Good day, ladies and gentlemen, and welcome to the first quarter 2018 Shutterstock, Inc. earnings call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. If anyone should require operator assistance during the conference, please press star, then zero on your telephone keypad. As a reminder, today's conference may be recorded. I would now like to turn the call over to Mr. Steven Cardello, Chief Accounting Officer. Sir, you may begin.
Thank you, operator. Good morning, everyone, and thank you for joining us for Shutterstock's first quarter 2018 earnings call. Joining me today is Jon Oringer, our Founder, Chief Executive Officer, and Chairman, and Steven Berns, our Chief Operating and Chief Financial Officer. During this call, management may make forward-looking statements that are subject to risk and uncertainty, including predictions, expectations, estimates, and other information. These include statements relating to long-term effects of our investments in our business, the future success and financial impact of new and existing product offerings, our future growth and profitability, our long-term strategy, growth potential, future results of efforts to reduce our expense footprint, implementation of large-scale business solutions, and 2018 guidance. Our actual results may differ materially from the results predicted, and reported results should not be considered as an indication of future performance.
Please refer to today's press release and reports and documents we file from time to time with the U.S. Securities and Exchange Commission, including the section entitled Risk Factors in the company's annual report on Form 10-K for the year ended December 31st, 2017, for discussions of important risk factors that could cause actual results to differ materially from those discussed in any forward-looking statements we may make on this call. On this call, we will refer to Adjusted EBITDA, Adjusted Net Income, revenue growth on a constant currency basis, and free cash flow, all of which are non-GAAP financial measures. You can find a description of these items along with a reconciliation to the most directly comparable GAAP financial measure in today's earnings release and in our Form 10-K, which are posted on the investor relations section of our website.
We believe that the use of these measures, in conjunction with GAAP financial measures, allow investors to consider our operating results on the same basis used by management. This provides them with important additional insights about the company's overall business and operating performance and enhances the comparability in assessing our financial reporting. However, these non-GAAP financial measures should not be considered as a substitute for or superior to financial information prepared in accordance with GAAP. With that, I would like to turn the call over to Jon.
Thanks, Steve. Thanks everyone for joining us today for Shutterstock's first quarter 2018 earnings call. During the first quarter, we continued to execute on our vision to be a global creative platform, empowering customers with compelling content, innovative tools, and valuable services that drive faster, more efficient content discovery and creation. We are seeing strong operational momentum from our many initiatives, including our upgraded technology platform and the introduction of new products, features, and functionality for our customers. Importantly, we're also continuing to attract and develop talented individuals that enable our success. While I'm pleased with the performance in our top-line growth during the quarter, we remain focused on also improving our margins, which, as noted in prior calls, have been impacted by the infrastructure and platform investments we have made and continue to make in our business.
While these critical investments have impacted our margins in the last several quarters, we believe they will result in long-term positive impacts on our financial results. In the first quarter of 2018, we completed the sale of our Webdam business on February 26th, 2018. Our reported revenue increased 17.5% to $153 million compared to the first quarter of 2017. On a constant currency basis, revenue grew approximately 12.8% compared to the first quarter of 2017. When excluding the impact of currency and Webdam, first quarter revenue grew 13.7%. Adjusted EBITDA was $22.1 million compared to $23.2 million in the first quarter of 2017. Webdam did not materially impact our Adjusted EBITDA results in either period. In addition, on a year-over-year basis, during the first quarter of 2018, our customer base grew by 9% to more than 1.8 million customers. Paid downloads increased by 0.5% to 43.7 million downloads.
Revenue per download grew 12% on a constant currency basis. We expanded our image library by 42% to nearly 187 million images, and increased our video library by 45% to nearly 10 million clips. As we've discussed on prior calls, over the last few years, we made investments that we believe evolve our marketplace into a platform that provides individuals and enterprises with the content types and tools needed to collaboratively design and build creative projects. In our e-commerce image business, we are experiencing solid customer growth. Our focus on offering the right pricing and packaging to our customers, while optimizing our customer acquisition funnel, has improved our conversion rates and customer lifetime value as compared to the first quarter of 2017.
During the first quarter of 2018, we launched a new pricing page, rolled out new localization and personalization features, and made significant progress on product offerings that we expect to launch in 2018. Within our motion business, we launched our new footage site and customer experience in the quarter. In addition, we built upon our fourth quarter 2017 launch of our new premiumbeat.com website, including favorable search engine optimization, additional language support to premiumbeat.com, and revamped our music search algorithm, dramatically improving search results. Together with our continued efforts to expand our quality, curated, royalty-free music catalog, this provides a much enhanced experience for our users. Turning to our enterprise business, we continue to enhance our customer experience to allow for efficient content discovery and creation, with our customers increasingly making multi-product purchases across content types.
Our geographic presence also continues to expand as we enhance our focus on localization and under-penetrated markets. Our enterprise business grew revenue at a rate of 31% year-over-year in the first quarter, and represented approximately 40% of our total revenue, compared to 35% of our revenue in the first quarter of 2017. We are also continuing to cover fantastic events for our editorial business. During the quarter, we covered nearly 1,000 entertainment and fashion events and 600 sporting events. While our sports entertainment and news content is in its early stages, we continue to increase our content offering. For example, last quarter we obtained exclusive rights to cover photography, distribution, and syndication services around key events and activities for The Football Association, the governing body of English football. Shutterstock Custom integration is going well, and we are pleased with the growing interest from customers in the custom offering.
In summary, I'm pleased with the quarter and our path forward. We continue to make progress by focusing on our technology platform, new products, and launching features and functionality for our growing customer base. With that, I'll turn the call over to Steven, who will provide a more detailed overview of our operations and financial performance.
Thanks, Jon, and thanks, everyone, for joining us today. Before I discuss our performance, as always, I want to let you know that we posted a brief information deck on our website that contains supporting material for today's call. As Jon has highlighted, we continued to execute against our strategic vision throughout the first quarter, resulting in revenue growth on a reported basis of 17.5% and an Adjusted EBITDA margin of 14.4%. While the company did benefit from foreign currency movements in the quarter, we saw a favorable growth at the local currency level. On a constant currency basis and excluding Webdam, revenue growth was 13.7% from the first quarter of 2017 to the first quarter of 2018.
As compared to the prior year first quarter, we saw revenue per download increase 17% on a reported basis and 12% on a constant currency basis, driven by the continued growth in our enterprise in-motion businesses, as well as a continued shift in our e-commerce image offerings towards our smaller subscription plans, which are sold at higher price per image rates than our traditional larger subscriptions. Revenues generated by our e-commerce business improved 11% as compared to the prior year first quarter, as we are continuing to see positive results from improved focus on product mix and improved optimization of our conversion funnel. Our enterprise business grew 31% compared to the prior year first quarter to approximately $60 million. Our reported enterprise revenue results now include sales from our API platform, which have historically been reported in other. All periods have been adjusted to reflect this change.
As Jon mentioned, international expansion and localization continues to be a core part of our growth strategy. These features include improved local currency payment functionality, improved contributor workflow, and continued improvements to our search algorithm. In the first quarter of 2018, of the approximately 66% of our revenues from customers outside the U.S., 51% was derived from customers in Europe, with the remaining 49% from Asia-Pacific and Latin America. Before we discuss expenses, I'd like to highlight two items affecting our first quarter 2018 revenue. First, at the end of February 2018, we completed the sale of our Webdam business. Webdam revenues were $2.7 million for the first two months of the first quarter of 2018, which is the period in which Shutterstock owned Webdam, versus $3.5 million for the first quarter of 2017, which represented a full first quarter.
In addition, we adopted the new revenue recognition standard on January 1st, 2018. This resulted in the company recognizing an additional $1 million of revenue in the first quarter compared to the revenue that would've been reported using the legacy revenue recognition standards. If you review footnote one in our Form 10-K, you'll see the disclosure of the impact of this new revenue recognition standard, and that 10-Q was filed this morning. While this does slightly improve the first quarter financial result, the impact is primarily a shift from other quarters within 2018 into the first quarter. Our operating expenses, excluding stock-based compensation for the first quarter of 2018, increased 2% versus the fourth quarter of 2017, and 25% increased from the first quarter of 2017. This has been driven primarily by investments we're making in both our infrastructure and our smaller, but high-growth, high-potential businesses.
First quarter contributor royalty expense was approximately 26.4% of revenue, which is essentially unchanged from our recent historical experience. Before I go into some of our major expense categories, I'd like to reiterate that we have taken and continue to take actions to reduce the growth of our expenses. This is an ongoing exercise that we believe will yield increasing results throughout 2018. For each category discussed, my comments exclude stock-based compensation expense and will highlight both sequential quarter changes as well as year-over-year changes from 2017 to 2018. Sales and marketing expense remained flat compared to the fourth quarter of 2017, and increased 28% as compared to the first quarter of 2017. Generally, this category is split equally between the sum of brand and performance marketing, and the cost of our enterprise sales organization.
Overall, our return on investment in this spend has been healthy and remains consistent with our historical results. As a percentage of revenue, sales and marketing expense was 26% in the first quarter of 2018, which is consistent with the fourth quarter of 2017, and up slightly from the 24% of revenue in the first quarter of 2017. Product development costs increased $1 million, or 6%, from the fourth quarter of 2017, and up 53% versus the first quarter of last year, primarily due to higher personnel and consulting costs related to the building of the more expansive customer platform we've discussed on many calls leading up to today, as well as on this call.
General and administrative expenses increased by 11% from the fourth quarter of 2017, and 15% from the prior year first quarter, driven primarily by higher personnel costs and consulting expenses related to our implementations of several large-scale business solutions, which we believe will enhance the organization's operational efficiency. As I have stated in prior calls, we are not pleased with our current margin performance, and believe that our margins will improve through 2018 as a result of cost management steps that have been actioned and will continue to be actioned throughout the year. As we have previously discussed in connection with the sale of our Webdam business in February of this year, we recognized a pre-tax gain of $38.6 million, and an after-tax gain of $27.9 million. Our effective tax rate for the quarter was 25.8%.
Our first quarter tax provision for income taxes of $11.3 million includes $10.7 million of expense related to the Webdam sale. Excluding the effects of first quarter 2018 discrete items, including the Webdam gain, the effective tax rate would've been 16.2%. The effective tax rate is based on the provisions of the Tax Cuts and Jobs Act, and our best estimate at this point of the impact of the relevant provisions of this act, based on all available information. The company will continue to monitor this rate as additional information and implementation guidance becomes available during the year. During the first quarter of 2018, the company's cash taxes were actually a net income tax refund of $1.8 million as compared to $2.1 million which was paid in the first quarter of 2017. A benefit in the first quarter of 2018 versus a payment in the first quarter of 2017.
GAAP net income in the first quarter was $32.6 million, or $0.92 per diluted share. Adjusted net income was $10.6 million, or $0.30 per diluted share for the first quarter of 2018. These adjusted results exclude the gain associated with the sale of Webdam. Diluted EPS would've been $0.13 per diluted share, excluding the gain on the Webdam sale. Overall, our revenue growth in the first quarter, in combination with our increase in operating expenses, translated into reported Adjusted EBITDA of $22.1 million, which compares to Adjusted EBITDA of $23.2 million in the same period a year ago. The decline in this level of Adjusted EBITDA is attributable to the expenses I mentioned earlier in my comments. Moving to cash flows in the balance sheet, we generated $21.1 million of cash from operations.
Free cash flow, which includes cash outflows for capital expenditures and content purchases, was $5.5 million versus $3 million in the first quarter of 2017. At the end of the first quarter, we had approximately $285 million of cash and cash equivalents. Moving to deferred revenue, total deferred revenue declined 12% from December 31, 2017, to the end of the first quarter of 2018, and the balance was $139.5 million at the end of March. It's important to note that this decline is attributable to three specific items. First, a cumulative effect adjustment pursuant to the new revenue recognition standards that reduced deferred revenue by $9.9 million. The sale of Webdam reduced deferred revenue by $10.2 million because that $10.2 million was attributable to the Webdam business. Those two declines in deferred revenue were offset by growth of $1.8 million in the company's operations.
Our continuing business of deferred revenue grew absent this accounting change for rev rec standards and the sale of Webdam. Of the March 31, 2018, balance, approximately 39% relates to our e-commerce business and 61% to our enterprise business. We are reiterating our previously provided financial guidance for 2018, which as a reminder, excludes Webdam, and this guidance is fully detailed in today's earnings press release. We expect 2018 revenue of between $625 million and $635 million, representing growth of between 15.5% and 17.4% versus 2017. For 2018, we expect Adjusted EBITDA of between $105 million and $110 million, representing growth of between 19% and 25%. Once again, our guidance excludes both for revenue and Adjusted EBITDA, the gain we recognized on the sale of Webdam, and it also excludes the revenue associated with Webdam that I just mentioned in the first quarter.
We appreciate your time today. Now Jon and I will be happy to answer any questions you may have. Victor, please prompt the participants for questions.
Yes, sir. Ladies and gentlemen, if you have a question at this time, please press star then the number one key on your telephone keypad. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. To prevent any background noise, we ask that you please place your line on mute once your question has been stated. Our first question comes from the line of Youssef Squali from SunTrust. You may begin.
Yeah. It's Naved Khan for Youssef. Just a couple of questions. Just on the paid downloads, the year-on-year growth slowed a bit. Is there something related to the pricing change that might have affected the growth here? Then just in regards to the guidance, you're obviously reiterating the annual guidance, but if I just look at the EBITDA growth at the low end, it implies 19%. What gives you the confidence that you can still hit those numbers? How should we be thinking about the shape of the year?
Sure. As it relates to the first question, I think, the paid downloads and the growth on a year-over-year basis. Keep in mind that in the first quarter of 2017, we did not have our small subscriptions out, and those were launched in the second quarter, and there was a shift. We saw both the benefits of that shift in our actual customer count, and we had significant growth in customers. In addition, we also had some shift from 350 per month and 750 per month subs that weren't utilizing the full benefit of those subscriptions shift to these small subs. The combination of those resulted in some shift in the actual number of paid downloads in terms of the growth of those.
When we look at all our images and obviously, paid downloads includes all of our products and all of the content, whether it be editorial or video or music. In total, though, images being the largest portion, this growth is not surprising to us, like I say, given that the first quarter of 2018, is the first quarter in this year in which we have the small subs, and I think the second quarter and the third quarter, you'll see slight benefits versus what you saw in this comparison. As it relates to our guidance, the first quarter is just the first quarter.
We don't give quarterly guidance, what I would say is based on our business plan, based on the activities we've seen, based on our revenue performance, based on the cost actions that we've taken and continue to take, we believe that the combination of our revenue performance and our cost management will result in us achieving the guidance that we've provided.
Thanks, Steve, that's helpful. I have one quick follow-up, if I may. Maybe this is a question for Jon. When should we start to think about the payoff from the increased localization and personalization effort that you are undertaking?
It's a continuous process. We've been implementing personalization, localization actually for many years. We're going to continue to evolve that. We can do it in a more efficient and optimized way on our new platform. Our new platform is a great place to run experiments because we have all of our code in one language across all of our different stacks and products. We're going to have all of our data in one place. We're going to have certain methodologies to process that data, clean that data in ways that we didn't before. It'll be standardized across all of our products. I would say it's an evolving process. We've seen some benefit from it. We'll continue to see more and more from the re-platform. Thank you.
Our next question comes on the line of Brian Fitzgerald from Jefferies. You may begin.
Thanks, guys. On the growth you're seeing in enterprise, can we get a little more detail on the mix, maybe whether new business is coming in from SMBs or is it larger multinationals? On the international side, roughly two-thirds of total revenue, would you call out any specific regions of products where you're seeing strong momentum? Maybe likewise in the U.S., any pockets of strength that you're seeing, particularly in the U.S. also. Thanks.
Sure. As it relates to the growth of enterprise, what I would say is that we've seen very good consumption from existing clients in terms of their activity on the platform. Our enterprise team has been extremely productive in terms of ensuring customers are aware of our new features and functionality that the platform is being utilized by them in a way that serves their needs best. I think that's a positive. On the bookings front, if you would, obviously future revenue, we continue to have lots of opportunities in all of our regions, including the U.S. as it relates to SMBs corporates. That's true on a global basis. As you probably know, I think as we've talked about, over the past couple of years, we've established, if you would, significant presence out of our London office, in our Berlin office, in our Singapore office.
We have local people in countries within each of the European, Asia-Pac, and Latin American regions to really drive the booking side, and ultimately that results in the utilization. We feel that the growth in enterprise, it's really a function of the work that we did in 2017 that resulted in the utilization, and of course, bookings are important, and that's what shows up in deferred revenue, to the extent it's a commitment and not a buy activity account. We feel that that will continue to be a positive.
As it relates to the two-thirds of the international, once again, I think that that has been relatively consistent over the years, and we think our localization efforts, we don't have a target, for instance, as I've talked about many years ago, companies would have a target as to what they wanted their percentage revenues to be from international versus domestic. We think that the implementation of our localization efforts, including localization of payment, localization of content, continued refinement of our localization of search, the continued benefits of the features and functionality on products around video and music, all of that will contribute to growth both in the U.S. and outside. We don't have specific targets by market. Jon?
Yeah, I would add to that a bit. There are no specific spots of momentum, but we sell to over 100 different countries. We source our images from 150 different countries. The six images we sell every single second is generating a lot of data for us that, again, on our new platform, in one code base with all of our data in one place, we're going to be able to get insights and sell images in better ways in the near future.
Great. Thanks, Steve and Jon. Maybe one follow-up, Jon, to your point on the platform and a bit of follow-up to your discussion on the previous question. You said it's an ongoing process, but how would you gauge you are in terms of this re-platforming process? Are we in the late innings of that, but it's going to be an ongoing process? Would you even characterize it like that?
I'd say it's never going to end if we're doing things right.
Yes.
Technology is changing all around us, we're adapting to it every single day. As the business gets bigger, it gets more complicated, and it introduces new types of technologies that we have to bring into the system and then optimize our code from before. It's a continuous rolling process. The big pieces of the re-platform, getting onto one stack, moving all of our code from multiple languages to one language, getting everybody on board with the direction of where we're going for the new stack, all of that is behind us now, and we're starting to see those pages go live and perform better.
Thank you.
Our next question comes in line of Ralph Schackart from William Blair. You may begin.
Good morning. Just focusing on the e-com business. I think you talked about optimizing the conversion funnel, new products, and price changes driving the strong double-digit growth. Any one of those factors you call out in terms of having more of a pronounced impact on the growth? As a follow-up, I think you talked about some new products that you're looking to roll out within that e-com business in 2018. Any perspective or color you could add on the new products and the potential impact on the growth rate going forward would be great, too. Thank you.
On the factors driving growth, I appreciate the question. When we think about the activity in the first quarter and all of the activities that led up to the first quarter of 2018, the performance is really the result of many small but important changes in our platform, in features and functionality, in our user experience, in our technology that creates a much richer environment for our users. While I know it's easy to try to find that one soundbite, it really doesn't exist. What I think it goes back to is what really began in late 2015 and really enabled us to have the growth that we had in the second half of last year, as we talked about in the second quarter of 2017. We saw that performance. I think this first quarter on e-commerce business is just a continuation of that effort.
On the video and music side, we have made significant improvements in those platforms. That also contributes to our e-commerce performance. Once again, there's not one thing that from a financial performance perspective you could point to. It's really the cumulative benefit of all of those. As it relates to the second part of your question.
For new products, I would point to a couple of them. I know you'll see tighter integration with Custom on our enterprise side, and that's going to spawn some new types of products as we integrate Custom and our other types of asset types, like commercial stock photography and editorial stock photography. Also on the enterprise side, you'll see more multi-asset types of deals where our customers will be able to, without much friction, move from purchasing one asset to another. We're developing plans that make this easier and easier for us to sell.
Okay, thank you.
Our next question comes to the line of Lloyd Walmsley from Deutsche Bank. You may begin.
Thanks. I had a couple. First, on the cost side, it sounds like you've identified a pretty firm commitment and a plan to control costs. Can you help us just understand which line items should start to show operating leverage over the rest of the year, and maybe from a timing perspective, when we should expect to start to see that leverage? Second one, you mentioned, I think it was about a $9 or $10 million reduction in deferred revenue impact, specifically from the accounting change. Just wondering if you can help us understand, is that recognized actually in this quarter as revenue, and that's why it came out? Or is it shifting into 2Q?
Any kind of additional color you can help us to understand that, since it has been historically a big source of contribution of free cash flow and it didn't look like it was more than slightly positive this quarter. Would love some help there.
Sure. Just to take the second question first. As is required by the standard, that deferred revenue that was recognized, was not recognized as revenue in Q1. It did not benefit but for the $1 million that I mentioned in my prior comments. Just for avoidance of any doubt, our revenue reflects a $1 million benefit from the accounting change. The deferred revenue adjustment of nearly $10 million was booked directly to retained earnings pursuant to the accounting standards. That is just a direct entry. There was not a cash impact as it relates to that deferred revenue, because keep in mind, the deferred revenue, it could be cash that we've collected in advance and ultimately just reflects effectively a liability that we have going forward that makes its way through the P&L in the form of GAAP revenue.
Okay. That kind of evaporates. We won't see that ever hit revenue.
Correct. It went right to retained earnings.
Okay. Then on the cost side, the first question.
On the cost side, G&A and product development, we'll continue to see cost improvements. On the COGS side, as well as sales and marketing, you'll continue to see growth that is proportional to revenue growth. We have a number of areas where our incremental revenue should be generating incremental margin without the same degree of cost, because as I talked about, the implementation of a number of factors, both internally generated and third-party applications. Our Workday environment, some of the internal tools and capabilities that we're building is, as we've talked about, our new platform enables the significant benefit from that platform in terms of the productivity of our engineering talent.
There are a number of things that our engineers used to do, where those are now done by our functions, whether those be the marketing function or other functions, whether it be our content marketing platform or other platforms that don't require the use of engineers. We have just many internal tools that are enabling us to be more productive, so we don't require the same level of resources for the incremental revenue being generated. There isn't any single other line I would highlight. I think we look at our total P&L and make the choices across that.
Okay, thank you.
Thank you. I'm showing no further questions at this time. I would now like to turn the call back to Mr. Steven Berns for closing remarks.
We appreciate everybody's time this morning. Thanks again, and we'll talk to you in the near future.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone have a great day.