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Rating Action:

Moody's downgrades Shutterfly's CFR to B3; outlook revised to negative

22 Jun 2020

Approximately $2.3 billion of rated debt impacted

New York, June 22, 2020 -- Moody's Investors Service, ("Moody's") has downgraded Shutterfly, LLC's ("Shutterfly" or the "company") Corporate Family Rating (CFR) to B3 from B2, Probability of Default Rating (PDR) to B3-PD from B2-PD, senior secured first-lien bank credit facilities ratings to B2 from B1, senior secured notes rating to B2 from B1 and senior unsecured notes rating to Caa2 from Caa1. The outlook was revised to negative from stable.

Following is a summary of today's rating actions:

Ratings Downgraded:

..Issuer: Shutterfly, LLC

Corporate Family Rating, Downgraded to B3 from B2

Probability of Default Rating, Downgraded to B3-PD from B2-PD

$300 Million Gtd Senior Secured First-Lien Revolving Credit Facility due 2024, Downgraded to B2 (LGD3) from B1 (LGD3)

$675 Million (originally $775 Million) Gtd Senior Secured First-Lien Term Loan B due 2026, Downgraded to B2 (LGD3) from B1 (LGD3)

$255 Million Gtd Senior Secured First-Lien Term Loan B-1 due 2026, Downgraded to B2 (LGD3) from B1 (LGD3)

$750 Million (originally $785 Million) 8.5% Gtd Senior Secured Notes due 2026, Downgraded to B2 (LGD3) from B1 (LGD3)

$300 Million 11.0% Gtd Senior Unsecured Notes due 2027, Downgraded to Caa2 (LGD6) from Caa1 (LGD6)

Outlook Actions:

..Issuer: Shutterfly, LLC

Outlook, Changed to Negative from Stable

RATINGS RATIONALE

The downgrade action reflects the significant impact that the novel coronavirus (a.k.a. COVID-19) pandemic and economic recession will have on Shutterfly's operating and financial performance in 2020 and 2021 given that its personalized photo products business is highly dependent on consumer discretionary spending. The postponement or cancellation of memorable life events, closure of schools and churches, and reduction in print marketing spend during the recent three-month shutdown of the US economy will lead to a temporary deterioration in Shutterfly's profitability and higher financial leverage. Moody's projects total debt to EBITDA will increase to around 7.5x (Moody's adjusted) at year end 2020 from roughly 6x at 31 March 2020 (excludes non-recurring transaction, restructuring and integration costs and other one-time adjustments associated with the September 2019 LBO) and free cash flow generation (defined as cash flow from operations less capex less dividends) will be negative, in Moody's opinion. To the extent the recent strong momentum in Shutterfly's consumer segment (30%+ year-over-year order growth in April and May) continues over the remainder of 2020 combined with a rebound in the Lifetouch segment, and the company exceeds Moody's baseline expectations, free cash flow could potentially turn positive this year. However, Moody's also expects some lost business volume will not be recovered this year.

As the virus subsides and consumer spending gradually rebounds in 2021, Moody's projects leverage will improve to the 6x-6.5x area by the end of next year. Moody's expects free cash flow to remain slightly negative in 2021 given the prospect for continued weak consumer sentiment and Shutterfly's print-based photo products to experience an acceleration of the secular decline that was evident prior to the pandemic. However, if the company outperforms Moody's projections and experiences better-than-expected demand from customers, realizes cost savings ahead of schedule and improves working capital metrics, free cash flow could be positive next year. Moody's thinks consumers will alter purchasing behavior and increasingly adopt digital and cloud-based photo products as a result of their online experience during COVID-19 stay-at-home measures.

The negative outlook reflects the likelihood that leverage will remain elevated above 6x (Moody's adjusted) and free cash flow will stay negative over the next two years, in Moody's opinion, owing to revenue challenges in some business segments and dependence on consumer discretionary spending, which Moody's expects will remain depressed for several quarters due to the economic recession. The negative outlook also embeds the numerous uncertainties related to the social considerations and economic impact from COVID-19 on the company's leverage, liquidity and cash burn in the January to September period. Given the higher-than-expected cash burn, underperformance relative to Moody's baseline expectations could lead Shutterfly to fully exhaust its existing liquidity sources during this period and require the company to need to access additional external liquidity. Pro forma for additional borrowings on the revolver in Q2 2020, at 31 March 2020, liquidity consisted of $145 million of revolver availability and $134 million in cash. The magnitude of the impact will depend on the depth and duration of the pandemic, the impact that government restrictions to curb the virus will have on consumer behavior, the duration of restrictions in regions that Shutterfly operates as well as the timeline for fully reopening those economies. Moody's regards the coronavirus outbreak as a social risk under its ESG framework, given the substantial implications for public health and safety. Moody's projects a decline in economic activity in the wake of the coronavirus outbreak, with US GDP growth contracting 5.7% in 2020, followed by a 4.5% rebound next year.

Moody's expects Shutterfly to experience adequate liquidity over the coming 12-15 months, however future underperformance could require the need for additional external liquidity. Historically, the business model was profitable from an EBITDA standpoint, required minimal capex and produced positive free cash flow. However, Moody's projects free cash flow conversion will be negative this year due to significant volume and revenue declines, EBITDA shortfalls and a highly leveraged capital structure from last year's LBO. Shutterfly will continue to produce the bulk of its positive free cash flow in the October-December quarter, but in Moody's opinion, it will not be enough to offset negative free cash flow produced during January to September. Over the next twelve months, Moody's projects negative free cash flow in the range of -$50 million to -$100 million and expects Shutterfly to rely more heavily on the $300 million revolving credit facility (RCF) and retain minimum cash balances of at least $60 million. As of 31 March 2020, cash totaled $79 million following the $100 million mandatory repayment on the term loan B in February.

The company is required to pay an annual amortization equal to 7% ($54.25 million) and 1% ($2.55 million) of the original principal amounts of term loan B and term loan B-1, respectively. Given the higher-than-expected cash burn in the first nine months of the year and diminished cash balances, Moody's projects Shutterfly will also rely on the RCF to fund these mandatory payments. The RCF matures in 2024 and currently has $155 million of borrowings outstanding. Further reliance on the RCF or any additional increases in senior secured debt obligations could pressure the senior secured debts' B2 ratings. While the term loan contains no covenants, the RCF maintains a springing maximum Net First-Lien Senior Secured Leverage Ratio covenant of 6.3x (as defined in the bank credit agreement) tested quarterly if at least 35% of the RCF is drawn. At 31 March 2020, the leverage ratio was 3.93x. Moody's will closely monitor the covenant headroom over the next several quarters given our expectation for diminished EBITDA.

In Q1 2020, Shutterfly's consumer segment (about 60% of revenue) increased 5% (excludes Snapfish). Branded photobooks and personalized gifts and home décor products experienced increased volumes as a result of strategic investments into improving the creation experience and product assortment, both of which are key drivers of new customer growth and retention; however other consumer products, particularly cards and stationery, decreased in the double-digit percentage range due to delayed or cancelled weddings and graduations. The value-oriented Snapfish brand, also experienced double-digit declines, primarily driven by continued weakness in CafePress. The Lifetouch segment (about 28% of revenue) declined 31% in the March quarter primarily due to shipment delays caused by closures of its operating facilities, reduced volumes due to cancellation of spring photo days arising from school closures, and to a lesser extent, church and portrait studio closures as a result of the outbreak. Since most of Lifetouch's studio revenue is derived from sales in JCPenny stores, the retailer's recent bankruptcy filing and planned store closures will permanently impact about $3-$4 million of annual Lifetouch revenue. The SBS segment (about 12% of revenue) experienced a 16% decline in the March quarter due to customer order cancellations, budget cuts and a pullback in discretionary print marketing spend from several enterprise customers.

To offset the impact from COVID-19 revenue declines, Shutterfly implemented an $85 million operating cost savings plan that will be realized in 2020, deferred non-critical IT investments and optimized working capital. The new plan is incremental to the $120 million of cost actions identified from the LBO and Snapfish combination. Approximately $8.4 million of the $120 million was realized in 2019 with $69.6 million expected to be achieved in 2020 and the remaining $42 million in 2021-22. While Moody's believes the entire amount is achievable and will help expand EBITDA margins longer-term, roughly $70-$80 million of one-time cash costs associated with the merger and necessary to achieve savings will be incurred this year, partially offsetting any near-term savings.

As the US economy gradually reopens, Moody's expects Shutterfly's business to experience mixed results. Continued social distancing practices, reduced occupancy guidelines and increased online participation for classroom education and church events, combined with reduced in-store retail customer traffic and high unemployment levels will curtail demand in parts of the consumer segment as well as the Lifetouch segment, which rely on life events and social gatherings. Further, the demand for print-based products will likely experience an accelerated secular decline amid increasing consumer adoption of digital-based photo products, services and methods for photo-sharing that became more prevalent during stay-at-home practices and continue to remain popular as coronavirus restrictions are relaxed. The accelerated pace of retailer store closures and increasing fragmentation of online retailers and consumer packaged goods (CPG) companies have redirected users to a wider range of e-commerce alternatives that could make it challenging for Shutterfly to sustain consumer engagement. In addition, the broad range of competitors selling photo merchandise similar to Shutterfly will likely result in more frequent competitive price discounting during the economic recession to stimulate shopper engagement.

Other parts of the consumer segment, such as photobooks and personalized gifts and home décor products, will likely experience stable-to-increasing online traffic and order volumes as consumers spend more time at home and avoid public gatherings. The consumer segment reported strong 30+% year-over-year order growth in April and May for both Shutterfly and Snapfish brands and expects Q2 2020 to finish with double-digit order growth, driven by investments and a rebound in cards and stationary orders that were deferred from Q1 2020. Lifetouch implemented a new and standardized pricing strategy to stimulate customer demand and expects to be well-positioned for Fall School Picture Day, however we expect Q2 2020 and Q3 2020 orders to remain pressured. The segment continues to receive orders and generate revenue on yearbook and other products based on photos taken since last year. In the SBS segment, Shutterfly has shifted the business from customers with more volatile discretionary print marketing needs to clients with steadier transactional and regulatory requirements. Nonetheless, volumes will likely remain lower than historical levels given the overall expected decline in advertising and marketing spend as a result of the recession.

Shutterfly's B3 CFR is constrained by its elevated financial leverage, exposure to cyclical consumer discretionary spending, highly seasonal business with idled capacity during non-peak selling periods and absence of meaningful international diversification. The rating also reflects its large consumer business, which has struggled to lift organic revenue growth due to exposure to print-based and other legacy consumer product categories that have become commoditized as new products, services and methods for personalizing and sharing photos have evolved. The B3 rating considers the intensely competitive marketplace and the company's lack of pricing power, evidenced by historically low single-digit operating margins. Shutterfly is heavily dependent on fourth quarter earnings to offset operating losses produced in the first nine months of the year, which stems from a sizable fixed cost base and large product discounting to stimulate consumer demand during the seasonally weak January to September period.

The rating is supported by Shutterfly's leadership position and manufacturing scale as a provider of personalized photo products and services increasingly via online customer engagement, broad range of customized products and seamless user experience that facilitate recurring customer usage. The company benefits from a vertically-integrated operation with low customer acquisition costs. Historically, Shutterfly exhibited prudent cash management and relatively good conversion of EBITDA to free cash flow, albeit generated chiefly in the fourth calendar quarter. Business line diversification is provided by Lifetouch, the US market leader in school photography, and Snapfish, a global online retailer of digital photography and personalized photo-based products, which gives Shutterfly greater exposure to the faster growth value segment.

ESG CONSIDERATIONS

The rapid and widening spread of the coronavirus outbreak, deteriorating global economic outlook, falling oil prices, and asset price declines are creating a severe and extensive credit shock across many sectors, regions and markets. The combined credit effects of these developments are unprecedented. The personalized consumer photo products and school photography sectors have been affected by the shock given their sensitivity to consumer demand and sentiment. More specifically, the weaknesses in Shutterfly's credit profile, including its exposure to the US economy, have left it vulnerable to shifts in market sentiment in these unprecedented operating conditions and Shutterfly remains vulnerable to the outbreak's continuing spread. Moody's regards the coronavirus outbreak as a social risk under our ESG framework, given the substantial implications for public health and safety. Today's action reflects the impact on Shutterfly of the breadth and severity of the shock, and the broad deterioration in credit quality it has triggered.

Though Shutterfly demonstrated prudent financial policies as a public company prior to the September 2019 LBO, as a privately-owned portfolio company of Apollo, Moody's expects the financial strategy to be more aggressive given the equity sponsor's tendency to tolerate high leverage and favor high capital return strategies.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS

The rating outlook could be revised to stable if Shutterfly experienced organic revenue growth in the low-single digit percentage range with 18%-20% adjusted LTM EBITDA margins, financial leverage in the 5.5x-6.5x band (Moody's adjusted) and positive free cash flow to debt in the 1% to 2% range (Moody's adjusted) on an annual basis.

A ratings upgrade is unlikely over the near-term given the negative impact the economic recession will have on consumer discretionary spending. Over time, an upgrade could occur if Shutterfly demonstrates organic revenue growth consistent with US online retail sales growth and EBITDA margin expansion leads to sustained reduction in total debt to EBITDA below 5.5x (Moody's adjusted) and free cash flow to adjusted debt of at least 2% (Moody's adjusted) on an annual basis. The company would also need to maintain a good liquidity position and exhibit prudent financial policies. A ratings downgrade could occur if financial leverage, as measured by total debt to EBITDA, was sustained above 7x (Moody's adjusted), EBITDA interest coverage declines below 1.5x (Moody's adjusted) or liquidity experiences deterioration such that free cash flow generation becomes meaningfully negative on an annual basis. Downward pressure could also transpire if Shutterfly experienced market share losses, a material slowdown or decline in customer and/or total order growth, deterioration in average order value and/or substantial increase in customer acquisition costs resulting in operating margin erosion. Debt-financed acquisitions and/or shareholder distributions that increase leverage could also result in a downgrade.

Headquartered in Redwood City, CA, Shutterfly, LLC is a leading online manufacturer and retailer of personalized consumer photo products and services through premium brands such as Shutterfly (photo books, personalized holiday cards, announcements, invitations, stationery and home decor products); and Tiny Prints Boutique (online cards and stationery boutique offering stylish announcements, invitations and personal stationery). The SBS business unit provides customized direct marketing and variable print-on-demand solutions to enterprise customers. The Lifetouch unit is a leading provider of school photography in the US serving over 50,000 schools. Apollo Global Management, LLC purchased Shutterfly in September 2019 and combined it with Snapfish, LLC, which was acquired in January 2020, for a total purchase price of $3 billion (including balance sheet cash and transaction fees and expenses). GAAP revenue totaled approximately $2.1 billion for the twelve months ended 31 March 2020.

The principal methodology used in these ratings was Business and Consumer Service Industry published in October 2016 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1037985. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

REGULATORY DISCLOSURES

For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.

These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1133569.

At least one ESG consideration was material to the credit rating action(s) announced and described above.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the EU and is endorsed by Moody's Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Gregory A. Fraser, CFA
Vice President - Senior Analyst
Corporate Finance Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Stephen Sohn
Associate Managing Director
Corporate Finance Group
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

No Related Data.
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