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EX-32.02 - EXHIBIT 32.02 - SHUTTERFLY INCex32_02q3-16.htm
EX-32.01 - EXHIBIT 32.01 - SHUTTERFLY INCex32_01q3-16.htm
EX-31.02 - EXHIBIT 31.02 - SHUTTERFLY INCex31_02q3-16.htm
EX-31.01 - EXHIBIT 31.01 - SHUTTERFLY INCex31_01q3-16.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 September 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 November 2, 2016
Common stock, $0.0001 par value per share
 
33,945,139
 

1


TABLE OF CONTENTS

 
Page
Number
Part I - Financial Information
 

 

3








Part II - Other Information
 
















2


PART IFINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

SHUTTERFLY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value amounts)
(Unaudited)
 
 
September 30, 2016
 
December 31, 2015
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
60,212

 
$
288,863

Short-term investments
32,643

 
22,918

Accounts receivable, net
44,759

 
55,222

Inventories
11,351

 
13,466

Prepaid expenses and other current assets
90,047

 
31,828

Total current assets
239,012

 
412,297

Long-term investments
16,114

 
29,005

Property and equipment, net
292,782

 
281,779

Intangible assets, net
47,501

 
62,323

Goodwill
408,975

 
408,975

Other assets
13,554

 
10,948

Total assets
$
1,017,938

 
$
1,205,327

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
17,865

 
$
35,329

Accrued liabilities
88,233

 
149,134

Deferred revenue, current portion
22,082

 
27,329

Total current liabilities
128,180

 
211,792

Convertible senior notes, net
275,108

 
264,361

Other liabilities
137,603

 
123,112

Total liabilities
540,891

 
599,265

Commitments and contingencies (Note 10)

 

Stockholders’ equity:
 
 
 
Common stock, $0.0001 par value; 100,000 shares authorized; 33,865 and 34,777 shares issued and outstanding on September 30, 2016 and December 31, 2015, respectively
3

 
4

Additional paid-in capital
937,026

 
900,218

Accumulated other comprehensive income (loss)
24

 
(68
)
Accumulated deficit
(460,006
)
 
(294,092
)
Total stockholders' equity
477,047

 
606,062

Total liabilities and stockholders' equity
$
1,017,938

 
$
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

Nine Months Ended

September 30,

September 30,
 
2016
 
2015

2016

2015
Net revenues
$
187,328

 
$
167,492


$
572,998


$
511,349

Cost of net revenues
117,754

 
107,991


336,069


299,345

Gross profit
69,574

 
59,501


236,929


212,004

Operating expenses:
 
 
 

 
 

 
 

Technology and development
43,284

 
38,066


122,866


111,928

Sales and marketing
41,903

 
43,052


135,284


138,028

General and administrative
26,181

 
27,449


83,462


85,730

Total operating expenses
111,368

 
108,567


341,612


335,686

Loss from operations
(41,794
)
 
(49,066
)

(104,683
)

(123,682
)
Interest expense
(5,726
)
 
(5,613
)

(17,062
)

(15,334
)
Interest and other income, net
130

 
433


379


655

Loss before income taxes
(47,390
)
 
(54,246
)

(121,366
)

(138,361
)
Benefit from (provision for) income taxes
18,235

 
(8,831
)

46,290


6,404

Net loss
$
(29,155
)
 
$
(63,077
)

$
(75,076
)

$
(131,957
)
 
 
 
 
 
 
 
 
Net loss per share - basic and diluted
$
(0.86
)
 
$
(1.73
)

$
(2.19
)

$
(3.54
)
 
 
 
 
 
 
 
 
Weighted-average shares outstanding - basic and diluted
33,932

 
36,369


34,235


37,291

 
 
 
 
 
 
 
 
Stock-based compensation is allocated as follows (Note 2):
 
 
 
 
 
 
 
Cost of net revenues
$
1,131

 
$
952


$
3,436


$
3,145

Technology and development
2,725

 
2,443


5,696


7,744

Sales and marketing
3,664

 
5,329


11,697


17,202

General and administrative
4,694

 
7,032


12,459


21,740


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
 
Nine Months Ended
 
September 30,
 
September 30,
 
2016
 
2015
 
2016
 
2015
Net loss
$
(29,155
)
 
$
(63,077
)
 
$
(75,076
)
 
$
(131,957
)
Other comprehensive income (loss), net of reclassification adjustments:

 

 

 

Unrealized gains (losses) on investments, net
(59
)
 
31

 
149

 
134

Tax benefit (expense) on unrealized gain / loss on investments, net
23

 
(12
)
 
(57
)
 
(51
)
Other comprehensive income (loss), net of tax
(36
)
 
19

 
92

 
83

Comprehensive loss
$
(29,191
)
 
$
(63,058
)
 
$
(74,984
)
 
$
(131,874
)

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)
 
Nine Months Ended
 
September 30,
 
2016
 
2015
Cash flows from operating activities:
 
 
 
Net loss
$
(75,076
)
 
$
(131,957
)
Adjustments to reconcile net loss to net cash used in operating activities:
 

 
 

Depreciation and amortization
69,314

 
63,435

Amortization of intangible assets
15,744

 
20,798

Amortization of debt discount and transaction costs
10,747

 
10,163

Stock-based compensation
33,288

 
49,831

Loss on disposal of property and equipment
378

 
1,475

Deferred income taxes
5,786

 
(14,414
)
Tax benefit from stock-based compensation
263

 
13,041

Excess tax benefits from stock-based compensation
(886
)
 
(13,666
)
Changes in operating assets and liabilities:
 

 
 

Accounts receivable
10,463

 
(17,797
)
Inventories
2,115

 
1,406

Prepaid expenses and other assets
(61,113
)
 
(12,146
)
Accounts payable
(15,105
)
 
(14,157
)
Accrued and other liabilities
(67,806
)
 
(63,712
)
Net cash used in operating activities
(71,888
)
 
(107,700
)
Cash flows from investing activities:
 

 
 

Purchases of property and equipment
(43,733
)
 
(46,448
)
Capitalization of software and website development costs
(27,136
)
 
(15,448
)
Purchases of investments
(21,891
)
 
(4,400
)
Proceeds from the maturities and sales of investments
25,070

 
52,460

Proceeds from sale of property and equipment
14,071

 
1,128

Acquisition of business and intangible assets, net of cash acquired

 
(127
)
Net cash used in investing activities
(53,619
)
 
(12,835
)
Cash flows from financing activities:
 

 
 

Proceeds from issuance of common stock upon exercise of stock options
1,935

 
2,670

Repurchases of common stock
(90,837
)
 
(134,084
)
Prepayment of accelerated share repurchase

 
(75,000
)
Refund of accelerated share repurchase

 
38,179

Excess tax benefits from stock-based compensation
886

 
13,666

Principal payments of capital lease and financing obligations
(15,128
)
 
(8,988
)
Net cash used in financing activities
(103,144
)
 
(163,557
)
Net decrease in cash and cash equivalents
(228,651
)
 
(284,092
)
Cash and cash equivalents, beginning of period
288,863

 
380,543

Cash and cash equivalents, end of period
$
60,212

 
$
96,451

 
 
 
 
Supplemental schedule of non-cash investing / financing activities:
 
 
 

Net decrease in accrued purchases of property and equipment
$
(1,274
)
 
$
(154
)
Net increase (decrease) in accrued capitalized software and website development costs
(97
)
 
363

Stock-based compensation capitalized with software and website development costs
1,322

 
1,001

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

 
17,161

Property and equipment acquired under capital leases
23,946

 
29,097

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 nine months ended September 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 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 the annual period ending December 15, 2016, and for annual periods and interim periods thereafter. 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 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. The Company plans to adopt this pronouncement beginning January 1, 2017.

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

7

SHUTTERFLY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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. Presently, the Company is not yet in a position to assess the application date. The Company has not yet completed its final review of the impact of this guidance, although the Company currently does not anticipate a material impact on its revenue recognition practices. The Company will continue to review variable consideration, potential disclosures, and the method of adoption to complete the evaluation of the impact on the consolidated financial statements. In addition, the Company will continue to monitor additional changes, modifications, clarifications or interpretations being undertaken by the FASB, which may impact its current conclusions.
    
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.

In August 2016, the FASB issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments. The new guidance clarifies the classification of certain cash receipts and cash payments in the statement of cash flows, including debt prepayment or extinguishment costs, settlement of contingent consideration arising from a business combination, insurance settlement proceeds, and distributions from certain equity method investees. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. Early adoption is permitted. The Company is evaluating the impact of adopting this new accounting guidance on the consolidated financial statements.

Out-of-period Correction

In the third quarter of 2016, the Company recorded an out-of-period correction to increase revenue $0.8 million relating to prepaid plan breakage and $0.5 million relating to other errors. These amounts were incorrectly deferred and should have been recorded in prior periods. Management believes this correction is not material to the current period financial statements or any previously issued financial statements.
    
Note 2 — Stock-Based Compensation

Stock Option Activity

A summary of the Company’s stock option activity for the nine months ended September 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
(93
)
 
20.69

 
 
 
 
Forfeited, cancelled or expired
(4
)
 
42.94

 
 
 
 
Balance as of September 30, 2016
959

 
$
46.44

 
6.3
 
$
1,633

Options vested and expected to vest at September 30, 2016
959

 
$
46.44

 
6.3
 
$
1,633

Options vested at September 30, 2016
108

 
$
31.95

 
3.3
 
$
1,623

 
During the nine months ended September 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 September 30, 2016 and 2015 was $1.9 million and $0.7 million, respectively. The total intrinsic value of options exercised during the nine months ended September 30, 2016 and 2015 was $2.6 million and $3.6 million, respectively.

Net cash proceeds from the exercise of stock options for the three months ended September 30, 2016 and 2015 were $1.2 million and $0.4 million, respectively. Net cash proceeds from the exercise of stock options for the nine months ended September 30, 2016 and 2015 were $1.9 million and $2.7 million, respectively.

8

SHUTTERFLY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



9

SHUTTERFLY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Valuation of Stock Options

The Company estimates the fair value of each option award on the date of grant using the Black-Scholes option-pricing model. The Company calculates 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 gives 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.

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 nine months ended September 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
1,261

 
41.73

Vested
(1,056
)
 
43.69

Forfeited
(292
)
 
45.07

Awarded and unvested as of September 30, 2016
3,063

 
$
43.36

RSUs expected to vest after September 30, 2016
2,493

 
 
 
Included in the RSU grants for the nine months ended September 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 nine months ended September 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 September 30, 2016, the Company had $94.6 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 the three and nine months ended September 30, 2016 and 2015 is as follows (in thousands, except per share amounts):

10

SHUTTERFLY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2016
 
2015
 
2016
 
2015
Net loss per share:
 
 
 
 
 
 
 
Numerator
 
 
 
 
 
 
 
Net loss
$
(29,155
)
 
$
(63,077
)
 
$
(75,076
)
 
$
(131,957
)
Denominator for basic and diluted net loss per share
 

 
 
 
 

 
 

Weighted-average common shares outstanding
33,932

 
36,369

 
34,235

 
37,291

Net loss per share - basic and diluted
$
(0.86
)
 
$
(1.73
)
 
$
(2.19
)
 
$
(3.54
)

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
 
Nine Months Ended
 
September 30,
 
September 30,
 
2016
 
2015
 
2016
 
2015
Stock options and restricted stock units
3,923

 
3,330

 
3,666

 
3,457


Note 4 — Investments

At September 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):
 
 
September 30, 2016
 
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
Short-term investments
 
 
 
 
 
 
 
 
Corporate debt securities
 
$
15,074

 
$
4

 
$
(4
)
 
$
15,074

Agency securities
 
10,750

 
16

 

 
10,766

Commercial paper
 
3,399

 

 

 
3,399

US Government securities
 
3,398

 
6

 

 
3,404

Total short-term investments
 
$
32,621

 
$
26

 
$
(4
)
 
$
32,643

Long-term investments
 
 
 
 
 
 
 
 
Corporate debt securities
 
$
6,599

 
$
4

 
$
(5
)
 
$
6,598

Agency securities
 
6,373

 
11

 
(1
)
 
6,383

US Government securities
 
3,126

 
7

 

 
3,133

Total long-term investments
 
$
16,098

 
$
22

 
$
(6
)
 
$
16,114



11

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

The following table summarizes the contractual maturities of the Company's investments as of September 30, 2016 and December 31, 2015 (in thousands):
 
September 30, 2016
 
December 31, 2015
One year or less
$
32,643

 
$
22,918

One year through three years
16,114

 
29,005

 
$
48,757

 
$
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 September 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):

12

SHUTTERFLY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 
Total Estimated Fair Value as of
 
September 30, 2016
 
December 31, 2015
 
Cash Equivalents
 
Investments
 
Cash Equivalents
 
Investments
Level 1 Securities:
 
 
 
 
 
 
 
Money market funds
$
20,808

 
$

 
$
24,577

 
$

Level 2 Securities:
 
 
 
 
 
 
 
Corporate debt securities

 
21,672

 
850

 
26,270

Agency securities

 
17,149

 

 
19,623

US Government securities

 
6,537

 

 
5,531

Commercial Paper

 
3,399

 

 
499

Total cash equivalents and investments
$
20,808

 
$
48,757

 
$
25,427

 
$
51,923


Convertible Senior Notes

As of September 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
 
September 30, 2016
 
December 31, 2015
Convertible senior notes
$
284,796

 
$
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.


13

SHUTTERFLY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 6 — Balance Sheet Components

Prepaid Expenses and Other Current Assets
 
September 30, 2016
 
December 31, 2015
 
(in thousands)
Intra-period income tax asset
$
52,787

 
$

Prepaid service contracts
8,883

 
12,539

Other prepaid expenses and current assets
28,377

 
19,289

 
$
90,047

 
$
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
 
September 30, 2016
 
December 31, 2015
 
(in thousands)
Computer equipment and software
$
183,918

 
$
172,048

Manufacturing equipment
182,977

 
148,820

Capitalized software and website development costs
133,197

 
108,837

Buildings under build-to-suit leases
56,468

 
56,468

Leasehold improvements
22,456

 
21,519

Rental equipment
18,604

 
17,414

Furniture and fixtures
11,762

 
11,351

 
609,382

 
536,457

Less: Accumulated depreciation and amortization
(316,600
)
 
(254,678
)
Net property and equipment
$
292,782

 
$
281,779

 
Included within manufacturing equipment is approximately $90.0 million and $72.9 million of capital lease obligations for various pieces of manufacturing facility equipment as of September 30, 2016 and December 31, 2015, respectively. Accumulated depreciation of assets under capital lease totaled $21.2 million at September 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 $23.0 million and $22.6 million for the three months ended September 30, 2016 and 2015, respectively. Depreciation and amortization expense totaled $69.3 million and $63.4 million for the nine months ended September 30, 2016 and 2015, respectively.

Included in property and equipment is approximately $12.7 million and $17.2 million of assets in construction as of September 30, 2016 and December 31, 2015, respectively, the majority of which relates to internal-use software.


14

SHUTTERFLY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Accrued Liabilities
 
September 30, 2016
 
December 31, 2015
 
(in thousands)
Accrued production costs
$
21,613

 
$
44,825

Accrued compensation
16,658

 
20,703

Capital lease obligations, current portion
15,971

 
14,090

Accrued marketing expenses
7,623

 
26,793

Accrued income and sales tax
3,938

 
17,843

Accrued other
22,430

 
24,880

 
$
88,233

 
$
149,134

 
Other Liabilities
 
September 30, 2016
 
December 31, 2015
 
(in thousands)
Financing obligations
$
55,736

 
$
56,771

Capital lease obligations, non-current portion
54,263

 
44,428

Deferred tax liability
18,789

 
12,447

Deferred revenue, non-current portion
5,641

 
6,564

Other liabilities
3,174

 
2,902

 
$
137,603

 
$
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

15

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 September 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):
 
September 30, 2016
 
December 31, 2015
Liability component:
 
 
 
Principal
$
300,000

 
$
300,000

Less: debt issuance costs, debt discount, net of amortization (1)
(24,892
)
 
(35,639
)
Net carrying amount
$
275,108

 
$
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
 
Nine Months Ended
 
September 30,
 
September 30,
 
2016
 
2015
 
2016
 
2015
0.25% coupon
$
188

 
$
188

 
$
562

 
$
563

Amortization of debt issuance costs
332

 
314

 
982

 
929

Amortization of debt discount
3,300

 
3,120

 
9,765

 
9,233

 
$
3,820

 
$
3,622

 
$
11,309

 
$
10,725

 


16

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 September 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)
 
2,060,901

 
$
44.08

 
$
90,837


(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.

17

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 nine months ended September 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, statement gifts 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.


18

SHUTTERFLY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2016
 
2015
 
2016
 
2015
Consumer
 
 
 
 
 
 
 
Net revenues
$
144,074

 
$
138,025

 
$
476,072

 
$
458,087

Cost of net revenues
84,825

 
82,760

 
256,438

 
246,925

Gross profit
$
59,249

 
$
55,265

 
$
219,634

 
$
211,162

Gross profit as a percentage of net revenues
41
%
 
40
%
 
46
%
 
46
%
 
 
 
 
 
 
 
 
Shutterfly Business Solutions (SBS)
 
 
 
 
 
 
 
Net revenues
$
43,254

 
$
29,467

 
$
96,926

 
$
53,262

Cost of net revenues
30,389

 
22,566

 
71,909

 
42,699

Gross profit
$
12,865

 
$
6,901

 
$
25,017

 
$
10,563

Gross profit as a percentage of net revenues
30
%
 
23
%
 
26
%
 
20
%

 
 
 
 
 
 
 
Corporate
 
 
 
 
 
 
 
Net revenues
$

 
$

 
$

 
$

Cost of net revenues
2,540

 
2,665

 
7,722

 
9,721

Gross profit
$
(2,540
)
 
$
(2,665
)
 
$
(7,722
)
 
$
(9,721
)

 
 
 
 
 
 
 
Consolidated
 
 
 
 
 
 
 
Net revenues
$
187,328

 
$
167,492

 
$
572,998

 
$
511,349

Cost of net revenues
117,754

 
107,991

 
336,069

 
299,345

Gross profit
$
69,574

 
$
59,501

 
$
236,929

 
$
212,004

Gross profit as a percentage of net revenues
37
%
 
36
%
 
41
%
 
41
%

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

19

SHUTTERFLY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Morgan Stanley Bank, N.A. joined the syndicate. From inception through September 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 with 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 September 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

20

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.


21


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 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 enable 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.

We reached key milestones on our Shutterfly 3.0 initiative which is our long term vision for creating a platform and device-agnostic memory management and personalized e-commerce solution. Our goals for 2016 were two-fold: first, completing the

22


migration of our most active customers to the All New Shutterfly Photos, and second, launching new Shutterfly mobile apps on iOS and Android. We delivered both of these projects in the third quarter.

Firstly, we integrated the ThisLife photo management service, referred to as the All New Shutterfly Photos, in to Shutterfly.com. In the third quarter we reached our full-year goal of migrating our most active customers to this service. We believe that our photo management service will deepen our relationship with customers by inspiring them to upload more photographs and by driving greater engagement, thereby creating more opportunities to present them with contextually relevant products. Coupled with our ability to use our machine learning capabilities to present personalized, pre-created products featuring customers' more relevant photos, we expect the All New Shutterfly Photos to drive increased sales over time. All New Shutterfly Photos customers now have the ability to view all of their photos on a timeline, organize them with albums, tags, places or favorites, identify and find people they care about in their pictures using our facial recognition technology, and easily create products from their favorite photos.

Secondly, our goal was to launch new Shutterfly mobile apps on iOS and Android. Both apps went live in September, well ahead of the fourth quarter peak season. The relaunched apps now include the ability to create and purchase cards and stationery, our largest category by annual revenue, and also feature a new, intuitive, easy-to-use creation experience that allows customers to create a card in as little as a minute. Our iOS app also adds a new photo book creation experience, where customers can create a photo book in just a few minutes. Both apps allow customers to automatically upload their photos and to easily create personalized products. The new mobile apps have been built using our new service-oriented architecture which means that the features and improvements we launch in the apps will be reusable elsewhere in Shutterfly. Over time we expect to only have one identity service, rather than building and maintaining login functionality separately across multiple websites and apps. This is a critical step forward towards reducing technical debt, enabling faster innovation, and moving to a build-once approach in which our customers across multiple brands benefit from new feature launches.

We also continue to innovate on new products and below are a few we launched in this third quarter:
In Cards and Stationery, we introduced pop-out cards, which feature photos that pop out of the card and can be displayed long after the occasion.
In Photo Books, we introduced standard layflat pages, featuring a hinge with new higher quality paper, allowing images on both sides of a page without a gap in the middle of the book.
Earlier this year, we launched our new Statement Gifts category on Shutterfly, leveraging the strength of the Shutterfly brand to expand our product range to personalized non-photo based gifts, increasing our ability to serve a wider range of our customers' gifting needs. In the third quarter, we expanded the Statement Gifts line to include etched glass vases, flasks, wine bags, and garden stones.
We also expanded our Home Decor category with the launch of our exclusive Drew Barrymore collection.

On the marketing front, we have launched our major holiday season campaign spanning mobile, online, direct mail, television and other channels. In addition, we launched a multi-channel campaign featuring the All New Shutterfly Photos. Our long-standing philanthropic partnership with the Ellen DeGeneres show recently entered its fifth season, continuing to help change the lives of those in need while increasing awareness for Shutterfly. These programs along with our many partnerships and robust holiday campaign will help drive awareness and engagement in the fourth quarter.

On the SBS side, we were successful in winning follow-on contracts from our existing key clients where our ability to execute on personalized print and digital communications at scale resulted in additional programs and volumes. We continue to develop deeper relationships with our existing customer base, while carefully building our sales pipeline with a target set of high-potential prospects.

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.

23



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, 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.


24


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, 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.

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:

25


 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2016
 
2015
 
2016
 
2015
Net revenues
100
 %
 
100
 %
 
100
 %
 
100
 %
Cost of net revenues
63
 %
 
64
 %
 
59
 %
 
59
 %
Gross profit
37
 %
 
36
 %
 
41
 %
 
41
 %
Operating expenses:


 


 
 
 
 
Technology and development
23
 %
 
23
 %
 
21
 %
 
22
 %
Sales and marketing
22
 %
 
26
 %
 
24
 %
 
27
 %
General and administrative
14
 %
 
16
 %
 
15
 %
 
17
 %
Total operating expenses
59
 %
 
65
 %
 
60
 %
 
66
 %
Loss from operations
(22
)%
 
(29
)%
 
(19
)%
 
(25
)%
Interest expense
(3
)%
 
(3
)%
 
(2
)%
 
(3
)%
Interest and other income, net
 %
 
 %
 
 %
 
 %
Loss before income taxes
(25
)%
 
(32
)%
 
(21
)%
 
(28
)%
Benefit from/(provision for) income taxes
10
 %
 
(5
)%
 
8
 %
 
1
 %
Net loss
(15
)%
 
(37
)%
 
(13
)%
 
(27
)%


26


Comparison of the Three Month Periods Ended September 30, 2016 and 2015
 
 
Three Months Ended September 30,
 
 
2016
 
2015
 
$ Change
 
% Change
 
 
(in thousands)
Consolidated
 
 
 
 
 
 
 
 
Net revenues
 
$
187,328

 
$
167,492

 
$
19,836

 
12
%
Cost of net revenues
 
117,754

 
107,991

 
9,763

 
9
%
Gross profit
 
$
69,574

 
$
59,501

 
$
10,073

 
17
%
Gross profit as a percentage of net revenues
 
37
%
 
36
%
 
 
 
 

Net revenues increased $19.8 million, or 12%, for the three months ended September 30, 2016 as compared to the same period in 2015. Cost of net revenues increased $9.8 million, or 9%, for the three months ended September 30, 2016 as compared to the same period in 2015. As a percentage of net revenues, cost of net revenues decreased to 63% in the three months ended September 30, 2016 from 64% in the same period in 2015, which increased gross margin to 37% in the three months ended September 30, 2016 from 36% in the same period in 2015.

 
 
Three Months Ended September 30,
 
 
2016
 
2015
 
$ Change
 
% Change
 
 
(in thousands)
Consumer
 
 
 
 
 
 
 
 
Net revenues
 
$
144,074

 
$
138,025

 
$
6,049

 
4
%
Cost of net revenues
 
84,825

 
82,760

 
2,065

 
2
%
Gross profit
 
$
59,249

 
$
55,265

 
$
3,984

 
7
%
Gross profit as a percentage of net revenues
 
41
%
 
40
%
 
 
 
 
 
 
Three Months Ended September 30,
 
 
2016
 
2015
 
Change
 
% Change
 
 
(in thousands)
Key Consumer Metrics
 
 
Total Customers
 
3,151

 
3,112

 
39

 
1
%
Total Number of Orders
 
5,395

 
5,344

 
51

 
1
%
Average order value (AOV)
 
$
26.71

 
$
25.83

 
$
0.88

 
3
%

Consumer Segment

Consumer net revenues increased $6.0 million, or 4%, in the three months ended September 30, 2016 compared to the same period in 2015.  The increase in Consumer net revenues was primarily a result of increased sales of photo gifts and mobile revenue. The increase is also reflected in the increases in customers and orders in three months ended September 30, 2016, as compared to the same period in 2015. AOV increased 3% primarily due to favorable product mix.

Consumer cost of net revenues increased $2.1 million, or 2%, for the three months ended September 30, 2016 as compared to the same period in 2015. Consumer gross margin increased to 41% in the three months ended September 30, 2016 from 40% in the same period in 2015. The increase in Consumer gross margin percentage from the same period a year ago is primarily driven by manufacturing efficiencies, resulting from facility consolidation and manufacturing automation efficiencies.


27


 
 
Three Months Ended September 30,
 
 
2016
 
2015
 
$ Change
 
% Change
 
 
(in thousands)
Shutterfly Business Solutions (SBS)
 
 
 
 
 
 
 
 
Net revenues
 
$
43,254

 
$
29,467

 
$
13,787

 
47
%
Cost of net revenues
 
30,389

 
22,566

 
7,823

 
35
%
Gross profit
 
$
12,865

 
$
6,901

 
$
5,964

 
86
%
Gross profit as a percentage of net revenues
 
30
%
 
23
%
 
 
 
 

SBS Segment

SBS net revenues increased $13.8 million, or 47%, in the three months ended September 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 our ability to execute on personalized print and digital communications at scale resulted in additional programs and volumes.

SBS cost of net revenues increased 7.8 million, or 35%, for the three months ended September 30, 2016 as compared to the same period in 2015. SBS gross margin increased to 30% in the three months ended September 30, 2016 from 23% in the same period in 2015. The increase in SBS gross margin is primarily due to improved customer targeting and favorable product mix as a result of expansion of projects with our existing customers.

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

 
$

 
$

 
 %
Cost of net revenues
 
2,540

 
2,665

 
(125
)
 
(5
)%
Gross profit
 
$
(2,540
)
 
$
(2,665
)
 
$
125

 
(5
)%

Corporate Segment

Corporate cost of net revenues decreased $0.1 million, or 5% in the three months ended September 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 September 30,
 
2016
 
2015
 
$ Change
 
% Change
 
(in thousands)
Technology and development
$
43,284

 
$
38,066

 
$
5,218

 
14
 %
Percentage of net revenues
23
%
 
23
%
 

 

Sales and marketing
$
41,903

 
$
43,052

 
$
(1,149
)
 
(3
)%
Percentage of net revenues
22
%
 
26
%
 

 

General and administrative
$
26,181

 
$
27,449

 
$
(1,268
)
 
(5
)%
Percentage of net revenues
14
%
 
16
%
 

 


Our technology and development expense increased $5.2 million, or 14%, for the three months ended September 30, 2016, compared to the same period in 2015. As a percentage of net revenues, technology and development remained flat at 23% in the three months ended September 30, 2016 and 2015. The overall increase in expense was primarily due to an increase of $3.0 million in personnel and related costs due to increased headcount, an increase of $2.6 million in professional fees, an increase of $1.3 million in facilities costs primarily resulting from additional network operations and security support, and an increase in stock-based compensation expense of $0.3 million. These factors were partially offset by an increase of $1.7 million in software and website development costs capitalized and by a decrease of $0.3 million in depreciation and amortization expense.


28


At September 30, 2016, headcount in technology and development increased by 13% compared to September 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 September 30, 2016, we capitalized $7.7 million in eligible salary and consultant costs, including $0.3 million of stock-based compensation expense, associated with software developed or obtained for internal use, compared to $5.9 million capitalized in the three months ended September 30, 2015, which included $0.3 million of stock-based compensation expense.

Our sales and marketing expense decreased $1.1 million, or 3%, in the three months ended September 30, 2016 compared to the same period in 2015. As a percentage of net revenues, total sales and marketing expense decreased to 22% in the three months ended September 30, 2016 from 26% in the three months ended September 30, 2015. The decrease in our sales and marketing expense was due to a decrease of $1.7 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 $1.6 million in depreciation and amortization expense. These factors were partially offset by an increase of $1.2 million related to our integrated marketing campaigns which included increased marketing partnerships and increased brand development costs. There was also an increase of $0.9 million in personnel costs due to increased headcount.

Our general and administrative expense decreased $1.3 million, or 5%, in the three months ended September 30, 2016 as compared to the same period in 2015. As a percentage of net revenues, general and administrative expense decreased to 14% in the three months ended September 30, 2016 from 16% in the three months ended September 30, 2015. The decrease in general and administrative expense was primarily due to a decrease of $2.3 million in stock-based compensation expense from the departure of our former Chief Executive Officer, a decrease of loss on asset disposition of $0.6 million, and a decrease of $0.2 million in depreciation and amortization expense. The decrease in general and administrative expense was partially offset by an increase of $1.0 million in professional fees, an increase of $0.6 million in facilities costs, and an increase of $0.4 million in personnel related costs.
 
Three Months Ended September 30,
 
2016
 
2015
 
Change
 
(in thousands)
Interest expense
$
(5,726
)
 
$
(5,613
)
 
$
(113
)
Interest and other income, net
130

 
433

 
(303
)

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 September 30, 2016 compared to $5.6 million during the same period a year ago. This increase in interest expense was primarily driven by an increase of $0.2 million in interest expense from our convertible debt compared to prior year.
 
Three Months Ended September 30,
 
2016
 
2015
 
(in thousands)
Benefit from (provision for) income taxes
$
18,235

 
$
(8,831
)
Effective tax rate
38
%
 
(16
)%

We recorded an income tax benefit of $18.2 million and an income tax provision of $8.8 million for the three months ended September 30, 2016 and 2015, respectively. Our effective tax rate was 38% for the three months ended September 30, 2016, compared to (16)% for the three months ended September 30, 2015. Factors that impacted the effective tax rate include the federal research and development credit, limitations on executive compensation, and disqualifying dispositions of employee incentive stock options. The tax expense related to the three months ended September 30, 2015 was highly sensitive to changes to our estimated effective tax rate for the prior year due to the near break-even taxable income.



29


Comparison of the Nine Month Periods Ended September 30, 2016 and 2015

 
 
Nine Months Ended September 30,
 
 
2016
 
2015
 
$ Change
 
% Change
 
 
(in thousands)
Consolidated
 
 
 
 
 
 
 
 
Net revenues
 
$
572,998

 
$
511,349

 
$
61,649

 
12
%
Cost of net revenues
 
336,069

 
299,345

 
36,724

 
12
%
Gross profit
 
$
236,929

 
$
212,004

 
$
24,925

 
12
%
Gross profit as a percentage of net revenues
 
41
%
 
41
%
 
 
 
 

Net revenues increased $61.6 million, or 12%, for the nine months ended September 30, 2016 as compared to the same period in 2015. Cost of net revenues increased $36.7 million, or 12%, for the nine months ended September 30, 2016 as compared to the same period in 2015. As a percentage of net revenues, cost of net revenues remained flat at 59% in the nine months ended September 30, 2016 and 2015. Gross margin also remained flat at 41% in the nine months ended September 30, 2016 and 2015.

 
 
Nine Months Ended September 30,
 
 
2016
 
2015
 
$ Change
 
% Change
 
 
(in thousands)
Consumer
 
 
 
 
 
 
 
 
Net revenues
 
$
476,072

 
$
458,087

 
$
17,985

 
4
%
Cost of net revenues
 
256,438

 
246,925

 
9,513

 
4
%
Gross profit
 
$
219,634

 
$
211,162

 
$
8,472

 
4
%
Gross profit as a percentage of net revenues
 
46
%
 
46
%
 
 
 
 

Consumer Segment

Consumer net revenues increased $18.0 million, or 4%, in the nine months ended September 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 nine months ended September 30, 2016, as compared to the same period in 2015.

Consumer cost of net revenues increased $9.5 million, or 4%, for the nine months ended September 30, 2016 as compared to the same period in 2015. Consumer gross margin remained flat at 46% in the nine months ended September 30, 2016 and 2015.

 
 
Nine Months Ended September 30,
 
 
2016
 
2015
 
$ Change
 
% Change
 
 
(in thousands)
Shutterfly Business Solutions (SBS)
 
 
 
 
 
 
 
 
Net revenues
 
$
96,926

 
$
53,262

 
$
43,664

 
82
%
Cost of net revenues
 
71,909

 
42,699

 
29,210

 
68
%
Gross profit
 
$
25,017

 
$
10,563

 
$
14,454

 
137
%
Gross profit as a percentage of net revenues
 
26
%
 
20
%
 
 
 
 

SBS Segment

SBS net revenues increased $43.7 million, or 82%, in the nine months ended September 30, 2016 compared to the same period in 2015. The increase in SBS net revenues is due to the expansion of projects, higher revenue volumes with existing customers, and our ability to execute on personalized print and digital communications at scale resulted in additional programs and volumes.

SBS cost of net revenues increased $29.2 million, or 68%, for the nine months ended September 30, 2016 as compared to the same period in 2015. SBS gross margin increased to 26% in the nine months ended September 30, 2016 from 20% in the same

30


period in 2015. The increase in SBS gross margin is primarily due to improved customer targeting and favorable product mix as a result of expansion of projects with our existing customers.

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

 
$

 
$

 
 %
Cost of net revenues
 
7,722

 
9,721

 
(1,999
)
 
(21
)%
Gross profit
 
$
(7,722
)
 
$
(9,721
)
 
$
1,999

 
(21
)%

Corporate Segment

Corporate cost of net revenues decreased $2.0 million, or 21% in the nine months ended September 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.
 
Nine Months Ended September 30,
 
2016
 
2015
 
$ Change
 
% Change
 
(in thousands)
Technology and development
$
122,866

 
$
111,928

 
$
10,938

 
10
 %
Percentage of net revenues
21
%
 
22
%
 

 

Sales and marketing
$
135,284

 
$
138,028

 
$
(2,744
)