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Shutterfly (NASDAQ:SFLY)

Q1 2014 Earnings Call

April 30, 2014 5:00 pm ET

Executives

Michael Look - Vice President of Investor Relations

Jeffrey T. Housenbold - Chief Executive Officer, President and Director

Brian M. Regan - Chief Financial Officer and Senior Vice President

Analysts

Youssef H. Squali - Cantor Fitzgerald & Co., Research Division

Colin A. Sebastian - Robert W. Baird & Co. Incorporated, Research Division

Heath P. Terry - Goldman Sachs Group Inc., Research Division

Paul Judd Bieber - BofA Merrill Lynch, Research Division

Rohit Kulkarni - RBC Capital Markets, LLC, Research Division

Mitchell O. Bartlett - Craig-Hallum Capital Group LLC, Research Division

Kerry K. Rice - Needham & Company, LLC, Research Division

Stephen Shin - Morgan Stanley, Research Division

Shawn C. Milne - Janney Montgomery Scott LLC, Research Division

Victor B. Anthony - Topeka Capital Markets Inc., Research Division

Trisha Dill - Wells Fargo Securities, LLC, Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Shutterfly First Quarter 2014 Financial Results Call. [Operator Instructions] I would like to turn the call over to your host, Michael Look, Vice President of Investor Relations. Please go ahead.

Michael Look

Thank you, operator. Good afternoon, everyone. Welcome to Shutterfly's first quarter fiscal 2014 financial results conference call. With us today are Jeff Housenbold, Chief Executive Officer of Shutterfly; and Brian Regan, Chief Financial Officer. By now, you should have received a copy of our earnings press release, which crossed the wire approximately 1 hour ago. If you need a copy of the press release, you can go to shutterfly.com under the Investor Relations link to find an electronic copy. We've also released the presentation that we will use as we go through this call. Call participants are advised that the audio of this conference call is being recorded for playback purposes and that a recording of this call will be made available on our website within a few hours. You can access these recordings 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 the Securities Act of 1933 and the Securities Exchange Act of 1934. These forward-looking statements include statements about our business outlook and strategy and the assumptions underlying those statements, and statements about historical financial results that may suggest trends for our business. For more information regarding the 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 Risk Factors section of our most recent Form 10-K and Form 10-Q and other filings with the SEC. I would also like to note that any forward-looking statements made on this call reflect information and analyses as of today, and we assume no obligation to update this information. This presentation contains certain financial performance measures that are different from the financial measures calculated in accordance with GAAP, and may be different from calculations or 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 first quarter fiscal 2014 financial results press release, which is posted on the Investor Relations section of our website at shutterfly.com.

Now I'd like to turn the call over to Shutterfly's CEO, Jeff Housenbold. Jeff?

Jeffrey T. Housenbold

Good afternoon, everyone, and welcome to our first quarter 2014 earnings call. As you can see from our press release issued earlier today, Shutterfly is off to a strong start to the year. We saw solid growth in our Consumer business, driven by increases in customers, orders and average order value, which drove Q1 financial results that were at or above the high end of our guidance ranges for revenue, adjusted EBITDA, net loss and earnings per share.

Q1 represented the 53rd consecutive quarter of growth in net revenues, which totaled $137.1 million, an increase of 17.5% from the prior year. Our better-than-expected first quarter revenue growth was driven by continued strength in our Consumer business, which grew 19% year-over-year, underscoring the improvements in brand awareness and customer engagement resulting from our integrated marketing approach and our data-driven pricing and promotional strategies.

Total unique transacting customers grew 14% during the quarter and resulted in a 13% increase in orders. At the same time, we were able to drive healthy improvements in average order value, which increased by more than 5% year-over-year to $33.76, a first quarter record.

Adjusted EBITDA for the quarter was $186,000, towards the top end of our guidance and down from Q1 of 2013. Year-over-year comparisons for Q1 EBITDA are difficult because we shifted certain investments into later quarters last year, plus we recognized higher annualized cost from previous acquisitions and costs associated with our larger Fort Mill, South Carolina facility. These additional costs were only partially offset by continued operational efficiency gains resulting from our increased scale.

During the first quarter, we made significant progress against several of our key strategic initiatives, including our ThisLife enhanced cloud service, the relocation of our data center to Nevada and the build-out of our Midwest production facility in Minnesota. These strategic initiatives are on track and, when completed, should address many of the emerging challenges that consumers face in managing their memories, and provide future scale and scope efficiencies that will improve our bottom line as we head into 2015.

Let me provide some more details into these strategic initiatives and our continued innovation during Q1, starting with ThisLife.

Our enhanced cloud team made great progress on ThisLife, introducing new features and functionality to our beta service. Recent enhancements include a new facial recognition algorithm, personal ratings for photos and videos, hide and filter capabilities and an easier and more comprehensive approach to searching memories using any combination of variables, such as people; place; tags; date taken; media type, such as photos and videos; favorites; camera model; import/upload source; uploader, if you happen to have a joint account; hidden moments; and whether the photo or video has an audio note.

During beta, we have been focused on aggregation across all devices and platforms and intelligent organizational features. We will continue to add features in these areas and shift our focus towards smart product creation in the latter part of 2014.

As we've indicated earlier, ThisLife remains on track to come out of beta this summer. In our core memories and social expression businesses, we continued our market-leading pace of innovation, adding several exciting new products, styles and premium options to our existing portfolio of high-quality personalized products, as well as improving our customer experience across all of our brands.

For example, in our Wedding Paper Divas brand, we updated our brand expression. We made several site navigation enhancements, driving higher conversion rates, and launched new products including a signature foil-stamped collection, new mini cards, new envelope colors and liners, invitation belly bands, circle sticker labels and wraparound address labels.

On our Shutterfly brand, we launched new personalized products, including metal prints, mugs, luggage tags and pillows, and expanded the frame assortments sold through Hallmark. We also optimized our award-winning Photo Book line with enhanced cross-sell capabilities, searchable design content and embellishment background and layout favoriting. We also launched the pilot of our new Make My Book service. This new service allows customers to specify book size, style and photos, and our concierge service team will create the book.

During the quarter, we also made enhancements to our iPad Photo Story app, including new styles, expanded layout and our newest feature, called doodle.

The Treat team launched hundreds of new cards, improved the reminder service, enhanced cross-sell for personalized gifts, expanded the gift card assortment and introduced new Treat Card Club packs and free digital cards. Our marketing and business development teams made solid progress during the quarter as well, generating increased marketing efficiencies and reaching new levels of brand awareness. We launched new partnerships with Macy's and Babies R Us and added industry-leading and celebrity designers such as Marchesa, Claire Pettibone and Victoria Justice. We also continue to work closely with our key advertising partners, including Facebook, where we participated in their new commerce program; Pinterest, where we're one of the few companies invited to their new partners program; and with Google, where we partnered on a case study to measure cross-device conversion, which was highlighted on their earnings call.

In addition to our browser-based consumer experience, we continued to expand and improve our mobile experience on both iOS and Android devices. Our mobile investments continued to gain traction with our customer base and resulted in mobile-related revenues for our flagship brand, more than doubling year-over-year. Mobile-related revenues represented more than 9% of Shutterfly brand revenue in Q1, up from 4% of revenues during the same period a year ago.

Now let me provide a brief update on our scale and operational infrastructure initiatives, starting with the relocation of our data center to Nevada. As we indicated 9 months ago on our Q2 2013 conference call, we have decided to invest in a new storage and co-location center to optimize our long-term cost structure and improve our service capabilities.

As previously mentioned, the build-out of this new data center located in Las Vegas is expected to add approximately $6 million to $8 million in onetime duplicative operating cost in 2014.

We will benefit from lower operating costs and the lapping of these onetime costs when the Las Vegas data center is fully operational in 2015. The build-out is on schedule and on budget, and we expect it to be fully operational in time for this year's peak holiday season.

Our other major infrastructure initiative this year is the opening of our Midwest production facility in Shakopee, Minnesota, which also remains on schedule and on budget. Our Shakopee facility is a core element of our supply chain optimization strategy. When completed, it will provide a level of redundancy in our manufacturing network; further support our scale and fulfillment strategies, such as next-day delivery; and increase customer satisfaction. Our lights on timeframe for this project is early Q3.

In summary, Q1 was another solid start to the fiscal year. We delivered robust customer and order growth while driving healthy increases in average order value. In addition, we leveraged our market-leading position and healthy balance sheet to further innovate our core businesses and early-stage initiatives such as Treat, wedding, mobile and ThisLife. We increased our overall brand awareness and made significant investments in our scale capacity, technology platform and operational infrastructure to drive our long-term profitable growth. I am pleased with our sustained high level of execution and remain confident in our strategy and ability to transform the multibillion dollar memories, social expression and personalized products markets from off-line to online. With that, I will now turn the call over to Brian to review our financial results and outlook in greater detail. Brian?

Brian M. Regan

Thanks, Jeff, and good afternoon, everyone. I'll begin my comments today with some observations about our first quarter performance, key metrics and operating results. I'll then conclude with an overview of our Q2 financial guidance and an update to our full year outlook for 2014 before opening the call up for your questions.

Earlier today, we posted first quarter results that were above expectations for net revenues, adjusted EBITDA, net loss and EPS. Taking a detailed look at our results. Net revenues for the first quarter totaled $137.1 million, representing a 17.5% increase over the prior year and above the $135 million high-end of our guidance range.

Q1 consumer revenue grew 19% year-over-year to $130.6 million, as strong sales of Photo Books, Photo Gifts and, to a lesser degree, calendars, drove robust growth in customers, orders and continued improvement in average order value.

Net revenues from our Enterprise business experienced a small year-over-year decline as some Enterprise projects were delayed into Q2.

As a result, Q1 Enterprise revenues decreased 6% year-over-year to $6.5 million. But this quarterly timing shift does not reduce our full year internal forecast for Enterprise.

As Jeff indicated earlier on the call, during the quarter, customers and orders grew 14% and 13% year-over-year, respectively, translating into $2.6 million unique transacting customers, which generated nearly 3.9 million orders across our 7 lifestyle brands.

Average order value for the first quarter was a record $33.76, up more than 5% from the prior year. Moving down to cost of revenues and gross margin. GAAP gross margin in the first quarter was 44.3%, 270 basis points lower than last year and slightly below our guidance range.

Our decline in gross margin was largely driven by higher depreciation, equipment and customer service expenses related to our new Fort Mill facility, as well as an unfavorable shift in product mix to lower gross margin products that are typically outsourced. These increases in cost of goods sold were partially offset by lower shipping rates and lower material costs related to our increased scale and in-sourcing.

Turning now to operating costs, excluding stock-based compensation, operating expenses totaled $84.4 million, reflecting increased headcount, the increased cost structure from acquisitions and purchase accounting amortization. Looking more specifically at our operating expense components, technology and development costs totaled $31.5 million for the quarter or 23% of net revenues.

Excluding stock-based compensation and depreciation, our technology and development spending increased approximately $4.9 million or 27% from the prior year. Q1's increase in technology and development spending largely reflects the incremental costs associated with recent acquisitions, as well as continuing strategic investments in technology and development headcount to support core products, mobile initiatives and ThisLife.

Sales and marketing expenses totaled $42.1 million in the quarter, representing 31% of net revenues and roughly in line with Q1 of last year. Excluding stock-based compensation and amortization, sales and marketing expense increased 17% from the prior year to $31.7 million or 23% of net revenues, also in line with Q1 of last year.

This increase in sales and marketing expense was largely driven by investments in our integrated marketing campaigns and a modest increase in headcount.

General and administrative expense for the quarter totaled $25.8 million or 19% of net revenues. Excluding stock-based comp and credit card processing fees, G&A expenses represented 11% of quarterly net revenues, which is slightly up from 10% in Q1 of last year, primarily driven by acquisition-related costs.

Adjusted EBITDA for the quarter was a positive $186,000 and near the high end of our adjusted EBITDA guidance range from a loss of $1.5 million to a positive $500,000.

Our Q1 EBITDA results reflect the combined impact of higher operating costs associated with our new manufacturing facilities and the annualized cost of acquisitions, partially offset by continued operational efficiency gains resulting from our increased scale.

Importantly, as Jeff alluded to earlier, it should be noted that in Q1, we also lapped the prior year shift of operating costs out of Q1 2013 to later in the year.

The effective tax rate for the quarter was 19.2%, and on a GAAP basis, our net loss for the quarter totaled $34.2 million or a loss of $0.89 per share, favorable to our guidance of net loss per share of $0.99 to $0.93 per share.

The weighted average shares used to calculate the net loss per share totaled 38.5 million shares. Our Q1 ending share count reflects the repurchase of 665,000 shares during the quarter at an average price of $52.04 for a total of $34.6 million under our previously announced share repurchase program.

Capital expenditures during the quarter totaled $21.5 million, including $12.6 million for technology equipment and software, $5.1 million in capitalized software development costs, $2.7 million for manufacturing and building improvements and $1.1 million for rental equipment.

And finally, cash and liquid investments as of March 31 totaled $315 million, reflecting our normal seasonal use of cash for working capital, as well as the use of cash for our share repurchase program and investments made during the quarter.

In addition, we continue to have access to up to $200 million in currently available funds from our untapped revolving credit facility.

To conclude our prepared remarks today, I'd like to summarize our outlook for the second quarter and fiscal year 2014. As Jeff stated at the start of this call, 2014 is off to a solid start. Our singular focus on consumers and our unwavering commitment to innovation, design-forward products and services, customer-friendly policies and industry-leading quality continues to enable Shutterfly to differentiate ourselves from the competition and drive solid financial performance. Based upon stable non-holiday growth rates with increased activity heading into Mother's Day, Father's Day and graduation period, we expect net revenues in Q2 to range from $154 million to $158 million, which reflects year-over-year growth of up to 18.4%.

We expect our Q2 GAAP gross margin to range from 46% to 47% of net revenues and our Q2 GAAP operating loss to range from $33.2 million to $32.9 million.

We estimate our adjusted EBITDA for Q2 will range between $6 million and $7 million and that our GAAP effective tax rate will range between 22% and 25%. We expect GAAP net loss per share to range from a loss of $0.75 to a loss of $0.72 per share based on approximately 38.5 million weighted average common shares.

Turning to the full year. We now expect our 2014 net revenues to total between $903 million and $920 million, continuing to reflect year-over-year growth of up to 17.4%.

We continue to expect the full year GAAP gross margin to range from 52% to 53% of net revenues and non-GAAP gross margin to be 53.6% to 54.6%. We now expect that our GAAP operating loss will range from approximately $0.6 million to GAAP operating income of $9.2 million, and our full year 2014 adjusted EBITDA margin guidance remains unchanged from 17.8% to 19% of net revenues.

The full year GAAP effective tax rate is expected to range from 15% to 23%. We now expect full year GAAP net loss per share to range from $0.38 to $0.15 per share based on 38.6 million weighted average common shares.

Excluding the effects of our convertible note offering, we expect non-GAAP net loss per share to range from a loss of $0.08 per share to a non-GAAP net income per share of $0.13.

And finally, our 2014 capital expenditure range remains unchanged from 9.5% to 10.5% of net revenues. So with that, we'll now open up the call for your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Youssef Squali with Cantor Fitzgerald.

Youssef H. Squali - Cantor Fitzgerald & Co., Research Division

Two quick questions, please. So I guess maybe just a clarification on that 19% growth in consumer revenues, was that all organic? If not, maybe you can just shed some light on what piece of it was nonorganic. And as you look at 2015 over 2014, maybe beyond just that $6 million to $8 million in onetime duplicative costs related to the data center in Nevada, can you also flesh out any other onetime costs that we are seeing in 2014 that are not going to be in there in 2015?

Jeffrey T. Housenbold

Sure, Youssef. This is Jeff. So we're not breaking out organic versus inorganic growth because most of what we've been acquiring are customer lists. And once we put them into our system and we start to push them throughout our CRM and promotional activity, it becomes more difficult to parse out, was it a acquired customer or existing customer, because there's often an overlap in those customer bases. There is some contribution from MyPublisher in the quarter and a small contribution from BorrowLenses as well. But we saw very healthy growth in our core business of Shutterfly during the quarter, with strength across-the-board of all of our products, photo books, cards and stationery, calendars, photo merchandise. So we're very pleased with the behavior of the consumer brands during the quarter. On your second question, there is $6 million to $8 million of duplicative OpEx cost, and then over a period of 3 years, we said there's about $35 million more of savings, mostly being generated from lower energy costs in Las Vegas versus in Santa Clara, that will flow through the P&L in 2015, '16 and '17 from the relocation of the data center. There is also some onetime costs and start-up costs related to Shakopee this year, but we will incur some start-up costs in 2015 from the opening of our new Arizona facility, where we're going to consolidate 4 existing locations into 1 better scale and better efficient plant, giving us also some growth capacity. So 2014, 2015 investment years, but you'll start to see, all things being equal, margins improve in 2015 as we lap the data center cost.

Brian M. Regan

And Youssef, it's Brian. One other additional note is in capital expenditures for this year, there is a bit of a onetime cost related to the Shakopee manufacturing facility startup. And we've said before that's in the mid-single-digit million dollar range. And that, coupled with the new Las Vegas co-location data center, is roughly the size, with that plus Shakopee, roughly the size of the capital that we spent for Fort Mill's opening. So that's just a little bit of color on the 2014 impact on capital expenditure.

Operator

Our next question comes from Colin Sebastian with Robert Baird.

Colin A. Sebastian - Robert W. Baird & Co. Incorporated, Research Division

I have a couple of questions, Jeff and Brian, first, just a clarification on the 2014 investment year, as we now sit here in Q2, are you still comfortable with the timing and progress of these investments? And related to that, as a follow-up on ThisLife, can you talk about, from your consumer testing, how users are using the app most frequently? And how you'll approach monetization as the beta test ends?

Jeffrey T. Housenbold

Sure. In the prepared remarks, I was thoughtful about calling out that all of our major initiatives are on track and on budget, and that includes Shakopee, as well as the data center, and we're on track to come out of beta into full release this summer for ThisLife. So very proud of the teams as they are executing under tight deadlines, they're meeting those deadlines and meeting our budget. On ThisLife, we are very pleased by the early receptivity by customers. They're aggregating photos across many of their devices and hard drives and cloud services. They're starting to use the feature functionality, they're providing input into some of the new features you saw us launch during the quarter, including favoriting and filters. And the conversion rate from free to purchase is very healthy. Now they're early adopters and so we would expect those conversion rates to be healthy, but people are paying for a product that says beta on them, and so that gives us encouragement. As we said in the past, there's different ways to monetize this. One is give it away free completely and get the downstream e-commerce. The other, on the opposite end, is charge for everyone. What we've decided to do is take a premium approach, giving away a base service of the cloud capabilities so people could get into it and use it and see how it helps their lives, and then some will convert and then we'll also get the downstream e-commerce. We're going to continue to play with different price points as we come out of beta here. We may give it away free to our best customers. We may provide discounts to some distribution partners. So we're going to kind of play in the early days to see what we think optimizes the long-term value of the asset for Shutterfly and our shareholders.

Colin A. Sebastian - Robert W. Baird & Co. Incorporated, Research Division

So is the emergence of Carousel, another sort of cloud-based application, that doesn't change your view on the pricing opportunity?

Jeffrey T. Housenbold

No, I mean, our pricing already is lower than Dropbox. And what you see from many of these cloud service companies, Microsoft, Amazon, Apple, Dropbox, Symantec, McAfee, Carbonite, Mozy, right, there's always been EMC and Seagate and Western Digital, there's been a lot of cloud storage companies out there. ThisLife is not trying to compete with cloud storage. ThisLife is a value-added application that helps people manage their memories and the ever-increasing volume of user-generated content in the form of photos and videos. We're not the only PowerPoint or Word or other types of documents. We're not positioning this as storage. This is really a way to interact with your memories and a faster way to make one-of-a-kind personalized products. And so the positioning is very different, the use case is different, and the capabilities will be different as well.

Operator

Our next question comes from Heath Terry with Goldman Sachs.

Heath P. Terry - Goldman Sachs Group Inc., Research Division

On the ThisLife product, just curious what you're seeing from an engagement standpoint in the early group of users on the product, whether it's best thought of either as a frequency or a photos uploaded perspective. What kind of profile in terms of users you're starting to see there, whether it's primarily existing Shutterfly users or potentially incremental users that are sort of new to the platform? And then when you look at sort of the contribution from mobile to the print business, is there anything that you see from a development standpoint, either on the app side of things or from a technology standpoint that you think will drive any sort of acceleration in mobile to bring you more in line with the contribution from mobile that other e-commerce sites see?

Jeffrey T. Housenbold

Sure. Thanks, Keith. I'll probably disappoint you a little bit, as we're not going to be giving away much data at this stage on the metrics -- the usage metrics for the customers on ThisLife. But I will say people are downloading it. They're adding sources, so beyond just Shutterfly and their desktop. They're interacting with it. They're tagging, particularly faces is a very popular tag. They're using it to create, they're coming back or adding other features, they're adopting it. So we're very pleased with the early adoption. There's still work to be done here. We haven't really done the go-to-market plan yet in terms of how we're going to position and market it to these customers. They're basically finding it on their own and they're engaging with it. And so that's encouraging. We think as we pour some fuel on the fire in terms of helping to guide them to the features, in marketing and building awareness. We are seeing people outside of Shutterfly use it. So first-time Shutterfly, Inc. kind of users are finding it, and that's encouraging as well. So as this exits beta and we get some non-beta traffic and data, we'll come back with some metrics that we'll share on a public basis. As it relates to your mobile question, we were very pleased with the more than doubling of mobile revenue during the quarter from 4% to more than 9%. And we saw that across our M.dot and T.dot enabled sites. We saw that across our iPhone and iPad and Android native apps. And so we're encouraged by that. As I've said before, I don't think mobile becomes as high a percentage of revenue for us than some other companies, for example, eBay or OpenTable, where it's an impulse buy, you got limited supply or you got an urgency of an auction ending or guilt where you know there's limited quantity. One of the reasons we have 18% to 20% EBITDA margins is because our products are unique, one-of-a-kind and you can't buy them on Amazon. And because they're unique, one-of-a-kind, the customer has to do more work to create them, and certain products don't lend themselves to certain devices like a photo book to a smartphone. So we're encouraged by the traction. We think it will continue to go up. But we don't think it's going to be as large as some other e-commerce companies.

Operator

Our next question comes from Paul Bieber with Bank of America.

Paul Judd Bieber - BofA Merrill Lynch, Research Division

AOVs continue to increase, and I'm wondering, are you guys effectively raising prices in core photo books and calendars and other core products? Or is there a mix shift going on towards higher AOV products like wedding-related?

Jeffrey T. Housenbold

Yes, Paul. It's primarily 2 things. One is a mix shift to higher base price books. So the 12x12s and the 10x10s. But it's also being driven by our cross-sell of premium features, premium leather, layflat, padded covers, cards. We see AOV increase from our scalloped and rounded corners, from foil embossment and hand grommet, from our direct mail, from our matched-back envelope liners and our matching address labels. So we're really driving a solution-based marketing approach versus a product-based, and we're getting good attach rates on up-sell and cross-sell, driving AOV up.

Paul Judd Bieber - BofA Merrill Lynch, Research Division

Okay. And one quick follow-up. At the top-end of the guidance range, it implies a little bit of acceleration sequentially. What gives you guys confidence in potential revenue acceleration?

Jeffrey T. Housenbold

We've been doing this quite a while and have a fairly robust forecasting mechanism. But in Q2, we talked often about the peaks and troughs. We have Mother's Day and Father's Day in Q2, which encourages us, given the growth of our personalized products. And then also you have graduation in Q2, which has been a very nice performing holiday for us for the last few years, just like Halloween has been. So Halloween, graduation, kind of emerging new holidays for our category, and as the leader, we are sweeping up more of that market share.

Operator

Our next question comes from Mark Mahaney with RBC Capital Markets.

Rohit Kulkarni - RBC Capital Markets, LLC, Research Division

This is Rohit Kulkarni. A broad question on your capital allocation philosophy, has anything changed as to typically how you approach build versus buy decisions? You have a very good track record of consolidating the space. But this year and next, it seems there is more focus on a lot of incremental internal things, fulfillment centers, data centers, stock repurchases. So does that take your attention away from inorganic growth opportunities?

Jeffrey T. Housenbold

No, I don't think at all. And, in fact, I don't think our strategy has changed. We've always been receptive to build, buy, partner or rent strategies, and we look at what is the best economic return given these set of opportunities, management bandwidth and the balance sheet at any given time. So we've always used our balance sheet to open new plants. We're doing that. Data center is another physical area where we're putting our balance sheet to work to significantly reduce OpEx costs in the out years. We still have plenty of firepower to do acquisitions and be able to digest those from management bandwidth. We are pouring more energy into hiring engineers into new services like ThisLife. But ThisLife was a combination of approaches that we did in December of '12, and we've been adding significant, with a 9, 10-person company, we've added significant internal resources to that as well. So it's going to continue to be a combination of build versus buy, and I don't see any changes in our historical patterns for '14 or '15.

Rohit Kulkarni - RBC Capital Markets, LLC, Research Division

Okay. And one quick question on the expense ramp and as it progresses through the year, it seems kind of the year-over-year deleverage seems to get less worse from Q1 to Q2 and flat in the second half. Any color around how we should think about Q4 margins? Would they actually expand year-over-year? Or how should we think about that?

Brian M. Regan

Yes, Rohit, it's Brian. So I think, first, you're going to see in the second half of the year, as we begin to lap the Fort Mill, South Carolina investment, that's going to be one component where we begin to reaccelerate, even getting -- going into Q2, we'll see gross margin, through a little bit more scale and revenue and volume in the business, begin to get some leverage in gross margin. And that will continue through the end of the year. So as we said the first time we made the big investment the size of Fort Mill, we literally saw a 6-month or less return on that investment as we saw gross margin in the fourth quarter of last year improved, and we still continue to invest whether it's build or buy, whether it's R&R Images on a buy or a build like the Shakopee, we continue to expect to get some leverage on those. Where we're getting delevered, as we indicated in this quarter, we are investing in customer service onshore and in-house, and we also have the depreciation and equipment expense to build out that scale. And so the direct variable cost of materials, labor and shipping continue to get leverage for us, and we continue to see and expect to see that through the fourth quarter of this year.

Operator

Next question comes from Mitch Bartlett with Craig-Hallum.

Mitchell O. Bartlett - Craig-Hallum Capital Group LLC, Research Division

Maybe you could just review Enterprise and why that business is so lumpy? And how the -- what the momentum looks like in Enterprise? And the second question would be on ThisLife, which we're all focused on. To what degree does that -- there's tons of customers who -- or individuals who have uploaded and used your storage services that are not active purchasers of your products. To what degree do they enter into the monetization and over what time frame?

Jeffrey T. Housenbold

Sure. Yes, we're very pleased with the progress on Enterprise. If you look, this, I believe, is the fifth year we've been operating in Enterprise, and revenues are growing at a very nice rate. The way it works, these are Enterprise customers who look at their marketing calendar and they decide to do different marketing campaigns and that changes frequently throughout the year. And if you recall, being a 4-color print-on-demand expert, in fact, the largest 4-color print-on-demand shop in the world, when they have those types of products and projects, they come to us. If they're going to do a static piece of marketing, okay, everyone get $20 off at Bed Bath & Beyond, then they don't need us, they go to offset. When they're doing personalized customer relationship management driving high ROI projects, then we're a best-of-breed partner. So it depends on the client, their marketing road map and the projects and the timing. It gets lumpy just like Enterprise sales because these are millions and millions to tens of millions of dollar projects that large companies like AT&T and Dell and UnitedHealth Group and other clients are doing. And so it just depends on the timing. In Q1, we had a couple of projects from existing customers kind of hit late in the quarter and they got shipped into the early part of Q2, and so that revenue is already booked in Q2. So no worries about the slight year-over-year decline in Enterprise revenue in Q1, we've already booked that in Q2. So very excited and optimistic about the future of Enterprise and where that's going. As it relates to ThisLife, Mitch, I think we are constantly going into our database into our inactive, so those are people who haven't transacted with us in the last 12 months, and try to reactivate them either by offering them a promotion on a single product or pushing a new feature functionality or new service like ThisLife. And we do that as a normal cadence of our CRM streams. We also take existing customers and we market to them in different ways depending on which data cell they fall into. We think there's -- because we have a relationship, because we have an e-mail address, because they like using our service and we have tens of millions of people use our free components that don't pay us, we think that's a rich database to be able to market ThisLife on a cost-effective basis as well. So we'll start doing that as we come out of beta.

Operator

The next question comes from Kerry Rice with Needham.

Kerry K. Rice - Needham & Company, LLC, Research Division

A lot of my questions have been answered or similar questions, but I think you touched on something with the last question that maybe you could expand on or help us understand a little bit. I think you guys are using data a lot more to kind of identify customers or maybe consumers that are on -- that could be on the verge of buying something. Can you maybe expand on kind of how you're using data to do some targeting? And how that might impact revenue growth through the year? Or maybe it doesn't impact this year or maybe it's 2015. And then the second question is kind of back to ThisLife. And I understand you said you probably aren't going to provide a lot of metrics. But one of the things that seems to come up is competition. And I know, not necessarily against the Dropbox or just kind of data storage, but more around maybe like Google's Picasa or stuff that Apple's doing. Can you talk a little bit about how you compete effectively against these products that have been out there for a while? I think Google's Picasa went through a refresh recently.

Jeffrey T. Housenbold

Sure. So we've always been big users of intelligent data, and we go from data to insight to recommendation to action. And it's just part of the DNA of the company. We have more PhDs and masters of statistics and econometrics and MBAs and math majors running around who are able to analyze that, and I think that's why we've been so successful with our conversion rates, our average order values, our cross-sell and our lifetime value. And with the advent of "big data", nothing's really changed in our approach, it's really just the tools have gotten better and cheaper for us. So we use data about the propensity and likelihood for you to purchase, which category will you purchase? How frequently will you come back? We'll use data about your age. Are you married? Did you come to us first for a Save the Date or a wedding invitation or a birth announcement? We know the age of your children because we're the largest online birth announcement company, the largest online wedding invitation company. We understand your purchase behavior and patterns. We overlay that with psychographic and demographic data so we can infer what products you might like. We look at your transactional data and which picture you use, and through our Photoccino acquisition, we're able to show you that picture on other projects and other products. Once you purchase, we look at how frequent do you upload, how often do you visit, do you have a share site, are you uploading with a mobile or DSLR? We use the data from that for cross-selling with BorrowLenses. So there's so much that we do with data. And the team every year gets a little bit better, a little bit smarter, and we eke out a little bit efficiency in our conversion rates and our adoption rates, and that drives top line revenue and bottom line profitability. So we're going to continue to invest in that. And given our scale and size and our expertise, we think that creates a true moat relative to our competitors, both traditional but also startups and large retailers. As it relates to your second question in ThisLife and competition. Keep in mind, we pioneered this industry in 1999. And since then, little David has been competing with the largest of companies like Walmart, Walgreens, CVS, Costco, Apple, Microsoft, AOL, Yahoo!, Kodak, HP, American Greetings, Hallmark, and Google, right? So we've been competing with these very large companies, and why we are winning in our space is because of singular focus and a relentless understanding of what our targeted demographic of moms want. And so we've been competing with Apple iPhoto and Google Picasa and SkyDrive and iCloud and Cloud Drive and all of these services for quite a while. We think it's a different approach. Most of our competitors, while larger and more funded, they really focus on storage and they focus on information and technology. We really focus on emotions and memories and engaging personal relationships between our customers and those that matter to them. And that may sound like a marketing speak to you guys, but it is really part and parcel of why we are successful. We understand the psyche of our targeted demographic, the 25 to 55-year old women. We build interfaces that are easy and intuitive that appeal to them. Our marketing communications and tones and voice is aligned with what they want. Our 300-plus in-house and external designers are able to look at what's on trend and what's fashionable and what designs they want. And then as an e-commerce company, we look at conversion rates and funnel optimization. So we feel very good about the product of ThisLife, its differentiated positioning in the marketplace, the early adoption and receptivity from our customers and our belief, sitting here today, about the future success of ThisLife.

Operator

The next question comes from Stephen Shin from Morgan Stanley.

Stephen Shin - Morgan Stanley, Research Division

This is like the second quarter of our marketing modestly deleveraged. And I wanted to talk through whether or not something has changed in the sales and marketing effort or whether this is just related to the acquisitions? And then more broadly speaking, how you think about as you have these internal projects that kind of that brings some savings both on the gross margin line and the OpEx line, how you think about whether allocating some of those dollars to kind of increasing the top of the funnel activity?

Jeffrey T. Housenbold

Yes, I think the marketing -- the sales and marketing line, my marketing department continues to do a wonderful job of driving efficiency where we can, right? It goes back to my previous comment to Kerry about data, how we use data. We're constantly doing experimental design on landing page, on offer, on tagline, on partner, on channel, on LTV and return on invested marketing dollars. So as we eke out those savings, basically, what I say to my CMO and my management team is we're going to keep running the company at a specified EBITDA margin. Any dollars above that, we get to plow back into the business to grow the top line. And that could come in the form of increased heads for tech and dev, increased marketing, or it could be through the balance sheet to acquire accretive companies. So as I look out any efficiencies, as long as we're maintaining our targeted EBITDA margins, we're going to plow back into the business to grow it. As we add new brands into the family of premium lifestyle brands, and today, we now have 7 of those, each one has slightly different efficiency metrics. So for example, wedding, it cost us more to get a wedding customer but she comes back and spends more. So even though the customer -- or the ACAC is high, the ARPU is high as well. So that's a different business. When you look at BorrowLenses, it has a different seasonality. Q3, when families are traveling on summer vacation, is their busiest quarter. And so you'll see marketing ramp into the Q3 period for that brand. Wedding's busiest quarter is actually Q1 versus Q4 for our memories and cards and stationery and social expression businesses. So I wouldn't read too much into small changes quarter-to-quarter but know that we're managing an optimized portfolio across our brand and that we are intent on plowing back efficiency gains into growing the top line.

Operator

Our next question comes from Shawn Milne with Janney Capital Markets.

Shawn C. Milne - Janney Montgomery Scott LLC, Research Division

And I apologize if you hit on this. But Jeff, have you talked at all about some of the issues with Tiny Print's customers? And I know you're going to provide some credits or incentives to those customers that were impacted by Q4, have you seen any change in sort of their repeat rate or stickiness, if you will? And then I have one quick follow-up.

Jeffrey T. Housenbold

We didn't mention Tiny Prints on this call, but as you referred to, last quarter, we mentioned we provided either a $50 or a $20 credit to that percentage of customers who had some fulfillment delays in the fourth quarter. Those credits are good for a year, and based upon historical behavior of having issued credits a few years ago prior to our acquisition, most of those credits get redeemed during the busy fourth quarter. So kind of since we issued those to date, the redemption rates have been right on plan of our internal expectation and consistent with historical norms. And we expect those folks will come back during the fourth quarter and use it. We also were very pleased by our customers' reactions on social media to the credits. Basically, 9 out of 10 people said, "Well, it was only late a day or 2, and it was fine, and you already gave to me free, and now you're giving me a credit. I love you, Tiny Prints." Or "Yes, I was a little miffed that it was a little late, but this totally makes up for it, I'll tell all my girlfriends about you." So the customers are responding well to that, and we think it was on brand for us to do that, given the premium positioning of Tiny Prints. It had a hit to Q1 EBITDA, but we think it drives the right long-term value of our customers and maintains the premium brand equity that we've built over the last 9 years.

Shawn C. Milne - Janney Montgomery Scott LLC, Research Division

Okay. And then that just sort of begs the follow-up, just from an accounting perspective, do the credits, do those contra revenue, were they all booked in the first quarter? Or are they booked as contra revenue as they're redeemed? And then, I think you said that you haven't given specific organic growth, but it looks like the organic growth looks healthy in the quarter. Was it healthy across Tiny Prints as well as Shutterfly brand?

Jeffrey T. Housenbold

Yes. The credits are just contra revenue, so they look like a promotion. So as someone redeems them, it reduces net revenue, and we report net revenue. And so that will come in. So we had some hit in Q1, but it'll hit mostly in Q4. But Q4 is our quarter of greatest utilization and highest margins. So we don't anticipate a huge impact in the fourth quarter, but certainly there'll be an impact. And in fact, we'd rather have an impact because that means people are redeeming it. As it relates to organic or not organic, we're not giving out specific brand metrics and which brand was growing faster or not faster. What I did say was I was very pleased by overall customer behavior across our brands, and I particularly called out our largest brand of Shutterfly having very good growth during the quarter. So we think we're on a good trajectory, revenues beat our guidance, and we're on track for our full year $903 million to $920 million.

Shawn C. Milne - Janney Montgomery Scott LLC, Research Division

Just one last follow-up. Did you mention capital allocation from a buyback perspective on the call?

Jeffrey T. Housenbold

It was in the prepared remarks, approximately $34 million of the $100 million issuance was put to work during the quarter. And we continue to buy back at lower prices here in the second quarter. So the average buyback price is going down every day. So we put about $34 million, about 630,000 shares that in average order -- average price, around $52.

Operator

Our next question comes from Victor Anthony from Topeka Capital Markets.

Victor B. Anthony - Topeka Capital Markets Inc., Research Division

Just a quick question on the customer growth, it was pretty strong throughout the quarter. You've touched upon some of this in response to the question in terms of how you leveraged data. But maybe you could give us a little bit more detail in terms of what anything different that you did throughout the quarter that drove the customer growth. And maybe you could discuss the mix across the different brands and whether or not you're seeing any sort of usage outside of your 25 to 55 year old women, particularly as you move up into mobile. So just an overall view of your customer growth, as well as maybe you could touch upon your acquisitions strategy going forward, and what you're seeing. You usually talk about the number of acquisitions you've had, so maybe if you could give us a quick update of how are you viewing things?

Jeffrey T. Housenbold

Yes. I think they all relate, Victor. So as of January 1, 2013 through today, we've looked at 149 different books in our space, broadly speaking, right, e-commerce, personalized products and services. And one thing that strikes us is that we've only seen maybe 5 or 6 companies who have stronger top line growth and profitability. So what we see is a lot of very subscale businesses that are growing negative 5% to plus 5%, who have 0 to 15% margins. And then we see a lot of companies that have growth in the 20%, 30%, 40% off of the small base but bleeding money. And many e-commerce companies have low profitability. And so we only have announced 3 of those transactions last year because we haven't found the right business model that we can take from -- maintain top line growth and take our leverage and make it profitable and that they have realistic valuations. And so it's been a combination app. But basically, given where the markets are, it seems like everyone is for sale. And we continue to be very, very financially disciplined in the acquisitions we do. We want to get great teams with great products at the right price and not at a crazy price. And I think we've seen a readjustment in the capital markets over the last 3 or 4 weeks from trading at 20x to 30x 2017 revenues back to an understanding that at some point, businesses need to actually generate EBITDA and free cash flow. So when I look at our customer growth on our base, adding 2.6 million customers in the quarter, I'm very pleased at that, doing close to 3.9 million orders with increasing average order value. So I feel very good given our size and scale of those growth rates and our continued improvement in conversion rates and AOV. As it relates to mobile and the customer mix, we don't see anything fundamentally different in kind of male, female. What we do see is mobile has quite a nice ratio of new customers to existing customers. So we're seeing that customers who have no relationship with the Shutterfly, Inc. family of brands are finding us through our mobile app, and that's a good thing for the health of the business going forward. And we're pushing that in different marketing channels. You also saw the customers grow from -- you asked what we did different. Well, we were one of the few customers Pinterest invited into their new beta. We've always been a good partner with Facebook and a very good partner with Google. So we get invited into extra things. Our overall integrated marketing mix is working. The top designers like Marchesa and Victoria Justice, who are partnering with us, adds to that. And then we have over 100 business development partners, from Coca-Cola to McDonald's to David's Bridal, who are all driving our brand and creating differentiation for their companies in their respective marketplaces. So there's not one silver bullet. It's really that integrated marketing mix, with an attention to pruning things that aren't working and being willing to put more resources behind those that are working.

Operator

[Operator Instructions] Our next question comes from Trisha Dill with Wells Fargo Securities.

Trisha Dill - Wells Fargo Securities, LLC, Research Division

First, I just had a follow-up on 2015. You talked about starting to see some OpEx savings but that you also see some more investment spend. How should we think about these savings offsetting that incremental spend? And I guess the specific question would be do you think you can return to the sort of 20% EBITDA margin levels that we saw in 2012 as soon as 2015, or do you think that's more likely to be a '16 event?

Jeffrey T. Housenbold

Thanks for the question, Trisha. We're not going to be giving 2015 or '16 guidance at this juncture. So I'll give you a kind of directionally correct. There are definitely OpEx savings from the data center. There's going to be shipping savings from Midwest facility because we're able to eliminate 1 to 2 shipping zones from our coastal manufacturing plants to the customers in the Midwest. There's additional scale efficiencies in both marketing and in operations that will occur in 2015. Those will be offset by the full year run rate of the people we're hiring in 2014, primarily in tech and dev, our investments in early-stage initiatives like ThisLife and Treat, our marketing initiatives around wedding and Shutterfly and our re-commitment to the premium brand in TinyPrints doing things like the credits but a re-branding exercise that we're going through and some additional marketing. So too early to give you guidance exactly where it falls out, but it's -- we can make this a mid-20s EBITDA model if we wanted to cut back on investments. Given our leadership position and the size of these markets and the early days in which most of the transactions are still occurring offline, we think we have a good balance between returning profits to the bottom line and investing in top line growth. So as we get closer to 2015, we'll update you on exactly where we think that's coming out, but we do feel good about the scale investments we're making this year.

Brian M. Regan

And Trisha, if it helps, just the one -- the couple of data points we have provided on top of the duplicative costs that will not occur in 2015 from the data center move -- the co-location data center move of $6 million to $8 million of savings, we have indicated that in 2015, 2016 and 2017, the aggregate savings from the co-location move and the new Shakopee facility is, in aggregate, $35 million. So you can model that to ramp up, it won't all happen on a straight-line basis, but we will see that ramp up. And so you'll see that on top of -- $35 million on top of the $6 million to $8 million, and that will give you a sense on kind of some of the OpEx savings you would expect us to see -- you expect to see in 2015 and beyond.

Trisha Dill - Wells Fargo Securities, LLC, Research Division

Okay. That's helpful. And then just a follow up on your capital investments, once you are finished here, you'll have 4 production facilities throughout the country. What level of capacity will you have then? Or what level of sales will your infrastructure support at that point?

Jeffrey T. Housenbold

Based upon the growth rates, if you imagine, Arizona comes online for Q4, in time for Q4 of next year, that would give us 3 to 4 years of capacity. Because remember, we build out the shell of the facility and then only add machines as the demand matches. So those shells should be able to handle the next 3 to 4 years, all other things being equal. If we launch a new suite of products or we move into an adjacent market or the growth rate of Enterprise changes or we do another customer consolidation play with the competitors list, those would change those numbers. But based upon the organic growth rate, we'd have 3 to 4 years of capacity exiting 2015.

Operator

Thank you. This ends the Q&A for today. I'll turn it back to management for closing remarks.

Jeffrey T. Housenbold

Thanks, everyone, for joining us on our Q1 2014 earnings call. As you can see from our prepared remarks and the Q&A, we had another solid quarter of year-on-year growth as we deliver both the top line and the full year profitability. We raised the bottom end of our guidance. We're making strategic investments in our physical infrastructure, our manufacturing capabilities, the feature functionality to our customers and launching our next-generation enhanced cloud service, ThisLife, in a matter of a few months. So we feel very good about our position in the market, the investments we're making and ability for our talented team to continue to delight our customers and execute against our strategic plan. So with that, I want to thank you, and we'll see you guys out on the road.

Operator

Ladies and gentlemen, thanks for participating in today's program. This concludes the program. You may all disconnect.

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