Shutterfly 2008 Annual Report Download - page 30

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This document, including the following Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements
within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 that are based upon our current expectations. These forward-
looking
statements include statements related to our expectations regarding the seasonality of our business, the decline in average
selling prices for prints, our capital expenditures for 2008
and the sufficiency of our cash and cash equivalents and cash generated from operations for the next 12 months and our ability to grow our personalized products and services as
a
percentage of our total revenues, as well as other statements regarding our future
operations, financial condition and prospects and business strategies. In some cases,
you can identify
forward
-looking statements by terminology such as “project,” “believe,” “anticipate,” “plan,” “expect,” “estimate,” “intend,” “continue,” “should,” “would,” “could,”
“potentially,” “will,” or “may,” or the negative of these terms or other comparable terminology. Forward-looking statements involve risks and
uncertainties. Our actual results and
the timing of events could differ materially from those anticipated in our forward-looking statements as a result of many factors,
including but not limited to, the seasonality of our
business, whether we are able to expand our customer base and increase our product and service offering,
competition in our marketplace and the other risks set forth below under
“Risk Factors” in Part I, 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 an Internet-
based social expression and personal publishing service that enables consumers to share, print and preserve their memories by leveraging our technology,
manufacturing, web-
design and merchandising capabilities. Today, our primary focus is on helping consumers manage their memories through the powerful medium of photos. We
provide a full range of personalized photo-
based products and services that make it easy, convenient and fun for consumers to upload, edit, enhance, organize, find, share, create, print
and preserve their memories in a creative and thoughtful manner.
Consumers use our products and services to stay connected to their friends and family, to organize their memories in a single location, to tell stories and to preserve their memories
for themselves and their children. Our customers purchase physical products both for their own personal use and for giving thoughtful and personalized gifts such as photo books,
calendars, greeting cards and other photo-based products and merchandise.
We currently generate the majority of our net revenues by producing and selling professionally-bound photo books, personalized calendars, greeting cards, other photo-
based
merchandise and high-quality prints (ranging in size from wallet to jumbo-
sized 20×30 enlargements). We manufacture substantially all of these items in our Hayward, California and
Charlotte, North Carolina manufacturing facilities. By controlling the production process in our own manufacturing facilities, we are able to produce high-
quality products, innovate
rapidly, maintain a favorable cost structure and ensure timely shipment to customers, even during peak periods of demand. Additionally, we sell a variety of photo-
based merchandise
that is currently manufactured for us by third parties, such as mugs, mouse pads, coasters, tote bags, desk organizers, puzzles, playing cards, multi-
media DVDs, magnets and keepsake
boxes, and ancillary products, such as frames, photo albums and scrapbooking accessories.
Our high-
quality products and services and the compelling online experience we create for our customers, together with our focus on continuous innovation, have earned us
numerous third-
party accolades and, more importantly, have allowed us to establish a premium brand. We believe that we realize the benefits of a premium brand through high
customer loyalty, low customer acquisition costs and premium pricing.
Our customers are a central part of our business model. They generate most of the content on our service by uploading their photos and storing their memories. In addition, they
share their photos electronically with their friends and families, extending and endorsing our brand and creating a sense of community. Finally, by giving Shutterfly-
branded products to
colleagues, friends and loved ones throughout the year, customers reinforce the Shutterfly brand. Through these various activities, our customers create a viral network of new users and
customers.
In addition to driving lower customer acquisition costs through viral marketing, our customers provide input on new features, functionalities and products. Close, frequent customer
interactions, coupled with significant investments in sophisticated integrated marketing programs, enable us to fine-
tune and tailor our promotions and website presentation to specific
customer segments. Consequently, customers are presented with a highly personalized Shutterfly shopping experience, which helps foster a unique and deep relationship with our
brand.
Our corporation was formed in 1999 and we have experienced rapid growth since launching our service in December 1999. During fiscal year 2007, we fulfilled more
than seven million orders, to more than two million customers, at an average order value of more than $26 per order.
In June 2005, we completed the acquisition of Memory Matrix, Inc., a Nevada engineering firm dedicated to improving the consumer digital photography experience, in exchange
for 109,302 shares of common stock. In June 2007, we acquired for $1.6 million, certain assets and liabilities of CustomAbility, LLC, a New Jersey publishing company that produces
customized children’s books under the brand name Make It About Me
. On January 4, 2008, for $10.0 million in cash and stock consideration of approximately $4.0 million, we
acquired Nexo Systems, a privately held on-line sharing and group services company based in Palo Alto, California.
Basis of Presentation
Net Revenues. We generate revenues primarily from the printing and shipping of photo-based products, such as photo books, cards and calendars, photo prints, photo-
based
merchandise, such as mugs, mouse pads and magnets, and ancillary products such as frames, photo albums and scrapbooking accessories. Revenues are recorded net of estimated
returns, promotions redeemed by customers and other discounts. Customers place orders via our website and pay primarily using credit cards.
Our personalized products and services revenues are derived from the sale of photo-based products, photo-
based merchandise and ancillary products and services, and the related
shipping revenues. Referral fees are also included in personalized products and services revenue. We believe our products and services are differentiated from other traditional photo
processors by our high quality production and numerous form factors and templates, which are key to attracting and retaining customers.
Our print revenues are derived from sales of our photo processing of digital images, including sales of 4×6 prints, and the related shipping revenues. From time to time, we have
made changes to our pricing structure for 4×6 prints in order to remain competitive. In December, 2007, one of our competitors lowered their list prices on 4×6 prints from $0.12 to
$0.09. To date, we have not made any additional changes to the price of our 4×6 prints as a result of this price cut. However, a drop in our 4×6 prices, without a corresponding
increase in volume, or decreases in volume as a result of competitive pressures would negatively impact our net revenues and could adversely affect our gross margins and overall
profitability.
To offset these periodic price declines and continue to generate net income, we have continued to invest in large scale manufacturing technology to enable us to reduce the cost of
manufacturing prints. We have also continued to recruit highly qualified personnel with specialized skills in print manufacturing. We believe that these strategies have allowed us, and
will continue to allow us, to compete successfully with other companies in our industry. In addition, we continue to focus on diversifying our business towards the large and growing
market for personalized products and services.
Our business is subject to seasonal fluctuations. In particular, we generate a substantial portion of our revenues during the holiday season in the calendar fourth quarter. We also
typically experience increases in net revenues during other shopping-related seasonal events, such as Easter, Mother’s Day, Father’
s Day, and Halloween. We generally experience
lower net revenues during the first, second and third calendar quarters and, as is typical in the retail industry, have incurred and may continue to incur losses in these quarters. Due to
the relatively short lead time required to fulfill product orders, usually one to three business days, order backlog is not material to our business.
To further understand net revenue trends, we monitor several key metrics including:
Total Customers.
We closely monitor total customers as a key indicator of demand. Total customers include the number of transacting customers in a given period. We