Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Stamps.com Inc. (STMP)

Q2 2006 Earnings Conference Call

July 25, 2006 2:00 pm ET

Executives

Ken McBride - President and Chief Executive Officer

Kyle Huebner - Chief Financial Officer

Jamie Harper - Investor Relations

Analysts

Russell Hoss - Roth Capital Partners

William Lennan - Wedbush Morgan Securities, Inc.

James Lee - America's Growth Capital

George Sutton - Craig-Hallum Capital Group

Justin Cable - B. Riley & Co.

Mark May - Needham & Co.

Presentation

Operator

Good day, and welcome to the Stamps.com second quarter 2006 financial results conference call. This call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to Jamie Harper. Please go ahead.

Jamie Harper

Thank you very much and welcome to the call today. With me on the call is Ken McBride, CEO, and Kyle Huebner, CFO. The agenda for the call is as follows: we will review the results of our second quarter and talk about the business outlook, then we will discuss financial results for the second quarter and talk about our guidance.

But first, the safe harbor statement. 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 involve risks and uncertainties. Important factors, including the company's ability to complete its products and obtain regulatory approval, which could cause actual results to differ materially from those in the forward-looking statements, are detailed in filings with the Securities and Exchange Commission made from time to time by Stamps.com, including its annual report on Form 10-K for the fiscal year ended December 31st, 2005, quarterly reports on Form 10-Q and current reports on Form 8-K.

Stamps.com undertakes no obligation to release publicly 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 over the call to Ken McBride, CEO.

Ken McBride

Good afternoon. Thank you for joining us today.

Today we announced second quarter results that we were pleased with. We showed continued revenue and strong earnings growth in PC Postage. PhotoStamp sales also continue to be strong, despite the expected second quarter seasonal weakness in consumer sales of that product.

We did $20.2 million total revenue, which was up 42% from the same quarter last year. The core business, which as you know is what we call the PC Postage business, excluding only the PhotoStamps business, had a good quarter with year over year growth in service fees of 31% despite a tough compare with last year, when service fees grew 57% in that quarter.

Our mailing and shipping supply store business growth rate slowed a bit in the second quarter, and store revenue was up 8% versus last year. We would note that the second quarter of last year saw a very high growth rate in this area of 49%, so this quarter did have a really tough compare for this area.

We are also clearly seeing some limitations in our current Windows-based system for our supply store. We will talk about more on that in just a moment.

Second quarter revenue also included approximately $3.7 million of PhotoStamps revenue, which represented approximately 210,000 sheets that we shipped to the customers during the quarter.

Net income, excluding the 123R related stock-based compensation expense, hit a new record at $4.9 million. This is now our eighth sequential quarter of increasing record profitability.

Earnings per fully diluted share came in at $0.20, excluding the 123R expense. On an apples-to-apples basis, EPS this quarter was up 122% versus $0.09 in the same quarter last year.

On the call today, I will discuss the core business in detail, then I will talk about PhotoStamps, and finally I will talk a little bit about the 2006 plan and some progress we have made towards it before handing the call over to Kyle.

Let me now begin with a discussion on the core business.

During the second quarter, we acquired 87,000 gross new customers in the core business. This was the second highest quarterly level of customer acquisition for us ever, and we were happy with the continued strong performance of our marketing programs. Our acquisition in the second quarter last year was 66,000, so we saw a nice increase in acquisition levels year over year.

It was good to see such brisk acquisition in the second quarter, which is typically one of our seasonally slowest quarters.

During the second quarter, we continued to experience a high acquisition rate in the enhanced promotion channel. Recall that this channel acquires customers through various online initiatives, where additional offers are made by the partner directly to the customer.

The channel continues to attract a higher portion of [lower] lifetime value customers, so it is characterized by higher fundamental churn than other channels. The bounty that we pay upfront is very low, relative to our other channels, so the economics are good.

It should be noted that our use of this channel may continue to amplify the apparent monthly churn of our overall business that we report each quarter. However, we also believe that this channel has contributed to our strong core business revenue and profit growth, and the positives of the channel outweigh any potential negative impacts on our reported metrics.

Consistent with the high second quarter acquisition level, we experienced a good customer acquisition cost level at $57 for the second quarter. This compares to $73 in the same quarter last year. The low acquisition cost was consistent with the high, enhanced promotion channel acquisition level.

We also continue to invest in direct mail, telemarketing, affiliates online promotions, partnerships in other channels, with good results across the board.

We continue to monitor and allocate budget among our alternative marketing channels based on our expected return on investment. We feel that the cost to acquire a customer continues to be attractive relative to the expected lifetime value of all of our channels.

Based upon USPS data, and based upon our own company estimates, we believe that the number of PC postage industry subscription paying customers that are Stamps.com customers continues to be in the mid-80% range.

During the second quarter, we saw some heavy marketing by our competitor, Endicia, who has teamed up with Dymo, and that partnership has caught the attention of many investors, so let me review that partnership now.

As you may recall, Dymo, the label writer manufacturer, is now offering Endicia’s insta-postage product through certain Dymo-branded professional label writers. Endicia’s insta-postage product is a knock-off on our net stamps product. Dymo and Endicia are currently offering the insta-postage product, which they brand DymoStamps, without a monthly service fee.

However, the customer must first purchase a high-end Dymo label writer which sells for $140 or more before they can print DymoStamps. Once the customer buys the printer, they can then purchase the insta-postage labels from Endicia at a cost of about $0.10 per label. So printing a single $0.39 stamp ends up costing about $0.49. By comparison, our regular net stamps range in cost from $0.033 to $0.045 per label, depending on volume purchased.

The DymoStamps service, Endicia and Dymo seem to be targeting lower-end customers with a transaction model versus our subscription model, which tends to attract larger volume small business mailing and shipping customers.

We saw the DymoStamps model as a bit of a paradox, as you still need to buy the $140 specialized printer in order to print DymoStamps, but we find that thermal label writer printer users within our target customers tend to be purchased primarily by high-volume mailers and shippers.

At a $140 price level, we believe that most small businesses tend to opt for a more general, useful device, such as a multi-function peripheral, which are far more versatile and available in the same price category. As an indicator of current usage in our base, Dymo label writer users currently represent less than 2% of our current customer base.

During the second quarter, Dymo spent very heavily marketing its label writers with the new DymoStamps feature. Based on the number of spots we have seen or heard about, including many primetime TV runs, and based on our own experience with the cost of TV campaigns, we estimate that the May-June TV campaign that Dymo ran could have easily cost several million dollars.

In addition, we believe that Dymo may have sent a promotional e-mail to many of their existing customer base during the second quarter. However, based on USPS data and our own estimates, we believe that the total second quarter sign-ups for the Endicia DymoStamp service were only around 4,000 gross sign-ups.

In making this estimate, we are using historical rates for Endicia sign-ups to remove what we believe to be regular Endicia customer sign-ups from those that are signing up for DymoStamps only.

We saw the sign-up numbers as pretty low in the face of the huge marketing spend. Keep in mind that a sign-up for DymoStamps requires absolutely no financial commitment on the customer’s part, no up-front purchase, and no service fee commitments.

We will continue watching this new partnership between Dymo and Endicia closely, but based on the early performance of the new business model, and our continued view of the business model as a paradox, we do not currently believe that this partnership will impact our business model in any meaningful way going forward.

Now, let me turn to a discussion of PhotoStamps.

During the second quarter, we started the third phase of the market test for PhotoStamps. The third phase is a one-year test with an option for the U.S. Postal Service to extend the test under the same agreement for a second year. The third phase also lifted the restrictions around commercial images that were in place during the second market test.

Today we announce that during the second quarter, we shipped and collected on approximately 210,000 sheets of PhotoStamps for a total of approximately $3.7 million in total Q2 PhotoStamps revenue. This compares to approximately 210,000 sheets in the first quarter, so sequentially we are approximately flat with Q1 in terms of total sheets ordered.

In the approximately one year -- actually, 13-and-a-half months since we began the second market test and mid-May, we have shipped a total of approximately 950,000 sheets, or a total of approximately 19 billion individual PhotoStamps to the customers.

Our image screening capability continues to scale well and to be very accurate. We now estimate that we have screened more than half-a-million images since the start of the second market test, with no publicized incident of an image getting through our screening process.

We feel that we have really developed an expertise in high-accuracy image screening that is unmatched by any company, and our current process is trending towards 6/9s of reliability, or fewer than one image per million misclassified.

We also continue to be pleased with other aspects of our operation, such as print and fulfillment. We continue to consistently ship a high-quality product in a timely manner.

On that front, we decided to move from an outsource model to an in-house model for print operations during the second quarter. We purchased a large digital press and finishing line, and moved print operations in-house this week.

We felt that owning our own printer gives us more direct control over the operations in this important area of the business. It allows us to make sure our customers received the highest quality products in the shortest time possible.

We also feel that owning our own print operations will give us more flexibility to meet the heavy seasonal aspects of capacity management in this area.

We continue to see good success in our marketing initiatives in PhotoStamps with several traditional media programs and other programs showing good results in the PhotoStamps area.

We began marketing the commercial aspects of PhotoStamps in the month of June. During June, we estimated that approximately 15% of our total sheets were business orders. Most of the interest to date has come from small businesses, but we have also taken some orders from larger businesses. Our largest business orders to date have been in the size range of tens of thousands of stamps per order. For orders over 100,000 stamps, we feel that the lack of presort discount rates has proven to be a barrier to acceptance of the product so far, particularly for the larger volume direct mailers.

For example, a business using presorted standard rates can mail a piece for as little as $0.20, or about half the full rate first-class amount of $0.39. This could add a significant amount to the overall cost of a direct-mail marketing program. Many direct mailers have felt that they will not be able to justify the additional cost with better open rates, so they have decided to hold off using the product for direct mail at this point.

We are continuing to speak with several opportunities where the cost of the mail piece is higher or the customer is less sensitive to the individual piece class. For example, in luxury goods or for event promotions.

We also continue to work on the USPS to add presort rates to our PhotoStamps capabilities. However, we currently do not think this is something that is going to changed in any meaningful way before next year, or possible even later.

We will also continue to test and optimize our own sales and marketing initiatives around commercial PhotoStamps during the third quarter in this area.

Based upon USPS postal service data and our own data, we estimate that our product, PhotoStamps, represented approximately 78% of the total customized postal sold in the U.S. during the second quarter. 78% was up slightly from the 77% we previously estimated for the first quarter of 2006 for PhotoStamps.

Now, let me give you some updates on the progress we made towards our 2006 plan.

As you recall, our plan on the technology front this year was to build out and unify our software platform for continued and future growth in all parts of our business. Last night we took a very big step in our technology plan when we launched a major new software platform.

The new platform includes a single web presentation and e-commerce system for all Stamps.com products and services, and we have migrated our old, homegrown technology onto this commercial software. This new platform will allow us to have richer cross sell, more effective up-sell, automated remarketing and better sku cataloguing and display. We will make these features available across all of our products and services.

The system will now run our new mailing and shipping supply store, along with PhotoStamps on a common platform, and it will also serve as the building blocks for all future Stamps.com e-commerce initiatives.

We have now also brought together our customer profiles and our customer login systems, so that we will have a single, unified system for all current and future customers. Prior to this change, PC Postage accounts and PhotoStamps accounts were maintained separately.

We expect this to reduce customer confusion and to improve our ability to cross sell our products and services across our various initiatives.

We also released a new unified payment processing system, which is integrated with our new e-commerce platform. We also plan to release our first new PC Postage client built to take advantage of the new platform, Version 6.0, this week. Version 6.0 also includes new international shipping with fully integrated customs forms. We plan to run Version 6.0 through a short beta before rolling it into full production during Q3.

In conjunction with the new platform, we have rolled out a brand new mailing and shipping supply store. It features a totally overhauled and reorganized store catalogue, same-day shipping capabilities, strong messaging on our free over 50 shipping promotion, cross sell during checkout, sku search capabilities, and new expedited and rush shipping options.

We also added 116 new skus to the new store. We are now around 279 skus and we are making good progress towards our stated year-end goal of 500 skus.

This week’s new platform release was the largest change in our technology platform since we first went live in our original PC Postage service in 1999.

We also plan to continue working on the other items in our stated technology plan during the second half of this year, including moving the web registration and other web aspects of our PC Postage service to our new e-commerce platform, letting multiple users access a single account balance in a single geographic location, adding a new flexible billing system, and enhancing our current enterprise reporting system with features such as centralized administration and control.

We currently expect these new technologies to begin coming online during the last part of 2006 or the first part of 2007.

As you may recall, our plan for 2006 also includes a renewed and intensified sales and marketing focus to move upstream to address larger businesses. During Q2, we had a more intense and sustained effort in our sales area with some good initial results. We feel that our pipeline has been growing in this area and that we are learning a lot about the market, now that we have a more effective sales effort in place.

Our PC Postage service is now in use by more than 30 multi-seed enterprise accounts, up from 3 accounts at the end of Q4 last year. We continue to expect to scale our corporate sales team up as we prove that the economics make sense for us to do so.

With these and other initiatives, we feel that we continue to growth the PC Postage and the PhotoStamps business at a good pace throughout 2006.

With that, let me turn the call over to Kyle.

Kyle Huebner

Thanks, Ken. First I will review the second quarter customer metrics.

Customer counts -- ending registered customers increased from approximately 371,000 at the end of Q1 to 376,000 at the end of Q2, an increase of 5,000. We successfully billed approximately 327,000 unique customers during Q2, compared with 324,000 during Q1 and 300,000 successfully billed during Q2 last year.

Average subscription related revenue per successfully billed customer was $49 for Q2 compared with $52 for Q1 and $43 for Q2 of last year. Note that subscription related revenue includes service fees, store and insurance revenue.

Customer acquisition -- we acquired 87,000 gross new registered customers in Q2 compared with 99,000 acquired in Q1 and 66,000 acquired in Q2 last year. The sequential decline was primarily attributable to the expected seasonal slowdown as we approached summer months and is consistent with seasonal slowdowns we have experienced in the past.

Total customer acquisition spend, which includes both marketing spend on the core business as well as promotional spend, which is included in cost of sales, was $4.9 million in Q2 compared with $5.3 million in Q1 and $4.8 million in Q2 last year.

Customer acquisition cost was $57 for Q2 compared with $54 for Q1 and $73 for Q2 last year.

Customer churn -- average monthly trial churn, which represents the churn rate for customers leaving during the 29-day no-risk trial period, was 34.7% for Q2 compared with 29.9% for Q1.

Average monthly base churn, which represents the churn rate for customers who stay past the trial period, was 5.3% for Q2 compared with 5.2% for Q1. The churn rates for Q2 are reflective of the heavy online acquisition activity over the past three quarters.

As mentioned by Ken, the enhanced promotion customers, which are a subset of our online acquisition channel, exhibit higher churn rates than our other discretionary marketing channels, but the bounties we pay are low relative to other channels as well, so the economics are favorable.

We continue to remain comfortable with the churn rates, customer lifetime value and return on our marketing spend within the enhanced promotion channel. We plan to continue acquiring customers in this channel.

We would also note that we have not see any fundamental change in the long-term models for our other discretionary marketing channels.

Trail churn for power plan customers acquired outside the enhanced promotion channel was 24% in Q2 this year versus 22% in Q2 last year. The average monthly base churn for power plan customers being outside the enhanced promotion channel was 3.9% in Q2 of this year, which was lower than the 4.2% in Q2 of last year.

Customer usage -- postage printed by customers was $55 million in Q2, up 22% compared with the $45 million printed in Q2 last year.

Now I will review our second quarter financial results.

Our second quarter GAAP financial results included $696,000 of non-cash stock-based compensation expense as a result of adopting FASB-123R, which we did at the beginning of 2006. The $696,000 of 123R expense was allocated to departments based on individual employee and board of director costs and position, which follows:

  • 42,000 was in cost of sales;
  • 68,000 was in sales and marketing;
  • $115,000 was in R&D; and
  • $470,000 was in G&A.

Our GAAP net income for Q2 was $4.2 million, or $0.17 per fully diluted share, and non-GAAP net income excluding the $696,000 in 123R expenses, was $4.9 million, or $0.20 per fully diluted share.

Revenue was $22.2 million in Q2, compared with $20.5 million in Q1 and up 42% from the $14.2 million in Q2 last year. PhotoStamps revenue was $3.7 million in Q2 compared with $3.9 million in Q1 and up 223% from the $1.2 million in Q2 last year.

As Ken mentioned, we estimate that approximately 15% of the sheets ordered in June of this quarter were business related.

Core business revenue was $16.4 million in Q2 compared with $16.7 million in Q1, and up 26% versus the $13.1 million in Q2 last year. Service fee revenue of $13.6 million was up 31% versus Q2 last year.

Online store revenue of $2 million was up 8% versus Q2 last year. Q2 total revenue mix was 68% service fees, 10% store, 19% PhotoStamps, and 3% insurance, licensing and other.

We note that the sequential decline in core business revenue was primarily driven by sequential decline in store revenues, which was attributable of the following factors:

  • We had a large, one-time increase in Q1 net stamp sales associated with the increase in postal rates that occurred in January of ’06 that did not repeat in Q2; and
  • The normal expected seasonal slowdown as Q2 and Q3 are seasonally slower quarters compared to Q4 and Q1;

We would note that with PhotoStamps, our business has become much more seasonal. As with our core business, we expect the summer months to be the seasonally slowest period for PhotoStamps.

For simplicity, and for easier comparisons to prior periods, we will provide all the following financial results on a non-GAAP basis excluding only the 123R expenses. More detailed reconciliation of non-GAAP to GAAP measures is contained in our earnings release posted on our website.

Total business gross margin, excluding 123R expense, was 73% for Q2 compared with 72% for Q1 and 72% in Q2 last year.

For the core business, gross margins were approximately 81% in Q2 compared with 80% in Q1 and versus 75% in Q2 last year.

Cost of sales included promotional expenses of approximately $570,000 in Q2 compared with $690,000 in Q1 and $750,000 in Q2 last year.

For the PhotoStamps business, gross margin was approximately 37% in Q3 compared with 38% in Q1 and 34% in Q2 last year. A reminder that with PhotoStamps, we recognize the postage face value in both the revenue and cost of sales, unlike our core subscription business where postage face value is not part of the revenue or cost of sales.

The reason for the different treatment is that with PhotoStamps, we take possession of the postage and resell it to customers, whereas with a core subscription business, postage purchases go directly from the customer to the USPS.

Sale to marketing spend, excluding 123R expenses, were $6.4 million in Q2 compared with $6.7 million in Q1 and $4.4 million in Q2 last year. Sale to marketing spend was 32% of revenue in Q2 compared with 31% of revenue in Q2 last year.

This sequential decline in spend was primarily attributable to lower customer acquisition levels in the core business.

R&D spend, excluding 123R expenses, was $2.0 million in Q2 compared with $2.0 million in Q1 and $1.6 million in Q2 last year. R&D spend was 10% of revenue in Q2 compared with 11% of revenue in Q2 last year.

G&A spend, excluding 123R expenses, was $2.7 million in Q2 compared with $2.9 million in Q1 and $2.5 million in Q2 last year. G&A spend was 14% of revenue in Q2 compared with 18% of revenue in Q2 last year. The sequential decrease in G&A was primarily attributable to decreases in legal and accounting fees.

Operating income was $3.5 million in Q2 compared with $3.1 million in Q1 and $1.7 in Q2 last year. Operating margin was 17.4% in Q2 compared with 15.0% in Q1 and 12.1% in Q2 last year.

Interest income was $1.4 million in Q2 compared with $1.1 million in Q1 and $446,000 in Q2 last year. The higher interest income was driven by higher interest rates and higher invested cash balances.

Net income excluding 123R expenses for Q2 was $4.9 million, or $0.20 per fully diluted share based on a 24.6 million fully diluted shares outstanding count, and compares with a $4.2 million, or $0.17 per fully diluted share in Q1 and compares with $2.1 million or $0.09 per fully diluted share in Q2 last year.

The year-over-year increase from 2005 second quarter GAAP earnings per share versus 2006 second quarter non-GAAP earnings per share was 122%.

We continue to invest in the PhotoStamps business opportunity, with estimated total sales in marketing expenses directly related to PhotoStamps exceeding PhotoStamps’ gross profits again for the second quarter.

Free cash flow, defined as net income excluding 123R expenses plus D&A less cap-ex, was positive $4.3 million for Q2. D&A for the quarter was approximately $720,00. Cap-ex for the quarter was approximately $1.2 million. We note that most of the investment costs of brining PhotoStamps printing in-house was contained in the second quarter’s cap-ex number.

We ended Q2 with approximately $117 million in cash and investments. In calculating the total cash and investments, we are including cash, cash equivalents, long-term investments, short-term investments, and restricted cash.

Share buyback -- we currently have an authorized $20 million repurchase program in place. Through the second quarter of 2006, we did not repurchase any shares under the current program. So far during the third quarter of 2006, we repurchased approximately 182,000 shares, for a total amount of $3.7 million.

Now turning to guidance. We expect the fiscal 2006 revenue will be between $85 million to $90 million. We expect fiscal 2006 GAAP EPS will be between $0.61 to $0.66 per fully diluted share. This includes an estimated $3 million of non-cash stock-based compensation expense related to the adoption of FASB-123R. Excluding the FASB-123R expense, we expect that non-GAAP fiscal 2006 EPS will be between $0.73 to $0.78 per fully diluted share. This represents an increase in guidance from the company’s prior range for this measure of $0.67 to $0.75.

[Technical Difficulties]

Question-and-Answer Session

(Operator Instructions)

We will have our first question from Russell Hoss of Roth Capital Partners.

Russell Hoss - Roth Capital Partners

Good morning. Can you talk a little bit about the gross margin? In the core business, it was up a little bit in Q2, but Q1 over Q4 there was a little bit of a jump there too, so I am just trying to reconcile the differences there.

Kyle Huebner

Yes, the core business, if you recall the promotional expenses, which are really related to customer acquisition, are included in the cost of sales, so we put them in the core business gross margin.

So you see the numbers I gave you. We had in Q4, if you recall, about a $250,000 one-time benefit that reduced promotional expenses in Q4, so I think we came in with an 82% gross margin. Then, in this quarter, the promotional expenses were down about $120,000 versus Q1, so that accounted for about 0.5% on the gross margin line.

In general, excluding promotional costs, the gross margin in the core business has been very stable in that range over the last three quarters, and including the promotional expenses, it has still been in a pretty tight range of 80% to 82%.

Russell Hoss - Roth Capital Partners

How should we think about it here in the next couple of quarters? Obviously it is going to depend a little bit on whether or not you go back to the direct mail channel versus the enhanced channel, but can we continue to see these sequential increases?

Kyle Huebner

On the core business side, I think the margins we are seeing now are pretty representative of the business as it exists today. Again, with the promotional expenses to the extent that when we enter the seasonally strong fall period, to the extent that acquisition increases, that could have a slightly negative impact on the gross margin, but I think overall, in the 80% to 82% range that we have seen is an accurate representation for the current state of the business.

Russell Hoss - Roth Capital Partners

On the enterprise side, Ken, I think you had mentioned 30 customers currently. Can you just elaborate on that?

Ken McBride

As everybody knows, we have been working on enterprise moving up-stream the past few quarters. The enterprise feature, as you know, it is the capability to manage a corporate-wide mailing and shipping expense by aggregating data across multiple accounts and multiple geographies. We have continued to focus on ramping up our marketing and sales effort in that area.

We have not given you any numbers to indicate any progress for a while, so this quarter we just figured we would give you the 30 number, which is up from 3 at the end of the fourth quarter.

When we talk about these more than 30 customers, they are all using multiple accounts per customer, and some in the several dozens of accounts.

We feel good. The pipeline is growing in the area. We are learning a lot about the market with a more effective sales effort, and we are continuing to try to scale things up as the economics make sense.

Russell Hoss - Roth Capital Partners

At some point, will you give us any kind of metrics that we can track and get a better idea of how big this business is and how profitable it is, et cetera?

Ken McBride

I think over time we will try to give you some insight into the business, like we did this quarter, with some kind of metrics. I do not think we are planning on giving out quarterly things at this point, but we can continue to provide insight into the business to the best of our ability.

Kyle Huebner

Over the course of time, to the extent that it becomes a more material part of the financial results, at that point we would look at it and try to determine what the most appropriate metrics to provide would be.

Russell Hoss - Roth Capital Partners

Last question on the PhotoStamps side, what are you seeing in terms of marketing and partnerships? If you could give us an idea of which channels are most effective on PhotoStamps.

Ken McBride

Marketing and partnerships, as you know, we went through a big test period in Q2 and Q3 of last year, and then we really started ramping things up in Q4 on the marketing front. Most of what we did in Q4 we continue to do today, although we kind of scale things up and down between the various initiatives, depending on how things are performing.

You know, we are using several online as well as offline initiatives, and we are continuing to pursue partnerships where it makes sense for the product.

Beyond that, I think we tend to remain close to the chest with our marketing programs because of the competitive situation.

Russell Hoss - Roth Capital Partners

Thank you.

Operator

We will have our next question from Bill Lennan, Wedbush Morgan.

William Lennan - Wedbush Morgan Securities, Inc.

Good afternoon. Two on PhotoStamps and then one generally on the USPS. Do you still think that you will break even on PhotoStamps for ’06? Part two, I was a little surprised by seasonality emerging so early. We are probably in the low part of the s-curve, I would think, so could you give us some markers as to what are the big events during the year besides Christmas? Where I am going with this is I thought maybe the kick-off of wedding season this year might boost PhotoStamps sales. If you could just give us an idea of what drives this business seasonally, and then I will come back with my USPS question.

Ken McBride

Can you repeat the first question?

William Lennan - Wedbush Morgan Securities, Inc.

Do you still think you will break even on PhotoStamps for ’06?

Kyle Huebner

Our stated goal of having PhotoStamps not have a material impact on the bottom line has not changed. What we are seeing is Q1 through Q3 are seasonally slower periods, so in those periods we are seeing the marketing spend directly on PhotoStamps, exceeding the gross profits. With the seasonally strong Q4 period, we would expect that to kind of reverse the situation so that the overall impact, there would not be a material impact.

William Lennan - Wedbush Morgan Securities, Inc.

Then on the seasonality, wedding season, Christmas we know is strong, but I am just trying to get a handle on what other type of events throughout the year would drive PhotoStamps sales. It does not feel like wedding season did it in Q2.

Ken McBride

If you look at the consumer-to-consumer mail market, I think it is a good indicator of what kind of seasonality you might expect from the product. As you already pointed out, the holiday season greeting cards portion of the consumer-to-consumer mail market is the largest segment. There are other segments, other greeting cards, letters to friends and relatives. Invitations and announcements as a segment is actually pretty small overall. It is about .5 billion of the 7 billion pieces.

If you look at how the consumer-to-consumer mail market shakes out and you take the non-holiday areas and you spread those out across the year, you end up with about 55% of all consumer-to-consumer mail happening during the fourth quarter. There is no reason for us to think that PhotoStamps is not going to follow some heavily seasonal pattern like that as well.

William Lennan - Wedbush Morgan Securities, Inc.

I have one on USPS. I get this one all the time, I thought it might be a good time to revisit it. I get the question from people all the time, I can do this free. I can go on USPS and print out postage. Part one is can you go over just to refresh investors’ minds, a refresh on what are the key differences between what you offer and USPS offers.

Two, I get the question of what is to stop the Post Office, who struggles to find revenue sources all the time, from really diving into this business and doing essentially what you do and competing with your more strongly than they might right now.

Ken McBride

The USPS click-and-ship product has been out there since 2002, so we have been largely dealing with that since the beginning of time. The product is primarily focused in the one-off low-volume consumer area. It has a limited number of mail classes, so it really just supports priority mail, express mail, some of the global areas. It does not support first class as an area. It does not support some of the other lower cost areas with that product.

It has been out there for a long time and we continue to deal with it. We do not think our customers, the customers we target typically find that product to be useful enough for their needs, so it continues to have that kind of mark against it.

The answer to the second question in terms of why doesn’t the USPS move more broadly into this area, ten years ago they decided to make PC Postage a private industry and companies like us invented a lot of technology and created a lot of technology around this area, so there are some pretty serious implications of the regulate/compete aspects of the federal government, having had full access to our technology and our capabilities for all this time and then turning around and using that same technology to build their own service.

We think that click-and-ship really represent the Postal Service’s answer to ups.com and fedex.com to allow the one-off printing, but it is really targeted at the low-end, one-time use consumer.

Kyle Huebner

I would just add to that. If you look at our service, we offer [inaudible] stamps, which have the ability to print postage without a date, without an address, the shipping label, things like the hidden postage feature, discounted insurance, the Internet postage product, which gives the address cleansing, the whole suite of mail classes.

So if you look at our solution relative to the click-and-ship, there is only a very limited part of what our bulk service solution offers that can be replicated on click-and-ship. Click-and-ship is only priority and express mail classes, you cannot do hidden postage, cannot do the net stamps or the address with the postage. Conceptually, click-and-ship is supposed to be the introductory, one-off shipping label for the lower volume user that, if they like it, they can then migrate up to the bulk service subscription offers that the PC Postage providers have.

I think if you look at the customer and what they do, there are clearly a lot of capabilities with our solution that cannot be obtained for free through the USPS website.

William Lennan - Wedbush Morgan Securities, Inc.

Thank you for the very thorough and helpful answers.

Operator

We will have our next question from James Lee, America's Growth Capital.

James Lee - America's Growth Capital

A quick question on the revenue guidance -- can you guys elaborate a little bit more? You guys obviously increased the low-end guidance. What is the up-side coming from? Is it coming from the core biz or PhotoStamps or the Internet storefront biz?

Kyle Huebner

I think when you look at revenue and you look at the growth drivers for the core business, we continue to focus on cost-effectively spending our marketing dollars to increase the customer base.

We also have the new technology platform coming on-line that Ken talked about that showed a positive impact, the mailing and shipping supplies growth and opportunity, and then also Version 6.0 and the new product features contained in that should provide additional value to the customer. I think those are some of the catalysts in the core business.

PhotoStamps -- it is going to be really driven by the Q4 holiday period. This will be our second time through the holiday season, so we are expecting that strength in the investment that we made off during the past four quarters to translate in Q4.

That is really what we see as the key factors for the second-half of the year on the revenue side.

James Lee - America's Growth Capital

Sounds like the up-side is coming pretty much evenly with respect to the core business and also your PhotoStamps business.

Kyle Huebner

We do not really break out the revenue guidance between the two. Again, as we look at the different businesses, we may shift our sales and marketing investment or resources between the two business lines. It is more a matter of just monitoring the returns and the success and allocating the marketing dollars, and that ultimately ends up resulting in the [inaudible] mix between the two businesses.

James Lee - America's Growth Capital

Kyle, maybe it is helpful, maybe you can talk about the increase of bottom-line guidance, maybe talk about what the up-side is coming from in terms of looking at your cost structure. Is it more coming from the gross margin side or maybe it is from the expenses below the line?

Kyle Huebner

I think it is contributed from several different areas. The one thing I would point out is the operating margin expanded from 15.0% in Q1 to 17.4% in this quarter. That is partly driven by some little bit higher on the gross margin side. Gross margins were about 1% higher sequentially, so [inaudible] there, a little bit was a promotional benefit and the rest is really cost management and the mix of PhotoStamps versus core business revenue.

On the G&A side, we had about a .5% sequential improvement. As I mentioned, that related to lower legal and accounting fees. The legal fees tend to be driven by litigation schedules and key events, and are variant over time. Then on the accounting side, Q1 is the heaviest period with the year-end audit and the 404 certification. That is something we got a sequential benefit, just from lower costs and cost management.

Sales and marketing, as a percent of revenue, it is about 1% better in this quarter, primarily, as I mentioned, resulting from somewhat lower customer acquisition levels in the quarter that are impacted as I mentioned by the seasonal aspects.

I think we did see margin expansion in the operating margin line as well as then the net margin, and that is the primary driver in the strong bottom line.

James Lee - America's Growth Capital

Thank you.

Operator

We will our next question from George Sutton with Craig-Hallum.

George Sutton - Craig-Hallum Capital Group

Thanks for the discussion on the Dymo marketing and the limited adds that they had. I thought that was helpful. I am not terribly familiar with it, exactly when they were marketing during the quarter. Have you seen consistent limited impacts thus far in the quarter as you saw in the prior quarter?

Ken McBride

Yes, they launched it in April, and then we started to really see a lot of activity in May, into June. We talked about estimate -- we estimated that it was a multi-million dollar TV campaign. We were just seeing primetime television spots all over the place. It is Q2 ads of 4K in light of that spend that we were really watching closely. That was the timing of this point.

We will continue watching as we move forward and continue estimating those ads to see how things go. The activity seems to have slowed down a little bit but we will keep watching it.

George Sutton - Craig-Hallum Capital Group

You mentioned that you had begun to buy back stock in Q3. Can you just discuss reasons you might not have bought stock back in Q2, but decided to in Q3? Is it just motivated by the lower price?

Kyle Huebner

Several factors go into establishing the buyback back program. I cannot comment on specific price targets or price numbers.

Clearly in the beginning of July we did see a pretty significant price decline over the month of July, so that was clearly a differentiating factor between July and the previous quarter, but I cannot comment on any specific prices.

George Sutton - Craig-Hallum Capital Group

There was no discussion on the premier plan on the call, and obviously that had been a nice focus for you to try to up-sell people to that plan. Can you give us an update on that?

Ken McBride

You know, we continue to work on the core business and the optimization. As you know, we have been testing and continue to test different pricing strategies, including Premier up-sell once customer gets into Pro, as well as testing Premier as an initial service.

We are continuing to try to optimize that model, testing Premier in different channels in different ways. I think we feel the results to date have been reasonable, and we included the average revenue per customer metric, and that includes the Premier effect for the quarter.

George Sutton - Craig-Hallum Capital Group

Lastly, on churn, obviously it clicked up a little bit sequentially. What sorts of numbers should we be looking for going forward? Assuming you remain fairly active on the enhanced marketing channel this quarter, we should see ostensibly similar results in Q3. Is there a level where you become less comfortable with that channel and we might see you pull back more aggressively from that channel?

Kyle Huebner

If you start with the base churn rates, there are a lot of factors that drive that reported number -- things such as the pricing plan and the price point, the type of customer, the mix of customers that were acquired by channel, all the age of the customer.

If you take a longer term view, we would expect the churn rate to vary somewhat over the course of time, depending on the above factors.

If you look specifically, Q2 was kind of on par with Q1, reflecting the heavier online enhanced promotion channel. When we look at it, we still think the best way to look at it is to look at the lifetime value of the customer acquired relative to the cost to acquire that customer. When you look at the lifetime value, churn is only one metric that goes into that, along with a number of different factors -- the spend in the store, insurance, billability, cost to serve -- things of that nature.

In terms of the channel, I do not think there is one churn number that would cause us to stop the program, because we really look at the aggregate economics of what the customer is worth relative to what we paid for him.

That said, we are always trying to look at the channel and optimize the results and try and allocate our resources towards particular networks or affiliates that have better performing results.

Again, it is not one churn number. It is the overall economics. We still feel the economics in that space are generating positive returns. We will continue to invest money in that channel.

George Sutton - Craig-Hallum Capital Group

Thank you.

Operator

We will have our next question from Justin Cable, B. Riley.

Justin Cable - B. Riley & Co.

I have a few questions here. First question is on the PC Postage service business, the service fees increased 1% sequentially, which was a little bit lower than what we had expected. Is this mainly just because the customer base increased only 1%, or were there any other factors that might have impacted that?

Kyle Huebner

The revenue per service fee is really driven by growth in the successfully billed customer base, and then the pricing and revenue per billed customer.

If you look at Q2, the sequential growth in the customer base did slow compared to Q1. When you break it down, it is primarily attributable to the lower acquisition. We had 87,000 acquired versus 99,000, so we saw a 12,000 sequential decrease in acquisition, which led to a lower growth in the customer base compared to Q1.

I think this is reflective of the seasonal patterns in the business I talked about. As we move from the slower summer months into the stronger seasonal fall and Q4, we would expect acquisition to benefit from the seasonal strength at that point.

Justin Cable - B. Riley & Co.

Last year in Q2, your net customer additions were 6,000, so not very far off that.

Kyle Huebner

I think when you look at last year, we did have the simple plan price increase going on, so to some degree that was contributing to the growth when you look at Q2 versus Q1.

This year, when you strip that out, you are seeing more of a seasonal pattern than you may have seen last year.

Justin Cable - B. Riley & Co.

I just wanted to make sure I did not miss anything there.

As far as the new platform switch and with Version 6.0, is this going to be rolled out gradually when it goes into full production, or is this something that is automatically upgraded for each customer? Have you found any kinks in the system? I guess just some more color around that.

Ken McBride

The new platform basically rolled out last night, so it is already in place. The product 6.0 is the PC Postage service that takes advantage of that new platform. What we are planning to do is go through a short beta here in the next few weeks and then roll into full production, assuming there are no issues with the beta. Then we start to roll that product out through the entire base, likely during Q3.

Most of the customers by the end of this current quarter should be up and running on 6.0 with the new platform.

Justin Cable - B. Riley & Co.

Is there any material change in the interface or the functionality from a customer perspective that might impede their use of the service in the interim?

Ken McBride

Impede? No, it is actually the opposite. This new platform is really allowing us to bring together our disparate accounts across the different properties. As you know, PhotoStamps accounts were separate from PC Postage accounts. That hindered our ability to cross sell between those two services.

The new platform includes a brand new mailing and shipping supply store, which is dramatically better than the previous Win32-based application, so we will have a lot more capability to provide a much richer service, as well as more effective marketing tools built within this platform as customers move up.

6.0 also includes some new capabilities in the client, the most significant of which is the international shipping capabilities. It provides the ability to have one-stop, fully integrated custom forms for international shipments, which we think helps continue to complete the product on the shipping front.

Justin Cable - B. Riley & Co.

Last question I have is just on the interest income. Kyle, are there any one-time benefits in the quarter, or is that just reflective of higher interest rates?

Kyle Huebner

Primarily it is reflective of the higher interest rate, higher cash balances. We view in the portfolio some of the investments that we made a year to two years ago at much lower interest rates are maturing and we are able to roll those investments into the higher yielding investments in the current environment.

I think the primary driver is really the higher interest rates and also the higher invested cash balances.

Justin Cable - B. Riley & Co.

Okay, good -- see you guys in New York.

Operator

We will have our next question from Mark May, Needham & Company.

Mark May - Needham & Co.

Thanks for taking my questions. I have a couple of them, the first has to do with this distinction between the different marketing channels. I thought the point you made earlier about understanding the lifetime value of the customers acquired through the different channels is the important thing. Along those lines, I was hoping you might be able to provide us with some additional metrics to help us figure that out. You gave us the churn numbers excluding the promotional channel.

I am wondering if you could give us -- we need three other metrics to do the calculation. One would be the churn metrics just for the promotional channel alone, and then if you could give us some idea of the differences between the customer acquisition costs between promotional and non-promotional channels, that would be great.

Connected to the conversation on the promotional channel, have you historically tended to use or change your mix seasonally? Do you use that channel more aggressively in Q4 and Q1, and less so in Q3, Q4?

Then I have a follow-up, if possible.

Kyle Huebner

A lot of questions there.

Typically, historically we have not broken out our metrics on a more detailed channel level, partly for competitive reasons. We did this time want to give quantitative numbers to support what we were saying, that the fundamental churn rates in the non-enhanced promotion channels have not changed materially, and that it is really mixed shift between the enhanced promotion and the non-enhanced promotion. Also, the fact that historically we had a lot of customers on the simple plan, which had a lower churn rate than the power plan.

If you are trying to isolate it down to the current fundamental channel, things have not significantly changed. We do not want to give out every metric at a detailed channel level.

What I can say qualitatively is our direct mail and our online are our two biggest channels. Profile-wise, direct-mail customers are more expensive to acquire because you can do a better job of targeting, but they have higher lifetime values, lower churn rates. They spend more in the store as compared to the online customers.

The lifetime values, direct-mail are higher but the cost to acquire is also higher. In both channels, we do earn what we consider is an acceptable positive ROI on the marketing spend.

The customer acquisition cost -- what I can point you to is if you look at last year in Q2 and Q3, we had a heavier focus on direct mail and the customer acquisition metric was in the high $70 to $80 range. For the quarters where we had the heavier mix of on-line acquisition, the acquisition cost has been in the low- to mid-50s.

I think that gives you some benchmark for the range of acquisition costs, depending on the focus.

Then, in terms of shifting between the channels, it really depends on the economics that we are seeing in the current market environment and the expected returns. If we see changes in the market economics in certain channels, then we may shift the dollars accordingly to take advantage of that.

It is not necessarily tied to a seasonal driver as much as just looking at the expected economics in the current market environment.

Mark May - Needham & Co.

That is very helpful. Just stepping back a little bit, can you give me an example of what you mean by a promotional marketing campaign? What would be an example of a typical one?

Ken McBride

Generally speaking, we call it enhanced promotion because the partner itself makes some kind of offer to the customer, so it is various places across the Internet where customers may come to try out services where there is a whole portfolio of different service that are available there. If they sign up for a certain number of services, they may get some additional promotion that is above and beyond say the promotion we may give directly to the customer, so the partner themselves is giving a promotion as well to get people through the process.

Mark May - Needham & Co.

Just real quickly, it looks like the PhotoStamps, if you exclude the 15% was down 15%, business logos down about 15% sequentially. Do you expect that business might be down again sequentially in the third quarter or flat? What seasonal trend in that business might you expect in the third quarter?

Then more of a housekeeping question to end -- does your guidance assume any additional share buybacks other than what you mentioned in the press release during the third quarter?

Kyle Huebner

On the PhotoStamps side, we have been saying that the summer months for PhotoStamps will be the seasonally slower time period, as we have seen historically in our core business, and then increasing as we move into the fall period, seasonal strength.

We do not specifically give out quarterly guidance, but I would say that the summer period, we expect PhotoStamps to be the slowest period for the year.

Then, in terms of the guidance, the guidance assumes only what we have seen in terms of the share buyback. Given the interest rate environment, it tends not to be a materially short-term, dilutive or accretive impact because you lose the interest income when you use the cash to buy back shares.

But specifically, the guidance only reflects what we have done to date.

Mark May - Needham & Co.

Thanks for answering my questions.

Operator

That is all the time we have for questions. I will turn the conference back over to Stamps.com for any additional or closing remarks.

Ken McBride

Thanks for joining us today. If you have additional follow-up questions, you can reach us at our Investor Relations line -- it is 310-482-5830. Thank you.

Operator

That does conclude today's conference call. You may disconnect at this time. We do appreciate your participation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Stamps.com Q2 2006 Earnings Conference Call Transcript (STMP)
This Transcript
All Transcripts