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SHUTTERFLY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In November 2008, the Company accepted an offer from UBS AG, one of its investment advisors, entitling the Company to sell at par value
auction-rate securities originally purchased from UBS (approximately $52.3 million, par value) at anytime during a two-
year period from June
30, 2010 through July 2, 2012. In accepting the Right, the Company also granted UBS the authority to sell or auction the ARS at par at any time
up until the expiration date of the offer and released UBS from any claims relating to the marketing and sale of ARS. Although the Company
expects to sell its ARS under the Rights, if the Rights is not exercised before July 2, 2012, it will expire and UBS will have no further rights or
obligation to buy the Company’
s ARS. The Rights represent a contractual agreement between the Company and UBS that will rank senior to
UBS' ordinary shares. Throughout the period from acceptance of the offer until the Rights are redeemed or UBS sells the securities, ARS will
continue to accrue interest as determined by the auction process or the terms outlined in the prospectus of the ARS if the auction process
fails. UBS’
s obligations under the Right are not secured by its assets and do not require UBS to obtain any financing to support its performance
obligations under the Rights. UBS has disclaimed any assurance that it will have sufficient financial resources to satisfy its obligations under the
Rights.
The Rights represents a firm agreement in accordance with FASB Statement No. 133, “
Accounting for Derivative Instruments and Hedging
Activities
” , (
SFAS 133), which defines a firm agreement with an unrelated party, binding on both parties and usually legally enforceable, with
the following characteristics: a) the agreement specifies all significant terms, including the quantity to be exchanged, the fixed price, and the
timing of the transaction, and b) the agreement includes a disincentive for nonperformance that is sufficiently large to make performance
probable. The enforceability of the Rights resulted in a recognition of a separate freestanding asset and was accounted for separately from the
ARS investment. As of December 31, 2008, the Company recorded $9.0 million as the fair value of the Rights, classified as long-
term
investment on the consolidated balance sheet as of December 31, 2008, with a corresponding credit to interest and other income, net, in the
consolidated statement of income for the year ended December 31, 2008. The Rights does not meet the definition of a derivative instrument
under SFAS 133. Therefore, the Company elected to measure the Rights at fair value under SFAS 159, which permits an entity to elect the fair
value option for recognized financial assets, in order to match the changes in the fair value of the ARS. The Company valued the Rights
as the
difference between the fair value and the original Par value of the ARS, adjusted for bearer risk, if any, associated with UBS ’
s financial ability
to repurchase the ARS beginning June 30, 2010 .
Prior to accepting the UBS offer, the Company recorded its ARS as available-for-
sale investments, and therefore recorded resulting
unrealized gains or losses, net of tax, in accumulated other comprehensive income in stockholders’
equity. In connection with the acceptance of
the UBS offer in November 2008, resulting in a right to require UBS to purchase the ARS at par value beginning on June 30, 2010, the Company
has reclassified its ARS subject to the Rights and held by UBS from available-for-sale to trading in accordance with FASB Statement No. 115, “
Accou
nting for Certain Investments in Debt and Equity Securities” (SFAS 115). The transfer to trading securities reflects management’
s intent
to exercise the Rights during the period June 30, 2010 to July 3, 2012. Prior to its agreement with UBS, the management’
s intent was to hold the
ARS until the earlier of anticipated recovery in market value or maturity. At December 2008, the Company recorded an other than temporary
impairment loss on its auction rate securities of $9.0 million in interest and other income, net, which had previously been recognized as a
component of other comprehensive income, net of tax. Any future gains or losses resulting from changes in the fair value of the ARS will be
recognized in earnings.
The following table provides a reconciliation for all assets measured at fair value using significant inputs (Level 3) as of December 31, 2008
(in thousands):
Rights
ARS
Balance at December 31, 2007
$
—
$
—
Purchase of ARS investments
—
52,250
Issuance of Rights
9,013
—
Unrealized loss included in earnings
—
(
9,013
)
Balance at December 31, 2008
$
9,013
$
43,237
83