Shutterfly (SFLY) Q4 2016 Results - Earnings Call Transcript

| About: Shutterfly, Inc. (SFLY)
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Shutterfly, Inc. (NASDAQ:SFLY) Q4 2016 Earnings Call February 1, 2017 5:00 PM ET

Executives

Shawn Tabak - Shutterfly, Inc.

Christopher North - Shutterfly, Inc.

Michael W. Pope - Shutterfly, Inc.

Analysts

Colin Alan Sebastian - Robert W. Baird & Co., Inc.

Naved Khan - Cantor Fitzgerald Securities

Christopher David Merwin - Barclays Capital, Inc.

Andrew Bruckner - RBC Capital Markets LLC

Kerry Rice - Needham & Co. LLC

Brian P. Fitzgerald - Jefferies & Company, Inc.

Heath Terry - Goldman Sachs & Co.

Operator

Good afternoon, everyone, and welcome to the Shutterfly Fourth Quarter and Full Year 2016 Earnings Conference Call. Please note that this event is being recorded. I would now like to turn the conference over to Shawn Tabak, Vice President of Investor Relations. Please go ahead.

Shawn Tabak - Shutterfly, Inc.

Thank you, operator. Good afternoon, everyone. Welcome to Shutterfly's fourth quarter 2016 earnings call. With us today are Christopher North, our Chief Executive Officer; and Mike Pope, our Chief Financial Officer. By now you should have received a copy of our earnings press release which crossed the wire just after the market closed. If you need a copy of the press release, please go to shutterflyinc.com to find an electronic copy. Our presentation is also available on our investor relations site. The audio of this conference call is being recorded for playback purposes, and a replay will be made available within a few hours.

Before we begin, I would like to note that our discussion today may 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 the assumptions underlying those statements, and statements about historical results that may suggest trends for our business. For more information regarding the 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 risk factors section of our most recent Form 10-K and Form 10-Q, and our other filings with the SEC.

I would also like to note that any forward-looking statements made on this call reflect information and analyses as of today, and we assume no obligation to update this information. This information may contain 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. A quantitative reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures is available on the Investor Relations section of our website at shutterflyinc.com.

Now, I would like to turn the call over to Chris. Chris?

Christopher North - Shutterfly, Inc.

Thank you, Shawn. Welcome to Shutterfly's Fourth Quarter 2016 Earnings Call. I'll start today's call by sharing the progress we made in 2016 against our key businesses and initiatives. Mike will then present our fourth quarter and full year financial results. After that, you'll hear from me again as I discuss our going forward strategy, including our 2017 plan. Finally, I'll turn the call back over to Mike to talk about what this means for our financials, providing full year and first quarter 2017 guidance, as well as our early thoughts on 2018. We're proud of many things in 2016. We delighted more customers than ever before, delivered against our key initiatives, and continued to make strong progress on operating income, demonstrating that our continued focus on improved profitability and quality of earnings is beginning to bear fruit. At the same time, we were disappointed that Q4 revenue growth came in towards the low end of our guidance range, which brought Q4 adjusted EBITDA slightly below our guidance.

We certainly have room to improve our execution on several dimensions. More fundamentally, as a team we've concluded that we need to make significant changes to focus and simplify our business model in 2017 and beyond as I'll discuss later on this call. I'll start with the positives. In 2016, Shutterfly and Tiny Prints retained their position as the two largest brands in our industry. Looking across all of our Consumer brands, we increased total unique customers by 4%, and total orders by 5%. Our customers remain loyal with over 75% of Shutterfly Consumer revenues coming from recurring customers. We launched a new Shutterfly mobile app on iOS and Android with an expanded product catalog, simplified product creation tabs, and auto upload functionality. We saw impressive uptake of the app, more than doubling both the number of app customers and the amount of revenue from the app year-over-year.

Our analysis shows that existing web customers who adopt our mobile app become significantly more valuable customers, which has led us to double down on marketing efforts to drive customers to the app. We launched Shutterfly Photos, our cloud photo management service, migrating most of our active Shutterfly customers prior to peak, and enabling all new Shutterfly customers since mid-year. Millions of customers both visited and actively engaged with Shutterfly Photos last year, including organizing their photos, using our facial recognition features, or initiating product creation and purchase, directly from their photos. Thanks to the combination of our mobile apps and Shutterfly Photos, we saw a significant increase in uploads year-over-year, and now store more than 30 billion photos on behalf of our customers.

We launched new physical products and a new category in 2016, including new designs and form factors, new home decor products, and the new statement gifts line of premium personalized gifts. Our Home Décor and Personalized Gifts categories continued to gain traction with customers, growing at a double-digit rate year-over-year. Our investments in customer experience and rigorous testing paid off in faster, more stable, easier-to-use websites and apps. So we know we have much further to go. Customer service contact rates for Shutterfly declined significantly year-over-year, which maybe an indication that customers are experiencing fewer problems. We made good progress in our multi-year migration to a modern, more scalable architecture. Our mobile apps, upload services, and Shutterfly Photos are now all built on a service-oriented architecture.

Our manufacturing platform maintained high levels of quality, speed and customer service at record-breaking volumes, producing hundreds of millions of cards, gifts and photo books in the fourth quarter. We successfully installed the new HP 10000 fleet of printers, establishing industry-leading quality, while reducing our need for seasonal labor. Shutterfly Business Solutions or SBS, continued to expand and mature as a business in 2016, with strong growth and margin expansion, demonstrating our ability to build on our world-class manufacturing platform.

Finally, we named four new independent directors to our Board of Directors. On behalf of the entire company, I want to thank our board for the support and hard work over 2016. While there's a lot to be proud of, we believe in sharing the bad news alongside the good, and we openly acknowledge some areas for improvement.

Growth in the Consumer segment came entirely from the Shutterfly brand, and was offset by revenue declines in the Tiny Prints, Wedding Paper Divas, MyPublisher, and BorrowLenses brands. With so many brands and technical platforms, our investment in the non-Shutterfly brands has been limited in recent years, and the declining performance reflects this. While most Shutterfly categories performed in line with our expectations, the Shutterfly cards and stationery category had disappointing growth in Q4, with the miss concentrated in our premium offerings.

By contrast, the new premium offerings on Tiny Prints were relatively successful in Q4. We attribute this mostly to our execution on Shutterfly, but it's also a useful reminder that Tiny Prints customers typically purchase more premium higher-priced offerings than Shutterfly customers. We recognize that Shutterfly relied too heavily in 2016 on complex promotional mechanics that didn't always deliver the results we wanted. While we believe that our industry will always have a significant promotional element, we need to streamline our promotions, particularly as our customers shift to mobile.

Although we met or beat our delivery promise for the overwhelming majority of customers, improving overall on-time delivery year-over-year, we let down a small group of Tiny Prints customers with late deliveries. We've since identified and resolved the root cause of the problem. Finally, on customer service, Shutterfly customers enjoyed improved service levels year-over-year, but staffing challenges on Tiny Prints led to unacceptably high wait times over several days.

If I step back and look at 2016 as a whole, I'd say that while we're pleased with the continued growth of SBS and with our improving quality of earnings, we're dissatisfied with the overall growth of the Consumer segment.

I'll hand over to Mike now to share the details of our financial results, and then we'll come back to share with you how we're thinking about the business going forward.

Michael W. Pope - Shutterfly, Inc.

Thank you, Chris, and good afternoon everyone. Overall, our results for the fourth quarter showed mixed performance. We finished Q4 with lighter than anticipated Consumer revenues, with some bright spots such as home décor and gifts, as well as mobile, offset by some areas for improvement such as Shutterfly cards and stationery premium offering. Net revenues for the fourth quarter totaled $561.2 million, representing an increase of 2% over the prior year, coming in at the low end of our guidance range. In the quarter, Consumer revenue grew 4% over the prior year to $521.5 million, driven by our Shutterfly brand, which grew mid single-digits over the fourth quarter of 2015.

Weaker revenue from our Tiny Prints and Wedding Paper Divas brands partially offset the growth in Shutterfly. While Shutterfly drove the year-over-year Consumer growth, the Shutterfly brand Q4 performance was mixed, resulting in our revenue results being at the lower end of our guidance range. Overall, our mobile investments delivered strong results during the holiday season, and exceeded our expectation on the heels of our new mobile app launch in the third quarter. Net revenues from our SBS business grew 29% over the prior year when normalized for the one-time SBS shipping revenue of $14 million in the fourth quarter of 2015 to $39.7 million.

In the fourth quarter, total unique customers grew 1% to 6.2 million, driven by growth in the Shutterfly brand, offset by our other brands. We generated 10.9 million orders across our portfolio of premium lifestyle brands, a 6% increase over the prior year, primarily driven by our growth in the Shutterfly mobile orders. Average order value, or AOV, for the quarter was $47.98, a 2% decrease from the same period a year ago, driven by product mix, promotions and mobile mix. GAAP gross margin of 59% decreased 80 basis points from the fourth quarter of 2015, when normalized for the one-time SBS shipping revenue of $14 million in the fourth quarter of 2015

In the fourth quarter of 2016, Consumer gross margin was 61.8%, a decrease of 60 basis points over the fourth quarter of 2015, primarily due to the decrease in average order value. SBS gross margin in the fourth quarter of 2016 was 27.9%, a 300 basis point improvement over the fourth quarter of 2015 when normalized for the one-time SBS shipping revenue of $14 million.

Operating expenses for the quarter totaled $177.4 million, flat with the prior year. Looking more specifically at our operating expense components, technology and development cost totaled $44.1 million for the quarter, an increase of 2% over the prior year, and remaining flat at 8% of net revenues. Sales and marketing expenses totaled $98.3 million in the quarter, relatively flat with the prior year, and remaining flat at 18% of net revenues. General and administrative expenses for the quarter totaled $35 million, down 1% from the prior year, and remaining flat at 6% of net revenues.

Our operating income for the quarter was $153.8 million, an 8% or $11.8 million increase over the fourth quarter of 2015. This improved profitability was driven by diligent expense control. Our adjusted EBITDA for the fourth quarter was $194.8 million, which was $1.5 million below the low end of our guidance range, due to the weaker Shutterfly Q4 results, largely due to the Shutterfly cards and stationery premium offering performance. Year-over-year, adjusted EBITDA increased by 7% or $13.2 million.

The effective tax rate for the quarter was 38.5%, a 34.6 point increase over the fourth quarter of 2015. Please note that the tax rate in the fourth quarter of 2015 included a true-up for prior quarter accruals, resulting in lower overall tax rate in that period.

Net income for the quarter on a GAAP basis totaled $91 million or $2.63 per share. The weighted average shares used to calculate the net income per share totaled 34.6 million shares. Net income in the fourth quarter decreased by $40 million over the fourth quarter of 2015 due to the prior tax year true-up previously mentioned.

Cash and total investments as of December 31 totaled $330.1 million, decreasing $10.7 million from 2015. Our decrease in cash was largely driven by share repurchases and capital expenditures. Capital expenditures during the quarter totaled $15.9 million. In the quarter, we repurchased over 460,000 shares for $21.6 million. The share repurchase program continues our long-term capital allocation strategy, which aims to maximize shareholder value, while maintaining flexibility to make strategic investments and acquisitions. Under this program since 2013, we have repurchased 9.4 million shares, resulting in a net reduction of 4.6 million shares, which is 14% of current shares outstanding.

I'll now turn to our full-year 2016 results. Our financial performance was solid throughout 2016. We transitioned to a new management team with a renewed commitment to profitable growth and creating shareholder value by generating free cash flow. We ended the year with revenue of $1.134 billion, a $74.8 million or 7% increase over 2015. The year-over-year growth was attributable to our Shutterfly brand and SBS segment, offset by declines in Tiny Prints, Wedding Paper Divas, MyPublisher and BorrowLenses brand. We continue to be unsatisfied with our overall Consumer growth rate.

2016 adjusted EBITDA grew 9% over 2015 to $208.5 million. Adjusted EBITDA for the year came in $1.5 million below our guidance range, primarily due to Shutterfly cards and stationery. In 2016, the quality of earnings improved as GAAP operating income improved by 169% over 2015 to $49.1 million, while earnings per share increased from a loss of $0.02 per share in 2015 to positive earnings of $0.45 per share in 2016. And finally, our adjusted EBITDA minus capital expenditures, increased 20% over 2015 to $132.9 million. In 2016, total unique customers grew 4% to 10.1 million. We generated 27.1 million orders across our portfolio of premium lifestyle brands, a 5% increase over the prior year. Average order value during 2016 declined by 1% to $36.80 due to the product mix, promotions, and mobile mix.

Now, I'll turn the call back to Chris to discuss our plans for 2017 and beyond.

Christopher North - Shutterfly, Inc.

Thanks, Mike. Since I joined the business eight months ago, we've taken a close look at every aspect of our business as a team, and we've had an open discussion about our strengths and weaknesses, our opportunities, and our challenges. As you've heard me articulate before, we have significant strengths to build on; notably, the strength of the Shutterfly brand, our loyal customer base, our world-class manufacturing platform, our consumer-facing technical capabilities, and our talented team. At the same time, we've had to acknowledge some challenges and some areas of weakness. I'll highlight several.

In recent years, we spread our resources thin across many businesses, brands and platforms, making it impossible to dedicate the right level of resource to each one. In particular, we think we should be investing more in creating world-class customer experiences than we're currently able to. Over much of our history, we prioritized revenue growth over profitability, and faced with slowing growth in recent years, we've increasingly felt compelled to optimize for short-term results at the expense of investing for the long-term.

So as we began to think through our strategy going forward, we articulated a few principles; innovate on behalf of customers, delivering great experiences; focus on a small number of high-potential opportunities; optimize for the long-term; and seek sustainable growth, balanced with profitability. With these principles firmly in mind, we're announcing plans today to significantly simplify our Consumer business in 2017 as the first step in our longer-term strategy. Our 2017 plan focuses our resources on four high-potential areas of opportunity, reduces overhead costs, consolidates our Consumer businesses on a single platform, and sets us up both to deliver greater profitability and to reinvest in the business for future growth.

But before I talk you through the 2017 plan, I first want to share our vision going forward. Our Consumer vision is to help people share life's joy by being the leading online retailer and manufacturer of high-quality personalized products. That vision is complemented by our enterprise vision of being the leading digital manufacturing platform for business. Our strategy for the next three years to five years supporting that vision has four components; first, make purchasing personalized products simple; second, offer customers a broader range of products; third, pivot towards mobile; and fourth, leverage our manufacturing platform. Let me take each component of the strategy in turn.

The first component of our strategy is to make purchasing personalized products simple. One thing that never ceases to surprise us is that while just about everyone knows our brands and loved our products, only 10 million customers purchase from us each year. I think the explanation is simple. Historically, it's been time-consuming and sometimes downright hard to create and purchase a product. When we look across our core categories, like cards and stationery, photo books and calendars, the overall industry is growing slowly. We think that the way to re-accelerate the growth in our core categories is by improving, and over time radically simplifying every aspect of the creation in purchase process.

We imagine a future in which customers are offered beautiful, contextually relevant, personalized products, automatically created for them, and ready to purchase with a single tap or click. It should be just as easy to purchase an iPhone case personalized with photos of your children or a photo book of your recent family trip, as it is to purchase a generic phone case or the latest best-selling novel. Our continued investments in our mobile app, in Shutterfly Photos, and in machine-learning-powered automated product creation, are all enablers of that future. At the same time, as we work towards that future, we see many opportunities to improve the customer experience we offer today: to remove friction, increase speed, and inspire our customers.

Across areas such as site speed and reliability, user interface, product design, delivery speed, promotions, customer service, and more, we expect to make meaningful improvements every year, while rigorously measuring the progress we're making in delivering a simple, fast and delightful experience. The second component of our strategy is to offer customers a broader range of products. Throughout Shutterfly's history, expanding the range of products we sell through category expansion and new products launches has been one of the most reliable drivers of growth. Indeed, we think that one reason for our current industry-leading position is that we offer customers the broadest selection of premium personalized products.

Over 17 years, Shutterfly expanded from prints to photo books, to cards and stationery, to personalized gifts, to home décor; and most recently, the statement gifts, our first collection of non-photo-based personalized products. At each step, our Shutterfly customers have followed us, demonstrating the breadth of the Shutterfly brand and the loyalty it enjoys. We believe that we've only scratched the surface of the range of products we can offer over time. We're setting ourselves the goal of offering a broadest possible selection of premium personalized products, while at the same time recognizing that our customers value inspiration and curation, as well as breadth.

Our Home Décor and Personalized Gift categories are now well in excess of $100 million in revenue, and growing at a double-digit rate, even though we offer fewer than 100 types of products. We see many years of extension and growth ahead in these two categories alone, including in 2017. In 2018 and in the years to follow, we expect to launch additional new categories, even as we continue to expand the range in existing categories. The third component of our strategy is to pivot towards mobile. Mobile naturally supports the first two elements of the strategy. Our new app demonstrates how simple and elegant the mobile creation experience can be, making it possible to create a card in seconds or a photo book in minutes, and we'll continue to extend our mobile offer to encompass our entire range over time.

But mobile is a core element of our growth strategy, in and of itself. App users can automatically upload all of their photos to Shutterfly Photos, enhancing our ability to present personalized products to customers. We're encouraged by the fact that as our existing web customers migrate to the app, they become more valuable customers, spending more with us each year. We're beginning to acquire new customers to mobile, whom we would not have acquired on the web. And over time, you can expect us to create mobile-first and mobile-only experiences as well.

The fourth component of our strategy is to leverage our manufacturing platform. Through our in-house manufacturing capabilities alone, we're already the world's largest four-color digital printer, with industry-leading scale, quality and cost. Through our extended manufacturing platform, comprising both our in-house capabilities and our extensive network of outsourced partners, as well as intelligent routing of demand across the network, we aspire to be the world's leading manufacturing platform for high-quality personalized products.

With SBS, we have already demonstrated that we can leverage our existing capabilities to build an entirely new business to a new set of customers; in the case of SBS, large Fortune 100 companies with variable printing and just-in-time printing needs, driving volume to our existing infrastructure. SBS historically has built dedicated systems to support each large customer, which, in the short term has meant an engineering resource, rather than market opportunity, constrained our ability to bring on new customers.

In 2016, and continuing in 2017, we've been developing a reusable platform that will reduce the dedicated work we need to do for each new customer, enabling us to bring on new customers and drive long-term growth. We continue to be excited by the potential of SBS. At the same time, we know there are many other potential enterprise customers for our manufacturing capabilities, even beyond the customer set that SBS serves today. Over time, we see opportunities to reach customers in further enterprise verticals, driving volume and EBITDA dollars through the platform. We'll use 2017 to develop the long-term plan to leverage our manufacturing platform further.

These are the four components of our strategy for the next three years to five years. It's important to add that as we begin to implement the strategy, we'll continue investing in the foundations to support sustainable growth, including a team aligned around delighting customers and creating long-term shareholder value. Now, I said earlier that 2017 would be a year in which we significantly simplify our Consumer business as the first step in a longer-term strategy; and that in 2017, we would refocus our resources on a small number of high-potential opportunities, reduce overhead costs, move towards a single consumer platform, and set ourselves up both to deliver greater profitability and to reinvest in the business for future growth.

How are we going to do all that? Today we're announcing a significant restructuring of our Consumer business. We're simplifying our brand portfolio over the course of 2017, exiting some consumer brands and consolidating others onto a single platform where the continuing brands will benefit from ongoing technical investment. Let me walk you through the details, brand-by-brand. We're recommitting to Tiny Prints as our premium cards and stationery brand, creating a Tiny Prints boutique on a dedicated tab on Shutterfly.com later this year; while, at the same time, taking steps to further differentiate Tiny Prints from Shutterfly.

The new Shutterfly Wedding Store will be the focus of our future wedding strategy, and will include a premium Wedding Paper Divas branded stationery collection. We will retire the MyPublisher brand entirely. For the Tiny Prints, Wedding Paper Divas, and MyPublisher brands, we'll seek to retain as many customers and as much revenue as possible, migrating customers to Shutterfly.com to the new Tiny Prints boutique, to the new Shutterfly Wedding store, and to our existing Shutterfly photo books category, respectively. This transition will happen over the course of the first three quarters of 2017, and will be complete before our holiday peak season.

As each brand completes its transition, we'll shut down the legacy Tiny Prints, Wedding Paper Divas and MyPublisher websites. While we hope that every customer follows us on this journey, we know that inevitably we'll lose some business in the transition, and have factored that into our financial plan. For the BorrowLenses business, we plan to engage advisers to undertake a strategic review. While the most likely outcome is that we'll sell the business, we will continue to operate it in the meantime.

Finally, we're shutting down several very small businesses entirely; the TripPix and FavPix apps, and the Shutterfly Pro Gallery service. These three businesses account for minimal revenue today. Once we've completed the transition, we'll be in an entirely different position from where we are today. Most importantly, we'll be building on a single consumer platform, going forward. That means that going forward, all of our customers will benefit from our continued investment in the Shutterfly.com platform, enjoying features that otherwise would have been unavailable to them on the Tiny Prints, Wedding Paper Divas or MyPublisher legacy websites.

In 2017, migrating customers will already see benefits, including access to Shutterfly Photos, automated product creation, and enhanced mobile web experience; a single shopping cart across brands, allowing easy cross-brand purchase; a single shared account, including login, payment, address book, and purchase history; and a single customer care team. Beyond 2017, our future investments in technology and customer experience will benefit our full Consumer customer base.

As you'd expect, at the same time as we go through this transition, we're also making significant changes to the organization. As we refocus our resources on the four elements of the strategy and as we simplify our business, our platforms, and our brand portfolio, we'll become a leaner company, eliminating some positions. This means, we'll say goodbye to more than 250 colleagues over the course of 2017. While having strong conviction that this is a necessary step for the business, we know that this will be a very big change for the people who are impacted. I want to acknowledge and thank each of them for their dedication and passion over their tenure at Shutterfly, and I'm proud that we'll be supporting them as they seek new roles outside the company.

The path we're embarking on today will certainly have twists and turns. We expect slower growth over the transition period of 2017 and 2018 as we build new customer experiences and businesses to power faster growth in 2019 and beyond. While we seek to optimize for the long-term, our plan strikes a balance between investing for growth and delivering improvements in profitability. In each of 2017 and 2018, we will deliver sequential improvements in profitability as well as quality of earnings, while funding re-investment in the business.

Before I turn it over to Mike to talk about our 2017 and 2018 financial outlook, I want to mention one other thing. As we embark on this multi-year journey, we believe that it's essential that the executive teams' incentives be tied to creating shareholder value over the long term. As such, we're making a significant change to the compensation structure for the executive team or eStaff, as we call them, transitioning their long-term incentives to a mix of options and restricted stock units, more closely mirroring the structure of my compensation.

Now, I'll turn it over to Mike to discuss our full year and first quarter 2017 financial guidance, as well as our early thoughts on 2018.

Michael W. Pope - Shutterfly, Inc.

Thanks, Chris. For 2017, we expect total net revenues to range from $1.135 billion to $1.165 billion. We are targeting 20% growth in our SBS business in 2017. We expect GAAP gross margin of 49% to 50%, and GAAP operating income ranging from $48.5 million to $68.5 million. We expect adjusted EBITDA to range from $210 million to $230 million, with earnings per share ranging from $0.45 per share to $0.80 per share, based on a 37.5% effective tax rate and 34.5 million diluted weighted average shares outstanding.

Our guidance for diluted weighted average shares outstanding assumes that we offset dilution from share-based compensation with share repurchases. Furthermore, capital expenditures are expected to be $75 million, and adjusted EBITDA minus capital expenditures to range from $135 million to $155 million. In 2017, we will continue to report revenue in two segments: Consumer and SBS. And starting in 2017, we will begin providing targeted annual growth rates for SBS.

These numbers exclude expected restructuring charges in 2017 ranging from $15 million to $20 million. These charges will occur in four broad areas: inventory; manufacturing equipment; other property, plant, and equipment; and employee costs related to severance and retention. 2017 also does not include any costs related to refinancing our convertible debt. Additionally, BorrowLenses is incorporated in this 2017 guidance, including revenue with positive contributions to adjusted EBITDA.

In an effort to provide a view into the full benefits of these changes, we are providing high level thoughts for 2018, our first full year operating after the restructuring. For 2018, we are targeting an increase to total net revenues of approximately $70 million, driven by continued growth in SBS of approximately 20% and mid-single-digit growth in the Consumer business. We are targeting an increase to GAAP gross profit of approximately $40 million and an increase to both adjusted EBITDA and GAAP operating income of approximately $50 million. We are targeting capital expenditures to remain flat at approximately $75 million. No restructuring charges are anticipated in 2018.

There are a couple of things to highlight about our 2017 guidance and our 2018 targets. As Chris mentioned, 2017 will be a transition year, with different brands transitioning at different times over the course of the first three quarters. At the midpoint of 2017 guidance, net revenues will grow 1% over 2016, as growth in the Shutterfly brand and SBS is offset by a forecasted loss of revenue in those businesses being shut down and lower revenue in those businesses being migrated. We expect to see the impact through the year as the restructuring unfolds, with low-single-digit year-over-year growth in the first half of 2017 and relatively flat revenues in the second half of 2017.

At the midpoint, adjusted EBITDA excluding 2017 restructuring charges will grow modestly by $11.5 million in 2017, and is targeted to grow by approximately $50 million in 2018, approaching a 22% adjusted EBITDA margin even after investing in growth initiatives. We will be a leaner business as we reduce head count by approximately 13% or 260 employees, close three offices, and consolidate our Santa Clara office into our Redwood City corporate headquarters. The majority of head count reductions will affect operations, customer support, marketing and technology, and will result in an annualized cost decrease of approximately $25 million.

Sales and marketing as a percentage of revenue will decrease from 20.6% in 2016 to the mid teens in 2018, as we consolidate marketing teams and as our mix of revenue shifts towards the more efficient Shutterfly brand, resulting in a decrease in working marketing dollars of approximately 300 basis points as a percentage of Consumer revenue. And finally, we expect to continue to see ongoing improvements to the quality of earnings.

For the first quarter of 2017, we expect total net revenues to range from $185 million to $190 million. We expect GAAP gross margin of 37% to 37.5%, and GAAP operating income ranging from a loss of $48 million to a loss of $45.5 million. We expect adjusted EBITDA to range from a loss of $7 million to a loss of $4.5 million, with earnings per share ranging from a loss of $1 per share to a loss of $0.95 per share based on 33.7 million basic weighted average shares outstanding and a 37.5% effective tax rate.

That concludes our prepared remarks. We will now open up the call for questions.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. And our first questioner today is Colin Sebastian with Robert Baird. Please go ahead.

Colin Alan Sebastian - Robert W. Baird & Co., Inc.

I have a couple of questions. First of all, I was hoping you could clarify the issues specifically faced with the Shutterfly branded cards and stationery, if there was a product or a pricing issue and if there are ways you were able to mitigate that weakness proactively during the quarter. And I have a follow-up.

Christopher North - Shutterfly, Inc.

Hi. Thanks, Colin. This is Chris. So, I think the answer to your question is yes and yes. When we look at Shutterfly cards and stationery, the miss was concentrated in our premium offering and we think that comes down to a couple things. First of all, some of our new products simply didn't connect with customers in the way that we'd anticipated, and so some of that comes down to the specific products that we launched. We also think that how we actually executed those products on the site and in our marketing campaigns could be improved, specifically with areas for room around pricing and promotions. And third, as we look through the overall cards and stationery experience, how we present our different offers to the customers, how we offer them opportunities to up-sell them to more premium offerings, we think there's room for simplification and streamlining there as well.

Colin Alan Sebastian - Robert W. Baird & Co., Inc.

Was there any reason that you weren't a little bit more promotional to perhaps offset some of the weakness in orders?

Christopher North - Shutterfly, Inc.

Yeah. As in any quarter or any period, we are constantly adapting our promotions based on the demand we see. So, we did go out in certain cases and change up our promotions to reflect what we were seeing. But, I think when I say that we have room to improve our pricing and promotions, I'd include both how we launched the products and some of the ways in which we reacted.

Colin Alan Sebastian - Robert W. Baird & Co., Inc.

Okay. Thanks. The second question is the implied Consumer segment growth in 2017, roughly flat. I was hoping you could break that a little bit more into little bits by segment, including the impact in revenues from restructuring, for example, I think the implied loss of traffic you mentioned to the sites that are being shuttered or migrated over to Shutterfly.

Michael W. Pope - Shutterfly, Inc.

Sure. Hey, Colin. So, I think broadly, when we think about 2017 and when we were putting our internal plan together for 2017, the revenue in both SBS and the revenue in Shutterfly is – I'm sorry, the revenue in Shutterfly that will grow in 2017 is offset by the brands that we are either shutting down, like MyPublisher, or migrating to the Shutterfly.com site. And the majority, if not all, of the growth that you see in 2017 on the top-line revenue is driven by SBS, which we went out there proactively and said we expect to grow at about 20%.

Colin Alan Sebastian - Robert W. Baird & Co., Inc.

Okay. Thank you.

Operator

Our next questioner today is Youssef Squali with Cantor Fitzgerald. Please go ahead.

Naved Khan - Cantor Fitzgerald Securities

Yeah. It's Naved Khan for Youssef. Good afternoon. Just a couple of questions. Chris, if I look back at Q4 performance and try to parse out Shutterfly, the core Shutterfly versus the rest of the brands, would you say that the rest of the brands sort of had a more soft performance versus Q3 or did the core Shutterfly sort of not grow as fast as the prior quarter, just in relative terms?

Christopher North - Shutterfly, Inc.

Right. Hi, Youssef (sic) [Naved]. Thanks for your question. So, let me step back for a second. When we look at Q4 and when we look at 2016 as a whole, we have two things happening that led to disappointing Consumer growth. First of all, we've continued to see softness and indeed declining performance in the non-Shutterfly brands across 2016. That's been getting worse over the last few years. So, the non-Shutterfly brands all declined in 2016 taken as a whole, and that's been a continuation of a trend that we've seen for several years as we've spread our investments so thin over so many different brands, businesses, and technical platforms in our Consumer business. Secondly, while most of the Shutterfly categories performed broadly in line with our expectations in Q4, the cards and stationery performance was disappointing, specifically in Q4 on Shutterfly brands. So, it's those two components that led to the overall disappointing performance in Consumer revenue growth.

Naved Khan - Cantor Fitzgerald Securities

And would you – how would you characterize sort of the external promotional environment? Would you say it's about the same or would you say it's been more?

Michael W. Pope - Shutterfly, Inc.

Yeah. I think when you look at the external promotional environment, the first thing to say is that we're in a very promotional industry and that's not going to change. But broadly speaking, when you look across Q4, while there were changes perhaps in the timing of promotions or some of the specific promotions that competitors did and we did, I think broadly speaking, it felt similar to what we've seen in past quarters and years.

Naved Khan - Cantor Fitzgerald Securities

Okay. Great. And then just on the guidance for 2017 and 2018, if I were to just think about the core Shutterfly, should we expect that to show improving growth trend? What are you baking in internally? And for 2018, I guess, you are kind of guiding to mid-single-digits. Do you think that's kind of a sustainable rate that we should think about the business going forward? How should we think about it?

Michael W. Pope - Shutterfly, Inc.

Yeah. I think a couple of things. When we look at the guidance for 2017 in particular, what we expect, as I said, is that the Shutterfly will be our flagship brand, it will become even more so in 2017 as we migrate the smaller brands to the platform. Remember that, that migration happens over the course of the first three quarters in 2017, so we'll still see a drag on the overall growth rate there. And then, once they're migrated, we obviously won't keep all of that revenue. So, the combination of those two offsets what we think will be continued growth in the Shutterfly brand.

With regard to 2018, if you look at the targets that we provided of $70 million of growth over the 2017 revenues, and you think about SBS as growing in the 20% range, roughly half of that growth in revenue will come from Consumer, and half of it will come from SBS. I'll remind you, 2018 is a little bit complicated, because for the first three quarters of the year we'll have comparisons to periods where we hadn't migrated or shut down businesses. So it makes it a tough year-on-year comparison.

Christopher North - Shutterfly, Inc.

Your last question was just about longer-term growth rates. So we're not giving any forecast today beyond 2018. What I would say is that the transitions that we're announcing today all have the goal of simplifying our business, allowing us to focus all of our investment on a single consumer technical platform, and against the four strategic areas of focus we described earlier on the call. And that we feel really good that those are the right places to focus our investment to drive long-term growth in the business.

Naved Khan - Cantor Fitzgerald Securities

Okay. And then, Chris, I know you spoke about mobile doing well. Can you guys just sort of give us a number in terms of how much new mobile accounted for the overall business in Q4 or for 2016?

Michael W. Pope - Shutterfly, Inc.

Yeah. So mobile is definitely something we're really excited about and where we're seeing really excellent results from the investments we've made to-date. It's also an area where we think we have a lot further that we can go. In Q4 2016, we said a couple of things about mobile. The first thing we said is that we more than doubled the number of customers and the amount of revenue in the app year-over-year. We also said that we're beginning to see that existing customers who migrate to mobile app become better customers in terms of their total spend every year, which is very encouraging. I think, I'll add one other detail about mobile which is, when we look at Shutterfly brand – and I'll just remind you that Shutterfly brand is the only brand that has a mobile app today, we saw the overall portion of our revenue coming from mobile – whether in the mobile web or the mobile app, increase to 18% for the full year, which is an increase of 500 basis points year-over-year. So altogether, we're seeing all the trends we want to see in our mobile business, and that really encourages us to double down on our investment in that business.

Naved Khan - Cantor Fitzgerald Securities

Great. Thanks. I'll put myself back in the queue.

Operator

Our next questioner today is Chris Merwin with Barclays. Please go ahead.

Christopher David Merwin - Barclays Capital, Inc.

All right. Thanks. I had a couple. So did anything change in the competitive environment? I know you've been asked about Amazon before, but just curious how if at all that affected you during the holiday quarter? And then just secondly, as you think about marketing for the Shutterfly brand, I think one of the things you mentioned is that we'll see sales and marketing decrease as a percentage of revenue. Obviously, if the category itself is maturing and the growth in the Consumer brand is a little bit lower, you'd like to see it. Can you talk about why it makes sense to pull back on sales and marketing spend? And also maybe more philosophically, how you think about acquiring customers especially in a mobile-first environment? Thank you.

Christopher North - Shutterfly, Inc.

Okay. So thanks, Chris. Let me take the first part of that one. So in terms of competition, I think when we look across the overall competitive landscape in Q4, we really didn't see a lot of changes. I know there was a lot of speculation, but we didn't really see that materialize. This is a place where one has imperfect data. But from what we can tell from internal/external data, we feel good that we maintained or even potentially gained share as a company within our industry. I think I'll turn it over to Mike on marketing, then.

Michael W. Pope - Shutterfly, Inc.

I think as we think about marketing going forward, we're really informed by a couple of things that we've seen in the past as we've had more separate brands and more separate brand marketing initiatives. And that is it has been more expensive for us on a working marketing dollars to attract and keep existing customers engaged on Tiny Prints and Wedding Paper Divas. So as we go forward through this restructuring with more of the revenue coming through the Shutterfly platform, we'll gain some efficiencies there. I think some of the other things that we've also done is we, every year, become better informed with data of where we're spending, in which channels we're spending our marketing dollars. And we feel like we can do a better job of allocating that going forward.

Christopher David Merwin - Barclays Capital, Inc.

All right. Great. Thank you.

Operator

Our next questioner today is Andrew Bruckner with RBC Capital Markets. Please go ahead.

Andrew Bruckner - RBC Capital Markets LLC

Thank you. Just thinking about the importance of the SBS business going forward, given that's going to be the primary growth engine, how do you think about the lumpiness of the business and what other verticals you can expand into? And any updates on large customer signings would be appreciated. Thank you.

Michael W. Pope - Shutterfly, Inc.

Sure. So with regard to SBS, I hope the folks appreciate the overall revenue guidance that we've provided today. We get more visibility into the SBS business as we grow that business from what was a sub-$100 million business a year ago to what was a $136 million plus this year. And we've got, as I've said before, a strong repeat customer base where the initiatives that we did on some of the transactional business, in particular, comes back year-after-year. So we have high visibility into what we'll get from existing customers, and that gives us a high degree of confidence in the guidance we're providing for 2017. And we continue to build that pipeline.

I'll remind you again, we build that pipeline in a very measured way, where we look for customers that are multi-million dollar customers over time that can meet our gross profit margin targets within the company. And I think you've seen that demonstrated in the improvements of gross margin over the last year, in particular. That said, this business is still a lumpy business. It's a business where, again, if we land a Fortune 100 company, and we start off on a pilot deal, that can sometimes turn into tens of millions of dollars, and in other cases remain at that level.

Christopher North - Shutterfly, Inc.

Mike, I think the only thing I'd add to that, because there was a question about future verticals. And I think you've heard us say before, certainly in recent history, the SBS growth has not been constrained by market opportunity or our ability to generate a customer pipeline. If anything, we've deliberately slowed down customer acquisition or expansion into new verticals because our business model today has required us to do a lot of dedicated systems work for each new customer we bring on. The work that we've done in 2016, and that we continue to do in 2017 to turn SBS into a true platform means that as time goes on, we'll be able to add additional customers with much less dedicated incremental work for each customer. And that will start to allow us both to go after more customers in the existing verticals that we already serve, and to expand to other verticals as well.

Andrew Bruckner - RBC Capital Markets LLC

Thank you. Quickly following up on that, I think you've mentioned before that you have $300 million of capacity for SBS. Is that true in the fourth quarter as well? Just thinking about kind of $75 million of revenue being your max capacity in that. Thank you.

Michael W. Pope - Shutterfly, Inc.

Yeah. I think, you recall the number correctly, which is when we look across our three factories and we look across the seasonality of our business, that the $300 million is on an annual basis. And we have specifically tried to target customers more towards Q1, Q2, and Q3. Inevitably, as we've gained success with customers, some of that has spilled into Q4 as well, so we have less capacity in Q4.

Andrew Bruckner - RBC Capital Markets LLC

Thank you.

Operator

Our next questioner today is Kerry Rice with Needham. Please go ahead.

Kerry Rice - Needham & Co. LLC

Thanks. Maybe just some clarification. So as we think about revenue growth in the Consumer business in 2017, I think for the at least, if I can remember correctly, back for the first three quarters of 2016, the Shutterfly brands grew at double-digit and then it dropped down, I think you said mid single-digit in Q4 here. How do we think about the core Shutterfly brands? Is that going to stay at kind of the mid single-digits? Is that the assumption for 2017, or does that reaccelerate back up to double-digits and then just offset is the transition brands? That's the first question.

Michael W. Pope - Shutterfly, Inc.

Yeah. I think you're absolutely right there, that whereas we saw higher growth in the Shutterfly brand for the first three quarters of the year, it was in the mid single-digits in the fourth quarter. So obviously that informs our forecast for 2017 as a whole. We're not going to get into specific brand-by-brand growth rates in 2017, as it becomes difficult, particularly as we start to migrate brands to the Shutterfly.com platform.

Kerry Rice - Needham & Co. LLC

Okay. And then on the margin expansion, it sounds like a big chunk of that is coming from the sales and marketing line. And then I assume the other, maybe the balance, is around the cost savings in the restructuring. Is there anything else that you would call out that is enabling Shutterfly to expand margins as we look out through 2018?

Michael W. Pope - Shutterfly, Inc.

Yeah Kerry, thanks. In an effort to be transparent, we called out two specific things, which you've highlighted here. One is that 260 people at Shutterfly will go away across the period of the first nine months of 2017. So while we see some benefit from that in 2017, the full effect of that is only realized in 2018 once we've completed the restructuring. Similarly, on the sales and marketing side of things, if you think about the Consumer business roughly being a $1 billion business today, a 300 basis point improvement in working marketing dollars would save you in the neighborhood of $30 million annually on a go-forward full year basis.

There are other things and head count – there are other things across the rest of the organization where we will get efficiencies from having less complex manufacturing lines and less technology, and a single customer care operation at the company. But the main items are what we talked about. And I'd just reiterate what Chris said, and what we said in the prepared remarks, is that all of those things on relatively modest revenue growth are reflected in a substantial increase in the quality of earnings, operating income and adjusted EBITDA, but particularly when we get into 2018.

Kerry Rice - Needham & Co. LLC

Okay. Final question, on mobile. I think, Chris, you mentioned that the customers are more valuable that are engaging, particularly through the mobile app. Are there any metrics you can give us? I know that you said the revenue doubled year-over-year. But maybe are they ordering more frequently? Are they generating a higher average order value? Just coming back more often? Any other metrics that you could give us?

Christopher North - Shutterfly, Inc.

Yeah. Thanks, Kerry. I think when we think about how mobile helps our business, there are a couple of different vectors. First of all, we did some really rigorous work in 2016 to understand what the causal incremental value is of an existing web-based customer who adopts our mobile app. And I should add, that doesn't necessarily mean they switch to our mobile app. We find that many customers then become multichannel customers, and multichannel customers are our most valuable customers. And we were really pleased to see that an existing web-based customer who adopts the mobile app becomes a significantly more valuable customer. And here I measure the value of a customer by the annual revenue they spend with us. The second way that mobile helps us is through allowing us to acquire new customers who we might not have had otherwise. And while we don't break out metrics on that, we've seen that mobile has become an important channel for us to acquire new customers. So those are really the two main ways we think about it.

Kerry Rice - Needham & Co. LLC

Okay. Thank you.

Operator

Our next questioner today is Brian Fitzgerald with Jefferies. Please go ahead.

Brian P. Fitzgerald - Jefferies & Company, Inc.

Maybe a quick follow up to the last question around mobile. Curious if you saw more repeat purchases in mobile versus web, how those dynamics are trending. And then also what was the effectiveness of push notifications from the new app in terms of driving promotional work that you're running?

Christopher North - Shutterfly, Inc.

Great. Thanks, Brian. So if I take your second question first, push notifications have become a marketing channel for us that complements our other marketing channels. We tend to think about push notifications as part of our extended CRM channel, which includes email as well as our catalog-based or other direct mail/direct marketing efforts. And so, push notifications aren't new for us. But we've been able to, with the new app, lean more heavily into that. We've been pleased with the results we've seen there. We also think there's a lot more we can do. And I'm sorry the first question was about?

Michael W. Pope - Shutterfly, Inc.

Mobile repeat.

Christopher North - Shutterfly, Inc.

Mobile repeat.

Brian P. Fitzgerald - Jefferies & Company, Inc.

Yeah, that's right.

Christopher North - Shutterfly, Inc.

Yeah. Thank you. So, we don't break out those metrics. I think that a trend that many Internet companies see, and that we would expect to see in our business over time is that mobile customers do engage more frequently. Certainly, as we acquire new customers in the business – I've already talked about how we think about the existing web-based customers – but as we acquire new customers – business via mobile, we're looking to understand what the quality of the customer is. That's not just a question of frequency, but it's how much they spend in each purchase, what their total expenditure is over the year, what the mix is. I think with the app only now being three-and-a-half months old, our new app, and with a lot more still to come in terms of the range of products we build into the app, new features we build into the app, and how we drive both existing and new customers in the app, that's an area where we're still going to be learning over the course of 2017.

Brian P. Fitzgerald - Jefferies & Company, Inc.

Great. Thanks, guys.

Operator

Our next questioner today is Heath Terry with Goldman Sachs. Please go ahead.

Heath Terry - Goldman Sachs & Co.

Great. Thanks. Just curious if you can kind of quantify for us how you're thinking about the digital-only side of the business, or the digital-first side of the business. Whether in the restructuring that you're doing, there is a place for the storage organization model that sort of started with the company's ThisLife acquisition, and has been at least part of the, what was called, the Shutterfly 3.0 strategy.

Christopher North - Shutterfly, Inc.

Right. Thanks, Heath. So I think you're referring to Shutterfly Photos, which I think you know, but I'll remind everyone that last year, one of our key initiatives was to integrate ThisLife, to migrate all of our most active customers into the new Shutterfly Photos, as we now call it, cloud-based photo management service that we now offer to all of our customers. And in addition from roughly mid-year, all new customers who joined the business have started out in that experience.

So there's a lot of things we've been pleased about to see in Shutterfly Photos. We've seen customers start to – I mean first of all, we're really pleased the migration went well. It was a major migration involving millions of customers and billions of photos, and it went pretty seamlessly. Secondly, we've been really pleased to see how customers have begun to engage with it. To-date, millions of customers have visited Shutterfly Photos, and millions of those have engaged actively with features such as organizing their photos into albums, sharing photos, using our facial recognition technology to identify people in the photos, and indeed initiating purchases from the photos.

I want to be clear, that the way we think about Shutterfly Photos is as one component in an overall strategy to drive purchases. So we see Shutterfly Photos, our algorithmic product creation capabilities based on machine learning, as well as the app, all those things that take us to a future where we're constantly able to present customers with contextually relevant, personalized products that are just one click away from purchasing.

So that's a big part of the long-term vision we articulated. Shutterfly Photos plays an important role in that. Something we aren't setting out to do is to try to make Shutterfly Photos a standalone business that we monetize as a cloud photo storage business. We think that's going to be a very, very competitive and ultimately commoditized space, so we're really proud that we offer one of the best services in the market. But we see that ultimately as a component that drives our business through purchase and engagement, rather than as something we monetize independently.

Heath Terry - Goldman Sachs & Co.

Got it. Okay. Thank you very much.

Operator

It looks like we have no further questions. So this will conclude our question-and-answer session. I would now like to turn the conference back over to Mike Pope for any closing remarks.

Michael W. Pope - Shutterfly, Inc.

Great. Well, thank you all for joining us on the call today. I'll let, actually, Chris close with a few remarks.

Christopher North - Shutterfly, Inc.

Yes, I simply want to summarize for me the key takeaways for us, both as we look back to 2016, as we look forward through the transition that we're going through in 2017, and the new strategic focus that we've announced today. As we look back to 2016, while Consumer growth in Q4 was disappointing, we think that within the 2016 results there's some really strong progress against mobile; category expansion, particularly in home decor and personalized gifts; and SBS; all of which now are substantial businesses growing at double-digit rates for us.

We are going through a restructuring in 2017 that will simplify our Consumer business, bring all of our brands onto a single platform, and focus our resources going forward on four high-potential areas of growth. And we think with that, we are set up both to deliver improved profitability and to invest in future growth. We've talked about those four strategic areas of focus. And we've talked about, as well, how we'll go through a period of slower growth in 2017 and 2018 through this transition process. But even over that period, we'll continue to deliver significant improvements in profitability, cash flow, and quality of earnings.

And at the same time, by focusing on our investment on these four strategic areas, we think we're setting ourselves up for a really bright future with faster growth in 2019 and beyond. Thank you very much.

Operator

The conference has now concluded. Thank you all for attending today's presentation. You may now disconnect your lines.

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