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SFLY > SEC Filings for SFLY > Form 10-Q on 6-May-2014All Recent SEC Filings

Show all filings for SHUTTERFLY INC

Form 10-Q for SHUTTERFLY INC


6-May-2014

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This report, 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 business strategy and plans, the seasonality of and growth of our business, the impact on us of general economic conditions, trends in key metrics such as total number of customers, total number of orders, and average order value, our capital expenditures for 2014, the sufficiency of our cash and cash equivalents and cash generated from operations for the next 12 months, our operating expenses remaining a consistent percentage of our net revenues, our manufacturing capabilities, effective tax rates, outstanding convertible senior notes, stock repurchase program 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 "believe," "anticipate," "expect," "estimate," "intend," "continue," "should," "would," "could," "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, economic downturns and the general state of the economy; changes in consumer discretionary spending as a result of the macroeconomic environment; competition, which could lead to pricing pressure; our ability to expand our customer base and increase sales to existing customers and meet production requirements; our ability to retain and hire necessary employees, including seasonal personnel, and appropriately staff our operations; the impact of seasonality on our business; our ability to develop technology on a timely basis, as well as consumer acceptance of, new products, features and services; our ability to successfully acquire businesses and technologies and to successfully integrate and operate these acquired businesses and technologies; our ability to achieve expected benefits of our partnerships; our ability to develop additional adjacent lines of business; unforeseen changes in expense levels; and our ability to timely upgrade and develop our infrastructure and facilities 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 compare these forward-looking statements to actual results.

Overview

We are the leading manufacturer and digital retailer of high-quality personalized products and services offered through a family of lifestyle brands. Our vision is to make the world a better place by helping people share life's joy. Our mission is to build an unrivaled service that enables deeper, more personal relationships between our customers and those who matter most in their lives. Our primary focus is on helping consumers manage their memories through the powerful medium of photography. 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 through our seven trusted premium lifestyle brands: Shutterfly, Tiny Prints, Wedding Paper Divas, Treat, ThisLife, MyPublisher and BorrowLenses.

We generate the majority of our revenues by producing and selling professionally-bound photo books, greeting and stationery cards, personalized calendars, other photo-based merchandise and high-quality prints ranging in size from wallet-sized to jumbo-sized 20x30 enlargements. We manufacture most of these items in our Fort Mill, South Carolina, Phoenix, Arizona and Elmsford, New York production facilities. By controlling the production process in our own production 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 calendars, mugs, canvas prints, mouse pads, magnets, and puzzles. We generate substantially all of our revenue from sales originating in the United States and our sales cycle has historically been highly seasonal as we generate more than 50% of our total net revenues during our fiscal fourth quarter. Our operations and financial performance depend on general economic conditions in the United States, consumer sentiment and the levels of consumer discretionary spending. We closely monitor these economic measures as their trends are indicators of the health of the overall economy and are some of the key external factors that impact our business.

Basis of Presentation

Net Revenues. Our net revenues are comprised of sales generated from our Consumer and Enterprise categories.


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Consumer. Our Consumer revenues include sales from all of our brands and are derived from the sale of photo-based products, such as photo books, stationery and greeting cards, other photo-based merchandise, photo prints, and the related shipping revenues as well as rental revenue from our BorrowLenses brand. Included in our photo-based merchandise are items such as mugs, iPhone cases, mouse pads, desktop plaques and puzzles. Photo prints consist of wallet, 4x6, 5x7, 8x10, and large format sizes. Revenue from advertising displayed on our websites is also included in Consumer revenues.

Enterprise. Our Enterprise revenues are primarily from variable, four-color direct marketing collateral manufactured and fulfilled for business customers. We continue to focus our efforts on expanding our presence in the Enterprise market.

Our business is subject to seasonal fluctuations. In particular, we generate a substantial portion of our revenues during the holiday season in the fourth quarter. 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 in our Consumer category, we monitor several key metrics including, total customers, total number of orders, and average order value.

Total Customers. We closely monitor total customers as a key indicator of demand. Total customers represents 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, and by conducting integrated marketing and advertising programs. We also acquire new customers through customer list acquisitions. Total customers have increased on an annual basis for each year since inception and we expect this trend to continue.

Total Number of Orders. We closely monitor total number of orders as a leading indicator of net revenue trends. We recognize 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 in approximately three 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 this trend to continue in the future.

Average Order Value. Average order value is Consumer net revenues for a given period divided by the total number of customer orders recorded during that same period. Average order value is impacted by product sales mix and pricing and promotional strategies, including our promotions and competitor promotional activity. As a result, we expect that our average order values may fluctuate on an annual basis.

We believe the analysis of these metrics and others described below under "Non-GAAP Financial Measures" 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 the facilities where we are the deemed owner (for accounting purposes only) of the building, 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, any third-party software or patents licensed, as well as the amortization of acquired developed technology, capitalized website and software development costs, and patent royalties. Cost of net revenues also includes certain costs associated with facility closures and restructuring.

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 websites, infrastructure and software. These expenses include depreciation of the computer and network hardware used to run our websites and store the customer data, including storage for our new ThisLife brand service, as well as amortization of purchased software. Technology and development expense also includes co-location, power 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


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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. Transaction costs are also included in general and administrative expense. 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.

Interest Expense. Interest expense consists of interest on our convertible senior notes arising from amortization of debt discount, amortization of debt issuance costs, and our 0.25% coupon payment; costs associated with our five-year syndicated credit facility that became effective in November 2011, as amended in May and December 2013; and costs associated with our capital leases and build-to-suit lease financing obligations.

Interest and Other Income, Net. Interest and other income, net primarily consists of the interest earned on our cash and investment accounts.

Income Taxes. We account 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. We are subject to taxation in the United States and Israel.

Critical Accounting Policies and Estimates

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 for the fiscal year ended December 31, 2013.


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Results of Operations

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

                                 Three Months Ended
                                     March 31,
                                  2014         2013
Net revenues                     100  %        100  %
Cost of net revenues              56  %         53  %
Gross profit                      44  %         47  %
Operating expenses:
Technology and development        23  %         21  %
Sales and marketing               31  %         30  %
General and administrative        19  %         17  %
Total operating expenses          72  %         68  %
Loss from operations             (28 )%        (21 )%
Interest expense                  (3 )%          -  %
Interest and other income, net     -  %          -  %
Loss before income taxes         (31 )%        (21 )%
Benefit from income taxes          6  %         10  %
Net loss                         (25 )%        (11 )%

Comparison of the Three Month Periods Ended March 31, 2014 and 2013

                                      Three Months Ended March 31,
                              2014          2013        $ Change    % Change
                                             (in thousands)
Net revenues
Consumer                   $ 130,621     $ 109,807     $ 20,814       19  %
Enterprise                     6,478         6,901         (423 )     (6 )%
Total net revenues           137,099       116,708       20,391       17  %
Cost of net revenues          76,343        61,853       14,490       23  %
Gross profit               $  60,756     $  54,855     $  5,901       11  %
Percentage of net revenues        44 %          47 %          -        -


Key Metrics
Customers             2,557      2,249       308    14 %
Orders                3,869      3,417       452    13 %
Average order value $ 33.76    $ 32.13    $ 1.63     5 %

Net revenues increased $20.4 million, or 17%, for the three months ended March 31, 2014 as compared to the same period in 2013. Consumer net revenues increased $20.8 million, or 19%, in the three months ended March 31, 2014 compared to the same period in 2013. The increase in Consumer net revenues was primarily a result of increased sales of photo books, photo-based merchandise, and revenue from our MyPublisher and BorrowLenses brands, which was not included in the three months ended March 31, 2013. The increase is also reflected in the increases in all of our key metrics in three months ended March 31, 2014, as compared to the same period in 2013, as noted above. Enterprise revenues decreased $0.4 million, or 6%, in the three months ended March 31, 2014 compared to the same period in 2013 due to a delay in some projects into the second quarter of 2014.

Cost of net revenues increased $14.5 million, or 23%, for the three months ended March 31, 2014 as compared to the same period in 2013. As a percentage of net revenues, cost of net revenues increased to 56% in the three months ended March 31, 2014 from 53% in the same period in 2013, which decreased gross margin to 44% in the three months ended March 31, 2014 from 47%


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in the same period in 2013. Overall, the increase in cost of net revenues was primarily the result of the increased volume of shipped products. The decrease in gross margin was primarily driven by higher depreciation and increased equipment lease and customer service expenses related to our Fort Mill, South Carolina manufacturing facility, which commenced operations in the second quarter of 2013.

                                      Three Months Ended March 31,
                              2014         2013       $ Change      % Change
                                             (in thousands)
Technology and development $ 31,483     $ 24,027     $    7,456        31 %
Percentage of net revenues       23 %         21 %            -         -
Sales and marketing        $ 42,133     $ 34,895     $    7,238        21 %
Percentage of net revenues       31 %         30 %            -         -
General and administrative $ 25,751     $ 19,897     $    5,854        29 %
Percentage of net revenues       19 %         17 %            -         -

Our technology and development expense increased $7.5 million, or 31%, for the three months ended March 31, 2014, compared to the same period in 2013. As a percentage of net revenues, technology and development expense increased to 23% in the three months ended March 31, 2014 from 21% in the three months ended March 31, 2013. The overall increase was primarily due to an increase of $3.9 million in personnel and related costs due to increased headcount. The increase in technology and development expense was also due to an increase of $2.1 million in depreciation expense, an increase of $1.5 million in professional fees, an increase of $0.5 million in stock-based compensation expense, and an increase of $0.4 million in facility costs primarily from co-location services. These factors were partially offset by an increase of $1.1 million in software and website development costs capitalized in the current period compared to the same period in the prior year.

At March 31, 2014, headcount in technology and development increased by 33% compared to March 31, 2013, reflecting our strategic focus on increasing the rate of innovation in our product and services offerings, to generate greater differentiation from our competitors, and improve our long-term operating efficiency. In the three months ended March 31, 2014, we capitalized $4.7 million in eligible salary and consultant costs, including $0.5 million of stock-based compensation, associated with software developed or obtained for internal use, compared to $3.6 million capitalized in the three months ended March 31, 2013, which included $0.5 million of stock-based compensation expense.

Our sales and marketing expense increased $7.2 million, or 21%, in the three months ended March 31, 2014 compared to the same period in 2013. As a percentage of net revenues, total sales and marketing expense increased to 31% in the three months ended March 31, 2014 from 30% in the three months ended March 31, 2013. The increase was primarily due to an increase of $2.6 million related to our integrated marketing campaigns. The increase in sales and marketing expense was also due to the expansion of our internal marketing team which contributed to an increase of $1.9 million in stock-based compensation expense and an increase of $1.7 million in personnel and related costs. The increase was also attributable to an increase of $0.7 million in intangible asset amortization from acquisition related intangibles, and an increase of $0.4 million in professional fees.

Our general and administrative expense increased $5.9 million, or 29%, in the three months ended March 31, 2014 as compared to the same period in 2013. As a percentage of net revenues, general and administrative expense increased to 19% in the three months ended March 31, 2014 from 17% in the three months ended March 31, 2013. The increase in general and administrative expense was primarily due to an increase of $1.6 million in stock-based compensation expense, an increase of $1.5 million in depreciation and amortization expense, primarily from acquisition related intangibles, and an increase of $1.2 million in personnel related costs as a result of increased headcount. The increase was also attributable to an increase of $1.0 million in facilities costs and an increase of $0.5 million in credit card fees which was driven by the increase in Consumer net revenues as compared to the prior year.

                                    Three Months Ended March 31,
                                   2014           2013       Change
                                           (in thousands)
Interest expense               $   (3,947 )     $ (139 )   $ (3,808 )
Interest and other income, net        227            7          220

Interest expense consists of interest on our convertible senior notes, issuance costs associated with our convertible senior notes and credit facility, capital leases and our financing obligation associated with our Fort Mill, South Carolina production


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facility. Interest expense was $3.9 million for the three months ended March 31, 2014 compared to $0.1 million during the same period a year ago. The increase was primarily due to interest expense associated with our May 2013 issuance of $300.0 million of 0.25% convertible senior notes. Interest and other income increased $0.2 million for the three months ended March 31, 2014 compared to the three months ended March 31, 2013. The increase in interest income was primarily due to the interest earned on money market funds and recently purchased investments.

Three Months Ended
                          March 31,
                      2014          2013
                        (in thousands)
Income tax benefit $   8,117     $ 11,691
Effective tax rate        19 %         49 %

We recorded an income tax benefit of $8.1 million and $11.7 million for the three months ended March 31, 2014 and 2013, respectively. Our effective tax rate was 19% for the three months ended March 31, 2014, compared to 49% for the three months ended March 31, 2013. Factors that impacted the effective tax rate include, but are not limited to, the federal domestic production activities deduction, limitations on executive compensation, non-deductible stock-based compensation expense, and disqualifying dispositions of employee incentive stock options.

                                       Three Months Ended March 31,
                               2014           2013        $ Change     % Change
                                              (in thousands)
Loss before income taxes   $ (42,331 )    $ (24,096 )    $ (18,235 )       76 %
Net loss                     (34,214 )      (12,405 )      (21,809 )      176
Percentage of net revenues       (25 )%         (11 )%           -          -

During the three months ended March 31, 2014, net loss was $34.2 million, an increase of $21.8 million as compared to a net loss of $12.4 million the same period in 2013. As a percentage of net revenues, net loss increased to 25% for the three months ended March 31, 2014 from a net loss of 11% for the three months ended March 31, 2013.

Liquidity and Capital Resources

At March 31, 2014, we had $314.9 million of cash and cash equivalents. In addition, we also had $55.4 million of investments, primarily agency securities and corporate bonds. To supplement our overall liquidity position, during the year ended December 31, 2013 we issued $300.0 million of 0.25% convertible senior notes due May 15, 2018. We also have access to a five-year senior secured syndicated credit facility to provide up to $200.0 million in additional capital resources. As of March 31, 2014, no amounts have been drawn against this facility.

Below is our cash flow activity for the three months ended March 31, 2014 and 2013:

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