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Section 382 Update

 

Under Internal Revenue Code Section 382, a change in ownership can occur whenever there is a shift in ownership by more than 50 percentage points by one or more 5% shareholders within a three-year period. When a change of ownership is triggered, our net operating loss ("NOL" or "NOLs") asset may be impaired. We estimate that, as of September 30, 2007 we were approximately at 35% compared with the 50% level that would trigger impairment of our NOL asset.

 

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As part of our ongoing program to preserve future use of our NOL assets, we strongly urge any person contemplating owning more than 900,000 of our shares to contact us before doing so.

 

Results of Operations

 

Total revenue for the third quarter 2007 was approximately $20.3 million, an increase of 7% compared to $18.9 million in the third quarter 2006. PC Postage subscriber related revenue, including service revenue, store revenue and insurance revenue, was $16.8 million, an increase of 9% compared to $15.3 million in the third quarter 2006. PC Postage paid customers, from whom we successfully collected service fees at least once during the quarter, increased by 11% to 345,000 during the third quarter 2007 from 311,000 during the third quarter 2006. PC Postage average monthly subscriber related revenue per paid customer decreased by 1% to $16.21 during the third quarter 2007 from $16.43 during the third quarter 2006. PhotoStamps revenue was approximately $3.5 million, an increase of 12% compared to $3.1 million in the third quarter 2006. PhotoStamps sheets shipped increased by 28% to 225,000 shipped during the third quarter 2007 from 176,000 shipped during the third quarter 2006. PhotoStamps revenue per sheet shipped decreased by 12% to $15.75 during the third quarter 2007 from $17.89 during the third quarter 2006.

 

During the third quarter 2007, we added to our PC Postage business approximately 67,000 new paid customers from whom we successfully collected service fee at least once, and lost approximately 48,000 existing paid customers, resulting in an increase of 19,000 net paid customers during the quarter.

 

The following table sets forth our results of operation as a percentage of total revenue for the periods indicated:

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2007			2006			2007			2006
Total Revenues
Service			70	%		69	%		67	%		67	%
PhotoStamps			17	%		17	%		18	%		18	%
Products			11	%		10	%		12	%		11	%
Insurance			2	%		2	%		2	%		2	%
Other			0	%		2	%		1	%		2	%
Total revenues			100	%		100	%		100	%		100	%
Cost of revenues
Service			12	%		12	%		12	%		12	%
PhotoStamps			12	%		11	%		12	%		12	%
Products			4	%		3	%		4	%		3	%
Insurance			0	%		1	%		0	%		1	%
Other			0	%		0	%		0	%		0	%
Total cost of revenues			28	%		27	%		28	%		28	%
Gross profit			72	%		73	%		72	%		72	%
Operating expenses:
Sales and marketing			39	%		32	%		39	%		32	%
Research and development			11	%		12	%		10	%		11	%
General and administrative			15	%		14	%		15	%		15	%
Total operating expenses			65	%		58	%		64	%		58	%
Income from operations			7	%		15	%		8	%		14	%
Other income (expense), net			5	%		7	%		6	%		6	%
Income before income taxes			12	%		22	%		14	%		20	%
Provision for income taxes			0	%		0	%		0	%		0	%
Net income			12	%		22	%		14	%		20	%

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Revenue. Our revenue is derived primarily from four sources: (1) service fees charged to customers for use of our PC Postage service; (2) PhotoStamps revenue from the sale of PhotoStamps; (3) product sales consisting of Supplies Store revenue from the direct sale of consumables and supplies; (4) insurance revenue from our branded insurance offering; and (5) other revenue consisting of advertising revenue from controlled access advertising to our existing customer base and licensing revenue. Total revenue increased to $20.3 million in the third quarter 2007 from $18.9 million in the third quarter 2006, an increase of 7%. Total revenue increased to $61.7 million during the nine months ended September 30, 2007 from $59.6 million during the nine months ended September 30, 2006, an increase of 4%.

 

Service fee revenue increased to $14.1 million in the third quarter 2007 from $13.1 million in the third quarter 2006, an increase of 8%. Service fee revenue increased to $41.3 million during the nine months ended September 30, 2007 from $40.1 million during the nine months ended September 30, 2006, an increase of 3%. The increase is primarily attributable to the increase in the number of paid customers during the third quarter 2007 as a result of our increased customer acquisition spend during the year. The total number of paid customers we successfully collected service fees from at least once during the quarter was approximately 345,000 and 311,000 during the third quarter 2007 and 2006, respectively. Average monthly service fee revenue per paid customer was approximately $13.64 and $14.00 during the third quarter 2007 and 2006, respectively. The decrease is primarily attributable to having a greater number of paid customers on lower priced plans as compared to last year. As a percentage of total revenue, service fee revenue increased one percentage point to 70% in the third quarter 2007 as compared to 69% in third quarter 2006. As a percentage of total revenue, service free revenue remained at 67% during each of the nine months ended September 30, 2007 and 2006. We intend to continue to increase our level of spending on customer acquisition in order to grow our service fee revenue in future periods.

 

PhotoStamps revenue increased to $3.5 million in the third quarter 2007 from $3.1 million in the third quarter 2006, an increase of 12%. PhotoStamps revenue increased to $11.3 million during the nine months ended September 30, 2007 from $10.8 million during the nine months ended September 30, 2006, an increase of 5%. The increase both during the quarter and the nine months ended September 30, 207 is primarily attributable to the increase in PhotoStamps sheets shipped. Total PhotoStamps sheets shipped were approximately 225,000 and 176,000 during the third quarter 2007 and 2006, respectively, and 705,000 and 596,000 during the nine months ended September 30, 2007 and 2006, respectively. Average revenue per PhotoStamps sheet shipped was approximately $15.75 and $17.89 during the third quarter 2007 and 2006, respectively. Both the increase in sheets shipped and the decrease in average revenue per sheet were primarily attributable to a higher mix of high volume business PhotoStamps orders, which carry a lower per sheet price. As a percentage of total revenue, PhotoStamps revenue during the third quarter 2007 and 2006 was 17% and 18% during the nine months ended September 30, 2007 and 2006. We plan to reduce our future level of sales and marketing spending on PhotoStamps in future periods on a year-over-year basis to improve profitability in PhotoStamps, which we expect will result in declining PhotoStamps revenue on a year-over-year basis.

 

Product revenue increased to $2.3 million in the third quarter 2007 from $1.9 million in the third quarter 2006, an increase of 19%. Product revenue increased to $7.1 million during the nine months ended September 30, 2007 from $6.3 million during the nine months ended September 30, 2006, an increase of 13%. The increase was attributable to the following: (1) we launched a new supplies store interface in September 2006 (2) growth in the paid customer base (3) marketing the store to our existing base (4) additional SKUs we added to the store and (5) growth in postage printed which helps drive sales of consumable supplies such as labels. Total postage printed was approximately $68 million and $55 million during the third quarter 2007 and 2006, respectively, and $195 million and $167 million during the nine months ended September 30, 2007 and 2006, respectively. As a percentage of total revenue, product revenue increased one percentage point to 11% in the third quarter 2007 as compared to 10% in the third quarter 2006. As a percentage of total revenue, product revenue increased slightly to 11% in the third quarter 2007 as compared to 10% in the third quarter 2006 and to 12% during the nine months ended September 30, 2007 as compared to 11% in the nine months ended September 30, 2006. We expect product revenue to continue to increase in future periods as we plan to add additional products to our supplies store, and as we continue to market these products to our new and existing customers.

 

Insurance revenue increased to $339,000 in the third quarter 2007 from $326,000 in the third quarter of 2006, an increase of 4%. The increase is primarily attributable to the increase in the average of dollar value insured per transaction. Insurance revenue was approximately $1.1 million each during the nine months ended September 30, 2007 and 2006. As a percentage of total revenue, insurance revenue remained at 2% in each of the three and nine months ended September 30, 2007 and 2006, respectively. We expect insurance revenue to increase in future periods to the extent that we realize our plans to grow our PC Potage business.

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Other revenue decreased to $0 in the third quarter 2007 from $453,000 in the third quarter 2006, a decrease of 100%. Other revenue decreased to $906,000 during the nine months ended September 30, 2007 from $1.4 million during the nine months ended September 30, 2006, a decrease of 34%. As a percentage of total revenue, other revenue decreased to 0% in the third quarter 2007 as compared to 2% in the third quarter 2006, and to 1% during the nine months ended September 30, 2007 as compared to 2% during the nine months ended September 30, 2006. The decrease in other revenue, both on an absolute basis and as a percentage of total revenue is mainly attributable to the expiration of a licensing agreement in June 2007. We do not expect other revenue to be material in future periods.

 

Cost of Revenue. Cost of revenue principally consists of the cost of customer service, certain promotional expenses, system operating costs, credit card processing fees, the cost of postage for PhotoStamps, image review, 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 $5.1 million in the third quarter 2006 to $5.7 million in the third quarter 2007, an increase of 12%. Cost of revenue increased to $5.7 million in the third quarter 2007 from $5.1 million in the third quarter 2006, an increase of 12%. Cost of revenue increased to $17.5 million during the nine months ended September 30, 2007 from $16.6 million during the nine months ended September 30, 2006, an increase of 6%. As a percentage of total revenue, cost of revenue was 27% and 28% during the third quarters of September 30, 2006 and 2007, respectively, and 28% during each of the nine months ended September 30, 2006 and 2007.

 

Cost of service revenue increased to $2.4 million in the third quarter of 2007 from $2.3 million in the third quarter of 2006, an increase of 2%. Cost of service revenue decreased to $7.1 million during the nine months ended September 30, 2007 from $7.3 million during the nine months ended September 30, 2006, a decrease of 2%. The increase during the third quarter 2007 is mainly attributable to headcount related expenses increasing in customer service. The decrease during the nine months ended September 30, 2007 is mainly attributable to the decrease in promotional expense as a result of a decrease in coupon redemption rates. As a percentage of total revenue, cost of service revenue remained at 12% during each of the three and nine months ended September 30, 2007 and 2006, respectively.

 

Included in cost of service revenue are promotional expenses. This includes free postage and a free digital scale offered to new customers, and was approximately $399,000 and $439,000 in the third quarter 2007 and 2006, respectively, and $1.2 million and $1.7 million during the nine months ended September 30, 2007 and 2006, respectively. Promotional expense, which represents a material portion of total cost of service revenue, is expensed in the period in which a customer qualifies for the promotion. However, the revenue associated with the acquired customer is earned over the customer's lifetime. Therefore, promotional expense for newly acquired customers may be higher than the revenue earned from those customers in the initial period.

 

Cost of PhotoStamps revenue increased to $2.5 million in the third quarter 2007 from $2.1 million in the third quarter 2006, an increase of 19%. Cost of PhotoStamps revenue increased to $7.6 million during the nine months ended September 30, 2007 from $6.9 million during the nine months ended September 30, 2006, an increase of 11%. As a percentage of total revenue, cost of PhotoStamps increased to 12% in the third quarter 2007 as compared to 11% in the third quarter 2006 and was 12% during each of the nine months ended September 30, 2006 and 2007. The increase, both on an absolute basis and as a percentage of total revenue, is primarily due to the increase in high volume business orders. Additionally, the gross margin from PhotoStamps is significantly lower than that of our other sources of revenue because we include the stated value of US Postal Service postage as part of our cost of PhotoStamps revenue. As a result, future increases in PhotoStamps sales would further increase the overall cost of Photostamps revenue as a percentage of total revenue. While we expect PhotoStamps revenue to decrease on year-over-year basis in future periods, cost of PhotoStamps revenue may grow on a year-over-year basis in future periods if high volume business PhotoStamps orders, which carry a lower gross margin compared with PhotoStamps website orders, compose a higher percentage of total orders.

 

Cost of product revenue increased to $760,000 in the third quarter of 2007 from $553,000 in the third quarter of 2006, an increase of 37%. Cost of product revenue increased to $2.4 million during the nine months ended September 30, 2007 from $2.0 million during the nine months ended September 30, 2006, an increase of 20%. As a percentage of total revenue, cost of product revenue increased to 4% during each of the three and nine months ended September 30, 2007, as compared to 3% in each of the three and nine months ended September 30, 2006. The increase, both on an absolute basis and as a percentage of revenue is mainly attributable to the increase in product sales. See “Product Revenue” in Results of Operation above for further discussion. We expect the cost of product sales to increase in future periods, which is consistent with our expectation that product sales will increase in future periods.

 

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Cost of insurance revenue increased to $105,000 in the third quarter of 2007 from $99,000 in the third quarter of 2006, an increase of 6%. Cost of insurance revenue increased to $331,000 during the nine months ended September 30, 2007 from $325,000 during the nine months ended September 30, 2006, an increase of 2%. This is mainly attributable to the increase in insurance sales as a result of the increase in the average of dollar value insured per transaction. As a percentage of total revenue, cost of insurance revenue decreased to less than one percentage point during each of the three and nine months ended September 30, 2007, as compared to 1% for each of the three and nine months ended September 30, 2006. We expect the cost of insurance to increase in future periods, which is consistent with our expectation that insurance revenue will increase in future periods.

 

Cost of other revenue decreased to $0 in the third quarter of 2007 from $26,000 in the third quarter of 2006, a decrease of 100%. Cost of other revenue decreased to $52,000 during the nine months ended September 30, 2007 from $78,000 during the nine months ended September 30, 2006, a decrease of 33%. The decrease in cost of other revenue is mainly attributable to the expiration of a licensing agreement in June 2007. As a percentage of total revenue, cost of other revenue remained at less than one percent during each of the three and nine months ended September 30, 2007 and 2006.

 

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 sales, marketing, and business development activities. Sales and marketing expense increased to $8.0 million in the third quarter 2007 from $6.0 million in the third quarter 2006, an increase of 33%. Sales and marketing expense increased to $23.7 million during the nine months ended September 30, 2007 from $19.2 million during the nine months ended September 30, 2006, an increase of 23%. As a percentage of total revenue, sales and marketing expense increased seven percentage points to 39% during each of the three and nine months ended September 30, 2007, as compared to 32% in each of the three and nine months ended September 30, 2006. The increase, both on an absolute basis and as a percentage of total revenue is primarily due to the increase in various marketing program expenditures relating to the acquisition of customers for our PC Postage business, partially offset by a decrease in marketing expenditures related to PhotoStamps. During the third quarter 2007, both PC Postage and PhotoStamps marketing expenditures increased as compared to the third quarter 2006. Ongoing marketing programs include the following: traditional advertising, partnerships, customer referral programs, customer re-marketing efforts, telemarketing, direct mail, and online advertising. We expect sales and marketing expenses in our PC Postage business to increase significantly on a year-over-year basis in future periods as we plan to continue our increased level of direct mail activity. We expect sales and marketing expenses in our PhotoStamps business to decrease on a year-over-year basis going forward, as we plan to decrease our spending on marketing programs with lower anticipated returns.

 

Research and Development. Research and development expense principally consists of compensation for personnel involved in the development of our services, depreciation of equipment and software and expenditures for consulting services and third party software. Research and development expense decreased to $2.1 million in the third quarter 2007 from $2.2 million in the third quarter 2006, a decrease of 6%. Research and development expense decreased to $6.3 million during the nine months ended September 30, 2007 from $6.7 million during the nine months ended September 30, 2006, a decrease of 6%. This decrease is primarily due to the decrease in SFAS 123R stock-based compensation and lower headcount related expenses. As a percentage of total revenue, research and development expense decreased by one percentage point to 11% and 10% in each of the three and nine months ended September 30, 2007, respectively, as compared to 12% and 11% in the three and nine months ended September 30, 2006, respectively. We currently expect research and development expense to increase in future periods primarily related to expected increase in headcount related expenses.

 

General and Administrative. General and administrative expense principally consists 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. General and administrative expense increased to $3.1 million in the third quarter 2007 from $2.6 million in the third quarter 2006, an increase of 19%. General and administrative expense increased to $9.1 million during the nine months ended September 30, 2007 from $9.0 million during the nine months ended September 30, 2006, an increase of 1%. The increase in general and administrative expense during the third quarter is primarily due to the increase in legal expenses relating to existing litigation and to increased SFAS 123R stock-based compensation expense. Stock-based compensation expense increased to $382,000 in the third quarter 2007 from $255,000 in the third quarter 2006 and decreased to $865,000 during the nine months ended September 30, 2007 from $973,000 during the nine months ended September 30, 2006. As a percentage of total revenue, general and administrative expense increased one percentage point to 15% in the third quarter of 2007 as compared to 14% in the third quarter of 2006 and was 15% during each of the nine months ended September 30, 2007 and 2006. We currently expect general and administrative expenses to increase in future periods primarily because of increased activity in existing litigation.

 

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Other Income, Net. Other income, net consists of interest income from cash equivalents and short-term and long-term investments. Other income, net decreased to $1.1 million in the third quarter 2007 from $1.3 million in the third quarter 2006, a decrease of 21%. Other income, net decreased to $3.4 million during the nine months ended September 30, 2007 from $3.8 million during the nine months ended September 30, 2006, a decrease of 10%. As a percentage of total revenue, other income, net decreased two percentage points to 5% in the third quarter 2007 as compared to 7% in the third quarter 2006 and was 6% during each of the nine months ended September 30, 2007 and 2006. The decrease, both on an absolute basis and as a percentage of total revenue is primarily attributable to lower investment balances as we sold certain investments and used the cash to repurchase shares of our common stock. We expect other income to decrease in future periods as a result of lower invested cash balance and lower interest rates.

 

Liquidity and Capital Resources

 

As of September 30, 2007 and December 31, 2006 we had approximately $84 million and $106 million, respectively, in cash, restricted cash and short-term and long-term investments. We invest available funds in short and long-term money market funds, commercial paper, corporate notes and municipal securities and do not engage in hedging or speculative activities.

 

In November 2003, we entered into a facility lease agreement commencing in March 2004 for our new corporate headquarters with aggregate lease payments of approximately $4 million through February 2010.

 

The following table is a schedule of our contractual obligations and commercial commitments which is comprised of the future minimum lease payments under operating leases at September 30, 2007 (in thousands):

		Operating
Nine months ending December 31, 2007		$	179
Years ending December 31:
2008			751
2009			787
2010			134
2011			-
		$	1,851

During the third quarter of 2007 we repurchased approximately 1.2 million shares of common stock for approximately $14.0 million. As of September 30, 2007 we have completed our latest stock repurchase program.

 

Net cash provided by operating activities was $10.2 million and $13.3 million during the nine months ended September 30, 2007 and 2006, respectively. The decrease in net cash provided by operating activities resulted primarily from the payment of marketing expenses which principally consist of costs associated with direct mail and online marketing.

 

Net cash provided by investing activities was $25.1 million during the nine months ended September 30, 2007. Net cash used in investing activities was $20.5 million during the nine months ended September 30, 2006. The decrease in net cash used in investing activities resulted primarily from the sale of investments to fund the repurchase of stock, as noted above.

 

Net cash used in financing activities was $32.0 million during the nine months ended September 30, 2007. Net cash provided by financing activities was $224,000 during the nine months ended September 30, 2006. The decrease in net cash provided by financing activities resulted primarily from the repurchase of our stock, as noted above.

 

We believe our available cash and marketable securities, together with the cash flow from operations will be sufficient to fund our business for the foreseeable future.

 

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Our exposure to market rate risk for changes in interest rates relates primarily to our investment portfolio. We have not used derivative financial instruments in our investment portfolio. Our cash equivalents and investments are comprised of money market, U.S. government obligations and public corporate debt securities with weighted average maturities of 317 days at September 30, 2007. Our cash equivalents and investments, net of restricted cash, approximated $83.4 million and had a related weighted average interest rate of approximately 4.9%. Interest rate fluctuations can impact the carrying value of our portfolio. We do not believe that the future market risks related to the above securities will have a material adverse impact on our financial position, results of operations or liquidity.

 

ITEM 4.  CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

We maintain disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act), designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

 

As of the end of the period covered by this Report, our management evaluated, with the participation of our Principal Executive Officer and Principal Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, our Principal Executive Officer and Principal Financial Officer have concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report in the timely and accurate recording, processing, summarizing and reporting of material financial and non-financial information within the time periods specified in the SEC’s rules and forms. Our management, with the participation of our Principal Executive Officer and Principal Financial Officer, has concluded that our disclosure controls and procedures are also effective to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is accumulated and communicated to management, including our Principal Executive Officer and Principal Financial Officer, to allow timely decisions regarding required disclosure.

 

Changes in Internal Controls

 

During the third quarter ended September 30, 2007, there has been no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II - OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

 

On October 22, 2004, Kara Technology Incorporated filed suit against us in the United States District Court for the Southern District of New York, alleging, among other claims, that Stamps.com infringed certain Kara Technology patents and that Stamps.com misappropriated trade secrets owned by Kara Technology, most particularly with respect to our NetStamps feature. Kara Technology seeks an injunction, unspecified damages, and attorneys’ fees. On February 9, 2005, the court granted our motion to transfer this suit to the United States District Court for the Central District of California. On August 23, 2006, the court granted our summary judgment motions on the trade secret and other non-patent claims. The court issued a “Markman” ruling, construing the terms of the Kara Technology patents on September 10, 2007. Following the Markman ruling, we filed two summary judgment motions regarding the patent claims, which have not yet been ruled on by the Court.  The Court has scheduled a trial commencement date of January 22, 2008.

 

On November 22, 2006, we filed a lawsuit against Endicia, Inc. and PSI Systems, Inc. in the United States District Court for the Central District of California for infringement of eleven Stamps.com patents covering, among other things, Internet postage technology. On January 8, 2007, Endicia, Inc. and PSI Systems, Inc. filed counterclaims asking for a declaratory judgment that all eleven patents are invalid, unenforceable and not infringed. The Court has scheduled a trial commencement date of March 25, 2008.

 

In May and June 2001, we were named, together with certain of our current and former board members and/or officers, as a defendant in 11 purported class-action lawsuits, filed in the U.S. District Court for the Southern District of New York. The lawsuits allege violations of the Securities Act of 1933 and the Securities Exchange Act of 1934 in connection with our initial public offering and a secondary offering of our common stock. The lawsuits also name as defendants the principal underwriters in connection with our public offerings, and allege that the underwriters engaged in improper commission practices and stock price manipulations in connection with the sale of our common stock. The lawsuits allege that we and/or certain of our officers or directors knew of or recklessly disregarded these practices by the underwriter defendants, and failed to disclose them in our public filings. Plaintiffs seek damages and statutory compensation, including interest, costs and expenses (including attorneys' fees). Over 1,000 similar lawsuits have been brought against over 250 companies which issued stock to the public in 1998-2000, and their underwriters. All of these lawsuits have been consolidated for pretrial purposes before U.S. District Court Judge Shira Scheindlin.

 

In June 2003, we approved a proposed Memorandum of Understanding among the plaintiffs, issuers and insurers as to terms for a settlement of the litigation against us, which was further documented in a Stipulation and Agreement of Settlement filed with the court. The proposed settlement, which would not require Stamps.com to make any payments, was preliminarily approved by the court in February 2005 and was the subject of a fairness hearing in April 2006.

 

In October 2004, however, the court issued an order regarding class certification in certain related matters. In December 2006, the U.S. Court of Appeals for the Second Circuit vacated that order, and determined that the related matters could not be certified as a class as currently defined. That appellate decision rendered uncertain whether our proposed settlement could be finally approved and consummated, and, in June 2007, the proposed settlement was terminated. As a result, plaintiffs have filed an amended complaint and proposed an alternative class definition in related litigation. If such a class definition does not receive final court approval and/or a later settlement is not consummated for any reason, we intend to defend the lawsuits vigorously.

 

On August 30, 2007, Sterling Realty Organization Co. filed suit against us in the Superior Court for the State of Washington for King County, alleging they are entitled under the doctrine of equitable subrogation to recover a $575,929 sales tax related payment for improvements under a lease related to our discontinued iShip business. The lawsuit also seeks pre-judgment interest and costs.

 

We are subject to various other routine legal proceedings and claims incidental to our business, or which involve primarily a claim for damages that does not exceed 10% of our consolidated assets. We believe that the ultimate results from these actions will not have a material adverse effect on our financial position, results of operations or cash flows.

 

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ITEM 1A. RISK FACTORS

 

You should carefully consider the following risks and the other information in this Report and our other filings with the SEC before you decide to invest in our company or to maintain or increase your investment. The risks and uncertainties described below are not the only ones facing Stamps.com. Additional risks and uncertainties may also adversely impact and impair our business. If any of the following risks actually occur, our business, results of operations or financial condition would likely suffer. In that case, the trading price of our common stock could decline, and you may lose all or part of your investment.

 

This Report contains forward-looking statements based on the current expectations, assumptions, estimates and projections about Stamps.com and the Internet. These forward-looking statements involve risks and uncertainties. Our actual results could differ materially from those discussed in these forward-looking statements as a result of many factors, including those described in this section and elsewhere in this Report. Stamps.com does not undertake to update publicly any forward-looking statements for any reason, even if new information becomes available or other events occur in the future.

 

Risks Related to Our Business

 

We may not successfully implement strategies to increase the adoption of our services and products which would limit our growth, adversely affect our business and cause the price of our common stock to decline.

 

Our continuing profitability depends on our ability to successfully implement our strategy of increasing the adoption of our services and products. Factors that might cause our revenues, margins and operating results to fluctuate include the factors described in the subheadings below as well as:

 

·	The costs of our marketing programs to establish and promote the Stamps.com brands;

·	The demand for our services and products;

·	Our ability to develop and maintain strategic distribution relationships;

·	The number, timing and significance of new products or services introduced by us and by our competitors;

·	Our ability to develop, market and introduce new and enhanced products and services on a timely basis;

·	The level of service and price competition;

·	Our operating expenses;

·	US Postal Service regulation and policies relating to PC Postage and PhotoStamps; and

·	General economic factors.

 

We have implemented pricing plans that may adversely affect our future revenues and margins.

 

Our ability to generate gross margins depends upon the ability to generate significant revenues from a large base of active customers. In order to attract customers in the future, we may run special promotions and offers such as trial periods, discounts on fees, postage and supplies, and other promotions. We cannot be sure that customers will be receptive to future fee structures and special promotions that we may implement. Even though we have established a sizeable base of users, we still may not generate sufficient gross margins to remain profitable. In addition, our ability to generate revenues or sustain profitability could be adversely affected by the special promotions or additional changes to our pricing plans.

 

If we do not successfully attract and retain skilled personnel for permanent management and other key personnel positions, we may not be able to effectively implement our business plan.

 

Our success depends largely on the skills, experience and performance of the members of our senior management and other key personnel. Any of the individuals can terminate his or her employment with us at any time. If we lose key employees and are unable to replace them with qualified individuals, our business and operating results could be seriously harmed. In addition, our future success will depend largely on our ability to continue attracting and retaining highly skilled personnel. As a result, we may be unable to successfully attract, assimilate or retain qualified personnel. Further, we may be unable to retain the employees we currently employ or attract additional qualified personnel to replace those key employees that may depart. The failure to attract and retain the necessary personnel could seriously harm our business, financial condition and results of operations.

 

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The success of our business will depend upon the continued acceptance by customers of our service.

 

We must minimize the rate of loss of existing customers while adding new customers. Customers cancel their subscription to our service for many reasons, including a perception that they do not use the service sufficiently. Also customers may feel the costs for service are too high, they may be going out of business, or they may have other issues that are not satisfactorily resolved. We must continually add new customers both to replace customers who cancel and to continue to grow our business beyond our current customer base. If too many of our customers cancel our service, or if we are unable to attract new customers in numbers sufficient to grow our business, our operating results will be adversely affected. Further, if excessive numbers of customers cancel our service, we may be required to incur significantly higher marketing expenditures than we currently anticipate to replace these customers with new customers.

 

If we fail to effectively market and sell our services and products, our business will be substantially harmed and could fail.

 

In order to acquire customers and achieve widespread distribution and use of our services and products, we must develop and execute cost-effective marketing campaigns and sales programs. We currently rely on a combination of marketing techniques to attract new customers including direct mail, online marketing and business partnerships. We may be unable to continue marketing our services and products in a cost-effective manner. If we fail to acquire customers in a cost-effective manner, our results of operations will be adversely affected.

 

If we fail to meet the demands of our customers, our business will be substantially harmed and could fail.

 

Our services and products must meet the commercial demands of our customers, which include home businesses, small businesses, corporations and individuals. We cannot be sure that our services will appeal to or be adopted by an ever-growing range of customers. If we are unable to ship products such as items from our Supplies Store or PhotoStamps in a timely manner to our customers, our business may be harmed. Moreover, our ability to obtain and retain customers depends, in part, on our customer service capabilities. If we are unable at any time to address customer service issues adequately or to provide a satisfactory customer experience for current or potential customers, our business and reputation may be harmed. If we fail to meet the demands of our customers our results of operations will be adversely affected.

 

A failure to further develop and upgrade our services and products could adversely affect our business.

 

Any delays or failures in developing our services and products, including upgrades of current services and products, may have a harmful impact on our results of operations. The need to extend our core technologies into new features and services and to anticipate or respond to technological changes could affect our ability to develop these services and features. Delays in features or upgrade introductions could cause a decline in our revenue, earnings or stock price. We cannot determine the ultimate effect these delays or the introduction of new features or upgrades will have on our revenue or results of operations.

 

Increases in payment processing fees would increase our operating expenses and adversely affect our results of operations.

 

Our customers pay for our services predominately using credit cards and debit cards and, to a lesser extent, by use of automated clearing house, (“ACH”). Our acceptance of these payment methods requires our payment of certain fees. From time to time, these fees may increase, either as a result of rate changes by the payment processing companies or as a result in a change in our business practices which increase the fees on a cost-per-transaction basis. If these fees for accepting payment methods increase in future periods, it may adversely affect our results of operations.

 

A decline in our ability to effectively bill our customers by credit card and debit card would adversely affect our results of operations.

 

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Our ability to effectively charge our customers through credit cards and debit cards is subject to many variables, including our own billing technology and practices, the practices and rules of payment processing companies, and the practices and rules of issuing financial institutions. If we do not effectively charge and bill our customers in future periods through credit cards and debit cards, it would adversely affect our results of operations.

 

Third party assertions of violations of their intellectual property rights could adversely affect our business.

 

Substantial litigation regarding intellectual property rights exists in our industry. Third parties may currently have, or may eventually be issued, patents upon which our products or technology infringe. Any of these third parties might make a claim of infringement against us. We may become aware of, or we may increasingly receive correspondence claiming, potential infringement of other parties’ intellectual property rights. We could incur significant costs and diversion of management time and resources to defend claims against us regardless of their validity. Any associated costs and distractions could have a material adverse effect on our business, financial condition and results of operations. In addition, litigation in which we are accused of infringement might cause product development delays, require us to develop non-infringing technology or require us to enter into royalty or license agreements, which might not be available on acceptable terms, or at all. If a successful claim of infringement were made against us and we could not develop non-infringing technology or license the infringed or similar technology on a timely and cost-effective basis, our business could be significantly harmed or fail. Any loss resulting from intellectual property litigation could severely limit our operations, cause us to pay license fees, or prevent us from doing business.

 

A failure to protect our own intellectual property could harm our competitive position.

 

We rely on a combination of patent, trade secret, copyright and trademark laws and contractual restrictions, such as confidentiality agreements and licenses, to establish and protect our rights in our products, services, know-how and information. We have a portfolio of issued and pending US and international patents. We also have a number of registered and unregistered trademarks. We plan to apply for more patents in the future. We may not receive patents for any of our patent applications. Even if patents are issued to us, claims issued in these patents may not protect our technology. In addition, a court might hold any of our patents, trademarks or service marks invalid or unenforceable. Even if our patents are upheld or are not challenged, third parties may develop alternative technologies or products without infringing our patents. If our patents fail to protect our technology or our trademarks and service marks are successfully challenged, our competitive position could be harmed. We also generally enter into confidentiality agreements with our employees, consultants and other third parties to control and limit access and disclosure of our confidential information. These contractual arrangements or other steps taken to protect our intellectual property may not prove to be sufficient to prevent misappropriation of technology or deter independent third party development of similar technologies. Additionally, the laws of foreign countries may not protect our services or intellectual property rights to the same extent as do the laws of the United States.

 

System and online security failures could harm our business and operating results.

 

Our services depend on the efficient and uninterrupted operation of our computer and communications hardware systems. In addition, we must provide a high level of security for the transactions we execute. We rely on internally-developed and third-party technology to provide secure transmission of postage and other confidential information. Any breach of these security measures would severely impact our business and reputation and would likely result in the loss of customers. Furthermore, if we are unable to provide adequate security, the US Postal Service could prohibit us from selling postage over the Internet.

 

Our systems and operations are vulnerable to damage or interruption from a number of sources, including fire, flood, power loss, telecommunications failure, break-ins, earthquakes and similar events. Our Internet host provider does not guarantee that our Internet access will be uninterrupted, error-free or secure. Our servers are also vulnerable to computer viruses, physical, electrical or electronic break-ins and similar disruptions. We have experienced minor system interruptions in the past and may experience them again in the future. Any substantial interruptions in the future could result in the loss of data and could completely impair our ability to generate revenues from our service. We do not presently have a full disaster recovery plan in effect to cover the loss of facilities and equipment. In addition, we do not have a fail-over site that mirrors our infrastructure to allow us to operate from a second location. We have business interruption insurance; however, we cannot be certain that our coverage will be sufficient to compensate us for losses that may occur as a result of business interruptions.

 

A significant barrier to electronic commerce and communications is the secure transmission of confidential information over public networks. Anyone who is able to circumvent our security measures could misappropriate confidential information or cause interruptions in our operations. We may be required to expend significant capital and other resources to protect against potential security breaches or to alleviate problems caused by any breach. We rely on specialized technology from within our own infrastructure to provide the security necessary for secure transmission of postage and other confidential information. Advances in computer capabilities, new discoveries in security technology, or other events or developments may result in a compromise or breach of the algorithms we use to protect customer transaction data. Should someone circumvent our security measures, our reputation, business, financial condition and results of operations could be seriously harmed. Security breaches could also expose us to a risk of loss or litigation and possible liability for failing to secure confidential customer information. As a result, we may be required to expend a significant amount of financial and other resources to protect against security breaches or to alleviate any problems that they may cause.

 

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Risks Related to Our Industry

 

US Postal Service regulations or fee assessments may cause disruptions or discontinuance of our business.

 

We are subject to continued US Postal Service scrutiny and other government regulations. The availability of our services is dependent upon our service continuing to meet US Postal Service performance specifications and regulations. The US Postal Service could change its certification requirements or specifications for PC Postage or revoke or suspend the approval of one or more of our services at any time. If at any time our service fails to meet US Postal Service requirements, we may be prohibited from offering this service and our business would be severely and negatively impacted. In addition, the US Postal Service could suspend or terminate our approval or offer services which compete against us, any of which could stop or negatively impact the commercial adoption of our service. Any changes in requirements or specifications for PC Postage could adversely affect our pricing, cost of revenues, operating results and margins by increasing the cost of providing our service.

 

The US Postal Service could also decide that PC Postage should no longer be an approved postage service due to security concerns or other issues. Our business would suffer dramatically if we are unable to adapt our services to any new requirements or specifications or if the US Postal Service were to discontinue PC Postage as an approved postage method. Alternatively, the US Postal Service could introduce competitive programs or amend PC Postage requirements to make certification easier to obtain, which could lead to more competition from third parties or the US Postal Service itself. If we are unable to compete successfully, particularly against large, traditional providers of postage products like Pitney Bowes who enter the online postage market, our revenues and operating results will suffer.

 

The US Postal Service could decide to suspend or cancel the current market test of PhotoStamps, and may do so in the event that there is sufficient cause to believe that the market test presents unacceptable risk to US Postal Service revenues, degrades the ability of the US Postal Service to process or deliver mail produced by the test participants, exposes the US Postal Service or its customers to legal liability, or causes public or political embarrassment or harm to the US Postal Service in any way. If the US Postal Service decides to suspend or cancel the market test of PhotoStamps, our revenues and operating results will likely suffer.

 

Additionally, the US Postal Service could decide to amend, renegotiate or terminate our credit card cost sharing agreement, which is a key agreement that governs the allocation of credit card fees paid by the US Postal Service and us for the postage purchased by our customers. If the US Postal Service decides to amend, renegotiate or terminate our credit card cost sharing agreement, our revenues and operating results will likely suffer.

 

In addition, US Postal Service regulations may require that our personnel with access to postal information or resources receive security clearance prior to doing relevant work. We may experience delays or disruptions if our personnel cannot receive necessary security clearances in a timely manner, if at all. The regulations may limit our ability to hire qualified personnel. For example, sensitive clearance may only be provided to US citizens or aliens who are specifically approved to work on US Postal Service projects.

 

If we are unable to compete successfully, particularly against large, traditional providers of postage products such as Pitney Bowes, our revenues and operating results will suffer.

 

The PC Postage segment of the market for postage is relatively new and is competitive. At present, Pitney Bowes and Endicia.com are authorized PC Postage providers with commercially available software and Zazzle.com and FujiFilm offer a competitive product to PhotoStamps using Pitney Bowes technology. If any more providers become authorized, or if Pitney Bowes or Endicia.com provide enhanced offerings, our operations could be adversely impacted. We also compete with other forms of postage, including traditional postage meters provided by companies such as Pitney Bowes, postage stamps and permit mail.

 

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We may not be able to establish or maintain a competitive position against current or future competitors as they enter the market. Many of our competitors have longer operating histories, larger customer bases, greater brand recognition, greater financial, marketing, service, support, technical, intellectual property and other resources than us. As a result, our competitors may be able to devote greater resources to marketing and promotional campaigns, adopt more aggressive pricing policies and devote substantially more resources to web site and systems development than us. This increased competition may result in reduced operating margins, loss of market share and a diminished brand. We may from time to time make pricing, service or marketing decisions or acquisitions as a strategic response to changes in the competitive environment. These actions could result in reduced margins and seriously harm our business.

 

We could face competitive pressures from new technologies or the expansion of existing technologies approved for use by the US Postal Service. We may also face competition from a number of indirect competitors that specialize in electronic commerce and other companies with substantial customer bases in the computer and other technical fields. Additionally, companies that control access to transactions through a network or Web browsers could also promote our competitors or charge us a substantial fee for inclusion. In addition, changes in postal regulations could adversely affect our service and significantly impact our competitive position. We may be unable to compete successfully against current and future competitors, and the competitive pressures we face could seriously harm our business.

 

If we do not respond effectively to technological change, our services and products could become obsolete and our business will suffer.

 

The development of our services, products and other technology entails significant technical and business risks. To remain competitive, we must continue to enhance and improve the responsiveness, functionality and features of our online operations. The Internet and the electronic commerce industry are characterized by rapid technological change; changes in user and customer requirements and preferences; frequent new product and service introductions embodying new technologies; and the emergence of new industry standards and practices.

 

The evolving nature of the Internet or the postage markets could render our existing technology and systems obsolete. Our success will depend, in part, on our ability to license or acquire leading technologies useful in our business; enhance our existing services; develop new services or features and technology that address the increasingly sophisticated and varied needs of our current and prospective users; and respond to technological advances and emerging industry and regulatory standards and practices in a cost-effective and timely manner.

 

Future advances in technology may not be beneficial to, or compatible with, our business. Furthermore, we may not be successful in using new technologies effectively or adapting our technology and systems to user requirements or emerging industry standards on a timely basis. Our ability to remain technologically competitive may require substantial expenditures and lead time. If we are unable to adapt in a timely manner to changing market conditions or user requirements, our business, financial condition and results of operations could be seriously harmed.

 

Our operating results could be impaired if we or the Internet become subject to additional government regulation and legal uncertainties.

 

Due to the increasing popularity and use of the Internet, it is possible that a number of laws and regulations may be adopted with respect to the Internet, relating to user privacy, pricing, content, copyrights, distribution, characteristics and quality of products and services, and export controls.

 

The adoption of any additional laws or regulations may hinder the expansion of the Internet. A decline in the growth of the Internet could decrease demand for our products and services and increase our cost of doing business. Moreover, the applicability of existing laws to the Internet is uncertain with regard to many issues, including property ownership, export of specialized technology, sales tax, libel and personal privacy. Our business, financial condition and results of operations could be seriously harmed by any new legislation or regulation. The application of laws and regulations from jurisdictions whose laws do not currently apply to our business, or the application of existing laws and regulations to the Internet and other online services could also harm our business.

 

We have employees and offer our services in multiple states, and we may in the future expand internationally. These jurisdictions may claim that we are required to qualify to do business as a foreign corporation in each state or foreign country. Our failure to qualify as a foreign corporation in a jurisdiction where we are required to do so could subject us to taxes and penalties. Other states and foreign countries may also attempt to regulate our services or prosecute us for violations of their laws. Further, we might unintentionally violate the laws of foreign jurisdictions and those laws may be modified and new laws may be enacted in the future.

 

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Risks Related to Our Stock

 

The tax value of our net operating losses could be impaired if we trigger a change of control pursuant to Section 382 of the Internal Revenue Code.

 

Under Internal Revenue Code Section 382 rules, a change in ownership can occur whenever there is a shift in ownership by more than 50 percentage points by one or more five-percent shareholders within a three-year period. When a change of ownership is triggered, the NOLs may be impaired. We estimate that, as of September 30, 2007 we were approximately at 35% compared with the 50% level that would trigger impairment of our NOL asset.

 

As part of our ongoing program to preserve future use of our NOL assets, we strongly urge any person contemplating owning more than 900,000 of our shares to contact us before doing so.

 

Our charter documents could deter a takeover effort, which could inhibit your ability to receive an acquisition premium for your shares.

 

The provisions of our certificate of incorporation, bylaws and Delaware law could make it difficult for a third party to acquire us, even if it would be beneficial to our stockholders. In addition, we are subject to the provisions of Section 203 of the Delaware General Corporation Law, which could prohibit or delay a merger or other takeover of our Company, and discourage attempts to acquire us.

 

The US Postal Service may object to a change of control of our common stock.

 

The US Postal Service may raise national security or similar concerns to prevent foreign persons from acquiring significant ownership of our common stock or of Stamps.com. The US Postal Service also has regulations regarding the change of control of approved PC Postage providers. These concerns may prohibit or delay a merger or other takeover of our Company. Our competitors may also seek to have the US Postal Service block the acquisition by a foreign person of our common stock or our Company in order to prevent the combined company from becoming a more effective competitor in the market for PC Postage.

 

Our stock price is volatile

 

The price at which our common stock has traded since our initial public offering in June 1999 has fluctuated significantly. The price may continue to be volatile due to a number of factors, including the following, some of which are beyond our control:

 

·	variations in our operating results,

 

·	variations between our actual operating results and the expectations of securities analysts,

 

·	investors and the financial community,

 

·	announcements of developments affecting our business, systems or expansion plans by us or others, and

 

·	market volatility in general.

 

As a result of these and other factors, investors in our common stock may not be able to resell their shares at or above their original purchase price. In the past, securities class action litigation often has been instituted against companies following periods of volatility in the market price of their securities. This type of litigation, if directed at us, could result in substantial costs and a diversion of management’s attention and resources.

 

Shares of our common stock held by existing stockholders may be sold into the public market, which could cause the price of our common stock to decline.

 

If our stockholders sell into the public market substantial amounts of our common stock purchased in private financings prior to our initial public offering, or purchased upon the exercise of stock options or warrants, or if there is a perception that these sales could occur, the market price of our common stock could decline. All of these shares are available for immediate sale, subject to the volume and other restrictions under Rule 144 of the Securities Act of 1933.

 

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ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS 

 

We did not have any unregistered sales of common stock during the quarter ended September 30, 2007.

 

Issuer Purchases of Equity Securities

 

Period		Total Number of shares Purchased			Average Price Paid per Share			Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs			Approximate Dollar Value of Shares That May Yet be Purchased Under the Plans or Programs (in 000’s)
July 1, 2007 - July 31, 2007			203,749		$	11.83			203,749		$	11,589
August 1, 2007 - August 31, 2007			964,711		$	12.01			964,711			—
September 1, 2007 - September 30, 2007			—			—			—			—

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

Not applicable.

 

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

None.

 

ITEM 5. OTHER INFORMATION

 

None.

 

ITEM 6. EXHIBITS 

31.1	Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

	STAMPS.COM INC.
	(Registrant)
November 8, 2007	By:	/s/ KEN MCBRIDE
		Ken McBride
		Chief Executive Officer

November 8, 2007	By:	/s/ KYLE HUEBNER
		Kyle Huebner
		Chief Financial Officer

 

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