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EX-32.02 - EXHIBIT 32.02 - SHUTTERFLY INCex32_02q2-16.htm
EX-32.01 - EXHIBIT 32.01 - SHUTTERFLY INCex32_01q2-16.htm
EX-31.02 - EXHIBIT 31.02 - SHUTTERFLY INCex31_02q2-16.htm
EX-31.01 - EXHIBIT 31.01 - SHUTTERFLY INCex31_01q2-16.htm
EX-10.05 - EXHIBIT 10.05 - SHUTTERFLY INCex10_05q2-16.htm
EX-10.04 - EXHIBIT 10.04 - SHUTTERFLY INCex10_04q2-16.htm
EX-10.03 - EXHIBIT 10.03 - SHUTTERFLY INCex10_03q2-16.htm
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
Form 10-Q
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2016
 
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from            to
Commission file number 001-33031

SHUTTERFLY, INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware
 
94-3330068
( State or Other Jurisdiction of Incorporation or Organization)
 
(IRS Employer Identification No.)

2800 Bridge Parkway
Redwood City, California
 
94065
(Address of Principal Executive Offices)
 
(Zip Code)

Registrant’s Telephone Number, Including Area Code
(650) 610-5200

Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes   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.
Class
 
Outstanding as at August 1, 2016
Common stock, $0.0001 par value per share
 
33,978,911
 

1


TABLE OF CONTENTS

 
Page
Number
Part I - Financial Information
 

 

3








Part II - Other Information
 
















2


PART IFINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Item 1. Condensed Consolidated Financial Statements

SHUTTERFLY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value amounts)
(Unaudited)
 
 
June 30, 2016
 
December 31, 2015
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
99,249

 
$
288,863

Short-term investments
31,564

 
22,918

Accounts receivable, net
28,946

 
55,222

Inventories
11,515

 
13,466

Prepaid expenses and other current assets
67,595

 
31,828

Total current assets
238,869

 
412,297

Long-term investments
18,504

 
29,005

Property and equipment, net
267,846

 
281,779

Intangible assets, net
51,763

 
62,323

Goodwill
408,975

 
408,975

Other assets
12,838

 
10,948

Total assets
$
998,795

 
$
1,205,327

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
11,642

 
$
35,329

Accrued liabilities
71,522

 
149,134

Deferred revenue, current portion
25,243

 
27,329

Total current liabilities
108,407

 
211,792

Convertible senior notes, net
271,476

 
264,361

Other liabilities
110,078

 
123,112

Total liabilities
489,961

 
599,265

Commitments and contingencies (Note 10)

 

Stockholders’ equity:
 
 
 
Common stock, $0.0001 par value; 100,000 shares authorized; 33,950 and 34,777 shares issued and outstanding on June 30, 2016 and December 31, 2015, respectively
3

 
4

Additional paid-in capital
926,956

 
900,218

Accumulated other comprehensive income (loss)
60

 
(68
)
Accumulated deficit
(418,185
)
 
(294,092
)
Total stockholders' equity
508,834

 
606,062

Total liabilities and stockholders' equity
$
998,795

 
$
1,205,327

 
The accompanying notes are an integral part of these condensed consolidated financial statements.

3


SHUTTERFLY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)


Three Months Ended

Six Months Ended

June 30,

June 30,
 
2016
 
2015

2016

2015
Net revenues
$
203,961

 
$
183,879


$
385,670


$
343,857

Cost of net revenues
109,592

 
96,647


218,315


191,354

Gross profit
94,369

 
87,232


167,355


152,503

Operating expenses:
 
 
 

 
 

 
 

Technology and development
41,313

 
36,502


79,582


73,862

Sales and marketing
47,539

 
50,446


93,381


94,976

General and administrative
26,592

 
28,676


57,281


58,281

Total operating expenses
115,444

 
115,624


230,244


227,119

Loss from operations
(21,075
)
 
(28,392
)

(62,889
)

(74,616
)
Interest expense
(5,661
)
 
(4,985
)

(11,336
)

(9,721
)
Interest and other income, net
128

 
120


249


222

Loss before income taxes
(26,608
)
 
(33,257
)

(73,976
)

(84,115
)
Benefit from income taxes
10,123

 
9,480


28,055


15,235

Net loss
$
(16,485
)
 
$
(23,777
)

$
(45,921
)

$
(68,880
)
 
 
 
 
 
 
 
 
Net loss per share - basic and diluted
$
(0.48
)
 
$
(0.63
)

$
(1.34
)

$
(1.82
)
 
 
 
 
 
 
 
 
Weighted-average shares outstanding - basic and diluted
34,177

 
37,537


34,386


37,753

 
 
 
 
 
 
 
 
Stock-based compensation is allocated as follows (Note 2):
 
 
 
 
 
 
 
Cost of net revenues
$
1,081

 
$
1,001


$
2,305


$
2,193

Technology and development
2,512

 
3,309


2,971


5,301

Sales and marketing
3,754

 
5,654


8,033


11,873

General and administrative
3,577

 
6,351


7,765


14,708


The accompanying notes are an integral part of these condensed consolidated financial statements.

4


SHUTTERFLY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME/(LOSS)
(In thousands)
(Unaudited)
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2016
 
2015
 
2016
 
2015
Net loss
$
(16,485
)
 
$
(23,777
)
 
$
(45,921
)
 
$
(68,880
)
Other comprehensive loss, net of reclassification adjustments:

 

 

 

Unrealized gains (losses) on investments, net
31

 
(23
)
 
208

 
103

Tax benefit (expense) on unrealized gain on investments, net
(11
)
 
9

 
(80
)
 
(39
)
Other comprehensive (income) loss, net of tax
20

 
(14
)
 
128

 
64

Comprehensive loss
$
(16,465
)
 
$
(23,791
)
 
$
(45,793
)
 
$
(68,816
)

The accompanying notes are an integral part of these condensed consolidated financial statements.


5


SHUTTERFLY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
Six Months Ended
 
June 30,
 
2016
 
2015
Cash flows from operating activities:
 
 
 
Net loss
$
(45,921
)
 
$
(68,880
)
Adjustments to reconcile net loss to net cash used in operating activities:
 

 
 

Depreciation and amortization
46,278

 
40,881

Amortization of intangible assets
11,193

 
14,419

Amortization of debt discount and transaction costs
7,115

 
6,728

Stock-based compensation
21,074

 
34,075

Loss on disposal of property and equipment
324

 
498

Deferred income taxes
(3,567
)
 
(6,623
)
Tax benefit from stock-based compensation
4,021

 
13,986

Excess tax benefits from stock-based compensation
(5,233
)
 
(14,372
)
Changes in operating assets and liabilities:
 

 
 

Accounts receivable
26,277

 
6,962

Inventories
1,951

 
2,552

Prepaid expenses and other assets
(34,045
)
 
(20,563
)
Accounts payable
(18,970
)
 
(17,753
)
Accrued and other liabilities
(77,504
)
 
(77,470
)
Net cash used in operating activities
(67,007
)
 
(85,560
)
Cash flows from investing activities:
 

 
 

Purchases of property and equipment
(33,067
)
 
(28,935
)
Capitalization of software and website development costs
(18,083
)
 
(9,297
)
Purchases of investments
(15,936
)
 
(4,400
)
Proceeds from the maturities of investments
17,890

 
32,358

Proceeds from sale of property and equipment
10,247

 
265

Net cash used in investing activities
(38,949
)
 
(10,009
)
Cash flows from financing activities:
 

 
 

Proceeds from issuance of common stock upon exercise of stock options
685

 
2,312

Repurchases of common stock
(78,172
)
 
(87,757
)
Prepayment of accelerated share repurchase

 
(75,000
)
Excess tax benefits from stock-based compensation
5,233

 
14,372

Principal payments of capital lease and financing obligations
(11,404
)
 
(5,347
)
Net cash used in financing activities
(83,658
)
 
(151,420
)
Net decrease in cash and cash equivalents
(189,614
)
 
(246,989
)
Cash and cash equivalents, beginning of period
288,863

 
380,543

Cash and cash equivalents, end of period
$
99,249

 
$
133,554

 
 
 
 
Supplemental schedule of non-cash investing / financing activities:
 
 
 

Net increase in receivable proceeds from the sale of property and equipment
$
3,765

 
$

Net increase (decrease) in accrued purchases of property and equipment
(5,565
)
 
2,242

Net increase in accrued capitalized software and website development costs
137

 
161

Stock-based compensation capitalized with software and website development costs
959

 
673

Increase in estimated fair market value of buildings under build-to-suit leases

 
16,414

Property and equipment acquired under capital leases

 
21,640

The accompanying notes are an integral part of these condensed consolidated financial statements.

6


SHUTTERFLY, INC.
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 provides Enterprise services: printing and shipping of direct marketing and other variable data print products and formats. The Company's Enterprise brand is called Shutterfly Business Solutions ("SBS") and is referred to as such in this document. 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, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016, or for any other period.

The December 31, 2015 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, 2015 included in the Company’s Annual Report on Form 10-K.

Recent Accounting Pronouncements

In April 2015, the FASB issued new guidance related to presentation of debt issuance 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 Company adopted this guidance beginning January 1, 2016. This guidance requires retrospective application to all prior periods presented. The effect of this change was to reduce the previously reported amounts within the accompanying condensed consolidated balance sheets as of December 31, 2015 for prepaid expenses and other current assets, other assets, and convertible senior notes, net by $1.3 million, $1.9 million, and $3.3 million, respectively. Adoption of this guidance did not affect the Company's condensed consolidated statements of operations and condensed consolidated statements of cash flows.
    
In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting (ASU 2016-09). The updated guidance changes how companies account for certain aspects of share-based payment awards to employees, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. The amendments in this update are effective for reporting periods beginning after December 15, 2016. Early adoption is permitted. The Company is currently evaluating the financial statement and disclosure impact of the pronouncement and has not early adopted.

In 2014, the FASB issued new accounting guidance related to revenue recognition. This new standard will replace all current GAAP guidance on this topic and eliminate all industry-specific guidance. The new revenue recognition guidance 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 can be applied either retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption. In 2015, the FASB issued guidance to defer the effective date to fiscal years beginning after December 15, 2017 with early adoption for fiscal years. In 2016, the FASB issued additional guidance to clarify the implementation guidance. The Company is evaluating the impact, if any, of adopting this new accounting guidance on its financial statements.
    

7

SHUTTERFLY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The new guidance requires the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous guidance. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. 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 six months ended June 30, 2016 is as follows (share numbers and aggregate intrinsic values in thousands):
 
Number of
Options
Outstanding
 
Weighted
Average
Exercise
Price
 
Weighted
Average
Contractual
Term (Years)
 
Aggregate
Intrinsic
Value
Balance as of December 31, 2015
206

 
$
27.08

 
 
 
 
Granted
850

 
48.30

 
 
 
 
Exercised
(31
)
 
21.56

 
 
 
 
Forfeited, cancelled or expired
(2
)
 
23.34

 
 
 
 
Balance as of June 30, 2016
1,023

 
$
44.90

 
6.3
 
$
3,398

Options vested and expected to vest at June 30, 2016
818

 
$
44.05

 
6.1
 
$
3,397

Options vested at June 30, 2016
170

 
$
28.12

 
3.1
 
$
3,358

 
During the six months ended June 30, 2016, the Company granted options to the Chief Executive Officer to purchase an aggregate of 850,000 shares of common stock at a exercise price of $48.30, with an estimated weighted-average grant-date fair value of $13.50. The total intrinsic value of options exercised during the three months ended June 30, 2016 and 2015 was $0.3 million and $1.3 million, respectively. The total intrinsic value of options exercised during the six months ended June 30, 2016 and 2015 was $0.7 million and $2.9 million, respectively.

Net cash proceeds from the exercise of stock options were $0.2 million and $1.1 million, respectively, for the three months ended June 30, 2016 and 2015. Net cash proceeds from the exercise of stock options were $0.7 million and $2.3 million, respectively for the six months ended June 30, 2016 and 2015.

Valuation of Stock Options

The Company estimated the fair value of each option award on the date of grant using the Black-Scholes option-pricing model and the assumptions noted in the following table. The Company calculated volatility using an average of its historical and implied volatilities as it had sufficient public trading history to cover the entire expected term. The expected term of options gave consideration to historical exercises, post vest cancellations and the options contractual term. The risk-free rate for the expected term of the option is based on the U.S. Treasury Constant Maturity at the time of grant. The assumptions used to value options granted during the three and six months ended June 30, 2016 and 2015 are as follows:

 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2016
 
2015
 
2016
 
2015
Dividend yield

 

 

 

Annual risk free rate of return
1.2
%
 

 
1.2
%
 

Expected volatility
32.9
%
 

 
32.9
%
 

Expected term (years)
4.1

 
0

 
4.1

 
0



8

SHUTTERFLY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


Restricted Stock Unit Activity

The Company grants restricted stock units (“RSUs”) to its employees under the provisions of the 2015 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 four year total vesting term. Compensation cost associated with RSUs is amortized on a straight-line basis over the requisite service period.

A summary of the Company’s RSU activity for the six months ended June 30, 2016, is as follows (share numbers in thousands):
 
Number of
Units
Outstanding
 
Weighted
Average
Grant Date
Fair Value
Awarded and unvested as of December 31, 2015
3,150

 
$
44.28

Granted
1,163

 
41.00

Vested
(938
)
 
43.69

Forfeited
(208
)
 
45.54

Awarded and unvested as of June 30, 2016
3,167

 
$
43.17

RSUs expected to vest after June 30, 2016
2,520

 
 
 
Included in the RSU grants for the six months ended June 30, 2016, are 185,000 performance-based RSUs ("PBRSUs") that have both performance criteria tied to the Company’s 2016 financial performance and four year service criteria. 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, 2016 and 2015, 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, 2016, the Company had $99.2 million of total unrecognized stock-based 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 RSUs 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 three and six months ended June 30, 2016 and 2015 is as follows (in thousands, except per share amounts):

9

SHUTTERFLY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2016
 
2015
 
2016
 
2015
Net loss per share:
 
 
 
 
 
 
 
Numerator
 
 
 
 
 
 
 
Net loss
$
(16,485
)
 
$
(23,777
)
 
$
(45,921
)
 
$
(68,880
)
Denominator for basic and diluted net loss per share
 

 
 
 
 

 
 

Weighted-average common shares outstanding
34,177

 
37,537

 
34,386

 
37,753

Net loss per share - basic and diluted
$
(0.48
)
 
$
(0.63
)
 
$
(1.34
)
 
$
(1.82
)

The following weighted-average outstanding stock options and restricted stock units were excluded from the computation of diluted net loss per common share for the periods presented because including them would have had an anti-dilutive effect (in thousands):

 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2016
 
2015
 
2016
 
2015
Stock options and restricted stock units
3,422

 
3,395

 
3,536

 
3,522


Note 4 — Investments

At June 30, 2016 and December 31, 2015, the estimated fair value of short-term and long-term investments classified as available for sale are as follows (in thousands):
 
 
June 30, 2016
 
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
Short-term investments
 
 
 
 
 
 
 
 
Corporate debt securities
 
$
18,332

 
$
16

 
$
(2
)
 
$
18,346

Agency securities
 
7,332

 
10

 

 
7,342

Commercial paper
 
3,095

 

 

 
3,095

US Government securities
 
2,773

 
8

 

 
2,781

Total short-term investments
 
$
31,532

 
$
34

 
$
(2
)
 
$
31,564

Long-term investments
 
 
 
 
 
 
 
 
Corporate debt securities
 
$
5,853

 
$
13

 
$

 
$
5,866

Agency securities
 
8,836

 
35

 

 
8,871

US Government securities
 
3,750

 
17

 

 
3,767

Total long-term investments
 
$
18,439

 
$
65

 
$

 
$
18,504



10

SHUTTERFLY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 
 
December 31, 2015
 
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
Short-term investments
 
 
 
 
 
 
 
 
Corporate debt securities
 
$
16,187

 
$
2

 
$
(14
)
 
$
16,175

Agency securities
 
6,246

 

 
(2
)
 
6,244

Commercial paper
 
499

 

 


499

Total short-term investments
 
$
22,932

 
$
2

 
$
(16
)
 
$
22,918

Long-term investments
 
 
 
 
 
 
 
 
Corporate debt securities
 
$
10,132

 
$

 
$
(37
)
 
$
10,095

Agency securities
 
13,421

 
1

 
(43
)
 
13,379

US Government securities
 
5,549

 

 
(18
)
 
5,531

Total long-term investments
 
$
29,102

 
$
1

 
$
(98
)
 
$
29,005


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, 2016 and no impairments were recorded in the period. The Company had no material realized gains or losses during the six months ended June 30, 2016.

The following table summarizes the contractual maturities of the Company's investments as of June 30, 2016 and December 31, 2015 (in thousands):
 
June 30, 2016
 
December 31, 2015
One year or less
$
31,564

 
$
22,918

One year through three years
18,504

 
29,005

 
$
50,068

 
$
51,923


Actual maturities may differ from the contractual maturities because borrowers may have certain prepayment conditions.

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, 2016.

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):

11

SHUTTERFLY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 
Total Estimated Fair Value as of
 
June 30, 2016
 
December 31, 2015
 
Cash Equivalents
 
Investments
 
Cash Equivalents
 
Investments
Level 1 Securities:
 
 
 
 
 
 
 
Money market funds
$
10,242

 
$

 
$
24,577

 
$

Level 2 Securities:
 
 
 
 
 
 
 
Corporate debt securities
270

 
24,212

 
850

 
26,270

Agency securities

 
16,213

 

 
19,623

US Government securities

 
6,548

 

 
5,531

Commercial Paper
9,061

 
3,095

 

 
499

Total cash equivalents and investments
$
19,573

 
$
50,068

 
$
25,427

 
$
51,923


Convertible Senior Notes

As of June 30, 2016, 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):
 
Total Estimated Fair Value as of
 
June 30, 2016
 
December 31, 2015
Convertible senior notes
$
281,883

 
$
270,192


The carrying value of other financial instruments, including accounts receivable, accounts payable and other payables, approximates fair value due to their short maturities.


12

SHUTTERFLY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 6 — Balance Sheet Components

Prepaid Expenses and Other Current Assets
 
June 30, 2016
 
December 31, 2015
 
(in thousands)
Intra-period income tax asset
$
28,958

 
$

Prepaid service contracts
12,170

 
12,539

Other prepaid expenses and current assets
26,467

 
19,289

 
$
67,595

 
$
31,828


Intra-period income 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.

Property and Equipment, Net
 
June 30, 2016
 
December 31, 2015
 
(in thousands)
Computer equipment and software
$
179,415

 
$
172,048

Manufacturing equipment
150,598

 
148,820

Capitalized software and website development costs
126,153

 
108,837

Buildings under build-to-suit leases
56,469

 
56,468

Leasehold improvements
21,840

 
21,519

Rental equipment
17,626

 
17,414

Furniture and fixtures
11,529

 
11,351

 
563,630

 
536,457

Less: Accumulated depreciation and amortization
(295,784
)
 
(254,678
)
Net property and equipment
$
267,846

 
$
281,779

 
Included within manufacturing equipment is approximately $66.0 million and $72.9 million of capital lease obligations for various pieces of manufacturing facility equipment as of June 30, 2016 and December 31, 2015, respectively. Accumulated depreciation of assets under capital lease totaled $17.9 million at June 30, 2016 compared to $14.1 million at December 31, 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 $23.3 million and $21.0 million for the three months ended June 30, 2016 and 2015, respectively. Depreciation and amortization expense totaled $46.3 million and $40.9 million for the six months ended June 30, 2016 and 2015, respectively.

Included in property and equipment is approximately $27.4 million and $17.2 million of assets in construction as of June 30, 2016 and December 31, 2015, respectively, the majority of which relates to internal-use software.


13

SHUTTERFLY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Accrued Liabilities
 
June 30, 2016
 
December 31, 2015
 
(in thousands)
Accrued compensation
$
15,085

 
$
20,703

Capital lease obligations, current portion
12,537

 
14,090

Accrued production costs
12,363

 
44,825

Accrued marketing expenses
9,951

 
26,793

Accrued income and sales tax
3,234

 
17,843

Accrued other
18,352

 
24,880

 
$
71,522

 
$
149,134

 
Other Liabilities
 
June 30, 2016
 
December 31, 2015
 
(in thousands)
Financing obligations
$
56,111

 
$
56,771

Capital lease obligations, non-current portion
34,965

 
44,428

Deferred tax liability
9,334

 
12,447

Deferred revenue, non-current portion
5,949

 
6,564

Other liabilities
3,719

 
2,902

 
$
110,078

 
$
123,112


Financing obligations represents the build-to-suit leases for the Company's manufacturing facilities in Fort Mill, South Carolina; Shakopee, Minnesota; and Tempe, Arizona.

Note 7 — Convertible Senior Notes

0.25% Convertible Senior Notes Due May 15, 2018
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

14

SHUTTERFLY, INC.
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, 2016, 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):
 
June 30, 2016
 
December 31, 2015
Liability component:
 
 
 
Principal
$
300,000

 
$
300,000

Less: debt issuance costs, debt discount, net of amortization (1)
(28,524
)
 
(35,639
)
Net carrying amount
$
271,476

 
$
264,361

 
 
 
 
Equity component (2)
$
63,510

 
$
63,510


(1)
In April 2015, the FASB issued new guidance related to presentation of debt issuance costs. Effective January 1, 2016 the Company has adopted the guidance and applied it on a retrospective basis.
(2)
Recorded in the consolidated balance sheets within additional paid-in capital, net of the $1.7 million of issuance costs in equity.
The following table sets forth total interest expense recognized related to the Notes (in thousands):
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2016
 
2015
 
2016
 
2015
0.25% coupon
$
188

 
$
188

 
$
375

 
$
375

Amortization of debt issuance costs
327

 
310

 
650

 
615

Amortization of debt discount
3,256

 
3,078

 
6,465

 
6,113

 
$
3,771

 
$
3,576

 
$
7,490

 
$
7,103

 


15

SHUTTERFLY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


Note Hedge
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 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. As of June 30, 2016, the Company's Board of Directors has approved increases to the program on the following dates:
On February 6, 2014, the Company's Board of Directors approved an increase of $100.0 million in addition to any amounts repurchased as of that date.
On February 9, 2015, the Company's Board of Directors approved an increase of $300.0 million in addition to any amounts repurchased as of that date.
On April 21, 2016, the Company's Board of Directors approved an increase of $100.0 million 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.
The following table provides information about our repurchase of shares of our common stock for fiscal years 2014, 2015, and 2016:
Period (1)
 
Total Number of Shares Purchased
 
Average Price Paid per Share
 
Total Dollar Value Spent on Repurchases (in thousands)
2014 Repurchases
 
1,961,085

 
$
45.29

 
$
88,815

2015 Repurchases (2)
 
4,907,675

 
$
43.99

 
$
215,911

2016 Repurchases to date (3)
 
1,797,449

 
$
43.49

 
$
78,172


(1)
All shares were purchased pursuant to the publicly announced share repurchase program described above. Shares are reported in a period based on the settlement date of the applicable repurchase. All repurchased shares of common stock have been retired.

16

SHUTTERFLY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


(2)
The Company entered into an accelerated share repurchase ("ASR") in the second quarter of 2015 under which a prepayment of $75 million was made. Final settlement of the ASR occurred on August 3, 2015, resulting in the delivery to the Company of 0.8 million shares of the Company’s common stock and a return of cash for the remaining amount not settled in shares of $38.2 million. In total, approximately 0.8 million shares of common stock were repurchased under the ASR for $36.8 million, resulting in an average price paid per share of $46.49 under the ASR.

(3)
Represents repurchases for the six months ended June 30, 2016.

Note 9 — Segment Reporting

The Company reports segment information based on its internal reporting used by management for making decisions and assessing performance as the source of its reportable segments.
    
The Chief Operating Decision Maker ("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 SBS segment consists of costs which are direct and incremental to the SBS segment. These include production costs of SBS 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.
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.
SBS - Includes revenues primarily from variable, 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 expense and amortization of intangible assets.


17

SHUTTERFLY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2016
 
2015
 
2016
 
2015
Consumer
 
 
 
 
 
 
 
Net revenues
$
176,617

 
$
171,274

 
$
331,998

 
$
320,062

Cost of net revenues
85,276

 
83,387

 
171,613

 
164,165

Gross profit
$
91,341

 
$
87,887

 
$
160,385

 
$
155,897

Gross profit as a percentage of net revenues
52
%
 
51
%
 
48
%
 
49
%
 
 
 
 
 
 
 
 
Shutterfly Business Solutions (SBS)
 
 
 
 
 
 
 
Net revenues
$
27,344

 
$
12,605

 
$
53,672

 
$
23,795

Cost of net revenues
21,810

 
10,245

 
41,520

 
20,133

Gross profit
$
5,534

 
$
2,360

 
$
12,152

 
$
3,662

Gross profit as a percentage of net revenues
20
%
 
19
%
 
23
%
 
15
%

 
 
 
 
 
 
 
Corporate
 
 
 
 
 
 
 
Net revenues
$

 
$

 
$

 
$

Cost of net revenues
2,506

 
3,015

 
5,182

 
7,056

Gross profit
$
(2,506
)
 
$
(3,015
)
 
$
(5,182
)
 
$
(7,056
)

 
 
 
 
 
 
 
Consolidated
 
 
 
 
 
 
 
Net revenues
$
203,961

 
$
183,879

 
$
385,670

 
$
343,857

Cost of net revenues
109,592

 
96,647

 
218,315

 
191,354

Gross profit
$
94,369

 
$
87,232

 
$
167,355

 
$
152,503

Gross profit as a percentage of net revenues
46
%
 
47
%
 
43
%
 
44
%

Note 10 — Commitments and Contingencies

Indemnifications

In the normal course of business, the Company enters into contracts and agreements that contain a variety of representations and warranties and provide for general indemnifications. The Company’s exposure under these agreements is unknown because it involves 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 in May 2013, Bank of America, N.A. and

18

SHUTTERFLY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Morgan Stanley Bank, N.A. joined the syndicate. From inception through June 30, 2016, 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.

On June 10, 2016, the Company renewed the Credit Agreement and the Banks. As part of this renewal, Fifth Third Bank, Silicon Valley Bank, US Bank and Citibank, N.A. left the syndicate and SunTrust Bank and BMO Harris Bank N.A. joined the syndicate. The Credit Agreement is for five years and provides for a $200.0 million senior secured revolving credit facility. As part of the renewal, the Company amended the Credit Agreement by and among the Company and the Banks to 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 for the fiscal quarter ended June 30, 2016 through March 31, 2017, at or below 3.25 to 1.00 for the fiscal quarter ending June 30, 2017 through March 31, 2018, and at or below 3.00 to 1.00 for the fiscal quarter ended June 30, 2018 and thereafter. 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, 2016, the Company is in compliance with these covenants.

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 the Company for alleged violations of the Delaware False Claims and Reporting Act, 6 Del C. § 1203(b)(2). The complaint asserts that the Company 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

19

SHUTTERFLY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Company had previously accrued. There are no amounts accrued which the Company believes would be material to its financial position and results of operations.


20


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

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This report, including the following Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 that are based upon our current expectations. These forward-looking statements include statements related to our business strategy and plans, 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 2016, 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 and implement innovative, new products and services on a timely and cost-effective basis, including our next generation Shutterfly platform; consumer acceptance of our products 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, MyPublisher, BorrowLenses and Groovebook.  

We generate the majority of our Consumer 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 generate the majority of our Shutterfly Business Solutions ("SBS") revenues by printing and shipping direct marketing and other variable data print products and formats. We manufacture most of these items in our Fort Mill, South Carolina; Shakopee, Minnesota; and Tempe, Arizona 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, magnets, pillows and blankets.  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.

In the second quarter of 2016, we launched our new Statement Gifts category on Shutterfly, enabling customers to share life's joy by providing premium non-photo personalized gifts. These high quality statement gifts, which include etched decanters, embroidered totes, and engraved cutting boards and glass frames are available in a variety of unique designs. These products

21


expand out gifting portfolio to better serve current and new customers. They are a convenient additional purchase for many of the occasions for which customers frequent our site.

We also made substantial progress on our Shutterfly 3.0 initiative. Shutterfly 3.0 is our long term vision for creating a platform and device-agnostic memory management and personalized e-commerce solution. Our goals for 2016 are two-fold; firstly, adding a set of next generation features and functionality in to our Shutterfly platform, and secondly, building out our integrated e-commerce capabilities. Our first goal of adding next generation features to Shutterfly is focused on creating a new photo management solution on Shutterfly by integrating ThisLife technology, which has superior organization and creation features. This new integrated photo management solution, which greatly enhances the legacy Shutterfly platform, is part of the All New Shutterfly. On the e-commerce side, we are focused on building an enhanced Shutterfly mobile app on iOS and Android that offers a broader product catalog.

During the second quarter we made strong progress on our migration to the All New Shutterfly. Our plan is to have our most active users on the All New Shutterfly platform in time for our Q4 peak season, including legacy ThisLife customers and new registrants. In Q2 we finished the migration of all legacy ThisLife customers and 100% of our new customers are starting on the All New Shutterfly. We are now focused on continuing the migration of our existing Shutterfly customers.

Customers that have moved on to the All New Shutterfly are taking advantage of a number of new features. Our new photo service provides a modern, intuitive user interface from which they can easily gather, find, create, and enjoy their photos across web and mobile. Users can view photos on a timeline and also organize them in to albums. New facial recognition functionality enhances the service, making it easy to tag and search by people, places and keywords. Combined with our simple and powerful upload tools for both desktop and mobile, including the ability to detect and auto upload new photos, All New Shutterfly customers can easily and quickly create gifts and keepsakes. We've begun demonstrating the potential of the All New Shutterfly's enhanced feature set through successful marketing campaigns we conducted for both Mother's Day and Father's Day, which included better product ideation for our customers.

Our second major project for 2016, building an enhanced Shutterfly mobile app with a broader product catalog, is expected to launch later this year. For the second quarter, the mobile app continues to drive a record number of Customers to Shutterfly, benefiting from successful marketing campaigns. We are making good progress on updating the user interface and feel confident in our ability to have a broad selection of holiday cards for creation and purchase from mobile devices in the fourth quarter as expected.

On the SBS side, we continued to develop our relationships with existing customers as we work on integrating our platform in to their systems and processes. Ultimately, our fully integrated end-to-end solution will allow us to work more closely with our customers in designing and implementing marketing programs.

We continue to invest in our printing capabilities with a customer-centric focus on automation and reducing our reliance on temporary labor. To that end, in the second quarter of 2015 we signed a deal with a third party to lease a number of state of the art, four-color digital printers. These technology leading-printers are better quality, more efficient, and should help improve our cost structure. Installation of these new presses will take place in the summer of 2016.

On the marketing front, we have continued to innovate to get the most for our marketing dollars in an environment of rising media costs. We are making focused investments in mobile and continue to leverage our omni-channel approach to drive customer engagement and conversion. For example, in the second quarter of 2016:
We launched a year-long partnership with celebrity mom and actress, Drew Barrymore, who will be designing a Shutterfly home decor and holiday collection;
We concluded our fourth season as the philanthropic partner for the Ellen DeGeneres Show; and
We continued to work with Baby 2 Baby and had a very successful Mother's Day event with Jessica Biel.

In the quarter, Shutterfly continued to build on its numerous partnerships to drive awareness and customer engagement. For example:
We continued our partnership with the United States Postal Service and were a featured placement in their e-commerce Spring/Summer campaign.
We also launched new partnerships with category leaders like:     
Avis/Budget aimed at increasing engagement with holiday travelers renting cars; and
PetSmart which is the largest pet goods retailer in the United States and the go-to pet products retailer for many pet parents looking to preserve memories with their beloved pets.


22


And finally, Christopher North, Shutterfly's new President and Chief Executive Officer, began his employment on May 31, 2016. Mr. North has joined us from Amazon UK where he most recently served as UK Managing Director of Amazon EU Sarl.

Basis of Presentation

Net Revenues.      Our net revenues are comprised of sales generated from Consumer and SBS 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, desktop plaques, candles, pillows, canvas prints and blankets. 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.
 
SBS. Our SBS revenues are primarily from variable, direct marketing collateral manufactured and fulfilled for business customers. We continue to focus our efforts in expanding our presence in this market.

In addition to the two reportable segments, we also have 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.

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 segment, 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.  An active customer is defined as one that has transacted in the last trailing twelve months. 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.

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 ("AOV") is Consumer net revenues for a given period divided by the total number of customer orders recorded during that same period. AOV 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 AOV may fluctuate on an annual basis.

Our SBS segment revenues are generated from the printing and shipping of direct marketing and other variable data print products and formats.     

We believe the analysis of these metrics and others described 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 SBS 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,

23


and photo book covers), shipping charges, packing supplies, distribution and fulfillment activities, third-party costs for photo-based merchandise, 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.

SBS.        Cost of net revenues for the SBS segment consists of costs which are direct and incremental to the SBS business. These included production costs of SBS 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 expense 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 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, radio advertising, television advertising, 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 was renewed in June 2016, and costs associated with our capital leases and build-to-suit lease financing obligations.

Interest and Other Income, Net.   Interest and other income, net primarily consists of the interest earned on our cash and investment accounts 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. Our critical accounting policies and estimates are discussed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2015.

24



Recent Accounting Pronouncements

Refer to Note 1 - The Company and Summary of Significant Accounting Policies of the financial statements for a discussion of the recent accounting pronouncements.

Results of Operations

The following table presents the components of our statement of operations as a percentage of net revenues:
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2016
 
2015
 
2016
 
2015
Net revenues
100
 %
 
100
 %
 
100
 %
 
100
 %
Cost of net revenues
54
 %
 
53
 %
 
57
 %
 
56
 %
Gross profit
46
 %
 
47
 %
 
43
 %
 
44
 %
Operating expenses:


 


 
 
 
 
Technology and development
20
 %
 
20
 %
 
21
 %
 
21
 %
Sales and marketing
23
 %
 
27
 %
 
24
 %
 
28
 %
General and administrative
13
 %
 
16
 %
 
15
 %
 
17
 %
Total operating expenses
56
 %
 
63
 %
 
60
 %
 
66
 %
Loss from operations
(10
)%
 
(16
)%
 
(17
)%
 
(22
)%
Interest expense
(3
)%
 
(3
)%
 
(2
)%
 
(3
)%
Interest and other income, net
 %
 
1
 %
 
 %
 
1
 %
Loss before income taxes
(13
)%
 
(18
)%
 
(19
)%
 
(24
)%
Benefit from income taxes
5
 %
 
5
 %
 
7
 %
 
4
 %
Net loss
(8
)%
 
(13
)%
 
(12
)%
 
(20
)%


25


Comparison of the Three Month Periods Ended June 30, 2016 and 2015
 
 
Three Months Ended June 30,
 
 
2016
 
2015
 
$ Change
 
% Change
 
 
(in thousands)
Consolidated
 
 
 
 
 
 
 
 
Net revenues
 
$
203,961

 
$
183,879

 
$
20,082

 
11
%
Cost of net revenues
 
109,592

 
96,647

 
12,945

 
13
%
Gross profit
 
$
94,369

 
$
87,232

 
$
7,137

 
8
%
Gross profit as a percentage of net revenues
 
46
%
 
47
%
 
 
 
 

Net revenues increased $20.1 million, or 11%, for the three months ended June 30, 2016 as compared to the same period in 2015. Cost of net revenues increased $12.9 million, or 13%, for the three months ended June 30, 2016 as compared to the same period in 2015. As a percentage of net revenues, cost of net revenues increased to 54% in the three months ended June 30, 2016 from 53% in the same period in 2015, which decreased gross margin to 46% in the three months ended June 30, 2016 from 47% in the same period in 2015.

In the second quarter of 2015, operating results benefited from the recognition of breakage revenue from unredeemed flash deals associated with a change in estimate. As a result, our Consumer net revenues recognized a benefit of $7.5 million. Excluding this amount from prior year, net revenues increased $27.6 million, or 16%, for the three months ended June 30, 2016 from $176.4 million to $204.0 million.

 
 
Three Months Ended June 30,
 
 
2016
 
2015
 
$ Change
 
% Change
 
 
(in thousands)
Consumer
 
 
 
 
 
 
 
 
Net revenues
 
$
176,617

 
$
171,274

 
$
5,343

 
3
%
Cost of net revenues
 
85,276

 
83,387

 
1,889

 
2
%
Gross profit
 
$
91,341

 
$
87,887

 
$
3,454

 
4
%
Gross profit as a percentage of net revenues
 
52
%
 
51
%
 
 
 
 
 
 
Three Months Ended June 30,
 
 
2016
 
2015
 
Change
 
% Change
 
 
(in thousands)
Key Consumer Metrics
 
 
Total Customers
 
3,260

 
3,134

 
126

 
4
%
Total Number of Orders
 
5,303

 
5,038

 
265

 
5
%
Average order value (AOV)
 
$
33.30

 
$
32.50

 
$
0.80

 
2
%

Consumer Segment

Consumer net revenues increased $5.3 million, or 3%, in the three months ended June 30, 2016 compared to the same period in 2015.  The increase in Consumer net revenues was primarily a result of increased sales of cards and stationery, photo gifts, photobooks, and mobile revenue. The increase is also reflected in the increases in customers and orders in three months ended June 30, 2016, as compared to the same period in 2015. Excluding the impact of breakage revenue from prior year, AOV increased 2% primarily due to increased average sales prices across Shutterfly brands and favorable product mix. Including the impact of breakage revenue in 2015, AOV decreased 2% from prior year.

Consumer cost of net revenues increased $1.9 million, or 2%, for the three months ended June 30, 2016 as compared to the same period in 2015. Consumer gross margin increased to 52% in the three months ended June 30, 2016 from 51% in the same period in 2015. The increase in Consumer gross margin percentage from the same period a year ago is primarily driven by rent reduction as a result of facilities consolidation related to the opening of our Tempe, Arizona facility and higher net revenues from our Shutterfly brand and mobile revenue.


26


 
 
Three Months Ended June 30,
 
 
2016
 
2015
 
$ Change
 
% Change
 
 
(in thousands)
Shutterfly Business Solutions (SBS)
 
 
 
 
 
 
 
 
Net revenues
 
$
27,344

 
$
12,605

 
$
14,739

 
117
%
Cost of net revenues
 
21,810

 
10,245

 
11,565

 
113
%
Gross profit
 
$
5,534

 
$
2,360

 
$
3,174

 
134
%
Gross profit as a percentage of net revenues
 
20
%
 
19
%
 
 
 
 

SBS Segment

SBS net revenues increased $14.7 million, or 117%, in the three months ended June 30, 2016 compared to the same period in 2015. The increase in SBS net revenues is primarily due to the expansion of projects, higher revenue volumes with existing customers, and acquisition of new customers.

SBS cost of net revenues increased 11.6 million, or 113%, for the three months ended June 30, 2016 as compared to the same period in 2015. SBS gross margin increased to 20% in the three months ended June 30, 2016 from 19% in the same period in 2015. The increase in SBS gross margin is primarily due to the expansion of projects with our existing customers.

 
 
Three Months Ended June 30,
 
 
2016
 
2015
 
$ Change
 
% Change
 
 
(in thousands)
Corporate
 
 
 
 
 
 
 
 
Net revenues
 
$

 
$

 
$

 
 %
Cost of net revenues
 
2,506

 
3,015

 
(509
)
 
(17
)%
Gross profit
 
$
(2,506
)
 
$
(3,015
)
 
$
509

 
(17
)%

Corporate Segment

Corporate cost of net revenues decreased $0.5 million, or 17% in the three months ended June 30, 2016 compared to the same period in 2015. The decrease in corporate cost of net revenues was primarily a result of fully amortized intangible assets relating to our business acquisitions in prior years.
 
Three Months Ended June 30,
 
2016
 
2015
 
$ Change
 
% Change
 
(in thousands)
Technology and development
$
41,313

 
$
36,502

 
$
4,811

 
13
 %
Percentage of net revenues
20
%
 
20
%
 

 

Sales and marketing
$
47,539

 
$
50,446

 
$
(2,907
)
 
(6
)%
Percentage of net revenues
23
%
 
27
%
 

 

General and administrative
$
26,592

 
$
28,676

 
$
(2,084
)
 
(7
)%
Percentage of net revenues
13
%
 
16
%
 

 


Our technology and development expense increased $4.8 million, or 13%, for the three months ended June 30, 2016, compared to the same period in 2015. As a percentage of net revenues, technology and development remained flat at 20% in the three months ended June 30, 2016 and 2015. The overall increase in expense was primarily due to an increase of $3.5 million in personnel and related costs due to increased headcount, an increase of $2.3 million in professional fees, an increase of $1.9 million in facilities costs primarily resulting from additional network operations and security support, and an increase in depreciation and amortization expense of $0.4 million. These factors were partially offset by an increase of $2.5 million in software and website development costs capitalized and by a decrease in stock-based compensation expense of $0.7 million.

At June 30, 2016, headcount in technology and development increased by 17% compared to June 30, 2015, 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, 2016, we capitalized $8.0

27


million in eligible salary and consultant costs, including $0.4 million of stock-based compensation expense, associated with software developed or obtained for internal use, compared to $5.5 million capitalized in the three months ended June 30, 2015, which included $0.3 million of stock-based compensation expense.

Our sales and marketing expense decreased $2.9 million, or 6%, in the three months ended June 30, 2016 compared to the same period in 2015. As a percentage of net revenues, total sales and marketing expense decreased to 23% in the three months ended June 30, 2016 from 27% in the three months ended June 30, 2015. The decrease in our sales and marketing expense was due to a decrease of $3.5 million attributed to our flash breakage catch-up of marketing expense from prior year. There was also a decrease of $1.9 million of stock-based compensation expense due to executive departures in the first quarter of 2016 and full vesting of prior acquisition grants and a decrease of $1.1 million in depreciation and amortization expense. These factors were partially offset by an increase of $1.8 million in advertising and promotional activity, $1.3 million in personnel costs due to increased headcount, and $0.3 million in professional fees.

Our general and administrative expense decreased $2.1 million, or 7%, in the three months ended June 30, 2016 as compared to the same period in 2015. As a percentage of net revenues, general and administrative expense decreased to 13% in the three months ended June 30, 2016 from 16% in the three months ended June 30, 2015. The decrease in general and administrative expense was primarily due to a decrease of $2.8 million in stock-based compensation expense from the departure of our former Chief Executive Officer and a decrease in taxes and miscellaneous fees of $0.3 million. The decrease in general and administrative expense was partially offset by an increase of $0.4 million in facilities costs, an increase of $0.2 million in depreciation and amortization expense, an decrease of $0.2 million in proceeds from intellectual property license agreements, and an increase of $0.2 million in credit card fees.
 
Three Months Ended June 30,
 
2016
 
2015
 
Change
 
(in thousands)
Interest expense
$
(5,661
)
 
$
(4,985
)
 
$
(676
)
Interest and other income, net
128

 
120

 
8


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 $5.7 million for the three months ended June 30, 2016 compared to $5.0 million during the same period a year ago. This increase in interest expense was primarily driven by $0.4 million of financing obligations related to our Tempe, Arizona facility that became operational in the second quarter of 2015 and an increase of $0.2 million in interest expense from our convertible debt compared to prior year.
 
Three Months Ended June 30,
 
2016
 
2015
 
(in thousands)
Income tax benefit
$
10,123

 
$
9,480

Effective tax rate
38
%
 
29
%

We recorded an income tax benefit of $10.1 million and $9.5 million for the three months ended June 30, 2016 and 2015, respectively. Our effective tax rate was 38% for the three months ended June 30, 2016, compared to 29% for the three months ended June 30, 2015. Factors that impacted the effective tax rate include the federal research and development credit, limitations on executive compensation, a discrete tax expense related to the Israel Tax Authority settlement in the second quarter of 2016, and disqualifying dispositions of employee incentive stock options.
 
During the second quarter of 2016 the Israel Tax Authority, as part of the 2012 to 2014 audit, issued an assessment for taxes due that resulted in a discrete tax expense of $0.3 million.




28


Comparison of the Six Month Periods Ended June 30, 2016 and 2015

 
 
Six Months Ended June 30,
 
 
2016
 
2015
 
$ Change
 
% Change
 
 
(in thousands)
Consolidated
 
 
 
 
 
 
 
 
Net revenues
 
$
385,670

 
$
343,857

 
$
41,813

 
12
%
Cost of net revenues
 
218,315

 
191,354

 
26,961

 
14
%
Gross profit
 
$
167,355

 
$
152,503

 
$
14,852

 
10
%
Gross profit as a percentage of net revenues
 
43
%
 
44
%
 
 
 
 

Net revenues increased $41.8 million, or 12%, for the six months ended June 30, 2016 as compared to the same period in 2015. Cost of net revenues increased $27.0 million, or 14%, for the six months ended June 30, 2016 as compared to the same period in 2015. As a percentage of net revenues, cost of net revenues increased to 57% in the six months ended June 30, 2016 from 56% in the same period in 2015, which decreased gross margin to 43% in the six months ended June 30, 2016 from 44% in the same period in 2015.

 
 
Six Months Ended June 30,
 
 
2016
 
2015
 
$ Change
 
% Change
 
 
(in thousands)
Consumer
 
 
 
 
 
 
 
 
Net revenues
 
$
331,998

 
$
320,062

 
$
11,936

 
4
%
Cost of net revenues
 
171,613

 
164,165

 
7,448

 
5
%
Gross profit
 
$
160,385

 
$
155,897

 
$
4,488

 
3
%
Gross profit as a percentage of net revenues
 
48
%
 
49
%
 
 
 
 

Consumer Segment

Consumer net revenues increased $11.9 million, or 4%, in the six months ended June 30, 2016 compared to the same period in 2015.  The increase in Consumer net revenues was primarily a result of increased sales of cards and stationery, photo gifts, and mobile revenue. The increase is also reflected in the increases in customers and orders in the six months ended June 30, 2016, as compared to the same period in 2015.

Consumer cost of net revenues increased $7.4 million, or 5%, for the six months ended June 30, 2016 as compared to the same period in 2015, which decreased Consumer gross margin to 48% in the six months ended June 30, 2016 from 49% in the same period in 2015. The decrease in Consumer gross margin percentage from the same period a year ago is largely driven by the expenses of our expanded manufacturing facilities which resulted in increases to depreciation and labor costs. Increased mobile promotional activity also impacted gross margin.

 
 
Six Months Ended June 30,
 
 
2016
 
2015
 
$ Change
 
% Change
 
 
(in thousands)
Shutterfly Business Solutions (SBS)
 
 
 
 
 
 
 
 
Net revenues
 
$
53,672

 
$
23,795

 
$
29,877

 
126
%
Cost of net revenues
 
41,520

 
20,133

 
21,387

 
106
%
Gross profit
 
$
12,152

 
$
3,662

 
$
8,490

 
232
%
Gross profit as a percentage of net revenues
 
23
%
 
15
%
 
 
 
 

SBS Segment


29


SBS net revenues increased $29.9 million, or 126%, in the six months ended June 30, 2016 compared to the same period in 2015. The increase in SBS net revenues is primarily due to the expansion of projects with existing customers and the acquisition of new customers.

SBS cost of net revenues increased $21.4 million, or 106%, for the six months ended June 30, 2016 as compared to the same period in 2015, which increased SBS gross margin to 23% in the six months ended June 30, 2016 from 15% in the same period in 2015. The increase in SBS gross margin is primarily due to increased efficiencies as a result of the expansion of projects with our existing customers.

 
 
Six Months Ended June 30,
 
 
2016
 
2015
 
$ Change
 
% Change
 
 
(in thousands)
Corporate
 
 
 
 
 
 
 
 
Net revenues
 
$

 
$

 
$

 
 %
Cost of net revenues
 
5,182

 
7,056

 
(1,874
)
 
(27
)%
Gross profit
 
$
(5,182
)
 
$
(7,056
)
 
$
1,874

 
(27
)%

Corporate Segment

Corporate cost of net revenues decreased $1.9 million, or 27% in the six months ended June 30, 2016 compared to the same period in 2015. The decrease in corporate cost of net revenues was primarily a result of fully amortized intangible assets relating to our business acquisitions in prior years.
 
Six Months Ended J