Stamps.com Inc. (NASDAQ:STMP)
Q2 2008 Earnings Call
July 23, 2008 5:00 pm ET
Jeff Carvari – Investor Relations
Kenneth McBride – President, Chief Executive Officer
Kyle Huebner – Chief Financial Officer
Kevin Liu - B. Riley and Co.
George Sutton - Craig Hallum
Welcome to the Stamps.com second quarter 2008 financial results conference call. (Operator Instructions) Now at this time, for opening remarks and introductions, I’ll turn the call over to 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 second 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 on Stamps.com, 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.
Stamps.com 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.
During the second quarter, we did $21.4 million in total revenue, just flat compared to the same quarter last year.
PC Postage(NYSE:R) subscriber-related revenue including service fee revenue, store revenue and insurance revenue was $18.5 million which was up 14% versus the subscriber-related revenue in the second quarter of 2007. This is the highest year-over-year growth we’ve experienced in six quarters for our PC Postage business and we were pleased to see the acceleration in growth.
PhotoStamps revenue was $2.9 million, which was down 38% which is the second quarter 2007. We reduced our PhotoStamps sales and marketing by approximately 55% versus the second quarter of 2007 as part of our continued program to increase profitability in the PhotoStamps business and that resulted in the large decrease in revenue. We would also note that Q2 last year in PhotoStamps was very strong so this quarter had a very tough compare.
Our second quarter non-GAAP net income was $2.9 million excluding the 123R expense and a one-time litigation charge related to a lawsuit emanating from our iShip business which was divested in 2001.
Earnings per fully diluted share came in at $0.15 excluding the non-cash items and the litigation charge. We felt our second quarter earnings were solid especially as we continue to make strong investment in our PC Postage business for the long-term.
On the call today, we’ll first talk about the PC Postage business in detail, then we’ll talk about PhotoStamps, and then we’ll discuss financial results and our business outlook.
Now, let me begin with a more detailed discussion of the PC Postage business and then we’ll talk about the progress we made against our 2008 plan for that business. As a reminder, we’ll only talk about the business using the new customer metrics which were introduced in the first quarter this year and that now exclude all enhanced promotion channel activity.
During the second quarter, we experienced small business cost per registered customer acquisition or CPA of $94 versus $87 in the second quarter of 2007. We increased small business customer acquisition spending by 37% year-over-year and CPA increased by 8% year-over-year. In light of the large increase in customer acquisition spend we did during Q2; we were pleased to see the small increase in the CPA which indicated that our marketing programs are continuing to scale well. The $94, we continued to see an outstanding return.
During the second quarter, we experienced our third highest quarterly gross acquisition level ever at 60,000 customers which is up 27% versus the same quarter last year. We’re also continuing to realize the benefits of our increased spending last year and this year with paid customers in the second quarter of 2008 increasing 16% versus the second quarter of 2007. Our paid customers have now increased by 43,000 over the past four quarters. Again, all the numbers we just gave excluded all enhanced promotion channel activity.
During the second quarter, we increased the size of our retention program and the increase had an impact on our second quarter paid customer numbers and on our second quarter service fees. You’ll recall that in this program, we’re working with the customers in various ways to try to understand their motivation for canceling and offering them ways to help them remain a customer. For example, if a customer has not had enough time to try the service effectively, we may offer them free service for an additional period of time. We think the short-term costs of the program will result in long-term gains, as we believe that the retention program is an effective way to help reduce cancelation rates for our service.
Our mailing and shipping supply store revenue was up 5% versus the same quarter last year. Second quarter store sales were a bit disappointing, driven by several factors including a lack of marketing and promotions in the store owing to some personnel turnover. We do expect to do more promotions for the store during Q3 to increase awareness in our customer base.
We also launched some new full-color themed stamps during Q2 and we’re hopeful that these will help store growth in Q3. The Enterprise PC Postage area, we continue to make good progress during the second quarter. Our new accounts added for the quarter were very strong. We were also encouraged by some of the initial economics in some of our marketing programs in that area. Although Enterprise is a very small part of our overall business, we continue to be excited about our opportunity in that area.
Now let’s turn to the 2008 plan for PC Postage and talk about progress that we’ve made against our plan to date.
At a high level, our plan for PC Postage includes at least four major items. First, we plan to continue increasing and optimizing our investments in all of our small business marketing channels wherever we can. Based on our most recent analysis and based on the most recent trends, we continue to find that the lifetime value of a non-enhanced promotion customer is more than two-times higher than the current costs of acquisition. Based on that outstanding return, we plan to continue increasing our investment in all of our profitable marketing channels in 2008. With the growth in this area, it represents a long-term investment in the business that will pay dividends for several years to come.
In the first half of 2008, we spent 39% more than the first half of 2007. We plan to continue to spend around that rate in the second half of the year.
In order to continue increasing our marketing investment, we plan to continue scaling our workforce direct-mail channel but we also plan to increase and refine our acquisition through online advertising, affiliates, partners, telemarketing, traditional media, and other areas. As always, we will also be looking to expand our portfolio of customer acquisition strategies that we employ.
In total, we continue to expect to increase our PC Postage acquisition spends outside the enhanced promotion channel by approximately 35% to 40% in 2008 versus the 2007 level. We believe that long-term growth of our customers and revenue will reflect our long-term investment in the sales and marketing activity while working to build a long-term high-growth model.
Second, in the 2008 plan, we’re going to continue to optimize our business model around converting and serving small business in home office customers. We launched a newer, more informational website in the second quarter which we think helps explain our service better. We also finalized Version 7.1 of our PC Postage product and released that new version at the beginning of May which includes a new simplified system for printing postage that we call the Postage Wizard which we think will improve the usability of our overall service for new users.
Third, in our 2008 plan, we’re trying to market our new multi-user capability. The new capability will allow multiple users to access a single account balance and the majority of our small business customers today are under five employees. The fact that we haven’t had this capability historically has limited our ability to successfully attract and retain larger businesses.
We continue to do price optimization on our multi-user price plans during Q2 and our current expectation is that a three-user, multi-user pricing plan will be priced at about $24.99 per month. We plan to begin driving awareness during Q3 through marketing initiatives that will target potential multi-user customers in our existing base and we also plan to begin testing new customer acquisition programs to target larger sized businesses with multi-user plans.
Fourth in the 2008 plan, we plan to continue ramping up our efforts around the Enterprise area. We show that we were successful in attracting a good number of Enterprise users to our service over the past several quarters and past few years at a low cost per acquisition relative to lifetime value of the customers. Customers continue to be attracted to us versus the postage meter based on our dramatically lower total cost of ownership and on the great visibility into individual activity that isn’t available with the postage meter.
In 2008, we plan to continue scaling up our Enterprise sales and marketing efforts in a cost-effective manner.
We began increasing our sales and marketing activity during the first and second quarter and we plan to continue to increase it so long as the cost per acquisition continues to remain a factor relative to our projected lifetime value. We also plan to continue enhancing our Enterprise product in 2008 and that will help our sale records. The multi-user capability that we just launched is a very important feature for many Enterprise customers and we have rolled that out to our sales team and several Enterprises have already adopted it.
We will also be adding more flexible payment methods for Enterprise users in 2008. We also recently completed our Enterprise version 1.0 system which will add more financial controls for Enterprise users, managing multiple locations and several customers began using that capability during the second quarter.
We plan to launch Enterprise version 2.0 in the second half of the year which will include improved Enterprise reporting and improved postage management tools.
Additionally, in our PC Postage business, we have been working on optimizing our price in that business. About a year ago, we launched a small test of different price points for new customers for our monthly service fees ranging from a few dollars lower up to several dollars higher. We continued running these tests of new customer acquisition at various price points in the first half of this year. Based on results to date, we now believe that a more optimal price point now exists at $17.99 per month for our service, which is $2.00 higher per month than our prior level of $15.99. As such, near the end of the second quarter, we switched the majority of our new customer acquisitions to the $17.99 price point.
We will continue to monitor the acquisition levels in turn at the higher price point but at this point, based on trends that we see in the business, we believe we will remain at this higher price point indefinitely for new customer acquisition. We will continue to monitor results for new customers at this price level before making any decision on pricing for our existing customer base.
We feel that the 2008 PC Postage plan is a very solid one. We feel that our opportunities to grow this business are very attractive and we’ll try to take advantage of them for the benefit of our long-term shareholders.
Now, let’s turn to a more detailed discussion of PhotoStamps. During the second quarter, we shipped approximately 171,000 sheets of PhotoStamps for a total of approximately $2.9 million in second quarter revenue which was down 38% versus the same quarter last year.
Consumer revenue was down year-over-year but was up sequentially versus the first quarter helped by the American Idol promotion in the second quarter. High-volume business revenue was also down year-over-year, although this was a tough comparative Q2 of last year which was our highest quarter ever in business revenue.
During the second quarter, 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 55% versus the second quarter of 2007. The decline in revenue during Q2 was expected given the magnitude of our decrease in sales and marketing activity. We would also note that it’s possible that the buyer-caused economic slowdown may be impacting PhotoStamps, as it is more of a luxury item than a necessity.
Despite the lower Q2 PhotoStamps revenue, we were encouraged to see the profitability picture improve for the PhotoStamps business this quarter versus the same quarter last year.
We will now discuss the go-forward plan for PhotoStamps and provide some updates on the plan. We’re going to continue our programs of focus, direct insights, PhotoStamps marketing spend, with a goal of keeping overall CAP, cost for acquisition at a level that provides a good financial return.
As we continue to drive fewer, 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 the high-volume business usage of PhotoStamps. Based on second quarter performance, this area may prove to be more difficult to grow without the support of the overall consumer marketing generating awareness, but we’re continuing to work on various programs to drive this area.
Second, we plan to continue to pursue consumer distribution partnerships like Adobe, HP Snapfish, Apple, Google Picasso, Costco and American Idol. Partnerships provide a cost-effective way to manage acquisition costs through a revenue share arrangement that aligns the interest of the partnership.
Third, we will be looking at entirely new ways and new business models to grow the PhotoStamps business line.
We expect the strategic changes that we have made to continue to improve the profitability picture for PhotoStamps going forward. We do expect 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 in the development of the business, to be moving the model more aggressively to profitability even if it is at a lower revenue level.
One final note on PhotoStamps is that the USPS recently extended the Phase 4 market tests for an additional year, May 16, 2009. We believe that this will be the final market test and the next move for the USPS will be to move the product to permanent status.
Now, Kyle will discuss our more detailed financial results and our business outlook.
Q2 customer metrics, all PC postage metrics we will discuss in this section will exclude all estimated enhanced promotion activity. We will now review the PC Postage metrics for the quarter.
Paid customers in the second quarter were 313,000, up 9,000 sequentially from the 305,000 paid customers in Q1 ’08, and up 43,000 or 16% year-over-year versus the 270,000 in paid customers in Q2 ’07. Paid customer number represents the unique number of customers successfully billed at least once during the quarter. Growth in the paid customers was driven by our increased investment in customer acquisition spend over the past year.
The 314,000 paid customers represents our highest level of paid customers ever and continues to demonstrate the acceleration in paid customer growth we’ve seen over the past year, with Q2 growing at 16% year-over-year versus Q2 ’07 which grew at 3% year-over-year.
The change in paid customers from Q1 ’08 to Q2 ’08 was composed of 48,000 new paid customers who were successfully billed for the first time during the quarter offset by 39,000 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.
Subscriber revenue per customer, subscriber-related revenue which includes service fee, store and insurance revenue excluding enhanced promotion customers was $16.1 million in Q2, up 14% versus $14.1 million in Q2 ’07. Average monthly subscriber revenue per paid customer was $17.14 for Q2 compared with $17 for Q1 ’08 and down 2% from $17.44 for Q2 ’07. This metric is calculated as total subscriber-related revenue for the quarter divided by paid customers from the quarter divided by three months. The year-over-year decline was primarily attributable to lower store and insurance revenue per paid customer.
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 Q2, up 37% versus $4.1 million in Q2 ’07. The increase in customer acquisition spend reflects year-over-year increases in all our channels including our direct mail channel. Small business cost per registered customer was $94 in Q2 versus $101 in Q1 ’08 and up 8% compared to $87 in Q2 ’07.
Paid customer cancel rate was 3.7% in Q2 versus 3.4% in Q1 and versus 3.5% in Q2 ’07. 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. They include the type of customer, the age of the customer, the levels of customer acquisition, the mix of customer acquisition channels, price and retention program offers, usability of the product and seasonality. As such, we expect to see some degree of normal fluctuations from quarter to quarter.
Specifically, we believe the following factors related to churn during Q2. We have seen several quarters of sustained higher levels of customer acquisition which result in more customers in the early part of their customer life where we tend to see higher churn rates. So this puts some upward pressure on the weighted average turn metric that we report as we grow the business and grow customer acquisition.
We increased our retention program efforts in Q2 which we believe had some short-term impact on our churn metric resulting from increased service fee waves. We would also note that we do typically experience higher churn rates in Q2 and that has been the case for each of the last three years. We will continue to focus on ways to reduce churn and optimize customer lifetime values.
Total postage used by all customers was $77 million in Q2, up 20% from $65 million in Q2 ’07. Both postage printing continues to outpace growth in paid customers which we view as a positive indicator that we are increasing the quality of the customers we’re acquiring.
In summary, we thought that our Q2 metrics and results continued to demonstrate solid fundamentals in the PC Postage business. We may potentially be seeing some impact on our metrics for macroeconomic factors although we do not believe that this has had a material impact on the overall Q2 results. We believe that the return on investment on our customer acquisition spend continues to be very attractive and we plan to continue our level of investment in the business during 2008.
Now we will review our second quarter financial results. Non-GAAP to GAAP reconciliation, we presented our second quarter 2008 financial results today on both a GAAP and non-GAAP basis to adjust for the following items. First, we had a one-time $710,000 litigation charge relating to a lawsuit related to our iShip business which we divested in 2001. Second, we had $903,000 of stock-based compensation expense which was allocated as follows: $69,000 in cost of sales, $172,000 in sales and marketing, $146,000 in R&D, and $516,000 in G&A.
GAAP operating income was $649,000 and non-GAAP operating income taking into account these two adjustments was $2.3 million. GAAP net income was $1.3 million or $0.07 per fully diluted share and non-GAAP net income again taking into account these adjustments was $2.9 million or $0.15 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.
Q2 financial results, revenue was $21.4 million in Q2, which was flat compared with Q2 ’07. PC Postage subscription revenue which includes service fee, store and insurance revenue and also including the enhanced promotion channel was $18.5 million in Q2 which was up 14% compared with Q2 ’07. The subscription revenue increase was attributable to the increase in paid customers resulting from our increase levels in customer acquisition spend. We were pleased with the continued acceleration of our year-over-year revenue growth.
PhotoStamps revenue was $2.9 million in Q2 which was down 38% compared to Q2 ’07. PhotoStamps revenue was down as expected due to lower PhotoStamps sales and marketing spend which was down 55% year-over-year. Q2 PhotoStamps revenue was impacted by the pullback in marketing spend to a greater degree than in Q1 as we have had two quarters now of significantly reduced marketing spend levels. In addition, high-volume business orders were down year-over-year as we had a difficult compare with Q2 last year which was our highest quarter ever for business orders.
Other revenue declined from $453,000 in Q2 ’07 to $0 in Q2 ’08 corresponding to the conclusion in Q2 ’07 of one of our patent licensing deals. This is the last quarter where the other revenue category will act as a drag on our year-over-year comparisons.
Gross margin excluding 123R expense was 75% in Q2 compared with 70% in Q2 ’07. PC Postage subscription-related revenue gross margin excluding 123R was 82% in Q2 compared with 80% in Q2 ’07.
Promotional expenses which are contained in cost of sales were a benefit of $266,000 in Q2. We have seen a downward trend in our customer promotion coupon redemption so we’ve revised our assumption of future redemption rates and this resulted in a reduction in promotional expenses in Q2. The year-over-year increase in PC Postage subscriptions was primarily attributable to the reduction in this promotional expense.
For the PhotoStamps business, gross margin excluding 123R expense was 28% in Q2 compared with 34% in Q2 ’07. 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 increase postage face value costs as postal rates increased in May but we did not raise our PhotoStamps prices.
Sales and marketing spend excluding 123R expenses was $8.6 million in Q2 which was up 10% compared with Q2 ’07. PC Postage sales and marketing including enhanced promotion channel increased by 32% while PhotoStamps sales and marketing decreased by 55%. The increase in PC Postage sales and marketing was driven by increased 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 while showing lower and more focused spend in our higher return programs.
R&D spend excluding 123R expenses was $2.0 million in Q2 which was flat with Q2 ’07. G&A expense excluding 123R expenses and the litigation charge was $3.2 million in Q2 which was up 13% compared with $2.9 million in Q2 ’07. Legal spend was up significantly driven primarily by the litigation costs in the current technology trial but the other areas of G&A were down on a year-over year basis.
Non-GAAP operating income was $2.3 million in Q2 compared with $2.4 million in Q2 ’07 as we continue to reinvest in the PC Postage non-enhanced promotion part of the business.
Adjusting for the loss of the patent licensing revenue, the increased legal spend and the reduced promotional expenses, non-GAAP operating income would have grown on a year-over-year basis and would have done so despite the much higher spend in the PC Postage acquisition.
Interest income was $736,000 in Q2 ’08 which was down 37% versus $1.2 million in Q2 ’07. The lower interest income compared with last year can be attributable to lower investment cash balances as a result of our share buyback activity and lower income yields in the lower interest rate environment.
Non-GAAP net income was $2.9 million or $0.15 per fully diluted share based on 19.7 million fully diluted shares compared to $3.4 million or $0.l6 per fully diluted share based on 21.7 million fully diluted shares in Q2 ’07.
We continue to believe that the returns in the PC Postage business are very attractive and the best way to maximize long-term shareholder value is to reinvest the profits and cash flows to grow the business as opposed to maximizing short-term EPS.
Pre-cash flow defined as non-GAAP net income plus D&A minus CapEx was +3.3 million in Q2. For the quarter, D&A was $486,000, and CapEx was $142,000.
We entered Q2 with $91 million in cash and investments, equivalent to $4.64 per fully diluted share. In calculating total cash and investments, we are including cash, cash equivalents, long-term investments, short-term investments, and restricted cash.
Net operating loss shareholder update, we have approximately $245 million in federal NOLs and $145 million in state NOLs which could save us as much as $95 million in taxes over the next 15 years. Under IRS Code, Section 382 rules, “a change in ownership can occur whenever there’s a shift in ownership by 50 percentage points by one or more 5% shareholders within a three-year period,” and when a change in ownership, under this definition, is triggered, our ability to use our NOLs may be limited.
We estimate as of June 30, 2008, we were at approximately a 35% ownership shift compared with a 50% ownership shift that would make possible a trigger in owners.
During the second quarter, we received shareholder approval to mend our articles of incorporation in order to protect our NOLs assets, and the NOL protective measures. Those measures are now in effect. Under the NOL protective measures, there is no change to the way that existing Stamps shares are held or traded but any person, company or investment firm who wishes to become a 5% shareholder of Stamps.com must first attain a waiver from the company’s Board of Directors.
In addition, any person, company or investment firm which is already a 5% shareholder of Stamps cannot make any additional purchases of Stamps stock without a waiver from the company’s Board of Directors. Stamps.com strongly urges any shareholder contemplating owning more than 775,000 shares to contact the company before doing so.
Share buyback, during Q2 ’08, the company proposed and implemented these NOL protective measures and following the implementation, updated the estimated shift in ownership under 382. As a result of these activities and market conditions, the company did not repurchase any shares under the existing share repurchase program during the second quarter.
In July ’08, the Board of Directors approved a new share repurchase program which will replace the current plan effective August 4 authorizing the company to purchase up to two million shares of Stamps.com stock over the next seven months.
Now turning to 2008 financial guidance, we expect fiscal 2008 revenue to be between $80 and $90 million. We expect fiscal 2008 GAAP net income to be between $0.55 and $0.65 per fully diluted share including an estimated $3.4 million of 2008 123R expense, the second quarter $710,000 litigation charge, the first quarter $445,000 asset write-off and the $3.7 million income tax benefit.
Excluding the 123R expense, the litigation charge, the asset write-off and the income tax benefit, the expected non-GAAP 2008 net income is between $0.60 and $0.70 per fully diluted share.
We continue to target double-digit revenue growth in the PC Postage subscription revenue excluding the enhanced promotion channel in 2008. We expect the enhanced promotion revenue to be flattened down for the remainder of the year. We continue to expect PhotoStamps revenue 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 approximately 35% to 40% in our small business touch acquisition spend outside the enhanced promotion channel and an expected decrease of approximately 25% to 35% in spend of the enhanced promotion channel.
We assume a material increase in legal expense in 2008 compared to 2007 due to a higher activity on the legal front related to our existing litigation. We assume our interest income will be down significantly in 2008 due to the lower interest rate environment.
We assume the GAAP factors will be 2% to 3% of pre-tax income for the remaining quarters in 2008.
While we do not provide specific numeric quarterly guidance, we wanted to highlight the few items related to our expectations for Q3. Q3 is our seasonably slowest quarter which impacts customer acquisition, store and insurance purchases, and PhotoStamp sales. As such, we’ve historically typically seen sequential declines from Q2 to Q3 in these categories. Any further deterioration in macroeconomic factors may potentially have some impact on our PC Postage customer metrics and PhotoStamps business in Q3.
We expect legal spend to decline sequentially with the conclusion of the trial in Q2, however we still expect to incur a high level of legal spend and legal-related spend during Q3. We expect interest income to continue to decline sequentially in Q3.
Our long-term growth rates will be driven by our ability to grow our sales and marketing investment at a reasonable cost per customer acquired level and our PC Postage business. We plan to grow the sales and marketing spend as fast as we can so our expected returns can continue to be attractive.
With our increased investment in 2008, we’ll continue to impact our earnings. We feel strongly it will enhance the long-term revenue and is the best thing for the long-term growth of the business. We continue to believe we can generate 15% to 20% annual revenue and earnings growth in our business over the long-term.
With that, we will open up for questions.
(Operator Instructions) Your first question comes from Kevin Liu - B. Riley and Co.
Kevin Liu - B. Riley and Co.
Kyle, in terms of that promotional expense benefit of the subscription, I was just wondering if you could quantify how much that was and perhaps where we can expect that number to go as we move into the back half of the year?
Effectively, what happened is, our promotional costs per customer has come down. So our future expected liability for promotional items that customers will redeem in the future was reduced to reflect the stock. So that resulted in the reduction to the Q2 promotional expenses.
It’s a little hard to quantify because some of the benefit of the reduced promotional expenses is really going to be an ongoing benefit going forward with lower promotional expenses. I don’t think it’s really all a one-time benefit in this quarter.
I think the best guidance that you can have is if you look at last year, our promotional expenses were $385,000 so on a year-over-year basis the benefit of 266 was somewhere around $650,000 benefit. As I said, I think some of that reflects as an ongoing benefit that we’ll see in terms of the promotional expenses.
Kevin Liu - B. Riley and Co.
In terms of your retention program, are you continuing to scale up either sales personnel or any training around that and I’m just curious to what we should expect in terms on investment around that?
I think we scaled it up quite a bit during the second quarter and so we’re probably more in a steady state mode now. We have added quite a few personnel to the retention process from the second quarter so we felt like we had saw some impact during the second quarter to both paid customers as well as service fees but net-net we’re excited about the retention program. We think it’s a very positive ROI investment and we plan to continue to run that program going forward.
Kevin Liu - B. Riley and Co.
In that program, have you seen any trends in terms of increases in your ability to keep ties or are you seeing any change in the return on that?
No, not really, we’re continuing to experiment with the different formulas, the different types of offers to make and different circumstances with customers until we refine our approach. I think net-net we’re getting better at it but I think we’re seeing similar economics as what we’ve seen all along. It’s an extremely positive ROI when we make the retention offer and see the customers.
Kevin Liu - B. Riley and Co.
Just briefly on the PhotoStamps division. How much money is your partners delivering as a percentage or if you could provide a number there? Also, it sounds like you are pretty committed to this business over the longer term even with the lower growth this year. I’m just wondering if you could update us on what possibilities you may have evaluated for this business.
Sure, on the partners, we haven’t really disclosed that in the past. For competitive reasons, I think we will remain fairly close to the chest. It is an area that you know from our prepared remarks; it is an area that we’re focusing on trying to scale up. The beauty of partnerships is the way you can structure a deal that is profitable and the customer on a rough share basis or a bounty basis is profitable with the customer immediately. It’s an area where we would like to continue to scale in the business going forward.
One other thing I would like to add, Kevin. When we were spending heavier on marketing, pre-Q4 of ’07, we were really using a very broad base consumer marketing push so we were doing things like a lot of traditional media, radio, TV, print. As we pull back on our marketing spend, we are more focused now on things like online, and partnerships, so those areas, I think, make up a bigger percentage of the spend today than they did a year ago when we were spending at a heavier level. What was the second part?
Kevin Liu - B. Riley and Co.
The second part was just in terms of evaluating how attractive this business is over the longer term. I was just wondering if you evaluated or not if you wanted to continue to run this even given the lower growth in the possibility or just your thoughts at this juncture on the long-term.
I think we’re continuing to work on the business and planning to keep working on the economics in lots of different ways, ways we outlined during the plan and in the remarks. I think the alternatives that we examined at this point; we really focused on running the business, trying to make the business work. The way we’ve really structured it with the cutback in marketing, we’re not really seeing much of an impact in the bottom line on a negative basis. We feel that is giving us some additional time to continue working on the economics of the business.
Kevin, is this year, 2008, is really focused on rationalizing the business under the new profitability model. Beyond that, I think it comes down to whether we can effectively grow the business at our target rates under the new profitability threshold. I think that’s something we will have to evaluate as we move into 2009, but for this point, 2008, really the focus is on rationalizing the business.
Your next question comes from George Sutton - Craig Hallum.
George Sutton - Craig Hallum
I wanted to talk about a couple of statements that you made and to make sure I understand them. First on the macro, here before, you said the macro really wasn’t impacting you at all and now you’re saying you may see some macro impact. Can you just discuss what you’ve seen shift there? Also a corollary to that would be the direct marketing spends which I believe you had planned to be up 40% year-on-year, and now you’re talking 25% to 40%. I know it’s on the margin; I just wanted to see if you could address those in more detail.
We largely continue to believe that the impact of the economy on the PC Postage side of the business, we see positives and negatives. On the one side, small businesses that are struggling and going out of business could impact our existing base, could increase churn. On the flip side, in a down economy, you do see individuals tend to start small businesses more. Businesses also tend to focus on cutting costs and lone of our key value propositions versus the postage meter is that we are a lot less expensive. We may have seen some benefit from that.
One of our marketing messages of avoiding the post office or don’t take a trip to the post office, is potentially resonating even more with the cost of gas as its skyrocketing. I think that we felt that during the second quarter, we did see some slight uptick in churn and there may have been some impact in that number from a weakening economy. Overall, we felt the metrics in Q2 were solid so it’s hard to say for sure that the economy may have impacted us, either in a positive or negative way.
I would add, if you would look at churn that I talked about. There are lots of factors that influence churn. I think it’s a little bit harder to isolate economic factors used specifically as a factor on the overall metric. I think as Ken said in general, churn picked up a little bit, that means, sequential growth in paid customers was 9,000 versus 11,000-12,000. I think the quarter was fundamentally sound but on the periphery, there may be some impact that we’re seeing from the economy but at this point, I think the metrics are good. We still can plan to continue that investment.
George Sutton - Craig Hallum
With respect to the pricing, you are now talking about a higher price point which is intriguing. I’m curious, what really drove that decision and you mentioned you’ve done some testing, I’m just curious if you can give us a little bit more behind the scenes as why that decision was made.
We do a lot of testing behind the scenes and we typically don’t really talk about it publically until we have some results that merit some changes in our business model. We’ve been at the $15.99 price point as our primary price point now since 2000 when we first launched it. I think there’s certainly some room for increasing the price just from a historical perspective but we’ve been testing the price point, we launched the test about a year ago for new customers. Typically when we do these things, we monitor the churn for a very long period of time so we’re watching the results for about a year and that price test we launched about a year ago.
We’ve also been continuing to look at the higher price point impact on new customer acquisition, particularly more recently in the first half of this year. Based on all those results, we feel that net-net we’ll see a higher lifetime value and the return on our investment will be higher at the $17.99 price point which is why we decided to move to that level.
George Sutton - Craig Hallum
Lastly, I’m curious on your Avery-Dennison partnership and congrats to your business as a team on picking that up. I just want to make sure I have a sense over what time frame are you looking to evaluate the success of that program. What time frame are you expecting to see success in that program?
The program is kicking off during the third quarter and we’ll begin to see Avery getting behind the co-branding service from a marketing perspective immediately. It was structured to be a long-term multi-year deal so we’re expecting a long-term relationship with Avery. We’re really excited about the things that Avery can bring.
As most people know, they’re one of the best-known brands in office products and they have a very, very large footprint in the retail channel especially in the office supply stores. So they’ll be marketing our service, the co-branded service through their retail relationships, through their retailed SKUs where it makes sense. We’re excited about the partnership and we’re looking forward to getting it kicked off here in the third quarter.
It appears there are no further questions at this time.
Thanks so much for joining us and, as always, if you have follow-up questions, you know the contact number for the company and the investor relations line is 310-482-5830.
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