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EDITED TRANSCRIPT SFLY - Q4 2011 SHUTTERFLY INC EARNINGS CONFERENCE CALL

EVENT DATE/TIME: FEBRUARY 01, 2012 / 10:00PM GMT

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FEBRUARY 01, 2012 / 10:00PM, SFLY - Q4 2011 SHUTTERFLY INC Earnings Conference Call
CO R P O R AT E PA RT I C I PA N T S
Michael Look Shutterfly - IR Jeff Housenbold Shutterfly - President, CEO Mark Rubash Shutterfly - SVP, CFO

CO N F E R E N C E C A L L PA RT I C I PA N TS
Jim Friedland Cowen and Company - Analyst Youssef Squali Jefferies & Company - Analyst Mark May Barclays Capital - Analyst Heath Terry Goldman Sachs - Analyst Shawn Milne Janney Montgomery Scott - Analyst Aaron Kessler Raymond James & Associates - Analyst Mitch Bartlett Craig-Hallum Capital Group - Analyst Victor Anthony Lazard Capital Markets - Analyst

P R E S E N TAT I O N
Operator Good day, ladies and gentlemen. And welcome to Shutterfly's fourth quarter and full year 2011 financial results conference call. At this time all participants are in a listen only mode. Later we will conduct a question and answer session and instructions will be given at that time. (Operator Instructions). As a reminder, this conference call may be recorded. I would now like to hand the conference over to Michael Look, Vice President of Investor Relations. Sir, you may begin.

Michael Look - Shutterfly - IR Thank you, operator and good afternoon.Welcome to Shutterfly's fourth quarter and full year 2011 conference call.With us today are Jeff Housenbold, Chief Executive Officer of Shutterfly; Mark Rubash, Chief Financial Officer; and Brian Manca, Chief Accounting Officer. By now you should have received a copy of our earnings press release which crossed the wire approximately one hour ago. If you need a copy of the press release, you can go to Shutterfly.com under the investor relations link to find an electronic copy. We have also released a presentation that we will use as we go through this call. Call participants are advised that the audio of this conference call is being recorded for playback purposes and that a recording of this call, both in streaming online format and to a downloadable podcast, will be made available on our Web site within a few hours. You can access all of these formats through the investor relations section of our Web site at Shutterfly.com. Before we begin, I'd like to note that our discussion today will include forward-looking statements within the meaning of the Securities Act of 1933 and the Securities Exchange Act of 1934. These forward-looking statements include statements about our business outlook and strategy, and statements about historical results that may suggest trends for our business. For more information regarding these and other risks and uncertainties that could cause actual results to differ materially from those expressed or implied in these forward looking statements, as well as risks relating to our business in general, we refer you to the sections entitled risk factors in the Company's most recent annual report on Form 10-K and it's other filings with the SEC. I'd also like to note that any forward-looking statements made on this call reflect information and analyses as of today. This presentation contains certain financial performance measures that are different from financial measures calculated in accordance with GAAP and may be different from the calculations or measures made by other companies. A quantitative reconciliation of these non-GAAP financial measures to the most directly
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FEBRUARY 01, 2012 / 10:00PM, SFLY - Q4 2011 SHUTTERFLY INC Earnings Conference Call
comparable GAAP financial measures is available in our fourth-quarter and full-year 2011 earnings press release, which is posted on our investor relations section of our Web site at Shutterfly.com. Now I would like to turn the call over to Shutterfly's CEO, Jeff Housenbold. Jeff?

Jeff Housenbold - Shutterfly - President, CEO Thanks, Mike and good afternoon everyone. I will start today's discussion with an overview of our fourth quarter and full year 2011 results followed by some initial thoughts on our strategy for the coming year. I will then turn the call over to Mark for a detailed review of our fourth quarter and full year 2011 financial results, as well as the initial financial guidance for 2012. We will then open up the call for your questions. Let's start with a brief review of our Q4 financial metrics.We delivered solid financial results despite unprecedented levels of competitive discounting throughout the holiday season. Total net revenues for the fourth quarter were $264 million, up 59% year-over-year and just below the guidance range we originally provided during our Q3 conference call back in October. Equally important, fourth-quarter adjusted EBITDA was $89 million, an increase of $29 million or 48% from the same period last year. This performance marks the 44th consecutive quarter of year-over-year growth for Shutterfly and reflects the on-time shipment of more than 140 million greeting cards, photo books, calendars and photo gifts to more than 3.25 million customers. Moving onto our full year performance, 2011 was another highly successful year for Shutterfly as we continue to extend our market leadership, enhance the richness of our customer experience, expand our customer base and further improve our operational efficiency. Let me take a moment to highlight some of 2011 key competence. First, we delivered very strong growth from our personalized products and services, our largest and most important source of revenue. Maintained solid revenue contributions from current and made meaningful progress on our commercial print initiative. Net revenues for 2011 totaled $473 million, a reported 54% year-over-year increase. Organically, total net revenues for the Shutterfly brand, excluding Tiny Prints, grew 24% year-over-year versus our initial 2011 net revenue guidance of 18% to 21.2%. Our continued commitment to innovation, outstanding product quality, stylish designs, exceptional customer service and over all value enabled Shutterfly to serve approximately 5.5 million unique customers in 2011. Second, we believe we have improved our ability to increase market share as the multiple billion dollar social expression and personal publishing market continue to transition from off-line and generic content to online and personalized content. Our acquisition of Tiny Prints, we established a multi-brand online platform that offers the broadest and deepest line of products, designs and styles at multiple price points. Our Tiny Prints integration remains on track with many of key systems and processes already migrated and a meaningful percentage of Tiny Prints order volume now being manufactured in-house. These successful integration efforts enabled improvement in Tiny Prints profit contribution as evidenced by our full year 2011 EBITDA margin of 17.7%. Lastly, we continue to make sizable investments in our products, services and infrastructure. These investments, many of which are only feasible for companies of our scale, will enable us to increase the rate of product and service innovation by creating more cost efficient solutions for image rendering and massive data storage, and maintain best in class automated manufacturing technologies. As a result, we believe that we are uniquely positioned to further differentiate our products and services, continue to achieve scale efficiencies and expand our product breadth in customer segments. We believe that all of these attributes will help strengthen our competitive position and increase the barrier success in these early and large markets. While 2011 was a good year for Shutterfly, we did see some industry challenges toward the back half of Q3 and into the fourth quarter. As we referenced at the start of the call, this past holiday season saw unprecedented levels of competitive discounting from both new and established companies.While early season discounting has not been uncommon over the course of the past 12 years, this Q4 saw deeper and longer duration promotions throughout the peak holiday season. This environment made new customer acquisition more challenging. We believe that many of the competitive promotions were breakeven at best and will likely not be sustainable. Given our belief in the long-term market opportunity, as well as our superior value proposition, we chose to strike a balance between growth and profitability rather than pursue top line growth at any cost. As a result, our Q4 net revenues and profitability were below our expectations. Moving forward into 2012, it is uncertain how long this promotional behavior will continue and we recognize an appropriate, strategic response is required. While we will not be providing specific details of our strategy on this call for competitive reasons, we will share with you some of our
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FEBRUARY 01, 2012 / 10:00PM, SFLY - Q4 2011 SHUTTERFLY INC Earnings Conference Call
high-level thoughts. First, we continue to believe that our long-term strategy is intact and that the strategies that enabled us to emerge as the online market share leader will continue to drive the core of our activities. Second, we made a number of improvements at the gross margin level which were offset by the increased holiday discounting. Mainly, we achieved cost efficiencies in manufacturing and shipping, designer royalties and online marketing due to the scale of our multi-brand portfolio.We also optimized our promotional strategy in Q4 which we will deploy for the full year 2012. Third, the biggest impact from the heavier promotional environment during Q4 centered on new customer growth, as existing customer metrics remained very healthy during the fourth quarter and throughout the entire year.We believe that our existing customer performance confirms that our commitment to innovation, design filled products and services, customer friendly policies and industry-leading quality is resonating with consumers who are familiar with our products, services and overall customer experience. Finally, our competitive landscape is complex and includes large established companies like Hewlett-Packard's Snapfish and American Greetings card store, as well as many sub scale companies focused on a single product category like photo books, cards, stationery, canvas prints or calendars.With nearly all of our competitors outsourcing manufacturing and the prevalence of deeper discounts, there will likely be even greater pressure on the smaller players as they struggle to achieve unit volume scale and try to manage fulfillment across a network of independent manufacturers. With these thoughts as a backdrop you can expect that our approach for the coming year will encompass an expansion of our core product offering, investments in new product categories, customer segments and supported devices, further optimization of our promotional programs, as well as initiatives that can lower our overall operating costs. And though it is still very early in the year with many questions still outstanding about the economy, the team has already begun working on a number of initiatives that we believe will enhance our near-term and long-term competitive position. In closing, 2011 was a another highly successful year for Shutterfly. We delivered solid financial results, completed a major acquisition, introduced major innovations in the photo book category, achieved operational efficiencies and extended our market leadership position. We continue to make significant progress towards transforming the multi-billion dollar social expression and personal publishing market, and remain confident in our strategy and in the early and large markets in which we operate. I would like to congratulate the entire Shutterfly team for another successful year and extend my sincere thanks to all of our customers and shareholders for there continued support. With that, I'll turn the call over to Mark to review our financial results in detail.

Mark Rubash - Shutterfly - SVP, CFO Thanks, Jeff and good afternoon everyone. I will begin my comments today with some observations about our fourth-quarter performance, followed by a review of key metrics and then a walk-through of this quarter's operating results. I will conclude my comments with an overview of our Q1 and initial full year 2012 financial guidance. Following that discussion we will open the call for questions. As Jeff mentioned earlier, throughout Q4, we experienced unusually heavy competitive discounting that had a dampening effect on our overall net revenue growth, particularly with respect to new customers. After considering our premium multi-brand position and the short but seasonally intense Q4 shopping period, we elected to take a balanced approach of growth and profitability to the market rather than pursue growth at any cost.This thoughtful response to Q4 competitive conditions resulted in solid revenue growth and profitability and record free cash flows. Let's get started with the net revenue details. Net revenues for the quarter totaled $263.8 million, reflecting 59% year-over-year growth as reported, and a 21% year-over-year growth on a pro forma organic basis. Personalized products and services increased 77% year-over-year to $219 million, print revenues remained flat at $40 million and commercial print contributed $5 million, a $2.3 million in increased from Q4 of last year. Excluding commercial print, net revenues from the core Shutterfly brand grew 20% year-over-year with 74% coming from existing customers and 26% coming from new. For Tiny Prints, Q4 net revenues increased 33% year-over-year to $62.2 million, with new and existing customers representing 48% and 52% of Tiny Prints net revenues respectively. In terms of overall product mix in Q4, personalized products and services represented 83% of total net revenues and prints and commercial print represented 15% and 2% respectively. For the full year, personalized products and services represented 79% of total net revenues. Prints contributed
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FEBRUARY 01, 2012 / 10:00PM, SFLY - Q4 2011 SHUTTERFLY INC Earnings Conference Call
18% and commercial print represented 3%. During Q4, customer engagement metrics at our Shutterfly brand remained healthy with accelerating double-digit year-over-year growth in visits, registrations and orders and a record number of shares sent. This activity translated into 2.8 million customers, generating 4.6 million orders with an average order value of $43.05. On a year-over-year basis, Shutterfly brand saw a 23% increase in customers, 24% increase in order volumes and a 3% decline in average order values which reflects the discount intensive environment. Customer engagement metrics at our Tiny Prints brand also saw double-digit growth in visits, total customers and orders, but lower customer conversion metrics. Our balanced promotional approach resulted in Tiny Prints net revenues increasing 33% year-over-year to $62.3 million, a meaningful acceleration from Q3 growth levels. In addition, excluding one-to-one greeting cards, the Tiny Prints brand realized a 10% year-over-year improvement in average order value which increased to $116.81. Moving to cost of net revenues and gross margins, we reported a gross margin of 58.9% in Q4 which is slightly below the low end of our original guidance and down from the 61.6% gross margin we reported last year. Our reported Q4 gross margin reflects the combined effect of deeper than normal discounting levels in our core products such as photo books, calendars and cards, and lower than expected unit volumes at Tiny Prints, partially offset by cost efficiencies in manufacturing and fulfillment and in designer royalties. For Q4, approximately 38% of Tiny Prints total unit volume was manufactured internally, a metric we expect to increase during 2012. Turning now too operating expenses, excluding stock-based compensation, overall operating expenses totaled $76.6 million reflecting the cost structure of the combined businesses and purchase accounting amortization, partially offset by acquisition synergies and savings from other cost management efforts. Looking more specifically at our expense components, technology and development costs totaled $17.5 million for the quarter, or 6.6% of revenue, which is down from the 7.3% incurred in Q4 of last year. Excluding stock-based compensation and depreciation, our tech and dev spending increased approximately $4 million, or 41% year-over-year. This increase primarily reflects the incremental cost of the Tiny Prints business together with modest increases for power, collocation space and bandwidth. Continuing down the income statement, sales and marketing expenses totaled $49.5 million in the quarter, representing 19% of total net revenues compared to 16% in 2010. Excluding stock-based compensation and purchase accounting amortization, Q4 sales and marketing expenses totaled $44.4 million, representing 17% of total net revenues compared to 15% on the same basis in 2010.The majority of the year-over-year dollar increase is associated with the incremental cost of the Tiny Prints business together with year-over-year increases in various marketing channels.Total sales and marketing costs per customer across our two brands remained essentially flat compared to Q4 of last year as the Company benefited from various operational efficiencies in online search and display marketing. General and administrative expenses for the quarter totaled $15.7 million, or 6% of net revenues, compared to 8% of net revenues in Q4 last year. Excluding stock-based compensation and credit card processing fees which vary with revenue volumes, G&A expenses represented 3% of net revenues in the quarter, down from 4% in Q4 2010. Continuing the discussion, adjusted EBITDA for the quarter increased $29.1 million over the prior year to $89.3 million, reflecting 48% year-over-year growth. Our solid Q4 EBITDA performance reflects both the impact of the heavier promotional environment and the realized integration synergies and savings from other cost management programs. For the year, adjusted EBITDA was $83.7 million, or 17.7% of total net revenues. Capital expenditures during the quarter totaled $7.2 million, or 3% of total net revenues, and included $3.7 million for technology, $1.3 million for manufacturing and building improvements, and $2.2 million in capitalized development costs. For the full year 2011, capital expenditures totaled $33.6 million, or 7.1% of total net revenues, resulting in a record $50.1 million in free cash flow. Finally, cash, cash equivalents and investments at December 31, 2011, totaled $180 million. The effective tax rate for the quarter was 51.2%, bringing our full-year rate to 8.6%.The year-over-year decrease in our full year effective tax rate is primarily the result of deductions from disqualifying dispositions of incentive stock options, and from increased research and development tax credits. On a GAAP basis, our net income for the quarter was $35.4 million, or $0.97 per share, based upon $36.5 million weighted average diluted shares. In summary, 2011 was another successful year for Shutterfly. Despite the competitive pressures during this holiday season, we delivered solid net revenue growth, successfully completed a major acquisition, continued to make significant process against our strategic objectives, and generated
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FEBRUARY 01, 2012 / 10:00PM, SFLY - Q4 2011 SHUTTERFLY INC Earnings Conference Call
record free cash flow.We continue to believe that our long-term strategy remains on target and that the strategies that have enabled us to emerge as the online market share leader will continue to distinguish us from the competition. To complete my discussion, I would now like to summarize our outlook for Q1 and the full year 2012 together with some insight into our underlying assumptions. As Jeff indicated earlier, we continue to believe that the deep discounting behavior that competitors exhibited throughout the holiday season was likely unprofitable and for many unsustainable. Unfortunately, we continue to see deep discounting even in these early days of 2012 and cannot confirm whether this will be a tangent or permanent market dynamic.This reality, combined with continued macro economic uncertainty, requires a very thoughtful strategic response and guidance that provide sufficient flexibility to execute on multiple dimensions, both short-term and long-term. Currently, we expect Q1 net revenues to range from $83 million to $85 million, which reflects year-over-year growth of up to 49% on a reported basis and 10% growth on a pro forma organic basis. We expect our GAAP gross margin to range from 42% to 43% of net revenues and our GAAP operating loss to range from $25 million to $28 million. We expect our adjusted EBITDA will range between a loss of $6.5 million and a loss of $8 million, and that our GAAP effective tax rate will range between 45% and 55%. Finally, we expect the GAAP net loss per share to range from a loss of $0.31 to a loss of $0.43, based on approximately 35.9 million weighted average common shares. Turning now to the full year 2012, we estimate that net revenues will range from $550 million to $569 million, which reflects year-over-year growth of up to 18% on a reported basis and up to 12% on a pro forma organic basis. We expect the full year GAAP gross margin to range from 52% to 54% of net revenues. We expect that our GAAP operating income will range from approximately $17 million to $24 million, and that our full year 2011 adjusted EBITDA margin will range from 17% to 18% of net revenues. The full year GAAP effective tax rate is expected to range from 45% to 55%.We expect full-year GAAP net income per share to range from $0.25 to $0.28 per share based on 38.9 million weighted average diluted shares. Finally, we expect that 2012 capital expenditures will range from 7% to 7.5% of net revenues. We believe that our initial Q1 and full year 2012 net revenue and profitability outlook gives appropriate weight to our most recent Q4 experience, anticipated 2012 market conditions, our current investment and competitive strategy, and to this early point in our annual business cycle. With that, I sincerely thank you for your time today and for your friendship and support throughout my time at Shutterfly. I look forward to speaking with many of you in the days and weeks ahead. We will now open the call for your questions.

QUESTIONS AND ANSWERS

Operator (Operator Instructions). Our first question comes from Jim Friedland from Cowen and Company.

Jim Friedland - Cowen and Company - Analyst Thanks, I realize you are not going to go into details of your strategic plan, but the guidance that you put in place for '12, does that contemplate a worst-case scenario assuming that Snapfish and some of the other key players just are relentless in pricing and even if you guys whether deep discounts or ramping marketing, is that the -- is the worst case scenario baked in? A second follow-up question related is what is your latest view on M&A potential in the space? We have Kodak Gallery is clearly up for sale and I'm sure you guys would like to consolidate Snapfish and also what is your feeling on some of the smaller players in the space? Thanks.

Jeff Housenbold - Shutterfly - President, CEO This is Jeff, and Mark feel free to chime in here. As we indicated in the prepared remarks, what we try to do was put an appropriate conservative guidance out there that gave us the flexibility from a strategic standpoint to continue to invest in the business on new feature functionality, new products, new device capability that will enhance long-term revenue growth and also give us the flexibility to try a number of tactical initiatives

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FEBRUARY 01, 2012 / 10:00PM, SFLY - Q4 2011 SHUTTERFLY INC Earnings Conference Call
that will allow us to continue to increase our market share. I think what we are trying to say is that there was a irrational pricing during the fourth quarter.We have seen continued heavier discount than normal into the first, lighter than the fourth quarter, but heavier than a typical Q1 and that we assume that is not sustainable, but if it is, our guidance reflects that kind of approach for the full year.

Jim Friedland - Cowen and Company - Analyst And thoughts on M&A?

Jeff Housenbold - Shutterfly - President, CEO On the M&A site, without referencing specific targets, I think we are in the best position to continues to consolidate this industry. We have the largest market share. We are one of the few, if not the only company in this space outside of Vistaprint who plays tangentially in our space that is profitable. We have a healthy balance sheet with about $140 million, $150 million in cash after paying off the payables. As of the December close about $180 million. We have $200 million in line of credit and we have a public currency in terms of the stock. We are evaluating a number of opportunities but we're going to continue to what we have always done, which is make sure it makes strategic sense, that we the capability to integrate post acquisition and that is accretive to our shareholders over a reasonable period of time. As you can imagine, many of the players are feeling the pinch of the competitive environment and we have seen many of their books and there are very, very few that are even close to break even in the industry. We think as they continue to run out of venture capital money, that the opportunities will increase for us to continue to consolidate.

Jim Friedland - Cowen and Company - Analyst One quick follow-up on working capital, generally it's been a positive benefit for the Company, this year it was a negative impact for the full year of I think $13 million. Was there any kind of one-time dynamics in timing that would explain that and do you expect it to return to a positive or beneficial cycle in 2012?

Mark Rubash - Shutterfly - SVP, CFO The only thing that I think is fundamentally different in 2011 is we brought on the Tiny Prints business in total and their employee base in late April. At the outset, they had a negative working capital burn just because of their scale compared to Shutterfly historically. Outside of that, the only thing meaningful that is incremental is we've made a fairly meaningful investment in automation equipment in front of Q4, for both the photo book line and card and stationery. That is not an annual recurring type and investment. With the synergies we get from in source manufacturing on Tiny Prints and some of the other scale efficiencies and material, labor and shipping costs and other parts of the P&L, that burn, I think, will be much more modest as we go across 2012.

Jeff Housenbold - Shutterfly - President, CEO Keep in mind, the beauty of our business model remains intact. We are essentially 100% credit cards. We get the cash even before we ship the product and we are adjusting to our manufacturer, so we are sitting on very little inventory with high inventory turn.

Jim Friedland - Cowen and Company - Analyst So, the current guidance seams would contemplate a return to the positive working capital cycle in '12?

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FEBRUARY 01, 2012 / 10:00PM, SFLY - Q4 2011 SHUTTERFLY INC Earnings Conference Call
Mark Rubash - Shutterfly - SVP, CFO I think historically, Q3 has been the low point of our cash and cash equivalents and investments. That is just seasonality at work. For the full year we've been generating pretty meaningful cash since 2008.

Jim Friedland - Cowen and Company - Analyst I will stop there and pass the baton.Thank you.

Operator Our next question comes from Youssef Squali from Jefferies and Company.

Youssef Squali - Jefferies & Company - Analyst Thank you very much, a couple questions. The first is just a clarification. The 33% year-on-year growth in Tiny Prints, the revenues in the quarter, that compares with 21% in the third quarter? Is that correct, Mark?

Mark Rubash - Shutterfly - SVP, CFO That's correct.

Youssef Squali - Jefferies & Company - Analyst Great. With regards to your guidance, I was wondering if maybe you can go one step further down that 12% pro forma organic growth and what is implied in terms of core Shutterfly versus Tiny Prints? I think in your prepared remarks you said that roughly 38% of all Tiny Prints unit volume was done internally, I was wondering what's the getting factor there? We would have thought that by now it would have been materially higher.

Jeff Housenbold - Shutterfly - President, CEO This is Jeff. Let me start and I will pass it to Mark. One of the other strategic color is as we saw competitors do what we think is irrational pricing, we don't think 80% off is a business model. We took the long-term view and said look, we're going to modestly increase our level of promotion to make sure we capture the high-value customers, but we're not going to become an unprofitable company and we're not going to diminish the brand equity that we have created across Tiny Prints, Shutterfly and Wedding Paper Divas. While there was a slight miss on the top line, that incremental increase in promotional activity flows straight to the bottom line because it comes right out of net revenue. We took what we think is a strategic long-term, appropriate response and the guidance we are giving is assuming that, that approach remains static and says we're not going to go chase that next unprofitable order, but we are going to continue to invest in feature, functionality, new products, design, quality customer service that will allow us to attract long-term profitable customers. You saw that in our retention rates and the growth rates out of revenue out of our existing customers on both the brands during the fourth quarter. The guidance assumes that but it also provides us flexibility that tested a number of different approaches that we might segment the market in different ways. I don't want to go too far beyond that for competitive reasons, but that is the philosophy as we went to guidance.

Youssef Squali - Jefferies & Company - Analyst To follow-up on that, does that imply mid- to high single digit organic growth in the core Shutterfly and maybe high teens or 20% at Tiny Prints, is that kind of a fair assessment of the break down of the 12%?
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FEBRUARY 01, 2012 / 10:00PM, SFLY - Q4 2011 SHUTTERFLY INC Earnings Conference Call

Jeff Housenbold - Shutterfly - President, CEO I think you're in the ballpark. I think something with a two handle on Tiny Prints and something in the high single digits on Shutterfly is in the ballpark and, again, that is assuming we don't go our and rent an order that we just continue to acquire profitable customers. That may have a dampening effect on the top line growth in the short-term, but we believe the investments we're making, our competitive position, our profitability from a long-term standpoint is the right approach to go.

Mark Rubash - Shutterfly - SVP, CFO On the second question on in store Tiny Prints volumes, the focus in Q4 was predominately on the Tiny Prints brand primarily to capture as much as we could in the window we had post acquisition before the Q4 holiday season. There was virtually no insourcing of any of the Wedding Paper Divas SKUs which tend to ramp up in Q1 and into the early part of Q2. One is getting the Wedding Paper Divas product SKUs in house is the next step. The second barrier, if you want to call it that, are things that we have to sort through is the nature of attached products. Our goal is to try and ensure the maximum amount of deliveries, everything is in a single order instead of splitting the order across vendors. This year we took an approach of most attached products. We kept out source to enable that to occur. In 2012 we will be bringing in some of those attached products internally which will enable a higher level of penetration, and likely take on a broader set of SKUs on the Tiny Prints platform. 38% in Q4, that is roughly 18% of their annual volume. Very rough math. If we didn't change a thing, the benefit would double in 2012 at that same penetration and we think there is room to meaningfully improve that.

Youssef Squali - Jefferies & Company - Analyst Thank you.

Operator Our next question comes from Mark May from Barclays.

Mark May - Barclays Capital - Analyst Thank you. Some of the efforts that you are alluding to that you will start to implement in Q1 that are having the effect of causing EBITDA to decline on a year-over-year basis in Q1, and I think probably organically your gross profit to also decline year-over-year, I haven't parsed through all the number, but I'm assuming that, that is not implied to continue throughout the rest of the year. Why -- is this sort of a one-time test? Kind of walk me through why would we not continue to see, on a year-over-year basis, a negative impact on gross profit and EBITDA as you are implementing these new reactive strategies to what is going on in the marketplace?

Mark Rubash - Shutterfly - SVP, CFO Keep in mind is that in 2011 Q1 we didn't own Tiny Prints and they had a EBITDA loss. A growth rate that is lower this year but a cost structure that is basically fully intact, outside of the improvements we have made on the manufacturing side, if we did report Tiny Prints separately, I think there would still be, at a minimum, an effect of pulling down the EBITDA margin and likely a small EBITDA loss. Having said that, the dynamic is really about how does the competitive discount environment impact our P&L is really what that work. Our MLS costs, our material, labor and shipping unit costs, all were very much improved over the course of the year. It's really about how much, one, volume we're going to print through our manufacturing plants to cover the fixed manufacturing overhead, and, two, what is the ASP level on the pricing. ASP, obviously, hits revenue and margin disproportionately because of a 100% flow through.

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FEBRUARY 01, 2012 / 10:00PM, SFLY - Q4 2011 SHUTTERFLY INC Earnings Conference Call
In the guidance there is basically an assumption that we will likely lose some volume because we're not going to be discounting at 80% levels like some competitors.That is fewer dollars from a historical perspective to cover the fixed manufacturing overhead. Likewise, we will probably continue to discount at a level that is somewhat deeper than Q1 of last year which has an ASP impact that hits top line and bottom line for the business that we do take in. From a total EBITDA standpoint, the biggest point of pressure is really unit volume and where that comes from and the timing and then, two, the ASP levels. From a cost standpoint, I actually feel very good about where the cost of manufacturing and even operating costs are moving in the right direction.

Mark May - Barclays Capital - Analyst It does imply that your cash operating expenses -- I don't have the detail of your P&L obviously, but it looks like your sales and marketing ratio on a year-over-year basis is going up 200, 300, 400 basis points, but is that mainly due to the Tiny Prints not being in a year ago?

Mark Rubash - Shutterfly - SVP, CFO Primarily. For one, you have to normalize that for the full year. Keep in mind that Tiny Prints has an average order value of over $115 per order. It is a different customer characteristic. Historically, they have always paid a higher percentage of revenue in their sales and marketing total. So, marketing working dollars than Shutterfly, particularly, they also don't have the broad product set that gets high repeat rates and longer-term consideration.The increase in sales and marketing as a percent of total revenues is almost exclusively due to the combination of Tiny Prints model into the Shutterfly model.To go back into my prepared remarks, we commented on the cost per customer was actually essentially flat year-over-year, even in our paid channels, on the CPC or CPA level. On the Shutterfly side, they actually declined Q4 to Q4 and on Tiny Prints it was up 4% to 6%, pretty modest because we are getting synergies on -- particularly in paid search, but also in display advertising.

Mark May - Barclays Capital - Analyst Okay, thanks. Best of luck on your next adventure.

Mark Rubash - Shutterfly - SVP, CFO Thank you, Mark.

Operator Our next question comes from Heath Terry from Goldman Sachs.

Heath Terry - Goldman Sachs - Analyst Jeff, I was wondering if you could us a since, when you look broadly across the industry and this competitive, kind of hyper competitive environment that we are in right now, could you kind of segment for us the degree of impact that you believe the deal channel just overall price competition and a higher marketing spend, whether on keywords or other online channels is really driving that? How would you weight those three things or maybe something else that we are not thinking of in terms of where you are really seeing this competition manifest?

Jeff Housenbold - Shutterfly - President, CEO This is Jeff.We're -- primarily the discounting was led by Hewlett-Packard Snapfish and American Greetings card store. Card store is the new endeavor for American Greetings. They were starting from round zero. Zero customers onto the base. They decided to spend money a meaningful amount of money on television advertising, as well as running 80% off for most of the season to try to get some brand recognition out there. Like you, I
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FEBRUARY 01, 2012 / 10:00PM, SFLY - Q4 2011 SHUTTERFLY INC Earnings Conference Call
read and listened to the American Greetings earnings call and it had a meaningful impact on their operating results from a margin standpoint. That was what they were doing in the marketplace on cards and stationery. Snapfish was running buy one get two free primarily throughout most of the season, so about 66% off on cards, photo books and calendars predominately. That impacts the broader base and more largely Shutterfly. We saw that we had a negative 3% decline in the average order value on Shutterfly because we decided to step up promotions somewhat, but certainly nowhere near to the level of HP and American Greetings. You saw average order value rise 10% on Tiny Prints, so we made a strategic position to preserve the pricing on the premium brand and take more margin there and still saw healthy reacceleration of growth from 21% to 33%. It's hard to quantify exactly, but most of it was the pricing from those two competitors and then you saw smaller sub scale players who were trying to acquire revenue in the fourth quarter, start to do more discounting but primarily through the flash channels. Large players did some of it, but most of the flash was filled by these third and fourth your competitors and they were doing it around photo books and canvas prints predominately throughout the quarter. On marketing spend, that was actually not a big issue. We saw normal rates for CPC and, as Mark indicated, we actually got quite a bit of efficiency from managing the multiple brands and optimizing the shelf space and the competitive dynamic between us and Tiny Prints, Shutterfly being the number one cards and stationery market share, TP the second. Now that we are part of the same company, we were able to optimize that, so we saw nice synergies and savings that we then redeployed some of those savings into the form of promotional dollars and into other channels. I would say predominately Snapfish and American Greetings with large discounts, it seems to me that, that plus flash you end up renting a customer, not acquiring a customer and the lifetime values and the ROI of that spend to us seems to be meaningfully negative and hence why we don't think it is sustainable in the long-term. Our guidance for the full year assumes that competitors are going to continue to do a rational thing, it assumes that we will have a modest approach to -- a balanced approach to pricing that will preserve the integrity and the brand equity.

Heath Terry - Goldman Sachs - Analyst I appreciate that, thank you.

Operator Our next question comes from Shawn Milne from Janney Capital Markets.

Shawn Milne - Janney Montgomery Scott - Analyst I wonder, Mark, if I could go back to the first-quarter revenue outlook. I can appreciate coming out of the rational pricing environment and that's continuing to some extent in Q1, but again the organic growth rates of both businesses certainly below expectations, but on Shutterfly nowhere near the 10% growth that you were guiding to you in the first quarter. Is there something more you can add around that? And then one follow-up.

Mark Rubash - Shutterfly - SVP, CFO I think the main additional thing I would say, as we mentioned in the prepared remarks, there was a disproportionate impact on our business with respect to new customers. Keep in mind that new customers are generally new to the category. They don't fully understand the different value propositions across the brands, the different fulfillment capabilities, qualities, selection, so one. Not knowing that and seeing deep discounts by a range of competitors, that is where we felt the biggest impact. When you go to Q1, and assuming that same level of discounting environment by competitors, Q1 doesn't have the same support from the existing customer base. Historically it has been slightly skewed towards new customers. Last year in particular we had very strong new customer growth in Q1 and Q2, and our guidance assumes that we're not going to be as successful this year. It is really taking an approach of Q1 does not benefit from the sentimental importance of our products that Q4 does, and therefore it is more dependent on existing customers and existing customers are going to be more challenging for us to attract.

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FEBRUARY 01, 2012 / 10:00PM, SFLY - Q4 2011 SHUTTERFLY INC Earnings Conference Call

Jeff Housenbold - Shutterfly - President, CEO If the competitive landscape stays status quo, new customer growth will continue to be impacted.

Shawn Milne - Janney Montgomery Scott - Analyst Secondly, coming back to an earlier question about Tiny Prints insourcing of volume, that struck me also as a low number, one that really wasn't described at the time of the acquisition. Can you piece some of that together with how Tiny Prints revenue ended up for the full year and maybe help us get down to what you would think Tiny Prints EBITDA margin would be in fiscal '11 and how you could continue to take some costs out of that in fiscal '12? Obviously there is -- you talked about more manufacturing in house, but it seems like in order to get those cost synergies you're talking about at the time of acquisition, there needs to be other changes.

Mark Rubash - Shutterfly - SVP, CFO Tiny Prints on a pro forma basis for the full year 2011 was roughly $119 million in total revenue if you include the pre- acquisition period Q1 and the first month roughly of Q2, and a 36% year-on-year organic growth rate. I would agree that 38% was below our expectations as to what we wanted to bring in Q4. Part of that, I think, is reflective in the unit volumes on Tiny Prints were lower than we had planned as well. And secondly, there's a dependency on the attached rates that all you can do is try to assume, based on your historical experience, what products are being attached and how many you can actually accommodate. I don't think -- getting to a higher penetration level, unless you go down into some of their very small volume SKUs, there's really nothing that is outside of our control. There are some things we would have to do differently in workflow within the plants because there is different papers and substrates that come into play, and some of them we may have to take more to a batch processing environment on kind of a small job shop approach, where our current configuration is really a very real-time process environment where we don't do a lot of batching. They are all things that the manufacturing teams understand well. They are very confident that they can increase that percentage and I think we made the best of what we could in the time we had in front of Q4.

Jeff Housenbold - Shutterfly - President, CEO If I can add to that, if you look historically the growth rates for Tiny Prints 2009, '10, and '11, 50% year-over-year in '09, 55% through an acceleration on an easier comp because '09, as we all know, was a tough year, and then 36% growth in 2011. Keep in mind, they had 2.5% EBITDA in 2010. So as we indicated, we were going to throttle back some of the inefficient marketing on the edges and get some operational efficiency, get some combination synergies and drive the EBITDA margin north of 2.5% versus our 21.8% as a stand-alone company in 2010. We made good progress in 2011. There's more to be done in 2012 and into the early part of 2013 and as we start to combine more of the prophecies and the systems, get to understand the interaction of the brands and the marketing dollars, continue to take more of the fulfillment in-house, we think that there is the opportunity for margin expansion as we fully integrate and fully optimize our multi-branded platform approach.

Operator Our next question comes from Aaron Kessler from Raymond James.

Aaron Kessler - Raymond James & Associates - Analyst Can you remind us of your investment initiatives for 2012 and 2013? I think previously you had talked about an e-commerce platform 2012 and potentially international in 2013.

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FEBRUARY 01, 2012 / 10:00PM, SFLY - Q4 2011 SHUTTERFLY INC Earnings Conference Call

Jeff Housenbold - Shutterfly - President, CEO I think we continue to make meaningful investments into our back end architecture, infrastructure, and technology platforms ranging from our product photo creation path, to our rendering platform, to our e-commerce platform, to our data warehouse. A number of those investments we made nice progress through 2011, but those projects will continue throughout 2012.We will get benefits throughout the year, but more meaningful benefits from some of those investments will manifest itself somewhat in Q4 2012 and then throughout 2013. We're also making investments in our data mining, CRM and revenue optimization through different various e-commerce flows, through promotional and pricing optimization, through further refinement of our customer segmentation and targeting capabilities in both online, on-site, e-mail and direct mail based marketing. We are also working on how do these brands coexist or not, and how do we try to drive from out of the Shutterfly brand deep customer base, how do we get them exposed to things like Wedding Paper Divas that we don't really play in wedding today on the Shutterfly side, but now we have this wonderful asset. How do we take all those folks who are doing save the dates on Shutterfly, but we don't offer wedding invitation. As an example, how do we better cross sell across the multiple brands. There's opportunities to further invest in automation in the manufacturing. We saw some nice returns from the earlier investment and photo book automation. We are going to continue that. Further optimization and order consolidation, and further cost savings from bringing more of the fulfillment, as Mark had just mentioned, from the Tiny Prints and Wedding Paper Divas business onto our manufacturing platform. Lastly, I would say we're making investments in new markets.We talked about one-to-one greetings that we are making an investment in and that business will launch in the first half of 2012. We are also investing in other areas that include different customer segments, commercial being one of those and a few we haven't yet talked about for competitive reasons. I feel really good about the early signs on investments we are making, the ability for us to, on a long-term basis, to continue to grow our market share and for the opportunity to continue to expand our margins after we fully digest the Tiny Prints acquisition.

Aaron Kessler - Raymond James & Associates - Analyst A quick follow-up, is the one-to-one, is that a mobile app? And then also, any update on the TV campaign? I don't know if you had any findings from that.

Jeff Housenbold - Shutterfly - President, CEO I think our one-to-one offering will be multi-dimensional, it will be both mobile and PC based or desktop-based environment. We think there is interesting occasions and a much better value proposition for the consumer than walking into your drugstore or your mass merchant and buying a Hallmark or American Greeting card that has static content and that costs $4, and you have to be inconvenienced by hopping in your car and getting out of your car. We think sitting down, being able to choose from thousands of designs, adding personalization, which may or may not include a photo, original content, the ability to have a stamp and address placed in our manufacturing and shipped right from the comfort of your keyboard or your mobile device at a lower price point with higher quality, better personalization and a much better wow effect for the recipient. We think we are uniquely positioned to be able to address that $6.5 billion market which we are not really addressing today and we are excited about that. On DRTV, we had indicated it was a small task and we ended up spending about $400,000, including the production costs and the media on it.The results, we had some good earnings from it. We saw high cross sell and up sell from it. We saw that in the markets in which we were dropping that the halo effect of an integrated marketing campaign impacted positively all of the marketing levers, and we think that on that scale the stand-alone cost of acquisitions didn't hit out typical thresholds. We think there is opportunity at scale and in combination with an integrated marketing approach for DRTV and other mass awareness channels to play in our overall marketing mix. I would call it a successful experiment in Q4 and we are going to continue to experiment and invest in new marketing channels as we have done historically as we branched into prints, our own catalog, direct mail, house parties and more than 41 active business partnerships. We think other

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FEBRUARY 01, 2012 / 10:00PM, SFLY - Q4 2011 SHUTTERFLY INC Earnings Conference Call
mass reach media has a place in our overall integrated marketing mix and as you know, we are very fact based and ROI based partners, so we will make sure that the numbers work.

Aaron Kessler - Raymond James & Associates - Analyst Thank you.

Operator Our next question comes from Mitch Bartlett from Craig-Hallum.

Mitch Bartlett - Craig-Hallum Capital Group - Analyst You've been talking about the new customers and how difficult it was in the promotional environment, so maybe we could talk about your existing base and how they performed during the quarter.You said that they did well. Were they loyal, did they wander off towards the more promotional competitive offering? Their AOV, was it -- did it also decline or was it up year-over-year? Just a little bit more color.

Jeff Housenbold - Shutterfly - President, CEO I would point you to page 13 in the investor relations deck that we ran concurrent with the call. I was very pleased with the response rates from our existing install base and as we have said over the years, we have exceptionally high net promoter scores. We have very strong loyalty from our customers. The overall experience on the brand, the customer centricity, the ease of use for design selection and the overall value proposition continues to resonate with our customers. We saw a 23% year-over-year growth of existing customers on the Shutterfly brand and we saw 53% year-over-year revenue growth on the Tiny Prints brand. Juxtapose that against new customer revenue growth of 11% on Shutterfly and 17% on Tiny Prints. That 17%, again, was in the face of raising prices in a fairly weak macro economic environment and a fairly competitive pricing environment. We were running an experiment there and we got some good data. Overall, pleased with the existing customer base and, as Mark said, we decided not to go buy unprofitable customers through 80% off and flash deal sites like our competitors that dampen the new customer growth and hence the revenue growth rates from that base. We believe, given the size of our install base, that provides kind of -- when you're looking at 74% and 52% of revenue from that base, that gives you pretty good comfort that we have an installed revenue stream that we can count on and that we're going to continue to find cost efficient, long-term strategically oriented channels for new customer growth.

Mark Rubash - Shutterfly - SVP, CFO I will just add that orders -- existing customers, Jeff described the growth. The orders from existing customers actually accelerated year-over-year and remain in a very healthy double digit level. AOV was down only slightly year-over-year, consistent with our overall AOV decline of about 3%. It was a very good turnout. They submitted more orders than they had historically, a nice increase, and the average order value held pretty much intact and consistent with where we were last year.

Mitch Bartlett - Craig-Hallum Capital Group - Analyst They don't appear to be pulled away from Shutterfly towards a competitive offering?

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FEBRUARY 01, 2012 / 10:00PM, SFLY - Q4 2011 SHUTTERFLY INC Earnings Conference Call
Jeff Housenbold - Shutterfly - President, CEO Given the numbers that we just described, I think our -- on the loyalty rates we have seen historically, from our customers, remains in tact and they perceive and come to Shutterfly and Tiny Prints for more than just price. There's a certain segment in the market that will be chasing price and there is a segment that values our free, unlimited storage, our non-compressed, non-deleted, non-down sampled image archives. They value our share sites, our thousands and thousands of designs, the ease of use, the embellishments and our next generation custom photo book path. The ease of our Simple Path. The way we talk to them, the relationship we have. The very price sensitive customers, they are going to chase that extra 20% off or flash deal site, but the high-value customers that have tended to come to the Tiny Prints and Shutterfly brand continue to do so and reward us with their loyalty.

Mitch Bartlett - Craig-Hallum Capital Group - Analyst Thank you.

Operator Our next question comes from Colin Sebastian from Robert W Baird.

Unidentified Participant - - Analyst This is [Greg Roshala] in for Colin. One thing that I would be really interested in trying to understand a little bit better is why do you guys think this competitive dynamic really fills up in 2011 of all years. You guys have been in business for over 10 years. We've gone through the worst recession since World War II and it seems like this is one of the most of the unusual quarters you guys have had from competitive discounting perspective. Most of the competitors, especially the larger ones are not new. American Greetings is probably new because of cost or on that perspective, but can you shed any other light on your thoughts on why this unfolded now?

Jeff Housenbold - Shutterfly - President, CEO Again, these are hypotheses, if you want answers from them you should ask those companies. Here's the hypothesis. We continue to grow our market share, we continue to grow faster than the market, we continue to increase our profitability as a stand-alone company, and then we made a transformative, strategic acquisition in Tiny Prints, combining the number one and number two online players into April time frame. I think the competitors started to say, wow these guys are really moving further ahead and all the investments we continue to make during the worst of that recession, as you may recall on our calls, we said we are cash flow positive, we have plenty of money on the balance sheet, we don't have any debt, we believe in the early stages of these markets. We believe they will continue to transform from offline and static to online and dynamic content. We're going to invest in new feature functionality like Simple Path, like our all new Custom Path with expanding the designs, and the assortment, and choices. We accelerated coming out of the recession. Our take is that the competitors who didn't make those investments, who haven't been as thoughtful and focused in this space had only one lever going into the fourth quarter where the vast majority, more than 50% of the sales and all the profits come from, so they pulled the lever, which is the easiest one called price.The big players pulled the price lever and then the smallest players, who don't have the scale and want to avoid further decline, decided to use a new channel called the flash sale to try to get their brand out there in a way that they didn't have available to them before. You had to buy keywords and hope someone clicked on it. Now Groupon will put your brand in front of 10 million people, and while that transaction is meaningfully unprofitable for them, at least they've gotten a transaction and that gives them some sense of hope that there is a business model there. I think that's what changed, was the flash sale sites and then the large competitors seem to continue to out execute and pulling the only lever that was available to them.

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FEBRUARY 01, 2012 / 10:00PM, SFLY - Q4 2011 SHUTTERFLY INC Earnings Conference Call
Operator The final question for today comes from Victor Anthony from Lazard Capital.

Victor Anthony - Lazard Capital Markets - Analyst I'm jumping on the call a bit late, so I apologize if you've answered these two questions I'm about to ask. First one, I wanted to see if you can discuss your international expansion plan? Give us an update on what you're thinking? With the print acquisition made in Europe, part of which has a consumer component, I wanted to get your thoughts on that. And second, there is a school of thought developing -- this is more of a longer term question. There is a school of thought developing that the high level of competition within the space in this category, which arguably is tied to consumers discretionary spending, could lead to a market that becomes commoditized and if that happens and average order value decline and so do revenues and profits. I wanted to get your sense on that, if you can give us your opinion? Thanks.

Jeff Housenbold - Shutterfly - President, CEO I think there were three questions there. One is we're not going to go into detail specifically around our international expansion plans for obvious competitive reasons. I will say that it remains as part of our overall multi-year strategy that we think the strength, and the scale, and the brand, and the consumer direct extend beyond the US borders. We have the hope and the intention to be a global company over time. On the second, we looked at the album printer deals. It was shopped four times to us over 18 months. Each time we decided it didn't fit strategically and the price was not right. You can look at the two recent acquisitions that Vistaprint made and the multiples that they paid were much higher than we were willing to pay. And strategically, we think through Europe, we didn't think that the album printer acquisition was the right one for us to start a [beach head].You will have to Vistaprint specifically about their strategic rationale. On the high-level competition, the commoditization, the AOV, I would say this is nothing new.We have been in business for 12 years and I've been at the helm of the Company for 7 plus now and we've had the same [details] from the day we went on the IPO road show. How are you possibly going to compete with Wal-Mart, Walgreens, CVS, Costco, Hewlett-Packard, Kodak, AOL, Microsoft, Yahoo, Hallmark, American Greetings, Sony, just to name a few. And we said we're going to do the same thing that many vertical players on the Web did, which is have a relentless focus on the customer, innovation, not being afraid to eat our own lunch and continue to out execute. That strategy, along with our vertical integration, our expertise and customer acquisition and conversion rates and e-commerce optimization, has allowed us, in my seven years, to go from a $50 million business to today's guidance of $550 million to $560 million. In seven years we have 10x and we have become the market share leader. During that period of time, we saw intense price competition in the four by six print arena. We saw large companies like HP and Kodak buy out Photo and Snapfish, but yet, during that period of time we continue to out execute.We diversify the product assortment.We optimized our business. And today, in 2011, four by six prints represented a little under 7% of revenue and our gross margins have remained fairly stable during that period of time as we expanded and increased our revenue base. Competition is always going to be, when you are playing in a $35 billion addressable market, but we think our scale, our singular focus, our extraordinary talented employee base, and our true customer centricity will allow us to continue to win. Lastly, I would say people talk about commoditization and that you can't make money in a commodity industry. I just think that's a completely -first of all, I don't believe there is commoditization. Second, I think that is just a completely false premise because when you look at Chevron and Exxon, they make plenty of money in a commodity. If you look at Procter & Gamble, they roll off hundreds of millions and billions of dollars in profits playing in commodity spaces in soap, and detergent, and personal care products. If you look at Wal-Mart and Amazon, they are throwing off billions of dollars in profits playing in pure commodity, standardized SKUs. Our e-commerce business is unique in that every single product we sell is unique. It is created by our customers and they care a lot more about the overall value proposition than just simply price. As we indicated in our prepared remarks, our strategy remains intact.We are confident in our ability to continue to execute and that we are confident in the early stages of the multi-billion dollar markets, and we are in the best position to transform from offline to online markets.

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FEBRUARY 01, 2012 / 10:00PM, SFLY - Q4 2011 SHUTTERFLY INC Earnings Conference Call

Victor Anthony - Lazard Capital Markets - Analyst Thank you very much.

Jeff Housenbold - Shutterfly - President, CEO In summary, I'd just like to thank everyone for their continued support and look forward to talking with all of you on the road in the next few days. Thank you.

Operator Thank you. Ladies and gentlemen, thank you for participating in today's conference.This concludes our program for today.You may all disconnect and have a wonderful day.

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