S&P upgrades Shutterfly credit rating from negative to developing

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S&P Global Ratings today upgraded the credit rating for Photo Holdings LLC (Shutterfly LLC) from negative to developing, based on the improving fortunes of North America’s largest personalized photo printing company. The company outperformed Shutterfly’s 2023 expectations by improving cash flow to $82 million, compared to a $31 million deficit the year before.

In a press release, S&P stated:

  • As a result, we affirmed our ‘CCC+’ issuer credit rating on Shutterfly and revised the outlook to developing from negative.

  • At the same time, we affirmed our ‘B’ rating on the company’s first-lien debt and ‘CCC+’ rating on its second-lien debt. The recovery ratings are unchanged.

  • The developing outlook reflects our view that we could lower or raise the ratings on Shutterfly, depending on the company’s ability to improve profitability and generate free cash flow to support operations over the next 12 months.

S&P Global Ratings reported Shutterfly’s results have improved, and they expect this trend to continue in 2024 and 2025. Operating results have strengthened over the past year, with revenue of $2.27 billion in 2023 (up roughly 3% year over year), adjusted EBITDA margins of 7.7% (up 30 basis points year-over-year), and cash flow from operations of about $82 million (versus a $79 million deficit in 2022). Recent results benefitted from revenue growth in its consumer brands (including Shutterfly, Snapfish, and Spoonflower) which generated total revenue of about $1.44 billion in 2023 (up 7% year over year), as well as ongoing cost savings initiatives (including headcount reductions, outsourcing, etc.), which resulted in roughly $64 million of savings. Free cash flow further benefitted from improvements in net working capital ($44 million inflow versus a $79 million outflow in 2022) and lower cash interest expense of $184 million versus $214 million in 2022, due to the June 2023 transaction which converted a significant portion of its debt to payment-in-kind (PIK).

Other highlights from the report:

We now expect continued growth of about 3% annually in the consumer segment to offset mid-single-digit percent revenue declines in the Lifetouch segment, resulting in total revenue growth of 1%-2% in 2024 and 2025. We also expect EBITDA margins will continue to improve to about 10% in 2024 and 11% in 2025, benefitting from cost-saving initiatives and profitability improvements in Lifetouch, which we forecast will generate break-even to slightly positive adjusted EBITDA in 2024. We expect free operating cash flow (FOCF) to improve to about $60 million-$70 million in 2024 (from $25 million in 2023), benefitting from lower cash interest expense of roughly $125 million-$130 million in 2024 (versus $184 million in 2023 due to a full-year benefit of PIK debt). This will offset higher net working capital outflows of about $16 million in 2024 (from an increase in bonus payouts).

Based on our updated projections, we now expect higher adjusted EBITDA of about $236 million in 2024 to offset an $70 million-$80 million increase in adjusted debt (from PIK interest accrued), reducing S&P Global Ratings-adjusted leverage to about 10.6x at year-end 2024 from 13.9x in 2023.

We forecast Shutterfly will generate sufficient free cash flow to support increased interest payments once its PIK debt converts to cash interest in 2025. We expect cash interest expense to decline to about $125 million-$130 million in 2024 as the company benefits from a full year of PIK debt. However, we expect cash interest expense to subsequently increase to $145 million-$150 million in 2025 (based on a half year of 50% PIK interest) and $175 million-$180 million in 2026 (based on a full year of 100% cash interest), when most of the PIK debt converts to cash. Our base-case forecast assumes Shutterfly generates adjusted EBITDA of $230 million-$240 million in 2024, improving to $260 million-$270 million in 2025 and $270 million-$280 million in 2026. We view this as sufficient to support the increased cash interest expense, combined with capital expenditure (capex) of about $70 million annually, resulting in FOCF of about $104 million in 2025 and $84 million in 2026.

Despite recent progress, we continue to view the business’s highly seasonal nature as a key risk constraining the rating. As of March 31, 2024, Shutterfly had roughly $250 million of liquidity, including $64 million cash and cash equivalents and $187 million of availability under its $277.5 million revolving credit facility (due in October 2026). We expect it will need to utilize $145 million-$165 million to fund operations before the fourth quarter of 2024 (after accounting for a $285 million cash burn in the first quarter). The first three quarters typically result in a substantial cash outflow before Shutterfly recoups that in the fourth quarter. Although our base-case forecast assumes Shutterfly’s liquidity position and cash generated in the fourth quarter will be sufficient to support operational needs of the business over the next 12 months, we believe there is risk to our base case and limited cushion for underperformance. In addition to highly seasonal products, Shutterfly’s offerings are discretionary and could be significantly impaired by an economic downturn or changes in consumer spending habits.

Shutterfly’s consumer segment, which comprises over 60% of total revenue, offers personalized, picture-related products including home decor, prints, and fabrics. If discretionary income were to tighten, we would expect consumer spending on nonessentials to drop, which would weaken demand and overall results. Therefore, while our base-case forecast is for continued growth of about 3% in the consumer segment, we believe changes in macroeconomic conditions or expectations could weaken operating results more than we expect and constrain cash flow and liquidity. As a result, a rating action depends on its fourth-quarter operating results and cash flow.

In addition, a slower-than-expected recovery in Lifetouch, which we forecast will generate break-even to positive EBITDA in 2024, could further reduce the ability to generate free cash flow and maintain adequate liquidity to support seasonal requirements during the first three quarters of 2025.

The developing outlook reflects our view that we could lower or raise the ratings on Shutterfly, depending on its ability to improve profitability and generate free cash flow to support operations over the next 12 months.

We could lower the rating on Shutterfly if:

  • Profitability and cash flow weaken such that its liquidity position deteriorates; and
  • We expect a default or subpar debt exchange within 12 months.

We could raise the rating on Shutterfly if:

  • The company executes its profitability initiatives, resulting in greater liquidity cushion and higher visibility into the company’s ability to generate sustained FOCF (when its PIK debt converts to cash pay), such that we no longer view the potential for a debt restructuring as likely; and

  • EBITDA interest coverage approaches 1.5x.