UPDATE: Ancora's Letter to Shutterfly Chair Philip Marineau

Philip MarineauShutterfly, Inc.2800 Bridge ParkwayRedwood City, CA 94065Dear Philip:Ancora Advisors LLC is a shareholder of Shutterfly Inc. and we have publicly shared our views oncompensation and capital allocation leading up to and shortly after the most recent annualmeeting. Since that time, we have held off on any public communication to provide Shutterfly'sboard of directors time to digest and respond to a dissident shareholder (Marathon Partners)winning two seats on the Company's board and the resounding vote by shareholders against theCompany's executive compensation plan. We had hoped these seemingly clear messages ofdissatisfaction by the Company's shareholders would incite the changes necessary to maximizeshareholder value and avoid another year of shareholder acrimony.Unfortunately, the persistent inaction by the board and the responses of Shutterfly's CEO to aquestion asked during the Company's 2Q'15 earnings call leaves us with little expectation that theboard will heed the owners of the Company and implement changes to the issues Marathonaddressed in its proxy contest. Specifically, Mr. Housenbold was asked the following question,"What changes should we expect following the recent proxy vote?" Mr. Housenbold replied thatthere were essentially no planned changes within three topics to which shareholders clearly votedfor transformation based on Marathon's proxy materials – corporate strategy, capital allocationand compensation. Mr. Housenbold commented on the call: Corporate Strategy: "while we are open to good ideas from anywhere, fromshareholders, from customers, from partners, from employees, we believe as we saidconsistently throughout the proxy process, we believe we have the right strategy, theright vision, the market leadership, the right platform and the right set of execution andimperatives to be able to fulfill the Shutterfly 3.0 vision. So, I don't see any changes in thecorporate strategy" Capital Allocation: "we have been very consistent in saying that we are going to returnexcess capital to shareholders in a tax efficient way, coupled with remaining flexibility onthe balance sheet to do smart accretive acquisitions and not to lever up the Company toofar, given changes in macroeconomic and financial markets that could create adistressed situation. So, I don't believe there's any changes to our capital allocationstrategy either" Compensation: "We made meaningful changes in CEO compensation during the proxyprocess. And our comp committee, along with our outside advisors, are doing a holisticbottoms-up review, which will be discussed at the board level over the next few months.We need to be competitive. You've heard a number of Internet companies in the Valleycite challenges from unicorns and the hiring market, particularly in technology andmarketing, so we need to be competitive. Our preference is to have additional shares inthe pool to align shareholders' and employees' interests and create upside and retentivevalue. But absent of additional shares in the pool, as we said during the process, wewould have to default to cash, not our choice. So after this bottoms-up analysis, we willbe coming back to shareholders with a new proposal for additional shares in the pool"Though not entirely surprised, we view these responses as obtuse when considering the resultsof the latest annual meeting. Mr. Housenbold specifically dismissed the need for change incorporate strategy and capital allocation, and refers to "meaningful changes" in compensationmade during the proxy contest, which we find somewhat amusing given the overwhelming voteagainst the compensation plan that included these changes.It is also clear that the status quo strategy which Mr. Housenbold refers to is not working forshareholders, as evidenced by the performance of Shutterfly's stock price. Regardless of theirinvestment time horizon, investors are likely to be frustrated with strategy given the near,medium, and long term performance of the stock relative to the market.SFLY performance vs. relevant indices1-year 2-year 5-yearNasdaq (27.6%) (54.6%) (51.0%)Russell 2000 (25.7%) (35.2%) (18.6%)S&P 500 (21.8%) (45.6%) (22.3%)(as of 10/9/15)If Shutterfly's board continues to blatantly ignore the demands of its shareholders, it is hard for usto envision a scenario where the Company does not face another proxy contest in 2016,particularly in light of the share price underperformance outlined in the table above.We have shared some of our views on the three topics Mr. Housenbold discussed on the mostrecent conference call below. We would hope that you and the rest of the board would begin tostrongly consider our and other shareholders' input when considering how to drive the Companyforward from years of subpar shareholder returns.Corporate StrategyOne of the points of contention that we believe is top of mind for investors regarding theCompany's corporate strategy is the inconsistent message from management on requiringsignificant incremental investment versus harvesting previous investments. Below are a numberof quotes that highlight the poor communication from the Company's management team toinvestors: February 2014: "(we) anticipate the trend of significant investments in our scale andoperational infrastructure will moderate in 2015" – Brian Regan, CFO July 2014: "we think that the margins will expand in 2015 from an EBITDA standpointrelative to 2014" – Jeff Housenbold, CEO October 2014: "We haven't given a long-term model because things change and it's justbeen our consistent policy. But what we have said in the past is, we think EBITDAmargins return to a two handle; we think that capex drops back between 7% and 8%, andwe think we can drive top-line growth and increase profitability. So I believe EBITDA andfree cash flow will grow at a quicker clip than revenue will over the next three to fouryears" – Jeff Housenbold, CEO February 2015: "We expect that our GAAP operating income will range fromapproximately $0.5 million to $7.5 million and that our full-year 2015 adjusted EBITDAmargin will range from 17.5% to 18.1% of net revenues" (implying margins down YoY) –Brian Regan, CFO July 2015: "We didn't make any specific commitments to 2016 margins except for ourreiterating our belief that the investments we're making in technology and manufacturingwill allow us to reduce our cost structure and gain additional scale and scope economies,and that the margin should expand in 2016" – Jeff Housenbold, CEOThroughout 2014, management repeatedly pledged showing returns on previous investments viaexpanding EBITDA margins in 2015, but then reneged on those promises when issuing 2015guidance in February. Initial discussions around 2016 margins are following a similar pattern tolast year, and given the lack of management credibility, we are not surprised that investors arehesitant to take the Company at its word for these claims.While investment in both the consumer and enterprise platforms is certainly necessary and weare encouraged by the opportunity created by this investment to penetrate the enterprise marketand expand the Company's industry leading share through product improvement in the consumerbusiness, management needs to be held accountable for delivering returns on these investments.We believe this can be achieved through the establishment and publishing of longer termfinancial targets (beyond 1 year guidance), and the tying of executive compensation to deliveringon these stated longer term goals.During the first quarter 2014 conference call, Mr. Housenbold boasted about his ability to expandmargins if he so chose: "So too early to give you guidance exactly where it falls out (for 2015), but we couldmake this a mid-20's EBITDA margin model if we wanted to cut back on investments"While we acknowledge the response was prior to the Groovebook acquisition and the increase inthe mix of enterprise revenues, both of which will weigh on near term margins, there needs to besome accountability for management's claims to shareholders. Applying 22% EBITDA margins(well below levels management indicated they could achieve) to consensus 2016 revenues wouldimply that Shutterfly would be currently trading at just over 6x 2016 Adjusted EBITDA (~8.5x iftreating stock compensation as a cash expense).As exemplified by the current valuation, investors do not have faith in the current corporatestrategy to drive shareholder returns. Better communication of the long term strategy of theCompany and visibility into the financial impact of that strategy are steps in the right direction forrestoring management credibility. However, only when the Company actually hits these targetswill investors truly regain faith in management. To this end, we believe a portion of the long-termincentive compensation for executives should be tied to these longer term targets to ensuremanagement is properly focused on achieving the Company's stated goals.Capital AllocationWe concur with Mr. Housenbold that capital should be returned to shareholders tax efficiently andthat the Company should not take on excessive leverage. Through conversation with CFO BrianRegan, we also acknowledge that the Company must maintain a minimum cash balance tomanage large 4Q/1Q working cap swings and to preserve long term balance sheet flexibility toaddress the 2018 maturity of the convertible notes. While taking these points into consideration,we still believe the Company has an opportunity to drive significant FCF / share accretion throughadding modest leverage and pursuing more aggressive buybacks. We also believe there shouldbe an extremely high bar for acquisitions given the current Shutterfly valuation, and that theCompany should carefully consider the accretion to FCF / share of any deal versus repurchasingadditional shares.Barring any strategic transactions or other unforeseen events, the Company should be in a netcash position at the close of 2015, assuming the completion of the ASR and a continuation ofshare repurchases in the back half at a similar pace to the first half of the year (excluding thecash allocated to the ASR). We believe that the Company has an untapped asset in its balancesheet that should be put to use, particularly in light of the recent pullback in the stock price.In July, we sent an analysis to Mr. Regan which indicated that targeting a conservative netleverage level of ~1.5x (a minimum cash adjustment for working capital in our analysis results inactual levels below 1.0x) at the end of 2016 and 2017 by using cash on hand and modestlytapping the Company's credit facility to buy back stock would result in FCF / share accretion ofnearly 20% by 2017. At the current stock price, the accretion is now even more attractive,delivering FCF / share of over $5 in 2017 (with what we believe to be conservative revenuegrowth and EBITDA margin expansion assumptions). We believe the modest use of the balancesheet in this case provides the Company significant flexibility to deal with the seasonal workingcapital swings, invest in growth, manage the 2018 convertible maturity, and continue to pursuestrategic acquisitions.Mr. Housenbold often cites the hundreds of deals the Company analyzes on an ongoing basis.We believe the most attractive deal in front of the Company today is repurchasing its own stock.Not only should every deal the Company looks at be weighed against using that capital forbuybacks, but we also believe the board should strongly consider putting the balance sheet assetto further use to repurchase stock more aggressively or even tender for shares at these levels,both of which are extremely accretive for shareholders over the next few years as the Companybenefits from EBITDA margin expansion and a reduction of capital intensity.We have included an updated version of the analysis we sent Mr. Regan at the end of the letter.CompensationWhile compensation issues at Shutterfly have been discussed at length during the Marathonproxy contest and in our previous letters, we find it deeply disturbing that Mr. Housenbold notedon the last conference call, "We made meaningful changes in CEO compensation during theproxy process." We would like to reiterate a portion of the conclusion by ISS after assessingShutterfly's compensation practices (emphasis is ours): May 2015: "CEO pay, however, hews closer to the trend in revenue growth than the trendin shareholder returns, resulting in what is a troublingly large multiple of total pay to eventhe median of the company's own pay peers, let alone a more representative selection.At some point – this may be that point – shareholders need ask the hard question theboard appears to be ignoring: what, exactly, is the value proposition that justifies thisexpense?"ISS points out another egregious trend, noting that stock compensation rose to 59% of 2014adjusted EBITDA from just 30% in 2008, exemplifying how the relative cost to shareholders hasrisen dramatically. Given the overwhelming vote by shareholders in June against thecompensation plan (26,651,987 against to 7,467,750 for), we thought that the message fordramatic overhaul to compensation had been delivered. We believe shareholders will require thatthe bottoms-up analysis that the Company is undertaking and subsequent proposal provide thetransformation in executive compensation demanded at the annual meeting, and we hope theproposal would include some of the elements we have previously discussed, including: TSR / relative TSR based performance triggers for PBRSUs (versus EBITDA triggers) Use of out of the money options instead of RSUs Longer dated vesting schedules Metrics that tie to long term operating targets, which include the cost of stockcompensation to shareholders such as EBITDA less capex per share (un-adjusted)From 2011-2014, Mr. Housenbold has been paid over $50m in total compensation (which wouldhave eclipsed $62m through 2015 had the board's incentive compensation passed). During thattime, he has sold nearly $90m of Shutterfly stock and, after the failure of the sale process, wasgiven excessive and off-cycle stock grants that provided no functional method for ensuring heremains with the Company in the medium to long term or drive shareholder value, whichappeared abnormal to us. Since the beginning of 2011, Mr. Housenbold has prosperedhandsomely, yet investors have seen the value of their shares appreciate by only 12.2% in nearly5 years, implying a 2.4% IRR. We struggle to find any way that the legacy compensation planshave instilled an owner's mentality among senior management, and we would urge you to keepthis in mind when considering the next plan that you present to shareholders.Finally, Mr. Housenbold indicated that if no plan was passed by shareholders, the Companywould default to cash compensation without shares available in the pool. Should the Shutterflyboard and shareholders remain at impasse on executive comp, we encourage the board toconsider the precedent at WebMD Health Corp. In order to add shares to the pool to ensureretention of key non-executive employees, the WebMD board recently proposed excludingexecutive officers and members of the board from grant eligibility for the new shares available.We believe a similar compromise could prove tenable as a bridge to finding a long term executivecompensation solution acceptable to shareholders.ConclusionWe strongly recommend that you and your fellow board members view the outcome of June'sannual meeting as a shareholder mandate for change. The Company's owners haveunquestionably spoken. If the board is unwilling to implement meaningful changes to its currentcorporate strategy, capital allocation plans, and compensation policies, then we believe anotheractive proxy season is inevitable come 2016.Sincerely,Fred DiSantoChief Executive Officer and Executive ChairmanAncora Advisors LLCJames ChadwickPortfolio ManagerAncora Advisors LLCcc. Shutterfly Board of Directors