Stamps.com 2004 Annual Report Download - page 25

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Promotional expense typically involves offering free postage and a free digital scale to new customers.
Such promotional expense was approximately $3.0 million and $3.6 million in the fiscal years 2003 and 2004,
respectively. Promotional expenses, which represent a significant portion of total cost of service revenue, are
expensed in the period when a customer is acquired. However, the revenue associated with the acquired customer is
earned over the customers’ lifetime. Therefore, promotional expenses for newly acquired customers may be higher
than the revenue earned from those customers in that period. For this reason, the cost of service revenue increases
may not correlate to the increases in service revenue for the same period. We expect the cost of service revenue to
increase in future periods as we acquire a greater number of customers resulting in larger promotional expense.
Cost of PhotoStamps revenue was approximately $1.5 million in fiscal 2004, which represented 4% of total
revenue; there was no cost of PhotoStamps revenue in fiscal 2003. Cost of PhotoStamps revenue includes the face
value of the postage, credit card processing fees, customer support costs, operating costs, and costs associated with
printing and fulfilling the PhotoStamps product.
Cost of product sales and other revenue increased from $1.1 million in fiscal 2003 to $2.3 million in fiscal
2004, an increase of 106%. As a percentage of total revenue, cost of product sales and other revenue increased from
5% to 6% for fiscal 2003 and 2004, respectively. The increase in cost of product sales and other revenue is primarily
due to the expansion of available products offered through our online store and the amortization cost of the patents
related to the licensing revenue. We expect the cost of product sales and other revenue to increase in future periods
as we continue to market and add additional skus to our online store.
Sales and Marketing. Sales and marketing expense principally consists of costs associated with strategic
partnership relationships, advertising, and compensation and related expenses for personnel engaged in marketing
and business development activities. Sales and marketing expense increased from $6.3 million in fiscal 2003 to
$12.6 million in fiscal 2004, an increase of 100%. As a percentage of total revenue, sales and marketing expense
increased from 30% in 2003 to 33% 2004. In the second half of 2003, we began increasing our marketing activities
as we transitioned from a phase in 2002 and the first half of 2003 when we were primarily focused on making
product enhancements and spending lower amounts of marketing dollars on testing marketing channels and
initiatives. During fiscal year 2004, we focused our acquisition efforts on existing programs as well as new
marketing channels. Ongoing marketing programs include the following: web partnerships; software and hardware-
based partnerships; retail partnerships; customer referral programs; customer remarketing efforts; telemarketing;
direct mail; and online advertising. During the third and fourth quarter of fiscal 2004, we spent approximately
$400,000 on incremental marketing related to PhotoStamps. Furthermore, during the first quarter of fiscal 2004, we
incurred a charge to sales and marketing of approximately $328,000 relating to cash and stock distributed to
employees to compensate them for the loss in value of employee stock options held by sales and marketing
personnel as a result of our return of capital cash dividend of $1.75 per share in February 2004. We did not incur a
similar charge in fiscal 2003 and we do not currently anticipate any similar charge in the future. We currently expect
sales and marketing expenses to increase in fiscal 2005 as we increase our customer acquisition efforts.
Research and Development. Research and development expense principally consists of compensation for
personnel involved in the development of our services and expenditures for consulting services and third party
software. Research and development expense increased from $4.8 million in fiscal 2003 to $6.2 million in fiscal
2004, an increase of 29%. As a percentage of total revenue, research and development expense decreased 7
percentage points from 23% in fiscal 2003 to 16% in fiscal 2004 due to the growth in revenues. The increase in
research and development expense is primarily due to the increase in our headcount as we focused on new products
and the improvement of existing products. In addition, during the first quarter of fiscal 2004, we incurred a charge of
approximately $900,000 relating to cash and stock distributed to employees to compensate them for the loss in value
of employee stock options held by research and development personnel as a result of our return of capital cash
dividend of $1.75 per share in February 2004. We did not incur a similar charge in the fiscal year 2003 and we do
not currently anticipate any similar charge in the future. We currently expect research and development expense to
increase in fiscal 2005 as we expect to increase the R&D headcount.
General and Administrative. General and administrative expense principally consist of compensation and
related costs for executive and administrative personnel, fees for legal and other professional services, depreciation
of equipment and software used for general corporate purposes and amortization of intangible assets and deferred
compensation. General and administrative expense decreased from $14.5 million in fiscal 2003 to $13.0 million in
fiscal 2004, a decrease of 10%. As a percentage of total revenue, general and administrative expenses decreased 34
percentage points from 68% in fiscal 2003 to 34% in fiscal 2004. During the first quarter of fiscal 2004, we incurred