Shutterfly’s Q3’14 Results Hit by Scaling-up Operations and Seasonal Slowdown

Leading internet based image publishing service, Shutterfly (NASDAQ:SFLY) reported its Q3 2014 earnings on October 29th.  The company, on the back of a failed acquisition deal, ^[1]  a seasonal slowdown of demand for its offerings, and internal restructurings, presented a lukewarm third quarter. Net revenues of $142 million (16% year-on-year growth) marked the 55th consecutive quarter of year-on-year increases. The topline performance was a consequence of customer order growths for the consumer brands, complemented by a boost from the enterprise business. Consumer net revenues for the quarter were $127.3 million, reflecting a 13% year-on-year rise. The Enterprise business displayed a 47% year-on-year rise in revenues amounting to $14.7 million. However, gross profit margin was lower by 506 basis points year-on-year due to production related expenses, relocation of the data center to Nevada, and the start-up of the Shakopee production facility. Hit by lower gross margins and increased M&A related expenses (due to inbound acquisition offers), adjusted EBITDA reflected a loss of $9.7 million as against a $1.1 million loss in Q3 2013. For Q4 2014, the company has guided net revenues between $466.7 million to $481.7 million with GAAP gross profit margin ranging from 57.5% to 59.1% of net revenues. ^[2]. In this article we discuss the key trends which affected Shutterfly’s performance in the third quarter.

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Striving To Boost Demand With Product Upgrades And New Feature Introductions

Shutterfly is on a constant trajectory of improvement and innovation across its wide array of offerings. This led to increased mobile monetization and the expansion of the customer base. The transacting customer base for Q3 2014 was 2.5 million, translating into a 6% year-on-year growth. Orders grew by 7% year-on-year to 4.2 million with an average order value (AOV) growth of 5% to $30.63. AOV is defined as total net revenues (excluding Enterprise) divided by total orders.

Q3 is a seasonally weak quarter with no big holidays and, according to the management, this is the reason for a slower growth. They are gearing up, however, for the holiday season of Q4 where they expect the demand to surge. Some of the initiatives taken in the third quarter are discussed here.

The Shutterfly flagship brand updated its popular tri-fold cards into ¾ fold cards, and migrated card options like oil stamping and additional edge treatments from TinyPrint to Shutterfly collection. Personalized stamps and an expanded variety of stationery types were also introduced. Within photo books, features such as new dust jackets, gift boxes and glossy pages were launched. Keeping the upcoming Christmas holiday season in mind, new products such as personalized gift wrap, glass ornaments, Christmas stockings, framed prints, candles, personalized portable chargers and iPhone 6 cases were launched. The TinyPrints brand also enhanced its collections, features, and user experience. In September, a TinyPrints mobile application was introduced. New features were added into the existing Shutterfly iPhone, Android, Kindle, and Fire phone applications.

The company is also trying to target the professional photographer clientele in a larger manner and might combine its two erstwhile acquisitions, MyPub and BorrowLenses, in the future ^[3].

Scaling Up Production Network And New Facility Start Up Costs Adversely Impact Margins

The third quarter margin performance was adversely impacted by the start-up costs of the Shakopee, Minnesota production facility, which went live in Q3. Also, the ramp-up of operations across the production network in anticipation of the upcoming holiday season led to hikes in manufacturing, customer services, labor, and training costs. This resulted in a $2 million hit on the gross profit margins, which contracted by 506 basis points year-on-year, to 36.8%. The product upgrades and new features, mobile initiatives, and ThisLife (ts new memory management solution) necessitated strategic investments in technology. This, along with the relocation of the data center to Nevada, resulted in higher depreciation expense, which led to a 22% year-on-year rise in technology and development spending to $33.5 million (24% of net revenues). Sales and marketing expense of $42.1 million amounted to a 20% year-on-year increase. This included headcount, advertising agency fees, direct response media, search fees and online media. However, the management believes that Shutterfly will observe healthier margin performance next year, as the expenses of opening new facilities get absorbed, and with the growth of ThisLife brand, and the wedding and mobile segments. ^[3].

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1. Shutterfly share losses continue after report of failed acquisition deal, Silicon Valley Business Journal, October 2014 [↩]
2. Shutterfly Announces Third Quarter 2014 Financial Results, October 29 [↩]
3. Shutterfly’s (SFLY) CEO Jeffrey Housenbold on Q3 2014 Results – Earnings Call Transcript, Seeking Alpha, October 2014 [↩] [↩]