sflyq308_10q.htm
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 September 30, 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 October 24, 2008
|
Common
stock, $0.0001 par value per share
|
25,072,312
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)
|
September
30,
|
|
December
31,
|
|
2008
|
|
2007
|
|
|
|
|
ASSETS
|
|
|
|
Current
assets:
|
|
|
|
Cash
and cash equivalents
|
$ |
40,635 |
|
$ |
122,582 |
|
Short-term
investments
|
|
- |
|
|
3,002 |
|
Accounts
receivable, net
|
|
3,144 |
|
|
4,480 |
|
Inventories
|
|
3,271 |
|
|
4,788 |
|
Deferred
tax asset, current portion
|
|
597 |
|
|
1,677 |
|
Prepaid
expenses and other current assets
|
|
8,063 |
|
|
4,510 |
|
Total
current assets
|
|
55,710 |
|
|
141,039 |
|
Long-term
investments
|
|
47,420 |
|
|
- |
|
Property
and equipment, net
|
|
51,830 |
|
|
48,416 |
|
Goodwill
and intangible assets, net
|
|
14,632 |
|
|
3,859 |
|
Deferred
tax asset, net of current portion
|
|
23,792 |
|
|
13,294 |
|
Other
assets
|
|
1,821 |
|
|
2,162 |
|
Total
assets
|
$ |
195,205 |
|
$ |
208,770 |
|
|
|
|
|
|
|
|
LIABILITIES
AND STOCKHOLDERS’ EQUITY
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
Accounts
payable
|
$ |
6,026 |
|
$ |
8,783 |
|
Accrued
liabilities
|
|
12,654 |
|
|
18,724 |
|
Deferred
revenue
|
|
9,167 |
|
|
8,699 |
|
Current
portion of capital lease obligations
|
|
514 |
|
|
808 |
|
Total
current liabilities
|
|
28,361 |
|
|
37,014 |
|
Other
liabilities
|
|
1,093 |
|
|
1,083 |
|
Capital
lease obligations, less current portion
|
|
22 |
|
|
107 |
|
Total
liabilities
|
|
29,476 |
|
|
38,204 |
|
Commitments
and contingencies (Note 7)
|
|
|
|
|
|
|
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; 25,071
and
|
|
|
|
|
|
|
24,805
shares issued and outstanding on September 30, 2008 and
|
|
|
|
|
|
|
December
31, 2007, respectively
|
|
2 |
|
|
2 |
|
Additional
paid-in-capital
|
|
199,478 |
|
|
190,849 |
|
Accumulated
other comprehensive loss
|
|
(3,139 |
)
|
|
(12 |
) |
Deferred
stock-based compensation
|
|
- |
|
|
(28 |
) |
Accumulated
deficit
|
|
(30,612 |
)
|
|
(20,245 |
) |
Total
stockholders' equity
|
|
165,729 |
|
|
170,566 |
|
Total
liabilities and stockholders' equity
|
$ |
195,205 |
|
$ |
208,770 |
|
The
accompanying notes are an integral part of these condensed consolidated
financial statements.
CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS
(In
thousands, except per share amounts)
(Unaudited)
|
|
Three
Months Ended
|
|
|
Nine
Months Ended
|
|
|
|
September
30,
|
|
|
September
30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
revenues
|
|
$
|
35,953
|
|
|
$
|
32,602
|
|
|
$
|
105,738
|
|
|
$
|
89,184
|
|
Cost
of net revenues (1)
|
|
|
18,430
|
|
|
|
17,240
|
|
|
|
53,739
|
|
|
|
45,107
|
|
Gross
profit
|
|
|
17,523
|
|
|
|
15,362
|
|
|
|
51,999
|
|
|
|
44,077
|
|
Operating
expenses (1):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Technology
and development
|
|
|
9,645
|
|
|
|
7,579
|
|
|
|
28,642
|
|
|
|
20,034
|
|
Sales
and marketing
|
|
|
10,087
|
|
|
|
7,042
|
|
|
|
26,762
|
|
|
|
19,421
|
|
General
and administrative
|
|
|
6,772
|
|
|
|
7,352
|
|
|
|
21,946
|
|
|
|
20,056
|
|
Total operating expenses
|
|
|
26,504
|
|
|
|
21,973
|
|
|
|
77,350
|
|
|
|
59,511
|
|
Loss
from operations
|
|
|
(8,981
|
)
|
|
|
(6,611
|
)
|
|
|
(25,351
|
)
|
|
|
(15,434
|
)
|
Interest
expense
|
|
|
(100
|
)
|
|
|
(54
|
)
|
|
|
(185
|
)
|
|
|
(147
|
)
|
Interest
income
|
|
|
455
|
|
|
|
1,350
|
|
|
|
2,514
|
|
|
|
4,252
|
|
Loss
before income taxes
|
|
|
(8,626
|
)
|
|
|
(5,315
|
)
|
|
|
(23,022
|
)
|
|
|
(11,329
|
)
|
Benefit
from income taxes
|
|
|
5,915
|
|
|
|
2,001
|
|
|
|
12,655
|
|
|
|
4,515
|
|
Net
loss
|
|
$
|
(2,711
|
)
|
|
$
|
(3,314
|
)
|
|
$
|
(10,367
|
)
|
|
$
|
(6,814
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss per share - basic and diluted
|
|
$
|
(0.11
|
)
|
|
$
|
(0.14
|
)
|
|
$
|
(0.41
|
)
|
|
$
|
(0.28
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average
shares outstanding - basic and diluted
|
|
|
25,067
|
|
|
|
24,425
|
|
|
|
25,020
|
|
|
|
24,165
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
Stock-based compensation is allocated as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
88
|
|
|
$
|
46
|
|
|
$
|
263
|
|
|
$
|
123
|
|
Technology
and development
|
|
|
610
|
|
|
|
162
|
|
|
|
1,539
|
|
|
|
618
|
|
Sales
and marketing
|
|
|
645
|
|
|
|
267
|
|
|
|
1,559
|
|
|
|
580
|
|
General
and administrative
|
|
|
1,087
|
|
|
|
549
|
|
|
|
2,974
|
|
|
|
1,487
|
|
The
accompanying notes are an integral part of these condensed consolidated
financial statements.
CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In
thousands)
(Unaudited)
|
|
Nine
Months Ended
|
|
|
|
September
30,
|
|
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
Cash
flows from operating activities:
|
|
|
|
|
|
|
Net
loss
|
|
$
|
(10,367
|
)
|
|
$
|
(6,814
|
)
|
Adjustments
to reconcile net loss to net cash used in operating
activities:
|
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
17,463
|
|
|
|
12,217
|
|
Amortization
of intangible assets
|
|
|
1,370
|
|
|
|
217
|
|
Stock-based
compensation, net of cancellations
|
|
|
6,335
|
|
|
|
2,808
|
|
Loss
on disposal property and equipment
|
|
|
308
|
|
|
|
230
|
|
Deferred
income taxes
|
|
|
(9,746
|
)
|
|
|
(4,547
|
)
|
Changes
in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Accounts
receivable, net
|
|
|
1,336
|
|
|
|
488
|
|
Inventories
|
|
|
1,518
|
|
|
|
(542
|
)
|
Prepaid
expenses and other current assets
|
|
|
(3,553
|
)
|
|
|
(936
|
)
|
Other
assets
|
|
|
352
|
|
|
|
(1,677
|
)
|
Accounts
payable
|
|
|
(2,757
|
)
|
|
|
(1,867
|
)
|
Accrued
and other liabilities
|
|
|
(6,087
|
)
|
|
|
6,931
|
|
Deferred
revenue
|
|
|
468
|
|
|
|
1,096
|
|
Net
cash (used in) provided by operating activities
|
|
|
(3,360
|
)
|
|
|
7,604
|
|
|
|
|
|
|
|
|
|
|
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
|
Purchases
of property and equipment
|
|
|
(16,760
|
)
|
|
|
(28,501
|
)
|
Capitalization of software and website development costs
|
|
|
(3,239
|
)
|
|
|
(2,417
|
)
|
Acquisition
of business and intangibles, net of cash acquired
|
|
|
(10,098
|
)
|
|
|
(2,655
|
)
|
Proceeds from sale of equipment
|
|
|
6
|
|
|
|
-
|
|
Proceeds
from sale of short-term investments
|
|
|
3,002
|
|
|
|
(3,002
|
)
|
Purchase
of auction rate securities
|
|
|
(52,250
|
)
|
|
|
-
|
|
Net
cash used in investing activities
|
|
|
(79,339
|
)
|
|
|
(36,575
|
)
|
|
|
|
|
|
|
|
|
|
Cash
flows from financing activities:
|
|
|
|
|
|
|
|
|
Principal
payments of capital lease obligations
|
|
|
(378
|
)
|
|
|
(1,871
|
)
|
Proceeds
from issuance of common stock upon exercise of stock
options
|
|
|
1,130
|
|
|
|
3,390
|
|
Net
cash provided by financing activities
|
|
|
752
|
|
|
|
1,519
|
|
|
|
|
|
|
|
|
|
|
Net
decrease in cash and cash equivalents
|
|
|
(81,947
|
)
|
|
|
(27,452
|
)
|
Cash
and cash equivalents, beginning of period
|
|
|
122,582
|
|
|
|
119,051
|
|
Cash
and cash equivalents, end of period
|
|
$
|
40,635
|
|
|
$
|
91,599
|
|
|
|
|
|
|
|
|
|
|
Supplemental
disclosures of cash flow information:
|
|
|
|
|
|
|
|
|
Cash
paid during the period for:
|
|
|
|
|
|
|
|
|
Interest
|
|
$
|
38
|
|
|
$
|
168
|
|
Income
taxes
|
|
|
511
|
|
|
|
760
|
|
The
accompanying notes are an integral part of these condensed consolidated
financial statements.
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 subsidiaries. In the opinion of
management, all adjustments 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 nine months ended September 30, 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 subsidiaries. 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 asset
valuations and useful lives, excess and obsolete inventories, deferred tax
valuation allowance, auction rate securities valuation, stock-based
compensation, restructuring and legal contingencies among others. Actual results
could differ from these estimates.
Marketable
Securities
The
Company evaluates 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 decline in fair value as “temporary” or
“other-than-temporary.” A temporary decline in fair
value 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 decline in fair value 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
include 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.
SHUTTERFLY,
INC.
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Income
Taxes
The
Company accounts for income taxes under the liability method. Under this method,
deferred tax assets and liabilities are determined based on the difference
between the financial statement and tax basis of assets and liabilities and net
operating loss and credit carryforwards using enacted tax rates in effect for
the year in which the differences are expected to reverse. Valuation allowances
are established when necessary to reduce deferred tax assets to the amounts
expected to be realized.
The
Company accounts for uncertain tax positions in accordance with FASB
Interpretation No. 48 Accounting for Uncertainty in Income
Taxes (“FIN 48”), an interpretation of FASB Statement No. 109 (“SFAS
109”). The application of income tax law is inherently complex. Laws and
regulations in this area are voluminous and are often ambiguous. 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. Accordingly, 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, Minnesota, 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
Loss
Comprehensive
loss consists of certain changes in equity that are excluded from net loss.
Specifically, unrealized gains and losses on available for sale marketable
securities are included in accumulated other comprehensive loss.
The
components of accumulated other comprehensive loss was as follows (in
thousands):
|
|
Three
Months Ended
September
30,
|
|
|
Nine
Months Ended
September
30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Unrealized
loss in investments, net of tax
|
|
$
|
(904
|
)
|
|
$
|
(20
|
)
|
|
$
|
(3,127
|
)
|
|
$
|
(2
|
)
|
Net
loss
|
|
|
(2,711
|
)
|
|
|
(3,314
|
)
|
|
|
(10,367
|
)
|
|
|
(6,814
|
)
|
Total
comprehensive loss
|
|
$
|
(3,615
|
)
|
|
$
|
(3,334
|
)
|
|
$
|
(13,494
|
)
|
|
$
|
(6,816
|
)
|
Unrealized loss in investments for the three months ended September 30,
2008 and 2007 are net of tax benefit of ($487) and ($11) respectively.
Unrealized loss in investments for the nine months ended September 30, 2008
and 2007 are net of tax benefit of ($1,684) and ($1) respectively.
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 which provides a one year deferral of the effective date
of SFAS 157 for all nonfinancial assets and liabilities except for those that
were recognized or disclosed in the financial statements at fair value
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 measurement 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 input levels, of which
the first two are considered observable and the last unobservable, as
follows:
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 (see Note
4).
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 has not elected 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
non-controlling 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 does not expect the adoption of FAS 141R will
have a material effect on its financial position and results of
operations.
In
December 2007, the FASB issued SFAS No. 160, “Non-controlling Interests in
Consolidated Financial Statements” (“FAS 160”) which amends ARB 51 to establish
accounting and reporting standards for the non-controlling interest in a
subsidiary and for the deconsolidation of a subsidiary. It clarifies that a
non-controlling 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 does not expect the adoption of FAS 160 will have a
material effect on its financial position and results of
operations.
In April 2008, the Financial Accounting Standards Board ("FASB") issued FASB
Staff Position ("FSP") No. 142-3, "Determination of the Useful Life of
Intangible Assets". FSP 142-3 amends the factors an entity should consider
in developing renewal or extension assumptions used in determining the useful
life or recognized intangible assets under FASB Statement No. 142, "Goodwill and
Other Intangible Assets". This new guidance applies prospectively to
intangible assets that are acquired individually or with a group of other assets
in business combinations and asset acquisitions. FSP 142-3 is effective
for financial statements issued for fiscal years and interim periods beginning
after December 15, 2008. Early adoption is prohibited. The Company
does not expect the adoption of FSP 142-3 will have a material effect on its
financial position and results of operations.
Note
2 — Stock-Based Compensation
A summary
of the Company’s stock option activity for the nine months ended
September 30, 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
|
|
Granted
|
|
|
147
|
|
|
|
13.51
|
|
|
|
|
|
|
|
Exercised
|
|
|
(55
|
)
|
|
|
9.14
|
|
|
|
|
|
|
|
Forfeited,
cancelled or expired
|
|
|
(57
|
)
|
|
|
20.88
|
|
|
|
|
|
|
|
Balances,
June 30, 2008
|
|
|
5,726
|
|
|
$
|
13.83
|
|
|
|
8.0
|
|
|
$
|
13,610
|
|
Granted
|
|
|
109
|
|
|
|
10.86
|
|
|
|
|
|
|
|
Exercised
|
|
|
(6
|
)
|
|
|
5.95
|
|
|
|
|
|
|
|
Forfeited,
cancelled or expired
|
|
|
(256
|
)
|
|
|
19.34
|
|
|
|
|
|
|
|
Balances,
September 30, 2008
|
|
|
5,573
|
|
|
$
|
13.53
|
|
|
|
7.6
|
|
|
$
|
7,183
|
|
Options
vested and expected to vest at September 30, 2008
|
|
|
5,181
|
|
|
$
|
13.09
|
|
|
|
7.5
|
|
|
$
|
7,159
|
|
Options
vested at September 30, 2008
|
|
|
2,788
|
|
|
$
|
9.27
|
|
|
|
6.7
|
|
|
$
|
6,448
|
|
During
the three months ended September 30, 2008, the Company granted options to
purchase an aggregate of 109,000 shares of common stock with an estimated
weighted-average grant-date fair value of $4.35 per share. The total intrinsic
value of options exercised during the three months ended September 30, 2008 was
$24,000. Net cash proceeds from the exercise of stock options were $36,000 for
the three months ended September 30, 2008. As permitted by SFAS No. 123R, the
Company has deferred the recognition of its excess tax benefit from
non-qualified stock option exercises and disqualifying dispositions from
incentive stock option exercises. As of September 30, 2008, there
were approximately 568,000 shares available for grant under the 2006 Equity
Incentive Plan (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 and nine months
ended September 30, 2008 and September 30, 2007, were as follows:
|
|
Three
Months Ended September 30,
|
|
Nine
Months Ended September 30,
|
|
|
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
|
|
|
(Unaudited)
|
|
(Unaudited)
|
|
(Unaudited)
|
|
(Unaudited)
|
|
|
Dividend
yield
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
Annual
risk free rate of return
|
|
|
2.9
|
%
|
|
4.2
|
% |
|
2.6
|
% |
|
4.6
|
% |
|
Expected
volatility
|
|
|
48.8
|
% |
|
44.8
|
%
|
|
50.4
|
%
|
|
42.0
|
% |
|
Expected
term (years)
|
|
|
4.7
|
|
|
4.4
|
|
|
4.4
|
|
|
4.3
|
|
|
Employee
stock-based compensation expense recognized in the three months ended September
30, 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 its 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 annually based on
either a two year, three year or four year total vesting term. In
accordance with Statement of Accounting Standards No. 123R, Share-Based Payment
(“FAS 123R”), compensation cost is amortized on a straight-line basis over
the requisite service period.
Restricted
Stock Unit Activity
A summary
of the Company’s restricted stock unit activity for the nine months ended
September 30, 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
|
|
Granted
|
|
|
512
|
|
|
|
14.12
|
|
Vested
|
|
|
—
|
|
|
|
—
|
|
Forfeited,
cancelled or expired
|
|
|
—
|
|
|
|
—
|
|
Balances, June
30, 2008
|
|
|
743
|
|
|
$
|
15.90
|
|
Granted
|
|
|
68
|
|
|
|
10.00
|
|
Vested
|
|
|
—
|
|
|
|
—
|
|
Forfeited,
cancelled or expired
|
|
|
(47)
|
|
|
|
14.19
|
|
Balances, September
30, 2008
|
|
|
764
|
|
|
$
|
15.40
|
|
Included
in the RSU grants for the nine months ended September 30, 2008 are 98,000
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 are consistent with the 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.
SHUTTERFLY, INC.
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Inducement
Awards
Included
in the stock option and restricted stock unit activity above, in the nine month
period ended September 30, 2008, the Company granted inducement stock option
awards and restricted stock units to an executive. These inducement
grants were approved by the Company’s Board of Directors and were not issued
under a shareholder approved plan. A total of 129,000 options to
purchase common stock and 7,000 restricted stock units were granted under this
nonqualified agreement. These grants have a 10 year term, and vest
over a four year period from the initial date of hire of the executive, in a
manner consistent with awards granted under the 2006 Plan. Included
in the three month period ended September 30, 2008 are 50,000 previously
issued inducement stock option awards which have been forfeited pursuant to the
termination of an executive.
At
September 30, 2008, the Company had $27,396,000 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 two and a half years.
Note
3 — Net Loss Per Share
Diluted
net loss per share 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.
|
|
Three
Months
|
|
|
Nine
Months
|
|
|
|
Ended
September 30,
|
|
|
Ended
September 30,
|
|
|
|
(in
thousands)
|
|
|
(in
thousands)
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Historical
net loss per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Numerator
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss
|
|
$
|
(2,711
|
)
|
|
$
|
(3,314
|
)
|
|
$
|
(10,367
|
)
|
|
$
|
(6,814
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average
common shares outstanding
|
|
|
25,067
|
|
|
|
24,434
|
|
|
|
25,022
|
|
|
|
24,182
|
|
Less:
Weighted-average unvested common shares
subject
to repurchase
|
|
|
(0
|
)
|
|
|
(9
|
)
|
|
|
(2
|
)
|
|
|
(17
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator
for basic net loss per share
|
|
|
25,067
|
|
|
|
24,425
|
|
|
|
25,020
|
|
|
|
24,165
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dilutive
effect of stock options, restricted stock units
and
shares subject to repurchase
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Denominator
for diluted net loss per share
|
|
|
25,067
|
|
|
|
24,425
|
|
|
|
25,020
|
|
|
|
24,165
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss per share — basic and diluted
|
|
$
|
(0.11
|
)
|
|
$
|
(0.14
|
)
|
|
$
|
(0.41
|
)
|
|
$
|
(0.28
|
)
|
|
|
Three
Months
|
|
Nine
Months
|
|
|
Ended
September 30,
|
|
Ended
September 30,
|
|
|
(in
thousands)
|
|
(in
thousands)
|
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
Options
to purchase common stock, common stock subject to repurchase and
restricted stock units
|
|
|
6,443
|
|
|
|
5,276
|
|
|
|
6,108
|
|
|
|
5,248
|
|
SHUTTERFLY,
INC.
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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 September 30, 2008 (in thousands):
|
|
September
30, 2008
|
|
|
|
Fair
Value
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
Cash
equivalents:
|
|
|
|
|
|
|
|
|
|
|
|
|
Money market funds
|
|
$
|
34,030
|
|
|
$
|
34,030
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Long-term
investments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Auction
rate securities
|
|
|
47,420
|
|
|
|
—
|
|
|
|
—
|
|
|
|
47,420
|
|
Total
financial assets
|
|
$
|
81,450
|
|
|
$
|
34,030
|
|
|
$
|
—
|
|
|
$
|
47,420
|
|
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
are the only securities 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 September 30,
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, the securities are called by the
issuer 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 90% 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
investments no longer approximates par value.
At
September 30, 2008, the Company utilized a discounted cash flow approach to
determine the Level 3 valuation for the ARS investments. This
analysis indicated a fair value of $47.4 million. 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 September 30, 2008. Based on this assessment of
fair value, as of September 30, 2008 the Company determined there was a decline
in fair value of its ARS investments of $4.8 million which was deemed
temporary. That amount has been recorded net of tax, as a component
of other comprehensive income. If in the future, the Company concludes
that the impairment is other-than-temporary, there would be a charge to the
income statement equal to the amount of the unrealized loss at the time that
conclusion was made.
The
following table provides a summary of changes in fair value of the Company’s ARS
investments (Level 3) as of September 30, 2008 (in thousands):
Balance
at December 31, 2007
|
|
$
|
—
|
|
Purchase
of ARS investments
|
|
|
52,250
|
|
Unrealized
loss included in other comprehensive income
|
|
|
(4,830
|
)
|
Balance
at September 30, 2008
|
|
$
|
47,420
|
|
SHUTTERFLY,
INC.
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note
5 — Balance Sheet Components
Property
and Equipment
|
|
September 30, 2008
|
|
|
December 31, 2007
|
|
|
|
(in
thousands)
|
|
Computer
and other equipment
|
|
$
|
76,978
|
|
|
$
|
66,663
|
|
Software
|
|
|
8,526
|
|
|
|
6,089
|
|
Leasehold
improvements
|
|
|
8,703
|
|
|
|
7,952
|
|
Furniture
and fixtures
|
|
|
2,561
|
|
|
|
2,282
|
|
Capitalized
software and website development costs
|
|
|
10,246
|
|
|
|
6,656
|
|
|
|
|
107,014
|
|
|
|
89,642
|
|
Less:
Accumulated depreciation and amortization
|
|
|
(55,184
|
)
|
|
|
(41,226
|
)
|
Net
property and equipment
|
|
$
|
51,830
|
|
|
$
|
48,416
|
|
Property
and equipment includes $3,356,000 and $5,121,000 of equipment under capital
leases at September 30, 2008 and December 31, 2007, respectively. Accumulated
depreciation of assets under capital leases totaled $2,893,000 and $3,798,000 at
September 30, 2008 and December 31, 2007, respectively.
Depreciation
and amortization expense totaled $6,226,000 and $4,749,000 for the three months
ended September 30, 2008 and 2007, respectively. Depreciation and amortization
expense totaled $17,463,000 and $12,217,000 for the nine months ended
September 30, 2008 and 2007, respectively.
As a
result of the Company’s decision to close its Hayward facility, the Company will
accelerate the depreciation of leasehold improvements at the Hayward facility
totaling approximately $800,000 as of the announcement date of July 2008,
through the closure date in early 2009. For the three months ended
September 30, 2008, the Company recorded $158,000 of accelerated depreciation
for these leasehold improvements.
Accrued
Liabilities
|
|
September 30, 2008
|
|
|
December 31, 2007
|
|
|
|
(in
thousands)
|
|
Accrued
marketing expenses
|
|
$
|
2,954
|
|
|
$
|
4,101
|
|
Accrued
compensation
|
|
|
2,893
|
|
|
|
3,053
|
|
Accrued
purchases and production facility expenses
|
|
|
1,710 |
|
|
|
4,697 |
|
Accrued
sales taxes
|
|
|
1,109
|
|
|
|
3,682
|
|
Accrued
consultant expenses
|
|
|
1,054
|
|
|
|
1,516
|
|
Accrued
other |
|
|
2,934 |
|
|
|
1,675 |
|
|
|
$
|
12,654
|
|
|
$
|
18,724
|
|
SHUTTERFLY,
INC.
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note
6 — Restructuring
In July 2008, the Company
announced that effective in early 2009, it would close its Hayward production
facility and begin operations at a new manufacturing facility to be located in
Phoenix, Arizona. As a result of this decision, the Company incurred
approximately $80,000 in contractual lease termination costs which was recorded
in the second quarter of the fiscal year. The Company will also incur
$794,000 in severance costs, which will be recognized ratably over the period
from the severance communication date in July 2008, through the facility closure
date in early 2009. As of September 30, 2008, the Company has
recognized $240,000 in severance costs. The Company expects to incur
up to $200,000 in additional costs associated with the relocation of certain
employees, which will be expensed as incurred in 2009.
Accrued
liabilities related to restructuring actions consist of (in
thousands):
|
|
Facility
Closure Costs
|
|
Workforce
Reduction Costs
|
|
Total
|
|
Balance,
December 31, 2007
|
|
$ |
- |
|
|
$ |
- |
|
|
$ |
- |
|
Restructuring
charges
|
|
|
80 |
|
|
|
240 |
|
|
|
320 |
|
Payments
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
Balance,
September 30, 2008
|
|
$ |
80 |
|
|
$ |
240 |
|
|
$ |
320 |
|
Note
7 — 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.
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.
Line
of Credit
In
April 2008, the Company entered into a line of credit facility (the
“Facility”) with JPMorgan Chase Bank, N.A. 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. The Company 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.
As of September 30, 2008, the Company has not drawn on the line of
credit. The Company incurred $236,000 of Facility origination costs
which have been capitalized within prepaid expenses and will be amortized over
the 12 month term of the Facility.
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 was denied by the
Court, and the Company subsequently filed an answer to the Amended Complaint on
October 8, 2008, as well as counterclaims seeking declarations of
non-infringement and invalidity of the patents-in-suit. The Court has
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 filed an
answer to the complaint on April 29, 2008. Plaintiff has moved to
consolidate this case with an earlier case filed against Netflix, Inc., et al.,
which the Company has opposed. A hearing on this motion is set for
November 6, 2008. In addition, the Company has joined a motion to
stay the litigation based on pending reexaminations of the patents-in-suit filed
in the U.S. Patent & Trademark Office. A hearing on this motion
is also set for November 6, 2008. The Court has set a schedule in this
matter, which includes a trial date of March 2, 2010. 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 September 30, 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
8 — 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 purchase price 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 to the Nexo founders contingent upon their 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.
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The total
purchase price of $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 the 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 the condensed
consolidated statement of operations and, accordingly, pro forma financial
information has not been presented.
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
|
|
|
September
30, 2008
|
|
Purchase
technology
|
|
$
|
3,350
|
|
|
$
|
5,100
|
|
|
$
|
(1,965
|
)
|
|
$
|
6,485
|
|
Customer
relationships
|
|
|
990
|
|
|
|
-
|
|
|
|
(357
|
)
|
|
|
633
|
|
Licenses
and other
|
|
|
186
|
|
|
|
70
|
|
|
|
(94
|
)
|
|
|
162
|
|
Total
intangible assets, net
|
|
$
|
4,526
|
|
|
$
|
5,170
|
|
|
$
|
(2,416
|
)
|
|
$
|
7,280
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Goodwill
|
|
$
|
379
|
|
|
$
|
6,973
|
|
|
|
-
|
|
|
$
|
7,352
|
|
Note 9
— Intellectual Property Cross-Licensing Agreement
On
September 17, 2008, the Company entered into a multi-million dollar
cross-licensing agreement for intellectual property with a digital imaging
company. Under the terms of the agreement, the digital imaging
company has rights to use the Company’s current and pending patented technology
and processes. In addition, the Company has rights to use certain of
the digital imaging company’s pending patented technology and
processes.
As
consideration for the rights under the agreement, the digital imaging company
will pay fees due under the agreement in two installments of which the first
installment was paid in September 2008 and the remaining installment is due in
September 2009. Such amounts are and will be recognized as a
reduction of general and administrative expense as each installment becomes due
and payable.
On
February 8, 2008, the Company entered into a multi-million dollar
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 of which the first installment was paid
in February 2008 and the remaining two installments are due in 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 10
— Subsequent Event
In
October 2008, the Company received an offer (the “Offer”) from UBS AG
(“UBS”). As a UBS client who holds Auction Rate Securities ("ARS"), if the
Company accepts the Offer it will receive ARS Rights, which will entitle the
Company to sell ARS to USB affiliates during the period from June 30, 2010 to
July 2, 2012 for a price equal to par value. In exchange for the issuance
of the ARS Rights, the UBS affiliates will have the discretionary right to sell
the Company's eligible ARS on the Company's behalf, without prior notification,
at any time before the expiration of the related ARS Right, so long as the
Company receives par value for the sold ARS. The Offer is non-transferable
and expires on November 14, 2008. The Company is currently evaluating the
Offer and its potential financial statement impact.
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, the effect of capital expenditures on our results of
operations , 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. 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.
In July 2008, we announced that we will be closing our Hayward, California
production facility in early 2009 and expect to begin ramping up operations in a
new manufacturing and production facility in Phoenix, Arizona. 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. In the future, we plan to increase the
outsourced manufacturing of certain additional components of our product
line.
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 September
30, 2008, we fulfilled more than 1.6 million orders, to approximately
916,000 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 and Shutterfly Share), 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.
Beginning in July 2008, costs of net revenues also include certain costs
associated with the closure of our Hayward manufacturing and production
facility.
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. To date, all of the payments we have received from our
intellectual property license agreements have been included as an offset to
general and administrative expense.
Interest Expense.
Interest expense consists of interest costs recognized under our
capital lease obligations and other borrowings as well as costs associated with
our working capital line of credit.
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 only operate within the United States. We expect our
full year 2008 effective tax rate to range from 22% to 50%.
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 nine month period ended September 30, 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 "Accounting for the Costs of Computer Software Developed
or Obtained for Internal Use" and EITF Issue No. 00-2 "Revenue
Arrangements with Multiple Deliverables". 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
|
|
|
Nine
Months
|
|
|
|
Ended
September 30,
|
|
|
Ended
September 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Net
revenues
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
100
|
%
|
Cost
of revenues
|
|
|
51
|
%
|
|
|
53
|
%
|
|
|
51
|
%
|
|
|
51
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
profit
|
|
|
49
|
%
|
|
|
47
|
%
|
|
|
49
|
%
|
|
|
49
|
%
|
Operating
expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Technology
and development
|
|
|
27
|
%
|
|
|
23
|
%
|
|
|
27
|
%
|
|
|
22
|
%
|
Sales
and marketing
|
|
|
28
|
%
|
|
|
22
|
%
|
|
|
25
|
%
|
|
|
22
|
%
|
General
and administrative
|
|
|
19
|
%
|
|
|
23
|
%
|
|
|
21
|
%
|
|
|
22
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
from operations
|
|
|
(25
|
)%
|
|
|
(21
|
)%
|
|
|
(24
|
)%
|
|
|
(17
|
)%
|
Interest
expense
|
|
|
0
|
%
|
|
|
0
|
%
|
|
|
0
|
%
|
|
|
0
|
%
|
Other
income (expense), net
|
|
|
1
|
%
|
|
|
4
|
%
|
|
|
2
|
%
|
|
|
5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
before income taxes
|
|
|
(24
|
)%
|
|
|
(17
|
)%
|
|
|
(22
|
)%
|
|
|
(12
|
)%
|
Benefit
from income taxes
|
|
|
16
|
%
|
|
|
6
|
%
|
|
|
12
|
%
|
|
|
5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss
|
|
|
(8
|
)%
|
|
|
(11
|
)%
|
|
|
(10
|
)%
|
|
|
(7
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comparison
of the Three and Nine Month Periods Ended September 30, 2008 and 2007
|
|
Three
Months Ended September 30,
|
|
|
|
|
|
Nine
Months Ended September 30,
|
|
|
|
|
2008
|
|
2007
|
|
%
Change
|
|
2008
|
|
2007
|
|
%
Change
|
|
|
(in
thousands)
|
|
|
|
|
|
(in
thousands)
|
|
|
|
|
Net
revenues
|
|
$
|
35,953
|
|
|
$
|
32,602
|
|
|
|
10
|
%
|
|
$
|
105,738
|
|
|
$
|
89,184
|
|
|
|
19
|
%
|
Cost
of net revenues
|
|
|
18,430
|
|
|
|
17,240
|
|
|
|
7
|
%
|
|
|
53,739
|
|
|
|
45,107
|
|
|
|
19
|
%
|
Percentage
of net revenues
|
|
|
51
|
%
|
|
|
53
|
%
|
|
|
|
|
|
|
51
|
%
|
|
|
51
|
%
|
|
|
|
|
Net
revenues increased $3.4 million, or 10%, for the three months ended
September 30, 2008, as compared to the same period in 2007. Net revenues
increased $16.6 million, or 19% for the nine months ended September 30,
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 revenues (“PPS”) increased $4.8 million,
or 32%, to $19.4 million for the three months ended September 30, 2008 as
compared to the same period in 2007. PPS increased $14.1 million, or 33%,
to $57.5 million for the nine months ended September 30, 2008 as compared
to the same period in 2007. This change was primarily the result of increased
sales of photo books and greeting cards, as well as an increase in referral
fees. PPS made up 54% of net revenues for the three months ended September 30,
2008, up from 45% for the same period in 2007. PPS made up 54% of net revenues
for the nine months ended September 30, 2008, up from 49% for the same period in
2007. Print revenues decreased $1.4 million, or 8%, to $16.6 million
for the three months ended September 30, 2008 as compared to the same period in
2007. Print revenues increased $2.5 million, or 5%, to $48.3 million
for the nine months ended September 30, 2008 as compared to the same period in
2007. During the third quarter of 2008, we made a permanent price adjustment on
4x6 prints, lowering the list price from $0.19 to $0.15 and we also reduced the
lowest tier in our prepaid plan to $0.10. Net revenue increases were
also the result of year-over-year increases in customers and average order value
(“AOV”), while total orders were flat. Average order value
improvement was a result of a continued mix shift from prints to higher value
personalized products particularly on photo books.
|
|
Three
Months Ended September 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
Change
|
|
%
Change
|
|
|
|
(In
thousands, except AOV amounts)
|
|
Customers
|
|
|
916
|
|
|
|
844
|
|
|
|
72
|
|
|
|
9
|
%
|
Orders
|
|
|
1,656
|
|
|
|
1,661
|
|
|
|
(5
|
)
|
|
|
--
|
|
Average
order value
|
|
$
|
21.71
|
|
|
$
|
19.63
|
|
|
$
|
2.08
|
|
|
|
11
|
%
|
Cost of
net revenues increased $1.2 million, or 7%, for the three months ended
September 30, 2008 as compared to the same period in 2007. As a percentage of
net revenues, cost of net revenues decreased from 53% to 51% for the same
comparable period, which increased gross margin from 47% in the third quarter of
2007 to 49% in the third quarter of 2008. Improvement in margin is
primarily a result of continued labor efficiencies from our Charlotte plant,
improvements in both material and shipping costs and reduced costs for equipment
rentals. Cost of net revenues increased $8.6 million, or 19%,
for the nine months ended September 30, 2008 as compared to the same period in
2007. As a percentage of net revenues, cost of
net revenues remained flat at 51% for the same comparable period, as did gross
margin at 49% in the first three quarters of 2007 and the first three quarters
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 two quarters of 2008 versus
one facility in 2007, and the impact of intangible amortization from
the Nexo acquisition which was not included in the nine months ended
September 30, 2007. In addition, we incurred approximately $0.2
million in accelerated tenant improvement depreciation and $0.2 million in
employee severance costs associated with the closure of our Hayward
manufacturing facility which was announced during the three months ended
September 30, 2008. These costs were offset in part by savings in
labor, shipping, and materials costs reflecting efficiencies realized in our
Charlotte facility, and other negotiated cost reductions.
|
|
Three
Months Ended September 30,
|
|
|
|
|
|
Nine
Months Ended September 30,
|
|
|
|
|
2008
|
|
2007
|
|
%
Change
|
|
2008
|
|
2007
|
|
%
Change
|
|
|
(in
thousands)
|
|
|
|
|
|
(in
thousands)
|
|
|
|
|
Technology
and development
|
|
$
|
9,645
|
|
|
$
|
7,579
|
|
|
|
27
|
%
|
|
$
|
28,642
|
|
|
$
|
20,034
|
|
|
|
43
|
%
|
Percentage of net
revenues
|
|
|
27
|
%
|
|
|
23
|
%
|
|
|
|
|
|
|
27
|
%
|
|
|
22
|
%
|
|
|
|
|
Sales
and marketing
|
|
|
10,087
|
|
|
|
7,042
|
|
|
|
43
|
%
|
|
|
26,762
|
|
|
|
19,421
|
|
|
|
38
|
%
|
Percentage of net
revenues
|
|
|
28
|
%
|
|
|
22
|
%
|
|
|
|
|
|
|
25
|
%
|
|
|
22
|
%
|
|
|
|
|
General
and administrative
|
|
|
6,772
|
|
|
|
7,352
|
|
|
|
(8)
|
%
|
|
|
21,946
|
|
|
|
20,056
|
|
|
|
9
|
%
|
Percentage
of net revenues
|
|
|
19
|
%
|
|
|
23
|
%
|
|
|
|
|
|
|
21
|
%
|
|
|
22
|
%
|
|
|
|
|
Our
technology and development expense increased $2.1 million, or 27%, for the three
months ended September 30, 2008 as compared to the same period in 2007. As a
percentage of net revenues, this expense increased from 23% to 27% for the same
comparable period. For the nine months ended September 30, 2008, technology and
development expense increased $8.6 million, or 43%, as compared to the same
period in 2007. As a percentage of revenue, technology and development expense
for the nine months ended September 30, 2008 increased from 22% to 27% for the
same comparable period. 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 $0.4 million and $2.5 million,
respectively. For the three and nine month periods ended September
30, 2008, depreciation expenses increased $0.7 million and $3.2 million, and
repair and maintenance expenses and co-location expenses increased $0.6 million
and $1.7 million, respectively, related to our investments in website
infrastructure hardware and bandwidth to support our continued revenue
growth. In addition, for the nine months ended September 30, 2008, we
incurred a loss on disposal of previously capitalized software development costs
due to that technologies obsolescence totaling $0.3 million. Stock-based
compensation expense was $0.6 million and $1.5 million in the three months and
nine months ended September 30, 2008, compared to $0.2 million and $0.6 million
in the three months and nine months ended September 30, 2007.
Our sales
and marketing expense increased $3.0 million, or 43%, for the three months
ended September 30, 2008 as compared to the same period in 2007. As a percentage
of net revenues, this expense increased from 22% to 28% for the same comparable
period. For the nine months ended September 30, 2008, sales and marketing
expense increased $7.3 million, or 38%, as compared to the same period in
2007. This expense increased as a percentage of net revenues from 22% to 25% for
the same comparable period. Personnel and related costs for employees and
consultants increased by $0.6 million and $2.1 million due to increased
headcount. Our expenditures incurred on customer acquisition and promotion
costs increased by $2.1 million and $4.1 million for the three months and nine
months ended September 30, 2008. Increases are primarily associated
with expanded online media and direct response marketing campaigns, along with
an expansion of our internal marketing team. In addition,
stock-based compensation expense was $0.6 million and $1.6 million in the three
months and nine months ended September 30, 2008, compared to $0.3 million and
$0.6 million in the same periods of 2007.
Our
general and administrative expense decreased $0.6 million, or 8%, for the
three months ended September 30, 2008 as compared to the same period in 2007.
This expense decreased as a percentage of net revenues from 23% to 19%. For the
nine months ended September 30, 2008, general and administrative expense
increased $1.9 million, or 9%, as compared to the same period in 2007. This
expense decreased as a percentage of net revenues from 22% to 21%. Personnel and
related costs for employees remained flat and increased by $0.7
million for the three months and nine months ended September 30, 2008 as
compared to the same periods in 2007 reflecting increased hiring in 2008 and an
increase in stock-based compensation to $1.1 million and $3.0 million, in
2008, compared to $0.5 million and $1.5 million in 2007. Accounting and
legal fees were flat and increased by $0.8 million for the three months and nine
months ended September 30, 2008 as compared to the same periods in 2007. Payment
processing fees paid to third parties were flat and increased by $0.2 million
during the three months and nine months ended September 30, 2008 as compared to
the same periods in 2007. Building rent and building management fees
increased $0.3 million and $0.6 million, and depreciation increased $0.2 million
and $0.6 million during the three months and nine months ended September 30,
2008 as compared to the same periods in 2007. Increases are
attributable to our office lease expansion and ERP implementation which is
offset by efficiencies from our Sarbanes-Oxley compliance efforts and reduced
contractor utilization. Also offsetting general and administrative
expenses for the three months ended September 30, 2008 was the first of two
installment payments from a multi-million dollar cross-licensing agreement
entered into with a digital imaging company. We expect to recognize
the remaining installment under the agreement when the amount is received in the
third quarter of 2009. Included in the general and administrative
expenses for the nine months ended September 30, 2008 was the receipt of the
first annual installment received in the first quarter of 2008 from
a multi-million dollar intellectual property cross-licensing agreement with
American Greetings, Inc. 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 September 30,
|
|
|
|
Nine
Months Ended September 30,
|
|
|
|
2008
|
2007
|
Change
|
|
2008
|
2007
|
|
Change
|
|
(in
thousands)
|
|
|
|
(in
thousands)
|
|
|
|
Interest
expense
|
|
$ |
(100 |
) |
|
$ |
(54 |
) |
|
$ |
(46 |
) |
|
$ |
(185 |
) |
|
$ |
(147 |
) |
|
$ |
(38 |
) |
Interest
income
|
|
|
455 |
|
|
|
1,350 |
|
|
|
(895
|
) |
|
|
2,514 |
|
|
|
4,252 |
|
|
|
(1,738
|
) |
Interest
expense increased by $46,000 or 85% and increased $38,000 or 26% for the three
and nine months ended September 30, 2008, respectively, as compared to the
same periods in 2007, due primarily to a decrease in interest expense on
capitalized lease obligations. For the three and nine months ended
September 30, 2008, $88,000 and $0.1 million has been amortized associated with
the line of credit origination costs.
Interest
income decreased by $0.9 million or 66% and $1.7 million or 41% for
the three and nine months ended September 30, 2008 as compared to the same
periods in 2007. This decrease for both the three and nine month periods
was the result of an overall lower yield on our investment portfolio, including
our auction rate securities, relative to our investment balances in the
comparable prior year periods.
|
|
Three
Months Ended September 30,
|
|
|
Nine
Months Ended September 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
|
(in
thousands)
|
|
|
(in
thousands)
|
Benefit
from income taxes
|
|
$
|
5,915
|
|
|
$
|
2,001
|
|
|
$
|
12,655
|
|
|
$
|
4,515
|
|
Effective
tax rate
|
|
|
69
|
%
|
|
|
38
|
%
|
|
|
55
|
%
|
|
|
40
|
%
|
As of
September 30, 2008, we had approximately $34 million of federal and
$31 million of California net operating loss carryforwards available to
reduce future taxable income. These net operating loss carryforwards begin to
expire in 2020 and 2014 for federal and California tax purposes,
respectively.
|
|
Three
Months Ended September 30,
|
|
|
|
|
|
Nine
Months Ended September 30,
|
|
|
|
|
2008
|
|
2007
|
|
%
Change
|
|
2008
|
|
2007
|
|
%
Change
|
|
|
(in
thousands)
|
|
|
|
|
|
(in
thousands)
|
|
|
|
|
Loss
before income taxes
|
|
$
|
(8,626
|
)
|
|
$
|
(5,315
|
)
|
|
|
62
|
%
|
|
$
|
(23,022
|
)
|
|
$
|
(11,329
|
)
|
|
|
103
|
%
|
Net
loss
|
|
|
(2,711
|
)
|
|
|
(3,314
|
)
|
|
|
(18)
|
%
|
|
|
(10,367
|
)
|
|
|
(6,814
|
)
|
|
|
52
|
%
|
Net
loss decreased by $0.6 million, or 18% and increased $3.6 million, or 52%,
for the three and nine months ended September 30, 2008 as compared to the
same period in 2007.
|
|
Nine
Months Ended September 30,
|
|
|
2008
|
|
2007
|
|
|
(in
thousands)
|
Consolidated
Statements of Cash Flows Data:
|
|
|
|
|
|
|
|
|
Purchases
of property and equipment
|
|
$
|
16,760
|
|
|
$
|
28,501
|
|
Capitalization
of software and website development costs
|
|
|
3,239
|
|
|
|
2,417
|
|
Depreciation
and amortization
|
|
|
18,833
|
|
|
|
12,434
|
|
Net
cash flows (used in) provided by operating activities
|
|
|
(3,360
|
)
|
|
|
7,604
|
|
Net
cash flows used in investing activities
|
|
|
(79,339
|
)
|
|
|
(36,575
|
)
|
Net
cash flows provided by financing activities
|
|
|
752
|
|
|
|
1,519
|
|
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
September 30, 2008, we had $40.6 million of cash and cash equivalents. Cash
equivalents are comprised of money market funds.
At
September 30, 2008, $47.4 million ($52.3 million par value) of our
marketable securities portfolio was invested in AAA rated investments in
auction-rate debt securities ("ARS"). 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. 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 September 30,
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, the securities are called by
the issuer 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 90% 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 our 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
September 30, 2008, we utilized a discounted cash flow approach to
determine the Level 3 valuation for the ARS investments. This
analysis indicated a fair value of $47.4 million. 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 September 30, 2008. Based on this assessment of fair value, as of
September 30, 2008 we determined there was a decline in fair value of its ARS
investments of $4.8 million which was deemed temporary. If in the
future, we conclude that the impairment is other-than-temporary, there
would be a change to our income statement equal to the amount of the unrealized
loss at the time that conclusion was made.
In
October 2008, we received an offer (the “Offer”) from UBS AG (“UBS”). As a
UBS client who holds Auction Rate Securities ("ARS"), if we accept the
Offer we will receive ARS Rights, which will entitle us to sell ARS to UBS
affiliates during the period from June 30, 2010 to July 2, 2012 for a price
equal to par value. In exchange for the issuance of the ARS Rights, the
UBS affiliates will have the discretionary right to sell our eligible ARS
on our behalf, without prior notification, at any time before expiration of the
related ARS Right, so long as we receive par value for the sold ARS. The
Offer is non-transferable and expires on November 14, 2008. We are
currently evaluating the Offer and its potential financial statement
impact.
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 September 30, 2008, we have access to our cash
and cash equivalents and our other liquid investments, totaling $40.6
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. As of September 30, 2008, no amounts had been drawn
against that facility.
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 that total capital expenditures will approximate $26 million in
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
nine months ended September 30, 2008, net cash used in operating activities
was $3.4 million, primarily due to our net loss of $10.4 million and the net
change in operating assets and liabilities of $8.7 million, adjusted for
non-cash items including $18.8 million of depreciation and amortization expense,
$9.7 million of benefit from income taxes and $6.3 million of stock-based
compensation.
For the
nine months ended September 30, 2007, net cash provided by operating activities
was $7.6 million, primarily due to our management of our working capital, in
particular a combined $5.1 million increase in accounts payable and accrued
liabilities, after adjusting for large non-cash items in the quarter including
$12.4 million of depreciation and amortization expense, $4.5 million benefit
from income taxes and $2.8 million of stock-based compensation.
Investing Activities. For the
nine months ended September 30, 2008, net cash used in investing activities
was $79.3 million. We used $20.0 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 the sale of the short term investments. We also paid
$10.1 million in cash consideration to acquire Nexo.
For the
nine months ended September 30, 2007, net cash used in investing activities was
$36.6 million. $30.9 million was used primarily for capital expenditures for
manufacturing equipment, computer and network hardware to support our website
infrastructure and information technology computer hardware. Capital
expenditures also include our internally developed software and website
costs. In addition, $2.7 million of net cash was used in the
acquisition of business and intangibles, and $3.0 million was used for the
purchase of short term investments.
Financing Activities. Our
financing activities for the nine months ended September 30, 2008 provided
cash of $0.7 million, primarily from $1.1 million of proceeds from issuance
of common stock less cash used of $0.4 million of principal payments on
capital lease obligations.
Our
financing activities for the nine months ended September 30, 2007 provided cash
of $1.5 million, primarily from $3.4 million of proceeds from issuance of common
stock less cash used of $1.9 million of principal payments on capital lease
obligations.
Off-Balance
Sheet Arrangements
We do not
have any relationships with unconsolidated entities or financial partnerships,
such as entities often referred to as structured finance or special purpose
entities, which would have been established for the purpose of facilitating
off-balance sheet arrangements or other contractually narrow or limited
purposes. In addition, we do not have any undisclosed borrowings or debt, and we
have not entered into any synthetic leases. We are, therefore, not materially
exposed to any financing, liquidity, market or credit risk that could arise if
we had engaged in such relationships. 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 through December 2008. As
of September 30, 2008, the total potential remaining earnout payment is $0.4
million.
Recent
Accounting Pronouncements
Effective
January 1, 2008, we adopted SFAS No. 157, “Fair Value Measurements”
(“FAS 157”). In February 2008, the FASB issued a staff position which
provides a one year deferral of the effective date of SFAS 157 for all
nonfinancial assets and liabilities except for those that were recognized
or disclosed in the financial statements at fair value at least annually.
Therefore, we have 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 our consolidated results of operations and financial
condition.
Effective
January 1, 2008, we 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. We
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
non-controlling 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. We do not expect the adoption of FAS 141R to have
a material effect on our financial position and results of
operations.
In
December 2007, the FASB issued SFAS No. 160, “Non-controlling Interests in
Consolidated Financial Statements” (“FAS 160”) which amends ARB 51 to establish
accounting and reporting standards for the non-controlling interest in a
subsidiary and for the deconsolidation of a subsidiary. It clarifies that a
non-controlling 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. We do not expect the adoption of FAS 160 to have a
material effect on our financial position or results of operations.
In
April 2008, the Financial Accounting Standards Board ("FASB") issued FASB Staff
Position ("FSP") No. 142-3, "Determination of the Useful Life of Intangible
Assets". FSP 142-3 amends the factors an entity should consider in
developing renewal or extension assumptions used in determining the useful life
or recognized intangible assets under FASB Statement No. 142, "Goodwill and
Other Intangible Assets". This new guidance applies prospectively to
intangible assets that are acquired individually or with a group of other assets
in business combinations and asset acquisitions. FSP 142-3 is effective
for financial statements issued for fiscal years and interim periods beginning
after December 15, 2008. Early adoption is prohibited. We do
not expect the adoption of FSP 142-3 to have a material effect on our
financial position or results of operations.
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 are 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
September 30, 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
September 30, 2008, we held auction rate security investments which were AAA
rated and 90% of the underlying assets were 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 $4.8 million below par value. We have
classified these ARS investments as long-term assets which reflect 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, for example, if the cost
of our materials or the cost of shipping our products to customers were to incur
substantial increases as a result of the rapid rise in the cost of oil, 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.
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 September 30, 2008. The term “disclosure controls and
procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934 (“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 September 30, 2008,
our chief executive officer and chief financial officer concluded that, as of
such date, the Company’s disclosure controls and procedures were
effective.
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
September 30, 2008 that has materially affected, or is reasonably likely to
materially affect, our internal control over financial
reporting except as indicated below.
During
the third quarter of 2008, we completed our implementation of our new enterprise
resource planning system. This is part of our strategy to provide scale in
our operations, thereby improving our internal controls.
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 was denied by the Court, and we
subsequently filed an answer to the Amended Complaint on October 8, 2008, as
well as counterclaims seeking declarations of non-infringement and invalidity of
the patents-in-suit. The Court has 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 filed an answer to the complaint
on April 29, 2008. Plaintiff has moved to consolidate this case with
an earlier case filed against Netflix, Inc., et al., which we have
opposed. A hearing on this motion is set for November 6,
2008. In addition, we have joined a motion to stay the litigation
based on pending reexaminations of the patents-in-suit filed in the U.S. Patent
& Trademark Office. A hearing on this motion is also set for
November 6, 2008. The Court has set a schedule in this matter, which
includes a trial date of March 2, 2010. At this time, we do not believe
that the amount of potential loss, if any, is reasonably estimable.
From time
to time, we may be involved in various legal proceedings arising in the ordinary
course of business. At September 30, 2008, in the opinion of management,
there are no other matters that are expected to have a material adverse effect
on our financial position, results of operations or cash flows.
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.
We also
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.
In
addition, our operations and performance depend on general economic
conditions. The U.S. economy recently experienced, and could continue
to experience, an economic downturn due to the crisis in credit markets, slower
economic activity, concerns about inflation, increased energy costs, decreased
consumer confidence, and other adverse business conditions. Such
fluctuations in the U.S. economy could cause, among others, deterioration and
continued decline in consumer spending and increase in the cost of labor and
materials. As a result, given the combination of the current economic
conditions, very low consumer sentiment, limited discretionary funds and an
abbreviated shopping period, we believe that this fourth quarter will be our
most challenging on record and that our top-line results will be difficult to
predict.
Our
limited operating history makes it difficult to assess the exact impact of the
seasonal factors on our business or the extent to which 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
housing and credit system and the liquidity issues in the auction rate
securities that we have invested in, have negatively impacted the economy
and may negatively affect our growth. 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 negative 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 continue to grow our current production capability to meet
our projected net revenue targets. We anticipate that total capital expenditures
will approximate $26 million in 2008, 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, and in July
2008 we announced that we will be closing our Hayward, California production
facility in early 2009 and expect to begin operations in a new
manufacturing and production facility in Phoenix, Arizona by April 1,
2009. Operational difficulties, such as a significant interruption in
the operation or opening of any of our plants could delay production or shipment
of our products. 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
connection with the start-up of our new Phoenix manufacturing and production
plant, there could be unforeseen construction, scheduling,
engineering, cost or other problems with the build-out of the facility where the
plant will be located that could cause the operation commencement date to differ
significantly from initial expectations. Any significant delay in the
commencement of operations at the new plant could cause a delay in our
production requirements and harm our business, financial condition and results
of operations. The new plant could also experience other operational
disruptions, including telecommunications system problems, disruptions in
transitioning fulfillment orders and problems or increased expenses associated
with operating the new plant, which could harm our business, financial condition
and results of operations.
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 at any of our 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:
|
•
|
general
economic conditions, including higher inflation and the possibility of a
recession and economic slowdown in the U.S. and worldwide, as well as
those economic conditions specific to the Internet and ecommerce
industries
|
|
•
|
demand
for our products and services, including seasonal
demand;
|
|
•
|
our
pricing and marketing strategies and those of our
competitors;
|
|
•
|
our
ability to attract visitors to our website and convert those visitors into
customers;
|
|
•
|
our
ability to retain customers and encourage repeat
purchases;
|
|
•
|
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;
|
|
•
|
the
costs of customer acquisition;
|
|
•
|
our
ability to manage our production and fulfillment
operations;
|
|
•
|
the
costs to produce our prints and photo-based products and merchandise and
to provide our services;
|
|
•
|
the
costs of expanding or enhancing our technology or
website;
|
|
•
|
a
significant increase in returns and credits, beyond our estimated
allowances, for customers who are not satisfied with our
products;
|
|
•
|
declines
or disruptions to the travel
industry;
|
|
•
|
variations
in weather, particularly heavy rain and snow which tend to depress travel
and picture taking;
|
|
•
|
the
timing of holidays;
|
|
•
|
volatility
in our stock price, which may lead to higher stock-based compensation
expense;
|
|
•
|
consumer
preferences for digital photography
services;
|
|
•
|
improvements
to the quality, cost and convenience of desktop printing of digital
pictures and products; and
|
|
•
|
macroeconomic
and geopolitical events such as recession, inflation, war, threat of war
or terrorist actions.
|
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 results in
operating losses in each of the first three quarters of our fiscal year. This
typically has enabled 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
have a limited public company operating history, which makes it difficult to
evaluate our business and prospects for the future.
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:
|
•
|
maintain
and increase the size of our customer
base;
|
|
•
|
maintain
and enhance our brand;
|
|
•
|
maintain
and grow our website and customer
operations;
|
|
•
|
enhance
and expand our products and
services;
|
|
•
|
successfully
execute our business and marketing
strategy;
|
|
•
|
continue
to develop and upgrade our technology and information processing
systems;
|
|
•
|
continue
to enhance our service to meet the needs of a changing
market;
|
|
•
|
provide
superior customer service;
|
|
•
|
respond
to competitive developments; and
|
|
•
|
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 policy 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.
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.
For example, in the second quarter of 2008, we experienced website performance
issues in conjunction with a large release of additional website functionality
which impacted our key metrics and revenue. 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 403 employees as of September 30, 2007 to 512 employees as of
September 30, 2008. We have website operations, offices and customer support
centers in Redwood City, California and Mesa, Arizona, and production
facilities in Charlotte, North Carolina, Hayward, California (through early
2009), and a new facility in Phoenix, Arizona that is expected to be operational
in early 2009. 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.
We
recently implemented a new enterprise resource planning system ("ERP") as part
of our strategy to provide scale in our operations. The ERP system is
complex and could have flaws that could negatively impact our business and
operations. Moreover, our internal processes may not be entirely
compatible with the ERP system, which may require additional resources to ensure
compatibility.
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. During the third
quarter of 2008, we lowered the list price of 4x6 prints from $0.19 to $0.15
based on the favorable results of a promotion in the second quarter of
2008. We expect to continue to test other pricing, promotion and
bundled service offerings, however, a significant 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, we
occasionally offer free or discounted products and services to attract and
retain customers. In the future, if we increase these offers to respond to
actions taken by our competitors, our results of operations may be
harmed.
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:
|
•
|
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;
|
|
•
|
“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;
|
|
•
|
Drug
stores such as Walgreens, CVS and others that offer in-store pick-up from
Internet orders;
|
|
•
|
Regional
photography companies such as Wolf Camera and Ritz Camera that have
established brands and customer bases in existing photography
markets;
|
|
•
|
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;
|
|
•
|
Home
printing service providers such as Hewlett-Packard, Epson, Canon, and
Kodak that are seeking to expand their printer and ink businesses by
gaining market share in the emerging digital photography marketplace;
and
|
|
•
|
Photo-related
software companies such as Adobe, Apple, Microsoft, Corel and
others.
|
Many of
our competitors have significantly longer operating histories, larger and
broader customer bases, greater brand and name recognition and greater
financial, research and development and distribution resources, 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
September 30, 2008, $47.4 million ($52.3 million par value) of our marketable
securities portfolio was invested in AAA rated investments in auction-rate debt
securities ("ARS"). 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. ARS 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.
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
September 30, 2008, we utilized a discounted cash flow approach to
determine the Level 3 valuation for the ARS investments. This
analysis indicated a fair value of $47.4 million. 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 September 30, 2008. Based on this assessment of fair value, as of
September 30, 2008 we determined there was a decline in fair value of its ARS
investments of $4.8 million which was deemed temporary. If in
the future, we conclude that the impairment is other-than-temporary, there would
be a charge to our income statement equal to the amount of the unrealized loss
at the time that conclusion was made.
In
October 2008, we received an offer (the “Offer”) from UBS AG (“UBS”). As a
UBS client who holds Auction Rate Securities ("ARS"), if we accept the
Offer we will receive ARS Rights, which will entitle us to sell ARS to UBS
affiliates during the period from June 30, 2010 to July 2, 2012 for a price
equal to par value. In exchange for the issuance of the ARS Rights, the
UBS affiliates will have the discretionary right to sell our eligible ARS
on our behalf, without prior notification, at any time before expiration of the
related ARS Right, so long as we receive par value for the sold ARS. The
Offer is non-transferable and expires on November 14, 2008. We are
currently evaluating the Offer and its potential financial statement
impact.
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 September 30, 2008, we have access to our cash
and cash equivalents and our other liquid investments, totaling $40.6
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. As of September 30, 2008, no amounts have been drawn
against this facility.
The
loss of key personnel and an inability to attract and retain additional
personnel could affect our ability to successfully grow our
business.
We are
highly dependent upon the continued service and performance of our senior
management team and key technical, marketing and production
personnel. The loss of these key employees, each of whom is “at will”
and may terminate his or her employment relationship with us at any time, may
significantly delay or prevent the achievement of our business
objectives.
We
believe that our future success will also depend in part on our continued
ability to identify, hire, train and motivate qualified personnel. We face
intense competition for qualified individuals from numerous technology,
marketing, financial services, manufacturing and e-commerce companies. In
addition, competition for qualified personnel is particularly intense in the San
Francisco Bay Area, where our headquarters are located. We may be unable to
attract and retain suitably qualified individuals who are capable of meeting our
growing operational and managerial requirements, or we may be required to pay
increased compensation in order to do so. Our failure to attract and
retain qualified personnel could impair our ability to implement our business
plan.
Our
annual option pool increase 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 three quarters of 2008, the Board authorized additional inducement
stock option grants and restricted stock awards totaling 515,000 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.
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.
The
online market for digital photography products and services is less developed
than the online market for other consumer products. If this market does not gain
widespread acceptance, our business may suffer. Our success will depend in part
on our ability to attract customers who have historically used traditional
retail photography services or who have produced photographs and other products
using self-service alternatives, such as printing at home. Furthermore, we may
have to incur significantly higher and more sustained advertising and
promotional expenditures or reduce the prices of our products and services in
order to attract additional online consumers to our website and convert them
into purchasing customers. Specific factors that could prevent prospective
customers from purchasing from us include:
|
•
|
the
inability to physically handle and examine product
samples;
|
|
•
|
delivery
time associated with Internet
orders;
|
|
•
|
concerns
about the security of online transactions and the privacy of personal
information;
|
|
•
|
delayed
shipments or shipments of incorrect or damaged products;
and
|
|
•
|
inconvenience
associated with returning or exchanging purchased
items.
|
If
purchasers of digital photography products and services do not choose to shop
online, our net revenues and results of operations would be harmed.
If
affordable broadband access does not become widely available to consumers, our
revenue growth will likely suffer.
Because
our business currently involves consumers uploading and downloading large data
files, we are highly dependent upon the availability of affordable broadband
access to consumers. Many areas of the country still do not have broadband
access, and the cost of broadband access may be too expensive for many potential
customers. To the extent that broadband access is not available or not adopted
by consumers due to cost, our revenue growth would likely suffer.
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 Charlotte, North Carolina, Hayward, California (through early 2009),
and a new facility in Phoenix, Arizona that is expected to be operational in
early 2009. 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 additional data centers in our facilities in Charlotte and our
new facility in Phoenix, Arizona. 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.
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 or any newly acquired entities,
technologies or services effectively, our business and results of operations
will suffer. The time and expense associated with finding suitable and
compatible businesses, technologies or services could also disrupt our ongoing
business and divert our 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 such as those currently being experienced in the U.S. and worldwide.
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
September 30, 2008, we had 20 patents issued and more than 26 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 have 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.
Future
tax audits by taxing agencies for the open tax years could 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.
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.
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:
|
•
|
price
and volume fluctuations in the overall stock
market;
|
|
•
|
changes
in operating performance and stock market valuations of other technology
companies generally, or those in our industry in
particular;
|
|
•
|
the
financial projections we may provide to the public, any changes in these
projections or our failure to meet these
projections;
|
|
•
|
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;
|
|
•
|
ratings
downgrades by any securities analysts who follow our
company;
|
|
•
|
the
public’s response to our press releases or other public announcements,
including our filings with the SEC;
|
|
•
|
announcements
by us or our competitors of significant technical innovations,
acquisitions, strategic partnerships, joint ventures or capital
commitments;
|
|
•
|
introduction
of technologies or product enhancements that reduce the need for our
products;
|
|
•
|
market
conditions or trends in our industry or the macro-economy as a
whole;
|
|
•
|
impairment
or loss in value of our investments in auction rate
securities;
|
|
•
|
the
loss of key personnel;
|
|
•
|
lawsuits
threatened or filed against us;
|
|
•
|
future
sales of our common stock by our executive officers, directors and
significant stockholders; and
|
|
•
|
other
events or factors, including those resulting from war, incidents of
terrorism or responses to these
events.
|
Some
provisions in our restated certificate of incorporation and restated bylaws and
Delaware law may deter third parties from acquiring us.
Our
restated certificate of incorporation and restated bylaws contain provisions
that may make the acquisition of our company more difficult without the approval
of our board of directors, including the following:
|
•
|
our
board is classified into three classes of directors, each with staggered
three-year terms;
|
|
•
|
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;
|
|
•
|
our
stockholders may take action only at a meeting of stockholders and not by
written consent;
|
|
•
|
vacancies
on our board of directors may be filled only by our board of directors and
not by stockholders;
|
|
•
|
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
|
|
•
|
advance
notice procedures apply for stockholders to nominate candidates for
election as directors or to bring matters before an annual meeting of
stockholders.
|
These
anti-takeover defenses could discourage, delay or prevent a transaction
involving a change in control of our company. These provisions could also
discourage proxy contests and make it more difficult for stockholders to elect
directors of their choosing and to cause us to take other corporate actions they
desire.
In
addition, we are subject to Section 203 of the Delaware General Corporation Law,
which, subject to some exceptions, prohibits “business combinations” between a
Delaware corporation and an “interested stockholder,” which is generally defined
as a stockholder who becomes a beneficial owner of 15% or more of a Delaware
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.
Unregistered
Sales of Equity Securities
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:
|
•
|
Underwriting
discounts and commissions —
$6,090,000
|
|
•
|
Other
expenses — $2,442,000
|
|
•
|
Total
expenses — $8,533,000
|
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
September 30, 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.
Not
applicable
Not
applicable
Not
applicable
|
|
Exhibit
|
|
Number
|
Description
|
10.01
|
Transition
Agreement between the Company and Stanford Au dated August 26,
2008.
|
10.02 |
Lease
Agreement between Liberty Cotton Center LLC and the Company, dated August
22, 2008, as amended on October 29, 2008 |
31.01
|
Certification
of Chief Executive Officer Pursuant to
Securities Exchange Act Rule
13a-14(a).
|
31.02
|
Certification
of Chief Financial Officer Pursuant to Securities Exchange Act
Rule 13a-14(a).
|
32.01
|
Certification
of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 and
Securities Exchange Act Rule 13a-14(b).**
|
32.02
|
Certification
of Chief Financial Officer Pursuant to 18 U.S.C. Section
1350 and Securities Exchange Act Rule
13a-14(b).**
|
____________
**
|
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.
|
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:
October 31, 2008
|
By: |
/s/ Jeffrey T.
Housenbold
Jeffrey
T.
Housenbold
President
& Chief Executive Officer
(Principal
Executive Officer and duly authorized
signatory)
|
|
|
|
Dated:
October 31, 2008
|
By: |
/s/ Mark J.
Rubash
Mark
J.
Rubash
Senior
Vice President & Chief Financial Officer
(Principal
Accounting Officer and duly authorized
signatory)
|
|
|
Exhibit
|
|
Number
|
Description
|
10.01
|
Transition
Agreement between the Company and Stephen Au dated August 26,
2008.
|
10.02 |
Lease
Agreement between Liberty Cotton Center LLC and the Company, dated August
22, 2008, as amended on October 29, 2008 |
31.01
|
Certification
of Chief Executive Officer Pursuant to Securities Exchange Act
Rule 13a-14(a).
|
31.02
|
Certification
of Chief Financial Officer Pursuant to Securities Exchange Act
Rule 13a-14(a).
|
32.01
|
Certification
of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 and
Securities Exchange Act Rule 13a-14(b).**
|
32.02
|
Certification
of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 and
Securities Exchange Act Rule
13a-14(b).**
|
____________
*
|
Incorporated
herein by reference to the corresponding exhibit of the
S-1.
|
|
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.
|