e10vq
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2007
Commission file number 001-33031
SHUTTERFLY, INC.
(Exact Name of Registrant as Specified in Its Charter)
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Delaware
(State or Other Jurisdiction of
Incorporation or Organization)
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94-3330068
(IRS Employer
Identification No.) |
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2800 Bridge Parkway, Suite 101
Redwood City, California
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94065 |
(Address of Principal Executive Offices)
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(Zip Code) |
(650) 610-5200
(Registrants Telephone Number, Including Area Code)
Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the Registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated
filer or a non-accelerated filer. See definition of accelerated filer and large accelerated filer
in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer o Accelerated Filer o Non-Accelerated Filer þ
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act). Yes o No þ
As of April 24, 2007, 24,007,033 shares of the Registrants common stock at $0.0001 par value
were outstanding.
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Item 1. Condensed Consolidated Financial Statements
SHUTTERFLY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value amounts)
(Unaudited)
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March 31, |
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December 31, |
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2007 |
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2006 |
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ASSETS |
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Current assets: |
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Cash and cash equivalents |
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$ |
109,666 |
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$ |
119,051 |
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Accounts receivable, net |
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1,139 |
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2,164 |
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Inventories |
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2,003 |
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2,493 |
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Deferred tax asset, current portion |
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2,005 |
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2,129 |
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Prepaid expenses and other current assets |
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2,866 |
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2,760 |
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Total current assets |
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117,679 |
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128,597 |
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Property and equipment, net |
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31,683 |
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30,919 |
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Intangible assets, net |
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1,364 |
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1,396 |
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Deferred tax asset, net of current portion |
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19,596 |
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18,754 |
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Other assets |
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477 |
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494 |
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Total assets |
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$ |
170,799 |
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$ |
180,160 |
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LIABILITIES AND STOCKHOLDERS EQUITY |
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Current liabilities: |
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Accounts payable |
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$ |
2,910 |
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$ |
9,385 |
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Accrued liabilities |
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7,195 |
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8,808 |
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Deferred revenue |
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6,123 |
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6,278 |
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Current portion of capital lease obligations |
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1,869 |
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1,961 |
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Total current liabilities |
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18,097 |
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26,432 |
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Other liabilities |
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595 |
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660 |
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Capital lease obligations, less current portion |
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794 |
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1,742 |
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Total liabilities |
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19,486 |
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28,834 |
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Commitments and contingencies (Note 5) |
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Stockholders equity |
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Undesignated preferred stock, $0.0001 par value; 5,000 shares authorized; no shares
issued and outstanding |
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Common stock, $0.0001 par value; 100,000 shares authorized; 24,007 and 23,705 shares
issued and outstanding on March 31, 2007 and December 31, 2006, respectively |
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2 |
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2 |
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Additional paid-in capital |
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182,879 |
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181,890 |
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Accumulated other comprehensive loss |
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(26 |
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(35 |
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Deferred stock-based compensation |
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(142 |
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(191 |
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Accumulated deficit |
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(31,400 |
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(30,340 |
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Total stockholders equity |
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151,313 |
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151,326 |
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Total liabilities and stockholders equity |
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$ |
170,799 |
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$ |
180,160 |
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The accompanying notes are an integral part of these condensed consolidated financial statements.
1
SHUTTERFLY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
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Three Months Ended |
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March 31, |
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2007 |
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2006 |
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Net revenues |
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$ |
26,705 |
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$ |
16,883 |
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Cost of revenues(1) |
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13,034 |
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8,749 |
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Gross profit |
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13,671 |
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8,134 |
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Operating expenses(1): |
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Technology and development |
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5,814 |
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3,983 |
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Sales and marketing |
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5,180 |
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3,693 |
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General and administrative |
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5,964 |
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3,397 |
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16,958 |
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11,073 |
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Loss from operations |
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(3,287 |
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(2,939 |
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Interest expense |
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(54 |
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(78 |
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Other income (expense), net |
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1,487 |
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475 |
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Loss before income taxes |
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(1,854 |
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(2,542 |
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Benefit from income taxes |
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794 |
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977 |
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Net loss |
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$ |
(1,060 |
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$ |
(1,565 |
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Net loss per share basic and diluted |
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$ |
(0.04 |
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$ |
(0.41 |
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Weighted-average shares outstanding basic and diluted |
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23,933 |
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3,805 |
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(1) Stock-based compensation is allocated as follows: |
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Cost of revenues |
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$ |
38 |
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$ |
11 |
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Technology and development |
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264 |
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143 |
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Sales and marketing |
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175 |
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87 |
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General and administrative |
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385 |
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170 |
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The accompanying notes are an integral part of these condensed consolidated financial statements.
2
SHUTTERFLY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
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Three Months Ended |
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March 31, |
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2007 |
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2006 |
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Cash flows from operating activities: |
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Net loss |
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$ |
(1,060 |
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$ |
(1,565 |
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Adjustments to reconcile net loss to net cash provided by (used in) operating activities
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Depreciation and amortization |
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3,485 |
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2,176 |
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Amortization of intangible assets |
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32 |
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88 |
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Amortization of stock-based compensation, net of cancellations |
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862 |
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411 |
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Change in carrying value of preferred stock warrant liability |
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(121 |
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Deferred income taxes |
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(723 |
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(970 |
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Changes in operating assets and liabilities
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Inventories |
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490 |
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403 |
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Accounts receivable, net |
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1,025 |
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280 |
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Prepaid expenses and other current assets |
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(106 |
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(384 |
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Other assets |
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17 |
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(106 |
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Accounts payable |
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(6,475 |
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(2,566 |
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Accrued and other liabilities |
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(1,667 |
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(8,159 |
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Deferred revenue |
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(155 |
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(181 |
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Net cash used in operating activities |
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(4,275 |
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(10,694 |
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Cash
flows from investing activities: |
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Purchases of property and equipment |
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(4,249 |
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(1,764 |
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Net cash used in investing activities |
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(4,249 |
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(1,764 |
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Cash
flows from financing activities: |
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Principal payments of capital lease obligations |
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(1,040 |
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(634 |
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Proceeds from issuance of common stock upon exercise of stock options |
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179 |
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8 |
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Repurchases of common stock |
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(2 |
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Net cash used in financing activities |
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(861 |
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(628 |
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Net decrease in cash and cash equivalents |
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(9,385 |
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(13,086 |
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Cash and cash equivalents, beginning of period |
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119,051 |
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39,153 |
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Cash and cash equivalents, end of period |
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$ |
109,666 |
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$ |
26,067 |
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Supplemental disclosures of cash flow information |
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Cash paid during the period for interest |
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$ |
50 |
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$ |
57 |
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Cash paid during the period for income taxes |
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760 |
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The accompanying notes are an integral part of these condensed consolidated financial statements.
3
SHUTTERFLY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts and percentages)
Note 1 The Company and Summary of Significant Accounting Policies
Shutterfly, Inc. (the Company) was incorporated in the state of Delaware in April 1999 and
began its services in December 1999. The Company is an Internet-based social expression and
personal publishing service that enables customers to share, print and preserve their memories by
leveraging a technology-based platform and manufacturing processes. The Company provides customers
a full range of products and services to organize and archive digital images, share pictures, order
prints and create an assortment of personalized items such as cards, calendars and photo books. The
Company is headquartered in Redwood City, California.
On September 29, 2006, the Company completed its initial public offering (IPO) in which the
Company sold 5,800 shares at a price to the public of $15.00 per share. As a result of the IPO, a
total of $87.0 million in gross proceeds was raised, with net proceeds to the Company of $78.5
million after deducting underwriting fees and commissions of $6.1million and other offering costs
of $2.4 million. Upon the closing of the IPO, all shares of the Companys outstanding redeemable
convertible preferred stock automatically converted into an aggregate of 13,863 common shares.
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of America for
interim financial information and, accordingly, do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial statements. The
accompanying unaudited condensed consolidated financial statements include the accounts of
Shutterfly, Inc. and its wholly owned subsidiary. In the opinion of management, all adjustments,
consisting primarily of normal recurring accruals, considered necessary for a fair statement of
the Companys results of operations for the interim periods reported and of its financial condition
as of the date of the interim balance sheet have been included. Operating results for the three
months ended March 31, 2007 are not necessarily indicative of the results that may be expected for
the year ending December 31, 2007 or for any other period.
These unaudited interim condensed consolidated financial statements should be read in
conjunction with the consolidated financial statements and related notes for the year ended
December 31, 2006 included in the Companys Form 10-K.
Principles of Consolidation
The
accompanying condensed consolidated financial statements include the accounts of the Company and its
wholly-owned subsidiary acquired in 2005. The wholly-owned subsidiary was dissolved in 2006 and was
merged into the Company. All intercompany transactions and balances have been eliminated.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally
accepted in the United States of America requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of the financial statements, as well as the reported amounts of revenues
and expenses during the reporting period. Significant items subject to such estimates and
assumptions include intangible assets valuation, legal contingencies, deferred tax asset valuation
allowance, and the valuation of equity instruments. Actual results could differ from these
estimates.
4
SHUTTERFLY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts and percentages) (Continued)
Stock-Based Compensation
Prior to January 1, 2006, the Company accounted for stock-based employee compensation
arrangements in accordance with the provisions of Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees (APB No. 25), and related interpretations, and followed
the disclosure provisions of Statement of Financial Accounting Standards No. 123, Accounting for
Stock-Based Compensation (SFAS No. 123). Under APB No. 25, compensation expense is based on the
difference, if any, on the date of the grant, between the fair value of the Companys stock and the
exercise price. Employee stock-based compensation determined under APB No. 25 is recognized based
on guidance provided in Financial Accounting Standards Board Interpretation No. 28, Accounting for
Stock Appreciation Rights and Other Variable Stock Option or Award Plans (FIN 28), which provides
for accelerated expensing over the option vesting period.
The Company accounts for equity instruments issued to non-employees in accordance with the
provisions of SFAS No. 123, Emerging Issues Task Force No. 96-18, Accounting for Equity
Instruments that are Issued to Other than Employees for Acquiring, or in Conjunction with Selling,
Goods or Services (EITF 96-18), and FIN 28.
Effective January 1, 2006, the Company adopted the fair value provisions of Statement of
Financial Accounting Standards No. 123R, Share-Based Payment (SFAS No. 123R), which supersedes
its previous accounting under APB 25. SFAS No. 123R requires the recognition of compensation
expense, using a fair-value based method, for costs related to all share-based payments including
stock options. SFAS No. 123R requires companies to estimate the fair value of share-based payment
awards on the date of grant using an option-pricing model. The Company adopted SFAS No. 123R using
the prospective transition method, which requires that for nonpublic entities that used the minimum
value method for either pro forma or financial statement recognition purposes, SFAS No. 123R shall
be applied to option grants after the required effective date. For options granted prior to the
SFAS No. 123R effective date, for which the requisite service period has not been performed as of
January 1, 2006, the Company will continue to recognize compensation expense on the remaining
unvested awards under the intrinsic-value method of APB 25. In addition, the Company will continue
amortizing those awards valued prior to January 1, 2006 utilizing an accelerated amortization
schedule, while all option grants valued after January 1, 2006 will be expensed on a straight-line
basis over the requisite period.
In November 2005, the Financial Accounting Standards Board (FASB) issued FASB Staff Position
No. FAS 123R-3, Transition Election Related to Accounting for Tax Effects of Share-Based Payment
Awards. The Company elected to adopt the prospective transition method provided in the FASB
Staff Position for calculating the tax effects of stock-based compensation pursuant to SFAS No.
123R.
Income Taxes
The Company accounts for income taxes under the liability method. Under this method, deferred
tax assets and liabilities are determined based on the difference between the financial statement
and tax basis of assets and liabilities and net operating loss and credit carryforwards using
enacted tax rates in effect for the year in which the differences are expected to reverse.
Valuation allowances are established when necessary to reduce deferred tax assets to the amounts
expected to be realized.
The Company accounts for uncertain tax positions in accordance with FASB Interpretation No. 48
Accounting for Uncertainty in Income Taxes (FIN 48), an interpretation of FASB Statement No. 109
(SFAS 109). The application of income tax law is inherently complex. Laws and regulations in this
area are voluminous and are often ambiguous. As such, the Company is required to make many
subjective assumptions and judgments regarding its income tax exposures. Interpretations and
guidance surrounding income tax laws and regulations change over time.
5
SHUTTERFLY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts and percentages) (Continued)
As such, changes in the Companys subjective assumptions and judgments can materially affect
amounts recognized in the consolidated balance sheets and statements of income.
As
of January 1, 2007, the date of adoption of FIN 48, the Company had
$1,200 of liabilities for unrecognized tax benefits. The amount of
liability for unrecognized tax benefits that,
if recognized, would decrease the Companys provision for income taxes and increase net income is $1,000, net of
the federal benefit on state issues. There was no significant cumulative impact to
retained earnings as a result of the adoption of FIN 48. As of March
31, 2007, the Company anticipates an additional increase to the
unrecognized tax benefits for fiscal 2007 in the amount of $309. The total
liability for unrecognized tax benefits and the increase in the
current period relate to reserves against the Companys research
and development tax credits claimed on Federal and California
returns.
The Company is subject to taxation in the United States, California,
and North Carolina, and is currently under examination by California
for the 2003 tax year. As of March 31, 2007, an estimate
of the range of impact on the liabilities for unrecognized tax
benefits in the next twelve months as a result of this audit cannot
be made. The material jurisdictions that are subject to examination
by tax authorities for tax years after 2003 primarily include
California and the United States.
Comprehensive Income (loss)
Comprehensive income (loss) consists of certain changes in equity that are excluded from net
income (loss). Specifically, unrealized gains and losses on marketable securities are included in
accumulated other comprehensive income (loss). Accumulated other comprehensive loss was $26 and
$35 at March 31, 2007 and December 31, 2006, respectively, resulting from unrealized gains and
losses on marketable securities.
Recent Accounting Pronouncements
In
September 2006, the FASB issued SFAS No. 157, Fair
Value Measurements (SFAS 157). SFAS 157
defines fair value, establishes a framework for measuring fair value and expands disclosures about
fair value measurements. SFAS 157 will be effective for the Company as of January 1, 2008. The
Company is currently evaluating the impact, if any, of adopting SFAS 157 on its consolidated
financial statements.
In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and
Financial Liabilities (SFAS 159), which permits entities to choose to measure many financial
instruments and certain other items at fair value that are not currently required to be measured at
fair value. SFAS 159 will be effective for the Company as of January 1, 2008. The Company is
currently evaluating the impact, if any, of adopting SFAS 159 on its financial position and results
of operations.
Note 2 Stock-Based Compensation
1999 Stock Plan
In September 1999, the Company adopted the 1999 Stock Plan (the 1999 Plan). Under the Plan,
the Company issued shares of common stock and options to purchase common stock to employees,
directors and consultants. Options granted under the 1999 Plan were incentive stock options or
non-qualified stock options. Incentive stock options (ISOs) were granted only to Company
employees, which includes officers and directors who were also employees of the Company.
Non-qualified stock options (NSOs) and stock purchase rights could be granted to employees,
non-employee directors and consultants. Options under the 1999 Plan were to be granted at prices
not less than 85% of the fair market value of the shares on the date of the grant as determined by
the Companys Board of Directors (the Board), provided, however, that (i) the exercise price of
an ISO was not less than 100% of the fair market value of the shares on the date of grant, and (ii)
the exercise price of an ISO or NSO granted to a stockholder who owned greater than 10% of the
voting power of all classes of stock was not less than 110% of the deemed fair value of the shares
on the date of grant. The Board determined the period over which options become exercisable and
vested. The term of the options was to be no longer than five years for ISOs to grantees who own
greater than 10% of the voting power of all classes of stock; and no longer than ten years for all
other options. Options granted under the 1999 Plan were exercisable in full as of the grant date,
and generally vested over four years. The Board of Directors determined that no further grants of
awards under the 1999 Plan would be made after the Companys IPO.
2006 Equity Incentive Plan
In June 2006, the Board adopted, and in September 2006 the Companys stockholders approved,
the 2006 Equity Incentive Plan (the 2006 Plan), and all shares of common stock available for
grant under the 1999 Plan transferred to the 2006 Plan. The 2006 Plan provides for the grant of
ISOs to employees (including officers and directors who are also employees) of the Company or of a
parent or subsidiary of the Company, and for the grant of
6
SHUTTERFLY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts and percentages) (Continued)
all other types of awards to employees, officers, directors, consultants, independent contractors
and advisors of the Company or any parent or subsidiary of the Company, provided such consultants,
independent contractors and advisors render bona-fide services not in connection with the offer and
sale of securities in a capital-raising transaction. Other types of awards under the 2006 Plan
include NSOs, restricted stock awards, stock bonus awards, stock appreciation rights, restricted
stock units, and performance shares.
Options granted under the 2006 Plan have terms not to exceed 10 years, and they are issued
with an exercise price equal to the fair market value of the shares of common stock on the date of
grant as determined by the Board; provided, however, that (i) the term of an option may be no
longer than five years for ISOs to grantees who own greater than 10% of the voting power of all
classes of stock; and (ii) the exercise price of an ISO granted to a stockholder who owns greater
than 10% of the voting power of all classes of stock must be not less than 110% of the fair market
value of the shares on the date of grant. Prior to the Companys IPO, the Board determined the
fair market value of common stock in good faith based on the best information available at the time
of the grant. Following the IPO, the fair market value of the Companys common stock is determined
as the last sale price of such stock on the Nasdaq Global Market on the date of the grant. Options
issued under the 2006 Plan typically vest and become exercisable with respect to 25% of the shares
one year after the options vesting commencement date, and the remainder ratably on a monthly basis
over the following three years.
At the time of adoption, there were 1,358 shares of common stock authorized for issuance under
the 2006 Plan plus 93 shares of common stock from the 1999 Plan that were unissued. The 2006 Plan
provides for automatic replenishments of shares on January 1 of 2008, 2009, and 2010, of the lesser
of (i) 4.62% of the stock options granted and outstanding on the December 31 immediately prior to
the date of increase or (ii) a lesser number as determined by the Board.
Stock Option Activity
A summary of the Companys stock option activity for the three months ended March 31, 2007 is
as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares |
|
|
|
|
|
|
Weighted |
|
|
Weighted |
|
|
|
|
|
|
Available |
|
|
Number of |
|
|
Average |
|
|
Average |
|
|
Aggregate |
|
|
|
for |
|
|
Options |
|
|
Exercise |
|
|
Contractual |
|
|
Intrinsic |
|
|
|
Grant |
|
|
Outstanding |
|
|
Price |
|
|
Term (Years) |
|
|
Value |
|
Balances, December 31, 2006 |
|
|
1,378 |
|
|
|
5,034 |
|
|
$ |
7.28 |
|
|
|
|
|
|
|
|
|
Granted |
|
|
(706 |
) |
|
|
706 |
|
|
|
16.41 |
|
|
|
|
|
|
|
|
|
Exercised |
|
|
|
|
|
|
(270 |
) |
|
|
0.65 |
|
|
|
|
|
|
|
|
|
Forfeited, cancelled or expired |
|
|
70 |
|
|
|
(70 |
) |
|
|
8.29 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances, March 31, 2007 |
|
|
742 |
|
|
|
5,400 |
|
|
$ |
8.79 |
|
|
|
8.5 |
|
|
$ |
39,486 |
|
Options vested and expected to
vest at March 31, 2007 |
|
|
|
|
|
|
5,089 |
|
|
$ |
8.64 |
|
|
|
8.5 |
|
|
$ |
37,936 |
|
Options vested at March 31, 2007 |
|
|
|
|
|
|
1,559 |
|
|
$ |
5.17 |
|
|
|
7.5 |
|
|
$ |
16,956 |
|
During the three months ended March 31, 2007, the Company granted stock options to
purchase an aggregate of 706 shares of common stock with an estimated weighted-average grant-date
fair value of $6.63 per share. The total fair value of options that vested during the three months
ended March 31, 2007 was $999. The total intrinsic value of options exercised during the three
months ended March 31, 2007 was $3,623. Net cash proceeds from the exercise of stock options were
$179 for the three months ended March 31, 2007. As permitted by SFAS No. 123R, the Company has
deferred the recognition of its excess tax benefit from non-qualified stock option exercises.
7
SHUTTERFLY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts and percentages) (Continued)
Stock-based
Compensation
The Company
estimated the fair value of each option award on the date of grant using the Black-Scholes
option-pricing model and the assumptions noted in the following table. Expected volatility is based
on the historical and implied volatility of a peer group of publicly traded entities. The expected
term of options gave consideration to historical exercises, post-vesting cancellations and the
options contractual term. The risk-free rate for the expected term of the option is based on the
U.S. Treasury Constant Maturity at the time of grant. The assumptions used to value options granted
during the three months ended March 31, 2007 were as follows:
|
|
|
|
|
|
|
Three Months |
|
|
|
Ended |
|
|
|
March 31, 2007 |
|
|
|
(Unaudited) |
|
Dividend yield |
|
|
|
|
Annual risk free rate of return |
|
|
4.5 |
% |
Expected volatility |
|
|
41.9 |
% |
Expected term (years) |
|
|
4.4 |
|
Employee stock-based compensation expense recognized in the three months ended March 31, 2007
was calculated based on awards ultimately expected to vest and has been reduced for estimated
forfeitures. SFAS No. 123R requires forfeitures to be estimated at the time of grant and revised,
if necessary, in subsequent periods if actual forfeitures differ from those estimates.
At March 31, 2007, the Company had $12,569 of total unrecognized compensation expense under
SFAS No. 123R, net of estimated forfeitures, related to stock option plans that will be recognized
over a weighted-average period of approximately three years.
8
SHUTTERFLY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts and percentages) (Continued)
Note 3 Net Loss Per Share
Basic net loss per share attributed to common shares is computed by dividing the net loss
attributable to common shares for the period by the weighted average number of common shares
outstanding during the period as reduced by the weighted average unvested common shares subject to
repurchase by the Company.
Diluted net loss per share attributed to common shares is computed by dividing the net loss
attributable to common shares for the period by the weighted average number of common and potential
common shares outstanding during the period, if the effect of each class of potential common shares
is dilutive. Potential common shares include restricted common stock, common stock subject to
repurchase rights, and incremental shares of common stock issuable upon the exercise of stock
options and warrants.
|
|
|
|
|
|
|
|
|
|
|
Three Months |
|
|
|
Ended March 31, |
|
|
|
2007 |
|
|
2006 |
|
Historical net loss per share: |
|
|
|
|
|
|
|
|
Numerator |
|
|
|
|
|
|
|
|
Net loss |
|
$ |
(1,060 |
) |
|
$ |
(1,565 |
) |
|
|
|
|
|
|
|
Denominator |
|
|
|
|
|
|
|
|
Weighted-average common shares outstanding |
|
|
23,958 |
|
|
|
3,996 |
|
Less:
Weighted-average unvested common shares subject to repurchase |
|
|
(25 |
) |
|
|
(191 |
) |
|
|
|
|
|
|
|
Denominator for basic net loss per share |
|
|
23,933 |
|
|
|
3,805 |
|
|
|
|
|
|
|
|
Dilutive effect of stock options and shares subject to repurchase |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator for diluted net loss per share |
|
|
23,933 |
|
|
|
3,805 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss per share basic and diluted |
|
$ |
(0.04 |
) |
|
$ |
(0.41 |
) |
|
|
|
|
|
|
|
The following weighted-average outstanding options, common stock subject to repurchase
and convertible preferred stock warrants were excluded from the computation of diluted net loss per
common share for the periods presented because including them would have had an antidilutive
effect:
|
|
|
|
|
|
|
|
|
|
|
Three Months |
|
|
|
Ended March 31, |
|
|
|
2007 |
|
|
2006 |
|
Options to purchase common stock and common stock subject to repurchase |
|
|
1,644 |
|
|
|
1,587 |
|
Convertible preferred stock (as converted basis) |
|
|
|
|
|
|
13,802 |
|
Convertible preferred stock warrants (as converted basis) |
|
|
|
|
|
|
57 |
|
9
SHUTTERFLY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts and percentages) (Continued)
Note 4 Balance Sheet Components
Inventories
Inventories are primarily raw materials and consist principally of paper, photo book covers,
and packaging supplies.
Property and Equipment
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
December 31, |
|
|
|
2007 |
|
|
2006 |
|
Computer and other equipment |
|
$ |
45,314 |
|
|
$ |
41,880 |
|
Software |
|
|
9,532 |
|
|
|
8,791 |
|
Leasehold improvements |
|
|
4,934 |
|
|
|
4,903 |
|
Furniture and fixtures |
|
|
1,393 |
|
|
|
1,348 |
|
|
|
|
|
|
|
|
|
|
|
61,173 |
|
|
|
56,922 |
|
Less: Accumulated depreciation and amortization |
|
|
(29,490 |
) |
|
|
(26,003 |
) |
|
|
|
|
|
|
|
Net property and equipment |
|
$ |
31,683 |
|
|
$ |
30,919 |
|
|
|
|
|
|
|
|
Property and equipment includes $6,502 of equipment under capital leases at both March 31,
2007 and December 31, 2006. Accumulated depreciation of assets under capital leases totaled $4,200
and $3,820 at March 31, 2007 and December 31, 2006, respectively.
Depreciation
and amortization expense totaled $3,485 and $2,176 for the three months ended
March 31, 2007 and 2006, respectively.
Accrued Liabilities
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
December 31, |
|
|
|
2007 |
|
|
2006 |
|
Accrued marketing expenses |
|
$ |
1,318 |
|
|
$ |
1,822 |
|
Accrued compensation |
|
|
1,512 |
|
|
|
1,201 |
|
Accrued taxes |
|
|
223 |
|
|
|
1,235 |
|
Accrued consultant expenses |
|
|
1,059 |
|
|
|
884 |
|
Accrued other |
|
|
3,083 |
|
|
|
3,666 |
|
|
|
|
|
|
|
|
|
|
$ |
7,195 |
|
|
$ |
8,808 |
|
|
|
|
|
|
|
|
10
SHUTTERFLY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts and percentages) (Continued)
Note 5 Commitments and Contingencies
Indemnifications
In the normal course of business, the Company enters into contracts and agreements that
contain a variety of representations and warranties and provide for general indemnifications. The
Companys exposure under these agreements is unknown because it involves claims that may be made
against the Company in the future, but have not yet been made. To date, the Company has not paid
any claims or been required to defend any action related to its indemnification obligations.
However, the Company may record charges in the future as a result of these indemnification
obligations.
In accordance with its bylaws and pursuant to indemnity agreements, the Company has
indemnification obligations to its officers and directors for certain events or occurrences,
subject to certain limits, while they are serving at the Companys request in such a capacity.
There have been no claims to date and the Company has a director and officer insurance policy that
enables it to recover a portion of any amounts paid for future claims.
Contingencies
From time to time, the Company may have certain contingent liabilities that arise in the
ordinary course of its business activities. The Company accrues contingent liabilities when it is
probable that future expenditures will be made and such expenditures can be reasonably estimated.
Legal Matters
On August 29, 2006, the Companys former chief financial officer, Virender Ahluwalia, sued the
Company in San Mateo County Superior Court alleging causes of action for reformation of contract,
breach of contract and breach of fiduciary duty. The plaintiff claims that he is entitled to
exercise stock options for 16 shares of the Companys common stock because his vesting schedule
should be deemed to have started one year earlier than contractually agreed. In addition, plaintiff
claims that withholding taxes were not due at the time of exercise of his nonqualified stock
options to purchase 277 shares of the Companys common stock in 2005. Plaintiff claims that,
because the Company required that he make provision for the applicable withholding taxes at the
time of exercise of such options, he was damaged by having to immediately sell a portion of those
shares upon his exercise in order to raise the funds necessary to pay applicable withholding taxes.
The plaintiff is seeking compensatory and punitive damages. The Company disputes the plaintiffs
claims, believes that it has meritorious defenses and intends to vigorously defend this action. At
this time, the Company does not believe that the amount of potential loss is reasonably estimable.
From time to time, the Company may be involved in various legal proceedings arising in the
ordinary course of business. At March 31, 2007, in the opinion of management, there are no other
matters that are expected to have a material adverse effect on the Companys financial position,
results of operations or cash flows.
11
ITEM
2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This document, including the following Managements Discussion and Analysis of Financial
Condition and Results of Operations, contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934
that are based upon our current expectations. These forward-looking statements include statements
related to our expectations regarding the seasonality of our business, the decline in average
selling prices for prints, revenue trends, operating expenses as a percentage of net revenues, our
capital expenditures for 2007, effective tax rates, realization of deferred tax assets, the
sufficiency of our cash and cash equivalents balances and cash generated from operations for the
next 12 months and our ability to grow our personalized products and services as a percentage of
our total revenues, as well as other statements regarding our future operations, financial
condition and prospects and business strategies. In some cases, you can identify forward-looking
statements by terminology such as project, believe, anticipate, plan, expect, estimate,
intend, continue, should, would, could, potentially, will, or may, or the negative
of these terms or other comparable terminology. Forward-looking statements involve risks and
uncertainties. Our actual results and the timing of events could differ materially from those
anticipated in our forward-looking statements as a result of many factors, including but not
limited to, the seasonality of our business, whether we are able to expand our customer base and
increase our product and service offering, competition in our marketplace and the other risks set
forth below under Risk Factors in Part II, Item 1A of this report. Given these risks and
uncertainties, readers are cautioned not to place undue reliance on such forward-looking
statements. We assume no obligation to update any of the forward-looking statements after the date
of this report or to conform these forward-looking statements to actual results.
Overview
We are an Internet-based social expression and personal publishing service that enables
consumers to share, print and preserve their memories by leveraging our technology-based platform
and manufacturing processes. Today, our primary focus is on helping consumers manage their memories
through the powerful medium of photos. We provide a full range of products and services that make
it easy, convenient and fun for consumers to upload, edit, enhance, organize, find, share, create,
print and preserve their digital photos in a creative and thoughtful manner.
We currently generate revenues by selling photo-based products such as greeting cards,
personalized calendars and professionally-bound photo books, and high-quality prints, ranging in
size from wallet- to jumbo-sized 20x 30 enlargements. We currently manufacture all of these items
in our Hayward, California manufacturing facility. We are expecting to also manufacture these
items in a new facility in Charlotte, North Carolina which is planned
to be fully operational by the
fourth quarter of 2007. By controlling the production process in these facilities, we are able to
manufacture high-quality products, maintain a favorable cost structure and provide timely shipments
to customers, even during peak demand. Additionally, we sell a variety of photo-based merchandise
that is currently manufactured for us by third parties, such as mugs, mouse pads, coasters, tote
bags, desk organizers, puzzles, playing cards, multi-media DVDs, magnets and keepsake boxes, and
ancillary products, such as frames, photo albums and scrapbooking accessories.
During the third quarter of 2006, we augmented our photo book offering with three new
square-book formats: the 12x12 Memory Book, the 8x8 Story Book and the 4x4 Brag Book. To help guide
customers and jump-start the photo book creation process, we organized our design choices into
popular occasions such as Wedding, Travel, Birthday, Baby, Kids, Class Year Book, Recipe Book,
Portfolio and Journal. Within each occasion, we have created more than 70 pre-set style templates
that include fonts, photo edges, page layouts and backgrounds all to facilitate the photo book
layout process for customers.
In the past two years, we have launched numerous new products, including canvas prints,
keepsake boxes, jewelry, desk organizers, multi-media DVD slideshows, magnets, coasters,
year-at-a-glance calendars, tiled mugs, playing cards, puzzles, scrapbooking supplies and frames,
as well as numerous enhancements to our photo books, including new covers, layouts, page designs,
and licensed content for childrens character-themed photobooks
12
including Sesame Street®, Clifford the Big Red Dog®, Angelina
Ballerina®, and Thomas the Tank Engine®. In addition to new products, we have
created new services, including: the ability to search, tag and organize photos; the launch of
Shutterfly Studio, our consumer desktop software application that allows for uploading, organizing,
printing, sharing and editing from the desktop; a redesigned and easier to use website; a new store
that makes shopping easier and more accessible; and dozens of new borders that customers can use to
enhance their pictures, cards and photo books.
In 2006, partnering with Scholastic, Inc. we launched Picture Perfect Language Arts, a
program to help teachers offer new ways to build students skills in language arts through the
powerful medium of photos. The program, developed for kindergarten through third grade teachers,
combines Shutterflys experience in digital photography and personal publishing with Scholastics
education expertise to offer a new perspective on teaching language arts while bringing more
creativity into the classroom.
We have experienced rapid growth since launching our service in December 1999. Since
inception through March 2007, we have fulfilled more than 15.9 million orders, sold more than 493
million prints and stored approximately 1-2 billion of our consumers photos in our image archives.
According to industry sources, in 2006, Shutterfly.com had approximately 28.9 million unique
visitors.
Basis of Presentation
Net Revenues. We generate revenues primarily from the printing and shipping of
photo-based products, such as photo books, cards and calendars, photo prints, and photo-based
merchandise, such as mugs, mouse pads and magnets, and ancillary products such as frames, photo
albums and scrapbooking accessories. Revenues are recorded net of estimated returns, promotions
redeemed by customers and other discounts. Customers place orders via our website and pay primarily
using credit cards. Historically, most of our revenues have been derived in the United States. For
the three months ended March 31, 2007, approximately 98% of our revenue came from customers with
billing addresses in the United States.
Our personalized products and services revenues are derived from the sale of photo-based
products, photo-based merchandise and ancillary products and services, and the related shipping
revenues from these sales. We believe our personalized photo-based products differentiate us from
other traditional photo processors and are key to attracting and retaining customers.
Our print revenues are derived from sales of our photo processing of digital images,
including sales of 4×6 prints, and the related shipping revenues from these sales. Historically,
average selling prices for prints have declined, and they may continue to decline in the future.
For example, in the second quarter of 2005, a competitor reduced the list price of its 4×6 prints
from $0.19 to $0.12. In response, we lowered the list price of our 4×6 prints from $0.29 to $0.19
in the fourth quarter of 2005. This decrease negatively affected our print revenues for the year
ended December 31, 2006. List pricing for 4×6 prints has generally stabilized in the marketplace
over the last year since we reduced our pricing. Further drops in our 4×6 prices, due to
competitive pricing pressure or otherwise, without corresponding increases in volumes would
negatively impact our net revenues and could adversely affect our gross margins.
To offset these price declines and to improve profitability, we have continued to invest
in large scale manufacturing technology to enable us to reduce the cost of manufacturing prints. We
have also continued to recruit highly qualified personnel with specialized skills in print
manufacturing. We believe that these strategies have allowed us, and will continue to allow us, to
compete successfully with other companies in our industry. In addition, we continue to focus on
diversifying our business towards the large and growing market for personalized products and
services.
Our business is subject to seasonal fluctuations. In particular, we generate a
substantial portion of our net revenues during the holiday season in the fourth quarter of the
calendar year. We also typically experience increases in revenues during other shopping-related
seasonal events, such as Mothers Day, Fathers Day, Halloween and Easter. We generally experience
lower net revenues during the first, second and third quarters. As is typical in the
retail industry, we have incurred and may continue to incur losses in these quarters. Due to
the relatively short lead time required to fulfill orders for our products, usually one to three
business days, order backlog is not material to our business.
13
To further understand revenue trends, we monitor several key metrics including:
Average Order Value. Average order value is net revenues for a given period of time
divided by the total number of customer orders recorded during that same period. We seek to
increase average order value as a means of increasing net revenues. Average order value has increased
on an annual basis for each year since 2000, and we anticipate that this trend may continue in the
future.
Total Number of Orders. We closely monitor total number of orders as an indicator of
revenue trends. We recognize the revenues associated with an order when the products have been
shipped and all other revenue recognition criteria have been met. This is consistent with our
revenue recognition policy discussed in Critical Accounting Policies and Estimates below. Orders
are typically processed and shipped within two business days after a customer places an order.
Total number of orders has increased on an annual basis for each year since 2000, and we anticipate
that this trend will continue in the future.
Personalized Products and Services Revenues as Percentage of Net Revenues. We strive to
increase our personalized products and services revenues as a percentage of net revenues through
the continued introduction and improvement of innovative quality products and services.
We believe the analysis of these metrics provides us with important information on our
overall revenue trends and operating results. Fluctuations in these metrics are not unusual and no
single factor is determinative of our net revenues and operating results.
Cost of Revenues. Cost of revenues consist primarily of direct materials (the majority
of which consists of paper and photo book covers), payroll and related expenses for direct labor,
shipping charges, packaging supplies, distribution and fulfillment activities, rent for production
facilities, depreciation of production equipment and third-party costs for photo-based merchandise.
Cost of revenues also includes payroll and related expenses for personnel engaged in customer
service. In addition, cost of revenues includes any third-party software or patents licensed, as
well as the amortization of capitalized website development costs. We capitalize eligible costs
associated with software developed or obtained for internal use in accordance with the American
Institute of Certified Public Accountants, or AICPA, Statement of Position No. 98-1, Accounting
for the Costs of Computer Software Developed or Obtained for Internal Use and Emerging Issues Task
Force, or EITF, Issue No. 00-02, Accounting for Website Development Costs. Costs incurred in the
development phase are capitalized and amortized in cost of revenues over the products estimated
useful life.
Operating Expenses. Operating expenses consist of technology and development, sales and
marketing, and general and administrative expenses. We anticipate that each of these categories of
operating expenses will increase in absolute dollar amounts, but as a percentage of net revenues
will remain consistent with the recent historical percentages.
Technology and development expense consists primarily of personnel and related costs for
employees and contractors engaged in the development and ongoing maintenance of our website,
infrastructure and software. These expenses include depreciation of the computer and network
hardware used to run our website and store the customer data that we maintain, as well as
amortization of purchased software. Technology and development expense also includes colocation and
bandwidth costs.
Sales and marketing expense consists of costs incurred for marketing programs and personnel
and related expenses for our customer acquisition, product marketing, business development and
public relations activities. Our marketing efforts consist of various online and offline media
programs, such as e-mail and direct mail promotions, the purchase of keyword search terms and
various strategic alliances. We depend on these efforts to attract customers to our service.
14
General and administrative expense includes general corporate costs, including rent for our
corporate offices, insurance, depreciation on information technology equipment and legal and
accounting fees. In addition, general and administrative expense includes personnel expenses of
employees involved in executive, finance, accounting, human resources, information technology and
legal roles. Third-party payment processor and credit card fees are also included in general and
administrative expense and have historically fluctuated based on revenues for the period. We expect
our general and administrative expense will increase in absolute dollars in the near to
intermediate term as we will incur additional legal and accounting costs in order to comply with
regulatory reporting requirements and the Sarbanes-Oxley Act of 2002, as well as additional costs
such as investor relations and higher insurance premiums.
Interest Expense. Interest expense consists of interest costs recognized under our capital
lease obligations and for borrowed money.
Other Income (Expense), Net. Other income (expense), net consists primarily of the interest
income on our cash accounts and the changes in the fair value of
our convertible preferred stock warrants under FASB Staff Position, or FSP 150-5, Issuers
Accounting under FASB Statement No. 150 for Freestanding Warrants and Other Similar Instruments on
Shares That Are Redeemable adopted in July 2005. Under FSP 150-5, the warrants were subject to
re-measurement at each balance sheet date, and changes in fair value were recognized as a component
of other income (expense), net. Subsequent to the completion of our initial public offering on
October 4, 2006, all of our warrants to purchase shares of preferred stock converted into warrants
to purchase shares of common stock. Accordingly, the liability for the convertible preferred stock
warrants was reclassified as common stock and additional paid-in capital and the warrants are no
longer subject to re-measurement.
Income Taxes. Provision for income taxes depends on the statutory rate in the countries
where we sell our products. Historically, we have only been subject to taxation in the United
States because we have sold almost all of our products to customers in the United States. If we
continue to sell our products primarily to customers located within the United States, we
anticipate that our long-term future effective tax rate will be between 38% and 45%, without taking
into account the use of any of our net operating loss carryforwards. However, we anticipate that in
the future we may further expand our sale of products to customers located outside of the United
States. In that case we would become subject to taxation based on the foreign statutory rates in
the countries where these sales took place and our effective tax rate could fluctuate accordingly.
Our fiscal year end for federal and state tax purposes is September 30. As our fiscal
year for financial reporting purposes is December 31, we plan on changing our fiscal year end for
federal and state tax purposes to December 31 by filing short-period income tax returns for federal
and state purposes covering October 1, 2006 through December 31, 2006. We do not expect this will
have a material impact on our income tax provision. As of March 31, 2007, for federal and state tax
purposes, we had approximately $43 million of federal and $41 million of state net operating loss
carryforwards available to reduce future taxable income. These net operating loss carryforwards
begin to expire in 2020 and 2008 for federal and state tax purposes, respectively.
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with accounting
principles generally accepted in the United States, or GAAP. The preparation of these consolidated
financial statements requires us to make estimates and assumptions that affect the reported amounts
of assets, liabilities, revenues, costs and expenses and related disclosures. We base our estimates
on historical experience and on various other assumptions that we believe to be reasonable under
the circumstances. In many instances, we could have reasonably used different accounting estimates,
and in other instances, changes in the accounting estimates are reasonably likely to occur from
period to period. Accordingly, actual results could differ significantly from the estimates made by
our management. To the extent that there are material differences between these estimates and
actual results, our future financial statement presentation of our financial condition or results
of operations will be affected.
In many cases, the accounting treatment of a particular transaction is specifically dictated
by GAAP and does not require managements judgment in its application. In other cases,
managements judgment is required in selecting among available alternative accounting standards
that allow different accounting treatment for similar
15
transactions. We believe that the accounting policies discussed below are the most critical to
understanding our historical and future performance, as these policies relate to the more
significant areas involving managements judgments and estimates.
Revenue Recognition. We generate revenues primarily from the printing and shipping of
photo-based products, such as photo books, cards and calendars, photo prints, photo-based
merchandise, such as mugs, mouse pads and magnets, and ancillary products such as frames, photo
albums and scrapbooking accessories. We generally recognize revenues from product sales upon
shipment when persuasive evidence of an arrangement exists (typically through the use of a credit
card or receipt of a check), the selling price is fixed or determinable and collection of resulting
receivables is reasonably assured. Revenues from amounts billed to customers, including prepaid
orders, are deferred until shipment of fulfilled orders. The Company also generates revenue from
order referral fees received from merchants for customer click-throughs and orders that are placed
on the merchants websites. Revenue generated from order referrals is recognized in the period that
the click-through impression is delivered, provided that there is persuasive evidence of an
arrangement, the fee is fixed or determinable, no significant obligations remain and collection is
reasonably assured.
We provide our customers with a 100% satisfaction guarantee whereby products can be returned
within a 30-day period for a reprint or refund. We maintain an allowance for estimated future
returns based on historical data. Revenues are recorded net of estimated returns and the provision
for estimated returns is included in accrued liabilities. During the three months ended March 31,
2007, returns totaled less than 1% of net revenues and have been within managements expectations.
We periodically provide incentive offers to our customers in exchange for setting up an account and
to encourage purchases. Such offers include free products and percentage discounts on current
purchases. Discounts, when accepted by customers, are treated as a reduction to the purchase price
of the related transaction and are reflected in net revenues. Production costs related to free
products are included in costs of revenues upon redemption. Shipping charged to customers is
recognized as revenues.
Inventories. Our inventories consist primarily of paper, photo book covers and packaging
supplies and are stated at the lower of cost on a first-in, first-out basis or net realizable
value. The value of inventories is reduced by an estimate for excess and obsolete inventories. The
estimate for excess and obsolete inventories is based upon managements review of utilization of
inventories in light of projected sales, current market conditions and market trends.
Software and Website Development Costs. We capitalize eligible costs associated with
software developed or obtained for internal use in accordance with the AICPA Statement of Position
No. 98-1 and EITF Issue No. 00-2. Accordingly, payroll and payroll-related costs incurred in the
development phase are capitalized and amortized over the products estimated useful life, which is
generally three years. Costs associated with minor enhancements and maintenance for our website are
expensed as incurred.
Income Taxes. We use the asset and liability method of accounting for income taxes.
Under this method, deferred tax assets and liabilities are recognized by applying the statutory tax
rates in effect in the years in which the differences between the financial reporting and tax
filing bases of existing assets and liabilities are expected to reverse. We have considered future
taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a
valuation allowance against our deferred tax assets. We believe that all net deferred tax assets
shown on our balance sheet are more likely than not to be realized in the future and no valuation
allowance is necessary. If actual results differ from those estimates or we adjust those estimates
in future periods, we may need to record a valuation allowance, which will impact deferred tax
assets and the results of operations in the period the change in made.
Effective January 1, 2007, we account for uncertain tax positions in accordance with FASB Interpretation No. 48
Accounting for Uncertainty in Income Taxes (FIN 48) an interpretation of FASB Statement No. 109
(SFAS 109). The application of income tax law is inherently complex. Laws and regulations in this
area are voluminous and are often ambiguous. As such, we are required to make many subjective
assumptions and judgments regarding our income tax exposures. Interpretations and guidance
surrounding income tax laws and regulations change over time. As such, changes in our subjective
assumptions and judgments can materially affect amounts recognized in the consolidated balance
sheets and statements of income.
16
Stock-based Compensation Expense. Effective January 1, 2006, we adopted the fair value
recognition provisions of SFAS No. 123R, Share-Based Payment, using the prospective transition
method, which requires us to apply the provisions of SFAS No. 123R only to new awards granted, and
to awards modified, repurchased or cancelled, after the effective date. Under this transition
method, stock-based compensation expense recognized beginning January 1, 2006 is based on the
following: (a) the grant-date fair value of stock option awards granted or modified after January
1, 2006; and (b) the balance of deferred stock-based compensation related to stock option awards
granted prior to January 1, 2006, which was calculated using the intrinsic value method as
previously permitted under APB Opinion No. 25.
Under SFAS No 123R, we estimate the fair value of stock options granted using the
Black-Scholes valuation model. This model requires us to make estimates and assumptions including,
among other things, estimates regarding the length of time an employee will retain vested stock
options before exercising them, the estimated volatility of our common stock price and the number
of options that will be forfeited prior to vesting. The fair value is then amortized on a
straight-line basis over the requisite service periods of the awards, which is generally the
vesting period. Changes in these estimates and assumptions can materially affect the determination
of the fair value of stock-based compensation and consequently, the related amount recognized in
our consolidated statements of operations.
Results of Operations
|
|
|
|
|
|
|
|
|
|
|
Three Months |
|
|
Ended March 31, |
|
|
2007 |
|
2006 |
Net revenues |
|
|
100 |
% |
|
|
100 |
% |
Cost of revenues |
|
|
49 |
% |
|
|
52 |
% |
|
|
|
|
|
|
|
|
|
Gross profit |
|
|
51 |
% |
|
|
48 |
% |
Operating expenses: |
|
|
|
|
|
|
|
|
Technology and development |
|
|
22 |
% |
|
|
24 |
% |
Sales and marketing |
|
|
19 |
% |
|
|
22 |
% |
General and administrative |
|
|
22 |
% |
|
|
20 |
% |
|
|
|
|
|
|
|
|
|
Loss from operations |
|
|
(12 |
)% |
|
|
(18 |
)% |
Interest expense |
|
|
0 |
% |
|
|
0 |
% |
Other income (expense), net |
|
|
6 |
% |
|
|
3 |
% |
|
|
|
|
|
|
|
|
|
Loss before income taxes |
|
|
(7 |
)% |
|
|
(15 |
)% |
Benefit from income taxes |
|
|
3 |
% |
|
|
6 |
% |
|
|
|
|
|
|
|
|
|
Net loss |
|
|
(4 |
)% |
|
|
(9 |
)% |
|
|
|
|
|
|
|
|
|
Comparison of the Three Month Periods Ended March 31, 2007 and 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
2007 |
|
2006 |
|
% Change |
|
|
(in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenues |
|
$ |
26,705 |
|
|
$ |
16,883 |
|
|
|
58 |
% |
Cost of revenues |
|
|
13,034 |
|
|
|
8,749 |
|
|
|
49 |
% |
Net revenues increased $9.8 million, or 58%, for the three months ended March 31, 2007 as
compared to the same period in 2006. Revenue growth was attributable to the increases in both
personalized product and services and print revenues. Personalized products and services revenues
increased $6.7 million, or 104%, to $13.1 million for the three months ended March 31, 2007 as
compared to the same period in 2006. Personalized products and services revenues were positively
affected by increased sales of photo books, calendars, folded greeting cards and photo-based
merchandise. This caused personalized products and services revenues to increase to 49% of
revenues in the first three months of 2007 from 38% for the same period in 2006. Print revenues
increased $3.2 million, or 30%, to $13.6 million for the three months ended March 31, 2007 as
compared to the same period in 2006. Print revenues were positively affected by increased sales
volumes of 4x6 and 4x8 prints. Total number of orders increased 31% to 1,288,000
17
for the three months ended March 31, 2007 as compared to the same period in 2006. Average order value increased 20% to $20.73
per order for the three months ended March 31, 2007 as compared
to the same period in 2006, as a
result of the increased sales of photo books which have higher prices.
Cost of revenues increased $4.3 million, or 49%, for the three months ended March 31,
2007 as compared to the same period in 2006. The cost of revenues increase was driven by the
increased volume of shipped products. Cost of revenues as a percentage of net revenues decreased by
3% for the three months ended March 31, 2007 as compared to the same period in 2006. The decrease
was primarily the result of lower shipping costs we negotiated in September 2006.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
2007 |
|
2006 |
|
% Change |
|
|
(in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Technology and development |
|
$ |
5,814 |
|
|
$ |
3,983 |
|
|
|
46 |
% |
Sales and marketing |
|
|
5,180 |
|
|
|
3,693 |
|
|
|
40 |
% |
General and administrative |
|
|
5,964 |
|
|
|
3,397 |
|
|
|
76 |
% |
Our technology and development expense increased $1.8 million, or 46%, for the three months
ended March 31, 2007 as compared to the same period in 2006, although this expense decreased as a
percentage of net revenues from 24% to 22%. The increase was attributable to increased personnel
and related costs for employees and consultants involved with website development and website
infrastructure support teams, which increased by $0.8 million, as well as increased third-party
hosting expenses which increased by $0.1 million. We also continued to invest in our website
infrastructure hardware to support our continued revenue growth, which resulted in increased
depreciation expense of $0.5 million. In addition, stock-based compensation expense from employee
grants was $0.3 million in the three months ended March 31, 2007, compared to $0.1 million in the
three months ended March 31, 2006.
Our sales and marketing expense increased $1.5 million, or 40%, for the three months
ended March 31, 2007 as compared to the same period in 2006, although this expense decreased as a
percentage of net revenues from 22% to 19%. Personnel and related costs for employees and
consultants increased by $0.5 million, and our expenditures incurred on customer acquisition and
promotion costs increased by $0.8 million. In addition, stock-based compensation expense from
employee grants was $0.2 million in the three months ended March 31, 2007, compared to $0.1 million
in the three months ended March 31, 2006.
Our general and administrative expense increased $2.6 million, or 76%, for the three
months ended March 31, 2007 as compared to the same period in 2006. This expense increased as a
percentage of net revenues from 20% to 22%. Personnel and related costs for employees increased
by $0.6 million for the three months ended March 31, 2007 as compared to the same period in 2006.
Legal and accounting fees increased by $0.2 million and $0.4 million, respectively for the three
months ended March 31, 2007 as compared to the same period in 2006. Consulting expenses increased
by $0.5 million for the three months ended March 31, 2007 as compared to the same period in 2006,
as a result of costs incurred primarily for Sarbanes-Oxley compliance efforts. Payment processing
fees paid to third parties increased by $0.3 million during the three months ended March 31, 2007
as compared to the same period in 2006 due to increased order volumes. Stock-based compensation
from employee grants was $0.4 million in the three months ended March 31, 2007, compared to $0.2
million in the three months ended March 31, 2006.
Interest expense decreased by $24,000 or 31% for the three months ended March 31, 2007 as
compared to the same period in 2006, due primarily to a decrease in interest expense on capitalized
lease obligations.
Other income (expense), net increased by $1.0 million for the three months ended March
31, 2007 as compared to the same period in 2006, due to larger invested cash balances and higher
interest rates. For 2006, other income (expense), net also included $0.1 million of income related
to changes in the fair value of our redeemable convertible preferred stock warrants under FSP
150-5. Upon the completion of our initial public offering on October 4, 2006, all of our warrants to purchase shares of preferred stock converted into warrants to
purchase shares
18
of common stock and accordingly, no additional amounts for the change in fair value
for the warrants will be recorded.
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
2007 |
|
2006 |
|
|
(in thousands) |
|
|
|
|
|
|
|
|
|
Income tax benefit |
|
$ |
794 |
|
|
$ |
977 |
|
Effective tax rate |
|
|
43 |
% |
|
|
38 |
% |
The benefit for income taxes was $0.8 million for the first three months of 2007, compared to
a benefit of $1.0 million for the same period in 2006 due to a decrease in loss before income
taxes, and changes in our effective tax rate, primarily due to the non-deductability of stock-based compensation.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
2007 |
|
2006 |
|
% Change |
|
|
(in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss before income taxes |
|
$ |
(1,854 |
) |
|
$ |
(2,542 |
) |
|
|
(27 |
)% |
Net loss |
|
|
(1,060 |
) |
|
|
(1,565 |
) |
|
|
(32 |
)% |
Net loss decreased by $0.5 million, or 32%, for the three months ended March 31, 2007 as
compared to the same period in 2006.
Liquidity and Capital Resources
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
2007 |
|
2006 |
|
|
(in thousands) |
|
|
|
|
|
|
|
|
|
Consolidated Statements of Cash Flows Data: |
|
|
|
|
|
|
|
|
Capital expenditures |
|
$ |
4,249 |
|
|
$ |
1,764 |
|
Depreciation and amortization |
|
|
3,485 |
|
|
|
2,176 |
|
Cash flows used in operating activities |
|
|
(4,275 |
) |
|
|
(10,694 |
) |
Cash flows used in investing activities |
|
|
(4,249 |
) |
|
|
(1,764 |
) |
Cash flows used in financing activities |
|
|
(861 |
) |
|
|
(628 |
) |
We anticipate that our current cash and cash equivalents balances and cash generated from
operations will be sufficient to meet our working capital requirements, capital lease obligations,
expansion plans and technology development projects for at least the next 12 months. The adequacy
of these resources to meeting our liquidity needs beyond that period will depend on our growth,
operating results and the capital expenditures required to meet possible increased demand for our
products. If we require additional capital resources to grow our business internally or to acquire
complementary technologies and businesses at any time in the future, we may seek to sell additional
equity. The sale of additional equity could result in additional dilution to our stockholders.
Financing arrangements may not be available to us, or may not be in amounts or on terms acceptable
to us.
Historically we have financed our operations and capital
expenditures through operations, private sales of preferred stock, our initial public
offering, lease financing and the use of bank and related-party loans. As a result of our
initial public offering in September 2006, we raised approximately $80.9 million of
proceeds, net of underwriters discount, which we received on October 4, 2006. At
March 31, 2007, we had $109.7 million of cash and cash equivalents, a decrease
from $119.1 million as of December 31, 2006. Cash equivalents are comprised of money market funds and investment-grade corporate bonds.
19
Our industry is competitive and has endured periods of intense price competition. Because
we plan to finance our operations and capital expenses largely through our operations, and because
our results of operations are sensitive to the level of competition we face, increased competition
could adversely affect our liquidity and capital resources. Increased competition could do so both
by reducing our revenues and net income, as a result of reduced sales, reduced prices and increased
promotional activities, among other factors, as well as by requiring us to spend cash on
advertising and marketing in an effort to maintain or increase market share in the face of such
competition. In addition, we intend to increase many of our expenses, including some capital
expenses and some sales and marketing expense, in advance of anticipated higher future revenues.
However, such increased expenses, while intended to support anticipated increases in future
revenues, must be funded from current capital resources or from borrowings or equity financings. As
a result, our ability to grow our business relying largely on funds from our operations is
sensitive to competitive pressures and other risks relating to our liquidity or capital resources.
We anticipate capital expenditures of $23 million to $25 million for the remainder of
2007, approximately 40% to 50% of which we expect will be used to add manufacturing capacity. These
expansion plans, while significant, are not outside the ordinary course of our business or
materially different from how we have expanded our business in the past. We expect that such
capital expenditures will increase our production capacity and help enable us to respond more
quickly and efficiently to customer demand. We believe that such capital expenditures will have a
positive effect on our results of operations if demand increases in line with increases in our
production capacity. However, these capital expenditures will have a negative effect on our results
of operations if demand does not increase as we expect, and will have a negative effect on our
results of operations in the short term if demand does not increase simultaneously, as we expect,
with the capital expenditures spent to support increased demand.
Operating Activities. For the three months ended March 31, 2007, net cash used in
operating activities was $4.3 million, primarily due to our net loss of $1.1 million and the net
change in operating assets and liabilities of $6.9 million, adjusted for non-cash items including
$3.5 million of depreciation and amortization expense, $0.7 million of provision for income taxes
and $0.9 million of stock-based compensation.
For the three months ended March 31, 2006, net cash used in operating activities of $10.7
million resulted from our net loss of $1.6 million and the net change in operating assets and
liabilities of $10.7 million, adjusted for non-cash items including $2.3 million of depreciation
and amortization expense, $1.0 million of benefit for income taxes, $0.4 million of amortization of
stock-based compensation and $0.1 million of change in carrying value of preferred stock warrant
liability.
Investing Activities. For the three months ended March 31, 2007, net cash used in
investing activities was $4.2 million for capital expenditures for computer and network hardware to
support our website infrastructure and information technology computer hardware and capitalized
website development costs related to projects that were placed into service.
For the three months ended March 31, 2006, net cash used in investing activities was $1.8
million for capital expenditures for computer and network hardware to support our website
infrastructure and information technology computer hardware and capitalized website development
costs related to projects that were placed into service.
Financing Activities. Our financing activities for the three months ended March 31, 2007
used cash of $0.9 million, primarily from $1.0 million of
principal payments on capital lease
obligations.
For the three months ended March 31, 2006, net cash used in financing activities was $0.6
million, primarily from principal payments on capital lease obligations.
Off-Balance Sheet Arrangements
We do not have any relationships with unconsolidated entities or financial partnerships, such
as entities often referred to as structured finance or special purpose entities, which would have
been established for the purpose of facilitating off-balance sheet arrangements or other
contractually narrow or limited purposes. In addition, we do not
have any undisclosed borrowings or debt, and we have not entered into any synthetic leases. We
are, therefore, not materially exposed to any financing, liquidity, market or credit risk that
could arise if we had engaged in such relationships.
20
Recent Accounting Pronouncements
In
September 2006, the FASB issued SFAS No. 157, Fair
Value Measurements (SFAS 157). SFAS 157
defines fair value, establishes a framework for measuring fair value and expands disclosures about
fair value measurements. SFAS 157 is effective for us as of January 1, 2008. We are currently
evaluating the impact, if any, of SFAS 157 on its consolidated financial statements.
In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and
Financial Liabilities (SFAS 159) which permits entities to choose to measure many financial
instruments and certain other items at fair value that are not currently required to be measured at
fair value. SFAS 159 will be effective for us as of January 1, 2008. We are currently evaluating
the impact, if any, of adopting SFAS 159 on its financial position and results of operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate and Credit Risk. We have exposure to interest rate risk that relates primarily
to our investment portfolio. All of our current investments are classified as cash equivalents and
carried at fair value. We do not currently use or plan to use derivative
financial instruments in our investment portfolio. The risk associated with fluctuating interest
rates is limited to our investment portfolio and we do not believe that a 10% change in interest
rates will have a significant impact on our interest income, operating results or liquidity.
As of March 31, 2007 and December 31, 2006, our cash and cash equivalents were maintained by
financial institutions in the United States and our deposits may be in excess of insured limits. We
believe that the financial institutions that hold our investments are financially sound and,
accordingly, minimal credit risk exists with respect to these investments.
Inflation. We do not believe that inflation has had a material effect on our current business,
financial condition or results of operations. If our costs were to become subject to significant
inflationary pressures, we may not be able to fully offset such higher costs through price
increases. Our inability or failure to do so could harm our business, financial condition and
results of operations.
ITEM 4. CONTROLS AND PROCEDURES
Our management, with the participation of our chief executive officer and chief financial
officer, evaluated the effectiveness of our disclosure controls and procedures as of March 31,
2007. The term disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e)
under the Exchange Act, means controls and other procedures of a company that are designed to
ensure that information required to be disclosed by a company in the reports that it files or
submits under the Exchange Act is recorded, processed, summarized and reported, within the time
periods specified in the SECs rules and forms. Disclosure controls and procedures include, without
limitation, controls and procedures designed to ensure that information required to be disclosed by
a company in the reports that it files or submits under the Exchange Act is accumulated and
communicated to the companys management, including its principal executive and principal financial
officers, as appropriate to allow timely decisions regarding required disclosure. Management
recognizes that any controls and procedures, no matter how well designed and operated, can provide
only reasonable assurance of achieving their objectives and management necessarily applies its
judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on
the evaluation of our disclosure controls and procedures as of March 31, 2007, our chief executive
officer and chief financial officer concluded that, as of such date, the Companys disclosure
controls and procedures were effective at the reasonable assurance level.
No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and
15d-15(f) under the Exchange Act) occurred during the quarter ended March 31, 2007 that has
materially affected, or is reasonably likely to materially affect, our internal control over
financial reporting.
21
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On August 29, 2006, our former Chief Financial Officer, Virender Ahluwalia, sued Shutterfly in
San Mateo County Superior Court alleging causes of action for reformation of contract, breach of
contract and breach of fiduciary duty. The plaintiff claims that he is entitled to exercise stock
options for an additional 15,535 shares of our common stock because his vesting schedule should be
deemed to have started one year earlier than the date stated in Shutterflys corporate records. In
addition, plaintiff claims that we initially advised him that withholding taxes were not due at the
time of exercise of his nonqualified stock options to purchase 277,139 shares of our common stock
in 2005, but that we later modified that tax advice, extended his option exercise date, and
required that he make provision for the applicable withholding taxes at the time of exercise of
such options. The plaintiff claims he was damaged by having to immediately sell a portion of those
shares upon his exercise in order to raise the funds necessary to pay applicable withholding taxes.
He also claims that our calculation of the fair market value of the shares increased his tax
liability. The plaintiff is seeking compensatory and punitive damages. In October 2006, we filed a
Petition to Compel Arbitration and to stay the litigation pending arbitration, and the plaintiff
has now stipulated to arbitration of the dispute. We dispute the plaintiffs claims, believe that
we have meritorious defenses and intend to vigorously defend this action. At this time, we do not
believe that the amount of potential loss, if any, is reasonably estimable.
In addition, in the ordinary course of our business, we are also subject to periodic lawsuits,
investigations and claims. Although we cannot predict with certainty the ultimate resolution of
lawsuits, investigations and claims asserted against us, we do not believe that any other currently
pending legal proceeding to which we are a party is likely to harm our business, results of
operations, cash flows or financial condition.
ITEM 1A. RISK FACTORS
Our net revenues, operating results and cash requirements are affected by the seasonal nature of
our business.
Our business is highly seasonal, with a high proportion of our net revenues, net income and
operating cash flows generated during the fourth quarter. For example, we generated approximately
53% of our net revenues for 2006 in the fourth quarter of 2006, and the net income that we
generated during the fourth quarter of 2006 was necessary for us to achieve profitability on an
annual basis for 2006. In addition, we incur significant additional expenses in the period leading
up to the fourth quarter holiday season in anticipation of higher sales volume in that period,
including expenses related to the hiring and training of temporary workers to meet our seasonal
needs, additional inventory and equipment purchases and increased advertising. If we are unable to
accurately forecast and respond to consumer demand for our products during the fourth quarter, our
financial results, reputation and brand will suffer and the market price of our common stock would
likely decline.
In addition, we base our operating expense budgets on expected revenue trends. A portion of
our expenses, such as office leases and various personnel costs, are fixed and are based on our
expectations of our peak levels of operations. We may be unable to adjust spending quickly enough
to offset any unexpected revenue shortfall. Accordingly, any shortfall in revenues may cause
significant variation in operating results in any quarter.
Our limited operating history makes it difficult to assess the exact impact of the seasonal
factors on our business or whether our business is susceptible to cyclical fluctuations in the U.S.
economy. In addition, our rapid growth may have overshadowed whatever seasonal or cyclical factors
might have influenced our business to date. Seasonal or cyclical variations in our business may
become more pronounced over time and may harm our results of operations in the future.
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If we are unable to meet our seasonal production requirements, our net revenues and results of
operations would be harmed.
We face significant production risks, particularly at peak holiday seasons, including the
risks of obtaining sufficient qualified seasonal production personnel. A majority of our workforce
during the fourth quarter of 2006 was seasonal, temporary personnel. We have had difficulties in
the past finding a sufficient number of qualified seasonal employees. We believe that we must
significantly grow our current production capability to meet our projected revenue targets. We
have announced that we are opening a new manufacturing and production plant in Charlotte, North
Carolina, which is planned to be fully operational by the fourth quarter 2007. We expect to spend
between $23 million and $25 million in capital expenditures in the remainder of 2007, approximately 40% to 50% of which we expect will be used to add manfacturing capacity. Our inability to launch our Charlotte facility on-time, or meet our seasonal
production requirements could lead to customer dissatisfaction and damage to our reputation and
brand, which would result in reduced net revenues. Moreover, if the costs of meeting production
requirements were to exceed our expectations, our results of operations would be harmed.
Our quarterly financial results may fluctuate, which may lead to volatility in our stock price.
Our future revenues and operating results may vary significantly from quarter-to-quarter due
to a number of factors, many of which are difficult for us to predict and/or control. Factors that
could cause our quarterly operating results to fluctuate include:
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demand for our products and services, including seasonal demand; |
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our pricing and marketing strategies and those of our competitors; |
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our ability to attract visitors to our website and convert those visitors into customers; |
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our ability to retain customers and encourage repeat purchases, particularly our
high-volume customers from whom we derive a high proportion of our net revenues; |
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our ability to sustain our profit margins, particularly our ability to sell to
consumers photo-based products such as photo books, calendars and cards; |
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the costs of customer acquisition; |
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our ability to manage our production and fulfillment operations; |
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the costs to produce our prints and photo-based products and merchandise and to
provide our services; |
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the costs of expanding or enhancing our technology or website; |
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a significant increase in returns and credits, beyond our estimated allowances, for
customers who are not satisfied with our products; |
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declines or disruptions to the travel industry; |
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variations in weather, particularly heavy rain and snow which tend to depress travel
and picture taking; |
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the timing of holidays; |
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volatility in our stock price, which may lead to higher stock-based compensation
expense under newly adopted accounting standards; |
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consumer preferences for digital photography services; and |
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improvements to the quality, cost and convenience of desktop printing of digital
pictures and products. |
Based on the factors cited above, we believe that quarter-to-quarter comparisons of our
operating results
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are not a good indication of our future performance. It is possible that in one
or more future quarters, our operating results may be below the expectations of public market
analysts and investors. In that event, the trading price of our common stock may decline.
We have incurred operating losses in the past and may not be able to sustain profitability in the
future. Recent accounting changes may make it more difficult for us to sustain profitability.
We have periodically experienced operating losses since our inception in 1999. In particular,
we make investments in our business that generally result in operating losses in each of the first
three quarters of our fiscal year. This typically enables us to generate the majority of our net
revenue during the fourth quarter and to achieve profitability for the full fiscal year. If we are
unable to produce our products and provide our services at commercially reasonable costs, if
revenues decline or if our expenses exceed our expectations, we may not be able to sustain or
increase profitability on a quarterly or annual basis. Also, as a publicly-traded company, we are
subject to the Sarbanes-Oxley Act of 2002, which will soon require that our internal controls and
procedures comply with Section 404 of the Sarbanes-Oxley Act. We expect compliance to be costly
and it could impact our results of operations in future periods. In addition, the Financial
Accounting Standards Board now requires us to follow Statement No. 123 (revised 2004), Share Based
Payment, or SFAS No. 123R. Under SFAS No. 123R, companies must calculate and record in their
statement of operations the cost of equity instruments, such as stock options or restricted stock,
awarded to employees for services received beginning in the first quarter of the 2006 fiscal year.
We expect that we will continue to use stock options to attract, incentivize and retain our
employees and will therefore incur the resulting stock-based compensation expense. This will
continue to adversely affect our operating results in future periods.
We have a limited operating history, which makes it difficult to evaluate our business and
prospects for the future.
Our company was formed in April 1999, and we have only a limited operating history on which
investors can base an evaluation of our business and future prospects. As an e-commerce company in
the early stage of development, we face many risks, uncertainties, expenses and difficulties. To
address these risks and uncertainties, we must do the following:
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maintain and increase our number of customers; |
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maintain and enhance our brand; |
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maintain and grow our website and customer operations; |
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enhance and expand our products and services; |
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successfully execute our business and marketing strategy; |
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continue to develop and upgrade our technology and information processing systems; |
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continue to enhance our service to meet the needs of a changing market; |
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provide superior customer service; |
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respond to competitive developments; and |
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attract, integrate, retain and motivate qualified personnel. |
We may be unable to accomplish one or more of these things, which could cause our business to
suffer. If we do accomplish one or more of these things, it might be very expensive, which could
harm our financial results.
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If we are not able to reliably meet our data storage and management requirements, customer
satisfaction and our reputation could be harmed.
As a part of our current business model, we offer our customers free unlimited online storage
and sharing of photographs and, as a result, must store and manage hundreds of terabytes of data.
This results in immense system requirements and substantial ongoing technological challenges, both
of which are expected to continue to increase over time. If we are not able to reliably meet these
data storage and management requirements, we could have disruptions in services which could impair
customer satisfaction and our reputation and lead to reduced net revenues and increased expenses.
Moreover, if the cost of meeting these data storage and management requirements exceeds our
expectations, our results of operations would be harmed.
Our data storage system could suffer damage or interruption from human error, fire, flood,
power loss, telecommunications failure, break-ins, terrorist attacks, acts of war and similar
events. In addition, our primary storage facilities are located near a major fault line, increasing
our susceptibility to the risk that an earthquake could significantly harm our data storage system.
If we experience disruption to our redundant systems located at our data storage center, such
disruption could result in the deletion or corruption of customer stored images. For example,
recently we experienced a loss of a small number of customer images due to an isolated server
failure. We identified the cause of this isolated server failure and addressed it. We have also
implemented new additional procedures for our multiple backup systems.
Interruptions to our website, information technology systems, print production processes or
customer service operations could damage our reputation and brand and substantially harm our
business and results of operations.
The satisfactory performance, reliability and availability of our website, information
technology systems, printing production processes and customer service operations are critical to
our reputation, and our ability to attract and retain customers and maintain adequate customer
satisfaction. We currently conduct periodic site maintenance
several times a quarter that require us to take the website down. The scheduled down times are
planned at non-peak hours, typically at midnight. Any interruptions that result in the
unavailability of our website or reduced order fulfillment performance or customer service could
result in negative publicity, damage our reputation and brand and cause our business and results of
operations to suffer. This risk is heightened in the fourth quarter, as we experience significantly
increased traffic to our website during the holiday season. Any interruption that occurs during
such time would have a disproportionately negative impact than if it occurred during a different
quarter.
We depend in part on third parties to implement and maintain certain aspects of our
communications and printing systems. Therefore many of the causes of system interruptions or
interruptions in the production process may be outside of our control. As a result, we may not be
able to remedy such interruptions in a timely manner, or at all. Our business interruption
insurance policies do not address all potential causes of business interruptions that we may
experience, and any proceeds we may receive from these policies in the event of a business
interruption may not fully compensate us for the revenues we may lose.
We may have difficulty managing our growth and expanding our operations successfully.
We have grown from 200 employees as of March 31, 2006 to 283 employees as of March 31, 2007.
We have website operations, offices and customer support centers in Redwood City, California and a
production facility in Hayward, California. Our growth has placed, and will continue to place, a
strain on our administrative and operational infrastructure. We have announced that we are opening
a new manufacturing and production plant in Charlotte, North Carolina, which is planned to be
fully operational by the fourth quarter 2007. Our ability to manage our operations and growth will
require us to continue to refine our operational, financial and management controls, human resource
policies and reporting systems.
If we are unable to manage future expansion, we may not be able to implement improvements to
our controls, policies and systems in an efficient or timely manner and may discover deficiencies
in existing systems and controls. Our ability to provide a high-quality customer experience could
be compromised, which would damage our reputation and brand and substantially harm our business and
results of operations.
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Competitive pricing pressures, particularly with respect to 4×6 print pricing and shipping, may
harm our business and results of operations.
Demand for our products and services is sensitive to price. Many external factors, including
our production and personnel costs and our competitors pricing and marketing strategies, can
significantly impact our pricing strategies. If we fail to meet our customers price expectations,
we could lose customers, which would harm our business and results of operations.
Changes in our pricing strategies have had, and may continue to have, a significant impact on
our net revenues and net income. For example, in the second quarter of 2005, certain of our
competitors reduced the list prices of their 4×6 prints from $0.19 to $0.12. In response, we
lowered the list price of our 4×6 prints from $0.29 to $0.19 in order to remain competitive. A drop
in our 4×6 prices, due to competitive pressures or otherwise, without a corresponding increase in
volume would negatively impact our net revenues and could adversely affect our gross margins.
We generate a significant portion of our net revenues from the fees we collect from shipping
our products. For example, these fees represented approximately 19% of our net revenues in 2005 and
approximately 20% of our net revenues in 2006. Many online businesses, including Shutterfly, offer
discounted or free shipping, with a minimum purchase requirement, during promotional periods to
attract and retain customers. If free shipping offers extend beyond a limited number of occasions,
are not based upon a minimum purchase requirement and/or become commonplace, our net revenues and
results of operations would be negatively impacted. In addition, many online businesses, including
Shutterfly, offer free or discounted products and services to attract and retain customers. In the
future, if we increase these offers to respond to actions taken by our competitors, our results of
operations may be harmed.
We face intense competition from a range of competitors and may be unsuccessful in competing
against current and future competitors.
The digital photography products and services industries are intensely competitive, and we
expect competition to increase in the future as current competitors improve their offerings and as
new participants enter the market or as industry consolidation further develops. Competition may
result in pricing pressures, reduced profit margins or loss of market share, any of which could
substantially harm our business and results of operations. We face intense competition from a wide
range of companies, including the following:
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Online digital photography services companies such as Kodak EasyShare Gallery
(formerly known as Ofoto), Snapfish, which is a service of Hewlett-Packard, Sonys ImageStation and
others; |
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Big Box retailers such as Wal-Mart, Costco and others that are seeking to offer low
cost digital photography products and services, such as in-store fulfillment and self-service
kiosks for printing; these competitors may, among other strategies, offer their customers heavily
discounted in-store products and services that compete directly with our offerings; |
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Drug stores such as Walgreens, CVS and others that offer in-store pick-up from
Internet orders; |
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Regional photography companies such as Wolf Camera and Ritz Camera that have
established brands and customer bases in existing photography markets; |
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Internet portals and search engines such as Yahoo!, AOL, Google and CNET that offer
broad-reaching digital photography and related products and services to their large user bases; |
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Home printing service providers such as Hewlett-Packard, Epson and Canon, that are
seeking to expand their printer and ink businesses by gaining market share in the emerging digital
photography marketplace; and |
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Photo-related software companies such as Adobe, Apple, Microsoft, Corel and others. |
Many of our competitors have significantly longer operating histories, larger and broader
customer bases, greater brand and name recognition and greater financial, research and development
and distribution resources than we do. The numerous choices for digital photography services can
cause confusion for consumers, and may cause them to select a competitor with greater name
recognition. Some competitors are able to devote substantially more
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resources to website and systems development, or to investments or partnerships with
traditional and online competitors. Competitors that are well-funded (particularly new entrants)
may choose to prioritize growing their market share and brand awareness instead of profitability.
Competitors and new entrants in the digital photography products and services industries may
develop new products, technologies or capabilities that could render obsolete or less competitive
many of the products, services and content that we offer. We may be unable to compete successfully
against current and future competitors, and competitive pressures could harm our business and
prospects.
If we are unable to adequately control the costs associated with operating our business, our
results of operations will suffer.
The primary costs in operating our business are related to producing prints, shipping
products, acquiring customers and compensating our personnel. If we are unable to keep these costs
aligned with the level of revenues that we generate, our results of operations would be harmed.
Controlling our business costs is challenging because many of the factors that impact these costs
are beyond our control. For example, the costs to produce prints, such as the costs of photographic
print paper, could increase due to a shortage of silver or an increase in worldwide energy prices.
In addition, we may become subject to increased costs by the third-party shippers that deliver our
products to our customers, and we may be unable to pass along any increases in shipping costs to
our customers. The costs of online advertising and keyword search could also increase significantly
due to increased competition, which would increase our customer acquisition costs.
The loss of key personnel and an inability to attract and retain additional personnel could affect
our ability to successfully grow our business.
We are highly dependent upon the continued service and performance of our senior management
team and key technical, marketing and production personnel. The loss of these key employees, each
of whom is at will and may terminate his or her employment relationship with us at any time, may
significantly delay or prevent the achievement of our business objectives.
We believe that our future success will also depend in part on our continued ability to
identify, hire, train and motivate qualified personnel. We face intense competition for qualified
individuals from numerous technology, marketing, financial services, manufacturing and e-commerce
companies. In addition, competition for qualified personnel is particularly intense in the San
Francisco Bay Area, where our headquarters are located. We may be unable to attract and retain
suitably qualified individuals who are capable of meeting our growing operational and managerial
requirements, or we may be required to pay increased compensation in order to do so. Our failure
to attract and retain qualified personnel could impair our ability to implement our business plan.
If we are unable to attract customers in a cost-effective manner, or if we were to become subject
to e-mail blacklisting, traffic to our website would be reduced and our business and results of
operations would be harmed.
Our success depends on our ability to attract customers in a cost-effective manner. We rely on
a variety of methods to bring visitors to our website and promote our products, including paying
fees to third parties who drive new customers to our website, purchasing search results from online
search engines, e-mail and direct mail. We pay providers of online services, search engines,
directories and other website and e-commerce businesses to provide content, advertising banners and
other links that direct customers to our website. We also use e-mail and direct mail to offer free
products and services to attract customers, and we offer substantial pricing discounts to encourage
repeat purchases. Our methods of attracting customers can involve substantial costs, regardless of
whether we acquire new customers. Even if we are successful in acquiring and retaining customers,
the cost involved in these efforts impact our results of operations. If we are unable to enhance or
maintain the methods we use to reach consumers, if the costs of attracting customers using these
methods significantly increase, or if we are unable to develop new cost-effective means to obtain
customers, our ability to attract new customers would be harmed, traffic to our website would be
reduced and our business and results of operations would be harmed.
In addition, various private entities attempt to regulate the use of e-mail for commercial
solicitation. These entities often advocate standards of conduct or practice that significantly
exceed current legal requirements and classify certain e-mail solicitations that comply with
current legal requirements as unsolicited bulk e-mails, or spam. Some of these entities maintain
blacklists of companies and individuals, and the websites, Internet service
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providers and Internet protocol addresses associated with those entities or individuals that
do not adhere to what the blacklisting entity believes are appropriate standards of conduct or
practices for commercial e-mail solicitations. If a companys Internet protocol addresses are
listed by a blacklisting entity, e-mails sent from those addresses may be blocked if they are sent
to any Internet domain or Internet address that subscribes to the blacklisting entitys service or
purchases its blacklist. If we become subject to blacklisting, it could impair our ability to
market our products and services, communicate with our customers and otherwise operate our
business.
We may not succeed in promoting, strengthening and continuing to establish the Shutterfly brand,
which would prevent us from acquiring new customers and increasing revenues.
A component of our business strategy is the continued promotion and strengthening of the
Shutterfly brand. Due to the competitive nature of the digital photography products and services
markets, if we are unable to successfully promote the Shutterfly brand, we may fail to
substantially increase our net revenues. Customer awareness of, and the perceived value of, our
brand will depend largely on the success of our marketing efforts and our ability to provide a
consistent, high-quality customer experience. To promote our brand, we have incurred, and will
continue to incur, substantial expense related to advertising and other marketing efforts.
Our ability to provide a high-quality customer experience also depends, in large part, on
external factors over which we may have little or no control, including the reliability and
performance of our suppliers and third-party Internet and communication infrastructure providers.
For example, some of our products, such as select photo-based merchandise, are produced and shipped
to customers by our third-party vendors, and we rely on these vendors to properly inspect and ship
these products. In addition, we rely on third-party shippers, including the U.S. Postal Service and
United Parcel Service, to deliver our products to customers. Strikes or other service interruptions
affecting these shippers could impair our ability to deliver merchandise on a timely basis. Our
products are also subject to damage during delivery and handling by our third-party shippers. Our
failure to provide customers with high-quality products in a timely manner for any reason could
substantially harm our reputation and our efforts to develop Shutterfly as a trusted brand. The
failure of our brand promotion activities could adversely affect our ability to attract new
customers and maintain customer relationships, which would substantially harm our business and
results of operations.
The success of our business depends on continued consumer adoption of digital photography.
Our growth is highly dependent upon the continued adoption by consumers of digital
photography. The digital photography market is rapidly evolving, characterized by changing
technologies, intense price competition, additional competitors, evolving industry standards,
frequent new service announcements and changing consumer demands and behaviors. To the extent that
consumer adoption of digital photography does not continue to grow as expected, our revenue growth
would likely suffer. Moreover, we face significant risks that, if the market for digital
photography evolves in ways that we are not able to address due to changing technologies or
consumer behaviors, pricing pressures, or otherwise, our current products and services may become
less attractive, which would likely result in the loss of customers, as well as lower net revenues
and/or increased expenses.
Purchasers of digital photography products and services may not choose to shop online, which would
harm our net revenues and results of operations.
The online market for digital photography products and services is less developed than the
online market for other consumer products. If this market does not gain widespread acceptance, our
business may suffer. Our success will depend in part on our ability to attract customers who have
historically used traditional retail photography services or who have produced photographs and
other products using self-service alternatives, such as printing at home. Furthermore, we may have
to incur significantly higher and more sustained advertising and promotional expenditures or reduce
the prices of our products and services in order to attract additional online consumers to our
website and convert them into purchasing customers. Specific factors that could prevent prospective
customers from purchasing from us include:
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the inability to physically handle and examine product samples; |
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delivery time associated with Internet orders; |
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concerns about the security of online transactions and the privacy of personal information; |
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delayed shipments or shipments of incorrect or damaged products; and |
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inconvenience associated with returning or exchanging purchased items. |
If purchasers of digital photography products and services do not choose to shop online, our
net revenues and results of operations would be harmed.
If affordable broadband access does not become widely available to consumers, our revenue growth
will likely suffer.
Because our business currently involves consumers uploading and downloading large data files,
we are highly dependent upon the availability of affordable broadband access to consumers. Many
areas of the country still do not have broadband access, and the cost of broadband access may be
too expensive for many potential customers. To the extent that broadband access is not available or
not adopted by consumers due to cost, our revenue growth would likely suffer.
If the single facility where substantially all of our computer and communications hardware is
located fails or if our production facility fails, our business and results of operations would be
harmed.
Our ability to successfully receive and fulfill orders and to provide high-quality customer
service depends in part on the efficient and uninterrupted operation of our computer and
communications systems. Substantially all of the computer hardware necessary to operate our website
is located at a single third-party hosting facility in Santa Clara, California, and our production
facility is in Hayward, California. Our systems and operations could suffer
damage or interruption from human error, fire, flood, power loss, telecommunications failure,
break-ins, terrorist attacks, acts of war and similar events. In addition, Hayward is located on,
and Santa Clara is located near, a major fault line, increasing our susceptibility to the risk that
an earthquake could significantly harm the operations of these facilities. We do not presently have
redundant systems in multiple locations, and our business interruption insurance may be
insufficient to compensate us for losses that may occur. In addition, the impact of any of these
disasters on our business may be exacerbated by the fact that we are still in the process of
developing our formal disaster recovery plan and we do not have a final plan currently in place.
Capacity constraints and system failures could prevent access to our website, which could harm our
reputation and negatively affect our net revenues.
Our business requires that we have adequate capacity in our computer systems to cope with the
high volume of visits to our website. As our operations grow in size and scope, we will need to
improve and upgrade our computer systems and network infrastructure to ensure reliable access to
our website, in order to offer customers enhanced and new products, services, capacity, features
and functionality. The expansion of our systems and infrastructure may require us to commit
substantial financial, operational and technical resources before the volume of our business
increases, with no assurance that our net revenues will increase.
Our ability to provide high-quality products and service depends on the efficient and
uninterrupted operation of our computer and communications systems. If our systems cannot be
expanded in a timely manner to cope with increased website traffic, we could experience disruptions
in service, slower response times, lower customer satisfaction, and delays in the introduction of
new products and services. Any of these problems could harm our reputation and cause our net
revenues to decline.
Our technology, infrastructure and processes may contain undetected errors or design faults that
could result in decreased production, limited capacity or reduced demand.
Our technology, infrastructure and processes may contain undetected errors or design faults.
These errors or design faults may cause our website to fail and result in loss of, or delay in,
market acceptance of our products and services. If we experience a delay in a website release that
results in customer dissatisfaction during the period required to correct errors and design faults,
we would lose revenue. In the future, we may encounter scalability
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limitations, in current or future technology releases, or delays in the commercial release of
any future version of our technology, infrastructure and processes that could seriously harm our
business.
We currently depend on third party suppliers for our photographic print paper, printing machines
and other supplies, which exposes us to risks if these suppliers fail to perform under our
agreements with them.
We have historically relied on an exclusive supply relationship with Fuji Photo Film U.S.A. to
supply all of our photographic paper for silver halide print production, such as 4×6 prints. We
have an agreement with Fuji that expires in September 2007, but if Fuji fails to perform in
accordance with the terms of our agreement and if we are unable to secure a paper supply from a
different source in a timely manner, we would likely fail to meet customer expectations, which
could result in negative publicity, damage our reputation and brand and harm our business and
results of operations. We are currently in the process of negotiating the renewal of the Fuji
paper supply agreement to extend it until April 2010. We purchase other photo-based supplies from
third parties on a purchase order basis, and, as a result, these parties could increase their
prices, reallocate supply to others, including our competitors, or choose to terminate their
relationship with us. In addition, we purchase or rent the machines used to produce certain of our
photo-based products from Hewlett-Packard, which is one of our primary competitors in the area of
online digital photography services. This competition may influence their willingness to provide us
with additional products or services. If we were required to switch vendors of machines for
photo-based products, we may incur delays and incremental costs, which could harm our operating
results.
If we are unable to develop, market and sell new products and services that address additional
market opportunities, our results of operations may suffer. In addition, we may need to expand
beyond our current customer demographic to grow our business.
Although historically we have focused our business on consumer markets for silver halide
prints, such as 4×6 prints, and photo-based products, such as photo books and calendars, we intend
to address, and demand may shift to, new products and services. In addition, we believe we may need
to address additional markets and expand our customer demographic in order to further grow our
business. We may not successfully expand our existing services or create new products and services,
address new market segments or develop a significantly broader customer base. Any failure to
address additional market opportunities could result in loss of market share, which would harm our
business, financial condition, and results of operations.
We may need to raise additional capital that may be required to grow our business, and we may not
be able to raise capital on terms acceptable to us or at all.
The operation of our business and growth efforts will require significant cash outlays and
advance capital equipment expenditures and commitments. If cash on hand and cash generated from
operations are not sufficient to meet our cash requirements, we will need to seek additional
capital, potentially through debt or equity financings, to fund our growth. We cannot ensure that
we will be able to raise needed cash on terms acceptable to us or at all. Financings may be on
terms that are dilutive or potentially dilutive to our stockholders. The holders of new securities
may also have rights, preferences or privileges which are senior to those of existing holders of
common stock. If new sources of financing are required, but are insufficient or unavailable, we
will be required to modify our growth and operating plans to the extent of available funding, which
would harm our ability to grow our business.
We may undertake acquisitions to expand our business, which may pose risks to our business and
dilute the ownership of our existing stockholders.
A key component of our business strategy includes strengthening our competitive position and
refining the customer experience on our website through internal development. However, from time to
time, we may selectively pursue acquisitions of businesses, technologies or services. Integrating
any newly acquired businesses, technologies or services is likely to be expensive and time
consuming. To finance any acquisitions, it may be necessary for us to raise additional funds
through public or private financings. Additional funds may not be available on terms that are
favorable to us, and, in the case of equity financings, would result in dilution to our
stockholders. If we do complete any acquisitions, we may be unable to operate the acquired
businesses profitably or otherwise implement our strategy successfully. If we are unable to
integrate any newly acquired entities, technologies or services effectively, our business and
results of operations will suffer. The time and expense associated with finding suitable and
compatible businesses, technologies or services could also disrupt our ongoing business and divert
our
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managements attention. Future acquisitions by us could also result in large and immediate
write-offs or assumptions of debt and contingent liabilities, any of which could substantially harm
our business and results of operations.
Our net revenues and results of operations are affected by the level of vacation and other travel
by our customers, and any declines or disruptions in the travel industry could harm our business.
Because vacation and other travel is one of the primary occasions in which our customers
utilize their digital cameras, our net revenues and results of operations are affected by the level
of vacation and other travel by our customers. Accordingly, downturns or weaknesses in the travel
industry could harm our business. Travel expenditures are sensitive to business and personal
discretionary spending levels and tend to decline during general economic downturns. Events or
weakness in the travel industry that could negatively affect the travel industry include price
escalation in the airline industry or other travel-related industries, airline or other travel
related strikes, safety concerns, including terrorist activities, inclement weather and airline
bankruptcies or liquidations. In addition, high gasoline prices may lead to reduced travel in the
United States. Any decrease in vacation or travel could harm our net revenues and results of
operations.
If we fail to develop and maintain adequate internal controls, we may be unable to timely and
accurately record, process and report financial data, fail to meet our periodic reporting
obligations or have material misstatements in our financial statements. These events could lead to
a decline in our stock price.
In connection with the audit of our 2005 consolidated financial statements for the year ended
and as of December 31, 2005 and the review of our 2006 quarterly financial statements for the
quarter ended June 30, 2006, our independent registered public accounting firm identified three
control deficiencies that represented material weaknesses in our internal control over financial
reporting. As of December 31, 2006, we had remediated the previously disclosed material weaknesses. However, we can
give no assurance that further material weaknesses will not be identified in the future. If further
material weaknesses in our internal control are identified, this could cause our investors to lose
confidence in the accuracy and completeness of our financial reports, leading to a decline in our
stock price.
Failure to adequately protect our intellectual property could substantially harm our business and
results of operations.
We rely on a combination of patent, trademark, trade secret and copyright law and contractual
restrictions to protect our intellectual property. These protective measures afford only limited
protection. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt
to copy aspects of our website features and functionalities or to obtain and use information that
we consider proprietary, such as the technology used to operate our website, our production
operations and our trademarks.
As of March 31, 2007, we had 16 patents issued and more than 30 patent applications pending in
the United States. We intend to pursue corresponding patent coverage in other countries to the
extent we believe such coverage is appropriate and cost efficient. We cannot ensure that any of our
pending applications will be granted. In addition, third parties could bring infringement,
invalidity, co-inventorship or similar claims with respect to any of our currently issued patents
or any patents that may be issued to us in the future. Any such claims, whether or not successful,
could be extremely costly, could damage our reputation and brand and substantially harm our
business and results of operations.
Our primary brand is Shutterfly. We hold registrations for the Shutterfly service mark in
our major markets of the United States and Canada, as well as in the European Community, Mexico,
Japan, Australia and New Zealand. An additional application for the Shutterfly mark is pending in
Brazil. Our competitors may adopt names similar to ours, thereby impeding our ability to build
brand identity and possibly leading to customer confusion. In addition, there could be potential
trade name or trademark infringement claims brought by owners of
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marks that are
similar to Shutterfly or one of our other marks. The Shutterfly brand is a critical component
of our marketing programs. If we lose the ability to use the Shutterfly service mark in any
particular market, we could be forced to either incur significant additional marketing expenses
within that market, or elect not to sell products in that market. Any claims or customer
confusion related to our marks could damage our reputation and brand and substantially harm our
business and results of operations.
If we become involved in intellectual property litigation or other proceedings related to a
determination of rights, we could incur substantial costs, expenses or liability, lose our
exclusive rights or be required to stop certain of our business activities.
Third parties may sue us for infringing its intellectual property rights. In addition, we have
in the past received claims, and in the future a third party may claim, that we have improperly
obtained or used its confidential or proprietary information. Likewise, we may need to resort to
litigation to enforce our intellectual property rights or to determine the scope and validity of
third-party proprietary rights.
The cost to us of any litigation or other proceeding relating to intellectual property rights,
whether or not initiated by us and even if resolved in our favor, could be substantial, and the
litigation would divert our managements efforts from growing our business. Some of our competitors
may be able to sustain the costs of complex intellectual property litigation more effectively than
we can because they have substantially greater resources. Uncertainties resulting from the
initiation and continuation of any litigation could limit our ability to continue our operations.
Alternatively, we may be required to, or decide to, enter into a license with a third party.
For example, in May 2005, we entered into a settlement and license agreement to resolve litigation
brought by a third party with respect to our alleged infringement of its patents. Under the terms
of the agreement, we agreed to pay the third party a total of $2.0 million, and we received a
license to its patents. Any future license required under any other partys patents may not be made
available on commercially acceptable terms, if at all. In addition, such licenses are likely to be
non-exclusive and, therefore, our competitors may have access to the same technology licensed to
us. If we fail to obtain a required license and are unable to design around a patent, we may be
unable to effectively conduct certain of our business activities, which could limit our ability to
generate revenues and harm our results of operations and possibly prevent us from generating
revenues sufficient to sustain our operations.
The inability to acquire or maintain domain names for our website could substantially harm our
business and results of operations.
We currently are the registrant of the Internet domain name for our website, Shutterfly.com,
as well as various related domain names. Domain names generally are regulated by Internet
regulatory bodies and are controlled also by trademark and other related laws. The regulations
governing domain names could change in ways that block or interfere with our ability to use
relevant domains. Also, we might not be able to prevent third parties from registering or retaining
domain names that interfere with our consumer communications, or infringe or otherwise decrease the
value of our trademarks and other proprietary rights. Regulatory bodies also may establish
additional generic or country-code top-level domains or modify the requirements for holding domain
names. As a result, we might not be able to acquire or maintain the domain names that utilize the
name Shutterfly in all of the countries in which we currently or intend to conduct business. This
could substantially harm our business and results of operations.
Our net revenues may be negatively affected if we are required to charge sales taxes in additional
jurisdictions or other taxes on purchases.
We
currently do not collect or have imposed upon us sales or other taxes related to the products
and services we sell, except for certain corporate level taxes and
sales tax in California, Nevada, Pennsylvania and North Carolina where we have a tax nexus. If circumstances require
us to collect sales or other taxes on the sale of our
products it could, discourage customers from
purchasing products from us, decrease our ability to compete with traditional retailers or
otherwise substantially harm our business and results of operations.
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Currently, decisions of the U.S. Supreme Court restrict the imposition of obligations to
collect state and local sales and use taxes with respect to sales made by a seller that is not physically present within the taxing jurisdiction. However,
implementation of the restrictions imposed by these Supreme Court decisions is subject to
interpretation by state and local taxing authorities. While we believe that these Supreme Court
decisions currently restrict state and local taxing authorities in the United States from requiring
us to collect sales and use taxes from purchasers located within their jurisdictions, taxing
authorities could disagree with our interpretation of these decisions. Moreover, a number of states
in the United States, as well as the U.S. Congress, have been considering various initiatives that
could limit or supersede the Supreme Courts position regarding sales and use taxes on Internet
sales. If any state or local taxing jurisdiction were to disagree with our interpretation of the
Supreme Courts current position regarding state and local taxation of remote sellers, or if any of
these initiatives were to address the Supreme Courts constitutional concerns and result in a
reversal of its current position, we could be required to collect additional sales and use taxes
from purchasers. The imposition by state and local governments of various taxes upon Internet
commerce could create administrative burdens for us and could decrease our future net sales.
Our effective tax rate may be subject to fluctuation from federal and state audits, and disqualifying dispositions of stock options.
We are currently under examination in the state of California for the 2003 tax year, and the result of that examination could lead to fluctuations in our effective tax rate because
they may disagree with certain assumptions we have made regarding appropriate credits and deductions in filing our tax returns.
Under current stock option tax regulations, we are entitled to a stock option compensation tax deduction when employees exercise and sell their incentive stock options within a two year period for a taxable gain. Our current effective tax rate estimate does not
incorporate this deduction as the extent of the deduction, based on employee option disposition activity is not currently determinable. A significant volume of these dispositions could lead to future fluctuations in our effective tax rate for any given quarter or year.
Government regulation of the Internet and e-commerce is evolving, and unfavorable changes or
failure by us to comply with these regulations could substantially harm our business and results of
operations.
We are subject to general business regulations and laws as well as regulations and laws
specifically governing the Internet and e-commerce. Existing and future laws and regulations may
impede the growth of the Internet or other online services. These regulations and laws may cover
taxation, restrictions on imports and exports, customs, tariffs, user privacy, data protection,
pricing, content, copyrights, distribution, electronic contracts and other communications, consumer
protection, the provision of online payment services, broadband residential Internet access and the
characteristics and quality of products and services. It is not clear how existing laws governing
issues such as property ownership, sales and other taxes, libel and personal privacy apply to the
Internet and e-commerce as the vast majority of these laws were adopted prior to the advent of the
Internet and do not contemplate or address the unique issues raised by the Internet or e-commerce.
Those laws that do reference the Internet are only beginning to be interpreted by the courts and
their applicability and reach are therefore uncertain. For example, the Digital Millennium
Copyright Act, or DMCA, is intended, in part, to limit the liability of eligible online service
providers for listing or linking to third-party websites that include materials that infringe
copyrights or other rights of others. Portions of the Communications Decency Act, or CDA, are
intended to provide statutory protections to online service providers who distribute third-party
content. We rely on the protections provided by both the DMCA and CDA in conducting our business.
Any changes in these laws or judicial interpretations narrowing their protections will subject us
to greater risk of liability and may increase our costs of compliance with these regulations or
limit our ability to operate certain lines of business. The Childrens Online Protection Act and
the Childrens Online Privacy Protection Act are intended to restrict the distribution of certain
materials deemed harmful to children and impose additional restrictions on the ability of online
services to collect user information from minors. In addition, the Protection of Children From
Sexual Predators Act of 1998 requires online service providers to report evidence of violations of
federal child pornography laws under certain circumstances. The costs of compliance with these
regulations may increase in the future as a result of changes in the regulations or the
interpretation of them. Further, any failures on our part to comply with these regulations may
subject us to significant liabilities. Those current and future laws and regulations or unfavorable
resolution of these issues may substantially harm our business and results of operations.
Legislation regarding copyright protection or content interdiction could impose complex and costly
constraints on our business model.
Because of our focus on automation and high volumes, our operations do not involve, for the
vast majority of our sales, any human-based review of content. Although our websites terms of use
specifically require customers to represent that they have the right and authority to reproduce the
content they provide and that the content is in full compliance with all relevant laws and
regulations, we do not have the ability to determine the accuracy of these representations on a
case-by-case basis. There is a risk that a customer may supply an image or other content that is
the property of another party used without permission, that infringes the copyright or trademark of
another party, or that would be considered to be defamatory, pornographic, hateful, racist,
scandalous, obscene or otherwise offensive, objectionable or illegal under the laws or court
decisions of the jurisdiction where that customer lives. There is, therefore, a risk that customers
may intentionally or inadvertently order and receive products from us that are in violation of the
rights of another party or a law or regulation of a particular jurisdiction. If we should become
33
legally obligated in the future to perform manual screening and review for all orders destined for
a jurisdiction, we will encounter increased production costs or may cease accepting orders for
shipment to that jurisdiction. That could substantially harm our business and results of
operations.
Our practice of offering free products and services could be subject to judicial or regulatory
challenge.
We regularly offer free products and free shipping as an inducement for customers to try our
products. Although we believe that we conspicuously and clearly communicate all details and
conditions of these offers for example, that customers are required to pay shipping, handling
and/or processing charges to take advantage of the free product offer we may be subject to
claims from individuals or governmental regulators that our free offers are misleading or do not
comply with applicable legislation. These claims may be expensive to defend and could divert
managements time and attention. If we become subject to such claims in the future, or are required
or elect to curtail or eliminate our use of free offers, our results of operations may be harmed.
Any failure by us to protect the confidential information of our customers and networks against
security breaches and the risks associated with credit card fraud could damage our reputation and
brand and substantially harm our business and results of operations.
A significant prerequisite to online commerce and communications is the secure transmission of
confidential information over public networks. Our failure to prevent security breaches could
damage our reputation and brand and substantially harm our business and results of operations. For
example, a majority of our sales are billed to our customers credit card accounts directly, orders
are shipped to a customers address, and customers log on using their e-mail address. We rely on
encryption and authentication technology licensed from third parties to effect the secure
transmission of confidential information, including credit card numbers. Advances in computer
capabilities, new discoveries in the field of cryptography or other developments may result in a
compromise or breach of the technology used by us to protect customer transaction data. In
addition, any party who is able to illicitly obtain a users password could access the users
transaction data, personal information or stored images. Any compromise of our security could
damage our reputation and brand and expose us to a risk of loss or litigation and possible
liability, which would substantially harm our business and results of operations. In addition,
anyone who is able to circumvent our security measures could misappropriate proprietary information
or cause interruptions in our operations. We may need to devote significant resources to protect
against security breaches or to address problems caused by breaches.
In addition, under current credit card practices, we are liable for fraudulent credit card
transactions because we do not obtain a cardholders signature. We do not currently carry insurance
against this risk. To date, we have experienced minimal losses from credit card fraud, but we
continue to face the risk of significant losses from this type of fraud. Our failure to adequately
control fraudulent credit card transactions could damage our reputation and brand and substantially
harm our business and results of operations.
Changes in regulations or user concerns regarding privacy and protection of user data could harm
our business.
Federal, state and international laws and regulations may govern the collection, use, sharing
and security of data that we receive from our customers. In addition, we have and post on our
website our own privacy policies and practices concerning the collection, use and disclosure of
customer data. Any failure, or perceived failure, by us to comply with our posted privacy policies
or with any data-related consent orders, Federal Trade Commission requirements or other federal,
state or international privacy-related laws and regulations could result in proceedings or actions
against us by governmental entities or others, which could potentially harm our business. Further,
failure or perceived failure to comply with our policies or applicable requirements related to the
collection, use or security of personal information or other privacy-related matters could damage
our reputation and result in a loss of customers.
Expansion of our international operations will require management attention and resources and may
be unsuccessful, which could harm our future business development and existing domestic operations.
To date, we have conducted limited international operations, but we intend to expand into
international markets in order to grow our business. These expansion plans will require significant
management attention and resources and may be unsuccessful. We have limited experience adapting our
products to conform to local cultures,
34
standards and policies. We may have to compete with local companies which understand the local
market better than we do. In addition, to achieve satisfactory performance for consumers in
international locations it may be necessary to locate physical facilities, such as production
facilities, in the foreign market. We do not have experience establishing such facilities overseas.
We may not be successful in expanding into any international markets or in generating revenues from
foreign operations. In addition, different privacy, censorship and liability standards and
regulations and different intellectual property laws in foreign countries may cause our business to
be harmed.
Maintaining and improving our financial controls and the requirements of being a public company may
strain our resources, divert managements attention and affect our ability to attract and retain
qualified board members.
As a public company, we are subject to the reporting requirements of the Securities Exchange
Act of 1934, the Sarbanes-Oxley Act of 2002 and the rules and regulations of The NASDAQ Stock
Market. The requirements of these rules and regulations will likely continue to increase our legal,
accounting and financial compliance costs, make some activities more difficult, time-consuming or
costly and may also place undue strain on our personnel, systems and resources.
The Sarbanes-Oxley Act requires, among other things, that we maintain effective disclosure
controls and procedures and effective internal control over financial reporting. Significant
resources and management oversight are required to design, document, test, implement and monitor
internal control over relevant processes and to, remediate any deficiencies. As a result,
managements attention may be diverted from other business concerns, which could harm our business,
financial condition and results of operations. These efforts also involve substantial accounting
related costs. In addition, if we are unable to continue to meet these requirements, we may not be
able to remain listed on The NASDAQ Global Market.
Under the Sarbanes-Oxley Act and the rules and regulations of The NASDAQ Stock Market, we are
required to maintain a board of directors with a majority of independent directors. These rules and
regulations may make it more difficult and more expensive for us to maintain directors and
officers liability insurance, and we may be required to accept reduced coverage or incur
substantially higher costs to maintain coverage. If we are unable to maintain adequate directors
and officers insurance, our ability to recruit and retain qualified directors and officers,
especially those directors who may be considered independent for purposes of Nasdaq rules, will be
significantly curtailed.
Our stock price may be volatile or may decline regardless of our operating performance.
The market price of our common stock may fluctuate significantly in response to numerous
factors, many of which are beyond our control, including:
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price and volume fluctuations in the overall stock market; |
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changes in operating performance and stock market valuations of other technology
companies generally, or those in our industry in particular; |
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the financial projections we may provide to the public, any changes in these
projections or our failure to meet these projections; |
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changes in financial estimates by any securities analysts who follow our company, our
failure to meet these estimates or failure of those analysts to initiate or maintain coverage of
our stock; |
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ratings downgrades by any securities analysts who follow our company; |
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the publics response to our press releases or other public announcements, including
our filings with the SEC; |
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announcements by us or our competitors of significant technical innovations,
acquisitions, strategic partnerships, joint ventures or capital commitments; |
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introduction of technologies or product enhancements that reduce the need for our products; |
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market conditions or trends in our industry or the economy as a whole; |
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the loss of key personnel; |
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lawsuits threatened or filed against us; |
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future sales of our common stock by our executive officers, directors and significant
stockholders; and |
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other events or factors, including those resulting from war, incidents of terrorism or
responses to these events. |
Some provisions in our restated certificate of incorporation and restated bylaws and Delaware law
may deter third parties from acquiring us.
Our restated certificate of incorporation and restated bylaws contain provisions that may make
the acquisition of our company more difficult without the approval of our board of directors,
including the following:
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our board is classified into three classes of directors, each with staggered
three-year terms; |
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only our chairman, our chief executive officer, our president or a majority of our
board of directors is authorized to call a special meeting of stockholders; |
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our stockholders may take action only at a meeting of stockholders and not by written
consent; |
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vacancies on our board of directors may be filled only by our board of directors and
not by stockholders; |
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our certificate of incorporation authorizes undesignated preferred stock, the terms of
which may be established and shares of which may be issued without stockholder approval; and |
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advance notice procedures apply for stockholders to nominate candidates for election
as directors or to bring matters before an annual meeting of stockholders. |
These anti-takeover defenses could discourage, delay or prevent a transaction involving a
change in control of our company. These provisions could also discourage proxy contests and make it
more difficult for stockholders to elect directors of their choosing and to cause us to take other
corporate actions they desire.
In addition, we are subject to Section 203 of the Delaware General Corporation Law, which,
subject to some exceptions, prohibits business combinations between a Delaware corporation and an
interested stockholder, which is generally defined as a stockholder who becomes a beneficial
owner of 15% or more of a Delaware corporations voting stock, for a three-year period following
the date that the stockholder became an interested stockholder. Section 203 could have the effect
of delaying, deferring or preventing a change in control that our stockholders might consider to be
in their best interests.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Unregistered Sales of Equity Securities
During the three months ended March 31, 2007, we issued 2,199 shares of common stock upon the
net exercise of outstanding warrants to purchase 2,809 shares of common stock. The issuance of
shares on exercise of the warrant was deemed to be exempt from registration under Section 4(2) of
the Securities Act and/or Regulation D promulgated thereunder, as a transaction by an issuer not
involving a public offering or transactions.
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Use of Proceeds
The S-1 relating to our initial public offering was declared effective by the SEC on September
28, 2006.
Through March 31, 2007, we had not utilized any of the net proceeds from the offering. We
intend to use the net proceeds of the offering for general corporate purposes, including working
capital and potential capital expenditures for manufacturing and website infrastructure equipment
and new and existing manufacturing facilities. We expect our capital expenditures to be between $23
million and $25 million during the remainder of 2007, which will be funded by a combination of our
cash and cash equivalents, expected cash flows from operations and the net proceeds from the
offering. We expect to spend approximately half of this amount to purchase manufacturing equipment,
obtain new manufacturing facilities and on improvements to our new and existing manufacturing
facilities. The remainder will be allocated for the purchase of website infrastructure equipment.
Although we may also use a portion of the net proceeds for the acquisition of, or investment in,
companies, technologies, products or assets that complement our business, we have no present
understandings, commitments or agreements to enter into any acquisitions or make any investments.
Our management will retain broad discretion in the allocation and use of the net proceeds of
our initial public offering, and investors will be relying on the judgment of our management
regarding the application of the net proceeds. Pending specific use of the remaining net proceeds
as described above, we have invested the net proceeds of the offering in short-term,
interest-bearing obligations, investment grade instruments, certificates of deposit or direct or
guaranteed obligations of the United States. The goal with respect to the investment of the net
proceeds will be capital preservation and liquidity so that such funds are readily available to
fund our operations.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
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ITEM 5. OTHER INFORMATION
Not applicable
ITEM 6. EXHIBITS
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Exhibit |
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Number |
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Description |
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31.01
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Certification of Chief Executive Officer Pursuant to Securities Exchange Act Rule 13a-14(a). |
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31.02
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Certification of Chief Financial Officer Pursuant to Securities Exchange Act Rule 13a-14(a). |
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32.01
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Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 and Securities
Exchange Act Rule 13a-14(b).** |
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32.02
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Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 and Securities
Exchange Act Rule 13a-14(b).** |
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** |
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This certification is not deemed filed for purposes of Section
18 of the Securities Exchange Act, or otherwise subject to the
liability of that section. Such certification will not be deemed
to be incorporated by reference into any filing under the
Securities Act of 1933 or the Securities Exchange Act of 1934,
except to the extent that Shutterfly specifically incorporates it
by reference. |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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SHUTTERFLY, INC. |
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(Registrant) |
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Dated: May 3, 2007 |
By: |
/s/ Jeffrey T. Housenbold
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Jeffrey T. Housenbold, |
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President and Chief Executive Officer |
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Dated: May 3, 2007 |
By: |
/s/ Stephen E. Recht
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Stephen E. Recht, |
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Chief Financial Officer |
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INDEX TO EXHIBITS
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Exhibit |
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Number |
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Description |
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31.01
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Certification of Chief Executive Officer Pursuant to Securities Exchange Act Rule 13a-14(a). |
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31.02
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Certification of Chief Financial Officer Pursuant to Securities Exchange Act Rule 13a-14(a). |
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32.01
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Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 and Securities
Exchange Act Rule 13a-14(b).** |
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32.02
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Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 and Securities
Exchange Act Rule 13a-14(b).** |
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* |
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Incorporated herein by reference to the corresponding exhibit of the S-1. |
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** |
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This certification is not deemed filed for purposes of Section 18 of
the Securities Exchange Act, or otherwise subject to the liability of
that section. Such certification will not be deemed to be incorporated
by reference into any filing under the Securities Act of 1933 or the
Securities Exchange Act of 1934, except to the extent that Shutterfly
specifically incorporates it by reference. |
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