Shutterfly (SFLY) Christopher North on Q2 2016 Results - Earnings Call Transcript

| About: Shutterfly, Inc. (SFLY)

Shutterfly, Inc. (NASDAQ:SFLY)

Q2 2016 Earnings Call

July 27, 2016 5:00 pm ET

Executives

Shawn Tabak - Investor Relations, Shutterfly, Inc.

Christopher North - President, Chief Executive Officer & Director

Michael W. Pope - Chief Financial Officer & Senior Vice President

Analysts

Kerry Rice - Needham & Co. LLC

Naved Khan - Cantor Fitzgerald Securities

Heath Terry - Goldman Sachs & Co.

Andrew Bruckner - RBC Capital Markets LLC

Christopher David Merwin - Barclays Capital, Inc.

Brian P. Fitzgerald - Jefferies LLC

Kevin Kopelman - Cowen & Co. LLC

Operator

Good afternoon and welcome to the Shutterfly Second Quarter 2016 Financial Results Conference Call. Please note this event is being recorded. I would now like to turn the conference over to Shawn Tabak, Vice President of Investor Relations. Please go ahead.

Shawn Tabak - Investor Relations, Shutterfly, Inc.

Thank you, operator. Good afternoon, everyone. Welcome to Shutterfly's second quarter 2016 earnings call. With us today are Chris North, our Chief Executive Officer; and Mike Pope, our Chief Financial Officer.

By now, you should have received a copy of our earnings press release, which crossed the wire just after the market closed. If you need a copy of the press release, please go to shutterflyinc.com under the Investor Relations link to find an electronic copy. Our presentation is also available on our Investor Relations site. The audio of this conference call is being recorded for playback purposes and a replay will be made available within a few hours.

Before we begin, I would like to note that our discussion today may include forward-looking statements within the meaning of the Securities Act 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 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 our 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 information may contain certain financial performance measures that are different from 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 on the Investor Relations section of our website at shutterflyinc.com.

Now, I would like to turn the call over to Chris. Chris?

Christopher North - President, Chief Executive Officer & Director

Thank you, Shawn. Good afternoon. I'm glad to have the opportunity to talk with you this afternoon. Today I'd like to touch briefly on three topics: why I joined Shutterfly, some initial observations of what I've seen over my first eight weeks, and finally what you can expect from us going forward.

I am delighted to have joined the team at Shutterfly. Joining Shutterfly was an easy decision to make. Shutterfly has all the ingredients for a great business. It's a powerful brand that connects strongly with its customers. It has a loyal customer base. It's the clear leader in its space with unrivaled manufacturing scale. It has a talented team of dedicated and innovative employees. I'm honored to be part of the team and believe that I can make a difference as Shutterfly begins the next chapter of its growth.

My focus since day one has been on listening and learning. I've visited almost all of our facilities including our production facilities in Fort Mill, Shakopee and Tempe. The team have taken me through more than 30 presentations to help me learn our key businesses and functions. I spent significant time with our leadership team, but also met individually and in small groups with hundreds of team members to understand their thoughts. I've listened in on customer calls and personally manufactured more than a dozen products. It's important to me that my first few months at the company are not only an opportunity for me to learn, but for the entire company to reflect on where we are and where we think we should go next. To that end I continue to share regular updates with the entire team.

I'm pleased to say that eight weeks in I've come away from these experiences even more impressed than I expected, from the quality and dedication of our teams to the technology, products, customer care and manufacturing operations. In the coming weeks I'll continue to learn more about the business while at the same time focusing my attention on our preparations for the all-important fourth quarter. Let me close by saying a few words about what you can expect from us going forward.

We will be laser focused on how we steadily create shareholder value over time. To do so, we'll be passionate about serving and innovating on behalf of our customers, and on continuing to build and nurture a great team. You can expect a thoughtful, analytic approach to investing for profitable growth. And we'll be transparent and frank. We'll set clear goals for ourselves, measure ourself rigorously against those goals and share both where we're succeeding as well as where we need to improve. I look forward to getting to know Shutterfly's investor community better in the coming months.

Now, Mike will take you through an update on the business and our financials in more detail. Mike?

Michael W. Pope - Chief Financial Officer & Senior Vice President

Thank you, Chris, and good afternoon everyone. Q2 was another strong quarter for Shutterfly. We met or exceeded guidance across our major metrics led by the good performance in our Shutterfly brand and another strong quarter for our SBS segment. We have made steady progress towards our goal of having the majority of our most active customers on the All New Shutterfly by the fourth quarter.

We also continued to expand our mobile footprint with a second consecutive quarter of more than 1 million app downloads. We finished the second quarter with revenues of $204 million, which is $20.1 million or 11% increase over the second quarter of last year. Adjusted EBITDA was $18.2 million which is $2.6 million or a 16% increase over Q2 of 2015.

Please note that Q2 of 2015 revenue included a one-time flash deferred revenue catch-up of $7.5 million which benefited Q2 2015 EBITDA by $4 million. Excluding these benefits in the second quarter of 2015, our sales grew 16% and adjusted EBITDA grew 58%. Our Consumer segment revenue grew 3% to $176.6 million. When normalized for the Q2 2015 flash revenue catch-up, Consumer revenue growth was 8%, an uptick from Q1. Our normalized Q2 results were led by the Shutterfly brand which grew double digits and benefited from strong performance around Q2 specific campaigns including graduations and weddings.

Tiny Prints and Wedding Paper Divas remained soft in Q2 in part due to our ongoing primary focus on executing against the All New Shutterfly experience. At Tiny Prints, we are concentrating on preparing for the fourth quarter, the most important season for the brand, and a time when we typically see loyal returning customer base. We are excited about the new holiday collection, which will reflect new and upscale designs.

During Q2, we launched our new statement gifts category on Shutterfly, enabling customers to share life's joy by providing premium non-photo personalized gifts. These high quality statement gifts which include etched decanters, embroidered totes and engraved cutting boards and glass frames are available in a variety of unique designs. These products expand our gifting portfolio to better serve current and new customers. They are a convenient, additional purchase for many of the occasions for which customers frequent our site.

Q2 was another strong quarter on mobile. Mobile related revenue for our Shutterfly brand grew double digits year-over-year, and represented 19% of Shutterfly brand revenue. The app continues to drive a record number of customers to Shutterfly, benefiting from successful marketing campaigns. This includes our Unlimited Free Prints campaign, which as I mentioned, for the second quarter drove more than 1 million downloads. As a result, in the second quarter 19% of Shutterfly brand new customers came from the app, boasting a 2.5x year-over-year growth rate.

Lastly, we are making good progress on updating the user interface and feel confident in our ability to have a broad selection of holiday cards for creation and purchase from mobile devices in the fourth quarter as expected. On the marketing front, we have continued to innovate to get the most for our marketing dollars in an environment of rising media costs. We are making focused investments in mobile and continue to leverage our omnichannel approach to drive customer engagement and conversion. For example, in the second quarter we launched a year-long partnership with celebrity mom and actress, Drew Barrymore, who will be designing a Shutterfly home decor and holiday collection.

We concluded our fourth season as the philanthropic partner for the Ellen DeGeneres Show, and we continued to work with Baby2Baby and had a very successful Mother's Day event with Jessica Biel. In the quarter, Shutterfly continued to build on its over 100 partnerships to drive awareness and customer engagement. In the second quarter we continued our partnership with the United States Postal Service and were a featured placement in their e-commerce spring-summer campaign which we hope many of you saw on TV, print and digital media.

In Q2 we also launched new partnerships with category leaders like Avis and Budget aimed at increasing engagement with holiday travelers renting cars. PetSmart, which is the largest pet goods retailer in the U.S. and the go-to pet products retailer for pet parents looking to preserve memories with their beloved pets.

Shifting to operations, we continue to invest in our printing capabilities with a customer-centric focus on automation and reducing our reliance on temporary labor. To that end, in the second quarter we signed a deal with HP to lease a number of state-of-the-art four-color digital printers. These best-in-class printers are higher quality, are more efficient, and should help to improve our cost structure.

On the SBS side, we had another strong quarter. We more than doubled revenue to $27.4 million with a gross profit of $5.5 million or 20.2%. We continued to develop our relationships with existing customers as we work on integrating our platform into their systems and processes. Ultimately, our fully integrated end-to-end solution will allow us to work more closely with our customers in designing and implementing marketing programs.

During the second quarter we made substantial progress on our 2016 goals for Shutterfly 3.0. As we have said in the past, Shutterfly 3.0 is our long-term architecture vision for creating a platform and device agnostic memory management and personalized e-commerce solution. Our goals for 2016 are two-fold. Number one is adding a set of next generation features and functionality into our Shutterfly platform. And number two is building out our integrated e-commerce capabilities.

Our first goal of adding next generation features to Shutterfly is focused on creating a new photo-management solution on Shutterfly by integrating ThisLife technology which has superior organization and creation features. This new integrated photo management solution, which greatly enhances the legacy Shutterfly platform, is called the All New Shutterfly.

On the e-commerce side we are focused on building enhanced Shutterfly mobile app on iOS and Android that offers a broader product catalogue. During the second quarter we made strong progress on our migration to the All New Shutterfly. Our plan is to have our most active users on the All New Shutterfly platform in time for our Q4 peak season. Including legacy ThisLife customers, existing Shutterfly customers and new registrants. During the quarter we finished the migration of all legacy ThisLife customers and a 100% of our new customers are starting on the All New Shutterfly so we are now focused on continuing the migration of our existing Shutterfly customers.

Customers that have moved on to the All New Shutterfly are taking advantage of a number of new features. Our new photo service provides a modern intuitive user interface from which they can easily gather, find, create and enjoy their photos across web and mobile. Users can view photos on a timeline and also organize them into albums. New facial recognition functionality enhances the service making it easy to tag and search by people, places and keywords. Combined with our simple but powerful upload tools for the – both the desktop and mobile including the ability to detect and auto upload new photos, All New Shutterfly customers can easily and quickly create gifts and keepsakes.

We've begun demonstrating the potential of the All New Shutterfly's enhanced feature set through successful marketing campaigns we conducted for both Mother's Day and Father's Day, which included better product ideation for our customers.

Our second major project for 2016, building an enhanced Shutterfly mobile app with a broader product catalogue, is expected to launch later this year. Check your app store for updates there.

As we look back on the first half of the year, we are pleased about the progress that the business has made. We hired a new CEO. We made great headway on our 2016 goals for Shutterfly 3.0. We made – we had over 2 million app downloads and expanded our mobile revenue channel while creating new products and services that serve our customers' needs. We went and developed strong relationships with our SBS customer base and signed a deal to lease state-of-the-art printers that will enhance our products while driving down costs.

Now let's dive deeper into the financials as well as Q3 and full year financial guidance. Net revenues for the quarter totaled $204 million representing an increase of 11% over the prior year exceeding the midpoint of our guidance range by $5.5 million. As I mentioned, after normalizing for the one-time flash deferred revenue catch-up in Q2 of 2015 year-over-year growth is approximately 16%. In the quarter, Consumer revenue grew 3% year-over-year to $176.6 million or 8% when normalized for the flash deferred revenue catch-up in Q2 of 2015.

The year-over-year growth was led by double digit growth in our Shutterfly brand. Weaker revenue from our Tiny Prints and Wedding Paper Divas brands partially offset the strength in Shutterfly.

Net revenues from our SBS business more than doubled growing 117% over the prior year to $27.4 million. In Q2 total unique customers grew 4% to 3.3 million. We generated 5.3 million orders across our portfolio of premium lifestyle brands, a 5% increase over the prior year. Average order value for AOV for the quarter was $33.30, up 2% from the same period a year ago driven by favorable product mix.

GAAP gross margin in the second quarter was 46.3%, down 110 basis points from a year ago. After normalizing for the one-time flash deferred revenue catch-up in Q2 of 2015, gross margin increased 110 basis points, driven by lower manufacturer overhead costs. Q2 Consumer gross margin was 51.7% and SBS gross margin was 20.2%.

Operating expenses for the quarter totaled $115.4 million, overall flat with the prior year. After normalizing for the marketing expenses of $3.5 million associated with one-time flash catch-up in Q2 of 2015, operating expenses as a percentage of net revenue decreased 700 basis points over the prior year primarily due to a decrease in stock-based compensation along with a continued focus on overall cost management.

Looking more specifically at our operating expense components, technology and development costs totaled $41.3 million for the quarter, up 13% over the prior year, and remaining flat at 20% of net revenues. We continued to invest in additional customer-facing enhancements with Shutterfly 3.0 and in our SBS business. Sales and marketing expenses totaled $47.5 million in the quarter, down 6% from the prior year at 23% of net revenues.

Please note that Q2 of 2015 marketing expense included a one-time flash marketing expense catch-up of $3.5 million. After normalizing for the one-time flash expense in the prior year, marketing expenses remained flat year-over-year. Marketing expense as a percentage of revenue decreased 340 basis points over the prior year, partially due to delay in Q2 marketing spend to the second half of 2016.

General and administrative expenses for the quarter totaled $26.6 million, down 7% from the prior year at 13% of net revenues, mainly due to lower stock-based compensation expense. Our operating loss for the quarter was $21.1 million, $7.3 million better than Q2 of 2015. This improved profitability was driven by diligent expense control and lower stock-based compensation.

Adjusted EBITDA for Q2 was $18.2 million, ahead of our guidance, driven by higher revenue, favorable product mix and moderated spending. Year-over-year adjusted EBITDA grew $2.6 million or approximately 16%. After normalizing for the one-time flash benefit in Q2 of 2015, adjusted EBITDA grew $6.7 million or 58% year-over-year. The effective tax rate for the quarter was 38%, slightly above our guidance range of 36% to 37.5%. Net loss for the quarter on a GAAP basis totaled $16.5 million or $0.48 per share. The weighted average shares used to calculate the net income per share totaled 34.2 million shares.

Cash and total investments as of June 30 totaled $149 million, decreasing $191 million from year-end. Our decrease in cash was largely driven by share repurchases and large seasonal expenses accrued during our peak Q4 quarter, which were paid in Q1. Capital expenditures during the quarter totaled $32.1 million. Included in this total is $9.8 million of presses which were previously under operating leases that we bought and immediately sold to a third party during the quarter.

In the quarter we repurchased a total of 659,000 shares for $31 million. The share repurchase program continues our long-term capital allocation strategy, which aims to maximize shareholder value while maintaining flexibility to make strategic investments and acquisitions. As of June 30, we had $117 million remaining under our authorized share repurchase program.

We now turn to guidance for Q3 and the full year. We expect Q3 net revenues to range from $179 million to $186 million, which reflects year-over-year growth of 9% at the midpoint. We expect our Q3 GAAP gross margin to range from 36.7% to 37.8% of net revenues and our GAAP operating loss to range from $44 million to $48 million. We expect our adjusted EBITDA loss to range between $1 million and $4 million. Our GAAP effective tax rate is expected to be approximately 38.5% and we expect GAAP net loss per share to range from a loss of $0.90 per share to a loss of $0.97 per share based on approximately 34 million basic weighted average common shares outstanding.

For the full year 2016 we are raising the low end of our guidance range. We are now estimating that net revenues will range from $1.13 billion to $1.16 billion. We now expect the full year GAAP gross margin will range from 51.3% to 51.7% of net revenues, up from 50.9% to 51.7%, and our GAAP operating income will range from approximately $40.8 million to $55.6 million.

Our full year 2016 adjusted EBITDA margin will now range from 18.6% to 19.2% of net revenues. The full year GAAP effective tax rate is expected to range from 38.5% to 39.5%. We expect full year GAAP earnings per share to range from $0.31 to $0.58 per share based on 35.3 million weighted average diluted shares. We continue to expect that 2016 capital expenditures will range from 7.1% to 7.8% of net revenues, or between $80 million and $90 million. Lastly, we expect free cash flow defined as EBITDA less capital expenditures to be between $130 million and $132.9 million or approximately 11.5% of net revenues. The free cash flow estimate does not include the $9.8 million of equipment that we acquired and immediately sold as part of the new lease deal.

In summary, the business performed well in the second quarter. We had solid year-over-year revenue growth led by our Shutterfly brand and our SBS segment. We made steady progress on our 2016 goals for Shutterfly 3.0 and continued to expand our mobile presence.

That concludes our prepared remarks. We will now open up the call for your questions.

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. The first question comes from Kerry Rice with Needham. Please go ahead.

Kerry Rice - Needham & Co. LLC

Thanks a lot. Maybe the first one for Christopher. Obviously, coming from Amazon has a great reputation in supply chain. How do we think about the experience you have maybe at Amazon and how you apply that if at all to Shutterfly, and maybe any other kind of things that you think about implementing in maybe the first couple quarters or over the first year?

And then maybe a little bit on the model for Mike. When we think about the rest of the year, or Q3, rest of the year, and I know that you probably don't get too specific on the drivers of the revenue growth, but this quarter we saw an uptick in ARPU, which we haven't seen in a while. Is that something that you think is sustainable, or was there kind of a – you talked about favorable product mix, is that a one-time thing? And then, any guidance at all on SBS? Obviously, you've seen really rapid growth there. We're coming up on some more challenging comps, so any insights there would be helpful. Thanks.

Christopher North - President, Chief Executive Officer & Director

Okay. Kerry, I think the first question was for me. This is Chris. Please call me, Chris. Only my mother called me Christopher, when usually she was very cross with me. The – so a couple things. I mean, first of all, I just wanted to say how excited I am to be here at Shutterfly. I'm really encouraged by what I've seen in my first eight weeks. And there's certainly a core set of strengths that I full expected to see in joining Shutterfly. I did do my due diligence before joining. But it's been great to see those across many dimensions even stronger than I'd expected. I'd really single out four. The first is the strength of the brand. The secondary is the strong customer loyalty. The third is the quality and scale of our manufacturing operations. And the fourth thing is just the strength of the team and the culture here at Shutterfly.

I think you asked specifically about what I might be able to bring to Shutterfly from my 10 years at Amazon, and the first thing I'd say to that is a lot of the best things that I saw at Amazon, I also see here at Shutterfly. I see a very strong focus on customers, a company that draws its energy from serving and innovating on behalf of customers. That's very powerful. Certainly, Shutterfly within its space is clearly the leading brand, just as Amazon was in its. Similar observations about customer loyalty.

You talked specifically about Amazon's supply chain. Shutterfly has a world-class manufacturing operation. Just really impressive capabilities. I had the opportunity to spend a full week visiting all three of our manufacturing sites. I got to personally not only walk around the operation, but actually go on the line and manufacture most of our different products. And I was very impressed by the scale, the discipline, the emphasis on continuous improvement, the degree of automation to drive efficiency and so on. So, I mean, all of those are things that I see as being very common between Shutterfly and Amazon.

I think if I had to pick one area where I hope my experience can be useful to Shutterfly and perhaps there'll be many smaller ones as well, it's in thinking about scaling. I had the great privilege of joining Amazon when it was a $7 billion company in revenue and leaving 10 years later a $120 billion company. And was lucky enough to be one of the senior team who participated in that experience. I think when you go through that kind of scaling, you learn a lot about the kinds of systems and processes and infrastructure and architecture that you need to set you up to scale. You learn a lot about mistakes – the things you wish you'd been able to anticipate. And so I hope that my experience will help Shutterfly as we think about the next stage of our growth. I think you had a question for Mike then?

Michael W. Pope - Chief Financial Officer & Senior Vice President

Yeah, Thanks, Kerry. Look with regard to your modeling questions. We saw as we noted an uptick in the Consumer revenue growth from Q1 to Q2 that was driven by – across all of the metrics whether it was number of customers or number of orders or our average order value when you exclude the breakage from the prior year. So pretty healthy there across the board. We have said throughout the year, as early as Q1 or Q4 when we provided guidance for the full year, that we expected the Consumer revenue growth to improve as the year went forward. I think, it was a little bit better than what we thought in Q2. We were able to drive people to up the site effectively for some of the occasions like Mother's Day and Father's Day and Graduation.

We have less of those in Q3 to drive people to the site, but as we said before, and I think, you're well aware, we are excited about the capabilities that 3.0 will provide to our customers for the all-important fourth quarter of the year. ThisLife as well as Cards and Stationary being available on mobile for the first time.

Kerry Rice - Needham & Co. LLC

And nothing – any comments on the SBS side of growth?

Michael W. Pope - Chief Financial Officer & Senior Vice President

Yeah, sure. Thank you for the reminder. SBS continues to be a bright spot for Shutterfly and we've seen rapid growth out of there. As I've said before, you should not expect a doubling of that business every quarter. We were happy to see that again this quarter. We're really focused on measured growth there. Getting the right customers with the right profile in terms of dollar volume that we can do as well as meeting our internal targets for profitability over the long term with those customers. I'll remind you that in the second half of the year, and particularly in the fourth quarter of the year, we had a non – a one-time benefit of $14 million for no margin shipping in the fourth quarter of last year. So that will certainly make the fourth quarter comparison more difficult.

Kerry Rice - Needham & Co. LLC

All right. Thank you.

Operator

The next question comes from Youssef Squali with Cantor Fitzgerald. Please go ahead.

Naved Khan - Cantor Fitzgerald Securities

Yeah, thank you. This is Naved Khan for Youssef. I had couple of questions, so – and congrats on the quarter. So just looking at the Consumer business, it seems like it saw a nice uptick sequentially and I was trying to figure out how much of that is driven by the ongoing migration to 3.0 versus some of the other things you might have done such as increasing the selection of products and things of that nature and mobile. So if you can comment on that, that would be great. I have a follow-up after that.

Michael W. Pope - Chief Financial Officer & Senior Vice President

Sure. Sure thing, Naved. One of the key things on Shutterfly 3.0 is we'll see the vast majority of the most active Shutterfly users migrate before Q4, so we're starting to see some benefit of that. I wouldn't point to an overall trend there yet. I think, we really need to look at that and come back to you more specifically after the fourth quarter of the year where we have a substantive amount of data to share. What we saw in the second quarter was we saw customers come in and we were able to drive them more effectively around some of the occasions. I think, we had some good marketing campaigns and effective things that drove new customers and generated a higher number of orders.

Naved Khan - Cantor Fitzgerald Securities

Okay. And then, I guess, Shutterfly, the core brand is growing double digits as you noted in the presentation, but do you think that over time it's possible to get the overall Consumer business to get into double digits or do you think that's a long shot, or do you think that's going to take a really long time?

Michael W. Pope - Chief Financial Officer & Senior Vice President

So I think as we've said in the past week, we tend not to provide guidance outside of the larger Shutterfly company as a whole. We have had concerted efforts over the course of the last couple quarters in particular where our customers are seeing the benefits of 3.0 for the first time to try and improve the overall Consumer growth. Obviously, Consumer growth as we had in the first quarter in the low single digits is not something that is satisfactory to us, and so we'll continue to make efforts on that as the year goes forward. I'm going to ask Chris to add.

Christopher North - President, Chief Executive Officer & Director

Well, I – Mike, I completely agree with that. The only thing I'd add is, remember that the majority of our investment today is going into our flagship brand, that's the Shutterfly brand. And in particular, the 3.0 investments. We talked about the All New Shutterfly photo service, photo storage service. We've talked about some of the investments we're making in mobile. Those are today are exclusively benefiting the Shutterfly brand. We do make other investments. We are making other investments in our other brands in the form of new designs, and new products, and new features. But the major investments are going into the Shutterfly brand.

Over time, we'd expect to be able to make some of those new features and functionality available across our brand, but that won't be the case this year. So, we're very optimistic about how these investments in 3.0 will play out in supporting our consumer growth. And as we're able to bring those benefits across the brand portfolio longer term, we'd be optimistic about what that means for Consumer growth overall.

Naved Khan - Cantor Fitzgerald Securities

Okay. That's helpful. And then lastly, for Mike, for the third quarter guidance, just looking at the EBITDA and the range that you provided, is it – and comparing that with versus what you had in the second quarter, is it just normal seasonality about Shutterfly sort of investing ahead of the heavy fourth quarter? How should we think about the guidance for EBITDA?

Michael W. Pope - Chief Financial Officer & Senior Vice President

Sure. So I think you have to look at the guidance as a whole and our revenue targets and our seasonality point to historically that Q3 at the revenue has been lower, at the revenue top line has been lower than the second quarter. And we have various costs that are fixed, and so our EBITDA sort of falls through there to be lower EBITDA in the third quarter than the second quarter. And there is an element of us getting prepared and making sure that we are making the right investments in our manufacturing facility and in our marketing campaigns to drive people to our site during the fourth quarter where we do the lion's share of our revenue and generate substantial EBITDA.

Naved Khan - Cantor Fitzgerald Securities

Thank you.

Operator

The next question comes from Heath Terry with Goldman Sachs. Please go ahead.

Heath Terry - Goldman Sachs & Co.

Great. Thanks. I was wondering if you could give us a sense – Mike mentioned some of the softness in Tiny Prints and Wedding Paper Divas in the quarter. Can you give us a sense about how the shift to mobile and 3.0 are impacting those brands in particular and how you plan to promote them as well as the product suites in the back half of the year to get reacceleration? And just – even just maybe more basically what degree of reacceleration, if any, in those brands is embedded in the full year guidance?

Christopher North - President, Chief Executive Officer & Director

Thanks for that, Heath. This is Chris. I'll take the first half of that question, then turn it over to Mike for the second half. So first of all, remember that today, while today the app, our primary app exclusively supports the Shutterfly brand. So customers can access the other brands such as Tiny Prints and Wedding Paper Divas through the mobile web, but not in the form of a dedicated app. So while across all of our brands we see a secular shift to mobile, there's no today dedicated investment in the app outside of the Shutterfly brand.

Longer term, as with other components of the 3.0 strategy, we've chosen to make those investments in the Shutterfly brand first because that's where we have the majority of our customers, though longer term we expect those benefits to be available to customers across the brand portfolio.

You asked about how we're preparing for the all-important fourth quarter for the other brands. I'd really think about Tiny Prints of course as the key brand outside of Shutterfly for the fourth quarter. Tiny Prints business is very Q4 centric even more so than the Shutterfly brand. And while the 3.0 investments are not relevant to Tiny Prints in 2016, we are investing to prepare Tiny Prints for the fourth quarter.

In particular, as with every year, there will be new products and new features and new designs available for those customers. The other thing I'd say is, we've seen consistently over a number of years that Tiny Prints benefits from a recurring loyal customer base during the holidays who come back year in and year out. And so I think we're optimistic that we have the right plans in place for the Tiny Print customer in the fourth quarter.

Michael W. Pope - Chief Financial Officer & Senior Vice President

Yes. I'd add that consistent with that, our guidance reflects what we believe Tiny Prints and Wedding Paper Divas will, how they'll perform in the fourth quarter. I'd underscore what Chris said, which is that the customers for Tiny Prints in particular, which by and large skews towards cards and stationary more so than in our Shutterfly brand, and therefore is heavily skewed to the fourth quarter, many of those customers have immense loyalty to the brand and come back year in and year out. So, relative to the first three quarters, we'd actually expect a better performance in the fourth quarter in Tiny Prints than we've seen thus far this year.

Heath Terry - Goldman Sachs & Co.

Great. Thank you very much.

Operator

The next question comes from Andrew Bruckner with RBC Capital Markets. Please go ahead.

Andrew Bruckner - RBC Capital Markets LLC

Thank you and welcome, Chris. Two questions, if I could. The first one would be if you have any larger thoughts on the competitive set, particularly with memory management with a lot of bigger competitors out there as you move to the 3.0 transition that seems like it's going to be increasingly important? There's a lot of well-capitalized competitors. And then secondly, this might be more for Mike, but I'm wondering if you've seen any changes in customer churn. And if you can make any comments in terms of customers who come on app first or mobile first versus desktop first, if you see any difference between those two cohorts. Thanks.

Christopher North - President, Chief Executive Officer & Director

Great. Thanks, Andrew. So when we turn to the memory or photo management service which is a component of what we're calling the All New Shutterfly, the first thing I'd say is we're really excited about that. That's increasingly available to more and more of our customers, as Mike said. All new customers, all legacy ThisLife customers, and by the peak of Q4, the majority of our active customers will be using that new service by default. And it's providing a modern and intuitive user interface, a better way of viewing photos on a timeline and organizing them, facial recognition capabilities, tagging by people, place, et cetera. Those of us who are using it internally love it and we're seeing promising early signs from how customers who have access to it are using it.

You asked about how we think about that in the competitive space, and I guess you have in mind some of the very large companies who also are offering photo management services. The thing I'd say to that is our investments in creating this photo management service come out of our need to serve our existing and future customers who love what we do for them in terms of letting them create physical products using their photographs. We don't think of ourselves as being first and foremost in the space of commoditized cloud storage of photographs in the cloud. Lots of people can do that. That very well may be the price of entry to serve our customers. Our customers trust us to provide safe storage for their photos, but we view that all through the lens of how we enable our customers to create the physical products that's what helps to share life's joy.

So, to put it another way, we're very optimistic that these investments are going to pay off in how we see our customers use our site to create more and more physical products. To the extent that gives us optionality to pursue a broader business in photo management and in value-added services around that, that's something we still have to give more thought for. We're not prepared to speak to today, but I just wanted to leave you with the thought that this is serving our core business first and foremost.

Michael W. Pope - Chief Financial Officer & Senior Vice President

Andrew, with regard to the second part of your question around customer churn, I think it's early. The app, we've had steady improvements to the app over the course of the year, but the major improvements to the app in terms of having cards and stationery on by the fourth quarter will happen between now and the fourth quarter. With regard to mobile, as we've said in the past and it remains true today, customers have a lower conversion rate on mobile, but they tend to come, and a lower AOV, but they tend to come back more often. I think the investments that we're making in ThisLife that allows us to have a greater and more frequent engagement with our customers and more targeted marketing are all initiatives that are aimed at lowering the customer churn or engaging the customer more often.

Andrew Bruckner - RBC Capital Markets LLC

Great. Thanks, Mike and Chris.

Operator

The next question comes from Chris Merwin with Barclays. Please go ahead.

Christopher David Merwin - Barclays Capital, Inc.

All right. Great. Thanks. Yes. I just had a couple questions. I guess first of all, it seems like the SEC is starting to take a closer look at non-GAAP financials in general and in terms of stock based comp, I mean, can you talk about your expectations for managing growth of that expense item to the extent that the if the SEC ever moves to preclude companies from using that as an add back and non-GAAP metrics? And then secondly, just in terms of, you know, the long term margins of the business, I mean, as SBS continues to grow faster than Consumer. And how should we be thinking about the longer term margins of Shutterfly? Thanks.

Michael W. Pope - Chief Financial Officer & Senior Vice President

Sure. So, this is Mike. I'll take both of those. With regard to the SEC and non-GAAP measures we're clearly watching that landscape. I'd say one of the key things that I think you've heard me say since my arrival here last fall was that not only did we need to look at the traditional measures that the company has measured itself against, which was both revenue growth and adjusted EBITDA, but also the quality of our earnings. And if you look at what our guidance implies to GAAP operating income improvement year-over-year, it's more than doubling at the low end of our guidance range, and I think, almost or slightly more than tripling at the high end of our guidance range on operating income for the full year.

At the same time, you've also seen that we've tried to continue to take a more thoughtful approach to stock based compensation. You've seen that reflected in a relatively substantial decrease in – through the P&L on that in year-over-year in both the first quarter and second quarter. And then lastly, as we committed to our shareholders back in December timeframe where we went up for new employee stock plan, we asked for 1.4 million shares to be authorized at that point which is lower dilution than we've historically had.

Christopher North - President, Chief Executive Officer & Director

I just want to add because I think it's important that you hear this from both Mike and me that Mike and I are very strongly aligned on this. We have a strong focus on discipline around not only adjusted EBITDA but CapEx and stock based compensation as well. We're clear that those are genuine expenses.

Michael W. Pope - Chief Financial Officer & Senior Vice President

Great. Thanks, Chris. I think, second part of your question, Chris, was around margins, and I think, I'll answer this consistently the same way I have in the past which is that from the area that we provide gross margin guidance on is for the company as a whole. We do so that there because in our SBS business it tends to be a more lumpy business and we may choose to take a more – we may choose to be opportunistic and take a customer that might have an initially low gross margin within the quarter and not have as much visibility as we do on the Consumer side of things. Where we have made progress and I think have shown some consistency on SBS is that the gross margin if you eliminate the shipping revenue in the fourth quarter of last year, has consistently remained at 20% or higher in there. I'm not committing that that will always be the case, but we're certainly cognizant of that as we go forward.

The other piece is – of your question was around, what can we expect as overall EBITDA, adjusted EBITDA margins for the company. And I think our guidance reflects a pretty nice improvement year-over-year in that. But again, as I've said more recently I think the right way that we think about it is, how do we drive absolute EBITDA dollars to the bottom line as perhaps an even more important metric.

Christopher David Merwin - Barclays Capital, Inc.

All right, great. Thank you.

Operator

The next question comes from Brian Fitzgerald with Jefferies. Please go ahead.

Brian P. Fitzgerald - Jefferies LLC

Thanks, guys. I wanted to ask about the kind of marketing that you're finding most effective in terms of bringing customers into the app. And then, do you have a sense of the amount of time spent in the app which leads up to a conversion or to an order. And then I had one follow-up.

Michael W. Pope - Chief Financial Officer & Senior Vice President

Great. Look I think that on the marketing effectiveness, it changes from time to time. Obviously SEM, SEO and display are important components to us. At the same time, with the new capabilities in our ThisLife integration into the All New Shutterfly, we can do more directed, personalized advertising to our customer base. So all of those are important. Equally important also though are the partnerships that we have and that we've been able to drive new customers into the Shutterfly site over time.

With regard to the conversion, I think in the app in particular, I think, it's too early to point to any specific trends there. I think as we get further functionality built out in the app and as we get customers actually creating cards and stationary on that app in the fourth quarter, we'll be able to speak more confidently around that in early 2017.

Brian P. Fitzgerald - Jefferies LLC

Great. Then the – the follow-on, and maybe it's related to that exact comment you just brought up. When you look at the mobile AOV, and it being lower, what are the main dynamics driving that? And does that alleviate as you start to add more functionality into the apps?

Christopher North - President, Chief Executive Officer & Director

Hi. This is Chris. I'll take that. Thanks for that, Brian. So to build on my comments there because I think it's directly relevant to your question. Remember that today, in the Shutterfly app, only a subset of our products are available for customers to purchase. Right now, for example, there are no cards and stationaries that customers can purchase, which is of course, our largest category in the consumer segment. So as we add more products into the app, and prior to Q4, our customers will be able to purchase a wide range of cards and stationary within the app for the first time, we fully expect that to flow through into growth of both mobile adoption and to mobile revenue. I think, it's early to speculate on what that will do to AOV metrics specifically. We'll really only get a read on that through Q4, but we'll certainly have a stronger sense of that then.

The other thing I'd say is I think when you look across many different kinds of consumer-facing Internet companies, it's very typical to see AOV lower on mobile. But so you know what we'll be looking to do by improving our app functionality, by driving more customers to the app and through the other 3.0 investments we're making is to drive customer growth and order growth, quite likely through order frequency, through frequency growth, that will more than offset that. And again, that's a typical dynamic you'd see across many companies in that secular shift to mobile.

Brian P. Fitzgerald - Jefferies LLC

Awesome. Thanks, Chris. Thanks, Mike.

Operator

The next question comes from Kevin Kopelman from Cowen and Company. Please go ahead.

Kevin Kopelman - Cowen & Co. LLC

Hi. Thanks. Just a quick question on the technology and development line. It's been pretty contained over the last couple of quarters, even excluding stock-based compensation. So can you give us any color just on how we should think about that investment line going forward and the kind of major components? Thanks.

Michael W. Pope - Chief Financial Officer & Senior Vice President

Sure. So on the tech and dev, tech and dev is the central part of Shutterfly's strategic advantage out there. We're able to outspend our competitors in this space. There's been a tendency to want to think about tech and dev having a dramatic drop-off when we "finish" 3.0. The reality is 3.0 is a multi-year initiative for us, and we expect that you're seeing the first customer-facing benefits of it this year in ThisLife and in mobile, but we'll roll out more next year. So I wouldn't expect any dramatic changes in tech and dev for the remainder of the year or even as we go out through 2017 and beyond.

Kevin Kopelman - Cowen & Co. LLC

Thank you.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Mike Pope for any closing remarks?

Michael W. Pope - Chief Financial Officer & Senior Vice President

Great. Thank you. Well, look, on behalf of myself and Chris, we want to thank you all for joining us this quarter and we look forward to talking to you at the end of next quarter.

Operator

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.

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