September 30, 2004, respectively, as compared to $4.5 million and $13.3 million for the corresponding periods in 2003. These decreases were primarily due to a decrease in sales of wedding supplies through our websites of $730,000 and $2.2 million, respectively, or by approximately 18% in each period. Merchandise revenue in 2004 has been affected by the leveling of our new membership growth, and we also believe there is further competition developing online with respect to the sale of wedding supplies products. Revenue for the nine months was further impacted by certain operational difficulties during the first quarter of 2004 affecting customer service performance, which arose from the installation of new warehouse management software at our Redding, California facility. In addition, site performance issues impacted merchandise revenue in May. Merchandise revenues amounted to 35% of our net revenues for the three months ended September 30, 2004 and 46% for the three months ended September 30, 2003. For the nine months ended September 30, 2004 and 2003, merchandise revenue was 35% and 47% of our net revenues, respectively.
Cost of revenues consists of the cost of merchandise sold, including outbound shipping costs, the costs related to the production of regional magazines and our national magazine, 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.
Cost of revenues decreased to $3.1 million and $9.0 million for the three and nine months ended September 30, 2004, respectively, from $3.4 million and $9.6 million for the corresponding periods in 2003. This was primarily due to decreases in the cost of revenues from the sale of merchandise of $307,000 and $914,000 for the three and nine month periods ended September 30, 2004, respectively, as compared to the corresponding periods in 2003, as a result of lower sales of wedding supplies. In addition, for the nine month period in 2004, advertising cost of revenue increased by $139,000 as a result of increased bandwidth costs while publishing and other cost of revenue increased by $156,000 as a result of an increase in national and local print revenue due, in part, to higher advertising pages sold. The impact on publishing and other cost of revenue for the three month period due to higher advertising pages sold was largely offset by production cost savings for the August issue of the national magazine. As a percentage of our net revenues, cost of revenues decreased to 29% for the three and nine months ended September 30, 2004, from 35% and 34% for the corresponding periods in the prior year. These margin improvements resulted primarily from a larger mix of higher margin sponsorship and advertising revenue. Merchandise margins have decreased in 2004 as a result of higher shipping costs and additional product promotions while publishing margins have improved as a result of the growth of national and local print revenue combined with production cost savings initiatives.
Product and content development expenses consist primarily of payroll and related expenses for editorial, creative and information technology personnel.
Product and content development expenses increased to $1.3 million and $3.7 million for the three and nine months ended September 30, 2004, respectively, or by $171,000 and $528,000 as compared to the corresponding periods in 2003. Personnel and related expenses increased by $102,000 and $270,000 for the three and nine month periods, respectively, due to additional investments in information technology staff. The balance of the increase for the two periods in 2004 resulted from additional costs to upgrade computer equipment and expenses associated with our e-commerce platform project. As a percentage of our net revenues, product and content development expenses increased to 12% for the three and nine months ended September 30, 2004, from 11% for the corresponding periods in
2003.
Sales and Marketing
Sales and marketing expenses consist primarily of payroll and related expenses for sales and marketing, customer service and public relations personnel, as well as the costs for promotional activities and fulfillment and distribution of merchandise.
Sales and marketing expenses decreased to $2.1 million for the three months ended September 30, 2004 and increased to $9.1 million for the nine months ended September 30, 2004 as compared to $3.0 million and $8.6 million for the corresponding periods in 2003. In September 2004, we entered into a settlement agreement with America Online, Inc. (“AOL”) with respect to amounts owed to AOL under the Amended and Restated Anchor Tenant Agreement effective July 23, 1999 between The Knot and AOL. As a result of the settlement, we made a cash payment of $1.2 million to AOL and we reversed the portion of a previously recorded liability to AOL that was in excess of the amount paid for which we recorded a non-cash benefit of $1.2 million as a reduction of sales and marketing expense. This benefit impacted both the three and nine month periods ended September 30, 2004. Personnel and related costs increased by $144,000 and $859,000 for the three and nine month periods in 2004, respectively. These increases resulted from investments in personnel to better sell our e-commerce product offerings, additional staff at our warehouse and fulfillment center in Redding, California and increases in our customer service and operations staff to support the growth of our local revenue streams. We incurred higher sales commissions of $158,000 and $424,000 for the three and nine month periods in 2004, respectively, as a result of increased online advertising and national and local print revenue. Facility costs in Redding, California have increased by $35,000 and $150,000 for the three and nine month periods in 2004, respectively, as a result of the move into our new and expanded warehouse. In addition, for the nine months in 2004, promotion costs increased by $150,000, as compared to the corresponding period in 2003, to support the launch of our rebranded local magazines, The Knot Weddings, and to expand our promotional efforts at local bridal shows. As a percentage of our net revenues, sales and marketing expenses decreased to 20% and 29% for the three months and nine months ended September 30, 2004, respectively, from 31% and 30% for the corresponding periods in 2003.
General and Administrative
General and administrative expenses consist primarily of payroll and related expenses for our executive management, finance and administrative personnel, legal and accounting fees, facilities costs, insurance and bad debt expenses.
General and administrative expenses increased to $3.1 million and $7.9 million for the three and nine months ended September 30, 2004, respectively, as compared to $1.9 million and $5.6 million for the corresponding periods in 2003. The increases were due to higher legal fees, primarily related to our current litigation with WeddingChannel.com, Inc., of $985,000 and $1.9 million for the three and nine month periods. We also incurred additional recruiting costs of $122,000 and $270,000 for the three and nine month periods, respectively, for additional senior management and other staff personnel. As a percentage of our net revenues, general and administrative expenses increased to 29% and 25%, respectively, for the three and nine months ended September 30, 2004, from 19% and 20% for the corresponding periods in 2003.
Non-Cash Compensation
We recorded no deferred compensation during the three and nine months ended September 30, 2004. All previously recorded deferred compensation was fully amortized during 2003. Amortization of deferred compensation was $1,000 and $33,000 for the three and nine months ended September 30, 2003, respectively
Depreciation and Amortization
Depreciation and amortization expenses consist of depreciation and amortization of property and equipment and capitalized software and amortization of intangible assets related to acquisitions.
Depreciation and amortization expenses increased to $191,000 for the three months ended September 30, 2004 from $174,000 for the three months ended September 30, 2003. Depreciation and amortization expenses
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decreased to $589,000 for the nine months ended September 30, 2004 from $665,000 for the corresponding period in 2003. The decrease was primarily due to a reduction in capital expenditures in fiscal 2002 and 2001 and the impact of certain assets acquired prior to 2001 becoming fully depreciated.
Interest and Other Income, Net
Interest income, net of interest expense, increased to $82,000 and $193,000 for the three and nine months ended September 30, 2004, respectively, as compared to $21,000 and $63,000 for the corresponding periods in 2003. These increases were primarily the result of higher cash balances available for investment and higher interest rates.
Provision for Taxes on Income
For the three and nine months ended September 30, 2004, we were subject to income tax expense of $21,000 and $78,000, respectively, due to operating income generated in certain states. No federal income tax has been provided as we utilize net operating loss carryforwards.
Liquidity and Capital Resources
As of September 30, 2004, our cash and cash equivalents amounted to $22.7 million. We currently invest primarily in short-term debt instruments that are highly liquid, of high-quality investment grade, and have maturities of less than three months, with the intent to make such funds readily available for operating purposes.
Net cash provided by operating activities was $273,000 for the nine months ended September 30, 2004. This resulted primarily from the net income for the period of $1,090,000, depreciation and amortization of $589,000 and a decrease in accounts receivable, net of deferred revenue, of $1,026,000 due to improved collection efforts and an increase in credit card usage by local vendors, and, in part, due to the timing of billings for local print advertising. Other current assets also decreased by $261,000. These sources of cash were offset by an increase in merchandise inventory of $737,000 and a decrease in accounts payable and accrued expenses of $2,072,000. In September 2004, we entered into a settlement agreement with AOL with respect to amounts owed to AOL under the Amended and Restated Anchor Tenant Agreement effective July 23, 1999 between The Knot and AOL. As a result of the settlement, we made a cash payment of $1.2 million to AOL and we reversed the portion of a previously recorded liability to AOL that was in excess of the amount paid for which we recorded a non-cash benefit of $1.2 million in the third quarter. Net cash provided by operating activities was $3.2 million for the nine months ended September 30, 2003. This resulted primarily from the net income for the period of $778,000, depreciation and amortization of $665,000, a decrease in accounts receivable, net of deferred revenue of $1,076,000, an increase in accounts payable of $342,000 and a decrease in deferred production and marketing costs of $284,000. These sources of cash were partially offset by an increase in inventory of $204,000. Effective October 1, 2002, local vendors are no longer pre-billed for their full contractual amounts via statements but are invoiced for individual amounts due in accordance with our standard payment terms. The impact of this billing modification reduced accounts receivable and deferred revenue in equal amounts of approximately $1.8 million from December 31, 2002 through September 30, 2003.
Net cash used in investing activities was $597,000 and $807,000 for the nine months ended September 30, 2004 and 2003, respectively, primarily for purchases of property and equipment.
Net cash provided by financing activities for the nine months ended September 30, 2004 and 2003 was $501,000 and $234,000, respectively, primarily from proceeds from the issuance of common stock in connection with the exercise of stock options and through our Employee Stock Purchase Plan.
Since our inception in May 1996, with the exception of fiscal 2003, we have experienced annual operating losses; and we have an accumulated deficit of $46.4 million as of September 30, 2004. We believe that our current cash and cash equivalents will be sufficient to fund our working capital and capital expenditure requirements for at least the next twelve months. This expectation is primarily based on internal estimates of revenue growth, as well as continuing emphasis on controlling operating expenses. However, there can be no assurance that actual costs will not exceed amounts estimated, that actual revenues will equal or exceed estimated amounts, or that we will sustain profitable operations, due to significant uncertainties surrounding our estimates and expectations.
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Contractual Obligations and Commitments
We do not have any special purposes entities or capital leases, and other than operating leases, which are described below, we do not engage in off-balance sheet financing arrangements.
In the ordinary course of business, we enter into various arrangements with vendors and other business partners principally for magazine production, inventory purchases, host services and bandwidth. There are no material purchase commitments for these arrangements extending beyond 2004.
As of September 30, 2004, we had commitments for capital expenditures of $428,000.
As of September 30, 2004, we had commitments under non-cancelable operating leases amounting to approximately $5.1 million.
At September 30, 2004, other long-term liabilities of $503,000 substantially represented accruals to recognize rent expense on a straight-line basis over the respective lives of two of our operating leases under which rental payments increase over the lease periods. These accruals will be reduced as the operating lease payments, summarized in the table of contractual obligations below, are made.
Our contractual obligations as of September 30, 2004 are summarized as follows:
| | Payments due by period | |
| |
| |
| | (in thousands) | |
Contractual Obligations | | Total | | Less than 1
year | | 1-3 years | | 3-5 years | | More than 5
years | |
| |
| |
| |
| |
| |
| |
Long term debt | | $ | 235 | | $ | 39 | | $ | 90 | | $ | 106 | | $ | — | |
Operating leases | | | 5,150 | | | 808 | | | 1,538 | | | 1,319 | | | 1,485 | |
Purchase commitments | | | 773 | | | 773 | | | — | | | — | | | — | |
| |
|
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|
| |
|
| |
|
| |
|
| |
Total | | $ | 6,158 | | $ | 1,620 | | $ | 1,628 | | $ | 1,425 | | $ | 1,485 | |
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Seasonality
We believe that the impact of the frequency of weddings from quarter to quarter results in lower merchandise revenues in the first and fourth quarters.
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RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
In addition to other information in this Quarterly Report on Form 10-Q, the following risk factors should be carefully considered in evaluating our business because such factors currently or may have a significant impact on our business, operating results or financial condition. This Quarterly Report on Form 10-Q may contain forward-looking statements that have been made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from those projected in the forward-looking statements as a result of the risk factors set forth below and elsewhere in this Quarterly 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.
Risks Related to Our Business
We have an unproven business model, and it is uncertain whether online wedding-related sites can generate sufficient revenues to survive.
Our model for conducting business and generating revenues is unproven. Our business model depends in large part on our ability to generate revenue streams from multiple sources through our online sites, including online sponsorship and advertising fees from third parties and online sales of wedding gifts and supplies.
It is uncertain whether wedding-related online sites that rely on attracting sponsors and advertisers, as well as people to purchase wedding gifts and supplies, can generate sufficient revenues to survive. For our business to be successful, we must provide users with an acceptable blend of products, information, services and community offerings that will attract wedding consumers to our online sites frequently. In addition, we must provide sponsors, advertisers and vendors the opportunity to reach these wedding consumers. We provide our services to users without charge, and we may not be able to generate sufficient revenues to pay for these services.
Moreover, we face many of the risks and difficulties frequently encountered in new and rapidly evolving markets, including the online advertising and e-commerce markets. These risks include our ability to:
| • | increase the audience on our sites; |
| • | broaden awareness of our brand; |
| • | strengthen user loyalty; |
| • | offer compelling content; |
| • | maintain our leadership in generating traffic; |
| • | maintain our current, and develop new, strategic relationships; |
| • | attract a large number of advertisers from a variety of industries; |
| • | respond effectively to competitive pressures; |
| • | continue to develop and upgrade our technology; and |
| • | attract, integrate, retain and motivate qualified personnel. |
These risks could negatively impact our financial condition if left unaddressed. Accordingly, we are not certain that our business model will be successful or that we can sustain revenue growth or profitability.
We have a history of significant losses since our inception and may incur significant losses in the future.
We have only recently achieved profitability in the last fiscal year, and have incurred significant accumulated losses. As of September 30, 2004, our accumulated deficit was $46.4 million. We expect to continue to incur significant operating expenses and, as a result, we will need to generate significant revenues to maintain profitability. We cannot assure you that we can sustain or increase profitability on a quarterly or annual basis in the future. Failure to maintain profitability may materially and adversely affect our business, results of operations and financial condition and the market price of our common stock.
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We lack significant revenues and may be unable to adjust spending quickly enough to offset any unexpected revenue shortfall.
Our revenues for the foreseeable future will remain dependent on online user traffic levels, advertising activity, both online and offline, and the expansion of our e-commerce activity. In addition, we plan to expand and develop content and to continue to upgrade and enhance our technology and infrastructure. We incur a significant percentage of our expenses, such as employee compensation, prior to generating revenues associated with those expenses. Moreover, our expense levels are based, in part, on our expectation of future revenues. We may be unable to adjust spending quickly enough to offset any unexpected revenue shortfall. If we have a shortfall in revenues or if operating expenses exceed our expectations or cannot be adjusted accordingly, then our results of operations would be materially and adversely affected.
If sales to sponsors or advertisers forecasted in a particular period are delayed or do not otherwise occur, our results of operations for a particular period would be materially and adversely affected.
The time between the date of initial contact and the execution of a contract with a national sponsor or advertiser is often lengthy, typically ranging from six weeks for smaller programs and several months for larger programs, and may be subject to delays over which we have little or no control, including:
| • | the occurrence of extraordinary events, such as the attacks on September 11, 2001; |
| • | customers’ budgetary constraints; |
| • | customers’ internal acceptance reviews; |
| • | the success and continued internal support of advertisers’ and sponsors’ own development efforts; and |
| • | the possibility of cancellation or delay of projects by advertisers or sponsors. |
During the sales cycle, we may expend substantial funds and management resources in advance of generating sponsorship or advertising revenues. Accordingly, if sales to advertisers or sponsors forecasted in a particular period are delayed or do not otherwise occur, we would generate less sponsorship and advertising revenues during that period, and our results of operations may be adversely affected.
Our quarterly revenues and operating results are subject to significant fluctuation, and these fluctuations may adversely affect the trading price of our common stock.
Our quarterly revenues 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 our control. These factors include:
| • | the level of online usage and traffic on our websites; |
| • | seasonal demand for e-commerce; |
| • | 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, as well as economic conditions specific to the Internet, online and offline media and electronic commerce. |
We do not believe that period-to-period comparisons of our operating results are necessarily meaningful and you should not rely upon these comparisons as indicators of our future performance.
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Due to the foregoing factors, it is also possible that our results of operations in one or more future quarters may fall below the expectations of investors and/or securities analysts. In such event, the trading price of our common stock is likely to decline.
Because the frequency of weddings vary from quarter to quarter, our operating results may fluctuate due to seasonality.
Seasonal and cyclical patterns may affect our revenues. In 2002, according to the National Center of Health Statistics, 19% of weddings in the United States occurred in the first quarter, 27% occurred in the second quarter, 30% occurred in the third quarter and 24% occurred in the fourth quarter. We have limited experience generating merchandise revenues. Based upon our limited experience, we believe wedding related merchandise revenues generally are lower in the first and fourth quarters of each year. As a result of these factors, we may experience fluctuations in our revenues from quarter to quarter.
We depend on our strategic relationships with other websites.
We depend on establishing and maintaining distribution relationships with high-traffic websites such as AOL and MSN for a portion of our traffic. There is intense competition for placements on these sites, and we may not be able to continue to enter into such relationships on commercially reasonable terms, if at all. Even if we enter into or maintain distribution relationships with these websites, they themselves may not attract a significant number of users. Therefore, our sites may not receive additional users from these relationships. Moreover, we may be required to pay significant fees to establish and maintain these relationships. Our business, results of operations and financial condition could be materially and adversely affected if we do not establish and maintain strategic relationships on commercially reasonable terms or if any of our strategic relationships do not result in increased use of our websites.
The market for Internet advertising is still developing, and if the Internet fails to gain further acceptance as a media for advertising, we would experience slower revenue growth than expected or a decrease in revenue and would incur greater than expected losses.
Our future success depends, in part, on a significant increase in the use of the Internet as an advertising and marketing medium. Sponsorship and advertising revenues constituted 23% of our net revenues for the year ended December 31, 2002, 34% of our net revenues for the year ended December 31, 2003 and 40% of our net revenues for the nine months ended September 30, 2004. Our national online sponsorship and advertising revenue was approximately $1.9 million for the year ended December 31, 2002, $4.4 million for the year ended December 31, 2003 and $4.4 million for the nine months ended September 30, 2004. The Internet advertising market is still developing, and it cannot yet be compared with traditional advertising media to gauge its effectiveness. As a result, demand for and market acceptance of Internet advertising solutions are uncertain. Many of our current and potential customers have little or no experience with Internet advertising and have allocated only a limited portion of their advertising and marketing budgets to Internet activities. The adoption of Internet advertising, particularly by entities that have historically relied upon traditional methods of advertising and marketing, requires the acceptance of a new way of advertising and marketing. These customers may find Internet advertising to be less effective for meeting their business needs than traditional methods of advertising and marketing. Furthermore, there are software programs that limit or prevent advertising from being delivered to a user’s computer. Widespread adoption of this software by users would significantly undermine the commercial viability of Internet advertising.
We may be unable to continue to build awareness of The Knot brand name which would negatively impact our business and cause our revenues to decline.
Building recognition of our brand is critical to attracting and expanding our online user base and our offline readership. Because we plan to continue building brand recognition, we may find it necessary to accelerate expenditures on our sales and marketing efforts or otherwise increase our financial commitment to creating and maintaining brand awareness. Our failure to successfully promote and maintain our brand would adversely affect our business and cause us to incur significant expenses in promoting our brand without an associated increase in our net revenues.
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Our business could be adversely affected if we are not able to successfully integrate any future acquisitions or successfully operate under our strategic partnerships.
In the future, we may acquire, or invest in, complementary companies, products or technologies or enter into new strategic partnerships. Acquisitions, investments and partnerships involve numerous risks, including:
| • | difficulties in integrating operations, technologies, products and personnel; |
| • | diversion of financial and management resources from existing operations; |
| • | risks of entering new markets; |
| • | potential loss of key employees; and |
| • | inability to generate sufficient revenues to offset acquisition or investment costs. |
The costs associated with potential acquisitions or strategic alliances could dilute your investment or adversely affect our results of operations.
To pay for an acquisition or to enter into a strategic alliance, we might use equity securities, debt, cash, or a combination of the foregoing. If we use equity securities, our stockholders may experience dilution. In addition, an acquisition may involve non-recurring charges, including writedowns of significant amounts of goodwill. The related increases in expenses could adversely affect our results of operations. Any such acquisitions or strategic alliances may require us to obtain additional equity or debt financing, which may not be available on commercially acceptable terms, if at all.
If we cannot protect our domain names, it will impair our ability to successfully brand The Knot.
We currently hold various Web domain names, including www.theknot.com. The acquisition and maintenance of domain names generally is regulated by Internet regulatory bodies. The regulation of domain names in the United States and in foreign countries is subject to change. Governing bodies may establish additional top-level domains, appoint additional domain name registrars or modify the requirements for holding domain names. As a result, we may be unable to acquire or maintain relevant domain names in all countries in which we conduct business. Furthermore, it is unclear whether laws protecting trademarks and similar proprietary rights will be extended to protect domain names. Therefore, we may be unable to prevent third parties from acquiring domain names that are similar to, infringe upon or otherwise decrease the value of our trademarks and other proprietary rights. We may not successfully carry out our business strategy of establishing a strong brand for The Knot if we cannot prevent others from using similar domain names or trademarks. This could impair our ability to increase market share and revenues.
Our business and prospects would suffer if we are unable to protect and enforce our intellectual property rights.
We rely upon copyright, trade secret and trademark law, assignment of invention and confidentiality agreements and license agreements to protect our proprietary technology, processes, content and other intellectual property to the extent that protection is sought or secured at all. The steps we might take may not be adequate to protect against infringement and misappropriation of our intellectual property by third parties. Similarly, third parties may be able to independently develop similar or superior technology, processes, content or other intellectual property. The unauthorized reproduction or other misappropriation of our intellectual property rights could enable third parties to benefit from our technology without paying us for it. If this occurs, our business and prospects would be materially and adversely affected. In addition, disputes concerning the ownership or rights to use intellectual property could be costly and time-consuming to litigate, may distract management from other tasks of operating the business, and may result in our loss of significant rights and the loss of our ability to operate our business.
Our products and services may infringe on intellectual property rights of third parties and any infringement could require us to incur substantial costs and distract our management.
Although we avoid knowingly infringing intellectual rights of third parties, including licensed content, we may be subject to claims alleging infringement of third-party proprietary rights. If we are subject to claims of infringement or are infringing the rights of third parties, we may not be able to obtain licenses to use those rights on commercially reasonable terms, if at all. In that event, we would need to undertake substantial reengineering to
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continue our online offerings. Any effort to undertake such reengineering might not be successful. Furthermore, a party making such a claim could secure a judgment that requires us to pay substantial damages. A judgment could also include an injunction or other court order that could prevent us from selling our products. Any claim of infringement could cause us to incur substantial costs defending against the claim, even if the claim is invalid, and could distract our management from our business.
Increased competition in our markets could reduce our market share, the number of our advertisers, our advertising revenues and our margins.
The Internet advertising and online wedding markets are still developing. Additionally, both the Internet advertising and online wedding markets and the wedding magazine publishing markets are intensely competitive, and we expect competition to intensify in the future. We face competition for members, users, readers and advertisers from the following areas:
| • | online services or websites targeted at brides and grooms as well as the online sites of retail stores, manufacturers and regional wedding directories; |
| • | bridal magazines, such as Bride’s and Modern Bride (both part of the Condé Nast family); and |
| • | online and retail stores offering gift registries, especially from retailers offering specific bridal gift registries. |
We expect competition to increase because of the business opportunities presented by the growth of the Internet and e-commerce. Our competition may also intensify as a result of industry consolidation and a lack of substantial barriers to entry. Many of our current and potential competitors have longer operating histories, significantly greater financial, technical and marketing resources, greater name recognition and substantially larger user, membership or readership bases than we have and, therefore, have significant ability to attract advertisers, users and readers. In addition, many of our competitors may be able to respond more quickly than we can to new or emerging technologies and changes in Internet user requirements, as well as devote greater resources than we can 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 that we develop or adapt more quickly than we do to new technologies, evolving industry trends or changing Internet user preferences. Increased competition could result in price reductions, lower margins or loss of market share. There can be no assurance that we will be able to compete successfully against current and future competitors.
Our potential inability to compete effectively in our industry for qualified personnel could hinder the success of our business.
Competition for personnel in the Internet and wedding industries is intense. We may be unable to retain employees who are important to the success of our business. We may also face difficulties attracting, integrating or retaining other highly qualified employees in the future. If we cannot attract new personnel or retain and motivate our current personnel, our business may not succeed.
Terrorism and the uncertainty of war may have a material adverse effect on our operating results.
Terrorist attacks, such as the attacks that occurred in New York and Washington, D.C. on September 11, 2001, and other acts of violence or war may affect the market on which our common stock will trade, the markets in which we operate or our operating results. Further terrorist attacks against the United States or U.S. businesses may occur. The potential near-term and long-term effect these attacks may have for our customers, the market for our common stock, the markets for our services and the U.S. economy are uncertain. The consequences of any terrorist attacks, or any armed conflicts which may result, are unpredictable, and we may not be able to foresee events that could have an adverse effect on our business.
We may not be able to obtain additional financing necessary to execute our business strategy.
We currently believe that our current cash and cash equivalents will be sufficient to fund our working capital and capital expenditure requirements for at least the next twelve months. Our ability to meet our obligations in the ordinary course of business is dependent upon our ability to maintain profitable operations and/or raise additional
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financing through public or private equity financings, or other arrangements with corporate sources, or other sources of financing to fund operations. However, there is no assurance that we will maintain profitable operations or that additional funding, if required, will be available to us in amounts or on terms acceptable to us.
Systems disruptions and failures could cause advertiser or user dissatisfaction and could reduce the attractiveness of our sites.
The continuing and uninterrupted performance of our computer systems is critical to our success. Our advertisers and sponsors, users and members may become dissatisfied by any systems disruption or failure that interrupts our ability to provide our services and content to them. Substantial or repeated system disruption or failures would reduce the attractiveness of our online sites significantly. Substantially all of our systems hardware required to run our sites are located at Globix Corporation’s facilities in New York, New York. Globix emerged from bankruptcy protection in April 2002. Fire, floods, earthquakes, power loss, telecommunications failures, break-ins, acts of terrorism and similar events could damage these systems. Our operations depend on the ability of Globix to protect its own systems and our systems in its data center against damage from fire, power loss, water damage, telecommunications failure, vandalism and similar unexpected adverse events. Although Globix provides comprehensive facilities management services, Globix does not guarantee that our Internet access will be uninterrupted, error-free or secure. In addition, computer viruses, electronic break-ins or other similar disruptive problems could also adversely affect our online sites. Our business could be materially and adversely affected if our systems were affected by any of these occurrences. We do not presently have any secondary “off-site” systems or a formal disaster recovery plan. Our sites must accommodate a high volume of traffic and deliver frequently updated information. Our sites have in the past experienced slower response times. These types of occurrences in the future could cause users to perceive our sites as not functioning properly and therefore cause them to use another online site or other methods to obtain information or services. In addition, our users depend on Internet service providers, online service providers and other site operators for access to our online sites. Many of them have experienced significant outages in the past, and could experience outages, delays and other difficulties due to system disruptions or failures unrelated to our systems. Although we carry general liability insurance, our insurance may not cover any claims by dissatisfied advertisers or customers or may not be adequate to indemnify us for any liability that may be imposed in the event that a claim were brought against us. Any system disruption or failure, security breach or other damage that interrupts or delays our operations could cause us to lose users, sponsors and advertisers and adversely affect our business and results of operations.
We may not be able to deliver various services if third parties fail to provide reliable software, systems and related services to us.
We are dependent on various third parties for software, systems and related services in connection with our hosting, placement of advertising, accounting software, data transmission and security systems. Several of the third parties that provide software and services to us have a limited operating history and have relatively new technology. These third parties are dependent on reliable delivery of services from others. If our current providers were to experience prolonged systems failures or delays, we would need to pursue alternative sources of services. Although alternative sources of these services are available, we may be unable to secure such services on a timely basis or on terms favorable to us. As a result, we may experience business disruptions if these third parties fail to provide reliable software, systems and related services to us.
We may be liable if third parties misappropriate our users’ personal information.
If third parties were able to penetrate our network security or otherwise misappropriate our users’ personal or credit card information, we could be subject to liability. Our liability could include claims for unauthorized purchases with credit card information, impersonation or other similar fraud claims as well as for other misuses of personal information, such as for unauthorized marketing purposes. These claims could result in costly and time-consuming litigation which could adversely affect our financial condition. In addition, the Federal Trade Commission and state agencies have been investigating various Internet companies regarding their use of personal information. We could have additional expenses if new regulations regarding the use of personal information are introduced or if our privacy practices are investigated.
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Our executive officers, directors and stockholders who each owned greater than 5% of our common stock exercise significant control over all matters requiring a stockholder vote.
As of September 30, 2004, our executive officers and directors and stockholders who each owned greater than 5% of our common stock, and their affiliates, in the aggregate, beneficially owned approximately 80% of our outstanding common stock. As a result, these stockholders are able to exercise control over all matters requiring approval by our stockholders, including the election of directors and approval of significant corporate transactions. This concentration of ownership could also have the effect of delaying or preventing a change in control.
Anti-takeover provisions in our charter documents and Delaware law may make it difficult for a third party to acquire us.
Provisions of our certificate of incorporation, our bylaws and Delaware law could make it more difficult for a third party to acquire us, even if doing so might be beneficial to our stockholders.
Risks Related to the Securities Markets
The delisting of our common stock from the Nasdaq National Market has resulted, and could continue to result, in a limited public market for our common stock and larger spreads in the bid and ask prices for shares of our common stock and could result in lower prices for shares of our common stock and make obtaining future equity financing more difficult.
On August 23, 2001, our common stock was delisted from the Nasdaq National Market. Our common stock is currently available for quotation on the OTC Bulletin Board. Selling our common stock has become, and may continue to be, more difficult because smaller quantities of shares are bought and sold on the OTC Bulletin Board, transactions could be delayed and news media coverage of us has been reduced. These factors have resulted, and could continue to result, in larger spreads in the bid and ask prices for shares of our common stock and could result in lower prices for shares of our common stock.
The delisting of our common stock from the Nasdaq National Market or declines in our stock price could also greatly impair our ability to raise additional necessary capital through equity or debt financing and significantly increase the dilution to stockholders caused by our issuing equity in financing or other transactions. The price at which we issue shares in such transactions is generally based on the market price of our common stock, and a decline in our stock prices could result in the need for us to issue a greater number of shares to raise a given amount of funding or acquire a given dollar value of goods or services.
In addition, because our common stock is not listed on the Nasdaq National Market, we are subject to Rule 15g-9 under the Securities Exchange Act of 1934, as amended. That rule imposes additional sales practice requirements on broker-dealers that sell low-priced securities to persons other than established customers and institutional accredited investors. For transactions covered by this rule, a broker-dealer must make a special suitability determination for the purchaser and have received the purchaser’s written consent to the transaction prior to sale. Consequently, the rule may affect the ability of broker-dealers to sell the common stock and affect the ability of holders to sell their shares of our common stock in the secondary market.
Our stock price has been highly volatile and is likely to experience extreme price and volume fluctuations in the future that could reduce the value of your investment and subject us to litigation.
The market price of our common stock has fluctuated in the past and is likely to continue to be highly volatile, with extreme price and volume fluctuations. These broad market and industry factors may harm the market price of our common stock, regardless of our actual operating performance, and for this or other reasons, we could continue to suffer significant declines in the market price of our common stock. In the past, companies that have experienced volatility in the market price of their stock have been the object of securities class action litigation. If we were to become the object of securities class action litigation, it could result in substantial costs and a diversion of our management’s attention and resources.
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Sales or the perception of future sales of our common stock may adversely affect our stock price.
Sales of substantial numbers of shares of our common stock in the public market, or the perception that significant sales are likely, could adversely affect the market price of our common stock. The number of shares of common stock subject to the registration statement we filed in December 2003, registering the resale of up to 2,800,000 shares of common stock by the selling stockholders named in the related prospectus, is much greater than the average weekly trading volume for our shares. No prediction can be made as to the effect, if any, that market sales of these or other shares of our common stock will have on the market price of our common stock. Sales of substantial amounts of our common stock in the public market could adversely affect the market price of our common stock.
Risks Related to the Internet Industry
If the use of the Internet and commercial online services as media for commerce does not continue to grow, our business and prospects would be materially and adversely affected.
We cannot assure you that a sufficiently broad base of consumers will adopt, and continue to use, the Internet and commercial online services as media for commerce, particularly for purchases of wedding gifts and supplies. Even if consumers adopt the Internet or commercial online services as a media for commerce, we cannot be sure that the necessary infrastructure will be in place to process such transactions. Our long-term viability depends substantially upon the widespread acceptance and the development of the Internet or commercial online services as effective media for consumer commerce and for advertising. Use of the Internet or commercial online services to effect retail transactions and to advertise is at an early stage of development. Convincing consumers to purchase wedding gifts and supplies online may be difficult.
Demand for recently introduced services and products over the Internet and commercial online services is subject to a high level of uncertainty. Few proven services and products exist. The development of the Internet and commercial online services into a viable commercial marketplace is subject to a number of factors, including:
| • | continued growth in the number of users of such services; |
| • | concerns about transaction security; |
| • | continued development of the necessary technological infrastructure; |
| • | consistent quality of service; |
| • | availability of cost-effective, high speed service; |
| • | uncertain and increasing government regulation; and |
| • | the development of complementary services and products. |
If users experience difficulties because of capacity constraints of the infrastructure of the Internet and other commercial online services, potential users may not be able to access our sites, and our business and prospects would be harmed.
To the extent that the Internet and other online services continue to experience growth in the number of users and frequency of use by consumers resulting in increased bandwidth demands, there can be no assurance that the infrastructure for the Internet and other online services will be able to support the demands placed upon them. The Internet and other online services have experienced outages and delays as a result of damage to portions of their infrastructure, power failures, telecommunication outages, network service outages and disruptions, natural disasters and vandalism and other misconduct. Outages or delays could adversely affect online sites, e-mail and the level of traffic on all sites. We depend on online access providers that provide our users with access to our services. In the past, users have experienced difficulties due to systems failures unrelated to our systems. In addition, the Internet or other online services could lose their viability due to delays in the development or adoption of new standards and protocols required to handle increased levels of Internet or other online service activity or to increased governmental regulation. Insufficient availability of telecommunications services to support the Internet or other online services also could result in slower response times and negatively impact use of the Internet and other online services generally, and our sites in particular. If the use of the Internet and other online services fails to grow or grows more slowly than expected, if the infrastructure for the Internet and other online services does not effectively support growth that may
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occur or if the Internet and other online services do not become a viable commercial marketplace, it is possible that we will not be able to maintain profitability.
We may be unable to respond to the rapid technological change in the Internet industry and this may harm our business.
If we are unable, for technological, legal, financial or other reasons, to adapt in a timely manner to changing market conditions or customer requirements, we could lose users and market share to our competitors. The Internet and e-commerce are characterized by rapid technological change. Sudden changes in user and customer requirements and preferences, frequent new product and service introductions embodying new technologies and the emergence of new industry standards and practices could render our existing online sites and proprietary technology and systems obsolete. The emerging nature of products and services in the online wedding market and their rapid evolution will require that we continually improve the performance, features and reliability of our online services. Our success will depend, in part, on our ability:
| • | to enhance our existing services; |
| • | to develop and license new services and technology that address the increasingly sophisticated and varied needs of our prospective customers and users; and |
| • | to respond to technological advances and emerging industry standards and practices on a cost-effective and timely basis. |
The development of online sites and other proprietary technology entails significant technological and business risks and requires substantial expenditures and lead time. We may be unable to use new technologies effectively or adapt our online sites, proprietary technology and transaction-processing systems to customer requirements or emerging industry standards. Updating our technology internally and licensing new technology from third parties may require significant additional capital expenditures.
If we become subject to burdensome government regulation and legal uncertainties related to doing business online, our sponsorship and advertising and merchandise revenues could decline and our business and prospects could suffer.
Laws and regulations directly applicable to Internet communications, privacy, commerce and advertising are becoming more prevalent. Laws and regulations may be adopted covering issues such as user privacy, freedom of expression, pricing, unsolicited commercial e-mail (spam), content, taxation quality of products and services, advertising, intellectual property rights and information security. Any new legislation could hinder the growth in use of the Internet and other online services generally and decrease the acceptance of the Internet and other online services as media of communications, commerce and advertising. The governments of states and foreign countries might attempt to regulate our transmissions or levy sales or other taxes relating to our activities. The laws governing the Internet remain largely unsettled, even in areas where legislation has been enacted. It may take years to determine whether and how existing laws such as those governing intellectual property, privacy, libel and taxation apply to the Internet and Internet advertising services. In addition, the growth and development of the market for e-commerce may prompt calls for more stringent consumer protection laws, both in the United States and abroad, which may impose additional burdens on companies conducting business online. The adoption or modification of laws or regulations relating to the Internet and other online services could cause our sponsorship and advertising revenues and merchandise revenues to decline and our business and prospects to suffer.
We may be sued for information retrieved from our sites.
We may be subject to claims for defamation, negligence, copyright or trademark infringement, personal injury or other legal theories relating to the information we publish on our online sites. These types of claims have been brought, sometimes successfully, against online services as well as other print publications in the past. We could also be subject to claims based upon the content that is accessible from our online sites through links to other online sites or through content and materials that may be posted by members in chat rooms or bulletin boards. Our insurance, which covers commercial general liability, may not adequately protect us against these types of claims.
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We may incur potential product liability for products sold online.
Consumers may sue us if any of the products that we sell online are defective, fail to perform properly or injure the user. To date, we have had limited experience selling products online and developing relationships with manufacturers or suppliers of such products. We sell a range of products targeted specifically at brides and grooms through The Knot Registry, The Knot Shop, Bridalink.com or other e-commerce sites that we may acquire in the future. Such a strategy involves numerous risks and uncertainties. Although our agreements with manufacturers typically contain provisions intended to limit our exposure to liability claims, these limitations may not prevent all potential claims. Liability claims could require us to spend significant time and money in litigation or to pay significant damages. As a result, any such claims, whether or not successful, could seriously damage our financial results, reputation and brand name.
We may incur significant expenses related to the security of personal information online.
The need to transmit securely confidential information online has been a significant barrier to e-commerce and online communications. Any well-publicized compromise of security could deter people from using the Internet or other online services or from using them to conduct transactions that involve transmitting confidential information. Because our success depends on the acceptance of online services and e-commerce, we may incur significant costs to protect against the threat of security breaches or to alleviate problems caused by such breaches.
| Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
Market risk represents the risk of loss that may impact the financial position, result of operations, or cash flows of the company due to adverse changes in financial market prices, including interest rate risk, foreign currency exchange rate risk, commodity price risk, and other relevant market rate or price risks.
We are exposed to some market risk through interest rates related to the investment of our current cash and cash equivalents of approximately $22.7 million as of September 30, 2004. These funds are generally invested in highly liquid debt instruments with short-term maturities. As such instruments mature and the funds are re-invested, we are exposed to changes in market interest rates. This risk is not considered material and we manage such risk by continuing to evaluate the best investment rates available for short-term, high quality investments.
We have no activities related to derivative financial instruments or derivative commodity instruments, and we are not currently subject to any significant foreign currency exchange risk.
| Item 4. | Controls and Procedures |
The Company’s management, including the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as that term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of September 30, 2004. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in the reports that the Company files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms, and to ensure that such information is accumulated and communicated to the Company’s management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
There were no changes in the Company’s internal control over financial reporting during the quarter ended September 30, 2004 identified in connection with the evaluation thereof by the Company’s management, including the Chief Executive Officer and Chief Financial Officer, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
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PART II. OTHER INFORMATION
| Item 1. | Legal Proceedings |
On September 19, 2003, WeddingChannel.com, Inc. (“WeddingChannel”) filed a complaint against The Knot in the United States District Court for the Southern District of New York. The complaint alleges that The Knot has violated U.S. Patent 6,618,753 (“Systems and Methods for Registering Gift Registries and for Purchasing Gifts”), and further alleges that certain actions of The Knot give rise to various federal statute, state statute and common law causes of actions. WeddingChannel is seeking, among other things, unspecified damages and injunctive relief. If The Knot is found to have willfully infringed the patent-in-suit, enhanced damages are awardable. This complaint was served on The Knot on September 22, 2003.
Based on information currently available, The Knot believes that the claims are without merit and is vigorously defending itself against all claims. On October 14, 2003, The Knot filed an answer and counterclaims against WeddingChannel. The Knot’s answer raises various defenses to the counts alleged by WeddingChannel. Additionally, The Knot has brought counterclaims including a request that the court declare the patent-in-suit is invalid, unenforceable and not infringed. The Knot’s counterclaims further allege that certain actions taken by, or on behalf of WeddingChannel give rise to various federal statutory claims, state statutory claims and common law causes of action.
The Knot is engaged in other legal actions arising in the ordinary course of business and believes that the ultimate outcome of these actions will not have a material effect on its results of operations and financial position or cash flows.
31.1 | Certification of Chairman and Chief Executive Officer Pursuant to Exchange Act Rule 13a-14(a), As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| |
31.2 | Certification of Chief Financial Officer Pursuant to Exchange Act Rule 13a-14(a), As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| |
32.1 | Certification of Chairman and Executive Officer Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| |
32.2 | Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: November 12, 2004 | | THE KNOT, INC. |
|
| | By: |
/s/ Richard Szefc
|
| | | |
|
| | | | Richard Szefc
Chief Financial Officer (Principal Financial Officer
and Duly Authorized Officer) |
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EXHIBIT INDEX
Number | Description |
| |
31.1 | Certification of Chairman and Chief Executive Officer Pursuant to Exchange Act Rule 13a-14(a), As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| |
31.2 | Certification of Chief Financial Officer Pursuant to Exchange Act Rule 13a-14(a), As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| |
32.1 | Certification of Chairman and Chief Executive Officer Pursuant to 18 U.S.C Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| |
32.2 | Certification of Chief Financial Officer Pursuant to 18 U.S.C Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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