sflyq108_10q.htm
UNITED
STATES SECURITIES AND EXCHANGE COMMISSION
Washington,
DC 20549
Form
10-Q
(Mark
One)
|
x
|
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
|
|
For
the quarterly period ended March 31, 2008
|
or
|
o
|
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
|
|
For
the transition period from
to
|
Commission
file number 001-33031
SHUTTERFLY,
INC.
(Exact
Name of Registrant as Specified in Its Charter)
Delaware
|
94-3330068
|
(State or Other Jurisdiction of
Incorporation or Organization)
|
(IRS
Employer Identification No.)
|
2800
Bridge Parkway, Suite 101
Redwood
City, California
|
94065
|
(Address
of Principal Executive Offices)
|
(Zip
Code)
|
Registrant’s
Telephone Number, Including Area Code
(650)
610-5200
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 x
No o
Indicate
by check mark whether the Registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting company. See
definition of “accelerated filer,” “large accelerated filer,” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.
Large
accelerated Filer o
Accelerated
Filer x
Non-accelerated
Filer o
Smaller
reporting company o
(Do not
check if a smaller reporting company)
Indicate
by check mark whether the Registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes o No x
Indicate
the number of shares outstanding of each of the issuer’s classes of common
stock, as of the latest practicable date.
Class
|
Outstanding
at April 25, 2008
|
Common
stock, $0.0001 par value per share
|
25,029,856 shares
|
TABLE
OF CONTENTS
PART
I — FINANCIAL INFORMATION
|
ITEM
1. FINANCIAL STATEMENTS
|
ITEM
2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
|
ITEM
3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
|
ITEM
4. CONTROLS AND PROCEDURES
|
PART
II — OTHER INFORMATION
|
ITEM
1. LEGAL PROCEEDINGS
|
ITEM
1A. RISK FACTORS
|
ITEM
2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
PROCEEDS
|
ITEM
3. DEFAULTS UPON SENIOR SECURITIES
|
ITEM
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
|
ITEM
5. OTHER INFORMATION
|
ITEM
6. EXHIBITS
|
SIGNATURES
|
INDEX
TO EXHIBITS
|
EXHIBIT
31.1
|
EXHIBIT
31.2
|
EXHIBIT
32.1
|
EXHIBIT
32.2
|
|
PART I — FINANCIAL
INFORMATION
ITEM
1. FINANCIAL STATEMENTS
Item
1. Condensed Consolidated Financial Statements
SHUTTERFLY,
INC.
CONDENSED
CONSOLIDATED BALANCE SHEETS
(In
thousands, except par value amounts)
(Unaudited)
|
|
March
31,
2008
|
|
|
December
31,
2007
|
|
ASSETS
|
|
|
|
|
|
|
Current
assets:
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$ |
42,822 |
|
|
$ |
122,582 |
|
Short-term
investments
|
|
|
— |
|
|
|
3,002 |
|
Accounts
receivable, net
|
|
|
2,726 |
|
|
|
4,480 |
|
Inventories
|
|
|
4,016 |
|
|
|
4,788 |
|
Deferred
tax asset, current portion
|
|
|
2,172 |
|
|
|
1,677 |
|
Prepaid
expenses and other current assets
|
|
|
3,886 |
|
|
|
4,510 |
|
Total
current assets
|
|
|
55,622 |
|
|
|
141,039 |
|
Long-term
investments
|
|
|
49,777 |
|
|
|
— |
|
Property
and equipment, net
|
|
|
52,181 |
|
|
|
48,416 |
|
Goodwill
and intangible assets, net
|
|
|
15,549 |
|
|
|
3,859 |
|
Deferred
tax asset, net of current portion
|
|
|
14,627 |
|
|
|
13,294 |
|
Other
assets
|
|
|
2,177 |
|
|
|
2,162 |
|
Total
assets
|
|
$ |
189,933 |
|
|
$ |
208,770 |
|
LIABILITIES
AND STOCKHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
|
Accounts
payable
|
|
$ |
3,264 |
|
|
$ |
8,783 |
|
Accrued
liabilities
|
|
|
8,033 |
|
|
|
18,724 |
|
Deferred
revenue
|
|
|
8,560 |
|
|
|
8,699 |
|
Current
portion of capital lease obligations
|
|
|
649 |
|
|
|
808 |
|
Total
current liabilities
|
|
|
20,506 |
|
|
|
37,014 |
|
Other
liabilities
|
|
|
1,208 |
|
|
|
1,083 |
|
Capital
lease obligations, less current portion
|
|
|
65 |
|
|
|
107 |
|
Total
liabilities
|
|
|
21,779 |
|
|
|
38,204 |
|
Commitments
and contingencies (Note 6)
Stockholders’
equity
Undesignated
preferred stock, $0.0001 par value; 5,000 shares authorized; no shares
issued and outstanding
|
|
|
— |
|
|
|
— |
|
Common
stock, $0.0001 par value; 100,000 shares authorized; 25,008 and 24,805
shares issued and outstanding on March 31, 2008 and December 31, 2007,
respectively
|
|
|
2 |
|
|
|
2 |
|
Additional
paid-in capital
|
|
|
193,644 |
|
|
|
190,849 |
|
Accumulated
other comprehensive loss
|
|
|
(1,608 |
) |
|
|
(12 |
) |
Deferred
stock-based compensation
|
|
|
— |
|
|
|
(28 |
) |
Accumulated
deficit
|
|
|
(23,884 |
) |
|
|
(20,245 |
) |
Total
stockholders' equity |
|
|
168,154 |
|
|
|
170,566 |
|
Total
liabilities and stockholders' equity |
|
$ |
189,933 |
|
|
$ |
208,770 |
|
The
accompanying notes are an integral part of these condensed consolidated
financial statements.
SHUTTERFLY,
INC.
CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS
(In
thousands, except per share amounts)
(Unaudited)
|
|
Three
Months Ended
March 31,
|
|
|
|
2008
|
|
|
2007
|
|
Net
revenues
|
|
$ |
34,338 |
|
|
$ |
26,705 |
|
Cost
of net revenues(1)
|
|
|
17,929 |
|
|
|
13,034 |
|
Gross
profit
|
|
|
16,409 |
|
|
|
13,671 |
|
Operating
expenses(1):
|
|
|
|
|
|
|
|
|
Technology
and development
|
|
|
9,164 |
|
|
|
5,814 |
|
Sales
and marketing
|
|
|
8,055 |
|
|
|
5,180 |
|
General
and administrative
|
|
|
7,621 |
|
|
|
5,964 |
|
Total
operating expenses
|
|
|
24,840 |
|
|
|
16,958 |
|
Loss
from operations
|
|
|
(8,431 |
) |
|
|
(3,287 |
) |
Interest
expense
|
|
|
(28 |
) |
|
|
(54 |
) |
Interest
income
|
|
|
1,347 |
|
|
|
1,487 |
|
Loss
before income taxes
|
|
|
(7,112 |
) |
|
|
(1,854 |
) |
Benefit
from income taxes
|
|
|
3,473 |
|
|
|
794 |
|
Net
loss
|
|
$ |
(3,639 |
) |
|
$ |
(1,060 |
) |
|
|
|
|
|
|
|
|
|
Net
loss per share — basic and diluted
|
|
$ |
(0.15 |
) |
|
$ |
(0.04 |
) |
Weighted-average
shares outstanding — basic and diluted
|
|
|
24,949 |
|
|
|
23,933 |
|
|
|
|
|
|
|
|
|
|
(1)
Stock-based compensation is allocated as follows:
|
|
|
|
|
|
|
|
|
Cost
of net revenues
|
|
$ |
84 |
|
|
$ |
38 |
|
Technology
and development
|
|
|
391 |
|
|
|
264 |
|
Sales
and marketing
|
|
|
411 |
|
|
|
175 |
|
General
and administrative
|
|
|
932 |
|
|
|
385 |
|
The
accompanying notes are an integral part of these condensed consolidated
financial statements.
SHUTTERFLY,
INC.
CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In
thousands)
(Unaudited)
|
|
Three
Months Ended
March 31,
|
|
|
|
2008
|
|
|
2007
|
|
Cash
flows from operating activities:
|
|
|
|
|
|
|
Net
loss
|
|
$ |
(3,639 |
) |
|
$ |
(1,060 |
) |
Adjustments
to reconcile net loss to net cash used in operating
activities:
|
|
|
|
|
|
|
|
|
Depreciation
and amortization |
|
|
5,428 |
|
|
|
3,485 |
|
Amortization
of intangible assets
|
|
|
457 |
|
|
|
32 |
|
Stock-based
compensation, net of cancellations
|
|
|
1,818 |
|
|
|
862 |
|
Loss
on disposal of property and equipment
|
|
|
(8 |
) |
|
|
— |
|
Deferred
income taxes
|
|
|
(2,981 |
) |
|
|
(723 |
) |
Changes
in operating assets and liabilities, net of acquisition:
|
|
|
|
|
|
|
|
|
Accounts
receivable, net
|
|
|
1,754 |
|
|
|
1,025 |
|
Inventories
|
|
|
772 |
|
|
|
490 |
|
Prepaid
expenses and other current assets
|
|
|
624 |
|
|
|
(106 |
) |
Other
assets
|
|
|
(4 |
) |
|
|
17 |
|
Accounts
payable
|
|
|
(5,519 |
) |
|
|
(6,475 |
) |
Accrued
and other liabilities
|
|
|
(10,596 |
) |
|
|
(1,667 |
) |
Deferred
revenue
|
|
|
(136 |
) |
|
|
(155 |
) |
Net
cash used in operating activities
|
|
|
(12,030 |
) |
|
|
(4,275 |
) |
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
|
Purchases
of property and equipment
|
|
|
(7,930 |
) |
|
|
(3,611 |
) |
Capitalization
of software and website development costs
|
|
|
(848 |
) |
|
|
(638 |
) |
Acquisition
of business and intangibles, net of cash acquired
|
|
|
(10,101 |
) |
|
|
— |
|
Proceeds
from sale of equipment
|
|
|
6 |
|
|
|
— |
|
Proceeds
from sale of short-term investments
|
|
|
3,002 |
|
|
|
— |
|
Purchases
of long-term investments
|
|
|
(52,250 |
) |
|
|
— |
|
Net
cash used in investing activities
|
|
|
(68,121 |
) |
|
|
(4,249 |
) |
Cash
flows from financing activities:
|
|
|
|
|
|
|
|
|
Principal
payments of capital lease obligations
|
|
|
(201 |
) |
|
|
(1,040 |
) |
Proceeds
from issuance of common stock upon exercise of stock
options
|
|
|
592 |
|
|
|
179 |
|
Net
cash provided by (used in) financing activities
|
|
|
391 |
|
|
|
(861 |
) |
Net
decrease in cash and cash equivalents
|
|
|
(79,760 |
) |
|
|
(9,385 |
) |
Cash
and cash equivalents, beginning of period
|
|
|
122,582 |
|
|
|
119,051 |
|
Cash
and cash equivalents, end of period
|
|
$ |
42,822 |
|
|
$ |
109,666 |
|
|
|
|
|
|
|
|
|
|
Supplemental
disclosures of cash flow information
|
|
|
|
|
|
|
|
|
Cash
paid during the period for interest
|
|
$ |
15 |
|
|
$ |
50 |
|
Cash
paid during the period for income taxes
|
|
|
370 |
|
|
|
760 |
|
The
accompanying notes are an integral part of these condensed consolidated
financial statements.
SHUTTERFLY,
INC.
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
Note 1 — The Company and Summary of
Significant Accounting Policies
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.
Basis
of Presentation
The
accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information and, accordingly, do
not include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. The accompanying
unaudited condensed consolidated financial statements include the accounts of
Shutterfly, Inc. and its wholly owned subsidiary. In the opinion of management,
all adjustments, consisting primarily of normal recurring accruals, considered
necessary for a fair statement of the Company’s results of operations for the
interim periods reported and of its financial condition as of the date of the
interim balance sheet have been included. Operating results for the three months
ended March 31, 2008 are not necessarily indicative of the results that may be
expected for the year ending December 31, 2008 or for any other
period.
The
year-end condensed consolidated balance sheet data was derived from audited
financial statements, but does not include all disclosures required by
accounting principles generally accepted in the United States of America. These
unaudited interim condensed consolidated financial statements should be read in
conjunction with the consolidated financial statements and related notes for the
year ended December 31, 2007 included in the Company’s annual report on Form
10-K.
Principles
of Consolidation
The
accompanying condensed consolidated financial statements include the accounts of
the Company and its wholly-owned subsidiary. 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 provision for sales returns, intangible assets
valuation and useful lives, excess and obsolete inventories, deferred tax
valuation allowance, and legal contingencies among others. Actual results could
differ from these estimates.
Marketable
Securities
The
Company reviews declines in fair value of marketable securities in accordance
with SFAS No. 115, Accounting for Certain Investments in Debt and Equity
Securities, and related guidance issued by the FASB and SEC in order to
determine the classification of the impairment as “temporary” or
“other-than-temporary.” A temporary impairment charge results in an
unrealized loss being recorded in the other comprehensive income (loss)
component of stockholders equity. Such an unrealized loss does not
affect net income (loss) for the applicable accounting period. An
other-than–temporary impairment charge is recorded as a realized loss in the
condensed consolidated statement of operations and reduces net income (loss) for
the applicable accounting period. The differentiating factors between
these classifications are primarily the length of time and extent to which the
market value has been less than cost, the financial condition of the issuer, and
the ability and intent of the Company to retain its investment in the issuer for
a period of time sufficient to allow for any anticipated recovery in market
value.
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.
SHUTTERFLY,
INC.
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
The
Company accounts for uncertain tax positions in accordance with FASB
Interpretation No. 48 Accounting for Uncertainty in Income Taxes (“FIN 48”), an
interpretation of FASB Statement No. 109 (“SFAS 109”). The application of income
tax law is inherently complex. Laws and regulations in this area are voluminous
and are often ambiguous. The Company is required to make subjective assumptions
and judgments regarding its income tax exposures. Interpretations and guidance
surrounding income tax laws and regulations change over time. As such, changes
in the Company’s subjective assumptions and judgments can materially affect
amounts recognized in the consolidated balance sheets and statements of
operations.
The
Company’s policy is to recognize interest and/or penalties related to all tax
positions in income tax expense. To the extent that accrued interest
and penalties do not ultimately become payable, amounts accrued will be reduced
and reflected as a reduction of the overall income tax provision in the period
that such determination is made.
The
Company is subject to taxation in the United States, California, North Carolina,
New Jersey, New York, and Arizona. The Company is subject to examination for tax
years including and after 2003 for the United States, 2004 for California, and
2007 for the remaining jurisdictions.
Comprehensive
Income (loss)
Comprehensive
income (loss) consists of certain changes in equity that are excluded from net
income (loss). Specifically, unrealized gains and losses on available for sale
marketable securities are included in accumulated other comprehensive income
(loss).
The
components of accumulated other comprehensive income (loss) were as follows (in
thousands):
|
|
Three
Months Ended
March 31,
|
|
|
|
2008
|
|
|
2007
|
|
Unrealized
income (loss) in investments, net of tax of $860 and $5
|
|
$ |
(1,596 |
) |
|
$ |
9 |
|
Net
income (loss)
|
|
|
(3,639 |
) |
|
|
(1,060) |
|
Total
comprehensive income (loss)
|
|
$ |
(5,235 |
) |
|
$ |
(1,051) |
|
Recent
Accounting Pronouncements
Effective
January 1, 2008, the Company adopted SFAS No. 157, “Fair Value
Measurements” (“FAS 157”). In February 2008, the FASB issued a staff
position that delays the effective date of SFAS 157 for all nonfinancial assets
and liabilities except for those recognized or disclosed at least annually.
Therefore, the Company has adopted the provision of FAS 157 with respect to its
financial assets and liabilities only. FAS 157 defines fair
value, establishes a framework for measuring fair value and expands disclosures
about fair value measurements. Fair value is defined under FAS 157 as the
exchange price that would be received for an asset or paid to transfer a
liability (an exit price) in the principal or most advantageous market for the
asset or liability in an orderly transaction between market participants on the
measure date. Valuation techniques used to measure fair value under
FAS 157 must maximize the use of observable inputs and minimize the use of
unobservable inputs. The standard describes a fair value hierarchy
based on three levels of inputs, of which the first two are considered
observable and the last unobservable, that may be used to measure fair value
which are the following:
Level
1 – Quoted prices in active markets for identical assets or
liabilities
Level
2 – Inputs other than Level 1 that are observable, either directly or
indirectly, such as quoted prices for similar assets or liabilities; quoted
prices in markets that are not active; or other inputs that are observable or
can be corroborated by observable market data for substantially the full term of
the assets or liabilities.
Level
3 – Unobservable inputs that are supported by little or no market
activity and that are significant to the fair value of the assets or
liabilities.
The
adoption of this statement did not have a material impact on the Company’s
consolidated results of operations and financial condition.
SHUTTERFLY,
INC.
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
Effective January 1,
2008, the Company adopted 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. The Company
did not elect to adopt the fair value option under this
Statement.
In
December 2007, the FASB issued FAS No. 141R, “Business Combinations” (“FAS
141R”) which replaces FAS No. 141 and establishes principles and requirements
for how the acquirer of a business recognizes and measures in its financial
statements the identifiable assets acquired, the liabilities assumed, and any
noncontrolling interest in the acquiree. FAS 141R also provides guidance for
recognizing and measuring the goodwill acquired in the business combination and
determines what information to disclose to enable users of the financial
statements to evaluate the nature and financial effects of the business
combination. This Statement applies prospectively to business combinations for
which the acquisition date is on or after the beginning of the first annual
reporting period beginning on or after December 15, 2008. Early adoption of FAS
141R is prohibited. The Company is currently evaluating the impact, if any, of
adopting FAS 141R on its financial position and results of
operations.
In December 2007, the
FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial
Statements” (“FAS 160”) which amends ARB 51 to establish accounting and
reporting standards for the noncontrolling interest in a subsidiary and for the
deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in
a subsidiary is an ownership interest in the consolidated entity that should be
reported as equity in the consolidated financial statements. In addition to the
amendments to ARB 51, this Statement amends FASB Statement No. 128, Earnings per
Share; so that earnings-per-share data will continue to be calculated the same
way those data were calculated before this Statement was issued. This Statement
is effective for fiscal years, and interim periods within those fiscal years,
beginning on or after December 15, 2008. The Company is currently evaluating the
impact, if any, of adopting FAS 160 on its financial position and results
of operations.
Note 2 — Stock-Based
Compensation
Stock
Option Activity
A summary
of the Company’s stock option activity for the three months ended March 31, 2008
is as follows (in thousands):
|
|
Number
of Options
Outstanding
|
|
|
Weighted
Average
Exercise
Price
|
|
|
Weighted Average
Contractual
Term (Years)
|
|
|
Aggregate
Intrinsic
Value
|
|
Balances,
December 31, 2007
|
|
|
5,642 |
|
|
$ |
13.39 |
|
|
|
|
|
|
|
Granted
|
|
|
338 |
|
|
|
15.73 |
|
|
|
|
|
|
|
Exercised
|
|
|
(200 |
) |
|
|
2.96 |
|
|
|
|
|
|
|
Forfeited,
cancelled or expired
|
|
|
(89 |
) |
|
|
15.37 |
|
|
|
|
|
|
|
Balances,
March 31, 2008
|
|
|
5,691 |
|
|
$ |
13.86 |
|
|
|
8.2 |
|
|
$ |
21,746 |
|
Options
vested and expected to vest at March 31, 2008
|
|
|
5,218 |
|
|
$ |
13.40 |
|
|
|
8.1 |
|
|
$ |
21,198 |
|
Options
vested at March 31, 2008
|
|
|
2,143 |
|
|
$ |
8.18 |
|
|
|
7.2 |
|
|
$ |
14,751 |
|
During
the three months ended March 31, 2008, the Company granted options to purchase
an aggregate of 338,000 shares of common stock with an estimated
weighted-average grant-date fair value of $6.85 per share. The total intrinsic
value of options exercised during the three months ended March 31, 2008 was
$3,284,000. Net cash proceeds from the exercise of stock options were $592,000
for the three months ended March 31, 2008. As permitted by SFAS No. 123R, the
Company has deferred the recognition of its excess tax benefit from
non-qualified stock option exercises. As of March 31, 2008, there
were approximately 1,050,000 shares available for grant under the 2006 Equity
Incentive Plan (the “2006 Plan”).
Inducement
Options
In the
three month period ended March 31, 2008, the company granted an inducement stock
option award to an executive. This inducement grant was approved by
the Company’s Board of Directors and was not issued under a shareholder approved
plan. A total of 90,000 shares of common stock were granted under
this nonqualified stock option. This option has a 10 year term, and
vests over a four year period from the initial date of hire of the executive, in
a manner consistent with options granted under the 2006 Plan.
SHUTTERFLY,
INC.
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
Valuation
of Stock Options
The
Company estimated the fair value of each option award on the date of grant using
the Black-Scholes option-pricing model and the assumptions noted in the
following table. Expected volatility is based on the historical and implied
volatility of a peer group of publicly traded entities. The expected term of
options gave consideration to historical exercises, post-vesting cancellations
and the options’ contractual term. The risk-free rate for the expected term of
the option is based on the U.S. Treasury Constant Maturity at the time of grant.
The assumptions used to value options granted during the three months ended
March 31, 2008 and March 31, 2007 were as follows:
|
|
Three
Months Ended
March 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
|
(Unaudited)
|
|
|
(Unaudited)
|
|
Dividend
yield
|
|
|
— |
|
|
|
— |
|
Annual
risk free rate of return
|
|
|
2.2 |
% |
|
|
4.5 |
% |
Expected
volatility
|
|
|
51.4 |
% |
|
|
41.9 |
% |
Expected
term (years)
|
|
|
4.3 |
|
|
|
4.4 |
|
Employee stock-based compensation expense recognized in the three months ended
March 31, 2008 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.
Restricted
Stock Units
In 2008, the Company began granting restricted stock units (“RSU”) to employees
under the provisions of the 2006 Plan. The cost of restricted stock units is
determined using the fair value of our common stock on the date of
grant. RSUs typically vest and become exercisable with respect to 25%
of the shares on the first, second, third, and fourth anniversaries of the
vesting commencement date. In accordance with Statement of Accounting
Standards No. 123R, Share-Based Payment (“FAS 123R”), compensation cost is
measured amortized on a straight-line basis over the requisite service
period.
Restricted Stock Unit Activity
A summary
of the Company’s restricted stock activity for the three months ended March 31,
2008 is as follows (in thousands):
|
|
Number
of Units
Outstanding
|
|
|
Weighted
Average
Grant
Date Fair Value
|
|
Balances,
December 31, 2007
|
|
|
— |
|
|
$ |
— |
|
Granted
|
|
|
231 |
|
|
|
19.83 |
|
Vested
|
|
|
— |
|
|
|
— |
|
Forfeited,
cancelled or expired
|
|
|
— |
|
|
|
— |
|
Balances,
March 31, 2008
|
|
|
231 |
|
|
$ |
19.83 |
|
Included
in the RSU grants in the current year were 27,000 RSUs that had both performance
and service vesting criteria (“PBRSU”). The performance condition is
tied to the Company’s future performance, and the service criteria is consistent
with the four year service vesting described in the 2006
Plan. Compensation cost associated with these PBRSUs is recognized
based on whether or not satisfaction of the performance criteria is
probable. If in the future, situations indicate that the performance
criteria are not probable, then no further compensation cost will be recorded,
and any previous costs will be reversed.
Also
included in the RSU grants in the current year are 193,000 RSUs granted in
conjunction with the Company’s acquisition of Nexo Systems,
Inc. These grants are subject to a two year service based vesting
term.
At March
31, 2008, the Company had $25,334,000 of total unrecognized compensation expense
under SFAS No. 123R, net of estimated forfeitures, related to stock options and
awards that will be recognized over a weighted-average period of
approximately three years.
SHUTTERFLY,
INC.
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
Note 3 — Net Loss Per
Share
Basic net
loss per share attributed to common shares is computed by dividing the net loss
attributable to common shares for the period by the weighted average number of
common shares outstanding during the period as reduced by the weighted average
unvested common shares subject to repurchase by the Company.
Diluted
net loss per share attributed to common shares is computed by dividing the net
loss attributable to common shares for the period by the weighted average number
of common and potential common shares outstanding during the period, if the
effect of each class of potential common shares is dilutive. Potential common
shares include restricted common stock, common stock subject to repurchase
rights, and incremental shares of common stock issuable upon the exercise of
stock options and warrants.
|
|
Three Months Ended March 31,
|
|
|
|
2008
|
|
|
2007
|
|
Historical
net loss per share:
|
|
|
|
|
|
|
Numerator
|
|
|
|
|
|
|
Net
loss
|
|
$ |
(3,639 |
) |
|
$ |
(1,060 |
) |
Denominator
|
|
|
|
|
|
|
|
|
Weighted-average
common shares outstanding
|
|
|
24,953 |
|
|
|
23,958 |
|
Less:
Weighted-average unvested common shares subject to
repurchase
|
|
|
(4 |
) |
|
|
(25 |
) |
Denominator
for basic net loss per share
|
|
|
24,949 |
|
|
|
23,933 |
|
Dilutive
effect of stock options, restricted stock units, and shares subject to
repurchase
|
|
|
— |
|
|
|
— |
|
Denominator
for diluted net loss per share
|
|
|
24,949 |
|
|
|
23,933 |
|
Net
loss per share — basic and diluted
|
|
$ |
(0.15 |
) |
|
$ |
(0.04 |
) |
The following
weighted-average outstanding options, common stock subject to repurchase, and
restricted stock were excluded from the computation of diluted net loss per
common share for the periods presented because including them would have had an
antidilutive effect:
|
|
Three Months Ended March 31,
|
|
|
|
2008
|
|
|
2007
|
|
Options
to purchase common stock, common stock subject to repurchase, and
restricted stock
|
|
|
5,776 |
|
|
|
5,073 |
|
Note 4 — Fair Value
Measurement
In
accordance with FAS 157, the following table represents the Company’s fair value
hierarchy for its financial assets (cash equivalents and available for sale
investments) as of March 31, 2008 (in thousands):
|
|
March
31, 2008
|
|
|
|
Fair
Value
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
Cash
equivalents:
|
|
|
|
|
|
|
|
|
|
|
|
|
Money market funds |
|
$
|
28,139 |
|
|
$ |
28,139 |
|
|
$ |
— |
|
|
$ |
— |
|
Commercial
paper
|
|
|
5,453 |
|
|
|
— |
|
|
|
5,453 |
|
|
|
— |
|
Long-term
investments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Auction
rate securities
|
|
|
49,777 |
|
|
|
— |
|
|
|
— |
|
|
|
49,777 |
|
Total
financial assets
|
|
$ |
83,369 |
|
|
$ |
28,139 |
|
|
$ |
5,453 |
|
|
$ |
49,777 |
|
SHUTTERFLY,
INC.
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
The
Company’s non-current auction rate securities make up the majority of the
Company’s combined financial assets subject to fair value measurement and
the single asset valued under the Level 3 hierarchy. Auction-rate
securities (“ARS”) are long-term variable rate bonds tied to short-term interest
rates. After the initial issuance of the securities, the interest rate on the
securities is reset periodically, at intervals established at the time of
issuance (primarily every twenty-eight days), based on market demand for a reset
period. Auction-rate securities are bought and sold in the marketplace through a
competitive bidding process often referred to as a “Dutch auction.” If
there is insufficient interest in the securities at the time of an auction, the
auction may not be completed and the rates may be reset to predetermined
“penalty” or “maximum” rates.
From the
inception of these investments in ARS in January 2008 through March 31,
2008, due to the recent uncertainties in the credit markets, all scheduled
auctions have failed. Consequently, the investments are not currently
liquid and the Company will not be able to access these funds until a future
auction of these investments is successful or a buyer is found outside of the
auction process. At the time of the initial investment and through
the date of this report, all of these auction-rate securities remain AAA rated.
The assets underlying each security are student loans and 95% of the principal
amounts are guaranteed by the Federal Family Education Loan Program
(“FFELP”). The Company believes it has the ability and intent to hold
these ARS investments until the lack of liquidity in these markets is
resolved. As a result, the Company has classified the entire balance
of ARS as non-current investments on its condensed consolidated balance
sheet.
Typically,
the fair value of ARS investments approximates par value due to the frequent
resets through the auction process. While the Company continues to
earn interest on its ARS investments at the contractual rate, these investments
are not currently trading and therefore do not have a readily determinable
market value. Accordingly, the estimated fair value of the ARS no
longer approximates par value.
At March
31, 2008, the Company’s investment advisor provided a Level 3 valuation for the
ARS investments which indicated a fair value of $49.8 million. The
investment advisor utilized a discounted cash flow approach to arrive at this
valuation, which was corroborated by a separate and comparable discounted cash
flow analysis prepared by the Company. The assumptions used in
preparing the discounted cash flow model include estimates for interest rates,
timing and amount of cash flows, credit and liquidity premiums, and expected
holding periods of the ARS. These assumptions are volatile and
subject to change as the underlying sources of these assumptions and market
conditions change. They represent the Company’s estimates given
available data as of March 31, 2008.
Based on
this assessment of fair value, as of March 31, 2008 the Company determined there
was a decline in fair value of its ARS investments of $2.5 million which was
deemed temporary. That amount has been recorded net of tax, as a
component of other comprehensive income.
The
following table provides a summary of changes in fair value of the Company’s ARS
investments (Level 3) as of March 31, 2008 (in thousands):
Balance
at December 31, 2007
|
|
$ |
— |
|
Purchase
of ARS investments
|
|
|
52,250 |
|
Unrealized
loss included in other comprehensive income
|
|
|
(2,473 |
) |
Balance
at March 31, 2008
|
|
$ |
49,777 |
|
SHUTTERFLY,
INC.
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
Note 5 — Balance Sheet
Components
Property
and Equipment
|
|
March
31, 2008
|
|
|
December
31, 2007
|
|
|
|
(in
thousands)
|
|
Computer
and other equipment
|
|
$ |
69,938
|
|
|
$ |
66,663 |
|
Software
|
|
|
6,946 |
|
|
|
6,089 |
|
Leasehold
improvements
|
|
|
8,199 |
|
|
|
7,952 |
|
Furniture
and fixtures
|
|
|
2,330 |
|
|
|
2,282 |
|
Capitalized
software and website development costs
|
|
|
7,917 |
|
|
|
6,656 |
|
|
|
|
95,330 |
|
|
|
89,642 |
|
Less:
Accumulated depreciation and amortization
|
|
|
(43,149 |
) |
|
|
(41,226 |
) |
Net
property and equipment
|
|
$ |
52,181 |
|
|
$ |
48,416 |
|
Property
and equipment includes $3,356,000 and $5,121,000 of equipment under capital
leases at March 31, 2008 and December 31, 2007, respectively. Accumulated
depreciation of assets under capital leases totaled $2,561,000 and $3,798,000 at
March 31, 2008 and December 31, 2007, respectively.
Depreciation
and amortization expense totaled $5,428,000 and $3,485,000 for the three months
ended March 31, 2008 and 2007, respectively.
Accrued
Liabilities
|
|
March
31, 2008
|
|
|
December
31, 2007
|
|
|
|
(in
thousands)
|
|
Accrued
compensation
|
|
$ |
2,195 |
|
|
$ |
3,053 |
|
Accrued
marketing expenses
|
|
|
1,756 |
|
|
|
4,101 |
|
Accrued
purchases
|
|
|
604 |
|
|
|
1,414 |
|
Accrued
consultant expenses
|
|
|
560 |
|
|
|
1,516 |
|
Accrued
sales taxes
|
|
|
439 |
|
|
|
3,682 |
|
Accrued
production facility expenses
|
|
|
318 |
|
|
|
3,283 |
|
Accrued
other
|
|
|
2,161 |
|
|
|
1,675 |
|
|
|
$ |
8,033 |
|
|
$ |
18,724 |
|
Note 6 — Commitments and
Contingencies
Indemnifications
In the
normal course of business, the Company enters into contracts and agreements that
contain a variety of representations and warranties and provide for general
indemnifications. The Company’s exposure under these agreements is unknown
because it involves claims that may be made against the Company in the future,
but have not yet been made. To date, the Company has not paid any claims or been
required to defend any action related to its indemnification obligations.
However, the Company may record charges in the future as a result of these
indemnification obligations.
SHUTTERFLY,
INC.
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
Contingencies
From time
to time, the Company may have certain contingent liabilities that arise in the
ordinary course of its business activities. The Company accrues contingent
liabilities when it is probable that future expenditures will be made and such
expenditures can be reasonably estimated.
Legal
Matters
On or
about June 18, 2007, Fotomedia Technologies, LLC filed a lawsuit in the United
States District Court for the Eastern District of Texas, against the Company and
several other defendants alleging patent infringement. The Fotomedia
Complaint seeks unspecified damages, costs, interest and attorneys’ fees, and an
injunction against all parties. In lieu of answering the Fotomedia
Complaint, the Company moved to dismiss it by joining in a motion filed by
co-defendant Photobucket.com, Inc. While the motion was pending and
not yet decided, on or about November 6, 2007, Fotomedia filed an Amended
Complaint. The Amended Complaint likewise alleges infringement of the
same three patents and seeks unspecified damages, costs, interest and attorneys’
fees, and a permanent injunction. However, the amended complaint
dropped the allegations of willful infringement against the Company in
connection with one of the patents-at-issue. Defendants moved to
dismiss the Amended Complaint as well. The motion has not yet been
ruled upon. As such, the Company has not yet been required to file an
answer or other responsive pleading. The Court has nonetheless set a
schedule in this matter, which includes a trial date of November 2, 2009.
At this time, the Company does not believe that the amount of potential loss, if
any, is reasonably estimable.
On or
about February 5, 2008, Parallel Networks, LLC filed a lawsuit in the United
States District Court for the Eastern District of Texas, against the Company and
several other defendants alleging patent infringement. The Parallel
Networks Complaint seeks unspecified damages, costs, interest and attorneys’
fees, and an injunction against all parties. The Company has not yet
answered or otherwise responded to the complaint. Plaintiffs have
moved to consolidate this case with an earlier case filed against Netflix, Inc.,
et al. The Company has joined a motion in an opposition to
consolidation filed by another defendant. The Court has set a
scheduling conference for May 14, 2008 in both this action and the case
filed against Netflix, Inc., et al. Presently there are six reexamination
requests (filed by others) in the U.S. Patent & Trademark Office regarding
the patents asserted in the Parallel Networks Complaint, all of which have been
granted and are pending. The Company is joining in a Motion to Stay
the litigation pending the outcome of these reexamination proceedings. At
this time, the Company does not believe that the amount of potential loss, if
any, is reasonably estimable.
From time
to time, the Company may be involved in various legal proceedings arising in the
ordinary course of business. At March 31, 2008, in the opinion of
management, there are no other matters that are expected to have a material
adverse effect on the Company’s financial position, results of operations or
cash flows.
Note 7 —
Acquisition
Nexo Systems,
Inc. On January 4, 2008, the Company acquired all of the
outstanding shares of Nexo Systems, Inc. ("Nexo") for total aggregate cash
proceeds of $10.1 million, including $0.1 million in fees; and $4.0 million in
restricted stock. Nexo has developed and launched an
internet-based platform, whereby groups can create customized, content-rich
personal and group websites. The acquisition was accounted for as a
non-taxable purchase transaction and, accordingly, the purchase price has been
allocated to the tangible assets, liabilities assumed, and identifiable
intangible assets acquired based on their estimated fair values on the
acquisition date. The excess of the purchase price over the aggregate fair
values was recorded as goodwill. The restricted stock award was
granted contingent upon continued employment for a period of two
years. As a result, the $4.0 million will be recognized as
stock-based compensation over the two year service
period.
Based
upon the report of an independent valuation consultant, of the total purchase
price, $5.1 million was allocated to developed technology and is being amortized
over an estimated useful life of five years, and $0.1 million was allocated to
all other assets and liabilities acquired. No amount was allocated to
in-process research and development. The remaining excess purchase
price of approximately $4.9 million was allocated to goodwill. In
addition, $2.0 million was recorded as a deferred tax liability representing the
difference between the assigned values of the assets acquired and the tax basis
of those assets, with the offset recorded as additional goodwill. The
results of operations for the acquired business have been included in our
condensed consolidated statement of operations for the period subsequent to our
acquisition of Nexo. Nexo's results of operations for periods prior to
this acquisition were not material to our condensed consolidated statement of
operations and, accordingly, pro forma financial information has not been
presented.
SHUTTERFLY,
INC.
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
The
following table provides a summary of the activity of the Company’s goodwill and
intangible asset balances due to the additions from the Nexo acquisition (in
thousands):
|
|
December
31, 2007
|
|
|
Additions
|
|
|
Accumulated
Amortization
|
|
|
March
31, 2008
|
|
Purchase
technology
|
|
$ |
3,350 |
|
|
$ |
5,100 |
|
|
$ |
(1,258 |
) |
|
$ |
7,192 |
|
Customer
relationships
|
|
|
990 |
|
|
|
- |
|
|
|
(193 |
) |
|
|
797 |
|
Licenses
and other
|
|
|
186 |
|
|
|
70 |
|
|
|
(52 |
) |
|
|
204 |
|
Total
intangible assets, net
|
|
$ |
4,526 |
|
|
$ |
5,170 |
|
|
$ |
(1,503 |
) |
|
$ |
8,193 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Goodwill
|
|
$ |
379 |
|
|
$ |
6,977 |
|
|
|
- |
|
|
$ |
7,356 |
|
Note 8 — Intellectual Property Cross-Licensing
Agreement
On February
8, 2008, the Company entered into a cross-licensing agreement for intellectual
property with American Greetings, Inc (“AGI”). Under the terms of the
agreement, AGI has rights to use the Company’s current and pending patented
technology and processes. In addition, the Company has rights to use
certain of AGI’s current and pending patented technology and
processes.
As
consideration for the rights under the agreement, AGI will pay fees due under
the agreement in three installments in February 2008, March 2009, and March
2010. Such amounts will be recognized as a reduction of general and
administrative expense as each installment becomes due and payable.
Note 9 — Subsequent
Event
Line of
Credit: In April 2008, the Company entered into a line of
credit facility with a financial institution. The facility is a $20.0
million 364-day revolving line of credit, and is collateralized by substantially
all of the assets of the Company. To date, no amounts have been drawn
on the line of credit.
ITEM 2. MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS.
CAUTIONARY
NOTE REGARDING FORWARD-LOOKING STATEMENTS
This document, including the
following Management’s Discussion and Analysis of Financial Condition and
Results of Operations, contains forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934 that are based upon our current expectations.
These forward-looking statements include statements related to our
expectations regarding the seasonality of our business, the decline in average
selling prices for prints, revenue trends, average order value, number of orders, number of
customers, operating
expenses as a percentage of net revenues, our capital expenditures for 2008, effective tax rates,
realization of deferred tax assets, the sufficiency of our cash and cash
equivalents balances and cash generated from operations for the next 12 months
and our ability to grow our personalized products and services as a
percentage of our total revenues, as well as other statements regarding our future
operations, financial condition and prospects and business strategies. In some
cases, you can identify forward-looking statements by terminology such as
“project,” “believe,” “anticipate,” “plan,” “expect,” “estimate,” “intend,”
“continue,” “should,” “would,” “could,” “potentially,” “will,” or “may,” or
the negative of these terms or other comparable terminology.
Forward-looking statements involve risks and uncertainties. Our actual results
and the timing of events could differ materially from those anticipated in
our forward-looking statements as a result of many factors, including but not
limited to, the seasonality of our business, whether we are able to expand our
customer base and increase our product and service offering, competition in our
marketplace and the other risks set forth below under “Risk Factors” in Part
II, Item 1A of this report. Given these risks and uncertainties, readers are
cautioned not to place undue reliance on such forward-looking statements. We
assume no obligation to update any of the forward-looking statements after the
date of this report or to conform these forward-looking statements to actual
results.
Overview
We are an
Internet-based social expression and personal publishing service that enables
consumers to share, print and preserve their memories by leveraging our
technology, 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 the majority of our 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-sized to jumbo-sized 20×30 enlargements). We manufacture these items in
our Hayward, California and Charlotte, North Carolina manufacturing facilities.
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 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. During the three months ended March 31,
2008, we fulfilled more than 1.6 million orders, to more than 895,000
customers, at an average order value of more than $21 per order.
On
January 4, 2008, for approximately $10.1 million in cash and stock consideration
of approximately $4.0 million, we acquired Nexo, a privately held on-line
sharing and group services company based in Palo Alto, California.
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 through 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. Referral fees are also included in
personalized products and services revenue. We believe our products
and services are differentiated from other traditional photo processors by our
high quality production and numerous form factors and templates, which are key
to attracting and retaining customers.
Our
business is subject to seasonal fluctuations. In particular, we generate a
substantial portion of our revenues during the holiday season in the calendar
fourth quarter. We also typically experience increases in net revenues during
other shopping-related seasonal events, such as Easter, Mother’s Day, Father’s
Day, and Halloween. We generally experience lower net revenues during the first,
second and third calendar 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 product orders, usually one to
three business days, order backlog is not material to our business.
To
further understand revenue trends, we monitor several key metrics
including:
Total Customers.
We closely monitor total customers as a key indicator of
demand. Total customers include the number of transacting customers
in a given period. We seek to expand our customer base by empowering
our existing customers with sharing and collaboration services (such as
Shutterfly Gallery, the Nexo platform, and Shutterfly Collections), and by
conducting integrated marketing and advertising programs. Total
customers have increased on an annual basis each year since inception, and we
anticipate that this trend will continue.
Average Order Value.
Average order value is net revenues for a given period divided by
the total number of customer orders recorded during that same period. We seek to
increase average order value as a means of increasing net revenues. Average
order value has increased on an annual basis for each year since 2000, and we
anticipate that this trend will continue in the future.
Total Number of Orders.
We closely monitor total number of orders as a leading indicator of
net revenue trends. We recognize the net revenues associated with an order when
the products have been shipped and all other revenue recognition criteria have
been met. Orders are typically processed and shipped within two
business days after a customer places an order. Total number of orders has
increased on an annual basis for each year since 2000, and we anticipate that
this trend will continue in the future.
Personalized Products and Services
Revenues as Percentage of Net Revenues. We continue to
innovate and improve our personalized products and services and expect the net
revenues from these products and services to increase as percentage of net
revenues as we continue to diversify our product
offerings. Personalized products and services as a percentage of
total net revenue increased from 51% in 2006 to 56% in 2007. In
addition, as a percentage of total net revenues, revenues from 4x6 prints have
been declining; from 37% in 2005, to 28% in 2006, and to 22% in
2007.
We
believe the analysis of these metrics provides us with important information on
our overall net 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 Net Revenues.
Cost of net revenues consist primarily of direct materials (the
majority of which consists of paper, ink, 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 net 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
acquired developed technology and capitalized website development
costs.
Operating Expenses.
Operating expenses consist of technology and development, sales and
marketing, and general and administrative expenses. We anticipate that each of
the following categories of operating expenses will increase in absolute dollar
amounts, but remain relatively consistent as a percentage of net
revenues.
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, as well as amortization of purchased software. Technology and development
expense also includes co-location 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 during
the period.
Interest Expense.
Interest expense consists of interest costs recognized under our capital lease
obligations and other borrowings.
Interest Income.
Interest income consists of the interest earned on our cash and
investment accounts.
Income
Taxes. 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 range between 49% and 78%.
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 management’s judgment in its application,
while in other cases, management’s 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
management’s judgments and estimates.
Revenue Recognition.
We generate revenues primarily from the printing and shipping of
prints and other photo-based products, and referral fees. We generally recognize
revenues from product sales upon shipment when persuasive evidence of an
arrangement exists (typically through the use of a credit card or receipt of a
check), the selling price is fixed or determinable and collection of resulting
receivables is reasonably assured. Revenues from amounts billed to customers,
including prepaid orders, are deferred until shipment of fulfilled orders. 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. During the three month period ended March 31, 2008,
returns totaled less than 1% of net revenues and have been within management’s
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 included in net revenues. Production costs
related to free products are included in costs of revenues upon
redemption. Shipping charged to customers is recognized as revenue at
the time of shipment. Revenue from referral fees for click-throughs
is recognized in the period that the click-through impression is
delivered.
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 management’s 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, including stock based compensation, incurred in the
development phase are capitalized and amortized over the product’s 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. On
January 1, 2006, we adopted FAS 123(R), which requires a fair value measurement
and recognition of compensation expense for all share-based payment awards made
to our employees and directors, including employee stock options and restricted
stock awards.
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.
The cost of restricted
stock awards and performance based restricted stock awards is determined using
the fair value of our common stock on the date of grant. Compensation
expense is recognized for restricted stock awards on a straight-line basis over
the vesting period. Compensation expense associated with performance
based restricted stock awards is recognized based on whether or not satisfaction
of the performance criteria is probable. If in the future, situations
indicate that the performance criteria are not probable, then no further
compensation cost will be recorded, and any previous costs will be
reversed.
Results
of Operations
|
|
Three Months Ended March 31,
|
|
|
|
2008
|
|
|
2007
|
|
Net
revenues
|
|
|
100 |
% |
|
|
100 |
% |
Cost
of net revenues
|
|
|
52 |
% |
|
|
49 |
% |
Gross
profit
|
|
|
48 |
% |
|
|
51 |
% |
Operating
expenses:
|
|
|
|
|
|
|
|
|
Technology
and development
|
|
|
27 |
% |
|
|
22 |
% |
Sales
and marketing
|
|
|
23 |
% |
|
|
19 |
% |
General
and administrative
|
|
|
22 |
% |
|
|
22 |
% |
Loss
from operations
|
|
|
(24 |
)% |
|
|
(12 |
)% |
Interest
expense
|
|
|
0 |
% |
|
|
0 |
% |
Interest income
|
|
|
4 |
% |
|
|
6 |
% |
Loss
before income taxes
|
|
|
(20 |
)% |
|
|
(7 |
)% |
Benefit
from income taxes
|
|
|
10 |
% |
|
|
3 |
% |
Net
loss
|
|
|
(10 |
)% |
|
|
(4 |
)% |
Comparison
of the Three Month Periods Ended March 31, 2008 and 2007
|
|
Three
Months Ended March 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
$
Change
|
|
|
%
Change
|
|
|
|
(in thousands)
|
|
Net
revenues
|
|
$ |
34,338 |
|
|
$ |
26,705 |
|
|
$ |
7,633 |
|
|
|
29 |
% |
Cost
of net revenues
|
|
|
17,929 |
|
|
|
13,034 |
|
|
|
4,895 |
|
|
|
38 |
% |
Percentage
of net revenues
|
|
|
52 |
% |
|
|
49 |
% |
|
|
|
|
|
|
|
|
Gross
profit
|
|
|
16,409 |
|
|
|
13,671 |
|
|
|
2,738 |
|
|
|
20 |
% |
Net
revenues increased $7.6 million, or 29%, for the three months ended March 31,
2008, as compared to the same period in 2007. Revenue growth was attributable to
the increases in both print and personalized products and services revenues.
Personalized products and services (“PPS”) revenues increased $5.3 million, or
41%, to $18.4 million for the three months ended March 31, 2008 as compared to
the same period in 2007. This change was primarily the result of increased sales
of photo books, calendars and folded greeting cards, as well as an increase in
referral fees. PPS made up 54% of net revenues for the three months
ended March 31, 2008, up from 49% for the same period in 2007. Print revenues
increased $2.3 million, or 17%, to $15.9 million for the three months ended
March 31, 2008 as compared to the same period in 2007. This increase was
primarily the result of increased sales of 4x6, large format and
photocard print sizes. In the first quarter of 2008, 4x6 print
revenues represented 29% of total net revenues versus 34% in the first quarter
of 2007. Net revenue increases were also the result of
year-over-year increases in all of our key metrics: customers, orders, and
average order value, as noted below:
|
|
Three
Months Ended March 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
Change
|
|
|
%
Change
|
|
|
|
(In
thousands, except AOV amounts)
|
|
Customers
|
|
|
895 |
|
|
|
693 |
|
|
|
202 |
|
|
|
29 |
% |
Orders
|
|
|
1,617 |
|
|
|
1,288 |
|
|
|
329 |
|
|
|
26 |
% |
Average
order value
|
|
$ |
21.23 |
|
|
$ |
20.73 |
|
|
$ |
0.50 |
|
|
|
2 |
% |
Cost of
net revenues increased $4.9 million, or 38%, for the three months ended March
31, 2008 as compared to the same period in 2007. As a percentage of net
revenues, cost of net revenues increased from 49% to 52% for the same comparable
period, which decreased gross margin from 51% in the first quarter of 2007 to
48% in the first quarter of 2008. Overall, the increase in cost of net revenues
was primarily the result of the increased volume of shipped products, fixed
costs associated with operating two manufacturing facilities in the first
quarter of 2008 versus one facility in 2007, and the impact of intangible
amortization from the Make It About Me and Nexo acquisitions which were not
included in the three months ended March 31, 2007. In addition, we
incurred increased discounting associated with product promotions for both the
Valentine’s Day and Easter holidays, both of which occurred in the first quarter
of 2008. These costs were offset by savings in labor, shipping, and
materials costs reflecting efficiencies realized in our Charlotte facility and
other negotiated cost reductions.
|
|
Three Months Ended March
31,
|
|
|
|
2008
|
|
|
2007
|
|
|
$
Change
|
|
|
%
Change
|
|
|
|
(in
thousands)
|
|
Technology
and development
|
|
$ |
9,164 |
|
|
$ |
5,814 |
|
|
$ |
3,350 |
|
|
|
58 |
% |
Percentage
of net revenues
|
|
|
27 |
% |
|
|
22 |
% |
|
|
|
|
|
|
|
|
Sales
and marketing
|
|
|
8,055 |
|
|
|
5,180 |
|
|
|
2,875 |
|
|
|
56 |
% |
Percentage
of net revenues
|
|
|
23 |
% |
|
|
19 |
% |
|
|
|
|
|
|
|
|
General
and administrative
|
|
|
7,621 |
|
|
|
5,964 |
|
|
|
1,657 |
|
|
|
28 |
% |
Percentage
of net revenues
|
|
|
22 |
% |
|
|
22 |
% |
|
|
|
|
|
|
|
|
Our technology and development expense increased $3.4 million, or 58%,
for the three months ended March 31, 2008 as compared to the same period in
2007; this expense increased as a percentage of net revenues from 22% to 27%.
The overall increase in technology and development expense was attributable to
increased personnel and related costs for employees and consultants involved
with website development and website infrastructure support teams, which totaled
$1.2 million, as well as increased depreciation expenses of $1.3 million
related to our investments in website infrastructure hardware to support our
continued revenue growth. For the three months ended March 31,
2008, we capitalized $1.3 million in eligible costs, including stock based
compensation, associated with software developed or obtained for internal
use, up from $0.5 million in 2007. Stock-based compensation expense
was $0.4 million in the three months ended March 31, 2008, compared to $0.3
million in the three months ended March 31, 2007.
Our sales
and marketing expense increased $2.9 million, or 56%, for the three months ended
March 31, 2008 as compared to the same period in 2007; this expense increased as
a percentage of net revenues from 19% to 23%. Personnel and related costs for
employees and consultants increased by $0.9 million, and our expenditures
incurred on customer acquisition and promotion costs increased by $1.7 million.
In addition, stock-based compensation expense was $0.4 million in the three
months ended March 31, 2008, compared to $0.2 million in the three months ended
March 31, 2007.
Our
general and administrative expense increased $1.7 million, or 28%, for the three
months ended March 31, 2008 as compared to the same period in 2007. This expense
remained flat as a percentage of net revenues at 22%. Personnel and related
costs for employees increased by $0.8 million for the three months ended March
31, 2008 as compared to the same period in 2007 reflecting increased hiring in
2008 and an increase in stock-based compensation to $0.9 million, in 2008,
compared to $0.4 million in 2007. Accounting and legal fees increased by
$0.7 million for the three months ended March 31, 2008 as compared to the same
period in 2007. Payment processing fees paid to third parties increased by $0.2
million during the three months ended March 31, 2008 as compared to the same
period in 2007 due to increased order volumes. Offsetting these costs
was the receipt of the first annual installment from a multi-million dollar
intellectual property cross-licensing agreement with American Greetings,
Inc. This cross-licensing agreement provides American Greetings with
access to our 23 patents and 30 of our pending patent
applications. We expect to recognize the remaining two installments
under the agreement when those amounts are received in the first quarter of both
fiscal year 2009 and 2010.
|
|
Three
Months Ended March 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
Change
|
|
|
|
(In
thousands)
|
|
Interest
expense
|
|
$ |
(28 |
) |
|
$ |
(54 |
) |
|
$ |
26 |
|
Interest
income
|
|
$ |
1,347 |
|
|
$ |
1,487 |
|
|
$ |
(140 |
) |
Interest
expense decreased by $26,000 or 48% for the three months ended March 31, 2008 as
compared to the same period in 2007, due primarily to a decrease in interest
expense on capitalized lease obligations.
Interest
income decreased by $0.1 million for the three months ended March 31, 2008 as
compared to the same period in 2007, due to smaller invested cash balances and
lower interest rates, off set partially by higher rates on the portion of our
investment portfolio invested in auction rate securities.
|
|
Three
Months Ended March 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
|
(in
thousands)
|
|
Income
tax benefit
|
|
$ |
3,473 |
|
|
$ |
794 |
|
Effective
tax rate
|
|
|
49 |
% |
|
|
43 |
% |
The
benefit for income taxes was $3.5 million for the first three months of 2008,
compared to a benefit of $0.8 million for the same period in 2007. Our effective
tax rate was 49% in 2008, up from 43% in 2007. This increase in our
effective tax rate is primarily the result of the elimination of any 2008
benefit from research and development credits from our full year
forecast. Congress has not yet approved an extension of that tax
credit for 2008 and therefore that credit is not currently factored into our
effective rate. We also are subject to tax rate sensitivities due to
the fixed nature of our remaining incentive stock option based permanent tax
differences.
As of
March 31, 2008, we had approximately $31 million of federal and
$32 million of state net operating loss carryforwards available to reduce
future taxable income. These net operating loss carryforwards begin to expire in
2020 and 2011 for federal and state tax purposes, respectively.
|
|
Three
Months Ended March 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
|
(in
thousands)
|
|
Loss
before income taxes
|
|
$ |
(7,112 |
) |
|
$ |
(1,854 |
) |
Net
loss
|
|
|
(3,639 |
) |
|
|
(1,060 |
) |
Net loss
increased by $2.6 million for the three months ended March 31, 2008 as compared
to the same period in 2007. As a percentage of net revenue, net loss was 10% and
3% for the three months ended March 31, 2008 and March 31, 2007,
respectively.
Liquidity
and Capital Resources
|
|
Three
Months Ended March 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
|
(in
thousands)
|
|
Consolidated
Statements of Cash Flows Data:
|
|
|
|
|
|
|
Purchases
of property and equipment
|
|
$ |
7,930 |
|
|
$ |
3,611 |
|
Capitalization
of software and website development costs
|
|
|
848 |
|
|
|
638 |
|
Depreciation
and amortization
|
|
|
5,885 |
|
|
|
3,517 |
|
Cash
flows used in operating activities
|
|
|
(12,030 |
) |
|
|
(4,275 |
) |
Cash
flows used in investing activities
|
|
|
(68,121 |
) |
|
|
(4,249 |
) |
Cash
flows provided by (used in) financing activities
|
|
|
391 |
|
|
|
(861 |
) |
We
anticipate that our current cash and cash equivalents balances, cash generated
from operations, and our line of credit 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 debt or equity. The sale of additional equity could result in
additional dilution to our stockholders. Financing arrangements may not be
available to us, or may not be in amounts or on terms acceptable to
us.
Historically
we have financed our operations and capital expenditures through operations,
private sales of preferred stock, our initial public offering, lease financing
and the use of bank and related-party loans. As a result of our initial public
offering in September 2006, we raised approximately $80.9 million of proceeds,
net of underwriters’ discount, which we received on October 4, 2006. At March
31, 2008, we had $42.8 million of cash and cash equivalents. Cash equivalents
are comprised of money market funds and commercial
paper.
At March
31, 2008, $52.3 million of our marketable securities portfolio was invested in
AAA rated investments in auction-rate debt securities. Auction-rate securities
are long-term variable rate bonds tied to short-term interest rates. After the
initial issuance of the securities, the interest rate on the securities is reset
periodically, at intervals established at the time of issuance (primarily every
twenty-eight days), based on market demand for a reset period. Auction-rate
securities are bought and sold in the marketplace through a competitive bidding
process often referred to as a “Dutch auction.” If there is insufficient
interest in the securities at the time of an auction, the auction may not be
completed and the rates may be reset to predetermined “penalty” or “maximum”
rates. Following such a failed auction, we would not be able to access our
funds that are invested in the corresponding auction-rate securities until a
future auction of these investments is successful or new buyers express interest
in purchasing these securities in between reset dates.
From the
inception of our investments in these ARS in January 2008, through March 31,
2008, due to the recent uncertainties in the credit markets, all scheduled
auctions for ARS have failed. Consequently, the investments are not
currently liquid and we will not be able to access these funds until a
future auction of these investments is successful or a buyer is found outside of
the auction process. At the time of our initial investment and
through the date of this report, all of our auction-rate securities remain AAA
rated. The assets underlying each security are student loans and 95% of the
principal amounts are guaranteed by the Federal Family Education Loan Program
(FFELP). We believe we have the ability and intent to hold these ARS
investments until the lack of liquidity in those markets is
resolved. As a result, we have classified the entire balance of ARS
as non-current investments on its condensed consolidated balance
sheet.
Typically,
the fair value of ARS investments approximates par value due to the frequent
resets through the auction process. While we continue to earn
interest on our ARS investments at the contractual rate, these investments
are not currently trading and therefore do not have a readily determinable
market value. Accordingly, the estimated fair value of the ARS no
longer approximates par value.
At March
31, 2008, our investment advisor provided a Level 3 valuation for the ARS
investments which indicated a fair value of $49.8 million. The
investment advisor utilized a discounted cash flow approach to arrive at this
valuation, which was corroborated by a separate and comparable discounted cash
flow analysis prepared by us. The assumptions used in preparing the
discounted cash flow model include estimates for interest rates, timing and
amount of cash flows, credit and liquidity premiums, and expected holding
periods of the ARS. These assumptions are volatile and subject to
change as the underlying sources of these assumptions and market conditions
change. They represent our estimates given available data as of March
31, 2008. Based on
this assessment of fair value, as of March 31, 2008 we determined there was a
decline in fair value of its ARS investments of $2.5 million which was deemed
temporary.
On an
annual basis, for the last three years our cash flows generated from operating
activities have been in excess of our capital expenditure
requirements. Accordingly, we continue to believe that we have
sufficient liquid capital to fund our operations and capital
requirements. As of March 31, 2008, we have access to our cash and
cash equivalents and our other liquid investments, totaling $42.8
million In addition, in April 2008, to supplement our overall
liquidity position, we entered into a 364-day revolving credit facility with a
financial institution to provide up to $20.0 million in additional capital
resources.
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 between $28 million to $31 million
for the remainder of 2008. These expenditures will be used to
purchase technology and equipment to support the growth in our business and
to increase our production capacity and help enable us to respond more quickly
and efficiently to customer demand. This range of capital expenditures, while
significant, is not outside the ordinary course of our business or materially
different from how we have expanded our business in the past. We believe that
such capital expenditures will have a positive effect on our results of
operations if demand increases in line with increases in our production
capacity. However, these capital expenditures will have a negative effect on our
results of operations if demand does not increase as we expect, and will have a
negative effect on our results of operations in the short term if demand does
not increase simultaneously, as we expect, with the capital expenditures spent
to support increased demand.
Operating Activities. For the
three months ended March 31, 2008, net cash used in operating activities was
$12.0 million, primarily due to our net loss of $3.6 million and the net change
in operating assets and liabilities of $13.1 million, adjusted for non-cash
items including $5.9 million of depreciation and amortization expense, $3.0
million of provision for income taxes and $1.8 million of stock-based
compensation.
For the
three months ended March 31, 2007, net cash used in operating activities was
$4.3 million, primarily due to our net loss of $1.1 million and the net change
in operating assets and liabilities of $6.9 million, adjusted for non-cash items
including $3.5 million of depreciation and amortization expense, $0.7 million of
provision for income taxes and $0.9 million of stock-based
compensation.
Investing Activities. For the
three months ended March 31, 2008, net cash used in investing activities was
$8.8 million for capital expenditures for computer and network hardware for our
website infrastructure and information technology systems, capital expenditures
for production equipment for our manufacturing and production operations at our
California and North Carolina facilities, and capitalized website development
costs. An additional $52.3 million was used to purchase auction rate securities,
offset by $3.0 million in proceeds from sale of short term investments. We also
paid $10.1 million in cash consideration to acquire Nexo.
For the
three months ended March 31, 2007, net cash used in investing activities was
$4.2 million for capital expenditures for computer and network hardware for our
website infrastructure and information technology systems, capital expenditures
for production equipment for our manufacturing and production operations at our
California facility, and capitalized website development costs related to
projects that were placed into service.
Financing Activities. Our
financing activities for the three months ended March 31, 2008 provided net cash
of $0.4 million, primarily from proceeds from issuance of common
stock.
For the
three months ended March 31, 2007, net cash used in financing activities was
$0.9 million, primarily for capital lease obligations.
Off-Balance
Sheet Arrangements
We do not
have any relationships with unconsolidated entities or financial partnerships,
such as entities often referred to as structured finance or special purpose
entities, which would have been established for the purpose of facilitating
off-balance sheet arrangements or other contractually narrow or limited
purposes. In addition, we do not have any undisclosed borrowings or debt, and we
have not entered into any synthetic leases. We are, therefore, not materially
exposed to any financing, liquidity, market or credit risk that could arise if
we had engaged in such relationships. As part of our June 2007
acquisition of Make It About Me! (“MIAM”), we agreed to make additional earnout
payments if certain milestones are achieved over the next 12
months. As of March 31, 2008, the total potential remaining earnout
payment is $0.4 million.
Recent
Accounting Pronouncements
Effective
January 1, 2008, the Company adopted SFAS No. 157, “Fair Value
Measurements” (“FAS 157”). In February 2008, the FASB issued a staff
position that delays the effective date of SFAS 157 for all nonfinancial assets
and liabilities except for those recognized or disclosed at least annually.
Therefore, the Company has adopted the provision of FAS 157 with respect to its
financial assets and liabilities only. FAS 157 defines fair
value, establishes a framework for measuring fair value and expands disclosures
about fair value measurements. Fair value is defined under FAS 157 as the
exchange price that would be received for an asset or paid to transfer a
liability (an exit price) in the principal or most advantageous market for the
asset or liability in an orderly transaction between market participants on the
measure date. Valuation techniques used to measure fair value under
FAS 157 must maximize the use of observable inputs and minimize the use of
unobservable inputs.
The
adoption of this statement did not have a material impact on the Company’s
consolidated results of operations and financial condition.
Effective January 1,
2008, the Company adopted 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. The Company
did not elect to adopt the fair value option under this
Statement.
In December 2007, the FASB
issued FAS No. 141R, “Business Combinations” (“FAS 141R”) which replaces FAS No.
141 and establishes principles and requirements for how the acquirer of a
business recognizes and measures in its financial statements the identifiable
assets acquired, the liabilities assumed, and any noncontrolling interest in the
acquiree. FAS 141R also provides guidance for recognizing and measuring the
goodwill acquired in the business combination and determines what information to
disclose to enable users of the financial statements to evaluate the nature and
financial effects of the business combination. This Statement applies
prospectively to business combinations for which the acquisition date is on or
after the beginning of the first annual reporting period beginning on or after
December 15, 2008. Early adoption of FAS 141R is prohibited. The Company is
currently evaluating the impact, if any, of adopting FAS 141R on its
financial position and results of operations.
In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements” (“FAS 160”) which amends ARB 51 to establish
accounting and reporting standards for the noncontrolling interest in a
subsidiary and for the deconsolidation of a subsidiary. It clarifies that a
noncontrolling interest in a subsidiary is an ownership interest in the
consolidated entity that should be reported as equity in the consolidated
financial statements. In addition to the amendments to ARB 51, this Statement
amends FASB Statement No. 128, Earnings per Share; so that earnings-per-share
data will continue to be calculated the same way those data were calculated
before this Statement was issued. This Statement is effective for fiscal years,
and interim periods within those fiscal years, beginning on or after December
15, 2008. The Company is currently evaluating the impact, if any, of adopting
FAS 160 on its financial position and results of
operations.
ITEM
3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate and
Credit Risk. We have
exposure to interest rate risk that relates primarily to our investment
portfolio. All of our current investments are classified as cash equivalents and
investments and carried at 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
March 31, 2008, 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.
At March
31, 2008, we hold auction rate security investments which are AAA rated and 95%
of the underlying assets are backed by FFELP. Due to the recent
uncertainties in the credit market, these securities have been rendered
temporarily illiquid, and the fair value of those investments is currently
estimated to be $2.5 million below par value. We have classified
these ARS investments as long-term assets which reflects our ability and intent
to hold these investments until the lack of liquidity in those markets is
resolved.
Inflation.
We do not
believe that inflation has had a material effect on our current business,
financial condition or results of operations. If our costs were to become
subject to significant inflationary pressures, we may not be able to fully
offset such higher costs through price increases. Our inability or failure to do
so could harm our business, financial condition and results of
operations.
ITEM
4. CONTROLS AND PROCEDURES
Our
management, with the participation of our chief executive officer and chief
financial officer, evaluated the effectiveness of our disclosure controls and
procedures as of March 31, 2008. 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 SEC’s 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 company’s management, including its
principal executive and principal financial officers, as appropriate to allow
timely decisions regarding required disclosure. Management recognizes that any
controls and procedures, no matter how well designed and operated, can provide
only reasonable assurance of achieving their objectives and management
necessarily applies its judgment in evaluating the cost-benefit relationship of
possible controls and procedures. Based on the evaluation of our disclosure
controls and procedures as of March 31, 2008, our chief executive officer and
chief financial officer concluded that, as of such date, the Company’s
disclosure controls and procedures were effective at the reasonable assurance
level.
No change
in our internal control over financial reporting (as defined in Rules 13a-15(f)
and 15d-15(f) under the Exchange Act) occurred during the quarter ended March
31, 2008 that has materially affected, or is reasonably likely to materially
affect, our internal control over financial reporting.
PART
II — OTHER INFORMATION
ITEM
1. LEGAL PROCEEDINGS
On or
about June 18, 2007, Fotomedia Technologies, LLC filed a lawsuit in the United
States District Court for the Eastern District of Texas, against us and several
other defendants alleging patent infringement. The Fotomedia
Complaint seeks unspecified damages, costs, interest and attorneys’ fees, and an
injunction against all parties. In lieu of answering the Fotomedia
Complaint, we moved to dismiss it by joining in a motion filed by co-defendant
Photobucket.com, Inc. While the motion was pending and not yet
decided, on or about November 6, 2007, Fotomedia filed an Amended
Complaint. The Amended Complaint likewise alleges infringement of the
same three patents and seeks unspecified damages, costs, interest and attorneys’
fees, and a permanent injunction. However, the amended complaint
dropped the allegations of willful infringement against us in connection with
one of the patents-at-issue. Defendants moved to dismiss the Amended
Complaint as well. The motion has not yet been ruled
upon. As such, we have not yet been required to file an answer or
other responsive pleading. The Court has nonetheless set a schedule
in this matter, which includes a trial date of November 2, 2009. At this
time, we do not believe that the amount of potential loss, if any, is reasonably
estimable.
On or
about February 5, 2008, Parallel Networks, LLC filed a lawsuit in the United
States District Court for the Eastern District of Texas, against us and several
other defendants alleging patent infringement. The Parallel Networks
Complaint seeks unspecified damages, costs, interest and attorneys’ fees, and an
injunction against all parties. We have not yet answered or otherwise
responded to the complaint. Plaintiffs have moved to consolidate this
case with an earlier case filed against Netflix, Inc., et al. We have
joined a motion in an opposition to consolidation filed by another
defendant. The Court has set a scheduling conference for May 14,
2008 in both this action and the case filed against Netflix, Inc., et al.
Presently there are six reexamination requests (filed by others) in the U.S.
Patent & Trademark Office regarding the patents asserted in the Parallel
Networks Complaint, all of which have been granted and are pending.
We are joining in a Motion to Stay the litigation pending the outcome
of these reexamination proceedings. 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.
ITEM 1A. RISK
FACTORS
Our
net revenues, operating results and cash requirements are affected by the
seasonal nature of our business.
Our
business is highly seasonal, with a high proportion of our net revenues, net
income and operating cash flows generated during the fourth quarter. For
example, we generated approximately 52% of our net revenues for 2007 in the
fourth quarter of 2007, and the net income that we generated during the fourth
quarter of 2007 was necessary for us to achieve profitability on an annual basis
for 2007. 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 net revenue trends.
A portion of our expenses, such as office, lab facility, and various equipment
leases and various personnel costs, are largely 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 net 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 historically 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 future operating
results.
Economic
trends could adversely affect our financial performance.
We are subject to macro-economic fluctuations in the U.S. economy. Recent
macro-economic issues involving the broader financial markets including the
liquidity issues in the auction rate securities that we invest in, may
negatively impact the economy and our growth in particular. In addition,
weak economic conditions and declines in consumer spending and consumption may
harm operating results. Purchases of our products are often
discretionary. If the economic climate deteriorates, customers or potential
customers could delay, reduce or forego their purchases of our products and
services, which could impact our business in a number of ways, including lower
prices for our products and services and reduced sales.
If the macro-economic conditions persist, or if the economy enters a prolonged
period of decelerating growth, our results of operations may be
harmed.
If
we are unable to meet our production requirements, our net revenues and results
of operations would be harmed.
We
believe that we must significantly grow our current production capability to
meet our projected net revenue targets. We expect to spend between $28 million
and $31 million in capital expenditures for the remainder of 2008, and a portion
of which we expect will be used to add manufacturing capacity. During 2007, we
opened a new manufacturing and production plant in Charlotte, North Carolina.
Our inability to meet our production requirements could lead to customer
dissatisfaction and damage to our reputation and brand, which would result in
reduced net revenues. Moreover, if the costs of meeting production requirements,
including capital expenditures, were to exceed our expectations, our results of
operations would be harmed.
In
addition, we face significant production risks at peak holiday seasons,
including the risks of obtaining sufficient qualified seasonal production
personnel. A majority of our workforce during the fourth quarter of 2007 was
seasonal, temporary personnel. We have had difficulties in the past finding a
sufficient number of qualified seasonal employees, and our failure to obtain
qualified seasonal production personnel both in our Hayward, CA and Charlotte,
NC production plants could harm our operations.
Our
quarterly financial results may fluctuate, which may lead to volatility in our
stock price.
Our
future revenues and operating results may vary significantly from
quarter-to-quarter due to a number of factors, many of which are difficult for
us to predict and control. Factors that could cause our quarterly operating
results to fluctuate include:
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•
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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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•
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our
ability to attract visitors to our website and convert those visitors into
customers;
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•
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our
ability to retain customers and encourage repeat
purchases;
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our
ability to sustain our profit margins, and our ability to diversify our
product offerings and sell to consumers photo-based products such as photo
books, calendars and cards;
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•
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the
costs of customer acquisition;
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•
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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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•
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the
costs of expanding or enhancing our technology or
website;
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•
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a
significant increase in returns and credits, beyond our estimated
allowances, for customers who are not satisfied with our
products;
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•
|
declines
or disruptions to the travel
industry;
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•
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variations
in weather, particularly heavy rain and snow which tend to depress travel
and picture taking;
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•
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the
timing of holidays;
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•
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volatility
in our stock price, which may lead to higher stock-based compensation
expense;
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•
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consumer
preferences for digital photography services;
and
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•
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improvements
to the quality, cost and convenience of desktop printing of digital
pictures and products.
|
Based on
the factors cited above, we believe that quarter-to-quarter comparisons of our
operating results 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.
We have
periodically experienced operating losses since our inception in 1999. In
particular, we make investments in our business that generally result in
operating losses in each of the first three quarters of our fiscal year. This
typically enables us to generate the majority of our net revenue during the
fourth quarter and to achieve profitability for the full fiscal year. If we are
unable to produce our products and provide our services at commercially
reasonable costs, if revenues decline or if our expenses exceed our
expectations, we may not be able to sustain or increase profitability on a
quarterly or annual basis.
We became
a public company in September 2006, and we have only a limited public operating
history on which investors can base an evaluation of our business and future
prospects. We face many risks, uncertainties, expenses and difficulties. To
address these risks and uncertainties, we must do the following:
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•
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maintain
and increase the size of our customer
base;
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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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•
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successfully
execute our business and marketing
strategy;
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•
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continue
to develop and upgrade our technology and information processing
systems;
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•
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continue
to enhance our service to meet the needs of a changing
market;
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•
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provide
superior customer service;
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•
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respond
to competitive developments; and
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•
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attract,
integrate, retain and motivate qualified
personnel.
|
We may be
unable to accomplish one or more of these requirements, which could cause our
business to suffer. Accomplishing one or more of these requirements 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
multiple petabytes of data. This results in immense system requirements and
substantial ongoing technological challenges, both of which are expected to
continue to increase over time. If we are not able to reliably meet these data
storage and management requirements, we could have disruptions in services which
could impair customer satisfaction and our reputation and lead to reduced net
revenues and increased expenses. Moreover, if the cost of meeting these data
storage and management requirements exceeds our expectations, our results of
operations would be harmed.
Our data
storage system could suffer damage or interruption from human error, fire,
flood, power loss, telecommunications failure, break-ins, terrorist attacks,
acts of war and similar events. In addition, our primary storage facilities are
located near a major fault line, increasing our susceptibility to the risk that
an earthquake could significantly harm our data storage system. If we experience
disruption to our redundant systems located at our data storage center, such
disruption could result in the deletion or corruption of customer stored images.
For example, in 2007, we experienced a loss of a small number of customer images
due to an isolated server failure.
Interruptions
to our website, information technology systems, print production processes or
customer service operations could damage our reputation and brand and
substantially harm our business and results of operations.
The
satisfactory performance, reliability and availability of our website,
information technology systems, printing production processes and customer
service operations are critical to our reputation, and our ability to attract
and retain customers and maintain adequate customer satisfaction. We currently
conduct periodic site maintenance several times a quarter that sometimes
requires us to take the website down. The scheduled down times are planned at
non-peak hours, typically at midnight. Any interruptions that result in the
unavailability of our website or reduced order fulfillment performance or
customer service could result in negative publicity, damage our reputation and
brand and cause our business and results of operations to suffer. This risk is
heightened in the fourth quarter, as we experience significantly increased
traffic to our website during the holiday season. Any interruption that occurs
during such time would have a disproportionately negative impact than if it
occurred during a different quarter.
We depend
in part on third parties to implement and maintain certain aspects of our
communications and printing systems. Therefore many of the causes of system
interruptions or interruptions in the production process may be outside of our
control. As a result, we may not be able to remedy such interruptions in a
timely manner, or at all. Our business interruption insurance policies do not
address all potential causes of business interruptions that we may experience,
and any proceeds we may receive from these policies in the event of a business
interruption may not fully compensate us for the revenues we may
lose.
We
may have difficulty managing our growth and expanding our operations
successfully.
We have
grown from 283 employees as of March 31, 2007 to 475 employees as of March 31,
2008. We have website operations, offices and customer support centers in
Redwood City, California and Mesa, Arizona, and production facilities in
Hayward, California and Charlotte, North Carolina. Our growth has placed, and
will continue to place, a strain on our administrative and operational
infrastructure. 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.
During
2008, we plan to implement a new enterprise resource planning system (“ERP”) as
part of our strategy to provide scale in our operations. These
projects are expensive, complex, and subject to delays. If we are not
able to effectively manage the deployment of this new ERP system, our results of
operations, or our ability to provide timely financial reporting information may
be harmed.
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. From time to time, we have made
changes to our pricing structure for 4×6 prints in order to remain
competitive. In December 2007, one of our competitors lowered their
list prices on 4×6 prints from $0.12 to $0.09. To date, we have not
made any additional changes to the price of our 4×6 prints as a result of this
price cut. However, a drop in our 4×6 prices, without a corresponding
increase in volume, or decreases in volume as a result of competitive pressures
would negatively impact our net revenues and could adversely affect our gross
margins and overall profitability.
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%,
20% and 19% of our net revenues in 2007, 2006 and 2005
respectively. We offer discounted or free shipping, with a
minimum purchase requirement, during promotional periods to attract and retain
customers. If free shipping offers extend beyond a limited number of occasions,
are not based upon a minimum purchase requirement or become commonplace, our net
revenues and results of operations would be negatively impacted. In addition,
Shutterfly occasionally offers free or discounted products and services to
attract and retain customers. In the future, if we increase these offers to
respond to actions taken by our competitors, our results of operations may be
harmed.
We
face intense competition from a range of competitors and may be unsuccessful in
competing against current and future competitors.
The
digital photography products and services industries are intensely competitive,
and we expect competition to increase in the future as current competitors
improve their offerings and as new participants enter the market or as industry
consolidation further develops. Competition may result in pricing pressures,
reduced profit margins or loss of market share, any of which could substantially
harm our business and results of operations. We face intense competition from a
wide range of companies, including the following:
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Online
digital photography services companies such as Kodak EasyShare Gallery
(formerly known as Ofoto), Snapfish, which is a service of
Hewlett-Packard, American Greetings’ Photoworks and Webshots brands, and
others;
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“Big
Box” retailers such as Wal-Mart, Costco and others that are seeking to
offer low cost digital photography products and services, such as in-store
fulfillment and self-service kiosks for printing; these competitors may,
among other strategies, offer their customers heavily discounted in-store
products and services that compete directly with our
offerings;
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Drug
stores such as Walgreens, CVS and others that offer in-store pick-up from
Internet orders;
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Regional
photography companies such as Wolf Camera and Ritz Camera that have
established brands and customer bases in existing photography
markets;
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Internet
portals and search engines such as Yahoo!, AOL, Google 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, and operate in
more geographic areas 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 and shipping
products, acquiring customers, compensating our personnel and acquiring
equipment and technology and leasing facilities. If we are unable to keep these
costs aligned with the level of revenues that we generate, our results of
operations would be harmed. Controlling our business costs is challenging
because many of the factors that impact these costs are beyond our control. For
example, the costs to produce prints, such as the costs of photographic print
paper, could increase due to a shortage of silver or an increase in worldwide
energy prices. In addition, we may become subject to increased costs
by the third-party shippers that deliver our products to our customers, and we
may be unable to pass along any increases in shipping costs to our customers.
The costs of online advertising and keyword search could also increase
significantly due to increased competition, which would increase our customer
acquisition costs.
We
invest in securities that are subject to market risk and the recent issues in
the financial markets could adversely affect the value of our
assets.
At March
31, 2008, $52.3 million of our marketable securities portfolio was invested in
AAA rated investments in auction-rate debt securities. Auction-rate securities
are long-term variable rate bonds tied to short-term interest rates. After the
initial issuance of the securities, the interest rate on the securities is reset
periodically, at intervals established at the time of issuance (primarily every
twenty-eight days), based on market demand for a reset period. Auction-rate
securities are bought and sold in the marketplace through a competitive bidding
process often referred to as a “Dutch auction.” If there is insufficient
interest in the securities at the time of an auction, the auction may not be
completed and the rates may be reset to predetermined “penalty” or “maximum”
rates. Following such a failed auction, we would not be able to access our
funds that are invested in the corresponding auction-rate securities until a
future auction of these investments is successful or new buyers express interest
in purchasing these securities in between reset dates.
From the
inception of our investments in these ARS in January 2008, through March 31,
2008, due to the recent uncertainties in the credit markets, all scheduled
auctions for ARS have failed. Consequently, the investments are not
currently liquid and we will not be able to access these funds until a future
auction of these investments is successful or a buyer is found outside of the
auction process. At the time of our initial investment and through
the date of this report, all of our auction-rate securities remain AAA rated.
The assets underlying each security are student loans and 95% of the principal
amounts are guaranteed by the Federal Family Education Loan Program
(FFELP). We believe we have the ability and intent to hold these ARS
investments until the lack of liquidity in those markets is
resolved. As a result, we have classified the entire
balance of ARS as non-current investments on its condensed consolidated balance
sheet.
Typically,
the fair value of ARS investments approximates par value due to the frequent
resets through the auction process. While we continue to earn
interest on our ARS investments at the contractual rate, these investments
are not currently trading and therefore do not have a readily determinable
market value. Accordingly, the estimated fair value of the ARS no
longer approximates par value.
At March
31, 2008, our investment advisor provided a Level 3 valuation for the ARS
investments which indicated a fair value of $49.8 million. The
investment advisor utilized a discounted cash flow approach to arrive at this
valuation, which was corroborated by a separate and comparable discounted cash
flow analysis prepared by us. The assumptions used in preparing the
discounted cash flow model include estimates for interest rates, timing and
amount of cash flows, credit and liquidity premiums, and expected holding
periods of the ARS. These assumptions are volatile and subject to
change as the underlying sources of these assumptions and market conditions
change. They represent our estimates given available data as of March
31, 2008. Based on
this assessment of fair value, as of March 31, 2008 we determined there was a
decline in fair value of its ARS investments of $2.5 million which was deemed
temporary.
On an
annual basis, for the last three years our cash flows generated from operating
activities have been in excess of our capital expenditure
requirements. Accordingly, we continue to believe that we have
sufficient liquid capital to fund our operations and capital
requirements. As of March 31, 2008, we have access to our cash and
cash equivalents and our other liquid investments, totaling $42.8
million In addition, in April 2008, to supplement our overall
liquidity position, we entered into a 364-day revolving credit facility with a
financial institution to provide up to $20.0 million in additional capital
resources.
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. In
addition, a majority of our executive team has recently joined Shutterfly, and
has tenure of less than one year. The loss of these key employees,
each of whom is “at will” and may terminate his or her employment relationship
with us at any time, may significantly delay or prevent the achievement of our
business objectives.
We
believe that our future success will also depend in part on our continued
ability to identify, hire, train and motivate qualified personnel. We face
intense competition for qualified individuals from numerous technology,
marketing, financial services, manufacturing and e-commerce companies. In
addition, competition for qualified personnel is particularly intense in the San
Francisco Bay Area, where our headquarters are located. We may be unable to
attract and retain suitably qualified individuals who are capable of meeting our
growing operational and managerial requirements, or we may be required to pay
increased compensation in order to do so. Our failure to attract and
retain qualified personnel could impair our ability to implement our business
plan.
Our
evergreen option pool is limited to 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. In
order to attract key personnel, in 2007 and during the first quarter of 2008,
the Board authorized additional inducement stock option grants totaling 470,000
to supplement our option pool. In the future, attracting key
personnel may require a level of option grants in excess of the amount available
in our option pool. Accordingly the Board may authorize additional
inducement grants which could further dilute existing shareholders.
If
we are unable to attract customers in a cost-effective manner, or if we were to
become subject to e-mail blacklisting, traffic to our website would be reduced
and our business and results of operations would be harmed.
Our
success depends on our ability to attract customers in a cost-effective manner.
We rely on a variety of methods to bring visitors to our website and promote our
products, including paying fees to third parties who drive new customers to our
website, purchasing search results from online search engines, e-mail and direct
mail. We pay providers of online services, search engines, directories and other
website and e-commerce businesses to provide content, advertising banners and
other links that direct customers to our
website. We also use e-mail and direct mail to offer free products and services
to attract customers, and we offer substantial pricing discounts to encourage
repeat purchases. Our methods of attracting customers, including acquiring
customer lists from third parties, can involve substantial costs, regardless of
whether we acquire new customers. Even if we are successful in acquiring and
retaining customers, the cost involved in these efforts impact our results of
operations. Customer lists are typically recorded as intangible assets and may
be subject to impairment charges if the fair value of that list exceeds its
carrying value. These potential impairment charges could harm our
results from operations. If we are unable to enhance or maintain the
methods we use to reach consumers, if the costs of attracting customers using
these methods significantly increase, or if we are unable to develop new
cost-effective means to obtain customers, our ability to attract new customers
would be harmed, traffic to our website would be reduced and our business and
results of operations would be harmed.
In
addition, various private entities attempt to regulate the use of e-mail for
commercial solicitation. These entities often advocate standards of conduct or
practice that significantly exceed current legal requirements and classify
certain e-mail solicitations that comply with current legal requirements as
unsolicited bulk e-mails, or “spam.” In addition, we have noted unauthorized
“spammers” utilize our domain name to solicit 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 company’s 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 entity’s service or purchases its blacklist. From time to time we
are blacklisted, sometimes without our knowledge, which could impair our ability
to market our products and services, communicate with our customers and
otherwise operate our business.
We
may not succeed in promoting, strengthening and continuing to establish the
Shutterfly brand, which would prevent us from acquiring new customers and
increasing revenues.
A
component of our business strategy is the continued promotion and strengthening
of the Shutterfly brand. Due to the competitive nature of the digital
photography products and services markets, if we are unable to successfully
promote the Shutterfly brand, we may fail to substantially increase our net
revenues. Customer awareness of, and the perceived value of, our brand will
depend largely on the success of our marketing efforts and our ability to
provide a consistent, high-quality customer experience. To promote our brand, we
have incurred, and will continue to incur, substantial expense related to
advertising and other marketing efforts.
Our
ability to provide a high-quality customer experience also depends, in large
part, on external factors over which we may have little or no control, including
the reliability and performance of our suppliers and third-party Internet and
communication infrastructure providers. For example, some of our products, such
as select photo-based merchandise, are produced and shipped to customers by our
third-party vendors, and we rely on these vendors to properly inspect and ship
these products. In addition, we rely on third-party shippers, including the U.S.
Postal Service and United Parcel Service, to deliver our products to customers.
Strikes or other service interruptions affecting these shippers could impair our
ability to deliver merchandise on a timely basis. Our products are also subject
to damage during delivery and handling by our third-party shippers. Our failure
to provide customers with high-quality products in a timely manner for any
reason could substantially harm our reputation and our efforts to develop
Shutterfly as a trusted brand. The failure of our brand promotion activities
could adversely affect our ability to attract new customers and maintain
customer relationships, which would substantially harm our business and results
of operations.
Purchasers
of digital photography products and services may not choose to shop online,
which would harm our net revenues and results of operations.
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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 facilities fail, our business and
results of operations would be harmed.
Our
ability to successfully receive and fulfill orders and to provide high-quality
customer service depends in part on the efficient and uninterrupted operation of
our computer and communications systems. Substantially all of the computer
hardware necessary to operate our website is located at a single third-party
hosting facility in Santa Clara, California, and our production facilities are
located in Hayward, California and Charlotte, North Carolina. Our systems and
operations could suffer damage or interruption from human error, fire, flood,
power loss, insufficient power availability, telecommunications failure,
break-ins, terrorist attacks, acts of war and similar events. In addition,
Hayward is located on, and Santa Clara is located near, a major fault line,
increasing our susceptibility to the risk that an earthquake could significantly
harm the operations of these facilities. We maintain business interruption
insurance, however, this insurance may be insufficient to compensate us for
losses that may occur, particularly from interruption due to an earthquake which
is not covered under our current policy. We do not presently have redundant
systems in multiple locations, although we are considering an additional data
center in our new facility in Charlotte. 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 in place.
Capacity
constraints and system failures could prevent access to our website, which could
harm our reputation and negatively affect our net revenues.
Our
business requires that we have adequate capacity in our computer systems to cope
with the high volume of visits to our website. As our operations grow in size
and scope, we will need to improve and upgrade our computer systems and network
infrastructure to ensure reliable access to our website, in order to offer
customers enhanced and new products, services, capacity, features and
functionality. The expansion of our systems and infrastructure may require us to
commit substantial financial, operational and technical resources before the
volume of our business increases, with no assurance that our net revenues will
increase.
Our
ability to provide high-quality products and service depends on the efficient
and uninterrupted operation of our computer and communications systems. If our
systems cannot be expanded in a timely manner to cope with increased website
traffic, we could experience disruptions in service, slower response times,
lower customer satisfaction, and delays in the introduction of new products and
services. Any of these problems could harm our reputation and cause our net
revenues to decline.
Our
technology, infrastructure and processes may contain undetected errors or design
faults that could result in decreased production, limited capacity or reduced
demand.
Our
technology, infrastructure and processes may contain undetected errors or design
faults. These errors or design faults may cause our website to fail and result
in loss of, or delay in, market acceptance of our products and services. If we
experience a delay in a website release that results in customer dissatisfaction
during the period required to correct errors and design faults, we would lose
revenue. In the future, we may encounter scalability 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 expose 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
April 2010, 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 purchase other photo-based supplies from
third parties on a purchase order basis, and, as a result, these parties could
increase their prices, reallocate supply to others, including our competitors,
or choose to terminate their relationship with us. In addition, we purchase or
rent the machines used to produce certain of our photo-based products from
Hewlett-Packard, which is one of our primary competitors in the area of online
digital photography services. This competition may influence their willingness
to provide us with additional products or services. If we were required to
switch vendors of machines for photo-based products, we may incur delays and
incremental costs, which could harm our operating results.
We
currently outsource some of our production of photo-based products to third
parties, which exposes us to risks if these parties fail to perform under our
agreements with them.
We
currently outsource the production of some our photo-based products to third
parties. If these parties fail to perform in accordance with the terms of our
agreements and if we are unable to secure another outsource partner 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.
If
we are unable to develop, market and sell new products and services that address
additional market opportunities, our results of operations may
suffer. In addition, we may need to expand beyond our current
customer demographic to grow our business.
Although
historically we have focused our business on consumer markets for silver halide
prints, such as 4×6 prints, and photo-based products, such as photo books and
calendars, we intend to address, and demand may shift to, new products and
services. In addition, we believe we may need to address additional markets and
expand our customer demographic in order to further grow our business. We may
not successfully expand our existing services or create new products and
services, address new market segments or develop a significantly broader
customer base. Any failure to address additional market opportunities could
result in loss of market share, which would harm our business, financial
condition and results of operations.
We
may 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, like our June 2007 acquisition of Make it About Me! (“MIAM”), our
January 2008 acquisition of Nexo and other technologies or services. Integrating
any newly acquired businesses, technologies or services is likely to be
expensive and time consuming. To finance any acquisition, 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.
Also, the value of our stock may be insufficient to attract acquisition
candidates. 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 MIAM, Nexo, or any other 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
management’s 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.
Failure
to adequately protect our intellectual property could substantially harm our
business and results of operations.
We rely
on a combination of patent, trademark, trade secret and copyright law and
contractual restrictions to protect our intellectual property. These protective
measures afford only limited protection. Despite our efforts to protect our
proprietary rights, unauthorized parties may attempt to copy aspects of our
website features and functionalities or to obtain and use information that we
consider proprietary, such as the technology used to operate our website, our
production operations and our trademarks.
As of
March 31, 2008, we had 23 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 have in the past and could in the future
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. The Shutterfly brand
is a critical component of our marketing programs. If we lose the ability to use
the Shutterfly service mark in any particular market, we could be forced to
either incur significant additional marketing expenses within that market, or
elect not to sell products in that market. Any claims or customer confusion
related to our marks could damage our reputation and brand and substantially
harm our business and results of operations.
If
we become involved in intellectual property litigation or other proceedings
related to a determination of rights, we could incur substantial costs, expenses
or liability, lose our exclusive rights or be required to stop certain of our
business activities.
Third
parties may sue us for infringing their intellectual property rights. In
June 2007, we were sued by FotoMedia Technologies, LLC alleging patent
infringement. In February 2008, we were also sued by Parallel
Networks, also alleging patent infringement. 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 management’s efforts from
growing our business. Some of our competitors may be able to sustain the costs
of complex intellectual property litigation more effectively than we can because
they have substantially greater resources. Uncertainties resulting from the
initiation and continuation of any litigation could limit our ability to
continue our operations.
Alternatively,
we may be required to, or decide to, enter into a license with a third party.
For example, in May 2005, we entered into a settlement and license agreement to
resolve litigation brought by a third party with respect to our alleged
infringement of its patents. Under the terms of the agreement, we agreed to pay
the third party a total of $2.0 million, and we received a license to its
patents. Any future license required under any other party’s patents may not be
made available on commercially acceptable terms, if at all. In addition, such
licenses are likely to be non-exclusive and, therefore, our competitors may have
access to the same technology licensed to us. If we fail to obtain a required
license and are unable to design around a patent, we may be unable to
effectively conduct certain of our business activities, which could limit our
ability to generate revenues and harm our results of operations and possibly
prevent us from generating revenues sufficient to sustain our
operations.
The
inability to acquire or maintain domain names for our website could
substantially harm our business and results of operations.
We
currently are the registrant of the Internet domain name for our website,
Shutterfly.com, as well as various related domain names. Domain names generally
are regulated by Internet regulatory bodies and are controlled also by trademark
and other related laws. The regulations governing domain names could change in
ways that block or interfere with our ability to use relevant domains. Also, we
might not be able to prevent third parties from registering or retaining domain
names that interfere with our consumer communications, or infringe or otherwise
decrease the value of our trademarks and other proprietary rights. Regulatory
bodies also may establish additional generic or country-code top-level domains
or modify the requirements for holding domain names. As a result, we might not
be able to acquire or maintain the domain names that utilize the name Shutterfly
in all of the countries in which we currently or intend to conduct business.
This could substantially harm our business and results of
operations.
We
may be subject to past or future liabilities for collection of sales and use
taxes, and the payment of corporate level taxes.
Our
policies concerning the collection of sales and use taxes and the payment of
certain corporate level taxes has been based upon decisions of the U.S. Supreme
Court that determine when a taxpayer is deemed to have nexus with a state
sufficient to impose tax obligations under the Commerce Clause of the U.S.
Constitution. Those Supreme Court decisions require that the taxpayer be
physically present before a state can require the collection of sales and use
taxes. States are currently attempting to expand the definition of what
constitutes physical presence for sales and use taxes. At the same
time, the standard governing the imposition of other taxes, for instance,
corporate income taxes, is less established and a number of state courts have
recently concluded that the Commerce Clause definition of nexus should be
expanded to include either “physical” or “economic” presence (essentially
marketing activities) which is a broader definition than is used for sales and
use tax.
In
reliance upon the U.S. Supreme Court’s decisions, we have continued to collect
sales and use taxes in California, Nevada, Pennsylvania, North Carolina, New
York, New Jersey, and Arizona where we have employees and/or property. Starting
in June 2007, we also began collecting sales and use taxes in other states where
we have implemented joint sales efforts with Target Corporation.
While we
believe the U.S. Supreme Court decisions support our policies concerning the
collection and payment of taxes, tax authorities could disagree with our
interpretations. If sustained, those authorities might seek to impose past as
well as future liability for taxes and/or penalties. Such impositions could also
impose significant administrative burdens and decrease our future sales.
Moreover, the U.S. Congress has been considering various initiatives that could
limit or supersede the U.S. Supreme Court’s position regarding sales and use
taxes.
We
recently resolved an audit examination by the State of California for the 2003
tax year, with a favorable result. Future audits of other tax years or by other
taxing authorities could also lead to fluctuations in our effective tax rate
because the taxing authority may disagree with certain assumptions we have made
regarding appropriate credits and deductions in filing our tax
returns.
Under
current stock option tax regulations, we are entitled to a stock option
compensation tax deduction when employees exercise and sell their incentive
stock options within a two year period for a taxable gain. Our current effective
tax rate estimate does not incorporate this deduction as the extent of the
deduction, based on employee option disposition activity is not currently
determinable. These disqualifying dispositions could lead to future fluctuations
in our effective tax rate for any given quarter or year.
Government
regulation of the Internet and e-commerce is evolving, and unfavorable changes
or failure by us to comply with these regulations could substantially harm our
business and results of operations.
We are
subject to general business regulations and laws as well as regulations and laws
specifically governing the Internet and e-commerce. Existing and future laws and
regulations may impede the growth of the Internet or other online services.
These regulations and laws may cover taxation, restrictions on imports and
exports, customs, tariffs, user privacy, data protection, pricing, content,
copyrights, distribution, electronic contracts and other communications,
consumer protection, the provision of online payment services, broadband
residential Internet access and the characteristics and quality of products and
services. It is not clear how existing laws governing issues such as property
use and 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 including (or 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 Children’s Online
Protection Act and the Children’s 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
website’s 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. That could
substantially harm our business and results of operations.
Our
practice of offering free products and services could be subject to judicial or
regulatory challenge.
We
regularly offer free products and free shipping as an inducement for customers
to try our products. Although we believe that we conspicuously and clearly
communicate all details and conditions of these offers — for example, that
customers are required to pay shipping, handling and/or processing charges to
take advantage of the free product offer — we may be subject to claims from
individuals or governmental regulators that our free offers are misleading or do
not comply with applicable legislation. These claims may be expensive to defend
and could divert management’s time and attention. If we become subject to such
claims in the future, or are required or elect to curtail or eliminate our use
of free offers, our results of operations may be harmed.
Any
failure by us to protect the confidential information of our customers and
networks against security breaches and the risks associated with credit card
fraud could damage our reputation and brand and substantially harm our business
and results of operations.
A
significant prerequisite to online commerce and communications is the secure
transmission of confidential information over public networks. Our failure to
prevent security breaches could damage our reputation and brand and
substantially harm our business and results of operations. For example, a
majority of our sales are billed to our customers’ credit card accounts
directly, orders are shipped to a customer’s 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
user’s password could access the user’s transaction data, personal information
or stored images. Any compromise of our security could damage our reputation and
brand and expose us to a risk of loss or litigation and possible liability,
which would substantially harm our business and results of operations. In
addition, anyone who is able to circumvent our security measures could
misappropriate proprietary information or cause interruptions in our operations.
We may need to devote significant resources to protect against security breaches
or to address problems caused by breaches.
In
addition, under current credit card practices, we are liable for fraudulent
credit card transactions because we do not obtain a cardholder’s 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.
International
expansion will require management attention and resources and may be
unsuccessful, which could harm our future business development and existing
domestic operations.
To date,
we have conducted limited international operations, but we intend to expand into
international markets in order to grow our business. These expansion plans will
require significant management attention and resources and may be unsuccessful.
We have limited experience adapting our products to conform to local cultures,
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.
The success of
our business depends on continued consumer adoption of digital
photography
Our
growth is highly dependent upon the continued adoption by consumers of digital
photography. The digital photography market is rapidly evolving, characterized
by changing technologies, intense price competition, additional competitors,
evolving industry standards, frequent new service announcements and changing
consumer demands and behaviors. To the extent that consumer adoption of digital
photography does not continue to grow as expected, our revenue growth would
likely suffer. Moreover, we face significant risks that, if the market for
digital photography evolves in ways that we are not able to address due to
changing technologies or consumer behaviors, pricing pressures, or otherwise,
our current products and services may become less attractive, which would likely
result in the loss of customers, as well as lower net revenues and/or increased
expenses.
Maintaining
and improving our financial controls and the requirements of being a public
company may strain our resources, divert management’s attention and affect our
ability to attract and retain qualified board members.
As a
public company, we are subject to the reporting requirements of the Securities
Exchange Act of 1934, the Sarbanes-Oxley Act of 2002 and the rules and
regulations of The NASDAQ Stock Market. The requirements of these rules and
regulations will likely continue to increase our legal, accounting and financial
compliance costs, make some activities more difficult, time-consuming or costly
and may also place undue strain on our personnel, systems and
resources.
The
Sarbanes-Oxley Act requires, among other things, that we maintain effective
disclosure controls and procedures and effective internal control over financial
reporting. Significant resources and management oversight are required to
design, document, test, implement and monitor internal control over relevant
processes and to, remediate any deficiencies. As a result, management’s
attention may be diverted from other business concerns, which could harm our
business, financial condition and results of operations. These efforts also
involve substantial accounting related costs. In addition, if we are unable to
continue to meet these requirements, we may not be able to remain listed on The
NASDAQ Global Market.
Under the
Sarbanes-Oxley Act and the rules and regulations of The NASDAQ Stock Market, we
are required to maintain a board of directors with a majority of independent
directors. These rules and regulations may make it more difficult and more
expensive for us to maintain directors’ and officers’ liability insurance, and
we may be required to accept reduced coverage or incur substantially higher
costs to maintain coverage. If we are unable to maintain adequate directors’ and
officers’ insurance, our ability to recruit and retain qualified directors and
officers, especially those directors who may be considered independent for
purposes of NASDAQ rules, will be significantly curtailed.
Our
stock price may be volatile or may decline regardless of our operating
performance.
The
market price of our common stock may fluctuate significantly in response to
numerous factors, many of which are beyond our control, including:
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price
and volume fluctuations in the overall stock
market;
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changes
in operating performance and stock market valuations of other technology
companies generally, or those in our industry in
particular;
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the
financial projections we may provide to the public, any changes in these
projections or our failure to meet these
projections;
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changes
in financial estimates by any securities analysts who follow our company,
our failure to meet these estimates or failure of those analysts to
initiate or maintain coverage of our
stock;
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ratings
downgrades by any securities analysts who follow our
company;
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the
public’s 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 macro-economy as a
whole;
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impairment
or loss in value of our investments in auction rate
securities;
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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 stockholders to elect
directors of their choosing and to cause us to take other corporate actions they
desire.
In
addition, we are subject to Section 203 of the Delaware General Corporation Law,
which, subject to some exceptions, prohibits “business combinations” between a
Delaware corporation and an “interested stockholder,” which is generally defined
as a stockholder who becomes a beneficial owner of 15% or more of a Delaware
corporation’s voting stock, for a three-year period following the date that the
stockholder became an interested stockholder. Section 203 could have
the effect of delaying, deferring or preventing a change in control that our
stockholders might consider to be in their best interests.
ITEM
2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Unregistered
Sales of Equity Securities
Not
applicable
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 ten 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
March 31, 2008, we have used approximately half of these proceeds to purchase
capital equipment, acquire businesses, and for general operating
purposes. We expect to continue to use the remainder of the net
proceeds for general corporate purposes, including working capital, operating
expenses, and capital expenditures. In addition, 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 retains broad discretion in the allocation and use of the net
proceeds of our initial public offering, and investors must rely 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 investment objective with respect to net
proceeds is capital preservation and liquidity so that such funds are readily
available to fund our operations.
ITEM
3. DEFAULTS UPON SENIOR SECURITIES
Not
applicable
ITEM
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not
applicable
ITEM
5. OTHER INFORMATION
Creation of a Direct Financial Obligation
On April 28,
2008, Shutterfly entered into a Credit Agreement (the “Credit Agreement”) by and
among Shutterfly, the lender parties thereto (the “Lenders”), and JPMorgan Chase
Bank, N.A., as administrative agent for the Lenders.
The Credit
Agreement provides for a $20 million secured credit facility (the “Facility”)
that will expire on April 27, 2009. Shutterfly will use amounts borrowed
under the Facility, if any, to finance the company’s working capital needs and
for general corporate purposes, including future acquisitions. Shutterfly
is not borrowing under the Facility at this time, but may borrow under the
Facility from time to time as opportunities and needs arise.
Loans under
the Credit Agreement will bear interest either at: (i) the higher of (a) the
Federal Funds rate plus 0.50% or (b) JPMorgan’s “prime rate” as announced from
time to time, plus (in the case of either (i)(a) or (i)(b)) 0.625%, or (ii) the
applicable London interbank offered rate (as adjusted for any statutory reserve
requirements), plus 1.625%. Shutterfly will also pay to each Lender
a facility fee of 0.375% per annum, payable quarterly in arrears, based on the
amount of such Lender’s commitment under the Facility (whether used or
unused).
The Credit
Agreement contains customary representations and warranties as well as customary
affirmative and negative covenants. Negative covenants include, among others,
limitations on incurrence of liens and limitations on incurrence of
indebtedness. In addition, the Credit Agreement requires that Shutterfly
maintain a ratio of consolidated debt to consolidated EBITDA of not greater than
1.50 to 1.00, and requires Shutterfly to maintain a specified minimum level of
cash and permitted investments.
The Credit
Agreement contains customary events of default. Upon the occurrence and during
the continuance of an event of default, the Lenders may declare the outstanding
loans and all other obligations under the Credit Agreement immediately due and
payable.
The Facility
is secured by a security interest in substantially all of the personal property
and assets of Shutterfly, subject to certain exceptions.
J.P. Morgan
Securities Inc. acted as sole bookrunner and sole lead arranger for the
Facility.
ITEM
6. EXHIBITS
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Exhibit
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Number
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Description
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31.01
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Certification
of Chief Executive Officer Pursuant to
Securities Exchange Act Rule
13a-14(a).
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31.02
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Certification
of Chief Financial Officer Pursuant to Securities Exchange Act
Rule 13a-14(a).
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32.01
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Certification
of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 and
Securities Exchange Act Rule 13a-14(b).**
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32.02
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Certification
of Chief Financial Officer Pursuant to 18 U.S.C. Section
1350 and Securities Exchange Act Rule
13a-14(b).**
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____________
**
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This
certification is not deemed “filed” for purposes of Section 18 of the
Securities Exchange Act, or otherwise subject to the liability of that
section. Such certification will not be deemed to be incorporated by
reference into any filing under the Securities Act of 1933 or the
Securities Exchange Act of 1934, except to the extent that Shutterfly
specifically incorporates it by
reference.
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SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
SHUTTERFLY, INC.
(Registrant)
Dated: May 1,
2008 By: /s/ Jeffrey T.
Housenbold
Jeffrey
T. Housenbold,
President and Chief Executive Officer
Dated: May 1,
2008 By: /s/ Mark J.
Rubash
Mark J. Rubash,
Senior Vice President and Chief Financial Officer
INDEX
TO EXHIBITS
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Exhibit
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Number
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Description
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31.01
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Certification
of Chief Executive Officer Pursuant to Securities Exchange Act
Rule 13a-14(a).
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31.02
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Certification
of Chief Financial Officer Pursuant to Securities Exchange Act
Rule 13a-14(a).
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32.01
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Certification
of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 and
Securities Exchange Act Rule 13a-14(b).**
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32.02
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Certification
of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 and
Securities Exchange Act Rule
13a-14(b).**
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____________
*
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Incorporated
herein by reference to the corresponding exhibit of the
S-1.
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**
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This
certification is not deemed “filed” for purposes of Section 18 of the
Securities Exchange Act, or otherwise subject to the liability of that
section. Such certification will not be deemed to be incorporated by
reference into any filing under the Securities Act of 1933 or the
Securities Exchange Act of 1934, except to the extent that Shutterfly
specifically incorporates it by
reference.
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