Jupitermedia To Acquire Creatas

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February 18, 2005

Early this week Jupitermedia Corporation announced that it had signed a definitive agreement to acquire Creatas, L.L.C., the parent company of Dynamic Graphics, Inc. (www.dgusa.com), and PictureQuest for $38,175,000 in cash and 1,483,073 restricted shares of Jupitermedia common stock. The value of the stock at today's price is about $21.8 million making the total value of the transaction about $60 million. Jupitermedia intends to finance the cash portion of the purchase price with cash on hand and borrowings under a credit facility to be obtained in connection with the transaction. The transaction is expected to close in March 2005 and is subject to customary closing conditions, including regulatory approvals.

The following day Jupitermedia reported revenues for its fourth quarter of 2004 of $21.0 million up from $18.8 million in the previous quarter and compared to revenues of $15.2 million for the same period in 2003, an increase of 38%. Net income for the fourth quarter was $5.5 million, or $0.16 per diluted share, compared to net income of $2.2 million or $0.08 per diluted share, for the same period last year.

For the year ended December 31, 2004, revenues were $71.9 million compared to $47.0 million for 2003, an increase of 53%. Net income for the year ended December 31, 2004 was $15.7 million, or $0.49 per diluted share, compared to net income of $1.4 million, or $0.05 per diluted share, for the prior year.

For fiscal 2005 Jupitermedia expects revenue between $108 and $111 million. This figure includes three quarters (April through December) of revenues from the Creatas acquisition, but the company emphasized that they have been very cautious in their estimate because they still do not control Creatas and there will be a very complex integration of the two companies. On a full year basis for the company the revenue from its existing businesses to grow at about 17.5%.

Online Images Division

The key question for those in the stock photography business revolves around that portion of the revenue of these two companies that is related to stock photography.

2004 revenue for the Images Division (Jupiterimages) that includes Comstock Images, Thinkstock Images, Thinkstock Footage, Photos.com, HemeraImages.com, Ablestock.com, Clipart.com and Animations.com was $22.6 million. However, because they owned many of their image properties for less than a full year they claim that they are at a $30 million per year annual run rate for this division.

The revenue that the Creatas properties will generate for Jupitermedia is a little harder to calculate. To begin with, there are two legitimate accounting systems for booking revenue and Jupitermedia's accountant, Deliotte Touche, has at this point not determined which system they want Jupiter to use. The two systems are called "gross" and "net" accounting. In "gross" accounting, the system Getty uses, the full price paid by the customer is recorded as revenue and the royalties paid to third parties become a "cost of sales". In "net" accounting the company only records that portion of the customer fee it will retain as revenue (not including any royalty payments it will make). The royalty is handled separately and is not added into the "cost of sales" from an accounting point of view. The net result and the net profit for the company for either system remain the same, but the expenses are handled differently. (While "net" accounting is not widely used in the stock photo industry it is interesting that it would give a much more accurate picture of the total revenue from stock photography because it would eliminate most of the double counting of revenue that currently takes place.)

Creatas has been operating on a "gross" system and Jupitermedia has been using a "net" system. For all of 2005 Jupitermedia has placed a conservative estimate of the revenue for the Creatas properties at between $32 million (net system) and $40 million (gross system). This does not include the magazines and events business that generates about another $4 million. In 2005 Jupiter will actually only recognize about three-quarters of this amount because they do not expect to take over Creatas until April 1, 2005.

This acquisition puts Jupiterimages solidly in third place in the world (after Getty Images and Corbis) as a seller of stock images. They also own the market for subscription stock sales as there is no one left of any significance licensing images by subscription. In 2005 over 50% of Jupitermedia revenue should come from the licensing of stock images and illustrations.

Low Royalty Payments

It does not necessarily follow that Creatas is only paying out an average of 20% in royalty to its image suppliers. They either own or have perpetual contracts to a significant portion of the images they represent and on these they pay no royalties. In addition some third party supplier contracts may be structured to provide additional payments that would not be counted as royalties and would still fall under costs in the "net" system.

Chairman and CEO Alan Meckler also told me that the RM share of Creatas and PictureQuest revenue is less than 25% of their total.

Synergies Between The Two Companies

During the conference call with analysts Meckler outlined some of the synergies between the two companies.

• Jupiter is already one of the largest distributors of imagery in the world, but now with Creatas they have a significant new distribution channel for several of their own brands. Creatas is known as a distributor, not as a producer of images but also gets significant revenue from the images it has produced.

• The possibilities for cross promotion of both businesses should dramatically increase volumes for both brands. All the Creatas brands will become better known because of Jupiter's mass of internet traffic. Meckler said, "Jupiter has always felt that the more ways you can distribute your wholly owned images the more profitable your business will be. We have a concept that is different from most. We have many brands as well as an umbrella brand and we will continue to build this in numerous ways."

• Jupiter has been an RF business and something in the range 80% of Creatas business is RF. But PictureQuest does have a significant RM segment to its business. Comstock has about 25,000 RM images (15% to 20% wholly owned) that are scanned and ready to go. They also have a fairly large additional RM library that has not been pushed very aggressively to date. By turning the Comstock images over to PictureQuest they should be able to significantly improve sales of that material and "a business that has been somewhat moribund will now start to grow significantly".

• While RM and the distribution of images they don't wholly own is a relatively new strategy for Jupiter, Meckler indicated that they would probably bring in more 3rd Party content. Some of that is likely to be RM. He said, "We're now going to open the doors to Rights Managed." Comstock has also been contacting some of the RM photographers they used in the past and asked them to start producing again. If Jupiter works to build a customer base for the Comstock's RM images that will probably also work to the advantage of other RM suppliers on PictureQuest.

• Dynamic Graphics has some of the more significant magazines in the field for Graphics and creative professionals. On a monthly basis Step In Design and Dynamic Graphics are probably passed along to 35,000 to 50,000 image, graphics and creative professionals. These publications can be used to promote Jupiter products. According to Meckler, Jupiter is "the only company in the industry that can face the image buying public in print, in person and on the web. No other company can make that statement."

• Creatas has a very powerful and unique multi-million dollar subscription service called Liquid Library that offers 50MB images. Not only is Jupiter the largest photographic subscription services in the world, but now through numerous brands it offers a variety of images sizes from 1MB up to 50MB at a variety of price points.

• One of the important factors that will aid in future growth are the strong Creatas and Picture Quest sales teams. The addition of sales operations in the UK, Germany and Australia will help Jupiter expand and market all its offerings in these areas. Jupiter seems to be very impressed with the Creatas sales team. Jupiter has developed different pools of buyers and an expertise in e-mail blast campaigns that separately target each group with offers specific to their needs. It is expected that the Creatas sales group will coordinate e-mail and personal contact to grow the business.

Meckler said, "While the gross margin in 2005 is likely to be down from 80% to approximately 75% (due to the royalties paid to some Creatas suppliers), when we get all the synergies in place we will certainly see these numbers rise going into 2006. With our multi-brand strategy, overbrand strategy, our subscription strategy, internet traffic strengthen strategy and our new magazine muscle Jupiterimages will have rapid and very profitable growth in 2005 and the years to come."

It has also been rumored that early next quarter Jupiter will offer a new site connected with Art.com (Jupiter Images brand) that will be a distributor of other brands, something like Picture Quest. Many of the brands that are already on PictureQuest and Creatas will be offered to opportunity to go on this new site.

With this announcement many Creatas and PictureQuest suppliers have breathed a sigh of relief. One of the chronic problems at Creatas over the last couple of years has been a delay in the payment of royalties to suppliers. When asked about this Meckler said, "Those days are over. We have the cash and we'll be cleaning that up very quickly. Obviously we need good relations will all our suppliers"