Stamps.com Inc.
Q1 2006 Earnings Call Transcript

Published: 26 Apr 2006

[Operator:]

Good day, and welcome to the Stamps.com first 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 Vice President of Finance and Investor Relations, Mr. Jamie Harper. Please go ahead, sir.

[Jamie Harper:]

Thank you. Welcome to the call today. With me on the call today is Ken McBride, CEO; and Kyle Huebner, CFO. The agenda for the call is as follows

[Ken McBride:]

Hi, good morning. Thank you for joining us today. Today we announced first quarter results that we are very pleased with. We showed continued revenue and earnings growth, particularly in our core PC Postage business. PhotoStamp sales also continued to be strong, despite the expected first quarter seasonal slowdown which followed the holiday period. We hit $20.5 million, up 74% from the same quarter last year, and we're very pleased with our first quarter revenue growth. The core business which, as you know, is what we call the PC Postage business, excluding only the PhotoStamps business, had a very good quarter with year-over-year total core revenue growth of 41%. Total first quarter revenue also included approximately $3.9 million of PhotoStamps revenue, which represented approximately 210,000 sheets that we shipped to the customers this quarter. Our net income excluding the 123R-related stock-based compensation expense, hit a new record at $4.15 million. This is now our seventh straight quarter of record high profitability. Earnings per fully diluted share came in at $0.17 excluding the 123-R expense. On an apples-to-apples basis, EPS this quarter was up 143% versus the same quarter last year. On the call today, I will first discuss the core business in detail; then I'll talk about PhotoStamps; and finally I will discuss our 2006 plan, and progress we have made towards that plan, before handing the call over to Kyle. So let me begin with a discussion of the core PC Postage business. During the first quarter, we acquired 99,000 gross new customers in the core business. This was the highest quarterly level of customer acquisition for us ever and we were very happy with the performance of our marketing programs. Our acquisition in the first quarter last year was 77,000 customers and last quarter was 85,000 customers. So we saw a nice increase, both sequentially and year-over-year. During the first quarter, we continued to experience a high acquisition rate in our enhanced promotion channel. You'll recall that this channel acquires customers through various online initiatives where additional offers are made by the partner directly to the customer. The channel tends to attract a higher portion of lower lifetime value customers, so it's characterized by higher fundamental churn than our other channels, but the bounty that we pay up front is very low relative to our other channels. The economics are very good. It should be noted that our use of this channel may continue to amplify the apparent monthly churn in our overall business that we report each quarter. However, we also believe that this channel has contributed to our strong core business revenue growth, and the positives of the channel outweigh any potential negative impact on our reported metrics. Consistent with the high first quarter acquisition level, we experienced a good customer acquisition cost level at $54 for the first quarter. The low acquisition cost was also consistent with the increase in the enhanced promotion channel acquisition. We continue to invest in direct mail, telemarketing affiliates, online promotions, partnerships in other channels, and we acquired a similar number of customers in those channels as we did during the previous quarter, the fourth quarter of 2005. We continue to monitor and allocate budget among our alternative marketing channels based on our expected return on investment and we feel that the cost to acquire a customer continues to be attractive relative to the expected lifetime value for all of our marketing channels. Based on USPS data and based on our own Company estimates, we believe that the number of PC postage industry subscribers that are Stamps.com customers continues to be in the mid-80% range. However, as we've told you before, we expect that as we do better, competitors may become more attracted to our space and we may now just be starting to see a bit of an increase in interest in our space. Let me provide an update on what we've seen recently on the competitive front. Our competitor, Pitney Bowes, continues to market its PC postage product that it launched during 2005 called ShipStream, which they charge $18.99 a month for. Pitney Bowes's ShipStream product is very similar in functionality to the other offering in the marketplace from Endicia. ShipStream continues to have limited capabilities in several areas versus our product such as usability, address book support, integration with Microsoft, and other things. So far, Pitney Bowes seems to be primarily positioning ShipStream as a complement to a postage meter for a shipping solution rather than as a postage meter replacement, the way we position our service. Our other competitor, Endicia, appears to continue to be focused in the high volume shipping market segment. As you'll recall, Endicia is a small private company in Northern California that has been a PC postage provider since 2001. Last year, Endicia did add the ability to print postage without an address and without a date, which they call InstaPostage. This feature is similar to our NetStamps product, although they decided to provide this feature on an application that runs separately from their regular PC postage application rather than integrating it into the main application the way we did with NetStamps. We do not think we have seen much competitive impact from the launch of Endicia's NetStamps-like offering. In fact, our first quarter this year was our strongest quarter for NetStamps label sales ever. Endicia continues to offer their PC postage service at prices ranging from $9.99 a month for their lowest end features up to $34.95 a month and up for higher level functionality. Recently, Endicia also announced a deal with DYMO, the label writer manufacturer, to offer their InstaPostage product through DYMO-branded professional label writers. For those of you who are not familiar with DYMO, their professional label writers are PC compatible specialized thermal printers that print on rolls of special paper up to 2.25 inches wide. The label writers are primarily used for labeling office items and other office uses. The DYMO label writers are available in most office supply stores and many computer retailers. The DYMO/Endicia partnership was interesting because of the different business model approach that they took. DYMO/Endicia are offering the InstaPostage product, which they brand DYMOStamps, without a monthly service fee. However, the customer must first purchase a higher end DYMO label writer which sells for $140 and up before they can print DYMOStamps. If a customer owns an older DYMO label writer, they must also upgrade to the newer printer. Once the customer buys the printer, they then purchase the InstaPostage labels from Endicia at a cost of $20.49 including shipping and handling for a roll of 200 InstaPostage labels or about $0.102 per label. So, printing a single $0.39 stamp ends up costing the consumer almost $0.50. By comparison, our regular NetStamps range in cost from $0.033 to $0.045 cents per label, depending on the volume purchased. With 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 printers within our target customers tend to be purchased primarily by higher volume mailing and shippers. Note that the DYMOStamps software does not print shipping labels or print directly on envelopes, which are the other two features our software supports besides the NetStamps feature. The DYMOStamps user must upgrade to a monthly subscription PC postage service in order to be able to print those types of postage. We would also note that most of our customers print all three types of postage, all three features that we offer, so a solution that only prints NetStamps may not meet customers' needs for a complete mailing and shipping solution. Finally, as an indicator of current usage in our base, DYMO Label writer users currently represent less than 2% of our current customer base. The other 98% prefer to use our service with ordinary office laser printers, ink jet printers, or multi-function peripherals. We will continue to watch this new partnership between DYMO and Endicia. As far as other new competitors, we have not heard anything concrete but we would note that five years ago NeoPost, the French meter company, was also in the USPS postage market and we think that it's possible that NeoPost might become attracted back into the USPS postage market at some point. Other than the current and historical participants in the USPS postage market, we have not heard of any other serious potential new entrants, but we will continue watching closely as we continue to build our industry. Now let me turn to a discussion of PhotoStamps. Today we announced that during the first quarter we shipped and collected on approximately 210,000 sheets of PhotoStamps for a total of approximately $3.9 million in total first quarter PhotoStamps revenue. This compares to 348,000 sheets in the fourth quarter last year, so we did see some sequential slowdown, which was expected following the holiday period. In the first approximately 10.5 months since we began the second market test in mid-May of 2005, we have now shipped a total of approximately 740,000 sheets or more than $14.5 million individual PhotoStamps. During the first quarter, we continued to see good success in several of the marketing programs that we had tested during the third and fourth quarter of last year. Our image screening capability continues to scale well and to be very accurate. We now estimate that we have screened approximately 400,000 images during the 10.5 month Phase II market test, with no publicized incidents of any 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 six nines of reliability, or fewer than one image per million misclassified. We also continue to be pleased with other aspects of our operations, such as print and fulfillment, as we continue to consistently ship a high quality product in a timely manner. We're currently authorized to sell PhotoStamps in a one-year market test that began in May of 2005 and goes through May of 2006. We currently expect a new phase for the USPS customized postage program to begin in the next several weeks, prior to the end of the Phase II of the market test, which is on May 16th. Beginning with this new phase, the U.S. Postal Service is expected to lift the restriction on business advertising on customized postage which has been in place since the second market test began in May 2005. Stamps.com plans to begin marketing PhotoStamps for business use as soon as the business advertising restriction is lifted. Based on U.S. Postal Service industry data and our own data, we estimate that our product, PhotoStamps, represented approximately 77% of the total customized postage sold in the U.S. during the first quarter. While the 77% was down slightly from the 81% we saw during the fourth quarter, we also estimated that most of the gain during the quarter by our competitors happened during the month of February, with the other two months continuing to show 80% or better numbers for us. We think there was a big one-month marketing push during February by our competitors. Note that with the launch of Business PhotoStamps, we currently expect that our ability to track and estimate the percentage of U.S. customized postage represented by PhotoStamps will likely become more difficult. We view the true revenue of the customized postage industry as the difference between the total sales price and the face value of postage. In order to provide the percentage of U.S. sales represented by PhotoStamps, we have been using USPS reports of total face value postage sold as a proxy for the industry revenue. So long as all competitors are selling their products at a similar markup over face value, as is the current practice, we believe that the USPS face value of postage reports provide a good proxy for industry revenue. However, once the industry begins to accept commercial images, the face value data will then represent a mix of two very different businesses

[Kyle Huebner:]

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

[Customer Count:]

Ending registered customers increased from approximately 349,000 at the end of Q4 to 371,000 at the end of Q1, an increase of 22,000. As expected, we completed the Simple Plan conversion process during Q1. We successfully billed approximately 324,000 unique customers during Q1, up 25,000 from the 299,000 successfully billed during Q4. Given than we now have very few customers on any plan other than the $15.99 per month plan, we no longer think it makes sense to break out our individual pricing plan and the metrics we report each quarter. Instead, we plan to simplify the customer metrics we report today and going forward to discuss total customer metrics only. In order to provide insight into the customer mix, we will now also begin reporting our average revenue per customer. Average subscription revenue per successfully billed customer was $52 for Q1 compared with $48 for Q4 and $39 for Q1 of last year. Note that subscription revenue includes service fees, store, and insurance revenue.

[Customer Acquisition:]

We acquired 99,000 gross new registered customers in Q1, up from the 85,000 acquired in Q4. 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 $5.3 million in Q1 compared with $4.3 million in Q4. Customer acquisition cost was $54 for Q1 compared with $51 for Q4 last year and $58 for the same quarter last year.

[Customer Churn:]

Average monthly trial churn, which represents the churn rate for customers leaving during their 29-day no-risk trial period, was 29.9% for Q1 compared with 26.8% for Q4 and 30.0% in the same quarter last year. Average monthly base churn, which represents the churn rates for customers who stay past their trial period, was 5.2% for Q1 compared with 3.2% for Q4 and compared to 4.0% for Q1 last year. The increase in our total churn figures this quarter is primarily attributable to our increased acquisition through the enhanced promotion channel during last quarter and this quarter. As Ken mentioned, the enhanced promotion channel customers exhibit higher churn rates than our other discretionary marketing channels, but the bounties we pay are low relative to those other channels, so the economics are favorable. We continue to remain comfortable with the churn rates, customer lifetime values, and return on our marketing spend with the enhanced promotion channel, and we plan to continue acquiring customers through this channel. We would also note that we did not see any fundamental change in the long-term model for our other discretionary marketing channels this quarter.

[Customer Usage:]

Postage printed by customers was $57 million in Q1, up 27% compared with the $45 million printed in Q1 last year. Now I will review our first quarter financial results. Our first quarter GAAP financial results included $795,000 of non-cash stock-based compensation expense as the result of adopting FASB 123R. The $795,000 123R expense was allocated to departments based on individual employee costs and positions as follows

[Operator:]

Thank you. (Operator Instructions) Our first question comes from Rusty Hoss with Roth Capital Partners.

[Rusty Hoss:]

Hi, guys. First, on selling and marketing expenses, can you elaborate a little bit on what you spent? If you can give us an idea of what was PhotoStamps' and what wasn't, or at least the magnitude of how much you spent on PhotoStamps?

[Kyle Huebner:]

Yes, Rusty. We don't specifically break out those numbers. I think the best direction I can give you is look at the total customer acquisition spend number that I gave you for proxy for the investment in the core business. That does include the promotional expenses, and then to look at the total sales and marketing relative to that; customer acquisition investment as a proxy for the PhotoStamps marketing spend. The other thing I would say is the total customer acquisition investment went up versus Q4 in the core business. I believe it went up from 4.3 to 5.3 and our total sales and marketing was the same. So the mix of marketing spend compared to Q4 was heavier in the core business and a little bit lighter in the PhotoStamps marketing spend.

[Rusty Hoss:]

On the PhotoStamps side, is it primarily online, traditional marketing, partnerships, or is it the same mix as you've said before?

[Kyle Huebner:]

Yes, on the PhotoStamps side, we're continuing to kind of do what we've talked about in the past

[Rusty Hoss:]

Okay. So there was no major change there?

[Kyle Huebner:]

No.

[Rusty Hoss:]

It looks like pricing was up a little bit. Is that partly because of seasonality on PhotoStamps?

[Kyle Huebner:]

Pricing with PhotoStamps or the core business?

[Rusty Hoss:]

In PhotoStamps. Looks like it was up about a dollar.

[Kyle Huebner:]

Yes, that relates to when the postage rates increased on January 8th. We increased the base pricing level by a dollar associated with the $0.40 increase in the postage face value.

[Rusty Hoss:]

Can you give us any update on Enterprise? I know it's off beta now, but in terms of new customers, or is that something you will not be talking about?

[Ken McBride:]

I mean, quantitatively, I think we're planning on continuing to talk about those customers as part of our overall metrics on customer and on ARPU. Qualitatively, I think we mentioned already in the call that we're happy with how things have gone so far. We've seen good adoption since we moved out of beta. We really haven't been marketing it much to date, so we're happy to see that it's being adopted despite that. So as we continue to start to really move into that phase, where we begin to market and sell the service more aggressively, we're optimistic with how it's going to do.

[Rusty Hoss:]

My last question is about the settlement with Acacia and the cost of that? If it was one-time and then what, exactly, that settlement was around.

[Kyle Huebner:]

The total settlement value we'd classify as immaterial relative to our overall results. We had some part of that settlement expense was contained in Q1 and then there will be a similar immaterial amount going forward through the end of 2007.

[Rusty Hoss:]

Like a license type situation?

[Kyle Huebner:]

Yes,

[Rusty Hoss:]

Okay. Thank you, guys.

[Kyle Huebner:]

Thanks.

[Operator:]

Next we'll move to George Sutton with Craig-Hallum.

[George Sutton:]

Hi, guys. I appreciate the discussion you had on the functionality of your competitors. Can you talk about what your competitors might be doing from a marketing perspective? Is that related at all? Are they working on enhanced marketing channels as well? Is that part of what you were mentioning?

[Ken McBride:]

Yes, well it's been a while since we've talked about the competitive landscape and there have been some changes, so we wanted to highlight some of the things that have happened. In terms of the approved PC postage vendors. There's basically still three today

[George Sutton:]

It does. Can you discuss on the Enterprise version. That seems to be a natural link with potential partners. Can give us a little peek at what you're doing on the business development side from an Enterprise perspective?

[Ken McBride:]

Yes. I think we prefer to not mention too much about what our plans are in detail with regard to how we're going to market it, other than what we've talked about generically with starting to build our own internal sales channel. But we will be looking at other ways to get that product out there, including third-party potential partnerships or other external sales efforts. Beyond that, I think we 'd really not like to mention much more.

[George Sutton:]

A question for Kyle, with respect to the churn number. Obvious a higher churn number than we've seen. Is there a point where the enhanced marketing channel is not as impressive to you, given higher churn rates? Just to help us understand the give and take there.

[Kyle Huebner:]

Yes, as I've talked about, the way we evaluate the channels internally is to measure the lifetime value of the customer relative to the cost to acquire him. When you're calculating the customer lifetime value, the churn metric is really only one metric that goes into the overall calculation, along with things like the revenue, the store sales, insurance sales, billability, your cost to serve that customer. As we mentioned, the incentive channel, the enhanced promotion channel, the economics we don't feel have fundamentally changed. We still believe that the lifetime value of that customer is attractive relative to the cost to acquire him and that the return on our marketing spend is attractive. So at this point, we do plan to continue utilizing that channel going forward.

[George Sutton:]

Last question with respect to cash. You did a good thing in returning a lot of cash to shareholders a little while back. You're now, I think, about $35 million, $40 million higher than that level at that time. Would you consider another give-back of cash or increased share repurchases, anything like that, that we could look for?

[Kyle Huebner:]

Yes. Actually, we returned the $78 million in the beginning of 2004. That dropped us to, I believe it was about an $80 million cash level. So at $114 million, we're still actually a fair degree below where we were before the return of capital of distribution. You know, at this point, we look at the market. We benchmark against comparable companies and looking at our cash as relative to our market cap. At this point we don't feel that we are sufficiently over-funded the way we were in the beginning of 2004 for the benchmarking at that point. So at this point, I 'd say there's no immediate plans to take on another return of capital. We continue to look at the cash balance and we'll utilize it for anything strategic that we believe would enhance shareholder value.

[George Sutton:]

Okay. Thanks, guys.

[Operator:]

Justin Cable with B. Riley will have our next question.

[Justin Cable:]

Thank you. Back on the churn rate, Kyle, are you saying that the 5.2% churn rate in the March quarter, a lot of that was basically customers that were retained from the enhanced promotion channel? Is that fair to say?

[Kyle Huebner:]

Yes. As a reminder, we saw a huge surge in acquisition in Q4 relative to Q3. In Q3 we acquired about 56,000 customers and it was a heavier mix of direct mail customers. In Q4, we acquired 85,000 customers with the heavier mix of the enhanced promotion. So, with churn, there tends to be -- and especially the base churn metric -- there tends to be a lag effect between the acquisition and when it manifests itself in the base churn numbers. Certainly, looking at the big increase in Q4 in acquisition and the lag effect takes you into Q1. The other thing I would note is that we did purge a group of non-paying customers at the end of Q4, which actually impacts the Q1 base churn calculation. There's a lower number of customers in that denominator. So as a result, Q4 and Q1 base churn numbers aren't an exact apples-to-apples comparison.

[Justin Cable:]

Okay, understood. Would you expect to purge any more customers at the year end this year or any time going forward? Or is that just something you look at of on a quarterly basis?

[Kyle Huebner:]

It really relates to the billing projects that we undertake, and improvements to our billing systems and collections systems. We do have some things planned for this year to try and improve our billing and collections system. I 'd say it's something that, over the course of time, we'll periodically evaluate the customer segments in the paying versus non-paying buckets, but that we don't have any immediate plans to do another purge in the short term.

[Justin Cable:]

As far as the Premier plan, did you guys give that out, what the customer count was there?

[Kyle Huebner:]

No. As I mentioned in the remarks, on the one end of the spectrum, we finished the Simple Plan conversion process. But there are some customers that pay less than $15.99 remaining on the system. For example, customers we may have saved through a drop-down offer at a slightly lower price. On the other end of the spectrum, we do have this segment of Premier customers, but both the former Simple Plan and the paid Premier Plan are still relatively small compared to all the $15.99 customers. At this point, we feel that the simplest, best way to look at it is to look at the total customers and the average revenue per customer. If we get to a point in the future where Premier becomes a meaningful part of the customer base, it may be something we revisit at that time.

[Justin Cable:]

Is it fair to say that the Premier customer account did grow sequentially in the quarter?

[Ken McBride:]

Yes.

[Kyle Huebner:]

Yes. That's an accurate characterization. Yes, I think, as a reminder, I think we did say in the last call we had about 9,000 customers. The Premier number did grow, but again, it's relative to 371,000 customers. Yes, again, that's still a fairly minority percentage.

[Justin Cable:]

Last question I have is just on PhotoStamps. I don't know if you guys can provide this, but did PhotoStamps have a positive or negative or neutral impact on EPS in the quarter?

[Kyle Huebner:]

Yes, what I said in the remarks, we don't break out a specific numeric number but following the very strong holiday period, with revenue at $3.8 million, we did invest in the PhotoStamps business at a loss to the EPS line. Our overall strategy of spending to maximize the market while not having a material impact on full year 2000 EPS hasn't changed, but given the seasonal patterns in the business, we did invest in the PhotoStamps business at a loss, and feel that it's a good investment to make for the long-term attractiveness of the market.

[Operator:]

Next we'll move to James Lee with America's Growth Capital.

[James Lee:]

Hey, Kyle. Can you just elaborate the 2000 guidance a little bit? It looks like for this quarter you outperformed versus Street consensus. If I were to look at the PhotoStamp business, run rate is actually $16 million, based on seasonally weak 1Q. It just seems like the '06 guidance is not a lot conservative. Maybe you can comment about that, what kind of assumptions you're sort of baking into the next three quarters of 2006. Also, last quarter you talked about the low end guidance for '06, for not counting the PhotoStamp business to continue while the high end is counting. That gap, it seems to only narrow a little bit. I was wondering why. Maybe you can talk about that as well.

[Kyle Huebner:]

I'll take that one first. So, our guidance last quarter on the revenue line was $75 million to $90 million. At the time I had indicated it would be appropriated to think about the low end to the mid-point as representing the scenario without PhotoStamps and kind of the mid-point to the upper end as representing a scenario with PhotoStamps. Given that we now are assuming PhotoStamps continues, I think the revenue guidance is consistent with the last quarter. On the EPS, previously we had given $0.65 to $0.75 as the range. We also had said we didn't expect PhotoStamps to have a material impact on the EPS. So by assuming PhotoStamps continues, there's no real change in the thinking in terms of the impact on the bottom line. So we did adjust that range to $0.67 to $0.75 range. In terms of setting the guidance, we don't provide quarterly guidance. Just to highlight a couple of things, in terms of the seasonality of the business, in the core business, Q4 is our strongest quarter. Q1 is actually our second strongest quarter, and then Q2 and Q3 tend to be a little seasonally slower. That's in terms of acquisition and store and insurance sales. So that's something to take into account. On the PhotoStamp side, we know that Q4 is definitely the seasonally strongest quarter, with the holiday period. Q1 benefits some from the marketing that happened in Q4. In terms of Q2 and Q3, we really have less experience there, as we had just really relaunched the product last May and we're in a test level marketing spend. So there's some seasonality that we take into account in setting the guidance. The other is we look at different scenarios in setting the guidance and try and balance the upside opportunities, the downside risks of the business. As we move through the year, we continually look for new opportunities to grow revenue or reduce costs, which could end up providing upside to the guidance numbers. So that's my thoughts in terms of how we approach and think about the guidance.

[James Lee:]

In terms of PhotoStamp, for business opportunity, is that baked into 2006 guidance?

[Kyle Huebner:]

What I would say is, we have incorporated the assumption that we're going to be allowed to accept as the business logo settings and thinking about the guidance. The thing is, we really only had the two months of experience from the mid-2004 first market test, which we didn't really do any marketing. So I would say there's more uncertainty as to what the actual revenue and profit impact is once we relaunch the business. So it's something I think we're assuming we are going to be able to accept them but it's something that we'll monitor as we get out and launch, we'll get more information as to the actual impact it has on the business.

[James Lee:]

Can we get a sense, what kind of timing can we expect the revenues to be starting to recognize for PhotoStamp for businesses. Second half this year? What are we looking at in terms of timing?

[Ken McBride:]

Hey, James, it's Ken. I think in our prepared remarks we said that we expect the next phase to begin in the next several weeks; at this point that's what we have. We do expect it to begin prior to the end of the current phase, which is May 16th of next month.

[Kyle Huebner:]

The other thing I guess I would just mention is when you look at business, PhotoStamps, there's certain orders are going to be smaller, smaller volume, small business logos, that might have a more immediate sort of realization. Larger volume orders, there's more likely to be a sales cycle associated with it, so you may see a little bit of a delay effect in terms of the impact.

[James Lee:]

All right. That makes sense. Last question here. Last quarter you guys talked about wanting to improve the user experience on your website to be able to integrate PhotoStamp into your core stamp business so people don't have to register for two different products. I was wondering, how is that progress coming along? Maybe either Kyle or Ken, you can talk about it a little bit.

[Ken McBride:]

Yes, we touched on that briefly during the prepared remarks in terms of the technology plan for the year. So we're still working o what we called the web presentation e-commerce system, where we're basically migrating in our existing home-grown technology and moving the existing customer bases into a single system. So we're on track in that effort and we expect that to be more impactful in the second half of the year, but we're on track right now in terms of that effort.

[James Lee:]

Okay, that's great. Thanks.

[Ken McBride:]

Thank you.

[Operator:]

Next we'll move to Bill Lennan with Wedbush Morgan.

[Bill Lennan:]

Hi, good afternoon. First a couple on PhotoStamps for Business as well. Can you just give us a sense for what type of business do you think this is going to be most interesting to? Because if you think about someone sending out thousands of mass mailings and they're trying to squeeze pennies, it's hard to imagine them paying a 100% mark-up or a 25% mark-up. So part one of the question, what type of business will be interested in this opportunity? Secondly, would you hazard a guess on general ballpark of where the mark-up might be on PhotoStamps for Business? Then on G&A, looks like an $868,000 sequential bump. Can you give us an idea of how much of that sequential bump was one time due to the legal and accounting and how much is organic? Final question, on the migration from Simple Plan, getting rid of the low price point, can you kind of give us a feel for what bump is left for ARPU, and I don't mean your fully loaded ARPU, just you subscription ARPU. How much juice do we have left that some of those people who migrated in Q1 become full payers in Q2? Thanks.

[Ken McBride:]

Okay. That's a lot of questions. I'll start with the first question you had, which was some insight into what potentially PhotoStamps for Business, who would be interested. As Kyle mentioned before, we really only have the first market test back in '04, where we marketed this product. So the first thing to note is that we really don't have experience other than the 7.5 weeks we were in that market test and we did see adoption from businesses, both small as well as larger businesses, for various applications. We estimated after that market test was done that about 5% of the overall images were businesses-related. But because of the higher volumes that we were seeing from those orders, it was estimated to be about a third of our total volume on a sheet basis for that market test. So you're right in pointing out that businesses that are doing mass mailings and very, very high volumes are looking to shave pennies. I mean, that's how we run our direct mail program so we understand that very well. PhotoStamps for Business in that application is going to require a clearer ROI, which really means an increase in open rates for the prospects who get the mailing. I would note one thing in that area, which is the existing PhotoStamps for Business product we believe will be limited, at least for now, to full rate classes. So we talked full rate first class versus when you get a discount for doing some portion of the work, you get a pre-sort discount. Most very large volume mailers do get that discount. So that does temper to some degree the ability to use, at least for now, the PhotoStamps in those really high volume mailings. We do think there will be an attractive element of the product in several areas with small businesses. Also in larger businesses that maybe aren't quite so penny cost sensitive, where the products maybe lend themselves to marketing efforts that are higher cost. Maybe luxury goods or things like that. So in terms of the mark-up, I guess it's really again too early to say how that may be. Again, you're right in pointing out that we don't expect businesses to pay the kinds of mark-ups that we ask for from the consumers, but the orders will also be much higher volume. If you look at our pricing, our public pricing on the website, we go up to 500 sheets and the price drops from the first sheet, which is in the high teens to once you start to order those kinds of quantities, you are looking at prices down in the $12, $13 range. We expect as the quantities go up, the price will continue to also go down to give a bigger discount to the higher volume users.

[Kyle Huebner:]

Let me take your other two. On the G&A, the apples-to-apples comparison is really stripping out the 123R expense. So G&A went up from $2.3 million, really, to $2.9 million, so about a $600,000 increase. In terms of one-time versus ongoing, the VCode litigation expense and settlement expense is a one-time event, now that that's been settled. In terms of the accounting, the big year-end audit and 404 compliance happens. A lot of that happens in Q1, so that's something, obviously, we have to do every year. But from a timing pattern, Q1 is definitely the heaviest period. We do have other litigation going on and so we would expect to continue to incur certain litigation expenses around our existing lawsuits. Then there are certain costs in the G&A that are driven by our revenue and our market cap, so as we've grown the Company, those would be permanent sort of increases in the cost structure. I guess as an overall view for the year, we do expect G&A to be up, but we expect it to be up less than revenue. So compared to 2005, we do expect to see an improved overall G&A as a percent of revenue. In terms of the conversion process in the ARPU, really we've seen all the benefit we're going to see from the Simple Plan conversion process; we've already seen it. It's already happened in Q1. So we're not expecting any benefit from the Simple Plan conversion process going forward. In terms of the driver of the overall ARPU, it's really going to be driven more over the course of time around the pricing and revenue optimization strategy. So things like the adoption of Premier, the growth in the enterprise segment, things of that nature. One thing Ken mentioned, we are testing Premier plan with new customers in certain of our channels. It's something that it usually takes three to six months, really, of churn data to measure the overall economics of that type of pricing plan in that channel. So, it is something further down the road, depending on those test results that could be a potential opportunity. But really, going forward, it's sort of the overall pricing optimization strategy that's going to drive the service fee ARPU.

[Bill Lennan:]

Thanks for that. One follow-up. On the purges from the last quarter, are you starting to see anybody trickle back in, like that we-can't-live-without-you crowd who has maybe found, miraculously, some way to pay you> If you are not see it now, do you expect to have any of that several thousand number coming back to you over the next 12 months or so?

[Kyle Huebner:]

You know, when we went through our assessment last quarter, these were really people we deem that were in what we call a permanently uncollectible state. So I would say there's been no real kind of benefit or impact in Q1 from those customers that we purged in Q4.

[Bill Lennan:]

Okay, thanks a lot.

[Ken McBride:]

Thanks, Bill.

[Operator:]

Our final question comes from Mark May from Needham & Co.

[Mark May:]

Last but, hopefully, not least. My question, I 'd like to talk a little bit more about the seasonality in your business, particularly in the second quarter. You've got a pretty tough comp here, with 99,000 gross adds and 24,000 net adds. I'm wondering, describe how your core business usually acts sequentially versus the first quarter. Is it possible that your paying sub base could actually decline on a sequential basis? I know a year ago I think you grew it on a net basis, but your gross adds declined by 14%. I'm just trying to get a sense of the core business and what to expect. I think along the same lines, I know you don't have as much history with the customized stamps business, but you're almost a third through the quarter. Can you talk a little bit about the seasonality in that business? I was a little surprised how good the numbers looked in the first quarter relative to the fourth quarter. So, is it possible that that business could be up sequentially?

[Kyle Huebner:]

Yes, in terms of the seasonality, when you look at the growth in the customer base and the customers acquired, there's three big drivers, really. One is the mix of marketing spend by channel. So when you are looking at last year, we did make some decisions in Q2 to shift marketing spend from some of the online programs to the direct mail programs, so that has an impact on your overall acquisition in customer growth. So one factor is that mix of channel spend. The second factor is seasonality in that we see as we move towards the summer months to some degree with our target customer being a small business owner or sole proprietor that there's less investment or time spent on their business, so that tends to have an influence on some of the seasonal aspects in terms of the acquisition. So we really don't break out the quarterly metrics, but it's really driven by that mix of channels, marketing spend channels, and then the overall seasonality. So that's really sort of the best guidance I can give.

[Mark May:]

So, based on the seasonality and based on the mix, the mix change in the second quarter, is it possible that your paying sub base could decline sequentially?

[Kyle Huebner:]

Yes. It's really driven by what we see develop over the rest of the quarter in terms of the seasonal impact and what happens in each of the channels. So I 'd say, it's theoretically possible but it's probably not our given expectation at this time.

[Mark May:]

On the PhotoStamps, this product seems to have legs outside of the holiday season. So I'm just wondering, what's your expectation in the second quarter in terms of seasonality? It's a fairly new product. Should we expect it to continue to grow on a sequential basis, at least for the remainder of '06?

[Ken McBride:]

Hey, Mark, it's Ken. I think that as we pointed out, we don't really have a great history particularly given that last year and we didn't even launch the second phase until mid-May. So it's hard to say for sure how the quarter may play out in terms of PhotoStamps revenue. I think Q1 is indicative that the product is attractive to people outside of the normal holiday application. So there's applications around non-holiday greeting cards. There's applications around invitations, wedding season is coming up. So that may provide some aspects to the product. Then there's overall applications that are kind of not really related to seasonal at all, like letters and letter sending and then collectors and scrapbooking. Those really seem to be less related to seasonal aspects. Given the lack of experience in Q2, all we could really point to in terms of factual information is what we know from what the Postal Service has said in terms of the overall market of 7 billion pieces. About a third of that overall volume is holiday season greeting cards and the other two-thirds kind of distributes out through the rest of the year. So clearly, the consumer application of the product seems to be -- at least market-wise -- heavily weighted towards the holiday period.

[Mark May:]

Is there any window as you are transitioning during this trial period where you may not be generating revenue from PhotoStamps?

[Ken McBride:]

No. We expect the next phase to begin in the next several weeks prior to the end of the second phase.

[Mark May:]

If I could just ask one last question for Kyle on the tax rate. The company's been GAAP profitable now for a while. You have substantial NOLs. I'm just wondering, at what point do you reverse your deferred tax asset? Maybe you can give us a sense of, should we be basing our '07 numbers on a fully taxed basis? My assumption is for several years to come you'll likely be paying very little cash taxes.

[Kyle Huebner:]

Yes. We have approximately $275 million in NOLs. The accounting on that is when you demonstrate sustained profitability but there's not a definitive numerical threshold for that. So where we feel pretty comfortable that 2006, we won't be bringing the deferred tax asset onto the balance sheet, whether it's 2007, 2008, we'll have to evaluate. Probably the most likely scenario is towards the end of 2007. And at this point, we bring the NOL onto the balance sheet as deferred tax asset and have a one-time gain to the net income. At that point, we would be recognizing GAAP taxes afterwards. But as you mention, from a cash tax perspective, we don't expect to be paying more than the minimal alternative minimum tax on a cash basis for the foreseeable future.

[Mark May:]

Thanks.

[Operator:]

That does conclude the question and answer session. I 'd like to turn the call back over to Mr. McBride and Mr. Huebner for any additional or closing remarks.

[Ken McBride:]

Well, thank you for joining us for the earnings call today. If you have any additional follow-up questions, you can reach our investor relations line at 310-482-5830. Thank you.

[Operator:]

That will conclude the call for today. Thank you for your participation.