Getty Has Disappointing Third Quarter

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October 25, 2006

Getty Images reported revenue for Q3 2006 of $198.1 million compared to $184.5 million for Q3 2005 and down from $204.8 million for Q2 2006. Excluding the effects of changes in currency exchange rates, revenue grew 5.3 percent. As a percentage of revenue, cost of revenue was 25.4 percent compared to 25.7 percent in the prior year.

Despite record revenues driven by growth in every region and every product line, for the third quarter in a row, the market punished the stock and drove it down to $45.12, an 18% drop, by the end of the first business day after the announcement. This is a more than 50% below the stock's high in November 2005. The stock hasn't been this low since December 2003.

"Our third quarter results reflect the dynamic changes that are occurring in our industry," said Jonathan Klein, co-founder and Chief Executive Officer. "Today we are announcing a vision (884) which will capitalize on the industry evolution, which is as exciting and as innovative as anything we have done in the past. We will manage aggressively through this transformation, directing resources to areas that provide the most compelling growth opportunities, thereby, setting the foundation for a new stage of growth. Sustained growth will be driven by continuous innovation and a dedication to serve our customers."

Income from operations was $54.7 million, compared to $58.7 million in the third quarter of 2005. Excluding stock-based compensation, income from operations increased to $59 million in the third quarter of 2006 consistent with the third quarter of 2005.

Net income for the third quarter was $37.6 million. Excluding stock-based compensation, net income grew 3 percent to $40.5 million compared to $39.3 million in the third quarter of 2005. Excluding stock-based compensation, earnings per diluted share grew 11.7 percent to $0.67 compared to $0.60 in the third quarter last year.

Net cash provided by operating activities was $181.5 million and the acquisition of property and equipment totaled $49.6 million in the first nine months of 2006.

Cash balances were $290.7 million at September 30, 2006, up from $259.5 million at June 30, 2006.

Getty's stock price dropped to $41.94, a 4% drop on the day and a 56% drop from its high almost a year ago.

Business Outlook

For the fourth quarter of 2006, the company expects to report revenue in the range of $196 million and diluted earnings per share of $0.60. Fourth quarter diluted earnings per share guidance excludes approximately $0.04 related to expected stock-based compensation.

For all of 2006, the company now expects to report revenue of approximately $800 million, and diluted earnings per share of $2.57. This is up from $733.7 million for 2005 but it is down significantly from what the company had estimated earlier this year. In the first quarter the company estimated revenue of $830 million to $850 million for the year and in the second quarter dropped that estimate to $820 million to $830 million.
(See Story 858). Full year earnings per share guidance excludes approximately $0.16 per share for stock-based compensation, and a total of approximately $0.25 per share for the loss on subleased property in New York, and loss on the sale of short-term investments, both announced in the second quarter of 2006.

The company has announced a realignment of resources that will result in a change of approximately $5 million in the fourth quarter of the year for employee related costs and a possible additional charge for consolidating certain office space of approximately $4 million. Full year and fourth quarter guidance excludes these charges.

Company guidance assumes approximately 60.6 million fully diluted shares in the third quarter and 61.7 million fully diluted shares for the full year.

For 2007, the company expects percentage revenue growth in the mid-single digit range and percentage growth in earnings per share of at least one and one-half times the revenue growth rate. Expectations for 2007 are currency neutral and exclude any revenue and expenses that would be obtained through acquisitions should they occur during 2007.

Revenue Breakdown

The above percentages translate into the following dollar figures for the last nine quarters (in millions of dollars).

Stock Revenue As Percentage of Total Revenue

Image Used Chart

** Note: In order to determine the revenue generated by single image RF sales, it is necessary to deduct the amount of RF revenue generated by CDs, DVDs, Virtual CDs, Subscription and Micropayment sales. The numbers in this column reflect total revenue for single image sales. The revenue from "Other RF" (not single image licenses) was 17% of total RF sales in the quarter.

**** Note: The average price per image data is global as of Q1 2004. Prior to Q1 2004, the PPI data reflects the total Americas and EMEA only

What's Happening With CD's And iStockphoto

It is worth taking a closer look at the combined CD and MicroPayment sales in the last three quarters to try to identify that portion that is MicroPayment. In Q4 2005 before iStock was acquired total revenue in this category was $8.99 million. If we assume that CD sales have remained flat in 2006 and the growth per quarter is entirely a result of micropayment then since the beginning of February through September the gross revenue for micropayment has been $10.54 million and iStock is on track for revenue of around $16 to $17 million for the year.

Klein said that iStockphoto had downloaded 2.5 million photos this quarter. Rumors have indicated that iStock had about 5 million downloads in 2005 and expects to reach about 10 million in 2006. If that were the case then the average price for an iStock image would be about $1.65. There is also a rumor that the average price is about $2.00. If the average price is higher then CD sales are probably down, or iStock's total downloads may be less than 10 million. With three different variables these numbers provide room for speculation, but at least we have a ballpark to work in.

RF Units

In determining the impact micro payment may have on RF it is important to focus on the number of images licensed in the last year in my Image Used Chart. In Q3 2005 Getty licensed rights to 265,451 images. That number dropped by 11,738 in Q4 and another 9,973 in Q1 2006. Granted, there was a big increase in Q2 2006, but I believed that raised some false hopes. We must keep in mind that Getty acquired Stockbyte at the beginning of Q2. Much of the increase probably resulted from the revenue and units licensed by Stockbyte's distributor network. In Q3 the total number of units licensed has again dropped 13,485. It seems to me that as micro payment grows we are likely to see a steady falloff of RF units licensed of this or greater magnitude.

Vision for the Future

During the conference call Klein said, "Our industry is in transition...Changes are being driven by two major factors - technology and marked shifts in customer behavior. These factors apply both generally and in the use of imagery. They are beginning to change our industry and, more importantly, beginning to change the way the customer segments we serve works."

He identified four key trends that are driving these changes.

1 - Broadband and other key technology adoption is driving the growth of new communications platforms.

2 - The advertising, publishing and media businesses are changing.


3 - Imagery will surpass the written word as globalization transforms the way the world communicates.


4 - We live in a novelty driven economy, like it or not.

Klein continued, "All of these trends contribute to an overall greater use of imagery and create new models of image consumption. Ultimately this represents long term opportunity for us and our industry. Some of these (trends) are at relatively early stages but now is the time to take action in relation to these trends."

1 - Market power is shifting from control of content to control of distribution....Much of today's volume growth is driven by the advent of the web and other platforms and also by the fact that customers have many choices as to how to source and buy their imagery.

2 - Images are being used differently. The eyeballs of the world are increasingly on digital devices of all types. We also need to recognize that the volume and the value of images on the web and other digital devices are significantly different from similar images in print.

3 - The third trend that applies to all industries, but is very significant to us, is that customers have much more power than ever before and they will demand still more in the future. We are living in the age of co-creation. The digital revolution has shifted information as well as some content creation to customers. Once this occurs there is an inextricable and irreversible shift of power toward customers.

4 - Fourth trend is that regionalization is becoming increasing more important than centralization.

Rights Ready Benefit

RM units were up 4% from Q3 2005, but down 3% from the previous quarter. This seems to indicate that the Rights Ready pricing model has not raised units licensed or revenue. The average price per unit licensed dropped 5% from $577 to $546 in the year. Klein notes that the average price of RM is really not a very good indicator because it is related to mix of editorial and commercial/advertising sales. What these figures seem to be telling us is that the volume of RM sales for low priced editorial use is going up while the volume of advertising sales is down proportionally. The combined total is down in terms of dollars and units from the previous quarter.

It is interesting to compare Corbis' results in RM average price for the first six months of 2006 with that of Getty. Corbis average went from $248 to $271, up 9%, while Getty's went from $578 to $546, down 5%. Granted I'm comparing two quarters with three quarters, but the trends are what is significant. I believe what is happening is that Corbis, which has always had very strong sales to the editorial segment of the market, is now making more inroads into the higher priced advertising market segment. Getty, on the other hand, which has always had very strong sales into the high priced advertising market is finding that the only way to sell more units is do a better job of penetrating the editorial segment of the market. Since the editorial units are being licensed at a lower price point their average return per image is going down.

Getty is focused on adding volume and Klein has said that pricing is not the issue. However, if all of Getty's increased volume comes on the lower priced side of the business average return per image and gross RM revenue could continue to drop unless there is very significant increased volume.

Getty may finally be recognizing that the print advertising market has reached a peak and that the editorial side of the business is the principle growth area. This may be why Klein is talking about making it easier for photographers to submit images because he realizes that the company doesn't have a large segment of the types of imagery customers want to buy.

Other Information Of Note

Klein said that the Rights Ready model has been received enthusiastically by the customers and that the industry could expect Getty Images to introduce two new licensing models in 2007, but he would not explain in any detail the proposed models.

One stock analyst predicted that future revenue growth at Getty may now be more in the 4% to 7% range of overall media spend than the higher growths GYI has seen in previous years.

Royalty Share

Almost the entire "Cost of Revenue" for the company is royalties paid out to image suppliers. Recently Getty decided to report this cost of revenue as a percentage of total revenue for each line of business. Below I have broken these percentages down into real numbers in millions and also provided an average total royalty in percent.

Photographers should recognize that in some cases this percentage is being paid out to a third party provider and the amount the photographer receives will actually be much lower, minus that 3rd party partner's share. Also, some of the money that Getty reports comes from distributors and delegates. In those cases the distributors has taken a share of the gross sales off the top and the figure Getty reports is not the gross paid by the customer to use the image.

This quarter the percentage of total revenue paid out by Getty in royalties was 25%, up from 24% in the previous quarter.

SG&A

Selling, general and administrative expenses (SG&A) were $73.6 million compared to $63.3 million in the third quarter of 2005. Excluding stock-based compensation of $4.2 million in the third quarter of 2006 and $0.3 million in the third quarter of 2005, SG&A was 35.0 percent of revenue in the third quarter of 2006 compared to 34.1 percent in the prior year and declined by $4.6 million compared to the second quarter of 2006.

Geographic Breakdown

The percentage of revenue for all regions remained relatively flat during the quarter compared with the previous quarter.