The Knot Q3 2006 Earnings Call Transcript

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 |  About: XO Group Inc. (XOXO)
by: SA Transcripts

The Knot, Inc. (KNOT) Q3 2006 Earnings Conference Call November 13, 2006 2:30 PM ET

Executives

Megan O'Brien - IR

David Liu - CEO

Richard Szefc - CFO

Analysts

Richard Ingrassia - Roth Capital Partners

Jeetil Patel - Deutsche Bank

Richard Fetyko - Merriman

Barton Crockett – JP Morgan

Presentation

Operator

At this time, I would like to welcome everyone to The Knot third quarter 2006 conference call. (Operator Instructions) At this time, I would like to turn the conference over to Ms. Megan O'Brien.

Megan O'Brien

Good afternoon and welcome to The Knot's third quarter conference call and webcast. During the course of this conference call, comments that we make regarding The Knot 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 provision 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 base our expectations may change, but we will not necessarily inform you if they do. The Knot's policy is to provide expectations only once per quarter, and not to update that information until 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: our unproven business model, limited operating history, our history of losses, significant fluctuations to which our quarterly revenues and operating results are subject to the seasonality of the wedding industry, and other factors described in documents that we have filed with the SEC.

Additionally, if you have not yet received a copy of today's press release, the release is now posted on the Investor Relations section of the Company's website at www.theknot.com. We have allotted up to one hour for today's conference call, including the question-and-answer session that follows. Please take note that the Company is operating under the SEC Regulation FC and encourages you to take full advantage of the question-and-answer session.

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

David Liu

Thank you, Megan. As our earnings release indicates, The Knot continued to deliver strong financial results in the third quarter of 2006. Our net income grew to $3 million, a fourfold increase from last year's third quarter. Third quarter revenues were up 41% to $18.5 million, with each of our revenue streams contributing to the gain. As you know, we acquired WeddingChannel on September 8th, and its results for 23 days are included in our consolidated results.

A lot has happened in the third quarter. We completed two rounds of financing. The first, a private placement of 2.75 million newly issued shares of common stock; and the second, a public offering of nearly 7.2 million shares of common stock, including approximately 2.8 million primary shares. The remaining shares came from existing stockholders. In total, from the two rounds of financing, the Company raised approximately $90 million, net of related costs.

We also announced two acquisitions in the third quarter. In July, we completed the acquisition of Lilaguide, a company that publishes 23 regional parenting guides, with rating and reviews of local vendor services and products accumulated from surveys of other parents in each local market. In September, we closed on our acquisition of WeddingChannel. Finally in the past quarter, we launched a national magazine for our newest brand, The Nest.

As the majority of you are already familiar with The Knot's business model, I would like to first spend some time on this call discussing the WeddingChannel business in greater detail, particularly with regard to its registry business. I'll then fill you in on our integration efforts over the last two months and finally go on to discuss some of the aforementioned exciting third quarter developments with The Knot and The Nest. Rich will speak more specifically about the numbers in his section.

It is interesting to note that there is little overlap in the non-WeddingChannel's core businesses, and the overlap in our audiences is estimated to be less than 20%. The Knot, for the most part, has been content and advertising-driven, and WeddingChannel has been registry transaction-driven. Although future brides may check out various websites early in their engagement, most women do not use multiple budgeting tools, guest list managers, or personal web page builders. They pick one site that they are comfortable with, and they tend to stay there.

Therefore, you can see why our audience will naturally bifurcate between The Knot and WeddingChannel, resulting in a relatively low overlap of members and unique visitors. As we said from the outset, we plan to maintain both brands as separate destinations, and will work to differentiate the unique and key advantages for both brands.

Most of you who have followed our progress over the past couple of years are familiar with the dynamics of the online advertising and wedding shop revenue streams. Although they had different pricing strategies and different gross margins on their products, WeddingChannel's efforts in these areas are basically mirroring our business. The WeddingChannel registry service, however, is the newest and most significant addition to our business. As many of you may know, WeddingChannel is the leading company for online bridal registry purchases, and the largest source of its revenue comes from commissions on registry transactions it handles for its retail partners.

Up until the merger, registry was a very tiny part of our business, approximately 1% of total revenue in 2005. I have received many questions about how the registry works and what opportunity there is to grow that business, so I would like to explain the dynamics and drivers of wedding gift registries and why it represents an important opportunity for growth.

The bridal gifting business is very large, with many different guesstimates out there as to its size. We estimate that somewhere north of $13 billion is spent each year on wedding gifts. We further estimate that close to half of that comes from gift registries. Last year, WeddingChannel handled over $130 million in registry gift purchases for its retail partners. One of the nice things about this business is that we bear no inventory risk, no customer service or fulfillment expense, and the marketing costs are borne by the retailers, as they must compete for the attention of the engaged couples, making this a high-margin, low-risk operation.

Most people would view the gift registry business as a simple retail transaction and therefore miss some important nuances unique to the business. Unlike a standard in-store or e-commerce purchase, every purchase off a wedding registry is really the result of two sales; let me explain. Before a wedding guest can purchase a gift off a registry, the retailer must first sell the bride and groom and get them to establish their registries with their store brand. So before the transaction that results in a sale can happen, the retailer must complete the cashless transaction of selling the bride and groom on the benefits of their store brand, and the quality and the selection of their merchandise.

This may seem obvious, but when this distinction is understood, you'll appreciate one of the biggest challenges of the registry business. Out of the two transactions that are required for a gift registry sale, retailers can only market to one of them, and that is to the bride and groom. It is virtually impossible to market to the guests of a wedding. Now 15 to 20 years ago when the average couple only registered at one store, there was no need to reach the guests. Once the retailer registered the couple, they could rely on receiving a decent amount of revenue from the gift purchases off of that registry. Today, the average couple registers with three to four stores. Therefore, not only is it competitive to register the brides, it has now become fiercely competitive for the guest purchases. Now that we've acquired WeddingChannel, we're better able to provide a solution to this marketing challenge.

The Knot is known for our ability to reach and inform the engaged couple. WeddingChannel has built a reputation as a destination to locate a couple's registry among the country's top retail brands. Between our two brands, we are uniquely positioned to assist retailers in both the sell-in to the brides and grooms, as well as the sell-through to the guests. Currently, only about 20% of wedding gift registry purchases are transacted online, a number that seems quite low. We think there is tremendous opportunity for growth, as more and more people are able to access information about the couple's registries, and elect to buy online. One of the problems for wedding guests is, in fact, the difficulty of locating where couples are registered, because the couples are often reluctant to tell people themselves since it is poor etiquette.

At The Knot and WeddingChannel, we offer free personal wedding web pages, which is a growing trend among couples. It is where engaged couples tell guests about how they met, details about the wedding, and importantly, where they are registered. With over 400,000 members establishing wedding web pages to date in 2006, The Knot and WeddingChannel are the largest publishers of personalized wedding web pages, and as a result, we've become the personal portal to couple's registries. Inevitably, as more people use wedding web pages and more registry transactions gravitate online, we expect to see more activity in that business.

Now let me update you on our integration progress. One of the more complicated integration efforts has actually turned out to be one of the quickest. Within the first couple of weeks of completing the acquisition, we closed the WeddingChannel warehouse and have consolidated all activities in our facility in Redding, California. Today, when you go to WeddingChannel's wedding store, you will see and purchase product from The Knot's inventory, masked by the WeddingChannel template.

Integration of our two operations on the local online advertising side is beginning to take place. Currently, we are selling, for the most part, as two separate organizations. However, we have already trained the WeddingChannel local sales staff on our back end systems, and are processing all new WeddingChannel contracts through The Knot's contract entry system. By early 2007, we will be able to begin to combine the local ad inventory across both brands into a package to be sold by a single, integrated local sales staff.

On the national online sales side, we are in the process of integrating our ad serving technology, and have found substantial differences in how each site is used and trafficked. We have seen dramatic differences in page views, banner impressions and click-through rates. As a result of these differences, we are looking to customize ad programs to maximize performance for each category, and in some cases, for each advertiser. A “one size fits all” strategy will not work to integrate the national ad inventory.

Between the membership of The Knot and WeddingChannel, we reach a majority of the engaged couples in the country. We have a major opportunity to start adding different types of services and products to continue the relationship with our bridal audience, as they become newlyweds and first-time parents.

In August, we launched the premier issue of The Nest magazine, which is a controlled circulation publication of about 400,000 copies to complement the website. The feedback from emails and our message boards have been encouraging. We have direct and constant feedback from our members on TheNest.com message boards, which enables us to have the pulse of what our newlyweds are interested in and what services and products they are looking for.

The fastest growing and largest community right now on The Nest revolves around our Babies On the Brain message board. With the acquisition of Lilaguide in July, we are now in position to expand the scope by which we can benefit both our advertisers and our consumers on a national and local level. We believe the opportunities in the prenatal space are large, as no one has yet been able to provide a cross-platform national and local media product targeting first-time parents. We are working on a newly designed Lilaguide website, expected to be launched in early 2007. By leveraging the over 30,000 user-generated vendor reviews in the Lilaguide database, we hope to provide a unique set of information and a community of first-time parents that will attract local and national advertisers.

These are exciting times with our many new opportunities. Recently, we added three new members to our Board of Directors. We are proud of the caliber of the people we've been able to attract, like Eileen Naughton, Regional Sales Director of Google; Ira Carlin, Chairman International of Magna Global Worldwide; and Peter Sachse, Chairman and CEO of Macys.com. Each brings a unique talent and expertise that will be valuable for guiding our company to the next level. Now I'll turn the call over to our CFO, Richard Szefc, who will give you the financial picture.

Richard Szefc

Thank you, David and good afternoon. As David mentioned, the results for the quarter and nine months ended September 30, 2006 include 23 days of results for WeddingChannel, which we acquired on September 8th. Also, as you may have noted on our earnings release, we have added an additional line to our profit and loss statement for registry services revenue, which represents commissions received from retail partners, primarily through the WeddingChannel operation. This line also includes commissions from The Knot's earlier retail partners, such as Michael C. Fina and Target, which have been reclassified for merchandise revenue. As we go through the specific numbers, I will touch on the impact of WeddingChannel on our third quarter results.

For the third quarter of 2006, we reported consolidated net revenues of $18.5 million, which is a 41% increase over the prior year. Revenue of approximately $1.5 million was contributed from the WeddingChannel operations. The remaining increase of $3.9 million represents a 30% increase from third quarter revenues of $13.1 million last year. Net income for the third quarter rose to $3.3 million, or $0.12 per basic and $0.11 per diluted share, from net income of $722,000 or $0.03 per basic and diluted share in the third quarter of 2005.

From a bottom line standpoint, WeddingChannel is generally breakeven for the period, after reflecting incremental depreciation and amortization of approximately $300,000 related to the fair market value of acquired intangibles and incremental value allocated to property and equipment, net of tax affects.

For the first nine months of 2006, total revenues grew to $51 million from $38.6 million a year ago, for a gain of 32%. Revenues grew 28% without the impact of WeddingChannel. Net income for the first nine months of this year was $8.8 million, or $0.36 per basic and $0.33 per diluted share, compared to $2.5 million or $0.11 per basic and $0.10 per diluted share for the same nine-month period in 2005.

Revenues from online advertising programs, exclusive of WeddingChannel, for national clients and local vendors increased by 35% to around $9 million in the recent third quarter, as compared to $6.7 million in the third quarter of '05. National and local advertising programs contributed approximately $1.2 million and $1.1 million respectively to this increase, with national growing by 56% and local by 25%. In addition, WeddingChannel contributed an additional $378,000 in online advertising revenue for the September period.

The growth for the recent quarter continues to be driven by increases in the average spending by national clients on expanded programs and increased frequency, as well as increases in the number of and average spending by local vendors. Our local vendor base increased to approximately 14,600 by the end of the recent quarter, as compared to a little under 13,000 as of September, 2005 or by roughly 12% to 13%. Revenue growth for local vendors of another 12% to 13% was derived from higher average spending, due to price increases and greater usage of premium programs. The pace of the local online revenue growth was slightly lower than the 28% year-over-year growth trend in the second quarter of 2006.

As we indicated during our last call, we recently instituted price increases for all local online advertisers, at a weighted average increase of slightly over 20%. The impact of this price increase began to take affect in July, and will build gradually as vendors renew their programs over the next 12 months. We do believe pricing and average spending will continue to be a more significant factor pacing local online revenue growth than in the past, including the impact of packaging local ad inventory across both The Knot and WeddingChannel websites. While the rate of increase in the number of local advertisers year-over-year has slowed, we believe there's room for continuing expansion in the local vendor base.

Our local reps early in the year were heavily focused on The Nest and local print advertising, which as you will note, is up substantially. In certain markets, they were also involved in our bridal events programs with The Four Seasons hotels. We've been redirecting our sales efforts once again to building The Knot's online wedding vendor base, and we're also planning on adding further sales resources for The Nest.

For the nine months ended September 30, our overall online advertising revenue was $25.5 million. Exclusive of the WeddingChannel, this represented growth of $6.6 million or 36% when compared to the corresponding period in the prior year. The national and local components grew 54% and 27% for the nine months respectively.

Registry services revenue, representing commissions from our retail partners, was $955,000 in the third quarter of 2006, of which approximately $800,000 was earned from WeddingChannel's retail partners. I should note that certain other revenues earned from retailers in connection with special systems-related projects, which historically has been included in registry revenue by WeddingChannel, has been reclassified to publishing and other revenue. This revenue amounted to $79,000 in September '06.

The rebound in merchandise revenue, which now represents only the sale of wedding supplies, has continued through the third quarter of 2006, with total revenue up 31% to $4.3 million over the prior year. The growth rate for the sale of supplies at retail was 27%, after excluding the impact of the WeddingChannel store, which contributed roughly $300,000 in revenue for the 23 days. Merchandise revenue also includes a very small component for wholesale supply sales to specialty shops and department stores, which continues to decline slightly. Effective August 2006, we are no longer pursuing wholesale customers.

As David indicated, the integration of WeddingChannel's supply business went very smoothly, and was substantially completed within two weeks of the acquisition. We have closed the WeddingChannel warehouse in Santa Fe Springs, California, incorporating the business into our existing warehouse and distribution facility in Redding, California. We look for the additional volume to provide further economies of scale for purchasing, personalized labor, and various fulfillment functions.

Publishing and other revenues for the third quarter in 2006 amounted to approximately $3.9 million, a gain of 26% over the comparable period in 2005. For the nine months ended September '06, publishing and other revenues grew to $12.2 million from $9.3 million last year, or a gain of 31%. WeddingChannel closed its magazine publishing program in March of 2006 and accordingly, provided only a small contribution in revenue from various retail systems projects to this line in September, as noted earlier.

The most significant component of growth for publishing was local print revenue, which increased by $436,000 for the three months ended September 30, 2006 or 35%. These gains were the result of an increase in advertising pages, including pages associated with the local section of our national magazine, and a small increase in rates. Revenue from our national magazines increased by over 18%, driven by increased advertising pages sold to both designers and national advertisers, and increases in our effective page rates for our Knot Weddings magazine. We also recorded a small amount of advertising revenue from the initial issue of The Nest magazine. We currently expect revenue from this publication to build slowly through the second holiday issue this year, and the four issues currently planned for 2007. We believe that the investment in this magazine represents an important strategy long-term for building The Nest brand.

For the first nine months of 2006, publishing and other revenues amounted to $12.2 million, representing a 31% increase over 2005, with local print revenue growing 30% and revenue from our national magazines growing 19%. In addition, in the first half of 2006, we delivered two new books in connection with our current book program, which encompasses both wedding and newlywed-related topics, and we reported related author royalty revenue of $360,000.

Before leaving revenue, I would note that we provided additional pro forma financial information regarding WeddingChannel in our Form 10-Q, including the impact on our consolidated results as if WeddingChannel had been acquired as of January 1, 2005 or January 1, 2006.

WeddingChannel pro forma revenue for the nine months ended September 30, 2006 was approximately $20.6 million, which represented an increase of a little over 20% compared to their pro forma revenue for the comparable period in 2005. Each revenue stream contributed to the increase. I would also note that the integration of the new Macy's stores resulting from Federated's acquisition of May Department stores last year into the WeddingChannel registry system was recently completed. We hope to begin to see a further impact on registry commissions from the larger Federated operation as we move into 2007.

With respect to margins, our overall percentage approximated 77% for the third quarter of both 2006 and 2005. For the nine months of 2006, gross profit margins were slightly improved. Generally, margin improvements resulting from a higher mix of registry services revenue in the third quarter and online advertising for the full nine months were offset by the investment in production costs for The Nest magazine in August, which reduced publishing margins. The Nest production costs for the inaugural issue were approximately $400,000. Also, we expect margins on the sale of retail supplies to the WeddingChannel store going forward to approximate our historical margins.

Our total operating expenses before depreciation and amortization for the recent quarter were $11.1 million, compared to $9.2 million in the comparable quarter last year. For the nine months, operating expenses increased to $30.3 million in 2006 from $26.8 million in 2005. After factoring out incremental legal fees associated with the prior WeddingChannel litigation, primarily in 2005, our operating expenses increased by $3.3 million and $7.1 million for the three and nine months ended September 30, 2006 when compared to the prior year.

Operating expenses associated with WeddingChannel were approximately $1 million in September. Again, I would note from a standpoint of operating expenses that are we are continuing to review opportunities for operating efficiencies and cost synergies in connection with the integration of the two companies. In this regard, currently we have identified annual payroll and payroll-related cost savings of approximately $4 million. We also expect to have additional savings from non-payroll sales and marketing and general and administrative expenses.

The principal components of the remaining operating expense increases for The Knot were additional investments we have made in our national and local sales staff of $227,000 and $1.4 million for the three and nine months ended September 30, 2006 respectively, in part as additional support for the sales efforts related to our new initiatives, including The Nest. We also increased our investment in information technology and editorial staff by $264,000 and $645,000 for the respective periods.

Within our general and administrative expenses, we have incurred costs aggregating $661,000 and $1.2 million for the three and nine months ended September 30, 2006 related to the development of a formal disaster recovery plan for the company, as well as consulting and incremental audit costs incurred in connection with work being performed to ensure our compliance with Sarbanes Oxley.

Apart from these increases, in the third quarter of 2006 we also recorded stock-based compensation totaling $388,000 the majority of which related to the issuance of restricted common shares. For the nine months, stock-based compensation amounted to $1.1 million. For the three and nine months ended September 30, 2005 we only recorded $24,000 in stock-based compensation. We currently believe that our stock-based compensation expense will range from $1.5 million to $1.6 million for all of 2006.

As of September 2006 our cash, cash equivalents, and short-term investments were approximately $77.7 million, representing an increase of $43.4 million over the third quarter. We raised approximately $90 million through our private placement and follow-on offering during the quarter, net of related costs. We paid roughly $53 million for both the cash portion of the purchase price for WeddingChannel, net of cash acquired, and for the purchase of the Lilaguides. The remaining cash generated of a little over $6 million resulted from operations for the quarter.

That is the financial review for The Knot for the third quarter of 2006. We will now open the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Richard Ingrassia - Roth Capital Partners.

Richard Ingrassia - Roth Capital Partners

Thanks. Good afternoon, everybody. David, can you say a little more about your plans to launch new local markets altogether, including some detail around what it exactly takes to do so? At one point, you were talking about expanding from 67 markets to 100 or more. If that's still the plan, some timeframe would be helpful.

David Liu

Market expansion is definitely a component to how we feel local has the opportunity to grow. It's not necessarily expansion in markets that are currently not served. We have hit most of the secondary and many tertiary markets in how the market sizes are defined. But the number of markets can be increased as we begin to sub-sect existing markets.

So for example right now, if you were to take New York City, it is a single market that covers all five boroughs. One of the areas that we're looking at, which are specifically the high density saturated markets that we've been successful in, is to decide whether or not we want to break up New York into five independent markets reflecting each of the separate boroughs therefore, increasing the number of featured vendor listings and other featured inventory that we can have there.

So that is still a part of the plan, and we're looking at each of the markets on a case-by-case basis, based on the density of the market, the number of brides and members, and also on the number of members that the WeddingChannel brings into the space as well.

Richard Ingrassia - Roth Capital Partners

Okay. So, New York City sounds like maybe a near-term plan, but you don't have any more specific timeframe than that?

David Liu

Nothing more specific.

Richard Ingrassia - Roth Capital Partners

If you could say a little bit about what it takes to do so? Is it just an IT or an infrastructure decision ?

David Liu

It's actually less IT and more editorial. Our city guides are anchored with a lot of the real wedding content and QA. So we just want to make sure that we would have enough content that would make the area robust for the consumers and as a result, attract enough consumers that will be valuable for the vendors.

Richard Ingrassia - Roth Capital Partners

Thanks, David. Just quickly for Rich, interest and other income was a little higher than we thought it would be in the quarter. Were there any one-time gains there to speak of?

Richard Szefc

No, it was pretty much interest income because of all the funds we have received and so we have the use of the money from the private placement for nearly the full quarter, and we basically had the money from the follow-on offering for a short period of time before we actually financed the purchase price of WeddingChannel.

Richard Ingrassia - Roth Capital Partners

An updated tax rate guidance for the year? Thanks.

Richard Szefc

The current tax rate we have now is about 4%, basically in state taxes and some small amount of federal tax related to the use of NOLs. So that's currently what we've got.

Richard Ingrassia - Roth Capital Partners

Thanks.

Operator

Your next question comes from Jeetil Patel - Deutsche Bank.

Jeetil Patel - Deutsche Bank

Thank you. Hi guys, a couple of questions. Can you talk about how much more inventory you have available as you progress into '07 from the local ad side of the world?

Second, as you look at the WeddingChannel acquisition at this point, you've had some time to actually dig into the operations a bit more relative to when you announced it. What are the issues and opportunities that you saw that you maybe missed out on or didn't see completely when you made the acquisition? I have a quick follow-up.

David Liu

From the local side, I think the opportunity is pretty robust. When you look at the members that we currently have and the small overlap of members we have, between the two sites we have over 80% of the people getting married in the country today, who are throwing a wedding. The way our local inventory is designed, we can keep adding more and more photographers to any one of our city guides, so that the inventory is almost instant, in terms of what we can grow to.

There were two things that maybe mitigate each other. But one is on the plus side and one is on the downside. On the plus side, we view the low overlap of members and unique visitors as being a great opportunity, because it's not really selling frequency to our advertisers, it is actually extending the reach that they have to a discreet group of people who currently aren't using The Knot. So it's an opportunity to expand their marketing reach into another brand.

On the downside, and what was a bit of a surprise was the state of the back end operations that was supporting the local side of the business there. We've taken a great deal of effort to train the local sales force on our back end systems to really begin to sort through the paperwork and the contracts. That's probably taking a little longer and was a little bit more complicated than we had thought going into it. Again, you can say that also represents an opportunity because as we sort through that, we were able to actually bring in additional people and additional accounts.

Jeetil Patel - Deutsche Bank

So is it on the local side? Do you have any idea of how much more inventory or opportunity you have with WeddingChannel? I guess I was looking at it from that standpoint, instead of just the advertiser set, how much more reach or traffic can you tap into inside WeddingChannel? Then on the registry side, you quote a number of 400,000 for, I believe that was more The Knot standalone. Can you give us a sense of what it looks like for WeddingChannel? When do you expect that type of integration for The Knot to play out as you look at '07?

David Liu

On the registry services revenue, we did about $955 million in the quarter, of which $800,000 relates to the WeddingChannel retail partners. So it wasn't $400,000. That was the cost related to The Nest magazine.

Jeetil Patel - Deutsche Bank

No, you talked about 400,000 member pages being created or that are available at the WeddingChannel.

David Liu

I'm sorry. That 400,000 are the wedding web pages that have been created on The Knot and WeddingChannel since the beginning of '06. We view the wedding web pages as being a very important and strategic position for access to registries. I think one of the things that sometimes people fail to realize is that while we can create a search tool that allows people to find registries across all these different retailers, it's in fact the wedding web pages where most of the traction and traffic going to the retailers are coming from. So having the ability to divert the traffic from these wedding web pages to the search tool that WeddingChannel provides is an opportunity to grow the revenue base there.

Operator

Your next question comes from Richard Fetyko - Merriman.

Richard Fetyko - Merriman

Hi guys, thanks for taking my question. A couple of them here. On the local ad sales with the consolidation that you're doing in terms of your ad sales force, could you give us an idea of how you're combining the WeddingChannel and The Knot local advertising packages, and how you're positioning that with the local vendors?

David Liu

Right now they are being sold separately. We've kept the WeddingChannel sales force selling WeddingChannel local inventory and The Knot sales force selling The Knot local inventory. In this process, we are training the local sales force on the WeddingChannel side on the tools and the contract entry system and so we're all working off the same platform on the back end. Meanwhile, we are going through all their old contracts and getting them inputted in so that we can begin to track and see who are the advertisers that are paying and who aren't.

I think moving forward, the goal is to begin to put together a single package that can be sold across both of the brands and both properties. One of the things that is forming how we're setting the pricing and how to position the market is the usage of the local areas in the two respective sites, which we have seen a pretty significant difference in. As a result, a lot of the local media we sell, while it is not a cost per click and cost per acquisition, it is often measured by the local folks based on an ROI; if they're are not getting the leads there, they are reluctant to pay.

So we have been looking at the various categories and the various click-through rates and the productivity that the profiles are getting on the two sites to put together the right pricing program for both sites.

Richard Fetyko - Merriman

So if I look at the average price in revenue per local vendor right now on The Knot, it's about $1,500. What should we expect the incremental WeddingChannel advertising to cost?

David Liu

It is yet to be determined.

Richard Fetyko - Merriman

Rich, you mentioned the $20.6 million number up 20% year over year. I missed the period that you were referencing and the business that you were referencing?

Richard Szefc

It's basically the nine months ended September '06 against nine months September '05.

Richard Fetyko - Merriman

For the WeddingChannel?

Richard Szefc

The WeddingChannel, that's right.

Richard Fetyko - Merriman

The WeddingChannel standalone?

Richard Szefc

Standalone.

Richard Fetyko - Merriman

Finally, the seasonality in WeddingChannel's business, I believe that the second or third quarters are seasonally strongest in the registry business. I just wanted to confirm that. What happens in the fourth and first quarters, just so we can model that out? Thanks.

Richard Szefc

It's stronger, obviously, in the second and third, often similar to the wedding supplies business. So if you look at the trends we have in wedding supplies, you'll probably see the same kind of trends in terms of registry commission. So maybe a 20/30/30/20 or 25/30/30/15 spread might work for that.

Richard Fetyko - Merriman

Thank you.

Operator

Your next question comes from Barton Crockett – JP Morgan.

Barton Crockett - JP Morgan

Great, thank you for taking the question; a couple of questions, actually. First, I want to talk a little bit about the cost reduction number you quoted, which I think was like $4 million and change or so for WeddingChannel payroll reductions. If we look at what was reported for that company in '05, the last full year that we have from one of your disclosures, I think it was like $19.9 million or so in cost, something like that.

Obviously there were some legal costs in there and some things that have gone away since. What would be a good view of the normalized run rate for that business, once you put in those savings and anything else you're looking at in '07 and beyond? Can you give us a sense there?

Richard Szefc

Well, if you pull out the litigation expense, their operating expenses for the first nine months of this year were about $13 million. They are currently at a run rate of about $17 million for the period, between $10 million and $11 million of that is payroll costs, so we're looking at about a $4 million cost savings there.

The other areas we're looking at closely on the balance of the costs is the non-payroll sales and marketing and non-payroll G&A. At the present time, obviously in the number that you quoted from 2005, the non-cash sales and marketing expense was a good chunk of that. It was about $2.4 million last year.

In the first nine months of this year, it was actually $900,000 and that's going away. So in terms of an annualized amount for that on a current run rate, that's over $1 million, and that expense will go away. We're also looking at savings in the G&A area that again are probably, at least on a preliminary basis, looking at $1 million there as well.

Barton Crockett - JP Morgan

So in terms of cash expense, we may see about $5 million annualized removed in '07 versus the '06 number?

Richard Szefc

I think at the present time, that's what we've got. We'll probably have some impact of that since we've made some of the changes already in the fourth quarter. But we would probably expect to begin to see the full annual effect of that probably as early as the first quarter.

Barton Crockett - JP Morgan

Is there any offset there in terms of inflationary expense growth, or does that pretty much all drop straight to the cost line?

Richard Szefc

Well, I think there's obviously going to be some general cost increases that will come into play, so there will be a little bit of cost increase offsetting that, just normal increases.

Barton Crockett - JP Morgan

Switching gears to take a look at the revenue side, can you give us a sense on the national advertising front for The Knot website versus the WeddingChannel website, what the degree of difference is in terms of the rate charged, and what opportunity you might have potentially to move up rate over time at the WeddingChannel, if any real opportunity are available? I assume they are well below The Knot right now.

David Liu

When we were going into this we were assuming that the price structure the WeddingChannel was marketing, which was running probably a little over one-third of what we were charging just from a CPM basis, was as a result of a competitive strategy. It turns out that it's actually more tied to the productivity of the banners and the inventory on the site.

So we've been doing a lot of work to look at the usage patterns to try to understood exactly what the consumers are doing, and try to begin to figure out why they are doing what they are doing on the WeddingChannel versus The Knot. We have been able to see certain navigational and design elements that we think have harmed the ability for WeddingChannel to generate page views and also promotional opportunities on the site. Those are things we're working on right now to adjust.

When we are able to demonstrate a higher productivity of the banner space and the inventory that's there, the goal is to begin to normalize the pricing between the two sites. But I would say one of the things that we had anticipated was an ability to simply go out and establish a common CPM for both sites. That's actually something that we will not be able to do in the short term until we get the traffic patterns adjusted for on the WeddingChannel.

Barton Crockett - JP Morgan

Do you think that's something that only takes a couple of years, or maybe a half year? Any ballpark of how long it takes to sort that out, in terms of the traffic patterns?

David Liu

It should definitely not take a couple years. The benefit, obviously, with our media product is that we churn audience 100% every year so you really have a 12-month window to work with the consumers. As you redesign and relaunch certain aspects of the site, the effects should be relatively immediate.

Keep in mind, our audience is actively seeking information to inform purchase decisions. So these are not passive consumers. If you put a banner that meets the needs of what they're looking for, they will click on it. That's where we just need to begin to adjust the design and navigation for WeddingChannel to enhance that experience.

Barton Crockett - JP Morgan

Then one final question for now and then I'll get off and let others ask questions. Can you give us a sense of the overlap in local merchants between The Knot and the WeddingChannel? How many do they have that overlap with you? How many do they have overall? How many markets are they in versus how many markets you're in? Just give us a sense there of the opportunity over time?

David Liu

The market sizes were relatively the same. They might have subdivided a little bit more than us, and so they had a few more. The vendor bases was much smaller; in terms of vendor accounts, it was actually much smaller because I think they had multiple doors for some of the national accounts they kind of threw in there to beef up the numbers. The overlap is not significant. So while there are a lot of back end challenges for the integration of the process and getting them on to the same system, we think the opportunity is still pretty significant when you look at the number of brides we're reaching between the two sites and the inventory that will be available.

Barton Crockett - JP Morgan

You guys quoted the 14,000 or so number for merchants. How many of those were from the WeddingChannel, if any?

David Liu

None from the WeddingChannel in that particular figure.

Barton Crockett - JP Morgan

No WeddingChannel in that figure. So they're not material, relative to that 14,000 number?

David Liu

Well, no, there is a decent number of vendors. I was using that number basically to guide the increase in our local advertising revenue from this year's third quarter against last year's third quarter for The Knot alone.

Barton Crockett - JP Morgan

They have a few thousand?

David Liu

Yes.

Barton Crockett - JP Morgan

Thanks a lot.

Operator

(Operator Instructions) Your next question comes from Barton Crockett – JP Morgan.

Barton Crockett - JP Morgan

I was wondering if you could also update us on what's happening with the Lilaguides, in terms of you guys have acquired them. I think that there's some hope that the guides could appear on the web, and there could be some integration with your sales force. If you could just apprise us of what's happening there and what might be the expectation for this to become more meaningful in terms of the P&L as we go into '07?

David Liu

We are looking to launch or relaunch the Lilaguide website in the first half of '07. The goal is to be able to bring on all the 30,000 or so reviews that they have in their databases and publish that online and to begin to really seed the community with the folks on The Nest who are obviously looking to get pregnant or are pregnant, and would benefit from that content. We're very excited about this new property.

When we look at the prenatal media space, there's not a lot of publications or online sites that actually have this level of depth of information that's user generated on the local level. We think the traffic that could be driven to this site could also begin to attract national advertisers if we're successful in how we build out the community. The fact that it is able to leverage a lot of the infrastructure, both from the sales side as well as from the publishing and IT side, makes it a relatively easy launch for us, considering that it's another life stage brand with similar national and local touch points.

Barton Crockett - JP Morgan

On the registry side, you said in the script that Federated had brought on stores related to the May's transaction. Can you give us a sense of what that means for the registry revenues, in terms of how much of an uplift is that going to represent? Are we basically not done with the uplift we're going to get from the integration there of Mays or is there something else yet to happen?

David Liu

Well, that is all going to be dependent on the integration efforts that Federated actually has with May. If they're able to successfully transition the customers who are used to shopping at the Meyer & Franks and Robinsons Mays and Marshall Fields to become Macy's and Bloomingdale's customers then obviously, the registry revenue should be reflected and the growth should be reflected in our system, since we're handling all the online transactions for the Federated gift registries. So we're a little bit beholden to the Federated integration efforts on that front.

Barton Crockett - JP Morgan

The registry that you're adding to the system, if they were to convert at a rate comparable to what we see at the Macy's stores, you would have some sense of how much impact this could have on the registry line just from that integration alone. Is there any way that you can at least guide us on that?

David Liu

Well, the number of registries that the retailers have, both from the Macy's and May department stores site is considered very confidential information, so we really can't talk about that.

Barton Crockett - JP Morgan

Thank you very much.

Operator

Your next question comes from Richard Fetyko - Merriman.

Richard Fetyko - Merriman

Just one more follow-up on that prior caller's questions. Just looking at the registry business, obviously there's two levers: one is adding retail stores, but also driving more brides to the registry business and getting more bridal registries. So with that aspect of that business, should we expect that you're going to be promoting that registry business on The Knot site, and within the existing Knot user base?

David Liu

It will certainly be linked and connected. I wouldn't say it's necessarily going to be promoted. The relationship that retailers have with The Knot website and the consumers on The Knot is very different from the experience that you have on WeddingChannel. So you won't see it, but you'll experience deeper links from The Knot into the WeddingChannel registry systems, so that as people are looking for registries, we would like to be able to drive the traffic to WeddingChannel so they can actually complete the transaction there.

Our role and our job for our retail partners is to help grow their business, both from an acquisition of the bride standpoint, as well as the guests’ transactions. So we're going to leverage the advantages of both brands respectively around the key assets. So The Knot will really be focused on registering the couples and providing an advertising and marketing platform for the retailers. WeddingChannel will really be focused on growing the guest transaction.

Richard Fetyko - Merriman

Thanks.

Operator

At this time, there are no further questions. Are there any closing remarks?

Megan O'Brien

Yes. We would like to thank you again for joining us this afternoon. We are looking forward to seeing some of you at the Lehman Brothers conference this Wednesday in Dana Point, California, and next month on December 7th at the Cowen Internet Conference in New York. 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 on the Investor Relations section of the company's website at www.TheKnot.com. A telephone replay is available for the next two weeks at 800-642-1687, reference number 8734121. If you have any additional questions, please don't hesitate to contact us at ir@TheKnot.com. Thank you and good bye.

Operator

This concludes today's conference call.

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