Shutterfly's (SFLY) CEO Philip Marineau on Q1 2016 Results - Earnings Call Transcript

| About: Shutterfly, Inc. (SFLY)
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Shutterfly, Inc. (NASDAQ:SFLY) Q1 2016 Earnings Call April 27, 2016 5:00 PM ET

Executives

Christiane Pelz – Vice President of Investor Relations and Risk Management

Philip Marineau – Chairman & Acting Chief Executive Officer

Michael Pope – Chief Financial Officer & Senior Vice President

Analysts

Andrew Bruckner – RBC Capital Markets

Chris Merwin – Barclays Capital, Inc.

Kerry Rice – Needham & Co.

Brian Fitzgerald – Jefferies

Mitchell Bartlett – Craig-Hallum Capital Group

Kevin Kopelman – Cowen & Co.

Operator

Good day and welcome to the Shutterfly First Quarter 2016 Financial Results Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. Please note that this event is being recorded.

I would now like to turn the conference over to Christiane Pelz. Please go ahead.

Christiane Pelz

Thank you, operator. Good afternoon, everyone. Welcome to Shutterfly's first quarter 2016 earnings conference call. With us today are Phil Marineau, our Chairman and Interim CEO; and Mike Pope, 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 of 1933 and the Securities Exchange Act of 1934. These forward-looking statements include statements about our business outlook and strategy and the assumptions underlying those statements and statements about historical 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 analysis 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 Phil. Phil?

Philip Marineau

Thank you, Christiane. Good afternoon, everyone. This has been a busy and productive first quarter for Shutterfly. We met or exceeded guidance across our major metrics with good performance in our Shutterfly brand and strong performance in our SBS segment. We began implementing the first phase of our Shutterfly 3.0 vision, and in March, we named our next CEO, Chris North from Amazon UK, who will start on May 31.

I'll add some color to each of these areas and then Mike Pope will provide a more detailed financial review. First, our results. Total revenues grew by $22 million to $182 million, up 14% over the first quarter of last year. And adjusted EBITDA was a negative $2.6 million compared to a negative $871,000 in Q1 of 2015. Excluding the previously announced $3.3 million in executive severance costs, adjusted EBITDA would have been a positive $716,000.

Our consumer revenue grew 4% to $155 million, led by the Shutterfly brand which grew nearly double-digits. We made a tremendous progress on mobile in Q1 as we executed a mobile marketing strategy through an unlimited free prints campaign. The campaign was very successful at efficiently driving new customers via the Shutterfly mobile app. The campaign resulted in a record 1 million downloads for the quarter and drove a record number of customers via the app, 2.7 times more than in last year's first quarter.

Mobile related revenue for our Shutterfly brand reached its highest contribution yet at 20%. On the SBS side, we more than doubled revenues from $11 million to $26 million. We deepened our relationships with existing customers and gained a new Fortune 250 customer. Gross margins were also more than doubled to 25.1%, reflecting our increasing scale, the operating leverage we're beginning to see from our manufacturing investments, and the efficiencies we're building into our processes such as increased automation in workflow, manufacturing and accounting.

We are also making good progress in building out our platform into a fully integrated end-to-end solution for our SBS customers, which will allow us to work more closely with them in designing and implementing marketing programs. During the first quarter, we made substantial progress on our strategic initiative, Shutterfly 3.0, our vision for creating a platform and device-agnostic world-class memory management service connected to the smartest personalized e-commerce solution.

As we've said in the past, 3.0 encompasses multiple projects. Our goals for 2016 are focused on creating a new photo management solution on Shutterfly by integrating ThisLife, with its superior organization and creation features, into Shutterfly as well as building an enhanced Shutterfly mobile app on iOS and Android that offers a broader product catalog. These moves will improve the Shutterfly customer experience and deepen relationships with our customers.

Phase one of Shutterfly 3.0, migrating ThisLife users to Shutterfly, began during the first quarter as planned. ThisLife is now closed to new registrants and on completion of the migration the ThisLife app will go away. We have begun migrating Shutterfly users to the all-new Shutterfly, and we plan to have the majority of active users on the new Shutterfly by the fourth quarter.

Customers moving into the all-new Shutterfly will see a number of new features. Our new photo service provides a modern, intuitive user interface in which users 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. The service makes it easy to tag and search by people, places and keywords. Combined with our simple but powerful upload tools for both desktop and mobile, including the ability to detect and auto upload new photos, we are helping our customers to easily and more quickly create gifts and keepsakes.

Finally, as we look to the future with the new CEO, we are excited to have Chris North joining Shutterfly. Chris brings fresh insight, enthusiasm and a valuable skill set to the company. He is a consumer driven strategist with strong expertise in e-commerce and retail, having spent 11 years at Amazon UK, during which time he helped grow the business to $9 billion. He has a demonstrated ability to build and manage high performing teams at a size and scale that make him the right fit for taking Shutterfly into the next phase of growth. He is also a very strong cultural fit being both performances driven and collaborative. Once he is fully on board, Chris is looking forward to meeting our investor community and will be introduced to you on the second quarter call.

Now, Mike Pope will take you through the financials in more detail.

Michael Pope

Thank you, Phil, and good afternoon, everyone. I'll begin my comments today with some observations about our first quarter performance and then conclude with an overview of the second quarter and an update to the full year financial guidance.

Net revenues for the first quarter totaled $181.7 million, representing an increase of 14% over the prior year, exceeding the midpoint of our guidance range by $5.2 million. In the quarter, consumer revenue grew 4% year-over-year to $155.4 million with nearly double-digit growth in our Shutterfly flagship brand. Weaker revenue from our Tiny Prints and Wedding Paper Divas brands partially offset this strength in Shutterfly.

Net revenues from our SBS business more than doubled, growing 135% over the prior year to $26.3 million. In Q1, total unique customers grew 4% to 3.3 million. We generated 5.5 million orders across our portfolio of premium lifestyle brands, a 7% increase over the prior year. Average order value or AOV for the quarter was $28.04, down 3% from the same period a year ago, reflecting an increase in the promotional activity to widen our footprint in mobile.

GAAP gross margin in the first quarter was 40.2%, a 60 basis point decrease from a year ago. This margin decline is driven by a higher mix of SBS revenue and our mobile promotional activity in the consumer business.

Q1 consumer gross margin was 44.4% and SBS gross margin was 25.1%. Operating expenses for the quarter totaled $114.8 million, up 3% over the prior year. These expenses included $3.3 million of severance related to executive departures announced in Q4. Excluding these severance costs and the $7.6 million reduction in stock-based compensation expense in Q1 of 2016, our operating expenses increased by 8% to $102.6 million. This stock-based compensation decline was driven by the executive departures announced in Q4 of 2015.

Looking more specifically at our operating expense components, technology and development costs totaled $38.3 million for the quarter, up 2% over the prior year at 21% of net revenues. We continue to invest in additional customer facing enhancements with Shutterfly 3.0 and in our SBS business.

Sales and marketing expenses totaled $45.8 million in the quarter, up 3% over the prior year at 25% of net revenues. The growth in sales and marketing expense was largely driven by higher customer acquisition costs due to rising media prices. General and administrative expense for the quarter totaled $30.7 million, up 4% from the prior year, or 17% of net revenues. Excluding the executive severance charge this quarter, G&A expenses were down 7% from last year, mainly due to lower stock-based compensation. Operating loss for the quarter was $41.8 million, $4.4 million better than Q1 of 2015. This improved profitability was driven by diligent expense control and lower stock-based compensation.

Adjusted EBITDA loss for the quarter was $2.6 million. Excluding severance charges, adjusted EBITDA would have been a profit of $0.7 million or 0.4% of net revenues, $1.6 million better than the same period last year. The effective tax rate for the quarter was 37.9%, above our guidance range of 31% to 34%, mainly due to the impact of additional non-deductible compensation, a reduced manufacturing deduction, and a reduced R&D credit.

Our net loss for the quarter on a GAAP basis totaled $29.4 million or $0.85 per share. The weighted average shares used to calculate the net income per share totaled 34.6 million shares. Cash and total investments as of March 31 totaled $194 million, decreasing $147 million from year-end. Our decrease in cash was largely driven by share repurchases and payments of large seasonal expenses accrued during our peak Q4 quarter.

Capital expenditures during the quarter totaled $13.7 million. In the quarter, we repurchased a total of 1.1 million shares for $47.5 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. We had $47.8 million remaining under our previously authorized share repurchase programs as of March 31, 2016.

Additionally, on April 21, 2016, the Board of Directors of Shutterfly authorized the repurchase of up to an additional $100 million of the company's common stock as further referenced in the 8-K filing of this earnings release, in addition to the $47.8 million remaining under our previously authorized program.

We now turn to guidance for Q2 and the full year. We expect Q2 net revenues to range from $195 million to $202 million, which reflects year-over-year growth of 7.9% at the midpoint. In Q2 of 2015, we recognized a benefit of $7.5 million in a deferred revenue catch-up from unredeemed flash deal sales. Excluding this revenue deferral in Q2 of 2015, year-over-year growth would be 12.6% at the midpoint.

We expect our Q2 GAAP gross margin to range from 44.8% to 45.3% of net revenues and our GAAP operating loss to range from $28.6 million to $31.2 million. We expect our adjusted EBITDA will range between $10 million and $13 million. One should note that last year's Q2 adjusted EBITDA benefited by approximately $4 million from the deferred flash revenue catch-up. Our GAAP effective tax rate is expected to range between 36% and 37.5%, and we expect GAAP net loss per share to range from a loss of $0.62 per share to a loss of $0.69 per share, based on approximately 34.3 million basic weighted average common shares outstanding.

For the full year 2016, we are reiterating our guidance for revenues, gross profit margin, operating income, adjusted EBITDA, earnings per share, capital expenditures and free cash flow that was provided on the February 2016 call. Net revenues will range from $1.12 billion to $1.16 billion. We continue to expect the full year GAAP gross margin to range from 50.9% to 51.7% of net revenues, and that our GAAP operating income will range from approximately $32.6 million to $53.9 million.

Our full year 2016 adjusted EBITDA margin will remain in the range of 18.2% to 19.2% of net revenues. The full year GAAP effective tax rate is expected to range from 36.0% to 37.5%, increasing from our prior range, driven by the same factors we addressed earlier. We expect full year GAAP earnings per share to range from $0.19 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 $124 million and $132.9 million, or 11% to 12% of net revenues.

I will now turn it back to Phil for some closing remarks.

Philip Marineau

In summary, our team is executing well, driving growth and improved margins. In my tenure as interim CEO at Shutterfly, I've been impressed with the commitment and performance of the entire team during this transitional period. We've come through the period in a strong position and now look forward to having Chris join the team. The pieces are in place for value creation. We have a clear vision for growth, a strong market position, and we're already on the path to improving profitability and growing free cash. We also continue to execute on share repurchases to augment shareholder returns.

With that, operator, I would like to open it up for questions.

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. [Operator Instructions] And our first question comes from Andrew Bruckner of RBC Capital Markets. Please go ahead.

Andrew Bruckner

Great. Thank you, and congratulations on hiring Chris. A couple questions on the enterprise side. If you could talk about where you think long-term enterprise margins can be, and then how enterprise is going to change your seasonality. If we should look to historic seasonality on the enterprise side as a predictor of the future or if that's going to change as you bring on some of these more large contracts? Thank you.

Michael Pope

Sure. Thank you, Andrew. This is Mike, the Chief Financial Officer. With regard to long-term margins we have not provided long-term expectations on the margins in the SBS business, but what you'll see is that we had a dramatic increase in the margins year-over-year and as we get scale in that business, we expect the margins to get better. It also tends to get better with the longer relationships we have with some of those customers.

With regard to the seasonality in that business it's our goal to help smooth out some of the seasonality. That said, this is a much more lumpy business, where we get customers and then we tend to grow them into multi-million dollar customers over a period of time. So, depending on when their high season is for those customers will depend on how much we're able to smooth out the seasonality.

Andrew Bruckner

Great. Thank you.

Operator

And our next question comes from Chris Merwin of Barclays. Please go ahead.

Chris Merwin

Great. Thank you. I just had a couple of questions. So, for the consumer business, it looks like order growth is slowing down a bit, but that's being offset by a stabilization in AOV. I know the dynamics between those two metrics can change a lot just depending on your pricing strategy, but I was wondering if you could talk a bit about, why order growth specifically is slowing down? And then I have a quick follow-up.

Philip Marineau

Yeah. Thanks, Chris. If you look at what we said in our prepared remarks, the Shutterfly flagship brand grew almost double digits within the quarter. So, we continue to see good growth in the flagship brand, Tiny Prints and WPD were – obviously hurt us in terms of lowering the overall growth. So, we remain committed to trying to invest in ways that we can improve consumer growth, and as you know 3.0 is a big part of how we expect to have consumer growth increase over the course of this year and beyond.

Chris Merwin

Got you. Thanks. And then just my second question was about mobile, you talked a lot about the success you've had with the mobile marketing campaign. And I think you said, mobile is 20% of revenue now, so as you're shifting more of your budget to mobile, has that affected the cost of customer acquisition in any way for you and maybe it's too early to know, but I guess the question would be do you anticipate higher or lower cost of customer acquisition and do you anticipate transitioning more of your budget to mobile in the future?

Michael Pope

Well, that's -

Philip Marineau

Go ahead.

Michael Pope

Go ahead.

Philip Marineau

No, you go ahead.

Michael Pope

That was a big part of our strategy. As you know, it's a big part of what we're investing in in 3.0 and what we've seen is that our external media cost have gone up across the board, whether it's for both the website or for mobile. We are spending more on mobile which has a lower cost per click, but that doesn't translate or doesn't convert into customers and purchases at the same rate as the website. So, we continue to search for the right balance there, and I think our team does a good job around that.

Philip Marineau

And I would only add that, that's the importance of the phone app and this portion of Shutterfly 3.0, and the more we are able to make that phone, the epicenter of people's photos on their phone, we think that there is promise to see both orders increase and order value, but that remains to be seen until we get the app out there and we see how well it works and how people behave.

Chris Merwin

All right. Great. Thank you.

Operator

And our next question comes from Kerry Rice with Needham. Please go ahead.

Kerry Rice

Thanks a lot. Mentioned a couple times, there was a slowdown in Tiny Prints and WPD, was that just maybe a pullback on marketing as you transition the platform, or was there anything else in there, anything structurally that changed that would cause that slowdown? And then maybe back to mobile, just one clarification. Was mobile 20% of total revenue or just the Shutterfly brand? I guess that's the first question there. And then can you talk a little bit, you mentioned the promotion around photos, are you planning on doing some more broader marketing of that app, maybe app downloads using some of the social media type of property to do that, and I'll stop there.

Philip Marineau

Well, I think, the 20% was 20% of Shutterfly.

Michael Pope

Brand...

Philip Marineau

Brand, yes. Brand Shutterfly. And yes, as we implement in the fall Shutterfly 3.0, the all new Shutterfly campaign will be aimed specifically at introducing people to what they can now do on their smartphones. And – but this promotion that we ran is very valuable as we said in our comments in terms of the number of people that downloaded the app. That gives you potential for future orders.

Kerry Rice

Maybe can I follow-up...

Michael Pope

And Kerry...

Kerry Rice

I was going to ask a follow-up. Sorry, about that. Go ahead.

Michael Pope

Kerry, with your question with regard to WPD and Tiny Prints, we expect the growth in that to lag the growth of the Shutterfly brand, largely because of the investments that we've been able to make in that, both from a technology standpoint and a marketing standpoint. So, that wasn't surprising to us.

Kerry Rice

Okay. Maybe a follow-up on the mobile, can you give us the metric on how much mobile is as a percentage of total revenue. I think last quarter you had indicated it was about 12%, unless I'm mistaken, and that was just part of the Shutterfly brand? And then as far as the catalogue and what's available on mobile, do you have a sense of what percentage that is, or where you are in providing that on mobile? Is it halfway done, is it 25%, any comments there?

Michael Pope

Yeah, Kerry, I think, we've always talked about mobile as a percent of the Shutterfly brand. So this was an uptick in mobile as a percent of the Shutterfly brand within the quarter. With regard to the percent of the product offerings on mobile, I don't have those numbers at my fingertips, but what I can tell you is the very important thing that we're trying to get done by the fourth quarter of the year on mobile is to make sure that cards and stationery, which haven't been available on mobile, are available by the fourth quarter, as well as trying to improve some of the functionality around photo books.

Kerry Rice

Thank you so much.

Operator

And our next question comes from Brian Fitzgerald of Jefferies. Please go ahead.

Brian Fitzgerald

Thanks, guys. Maybe one on core, then one on enterprise, you mentioned in the press release beginning the migration to new Shutterfly. How long do you envision that migration taking place, is it going to be completed as we roll into next year? Do you think the cadence is going to accelerate as you get the branding efforts out there? And then I'd like to come back with an enterprise question too.

Michael Pope

Yeah. So, our goal is to get the majority of the active users of Shutterfly onto the all new Shutterfly by the fourth quarter of the year. We began that migration this past quarter. We're ramping that up as we speak, and as we learn more as we go along, we'll be able to provide you a better answer as to what percent of the customers will be on there, but it may well extend beyond the fourth quarter of the year to get all of the Shutterfly customers on there.

Brian Fitzgerald

Got it. And then on the enterprise side, Business Solutions is progressing well. Any changes to the sales cycle there, how does the pipeline look from your perspective? And then could you give us a sense of what repeat order trends look like, specifically for your enterprise customers?

Philip Marineau

No, go ahead. I'll let Mike answer that.

Michael Pope

So, with regard to the sales cycle, we're not seeing any noticeable difference in the sales cycle as it relates to new customers. We are seeing that the customers that we get tend to do additional programs with us and the sales cycle for additional programs is obviously shorter, as it is in most enterprise businesses in that regard.

The pipeline looks healthy, we are cautious in terms of the pipeline and how quickly we build the pipeline there. As you know, part of what we're trying to do with our technology spend in 2016 extends beyond the consumer side into the SBS platform and in order to scale that business dramatically to the next level, we have to make some investments in that area.

Brian Fitzgerald

Got it. Thanks, Mike. Thanks, Phil.

Operator

And our next question comes from Mitchell Bartlett of Craig-Hallum. Please go ahead.

Mitchell Bartlett

Just want to focus on the commentary on the mobile side. So, it's 20% of revenues. I'm sure it's because the average order value is probably a lot less, it's a significant higher percentage of total traffic for just the Shutterfly brand. But you got 1 million downloads of the app in Q1. It doesn't sound like you're pushing on it or are spending heavily on the advertising side; I think I heard you say, you're going to do that in the fall. So how does this all come together and where is the peak, where is the crossover that it really starts to ramp significantly and are we skewing the business more towards the fourth quarter, when this app is out there and fully advertised against?

Philip Marineau

Well, I think the first thing to say is we're not skewing the business to the fourth quarter. That's where the peak of the business is primarily because of the holiday season, gift giving and people sending cards, and what you want to do with the -

Mitchell Bartlett

Yeah, more...

Philip Marineau

...what, pardon me?

Mitchell Bartlett

I just mean more towards the fourth quarter.

Philip Marineau

Well, I mean, all I'm saying is that's where the demand is and that's where the peak of the addressable market is and you want to intercept that as fast and as much as you possibly can. So the phone, when we launch it at the end of the summer or the beginning of the fall is designed to make that smartphone much more functional in terms of being able to make cards and stationary, to be able to make photo books, so that the people who have downloaded it can actually use it into buy things that are difficult to do on the phone right now and on the app.

Mitchell Bartlett

Great. Thank you.

Operator

And our next question comes from Kevin Kopelman of Cowen & Company. Please go ahead.

Kevin Kopelman

Thanks. First, can you give us any more color on how you're thinking about or what you're seeing in consumer growth and SBS growth for the second quarter? And then secondly, can you give us some more color on the free prints campaign, what was it exactly, how did it impact metrics and do you expect to repeat it in the second quarter? Thanks.

Michael Pope

So, we provide overall guidance with regard to revenue per the quarter and the year, so we don't break it out specifically as it relates to SBS versus consumer. I'd say what we have said and what I'm comfortable continuing to say is that we expect the consumer growth will get better as we go through the remainder of the year because of the migration of customers onto the Shutterfly 3.0 platform on the consumer side. On the SBS side of the business that is a business that is very healthy. We expect it to continue to grow. We don't expect it to continue to double quarter-over-quarter. So, I think that was your first question.

With regard to the free prints promo results, the free prints promo results was unlimited free prints, if you downloaded our app, and it was off of our app during the first quarter. We would expect to continue to run that promotion throughout the second quarter, and obviously it is, as you point out, a lower average order value, so that drags that metric down.

Philip Marineau

And I would only add...

Kevin Kopelman

Is that a permanent? Sorry.

Philip Marineau

We will run this. It is going to run in the second quarter. And we will take it one quarter at a time and see how well it's doing, whether its effectiveness dissipates, then we might change our mind, but if it continues to be strong, we'll continue to do it. And the early signs and it's very early to tell is if the repeat purchase rate and the people who have downloaded from that promotion has some positive signs associated with it, and again it's too early to tell, but the initial indications is that this is working in terms of getting new users engaged in the brand.

Kevin Kopelman

Okay. Thank you very much.

Operator

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

Philip Marineau

Thank you for joining us today. We look forward to the new CEO next quarter giving you Shutterfly results and telling you about the progress that we're making on 3.0.

Michael Pope

Thank you.

Operator

And ladies and gentlemen, the conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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