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XO Group (NYSE:XOXO)

Q3 2013 Earnings Call

November 07, 2013 4:30 pm ET

Executives

Malindi Davies

David Liu - Co-Founder, Executive Chairman, Chief Executive Officer and Member of Executive Committee

John P. Mueller - Chief Financial Officer, Principal Accounting Officer and Treasurer

Analysts

Bradley G. Safalow - PAA Research LLC

George I. Askew - Stifel, Nicolaus & Co., Inc., Research Division

Operator

At this time, I would like to welcome everyone to the XO Group's Third Quarter 2013 Earnings Conference Call. [Operator Instructions]. As a reminder, ladies and gentlemen, this conference is being recorded. At this time, I would like to turn the conference over to the company.

Malindi Davies

Thank you. Welcome to XO Group's Third Quarter 2013 Conference Call and Webcast. During the course of this conference call, comments that we make regarding XO Group that are not historical facts are forward-looking statements and are subject to risks and uncertainties that could cause the actual future events or results to differ materially from these statements. Any such forward-looking statements are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

Forward-looking statements can be identified by the use of words like may, should, expect, plan, intend and other similar terms. You are cautioned that these forward-looking statements speak only as of today's date. Our internal projections and beliefs, upon which we based our expectations, may change but we will not necessarily inform you if they do. XO Group's policy is to provide expectations only once per quarter and not to update that information until the next quarter.

The important factors that could cause actual results to differ materially from any forward-looking statements mentioned today include, but are not limited to: One, our wedding-related and other websites may fail to generate sufficient revenue to survive over the long term; two, we incur losses for many years, following our inception, and may incur losses in the future; three, we may be unable to adjust spending quickly enough to offset any unexpected revenue shortfall; four, sales to sponsors or advertisers may be delayed or canceled; five, efforts to launch new technology and features may not generate sufficient new revenue or may reduce revenue from existing services; six, we may be unable to develop solutions that generate revenue from advertising delivered to mobile phones and wireless devices; seven, the significant fluctuation to which our quarterly revenue and operating results are subject; eight, the seasonality of the wedding industry; nine, our e-commerce operations are dependent on Internet search engine rankings, and our ability to influence those rankings is limited; 10, the dependence of our registry services business on third party; and 11, other factors detailed in documents we file from time to time with the Securities and Exchange Commission.

Additionally, if you have not received a copy of today's press release, the release is now posted on the Investor Relations section of the company's website at ir.xogroupinc.com.

We have allotted up to 1 hour for today's conference call, including the question-and-answer section that follows. Please take note that the company is operating under the SEC Regulation FD and encourage you to take full advantage of the Q&A section.

During this call, David will first give you an overview of XO Group's performance and key achievements, followed by John with an outline of the financial results, and then David and John will be available for a question-and-answer session to complete the call.

At this time, I'll turn over the call to our Chief Executive Officer, David Liu.

David Liu

Welcome to our third quarter earnings call, and thank you for joining us. We are pleased with our third quarter results, which reflect strong momentum across our brands, led by continued growth in our online advertising and registry services businesses.

I'll start the third quarter review with our local business, where we continue to build out our local vendor products, driving growth for both our company and our local partners. Since the introduction of our new vendor storefront back in April of this year, we have seen a 30% increase in traffic to our local profiles, increasing the value we are delivering to our vendors. The key to continued success with this business is to ensure that our brides are locating and connecting with the right local vendors during the planning process. To this end, we are working to improve our ability to promote vendors in a more personalized and intuitive way. For example, the recent update of our LookBook app for the iPhone not only allows a bride to search our extensive archive of dresses, but also it enables her to locate and connect with local bridal salons carrying her favorite designers.

Our national online business continues to grow incrementally, as our advertisers know the value of our young audience accessing content and tools as they plan major life-stage transition.

Our wedding-related advertising was flat for the quarter, with retail and automotive categories up nicely, but offset by declines in the financial services and consumer packaged goods category. Our pregnancy and parenting website, TheBump.com, continues to post strong gains and attract new advertisers. While national online advertising revenues have improved over these last several months, we expect the business to be pressured by macroeconomic conditions in the fourth quarter.

Turning to registry. The re-platform launch in the spring continues to pay dividends. Enhancements to our platforms, specifically improvements to our couple search tool, are delivering more traffic to our partners, and as a result, are increasing conversion rates.

Over the past several months, we've also signed some new partnerships that provide our brides, expected moms and their guests access to additional top retailers, including the Container Store and Babies"R"Us. We've also signed partnerships with meeting online invitation providers, Evite and Paperless Post, which will enable our members to share their life events and to add convenient registry information to the appropriate invitations.

Our publishing business, again, delivered a solid quarter, led by strong gains in bridal fashion and retail categories.

Advertising revenue has grown every quarter this year, as our advertising partners continue to see the value in our beautifully designed and curated magazines.

Our e-commerce business continues to face headwinds, as Google Algorithm changes and the impact from increased usage of mobile devices by our users continues to negatively affect traffic, and in turn, sales. In order to help mitigate these declines, we recently launched the redesign of The Knot Wedding Shop desktop site. The redesign includes enhanced visibility of our merchandise with larger images and an improved search feature powered by Google Search algorithms.

Along with the site redesign, we're working to refine our product offerings to ensure that they're as inspiring and captivating as our content.

With that overview of the current state of our business lines, I will transition to a brief overview of our future goals and vision. Our users have always been an important part of the success of this company, but over the past few years, revenue-driven products have made it to the top of the list of our roadmaps with high frequency. These revenue-driven products have not always provided the best user experience. And over the past 12 months or so, we have been shifting our focus to ensure that our audiences' needs are not just met but surpassed. We expect this will lead to better marketing opportunities for our advertising partners over time, as an engaged audience will be more receptive to their messaging.

The first step in this process was last December's launch of a completely redesigned homepage, with a fresh, clean look, which did also sacrifice some banner space. The response to this upgrade a year or so later has been overwhelmingly positive for both our members and advertising partners.

Also critical is making sure our content, products and tools are socially enabled. Our brides and expectant mothers are used to having instant feedback during key life-stage moments, as we help a bride decide whether to purchase the dress with a simple white trim or the one with off-white lace, or help an expecting couple decide whether or not to find out the baby's gender. We want to enable the conversation to be even wider, including the brides and couple social networks, too.

Recent upgrades to our sites and mobile apps have started to facilitate this communication. For example, not only can a member share the Pinterest, Facebook, Twitter and Instagram, we have created our own Love It button, which allows our users to favorite photos across the Internet in order to share them with their social circle on The Knot platform.

As we have seen in the past, with our platform upgrades to local and the more recent platform upgrades to registry, when you deliver an improved user experience, positive business results follow. We believe the renewed focus on the consumer experience will benefit our business overall in the long run. But this is just the start.

Let me share with you some thoughts on our mobile strategy. It is clear that the future of any digital media or commerce business is mobile. Our business and our industry is no exception. Mobile technologies are as disruptive to digital media businesses as the Internet was to traditional analog media companies.

Enormous value will be destroyed, and even greater opportunities are being created. Our business and the industries we serve will be completely transformed by mobile technologies, and we plan to lead the disruption. To do this, we need to become a mobile first organization. And over the past 2 years, we've been moving towards this transformation. First, we must make our sites and products more mobile friendly. Brides, newlyweds and first-time parents increasingly expect our content and tools to be available wherever and whenever.

Almost half of our visitors are accessing our sites via mobile devices, so the XO experience on smartphones and tablets has to be just as useful, entertaining and beautiful as it has been on the desktop for the last 17 years.

We've been evolving our technology and organization to meet this demand. First, launching mobile-optimized sites for The Knot and The Bump, then building the mobile friendly e-commerce.

However, a mobile-enabled web experience is not enough. We believe that mobile is not an extension of our media platform, but rather a platform that allows us to deliver highly personalized services. And to be a mobile first organization, we must identify and align our organization around these services. To that end, over the last year, we have embarked on a company-wide structural reorganization, forming several autonomous units, which align product, technology and business people to focus on specific consumer services.

Just a couple of weeks ago, we launched the updated LookBook app. It is a great example of our focus on creating awesome, personalized consumer experiences. In the short time, the updated app has been available. We have seen hundreds of thousands of gowns viewed and thousands of dresses favorited on a daily basis. These early results are a good sign of things to come as we continue to invest in our mobile products in order to provide the best service for our members.

The key to transforming our products across all brands and our future success lies in our ability to attract new talent. On this front, we have made some great progress. We have recently hired several senior level product leads, and with our recent acquisition of a small mobile development company, we have fresh perspective in needed domain expertise into our organization.

In addition, our new President, Mike Steib, was appointed in July to accelerate XO Group's transformation towards a socially-enabled, user-centric mobile services organization. In just 3 months, Mike has helped to attract new talent and bring a laser focused reorganizing operations of the company and prioritizing our product roadmap.

In the 17 years of our company's history, this is the most difficult challenge we have faced. Transforming the user experience, the technology staff, the organizational structure and creating new business opportunities while maintaining a growing and profitable legacy business requires stamina and patience. We have made great strides so far this year, but we have much more to do. With our operations and organization aligned and focused on delivering exceptional mobile consumer services, we believe we will be able to drive accelerated growth for our shareholders in the years to come.

With that, I'll turn it over to John for the financial review.

John P. Mueller

Thank you, David. Total revenue for the third quarter was $34 million, up 7% compared to the prior year. The results were led by local online advertising revenue and registry services revenue, which grew 9.6% and 35.8%, respectively, year-over-year. National online revenue grew 7% in the 3 months ended September 30, 2013, compared to the prior year period. Publishing and other revenues were up 6.4%. Merchandising revenue was down 8.3% compared to the third quarter last year.

For the quarter ended September 30, 2013, the company's operating profit was $5.3 million compared to $3.3 million in the prior year quarter. The $2 million increase in operating profit was primarily due to increased revenue in the online sponsorship and advertising business and lower intangible asset impairment expense. These incrementally positive factors were partially offset by increased technology-related investments and increased compensation expense.

Operating expenses for the third quarter were $23.5 million compared to $23.2 million for the corresponding period in 2012. The increase in operating expense for the third quarter was primarily due to increased technology-related investments, and specifically additional personnel and software. Also contributing to the increase in operating expense was increased compensation-related expense, mainly due to higher sales performance. These increases were partially offset by decreased stock-based compensation and a nonrecurring intangible asset impairment charge that we recorded in the third quarter of last year.

Net income for the quarter was $3.1 million or $0.12 per diluted share compared to $2.1 million or $0.08 per diluted share in the prior year quarter. We ended the quarter with $86.2 million in cash and no debt. As of today's date, we have not purchased any shares under the $20 million stock repurchase authorization announced on April 10, 2013.

These results are in our press release issued this afternoon. In addition, the supplemental data tables in our press release contain local online advertising metrics, gross profit and margin by business and stock-based compensation charges broken out by product and content, sales and marketing, and G&A expense line items.

With that overview, let me give you a little more detail on our financial performance during the quarter. Our local online advertising revenue increased 9.6% in the third quarter over the prior year quarter. Increases in our vendor count and average vendor spend contributed to the year-over-year growth. We had approximately 22,600 vendors, displaying 30,200 profiles at the close of the third quarter, compared to 22,100 vendors displaying 29,700 profiles during the same period last year.

The churn rate was 29.4% at the end of September, down 80 basis points from 30.2% at December 31 and down slightly from 29.8% a year ago.

The average revenue per vendor was $2,400, up from $2,300 in the third quarter last year. National online advertising revenue increased 7% in the third quarter of 2013 compared to the same period last year. The year-over-year growth was primarily due to continued strength in online advertising on TheBump.com, partially offset by declines in the financial services and consumer packaged goods categories on our bridal properties.

For the third quarter of 2013, the share of bridal and non-bridal advertising revenue was 71% and 29%, respectively. The share of bridal advertising revenue declined slightly from 72% a year ago. Publishing and other revenues were $5.3 million for the quarter ended September 30, up 6.4% compared to the same period last year. Increases in revenue per ad page in a number of ad pages in both our national and local publications contributed to the year-over-year growth. These gains were partially offset by lower newsstand sales.

Turning to the registry business. Third quarter revenue increased 35.8% to $2.8 million compared to $2.1 million during the same period last year. Enhancements made to the registry platform back in April of this year led to increases in conversion for our retailers, which was the main driver for the year-over-year increase.

Our e-commerce business declined 8.3% in the third quarter of 2013 compared to the prior year. The year-over-year decline was mainly due to decreases in traffic across our sites as a result of SEO challenges.

Changes to Google Search algorithm throughout the year continued to negatively affect the SEO rankings of our American Bridal stores, causing a significant decline in traffic. Also contributing to the decline was the impact from the increased usage of mobile devices by our users. Our user base is increasingly accessing our sites via mobile devices, on which it's more difficult to purchase our core personalized products due to the small screen.

On a positive note, we are starting to see our overall conversion metrics stabilize as we continuously monitor the mobile and desktop site experiences in order to improve usability, and ultimately, conversion.

Operating expenses were $23.5 million for the quarter compared to $23.2 million for the corresponding period in 2012. The increase in operating expenses for the third quarter was primarily due to increased technology-related investments, specifically additional personnel and software expenses. Increased compensation-related expense also contributed to the year-over-year increase, driven primarily by compensation related to higher sales performance. These increases in operating expenses were partially offset by a nonrecurring intangible assets impairment charge related to the WeddingChannel and American Bridal trade names that we had recorded in the third quarter of last year.

Also stock-based compensation expense was slightly lower. The decrease in stock-based compensation is the result of lower estimated accrual compared to last year.

Our net expenditures on Ijie.com were $1 million for the third quarter of 2013, and that's flat compared to the prior year quarter.

The company's balance sheet at September 30 reflects cash and cash equivalents of $86.2 million, which is up $8.8 million from $77.4 million at December 31, 2012.

The third quarter results reflect the continued strength in our highest contribution business, local online, and strong gains in our registry service businesses, driven by some of the investments we made over the past 12 months. We're pleased with the incremental growth in our national business, but we remain cautious as the recent macroeconomic events may have a negative effect on this business. Finally, our e-commerce business continued to face challenges, but our team is working hard to improve our site and product offerings.

This concludes our prepared remarks. I will now open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Brad Safalow with PPA Research.

Bradley G. Safalow - PAA Research LLC

Just a quick question on the e-commerce business. You guys seem to have stabilized the gross margins there around 42% on average for the past 2 quarters. Do you feel like that's the baseline even with everything that you have going on? Competitively with the algos, I know you went through a lot of work to get the warehouse more efficient. Where do we stand on gross margins there?

John P. Mueller

Hi Brad, it's John. We're pretty comfortable with gross margins. I think we have stabilized that and largely due to the improvements in the back office and the operations warehouse management systems. I think, as we mentioned on the call or in my prepared remarks, I think the biggest challenge for us right now is making sure that we keep up with all the algorithm changes and keep driving traffic to the e-commerce sites.

Bradley G. Safalow - PAA Research LLC

Okay. And then on the Hoppit acquisition, how much did you guys spend? And what is -- what will be the priority for that team as part of the company?

John P. Mueller

Total cash outlay was about 7.50 [ph]. David wants to speak to the strategic aspects of that.

David Liu

Yes, there's a team that -- was a mobile first group that had created, I think, a very compelling search engine technology that we were looking to utilize to help glean, I think, a lot of the data and the information we have within our Real Wedding stack and our photos and then within the tag structures of our content. We actually think that the context that they provide within their ability to search through the profiles, the restaurants and venues will allow us to provide much better search results for our brides. So we're very excited to have to bring on their domain expertise, not only in the mobile development site, but then also in their search algorithm.

Bradley G. Safalow - PAA Research LLC

Okay. And then just on your hiring plan, as we talked about that last quarter. It sounds like you made some progress this quarter. When we look at the OpEx, I think, it's only up 5% year-over-year. Is that something you think is kind of -- you've always talked about a measured pace of hiring. Is that kind of the rate of growth you're comfortable with in terms of increasing the expense structure of the company? Or should we expect more faster rate going forward?

John P. Mueller

Well, I think, a couple of things to note in this quarter. We benefited, as I mentioned, from the fact that in the previous year's quarter, there was a $1 million impairment charge. So that contributed to a fairly uneasier comparison to that quarter. I think you back that out, it looks like a little bit higher growth rate. I think the second thing you have to keep in mind was, there was an adjustment last year to the accrual that we had for stock-based compensation expense, which was related to some incentive plans that we've got in place here at the company. And we've benefited from that favorable adjustment, really, throughout the year as well. So we don't, obviously, give outlooks on our expectations in any kind of detail going forward, but I think if you backed out some of those extraordinary items, I think, you'd kind of see a more closer picture of what our sort of run rate is on expense growth.

Bradley G. Safalow - PAA Research LLC

Okay. And then just as part of the discussion of mobile, how quickly can you really -- I mean, it's a broad question, but your expectations of how quickly you can tackle some of these issues? For example, some of your businesses, it seems like, have a better mobile presence than other. So is there a prioritization, between like, hey, right now, I just want to know, at least, I have an Android phone, there is no Wedding Channel mobile app, and if it is, it's not in the top 10, for example, or maybe your site is not maximized for mobile yet. However, we see not platform, there's a lot more kind of mobile-centric work that's been done. Can you comment on that in terms of -- across your operating divisions, which platforms are -- you're further along on?

David Liu

Sure. I think to provide a little more context, mobile accessibility is, obviously, important. And as more people are using mobile devices to search web and get information, I talked about how we do need to make our brand and our destinations more mobile-friendly. Now whether or not every one of our properties needs to be mobile-friendly is a process that we're, right now, sort of triaging and prioritizing based on what services we think we can provide. The bigger transformation that I am sort of trying to emphasize here is that mobile accessibility, mobile-friendly is necessary, but it's not adequate. We actually are now looking at various aspects of our business, and in particular, services that we have designed and developed for our brides, and looking at it from the lens of a mobile first experience. And on that front, we have a lot that's in development that we'll be rolling out in the coming months. The first example is this new LookBook app. I encourage everyone to download it and take a look because it will begin to demonstrate a very significant departure from a user experience that is very personal and very mobile versus a desktop experience. And we actually think the quality of interaction, the types of services, and, in fact, the kind of the business that can be built on these new experiences are very different from what we've been able to create on the desktop.

Operator

Your next question comes from the line of George Askew with Stifel.

George I. Askew - Stifel, Nicolaus & Co., Inc., Research Division

On the mobile first push, you guys are kind of at the center of a pretty broad ecosystem, local vendors on one side and national advertisers, obviously, registry partners, et cetera. Is there a risk of you guys, frankly, moving faster than your partners? In other words, if you guys are -- if they're not -- is mobile optimized and yet your local vendors are not, does it somehow degrade the experience? Or do you have to provide incremental resources to your local vendor partners to be able to kind of work within your new mobile first environment?

David Liu

Great question. I think what is interesting is that, you're right, between the large retailers, the national advertisers, as well as the local vendors, adoption, utilization, and even just effective new marketing platforms within these new mobile devices have really yet to be invented. And we're at the very early stages of the commercialization of this platform. What is racing ahead, is, in fact, user consumption and utilization. So if our shift this past year has really been about putting that consumer first, and I talked about this a couple of earnings calls ago, where -- when we actually began to look at our product roadmaps and look at where we're investing our resources and what was really getting the primary attention of key people internally, we had become very much focused on the commercial ventures and the revenue-generating activities and services and features, which, unfortunately, do not necessarily create the best consumer experience. And this past year, with a very rigorous focus on triaging and prioritizing, Mike has come in to specifically look at some of these experiences and services and figure out how do we truly become a product-centric and a consumer-focused organization. By doing that, mobile really rises to the surface. You start looking at the utilization and the access to our sites. We have now 50% of our users accessing our 3 brands through mobile device, with The Bump now almost approaching 70% of the utilization coming through mobile device. So I don't think that we would be getting ahead of our core -- our consumer. And I think by being close to and paying attention to how the consumers are using the technology, we're in a better position to provide the solutions that our marketing partners will need. And I talked about how we believe we are well positioned to be the disruptor as mobile really begins to impact this industry, and we're beginning to see a lot of the assets that we've been able to accumulate over the last 17 years become really enhancing our leadership position in the category in the mobile comp space.

George I. Askew - Stifel, Nicolaus & Co., Inc., Research Division

As you kind of contemplate that through the lens of margins, not just gross margins, but operating margins and whatnot, how does -- does that -- will your margin structure change? And I'm kind of begin -- thinking in terms of national ads and local ads, specifically.

David Liu

Not dramatically. I think one of the things that is going to surface is that as we begin to develop more robust experiences through these mobile devices and mobile services, we're going to -- and we are going to experiment with new revenue streams. So without a doubt, national and local advertising, if you provide our partners with a more effective, more targeted, more personal way to communicate with the brides who are looking for their services, those dollars will begin to shift towards the mobile experience. But we actually are very excited by the fact that having a deeper and more connected relationship with our consumers, that is everywhere and always on, is actually going to provide for additional business opportunities. And I don't think it should impact our margins. And ideally, it should improve it.

George I. Askew - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And then my final question. You kind of mentioned, David, that, in your prepared remarks, that you expect some economic weakness, some macro weakness in the fourth quarter. Can you kind of drill into that just a little bit? I mean, is it the government shutdown you're talking about? Is it the consumer sentiment and spending? Is it the specific markets? What are you really seeing kind of beyond 1 or 2 layers?

David Liu

Well, so -- that was, specifically, in reference to our national advertising business. And national advertising has always been sort of this general barometer for the macroeconomic condition. Fourth quarter is always the one that's most volatile. When the economy's doing well, we see a lot of our clients having budget and having available last-minute budget to be allocated, and we will often see a nice pop. When things are not going quite so well, we see people getting very tentative and clawing back. Oftentimes, there's the dreaded cancellation of contracts that have already been signed. Going into this fourth quarter, we are seeing weaknesses in categories like financial services, some home -- and I'm not able to attribute, specifically, to the government shutdown to those things, but I would say that the sentiment that we've sensed from some of our sort of endemic and quasi-endemic category advertisers is they're a little tentative.

Operator

[Operator Instructions] At this time, there are no further questions. Are there any further remarks?

Malindi Davies

Yes. We'd like to thank you, again, for joining us this afternoon. Our upcoming conference schedule is posted on the Investor Relations section of our website. If you have missed any part of today's call, you can access the replay of the entire conference call in the Investor Relations section of the company's website at xogroupinc.com or at (855) 859-2056; conference ID, 93559866. If you have any additional questions, please don't hesitate to contact us at ir@xogrp.com. Thank you.

Operator

Thank you. This concludes today's conference call. Please disconnect.

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