Shutterfly’s third-quarter consumer business disappoints, company misses target

Shutterfly reported a third-quarter net loss of $73.5 million, compared to last year’s $25.6 million loss, on net revenues of $368.8 million. The company’s shares dropped more than 12 percent in after-hours trading because revenues were below analysts’ consensus of $377.5 million. In particular, the company highlighted contributions of its newly acquired Lifetouch school-photo business but the consumer business dropped 6 percent in the quarter.

The company also announced it will close Lifetouch facilities in Loves Park, IL, and Bloomington, Minn. to consolidate volume in existing Shutterfly plants.

In a transcript of the analyst call, Christopher North, president and CEO, reinforced his past statements the company would be moving past freebie promos in its consumer business:

We struggled with customer growth in Q3 and while seasonality and year-over-year comps played a role, the most important levers to achieve better results remain within our control. I’ll highlight two factors in particular; first, our promotional strategy didn’t deliver enough fresh, relevant promotions in Q3, a period when we need to work hardest to get – to engage customers given the lack of holidays; secondly, in the face of continuing cost increases in paid online channels we need to move faster to develop additional cost effective mechanisms to acquire new customers and engage existing customers.

Let me expand on each of these factors briefly. Q3 was impacted by comps and seasonality in two ways. As expected we comped the shutdown of the Wedding Paper Divas website in Q3, which took place towards the end of the third quarter of last year. In addition, the continuing strength in our cards and stationery business which strongly benefited in Q1 and Q2 did not benefit Q3 as much, given the seasonally low mix of the category. Aside from constant seasonality, the largest impact on revenue and customer growth came from the continuing mix shift away from free promotions and towards paid purchases, but also from less effective paid promotions.

North also acknowledged the company relied too heavily on repeat promotions to draw buyers:

In particular, we saw the successful promotions we launched a year or more ago declined in their effectiveness as we repeated them too many times. We’re making significant changes to ensure that we have a steady pipeline of fresh relevant promotions. We welcomed a new VP of pricing and promotions to the company in Q3, launched significant improvements to our pricing platform in Q3, to enable a wide range of new types of promotions beginning in Q4, including up-sell to free shipping, implemented new tools and processes to allow a greater degree of targeting and personalization.

He added, “Shutterfly Consumer business has faced weak customer growth for some time… [O]ver the years we became more reliant – I’d even say over-reliant on ever-more aggressive blanket promotions to drive revenue growth…Over the long-term [the company] was at the risk of not only becoming less effective as a strategy as we repeated the same promotions too frequently and saw them become less effective, but also that it was inconsistent with our long-term brand positioning and inconsistent with driving the quality of revenues we aspire to long-term.”

North outlined the positive steps the company is taking, which are already showing good results.

• The new Kids and Pets categories launched in Q3 meeting our sales expectations for the quarter.
• Shutterfly launched 16 new products in the quarter, including a new line of personalized children storybooks with licensed content from Nickelodeon. The company finished the quarter with 63 total products in the Kids and Pets and children’s storybooks categories, including 26 brand new products and 37 existing products with new designs
• Mobile continued its strong growth with the mix of mobile purchases increasing 430 basis points year-over-year to 33 percent of total Shutterfly brand revenue. In the third quarter, the company had more than 1 million app downloads.
• Shutterfly also launched a new app-exclusive program called, “Free Book a Month,” which presents pre-created photo books meant to be an impulse purchase.
• Beginning this week and rolling out over the next few weeks, Lifetouch school-photo customers who purchased digital images from MyLifetouch.com will be able to access these pictures directly within Shutterfly Photos. Customers will go through a process to link their Lifetouch and Shutterfly accounts which will transfer their photos to Shutterfly.

“Looking forward, our single greatest opportunity to reaccelerate customer growth is integrating Lifetouch to give Shutterfly access to as many of Lifetouch’s more than 10 million purchasing households as possible,” said North. “These are our ideal target customer. Parents with school-aged children who purchase high-quality photographs. At the same time, expanding our product and category range, driving mobile innovation, simplifying the process of creating and purchasing our products and optimizing pricing and promotions will all contribute to Shutterfly customer growth.

An abridged version of the press release is below. The complete release is here.

Shutterfly Announces Third Quarter 2018 Financial Results

REDWOOD CITY, Calif.–(BUSINESS WIRE)–Shutterfly, Inc. (NASDAQ:SFLY), the leading retailer and manufacturing platform dedicated to helping capture, preserve, and share life’s important moments, today announced financial results for the third quarter ended September 30, 2018.

“With the closing of the Lifetouch acquisition earlier this year, Shutterfly, Inc. now encompasses a portfolio of large, industry-leading businesses with loyal customers and significant cash flow,” said Christopher North, President and Chief Executive Officer. “Thanks to the Lifetouch acquisition, our non-GAAP net revenues increased 91% year-over-year. We have large opportunities to create shareholder value through organic growth, by realizing key synergies between Lifetouch and Shutterfly, through M&A that leverages our manufacturing and technology platforms, as well as through return of capital.”

“Our results in the third quarter were mixed, with strong performance in Lifetouch and solid results in SBS offset by disappointing performance in Shutterfly Consumer. Coming out of the quarter, we’ve identified clear opportunities to improve the consistency of our results in Shutterfly Consumer. At the same time, we made good progress against key initiatives including a good start to the Lifetouch Fall picture day peak season. Across Shutterfly Consumer, we launched new categories and products, rolled out significant new mobile app features and simplified product creation experiences, and put in place strong preparations for Q4.”

Third Quarter 2018 Financial Highlights

GAAP net revenue was $369 million. Shutterfly Consumer segment net revenue totaled $127 million, a 6% year-over-year decrease. Lifetouch segment net revenue was $183 million. Shutterfly Business Solutions segment net revenue totaled $59 million, a 2% year-over-year decrease. GAAP operating loss totaled $87 million. Net loss was $74 million, or a loss of $2.20 per share.

Non-GAAP net revenue, excluding purchase accounting adjustments related to the deferred revenue write-down, was $373 million, a 91% year-over-year increase driven by the Lifetouch acquisition. Non-GAAP Lifetouch segment net revenue was $187 million. Normalized operating loss, excluding acquisition-related charges and purchase accounting adjustments related to the deferred revenue write-down, was $80 million. Normalized net loss was $71 million. Adjusted EBITDA loss was $26 million.

Today the Company announced it will be closing two Lifetouch facilities in 2019; Loves Park, Illinois and Bloomington, Minnesota, and will consolidate this volume into existing Shutterfly facilities. Given the adjacent peak periods in its Shutterfly Consumer and Lifetouch divisions, the Company expects these facility closures to reduce its reliance on temporary labor while improving the utilization of its existing assets.

Business Outlook^[1][2]

The Company is revising its guidance on net revenue and adjusted EBITDA, and is updating non-GAAP quarterly target for the fourth quarter of 2018 to the following (in millions, except per share amounts):

Notes to the Third Quarter 2018 Financial Results and Operating Metrics and 2018 Business Outlook

Adjusted EBITDA is a non-GAAP financial measure that the Company defines as earnings before interest, taxes, depreciation, amortization, stock-based compensation, capital lease termination, restructuring and acquisition-related costs.

The Company expanded segment reporting in the second quarter of 2018, which now includes segment margin. Segment reporting continues to report net revenue and cost of net revenue, consistent with previous reporting, but now it also includes technology and development, sales and marketing, and credit card fees, arriving at a margin for the segment. The margin of the Company’s three segments compares to non-GAAP operating income by adding corporate expenses, amortization of intangible assets, stock-based compensation, and other non-recurring items including restructuring and acquisition-related charges.

Shutterfly Consumer segment includes sales from the Shutterfly brand, the Tiny Prints boutique and BorrowLenses, and are derived from the sale of a variety of products such as, professionally-bound photo books, cards and stationery, custom home décor products and unique photo gifts, calendars and prints, and the related shipping revenue, as well as rental revenue from the BorrowLenses brand. Consumer also includes revenue from advertising displayed on the Company’s website.

Lifetouch segment includes net revenue from professional photography services for schools, preschools and churches, as well as retail studios operated by Lifetouch under the JCPenney Portrait brand.

Shutterfly Business Solutions (“SBS”) segment includes net revenue from personalized direct marketing and other end-consumer communications as well as just-in-time, inventory-free printing for the Company’s business customers.

Average Order Value (“AOV”) is defined as total net revenue (excluding Lifetouch and SBS) divided by total orders.

The financial guidance herein replaces any of the Company’s previously issued financial guidance which should no longer be relied upon.

Shutterfly, Inc. Consolidated Statements of Operations – GAAP (In thousands, except per share amounts) (Unaudited)
				Three Months Ended September 30,						Nine Months Ended September 30,
				2018			2017			2018			2017
Net revenue				$	368,757		$	195,443		$	1,011,853		$	596,447
Cost of net revenue				224,738			131,108			584,012			365,432
Restructuring				—			39			—			1,475
Gross profit				144,019			64,296			427,841			229,540
Operating expenses:
Technology and development				44,735			39,614			127,659			124,968
Sales and marketing				135,375			33,331			303,737			119,205
General and administrative[1]				50,445			23,894			137,050			79,200
Capital lease termination				—			—			—			8,098
Restructuring[2]				—			3,278			2,952			15,491
Total operating expenses				230,555			100,117			571,398			346,962
Loss from operations				(86,536)			(35,821)			(143,557)			(117,422)
Interest expense				(16,660)			(6,699)			(44,063)			(18,617)
Interest and other income, net				856			253			4,166			687
Loss before income taxes				(102,340)			(42,267)			(183,454)			(135,352)
Benefit from income taxes				28,797			16,660			56,234			53,713
Net loss				$	(73,543)		$	(25,607)		$	(127,220)		$	(81,639)
Net loss per share – basic and diluted				$	(2.20)		$	(0.78)		$	(3.84)		$	(2.45)
Weighted-average shares outstanding – basic and diluted				33,470			32,878			33,139			33,363
Stock-based compensation is allocated as follows:
Cost of net revenue				$	909		$	1,041		$	2,851		$	3,284
Technology and development				2,545			2,512			7,546			7,388
Sales and marketing				3,057			2,864			9,502			9,017
General and administrative				5,420			4,319			15,422			13,021
Restructuring				—			—			—			814
				$	11,931		$	10,736		$	35,321		$	33,524
Depreciation and amortization is allocated as follows:
Cost of net revenue				$	24,533		$	14,681		$	61,918		$	44,733
Technology and development				6,125			6,634			19,841			21,522
Sales and marketing				9,645			2,484			21,215			8,271
General and administrative				1,667			1,016			4,271			3,611
Restructuring				—			665			—			5,999
				$	41,970		$	25,480		$	107,245		$	84,136
[1] The General and administrative expenses of $50 million and $137 million for the three and nine months ended September 30, 2018, respectively, include $2.4 million and $15 million, respectively, of acquisition-related charges.
[2] The exit of iMemories business resulted in restructuring charges of $3.0 million for the nine months ended September 30, 2018.

The Company expanded segment reporting, which now includes segment margin. Segment reporting continues to report net revenue and cost of net revenue, consistent with previous reporting, but now it also includes technology and development, sales and marketing, and credit card fees, arriving at a margin for the segment. The margin of the Company’s three segments compares to non-GAAP operating income by adding corporate expenses, amortization of intangible assets, stock-based compensation, and other non-recurring items including restructuring and acquisition-related charges.