Shutterfly Inc. Q1 2010 Earnings Call Transcript

Apr.28.10 | About: Shutterfly, Inc. (SFLY)

Shutterfly Inc. (NASDAQ:SFLY)

Q1 2010 Earnings Call

April 28, 2010 5:00 pm ET

Executives

John Kaelle – Vice President, Finance

Jeffrey Housenbold – Chief Executive Officer

Mark Rubash – Chief Financial Officer

Analysts

Youssef Squali – Jefferies & Company

Mitch Bartlett – Craig Hallum Capital Group

Analyst for Jim Friedland – Cowen & Company

Shawn Milne – Janney Capital Markets

Kristine Koerber – JMP Securities

Imran Khan – JP Morgan Securities

Colin Sebastian – Lazard

Scott Devitt – Morgan Stanley

Joseph Okleberry – Morgan Stanley

James Cakmak – Sidoti & Company

Operator

Welcome everyone to the Shutterfly first quarter 2010 earnings conference call. Today's call is being recorded. I would now like to turn the call over to John Kaelle, Vice President of Finance for Shutterfly.

John Kaelle

Thank you, operator. Good afternoon everyone. Welcome to Shutterfly's first quarter 2010 conference call. With us today are Jeff Housenbold, Chief Executive Officer of Shutterfly, and Mark Rubash, Chief Financial Officer.

A press release detailing our results is available on shutterfly.com and an archived copy will be kept on our site. We have also released some visuals that we 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 podcast. You can access all of these through the Investor Relations section of our website at shutterfly.com.

Before we begin, I would like to note that our discussion today will include forward-looking statements within the meaning of the Securities Act of 1933 and the Securities and 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 these risks and uncertainties that could cause actual results to differ materially from those expressed or implied in these forward-looking statements, as well as risks relating to our business in general, we refer you to the section entitled Risk Factors in the company's last annual report on Form 10K 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. A quantitative reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures is available in our Q1 2010 earnings 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's CEO, Jeffrey Housenbold.

Jeffrey Housenbold

Thanks, John, and welcome everyone. I will start today with a review of Q1 2010 and then turn the call over to Mark to review our financials in detail and provide our financial guidance for Q2 and full-year 2010. We will then open up the call for Q&A.

As you listen to our remarks today I would like you to keep in mind the following key messages; During Q1 we continued to gain momentum and market share across the business as we demonstrated strong execution against our strategy. Our consistent innovation, design forward products and services, customer friendly policies and industry leading quality attracted record new customers and continued high loyalty rates among our existing customers.

Throughout 2010 we will continue to make appropriately sized investments in our product and services offerings, customer insights and analytics and other activities that leverage our manufacturing assets and active customer base. We believe these types of investments will enable increases in market penetration along with continued growth in top line revenues, bottom line profitability and free cash flows.

With those messages in mind I will summarize our first quarter headline financial results. Consistent execution against our key strategic initiatives; relentless focus on the customer and strong financial discipline resulted in solid financial results for Q1. The first quarter marked our 37th consecutive quarter of year-over-year revenue growth and we delivered a top line with better than expected margins.

During Q1 we delivered $45.7 million in revenue representing a 27% year-over-year increase. Our strong performance was fueled by continued growth in our line of personalized products and services which grew 43% over Q1 2009.

Now I will briefly recap some of the progress we made during the quarter starting with our products. In Q1 we continued to see increased momentum in our Photo Book business which included a significant uptick in first time buyers. Based on learnings from our strong fourth quarter we made a number of enhancements to our Simple Path creation experience making it even easier for customers to make a Personalized Photo Book in just one-click. We also launched our Local Picture Access feature which further lowers the barriers to creating a Photo Book.

With local picture access users can select pictures from their desktop and then are immediately sent to the Simple Path creation process where they can create a Photo Book without having to register or for photos to upload. Once the book is complete and the customer places her order the Photo Book is uploaded in the background, thus reducing time and complexity.

Now turning to cards and stationery. We further grew our collection by giving customers more opportunities to make personalized, premium invitations for occasions like baptisms, first communion and Easter. We also launched a variety of children and adult birthday invitations as part of our own 10th birthday celebration. Finally, based on customer feedback from Q4 we introduced a series of enhancements to the cards in stationery shopping and creation experience.

Now moving onto prints and total gifts. During the quarter we also saw healthy, double digit increases in our print volumes and in January we expanded our photo gift offering to include wall decals; life-size, peel and stick photo cut outs that come in 3, 4 and 5 foot sizes. In addition to enhancing our product assortment we continued to increase customer adoption and engagement through our feature-rich services. Leveraging our robust sharing platform we introduced new features including; Facebook Connect allowing share site visitors to sign into their Facebook accounts to leave comments on photos, albums, photos, videos, journals, Photo Books and the activity feed without having to create a Shutterfly account.

We launched Picture Tag. Users can now tag and search photos making product creation easier. Email address import, enabling users to import contacts from Outlook, Outlook Express and Mac address book. We improved commenting tools and notification settings increasing the time and frequency our customers spend with their Share Sites. And in time for spring sports season we made enhancements to our new sports module and announced a partnership with Washington Youth Soccer to create its first ever Sideline [Path] program. This allows parents to take great photos of the kid’s soccer games and easily make Shutterfly products.

From a business model standpoint share sites are driving customer acquisition and loyalty, product sales and while still in the early stages advertising and subscription revenues. Share site’s adoption continues to grow and we ended the quarter with more than 1.9 million Share sites and a significant year-over-year increase in shares sent.

In addition to Share Sites we continue to explore and invest in the growing mobile marketplace providing new ways for people to share their memories while on the go with Shutterfly for iPhone and Wink. In March we integrated Wink into the Shutterfly store allowing customers to use images from their Shutterfly account to create Wink photo strips. Since the December launch of Wink the application has been downloaded more than 285,000 times.

We continue to expand our presence and use of emerging social media channels like Facebook and Twitter to increase awareness, brand favorability and customer insight. During the quarter the number of Shutterfly Facebook fans reached more than 88,000. We continue to see strong fan engagement and activity on our page. The Shutterfly blog, Picture More, continues to be a popular customer destination for inspiration, tips and tools for new and existing Shutterfly users. To make it even easier for Shutterfly users to engage in our various social media activities we created a Community Tab on our Home Page bringing together our Photo Book gallery, Picture More blog, Facebook and Twitter pages, the new Shutterfly YouTube channel and our Share Central forums.

Now moving on to our accomplishments in manufacturing. We continue to invest in manufacturing innovation to drive new product introductions and improvements in throughput, quality and efficiency. On the commercial printing front we made solid progress against our goal of offering a diverse suite of printing on demand capabilities with Fortune 1,000 clients resulting in $1.5 million in revenue for the first quarter. So that closes my comments about the accomplishments in Q1 2010.

In summary, Shutterfly started off 2010 with strong momentum. We will endeavor to gain market share in Photo Book, cards and stationery and memory sharing categories through innovation, design forward products and services, customer friendly policies and industry leading quality. Throughout 2010 we will make measured investments that will help us better leverage our existing assets and grow the business. This strategy combined with our commitment to solid execution and financial discipline will enable us to maintain our record of increased revenue, free cash flows and long-term shareholder value.

With that I will turn the call over to Mark to review our financial details. Mark?

Mark Rubash

Thanks Jeff. I will start my discussion today with some observations about our first quarter performance followed by a review of our key metrics and then a walkthrough of this quarter’s operating results. I will conclude my comments with an overview of our updated 2010 financial guidance. Following that discussion we will open the call for your questions.

I think it goes without saying we are continuing to execute in a difficult economic climate where consumers are challenged with high unemployment and limited resources for discretionary spending. While we have seen clear improvements in our business across 2009 and in our most recent quarter we continue to believe the economy and the early indications of recovery remain fragile. Similar to the relative success we had in Q4 we continued to see positive trends in many areas of our business in Q1. We set first quarter records for visits, user registrations, unique uploaders, image shares, customers, orders, average order value and net revenues with all metrics showing clear improvement from the environment we saw in Q1 2009.

During Q1 we had approximately 1.1 million transacting customers who generated nearly 1.7 million orders with an average order value of $26.43. This strong transaction activity translated into 21% year-over-year growth in customers, 14% growth in order volumes and 10% growth in average order value. The average order value improvement was largely a result of a continued shift in product mix from prints to higher value personalized products.

Let’s now move to our reported results starting with net revenues. Net revenues for the quarter totaled $45.7 million, reflecting 27% year-over-year growth. The allocation of net revenues between new and existing customers was 24% and 73% respectively with notable improvement in new customer growth over the prior year. In terms of product mix, personalized products and services represented 67% of total net revenue and total prints represented 30%.

Net revenues from 4 x 6 prints contributed 17% of total net revenues, down from 23% in the prior year. Net revenues from web loyalty referral fees totaled $2.25 million and net revenues from commercial print added $1.5 million more than doubling the total from Q1 of last year. In terms of net revenue growth rates, personalized products and services increased 43% year-over-year led by continued strong, double digit growth in Photo Books as well as significant contributions from our designer cards and stationery collection and from calendars.

I am also pleased to report that Q1 marked the fourth consecutive quarter of accelerating revenue growth from our personalized products and services. Total print revenues declined 2% from the prior year though a notable improvement from the 12% decline we saw in Q1 of 2009. The growth rate increase was driven primarily by healthy, double digit growth in 4 x 6 unit volumes.

Moving to cost of net revenues and gross margin we reported a gross margin of 51% during Q1, exceeding our guidance and well ahead of the 45% margin reported in the prior year. This strong margin performance resulted from several factors including improved product mix, labor efficiencies, lower material costs and lapping the 2009 Hayward closure costs partially offset by promotional discounts and lower margin commercial print revenues.

Technology and development costs totaled $12.2 million for the quarter, an increase of approximately 11% over the prior year. Excluding stock based compensation and depreciation our tech and dev spending increased approximately $1.2 million or 17% from the prior year. The substantial majority of this amount is attributed to the engineering investments we are making to improve the depth and quality of our product and services offerings.

Continuing down the income statement sales and marketing costs totaled $10.2 million in the quarter representing 22% of net revenues, consistent with the prior year. Approximately 60% of the year-over-year cost increase is associated with expanded online media, direct response and partner marketing campaigns with the balance primarily associated with the expansion of our internal marketing team. Our Q1 customer acquisition costs increased about 4% from the prior year with the majority of these increases being offset by improving product mix and average order value per customer.

General and administrative expenses for the quarter totaled $8.8 million or 19.2% of net revenues compared to 19.3% in Q1 of last year. Excluding stock based compensation and credit card processing fees which vary with revenue volume, G&A expenses represented 11.4% of net revenues in the quarter, down from 12.8% in Q1 of last year. Quarterly G&A expenses included increases for employee compensation and professional fees partially offset by an increased amount from the final installment of our existing IP licensing arrangements.

Adjusted EBITDA for the quarter was approximately $3.4 million, exceeding our guidance and representing a $3.3 million improvement from Q1 2009. This continued growth in EBITDA profitability resulted primarily from increased demand for our products and services, improvements in product mix and consistent efforts to manage our cost structure in line with our revenue growth.

The effective tax rate for the quarter was 38.9% reflecting Q1 discrete tax items and our full-year estimated effective tax rate. On a GAAP basis our net loss for the quarter totaled $4.7 million or $0.18 per share based on 26.2 million outstanding shares.

Now I would like to provide some additional insight on our capital expenditures and liquidity. Capital expenditures during the quarter totaled $6.5 million including $4.1 million for technology equipment and software, $1.4 million for manufacturing equipment and building improvements and $954,000 in capitalized software development costs. Cash and liquid investments at quarter end totaled $109.2 million and our investments in auction rate securities had a fair value of $41.1 million. In addition, we continue to carry assets valued at $6.5 million representing the estimated fair value of the UBS right, which is exercisable beginning June 30 of this year.

At March 31, 2010 approximately 76% of our auction rate securities were AAA rated and 24% were AA rated and all investments continue to pay interest on schedule. We remain confident that the combined $156.8 million in available cash, investment and auction related balances are adequate to meet our current and future operating cash requirements. In addition, we continue to maintain a $20 million line of credit that is available through June 23, 2010.

To complete my discussion today I would now like to summarize our revised outlook for Q2 and the full-year 2010 together with some insight on our underlying assumptions. Consistent with our historical trends across each month in Q1 and continuing through this week we have seen a seasonal moderation in our site traffic and order volumes. While Q2 quarter to date growth rates are currently outperforming the lower levels from 2009 we expect the current economic challenges of high unemployment and low wage growth will continue to impact our business throughout 2010.

I would also like to emphasize that our growth rates in 2009 progressed from 5% in Q1 to 10% in Q2, 13% in Q3 and 22% in Q4. As a result of these increasing prior-year comps and the loss of $4 million in current year referral fee revenue, we expect to see continued healthy growth in our core business and a modest improvement in our annual revenue growth rates.

In terms of the components of net revenues we continue to expect some improvement in non-holiday growth rates with more elevated increases around the traditional holiday and gift giving periods. We expect a consistent mix of revenues between new and existing customers with modest growth in average order values. Finally, we expect a continued shift of revenues from 4 x 6 and other print categories to our award winning line of personalized products and services.

With respect to our commercial print initiatives, we continue to make steady progress expanding our customer base and the number and variety of commercial print transactions. Consistent with our earlier guidance we believe 2010 commercial print revenues will likely range from $5-7 million and we have reflected this range in today’s financial guidance.

Finally, I would like to confirm that our referral fee program with Web Loyalty concluded effective March 31, 2010. As a result, we expect the total 2010 referral fee revenue of $2.25 million will represent less than 1% of our full-year revenue and that our reported 2010 average order value growth will moderate as a result of this change.

In terms of our cost structure for 2010 we remain firmly committed to our strategy of carefully balancing investments for growth with our philosophy of increased profitability and free cash flows. With the recent trends of improving business performance we are on plan with a number of new technology initiatives we believe will both increase the rate of innovation in our products and services as well as significantly improve our long-term operating efficiency. These investments are focused primarily on our core technology platform and user experience but also extend to our CRM and other marketing and analytical systems.

With these comments as context I will now summarize our updated guidance for Q2 and the full-year 2010. Starting with Q2. We expect net revenues to range from $43.5-45.5 million with year-over-year growth rates of up to 17%. Excluding referral fees this guidance reflects net revenue growth rates of up to 21%. We expect our GAAP gross margin to range from 45-47% of net revenues and our GAAP operating loss to range from $14 million to $13 million. Excluding referral fees this guidance reflects a year-over-year gross margin improvement of up to two percentage points.

As a result of reduced referral fee revenues and fees from IP licensing arrangements we expect our adjusted EBITDA will range between a loss of $2.5 million and a loss of $1.5 million and that our GAAP effective tax rate will range between 32-38%. Finally we expect the GAAP net loss per share to range between $0.34 to $0.29 based on approximately 26.9 million weighted average common shares.

Turning now to the full-year 2010, we now estimate net revenues will total between $275-285 million with year-over-year growth rates ranging from 12-16%. Excluding referral fees this guidance reflects year-over-year revenue increases ranging from 14-18% versus a 16% comparable growth rate in 2009. We expect the full-year GAAP gross margin to range from 53-55% of net revenues. Excluding referral fees this guidance represents a gross margin improvement of up to 2 percentage points over 2009.

We expect our GAAP operating income will range from approximately $8-13 million and our full-year 2010 EBITDA margin will range from 19-20% of net revenues. Excluding referral fees this revised guidance reflects year-over-year improvement of up to 1.4 percentage points in our annual EBITDA profitability. The full-year GAAP effective tax rate is expected to range from 33-37%. As a reminder, as of December 31, 2009 we had substantially utilized our federal net operating loss carry forwards. As a result, we expect to accrue taxes payable for federal purposes during 2010 and will begin remitting cash taxes in early 2011. We continue to maintain net operating loss carry forwards for California state taxes and do not expect to generate any significant California tax liabilities during 2010.

We now expect the full-year GAAP net income per share will range from $0.20 to $0.29 per share based on 29 million weighted average diluted shares. Consistent with our prior guidance we expect that full-year 2010 capital expenditures will range from 7-9% of net revenues.

Finally, I would like to comment on our equity compensation program and our expected levels of stock based compensation. Like nearly all technology driven e-commerce companies we include stock options and restricted stock grants as key components of our total employee compensation arrangement. These programs are essential to our efforts to attract, motivate and maintain top employee talent and are regularly updated to ensure they are as effective and efficient as possible. Over the past three years the net dilution from our employee grant has steadily decreased and approximated 3.6% for the full-year 2009. Like our philosophy of improving profitability and free cash flow we also believe that optimizing the use of equity capital is essential to maximizing shareholder value.

With respect to the amount of stock based compensation recognized in our financial statements, it is important to note the amount of stock based compensation is based on the grant date fair value. By definition these fair value calculations are very sensitive to stock price changes as well as to the number of new and existing employees. With our stock price increasing approximately 130% in the past year, combined with the planned increases in strategic hiring described earlier, our current forecast for stock based compensation is necessarily greater than our beginning of the year estimate.

In summary, in light of the challenging economic environment we believe that our updated Q2 and full-year 2010 net revenue and profitability guidance reflects our most recent operating performance and is appropriately thoughtful given current market conditions.

With that, I thank you for your time today and look forward to speaking with many of you in the days and weeks ahead. We will now open the call for your questions.

Question and Answer Session

Operator

(Operator Instructions) The first question comes from the line of Youssef Squali – Jefferies & Company.

Youssef Squali – Jefferies & Company

Can you help us get insight into how much of the upside this quarter was from just the macro environment improvement? I know it is a tough question but Mark in his remarks talked about how the macro environment continues to be tough which would imply that most of the upside that we have seen this quarter is from your own doing. Can you maybe shed a little more light on that? Then, any more seasonality this quarter I guess Q1 to Q2 versus prior years that would justify the flat sequential guidance?

Jeffrey Housenbold

It is hard to fully quantify. I do think we hit the bottom of the macroeconomic cycle in Q1 of last year as it was reflected in our year-over-year revenue growth. Last year we had 5% revenue growth so I think we were lapping a little bit easier comps and that will get tougher as we go throughout the year. Clearly the initiatives we have been executing against are starting to pay off. Simple Path is crossing the chasm to mainstream users and selling more Photo Books, our re-design of our cards and stationery line along with enhancements to the user experience, both of those contributed to a 43% growth in our personalized products and services. That was driving higher average order value.

As well, we saw a significant uptick in our new customer acquisition during the quarter. So our integrated marketing plans and execution against those across both online, offline and partners seems to be working and the overall product proposition relative to the analog retail print at home, I think people are becoming more aware of the space and the differentiated products and services we are offering. Overall it was a very strong quarter for us. I think the momentum we had in the fourth quarter continued into the first quarter. I think we benefited slightly from the easier comps and I think those will get a little tougher throughout the year.

Youssef Squali – Jefferies & Company

So wouldn’t that mean as the economy improves and everybody seems to agree things are getting better particularly for the consumer, if anything should actually see further improvement or an acceleration? Anything you are doing yourself is obviously sustainable.

Jeffrey Housenbold

I am not sure and I will let Mark add his comments here. I think the panic has subsided and I think people’s perception we are just in for a long haul of moderate growth with sustained high unemployment. If you look at unemployment and under employment rates if you look at housing values and if you look at the tightening of consumer credit, all of those things remain very difficult for the consumer. I am not sure I agree we are in a substantially better economic environment than we were. I think we have stability in the financial systems and I think there is some concern about weakening dollar and unsustainable government subsidies that might lead to inflation. But clearly the sentiment has improved but I am not sure the underlying metrics have.

Mark Rubash

I would only add that at least from the data I have been looking at a lot of the consumer spending is coming out of savings right now. It is not coming out of employment growth or wage growth. Ultimately I don’t think that is going to be sustainable although certainly it is improved from where we were. To your other question on the Q1 to Q2 guidance, in terms of dollars and growth rate I think it is relatively flat. The trends we are seeing so far, as I mentioned in the prepared remarks, clearly January was our strongest month of the quarter and historically that has always been the case.

All of the metrics tend to kind of decline sequentially in months and have continued to do that into April. It really is about the time once you get past Mother’s Day and into Father’s Day and the latter part of Q2 that you start seeing any upward trend because of those holidays. One, it is early in the quarter. I think adjusted for Web Loyalty growth rate of about 21% combined with the 5% increase in the comp puts you at a pretty comparable growth rate we saw in Q1 which for the industry and the economy I think is a pretty good place to be.

Operator

The next question comes from the line of Mitch Bartlett – Craig Hallum Capital Group.

Mitch Bartlett – Craig Hallum Capital Group

Maybe you could describe from both the perspective that I am a Shutterfly customer and I am not a Shutterfly customer and I am an avid Facebook user, what can I do on Facebook now from both those perspectives? How are you reaching me if I am not a Shutterfly customer?

Jeffrey Housenbold

If you are an existing Shutterfly customer you can create a Shutterfly Photo Book and you can share that digitally today and we allow you to share that digitally via email or post it to your Facebook account, MySpace account, blog, live journal and other places across the web. So you can start to showcase the products you are making. If you are a Shutterfly share site owner we are now connected to Facebook connect allowing you to leave comments, tag people and do a variety of other tasks without logging in directly. If you have an iPhone or a Facebook account you can make a Shutterfly photo strip through Wink using your Facebook, iPhone or Shutterfly or Flickr images. So you can see we are starting to open up the platform and become more interoperable with the various places that people have images stored across the web.

I think what continues to make us unique is we take the original resolution image, we offer highly tuned, easy to use creation paths that allow you to turn your memories into everlasting, high quality products. If you are not a Shutterfly user today you can use Wink and again through Facebook but Facebook down samples and compresses their images and so you can make some products from Facebook images today but certainly not at the size and the quality that you can if those original resolution images are sitting on Shutterfly.

We hope in the future as Facebook continues to evolve that they continue to open up the platform and make accessible interactivity between the Facebook images and services like Shutterfly. Lastly, Shutterfly is using Facebook in their adverts as a way to attract new customers so our fan page at the end of the quarter had attracted more than 88,000 customers. We are also doing some advertising across Facebook making people aware of our products and services. It is still early days in the social media landscape and I think we are ahead of the competition and it is a testament to some of the activities we recently did on the home page with our Community Tab using social media to attract new customers and provide a place for our evangelical, loyal customers to kind of help sell on our behalf.

Mitch Bartlett – Craig Hallum Capital Group

Have you seen any Photo Book fatigue on older customers? What percentage of the business are Photo Book at this point?

Jeffrey Housenbold

One of the interesting things about a year ago we did an in depth study of Photo Book users because we weren’t seeing the level of repeat transactions we had anticipated. We went out and talked to our customers and essentially we were asking them why they left Shutterfly. The resounding answer was we didn’t leave Shutterfly. We just didn’t have another 50th wedding anniversary or new baby or wedding or some monumental kind of life milestone. That is when we kind of transitioned from our customers felt our books were so nice they felt they looked for special occasions. When we started to build in enhancements to the creation path and ultimately Simple Path so that people can engage with their memories on a more frequent basis without the complexity, the time and perhaps the price point of our large, hard covered Photo Books. So the introduction of soft cover Photo Books and the introduction of Simple Path is creating more frequency of purchase and again our goal is to cannibalize those 450 million 4 x 6 print transactions that happen in America every year and migrate those into Photo Book creations by using Simple Path and other enhancements we are working on.

In terms of Photo Books as a percentage of revenue we haven’t broken that out specifically. What we have said is Photo Books this year will be the biggest product line for us in terms of revenue and the fastest growing and we believe we are by far and away the market share leader in the Photo Book space in the United States.

Mitch Bartlett – Craig Hallum Capital Group

The AOV confuses me. It has just popped tremendously yet your print was obviously up in volume and down in price. I am trying to reconcile that. What would be the AOV increase on the personalized products and services? It was dramatic.

Jeffrey Housenbold

I don’t have that exactly in front of me. We were very pleased to see unit growth on prints up double digit percentage. Again, we have the highest quality and the lowest cost because we manage our own manufacturing and we have a price umbrella so we make a very nice profit on the 4 x 6 prints and we are using that profit to reinvest in the Photo Book cards, calendar and personalized products and services business. So it is nice that consumers are recognizing the overall value proposition. We don’t delete. We don’t down sample. We don’t compress. We offer free share sites. We offer 100% satisfaction guarantee, the most designs, the easiest to use creation paths and the highest quality products. That is a value proposition not just a price game. We think that is going to bode well for us through this soft macroeconomic environment and will continue to allow us to expand both the top line and the bottom line as the economy continues to improve.

Mark Rubash

I would just add that I think the trend we are seeing in AOV continues to be primarily driven by a combination of one, a shift to personalized products away from prints. You are having less frequent orders per period whether it is quarter or for the year but the size of the order is larger because they are increasingly Photo Books and multiple copies or large volumes of calendars in the case of Q1. The other is the continued use of free shipping with a minimum purchase hurdle. This continues to be a healthy thing for our business and a favored promotion by our customers that causes order consolidation. I think those two factors are what is contributing to the longer term trend of increase in AOV.

Operator

The next question comes from the line of Analyst for Jim Friedland – Cowen & Company.

Analyst for Jim Friedland – Cowen & Company

In Q4 you mentioned non-holiday demand was modest. Could you talk a little bit more about holiday versus non-holiday demand in Q1 and also how that compares to what you have seen in April?

Mark Rubash

I think I would say it was slightly better in particularly the latter part of January and February than what we saw last year. The trends I would say are pretty consistent with Q4. Certainly better. Q4 was an anomaly just because of the size but Q1 to Q1 we definitely saw improvement in the first part of January which we view as a holiday period because our customers have lots of photos coming off of the Christmastime holidays and New Years as well as the calendar activities.

The non-holiday growth periods are looking pretty consistent with what we saw in Q3 and the early part of Q4. It is better than 2009 but certainly not as strong as the core holiday and gift giving periods.

Analyst for Jim Friedland – Cowen & Company

On the commercial print, do you have any plans to hire more sales people now that it seems like it is growing pretty well?

Jeffrey Housenbold

Our intent is to continue to work through our channel partners like Groupo and [Inner Workings] who are already aggregating demand. We will opportunistically add or subtract sales people as their particular vertical expertise or their ability to hit their sales quota but we are not anticipating building a large, direct sales team.

Analyst for Jim Friedland – Cowen & Company

You talked a couple of times about share sites. Is that at this point a significant percentage of photo uploads or is it still just sort of early and growing?

Jeffrey Housenbold

It is early and growing. What we saw in the quarter was very healthy growth in the number of shares sent via our share sites. We kind of think about three, if you will, activities for our share sites; site creation, site engagement and site monetization and for the quarter we focused largely on site engagement through the work we did with Facebook Connect and the tagging and some of the added features and the redesign of the experience so we could get people not to just create them and share once or twice but to make it such they want to use this as an ongoing vehicle for sharing their photos for the aggregation of pictures across multiple camera users for the creation of product downstream where we get greater monetization.

Share sites is having an impact on new customer growth, the number of share sent and the number of photos uploaded all in a very positive way and it helps differentiate us further across the mainstream competitors we have in terms of the retailers who are Snapfish and Kodak.

Operator

The next question comes from the line of Shawn Milne – Janney Capital Markets.

Shawn Milne – Janney Capital Markets

I apologize if this is redundant. I was just jumping on from another call. I wonder if you could talk about the acceleration in [NPP&S] growth up over 40%. How much did Simple Path play into that?

Jeffrey Housenbold

We saw healthy growth across the [PP&S] landscape primarily calendars were stronger than anticipated. In January we saw very healthy growth throughout the entire quarter of Photo Books and our new stationery and our traditional greeting card line performed very well. We added some new occasions like baptism and Easter. We added new birthday lines. We continue to add fresh designs month after month. So there was strength across the entire line but Photo Books were particularly strong in the quarter and Simple Path definitely had a contribution to that in attracting new customers into the Shutterfly franchise and in increasing orders from existing customers who might not have made a Photo Book but simply might have needed prints in the past but given the opportunity and ease of use of Simple Path are now engaging in Photo Books where in the past they might have engaged in simply 4 x 6 prints.

Shawn Milne – Janney Capital Markets

With the anniversary of the price cut on the print side do you think you are just pulling a little bit away with Simple Path from the prints which is of course the trade off you would make?

Jeffrey Housenbold

It is hard to specifically tell because we saw, as I indicated, healthy, double digit growth rates in units of both 4 x 6 prints and prints overall. So we saw growth there and we saw growth in our Photo Books. So I think we are benefiting from that secular trend from analog to digital, from print at home to utilizing the web to be more creative and we are benefiting from our singular focus and the high quality and brand equity we have been building vis a vie the competition.

Operator

The next question comes from the line of Kristine Koerber – JMP Securities.

Kristine Koerber – JMP Securities

On the social networking platform, can you really monetize that customer down the road? Typically that customer is more into photo sharing. How are you going to go about monetizing that customer?

Jeffrey Housenbold

I get asked this question a lot from the mainstream press which is isn’t the social media phenomenon killing your business. The opposite is true. If you look at our growth rates in both revenue and EBITDA and free cash flow, 2009 was a record year. Q1 here in 2010 we continue to outperform overall e-commerce. I think the proliferation of digital cameras, broadband connectivity and social media is just increasing the awareness and the accessibility and frequency in which people are taking pictures, sharing them and interacting with their memories. There are both occasion based and psychographic and demographic based reasons why people want to continue to print, send invitations or make personalized gifts.

I think a lot of that is demographic based as people move into their late 20’s they start to get engaged, travel, buy a home, have a wedding, have children, those occasions tend to generate a shift in people’s behavior to more of a preservation of memories versus just simply a sharing of memories and where they want to give gifts about weddings and new babies and firsts in the children’s lives. It is still early on in these days but the investments and innovation we are making through our mobile iPhone app, Wink, our initiatives on Facebook and Twitter, all of those and making Simple Path targeted and our designs targeted to a wider socioeconomic base I think is going to benefit us in the future.

While a lot of pictures are being shared across Facebook the number of images being printed is relatively stable. It is just that people don’t have a cost anymore of taking images so they take a lot. I think we have been a leader in integrating with the social media both on our own Share Sites and places like Facebook in that we have a demonstrable lead in that space and we look to continue to innovate it.

Kristine Koerber – JMP Securities

Any idea on how long it is going to take or how far down the road before we do see some revenues generated or kind of the shift to more print than sharing?

Jeffrey Housenbold

I think we are already seeing benefits from our Share Sites. They show up in our new customer numbers, in our revenue numbers as well. Then today Facebook doesn’t make any money from the images that are flying across their network directly. It attracts people and so they sell advertising. They are not in the photo business in the way that we are. It is a service they offer to get advertising where we are kind of a nice complement to what they are doing. As we continue to open up our platform and continue to interoperate with them we think there is opportunity to further monetize the Facebook phenomenon.

Kristine Koerber – JMP Securities

As far as the competitive environment, any significant or meaningful changes recently? Do you have any data on market share gains from the competition?

Jeffrey Housenbold

Nothing significant in the competitive landscape. We haven’t seen any significant innovation out of the mainstream competitors. Again this is just a part of what they do be it if you are a Wal-Mart or if you are an HP or Kodak the direct to consumer online piece is a very small part of what they do. So they are not focused on innovation in that space. So it has been a relatively stable environment for us. Because we have a very strong balance sheet and that singular focus during the market downturn investments we made during that period are starting to bear fruit in 2010 and I think will allow us to expand our lead in 2011 and beyond.

In terms of specific market share we certainly do our own proprietary channel checks. It indicates that we are continuing to take share of the existing customers but also take a larger share of new customers coming into this space. Then really from an external standpoint InfoTrends is the only third-party who really does a market share study. To my knowledge their report will be coming out in the next week or two which we are hopeful and confident it will validate our continued share leadership.

Operator

The next question comes from the line of Imran Khan – JP Morgan Securities.

Imran Khan – JP Morgan Securities

In terms of gross margin did you say how much your gross margins would have been up if you take out the referral revenue from both Q1 of 2009 and 2010? Secondly, it seems like Easter was a week earlier, April 4th versus April 11th last year, did you see any impact from that? Did that help your revenue growth rate? If so any kind of quantification would be helpful.

Mark Rubash

On the first part of gross margin if you exclude web loyalty from all periods our guidance for Q2 and the full-year at the high end would reflect up to a 2% increase in gross margin.

Imran Khan – JP Morgan Securities

I was talking about Q1. Not guidance. I got that. I was trying to figure out how much…I think your gross profit margin [inaudible] 600 basis points in Q1.

Mark Rubash

It was less than that. The web loyalty was slightly higher in Q1 this year than last. The biggest components of the gross margin improvement this year the biggest part for sure came from improvement in mix. But also significant improvement from labor efficiencies, material cost improvements and shipping cost improvements. Those partially offset by the level of product discounts we do. Then the dollars that we were lapping from the Hayward move, it was about $600,000 from last year that did not recur this year. So that is also a component.

Clearly the lion’s share of the dollars and the percent improvement in Q1 is from product mix and manufacturing efficiency.

Jeffrey Housenbold

We are taking about $4 million of revenue out from the web loyalty for this year and yet we have increased the bottom range on EBITDA for the full-year and we are seeing sustained gross margin improvement in the core business. I think that is a testament to the strength of the core business and the discipline we have been putting in on the cost side over the last 24 months.

Imran Khan – JP Morgan Securities

With regard to Easter, did you have any impact from Easter in Q1 results? The timing of Easter?

Jeffrey Housenbold

It was a modest impact. Easter is not a particularly large holiday for us. It had a modest impact and was largely just timing.

Imran Khan – JP Morgan Securities

Going back to the gross margins question it seems like mix shift and labor efficiencies doesn’t sound like a one-time event. Why do you think the gross margin [only took] a 200 basis point improvement throughout the year? Are you expecting mix to reverse shift? That doesn’t make a lot of sense.

Mark Rubash

200 basis points, we have been at 55% for the last five years. To actually move two percentage points in one year is a pretty significant achievement in a tough economy and a competitive environment. So we actually feel pretty good about the improvements we are making.

Operator

The next question comes from the line of Colin Sebastian – Lazard.

Colin Sebastian – Lazard

First of all I was wondering if you could provide an update on any impact you are seeing from the Share Sites and the mobile apps on order patterns? Separately, any changes in your potential uses of cash?

Jeffrey Housenbold

We haven’t broken out the detail on the share sites. I think the previous comment was that share sites are becoming a meaningful new customer acquisition tool that is having a very positive impact on the number of shares sent which means people are interacting with their images on a more frequent basis. It is benefiting groups like classes, youth sports and companies and teams and bringing those people into the fold. So we are very pleased with the investment in our share sites and believe it continues to differentiate us in the marketplace and we have the technology learning curve we have built up in building a flexible social network is a very valuable comparative advantage. We haven’t spoken about the order patterns specifically.

As it relates to cash we have approximately $156-159 million in cash and cash equivalents plus auction rates and we continue to keep that as a war chest for potential mergers and acquisitions.

Colin Sebastian – Lazard

Is there any change on the acquisition front? Anything closer to the front burner?

Jeffrey Housenbold

Nothing we can talk about today. I think you know we as a leader in this space with a healthy balance sheet and a focus we are part of all of the meaningful conversations that are going on in the industry and will continue to evaluate M&A and organic growth as it relates to our strategic plan over the next few years.

Operator

The next question comes from the line of Scott Devitt – Morgan Stanley.

Scott Devitt – Morgan Stanley

First, the number of iPhone app downloads you have had. If you disclosed that or if you could that would be great. Secondly, the Kodak gallery and Snapfish both in different ways have begun to charge or force customers to actually buy product and have content stored on the site over time and I was wondering if you had any information in terms of customer acquisition that you have gotten from changes in their competitive initiatives over time maybe in the past six months? Any update on the possibility of a premium product offering in your business of offering more storage for a price?

Jeffrey Housenbold

I don’t have the specific number of iPhone apps in front of me. On the prepared comments we talked about the number of Wink application downloads. Both the Wink and the iPhone application are not a meaningful contributor to revenue today. I think it is still an early kind of sandbox experiment not only for Shutterfly but for many companies as they are trying to figure out the use of mobile. So we will continue to test and learn. But the folks who have downloaded the app, the comments we get and the ratings seem to be very favorable.

Kodak, Snapfish and the industry as it relates to storage, yes they do charge for storage or they force delete images but that extends beyond them. If you look at Flickr and Photoshop and SmugMug most of the players in the industry are charging for storage. We have never charged for storage. We don’t down sample, compress or force delete and we think that is part of the reason why we are outpacing the customer centered approach of delivering both high quality and the good user experience. The cost continues to decrease as we get efficiencies in the storage architecture and the cost of hardware continues to decrease in the environment.

The way we think about internally our storage costs and our policy it is really part of the customer acquisition and the customer retention spend and we look at that as a totality of how much we spend on advertising and the positive word of mouth that comes from the happy customers that are part of our franchise. We will continue to offer free, unlimited, no forced delete policies.

In terms of premium storage products we continue to evaluate what is out in the marketplace. There are a number of players from EMC and Iron Mountain and Picasa and Microsoft and Apple who have subscription models but their storage covers more than just photos. They cover all types of file types so we are still in the evaluation stage of trying to figure out what is a premium subscription services we would offer that goes beyond just simply offering storage.

Operator

The next question comes from the line of Joseph Okleberry – Morgan Stanley.

Joseph Okleberry – Morgan Stanley

In terms of customer acquisition we saw this quarter a lot of the display advertising companies report really strong growth year-over-year and much of that strength was driven by increases in pricing. I wanted to get a comment from you guys on what you are seeing on the advertising front and if you are seeing any pressure on ROI from customer acquisitions.

Jeffrey Housenbold

I think Mark said in his prepared comments we saw about a 4% increase in the cost of customers. Part of that is the competitive landscape of our vertical. Part of that is just a rebound in the economy. Part of that is as companies feel better they are going back to spending. We look at not only the cost of advertising but we look at the total cost of acquisition per customer. We get the benefit of the viral nature, word of mouth, share sites and some of the partner marketing we do so our overall cost of acquisition continues to remain very low.

Some increases in CPC and display rate is being offset by optimization and landing page creative and mix, and also as ad networks continue to become a bigger piece of the overall mix we don’t have to go pay the premium CPMs on a targeted site. We can now start to target those customers who visit that site, off of that site through the networks and pay a much lower CPM to get our message in front of them. So I think overall a slight increase in cost of acquisition offset by the increased average order value and the optimization that we are doing.

Joseph Okleberry – Morgan Stanley

I think you mentioned you are doing some experimenting with advertising on Facebook and I just wanted to get your sense on how that is performing.

Jeffrey Housenbold

It is still kind of I would say in that experiment phase as we learn how to target users on Facebook. Unlike, say the social gaming companies where you can play the app, if you will, within the Facebook environment we are trying to get people to click off of Facebook which not only for us but it has been a hard thing for many advertisers. So people are using it as an awareness build and more of a run of network. So at the high level the ROI on our Facebook spend has been positive but paid search and some other CPM buys we have been doing have a higher ROI.

Operator

The next question comes from the line of James Cakmak – Sidoti & Company.

James Cakmak – Sidoti & Company

You talk about the elevated level of investments you are going to make particularly in technology and yet the technology and development line was an expense line you were able to leverage the most. Can you provide some more depth into where those investments are going and how they are being allocated?

Mark Rubash

Keep in mind in the tech and dev line there is really three major components; one is the engineering change where we are actually adding quite a few people. A number of folks joined in the quarter. We expect another increment will join in Q2 and a few in Q3. So we are definitely adding engineers and QA types in working on the platform and user experience. Where we are getting the leverage is on the site operations side. So the cost of co-lo centers, bandwidth, telecommunications and so on, those areas were roughly flat year-over-year where they had been increasing mostly in the past few quarters.

We are also getting the benefit from a declining depreciation rate as our capital spending continues to come down from where it was a few years back. What you are seeing is the leverage coming from the operating side of running the website and lower capital expenditure rte being used to finance investments in technology innovation. I would expect the tech and dev line will increase as a percent of revenue as the employees we are bringing on board get in place over the next couple of quarters.

Jeffrey Housenbold

As Mark and I said in our prepared comments, we are investing in platform, new feature functionality and new product lines and in customer analytics and one-to-one marketing capabilities so we can continue to enhance the conversion rates from visit to purchase.

James Cakmak – Sidoti & Company

If you haven’t already addressed this was there any update on the potential opportunities for international expansion?

Jeffrey Housenbold

We didn’t comment on it. We continue to evaluate the [build by] partner scenario. We think there remains an opportunity for Shutterfly to take our products and our service and our brand on a global basis.

Operator

There appears to be no further questions in the queue. I would like to turn the program back over to you for any final comments.

Jeffrey Housenbold

I want to thank everyone for joining us for our Q1 2010 earnings call. I think we had very solid execution across the business. Top line revenue growth, improvement in gross margin and EBITDA reflected in our updated guidance and we are excited about the innovations we continue to drive in the industry. We look forward to talking to you guys a quarter from now.

Operator

Ladies and gentlemen this does conclude today’s program. Thank you for your participation. Have a wonderful day.

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