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Shutterfly (NASDAQ:SFLY)

Q3 2012 Earnings Call

November 01, 2012 4:20 pm ET

Executives

Michael Look - Vice President of Investor Relations

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

Brian 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

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

Andrew Ruud - Morgan Stanley, Research Division

Atul Bagga - Lazard Capital Markets LLC, Research Division

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

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

Operator

Welcome, everyone, to Shutterfly, Inc. Third Quarter 2012 Financial Results Conference Call. This call is being recorded. I would now like to turn the call over to Michael Look, Vice President of Investor Relations for Shutterfly. Please go ahead.

Michael Look

Thank you, operator. Good afternoon, everyone, and welcome to Shutterfly's Third Quarter Fiscal 2012 Conference Call. With us today are Jeff Housenbold, Chief Executive Officer of Shutterfly; and Brian Reagan, Chief Financial Officer.

By now, you should have received a copy of our earnings press release, which crossed the wire approximately 15 minutes 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 have also released a 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 then 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, the share repurchase program and statements about historical results that may suggest trends for our business. For more information regarding these and other 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 sections entitled Risk Factors in the company's most recent annual report on Form 10-K and its other filings with the SEC.

I would also like to note that any forward-looking statements made on this call reflect information and analyses as of today. 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 third quarter fiscal 2012 earnings 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

Thanks, Mike. Good afternoon, everyone, and welcome to our third quarter earnings call. So let me start by welcoming Brian, our new CFO, to his first quarterly earnings call. Brian will review our Q3 financial results in detail during our call this afternoon. But before he does, I'd like to take a moment to share some thoughts on our Q3 results and year-to-date performance as we head into this year's Q4 holiday season.

As you can see from our Q3 press release, Shutterfly continues to distinguish itself from our competition by delivering very solid results in our lowest seasonal quarter of the year. In the third quarter, net revenues increased 29% to $98.5 million. Our solid revenue growth was largely driven by robust customer and transaction growth across all 4 of our lifestyle brands, better-than-expected Enterprise revenue growth and to a lesser degree, revenue contribution from new Kodak customers following the early completion of the Kodak migration project.

The top line strength of our Enterprise business reinforces our view that a meaningful Commercial Print opportunity exists for us. We will continue to be opportunistic in our approach to expanding this business and expect results from our Enterprise sales to continue to be variable during this early stage of market development. I am very pleased with the progress we've made over the past few years. Our Enterprise business continues to add revenues in nonpeak seasonal periods and generate incremental cash flow by leveraging our core assets through an expanding roster of Fortune 1000 corporate clients.

Moving to the Consumer side of our business. Shutterfly drove accelerating double-digit growth in visits, registrations, uploaded images and a record number of shares sent during the third quarter. This strong top-of-the-funnel activity translated into 40% year-over-year increases in both transacting customers and orders, or more than 2.2 million unique customers generated more than 3.5 million orders across our 4 lifestyle brands.

As I indicated earlier, we also benefited from the early completion of Kodak migration project. As you all know, in July, we began the process of migrating Kodak's Gallery customer accounts and images over to the Shutterfly cloud. Initial estimates indicated that it would take the rest of the year to complete what we believe is one of the largest, if not the largest, peacetime transfers of data. This massive technical undertaking involve transferring more than 5.5 billion images or 7-plus petabytes of data from Kodak's colocation vendor to Shutterfly's cloud.

To give everyone a sense of scale, if we were to print each migrated image on a 4x6 print and lay them by side-by-side, it would span from the Earth to the Moon and back. Our Internet operations team was able to complete this data migration project ahead of schedule, resulting in a slight acceleration in the modernization of these newly migrated Kodak customers and some operating cost savings as well. Our third quarter's higher net revenues, combined with Kodak colocation savings and a shifting of certain marketing and investments into the fourth quarter resulted in Q3 adjusted EBITDA loss of $3.1 million, meaningfully better than the $6 million to $7.5 million adjusted EBITDA loss guidance range we provided on our last conference call.

Our ability to drive strong customer growth and increasing revenue scale against the headwinds of an elevated promotional environment and continuing macroeconomic uncertainty confirms that our commitment to innovation, design-forward products and services, customer-friendly policies, industry-leading quality and focused financial discipline is resonating well with consumers and continues to distinguish Shutterfly from our competition.

We believe our strong revenue growth validates our view that we are still in the early stages of multiple, multibillion dollar markets and gives us confidence in continuing to make strategic investments in our business. These investments will further differentiate our products and services, enable us to achieve greater scale and efficiencies and expand our product breadth in customer segments.

One example of our focused investment is in mobile, where we already have more than 3.6 million cumulative downloads, more than 620,000 active monthly users and are committed to being a leading innovator. Here, the long-term goal is to give consumers the choice and convenience of preserving, sharing and transforming their memories into high-quality photo products regardless of device, platform or location.

Just in the past 2 months, a great deal of progress has been made on the mobile front. Recently, we announced the availability of our new Treat iPhone mobile app. Utilizing this exciting new 1:1 greeting card app, consumers now have the ability to find, create and mail the perfect birthday card in 3 minutes or less directly from their iPhone.

Also in September, we completed our acquisition of Penguin Digital. This acquisition expands Shutterfly's mobile capabilities by adding a talented and proven team of mobile application developers that are already providing consumers through their mobile photo app with fun and easy ways to create, share and purchase photo merchandise directly from their mobile devices. Together, the combined Shutterfly and Penguin Digital mobile team is working hard to integrate the MoPho application into the existing Shutterfly app.

We also continue to make strategic investments in our integrated marketing strategy. As we become even more efficient in our marketing initiatives, we're able to reinvest these savings into new initiatives across a variety of media and channels, including Internet marketing, social media, mobile, broadcast media and retail partnerships. Examples of some of these new marketing programs include: our first-ever national cable television campaign for this holiday season launching next week; new Internet marketing programs, such as the Facebook Exchange; a nationwide ship-to-store partnership with Costco; a multifaceted partnership with Coca-Cola; and a marketing program called Thank the Troops. Our Thank the Troops program invites Americans to send a card of thanks and show our support to all 1.5 million active U.S. military members and veterans in VA hospitals, which launched today in time for Veterans Day.

We continue to lead our markets in terms of revenue and innovation. And thus, as we head into my eighth holiday season here at Shutterfly, I'm excited about this year's holiday lineup of products, services and user experiences. Let me share a few recent enhancements available for the fourth quarter.

We have launched premium, layflat Photo Books with 2-page spreads in genuine leather covers; additional premium designs, which are available for an additional charge; new photo filters; and twice as many Photo Book styles than last year. In addition, we have integrated the Photoccino technology into our Year in Review Photo Books and Calendars. In Cards & Stationery, we added over 2,200 new designs across our holiday card assortment. We've introduced 6x8 greeting cards, added premium DoubleThick Matte paper, new back-of-the-card printing options and a nationwide ship-to-store partnership with Costco for our Tiny Prints and Wedding Paper Divas brands.

With respect to photo gifts, we are introducing a number of exciting new products, such as personalized iPhone 5 cases, personalized stickers, dimensional wall art, photo travel mugs and a mini photo cube ornament on Shutterfly. And we've also added to the photo gift selection available on Tiny Prints. In addition to these new products and services, we've refreshed the Shutterfly brand, including our homepage, our logo, color palette, photography, tone and voice all to better resonate with our existing and new customers. We also added a multibranded header across our 4 lifestyle brands that is driving increased awareness and traffic. Lastly, we are in the midst of transferring Fuji SeeHere customers over to the Shutterfly cloud just in time for the holiday season.

Now I'd like to share some thoughts on our recent decision to expand our East Coast manufacturing operations. The continued ramp in our order growth means that we will need to expand our manufacturing capacity before the 2013 holiday season. And with this new facility, we will be able to triple our manufacturing footprint at a similar annual lease cost of our current production facility while realizing meaningful future operational flexibility and cost savings. These savings will result from lower lease payments on a per square foot basis and through selected insourcing of some currently outsourced products that have achieved sufficient scale and volume, making insourcing economically beneficial.

Before I conclude my prepared comments, as you can see from our Q3 press release, our Board of Directors has authorized the repurchase of up to $60 million of Shutterfly common stock. We believe this share repurchase program is consistent with our long-term capital allocation strategy, which aims to optimize our flexibility, to make strategic investments and acquisitions along with maximizing shareholder value. Given our business momentum, our profitable business model and our anticipated future cash balance, we believe we can prudently repurchase our shares and still be able to make smart investments, nurture new business initiatives like Treat, mobile and Enterprise and make both small and large strategic acquisitions.

In summary, I'm pleased with our continued momentum and a strong execution we are delivering across our business. I remain optimistic about the market potential for our platform and solutions, and Q3 was another very successful quarter. We delivered solid Consumer and Enterprise revenue growth, completed our migration of Kodak's customer accounts and images to Shutterfly early and generated healthy customer behavior across all 4 of our lifestyle brands.

We continue to execute at a very high level and believe our results through the first 9 months of this year validate that our long-term strategy remains on target and our market opportunity remains significant and that the strategies that have enabled us to emerge as the online market share leader will continue to distinguish us from the competition.

With that, I will now turn the call over to Brian to review our financial results and outlook in greater detail. Brian?

Brian Regan

Thanks, Jeff, and good afternoon, everyone. I'll start today with a review of our key metrics in this quarter's operating results followed by a brief discussion on our decision to expand our East Coast manufacturing facility. I'll then provide an update to our fourth quarter and full year outlook for 2012 before opening the call up for your questions.

As Jeff indicated earlier, net revenues for the third quarter were $98.5 million, up 29% year-over-year and meaningfully above the $91.5 million high end of our guidance range. Net revenue from our Consumer businesses totaled $90.4 million, reflecting 24% year-over-year growth. Increase in our Consumer revenues was driven by strength across all of our core products, led by Photo Books in Cards & Stationery and better-than-forecasted growth in 4x6 prints in the quarter. Net revenues from our Enterprise business exceeded our expectations, more than doubling year-over-year to $8.1 million. The strong performance of Enterprise in the third quarter was driven by robust organic growth at a number of existing clients resulting in Enterprise revenue representing 8% of total net revenues in the quarter, up from 5% a year ago.

This quarter's average order value was $25.06, down 11% from the same period last year primarily due to marketing promotions designed to engage new Photo Book users and Kodak customers for the first time, a higher product mix of print orders from new Kodak Gallery customers, as well as strong growth in Treat orders.

Moving to cost of net revenues and gross margins. Gross margin in the third quarter was 44.1%, below the 45% low end of our guidance range. Q3's lower gross margin was primarily driven by a higher-than-expected mix of Enterprise revenue, a lease termination fee related to the pending move of our East Coast production facility and increased customer service costs related to the Kodak Gallery migration.

Turning now to operating costs. Operating expenses, excluding stock-based compensation, totaled $59 million, reflecting Kodak migration costs and the increased cost structure of recently combined businesses, primarily Photoccino, plus purchase accounting amortization, all of which was offset by a shift in the timing of various marketing and product development investments into Q4.

Taking a closer look at our operating expense components, technology and development costs totaled $21.5 million for the quarter or 22% of net revenues. Excluding stock-based compensation and depreciation, our technology and development spending increased approximately $3 million or 24% from the prior year. Q3's increase in technology and development spending reflects the incremental cost associated with our acquisition of Photoccino and Kodak Gallery's accounts, including facilities costs, increased storage, power, bandwidth and technical support costs, as well as increased investments in engineering headcount.

Sales and marketing expenses totaled $29.6 million in the quarter, representing 30% of net revenues compared to 33% in Q3 of last year. Excluding stock-based comp and amortization, sales and marketing expense increased approximately $3 million or 18% from the prior year and represented 23% of net revenues, down from 25% of net revenues in Q3 of last year. Q3's year-over-year increase in sales and marketing expense reflects a larger marketing team with a smaller, more efficient increase in working marketing dollars as we shifted certain marketing investments into Q4 as part of our first national cable TV campaign and a number of other online and offline marketing promotions and sponsorships.

General and administrative expenses for the quarter totaled $16 million or 16% of net revenues. Excluding stock-based comp and credit card processing fees, G&A expenses represented 10% of quarterly net revenues, down slightly from 11% in Q3 of last year.

As Jeff indicated earlier, the adjusted EBITDA loss for the quarter was $3.1 million and better than the high end of our most recent guidance. Our favorable Q3 EBITDA performance was primarily driven by strength in our Consumer activity across our 4 lifestyle brands, higher-than-anticipated Enterprise revenue and a shift in the timing of certain marketing and product development investments into Q4.

The effective tax rate for the quarter was 56%, reflecting the impact of disqualifying dispositions of incentive stock options during the quarter. On a GAAP basis, our net loss for the quarter totaled $10.5 million or a loss of $0.29 per share and $0.13 better than the midpoint of our guidance range. The weighted average shares used to calculate the net loss per share totaled 36.1 million shares.

Finally, capital expenditures during the quarter totaled $20.4 million, including $6.8 million for technology equipment and software, $9.9 million for manufacturing equipment and building improvements and $3.7 million in capitalized software development costs. Q3's increase in technology equipment and software CapEx reflects Shutterfly's increased data storage related to the migration of Kodak customers' accounts and data.

Cash and liquid investments at quarter end totaled $90 million, reflecting our normal seasonal low as we anticipate a year-end cash balance of over $160 million. In addition, we continue to have access to up to $200 million in available funds from our untapped revolving credit facility.

As Jeff mentioned earlier, we expect to triple the capacity of our existing East Coast production facility next year for approximately the same annual lease costs. The new larger facility is located only 10 miles away from our current Charlotte facility, so we expect to fully leverage our existing workforce with opportunities to drive increased cost synergies by insourcing selected products and provide more U.S.-based customer service. We expect to begin making capital improvements by the end of this year and the significance of our investment will impact how we account for the building and our lease costs.

Essentially, we will be deemed the accounting owner of the building during the construction period, replace the fair market value of the building on our balance sheet with a corresponding financing obligation. You can see that fair market value of $4.9 million on our latest balance sheet classified as an asset in construction and a corresponding amount as a component of other noncurrent liabilities. We will increase this asset and financing obligation on the balance sheet if additional building improvement costs are incurred and paid by the landlord. And any improvement costs paid by Shutterfly will be treated as typical capital expenditures.

Once construction ends and lease payments begin, most of these payments will be treated as interest expense and we will reduce the financing obligation over the 10-year lease term. The building assets will then be depreciated over 30 years, its estimated useful life. In other words, the accounting for this new facility is very similar in nature to a typical capital lease.

We'll provide more detailed guidance on how the accounting should impact our 2013 results in a few moments as well as during our year-end call. And the Q4 guidance I'm about to update includes the expected capital expenses related to the new building in the interim.

Looking forward, as we enter Q4, we're pleased with our year-to-date results as Shutterfly has been able to consistently distinguish itself from our competition and build brand momentum despite global macroeconomic concerns and elevated promotional environment. Our ability to leverage our scale and scope economies, vertical integration, solid balance sheet and profitable business model has allowed us to expand our market position through organic growth and disciplined acquisitions, clearly enabling us to differentiate ourselves from our competitors.

However, as a consumer-facing business, we are acutely aware of the potential impacts of Hurricane Sandy, the current fragile global macroeconomic backdrop, the looming fiscal cliff, persistent underemployment levels, election year uncertainty around taxes and other external factors that could affect this year's holiday season. We believe our Q4 strategic plan and guidance incorporate many of these factors. However, the effects of Hurricane Sandy are not fully understood at this time.

We expect Q4 net revenues to range from $300 million to $310 million, which reflects year-over-year growth of up to 17.5%. We expect our GAAP gross margin to range from 56% to 57.5% and Q4 GAAP operating income is expected to range from $71.6 million to $78.1 million. Q4 adjusted EBITDA is expected to range from $96.5 million to $103 million. We expect our GAAP effective tax rate to be approximately 49% and Q4 GAAP net income per share to range from $0.94 to $1.02 per share based on approximately $38.8 million weighted average common shares.

Summarizing for the full year 2012, we are increasing our net revenue guidance as we now estimate net revenues will total between $589 million and $599 million, which reflects year-over-year growth of up to 26.6%. Based on Q3 actuals, our full year GAAP gross margin guidance is now 51% to 52%. And we expect that our GAAP operating income will range from approximately $11 million to $17.6 million.

For the full year 2012, we expect adjusted EBITDA to range from $97.5 million to $104 million or 16.6% to 17.4% of revenue. The full year effective tax rate is now expected to be approximately 47%. We expect full year GAAP net income per share now range from $0.14 to $0.24 per share based on 38.3 million weighted average diluted shares. And finally, we are maintaining our 2012 CapEx guidance range of 9.7% to 10.2% of net revenues, which includes some of the initial building improvement costs for our new Fort Mill production facility.

As we had indicated on prior calls, our 2012 one-time Kodak-related CapEx was estimated to be $9 million and our projected 2012 Kodak CapEx investment remains unchanged. Our combined growth capital investments in the Kodak Gallery migration plus the new Fort Mill facility is expected to be approximately $12 million in total for 2012 and we further estimate approximately $14 million of capital expenditures in 2013 related to these growth investments before returning to a more normalized level of capital spending.

In summary, we're pleased with our Q3 results and the continued strength of our business in the first 9 months of this year. We remain confident of our market position and product offerings and intend on continuing to invest in innovation and growth. 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 of Cantor Fitzgerald.

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

Couple of questions, please, maybe starting with you, Jeff. Can you just talk a little bit about the promotional intensity that you've seen throughout Q3 and what you're seeing so far in Q4 and basically what your guidance kind of anticipates? And two, maybe, Brian, can you delve a little deeper into the acceleration in customer and order growth and ARPU decline? How much of it was just a mix shift? And how much -- so maybe you can go back and -- to help us get a more of an apples-to-apples comparison. Was there acceleration in just traditional Shutterfly products, like Photo Books, et cetera? Was it really kind of the Treat effect that drove the customer and order growth and lowered the ARPU?

Jeffrey T. Housenbold

Youssef, this is Jeff. What we've been consistently saying throughout the year is that as we came out of Q4 of last year, our competitors who have not invested in innovation to the extent that we have often been pulling the only lever available to them, which is the promotional lever. And we've been seeing that throughout the year in an elevated level higher than the same period in 2011. We've seen periods of abatement. We've seen periods of strength, usually around the holidays as people are trying to acquire orders. And so I'd say it's pretty consistent with the flow that we saw throughout the first half of the year into Q3. You're seeing promotional activity again here around Halloween, which is seasonally normal. But what we've said all year long is that our guidance incorporates a high level of, if you will, irrationality and desperation out of the competitors. And that's modeled into our Q4 and our full year guidance at this juncture. As it relates to your second question, we saw strength across-the-board. So if you take out Treat and you take out the Kodak customers that were acquired, just organic growth across our brands was very healthy double-digit. We benefited, obviously, from the Kodak customers on top and we're benefiting, to a much lesser extent, Treat, because it's still a relatively small business for us but pleased about how our portfolio of lifestyle brands are resonating both with current customers but also attracting new customers. And that's partly because our brand equity is increasing, partly because of our scale allowed us to invest on deeper and wider into an integrated marketing approach that many of our subscale competitors can't afford to match, like our national television advertising that will be kicking off here in just a week. So delighted by kind of the business metrics across the board.

Brian Regan

And one more thing to add is that, Youssef, I think we had some very specific marketing promotions to engage Kodak Gallery customers for the first time. And they traditionally view -- have a higher propensity to buy prints, and so we had a higher mix shift, to your point earlier, a higher mix shift of print orders from those new Kodak customers.

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

Was there an acceleration in the organic Shutterfly products as well when you strip out Kodak and Treat?

Jeffrey T. Housenbold

Yes. We saw strength across Photo Books, Cards & Stationery, photo gifts and even prints. So while prints is roughly 5% of our total revenue at this stage of our development, we still continue to take share from the market while we have the highest price to lowest cost because of our vertical integration, we take those profits from prints. We funnel that back into continued innovation, design, new services and marketing.

Operator

Our next question comes from Colin Sebastian from Robert Baird & Co.

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

Bigger-picture perspective -- I just have a couple of questions. Jeff, maybe beginning from a bigger-picture perspective. I wonder if we should be viewing what last year seemed like irrational pricing or promotions in the Photo Book category now as perhaps just normal pricing. And even with that, you're obviously very profitable but perhaps similar to what we saw occur in the print market a couple of years ago. And then secondly, as a follow-up on your comments about mobile trends, I wonder if there's more color around that related to how the shift is impacting order and usage trends among existing customers. Or if mobile is more a new customer cohort that perhaps acts differently than legacy users, if you could maybe segment that a little bit more.

Jeffrey T. Housenbold

Sure. It'll be interesting to tell if the promotional activity that's occurring in Photo Books and Cards & Stationery is the new norm. The key difference between 4x6 prints is people took a rate card deduction there, where the industry hasn't really changed the list price for photo books and cards for about 5 years, they're doing it through promotions. Some of that is on their sites, some of that is just targeted emails to select cohorts of customers, some of that is through some of the Flash sale sites. But certainly what we've seen over the last few years is a continued consolidation of the industry as people realize that, that's not a terribly winning formula, particularly when they're not vertically integrated. So Kodak couldn't make a go of it. You've seen recently, we've picked up the Fuji SeeHere customers. We've picked up American Greetings PhotoWorks customers, Yahoo! photo customers and Sony ImageStation customers or the more well-known companies who tried to make a go at it. And so it's too soon to tell. But as you indicated, because we're vertically integrated because we keep getting more scale, we're automating more and more now in our manufacturing facilities. We're driving the cost of production down for us on our core products and we're able to get a greater lifetime value, higher conversion rates, higher stickiness and repeat rates, in all our customers because of the brand equity that we're building. And so we continue have nice EBITDA margins, very nice free cash flow profile, increasing top line growth, even in that environment. So I'm very pleased by the execution of the team and remain optimistic about the early days of these very large markets. As we think about mobile, it's still early in what our customers do with mobile versus, say, social networks, right? Social network, you might take a single picture of your kids in a Halloween costume, you might take a picture of the sushi you ate for lunch. What gets up to our side are in the most important precious memories of our customers, and we have more than 16 billion of those precious memories up in the Shutterfly cloud. And so our customers come to us for a different purpose. As we continue to invest in mobile, we're -- we need to make it easier for people to actually transact on mobile devices. So our Shutterfly app to date has largely been a take a picture, share a picture, upload a picture, but then you have to go to your Web browser to be able to do something with that picture and give us your credit card. The acquisition of Penguin Digital and their MoPho app and integration into the Shutterfly app here over the next few weeks and months will allow us to actually start to monetize our mobile investments. We're also making investments in Treat, which launched a couple weeks ago. So now on the go, you can make the perfect personalized card through our Treat Birthday app. And so you'll see more and more from us on the mobile side, where people can actually transact. We're also seeing as many retailers and some of the work you've published indicates is that more and more retailers are seeing customers view their websites through mobile devices, and we're certainly part of that trend as well. And so we're in the process of continuing to mobilize our browser-based website, so it's easier for people to interact and use some of the swiping and the double-clicking gestures that are available in the mobile environment. So it's still early days. But for me, that presents opportunity as we go forward to get greater share of wallet of our existing customers but also to attract a new segment of customers who might be more mobile-centric.

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

Okay. You mentioned social. Is there any way to quantify how much of the content of the photos is coming from the APIs or otherwise from Facebook, Instagram and Twitter? Or is that hard to really calculate?

Jeffrey T. Housenbold

I'd say it's very easy for us to calculate internally. But as you look at the percentage of images that are printed or put into a Photo Book or used in a card from Shutterfly customers, that still remains single-digits when you add up across all the social sites that we integrate and allow through our universal uploader.

Operator

Our next question comes from Kevin Kopelman of Cowen and Company.

Unknown Analyst

This is Andrew Merrick [ph] on for Kevin. I just had a couple of quick questions. Did you mention the Kodak Gallery revenue contribution in Q3. I was just wondering if you had any updated expectations for Kodak Gallery revenue in 2013? I believe $35 million was the last figure we'd heard. And the second question, just what percentage of your revenue is coming from existing customers?

Jeffrey T. Housenbold

We did not give an update to the Kodak customers and we're not planning on -- we saw a little bit of upside to our model because of the early completion in the migration. We suggested about $21 million for calendar year 2012, about $35 million for 2013. I think those numbers are still good to model and we'll see how those customers and that cohort performs during the fourth quarter. Brian mentioned in his prepared remarks that the Kodak customers tend to be a little more 4x6 print-centric. That's certainly is in line with what our expectations were and I think the street's expectations. And the marketing teams are busy working on targeted communication and offers to those customers to expose them the more robust and more elegant product assortment that we have to offer that they may not have been able to avail themselves of previously. And so our hope over time, as we did with Sony and Yahoo! customers and others, is we make them look more like a traditional Shutterfly customer. So we'll give you a little more perspective perhaps as we roll into 2013 and get through the fourth quarter. And as far as new versus existing, we saw -- Brian will tell you the specific amount, but we saw an uptick in new this quarter party because of our integrated marketing efforts but also because the Kodak customers were treated as new customers for us. And so we're going to have to get through a period here of a couple of quarters until you get kind of normalized of absorbing the Kodak customers. But Brian, the percentage from new versus existing?

Brian Regan

Yes. So the growth in the new customers was quite strong. So obviously, existing is going to represent a little bit smaller than what it was traditionally. So it's closer to around 2/3 of our total revenue coming from existing customers in this last quarter.

Operator

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

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

Jeff, I've got a longer question, but just following up on the housekeeping on the last one. Brian, what was -- multiple companies here dealing with numbers. What was the existing customer revenue growth in the quarter?

Brian Regan

I think -- I don't think we disclose that traditionally. We haven't broken out the growth numbers. But I will tell you that it is a 2/3 existing, where it traditionally it was closer to 75%. And that largely that 40% customer growth came from new customers.

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

Okay. Jeff, as you think about -- you made an announcement a little while ago about expanding your manufacturing capacity on the East Coast. And as you think about in the next several quarters on the margin front in terms of the core business to perhaps lower unit cost of Shutterfly, maybe absorb more of Tiny Prints' volumes into your internal manufacturing, and then later on Kodak. I mean, maybe just can you walk us through some of the thought process as we move into '13 and incorporate and think about your sort of expanding manufacturing capability fix?

Jeffrey T. Housenbold

Sure. And we haven't given 2013 or beyond guidance yet, but I think there's going to be a mix of puts and takes. So as we increase the volume of in-house production for the Tiny Prints brand, that will benefit us, as you indicated. This year, we had mentioned that we believe that Kodak customers will be at roughly breakeven from an EBITDA standpoint and we expect them to be more accretive next year. And we expect some of the early investments we made to start to pay off and then their scale and scope economies. Those will be offset in part through some of the strategic growth initiatives that we have underway: continued investment in Treat; continued investment in our Enterprise business, which pulls down margins; continued investment into mobile, with our Penguin Digital acquisition; our investment in smart technology to understand your collection of pictures through our Photoccino acquisition; increased investments in integrated marketing; and then expansion projects that we haven't yet talked about. So it's kind of a put and take. I think when you look at the core Shutterfly margins and if you stripped out all of that kind of new initiatives, you would see that expanding. But because we believe that we're in the early days of these large multibillion-dollar markets, we think laying the track so that we continue to have healthy top line growth is the right balance of our investments. And so as we get through the fourth quarter and we come back in late January, early February to chat with you guys, we'll give you a sense of kind of model that for 2013. But I think the key message I want you to take away, Colin, is that -- sorry, Shawn, is that we're not dropping it all to the bottom line. We think our momentum and our market position warrants that we invest some of that synergies and scope efficiencies back into the model.

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

Okay. I mean, that seemed like the list of takes was a little longer there.

Jeffrey T. Housenbold

Yes. There's also projects that we haven't yet talked about that are new initiatives that we think are important to invest in. And as we get a little bit more traction and they come closer to fruition, we'll share that with the street.

Operator

Our next question comes from Andrew Rudd of Morgan Stanley.

Andrew Ruud - Morgan Stanley, Research Division

Curious if you could talk about the ability to put marketing dollars behind the Treat initiative. And kind of what that is relative to kind of the Photo Book category or some of the other categories. And I have a follow-up.

Jeffrey T. Housenbold

Sure. So what we've said is our plan around Treat is to get it launched this year, check that box; to optimize the user experience both on the desktop and through the browser but also in mobile; and to get that formula right. And so we have millions of dollars of investment in the model this year and almost no revenue, really, in the model from Treat. Once we're confident that we have the right mixture, then we'll start to look to put more fuel behind its growth through hard marketing dollars. One of the things I'm really encouraged about if you think about Treat's main competitor online it's American Greetings Cardstore. And if you go to Compete or Alexa or comScore and you look at our unique visitors against Cardstore, we're starting to -- we're growing and they're shrinking and they've spent tens of millions of dollars in hard marketing. So that combined with our internal surveys of the Net Promoter Score coming from the people who've used Treat, it's doing really well from those measures, but it's very early days and changing consumer behavior takes a while. So once we get the formula right, you'll start to see us putting marketing dollars behind it but nothing yet is built-in to the model for meaningful, hardworking dollars against Treat. And just -- you asked about the opportunity. The 1:1 greeting card industry is billions and billions, and it's orders of magnitude larger than the existing photo book market. And so if this resonates with customers, if we're successful at changing user behavior, 1:1 greetings could be a meaningful contributor in the outyears to the business model. That's why we're excited, but it also takes a while to build a new business and to change consumer behavior.

Andrew Ruud - Morgan Stanley, Research Division

Okay. Well, I also think that there is probably an opportunity for marketing arbitrage because it seems like you guys picked up a lot of customers and largely due to Treat.com. So being able to convert those in the fourth quarters should be an opportunity, right?

Jeffrey T. Housenbold

Theoretically, yes. I just want -- because we didn't break this out and you're the second person to ask. The 40% growth in customers was -- there was a very de minimis impact from Treat customers, okay? The large part of that is just organic growth coming to our other brands of Wedding Paper Divas, Tiny Prints and Shutterfly plus the Kodak customers in the quarter. Treat certainly was accretive to that, but it was the de minimis piece. So that gives us, in my mind, more of an opportunity to market Treat outside of the holiday season to our install base of millions and millions of paying customers.

Operator

[Operator Instructions] Our next question comes from Atul Bagga of Lazard Capital.

Atul Bagga - Lazard Capital Markets LLC, Research Division

I have a couple of questions for you. On Facebook, can you share your thoughts? How do you see that opportunity? Do you see this more as a revenue opportunity? Is it more of a brand awareness opportunity? And second, on the cable TV advertising campaign, can you talk about what is the investment you're looking? And what would be your expectation from this campaign?

Jeffrey T. Housenbold

As it relates to Facebook, we're delighted to be partnering with them in their new Gift initiative, which for those of you not aware, they bought a company called Karma, and they're allowing people to send gifts, physical gifts, to the people who are in your social network. And they chose us to partner -- both our Treat and our Shutterfly brand is providing the vast majority of the cards that will go along with those gifts. And so we're not charging for that set of designs today. It really is about a brand awareness capability for us. And given the breadth and the different demographic that Facebook attracts, I think it's a great opportunity for us. We're delighted about the partnership and the relationship with Facebook. It's early days in that program. And as that continues to progress, I think both parties are hopeful that there'll be more for us to do together. As it comes on the television front, last year, we said we did a direct-response television campaign that was less than $0.5 million in the fourth quarter as a test. We continue to do some testing throughout the first 3 quarters of the year. Based upon the positive results from that test, we expanded from a smaller test to a national campaign, targeting on cable to the demographics that we believe will resonate most to our products and services this holiday season. It's a fairly small program for us, but it's certainly expanded from the less than $0.5 million. And the way we're measuring it is we're able to look in certain markets, where we're dropping it versus matched pairs, where we're not. We're looking at those markets, where we're dropping catalogs or doing other integrated marketing both on and offline. And so the team that did that with me at eBay are now at Shutterfly and very sophisticated and capable in measuring the impact of the various levers in an integrated, multifaceted marketing campaign. So we're excited to measure awareness, transactions, lifetime value and all of those things, not just in period but on a longitudinal basis. And so as you guys know, Shutterfly's a very fact-based, very quantitative-led marketing organization. And we'll look at the efficacy of this program, which we're excited about, resonating with the test consumers very well. And we'll report back to you guys in the new year, how we think it performed and what our intent of TV as part of the fuel mixture will be.

Atul Bagga - Lazard Capital Markets LLC, Research Division

Very helpful. And just one quick question on mobile. Did you guys share how many downloads you have seen so far on mobile? And if you can break that, how many downloads were within the existing customers versus new users?

Jeffrey T. Housenbold

Yes. So we did say we had 3.6 million cumulative downloads. That's both across the iPhone and the iPad. We have not broken down between new and existing nor do we intend to. It's I would say it's largely existing because that app as it stands, one, we haven't done hard marketing against it, so some new customers stumble across it in the iTunes Store. Second, you can't transact. And third, you have to be able to have a Shutterfly account to log in to be able to use the app beyond just the simple picture-taking. And so our existing customers find it an incredibly useful and powerful thing on the go to be able to take all those mobile pictures they took with their iPhone, have those uploaded to their Shutterfly cloud for safe protection and to be able to share on the go. And now with the Penguin Digital acquisition, we're excited to be able to help them do more with those memories and be able to start to monetize that crowd. And we haven't really spent any hard marketing dollars against it to build awareness. Once we get functionality that we think makes it useful to new customers, we will look to do that.

Operator

Our next question comes from Mitch Bartlett of Craig-Hallum.

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

Brian, I missed your conversation about gross profit margin this quarter and next and the impacts associated with it. There was something about an Enterprise lease termination fee and other things. Could you go through that list again? And maybe you could also just -- how much, the expansion of the facility next year? And how much that is impacting Q4 or for the full year?

Brian Regan

Sure. So the gross margin conversation included really 3 key attributes as to what the lower gross profit margin was in the quarter. First and foremost, the predominant driver was greater-than-expected Enterprise revenue. So the doubling of Enterprise revenues to $8 million in the quarter was the predominant driver. There were 2 smaller factors that included an actual lease termination fee from the current East Coast facility, the Charlotte facility, and then increased customer service cost as ramped up the migration of the Kodak Gallery customer base. So those are the 3 main drivers. But the predominant driver in the quarter was still the growth from the Enterprise business.

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

And what's the lease termination fee?

Brian Regan

We're not going to disclose that because we're still in conversations with the current landlord on that. So we don't want to disclose that. And then when it comes to overall...

Jeffrey T. Housenbold

Margin impact from Fort Mill in the fourth quarter.

Brian Regan

Yes. So basically, as we've said, we're absorbing -- we have not changed our fourth quarter CapEx guidance for the fourth quarter, indicating that in total for all of 2012. Our Kodak Gallery plus the early investments into the Fort Mill facility will be $12 million, but the majority of that investment obviously, as we said, prior for Kodak was $9 million. So you're really looking at around a $3 million estimated impact on a CapEx basis going into the fourth quarter. And there won't be anything else besides balance sheet moves, maybe some small out-of-pockets. But the de minimis impact on our EBITDA in the fourth quarter from the Fort Mill facility.

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

And just maybe -- I know you've touched on it with Youssef on this, but just one more time. Promotional environment currently, I see you've been fairly aggressive lately both to the base and on the website. What is the strategy as far as customer acquisition into the fourth quarter as a competitive tool?

Jeffrey T. Housenbold

Yes. I think -- let me talk a little more broadly than the fourth quarter. I think given our market leadership position and InfoTrends estimates, we have somewhere between 51% and 52% of the online photo-related market today. Given our vertical integration, given our sophistication of our customer relationship management, our market segmentation, our ability to target and personalize, given our integrated marketing campaign from home parties to catalog to television to rich media to social media, we have the ability to kind of be smarter and outnavigate most of the competition as it relates. And because we own manufacturing, we have better margin, so we're able to different segments to try to create 1:1 marketing to get them to do behaviors that we think drive lifetime value. And so I think, ideally, people would not be discounting. But across the entire retail spectrum, from Bloomingdale's and Saks Fifth Avenue, all the way down, we still remain in a tough macroeconomic environment and consumers respond to that. I think where we excel is once we get them in the door is to move them through that life stage and get them to be profitable customers for us. And as we looked at our experimentation with daily deal sites and Flash sales sites last year, we got smarter about what that fuel mixture is, and we've been deploying that. We've gotten smarter about the specific promotions that worked and didn't work. And so even though our competitors are doing that and driving the net price down, we've been 3 quarters in a row have delivered on both the top and the bottom line. And so for the things that are in our control, I feel very good going into the fourth quarter.

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

Great. And then just one last one. On Kodak Gallery and the continued mining of that customer base that came over, what is the plan there? How does that look, intermediate-term?

Jeffrey T. Housenbold

Well, we've picked up a significant amount of images and customer accounts and our job now is to turn those into healthy customers. We did that through targeted promotions, through targeted communication, through targeted inspiration during the third quarter. We'll continue to do that through the fourth quarter. But we've conceived an entire marketing campaign to that segment or cohort of customers that are specific and tailored to their behavior, their social economic, what they are accustomed to and what we think we need to do to get them to look more like the traditional Shutterfly customer. So I'm very proud of the team, how they moved quickly, got that project done and how it's been resonating. And so too early to tell, but their early indications are positive.

Operator

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

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

Yes. I want to start by your comment that in conjunction with the share repurchase, you will be making both small and large acquisitions. So I wanted to just discuss acquisitions as a part of your capital allocation for the next year, and in particular, your feelings about Snapfish.

Jeffrey T. Housenbold

Yes. So what we've always said, I think there's really 3 key buckets when a company looks at an acquisition. First, you have to make sure there's sound, strategic rationale for the acquisition. Second is you have to be sensitive to what you're paying for it, right? What its profitability profile is today and what it can be? What are the hard and soft synergies? What are the operational things that you need to do to realize that. And then the third is what I'll call post-merger integration that encompasses both the technological, the people, the cultural and the business rationale to bring it to life so that you can achieve the synergies and the accretion for your shareholders. So we're very disciplined. We have a very experienced executive team who've done dozens and dozens of deals ranging from $100,000 to multibillion in our careers. And so I think we've had demonstrated very strong discipline around M&A. As it relates to our share buyback, when we look at where we're trading vis-à-vis other Internet peers on an EBIT, EBITDA, or EBITDA free cash flow basis or EBITDA revenue basis, we think our stock is undervalued relative to the peers. We also want to be shareholder-friendly. And that as we continue to spit off more cash and as we looked at our likely cash balance rolling forward over next few years, that stock pile was going to grow. And given some of the changes in the tax laws and dividends versus share repurchase, we thought the share repurchase was the most effective way to return some capital to the shareholders that are above our anticipated needs. Having said that, and you know, M&A sometimes is opportunistic, we believe the partnership we have with JPMorgan and Wells Fargo and the other lenders in our line of credit, our anticipated balance sheet both from a cash and from, should we need stock, we think we have plenty of firepower to do small technology tuck-ins, like Photoccino, acu-hires [ph] that we've been doing, deals like Penguin Digital to expand into important mobile or to do large deals like we did with Tiny Prints. So we're in a very fortunate position with no debt, a healthy balance sheet to have flexibility to move in any direction that we think is strategic and the right thing for our shareholders.

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

I do have one more question. Not that you don't have enough going on, but you haven't talked about your international plans in quite some time. Wondering if you could just give us an update into you're thinking about that.

Jeffrey T. Housenbold

I'm sorry, you were breaking up. Which plans? International? Was that what you said?

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

Yes. You haven't discussed international as part of your growth. So I was just wonder if you could discuss that.

Jeffrey T. Housenbold

Yes. I think our vision remains consistent that we aspire to be a global lifestyle portfolio of brands that resonate with customers and that we think there's opportunities for additional growth here domestically but also across the world. Everywhere, it's universal, people want to share and preserve and do more with their images and their memories. And as digital phones and smartphones penetration takes off both in the developed and developing world, I think that presents a great opportunity for Shutterfly. So we're not detailing the specific plans about international. But we're thoughtful about both organic, partner and M&A activity to expand beyond just the U.S. and we think that's a great opportunity and upside for Shutterfly and our shareholders going forward.

Operator

I'm showing no further questions and would like to turn the conference back over to Mr. Jeff Housenbold for any closing remarks.

Jeffrey T. Housenbold

Thanks, everyone, for joining us today. I know with the Hurricane Sandy, it's put a lot of people's lives into a frenzy, and certainly, the sell-side analysts with a lot of calls today. So thank you for joining us here.

In summary, hopefully, you took away a couple of key things. We had another solid quarter performance. The Shutterfly, Inc. team across all of our 4 lifestyle brands continue to execute and outpace our competition. And the first 9 months of the year have been successful in my mind. Our continued investments in innovation and customer-centricity, design, quality and vertical integration to control our destiny are paying off. I'm excited about where we are going into Q4 and the things that we could control, the designs, the new product assortment, our mobile initiatives, the Photoccino stuff, Treat. And so this is my eighth quarter -- fourth quarter here at Shutterfly. And what the team's doing and what's in our control has been better this year than ever before.

But as Brian mentioned, we are also acutely aware of the externalities that continue to persist that are outside of our control. And let me just name a couple: one, is a continued fragile economy; two, is the uncertainty around election and the potential impact of a fiscal cliff that could have on the equity markets and the wealth effect or negative wealth effect potential; irrationality by competitors though we've seen that for several quarters and have incorporated that into guidance; and then lastly, certainly many retailers and companies have been impacted by Hurricane Sandy here over a few days, as millions are without electricity and they come back online. That is a temporary blip, and it's -- but there is still some impact to be felt as people are focused on recovering from that tragedy and may impact sales.

We took all of what we know today into account in our guidance and think our competitive position and our strong record of solid execution in up-and-down markets puts us in the best position as possible as we go into the fourth quarter. So with that, I'm excited. Make sure you get ahead of the lines and make your holiday cards on Shutterfly. And we look forward to coming back and updating you in 2013.

Operator

Ladies and gentlemen, this does conclude today's conference. You may all disconnect, and have a wonderful day.

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