Ongoing Relocation Expenses To Weigh On Shutterfly’s Q3FY14 Earnings

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Shutterfly (NASDAQ:SFLY) reported its second quarter earnings Wednesday, July 30. Second quarter revenues continued to display a slowdown in year-on-year growth, registering a 19% growth this quarter to reach $159 million against 35% in Q2FY13. Revenues from its consumer printing business increased 20% to reach $150 million while enterprise revenues increased at a slower pace of 5% to reach $9 million.

In terms of customer uptake, total transacting customers increased 13% to reach 2.6 million while the number of orders processed increased 16% to 4.2 million. This represents an average order rate of 1.61 orders per customer for the quarter compared to 1.56 orders per customers in Q2FY13 and 1.5 orders per customer in Q1FY14. The increase in orders completed per customer highlights greater cross-selling of products from Shutterfly.

Quarterly margins witnessed an expansion in Q2FY14 on the back of timing shift in expenditures relating to marketing and hiring for the peak season that starts towards the end of the third quarter. Second quarter gross margins stood at 47.6%, higher than the company’s guidance of 46%-47% in Q1FY14. As as result of higher gross profit margins, adjusted EBITDA was also higher than guidance, at $11.7 million versus a guided range of $6-$7 million for the quarter.

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In this earnings article, we highlight key takeaways from the second quarter earnings for Shutterfly.

See our complete analysis of Shutterfly

New Product Launches Accelerate Order Bookings for Shutterfly

During the second quarter, revenues from the company’s flagship Shutterfly brand expanded 21% on a year-on-year basis, driven by growth in cards, stationary and photo gifts for Easter, Mother’s Day, Father’s Day and graduation gift giving periods. [1] While the company doesn’t disclose information on the revenue share of individual brands, we believe its flagship brand Shutterfly commands the maximum revenue share for the company.

The company’s strong revenues growth within the Shutterfly brand was facilitated by product launches in areas of interior design and other home decor collections. [1] Additionally, new introductions in the photo book category such as new styles, matter, satin and silk covers and other memorabilia pockets could have contributed to the outpaced growth of the Shutterfly brand in comparison to overall revenue growth. [1]

Similar product introductions in the Tiny Prints and Wedding Divas brands included new gifts and decor items, a graduation stationery collection and new envelope packagings, embellishments and enclosures in the wedding card product line. [1] Continued improvements and trendy product launches such as these should resonate with higher bookings and contribute to an acceleration in revenues for the company.

Q3 Earnings to be Impacted by Operation Start-up Expenses

Shutterfly entered into leases for new facilities in Shakopee, Minnesota and Tempe, Arizona which are expected to be operational in 2014 and 2015. The leases on these new facilities resulted in greater depreciation expenses on its older manufacturing facilities, which has depressed margin performance historically. In the forthcoming quarter, the company expects the Shakopee facility to go live and guides third quarter margins to be impacted by various expenses related to the start-up of operations. Additionally, Q3FY14 margins are likely to be depressed by the continued scaling at Shutterfly’s manufacturing facility in Fort Mill, South Carolina to meet peak demand requirements for the fourth quarter.

In addition to these manufacturing related expenses, the relocation of its data center to Nevada is expected to incur a full quarter of duplicate data center costs. The upgradation of data center facilities should deliver cost advantages in terms of energy efficiency and lower operating expenses for Shutterfly in the long term. However, migrating customer data from one data center to another without any loss of information means operating both data centers at suboptimal levels through the third quarter. This margin contraction in third quarter top line should weigh on earnings for Shutterfly. The third quarter earnings guidance for the company is expected to range between (-$1.29) to (-$1.27) per share compared to (-$0.27) per share in Q3FY13.

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Notes:
  1. Shutterfly’s (SLFY) CEO Jeff Housenbold on Q2 2014 Results – Earnings Call Transcript, Seeking Alpha, July 2014 [] [] [] []