happened with royalty-free it was a new model. It was simpler. It was digital. The pricing was straightforward. It was significantly cheaper and 10 or 11 years later we still have more rights-managed revenue than we have royalty-free revenue and royalty free is robust. Right-s managed is robust and micro payments has entered the market. So there are now four models, micro payments, and subscription, royalty-free and rights-managed.

If you give me a bit more time I'm going to show you in the next several months some other models so that we will be able to serve customers at every price point and at every stage in the production process. Often a customer will just download an image because he's trying something out and they don't want to pay hundreds of dollars for that. Other times a customer needs a special image or special campaigns with rights and they'll pay tens of thousands of dollars. So yeah the 8% will go up over time but those are more than made up for by the fact that the 92% have never bought a picture before probably. So we're introducing new buyers to the market. At the same time as that we're introducing new sources of photography to the market and creating an extraordinary community. It's very viral and it's bringing us a lot of new opportunity. So overall we're extremely pleased about it. As a leader in the industry we've got to be pleased more people are paying for imagery and we're managing all of these different licensing models.

The third question was return on marketing spent. Anything we can measure, and that's direct marketing, e-marketing, paid search; we're getting phenomenal returns and as a result of that we've invested more money and continue to invest more money. And at the same time as that we're doing a number of brand related awareness related work that is harder to measure but, again, we're proving very successful in that and we feel that we are very much cementing our position as the first choice for imagery. That's never been in doubt and I think most research shows that by a significant margin that we're the first choice for imagery. The brand work cements that, as well as the measurable tactical marketing work, as well as the much more customer touches by our sales people and marketing people, and creative people. So that's where the money's going and we still feel that for a business of our size and you heard the guidance. For $820 to $830 million-dollar business our discretionary market is spent at right about the $20 million dollar level. It's hardly far from excessive.

Operator

We'll have our final question from Steve Ashley with Robert Baird.

Steve Ashley – Robert Baird

Hi guys. First off Tom, can you just mention again what the RM volume change was year-over-year?

Tom Oberdorf – Getty Images, Inc.

The RM volume change. All right. Rights-managed volume grew 4%.

Steve Ashley – Robert Baird

Great. And then in terms of the expected decline in operating expenses in the third and then again in the fourth, I realize the personnel has been integrated and that whole runoff. Is there anything else going on the expense side of the equation that would lead to that cascading projection?

Tom Oberdorf – Getty Images, Inc.

There is a couple things. We certainly have the stock price, which cuts off and we talked about marketing spend. We've had higher marketing spend. We're going to do it through the year but we've had a higher marketing spend in the second quarter. I think overall we're bringing our cost down. I see migration. This has been an important quarter for us in the second quarter to get this thing up and running. We expect to have it up and running very shortly. As a result of that we've spent some special services doing that. That's basically it. Like I said we are projecting for the cost to come down in Q3 and Q4 versus Q2.

Steve Ashley – Robert Baird

Then lastly under cash balance, how much cash do you think you need to run the business and does this limit your future ability to do acquisitions?

Tom Oberdorf – Getty Images, Inc.

That's a big question. I would say the amount of cash that we get is more than sufficient to run the business. We generate cash. If we weren't generating cash we would be slightly above the break even on a cash level. I would say I was concerned. In fact we'll generate $190 million of cash while being a tax payer this year.

Jonathan Klein, Getty Images, Inc.

Yeah, I was hoping that Tom would point that out. On the same piece of it, it looks like cash from operations in the quarter was slightly lower than one might have expected but for the first time we paid significant amounts of money to the treasury. We also spent $175 on buying our own stock. So the perennial question, which we've had over the last three years is you generate so much cash what are you going to do with it? I think we're beginning to answer.

Steve Ashley – Robert Baird

Great. Thanks so much.

Jonathan Klein, Getty Images, Inc.

You're welcome.

Operator

That's all the time we have for questions. I'll turn the conference back over to Mr. Klein for any additional or closing remarks.

Jonathan Klein, Getty Images, Inc.

Just very briefly I always thank you on these calls for your interest in Getty Images and I have to say that we've spent a fair amount of time during the q and a on the challenges but, as I said during my prepared remarks, we remain extremely confident about our industry, the growth in our industry, our business model, the position in our industry and the fact that we're having a good time doing it even though we've been doing it now, as I said earlier on, this is my 40th quarterly conference call and I hope to do many more with you all. So we'll be around. We're always around. You know where to find us and once again we really appreciate your interest and support for Getty Images. Thanks so much. Bye, bye.

Operator

That does conclude the Getty Images Second Quarter 2006 Earnings Conference Call. You may disconnect at this time. We do appreciate your participation.

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Source: Getty Images Q2 2006 Earnings Conference Call Transcript (GYI)
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