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XOXO > SEC Filings for XOXO > Form 10-K on 18-Mar-2013All Recent SEC Filings

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Form 10-K for XO GROUP INC.


18-Mar-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

You should read the following discussion and analysis in conjunction with our financial statements and related notes included elsewhere in this report. This discussion contains forward-looking statements relating to future events and the future performance of XO Group based on our current expectations, assumptions, estimates and projections about us and our industry. These forward-looking statements involve risks and uncertainties. Actual results or events could differ materially from those anticipated in such forward-looking statements as a result of certain factors, as more fully described in this section and elsewhere in this report. We undertake no obligation to update publicly any forward-looking statements for any reason, even if new information becomes available or other events occur in the future.

Executive Overview

XO Group Inc. is the premier media and technology company devoted to weddings, pregnancy, and everything in between, providing young women with the trusted information, products, and advice they need to guide them through the most transformative events of their lives. Our family of premium brands began with the number one wedding brand, The Knot, and has grown to include WeddingChannel.com, The Nest, The Bump, and Ijie.com. XO Group Inc. is recognized by the industry for innovation in all media - from the web to social media and mobile, magazines and books, and video - and our groundbreaking social platforms have ignited passionate communities across the world. XO Group has leveraged its customer loyalty into successful businesses in online sponsorship and advertising, registry services, e-commerce and publishing.

In order to sustain growth within the customer groups we serve, we focus on our key growth strategy, which is to expand our position as a leading lifestage media company providing comprehensive information, services and products to couples from engagement through pregnancy on multiple platforms that remain relevant to the changing media landscape. To that end, we are focused on the following objectives:

• Develop products and services to meet the needs of our audience members during critical lifestages. We continuously build tools and create services for our newly engaged, newlywed, and pregnant audiences in order to meet their needs for information and services across multiple media streams. We have built several mobile apps, including popular apps such as The Knot Wedding Planner, The Wedding Dress Look Book, and My Pregnancy Calendar by The Bump. Tools such as our newly designed global wedding planner present our lifestage content in innovative ways. On Valentine's Day 2013, we streamed our first ever live wedding, the culmination of our Knot Dream Wedding Contest in which our audience voted on the couple and elements of the wedding, and we continue to look for ways to increase our connection with our audience in innovative ways.

• Leverage our strong brand and engaged audience for scalable advertising revenue growth. We have made significant investments in our infrastructure, especially that which supports our local advertising business. For example, we have launched a self-service platform that allows local vendors to automatically select their advertising programs. We have improved our ability to price display inventory dynamically, and we have launched a wedding vendor review site that enables brides to read reviews written by other recent brides. In February 2013, we launched updated local vendor store fronts, which operate like mini-websites for our vendors, featuring functionality including unlimited photos, videos, and reviews.We have launched partnerships to increase the reach for our local vendors, including a microsite built for KleinfeldBridal.com. We partner with our national advertisers to design highly targeted, integrated campaigns which reach our engaged audience. Recent campaigns have featured events organized by The Knot, The Knot Live TV, sponsorships of our mobile apps, and other lifestage buys across our brands and platforms.

• Improve transaction growth with innovative solutions for our membership base. Our relationship with our audience also includes services that we provide directly, including the recently upgraded e-commerce shops for wedding and baby gift items, the WeddingChannel registry platform, and other books, products, and services that we may sell from time to time. We are focused on connecting directly with our audience, presenting hard-to-find items, tools specific to the lifestages we serve as well as transactional opportunities.

• Increase awareness of our brands and products. We believe that we have generally excelled at marketing to our consumers with compelling brands, engaging content and products and a highly successful consumer public relations program. We continue to garner attention for our brands via editorial appearances on national television, presence on newsstands, content syndication partnerships, and award-winning technology products. Our editors appear frequently on national and local television and radio programs, as well as attending industry trade shows around the country. In 2010, we increased the publication frequency of The Knot Weddings national magazine from semi-annually to quarterly. We also increased the publication frequency of The Bump local market guides from annually to semi-annually. Our content syndication and


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content distribution partnerships include AOL, MSN, Sling Media, Sugar Inc., McClatchy Tribune, YouTube, Yahoo! and The Huffington Post, among others, and we continue to release new products.

• Expand our brands internationally. We are focused on identifying opportunities in large international markets where we can use our brand recognition and editorial authority on the key lifestages of engagement, newlywed and first-time pregnancy to drive further growth. In 2009, we established a software development center in Guangzhou, China for the purpose of increasing technology development productivity without materially growing technology costs. The software development center also is serving as a development resource for expanding our business in China. With a large number of weddings and an affinity for Western styles, we believe there is a substantial opportunity to serve Chinese couples with information and services about Western-style weddings, through the offices we opened in Beijing and Shanghai. In November 2010, we launched Ijie.com. The website provides Western inspiration and local resources for weddings, newlyweds and pregnancy in China. During the year, we launched partnerships with two of the largest portals in China, SINA and cn.msn.com, for which we provide wedding and lifestyle content on cobranded "Wedding" channels. In addition, we have established an exclusive licensing arrangement for a major Australian media company to represent our brands in Australia.

Since our company's inception, we have produced relevant content for our audience and introduced efficient marketing platforms for our advertisers, both online and offline, which has enabled us to gain a significant market share. But with a strong digital focus to our products and services, we believe that many aspects of the industries in which we operate, such as wedding planning, remain substantially analog. For example, a bride has to taste the cake at the bakery, tour the reception site, sample the caterer's menu, try on the dress at a salon, and so on. Even with digital marketing, social media, and other communication between bride and vendor, a substantial amount of wedding spending is transacted offline and has not been disrupted by digital technologies.

Recently, consumers have rapidly adopted smartphones, tablet computers and other mobile technology and have been using these devices as their primary access point to digital services. We believe this behavior has started to become and will continue to be a disruptive force in the wedding services industry, similar to what many other industries experienced with the initial adoption of the commercial Internet, as more efficient marketplaces were created between buyers and sellers that reduced inefficiencies inherent in legacy business models. We believe this disruption creates opportunity to tap into a greater portion of the $70 billion wedding industry than our current business does today.

For this reason, we expect to increase operating expenses in order to launch new technology and features in the near future that we think will enable our brides to find the exact wedding services, products and information that they want more easily, and will let our brides and vendors conduct business with each other much more efficiently. Our goal is to create a new way for women to navigate one of the most transformative events of their lives, allowing our brides to orchestrate each aspect of their wedding planning process, from discovery to purchase and everything in between, with a set of simple yet useful online digital services.

We believe we are well-positioned to capitalize on the opportunity because we already have deep engagement with a substantial number of the brides who are planning a wedding in the United States, from a perspective of both brand recognition and useful information. We have also developed strong commercial relationships over many years with the vendors and marketers who want to reach these brides. We believe the engagement and commercial relationships have proved to our brides, vendors and advertisers that we deliver value through our existing products and services, and we expect these relationships to provide us with a competitive advantage as we begin to deliver new products and services.

Our quarterly revenue and operating results have fluctuated significantly in the past and are expected to continue to fluctuate significantly in the future as a result of a variety of factors, many of which are outside of our control. These factors include the level of online usage and traffic on our websites, seasonal demand for e-commerce, including sales of registry products and wedding-related merchandise, the addition or loss of advertisers, the advertising budgeting cycles of specific advertisers, the regional and national magazines' publishing cycles, the amount and timing of capital expenditures and other costs relating to the expansion of our operations, including those related to acquisitions, the introduction of new sites and services by us or our competitors, changes in our pricing policies or the pricing policies of our competitors, and general economic conditions, such as the current recession, as well as economic conditions specific to the Internet, online and offline media and electronic e-commerce.

The Internet advertising and online markets in which our brands operate are rapidly evolving and intensely competitive, and we expect competition to intensify in the future. There are many wedding-related and baby-related sites on the Internet, which are developed and maintained by online content providers. New media platforms such as blogs, microblogs, social networks, and publisher networks are proliferating rapidly, including popular new sites like WeddingWire, Project Wedding, Wedding Bee, BabyCenter (published by Johnson & Johnson), Kaboose (published by Disney), and Cafι Mom, retail stores, manufacturers, wedding magazines and regional wedding directories also have online sites that compete with us for online advertising and merchandise revenue. We expect competition to increase because of the business opportunities presented by the growth of the


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Internet and e-commerce. Competition may also intensify as a result of industry consolidation and a lack of substantial barriers to entry in our market. In the wedding market, we also face competition for our services from bridal magazines. Brides magazine (published by Condι Nast), Bridal Guide (published by RFP LLC), and Martha Stewart Weddings (published by Martha Stewart Living Omnimedia) are dominant bridal publications in terms of revenue and circulation. Leading publications for parents include Parenting (published by Bonnier), Parents (published by Meredith), and American Baby (published by Meredith). We believe that the principal competitive factors in the wedding market are brand recognition, convenience, ease of use, information, quality of service and products, member affinity and loyalty, reliability and selection. As to these factors, we believe that we compete favorably. Our dedicated editorial, sales and product staffs concentrate their efforts on producing the most comprehensive wedding resources available. Generally, many of our current and potential competitors have longer operating histories, significantly greater financial, technical and marketing resources and high name recognition. Therefore, these competitors have a significant ability to attract advertisers and users. In addition, many independent or start-up competitors may be able to respond more quickly than we can to new or emerging technologies and changes in Internet user requirements, and other competitors may be able to devote greater resources than we do to the development, promotion and sale of services. There can be no assurance that our current or potential competitors will not develop products and services comparable or superior to those developed by us or adapt more quickly than we do to new technologies, evolving industry trends or changing Internet user preferences. Any such developments or advantages of our competitors may have an impact on our future operations and may cause our past financial results not to be necessarily indicative of future operating results. Increased competition could result in price reductions, reduced margins or loss of market share, any of which would materially and adversely affect our business, results of operations and financial condition.

2012 Highlights

During 2012, our net revenue and net income increased compared to 2011. The highlights of 2012 were:
• Total net revenue increased 3.9% to $129.1 million.

• National online advertising decreased 0.2% to $26.6 million.

• Local online advertising revenue increased 14.9% to $49.9 million.

• Registry services revenue decreased by 2.6% to $6.2 million.

• Merchandise revenue decreased 16.0% to $21.4 million.

• Publishing and other revenue increased by 12.0% to $25.1 million.

• We generated operating income of $14.2 million, compared to $10.1 million in the prior year. The year-over-year increase in operating income was primarily due to increased revenue and gross profit partially offset by increased operating expenses. The increase in revenue was driven by local online advertising and publishing and other revenue. These increases were partially offset by lower merchandise and registry revenue. The increase in operating expenses was due in part to additional personnel related to Ijie.com in China and higher software technology expenses.

• Net income attributable to XO Group in 2012 was $8.7 million, or $0.35 per basic share and $0.35 per diluted share, compared to $6.0 million, or $0.21 per basic share and $0.20 per diluted share in 2011.

• At December 31, 2012, our total cash and cash equivalents were $77.4 million, which was unchanged from the balance at December 31, 2011. Cash generated from operations in 2012 was offset by the repurchase of $18.9 million of our common stock, capital expenditures of $3.0 million and investments in equity interests of $1.5 million. During the year ended December 31, 2012, we repurchased 2.1 million shares for an aggregate cost of $18.9 million, including commissions. For more information, refer to Note 11 of Consolidated Financial Statements included herein.

• At December 31, 2012, we had no debt.


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Results of Operations

Year Ended December 31, 2012 Compared to Year Ended December 31, 2011

The following table summarizes results of operations for 2012 compared to 2011:

                                                  Year Ended December 31,
                              2012                        2011                  Increase/(Decrease)
                                    % of Net                    % of Net
                       Amount       Revenue        Amount       Revenue         Amount            %
                                         (In Thousands, Except for per Share Data)
Net revenue         $  129,131        100.0 %   $  124,257        100.0 %   $     4,874            3.9 %
Cost of revenue         22,602         17.5         25,086         20.2          (2,484 )         (9.9 )
Gross profit           106,529         82.5         99,171         79.8           7,358            7.4
Operating
expenses                92,280         71.5         89,092         71.7           3,188            3.6
Income from
operations              14,249         11.0         10,079          8.1           4,170           41.4
Loss in equity
interest                   (55 )          -           (269 )       (0.2 )           214           79.6
Interest and
other income, net          113          0.1            203          0.2             (90 )        (44.3 )
Income before
income taxes            14,307         11.1         10,013          8.1           4,294           42.9
Provision for
income taxes             5,658          4.4          4,025          3.2           1,633           40.6
Net income               8,649          6.7          5,988          4.8           2,661           44.4
Plus: net loss
attributable to
noncontrolling
interest                    65            -             52            -              13           25.0
Net income
attributable to
XO Group Inc.       $    8,714          6.7 %   $    6,040          4.9 %   $     2,674           44.3 %
Net income per
share
attributable to
XO Group Inc.
common
stockholders:
Basic               $     0.35                  $     0.21                  $      0.14           66.7 %
Diluted             $     0.35                  $     0.20                  $      0.15           75.0 %

Net Revenue

Net revenue increased to $129.1 million for the year ended December 31, 2012,
from $124.3 million for the year ended December 31, 2011. The following table
sets forth revenue by category for the year ended December 31, 2012 compared to
the year ended December 31, 2011, the percentage increase or decrease between
those periods, and the percentage of total net revenue that each category
represented for those periods:

                                                      Year Ended December 31,

                                                             Percentage          Percentage of
                                       Net Revenue            Increase/        Total Net Revenue
                                   2012           2011       (Decrease)       2012           2011
                                                          (In Thousands)
National online sponsorship
and advertising                $   26,561     $   26,617         (0.2 )%       20.6 %         21.4 %
Local online sponsorship and
advertising                        49,914         43,450         14.9          38.7           35.0
Total online sponsorship and
advertising                        76,475         70,067          9.1          59.3           56.4
Registry services                   6,231          6,398         (2.6 )         4.8            5.1
Merchandise                        21,359         25,420        (16.0 )        16.5           20.5
Publishing and other               25,066         22,372         12.0          19.4           18.0
Total net revenue              $  129,131     $  124,257          3.9  %      100.0 %        100.0 %


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Online sponsorship and advertising - The increase in total online sponsorship and advertising of 9.1% was primarily driven by an increase in revenue from local advertising programs. Local online sponsorship and advertising revenue increased 14.9%, primarily attributable to an increase in the number of local vendors advertising with us on our network of websites, as well as an increase in average vendor spending. As of December 31, 2012, we had over 22,000 local vendors displaying over 29,000 profiles, compared to nearly 21,000 vendors displaying over 28,000 profiles as of December 31, 2011. Revenue from national online sponsorship and advertising was generally flat year over year.

Registry services - The decrease of 2.6% was primarily driven by a decrease in sales and higher returns from Macy's Inc. ("Macy's"), partially offset by increased registry commissions from our new and historic registry retail partners. The overall decrease in registry sales compared to the prior year can be attributed to a significant shift of our traffic from desktop to mobile. Due to various improvements needed to optimize the current mobile user experience by both the Company and our registry partners, the shift to mobile resulted in a decrease in registry commissions earned in the current year.

Merchandise - The decrease of 16.0% was primarily driven by lower revenue from the WeddingChannel Store due to a steady decline in traffic to that site. As a result, in August 2012, all WeddingChannel Store traffic was redirected to The Knot Shop. Also contributing to the decrease was lower revenue generated from an e-commerce company we acquired in May 2009 due to reduced site traffic, which was impacted by the changes in the environment for search engine optimization.

Publishing and other - The increase of 12.0% was primarily driven by an increase in advertising pages and revenue per advertising page sold related to The Knot national and regional magazines. Higher sales and the addition of a second publication of The Bump magazine in two of its cities also contributed to the increase.

Gross Profit/Gross Margin

Cost of revenues consists of the cost of merchandise sold, including outbound shipping costs, costs related to the production of national and regional magazines, payroll and related expenses for our personnel who are responsible for the production of online and offline media, and costs of Internet and hosting services. The majority of the costs are shared over various revenue streams. Gross margin improved 2.7% to 82.5%, compared to 79.8% in 2011. The following table presents the components of gross profit and gross margin for the year ended December 31, 2012 compared to the year ended December 31, 2011:

                                                  Year Ended December 31,
                              2012                        2011                  Increase/(Decrease)
                       Gross         Gross         Gross         Gross          Gross           Gross
                       Profit       Margin %       Profit       Margin %        Profit         Margin %
                                                       (In Thousands)
Online
sponsorship and
advertising
(national and
local)              $   74,734         97.7 %   $   67,963         97.0 %   $     6,771            0.7 %
Registry                 6,231        100.0          6,398        100.0            (167 )            -
Merchandise              8,905         41.7          9,759         38.4            (854 )          3.3
Publishing and
other                   16,659         66.5         15,051         67.3           1,608           (0.8 )
Total gross
profit              $  106,529         82.5 %   $   99,171         79.8 %   $     7,358            2.7 %

The increase in gross margin was primarily attributable to the increase in online sponsorship and advertising gross profit. Although online sponsorship and advertising gross margin was only slightly higher than last year, it remains a high gross margin business. The increase in net revenue for the year ended December 31, 2012 attributable to local online sponsorship and advertising was the primary driver of the increase in our total gross profit and gross margin over the prior year comparable period.

Operating Expenses

Operating expenses increased 3.6% to $92.3 million, compared to $89.1 million in 2011, primarily attributable to increased personnel and information technology costs to support our growth initiatives. As a percentage of net revenue, operating expenses were 71.5% and 71.7% for the years ended December 31, 2012 and 2011, respectively.

The following table presents the components of operating expenses and the percentage of revenue that each component represented for the year ended December 31, 2012 compared to the year ended December 31, 2011:


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                                                      Year Ended December 31,

                                                              Percentage          Percentage of
                                    Operating Expenses         Increase/        Total Net Revenue
                                   2012            2011       (Decrease)       2012           2011
                                                           (In Thousands)
Product and content
development                    $    26,229     $   24,276           8.0 %       20.4 %         19.5 %
Sales and marketing                 40,239         38,738           3.9         31.2           31.2
General and administrative          20,980         20,660           1.5         16.2           16.6
Long-lived asset impairment
charges                                958            716          33.8          0.7            0.6
Depreciation and
amortization                         3,874          4,702         (17.6 )        3.0            3.8
Total operating expenses       $    92,280     $   89,092           3.6 %       71.5 %         71.7 %

Product and Content Development - The increase of 8.0% was primarily attributable to an increase in expenditures related to our technology development projects, as well as incremental operating expenses related to our Beijing, China office and our software development center in Guangzhou, China. The expenses were primarily related to personnel and occupancy.

Sales and Marketing - The increase of 3.9% was primarily attributable to an increase in employee headcount to support our growth initiatives domestically and internationally.

General and Administrative - The increase of 1.5% was primarily attributable to an increase in employee headcount to support our growth initiatives domestically and internationally, an increase in rent expense for our Beijing, China office, as well as incremental operating expenses related to our Shanghai, China branch.

Long-lived asset impairment charges - Impairment charges were $958,000 for the year ended December 31, 2012. During the third quarter of 2012, we concluded there were impairment indicators with respect to the tradenames of WeddingChannel and an e-commerce company we acquired in May 2009. Recent trending of lower overall e-commerce sales, a decrease in advertising and registry sales attributable to the WeddingChannel tradename and lower projected revenues in the future resulted in an impairment charge of $736,000 on the WeddingChannel tradename and $222,000 on the tradename of the company we acquired in May 2009.

Depreciation and Amortization - The decrease of 17.6% was primarily attributable to the amortization expense recorded in the prior year of $688,000 related to WeddingChannel's technology intangible asset, before writing off the remaining balance in the third quarter of 2011 due to impairment.

Interest and Other Income

Interest and other income, net decreased 44.3% to $113,000, compared to $203,000 . . .

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