Stamps.com 2005 Annual Report Download - page 31

2004. In addition, in October 2003, we introduced our parcel insurance offering provided in partnership with Parcel Insurance Plan and
underwritten by Fireman’s Fund.
Cost of Revenue. Cost of revenue principally consisted of the cost of customer service, certain promotional expenses, system operating
costs, credit card processing fees, the cost of postage for PhotoStamps, printing and fulfillment costs for PhotoStamps, parcel insurance
offering costs, customer misprints and products sold through our Supplies Store and the related costs of shipping and handling. Cost of revenue
increased from $8.3 million in fiscal 2003 to $13.3 million in fiscal 2004, an increase of 61%. As a percentage of total revenue, cost of revenue
decreased four percentage points from 39% in fiscal 2003 to 35% in fiscal 2004. This decrease primarily relates to the promotional expense
decline as a percentage of revenue from 15% in 2003 to nine percent in 2004.
Cost of service revenue increased from $7.2 million in fiscal 2003 to $9.5 million in fiscal 2004, an increase of 33%. As a percentage of
total revenue, cost of service revenue decreased nine percentage points from 34% in fiscal 2003 to 25% in fiscal 2004. The increase in cost of
service revenue is primarily due to the increase in credit card processing fees and customer support costs as a result of our larger customer base.
In addition, promotional expense increased by approximately $573,000 in fiscal 2004 compared to fiscal 2003, an increase of 19%. The
increase in promotional expense is also due to the increase in our customer base. The decrease in cost of service revenue as a percentage of
total revenue is due to the promotional expense decline as a percentage of revenue from 15% in 2003 to nine percent in 2004.
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 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 four percent 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 five percent to six percent 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
Supplies Store and the amortization cost of the patents related to the licensing revenue.
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.
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
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