Thursday, May 22, 2008

Shutterfly Shareholder Meeting, May 22, 2008

Shutterfly's (SFLY) meeting was as simple as Netflix's but with a completely different attitude. The first thing you notice is that the employees are happy and actually like being there. The vibe is absolutely wonderful, and if you are looking for a job in Redwood City, CA, you may want to apply at this company. I've never seen so many friendly people at a shareholder meeting. Of course, I was the only person there not on the payroll, so I did look out of place. Rather than ignore me, however, the staff approached me with interest.

The format of the meeting was exactly the same as NFLX's. No presentation, just the company logo in the back. As soon as the formal part of the meeting was over, we went straight to the Q&A session. I was the only one who asked questions.

The formal part of the presentation was well-organized. Specific employees had been trained beforehand to make motions and second them. They even began their motions with "Mr. Secretary," which added to the professional atmosphere. The food was standard--some fruit, some cookies, and coffee. These food items were near some company products, such as children's books, mugs, and other merchandise, showing SFLY's diverse product line.

First, I have to say that I was impressed with SFLY's CEO, Jeffrey Housenbold. Mr. Housenbold is one of the most articulate and prepared CEOs I have ever met. His responses to my questions were detailed and on point. My first question actually combined three issues, and he methodically responded to each issue with statistics and easy-to-understand responses that bolstered the company's image. Not once did I feel as if I was getting a prepared line--he was a breath of fresh air, especially after the NFLX CEO's terse responses. (SFLY's meeting, by the way, was held at 11AM, another indicator that the company wanted to welcome shareholders rather than drive them away by holding the meeting at 3PM.) SFLY's proxy statement also contains pictures and bios of the management team, which is an astute business move, because the pictures personalize the company more.

Some background from the company's Yahoo's Finance profile page: Shutterfly "produces and sells photo books; personalized calendars; greeting cards; photo-based merchandise, including mugs, mouse pads, coasters, tote bags, desk organizers, puzzles, playing cards, multi-media DVDs, magnets, and keepsake boxes; ancillary products, such as frames, photo albums, and scrapbooking accessories; and photo prints. It also produces customized children's books. "

My first question was what competitive advantage SFLY had over Flickr, whether the company was going to enter into partnerships like Flickr and Yahoo's, and what strategies the company had for growth.

Mr. Housenbold responded that SFLY manufactured its own products and was capitalizing on demand for various products, such as calendars, mugs, scrapbooking, and other merchandise. [from 10K: SFLY owns production facilities in Hayward, CA and Charlotte, NC, and may open more facilities in Charlotte.] He said that SFLY's business model was "permission-based sharing of memories," versus the less personal Flickr model. He indicated that less than 1% of Flickr's users generated about 40% of their content (my number may be incorrect, as I was quickly taking notes--but it was a very high number) and unlike SFLY, Flickr's revenue came from advertising rather than directly from its users and customers. Also, because SFLY controls its own manufacturing, they can enforce high quality standards, while Flickr cannot. The CEO continued to focus on how his company delivered quality. It was a flashback to Peet's vision, where Peet's CEO was basically saying that the company was going to focus on quality and let the product speak for itself through word of mouth.

Mr. Housenbold then talked about "customer centricity," a fun phrase. He said that his company offered 49 combinations of designs and its software and website were easy to use. On the other hand, Flickr did not have a direct e-commerce model and relied on advertising revenue, which implied that Flickr would be more beholden to its advertisers than its actual customers and consumers.

He said that Yahoo/Flickr had achieved [only] around 4 million dollars of revenue from 100 million accounts through ad-based generation (these numbers was be off due to my slow handwriting and attempt to capture all of his responses verbatim). In fact, Yahoo had actually shut down part of Flickr because it wasn't generating sufficient ad revenue. Meanwhile, with respect to growth, in 1999, SFLY started with 2 million customers and now had 9 million customers. The company was benefiting from a "viral marketing effect," where its brand name was entering the public sphere through its reputation and word of mouth on the internet.

As far as partnerships were concerned, his company has partnerships with, Border's, Target, and many other major companies. 78% of SFLY's revenue came from existing customers, which is impressive but indicates that the company isn't growing its customer base very quickly.

My second question was that I now understood how SFLY was different from Flickr (ad revenue business model vs. direct e-commerce model), but how was his company different from Snapfish? (a more similar competitor)

Mr. Housenbold first said that Snapfish ( didn't own any manufacturing facilities, a hit on the quality of their products. He said that Snapfish has said they want to be the Walmart of online photos, and they are gearing their services towards consumers who are more "price-conscious." It was a very nice dig, i.e., if you're poor and dislike quality, you go to Snapfish, not us. He also politely attacked Snapfish's loyalty to its customers by saying that after 6 months of non-activity, Snapfish deletes all memory. Basically, SFLY was "Nordstrom," while Snapfish was Walmart. And if that style of polite dismantling of a competitor doesn't impress you, he ended with this riposte: as far as he knew, Snapfish has never been profitable, while SFLY has generated a profit. If I was Snapfish's CEO, I would have felt compelled to commit seppuku after hearing how different the companies were. Snapfish's own website states that it is the "best value in photography," which doesn't sound so great after hearing the comparison to Walmart. One wants a quality product when it comes to memories.

My friend, who has used SFLY's website, said that she was impressed with it. She said that the website, for free, allows users to modify their pictures, making them lighter, darker, etc. She said she was also impressed with the available products, such as the mugs. She hoped that SFLY would allow consumers to continue to keep their photos stored online for free. I indicated that the company had an incentive to allow free photo storage, because it would encourage consumers to buy SFLY's products in the future.

SFLY's 10K was one of the best-drafted 10Ks I've ever read. It had a great explanation of the U.S. Supreme Court ruling that established the principle of non-taxation for internet companies lacking a proper nexus with certain states. The 10K doesn't list any cases by name, but it is referring primarily to Quill v. North Dakota (1992). See the following webpage for more information on the list of other relevant cases, i.e. Oklahoma Tax Comm'n v Jefferson Lines (1995) and Complete Auto Transit v Brady (1977):

Basically, a company needs to have a sufficient nexus with a state before being able to tax the company. A physical presence, such as a warehouse with employees, is obviously sufficient to form the necessary connection because the company derives benefits from the state, but there are many gray areas. SFLY states that it is collecting sales and use taxes where it has "property and/or employees." (10K, page 25)

If it's not obvious by now, I am very impressed with this company. However, its share price hovers near a 52 week low. Is SFLY a value play? Here is my thinking:

1) Why does this company need to be public rather than private? There are no major liability issues or a need for money to expand or build stores. The CEO never mentioned that he wanted to build retail stores to sell directly to the public. It seems very strange that such a company would prefer to be public and endure Sarbanes-Oxley compliance and other issues that divert resources from serving its customers. I predict that at some point, perhaps within five years, if the stock price remains stagnant, this company will be bought out, merge, or go private.

2) Flickr actually does allow permission-based photo sharing--you can set certain photos to be seen only by your friends and family and can restrict permissions. But that's a minor issue, because Flickr obviously doesn't allow its users to modify photos and is clearly geared towards a different audience, just as the CEO indicated.

3) The majority (52%) of SFLY's revenue comes in the last quarter of the year, probably in X-Mas and Thanksgiving sales. (From 10K, page 14)

4) If it can convince Wall Street that it will be able to grow at double-digit rates, SFLY's stock price will increase. For now, however, I don't see how SFLY is going to achieve a high growth rate. It doesn't really advertise--and it seems like it's taking the Peet's grass roots marketing model, where word of mouth drives growth. But the problem with a company like SFLY using Peet's marketing strategy of "quality + reputation + product-sells-itself = success" (my words, not theirs) is that Peet's has retail stores, making it is easier for others to recognize its products. I am sure you can all recognize a Peet's paper cup instantly if you saw one. But SFLY's products won't enter the mainstream as readily as a food item. Instead, the growth will probably happen as family members, the ones most likely to pay for products like children's books, get introduced to the services and products. If SFLY's strategy is focused on families and grandparents, that's a slower way to grow than trying to get national brand name recognition through general advertising and by directing traffic to its website.

5) SFLY is currently being sued by Fotomedia and Parallel Networks in the Eastern District of Texas. (What's so special about the Eastern District of TX? There's definitely some forum shopping going on there.) I suspect it may be difficult to see future prospects clearly until these lawsuits get resolved.

I will keep my eye on this company. The CEO was friendly and humble and came up to me after the meeting to talk. He indicated that he was a user of SFLY before he became the CEO, which is another plus. Another shareholder came late to the meeting, and the CEO sought him out and went to speak to him. This is a friendly company that should continue to have a great reputation.

See also, Interview with Mr. Housenbold:


Anonymous said...

This is the funniest analysis that I have seen yet. You fail to question ANYTHING that Housenbold said. Amazing.

You also fail to bring up anything from the 10-K that Housenbold didn't highlight himself. How about the fact that much of Shutterfly's cash is tied up in securities that are now illiquid and they couldn't sell them at auction. They may eventually recover some of the funds but at less than the price they paid.

Why does that matter?

A. To the consumer: Because they keep their most treasured memories online as a backup and if the company goes under, they're lost.

B. To the shareholder: Shutterfly stated that despite the cash tie-up, they can fund operations for at least the next 12 months. If they can't last longer, they will either go under or dilute shareholders. Just read their 10-k.

Anonymous said...

And one more thing -- the litigation by Fotomedia (started one year ago) is not likely to die. Fotomedia just filed a similar lawsuit against other online photo sharing services.