Shutterfly Flutters To Higher Growth Across All Brands

Shutterfly (NASDAQ:SFLY), a manufacturer and online retailer of photo-based personalized products and services in the U.S., posted net revenue growth of 35% y-o-y to $133.5 million in Q2 2013. The strong growth in top line was underscored by robust performance across all the key brands and the enterprise segment. Key operating metrics such as transacting customers, orders and average order value also saw y-o-y improvement during the second quarter.

Shutterfly’s gross margin declined from 48.8% in Q2 2012 to 46.3% in the quarter, owing to higher depreciation, equipment expenses and customer service costs as well as a change in product mix, which was partially offset by decrease in input costs and shipping expenses. The loss from operations was recorded at ($23.9) million in Q2 even as certain marketing and other investments were shifted to the third quarter.

We expect the revenue growth to be slower in the third quarter due to a lack of major gift-giving occasions and then accelerate in the fourth quarter with the holiday season. While Shutterfly’s profitability will continue to be weak in the near future due to its various investments, we expect it to improve in the long run as it leverages cost savings through new manufacturing facilities.

Check out our complete analysis of Shutterfly

Strong Growth Seen Across All The Brands And The Enterprise Segment

Consumer net revenue rose by 32% annually in Q2 2013 to $124.9 million, on the back of strong performance across brands such as Shutterfly, Tiny Prints,Wedding Paper Divas and Treat. Revenue growth across Tiny Prints and Treat, was driven by occasions such as Mother’s day, Father’s day, baby shower, birthdays and graduation.

A healthy improvement in all of the key operating metrics was seen during the quarter. Transacting customers and orders grew by 24% and 20% annually respectively, to 2.3 million and 3.6 million. The average order value also witnessed 10% y-o-y growth to reach $34.96. We find the growth in average order value to be especially encouraging as it indicates that consumers are purchasing more premium products and the company’s strategy to launch innovative products is gaining traction.

The enterprise segment also saw 86% annual growth in revenue due to new business with existing clients. We are encouraged by this development and expect this business to record strong growth in the future as well, which will drive increased utilization of existing facilities leading to enhancement in profitability.

Shutterfly plans to launch next day delivery for certain products in its Tiny Prints brand. It will leverage its manufacturing base and vertical integration to provide this differentiated service to its customers. If this new service gains traction with customers, the company could offer the same across its other brands. We believe this service differentiation will help the company gain competitive advantage, and will contribute to increase in its customer base.

Increased Investments In Manufacturing Facility

Shutterfly recently opened a new production facility in Fort Hill (South Carolina), which enhanced its manufacturing footprint. It will add another 215,000 square feet manufacturing facility at Shakopee (Minnesota), which is expected to open in Q3 2014. In addition, the company also plans to open a new storage and colocation center as part of its move to launch enhanced cloud service for its users. Owing to large storage requirement as well as high energy costs in California, the company will shift to this new storage center. ^[1]

We believe these growth plans will have a negative impact on the company’s profitability in 2013 and 2014. Over time, we believe these investments will lead to cost savings as the company will leverage lower shipping costs and reduced outsourcing of production. The company estimates OpEx saving through these new facilities during 2015-2017 at around $35 million. ^[2]

Mobile Platform Development Represents A Key Strategy For Shutterfly

Shutterfly continues to invest in mobile platform development to leverage rising traffic from mobile devices. Recently, the company launched a new Shutterfly app for iPad. Moreover, it introduced its first mobile app for Android devices. The company is seeing some success with its mobile strategy as around 5% of its revenue in the Shutterfly brand was recorded through mobile sources as compared to 4% in the previous quarter. ^[1] It will continue to optimize its mobile applications for better usage and enhanced monetization.

Outlook for Q3 2013

– Revenue to range from $115.5 million to $117.5 million, representing an annual growth rate of 17.2% to 19.2%

– GAAP gross margin to range between 40.5% to 41.5%

– GAAP operating loss between ($41.0) million and ($43.0) million

We are in the process of updating our price estimate for Shutterfly’s stock.

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1. Shutterfly Management Discusses Q2 2013 Results – Earnings Call Transcript, Seeking Alpha, July 31, 2013 [↩] [↩]
2. Shutterfly Management Discusses Q2 2013 Results – Earnings Call Transcript, Seeking Alpha, July 31, 2013 [↩]