Shutterfly Earnings Preview: Failed Acquisition, Increased Competition, and Restructuring May Dampen Results

Shutterfly (NASDAQ: SFLY), the internet based image publishing service, is set to release its earnings for Q3 2014 on October 29th. Revenue for the first half of FY 2014 was $296 million with a growth rate of 18%, as against a 31% rise for the same period in 2013. Revenue growth was primarily stimulated by constant product upgrades, new offers, and investments. The gross profit margin for the first half was 46% as compared to a 47% gross margin in HY 2013. The second quarter experienced a hike in margins due to the slack in marketing and hiring expenditures which have been pushed back to the end of Q3. The company seems to be growing but the rate of growth has substantially fallen in the present year. For Q3 2014, the management guided to a revenue range between $140.5 million to $143.5 million. GAAP gross revenue margin is expected to fall within 38% to 39% , due to a combined impact of the  start of the Shakopee Minnesota production facility, scaling of the Fort Mill South Carolina operations, higher depreciation and amortization expenses due to acquisitions, a greater proportion of enterprise revenue, and continued sales growth of photo gifts which are typically outsourced.

In this article we examine the different trends affecting the growth of Shutterfly, and those which will shape its earnings performance in Q3 2014. We will update our price estimate for Shutterfly after the Q3 earnings.

See our complete analysis of Shutterfly

Shutterfly Loses Out On Creating A Bigger Brand Value With Failed Acquisition Deal

On October 13, 2014 Shutterfly experienced a 10% decrease in its share price after the news that the private equity firm, Silver Lake Partners had put their plan of acquiring and combining Shutterfly and Hewlett-Packard’s Snapfish on hold ^[1]. Shutterfly’s stock was down by $4.71 (10%) to $42.25, lowering its market capitalization to around $1.63 billion. However, the company is still open to talks with Shutterfly. Silver Lake had valued Shutterfly at 12 times forward EBITDA (earnings before interest, taxes, depreciation and amortization) which approximately amounts to $2.57 billion based on estimated 2015 EBITDA of $214 million, according to data compiled by Bloomberg. ^[2]

The merger of Shutterfly and Snapfish—both companies operating in the photo storage and printing space—would have created a bigger entity, expanded the customer base, and posed substantial threat in this market space witnessing continuous influx of players. However, with the fallout of the deal, at least for the time being, Shutterfly might have to face significant loss of confidence of its shareholders.

Increased Mobile Penetration: A Double Edged Sword In Shutterfly’s Growth Path

Shutterfly’s brand revenues from its mobile and tablet applications increased to 11% in Q2 2014, as against 5% in Q2 2013, driven by the ever increasing adoption of smartphones and tablets in recent times. The company is constantly upgrading and developing new applications which are supported by iPhone, iPad, and Android devices. Shutterfly’s recent launch of the Tiny Prints brand for the iPad ^[3] is a new addition in this space. Hence, the attractive products and services on offer are also a primary drivers for expansion of its customer base and generation of higher revenues. However, the competition in this digital marketplace is stronger than ever.  Contenders include digital picture albums offered by Facebook and Google, and picture messaging applications like Snapchat, all of which act as formidable competitors in the path of Shutterfly’s growth.

New Product Features, Upgrades, and Planned Investments Imply Growth Opportunities

The company’s earnings in the second quarter were positively impacted by the flagship brand and  Shutterfly grew 21%  on a year-on-year basis. A series of holidays (including Easter, Mother’s Day, Father’s Day and Memorial Day), coupled with the graduation season, all boosted the sale of cards, stationery, and photo gifts. Revenue growth was further propelled by the  launch of a vast array of Shutterfly branded products, including interior design and other home décor collections, metal wall art, pillows, glass prints, new styles of iPad cases, personalized lunch bags, smartphone battery cases, as well as satin and silk covers and other memorabilia pockets.

Shutterfly made additional investments in its enterprise business for plans which will be executed in the second half of 2014. The managed care practice and retail verticals show major growth opportunities which the company wants to leverage upon. The company expects accelerated revenue growth in Q3 on the basis of their sales pipeline.

New Facility’ Start-up Expenses, Scaling Costs, and Relocation Costs Might Dampen Q3 Margin

Shutterfly’s lease expense for its new facilities in Shakopee, Minnesota and Tempe, Arizona has led to a decline in its margin performance. The Shakopee facility with its start-up costs is expected to further dampen Q3 margins as it wemt live in the third quarter of 2014. The scaling of operations at the Fort Mill  manufacturing facility in South Carolina to meet the higher demand  during the holiday season of Q4, will adversely impact the Q3 margins. Shutterfly is also relocating its data center to Nevada. The migration required operating both the existing and new data centers for the entire third quarter, to ensure that no data was lost during transfer. This likely mposed additional costs and put downward pressure on Q3 earnings. The earnings per share guidance for Q3 is for a loss of between -$1.29 and -$1.27, versus prior year loss of -$0.27 in Q3FY13.

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1. Shutterfly share losses continue after report of failed acquisition deal, Silicon Valley Business Journal, Oct 13, 2014 [↩]
2. Silver Lake Said to Shelve bid for Shutterfly, Snapfish, Bloomeberg, Oct 11, 2014 [↩]
3. Shutterfly brings its online boutique Tiny Prints to the iPad, Techcrunch, September 5, 2014 [↩]