Shutterstock, Inc.: Form 10-Q for the period ended Sep 30, 2023

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our interim unaudited consolidated financial statements and related notes contained elsewhere in this Quarterly Report on Form 10-Q and with information contained in our other filings, including the audited consolidated financial statements included in our 2022 Form 10-K.

In addition to historical consolidated financial information, this discussion contains forward-looking statements including statements about our plans, estimates and beliefs. These statements involve risks and uncertainties and our actual results could differ materially from those expressed or implied in forward-looking statements. See “Forward Looking Statements” above. See also the “Risk Factors” disclosures contained in our 2022 Form 10-K for additional discussion of the risks and uncertainties that could cause our actual results to differ materially from those expressed or implied in our forward-looking statements.

Overview and Recent Developments

Shutterstock, Inc. (referred to herein as the “Company”, “we,” “our,” and “us”) is a leading global creative platform offering high-quality content and full-service creative workflow solutions for transformative brands, digital media and marketing companies. In addition, Shutterstock also licenses the metadata associated with images, footage clips, music tracks and 3D models.

Our platform brings together users and contributors of content by providing readily-searchable content that our customers pay to license and by compensating contributors as their content is licensed. Contributors upload their content to our web properties in exchange for royalty payments based on customer download activity. Beyond content, customers also leverage the Company’s platform to assist with the entire creative process from ideation through creative execution.

Our key content offerings include:

• Images - consisting of photographs, vectors and illustrations. Images are typically used in visual communications, such as websites, digital and print marketing materials, corporate communications, books, publications and other similar uses.
• Footage - consisting of video clips, premium footage filmed by industry experts and cinema grade video effects, available in HD and 4K formats. Footage is often integrated into websites, social media, marketing campaigns and cinematic productions.
• Music - consisting of high-quality music tracks and sound effects, which are often used to complement images and footage.
• 3 Dimensional (“3D”) Models - consisting of 3D models, used in a variety of industries such as advertising, media and video production, gaming, retail, education, design and architecture.
• GIFs - consisting of GIFs (graphics interchange format visuals) that serve as a critical ingredient in text- and message- based conversations and in contextual advertising settings.

Our offerings are distributed to customers under the following brands: Shutterstock; Pond5; Giphy; TurboSquid; Offset; PremiumBeat; Bigstock; PicMonkey; and Splash News.

Shutterstock, our flagship brand, includes various content types such as image, footage, music and editorial. For customers seeking specialized solutions, Shutterstock Studios extends our offerings by providing custom, high-quality content matched with production tools and services at scale.

In addition, we also license the metadata associated with our images, footage clips, music tracks and 3D models through our computer vision data partnerships offering, which is used by large technology companies as training data for their individual generative AI and machine learning needs. During the three and nine months ended September 30, 2023, we have recognized $45.5 million and $79.5 million of revenue associated with our computer vision data partnerships offering.

Pond5 is a video-first content marketplace which expands the Company’s content offerings across footage, image and music. PicMonkey is a leading online graphic design and image editing platform. TurboSquid operates a marketplace that offers more than one million 3D models and a 2 dimensional (“2D”) marketplace derived from 3D objects. Our Offset brand provides authentic and exceptional content for high-impact use cases that require extraordinary images, featuring work from top assignment photographers and illustrators from around the world. PremiumBeat offers exclusive high-quality music tracks and provides producers, filmmakers and marketers the ability to search handpicked production music from the world’s leading composers. Bigstock maintains a separate content library tailored for creators seeking to incorporate cost-effective imagery into their projects.

Over 2.1 million active, paying customers contributed to our revenue for the twelve-month period ended September 30, 2023. Our library has grown to more than 757 million images and more than 52 million footage clips as of September 30, 2023. This makes our collection of content one of the largest of its kind, and we delivered 117.6 million paid downloads to our customers across all of our brands during the nine months ended September 30, 2023.

Contributors of content typically earn a royalty each time their work is licensed. Contributors earn royalties based on our published earnings schedule that is based on annual licensing volume, which determines the contributor’s earnings tier and the purchase option under which the content was licensed. Royalties represent the largest component of our operating expenses, are reported within cost of revenue, tend to fluctuate proportionately with revenue and paid downloads and may be impacted by the mix of products sold.

Through our platform, we generate revenue by licensing content to our customers. During the nine months ended September 30, 2023, 51% of our revenue and the majority of our content licenses came from our E-commerce sales channel. The majority of our customers license content directly through our self-service web properties. E-commerce customers have the ability to purchase plans that are paid on either a monthly or annual basis or to license content on a transactional basis. E-commerce customers generally license content under our standard or enhanced licenses, with additional licensing options available to meet customers’ individual needs.

Customers in our Enterprise sales channel generally have unique content, licensing and workflow needs. These customers benefit from communication with our dedicated sales, service and research teams which provide a number of personalized enhancements to their creative workflows including non-standard licensing rights, multi-seat access, ability to pay on credit terms, multi-brand licensing packages, increased indemnification protection and content licensed for use-cases outside of those available on our e-commerce platform. Customers in our enterprise sales channel may also benefit from access to (i) Shutterstock Editorial, which includes our library of editorial images and videos, (ii) Shutterstock Studios, our offering which provides custom, high-quality content matched with production tools and services at scale, and (iii) computer vision, our data partnerships offering which provides metadata associated with our content collection, used to train AI models. Our range of solutions, including the depth of our API platform integrations, appeals to a broad and diverse customer base and enables us to adapt and evolve with the needs of our more high touch clients to deliver capabilities that embed deep within their workflows. Our Enterprise sales channel provided approximately 49% of our revenue for the nine months ended September 30, 2023.

Acquisition of Giphy, Inc.

On May 22, 2023, we entered into a Stock Purchase Agreement with Meta Platforms, Inc. (“Meta”) dated May 22, 2023 (the “Purchase Agreement”). On June 23, 2023, we completed our acquisition of all of the outstanding shares of Giphy, Inc. (“Giphy”) from Meta. The consideration payable, pursuant to the Purchase Agreement, was $53 million in net cash, in addition to cash acquired, assumed debt and other working capital adjustments. The consideration was paid with existing cash on hand. Giphy is a New York-based company that operates a collection of GIFs and stickers that supplies casual conversational content. The Company believes its acquisition of Giphy extends Shutterstock’s audience touchpoints beyond primarily professional marketing and advertising use cases and expands into casual conversations.

In January 2023, the United Kingdom Competition and Markets Authority (the “CMA”) issued its final order requiring Meta to divest its ownership of Giphy, which Meta acquired in 2020. In connection with the closing of the acquisition, whose terms were preapproved by the CMA, Shutterstock and Meta entered into a transitional services agreement (the “TSA”) pursuant to which Meta is responsible for certain costs related to retention of Giphy employees, including (i) recurring salary, bonus, and benefits through August 2024, which would be $35.6 million if all employees are retained through August 2024, and (ii) nonrecurring items, totaling $87.9 million, comprised of one-time employment inducement bonuses and the cash value of unvested Meta equity awards (the “Giphy Retention Compensation”).

The Giphy Retention Compensation will be paid to the individuals for being employees of the Company subsequent to the completion of the acquisition. Accordingly, we determined that the payments are for future service requirements and will be reflected as operating expenses, less any amounts earned by the employees prior to the acquisition, in our Statements of Operations as incurred. The Giphy Retention Compensation is reflected as a reduction of the purchase price and has been funded into an escrow account.

Upon closing of the acquisition, the Company also entered into an agreement with Meta whereby the Company will provide Meta with Giphy content through API services for a period of two years.

Key Operating Metrics

In addition to key financial metrics, we regularly review a number of key operating metrics to evaluate our business, determine the allocation of resources and make decisions regarding business strategies. We believe that these metrics can be useful for understanding the underlying trends in our business.

Subscribers, subscriber revenue and average revenue per customer from acquisitions are included in these metrics beginning twelve months after the closing of the respective business combination. Accordingly, the metrics include Subscribers, Subscriber revenue, and Average revenue per customer from TurboSquid beginning February 2022, from PicMonkey beginning September 2022, and from Pond5 and Splash News beginning May 2023. These metrics exclude the respective counts and revenues from Giphy.

Subscribers

We define subscribers as those customers who purchase one or more of our monthly recurring products for a continuous period of at least three months, measured as of the end of the reporting period. We believe the number of subscribers is an important metric that provides insight into our monthly recurring business. We believe that an increase in our number of subscribers is an indicator of engagement in our platform and potential for future growth.

Subscriber Revenue

We define subscriber revenue as the revenue generated from subscribers during the period. We believe subscriber revenue, together with our number of subscribers, provide insight into the portion of our business driven by our monthly recurring products.

Average Revenue Per Customer

Average revenue per customer is calculated by dividing total revenue for the last twelve-month period by customers. We define customers as total active, paying customers that contributed to total revenue over the last twelve-month period. Changes in our average revenue per customer will be driven by changes in the mix of our subscription-based and transactional products as well as pricing in our transactional business.

Paid Downloads

We define paid downloads as the number of downloads that our customers make in a given period of our content. Paid downloads exclude content related to our Studios business, downloads of content that are offered to customers for no charge (including our free trials), and downloads associated with our computer vision offering. Measuring the number of paid downloads that our customers make in a given period is important because it is a measure of customer engagement on our platform and triggers the recognition of revenue and contributor royalties.

Revenue per Download

We define revenue per download as the amount of revenue recognized in a given period divided by the number of paid downloads in that period excluding revenue from our Studios business, revenue that is not derived from or associated with content licenses and revenue associated with our computer vision offering. This metric captures any changes in our pricing, including changes resulting from the impact of competitive pressures, as well as the mix of licensing options that our customers choose, some of which generate more revenue per download than others, and the impact that changes in foreign currency rates have on our pricing. Changes in revenue per download are primarily driven by the introduction of new product offerings, changes in product and sales channel mix and customer utilization of our products.

Content in our Collection

We define content in our collection as the total number of approved images (photographs, vectors and illustrations) and footage (in number of clips) in our library at the end of the period. We exclude content from this collection metric that is not uploaded directly to our site but is available for license by our customers through an application program interface, content from our Studios business and AI generated content. Prior to December 31, 2022, this metric only included approved images and footage clips in our library on shutterstock.com at the end of the period. We believe that our large selection of high-quality content enables us to attract and retain customers and drives our network effect.

The following table summarizes our key operating metrics, which are unaudited, for the three and nine months ended September 30, 2023 and 2022:

1 Subscribers, Subscriber Revenue and Average Revenue Per Customer from acquisitions are included in these metrics beginning twelve months after the closing of the respective business combination. Accordingly, the metrics include Subscribers, Subscriber revenue, and Average revenue per customer from TurboSquid beginning February 2022, from PicMonkey beginning September 2022, and from Pond5 and Splash News beginning May 2023. These metrics exclude the respective counts and revenues from our acquisition of Giphy.

Critical Accounting Estimates

Our financial statements are prepared in accordance with GAAP. The preparation of the consolidated financial statements in conformity with GAAP requires our management to make a number of estimates and assumptions relating to the reported amounts of assets and liabilities, the disclosure or inclusion of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenue and expenses during the period. We evaluate our significant estimates on an ongoing basis, including, but not limited to, estimates related to allowance for doubtful accounts, the volume of expected unused licenses used in revenue recognition for our subscription-based products, the fair value of acquired goodwill and intangible assets and income tax provisions. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about carrying value of assets and liabilities that are not readily apparent from other sources. Therefore, we consider these to be our critical accounting estimates. Actual results could differ from those estimates.

A description of our critical accounting policies that involve significant management judgments appears in our 2022 Form 10-K, under “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Estimates.”

See Note 1 to our Unaudited Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for a full description of the impact of the adoption of new accounting standards on our financial statements. There have been no material changes to our critical accounting estimates as compared to our critical accounting policies and estimates included in our 2022 Form 10-K.

Key Components of Our Results of Operations

Revenue

We distribute our content offerings through two primary channels:

E-commerce: The majority of our customers license content directly through our self-service web properties. E-commerce customers have the flexibility to purchase a subscription-based plan that is paid on a monthly or annual basis or to license content on a transactional basis. These customers generally license content under our standard or enhanced licenses, with additional licensing options available to meet customers’ individual needs. E-commerce customers typically pay the full amount of the purchase price in advance or at the time of license, generally with a credit card.

Enterprise: We also have a base of customers with unique content, licensing and workflow needs. These customers benefit from communication with our dedicated sales, service and research teams which provide a number of tailored enhancements to their creative workflows including non-standard licensing rights, multi-seat access, ability to pay on credit terms, multi-brand licensing packages, increased indemnification protection and content licensed for use-cases outside of those available on the e-commerce platform.

The Company’s revenues by distribution channel for the three and nine months ended September 30, 2023 and 2022 are as follows (in thousands):

Costs and Expenses

Cost of Revenue. Cost of revenue consists of royalties paid to contributors, credit card processing fees, content review costs, customer service expenses, infrastructure and hosting costs related to maintaining our creative platform and cloud-based software platform, depreciation and amortization of capitalized internal-use software, purchased content and acquisition-related intangible assets, allocated facility costs and other supporting overhead costs. Cost of revenue also includes employee compensation, including non-cash equity-based compensation, bonuses and benefits associated with the maintenance of our creative platform and cloud-based software platform.

Sales and Marketing. Sales and marketing expenses include third-party marketing, advertising, branding, public relations and sales expenses. Sales and marketing expenses also include associated employee compensation, including non-cash equity-based compensation, bonuses and benefits, and commissions as well as allocated facility and other supporting overhead costs.

Product Development. Product development expenses consist of employee compensation, including non-cash equity-based compensation, bonuses and benefits, and expenses related to vendors engaged in product management, design, development and testing of our websites and products. Product development costs also includes software and other IT equipment costs, allocated facility expenses and other supporting overhead costs.

General and Administrative. General and administrative expenses include employee compensation, including non-cash equity-based compensation, bonuses and benefits for executive, finance, accounting, legal, human resources, internal information technology, internet security, business intelligence and other administrative personnel. In addition, general and administrative expenses include outside legal, tax and accounting services, bad debt expense, insurance, facilities costs, other supporting overhead costs and depreciation and amortization expense.

Bargain Purchase Gain. A bargain purchase gain is recognized subsequent to an acquisition, if the fair value of the net assets acquired and liabilities assumed exceeds the net consideration.

Other Income / (Expense), Net. Other income, net consists of non-operating costs such as foreign currency transaction gains and losses in addition to interest income and expense.

Income Taxes. We compute income taxes using the asset and liability method, under which deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted statutory income tax rates in effect for the year in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce net deferred tax assets to the amount expected to be realized.

Results of Operations

The following table presents our results of operations for the periods indicated. The period-to-period comparisons of results are not necessarily indicative of results for future periods.

(in thousands)

The following table presents the components of our results of operations for the periods indicated as a percentage of revenue:

Note: Due to rounding, percentages may not sum to totals.

Comparison of the Three Months Ended September 30, 2023 and 2022

The following table presents our results of operations for the periods indicated (in thousands):

*Not meaningful

Revenue

Revenue increased by $29.2 million, or 14%, to $233.2 million in the three months ended September 30, 2023 compared to the same period in 2022. On a constant currency basis, revenue increased approximately 12% in the three months ended September 30, 2023, compared to the same period in 2022.

The Company’s E-commerce revenues decreased by 15%, to $106.0 million in the three months ended September 30, 2023, compared to the same period in 2022. On a constant currency basis, E-commerce revenues decreased by 16% in the three months ended September 30, 2023, compared to the same period in 2022. The decline in our E-commerce revenues was primarily driven by weakness in new customer acquisition.

The Company’s Enterprise revenues increased by 60%, to $127.2 million in the three months ended September 30, 2023, compared to the same period in 2022. On a constant currency basis, Enterprise revenues increased by 57% in the three months ended September 30, 2023, compared to the same period in 2022. The increase in Enterprise revenues was primarily driven by growth in our computer vision data partnerships which generated $45.5 million and $1.5 million of revenue in the three months ended September 30, 2023 and 2022, respectively.

In the three months ended September 30, 2023 and 2022, we delivered 36.4 million and 42.8 million paid downloads, respectively, and our revenue per download was $4.76 and $4.43 for the three months ended September 30, 2023 and 2022, respectively. During the three months ended September 30, 2023, the decline in paid downloads is attributed to the decline in the E-commerce business.

Changes in our revenue by region were as follows: revenue from North America increased by $34.3 million, or 38%, to $123.3 million, revenue from Europe decreased by $0.7 million, or 1%, to $56.6 million and revenue from outside Europe and North America decreased by $4.4 million, or 8%, to $53.4 million, in the three months ended September 30, 2023 compared to the same period in 2022.

Costs and Expenses

Cost of Revenue. Cost of revenue increased by $14.3 million, or 18% to $94.2 million in the three months ended September 30, 2023 compared to the same period in 2022. This increase was primarily driven by: (i) increased royalty, content and reviewer costs; (ii) higher costs associated with website hosting, hardware and software licenses; (iii) increased depreciation and amortization expense driven by our acquisition of Giphy, and (iv) Giphy employee-related costs comprised of $2.3 million of recurring Giphy Retention Compensation and $0.9 million of non-recurring Giphy Retention Compensation not considered necessary to operate our business. We expect that our cost of revenue will continue to fluctuate in-line with changes in revenue.

Sales and Marketing. Sales and marketing expenses increased by $8.4 million, or 18%, to $56.2 million in the three months ended September 30, 2023 compared to the same period in 2022. As a percent of revenue, sales and marketing expenses increased to 24% for the three months ended September 30, 2023, from 23% for the same period in 2022. This was primarily driven by $4.6 million in higher employee-related costs and sales commission and $1.6 million in higher consulting costs. For the three months ended September 30, 2023, sales and marketing expenses included (i) $1.2 million in severance costs associated with strategic workforce optimizations and (ii) $0.2 million of expense associated with non-recurring Giphy Retention Compensation not considered necessary to operate our business. We expect sales and marketing expenses to continue to fluctuate as we optimize our sales channels and invest in new customer acquisition, products and geographies.

Product Development. Product development expenses increased by $10.6 million, or 60%, to $28.1 million in the three months ended September 30, 2023 compared to the same period in 2022. The increase in product development was primarily driven by Giphy employee-related costs comprised of $2.7 million of recurring Giphy Retention Compensation and $5.6 million of non-recurring Giphy Retention Compensation not considered necessary to operate our business. For the three months ended September 30, 2023, product development expenses included $1.5 million in severance costs associated with strategic workforce optimizations. We expect product development expenses, of which a portion will be capitalized, to continue in the foreseeable future, as we pursue opportunities to invest in developing new products and internal tools and enhance the functionality of our existing products and technologies.

General and Administrative. General and administrative expenses increased by $7.4 million, or 24%, to $37.6 million in the three months ended September 30, 2023 compared to the same period in 2022. This increase was driven by (i) $2.6 million in higher non-cash equity-based compensation expense; (ii) $0.9 million of recurring Giphy Retention Compensation and (iii) $1.4 million of non-recurring Giphy Retention Compensation not considered necessary to operate our business. For the three months ended September 30, 2023, general and administrative expenses included $2.1 million in severance costs associated with strategic workforce optimizations.

Bargain Purchase Gain. In the three months ended September 30, 2023, we increased our Giphy acquisition bargain purchase gain by $9.9 million associated with updates to deferred income tax balances recorded in the Giphy opening balance sheet.

Other Income / (Expense), Net. In the three months ended September 30, 2023, other income / (expense), net substantially consisted of $1.9 million of interest income, partially offset by $0.8 million of unfavorable unrealized foreign currency fluctuations and $0.6 million of interest expense related to our credit facility. During the three months ended September 30, 2022, other income / (expense), net substantially consisted of $1.1 million of unfavorable unrealized foreign currency fluctuations. As we increase the volume of business transacted in foreign currencies resulting from international expansion and as currency rates fluctuate, we expect foreign currency gains and losses to continue to fluctuate.

Income Taxes. Income tax expense decreased by $4.9 million for the three months ended September 30, 2023, compared to the same period in 2022. Our effective tax rates were 2.9% and 15.1% for the three months ended September 30, 2023 and 2022, respectively.

For the three months ended September 30, 2023, the net effect of discrete items decreased the effective tax rate by 14.9%. The discrete items for the three months ended September 30, 2023, primarily relate to the effect of the U.S. Research and Development (“R&D”) tax credit claimed on the Company’s 2022 tax return, which was substantially completed in the third quarter of 2023. Excluding discrete items, our effective tax rate would have been 12.0% for the three months ended September 30, 2023.

For the three months ended September 30, 2022, the effective tax rate decreased by 3.3% related primarily to the effect of the U.S. Research and Development (“R&D”) tax credit claimed on the Company’s 2021 tax return, which was substantially completed in the third quarter of 2022. Excluding discrete items, our effective tax rate would have been 18.4% for the three months ended September 30, 2022.

As we continue to expand our operations outside of the United States, we have been and may continue to become subject to taxation in additional non-U.S. jurisdictions and our effective tax rate could fluctuate accordingly.

Comparison of the Nine Months Ended September 30, 2023 and 2022

The following table presents our results of operations for the periods indicated:

(in thousands)

*Not meaningful

Revenue

Revenue increased by $47.3 million, or 8%, to $657.4 million in the nine months ended September 30, 2023 compared to the same period in 2022. Foreign currency fluctuations did not have a significant impact on the Company’s revenues in the nine months ended September 30, 2023.

The Company’s E-commerce revenues decreased by 11%, to $337.7 million in the nine months ended September 30, 2023, compared to the same period in 2022. Foreign currency fluctuations did not have a significant impact on the Company’s E-commerce revenues in the nine months ended September 30, 2023. The decline in our E-commerce revenues was driven by weakness in new customer acquisition, partially offset by revenues generated from our acquisition of Pond5, which was completed on May 11, 2022.

The Company’s Enterprise revenues increased by 38%, to $319.7 million in the nine months ended September 30, 2023, compared to the same period in 2022. Foreign currency fluctuations did not have a significant impact on the Company’s Enterprise revenues in the nine months ended September 30, 2023. The increase in Enterprise revenues was primarily driven by (i) growth in our computer vision data partnerships, which generated $79.5 million and $4.4 million of revenue in the nine months ended September 30, 2023 and 2022, respectively; and (ii) revenue generated from our acquisitions of Pond5 and Splash News, which were completed on May 11, 2022 and May 28, 2022, respectively.

In the nine months ended September 30, 2023 and 2022, we delivered 117.6 million and 130.8 million paid downloads, respectively, and our revenue per download was $4.63 and $4.37 for the nine months ended September 30, 2023 and 2022, respectively. During the nine months ended September 30, 2023, the decline in paid downloads is attributed to the decline in the E-commerce business.

Changes in our revenue by region were as follows: revenue from North America increased by $63.8 million, or 25%, to $318.7 million, revenue from Europe decreased by $8.8 million, or 5%, to $174.0 million and revenue from outside Europe and North America decreased by $7.7 million, to $164.7 million, in the nine months ended September 30, 2023 compared to the same period in 2022.

Costs and Expenses

Cost of Revenue. Cost of revenue increased by $30.4 million, or 13%, to $256.8 million in the nine months ended September 30, 2023 compared to the same period in 2022. This increase was primarily driven by: (i) increased depreciation and amortization expense driven by our recent acquisitions; (ii) increased royalty, content and reviewer costs; (iii) higher costs associated with website hosting, hardware and software licenses; and (iv) Giphy employee-related costs comprised of $2.5 million of recurring Giphy Retention Compensation and $3.6 million of non-recurring Giphy Retention Compensation not considered necessary to operate our business. We expect that our cost of revenue will continue to fluctuate in line with changes in revenue.

Sales and Marketing. Sales and marketing expenses decreased by $3.3 million, or 2%, to $152.1 million in the nine months ended September 30, 2023 compared to the same period in 2022. As a percent of revenue, sales and marketing expenses decreased to 23% for the nine months ended September 30, 2023, from 25% for the same period in 2022. This was primarily driven by (i) $13.4 million in decreased performance marketing spend and (ii) $0.9 million in lower occupancy costs. These decreases were partially offset by (i) $5.5 million in higher employee-related costs and sales commissions, (ii) $1.1 million in higher non-cash equity-based compensation expense; and (iii) Giphy employee-related costs comprised of $0.6 million of recurring Giphy Retention Compensation and $0.8 million of non-recurring Giphy Retention Compensation not considered necessary to operate our business. For the nine months ended September 30, 2023, sales and marketing expenses included $1.2 million in severance costs associated with strategic workforce optimizations. We expect sales and marketing expenses to continue to fluctuate as we optimize our sales channels and invest in new customer acquisition, products and geographies.

Product Development. Product development expenses increased by $24.4 million, or 50%, to $72.7 million in the nine months ended September 30, 2023 as compared to the same period in 2022. This increase in product development was primarily driven by (i) Giphy employee-related costs comprised of $2.8 million of recurring Giphy Retention Compensation, net of capitalized labor and $16.7 million of non-recurring Giphy Retention Compensation not considered necessary to operate our business, (ii) $2.9 million in higher non-cash equity-based compensation expense for the nine months ended September 30, 2023 compared to the same period in 2022, and (iii) $1.5 million of severance costs associated with strategic workforce optimizations. We expect product development expenses, of which a portion will be capitalized, to continue in the foreseeable future, as we pursue opportunities to invest in developing new products and internal tools and enhance the functionality of our existing products and technologies.

General and Administrative. General and administrative expenses increased by $15.4 million, or 16%, to $109.5 million in the nine months ended September 30, 2023 compared to the same period in 2022. This increase was driven by (i) $8.4 million in higher non-cash equity-based compensation expense for the nine months ended September 30, 2023 compared to the same period in 2022; (ii) Giphy employee-related costs comprised of $1.0 million of recurring Giphy Retention Compensation, net of capitalized labor and $4.3 million of non-recurring Giphy Retention Compensation not considered necessary to operate our business, and (iii) $3.9 million of severance costs associated with strategic workforce optimizations. These increases are partially offset by $1.1 million in lower occupancy costs and $0.9 million in lower professional fees. For the nine months ended September 30, 2023 and 2022, general and administrative expenses included $3.0 million and $3.9 million in transaction costs related to the Giphy and Pond5 acquisitions, respectively.

Bargain Purchase Gain. In the nine months ended September 30, 2023, we recognized a bargain purchase gain of $51.8 million related to the acquisition of Giphy, which represents the excess of the fair value of the net assets acquired in addition to the net negative purchase price.

Other Income / (Expense), Net. During the nine months ended September 30, 2023, other income, net substantially consisted of $2.7 million of interest income and $0.9 million of favorable unrealized foreign currency fluctuations, partially offset by $1.3 million of interest expense related to our credit facility. During the nine months ended September 30, 2022 other expense, net consisted of $2.9 million unfavorable unrealized foreign currency fluctuations. As we increase the volume of business transacted in foreign currencies resulting from international expansion and as currency rates fluctuate, we expect foreign currency gains and losses to continue to fluctuate.

Income Taxes. Income tax expense decreased by $4.3 million for the nine months ended September 30, 2023 as compared to the same period in 2022. Our effective tax rates for the nine months ended September 30, 2023 and 2022 were 7.6% and 16.3%, respectively.

For the nine months ended September 30, 2023, the net effect of discrete items decreased the effective tax rate by 8.9%. The discrete items for the nine months ended September 30, 2023, primarily relate to the non-taxable bargain purchase gain associated with the acquisition of Giphy and the effect of the U.S. Research and Development (“R&D”) tax credit claimed on the Company’s 2022 tax return, which was substantially completed in the third quarter of 2023. Excluding discrete items, our effective tax rate would have been 16.5% for the nine months ended September 30, 2023.

For the nine months ended September 30, 2022, the effective tax rate decreased by 2.5% related primarily to windfall tax benefits associated with equity-based compensation, as well as the effect of the R&D tax credit and the FDII deduction claimed on the Company’s 2021 tax return, which was substantially completed in the third quarter of 2022. Excluding discrete items, our effective tax rate would have been 18.8% for the nine months ended September 30, 2022.

As we continue to expand our operations outside of the United States, we have been and may continue to become subject to taxation in additional non-U.S. jurisdictions, and our effective tax rate could fluctuate accordingly.

Quarterly Trends

Our operating results may fluctuate from quarter to quarter as a result of a variety of factors, including the effects of some seasonal trends in customer behavior, timing of acquisitions and the timing of revenue recognition associated with computer vision data partnerships. For example, we expect that certain customers’ usage may decrease at times during the third quarter of each calendar year due to the summer vacation season and may increase at times during the fourth quarter of each calendar year as demand is generally higher to support marketing campaigns in advance of the fourth quarter holiday season. While we believe seasonal trends have affected and will continue to affect our quarterly results, our growth trajectory may have overshadowed these effects to date.

In addition, expenditures on content by customers tend to be discretionary in nature, reflecting overall economic conditions, the economic prospects of specific industries, budgeting constraints, buying patterns and a variety of other factors, many of which are outside our control. As a result of these and other factors, the results of any prior quarterly or annual periods should not be relied upon as indicators of our future operating performance.

Liquidity and Capital Resources

As of September 30, 2023, we had cash and cash equivalents totaling $75.2 million which consisted primarily of bank balances. Since inception, we have financed our operations primarily through cash flows generated from operations. In addition, if necessary, we have the ability to draw on our credit facility, which was obtained on May 6, 2022.

Historically, our principal uses of cash have included funding our operations, capital expenditures, content acquisitions, business combinations and asset acquisitions that enhance our strategic position, cash dividend payments and share purchases under our share repurchase programs. We plan to finance our operations, capital expenditures and corporate actions largely through cash generated by our operations and our credit facility. Since our results of operations are sensitive to the level of competition we face, increased competition could adversely affect our liquidity and capital resources.

Dividends

We declared and paid cash dividends of $0.81 per share of common stock, or $29.0 million during the nine months ended September 30, 2023.

On October 23, 2023, our Board of Directors declared a quarterly cash dividend of $0.27 per share of outstanding common stock payable on December 14, 2023 to stockholders of record at the close of business on November 30, 2023. Future declarations of dividends are subject to the final determination of our Board of Directors, and will depend on, among other things, our future financial condition, results of operations, capital requirements, capital expenditure requirements, contractual restrictions, anticipated cash needs, business prospects, provisions of applicable law and other factors our Board of Directors may deem relevant.

Share Repurchase Program

In October 2015, our Board of Directors approved a share repurchase program (the “2015 Share Repurchase Program”), authorizing us to repurchase up to $100 million of our common stock and, in February 2017, our Board of Directors approved an increase to the share repurchase program, authorizing us to repurchase up to an additional $100 million of our outstanding common stock. As of December 31, 2022, we have fully utilized our authorization for repurchases under the 2015 Share Repurchase Program.

In June 2023, our Board of Directors approved a share repurchase program (the “2023 Share Repurchase Program”), providing authorization to repurchase up to $100 million of our common stock.

We expect to fund future repurchases, if any, through a combination of cash on hand, cash generated by operations and future financing transactions, if appropriate. Accordingly, our share repurchase program is subject to us having available cash to fund repurchases. Under the share repurchase program, management is authorized to purchase shares of our common stock from time to time through open market purchases or privately negotiated transactions at prevailing prices as permitted by securities laws and other legal requirements, and subject to market conditions and other factors.

During the nine months ended September 30, 2023, we repurchased approximately 431,400 shares of our common stock at an average cost of $44.06. As of September 30, 2023, we had $81 million of remaining authorization for repurchases under the 2023 Share Repurchase Program.

Revolving Credit Facility

On May 6, 2022, we entered into a five-year $100 million unsecured revolving loan facility (the “Credit Facility”) with Bank of America, N.A., as Administrative Agent and other lenders. The Credit Facility includes a letter of credit sub-facility and a swingline facility and it also permits, subject to the satisfaction of certain conditions, up to $100 million of additional revolving loan commitments with the consent of the Administrative Agent.

At our option, revolving loans accrue interest at a per annum rate based on either (i) the base rate plus a margin ranging from 0.125% to 0.500%, determined based on the Company’s consolidated leverage ratio or (ii) the Term Secured Overnight Financing Rate (“SOFR”) (for interest periods of 1, 3 or 6 months) plus a margin ranging from 1.125% to 1.5%, determined based on our consolidated leverage ratio. We are also required to pay an unused commitment fee ranging from 0.150% to 0.225%, determined based on the Company’s consolidated leverage ratio. In connection with the execution of this agreement, we paid debt issuance costs of approximately $0.6 million.

As of September 30, 2023 and December 31, 2022, we had $30 million and $50 million, respectively, of outstanding borrowings under the Credit Facility. As of September 30, 2023, we had a remaining borrowing capacity of $67 million, net of standby letters of credit. For the three and nine months ended September 30, 2023, cash interest paid was not significant.

The Credit Facility contains financial covenants and requirements restricting certain of our activities, which are usual and customary for this type of loan. We are also required to maintain compliance with a consolidated leverage ratio and a consolidated interest coverage ratio, in each case, determined in accordance with the terms of the Credit Facility. As of September 30, 2023, we are in compliance with these covenants.

Sources and Uses of Funds

We believe, based on our current operating plan, that our cash and cash equivalents, and cash from operations, will be sufficient to meet our anticipated cash needs for at least the next 12 months. Our longer-term liquidity is contingent upon future operating performance. Future capital expenditures will generally relate to building enhancements to the functionality of our current platform, the acquisition of additional storage, servers, network connectivity hardware, security apparatus and software, leasehold improvements and furniture and fixtures related to office expansion and relocation, content and general corporate infrastructure.

As of September 30, 2023, we had approximately $76 million in unconditional cash obligations, consisting primarily of purchase obligations related to contracts for cloud-based services, infrastructure and other business services as well as minimum royalty guarantees in connection with certain content licenses, of which the majority is due to be paid within the next two years. In addition, as of September 30, 2023, we had approximately $48 million in operating lease obligations with lease payments extending through 2029.

See Note 14 to our Unaudited Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for information regarding our existing capital commitments as of September 30, 2023.

Cash Flows

The following table summarizes our cash flow data for the nine months ended September 30, 2023 and 2022 (in thousands):

Operating Activities

Our primary source of cash from operating activities is cash collections from our customers. The majority of our revenue is generated from credit card transactions and is typically settled within one to five business days. Our primary uses of cash for operating activities are for the payment of royalties to content contributors, employee-related expenditures and the payment of other operating expenses incurred in the ordinary course of business.

Net cash provided by operating activities was $106.6 million for the nine months ended September 30, 2023, compared to $97.3 million for the nine months ended September 30, 2022. In the nine months ended September 30, 2023, operating cash flows were favorably impacted from changes in the timing of cash collections from our computer vision customers and payments pertaining to operating expenses, which can cause operating cash flow to fluctuate from period to period.

In addition, operating cash flows for the nine months ended September 30, 2023 were unfavorably impacted by the recurring and non-recurring payments made to the Giphy workforce, the reimbursement of which is reflected in Investing Activities on the Statement of Cash Flows. Operating cash flows for the nine months ended September 30, 2022 were unfavorably impacted by several large accounts payables and accrued expense items from 2021 that were paid in 2022.

Investing Activities

Cash used in investing activities for the nine months ended September 30, 2023 was $61.9 million, consisting primarily of (i) $53.7 million used in the acquisition of Giphy, net of cash acquired, (ii) capital expenditures of $34.7 million for internal-use software and website development costs and purchases of software and equipment, and (iii) $9.7 million paid to acquire the rights to distribute certain digital content into perpetuity. These cash outflows were partially offset by (i) $34.7 million of Giphy Retention Compensation, as reimbursed by the Giphy seller.

Cash used in investing activities in the nine months ended September 30, 2022 was $257.9 million, consisting primarily of (i) $211.8 million used in the acquisitions of Pond5 and Splash News, net of cash acquired, (ii) capital expenditures of $32.9 million for internal-use software and website development costs and purchases of software and equipment, and (iii) $11.2 million paid to acquire the rights to distribute certain digital content in perpetuity.

Financing Activities

Cash used in financing activities in the nine months ended September 30, 2023 was $83.2 million, consisting of (i) $50.0 million used for the repayment of our Credit Facility; (ii) $29.0 million, related to the payment of the quarterly cash dividend, (iii) $19.0 million used in connection with the repurchase of common stock under our 2023 Share Repurchase Program and (iv) $15.2 million paid in settlement of tax withholding obligations related to employee stock-based compensation awards. These amounts were partially offset by $30.0 million proceeds received from our Credit Facility.

Cash used in financing activities in the nine months ended September 30, 2022 was $70.3 million, consisting of (i) $73.5 million in connection with the repurchase of common stock under our share repurchase program; (ii) $26.0 million related to the payment of the quarterly cash dividend; and (iii) $22.0 million paid in settlement of tax withholding obligations related to employee stock-based compensation awards. These amounts were partially offset by $50.0 million proceeds received from our Credit Facility.

Non-GAAP Financial Measures

To supplement our consolidated financial statements presented in accordance with the accounting principles generally accepted in the United States, or GAAP, our management considers certain financial measures that are not prepared in accordance with GAAP, collectively referred to as non-GAAP financial measures, including adjusted EBITDA, adjusted EBITDA margin, adjusted net income, adjusted net income per diluted common share, revenue growth (including by distribution channel) on a constant currency basis (expressed as a percentage), and free cash flow. These non-GAAP financial measures are included solely to provide investors with additional information regarding our financial results and are not based on any standardized methodology prescribed by GAAP and are not necessarily comparable to similarly-titled measures presented by other companies.

These non-GAAP financial measures have not been calculated in accordance with GAAP, should be considered only in addition to results prepared in accordance with GAAP and should not be considered as a substitute for, or superior to, GAAP measures. In addition, adjusted EBITDA, adjusted EBITDA margin, adjusted net income, adjusted net income per diluted common share, revenue growth (including by distribution channel) on a constant currency basis (expressed as a percentage) and free cash flow should not be construed as indicators of our operating performance, liquidity or cash flows generated by operating, investing and financing activities, as there may be significant factors or trends that they fail to address. We caution investors that non-GAAP financial information, by its nature, departs from traditional accounting conventions; accordingly, its use can make it difficult to compare our current results with our results from other reporting periods and with the results of other companies.

Our management uses these non-GAAP financial measures, in conjunction with GAAP financial measures, as an integral part of managing the business and to, among other things: (i) monitor and evaluate the performance of our business operations, financial performance and overall liquidity; (ii) facilitate management’s internal comparisons of the historical operating performance of its business operations; (iii) facilitate management’s external comparisons of the results of its overall business to the historical operating performance of other companies that may have different capital structures and debt levels; (iv) review and assess the operating performance of our management team and, together with other operational objectives, as a measure in evaluating employee compensation and bonuses; (v) analyze and evaluate financial and strategic planning decisions regarding future operating investments; and (vi) plan for and prepare future annual operating budgets and determine appropriate levels of operating investments.

Management believes that adjusted EBITDA, adjusted EBITDA margin, adjusted net income, adjusted net income per diluted common share, revenue growth (including by distribution channel) on a constant currency basis (expressed as a percentage) and free cash flow are useful to investors because these measures enable investors to analyze our operating results on the same basis as that used by management. Additionally, management believes that adjusted EBITDA, adjusted EBITDA margin, adjusted net income and adjusted net income per diluted common share provide useful information to investors about the performance of the Company’s overall business because such measures eliminate the effects of unusual or other infrequent charges that are not directly attributable to our underlying operating performance. Management believes that revenue growth (including by distribution channel) on a constant currency basis (expressed as a percentage) provides useful information to investors by eliminating the effect of foreign currency fluctuations that are not directly attributable to our operating performance. Management also believes that providing these non-GAAP financial measures enhances the comparability for investors in assessing our financial reporting. Management believes that free cash flow is useful for investors because it provides them with an important perspective on the cash available for strategic measures, after making necessary capital investments in property and equipment to support the Company’s ongoing business operations and provides them with the same measures that management uses as the basis for making resource allocation decisions.

Our use of non-GAAP financial measures has limitations as an analytical tool, and these measures should not be considered in isolation or as a substitute for an analysis of our results as reported under GAAP, as the excluded items may have significant effects on our operating results and financial condition. Additionally, our methods for measuring non-GAAP financial measures may differ from other companies’ similarly titled measures. When evaluating our performance, these non-GAAP financial measures should be considered in addition to other financial performance measures, including various cash flow metrics, net income and our other GAAP results.

Our method for calculating adjusted EBITDA, adjusted EBITDA margin, adjusted net income, adjusted net income per diluted common share, revenue growth (including by distribution channel) on a constant currency basis (expressed as a percentage) and free cash flow, as well as a reconciliation of the differences between adjusted EBITDA, adjusted net income, revenue growth (including by distribution channel) on a constant currency basis (expressed as a percentage) and free cash flow, and the most comparable financial measures calculated and presented in accordance with GAAP, are presented below.

The expense associated with the Giphy Retention Compensation related to (i) the one-time employment inducement bonuses and (ii) the vesting of the cash value of unvested Meta equity awards held by the employees prior to closing, which are reflected in operating expenses (together, the “Giphy Retention Compensation Expense - non-recurring”), are required payments in accordance with the terms of the acquisition. Meta’s sale of Giphy was directed by the CMA and accordingly, the terms of the acquisition were subject to CMA preapproval. Management considers the operating expense associated with these required payments to be unusual and non-recurring in nature. The Giphy Retention Compensation Expense - non-recurring is not considered ongoing expense necessary to operate the Company’s business. Therefore, such expenses have been included in the below adjustments for calculating adjusted EBITDA, adjusted EBITDA margin, adjusted net income and adjusted net income per diluted common share. For the three and nine months ended September 30, 2023, the Company also incurred $6.5 million and $7.0 million, respectively, of Giphy Retention Compensation expense related to recurring employee costs, which is included in operating expenses, and are not included in the below adjustments for calculating adjusted EBITDA, adjusted EBITDA margin, adjusted net income and adjusted net income per diluted common share.

Adjusted EBITDA and Adjusted EBITDA Margin

We define adjusted EBITDA as net income adjusted for depreciation and amortization, non-cash equity-based compensation, bargain purchase gain related to the acquisition of Giphy, Giphy Retention Compensation Expense - non-recurring, foreign currency transaction gains and losses, severance costs associated with strategic workforce optimizations, interest income and expense and income taxes. We define adjusted EBITDA margin as the ratio of adjusted EBITDA to revenue.

The following is a reconciliation of net income to adjusted EBITDA for each of the periods indicated (in thousands):

(1) Other adjustments, net includes unrealized foreign currency transaction gains and losses, severance associated with strategic workforce optimizations and interest income and expense.

Adjusted Net Income and Adjusted Net Income Per Diluted Common Share

We define adjusted net income as net income adjusted for the impact of non-cash equity-based compensation, the amortization of acquisition-related intangible assets, bargain purchase gain related to the acquisition of Giphy, Giphy Retention Compensation Expense - non-recurring, severance costs associated with strategic workforce optimizations and the estimated tax impact of such adjustments. We define adjusted net income per diluted common share as adjusted net income divided by weighted average diluted shares.

The following is a reconciliation of net income to adjusted net income for each of the periods indicated (in thousands, except per share data):

(in thousands)

(1) Statutory tax rates are used to calculate the tax effect of the adjustments.

Revenue Growth (including by distribution channel) on a Constant Currency Basis

We define revenue growth (including by distribution channel) on a constant currency basis (expressed as a percentage) as the increase in current period revenues over prior period revenues, utilizing fixed exchange rates for translating foreign currency revenues for all periods in the comparison.

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Free Cash Flow

We define free cash flow as our cash provided by operating activities, adjusted for capital expenditures, content acquisition and cash received related to Giphy Retention Compensation in connection with the acquisition of Giphy.

The following is a reconciliation of net cash provided by operating activities to free cash flow for each of the periods indicated (in thousands):

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We are exposed to market risks in the ordinary course of our business, including risks related to foreign currency exchange rate fluctuation, interest rate fluctuation and inflation.

Foreign Currency Exchange Risk

Our sales to international customers are denominated in multiple currencies, including but not limited to the U.S. dollar, the euro, the British pound, the Australian dollar and the Japanese yen. Revenue denominated in foreign currencies as a percentage of total revenue was approximately 29% and 33% for the nine months ended September 30, 2023 and 2022, respectively. Changes in exchange rates will affect our revenue and certain operating expenses to the extent that our revenue is generated and expenses are incurred in currencies other than the U.S. dollar. Royalties earned by and paid to contributors are denominated in the U.S. dollar and will not be affected by changes in exchange rates. Based on our foreign currency denominated revenue for the nine months ended September 30, 2023, we estimate that a 10% change in the exchange rate of the U.S. dollar against all foreign currency denominated revenues would result in an approximately 3% impact on our revenue.

We have established foreign subsidiaries in various countries and have concluded that the functional currency of these entities is generally the local currency. Business transacted in currencies other than each entity’s functional currency results in transactional gains and losses. Translation adjustments resulting from converting the foreign subsidiaries’ financial statements into U.S. dollars are recorded as a component of accumulated other comprehensive loss in stockholders’ equity. We do not currently enter into derivatives or other financial instruments in order to hedge our foreign currency exchange risk, but we may do so in the future.

Our historical revenue by currency is as follows (in thousands):

(1) Includes no single currency which exceeded 5% of total revenue for any of the periods presented.

Interest Rate Fluctuation Risk

Our cash and cash equivalents consist of cash and money market accounts. The primary objective of our investment activities is to preserve principal while maximizing income without significantly increasing risk. The fair value of our cash and cash equivalents is not particularly sensitive to interest rate changes.

Amounts borrowed under our Credit Facility accrue interest at a per annum rate based on either (i) the base rate plus a margin ranging from 0.125% to 0.500%, determined based on our consolidated leverage ratio or (ii) the Term Secured Overnight Financing Rate (for interest periods of 1, 3 or 6 months) plus a margin ranging from 1.125% to 1.5%, determined based on our consolidated leverage ratio. A hypothetical 10% change in interest rates would not have a material impact on our interest expense as of September 30, 2023.

Inflation Risk

We do not believe that inflation has had a material effect on our business, financial condition or results of operations. If our costs were to become subject to significant inflationary pressures, we may not be able to fully offset such higher costs through price increases. Our inability or failure to do so could harm our business, financial condition and results of operations.

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2023. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. However, any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objective.

Based on the evaluation of our disclosure controls and procedures as of September 30, 2023, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting identified in management’s evaluation pursuant to Rules 13a-15(d) or 15d-15(d) of the Exchange Act during the period covered by this Quarterly Report on Form 10-Q that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

We operate in a rapidly changing environment that involves a number of risks that could materially affect our business, financial condition or future results, some of which are beyond our control. In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our 2022 Form 10-K, which could materially affect our business, financial condition or future results. During the three months ended September 30, 2023, there were no material changes to these risk factors as described in our 2022 Form 10-K.