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 twelve 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, stationery and other photo-based products and merchandise.

We currently generate the majority of our net revenues by producing and selling professionally-bound photo books, greeting cards and stationery, personalized calendars, other photo-based merchandise and high-quality prints ranging in size from wallet to jumbo-sized 20x30 enlargements. We currently manufacture these items in our Charlotte, North Carolina and Phoenix, Arizona manufacturing facilities. Our new manufacturing and production facility in Phoenix, Arizona began operations in April 2009, and replaced our Hayward, California facility, which ceased operations in January 2009. 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 periods of peak demand. Additionally, we sell a variety of photo-based merchandise that is currently manufactured for us by third parties, such as calendars, mugs, mouse pads, coasters, tote bags, desk organizers, puzzles, playing cards, multi-media DVDs, magnets, keepsake boxes, notebooks, notepads, address labels and stickers.

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 operations and financial performance depend on general economic conditions. The U.S. economy continues to experience, an economic downturn due to slower economic activity, concerns about inflation, decreased consumer confidence, high consumer debt levels and higher unemployment rates and other adverse business conditions. Such fluctuations in the U.S. economy could cause, among other things, 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 and limited discretionary funds, the economic slowdown could exacerbate the seasonal decline in sales that we typically see in the first three quarters of the calendar year and could negatively effect sales in the fourth quarter, which has historically been the source of a substantial portion of our revenues. Throughout this period we intend to focus on actions that are within our control and initiatives that are intended to increase revenue, earnings, free cash flow and long-term shareholder value.

Basis of Presentation

Net Revenues. We generate revenues primarily from the printing and shipping of photo-based products, such as photo books, cards and stationery, calendars, photo prints, and photo-based merchandise, such as mugs, mouse pads and magnets. 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. Revenue from advertising displayed on our website and 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. We also provide commercial print services which is a component of our net revenues.

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 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 net 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 Sites), and by conducting integrated marketing and advertising programs. Total customers have increased on an annual basis for each year since inception and while we expect this trend to continue, the number of customers is dependent on whether we are successful in executing our strategy in addition to the conditions of the overall economic environment.

Average Order Value. Average order value is net revenues, excluding revenues from our commercial print initiative, 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 as consumers shift from prints into personalized products and services.

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 while we anticipate this trend to continue in the future, the number of orders is dependent on whether we are successful in executing our strategy, the conditions of the overall economic environment and a continued increase in consumer trends towards photo-based products.

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 was 51% in 2006, 56% in 2007 and 61% in 2008. In addition, as a percentage of total net revenues, revenues from 4x6 prints have been declining; from 28% in 2006, to 22% in 2007, and to 19% in 2008.

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 consists 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. Cost of net revenues also includes 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. All of the payments we have received from our intellectual property license agreements have been included as an offset to general and administrative expense. In the nine month period ending September 30, 2009, we received annual payments from two different multi-million dollar cross-licensing agreements. We expect to recognize a final payment due under one of the agreements when it is received in the first quarter of fiscal year 2010.

Interest Expense. Interest expense consists of interest costs recognized under our capital lease obligations as well as costs associated with our line of credit facility.

Interest and other income, net. Interest and other income, net consists of the interest earned on our cash and investment accounts as well as gains/losses on our trading securities and the Right from UBS entitling us to sell at par value auction-rate securities purchased from UBS (approximately $48.4 million, par value) at anytime during a two-year period from June 30, 2010 through July 2, 2012.

Income Taxes. Historically, we have only been subject to taxation in the United States because we only operate within the United States.

The discussion and analysis of our financial condition and results of operations are based upon our unaudited condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an on-going basis, we evaluate our critical accounting policies and estimates. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Our critical accounting policies and estimates are discussed in our Annual Report on Form 10-K-/A for the fiscal year ended December 31, 2008.

Results of Operations

The following table presents the components of our income statement as a
percentage of net revenues:

                                                     Three Months                           Nine Months
                                                  Ended September 30,                   Ended September 30,
                                              2009                2008              2009                2008
                                                              (as restated)                         (as restated)
Net revenues                                      100 %                  100 %          100 %                  100 %
Cost of revenues                                   53 %                   51 %           53 %                   51 %

Gross profit                                       47 %                   49 %           47 %                   49 %
Operating expenses:
Technology and development                         28 %                   27 %           29 %                   27 %
Sales and marketing                                23 %                   28 %           23 %                   25 %
General and administrative                         18 %                   19 %           20 %                   21 %

Loss from operations                             (22) %                 (25) %         (25) %                 (24) %
Interest expense                                    0 %                    0 %            0 %                    0 %
Interest and other income, net                      0 %                    0 %            1 %                    2 %

Loss before income taxes                         (22) %                 (25) %         (24) %                 (22) %
Benefit from income taxes                           6 %                   17 %            8 %                   12 %

Net loss                                         (16) %                  (8) %         (16) %                 (10) %

Comparison of the Three Month Period Ended September 30, 2009 and 2008

                                                                                Three Months Ended September 30,
                                                                  2009               2008             $ Change          % Change
                                                                                         (in thousands)
                                                                                 (as restated)
Net revenues                                                    $    40,495       $       35,953            4,542              13  %
Cost of net revenues                                                 21,420               18,451            2,969              16  %
  Percentage of net revenues                                             53 %                 51 %
Gross profit                                                        19,075                17,502            1,573                9 %

Net revenues increased $4.5 million, or 13%, for the three months ended September 30, 2009, as compared to the same period in 2008. Revenue growth was attributable to an increase in personalized products and services revenues and revenue from our commercial print initiative, offset by a decrease in print revenue. Personalized products and services ("PPS") revenues increased $5.5 million, or 28%, to $24.9 million for the three months ended September 30, 2009 as compared to the same period in 2008. The increase in PPS is primarily a result of increased sales of photo books and stationery cards. PPS represented 61% of revenue compared to 54% in the same period in 2008. Revenue from our commercial print initiative totaled $1.2 million, and represented 3% of our total net revenues. Print revenue decreased $0.9 million, or 6%, to $15.6 million for the three months ended September 30, 2009, as compared to the same period in 2008. Print revenue represented 39% of revenue compared to 46% in the same period in 2008. The decrease in overall print revenue is primarily due to a lower average sales price for 4x6 prints which is a result of our price change in September 2008 offset partially by continued stable growth in unit volumes.
In the third quarter of 2009, 4x6 print revenues represented 24% of total net revenues versus 29% in the third quarter of 2008.

Excluding commercial print revenues, net revenue increases were also the result of year-over-year increases in all of our key metrics: customers, orders and average order value, as noted below:

                                                                            Three Months Ended September 30,
                                                                 2009             2008           $ Change          % Change
                                                                           (in thousands, except AOV amounts)
Customers                                                              982              916               65                7 %
Orders                                                               1,705            1,656               49                3 %

Cost of net revenues increased $3.0 million, or 16%, for the three months ended September 30, 2009 as compared to the same period in 2008. As a percentage of net revenues, cost of net revenues increased from 51% to 53% for the same comparable period, which decreased gross margin from 49% in the third quarter of 2008 to 47% in the third quarter of 2009. The decrease in our gross margin percentage is primarily due to cost increases from the transition of our Hayward manufacturing facility to our new Phoenix manufacturing facility and higher equipment rental expenses compared to the same period in 2008. However, these factors were partially offset by favorable improvements from product mix and continued savings in shipping and materials costs due to operational efficiencies and negotiated cost reductions.

                                         Three Months Ended September 30,
                                2009             2008           $ Change    % Change
                                                  (in thousands)
                                             (as restated)
Technology and development   $   11,390     $         9,689     $   1,701          18 %
Percentage of net revenues           28 %                27 %
Sales and marketing               9,377              10,138         (761)         (8) %
Percentage of net revenues           23 %                28 %
General and administrative        7,363               6,901           462           7 %
Percentage of net revenues           18 %                19 %

Our technology and development expense increased $1.7 million, or 18%, for the three months ended September 30, 2009, as compared to the same period in 2008. As a percentage of revenue, this expense increased slightly from 27% to 28% for the same comparable period. The increase in technology and development expense was primarily due to an increase of $0.7 million in third party hosting and connectivity costs compared to the same period in 2008. Depreciation expense also increased by $0.1 million as we continued to invest in our website infrastructure hardware to support our continued revenue growth. Personnel and related costs for employees and consultants involved with website development and website infrastructure support teams increased by $0.4 million. For the three months ended September 30, 2009, we capitalized $1.5 million in eligible costs, which includes $0.4 million of stock based compensation, associated with software developed or obtained for internal use, compared to $1.3 million in the same period in the prior year.

Our sales and marketing expense decreased $0.8 million, or 8%, for the three months ended September 30, 2009 as compared to the same period in 2008. As a percentage of net revenues, sales and marketing expense for the three months ended September 30, 2009 decreased from 28% to 23% for the same comparable period. The decrease in sales and marketing expense is primarily due to a decrease of $1.4 million in customer acquisition costs reflecting greater emphasis on promotional offers and product trials and a reduction in external marketing spend. Overall decrease is offset by an increase of $0.3 million in personnel and related costs primarily due to a slight increase in headcount. In addition, stock base compensation increased by $0.3 million compared to the same period in the prior year.

Our general and administrative expense increased $0.5 million, or 7%, for the three months ended September 30, 2009 as compared to the same period in 2008. As a percentage of net revenues, general and administrative expense decreased from 19% to 18% as compared to the same comparable period. The overall fluctuation in general and administrative expense is primarily due to an increase of $0.8 million in stock based compensation offset by a continued decrease in professional services costs of $0.2 million.

                                           Three Months Ended September 30,
                                   2009         2008        $ Change       % Change
                                                    (in thousands)
Interest expense                 $   (22)      $ (100)     $     (78)          (78) %
Interest and other income, net         74          455          (381)          (84) %

Interest expense decreased by $78,000 or 78% for the three months ended September 30, 2009, as compared to the same periods in 2008, due to the expiration of the line of credit with JP Morgan in April 2009. We completed a replacement facility in June 29, 2009 and incurred lower origination costs resulting in a decrease in amortization expense as compared to the same period in the prior year.

Interest and other income, net decreased by $0.4 million or 84% for the three months ended September 30, 2009, as compared to the same period in 2008. The decrease is primarily due to an overall lower yield on our investment portfolio relative to our investment balances in the comparable prior year period. During the three months ended September 30, 2009, we recorded a $0.9 million mark-to-market gain on our auction-rate securities that have been classified as trading securities which was entirely offset by a $0.9 million loss on the UBS Right.

                         Three Months Ended September 30,
                          2009                     2008
                                  (in thousands)
                                              (as restated)
Income tax benefit   $         2,657         $         6,071
Effective tax rate                30 %                    68 %

The benefit for income taxes was $2.7 million for the three months ended . . .