, Inc. Q3 2008 Earnings Call Transcript

| About: Inc. (STMP), Inc. (NASDAQ:STMP)

Q3 2008 Earnings Call

October 23, 2008 5:00 pm ET


Jeff Carvari – Investor Relations

Kenneth McBride – President and Chief Executive Officer

Kyle Huebner - Chief Financial Officer


George Sutton - Craig-Hallum Capital

[Carl Kwa] - Needham & Company

Kevin Liu - B. Riley & Company, Inc.

Mark May - Needham & Company

[F. E. Wahls] - GSI Investments


Welcome to the third quarter 2008 financial results conference call. (Operator Instructions) Now at this time, for opening remarks and introductions, I’ll turn the conference over to Jeff Carvari.

Jeff Carvari

On the call today is Ken McBride, CEO, and Kyle Huebner, CFO. The agenda of today’s call is as follows, we will review the results of our third quarter and talk about the business outlook, and then we’ll discuss financial results and talk about our business outlook.

But first, the Safe Harbor Statements. The Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995, this release contains forward-looking statements such as our expectations and financial guidance that involves risks and uncertainties. Important factors include the company’s ability to complete and ship its products, maintain desirable economics for its products and obtain or maintain regulatory approval which could cause actual results to differ materially from those in the forward-looking statements, are detailed in the filings with the Securities Exchange Commission stated from time-to-time by, including its annual reports on Form 10-K for the first year, for the fiscal year ended December 31, 2007, quarterly reports on Form 10-Q and quarterly reports on Form 8-K. understates no obligation to update or make any revisions to any forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

Now, let me hand the call over to Ken McBride.

Kenneth McBride

During the third quarter we did $20.2 million in total revenue, total PC Postage subscriber-related revenue, which includes service revenue, store revenue and insurance revenue, was $18.1 million, which was up 8% versus the subscriber-related revenue in the third quarter of 2007. Excluding the enhanced promotion channels, subscriber-related revenue was $16.0 million which was up 11% from the third quarter of 2007.

PhotoStamps revenue was $2.0 million, down 43% from the third quarter of 2007. We reduced the PhotoStamps sales and marketing by approximately 68% versus the third quarter of 2007 as part of our continuing program to increase profitability in the PhotoStamps business and that resulted in an increase in revenue.

Our non-GAAP income from operations for the third quarter was $2.7 million which was up 20% versus the third quarter of 2007. This is our best quarterly growth in operating earnings in the past two years.

Non-GAAP earnings per fully diluted share came in at $0.17, which is up 6% versus the third quarter of 2007.

In the current tight macroeconomic environment we are happy with the strength in our earnings this quarter.

On the call today we will talk about PC Postage business in detail, then we will talk about PhotoStamps, and then we will discuss financial results and our business outlook.

Now let’s begin a more detailed discussion of the PC Postage business. As a reminder, we will only talk about our business using the new customer metrics which were introduced in the first quarter of this and that now exclude all enhanced promotional channel activity.

During the third quarter we acquired 49,000 gross customers, which is down 8% versus the third quarter last year. We believe the weak economy was the primary cause of this slowdown in gross customer acquisition. The slowdown in customer acquisition was driven by a decline in the overall traffic of prospects coming to our website.

It seems that uncertainty about the future on the part of small businesses is primarily translating, for us, into fewer prospects considering our service. Small business may be less willing to take on new monthly expenses when they are struggling.

The contrast, or churn, during the third quarter declined to 3.6% versus 3.7% in the second quarter so we have not seen as much of an impact from the poor economy in churn rates as we did in acquisition. We believe that customers that have already adopted our service and worked it into their regular work flows may be less willing to give it up, as it is a relatively small monthly expense and it does save time and save money versus alternatives, such as postage meters or going to the post office.

With the lower customer acquisition this quarter, we also experienced an increase in our cost per registered customer acquisition, or CPA, to $115 compared to $101 in the first quarter and $94 in the second quarter this year.

While we continue to see a very good return on our marketing investment at the $115 CPA level, we were disappointed to see an increase in the symmetric this quarter. As a result of the slower third quarter growth acquisition, we slowed our acquisition spend during the third quarter to a growth rate of 25% year-over-year versus the 40% and 37% growth rates we did in the first and second quarters of this year respectively.

We continue to see a very good ROI on our marketing spend so we plan to continue to spend for long-term growth but we now expect that we will spend at a more modest rate than our prior expectations. For fiscal 2008, as a whole, we now expect to grow total customer acquisition spend at 25% to 30% versus 2007 and that is down from our prior expectation for 2008 growth of 35% to 40%.

The slowdown in acquisition also resulted in some slowing in growth of our paid customer this quarter with paid customers in the third quarter of 2008 increasing 11% versus the third quarter of 2007.

With the launch of our $17.99 price point for new customers last quarter we were able to successfully increase the average revenue per paid customer we get from service fees and a result our subscription service fees grew 13% year-over-year, which was 2% faster than our paid customer growth rate.

Note that we did have some concern that our new $17.99 price point might be a contributing factor to our Q3 acquisition slowdown so we recently retested the pricing plan versus our prior $15.99 plan but we found that the two plans showed a negligible difference in customer acquisition rates. At this point we plan to continue forward with the $17.99 pricing plan as our main plan for new customers indefinitely.

Again, all the numbers we just gave excluded all enhanced promotion channel activity.

Our mailing and shipping supplies store revenue was up 1% versus the same quarter last year. We believe that customers purchased fewer supplies as their business activity slowed during Q3.

During the third quarter we finalized pricing and began marketing our new multi-user capability. This new capability will allow multiple users to access a single account balance. Based on our pricing tests we ran over the last couple of quarters, we decided to bundle a three-user multi-user license into our $24.99 per month Premier plan. So our Premier plan now includes FedEx, Certified Mail, and multi-user in a bundled package at $24.99 a month. We expect that adding multi-user will improve the value proposition in Premier relative to our Pro plan and will lead to more upgrades to that plan.

We also felt that a two-tier pricing strategy is sufficient to represent the array of services we offer and more than two tiers could lead to undue customer confusion.

We also recently received an increased discount for our customers from FedEx so we are now able to offer our customers a discount off those prices of 21% versus the prior discount of 10%, further enhancing the value proposition of our premier plan.

We began driving awareness of the new Premier bundle during Q3 through marketing initiatives such as e-mail pop-ups and inserts into our store orders.

Through the multi-user launch and Premier marketing we have done so far, we estimate that we have been able to increase the size of our customer base of these higher-tier customers by more than 10% since the beginning of the year.

In the enterprise PC Postage area we continued to make good progress during the third quarter. Although it is a small part of our overall business we continue to be excited about our opportunity in enterprise. Customers continue to be attracted to us versus a postage meter based on our dramatically lower total cost of ownership and based on the great visibility into individual employee activity that isn’t available with a meter.

Our new accounts added for the quarter were strong and during the third quarter we added to our enterprise sales team and remained encouraged by some of the initial economics in some of our marketing programs. We plan to continue scaling up our enterprise sales and marketing efforts in a cost-effective manner.

Overall, despite the tough macroeconomic environment, we are confident in our ability to continue to grow our PC Postage business for the long term, even if it grows at a somewhat slower rate than we originally expected during tougher times for the economy.

Now, let’s turn to a more detailed discussion of PhotoStamps. During the third quarter we shipped approximately 120,000 sheets of PhotoStamps for a total of approximately $2.0 million in third quarter PhotoStamps revenue, which is down 43% versus the same quarter last year.

Vendor revenue and high-volume business revenue were down year-over-year. During Q3 we continued our program to increase profitability in the PhotoStamps area with a smaller and more focused marketing plan and we decreased our total sales and marketing spend for PhotoStamps by 68% versus the third quarter of 2007. The decline in revenue during Q3 was expected given the magnitude of our decreasing sales and marketing activity.

We would also note that it is possible that the broader economic slowdown may be impacting PhotoStamps stamps as it is more of a luxury item than a necessity.

Despite the lower Q3 PhotoStamps revenue we were still encouraged to see the profitability picture improve for the PhotoStamps business this quarter versus the same quarter last year.

For the PhotoStamps go-forward plan we are planning to continue our programs of a more focused, direct-to-site PhotoStamps marketing spend with a goal of keeping our overall cost per acquisition at a level that provides a good financial return.

As we continue to drive fewer but more profitable orders to our website through our own consumer marketing activity we plan to focus on three areas to drive the overall business. First, we plan to continue working on growing high-volume business usage of PhotoStamps. Based on recent performance, this area may prove more difficult to grow without the support of overall consumer marketing generating the awareness but we are continuing to work on various programs to drive this area.

Second, we plan to continue to pursue consumer distribution partnerships like our Adobe and our HP SnapFish partnerships. Partnerships provide a cost-effective way to manage acquisition costs through a revenue share or bounty arrangement that aligns the interest of the partnership.

Third, we are driving PhotoStamps broadly into retail with national placements with several well-known retail chains. This includes retailers such as Cosco, Walgreens, Staples, Office Depot, Retail Post Offices, and several other national retailers.

The model we are currently pursuing in retail is a boxed product that is about the size of a DVD case. Each box contains a CD ROM with design software for the PC or Mac and it contains credit for one sheet of PhotoStamps redeemable at our website. The boxes are sold by most retailers at a $19.99 price point.

We began this model in fourth quarter of 2007 with tests with several retailers and we saw very good initial success with the program. For the 2008 holiday season we expect to have these PhotoStamps boxes available at over 20,000 retail locations across the country. We wish were weren’t launching this new retail initiative in the midst of perhaps the worst retail holiday season in a long time, but we are nonetheless excited about this initiative and we think this could be a great long-term model for the PhotoStamps business.

We expect the strategic changes we have made in our approach to the PhotoStamps business line will continue to improve the profitability picture for PhotoStamps going forward. We do expect that as a result of this shift we will continue to see lower reported revenue in the near term in the business model. However, we believe that it is important at this stage of the development of the business to move the model aggressively to profitability, even if it is at a lower revenue level.

Now, I will turn the call over to Kyle who will discuss more detailed financial results and our business outlook.

Kyle Huebner

Q3 customer metrics. All PC Postage metrics we will discuss in the section exclude all estimated enhanced promotion activity. We will now review the PC Postage metrics for the third quarter in more detail.

Paid customers. Paid customers in the third quarter were 312,400, down 1,300 from the 312,700 paid customers in Q2 2008 and up 31,000, or 11%, versus the 281,000 paid customers in Q3 2007. The paid customer number represents the unique number of customers successfully billed at least once during the quarter.

The change in paid customers from Q2 2008 to Q3 2008 was composed of 36,000 new paid customers that were successfully billed for the first time during the quarter, offset by 37,000 lost paid customers. Lost paid customers are defined as customers who were successfully billed in the previous quarter but not successfully billed in the current quarter, less any recaptured paid customers from prior quarters.

The sequential decline in paid customers was primarily attributable to lower new paid customers resulting from the slowdown in customer acquisition.

Customer acquisition. PC Postage small business customer acquisition spend, which includes both sales and marketing spend as well as promotional spend, which is included in cost of sales, was $5.6 million in Q3, up 25% versus $4.5 million in Q3 2007. Small business costs per new registered customer was $115 in Q3 versus $94 in Q2 2008 and compared with $84 in Q3 2007.

We experienced a slowdown in customer acquisition, which we believe was primarily related to a weaker macroeconomic environment as Ken discussed. We are still earning an attractive ROI on our marketing spend and so we believe it is still important to continue to invest in the business for the long term, however we expect to pull back modestly on our marketing spend in the short term.

Subscriber revenue. Subscriber-related revenue, which includes service fee, store, and insurance revenue, excluding the enhanced promotion customers was $16.0 million in Q3 2008, which was up 11% versus $14.4 million in Q3 2007.

Average monthly subscriber revenue per paid customer was $17.07 for Q3, which was up 0.3% versus $17.03 for Q3 2007. This metric is calculated as total subscriber-related revenue for the quarter divided by paid customers from the quarter, divided by three months.

Service fee revenue, excluding the enhanced promotion channel, was $13.4 million in Q3, which was up sequentially from the $13.25 million in Q2 2008 despite the slight decrease in paid customers as we saw some of the benefit of the $17.99 price increase to new customers start to flow through the metrics.

Paid customer cancel rate was 3.6% in Q3 versus 3.7% in Q2 2008 and versus 3.0% in Q3 2007. Paid customer cancel rate is calculated as total lost paid customers in the quarter divided by the sum of prior quarter paid customers and current quarter new paid customers, divided by three months.

There are many factors that influence churn rates, including the type of customer, the age of the customer, levels of acquisition, mix of customer acquisition channels, pricing, retention program offers, usability of the product, and the economy, and as such we expect to see some degree of fluctuation from quarter to quarter.

Churn did improve sequentially so we believe the macroeconomic factors impacted acquisition to a greater degree than churn in Q3 relative to Q2. We will continue to focus on ways to reduce churn and optimize lifetime values.

Customer usage. Total postage used by all customers was $77.0 million in Q3 2008, up 13% from $68.0 million in Q3 2007.

Now we will review our third quarter financial results.

Non-GAAP to GAAP reconciliation. We presented our third quarter 2008 financial results today on both a GAAP and non-GAAP basis to adjust for the following items.

First, we had litigation charges of $61,000 representing adjustments to the prior one-time litigation charge related to a lawsuit emanating from the company’s iShip operations and also representing expected settlements in other litigation matters.

Second, we had $880,000 of stock-based compensation expense which was allocated as follows. $84,000 in cost of sales, $204,000 in sales and marketing, $182,000 in R&D, with $410,000 in G&A.

Third, we incurred approximately $350,000 of additional California State income tax due to the state’s temporary suspension of the use of net operating losses based on new legislation which was signed on September 23, 2008, and is effective for the tax years 2008 and 2009.

GAAP operating income was $1.8 million and non-GAAP operating income, taking into account the three adjustments described above, was $2.7 million.

GAAP net income was $2.1 million, or $0.10 per fully diluted share and non-GAAP net income, taking into account these adjustments, was $3.4 million, or $0.17 per fully diluted share.

The rest of the financial results discussion will be based on the non-GAAP numbers. A more detailed reconciliation of non-GAAP to GAAP measures is contained in the earnings release posted on our website.

Q3 financial results. Revenue was $20.2 million in Q3 which was down 1% compared with Q3 2007. PC Postage subscription revenue, which includes service fees, store, and insurance revenue, and it also includes the enhanced promotion channel, was $18.1 million in Q3, which was up 8% compared with Q3 2007.

Subscription revenue, excluding the enhanced promotion, was $16.0 million Q3 which was up 11% compared with Q3 2007.

Year-to-date 2008 subscription revenue, excluding the enhanced promotion channel, was up 12% versus the comparable year-to-date 2007 period. So we are still on track to meet our goal of double-digit revenue growth for 2008 subscription revenue excluding the enhanced promotion channel.

Subscription revenue from the enhanced promotion channel was $2.1 million in Q3, which was down 11% compared with Q3 2007. The decline in revenue was primarily attributable to the lower marketing spend, which was down 35% in the enhanced promotion channel compared with Q3 2007.

PhotoStamps revenue was $2.0 million in Q3, which was down 43% compared with Q3 2007. PhotoStamps revenue was down as expected, due to lower PhotoStamps sales and marketing spend, which was down 68% year-over-year.

Gross margin, excluding 123(NYSE:R) expense, was 75.4% in Q3 compared with 72.2% in Q3 2007. The increase in gross margin was due to a higher mix of PC Postage revenue which carries a higher gross margin as compared to PhotoStamps revenue.

For PC Postage subscription-related revenue, gross margin, excluding 123(R) expense, was 80.8% in Q3 which is comparable with the 81.1% in Q3 2007.

Cost of sales included promotional expenses of $290,000 for Q3. For the PhotoStamps business gross margin, excluding 123(R) expense, was 26.7% in Q3 compared to 29.9% in Q3 2007.

The year-over-year decrease in PhotoStamps gross margin was primarily attributable to less fixed-cost leverage associated with the current lower levels of PhotoStamps revenue and to increased postage face value costs as postal rates increased in May 2008 but we did not raise our PhotoStamps prices.

Sales and marketing, excluding 123(R) expense, was $7.5 million in Q3, which was down 4% compared with Q3 2007.

PC Postage sales and marketing, including the enhanced promotion channel, increased by 15% while PhotoStamps sales and marketing spend decreased by 68%. The increase in PC Postage sales and marketing was driven by increase investment in marketing programs to grow future subscription revenue. The decrease in PhotoStamps sales and marketing spend was part of our ongoing effort to improve profitability in the PhotoStamps business line through lower and more focused spend on higher-return programs.

R&D spend, excluding 123(R) expense, was $2.1 million in Q3, which was up 8% compared with $1.9 million in Q3 2007. The increase was primarily attributable to increased headcount-related costs.

G&A spend, excluding 123(R) expenses and the litigation charges, was $2.9 million in Q3, which was up 9% compared with $2.7 million in Q3 2007. Legal spend declined sequentially from Q2 2008 but was up compared with Q3 2007.

Non-GAAP operating income was therefore $2.7 million in Q3, which was up 20% compared with $2.3 million in Q3 2007. The 20% year-over-year growth in operating income was our best growth since Q3 2006.

Interest income was $697,000 in Q3, which was down 34% versus the $1.1 million in Q3 2007. The lower interest income compared with last year was attributable to lower income yields in the lower interest rate environment.

Non-GAAP net income was $3.4 million, or $0.17 per fully diluted share, based on 19.7 million fully diluted shares outstanding compared with $3.3 million, or $0.16 per fully diluted share based on 20.6 million fully diluted shares in Q3 2007.

We were very pleased with our bottom line as the $0.17 EPS represents our highest EPS since Q4 2006, which we achieved while still investing for the future of the business.

Free cash flow, defined as non-GAAP net income plus DNA less capex was positive $3.4 million in Q3. For the quarter DNA was $365,000 and capex was $278,000.

We ended Q3 with $94.0 million in cash and investments, which is equivalent to $4.74 per fully diluted share. In calculating the total cash and investments we are including cash, cash equivalents, long-term investments, short-term investments, and restricted cash.

Share buyback. On July 16, 2008,’s Board of Directors approved a share repurchase program authorizing the company to repurchase up to 2.0 million shares of stock through February 2009. The company purchased approximately 1.2 million shares for a total cost of $13.0 million under that program during the third quarter and fourth quarter to date. Of this amount approximately 250,000 shares were repurchased during Q3 and the remainder were repurchased during Q3. Including all repurchases to date, our estimated current cash and investments are approximately $84.0 million. On October 16, 2008,’s Board of Directors amended the current share repurchase program so that the company may now purchase up to 3.0 million shares of stock, including the 1.2 million shares that have already been purchased through February 2009.

Net operating loss shareholder update. We have approximately $240.0 million in federal NOLs and $150.0 million in state NOLs, which can save us as much as $95.0 million in taxes over the next 15 years. Under IRS code section 382 rules a change in ownership can occur whenever there is a shift in ownership by more than 50 percentage points by one or more 5% shareholder within a three-year period.

And when the change in ownership under this definition is triggered, our ability to use our NOLs may be limited. We estimate that the company is currently at approximately 37% ownership shift compared with the 50% ownership shift that would trigger a possible impairment.

During the second quarter we received shareholder approval to amend our Articles of Incorporation in order to protect our NOL assets, the NOL protected measures. And those measures are now in effect. Under the NOL protected measures there is no change to the way that existing shares are held or traded, but any person, company, or investment firm who wishes to become a 5% shareholder of must first obtain a waiver from the company’s Board of Directors.

In addition, any person, company, or investment firm which is already a 5% shareholder of cannot make any additional purchases of stock without a waiver from the company’s Board of Directors.

We currently have approximately 18.2 million shares outstanding so ownership of approximately 910,000 or greater would currently constitute a 5% shareholder. strongly urges any shareholder contemplating owning more than 725,000 shares to contact the company before doing so.

Now turning to guidance. We expect fiscal 2008 revenue to be between $80.0 million to $90.0 million. We expect fiscal 2008 GAAP net income to be between $0.52 to $0.62 per fully diluted share, including an estimated $3.4 million of 2008 123(R) expense, the second and third quarter $771,000 litigation charges, the first quarter $445,000 asset write-off, the first quarter $3.7 million income tax benefit, with an estimated $500,000 of 2008 NOL California income tax adjustment.

Excluding the 123(R) expenses, litigation charge, asset write-off, income tax benefit, and NOL tax adjustment, we expect 2008 non-GAAP net income to between $0.60 to $0.70 per fully diluted share.

We expect double-digit revenue growth in PC Postage subscription revenue, excluding the enhanced promotion channel, for the full year of 2008.

From a customer metrics prospective, we see Q4 so far as being on par with Q3. Q4 is typically our seasonally strongest quarter so that could help relative to Q3 but the seasonality benefit could be offset if we experience further deterioration in the economy.

We expect enhanced promotion revenue to continue to be down for the remainder of 2008 as we reduce our investment in that channel.

We expect PhotoStamps revenue to continue to be down materially in 2008 as we continue to focus on profitability in the PhotoStamps business as discussed.

We expect to continue investing in the PC Postage business with an expected increase of 25% to 30% in our small business customer acquisition spend outside the enhanced promotion channel for the full year of 2008.

We expect a decrease of 25% to 30% marketing spend in the enhanced promotion channel for 2008.

We expect legal spend to be up modestly in Q4 versus Q3.

We expect interest income to decline sequentially in Q4 versus Q3.

We expect GAAP taxes in Q4 to be approximately 9% to 10% of pre-tax income and non-GAAP taxes to be approximately 3% to 4% of pre-tax income.

I will now turn it back over to Ken for a summary.

Kenneth McBride

So given the uncertain economic environment we thought it would be a good time for us to maybe highlight some of the strengths and assets of our business.

PC Postage is a strong business model that we believe can produce solid earnings even in a prolonged economic downturn. We have a recurring revenue model which provides a high degree of stability and predictability and provides downside protection in a bad economy as our investment in building our paid customer base over the past years continues to generate revenue going forward.

We have 80% gross margins, which drive a very profitable customer lifetime value. As an indication of the strength of our model, we were able to increase our non-GAAP operating income by 20% this quarter and delivered our highest operating and net income since 2006.

Our fundamental customer unit economics continue to be very attractive. Even with the higher cost for acquisition that we saw this quarter, we estimate that our customer lifetime values are over 2x our customer acquisition costs, providing a very attractive return on investment to our marketing spend.

In addition, we have been able to raise our price to new customers by 12.5% during these uncertain times and that has further increased our customer lifetime value and our ROI on marketing spend.

Our business generates strong free cash flow. Even with our dramatically stepped-up investment and our marketing programs over the past two years we have generated significant cash flow.

We have low working capital and capital expenditure needs, spending less than 1% of revenue on capex over the past two years.

Over the past four quarters we generated $13.5 million in free cash flow which is more than 15% of total revenue during the period.

We have a very strong balance sheet and a large NOL asset. We currently have no debt and approximately $84.0 million in cash and investments, which is equivalent to approximately $4.60 per share.

In addition, we do not pay ordinary income taxes, owing to our large NOL asset, which we believe may save us as much as $95.0 million, the equivalent of $5.20 per share, in taxes over the next 15 years.

Finally, we have been very aggressive buying back stock. Over the past two years the company has repurchased $77.0 million worth of stock removing 5.7 million shares, or 23%, of our prior shares outstanding. In addition, the Board just increased the authorization in the current share repurchase plan allowing an additional 1.8 million shares, or another 10% of our current shares outstanding, to be purchased through February of next year.

In summary, despite the difficult economic environment we believe we have a solid business model, attractive market opportunity, fundamentally sound customer economics, and a strong financial condition and we continue to be optimistic about our long-term prospect.

With that, we will open it up for questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from George Sutton – Craig-Hallum Capital.

George Sutton - Craig-Hallum Capital

I am curious, Ken, how you are changing your marketing message in this kind of environment. You have talked in the past about your price point relative to the Pitney meter and I know on your site you do talk about that a little bit, but is there a way that you are trying to enhance and take advantage of the cost savings in this environment?

Kenneth McBride

Yes, I think the fact that we’re less expensive as an option to a postage meter has always been a real positive for our business model and I think in an economic pinch when businesses are focused on ways of cutting costs that certainly increases in terms of resonating with customers as a message point.

We think that messaging is particularly helpful in the enterprise area where we see the vast majority of our sales come from converted meter users. In the small business area we have more customers that tend to come from post office retail as their prior experience, so that tends to resonate a little bit less if you don’t actually have a postage meter at the time.

And that’s where I think we’re some of the small business right now less willing to take on a new monthly expense versus the enterprise situation where you are actually decreasing your expense by using

We’re trying to focus on the cost-saving message. We have been focusing on the save-the-trip messaging as well with gas prices being at the forefront of people’s minds over the summer time.

George Sutton - Craig-Hallum Capital

Now you in the past have discussed market share a little bit and I’m just curious with your increase to $17.99, have you seen a turn down in your market share?

Kenneth McBride

No, we haven’t really seen much change. We still believe that we’re approximately 85% of all subscription paying customers in the PC Postage industry. We really haven’t seen much change there.

And like we said, the $17.99 price point has really impacted our acquisition. We think it’s more a broader, macroeconomic issue.

George Sutton - Craig-Hallum Capital

With respect to churn, how much of a function is your ability to keep your churn at similar levels to what you saw in prior quarter? How much of that is a function of the retention programs? You didn’t discuss retention programs on the call.

Kenneth McBride

We are continuing to run and optimize our retention program. During the third quarter I would say it has reached more of a steady state. We are kind of running the program at full scale now and we are happy with how it has allowed us to continue to extend the lifetime value of these customers.

As a respect to the specific, quantifying what exact effect it has had on churn, I don’t think we have those numbers. But it has certainly been a factor, we think, in being able to keep the churn rates low.

George Sutton - Craig-Hallum Capital

As we look forward with your lowered marketing spend, obviously the logical impact would be continued lowered growth in subscribers. Is there something magical that we should see over the next 12 months in your cost per gross add, that might come down because your costs are getting more efficient? Anything we should look at as an offset?

Kyle Huebner

A couple of thoughts. One is I think as you look over 12 months a lot of what our marketing spend will be will be something that’s driven by what happens with the economy and our acquisition trends, moving forward. I don’t think that this is a permanent shift in our long-term strategy about growing the business. I think it’s more just trying to optimize where we spend the money relative to the current environment.

So I don’t think this is a permanent kind of reduction in our growth potential. I think it’s something that we will continue to monitor the economic environment and the acquisition trends and adjust accordingly as we move into 2009.

In terms of the CPA, I guess there’s a couple of things. One is as we spend marketing money, some of it is pay-per-performance so to the extent that you acquire fewer customers your spend comes down, but your CPA remains constant. In some of the fixed spend programs and with fixed marketing overhead, to the degree that you acquire fewer customers, then that actually causes your CPA to go up slightly and I think that’s a little bit what you saw in this quarter.

Going forward the CPAs are really a reflection of where you spend your marketing money, which channels and their CPAs and so we continue to focus on things like direct mail, which has a higher CPA, could bring in higher quality customers and that’s an area where you may, with things like cheaper-than-a-meter messaging may be able to target that better with something like a direct mail campaign.

So we still believe there is value in spending across all our channels. It’s hard to predict the exact impact on the CPA. I think at lower spends you get some more efficiencies but then it really is driven by the mix of the spend beyond that.


Your next question comes from

[Carl Kwa] - Needham & Company

I thought that RPU was down quarter-over-quarter, despite the roll out of the new price point. If you could explain the dynamics of that.

Kyle Huebner

So the RPU consists of the three revenue components and so there is service fee, store, and insurance revenue. And so the service fee RPU was actually up quarter-over-quarter by about $0.20 or so. But then the average store revenue per customer was down and kind of offset the gain in the service fee side. The store RPU down sequentially is not unexpected. In Q2 with the USPS rate increase we typically see higher level of store sales and that’s stamp sales. Q3 is our seasonally slowest quarter. So the sequential decline in store RPU is not surprising. So effectively the service fee RPU picked up and the store RPU offset it.

The other thing I would note is the $17.99 price increase was only for new customers. So that’s something that will work its way into the base over the course of time. So with each quarter a higher mix of the base will be on the $17.99 and we expect to see the benefit from the $17.99 kind of accumulate over the coming quarters.

[Carl Kwa] - Needham & Company

And it looks like interest income held up pretty well sequentially. Now most companies in our universe saw pretty significant declines, at least in the yield they get off cash. How is it that your interest income does so well and is this sustainable going forward?

Kyle Huebner

We started about a year ago a strategy as all our investments matured we rolled them over into cash and money markets. So if you look at Q2 we were very heavily already in money markets and I think our portfolio already reflected that lower yield environment. As we moved into Q3 we had some additional stuff mature and roll in but the bulk of it is still in cash and money market and there weren’t any significant rate changes during Q3. Just the one we way in the last couple of weeks.

If you look at the overall yield, if you look at the interest income as the cash balance, it was about 3.0% in Q3. So I think relative money market rates we are not really earning excessive interest income. So the fact that it didn’t decline that much, I would summarize as being reflective of the fact that we were already getting low yields in the previous quarter.

As we look forward to 2009 we are, we did start buying back shares more aggressively here so obviously we are going to have lower cash balances going into 2009 but at a 2% to 3% interest rate, the share repurchase is accretive to EPS so I think to the extent that we bought back shares and continue to buy back shares that will actually be accretive.

The yields I would expect to come down a little more. We did see the half point rate cut a couple of weeks ago so that is something that will flow through the interest income. But I think it will be more driven actually by the share repurchase as we move into Q4 and 2009.

[Carl Kwa] - Needham & Company

If you could give a little more color on the, you weren’t able to utilize your NOLs this quarter. What’s going on there and how does it look for the future?

Kyle Huebner

What happened is, given the State of California’s budget, the legislation got signed in September that effectively said companies cannot utilize their California State NOLs to shield state income taxes for the tax years 2008 and 2009. We would expect to be able to start using them again in 2010.

So as the result of not being able to use our California State NOLs we will incur about $350,000 more in taxes for the first three quarters and about $500,000 for the year. So what we did was we thought it would be useful, just make it more comparable with past periods and in the future if we’re able to use them to break out what our normal tax would have been had we been able to use the NOLs, and that would have been the $80,000 and then the $350,000 was kind of the additional impact from this temporary change in the tax law.

[Carl Kwa] - Needham & Company

Do you get that money back at the end of the period or do they just kind of delay it?

Kyle Huebner

Yes, it’s a delay. The expiration years on the NOLs get rolled out two years so you can’t use them in 2009. You can start using them again in 2010 and the expiration will be pushed out two years. So it’s really just a timing difference.

[Carl Kwa] - Needham & Company

How much of a lag is there between your non-enhanced marketing spend and when you begin to see revenues? I’m trying to gauge the impact of your reduced marketing spend. When will that start to hit the top line?

Kyle Huebner

I think if you look at Q3 in the metrics, the new paid customers, we had 47,000 in Q2 and 36,000 in Q3. So I think the lower marketing spend or the reduction in the growth was reflected in Q3 in that new paid customer number. I think what we said as we look to Q4, based on what we’ve seen so far, in Q4 it looks like our best expectation is it would be comparable to Q3. At this point, and again, there is uncertainty as to what happens with the economy, but at this point I think we would aim to do our best to keep the paid customer numbers at their current levels and then hopefully see some of the RPU benefit from the $17.99 price increase.

[Carl Kwa] - Needham & Company

And just to make sure I heard you right, you said that you have 18.2 million shares outstanding now, after all the buy backs year to date?

Kyle Huebner

Yes. So for balance sheet shares outstanding, including the 122 million that had been repurchased, the current balance sheet shares outstanding is 18.2 million.


Your next question comes from Kevin Liu - B. Riley & Company, Inc..

Kevin Liu - B. Riley & Company, Inc.

It sounds like you are at least getting some positive traction on the enterprise side. It sounds like you’re increasing the sales and marketing around that effort so I was curious if you could provide us with any metrics either in terms of customer additions or just speak to how willing are enterprise customers willing to speak with you, just given the challenges in the current environment?

Kenneth McBride

I think we’re optimistic in the enterprise area. Summer time is slow for all of our business area, particularly small business as well as enterprise. But we think that going into the fall here we have definitely seen positive traction through some of the marketing programs, positive traction with some our sales initiatives and we have been continuing to scale that area up. I think it is the kind of thing where in a pinch, businesses seem to be definitely more focused on how to save costs and with a 50 location or 100 location situation, when they start looking at the cost of the postage meter, multiplied by 50 or 100, relative to our solution, which could be 50% or even 75% cheaper, there are some real savings there.

Some of our customers have told us that they could be seeing savings of several million dollars by switching to us. So it is certainly something that we think in a bad economy we may actually see more traction in our marketing messaging with enterprise area. We’re excited about continuing to forge ahead in that area.

Kevin Liu - B. Riley & Company, Inc.

And in terms of customer cancellations as it relates to churn as well as just customers cancelling coming out of the trial period, have you seen any sort of change in the reasons why they’re cancelling? Are there customers who just simply don’t want to pay that subscription fee going in in this environment or are customers still just not having time to use the product?

Kenneth McBride

We do monitor the reasons for churn, although I don’t think we have perfect information in that area. I think we’ve seen probably some incremental increase in the number of people that are saying it’s related to like a business decline. But at the same time, we’ve seen other areas come down that don’t make quite as much sense. So it’s not clear there’s been a major shift in terms of any kind of reasons that people may be considering the service, relative to what we saw in the past.

We certainly are happy with the fact that the churn rate came down in Q3 relative to Q2. It certainly was a positive for us, amongst lower acquisition and other issues we had to deal with.

Kevin Liu - B. Riley & Company, Inc.

Has there been any change in terms of you ability to convert a trial customer into a paying customer?

Kyle Huebner

I wouldn’t say there was any material change. If you look at metrics you can look at the new paid customers as a percent of the gross registered customers. There is a 30-day lag with the trial period in those numbers. So if you look at the last four quarters I think the average was about 75% and then Q3 it was 74% . Relative to the historical averages. I don’t think there was any material change in the trial conversion. It seemed that it was more a matter of fewer people signing up for the trials than our ability to convert them.

Kevin Liu - B. Riley & Company, Inc.

On PhotoStamps with kind of the roll out in the 20,000 retail locations, how much incremental spend is that for you and then what type of normal seasonal ramp and then marketing spend around PhotoStamps would we expect to see going from Q3 to Q4?

Kenneth McBride

In terms of the initiative with the boxed product, the spend is really not a huge number because essentially what it is a box about the size of a DVD case with a CD Rom, it includes our design software and a gift code for redemption for one sheet. The cost of manufacturing of that box is pretty low and not too significant. So that’s not really going to be something that you are going to see show up in the Q4 numbers.

In terms of the seasonal spend, we do continue to see Q4 as our strongest period each year in terms of the messaging and the spend. I think we plan to spend at a higher level than we have spent in Q1 through Q3, although I don’t think given the current economic environment that we plan to spend as much as we did last year, just given what’s going in the world and given the fact that a lot of people expect a pretty poor holiday season.

We’re going to monitor the metrics with the marketing spend and really focus on continuing to drive the profitability in the business during Q4.


Your next question comes from Mark May - Needham & Company.

Mark May - Needham & Company

With regard to share repurchases, what are the limits as it regards to preserving the NOL assets? In terms of how active you can be in share repurchases over the next month or two? And I think you have over $90.0 million in cash on the balance sheet. You’re profitable and not a lot of need for use of cash. Would you consider a dividend and if so are there any restrictions as it relates to preserving the NOL asset as it relates to sizeable dividends?

Kyle Huebner

In terms of our share repurchase, the share repurchase does impact the 382 shift calculation. We’re currently at 37% shift. In the existing share repurchase plan that is something we take into account. So we are comfortable that repurchasing 1.8 million shares will not impose any kind of undue risk from a section 382 perspective.

The other thing to keep in mind is that the shift calculation is over a trailing three-year rolling period, so as time progresses, you hit points where some of the ownership shift actually falls out of the calculation and reduces the shift, so as we move to 2009 and there is part of the shift that will fall off in early 2009 and then a much greater shift will fall off in early 2010. So the more time goes by the more that increases kind of our flexibility and our ability to repurchase additional shares. So at this point the 1.8 million we are comfortable from a 382 perspective that by February there won’t be any kind of increase section 382 risk from that prospective.

Mark May - Needham & Company

If you did no more repurchases, do you know what that number would go down to in early 2009, what the 37% number would go to?

Kyle Huebner

I believe there’s about 5% or 6% that would roll off if we didn’t do any additional share repurchases.

On the dividend question, at this point our main focus is the share repurchase program and I think especially with what we’ve seen in the stock market and with valuations coming down, we have about $84.0 million cash and investments including the $1.2 million that was already repurchased. So if we did another 1.8 million we would be somewhere around $65.0 million cash and investments, including that additional amount. That would actually be our lowest cash level since 1999 when we went public.

So I think there’s still room to buy back under the buyback program and that’s our primary focus on the cash. If we reach a point where we feel that we can’t buy back any more shares, either because of 382 or because of the value of the stock, I think we will consider alternative uses of the cash, such as the dividend.

In terms of the dividend’s impact on 382, because you’re not affecting the ownership structure, there is not a direct impact on the 382 calculation. In the event that a limitation were actually triggered, there is some test as a cash as a percent of assets where the level of cash comes into play. But just in terms of the shift calculation there is no immediate impact on the shift calculation because there is no change in the ownership structure with a dividend.


Your next question comes from [F. E. Wahls] - GSI Investments.

[F. E. Wahls] - GSI Investments

I don’t mean to beat a dead horse but I wouldn’t mind a little more detail on the retention program and what exactly it entails. Has anything been done in terms of a focus group, maybe bringing in 10 to 15 customers from around the area to talk about why they’re leaving, etc. It just seems if we could stem this 40% annual churn, without spending money, revenue could really see a lot of growth. Just your thoughts on that.

Kenneth McBride

We focus intensely on trying to reduce churn. The retention program is just one thing that we’re doing and just as a review of the kind of things that program includes, basically we try to talk to every customer when they call in wanting to cancel their account. We try to understand what their motivation is for cancelling. We try to offer them ways that are responsive to that motivation.

Sometimes we find customers are just having technical difficulty and they’ve given up and if we can work them through that process we can retain them as a customer. Sometimes if find that customers haven’t had enough time to try the service and they’re just too busy and the 30-day period just ticked away and they just didn’t get around to it, then we offer them an additional 30 days to try to work into the program. We may offer them a lower price point to try to keep them on a lower-functionality product using the service and keep them as a customer.

So it’s definitely a program that we have ramped up in the past year. Like I said, we are kind of running steady state and we are happy with how that program is going.

Beyond that, we’ve talked a lot about in the past of different ways that we really try to make our products better, more useable, and that continues to be a focus of ours. As you know, earlier in the year we launched some usability enhancements to our product and as we’re working on new versions of the product, we spend a lot of time in focus groups in trying to understand complexities the customers object to and issues they may have in becoming a customer and kind of getting them up and running and printing postage.

So we continue to focus on that area. We have lots of stuff that we’re still working on for next year, around things like customers continue to quit for reasons like misprints. It’s an area that we have traditionally had as a focus. We’re trying to improve that process. When somebody has a problem with their printer, how do they get their money back. Over time we have managed to improve that quite a bit and it has made a difference but we still have some more things we’re working on to try to make that even better. So certainly churn is a bit focus of ours and the retention program has been areas that we have intensely focused on in the last couple of years.


There are no further questions.

Kenneth McBride

We appreciate your joining us today and if you have any follow-up questions you can contact us at 310-482-5830.


This concludes today’s conference call.

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