SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------- FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended December 31, 2003 Commission File Number 000-28271 ---------- THE KNOT, INC. (Exact name of registrant as specified in its charter) Delaware 13-3895178 (State or other jurisdiction of (I.R.S. Employer Identification Number) incorporation or organization) 462 Broadway, 6th Floor New York, New York 10013 (Address of principal executive offices and zip code) (212) 219-8555 (Registrant's telephone number, including area code) ---------- Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01 par value ---------- Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2) Yes [ ] No [X] The aggregate market value of voting stock held by non-affiliates of the registrant as of June 30, 2003 was approximately $14,331,582 (based on the last reported sale price on the OTC Bulletin Board on that date). The number of shares outstanding of the registrant's common stock as of March 3, 2004 was 21,852,405. The registrant does not have any non-voting stock outstanding. ---------- Documents Incorporated By Reference Portions of Registrant's Proxy Statement for the 2004 Annual Meeting of Stockholders, which is to be filed subsequent to the date hereof, are incorporated by reference into Part III. 1 THE KNOT, INC. 2003 FORM 10-K ANNUAL REPORT TABLE OF CONTENTS Page ---- PART I Item 1. Business................................................................ 3 Item 2. Properties.............................................................. 21 Item 3. Legal Proceedings....................................................... 21 Item 4. Submission of Matters to a Vote of Security Holders..................... 22 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters... 22 Item 6. Selected Financial Data................................................. 23 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations................................................... 26 Item 7A. Quantitative and Qualitative Disclosures About Market Risk.............. 35 Item 8. Consolidated Financial Statements and Schedule.......................... 36 Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure.................................................... 59 Item 9A. Controls and Procedures................................................. 59 PART III Item 10. Directors and Executive Officers of the Registrant...................... 59 Item 11. Executive Compensation.................................................. 59 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters............................................. 59 Item 13. Certain Relationships and Related Transactions.......................... 60 Item 14. Principal Accountant Fees and Services.................................. 60 PART IV Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K......... 60 2 THIS REPORT MAY CONTAIN PROJECTIONS OR OTHER FORWARD-LOOKING STATEMENTS REGARDING FUTURE EVENTS OR THE FUTURE FINANCIAL PERFORMANCE OF THE KNOT. THESE STATEMENTS ARE ONLY PREDICTIONS AND REFLECT THE CURRENT BELIEFS AND EXPECTATIONS OF THE KNOT. ACTUAL EVENTS OR RESULTS MAY DIFFER MATERIALLY FROM THOSE CONTAINED IN THE PROJECTIONS OR FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS, AS MORE FULLY DESCRIBED IN THIS SECTION AND ELSEWHERE IN THIS REPORT. THE KNOT UNDERTAKES 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. PART I Item 1. Business Overview The Knot is one of the world's leading wedding media and services companies providing products and services to couples planning their weddings and future lives together. Our website, at www.theknot.com, is the most trafficked wedding destination online and offers comprehensive content, extensive wedding-related shopping, an online wedding gift registry and an active community. The Knot is the leading wedding content provider to America Online (AOL) and MSN. We publish The Knot Magazine, which features editorial content covering every major wedding planning decision and is distributed to newsstands and bookstores across the nation. Through our subsidiary, Weddingpages, Inc., we publish regional wedding magazines in 18 markets in the United States. We also author books on wedding related topics. We are based in New York and have several other offices across the country. We commenced operations in May 1996 and recorded our first revenues in September 1996, immediately following the launch of our first online property. Our website was launched in July 1997. We launched The Knot Registry, our online gift registry, in November 1998. In July 1999, we acquired the assets of Bridalink.com, an Internet wedding supply store. In March 2000, we acquired Weddingpages, the largest publisher of regional wedding magazines in the nation. Industry Background The Wedding Industry Each year, approximately 2.3 million couples get married in the United States. According to an independent research report, the domestic wedding market generates approximately $70 billion in retail sales annually. Presumed to be a once-in-a-lifetime occasion, a wedding is a major milestone event and, therefore, consumers tend to allocate significant budgets to the wedding and related purchases. The average amount spent on a wedding is approximately $22,000, excluding the honeymoon. Planning a wedding can be a stressful and confusing process. Engaged couples must make numerous decisions and expensive purchases. A typical wedding requires decisions and planning relating to bridal registries, invitations, wedding gowns and wedding party attire, wedding rings, photographers, music, caterers, flowers, honeymoons and more. In addition to the number of decisions faced by engaged couples, the fixed date and the emotional significance of the event intensify the stress. For the majority of engaged couples, the process of planning a wedding is an entirely new one. They do not know where to find the necessary information and services, how much services or goods should cost or when decisions need to be made. These planning decisions are further complicated because many couples choose to have their weddings in locations other than where they live. Researching and soliciting local wedding services from distant locations without traveling and making an enormous time commitment is extremely difficult. Today's to-be-weds are seeking reliable resources and information to assist in their planning and purchase decisions. Vendors and advertisers highly value to-be-weds as a consumer group. Replenished on an annual basis, wielding substantial budgets and facing a firm deadline, engaged couples are ideal recipients of advertisers' messages and vendors' products and services. During the six months prior to and the six months following a wedding, the average couple will 3 make more buying decisions and purchase more products and services than at any other time in their lives. The challenges and obstacles that engaged couples face make them especially receptive to marketing messages. Therefore, a disproportionate amount of advertising revenues are generated per subscriber by bridal magazines. According to Advertising Age, in 2002 the top three bridal magazines generated an average of $245 in revenues per reader, compared to an average of $78 in revenues per reader in the top three travel magazines and an average of $70 in revenues per reader in the top three women's magazines. The wedding market also represents significant opportunities for the retail industry. Engaged couples receive gifts from an average of 200 guests, most of whom are spending between $70 and $100. Because items are selected by the engaged couple but paid for by their guests, price sensitivity is minimal and registry products are rarely discounted by retailers. Registry for products in all categories has grown, prompting many national retailers -- previously without registries -- to enter the gift registry market. Weddings also generate substantial revenues for travel services companies. Honeymoon travel generates an estimated $4.5 billion annually. Over 99% of all newlyweds go on a honeymoon with an average cost of approximately $3,660 per couple. The Internet and the Wedding Industry To-be-weds are seeking a comprehensive resource to assist in their preparation and planning for a wedding. Because of its global reach and capacity to transmit information rapidly, the Internet represents an ideal medium over which to-be-weds can easily access information and communicate with the widely-dispersed providers of local wedding resources. According to the 2000 Census, the median age was 25 for first-time brides and 27 for first-time grooms, placing them in the demographic age group, 18 to 34 years, which currently comprises approximately 33.5% of all Web users. As Internet use continues to increase, engaged couples are turning to online resources as the first place they look for wedding products, information and registry services. In 2000, websites became the primary source of wedding information, with 30% of brides using the Internet at some point in their wedding planning, according to Brides Decide II by Greenfield Online. In addition, a USA Today poll found that 80% of the more than 2 million couples that married in 2001 used the Internet to help plan their wedding. Recognizing this trend, traditional providers of wedding resources are offering their services and products online. Like their offline equivalents, however, these online offerings are single-service/product focused. To-be-weds continue to search for a comprehensive solution to their information, planning and purchasing needs at a single destination. The Knot Services We offer both online and offline services to the wedding market. Our services include: Online Services Relevant Wedding Content. We provide creative up-to-date information and resources to attract users to our sites. Weddings are information-intensive events requiring extensive research, planning and decision-making. Our sites provide future brides and grooms with a searchable database that draws on thousands of articles on wedding planning and numerous interactive wedding planning tools including wedding checklists, a budgeter, a guest list manager personal wedding and newlywed Web pages and an online notebook, which may store favorite gowns, articles, vendors, honeymoons, wedding supplies and other planning information. Our online content is organized into five major areas of the site, which are My Knot, Ideas & Advice, Gowns, Local Resources and Index. The My Knot area organizes a member's profile information, interactive tool results, online notebook and local message boards, allowing him or her to easily access all the couple's wedding planning information in one place. We offer search tools for honeymoon locations, jewelry and tabletop products and each tool can be accessed from the My Knot area and from other appropriate content areas throughout the site. The Ideas & Advice area is further organized into channels, which cover all main content categories including planning, "Ask Carley", real weddings, proposals, fashion, beauty, grooms, the wedding party, love and life and honeymoons. Each of the channels offers articles, ideas and advice covering a wide range of perspectives, budgets, traditions and ethnicities. The Gowns area of the site offers a searchable bridal gown database with more than 20,000 gown images from over 200 designers plus searchable databases for bridesmaids, mother-of-the-bride and flower girl dresses, bridal accessories including headpieces, shoes and purses, engagement and wedding rings and tuxedos. In June 2003, we 4 launched The Knot Video Runway, a new broadband application available in the Gowns area. The Knot Video Runway is the first subscription-based online resource of its kind proving brides access to more than 60 wedding gown fashion shows offering previews of next season's wedding gowns well before they arrive in local salons. The Local Resources area provides access to the local wedding market through 60 online city guides that host profiles for thousands of local vendors, such as reception halls, bands, florists and caterers. Each local city guide provides a listing of the area's marriage license offices and upcoming bridal shows, a question and answer section with a local wedding expert and local message boards, where to-be-weds can discuss vendors in their market. Region-specific articles on many wedding topics including real wedding stories about local couples are also featured in the city guides. Through our local market expansion, we are able to influence many of the wedding-related decisions and purchases made on the local level. The Index area further organizes our content offerings with an "A-Z" of keywords which allows users to find information on 125 pre-selected wedding topics. For each selected keyword, a page displays articles, message board postings, "Ask Carley" questions and answers, promotions and other resources relating to that keyword as well as appropriate e-commerce offerings. The Index area also provides access to a dozen interactive search tools and more than 10 special feature content areas covering topics ranging from Registry Dos and Don'ts to Great Wedding Hairdos. Convenient, Comprehensive Shopping Experience. We integrate our informative content with comprehensive shopping services, which range from wedding gifts to a comprehensive array of supplies that relate to the wedding itself. We have created two shopping areas on The Knot website called The Knot Gift Store & Registry and The Knot Wedding Shop. The Knot Gift Store & Registry, which we believe is the Internet's most comprehensive wedding gift registry, offers a broad selection of products and services from over 700 well-recognized brands. Wedding guests can quickly and easily purchase gifts online or via phone or fax, 24-hours a day. We buy the majority of our products directly from manufacturers. This enables us to provide our users with a large selection of products from a wide range of categories, while maintaining a high level of customer service. We offer traditional registry categories such as tabletop, household appliances and electronics, in addition to non-traditional categories, such as outdoor recreational gear, barbeque grills and hi-tech entertainment products. In April 1999, we entered into a services agreement with QVC. Under this agreement, QVC provides us warehousing, sales, fulfillment and distribution services in connection with The Knot Registry. Our services agreement with QVC expired in December 2003; however, pursuant to the agreement, we had the option to continue to operate under the services agreement for an additional l80 days, which we are currently doing. We expect to begin to use our Redding, California warehouse and distribution facility to service The Knot Registry during 2004. We continue to explore other strategic distribution partnerships that would position us to capture a greater portion of the $17 billion wedding gift registry market. We have entered into agreements with two strategic partners through whom we are able to provide engaged couples access to an even wider range of products in the categories of tabletop and linens. In addition to product sourcing, these partners also provide us with fulfillment and distribution services with respect to these products. In February 2002, we initiated a strategic marketing alliance with May Department Stores Company ("May') that links our website to the wedding gift registry sites of May's full-line department store companies. Together, we have implemented a multi-platform marketing campaign to promote May's department store companies which offer wedding registry services -- Hecht's, Strawbridge's, Foley's, Robinsons-May, Filene's, Kaufmann's, Famous-Barr, L.S. Ayres, The Jones Stores and Meier & Frank -- to our online and offline audience of engaged couples and wedding guests. We sell wedding supplies to consumers through our integrated shopping destination, The Knot Wedding Shop, as well as through Bridalink.com. Bridalink.com is our separate online store for wedding supplies, which we maintain in order to attract additional users and generate further revenue. We offer 1,000 products, including decorated disposable cameras, wedding bubbles and bells, ring pillows, toasting flutes, car decorating kits, table centerpieces, goblets and glasses, garters and unity candles. These highly specialized items are often difficult to find through traditional retail outlets, and the purchase of these items is often left to the last minute. We offer personalization options for many of our wedding supplies such as toasting glasses, cake servers, napkins and wedding attendant gifts and favors. We have launched our own line of Knot-branded wedding supplies called The Knot Wedding Collections and our own line of 5 wedding-themed apparel. The Knot Wedding Collections which can be personalized as well, include ring pillows, flower girl baskets, guest books and pens. Consumers can place orders online, through a toll-free number, fax or via mail, 24-hours a day. In addition, we sell wedding supplies directly to other select bridal retailers through our wholesale wedding supplies division. This division offers all 800 products which are featured online at our wholesale website, WeddingSuppliesDirect.com, or in our wholesale catalog. Participating bridal retailers, numbering more than 1,000, have recognized that The Knot is a one-stop supplier for these items. Normally, retailers must purchase wedding supplies from as many as 10 suppliers to obtain the product mix offered through our wholesale program. Retailers can place orders through a toll-free number or fax during business hours or via mail. We fulfill all retail and wholesale wedding supplies orders from our warehouse and distribution facility located in Redding, California. Active Membership and Community Participation. The talk area of our online sites generate a high degree of member involvement through chats, message boards and personalized interactive services. To-be-weds actively seek forums to exchange ideas and ask questions during the planning process. We encourage and promote active participation within our online community. The Knot community features include 24-hour chat rooms on both America Online and the Web which allow our members to interact with other couples, as well as our own experts, on wedding planning issues and concerns. In addition to being topic-specific, the message boards can be regionalized, so a member can seek advice from other members in the same geographical area. Other interactive services allow users to prepare and modify their wedding budget, compile and manage their guest list and create personalized checklists and Web pages. Additionally, we send out several newsletters and emails to our members, many of which are targeted with specific information for the stage where these members are in their wedding planning process. Other newsletters and emails are focused on specific topics, such as registries and accessories or upcoming bridal events and new features on our site. Offline Services Local Wedding Magazines. Our subsidiary Weddingpages, Inc. publishes local wedding magazines in 18 markets. During 2003, we terminated our remaining franchise agreements. We currently license the name Weddingpages for use in publication by four former franchisees in five local markets. In our markets, The Knot WEDDINGPAGES magazines feature the look and feel of The Knot brand and combines the editorial expertise of The Knot with up-to-date, region-specific information, making these publications a must-have wedding planning companion for engaged couples. The Knot Magazine. We publish The Knot Magazine semiannually. This 700 plus page national publication is a comprehensive, searchable shopping guide providing directories of wedding gowns, fine jewelry, china, home products, invitations, wedding supplies and honeymoon packages. The gown section, which features over 800 dresses from the industry's top designers, is organized alphabetically by designer, and each gown image includes essential information that is not found in other bridal magazines - price range, detailed description and a coordinating URL that directs readers to The Knot website for additional dresses by the same designer. Also featured are over 600 photos of wedding party attire and accessories, including bridesmaid, mother-of-bride and flower girl dresses, veils, shoes, and tuxedos. Understanding the importance of localized wedding-planning information, we include a unique tool in the magazine - a store locator. As one of the most comprehensive bridal salon listings in the bridal magazine market, brides can comb through the store locator's organized, detailed salon listings to locate stores in their state that carry the designers they love. We sell The Knot Magazine through newsstands and bookstores across the nation and on our website. The Knot Book Series. The Knot has two book series. Our first book series consists of three books which have been published by Broadway Books, a division of Random House. We developed the content of each book through the interaction between our users and our wedding experts. This "real-world" approach, directed by our editorial team and based on user experience and feedback, distinguishes us from the approach of traditional wedding resources. The first two books in the series are detailed wedding-planning resources for to-be-weds, offering the information a bride and groom need to plan their wedding and include worksheets, checklists, etiquette, tips, calendars and answers to frequently-asked questions. Our third book in this series tackles tricky wedding-related topics including toasts, readings, music and personal vows and explains how couples can utilize each to personalize their own ceremony or reception. Our second book series consists of two books which have been published by Chronicle Books. This book series expands the consumer reach of The Knot to the gift book category. The first book, The Knot Book of Wedding Gowns, celebrates the evolution of the wedding gown while providing brides with all the information they need to make the big purchase. The second book, The Knot Book of Wedding Flowers, features over 175 pages of pictures and illustrations of bouquets, centerpieces and innovative ideas for floral accents. 6 Integrated Media Programs We provide advertisers and sponsors with targeted access to couples actively seeking information and advice and making meaningful spending decisions relating to all aspects of their weddings. We also offer advertisers and sponsors an opportunity to establish brand loyalty with first-time purchasers of many products and services. Editorial content and advertising are often integrated on our sites. For example, an article about wedding rings might feature an advertisement for a jeweler. Instead of traditional banners or buttons, our sponsors usually select our custom-developed marketing programs that offer special features, including interactive tools. Companies can also enter into arrangements to exclusively sponsor entire editorial areas or special features. We may also offer sponsors additional online promotional events such as a sweepstakes, newsletter and direct e-mail programs, or inclusion of their special offers in our membership gateway. With the acquisition of Weddingpages and the further development of The Knot Magazine, we have expanded the scope of the integrated marketing programs we offer to our online advertisers to include many offline features. For example, a program for an online sponsor could also include regional or national print advertising in these magazines. We have designed category specific standardized advertising programs in The Knot Magazine for Jewelry, Health and Beauty, Tabletop, Retail, Home, Finance and Travel. These programs allow a broad range of advertisers in these markets to gain targeted national exposure through a combination of our online programs and the national magazine. We have also expanded the programs that we are able to offer The Knot WEDDINGPAGES print advertisers. Local wedding vendors can supplement their print advertisements with profiles and sponsorship badges within their appropriate online city guide, and they can also reach their market areas through targeted local newsflash emails. Also, in 2003, we began to offer programs to local vendors that include advertising placement in The Knot Magazine. The current local resource directory in The Knot Magazine now approximates 100 pages with nearly 1,000 individual local vendor listings. The Knot Strategy Our objective is to expand our position as a leading wedding media and services company providing comprehensive wedding planning, information, products and services. Key elements of our business strategy include the following: Build Strong Brand Recognition. Building a dominant brand is critical to attracting and expanding both our online and offline user base and securing our leading position in the bridal market. We promote our brand through aggressive public relations outreach, securing television appearances featuring Carley Roney, our Editor in Chief and lead wedding expert. During 2003, she appeared on more than 30 national and local television programs including The Oprah Winfrey Show, NBC's TODAY, ABC's The View, Live with Regis & Kelly, CBS's The Early Show, CNN Headline News, Inside Edition and Fox News Report. Carley's presentations cover a variety of wedding topics from the most desirable engagement ring to the latest trends in wedding fashions or wedding registry must-haves, all of which relate to information or services available on our sites. In addition, Carley is frequently consulted for her wedding expertise by the nation's top print publications including The New York Times, Wall Street Journal, USA Today, InStyle, Vogue and Cosmopolitan. In January 2003, "Real Weddings from The Knot" -- our very own branded televised miniseries -- premiered on the Oxygen Network, and the second series aired in January 2004. The Knot collaborated with Oxygen in the creation and production of these two series, which followed couples planning through their wedding process in the weeks leading up to their nuptials. Through this reality-based show, we expanded the awareness of our brand and services to a broad national audience. Through The Knot WEDDINGPAGES magazines and the expansion of our in-depth online city guides, we are aggressively increasing our brand awareness at the local level. At the same time, we are taking advantage of the cross-promotional opportunities that offline publications afford our online properties and services. Our local advertising sales force further supports The Knot brand through participation in their local wedding professional associations and appearances at local bridal events. We continue to be the leading wedding content partner for AOL and MSN, providing their members and users with in-depth wedding planning information, interactive tools, wedding gown galleries and an online community. In 7 October 2003, we also became the exclusive wedding content provider for Comcast.net, extending our reach to their high-speed Internet customers. Aggressively Attract New Membership. We believe a large and active membership base is critical to our success. Membership enrollment is free. Our members enjoy the use of personal Web pages, message boards, budgeting and planning tools, wedding checklists and wedding fashion and honeymoon searches. During the first two months of 2004, we were enrolling an average of approximately 4,100 new members per day. Our priority is to increase member usage through our content and product offerings, interactive services, active community participation and strategic relationships. We recognize the importance of maintaining confidentiality of member information, and we have established a privacy policy to protect personal information. Our current privacy policy is set forth on our sites, and we are a licensee of the TRUSTe Privacy Program. Our policy is not to tell any third party any member's personal identifying information, but we may share aggregated information about our members with other pre-screened organizations who have specific direct mail product and service offers we think may be of interest to our members. We may share aggregated member information with third parties, such as zip code or gender. In addition, we may use information revealed by members and information built from user behavior to target advertisements, content and email. Capitalize on Multiple Revenue Opportunities. We intend to leverage the size and favorable demographics of our online and offline communities to continue to generate multiple revenue streams. We are focused on providing our sponsors and advertisers with targeted access to couples actively seeking information and making purchase decisions. We maximize our advertising revenues by offering targeted marketing opportunities to both our national advertising sponsors and local wedding vendors through the integration of advertising with editorial content on our site and in our magazines. With the addition of category specific advertising programs to our customized marketing campaigns, we have broadened the group of potential advertisers and sponsors who can benefit from targeting The Knot's audience. We have continued to expand the number of online markets and specific programs available to local vendors. Our efforts to attract advertisers are supported by a national sales force in New York, by a local sales force of approximately 45 people positioned in markets around the United States and by independent sales representative agencies. We expect to generate increasing online revenues from The Knot Registry and our convenient gift and wedding supplies shops. Through our wholesale wedding supplies division, we are extending our presence in the wedding supplies business to the offline retail market. We will pursue additional revenue opportunities in connection with the needs of today's engaged and newly married couples including premium services such as The Knot Video Runway. We also intend to extend the relationship we build with our users and provide access to additional products and services relevant to newlyweds and growing families. The pursuit of these strategies may involve potential acquisitions, or investments in, complementary businesses or products. Competition The Internet advertising and online wedding markets are new, rapidly evolving and intensely competitive, and we expect competition to intensify in the future. We face competition primarily from three separate areas: online sites, magazines and gift registries. There are many wedding-related sites on the Internet developed and maintained by online content providers. Retail stores, manufacturers, wedding magazines and regional wedding directories also have online sites which compete with us. We expect competition to increase because of the business opportunities presented by the growth of the Internet and e-commerce. Competition may also intensify as a result of industry consolidation and a lack of substantial barriers to entry in our market. We also face competition for our services from bridal magazines. Bride's and Modern Bride, both published by Conde Nast, are the two dominant bridal publications in terms of revenue and circulation. According to Advertising Age, these two magazines and Bridal Guide, the third leading bridal magazine, generated gross advertising revenues of $231.2 million in 2002. The Knot Registry faces competition from online sources such as registry aggregators. We compete with retail stores offering gift registries, especially from retailers offering specific bridal gift registries. These stores, particularly national department store chains, have strong brand awareness, many years of retailing experience and most now have 8 online transactional capabilities. Our wedding supplies business also faces competition from online sources and retail stores offering similar products. We believe that the principal competitive factors in the wedding market are brand recognition, convenience, ease of use, information, quality of service and products, member affinity and loyalty, reliability and selection. As to these factors, we believe that we compete favorably. Our dedicated editorial, sales and product staffs concentrate their efforts on producing the most comprehensive wedding resources available. Generally, many of our current and potential competitors have longer operating histories, significantly greater financial, technical and marketing resources and high name recognition. Therefore, these competitors have significant ability to attract advertisers and users. In addition, many of these competitors may be able to respond more quickly than we can to new or emerging technologies and changes in Internet user requirements and to devote greater resources than we do to the development, promotion and sale of services. There can be no assurance that our current or potential competitors will not develop products and services comparable or superior to those developed by us or adapt more quickly than we do to new technologies, evolving industry trends or changing Internet user preferences. Increased competition could result in price reductions, reduced margins or loss of market share, any of which would materially and adversely affect our business, results of operations and financial condition. Infrastructure, Operations and Technology Our technology infrastructure provides for continuous availability of our online services. There are three major components to our online services comprised of our Web, domain name service ("DNS") and Database servers. Our Web and DNS servers are fully redundant and allow for the failure of multiple components. We have multiple Database servers serving various parts of our site allowing us to section parts of the site for maintenance and upgrades. Our operation is dependent on the ability to maintain our computer and telecommunications system in effective working order and to protect our systems against damage from fire, theft, natural disaster, power loss, telecommunications failure or similar events. Our system hardware is co-located at Globix Corporation's New York, New York data center; and our operations depend, in part, on Globix's ability to protect its own systems and our systems from similar unexpected adverse events. Globix provides us with auxiliary power through the use of battery and diesel generators in the event of an unexpected power outage. We maintain multiple backups of our data, thus allowing us to quickly recover from any disaster. Additionally, at least once a week, copies of backup tapes are sent to off-site storage. Regular capacity planning allows us to quickly upgrade existing hardware and integrate new hardware to react quickly to a rapidly expanding member base and increased traffic to our sites. We generally operate at 99% uptime and no unexpected downtime. Key content management and e-commerce components are designed, developed and deployed by our in-house technology group. We also license commercially available technology when appropriate in lieu of dedicating our own human and financial resources. We employ several layers of security to protect data transmission and prevent unauthorized access. We keep all of our production servers behind firewalls. No outside access is allowed. Strict password management and physical security measures are followed. All systems are monitored 24/7, and emergency response teams respond to all alerts. We have also contracted the services of an outside company to independently monitor the site, including the e-commerce section of the site, to ensure that the site is available, that users can add items to their cart and that the checkout process completes successfully. E-commerce transactions employ secure sockets layer encryption to secure data transmitted between clients and servers. Credit card information captured during e-commerce transactions is never shared with outside parties, and we provide shoppers with a toll-free number to place orders by phone as an alternative to completing a transaction online. Government Regulation Laws applicable to e-commerce, online privacy and the Internet generally are becoming more prevalent. It is possible that new laws and regulations may be adopted regarding the Internet or other online services in the United States and foreign countries. Such new laws and regulations may address user privacy, freedom of expression, unsolicited commercial e-mail (spam), pricing, content and quality of products and services, taxation, advertising, intellectual property rights and information security. The nature of such legislation and the manner in which it may be interpreted and enforced cannot be fully determined at this time. Such legislation could subject us and/or our customers to potential liability or restrict our present business practices, which, in turn, could have an adverse effect on our business, results of operations and financial condition. In addition, the FTC has investigated the privacy practices of several companies that 9 collect information about individuals on the Internet. The adoption of any such laws or regulations might also decrease the rate of growth of Internet use generally, which, in turn, could decrease the demand for our service or increase our cost of doing business or in some other manner have a material adverse effect on our business, results of operations and financial condition. Specifically, several states have proposed legislation that would limit the use and disclosure of personally identifiable information gathered online about users. To obtain membership on our sites, a user must disclose their name, address, e-mail address and role in the wedding. We do not currently share any member's personal identifying information to third parties without the member's prior consent. We may share aggregated member information with third parties, such as a member's zip code or gender and may use information revealed by members and information built from user behavior to target advertising, content and e-mail. Because we rely on the collection and use of personal data from our members for targeting advertisements, we may be harmed by any laws or regulations that restrict our ability to collect or use this data. Privacy concerns in general may cause visitors to avoid online sites that collect behavioral information and even the perception of security and privacy concerns, whether or not valid, may indirectly inhibit market acceptance of our services. In addition, if our privacy practices are deemed unacceptable by watchdog groups or privacy advocates, such groups may attempt to harm our business by blocking access to our sites or disparaging our reputation and our business, and may have a material effect on our results of operation and financial condition. In addition, applicability to the Internet of existing laws governing issues such as property ownership, copyrights and other intellectual property issues, taxation, libel, obscenity and personal privacy is uncertain. It is uncertain how such existing laws may apply to or address the unique issues of the Internet and related technologies. For example, because our services are accessible throughout the United States, other jurisdictions may claim that we are required to qualify to do business as a foreign corporation in a particular state. We are currently qualified to do business in several states, however, our failure to qualify as a foreign corporation in a jurisdiction where we are required to do so could subject us to taxes and penalties for the failure to qualify and could result in our inability to enforce contracts in such jurisdictions. Any new legislation or regulation regarding the Internet, or the application of existing laws and regulations to the Internet, could harm us. The international regulatory environment relating to the Internet market could have a material and adverse effect on our business, results of operations and financial condition if we elect to expand internationally. In particular, the European Union privacy regulations limit the collection and use of some user information and subject data collectors to a restrictive regulatory regime. The cost of such compliance could be material, and we may not be able to comply with the applicable national regulations in a timely or cost-effective manner, if at all. Changes to existing laws or the passage of new laws intended to address these issues, including some recently proposed changes, could create uncertainty in the marketplace that could reduce demand for our services or increase the cost of doing business as a result of litigation costs or increased service delivery costs, or could in some other manner have a material adverse effect on our business, results of operations and financial condition. Intellectual Property and Proprietary Rights We regard our copyrights, service marks, trademarks, trade dress, trade secrets, proprietary technology and similar intellectual property as critical to our success, and rely on trademark and copyright law, trade secret protection, confidentiality and assignment of invention agreements, and/or license agreements with employees, customers, independent contractors, partners and others to protect our proprietary rights. We strategically pursue the registration of our trademarks and service marks in the United States, and have applied for and obtained registration in the United States for some of our trademarks and service marks, including "THE KNOT". Effective trademark, service mark, copyright and trade secret protection may not be available in every country in which our products and services are made available online. We have licensed in the past, and expect to continue to license in the future, some of our proprietary rights, such as trademarks or copyrighted material, to third parties. While we attempt to ensure that the quality of our brand is maintained by our licensees, there can be no assurance that our licensees will not take actions that might materially 10 adversely affect the value of our proprietary rights or reputation, which could have a material adverse effect on our business, financial condition and results of operations. The steps we have taken to protect our proprietary rights may not be adequate and third parties may infringe or misappropriate our copyrights, trademarks, trade secrets and similar proprietary rights. In addition, other parties may assert claims of infringement of intellectual property against us. Although we believe that our products and services do not infringe upon the intellectual property rights of others and that we have all rights necessary to utilize the intellectual property employed in our business, we may nonetheless be subject to claims alleging infringement of third-party intellectual property rights. Any such claims could require us to spend significant sums on litigation, pay damages, delay product installments, develop non-infringing intellectual property or acquire licenses to intellectual property that is the subject of any such infringement, which licenses may not be available on commercially reasonable terms, if at all. Therefore, such claims could have a material adverse effect on our business, results of operations and financial condition. Employees As of December 31, 2003, we had a total of 243 employees, of which 51 were involved in product and content development, 161 were involved in sales and marketing and 31 were involved in general and administrative functions. None of our employees is represented by a labor union. We have not experienced any work-stoppages, and we consider relations with our employees to be good. Available Information The Knot's website is located at www.theknot.com. The Knot makes available free of charge, on or through our website, our annual, quarterly and current reports, and any amendments to those reports, as soon as reasonably practicable after electronically filing such reports with, or furnishing to, the Securities and Exchange Commission ("SEC"). Information contained on The Knot's website is not part of this report or any other report filed with the SEC. The Knot's Code of Business Conduct and Ethics that applies to all officers, directors and employees, Code of Ethics for the Chief Executive Officer and Senior Financial Officers (and any amendments to, or waivers under such code) and the charters of the Audit and Compensation Committees of our Board of Directors are also available on The Knot's website and are available in print to any stockholder upon request by writing to The Knot, Inc., 462 Broadway, 6th floor, New York, New York, 10013, Attention: Investor Relations. 11 RISK FACTORS THAT MAY AFFECT FUTURE RESULTS Important Factors Regarding Forward-Looking Statements In addition to other information in this Annual Report on Form 10-K, 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 Annual Report on Form 10-K 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 Annual 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: o increase the audience on our sites; o broaden awareness of our brand; o strengthen user-loyalty; o offer compelling content; o maintain our leadership in generating traffic; o maintain our current, and develop new, strategic relationships; o attract a large number of advertisers from a variety of industries; o respond effectively to competitive pressures; o continue to develop and upgrade our technology; and o 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 December 31, 2003, our accumulated deficit was $47.4 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 12 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. 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: o the occurrence of extraordinary events, such as the attacks on September 11, 2001; o customers' budgetary constraints; o customers' internal acceptance reviews; o the success and continued internal support of advertisers' and sponsors' own development efforts; and o 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: o the level of online usage and traffic on our websites; o seasonal demand for e-commerce; o the addition or loss of advertisers; o the advertising budgeting cycles of specific advertisers; o the regional and national magazines' publishing cycles; o the amount and timing of capital expenditures and other costs relating to the expansion of our operations, including those related to acquisitions; o the introduction of new sites and services by us or our competitors; o changes in our pricing policies or the pricing policies of our competitors; and o general economic conditions, as well as economic conditions specific to the Internet, online and offline media and electronic commerce. 13 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. 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 20% of our net revenues for the year ended December 31, 2001, 23% of our net revenues for the year ended December 31, 2002 and 34% of our net revenues for the year ended December 31, 2003. Our national online sponsorship and advertising revenue was approximately $1.7 million for the year ended December 31, 2001, $1.9 million for the year ended December 31, 2002 and $4.4 million for the year ended December 31, 2003. 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. 14 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: o difficulties in integrating operations, technologies, products and personnel; o diversion of financial and management resources from existing operations; o risks of entering new markets; o potential loss of key employees; and o 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 continue our online offerings. Any 15 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. We depend upon QVC to provide us warehousing, fulfillment and distribution services, and system failures or other problems at QVC could cause us to lose customers and revenues. We have a services agreement with QVC to warehouse, fulfill and arrange for distribution of approximately 32% of our products, excluding products sold through our retail partners. Our services agreement with QVC expired in December 2003; however, pursuant to the agreement, we had the option to continue to operate under the services agreement for an additional l80 days, which we are currently doing. We expect to begin to use our Redding, California warehouse and distribution facility to service The Knot Registry during 2004. QVC does not have any obligation to renew this agreement. If we are unable to transfer these services to our facility and we are unable to further extend the services agreement with QVC, we would not be able, at least temporarily, to sell or ship certain of our products to our customers. We may be unable to engage alternative warehousing, fulfillment and distribution services on a timely basis or upon terms favorable to us. 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: o online services or websites targeted at brides and grooms as well as the online sites of retail stores, manufacturers and regional wedding directories; o bridal magazines, such as Bride's and Modern Bride (both part of the Conde Nast family); and o 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, high 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. 16 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 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 17 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. 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 December 31, 2003, 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 and 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 18 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. 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: o continued growth in the number of users of such services; o concerns about transaction security; o continued development of the necessary technological infrastructure; o consistent quality of service; o availability of cost-effective, high speed service; o uncertain and increasing government regulation; and o 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. 19 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 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: o to enhance our existing services; o to develop and license new services and technology that address the increasingly sophisticated and varied needs of our prospective customers and users; and o 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 20 services could cause our sponsorship and advertising 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. 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 2. Properties We currently lease approximately 20,000 square feet of space at our headquarters in New York City and we lease approximately 44,000 square feet of space for warehousing and operations in Redding, California. Weddingpages, our subsidiary in Omaha, Nebraska, leases approximately 16,000 square feet. The New York, Redding and Omaha leases expire on March 31, 2012, July 24, 2008 and October 15, 2005, respectively. Item 3. 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 21 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. Item 4. Submission of Matters to a Vote of Security Holders None. PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters PRICE RANGE OF COMMON STOCK Our common stock was quoted on the Nasdaq National Market under the symbol "KNOT" through August 22, 2001. Since that time, our common stock has been available for quotation on the OTC Bulletin Board under the symbol "KNOT.OB". The following table sets forth, for the periods indicated, the high and low sales prices per share of our common stock as reported on the OTC Bulletin Board: High Low ----- ----- 2002: First Quarter............... $0.94 $0.33 Second Quarter.............. $0.85 $0.36 Third Quarter............... $1.05 $0.22 Fourth Quarter.............. $0.95 $0.65 2003: First Quarter............... $1.05 $0.71 Second Quarter.............. $2.90 $0.90 Third Quarter............... $4.55 $2.60 Fourth Quarter.............. $5.00 $2.75 On December 31, 2003, the last reported sale price of the common stock on the OTC Bulletin Board was $4.00. On March 16, 2004, the last reported sale price of our common stock on the OTC Bulletin Board was $4.10. HOLDERS As of March 16, 2004, there were approximately 168 holders of record of our common stock. DIVIDEND POLICY We have never declared or paid any cash dividends on our capital stock. We currently intend to retain future earnings, if any, to finance the expansion of our business and do not expect to pay any cash dividends for the foreseeable future. Securities Authorized for Issuance Under Equity Compensation Plans Incorporated by reference to the section entitled "Equity Compensation Plan Information" in Item 12. 22 Recent Sale of Unregistered Securities On November 18, 2003, we sold an aggregate of 2,800,000 newly-issued shares of common stock, par value $0.01, for aggregate gross proceeds of $10.5 million, before placement fees and offering expenses. Allen & Company LLC acted as placement agent and received a fee of $525,000. The issuance was made under the exemption from registration provided by Section 4(2) of the Securities Act of 1933, as amended, because the issuance did not involve any public offering. We sold shares and received gross proceeds as follows: Purchaser Shares Gross Proceeds - ------------------------------------------------- --------- -------------- T. Rowe Price Associates, Inc. (1): T. Rowe Price New Horizons Fund .............. 1,350,000 $ 5,062,500 T. Rowe Price Global Technology Fund ......... 10,000 $ 37,500 T. Rowe Price Media & Telecommunications Fund 75,000 $ 281,250 TD Entertainment & Communications Fund ....... 15,000 $ 56,250 NYC 457/401K Small Cap Account ............... 50,000 $ 187,500 --------- ----------- Total ............................... 1,500,000 $ 5,625,000 Capital Research and Management Company (2): Smallcap World Fund, Inc. .................... 1,200,000 $ 4,500,000 American Funds Insurance Series - Global Small Capitalization Fund ....................... 100,000 $ 375,000 --------- ----------- Total .................................. 1,300,000 $ 4,875,000 ========= =========== Aggregate Total ........................ 2,800,000 $10,500,000 (1) These shares are owned by various individual and institutional investors, for which T. Rowe Price Associates, Inc. (Price Associates) serves as investment adviser with power to direct investments and/or sole power to vote the shares. For purposes of the reporting requirements of the Securities Exchange Act of 1934, as amended, Price Associates is deemed to be a beneficial owner of such shares; however, Price Associates expressly disclaims that it is, in fact, the beneficial owner of such shares. (2) These shares are owned by funds for which Capital Research and Management Company (Capital Research) serves as investment adviser. For purposes of the reporting requirements of the Securities Exchange Act of 1934, as amended, Capital Research is deemed to be a beneficial owner of such shares; however, Capital Research expressly disclaims that it is, in fact, the beneficial owner of such shares. Item 6. Selected Financial Data The selected balance sheet data as of December 31, 2003 and December 31, 2002 and the selected statement of operations data for the years ended December 31, 2003, 2002 and 2001 have been derived from our audited financial statements included elsewhere herein. The selected balance sheet data as of December 31, 2001, 2000 and 1999 and the statement of operations data for the years ended December 31, 2000 and 1999 have been derived from our audited financial statements not included herein. Unaudited pro forma basic and diluted net loss per share have been calculated assuming the conversion of all previously outstanding preferred stock into common stock, as if the shares had converted immediately upon their issuance. You should read these selected financial data in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations," our financial statements and the notes to those statements included elsewhere herein. Year Ended December 31, ----------------------------------------------------------------- 2003 (a) 2002 (b) 2001 (d) 2000(c)(d) 1999 (d) ----------- ----------- ----------- ----------- ---------- (in thousands, except share and per share data) Statement of Operations Data: Net revenues ................................... $ 36,697 $ 29,476 $ 24,120 $ 24,235 $ 5,126 Cost of revenues ............................... 11,717 10,224 8,872 6,689 1,441 ----------- ----------- ----------- ----------- ---------- 23 Gross profit ................................... 24,980 19,252 15,248 17,546 3,685 Operating expenses: Product and content development ............. 4,220 3,870 4,440 5,556 2,678 Sales and marketing ......................... 11,354 11,243 13,870 16,728 5,148 General and administrative .................. 7,505 7,295 8,801 8,840 3,629 Non-cash compensation ....................... 33 139 332 789 1,072 Non-cash sales and marketing ................ -- 653 653 653 290 Depreciation and amortization ............... 858 1,244 2,545 2,195 547 ----------- ----------- ----------- ----------- ---------- Total operating expenses ....................... 23,970 24,444 30,641 34,761 13,364 ----------- ----------- ----------- ----------- ---------- Income (loss) from operations ............... 1,010 (5,192) (15,393) (17,215) (9,679) Interest income, net ........................ 102 112 306 1,425 483 ----------- ----------- ----------- ----------- ---------- Income (loss) before income taxes ........... 1,112 (5,080) (15,087) (15,790) (9,196) Provision for income taxes .................. 50 -- -- -- -- ----------- ----------- ----------- ----------- ---------- Net income (loss) ........................... $ 1,062 $ (5,080) $ (15,087) $ (15,790) $ (9,196) =========== =========== =========== =========== ========== Earnings (loss) per share: Basic ....................................... $ 0.06 $ (0.28) $ (1.03) $ (1.08) $ (2.31) =========== =========== =========== =========== ========== Diluted ..................................... $ 0.05 $ (0.28) $ (1.03) $ (1.08) $ (2.31) =========== =========== =========== =========== ========== Weighted average number of shares used in calculating earnings (loss) per share: Basic ....................................... 18,900,861 17,909,492 14,716,741 14,603,381 3,982,358 =========== =========== =========== =========== ========== Diluted ..................................... 20,308,658 17,909,492 14,716,741 14,603,381 3,982,358 =========== =========== =========== =========== ========== Pro forma earnings (loss) per share: Basic ....................................... $ 0.06 $ (0.28) $ (1.03) $ (1.08) $ (0.96) =========== =========== =========== =========== ========== Diluted ..................................... $ 0.05 $ (0.28) $ (1.03) $ (1.08) $ (0.96) =========== =========== =========== =========== ========== Pro forma weighted average number of shares used in calculating net earnings (loss) per share Basic ....................................... 18,900,861 17,909,492 14,716,741 14,603,381 9,628,454 =========== =========== =========== =========== ========== Diluted ..................................... 20,308,658 17,909,492 14,716,741 14,603,381 9,628,454 =========== =========== =========== =========== ========== December 31, ----------------------------------------------- 2003(a) 2002(b) 2001 2000(c) 1999 ------- ------- ------- ------- ------- (in thousands, except share and per share data) Balance Sheet Data: Cash and cash equivalents ...... $22,511 $ 9,306 $ 6,782 $15,860 $40,006 Working capital ................ 16,933 5,563 3,790 16,078 41,137 Total assets ................... 38,707 27,775 26,010 41,354 45,486 Total stockholders' equity ..... 27,300 16,017 15,320 29,391 43,575 (a) As described in Note 9 of our financial statements, on November 20, 2003, the Company completed the sale of 2,800,000 shares of common stock to two institutional investor groups. Net proceeds after placement fees and other offering expenses were $9,872,000. (b) As described in Note 8 of our financial statements, on February 19, 2002, the Company entered into a Common Stock Purchase Agreement with May Bridal Corporation ("May Bridal"), an affiliate of May Department Stores Company, pursuant to which the Company sold 3,575,747 shares of its common stock to May Bridal for $5,000,000 in cash. (c) On March 29, 2000, the Company acquired Weddingpages, Inc. for $10.0 million in cash. (d) Includes amortization of goodwill. Quarterly Results of Operations Data The following table sets forth certain unaudited consolidated quarterly statement of operations data for the eight quarters ended December 31, 2003. This information is unaudited, but in the opinion of management, it has been prepared substantially on the same basis as the audited consolidated financial statements appearing elsewhere in this report and all necessary adjustments, consisting only of normal recurring adjustments, have been included in the amounts 24 stated below to present fairly the unaudited consolidated quarterly results of operations. The consolidated quarterly data should be read in conjunction with our audited consolidated financial statements and the notes to such statements appearing elsewhere in this report. The results of operations for any quarter are not necessarily indicative of the results of operations for any future period. Three Months Ended ------------------------------------------------------------------------------- Dec. 31 Sept. 30 June 30 Mar. 31 Dec. 31 Sept. 30 June 30 Mar. 31 2003 2003 2003 2003 2002 2002 2002 2002 ------- -------- ------- ------- ------- -------- ------- ------- (in thousands, except per share data) Net revenues $8,149 $9,739 $10,143 $8,665 $7,034 $8,036 $ 8,274 $ 6,132 Gross profit 6,060 6,345 6,840 5,735 5,026 5,145 5,341 3,740 Net income (loss) 284 202 772 (195) (551) (977) (1,061) (2,491) Net earnings (loss) per share --- Basic $ 0.01 $ 0.01 $ 0.04 $(0.01) $(0.03) $(0.05) $ (0.06) $ (0.15) Diluted $ 0.01 $ 0.01 $ 0.04 $(0.01) $(0.03) $(0.05) $ (0.06) $ (0.15) 25 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations You should read the following discussion and analysis in conjunction with our financial statements and related notes included elsewhere in this report. This discussion contains forward-looking statements relating to future events and the future performance of The Knot based on our current expectations, assumptions, estimates and projections about us and our industry. These forward-looking statements involve risks and uncertainties. Our actual results and timing of various events could differ materially from those anticipated in such forward-looking statements as a result of a variety of factors, as more fully described in this section and elsewhere in this report. We undertake no obligation to update publicly any forward-looking statements for any reason, even if new information becomes available or other events occur in the future. Overview The Knot is one of the world's leading wedding media and services companies providing products and services to couples planning their weddings and future lives together. Our website, at www.theknot.com, is the most trafficked wedding destination online and offers comprehensive content, extensive wedding-related shopping, an online wedding gift registry and an active community. The Knot is the leading wedding content provider to America Online (AOL) and MSN. We publish The Knot Magazine, which features editorial content covering every major wedding planning decision and is distributed to newsstands and bookstores across the nation. Through our subsidiary, Weddingpages, Inc., we publish regional wedding magazines in 18 markets in the United States. We also author books on wedding related topics. We are based in New York and have several other offices across the country. For the year ended December 31, 2003, we recorded net income of $1.1 million as compared to a net loss of $5.1 million for the year ended December 31, 2002. Our primary goal in 2003 was to achieve profitability, which we accomplished over the last three quarters and for the full fiscal year. The most significant factor contributing to the improvement in our bottom line in 2003 as compared to 2002 was the growth of national and local online advertising revenue. While overall revenues increased to $36.7 million for the year ended December 31, 2003 or 24% higher than revenues of $29.5 million in 2002, our higher margin online advertising revenues grew by $5.6 million to $12.5 million or over 80% as a result of the increased expansion of our client base at both the national and local level. Merchandise revenue, which primarily represents the sale of wedding supplies, increased by $1.8 million in 2003 or 13% over 2002, generally as a result of revenue increases of approximately 20% in the first six months of 2003 compared to the first six months of 2002. For the last six months of 2003, merchandise revenue increased by 5% compared to the last six months of 2002, which was due, in part, to the leveling of our new membership at approximately 1.1 million members in 2003 and 2002. New membership impacts supplies sales directly since our brides or members are the buyers. To respond to this trend, we have been developing a new e-commerce strategy which we expect to deploy during 2004 to improve our product merchandising, product selection and the online shopping experience on our sites. As part of this strategy, we also plan to install a new e-commerce platform, currently scheduled to launch in the fourth quarter of fiscal 2004, which we believe will help us better target and communicate with our members. Our primary goal is to increase the percentage of members who purchase merchandise from us online and their average spending to support further revenue growth from our existing membership. Publishing and other revenue declined slightly to $8.7 million in 2003 as compared to $8.9 million in 2002. An increase in national print revenue from The Knot Magazine of approximately $900,000 was generally offset by a decrease of $865,000 in local print advertising. The growing interest in online programs by local vendors continued to have some downward impact on their tendencies to buy print. We have responded to this trend by offering a new extended reach program to local vendors, which integrates local print and online media with placement in our national print publication. We believe that this program will help to augment local print revenue as we publish in 2004. Overall, product and content, sales and marketing and general and administrative expenses increased to an aggregate amount of $23.1 million from $22.4 million in 2002, or 3%. Personnel and related expenses increased by approximately $785,000 due to general compensation increases as well as staff increases in information technology and warehouse and fulfillment personnel to support growth in shipments of wedding supplies products. In 2003, we were generally able to leverage our existing national and local sales forces to support growth in our advertising revenue streams with sales force expense increases primarily related to higher sales commission expense of $655,000. Fulfillment and other costs related to the distribution of The Knot Magazine rose by approximately $240,000 due to an increase in the 26 number of copies printed. Operating expenses in 2003 were favorably impacted by the elimination of quarterly online distribution fees, which amounted to $1.2 million in 2002. With respect to non-cash charges, depreciation and amortization expenses decreased by $386,000 in 2003, as compared to 2002, due to the reduction of capital expenditures in 2001 and 2002 and as a result of certain assets acquired prior to 2001 becoming fully depreciated. In addition, amortization of non-cash sales and marketing, related to the issuance of a warrant to AOL in 1999, was completed as of December 31, 2002. In 2002, this amortization amounted to $653,000. In November 2003, we completed the sale of 2,800,000 shares of common stock to two institutional investor groups. Net proceeds after placement fees and other offering expenses were $9,872,000. We intend to use these proceeds for general corporate purposes including potential acquisitions, or investments in, complementary businesses or products. Critical Accounting Policies The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities on an on-going basis. We evaluate these estimates including those related to revenue recognition, allowances for doubtful accounts and returns, inventory reserves, impairment of intangible assets including goodwill and deferred taxes. Actual results may differ from these estimates under different assumptions or conditions. Revenue Recognition We derive revenues from the sale of online sponsorship and advertising contracts, from the sale of merchandise and from the publication of magazines. Online sponsorship revenues are derived principally from longer-term contracts currently ranging up to thirty-six months. Sponsorships are designed to integrate advertising with specific online editorial content. Sponsors can purchase the exclusive right to promote products or services on a specific online editorial area and can purchase a special feature on our sites. These programs commonly include banner advertisements and direct e-mail marketing. Online advertising revenues are derived principally from short-term contracts that typically range from one month up to one year. These contracts may include online banner advertisements, placement in our online search tools and direct e-mail marketing. They also include online listings, including preferred placement and other premium programs, in the local area of our website for local wedding vendors. Local vendors may purchase online listings through fixed term or open-ended subscriptions. Certain online sponsorship and advertising contracts provide for the delivery of a minimum number of impressions. Impressions are the featuring of a sponsor's advertisement, banner, link or other form of content on our sites. To date, we have recognized our sponsorship and advertising revenues over the duration of the contracts on a straight-line basis, as we have exceeded minimum guaranteed impressions. To the extent that minimum guaranteed impressions are not met, we are generally obligated to extend the period of the contract until the guaranteed impressions are achieved. If this were to occur, we would defer and recognize the corresponding revenues over the extended period. For the year ended December 31, 2003, our top seven advertisers accounted for 5% of our net revenues. For the year ended December 31, 2002, our top seven advertisers accounted for 4% of our net revenues. For the year ended December 31, 2001, our top eight advertisers accounted for 6% of our net revenues. Merchandise revenues include the selling price of wedding supplies and products from our gift registry sold by us through our websites as well as related outbound shipping and handling charges. Merchandise revenues also include commissions earned in connection with the sale of products from our gift registry under agreements with certain strategic partners. Merchandise revenues are recognized when products are shipped to customers, reduced by discounts as well as an allowance for estimated sales returns. 27 Publishing revenue includes print advertising revenue derived from the publication of The Knot Magazine and the publication of regional magazines by our subsidiary Weddingpages, Inc., as well as fees from the license of the Weddingpages name for use in publication by certain former franchisees. These revenues and fees are recognized upon the publication of the related magazines, at which time all material services related to the magazine have been performed, or as fees are earned under the terms of license agreements. Additionally, publishing revenues are derived from the sale of magazines on newsstands, in bookstores and online and from author royalties received related to book publishing contracts. Revenues from the sale of magazines are recognized when the products are shipped, reduced by an allowance for estimated sales returns. Royalties are recognized when all contractual obligations have been met, which typically include the delivery and acceptance of a final manuscript. For contracts with multiple elements, including programs which combine online and print advertising components, we allocate revenue to each element based on evidence of its fair value. Evidence of fair value is the normal pricing and discounting practices for those deliverables when sold separately. We defer revenue for any undelivered elements and recognize revenue allocated to each element in accordance with the revenue recognition policies set forth above. Allowance for Doubtful Accounts We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. During 2003, we experienced a further improvement in our collection efforts due, in part, to increased credit card usage and the receipt of amounts owed by former franchisees. Accordingly, as of December 31, 2003, we reduced our allowance for doubtful accounts to $414,000 from $774,000 as of December 31, 2002. In determining these allowances, we evaluate a number of factors, including the credit risk of customers, historical trends and other relevant information. If the financial condition of our customers were to deteriorate, additional allowances may be required. Inventory In order to record our inventory at its lower of cost or market, we assess the ultimate realizability of our inventory, which requires us to make judgments as to future demand and compare that with current inventory levels. We record a provision to adjust our inventory balance based upon that assessment. As our merchandise revenues grow, the investment in inventory will likely increase. It is possible that we may need to further increase our inventory provisions in the future. Goodwill As of December 31, 2003, we had recorded goodwill and other intangible assets of $8.7 million. In our most recent assessment of impairment of goodwill as of October 1, 2003, we made estimates of fair value using several approaches. In our ongoing assessment of impairment of goodwill and other intangible assets, we consider whether events or changes in circumstances such as significant declines in revenues, earnings or material adverse changes in the business climate, indicate that the carrying value of assets may be impaired. As of December 31, 2003, no impairment has occurred. Future adverse changes in market conditions or poor operating results of strategic investments could result in losses or an inability to recover the carrying value of the investments, thereby possibly requiring impairment charges in the future. Deferred Taxes A tax valuation allowance is established, as needed, to reduce net deferred tax assets to the amount for which recovery is probable. As of December 31, 2003, we have established a full valuation allowance of $18.8 million against our net deferred tax assets because of our history of operating losses. Depending on the amount and timing of taxable income we may ultimately generate in the future, as well as other factors including limitations which may arise from changes in the Company's ownership, we could recognize no benefit from our deferred tax assets, in accordance with our current estimate, or we could recognize some or all of their full value. Stock-Based Compensation 28 We account for stock-based compensation by using the intrinsic value based method in accordance with the provisions of Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. Accordingly, we only record compensation expense for any stock options granted with an exercise price that is less than the fair market value of the underlying stock at the date of grant. Results of Operations The following table sets forth for the periods presented certain data from our statement of operations, expressed as a percentage of net revenues. Year Ended December 31, -------------------------------------- 2003 2002 2001 2000 1999 ----- ----- ----- ----- ------ Net revenues......................... 100.0% 100.0% 100.0% 100.0% 100.0% Cost of revenues..................... 31.9 34.7 36.8 27.6 28.1 ----- ----- ----- ----- ------ Gross profit......................... 68.1 65.3 63.2 72.4 71.9 Operating expenses: Product and content development... 11.5 13.1 18.4 22.9 52.2 Sales and marketing............... 30.9 38.1 57.5 69.0 100.4 General and administrative........ 20.5 24.8 36.4 36.5 70.8 Non-cash compensation............. 0.1 0.5 1.4 3.3 20.9 Non-cash sales and marketing...... 0.0 2.2 2.7 2.7 5.7 Depreciation and amortization..... 2.3 4.2 10.6 9.1 10.7 ----- ----- ----- ----- ------ Total operating expenses............. 65.3 82.9 127.0 143.5 260.7 Income (loss) from operations........ 2.8 (17.6) (63.8) (71.1) (188.8) Interest income, net................. 0.2 0.4 1.3 5.9 9.4 ----- ----- ----- ----- ------ Income (loss) before income taxes.... 3.0 (17.2) (62.5) (65.2) (179.4) Provision for income taxes........... 0.1 0.0 0.0 0.0 0.0 ----- ----- ----- ----- ------ Net Income (loss).................... 2.9% (17.2)% (62.5)% (65.2)% (179.4)% ===== ===== ===== ===== ====== Years Ended December 31, 2003 and December 31, 2002 Net revenues increased to $36.7 million for the year ended December 31, 2003 from $29.5 million for the year ended December 31, 2002. Sponsorship and advertising revenues increased to $12.5 million for the year ended December 31, 2003, as compared to $6.9 million for the year ended December 31, 2002. Revenue from local vendor online advertising programs increased by $3.1 million or approximately 63% as a result of additional contracts sold which was due, in part, to the expansion in the number of local markets serviced and in the number of programs offered. In addition, there was an increase of approximately $2.4 million in national online sponsorship and advertising revenue due to a larger number of contracts sold including contracts related to our category specific programs. Sponsorship and advertising revenues amounted to 34% of our net revenues for the year ended December 31, 2003 and 23% of our net revenues for the year ended December 31, 2002. Merchandise revenues increased to $15.5 million for the year ended December 31, 2003, as compared to $13.7 million for the year ended December 31, 2002. This increase was primarily due to an increase in the sales of wedding supplies through our websites of $2.0 million or approximately 16% as a result of the expansion of product and service offerings and increases in the number of orders. Merchandise revenues amounted to 42% of our net revenues for the year ended December 31, 2003, as compared to 46% of our net revenues for the year ended December 31, 2002. Publishing and other revenues decreased to $8.7 million for the year ended December 31, 2003, as compared to $8.9 million for the year ended December 31, 2002. Revenue derived from The Knot Magazine increased by approximately $900,000 due to the sale of a larger number of designer and national advertising contracts and an increase in the number of copies sold as a result of increased distribution. This increase was generally offset by a decrease in local 29 print advertising of $866,000 due to a reduction in advertising pages sold in a majority of local markets. In addition, franchise service fees and royalties declined by $325,000 due to the termination of all remaining franchise agreements. This decline was offset, in part, by additional license fees of $140,000 from several former franchisees who continue to license the use of the Weddingpages name in their markets. Publishing and other revenue amounted to 24% of our net revenues for the year ended December 31, 2003, and 30% of our net revenues for the year ended December 31, 2002. Cost of Revenues Cost of revenues consists primarily 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 increased to $11.7 million for the year ended December 31, 2003 from $10.2 million for the year ended December 31, 2002. This was due, in part, to an increase in the cost of revenues from the sale of merchandise, which increased by $1.1 million as a result of increased sales of wedding supplies. Cost of revenues related to publishing also increased by $408,000 due to higher costs of $693,000 associated with The Knot Magazine as a result of both increased distribution and average book size. This increase was offset, in part, by a decline in cost of revenues of $286,000 related to regional print magazines as a result of a reduction in average book sizes. As a percentage of our net revenues, cost of revenues decreased to 32% for the year ended December 31, 2003, from 35% for the year ended December 31, 2002. The margin improvement resulted primarily from a greater mix of higher margin sponsorship and advertising revenue. This improvement was offset, in part, by a reduced publishing margin due to the investment associated with the increased number of copies distributed of The Knot Magazine in 2003. We expect to recover this investment from further growth in print advertising in future issues of this publication. Product and Content Development 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 $4.2 million for the year ended December 31, 2003, as compared to $3.9 million for the year ended December 31, 2002. These increases were primarily the result of higher personnel and related expenses primarily related to information technology staff and additional computer hardware and software costs to upgrade equipment and applications. As a percentage of our net revenues, product and content development expenses decreased to 11% for the year ended December 31, 2003, from 13% for the year ended December 31, 2002. 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 advertising and promotional activities and fulfillment and distribution of merchandise. Sales and marketing expenses increased to $11.4 million for the year ended December 31, 2003, from $11.2 million for the year ended December 31, 2002. Increases in personnel and related expenses of $536,000 to support the growth in sales of wedding supplies products, sales commission expense of $655,000 related to increased advertising revenue and $240,000 of higher fulfillment and other costs related to the increased distribution of The Knot Magazine was generally offset by the elimination of $1.2 million of annual distribution fees under our anchor tenant agreement with AOL. As a percentage of our net revenues, sales and marketing expenses decreased to 31% for the year ended December 31, 2003, from 38% for the year ended December 31, 2002. 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 debts. General and administrative expenses increased to $7.5 million for the year ended December 31, 2003, from $7.3 million for the year ended December 31, 2002. This increase was primarily due to higher personnel and related expenses 30 of $367,000 and increased fees of $146,000 for credit card usage related to higher merchandise and local online advertising revenue and a greater proportion of local vendors paying by credit card. These increases were offset, in part, by reduced bad debt expense of $250,000 as a result of improved collections from national advertisers, local vendors and former franchisees. As a percentage of our net revenues, general and administrative expenses decreased to 20% for the year ended December 31, 2003, from 25% for the year ended December 31, 2002. Non-Cash Compensation We recorded no deferred compensation during the year ended December 31, 2003. Amortization of deferred compensation decreased to $33,000 for the year ended December 31, 2003, from $139,000 for the year ended December 31, 2002. Non-Cash Sales and Marketing We recorded deferred sales and marketing of $2.3 million related to the issuance of a warrant to AOL in connection with our amended anchor tenant agreement in July 1999. Deferred sales and marketing was fully amortized as of December 31, 2002. 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 decreased to $858,000 for the year ended December 31, 2003, from $1.2 million for the year ended December 31, 2002. This 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 Interest and other income, net of interest expense, decreased to $102,000 for the year ended December 31, 2003, from $112,000 for the year ended December 31, 2002. This decrease was primarily the result of lower interest rates earned on cash invested. Provision for Taxes on Income For the year ended December 31, 2003, we were subject to income tax expense of $50,000 due to operating income generated in certain states. No federal income tax has been provided as we utilize net operating loss carryforwards. Years Ended December 31, 2002 and December 31, 2001 Net Revenues Net revenues increased to $29.5 million for the year ended December 31, 2002 from $24.1 million for the year ended December 31, 2001. Sponsorship and advertising revenues increased to $6.9 million for the year ended December 31, 2002, as compared to $4.9 million for the year ended December 31, 2001. Revenue from local vendor online advertising programs increased by $1.7 million or approximately 54% for the year ended December 31, 2002, primarily as a result of additional contracts sold and, in part, due to expansion in the number of local market services and programs offered. In addition, there was an increase of approximately $218,000 in national online sponsorship and advertising revenue primarily due to the launch of category specific programs. Sponsorship and advertising revenues amounted to 23% of our net revenues for the year ended December 31, 2002 and 20% of our net revenues for the year ended December 31, 2001. Merchandise revenues increased to $13.7 million for the year ended December 31, 2002, as compared to $8.1 million for the year ended December 31, 2001. This increase was primarily due to an increase in sales of wedding 31 supplies through our websites of $5.4 million, or by approximately 79% as a result of the expansion of product and service offerings, an increase in the average order size and increased traffic. Merchandise revenues amounted to 46% of our net revenues for the year ended December 31, 2002 and 34% of our net revenues for the year ended December 31, 2001. Publishing and other revenues decreased to $8.9 million for the year ended December 31, 2002, as compared to $11.1 million for the year ended December 31, 2001. An increase in revenue from The Knot Magazine of approximately $562,000 due primarily to a larger number of print advertising contracts sold was more than offset by a decrease in publishing revenue derived from the Weddingpages operation of $2.5 million. This decrease included approximately $695,000 associated with a reduction in the number of magazines published in local markets in 2002, principally in Florida, and $682,000 due to a net reduction in advertising pages sold in comparable markets, offset, in part, by $141,000 of additional revenue due to the timing of publication of The Knot WEDDINGPAGES magazines in certain markets. In addition, franchise service fees and royalties declined by $1.2 million due primarily to the termination of certain franchisees. Publishing and other revenues amounted to 30% for the year ended December 31, 2002 and 46% for the year ended December 31, 2001. Cost of Revenues Cost of revenues consists of the cost of merchandise sold, including outbound shipping costs, the costs related to the production of regional The Knot WEDDINGPAGES magazines and The Knot 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 $10.2 million for the year ended December 31, 2002, from $8.9 million for the year ended December 31, 2001. Cost of revenues from the sale of merchandise increased by $2.4 million for the year ended December 31, 2002, primarily as a result of the increased sales of wedding supplies. These increases were offset, in part, by a reduction in cost of revenue as a result of a decrease in publishing revenue due to fewer advertising pages sold and printed and by improved margins with respect to merchandise sales and publishing revenue. Our margins on the sale of wedding supplies have improved as a result of sourcing products at lower costs and the introduction of higher margin products. Publishing margins improved as a result of higher effective rates for print advertising in our regional The Knot WEDDINGPAGES magazines. As a percentage of our net revenues, cost of revenues decreased to 35% for the year ended December 31, 2002, from 37% for the year ended December 31, 2001. Product and Content Development Product and content development expenses consist primarily of payroll and related expenses for editorial, creative and information technology personnel. Product and content development expenses decreased to $3.9 million for the year ended December 31, 2002 from $4.4 million for the year ended December 31, 2001. This decrease was primarily the result of cost reduction initiatives, which reduced personnel and related expenses. As a percentage of our net revenues, product and content development expenses decreased to 13% for the year ended December 31, 2002, from 18% for the year ended December 31, 2001. 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 AOL anchor tenant agreements, advertising and promotional activities and fulfillment and distribution of merchandise. Sales and marketing expenses decreased to $11.2 million for the year ended December 31, 2002 from $13.9 million for the year ended December 31, 2001. The decrease was the result of various cost reduction initiatives, which reduced personnel and related expenses, commission expense and promotion expense by $704,000, $484,000, and $724,000, respectively. In addition, there was a reduction in fees of $823,000 under our International Anchor Tenant agreement with AOL. This agreement was amended effective March 31, 2001, to limit to France the international markets where we receive distribution from AOL. To effect this amendment with AOL, we incurred a one-time restructuring fee in the first quarter of 2001. As a percentage of our net revenues, sales and marketing expenses decreased to 38% for the year ended December 31, 2002, from 58% for the year ended December 31, 2001. 32 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 debts expenses. General and administrative expenses decreased to $7.3 million for the year ended December 31, 2002 from $8.8 million for the year ended December 31, 2001. This decrease was primarily due to reduced bad debt expense of $1.4 million as a result of improved collections from local vendors due, in part, to a higher proportion of payments made through credit cards, as well as improved collections from national advertisers and franchisees. In addition, general and administrative expenses were reduced as a result of cost reduction initiatives, which reduced personnel and related expenses by approximately $281,000. As a percentage of our net revenues, general and administrative expenses decreased to 25% for the year ended December 31, 2002 from 36% for the year ended December 31, 2001. Non-Cash Compensation We recorded no deferred compensation during the year ended December 31, 2002. Amortization of deferred compensation decreased to $139,000 from $332,000 for the year ended December 31, 2001. Non-Cash Sales and Marketing We recorded deferred sales and marketing of $2.3 million related to the issuance of a warrant to AOL in connection with our amended anchor tenant agreement in July 1999. Amortization of deferred sales and marketing was $653,000 for each of the years ended December 31, 2002 and 2001. Depreciation and Amortization Depreciation and amortization expenses consist of depreciation and amortization of property and equipment and capitalized software and amortization of goodwill and other intangible assets related to acquisitions. Depreciation and amortization expenses decreased to $1.2 million for the year ended December 31, 2002, from $2.5 million for the year ended December 31, 2001. The decrease was primarily due to the implementation of SFAS No. 142, effective January 1, 2002, resulting in goodwill no longer being amortized. For the year ended December 31, 2001, we recorded goodwill amortization of $1.2 million. We perform goodwill impairment tests on at least an annual basis. There can be no assurance that future goodwill impairment tests will not result in a charge to income. Interest Income Interest income, net of interest expense, decreased to $112,000 for the year ended December 31, 2002, from $307,000 for the year ended December 31, 2001. This decrease resulted from lower interest rates and lower average amounts of cash and cash equivalents available for investment. Recent Accounting Pronouncements In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 143, Accounting for Asset Retirement Obligations. This standard addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement of tangible long-lived assets and the associated asset retirement costs. We adopted SFAS No. 143 effective January 1, 2003. The adoption of this new statement did not have a material impact on our operating results or financial position. In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. This standard addresses issues regarding the recognition, measurement, and reporting of costs that are associated with exit and disposal activities, including restructuring activities that currently are accounted for pursuant to the guidance that the Emerging Issues Task Force set forth in Issue No. 94-3. The scope of SFAS No. 146 also includes (1) costs related to 33 terminating a contract that is not a capital lease, (2) termination benefits that employees who are involuntarily terminated receive under the terms of a one-time benefit arrangement that is not an ongoing benefit arrangement or an individual deferred compensation contract and (3) costs to consolidate facilities or relocate employees. SFAS No. 146 is required to be effective for exit or disposal activities initiated after December 31, 2002 and does not affect the recognition of costs under our current activities. Adoption of this standard may impact the timing of the recognition of costs associated with future exit or disposal activities, depending upon the actions initiated. In November 2002, the Emerging Issues Task Force (EITF") reached a consensus opinion on EITF 00-21 Revenue Arrangements with Multiple Deliverables. This Issue addresses the determination of whether an arrangement involving more than one deliverable contains more than one unit of accounting and how arrangement consideration should be measured and allocated to the separate units of accounting. The provisions of EITF Issue 00-21 are effective for revenue arrangements entered into for fiscal quarters beginning after June 15, 2003. The adoption of EITF No. 00-21 did not have a significant impact on our operating results or financial position. Liquidity and Capital Resources As of December 31, 2003, our cash and cash equivalents amounted to $22.5 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 $4.0 million for the year ended December 31, 2003. This resulted primarily from the net income for the period, as adjusted for depreciation and amortization, of $2.0 million, a decrease in accounts receivable, net of deferred revenue, of approximately $1.0 million due to improved collection efforts and an increase in credit card usage by local vendors, and an increase in accounts payable and accrued expenses of $647,000 due, in part, to the timing of payment of magazine production costs. 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 December 31, 2003. Net cash used in operating activities was $525,000 for the year ended December 31, 2002. This resulted primarily from the loss for the period, as adjusted for depreciation and amortization, of $3.0 million and an increase in inventory of $580,000, partially offset by an increase in accounts payable and accrued expenses of $1.5 million and a decrease in accounts receivable, net of deferred revenue, of approximately $1.4 million. Net cash used in investing activities was $866,000 for the year ended December 31, 2003 primarily due to purchases of property and equipment. Net cash used in investing activities was $383,000 for the year ended December 31, 2002, primarily due to purchases of property and equipment of $229,000, net of proceeds from the sale of property and equipment, and cash paid of $154,000 with respect to a termination liability resulting from the acquisition of Weddingpages. Net cash provided by financing activities was $10.1 million for the year ended December 31, 2003, primarily due to net proceeds of $9.9 million received in connection with a private placement of 2.8 million shares of common stock in November 2003. Net cash provided by financing activities was $3.4 million for the year ended December 31, 2002, primarily due to proceeds from May Bridal Corporation in connection with the issuance of 3,575,747 shares of our common stock for $5.0 million, less related costs, partially offset by debt repayments of $1.6 million, primarily the outstanding balance under Weddingpages' expired line of credit agreement. 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 $47.4 million as of December 31, 2003. 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. 34 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 December 31, 2003, we had no material commitments for capital expenditures. As of December 31, 2003, we had commitments under non-cancelable operating leases amounting to approximately $5.8 million. At December 31, 2003, other long term liabilities of $490,000 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 December 31, 2003 are summarized as follows: Payments due by period ----------------------------------------------------- (in thousands) Less than 1 1-3 3-5 More than 5 Total year years years years ------ ----------- ------ ------- ----------- Contractual Obligations Long term debt............... $ 235 $ 39 $ 90 $ 106 $ -- Operating leases............. 5,761 830 1,539 1,485 1,907 Purchase commitments......... 1,300 1,300 -- -- -- ------ ------ ------ ------ ------ Total.................. $7,296 $2,169 $1,629 $1,591 $1,907 ====== ====== ====== ====== ====== 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. Item 7A. 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 and cash equivalents of approximately $22.5 million as of December 31, 2003. 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. 35 Item 8. Consolidated Financial Statements and Schedule (a)(1) Consolidated Financial Statements INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE Page ---- Report of Independent Auditors................................................. 37 Consolidated Balance Sheets as of December 31, 2003 and 2002 .................. 38 Consolidated Statements of Operations for the years ended December 31, 2003, 2002 and 2001............................................................... 39 Consolidated Statements of Stockholders' Equity for the years ended December 31, 2003, 2002 and 2001 ........................................... 40 Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2002 and 2001............................................................... 41 Notes to Consolidated Financial Statements..................................... 43 Schedule II - Valuation and Qualifying Accounts............................... 58 The unaudited supplementary data regarding quarterly results of operations are incorporated by reference to the information set forth in Item 6, "Selected Financial Data", in the section captioned, "Quarterly Results of Operations Data". 36 Report Of Independent Auditors The Board of Directors and Stockholders of The Knot, Inc. We have audited the accompanying consolidated balance sheets of The Knot, Inc. (the "Company") as of December 31, 2003 and 2002, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2003. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company at December 31, 2003 and 2002, and the consolidated results of its operations and cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principle generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. Ernst & Young LLP New York, New York February 20, 2004 37 The Knot, Inc. Consolidated Balance Sheets December 31, 2003 2002 --------------------------- Assets Current assets: Cash and cash equivalents $ 22,511,025 $ 9,305,670 Restricted cash -- 251,871 Accounts receivable, net of allowances of $614,932 and $960,223 at December 31, 2003 and December 31, 2002, respectively. 2,882,784 4,791,458 Inventories 1,194,997 1,291,866 Deferred production and marketing costs 317,903 443,502 Other current assets 747,467 556,358 --------------------------- Total current assets 27,654,176 16,640,725 Property and equipment, net 2,005,977 1,948,481 Intangible assets, net 8,734,136 8,834,136 Other assets 312,741 351,570 --------------------------- Total assets $ 38,707,030 $ 27,774,912 =========================== Liabilities and stockholders' equity Current liabilities: Accounts payable and accrued expenses $ 5,790,211 $ 5,112,586 Deferred revenue 4,891,430 5,827,432 Current portion of long-term debt 39,446 137,674 --------------------------- Total current liabilities 10,721,087 11,077,692 Long term debt 195,455 234,901 Other liabilities 490,203 445,088 --------------------------- Total liabilities 11,406,745 11,757,681 Commitments and contingencies Stockholders' equity: Preferred stock, $0.001 par value; 5,000,000 shares authorized; no shares issued and outstanding at December 31, 2003 and 2002 -- -- Common stock, $.01 par value; 100,000,000 shares, authorized; 21,734,952 shares and 18,373,327 shares issued and outstanding at December 31, 2003 and 2002, respectively 217,349 183,733 Additional paid-in capital 74,532,686 64,399,894 Deferred compensation -- (54,835) Accumulated deficit (47,449,750) (48,511,561) --------------------------- Total stockholders' equity 27,300,285 16,017,231 =========================== Total liabilities and stockholders' equity $ 38,707,030 $ 27,774,912 =========================== See accompanying notes. 38 The Knot, Inc. Consolidated Statements Of Operations Year ended December 31, 2003 2002 2001 ---------------------------------------- Net revenues $36,696,947 $29,476,173 $ 24,120,463 Cost of revenues 11,717,657 10,223,839 8,872,203 ---------------------------------------- Gross profit 24,979,290 19,252,334 15,248,260 Operating expenses: Product and content development 4,219,332 3,870,493 4,439,834 Sales and marketing 11,354,316 11,242,814 13,870,456 General and administrative 7,505,181 7,294,694 8,801,435 Non-cash compensation 32,623 139,069 332,186 Non-cash sales and marketing -- 653,213 653,232 Depreciation and amortization 858,360 1,244,289 2,544,836 ---------------------------------------- Total operating expenses 23,969,812 24,444,572 30,641,979 ---------------------------------------- Income (loss) from operations 1,009,478 (5,192,238) (15,393,719) Interest income, net 102,333 111,859 306,570 ---------------------------------------- Income (loss) before income taxes 1,111,811 (5,080,379) (15,087,149) Provision for income taxes 50,000 -- -- ---------------------------------------- Net income (loss) $ 1,061,811 $(5,080,379) $(15,087,149) ======================================== Net earnings (loss) per share - basic $ 0.06 $ (0.28) $ (1.03) ======================================== Net earnings (loss) per share - diluted $ 0.05 $ (0.28) $ (1.03) ======================================== Weighted average number of common shares outstanding Basic 18,900,861 17,909,492 14,716,741 ======================================== Diluted 20,308,658 17,909,492 14,716,741 ======================================== See accompanying notes. 39 THE KNOT, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Preferred Stock Common Stock Additional --------------- ---------------------- Paid-In Deferred Shares Amount Shares Par Value Capital Compensation ------ ------ ---------- --------- ----------- ------------ Balance at December 31, 2000 ................. -- $-- 14,676,253 $146,762 $59,657,388 $(763,074) --- --- ---------- -------- ----------- --------- Issuance of common stock in connection with exercise of vested stock options .......... -- -- 14,579 146 3,215 -- Issuance of common stock in connection with employee stock purchase plan .............. -- -- 45,221 452 27,495 -- Amortization of deferred compensation ........ -- -- -- -- -- 332,186 Amortization of deferred sales and marketing ................................. -- -- -- -- -- -- Reversal of deferred compensation related to common stock options forfeited ......... -- -- -- -- (175,905) 175,905 Net loss for the year ended December 31, 2001 ......................... -- -- -- -- -- -- --- --- ---------- -------- ----------- --------- Balance at December 31, 2001 ................. -- $-- 14,736,053 $147,360 $59,512,193 $(254,983) --- --- ---------- -------- ----------- --------- Issuance of common stock to May Bridal Corp., net of costs of approximately $33,000 ..... -- -- 3,575,747 35,758 4,931,243 -- Issuance of common stock in connection with employee stock purchase plan .............. -- -- 61,527 615 17,538 -- Amortization of deferred compensation ........ -- -- -- -- -- 139,068 Amortization of deferred sales and marketing ................................. -- -- -- -- -- -- Reversal of deferred compensation related to common stock options forfeited ............ -- -- -- -- (61,080) 61,080 Net loss for the year ended December 31, 2002 ......................... -- -- -- -- -- -- --- --- ---------- -------- ----------- --------- Balance at December 31, 2002 ................. -- $-- 18,373,327 $183,733 $64,399,894 $ (54,835) --- --- ---------- -------- ----------- --------- Issuance of common stock in connection with a private placement, net of costs of approximately $628,000 ................. -- -- 2,800,000 28,000 9,844,000 -- Issuance of common stock in connection with exercise of vested stock options .......... -- -- 501,875 5,019 294,864 -- Issuance of common stock in connection with employee stock purchase plan .............. -- -- 59,750 597 16,140 -- Amortization of deferred compensation ........ -- -- -- -- -- 32,623 Reversal of deferred compensation related to common stock options forfeited ............ -- -- -- -- (22,212) 22,212 Net income for the year ended December 31, 2003 ......................... -- -- -- -- -- -- --- --- ---------- -------- ----------- --------- Balance at December 31, 2003 ................. -- $-- 21,734,952 $217,349 $74,532,686 $ -- --- --- ---------- -------- ----------- --------- Deferred Total Sales and Accumulated Stockholders' Marketing Deficit Equity ----------- ------------ ------------- Balance at December 31, 2000 ................. $(1,306,445) $(28,344,033) $ 29,390,598 ----------- ------------ ------------ Issuance of common stock in connection with exercise of vested stock options .......... -- -- 3,361 Issuance of common stock in connection with employee stock purchase plan .............. -- -- 27,947 Amortization of deferred compensation ........ -- -- 332,186 Amortization of deferred sales and marketing ................................. 653,232 -- 653,232 Reversal of deferred compensation related to common stock options forfeited ......... -- -- -- Net loss for the year ended December 31, 2001 ......................... -- (15,087,149) (15,087,149) ----------- ------------ ------------ Balance at December 31, 2001 ................. $ (653,213) $(43,431,182) $ 15,320,175 ----------- ------------ ------------ Issuance of common stock to May Bridal Corp., net of costs of approximately $33,000 ..... -- -- 4,967,001 Issuance of common stock in connection with employee stock purchase plan .............. -- -- 18,153 Amortization of deferred compensation ........ -- -- 139,068 Amortization of deferred sales and marketing ................................. 653,213 -- 653,213 Reversal of deferred compensation related to common stock options forfeited ......... -- -- -- Net loss for the year ended December 31, 2002 ......................... -- (5,080,379) (5,080,379) ----------- ------------ ------------ Balance at December 31, 2002 ................. $ -- $(48,511,561) $ 16,017,231 ----------- ------------ ------------ Issuance of common stock in connection with a private placement, net of costs of approximately $628,000 ................. -- -- 9,872,000 Issuance of common stock in connection with exercise of vested stock options .......... -- -- 299,883 Issuance of common stock in connection with employee stock purchase plan .............. -- -- 16,737 Amortization of deferred compensation ........ -- -- 32,623 Reversal of deferred compensation related to common stock options forfeited ......... -- -- -- Net income for the year ended December 31, 2003 ......................... -- 1,061,811 1,061,811 ----------- ------------ ------------ Balance at December 31, 2003 ................. $ -- $(47,449,750) $ 27,300,285 ----------- ------------ ------------ See accompanying notes. 40 The Knot, Inc. Consolidated Statements of Cash Flows Year ended December 31, 2003 2002 2001 ---------------------------------------- Operating activities Net income (loss) $ 1,061,811 $(5,080,379) $(15,087,149) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization 758,360 1,144,289 1,276,879 Amortization of intangibles 100,000 100,000 1,267,957 Amortization of deferred compensation 32,623 139,069 332,186 Amortization of deferred sales and marketing -- 653,213 653,232 Reserve for returns 1,523,832 942,698 881,841 Allowance for doubtful accounts 51,414 301,713 1,701,619 Other non-cash charges 16,764 64,667 114,921 Changes in operating assets and liabilities: Restricted cash 251,871 (67,452) (184,419) Accounts receivable 333,428 (1,023,939) 539,331 Inventories 96,869 (580,286) 94,373 Deferred production and marketing costs 125,599 (149,973) 856,080 Other current assets (191,109) 222,417 131,875 Other assets 38,829 21,304 17,898 Accounts payable and accrued expenses 647,208 1,525,894 (143,356) Deferred revenue (936,002) 1,144,539 (526,466) Other liabilities 45,115 117,665 131,415 ---------------------------------------- Net cash provided by (used in) operating activities 3,956,612 (524,561) (7,941,783) Investing activities Purchases of property and equipment (827,739) (277,135) (397,105) Proceeds from sales of property and equipment -- 48,000 - Acquisition of businesses, net of cash acquired (38,400) (153,599) (349,605) ---------------------------------------- Net cash used in investing activities (866,139) (382,734) (746,710) Financing activities Proceeds from short term borrowings -- -- 497,295 Repayment of short term and current portion of long term borrowings (99,274) (1,554,240) (917,683) Issuance costs (602,464) (33,000) -- Proceeds from issuance of common stock 10,516,737 5,018,154 27,947 Proceeds from exercise of stock options 299,883 -- 3,361 ---------------------------------------- Net cash provided by (used in) financing activities 10,114,882 3,430,914 (389,080) ---------------------------------------- Increase (decrease) in cash and cash equivalents 13,205,355 2,523,619 (9,077,573) Cash and cash equivalents at beginning of year 9,305,670 6,782,051 15,859,624 ---------------------------------------- Cash and cash equivalents at end of year $22,511,025 $ 9,305,670 $ 6,782,051 ======================================== 41 The Knot, Inc. Consolidated Statements of Cash Flows (continued) Year ended December 31, 2003 2002 2001 ------------------------- Summary of non-cash investing and financing activities Accrued financing costs in connection with a private placement of common stock $25,536 $-- $ -- Forgiveness of accounts receivable in connection with a business acquisition -- -- 226,951 ------------------------- Total non-cash investing and financing activities $25,536 $-- $226,951 ========================= Supplemental disclosure of cash flow information: Year ended December 31, 2003 2002 2001 ---------------------------- Cash paid for interest $29,287 $61,843 $173,302 Cash paid for income taxes $94,000 -- -- See accompanying notes. 42 THE KNOT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2003 1. Organization and Nature of Operations The Knot, Inc. (the "Company") was incorporated in the state of Delaware on May 2, 1996. The Company is one of the world's leading wedding media and services companies providing products and services to couples planning their weddings and future lives together. The Company's website, at www.theknot.com, is the most trafficked wedding destination online and offers comprehensive content, extensive wedding-related shopping, an online wedding gift registry and an active community. The Company is the leading wedding content provider to America Online (AOL) and MSN. The Company publishes The Knot Magazine, which features editorial content covering every major wedding planning decision and is distributed to newsstands and bookstores across the nation. Through its subsidiary, Weddingpages, Inc., the Company publishes regional wedding magazines in 18 markets in the United States. The Company also authors books on wedding related topics. The Company is based in New York and has several other offices across the country. Since its inception in May 1996, with the exception of fiscal 2003, the Company has experienced annual operating losses and has an accumulated deficit of $47,449,750 as of December 31, 2003. The Company believes that its current cash and cash equivalents will be sufficient to fund its 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 the Company will sustain profitable operations, due to significant uncertainties surrounding its estimates and expectations. 2. Summary of Significant Accounting Policies Principles of Consolidation The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. Use of Estimates Preparing financial statements in conformity with accounting principles generally accepted in the Unites States requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Actual results may differ from these estimates. Interim results are not necessarily indicative of results for a full year. Restricted Cash Restricted cash as of December 31, 2002 included money held in escrow with the Company's bankcard processing services provider. 43 Fair Value of Financial Instruments The carrying amounts of cash and cash equivalents, accounts receivable and accounts payable approximate fair value due to the short-term nature of these instruments. The carrying amounts of outstanding borrowings approximate fair value. Cash and Cash Equivalents The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Cash equivalents were approximately $21,203,000 and $8,067,000 at December 31, 2003 and 2002, respectively. The market value of the Company's cash equivalents approximates their cost plus accrued interest. Inventory Inventory consists of finished goods and raw materials. Inventory costs are determined principally by using the average cost method and are stated at the lower of cost or net realizable value. Deferred Production and Marketing Costs Deferred production and marketing costs include certain magazine production and commission costs which are deferred and expensed upon publication and prepaid sales commissions which are expensed as the related revenue is recognized. Property and Equipment Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets which range from three to seven years. Leasehold improvements are amortized over the shorter of their estimated useful lives or the term of the related lease agreement. Goodwill, Other Intangible and Long-Lived Assets Goodwill is the excess of purchase price over the fair value of identified net assets of businesses acquired. The Company adopted Statement of Financial Accounting Standards ("SFAS") No. 142 Goodwill and Other Intangible Assets and SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, effective January 1, 2002. Goodwill and intangible assets deemed to have indefinite lives are no longer amortized but instead are subject to annual impairment tests in accordance with the provisions of SFAS No. 142. Other intangible assets are amortized over their respective useful lives and reviewed for impairment whenever events or changes in circumstances such as significant declines in revenues, earnings or cash flows or material adverse changes in the business climate indicate that the carrying amount of an asset may be impaired. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the assets to future estimated undiscounted net cash flows expected to be generated by the assets. If the assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. As of December 31, 2003, no impairment has occurred. Income Taxes The Company accounts for income taxes on the liability method as required by SFAS No. 109, Accounting for Income Taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequence attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. 44 Deferred tax liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax liabilities of a change in tax rates is recognized in results of operations in the period that includes the enactment date. Net Revenues by Type Net revenues by type are as follows: Year Ended December 31, --------------------------------------- 2003 2002 2001 ----------- ----------- ----------- Sponsorship and advertising...... $12,462,452 $ 6,888,024 $ 4,922,866 Merchandise...................... 15,510,269 13,673,709 8,097,671 Publishing and other............. 8,724,226 8,914,440 11,099,926 ----------- ----------- ----------- Total............................ $36,696,947 $29,476,173 $24,120,463 =========== =========== =========== For the years ended December 31, 2003, 2002 and 2001, merchandise revenue included outbound shipping and handling charges of approximately $1,756,000, $1,614,000 and $923,000, respectively. Revenue Recognition The Company derives revenues from the sale of online sponsorship and advertising contracts, from the sale of merchandise and from the publication of magazines. Online sponsorship revenues are derived principally from longer-term contracts currently ranging up to thirty-six months. Sponsorships are designed to integrate advertising with specific online editorial content. Sponsors can purchase the exclusive right to promote products or services on a specific online editorial area and can purchase a special feature on our sites. These programs commonly include banner advertisements and direct e-mail marketing. Online advertising revenues are derived principally from short-term contracts that typically range from one month up to one year. These contracts may include online banner advertisements, placement in our online search tools and direct e-mail marketing. They also include online listings, including preferred placement and other premium programs, in the local area of our website for local wedding vendors. Local vendors may purchase online listings through fixed term or open-ended subscriptions. Certain online sponsorship and advertising contracts provide for the delivery of a minimum number of impressions. Impressions are the featuring of a sponsor's advertisement, banner, link or other form of content on our sites. To date, the Company has recognized its sponsorship and advertising revenues over the duration of the contracts on a straight-line basis, as the Company has exceeded minimum guaranteed impressions. To the extent that minimum guaranteed impressions are not met, the Company is generally obligated to extend the period of the contract until the guaranteed impressions are achieved. If this were to occur, the Company would defer and recognize the corresponding revenues over the extended period. Merchandise revenues include the selling price of wedding supplies and products from the Company's gift registry sold through its websites as well as related outbound shipping and handling charges. Merchandise revenues also include commissions earned in connection with the sale of products from the Company's gift registry under agreements with certain strategic partners. Merchandise revenues are recognized when products are shipped to customers, reduced by discounts as well as an allowance for estimated sales returns. 45 Publishing revenue includes print advertising revenue derived from the publication of The Knot Magazine and the publication of regional magazines by the Company's subsidiary Weddingpages, Inc., as well as fees from the license of the Weddingpages name for use in publication by certain former franchisees. These revenues and fees are recognized upon the publication of the related magazines, at which time all material services related to the magazine have been performed, or as fees are earned under the terms of license agreements. Additionally, publishing revenues are derived from the sale of magazines on newsstands, in bookstores and online and from author royalties received related to book publishing contracts. Revenues from the sale of magazines are recognized when the products are shipped, reduced by an allowance for estimated sales returns. Royalties are recognized when all contractual obligations have been met, which typically include the delivery and acceptance of a final manuscript. For contracts with multiple elements, including programs which combine online and print advertising components, the Company allocates revenue to each element based on evidence of its fair value. Evidence of fair value is the normal pricing and discounting practices for those deliverables when sold separately. The Company defers revenue for any undelivered elements and recognizes revenue allocated to each element in accordance with the revenue recognition policies set forth above. Deferred Revenue Deferred revenue represents payments received or billings in excess of revenue recognized related to online and print advertising contracts. Cost of Revenues Cost of revenues consists of the cost of merchandise sold, including outbound shipping costs, the production costs of regional and national wedding magazines, payroll and related expenses for personnel who are responsible for the production of online and offline media and costs of Internet and hosting services. Cost of revenues by type are as follows: Year Ended December 31, -------------------------------------- 2003 2002 2001 ----------- ----------- ---------- Sponsorship and advertising......... $ 446,479 $ 504,297 $ 585,942 Merchandise......................... 8,041,269 6,897,402 4,534,482 Publishing and other................ 3,229,909 2,822,140 3,751,779 ----------- ----------- ---------- Total............................... $11,717,657 $10,233,839 $8,872,203 =========== =========== ========== Advertising Costs Advertising costs are expensed as incurred. Advertising expense totaled approximately $114,000, $103,000 and $82,000 for the years ended December 31, 2003, 2002 and 2001, respectively. Concentration of Credit Risk Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents and accounts receivable. Cash and cash equivalents are deposited with three major financial institutions. The Company's customers are primarily concentrated in the United States. The Company performs on-going credit evaluations, generally does not require collateral, and 46 establishes an allowance for doubtful accounts based upon factors surrounding the credit risk of customers, historical trends and other information. To date, such losses have been within management's expectations. At December 31, 2003 and December 31, 2002, no single customer accounted for more than 2% and 3%, respectively, of accounts receivable. Stock-Based Compensation Stock-based compensation is accounted for by using the intrinsic value-based method in accordance with the provisions of Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations, and the Company complies with the disclosure provisions of SFAS No. 123, Accounting for Stock-Based Compensation as amended by SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure. Accordingly, the Company only records compensation expense for any stock options granted with an exercise price that is less than the fair market value of the underlying stock at the date of grant. The Company does not record compensation expense for rights to purchase shares under its Employee Stock Purchase Plan ("ESPP") because it satisfies certain conditions under APB 25. 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 (see Note 10). Year Ended December 31, --------------------------------------- 2003 2002 2001 ---------- ----------- ------------ Net income (loss), as reported ................... $1,061,811 $(5,080,379) $(15,087,149) Add: Total stock-based employee compensation expense included in reported net income (loss) ........................................ 32,623 139,069 332,186 Deduct: Total stock-based employee compensation expense determined under fair value method for all awards ................................ (588,692) (573,683) (970,896) ---------- ----------- ------------ Net income (loss), pro forma $ 505,742 $(5,514,993) $(15,725,859) ========== =========== ============ Basic earnings (loss) per share, as reported $ 0.06 $ (0.28) $ (1.03) ========== =========== ============ Basic earnings (loss) per share, pro forma $ 0.03 $ (0.31) $ (1.07) ========== =========== ============ Diluted earnings (loss) per share, as reported $ 0.05 $ (0.28) $ (1.03) ========== =========== ============ Diluted earnings (loss) per share, pro forma $ 0.02 $ (0.31) $ (1.07) ========== =========== ============ The fair value for options and ESPP rights granted have been estimated on the date of grant using the minimum value method option pricing model from inception through December 1, 1999, the day prior to the Company's initial public offering of its common stock, and using the Black-Scholes pricing model thereafter. For purposes of pro forma disclosures, the estimated fair value of stock-based employee compensation is amortized to expense over the related vesting period and valuation allowances are included for net deferred tax assets. Net Income/Loss Per Share The Company computes net income or loss per share in accordance with SFAS No. 128, "Earnings per Share." Basic net income or loss per share is computed by dividing net income or loss by the weighted average number of common shares outstanding during the period. Diluted net income or loss per share adjusts basic income or loss per share for the effects of convertible securities, stock options and other potentially dilutive financial instruments, only in the periods in which such effect is dilutive. For the year ended December 31, 2003, the weighted average number of shares used in calculating diluted earnings per 47 share includes options to purchase common stock of 1,407,798. The calculation of earnings or loss per share for the year December 31, 2003 excludes the weighted average number of securities listed below because to include them in the calculation would be antidilutive. Year Ended December 31, 2003 --------- Options to purchase common stock 737,000 Common stock warrant 438,000 --------- 1,175,000 ========= There were no dilutive securities for the years ended December 31, 2002 and 2001. Segment Information The Company operates in one segment. Comprehensive Income SFAS No. 130, Reporting Comprehensive Income establishes standards for reporting and displaying comprehensive income and its components in a full set of general purpose financial statements. The Company's comprehensive net loss is equal to its net loss for all periods presented. Software Development Costs The costs of computer software developed or obtained for internal use are being amortized over their estimated useful lives, which has been determined by management to range from one to three years. Amortization of software development costs begins when the software is ready for its intended use. Recent Accounting Pronouncements In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 143, Accounting for Asset Retirement Obligations. This standard addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement of tangible long-lived assets and the associated asset retirement costs. The Company adopted SFAS No. 143 effective January 1, 2003. The adoption of this new statement did not have a material impact on the Company's operating results or financial position. In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. This standard addresses issues regarding the recognition, measurement, and reporting of costs that are associated with exit and disposal activities, including restructuring activities that currently are accounted for pursuant to the guidance that the Emerging Issues Task Force set forth in Issue No. 94-3. The scope of SFAS No. 146 also includes (1) costs related to terminating a contract that is not a capital lease, (2) termination benefits that employees who are involuntarily terminated receive under the terms of a one-time benefit arrangement that is not an ongoing benefit arrangement or an individual deferred- compensation contract and (3) costs to consolidate facilities or relocate employees. SFAS No. 146 is required to be effective for exit or disposal activities initiated after December 31, 2002 and does not affect the recognition of costs under the Company's current activities. Adoption of this standard may impact the timing of the recognition of costs associated with future exit or disposal activities, depending upon the actions initiated. 48 In November 2002, the Emerging Issues Task Force ("EITF") reached a consensus opinion on EITF 00-21 Revenue Arrangements with Multiple Deliverables. This Issue addresses the determination of whether an arrangement involving more than one deliverable contains more than one unit of accounting and how arrangement consideration should be measured and allocated to the separate units of accounting. The provisions of EITF Issue 00-21 are effective for revenue arrangements entered into for fiscal quarters beginning after June 15, 2003. The adoption of EITF 00-21 did not have a material impact on the Company's operating results or financial position. 3. Inventory Inventory consists of the following: December 31, 2003 2002 ---------- ---------- Raw materials ................................... $ 127,713 $ 91,556 Finished goods .................................. 1,067,284 1,200,310 ---------- ---------- $1,194,997 $1,291,866 ========== ========== 4. Property and Equipment Property and equipment consists of the following: December 31, 2003 2002 ---------- ---------- Leasehold improvements .......................... $1,467,901 $1,415,718 Software ........................................ 1,461,041 1,186,547 Furniture and fixtures .......................... 218,866 216,011 Computer and office equipment ................... 3,092,962 2,617,735 ---------- ---------- $6,240,770 $5,436,011 Less accumulated depreciation and amortization .. 4,234,793 3,487,530 ---------- ---------- $2,005,977 $1,948,481 ========== ========== 5. Intangible Assets Intangibles assets consists of the following: December 31, 2003 2002 ---------- ---------- Goodwill, net .................................. $8,409,136 $8,409,136 ---------- ---------- Covenant not to compete ........................ 700,000 700,000 Less accumulated amortization ............... (375,000) (275,000) ---------- ---------- Covenant not to compete, net ................... 325,000 425,000 ---------- ---------- Total .......................................... $8,734,136 $8,834,136 ========== ========== 49 The Company completed its most recent goodwill impairment test as of October 1, 2003. The tests involved the assessment of the fair market value of the Company as the single reporting unit. No impairment of goodwill was indicated at that time. Under SFAS No. 142, the Company is required to perform goodwill impairment tests on at least an annual basis or more frequently if circumstances dictate. There can be no assurance that future goodwill impairment tests will not result in a charge to income. A reconciliation of reported net loss to net loss adjusted to reflect the impact of the discontinuance of the amortization of goodwill for the year ended December 31, 2001 is as follows: Year Ended December 31, 2001 ------------ Reported net loss ................................... $(15,087,149) Goodwill amortization ............................... 1,167,956 ------------ Adjusted net loss ................................... $(13,919,193) ============ Reported basic and diluted net loss per share ....... $ (1.03) Goodwill amortization ............................... $ 0.08 ------------ Adjusted basic and diluted net loss per share ....... $ (0.95) ============ The covenant not to compete is being amortized over the related contractual period of seven years and amortization expense was $100,000 for each of the years ended December 31, 2003, 2002 and 2001. Estimated annual amortization expense of the covenant not to compete is $100,000 in each of fiscal years 2004 through 2006 and $25,000 in fiscal 2007. 6. Accounts Payable and Accrued Expenses Accounts payable and accrued expenses consist of the following: December 31, 2003 2002 ---------- ---------- Accounts payable ................................ $1,055,748 $ 768,329 Distribution and other service fees ............. 2,569,248 2,574,024 Compensation and related benefits ............... 1,292,901 1,020,916 Other accrued expenses .......................... 872,314 749,317 ---------- ---------- $5,790,211 $5,112,586 ========== ========== 7. Long Term Debt Long-term debt as of December 31, 2003 and 2002 consists of the following: December 31, 2003 2002 -------- -------- Note due in annual installments of $60,000 through October 2008, based on imputed interest of 8.75% .......................... $234,901 $271,173 10.0% equipment installment note, due in monthly installments of $8,131 through August 2003 ............................... $ -- $ 63,002 50 Termination liability, due in monthly installments of $12,800 through March 2003 ............................... $ -- $ 38,400 -------- -------- Total long-term debt ........................................... $234,901 $372,575 Less current portion ........................................... $ 39,446 $137,674 -------- -------- Long term debt, excluding current portion ...................... $195,455 $234,901 ======== ======== Maturities of long-term obligations for the five years ending December 31, 2008 are as follows: 2004, $39,446; 2005, $42,898; 2006, $46,651; 2007, $50,733 and 2008, $55,173. 8. Relationship with AOL, QVC, Inc. and May AOL In July 1999, the Company entered into an amended and restated Anchor Tenant Agreement with AOL ("AOL Agreement"). Pursuant to the AOL Agreement, the Company issued a warrant to purchase 366,667 shares of the Company's common stock at $7.20 per share, subject to certain anti-dilution provisions. As of December 31, 2003, the effect of these anti-dilution provisions was to reduce the exercise price under the warrant to $5.73 per share. The warrant is immediately exercisable and expires in July 2007. The Company valued this warrant at approximately $2,250,000, by using the Black-Scholes option pricing model with an expected volatility factor of 55%, risk free interest rate of 5%, no dividend yield, and a 2-year life, which was recognized as non-cash sales and marketing expense on a straight-line basis over the term of the AOL Agreement, which expired January 6, 2003. The Company entered into a further amendment of the AOL Agreement, which extended the term to January 6, 2004 and eliminated quarterly carriage fees. On May 1, 2000, the Company entered into an International Anchor Tenant Agreement with AOL, whereby the Company received distribution within AOL and its affiliates within certain international markets. The agreement originally provided for an expiration date of May 1, 2003 and for quarterly carriage fees payable by the Company over the term of the agreement. Effective March 31, 2001, the International Anchor Tenant Agreement was amended to limit the International Markets where the Company will receive distribution from AOL to France. In exchange for this amendment, the Company paid in May 2001 a one-time restructuring fee of $550,000 and a total carriage fee for France for the remaining term of the amended agreement of $200,000. The amended agreement expired on May 1, 2003. The Company recorded aggregate carriage fees to AOL in the amount of $1,200,000 and $2,023,000 for the years ended December 31, 2002 and 2001, respectively. QVC, Inc. ("QVC") On April 13, 1999, the Company sold 4,000,000 shares of Series B Convertible Preferred Stock ("Series B") for $15,000,000 to QVC. The Company also entered into a Services Agreement with QVC (the "Services Agreement"), whereby QVC provides warehousing, fulfillment and distribution, and billing services with respect to the Company's gift registry products. The fees for such services were negotiated on an arm's length basis. The Services Agreement with QVC expired in December 2003; however, pursuant to the agreement, the company had the option to continue to operate under the services agreement for an additional l80 days, which it is currently doing. The Company expects to begin to use its Redding, California warehouse and distribution facility to service The Knot Registry during 2004. 51 For the years ended December 31, 2003, 2002 and 2001, the Company purchased merchandise and incurred warehousing, fulfillment, distribution and billing costs under the Services Agreement with QVC in the aggregate amounts of $123,000, $118,000 and $128,000, respectively. At December 31, 2003 and 2002, the Company had recorded a receivable due from QVC of approximately $51,000 and $48,000, respectively. May On February 19, 2002, the Company entered into a Common Stock Purchase Agreement (the "Agreement") with May Bridal, pursuant to which the Company sold 3,575,747 shares of its common stock to May Bridal for $5,000,000 in cash. The Agreement provides that if the Company proposes to sell, transfer or otherwise issue any common or preferred stock or other interest convertible into common stock ("equity interests") to any third party (other than shares previously reserved or certain shares which shall be reserved for future issuance pursuant to Stock Incentive Plans approved by the Board of Directors or stockholders of the Company) and which transaction would dilute May Bridal's interest in the common stock or voting power of the Company prior to such transaction by more than one percentage point, then the Company shall offer May Bridal the right to acquire a similar equity interest, on the same terms and conditions as offered to the third party, in such amount as to preserve its percentage interest in the common stock and voting power of the Company. If the Company proposes to acquire any equity interest from a third party, which transaction would result in May Bridal's interest in the common stock or voting power of the Company exceeding 20%, then the Company shall offer to acquire equity interests from May Bridal on the same terms as offered to the third party, to permit May Bridal to own less than 20% of the common stock or voting power of the Company after the transaction. In addition, under an amendment to the Agreement dated November 11, 2003, so long as May Bridal owns more than 10% of the common stock or voting power of the Company, May Bridal shall have the right to designate one member of the Board of Directors of the Company and to nominate and submit such person for election by the stockholders of the Company. May Bridal waived its right to acquire equity interests in connection with the sale of common stock by the Company in November 2003 (see Note 9). The Company has also entered into a Media Services Agreement with May pursuant to which the Company and May are developing an integrated marketing program to promote and support May department store companies, which offer wedding registry services. The Media Services Agreement, as amended, has an initial term of three years, which may be extended under certain conditions, and may be renewed by May for up to three additional one-year terms. For the years ended December 31, 2003 and 2002, the Company recorded revenues under the Media Services Agreement in the amounts of $253,000 and $151,000, respectively 9. Capital Stock The Company's Amended and Restated Certificate of Incorporation provides for 105,000,000 authorized shares of capital stock consisting of 100,000,000 shares of common stock each having a par value of $0.01 per share and 5,000,000 shares of preferred stock, each having a par value of $0.001. Preferred Stock The Board of Directors is authorized, without further stockholder approval, to issue from time to time up to an aggregate of 5,000,000 shares of preferred stock in one or more series and to fix or alter the designations, preferences, rights, and any qualifications, limitations or restrictions, of the shares of each series thereof, including the dividend rights, dividend rates, conversion rights, voting rights, terms of redemption, including sinking fund provisions, redemption price or prices, liquidation preferences and the number of shares constituting any series or designation of series. 52 Common Stock At December 31, 2003, the Company had reserved the following shares of common stock for future issuance: Options under the 1999 Stock Incentive Plan......................... 5,073,031 Options under the 2000 Stock Incentive Plan......................... 420,000 Common stock warrant................................................ 460,976 Shares under the Employee Stock Purchase Plan....................... 240,250 Options related to the acquisition of Bridalink.com................. 10,000 --------- Total common stock reserved for future issuance..................... 6,204,257 ========= Private Placement of Common Stock On November 20, 2003, the Company completed the sale of 2,800,000 shares of common stock to two institutional investor groups for gross proceeds of $10,500,000. Net proceeds after placement fees and other offering expenses were $9,872,000. 10. Stock Plans The 1999 Stock Incentive Plan (the "1999 Plan") was adopted by the Board of Directors and approved by the stockholders in November 1999, as a successor plan to the Company's 1997 Long Term Incentive Plan (the "1997 Plan"). All options under the 1997 Plan have been incorporated into the 1999 Plan and no further option grants will be made under the 1997 Plan. The 1999 Plan became effective upon completion of the Company's initial public offering of its common stock. Under the terms of the 1999 Plan, 3,849,868 shares of common stock of the Company were initially reserved for incentive stock options, nonqualified stock options (incentive and nonqualified stock options are collectively referred to as "Options"), stock issuances, or any combination thereof. On May 15, 2001, the Company's stockholders approved a further increase of 1,000,000 to the number of shares reserved for issuance under the 1999 Plan. Through December 31, 2003, an additional 955,713 shares were added to the reserve pursuant to the automatic share increase provisions of the 1999 Plan. Awards may be granted to such non-employee directors, officers, employees and consultants of the Company as the Compensation Committee of the Board of Directors shall in its discretion select. Only employees of the Company are eligible to receive grants of incentive stock options. The shares reserved under the 1999 Plan will automatically increase on the first trading day in January each calendar year, beginning with calendar year 2001, by an amount equal to two percent (2%) of the total number of shares of the Company's common stock outstanding on the last trading day of December in the prior calendar year, but in no event will this annual increase exceed 1,000,000 shares (or such other lesser number determined by the Board of Directors). Generally, options are granted at the fair market value of the stock on the date of grant which was determined by the Board of Directors prior to the completion of the Company's initial public offering of its stock in December 1999. Options vest over periods up to four years and have terms not to exceed 10 years. During 1998 and 1999, the Company granted certain options with exercise prices that were subsequently determined to be less than the value for financial reporting purposes on the date of grant. As a result, the Company recorded deferred compensation of approximately $2,948,000, net of reversals of stock options forfeited. This amount was recognized as noncash compensation expense on an accelerated basis over the vesting period of the options and was fully amortized as of December 31, 2003. The 2000 Non-Officer Stock Incentive Plan (the "2000 Plan") was approved by the Board of Directors in June 2000. Under the terms of the 2000 Plan, 435,000 shares of common stock of the Company 53 have been reserved for nonqualified stock options, stock issuances or any combination thereof. Awards may be granted to employees (other than officers or directors of the Company) and consultants and other independent advisors who provide services to the Company. Options are granted at the fair market value of the stock on the date of grant. Generally, options vest over a four-year period and have terms not to exceed 10 years. The Employee Stock Purchase Plan (the "ESPP") was adopted by the Board of Directors and approved by the stockholders in November 1999 and became effective upon completion of the Company's initial public offering of its common stock. Under the ESPP, employees of the Company who elect to participate are granted options to purchase common stock at a 15 percent discount from the market value, as defined, of such stock. The ESPP permits an enrolled employee to make contributions to purchase shares of common stock by having withheld from his or her salary an amount between 1 percent and 15 percent of compensation. The Compensation Committee of the Board of Directors administers the ESPP. 300,000 shares of common stock of the Company were initially reserved for issuance under the ESPP. The shares reserved automatically increase on the first trading day in January of each calendar year, beginning in calendar year 2001, by the lesser of the (i) the number of shares of common stock issued under the ESPP in the immediately preceding calendar year, (ii) 300,000 shares or (iii) such other lesser amount approved by the Board of Directors. Through December 31, 2003, 198,340 shares were issued under the ESPP and 138,590 were added to the reserve pursuant to the automatic increase provision. The following represents a summary of the Company's stock option activity under the 1999 and 2000 Plans and related information: Weighted Average Shares Exercise Price ---------- -------------- Options outstanding at December 31, 2000 ......... 3,001,661 $2.61 Options granted .................................. 1,357,117 0.68 Options exercised ................................ (14,579) 0.23 Options canceled ................................. (1,237,831) 2.49 ---------- ----- Options outstanding at December 31, 2001 ......... 3,106,368 $1.83 ---------- ----- Options granted .................................. 242,800 0.63 Options exercised ................................ -- -- Options canceled ................................. (239,346) 2.68 ---------- ----- Options outstanding at December 31, 2002 ......... 3,109,822 $1.67 ---------- ----- Options granted .................................. 990,200 2.81 Options exercised ................................ (501,875) 0.60 Options canceled ................................. (296,475) 3.06 ---------- ----- Options outstanding at December 31, 2003 ......... 3,301,672 $2.05 ========== ===== The following table summarizes information about options outstanding at December 31, 2003: Options outstanding Options exercisable ---------------------- ---------------------- Weighted average Number remaining Weighted Number Weighted outstanding contractual average exercisable average as of life exercise as of exercise Range of exercise price 12/31/03 (in years) price 12/31/03 price - ----------------------- ----------- ----------- -------- ----------- -------- 54 $0.27 to $1.06......... 1,539,751 6.99 $0.73 1,248,907 $0.69 $1.37 to $4.10......... 1,660,021 7.91 2.86 823,164 2.71 $9.00.................. 101,900 5.61 9.00 101,900 9.00 --------- ---- ----- --------- ----- 3,301,672 7.41 $2.05 2,173,971 $1.85 ========= ==== ===== ========= ===== At December 31, 2003, there were 1,934,859 shares available for future grants under the 1999 Plan and 256,500 shares available for the 2000 Plan. The per share weighted average fair value of options granted were $1.62, $0.43 and $0.35 in 2003, 2002 and 2001, respectively. The per share weighted average fair value of ESPP rights were $0.94, $0.18 and $0.29 in 2003, 2002 and 2001, respectively. The fair value for options and ESPP rights granted have been estimated on the date of grant using the minimum value method option pricing model from inception through December 1, 1999 and using the Black-Scholes option pricing model thereafter, with the following range of assumptions: Year Ended December 31, ------------------------------------------------ 2003 2002 2001 -------------- -------------- -------------- Expected option lives....... 1.25 - 4 years 1.25 - 4 years 1.25 - 4 years Risk-free interest rate..... 1.66% - 2.27% 2.02% - 4.38% 4.77% - 5.74% Expected volatility......... 76.4% 83.1% 70.5% Dividend yield.............. 0% 0% 0% See Note 2 for the Company's accounting policy for stock based compensation, as well as the effect on net loss and net loss per share had compensation for the stock plans been determined consistent with the provisions of SFAS No. 123, as amended. 11. 401(k) Plan In June 2003, the Company adopted a 401(k) plan covering all eligible employees and provides for a Company match on a portion of participant contributions. Employees may contribute up to 15% of their base salary, subject to IRS maximums. The Company matches 25% of the first 4% of eligible compensation contributed. The Company's matching contributions are made in cash and amounted to $21,000 for the year ended December 31, 2003. 12. Income Taxes Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and amounts used for income tax purposes. Significant components of the Company's deferred tax assets and liabilities consist of the following: December 31, ------------------------- 2003 2002 ----------- ----------- Deferred tax assets: Net operating loss carryforwards ......... $16,039,000 $16,376,000 Depreciation and amortization ............ 2,019,000 1,773,000 Accrued expenses ......................... 1,131,000 1,031,000 55 Allowance for doubtful accounts and reserve for returns ...................... 223,000 366,000 Other .................................... 255,000 230,000 ------------ ------------ Total deferred tax assets ................... 19,667,000 19,776,000 Deferred tax liabilities: Capitalized software costs .................. (628,000) (502,000) Other ....................................... (212,000) -- ------------ ------------ Total deferred tax liabilities .............. (840,000) (502,000) ------------ ------------ Net deferred tax assets ..................... 18,827,000 19,274,000 Valuation allowance ......................... (18,827,000) (19,274,000) ------------ ------------ Total net deferred tax assets ............... $ -- $ -- ============ ============ Net deferred tax assets have been fully offset by a valuation allowance due to the uncertainty of realizing such benefit. At December 31, 2003, the Company had net operating loss carryforwards of approximately $37 million for federal tax purposes which are set to expire in years 2011 through 2023. The reconciliation of income tax expense computed at the U.S. federal statutory rate to income tax expense for the years ended December 31, 2003, 2002 and 2001 are as follows: Year Ended December 31, ------------------------------------- 2003 2002 2001 --------- ----------- ----------- Income taxes (benefit) at federal statutory rate (35%) ... 389,000 (1,778,000) (5,280,000) State income taxes, net of federal benefit ............... 33,000 -- -- Expenses not deductible for U.S. tax purposes ............ 75,000 106,000 538,000 Change in valuation allowances and other ................. (447,000) 1,672,000 4,742,000 --------- ----------- ----------- Provision for income taxes $ 50,000 $ -- $ -- ========= =========== =========== 13. Commitments and Contingencies Operating Leases The Company leases office facilities and certain warehouse space under noncancelable operating lease agreements which expire at various dates through 2012. Future minimum lease payments under noncancelable operating leases are as follows: Year ending December 31: 2004............................................................... $ 830,000 2005............................................................... 777,000 2006............................................................... 762,000 2007............................................................... 787,000 2008............................................................... 698,000 Thereafter......................................................... 1,907,000 ---------- Total.............................................................. $5,761,000 ========== Rent expense for the years ended December 31, 2003, 2002, and 2001 amounted to approximately $798,000, $754,000 and $810,000, respectively. Sublease income was $24,000 for the year ended December 31, 2003. 56 Legal Proceedings On September 19, 2003, WeddingChannel.com, Inc. ("WeddingChannel") filed a complaint against the Company in the United States District Court for the Southern District of New York. The complaint alleges that the Company 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 Company 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 Company is found to have willfully infringed the patent-in-suit, enhanced damages are awardable. This complaint was served on the Company on September 22, 2003. Based on information currently available, the Company believes that the claims are without merit and is vigorously defending itself against all claims. On October 14, 2003, the Company filed an answer and counterclaims against WeddingChannel. The Company's answer raises various defenses to the counts alleged by WeddingChannel. Additionally, the Company has brought counterclaims including a request that the court declare the patent-in-suit is invalid, unenforceable and not infringed. The Company'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 Company 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. 57 SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS Write-Offs, Balance Charged to Charged to Net of Balance at Beginning Costs and Other Recoveries & End of Year Ended December 31, 2003 of Year Expenses Accounts Actual Returns Year --------- ---------- ---------- -------------- ---------- Allowance for Doubtful Accounts..... $774,222 $ 51,414 $-- $ 411,301 $414,335 Allowance for Returns............... $186,001 $1,523,832 $-- $1,509,236 $200,597 Year Ended December 31, 2002 Allowance for Doubtful Accounts..... $814,098 $ 301,713 $-- $ 341,589 $774,222 Allowance for Returns............... $196,517 $ 942,698 $-- $ 953,214 $186,001 Year Ended December 31, 2001 Allowance for Doubtful Accounts..... $821,963 $1,701,619 $-- $1,709,484 $814,098 Allowance for Returns............... $ 43,494 $ 881,841 $-- $ 728,818 $196,517 58 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. Item 9A. 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 December 31, 2003. 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 December 31, 2003 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 III Item 10. Directors and Executive Officers of the Registrant Incorporated by reference from the information in our proxy statement for the 2004 Annual Meeting of Stockholders which we will file with the Securities and Exchange Commission within 120 days of the end of the fiscal year to which this report relates. Item 11. Executive Compensation Incorporated by reference from the information in our proxy statement for the 2004 Annual Meeting of Stockholders which we will file with the Securities and Exchange Commission within 120 days of the end of the fiscal year to which this report relates. Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters EQUITY COMPENSATION PLAN INFORMATION The following table summarizes information about our equity compensation plans as of December 31, 2003. All outstanding awards relate to our common stock. For additional information about our equity compensation plans, see notes 8 and 10 to our financial statements in Item 8. 59 Number of securities remaining available for Number of securities to Weighted-average future issuance under equity be issued upon exercise exercise price of compensation plans of outstanding options, outstanding options, (excluding securities Plan Category warrants and rights warrants and rights reflected in column) (a) - ----------------------------------------- ----------------------- -------------------- ---------------------------- (a) (b) (c) Equity compensation plans approved by security holders...................... 3,138,172 $1.9533 1,934,859 Equity compensation plans not approved by security holders...................... 624,476(1) $5.2591 256,500 --------- ------- --------- 3,762,648 $2.5020 2,191,359 ========= ======= ========= (1) Includes 460,976 shares of common stock to be issued upon exercise of a warrant issued in July 1999, prior to our initial public offering. The other information required by this Item is incorporated herein by reference from the information in our proxy statement for the 2004 Annual Meeting of Stockholders which we will file with the Securities and Exchange Commission within 120 days of the end of the fiscal year to which this report relates. Item 13. Certain Relationships and Related Transactions Incorporated by reference from the information in our proxy statement for the 2004 Annual Meeting of Stockholders which we will file with the Securities and Exchange Commission within 120 days of the end of the fiscal year to which this report relates. Item 14. Principal Accountant Fees and Services Incorporated by reference from the information in our proxy statement for the 2004 Annual Meeting of Stockholders which we will file with the Securities and Exchange Commission within 120 days of the end of the fiscal year to which this report relates. Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K (a) 1. Financial Statements. See Index to Consolidated Financial Statements and Schedule on page 36. 2. Financial Statement Schedules. See Index to Consolidated Financial Statements and Schedule on page 36. (b) Reports on Form 8-K Items 7 and 12, dated and furnished November 13, 2003 reporting that we issued a press release and conducted a conference call announcing our financial results as of and for the three months ended September 30, 2003. Items 5 and 7, dated and filed November 19, 2003 reporting that we issued a press release announcing that we had entered into definitive agreements relating to a private placement of 2,800 000 newly-issued shares of common stock to institutional investors. Items 5 and 7, dated and filed November 20, 2003 reporting that we issued a press release announcing the full funding of a private placement of 2,800,000 new-issued shares of common stock to institutional investors. 60 Information in any of our Current Reports on Form 8-K furnished under Item 12, "Results of Operations and Financial Condition," shall not be deemed to be "filed" for the purposes of Section 18 of the Exchange Act, or otherwise subject to the liabilities of that section, nor shall it be incorporated by reference into a filing under the Securities Act of 1933, as amended, or the Exchange Act, except as shall be expressly set forth by specific reference in such a filing. (c) Exhibits Number Description - ------ ----------- 2.1 Agreement and Plan of Merger, dated as of February 1, 2000, by and among the Registrant and Weddingpages, Inc. (Incorporated by reference to Registrant's Current Report on Form 8-K filed with the S.E.C. on February 11, 2000) 3.1 Amended and Restated Certificate of Incorporation (Incorporated by reference to the Registrant's Registration Statement on Form S-1 (Registration number 333-87345) (the "Form S-1")) 3.2 Amended and Restated Bylaws (Incorporated by reference to the Form S-1) 4.1 Specimen Common Stock certificate (Incorporated by reference to the Form S-1) 4.2 See Exhibits 3.1 and 3.2 for provisions defining the rights of holders of common stock of the Registrant 4.3 Warrant Agreement of America Online, Inc. (Incorporated by reference to the Form S-1) 4.4 Subscription Agreement by and between The Knot and T. Rowe Price Associates, Inc. on behalf of its participating clients specified therein, dated as of November 18, 2003 (Incorporated by reference to the Registrant's Registration Statement on Form S-3 (Registration number 333-111060) (the "Form S-3")) 4.5 Subscription Agreement by and between The Knot and investment funds advised by Capital Research and Management Company, dated as of November 18, 2003 (Incorporated by reference to the Form S-3) 10.1* Employment Agreement between The Knot, Inc. and David Liu (Incorporated by reference to the Form S-1) 10.2* Employment Agreement between The Knot, Inc. and Carley Roney (Incorporated by reference to the Form S-1) 10.3* Employment Agreement between The Knot, Inc. and Richard Szefc (Incorporated by reference to the Form S-1) 10.4* Employment Agreement between The Knot, Inc. and Sandra Stiles (Incorporated by reference to the Form S-1) 10.5* 2000 Non-Officer Stock Incentive Plan (Incorporated by reference to Exhibit 99.1 to Registrant's Registration Statement on Form S-8 (Registration number 333-41960)) 10.6* Amended and restated 1999 Stock Incentive Plan (Incorporated by reference to Exhibit 99.1 to the Registrant's Registration Statement on Form S-8 (Registration number 333-74398)) 10.7* Employee Stock Purchase Plan (Incorporated by reference to the Form S-1) 10.8 Third Amended and Restated Investor Rights Agreement (Incorporated by reference to the Form S-1) 10.9+ Services Agreement between The Knot, Inc. and QVC, Inc. (Incorporated by reference to the Form S-1) 10.10+ Amended and Restated Anchor Tenant Agreement between The Knot, Inc. and America Online, Inc. (Incorporated by reference to the Form S-1) 10.11* Form of Indemnification Agreement (Incorporated by reference to the Form S-1) 61 10.12 Common Stock Purchase Agreement between The Knot, Inc. and May Bridal Corporation (Incorporated by reference to Exhibit 10.12 to Registrant's Annual Report on Form 10-K filed on March 29, 2002) 10.13 Amendment to Common Stock Purchase Agreement between The Knot and May Bridal Corporation, dated as of November 11, 2003 (Incorporated by reference to the Form S-3) 21.1 Subsidiaries 23.1 Consent of Ernst & Young LLP 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. - --------------- + Confidential treatment has been granted for certain portions omitted from this Exhibit pursuant to Rule 406 promulgated under the Securities Act. Confidential portions of this Exhibit have been separately filed with the Securities and Exchange Commission. * Management contract or compensatory plan or arrangement 62 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, The Knot, Inc. has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized in the City of New York, State of New York, on this 19th day of March, 2004. THE KNOT, INC. By: /s/ DAVID LIU ---------------------------------- David Liu President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this Report has been signed by the following persons on behalf of the registrant and in the capacities indicated on March 19, 2004. Signature Title(s) --------- -------- President, Chief Executive Officer and Chairman of /s/ DAVID LIU the Board of Directors (principal executive officer) - --------------------------------------- David Liu Chief Financial Officer, Treasurer and Secretary /s/ RICHARD SZEFC (principal financial and accounting officer) - --------------------------------------- Richard Szefc Chief Operating Officer, Assistant Secretary and /s/ SANDRA STILES Director - --------------------------------------- Sandra Stiles /s/ RANDY RONNING Director - --------------------------------------- Randy Ronning /s/ ANN WINBLAD Director - --------------------------------------- Ann Winblad /s/ JOSEPH BREHOB Director - --------------------------------------- Joseph Brehob 63 EXHIBIT INDEX Number Description - ------ ----------- 2.1 Agreement and Plan of Merger, dated as of February 1, 2000, by and among the Registrant and Weddingpages, Inc. (Incorporated by reference to Registrant's Current Report on Form 8-K filed with the S.E.C. on February 11, 2000) 3.1 Amended and Restated Certificate of Incorporation (Incorporated by reference to the Registrant's Registration Statement on Form S-1 (Registration number 333-87345) (the "Form S-1")) 3.2 Amended and Restated Bylaws (Incorporated by reference to the Form S-1) 4.1 Specimen Common Stock certificate (Incorporated by reference to the Form S-1) 4.2 See Exhibits 3.1 and 3.2 for provisions defining the rights of holders of common stock of the Registrant 4.3 Warrant Agreement of America Online, Inc. (Incorporated by reference to the Form S-1) 4.4 Subscription Agreement by and between The Knot and T. Rowe Price Associates, Inc. on behalf of its participating clients specified therein, dated as of November 18, 2003 (Incorporated by reference to the Registrant's Registration Statement on Form S-3 (Registration number 333-111060) (the "Form S-3")) 4.5 Subscription Agreement by and between The Knot and investment funds advised by Capital Research and Management Company, dated as of November 18, 2003 (Incorporated by reference to the Form S-3) 10.1* Employment Agreement between The Knot, Inc. and David Liu (Incorporated by reference to the Form S-1) 10.2* Employment Agreement between The Knot, Inc. and Carley Roney (Incorporated by reference to the Form S-1) 10.3* Employment Agreement between The Knot, Inc. and Richard Szefc (Incorporated by reference to the Form S-1) 10.4* Employment Agreement between The Knot, Inc. and Sandra Stiles (Incorporated by reference to the Form S-1) 10.5* 2000 Non-Officer Stock Incentive Plan (Incorporated by reference to Exhibit 99.1 to Registrant's Registration Statement on Form S-8 (Registration number 333-41960)) 10.6* Amended and restated 1999 Stock Incentive Plan (Incorporated by reference to Exhibit 99.1 to the Registrant's Registration Statement on Form S-8 (Registration number 333-74398)) 10.7* Employee Stock Purchase Plan (Incorporated by reference to the Form S-1) 10.8 Third Amended and Restated Investor Rights Agreement (Incorporated by reference to the Form S-1) 10.9+ Services Agreement between The Knot, Inc. and QVC, Inc. (Incorporated by reference to the Form S-1) 10.10+ Amended and Restated Anchor Tenant Agreement between The Knot, Inc. and America Online, Inc. (Incorporated by reference to the Form S-1) 10.11* Form of Indemnification Agreement (Incorporated by reference to the Form S-1) 10.12 Common Stock Purchase Agreement between The Knot, Inc. and May Bridal Corporation (Incorporated by reference to Exhibit 10.12 to Registrant's Annual Report on Form 10-K filed on March 29, 2002) 10.13 Amendment to Common Stock Purchase Agreement between The Knot and May Bridal Corporation, dated as of November 11, 2003 (Incorporated by reference to the Form S-3) 21.1 Subsidiaries 23.1 Consent of Ernst & Young LLP 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. 64 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. - --------------- + Confidential treatment has been granted for certain portions omitted from this Exhibit pursuant to Rule 406 promulgated under the Securities Act. Confidential portions of this Exhibit have been separately filed with the Securities and Exchange Commission. * Management contract or compensatory plan or arrangement 65