Pictures don't lack demographic targeting. You can make a lot of demographic assumptions from the content inside of a picture.
Example: facial recognition says that this blob with eyes in the photo is a child. Flag may have signed up Babies R Us as an advertiser. Based on the notion that it's a baby on the front of the photo the back as should be for formula, college funds, or diapers.
The tricky part is building up the tooling to automate that process. But hey, most of that exists in the wild already.
actually, I don't think their business model relies on the ads.
They mentioned a bunch of other features, I think this is a pretty clear-cut freemium SaaS model. They send you the 20 pics a month, and try to upsell you with nicer ones. They'll probably say "only $5 a month and your 20 prints can have rounded edges, $10 a month and you get 40!"
The ads on the back of pictures seems almost like a ruse to convince people that this is a real business (because upselling is a lot harder to explain to people than "ads")
The hard part of this entire business model is getting advertisers, yet they've left that as the last step to test.