Getty Third Quarter 2005

67

October 24, 2005

Getty Images reported revenue for Q3 of 2005 of $184.5 million compared to $153.5 million for Q3 of 2004 and $185.3 million in the previous quarter. Excluding the effects of changes in currency exchange rates, revenue grew 19.9 percent. Approximately 6% of the growth was attributable to the Digital Vision and Photonica acquisitions that closed in the previous quarter.

Operating income for the third quarter of 2005 grew 40.8 percent to $58.7 million, or 31.8 percent of revenue, compared to $41.7 million, or 27.2 percent of revenue in the same quarter last year.

Net income for the third quarter was $39.1 million, or $0.60 per diluted share compared to $26.7 million, or $0.44 per diluted share the prior year.

Cash and short-term investment balances increased to $451.6 million at September 30, 2005, from $418.8 million at June 30, 2005. For the first nine months of 2005, net cash provided by operating activities was $181.3 million compared to $128.8 million in the first nine months of 2004.

Business Outlook

For the fourth quarter of 2005 the company expects to report revenue in the range of $187 million to $191 million and earnings per diluted share of $0.60 to $0.62. For all of 2005 the company has increased guidance and expects revenue in the range of $735 million to $739 million and earnings per diluted share of $2.24 to $2.27, respectively. The number of fully diluted shares assumed in the earnings per share guidance is approximately 66 million for the fourth quarter and 65 million for the full year.

Revenue Breakdown

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 CD's, DVD's and Subscription sales. The numbers in this column reflect total revenue for single image sales. The number of people buying CD's and Virtual CD's compared to single images made a jump upward this quarter to 12.7% of revenue after having steadily declined over the last six quarters. There are two things that could have brought about this change. First, included in this percentage figure is Subscription licensing that was launched in late August of this year. In the future all subscription revenue will be included as part of this percentage number. Getty also launched a major direct marketing campaign at the end of Q2 to try to increase CD and Virtual CD sales and this certainly had some effect.

**** 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

Medio Images and Rubberball

In the quarter Getty Images acquired full rights to the images belonging to two of its Image Partners. The company obtained approximately 35,000 images from Medio Images, a company specializing in images of Latino lifestyle and travel categories. Less than one-third of these images were on the Getty Images site prior to acquisition. They also acquired approximately 15,000 images from Rubberball. In both cases these companies generated revenue, not only from Getty Images, but from over 100 other distributors around the world and Getty Images will now benefit from that revenue stream.

In the case of Medio Images, Getty purchased the company name as well as the images. It is believed that the owners of Medio Images will launch a new brand with newly created images in the near future. The owners of Rubberball retained their brand name and will continue to produce wholly owned images, but are also looking for quality work from other photographers that their company can represent. Rubberball expects to add about 1,000 images a month to its collection.

The acquisition prices were not revealed, but sources in the industry believe Getty paid $9 million, or approximately $600 per image, for the Rubberball images. It is also believed that Medio received approximately the same price per image for the images it sold. In both cases all the images were wholly owned. CEO Jonathan Klein told analysts that they could "expect to see many more of these image acquisitions. They are financially very attractive, an excellent use of our cash, and they increase our ability to offer high quality, wholly owned imagery on a variety of different platforms," he continued.

The company is also buying collections from individual photographers as well as from companies. And Getty has increased the size this year of its dedicated team that is focused on producing wholly owned images for the company. Klein said, "We are only getting started on a big ramp up of shooting our own imagery."

Removal Of Third Party Suppliers

During the conference call Troy Matsin of William Blair & Company asked if there had been any impact or falloff from the removal of third parties from the site. Klein took the opportunity to give the following explanation of what has happened and what is expected.

"None whatsoever, but I know there have been a number of questions on this issue, so why don't I put a little bit of context around it. . Firstly, we've never distributed content owned or represented by Corbis and they've never had the rights to distribute our content. We've competed with them for 10 years, the notion of distributing each others content has never been on the table and in relation to them nothing has changed," Klein said.

"Jupiter is a relatively new entry into the market. As you know many of the collections that they acquired did have distribution relationships with us. In many cases they relied very heavily on our distribution of their product and under the previous ownership of these companies we were more than comfortable to provide them with a significant percentage of their revenues. Once they were acquired by Jupiter, the situation became directly analogous to the Corbis situation. In other words we have no wish to generate revenue for our competitors and so we no longer distribute these collections."

"In terms of their impact on us, and the replacement of the revenue, remember none of the collections in question are material in the context of Getty Images. And, in fact if you add up the annual run rate of all of them combined it is still immaterial to us. So the revenue contribution from us to those collections and now to their new owners was and is very material, but the other way not. More importantly, the imagery is totally replaceable which is why we have suffered no impact to date and do not expect any more in the future."

"Better still in most cases the imagery we have replaced it with is better and often comes to us at a higher margin. Furthermore, the terminations of these various collections are staggered allowing us to add new collections; so for example we added ten new creative collections in the third quarter."

"So just one final point on this; we're not here to serve our competitors, we exist to serve our customers and our aim is always to make sure that the customer experience is enhanced, that it is better than anywhere else in the industry and is never negatively impacted. WE HAVE MILLIONS OF SEARCHES ON OUR SITE, and let me assure you that CUSTOMERS PRACTICALLY NEVER SEARCH OUR SITE BY COLLECTION OR BRAND. They search by subject, and sometimes by licensing model. We maintain the individual brands of our collections out of respect for our image partners to highlight the depth and breadth of our offering, and to address the importance of choice to what is a creative community. We know that there will be no customer attrition from dropping these collections, and we know that it will have no negative impact on our revenue," Klein concluded.

Then Matson asked, "Can we extend that into another partnership that you've struck in the last 12 or so months with Adobe. I think there is some talk of them maybe changing their model a little bit to where they may be a little more in competition with you. I'm not sure that has happened yet, but can you give me some thoughts there: 'A' is a meaningful partnership yet and 'B' if they make a move to be a little more competitive with you by maybe working directly with others..."

Klein continued, "I don't think so. I think it is fair to say it is very early in the relationship with Adobe. Just remember what Adobe is doing. They are launching a completely new suite of software products, called Creative Suite 2. Until there is a large installed base of CS2, and until customers get habituated with using it, and until they discover the stock photo component on it, no one should expect serious traction on that site. So Adobe are continuing to promote the distribution of that and what we know and Adobe know is that if it is successful Getty Images will be responsible for the overwhelming majority of the image licenses. That's clear. We're responsible at the moment for the overwhelming majority of the image licenses in our industry and that would be the case on them too. What we hope, and believe, is that the Adobe will be a smart and incremental distribution channel for us for certain of our collections. In many ways I see it as very similar to the many other channels of distribution outlets we use for royalty free. At this point Adobe has shown no interest in having their own content so they will continue to be reliant on content partners. We'll see how it goes."

[It is worth noting here that while there has been no public announcement of the percentage of gross revenue that Adobe is taking from any sales it makes for its partners, it is believed that Adobe will retain about 50%. (Given the importance of its content Getty may be getting a slightly better deal.) Other Royalty Free brands currently represented on Gettys site will have an interesting decision to make in the near future. Currently, it is believed that Getty is keeping 70% to 80% of the net RF revenue it receives. This leaves these 3rd Party brands with 10% to 15% of the gross revenue and in many cases that would have to be split with the photographers who created the imagery. Considering that photographers often get 25% of the net revenue to the RF producing company, the photographer could end up with as little as 2.5% of the Gross license price of the image -- hardly worth the trouble.


However, companies like IPN Relay are offering RF suppliers -- both individual photographers and RF production companies -- 30% of the GROSS fee collected by Adobe. (ImageSource and Masterfile have also been authorized to place images from other providers on Adobe, but as of this writing I have not been able to determine the specifics of their offers.) Thus, it would probably be much to the advantage of RF producers desiring to have their work represented on Adobe to strike deals with IPN Relay, Masterfile or Image Source rather that going through Getty.]

Klein made the point that Getty's acceleration in growth is unconnected with collections coming on or being removed. When collections come off he says they replace them with similar content and thus don't see the loss of any particular content as being an issue. He also pointed out that the collections coming off are staggered and to date very few collections have actually come off. He said, "You shouldn't juxtapose in any way collections coming on or off the site with growth rates. I do, however, believe that it will be impossible for the competitor to replace those revenues very quickly. So it will be meaningful to look at their numbers in terms of how they're doing without the Getty Images distribution rather than the other way around."

Print Advertising Usage

Klein pointed out that the Publishers Information Bureau reports that for the first 9 months of 2005 advertising pages in magazines are down 1% compared to the previous year. He said this metric is less interesting than it has been historically because Getty Images is now doing more and more business outside the magazine and advertising segment. The key uses of creative imagery during the quarter were for internal company uses, editorial, publishing and web site uses.

Use Of Images On The Internet

One question that keeps coming up is the portion of revenue that comes from the licensing of usages for the Internet and web sites. CFO Liz Huebner pointed out that about 10% of the RM business (almost $8 million for the quarter) is being sold for web use and this is up from about 5% a year ago. Klein said, "We don't know how Royalty Free images are used, but when we look at Rights Managed imagery, that may be a proxy for RF."

"Our revenues and volumes licensing RM images to web sites are exploding so by the nature of RF imagery it is not unreasonable to suggest that the same categories would be up for RF usage, and in fact in the web based category even more so. So we know with web applications continuing to accelerate in RM and presumably even more so in RF, that's a very positive trend," he continued.

Collecting On Unauthorized Use

Another trend to increase revenue is to use PicScout to locate unauthorized uses. Klein acknowledged that the degree of unauthorized usage is significantly larger than the company had thought. People had thought it was confined to small customers and to China, but with the new technology they have discovered that there is a reasonably high incidence among big customers and here in the United States. Sometimes it is inadvertent. So far this year they have collected more than $2 million from unauthorized usage. The Getty strategy for collection is not to sue, but to point out the infringement and in that way get some money and also develop a better relationship with the customer. Klein saidy, "There is a lot of extra revenue there and we are just beginning to pick it up."

Gross Margins

CFO Liz Huebner said the increase in gross margin resulted from no longer incurring royalty payments to Digital Vision and she expects the margin will continue to rise in the Q4 as the positive effects of the acquisition of Medio Images and Rubberball, and the production of more wholly owned imagery begin to be seen.

SG&A

Selling, general & administrative expenses (SG&A) totaled $63.3 million, up from $54.4 million in the second quarter of 2004. This was down slightly from the SG&A in Q2 2005. As a percentage of revenue, SG&A declined to 34.3 percent in the third quarter of 2005, compared to 35.6 percent in the same quarter last year.

Geographic Breakdown

The revenues from EMEA (Europe, the Middle East and Africa) were strongly up in the quarter resulting in a continued downward trend in the percent of overall revenue coming from the Americas.