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XO Group (NYSE:XOXO)

Q2 2014 Earnings Call

August 05, 2014 4:30 pm ET

Executives

Ivan Marmolejos -

Michael Steib - Chief Executive Officer, President and Director

Gillian Munson - Chief Financial Officer, Principal Accounting Officer and Treasurer

Analysts

George I. Askew - Stifel, Nicolaus & Company, Incorporated, Research Division

Operator

At this time, I would like to welcome everyone to XO Group Inc.'s Second Quarter 2014 Earnings Conference Call. [Operator Instructions] As a reminder, ladies and gentlemen, this conference is being recorded. At this time, I'd like to turn the conference over to the company.

Ivan Marmolejos

Thank you. Welcome to XO Group's second quarter 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. 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, planned, intend and other similar terms. You are cautioned that these forward-looking statements speak only as of today's date. Changes in economic, business, competitive, regulatory and other factors could cause our actual results to differ materially from these expressed or implied by the projections or forward-looking statements made today.

For more detailed information about these factors and other risks that may impact our business, please review the periodic reports and other documents filed from time to time by XO Group with the Securities and Exchange Commission. Our internal projections and beliefs upon which we base 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.

We will refer to our investor presentation on this call. We encourage you to review the complete presentation, which is available on our website, ir.xogroupinc.com, under the Presentation tab. Today's discussion will also include non-GAAP measures. A reconciliation of the non-GAAP measures to comparable GAAP financial measures is included in today's earnings release. The press release is available on our website at ir.xogroupinc.com.

During this call, Mike will give an overview of XO Group's strategic position and key achievements, followed by Gillian with an outline of the financial results. And then we'll open the line up for a question-and-answer session.

Please take note that the company is operating under the SEC Regulation FD and encourages you to take full advantage of the Q&A session. Thank you for your participation and interest in XO Group.

I will now pass the call to our Chief Executive Officer, Mike Steib.

Michael Steib

Thank you, Ivan, and welcome, everyone, to our second quarter earnings call. Let me begin by briefly reviewing every our results for the quarter, and then I'll turn it into a broader discussion of our business and our strategic plan. During the second quarter, we delivered solid earnings results on stable revenue growth. Total revenue for the quarter increased by 3.6% year-over-year, driven by our core local and national advertising offerings, strong quarter for our registry business. Combined, these 3 core businesses grew around 8% year-over-year, essentially in line with the growth rate of Q1.

Earnings per share were $0.12, down from $0.16 a year ago, reflecting the investment in operating expenses we are making to support our long-term goals.

As you know, I've been CEO of XO for a little over 4 months now, and I want to take this opportunity to discuss our core value proposition and the strategic transformation we've put in motion to accelerate growth and enhance shareholder value. Throughout the call, I'll refer to select slides from the presentation posted on our IR website that Ivan mentioned in his introduction.

Let's start by highlighting XO's key strategic advantages, and if you're looking at our slide deck, I'll refer you to Slides 4, 5, 6 and 7.

The Knot is the #1 online wedding property by far. We have a steadily growing visitor base. We also have a growing baby property in The Bump. Both The Knot and The Bump are strong, multi-platform brands that enjoy a replenishing audience and an attractive demographic. These dynamics allow us to generate diverse revenue streams and provide XO with healthy margins. With this solid foundation in place, we are undergoing a strategic transformation to drive growth and realize our full potential. The key pillars of this transformation are: number one, we see a tremendous opportunity to leverage our strong core wedding business and evolve The Knot into a digital marketplace; number two, we are reinvesting in our business and reinvigorating our product roadmap to drive more audience and vendor engagement; number three, we're conducting a rigorous examination of our underperforming businesses. I would like to take a few moments to discuss each of these in a little greater detail.

There are a few key characteristics that define a digital marketplace. If you're viewing our presentation, take a look at Slide 9. This includes technology that enhances the user experience, efficient connections of fragmented market participants and a large market with a high percentage of the market likely to use an online alternative.

Look no further than to companies like OpenTable, TripAdvisor or Yelp to understand how a digital marketplace can transform an industry. The Knot has all of the key characteristics required to create a successful marketplace. We are an indispensable digital resource to brides and have aggregated a large number of local wedding vendors. We now need to stimulate the frequency of connections between those brides and vendors or, as we would call it, create marketplace liquidity.

Let me walk you through some of the initiatives we're working on in order to accomplish this goal. Our first 2 next-generation consumer mobile products, The Knot LookBook and Wedding Planner by The Knot, are off to a strong start. User sessions increase every month and our vendors are receiving a significant number of added mobile impressions. Specifically, we're seeing our mobile app users connect with our vendors via calls, favorites, and messages and clicks to their websites at 5x the rate of our website users. Now this audience represents a smaller percentage of our user base, but these early signs illustrate the economic upside of building great products.

Additionally, the investments we have made in our platform are allowing us to continuously roll out new updates, a feat that would've been impossible under our legacy infrastructure.

In early July, we debuted The Knot Pro, the first ever iOS app exclusively for wedding professionals. The Pro app includes several features that enhance the bride-vendor relationship, including messaging and consumer intelligence. These features allow our vendors to deliver more relevant and personalized content to our brides. This is an important step in closing the loop between our brides and vendors and increasing our marketplace liquidity.

Looking ahead, we're also growing our vendor listings and the number of reviews on The Knot. Currently, we have around 30,000 vendor profiles on our site, and our goal is to expand that number to more than 200,000 by the end of the year. By the end of this month, we will have already added hundreds of thousands of reviews of vendors previously available only on WeddingChannel.com. These steps will make The Knot an even more useful tool to our brides.

Through our March 2014 acquisition of Two Bright Lights, we will have a constantly replenishing set of unique images, including millions of real wedding photos that keep brides coming to the site again and again, giving us access to the largest real wedding database out there today by a wide margin. As we continue to grow, the Two Bright Lights technology will provide a way for us to visually support our products much more efficiently.

As we work to fully evolve to a marketplace, brides will be able to use simple interfaces for more personalized and seamless experience. For example, requesting a quote or booking an appointment on all of our platforms. We believe that a more integrated engagement between a bride and a vendor is much more likely to generate direct business and lead to a transaction. Through information gathering and sharing, including a better sense of a bride's preferences, The Knot can provide her a more personalized set of solutions. All this can create new revenue opportunities for XO.

Next, we're bringing all the great properties and functionalities of our mobile apps to our website. Earlier this year, we decided to completely rebuild TheKnot.com to a fully responsive platform-agnostic site. This is a major undertaking. Our underlying technology is being upgraded, and completely new user interfaces are being designed, all while continuing to operate and support our existing platform. In Q4, we will launch the beta version of our new responsive mobile site. The broader launch including the desktop website will come in the spring of 2015. I look forward to sharing our progress in the coming quarters.

We're also launching new technologies to drive growth at The Bump. In late June, we launched an updated version of our Bump Pregnancy iOS app. We completely re-architected the app, shifting from a portal experience to a personalized feed of relevant text, images, video and commercial content. In my opinion, this app is now a must for expecting parents.

The early signs are very encouraging. The app shows commercial promise as the launch as sponsored by 3 big brand advertisers, and Apple promoted the app as one of the best new apps in the store. The Bump has jumped into the top 20 in its respective app category from its previous rank north of 100. So as you can see, there's a lot of positive progress, thanks to the investments we're making into our core business.

Now at the same time, we're also conducting a rigorous examination of our underperforming businesses. For instance, with Ai Jie, we're aggressively exploring our strategic options. As we stated in the past, we expect 2014 to be our last year of losses in the Ai Jie business.

We're also working on a plan to improve the economics of our e-commerce business. This business has been challenged over the past several months. However, we know couples still seek products that make their wedding personalized and special. In order to continue to provide value to our members and to our company, we must adjust the historical role we've played in that space. So to that end, we're working on strategies, including innovative partnerships that could allow us to more efficiently structure this business. I look forward to sharing our progress with you in the coming months.

Over the past 5 years, our company has had a 5% compound annual revenue growth rate. We believe the investments we are making will accelerate that rate of growth. During the second half of 2015, you should start to see the initial benefits of these investments. And when we look at our longer-term horizon, we believe we can deliver solid double-digit growth. Gillian is going to provide some more specific targets around our long-term financial model.

As I look back at the past few months, we've made a lot of positive changes. Our new management team has refocused on execution. We have reinvested in our talent pool and reinvented many of our products. We've taken a hard look at our assets, and are taking the steps needed to accelerate growth and position XO for the future. Throughout all this change, our employees have come together and continued to perform at a high level. I really want to thank our employees for their dedication, for their hard work, and I want to thank our shareholders for your support throughout this transition. There's a lot of work ahead over the coming months, but our team is energized by this task at hand and we look forward to keeping you updated on our progress.

Finally, I'd like to welcome Barbara Messing to the XO Group Board of Directors. As Chief Marketing Officer of TripAdvisor, Barbara brings an invaluable marketplace perspective to the team. I would also like to welcome Tanusha Shivaji [ph], our new Executive Vice President of Marketing. Tanusha [ph] has an impressive digital and mobile marketing background, and will be a key contributor to our marketplace transformation. With all that, I'll turn it over to Gillian for the financial review.

Gillian Munson

Thanks, Mike. Our Q2 performance reflects the strategy we laid out in the beginning of the year, working to maintain steady single-digit revenue growth balanced with a targeted step up in spending inside the business that we believe will position the company for the future and provide compelling returns over the next several years.

Total revenue for the second quarter rose 3.6% year-over-year to $38.3 million. Our net income was $3 million, driving fully diluted earnings per share of $0.12. For the quarter, EPS were down from $0.16 per share last year, reflecting roughly $2.5 million to $3 million in accelerated investment spending and accelerated G&A over what we would have typically had as a run rate.

Our adjusted EBITDA was $8.3 million for the quarter, and we added $3.9 million to our cash balance during the quarter.

Looking at our revenue lines individually, local online grew 8.3% year-over-year in the quarter including revenue from recently acquired Two Bright Lights, which added roughly 1 point to the growth rate. The trends driving this growth echoes those we have seen in the last 2 quarters. We saw an increase of 4.9% in our vendor count, an increase in average revenue per vendor to $2,516 and a further reduction in our churn to an all-time company low of 25.2%.

National online advertising revenue grew 2.3% year-over-year in the quarter, with growth driven primarily by TheBump.com. Publishing and other revenues were up 14.1% year-over-year for the second quarter. Strong advertising sales in both our local and national publications drove the year-over-year increases. It's important to note that our sales teams often sell both online and print to their customers, so we tend to look at the growth of these 2 businesses in conjunction with one another. These revenue lines together grew 8.2% for the quarter and 7.4% for the first 6 months of the year.

Turning to our registry business. Revenue increased 21.8% during the quarter compared to the prior year, a solid result for this profitable business line. We continue to benefit from the platform enhances we did last year. But just as Q2's year-over-year rate of growth has slowed from the 47.4% we enjoyed in Q1, we think the second half of the year growth rate will slow further due to the anniversary of our re-platform. Product enhancements typically drive registry growth, and a product refresh that will benefit this business won't happen until the launch of the new Knot site, as Mike discussed earlier. As we model that out, we think registry growth will be minimal in the second half of this year.

Our e-commerce business continues to be challenged. Revenue fell 23.7% year-over-year in the quarter, making this the 10th quarter in a row of year-over-year decline for this business. It is clear to us that this business model, on its current trajectory, needs a hard look. Kathy Brady and her team are very focused on it.

Second quarter consolidated gross margin increased to 84.2% from 81.1% in the prior year period, predominantly due to a positive revenue mix shift towards our higher-margin businesses. Sequentially, our gross margin fell 200 basis points, partially due to seasonality. Q2 typically has the largest sequential growth in our lower-margin businesses like e-commerce.

Total operating expenses in the second quarter were up 17.3% year-over-year, or $4.1 million, driven by increases in our product and content and general and administrative lines. Many of you have asked us to size the amount we have targeted in terms of accelerated spend as part of our transformation work, and as I said at the beginning of my remarks, we size that at roughly $2.5 million to $3 million for Q2.

Of course, it's hard to wall off the spend specifically from everything else we do, but all things equal, and if our company is growing revenue in the single digits as we have guided, our business model would anticipate growing OpEx at similar rates. The delta above that is what we would describe as accelerated spend.

In the second quarter, product and content expenses grew 23.8% year-over-year, predominately driven by increased headcount and product initiatives. Our team has accelerated a lot, and we continue to attract great talent. However, there's still a lot more work to do and we would expect to see another uptick in spend in Q3.

Sales and the marketing expenses increased 5.8% year-over-year in the quarter. In general, our transformation work first require an uptick in fundamental infrastructure costs and later in investment in sales and marketing to support growth. As such, we would expect the rates of sales and marketing expense growth to increase in the second half of the year.

Our G&A expenses increased 20.1% year-over-year. Headcount in our G&A group is just up slightly from last year, and we have limited incremental headcount to add to this group. However, transition spending, including cost for new and replaced team members as well as fees for outside services, are adding to our spent this year. The net loss on Ai Jie in the quarter was $1.1 million, essentially in line with Q1. Our guidance on Ai Jie is unchanged. We are planning for losses similar to 2013's $5 million loss.

As Mike outlined, we are evaluating strategic options for our China business, and we continue to plan for 2014 to be our last year of losses in China.

Depreciation and amortization was $1.8 million, up 61.3% year-over-year, reflecting accelerated amortization of the WeddingChannel trade name, as disclosed during our Q4 2013 earnings call, and the impact of product launch timing. Stock-based compensation was $1.8 million in the quarter, and our effective tax rate was 32.9%.

Our balance sheet is strong. We ended the quarter with an overall cash balance of $79.4 million, up from $75.5 million at March 31. The primary driver of this change was our net income. During the quarter, we did not repurchase any shares under our previously announced stock repurchase authorization.

Before I open the call for questions, I want to provide you with an update to help you with your modeling of our company's financials. First, as a reminder, our guidance for 2014 is for the company to have single-digit revenue growth, in line with the past 5 years, paired with an accelerated spending to support our transformation work. That guidance remains unchanged. I should, however, remind you that Q3 is typically a seasonally down quarter in terms of both revenue and earnings, and we see no reason to believe that it wouldn't be the case this year.

On this call, we want to give you a little more color around our full year operating expense plans. All things being equal, and if XO continued on the same trajectory of prior years, we would have expected full year operating expense growth in the 5% range paired with our expected single-digit revenue growth. The investments we are making to transform the company have shifted us from that path.

For 2014, we believe our accelerated spending will add roughly $15 million of expense to 2014 as operating expense run rates. Of that spending, roughly $6 million to $7 million has already occurred in the first half of the year. To make these comparisons easier to understand, we've netted out the incremental spending items outlined in Q4 '13 and Q1 '14 in our non-GAAP financials.

Importantly, and to help you understand the ROI for the investment we are making in our business, I wanted to give you some color on the way we are thinking about our longer-term business model, which you will see in our new investor deck. We are targeting a long-term business model with revenue growth in the double digits; target gross margins of roughly 83% to 85%, depending somewhat on our eventual mix of e-commerce revenue; operating expense growth below our revenue growth; and adjusted EBITDA margins of at least 15% to 20%.

This model is an annual model, and given the seasonality in our business, we would expect certain quarters to be more or less aligned to the model. We believe ROI on our accelerated 2014 spending should be delivered in terms of rising free cash flow. We believe that as our company moves towards this more optimized state, the business model outline here can generate solid cash flow ROI on the investments we are now making.

As we have discussed, 2014 is an investment year. During 2015, we will need to incorporate any changes we eventually make to our businesses under review into our financials, as well as finish out a number of accelerated spending projects in the first half of the year.

In 2015, we won't get to all aspects of the target model I described, but we would be disappointed if we can't show solid progress towards them, particularly in the second half. As such, we want to remind you to think of this as a target we are committed to working towards, and against which, we will give you progress updates as we move forward.

Thank you for your interest. This concludes our prepared remarks. I will now open the call for your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of George Askew with Stifel.

George I. Askew - Stifel, Nicolaus & Company, Incorporated, Research Division

As you work through your strategic transition, do you expect to change the services you provide to users? Or do you simply expect to change the way those services are provided?

Michael Steib

George, I would say it's more of the latter. I think we are going to build on the strength of these assets and do a better job of giving our brides the solutions that they need to plan their weddings, and our moms, the solutions and the content that they need to have a great pregnancy and a great baby. An example in the case of weddings, where we're looking to provide the service in a better way is we already offer 23,000 vendor solutions to our brides on our website that, in many ways, can help make the best day of their wedding. We can do a better job by introducing many more vendors, better personalizing in delivering those results, and shortening the path for our bride from inspiration in her wedding to the actual execution of her wedding.

George I. Askew - Stifel, Nicolaus & Company, Incorporated, Research Division

Okay. Is it -- it seems like you're clearly deemphasizing, to some extent, The Nest. I know it's just 1% of revenue based on one of your slides. Is that -- I mean, is the emphasis, obviously, The Knot and The Bump going forward, and just those 2 brands?

Michael Steib

At this point, you're seeing us emphasize some of the significant changes that we're making in the business this year. And the investments we're making in the business this year, The Knot and The Bump are 2 of the areas where we're making those investments and that's really why we're highlighting those assets for you.

George I. Askew - Stifel, Nicolaus & Company, Incorporated, Research Division

Got it. Okay. And can you kind of refresh the -- your reference to your comments around reviews? And I hope I got it right, but basically, 30,000 today, 200,000 by year end, and all of them are currently on one of your sites. Is that basically the gist of it?

Michael Steib

I would unpack 2 things. One is the number of vendors that a bride can discover on TheKnot.com. And the second is the reviews that build trust in the -- those vendor profiles and help brides to find the right vendors who meet their needs. Today, we have 23,000 vendors and roughly 30,000 profiles on TheKnot.com for vendors providing services in local markets. We're going to take that number to over 200,000 by the end of the year so that our brides can always find the venue, the DJ, the florist, the photographer that can make her day perfect. Then, we are increasing -- we're investing in increasing the number of reviews available to our brides for those vendors, for those services to help her pick the right one.

George I. Askew - Stifel, Nicolaus & Company, Incorporated, Research Division

So it sounds like there's kind of a freemium model being created here. I mean, or do you -- what kind of paying ratio do you expect on the vendors by year end? Something like that.

Michael Steib

That's right. So we will be supplementing -- you're exactly right. We'll be supplementing the paid results on our site and in our app with free results, creating a sort of full selection for our brides while continuing to give our vendors the opportunity to pay for advantage in those results, and opening up for us more of the greenfield opportunity of the next, call it, 175,000 vendors who we have not, in the past, converted to paying advertisers.

George I. Askew - Stifel, Nicolaus & Company, Incorporated, Research Division

Got it. Got it. And just final question and it gets right to that -- to your last answer. Many of the marketplaces you cite have a CPC or similar kind of performance-based revenue model. Is that a direction we should expect out of XO Group going forward? And will your first half '15 website refresh enable this kind of functionality?

Michael Steib

Expect us to do 2 things, George. One, work very hard to shorten the path for our bride from wedding inspiration to executing a great wedding. That could be something like a pay-per-lead model, that could be something like book an appointment or book a tour at a venue or what-have-you. It really depends vertical by vertical. Secondly, look for us to take advantage of all of these new products we're shipping. To create -- to seek to create new revenue streams. And whether or not those 2 strategic directions come together specifically into a pay-per-lead model, I'd rather not answer and say look for us to close that loop more for our brides and our vendors and look for us to find new ways to monetize those connections.

Operator

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

Michael Steib

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 the website. If you 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. A telephone replay is available for the next week at (855) 859-2056, conference ID 74637798. 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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