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Shutterfly Inc  (SFLY)
Q4 2018 Earnings Conference Call
Feb. 05, 2019, 5:00 p.m. ET


Prepared Remarks:


Good afternoon, and welcome to the Shutterfly, Inc. Fourth Quarter 2018 Financial Results Conference Call. All participants will be in listen-only mode. (Operator Instructions) After today's presentation, there will be an opportunity to ask questions. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Shawn Tabak, VP, Investor Relations. Please go ahead.

Shawn Tabak -- Vice President of Investor Relations

Thank you, operator. Good afternoon, everyone, and welcome to Shutterfly's fourth quarter 2018 earnings call. With us today are Christopher North, President and Chief Executive Officer; and Mike Pope, Chief Financial Officer.

By now, you should have received a copy of our earnings announcement, 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 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 performance measures calculated in accordance with GAAP and may be different from calculations or measures made by other companies. To the extent possible, 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 -- President and Chief Executive Officer

Thanks, Shawn. I'd like to welcome everyone to today's call. We made several important announcements this afternoon, and I'd like to address two of them right at the beginning before we discuss our quarterly and annual results. First, as noted in our press release, our Board of Directors has formed a Strategic Review Committee and retained Morgan Stanley as financial advisor as it continues an ongoing review of strategic alternatives. The Strategic Review Committee is also evaluating the Company's capital structure and capital return policy.

In recent months, Shutterfly was approached by a third party about the potential acquisition of the Company. The Company and Board subsequently engaged with several additional third parties regarding a potential acquisition of the Company, but no proposals have been received. The Board has not set a timetable for the conclusion of its review of strategic alternatives, and it does not intend to comment further unless and until the Board has approved a specific course of action where the company has otherwise determined that further disclosure is appropriate or required by law. There can be no assurance that the review of strategic alternatives will result in a transaction or other outcome. At the same time, we've updated our capital allocation strategy after a detailed discussion with the Board. And Mike will discuss this in more detail later in today's call.

Secondly, we also announced in a press release today that I'll be stepping down at the end of August 2019 in order to return to the UK with my family. I'll be staying on as CEO through August 31, continuing to lead the Company through that period as well as supporting the Board in identifying and effecting a smooth transition to my successor. On a personal note, I want to say that it's a great privilege to be part of the Shutterfly family and to work with such a talented and committed team. I'm proud of the work that the team has done to put Shutterfly in such a strong foundation, and I've never been more excited about the future for the Company. As the CEO search process unfolds, rest assured that the team and I are laser focused on executing on our strategy and 2019 plans.

I'll now discuss our fourth quarter and full year 2018 results and then discuss our plans for 2019. After that, Mike will present financial results for the fourth quarter and full year 2018 and provide an update on our guidance and targets. 2018 was a transformational year for Shutterfly with the Lifetouch acquisition almost doubling the size of the Company. We've articulated a unique value proposition for our customers going forward. Together, Shutterfly and Lifetouch will help customers capture, preserve and share the most important memories in their lives.

We're bringing together Shutterfly's strengths as the leader in personalized photo-based products coupled with photo storage, together with Lifetouch's strengths as the leader in school and family photography to create the only end-to-end memory solution for families. In doing so, we've significantly increased our potential to create shareholder value. Looking forward, value creation will come from continuing to drive growth in all three of our divisions from delivering substantial cost and revenue synergies from the Lifetouch integration and from returning capital to shareholders.

We ended 2018 with non-GAAP net revenue of $2.001 billion, adjusted EBITDA of $385 million and $178 million of free cash flow. To put this in context, in 2015, the Company had revenue of $1.06 billion, adjusted EBITDA of $192 million and $88 million of free cash flow. Looking at Q4 specifically, Q4 non-GAAP net revenue of $952 million was at the low end of our expectations. Strong performance in SBS and solid performance in Lifetouch were offset by weak growth in Shutterfly Consumer. Q4 non-GAAP earnings per share of $5.47 was consistent with our expectations, but adjusted EBITDA of $320 million was below our expectations. While we're proud of many accomplishments in 2018 and excited about our future prospects, we were disappointed by Shutterfly Consumer growth in Q4, which came in well below our expectations.

I'll now discuss our Q4 performance in each of our divisions before turning to our plans for 2019. Starting with the Shutterfly Consumer segment, net revenue was $528 million or 1% year-over-year increase. Within this segment, Shutterfly brand revenue growth of 3% was offset by a decline of 17% in the Tiny Prints boutique. Our weak overall results in consumer, were particularly disappointing given that in so many areas, our strategic investments are delivering results, most notably in Mobile and in category and range expansion. Mobile significantly outperformed our expectations with mobile purchases increasing 560 basis points year-over-year to 27% of total Shutterfly brand revenue in Q4 and app revenue increasing 68% year-over-year to $97 million.

For the full year, 2018 app revenues grew 59% year-over-year, increasing from 13% of Shutterfly.com revenue in 2017 to 20% of Shutterfly.com revenue in 2018. Customers use our app to purchase across our categories with more than two-thirds of Q4 app purchases coming from cards and stationery and personalized gifts and home decor. The app delivered strong performance across all key metrics including growth in new customers, repeat customers and revenue per customer as well as continuing to be a cost efficient platform for new customer acquisition. We also expanded our machine learning based automated product creation experiences in the app, generating significant lift in purchases.

The Shutterfly app also drove a large increase in photo uploads. In Q4, customers uploaded 2.7 billion photos, a 34% increase over the fourth quarter of 2017. We now manage more than 50 billion photos in Shutterfly photos on behalf of our customers, a valuable source of not only loyalty and engagement, but also a large data set to train our algorithms on to further simplify and enhance customer experience. Personalized Gifts and Home Decor, also known as PGHD, delivered a significant reacceleration of growth, thanks to the faster rate of new product introduction as well as the new categories. We launched 47 new products in 2018, double the number launched in 2017, while also introducing the new Kids and Pets categories.

Overall, Q4 PGHD revenue growth was 15% in Q4 with paid revenues growing 16%, the fastest -- the fastest rate of paid revenue growth in more than three years. In fact, PGHD growth would have been around 20% had we not had to restrict orders due to unexpected capacity constraints as hurricane Michael damaged one key supplier's facility and a second supplier went out of business. New categories were in line with our expectations. I'll also note that we have now largely completed the mix shift from free-to-pay Q1 2019 with the last quarter that we will have an unfavorable comparison to the prior year.

These areas of strong performance were more than offset by mixed results in our core paper-based categories where aggregate revenue declined 2% year-over-year. Both Photo Books and Calendars, both delivered solid results, we had poor performance in both Prints and Cards & Stationery. Prints continued to decline in line with Q3 trends and Cards & Stationery revenues came in well behind our expectations. First, we continue to increase Cards & Stationery revenue from our loyal Shutterfly brand customers but not as much as expected. Second, we saw a significant continued decline from prior Tiny Prints customers. And finally, we are not acquiring enough new customers to our overall Cards & Stationery offering.

Stepping back and looking at the broader Prints and Holiday cards triangulating from first and third-party data, total U.S. customer spend on holiday cards appears stable to slightly declining in Q4 '18. Notably, we saw a significantly greater marketing presence and more aggressive promotional activity from competitors this year than in recent years with competition both at the value and premium ends of the spectrum. While Shutterfly continues to be by far the largest seller of personalized holiday cards in the U.S. with our mass premium positioning, allowing us to address the largest customer base, we need to do a better job serving both value and premium customers in 2019.

Turning to Lifetouch, non-GAAP revenue was $350 million in the fourth quarter in line with our expectations. Overall, we continue to be pleased with Lifetouch's performance in its third quarter as part of Shutterfly. Q4 is Lifetouch's largest quarter, helping millions of families capture important milestone through Fall School Picture Day. In Q4, solid performances in both schools and preschool were supported by good account retention and continued growth in new accounts, leading to net account growth.

In the schools business unit, retention of Fall School Picture Day accounts increased 40 basis points year-over-year to 93.5%, while new accounts increased 3%. Net account growth was partially offset by participation rate which was slightly below our expectations. We plan significant investment in driving participation rate in 2019 and beyond which was not possible in 2018 given the limited time between the acquisition close and peak. Lifetouch customers also continue to shift to online purchasing. For example, 58% of the Fall School Picture Day orders were purchased online, a 710 basis point increase year-over-year. Studios had a strong performance offsetting the Church business which continues to decline. As a reminder, more than three quarters of Lifetouch revenue and an even higher proportion of profits are in schools and preschool.

Turning to the Lifetouch integration, we're focused on realizing substantial cost and revenue synergies over a multiyear period. In Q4, we tested a broad range of marketing approaches and Shutterfly benefits for Lifetouch customers including a lightweight first phase of technology integration as a step toward a broader integration in 2019 and beyond. As a reminder, our integration tests were limited first step and reached only a subset of Lifetouch customers. Our test generated approximately $10 million of revenue synergies in Q4 consistent with our expectations. Most importantly, through dozens of customer-facing tests we gained valuable insight to inform our integration plans for 2019. Our 2018 earnings give us increasing confidence in our revenue synergies in 2019 and beyond.

Turning to Shutterfly Business Solutions or SBS, revenue of $74 million in the fourth quarter exceeded our expectations driven by higher expected volumes from existing customers capping a strong 2018. As anticipated, we were able to improve gross margins in certain programs after an initial onboarding period and we ended the year with a promising sales pipeline.

I'll now discuss our plans for 2019. Overall, we had many successes in 2018 including in Lifetouch schools account growth as well as preschool and studios overall performance; in SBS strong growth and margin improvements; in Shutterfly Consumer Personalized Gifts and Home Decor growth reacceleration, new category launches and rapid mobile growth. We also made significant progress against the Lifetouch integration. Our 2019 plan builds on all these areas of strength but also addresses the key areas of weakness in 2018.

In Shutterfly Consumer, we'll continue to drive growth in Personalized Gifts and Home Decor including Kids and Pets by further accelerating the pace of new product introduction launching around 60 new products in 2019 versus 47 in 2018. We expect our next major category launch to be in early 2020. Mobile will continue to grow rapidly in 2019 where we'll focus both on acquiring new customers and monetizing existing customers, adding more products to the app, enhancing the customer experience and leveraging our machine learning-based automated product creation technology. Marketing and promotions are a key area of focus for 2019 in Consumer. Having onboarded our new CMO and our new pricing leader, increased the flexibility of our promotional platform and integrated best-in-class third-party marketing platforms in 2018 will drive deeper more personalized engagement with our customers in 2019.

In addition, we'll allocate more of our marketing spend toward brand, ensuring our rightful share of voice as the category leader. The two key areas to address in Consumer in 2019 are Prints and holiday cards. Our Prints business declined 8% in 2018, disappointing, given that the U.S. Consumer expenditure on Prints is stable to modestly declining. We have several clear opportunities to improve customer experience that we'll address in 2019. Improving our holiday card offer is a critical priority in 2019. We expect to have a good better best range strategy optimizing customer acquisition across Shutterfly and Tiny Prints. Shutterfly will continue to have its mass premium offering for our existing loyal customers. But we'll create a more compelling offering for value-oriented customers. Tiny Prints will be the focus of our differentiated premium offering. Our brand spend will also support reinforcing Shutterfly as the definitive place for holiday cards.

Turning to Lifetouch. Lifetouch was part of the Shutterfly family for nine months in 2018. The Schools, Preschool and Studios business units performed well, meeting our expectations for the year while the Church business continues to decline as expected. We continue to see a number of levers that impacts the Lifetouch growth rate including continued account growth AOV and participation rate. A significant driver of participation is awareness. And in 2019, we'll further develop our schools and programs to drive awareness, including investing and building marketing teams, integrating platforms, developing programs and dramatically increasing the portion of the customer base we can reach with direct-to-consumer communications.

Lifetouch also represents our best opportunity to step change the size of the Shutterfly Consumer customer base. As a reminder, Lifetouch is more than 15 million estimated three-year active customers, that is customers that have been any purchase in the last three years. With only 27% overlap with Shutterfly, leaving more than 11 million estimated non-overlapping three-year active customers. Our 2018 testing and research confirmed that Lifetouch customers want their photos on Shutterfly and see it as a natural extension of their Lifetouch buying experience. We also discovered something we had not expected, that Lifetouch could be an effective channel for reengaging overlapping customers who had lapsed on Shutterfly.

In 2019, we'll build on the integrations we tested in 2018. We'll significantly expand the number of Lifetouch customers eligible for an integrated experience by adding business units and programs including Fall Picture Day, the Prestige Portraits Graduation business, Preschool and Studios. And by expanding the proportion of Lifetouch packages eligible for digital delivery. For these Lifetouch customers, Shutterfly photos will be exclusive delivery method for their digital photos. From there, Lifetouch customers will be able to store, organize and share their Lifetouch photos as well as any personal photos they upload with ample opportunities to create and purchase.

The integrated experience will be significantly simplified with common customer identity and payment systems meaning a customer will only need a single set of account credentials across Lifetouch and Shutterfly. While most Lifetouch customers will still place orders on existing Lifetouch websites in 2019, we're undertaking significant work this year to prepare for integrated customer-facing e-commerce systems in 2020, and we'll be making a number of improvements in the existing platforms in the interim.

Our plans for cost synergy is center on establishing a common manufacturing platform achieving greater utilization given our adjacent peak periods and leveraging our combined purchasing power and scale. In Q4, we further developed our long-term plans to establish a single next- generation manufacturing platform serving Shutterfly Consumer, Lifetouch and SBS, an initiative we refer to as Project Aspen. Project Aspen will yield a total of approximately $130 million in cash savings over five years with annual run rate savings from manufacturing operations of approximately $35 million from 2022 onwards.

While Project Aspen requires net investments in 2019, we expect net cash savings in every year beginning in 2020. In the first phase of Project Aspen, we'll close four legacy Lifetouch facilities including the two sites previously announced as well as two additional facility closures we announced today, Chico, California and Chattanooga Tennessee, both of which will close in the second half of 2019. We'll also open a new 237,000 square foot facility in Texas in the first half of 2020 which will serve both Lifetouch and Shutterfly. We'll share further details about Project Aspen as it progresses.

Shifting to SBS. In 2018, SBS ramped the major new program signed in Q3 2017, successfully improving overall gross margins. Based on what we've learned over the last few years, we're increasingly focusing on closing large deals with programs that repeat reliably over many years. This approach yields higher value customers but it is also lumpier and harder to predict growth. In 2019, SBS will continue to focus on serving its existing clients while building out the technology platform and focusing the pipeline on winning new accounts that have the potential to generate multi-million dollars in revenue contribution.

I also wanted to share our updated thinking about our $450 million adjusted EBITDA target. As a reminder, the revenue and cost synergies from the Lifetouch acquisition are expected to generate between $60 million and $75 million of incremental annual adjusted EBITDA in the next three years. We are updating the previously communicated 2020 adjusted EBITDA target of $450 million for two reasons. First, we had lower-than-expected Shutterfly Consumer growth in Q4 '18 and have moderated Shutterfly Consumer growth expectations in the near term. In addition, while Project Aspen is expected to generate greater run rate savings, it will also delay some of our 2020 cost synergies by one year. We now expect to achieve between $400 million and $450 million of adjusted EBITDA in 2021. Mike will share more details in a little bit.

Overall, 2019 is a year of critical investments aimed at realizing our large value creation opportunities over the next few years. We'll invest in the Lifetouch integration, focused on realizing our opportunity with the Lifetouch customer base. We're also investing in a common next-generation manufacturing platform, increasing the utilization and efficiency of our facilities. At the same time, we're making modest investments across a range of initiatives in each of our three divisions focused on 2019 growth.

Now Mike will share the details of our Q4 and full year 2018 financial results.

Michael Pope -- Senior Vice President and Chief Financial Officer

Thank you, Chris, and good afternoon, everyone. I'll start by addressing a few housekeeping items. As anticipated, there were non-cash purchase accounting adjustments in Q4 related to the Lifetouch deferred revenue writedown which lowered Q4 GAAP reported net revenue by $2 million. The announced (ph) quarter on this earnings call are normalized for this deferred revenue non-GAAP adjustment as we believe they would provide investors a better understanding of our business. We've included a bridge on Page 14 of our press release in Appendix 3.1 to help investors understand this non-GAAP adjustment.

Non-GAAP net revenue normalized for the purchase accounting deferred revenue writedown was $952 million with Shutterfly Consumer representing 55%; Lifetouch 37%; and SBS 8% of the total. Q4 non-GAAP net revenue increased 60% over the prior year driven by the Lifetouch acquisition. In the quarter, Shutterfly Consumer net revenue was $528 million, an increase of 1% over the prior year. Non-GAAP Lifetouch net revenue was $350 million, consistent with our expectations. In the fourth quarter, net revenue from our SBS business was $74 million.

Shifting to our Shutterfly Consumer metrics. Total unique customers were 6.1 million, a decrease of 1% over the fourth quarter of 2017. We generated 9.8 million orders, a decrease of 7% over the fourth quarter of 2017, primarily driven by declines in our Prints category and the Tiny Prints boutique. Average order value or AOV for the quarter was $54.03, an increase of 8% over the fourth quarter of 2017. AOV increased primarily due to the product mix and larger basket sizes. Non-GAAP gross margin normalized for the purchase accounting deferred revenue writedown was 60.3% below the midpoint of our guidance, primarily due to the segment mix as Shutterfly Consumer revenue was lower than expected.

Shutterfly Consumer gross margin was 62.1%, a decrease of 90 basis points over the fourth quarter of 2017, primarily due to product mix, lower volumes and competitive pricing pressure, partially offset by higher AOV. Lifetouch gross margin was 67.4% in the fourth quarter in line with our expectations. SBS gross margin in the fourth quarter of 2018 was 19.4%, an increase of 120 basis points over the fourth quarter of 2017. The increase comes as we anniversary the deal we signed in Q3 of 2017 with an existing technology client and reflects the improved profitability of this client. Normalized operating expenses for the quarter totaled $311 million and exclude restructuring and acquisition-related charges and purchase accounting adjustments of $2.5 million. Lifetouch added approximately $143 million of non-GAAP operating expense in the quarter.

I will now address our segment margins. Shutterfly Consumer segment margin in Q4 was $203 million, down from the prior year due to the decrease in gross margin and an increase in sales and marketing expenses. Lifetouch segment margin in Q4 was a $115 million consistent with our expectations as Q4 is Lifetouch's largest and most profitable quarter. SBS segment margin in Q4 was $10 million, an increase over the fourth quarter of 2017 driven by higher revenue, gross margin and a reduction in technology-related expenses. Total corporate expenses which primarily consist of general and administrative expenses were $39 million and reflect the addition of Lifetouch.

Our non-GAAP operating income normalized exclude restructuring and acquisition-related charges and purchase accounting adjustments was $264 million. In the fourth quarter, our adjusted EBITDA was $320 million. The GAAP effective tax rate for the quarter was 26.9%. Our effective tax rate decreased 8 percentage points over the fourth quarter of 2017 driven by tax reform. Non-GAAP net income normalized to exclude restructuring and acquisition-related charges and purchase accounting adjustments totaled $187 million resulting in non-GAAP diluted net income per share of $5.47 per share based on diluted weighted average shares outstanding of 34.2 million.

Cash and investments as of December 31, totaled $566 million. In January 2019 as we had previously committed, we repaid $200 million of our Term Loan B debt that was used to finance the acquisition of Lifetouch. We ended January with cash and investments of approximately $225 million down from December 31, due to debt repayment and working capital used to pay vendors and suppliers we used in Q4. As Chris indicated, we are taking a thoughtful approach to capital allocation that will balance targeted levels of leverage with prudent capital returns to shareholders in line with the seasonal cash generation profile of the business. We currently expect to maintain a gross leverage ratio between 2.5 times and 3.0 times adjusted EBITDA.

As a reminder, the Company generates the majority of its cash in the fourth quarter of the year and uses cash during Q1 to Q3 primarily on working capital, capital expenditures and debt and capital lease service. Therefore, starting in the fourth quarter, we expect to be in a position to resume returning capital to shareholders. Capital expenditures in the quarter were $27 million.

Now I'll shift to our full year 2018 results. 2018 non-GAAP revenue normalized for the purchase accounting deferred revenue writedown of $39 million, increased by 68% to $2 billion. We ended the year with Shutterfly Consumer revenue of $972 million, a 3% year-over-year decrease as 3% organic Shutterfly brand growth was offset by lost revenue from the brands and websites we shutted in the 2017 platform consolidation and a year-over-year decline in the Tiny Prints boutique. Within the Shutterfly brand, we had 9% organic Shutterfly brand growth in Personalized Gifts and Home Decor and 2% organic Shutterfly brand growth in core paper-based products.

We closed the Lifetouch acquisition on April 2. Lifetouch generated $799 million of non-GAAP revenue for the nine months ended December 31, 2018 with strong performance in schools, preschool, and studios offset by expected declines in Church. SBS grew revenues by 19% in 2018 to $231 million driven by growth with large clients. 2018 non-GAAP operating income normalized to exclude restructuring and acquisition-related charges and purchase accounting adjustments was $186 million. 2018 adjusted EBITDA was $385 million. As a reminder, we do not own Lifetouch in Q1 of 2018 when they typically have an adjusted EBITDA loss of approximately $35 million. Pro forma for this Q1 loss, our 2018 adjusted EBITDA would have been $350 million, a $116 million increase over 2017.

2018 non-GAAP earnings per share was $3.05. 2018 free cash flow normalized for the impact of nonrecurring convert settlement in Q2 of $64 million was $178 million. In 2018, total unique Shutterfly Consumer customers were 9.8 million, a decrease of 3% over 2017 primarily due to the 2017 platform consolidation. We generated 24 million orders, a decrease of 10% over 2017, primarily due to the 2017 platform consolidation, the mix shift toward paid purchases away from pre-promotions and a decline in the Prints category. Average order value during 2018 was $41.13, a 9% increase over 2017, primarily due to the mix shift toward paid revenues and away from free as well as product mix.

Now I'll turn to our outlook. Please note that the new lease standard ASC 842 is effective for the Company on January 1, 2019. Under this new accounting standard, the Company's build-to-suit leases will now be accounted for as operating leases and will be recorded as right-of-use assets and lease liabilities with rent expense recorded in the income statement. Previously, the Company's build-to-suit leases were recorded as assets and financing obligations with depreciation expense and interest expense recorded in the income statement respectively. As a result, the Company expects that its adjusted EBITDA in 2019 will be negatively impacted by approximately $5 million as ASC 842 will result in incremental operating expense. The adoption of ASC 842 will not impact the company's cash flows.

As Chris mentioned, we now expect to achieve between $400 million and $450 million of adjusted EBITDA in 2021. We included a bridge in this presentation to help investors understand this target. Starting with our 2019 adjusted EBITDA guidance range, which is $315 million at the low end and $340 million at the high end. Incremental manufacturing cost synergies driven by Project Aspen in 2021 of $24 million, reduced integration costs in 2021 of $18 million, adding between $25 million and $33 million of adjusted EBITDA from revenue synergies from the Lifetouch integration and medium-term growth in our baseline businesses ranging from 3% to 5%.

Moving on to our 2019 guidance. Overall, our guidance for 2019 reflects moderate growth in revenue in Shutterfly Consumer. Faster growth in PGHD is offset by a modest growth in core paper-based products. In Lifetouch growth in schools and preschools is offset by a modest decline in Studios and a continued decline in Church. SBS growth is driven by new and existing clients. Overall, this growth in adjusted EBITDA will be offset by incremental investments in the Lifetouch integration and against the revenue and cost synergies, modest investments across a range of initiatives to underpin 2019 growth in each of our three segments and higher operating costs.

Many of these investments will impact each quarter of the year by a similar amount resulting in greater adjusted EBITDA loss in Q1 to Q3 and consequently resulting in a more back-end weighted adjusted EBITDA toward Q4 which is our largest quarter. We'll also invest in capital expenditures in 2019 as we build out our new manufacturing facility in Texas and execute against Project Aspen. While we plan to lease the facility in the presses, we'll have capital expenditures related to building out the facility in our technical manufacturing platform. Our guidance excludes any costs related to executive transition, the strategic review and the facility closures in 2019 or any nonrecurring charges related to the $200 million debt repayment made in January 2019.

Guidance also excludes any proceeds from the sale of existing facilities. Please see Appendix 5.1 on Page 18 of our press release. Here's our guidance for 2019. Net revenue ranging from $2.130 billion to $2.210 billion with growth of 8% at the midpoint driven by an additional quarter of ownership of Lifetouch in 2019. Shutterfly Consumer net revenue ranging from $975 million to $1.025 billion including approximately $25 million of revenue related to Lifetouch synergies and with growth of 3% at the midpoint.

Lifetouch net revenue ranging from $915 million to $935 million which is relatively flat with 2018 at the midpoint. SBS revenue ranging from $240 million to $250 million with growth of 6% at the midpoint which reflects lower growth than we've seen in the past as we focus on closing larger deals with higher valued customers. But it is also lumpier and harder to predict this growth. And overall gross margin of approximately 51.6%, operating income ranging from $76 million to $101 million, adjusted EBITDA ranging from $315 million to $340 million. The midpoint of 2019 adjusted EBITDA of $327 million compares to 2018 adjusted EBITDA of $385 million as follows.

Shutterfly Consumer growth at the midpoint of guidance adds approximately $15 million of incremental adjusted EBITDA and is offset by the following five items. The first is Lifetouch's Q1 EBITDA loss. In Q1 Lifetouch typically has a $35 million adjusted EBITDA loss. And as a reminder, we didn't own Lifetouch in the first quarter of 2018. The second is incremental technology investments to support revenue synergies which will add approximately $5 million of expense. Please note these investments are expected to generate $25 million of revenue in Shutterfly Consumer in 2019 and higher revenue synergies in 2020 and beyond.

The third is an increase in integration costs and costs related to Project Aspen, net of cost synergies which will add approximately $6 million of expense. The fourth is higher personnel expenses including merit increases, higher labor rates and bonuses which will add approximately $20 million of expense. The majority of this increase relates to funding bonuses in 2019 as we did not pay full bonuses in 2018. The fifth is the new lease accounting standard which will add approximately $5 million of operating expense. Please note that 2019 operating income includes these items that impacted adjusted EBITDA as well as higher depreciation of $22 million driven by an additional quarter of Lifetouch in 2019 and higher capital investment, higher amortization of $11 million driven by an additional quarter of Lifetouch in 2019 and higher share-based compensation of $6 million.

Earnings per share are expected to range from $0.55 to $1.06 per share based on 34.8 million weighted average shares outstanding and an effective tax rate of 28%. Our tax rate for 2019 is expected to increase over 2018 as we are forecasting a shortfall from share-based compensation as opposed to 2018 where we had a windfall. We expect capital expenditures of approximately $128 million at the high end of our expected capital expenditure range of 5% to 6% of revenue as 2019 capital expenditures include the additional investments related to Project Aspen.

I also wanted to give a little perspective on our quarterly performance throughout 2019. Shutterfly Consumer growth is expected to be relatively flat in Q1 with improving growth rates as we go throughout the year. Lifetouch is expected to be relatively flat throughout the year.

SBS is expected to be flat to modest declines in the first half of the year with improving growth rates in the second half of the year. From a profitability standpoint, we expect adjusted EBITDA to decline year-over-year in the first three quarters and grow in the fourth quarter as we invest in advance of Q4.

I'll now turn to our guidance for Q1. Net revenue is expected to range from $317 million to $328 million with growth of 61% at the midpoint, driven by the additional quarter of Lifetouch. Shutterfly Consumer net revenue ranging from $146 million to $150 million which is a decline of 3% at the midpoint. Please note that we started Q1 with a lower year-over-year backlog driven by weaker-than-expected Q4 2018 sales compared to stronger Q4 2017 sales as well as the calendar impact of the final two days of 2017 ending on a weekend. This has a corresponding impact on our Q1, '19 Shutterfly Consumer revenue growth which is reported on a shipped basis rather than on an order basis.

In total, backlog is expected to negatively impact Q1 Shutterfly Consumer revenue by approximately $5 million. We expect Lifetouch Q1 revenue to range from $126 million to $130 million which is relatively flat with the prior year after normalizing for the iMemories exit in the second quarter of 2018 which was $4 million of revenue. We expect SBS net revenue to range from $45 million to $48 million, a 2.5% decline at the midpoint. We expect an overall gross margin of approximately 36.3%. We expect an operating loss ranging from $107 million to $102 million, adjusted EBITDA loss ranging from $48 million to $43 million.

Please note that the Q1 operating loss adjusted EBITDA and net loss per share include the impact of incremental investments discussed above. The midpoint of Q1 '19 adjusted EBITDA loss of $46 million compares to Q1 '18 adjusted EBITDA of $7 million as follows. Lifetouch's Q1 EBITDA loss of $35 million as discussed above; an increase in integration costs and costs related to Project Aspen net of cost synergies; and technology investments in a better experience for Lifetouch customers purchasing on Shutterfly.

I'll now turn it back over to Chris for his closing remarks before Q&A.

Christopher North -- President and Chief Executive Officer

Thanks, Mike. Overall, we had a transformational year in 2018 reaching $2 billion in non-GAAP net revenue and $178 million of free cash flow with several areas of strength in our portfolios of business. In Shutterfly Consumer, our strategies around Mobile and category range expansion are yielding strong results. In SBS, we delivered strong growth and margin improvement. In Lifetouch, we've seen solid results and feel incrementally positive about our ability to drive modest growth in this business in the medium term. As we bring these businesses together over the next few years, we have opportunities to create significant value through the cost and revenue synergies.

These opportunities will require investment in 2019 but they set us up to deliver significant value creation in 2020 and in 2021 by which time we expected to grow adjusted EBITDA to between $400 million and $450 million. And finally, given the strong cash flow profile of the business, we expect to be in a position to resume returning capital to shareholders in the fourth quarter of this year.

We'll now open the call for your questions.

Questions and Answers:


Thank you. We will now begin the question-and-answer session. (Operator Instructions) Our first question today will come from Youssef Squali of SunTrust. Please go ahead.

Youssef Squali -- SunTrust -- Analyst

Great. Thank you very much. Two questions from me. First on the Tiny Print boutique negative 17% is somewhat surprising. Just considering how strong some of your peers seem to be doing. So maybe can you just expand on what do you think is actually causing that? Is it just -- is it on the product side? Is it on the marketing side? And kind of how do you see that faring in 2019? What's kind of baked into your numbers? And just kind of stepping back a little bit and looking at the Shutterfly Consumer business overall, Mike I think you talked about a 3% growth year-on-year embedded into your guidance for the year, but negative 3% in the first quarter. So just trying to understand what kind of confidence do you have in your ability to turn it around considering just the numbers that you just put out? Thank you.

Christopher North -- President and Chief Executive Officer

Hi, Youssef. This is Chris. Let me take your first question and I'll ask Mike to take the second. You're definitely right that the performance of the TP boutique was disappointing and well below our expectations. I think you put that in context there's a couple of things to keep in mind here. One is, that represents the revenue of purchases of cards in the boutique this year. A different but important question and the way we often think about is now that both Shutterfly brands and Tiny Prints brand are on the same platform is how we're doing with customers. And when we go and look at the Cards customers in general we've seen that our loyal customers continue to be loyal on the Shutterfly brand historical card customers so the customers historically been loyal to the Shutterfly brand, we've seen them continue to be loyal. We didn't get as much growth there as we expected but we have seen continued loyalty.

When we look at the customers, who's historically purchasing the Tiny Prints brand, we've actually seen that we're retaining those customers reasonably well as well. There are some of them are starting to migrate their purchases to Shutterfly brand, others are continuing to purchase on Tiny Prints. Our challenge really has been if you step back and look not only at 2018, not only Q4, 2018 but across all of 2018 when you look back several years, really comes back to our challenge in attracting the number of new customers we need both specifically to Cards & Stationery in more general to the platform. So some of the shortfall we're seeing in Tiny Prints this year for example comes from the fact that we have not been acquiring as many customers as we needed to the Tiny Prints boutique this year or last year and that just flows through year-over-year as you retain some but not all of those customers.

So like in total in Cards & Stationery, I'd say we're doing satisfactorily in retaining our loyal customers within Cards & Stationery. We'd like to do even better to increase the revenue from those customers but that continues to be a very stable part of our business. We are not doing as well as we need to in attracting new customers to Shutterfly as a whole or to Cards & Stationery specifically holiday card specifically. And when we look at that, we think in particular in Q4 of this year, the competition for the new incremental cards buyer, holiday cards buyer was very much fiercely fought at -- for the value-oriented customer. And quite frankly we did not have as competitive or compelling offer for that customer this year. We're very clear about what we need to do to correct that.

And I've spoken about a kind of good better best strategy for holiday cards as we go into 2019 and we think that's the right way both to serve the loyal Shutterfly brand customer to serve our more premium Tiny Prints customer and also to win over the new customers who often are more value-oriented.

Michael Pope -- Senior Vice President and Chief Financial Officer

Yes. Youssef, just following on the second part of your question. If you look at Shutterfly Consumer net revenue and this will be a like-for-like comparison in '19 for the first time in a long time at the low end of our range it's $975 million which is relatively flat with this year which was $972 million. At the midpoint you point out correctly it's 3% growth at $1 billion. And at the high end, it's closer to 6% growth. We're going to add a little more color to the midpoint of that range. At the midpoint what we said is that we have built in $25 million of Lifetouch revenue synergy into '19 where we'll have all what we were able to start to do this year to start to transition the Lifetouch customers to become Shutterfly customers as well, but significant improvements in the customer experience, as Chris called out in his prepared remarks, that give us a high degree of confidence in that $25 million.

So another way that you could think about that, at the midpoint of our range is we've essentially said a flat Consumer net revenue and most of the growth is coming out of the Lifetouch Consumer revenue. Now clearly we hope to do better than that. But coming off of our quarter where we grew 1% we thought it was prudent to have this range of guidance.

Youssef Squali -- SunTrust -- Analyst

Okay, that's helpful. Thanks, Mike. Thanks, Chris.


Our next question will come from Colin Sebastian of Robert W. Baird. Please go ahead.

Benjamin Gaither -- Robert W. Baird -- Analyst

Hi. It's Ben on for Colin. A couple of questions. First, given some of the recent capital raises from competitors, could you comment a little bit on the competitive landscape more broadly and how that's impacting, how you guys kind of approach the new promotional strategy? And then second, maybe an update on how some of the new categories like Kids and Pets are progressing relative to the initial expectations?

Christopher North -- President and Chief Executive Officer

Right. Hi Ben. This is Chris. I'll take those. So with respect your first question, there's no doubt at least (ph) a degree a competitive dynamic this holiday season that was different and more intense than we've seen in recent years. We saw across a range of different companies much more aggressive marketing. We also saw price competition both through headline price and through promotions at a level of intensity we haven't seen in some years. Now we did our best to react to that. You will see some more aggressive promotions from us as we've done in the past. We stepped up some of our marketing response as well.

And I think we had frankly mixed results with that. I think it was better than doing nothing, but it wasn't as good as we planned those from the start. Inevitably when you're reacting, your marketing and pricing and promotional investments are less effective and less efficient than they would have been. And so we're planning for 2019 assuming that that competitive dynamic will continue to be the case. When it comes to competitors and capital raises, I think it's interesting to note that according to publicly available data -- excuse me, according to the data that we're able to obtain from various sources, we think we saw there are number of companies out there whose growth was relatively modest in the holiday card space.

And we certainly heard from public statements that some of the capital raises you're referring to are very much oriented toward a wholesale strategy rather than a consumer strategy,

obviously remains to be seen what actually happens. I think -- could you just repeat your second question? Oh Kids and Pets excuse me. On Kids and Pets, we were pleased with what we saw in Q4, generally came in, in line with our expectations. I think Kids and Pets is clearly contributing to this very exciting reacceleration of growth that we're seeing in Personalized Gifts and Home Decor where we saw growth rates.

In overall, Personalized Gifts and Home Decor but also in the paid segment that represented a significant reacceleration versus several years previous growth. And it was unfortunate that we hit these capacity constraints where we were impacted by two suppliers availability but the growth would have been even stronger if we hadn't faced those and we think we're set up well to have the right capacity and the right redundancy for this year.

Benjamin Gaither -- Robert W. Baird -- Analyst

Got it. Thank you.


Our next question will come from Victor Anthony of Aegis Capital. Please go ahead.

Victor Anthony -- Aegis Capital -- Analyst

Hi, guys, a lot to digest. And Chris, it's sad to see you go, but few questions guys. First, are you guys able to tell us whether or not it's a financial strategic buyer that approached you? That's one. And second, the industry clearly got a lot more competitive in the fourth quarter as you just discussed. Is there something structural about the industry that made that happen in the fourth quarter? That's my second question. And third, how do you guys, I guess, tend to justify the elevated expenses, personnel expenses that is given the performance in '18 and the implied guidance that you have for '19? And fourth, is really just in your gross margins, they seem to be a bit low overall. I wanted to see if you could unpack that a bit for me. Thanks.

Michael Pope -- Senior Vice President and Chief Financial Officer

Sure. So, this is Mike. I'll jump in with the first question which I think was can we provide more color around the strategic -- the interest in the fourth quarter of the year. We pretty much detailed a pretty exhaustive process in our press release today and we've had interest from a number of parties over the last several years frankly as recent as the last couple of months. But we don't think it's prudent to get into disclosing whether it's strategic or financial buyer.

With regard to personnel expenses, I think I called out in the EBITDA reconciliation from the $385 million in 2018 to the $327 million at the midpoint that we had roughly $20 million of personnel-related expenses. Those extend across merit bonus and some increases in direct labor that we're seeing out there.

I think from our perspective, as the leader in our space, we continue to believe it's important to incent and keep the right people at the Company and we use a combination of factors. So we're thinking about this for the medium term, long term and believe that that's the right approach to take. I also mentioned that the increases in 2019 with regard to bonus in particular were a result from the fact that we did not pay for bonuses at either Lifetouch or Shutterfly in 2018.

Christopher North -- President and Chief Executive Officer

Appropriately so given our performance. And to come to your second question, Victor, this is Chris, you asked about what was behind competition. I think here we're making inferences from our own data from third-party data and from what we can observe from competitors behaviors. We obviously don't know what their intent was. I think there's a couple of things happening here. First is, as we've said, it looks to us triangulating from various sources of data the total expenditure against holiday cards was flat to very slightly down. And when we decompose that, it's clear that for the industry as a whole there's just a lot of competition for that incremental cards buyer. And that incremental new cards buyer will tend on average to be a more value-oriented buyer, a new household formation and maybe somebody who switches from year to year between personalized cards and boxed cards and so on.

And when I think about that kind of competition it's not a mere mistake to think about it as just price competition. Certainly price matters, but I think it's really first of all about the value. So it's about having the right cards offering, the right design, the right formats. And frankly, we did not have the right offering for the more value-oriented consumer. We had in 2018 as we have had in prior years focused our value offering on photo paper-based cards. And what we saw in 2018 is that the battle for the value of customer really switched into card stock-based cards. That's an area where we can be very competitive. We have meaningful cost advantages in particular around card stock-based cards but our value offering in 2018 was focused on photo paper. So that's something that's clearly we're going to think about for 2019.

I think the other angle is really the marketing battle. And as you've heard me say before, the changes we made, the reductions in marketing spend from 2016 to 2017 which -- and in addition the reallocation of how we spent the money, generally away from brand and awareness and toward performance marketing, seem to be very effective to us in 2017. In 2018 we saw a number of companies stepping into fill that, that we had left and trying to find themselves is the definitive destination for cards. And I think with retrospect we've hold that too far. So as we look forward to 2019 and with the new CMO on board, what we think our overall level of marketing expenditure for Shutterfly is right. We're going to be leaning more into brand in order to retake our rightful position given that we're the category leader as the definitive destination for cards.

Michael Pope -- Senior Vice President and Chief Financial Officer

Yes. Chris, I wanted to go back and just add, I realized that I didn't answer the final part of Youssef's question with regard to Q1 consumer growth being down 3% at the midpoint. And what -- as I called out in my prepared remarks, there's really about a $5 million bad guide because of the backlog being lower going into Q1 than in the previous year and $5 million on Q1 revenue on the Consumer side of roughly $150 million is somewhere between 3% and 3.5%. So I think on an apples-to-apples basis you can think about it as flat to slightly up at the midpoint. And the last part I'd add there is that the Lifetouch revenue synergies will disproportionately benefit us in Q4 for two reasons. One it's our largest quarter; and two, we'll have more time to make some of the exciting technology advances that will benefit those customers.


(Operator Instructions) Our next question will come from Edward Yruma of KeyBanc Capital Markets. Please go ahead.

Sarah McCann -- KeyBanc Capital Markets -- Analyst

Hi. This is Sarah McCann on for Ed. Thanks for taking our question. So stepping back, do you think lapping the shift from pre to paid revenues during 2019 will benefit revenue growth in any way during the year? And then can you walk us through some examples of how you're planning to reinvigorate the Prints business this year? Thanks.

Christopher North -- President and Chief Executive Officer

Yes. This is Chris. Let me -- I'll take those. So on your first question on pre and paid, as we said in our prepared remarks, we're now largely through that transition. Q1 was the last quarter where there's an unfavorable comparison year-over-year. And we think that we're now using free in the way we intend in a strategic way. We continue to want to serve the customer who loves free promotions but we're using them in a more targeted and a more rationalized way going forward. So I think we're now at the right level. So I don't expect that to be either a significant headwind or a tailwind going forward.

I think with respect to your question on Prints, I think there are a couple of areas of customer experience that it's very clear from the customer feedback that we have room to improve on. One clear example for me is around our cropping experience. Without going into sort of fine details here, a typical Prints' customer orders many prints, it could be any given orders as many as 100 prints. And we made exchanges to our cropping workflow, that worked very well for most of our products but are not very convenient for our Prints' customers and that's led to some customer's satisfaction. So I give that one as one but not the only example, some UI improvements.

I think the other thing is that our Prints growth if I look back to '17 and '16, really was supported by some very successful promotions, in particular promotion we call unlimited free prints that would prove extremely popular with customers. Now that we've been running that promotion for several years as happens with promotions becoming tired and it's no longer a favorable comparison for us. So we have a number of promotional experiments we're running on Prints to reinvigorate our promotional slate there. So I think between the UI and CX changes and the work we're doing on the pricing and promotion sides of Prints, that we feel that we have levers to improve the performance of that business.


Our next question is a follow-up from Victor Anthony of Aegis Capital. Please go ahead.

Victor Anthony -- Aegis Capital -- Analyst

Hi, guys, thanks for taking the follow-up. I just wanted to be clear about your response to the potential acquisitions. I think the press release read that you guys received an offer, and I think the Board may have gone out and seek -- sought out competing offers. Correct me if I'm wrong. Or in your response from earlier, it seems that you seem to imply that you see multiple different offers. And second, I think in response to my gross margin question, I wanted to get a sense on it. It seems that the gross margin number overall was a bit lower than probably what it should have been. So I wanted to see if you can unpack that a little bit for me.

Michael Pope -- Senior Vice President and Chief Financial Officer

So, Victor, I'd point you to the press release itself along the lines of the announcing the formation of the Strategic Review Committee. What we said in there was 100% accurate which is, the Company was approached by a third party about a potential acquisition of the Company. We did not say that the Company received an offer. And we said based on that we subsequently engaged with several additional third parties but that no proposals have been received. So I think the prepared remarks again pointed out that the Board felt that given the multiple expressions of interest over sustained period of time, it made sense to forming the Strategic Review Committee to look at potential expressions of interest as well as things like the capital structure, the debt leverage and other strategic things.

Christopher North -- President and Chief Executive Officer

And then you had question about margin?

Michael Pope -- Senior Vice President and Chief Financial Officer

Yes. So can you repeat your question on gross margin?

Victor Anthony -- Aegis Capital -- Analyst

Yes. It seems that the overall gross margins appeared a bit lower than what would be implied by the individual buckets. And so I wanted to see those in sort of maybe -- yes, sure.

Michael Pope -- Senior Vice President and Chief Financial Officer

Yes, I think -- it's on gross margin, the overall gross margin for Q4 on a non -- was 60.3% and the guidance that we had provided was 61.6%. And the difference there was really driven by mix across our three segments. So Shutterfly Consumer was a lower percent of the mix than we thought. Lifetouch was about where we thought. It would be -- and SBS was a higher percent than we thought. So there's -- and then obviously there's dynamics within each of the segments that affect gross margin. But if you look at the segments in the gross margin, I'd say they were fairly close to in line with what our expectations were. With Shutterfly Consumer down, again a bit because we had a shortfall in cards which is our highest gross margin and we didn't achieve the overall revenue on Shutterfly Consumer that we would have hoped to.

Victor Anthony -- Aegis Capital -- Analyst

Okay. Thank you very much.


And ladies and gentlemen, this will conclude our question-and-answer session. At this time, I'd like to turn the conference back over to Mike Pope for any closing remarks.

Christopher North -- President and Chief Executive Officer

Hi. This is Chris. I'll just mention a couple of things in closing. I think our priorities for 2019 are very clear. In SBS, we're going to be focused on serving our existing large customers and landing large new customers. In Lifetouch, we'll be continuing to drive account growth in schools and preschools. We're looking to improve our participation rate through awareness supported by direct-to-consumer communications. In the Shutterfly Consumer business, we'll be continuing to build on our successes in mobile, in range expansion, in the reacceleration of Personalized Gifts and Home Decor while making improvements in our Prints and our holiday cards offering supporting by -- supported by marketing and promotional investments. And of course we'll be continuing our path toward a single manufacturing platform to realize $130 million of cost synergies over the next five years.

And finally, we'll be very focused on driving the Lifetouch revenue synergies in 2019. At the same time as we build out the integrated customer-facing platforms that we'll deploy in 2020 and beyond. Thank you.


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

Duration: 67 minutes

Call participants:

Shawn Tabak -- Vice President of Investor Relations

Christopher North -- President and Chief Executive Officer

Michael Pope -- Senior Vice President and Chief Financial Officer

Youssef Squali -- SunTrust -- Analyst

Benjamin Gaither -- Robert W. Baird -- Analyst

Victor Anthony -- Aegis Capital -- Analyst

Sarah McCann -- KeyBanc Capital Markets -- Analyst

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