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Shutterfly, Inc. (NASDAQ:SFLY)

Q1 2009 Earnings Call

April 29, 2009; 5:00 pm ET

Executives

Jeff Housenbold - President & Chief Executive Officer

Mark Rubash - Chief Financial Officer

John Kaelle - Vice President of Finance

Analysts

Youssef Squali - Jefferies & Co.

Imran Khan - JP Morgan

Kristine Koerber - JMP Securities

Mitch Bartlett - Craig-Hallum

Kevin Kopelman - Cowen & Co.

Alan Gould - Natixis

Operator

Good day everyone and welcome to Shutterfly’s first quarter 2009 financial earnings conference call. This call is being recorded. I would now like to turn the call over to the John Kaelle for Shutterfly; please go ahead sir.

John Kaelle

Thank you, operator. Good afternoon everyone and welcome to Shutterfly’s first quarter 2009 conference call. With us today are Jeff Housenbold, Chief Executive Officer of Shutterfly and Mark Rubash, Chief Financial Officer. The press release detailing our results is available on shtterfly.com and an archived copy will be kept on our site. We’ve also released some visuals that we’ll use as we go through the call.

Additionally, within a few hours we will release a recording of this call both in a streaming online format and through a downloadable broadcast. You can access all of these through the Investor Relations section of our website at shutterfly.com.

Before we begin I’d like to note that our discussion today will include forward-looking statements within the meaning of this Securities Act of 1933 and Securities Exchange Act of 1934, these forward-looking statements include, statements about our business outlook and strategy and statements about historical results that may suggest trends for our business.

For more information regarding this risks and uncertainties that could actual results to differ materially from those expressed or implied in these forward-looking statements as well as risk relating to our business in general, we refer you to the section entitled Risk Factors in the company’s last annual report on Form 10-K and its other filings with the SEC.

I would also like to note that any forward-looking statements made on this call reflect analysis as of today. This presentation contains certain financial performance measures that are different from financial measures calculated in accordance with GAAP and may be different from calculations of measures made by other companies.

The quantitative reconciliation of these non-GAAP financial measures the most directly comparable GAAP financial measure is available in our Q1, 2009 earning press release which is posted on the Investor Relations section of our website at shutterfly.com.

Now I would like to turn the call over to Shutterfly CEO, Jeff Housenbold

Jeff Housenbold

Thanks John and welcome everyone. Our agenda today will start with a review of our Q1, 2009 performance followed some brief comments regarding our 2009 outlook. Then I’ll turn the call over to Mark to review our Q1, financial performance in detail and to provide financial guidance for Q2 in the full year 2009.

We’ll then open up the call for questions-and-answers, so let’s get started. Shutterfly delivered very solid first quarter result despite the continuing tough macroeconomic environment Q1 marked our 33 consecutive quarter of year-over-year revenue growth and we delivered that top line with better than expected margin recognizing that we cannot change the macroeconomic recession, we focused on faster and higher quality execution across all factors of the business with stronger alignment with our top three strategic imperative, increasing our market lead in photo books, cards and stationery and memory sharing.

Now I’ll briefly recap some of our Q1 progress starting with our products and then turning to our services, marketing and manufacturing efforts. Our primary goal for photo books during 2009 is to increase awareness in adoption and supported that goal, we expanded our assortment by launching a personalized 8/8 soft cover photo book, priced at $19.99 to compliment our hardcover edition priced at $29.99.

We believe that new soft cover option will incur as trial, increased gift giving and expand consideration to more casual occasion. In addition to launching the new soft cover option, we continue to improve the overall photo book experience with a goal of increasing conversion rates from new and repeat customers.

During the quarter, the main focus for our products team was to significantly enhance our stationary collection. Those efforts came to provision in early April, when we expanded our product offering to include in array of new and elegant personalized products that include baby shower, birthday and baptism invitation, coordinating Thank you Card, graduation and moving announcement, notepad and custom gift tags.

We also updated our stationary creation path to improve the customer experience with the template driven approach that saves time and that offers assistance for occasion based elegant. Building on Shutterfly’s market leading position in online greeting cards, we believe these new editions were brought in our PL and increase our share in the rapidly growing market or social expression products.

Shutterfly’s stationary collection is distinguished by a refined paper stock, an exclusive and stylish design from notable designers, such as Letterspace, Boatman Geller, Stacy Claire Boyd and our own signature Yours Truly line. In addition our best-in-class in-house manufacturing ensures that Shutterfly’s customers received exceptional quality printing and best delivery times.

Rounding out our Q1 products enhancements, we upgraded our canvas print, added new center stage puzzles featuring Disney and Hasbro characters and expanded the Center Stage Poster line up to include Hasbro’s popular Littlest Pet Shop characters.

Now let’s review our progress on Shutterfly services and overall user experience starting with our Share site. As a remainder it’s all the Shutterfly Share sites is to be the best place on the web for families, friends and groups to create their own secure website, they connected and share their memory. Our sharing platform combines the power and benefits of photo sharing, blogging, self publishing and social networking sites with a sophisticated security layer and an easy-to-use interface.

From a business model standpoint, Share sites are driving customer acquisition, product sales and while still in the early stages advertising revenue. Share sites adoption continues to be strong. They ended the quarter with more than and 920,000 sites and more than 181 million photos posted, up from 650,000 Share sites and 160 million photos posted in the most recent quarter.

During Q1, we delivered a number of Share site enhancements focused on driving site creation, user engagement and increased e-commerce transaction. Some examples include enhanced permissions and notification, improved stability to order prints and photo books and enhanced and serving capability.

Most existing from a customer standpoint were improvements in the ability to share Shutterfly photo books and pictures to popular social networking and blogging sites, such as Facebook, MySpace, Blogger WordPress and LiveJournal. We also made it easy for customers to download and share their photos in high quality resolution. Our goal is to make Shutterfly more opened service that makes it easy to share and stay connected, which in turn will increase customer acquisition and loyalty.

In early April, we launched our first application for the iPhone and the iPod Touch. Users can now view, share, upload and preserve their memories for free, while onto go. In addition, users can post their iPhone pictures directly to their Shutterfly Share site. Adoption of our iPhone application has been very strong. Since launch, we have become the number one free photo application and now rank in the top 100 of all free applications. Apple has featured Shutterfly in the homepage of the iTunes Store and customer’s feedback has been very positive.

Let me share with you just two of many positive comments. This rocks; I love my iPhone and I thought it was the best thing ever made and that it cannot get better, but your actions actually made my iPhone even better. I love having all my pictures on my phone and the ability to upload from my phone is outstanding Bravo, and from another customer, I love the Shutterfly application. It comes in handy, when I haven’t had a chance to think my phone, but now I can still access and show of my pics to friends and family.

We also make good process on improving our funnel conversion metrics. We’ve launched a newly designed home page, which positively impacted registration abandonment and conversion rate and improved our natural search ranking. We also updated our registration page and promotions engine, which increased registration and transaction conversion rate and improved our ability to segment and target our marketing messages.

Lastly, we released a new version of our iPhoto Export Assistant making it even easier for Apple customer to use Shutterfly and reduce their upload time. As you know, Shutterfly has always had a very customer friendly policy. No registration required to view and share pictures, unlimited storage with no forced deletion and a 100% satisfaction guarantee.

These policies have allowed us to attract new customers and maintain strong customer loyalty. Concentrate to our customer friendly approach, you may have noticed the Kodak recently changed their storage policy and began forcing customer to make a minimum annual purchase of either $4.99 or $19.99 depending on the amount of storage used or they will delete all of your photos.

Snapfish also has a minimum annual purchase requirement or they to will delete users photos. As a result of the confusion created in the marketplace, we reminded our customers that we value their business and that we understand that the interest us with not just their photos, but their precious memories.

We received an unprecedented number of emails from current customers, thanking us for our approach and from perspective customers asking us how to transfer their images from their current provider. We believe our customers centric approach positively impact on new user acquisition cost, customer loyalty rates, life-time values and brand equity.

That summarizes our progress on products, services and user experience. Now I’ll briefly cover some highlights from our marketing business development and manufacturing efforts. In January, we announced a new collaboration with Adobe that we’ll have customers make the most of their digital images.

Shutterfly’s services are now integrated as the default print solution for Adobe Photoshop Elements 6 & 7, Photoshop Album Starter Edition and Photoshop.com. This enhanced integration allows Adobe users to create quality photo books, cards, calendars and prints in just a few clicks. In addition to Adobe, we also extended our relationship with Target by enhancing our integration into their successful Wedding and Baby Registry programs.

During Q1, we enhanced our shopping and merchandising experience by launching a baby solution center to help expecting and new moms with ideas for picking the perfect birth announcement, taking great photos of babies, creating the Share Site and making a photo book. Lastly the industry continues to recognize Shutterfly for our high quality products and services. In the past few months, we were ordered the national parenting centers 2009, CL of approval for our Share Site and the eye parenting award for our Center Stage storybooks.

Now, let me make a few comments about manufacturing. Our manufacturing team executed very well throughout the quarter. We successfully closed our Hayward plant, ensured customers, received high quality and fast delivery times through our Charlotte plant and opened our new Phoenix facility on time and on budget. The Phoenix team is currently ramping production and will be fully operational for the upcoming Mother’s Day Holiday.

In addition to great execution on the manufacturing front, the team also made progress growing our commercial printing initiative. The team delivered nearly a $700,000 in revenue from six different clients, hired two sales people and implemented new work flow systems and processes to scale the business.

In addition to our Q1 operational progress, we also made some changes to our organizational structure and people to support our growth and maximize progress against our strategic imperative. Specifically, we shifted to a structure that plays its greater emphasis on product and services strategy and less emphasis on traditional functional roles.

As part of these changes Kathryn Olson, our CMO will be departing the company in June and Peter Elarde, who has served as the head of product management and our services business has been promoted to Senior Vise President and Chief Marketing Officer. In addition Dan McCormick, our VP of products has been promoted to Vice President and General Manager of our products and services business units. I believe these changes will enhance the quality of our execution, improve speed to market and increase our efficiencies front scale.

Lastly, we have also made very good progress on our CTO search and I believe we‘ll be able to announce our choice in the very near future. So, that summarizes our Q1, 2009 accomplishment. Given the challenging economic backdrop, I’m pleased with our results and the progress we have made and improving our market leading position and believe we are well position for the upcoming Mother’s day and Father’s day holiday.

During Q2, we will continue to execute against our goal to increasing our lead in the photo book, cards and stationary and memory sharing markets. We will focus on things that are within our control and the initiatives that will increase revenue, free cash flows and long term share holder value.

Turning now to 2009, anticipate the macroeconomic environment will continue to be extremely challenging. However, I’m optimistic that consumers will continue to use Shutterfly’s product and services to connect with family and friends throughout the year. I believe we have the right strategy to win in a large and early markets, we are addressing.

We are the leaders in our market with the best products, services and brand, a track record of profitably since 2003, a very strong balance sheet, a deep bench of talented managers with a history of executing in good and bad economy cycles and a commitment to financial discipline with the focus on improving free cash flows.

With that I’ll turn the call over to Mark to review our financials in detail. Mark

Mark Rubash

Thanks Jeff, I’ll begin my comments today with some observations about our first quarter performance, followed by a review of our key metrics and then I’ll walk through of this quarters operating results, I’ll conclude my comments with an overview of our Q2 and full year 2009 financial guidance following that discussion we’ll open the call for your question.

As I’ve mentioned throughout 2008 and earlier this year, we continue to execute against a very difficult economic climate. The weak economy continues to dampen consumers funding and has greatly reduce consumer confidence. While there are some earlier indicators of a stabilizing environment, there is still no clear indication of when business conditions will improve.

As a result, we continue to maintain our cost structure and capital investments inline with our revenue growth and remains focused on the key elements of our strategy. Despite, these continuing headwinds there are some clear positives for us in the start to 2009. We set Q1 records for visits unique uploaders, photo shares, average order value and net revenues. We also set records for Q1 unit volumes in photo books, greeting and photo cards and calendars.

What continuous to be very clear, is about our strong brand, combined with a relatively low cost high sentimental value and gift oriented product line can produce solid operating results even in times of great economic challenge. So, let’s now go a bit further into our metrics. During Q1, our key engagement metrics continue to show consistent trends with low activity during the non-gift giving periods and stronger performance during the traditional gift-giving holiday.

For Q1, we consider the first two weeks of January and Valentines Day as the primary seasonal periods. For the fourth quarter site visits were up slightly year-over-year with fairly consistent growth rates across the quarter. Growth in registered users accelerated significantly from Q4 and showed double-digit year-over-year growth from the relatively strong Q1, 2008 quarter.

While unique uploaders were up only slightly year-over-year, image uploads and photo shares both showed strong double-digit growth. During Q1, we had nearly 900,000 transacting customers who generated over $1.4 million orders with an average order value of $24.48.

This activity translated into a 1% decline in customer growth and 9% decline in orders offset however, by 15% growth in average order value. This continued strength trend a strong average order value growth was largely the result of mix shift from friends to higher value personalized products, particularly our award winning line of photo books.

Let’s now move through a discussion of our reported results starting with net revenues. Net revenues for the quarter totaled $36 million reflecting 5% year-over-year growth. The allocation of net revenues between new and existing customers was 21% and 79% respectively very consistent with last years Q1.

In terms of product mix, net revenue from prints and personalized products and service totaled 39% and 61% respectively. Also, net revenue from 4/6 prints represented 23% of total net revenues, down from the 29% revenue contribution in the prior year. In terms of net revenue growth rates prints, declined 12% year-over-year primarily as a result of the lower ASP on 4/6 prints.

Personalized products and services increased 19% year-over-year lead again by continued strong double-digit growth in photo books and a 680,000 revenue contribution from our commercial print initiative. As most of you’re aware in September of last year, we lowered our everyday price for 4/6 to $0.15 and reduced the lowest year in our prepaid plan to $0.10.

While this pricing move continues to generate solid unit volumes, the volumes have not been sufficient to fully offset the revenue loss from the price change. However, we continue to believe that these new price levels are competitive and appropriate given our overall value proposition and quality.

Moving to cost of net revenues and gross margin, we reported a gross margin of 45.4% during Q1, a 2.4 percentage point decline from the prior year, though well ahead of our expectations. This stronger than expected margin performance reflects cost increases from our planned manufacturing transition from Hayward to Phoenix partially offset by year-over-year improvements in shipping and materials cost and some improved product mix.

Technology and development costs totaled $11 millions for the quarter and include year-over-year increases of 635,000 for depreciation, amortization and stock-based compensation. Excluding these amounts, our tech and dev spending, increased approximately $1.2 million or 20.4% from the prior year. The majority of this increase is attributed to cost increases for power, collocations base and bandwidth.

Technology and development headcount was flat year-over-year. Continuing down the income statement, sales and marketing cost totaled $7.8 million in the quarter, representing 22% of net revenues down slightly from the 23% expense level in the prior year.

Excluding stock-based compensation, sales and marketing cost represented 19.7% of net revenues, down from the 22.3% of net revenues in the prior year quarter. Our Q1 customer acquisition costs decreased about 4% from the prior year, reflecting improved performance from our search engine optimization efforts and greater promotional efficiency.

General and administrative expanses totaled $6.9 million in Q1 or 19% of net revenues, compared to $7.6 million and 22% of net revenues in Q1 of last year. Excluding stock-based compensation, Q1 general and administrative expenses totaled $5.6 million or 15.5% of net revenues. The year-over-year decrease is attributed primarily to headcount reductions and lower use of outside consultants and contractors partially offset by increased cost for office space.

Continuing the discussions, adjusted EBITDA was essentially breakeven during Q1 far better than our guidance, which range from a loss of $3.2 million to a loss of $5.6 million. This EBITDA improvement resulted from a consistent sustained effort to manage our cost structure inline with our revenue growth and a strong evidence of our commitment to deliver increasing profitability and free cash flows.

The quarterly effective tax rate was 32%, compared to our guidance, which ranged from 42% to 72%. The lower rate assumption is attributed primarily to improved full year profit expectations, as well as increased research and development credits. As a remainder, please note that our cash tax rate continues to be extremely low due to the availability of net operating loss benefits and that our GAAP tax rate is very sensitive to changes and either pretax income or permanent tax differences.

On a GAAP basis, our net loss for the quarter totaled $6.2 million or a net loss of $0.25 per share. On a non-GAAP basis, the net loss totaled $4.1 million or $0.16 per share. Shares used to compute the quarterly net loss totaled $25.1 million.

Now I’d like to provide some additional details on our capital expenditure and on our cash investment and liquidity status. Capital expenditures during the quarter totaled $5 million, which included $2.6 million for technology equipment and software approximately 300,000 for manufacturing and office equipment, $1.3 million in building improvements and 800,000 in capitalized software development cost.

Cash and liquid investments at March 31 totaled $65.9 million. In addition, we continue to carry investments in auction rate securities with a fair value of $45 million, which reflects a total impairment of $7.3 million. For you reference, all of our auction rate securities continued to be AAA rated and we continue to receive interest payments on schedule.

Our balance sheet at March 31, 2009 also reflects a long term assets, totaling $7.3 million representing the estimated fair value of the UBS write, which is exercisable beginning June 30, 2010. Regarding our cash resources, we’re confident that the $65.9 million in available liquid cash and securities balance is adequate to meet our current and future operating cash requirement.

In addition, we expect to renew on substantially similar terms, a $20 million line of credit that expired today. To complete my discussion, I’d now like to summarize our revised outlook for Q2 and the full year 2009, together with some additional insight on our underlying assumption. The complete details of our revised 2009 financial guidance are included in today’s press release.

Like most retail and consumer e-commerce companies, since the end of the Q4 holiday shopping period and continuing through this week, we’ve seen the expected seasonal slowdown in traffic to our site and order volumes for our products. Given the continuing recessionary pressures on consumers, we continue to believe that 2009 will be our most challenging year on record and that our quarterly and full year top line results will be difficult to predict.

Accordingly, we continue to be appropriately cautious with our revenue guidance. In terms of components of net revenues, we expect that we’ll see the continued trend of weak no seasonal order volumes, with modest year-over-year increases around the traditional seasonal shopping periods.

We expect a consistent mix of revenues between new and existing customers with modest growth in average order value and finally we expect a continue shift of revenues from 4/6 and other print categories to our line of personalized products and services.

Will respect to our commercial printing initiative we continued to make steady progress with our group “O” relationship as well as with a number of new customers. During Q1 we generated approximately 680,000 in commercial print revenues and expect to substantially build on that amount throughout 2009.

Because our commercial initiative is still in the early business development phase we are not providing any guidance for 2009 today but, will report our progress to you each quarter. In terms of our cost structure we have already implemented a number of cost management strategies and will continue to thoughtfully manage our cost throughout 2009.

Finally while we remained firmly committed to our plan of increasing profitability and free cash flow in the event that net revenues fall to low end of our guidance or below it is unlikely that we will be able to maintain our EBITDA margins at historical level. With these comments as context I will now summarize or revise guidance for 2009 starting with the full year.

We now estimate that net revenues will total between $195 million and $215 million reflecting a year-over-year decline of approximately 9% to year-over-year growth of approximately 1% also please note that these amounts exclude any additional 2009 net revenues from our commercial printing initiatives.

We expect the full year GAAP gross margin to range from 51 to 53 of net revenues and our non-GAAP gross margin range from 52% to 54% of net revenue. The year-over-year decline is attributed primarily to margin loss form 4/6 print prizing and 2009 cost per severance and with transition to our new Phoenix manufacturing plant. We expect that our full year 2009 EBITDA margin will range from 14% to 18% of net revenues and the capital expenditures will range from a 11% to 12% of net revenues.

Turning now to Q2, we expect net revenues to range from 34 million to 37 million which reflects a year-over-year decline of approximately 4% to year-over-year growth of approximately 4% we expect our GAAP gross margin will range from 45% to 47% of net revenue and our non-GAAP gross margins range from 47% to 49%. We expect our adjusted EBITDA will range from a loss of 3 million to a loss of $1 million.

So in summary, in light of the uncertainty and continued challenges presented by the current economic environment, we believe that our Q2 and revised full year 2009 net revenue and profitability guidance, continues to be appropriately cautious and reflects the significant uncertainty in today’s marketplace. In addition, we have already taken many of the steps necessary to preserve the opportunity for full year profitability and increased free cash flow and will continue to focus on our strategy and on strong execution during these challenging times.

So, with that I thank you for time today and look forward to speaking with many of you in the days and weeks ahead. We’ll now open the call for our questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Youssef Squali - Jefferies & Co.

Youssef Squali - Jefferies & Co.

A couple of questions, I guess starting with you Jeff. If I look at the velocity of orders or jus the order per customer that you have throughout I guess the last five quarters, it’s been coming down from about 1.8 to 1.6 or 1.67. I was wondering if you could help us understand the reason behind that.

Is it all macro driven or is it a, are you just seeing, people maybe buying more of the photo books and therefore, often not to buy additional product because of the higher price point. So, if you can just help us understand that would be great. Then on your Q1 guidance versus the actual, where did you guys go wrong, what was the biggest delta between guidance and actual? Then I have a follow-up.

Jeff Housenbold

So, on the frequency of orders by customer, we have being seen a decline in that. I think there are three causes or factors to that. The first and probably the majority of it is a continuing mix shift from prints to photo books. So, in the past customers would come in and the industry average was 40 to 50 prints.

You could put several 100 images into one of our photo books and so they’ve been batching up with historically what were more frequent lower basket size purchases on 4/6 prints and then batching those up to a higher ASP orders from their photo books. So, a lot it’s mix shift.

Second, I think there is some macroeconomic impact in that. We’ve been seeing stronger growth around holidays and less growth around the non-holidays and so people were spending when it matters and when they’re gift giving occasions rather than spending on themselves.

Then lastly our promotional strategies as we’ve been moving more to free shipping on hurdles of $25 to $50 per quarter. We’ve been creating a reason for people to weigh until they have sizable orders, so that they can get the free shipping.

In terms of variances from our guidance, probably the biggest and it was a positive surprise, was really a little bit on the volume side, but more importantly an improvement in mix to personalize products and services and higher ASPs, particularly for calendars and photo books during the quarter. Outside of that, our cost structure came in pretty much where we had hoped it would throughout the quarter.

Youssef Squali - Jefferies & Company

Okay, that’s very helpful. I guess lastly, as I look into your gross margins for Q1 of 45.6, how much duplicates costs was in that line from having I guess had the two facilities for even partial part of the quarter. I guess closing one and kind of getting the other one up in running.

Mark Rubash

Yes, there was a combination. If you look at peer facilities, there was about around $300,000 of cost related to accelerating the leasehold improvements in the Hayward and about $250,000 to $300,000 for rent that we actually started recognition in February for the Phoenix facility.

Outside of that, you had what we had anticipated for severance with the Hayward team, that wrapped up about the end of January and then we started hiring for essential almost an entirely new team in Phoenix. In total, it’s in the $1 million to $2 million range in terms of total transition cost from one facility to the new one, in terms of operating expenses.

So there will continue to be some ramp up caused in Q2, the physical plants started ramping up as far as being able to bring an equipment and start testing in the March timeframe and in early April as when we started wrapping up the head count and burning in system. So, we’ll have some additional costs in Q2, but not as significant as Q1.

Operator

Your next question comes from Imran Khan – JP Morgan.

Imran Khan – JP Morgan

Two questions, following up Youssef’s question, if I look at your Q1 to Q2 revenue guidance, Q2 revenue guidance is roughly inline with Q1 numbers, but EBITDA you are guiding negative $3 million to negative $1 million EBITDA. Considering you had more onetime costs in Q1, why should EBITDA be worse in Q2?

Second question, Jeff you talked about Kodak charging consumers for hosting pictures and also talked about your application. Could you give us some quantification in terms of once Kodak sends out that email about charging, what kind of increase you’re saying in terms of activated level; people shifting their pictures to Shutterfly and things like that. Can you give some color and can you give some numbers? Thank you.

Jeff Housenbold

I’ll try on the first one. I think it would primarily say is; one, in Q1 we were I would say fairly constrained on our marketing line intentionally, because there weren’t any real significant gift giving holidays. So, our actual customer acquisition costs came in quite favorable for the quarter.

Q2 with these Easter’s, Mother’s Day, Father’s Day will be increasing our spend on the marketing side. That combined with the ramp up cost of the Phoenix facility that I mentioned earlier and then probably just being I’d say thoughtful on whether or not the types of mix in ASP improvement we saw in Q1, whether that will hold through the Q2 holiday periods.

Mark Rubash

On the second question Imran around Kodak charging, I think it’s difficult to have a specific number because we have a confluence of things going on simultaneously here. We’re headed into the Mother’s Day season and right around the same time, when Kodak change their policies and got a lot of negative press about that, we also launched our iPhone out, which took off from beyond our expectations and we’re seeing a lot more in new customers and upload from that as well.

They’re hard to stop when start leaving, I believe this middle of May and so we’re expecting that continue to see ramp with new customers coming from the competition, but that doesn’t happen overnight. I think as people’s images get wiped out and that stories start spreading by or word of mouth, I think we’ll see more impact over it in the trailing few months.

Imran Khan – JP Morgan

So, I have follow-up question for Mark. I think you talked about how second quarter has more event in terms of Mother’s Day. Easter is actually in the second quarter and you will spend more marketing dollar. So the question is, why is that revenue growth rate will weaken from Q1, just because of Easter shift your revenue growth that should be better and on top of that you expect to spend more money, so why the revenue growth of guidance is negative 4% compared to 5% growth in Q1?

Secondly, with regard to the marketing cost side my understanding is online customer acquisition cost is coming down, considering the remnant advertising pricing down pretty significantly. So, why are you not seeing the leverage from that pricing down?

Mark Rubash

As far as the revenue growth in marketing, we have a fairly consistent approach in terms of marketing and the forecasting models. Most of the strength that we saw in Q1 came out of the Q4, so the first part of January was the strongest part of the quarter. We saw quite bit of softening in February and I’ll call it stabilization in terms of order volumes and ASP’s in March.

I can’t predict how people are going to perform, so we’re just trying to be as thoughtful as we can on where revenue is going to be. In terms our marketing approach, we will continue to costar much of our marketing and promotional activity is possible around, these gift giving periods and hopefully they will be effect and will do better than the guidance, but still a very tough economy to work through.

Operator

Your next question comes from Kristine Koerber - JMP Securities

Kristine Koerber - JMP Securities

A couple of questions; first on the product mix; as you continued to focus on the personalize products I mean where do we see that billing as a percent of mix. I mean obviously 61% of revenues in Q1, very strong and how high do you think that can be, and just a second part to the question; some of the new products introduced, what kind of margins are we seeing on these products?

Jeff Housenbold

So on the product mix, we are proud that we continue dip on new streams, beyond 4/6 prints and continue to get adoption of our award winning personalize products and services. I don’t think prints go away, but do think one should expect that that mix shift should continue to happen and over time, over the next several years principle probably will be sub 20% of that revenue.

In terms of new products, we just launched our stationary line. Those have margins very similar to our designer cards and our greeting cards which tend to be higher, contributors and total revenue and total margin dollars than the print business, but we are coming off of a very small base and it’s a new product line, but overtime we believe that as we continue to launch higher ASP products, that we will be able to continue to grow the average order size which is up 15% for the quarter

Kristine Koerber - JMP Securities

Okay and then a question on the storage. I mean talked about possibly charging for storage in the past and now it seems like you’re de-emphasizing that and really focusing on the benefits and free storage though your site. Can you kind of update us on your thoughts as far as charging for storage down the road?

Jeff Housenbold

Yes, I think we still believe there is an opportunity for premium services that would allow us to generate subscription revenue around a much more broad and holistic offering than just simple storage. So you could imagine access to exclusive designs and perhaps video and number of prints and photo books per year, so you can put a bundled package together.

So I don’t think we ever intended on where we are charged across the board for storage, but find out the points in which certain storage limits are important to certain customers and be able to charge people for what they value versus what I think the marketplace is doing the same. Hey you have to make a minimum purchase or we’ll wipe out your photos.

So, I think the key difference here is being customer centric. We don’t see these as photos they are people’s memories of life’s important events and so I don’t think we intend on wiping out people’s images.

Operator

Your next question comes from Mitch Bartlett - Craig-Hallum.

Mitch Bartlett - Craig-Hallum

First question will be on the commercial side; 680,000 of additional revenues, but you had one of your two plants close for much after quarter. Will there be an incremental amount of capacity to provide for folks or was that a constrained at all. It sounded like you hired focus during the quarter, so were they fully operational to be selling the excess capacity during the quarter or will that just ramp from here.

Jeff Housenbold

Thanks for the question Mitch. We are not capacity constrained in the early quarters at all, so really it was the demand side and that the two sales people we brought on Board for late in the quarter and kind of just getting ramped up and so it’s new in the sales cycle.

Also with the macroeconomic situation, we’re going after people who are spending a marketing collateral, so the sales cycles are getting lengthened a bid and so we’re going in there and having to talk about the return on investment in Digital printing and personalization in direct mail capabilities, which is very logical, the ROI is higher, but you’re in an environment where people are more price sensitive than they are ROI focused and so the sales cycles are a little longer.

I think as the team comes on board here they get trained. We continue to push the value proposition into the marketplace and also would help the partners like Xerox who are out there, talking about the same thing and Group O and inner workings and all the folks in the industry are pushing this new Digital technology for personalization. I think that message in that sales cycle should shrink overtime, but it’s early out. We’re proud of the ramp up in the business and we look forward to continuing to grow that business.

Mitch Bartlett - Craig-Hallum

You talked about an operating margin, when you achieve the $30 million to $40 million of total revenue that you could possibly do, being a third of revenues are so? Do we need to get up to that level to get that operating margin or is it just incremental from the get go?

Jeff Housenbold

I think that you don’t need to be fully utilized to get to those margins, but there is a ramp up period as we’re spending some money on software processes, a little bit on specialized equipment, but the margin should be very nice on an incremental contribution basis from each dollar after you get up to kind of a minimum threshold.

Mitch Bartlett - Craig-Hallum

Share sites, can you track to an e-commerce transaction that’s coming from these 900,000?

Jeff Housenbold

In two ways, one is direct and one is indirect. So direct is, people purchasing the pictures that are on the share sites. So, let say it to Youth Soccer team and all the mums and dads are posting pictures, we could track the number of dollars coming directly half of that Share site.

Indirect in that, there’s 30 kids and 30 families on the team who are acquiring new customers, who may not make a direct purchase off of that Share site today, but they’re exposed to the end of the year, year book and they may comeback and purchase one from themselves or comeback around Christmas and do holiday cards. So, there is not indirect and direct revenue, but for competitive reasons we’re not in a position to give out the details at this time.

Mitch Bartlett - Craig-Hallum

But you are seeing conversion on the indirect site?

Jeff Housenbold

We are; on both direct and indirect, and our focus is really about get usage and get engagement, so that people are active and then get monetization both in the form of direct e-commerce, customer acquisitions and then secondarily early on, but we’re generating modest incremental revenue on the advertising and sponsorship side today.

Mitch Bartlett - Craig-Hallum

Last question, growth rate of the photo books site; in the past you’ve talked about that being your fastest growing category; is that still the case?

Jeff Housenbold

It was the second fastest growing in Q2, but certainly continuous to be the absolute largest in Q1. Our calendar was one of the fastest growing for the logical seasonal reason, the beginning of Q1, but if you eliminate the seasonality, it continues to be the largest Q and definitely the fastest growing over the course of a full year in healthy double-digit rates.

Mitch Bartlett - Craig-Hallum

Is the average order sites between new and repeat customers basically the same at all?

Jeff Housenbold

Essentially, the same; very, very close.

Operator

Your next question comes from Jim Friedland - Cowen and Company

Kevin Kopelman - Cowen & Co.

It’s Kevin Kopelman for Jim. I just had a couple of questions. First clarification on guidance, when you said that you’re not expecting any additional commercial printing revenue, is that mean your guidance assumes about 700,000 quarter? Is than an agreement?

Mark Rubash

No, it includes the 680,000 we recognized in Q1 for the full year number, but does not include any additional beyond the Q1 numbers. We’re not including commercial revenues and in our guidance, but we are reporting our actual results each quarter.

Kevin Kopelman - Cowen & Co.

Okay and that goes for both revenue and possibility guidance?

Mark Rubash

Correct.

Kevin Kopelman - Cowen & Co.

Could you comment on what you guys think as far as opportunities for consolidation industry, if you have any beyond that?

Jeff Housenbold

Yes, I think if we’ve seen a couple of ways of consolidation already over the last few years with AOL exiting, Sony exiting, Yahoo exiting the business. We’ve seen other kind of exit because they went bankrupt and I think this is the scale gain and we’re down to a couple large players in the U.S. with us being the market share leader and similarly focused on this marketplace.

I think there is on the backend and manufacturing, enough capacity in the marketplace that I think additional consolidation is likely to occur over the next several quarters, as people look towards scale efficiencies.

Operator

(Operator Instruction) Your next question comes from Alan Gould - Natixis.

Alan Gould - Natixis

I’ve got a few questions here. First, can you give us, what you’re market share is currently in prints and if you have it on personal products?

Jeff Housenbold

Alan, it’s hard to determine outside that what the InfoTrends reports, because we are the only company that’s independent and public and report those numbers, but as of the last report, which I believe was for the year 2007 with estimates of 2008, they put us at roughly 30% to 33% in the market.

Our own proprietary channel checks indicate that we have on the total revenue basis for the business in much larger market share than that, but we don’t have specific shares on prints versus personalized products and services, but we do believe strongly that we are the market leader in photo books and cards and should be the market leader over the next year or so in the personalized stationary arena as well.

Alan Gould - Natixis

Okay. Next, you guys were probably the first company or one of first companies to see us going into this recession back five quarters or so ago. Some companies are saying, they’re starting to feel were at the bottom. I assume by your comments you don’t have that visibility as yet to feel that we’re at the bottom?

Jeff Housenbold

Yes, I think there’s still a lot of uncertainty in the marketplace and unemployment continues to rise. People who had moratoriums on their foreclosures; there’s moratoriums going away and you see foreclosure numbers continue to escalate quickly. So, I think we’ve seen some stabilization, but it’s not clear that we’ve seen the up tick upwards and in our business, it’s a little more difficult to tell that given that seasonality with more than 50% of that revenue in the fourth quarter.

So, we continue to invest in the right strategic thing so that we continue to grow the business and come out of this recession stronger, but we also are being prudent with our cost basis and with our guidance.

Alan Gould - Natixis

That explains you beat the top end of the revenues guidance by $4 million, but you only increased the full year revenue guidance by $5 million?

Mark Rubash

Yes, essentially we increased the guidance by the amount of over performance in Q1, but outside for this early in the year we’re sticking more or less for our original outlook for Q2. We did increase Q2 slightly from where we have originally started, but still being quite cautious.

I think just to add to Jeff’s comments on the economies, I’ve mentioned to a number of folks, the very high correlation our business has and most consumer e-commerce had was consumer confidence. You saw the Conference Board report yesterday; we’re more highly correlated with the Michigan Index. I expect both of those, they’re kind of traveling from left to right, right now, which is encouraging but it’s not continuing to go down, but we’re not seeing significant strength upwards.

I think as the consumer feels more secure in their financial surroundings, then some of the things like our products that they enjoy doing will start coming to top of mind, but again, it’s just that half our year is in Q4, and we’d like see how the business performs through some of the key gift giving holidays in Q2 before we develop any exuberance.

Alan Gould - Natixis

I assume Q2, it’s too early at this point to what the Mother’s Day books like; are those orders in already or that all probably comes in the last two days before Mother’s Day?

Jeff Housenbold

Yes, it’s pretty tightly cosseted around the holidays. Father’s days actually is a stronger period for us than Mother’s Day is.

Alan Gould - Natixis

My last question towards respect to CapEx, it was three million for the quarter versus $8 million last year. Your guidance is somewhere around the $23 million area. It seems a little bit high, is most of that expanding all going to additional storage?

Jeff Housenbold

No, the quarterly number was $5 million, which includes capitalized development cost and of that amount, there is a fair amount of this quarter’s activity that relates to the leasehold improvement, kind of infrastructure part of the Phoenix build out. In terms of full year CapEx, we’re looking at a number at least early on here, fairly consistent with last year and if I was an optimist, we’re constantly trying to drive that down.

One thing that is growth certainly at a very healthy rate, are the number of images that are being uploaded. We have seen very strong growth in new registrants, particularly in the last month and a half or so and an increase of images coming on to the site and while that does drive storage requirement, it’s also one of the leading indicators of intend to purchase, particularly on the gift giving holidays.

Alan Gould - Natixis

Is Phoenix, pretty much finished now?

Jeff Housenbold

There’ll be a small amount that will come through in Q2 compared to Q1, but its operational today. We’ve been producing for a couple of weeks and by the time; I think part of the end of Mother’s Day cycle will pretty much be in full swing there.

Operator

Your next question comes from Mitch Bartlett - Craig-Hallum.

Mitch Bartlett - Craig-Hallum

Just one last question; Jeff you talked about in response to a question, the launch of higher ASP products, I wonder if you could just discuss that in general. It sounded like within photo books, you’re trying to spur initial usage with a lower priced softcover book. Can you maybe talk specifically perhaps to photo books on the ASP side and then what you are meaning by the higher ASP products that you’re going to launch?

Jeff Housenbold

Sure, my initial comment was about prints versus the photo books. So, our base photo book is $30 and the average selling price is higher than that, because people tend to choose different cover options like leather or padded. They tent to include additional pages, which are $1 to $50 for each incremental page. So, our actual average selling price for a photo books is north of $30.

So, I was comparing that to a typical principle order, which for the industry not satisfy specific, but the industry tends to be about 40 prints at about $0.15; with shipping, looking at an order size of $7 or $8. So that shift is what’s driving the 15% increase in our ALB for the quarter.

Second is the strategy around the 8/8 softcover; is that in talking to customers, they said “We love your photo books and we love for giving for a birthday or 40 wedding anniversary or a wedding or a new baby” and they seem to think about it because of the effort and beauty of this professionally bound coffee table quality book as special occasions.

So, the softcover is the way to kind of remind people, and our positioning will be around life is fullest of special moments and that you can make a casual book at an affordable price point in those if you will, non-gift giving season throughout the year and then you can upgrade to the larger, more expensive ones around that gift giving holiday.

So it’s really about filling out the assortment, just like we did in our greeting cards, where we had a 4/8 card and we had a 5/7 folded. We introduced a 5/7 photo below it and we introduced designer cards above the folded greeting cards today. We were giving choice to a wider socioeconomic base, but also the same customer around different use occasions.

So, its part and partial of our ongoing strategy to provide more designs, more foreign factors and more choice, so that you get greater adoption throughout the year, not just during the seasonally strong fourth quarter.

Operator

(Operator Instructions) We have no further questions in our queue at this time. I’ll turn the conference back over to our speaker’s for any final or additional comments.

Jeff Housenbold

Mark and I just want to thank you all for joining again for our Q1 call. We believe that we’re continuing to invest in the right priorities and driving our photo book, cards and stationary and our sharing business that will yield strong results throughout the year and build a base for continued development and increasing shareholder value of their long term and we look forward to seeing you guys on the road over the next few weeks. Thanks

Operator

That does conclude our conference call for today. Thank you everyone for your participation.

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