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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 ý No o
Indicate by check mark whether the Registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).
Yes ý 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 x
Accelerated Filer o
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 ý
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Common
stock, $0.0001 par value; 100,000 shares authorized; 37,215 and 37,906 shares issued and outstanding on June 30, 2015 and December 31, 2014, respectively
4
4
Additional paid-in capital
814,359
838,313
Accumulated
other comprehensive income/(loss)
11
(53
)
Accumulated deficit
(237,095
)
(80,458
)
Total stockholders' equity
577,279
757,806
Total
liabilities and stockholders' equity
$
1,088,515
$
1,332,278
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” or “Shutterfly”) was incorporated in the state of Delaware in 1999 and began its services in December 1999. The Company is the leading manufacturer and digital retailer of high-quality personalized products and services offered through a family of lifestyle brands. 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 photo books, greeting cards and stationery and calendars. Shutterfly also operates a premier online marketplace for high-quality photographic and video equipment rentals. The Company also provides enterprise services; printing
and shipping of direct marketing and other variable data print products and formats. 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 ("U.S. GAAP") 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, consisting primarily of normal recurring accruals, considered necessary for a fair statement of the Company’s results of operations for the interim periods reported and of its financial condition as of the date of the interim balance sheet have been included. Operating results for the three and six months ended June 30, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015, or for any other period.
The December 31, 2014
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, 2014 included in the Company’s Annual Report on Form 10-K.
Fair Value
The Company records its financial assets and liabilities
at fair value. The accounting standard for fair value provides a framework for measuring fair value, clarifies the definition of fair value, and expands disclosures regarding fair value measurements. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the reporting date. The accounting standard establishes a three-tier hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value:
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.
Investments
Investments, which may include agency bonds, corporate debt securities, and U.S. government securities, are classified as available-for-sale and are reported at fair value using the specific identification method. Unrealized gains and losses are excluded from earnings and reported as a component
of other comprehensive income (loss), net of related estimated tax provisions or benefits. Investments whose maturity dates are less than twelve months are classified as short-term, and those with maturity dates greater than twelve months are classified as long-term.
The Company assesses whether an other-than-temporary impairment loss on its investments has occurred due to declines in fair value or other market conditions. With respect to the Company's debt securities, this assessment takes into account the severity and duration of the decline in value, its intent to sell the security, whether it is more likely than not that it will be required to sell the security before recovery of its amortized cost basis,
and whether it expects to recover the entire amortized cost basis of the
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
security (that is, whether a credit loss exists). The Company did not recognize an other-than-temporary impairment loss on its investments in the three and six months ended June 30, 2015.
Income
Taxes
The Company uses the 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.
The Company assesses its ability to recover its deferred tax assets on an ongoing basis. Significant management judgment is required in determining any valuation allowance recorded against deferred tax assets. In evaluating the ability to recover deferred tax assets, the
Company considers available positive and negative evidence including its recent cumulative losses, its ability to carry-back losses against prior taxable income and its projected financial results. The Company also considers, commensurate with its objective verifiability, the forecast of future taxable income including the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. A valuation allowance may be recorded in the event it is deemed to be more-likely-than-not that the deferred tax asset cannot be realized. If recorded, it would have an adverse impact on the Company’s operating results.
The
Company reports a liability for unrecognized tax benefits resulting from uncertain tax positions taken or expected to be taken in a tax return. The application of income tax law is inherently complex. Laws and regulations in this area are voluminous and are often ambiguous. The Company is required to make subjective assumptions and judgments regarding its income tax exposures. Interpretations and guidance surrounding income tax laws and regulations change over time. As such, changes in the Company's subjective assumptions and judgments can materially affect amounts recognized in the consolidated balance sheets and statements of operations.
The
Company's policy is to recognize interest and /or penalties related to all tax positions in income tax expense. To the extent that accrued interest and penalties do not ultimately become payable, amounts accrued will be reduced and reflected as a reduction of the overall income tax provision in the period that such determination is made. No interest and penalties were accrued as of June 30, 2015 and December 31, 2014.
The Company is subject to taxation in jurisdictions within the United States and Israel.
Segment
Reporting
The Company reports as two operating segments with the Chief Executive Officer (“CEO”) acting as the Company’s chief operating decision maker. The Company defined two reportable segments based on factors such as how management manages the operations and how its chief operating decision maker views results. The Company has the following reportable segments:
Consumer - Includes sales from the
Company's 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 its BorrowLenses brand.
Enterprise - Includes revenues primarily from variable, four-color direct marketing collateral manufactured and fulfilled for business customers.
In addition to the above reportable segments, the Company has a corporate category that includes activities that are not directly attributable or allocable to a specific segment. This category consists of stock-based compensation and amortization of intangible assets.
Revenue
Recognition
The Company recognizes revenue from Consumer and Enterprise product sales, net of applicable sales tax, upon shipment of fulfilled orders, when persuasive evidence of an arrangement exists, the selling price is fixed or determinable and collection of resulting receivables is reasonably assured. Customers place Consumer product orders through the Company's websites and pay primarily using credit cards. Enterprise customers are invoiced upon fulfillment. Shipping charged to customers is recognized as revenue at the time of shipment.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For camera, lenses, and video equipment rentals from its BorrowLenses brand, the Company recognize rental revenue and the related shipping and insurance revenue, ratably over the rental period. Revenue from the sale of rental equipment is recognized upon shipment of the equipment.
For gift card sales and flash deal promotions through group buying websites, the Company
recognizes revenue on a gross basis, as it is the primary obligor, when redeemed items are shipped. Revenues from sales of prepaid orders on its websites are deferred until shipment of fulfilled orders or until the prepaid period expires. The Company’s share of revenue generated from its print to retail relationships, is recognized when orders are picked up by its customers at the respective retailer.
In the second quarter of 2015, the Company changed its accounting estimate related to flash deal deferred revenue. Beginning in 2010, the
Company began to market product offers on flash deal websites such as Groupon and LivingSocial. With limited history as to customer redemption patterns, the Company had been deferring all amounts to a flash deal deferred revenue liability until customer redemption. The Company now has sufficient relevant historical flash deal redemption data to support a change in estimate of the flash deal deferred revenue based on historical customer redemption patterns. The historical data supports the probability of redemption after two years from the issuance of a flash deal offer as remote. In addition, the
Company's attempts to re-market the unredeemed flash deals over the last six months resulted in no meaningful change in customer behavior. Accordingly, flash deal breakage revenue is now recognized based upon its historical redemption patterns and represents the unredeemed flash deal offers for which the Company believes customer redemption is remote and it is not probable that the Company has an obligation to escheat the value of the flash deal revenue under unclaimed property laws. In the second quarter of 2015, the Company recognized a revenue catch-up of $7.5 million associated with this change.
The
Company provides its customers with a 100% satisfaction guarantee whereby products can be returned within a 30-day period for a reprint or refund. The Company maintains an allowance for estimated future returns based on historical data. The provision for estimated returns is included in accrued expenses.
The Company periodically provides incentive offers to its customers in exchange for setting up an account and to encourage purchases. Such offers include free products and percentage discounts on current purchases. Discounts, when accepted by customers, are treated as a reduction to the purchase price of the related transaction and are presented in net revenues.
Production costs related to free products are included in cost of revenues upon redemption.
Recent Accounting Pronouncements
No new accounting standards have been adopted since the Company filed its Annual Report on Form 10-K for the fiscal year ended December 31, 2014.
In May 2014, the Financial Accountings Standards Board ("FASB") issued new accounting guidance related to revenue recognition. This new standard will replace all current U.S. GAAP guidance on this topic and eliminate all industry-specific guidance. The new revenue recognition standard provides
a unified model to determine when and how revenue is recognized. The core principle is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration for which the entity expects to be entitled in exchange for those goods or services. This guidance will be effective for the Company beginning January 1, 2018 and can be applied either retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption. The Company is evaluating the impact, if any, of adopting this new accounting guidance on its financial statements.
In August 2014, the FASB
issued new guidance related to the disclosures around going concern. The new standard provides guidance around management's responsibility to evaluate whether there is substantial doubt about an entity's ability to continue as a going concern and to provide related footnote disclosures. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. Early adoption is permitted. The adoption of this standard is not expected to have a material impact on the Company's financial statements.
In April 2015, the FASB issued new guidance related to presentation of debt issue costs. The new standard requires that debt issuance costs related to a recognized debt liability be presented in
the balance sheet as a direct deduction from the carrying amount of that debt liability. The adoption of this guidance will be effective for the Company beginning January 1, 2016, and is not expected to have a material impact on the Company's financial statements.
In April 2015, the FASB issued new guidance related to accounting for fees paid in a cloud computing arrangement. The new standard provides guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, then the customer should account for the software license element of the
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The adoption of this guidance will be effective for the Company beginning January 1, 2016, and is not expected to have a material impact on the Company's financial statements.
In
July 2015, the FASB issued ASU 2015-11, Inventory - Simplifying the Measurement of Inventory (Topic 330). ASU 2015-11 requires inventory to be subsequently measured using the lower of cost and net realizable value, thereby eliminating the market value approach. Net realizable value is defined as the “estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation.” ASU 2015-11 is effective for reporting periods beginning after December 15, 2016 and is applied prospectively. Early adoption is permitted. The Company is evaluating the impact, if any, of adopting this new accounting guidance on its financial statements.
Note
2 — Stock-Based Compensation
Stock Option Activity
A summary of the Company’s stock option activity for the three and six months ended June 30, 2015 is as follows (share numbers and aggregate intrinsic values in thousands):
During
the three and six months ended June 30, 2015, the Company did not grant any options. The total intrinsic value of options exercised during the three and six months ended June 30, 2015 was $1.3 million and $2.9 million, respectively. Net cash proceeds from the exercise of stock options were $1.1 million and $2.3 million for the three and six months ended June 30, 2015, respectively.
Restricted
Stock Unit Activity
The Company grants restricted stock units (“RSUs”) to its employees under the provisions of the 2006 Plan and inducement awards to certain new employees upon hire in accordance with NASDAQ Listing Rule 5635(c)(4). The cost of RSUs is determined using the fair value of the Company’s common stock on the date of grant. RSUs typically vest and are settled annually, based on a three or four year total vesting term. Compensation cost associated with RSUs is amortized on a straight-line basis over the requisite service period.
Included
in the RSU grants for the six months ended June 30, 2015, are 681,000 RSUs that have both performance criteria tied to the Company’s 2015 financial performance and four year service criteria, as well as grants made to the CEO that vest upon the achievement of 2015 financial performance and two-year shareholder return-based goals (“PBRSUs”). Compensation cost associated with these PBRSUs is recognized on an accelerated attribution model and ultimately 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.
Employee stock-based compensation expense recognized in the three and six months ended June 30, 2015 and 2014, was calculated based on awards ultimately expected to vest and has been reduced for estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.
At June 30, 2015, the Company had $113.9
million of total unrecognized compensation expense, net of estimated forfeitures, related to stock options, RSUs and PBRSUs that will be recognized over a weighted-average period of approximately three years.
Note 3 — Net Loss Per Share
Basic net loss per share attributed to common shares is computed by dividing the net loss attributable to common shares for the period by the weighted average number of common shares outstanding during the period.
Diluted net loss per share attributed to common shares is computed by dividing the net loss attributable to common shares for
the period by the weighted average number of common and potential common shares outstanding during the period, if the effect of each class of potential common shares is dilutive. Potential common shares include restricted stock units and incremental shares of common stock issuable upon the exercise of stock options, conversion of warrants, and the impact of convertible senior notes.
A summary of the net loss per share for the three and six months ended June 30, 2015 and 2014 is as follows (in thousands, except per share amounts):
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 4 — Investments
At June 30, 2015 and December 31, 2014, the estimated fair value of short-term and long-term investments classified as available for sale are as follows (in thousands):
The
Company had no short-term or long-term investments that have been in a continuous unrealized loss position for more than 12 months as of June 30, 2015 and no impairments were recorded in the period. The Company had no material realized gains or losses during the six months ended June 30, 2015.
The following table summarizes the contractual maturities of the Company's investments as of June 30, 2015
(in thousands):
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 5 — Fair Value Measurement
Cash Equivalents and Investments
The
Company measures the fair value of money market funds and investments based on quoted prices in active markets for identical assets or liabilities. All other financial instruments were valued either based on recent trades of securities in inactive markets or based on quoted market prices of similar instruments and other significant inputs derived from or corroborated by observable market data. The Company did not hold any cash equivalents or investments categorized as Level 3 as of June 30, 2015.
The following table summarizes, by major security type, the Company's cash equivalents and investments that are
measured at fair value on a recurring basis and are categorized using the fair value hierarchy (in thousands):
As of June 30, 2015, the fair value of the convertible senior notes, which was determined based on inputs that are observable in the
market or that could be derived from, or corroborated with, observable market data, including our stock price, interest rates and credit spread (Level 2) were as follows (in thousands):
Intra-period
deferred tax asset represents the cumulative income tax benefit recorded as of the balance sheet date, which will offset against taxes payable or become a component of deferred taxes on a full year basis.
Other
assets includes the long-term portion of intellectual property prepaid royalties, the long-term portion of issuance costs related to the Company's 0.25% Convertible Senior Notes, the long-term portion of prepaid service contracts, and deposits on long-term leases and other contracts.
Capitalized software and website development costs
98,116
89,311
Buildings
under build-to-suit leases
55,721
39,307
Leasehold improvements
21,776
20,876
Rental equipment
17,027
14,591
Furniture
and fixtures
11,858
10,683
511,227
453,633
Less: Accumulated depreciation and amortization
(231,833
)
(211,891
)
Net
property and equipment
$
279,394
$
241,742
Building value of $55.7 million under build-to-suit leases represents the estimated fair market value of buildings under build-to-suit leases of which the Company is the "deemed owner" for accounting purposes only. See Note 11
- Commitments and Contingencies for further discussion of the Company's build-to-suit leases.
Included within Manufacturing equipment is approximately $65.7 million of capital lease obligations. Accumulated depreciation of assets under capital lease totaled $7.8 million at June 30, 2015.
Rental equipment includes camera lenses, camera bodies, video equipment and other camera peripherals which are rented through the BorrowLenses website.
Depreciation
and amortization expense totaled $21.0 million and $15.0 million for the three months ended June 30, 2015 and 2014, respectively. Depreciation and amortization expense totaled $40.9 million and $29.2 million for the six months ended June 30, 2015 and 2014, respectively.
In May 2013, the Company issued $300.0 million aggregate principal amount of 0.25% convertible senior notes (the "Notes")
due May 15, 2018, unless earlier purchased by the Company or converted. Interest is payable semiannually in arrears on May 15 and November 15 of each year, commencing on November 15, 2013.
The Notes are governed by an Indenture between the Company, as issuer, and Wells Fargo Bank, National Association, as trustee. The Notes are unsecured and rank senior in right of payment to the Company's future indebtedness that is expressly subordinated
in right of payment to the Notes and rank equal in right of payment to the Company's existing and future liabilities that are not so subordinated and are effectively subordinated in right of payment to any of the Company's cash equal to the principal amount of the Notes, and secured indebtedness to the extent of the value of the assets securing such indebtedness and are structurally subordinated to all existing and future indebtedness and liabilities incurred by the Company's subsidiaries.
Upon conversion, the
Company will pay or deliver, as the case may be, cash, shares of the Company's common stock or a combination of cash and shares of common stock, at the Company's election.
The initial conversion rate is 15.5847 shares of common stock per $1,000 principal amount of Notes. The initial conversion price is $64.17 per share of common stock. Throughout the term of the Notes, the conversion rate may be adjusted upon the occurrence of certain events. Holders of the Notes will not receive any cash payment representing accrued and unpaid interest upon conversion of a Note. Accrued but unpaid interest will be deemed to be
paid in full upon conversion rather than cancelled, extinguished or forfeited. Holders may convert their Notes only under the following circumstances:
•
during any calendar quarter commencing after the calendar quarter ending on September 30, 2013 (and only during such calendar quarter), if the last reported sale price of the Company's common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
immediately preceding calendar quarter is greater than or equal to 130% of the conversion price on each applicable trading day;
•
during the five business day period after any ten consecutive trading day period (the “Notes Measurement Period”)
in which the "trading price" (as the term is defined in the Indenture) per $1,000 principal amount of notes for each trading day of such Notes Measurement Period was less than 98% of the product of the last reported sale price of the Company's common stock on such trading day and the conversion rate on each such trading day;
•
upon the occurrence of specified corporate events; or
•
at
any time on or after December 15, 2017 until the close of business on the second scheduled trading immediately preceding the maturity date.
As of June 30, 2015, the Notes are not yet convertible.
In accounting for the issuance of the Notes, the Company separated the Notes into liability and equity components. The carrying amount of the liability component was calculated by measuring the fair value of a similar liability that does not have an associated convertible feature. The carrying amount of the equity component representing the conversion option was determined by deducting the fair value
of the liability component from the face value of the Notes as a whole. The excess of the principal amount of the liability component over its carrying amount (“debt discount”) is amortized to interest expense over the term of the Notes. The equity component is not remeasured as long as it continues to meet the conditions for equity classification.
In accounting for the transaction costs related to the Note issuance, the Company allocated the total amount incurred to the liability and equity components based on their relative values. Issuance costs attributable to the liability component, totaling $6.4 million, are being amortized to expense over the term of the Notes, and issuance costs attributable to the equity component, totaling $1.7 million,
were netted with the equity component in stockholders' equity. Additionally, the Company recorded a deferred tax asset of $0.6 million on a portion of the equity component transaction costs which are deductible for tax purposes.
Concurrently with the Note issuance, the Company repurchased 0.6 million shares of common stock for approximately $30.0 million.
The Notes consist of the following (in thousands):
To minimize the impact of potential economic dilution upon conversion of the Notes, the Company entered into convertible note hedge transactions with respect to its common stock (the “Note Hedge”). In May 2013, the Company paid an aggregate amount of $63.5 million for the Note Hedge. The Note Hedge will expire upon maturity of the Notes. The Note Hedge is intended to offset the potential dilution upon conversion of the Notes and/or offset any cash payments the Company is required to make in
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
excess of the principal amount upon conversion of the Notes in the event that the market value per share of the Company's common stock, as measured under the Notes, is greater than the strike price of the Note Hedge, which initially corresponds to the conversion price of the Notes and is subject to anti-dilution adjustments substantially similar to those applicable to the conversion rate of the Notes.
Warrant
Separately, in May 2013, the Company entered into warrant transactions
(the “Warrant”), whereby the Company sold warrants to acquire shares of the Company's common stock at a strike price of $83.18 per share. The Company received aggregate proceeds of $43.6 million from the sale of the Warrant. If the average market value per share of the Company's common stock for the reporting period, as measured under the Warrant, exceeds the strike price of the Warrant, the Warrant will have a dilutive effect on the Company's
earnings per share. The Warrant is a separate transaction, entered into by the Company and is not part of the Notes or the Note Hedge, and has been accounted for as part of additional paid-in capital. Holders of the Notes and Note Hedge will not have any rights with respect to the Warrant.
Note 8 — Share Repurchase Program
On October 24, 2012, the Company's Board of Directors conditionally authorized and the Audit Committee subsequently approved a share repurchase program for up to $60.0
million of the Company's common stock. On February 6, 2014, the Company's Board of Directors approved an increase to the program, authorizing the Company to repurchase up to $100.0 million of the Company's common stock in addition to any amounts repurchased as of that date. On February 9, 2015, the Company's Board of Director's approved an increase to the program, authorizing
the Company to repurchase up to $300.0 million of the Company's common stock in addition to any amounts repurchased as of that date. The share repurchase program is subject to prevailing market conditions and other considerations; does not require the Company to repurchase any dollar amount or number of shares; and may be suspended or discontinued at any time. The share repurchase authorization, which was effective immediately, permits the Company to effect repurchases for cash from time to time through open market, privately negotiated or other transactions, including pursuant to
trading plans established in accordance with Rules 10b5-1 and 10b-18 of the Securities Exchange Act of 1934, as amended, or by a combination of such methods.
In May 2015, the Company entered into an accelerated share repurchase agreement (“ASR”) with a financial institution to repurchase shares of its common stock. Under the ASR, the Company prepaid $75.0 million. The Company did not receive any shares in the second quarter of 2015. Final settlement will occur no later than August 17, 2015. Upon final settlement, the
Company will receive shares repurchased under the ASR and a return of cash for the remaining amount not settled in shares. The ASR was entered into pursuant to the Company’s existing share repurchase program.
The Company accounted for the ASR as a forward contract indexed to the Company’s own common stock. The Company has determined that the forward contract, indexed to its common stock, met all of
the applicable criteria for equity classification.
The Company recorded $75.0 million, the implied value of the forward contract, in additional paid-in capital on the condensed consolidated balance sheets as of June 30, 2015. The final number of shares to be repurchased will be based on the Company’s volume-weighted average stock price during the term of the transaction, less a discount. All repurchased shares under this ASR will be retired. Upon delivery of the repurchased shares and return of cash not settled in shares to the
Company in the third quarter of 2015, the fair value of shares repurchased will be reclassified from additional paid-in capital to retained earnings.
In addition to the repurchase under this ASR, during the first six months of 2015, the Company repurchased 1,924,315 shares of its outstanding common stock at an average price of $45.60 per share pursuant to the share repurchase program.
In 2014, the Company repurchased 1,961,085 shares of its outstanding common stock at an average price of $45.29 per share pursuant to the share
repurchase program.
In 2013, the Company repurchased 70,313 shares of its outstanding common stock at an average price of $31.87 per share pursuant to the share repurchase program.
All repurchased shares of common stock have been retired.
NOTES TO UNAUDITED
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 9 — Restructuring
During the first quarter of 2015, the Company decided to discontinue the Treat brand as well as close the manufacturing operations in Elmsford, New York as part of the Company's strategic initiatives. As a result, the Company will incur a reduction to headcount and lease charges related to the Elmsford, New York manufacturing operations. The assets related to the Treat brand were written off in the first quarter of 2015 upon the discontinuation of the Treat brand. These restructuring costs will impact
cost of revenues and operating expenses through the first quarter of 2016.
The following table summarizes the restructuring costs recognized during the three and six months ended June 30, 2015:
The Company reports segment information based on the "management" approach. The management approach designates the internal reporting used by management for making decisions and assessing performance as the source of its reportable segments.
The Company's Chief Operating Decision Maker ("CODM") function is comprised of its chief executive officer. Effective in the fourth quarter of 2014, the Company defined two reportable segments based on factors such as how management manages the operations and
how the chief operating decision maker views results. Prior to the fourth quarter of 2014, the Company reported as a single operating and reportable segment. Accordingly, the Company has recasted its financial information and disclosures for prior periods to reflect the segment disclosures as if the current operating structure had been in effect throughout all periods presented.
The CODM function uses gross profit to evaluate the performance of the segments and allocate resources. Management considers gross margin to be the appropriate metric to evaluate and compare the ongoing performance of each reportable segment as it is the level which direct costs associated with the performance of the segment are monitored.
Cost of revenue for the Consumer segment consists of costs directly attributable to the production of personalized products for all of the Company's brands, including direct materials, shipping charges, and payroll and related expenses for direct labor; rent for production facilities, and depreciation of production equipment and facilities where the Company is the deemed owner. Cost of net revenues for the Enterprise segment consists of costs which are direct and incremental to the Enterprise business. These include production costs of Enterprise products, such as materials, labor and printing costs and costs associated with third-party production of goods. They also include shipping costs and indirect overhead.
Due
to the nature of the Company's operations, a majority of its assets are utilized across all segments. In addition, segment assets are not reported to, or used by, the CODM to allocate resources or assess performance of the Company's segments. Accordingly, the Company has not disclosed asset information by segment.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The
Company’s segments are determined based on the products and services it provides and how the CODM evaluates the business. The Company has the following reportable segments:
Consumer - Includes sales from the Company's 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 its BorrowLenses brand.
Enterprise - Includes revenues primarily from variable, four-color direct marketing collateral manufactured and fulfilled for business customers.
In addition
to the above reportable segments, the Company has a corporate category that includes activities that are not directly attributable or allocable to a specific segment. This category consists of stock-based compensation and amortization of intangible assets.
During the year ended December 31, 2013, the Company executed a lease for a new 237,000 square foot production facility in Tempe, Arizona. This facility consolidated all of the Company's locations in the greater Phoenix area, including the acquired R&R Images facility, offers flexibility for future expansion, and became operational in the second quarter of 2015. Both the landlord and the
Company incurred costs to construct the facility according to the Company's operating specifications, and as a result, the Company has concluded that it is the “deemed owner” of the building (for accounting purposes only) during the construction period. During the six months ended June 30, 2015 and the year ended December 31, 2014, the landlord incurred $16.4 million and $9.1 million of building construction costs, including capitalized interest, respectively, which the Company has recorded as
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
an asset, with a corresponding construction financing obligation, as a component of other non-current liabilities. The Company increased the asset and financing obligation for building uplift costs incurred by the landlord during the construction period.
Upon completion of the construction of the facility in Tempe, Arizona in the second quarter of 2015, the Company evaluated the de-recognition of the asset and liability under the provisions for sale-leaseback transactions.
The Company concluded that it had forms of continued economic involvement in the facility, and therefore did not comply with the provisions for sale-leaseback accounting. Instead, the lease will be accounted for as a financing obligation and lease payments will be attributed to (1) a reduction of the principal financing obligation; (2) imputed interest expense; and (3) land lease expense (which is considered an operating lease and a component of cost of goods sold) representing an imputed cost to lease the underlying land of the facility. In addition, the underlying building asset will be depreciated over the building's estimated useful life of 30 years. At the conclusion of the lease term, the Company would de-recognize both the net book values of the asset and financing obligation. In conjunction
with the consolidation of facilities in the greater Phoenix area to our new Tempe facility, the Company incurred $1.7 million in early termination costs, which is included in cost of net revenues in the Company's consolidated statements of operations.
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 future claims that may be made against the Company, but have not yet been made. To date, the Company has not paid any claims or been required to defend any action related to its indemnification obligations. However, the Company may record charges in the future as a result of these indemnification obligations.
Contingencies
From
time to time, the Company may have certain contingent liabilities that arise in the ordinary course of its business activities. The Company accrues contingent liabilities when it is probable that future expenditures will be made and such expenditures can be reasonably estimated.
Syndicated Credit Facility
On November 22, 2011, the Company entered into a credit agreement (“Credit Agreement”) with J.P. Morgan Securities LLC, Wells Fargo Securities, LLC, Fifth Third Bank, Silicon
Valley Bank, US Bank and Citibank, N.A. (“the Banks”). JPMorgan Chase Bank, N.A. acted as administrative agent in the Credit Agreement. The Credit Agreement is for five years and provides for a $125.0 million senior secured revolving credit facility (the “credit facility”) and if requested by the Company, the Banks may increase the credit facility by $75.0 million subject to certain conditions. In December 2013, the Company requested and received the entire incremental amount for a total credit facility of $200.0 million. As part of the expansion, Bank of America, N.A. and Morgan Stanley Bank, N.A. joined
the syndicate. From inception through June 30, 2015, the Company has not drawn on the credit facility.
At the Company’s option, loans under the Facility will bear stated interest based on the Base Rate or Adjusted LIBO Rate, in each case plus the Applicable Rate (respectively, as defined in the Credit Agreement). The Base Rate will be, for any day, the highest of (a) 1/2 of 1% per annum above the Federal Funds Effective Rate (as defined in the Credit Agreement), (b) JPMorgan Chase Bank’s prime rate and (c) the Adjusted LIBO Rate for a term of one month plus 1.00%. Eurodollar borrowings may be for one, two, three
or six months (or such period that is 12 months or less, requested by Intersil and consented to by all the Lenders) and will be at an annual rate equal to the period-applicable Eurodollar Rate plus the Applicable Rate. The Applicable Rate for all revolving loans is based on a pricing grid ranging from 0.05% to 1.25% per annum for Base Rate loans and 1.50% to 2.25% for Adjusted LIBO Rate loans based on the Company’s Leverage Ratio (as defined in the Credit Agreement).
On May 10, 2013, the
Company amended the Credit Agreement by and among the Company and the Banks to (i) permit the issuance of the Notes and the related Note Hedge and Warrant, (ii) amend certain of the restrictive covenants set forth in the Credit Agreement, (iii) increase the Leverage Ratio (as defined the Credit Agreement) to be maintained by the Company to be at or below 3.50 to 1.00, and (iv) add a covenant requiring that the Company not permit its Senior Secured Leverage Ratio (as defined in the Credit Agreement) to exceed 1.60 to 1.00. Unchanged from the initial credit agreement, the Credit Agreement contains customary representations
and warranties, affirmative and negative covenants, and events of default. Also, the Company may not permit the ratio of its Consolidated EBITDA for any period of four consecutive fiscal quarters to its interest and rental expense and the amount of scheduled principal payments on long-term debt, for the same period, to be less than 2.50 to 1.00. As of June 30, 2015, the Company is in compliance with these covenants.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Amounts repaid under the Facility may be reborrowed. The revolving loan facility matures on the fifth anniversary of its closing and is payable in full upon maturity. The Company intends to use the new Facility from time to time for general corporate purposes, working capital and potential acquisitions.
Legal Matters
The Company is subject to the various legal proceedings and claims discussed below as well as certain other legal proceedings and claims that
have not been fully resolved and that have arisen in the ordinary course of business. Although adverse decisions (or settlements) may occur in one or more of these proceedings, it is not possible to estimate the possible loss or losses from each of these proceedings. The final resolution of these proceedings, individually or in the aggregate, is not expected to have a material adverse effect on the Company's business, financial position or results of operations. Cases that previously were disclosed may no longer be described because of rulings in the case, settlements, changes in our business or other developments rendering them, in our judgment, no longer material to our business, financial position or results of operations.
The State of Delaware v. Shutterfly, Inc.
On
May 1, 2014, the state of Delaware filed a complaint against us for alleged violations of the Delaware False Claims and Reporting Act, 6 Del C. § 1203(b)(2). The complaint asserts that we failed to report and remit to Delaware cash equal to the balances on unused gift cards under the Delaware Escheats Law, 12 Del. C. § 1101 et seq. The Company believes the suit is without merit.
In all cases, at each reporting period, the Company evaluates whether or not a potential loss amount or a potential range of loss is probable and reasonably estimable under the provisions of the authoritative guidance that addresses accounting for contingencies. In such cases, the
Company accrues for the amount, or if a range, the Company accrues the low end of the range as a component of legal expense. The Company monitors developments in these legal matters that could affect the estimate the Company had previously accrued. There are no amounts accrued which the Company believes would be material to its financial position and results of operations.
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, restructuring activities, technology initiatives, 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 2015, 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, our new production facilities, 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,”“seek,”“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, 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 innovative, new products and services on a timely and cost-effective basis, as well as consumer acceptance of our
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 and maintain 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 trusted premium lifestyle brands: Shutterfly, Tiny Prints, Wedding Paper Divas, ThisLife, MyPublisher, BorrowLenses and GrooveBook.
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, Tempe, Arizona, and Shakopee, Minnesota 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.
During the third quarter of 2014, we received bids by several outside parties to acquire the Company. With the help of outside legal and financial advisors, the Board of Directors undertook a deliberate and thoughtful evaluation of all aspects of the various offers. Based upon this review, the Board of Directors unanimously concluded that it was in the
best interest of all stakeholders
to remain independent at this time. The Board will continue to exercise its fiduciary responsibility to shareholders and will evaluate all credible offers and strategic alternatives with a goal of maximizing long-term shareholder value.
In the first quarter of 2015, we decided to discontinue the Treat brand. Treat was originally launched as an early stage growth initiative over three years ago, and during that time we invested in building a distinct one-to-one card experience that has delighted our customers, but that failed to attract a large enough standalone
user base. As of March 2015, customers were no longer able to place orders on Treat.com and they are now redirected to Shutterfly.com where we will enhance the one-to-one card experience under our flagship brand identity.
Also in the first quarter of 2015, we decided to close our manufacturing operations at the Elmsford, New York facility which was acquired with the MyPublisher acquisition. Although the Elmsford team produced a high quality product, the small size of the facility relative to our other facilities limited its ability to scale and drive efficiencies. The manufacturing work done in Elmsford will be transitioned to our Fort Mill, Tempe and Shakopee facilities. We officially ceased operations and customer service in Elmsford at the end of July 2015.
In the second quarter of
2015, we continued our initiative to build the next generation of Shutterfly, Shutterfly 3.0. We began to intentionally slow investments and innovation in the Tiny Prints and Wedding Paper Divas technology to redirect resources to the new Shutterfly platform, which will allow these brands to be supported by a common set of shared technology services, including cart, creation paths, login, address book and media storage platform. We expect these efforts to continue throughout 2015.
In the second quarter of 2015, we entered into a multi-year agreement with a Fortune 50 enterprise customer. We will continue to make investments in our enterprise platform and seek additional partnerships.
Basis of Presentation
Net
Revenues. Our net revenues are comprised of sales generated from our Consumer and Enterprise segments.
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.
In
the second quarter of 2015, we changed our accounting estimate related to flash deal deferred revenue. Beginning in 2010, we began to market product offers on flash deal websites such as Groupon and LivingSocial. With limited history as to customer redemption patterns, we had been deferring all amounts to our flash deal deferred revenue liability until customer redemption. We now have sufficient relevant historical flash deal redemption data to support a change in estimate of the flash deal deferred revenue based on historical customer redemption patterns. The historical data supports the probability of redemption after two years from the issuance of a flash deal offer as remote. In addition, our attempts to re-market the unredeemed flash deals over the last six months resulted in no meaningful change in customer behavior. Accordingly, flash deal breakage
revenue is now recognized based upon our historical redemption patterns and represents the unredeemed flash deal offers for which we believe customer redemption is remote and it is not probable that we have an obligation to escheat the value of the flash deal revenue under unclaimed property laws. In the second quarter of 2015, we recognized a revenue catch-up of $7.5 million associated with this change.
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 in expanding our presence in this market.
Our Consumer segment 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. Our cost of net revenues is split between our Consumer and Enterprise segments and our Corporate category.
Consumer. Cost of net revenues for the Consumer segment consists of costs directly attributable to the production of personalized products for all of our brands, including direct materials (the majority of which consists of paper, ink, and photo book covers), shipping charges, packing supplies, distribution and fulfillment activities, third-party costs for photo-based merchandise,
and payroll and related expenses for direct labor and customer service; rent for production facilities, and depreciation of production equipment and facilities where we are the deemed owner. Cost of net revenues also includes 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.
Enterprise. Cost of net revenues for the Enterprise segment consists of costs which are direct and incremental to the Enterprise business. These include production costs of Enterprise products, such as materials, labor and printing
costs and costs associated with third-party production of goods. They also include shipping costs and indirect overhead.
Corporate. Our corporate category includes activities that are not directly attributable or allocable to a specific segment. This category consists of stock-based compensation and amortization of intangible assets.
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 data storage for our 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 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 consist of the interest earned on our cash and investment accounts and realized gains and losses on the sale of our investments.
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.
In the second quarter of 2015, we changed our accounting estimate related to flash deal deferred revenue. Beginning
in 2010, we began to market product offers on flash deal websites such as Groupon and LivingSocial. With limited history as to customer redemption patterns, we had been deferring all amounts to our flash deal deferred revenue liability until customer redemption. We now have sufficient relevant historical flash deal redemption data to support a change in estimate of the flash deal deferred revenue based on historical customer redemption patterns. The historical data supports the probability of redemption after two years from the issuance of a flash deal offer as remote. In addition, our attempts to re-market the unredeemed flash deals over the last six months resulted in no meaningful change in customer behavior. Accordingly, flash deal breakage revenue is now recognized based upon our historical redemption patterns and represents the unredeemed flash
deal offers for which we believe customer redemption is remote and it is not probable that we have an obligation to escheat the value of the flash deal revenue under unclaimed property laws. In the second quarter of 2015, we recognized a revenue catch-up of $7.5 million associated with this change.
Our critical accounting policies and estimates are discussed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014.
Net revenues increased $24.7 million, or 16%, for the three months ended June 30, 2015 as compared to the same period in 2014. Cost of net revenues increased $13.3 million, or 16%, for the three months ended June 30, 2015 as compared to the same period in 2014. As a percentage of net revenues, cost of net revenues increased to 53% in the three months ended June 30, 2015 from 52%
in the same period in 2014, which decreased gross margin to 47% in the three months ended June 30, 2015 from 48% in the same period in 2014.
In addition, the operating results in the second quarter of 2015 also benefited from the recognition of breakage revenue from unredeemed flash deals associated with a change in estimate. As a result, our Consumer net revenues incurred a benefit of $7.5 million. Excluding this amount, total net revenues for the three months ended June 30, 2015 totaled $176.4 million, an 11% increase as compared to the same period in 2014, and gross margin decreased to 45% in the three months ended June
30, 2015 from 48% in the same period in 2014. Consumer net revenues excluding this amount for the three months ended June 30, 2015 totaled $163.8 million, a 9% increase as compared to the same period in 2014, and gross margin decreased to 49% for the three months ended June 30, 2015 from 52% in the three months ended June 30, 2014.
Consumer Segment
Consumer net revenues increased $21.1 million, or 14%, in the three months ended June 30,
2015 compared to the same period in 2014. The increase in Consumer net revenues was primarily a result of increased sales of greeting cards and stationery, photobooks, and mobile revenue. The increase is also reflected in the increases in customers and orders in three months ended June 30, 2015, as compared to the same period in 2014. Excluding the impact of breakage revenue, average order value decreased 10% which reflects Groovebook's lower average order value compared to our core brands and increasing partner promotions as compared to the prior year.
Consumer cost of net revenues increased $11.1 million, or 15%, for the three months ended June 30,
2015 as compared to the same period in 2014, which decreased Consumer gross margin to 51% in the three months ended June 30, 2015 from 52% in the same period in 2014. The decrease in Consumer gross margin percentage from the same period a year ago is largely driven by the expenses of our new Shakopee, Minnesota production facility which resulted in increases to depreciation and labor costs.
Enterprise Segment
Enterprise net revenues increased $3.6 million, or 40%, in the three months ended
June 30, 2015 compared to the same period in 2014. The increase in Enterprise net revenues is primarily due to the expansion of projects with existing customers and the acquisition of new customers.
Enterprise cost of net revenues increased $2.9 million, or 39%, for the three months ended June 30, 2015 as compared to the same period in 2014, which increased Enterprise gross margin to 19% in the three months ended June 30, 2015 from 18%
in the same period in 2014. The increase in Enterprise gross margin is primarily due to increased efficiencies as a result of the expansion of projects with our existing customers.
Our technology and development expense increased $4.4 million,
or 14%, for the three months ended June 30, 2015, compared to the same period in 2014. As a percentage of net revenues, technology and development expense remained flat at 20% in the three months ended June 30, 2015 and 2014. The overall increase was primarily due to an increase of $1.4 million in personnel and related costs due to increased headcount and an increase of $1.4 million in professional fees. The increase in technology and development expense was also due to an increase of $1.0 million in depreciation
expense and an increase in stock-based compensation expense of $0.8 million. These factors were partially offset by a decrease of $0.2 million in website and brand development costs and an increase of $0.2 million in software and website development costs capitalized.
At
June 30, 2015, headcount in technology and development increased by 7% compared to June 30, 2014, 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 June 30, 2015, we capitalized $5.5 million in eligible salary and consultant costs, including $0.3 million of stock-based compensation, associated with software developed or obtained for internal use, compared to $5.3 million
capitalized in the three months ended June 30, 2014, which included $0.4 million of stock-based compensation expense.
Our sales and marketing expense increased $6.0 million, or 13%, in the three months ended June 30, 2015 compared to the same period in 2014. As a percentage of net revenues, total sales and marketing expense decreased to 27% in the three months ended June 30, 2015 from 28% in the three months ended
June 30, 2014. Our sales and marketing expense was also impacted by the change in estimate related to flash deal deferred costs resulting in $3.4 million in incremental expenses. Excluding these costs, sales and marketing expense increased $2.5 million, or 6% in the three months ended June 30, 2015 compared to the same period in 2014 and had no impact as a percentage of net revenues. The increase in our sales and marketing expense was also due to an increase of $2.7 million related to our integrated marketing campaigns which included increased marketing partnerships and increased online and television advertising.
Our general and administrative expense increased $2.8
million, or 11%, in the three months ended June 30, 2015 as compared to the same period in 2014. As a percentage of net revenues, general and administrative expense remained flat at 16% in the three months ended June 30, 2015 and 2014. The increase in general and administrative expense was primarily due to an increase of professional fees of $1.1 million related to proxy-related costs. There were also an increase of $0.7 million in credit card fees driven by an increase in Consumer net revenues as compared to the prior year,
an increase of $0.6 million in stock-based compensation expense and an increase of $0.5 million in insurance costs. The increase was also due to an increase of $0.4 million in personnel related costs as a result of increased headcount and an increase of $0.2 million in facilities costs. The increase was partially offset by a decrease of $0.5 million in depreciation expense and by proceeds from intellectual property license agreements of $0.2 million.
Interest expense consists of interest on our convertible senior notes, amortization of the issuance costs associated with our convertible senior notes and credit facility, capital leases and our financing obligation associated with our production facilities in Fort Mill,
South Carolina, Shakopee, Minnesota, and Tempe, Arizona which became operational in the second quarter of 2015. Interest expense was $5.0 million for the three months ended June 30, 2015 compared to $3.9 million during the same period a year ago.
We
recorded an income tax benefit of $9.5 million and $3.4 million for the three months ended June 30, 2015 and 2014, respectively. Our effective tax rate was 29% for the three months ended June 30, 2015, compared to 11% for the three months ended June 30, 2014. Factors that impacted the effective tax rate include a discrete tax benefit related to an IRS settlement in the second quarter of 2015, the federal domestic production activities deduction, limitations on executive compensation, non-deductible
stock-based compensation expense, and disqualifying dispositions of employee incentive stock options
During the second quarter of 2015 the Internal Revenue Service (“IRS”), as part of the 2010 audit, issued a notice of proposed adjustment (“NOPA”) for federal research and development credits generated from 2007 through 2010. The settlement resulted in a discrete tax benefit of $1.8 million during the current quarter.
During
the three months ended June 30, 2015, net loss was $23.8 million, an increase of $3.3 million as compared to a net loss of $27.1 million the same period in 2014. As a percentage of net revenues, net loss decreased to 13% for the three months ended June 30, 2015 from 17% for the three months ended June 30, 2014. Excluding the benefit relating to flash deal deferred revenue change in estimate, net loss during the three months ended June 30, 2015 was $27.9 million,
a decrease of $0.8 million as compared to the same period in 2014, and as a percentage of net revenues, net loss decreased to 16% for the three months ended June 30, 2015 from 17% for the three months ended June 30, 2014.
Net revenues increased $47.6 million,
or 16%, for the six months ended June 30, 2015 as compared to the same period in 2014. Cost of net revenues increased $31.7 million, or 20%, for the six months ended June 30, 2015 as compared to the same period in 2014. As a percentage of net revenues, cost of net revenues increased to 56% in the six months ended June 30, 2015 from 54% in the same period in 2014, which decreased gross margin to 44% in the six months
ended June 30, 2015 from 46% in the same period in 2014.
In addition, the operating results in the second quarter of 2015 also benefited from the recognition of breakage revenue from unredeemed flash deals associated with a change in estimate. As a result, our Consumer net revenues incurred a benefit of $7.5 million. Excluding this amount, total net revenues for the six months ended June 30, 2015 totaled $336.3 million, a 14% increase as compared to the same period in 2014, and gross margin decreased to 43% in the six months ended June 30, 2015 from 46% in the same period in 2014. Consumer net revenues
excluding this amount for the six months ended June 30, 2015 totaled $312.5 million, an 11% increase as compared to the same period in 2014, and gross margin decreased to 47% for the six months ended June 30, 2015 from 51% in the six months ended June 30, 2014.
Consumer net revenues increased $39.3 million,
or 14%, in the six months ended June 30, 2015 compared to the same period in 2014. The increase in Consumer net revenues was primarily a result of increased sales of photobooks, greeting cards and stationery, and mobile revenue.
Consumer cost of net revenues increased $25.5 million, or 18%, for the six months ended June 30, 2015 as compared to the same period in 2014, which decreased Consumer gross margin to 49% in the six months ended June 30,
2015 from 51% in the same period in 2014. The decrease in Consumer gross margin percentage from the same period a year ago is largely driven by the expenses of our Shakopee, Minnesota production facility which became operation in the second quarter of 2014 resulted in increases to depreciation and labor costs.
Enterprise Segment
Enterprise net revenues increased $8.3 million, or 54%, in the six months ended June 30, 2015 compared to the same period in 2014. The increase in Enterprise net revenues is primarily due to the expansion
of projects with existing customers and the acquisition of new customers.
Enterprise cost of net revenues increased $6.7 million, or 49%, for the six months ended June 30, 2015 as compared to the same period in 2014, which increased Enterprise gross margin to 15% in the six months ended June 30, 2015 from 13% in the same period in 2014. The increase in Enterprise gross margin is primarily due to increased efficiencies as a result of the expansion of projects with our existing customers.
Our technology and development expense increased $10.2 million,
or 16%, for the six months ended June 30, 2015, compared to the same period in 2014. As a percentage of net revenues, technology and development expense remained flat at 21% in the six months ended June 30, 2015 and 2014. The overall increase was primarily due to an increase of $4.2 million in personnel and related costs due to increased headcount, an increase of $2.6 million in depreciation expense, and an increase of $2.5 million in professional fees. The increase in technology and development expense
was also due to a decrease of $0.4 million in software and website development costs capitalized.
In the six months ended June 30, 2015, we capitalized $9.6 million in eligible salary and consultant costs, including $0.6 million of stock-based compensation, associated with software developed or obtained for internal use, compared to $10.0 million capitalized in the three months ended June 30, 2014, which included $0.9
million of stock-based compensation expense.
Our sales and marketing expense increased $8.4 million, or 10%, in the six months ended June 30, 2015 compared to the same period in 2014. As a percentage of net revenues, total sales and marketing expense decreased to 28% in the six months ended June 30, 2015 compared to 29% in the six months ended June 30, 2014. The increase in sales and marketing expense was primarily due to an increase of
$3.9 million related to our integrated marketing campaigns and also due to increases of $0.6 million in stock-based compensation expense and $0.6 million in personnel and related costs resulting from the expansion of our internal marketing team. Our sales and marketing expense was also impacted by the change in estimate related to flash deal deferred costs resulting in $3.4 million in incremental expenses. Excluding these costs, sales and marketing expense increased $4.9 million, or 6% in the six months ended June 30, 2015 compared to the same period in 2014 and as a percentage of net revenue, sales and marketing expense decreased to 27% for the six months ended June 30, 2015 from 29% in
the six months ended June 30, 2014.
Our general and administrative expense increased $6.6 million, or 13%, in the six months ended June 30, 2015 as compared to the same period in 2014. As a percentage of net revenues, general and administrative expense remained flat at 17% in the six
months ended June 30,
2015 and 2014. The increase in general and administrative expense was primarily due to an increase of $2.0 million in stock-based compensation expense and an increase of $1.2 million in personnel related costs as a result of increased headcount. There was also an increase of $1.9 million in credit card fees driven by an increase in Consumer net revenues as compared to the prior year. The increase was also due to an increase in professional fees of $1.5 million related to proxy-related costs, an increase of $0.7 million in insurance costs, and losses on asset disposition of $0.4 million. The increase was partially offset
by a decrease of $0.9 million in depreciation expense.
Interest
expense consists of interest on our convertible senior notes, amortization of the issuance costs associated with our convertible senior notes and credit facility, capital leases and our financing obligation associated with our production facilities in Fort Mill, South Carolina, Shakopee, Minnesota and Tempe, Arizona. Interest expense was $9.7 million for the six months ended June 30, 2015 compared to $7.8 million during the same period a year ago.
We recorded an income tax benefit of $15.2 million and $11.6 million for the six months ended June 30, 2015 and 2014, respectively. Our effective tax rate was 18% for the six months ended June 30,
2015, compared to 16% for the six months ended June 30, 2014. Factors that impacted the effective tax rate include a discrete tax benefit related to an IRS settlement in the second quarter of 2015, the federal domestic production activities deduction, limitations on executive compensation, non-deductible stock-based compensation expense, and disqualifying dispositions of employee incentive stock options.
During the second quarter of 2015 the IRS, as part of the 2010 audit, issued a NOPA for federal research and development credits generated from 2007 through 2010. The settlement resulted in a discrete tax benefit of $1.8 million during the current quarter.
During
the six months ended June 30, 2015, net loss was $68.9 million, an increase of $7.6 million as compared to a net loss of $61.3 million the same period in 2014. As a percentage of net revenues, net loss decreased to 20% for the six months ended June 30, 2015 from 21% for the six months ended June 30, 2014. Excluding the benefit related to flash deal deferred revenue change in estimate, net loss during the six months ended June 30, 2015 was $73.0 million, a
decrease of $11.7 million as compared to the same period in 2014, and as a percentage of net revenues, net loss increased to 22% for the six months ended June 30, 2015 from 21% for the six months ended June 30, 2014.
Liquidity and Capital Resources
At June 30, 2015, we had $133.6 million of cash and cash equivalents and $66.5 million of investments, primarily agency securities and corporate bonds. To supplement our overall liquidity position,
in May 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 June 30, 2015, no amounts have been drawn against this facility.
Capitalization
of software and website development costs
9,297
9,744
Cash flows used in operating activities
(85,560
)
(85,191
)
Cash
flows used in investing activities
(10,009
)
(144,369
)
Cash flows used in financing activities
(151,420
)
(29,673
)
We
anticipate that our current cash balance and cash generated from operations will be sufficient to meet our strategic and working capital requirements, lease obligations, share repurchase program, technology development projects, and coupon payments for our 0.25% convertible senior notes for at least the next twelve months. Whether these resources are adequate to meet 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 additional equity. The sale of additional equity or convertible debt could result in significant dilution to our stockholders. Financing arrangements may not be available to us, or may not be in amounts or on terms acceptable to us.
We
anticipate that total 2015 capital expenditures will range from 8.4% to 9.0% of our expected net revenues in 2015, which includes additional investments related to our Shakopee, Minnesota production facility, which commenced operations in the second quarter of 2014, and our Tempe, Arizona production facility, which became operational in second quarter of 2015. These expenditures will be used to purchase technology and equipment to support the growth in our business, to increase our production capacity, and help enable us to respond more quickly and efficiently to customer demand. A smaller but significant component of these expenditures includes costs associated with capitalized software and website development, as we continue to support our innovative engineering and product development strategies. This range of capital expenditures is not outside
the ordinary course of our business or materially different from how we have expanded our business in the past.
The following table shows total capital expenditures including amounts accrued but not yet paid by category for the six months ended June 30, 2015 and 2014:
Total
capital expenditures percentage of net revenues
12
%
18
%
Operating Activities. For the six months ended June 30, 2015, net cash used in operating activities was $85.6 million, primarily due to our net loss of $68.9 million and the net change in operating assets
and liabilities of $106.3 million. Net cash used in operating activities was adjusted for non-cash items including $40.9 million of depreciation and amortization expense, $34.1 million of stock-based compensation expense, $14.4 million of amortization of intangible assets, $6.7 million for amortization of debt discount and $6.6 million benefit from deferred income taxes.
For
the six months ended June 30, 2014, net cash used in operating activities was $85.2 million, primarily due to our net loss of $61.3 million and the net change in operating assets and liabilities of $98.9 million. Net cash used in operating activities was adjusted for non-cash items including $30.7 million of stock-based compensation expense, $29.2 million of depreciation and amortization expense, $17.3 million of amortization of intangible assets and $8.4 million benefit from deferred income taxes.
Investing Activities. For the six months ended June 30, 2015, net cash used in investing activities was $10.0 million. We used
$28.9 million for capital expenditures for computer and network hardware to support our website infrastructure and information technology systems and production equipment for our manufacturing and production operations, $9.3 million for capitalized software and website development, and $4.4 million to purchase investments. This was partially offset by proceeds from the sale of investments of $32.4 million.
For the six months ended June
30, 2014, net cash used in investing activities was $144.4 million. We used $101.3 million to purchase investments. We also used $34.5 million for capital expenditures for computer and network hardware to support our website infrastructure and information technology systems and for production equipment for our manufacturing and production operations and $9.7 million for capitalized software and website development.
Financing Activities. For the six months ended June 30, 2015, net
cash used in financing activities was $151.4 million. We used $87.8 million to repurchase shares of our common stock including a prepayment of $75 million under an accelerated share repurchase agreement that will settle in August 2015. We also recorded $14.4 million in excess tax benefit from stock-based compensation expense and $2.3 million of proceeds from the issuance of common stock from the exercise of stock options.
For the six months ended June 30, 2014, net cash used in financing activities was $29.7 million. We used $46.0 million to repurchase shares of common stock. We also received $15.7 million in excess tax benefit from stock-based compensation
expense and $1.5 million of proceeds from the issuance of common stock from the exercise of stock options.
Non-GAAP Financial Measures
Regulation G, conditions for use of Non-Generally Accepted Accounting Principles ("Non-GAAP") financial measures, and other SEC regulations define and prescribe the conditions for use of certain Non-GAAP financial information. We closely monitor three financial measures, adjusted EBITDA, free cash flow, and Non-GAAP earnings per share which meet the definition of Non-GAAP financial measures. We define adjusted EBITDA as earnings before interest, taxes, depreciation, amortization, and stock-based compensation. Free cash flow is defined as adjusted EBITDA less purchases of property and
equipment and capitalization of software and website development costs. Free cash flow has limitations due to the fact that it does not represent the residual cash flow for discretionary expenditures. For example, free cash flow does not incorporate payments made on capital lease obligations or cash requirements to comply with debt covenants. Non-GAAP earnings per share is defined as Non-GAAP net income (loss), which excludes interest expense related to the issuance of our 0.25% convertible senior notes in May 2013, divided by diluted non-GAAP shares outstanding, which is GAAP weighted average shares outstanding less any shares issuable under our convertible senior notes. Management believes these Non-GAAP financial measures reflect an additional way of viewing our profitability and liquidity that, when viewed with our GAAP results, provides a more
complete understanding of factors and trends affecting our earnings and cash flows. Refer below for a reconciliation of adjusted EBITDA, free cash flow, and Non-GAAP earnings per share to the most comparable GAAP measure.
To supplement our consolidated financial statements presented on a GAAP basis, we believe that these Non-GAAP measures provide useful information about our core operating results and thus are appropriate to enhance the overall understanding of our past financial performance and our prospects for the future. These adjustments to our GAAP results are made with the intent of providing both management and investors a more complete understanding of our underlying operational results and trends and performance. Management uses these Non-GAAP measures to evaluate our financial results, develop budgets, manage expenditures, and determine employee compensation. The presentation
of additional information is not meant to be considered in isolation or as a substitute for or superior to net income (loss) or net income (loss) per share determined in accordance with GAAP. We believe that it is important to view free cash flow as a complement to our reported consolidated financial statements. Management strongly encourages shareholders to review our financial statements and publicly-filed reports in their entirety and not to rely on any single financial measure.
The table below shows the trend of adjusted EBITDA and free cash flow as a percentage of net revenues and
Non-GAAP net loss per share for the three and six months ended June 30, 2015 and 2014 (in thousands, except per share amounts):
For
the three months ended June 30, 2015 and 2014, our adjusted EBITDA was $15.6 million and $11.7 million, respectively. In addition, during the three months ended June 30, 2015 and 2014, we experienced negative free cash flows of $7.0 million and $16.3 million, respectively. Our Non-GAAP net loss per share was $0.56 and $0.63 for the three months ended June 30, 2015 and 2014, respectively.
For
the six months ended June 30, 2015 and 2014, our adjusted EBITDA was $14.8 million and $11.9 million, respectively. In addition, during the three months ended June 30, 2015 and 2014, we experienced negative free cash flows of $25.9 million and $37.7 million, respectively. Our Non-GAAP net loss per share was $1.67 and $1.45 for the six months ended June 30, 2015 and 2014, respectively.
By
carefully managing our operating costs and capital expenditures, we are able to make the strategic investments we believe are necessary to grow and strengthen our business while maintaining the opportunity for full year adjusted EBITDA profitability and positive free cash flows.
The following is a reconciliation of adjusted EBITDA, free cash flow, and Non-GAAP loss per share to the most comparable GAAP measure, for the three and six months ended June 30, 2015 and 2014 (in thousands):
Reconciliation
of Net Loss to Non-GAAP Adjusted EBITDA
We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we do not have any undisclosed borrowings or debt and we have not entered into any synthetic leases. We are, therefore, not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.
Recent Accounting Pronouncements
No new accounting standards have been adopted since our Annual Report
on Form 10-K for the fiscal year ended December 31, 2014 was filed.
In May 2014, the FASB issued new accounting guidance related to revenue recognition. This new standard will replace all current U.S. GAAP guidance on this topic and eliminate all industry-specific guidance. The new revenue recognition standard provides a unified model to determine when and how revenue is recognized. The core principle is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration for which the entity expects
to be entitled in exchange for those goods or services. This guidance will be effective for us beginning January 1, 2018 and can be applied either retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption. We are evaluating the impact of adopting this new accounting standard on our financial statements.
In August 2014, the FASB issued new guidance related to the disclosures around going concern. The new standard provides guidance around management's responsibility to evaluate whether there is substantial doubt about an entity's ability to continue as a going concern and to provide related footnote disclosures. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016.
Early adoption is permitted. The adoption of this standard is not expected to have a material impact on our financial statements.
In April 2015, the FASB issued new guidance related to presentation of debt issue costs. The new standard requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability. The adoption of this guidance will be effective beginning January 1, 2016, and is not expected to have a material impact on our financial statements.
In April 2015, the FASB issued new guidance related to accounting for fees paid in a cloud computing arrangement. The new standard provides guidance to customers about whether a cloud
computing arrangement includes a software license. If a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The adoption of this guidance will be effective beginning January 1, 2016, and is not expected to have a material impact on our financial statements.
In July 2015, the FASB issued ASU 2015-11, Inventory - Simplifying the Measurement of Inventory (Topic 330). ASU 2015-11 requires inventory to be subsequently
measured using the lower of cost and net realizable value, thereby eliminating the market value approach. Net realizable value is defined as the “estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation.” ASU 2015-11 is effective for reporting periods beginning after December 15, 2016 and is applied prospectively. Early adoption is permitted. We are currently evaluating the impact that this guidance will have on our financial statements and disclosure.
ITEM
3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate and Credit Risk. We have exposure to interest rate risk that relates primarily to our investment portfolio and our syndicated credit facility. We maintain our portfolio of cash equivalents and investments in a variety of agency bonds and corporate debt securities. All of our cash equivalents are carried at market value. We may draw funds from our syndicated credit facility under interest rates based on either the Federal Funds Rate or the Adjusted London Interbank Offered Rate (“LIBO rate”). If these rates increase significantly, our costs to borrow these funds will also increase. To date, we have not borrowed any funds under our syndicated credit facility. We do not believe that a 10% change in interest rates would have a significant impact on our
interest income and expense, operating results, or liquidity.
Market Risk and Market Interest Risk. In May 2013, we issued $300.0 million of 0.25% convertible senior notes due May 15, 2018. We carry this instrument at face value less unamortized discount on our balance sheet. Since this instrument bears interest at fixed rates, we have no financial statement risk associated with changes in interest rates. However, the fair value of these instruments fluctuates when interest rates change, and in the case of convertible notes, when the market price of our stock fluctuates.
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.
Investment. The primary objective of our investment activities is to preserve principal while at the same time improving yields without significantly increasing risk. To achieve this objective, we maintain our portfolio of cash equivalents and short-term and long-term investments in a variety of asset types, including bank deposits, money market funds, agency bonds and corporate debt securities. As of
June 30, 2015, our investments totaled $66.5 million, which represented approximately 61% of our total investment portfolio.
ITEM 4. CONTROLS AND PROCEDURES
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of June 30, 2015. 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 June 30, 2015, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, the Company's disclosure controls and procedures were effective at the reasonable assurance level.
No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the quarter ended June 30, 2015 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
We are subject to the various legal proceedings and claims discussed below as well as certain other legal proceedings and claims that have not been fully resolved and that have arisen in the ordinary course of business. Although adverse decisions (or settlements) may occur in one or more of these proceedings, it is not possible to estimate the possible loss or losses from each of these proceedings. The final resolution of these proceedings, individually or in the aggregate, is not expected to have a material adverse effect on our business, financial position or results of operations. Cases that previously were disclosed may no longer be described because
of rulings in the case, settlements, changes in our business or other developments rendering them, in our judgment, no longer material to our business, financial position or results of operations. No material legal proceeding was terminated during the second quarter of 2015.
The State of Delaware v. Shutterfly, Inc.
On May 1, 2014, the state of Delaware filed a complaint against us for alleged violations of the Delaware False Claims and Reporting Act, 6 Del C. § 1203(b)(2). The complaint asserts that we failed to report and remit to Delaware cash equal to the balances on unused gift cards under the Delaware Escheats Law, 12 Del. C. § 1101 et seq. We believe the suit is without merit.
ITEM
1A. RISK FACTORS
Risks Related to Our Business and Industry
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 more than 50% of our net revenues in the fourth quarter during each of the last three years, and the net income that we generated during the fourth quarter of 2013 and 2012 was necessary for us to achieve profitability on an annual basis in each of those years. In addition, we incur significant additional expenses in the period leading up to the fourth quarter
holiday season 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 brands 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, production facility, and various equipment leases and 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.
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. Our capital expenditures were approximately 10%, 10% and 9% of total net revenues for the years ended December 31, 2014, 2013 and 2012, respectively. We anticipate that total capital expenditures for the year ending December 31, 2015 will range from 8.4% to 9.0% of 2015 net revenues. Operational difficulties, such as a significant interruption in
the operations of our Fort Mill, South Carolina, Tempe, Arizona, or Shakopee, Minnesota production facilities, could delay production or shipment of our products. In addition, inclement weather, particularly heavy rain and snow could impair our production capabilities. Our inability to meet our production requirements could lead to customer dissatisfaction and damage our reputation and brands, which would result in reduced net revenues. Moreover, if the costs of meeting production requirements, including capital expenditures, were to exceed our expectations, our results of operations would be harmed.
In addition, we face significant production risks at peak holiday seasons, including the risk of obtaining sufficient qualified seasonal production personnel. A majority of our workforce during the fourth quarter of 2014 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 facilities could harm our operations.
Uncertainties in general economic conditions and their impact on consumer spending patterns, particularly in the personalized products and photofinishing services categories, could adversely impact our operating results.
Our financial performance depends on general economic conditions in the United States and their impact on levels of consumer
spending, particularly spending on personalized products and photofinishing services. Consumer revenue as a percentage of total revenue was 95% in 2014, 95% in 2013 and 96% in 2012. Some of the macroeconomic conditions that are adversely affecting consumer spending levels in the United States include high unemployment rates, high consumer debt levels, stock market volatility and its effect on net worth, uncertainty in real estate markets and home values, fluctuating energy and commodity costs, limited credit availability and uncertainty about the future economic environment. If general economic conditions do not improve or continue to improve slowly, customers or potential customers could delay, reduce or forego their purchases of our products and services, which are often discretionary. Any decrease in the demand for our products and services could impact our business in a number of ways, including lower prices for our products and services and reduced revenues. In
addition, adverse economic conditions may lead to price increases by our suppliers or increase our operating expenses due to, among other factors, higher costs of labor, energy, equipment and facilities which could in turn lead to additional restructuring actions by us and associated expenses. We may not be able to pass these increased costs on to our customers due to the macroeconomic environment and the resulting increased expenses and/or reduced income could have a material adverse impact our operating results.
Competitive pricing pressures, particularly with respect to pricing and shipping, may harm our business and results of operations.
Demand for our products and services is sensitive to price, especially in times of slow or uncertain economic growth and consumer conservatism. Many
factors can significantly impact our pricing strategies, including production and personnel costs, and ones outside of our control, such as consumer sentiment and our competitors’ pricing and marketing 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, specifically for 4x6 prints, in order to remain competitive. Most of our other products, including photo books, calendars, cards and stationery and other photo merchandise are also offered by our competitors. Many of our competitors discount those products at significant levels and as a result, we may be compelled to change our discounting strategy,
which could impact our acquisition of new customers, average order value, net revenues, gross margin, and adjusted EBITDA and net income profitability measures. If in the future, due to competitor discounting or other marketing strategies, we significantly reduce our prices on our products without a corresponding increase in volume, it 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, shipping revenue for the Shutterfly brand website represented approximately 16% of our net revenues in each of 2014, 2013 and 2012. 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.
We face intense competition from a range of competitors and may be unsuccessful in competing against current and future competitors.
The digital photography products and services industry is intensely competitive, and we expect competition to increase in the future as current competitors
improve their offerings, including developing, acquiring and expanding mobile and cloud-based 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 Snapfish, Vistaprint, and many others;
•
Social
media companies that host and enable mobile access to and posting of images such as Facebook, Instagram, Twitter, and Google+;
•
Photo hosting websites that allow users to upload and share images at no cost such as Apple iTunes, Picasa, and Flickr;
“Big
Box” retailers such as Wal-Mart, Costco, Sam’s Club, Target, and others that offer low cost digital photography products and services. These competitors provide in-store fulfillment and self-service kiosks for printing, and 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/pharmacy, and others that offer low-cost photography products and services as well as in-store pick-up from their photo website internet orders;
•
Mobile
digital photography services companies such as Instagram and iPhoto;
•
Self-publishing companies and services such as Lulu, CafePress, and Zazzle;
•
Cloud-based storage services and file-syncing services such as Dropbox, Box, Amazon Cloud Drive, and iCloud;
•
Specialized companies in the photo
book and stationery business such as Hallmark, Cardstore by American Greetings, Minted, Picaboo, Blurb, and Mixbook;
•
Photo-related software companies such as Apple, Microsoft, and Adobe;
•
Internet portals and search engines such as Yahoo! and Google that offer broad-reaching digital photography uploading and storage as well as related products and services to their large user bases;
•
Home
printing service providers such as Hewlett-Packard and Epson that are seeking to expand their printer and ink businesses by gaining market share in the digital photography marketplace;
•
Enterprise digital and print communications companies such as RR Donnelley and Sons Company, O'Neil Data Systems, Inc., Quad/Graphics, Inc. and Viatech Publishing Solutions, Inc.;
•
Regional photography companies such as Ritz Camera that have established brands and customer bases in existing photography markets; and
•
Camera
and photographic supply companies that rent equipment nationwide both online and in brick-and-mortar stores such as LensRentals.com, LensProToGo, Cameralends, AbelCine, and Adorama.
Many of our competitors have significantly longer operating histories, larger and broader customer bases, greater brand and name recognition, greater financial, research and development and distribution resources, and operate in more geographic areas than we do. Well-funded competitors may be better able to withstand economic downturns and periods of slow economic growth and the associated periods of reduced customer spending and increased pricing pressures. 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. Well-funded competitors, 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 industry may develop new products, technologies or capabilities that could render obsolete or less competitive many of our products, services and content. We may be unable to compete successfully against current and future competitors, and competitive pressures could harm our business and prospects.
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 recession and slow economic growth in the U.S. and worldwide and higher inflation;
•
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 websites and convert those visitors into customers;
•
our ability to retain customers and encourage repeat purchases;
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 websites;
•
a significant increase in returns and credits, beyond our estimated allowances, for customers who are not satisfied with our products;
•
our ability to achieve the expected benefits of strategic partnerships or the loss of any such partnership;
•
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 and the duration of the holiday shopping season;
•
our ability to address increased shipping delays caused by our third party
shippers' inability to handle the ever increasing number of consumers ordering goods online, particularly during the holiday shopping season;
•
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
•
global and geopolitical events with indirect economic effects such as pandemic disease, hurricane and other natural disasters, war, threat of war or terrorist actions. For example, we have significant engineering resources in Haifa, Israel and any military actions in that part of the world may impact those resources.
Based on the factors cited above, and in light of the seasonal nature of our business, we believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance. It is possible that in one or more future quarters, our operating
results may be below the expectations of public market analysts and investors. In that event, the trading price of our common stock may decline.
We have incurred operating losses in the past and may not be able to sustain profitability in the future.
We have periodically experienced operating losses since our inception in 1999. In particular, we make investments in our business that generally result in operating losses in each of the first three quarters of our fiscal year. This typically 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 consumer demand decreases and revenues decline or if our expenses
exceed our expectations, we may not be able to achieve, sustain or increase profitability on a quarterly or annual basis.
We face many risks, uncertainties, expenses and difficulties relating to increasing our market share and growing our business.
To address the risks and uncertainties of increasing our market share and growing our business, we must do the following:
•
maintain and increase the size of our customer base;
•
maintain
and enhance our brands;
•
enhance and expand our products and services;
•
maintain and grow our websites and customer operations;
•
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 a high quality customer experience, including superior customer service and timely product deliveries;
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.
Our sales to enterprise customers can
be unpredictable and a decrease in Enterprise revenue could adversely impact total net revenue.
Enterprise revenue as a percentage of total net revenue was 5% in 2014, 5% in 2013 and 4% in 2012. Our Enterprise revenue is highly concentrated in a few customers and the loss of one or more of our enterprise customers could decrease Enterprise revenue and adversely impact our total net revenue. Our enterprise customers also come from a wide variety of industries, creating new regulatory compliance issues for us as well as the need to maintain security for third party data. These enterprise customers also demand strict security requirements and specified service levels. If we fail to meet these service levels, we may not only lose an enterprise customer but may have to pay punitive costs for such failures. As our Enterprise business grows, issues that impact our sales to enterprise
customers may have a negative impact on our total sales. Our core business is consumer focused and we have less experience managing sales to enterprise customers and may not sell as successfully to enterprise customers, who often have long sales cycles, long implementation periods and significant upfront costs. To compete effectively in the enterprise market, we have in the past, and may in the future, be forced to offer significant discounts to large enterprise customers at lower margins and/or reduce or withdraw from existing relationships with smaller enterprise customers, which could negatively impact our net revenues and could adversely affect our gross margins and overall profitability.
If we are not able to reliably meet our technology, data storage and management requirements, our customers may become dissatisfied with our service and our reputation and brands 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 many 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, damage our reputation and brands, 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. For example, in 2011, after massive flooding shut down major hard disk drive production sites in Thailand, our ability to timely
acquire data storage products was adversely affected.
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, some of our corporate data center infrastructure is 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 systems located at our data storage center, such disruption could result in the deletion or corruption of customers' stored images, which could impair customer satisfaction and lead to decreased revenues.
An increasing number of our customers are using smartphones, tablets and other mobile devices to order
products and access services. If we are unable to develop mobile applications that are adopted by our customers or if we are unable to generate revenue from our mobile applications, our results of operations and business could be adversely affected.
The number of people who access information about our services and our websites through mobile devices, including smartphones and handheld tablets or computers, has increased significantly in recent years and is expected to continue increasing. As new mobile devices and platforms are released, it is difficult to predict the problems we may encounter in developing products for these alternative devices and platforms, and we may need to devote significant resources to the creation, support, and maintenance of such products.
In addition, if we experience difficulties integrating our mobile applications into mobile devices or if problems arise with our relationships with providers of mobile operating systems or mobile application download stores, such as Apple or Google, if our applications receive unfavorable treatment compared to the promotion and placement of competing applications, such as the order of our products in the Apple AppStore or Google Play, or if we face increased costs to distribute our mobile applications, our future growth and our results of operations could suffer.
Interruptions to our websites,
mobile applications, information technology systems, print production processes or customer service operations could damage our reputation and brands and substantially harm our business and results of operations.
The satisfactory performance, reliability and availability of our websites and mobile applications, 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. Any interruptions that result in the unavailability of our websites or mobile applications, reduced order fulfillment performance,
or the unavailability of our customer service operations could result in negative publicity, damage our reputation and brands, and cause our business and results of operations to suffer. This risk is heightened in the fourth quarter, as we experience significantly increased traffic to our websites and mobile applications during the holiday season and significantly higher order volumes. Any interruption that occurs during such time would have a disproportionately negative impact on our results of operations than if it occurred during a different quarter. For example, during the fourth quarter of 2014, unusually high seasonal traffic combined with system misconfigurations arising from the data center move resulted in some days when customers could not place orders from our Tiny Prints brand. Once the bug was identified and corrected, many of those orders
were not received by customers within the expected time frame. As a result, we refunded many of those orders which reduced net revenue, and we recognized excess costs related to expedited shipping upgrades and increased customer service costs which impacted our gross margin and our brand.
We depend in part on third parties to implement and maintain certain aspects of our Internet and communications infrastructure 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 website operations, offices and customer support centers in Redwood City, California, Santa Clara, California, and Tempe, Arizona and production facilities in Fort Mill, South Carolina, Shakopee, Minnesota and a new facility in Tempe, Arizona which became operational in the second quarter of 2015. 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 brands and substantially harm our business and results of operations.
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, 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.
If
the third-party vendors who we depend upon to produce many of our products or those that deliver our products experience delays or interruptions in service, our customer experience will suffer.
Our ability to provide a high-quality customer experience depends, in large part, on external factors over which we may have little or no control, including the reliability and performance of our suppliers, third-party product providers and shipping partners. 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, United Parcel Service and FedEx, to deliver our products to customers. Strikes, furloughs, reduced operations, increased shipping delays particularly
during the holiday shopping season, or other service interruptions affecting these shippers could impair our ability to deliver merchandise on a timely basis. 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 trusted brands, which would substantially harm our business and results of operations.
We may undertake acquisitions to expand our business, which may pose risks to our business and dilute the ownership of our existing stockholders.
A
key component of our business strategy includes strengthening our competitive position and refining the customer experience on our websites and mobile applications through internal development. However, from time to time, we may selectively pursue acquisitions of complementary businesses, such as our 2014 acquisition of selected assets of Dot Copy, Inc. ("Groovebook") and our 2013 acquisitions of BorrowLenses LLC, R&R Images, Inc. and MyPublisher, Inc. The identification of suitable acquisition candidates can be time-consuming and expensive, and we may not be able to successfully complete identified acquisitions. Furthermore, even if we successfully complete an acquisition, we may not achieve the anticipated benefits we expect due to a number of factors including the loss of management focus on and the diversion of resources from existing
businesses; difficulty retaining key personnel of the acquired company; cultural challenges associated with integrating employees from an acquired company into our organization; difficulty integrating acquired technologies into our existing systems; entry into a business or market with which we have historically had little experience; difficulty integrating data systems; the need to implement or remediate the controls, procedures or policies of the acquired company; and increased risk of litigation. For example, in March 2013, we filed a complaint for damages and injunctive relief, which was dismissed in April 2014, alleging that Eastman Kodak failed to comply with the non-compete provisions of the transfer agreement that it had entered into with us in April 2012. Groovebook, a subscription-based digital print service and BorrowLenses LLC, an online photography and video equipment rental business, are new business models for us and could result in operational challenges. Failure
to achieve the anticipated benefits of such acquisitions or the incurrence of debt, contingent liabilities, amortization expenses, or write-offs of goodwill in connection with such acquisitions could harm our operating results.
In addition, we may issue equity securities to complete an acquisition, which would dilute our existing shareholders' ownership, perhaps significantly depending on the terms of such acquisitions and could adversely affect the price of our common stock. To finance any future acquisitions, it may also be necessary for us to raise additional funds through public or private debt and equity 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.
Our
restructuring activities may adversely affect our business and results of operations.
In February 2015, we announced strategic initiatives designed to reduce long-term operating costs and improve our business operations, including building our next-generation platform, Shutterfly 3.0, combining our Shutterfly, Tiny Prints and Wedding Paper Divas creation platforms, discontinuing our Treat brand, and closing our Elmsford, New York manufacturing facility. We expect to incur one-time non-recurring charges related to these initiatives and proxy-related costs of between $12.0 million to $14.0 million during 2015. Actual charges could exceed our estimate as a result of many factors including our ability to implement planned technology improvements, renegotiate existing contracts and adequately
anticipate costs. In addition, these strategic initiatives could result in a disruption of our operations, the loss of customers who are dissatisfied with the changes to our platform, reduced effectiveness of our marketing programs, including our search engine optimization efforts as a result of reduction in the number of available search terms on our websites, decreased employee morale and productivity, and loss of sales, service and engineering talent.
These activities will also require management time and attention and may divert our management from other important work. Moreover, we could encounter delays in executing restructuring plans, which would cause further disruption and additional unanticipated expense.
The
loss of key personnel and an inability to attract and retain additional key personnel could affect our ability to successfully grow our business.
We are highly dependent upon the continued service and performance of our Chief Executive Officer, 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. A lack of management continuity could result in operational, technological, and administrative inefficiencies and added costs, which could adversely impact our results of operations and stock price and may make recruiting for future management positions more difficult. Changes in key management positions may temporarily affect our financial performance
and results of operations as new management becomes familiar with our business. For example, we hired a new Chief Technology Officer in November 2014.
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.
If we do not obtain stockholder approval for the issuance of additional shares under our 2006 Equity Incentive Plan, as amended (the “2006 Plan”), and an extension to the term of the 2006 Plan, our ability to attract and retain key personnel may be adversely affected.
Equity awards are a critical component of our compensation programs and if we are forced to reduce, modify or eliminate our equity compensation programs, we may have difficulty attracting and retaining key personnel. We have a limited number of shares
of common stock available for grant under the 2006 Plan. The last stockholder-approved increase to the 2006 Plan occurred on January 1, 2015 and was for 1.2 million shares of common stock. In addition, the 2006 Plan expires in June 2016. As a result, we will need to seek stockholder approval for the issuance of additional shares under the 2006 Plan and to extend its term at or before the 2016 annual meeting of stockholders if we are to continue to use equity awards to attract and retain key personnel beyond 2016. If our stockholders do not approve a proposal to increase the number of shares available for issuance under the 2006 Plan and extend its term, we will be significantly limited in our ability to grant equity awards, which would put us at a significant disadvantage to other companies with whom we compete for qualified personnel in the San Francisco Bay Area. Accordingly, our ability to hire, retain and motivate
current and prospective employees would be harmed, the result of which could negatively impact our business operations.
In order to attract new personnel, we may grant inducement equity awards to new employees outside of our 2006 Plan, which would dilute the ownership of our existing stockholders.
Since 2007, our board of directors has approved inducement equity awards outside of our 2006 Plan to new employees upon hire and in connection with mergers and acquisitions without stockholder approval in accordance with NASDAQ Listing Rule 5635(c) for an aggregate of 2,038,561 shares of our common stock. The use of inducement equity awards may dilute the equity interest of our stockholders, which could in turn adversely affect prevailing market prices for our common stock.
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 websites 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 websites and promote our products, including paying fees to third parties who drive new customers to our websites, purchasing search results from online search engines, e-mail
and direct mail. We pay providers of online services, search engines, directories and other websites and e-commerce businesses to provide content, advertising banners and other links that direct customers to our websites. 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, such as our acquisitions of customer lists from Kodak, Fuji, American Greetings, Sony and Yahoo!, 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 impacts 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 websites would be reduced and our business and results of operations would be harmed.
In addition, various private entities attempt to regulate the use of e-mail for commercial solicitation.
These entities often advocate standards of conduct or practice that significantly exceed current legal requirements and classify certain e-mail solicitations that comply with current legal requirements as unsolicited bulk e-mails, or “spam.” Some of these entities maintain blacklists of companies and individuals, and the websites, Internet service providers and Internet protocol addresses associated with those entities or individuals that do not adhere to what the blacklisting entity believes are appropriate standards of conduct or practices for commercial e-mail solicitations. If a company’s Internet protocol addresses are listed by a blacklisting entity, e-mails sent from those addresses may be blocked if they are sent to any Internet domain or Internet address that subscribes to the blacklisting entity’s service or purchases its blacklist.
From time to time we are blacklisted, sometimes without our knowledge, which could impair our ability to market our products and services, communicate with our customers and otherwise operate our business. In addition,
we have noted that unauthorized “spammers” utilize our domain name to solicit spam, which increases the frequency and likelihood that we may be blacklisted.
Our business could be negatively affected by changes in search engine algorithms and dynamics, or search engine disintermediation.
We rely on Internet search engines such as Google, Yahoo!
and Bing, including through the purchase of keywords related to photo-based products, to generate traffic to our websites. We obtain a significant amount of traffic via search engines and, therefore, utilize techniques such as search engine optimization and search engine marketing to improve our placement in relevant search queries. Search engines, including Google, Yahoo! and Bing, frequently update and change the logic that determines the placement and display of results of a user's search, such that the purchased or algorithmic placement of links to our websites can be negatively affected. Moreover, a search engine could, for competitive or other purposes, alter its search algorithms or results causing our websites
to place lower in search query results. If a major search engine changes its algorithms in a manner that negatively affects our paid or unpaid search ranking, or if competitive dynamics impact the effectiveness of search engine optimization or search engine marketing in a negative manner, our business and financial performance would be adversely affected, potentially to a material extent.
We may not succeed in promoting and strengthening our brands, 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, Tiny Prints, Wedding Paper Divas, BorrowLenses and ThisLife brands. Due to the competitive nature of the digital photography products and services markets, if we are
unable to successfully promote our brands, we may fail to attract new customers, increase the engagement of existing customers with our brands or substantially increase our net revenues. Customer awareness and the perceived value of our brands will depend largely on the success of our marketing efforts and our ability to provide a consistent, high-quality customer experience. To promote our brands, we have incurred, and will continue to incur, substantial expense related to advertising and other marketing efforts. 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.
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 4x6 prints, and photo-based products, such as photo books, stationery cards and calendars, we continually evaluate the demand for new products and services and the need to address these trends. For example, in 2013, we began to offer online photography and video equipment rentals. In the future, we may need to address additional markets and expand our customer demographic to grow our business. Our efforts to expand our existing services, create new products and services, address new market segments or develop a significantly broader customer base may not be successful. Any failure to address additional market opportunities could result in loss of market share, which could harm our
business, financial condition and results of operations.
If we do not successfully develop and maintain a relevant multichannel experience for our customers, our results of operations may suffer.
Our customers are increasingly using computers, tablets, mobile phones, and other devices to produce photos and photo-based products online. As part of our multichannel strategy, we are making technology investments in our websites and recently launched a mobile application for mobile phones and other electronic devices. If we are unable to make, improve, or develop relevant customer-facing technology in a timely manner, our ability to compete could be adversely affected and
may result in the loss of market share, which could harm our results of operations. In addition, if our technology systems do not function as designed, we may experience a loss of confidence, data security breaches or lost sales, which could adversely affect our reputation and results of operations.
If the facility where our computer and communications hardware is located fails or if any of our production facilities fail, our business and results of operations would be harmed.
Our ability to successfully receive and fulfill orders and to provide high-quality customer service depends in part on the efficient and uninterrupted operation of our computer and communications systems. During 2014, we migrated the computer hardware necessary to operate our website
to a new location in Las Vegas, Nevada. We also have computer hardware located in our production facilities in Fort Mill, South Carolina, and Tempe, Arizona. 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, our headquarters are located near a major fault line increasing our susceptibility to the risk that an earthquake could significantly harm our operations. 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. 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 websites, 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 websites.
As our operations grow in size and scope, we continually need to improve and upgrade our computer systems and network infrastructure to ensure reliable access to our websites, 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 websites and mobile applications 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 or mobile application 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 purchase photo-based product
supplies from third parties. These parties could increase their prices, reallocate supply to others, including our competitors, or choose to terminate their relationship with us. If one of these third parties chooses not to renew their agreements or fails to perform in accordance with the terms of their agreements and we are not able to secure supplies and services from a different source in a timely manner, we could fail to meet customer expectations, which could damage our reputation and harm our business. For example, we purchase or rent a substantial portion of the machines used to produce certain of our photo-based products from Hewlett-Packard, who is also 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 off-line and on-line marketing, and some of our customer service activities to third parties, which exposes us to risks if these parties fail to perform under our agreements with them.
We currently outsource some of our off-line and on-line marketing, and some of our customer service activities 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 brands and 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 slowdowns such as those experienced in the United States and worldwide. Events or weaknesses 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, work stoppages or labor unrest, safety concerns, including terrorist activities, political instability or regional hostility, pandemic disease (including the influenza virus), inclement weather, airline bankruptcies or liquidations, increases in fuel prices, and the imposition of taxes or surcharges by regulatory authorities. 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 websites, our production operations and our trademarks.
As of June 30, 2015, Shutterfly had 83 patents issued, and had more than 30 patent applications
pending in the United States. We intend to pursue corresponding patent coverage in other countries to the extent we believe such coverage is appropriate and cost efficient. We cannot ensure that any of our pending applications will be granted. In addition, third parties have in the past and could in the future bring infringement, invalidity, co-inventorship or similar claims with respect to any of our currently issued patents or any patents that may be issued to us in the future. Any such claims, whether or not successful, could be extremely costly to defend, divert management’s time and attention, damage our reputation and brands and substantially harm our business and results of operations.
Our primary brands are “Shutterfly,”“Tiny Prints,”“Wedding Paper Divas,”“BorrowLenses,” and “ThisLife.” We hold applications and/or registrations for
the Shutterfly, Tiny Prints, Wedding Paper Divas, BorrowLenses and ThisLife trademarks in our major markets of the United States and Canada as well as in the European Community. Our marks are critical components of our marketing programs. If we lose the ability to use these marks 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.
From time to time, third parties have adopted names similar to ours, have applied to register trademarks similar to ours, and we believe have infringed or misappropriated our intellectual property rights and impeded our ability to build brand identity and possibly leading to customer confusion. In addition, we have been and may continue to be subject to potential trade name or trademark infringement claims brought by owners of marks that
are similar to Shutterfly, Tiny Prints, Wedding Paper Divas, BorrowLenses, ThisLife or one of our other marks.
We respond on a case-by-case basis and where appropriate may send cease and desist letters or commence opposition actions and litigation. For example, in July 2013, we filed a complaint for damages and injunctive relief, which was settled in July 2014, alleging that Interactive Memories, Inc. (dba "Mixbook") infringed two of our patents. However, we cannot ensure that the steps we have taken to protect our intellectual property rights are adequate, that our intellectual property rights can be successfully defended and asserted in the future or that third parties will not infringe upon or misappropriate any such rights. In addition, our trademark rights and related registrations may be challenged in the future and could be canceled or narrowed. Failure to protect
our trademark rights could prevent us in the future from challenging third parties who use names and logos similar to our trademarks, which may in turn cause consumer confusion or negatively affect consumers' perception of our brands, products, and services. Any claims or consumer confusion related to our marks could damage our reputation and brands 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.
From time to time, we have received, and likely will continue to receive, communications from third parties inviting us to
license their patents or accusing us of infringement. There can be no assurance that a third party will not take further action, such as filing a patent infringement lawsuit, including a request for injunctive relief to bar the manufacture and sale of our products and services in the United States or elsewhere. We may also choose to defend ourselves by initiating litigation or administrative proceedings to clarify or seek a declaration of our rights. Additionally, from time to time, we have to defend against infringement of our intellectual property by bringing suit against other parties. As competition in our market grows, the possibility of patent infringement claims against us or litigation we will initiate increases.
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. 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.
Various governmental legal proceedings, investigations or audits may adversely affect our business and financial performance.
We may be subject to investigations or audits by governmental authorities and regulatory agencies, which can occur in the ordinary course of business or
which can result from increased scrutiny from a particular agency towards an industry, country or practice. For example, we are currently under audit by the Internal Revenue Service (IRS) for the tax year ended December 31, 2010. The resolution of such legal proceedings, investigations or audits could require us to pay substantial amounts of money or take actions that adversely affect our operations. In addition, defending against these claims may involve significant time and expense. Given the visibility of our brands, we may regularly be involved in legal proceedings, government investigations or audits that could adversely affect our business and financial performance.
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 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.
We collect sales and use taxes in jurisdictions where we have employees and/or property.
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.
Our effective tax rate may be subject to fluctuation
from federal and state audits, and stock-based compensation activity.
Tax audits by taxing agencies for 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.
Our effective tax rate is also subject to fluctuations under current stock option tax regulations as a result of stock-based compensation activity. This activity includes items such as shortfalls associated with the vesting of restricted stock units and restricted stock awards, disqualifying dispositions when employees exercise and sell their incentive stock options within a two year period, and cancellation of vested non-qualified stock options.
Government
regulation of the Internet and e-commerce is evolving, and unfavorable changes or failure by us to comply with these regulations could substantially harm our business and results of operations.
We are subject to general business regulations and laws as well as regulations and laws specifically governing the Internet and e-commerce. Existing and future laws and regulations may impede the growth of the Internet or other online services. These regulations and laws may cover taxation, restrictions on imports and exports, customs, tariffs, user privacy, data protection, pricing, content, copyrights, distribution, electronic contracts and other communications, consumer protection, the provision of online payment services, broadband residential Internet access and the characteristics and quality
of products and services. It is not clear how existing laws governing issues such as property use and ownership, sales and other taxes, fraud, 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 continue to be interpreted by the courts and their applicability and reach are therefore uncertain. For example:
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The
Digital Millennium Copyright Act (“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 (“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.
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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.
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The Credit Card Accountability, Responsibility and Disclosure Act (“CARD Act”) is intended to protect consumers from unfair credit card billing practices and adds new regulations on the use of gift cards, limiting
our ability to expire them. In addition, several states are also attempting to pass new laws regulating the use of gift cards and amending state escheatment laws to try and obtain unused gift card balances. For example, in April 2014, the State of Delaware brought a complaint against us and numerous other defendants in the Superior Court of the State of Delaware alleging that Shutterfly held $1,096,361 in unclaimed gift cards that was owed to the state of Delaware, a fact that we strenuously deny.
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The Restore Online Shoppers’ Confidence Act (“ROSCA”) prohibits and prevents Internet-based post-transaction third party sales and imposes specific requirements on negative option features.
The
costs of compliance with these regulations may increase in the future as a result of changes in the regulations or the interpretation of them. Further, any failures on our part to comply with these regulations may subject us to significant liabilities. Those current and future laws and regulations or unfavorable resolution of these issues may substantially harm our business and results of operations.
Legislation regarding copyright protection or content interdiction could impose complex and costly constraints on our business model.
Because of our focus on automation and high volumes, our operations do not involve, for the vast majority of our sales, any human-based review of content. Although our websites'
terms of use specifically require customers to represent that they have the right and authority to reproduce the content they provide and that the content is in full compliance with all relevant laws and regulations, we do not have the ability to determine the accuracy of these representations on a case-by-case basis. There is a risk that a customer may supply an image or other content that is the property of another party used without permission, that infringes the copyright or trademark of another party, or that would be considered to be defamatory, pornographic, hateful, racist, scandalous, obscene or otherwise offensive, objectionable or illegal under the laws or court decisions of the jurisdiction where that customer lives. There is, therefore, a risk that customers may intentionally or inadvertently order and receive products from us that are in violation of the rights of another party or a law or regulation of a particular jurisdiction. If we should become legally
obligated in the future to perform manual screening and review for all orders destined for a jurisdiction, we will encounter increased production costs or may cease accepting orders for shipment to that jurisdiction which could substantially harm our business and results of operations.
Our practice of offering free products and services could be subject to judicial or regulatory challenge.
We regularly offer free products 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 brands 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 brands 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. Our use of cloud-based services could also increase the risk of security breaches as cyber attacks on cloud environments are increasing to almost the same level as attacks on traditional information technology systems. For example, in 2014, we experienced a cyber-attack on our Tiny Prints, Treat and Wedding Paper Divas websites, which may have exposed the email addresses and encrypted passwords used by our customers to login to their accounts. We encrypt customer credit and debit card information, and we have no evidence that such information was compromised; however, any compromise of our security could damage our reputation and brands 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, contractors that we hire as well as other employees have access to confidential information, including credit card data. Although we take steps to limit this access, this data could be compromised by these contractors or other employee personnel. 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
and use of confidential information could damage our reputation and brands and substantially harm our business and results of operations.
The inability to acquire or maintain domain names for our brands could substantially harm our business and results of operations.
We currently are the registrant of the Internet domain name for Shutterfly.com, TinyPrints.com, WeddingPaperDivas.com, MyPublisher.com, BorrowLenses.com and Groovebook.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. Recently, regulatory bodies have approved expanded generic top-level domain names, which involves substantial costs and may lead to an increase in cybersquatting. 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, TinyPrints, WeddingPaperDivas, MyPublisher, BorrowLenses or Groovebook in all of the countries in which we currently or intend to conduct business. This could substantially harm our business and results of operations.
Changes
in regulations or user concerns regarding privacy and protection of user data could harm our business.
Federal, state and international laws and regulations govern the collection, use, sharing and security of data that we receive from our customers. In addition, we have and post on our websites 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 hope 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 established local or regional 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, acquiring or operating 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 our ability to adapt to the continued evolution 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 result in the loss of customers, as well as lower net revenues and/or increased expenses.
Purchasers
of digital photography products and services may not choose to shop or rent online, which would harm our net revenues and results of operations.
The online market for digital photography products and services, including photographic and video equipment rentals, 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 historically have 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 websites
and convert them into purchasing customers. Specific factors that could prevent prospective customers from purchasing from us include:
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the inability to physically handle and examine product samples;
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delivery time associated with Internet orders;
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concerns about
the security of online transactions and the privacy of personal information;
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delayed shipments or shipments of incorrect or damaged products; and
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inconvenience associated with returning or exchanging purchased items.
If purchasers of digital photography products and services do not choose to shop or rent 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 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.
The third party software systems that we utilize to assist us in the calculation and reporting of financial data may contain errors that we may not identify in a timely manner.
We
use numerous third party licensed software packages, most notably our equity software and our enterprise resource planning software, which are complex and fully integrated into our financial reporting. Such third party software may contain errors that
we may not identify in a timely manner. If those errors are not identified and addressed timely, our financial reporting may not be in compliance with generally accepted accounting principles.
If our internal controls are not effective, there may be errors in our financial information that could require a restatement or delay our SEC filings,
and investors may lose confidence in our reported financial information, which could lead to a decline in our stock price.
It is possible that we may discover significant deficiencies or material weaknesses in our internal control over financial reporting in the future. Any failure to maintain or implement required new or improved controls, or any difficulties we encounter in their implementation, could cause us to fail to meet our periodic reporting obligations, or result in material misstatements in our financial information. Any such delays or restatements could cause investors to lose confidence in our reported financial information and lead to a decline in our stock price.
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. In addition, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 contains various provisions applicable to the corporate governance functions of public companies. Additional or new regulatory requirements may be adopted in the future. The requirements of existing and potential future 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 Select 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.
Risks Related to Our Common Stock
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. In particular, the stock market as a whole recently has experienced extreme price and volume fluctuations that have affected the market price of many technology companies in ways that may have been unrelated to those companies’ operating performance. Factors that could cause our stock price to fluctuate include:
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slow economic growth, and market conditions or trends in our industry or the macro-economy as a whole;
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price and volume
fluctuations in the overall stock market;
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changes in operating performance and stock market valuations of other technology companies generally, or those in our industry in particular;
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the financial projections we may provide to the public, any changes in these projections or our failure to meet these projections;
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changes
in financial estimates by any securities analysts who follow our company, our failure to meet these estimates or failure of those analysts to initiate or maintain coverage of our stock;
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ratings downgrades by any securities analysts who follow our company;
the
public’s response to our press releases or other public announcements, including our filings with the SEC;
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announcements by us or our competitors of significant technical innovations, acquisitions, strategic partnerships, joint ventures or capital commitments;
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introduction of technologies or product enhancements that reduce the need for our products;
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the
loss of key personnel;
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lawsuits threatened or filed against us;
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business disruptions and costs related to shareholder activism;
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future sales of our common stock by our executive officers, directors and significant stockholders; and
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other
events or factors, including those resulting from war, incidents of terrorism or responses to these events.
Our restated certificate of incorporation and restated bylaws contain provisions that may make the acquisition of our company more difficult
without the approval of our board of directors, including the following:
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our board is classified into three classes of directors, each with staggered three-year terms;
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only our chairman, our chief executive officer, our president, or a majority of our board of directors is authorized to call a special meeting of stockholders;
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our
stockholders may take action only at a meeting of stockholders and not by written consent;
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vacancies on our board of directors may be filled only by our board of directors and not by stockholders;
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our certificate of incorporation authorizes undesignated preferred stock, the terms of which may be established and shares of which may be issued without stockholder approval; and
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advance
notice procedures apply for stockholders to nominate candidates for election as directors or to bring matters before an annual meeting of stockholders.
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.
Our stock repurchase program could affect the price of our common stock and increase volatility and may be suspended or terminated at any time, which may result in a decrease in the trading price of our common stock.
Through June 30, 2015, we have repurchased $140.0 million in stock under our total authorized amount of $406.0 million. The timing and actual number of shares we repurchase will depend
on a variety of factors including the timing of open trading windows, price, corporate and regulatory requirements, an assessment by management and our board of directors of cash availability and other market conditions. The stock repurchase program may be suspended or discontinued at any time without prior notice. Repurchases pursuant to our stock repurchase program could affect the price of our common stock and increase its volatility. The existence of our stock repurchase program could also cause the price of our common stock to be higher than it would be in the absence of such a program and could potentially reduce the market liquidity for our common stock. Additionally, repurchases under our stock repurchase program will diminish our cash reserves, which could impact our ability to further develop our technology, access and/or retrofit additional facilities and service our indebtedness. There can be no assurance that any stock repurchases will enhance stockholder
value because the market price of our common stock may decline below the levels at which we repurchased such shares. Any failure to repurchase shares after we have announced our intention to do so may negatively
impact our reputation and investor confidence in us and may negatively impact our stock price. Although our stock repurchase program is intended to enhance long-term stockholder value, short-term stock price fluctuations could reduce the program’s effectiveness.
We do not intend to pay dividends on our common stock for the foreseeable future.
We
have never declared or paid cash dividends on our common stock. In addition, we must comply with the covenants in our credit facilities if we want to pay cash dividends. We currently intend to retain our future earnings, if any, to finance the further development and expansion of our business and do not intend to pay cash dividends in the foreseeable future. Any future determination to pay dividends will be at the discretion of our board of directors and will depend upon our financial condition, results of operations, capital requirements, restrictions contained in current or future financing instruments and such other factors as our board of directors deems relevant.
Risks Related to Our 0.25% Senior Convertible Senior Notes Due in 2018 (the "Notes")
Although the notes are referred
to as convertible senior notes, they are effectively subordinated to any of our secured debt and any liabilities of our subsidiaries.
The notes will rank senior in right of payment to any of our indebtedness that is expressly subordinated in right of payment to the notes; equal in right of payment to any of our liabilities that are not so subordinated; effectively junior in right of payment to any of our secured indebtedness to the extent of the value of the assets securing such indebtedness; and structurally junior to all indebtedness and other liabilities (including trade payables) of our subsidiaries. In the event of our bankruptcy, liquidation, reorganization or other winding up, our assets that
secure debt ranking senior in right of payment to the notes will be available to pay obligations on the notes only after the secured debt has been repaid in full from these assets, and the assets of our subsidiaries will be available to pay obligations on the notes only after all claims senior to the notes (including any amounts drawn under our credit facility) have been repaid in full. There may not be sufficient assets remaining to pay amounts due on any or all of the notes then outstanding. The indenture governing the notes does not prohibit us from incurring additional senior debt or secured debt, nor does it prohibit any of our subsidiaries from incurring additional liabilities.
Recent
and future regulatory actions and other events may adversely affect the trading price and liquidity of the notes.
We expect that many investors in, and potential purchasers of, the notes will employ, or seek to employ, a convertible arbitrage strategy with respect to the notes. Investors would typically implement such a strategy by selling short the common stock underlying the notes and dynamically adjusting their short position while continuing to hold the notes. Investors may also implement this type of strategy by entering into swaps on our common stock in lieu of or in addition to short selling the common stock. The Securities and Exchange Commission ("SEC") and other regulatory and self-regulatory authorities have implemented various rules and taken certain actions, and may in the future adopt additional rules and take other actions, that may impact those engaging
in short selling activity involving equity securities (including our common stock). Such rules and actions include Rule 201 of SEC Regulation SHO, the adoption by the Financial Industry Regulatory Authority, Inc. and the national securities exchanges of a “Limit Up-Limit Down” program, the imposition of market-wide circuit breakers that halt trading of securities for certain periods following specific market declines, and the implementation of certain regulatory reforms required by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Any governmental or regulatory action that restricts the ability of investors in, or potential purchasers of, the notes to effect short sales of our common stock or enter into swaps on our common stock could adversely affect the trading price and the liquidity of the notes.
In addition, if investors and potential purchasers
seeking to employ a convertible arbitrage strategy are unable to borrow or enter into swaps on our common stock, in each case on commercially reasonable terms, the trading price and liquidity of the notes may be adversely affected.
Volatility in the market price and trading volume of our common stock could adversely impact the trading price of the notes.
The stock market in recent years has experienced significant price and volume fluctuations that have often been unrelated to the operating performance of companies. The market price of our common stock could fluctuate significantly for many reasons, including in response to the risks described in this section, or for reasons unrelated to our operations, such as reports by industry analysts, investor perceptions or negative announcements
by our customers, competitors or suppliers regarding their own performance, as well as industry conditions and general financial, economic and political instability. A decrease in the market price of our common stock would likely adversely impact the trading price of the notes. The price of our common stock could also be affected by possible sales of our common stock by investors who view the notes as a more attractive means of equity participation
in us and by hedging or arbitrage trading activity that we expect to develop involving our common stock. This trading activity could, in turn, affect the trading prices of the notes.
We
may still incur substantially more debt or take other actions which would intensify the risks discussed above.
We and our subsidiaries may be able to incur substantial additional debt in the future, subject to the restrictions contained in our debt instruments, some of which may be secured debt. We will not be restricted under the terms of the indenture governing the notes from incurring additional debt, securing existing or future debt, recapitalizing our debt or taking a number of other actions that are not limited by the terms of the indenture governing the notes that could have the effect of diminishing our
ability to make payments on the notes when due. Our existing credit facility restricts our ability to incur additional indebtedness, including secured indebtedness, but if the facility matures or is repaid, we may not be subject to such restrictions under the terms of any subsequent indebtedness.
We may not have the ability to raise the funds necessary to settle conversions of our notes in cash or to repurchase the notes upon a fundamental change, and our current debt contains, and our future debt may contain, limitations on our ability to pay cash on conversion or repurchase the notes.
Holders of the notes have the right to require us to repurchase their notes upon the occurrence of a fundamental change at a repurchase price equal to 100% of their principal amount, plus accrued and unpaid
interest, if any. In addition, upon conversion of the notes, unless we elect to deliver solely shares of our common stock to settle such conversion (other than paying cash in lieu of delivering any fractional share), we will be required to make cash payments in respect of the notes being converted. However, we may not have enough available cash or be able to obtain financing at the time we are required to make repurchases of notes surrendered therefor or notes being converted.
In addition, our ability to repurchase the notes and settle conversions in cash is limited by our credit facility and may be limited by law, by regulatory authority or by agreements governing our future indebtedness. Our failure to repurchase notes at a time when the repurchase is required by the indenture would constitute
a default under the indenture. A default under the indenture or the fundamental change itself could also lead to a default under the credit facility agreements governing our future indebtedness. Moreover, the occurrence of a fundamental change under the indenture would constitute an event of default under our credit facility. If the payment of the related indebtedness were to be accelerated after any applicable notice or grace periods, we may not have sufficient funds to repay the indebtedness and repurchase the notes or to pay cash upon conversion of the notes.
The conditional conversion feature of the notes,
if triggered, may adversely affect our financial condition and operating results.
In the event the conditional conversion feature of the notes is triggered, holders of notes will be entitled to convert the notes at any time during specified periods at their option. If one or more holders elect to convert their notes, unless we elect to satisfy our conversion obligation by delivering solely shares of our common stock (other than paying cash in lieu of delivering any fractional share), we would be required to settle a portion or all of our conversion obligation in cash, which could adversely affect our liquidity. In addition, even if holders do not elect to convert their notes, we could be required under applicable accounting rules to reclassify all or a portion of the outstanding principal of the notes as a current rather than long-term liability, which would result in a material
reduction of our net working capital.
The accounting method for convertible debt securities that may be settled in cash, such as the notes, could have a material effect on our reported financial results.
In May 2008, the Financial Accounting Standards Board, which we refer to as FASB, issued FASB Staff Position No. APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash Upon Conversion (Including Partial Cash Settlement), which has subsequently been codified as Accounting Standards Codification 470-20, Debt with Conversion and Other Options, which we refer to as ASC 470-20. Under ASC 470-20, an entity must separately account for the liability and equity components of the convertible debt instruments (such as the notes) that may be settled entirely or partially
in cash upon conversion in a manner that reflects the issuer's economic interest cost. The effect of ASC 470-20 on the accounting for the notes is that the equity component is required to be included in the additional paid-in capital section of stockholders' equity on our consolidated balance sheet and the value of the equity component would be treated as original issue discount for purposes of accounting for the debt component of the notes. As a result, we will be required to record a greater amount of non-cash interest expense in current periods presented as a result of the amortization of the discounted carrying value of the notes to their face amount over the term of the notes. We will report lower net income in our financial results because ASC 470-20 will require interest to include both the current period's amortization of the debt discount and the instrument's coupon interest, which could adversely affect our reported or future financial results, the trading
price of our common stock and the trading price of the notes. In addition, under certain circumstances, convertible debt instruments (such as the notes) that may be settled entirely or partly in cash are currently accounted
for utilizing the treasury stock method, the effect of which is that any shares issuable upon conversion of the notes are not included in the calculation of diluted earnings per share except to the extent that the conversion value of the notes exceeds their principal amount. Under the treasury stock method, for diluted earnings per share purposes, the transaction is accounted for as if the number of shares of common stock that would be necessary to settle
such excess, if we elected to settle such excess in shares, are issued. We cannot be sure that the accounting standards in the future will continue to permit the use of the treasury stock method. If we are unable to use the treasury stock method in accounting for the shares issuable upon conversion of the notes, then our diluted earnings per share would be adversely affected.
Future sales of our common stock in the public market could lower the market price for our common stock and adversely impact the trading price of the notes.
In the future, we may sell additional shares of our common stock to raise capital. In addition, a substantial number of shares of our common stock is reserved for issuance upon the exercise of stock options, the vesting of restricted stock units and other equity
awards pursuant to our employee benefit plans, upon conversion of the notes, and in relation to the convertible note hedge and warrant transactions entered into in connection with the pricing of the notes. We cannot predict the size of future issuances or the effect, if any, that they may have on the market price for our common stock. The issuance and sale of substantial amounts of common stock, or the perception that such issuances and sales may occur, could adversely affect the trading price of the notes and the market price of our common stock and impair our ability to raise capital through the sale of additional equity securities.
Repurchases by us of our common stock may affect the value of the notes and our common stock.
We used $30.0 million of the net proceeds from the notes offering
to repurchase shares of our common stock from purchasers of notes in the offering in privately negotiated transactions effected through Morgan Stanley & Co. LLC as our agent. We may from time to time repurchase additional shares of our common stock pursuant to our stock repurchase program. These repurchases could increase, or prevent a decrease in, the market price of our common stock or the notes.
Holders of notes will not be entitled to any rights with respect to our common stock, but they will be subject to all changes made with respect to them to the extent our conversion obligation includes shares of our common stock.
Holders of notes will not be entitled to any rights with respect to our common stock (including, without limitation, voting rights and rights to receive any dividends
or other distributions on our common stock) prior to the conversion date relating to such notes (if we elect to settle the relevant conversion by delivering solely shares of our common stock (other than paying cash in lieu of delivering any fractional share)) or the last trading day of the relevant observation period (if we elect to pay and deliver, as the case may be, a combination of cash and shares of our common stock in respect of the relevant conversion), but holders of notes will be subject to all changes affecting our common stock. For example, if an amendment is proposed to our certificate of incorporation or bylaws requiring stockholder approval and the record date for determining the stockholders of record entitled to vote on the amendment occurs prior to the conversion date related
to a holder's conversion of its notes (if we have elected to settle the relevant conversion by delivering solely shares of our common stock (other than paying cash in lieu of delivering any fractional share)) or the last trading day of the relevant observation period (if we elect to pay and deliver, as the case may be, a combination of cash and shares of our common stock in respect of the relevant conversion), such holder will not be entitled to vote on the amendment, although such holder will nevertheless be subject to any changes affecting our common stock.
The conditional conversion feature of the notes could result in holders receiving less than the value of our common stock into which the notes would otherwise be convertible.
Holders of notes may convert their notes only if specified
conditions are met. If the specific conditions for conversion are not met, holders will not be able to convert their notes, and may not be able to receive the value of the cash, common stock or a combination of cash and common stock, as applicable, into which the notes would otherwise be convertible.
Upon conversion of the notes, holders may receive less valuable consideration than expected because the value of our common stock may decline after holders exercise their conversion rights but before we settle our conversion obligation.
Under the notes, a converting holder will be exposed to fluctuations in the value of our common stock during the period from the date such holder surrenders notes for conversion until the date we settle our conversion obligation. Upon conversion of the notes,
we have the option to pay or deliver, as the case may be, cash, shares of our common stock, or a combination of cash and shares of our common stock. If we elect to satisfy our conversion obligation in cash or a combination of cash and shares of our common stock, the amount of consideration that holders will receive upon conversion of their notes will be determined by reference to the volume weighted average prices of our common stock for each trading day in a 30 trading-day observation period. Accordingly, if the price of our common stock decreases during such observation period, the amount and/or value of consideration holders
receive will be adversely affected. In addition,
if the market price of our common stock at the end of such period is below the average of the volume weighted average price of our common stock during such period, the value of any shares of our common stock that holders will receive in satisfaction of our conversion obligation will be less than the value used to determine the number of shares that holders will receive.
If we elect to satisfy our conversion obligation solely in shares of our common stock upon conversion of the notes, we will be required to deliver the shares of our common stock, together with cash for any fractional share, three business days after the relevant conversion date. Accordingly, if the price of our common stock decreases during this period, the value of the shares that holders receive will be adversely affected and would be less than the conversion value of the notes on the conversion date.
The
notes are not protected by restrictive covenants.
The indenture governing the notes does not contain any financial or operating covenants or restrictions on the payments of dividends, the incurrence of indebtedness or the issuance or repurchase of securities by us or any of our subsidiaries. The indenture contains no covenants or other provisions to afford protection to holders of the notes in the event of a fundamental change or other corporate transaction involving us except under limited circumstances.
The increase
in the conversion rate for notes converted in connection with a make-whole fundamental change may not adequately compensate holders for any lost value of their notes as a result of such transaction.
If a make-whole fundamental change occurs prior to the maturity date, under certain circumstances, we will increase the conversion rate by a number of additional shares of our common stock for notes converted in connection with such make-whole fundamental change. The increase in the conversion rate will be determined based on the date on which the specified corporate transaction becomes effective and the price paid (or deemed to be paid) per share of our common stock in such transaction. The increase in the conversion rate for notes converted in connection with a make-whole fundamental change may not adequately compensate holders for any lost value of their notes as a result of such
transaction. Our obligation to increase the conversion rate for notes converted in connection with a make-whole fundamental change could be considered a penalty, in which case the enforceability thereof would be subject to general principles of reasonableness and equitable remedies.
The conversion rate of the notes may not be adjusted for all dilutive events.
The conversion rate of the notes is subject to adjustment for certain events, including, but not limited to, the issuance of certain stock dividends on our common stock, the issuance of certain rights or warrants, subdivisions, combinations, distributions of capital stock, indebtedness, or assets, cash dividends and certain issuer tender or exchange offers. However, the conversion rate will not be adjusted for other events, such
as a third-party tender or exchange offer or an issuance of common stock for cash that may adversely affect the trading price of the notes or our common stock. An event that adversely affects the value of the notes may occur, and that event may not result in an adjustment to the conversion rate.
Provisions in the indenture for the notes may deter or prevent a business combination that may be favorable to holders of the notes.
If a fundamental change occurs prior to the maturity date of the notes, holders of the notes will have the right, at their option, to require us to repurchase all or a portion of their notes. In addition, if a make-whole fundamental change occurs prior to the maturity date
of the notes, we will in some cases be required to increase the conversion rate for a holder that elects to convert its notes in connection with such fundamental change. Furthermore, the indenture for the notes prohibits us from engaging in certain mergers or acquisitions unless, among other things, the surviving entity assumes our obligations under the notes. These and other provisions in the indenture could deter or prevent a third party from acquiring us even when the acquisition may be favorable to holders of the notes.
Some significant restructuring transactions may not constitute a fundamental change, in which case we would not be obligated to offer to repurchase the notes.
Upon
the occurrence of a fundamental change, holders have the right to require us to repurchase their notes. However, the fundamental change provisions will not afford protection to holders of notes in the event of other transactions that could adversely affect the notes. For example, transactions such as leveraged recapitalizations, refinancings, restructurings, or acquisitions initiated by us may not constitute a fundamental change requiring us to repurchase the notes. In the event of any such transaction, the holders would not have the right to require us to repurchase the notes, even though each of these transactions could increase the amount of our indebtedness, or otherwise adversely affect our capital structure or any credit ratings, thereby adversely affecting the holders of notes.
We have not registered the notes or the common stock issuable upon conversion, if any, which will limit holders' ability to resell them.
The notes and the shares of common stock issuable upon conversion of the notes, if any, have not been registered under the Securities Act of 1933, as amended, or the Securities Act, or any state securities laws. Unless the notes and any shares of common stock issuable upon conversion of the notes have been registered, they may not be transferred or resold except in a transaction exempt from or not subject to the registration requirements of the Securities Act and applicable state securities laws. We do not intend to file a registration statement for the resale of the notes and the common stock, if any, into which the notes are
convertible.
An active trading market may not develop for the notes.
Prior to our issuance of the notes, there had been no trading market for the notes. We do not intend to apply to list the notes on any securities exchange or to arrange for quotation on any automated dealer quotation system. The liquidity of the trading market in the notes, and the market price quoted for the notes, may be adversely affected by changes in the overall market for this type of security and by changes in our financial performance or prospects or in the prospects for companies in our industry generally. As a result, we cannot assure holders that an active trading market will develop for the notes. If an active trading market does not develop or is not maintained, the market price and liquidity of the notes
may be adversely affected. In that case holders may not be able to sell their notes at a particular time or holders may not be able to sell their notes at a favorable price.
Any adverse rating of the notes may cause their trading price to fall.
We do not intend to seek a rating on the notes. However, if a rating service were to rate the notes and if such rating service were to lower its rating on the notes below the rating initially assigned to the notes or otherwise announces its intention to put the notes on credit watch, the trading price of the notes could decline.
Holders of the notes may be subject to tax if we make or fail to make certain adjustments to the conversion
rate of the notes even though such holders do not receive a corresponding cash distribution.
The conversion rate of the notes will be adjusted in certain circumstances. Under Section 305(c) of the Internal Revenue Code of 1986, or the Code, adjustments (or failures to make adjustments) that have the effect of increasing the holders' proportionate interest in our assets or earnings may in some circumstances result in a deemed distribution to the holders. Certain of the conversion rate adjustments with respect to the notes (including, without limitation, adjustments in respect of taxable dividends to holders of our common stock) will result in deemed distributions to the holders of notes even though they have not received any cash or property as a result of such adjustments. In addition, an adjustment to the conversion rate in connection with a make-whole fundamental change may
be treated as a deemed distribution. Any deemed distributions will be taxable as a dividend, return of capital, or capital gain. If holders are a “non-U.S. holder” under the Code any deemed dividend may be subject to U.S. withholding tax at a 30% rate or such lower rate as may be specified by an applicable tax treaty, which may be set off against subsequent payments on the notes (or in certain circumstances, on the common stock). Under proposed regulations relating to certain “dividend equivalent” payments, an adjustment to the conversion rate of the notes as a result of a dividend on our common stock may be subject to withholding tax at a different time or in a different amount than the withholding tax otherwise imposed on dividends and constructive dividends.
The convertible note hedge and warrant transactions may affect the value of the notes and our common
stock.
In connection with the pricing of the notes, we entered into convertible note hedge transactions with Morgan Stanley & Co. International plc, Credit Suisse International, Citibank, N.A., and Bank of America, N.A., or the option counterparties. We also entered into warrant transactions with the option counterparties pursuant to which we will sell warrants for the purchase of our common stock. The convertible note hedge transactions are expected generally to reduce the potential dilution upon any conversion of notes and/or offset any cash payments we are required to make in excess of the principal amount upon conversion of the notes. The warrant transactions could separately have a dilutive effect to the extent that the market price per share of our common stock exceeds the strike price of the warrants. However, subject to certain conditions, we may elect to settle the
warrant transactions in cash.
The option counterparties and/or their respective affiliates may modify their hedge positions by entering into or unwinding various derivatives with respect to our common stock and/or purchasing or selling our common stock in secondary market transactions following the pricing of the notes and prior to the maturity of the notes (and are likely to do so during any observation period related to a conversion of notes or following any repurchase of notes by us on any fundamental change repurchase date or otherwise). This activity could also cause or avoid an increase or a decrease in the market price of our common stock or the notes,
which could affect holders' ability to convert the notes and, to the extent the activity occurs during any observation period related to a conversion of notes, it could affect the amount and value of the consideration that holders will receive upon conversion of the notes.
In addition, if any such convertible note hedge and warrant transactions fail to become effective, the option counterparties may unwind their hedge positions with respect to our common stock, which could adversely affect the value of our common stock and the value of the notes. The potential effect, if any, of these transactions and activities on the market price of our common stock or the notes will depend in part on market conditions and cannot be ascertained at this time. Any of these activities could adversely affect the value of our
common stock and the value of the notes (and as a result, the value of the consideration, the amount of cash and/or the number of shares, if any, that holders would receive upon the conversion of the notes) and, under certain circumstances, holders' ability to convert the notes. The convertible note hedge transactions and the warrant transactions are separate transactions (in each case entered into between us and the option counterparties), are not part of the terms of the notes and will not affect the holders' rights under the notes. Holders of the notes will not have any rights with respect to the convertible note hedge transactions or the warrant transactions.
We do not make any representation or prediction as to the direction or magnitude of any potential effect that the transactions described above may have on the price of the notes or our common stock. In addition, we do
not make any representation that the option counterparties will engage in these transactions or that these transactions, once commenced, will not be discontinued without notice.
We are subject to counterparty risk with respect to the convertible note hedge transactions.
The option counterparties are financial institutions, and we will be subject to the risk that any or all of them might default under the convertible note hedge transactions. Our exposure to the credit risk of the option counterparties will not be secured by any collateral. Recent global economic conditions have resulted in the actual or perceived failure or financial difficulties of many financial institutions. If an option counterparty becomes subject to insolvency proceedings, we will become an unsecured creditor in
those proceedings, with a claim equal to our exposure at that time under our transactions with that option counterparty. Our exposure will depend on many factors but, generally, an increase in our exposure will be correlated to an increase in the market price and in the volatility of our common stock. In addition, upon a default by an option counterparty, we may suffer adverse tax consequences and more dilution than we currently anticipate with respect to our common stock. We can provide no assurances as to the financial stability or viability of the option counterparties.
(1)
All shares were purchased pursuant to the publicly announced share repurchase program described in footnote 2 below. Shares are reported in a period based on the settlement date of the applicable repurchase.
(2) On November 1, 2012, we announced a share repurchase program authorized by our Board of Directors and approved by our Audit Committee to repurchase up to $60 million of our common stock. On February 6, 2014, our Board of Directors approved an increase to the share repurchase program to allow for repurchases of up to an additional $100 million of shares in addition to any amounts repurchased as of the approval date. On February 9, 2015, our Board of Directors approved an increase to the share repurchase program to allow for
repurchases of up to an additional $300 million of shares in addition to any amounts repurchased as of the approval date.
Shutterfly,
Inc. 2015 CEO Compensation Plan (as amended May 22, 2015)*
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).**
101
The following materials from the Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2015, formatted in XBRL (Extensible Business Reporting Language): (i) Condensed Consolidated Balance Sheets, (ii) Condensed Consolidated Statements of Operations, (iii) Condensed Consolidated Statements of Comprehensive Income/(Loss), (iv) Condensed Consolidated Statements of Cash Flows, and (v) Notes to Condensed Consolidated Financial Statements, tagged at Level I through IV.
*
Represents
a management contract or compensatory plan
**
This certification is not deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, 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. 2015 CEO Compensation Plan (as amended May 22, 2015)*
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).**
101
The following materials from the Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2015, formatted in XBRL (Extensible Business Reporting Language): (i) Condensed Consolidated Balance Sheets, (ii) Condensed Consolidated Statements of Operations, (iii) Condensed Consolidated Statements of Comprehensive Income/(Loss), (iv) Condensed Consolidated Statements of Cash Flows, and (v) Notes to Condensed Consolidated Financial Statements, tagged at Level I through IV.
*
Represents
a management contract or compensatory plan
**
This certification is not deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, 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.
65
Dates Referenced Herein and Documents Incorporated by Reference
