Shutterfly Q4 2014 Earnings Preview: Margins Likely Remain Under Pressure

Leading internet based image publishing service, Shutterfly (NASDAQ:SFLY) will report its Q4 2014 earnings on February 12th. For the nine months ended September 30, 2014, net revenues increased by 18% on a year-over-year basis, to $438 million. Consumer net revenues increased by 17% to $408 million. The increase in Consumer net revenues was primarily a result of increased sales of photobooks, cards and stationery, photo-based merchandise, and revenue from the MyPublisher and BorrowLenses brands. Enterprise revenues increased to $30 million, or by 19% year on year, due to the expansion of projects with existing customers. ^[1]

Shutterfly’s revenue for the six months 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 had been pushed back to the end of Q3.

The company, on the back of a failed acquisition deal, ^[2]  a seasonal slowdown of demand for its offerings, and internal restructurings, reported 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 growth for the consumer brands, complemented by a boost from the enterprise business. However, gross profit margin was lower by 506 basis points year-on-year due to production related expenses, the 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.

The company seems to be growing but the rate of growth has substantially fallen in 2014. In this article we examine the different trends affecting the growth of Shutterfly, and those which will shape its earnings performance in Q4 2014.

Our $45 price estimate for Shutterfly is in line with current market price. We will update our valuation post the fourth quarter earnings.

See our complete analysis for Shutterfly

Shutterfly’s Failed Acquisition Deal With Silver Lake Partners

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 ^[3]. However, Sliver Lake 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. ^[4]

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.

Shutterfly Acquired Grovebook To Provide End To End Services And To Enhance Cross Selling Of Its Products

Shutterfly acquired GrooveBook, a mobile photo book application subscription service, in November 2014. Valued at $14.5 million, the deal includes an upfront purchase amount and a future performance-based earn-out. Grovebook prints up to 100 photos stored in the mobile phone, in a 4.5″ x 6.5″ GrooveBook format. It then mails the keepsake book to customers, for a monthly charge of $2.99. ^[5] GrooveBook has more than 1 million downloads, 200 million photo uploads and a subscriber base of around 7 million. ^[6]

Shutterfly has a history of acquiring start-ups related to the photography domain. It has earlier acquired companies including ThisLife (photos and videos organizer), Tiny Prints (premium cards and stationery for all occasions), Treat (allows users to create personalized greeting cards), Wedding Paper Divas (wedding related stationery), BorrowLenses (online photo and video equipment rental service), and others. According to Brian Whiteman, GrooveBook’s founder, GrooveBooks’s acquisition by Shutterfly will enable the former to leverage the latter’s technological and manufacturing platform to scale up operations, which will allow it to increase its profitability and brand value.

Shutterfly tries to control its business chain from end-to-end. They even have their own manufacturing facilities. Hence, the acquisition of Grovebook seems strategically relevant as the company prints photo books from photos saved in mobile phones, which is the next logical step for Shutterfly, after offering customers photo-printed cards, mementos, and accessories. Shutterfly had transformed from a single brand market leader to a family of brands, which in turn helps it “cross pollinate”, that is, sell products from one brand to a customer in a different brand. These cross-selling activities should lead to further expansion in the company’s average order value (AOV). Additionally, good cross-selling activities should improve customer retention and increase overall customer base in the long term.

Increased Mobile Penetration Aids Shutterfly’s Growth But It Also Generates Threat From Competitors

Shutterfly’s brand revenues from its mobile and tablet applications witnessed double digit growth in the first nine months of 2014, 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 launch of the Tiny Prints brand for the iPad ^[7] 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.

Margins Might Continue Being Dampened In Q4 Due To Production Scale-Up Costs And New Facility Start Up Costs

The cost of net revenues for the first nine months increased to $249 million , or 22% on a year-over-year basis. As a percentage of net revenues, cost of net revenues increased to 57% in the first nine months of 2014 from 55% in the same period in 2013. This in turn decreased gross margin to 43% in 2014, from 45% in the same period in 2013. Overall, the increase in cost of net revenues was primarily the result of the increased volume of shipped products, and higher depreciation (48% year-on-year rise to $46 million), increased equipment lease costs, and headcount expenses related to the Fort Mill, South Carolina and Shakopee, Minnesota manufacturing facilities.

The product upgrades and new features, mobile initiatives, and ThisLife (its new memory management solution) necessitated strategic investments in technology. Technology and development cost increased by 24% to $97 million. This, along with the relocation of the data center to Nevada, resulted in higher depreciation expense (depreciation increased by 48% to $46 million). Sales and marketing expense of $129  million translated to a 17% year-on-year increase. This included headcount, advertising agency fees, direct response media, search fees and online media.

Management believes that Shutterfly will observe healthier margin performance in 2015, as the expenses of opening new facilities get absorbed, and with the growth of ThisLife brand, and the wedding and mobile segments. ^[8].

View Interactive Institutional Research (Powered by Trefis):
Global Large Cap | U.S. Mid & Small Cap | European Large & Mid Cap
More Trefis Research

1. Shutterfly INC Form 10-Q for the Period Ending 09/30/14 [↩]
2. Shutterfly share losses continue after report of failed acquisition deal, Silicon Valley Business Journal, October 2014 [↩]
3. Shutterfly share losses continue after report of failed acquisition deal, Silicon Valley Business Journal, Oct 13, 2014 [↩]
4. Silver Lake Said to Shelve bid for Shutterfly, Snapfish, Bloomeberg, Oct 11, 2014 [↩]
5. Shutterfly Inc. Acquires GrooveBook, Shutterfly, Nov 2014 [↩]
6. Shark Tank-Backed GrooveBook Acquired By Shutterfly For $14.5 Million, Tech Crunch, Nov 2013 [↩]
7. Shutterfly brings its online boutique Tiny Prints to the iPad, Techcrunch, September 5, 2014 [↩]
8. Shutterfly’s (SFLY) CEO Jeffrey Housenbold on Q3 2014 Results – Earnings Call Transcript, Seeking Alpha, October 2014 [↩]