employees and non-employee directors at fair value on the date of grant and recognition of compensation expense over the related service periods for awards expected to vest. Under the modified perspective method, we recognize compensation expense for all stock awards granted after December 31, 2005, and for awards granted prior to January 1, 2006 that remained unvested as of that date or which may be subsequently modified.
The fair value of restricted stock is determined based on the number of shares granted and the quoted price of our common stock, and the fair value of stock options is determined using the Black-Scholes valuation model. The calculation for fair value of stock options requires considerable judgment including the estimation of stock price volatility, expected option lives and risk-free investment rates. We develop estimates based on historical data and market information which may change significantly over time and, accordingly, have a large impact on valuation.
Refer to the section entitled “Stock-Based Compensation” on page 22 for a further discussion of the impact of SFAS No. 123(R) on our recording of stock-based compensation for the three and six months ended June 30, 2006.
Net revenues were $17.7 million and $32.5 million for the three and six months ended June 30, 2006, respectively, compared to $13.6 million and $25.5 million for the corresponding periods in 2005.
Online sponsorship and advertising revenues increased to $8.4 million and $16.2 million for the three and six months ended June 30, 2006, respectively, as compared to $6.1 million and $11.8 million for the corresponding periods in 2005. Revenue from local vendor online advertising programs increased by $1.2 million and $2.3 million for the three and six months ended June 30, 2006, respectively, or by approximately 28% and 29% when compared to the corresponding periods in 2005, primarily as a result of an increase in the number and average spending of local vendor clients, including the continuing impact of price increases. In addition, there was an increase of $1.1 million and $2.0 million in national online sponsorship and advertising revenue for the three and six months ended June 30, 2006, or approximately 61% and 54%, respectively, when compared to the corresponding periods in 2005, largely due to an increase in the average spending by our national accounts. Online sponsorship and advertising revenues amounted to 47% of our net revenues for the three months ended June 30, 2006 and 45% for the three months ended June 30, 2005. For the six months ended June 30, 2006 and 2005, sponsorship and advertising revenues amounted to 50% and 46% of our net revenues, respectively.
Merchandise revenues, which consist primarily of the sale of wedding supplies, increased to $4.9 million and $8.0 million for the three and six months ended June 30, 2006, respectively, as compared to $4.1 million and $7.5 million for the corresponding periods in 2005. While retail supplies revenues were relatively flat in the first quarter of 2006, these revenues increased by $1.0 million in the three months ended June 30, 2006 or 28%. Site improvements and more effective marketing efforts resulted in increased traffic and sales with respect to the shopping areas on our site. The sale of wedding supplies to wholesale customers decreased by $102,000 and $225,000 for the three and six months ended June 30, 2006, respectively, as compared to the prior year. We previously conducted a review of our wholesale customer base and eliminated a number of marginally profitable accounts in 2004 and 2005. The balance of the merchandise revenue variance relates to registry revenue. In 2006, we are no longer maintaining inventory and recording sales of registry-related products. We are now generally receiving only commissions from the sale of products through our retail partnerships. Merchandise revenues amounted to 28% of our net revenues for the three months ended June 30, 2006 and 30% for the three months ended June 30, 2005. For the six months ended June 30, 2006 and 2005, merchandise revenue was 25% and 29% of our net revenues, respectively.
Publishing and other revenues increased to $4.5 million and $8.3 million for the three and six months ended June 30, 2006, respectively, as compared to $3.4 million and $6.2 million for the corresponding periods in 2005. Local print revenue increased by $875,000 and $1.2 million for the three and six months ended June 30, 2006, respectively, or approximately 28% and 29%, respectively, when compared to the corresponding periods in 2005, due to an increase in advertising pages sold, including pages associated with the local section of our national magazine, and a small increase in pricing. For the six months ended June 30, 2006, national print revenue increased by $309,000 or 19% as a result of an increase in the number of designer advertisers and advertising page rates for both designer and national advertisers. In 2006, we also recorded $131,000 and $361,000 in author royalties for the three and six months ended June 30, 2006, respectively, upon the delivery and acceptance of two new books from our current program of wedding and newlywed-related publications. Additionally, for the three and six months ended June 30, 2006, respectively, we recorded revenues of $263,000 and $309,000 from our bridal events program in partnership with Four Seasons Hotels and Resorts. Publishing and other revenue amounted to 25% of our net revenues for the three months ended June 30, 2006 and 2005. For the six months ended June 30, 2006 and 2005, publishing and other revenue was 26% and 24% of our net revenues, respectively.
Cost of Revenues
Cost of revenues consists of the cost of merchandise sold, including outbound shipping costs, 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 increased to $4.1 million and $7.2 million for the three and six months ended June 30, 2006, respectively, from $2.9 million and $5.8 million for the corresponding periods in 2005. Online advertising cost of revenue increased by $138,000 and $296,000 for the three and six months ended June 30, 2006, respectively, primarily due to the publication costs associated with The Knot TV. The cost of revenues from the sale of merchandise increased by $478,000 and $428,000 for the three and six months ended June 30, 2006, respectively, due to the increase in revenue in the second quarter and a small decline in margin as a result of increased product promotions. Publishing and other cost of revenue increased by $566,000 and $676,000 for the three and six months ended June 30, 2006, respectively, due to higher costs for both our national and local print publications as a result of increased advertising page counts and direct costs related to the bridal events program. These higher costs were offset, in part, by improved margins for our print publications driven by the gains in print advertising revenue. As a percentage of our net revenues, cost of revenues was 23% and 22% for the three and six months ended June 30, 2006, respectively, as compared to 21% and 23% for each of the corresponding periods in the prior year.
Product and Content Development
Product and content development expenses consist primarily of payroll and related expenses for editorial, creative and information technology personnel and computer hardware and software costs.
Product and content development expenses were relatively flat for the three months ended June 30, 2006 and 2005, and increased to $3.6 million for the six months ended June 30, 2006, as compared to the corresponding period in 2005. Personnel and related expenses increased by $202,000 and $404,000 for the three and six months ended June 30, 2006, respectively, primarily due to additional investments in information technology staff. These increases included approximately $25,000 and $54,000, respectively, related to stock-based compensation and were generally offset by reductions in costs for computer hardware and software and outside consultants. In addition, for the six months ended June 30, 2005, we incurred severance and other costs of approximately $120,000 in connection with the relocation of a significant portion of our information technology function to Austin, Texas. As a percentage of our net revenues, product and content development expenses decreased to 10% and 11%, respectively, for the three and six months ended June 30, 2006 from 13% and 14% for each of the corresponding periods in 2005.
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 increased to $4.4 million and $9.1 million for the three and six months ended June 30, 2006, respectively, from $3.5 million and $7.2 million for the corresponding periods in 2005. Personnel and
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related costs increased by $537,000 and $1.3 million for the three and six months ended June 30, 2006, respectively, primarily as a result of investments in national and local sales staff, in part, as additional support for sales efforts for new initiatives, including The Nest. These increases included approximately $68,000 and $122,000, respectively, related to stock-based compensation. We also incurred additional promotion costs of $135,000 and $289,000 for the three and six months ended June 30, 2006, respectively, as compared to the corresponding periods in 2005. For the six months ended June 30, 2006, we also incurred higher sales commissions and incentives of $122,000 in 2006 as a result of the increases in online advertising and print revenue. As a percentage of our net revenues, sales and marketing expenses were 25% and 28% for the three and six months ended June 30, 2006, respectively, and 26% and 28% for the corresponding periods in 2005.
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 decreased to $3.3 million and $6.6 million for the three and six months ended June 30, 2006, respectively, as compared to $3.9 million and $7.0 million for the corresponding periods in 2005. Legal and other professional costs related to our current litigation with WeddingChannel amounted to $11,000 and $151,000 during the three and six months ended June 30, 2006, respectively. On January 17, 2006, a stay was entered in the litigation between The Knot and WeddingChannel for a period of not less than 60 days, upon the joint request of the parties. Prior to the stay, we filed a series of summary judgment motions seeking to dismiss entirely and/or limit WeddingChannel’s claims for patent infringement, and WeddingChannel filed certain “cross-motions” for summary judgment concerning certain of our defenses. These motions were argued before the Court on September 28 and October 19, 2005, and have not yet been decided. On June 5, 2006, we entered into a definitive Agreement and Plan of Merger and Reorganization with WeddingChannel to acquire WeddingChannel. We expect that the litigation will be withdrawn effective as of the closing of the Merger. If, however, the Merger is not consummated, it is likely that the stay will be lifted and that the litigation will resume. In such an event, if our motions are unsuccessful and all or a portion of WeddingChannel’s patent infringement claims remain, the case may go to trial in the second half of 2006. Legal costs related to this litigation were $1.6 million and $2.3 million in the three and six months ended June 30, 2005, respectively. For the three months ended June 30, 2006, we recorded stock-based compensation expense of approximately $268,000, $129,000 in costs with respect to the development of a formal disaster recovery plan for the Company, consulting costs related to Sarbanes-Oxley compliance of $192,000, and additional professional and other legal costs of $214,000. For the six months ended June 30, 2006, we recorded stock-based compensation expense of approximately $513,000, $327,000 in costs with respect to the development of a formal disaster recovery plan for the Company, consulting costs related to Sarbanes-Oxley compliance of $260,000, and additional professional and other legal costs of $393,000. In March 2005, we incurred $95,000 in fees in connection with our re-listing on the Nasdaq National Market. As a percentage of our net revenues, general and administrative expenses decreased to 19% and 20% for the three and six months ended June 30, 2006, respectively, from 28% and 27% for each of the corresponding periods in 2005.
Stock-Based Compensation
The following table details the effect on net income and earnings per share had stock-based compensation expense been recorded based on the fair value method under SFAS No. 123, as amended, for the three and six months ended June 30, 2005.
| | | | | | | | |
| | | Three Months
Ended
June 30, 2005 | | Six Months
Ended
June 30, 2005 | |
| | |
| |
| |
| Net income, as reported | | $ | 1,339,609 | | $ | 1,748,717 | |
| Add: Total stock-based employee compensation expense included in reported net income | | | 0 | | | 0 | |
| Deducted: Total stock-based employee compensation expense determined under fair value method for all awards | | $ | (222,138 | ) | $ | (461,229 | ) |
| | |
|
| |
|
| |
| Net income, pro forma | | $ | 1,117,471 | | $ | 1,287,488 | |
| | |
|
| |
|
| |
| Basic earnings per share, as reported | | $ | 0.06 | | $ | 0.08 | |
| | |
|
| |
|
| |
| Basic earnings per share, pro forma | | $ | 0.05 | | $ | 0.06 | |
| | |
|
| |
|
| |
| Diluted earnings per share, as reported | | $ | 0.05 | | $ | 0.07 | |
| | |
|
| |
|
| |
| Diluted earnings per share, pro forma | | $ | 0.05 | | $ | 0.05 | |
| | |
|
| |
|
| |
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As of June 30, 2006, total unrecognized estimated compensation expense related to nonvested stock options, restricted shares and ESPP rights was $2.4 million, which is expected to be recognized over a weighted average period of 2.4 years. We currently believe that stock-based compensation expense for the calendar year ended December 31, 2006 will range from $1.5 million to $1.8 million.
Since June 2005, we have awarded shares of restricted stock as our primary form of stock-based compensation. However, we may elect to resume granting stock options in the future.
Depreciation and Amortization
Depreciation and amortization consists of depreciation and amortization of property and equipment and capitalized software, and amortization of intangible assets related to acquisitions.
Depreciation and amortization increased to $453,000 and $825,000 for the three and six months ended June 30, 2006, respectively, as compared to $280,000 and $561,000 for the corresponding periods in 2005. The increase was primarily due to increasing capital expenditures over calendar year 2005 and in the six months ended June 30, 2006, including amounts for our new e-commerce platform and additional computer hardware and software to establish secondary back-up systems in connection with the development of a formal disaster recovery plan for our Company and due to leasehold improvements to be made at our Omaha facility.
Interest Income
Interest income, net of interest expense, increased to $363,000 and $663,000 for the three and six months ended June 30, 2006, respectively, as compared to $167,000 and $297,000 for the corresponding periods in 2005. These increases were primarily the result of higher funds available for investment and higher interest rates.
Provision for Taxes on Income
For the three and six months ended June 30, 2006, we incurred income tax expense of $173,000 and $276,000, respectively, as compared to $79,000 and $114,000 for the corresponding periods in 2005. This was primarily due to operating income generated in certain states and a provision for federal minimum tax related to the use of our net operating loss carryforwards.
Liquidity and Capital Resources
As of June 30, 2006, our cash, cash equivalents and short-term investments amounted to $34.3 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 $6.4 million for the six months ended June 30, 2006. This resulted primarily from the net income for the period of $5.6 million, depreciation, amortization, non-cash services expense and stock-based compensation of $1.8 million, a decrease in accounts receivable, net of deferred revenue, of $961,000 due to improved collection efforts and further credit card usage by local vendors. These sources of cash were offset, in part, by an increase in other assets of $1.1 million due primarily to legal and other costs associated with the merger agreement with WeddingChannel, a decrease in accounts payable and accrued expenses of $456,000 and an increase in deferred production and marketing expenses of $204,000. Inventory also increased by $163,000 due to higher seasonal sales of wedding supplies in the second and third quarters. Net cash provided by operating activities was $3.7 million for the six months ended June 30, 2005. This resulted from the net income for the period of $1.7 million, depreciation, amortization and non-cash services expense of $779,000, a decrease in accounts receivable, net of deferred revenue, of $519,000 due to improved collection efforts and further credit card usage by local vendors and an increase in accounts payable and accrued expenses of $668,000. These sources of cash were offset, in part, by a small increase in inventory of $76,000.
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Net cash provided by investing activities was $17,000 for the six months ended June 30, 2006 due primarily to the sale of short-term investments, net of purchases, of $2.0 million offset, in part, by the purchases of property, equipment and software of $1.9 million. Net cash provided by investing activities was $7.8 million for the six months ended June 30, 2005 and consisted primarily of proceeds from the sale of short-term investments, net of purchases, of $9.6 million offset, in part, by purchases of property and equipment of $1.1 million and cash paid for the acquisition of the business and assets of GreatBoyfriends LLC of $621,000. We currently believe that purchases of property and equipment for the calendar year ended December 31, 2006 will increase to between $3.5 million and $4.0 million as a result of the planned acquisition of additional computer hardware and software to establish secondary back-up systems in connection with the development of a formal disaster recovery plan for our Company and due to leasehold improvements to be made at our Omaha facility.
Net cash provided by financing activities was $526,000 and $710,000 for the six months ended June 30, 2006 and 2005, respectively, primarily due to proceeds from the issuance of common stock in connection with the exercise of stock options and through our Employee Stock Purchase Plan.
Through June 30, 2006, we have reserved all future tax benefits resulting from tax deductions in excess of recognized stock-based compensation expense and, accordingly, we have not reflected any such benefits in our consolidated statements of cash flows.
We have only achieved operating income in recent periods, and we have an accumulated deficit of $36.7 million as of June 30, 2006. We believe that our current cash and cash equivalents will be sufficient to fund our working capital and capital expenditure requirements for the foreseeable future. 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.
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.
As of June 30, 2006, we had no material commitments for capital expenditures.
As of June 30, 2006, we had commitments under non-cancelable operating leases amounting to approximately $4.6 million.
As of June 30, 2006, other long-term liabilities of $480,000 substantially represented accruals to recognize rent expense on a straight-line basis over the respective lives of three 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 June 30, 2006 are summarized as follows:
| | | | | | | | | | | | | | | | |
| | Payments due by Period | |
| |
| |
Contractual Obligations | | Total | | Less than 1
year | | 1-3
years | | 3-5
years | | More than 5
years | |
| |
| |
| |
| |
| |
| |
| | (in thousands) | |
| | | |
Long term debt | | $ | 153 | | $ | 47 | | $ | 106 | | $ | — | | $ | — | |
Operating leases | | | 4,573 | | | 969 | | | 1,732 | | | 1,415 | | | 457 | |
Purchase commitments | | | 1,578 | | | 1,010 | | | 568 | | | — | | | — | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total | | $ | 6,304 | | $ | 2,026 | | $ | 2,406 | | $ | 1,415 | | $ | 457 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
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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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Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market risk represents the risk of loss that may impact the financial position, results 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, cash equivalents and short-term investments of approximately $34.3 million as of June 30, 2006. These funds are generally invested in highly liquid debt instruments. 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 June 30, 2006. 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 June 30, 2006 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.
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, damages and injunctive relief. If The Knot is found to have willfully infringed the patent-in-suit, enhanced damages may be awarded. This complaint was served on the Company 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 that the patent-in-suit is invalid, unenforceable and not infringed. On April 15, 2005, WeddingChannel specified that they were seeking damages in an amount ranging from approximately $1.1 million to in excess of approximately $13 million plus interest. The Knot raised defenses to WeddingChannel’s patent and other claims, which, if successful, would obviate or substantially limit any potential damages payments. WeddingChannel has also requested unspecified damages in connection with other claims set forth in its complaint.
The Knot has filed a series of summary judgment motions seeking to dismiss entirely and/or limit WeddingChannel’s claims for patent infringement, and WeddingChannel filed certain “cross-motions” for summary
26
judgment concerning certain of The Knot’s defenses. These motions were argued before the Court on September 28 and October 19, 2005, and have not yet been decided.
On January 17, 2006, a stay was entered in the litigation between The Knot and WeddingChannel for a period of not less than 60 days, upon the joint request of the parties. On June 5, 2006, we entered into a definitive Agreement and Plan of Merger and Reorganization (the “Merger Agreement”) pursuant to which WeddingChannel will become a wholly-owned subsidiary of The Knot (the “Merger”). We expect that the litigation will be withdrawn effective as of the closing of the Merger, and, therefore, that we will not suffer any harm to our business, results of operations or financial condition relating to this litigation.
If, however, the Merger is not consummated, it is likely that the stay will be lifted and that the litigation will resume. In such an event, if our motions are unsuccessful and all or a portion of WeddingChannel’s patent infringement claims remain, the case may go to trial in the second half of 2006. There can be no assurance that our answer or counterclaims against WeddingChannel will be successful. If our answer and our defenses do not succeed or if its counterclaims are found to be without merit, or if we determine to settle this litigation at a later date, we could suffer harm to our business and a material adverse effect to our financial condition and results of operations.
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, financial position or cash flows.
Item 1A. Risk Factors
Risks that could have a negative impact on our business, results of operations and financial condition include without limitation, (i) The Knot’s unproven business model, (ii) The Knot’s history of significant losses, (iii) the significant fluctuation to which The Knot’s quarterly revenues and operating results are subject, (iv) the risks and related costs associated with ongoing litigation, (v) the seasonality of the wedding industry and (vi) other factors detailed in documents The Knot files from time to time with the Securities and Exchange Commission. A more detailed description of each of these and other risk factors can be found under the caption “Risk Factors” in our most recent Annual Report on Form 10-K, filed on March 17, 2006.
In addition, the following risks could have a negative impact on our business, results of operations and financial condition:
Risks Related to the Pending Merger with WeddingChannel
We may fail to consummate our pending Merger with WeddingChannel, which could materially and adversely affect our business, results of operations and financial condition, as well as the trading price of our common stock.
On June 5, 2006, we announced that we entered into a definitive merger agreement (the “Merger Agreement”) with WeddingChannel, a privately-held provider of wedding planning and gift buying services. We refer to this transaction in this Quarterly Report on Form 10-Q as the “Merger.” Under the terms of the Merger Agreement, we will pay approximately $57.9 million in cash and issue 1,150,000 shares of our common stock in exchange for all of the outstanding capital stock and stock options of WeddingChannel. We intend to finance the cash portion of the purchase price through our existing cash resources and, subject to market conditions, the proceeds of a public offering of our common stock (the “Follow-On Offering”).
Separately, on July 10, 2006, we issued and sold 2,750,000 shares of its common stock in a private placement (the “Private Placement”) to three institutional investors at a price of $18.25 per share. The proceeds from the Private Placement will be used for general corporate purposes, including working capital and capital expenditures.
On August 10, 2006, we priced the Follow-On Offering for the sale of 2,000,000 shares of our common stock, at a public offering price of $16.00. We expect that the Follow-On Offering, the net proceeds of which we intend to use to fund part of the cash portion of the purchase price for our pending Merger with WeddingChannel, will be consummated on August 15, 2006, prior to the completion of the Merger. The consummation of the Merger is subject to closing conditions, including, among others, receipt of approval of WeddingChannel’s stockholders, receipt of necessary regulatory approvals, the absence of a material adverse effect on either party and material performance of
27
each party’s obligations under the Merger Agreement. We intend to consummate the Merger as soon as possible; however, we cannot assure you that the conditions required to consummate the Merger will be satisfied or waived on the anticipated schedule or at all.
In the event that we complete the Follow-On Offering but fail to consummate the Merger, we will have issued a significant number of additional shares of our common stock, but we will not have acquired the additional revenue sources anticipated to result from the Merger. Among other consequences, our earnings per share would likely decline because our earnings may not increase to an extent commensurate with the increase in our outstanding shares of common stock following the Follow-On Offering as well as our recently completed Private Placement. In addition, if the Merger is not completed, we estimate that we would have an additional $29.5 million of net proceeds from the Follow-On Offering, exclusive of net proceeds, if any, in the event the underwriters exercise some or all of their overallotment option of 952,500 shares of our common stock. These proceeds would be utilized by our management in its sole discretion. Furthermore, WeddingChannel’s litigation with us is likely to proceed if the Merger is not consummated. As a result, failure to consummate the Merger could materially and adversely affect our business, results of operations and financial condition, as well as the trading price of our common stock.
We may not realize the anticipated benefits of acquiring WeddingChannel.
The Knot and WeddingChannel entered into the Merger Agreement in order to, among other objectives, create a combined company that will serve as a more effective marketing resource for advertisers and that will achieve cost savings and operating efficiencies. Achieving the anticipated benefits of the Merger is subject to uncertainties, including whether The Knot integrates WeddingChannel in an efficient and effective manner, and general competitive factors in the marketplace. Failure to achieve these anticipated benefits could result in increased costs, decreases in expected revenues and diversion of management’s time and energy and could materially and adversely impact The Knot’s business, financial condition and results of operations.
We may experience difficulties integrating WeddingChannel with The Knot.
Integrating WeddingChannel’s operations into The Knot’s business will be a time-consuming process that will require considerable attention on the part of our management. We may experience unanticipated difficulties or expenses in connection with the integration of editorial, information technology and customer service functions. Similarly, the process of combining sales and marketing forces, consolidating information technology, communications and administrative functions, and coordinating product and service offerings can take longer, cost more, and provide fewer benefits than initially projected. To the extent any of these events occurs, the anticipated benefits of the Merger may not be realized, or may be realized more slowly than is currently expected. In addition, any failure to integrate the two companies in a timely and efficient manner may increase the risk that the Merger will result in the loss of customers or key employees or the continued diversion of the attention of management.
The Merger may result in a loss of customers, advertisers or suppliers, or a reduction in revenues from existing customers or advertisers.
Some customers of The Knot or WeddingChannel may seek alternative sources of services or products due to, among other reasons, a desire not to do business with the combined company or perceived concerns that the combined company may not continue to support and maintain certain services or customer service standards or develop certain product lines. Difficulties in combining operations could also result in the loss of suppliers or potential disputes or litigation with customers, suppliers or others. Any steps by management to counter such potential increased customer or supplier attrition may not be effective. Failure by management to control attrition could result in worse than anticipated financial performance.
Some advertisers have historically placed ads on both The Knot’s website and WeddingChannel’s website. It is possible, following the completion of the Merger, that these advertisers will decide to reduce their overall spending with the combined company as compared to their prior advertising spending with the two websites when they were separate and run by unrelated companies. To the extent that this occurs, this may have a material adverse effect on our business, financial condition and results of operations.
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The combined company will depend on a limited number of customers for some significant portion of our sales, and our financial success is linked to the success of our customers, our customers’ commitment to our services and products, and our ability to satisfy and retain our customers.
One customer would have accounted for more than 10% of our pro forma consolidated net revenues, after giving effect to the Merger, during the year ended December 31, 2005. We expect that this customer will continue to represent a significant portion of our net revenues in the future, especially with the consolidation that is occurring in the retail industry. The loss of this customer or a reduction in the amount of our net revenues generated by this customer could have a material adverse effect on our business, results of operations or financial condition.
The combined company will generate significant revenues from its registry services business, in which we will face various risks.
The registry services business of the combined company is dependent on the continued use of our website by our retail partners whose registries are posted on the website. While Federated Department Stores, Inc. (“Federated”) has entered into an extension of their current registry services contract with WeddingChannel, contingent upon the closing of the Merger, various other retailers have contracts with WeddingChannel that are coming up for renewal in the near future. In the event that one or more retail partners should decide not to renew their registry services agreements with WeddingChannel following the completion of the Merger, that could materially and adversely affect our business, results of operations and financial condition.
The registry services business of the combined company is also dependent on our retail partners keeping their respective websites operational, as well as on the traffic which visits those sites. We also rely on information provided by these partners to update and integrate registry information daily. Any decline in traffic or technical difficulties experienced by these websites may negatively affect the revenues of the combined company.
The fulfillment and delivery of products purchased by customers using our registry services is administered by our retail partners and, therefore, we are dependent on our retail partners to manage inventory, process orders and distribute products to our customers in a timely manner. If our retail partners experience problems with customer fulfillment or inventory management, or if we cannot integrate our processes with those of our partners, our business, results of operations and financial condition would be harmed.
The retail services business is highly competitive. Our retail partners compete for customers, employees, locations, products and other important aspects of their businesses with many other local, regional, national and international retailers, both online and offline. We are dependent on our retail partners to manage these competitive pressures, and to the extent they are unable to do so, we may experience lower revenue and/or higher operating costs, which could materially and adversely affect our results of operations.
The services and products of the combined company 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 will avoid knowingly infringing intellectual property rights of third parties, including licensed content, the combined company 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 continue our online offerings. Any effort to undertake such reengineering might not be successful.
The combined company will be dependent on certain key personnel, and the loss of any of these persons may prevent us from implementing our combined business plan in an effective and timely manner.
Our success depends, and the success of the combined company will depend, largely upon the continued services of our executive officers and other key personnel, including operational and information technology executives. Any loss or interruption of the services of one or more of our executive officers or these key personnel could result in our inability to manage our operations effectively and/or pursue our business strategy.
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The operating results of the combined company may fluctuate due to seasonality.
Seasonal and cyclical patterns may affect our revenues. Commissions from the sale of registry products and revenues from the sale of wedding-related merchandise are generally higher in the second and third quarters of each year. As a result of these factors, we may experience fluctuations in our revenues from quarter to quarter.
The Merger may adversely affect our financial results.
We are accounting for the Merger using purchase accounting. As a result, we expect to take a charge against our earnings for amortization of intangibles with a finite life, and we may be required to take other non-recurring charges, including writedowns of significant amounts of intangible assets with indefinite lives or goodwill. Our business, results of operations and financial condition may be harmed by such charges.
Future sales of shares of our common stock, or the perception that these shares might be sold, could cause the market price of our common stock to drop significantly.
If we complete the Follow-On Offering, we will have approximately 28,383,664 shares of our common stock outstanding (which includes the 2,750,000 shares of common stock issued in our recently completed Private Placement). Only certain of these shares are subject to lock-up restrictions with the underwriters of the Follow-On Offering, and these lock-up restrictions will expire 90 days following the date of the pricing of the Follow-On Offering. In addition, we will issue 1,150,000 shares of our common stock as part of the consideration paid to stockholders of WeddingChannel upon the completion of the Merger, and most of those shares will be freely tradeable following the closing of the Merger.
On July 20, 2006, The Knot first filed a shelf registration statement covering resales of the 2,750,000 shares of common stock by the institutional investors who purchased shares in the Private Placement. Those shares are freely tradeable.
Contingent upon the closing of the Merger, The Knot will grant to Federated registration rights for as long as it owns at least 5% of the outstanding common stock of The Knot, which rights will be exercisable commencing one year from the date on which the Merger is consummated. Certain other holders of our securities have, and certain future holders may be granted, rights to participate in, or require us to file, registration statements with the SEC for resales of common stock.
We cannot predict the effect, if any, that future sales of shares of our common stock into the market, or the availability of shares of common stock for future sale, will have on the market price of our common stock. Sales of substantial amounts of common stock (including shares issued upon the exercise of outstanding stock options), or the perception that such sales could occur, may materially and adversely affect prevailing market prices for our common stock.
In the event that the Merger is not consummated, it is likely that our litigation with WeddingChannel will resume.
As previously disclosed, in September 2003, WeddingChannel filed a complaint against us alleging, among other claims, that we have violated their U.S. Patent 6,618,753 (“Systems and Methods for Registering Gift Registries and for Purchasing Gifts”), and further alleging 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, damages and injunctive relief. If we are found to have willfully infringed the patent-in-suit, enhanced damages may be awarded.
We have filed an answer and counterclaims against WeddingChannel. Our answer raises various defenses to the counts alleged by WeddingChannel. Additionally, we have brought counterclaims including a request that the court declare that the patent-in-suit is invalid, unenforceable and not infringed.
On January 17, 2006, a stay was entered in the litigation between The Knot and WeddingChannel for a period of not less than 60 days, upon the joint request of the parties. Based on the pending Merger, we expect that the litigation will be withdrawn effective as of the closing of the Merger and, therefore, that we will not suffer any harm to our business, results of operations or financial condition relating to this litigation.
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If, however, the Merger is not consummated, it is likely that the stay will be lifted and that the litigation will resume. In such an event, if our motions are unsuccessful and all or a portion of WeddingChannel’s patent infringement claims remain, the case may go to trial in the second half of 2006. We cannot assure you that our answer or counterclaims against WeddingChannel will be successful. If our answer and our defenses do not succeed or if our counterclaims are found to be without merit, or if we determine to settle this litigation at a later date, we could suffer harm to our business and a material adverse effect to our financial condition and results of operations.
Our general and administrative expenses increased to $14.5 million for the year ended December 31, 2005, from $11.1 million for the year ended December 31, 2004 and $7.5 million for the year ended December 31, 2003. These expenses include legal fees related to the litigation with WeddingChannel of $4.8 million, $3.1 million and $136,000, respectively. Our general and administrative expenses were $3.3 million for the three months ended March 31, 2006 as compared to $3.1 million for the three months ended March 31, 2005, which include legal fees relating to the litigation with WeddingChannel of $180,000 and $683,000, respectively. We cannot predict at this time the amount of additional legal fees that we may incur. There can be no assurance that we will not incur substantial legal fees in 2006 or beyond in connection with this litigation, at levels equal to or greater than the amount of fees incurred in 2005.
Risks Related to the Securities Markets
Our stock price has been highly volatile and is likely to experience significant price and volume fluctuations in the future, which could result in substantial losses for our stockholders and subject us to litigation.
The equity trading markets may experience periods of volatility, which could result in highly variable and unpredictable pricing of equity securities. The market price of our common stock could change in ways that may or may not be related to our business, our industry or our operating performance and financial condition. In addition, the trading volume in our common stock may fluctuate and cause significant price variations to occur. Our common stock has experienced significant volume and price fluctuations in the past. For example, from July 1, 2005 through June 30, 2006, the market price of our common stock tripled, increasing from $6.95 to $20.93. Our current market price and valuation may not be sustainable. If the market price of our common stock declines significantly, you may be unable to resell your common stock at or above your purchase price. 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 subject of securities class action litigation, we could face substantial costs and be negatively affected by diversion of our management’s attention and resources. We cannot assure you that the market price of our common stock will not fluctuate or decline significantly, including a decline below your purchase price, in the future. In addition, the stock markets in general can experience considerable price and volume fluctuations, which could result in substantial losses for our stockholders.
Provisions in our articles of incorporation, bylaws and Delaware law may make it more difficult to effect a change in control, which could adversely affect the price of our common stock.
Provisions of our certificate of incorporation, bylaws and Delaware law could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders. We may issue shares of preferred stock in the future without stockholder approval and upon such terms as our board of directors may determine. Our issuance of this preferred stock could have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from acquiring, a majority of our outstanding stock and potentially prevent the payment of a premium to stockholders in an acquisition. In addition, our certificate of incorporation includes provisions giving the board the exclusive right to fill all board vacancies, providing for a classified board of directors and permitting removal of directors only for cause and with a super-majority vote of the stockholders.
These provisions also could discourage proxy contests and make it more difficult for you and other stockholders to elect directors and take other corporate actions. As a result, these provisions could make it more difficult for a third party to acquire us, even if doing so would benefit our stockholders, and may limit the price that investors are willing to pay in the future for shares of our common stock.
We are also subject to provisions of the Delaware General Corporation Law that prohibit business combinations with persons owning 15% or more of the voting shares of a corporation’s outstanding stock for three years following the date that person became an interested stockholder, unless the combination is approved by the board of directors
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prior to the person owning 15% or more of the stock, after which the business combination would be subject to special stockholder approval requirements. This provision could deprive our stockholders of an opportunity to receive a premium for their common stock as part of a sale of our company or may otherwise discourage a potential acquiror from attempting to obtain control from us, which in turn could have a material adverse effect on the market price of our common stock.
We have not paid cash dividends on our common stock and do not anticipate paying any dividends on our common stock in the foreseeable future.
We anticipate that we will retain all future earnings and other cash resources for the future operation and development of our business. As a result, we do not intend to declare or pay any cash dividends on our common stock in the foreseeable future. Payment of any future dividends will be at the discretion of our board of directors after taking into account many factors, including our operating results, financial conditions, current and anticipated cash needs and plans for expansion. Accordingly, investors must rely on sales of their common stock after price appreciation, which may not occur, as the only way to realize any future gains on their investment. Investors seeking cash dividends should not purchase our common stock.
Our executive officers, directors and principal stockholders exercise significant control over all matters requiring a stockholder vote.
As of August 7, 2006, our executive officers and directors and 5% stockholders, and their affiliates, in the aggregate, beneficially owned approximately 61.4% of our outstanding common stock. As a result, if some or all of these stockholders act as a group, they would be 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.
Item 4. Submission of Matters to a Vote of Security Holders
The Company held its Annual Meeting of Stockholders on May 24, 2006.
The stockholders elected Ann Winblad and Matthew Strauss to the class of directors whose terms expire at the 2009 Annual Meeting of Stockholders or until their successors are elected and have qualified.
The stockholders ratified the appointment of Ernst & Young LLP as the Company’s independent registered public accounting firm for the calendar year ending December 31, 2006.
Shares of common stock were voted as follows:
| | | | | | | | | | | | | |
Director Nominee or Proposal | | | For | | | Against/Withheld | | | Abstentions | | | Broker Non-
Votes | |
| | |
| | |
| | |
| | |
| |
Ann Winblad | | | 21,567,443 | | | 46,430 | | | 0 | | | 154,142 | |
Matthew Strauss | | | 21,564,752 | | | 49,121 | | | 0 | | | 154,142 | |
Ratification of Auditors | | | 21,563,205 | | | 46,291 | | | 4,376 | | | 154,143 | |
Item 6. Exhibits
| | |
| 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. |
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| | |
| 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. |
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: August 14, 2006 | 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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