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Shutterfly (NASDAQ:SFLY)

Q1 2011 Earnings Call

April 27, 2011 5:00 pm ET

Executives

Jeffrey Housenbold - Chief Executive Officer, President and Director

Annie Leschin - IR

Mark Rubash - Chief Financial Officer, Principal Accounting Officer, Senior Vice President and Secretary

Analysts

Scott Devitt - Morgan Stanley

Shawn Milne - Janney Montgomery Scott LLC

Justin Patterson - Morgan Keegan & Company, Inc.

James Friedland - Cowen and Company, LLC

Sachin Khattar - Jefferies & Company, Inc.

Mitch Barlett - Craig-Hallum Capital Group LLC

Heath Terry - Canaccord Genuity

Operator

Good day, ladies and gentlemen and welcome to the Shutterfly Inc. First Quarter 2011 Financial Results Conference Call. [Operator Instructions] As a reminder, today's conference call is being recorded. Now I would like to turn the conference over to your host, Annie Leschin with Investor Relations.

Annie Leschin

Thank you, operator. Good afternoon, everyone. Welcome to our call today. With us on the call are Jeff Housenbold, Chief Executive Officer of Shutterfly; and Mark Rubash, Chief Financial Officer. A press release detailing our results is available on shutterfly.com and an archived copy will be kept on our website.

We've also posted some slides that we'll use as we go through this call. Additionally, within a few hours, we will release a recording of this call both in a streaming online format and through a downloadable podcast. You can access all of these through the Investor Relations section of our website 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 Private Securities Litigation Reform Act of 1995. These forward-looking statements include statements related to the acquisition of Tiny Prints, our business outlook and strategy and statements about historical results that may suggest trends for our business.

Actual results could differ materially from those projected in the forward-looking statements. From those expressed to imply and forward-looking statements and for more information regarding the addressed and uncertainties that could cause actual results to differ materially, including risks relating to the acquisition of Tiny Prints and our business in general, we refer you to sections entitled Risk Factors in the company's last annual report on Form 10-K and its other SEC filings.

I'd also like to note that any forward-looking statements made on this call today reflect our analysis 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 calculations or measures made by other companies. The quantitative reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures is available in our first quarter earnings press release, which is posted on the Investor Relations section of our website at shutterfly.com.

Now I'd like to turn the call over to Shutterfly's CEO, Jeff Housenbold. Jeff?

Jeffrey Housenbold

Thanks, Annie, and welcome, everyone. I'll start today with the review of our Q1 2011 progress and financial results and then turn the call over to Mark to review our financials in detail and provide financial guidance for Q2 and full year 2011.

We'll then open up the call for Q&A.

2011 began with a solid quarter, successful acquisition and several improvements to our products, services and internal infrastructure as we prepare for what we believe will be another strong year of continued growth and innovation.

Let me quickly highlight the key themes for today's call. First, our solid Q1 revenue gains were once again driven by our industry-leading Photo Books and Cards and Stationery categories. Combined, these two categories contributed nearly 60% of total net revenue this quarter and grew 40% year-over-year. Our continued innovation, design forward products and services, customer friendly policies and industry-leading quality all combine to present a compelling offering to a record level of new and existing customers.

Second, we continue to invest in Photo Books and Cards and Stationery, our key growth categories. We launched the external beta version of our new Photo Book platform and announced the acquisition of Tiny Prints, bolstering our market-leading position in the online cards and Stationery market. The combination of Tiny Prints and Shutterfly offers a rare and compelling strategic and synergistic acquisition. Both companies share a common commitment to delivering high-quality products, stylish designs and exceptional customer service. Shutterfly brings its expertise in scale and manufacturing and logistics. Tiny Prints adds access to customers that value a stylish, high-quality products across the Tiny Prints and Wedding Paper Divas brands as well as its world-class customer service. Together, we believed we have a unique opportunity to transform the multi-billion dollar Cards and Stationery industry.

And third, as in years past, we will continue to make prudent investments in our business to drive future growth, market penetration and free cash flow. We believe our market-leading position combined with our growing customer base, scale, vertical integration and brand equity will allow us to grow the Shutterfly franchise.

With these messages in mind, let me summarize our first quarter headline financial results. Consistent focus on our core customers and execution against key strategic initiatives resulted in our 41st consecutive quarter of year-over-year net revenue growth. We delivered net revenues of $57.2 million, a 25% increase over last year. This strong performance was once again fueled by growth in our line of Personalized Products & Services, which grew 34% year-over-year.

Now I'll briefly recap some of the progress we made due to our solid execution during the quarter starting with our products. We continue to differentiate our flagship Photo Book product demonstrated by the recent launch of the external beta version of our new custom-path Photo Book experience. This represents the most significant innovation Shutterfly has made in Photo Books since we first launched the category in 2001 with Snapbooks. The improved experience gives customers more creative control, yet remains easy to use and includes many of the top requested features like moveable text boxes, the ability to collect photos from multiple sources including Facebook, more design options including digital embellishments and the ability to customize everything on a page by easily dragging and dropping elements. We believe our new custom path, which balances ease of use with creative control will further differentiate Shutterfly's Photo Book offering and expand our lead in this important category.

While the beta program is only 2 weeks old, initial feedback from the beta testers has been overwhelmingly positive and we are looking forward to a very successful product launch.

On to Cards and Stationery. Our goal is to make the online shopping experience more inviting by providing the customer greater choice while enhancing their ability to search and find the perfect card for their occasion and personal style.

During Q1, we leveraged many insights from our successful Q4 holiday season to further improve the consumer shopping experience. Our updated card category page, now showcases key attributes such as color, form factor and gift-giving occasions and provides links to other related occasions. For example, events such as weddings now have links to rehearsal dinners, showers and bachelorette parties, increasing the potential for additional sales. To keep the line fresh and drive new customer adoption, we also introduced several new card designs for wedding, baby and graduation and then current [ph] the site for search engine optimization.

Turning now to Tiny Prints. Clearly, one of the highlights for the last month was our acquisition of Tiny Prints, which closed on Monday of this week. While we are only at the beginning of our integration, we continue to be very excited about our long-term goal of creating a world-class online Cards and Stationery offering. This year, we expect to see increased activity from Tiny Prints in the Cards and Stationery category especially ahead of the summer wedding season and from ongoing occasions such as baby announcements.

We also anticipate some initial cross-selling opportunities between Photo Books, Calendars and share sites, and we have plans for greater merchandising at Wedding Paper Divas.

Finally, as we discussed initially, we believe the greatest opportunity for near-term cost synergies is in manufacturing and fulfillment. Where we plan to insource a majority of Tiny Prints unit volumes beginning as early as Q3 of this year.

Moving on to services. We continue to increase customer adoption and engagement through our future risk services including share sites and mobile. From a strategic standpoint, share sites are a key component in driving new customer acquisition and loyalty, product sales and advertising and subscription revenues, all of which are still in the early stages of development. We ended the quarter with just over 3 million share sites and double-digit year-over-year growth in the number of shares sent. We continue to offer robust features based upon customer feedbacks and introduced 2 new capabilities during the first quarter. One, a key contacts module for youth sports teens and classroom sites allowing coaches, teachers and parents to track contact information. Users may select a key contract role such as visitor, member or owner and customize their desired privacy settings. And second, an improved photo viewing experience that also allows users to click through to the album and photo detail pages and to see their pictures in the context of our products. In addition to our share sites, we continue to build applications for desktops, laptops and mobile devices on both the Mac and PC platforms. Our long term goal is to get users the ability to enhance and share their photos and create stylish products regardless device, platform or location. This quarter, we launched version 1.1 of the Shutterfly iPad app, which is currently available on iTunes. This version takes advantage of many new capabilities available on IOS 4.2. New features include the ability to select all and upload pictures in your iPad photo album, upload pictures in full resolution with all meta data, multitask while uploading in the background and an improved user experience for loading large albums.

Now turning to our business development activities. We continue to partner with leading companies to increase the awareness and adoption of Shutterfly products and services. During the quarter, American Greetings decided to close PhotoWorks, its photo sharing site, and direct all of its customers exclusively to Shutterfly. The migration began on March 7 and should continue through May 5. During this period, PhotoWorks customers will see messaging on PhotoWorks.com and receive e-mails notifying them that American Greetings will be closing PhotoWorks and providing them with incentives to migrate their photos to Shutterfly free of charge. Our goal is to convert as many PhotoWorks users into active Shutterfly customers, and we believe we're off to a very good start.

To support our goals making Shutterfly a complementary destination for social networking activities, we introduced a new feature that allows customers to share a digital version of any Shutterfly product on Facebook. With a click of our new Facebook share bottom on Shutterfly, customers can post product images and details on their Facebook walls and news feeds.

Now anyone browsing on Shutterfly can shop socially and spread the word about our products. We believe this new enhancement will drive greater awareness and lead to increased revenues from Facebook and Shutterfly customers. We also continue to expand our presence and use of emerging social media channels like Facebook and Twitter to increase awareness, brand favorability and customer insights.

During Q1, the number of Shutterfly Facebook fans reached more than 200,000 and we are seeing strong fan engagement and activity on our page. The Shutterfly blog, Picture More continues to be a popular customer destination for inspiration, pics and tools for new and existing Shutterfly users.

Lastly, during the course of 2011, we will begin to coordinate our social media activates across the Shutterfly, Tiny Print and Wedding Paper Divas brands. And finally, let me discuss some of our accomplishments in manufacturing. Our investments in product innovation are resulting in improvements in throughput, quality and efficiency, which are in turn, reducing our costs and improving overall customer satisfaction. We made solid progress on the commercial printing front resulting in $2.3 million in net revenue for the first quarter.

In addition, we successfully integrated the employees, clients and assets of WMSG into our existing Commercial Print business.

So in closing, Shutterfly began 2011 with strong momentum across its core product lines. We're working hard to increase our market share lead in the Photo Book, Cards and Stationery and memory-sharing categories. And we will continue to deliver innovative design for our products and services, customer-friendly policies and industry-leading quality. With the acquisition of Tiny Prints, we've taken an important strategic step in growing our plan to transform the online Cards and Stationery market and to create significant long-term shareholder value.

With that, I'll turn the call over to Mark to review our financials in details. Mark?

Mark Rubash

Thanks, Jeff. And thank all of you for joining our call today. I'll start today's discussion with some observations about our first quarter performance followed by a review of our key metrics and operating results, an update on the Tiny Prints transaction and end with second quarter and revised full-year 2011 financial guidance. Following my prepared remarks, we'll open the call to your questions.

We're very pleased with our strong first quarter performance especially given the significant 2010 growth rate comparison. Our product net revenues from Photo Books and Cards and Stationery increased 40% year-over-year and continue to represent approximately 60% of our total net revenues. With the addition of Tiny Prints and Wedding Paper Divas, we're more confident than ever that we have the right strategy, products and team to maximize the early and large markets in which we operate.

Our growth during the quarter was driven by solid performance in our top global metrics and healthy demand across all Shutterfly products and services. Growth in site visits were as consistent with the prior year. Registrations and unique uploaders accelerated meaningfully, reflecting our recent acquisition of PhotoWorks' customers from American Greetings.

And finally, we continue to see healthy, double-digit growth in new share sites and shares sent. During Q1, we had approximately 1.3 million customers who generated nearly $2.1 million orders with an average order value of $26.64. This strong transaction activity resulted in 25% year-over-year growth in customers, 23% growth in order volumes and 1% growth in average order value.

Let's now move to our financial results starting with net revenues. Net revenues for the quarter totaled $57.2 million, reflecting 25% year-over-year growth. The allocation of net revenues between new and existing customers was 24% and 72%, respectively with notable improvements in new customer growth over last year.

Commercial Print customers contributed $2.3 million or 4% of net revenues this quarter including contributions from our recent acquisition of WMSG. Excluding our Commercial business and referral fees, net revenue growth in our core business accelerated 31% year-over-year.

In terms of product mix, personalized products and services represented 71% of total net revenues, an increase of 34% over the same period last year. This increase was once again driven by significant growth in Cards and Stationery and Photo Books. Total prints represented 25% of net revenues, increasing 3% year-over-year and net revenues from 4x6 prints decreased 5% from last year and contributed 13% of total net revenues.

Moving now to cost of net revenues and gross margin. We reported a gross margin of 48.4% during Q1, in line with our guidance and slightly above the prior year after excluding referral fees. The reported gross margin percentage reflects scale efficiencies from higher volumes and improved product mix, offset by increased promotional activity, lower margin commercial revenues and WMSG integration costs.

Turning now to operating expenses. Overall, we believe our operating expenses are in line with historical levels and consistent with our strategy. Q1 expense levels reflect a number of ongoing investments and technology development and infrastructure projects and in variable marketing programs, but also includes some infrequent transaction that should be considered when making year-over-year comparisons.

First, during Q1 of 2010, we recognized approximately $1.8 million associated with IT licensing arrangements, which was reported as a reduction of G&A expense. And second, during Q1 of this year, we recognized approximately $1.3 million in transaction cost associated with the Tiny Prints acquisition and about $700,000 of incremental payroll taxes associated with employee equity awards.

Looking more specifically at our operating expense components, technology and development costs totaled $13.1 million for the quarter, an increase of 8% over the prior year. Excluding stock-based compensation and depreciation, our technology and development spending increased approximately $1.7 million or 21% from the prior year due primarily to increases in engineering headcount and other product development costs.

Sales and marketing expenses totaled $14.3 million in the quarter, representing 25% of net revenues compared to 22% in Q1 2010. The increase was driven primarily by key additions to our marketing team, expanded online marketing and improved partner marketing performance. Total sales and marketing expense per transacting customer, excluding stock-based compensation showed a modest increase but remained below $10.

General and administrative expenses for the quarter totaled $13.3 million or 23% of net revenues compared to 19% of net revenues in Q1 2010. Excluding stock-based compensation and credit card processing fees, G&A expenses represented 15.6% of net revenues in the quarter, up from 11.4% in Q1 of last year.

Further adjusting for IT licensing fees in Q1 2010 and the Tiny Prints transaction costs in the current quarter, G&A expenses declined 2 percentage points to 13.3% of net revenues. Adjusted EBITDA for the quarter was a loss of $1.9 million, consistent with our most recent guidance. Adjusting for the discrete items mentioned previously, including IT licensing and referral fees totaling $4.1 million in 2010 an acquisition cost of $1.3 million and incremental payroll taxes of $700,000 in the current quarter, adjusted EBITDA would have improved approximately $800,000 over the prior year.

The effective tax rate for the quarter was 40.2%, reflecting Q1 discrete items and our full year estimated tax rate. On a GAAP basis, our net loss for the quarter totaled $7.8 million or $0.27 per share based on $28.7 million outstanding shares.

Now I'd like to provide some additional insights on our capital expenditures and liquidity. Capital expenditures during the quarter totaled $7.8 million, including $3.8 million for technology equipment and software, $1.7 million for manufacturing equipment and building improvements and $2.3 million in capitalized research and development. Cash and liquid investments at quarter end totaled $216.3 million.

I'd now like to offer a brief update on the Tiny Prints transaction, which was completed on Monday of this week. To summarize the terms of the transaction, we purchased the company for $146.5 million in cash and 4 million shares of Shutterfly common stock. Upon the close of the transaction, our combined cash and investment balances approximated $80 million. In addition, we have reserved approximately 1.4 million shares as consideration for the employee equity awards assumed in the transaction. Tiny Prints stockholders now own approximately 12% of the combined company and have restrictions on the sale of their shares that range from 6 to 18 months. While Tiny Prints was not included in our first quarter results, the company performed extremely well across both the Tiny Prints and Wedding Paper Divas brand with 52% combined year-over-year net revenue growth. We're extremely excited about this important acquisition and look forward to reporting our integration progress on future calls.

To complete my discussion today, I'd now like to summarize our outlook for the second quarter and the full year 2011, including the estimated impact of the Tiny Prints business effective April 25, 2011. In terms of net revenues, we expect stable, non-holiday growth rates with increased activity during the Easter, Mother's Day, Father's Day and graduation periods. In addition, we expect increased performance across our Cards and Stationery categories with incremental contributions from Wedding Paper Divas during key wedding seasons. As Jeff mentioned, we believe there are significant synergy opportunities between Shutterfly and Tiny Prints that we expect to realize over the next few years.

During 2011, we will work to optimize Tiny Prints revenue growth with improved profitability levels and will focus our integration efforts primarily on manufacturing, fulfillment and bringing Tiny Prints onto our ERP, planning and data warehouse platforms. With a short window for technology development before the important Q4 holiday season, we expect the majority of our product integration efforts to roll out beginning in 2012. With respect to our Commercial Print initiative, we continue to make progress with a number of new customers, as well expanded relationships with existing customers. We remain on track to deliver 2011 Commercial Print revenues ranging from $8 million to $10 million, which is included in today's financial guidance.

In terms of our cost structure for 2011, we remain committed to balancing our investments for growth with our commitment to increasing profitability and free cash flow. We will continue our efforts on a number of technology initiatives that should improve our overall operating efficiency.

And finally, in connection with the Tiny Prints acquisition, we expect to incur approximately $6 million in one-time acquisition-related costs during 2011 with approximately $3 million occurring in Q2. These costs relate to a range of items including investment banking and legal cost to complete the transaction, ERP integration, tax and Sarbanes-Oxley compliance, site infrastructure and PCI compliance and payroll taxes on anticipated option exercises.

In addition, we expect that our Q2 and 2011 GAAP financial results will include amortization of purchased intangible assets of approximately $3.3 million and $9.8 million, respectively. Similarly, we expect to incur incremental stock-based compensation of approximately $2.9 million in Q2 and $9.6 million for the full year 2011.

With these comments as context, I'll now summarize our guidance starting with Q2. We expect net revenues to range from $68 million to $72 million, which reflects year-over-year growth of up to 54%. We expect our GAAP gross margin to range from 46% to 48% of net revenues and our GAAP operating loss to range from $25 million to $27 million. We expect our adjusted EBITDA will range between a loss of $5 million and a loss of $7 million and that our GAAP effective tax rate will range between 45% and 55%. We expect the GAAP net loss per share to range from a loss of $0.35 to a loss of $0.46 based on approximately 32 million weighted average common shares.

Turning now to the full year 2011. We estimate that net revenues will total between $468 million and $478 million, reflecting year-over-year increases ranging from 52% to 55%. We expect the full year GAAP gross margin to range from 54.5% to 56.5% of net revenues.

We expect that our GAAP operating income will range from approximately $23 million to $31 million and that our full year 2011 adjusted EBITDA margin will range from 18.5% to 19.5% of net revenues. The full year GAAP effective tax rate is expected to range from 40% to 50%. We expect full year GAAP net income per share to range from $0.39 to $0.44 per share based on 35.1 million weighted average diluted shares. And finally, we now expect that 2011 capital expenditures will range from 6.5% to 7.5% of net revenues. This range includes approximately $2.1 million for landlord funded tenant improvements and up to 2.5% of net revenues in capitalized R&D costs.

In summary, we believe that our initial Q2 and revised full year 2011 financial guidance gives appropriate weight to our most recent business performance, the current and anticipated market conditions and the expected impact of the Tiny Prints acquisition. As we move forward with our integration plan, we'll provide additional updates on our progress.

So with that, I sincerely thank you for your time today and look forward to speaking with many of you in the days and weeks ahead. We'll now open the call for your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Jim Friedland from Cowen and Company.

James Friedland - Cowen and Company, LLC

So I wanted to get clarity on the Q2 EBITDA guidance. So the loss of $5 million to $7 million. Does that include the loss of $3 million in transaction costs coming in Q2? So without it, the range would have been like $2 million to $4 million or are you excluding it?

Mark Rubash

Jim, this is Mark. Yes, it does include the $3 million. And the $3 million really represent our best estimate of nonrecurring integration cost. So these are costs that will likely incur in 2011 that should not recur with any significant amount in the following years. So the EBITDA, not only includes the Tiny Prints business, the $3 million of nonrecurring incremental cost will also include their operating costs and other recurring types of integration charges.

James Friedland - Cowen and Company, LLC

Okay, great. And then just a quick one on the American Greetings site takeover. Is that material, all the customers come over? And any sense you can give as to how many have come over or is this just sort of an incremental bump that's helpful? Can you give us any kind of context?

Jeffrey Housenbold

Sure. This is Jeff. We are very pleased that American Greetings chose us as a partner. It's an incremental add to our active customer base. I don't it's going to be a step function change. It was a relatively small business. But these folks are active purchasers in the category. So we're hoping with our streamlined CRM, our broader product suite and our conversion rates that we'll be able to convert them into customers that look more like on the average Shutterfly customer in June quarters.

James Friedland - Cowen and Company, LLC

And do you think there's a potential for actually taking over the websites of some of the other players out there especially maybe some of the more traditional providers like drugstores, say Walgreens?

Jeffrey Housenbold

I think the industry continues to evolve and as we continue to expand our market leadership position and gain efficiencies from scale and continue to innovate in both the product side and the services side, that we're having more and more conversations where in the past, a lot of the folks and what you're identifying as retail have often wanted a private label or a white label solution where we've been a branded solution. And so folks like Target and CVS and Walgreens that we added in the fourth quarter, I think they're illustrative of where the industry is going that retailers want to sell the best-of-breed brands across all different product lines in their store. And so I think there's opportunities to continue to partner with a number of folks both online and offline in the years to come.

Operator

Our next question comes from Youssef Squali from Jefferies.

Sachin Khattar - Jefferies & Company, Inc.

This is actually Sachin, sitting in for Youssef. A couple of questions on the Tiny Prints acquisition. Just to confirm from your prepared remarks, are you guys taking in any sort of cross-selling synergies for in your revised guidance for Tiny Prints? And then number two, how quickly do you think you can ramp up gross margins for Tiny Prints?

Jeffrey Housenbold

So in terms of cross-selling, we do expect some synergies in 2011 primarily I think it's going to be like Q3 and then primarily Q4. As I mentioned on the call there's a pretty short window to do any type of heavy lifting product or platform integration this year. But we will be working on different programs to introduce the Tiny Prints customers to our broad product selection and vice versa. So we do expect some. And in terms of cost synergies, we have fully believe that the bulk of what we'll see this year will be related to manufacturing cost and fulfillments. And we'll probably start seeing those maybe at the very late end of Q3 predominantly in Q4. There is some work that has to be done both on the Tiny Prints platform and in our manufacturing workflow environment to make that happen. So the time between now and late Q3 or Q4 is when we expect to get that done.

Operator

Our next question is from Shawn Milne from Janney Capital Markets.

Shawn Milne - Janney Montgomery Scott LLC

Thanks and thanks for taking the questions. I just want to follow up again on Tiny Prints and then I do have a follow up just on the first quarter. Mark, can you give us a sense for what you're expecting in second quarter revenue for 2/3 of the quarter? Is it in the range of sort of $10 million, $11 million for Tiny Prints? And if you look at -- you've given some original clarity on when you did the deal. But any further sense on the cost structure of Tiny Prints? I mean, we're assuming -- it's my assumption is that you can add it on in terms of manufacturing at the same kind of gross margin level. Any more clarity on sort of the OpEx side for Tiny Prints? And then maybe how much of an EBITDA drag do you expect it to be in fiscal '11? And I'll follow up on the first quarter question.

Jeffrey Housenbold

So with respect to Q2, I think that a couple of points to keep in mind. One, Tiny Prints continued to grow at a very healthy rate. I mentioned in the prepared remarks, their Q1 top line growth was 52%. As part of Shutterfly, we're going to work to try and find the optimal level of revenue while delivering the optimum profitability. So we do expect that their growth rate will come down to some extent in Q2 as we change the marketing mix and approach. But we think that will overall create a healthier business and a more profitable one. In terms of cost savings and EBITDA impact for the year, I think a couple of things, one, we're not planning to provide separate P&L guidance or profitability guidance for the two brands going forward. But I will say that, on the Shutterfly side in Q1, we had, I think, a very healthy quarter on the core product side of the business, Commercial contributed as well. And the implied guidance for the full year basically, I think, keeps our prior guidance intact adjusted for the upside we saw in Q1. So our profitability on the Shutterfly side, we continue to feel very confident about, as well as the revenue growth. So the change in our previous guidance to this new revised guidance for the full year really reflects the expected impact of Tiny Prints combined with some of the upsell, cross-sell synergies we hope to realize in Q4 but primarily, the integration costs and the manufacturing synergies that'll come later in the year.

Shawn Milne - Janney Montgomery Scott LLC

Right. And just to be clear, you mentioned that in about the second quarter, but the full year EBITDA guidance would pick up the full year of integration costs, correct?

Jeffrey Housenbold

That's correct. That's correct.

Shawn Milne - Janney Montgomery Scott LLC

Okay. And Jeff, I don't know if you want to take that stab at this, but we were modeling Tiny Prints and based on your revenue guidance for the year and I think Mark sort of added at this that we're thinking that Tiny Prints would be growing around 40% for the rest of the year. Do you think, if you add Photo Books and Calendars and some of the other options, do you think Tiny Prints could actually accelerate into fiscal '12?

Jeffrey Housenbold

Yes, I think a couple of things to reiterate that Mark talked about in his prepared statements and try to provide a little bit of color for you guys. They had a very healthy year last year growing quite rapidly and Q1 was a strong as well with 52% growth. We're going to moderate that growth to a little bit to increase the profitability, kind of optimize the marketing spend. And then one of the top thing that their customers have requested from Tiny Prints has been Photo Books. And so for this fourth quarter, we're going to do a very, very light cross-sell probably be not integrated into the core platform and services Tiny Prints as one might want for this season. But I think there's opportunities next year to do deeper integration, more efficient pricing promotion and marketing coordination and really get more of the power of the synergies from a combination of our 2 combined customer basis. So I do think their growth rates will moderate in Q2 through Q4 from where it was last year and in Q1, but there is opportunity to reaccelerate those in the up years as we pull on some of the levers that we intend to do.

Operator

Our next question is from Mitch Barlett from Craig-Hallum.

Mitch Barlett - Craig-Hallum Capital Group LLC

Jeff, could you go back to your comments on Photo Books and maybe the new beta site of that? And perhaps provide just a little bit more detail on what it is you are rolling out on Photo Books?

Jeffrey Housenbold

Sure. We launched a couple of weeks ago, our all-new custom-path Photo Book experience, which is out in beta and a full roll out later in this quarter. And we've taken from a technological standpoint our old Custom Path which was on a Java platform with an AJAX/Front end , and we migrated that to a Flash Flex-based platform, which allows for our customers to be much more creative and to build Photo Books in a more rich content and design way, while improving the user experience. And so our customers are going to be able to use photos as the background, put text boxes in where they want and stickers and embellishments onto the page to augment and accent the photos of the story that they're writing. They'll be able to have many more design templates and idea pages where we help inspire them and things that they can do. They'll be able to share their Photo Book out across social networks and on to their share sites. And so it's essentially taking off-line scrap booking and that whole experience and the power and the richness of that creative suite and bringing that online in an easy-to-use, very intuitive interface that a neophyte could use but the output is beautiful and fantastic?

Mitch Barlett - Craig-Hallum Capital Group LLC

You said, you're extremely excited about it. Are you excited on -- can you measure a lift, a response rate improvement? How are you seeing this affect your customers' behavior?

Jeffrey Housenbold

It's too early to tell. We put it out in a very limited beta, where we invited a handful, call it tens of thousands of customers to try the beta and give us feedback. So it's too early to indicate what the impact on the business is going to be. But if you take a long-term view, we believe our flagship product, the Photo Book line is very important to our growth and still in the early stage of penetration. And so we're making the product better and easier and more powerful and meaningfully leapfrogging the competition and anything that is out in the marketplace. So we are very excited about what it's going to do for a new customer acquisition for existing customer retention and loyalty. But also in reducing the barrier allowing us to cross the chasm to the main stream so that they can enjoy and try the excitement that Photo Books provide them, their memory-sharing, memory-keeping activities.

Operator

Our next question is from Justin Patterson of Morgan Keegan.

Justin Patterson - Morgan Keegan & Company, Inc.

First, I was hoping if you could update us on your thoughts on international expansion given the scope of the Tiny Prints acquisition? I'm imagining that's probably a 2012, 2013 event at this point. And secondly, Jeff, during the prepared remarks, you talked quite a bit about mobile and social as, I think, pretty meaningful opportunities. I was hoping you could elaborate on your comments there.

Jeffrey Housenbold

Sure. Let me take the second question first, Jeff. Facebook is now the largest photo-sharing platform outside of the e-mail. E-mail still remains number one way people share photos. And as people are becoming more accustomed to taking pictures because they always have a camera in their pocket, usually attached to a cellphone or a smartphone and then they're getting more used to sharing life's joy and the memories and the moments that make up their lives. We want to turn Shutterfly into an application that has access to anywhere your photo's out in the lift, it might be on your iPhone, it might be on your iPad, it might an Android or Blackberry device, maybe on your PC or Shutterfly share sites. Maybe on Google Picasa or Yahoo's Flicker. So we want to be able to help customers be able to take their photos wherever they reside regardless of platform they're working on, PC or Mac and regardless to what the capturing device, be able to turn those pictures into memorable stories using either our Photo Book platform or other creative suites or products on our platform. And so we think the things that we've done in terms of connecting to that social graph make it easier and better for our customers and it differentiates us in the marketplace. As it relates to mobile, the primary plate for us again is the ability to access your photos from anywhere, be able to share on when you run into a friend in the airport or you're travelling back East and you don't have to look around photo albums. The ability to take pictures with your device and put them up over the cloud into Shutterfly and ultimately the ability to make products on the fly using our smart technology so that you can get memorable and personalized gifts or create fantastic keepsakes of your memories. So that's kind of where we're headed in terms of mobile and social. In terms of international expansion, we are very focused about executing, yes, the Shutterfly plan and integrating Tiny Prints successfully. But as we've talked about in the past, we believe the space that we play in is truly global and that the marketplace is still wide open across the globe outside the U.S. with the strength of our brand and the scale that the Tiny Prints acquisition provides us and the multi-brand strategy. We do believe that being a global company is in our future. And as you indicated, it's unlikely to be a 2011 activity.

Operator

[Operator Instructions] Our next question is from Heath Terry from Canaccord.

Heath Terry - Canaccord Genuity

If we look at the guidance that you implied for Tiny Prints this year, it seems like we're seeing a pretty significant deceleration in the growth rates from last year which you've touched on but we're getting to kind of around 30% of separate just back at the envelopes. How much of that is just natural maturing of the business versus a different strategy towards marketing spend now that Tiny Prints is part of the Shutterfly versus what was like a very much more aggressive spends when they were a private company?

Mark Rubash

I would say, I don't see anything that's changing in the growth trajectory of the business. A couple of things to keep in mind. One, we're only consolidating Tiny Prints from the end of April. So the first part of the year, which is a meaningful part for their full year, won't be part of this year's results. But I think the tempering of the guidance is really about -- we are planning to kind of overlay the Shutterfly approach or Play Book onto the Tiny Prints business. We don't exactly know how their customer base will respond, how the revenue will respond. So I think by definition, we need to be a little bit conservative when we make these types of structural changes and approach. So to the extent that we find the right formula that can optimize top line and bottom line, there may be upside as we go through the year. But this far away from Q4, no matter what the nature of an M&A transaction there are distractions to both sides in the normal course as you go through integration, and we're going to be adjusting the dial. So I think as Jeff said earlier, the markets for online Cards and Stationery is very robust across all of our PPS product line, Cards and Stationery are the fastest growing and continue to be so. So we're very, very optimistic about where this part of the business goes this year as well as into the future.

Heath Terry - Canaccord Genuity

Great and I appreciate that. One other question, you talked before about making some infrastructure and kind of systems architecture upgrades that were planned that would increase in part, helped improve average order size. Does that needed to get put on hold now as you work through the technical side of the integration?

Mark Rubash

No, not at all. In fact, a number of the big projects that we've been working on we're making actually very good progress. Jeff mentioned the new Custom Path is getting close to launch and it's probably the biggest undertaking. We're making solid progress on a very robust data warehouse environment that will also benefit the Tiny Prints business whether they have not yet made an investment in data warehousing and customer data and segmentation. CRM and E-commerce environments are also well underway and parts of them are nearing deployment that gives us the ability for more improved merchandising, upsell, cross-sell and promotion optimization. And then one thing we did go live with in Q1 was the pure disk storage environment where we now have a second and almost equal in performance but dramatically lower in cost storage environment for our photos. So we continue to believe that full resolutions forever for free storage. It's the best policy on the Internet. It's the best policy for consumers without exception and an integral part of our business. And now we can offer that at an even lower cost going forward.

Operator

Our next question comes from Scott Devitt from Morgan Stanley.

Scott Devitt - Morgan Stanley

Mark, you had mentioned that you anticipated 70% to 80% of Tiny Prints integrated into your manufacturing at the end of the third quarter this year, and so I was just checking to see if that's still the number? And then what you expect that to be by the end of 2012? Because I know there is going to continue be some outsourcing that occurs.

Mark Rubash

Yes, we're still targeting in terms of foreign factors and paper and sizes and the cards. You can take the top 3 or 4 SKUs and actually achieve 70% to 80% of their total unit volume. We're not, but we're focused on bringing in-house, and as I mentioned early on the call, it's going to be late Q3 and into Q4 before that happens. I think long term, there's always going to be some products that might be very unique SKUs or hard to manufacture or lower volumes that there's a better opportunity to outsource, we'll continue to do that. And I think over the course of the summer, we're going to learn a lot about all the different other products of Tiny Prints and even Shutterfly that might attach to orders and work through that in our workflow environment. So we're still confident that there are meaningful significant synergies coming out in the manufacturing side exactly how they will manifest themselves. We'll know more as we work through the year.

Scott Devitt - Morgan Stanley

Great. And then as it relates to seasonality. Is the seasonality of the business the same with the wedding business? I don't know if there's any significant differences from the Shutterfly business.

Mark Rubash

Yes. In terms of a -- sometimes you almost have to think of the Tiny Prints business look very, very similar to the Shutterfly Card and Stationery business. The Wedding Paper Divas really hits its stride in the early part of the wedding season where you're sending out a lot of save the date cards and bridal shower invitations and so on. So they tend to, the Wedding Paper Divas business tends to be more robust in the March timeframe. But you'll also see some capacity growth in the fall for autumn weddings. So when you layer that on to the existing Shutterfly business, I think it has a nice balance. I don't think it will structurally change seasonality in any significant way. Tiny Prints had 53% of their revenue last year in Q4 identical to ours. But there might be a little bit different cadence across the first 9 months of the year.

Operator

I show a follow up in queue from Shawn Milne of Janney Capital.

Shawn Milne - Janney Montgomery Scott LLC

Just a quick follow up on the CapEx, guidance and maybe the forward outlook there, Mark, I think in your prior call when you announced there you mentioned that Tiny Prints' CapEx was less than 3% of revenue. What's your sense incrementally moving forward? I mean, you just discuss your own storage cost continued to go down. I would assume that would be potential leverage, further leverage point for Tiny Prints, any more color on that?

Jeffrey Housenbold

Yes, we think, unless that they had a chance, as we did lower the CapEx guidance as a percent of revenue, the 6.5% to 7.5% of net revenue. That amount obviously reflects the Tiny Prints business but it also includes a couple of things that I don't think are our every year types wondered, there's a couple of million of leasehold improvements that our landlord is paying for our Redwood City headquarters. That's reflected in that 6.5% to 7.5%. There's also because of the major infrastructure projects that we have underway this year, there's a fair amount of capitalized software development cost. Those are all included in that range. And then we're also exploring some automation to our Photo Book and Cards and Stationery manufacturing line that could be incremental, $3 million to $5 million of additional CapEx this year. But very fast pace in terms of reducing the variable labor that's required in Q4 and extending the length of time before we would need a third manufacturing plant. That $3 million to $5 million of potential spend relating to automation equipment is also in that 6.5% to 7.5% range. So when you kind of take all of the puts and takes together, we're actually continuing to see a very healthy decline in our capital intensity as a percent of revenues.

Scott Devitt - Morgan Stanley

Right. And so if I take some of those, add it fiscal '11 investments and then maybe roll it out and then get out the end type, it's not to be repetitive. It looks like you're going to be drifting below and maybe it's just 6% or even below range in fiscal '12 in total revenue?

Jeffrey Housenbold

I think it's certainly possible. We're probably ahead our ability to forecast exactly where we're going to be next year. But I've been pretty consistent over the years. I think that the trends are in our favor. Equipments and hardware are getting more efficient and lower cost and we're finding better and better ways to deploy that. So I think that certainly is something we may see next year.

Operator

And at this point, I would like to turn the call back to Jeff Housenbold for any concluding remarks.

Jeffrey Housenbold

I want to thank everyone for joining us today. Hopefully to reiterate the takeaways, we've had a very solid Q1. We still have meaningful momentum in the business as our Photo Books, Cards and Stationery business lines particularly are resonating with our existing customers but also with new customers that are driving top line growth. We continue to get more efficient with our capital intensity and throughput lowering the overall cost in the business, increasing margins and free cash flow. And the acquisition of Tiny Prints helps us create a meaningful position in the online, Cards and Stationery market, which is still in their earliest days and also helps bring additional scale to the company and I believe we will prove powerful in helping to extend the size of the franchise in the years to come. So we're excited about the future and 2011. We welcome now officially all the Tiny Prints employees, and we look forward to catching up with you guys in a couple of months. Thanks, again.

Operator

Ladies and gentlemen, thank you for your participation on today's conference. This does conclude the program. And you may now disconnect. Everyone, have a great day.

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