Stamps.com Inc.
Q3 2006 Earnings Call Transcript

Published: 20 Oct 2006

[Operator:]

Good day and welcome to the Stamps.com Third 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, Vice President of Investor Relations. Please go ahead, sir.

[Jamie Harper:]

Thank you and welcome to the call. With me on the call today is Ken McBride, CEO and Kyle Huebner, CFO. The agenda for the call is as follows. We will review the results of our third quarter and talk about the business outlook, then we will discuss financial results for the third 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 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 31, 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 the call over to Ken McBride, CEO.

[Ken McBride:]

Hi. Good afternoon. Thank you for joining us today. Today we announced third quarter results which we thought were good in light of some of the challenges we faced during the quarter especially for earnings. With two to three months falling in summer time, the third quarter has historically been our seasonally slowest quarter of the year and this year was no different. We also faced some unexpected challenges in the core business in the billing and collections area during the third quarter. During the third quarter, we did $18.9 million total revenue, which was up 24% versus the same quarter last year. The core business, which as you know was what we call the PC Postage business, excluding only the PhotoStamps business as a whole was up 17%. Within the core business service fees were up 19%. Service fee growth was hampered by a drop in our billing and collection efficiency during Q3, more on that in a moment. Our mailing and shipping supply store business growth rate was 9% versus last year. We believe that the low growth rate was a direct result of continued limitations in our Windows-based system for our supply store, which was still in place for the majority of the customers throughout the third quarter since the majority of our 6.0 upgrades had occurred during October. Total third quarter revenue also included approximately $3.1 million of PhotoStamps revenue, which represented approximately 176,000 sheets that we shipped to the customers. PhotoStamps revenue grew nicely at 76% year-over-year, but was down sequentially around 600,000 versus the second quarter. This slowdown in the third versus the second quarter was a direct result of a decision we made to slow our marketing activity during the seasonally slower summer months in Q3. Despite the challenges we faced in the core business, we kept a tight rein on cost for the quarter and our net income excluding the 123R related to stock-based compensation expense had a new record at 5.0 million. This is now our fourth -- our ninth straight quarter of sequentially increasing record profitability. Earnings for fully diluted share came in at $0.21 excluding the 123R expense. On an apples-to-apples basis, EPS this quarter was up 92% versus $0.11 in the same quarter last year. On the call today, I will first discuss the core business in detail, then I'll talk about PhotoStamps, finally I will discuss our business plans before handing the call over to Kyle. So, let me begin with a more detail discussion of the core business. During the third quarter, we acquired 85,000 gross new customers in the core business. Even though this was the lightest acquisition level we have seen over the past four quarters, it was still up nicely versus last year when we acquired 56,000 customers in the third quarter of 2005. It's good to see such brisk acquisition in the third quarter, which is typically one of our seasonally slowest quarters. However, despite the strong new customer acquisition, our total successfully billed customers during Q3 dropped to 311,000 from 327,000 in Q2 of this year. During the third quarter, we experienced a decline in overall billing and collections efficiency in our core customer base. We primarily attribute the decline to two things. First, based on discussions with industry participants and experts, we believe that there has been a broad industry-wide degradation in general credit card billing success rates. There seems to have been a change in policy, process and/or change in systems during the third quarter at several issuing banks with regard to processing credit cards. We do not currently fully understand the nature or scope of the changes, but we have been told that it may have had an effect of several companies that rely on Card Not Present credit card transactions in their business model. Second, we were unable to implement an internal system that updates some of our credit card information automatically from information provided by issuing banks. That system was in place as part of our old platform, but we are unable to implement it in time for the July release of our new platform and as such we did not capitalize on those updates for most of the third quarter. We are in the final stages of completing that system now, and we are hopeful that we will still be able to collect a portion of the outstanding subscription fees owed to us during the fourth quarter. We are doing everything at our power to maximize our collections rates in light of the shifting landscape in Card Not Present world and we are hopeful that we will be able to make improvement with the efficiency of our billing operations going forward. We would also remind you that we recognize our subscription revenue based on our cash collections. So, the revenue numbers we report are always conservatively tied to cash that comes in through the door during the quarter. This quarter our net customer growth was approximately 20,000 customers. The growth in net add versus the previous two quarters was driven primarily by a decrease in churn customers during the third quarter. During the third quarter, we churned out approximately 65,000 customers, which was down versus the churn customers of 82,000 in the second quarter and 77,000 in Q1this year. We would note that there was an interplay between churn customers and billing efficiency because as a customer moves into an un-billable state, the customer maybe not be compelled to actively quit our service, without the monthly reminders of the Stamps.com credit card charge. Because of the drop in our billing and collections efficiency, we feel that the third quarter's churn customer numbers may not be as comparative to periods before the billing efficiency issue arose, and therefore our net overall customer growth in Q3 is not easily compared to prior periods as well. During the third quarter, we continue to experience a high acquisition rate in the enhanced promotion channel. The channel tends to attract a higher portion of lower life time value customers so it is characterized by higher fundamental churn than the other channels, but the bounty that we pay upfront are low relative to our other channels as well, so the economics are good. Consistent with the high third quarter acquisition level, we experienced a good customer acquisition cost level at $59 for the third quarter versus $80 in the same quarter last year. Low acquisition cost was consistent with the high enhanced promotion channel acquisition level. We also continued to invest in direct mail, telemarketing affiliates, online promotions, partnerships and other channels with good results. 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 channels. Note that when we calculate lifetime value, we do so based on actual cash collections experience and not theoretical revenue. So, with the shifts that happened during the third quarter in the billings and collections area, we'll be closely monitoring the performance of each of our marketing channels, and we will reallocate budget between our alternatives whenever it make sense to do so. For example, our overall billing success rate has always been higher in the direct mail channel than in the enhanced promotion channel. So, a shift in industry billing success rates will impact the enhanced promotion channel more than the direct mail channel and will likely lead us to decide to allocate more budget into direct mail in future periods. Based on USPS data and based on our own company estimates, we believe that the number of PC Postage industry's 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 this partnership previously caught the attention of many investors. So, let me review the most recent trends in that partnership now. Based on the USPS data and our own estimates, we believe that the total third quarter sign-ups for the Endicia DYMO Stamp service were only around 4,000 net sign-ups. The third quarter performance was about flat with the overall second quarter performance, but we would note that we have seen a decline in each succeeding months since the big marketing push by DYMO happened in May and June and September acquisition came in at less than half of June acquisition levels. Keep in mind that the sign-up for DYMO Stamps requires no financial commitment whatsoever on the customer's part, no upfront purchase and no service fee commitments. In making our estimates, we are using historical rates for Endicia sign-ups to remove what we believe to be regular Endicia customers sign ups from those that are required -- those that are signing up for DYMO Stamps only. We saw the Q3 sign-up numbers as pretty low in the face of the huge efforts in the multi-million dollar spend by DYMO last quarter. We will continue watching this new partnership between DYMO and Endicia closely, but based on the first few quarter 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 in any meaningful way going forward. Now, let me turn to a more detailed discussion of PhotoStamps. Today we announced that during the third quarter we shipped and collected on approximately 176,000 sheets of PhotoStamps, for a total of approximately $3.1 million in total Q3 PhotoStamps revenue. This compares to approximately 210,000 sheets in the second quarter, so sequentially we were down approximately 34,000 sheets. In the -- approximately 16 months, since we began the third market test in mid-May 2005, we have now shipped a total of more than 1.1 million sheets or more than 22 million individual PhotoStamps. During the third quarter, we made a decision to slow our marketing activity in the seasonally slower summer months. We decided the marketing spend would be a less efficient investment during July and August when consumer to consumer mail volume is very light and consumers are not as receptive to our marketing. We continue to believe that the most efficient marketing period for consumer use of PhotoStamps will be the fourth quarter of each year. In light of the magnitude of our investment and marketing this quarter, we were happy to see 76% revenue growth versus last year, and we felt that repeat of orders showed a good trend for the quarter. We also made some good strides during the quarter in the business area of PhotoStamps. During Q3, we estimated that approximately 18% of the total dollar value of orders received were business related, up from an estimated level of 7% for Q2. We also saw a nice sequential increase in that percentage each month during Q3. We would note that the quarter versus quarter comparison isn’t entirely fair since we were not allowed to accept business logo until mid Q2. We would also note that the lower consumer marketing activity may have amplified the business percentages for Q3. Our largest business orders to date have been in the size range of around 50,000 to 75,000 stamps but for larger orders we believe the lack of a presort discount continues to be a barrier to acceptance of the product. We are continuing to work on trying to convince the USPS that it makes sense to add presort rates to our PhotoStamps capabilities, but we do not currently believe that this is something that is going to be changed in any meaningful way prior to the end of the current Phase III market test. On a competitive front, we've heard some rumors that there may be a fourth customized Postage product at some point directly from Pitney Bowes in competition with its current offering through this partnership with Zazzle. We expect that a direct Pitney offering may be more focused on the business opportunity for customized postage. We will keep you up to date as we hear more on that front. Based on the latest USPS postal service data, industry data and our own data, we estimate that our product PhotoStamps represented approximately 78% of the total customized postage sold in the U.S. during the third quarter. The 78% was the same as the 78% we previously estimated for the second quarter of 2006 for PhotoStamps. Note that with the increase in business PhotoStamps and with the possibility of Pitney Bowes becoming a direct vendor focused in the business area, we currently expect that our ability to track and estimate the percentage of U.S. customized postage represented by PhotoStamps may become more difficult owing to the very different margins in consumer versus high volume business orders. Unfortunately, the USPS does not currently distinguish in its industry data reports between consumer and business applications. We have requested this data and hopefully we will be able to get it and use it to more accurately shape a view of the industry as business applications become a larger part of the overall industry mix. Now, let me give you some more detailed updates on our product and business plans. As you may 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. Beginning part of Q3, 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. The new platform will allow us to have richer cross sell, more effective up-sell, automated remarketing and better SKU cataloguing and display, and 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 will also serve as the building blocks for all future Stamps.com e-commerce initiatives. We also released a new unified payment processing system, which is integrated with our new e-commerce platform. The new platform release was the largest change in our technology platform since we went live with our original PC Postage Service in 1999. In September, we released Version 6.0 of our new PC Postage client into production. This is the first client built to take advantage of our new platform. Version 6.0 is rolling out of the base now with the majority of upgrades to 6.0 so far happening during the month of October. So, we won't really begin to see the effects of the improvements we have made until the fourth quarter. In conjunction with the new platform, we have rolled out a brand new mailing and shipping supply store in Version 6.0, the PC Postage client. Features a totaling overhauled and reorganized store catalog, same day shipping capabilities, strong messaging of our free over 50 shipping promotion, strong cross sell during checkout, SKU search capabilities, and new expedited and rush shipping options. So far, the new store seems to be well received by customers with early indications that conversion rate, an average order or size is better in the new store. Also in early September, we announced the launch of an exciting new product called Photo NetStamps on our new e-commerce platform. This new product brings the excitement in customization of PhotoStamps to our PC Postage customers in a way that makes the most sense for that customer segment. To date, we have seen a lukewarm acceptance by PhotoStamps -- of PhotoStamps by our PC Postage customers. We believe that is because PC Postage customers have adopted our service for the convenience of being able to print exactly the postage they need when they need it. And PhotoStamps requires you to pre-select your postage amounts when you order your product. Photo NetStamps compares the customization and personalization that is available in PhotoStamps with the convenience of NetStamps, giving our PC Postage customers a great new way to generate awareness for their products so to build their brand, while maintaining the convenience and ease of use that has made NetStamps so popular. Let me explain the process in a little bit more detail. Through our new version 6.0 supply store interface, PC Postage customers upload a digital image or business photo and then order sheets of photo NetStamps labels in the same way they would order regular NetStamps or other store items. We print the customer's image in full photo quality color and the image area of each label on a sheet of 24 labels and we ship the photo NetStamp sheet to the customer. Customers can then print on the same sheet exactly the postage amount and volume they need when they need it on their own printer in the postage portion of each label. The end product, once the customer has printed the postage ends up looking similar to PhotoStamps, but the process to get there is different. We have also priced Photo NetStamps at about half the per sheet cost of PhotoStamps at similar volumes, excluding the postage portion. And that pricing provides a nice benefit of being a subscription member of PC Postage. Over the past year, we have sold over 6 million sheets or more than a 150 million individual NetStamps or approximately eight times the number of individual PhotoStamps that we have sold in the same period. Therefore, if we see even a reasonable percentage of diversion from regular NetStamps and to Photo NetStamps, we believe the volumes could be significant for this new product. We are also continuing to work on other items in our technology plan, including moving the web registration and other 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 in 2007. As you may recall, our plan for 2006 also included a renewed and intensified sales and marketing focus to move upstream to address larger businesses. During Q3, we continued our more intense and sustained effort in this area with some good initial results. We feel that our pipeline has been growing and that we are learning a lot about the market, now that we have a more effective sales effort in place. The total number of seats under contract grew by about 30% sequentially in Q3 versus Q2. The growth was on a very small base, but we are encouraged and 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 we can continue to grow the core PC Postage and the PhotoStamps businesses at a good pace. Now, let me turn the call over to Kyle.

[Kyle Huebner:]

Thanks, Ken. First I will review the third quarter customer metrics. Customer accounts, ending registered customers increased from approximately 375,600 at the end of Q2 395,400 at the end of Q3, an increase of approximately 20,000. We successfully billed approximately 311,000 unique customers during Q3, compared with 327,000 successfully billed during Q2 and 293,000 successfully billed during Q3 last year. We experienced the decline in the billability of our customer base during the quarter due to the reasons discussed by Ken earlier. Revenue per customer, average subscription related revenue per successfully billed customer was $49 for Q3 compared with $49 for Q2 and $44 for Q3 of last year. Note that subscription related revenue includes service fee, store and insurance revenue. Customer acquisition, we acquired 85,000 gross new registered customers in Q3 compared with 87,000 acquired in Q2 and 56,000 acquired in Q3 last year. 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 $5.0 million in Q3 compared with $4.9 million in Q2 and compared with $4.5 million in Q3 last year. Customer acquisition cost was $59 for Q3 compared with $57 for Q2 and $80 for Q3 last year. We did modestly increase our direct mail spend in Q3 compared with previous quarters. Customer churn, average monthly trial churn, which represents the churn rate for customers leaving during the 29-day no-risk trial period was 32.1% for Q3 compared with 34.7% for Q2. Average monthly base churn, which represents the churn rate for customers who stay past the trial period, was 3.9% for Q3 compared with 5.3% for Q2. While we did see a large decline in base churn rates, we do not believe the Q3 reported base churn rate is necessarily representative of the two underlying churn due to the lower billability of customers as discussed earlier in the call. We would note that trial churns should not be impacted by billability and we did see a sequential decline in the trial churn rate. Customer usage, postage printed by customers was 55 million in Q3, up 19% compared with the 46 million printed in Q3 of last year. Now I will review our third quarter financial results. Our third quarter GAAP financial results included $719,000 of non-cash stock-based compensation expense as a result of adopting FASB 123R at the beginning of this year. The $719,000 123R expense was allocated to departments based on individual employee costs and positions as follows -- $103,000 in cost of sales, $99,000 in sales and marketing, $245,000 in R&D, and $272,000 in G&A. Our GAAP net income for Q3 was $4.3 million or $0.18 per fully diluted share, and non-GAAP net income excluding the $719,000 in 123R expenses was 5.0 million or $0.21 per fully diluted share. Revenue was $18.9 million in Q3 compared with $20.2 million in Q2, and up 24% from $15.3 million in Q3 last year. PhotoStamps revenue was $3.15 million in Q3 compared with $3.75 million in Q2 and up 76% from $1.8 million in Q3 last year. Note that this is the first fall full quarter year-over-year comparison available for PhotoStamps revenue since the re-launch of PhotoStamps in May of 2005. We did spend less on PhotoStamps marketing during the seasonally slower months and as a result Q3 PhotoStamps revenue was lower than in previous quarters. Core business revenue was $15.8 million in Q3 compared with $16.4 million in Q2 and up 17% versus $13.5 million in Q3 last year. Service fee revenue of $13.1 million was up 19% versus Q3 last year. Service fee revenue in Q3 was negatively impacted by lower billability and collections as previously discussed. Online store revenue of $1.9 million was up 9% versus Q3 last year. Version 6.0 upgrades for existing customers occurred primarily in October, so we did not see a material impact from Photo NetStamps or from the launch of a new store during Q3. We have seen higher average order sizes in the new store for those customers that have already upgraded. Q3 total revenue mix was 69% service fees, 10% store, 17% PhotoStamps, and 4% insurance, licensing, and other. For simplicity and for easier comparisons to prior periods, we will provide all of the following financial results on a non-GAAP basis excluding only the 123R expenses. A more detailed reconciliation of non-GAAP to GAAP measures is contained in our earnings release posted on our website. Total business gross margins excluding 123R expense was 74% for Q3 compared with 73% for Q2 and 73% in Q3 last year. For the core business, gross margin was approximately 81% in Q3 compared with 81% in Q2 and versus 78% in Q3 last year. Cost of sales includes promotional expenses of approximately $439,000 in Q3 compared with $437,000 in Q3 last year. For the PhotoStamps business, gross margin was approximately 34% in Q3, compared with 37% in Q2 and 34% in Q3 last year. The sequential decrease in PhotoStamps gross margin was primarily due to lower revenue. Higher volume business orders, which are typically lower margin business, also had some minor impact on Q3 PhotoStamps gross margins. As a reminder, with PhotoStamps, we have recognized 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 the core business, postage purchases go directly from the customer to the USPS. Sales and marketing spend, excluding 123R expenses was $5.9 million in Q3 compared with $6.4 million in Q2 and $5.0 million in Q3 last year. Sales and marketing spend was 31% of revenue in Q3 compared with 32% of revenue in Q3 last year. The sequential decline in spend was primarily attributable due to lower marketing spend on photo stamps. R&D spend, excluding 123R expenses, was $2.0 million in Q3 compared with $2.0 in Q2 and $1.7 million in Q3 last year. R&D spend was 11% of revenue in Q3 compared with 11% of revenue in Q3 last year. G&A spend excluding 123R expenses was $2.4 million in Q3 compared with $2.7 million in Q2 and $2.4 million in Q3 last year. G&A spend was 12% of revenue in Q2 compared with 16% of revenue in Q2 last year-- sorry, Q3 last year. The sequential decrease in G&A was primarily attributable to a decrease in legal fees. Operating income was $3.7 million in Q3 compared with $3.5 million in Q2 and $2.0 million in Q3 last year. Operating margin was 19.6% in Q3 compared with 17.4% in Q2 and 13.3% in Q3 last year. Interest income was $1.3 million in Q3 compared with $1.4 million in Q2 and $588,000 in Q3 last year. The higher interest income compared with last year was driven by higher interest rates and higher invested cash balances. Net income excluding 123R expenses for Q3 was $5.0 million or $0.21 per fully diluted share on a 24.1 million fully diluted shares outstanding count compared with $4.9 million or $0.20 per fully diluted share in Q2 and compared with $2.6 million or $0.11 per fully diluted share in Q3 last year. Thus the year-over-year increase from 2005 third quarter GAAP earnings per share versus 2006 third quarter non-GAAP earnings, excluding 123R expenses was 92% increase. We continue to invest in the PhotoStamps business opportunity, with estimated total sales and marketing expenses directly related to PhotoStamps exceeding PhotoStamps' gross profits for the third quarter. Free cash flow, defined as net income excluding 123R expenses plus D&A, less CapEx was positive $5.4 million for Q3. D&A for the quarter was approximately $750,000. CapEx for the quarter was approximately $325,000. We ended Q3 with approximately $116 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. During the third quarter and the fourth quarter to date, the company has repurchased approximately 415,000 shares for a total amount of $8.0 million. Now turning to guidance, 2006 financial guidance. We expect that fiscal 2006 revenue will be between $82 million to $85 million. We expect that fiscal 2006 GAAP EPS will be between $0.64 to $0.67 per fully diluted share. This includes an estimated $2.7 million of non-cash stock-based compensation expense related to the adoption of FASB-123R. Excluding the FASB-123R expenses, we expect that non-GAAP fiscal 2006 EPS will be between $0.75 to $0.78 per fully diluted share. For the full year 2006, we currently expect PhotoStamps to have a non-material negative impact on EPS. 2007 financial guidance, we expect that fiscal 2007 revenue will be between $90 million to $100 million. We expect that fiscal 2007 GAAP EPS will be between $0.70 to $0.80 per fully diluted share. This includes an estimated $2.4 million of non-cash stock-based compensation expense related to the adoption of FASB-123R. Excluding the FASB-123R expenses, we expect that non-GAAP fiscal 2007 EPS will be between $0.80 to $0.90 per fully diluted share. We note the following assumptions for our 2007 guidance. We assume that the USPS exercises its option to continue the current customized postage market test until May 2008. We assume a decline in our other revenue line owing to an expected 2007 end in one of our patent licensing deals. We assume a modest shift in customer acquisition spend towards direct mail where the revenue is spread over a longer period of time and where we incur a higher upfront loss at the time a customer is acquired. We assume an increase in legal expenses owing to an expected uptick in 2007 activity on the legal front. We assume PhotoStamps will not contribute materially to earnings in 2007 as we continue to invest in this category and build the business. We assume our 2007 effective tax rate will continue to be approximately 1% of pre-tax income, representing the AMT cash taxes not covered by the use of our NOLs. Note that we do not expect to bring any of our NOLs onto the balance sheet in the form of a deferred tax asset during 2007. With that, we will open up for questions.

[Operator:]

(Operator Instructions). And we'll take our first question from Mark May from Needham and Company.

[Mark May:]

Hi. Thank you. I just dialed in, so I apologize. I did catch that you mentioned something about additional or more legal expenses expected next year, may be if you could just provide some greater detail on that unless you already have and we can talk about offline. I think [I heard some cost] that you said your mix of marketing will shift more to direct mail, which tend to have a little bit higher customer acquisition costs longer lifetime. Does that also mean, I know, your gross ads tend to be a little lower in that channel versus some of your other channels. So, can you talk about sort of what your expectation is in terms of gross and net ads, what's baked into your numbers next year? Thanks.

[Kyle Huebner:]

Yeah. Mark on the first one in terms of the legal expenses, as you are aware, we have a litigation with current technologies that’s been ongoing for some point some time. At this point, the trial is currently scheduled for 2007. So as we head towards trial, we do expect to see increased activity and expenses on the legal front in addition to kind of our ongoing day to day legal expenses. So that’s one of the primary factors there. In terms of the channel mix, one of the things we talked about earlier on the call is that we saw a decline in the billability and collectibility of our customer base. And so the direct mail customers tend to have a higher collectibility than the enhanced promotion channel. So that will likely lead us to consider shifting on some of our marketing budget as we analyze the economics with the new sort of current billing environment. And so that’s the -- was the thought process behind that. In terms of the impact on the numbers, from a metric standpoint direct mail customer does have a higher customer acquisition cost associated with them and so on the same marketing spend, you would acquire fewer direct mail customers than let's say in enhanced promotion customer, but those customers then have lower churn rates and longer lifetime. So you would then financially get more revenue over a longer period of time. From a financial perspective, the other impact is that because the acquisition costs are higher, you incur a higher upfront loss when you -- at the time you acquire that customer again and then the revenue and process payback over a longer period of time. So, it really depends on the degree of impact or the degree of shift. At this point, I will characterized it as kind of we expect probably a more modest shift as opposed to a full scale shift. We don’t actually provide customer guidance and customer metrics, but I think that kind of overview is -- should help you think through it.

[Mark May:]

In terms of use of cash in kind of growth capital where -- I know you have a share buyback program but beyond that where are you looking to put your money to work to grow the business going forward? Are you expecting to grow your marketing budget next year or so by how much are you considering acquisitions maybe if you could talk to us a little bit about how you are using your cash?

[Kyle Huebner:]

Yes. During -- since the beginning of Q3 to date, I'd mention, we used about $8 million in the share repurchase program ahead of an authorized $20 million. So, we certainly are active on that front. So, we will, going forward, continue to look at share repurchase as for use of cash. Beyond that we will look at the different available uses of cash, which could be investing back in the existing business lines. In terms of acquisitions, it is something I'd say we would consider over more of a medium term that made strategic sense. But it's not something we have, kind of, immediate short-term plans to be active on the acquisition front, but would want to preserve cash for potential down the road uses in that area. In terms of the marketing budget, our goal is to increase the marketing budget and the marketing spend to grow the business, but at the same time we will only do that to the extent that we can grow the spend in a way that that preserves profitability and results in attractive customer economics on the additional spend. So, I would expect we would increase marketing spend next year, but again in a way that maintains the customer economics and only to that degree.

[Mark May:]

Thanks guys, for answering my questions, thanks.

[Ken McBride:]

Thanks.

[Operator:]

Our next question comes from Rusty Hoss from Roth Capital Partners.

[Rusty Hoss:]

Hi guys; on the successfully billed issue, can you kind of walk through maybe what normally happens and then what was happening and when during the quarter did you notice this and then I guess how should we look at it in Q4?

[Kyle Huebner:]

So, in a recurring billing model we essentially have customer's financial payment information on file, we then initiate a transaction against that card on their monthly anniversary date for their subscription fees. So, an example is we have a customer that we might have -- had successful authorizations in the preceding months, but then when we attempt the transaction now it gets declined, and part of the challenges, it can be hard to figure out why the transaction is being declined. In some banks, they will just return a generic decline code, that do not honor the transaction, that really doesn’t give you a lot of insight into what happened and why is now being declined. Another example might be, if you have an issuing bank that you are going to deposit against, they in some cases might make a system related change that results in a recurring revenue transaction now getting declined where it was accepted previously. So, what we essentially know is that when we send over the credit card transactions fewer of them are getting approved and we continue to analyze the data, monitor that environment and look to improve our collectibility of our customers. In terms of expectations for Q4, the one thing in terms of the internal system would be updating the card numbers, that’s something we expect to go live shortly. So, we are hoping that that has a positive impact. Otherwise I would say there is still a degree of uncertainty in terms for the billing environment, our hope is that we see at minimum a stabilization, that’s an uptick in the collectibilties relative to Q3 rates. But, again it is something that, there is a degree of uncertainty and we are monitoring closely.

[Rusty Hoss:]

Does this or do you know of this has anything to do specifically with, I guess maybe the channel or the customers acquired, and that’s why your going to focus more on the direct channel mix next year?

[Kyle Huebner:]

Yes, what I would say, if you look at the enhanced promotion channel, we noted that they do generally have a lower billability relative to something like a direct mail customer. So, over the long term, to the extent that one group of customers versus the other becomes a bigger part of the customer base. I think that can influence your long-term collectibility rates. But in terms of Q3, we saw declines in all the different channels, the enhanced promotion as well as the non-enhanced promotion channels. So, I don’t think the mix of customers really explains the decline in collectibility we saw specifically in Q3. But, over the long-term it does influence that rate. And so, as we look at the individual programs in those economics to the extent that we are collecting less cash from one channel, customers brought in by one channel that does change the economic and the economic returns and so that is information that we will incorporate in our decision making and when it comes to allocating the marketing budget.

[Rusty Hoss:]

Okay. And to get kind of a magnitude of the issue, is it fair to just look at the successfully billed this quarter versus last year relative to the total subscribers that you have? Is that how I should look at it?

[Kyle Huebner:]

Yes, I would -- I think, you probably to better understand it, should look at Q2 of this year relative to Q3 of this year. So, if you look at the successfully billed as a percentage of the average customers, ending customers in Q2 versus Q3, we had a decline of about 6 percentage points. And looking at those numbers, you do have some customers in their trial state where we didn't attempt to bill those customers. But since acquisition was barely consistent in Q2 and Q3 that that's not really a differentiating factor. So I think that's the best way to kind of look at and quantify the impact is to look at last quarter versus this quarter.

[Rusty Hoss:]

Okay. Thank you, Kyle.

[Operator:]

We'll take our next question from Justin Cable from B. Riley & Company.

[Justin Cable:]

Thanks. I was wondering if you can give us sort of a dollar amount as far as the impact from these billing issues that you might have kind of estimated for Q3?

[Kyle Huebner:]

Yeah. There is -- because there is different factors that work, it is pretty hard to actually quantify when you look at the different influences. The internal system with the count card updating program, once we go live with that, we'll be able to see the results of what we can recapture in terms of lost dollars during the quarter. But at this point, it's really hard to quantify. At a high level I would say the kind of industry degradation we talked about was a more primary factor or bigger factor relative to the internal count card updating program.

[Justin Cable:]

Okay. May be another way I can ask this is, if you look at the service fee revenues for the quarter, how does that compare to sort of your internal expectation and was the difference primarily just attributable to these billing challenges? And were you happy with the net customer additions during the quarter?

[Kyle Huebner:]

Yeah. Again it's because of the interplay we talked about between churn and billability. It is difficult to compare kind of the results this quarter to the previous quarter. 20,000 customer growth in our seasonally slowest period is not what we would have expected. If you look at last year, our net customer ads were the lowest level in Q3 of the whole year. So again, that’s why we say the 20,000 growth would have been a number we would have been very happy with, but it's also kind of not consistent with seasonality and past historical trends. I think we can say that the decline in the service fee revenue was primarily attributable to the successfully billed customer number. The average revenue per successfully billed customer was unchanged from Q2 to Q3, the overall customer base appear to have grown. So, really the primary thing that I think caused the sequential decline in the service fee line was around the number of successfully billed customers.

[Justin Cable:]

Right. Okay. That’s helpful. As far as the trial churn rates that you said showed some improvement, was there any reason for the improvement or anything that you might have changed in that?

[Kyle Huebner:]

Yeah. The trial churn rate -- probably the biggest impact on the trial churn rate is going to be the type of customer that you acquired through the different channels. So, we do in the enhanced promotion channel has the higher trial churn rate relative to the other channels. We do on an ongoing basis -- not just -- we look at the total channel results, but also the individual programs and partners. And so we always are trying to optimize kind of our economics by discontinuing underperforming partners while trying to pick up better performing partners and networks. So, I think the decrease was probably primarily related to just ongoing fine tuning that we do in terms of our marketing spend.

[Justin Cable:]

Okay. That's all I have for now. Thanks.

[Operator:]

And we will take our last question from George Sutton from Craig-Hallum.

[George Sutton:]

Hi, guys. I am just curious on this Card Not Present issue, I assume you have discussions during the quarter with your processor and I assume that you've further talked to some of the banks to understand why a greater than average number were being declined. What kind of feedback did you get from that?

[Kyle Huebner:]

I think it's sort of what we have described right now. When you look at billing and collections in the recurring revenue model there, there are a lot different components to add, a lot of different nuances, and so lot of different banks, issuing banks are processing the transaction. So, I think what we heard back is generally reflected in the information we gave and that there are certain things where an issuing bank makes the system change that can impact the collectibility in the recurring revenue model, which would impact us as well as if other merchants are recurring revenue and have customers with that particular issuing bank as well. So, I think what the feedback we got is as we described that there has been sort of a general lower approval rate in the Card Not Present recurring revenue industry.

[George Sutton:]

You have in the past talked about the ROI for the enhanced marketing channel being nicely higher than your other channels, was that -- did that continue to be the case this past quarter with this issue or were you finding that direct marketing actually would be the higher ROI given this change?

[Kyle Huebner:]

I mean we look at the difference, again the economics for both channels and they are very different economic profiles. So, I think the direct mail has, as we have said in the past has a higher life time value, higher cost to acquire relative to the enhanced promotion. The ROIs between the two programs historically have both met the level of returns that justify continued investment in those channels. In this case, the lower collectibility on the enhanced promotion would have a disproportionate impact on the ROI for the enhanced promotion channel relative to direct mail. We still believe they are both positive and still will be a part of our marketing mix. It's just that the change might justify looking at the allocation of a little bit more of the direct mail dollars going into the marketing budget.

[George Sutton:]

Okay, thanks guys.

[Operator:]

And gentlemen, at this time I would like to turn the conference back over to you for any additional or closing remarks.

[Ken McBride:]

Thank you for joining us on the call. As always, if you have follow-up questions, you can contact us either at our Investor Relations website, investor.stamps.com or at 310-482-5830. Thanks.

[Operator:]

At this time that will conclude today's presentation. We do thank you for your participation and say now you may disconnect your lines.