Getty Images Q2 2007 Earnings Call Transcript

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Getty Images, Inc. (GYI)
Q2 2007 Earnings Call
August 1, 2007 5:00 pm ET

Executives

Alan Pickerill - Director, Investor Relations
Jonathan D. Klein - Chief Executive Officer, Director
Thomas W. Oberdorf - Chief Financial Officer, Senior Vice President

Analysts

Matthew Troy - Citigroup
Troy Mastin - William Blair & Company
Christa Sober Quarles - Thomas Weisel Partners
Peter Appert - Goldman Sachs
Steven Ashley - Robert W. Baird
Herman Lee - Deutsche Bank

Presentation

Operator

Good day and welcome everyone to the Getty Images second quarter 2007 earnings conference call. Today’s call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to the Director of Investor Relations, Mr. Alan Pickerill. Please go ahead, sir.

Alan Pickerill

Thank you and welcome, everyone. Following this call, a telephone replay as well as a webcast will be made available. Information on both is available on our website.

Some of the statements made on today’s call are forward-looking and involve risks and uncertainties concerning our expected financial performance, as well as our strategic and operational plan. Such statements are based on our best view of the world and our business as we see it today. Of course, the environment in which we do business changes rapidly and our future results may differ materially from our current expectations.

We would ask that you view all of our comments in that light.

For more information on factors that may affect our future performance, please review our filings with the SEC; in particular, our amended annual report on Form 10-KA for 2006 and our quarterly reports on Form 10-Q. We currently do not intend to update or revise these forward-looking statements until our next quarterly conference 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 will now turn the call over to Jonathan Klein.

Jonathan D. Klein

Thanks very much, Alan. Good afternoon and welcome to our second quarter conference call. Revenues in the quarter were exactly in line with our guidance and earnings per share were $0.02 below as a result of a higher effective tax rate.

The revenues of $218 million were a record for Getty Images. However, we are far from pleased as we are not growing on an organic currency neutral basis due to a decline in revenues for our traditional Creative Stills imagery business.

Reported revenues were $218 million, representing growth of 6.5% or 2.4% on a currency neutral basis. Excluding the acquisitions we made, and also excluding the positive impact of currency, our revenues declined about 2% over the equivalent quarter of 2006. And in many ways, the results for the second quarter were similar or had similar characteristics to those of the first quarter of the year.

We continue to see very strong growth in entertainment, news, and archival imagery. There is excellent growth in all our services and related products, including media manager, photo assignments, and image net.

There is particularly strong momentum at iStockphoto and we are seeing excellent progress on all of our key initiatives.

The acquisitions we made in the quarter, as well as the one that we did not make, tell you much about how we see our business developing over the coming years. We acquired Wire Image, the leader in entertainment imagery, which is our fastest growing category. We also acquired Punch Stock. Punch Stock is a base for our multi-site strategy which helps us reach the value-based buyer. And finally, at the end of the quarter we acquired Pump Audio and this moves us into commercial music licensing. We also began building our consumer offering with the addition of a wonderful team to build the site.

You all know about the one acquisition that we did not do.

The Creative Stills business was flat year over year. On a currency neutral basis, revenues declined 4%. The performance of the traditional Creative Stills business, and let me define that for you, that is rights-managed, rights-ready, and traditional royalty-free imagery, showed a larger decline in revenue as the micropayment numbers are included in the overall Creative Stills revenue number.

Let me break this down a little for you. Royalty-free overall grew 4.6%, or just over 1% currency neutral, while rights-managed, including the new rights-ready model, declined 4.7% or about 8.8% on a currency neutral basis. Those were revenue numbers.

Moving now to volumes, volumes for the traditional Creative Stills products fell 6% for rights-managed and rights-ready, and fell 11% for royalty-free. The volume declines for royalty-free are primarily in the U.S. and the U.K. As we have pointed out in previous calls over the last several months, volume is a challenge rather than price. Logic dictates now that I move to price; average prices fell slightly for rights-managed, about 2%, and this was due to mix. On a sequential basis, average prices were broadly in line with the first quarter for the rights-managed and rights-ready collections. Prices increased for royalty-free imagery over the prior year quarter and also increased sequentially compared to the first quarter of 2007. These pricing trends are of course positive.

Let’s dive a little deeper. Within rights-managed and rights-ready, we are seeing strength in editorial uses relative to commercial uses and due to the fact that editorial price points are rather lower than commercial, this helps explain the very small movement in average price for rights-managed and rights-ready.

We continue to be very pleased with the traction we are seeing in the rights-ready license model. We added significant new content to it in the quarter and we will continue to add content, features, and refinements to this licensing model both during the rest of this year and into next year. We also introduced rights-ready to our footage business in the quarter.

I would like to talk a little bit more about traditional Creative Stills, as this is the area where we are feeling most pressure. Just to remind you, when an image is licensed in the royalty-free model, we do not know how or where it will be used by the customer, as we do not need that information to price the image. The pricing is purely done on file size. It is not unreasonable to conclude that the smallest file sizes are largely for online use and as it happens, the area of greatest volume pressure for us in this area is for imagery at the lower end of the price range -- in other words, for the smaller file sizes. This is the area where we are seeing the bulk of volume declines.

Turning to rights-managed and rights-ready, the opposite occurs in that we know exactly how the image is used, where it is being used as we need that information in order to price the image. Pricing is based on usage. And in this space, the volume declines have been most pronounced in two usage areas in particular; print brochures and print advertising.

Of course, with the modest shifts towards more online communication in the overall mix, especially in the U.S. and the U.K., we would expect some continuing pressure in these two usage areas. This pressure is incidentally being mitigated somewhat by the rights-ready model.

Another way to look at our business, and one which we are very focused on, is to look closely at the different segments of our customer base. We are doing well with media customers and making progress with corporate customers. However, the agency segment is responsible for the bulk of the volume declines for both rights-managed and the traditional royalty-free imagery.

So having outlined where we are suffering pressure, let me stress -- stabilizing our traditional Creative Stills business is our number one priority. The volume issues that I have just described are primarily due to industry transitions which include many, many factors. Just to touch on some: the shift of advertising to the web; more companies spending more dollars on paid search, where there is clearly at this moment no opportunity for us to license pictures into a text ad; also, the increase in content, and this is due to the proliferation of digital equipment and of course, the related increase in content providers.

We address this in many ways. Of course, we are pleased to be diversifying our revenue streams. We are also managing expenses aggressively, including the announcement today of a restructuring that will result in a reduction in our workforce with significant annualized savings. Tom will give you all the details of that in a moment.

But as I said a moment ago, stabilizing traditional Creative Stills is a major focus and we have many initiatives ongoing. Without diving into detail of each, I would like to just tell you about a few of them.

Launching the new Getty Images.com is important. It is set for launch this quarter. It is of course being accompanied by significant outreach, both by sales and marketing. Many customers have experienced the site over the last few months during the preview phase and feedback has been overwhelmingly positive. Of course, we are excited about the launch and of course we think it will help this important part of our business.

Adding new license models and services are part of what we see as a solution to the challenges with traditional Creative Stills. I have touched on rights-ready and we are adding some more features in the coming quarter, which we believe will further accelerate its very healthy growth.

Customers sometimes want subscription. We have a subscription product, Creative Express, but we have created a new, customizable subscription product for the larger customers who are heavier users of imagery. We call this Premium Access. Premium Access has many customers already, is receiving excellent feedback and has a very healthy pipeline.

We are also taking many steps in many different ways to address the value conscious part of the market. I should remind you that we were rather prescient and forward-looking in the first step that we took in that regard some 18 months ago when we acquired iStockphoto. In addition, we are employing a multi-site strategy to reach these customers. Again, more on that later.

We are also looking at some innovative and some would say bold ways to capture much more of the online user market for imagery. What I mean by that is those folks who are using imagery for online purposes without using the image in a print or related communication. We are far advanced on this plan and we hope to launch during the current quarter, the third quarter.

I have talked in the past about regular contact with customers and there is no doubt whatsoever that increasing regular contact with key customers quite simply drives sales increases with those customers.

We have assigned more accounts to sales people. We have more outbound activity. The advent of market development executives that I’ve talked about in the past is working, as well as the increase in direct customer contact. We are much more outbound focus. We have more feet on the street. We have now hired the majority of our MDEs, and we have assigned all of our top accounts.

As I said a moment ago, I would return to the multi-site strategy -- we now have three main creative websites, gettyimages.com, punchstock.com, and iStockphoto. These sites serve the unique and distinct needs of customers, and having distinct sites enables us to better serve our customer base over time.

I mentioned last time about how the Punch Stock offering is going to be aimed at customers who are more value-oriented or budget-conscious, and we are launching a new offering on the Punch Stock site later this quarter that addresses these customers specifically and directly.

A big issue for us, and something which we’ve done internally but I will share for you, is that we are taking our efforts to the next level around segment focus. We have created small, dedicated cross-functional teams led by senior vice presidents to capture the opportunities across the three different segments of our customer base.

The teams are making progress already and we are optimistic about the impact that these efforts will have. The efforts are broad-ranging and the initiatives touch many areas of our business. They include changes to licensing, innovative approaches to prospecting, new offerings, as well as promotion and marketing efforts. They are also being supplemented by changes that we have announced today to our marketing organization, including the recruitment of a Senior Vice President of Marketing to be based together with me in New York from September.

Now of course, I would far rather be talking about all the areas of our business that are growing, and I hope that you will permit me a couple of minutes now to touch on some of those areas.

In addition to all the work in traditional Creative Stills, we are investing in areas that are showing strong growth already and we know will also provide excellent opportunity for future growth. I will be brief as I touch on a number of them.

It would be remiss of me not to mention micropayment. iStockphoto, the leader in this segment, continues to perform very well. In the quarter, that’s the second quarter, over 4.25 million images were downloaded. Just to remind you, that compares with 3.5 million downloads in the first quarter of 2007 and over 3 million in the fourth quarter of 2006.

Of course we are pleased with the growth of this business. More importantly, we are excited about where it can go and its potential. Average price per image is increasing in this area and we are continuing to see many different ways to optimize revenue streams for this business. We are also seeing increases in the average spend per customer.

I am very pleased we entered the editorial imagery market a few years ago and in the quarter, editorial had its best growth ever. Editorial imagery grew more than 40%, or about 38% currency neutral, and represented 17% of Getty Images revenue. We expect its contribution to continue to grow. Entertainment revenue growth continues to be the celebrity here, but we also saw solid growth in news and a good performance in archive.

Let me talk a little bit about multimedia. The rapid growth of online and mobile multimedia platforms is driving an ever-expanding appetite for fresh digital content. This trend will accelerate as new media absorbs an increasing share of both customer attention and marketing spend. We have decided to make aggressive moves into multimedia. In fact, soon all of our photographers will be covering news and entertainment with video cameras and will also be wired for sound.

Our customers need multimedia product. Often they don’t have the time, the content, the expertise, or the resource to create it themselves and this is exactly where we come in. We are already creating many multimedia packages on the back of our expansion into editorial footage, and we find that many customers don’t just want the still image, they don’t just want the raw moving image -- they want them together.

We are offering customers many more multimedia products and they include still images, footage and sound -- sometimes narration, sometimes music, sometimes both. These products offer something to customers that help them serve up the best, richest content without the usual time and expense of creating it themselves, not dissimilar to our entire business, where we provide our customers with raw content to enable them to do great work.

I should talk about footage. We call it footage these days. We’ve called it film at certain parts in our lives, sometimes it’s called video, but it’s the same thing -- the moving stuff. In the second quarter, we launched our new footage website and enabled a full e-commerce solution for this product.

This vastly improves the way customers buy or license footage. Unfortunately in the second quarter, we had an execution glitch with the result that clips were displayed incorrectly and were not included in certain search returns. We estimated that the loss of revenue in the quarter due to this glitch was about $1.5 million. The bad news is that it happened. The good news is that it has been fixed since then.

We have tremendous efforts underway and are making significant investments in footage. In the interests of time, I won’t go through them in any detail now but I would encourage you to take a look at our new footage site where for the first time footage is available through pure search, purchase and download -- full e-commerce of these clips. We have migrated all of our rights-managed clips over to a royalty-free model to offer alongside the royalty-free selections. As you know, iStockphoto already has video.

We are also adding to the core Getty Images video content or footage content content -- too many contents in that section, but basically we keep adding additional collections and bringing in new footage. We are also working hard on improving the digital workflow and we are marketing our footage products appropriately.

I have no doubt that we will accelerate the growth of footage and it will become a more substantial percentage of our revenue.

At this point, I should break into song and talk to you a little bit about music. I’m not really in the mood for singing, for obvious reasons. We’ve been looking at the music space for quite some time. We entered the market in the second quarter by acquiring Pump Audio.

Getty Images powered the forward momentum of the visual content industry over the past 12 years and delivered most of the major innovations and in doing so, brought new opportunities to partners and customers. There is wide agreement in the music industry that the market for commercial music licensing is fragmented, inefficient and confusing -- exactly the same as the imagery market once was before we entered the industry.

We are confident that bringing our digital distribution, e-commerce expertise, and our customer relationships, as well as our deep understanding of intellectual property to this industry will have a similarly positive impact.

Of course, a move into music marks a significant development in our ongoing strategy to build a comprehensive digital media offering to meet the growing needs of media, advertising and corporate customers. As I said a moment ago, we see many similarities to the visual content licensing business, and we intend to streamline commercial music licensing to the benefit of both customers of music as well as creators of music.

The platform we have is designed to allow customers to license pre-cleared original professional quality music to enhance their own project. The music will of course be integrated into all the various Getty Images websites and will also be available to customers through our extensive sales force.

Today, the music offering from Pump Audio consists of 100,000 original pieces of music from talented artists all over the world. The music is not production or stock music but it is not by well-known artists and it doesn’t come from major labels or publishers. In fact, Pump’s content is provided by people who do not have a contract with a label. Pump is revolutionizing the music publishing business by providing access to a commercial licensing audience for artists who would otherwise have none. At the same time, it is providing users of music in the commercial space with access to great music in an affordable, ready-to-use, simple model.

Pump Audio is a proven innovator who has already made it easier and more affordable for customers to license music for commercial use, while allowing artists to retain ownership of and profit from their music.

We like it, and we will build it out with more music, integrating it into our own collections, allowing people to view it together with still and moving imagery, and to listen to it while they change different clips. Of course, we will bring our broad geographical reach to the product and the access to our qualified customer base is clearly going to be helpful.

We will also announce new platforms and partnerships that will continue to expand the marketplace, providing creative solutions to customers and offering music owners additional ways to support their work.

In addition to the independent artists whose content Pump Audio currently distributes, these platforms will offer incremental revenue opportunities for major labels and publishers and other owners of high quality audio content.

The market for commercial music licensing for synchronization and performance rights, the areas in which we are going to operate, is about or in excess of $3 billion, according to 2006 Enders Analysis data and Wall Street research.

Let’s talk for a minute about consumer. In October last year, I mentioned -- and I mentioned it very much in passing, I don’t think anybody noticed -- that we intend to monetize our assets beyond our traditional customer base and a consumer offering is in the works to do just this.

Remember what we have -- unrivaled still and moving content of our own, great relationships with others who have content, over 8 million unique visitors a month to our various B-to-B websites, and we also have something that we didn’t create; the simple fact that people love looking at, discussing, enjoying, and sharing imagery.

You will see a consumer-facing offering sooner than you might expect and we believe that there will be revenues here not just from advertising but also from commerce. Now, of course, if I had more time I would tell you about the 40% growth in photo assignments, the more than 80% growth for our asset management products, as well as success with our other products and services. However, you and we are appropriately focused on that part of our business that is not growing.

There is no way for me to cover everything we are doing on this short call but I hope that you understand both the challenges that we face as well as the exciting opportunities ahead of us. We thrive on these challenges and on the opportunities to grow our business. I believe that we are doing the right things to return our company to growth rates that both you and we will find much more compelling.

Now I would like to hand the call over to Tom to walk through the financial results and the guidance in some more detail.

Thomas W. Oberdorf

Thanks, Jonathan. For the second quarter, we reported revenue of $218 million, up 6.5% over the second quarter of 2006, or 2.4% on a currency neutral basis. This quarter, 75% of revenue came from our Creative Stills imagery, which was flat year over year, declining 3.8% on a currency neutral basis. Rights-managed revenue, including rights-ready, represented about half our total Creative Stills revenue and declined 4.7%, or 8.8% on a currency neutral basis. Royalty-free represent the other half of Creative Stills revenue and grew 4.6%, or 1.2% currency neutral in the quarter.

As Jonathan pointed out, rights-managed volumes, including rights-ready, were down about 6%, while average prices were off about 2% compared to last year. Average prices for these images were in line with the first quarter of this year.

Single image traditional royalty-free volumes declined about 11% compared to last year, with average prices increasing slightly. Other royalty-free revenue, which includes revenue from iStockphoto, CDs and VCDs, and subscriptions, represented 27% of total royalty-free revenue compared to 16% last year.

Editorial imagery revenue grew 44%, or 38% on a currency neutral basis. Editorial imagery represented about 17% of second quarter revenue.

For Getty Images overall, about 46% of sales were in the Americas, growing 5% year over year; 45% came from EMEA, which grew about 8%; and the remaining 9% from Asia-Pacific, which grew about 6%. On an organic currency neutral basis, we estimate that revenue declined about 2% on a year-over-year basis.

Overall, average royalty rates increased to 26.7% in the quarter compared to 24.8% last year. The average royalty rate for rights-managed imagery was 33% compared to 34% last year.

For royalty-free imagery, it was 19%, up from 15% a year ago. Two growing RF categories are micropayments and image partners, both of which have higher royalty rates than our house collections.

For editorial imagery, the royalty rate increased to 30% compared to 25% in the prior year, primarily as a result of the addition of Wire Image during the quarter, some minimums and guarantees that were paid, and the growth of some products like exclusives that have higher average royalty rates.

For footage, the average royalty rate was 30%.

Selling, general and administrative expenses for the quarter were $84.1 million, including a $1.3 million of professional fees associated with our stock option review. Excluding these expenses, and on a currency neutral basis, SG&A grew by 2.4%. Excluding costs associated with acquisitions, SG&A actually declined on a year-over-year basis.

You can be sure that we will continue to manage our expenses appropriately in times of slower revenue growth. In the third quarter, we initiated a restructuring that resulted in the elimination of about 100 jobs. This will result in an annualized savings of about $20 million in staff and staff-related costs.

We remain committed to staffing appropriately for our strategic initiatives and investing in areas with the highest opportunities for growth. The restructuring or severance charge will be about $4 million in the third quarter.

Depreciation was $15.1 million and amortization was $7.1 million for the quarter, compared to $13.3 million and $5.2 million in the second quarter of the prior year. These increases are primarily the result of expenses from acquired companies, as well as increased depreciation of our recent capital expenditures. Capital expenditures were $19.6 million in the second quarter and we expect to have total expenditures between $60 million and $65 million for the full year, consistent with the level of expenditures in the prior year and in line with our prior guidance.

In the second quarter, we reported operating income of $53.1 million, representing an operating margin of 24.4%. Excluding the $1.3 million in fees I just mentioned, our operating margin was $54.4 million, or 24.9%.

In the second quarter of 2006, we had a restructuring charge of $16.5 million, primarily related to the New York lease loss. Excluding this item, operating income last year was $57.7 million, or 28.2%.

Our effective tax rate, income tax rate was 37.6% compared to 34.2% in the first quarter of this year. The increase in the rate sequentially was due to increased profitability in higher tax jurisdictions and also due to newly accruing interest on our tax reserves as a result of recently becoming a U.S. federal cash taxpayer.

Net income was $33.7 million and EPS was $0.56 per share. Excluding the professional fees associated with the stock option review during the second quarter, EPS was $0.57 per share. Net income in the second quarter of 2006 was $23.2 million, or $0.37 per share. Excluding the restructuring charge, as well as the losses on investments sold during the quarter, net income was $37.3 million, or $0.59 per share in the second quarter of last year.

Cash generated from operations was $48.8 million in the second quarter and cash balances at the end of the quarter were $289 million. During the quarter, we spent a total of $248 million for acquisitions, of which $120 million was financed through our senior credit facility and the remaining $128 million paid from our cash balances.

Our convertible debt was reclassified this quarter from long-term to short-term due to the provisions of the debt which gives the holders the ability to require us to redeem the debentures on June 9, 2008.

The following forward-looking statements reflect Getty Images' expectations as of August 1, 2007. Currently, the company does not intend to update these forward-looking statements until the next quarterly results announcement.

As I mentioned earlier, the company is announcing a restructuring and related reduction in workforce that will result in a charge of approximately $4 million in the third quarter of 2007 and is expected to result in annualized savings of approximately $20 million in salary and salary related costs. We will not see a full quarter of benefit until the fourth quarter of this year.

Our revenue expectations for the second-half of 2007 reflect lower outlook of our traditional Creative Stills business. Although we see many positive signs from our initiatives, it will take a few more quarters to see an improvement in this part of the business.

For the third quarter of 2007, the company expects revenue of approximately $210 million. For the full year 2007, the company expects revenues of approximately $855 million. We expect diluted earnings per share of $0.47 in the third quarter and approximately $2.22 for the full year 2007, both of which exclude a charge of about $0.04 for the restructuring.

Let me walk you through some main differences between the guidance and the numbers provided previously. We have reduced our full year revenue outlook by $25 million. We are estimating a higher effective tax rate for the year, which of course had an impact on Q2 as well as the second half of the year. We estimate the impact on EPS in the neighborhood of $0.07 per share for this change. This increase is due to interest to be accrued on tax reserves, a change in the U.K. tax rate in the third quarter, and shifts in the geographic mix of our income. We continue to expect our effective tax rate to decline over time.

The acquisition of Pump Audio is expected to be dilutive for the full fiscal year 2007 by approximately $0.04 and lastly, we have modeled a positive impact to EPS as a result of the cost reductions that we mentioned earlier.

Guidance for 2007 assumes just over 60 million fully diluted shares for both the third quarter and the full year.

With that, I will turn it back to Jonathan to wrap up.

Jonathan D. Klein

Before I hand back to you for questions, I would just like to touch on a couple of items, the first is our business model. We have the perfect business model when revenues are increasing, as we have a strong gross margin and relatively fixed SG&A. Two-thirds of our SG&A is in people and people-related costs. In addition to that, we have modest capital expenditure.

We also have a business model which turns revenue and profit into cash very effectively and in times when there is revenue pressure, we do two things. We act quickly and decisively to invigorate revenues at the same time as reducing costs.

I want to be very clear on what is going on here at Getty Images. First and foremost, we are facing a challenging environment in the traditional Creative Stills business. I have shared some of the initiatives that are underway with you and we will do our best to get this business growing again, at rates which we and you find acceptable. From the guidance, you can see that we do not expect that to happen this year.

At the same time as working on the traditional Creative Stills business, we are working hard on a number of exciting new initiatives for our company, some newer than others, all of which we expect over the near- to long-term to grow rather faster than the traditional Creative Stills business.

You are very familiar with editorial imagery and how well it is doing, as well as our services businesses. We think footage has tremendous growth potential. We are doing very well in the micropayment space and we have recently added music and will soon be adding consumer. These all present excellent opportunities and we are pursuing them with vigor.

But I am sure there are many questions, so it is best for me to stop and let you ask them right now.

Question-and-Answer Session

Operator

(Operator Instructions) We’ll take our first question from Matthew Troy with Citigroup.

Matthew Troy - Citigroup

Good afternoon. I just wanted to ask a broad question and that was as you pursue these alternative business models that display promise with vigor, as you say, and look at a pay-off period that is not as near-term as the market would like, I was wondering if we could just get your thoughts on the public versus private debate. You are making some investments in some very interesting businesses that no doubt have potential, but could you be doing more as a non-public company? Could you just give us your updated thoughts there?

Jonathan D. Klein

Matt, I think it is wrong and inappropriate for me to entertain any hypotheticals. Getty Images has been publicly traded for 11 years now and that is how we run the company. That is how we focus on things. The decisions which we are taking are the right long-term decisions for the business and we very much hope that we will be able to reinvigorate the Creative Stills business. We know that we will be successful in a number of these new initiatives. We know that one or two may not work. That is life.

Whether the market is going to be patient or reward us or not for how we do quarter on quarter is really up to the market to decide and up to the people who own the company, the shareholders to decide.

But as far as we are concerned, we press on. We think we have a terrific business. There are other times in our history where growth has slowed down. In fact, there are periods where growth has been aggressively backwards and we faced challenges in the past and we’ve innovated our way out of them and we are pretty confident we’ll do that again.

Matthew Troy - Citigroup

I appreciate that answer. One question then on the paid search. You’ve talked about that in the past and perhaps Getty’s ability to participate more on the paid search side. Any update on your thoughts there in terms of opportunity, near or long-term? Thanks.

Jonathan D. Klein

Matt, is your question about how we can benefit from the growth in paid search by imagery, still or moving, being included with search?

Matthew Troy - Citigroup

Right, right, to the sense that it has been a category that has hurt your business at the margin hitherto, it may one day soon transition to opportunity. I was wondering if you could just talk about that, how you can participate.

Jonathan D. Klein

What we do know at this point is that the giants in the search world are all looking very closely at the integration of rich media into their paid search product. They also know that click-through rates on the web where there is an image are significantly higher than when there is no image, and they could also tell you what percentage of the overall traffic on those major sites is related to imagery, and it is a very big percentage. So they are all looking at a seamless, easy way to integrate imagery into a paid search experience.

We are talking to all of them about this but of course when one is working with companies of that size and when they are making adjustments to a key part of their own business model, these things take time and they run pilots and they do tests before they push the button.

I am pleased to say that we are involved in all of those discussions with all of the major players in the space and we know that we will have an important role to play as and when they are able to introduce that product in a major way to the market, and they clearly want to do it because of click-through rates.

Matthew Troy - Citigroup

Interesting. Thanks, Jonathan.

Operator

We’ll take our next question from Troy Mastin with William Blair & Company.

Troy Mastin - William Blair & Company

Good evening. Thank you. I wanted to ask about your statement regarding the softness you are seeing from the agency segment of your business, if you can give us some insight where the slowdown might be there, or the source of the slowdown if it relates to maybe a particular class of agencies, does it seem to be competitive in nature, is it due to alternative licensing models, maybe secular softness in certain media -- any deeper insight you might have would be helpful.

Jonathan D. Klein

I wish I could give you a lot more information and as you know better than most, when you use the word agencies, it covers so many different kinds of agencies. We include under the agency definition any body doing work on behalf of somebody else, so it could be a one-person design agency operated from somebody’s living room right up to the major ad agencies in the world.

Of course, under the agency heading, it is not just advertising, it is not just below the line or above the line advertising, it is also PR design and all the rest of it.

What we are finding though is that the weakness with agencies is somewhat across the board and I think there are a number of factors driving that. I think their business is changing. I think in addition to that, that a lot of the work is going to -- quite often a lot of the creative work is sometimes going to much smaller agencies. The way they charge their clients has also changed over the five or so years. The date in which an agency would pass on the cost of everything they acquire from a third party with a big mock-up is behind them. They are also learning to work across many media and that is also having an impact.

What we are finding with the agency segment is that the segment overall had some challenges. These challenges are somewhat hidden when you look at overall ad spend because that doesn’t affect us.

I would say that that’s definitely a part of it. Also, the online agencies or the interactive agencies do work in a different way and one of the reasons we are evolving our model much more to a ready-to-wear, easier to use, easier to get the image, and that’s what rights-ready is about, that’s clearly what royalty-free is about and microstock, is because they are wanting to use more and more images, more and more pieces of images, and they want to operate very, very quickly in an all-digital environment, because time is money for them because they can no longer charge the way they used to.

So yes, I think the agency segment is one where we are spending a lot of time, doing a lot of work and, as I said, we have teams dedicated to that. But we are finding across the board pretty much that that’s the area which is seeing the greatest revenue pressure and volume pressure -- not margin pressure, volume pressure in fact. What we are seeing revenue wise from the other segments was increases but in agency, not.

Troy Mastin - William Blair & Company

It sounds like you are describing these as relatively secular shifts rather than some sort of a cyclical downturn. Is that a fair encapsulation of your statement?

Jonathan D. Klein

I think it is fair to say, even when I step back from agency, when I talk more generally about the whole of the traditional Creative Stills business, there are changes and the changes, which I talked about in detail last year, are continuing. And perhaps what is happening -- perhaps -- is that the changes are happening slightly faster than we all would have hoped and that is what is putting pressure on us this year relative to what we expected.

I would say it is certainly not a seasonal issue and I don’t believe it’s something to do inherently with the ad cycle. I think there is more and more imagery and it is used in many, many different ways and at the same time as that, the agencies are finding that their business is changing. So yes, I think it is secular.

Troy Mastin - William Blair & Company

Okay, and then on the editorial side, kind of two questions here; one, can you refresh our memories on your exposure to newspapers within the editorial segment? And then within that segment, you had great growth in the quarter. Most was due to the acquisition of Wire Image, I believe. What was the underlying growth if you could strip out Wire Image so we could get a sense of how that has grown versus past quarters?

Jonathan D. Klein

We can tell you the editorial growth excluding Wire Image was in the mid to upper teens, so even if you exclude the acquisition, we were very pleased with it. And remember, I know you know this, Troy, because you are an expert, but I will remind those who are less expert, that this is an odd number year ending in a seven, which means it is a slower growth year for sports because there are not many major sporting events. So mid to upper teens organic growth rate for editorial imagery in a flattish year for sports is a very good performance, as I said excluding the acquisitions.

In terms of newspapers, it is not a massive part of our business but, depending on the geographies, it is an important part of our business and we are doing very well with newspapers because they are needing more and more pictures because all of them actually have a significant online presence. And if we sell one picture of a sports news or entertainment event for the print edition, we are likely to sell 10, 20 or 30 of the same event for the online edition.

We are not concerned about the challenges that the traditional newspaper industry faces over, of course, like any other print-based media which is migrating, they are trying to figure out how to do that and we have a good role to play because as they reduce their cost bases, which they inevitably have to do, we get more and more of their content because they have fewer photographers and they are spending less money themselves on generating the imagery and relying more on us as their outsource partner to do that for them.

Troy Mastin - William Blair & Company

Thank you very much.

Operator

We’ll take our next question from Christa Sober Quarles with Thomas Weisel Partners.

Christa Sober Quarles - Thomas Weisel Partners

First question is really just a macro question. I guess as we’ve seen some of the earnings reports from both the online and offline companies, I would say that display advertising in general has not been strong, even in the online side. I was just wondering, when you talk to your customers, are you feeling that there is a macro pullback in effect, in addition to obviously the secular one?

And then the second one is just a quick housekeeping -- thank you so much for giving me organic growth or decline for Q2. I am going to be greedy enough if you could give it for Q1.

Jonathan D. Klein

I don’t know if we have it for Q1 handy but I think there was a strong feeling that we should give organic decline or growth for Q2, so we decided that what we would do is that we would give it at a time when there was a decline, when we couldn’t be accused of handing out information just when we looked okay and I think the other point about it is we also knew that if we gave you Q2, you would ask for Q1.

Tom may be able to help you if he is feeling charitable.

Thomas W. Oberdorf

You know, listen, Q1 was -- I am not going to give you Q1 because I don’t have all the numbers in front of me for Q1 but Q1 was not really the issue when we look at organic growth because if you look at all the acquisitions we made, they were all in the second quarter. If you really phase back, I mean, you did have iStock that came in in February of last year, so Q1 probably isn’t going to move the needle one way or the other.

I will give you the full year though. When we looked at the full year, ’07, and we think it is going to be about the same rates that we gave for the second quarter. So looking forward, we’ve actually looked at organic growth rate and we think that the full year will mirror that of the second quarter. That’s implicit in the guidance.

Christa Sober Quarles - Thomas Weisel Partners

And the macro picture?

Jonathan D. Klein

Well, your question about the overall macro environment for advertising --

Christa Sober Quarles - Thomas Weisel Partners

Yes, I mean, just looking at Viacom stock has declined recently, Yahoo!’s display advertising is weak, AOL reported weak numbers this morning -- it just -- it feels like there is -- and maybe this is what the market is trying to tell us but it just feels like there is an overall pullback or fear from an advertising standpoint. I was just wondering if you had any anecdotes or sense around that, in addition to obviously some of the secular concerns but just overall macro.

Jonathan D. Klein

I think it is quite difficult to tell because it is the summer and you never know when things slow down in the summer whether it is your typical seasonal summer slowdown, especially for a business as international as us where they don’t do a lot of work in Europe in the summer -- some people say they don’t do a lot of work all year but I think that is unfair.

So it is difficult to tell in relation to that but what I would say is that we do know that display has been weaker. We know that the returns that people are getting on paid search are not as great as they were and we know that there are signs of certain economies slowing down. And we also know from any period that one of the first areas to feel that is advertising, and typically the kind of advertising that you can’t measure. That’s the one that people reduce first.

If you have advertising which you can very easily measure, like direct response, EMDM, or paid search, you can turn that up and down very quickly. So where we sit, I don’t think we are anymore wise than the overall market in relation to this but what we do know is that we didn’t get enormous benefit from a strong advertising environment because of the secular changes I have talked about in the previous question and we are not concerned about a slowdown in the overall advertising environment because of the particular dynamics of the industry.

What we do know, plain and simple, and I should have made the point, is that the number and volume of images, still and moving, as well as the demand for multimedia products, will continue to grow exponentially. The question which we have to answer is can we transition our Creative Stills business, traditional Creative Stills business, so that it is better attuned to those very high volumes, ready-to-wear, easy to use approaches at the same time, of course, as building our user-generated and social media businesses.

But will there be more images no matter what the advertising environment? No doubt about it -- exponentially more.

Christa Sober Quarles - Thomas Weisel Partners

Great. Thanks.

Operator

We’ll take our next question from Peter Appert with Goldman Sachs.

Peter Appert - Goldman Sachs

Jonathan, it feels like maybe the pressure on operating results is a function of both competitive dynamics and changes in usage patterns. My question is number one, do you agree that those are the two main things? Number two, is it possible to assess the relative importance of these issues as you see it? And then number three, just some comments maybe on your assessment on the competitive dynamic, because it feels like it is not just the traditional bigger players that are impacting you. It is a lot of newer players that are harder to get your hands around.

Jonathan D. Klein

That is a very good question. Let me just break it down. Let’s talk about the competitive dynamics. There has been no change in the traditional competitive landscape in the last several quarters. The traditional Creative Stills business is tough for us all. All of the companies who we’ve competed with in this area, including of course Corbis, are finding this business tough. You may have seen that Corbis announced some staff reductions not so long ago. So the traditional competitors are simply not the issue for us at the moment.

So then you talk about new entrants -- would I agree that new entrants are an issue? I would say yes and no, and the reason I am equivocal on it is that the new entrants in the main don’t have any traction to speak of. The micropayment part of the industry, which is growing very fast, is one which we know inside out. We invented it. We are by far the major player in that area and we know and understand that very clearly. Are there other micropayment players? Absolutely, but again, it’s a segment where you really need a lot of traction to make an impact and there aren’t many micropayment players doing that.

Then we look at the second area where people say what about the giants, Google Images and Yahoo!? Well, the reality is that they get a ton of traffic for their images. The reality also is that you cannot license any of those images for commercial use. They are not owned by those portals. They have no right to license them. They have no sales people to help in the transaction and they are simply going out and crawling the web. So we are not seeing a significant -- we are not seeing any issue there.

But I think what it is is that there is just a lot of imagery there and at the other end of the scale, given how much imagery is being used on the web, customers often do not need a great image for the web, they need a good enough image. They don’t need it at high resolution, which is why we are seeing much more pressure in our royalty-free business at the lower resolution, lower-priced areas.

So I think it has way more to do with usage pattern. It’s got nothing to do with existing competitors and it has a little bit to do with newer players but that is more driving in terms of proliferation of imagery and availability of imagery.

I don’t know if that helps but that is broadly how we would see the landscape.

Peter Appert - Goldman Sachs

That is very helpful. Thank you. And one other issue, Jonathan; can you just comment on your planned move to New York and what that’s about?

Jonathan D. Klein

It is to get closer to certain of my friends and as far away from you as possible, Peter. Leaving that aside, it is really -- I plan to spend about a year in New York. Over time, we have migrated more and more of the core of Getty Images in the U.S. towards the New York office. It is our second-largest office in terms of number of people. We have more sales people there. We have our editorial picture disc, we have our footage operations. We have most aspects of what is customer facing and customer touching in New York.

Our headquarters remain in Seattle but we have not had a sales presence in Seattle for seven years and what we are trying to do is we are trying as a company to get closer to our customers as well as our partners, as well as use this to drive the next stage of our development. As we enter into other areas of digital media, it is sensible for us to have a more senior presence there. So that’s really what is driving it, which is why it is logical for our Senior Vice President of Marketing, who we are in the process of hiring, to be based there and we are also going to move our leadership of communications and public relations to New York as well.

So it is really around those broad issues. Also, from a practical and pragmatic perspective, it just works. We have a ton of business in Europe and it is simply easier from a time zone perspective, not just flying there but just connecting with people. So that is what we are doing.

Peter Appert - Goldman Sachs

Thank you. Should we read this, Jonathan, though as an indication that maybe you are just planning to step up the corporate development activity from an M&A standpoint, that perhaps some bigger transactions are coming for Getty?

Jonathan D. Klein

I wouldn’t read it as that at all from an M&A standpoint, but from a business development standpoint, I would say this -- I’ve made it pretty clear that we plan to add significant music from labels and publishers and New York has a role to play there. I’ve also made it clear that our consumer offering would have not just our content but also other major players who have still and moving imagery. And that makes sense there too.

So from a business development, corporate development perspective, yes but not from an acquisition perspective. As we’ve shown through our history, I’ve not spent any time based in New York since we started the company and that hasn’t stopped us making 70 acquisitions in 12 years, so we don’t really need to be in New York for that.

Peter Appert - Goldman Sachs

Okay, great. Thanks, Jonathan.

Operator

We’ll take our next question from Steven Ashley with Robert W. Baird.

Steven Ashley - Robert W. Baird

Thank you. I would just like to get a clarification on some of the metrics you provided around the RF business. You mentioned that had grown year over year 4.6%. Did that revenue growth include iStockphoto?

Jonathan D. Klein

Yes, it did.

Steven Ashley - Robert W. Baird

And then the volume and ASP comments did not include iStockphoto, is that correct?

Jonathan D. Klein

Absolutely correct, Steve, yes.

Steven Ashley - Robert W. Baird

And doesn’t that just suggest that that RF business is shifting more to the micropayments market and we are seeing that shift perhaps among the agency customers?

Jonathan D. Klein

What Tom said I think, if I remember correctly, is that other royalty-free, which includes iStockphoto, represented --

Steven Ashley - Robert W. Baird

27.

Jonathan D. Klein

27% compared to 16% last year, so what that tells you is that in the overall mix of royalty-free, iStockphoto is taking a bigger share. It tells you nothing about the agency segment.

Steven Ashley - Robert W. Baird

It seems we’ve seen an acceleration here or some kind of inflection point. Has anything changed in the market? Is it the ability to buy at iStockphoto under payable terms, has that changed or has anything changed in the market dynamics?

Jonathan D. Klein

As far as iStock is concerned, no. We still have not rolled out broad-based terms to iStock customers. The bulk of their business is still done on credit card so we’ve not made any major changes there. Their customer base is pretty much the way it has always been, with about 80% being very, very small enterprises, about 10% being bigger corporations and the balance being more like consumers. So there’s not been a huge change there. That’s not driven the acceleration.

I think what’s happened is the secular trends we’ve talked about and what we are trying to do is also reach the value-based customer in a different way. The reason for the second site, Punch, is to reach those customers.

On gettyimages.com, we do not do any of the following: massive discounts, big promotions, buy a bunch of images and get a free t-shirt, we don’t have other asset or content types like clipart or animation. We don’t, on gettyimages.com, have massive subscriptions. We have a high-end subscription called Creative Express and the Getty Images brand is very, very powerful but it does not reach the value-based or budget conscious customer.

And at the other end of the scale, we have iStock, which is very, very strong in that space so the idea behind Punch Stock is for us to have different offerings, different content, and a different way of reaching the value conscious customer. It will take some time. We’ve only just bought Punch but we think that it bears promise.

Steven Ashley - Robert W. Baird

And just lastly, Tom, do you have any guidance you could provide around what 2007 cash flow from operations and/or plant property and equipment spend might be?

Thomas W. Oberdorf

Well, we gave the plant property and equipment. We think it is going to be between $60 million and $65 million for the fiscal year. We really haven’t given guidance on the cash flow but I mean, you know -- all I want to caution you is that this year we are a full cash taxpayer, so you should be looking at the current quarter versus last year and keeping that in mind.

Steven Ashley - Robert W. Baird

Thank you.

Operator

We’ll take our next question from Jeetil Patel from Deutsche Bank.

Herman Lee - Deutsche Bank

This is actually Herman Lee calling for Jeetil Patel. Just a couple of questions; specifically, I guess you talked about the bulk declines coming from the agencies specifically on the rights-managed, royalty-free side. My question is on basically the rights-managed side, if agency economics have changed specifically in that segment, whereby more agencies are kind of developing in-house pictures to kind of save on the economics of the rights-managed side.

The second question I have is regarding your restructuring plan, whether or not you can break out the specific areas you are cutting in or specific geographies that you are going in, and I have a follow-up.

Jonathan D. Klein

As far as the rights-managed and agency dynamic, they are not producing images in-house. What is basically happening is that the corporates are occasionally taking more of the imagery themselves and are building their own imagery collections and we are helping them to do that.

An agency won’t do significantly more in-house and they won’t do anything on spec. In other words, if they have a client and they need an image, they can either shoot it or they can come to get it from stock photography. If they shoot it, we can give them that through our assignment business and if they want it from stock photography, we’ve got that for them.

So I wouldn’t juxtapose a rights-managed weakness within the agency segment. The agencies buy everything. The agencies are perceived to be high-end and therefore are perceived the higher end, higher production value imagery, but that is not the case. The agencies, as I said earlier, vary from a one-person design agency to the biggest in the world. They have different customers with different budgets and they are working for their clients on a daily basis. Sometimes they are hiring a photographer who they will pay $50,000 for a day’s shoot and sometimes they are downloading 30 or 40 images from iStockphoto at $1 each. So those are really different dynamics.

As far as the headcount is concerned, I think the most important factor in the headcount is that we have reduced heads by less than 100 people. We’ve focused at the senior levels of the company, so from 25% of the heads are a director or above level. And in the main, it is pretty hard to generalize but I would say that the move towards a segment-based marketing organization, the move of, if you like, the center of gravity for marketing being in New York, as well as giving our regional marketing more resource and authority, would mean that the marketing organization in Seattle probably had a larger impact than other parts of the company

Interestingly enough, the headcount at the end of the year will be pretty similar to the headcount at the beginning of the year because remember, this year we made a number of acquisitions which we intend to grow as opposed to acquisitions where we just integrate and ask the people to leave, and that obviously applies in particular to Pump, as well as building our entertainment business.

Herman Lee - Deutsche Bank

Got it. And it also sounds like you guys have a few initiatives, new initiatives kind of lined up. On your new website, you have a consumer offering that’s kind of in the works and you have your multi-site strategy. I was just wondering if you can comment on your priority on your sales and marketing spending behind some of these initiatives over the second-half and well into 2008.

Jonathan D. Klein

The top priority and focus around sales and marketing is to reinvigorate the traditional Creative Stills business. That remains the top priority. We are spending appropriately in order to do that and we are also feeling that we need to continue to have high touch with some customers and absolutely no touch with others.

I would say if we are to analyze that in one or two sentences, we haven’t had sufficiently high-touch with certain customers up until recently and we have too much touch with other customers. By simplifying the licensing model and making it easier to buy stock photography, we will reduce our assist rates, which will give us more resource and time for the higher touch with other customers, also bringing a very strong segment focus to this has assisted already in analyzing much more closely the key issues for each customer base.

So for some customers who buy thousands and thousands of images, the ability for us to do that for them seamlessly online and to have everything in place in advance is way more important than anything else, and we are doing a lot of that for them.

But the top priority is to reinvigorate the traditional Creative Stills business, because the rest of our businesses are growing extremely well.

Herman Lee - Deutsche Bank

Thanks.

Operator

And that is all the time we have for questions. At this time, I would like to turn the conference back over to our speakers for any additional or closing comments.

Jonathan D. Klein

I don’t think we had anymore to add, except I thank you again for your interest in Getty Images. As I said in response to a question not so long ago, we’ve been public for 11 years and we have some good quarters, we have some great quarters, and we have some quarters which we are not particularly pleased with. I am confident that we are doing the right things, we are taking the right hard decisions. We have our priorities right but we do have some issues to deal with, some of which are not of our own making and are somewhat out of our control.

I hope that the guidance reflects the realism in terms of what we can do and the fact that it will take some time, as well as I hope I got across some of the excitement and some of the growth opportunity inherent in our businesses.

With that, I am going to jump off the phone and leave you as such. Bye-bye.

Operator

And that does conclude today’s conference call. We thank you all for your participation and you may now disconnect.

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