e10vk
UNITED STATES SECURITIES AND
EXCHANGE COMMISSION
Washington, DC 20549
Form 10-K
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(Mark One)
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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For the fiscal year ended
December 31, 2006
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or
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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For the transition period
from to
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Commission file number:
001-33031
SHUTTERFLY, INC.
(Exact Name of Registrant as
Specified in Its Charter)
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Delaware
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94-3330068
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(State or Other Jurisdiction
of
Incorporation or Organization)
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(I.R.S. Employer
Identification No.)
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2800 Bridge Parkway,
Suite 101
Redwood City, California
(Address of Principal
Executive Offices)
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94065
(Zip
Code)
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Registrants telephone number, including area code
(650) 610-5200
Securities registered pursuant to Section 12(b) of the
Act:
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Title of Each Class
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Name of Each Exchange on Which Registered
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Common Stock, $0.0001 Par
Value Per Share
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Nasdaq Global Market
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Securities registered pursuant to Section 12(g) of the
Act:
None
Indicate by check mark if the Registrant is a well-known
seasoned issuer, as defined in Rule 405 of the Securities
Act. Yes o No þ
Indicate by check mark if the Registrant is not required to file
reports pursuant to Section 13 or 15(d) of the
Act. Yes o No þ
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 if disclosure of delinquent filers
pursuant to Rule 405 of
Regulation S-K
is not contained herein, and will not be contained, to the best
of Registrants knowledge, in definitive proxy or
information statements incorporated by reference in
Part III of this
Form 10-K
or any amendment to this
Form 10-K. 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 June 30, 2006, the last business day of our most
recently completed second fiscal quarter, the registrants
common stock was not listed on any exchange or
over-the-counter
market. The registrants common stock began trading on the
Nasdaq Global Market on September 29, 2006.
Indicate the number of shares outstanding of each of the
issuers classes of common stock, as of the latest
practicable date.
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Class
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Outstanding at March 9, 2007
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Common stock, $0.0001 par
value per share
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24,003,116 shares
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DOCUMENTS
INCORPORATED BY REFERENCE
Portions of the documents listed below have been incorporated by
reference into the indicated parts of this reports, as specified
in the responses to the item numbers involved:
Designated portions of the Proxy Statement relating to the 2007
Annual Meeting of the Stockholders (the Proxy
Statement): Part III
(Items 10, 11, 12, 13 and 14). Except with
respect to information specifically incorporated by reference in
the
Form 10-K,
the Proxy Statement is not deemed to be filed as part hereof.
Shutterfly,
Inc.
Table of
Contents
PART I
Except for historical financial information contained herein,
the matters discussed in this
Form 10-K
may be considered forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933, as amended,
and Section 21E of the Securities Exchange Act of 1934, as
amended, and subject to the safe harbor created by the
Securities Litigation Reform Act of 1995. Such statements
include declarations regarding our intent, belief, or current
expectations and those of our management. Prospective investors
are cautioned that any such forward-looking statements are not
guarantees of future performance and involve a number of risks,
uncertainties and other factors, some of which are beyond our
control; actual results could differ materially from those
indicated by such forward-looking statements. Important factors
that could cause actual results to differ materially from those
indicated by such forward-looking statements include, but are
not limited to: (i) that the information is of a
preliminary nature and may be subject to further adjustment;
(ii) those risks and uncertainties identified under
Risk Factors; and (iii) the other risks
detailed from
time-to-time
in our reports and registration statements filed with the
Securities and Exchange Commission, or SEC. Except as required
by law, we undertake no obligation to revise or update publicly
any forward-looking statements, whether as a result of new
information, future events or otherwise.
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,
manufacturing, web-design and merchandising capabilities. Today,
our primary focus is on helping consumers manage their memories
through the powerful medium of photos. We provide a full range
of personalized photo-based products and services that make it
easy, convenient and fun for consumers to upload, edit, enhance,
organize, find, share, create, print and preserve their memories
in a creative and thoughtful manner.
Consumers use our products and services to stay connected to
their friends and family, to organize their memories in a single
location, to tell stories and to preserve their memories for
themselves and their children. Our customers purchase physical
products both for their own personal use and for giving
thoughtful and personalized gifts such as photo books,
calendars, greeting cards and other photo-based products and
merchandise.
We currently generate revenues by producing and selling
professionally-bound photo books, personalized calendars,
greeting cards, other photo-based merchandise and high-quality
prints (ranging in size from wallet to jumbo-sized 20×30
enlargements). We manufacture these items in our Hayward,
California manufacturing facility. We have also announced that
we are opening a new manufacturing plant in Charlotte, North
Carolina, which is planned to be operational by the fourth
quarter 2007. By controlling the production process in our own
manufacturing facilities, we are able to produce high-quality
products, innovate rapidly, maintain a favorable cost structure
and ensure timely shipment to customers, even during peak
periods of 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.
Our high-quality products and services and the compelling online
experience we create for our customers, together with our focus
on continuous innovation, have earned us numerous third-party
accolades and, more importantly, have allowed us to establish a
premium brand. We believe that we realize the benefits of a
premium brand through high customer loyalty, low customer
acquisition costs and premium pricing.
Our customers are a central part of our business model. They
generate most of the content on our service by uploading their
photos and storing their memories. In addition, they share their
photos electronically with their friends and families, extending
and endorsing our brand and creating a sense of community.
Finally, by giving Shutterfly-branded products to colleagues,
friends and loved ones throughout the year, customers reinforce
the Shutterfly brand. Through these various activities, our
customers create a viral network of new users and customers.
In addition to driving lower customer acquisition costs through
viral marketing, our customers provide input on new features,
functionalities and products. Close, frequent customer
interactions, coupled with significant
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investments in sophisticated integrated marketing programs,
enable us to fine-tune and tailor our promotions and website
presentation to specific customer segments. Consequently,
customers are presented with a highly personalized Shutterfly
shopping experience, which helps foster a unique and deep
relationship with our brand.
Our corporation was formed in 1999 and we have experienced rapid
growth since launching our service in December 1999. Since
inception though December 2006, we have fulfilled more than
14.7 million orders, sold approximately 450 million
prints and stored between approximately 1-2 billion of our
consumers photos in our image archives. According to
industry sources, in 2006, Shutterfly.com had approximately
29 million unique visitors.
Vision
and Mission
Our vision is to make the world a better place by helping people
share lifes joy. Our mission is to build an unrivaled
service that enables deeper, more personal relationships between
our customers and those who matter most in their lives.
We believe that people have an intrinsic desire for social
expression, as they wish to capture and share their experiences
and pass them on to future generations. Since the beginning of
humankind, people have shared detailed stories of their lives
through visual expression. Today, with the evolution of digital
cameras and technology, millions of people around the world are
capturing their memories and communicating in deeper, more
meaningful ways.
We believe people will continue to take pictures of important
moments in their lives across various touch points throughout
the year, including vacations, weddings, birthdays,
anniversaries, graduations, family reunions and holidays. Our
products and services make sharing, printing and preserving
those memories easy, convenient and fun, and allow for our
customers to be more thoughtful and creative with their
memories. As our customers share these joyous memories, either
digitally through our sharing service or physically through
giving personalized photo-based gifts, they are enhancing their
personal relationships, creating more joy in the world and
making the world a better place.
Industry
Overview
Historically, preserving photos and creating original,
thoughtful compilations of memories was a difficult, expensive,
manual, time-consuming and often inconvenient process for
consumers. As a result of these constraints, the desire for
easy, convenient, versatile, affordable and trusted online photo
services has emerged.
Until the widespread adoption of the Internet and digital
cameras, there were significant inefficiencies and quality
limitations associated with capturing, developing, processing,
storing, editing and sharing images. Photos had to be stored in
physical form and were vulnerable to deterioration, destruction
or loss. Most people chose the limited option of storing their
4x6 prints in shoeboxes or simple photo albums because
photography-related markets including film
processing, photo printing and scrapbooking either
did not exist or were not
well-integrated.
In particular, convenient options for photo production, storage
and sharing were very limited; consumers had to settle for
ordering duplicate 4x6 prints from either mail-order or local
processing labs with varied capabilities and often poor quality
control. Furthermore, the shoebox approach created
significant difficulties for consumers in organizing their
photos and limited their ability to be thoughtful and creative
with their memories. The photo-related industries had not found
a way to capitalize on the publics need to preserve
memories across generations in a secure, convenient, creative
and engaging manner.
Internet and digital photo-based technology enables consumers to
create an archive of memories that extends beyond photos to
include highly personalized, more engaging products and services
that can be protected and preserved for future generations. We
believe that the key forces driving the expansion of the market
for these products and services are:
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Proliferation of digital cameras and penetration of
high-speed connectivity. The growing use of
digital cameras, largely driven by price decreases, has
increased the demand for online photo-printing services.
High-bandwidth, high-speed Internet access has spurred the
integration of the Internet into daily life and provides
consumers with improved performance and speed for sharing
information, especially large files sizes such as digital
images. Industry sources estimate that in 2005, worldwide
shipments of digital cameras reached approximately
94 million units, a 27% increase from the approximately
74 million units shipped in
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2004. Industry sources estimate that by the end of 2006, there
will be more than 1 billion Internet users worldwide. In
the U.S., industry sources estimate that approximately
58 million households have both Internet connectivity and a
digital camera.
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Increasing convenience and quality of online photo
services. Online photo services provide multiple
advantages over at-home or retail printing. Although at-home
photo printing is instantaneous, it requires an investment in a
printer, photo paper and ink, resulting in a much higher cost
per print and is time consuming. In addition, the quality
rendered is usually inferior compared to commercially produced
prints. Retail printing, while offering higher quality than
at-home printing, requires the consumer to make a trip to the
retail establishment to pick up his or her prints. Both at-home
and retail printing can produce prints of inconsistent quality,
have a limited variety of photo-based products and few or no
personalization options, and require the consumer to handle
shipping or delivery of the product to the final recipient,
often with additional costs in time and money.
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In contrast, online photo services conveniently provide a wide
variety of customized, high-quality photo-based products
delivered directly to consumers doorsteps.
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Growing consumer desire to find easy, hassle-free ways to
generate personalized content. Consumers are
interested in creating highly customized and personalized
photo-based products and merchandise to preserve their precious
memories, express their creativity and make gift giving more
personal and thoughtful. Improvements in software and photo
editing tools have enabled consumers to modify their photos
quickly and easily using a personal computer. Consumers are now
able to create digital compilations of memories that were
previously only possible through a physical and more
time-consuming process.
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Participation in online communities. Consumers
have become increasingly comfortable with using the Internet as
a forum for sharing and publishing information in open or
permission-based networks. Many of the most popular online
communities include user-generated, rich-media content such as
photos and videos because of visual contents inherent
ability to communicate more powerfully than the written word.
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Addressable
Markets
Digital cameras, digital image processing and the Internet have
dramatically changed the photo-related services market, and have
created entirely new ways for consumers to capture, edit,
enhance, organize, find, share, create, print and preserve
images. In particular, the range and quality of printed photos,
photo-based products, photo-based merchandise and ancillary
products have expanded and improved significantly, while
associated production costs and the time required to create this
output have decreased dramatically. Consequently, companies like
Shutterfly are now addressing a wide variety of consumer needs
and multiple, large markets in ways not possible with earlier
technology.
We currently address several adjacent markets related to
consumers desire to be thoughtful and creative with their
memories. These include, but are not limited to:
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Greeting cards and stationery. According to
the Greeting Card Associations website,
U.S. consumers purchase approximately 7 billion
greeting cards each year, generating nearly $7.5 billion in
retail sales. More than 90 percent of all
U.S. households buy greeting cards, with the average
household purchasing 30 individual cards per year. The
Greeting Card Association also reports that nine out of ten
Americans say they look forward to receiving personal letters
and greeting cards because cards allow them to keep in touch
with friends and family and make them feel they are important to
someone else.
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Scrapbooks. According to a 2004 survey by
Creating Keepsakes and Craftrends magazine, the
U.S. scrapbook industry was approximately
$2.55 billion in 2004, up 27.8% from 2001. Additionally,
approximately 61% of scrapbookers have at least a college degree
and spend almost three hours a week assembling their memories
into scrapbooks.
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Calendars. A 2002 guide published by the
Calendar Marketing Association estimated that 500 million
calendars are produced annually in the United States and that
approximately 98% of American households have at least one
calendar.
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Photo prints. Industry sources estimate that
the worldwide market for digital photo prints was approximately
$38 billion in 2005, growing to approximately
$107 billion in 2009, and the U.S. market for digital
photo prints was approximately $10 billion in 2005, growing
to approximately $30 billion in 2009. In addition, industry
sources predict that in the United States, photos ordered over
the Internet for mail delivery will grow from approximately
$424 million in 2005 to approximately $1.9 billion in
2009.
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Photo-based merchandise. Photo-based
merchandise is a substantial market opportunity that includes
any product that can be customized with the imprint of a digital
image. Photo-based merchandise includes, but is not limited to,
mugs, mouse pads, bags, puzzles, playing cards and apparel.
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We generally characterize our products as either
personalized products and services (formerly called
non print) or prints. Our personalized
products and services revenues are derived from sales of
greeting cards, calendars, photobooks, and ancillary products
such as scrapbooking accessories and other photo-based
merchandise, and the related shipping revenue from these sales,
while our print revenues are derived from sales of photo prints
and the related shipping revenue from these sales. In 2004, 2005
and 2006, our personalized products and services revenues
represented approximately 35%, 42% and 51% of our total net
revenues, respectively, and our print revenues represented
approximately 65%, 58% and 49% of our total net revenues,
respectively.
The addressable market for our products and services includes
every person who enjoys the memories created by digital
photographic devices such as cameras, camera cell phones or
camcorders. Although photofinishing products and services are
purchased by a broad consumer base, we believe that women, in
particular, play a key role in many photo-based purchasing
decisions. The U.S. Census Bureau reports that there were
approximately 42 million women
age 25-44
in 2005, and, according to industry sources during 2002, more
than 85% of women 18 years and older identified themselves
as the principal shopper in their household. Securing the
loyalty of this core consumer base represents a sizable market
opportunity.
Value for
Our Customers
Creating value for our customers is the basis for our success.
We offer customers easy, convenient and fun ways to:
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share and preserve memories for family, friends and themselves;
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organize all of their photos in a safe and easily accessible
location;
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maintain emotional connections with friends and family, despite
being time-constrained, through thoughtful and personal
photo-based communications and gifts; and
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achieve satisfaction and self-expression through creativity and
telling stories via photos and personalized photo-based products
and services.
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We accomplish this through providing the following benefits to
our customers:
Broad offering. We offer a wide variety of
premium products to customers, including prints, and photo-based
products that include, but are not limited to, greeting cards,
calendars, photo books, mugs, mouse pads, frames, photo albums
and scrapbooking accessories. In addition, we provide a number
of valuable tools and services, such as the ability to upload
and edit photos online, share photos with friends and family and
store an unlimited number of photos on our system at no cost.
With many creative options from which to choose, we enable
customers to become engaged in the Shutterfly experience and
feel a sense of pride in their creations.
Exceptional quality and service. We have built
strong relationships with our customers who trust us to preserve
and protect their memories in a central storage repository. We
enable customers to enhance, share and make projects with their
photos at their convenience. Our focus on ease of use, image
quality, secure photo storage, high-quality products and
first-rate packaging has established Shutterfly as a premium
brand. Our customers have come to expect the best quality and
service from us. This trust is maintained by fast, consistent
fulfillment times, responsive customer service and continuous
innovation.
Customer-focused approach. The entire
Shutterfly customer experience reflects our customer-centered
approach. Membership is free and offers customers the ability to
upload, edit, store and share an unlimited number of photos.
Membership is not required to view friends and
familys shared pictures, which can be
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viewed with a simple click. We conveniently mail orders to our
customers homes or offices, or directly to a gift
recipient. We also offer a year-round direct-mail greeting card
service where customers upload their electronic address books to
Shutterfly and we mail their cards and party invitations on
their behalf. We take special care to focus on our
customers requests for new features and functionality,
products and services.
The
Shutterfly Solution
We have developed a portfolio of products and services along
with specialized manufacturing capabilities that allow us to
offer consumers an easy, convenient and fun way to enjoy, share
and preserve their memories. We satisfy traditional consumer
needs by introducing consumers to new forms of
communication and creative expression through our website
features and functionality, photo prints, and personalized
photo-based products and services. We also provide photo
printing, storing and sharing. We believe that many people are
intimidated by the process of creating photo-based products or
merchandise or fear that it will take too much work. We believe
that we have removed much of the difficulty and intimidation of
the process and have made it easy and enjoyable. In addition to
these consumer benefits, we believe that our business model is
supported by the following characteristics:
Viral network effect. We benefit from a viral
network in several ways. When our existing customers upload and
share their personal memories through photos, they are providing
compelling user-generated content that attracts their friends
and family to our website, thus enlarging our network of users
and potential customers. This implicit endorsement, coupled with
user-friendly policies, such as not requiring share recipients
to register to view pictures, reinforces our trusted brand and
leads to lower customer acquisition costs. In addition, as our
customers create and give thoughtful and unique physical gifts
such as greeting cards, calendars and photo books, these
products create numerous opportunities for potential customers
to interact with our brand. Many of our customers also use our
website to create community-oriented products such as a photo
book celebrating a school play or a yearbook for their
childrens soccer team, and they often proactively
introduce and sell these items to larger groups of potential new
customers. As our products and services delight our customers,
they often become enthusiastic evangelists for Shutterfly and
introduce our products and services to their friends and family
through
word-of-mouth
referrals and endorsements.
Attractive target demographics reflected in our loyal
customer base. We send a survey every month to
approximately 5,000 of our customers. We select customers who
have made varying numbers of purchases from us historically and
who have purchased products from us within the prior
30 days. We typically receive a response rate of
approximately 15%. Based upon these surveys, we believe that our
current customer base fits the following profile: approximately
84% female, approximately 63% in the
25-44 age
range and approximately 53% with children. Our surveys also
indicate that the average household income of our customers is
greater than $75,000. Our customers have described themselves as
being interested in maintaining personal connections with
friends and family, wanting to tell stories, wishing to preserve
their memories for themselves and their children and wanting an
offering that is intuitive and easy to use. As a result, we
believe that they are looking for an easy and convenient way to
be both thoughtful and creative with their memories. Our
customers use our website to share, enhance and preserve
memories from vacations, holidays and family events and to
create gifts for events such as birthdays, weddings,
anniversaries, Halloween, Hanukkah, Christmas, Valentines
Day, Easter, Mothers Day and Fathers Day. We believe
that our customer loyalty is also aided by high switching costs.
If a customer were to leave Shutterfly, he or she would have to
spend significant time uploading and organizing photos on a new
service.
Premium pricing power. We believe that we are
able to maintain premium pricing power for many of our products
because of our market position and the loyal customer base we
have created. We believe that our market position and loyal
customer base exist because we have differentiated ourselves in
the marketplace by delivering high-quality products, outstanding
customer service, an intuitive and easy user experience and
continuous innovation across our products and services.
Deep understanding of our customers. Customer
insights are an important source of new product and service
innovation for us, and we continually strive to understand our
customers needs in order to improve customer satisfaction.
We invest significant time and resources to understand and
address the needs of our customers through market research,
focus groups, customer surveys, usability testing, customer
response to
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promotions and customer service interactions. We believe a
coordinated focus on understanding the customer allows us take
measures to increase customer loyalty, consumer awareness of
Shutterfly, customer satisfaction and repeat purchases.
Vertical integration and superior
technology. We derived approximately 90% of our
net revenues in 2006 from products we manufactured in our
Hayward, California facility. Our vertically integrated and
highly technical manufacturing approach is essential to our
quality control, agility in rolling out new products and ability
to secure capacity at critical peak demand periods. We believe
that vertical integration provides us with quality, cost,
flexibility and innovation advantages, including:
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greater consistency and quality of output;
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increased ability to control and optimize costs for raw
materials and production;
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fully automated image processing and print scheduling;
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more flexibility to provide rapid, responsive order fulfillment
and processing;
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assured high-quality capacity, even during peak demand such as
the fourth quarter holiday season;
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additional insights into new and existing photo products and
production processes;
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rapid prototyping, testing and refinement of new products and
services; and
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the ability to address customer inquiries quickly.
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We have devoted more than six years to developing our
proprietary software, technology and production systems that we
believe give us an advantage over our competitors. It is our
intention to continue investing in and protecting our
proprietary technology, platforms and processes that help us
differentiate ourselves from the competition and control costs.
Our
Growth Strategy
Our goal is to grow our business, build a premium lifestyle
brand and become the leading online provider of products and
services dedicated to improving the sharing and preservation of
personal memories via social expression and personal publishing.
We believe the combination of our focus, our dedication to
customers and the benefits we derive from our vertically
integrated production facilities will allow us to profitably
capture a significant share of our addressable markets. In
addition to strong consumer trends supporting our
business such as the proliferation of digital
cameras, higher broadband penetration and greater adoption of
Internet related
e-commerce
and communication services we believe our growth
will be supported by the following initiatives:
Expand customer base. We intend to expand our
customer base and continue to promote the Shutterfly brand. We
will leverage existing channels, which include
word-of-mouth
referrals from existing customers, print advertising, catalogs,
online advertising, search engine marketing and complementary
strategic alliances with other
e-commerce
companies such as Amazon.com, Scholastic, Davids Bridal
and HSN.
Expand product and service offerings. We will
continue to innovate in order to increase the breadth and depth
of our products and services, including prints, photo-based
products, photo-based merchandise and ancillary products. For
example, in the past 18 months, we have launched numerous
new products, including canvas prints, keepsake boxes, desk
organizers, multi-media DVD slideshows, magnets, coasters,
year-at-a-glance
calendars, tiled mugs, playing cards, puzzles, scrapbooking
supplies and frames. We have also made numerous enhancements to
our photo books, including new covers, layouts, page designs,
and licensed content for childrens character-themed
photobooks 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 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.
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Increase sales to existing customers. We
intend to increase both average order size and repeat orders per
customer by expanding our products and services, tailoring our
offerings to encourage additional purchases for different
holidays and life events and increasing our cross-selling and
up-selling activities.
Leverage vertical integration. We will
continue to invest in making our business even more vertically
integrated by adding additional in-house production
capabilities. We believe this will allow us to extend our
objectives to provide the highest quality products and services
at the lowest possible costs, to provide exceptional fulfillment
and customer service, even at peak demand periods, and to
continue to innovate rapidly with new products and services.
Develop new lines of business. We intend to
continue to leverage our existing systems and capabilities to
develop additional adjacent lines of business. For example, our
Pro Gallery service, targeted to professional photographers,
provides
end-to-end
fulfillment services, including hosting online photo galleries
and providing the printing, payment and order fulfillment
functions. For our Pro Gallery line of business, we earn
revenues from annual gallery maintenance fees, individual print
orders and a transaction fee.
In addition, 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.
International expansion. We intend to develop
additional business opportunities through international
expansion, targeting consumers in key geographies where digital
camera penetration is high and where Internet usage and
e-commerce
are widespread.
Products
and Services
Using the Shutterfly service is easy, convenient and fun. Our
website is designed to be simple, uncluttered and inviting, and
we work continuously to enhance the customer experience of the
website, while also improving ease of use. In the second half of
2006, Shutterfly announced the first phase of our innovative
personal publishing platform, which includes:
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an
easy-to-use
AJAX-based,
drag-and-drop
website experience;
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enhanced sharing and personalization features;
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a significantly expanded product offering, with many form
factors and design choices;
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a wide variety of background designs;
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dozens of collage formats on our greeting-cards; and
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licensed content and customized storybooks.
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There are only five navigational tabs, which
correspond to the primary activities offered by the
website Add Pictures, View & Enhance, Share
Online, Order Prints and Shutterfly Store. If consumers decide
to either upload pictures or purchase products, they register on
the website and begin the following process:
Upload. Customers can upload digital photos
from their computer to our website one at a time, many at once
through simple
drag-and-drop
or by using Shutterfly Studio, our new photo organization
software. There are no limits to photo file sizes and the upload
processes are accelerated by multi-threading, which enables
photos to be uploaded simultaneously, thereby reducing image
upload times. Unlike some competitive
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services, we do not compress image files as part of the upload
process, which we believe preserves quality and photo resolution.
Organize and find. Customers initially upload
their photos into user-defined albums. We offer multiple ways to
further organize and find pictures. For example, customers can
automatically sort photos within albums by upload date, photo
titles or original filenames. Additionally, customers can
quickly search for photos in a number of ways, including by
text, date taken, upload date and images ordered on prints or
specified products. Customers can also use our
favorites function to tag their favorite photos with
a star rating system on both the website and within Shutterfly
Studio.
View and enhance. Once photos have been
uploaded to Shutterfly, customers can choose to view their
photos in a variety of ways, including photo slideshows. To
improve picture quality, customers also have access to our free
online editing and image enhancement tools. In addition to
cropping and red-eye removal, we offer a variety of creative
options, such as saturating photos with additional color or
changing color shots to
black-and-white
or sepia. Customers are also able to choose from a wide variety
of photo borders. We offer free customized back printing on
photos and the option to add captions to many of our products.
Customers can view and enhance their photos online or on their
desktop via Shutterfly Studio, which easily integrates with our
website. Shutterfly Studio provides advanced viewing and
enhancing capabilities such as full screen slideshows, cropping,
red-, blue- and green-eye removal, sharpening, auto adjustments
and captioning.
Create. We enable customers to create a
variety of personalized products from their photos, including
prints in wallet, 4×6, 5×7, 8×10, 11×14,
16×20 and 20×30 sizes, greeting cards, calendars,
photo books and other photo-based products and merchandise. Our
highly-interactive, design-it-yourself creation
paths help even first-time customers make
professional-looking, high-quality prints and products.
Customers can easily design each product by following simple
step-by-step
instructions and using intuitive features, such as dragging and
dropping an image into a template. Our technology then generates
an image of the customers product on screen so that
customers can make any desired design choices or changes and
then view the final product to ensure satisfaction before
purchase. Customers can also save in-process projects and return
to them at a more convenient time to finish and purchase.
Recent enhancements made possible from innovations in our
personal publishing platform include:
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a significantly expanded product offering, with many form
factors and design choices including personalized photo covers
with printing on the spine, 8x8 Story Books and 12x12 Memory
Books;
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a wide variety of background designs including 70 pre-set style
templates organized across popular life occasions
such as Wedding, Travel, Birthday, Baby, Kids, Class Year
Book, Recipe Book, Portfolio and Journal;
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dozens of collage formats on our greeting-cards;
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licensed content such as Clifford the Big Red
Dog®,
Thomas the Tank
Engine®
and Angelina
Ballerina®;
and
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customized storybooks featuring Sesame
Street®
and the ABCs.
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Share. We enable our customers to share images
in several different ways. Customers can
e-mail
friends, family and colleagues a link to an individual album
that can be viewed as a slideshow of images. In order to view
those images,
e-mail
recipients simply click on the URL link in the
e-mail and
view images immediately without the need to register with
Shutterfly. Recipients can then order prints or save them into
their own album. Similarly, customers can share their photobooks
electronically by sending an
e-mail to
friends and family with a link to a photobook project, thereby
improving the ease of photobook development and collaboration,
and sharing of personalized content. Yet another way to share
photos is by creating a Shutterfly Collection, which is linked
to a personal web address that is powered by Shutterfly. This
allows customers to store and share an unlimited number of photo
albums. Customers can invite friends and family to view the
photos, add additional photos and post comments to both albums
and individual photos via the Guestbook feature. To ensure the
privacy of Collections, we offer users optional password
protection. Shutterfly customers can create up to two free
Collections. We also sponsor seasonal and topical photo
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contests that promote sharing of photos by our customers. To
save our customers time, we offer an easy way to copy names,
e-mail
addresses and mailing addresses from various software such as
Outlook, Outlook Express, Entourage, Palm and Eudora into their
Shutterfly address book.
Order and ship. We provide convenient ordering
and flexible shipping options. To order a product after it is
created, the customer adds it to his or her shopping cart and
completes the billing and shipping information. Shipping
addresses can be typed in or easily added directly from a
customers Shutterfly address book. When a picture or
product is being ordered, we flag photos of poor quality,
usually due to low resolution, to alert customers of potential
quality issues. This helps ensure that a customer does not order
an
out-of-focus
or poor quality picture. Customers can ship single orders to
multiple recipients. We also offer several different shipping
options, such as
next-day,
two-day or
regular service. Standard turn-around times from the time an
order is placed to the time it is shipped are one business day
for most print orders and two business days for other
photo-based products manufactured by Shutterfly. For our
photo-based merchandise manufactured on our behalf by third
parties, turn-around times vary, but generally range from two to
five days from the time we receive the order and transmit it to
our manufacturer. We also offer premium services for addressing,
stamping and mailing greeting cards directly to recipients.
Archive. We provide customers with unlimited
storage of their photos, Collections and projects at no cost to
the customer. Customers can also order a copy of their photos on
a CD or DVD for an extra fee.
Marketing,
Advertising and Promotion
We use a variety of integrated marketing programs, including
advertising, direct marketing technologies, channels, methods
and strategic alliances to attract and retain our customers.
These methods include direct marketing over the Internet,
e-mail
marketing to prospects and existing customers, search engine
marketing, and traditional direct marketing mailings such as
postcards and seasonal catalogs. In addition, because many of
our products are either shared via the Internet or given as
gifts, the appearance of our brand on the products and packaging
provides ongoing distribution as well as viral advertising.
We place advertisements that cater to women and families on
websites and in publications, contract for targeted
e-mail
marketing services and contract for advertising placement on
leading search engines. We also maintain an affiliate program
under which we pay program participants for referral sales
generated from hyperlinks to our website from the
affiliates website and in promotional materials.
We maintain strategic alliances with complementary
e-commerce
companies. For example, we are the sole photo services provider
to Amazon.coms customers. We have other co-marketing and
promotion arrangements with companies such as eTeamz, a leading
website resource for parents, coaches and sports league
administrators.
We also sponsor and manage photo contests as a turn-key offering
for major corporations. In 2006, we conducted photo contests for
1-800-Flowers.com,
Home Shopping Network, and Procter & Gamble. These
corporations promote the photo contests to their own customers,
which in turn introduces new users to Shutterfly.
In addition, from time to time we create co-branded versions of
our website. In general, these arrangements involve payment of a
commission to or revenue sharing with these companies for sales
of our products and services generated through these websites.
Technology
and Production Systems
We use a combination of proprietary and third-party technology,
including the following:
Customer relationship management, or CRM,
system. Our integrated CRM system is comprised of
various sophisticated tools designed to convert first-time
customers into repeat buyers. We seek to increase average order
sizes by expanding customer awareness, providing targeted,
segmented offers to customers and encouraging cross- and
up-selling. The system uses a variety of data, including website
usage patterns, order size, order frequency, products purchased,
seasonality factors, image upload and share usage, as well as
customer satisfaction information. This data is continually
updated and refreshed in a data warehouse, from
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which different customer segments are identified and modified on
a continuing basis for targeted marketing communications.
By using this deep customer intelligence and ongoing analysis,
we are able to offer customers a more personalized website
experience and to target them with specific website promotions,
discounts, specialized
e-mail and
direct mail offers. Our promotion engine generates special
offers that are account specific and applied automatically at
checkout. This enables us to run multiple offers at any given
time that are targeted to specific customer profiles.
We are also able to dynamically assign visitors to test and
control groups who are shown different versions of our service.
This testing enables us to continuously optimize products,
pricing, promotions and user interaction with our website. We
are able to run multiple tests at once, which enables us to
rapidly launch new products and services and enhances our
financial results.
Website system. Our website powers our service
and
e-commerce
functionality. We have designed our user interface to be simple,
uncluttered and inviting. There are only five navigational
tabs that correspond to the primary activities
offered by the website Add Pictures, View &
Enhance, Share Online, Order Prints and Shutterfly Store, which
includes personalized product creation.
We have designed our website system to be highly available,
secure and cost-effective. We can scale to increasing numbers of
customers by adding relatively inexpensive industry-standard
computers and servers. We have a strong commitment to our
privacy policy, and we utilize technologies such as firewalls,
encryption technology for secure transmission of personal
information between customers computers and our website
system and intrusion detection systems to ensure compliance with
that policy.
Image archive. We store our customers
images in our image archive. Once a customer uploads a photo to
our website, it is copied to multiple redundant systems,
including an off-site copy. At present, our image storage
capacity is hundreds of terabytes. We continue to expand our
storage capacity to meet increasing customer demand. Our
innovative storage architecture provides extremely low storage
costs, facilitates the safe, secure archiving of customers
images and delivers the speed and performance required to enable
customers to access, enhance and edit their images in real-time.
When we store and archive a customers image, we do not
alter the original image (for example, we do not reduce the data
file size), which preserves the quality and integrity of the
image. This also lets customers enhance the image using a
duplicate, while giving them the ability to recall the original
at any time.
Render farm. Once a customer orders a photo or
any photo-based product or photo-based merchandise, the render
farm performs fully automated image processing on the image
prior to production. The customers original uploaded image
is retrieved from the image archive, and automatic algorithms
enhance the color, contrast and sharpness of the image. The
render farm also performs customer-requested edits such as crop,
borders, customized back-printing and red-eye removal.
To ensure that output is of consistent quality, we apply our
proprietary ColorSure technology during this render stage.
ColorSure creates an automated mapping of the images
specific attributes to the printers specific print
calibrations and attributes, at which time the rendered image is
scheduled for production. For example, this allows a photo that
is printed on a 4x6 print to look the same as a photo printed on
an enlargement or in a photo book, even if they are ordered at
separate times.
Production system. We operate our own
production facility in Hayward, California, which we believe is
one of the largest all-digital labs in the world. Our automated
production system controls our bar code-driven production
processes, including order management and pick, pack and ship
operations. Using complex algorithms, the production system
analyzes tens of thousands of orders daily and automates the
workflow into our high-volume silver halide photofinishing
machines and our
state-of-the-art
digital offset presses.
10
Competition
The market for digital photography products and services is
large, evolving and intensely competitive, and we expect
competition to increase in the future. 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. These competitors provide in-store
fulfillment and self-service kiosks for printing, which 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.
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We believe the primary competitive factors in attracting and
retaining customers are:
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brand recognition and trust;
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quality of products and services;
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breadth of products and services;
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user affinity and loyalty;
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customer service;
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ease of use;
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convenience; and
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price.
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We believe that we compete favorably with respect to many of
these factors, particularly customer trust and loyalty, quality
and breadth of products and services, and customer service. None
of our competitors offers a comparable value proposition,
trusted brand or singular focus on customers. Many of our
competitors promote their products on the basis of low prices or
the convenience of
same-day
availability for digital photos printed in drugstores or other
retail outlets. As a general matter, we currently plan to
distinguish ourselves from such competitors principally on the
basis of product quality and innovation, rather than price or
same-day
delivery.
The level of competition in our industry is likely to increase
as current competitors improve their offerings and as new
participants enter the market or as industry consolidation
further develops. These competitors have or could develop a
variety of competitive advantages over us, including
significantly longer operating histories; larger and broader
customer bases; greater brand recognition; greater financial,
research and development and distribution resources; and greater
ability to acquire, invest in or partner with traditional and
online competitors. Well-funded new entrants may choose to
prioritize growing their market share and brand awareness
instead of profitability. We may be unable to compete
successfully against current and future competitors, and
competitive pressures could harm our business and prospects.
11
Intellectual
Property
Protecting our intellectual property rights is part of our
strategy for continued growth and competitive differentiation.
We seek to protect our proprietary rights through a combination
of patent, copyright, trade secret and trademark law. We enter
into confidentiality and proprietary rights agreements with our
employees, consultants and business partners, and control access
to and distribution of our proprietary information.
As of December 31, 2006, we had 15 issued patents, which
expire at various dates between November 2019 and May 2025, and
more than 30 patent applications pending in the United States.
Our issued patents and patent applications relate generally to
the user interface for our website, our computer network
infrastructure and software, personalized photo-related products
and automated workflow and digital printing. We intend to pursue
corresponding patent coverage in additional countries to the
extent we believe such coverage is appropriate and cost
efficient. However, we cannot be certain that any of our pending
or any future applications will be granted. In addition, third
parties could bring 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.
We have in the past received claims, and in the future a third
party may claim, that we have infringed its patent rights. This
can result in litigation and/or require us to enter into a
license agreement with a third party. For example, effective
May 1, 2005, Shutterfly entered into a settlement and
license agreement to resolve litigation with respect to alleged
infringement of certain processes under U.S. patents
relating to uploading, storing, sharing, accessing, downloading
and/or
requesting or obtaining digital images or prints of digital
images or merchandise to which such images are applied. Under
the terms of the agreement, Shutterfly paid $2.0 million
for a license to certain patents, including a non-exclusive,
fully-paid up, royalty-free, worldwide license to the patents
underlying the litigation, and a mutual release of claims.
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. We also hold Shutterfly.com
Internet domain registrations in the United States, Mexico,
Australia and New Zealand, and a Shutterfly and
Design trademark, Shutterfly Express,
Shutterfly Collections and Postcards by
Shutterfly service mark registrations in the United
States. An additional application for the Shutterfly mark is
pending in Brazil. We also hold a registration for the
VividPics service mark in the United States and
Mexico, and have pending applications for additional marks,
including Shutterfly Studio, a Shutterfly
Studio and Design trademark, Your pictures and
more, Marking it personal, and Memory
Vault.
These brand registrations are a critical component of our
marketing programs. If we lose the ability to use our Shutterfly
mark in a particular country or our domain name, we could be
forced to either incur significant additional expenses to market
our products within that country or elect not to sell products
in that country. In addition, regulations governing domain names
and laws protecting trademarks and similar proprietary rights
could change in ways that block or interfere with our ability to
use our current brand and 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.
Government
Regulation
The legal environment of the Internet is evolving rapidly in the
United States and elsewhere. The manner in which existing laws
and regulations will be applied to the Internet in general, and
how they will relate to our business in particular, is unclear
in many cases. Accordingly, we often cannot be certain how
existing laws will apply in the online context, including with
respect to such topics as privacy, defamation, pricing, credit
card fraud, advertising, taxation, sweepstakes, promotions,
content regulation, quality of products and services and
intellectual property ownership and infringement. In particular,
laws relating to the liability of providers of online services
for activities of their users are currently unsettled both
within the United States and abroad.
Numerous laws have been adopted at the national and state level
in the United States that could have an impact on our business.
These laws include the following:
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The CAN-SPAM Act of 2003 and similar laws adopted by a number of
states. These laws are intended to regulate unsolicited
commercial
e-mails,
create criminal penalties for unmarked sexually-oriented
material and
e-mails
containing fraudulent headers and control other abusive online
marketing practices.
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The Communications Decency Act, which gives statutory protection
to online service providers who distribute third-party content.
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The Digital Millennium Copyright Act, which is intended to
reduce the liability of online service providers for listing or
linking to third-party websites that include materials that
infringe copyrights or other rights of others.
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The Childrens Online Privacy Protection Act and the
Prosecutorial Remedies and Other Tools to End Exploitation of
Children Today Act of 2003, which 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.
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Statutes adopted in the State of California require online
services to report certain breaches of the security of personal
data, and to report to California consumers when their personal
data might be disclosed to direct marketers.
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To resolve some of the remaining legal uncertainty, we expect
new laws and regulations to be adopted over time that will be
directly applicable to the Internet and to our activities. Any
existing or new legislation applicable to Shutterfly could
expose us to substantial liability, including significant
expenses necessary to comply with such laws and regulations, and
could dampen the growth in the use of the Internet in general.
We post on our website our privacy policies and practices
concerning the use and disclosure of user data. Any failure by
us to comply with our posted privacy policies, Federal Trade
Commission requirements or other privacy-related laws and
regulations could result in proceedings by governmental or
regulatory bodies that could potentially harm our business,
results of operations and financial condition. In this regard,
there are a large number of legislative proposals before the
United States Congress and various state legislative bodies
regarding privacy issues related to our business. It is not
possible to predict whether or when such legislation may be
adopted, and certain proposals, if adopted, could harm our
business through a decrease in user registrations and revenues.
These decreases could be caused by, among other possible
provisions, the required use of disclaimers or other
requirements before users can utilize our services.
Due to the global nature of the Internet, it is possible that
the governments of other states and foreign countries might
attempt to regulate its transmissions or prosecute us for
violations of their laws. We might unintentionally violate such
laws, such laws may be modified and new laws may be enacted in
the future. Any such developments could harm our business,
operating results and financial condition. We may be subject to
legal liability for our online services. The law relating to the
liability of providers of these online services for activities
of their users is currently unsettled both within the United
States and abroad. Claims may be threatened against us for
aiding and abetting, defamation, negligence, copyright or
trademark infringement, or other theories based on the nature
and content of information to which we provide links or that may
be posted online.
Employees
As of December 31, 2006, we had 275 full time employees.
Approximately 79 employees were engaged in engineering, 101 in
photo lab operations, 39 in sales and marketing, 16 in customer
service and 40 in general and administrative functions. During
the peak holiday season, we obtain contract workers on a
temporary basis from third-party outsourcing firms. For example,
during our peak production day in the fourth quarter of 2006, we
used more than 800 of these temporary workers to assist in our
production and fulfillment operations during high-demand
periods. None of our employees is represented by a labor union
or is covered by a collective bargaining agreement. We have
never experienced any employment-related work stoppages and
consider our employee relations to be good.
Available
Information
Our Internet website is located at http://www.shutterfly.com.
The information on our website is not a part of this annual
report. We make available free of charge on our website our
annual report on
Form 10-K,
quarterly reports on
Form 10-Q,
current reports on
Form 8-K
and amendments to those reports filed or furnished pursuant to
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Section 13(a) or 15(d) of the Securities Exchange Act of
1934, as soon as reasonably practicable after we electronically
file such material with, or furnish it to, the Securities and
Exchange Commission. Our SEC reports can be accessed through the
investor relations section of our Internet website.
The public may also read and copy any materials we file with the
Securities and Exchange Commission at the Securities and
Exchange Commissions Public Reference Room at 100 F
Street, NE, Washington, DC 20549. The public may obtain
information on the operation of the Public Reference Room by
calling the Securities and Exchange Commission at
1-800-SEC-0330.
The Securities and Exchange Commission also maintains an
Internet website that contains reports, proxy and information
statements and other information regarding issuers that file
electronically with the Securities and Exchange Commission. The
Securities and Exchange Commissions Internet website is
located at http://www.sec.gov.
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.
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 and hiring
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 and, to date,
have not yet identified or built out locations for the
additional production capacity we expect to need beginning in
2007. We expect to invest between $25 million and
$29 million in capital expenditures in 2007. Our inability
to meet our seasonal production requirements could lead to
customer dissatisfaction and reduced net revenues. Moreover, if
the costs of meeting production requirements were to increase,
our results of operations would be harmed.
14
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 outside of our
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 additional 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 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, particularly Easter;
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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.
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Based on the factors cited above, we believe that
quarter-to-quarter
comparisons of our operating results 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, and we make investments in our business that
generally result in operating losses in each of the first three
quarters of our fiscal year to enable us to generate net income
during the fourth quarter. This net income is necessary for us
to achieve profitability on an annual basis. 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. In addition, 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 be compliant with Section 404 of the
Sarbanes-Oxley Act, which we expect to be costly and 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
15
continue to use stock options to attract, incentivize and retain
our employees and will therefore incur the resulting stock-based
compensation expense, which 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.
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 prospects. As an
e-commerce
company in the early stage of development, we face increased
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.
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We may be unable to accomplish one or more of these things,
which could cause our business to suffer. In addition,
accomplishing one or more of these things might be very
expensive, which could harm our financial results.
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 or
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
16
and retain customers and to maintain adequate customer
satisfaction. We currently conduct scheduled software releases
and 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, and any interruption that occurs during such
time would have a disproportionate impact than if it occurred
during a different quarter.
Because we depend in part on third parties for the
implementation and maintenance of certain aspects of our
communications and printing systems, and because many of the
causes of system interruptions or interruptions in the
production process may be outside of our control, 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 190 employees as of January 1, 2006 to
275 employees as of December 31, 2006, with 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. To
alleviate this strain we have announced that we are opening a
new manufacturing and production plant in Charlotte, North
Carolina, which is planned to be 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.
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 $0.29 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.
In addition, 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. We believe that these results are consistent with our
seasonal historical trends. Many online businesses, including
Shutterfly, offer discounted or free shipping during promotional
periods and usually based upon a minimum purchase requirement as
a means of attracting or retaining customers. In the event that
free shipping offers extend beyond a limited number of
occasions, are not based upon a minimum purchase requirement and
become commonplace, our net revenues and results of operations
would be negatively impacted. In addition, many online
businesses, including Shutterfly, make offers for 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.
17
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, and that 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.
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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 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, and if we are unable to keep these
costs aligned with the level of revenues that we generate, our
results of operations would be harmed. The challenge in
controlling our business costs is made more difficult by the
fact that 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.
18
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 may be
required to pay increased compensation in order to do so, and
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 the
payment of fees to third parties who drive new customers to our
website, purchased 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 as a means of
attracting customers, and offer substantial pricing discounts as
a means of encouraging 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 may negatively impact our results of operations. If we
are unable to enhance or maintain the methods we use to reach
consumers, the costs of attracting customers using these methods
significantly increase, or 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
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
19
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, and,
as a result, 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 unattractive, which would likely result in
the loss of customers and a decline in 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.
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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
20
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. We are opening a new manufacturing and production
plant in Charlotte, North Carolina, which is planned to be
operational by the fourth quarter 2007. 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 Sunnyvale 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 in the ordinary course of business 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 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 also 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,
and 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 incremental costs, which could harm our operating results.
21
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, expanding into 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 assure you 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 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.
22
If we
fail to develop and maintain the adequacy of our 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. Specifically, we did not maintain
effective controls to ensure adequate analysis, documentation,
reconciliation and review of accounting records and supporting
data, we did not maintain effective controls over the
completeness and accuracy of revenue and deferred revenue to
prevent our personnel from reinstating expired prepaid print
plans, and we did not maintain effective controls over the
accounting for income taxes, including the completeness and
accuracy of our deferred income tax assets and liabilities and
the related provision for income taxes. 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 December 31, 2006, we had 15 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 marks that are similar
to Shutterfly or one of our other marks. 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
23
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 Shutterfly
mark in numerous jurisdictions and 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. If we lose the ability to use our Shutterfly mark
in a particular country or our domain name, we could be forced
to either incur significant additional expenses to market our
products within that country, including the development of a new
brand and the creation of new promotional materials and
packaging, or elect not to sell products in that country. Either
result could substantially harm our business and results of
operations.
Furthermore, the regulations governing domain names and laws
protecting trademarks and similar proprietary rights could
change in ways that block or interfere with our ability to use
relevant domains or our current brand. 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.
Our
net revenues may be negatively affected if we are required to
charge sales taxes in additional jurisdictions or other taxes on
purchases.
We 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 and
Pennsylvania where we have a tax nexus. As of February 2007 we
began collecting sales tax in North Carolina. However,
additional states or one or more countries may seek to impose
sales or other tax collection obligations on us in the future. A
successful assertion by any country or state in which we do
business that we should be collecting sales or other taxes on
the sale of our products could result in substantial tax
liabilities for past sales, 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.
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 over the Internet. 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 Internet
sales, 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
24
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.
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 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 which 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 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
25
comply with applicable legislation, which 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.
Our
failure 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 or personal information. 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 management
attention and resources and may be unsuccessful. We have limited
experience adapting our products to conform to local cultures,
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.
26
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 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 will
require that we maintain effective internal control over
financial reporting. This can be difficult to do. In order to
maintain and improve the effectiveness of our disclosure
controls and procedures and internal control over financial
reporting, significant resources and management oversight are
required. We have a substantial effort ahead of us to implement
and maintain appropriate processes, document the system of
internal control over relevant processes, assess their design,
remediate any deficiencies, and test their operation. 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 will 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.
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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.
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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 you and other stockholders to elect
directors of your choosing and cause us to take other corporate
actions you 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.
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ITEM 1B.
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UNRESOLVED
STAFF COMMENTS.
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Not applicable.
We maintain our corporate headquarters in Redwood City,
California in a leased facility of approximately
48,384 square feet. The lease for this facility expires on
May 31, 2010.
We maintain our production and fulfillment operations in
Hayward, California in leased facilities totaling approximately
71,708 square feet. The lease for the facility for
approximately 25,206 square feet expires on
September 30, 2007. We have an option to extend the lease
for five years and a first right of refusal to lease any
immediately adjacent contiguous space. The leases for the other
46,502 square feet expire on July 31, 2010.
We have another production and fulfillment operations under
construction in Charlotte, North Carolina in leased facilities
totaling approximately 102,400 square feet. The lease for
the facility commences on the later of April 30, 2007 or
substantial completion of certain landlords work, and
expires on last day of the eighty-ninth month thereafter. We
have an option to extend the lease for three additional periods
of either three or five years in length, and first rights of
refusal to lease space in certain adjacent buildings.
We have certain temporary office and warehouse space in
Charlotte, North Carolina in leased facilities totaling
approximately 6,400 square feet. The lease for the space is
month-to-month,
commenced on March 1, 2007 and expires no later than
July 31, 2007.
28
We believe that our existing facilities are adequate to meet our
needs through the first half of 2007, although we expect to
require additional corporate facilities to handle future growth.
We believe that suitable additional space will be available in
the future on commercially reasonably terms as needed.
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ITEM 3.
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LEGAL
PROCEEDINGS.
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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
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.
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ITEM 4.
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SUBMISSION
OF MATTERS TO A VOTE OF SECURITY HOLDERS.
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Not applicable.
PART II
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ITEM 5.
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MARKET
FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES.
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Shutterflys common stock has been traded on the NASDAQ
Global Market under the symbol SFLY since
September 29, 2006. As of March 9, 2007, there were
approximately 316 stockholders of record, excluding stockholders
whose shares were held in nominee or street name by brokers. We
have not paid any cash dividends and do not currently have plans
to do so in the foreseeable future.
The following table sets forth the high and low sales price per
share for Shutterflys common stock for the periods
indicated:
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Year Ended December 31, 2006
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High
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Low
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Third Quarter (September 29,
2006 only)
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$
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16.73
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$
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15.01
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Fourth Quarter
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$
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16.29
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$
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12.05
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Purchases
of Equity Securities of the Issuer and Affiliated
Purchasers
Neither we nor any affiliated purchaser repurchased any of our
equity securities in the fourth quarter of fiscal year 2006.
29
Use of
Proceeds
The S-1
relating to our initial public offering was declared effective
by the SEC on September 28, 2006 (Registration Statement
File
No. 333-135426),
and the offering commenced the same day. J.P. Morgan
Securities Inc. acted as the sole book-running manager for the
offering and Piper Jaffray & Co. and
Jefferies & Company, Inc. acted as co-managers of the
offering.
The securities registered were 5,800,000 shares of common
stock, plus 870,000 additional shares to cover the
underwriters over-allotment option. The underwriters
over-allotment option expired on October 28, 2006 and was
not exercised by the underwriters. The aggregate public offering
price of the offering amount registered, including shares to
cover the underwriters over-allotment option, was
$100,050,000. We sold 5,800,000 shares of our common stock
for an aggregate offering price of $87,000,000, and the offering
has terminated.
Expenses incurred in connection with the issuance and
distribution of the securities registered were as follows:
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Underwriting discounts and commissions $6,090,000
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Other expenses $2,442,000
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Total expenses $8,533,000
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None of such payments were direct or indirect payments to any of
our directors or officers or their associates or to persons
owning 10 percent or more of our common stock or direct or
indirect payments to others.
The net offering proceeds to us after deducting
underwriters discounts and the total expenses described
above was approximately $78.5 million.
Through December 31, 2006, 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 $25 million and $29 million
for 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
40% to 50% of this amount to purchase manufacturing equipment
and on improvements to our new and existing manufacturing
facilities, with the remainder to be allocated for the purchase
of website infrastructure equipment. 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.
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
utilization of the 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.
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ITEM 6.
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SELECTED
FINANCIAL DATA.
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The consolidated statements of operations data for the years
ended December 31, 2004, 2005 and 2006 and the consolidated
balance sheet data as of December 31, 2005 and 2006 have
been derived from our audited consolidated financial statements
included elsewhere in this annual report. The consolidated
statements of operations data for the years ended
December 31, 2002 and 2003 and the consolidated balance
sheet data as of December 31, 2002, 2003 and 2004 have been
derived from our audited consolidated financial statements not
included in this annual report. The following selected
consolidated financial data should be read in conjunction with
our Managements Discussion and Analysis of Financial
Condition and Results of Operations and consolidated
financial statements and related notes to those statements
included elsewhere in this annual report.
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Year Ended December 31,
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2006
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2005
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2004
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2003
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2002
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(In thousands, except per share amounts)
|
|
|
Consolidated Statements of
Operations Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenues
|
|
$
|
123,353
|
|
|
$
|
83,902
|
|
|
$
|
54,499
|
|
|
$
|
31,395
|
|
|
$
|
16,009
|
|
Cost of revenues(1)
|
|
|
55,491
|
|
|
|
36,941
|
|
|
|
24,878
|
|
|
|
14,310
|
|
|
|
7,871
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
67,862
|
|
|
|
46,961
|
|
|
|
29,621
|
|
|
|
17,085
|
|
|
|
8,138
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Technology and development(1)
|
|
|
19,087
|
|
|
|
13,152
|
|
|
|
7,433
|
|
|
|
4,970
|
|
|
|
4,039
|
|
Sales and marketing(1)
|
|
|
21,940
|
|
|
|
15,252
|
|
|
|
7,705
|
|
|
|
3,991
|
|
|
|
2,786
|
|
General and administrative(1)
|
|
|
19,216
|
|
|
|
13,657
|
|
|
|
10,126
|
|
|
|
5,629
|
|
|
|
4,421
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expense
|
|
|
60,243
|
|
|
|
42,061
|
|
|
|
25,264
|
|
|
|
14,590
|
|
|
|
11,246
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from operations
|
|
|
7,619
|
|
|
|
4,900
|
|
|
|
4,357
|
|
|
|
2,495
|
|
|
|
(3,108
|
)
|
Interest expense
|
|
|
(266
|
)
|
|
|
(367
|
)
|
|
|
(471
|
)
|
|
|
(392
|
)
|
|
|
(478
|
)
|
Other income (expense) net
|
|
|
2,387
|
|
|
|
(103
|
)
|
|
|
81
|
|
|
|
9
|
|
|
|
12
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income taxes
and cumulative effect of change in accounting principle
|
|
|
9,740
|
|
|
|
4,430
|
|
|
|
3,967
|
|
|
|
2,112
|
|
|
|
(3,574
|
)
|
Benefit (provision) for income
taxes(2)
|
|
|
(3,942
|
)
|
|
|
24,060
|
|
|
|
(258
|
)
|
|
|
(68
|
)
|
|
|
(3
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) before
cumulative effect of change in accounting principle(2)
|
|
|
5,798
|
|
|
|
28,490
|
|
|
|
3,709
|
|
|
|
2,044
|
|
|
|
(3,577
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cumulative effect of change in
accounting principle
|
|
|
|
|
|
|
442
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)(2)
|
|
$
|
5,798
|
|
|
$
|
28,932
|
|
|
$
|
3,709
|
|
|
$
|
2,044
|
|
|
$
|
(3,577
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.67
|
|
|
$
|
1.45
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
(2.55
|
)
|
Diluted
|
|
$
|
0.56
|
|
|
$
|
1.02
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
(2.55
|
)
|
Shares used in computing net
income (loss) per share attributable to common stockholders:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
8,622
|
|
|
|
3,255
|
|
|
|
2,231
|
|
|
|
1,574
|
|
|
|
1,404
|
|
Diluted
|
|
|
10,331
|
|
|
|
4,609
|
|
|
|
2,231
|
|
|
|
1,574
|
|
|
|
1,404
|
|
31
|
|
|
(1) |
|
Includes stock-based compensation as follows: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2003
|
|
|
2002
|
|
|
|
(In thousands)
|
|
|
Cost of revenues
|
|
$
|
96
|
|
|
$
|
28
|
|
|
$
|
21
|
|
|
$
|
3
|
|
|
$
|
|
|
Technology and development
|
|
|
736
|
|
|
|
826
|
|
|
|
263
|
|
|
|
32
|
|
|
|
|
|
Sales and marketing
|
|
|
521
|
|
|
|
239
|
|
|
|
117
|
|
|
|
11
|
|
|
|
|
|
General and administration
|
|
|
947
|
|
|
|
2,217
|
|
|
|
1,790
|
|
|
|
124
|
|
|
|
20
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
2,300
|
|
|
$
|
3,310
|
|
|
$
|
2,191
|
|
|
$
|
170
|
|
|
$
|
20
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(2) |
|
During the fourth quarter of 2005, we concluded that it was more
likely than not that we would be able to realize the benefit of
our deferred tax assets in the future. Consequently, we
recognized a non-cash tax benefit of $24.1 million in the
fourth quarter of 2005 resulting primarily from the release of
the entire net deferred tax valuation allowance. See
Managements Discussion and Analysis of Financial
Condition and Results of Operations Critical
Accounting Policies and Estimates Income Taxes
for a discussion of the uncertainty related to our deferred tax
asset. |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2003
|
|
|
2002
|
|
|
|
(In thousands)
|
|
|
Consolidated Balance Sheets
Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
119,051
|
|
|
$
|
39,153
|
|
|
$
|
13,781
|
|
|
$
|
10,670
|
|
|
$
|
3,658
|
|
Property and equipment, net
|
|
|
30,919
|
|
|
|
20,761
|
|
|
|
11,723
|
|
|
|
5,140
|
|
|
|
3,617
|
|
Working capital
|
|
|
102,165
|
|
|
|
22,687
|
|
|
|
690
|
|
|
|
2,002
|
|
|
|
(1,050
|
)
|
Total assets
|
|
|
180,160
|
|
|
|
89,552
|
|
|
|
29,865
|
|
|
|
17,754
|
|
|
|
8,831
|
|
Capital lease obligations, less
current portion
|
|
|
1,742
|
|
|
|
3,646
|
|
|
|
2,709
|
|
|
|
1,314
|
|
|
|
1,292
|
|
Preferred stock warrant liability
|
|
|
|
|
|
|
1,535
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Redeemable convertible preferred
stock
|
|
|
|
|
|
|
89,652
|
|
|
|
69,822
|
|
|
|
69,668
|
|
|
|
69,230
|
|
Total stockholders equity
(deficit)
|
|
|
151,326
|
|
|
|
(27,262
|
)
|
|
|
(59,568
|
)
|
|
|
(65,333
|
)
|
|
|
(67,752
|
)
|
32
|
|
ITEM 7.
|
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, our capital expenditures for
2007 and 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 I,
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, and we are expecting to also
manufacture these items in a new facility in Charlotte, North
Carolina which is planned to be 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 12×12
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 18 months, we have launched numerous new
products, including canvas prints, keepsake boxes, 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
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
33
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 December 2006, we have
fulfilled more than 14.7 million orders, sold more than
450 million prints and stored between 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, 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.
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 products and services
are differentiated from other traditional photo processors by
our personalized photo-based products and merchandise, which 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 continue to generate net
income, 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. Historically, a substantial majority of
our revenues have been derived in the United States. For each of
the years ended December 31, 2006, 2005, and 2004,
approximately 98% of our revenue came from customers with
billing addresses in the United States.
Our business is subject to seasonal fluctuations. In particular,
we generate a substantial portion of our 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
and, as is typical in the retail industry, 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.
34
To further understand revenue trends, we monitor several key
metrics including:
Average Order Size. Average order size 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 size as a means of increasing net
revenues. Average order size has increased on an annual basis
for each year since 2000, and we anticipate that this trend will
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, which 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 may 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 sales and marketing, research and development and general and
administrative expenses. We anticipate that each of the
following 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.
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
the near to intermediate term as we will
35
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 net income (expense) related to 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 which 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 December 31, 2006, 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, while in
other cases, managements judgment is required in selecting
among available alternative accounting standards that allow
different accounting treatment for similar 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 prints, photo-based
products, such as photo books, cards and calendars, photo-based
merchandise, such as mugs, mouse pads and magnets, and ancillary
products such as frames, photo albums and scrapbooking
accessories. We generally
36
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. 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. The provision
for estimated returns is included in accrued liabilities. During
the year ended December 31, 2006, 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 presented 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. In the event that 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.
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.
37
Results
of Operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Net revenues
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
100
|
%
|
Cost of revenues
|
|
|
45
|
%
|
|
|
44
|
%
|
|
|
46
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
55
|
%
|
|
|
56
|
%
|
|
|
54
|
%
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Technology and development
|
|
|
15
|
%
|
|
|
16
|
%
|
|
|
14
|
%
|
Sales and marketing
|
|
|
18
|
%
|
|
|
18
|
%
|
|
|
14
|
%
|
General and administrative
|
|
|
16
|
%
|
|
|
16
|
%
|
|
|
19
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from operations
|
|
|
6
|
%
|
|
|
6
|
%
|
|
|
7
|
%
|
Interest expense
|
|
|
0
|
%
|
|
|
0
|
%
|
|
|
1
|
%
|
Other income (expense), net
|
|
|
2
|
%
|
|
|
0
|
%
|
|
|
0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes
|
|
|
8
|
%
|
|
|
6
|
%
|
|
|
6
|
%
|
Benefit (provision) for income
taxes
|
|
|
(3
|
)%
|
|
|
29
|
%
|
|
|
0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
5
|
%
|
|
|
35
|
%
|
|
|
6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comparison
of the Years Ended December 31, 2006 and 2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
% Change
|
|
|
|
(In thousands)
|
|
|
|
|
|
Net revenues
|
|
$
|
123,353
|
|
|
$
|
83,902
|
|
|
|
47
|
%
|
Cost of revenues
|
|
|
55,491
|
|
|
|
36,941
|
|
|
|
50
|
%
|
Net revenues increased $39.5 million, or 47%, from 2005 to
2006. Revenue growth was attributable to the increases in both
print and personalized products and services revenues.
Personalized products and services revenues increased
$27.2 million, or 77%, to $62.4 million from 2005 to
2006. Personalized products and services revenues were
positively affected by increased sales of photo books,
calendars, folded greeting cards and photo-based merchandise,
which caused personalized products and services revenues to
increase to 51% of revenues in 2006 from 42% in 2005. Print
revenues increased $12.2 million, or 25%, to
$60.9 million from 2005 to 2006. Print revenues were
positively affected by increased sales volumes of 4x6 prints,
but negatively affected by a decrease in 4x6 print average
selling prices due to competitive pricing pressures. We reduced
the list price of our 4x6 prints by 34% from $0.29 to $0.19 in
the fourth quarter of 2005. Total orders increased 40% to
5,105,000 from 2005 to 2006. Average order size increased 5% to
$24.16 per order from 2005 to 2006, a result of the
increased sales of photo books which have higher prices.
Cost of revenues increased $18.6 million, or 50%, from 2005
to 2006. The cost of revenues increase was driven by the
increased volume of shipped products. Cost of revenues as a
percentage of net revenues increased by 1% from 2005 to 2006.
The increase was the result of the 34% decline in the list 4x6
print prices, partially offset by the favorable impact of lower
paper prices we negotiated in September 2005, lower shipping
costs we negotiated in September 2006, and the reorganization of
our workflows to achieve greater efficiencies which occurred
during the third and fourth quarters of 2005.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
% Change
|
|
|
|
(In thousands)
|
|
|
|
|
|
Technology and development
|
|
$
|
19,087
|
|
|
$
|
13,152
|
|
|
|
45
|
%
|
Sales and marketing
|
|
|
21,940
|
|
|
|
15,252
|
|
|
|
44
|
%
|
General and administrative
|
|
|
19,216
|
|
|
|
13,657
|
|
|
|
41
|
%
|
38
Our technology and development expense increased
$5.9 million, or 45%, from 2005 to 2006. 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
$3.1 million, as well as increased third-party hosting
expenses which increased by $0.6 million. We also continued
to invest in our website infrastructure hardware to support our
continued revenue growth, which resulted in increased
depreciation expense of $1.8 million. In addition,
stock-based compensation expense from employee grants was
$0.7 million in 2006, compared to $0.8 million in 2005.
Our sales and marketing expense increased $6.7 million, or
44%, from 2005 to 2006. For 2006, personnel and related costs
for employees and consultants increased by $1.9 million,
and our expenditures incurred on customer acquisition and
promotion costs increased by $4.6 million. In addition,
stock-based compensation expense from employee grants was
$0.5 million in 2006, compared to $0.2 million in 2005.
Our general and administrative expense increased
$5.6 million, or 41%, from 2005 to 2006. Personnel and
related costs increased by $1.6 million in 2006. While
legal fees decreased by $0.8 million in 2006, accounting
fees increased by $0.8 million. Consulting expenses
increased by $0.8 million, while rent and related
facilities charges increased by $1.0 million for 2006.
Payment processing fees paid to third parties increased by
$1.2 million during 2006 due to increased order volumes. In
September 2006, we made a non-recourse, non-refundable
contribution of 65,000 shares of common stock to Silicon
Valley Community Foundation, a California non profit public
benefit corporation, in order to establish the Shutterfly
Foundation as a corporate-advised charitable fund within the
Community Foundation, and recognized $0.9 million of
charitable contribution expense for 2006. We intend to work with
Silicon Valley Community Foundation to develop a charitable
program dedicated to enhancing communities in the
San Francisco Bay Area and around the world. We had no
charitable contribution expense in 2005 and we do not expect to
make further donations to the Silicon Valley Community
Foundation for the foreseeable future. Stock-based compensation
from employee grants was $0.9 million, in 2006, compared to
$2.2 million in 2005.
Interest expense decreased by $0.1 million, or 28%, for
2006, due primarily to a decrease in interest expense on
capitalized lease obligations.
Other income (expense), net increased by $2.4 million for
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 of common stock and
accordingly, no additional amounts for the change in fair value
for the warrants will be recorded.
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
|
(In thousands)
|
|
|
Income tax benefit (provision)
|
|
$
|
(3,942
|
)
|
|
$
|
24,060
|
|
Effective tax rate
|
|
|
(40
|
)%
|
|
|
494
|
%
|
The provision for income taxes was $3.9 million for 2006,
compared to a benefit of $24.1 million for 2005, due to
changes in our effective tax rate as a result of releasing our
valuation allowance in the fourth quarter of 2005.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
% Change
|
|
|
|
(In thousands)
|
|
|
|
|
|
Income before income taxes and
cumulative effect of change in accounting principle
|
|
$
|
9,740
|
|
|
$
|
4,430
|
|
|
|
120
|
%
|
Net income
|
|
|
5,798
|
|
|
|
28,932
|
|
|
|
(80
|
)%
|
Net income decreased by $23.1 million, or 80%, for 2006 as
compared to 2005. Included in 2005 net income was a
$24.1 million non-cash tax benefit due to releasing our net
deferred tax valuation allowance in the fourth quarter of 2005.
Net income for 2005 also increased by $0.4 million for a
cumulative effect of a change in accounting principle related to
the adoption of FSP
150-5 in
July 2005. We believe that income before income taxes
39
and cumulative effect of change in accounting principle is
relevant and useful information to assist investors in comparing
our performance between 2006 and 2005. Income before income
taxes and cumulative effect of change in accounting principle
increased by $5.3 million, or 120%, from $4.4 million
in 2005 to $9.7 million in 2006. This increase was
primarily attributable to our increased net revenues of
$39.5 million, or 47%, from 2005 to 2006, partially offset
by increased cost of revenues of $18.5 million, or 50%,
increased technology and development expense of
$5.9 million, or 45%, increased sales and marketing expense
of $6.7 million, or 44%, and increased general and
administrative expense of $5.6 million, or 41%, from 2005
to 2006.
Comparison
of the Years Ended December 31, 2005 and 2004
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2005
|
|
|
2004
|
|
|
% Change
|
|
|
|
(In thousands)
|
|
|
|
|
|
Net revenues
|
|
$
|
83,902
|
|
|
$
|
54,499
|
|
|
|
54
|
%
|
Cost of revenues
|
|
|
36,941
|
|
|
|
24,878
|
|
|
|
48
|
%
|
Net revenues increased $29.4 million, or 54%, from 2004 to
2005, attributable to the increase in both personalized products
and services and print revenues. Personalized products and
services revenues increased from $18.9 million in 2004 to
$35.2 million in 2005, an increase of $16.3 million,
or 86%. The revenue growth for personalized products and
services was more than twice the 37% growth in print revenues
and caused personalized products and services revenues to
increase to 42% of revenues in 2005 from 35% in 2004. 2005
represented the first full year of photo book sales, and we also
added photo-based merchandise to our product offering. Print
revenues increased from $35.6 million in 2004 to
$48.7 million in 2005, an increase of $13.1 million or
37%. Print revenues were positively affected by increased
4×6 print sales and negatively affected by a decrease in
4×6 print average selling prices due to competitive pricing
pressures. Total orders increased from 2,618,000 in 2004 to
3,650,000 in 2005, or 39%. The overall growth during the period
was driven by increases in average order sizes. Average order
size increased from approximately $21 per order in 2004 to
$23 per order in 2005.
Cost of revenues increased by $12.1 million, or 48%, from
2004 to 2005, driven by the increased volume of shipped products
during this period. Cost of revenues as a percent of net
revenues decreased by 2% to 44% from 2004 to 2005. This
improvement was driven by labor and production efficiencies
which offset a decline in 4×6 average selling prices.
During the fourth quarter holiday season, we employ a
significant amount of temporary workers through several
temporary staffing agencies, and in 2005, we were able to
negotiate savings in these staffing costs. During 2005, we also
negotiated lower paper prices and reorganized our workflows to
achieve greater efficiencies.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2005
|
|
|
2004
|
|
|
% Change
|
|
|
|
(In thousands)
|
|
|
|
|
|
Technology and development expense
|
|
$
|
13,152
|
|
|
$
|
7,433
|
|
|
|
77
|
%
|
Sales and marketing expense
|
|
|
15,252
|
|
|
|
7,705
|
|
|
|
98
|
%
|
General and administrative expense
|
|
|
13,657
|
|
|
|
10,126
|
|
|
|
35
|
%
|
Our technology and development expense increased
$5.7 million, or 77%, from 2004 to 2005. 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
$2.4 million, as well as increased third-party hosting
expenses which increased by $0.7 million in 2005. We also
continued to invest in our website infrastructure to support our
continued revenue growth, which resulted in increased
depreciation expense of $1.5 million for 2005. In addition,
charges from the amortization of deferred stock-based
compensation from employee grants were $0.3 million in
2004, compared to $0.8 million in 2005.
Our sales and marketing expense increased $7.5 million, or
98%, from 2004 to 2005. Personnel and related costs for
employees and consultants increased by $1.6 million in 2005
and our customer acquisition and promotion costs increased by
$5.7 million in 2005 as we increased our online and offline
advertising, survey and research activities. In addition,
charges from the amortization of deferred stock-based
compensation related to employee grants were $0.1 million
in 2004, compared to $0.2 million in 2005.
40
Our general and administrative expense increased by
$3.5 million, or 35%, from 2004 to 2005. Personnel and
related costs increased by $0.8 million and legal and
accounting costs increased $0.5 million over 2004
expenditures. Recruiting costs increased by $0.5 million
due to increased hiring and depreciation increased
$0.2 million related to our information technology
equipment from 2004 to 2005. In addition, charges from the
amortization of deferred stock-based compensation related to
employee grants were $1.8 million in 2004, compared to
$2.2 million in 2005. Payment processing fees paid to third
parties also increased by $0.9 million in 2005 due to
increased order volumes.
Interest expense decreased by $0.1 million, or 22%, from
2004 to 2005, due to the repayment of a loan from Monaco
Partners, L.P., which is controlled by James Clark, a former
member of our board of directors, in 2004. Interest expense in
2005 also included amounts representing interest expense on
capitalized lease obligations and interest expense and related
loan fees for a term loan entered into and repaid during 2005.
Other income (expense), net decreased by $0.2 million, or
227%, from 2004 to 2005, due to larger invested cash balances
and higher interest rates, offset by $0.5 million of
expense related to changes in the fair value of our redeemable
convertible preferred stock warrants under FSP
150-5.
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2005
|
|
|
2004
|
|
|
|
(In thousands)
|
|
|
Income tax benefit (provision)
|
|
$
|
24,060
|
|
|
$
|
(258
|
)
|
Effective tax rate
|
|
|
494
|
%
|
|
|
7
|
%
|
In 2004, we recorded a provision for income taxes that was
principally attributable to California state taxes and other
minimum corporate taxes. In 2004, we offset our remaining
taxable income through the utilization of net operating loss
carryforwards. In the fourth quarter of 2005, we determined that
it would be more likely than not that the cumulative net
operating losses and other deferred tax benefits would be
recoverable by us, creating a $24.1 million income tax
benefit due to the deferred tax asset recorded on our balance
sheet at the end of 2005.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2005
|
|
|
2004
|
|
|
% Change
|
|
|
|
(In thousands)
|
|
|
|
|
|
Income before income taxes and
cumulative effect of change in accounting principle
|
|
$
|
4,430
|
|
|
$
|
3,967
|
|
|
|
12
|
%
|
Net income
|
|
$
|
28,932
|
|
|
$
|
3,709
|
|
|
|
680
|
%
|
Net income increased by $25.2 million, or 680%, from
$3.7 million in 2004 to $28.9 million in 2005.
Included in 2005 net income was a $24.1 million
non-cash tax benefit due to releasing our net deferred tax
valuation allowance in the fourth quarter of 2005. We expect
that our long-term future effective tax rate will be between 38%
and 45%. Net income for 2005 also increased by $0.4 million
for a cumulative effect of a change in accounting principle
related to the adoption of FSP
150-5 in
July 2005. We believe that income before income taxes and
cumulative effect of change in accounting principle is relevant
and useful information to assist investors in comparing our
performance between 2005 and 2004. Income before income taxes
and cumulative effect of change in accounting principle
increased by $0.5 million, or 12%, from $4.0 million
in 2004 to $4.4 million in 2005. This increase was
primarily attributable to our increased net revenues of
$29.4 million, or 54%, from 2004 to 2005, partially offset
by increased cost of revenue of $12.1 million, or 48%,
increased technology and development expense of
$5.7 million, or 77%, increased sales and marketing expense
of $7.5 million, or 98%, and increased general and
administrative expense of $3.5 million, or 35%, from 2004
to 2005.
41
Liquidity
and Capital Resources
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
|
(In thousands)
|
|
|
Consolidated Statements of Cash
Flows Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital expenditures
|
|
$
|
20,681
|
|
|
$
|
10,858
|
|
|
$
|
7,400
|
|
Depreciation and amortization
|
|
|
10,525
|
|
|
|
6,246
|
|
|
|
3,769
|
|
Cash flows from operating
activities
|
|
|
23,484
|
|
|
|
18,606
|
|
|
|
13,067
|
|
Cash flows from investing
activities
|
|
|
(20,681
|
)
|
|
|
(10,613
|
)
|
|
|
(7,386
|
)
|
Cash flows from financing
activities
|
|
|
77,095
|
|
|
|
17,379
|
|
|
|
(2,570
|
)
|
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
December 31, 2006 we had $119.1 million of cash and
cash equivalents. Cash equivalents are compromised of money
market funds and investment-grade corporate bonds.
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 $25 million to
$29 million for 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 2006, net cash
provided by operating activities was $23.5 million,
primarily due to our net income of $5.8 million and the net
change in operating assets and liabilities of $0.7 million,
adjusted for non-cash items including $10.5 million of
depreciation and amortization expense, $3.2 million of
provision for income taxes, $2.3 million of stock-based
compensation and $0.9 million for charitable contribution
expense related to our
42
September 2006 donation of 65,000 shares to Silicon Valley
Community Foundation. We do not expect to make additional
donations to Silicon Valley Community Foundation in the
foreseeable future.
In 2005, net cash provided from operating activities of
$18.6 million resulted from net income of
$28.9 million that was adjusted for $6.2 million of
depreciation and amortization, $23.8 million of income tax
benefit and $3.3 million of non-cash amortization of
stock-based compensation. In addition, net cash from operating
activities increased due to a $4.1 million increase in
accounts payable and accrued liabilities due to seasonally high
balances at December 31, 2005 related to increased
purchasing for the fourth quarter holiday season. Accounts
payable and accrued liability balances were higher as of
December 31, 2005 compared to as of December 31, 2004
due to higher sales in the 2005 fourth quarter holiday season.
Investing Activities. For 2006, cash used in
investing activities was $20.7 million for capital
expenditures for computer and network hardware to support our
website infrastructure and information technology computer
hardware, capital expenditures for production equipment for our
manufacturing and production operations at our Hayward,
California facilities, and capitalized website development costs
related to projects that were placed into service.
For 2005, net cash used in investing activities was
$10.6 million for capital expenditures for computer and
network hardware to support our website infrastructure and
information technology computer hardware, capital expenditures
for production equipment for our manufacturing and production
operations at our Hayward, California facilities, and
capitalized website development costs related to projects that
were placed into service.
Financing Activities. Our financing activities
for 2006 provided cash of $77.1 million, primarily from
$78.5 million of IPO proceeds, net of underwriters
fees and offering costs, offset by $1.4 million of
capitalized lease obligations.
For 2005, we generated cash of $17.4 million, primarily the
result of receiving net proceeds of $19.8 million from the
sale of our Series F preferred stock in November 2005. This
increase in cash was offset by $2.4 million in principal
payments on capital lease obligations.
Contractual
Obligations
We lease office space in Redwood City, California and production
facilities in Hayward, California under various non-cancelable
operating leases that expire between 2007 and 2010. In December
2005, we entered into a non-cancelable operating lease for a new
production facility in Charlotte, North Carolina, with lease
payments anticipated to commence in the second quarter of 2007
and expire in 2014. We also lease website infrastructure
computer and network hardware, production equipment, information
technology equipment and software under various capital leases
that expire through the year 2009. We also have a colocation
agreement with a third-party hosting facility that expires in
2009. As a result of our growth strategies, we believe that our
liquidity and capital resources requirements will grow in
absolute dollars but will be generally consistent with
historical periods on an annual basis as a percentage of net
revenues. During 2006, all of our capital expenditures were made
in cash. We anticipate leasing additional office space,
production facilities and hosting facilities, consistent with
our historical business model.
The following are contractual commitments at December 31,
2006 associated with lease obligations and contractual
commitments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less Than
|
|
|
|
|
|
|
|
|
More Than
|
|
|
|
Total
|
|
|
1 Year
|
|
|
1-3 Years
|
|
|
3-5 Years
|
|
|
5 Years
|
|
|
|
(In thousands)
|
|
|
Contractual
Obligations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital lease obligations
|
|
$
|
3,942
|
|
|
$
|
2,095
|
|
|
$
|
1,847
|
|
|
$
|
|
|
|
$
|
|
|
Operating lease obligations
|
|
|
9,263
|
|
|
|
1,462
|
|
|
|
3,784
|
|
|
|
2,122
|
|
|
|
1,895
|
|
Purchase obligations(1)
|
|
|
4,006
|
|
|
|
1,996
|
|
|
|
2,010
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total contractual obligations
|
|
$
|
17,211
|
|
|
$
|
5,553
|
|
|
$
|
7,641
|
|
|
$
|
2,122
|
|
|
$
|
1,895
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
43
|
|
|
(1) |
|
Purchase obligations include commitments under non-cancelable
marketing agreements, software patent license agreements and
third-party hosting services. In March 2007, we entered into a
five year non-cancelable agreement for high bandwidth
fiber-optic connectivity between our data centers. The purchase
obligations do not reflect the new fiber-optic connectivity
agreement as it was entered into subsequent to December 31,
2006. As a result of this new agreement, our purchase
obligations in the less than one year category have increased by
$1.6 million. |
Other than the obligations, liabilities and commitments
described above, we have no significant unconditional purchase
obligations or similar instruments. We are not a guarantor of
any other entities debt or other financial 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.
Recent
Accounting Pronouncements
In June 2006, the FASB issued Interpretation No. 48,
Accounting for Uncertainty in Income Taxes
(FIN 48), which prescribes detailed guidance
for the financial statement recognition, measurement and
disclosure of uncertain tax positions recognized in an
enterprises financial statements in accordance with FASB
Statement No. 109, Accounting for Income Taxes.
Tax positions must meet a more-likely-than-not recognition
threshold at the effective date to be recognized upon the
adoption of FIN 48 and in subsequent periods. FIN 48
will be effective for fiscal years beginning after
December 15, 2006, and the provisions of FIN 48 will
be applied to all tax positions accounted for under Statement
No. 109 upon initial adoption. The cumulative effect of
applying the provisions of this interpretation will be reported
as an adjustment to the opening balance of retained earnings for
that fiscal year. The Company does not believe the adoption of
FIN 48 will have a material impact on its financial
position and results of operations.
In September 2006, the Securities and Exchange Commission
(SEC) issued Staff Accounting Bulletin
(SAB) No. 108, Considering the Effects of
Prior Year Misstatements when Quantifying Misstatements in
Current Year Financial Statements. SAB 108 provides
guidance on the consideration of effects of the prior year
misstatements in quantifying current year misstatements for the
purpose of a materiality assessment. The SEC staff believes
registrants must quantify errors using both a balance sheet and
income statement approach and evaluate whether either approach
results in quantifying a misstatement that, when all relevant
quantitative and qualitative factors are considered, is
material. SAB 108 is effective for the first annual period
ending after November 15, 2006 with early application
encouraged. SAB 108 did not have a material impact on the
Companys financial position, results of operations and
cash flows.
In September 2006, the FASB issued FAS No. 157,
Fair Value Measurements (FAS 157).
FAS 157 defines fair value, establishes a framework for
measuring fair value and expands disclosures about fair value
measurements. FAS 157 is effective for the Company as of
January 1, 2008. The Company is currently evaluating the
impact, if any, of FAS 157 on its consolidated financial
statements.
In February 2007, the FASB issued FAS No. 159,
The Fair Value Option for Financial Assets and Financial
Liabilities (FAS 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 on January 1, 2008. The Company
is currently evaluating the impact, if any, of adopting
SFAS 159 on its financial position and results of
operations.
44
|
|
ITEM 7A.
|
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 cost, which
approximates market 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 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.
45
|
|
ITEM 8.
|
FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA.
|
SHUTTERFLY,
INC.
INDEX TO
CONSOLIDATED FINANCIAL STATEMENTS
46
REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Shutterfly, Inc.
In our opinion, the accompanying consolidated balance sheets and
the related consolidated statements of operations, of redeemable
convertible preferred stock and stockholders equity
(deficit) and of cash flows present fairly, in all material
respects, the financial position of Shutterfly, Inc. and its
subsidiary (the Company) at December 31, 2006
and 2005, and the results of their operations and their cash
flows for each of the three years in the period ended
December 31, 2006 in conformity with accounting principles
generally accepted in the United States of America. These
financial statements are the responsibility of the
Companys management. Our responsibility is to express an
opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with the
standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant
estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
As discussed in Note 2 to the consolidated financial
statements, effective January 1, 2006, the Company changed
its method of accounting for stock-based compensation.
/s/ PricewaterhouseCoopers
LLP
San Jose, California
March 16, 2007
47
SHUTTERFLY,
INC.
(In thousands, except per share amounts)
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
ASSETS
|
Current assets:
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
119,051
|
|
|
$
|
39,153
|
|
Accounts receivable, net of
allowance $- and $21 at December 31, 2006 and 2005
|
|
|
2,164
|
|
|
|
949
|
|
Inventories
|
|
|
2,493
|
|
|
|
1,077
|
|
Deferred tax asset, current portion
|
|
|
2,129
|
|
|
|
1,408
|
|
Prepaid expenses and other current
assets
|
|
|
2,760
|
|
|
|
1,558
|
|
|
|
|
|
|
|
|
|
|
Total current assets
|
|
|
128,597
|
|
|
|
44,145
|
|
Property and equipment, net
|
|
|
30,919
|
|
|
|
20,761
|
|
Intangible assets, net
|
|
|
1,396
|
|
|
|
1,618
|
|
Deferred tax asset, net of current
portion
|
|
|
18,754
|
|
|
|
22,655
|
|
Other assets
|
|
|
494
|
|
|
|
373
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
180,160
|
|
|
$
|
89,552
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES, REDEEMABLE
CONVERTIBLE PREFERRED STOCK AND
STOCKHOLDERS EQUITY (DEFICIT)
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
9,385
|
|
|
$
|
3,871
|
|
Accrued liabilities
|
|
|
8,808
|
|
|
|
11,520
|
|
Deferred revenue
|
|
|
6,278
|
|
|
|
4,564
|
|
Current portion of capital lease
obligations
|
|
|
1,961
|
|
|
|
1,503
|
|
|
|
|
|
|
|
|
|
|
Total current liabilities
|
|
|
26,432
|
|
|
|
21,458
|
|
Other liabilities
|
|
|
660
|
|
|
|
523
|
|
Capital lease obligations, less
current portion
|
|
|
1,742
|
|
|
|
3,646
|
|
Preferred stock warrant liability
|
|
|
|
|
|
|
1,535
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
28,834
|
|
|
|
27,162
|
|
Commitments and contingencies
(Note 6)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Redeemable convertible preferred
stock, $0.0001 par value; no shares authorized at
December 31, 2006; 15,454 shares authorized at
December 31, 2005; no shares issued and outstanding at
December 31, 2006; 13,802 shares issued and
outstanding at December 31, 2005
|
|
|
|
|
|
|
89,652
|
|
|
|
|
|
|
|
|
|
|
Stockholders equity (deficit)
|
|
|
|
|
|
|
|
|
Undesignated preferred stock,
$0.0001 par value; 5,000 shares authorized at
December 31, 2006; no shares authorized at
December 31, 2005; no shares issued and outstanding
|
|
|
|
|
|
|
|
|
Common stock, $0.0001 par
value; 100,000 and 38,251 shares authorized at
|
|
|
|
|
|
|
|
|
December 31, 2006 and 2005,
respectively; 23,705 and 3,790 shares issued and
outstanding at December 31, 2006 and December 31,
2005, respectively
|
|
|
2
|
|
|
|
|
|
Additional paid-in capital
|
|
|
181,890
|
|
|
|
10,501
|
|
Accumulated other comprehensive
loss
|
|
|
(35
|
)
|
|
|
|
|
Deferred stock-based compensation
|
|
|
(191
|
)
|
|
|
(1,625
|
)
|
Accumulated deficit
|
|
|
(30,340
|
)
|
|
|
(36,138
|
)
|
|
|
|
|
|
|
|
|
|
Total stockholders equity
(deficit)
|
|
|
151,326
|
|
|
|
(27,262
|
)
|
|
|
|
|
|
|
|
|
|
Total liabilities, redeemable
convertible preferred stock and stockholders equity
(deficit)
|
|
$
|
180,160
|
|
|
$
|
89,552
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
48
SHUTTERFLY,
INC.
(In thousands, except per share amounts)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Net revenues
|
|
$
|
123,353
|
|
|
$
|
83,902
|
|
|
$
|
54,499
|
|
Cost of revenues(1)
|
|
|
55,491
|
|
|
|
36,941
|
|
|
|
24,878
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
67,862
|
|
|
|
46,961
|
|
|
|
29,621
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses(1):
|
|
|
|
|
|
|
|
|
|
|
|
|
Technology and development
|
|
|
19,087
|
|
|
|
13,152
|
|
|
|
7,433
|
|
Sales and marketing
|
|
|
21,940
|
|
|
|
15,252
|
|
|
|
7,705
|
|
General and administrative
|
|
|
19,216
|
|
|
|
13,657
|
|
|
|
10,126
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
60,243
|
|
|
|
42,061
|
|
|
|
25,264
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from operations
|
|
|
7,619
|
|
|
|
4,900
|
|
|
|
4,357
|
|
Interest expense
|
|
|
(266
|
)
|
|
|
(367
|
)
|
|
|
(471
|
)
|
Other income (expense), net
|
|
|
2,387
|
|
|
|
(103
|
)
|
|
|
81
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes and
cumulative effect of change in accounting principle
|
|
|
9,740
|
|
|
|
4,430
|
|
|
|
3,967
|
|
Benefit (provision) for income
taxes
|
|
|
(3,942
|
)
|
|
|
24,060
|
|
|
|
(258
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income before cumulative
effect of change in accounting principle
|
|
|
5,798
|
|
|
|
28,490
|
|
|
|
3,709
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cumulative effect of change in
accounting principle
|
|
|
|
|
|
|
442
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
5,798
|
|
|
$
|
28,932
|
|
|
$
|
3,709
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per share
basic and diluted:
|
|
|
|
|
|
|
|
|
|
|
|
|
Before cumulative effect of change
in accounting principle
|
|
$
|
0.67
|
|
|
$
|
1.31
|
|
|
$
|
|
|
Cumulative effect of change in
accounting principle
|
|
|
|
|
|
|
0.14
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per share
basic
|
|
$
|
0.67
|
|
|
$
|
1.45
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per share
diluted
|
|
$
|
0.56
|
|
|
$
|
1.02
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares
outstanding used in calculating net income per common share:
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
8,622
|
|
|
|
3,255
|
|
|
|
2,231
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
|
10,331
|
|
|
|
4,609
|
|
|
|
2,231
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) Stock-based compensation
is allocated as follows (Notes 2 and 8):
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of revenues
|
|
$
|
96
|
|
|
$
|
28
|
|
|
$
|
21
|
|
Technology and development
|
|
|
736
|
|
|
|
826
|
|
|
|
263
|
|
Sales and marketing
|
|
|
521
|
|
|
|
239
|
|
|
|
117
|
|
General and administrative
|
|
|
947
|
|
|
|
2,217
|
|
|
|
1,790
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
49
SHUTTERFLY,
INC.
STOCKHOLDERS
EQUITY (DEFICIT)
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
Total
|
|
|
|
Redeemable Convertible
|
|
|
|
|
|
|
|
|
|
Additional
|
|
|
Deferred
|
|
|
Accu-
|
|
|
Other
|
|
|
Stockholders
|
|
|
|
Preferred Stock
|
|
|
|
Common Stock
|
|
|
Paid-In
|
|
|
Stock-Based
|
|
|
mulated
|
|
|
Comprehensive
|
|
|
Equity
|
|
|
|
Shares
|
|
|
Amount
|
|
|
|
Shares
|
|
|
Amount
|
|
|
Capital
|
|
|
Compensation
|
|
|
Deficit
|
|
|
Loss
|
|
|
(Deficit)
|
|
Balances, December 31, 2003
|
|
|
12,198
|
|
|
$
|
69,668
|
|
|
|
|
1,902
|
|
|
$
|
|
|
|
$
|
3,844
|
|
|
$
|
(398
|
)
|
|
$
|
(68,779
|
)
|
|
$
|
|
|
|
$
|
(65,333
|
)
|
Issuance of common stock upon
exercise of options, net of repurchases
|
|
|
|
|
|
|
|
|
|
|
|
925
|
|
|
|
|
|
|
|
217
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
217
|
|
Issuance of convertible preferred
stock upon exercise of warrants
|
|
|
250
|
|
|
|
154
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred stock-based compensation,
net of cancellations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,444
|
|
|
|
(3,444
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization of deferred
stock-based compensation, net of cancellations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
858
|
|
|
|
|
|
|
|
|
|
|
|
858
|
|
Stock-based compensation expense in
connection with option modifications
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
981
|
|
|
|
|
|
|
|
|
|
|
|
981
|
|
Comprehensive income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,709
|
|
|
|
|
|
|
|
3,709
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,709
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances, December 31, 2004
|
|
|
12,448
|
|
|
$
|
69,822
|
|
|
|
|
2,827
|
|
|
$
|
|
|
|
$
|
7,505
|
|
|
$
|
(2,003
|
)
|
|
$
|
(65,070
|
)
|
|
$
|
|
|
|
$
|
(59,568
|
)
|
Issuance of common stock upon
exercise of options, net of repurchases
|
|
|
|
|
|
|
|
|
|
|
|
750
|
|
|
|
|
|
|
|
205
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
205
|
|
Issuance of Series F preferred
stock, net of issuance cost of $131
|
|
|
1,354
|
|
|
|
19,830
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock-based compensation expense in
connection with option modifications
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,100
|
|
|
|
|
|
|
|
|
|
|
|
1,100
|
|
Shares issued in connection with a
settlement agreement with a former employee
|
|
|
|
|
|
|
|
|
|
|
|
65
|
|
|
|
|
|
|
|
352
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
352
|
|
Vested shares issued upon
acquisition
|
|
|
|
|
|
|
|
|
|
|
|
109
|
|
|
|
|
|
|
|
656
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
656
|
|
Restricted shares issued upon
acquisition
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
671
|
|
|
|
(671
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Vesting of restricted shares
|
|
|
|
|
|
|
|
|
|
|
|
39
|
|
|
|
|
|
|
|
|
|
|
|
500
|
|
|
|
|
|
|
|
|
|
|
|
500
|
|
Deferred stock-based compensation,
net of cancellations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,261
|
|
|
|
(2,261
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Tax benefit of stock options
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
365
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
365
|
|
Amortization of deferred
stock-based compensation, net of cancellations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,710
|
|
|
|
|
|
|
|
|
|
|
|
1,710
|
|
Reclassification of preferred stock
warrants to liability
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,514
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,514
|
)
|
Comprehensive income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
28,932
|
|
|
|
|
|
|
|
28,932
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
28,932
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances, December 31, 2005
|
|
|
13,802
|
|
|
$
|
89,652
|
|
|
|
|
3,790
|
|
|
$
|
|
|
|
$
|
10,501
|
|
|
$
|
(1,625
|
)
|
|
$
|
(36,138
|
)
|
|
$
|
|
|
|
$
|
(27,262
|
)
|
50
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
Total
|
|
|
|
Redeemable Convertible
|
|
|
|
|
|
|
|
|
|
Additional
|
|
|
Deferred
|
|
|
Accu-
|
|
|
Other
|
|
|
Stockholders
|
|
|
|
Preferred Stock
|
|
|
|
Common Stock
|
|
|
Paid-In
|
|
|
Stock-Based
|
|
|
mulated
|
|
|
Comprehensive
|
|
|
Equity
|
|
|
|
Shares
|
|
|
Amount
|
|
|
|
Shares
|
|
|
Amount
|
|
|
Capital
|
|
|
Compensation
|
|
|
Deficit
|
|
|
Loss
|
|
|
(Deficit)
|
|
Balances, December 31, 2005
|
|
|
13,802
|
|
|
$
|
89,652
|
|
|
|
|
3,790
|
|
|
$
|
|
|
|
$
|
10,501
|
|
|
$
|
(1,625
|
)
|
|
$
|
(36,138
|
)
|
|
$
|
|
|
|
$
|
(27,262
|
)
|
Issuance of common stock upon
exercise of options, net of repurchases
|
|
|
|
|
|
|
|
|
|
|
|
127
|
|
|
|
|
|
|
|
101
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
101
|
|
Issuance of common stock upon
effective date of initial public offering (IPO), net
of underwriting fees of $6,090 and other expenses of $2,442
|
|
|
|
|
|
|
|
|
|
|
|
5,800
|
|
|
|
1
|
|
|
|
78,467
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
78,468
|
|
Automatic conversion of preferred
stock to common stock upon effective date of IPO
|
|
|
(13,863
|
)
|
|
|
(89,795
|
)
|
|
|
|
13,863
|
|
|
|
1
|
|
|
|
89,794
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
89,795
|
|
Transfer of preferred stock warrant
liability upon conversion of preferred stock warrants into
common stock warrants
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
510
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
510
|
|
Issuance of Series A preferred
stock upon net exercise of warrants
|
|
|
61
|
|
|
|
143
|
|
|
|
|
|
|
|
|
|
|
|
|
(143
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(143
|
)
|
Transfer of preferred stock warrant
liability related to Series A preferred stock
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
871
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
871
|
|
Reversal of unearned stock based
compensation upon modification of options
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(526
|
)
|
|
|
526
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vesting of restricted shares
|
|
|
|
|
|
|
|
|
|
|
|
60
|
|
|
|
|
|
|
|
|
|
|
|
94
|
|
|
|
|
|
|
|
|
|
|
|
94
|
|
Cancellation of common stock
options and restricted shares
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(249
|
)
|
|
|
249
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization of deferred
stock-based compensation, net of cancellations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
565
|
|
|
|
|
|
|
|
|
|
|
|
565
|
|
Employees stock-based compensation
expense recognized under SFAS No. 123R, net of
estimated forfeiture
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,641
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,641
|
|
Donation of common stock to a
charitable foundation
|
|
|
|
|
|
|
|
|
|
|
|
65
|
|
|
|
|
|
|
|
923
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
923
|
|
Comprehensive income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in unrealized loss in
investments, net of tax
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(35
|
)
|
|
|
(35
|
)
|
Net income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,798
|
|
|
|
|
|
|
|
5,798
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,763
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances, December 31, 2006
|
|
|
|
|
|
|
|
|
|
|
|
23,705
|
|
|
$
|
2
|
|
|
$
|
181,890
|
|
|
$
|
(191
|
)
|
|
$
|
(30,340
|
)
|
|
$
|
(35
|
)
|
|
$
|
151,326
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
51
SHUTTERFLY,
INC.
(In
thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Cash flows from operating
activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
5,798
|
|
|
$
|
28,932
|
|
|
$
|
3,709
|
|
Adjustments to reconcile net income
to net cash provided by operating activities
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
10,525
|
|
|
|
6,246
|
|
|
|
3,769
|
|
Amortization of intangible assets
|
|
|
222
|
|
|
|
276
|
|
|
|
379
|
|
Amortization of deferred
stock-based compensation, net of cancellations
|
|
|
2,300
|
|
|
|
3,310
|
|
|
|
2,191
|
|
Charitable contribution expense for
shares issued to charitable foundation
|
|
|
923
|
|
|
|
|
|
|
|
|
|
Amortization of preferred stock
warrants
|
|
|
|
|
|
|
|
|
|
|
83
|
|
Change in carrying value of
preferred stock warrant liability
|
|
|
(152
|
)
|
|
|
21
|
|
|
|
|
|
Loss/(gain) on disposal of property
and equipment
|
|
|
(29
|
)
|
|
|
207
|
|
|
|
26
|
|
Deferred income taxes
|
|
|
3,199
|
|
|
|
(23,833
|
)
|
|
|
|
|
Changes in operating assets and
liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
Inventories
|
|
|
(1,419
|
)
|
|
|
(253
|
)
|
|
|
(397
|
)
|
Accounts receivable, net
|
|
|
(1,215
|
)
|
|
|
(547
|
)
|
|
|
100
|
|
Prepaid expenses and other current
assets
|
|
|
(1,171
|
)
|
|
|
(398
|
)
|
|
|
(536
|
)
|
Other assets
|
|
|
(121
|
)
|
|
|
(40
|
)
|
|
|
36
|
|
Accounts payable
|
|
|
5,514
|
|
|
|
(434
|
)
|
|
|
828
|
|
Accrued and other liabilities
|
|
|
(2,603
|
)
|
|
|
4,550
|
|
|
|
1,731
|
|
Deferred revenue
|
|
|
1,714
|
|
|
|
569
|
|
|
|
1,148
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating
activities
|
|
|
23,485
|
|
|
|
18,606
|
|
|
|
13,067
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from investing
activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchases of property and equipment
|
|
|
(20,681
|
)
|
|
|
(10,858
|
)
|
|
|
(7,400
|
)
|
Cash acquired from acquisition of
business
|
|
|
|
|
|
|
239
|
|
|
|
|
|
Proceeds from sale of property and
equipment
|
|
|
|
|
|
|
6
|
|
|
|
14
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in investing
activities
|
|
|
(20,681
|
)
|
|
|
(10,613
|
)
|
|
|
(7,386
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from financing
activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Proceeds from IPO shares issued,
net of issuance costs
|
|
|
78,468
|
|
|
|
|
|
|
|
|
|
Principal payments of capital lease
obligations
|
|
|
(1,446
|
)
|
|
|
(2,379
|
)
|
|
|
(540
|
)
|
Repayment of loan from a related
party
|
|
|
|
|
|
|
|
|
|
|
(2,500
|
)
|
Proceeds from term loan
|
|
|
|
|
|
|
2,571
|
|
|
|
|
|
Repayment of term loan
|
|
|
|
|
|
|
(2,571
|
)
|
|
|
|
|
Principal payment of note payable
obligation
|
|
|
|
|
|
|
(192
|
)
|
|
|
|
|
Proceeds from issuance of
redeemable convertible preferred stock, net of issuance costs
|
|
|
|
|
|
|
19,830
|
|
|
|
154
|
|
Proceeds from issuance of common
stock upon exercise of stock options
|
|
|
83
|
|
|
|
134
|
|
|
|
316
|
|
Repurchases of common stock
|
|
|
(11
|
)
|
|
|
(14
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in)
financing activities
|
|
|
77,094
|
|
|
|
17,379
|
|
|
|
(2,570
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net increase in cash and cash
equivalents
|
|
|
79,898
|
|
|
|
25,372
|
|
|
|
3,111
|
|
Cash and cash equivalents,
beginning of period
|
|
|
39,153
|
|
|
|
13,781
|
|
|
|
10,670
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents, end of
period
|
|
$
|
119,051
|
|
|
$
|
39,153
|
|
|
$
|
13,781
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental disclosures of cash
flow information
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash paid during the period for
interest
|
|
$
|
205
|
|
|
$
|
410
|
|
|
$
|
490
|
|
Cash paid during the period for
income taxes
|
|
|
|
|
|
|
70
|
|
|
|
152
|
|
Supplemental schedule of
non-cash investing and financing
activities
|
|
|
|
|
|
|
|
|
|
|
|
|
Additions to property and equipment
acquired under capital lease obligations and notes payable
|
|
|
|
|
|
|
3,516
|
|
|
|
2,992
|
|
Net non-cash assets acquired upon
acquisition
|
|
|
|
|
|
|
551
|
|
|
|
|
|
Vested shares issued upon
acquisition
|
|
|
|
|
|
|
656
|
|
|
|
|
|
Restricted shares issued upon
acquisition
|
|
|
|
|
|
|
724
|
|
|
|
|
|
Reclassification of preferred stock
warrants to liability
|
|
|
|
|
|
|
1,514
|
|
|
|
|
|
Deferred stock-based compensation,
net of cancellations
|
|
|
|
|
|
|
1,225
|
|
|
|
2,299
|
|
Deferred stock-based compensation
in connection with option modifications
|
|
|
|
|
|
|
1,100
|
|
|
|
1,145
|
|
Tax benefit of stock options
recorded in additional paid-in capital
|
|
|
|
|
|
|
365
|
|
|
|
|
|
Conversion of preferred stock
|
|
|
89,795
|
|
|
|
|
|
|
|
|
|
Conversion of preferred stock
warrant liability into APIC
|
|
|
1,381
|
|
|
|
|
|
|
|
|
|
Preferred stock warrants exercised
on net basis
|
|
|
143
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
52
SHUTTERFLY,
INC.
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(In
thousands, except per share amounts)
|
|
Note 1
|
Formation
and Business of the Company
|
Shutterfly, Inc., (the Company) was incorporated in
the state of Delaware in 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 $6.1 million 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.
|
|
Note 2
|
Summary
of Significant Accounting Policies
|
Principles
of Consolidation
The accompanying consolidated financial statements include the
accounts of the Company and its wholly owned subsidiary acquired
in 2005 (see Note 5). 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.
Cash,
Cash Equivalents and Marketable Securities
The Company considers all highly liquid investments purchased
with original maturities (at the date of purchase) of three
months or less to be cash equivalents. Cash equivalents consist
principally of money market funds and commercial paper.
Management determines the appropriate classification of cash
equivalents at the time of purchase and reevaluates such
designations at each balance sheet date.
At December 31, 2006 all investments are classified as
available-for-sale.
Available-for-sale
securities are carried at fair value, with the unrealized gains
and losses, net of tax reported in a separate component of
accumulated other comprehensive income (loss) in
shareholders equity (deficit). Realized gains and losses
and declines in value judged to be
other-than-temporary
on
available-for-sale
securities are reported in other income (expense), net. The cost
of securities sold is based on the specific identification
method. Interest on securities classified as
available-for-sale
is included as a component of other income (expense), net.
The fair value of cash equivalents amounted to $109,897 and
$22,122 at December 31, 2006 and 2005, respectively. At
December 31, 2006, the Company had $35 of unrealized
losses, net of tax.
53
SHUTTERFLY,
INC.
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(In
thousands, except per share
amounts) (Continued)
Fair
Value of Financial Instruments
The carrying amount of certain of the Companys financial
instruments, including accounts receivable and accounts payable,
are carried at cost, which approximates their fair value because
of their short-term maturities. Based on borrowing rates
available to the Company for loans with similar terms, the
carrying value of borrowings, including capital lease
obligations, approximates fair value.
Concentration
of Credit Risk
Financial instruments that potentially subject the Company to
credit risk consist principally of cash, cash equivalents and
accounts receivable. Most of the Companys cash and cash
equivalents as of December 31, 2006 were deposited with
financial institutions in the United States and Company policy
restricts the amount of credit exposure to any one issuer and to
any one type of investment. Deposits held with financial
institutions may exceed federally insured limits.
The Companys accounts receivable are derived primarily
from sales to customers located in the United States who make
payments through credit cards. Credit card receivables settle
relatively quickly. The Company maintains allowances for
potential credit losses on customer accounts when deemed
necessary. To date, such losses have not been material and have
been within managements expectations. As of
December 31, 2006, one customer accounted for 14% of the
Companys net accounts receivable and as of
December 31, 2005, another customer accounted for 18% of
the Companys net accounts receivable.
Inventories
Inventories 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 estimates 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. Inventories are primarily raw
materials and consist principally of paper, photo book covers
and packaging supplies.
Property
and Equipment
Property and equipment, including equipment under capital
leases, are stated at historical cost, less accumulated
depreciation and amortization. Depreciation and amortization are
computed using the straight-line method over the estimated lives
of the assets, generally three to five years. Amortization of
equipment acquired under capital lease obligations is computed
using the straight-line method over the shorter of the remaining
lease term or the estimated useful life of the related assets,
generally three to four years. Leasehold improvements are
amortized over their estimated useful lives, or the lease term
if shorter, generally three to five years. Upon retirement or
sale, the cost and related accumulated depreciation are removed
from the balance sheet and the resulting gain or loss is
reflected in operating expenses. Major additions and
improvements are capitalized, while replacements, maintenance
and repairs that do not extend the life of the asset are charged
to expense as incurred.
Website
Development Costs
The Company capitalizes eligible costs associated with software
developed or obtained for internal use in accordance with AICPA
Statement of Position
98-1,
Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use, and EITF
00-02,
Accounting for Web Site Development Costs. Accordingly,
the Company expenses all costs that relate to the planning and
post implementation phases. Costs incurred in the development
phase are capitalized and amortized over the products
estimated useful life. The Company has capitalized website
development costs incurred in the application development phase
and unamortized cost is included in property and equipment and
totaled approximately $2,582 and $2,187 at December 31,
2006 and 2005,
54
SHUTTERFLY,
INC.
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(In
thousands, except per share
amounts) (Continued)
respectively. Capitalized costs are amortized over the useful
life, which is generally three years. Amortization of
capitalized costs totaled approximately $993, $404 and $204 for
the years ended December 31, 2006, 2005 and 2004,
respectively. Costs associated with minor enhancements and
maintenance for the Companys website are expensed as
incurred.
Long-Lived
Assets
The Company reviews long-lived assets for impairment whenever
events or changes in circumstances indicate that the carrying
amount of an asset may not be recoverable in accordance with
Statement of Financial Accounting Standards No. 144,
Accounting for the Impairment or Disposal of Long-Lived
Assets (SFAS No. 144). Recoverability
is measured by comparison of the carrying amount to the future
net cash flows which the assets are expected to generate. If
such assets are considered to be impaired, the impairment to be
recognized is measured by the amount by which the carrying
amount of the assets exceeds the projected discounted future
cash flows arising from the asset using a discount rate
determined by management to be commensurate with the risk
inherent to the Companys current business model.
Intangible
Assets
The Company accounts for intangible assets in accordance with
Statement of Financial Accounting Standards No. 142,
Goodwill and Other Intangible Assets
(SFAS No. 142). Goodwill and intangible
assets with indefinite lives are not amortized but are tested
for impairment on an annual basis or whenever events or changes
in circumstances indicate that the carrying amount of these
assets may not be recoverable. Intangible assets with finite
useful lives are amortized using the straight-line method over
their useful lives and are reviewed for impairment in accordance
with SFAS No. 144.
In May 2005, the Company entered into a settlement and license
agreement (the Agreement) to resolve litigation
brought by a third party with respect to alleged infringement of
certain processes under U.S. patents. Under the terms of
the Agreement, the Company agreed to pay a total of $2,000,
$1,000 of which was paid in 2005, and the remaining $1,000 was
paid in January 2006. The Agreement provides the Company with a
license to the third partys patents, including a non-
exclusive, fully
paid-up,
royalty-free, worldwide license to the patents underlying the
litigation. In conjunction with the agreement, the third party
and the Company agreed to a mutual release of claims, the
Company agreed to pay $2,000, of which $379 was recorded as a
settlement expense in 2004 for the alleged patent infringement
that occurred during 2002 through 2004 and the remaining $1,621
was recorded as an intangible asset. The intangible asset is
amortized ratably over its estimated life through 2017, the
expiration dates of the
patents-in-suit.
The Company recorded amortization expense of $126 and $126, in
2006 and 2005, respectively.
Intangible assets related to acquired workforce were amortized
on a straight-line basis over the estimated useful life of one
year (Note 5).
Freestanding
Preferred Stock Warrants
Freestanding warrants and other similar instruments related to
shares that are redeemable are accounted for in accordance with
Statement of Financial Accounting Standards No. 150,
Accounting for Certain Financial Instruments with
Characteristics of Both Liabilities and Equity
(SFAS No. 150). Under
SFAS No. 150, the freestanding warrants that were
related to the Companys redeemable convertible preferred
stock were recorded as liabilities on the consolidated balance
sheet. The warrants were subject to re-measurement at each
balance sheet date and any change in fair value was recognized
as a component of other income (expense), net. Subsequent to the
Companys IPO and the associated conversion of the
Companys outstanding redeemable convertible preferred
stock to common stock, the warrants to exercise the redeemable
convertible preferred stock converted into common stock
warrants; accordingly, the liability related to the redeemable
convertible preferred stock warrants was
55
SHUTTERFLY,
INC.
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(In
thousands, except per share
amounts) (Continued)
transferred to common stock and additional
paid-in-capital
and the common stock warrants are no longer subject to
re-measurement.
Revenue
Recognition
The Company generally recognizes revenue from product sales upon
shipment when persuasive evidence of an arrangement exists, 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 provides its customers with a 100% satisfaction
guarantee whereby products can be returned within a
30-day
period for a reprint or refund. The Company maintains an
allowance for estimated future returns based on historical data.
The provision for estimated returns is included in accrued
liabilities. During the years ended December 31, 2006, 2005
and 2004, returns totaled less than 1% of net revenues and have
been within managements expectations.
The Company periodically provides incentive offers to its
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 presented in net revenues.
Production costs related to free products are included in cost
of revenues upon redemption.
Shipping charged to customers is recognized as revenue.
Cost
of Revenues
Cost of revenues consist primarily of direct materials, the
majority of which consists of paper, 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.
Technology
and Development Expense
Technology and development expense consists primarily of payroll
and related expenses for the development and ongoing maintenance
of the Companys website, infrastructure and software.
These expenses include depreciation of the computer and network
hardware used to run the Companys website and store the
customer data that the Company maintains, as well as
amortization of purchased software. Technology and development
expense also includes colocation and bandwidth costs. Technology
and development costs are charged to operations as incurred.
Sales
and Marketing Expense
Sales and marketing expense consists of costs incurred for
marketing programs and personnel and related expenses for
customer acquisition, product marketing, business development
and public relations activities. The Companys 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. Fees paid to third parties who
drive new customers to our website are charged to expense as
incurred.
56
SHUTTERFLY,
INC.
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(In
thousands, except per share
amounts) (Continued)
Advertising costs are expensed as incurred. Such costs are
included in selling and marketing expenses and totaled
approximately $5,710, $4,878 and $2,361 during the years ended
December 31, 2006, 2005 and 2004, respectively.
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 Abstract
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, 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 has
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.
57
SHUTTERFLY,
INC.
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(In
thousands, except per share
amounts) (Continued)
Net
Income (Loss) Per Share
Basic net income (loss) per share attributed to common shares is
computed by dividing the net income (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. Net income (loss) available to common stockholders
is calculated using the two class method as the net income
(loss) less preferred stock dividends for the period and amounts
allocated to preferred stock to reflect the rights of the
preferred stock to receive dividends in preference to common
stock.
Diluted net income (loss) per share attributed to common shares
is computed by dividing the net income (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 and upon conversion of preferred
stock.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Historical net income per
share:
|
|
|
|
|
|
|
|
|
|
|
|
|
Numerator
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income before cumulative
effect of change in accounting principle
|
|
$
|
5,798
|
|
|
$
|
28,490
|
|
|
$
|
3,709
|
|
Cumulative effect of change in
accounting principle
|
|
|
|
|
|
|
442
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
5,798
|
|
|
|
28,932
|
|
|
|
3,709
|
|
Income allocable to preferred
stockholders
|
|
|
|
|
|
|
(24,212
|
)
|
|
|
(3,709
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income allocable to common
stockholders
|
|
$
|
5,798
|
|
|
$
|
4,720
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average common shares
outstanding
|
|
|
8,729
|
|
|
|
3,619
|
|
|
|
2,904
|
|
Less: Weighted-average unvested
common shares subject to repurchase
|
|
|
(107
|
)
|
|
|
(364
|
)
|
|
|
(673
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator for basic net income
per share
|
|
|
8,622
|
|
|
|
3,255
|
|
|
|
2,231
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dilutive effect of stock options
and shares subject to repurchase
|
|
|
1,709
|
|
|
|
1,307
|
|
|
|
|
|
Dilutive effect of outstanding
preferred stock warrants
|
|
|
|
|
|
|
47
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator for diluted net income
per share
|
|
|
10,331
|
|
|
|
4,609
|
|
|
|
2,231
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per share
basic and diluted
|
|
|
|
|
|
|
|
|
|
|
|
|
Before cumulative effect of
change in accounting principle
|
|
$
|
0.67
|
|
|
$
|
1.31
|
|
|
$
|
|
|
Cumulative effect of change in
accounting principle
|
|
|
|
|
|
|
0.14
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per share
basic
|
|
$
|
0.67
|
|
|
$
|
1.45
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per share
diluted
|
|
$
|
0.56
|
|
|
$
|
1.02
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
58
SHUTTERFLY,
INC.
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(In
thousands, except per share
amounts) (Continued)
The following weighted-average outstanding options, common stock
subject to repurchase and convertible preferred stock warrants
were excluded from the computation of diluted net income per
common share for the periods presented because including them
would have had an antidilutive effect:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Options to purchase common stock
and common stock subject to repurchase
|
|
|
|
|
|
|
|
|
|
|
955
|
|
Convertible preferred stock (as
converted basis)
|
|
|
10,509
|
|
|
|
12,633
|
|
|
|
12,199
|
|
Convertible preferred stock
warrants (as converted basis)
|
|
|
|
|
|
|
|
|
|
|
25
|
|
Comprehensive
Loss
FASB Statement No. 130, Reporting Comprehensive
Income, establishes standards for reporting and displaying
comprehensive income and comprehensive loss and its components
in the consolidated financial statements. Comprehensive income
is defined as the change in equity of a business enterprise
during a period from transactions and other events and
circumstances from non-owner sources. Comprehensive income
(loss) is composed of net income (loss) and unrealized gains and
losses on marketable securities, which are disclosed in the
accompanying consolidated statements of redeemable convertible
preferred stock and shareholders equity (deficit).
The components of accumulated other comprehensive loss were as
follows:
|
|
|
|
|
|
|
December 31, 2006
|
|
|
Unrealized loss in investments,
net of tax of $19
|
|
$
|
(35
|
)
|
|
|
|
|
|
Other comprehensive loss
|
|
$
|
(35
|
)
|
|
|
|
|
|
For the years ended December 31, 2005 and 2004, there were
no differences between the Companys comprehensive income
and net income.
Segment
Reporting
The Company operates in one industry segment digital
photofinishing services. The Company operates in one geographic
area, being the United States of America.
FASB Statement No. 131, Disclosures about Segments of an
Enterprise and Related Information, establishes standards
for reporting information about operating segments. Operating
segments are defined as components of an enterprise about which
separate financial information is available that is evaluated
regularly by the chief operating decision maker, or decision
making group, in deciding how to allocate resources and in
assessing performance. The Companys chief operating
decision maker is its Chief Executive Officer. The
Companys Chief Executive Officer reviews financial
information presented on a consolidated basis for purposes of
allocating resources and evaluating financial performance. The
Company has one business activity and there are no segment
managers who are held accountable for operations, operating
results and plans for products or components below the
consolidated unit level. Accordingly, the Company reports as a
single operating segment.
Recent
Accounting Pronouncements
In June 2006, the FASB issued Interpretation No. 48,
Accounting for Uncertainty in Income Taxes
(FIN 48), which prescribes detailed guidance
for the financial statement recognition, measurement and
disclosure of uncertain tax positions recognized in an
enterprises financial statements in accordance with FASB
Statement No. 109, Accounting for Income Taxes.
Tax positions must meet a more-likely-than-not recognition
59
SHUTTERFLY,
INC.
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(In
thousands, except per share
amounts) (Continued)
threshold at the effective date to be recognized upon the
adoption of FIN 48 and in subsequent periods. FIN 48
will be effective for fiscal years beginning after
December 15, 2006, and the provisions of FIN 48 will
be applied to all tax positions accounted for under Statement
No. 109 upon initial adoption. The cumulative effect of
applying the provisions of this interpretation will be reported
as an adjustment to the opening balance of retained earnings for
that fiscal year. The Company does not believe the adoption of
FIN 48 will have a material impact on its financial
position and results of operations.
In September 2006, the Securities and Exchange Commission
(SEC) issued Staff Accounting Bulletin
(SAB) No. 108, Considering the Effects of
Prior Year Misstatements when Quantifying Misstatements in
Current Year Financial Statements. SAB 108 provides
guidance on the consideration of effects of the prior year
misstatements in quantifying current year misstatements for the
purpose of a materiality assessment. The SEC staff believes
registrants must quantify errors using both a balance sheet and
income statement approach and evaluate whether either approach
results in quantifying a misstatement that, when all relevant
quantitative and qualitative factors are considered, is
material. SAB 108 is effective for the first annual period
ending after November 15, 2006 with early application
encouraged. SAB 108 did not have a material impact on the
Companys financial position, results of operations and
cash flows.
In September 2006, the FASB issued FAS No. 157,
Fair Value Measurements (FAS 157).
FAS 157 defines fair value, establishes a framework for
measuring fair value and expands disclosures about fair value
measurements. FAS 157 is effective for the Company as of
January 1, 2008. The Company is currently evaluating the
impact, if any, of FAS 157 on its consolidated financial
statements.
In February 2007, the FASB issued FAS No. 159,
The Fair Value Option for Financial Assets and Financial
Liabilities (FAS 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 on 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 3
|
Change in
Accounting Policy
|
On June 29, 2005, the FASB issued Staff Position
150-5,
Issuers Accounting under FASB Statement No. 150
(SFAS 150) for Freestanding Warrants and Other
Similar Instruments on Shares That Are Redeemable
(FSP
150-5).
Under FSP
150-5, the
freestanding warrants that were related to the Companys
redeemable convertible preferred stock were classified as
liabilities and were recorded at fair value. The Company
previously accounted for freestanding warrants for the purchase
of redeemable convertible preferred stock under EITF Issue
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).
The Company adopted FSP
150-5 and
accounted for the cumulative effect of the change in accounting
principle as of July 1, 2005. For the year ended
December 31, 2005, the impact of the change in accounting
principle was to increase net income by $442, or $0.14 per
share. There was $464 of additional expense recorded in other
income (expense), net to reflect the increase in fair value
between July 1, 2005 and December 31, 2005. In the
year ended December 31, 2006, the Company recorded $153 of
additional income reflected as other income (expense), net to
reflect the decrease in fair value of the warrants.
The pro forma effect of the adoption SFAS No. 150 on
the Companys results of operations for 2006, 2005 and
2004, if applied retroactively, assuming SFAS No. 150
had been adopted in those years, has not been disclosed, as
these amounts would not be materially different from the
reported amounts.
60
SHUTTERFLY,
INC.
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(In
thousands, except per share
amounts) (Continued)
|
|
Note 4
|
Balance
Sheet Components
|
Property
and Equipment
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
Computer and other equipment
|
|
$
|
41,880
|
|
|
$
|
25,658
|
|
Software
|
|
|
8,791
|
|
|
|
7,524
|
|
Leasehold improvements
|
|
|
4,903
|
|
|
|
3,189
|
|
Furniture and fixtures
|
|
|
1,348
|
|
|
|
990
|
|
|
|
|
|
|
|
|
|
|
|
|
|
56,922
|
|
|
|
37,361
|
|
Less: Accumulated depreciation and
amortization
|
|
|
(26,003
|
)
|
|
|
(16,600
|
)
|
|
|
|
|
|
|
|
|
|
Net property and equipment
|
|
$
|
30,919
|
|
|
$
|
20,761
|
|
|
|
|
|
|
|
|
|
|
Property and equipment includes $6,502 and $7,050 of equipment
and software under capital leases at December 31, 2006 and
2005, respectively. Accumulated depreciation of assets under
capital leases totaled $3,820 and $2,703 at December 31,
2006 and 2005, respectively.
Depreciation and amortization expense for the years ended
December 31, 2006, 2005 and 2004 was $10,525, $6,246 and
$3,769, respectively.
Intangible
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
Gross
|
|
|
Amortization
|
|
|
Net
|
|
|
As of December 31, 2005
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchased technology
|
|
$
|
2,030
|
|
|
$
|
(505
|
)
|
|
$
|
1,525
|
|
Acquired workforce
|
|
|
279
|
|
|
|
(186
|
)
|
|
|
93
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
2,309
|
|
|
$
|
(691
|
)
|
|
$
|
1,618
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchased technology
|
|
$
|
2,030
|
|
|
$
|
(634
|
)
|
|
$
|
1,396
|
|
Acquired workforce
|
|
|
279
|
|
|
|
(279
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
2,309
|
|
|
$
|
(913
|
)
|
|
$
|
1,396
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization expense of intangibles for the years ended
December 31, 2006, 2005 and 2004 was $222, $276 and $379,
respectively. Amortization of existing intangibles is estimated
to be approximately $128 per year through 2017.
61
SHUTTERFLY,
INC.
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(In
thousands, except per share
amounts) (Continued)
Accrued
Liabilities
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
Accrued marketing expenses
|
|
$
|
1,822
|
|
|
$
|
1,318
|
|
Accrued compensation
|
|
|
1,201
|
|
|
|
977
|
|
Accrued purchases
|
|
|
483
|
|
|
|
3,845
|
|
Accrued income taxes
|
|
|
1,235
|
|
|
|
221
|
|
Current portion of accrued license
fee
|
|
|
|
|
|
|
1,000
|
|
Accrued consultant expenses
|
|
|
884
|
|
|
|
1,059
|
|
Accrued production facility
expenses
|
|
|
1,784
|
|
|
|
1,316
|
|
Accrued other
|
|
|
1,399
|
|
|
|
1,784
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
8,808
|
|
|
$
|
11,520
|
|
|
|
|
|
|
|
|
|
|
On June 1, 2005, the Company acquired 100% of Memory
Matrix, Inc., (Memory Matrix) a Nevada corporation,
in exchange for 109 shares of common stock. The acquisition
was effected using a reverse triangular merger in
which a wholly owned Shutterfly subsidiary was merged with and
into Memory Matrix, resulting in Memory Matrix becoming a wholly
owned subsidiary of Shutterfly. Memory Matrix was considered to
be a developmental stage enterprise and did not meet
the definition of a business under
SFAS No. 141, Business Combinations, for
business combination purposes. In accordance with
SFAS No. 141, the acquisition of Memory Matrix was
accounted for as an acquisition of assets.
As additional consideration for the acquisition, the Company
also issued 121 shares of common stock to the employees of
Memory Matrix, subject to vesting and repurchase rights over a
period of 18 months, in exchange for unvested Memory Matrix
restricted shares held by such employees prior to the merger.
$671 of deferred stock-based compensation was recorded based on
the intrinsic value of the shares at the time of the
acquisition. The Company recognized $94 and $500 of stock-based
compensation expense for the year ended December 31, 2006
and 2005, respectively, relating to the vesting of the
restricted shares.
The total purchase price was $690, based on an estimated per
share fair value of $6.00 on the date of the transaction, and
was allocated to various tangible and intangible assets, which
consisted of $239 of cash, $9 of prepaids, $35 of fixed assets,
$279 of acquired workforce, $564 of core technology, related
deferred tax liability of $336 and assumed liabilities of $100.
In addition, the Company recorded a deferred tax asset on the
date of acquisition of $201, which was offset in full by a
valuation allowance. In the fourth quarter of 2005, the
valuation allowance was released, which reduced non-current
intangibles accordingly.
The acquired workforce intangible asset was amortized on a
straight-line basis over one year. The net core technology asset
is amortized on a straight-line basis over the assets
life, which is estimated as three years.
|
|
Note 6
|
Commitments
and Contingencies
|
Leases
The Company leases office and production space under various
non-cancelable operating leases that expire no later than August
2014. Rent expense was $1,295, $1,181 and $1,131, for the years
ended December 31, 2006, 2005 and 2004, respectively.
62
SHUTTERFLY,
INC.
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(In
thousands, except per share
amounts) (Continued)
Rent expense is recorded on a straight-line basis over the lease
term. When a lease provides for fixed escalations of the minimum
rental payments, the difference between the straight-line rent
charged to expense, and the amount payable under the lease is
recognized as deferred rent.
The Company leases certain equipment, software and colocation
services under non-cancelable capital leases, operating leases
or long-term agreements that expire at various dates through the
year 2010. The leased equipment is subject to a security
interest. The total outstanding obligation under capital leases
at December 31, 2006 and 2005 was $3,703 and $5,149,
respectively.
At December 31, 2006, the total future minimum payments
under non-cancelable scheduled rentals are as follows:
|
|
|
|
|
|
|
|
|
|
|
Operating
|
|
|
Capital
|
|
|
|
Leases
|
|
|
Leases
|
|
|
Year Ending:
|
|
|
|
|
|
|
|
|
2007
|
|
$
|
1,462
|
|
|
$
|
2,095
|
|
2008
|
|
|
1,704
|
|
|
|
1,364
|
|
2009
|
|
|
2,080
|
|
|
|
483
|
|
2010
|
|
|
1,397
|
|
|
|
|
|
2011 and thereafter
|
|
|
2,620
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total minimum lease payments
|
|
$
|
9,263
|
|
|
|
3,942
|
|
|
|
|
|
|
|
|
|
|
Less: amount representing interest
|
|
|
|
|
|
|
(239
|
)
|
|
|
|
|
|
|
|
|
|
Present value of future minimum
lease payments
|
|
|
|
|
|
|
3,703
|
|
Less: current portion
|
|
|
|
|
|
|
(1,961
|
)
|
|
|
|
|
|
|
|
|
|
Non-current portion of capital
lease obligations
|
|
|
|
|
|
$
|
1,742
|
|
|
|
|
|
|
|
|
|
|
Purchase obligations consist of non-cancelable marketing
agreements and colocation services. As of December 31,
2006, the Companys purchase obligations totaled $4,006.
Indemnifications
In the normal course of business, the Company enters into
contracts and agreements that contain a variety of
representation and warranties and provide for general
indemnifications. The Companys exposure under these
agreements is unknown because it involves future claims that may
be made against the Company, 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, 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.
63
SHUTTERFLY,
INC.
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(In
thousands, except per share
amounts) (Continued)
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
December 31, 2006, 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.
Note 7
Loan Payable
In February 2003, the Company received a $2,500 loan from a
stockholder to finance working capital. The loan was repayable
commencing March 2004, based on a
36-month
repayment schedule. Any remaining outstanding balance was due
and immediately payable at the end of February 2006. The loan
bore an annual interest rate of 5% above the Prime Rate, as
published in the Wall Street Journal, and not to exceed 12%. The
Prime Rate was adjusted on a monthly basis. The Company granted
the lender a continuing security interest in all of its assets.
The loan agreement provided for certain financial and
non-financial covenants, the breach of which could have resulted
in an increase in the interest rate or the loan being
immediately callable.
In connection with this loan, the Company issued warrants to
purchase 138 and 113 shares of Series D and E
convertible preferred stock, respectively. The warrants each had
an exercise price of $0.615 per share. The fair value of
the warrants was estimated at an aggregate of $115 using the
Black-Scholes valuation model with the following assumptions:
expected volatility of 70%, risk free interest rate of 4.24%,
expected life of 10 years and no dividends. The fair value
of the warrants was recorded as a discount to the loan and was
amortized to interest expense using the effective interest rate
method over the loan term. The Company repaid the entire amount
of the loan during 2004. A total of $83 was recognized as
interest expense during the period ended December 31, 2004.
The warrants were fully exercised in 2004.
In August 2005, the Company entered into a $7,000 term loan
agreement with Silicon Valley Bank to finance equipment
purchases. The loan was repayable commencing September 2005,
based on a
36-month
repayment schedule. Any remaining outstanding balance would have
been due and immediately payable at the beginning of August
2008. The loan bore an annual interest rate on the outstanding
principal amount from the date when made until paid in full at a
rate per annum equal to the Prime Rate plus the Applicable Term
Margin. The Applicable Term Margin was based on the Cash Flow
Leverage Ratio, and ranged from 0.50% to 1.0%. The loan
agreement provided for certain financial and non-financial
covenants, the breach of which could have resulted in an
increased interest rate or the loan being immediately callable.
The Company borrowed $2,571 on this loan in August 2005, and
repaid the full balance in November 2005. A total of $125 was
recognized as interest expense during the year ended
December 31, 2005.
64
SHUTTERFLY,
INC.
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(In
thousands, except per share
amounts) (Continued)
Note 8
Common Stock
In October 2006, the Company completed its IPO of common stock
in which it sold and issued 5,800 shares of common stock,
at an issue price 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 $6.1 million
and other offering costs of $2.4 million.
Upon the closing of the IPO, all shares of the Companys
redeemable convertible preferred stock outstanding automatically
converted into 13,863 shares of common stock.
Warrants
for Common Stock
Upon the effective date of the IPO, warrants to purchase
41 shares of redeemable convertible preferred stock
converted into warrants to purchase 41 shares of common
stock, and warrants to purchase 41 shares of redeemable
convertible preferred stock expired.
As discussed in Note 3, in 2005 the Company reclassified
the freestanding preferred stock warrants as a liability and
began adjusting the warrants to fair value at each reporting
period until the completion of the IPO.
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
Plan were incentive stock options or non-qualified stock
options. Incentive stock options (ISO) were granted
only to Company employees, which includes officers and directors
of the Company. Non-qualified stock options (NSO)
and stock purchase rights were able to be granted to employees
and consultants. Options under the Plan were to be granted at
prices not less than 85% of the deemed fair 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 and NSO was not less
than 100% and 85% of the deemed fair value of the shares on the
date of grant, respectively, and (ii) the exercise price of
an ISO and NSO granted to a 10% stockholder 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. The term of the options was to be no longer than
five years for ISOs for which the grantee owns 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 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 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 NSO restricted stock awards,
stock bonus awards, restricted stock units, and performance
shares.
Options issued under the 2006 Plan are generally for periods not
to exceed 10 years and are issued at the fair value of the
shares of common stock on the date of grant as determined by the
Board. Prior to the Companys IPO, the Board determined the
fair value of common stock in good faith based on the best
information available to the
65
SHUTTERFLY,
INC.
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(In
thousands, except per share
amounts) (Continued)
Board and Companys management at the time of the grant.
Following the IPO, the fair value of the Companys common
stock is determined by the last sale price of such stock on the
Nasdaq Global Market. Options issued under the 2006 Plan
typically vest 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.
Option holders under the 2006 Plan are allowed to exercise
options prior to vesting.
At the time of adoption of the 2006 Plan, 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 on January 1 of 2008, 2009, and 2010, of the
lesser of a) 4.62% of stock options issued and outstanding
on the December 31 immediately prior to the date of
increase or b) a lesser number as determined by the Board.
Stock
Option Activity
A summary of the status of the Companys stock option plans
at December 31, 2006 and changes during the period then
ended is presented in the table below (share numbers and
aggregate intrinsic value in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares
|
|
|
|
|
|
Weighted
|
|
|
Weighted
|
|
|
|
|
|
|
Available
|
|
|
Number of
|
|
|
Average
|
|
|
Average
|
|
|
Aggregate
|
|
|
|
for
|
|
|
Options
|
|
|
Exercise
|
|
|
Contractual
|
|
|
Intrinsic
|
|
|
|
Grant
|
|
|
Outstanding
|
|
|
Price
|
|
|
Term (Years)
|
|
|
Value
|
|
|
Balances, December 31, 2003
|
|
|
155
|
|
|
|
2,137
|
|
|
$
|
0.31
|
|
|
|
|
|
|
|
|
|
Additional authorized
|
|
|
1,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
(687
|
)
|
|
|
687
|
|
|
|
0.30
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
|
|
|
|
(1,448
|
)
|
|
|
0.22
|
|
|
|
|
|
|
|
|
|
Forfeited, cancelled or expired
|
|
|
42
|
|
|
|
(40
|
)
|
|
|
0.50
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances, December 31, 2004
|
|
|
510
|
|
|
|
1,336
|
|
|
|
0.40
|
|
|
|
|
|
|
|
|
|
Additional authorized
|
|
|
2,720
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
(2,372
|
)
|
|
|
2,372
|
|
|
|
5.12
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
|
|
|
|
(315
|
)
|
|
|
0.35
|
|
|
|
|
|
|
|
|
|
Forfeited, cancelled or expired
|
|
|
501
|
|
|
|
(375
|
)
|
|
|
2.89
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances, December 31, 2005
|
|
|
1,359
|
|
|
|
3,018
|
|
|
|
3.91
|
|
|
|
|
|
|
|
|
|
Additional authorized
|
|
|
2,055
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
(2,269
|
)
|
|
|
2,269
|
|
|
|
11.11
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
|
|
|
|
(52
|
)
|
|
|
1.61
|
|
|
|
|
|
|
|
|
|
Forfeited, cancelled or expired
|
|
|
233
|
|
|
|
(201
|
)
|
|
|
6.10
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances, December 31, 2006
|
|
|
1,378
|
|
|
|
5,034
|
|
|
$
|
7.28
|
|
|
|
8.5
|
|
|
$
|
35,914
|
|
Options vested and expected to
vest at December 31, 2006
|
|
|
|
|
|
|
4,788
|
|
|
$
|
7.17
|
|
|
|
8.4
|
|
|
$
|
34,666
|
|
Options vested at
December 31, 2006
|
|
|
|
|
|
|
1,485
|
|
|
$
|
3.75
|
|
|
|
7.3
|
|
|
$
|
15,808
|
|
As of December 31, 2005 and 2004, there were 489 and
645 shares exercisable, respectively.
Options granted in 2006 are grouped as follows:
66
SHUTTERFLY,
INC.
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(In
thousands, except per share
amounts) (Continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
Weighted
|
|
|
|
Options
|
|
|
Average
|
|
|
Average
|
|
|
|
Granted
|
|
|
Fair Value
|
|
|
Exercise Price
|
|
|
Options with exercise price less
than reassessed market price on the grant date
|
|
|
255
|
|
|
$
|
4.43
|
|
|
$
|
10.00
|
|
Options with exercise price equal
to reassessed market price on the grant date
|
|
|
2,014
|
|
|
$
|
5.06
|
|
|
$
|
11.25
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
2,269
|
|
|
$
|
4.99
|
|
|
$
|
11.11
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The total intrinsic value of options exercised during the twelve
months ended December 31, 2006, 2005, and 2004 was $531,
$3,274, and $4,259, respectively. Net cash proceeds from the
exercise of stock options were $83 for the twelve months ended
December 31, 2006.
The following table summarizes information about stock options
outstanding, vested and exercisable at December 31, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Vested and
|
|
|
|
Options Outstanding
|
|
|
Exercisable
|
|
|
|
|
|
|
Weighted Avg.
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares Underlying
|
|
|
Remaining
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding Options
|
|
|
Contractual
|
|
|
Weighted Avg.
|
|
|
As of
|
|
|
Weighted Avg.
|
|
Range of Exercise Prices
|
|
as of
12/31/06
|
|
|
Term (Years)
|
|
|
Ex Price
|
|
|
12/31/06
|
|
|
Ex Price
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ 0.10 - $ 0.50
|
|
|
747
|
|
|
|
6.3
|
|
|
$
|
0.35
|
|
|
|
551
|
|
|
$
|
0.37
|
|
$ 3.50 - $ 3.50
|
|
|
14
|
|
|
|
3.3
|
|
|
$
|
3.50
|
|
|
|
14
|
|
|
$
|
3.50
|
|
$ 5.50 - $ 5.50
|
|
|
1,622
|
|
|
|
8.1
|
|
|
$
|
5.50
|
|
|
|
739
|
|
|
$
|
5.50
|
|
$ 6.00 - $ 6.56
|
|
|
412
|
|
|
|
8.6
|
|
|
$
|
6.10
|
|
|
|
145
|
|
|
$
|
6.09
|
|
$10.00 - $10.00
|
|
|
269
|
|
|
|
9.0
|
|
|
$
|
10.00
|
|
|
|
21
|
|
|
$
|
10.00
|
|
$10.39 - $10.39
|
|
|
1,482
|
|
|
|
9.4
|
|
|
$
|
10.39
|
|
|
|
11
|
|
|
$
|
10.39
|
|
$12.00 - $12.00
|
|
|
97
|
|
|
|
9.5
|
|
|
$
|
12.00
|
|
|
|
|
|
|
|
|
|
$14.20 - $14.20
|
|
|
282
|
|
|
|
9.7
|
|
|
$
|
14.20
|
|
|
|
4
|
|
|
$
|
14.20
|
|
$14.62 - $14.62
|
|
|
18
|
|
|
|
9.9
|
|
|
$
|
14.62
|
|
|
|
|
|
|
|
|
|
$14.91 - $14.91
|
|
|
91
|
|
|
|
10.0
|
|
|
$
|
14.91
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ 0.10 - $14.91
|
|
|
5,034
|
|
|
|
8.5
|
|
|
$
|
7.28
|
|
|
|
1,485
|
|
|
$
|
3.75
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Early
Exercise of Employee Options
Stock options granted under the Companys stock option
plans provide employee option holders the right to elect to
exercise unvested options in exchange for restricted common
stock. Unvested shares, which amounted to 31, 138, and 698
at December 31, 2006, 2005, and 2004, respectively, were
subject to a repurchase right held by the Company at the
original issuance price in the event the optionees
employment is terminated either voluntarily or involuntarily.
For exercises of employee options, this right lapses 25% on the
first anniversary of the vesting start date and in 36 equal
monthly amounts thereafter. These repurchase terms are
considered to be a forfeiture provision and do not result in
variable accounting. In accordance with EITF
No. 00-23,
Issues Related to the Accounting for Stock Compensation under
APB No. 25, the shares purchased by the employees
pursuant to the early exercise of stock options are not deemed
to be outstanding until those shares vest. In addition, cash
received from employees for exercise of unvested options is
treated as a refundable deposit shown as a liability in the
Companys financial statements. As of December 31,
2006, 2005, and 2004, cash received for early exercise of
options of $9, $38, and
67
SHUTTERFLY,
INC.
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(In
thousands, except per share
amounts) (Continued)
$123, was included in refundable deposits, respectively. Amounts
so recorded are transferred into common stock and additional
paid-in capital as the shares vest.
Stock-based
Compensation Associated with Awards to Employees
All options granted were intended to be exercisable at a price
per share not less than fair market value of the shares of the
Companys stock underlying those options on their
respective dates of grant. The Board determined these fair
market values in good faith based on the best information
available to the Board and Companys management at the time
of the grant. Although the Company believes these determinations
accurately reflect the historical value of the Companys
common stock, management has retroactively revised the valuation
of its common stock for the purpose of calculating stock-based
compensation expense. Accordingly, in the periods ending
December 31, 2004 and 2005 for such stock and options
issued to employees, the Company has recorded deferred
stock-based compensation of $2,299 and $1,225, respectively, net
of cancellations, of which the Company amortized $565, $1,547
and $858 of stock-based compensation in the years ended
December 31, 2006, 2005 and 2004, respectively.
At December 31, 2006, the Company had deferred stock-based
compensation under APB 25, as shown in the consolidated
statement of redeemable convertible preferred stock and
stockholders equity (deficit) of $191, of which $165 is
expected to be amortized in 2007 and $26 in 2008.
On July 28, 2004, the Company entered into a transition
agreement with one of its executive officers whereby vesting of
previously granted options was accelerated resulting in a new
measurement date at the date of modification. This executive
officer resigned effective January 31, 2005. A total of
316 shares would have been forfeited under the original
option terms resulting in total compensation expense of $1,145.
The total compensation expense was measured in accordance with
guidance provided by Financial Accounting Standards Board
Interpretation No. 44, Accounting for Certain
Transactions Involving Stock Compensation, an Interpretation of
APB Opinion No. 25 (FIN 44), as the
intrinsic value of the modified award at the date of
modification in excess of the amount measured at the original
measurement date. A total of $981 and $164 was recognized in the
years ended December 31, 2004 and 2005, respectively.
On August 13, 2004 the Company entered into a transition
agreement with one of its executive officers. Upon termination,
the agreement provided for acceleration of 25% of the
officers unvested options. The agreement also provided for
an extension of the time to exercise any vested options, from
90 days to 270 days from the date of the
officers termination. In February 2005, this executive
officer resigned and 17 shares that would have been
forfeited under the original option terms were accelerated,
resulting in total stock-based compensation expense of $65. In
November 2005, this executive officer exercised options for
293 shares. As expense recognition for the additional
276 shares was contingent on whether this executive officer
took the benefit of the vesting extension, additional
stock-based compensation expense was not recognized until the
November exercise when $1,035 was recorded. Stock-based
compensation expense for the February and November 2005 charges
was measured in accordance with guidance provided by FIN 44
as the intrinsic value of the modified award at the date of
modification in excess of the amount measured at the original
measurement date.
In March 2005, the Company entered into a settlement agreement
with a former employee, whereby the Company allowed the former
employee to retain 65 shares of common stock and
repurchased 29 shares of common stock at its original
purchase price. These shares were previously deemed repurchased
by the Company. In connection with this settlement, the Company
recorded $352 as stock-based compensation as of
December 31, 2004, computed at the fair value of the common
stock at the date of settlement, in accordance with guidance
provided by FIN 44.
68
SHUTTERFLY,
INC.
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(In
thousands, except per share
amounts) (Continued)
Adoption
of SFAS No. 123R
The Company adopted SFAS No. 123R on January 1,
2006. Under SFAS No. 123R, the Company estimated the
fair value of each option award on the date of grant using the
Black-Scholes option-pricing model using 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 vest 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 twelve months ended December 31, 2006
were as follows:
|
|
|
|
|
|
|
Year Ended
|
|
|
|
December 31,
|
|
|
|
2006
|
|
|
Dividend yield
|
|
|
|
|
Annual risk free rate of return
|
|
|
5.0
|
%
|
Expected volatility
|
|
|
45.8
|
%
|
Expected term (years)
|
|
|
4.6
|
|
Employee stock-based compensation expense recognized in the
twelve months ended December 31, 2006 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.
As a result of adopting SFAS No. 123R on
January 1, 2006, the Companys net income for the
twelve months ended December 31, 2006, was higher by
$1,950, net of tax effect, than if the Company had continued to
account for stock-based compensation under APB 25. Basic
and diluted net income per share for the twelve months ended
December 31, 2006 would have been lower by $0.23 if the
Company had not adopted SFAS No. 123R. At
December 31, 2006, the Company had $9,027 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. In accordance with
SFAS No. 123R, unamortized compensation expense on
stock option grants after January 1, 2006 is not included
in deferred stock-based compensation on the equity statement.
The balance in deferred stock-based compensation as of
December 31, 2006 is $191, which is comprised primarily of
employee stock option grants prior to December 31, 2005.
In 2006, based on a reassessment of the value of its common
stock during 2005, the Company offered to the employees who were
granted options from January 2005 to October 2005 the ability to
amend the terms of their options to increase the exercise prices
in order to help them avoid potential adverse personal income
tax consequences. On June 29, 2006 and December 22,
2006, options to purchase 1,789 and 3 shares, respectively,
of the Companys common stock that had been granted at
exercise prices ranging from $5.00 to $5.50 per share were
amended to exercise prices between $5.50 and $6.56 per
share. No other terms of the option grants were modified. The
transactions were deemed to be modifications under
SFAS No. 123R; deferred stock-based compensation
computed under APB 25 was reduced by $526, which will be
amortized under SFAS No. 123R, and there was no
incremental stock-based compensation expenses from the
amendments.
69
SHUTTERFLY,
INC.
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(In
thousands, except per share
amounts) (Continued)
Note 9
Income Taxes
The following table reflects the components of the provision for
income taxes of the Company:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Federal:
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
|
|
$
|
610
|
|
|
$
|
(187
|
)
|
|
$
|
194
|
|
Deferred
|
|
|
2,809
|
|
|
|
(20,230
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
3,419
|
|
|
$
|
(20,417
|
)
|
|
$
|
194
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
State:
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
|
|
$
|
133
|
|
|
$
|
(40
|
)
|
|
$
|
64
|
|
Deferred
|
|
|
390
|
|
|
|
(3,603
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
523
|
|
|
$
|
(3,643
|
)
|
|
$
|
64
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total income tax expense (benefit):
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
|
|
$
|
743
|
|
|
$
|
(227
|
)
|
|
$
|
258
|
|
Deferred
|
|
|
3,199
|
|
|
|
(23,833
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
3,942
|
|
|
$
|
(24,060
|
)
|
|
$
|
258
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Companys actual tax expense (benefit) differed from
the statutory federal income tax rate of 34.0%, as shown in the
following schedule:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Income tax expense at statutory
rate
|
|
|
34.0
|
%
|
|
|
34.0
|
%
|
|
|
34.0
|
%
|
State income taxes
|
|
|
5.8
|
%
|
|
|
5.8
|
%
|
|
|
5.8
|
%
|
Stock-based compensation
|
|
|
4.3
|
%
|
|
|
10.7
|
%
|
|
|
7.4
|
%
|
Non-qualified deductions
|
|
|
|
|
|
|
(13.1
|
)%
|
|
|
|
|
Change in valuation allowance
|
|
|
|
|
|
|
(527.7
|
)%
|
|
|
(38.0
|
)%
|
Other
|
|
|
(3.7
|
)%
|
|
|
(3.5
|
)%
|
|
|
(2.7
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
40.4
|
%
|
|
|
(493.8
|
)%
|
|
|
6.5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At December 31, 2006, the Company had approximately $43,000
and $41,000 of federal and state net operating loss
carryforwards, respectively, to reduce future regular taxable
income. These carryforwards will expire beginning in the year
2020 through 2022 for federal and 2008 through 2012 for state
purposes, if not utilized.
The Tax Reform Act of 1986 limits the use of net operating loss
and tax credit carryforwards in the case of an ownership
change of a corporation or separate return loss year
limitations. Any ownership changes, as defined, may restrict
utilization of carryforwards.
The Company also had federal and state research and development
credit carryforwards of approximately $700 and $500 for federal
and state income tax purposes, respectively, at
December 31, 2006. The research and development credits may
be carried forward over a period of 20 years for federal
tax purposes, and indefinitely for California tax purposes.
70
SHUTTERFLY,
INC.
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(In
thousands, except per share
amounts) (Continued)
The components of the net deferred tax assets as of
December 31, 2006 and 2005 are:
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
Deferred tax assets
|
|
|
|
|
|
|
|
|
Net operating loss carryforwards
|
|
$
|
17,028
|
|
|
$
|
22,646
|
|
Reserves and other tax benefits
|
|
|
2,111
|
|
|
|
1,408
|
|
Tax credits
|
|
|
1,800
|
|
|
|
823
|
|
Depreciation and amortization
|
|
|
32
|
|
|
|
|
|
Other
|
|
|
19
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred tax assets
|
|
|
20,990
|
|
|
|
24,877
|
|
Deferred tax
liabilities
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
|
|
|
|
(632
|
)
|
Other deferred tax liabilities
|
|
|
(107
|
)
|
|
|
(182
|
)
|
|
|
|
|
|
|
|
|
|
Deferred tax liabilities
|
|
|
(107
|
)
|
|
|
(814
|
)
|
Valuation allowance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net deferred tax assets
|
|
$
|
20,883
|
|
|
$
|
24,063
|
|
|
|
|
|
|
|
|
|
|
Note 10
Employee Benefit Plan
In 2000, the Company established a 401(k) plan under the
provisions of which eligible employees may contribute an amount
up to 50% of their compensation on a pre-tax basis, subject to
IRS limitations. The Company matches employees
contributions at the discretion of the Board.
In 2006, the Company made a discretionary contribution of $63.
There were no contributions in 2005.
Note 11
Related Party Transactions
During the years ended December 31, 2004 and 2003, the
Company entered into several transactions with one of its
stockholders. The transactions involved issuance of warrants and
conversion of certain loans into Series E Convertible
preferred stock (see Note 7). During the year ended
December 31, 2004, the Company recorded $206 of interest
expense related to this loan.
On June 1, 2005, the Company acquired Memory Matrix (see
Note 5). Monaco Partners, L.P., a beneficial owner of the
Companys capital stock, owned 14.1% of Memory Matrix
immediately prior to the closing of the acquisition. James H.
Clark, who is a stockholder of the Company, and was a member of
the Board, controlled Monaco Partners, L.P. Mr. Clark was a
member of the board of directors of Memory Matrix immediately
prior to the acquisition.
71
SHUTTERFLY,
INC.
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(In
thousands, except per share
amounts) (Continued)
Note 12
Quarterly Financial Data (Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, 2006
|
|
|
|
First
|
|
|
Second
|
|
|
Third
|
|
|
Fourth
|
|
|
|
Quarter
|
|
|
Quarter
|
|
|
Quarter
|
|
|
Quarter
|
|
|
Net Revenues
|
|
$
|
16,883
|
|
|
$
|
19,637
|
|
|
$
|
21,155
|
|
|
$
|
65,678
|
|
Gross Profit
|
|
|
8,134
|
|
|
|
9,881
|
|
|
|
10,289
|
|
|
|
39,558
|
|
Net income (loss)
|
|
$
|
(1,565
|
)
|
|
$
|
(2,093
|
)
|
|
$
|
(2,747
|
)
|
|
$
|
12,203
|
|
Net income (loss) allocable to
common shareholders
|
|
$
|
(1,565
|
)
|
|
$
|
(2,093
|
)
|
|
$
|
(2,747
|
)
|
|
$
|
12,203
|
|
Net income (loss) per common share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.41
|
)
|
|
$
|
(0.54
|
)
|
|
$
|
(0.70
|
)
|
|
$
|
0.53
|
|
Diluted
|
|
$
|
(0.41
|
)
|
|
$
|
(0.54
|
)
|
|
$
|
(0.70
|
)
|
|
$
|
0.50
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, 2005
|
|
|
|
First
|
|
|
Second
|
|
|
Third
|
|
|
Fourth
|
|
|
|
Quarter
|
|
|
Quarter
|
|
|
Quarter
|
|
|
Quarter
|
|
|
Net Revenues
|
|
$
|
13,156
|
|
|
$
|
14,115
|
|
|
$
|
15,610
|
|
|
$
|
41,021
|
|
Gross Profit
|
|
|
6,710
|
|
|
|
7,311
|
|
|
|
8,801
|
|
|
|
24,139
|
|
Income (loss) before income taxes
and cumulative effect of change in accounting principle
|
|
|
(683
|
)
|
|
|
(677
|
)
|
|
|
(1,650
|
)
|
|
|
7,440
|
|
Net income (loss)
|
|
$
|
(683
|
)
|
|
$
|
(609
|
)
|
|
$
|
(1,276
|
)
|
|
$
|
31,500
|
|
Net income (loss) allocable to
common shareholders
|
|
$
|
(683
|
)
|
|
$
|
(609
|
)
|
|
$
|
(1,276
|
)
|
|
$
|
6,372
|
|
Net income (loss) per common share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.23
|
)
|
|
$
|
(0.19
|
)
|
|
$
|
(0.38
|
)
|
|
$
|
1.78
|
|
Diluted
|
|
$
|
(0.23
|
)
|
|
$
|
(0.19
|
)
|
|
$
|
(0.38
|
)
|
|
$
|
1.23
|
|
72
|
|
ITEM 9.
|
CHANGES
IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
|
Not applicable.
|
|
ITEM 9A.
|
CONTROLS
AND PROCEDURES.
|
Evaluation
of Disclosure 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 the end of the
period covered by this Annual Report on
Form 10-K.
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. Based on the evaluation
of our disclosure controls and procedures as of
December 31, 2006, our chief executive officer and chief
financial officer concluded that, as of such date, the
Companys disclosure controls and procedures were effective.
Remediation
of Prior Material Weaknesses
As previously reported in our Registration Statement on
Form S-1
(File
No. 333-135426),
as amended (the
S-1),
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 represent material weaknesses in our internal control over
financial reporting.
The material weaknesses in our internal control over financial
reporting were as follows:
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We did not maintain effective controls to ensure adequate
analysis, documentation, reconciliation and review of accounting
records and supporting data. Specifically, we did not maintain
effective controls to ensure that accruals and accounts payable
were completely and accurately recorded in the proper period. We
believe this occurred primarily because of insufficient
management oversight and because several positions in our
accounting and finance organization were unfilled or were
staffed by temporary personnel unfamiliar with our policies and
procedures. In addition, some personnel performing these
functions did not have an appropriate level of accounting
knowledge, experience and training.
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We did not maintain effective controls over the completeness and
accuracy of revenue and deferred revenue to prevent our
personnel from reinstating expired prepaid print plans. Under
our prepaid print plans, we offer customers the opportunity to
purchase in advance larger quantities of prints at a discounted
price from our current list price for prints. Our lack of
controls resulted in the overstatement of revenue and
understatement of deferred revenue.
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We did not maintain effective controls over the accounting for
income taxes, including the completeness and accuracy of our
deferred income tax assets and liabilities and the related
provision for income taxes. Specifically, we did not maintain
effective controls to properly estimate and reconcile the change
in our deferred tax assets and liabilities in the calculation of
our income tax provision or properly calculate the applicable
tax rate to be applied to income on an interim basis.
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We have implemented and will continue to implement changes to
our processes to improve our internal control over financial
reporting. The following steps have been taken to remediate the
conditions leading to the above stated material weaknesses:
(1) hiring a corporate controller, senior tax manager and
additional experienced financial personnel, (2) developing
and implementing formal policies and procedures to manage and
track the monthly accounting close process, (3) modifying
our website system controls to remove the capability of our
customer
73
service personnel to take certain actions related to our prepaid
print plans and clarifying our policies related to our prepaid
print plans for our personnel, and (4) continuing to
improve the skills, knowledge and experience available to us for
the preparation and review of our tax provision, additional
training of our finance and accounting personnel, and, with
respect to our tax provision, implementing an additional level
of review of the workpapers supporting the calculation of the
tax provision and related deferred tax amounts.
Based on our evaluation of these enhanced procedures and
increased staffing levels, management determined that, as of
December 31, 2006, we have remediated the material
weaknesses in internal control over financial reporting as
disclosed in the
S-1.
Limitation
on Effectiveness of Controls
It should be noted that any system of controls, however well
designed and operated, can provide only reasonable, and not
absolute, assurance that the objectives of the system are met.
The design of any control system is based, in part, upon the
benefits of the control system relative to its costs. Control
systems can be circumvented by the individual acts of some
persons, by collusion of two or more people, or by management
override of the control. In addition, over time, controls may
become inadequate because of changes in conditions, or the
degree of compliance with the policies or procedures may
deteriorate. Because of these and other inherent limitations of
control systems, there can be no assurance that any design will
succeed in achieving its stated goals under all potential future
conditions, regardless of how remote.
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ITEM 9B.
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OTHER
INFORMATION.
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None.
PART III
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ITEM 10.
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DIRECTORS,
EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
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The information concerning our directors required by this Item
is incorporated by reference to the section in our Proxy
Statement entitled Proposal No. 1
Election of Directors.
The information concerning our executive officers required by
this Item is incorporated by reference to the section in our
Proxy Statement entitled Executive Officers.
The information concerning compliance with Section 16(a) of
the Securities Exchange Act of 1934 required by this Item is
incorporated by reference to the section in our Proxy Statement
entitled Section 16(a) Beneficial Ownership Reporting
Compliance.
We have adopted a written code of ethics for financial employees
that applies to our principal executive officer, principal
financial officer, principal accounting officer, controller and
other employees of the finance department designated by the
companys Chief Financial Officer. This code of ethics,
titled the Code of Ethics for Chief Executive Officer and
Senior Financial Department Personnel, is attached to this
annual report as exhibit 14.01.
The information concerning material changes to the procedures by
which stockholders may recommend nominees to the Board of
Directors required by this Item is incorporated by reference to
information set forth in the Proxy Statement.
The information concerning the audit committee of the Board of
Directors required by this Item is incorporated by reference to
information set forth in the Proxy Statement.
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ITEM 11.
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EXECUTIVE
COMPENSATION.
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The information required by this Item with respect to executive
compensation and the compensation committee of the Board of
Directors is incorporated by reference to information set forth
in the Proxy Statement.
74
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ITEM 12.
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SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.
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The information required by this Item is incorporated by
reference to information set forth in the Proxy Statement under
the headings Security Ownership of Certain Beneficial
Owners and Management and Equity Compensation Plan
Information.
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ITEM 13.
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CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE.
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The information required by this Item with respect to director
independence is incorporated by reference to information set
forth in the Proxy Statement.
The information concerning certain relationships and related
transactions required by this Item is incorporated by reference
to the section in our Proxy Statement entitled Certain
Transactions.
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ITEM 14.
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PRINCIPAL
ACCOUNTANT FEES AND SERVICES.
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The information concerning principal accountant fees and
services required by this Item is incorporated by reference to
the section in our Proxy Statement entitled Ratification
of Selection of Independent Registered Public Accounting
Firm.
PART IV
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ITEM 15.
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EXHIBITS AND
FINANCIAL STATEMENT SCHEDULES.
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(a) The following documents are filed as part of this
annual report:
1. Financial Statements. The consolidated
financial statements of Shutterfly, Inc. are incorporated by
reference to Part II, Item 8 of this annual report.
2. Financial Statement
Schedules. Valuation and Qualifying Accounts
Report of
Independent Registered Public Accounting Firm
on
Financial Statement Schedule
To the Board of Directors and Stockholders
of Shutterfly, Inc.:
Our audits of the consolidated financial statements referred to
in our report dated March 16, 2007 appearing in this
Form 10-K of Shutterfly, Inc. also included an audit of the
financial statement schedule listed in Item 15(a)(2) of
this Form 10-K. In our opinion, this financial statement
schedule presents fairly, in all material respects, the
information set forth therein when read in conjunction with the
related consolidated financial statements.
/s/ PricewaterhouseCoopers
LLP
March 16, 2007
75
Schedule II
Valuation
and Qualifying Accounts
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Balance at
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Additions
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Balance at
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Beginning
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Charged to Costs
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Charged to Other
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End of
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of Period
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and Expenses
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Accounts
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Deductions
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Period
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Deferred tax valuation allowance
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Year ended December 31, 2004
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$
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28,058
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$
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$
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$
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(3,050
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)(1)
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$
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25,008
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Year ended December 31, 2005
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25,008
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(230
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)(2)
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(24,778
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)(3)
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Year ended December 31, 2006
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(1) |
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Decrease in the valuation allowance is due to a decrease in
deferred tax assets. |
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(2) |
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Reflects amounts related to items with no income statement
effect. |
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(3) |
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Decrease in the Valuation allowance is due to the reversal of
the valuation allowance in the fourth quarter of 2005. |
3. Exhibits.
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Incorporated by Reference
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Exhibit
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Date of
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Exhibit
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Provided
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Number
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Exhibit Description
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Form
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File No.
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First Filing
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Number
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Herewith
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3
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.01
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Registrants Restated
Certificate of Incorporation.
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S-1
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333-135426
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June 29, 2006
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3
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.03
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3
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.02
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Registrants Restated Bylaws.
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S-1
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333-135426
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June 29, 2006
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3
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.05
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4
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.01
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Form of Registrants common
stock certificate.
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S-1
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333-135426
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June 29, 2006
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4
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.01
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4
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.02
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Fifth Amended and Restated
Investors Rights Agreement, dated as of November 11,
2005, by and among the Registrant and certain investors of
Registrant.
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S-1
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333-135426
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June 29, 2006
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4
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.02
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10
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.01
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Form of Indemnity Agreement.
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S-1
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333-135426
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June 29, 2006
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10
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.01
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10
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.02
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1999 Stock Plan and forms of stock
option agreement and a stock option exercise agreement.*
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S-1
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333-135426
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June 29, 2006
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10
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.02
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10
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.03
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2006 Equity Incentive Plan and
forms of stock option agreement, stock option exercise
agreement, restricted stock agreement, restricted stock unit
agreement, stock appreciation right agreement and stock bonus
agreement.*
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S-1/A
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333-135426
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June 29, 2006
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10
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.03
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10
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.04
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Lease Agreement, as amended, dated
July 5, 1999, by and between the Registrant and Westport
Joint Venture, as amended to date.
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S-1
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333-135426
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June 29, 2006
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10
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.04
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10
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.05
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Agreement of Lease, dated as of
August 1, 2005, by and between the Registrant and DCT-CA
2004 RN Portfolio L, LP, as amended to date
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S-1
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333-135426
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June 29, 2006
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10
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.05
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10
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.06
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Lease, dated as of March 7,
2000, by and between the Registrant and 3168 Corporate Place
Associates, LLC, as amended to date.
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S-1
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333-135426
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June 29, 2006
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10
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.06
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76
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Incorporated by Reference
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Exhibit
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Date of
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Exhibit
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Provided
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Number
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Exhibit Description
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Form
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File No.
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First Filing
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Number
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Herewith
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10
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.07
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Lease, dated as of April 6,
2000, by and between the Registrant and 3168 Corporate Place
Associates, LLC, as amended to date
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S-1
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333-135426
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June 29, 2006
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10
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.07
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10
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.08
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Offer letter dated January 5,
2005 for Jeffrey T. Housenbold.*
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S-1
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333-135426
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June 29, 2006
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10
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.08
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10
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.09
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Offer letter dated June 23,
2004 for Stephen E. Recht.*
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S-1
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333-135426
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June 29, 2006
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10
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.09
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10
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.10
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Offer letter dated July 22,
2001 for Jeannine M. Smith Thomas.*
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S-1
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333-135426
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June 29, 2006
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10
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.10
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10
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.11
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Offer letter dated July 12,
2001 for Andrew F. Young.*
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S-1
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333-135426
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June 29, 2006
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10
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.11
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10
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.12
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Offer letter dated March 25,
2005 for Douglas J. Galen.*
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S-1
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333-135426
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June 29, 2006
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10
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.12
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10
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.13
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Offer letter dated April 3,
2006 for Stanford S. Au.*
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S-1
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333-135426
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June 29, 2006
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10
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.13
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10
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.14
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Supply agreement, dated as of
September 15, 2005, by and between Registrant and Fuji
Photo Film U.S.A., Inc.**
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S-1
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333-135426
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June 29, 2006
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10
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.14
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10
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.15
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Offer letter dated
January 17, 2007 for Dwayne Black.*
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X
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10
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.16
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Confidential Separation Agreement
and General Release of Claims, dated January 23, 2007, by
and between the Registrant and Jeannine M. Smith Thomas.*
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X
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10
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.17
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Confidential Separation Agreement
and General Release of Claims, dated January 19, 2007, by
and between the Registrant and Andrew F. Young.*
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X
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14
|
.01
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Code of Ethics for Chief Executive
Officer and Senior Financial Department Personnel
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X
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21
|
.01
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Subsidiaries of the Registrant
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X
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23
|
.01
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Consent of Independent Registered
Public Accounting Firm
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X
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24
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.01
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Power of Attorney. (See
page 79 of this
Form 10-K)
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X
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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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X
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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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X
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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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X
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77
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Incorporated by Reference
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|
|
Exhibit
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Date of
|
|
Exhibit
|
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Provided
|
Number
|
|
Exhibit Description
|
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Form
|
|
File No.
|
|
First Filing
|
|
Number
|
|
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Herewith
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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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X
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* |
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Represents a management contract or compensatory plan. |
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** |
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Confidential treatment has been granted for certain portions of
this document pursuant to an application for confidential
treatment sent to the Securities and Exchange Commission. Such
portions are omitted from this filing and were filed separately
with the Securities and Exchange Commission. |
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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. |
78
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
SHUTTERFLY, INC.
(Registrant)
Stephen E. Recht, Chief Financial Officer
Dated: March 20, 2007
POWER OF
ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose
signature appears below constitutes and appoints Jeffrey T.
Housenbold and Stephen E. Recht, jointly and severally, his or
her
attorneys-in-fact,
each with the power of substitution, for him or her in any and
all capacities, to sign any amendments to this Report on
Form 10-K
and to file same, with exhibits thereto and other documents in
connection therewith, with the Securities and Exchange
Commission, hereby ratifying and confirming all that each of
said
attorneys-in-fact,
or his substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons
on behalf of the registrant and in the capacities and dates
indicated.
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Signature
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Title
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Date
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/s/ Jeffrey
T. Housenbold
Jeffrey
T. Housenbold
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President, Chief Executive Officer
and Director
(Principal Executive Officer)
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March 20, 2007
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/s/ Stephen
E. Recht
Stephen
E. Recht
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Chief Financial Officer
(Principal Financial Officer)
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March 20, 2007
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/s/ Philip
A. Marineau
Philip
A. Marineau
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Chairman of the Board of Directors
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March 20, 2007
|
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/s/ Patricia
A. House
Patricia
A. House
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|
Director
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March 20, 2007
|
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/s/ Eric
J. Keller
Eric
J. Keller
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|
Director
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March 20, 2007
|
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|
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/s/ Nancy
J. Schoendorf
Nancy
J. Schoendorf
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Director
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March 20, 2007
|
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/s/ James
N. White
James
N. White
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|
Director
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March 20, 2007
|
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/s/ Stephen
J. Killeen
Stephen
J. Killeen
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|
Director
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March 20, 2007
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79