UNITED
STATES
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, 2008
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF
THE SECURITIES EXCHANGE ACT OF 1934
For
the transition period from _____ to _____
Commission
file number 001-33720
________________________________________
HSW
INTERNATIONAL, INC.
(Exact
name of Registrant as specified in its charter)
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Delaware
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33-1135689
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(State
or other jurisdiction of
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(I.R.S.
Employer
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incorporation
or organization)
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Identification
No.)
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One
Capital City Plaza
3350
Peachtree Road, Suite 1600
Atlanta,
Georgia 30326
(Address
of principal executive offices, including zip code)
(404)
364-5823
(Registrant’s
telephone number, including area code)
Securities
registered pursuant to Section 12(b) of the Act:
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Title of each
class
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Name of each exchange
on which registered
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Common
Stock, $0.001 Par Value
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NASDAQ
Global Market
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Securities
registered pursuant to Section 12(g) of the Act: None.
Indicate
by check mark if the Registrant is a well-known seasoned issuer (as defined in
Rule 405 of the Securities Act).
Yes o No x
Indicate
by check mark if the Registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act.
Yes o No x
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, as amended, 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 o
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. o
Indicate
by check mark whether the Registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company. See definition of “large accelerated filer” “accelerated
filer” and smaller reporting company” in Rule 12b-2 of the Act (Check
one):
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Large
accelerated filer o
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Accelerated
filer o
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Non-accelerated
filer o
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Smaller
reporting company x
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(Do
not check if a smaller reporting company)
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Indicate
by check mark whether the Registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes o No x
At
March 30, 2009, 53,698,292 shares of the Registrant’s common stock, $0.001
par value per share, were outstanding. The aggregate market value of
shares of common stock held by nonaffiliates as of June 30, 2008, was
$70,617,793.
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Our
disclosure and analysis in this report concerning our operations, cash flows and
financial position, including, in particular, the likelihood of our success in
expanding our business and our assumptions regarding the regulatory environment
and international markets, include forward-looking
statements. Statements that are predictive in nature, that depend
upon or refer to future events or conditions, or that include words such as
“expect,” “anticipate,” “intend,” “plan,” “believe,” “estimate,” “may” and
similar expressions are forward-looking statements. Although these
statements are based upon reasonable assumptions, they are subject to risks and
uncertainties that are described more fully in this report in the section titled
“Part I, Item 1A. Risk Factors”. These forward-looking
statements represent our estimates and assumptions only as of the date of this
filing and are not intended to give any assurance as to future results. As a
result, you should not place undue reliance on any forward-looking
statements. We assume no obligation to update any forward-looking
statements to reflect actual results, changes in assumptions or changes in other
factors, except as required by applicable securities laws.
Overview
HSW
International, Inc. (“HSW International”) is an online publishing company that
develops and operates Internet businesses focused on providing consumers in the
world’s digital economies with locally relevant, high quality information and
ways to connect with each other. Our international websites published
under the HowStuffWorks brand provide readers in China and Brazil with thousands
of articles about how the world around them works, serving as destinations for
credible, easy-to-understand reference information. HSW International
is the exclusive licensee in China and Brazil for the digital publication of
translated content from HowStuffWorks.com, a subsidiary of Discovery
Communications, Inc., and in China for the digital publication of translated
content from World Book Inc., publishers of World
Book Encyclopedia. Our DailyStrength brand, which was acquired
on November 26, 2008, helps hundreds of thousands of readers share information
and support on www.dailystrength.org,
a comprehensive health-related social media website. The acquisition
of DailyStrength was completed in part to diversify our business and to publish
another product which offers insight on highly relevant topics. We
generate revenue primarily through the sale of online advertising on our
websites. We were incorporated in Delaware in March 2006. Our
headquarters are located at One Capital City Plaza, 3350 Peachtree Road, Suite
1600, Atlanta, Georgia 30326.
Products
and Services
ComoTudoFunciona – HowStuffWorks
Brazil
We
entered the Brazilian online publishing market in March 2007 with the
launch of our website ComoTudoFunciona
(http://hsw.com.br), utilizing the exclusively licensed HowStuffWorks digital
content. At December 31, 2008, we had published approximately 5,500
articles that were either (i) articles from the HowStuffWorks content database
translated from English to Portuguese, or (ii) originally created
content. We are continuing the development of our business strategy
in Brazil as we focus on expansion by (i) adding original proprietary digital
content designed to meet the information needs of the Brazilian online
community, (ii) expanding the amount of translated content from HowStuffWorks,
and (iii) refining local marketing strategies.
BoWenWang – HowStuffWorks
China
In June
2008, we entered China’s online publishing market utilizing a combination of the
contributed assets from HowStuffWorks with the benefit of our predecessor
INTAC’s relationships and knowledge of the Chinese markets in obtaining our
Internet licenses. Our Beijing-based website BoWenWang (http://www.bowenwang.com.cn)
initially launched with a combination of HowStuffWorks content translated from
English to Chinese and original content created by our China division, including
several hundred articles about the Beijing Olympics. In September
2008, we entered into an exclusive content partnership with World Book, Inc. to
dramatically increase the amount of content published on BoWenWang. In
2009, World Book will create thousands of original Chinese-language articles
providing information on all branches of knowledge, including arts, sciences,
history, technology, mathematics, sports, and recreation, exclusively for our
Chinese website. At December 31, 2008, we had published approximately
4,400 articles in China.
1
DailyStrength
In
November 2008, we acquired Daily Strength, Inc. (“DS”), publisher of the health
social networking website DailyStrength (http://www.dailystrength.org). DailyStrength.org
offers content authored by medical professionals based on current topics,
support groups, a treatment directory with definitions, private messaging,
one-on-one chat forums and personal goal trackers, and primarily serves
English-speaking territories such as the United States, Canada, Australia and
the United Kingdom. The medical panel of professionals contributes
articles and journals providing insight to a number of topics relevant to the DS
user group and communities. Additionally, DS offers users and members
the opportunity to launch a community for a group of like-minded individuals
regarding a topic of personal significance using best-of-breed community tools
to interact.
DS was
founded in 2006 by Internet veterans with more than 20 years of experience
conceiving, building, and running communities on the web, including Yahoo,
GeoCities, Facebook and more. DS hosts more than 500 communities
focused on issues such as weight loss, divorce, parenting and
illnesses.
Our
History
HSW
International was formed on March 14, 2006, as a wholly owned subsidiary of
HowStuffWorks, Inc. in order to (i) develop businesses using exclusive
digital publishing rights to HowStuffWorks’ content for the countries of China
and Brazil, and (ii) effect the INTAC International, Inc. merger (the
“INTAC Merger”). We completed the INTAC Merger to assist in the
development of our digital content database exclusively licensed from
HowStuffWorks by (i) accelerating our obtaining Internet licenses in China
for launching our Internet platform, (ii) obtaining INTAC’s knowledge of
the Chinese markets, relationships, and core competencies to accelerate the
growth of our Internet platforms in China, and (iii) providing additional
cash flow from INTAC’s established businesses. These established
businesses included services related to wireless telephone training and the
development and sale of educational software delivered to customers in China
(“INTAC Legacy Businesses”). As discussed below, these legacy
businesses were subsequently disposed.
Our
initial focus was online publishing of localized, translated Chinese and
Brazilian editions of the HowStuffWorks Internet site, utilizing strategies
based on those employed by HowStuffWorks, Inc., as tailored to the needs of each
localized market. In
November 2008, we acquired Daily Strength, Inc. (“DS”), publisher of the health
social networking website DailyStrength (http://www.dailystrength.org). Our
acquisition of DS allows us to further leverage our web publishing
infrastructure, provides us with an opportunity to diversify our initial focus
on the emerging economies, and enter the healthcare digital
market. The online healthcare market in the United States has matured
over the past 10 years and now represents a significant market for online
advertising. While the global economic credit market has lowered
expectations for near-term growth in the emerging economies, our diversification
into the world’s largest online advertising economy – the United States –
provides greater access to digital revenues.
The
INTAC Merger
The INTAC
Merger and related transactions were consummated pursuant to a merger agreement
dated April 20, 2006, as amended January 29, 2007. On October 2,
2007, we completed the INTAC Merger and related transactions pursuant to
which:
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HowStuffWorks
contributed to us, in exchange for shares of our common stock, perpetual,
fully paid up, royalty-free, exclusive digital publishing rights to
HowStuffWorks’ existing content for the countries of China and Brazil
which we are translating and localizing into the predominant languages of
China and Brazil.
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A
wholly owned subsidiary of ours was merged into INTAC, with INTAC
surviving as our wholly owned subsidiary, and holders of INTAC common
stock received one share of our common stock in exchange for each of their
shares of INTAC common stock.
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Certain
investors (referred to in this report as American investors) purchased or
agreed to purchase shares of our common stock having an aggregate value of
approximately $39.4 million, of which $22.5 million and $16.9 million
(both before expenses) were received in October 2007, and January and
February 2008, respectively. Shelf registration statements
covering the resale of these shares were subsequently
filed.
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Our
stock became publicly traded on the NASDAQ Global Market under the symbol
“HSWI” in connection with the INTAC Merger. Prior to the INTAC
Merger, INTAC’s common stock was traded on the NASDAQ Capital Market under
the symbol “INTN”.
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In
connection with and as a condition of the INTAC Merger, INTAC sold its
wireless handset and prepaid calling cards distribution businesses
(“distribution companies”), to an entity controlled by Wei Zhou, CEO,
director and significant stockholder of INTAC prior to the INTAC Merger
and a member of our Board of Directors from October 2007 to December 2007,
in exchange for 3.0 million shares of our common stock held by Mr.
Zhou. The 3.0 million shares of our common stock were recorded
as treasury shares valued at cost as determined by a third party
valuation.
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On
January 31 and February 1, 2008, also in connection with the INTAC
Merger, certain investors (referred to in this report as the European investors)
purchased $5.8 million, before expenses, of our common stock and $11 million of
our shares held as treasury stock, respectively, for a price per share of
$3.68. In this transaction, we issued approximately 1.6 million shares of
our common stock and sold 3.0 million treasury shares in the aggregate to the
European investors.
Our
Relationship with Discovery Communications, Inc.
Following
the grant of rights from HowStuffWorks to us, HowStuffWorks merged with
Discovery Communications, Inc. (“Discovery”) on December 17, 2007 (the
“Discovery Merger”), and became a wholly owned subsidiary of
Discovery. The following summarizes the material agreements between
the parties.
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We
hold a perpetual, fully paid, royalty-free, sublicensable exclusive
license to certain of the content published on HowStuffWorks.com in local
languages and the HowStuffWorks brand for Brazil and
China.
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HowStuffWorks
provides to us new and updated content published on HowStuffWorks.com,
upon our request and pursuant to the same license
terms.
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We
have the right to an exclusive license for the HowStuffWorks
trademarks for our Brazil and China websites that display the
HowStuffWorks content.
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We
hold a perpetual, fully paid up, royalty-free, sublicensable license to
the software code for HowStuffWorks’ content management
platform.
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HowStuffWorks
has the right to designate three members of our Board of Directors, and
the chairperson of the Nominating and Governance
Committee. Additionally, to the extent that HowStuffWorks owns
any shares of our common stock in excess of 45% of the outstanding shares,
HowStuffWorks is required to vote such excess shares in the exact
proportion to the vote of our other shareholders. HowStuffWorks
may vote in its discretion its shares of our common stock up to and
including 45% of the outstanding shares of our common stock as of any
applicable record date.
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The
merger agreement between Discovery and HowStuffWorks provided that payment to
the former HowStuffWorks shareholders for a significant portion of its ownership
of our common stock would not be paid at the October 2007 closing of the
transaction, but instead will be available to be paid in three semi-annual
installments during a period which began in October 2008. Such payments
will be in the form of cash or shares of HSWI stock now held by
HowStuffWorks. Accordingly, the amount of shares of our common stock
indirectly owned by Discovery in the future may fall or rise due to a
combination of the potential distributions pursuant to the terms of the
Discovery merger or our exercise of the options to publish HowStuffWorks content
in local languages in Russia and India. All of our rights to publish
HowStuffWorks content will remain effective regardless of the number of shares
owned by HowStuffWorks in the future. At December 31, 2008,
Discovery, through its wholly owned subsidiary HowStuffWorks, owned
approximately 42.8% of our outstanding common stock, and had not made any share
distributions of our common stock to former HowStuffWorks
shareholders.
Sale
of the INTAC Legacy Businesses and Related Transactions
Due to an
increased focus of our management and resources on our primary Internet
publishing business, a change of control in our majority ownership leading to
further refinement in our strategies, and an under-performance of the INTAC
Legacy Businesses after the INTAC Merger, in early 2008 we decided to dispose of
those businesses. The INTAC Legacy Businesses were comprised of two
lines of business unrelated to our core Internet platform
businesses.
We
decided that it was critical that all our current resources be fully focused on
expanding our Brazilian Internet platform and the June 2008 launch of our
Chinese Internet platform. Although we believe we benefited in the
short-term from INTAC’s relationships and knowledge of the Chinese markets in
obtaining our Internet licenses, this refined strategic focus did not allow us
the time required to realize the expected long-term synergies, embodied in our
acquired INTAC goodwill, from INTAC’s knowledge of the Chinese markets,
relationships, and core competencies. In addition, we were provided with
and acted on an opportunity to sell the INTAC Legacy Businesses for
approximately their stand-alone appraised value, and through simultaneous sale
of the treasury stock received, generate significant additional cash to invest
into our core Internet businesses.
3
In
February and March 2008, we sold the INTAC Legacy Businesses to an entity
owned by Mr. Zhou. We funded the businesses with $4.3 million of
cash, net of disposition expenses, and received 5.0 million shares of our stock
in exchange. As of December 31, 2008, all of HSWI’s assets were in our
core Internet business and the sole assets we retained from the INTAC Merger
were the Internet licenses intangible asset we used to enter the Chinese markets
in June 2008.
On
February 15, 2008, we entered into a stock purchase agreement where we
agreed to sell, and two qualified institutional buyers agreed to purchase, the
5.0 million shares of our common stock received from the INTAC Legacy Businesses
disposition at a purchase price of $3.68 per share. We simultaneously sold
5.0 million shares to institutional buyers in a private placement raising $18.4
million additional cash.
Sales &
Support
We have
sales teams in Brazil and the United States to service advertisers and customers
for our businesses. We conduct sales for the websites in Brazil and the
U.S. through a direct sales force, as well as strategic relationships with
companies that can represent advertising inventory. We
are implementing the same model in China.
Marketing
The
primary business model for our websites is the sale of advertising, sponsorships
and related products and services. By focusing on providing high-quality
web properties to end users in Brazil, China and the United States, we aim to
establish a user base attractive to advertisers. We primarily sell
advertising based on the quantity of views delivered to advertisers or the
success of various advertising-related metrics.
Much of
our marketing effort is in fostering word-of-mouth momentum by providing
high-quality products and services and using public relations efforts.
Additionally, we enter into relationships with existing businesses to provide
awareness of and traffic to our products and services. We also engage in
advertising designed to inform potential users and customers about our products
and services.
Competition
The
online publishing business is highly competitive. We encounter significant
competition in each market in which we offer our products and
services. Our competitors include national Internet portals in China
such as Baidu, NetEase.com, Shanda Interactive Entertainment, Sina, sohu.com and
tom.com; national websites in Brazil such as Terra and UOL; and health social
media websites like MedHelp.com and trusera.com, which compete with us for
online advertising revenue and end users.
Intellectual
Property
We rely
upon patent, trademark, copyright and trade secret laws in various
jurisdictions, as well as confidentiality procedures and contractual provisions
to protect our proprietary assets and brand. We do not own any patent or
copyright registrations. We hold various trademarks for our brands,
and we have additional applications pending.
A number
of threats exist to our intellectual property rights. Effective
intellectual property protection may not be available in every country in which
we intend to distribute products and services. Additionally, it may be
time consuming and costly for us to protect our intellectual property and even
then such steps may not be sufficient or effective.
4
Government
Regulation
Our
operations in China and Brazil are subject to a number of foreign and domestic
laws and regulations that affect companies conducting business on the
Internet. Laws and regulations are being debated and considered for
adoption in these countries and others throughout the world in areas relating to
user privacy, freedom of expression, content, advertising, information security
and intellectual property rights.
Additionally,
the Internet infrastructures in China and Brazil are subject to regulatory
control and, in the case of China, ownership by the Chinese government.
The PRC regulates its Internet sector by enacting legislation or issuing
regulations regarding the legality of foreign investment in the PRC Internet
sector and the existence and enforcement of content restrictions on the
Internet. We believe that our current ownership structure and localized
content complies with PRC laws and regulations. There are, however,
substantial uncertainties regarding the interpretation and enforcement of PRC
Internet laws and regulations. Accordingly, it is possible that the PRC
government will ultimately take a view contrary to ours.
The PRC
Ministry of Information Industry (“MII”), the Chinese governmental agency that
regulates the Internet in China, has stated that the activities of Internet
content providers are subject to regulation by various PRC government
authorities, depending on the specific activities conducted by the Internet
content provider. Various government authorities have stated publicly that
they are in the process of preparing new laws and regulations that will govern
these activities. The areas of regulation include, among others, online
advertising, online news reporting, online publishing, online securities
trading, online community, online video, and the provision of industry specific
(e.g., pharmaceutical-related) information over the Internet. Other
aspects of our online operations may be subject to regulation in the
future.
The MII
also promulgated a directive, effective January 31, 2008, providing that
online videos can only be broadcast or streamed by state-owned or controlled
companies. Subsequent interpretation was provided to exclude certain
websites that existed prior to the directive. This directive may
prevent our Chinese website from displaying online videos, which could have a
material effect on the business.
Because
our services are accessible worldwide, certain foreign jurisdictions may claim
that we are required to comply with their laws, even where we have no local
entity, employees or infrastructure. This could also be detrimental
to our business.
Employees
As of
December 31, 2008, we had 70 employees, located in Georgia and California,
USA; Brazil and China.
Seasonality
We expect
our business to be affected by seasonal fluctuations in Internet usage and
traditional retail seasonality. Internet usage generally slows during the
summer months, and online shopping and related advertising typically increases
in the fourth quarter of each year. These seasonal trends will likely
cause fluctuations in quarterly results, including fluctuations in sequential
revenue growth rates.
Available
information
Our
website address is www.hswinternational.com. Information on our website is
not incorporated by reference herein and should not be considered a part of this
report. We make available free of charge through our website our annual
report on Form 10-K, quarterly reports on Form 10-Q, current reports
on Form 8-K, and all amendments to those reports as soon as reasonably
practicable after such material is electronically filed with or furnished to the
SEC.
5
This
report contains forward-looking statements that involve risks and
uncertainties. Our actual results could differ materially from those
discussed in this report. Factors that could cause or contribute to these
differences include, but are not limited to, those discussed below and elsewhere
in this report and in any documents incorporated in this report by
reference.
We
are in the early development of our business and prospects are difficult to
evaluate.
We have
no significant operating history, and limited experience in the Chinese and
Brazilian markets. We are in the early development of our business,
including the new strategy of entering the health social networking market with
the DailyStrength acquisition in November 2008, with a limited operating history
upon which investors and others can evaluate our current business and
prospects. Our prospects must be considered in light of the many risks,
uncertainties, expenses, delays, and difficulties frequently encountered by
companies in their early stages of development. Some of the risks and
difficulties we expect to encounter include our ability to:
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successfully
commercialize and monetize the contributed and acquired
assets;
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continue
to raise additional working capital, the lack of which would likely have a
significant negative impact on our long term business plan and our ability
to take advantage of our strategic alliances and to successfully execute
our expansion plan;
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manage
our expense structure as a U.S. public company including, without
limitation, compliance with the Sarbanes Oxley
Act;
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manage
the anticipated rise in operating
expenses;
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manage
and implement successfully new business strategies including, if
applicable, new strategies resulting from the Discovery Merger and the
accompanying changes to the agreements between HowStuffWorks and
us;
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adapt
and successfully execute our evolving and unpredictable business model,
with which we will have only limited
experience;
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establish
and take advantage of contacts and strategic
relationships;
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adapt
to our potential diversification into other industries and geographic
regions;
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manage
and adapt to rapidly changing and expanding
operations;
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implement
and improve operational, financial and management systems and
processes;
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respond
effectively to competitive
developments;
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attract,
retain and motivate qualified personnel;
and
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manage
each of the other risks set forth in this
report.
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Because
of our lack of operating history and the early stage of development of our
business, we will have limited insight into trends and conditions that may exist
or might emerge and affect our business, especially with respect to the online
publishing market. We cannot be certain that our business strategy will be
successful or that it will successfully address these risks. Any failure
by us to successfully implement our new business plans could have a material
adverse effect on our business, results of operations and financial
condition.
We
may not have sufficient liquidity to support the time required for our business
to fully develop.
The
Company is in the process of launching Internet businesses in three different
markets, including publishing businesses in two emerging markets. We
believe that our cash resources on hand are sufficient to fund these businesses
for less than 24 months unless revenues increase significantly or we find other
sources of capital, neither of which can be assured. Our management and
directors continually evaluate our progress and likelihood of success in each of
our markets, and our ability to raise additional capital, against the relative
value of our resources and other opportunities. Accordingly, we might decide to
suspend our activities in one or more of our markets in order to focus our
limited resources in the other(s).
6
We
may not succeed in marketing and monetizing our assets to potential customers or
developing strategic partnerships for the distribution of our products and
services.
Our plans
to market and monetize our assets in the Chinese and Brazilian online markets
through the Internet are new and unproven. Moreover, we will have limited
experience in determining the pricing of the products and services that we plan
to develop. Because we have never marketed or sold these products and
services, we may not be successful in establishing a customer base or strategic
partnerships for the distribution of our products and services. If we are
not successful in developing, releasing and marketing these products and
services on a profitable basis, our results of operations would be materially
and adversely affected.
We do not
have significant experience in the Brazilian and Chinese marketplaces.
Additionally, we may not have the resources available to simultaneously develop
operations in China and Brazil. Accordingly, there may be a delay in
developing such operations or we might decide not to pursue these markets, which
could affect our business plan and results of operations.
In
addition, any delay in developing our operations in Brazil and China may impact
our decision to exercise our option to acquire the exclusive digital publishing
rights for the content in India and Russia. The option expires in May 2009
and our failure to exercise such option may have an adverse affect on our
ability to expand our international operations, which could affect our business
plan and results of operations. Exercise of this option requires our
issuing additional shares to HowStuffWorks and we will consider the cost of the
option and the opportunities of the specific market when considering whether or
not to exercise each option. At this time we have made no determination
concerning whether these options will be exercised.
The
growth we seek is rare.
Substantial
future growth will be required in order for us to realize our business
objectives. Growth of this magnitude is rare. To the extent we are
capable of growing our business as necessary, we expect that such growth will
place a significant strain on our managerial, operational and financial
resources. We must manage our growth, if any, through appropriate systems
and controls in each of these areas. We must also establish, train and
manage a larger work force. If we do not manage the growth of our business
effectively, our business, results of operations and financial condition could
be materially and adversely affected.
We
face intense competition, which could have an adverse effect on our business,
financial condition and results of operations.
The
online publishing market is highly competitive. We encounter significant
competition across our business lines and in each market in which we offer our
products and services. In the online publishing market, we expect that our
competitors will include national Internet portals in China such as Baidu,
NetEase.com, Shanda Interactive Entertainment, Sina, sohu.com and tom.com;
national websites in Brazil such as Terra and UOL; and health information
websites in the U.S. like MedHelp.com and trusera.com, which will compete with
us for online advertising revenue and end users. Many of our
competitors have more experience, resources and visitors than us.
The
sale of INTAC’s Legacy Businesses, leaving our strategic focus on the online
publishing, could have an adverse effect on our business, financial condition
and results of operations.
INTAC’s
wireless handset distribution business accounted for approximately 95% of its
total revenues for the third quarter of fiscal year 2007, and approximately 92%
of its total revenues for the fiscal year ended September 30, 2006.
We sold the INTAC Legacy Businesses in February 2008 which eliminates
future revenues from the INTAC Merger. All future revenue will be derived
from online publishing market and other future business strategies. There
is no guarantee that we will be able to offset the sale of the wireless handset
distribution business and the INTAC Legacy Businesses through comparable growth
in our online publishing businesses.
Resales
of our common stock and additional obligations to issue our common stock may
cause the market price of our stock to fall.
We have
registered for resale an aggregate of 33,634,192 shares of our common stock held
by INTAC affiliates, HowStuffWorks and investors that participated in our equity
financings, although HowStuffWorks agreed not to sell or otherwise transfer
one-third of its shares until October 2008, one-third of its shares until
April 2009 and one-third of its shares until October 2009. In
addition, we granted HowStuffWorks a warrant to purchase 500,000 (250,000
of which are now expired) shares of our common stock. The issuance of
these new shares and the resale of additional shares of our common stock could
depress the market price for our common stock.
7
Various
factors could negatively affect the market price or market for our common
stock
The
market for and price of our common stock could be affected by the following
factors:
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general
market and economic conditions;
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our
common stock has been thinly traded;
and
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minimal
third party research is available regarding our
company.
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Additionally,
the terms of the Discovery merger provided that payment to HowStuffWorks
shareholders for a significant portion of HowStuffWorks’ ownership of our common
stock would not be paid at the October 2007 closing of the transaction and
instead will be paid to HowStuffWorks’ former shareholders in three semi-annual
installments beginning on or about October 2008. Such payments will be in
the form of cash or shares of HSWI stock now held by HowStuffWorks.
Accordingly, the amount of shares of our common stock indirectly owned by
Discovery in the future may fall or rise due to a combination of the potential
distributions pursuant to the terms of the Discovery merger or our exercise of
the options to publish HowStuffWorks content in local languages in Russia and
India. All of our rights to publish HowStuffWorks content will remain
effective regardless of the number of shares owned by HowStuffWorks in the
future. If Discovery and HowStuffWorks’ former shareholders’
representative elect to distribute shares of our common stock to former
HowStuffWorks shareholders, a significant number of shares may be sold by such
shareholders relative to the daily market trading volumes for our common stock.
While we intend to take reasonable measures aimed to ensure that any such
potential sales are not disruptive to the market for our common stock, we cannot
be certain as to the outcome.
These
factors may similarly affect our common stock, and may have the effect of
depressing the market price for our common stock or limiting the market for
resale of our common stock.
Our
internal control over financial reporting and our disclosure controls and
procedures may not prevent all possible errors that could occur. Internal
control over financial reporting and disclosure controls and procedures, no
matter how well designed and operated, can provide only reasonable, not
absolute, assurance that the control system’s objective will be
met.
A control
system, no matter how well designed and operated, can provide only reasonable,
not absolute, assurance that the control system’s objectives will be
satisfied. Internal control over financial reporting and disclosure
controls and procedures are designed to give a reasonable assurance that they
are effective to achieve their objectives. We cannot provide absolute
assurance that all of our possible future control issues will be detected.
These inherent limitations include the possibility that judgments in our
decision making can be faulty, and that isolated breakdowns can occur because of
simple human error or mistake. The design of our system of controls is
based in part upon certain assumptions about the likelihood of future events,
and there can be no assurance that any design will succeed absolutely in
achieving our stated goals under all potential future or unforeseeable
conditions. Because of the inherent limitations in a
cost effective control system, misstatements due to error could occur and not be
detected.
We
may have additional tax liabilities if tax positions we have taken in prior
years are challenged.
We and
our subsidiaries are subject to taxes in the United States and various foreign
jurisdictions. We believed that our tax returns appropriately reflected
our tax liability when those tax returns were filed. However, our tax
positions may be challenged by the applicable tax authorities. Any
successful challenge to one or more of our prior tax positions could result in a
material tax liability to us or to one or more of our subsidiaries, including
INTAC, for one or more prior years.
8
The
state of the Internet infrastructure in China and Brazil may limit our
growth.
We rely
on the Internet for certain aspects of our business, including the publication
of content online and our Internet portals. The Internet infrastructures
in China and Brazil are not well developed and are subject to regulatory control
and, in the case of China, ownership by the Chinese government. The cost
of Internet access is high relative to the average income in China.
Failure to further develop these infrastructures could limit our ability to
grow. Alternatively, as these infrastructures improve and Internet use
increases, we may not be able to scale our systems proportionately. Our
reliance on these infrastructures will make us vulnerable to disruptions or
failures in service, without sufficient access to alternative networks and
services. Such disruptions or failures could reduce our user
satisfaction. Should these risks be realized, our ability to increase
revenues and profitability would be impaired.
Our
operations are vulnerable to natural disasters and other events.
While we
believe we have adequate backup systems in place, we could still experience
system failures and electrical outages from time to time in the future, which
could disrupt our operations. All of our servers and routers are currently
hosted in a single location, a Tier 4 data center. We do not have a
documented disaster recovery plan in the event of damage from fire, floods,
typhoons, earthquakes, power loss, and telecommunications failures, break ins
and similar events. If any of the foregoing occurs, we may experience a
temporary system shutdown. If there is significant disruption or damage to
the data center hosting our web servers, our ability to provide access to our
websites would be interrupted. We do not carry any business interruption
insurance. Although we carry property insurance, our coverage may not be
adequate to compensate us for all losses, particularly with respect to loss of
business and reputation that may occur.
Our
network operations may be vulnerable to hacking, viruses and other disruptions,
which may make our products and services less attractive and
reliable.
Internet
usage of our products could decline if any well publicized compromise of our
security occurs. “Hacking” involves efforts to gain unauthorized access to
information or systems or to cause intentional malfunctions or loss or
corruption of data, software, hardware or other computer equipment.
Hackers, if successful, could misappropriate proprietary information or cause
disruptions in our service. We may be required to expend capital and other
resources to protect our website against hackers. We cannot assure you
that any measures we may take will be effective. In addition, the
inadvertent transmission of computer viruses could expose us to a material risk
of loss or litigation and possible liability, as well as materially damage our
reputation and decrease our user traffic.
Unauthorized
use of our intellectual property by third parties, and the expenses incurred in
protecting our intellectual property rights, may adversely affect our
business.
We regard
our copyrights, service marks, trademarks, trade secrets and other intellectual
property as critical to our success. Unauthorized use of our intellectual
property by third parties may adversely affect our business and
reputation. We rely on trademark and copyright law, trade secret
protection and confidentiality agreements with our employees, customers,
business partners and others to protect our intellectual property rights.
Despite our precautions, it is possible for third parties to obtain and use our
intellectual property without authorization. Furthermore, the validity,
enforceability and scope of protection of intellectual property in Internet
related industries are uncertain and still evolving. In particular, the
laws of the PRC, Brazil and certain other countries are uncertain or do not
protect intellectual property rights to the same extent as do the laws of the
United States. Moreover, litigation may be necessary in
the future to enforce our intellectual property rights, to protect our trade
secrets or to determine the validity and scope of the proprietary rights of
others. Future litigation could result in substantial costs and diversion
of resources.
We
may be subject to intellectual property infringement claims, which may force us
to incur substantial legal expenses and, if determined adversely against us,
materially disrupt our business.
We cannot
be certain that our products and services will not infringe valid patents,
copyrights or other intellectual property rights held by third parties. We
may in the future be subject to legal proceedings and claims from time to time
relating to the intellectual property of others in the ordinary course of our
business. In particular, if we are found to have violated the intellectual
property rights of others, we may be enjoined from using such intellectual
property, and may incur licensing fees or be forced to develop
alternatives. We may incur substantial expenses in defending against these
third party infringement claims, regardless of their merit. Successful
infringement claims against us may result in substantial monetary liability or
may materially disrupt the conduct of our business.
9
Our
sublicensed content is subject to the terms and conditions of agreements between
HowStuffWorks and third parties.
Under the
terms of our contribution agreements, HowStuffWorks transferred and
contributed to us all rights, but only those rights, which belong to and are
held by HowStuffWorks pursuant to third-party licenses. Some of those
licenses, including those with Publications International, Inc. contain
restrictions on the use of such content and termination provisions for breaches
of the license agreements. Accordingly, a breach of any third party
license by HowStuffWorks may cause us to lose our license with such third
party, which could have a material adverse effect on the implementation of our
business plan, value of our content offering and results of our
operations.
A
slowdown or other adverse developments in the PRC or Brazil economy may
materially and adversely affect our customers, demand for our services and our
business.
Although
the PRC economy has grown significantly in recent years, we cannot assure you
that such growth will continue and we may be sensitive to a slowdown in economic
growth or other adverse changes in the PRC and Brazil economies. This is
particularly true in light of current financial and economic
uncertainties. In response to adverse economic developments,
companies may reduce spending on marketing and advertising. As a result, a
slowdown in overall economic growth, an economic downturn or recession or other
adverse economic developments in China or Brazil may materially reduce the
demand for our services and materially and adversely affect our
business.
PRC
laws and regulations related to the PRC Internet sector are unclear and will
likely change in the near future. If we are found to be in violation of
current or future PRC laws or regulations, we could be subject to severe
penalties.
The PRC
regulates its Internet sector by making pronouncements or enacting regulations
regarding the legality of foreign investment in the PRC Internet sector and the
existence and enforcement of content restrictions on the Internet. There
are substantial uncertainties regarding the interpretation of current PRC
Internet laws and regulations, including those discussed below.
The PRC
enacted regulations applying to Internet related services and telecommunications
related activities. While many aspects of these regulations remain
unclear, they purport to limit and require licensing of various aspects of the
provision of Internet information services. The MII has also stated that
the activities of Internet content providers are subject to regulation by
various PRC government authorities, depending on the specific activities
conducted by the Internet content provider. Various government authorities
have stated publicly that they are in the process of preparing new laws and
regulations that will govern these activities. The areas of regulation
currently include online advertising, online news reporting, online publishing,
online securities trading and the provision of industry specific (e.g., drug
related) information over the Internet. Other aspects of our online
operations may be subject to regulation in the future.
Under the
agreement reached in November 1999 between the PRC and the United States
concerning the United States’ support of China’s entry into the World Trade
Organization, or the WTO, foreign investment in PRC Internet
services was to be liberalized to allow for 30% foreign ownership in key
telecommunication services, including PRC Internet ventures, for the first year
after China’s entry into the WTO, 49% in the second year and 50%
thereafter. China officially entered the WTO on December 11,
2001. However, the implementation of China’s WTO accession agreements is
still subject to various conditions.
The
interpretation and application of existing PRC laws and regulations, the
directives of the MII and the possible new laws or regulations have created
substantial uncertainties regarding the legality of existing and future foreign
investments in, and the businesses and activities of, PRC Internet companies,
including us. Accordingly, it is possible that the relevant PRC
authorities could, at any time, assert that any portion or all of our ownership
structure and business violate existing or future PRC laws, regulations or
policies. It is also possible that the new laws or regulations governing
the PRC Internet sector that have been adopted or may be adopted in the future
will prohibit or restrict foreign investment in, or other aspects of, any of our
proposed businesses and operations. In addition, these new laws and
regulations may be retroactively applied to us.
10
If we are
found to be in violation of any existing or future PRC laws or regulations, the
relevant PRC authorities would have broad discretion in dealing with such
violation, including, without limitation, the following:
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levying
fines;
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confiscating
our income;
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revoking
our business licenses;
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shutting
down our servers and/or blocking our
websites;
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requiring
us to restructure our ownership structure or operations;
and
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requiring
us to discontinue any portion or all of our Internet
business.
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Any of
these actions could have a material adverse effect on our financial condition
and results of operations.
The
online advertising markets in China and Brazil are still developing, and present
risk to our revenues to be generated from our online publishing business using
the contributed assets.
Our
online publishing businesses in China and Brazil are expected to derive
significant revenue from online advertisements. The online advertising
markets in China and Brazil are still developing, and future growth and
expansion of these markets is uncertain. If these online advertising
markets do not grow at expected rates, our results of operations and financial
condition will be materially adversely affected.
Our
international operations subject us to other significant risks including
unpredictable governmental regulation in China and Brazil.
Our
international operations expose us to a wide variety of other risks including
increased credit risks, customs duties, import quotas and other trade
restrictions, potentially greater inflationary pressures, and the risk of
failure or material interruption of wireless systems and services. Changes
may occur in foreign trade and investment laws in the territories and countries
where we will operate. U.S. laws and regulations relating to investment
and trade in foreign countries could also change to our detriment. Any of
these factors could materially and adversely affect our revenues and
profits. We are subject to risk of political instability and trade
sanctions within China.
China has
traditionally been a closed market with strict political controls. As
China shifts to a market economy, growing economic and social freedoms may
conflict with the more restrictive political and governmental policies. In
addition, democratic countries throughout the world have, from time to time,
attempted to use economic and other sanctions to achieve political or social
change in other countries. Each of these factors could result in economic
sanctions, economic instability, the disruption of trading and war within China
and the Asia Pacific Rim, any of which could result in our inability to conduct business operations in China. Because a
substantial amount of our business is expected to be within China, the
disruption of distribution channels into China would have material and adverse
consequences to our business.
In the
past, the Brazilian government has intervened in the Brazilian economy and
occasionally made drastic changes in economic policy. The Brazilian
government’s actions to control inflation and affect other policies have
included high interest rates, wage and price controls, currency devaluations,
capital controls and limits on exports, among other actions. Our business,
financial condition, revenues, results of operations, prospects and the market
price of our securities may be adversely affected by changes in Brazilian
government policies, as well as general economic factors,
including:
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currency
fluctuations;
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exchange
controls and restrictions on remittances abroad, such as those that were
briefly imposed on such remittances (including dividends) in 1989 and in
the beginning of 1990;
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inflation;
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price
instability;
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energy
policy;
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interest
rate increases;
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liquidity
of domestic capital and lending
markets;
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changes
in tax policy; and
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other
political, domestic, social and economic developments in or affecting
Brazil.
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11
Also, the
President of Brazil has considerable power to determine governmental policies
and actions that relate to the Brazilian economy and, consequently, affect the
operations and financial performance of businesses operating in Brazil. We
have no control over, and cannot predict what policies or actions the Brazilian
government may take in the future.
Further
risks relating to international operations include, but are not restricted to,
unexpected changes in legal and regulatory requirements, changes in tariffs,
exchange rates and other barriers, political and economic instability, possible
effects of war and acts of terrorism, difficulties in account receivable
collection, difficulties in managing distributors or representatives,
difficulties in staffing and managing international operations, difficulties in
protecting our intellectual property overseas, seasonality of sales and
potentially adverse tax consequences. Any of these factors could
materially and adversely affect our revenues and profits.
Restrictions
on currency exchange may limit our ability to utilize our revenues
effectively.
Some of
our operating expenses are denominated in Chinese Renminbi. Currently, we
may purchase foreign exchange for settlement of “current account transactions”
without the approval of the Chinese State Administration for Foreign Exchange,
or SAFE. We may also retain foreign exchange in our current account
(subject to a ceiling approved by the SAFE) to satisfy foreign exchange
liabilities or to pay dividends. However, the relevant PRC governmental
authorities may limit or eliminate our ability to purchase and retain foreign
currencies in the future.
Additionally,
some of our revenues and operating expenses are denominated in Brazilian Reais. Brazilian law
allows the Brazilian government to impose restrictions on the conversion of the
Real into foreign
currencies and on the remittance to foreign investors of proceeds from their
investments in Brazil. The government may impose such restrictions
whenever there is a serious imbalance in Brazil’s balance of payments or there
are reasons to foresee a serious imbalance. The Brazilian government last
imposed remittance restrictions for approximately six months in 1989 and early
1990. The likelihood that the Brazilian government would impose such
restrictions again may depend on the extent of Brazil’s foreign currency
reserves, the availability of foreign currency in the foreign exchange markets
on the date a payment is due, the size of Brazil’s debt service burden relative
to the economy as a whole, Brazil’s policy toward the International Monetary
Fund and other factors.
Since a
significant amount of our revenues will be denominated in Renminbi, existing and
future restrictions on the exchange of Renminbi to other currencies may limit
our ability to use revenue generated in Renminbi to fund our business activities
outside China, if any, or expenditures denominated in foreign currencies.
Similarly, in the event that a significant amount of our revenues are
denominated in Reais,
any future restrictions on the exchange of Reais for other currencies or
the remittance to foreign investors of proceeds from their investments in Brazil
may limit our ability to use revenue generated in Reais to fund our business
activities outside Brazil, or expenditures denominated in foreign
currencies.
We
are subject to risks of currency fluctuations and exchange
restrictions.
Currency
fluctuations, devaluations and exchange restrictions may adversely affect our
liquidity and results of operations. In some countries, local currencies
may not be readily converted into Euros or U.S. dollars (or other “hard
currencies”) or may only be converted at government controlled rates, and, in
some countries, the transfer of hard currencies offshore has been restricted
from time to time. Very limited hedging transactions are available in
China to reduce its exposure to exchange rate fluctuations. To date, we
have not entered into any hedging transactions in an effort to reduce our
exposure to foreign currency exchange risk. While we may decide to enter
into hedging transactions in the future, the availability and effectiveness of
these hedges may be limited and we may not be able to successfully hedge our
exposure, if at all. Our revenues as expressed in our U.S. dollar
financial statements will decline in value if Renminbi or Reais depreciate relative to
the U.S. dollar. In addition, our currency exchange losses may be
magnified by PRC exchange control regulations that restrict our ability to
convert Renminbi into U.S. dollars or by Brazilian exchange control regulations
that restrict our ability to convert Reais into U.S.
dollars.
12
Regulation
and censorship of information collection and distribution in China may adversely
affect our business.
China has
enacted regulations governing Internet access and the distribution of news and
other information. Furthermore, the Propaganda Department of the Chinese
Communist Party has been given the responsibility to censor news published in
China to ensure, supervise and control a particular political ideology. In
addition, the MII has published implementing regulations that subject online
information providers to potential liability for content included on their
portals and the actions of subscribers and others using their systems, including
liability for violation of PRC laws prohibiting the distribution of content
deemed to be socially destabilizing. Because many PRC laws, regulations
and legal requirements with regard to the Internet are relatively new and
untested, their interpretation and enforcement may involve significant
uncertainty. In addition, the PRC legal system is a civil law system in
which decided legal cases have limited binding force as legal precedents.
As a result, in many cases it is difficult to determine the type of content that
may result in liability for a website operator.
Periodically,
the Ministry of Public Security has stopped the distribution over the Internet
of information which it believes to be socially destabilizing. The
Ministry of Public Security has the authority to cause any local Internet
service provider to block any website maintained outside China at its sole
discretion. If the PRC government were to take action to limit or
eliminate the distribution of information through our portals or to limit or
regulate current or future applications available to users of our portals, our
business would be adversely affected.
The State
Secrecy Bureau, which is directly responsible for the protection of state
secrets of all PRC government and Chinese Communist Party organizations, is
authorized to block any website it deems to be leaking state secrets or failing
to meet the relevant regulations relating to the protection of state secrets in
the distribution of online information. Under the applicable regulations,
we may be held liable for any content transmitted on our portal.
Furthermore, where the transmitted content clearly violates the laws of the PRC,
we will be required to delete it, and where the transmitted content is
considered suspicious, we are required to report such content. We must
also undergo computer security inspections, and if we fail to implement the
relevant safeguards against security breaches, our operations in the PRC may be
shut down.
Although
the PRC has several laws and regulations relating to the use of the Internet,
addressing personal privacy in use of the Internet and the freedom of
communications, the PRC government does not restrict online service providers in
the collection, transmission and commercial use of personal information or
data. Personal data is protected from unlawful use by general statutes and
by any contractual arrangement between the user and the service
provider.
Potential
additional Chinese regulation could affect our business in China.
The
Ministry of Information Industry, the Chinese governmental agency which
regulates the Internet in China, promulgated a directive effective
January 31, 2008, providing that online videos can only be broadcast or
streamed by state-owned or controlled companies. Subsequently, the
Ministry of Information Industry acted to provide exceptions for certain
non-state-owned or controlled companies. While it is possible that our
Chinese website would not be permitted to display online videos, which could
have a material effect on the content provided on such website, it is not yet
clear what, if any, effect this regulation has upon our business in
China.
13
Political
and economic policies of the PRC government could affect our
business.
A
significant portion of our business, assets and operations are located in China
and a significant portion of our future revenues are expected to be derived from
our operations in China. Accordingly, our business could be adversely
affected by changes in political, economic or social conditions in China,
adjustments in PRC government policies or changes in laws and
regulations.
The
economy of China differs from the economies of most countries belonging to the
Organization for Economic Cooperation and Development in a number of respects,
including:
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structure;
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level
of government involvement;
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level
of development;
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level
of capital reinvestment;
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growth
rate;
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control
of foreign exchange; and
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methods
of allocating resources.
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Since
1949, China has been primarily a planned economy subject to a system of
macroeconomic management. Although the Chinese government still owns a
significant portion of the productive assets in China, economic reform policies
since the late 1970s have emphasized decentralization, autonomous enterprises
and the utilization of market mechanisms. We cannot predict what effects
the economic reform and macroeconomic measures adopted by the Chinese government
may have on our business or results of operations.
The
PRC legal system embodies uncertainties which could limit the legal protections
available to us.
The PRC
legal system is a civil law system based on written statutes. Unlike
common law systems, it is a system in which decided legal cases have little
precedential value. In 1979, the PRC government began to promulgate a
comprehensive system of laws and regulations governing economic matters in
general. We are subject to laws and regulations applicable to foreign
investment in mainland China. However, these laws, regulations and legal
requirements are relatively recent, and their interpretation and enforcement
involve uncertainties. These uncertainties could limit the legal
protections available to us and other foreign investors. In addition, we
cannot predict the effect of future developments in the PRC legal system,
particularly with regard to the Internet, our ownership
structure and currency exchange, including the promulgation of new laws, changes
to existing laws or the interpretation or enforcement thereof, or the preemption
of local regulations by national laws.
It
may be difficult to enforce any civil judgments against us or our board of
directors or officers, because in the future a significant portion of our assets
could be located outside of the United States.
Although
the combined company is incorporated in the State of Delaware, in the future a
substantial portion of our assets could be located in the PRC. As a
result, it may be difficult for investors to enforce outside the United States
any actions brought against us in the United States, including actions
predicated upon the civil liability provisions of the federal securities laws of
the United States or of the securities laws of any state of the United
States. In addition, certain of our directors and officers and all or a
substantial portion of their assets may be located outside the United States
(principally in the PRC). As a result, it may not be possible for
investors to effect service of process within the United States upon those
directors and officers, or to enforce against them or us judgments obtained in
United States courts, including judgments predicated upon the civil liability
provisions of the federal securities laws of the United States or of the
securities laws of any state of the United States. There is doubt as to
the enforceability in the PRC, in original actions or in actions for enforcement
of judgments of United States courts, of civil liabilities predicated solely
upon the federal securities laws of the United States or the securities laws of
any state of the United States.
14
If
we are not able to attract and retain key management and consultants, we may not
successfully integrate the contributed assets into our historical business or
achieve our other business objectives.
We will
depend upon our senior management and consultants for our business
success. Key members of the senior team include Jeff Arnold, a consultant
and our current Chairman of the Board. Our consulting agreement with
Mr. Arnold, which commenced in 2006, runs through May 31, 2009. The
loss of the service of any of the key members of our senior management may
significantly delay or prevent the integration of the contributed assets and
other business objectives. Our ability to attract and retain qualified
personnel, consultants and advisors will be critical to our success. We
may be unable to attract and retain these individuals, and our failure to do so
would adversely affect our business.
The
concentration of our stock ownership will likely limit your ability to influence
corporate matters.
HowStuffWorks beneficially
owns a significant percentage of our outstanding common stock and entered into a
stockholders agreement. The stockholders agreement entitles
HowStuffWorks to designate nominees to our board of directors.
Furthermore, Jeff Arnold, our current Chairman of the Board, is the Chief
Executive Officer and Chairman of HowStuffWorks, and another member of our Board
of Directors is President-Digital Media and Business Development of its parent
company, Discovery. As a result, HowStuffWorks has the ability to
influence our management and affairs and determine the outcome of matters
submitted to stockholders for approval, including the election and removal of
directors, amendments to the charter, approval of equity-based employee
compensation plans and any merger, consolidation or sale of all or substantially
all of our assets.
The
concentration of our stock ownership, as well as our Amended and Restated
Certificate of Incorporation, Amended and Restated Bylaws, stockholders
agreement and Delaware law contain provisions that may make our acquisition more
difficult without the approval of our board of directors, which could
discourage, delay or prevent a transaction involving our change of
control.
As of
March 30, 2009, HowStuffWorks owned approximately 43% of our outstanding
shares of common stock. As a result, it will be difficult for our other
stockholders to approve a takeover of us without the cooperation of
HowStuffWorks.
Furthermore,
our Amended and Restated Certificate of Incorporation and Amended and Restated
Bylaws contain certain anti-takeover provisions, including but not limited to
the following provisions:
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only
our board of directors may call special meetings of our
stockholders;
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our
stockholders may take action only at a meeting of our stockholders and not
by written consent;
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we
require advance notice for stockholder proposals of not less than 60 nor
more than 90 days prior to a meeting at which stockholder proposals
may be introduced.
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In
addition, the stockholders agreement gives HowStuffWorks the right to
designate nominees to our board of directors.
These
anti-takeover defenses could discourage, delay or prevent a transaction
involving a change of control of us. These provisions could also
discourage proxy contests and make it more difficult for you and other
stockholders to cause us to take other corporate actions you may
desire.
Section 203
of the Delaware General Corporation Law may also delay, defer or prevent a
change in control that our stockholders might consider to be in their best
interest. We are subject to Section 203 of the Delaware General
Corporation Law which, subject to certain exceptions, prohibits “business
combinations” between a publicly-held Delaware corporation and an “interested
stockholder,” which is generally defined as a stockholder who becomes a
beneficial owner of 15% or more of a Delaware corporation’s voting stock for a
three-year period following the date that such stockholder became an interested
stockholder. Section 203 could have the effect of delaying, deferring
or preventing a change in control of us that our stockholders might consider to
be in their best interest.
15
Acquisitions,
business combinations and other transactions present integration risk and may
have negative consequences for our business and our
stockholders.
The
process of integrating acquired businesses, like DailyStrength, into our
existing operations may result in unforeseen difficulties and liabilities and
may require a disproportionate amount of resources and management attention.
Difficulties that we may encounter in integrating the operations of acquired
businesses could have a material adverse effect on our results of operations and
financial position. Moreover, we may not realize any of the anticipated benefits
of an acquisition and integration costs may exceed anticipated amounts. We may
enter into joint ventures, strategic alliances or similar arrangements with
third parties. These transactions may result in changes in the nature
and scope of our operations and changes in our financial condition.
Financing for these transactions may come from cash on hand, proceeds from
the issuance of additional common stock or proceeds from debt
financing.
The
issuance of additional equity or debt securities could:
|
·
|
cause
substantial dilution of the percentage ownership of our stockholders at
the time of the issuance;
|
|
·
|
cause
substantial dilution of our earnings per
share;
|
|
·
|
subject
us to the risks associated with increased
leverage;
|
|
·
|
subject
us to restrictive covenants that could limit our flexibility in conducting
future business
activities; and
|
|
·
|
adversely
affect the prevailing market price for our outstanding
securities.
|
We
may not be able to raise additional funds when needed for our business or to
exploit opportunities.
We may
need to raise additional funds to support expansion, develop new or enhanced
applications and services, respond to competitive pressures, acquire
complementary businesses or technologies or take advantage of unanticipated
opportunities. If required, we may attempt to raise such additional funds
through public or private debt or equity financing, strategic relationships or
other arrangements. There can be no assurance that such financing will be
available on acceptable terms, if at all, or that such financing will not be
dilutive to our stockholders.
We
face competition from other social media companies.
We face
competition for our DailyStrength website from other social media companies,
including start-ups as well as developed companies that are enhancing or
developing social media technologies. Also, we may compete with companies
that provide health-focused websites because these companies, like us, are
trying to sell advertising for health content on the Internet. Among the
social media and health-focused website companies, there are a number of large,
established competitors with significantly greater employees and cash resources
than we have. We expect that some of these companies will increasingly use
their resources to compete against us in a variety of ways, including by making
acquisitions, investing more aggressively in research and development, and
competing more aggressively for advertisers and users. If our competitors
are successful in providing similar or better social media destinations for
health, we could experience a decline in user traffic. Any such decline
could negatively affect our revenues and growth
opportunities.
We
may not be able to successfully grow and monetize our social media
business.
Formidable
growth of users and revenue is required for our DailyStrength social media
business to generate sufficient revenue to cover operating costs. If we
fail to maintain and enhance the “DailyStrength” brand, if we are unable to
attract sufficient users for our DailyStrength website, or if we incur excessive
expenses in these efforts, our business, operating results and financial
condition will be materially and adversely affected.
We
generate our revenue almost entirely from advertising, and the reduction in
spending by or loss of advertisers could seriously harm our
business.
We
generated the majority of our revenues in 2008 from our advertisers. Our
advertisers can generally terminate their contracts with us at any time.
Advertisers will not continue to do business with us if their investment
in advertising with us does not generate sales leads, and ultimately customers,
or if we do not deliver their advertisements in an appropriate and effective
manner. If we are unable to be competitive and provide value to our
advertisers, they may stop placing ads with us, which would negatively harm our
revenues and business. In addition, expenditures by advertisers tend to be
cyclical, reflecting overall economic conditions and budgeting and buying
patterns. Any decreases in or delays in advertising spending due to
general economic conditions could reduce our revenues or negatively impact our
ability to grow our revenues.
16
None.
Our
corporate headquarters are located at One Capital City Plaza, 3350 Peachtree
Road, Suite 1600, Atlanta, Georgia, which consists of approximately 6,000
square feet of leased space. At December 31, 2008, we also leased
approximately 5,700 square feet in Beijing, China, approximately 700 square feet
in Sao Paulo, Brazil, as well as a nominal amount in California. We
do not own any real property. We believe that our existing facilities are
adequate to meet our needs in the near term.
As of
December 31, 2008, our current total remaining lease obligations are U.S.
$465,439.
We are
not subject to any material pending legal proceeding, nor are we aware of any
material threatened claims against us.
No
matters were submitted to a vote of our security holders during the fourth
quarter of the year ended December 31, 2008.
17
ITEM
5. MARKET FOR THE REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
Our
common stock has been traded on the NASDAQ Global Market under the symbol “HSWI”
since October 2, 2007, and INTAC traded on the NASDAQ Capital Market under
the symbol “INTN” prior to that time. The following table sets forth the
high and low sales prices of our and INTAC’s common stock, as reported per the
appropriate market.
|
High
|
Low
|
|||||||
|
Year
ended December 31, 2007
|
||||||||
|
First
Quarter
|
$ | 8.92 | $ | 5.65 | ||||
|
Second
Quarter
|
8.00 | 6.50 | ||||||
|
Third
Quarter
|
11.48 | 5.00 | ||||||
|
Fourth
Quarter
|
11.25 | 4.18 | ||||||
|
Year
ended December 31, 2008
|
||||||||
|
First
Quarter
|
$ | 6.23 | $ | 3.20 | ||||
|
Second
Quarter
|
5.30 | 2.61 | ||||||
|
Third
Quarter
|
3.90 | 2.05 | ||||||
|
Fourth
Quarter
|
2.74 | 0.15 | ||||||
Holders
of Record
As of
March 30, 2009, the last sale price of our common stock on NASDAQ Global
Market was $0.15 per share. As of March 30, 2009, there were
approximately 25 stockholders of record.
Dividend
Policy
We have
neither paid nor declared dividends on our common stock since our inception and
do not plan to pay dividends in the foreseeable future. Any earnings that
we may realize will be returned to finance our growth.
18
The
following table sets forth consolidated financial data with respect to us as of
and for the years ended December 31, 2008 and 2007. The selected
consolidated financial data below should be read in conjunction with the audited
consolidated financial statements and related notes included elsewhere in this
Annual Report on Form 10-K and “Management’s Discussion and Analysis of
Financial Condition and Results of Operations” included in Item 7. This is
particularly true because our historical financial data is difficult to compare
from period to period because of the mergers and business dispositions we have
recently consummated, as described therein.
The
following data, insofar as it relates to the years ended December 31, 2008
and 2007, has been derived from the audited consolidated financial statements,
including the consolidated balance sheets at December 31, 2008, and 2007,
and the related consolidated statements of operations, cash flows and
stockholders’ equity and comprehensive income for the years ended
December 31, 2008 and 2007, and notes thereto appearing elsewhere in this
report.
As
discussed in Notes 1, 2, and 3 to the consolidated financial statements included
elsewhere in this report, HSWI merged with INTAC International Inc. on
October 2, 2007, and the INTAC Legacy Businesses were subsequently disposed
on February 29, 2008. Following the disposition, the sole asset we
retained from INTAC is the indefinite lived Internet Licenses intangible asset
and no revenue was realized from this asset in 2008 or 2007.
|
Years
Ended December 31,
|
||||||||
|
2008
|
2007
|
|||||||
|
Operating
revenue
|
$ | 457,006 | $ | 147,535 | ||||
|
Cost
of services
|
987,266 | 1,242,252 | ||||||
|
Gross
loss
|
(530,260 | ) | (1,094,717 | ) | ||||
|
Operating
expenses
|
23,751,913 | 13,768,471 | ||||||
|
Loss
from operations
|
(24,282,173 | ) | (14,863,188 | ) | ||||
|
Other
income
|
515,238 | 11,842 | ||||||
|
Deferred
income tax benefit
|
1,962,500 | — | ||||||
|
Loss
from continuing operations
|
(21,804,435 | ) | (14,851,346 | ) | ||||
|
Loss
from discontinued operations
|
(133,526 | ) | (24,687,959 | ) | ||||
|
Net
loss
|
$ | (21,937,961 | ) | $ | (39,539,305 | ) | ||
|
Per share
data:
|
||||||||
|
Basic
and diluted loss per share from continuing operations
|
$ | (0.41 | ) | $ | (1.29 | ) | ||
|
Basic
and diluted loss per share from discontinued operations
|
— | (2.13 | ) | |||||
|
Basic
and diluted loss per share
|
$ | (0.41 | ) | $ | (3.42 | ) | ||
|
Weighted
average shares outstanding – basic and diluted
|
52,941,525 | 11,544,818 | ||||||
Consolidated
Balance Sheet Data:
|
December
31,
|
||||||||
|
2008
|
2007
|
|||||||
|
Cash
and cash equivalents
|
$ | 18,020,159 | $ | 3,476,673 | ||||
|
Goodwill
and other intangibles
|
5,799,066 | 10,021,476 | ||||||
|
Total
assets
|
26,309,653 | 34,745,160 | ||||||
|
Total
liabilities
|
1,833,231 | 9,834,723 | ||||||
|
Stockholders’
equity
|
24,476,422 | 24,910,437 | ||||||
19
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
You
should read the following discussion together with our consolidated financial
statements and the related notes and other financial information included
elsewhere in this report. The discussion in this report contains forward-looking
statements that involve risks and uncertainties, such as statements of our
plans, objectives, expectations and intentions. The cautionary statements made
in this report should be read as applying to all related forward-looking
statements wherever they appear in this report. Our actual results could differ
materially from those discussed here.
Business
Overview and Recent Events
HSW
International is an online publishing company that develops and operates
Internet businesses focused on providing consumers in the world’s digital
economies with locally relevant, high quality information and ways to connect
with each other. Our international websites published under the
HowStuffWorks brand provide readers in China and Brazil with thousands of
articles about how the world around them works, serving as destinations for
credible, easy-to-understand reference information. HSW International
is the exclusive licensee in China and Brazil for the digital publication of
translated content from HowStuffWorks.com, a subsidiary of Discovery
Communications, Inc., and in China for the digital publication of translated
content from World Book Encyclopedia. Our DailyStrength business,
which was acquired on November 26, 2008, helps hundreds of thousands of readers
share information and support on www.dailystrength.org,
a comprehensive health-related social media website. The acquisition
of DailyStrength was completed in part to diversify our business and to publish
another product which offers insight on highly relevant topics. We
generate revenue primarily through the sale of online advertising on our
websites. We were incorporated in Delaware in March 2006. Our
headquarters are located at One Capital City Plaza, 3350 Peachtree Road, Suite
1600, Atlanta, Georgia 30326.
Business
Trends
The
number of unique visitors, page views and time spent on our Web sites indicates
volume of traffic to our sites and are key non-financial metrics we monitor,
because they can influence our advertising revenue rates and our overall
advertising revenue. We also monitor overall Internet advertising
trends as indicators of our performance. Because data on Brazil and China
is limited, we watch U.S. trends as a proxy, although trends might vary
country-by-country.
The
advertising market overall declined in 2008 due to the economic
slowdown. This decline affected online advertising expenditures as
well. The result for us has been lower revenue than expected, even in
Brazil.
In this
tough economy, we are cautious regarding our operating expenses and have cut
costs in 2009 to attempt to better align our spending with our expectations for
growth within each product line. We acquired DailyStrength in November
2008 and accordingly have added related operating expenses to our 2009 budget.
Since then, we have implemented cost-cutting measures in our headcount and
third-party and other professional services to better align our operating costs
with our revised growth expectations and partially offset the additional charges
related to DailyStrength. As described above, we expect challenges in our
revenue growth and margins for 2009. As a result, we closely monitor
our cash status and our progress and likelihood of success in each of our
markets. Accordingly, we might decide to suspend our activities in
one or more of our markets in order to focus our limited resources in the
other(s).
The
INTAC Merger
We
completed the INTAC Merger on October 2, 2007 to assist in the development of
our digital content database exclusively licensed from HowStuffWorks by
(i) accelerating our obtaining Internet licenses in China for launching our
Internet platform, (ii) obtaining INTAC’s knowledge of the Chinese markets,
relationships, and core competencies to accelerate the growth of our Internet
platforms in China, and (iii) providing additional cash flow from INTAC’s
established businesses. These established businesses included services
related to wireless telephone training and the development and sale of
educational software delivered to customers in China (“INTAC Legacy
Businesses”). As discussed below, the INTAC Legacy Businesses were
subsequently disposed.
Prior to
the consummation of the merger with INTAC, we had only limited assets and
operations incident to our formation and in preparation for the merger with
INTAC and subsequent business.
20
In
conjunction with the INTAC Merger:
|
·
|
HowStuffWorks
contributed exclusive digital publishing rights to HowStuffWorks’ content
for China and Brazil;
|
|
·
|
our
stock became publicly traded on the NASDQ Global Market under the symbol
“HSWI”; and
|
|
·
|
certain
investors contributed $39.4 million (before
expenses).
|
As more
fully discussed in Note 2 to the consolidated financial statements included in
this Annual Report to Form 10-K, the preliminary allocation of the purchase
price of $47.9 million resulted in approximately $29.0 million of goodwill
primarily from our expectations that we could utilize INTAC’s knowledge of the
Chinese markets, relationships, and core competencies to accelerate the growth
of our Internet platforms in China. However, as discussed below, we
disposed of the entire INTAC Legacy Businesses on February 29,
2008.
Business
Development
On
November 26, 2008, we acquired DailyStrength to diversify our
business. This acquisition provides us with a footprint in the US
healthcare market and we believe this addition is synergistic to our existing
technology. The DailyStrength acquisition extends HSW International’s proven
publishing platform with social networking applications and
communities. DailyStrength hosts more than 500 communities focused on
issues such as weight loss, divorce, parenting and illnesses. Users of the site
both read and interact with high-quality, reference information. The site
features health journals, discussion forums, virtual hugs, member-created
groups, and treatment reviews plus unique content provided on a daily basis by
physicians and other health professionals.
Our
Operations
We
entered the Brazilian online publishing market in March 2007. At
December 31, 2008, we had approximately 5,500 articles that were either (i)
articles from the HowStuffWorks content database translated from English to
Portuguese, or (ii) originally created content. The web site address
is http://hsw.com.br/. We
are continuing the development of our business strategy in Brazil as we continue
to expand by (i) adding original proprietary digital content designed to meet
the information needs of the Brazilian online community, (ii) expanding the
amount of translated content from HowStuffWorks, and (iii) refining local
marketing strategies. We recognized approximately $405,000 and
$148,000 of revenue during the years ended December 31, 2008 and 2007,
respectively.
In June
2008, we entered China’s online publishing market utilizing a combination of the
contributed assets from HowStuffWorks with the benefit of INTAC’s relationships
and knowledge of the Chinese markets in obtaining our Internet licenses. In
September 2008, we announced an exclusive content partnership with World Book,
Inc. In 2009, World Book will create thousands of original Chinese-language
articles providing information on all branches of knowledge, including arts,
sciences, history, technology, mathematics, sports, and recreation, exclusively
for HSW International's Beijing-based website, BoWenWang (http://www.bowenwang.com.cn/).
At December 31, 2008, we had approximately 4,400 articles.
We are
developing our business strategy for DailyStrength with emphasis on expanding
its offerings, in addition to integrating the best of DailyStrength’s social
media technologies into HSW International’s web publishing
platform. DailyStrength.org offers content authored by medical
professionals based on current topics, support groups, a treatment directory
with definitions, private messaging, one-on-one chat forums and personal goal
trackers, and primarily serves English speaking territories, such as the United
States, Canada, Australia and the United Kingdom. The medical panel
of professionals contributes articles and journals providing insight to a number
of topics relevant to the DS user group and
communities. DailyStrength and its user group create online
communities and support services to help people cope with health, stress and
other challenges of modern life – issues that people the world over face
daily.
Sale
of the INTAC Legacy Businesses (Discontinued Operations) and Related
Transactions
21
We had
originally estimated when deciding to acquire the INTAC Legacy Businesses that,
in addition to accelerating our obtaining Internet licenses in China for
launching our Internet platform, INTAC would provide us (i) further
knowledge of the Chinese markets, relationships, and core competencies to
accelerate the growth of our Internet platforms in China, and
(ii) additional cash flow from its established
businesses. Following the underperformance of the INTAC Legacy
Businesses in the fourth quarter of 2007, that resulted in short-term negative
cash flow from these operations of $1.1 million, and a change-in-control of our
business through the acquisition of our largest shareholder, HowStuffWorks, by
Discovery, we reconsidered the potential risk of excessive short-term
consumption of cash and management resources by our acquired non-core INTAC
Legacy Businesses and refined our strategic direction.
We
decided that it was critical that all our current resources be fully focused on
expanding our Brazilian platform and the June 2008 launch of our Chinese
Internet platform. Although we believe we have benefited in the
short-term from INTAC’s relationships and knowledge of the Chinese markets in
obtaining our Internet licenses, this refined strategic focus did not allow us
the time required to realize the expected long-term synergies, embodied in our
acquired INTAC goodwill, from INTAC’s knowledge of the Chinese markets,
relationships, and core competencies. In addition, we were provided
with and acted on an opportunity to sell the unrelated INTAC Legacy Businesses
for approximately their stand-alone appraised value, and through simultaneous
sale of the treasury stock received, generate significant additional cash
resources for investing into our core Internet businesses.
At
December 31, 2007, we recognized a loss of $24.7 million related to the February
29, 2008, INTAC legacy disposition and has been recorded as discontinued
operations in the accompanying consolidated financial statements. During the
year ended December 31, 2008, we recognized a loss of $133,526, which has been
recorded as discontinued operations in the accompanying consolidated financial
statements. All the goodwill resulting from the INTAC acquisition was
included in the INTAC Legacy Businesses when we determined the potential write
off, because such operations had not been integrated with our online publishing
segment prior to our decision to dispose of the INTAC Legacy
Businesses.
On
February 29, 2008, we completed the sale of the INTAC Legacy
Businesses. The INTAC Legacy Businesses were sold to China Trend
Holdings Ltd., a British Virgin Islands corporation that is owned by Mr. Zhou,
CEO, director and significant stockholder of INTAC prior to the INTAC Merger in
October 2007. Mr. Zhou was also a member of our board of directors
from October 2007 to December 2007. In accordance with the share
purchase agreement with China Trend Holdings, we were to receive 5.0 million of
our common shares owned by Mr. Zhou. In addition, as a condition to
the February 29, 2008, INTAC Legacy Businesses disposition, the INTAC Legacy
Businesses were to include $4.5 million in cash at closing.
At the
February 29, 2008, INTAC Legacy Businesses disposition, we received only 4.5
million shares of our common stock from Mr. Zhou and accordingly, we only funded
the INTAC Legacy Businesses with $2.7 million in cash. Mr. Zhou
delivered his additional 0.5 million shares of our common stock to us on March
26, 2008, and on March 31, 2008, we released another $1.6 million in cash to the
INTAC Legacy Businesses ($1.8 million for the stock received net of an estimated
$0.2 million withheld for disposition expenses). As of December 31,
2008, all of HSWI’s assets were in our core Internet businesses and the sole
asset we retained from the INTAC Merger is the Internet licenses intangible we
used to enter the Chinese markets in June 2008.
On
February 15, 2008, we entered into a stock purchase agreement where we agreed to
sell and two qualified institutional buyers agreed to purchase the 5.0 million
shares of our common stock received from the INTAC Legacy Businesses disposition
at a purchase price of $3.68 per share. Simultaneously with the
February 29, 2008 disposition, we sold the 4.5 million shares we received to the
institutional buyers. Subsequently on March 26, 2008, we sold the
additional 0.5 million shares from Mr. Zhou to the institutional
buyers.
22
Results
of Operations – Year Ended December 31, 2008 Compared to Year Ended December 31,
2007
The
following table sets forth our results of operations for the years ended
December 31, 2008 and 2007. As discussed in Notes 1,
2, and 3 to the consolidated financial statements included in this Annual Report
on Form 10-K, HSWI merged with INTAC International Inc. on October 2,
2007, and the INTAC Legacy Businesses were subsequently disposed on
February 29, 2008. Following the disposition, the sole asset we
retained from INTAC is the indefinite-lived Internet Licenses intangible asset
and no revenue was realized from this asset in 2008 or 2007. INTAC’s
results of operations have been recorded within discontinued operations for both
years presented.
HSW
INTERNATIONAL, INC. and SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF OPERATIONS
(expressed
in U.S. Dollars)
|
Years
Ended December 31,
|
||||||||
|
2008
|
2007
|
|||||||
|
Operating
revenue
|
||||||||
|
Digital online
publishing
|
$ | 234,144 | $ | 147,535 | ||||
|
Sales to
affiliates
|
222,862 | — | ||||||
|
Total revenue
|
457,006 | 147,535 | ||||||
|
Cost
of services
|
987,266 | 1,242,252 | ||||||
|
Gross
margin
|
(530,260 | ) | (1,094,717 | ) | ||||
|
Operating
expenses
|
||||||||
|
Selling, general and
administrative (including stock-based
|
||||||||
|
compensation expense of
$4,787,756 and $7,203,738
|
||||||||
|
in 2008 and 2007,
respectively)
|
15,678,365 | 13,710,723 | ||||||
|
Licenses to operate in China
impairment
|
7,850,000 | — | ||||||
|
Depreciation and
amortization
|
223,548 | 57,748 | ||||||
|
Total operating
expenses
|
23,751,913 | 13,768,471 | ||||||
|
Loss
from continuing operations before other income
|
||||||||
|
(expense) and income
taxes
|
(24,282,173 | ) | (14,863,188 | ) | ||||
|
Other
income (expense)
|
||||||||
|
Interest income
|
515,238 | 51,754 | ||||||
|
Interest expense
|
— | (39,912 | ) | |||||
|
Total other income
(expense)
|
515,238 | 11,842 | ||||||
|
Loss
from continuing operations before income taxes
|
(23,766,935 | ) | (14,851,346 | ) | ||||
|
Deferred
income tax benefit
|
1,962,500 | — | ||||||
|
Loss
from continuing operations
|
(21,804,435 | ) | (14,851,346 | ) | ||||
|
Loss
from discontinued operations, net of income taxes
|
(133,526 | ) | (24,687,959 | ) | ||||
|
Net
loss
|
$ | (21,937,961 | ) | $ | (39,539,305 | ) | ||
|
Basic
and diluted weighted average shares outstanding
|
52,941,525 | 11,544,818 | ||||||
|
Net
loss per basic and diluted shares
|
$ | (0.41 | ) | $ | (3.42 | ) | ||
23
Revenues
Revenue
for the years ended December 31, 2008 and 2007 of approximately $405,000 and
$148,000, respectively, was generated in Brazil, where we launched our website
in March 2007. For the year ended December 31, 2008, approximately
86% of revenue was generated from paid-for-impression advertising and 14% was
generated from pay-per-performance ads. DailyStrength contributed
approximately $52,000 of revenue for the year ended December 31,
2008. There was no China digital online publishing revenue during
2008 or 2007 as the website in China was launched in June
2008.
Cost
of Services
Cost of
services includes the ongoing third-party costs to translate, localize and
enhance articles from English to Portuguese and Mandarin Chinese, as well as
costs incurred to acquire original articles written by third
parties. Portuguese article translation costs totaled $777,000 and
$719,000 and Chinese translation costs totaled $194,000 and $523,000 for the
years ended December 31, 2008 and 2007, respectively.
Operations
– Selling, General and Administrative Expenses
Our total
selling, general and administrative expenses increased by
$2.0 million for the year ended December 31, 2008 as compared to
2007. The increase is primarily attributable to increased costs of
establishing our operations related to the Brazil website, and launching the
China website, as well as additional costs incurred for compliance and operation
as a public company. The increases over 2007 are primarily comprised
of $1.8 million in personnel costs, $2.1 million in professional fees related to
operating as a public company, as well as continued investment in our platform
and technology and $0.5 million associated with directors and officers insurance
costs. The increase is partially offset by a $2.4 million decrease in
stock-based compensation expense for the year ended December 31, 2008 as
compared to 2007 (see Note 10 to Notes to the Consolidated Financial
Statements included in this Annual Report to
Form 10-K). Stock-based compensation expense is a non-cash item,
and in 2008 totaled $4.8 million. This amount was based primarily on
vesting during the year of options at exercise prices ranging from $6.50 per
share to $7.10 per share, reflecting our higher stock price in earlier periods
when the options were granted.
Impairment
Loss
We
recorded an impairment charge related to the licenses to operate in China
intangible asset in the amount of $7.9 million (see Note 6).
Other
Income (Expense)
Other
income (expense) increased approximately $503,000 for the year ended
December 31, 2008 as compared to 2007. The increase in interest
income reflects an increase in cash on hand resulting from the sale of our stock
to certain institutional investors during our first quarter. The
decrease in interest expense is due to full payment on an affiliated party loan
during the fourth quarter of 2007.
Deferred
Income Tax Benefit
We
recorded a $2.0 million tax benefit related to the impairment charge against the
licenses to operate in China intangible asset.
24
Discontinued
Operations – INTAC Legacy Businesses
The
discussion that follows relates to the INTAC Legacy Businesses results of
operations for the years ended December 31, 2008 and 2007. Revenue
was for services related to wireless telephone training and the development and
sale of educational software in China. The $0.5 million loss from
discontinued operations in 2008 was reduced by a $0.4 million gain upon final
disposition on February 29, 2008. The $24.7 million loss from
discontinued operations in 2007 was primarily due to a goodwill write off of
approximately $22.5 million related to the February 29, 2008 disposition of the
INTAC Legacy Businesses.
|
Years
Ended December 31,
|
||||||||
|
2008
|
2007
|
|||||||
|
Revenues
|
$ | 38,849 | $ | 198,627 | ||||
|
Loss
from discontinued operations (before income taxes)
|
(133,526 | ) | (24,687,959 | ) | ||||
|
Loss
from discontinued operations
|
$ | (133,526 | ) | $ | (24,687,959 | ) | ||
As
discussed above and more fully in Notes 2 and 3 to the Consolidated Financial
Statements included in this Annual Report on Form 10-K, the goodwill write
off is the result of the subsequent sale of the INTAC Legacy Businesses on
February 29, 2008.
Liquidity
and Capital Resources
We expect
to expend significant resources in expanding and gaining market share for our
Internet platforms in Brazil and China and to develop our healthcare social
networking strategy, including up-front expenditures to create or acquire
content. These expenditures will be made in the respective markets
based on our success and anticipated market conditions and trends. We
expect that most of these expenditures will be paid or under commitment before
we begin to realize significant revenues. We believe that our current
cash balance and expected cash generated from future operations will be
sufficient to fund operations for longer than the next twelve
months. If cash on hand and generated from operations is insufficient
to satisfy our working capital and capital expenditure requirements, we may be
required to sell additional equity or obtain bank financing to fund further
development and attain profitability. There is no assurance that such
financing will be available or that we will be able to complete financing on
satisfactory terms, if at all.
Cash and
cash equivalents was $18.0 million at December 31, 2008, compared to $3.5
million at December 31, 2007. The increase in cash is primarily
attributable to the sale of our stock during the first quarter of
2008.
As of
December 31, 2008, our cumulative losses were $74.2 million, which included
non-cash expenses of $21.8 million for stock-based compensation, $22.5 million
goodwill write-off related to the February 29, 2008 INTAC Legacy Businesses
disposition and an impairment charge of $5.9 million, net of tax. We
used a significant amount of the $21.0 million net proceeds from the October 2,
2007, sale of stock to pay transaction costs, to pay off advances from
HowStuffWorks, and to fund operations. As previously disclosed, in the
first quarter of 2008, we received an additional $33.4 million before expenses
from the sale of our stock.
Our net
cash used in continuing operating activities during 2008 increased by $4.3
million compared to the prior year. The increase was due to increased
funding requirements to support our operations in Brazil and China while
building and maintaining our technology infrastructure. Net cash used
in discontinued operating activities was $0.5 million and $5.1 million for the
years ended December 31, 2008 and 2007.
Cash
used in investing activities
During
the year ended December 31, 2008, net cash used in investing activities was $8.5
million compared to $0.6 million in 2007. Cash used in investing
activities during the year ended December 31, 2008 reflects $4.5 million of cash
used in conjunction with the sale of our INTAC Legacy Businesses, $3.2 million
of cash used to acquire DailyStrength, as well as the purchases of property and
equipment.
25
Cash
flows from financing activities
For the
year ended December 31, 2008, net cash provided by financing activities was
approximately $35.2 million versus $16.5 million for 2007. The
significant increase in 2008 is a direct result of the proceeds we received from
the sale of our common stock during the first quarter.
Critical
Accounting Policies
Our
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. We believe that of our significant accounting
policies, revenue recognition, stock-based compensation and long-lived assets
including goodwill and other intangible assets may involve a higher
degree of judgment and complexity.
Revenue
Recognition
Online
publishing revenue is generally recognized as visitors are exposed to or react
to advertisements on our website. Revenue is generated from
advertising in the form of sponsored links and image ads. This
includes both pay-per-performance ads and paid-for-impression
advertising. In the pay-per-performance model, we earn revenue based
on the number of clicks associated with such ad; in the paid-for-impression
model (sponsorships), revenue is derived from the display of ads.
We
recognize revenue when the service has been provided, and the other criteria set
forth in Staff Accounting Bulletin (“SAB”) 104, Revenue Recognition, have
been met; namely, the fees we charge are fixed or determinable, we and our
advertisers understand the specific nature and terms of the agreed-upon
transactions and the collectability is reasonably assured.
Stock-Based
Compensation
Under the
2006 Equity Incentive Plan adopted April 13, 2006 (the “Plan”), HSWI authorized
8,000,000 shares for grant as part of a long term incentive plan to attract,
retain and motivate its eligible executives, employees, officers, directors and
consultants. Options to purchase common stock under the Plan have
been granted to our officers and employees with an exercise price equal to the
fair market value of the underlying shares on the date of
grant. Additionally in 2008, restricted shares were granted to
certain members of our Board of Directors and executives at the fair market
value on the grant date. As of December 31, 2008, no options had been
exercised under the Plan.
We
account for stock-based compensation in accordance with SFAS 123(R) which
requires us to recognize expense related to the fair value of our stock-based
compensation awards.
SFAS
123(R) requires the use of a valuation model to calculate the fair value of the
stock based awards. We have elected to use the Black-Scholes options
pricing model to determine the fair value of stock options on the dates of
grant, consistent with that used for pro forma disclosures under SFAS
123. We measure stock-based compensation based on the fair values of
all stock-based awards on the dates of grant, and recognize stock-based
compensation expense using the straight-line method over the vesting
periods. Stock-based compensation expense was $4.8 million and $7.2
million for the years ended December 31, 2008 and 2007,
respectively.
Long-Lived
Assets Including Goodwill and Other Intangible Assets
We review
property and equipment and amortizable intangible assets for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. Recoverability of property and equipment is
measured by a comparison of the carrying amounts to future net cash flows the
assets are expected to generate. The carrying value of the intangible
asset is compared to the fair value in order to determine if an impairment
exists. Assets to be disposed of are reported at the lower of the
carrying amount or fair value less costs to sell.
26
In
accordance with SFAS 142, Goodwill and Other Intangible
Assets, we test goodwill and indefinite lived intangible assets for
impairment annually at December 31, or more frequently if events or changes in
circumstances indicate that this asset may be impaired. SFAS 142 also
requires that intangible assets with definite lives be amortized over their
estimated useful lives and reviewed for impairment whenever events or
circumstances indicate an asset’s carrying value may not be recoverable in
accordance with SFAS 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. We amortize our acquired
intangible assets with definite lives over three to eleven years. We
recorded an impairment charge of $5.9 million, net of tax, of the licenses to
operate in China intangible asset due to the results of the December 31, 2008
impairment analysis.
Recent
Accounting Pronouncements
In
September 2006, the FASB issued SFAS 157, Fair Value
Measurements. SFAS 157 defines fair value, establishes a
framework for measuring fair value in accordance with generally accepted
accounting principles in the United States (“GAAP”), and expands disclosures
about fair value measurements. SFAS 157 emphasizes that fair value is
a market-based measurement, not an entity-specific
measurement. Therefore, a fair value measurement would be determined
based on the assumptions that market participants would use in pricing the asset
or liability. SFAS 157 is effective for fiscal years beginning after
November 15, 2007, except for non-financing assets and
liabilities. The adoption of SFAS 157 did not have a material impact
on our consolidated financial statements as the Company had no financial assets
other than cash and accounts receivable.
In
February 2008, the FASB issued FASB Staff Position (“FSP”) 157-2, Partial Deferral of the Effective
Date of SFAS 157, which delayed the effective date of SFAS 157 for all
nonrecurring fair value measurements of nonfinancial assets and nonfinancial
liabilities until January 1, 2009. We are currently evaluating the
impact FSP 157-2 will have on our consolidated financial
statements.
An
associated pronouncement, SFAS 159, The Fair Value Option for Financial
Assets and Financial Liabilities, was also effective at the beginning of
the Company’s 2008 fiscal year. The Company has elected not to apply
the fair value option to measure any of the financial assets and liabilities on
its balance sheet not already valued at fair value under other accounting
pronouncements. These other financial assets and liabilities are
primarily accounts receivable and accounts payable, which are reported at
historical value. The fair value of these financial assets and
liabilities approximate their fair value because of their short
duration.
In
December 2007, the FASB issued SFAS 141(R), Business
Combinations. SFAS 141(R) expands the definition of a business
combination and requires the fair value of the purchase price of an acquisition,
including the issuance of equity securities, to be determined on the acquisition
date. SFAS 141(R) also requires that all assets, liabilities,
contingent considerations, and contingencies of an acquired business be recorded
at fair value at the acquisition date. In addition, SFAS 141(R)
requires that acquisition costs generally be expensed as incurred, restructuring
costs generally be expensed in periods subsequent to the acquisition date, and
changes in accounting for deferred tax asset valuation allowances and acquired
income tax uncertainties after the measurement period impact income tax
expense. SFAS 141(R) is effective for fiscal years beginning after
December 15, 2008 with early adoption prohibited. We are
currently evaluating the impact SFAS 141(R) will have on our consolidated
financial statements.
In
December 2007, the FASB issued SFAS 160, Noncontrolling Interests in
Consolidated Financial Statements, an Amendment of ARB
51. SFAS 160 changes the accounting and reporting for minority
interests such that minority interests will be recharacterized as noncontrolling
interests and will be required to be reported as a component of equity, and
requires that purchases or sales of equity interests that do not result in a
change in control be accounted for as equity transactions and, upon a loss of
control, requires the interest sold, as well as any interest retained, to be
recorded at fair value with any gain or loss recognized in
earnings. SFAS 160 is effective for fiscal years beginning on or
after December 15, 2008 with early adoption prohibited. We do
not expect the implementation of SFAS 160 will have a material impact on our
consolidated financial statements.
Off-Balance
Sheet Arrangements
None.
27
Financial
instruments that potentially subject us to a concentration of credit risk
consist principally of cash and accounts receivables. At December 31, 2008, 99%
of our cash was denominated in U.S. dollars. The remaining 1% was
denominated in Brazilian Reais, Chinese Renminbi or Hong Kong
Dollars. All our cash is placed with financial institutions we
believe are of high credit quality. Our cash is maintained in bank
deposit accounts, which, at times, may exceed federally insured
limits. We have not experienced any losses in such accounts and do
not believe our cash is exposed to any significant credit risk.
We do not
use financial instruments to hedge our foreign exchange exposure because the
effects of the foreign exchange rate fluctuations are not currently
significant. We do not use financial instruments for trading
purposes. The net assets of our foreign operations at December 31,
2008, were approximately $0.5 million.
We have
not entered into long-term agreements or borrowing arrangements with third
parties under which any amounts were outstanding during 2008. Therefore,
we do not believe we have any material exposure to market risk changes in
interest rates.
We do not
use any derivative financial instruments to mitigate any of our currency
risks. We do not currently have any credit facilities and therefore
are not subject to interest rate risk. Due to the nature of our
short-term investments and our lack of debt, we have concluded that we face no
material market risk exposure.
28
CONSOLIDATED FINANCIAL
STATEMENTS
|
30
|
|
|
31
|
|
|
32
|
|
|
33
|
|
|
34
|
|
|
35
|
For
supplemental quarterly financial information, see Note 13, Quarterly Results of
Operations (unaudited), of the Notes to Consolidated Financial
Statements.
29
Board of
Directors and Shareholders
HSW
International, Inc. and subsidiaries:
We have
audited the accompanying consolidated balance sheets of HSW
International, Inc. (a Delaware corporation) and subsidiaries (“the
Company”) as of December 31, 2008 and 2007, and the related consolidated
statements of operations, stockholders’ equity and comprehensive income, and
cash flows for the years then ended. Our audits of the basic
financial statements included the consolidated financial statement schedule
listed in the table of contents appearing under Item 15 Schedule
II. These financial statements and financial statement schedule are
the responsibility of the Company’s management. Our responsibility is
to express an opinion on these financial statements and financial statement
schedule based on our audits.
We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (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. The
Company is not required to have, nor were we engaged to perform an audit of its
internal control over financial reporting. Our audit included
consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but not
for the purpose of expressing an opinion on the effectiveness of the Company’s
internal control over financial reporting. Accordingly, we express no
such opinion. An audit also includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
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 consolidated financial statements referred to above present fairly,
in all material respects, the financial position of HSW International, Inc.
and subsidiaries as of December 31, 2008 and 2007, and the results of its
operations and its cash flows for the years then ended in conformity with
accounting principles generally accepted in the United States of
America. 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.
/s/ GRANT
THORNTON LLP
Atlanta,
Georgia
March 25,
2009
30
(expressed
in U.S. Dollars)
|
December
31,
|
||||||||
|
2008
|
2007
|
|||||||
|
Assets
|
||||||||
|
Current
assets
|
||||||||
|
Cash and cash
equivalents
|
$ | 18,020,159 | $ | 3,476,673 | ||||
|
Trade accounts receivable (net of
allowance for doubtful accounts
|
||||||||
|
of $15,343 and $0 at December 31,
2008 and 2007, respectively)
|
103,020 | 23,212 | ||||||
|
Prepaid expenses and other current
assets
|
1,660,097 | 942,588 | ||||||
|
Assets held for
sale
|
— | 19,988,029 | ||||||
|
Total current
assets
|
19,783,276 | 24,430,502 | ||||||
|
Property
and equipment, net
|
727,311 | 293,182 | ||||||
|
Licenses
to operate in China
|
2,150,000 | 10,000,000 | ||||||
|
Goodwill
|
1,972,944 | — | ||||||
|
Intangibles,
net
|
1,676,122 | 21,476 | ||||||
|
Total assets
|
$ | 26,309,653 | $ | 34,745,160 | ||||
|
Liabilities and Stockholders’
Equity
|
||||||||
|
Current
liabilities
|
||||||||
|
Accounts payable
|
$ | 554,673 | $ | 537,418 | ||||
|
Accrued expenses and other current
liabilities
|
322,094 | 561,247 | ||||||
|
Advances from shareholder and
affiliate
|
83,044 | 72,927 | ||||||
|
Liabilities held for
sale
|
— | 6,163,131 | ||||||
|
Total current
liabilities
|
959,811 | 7,334,723 | ||||||
|
Deferred
tax liability
|
873,420 | 2,500,000 | ||||||
|
Commitments
and contingencies
|
||||||||
|
Stockholders’
equity
|
||||||||
|
Preferred stock, $.001 par value,
10,000,000 shares authorized, none issued
|
— | — | ||||||
|
Common stock, $.001 par value,
200,000,000 shares authorized, 53,638,784 issued and
|
||||||||
|
outstanding at December 31, 2008,
and 49,306,107 issued and 46,306,107 outstanding
|
||||||||
|
at December 31,
2007
|
53,639 | 49,306 | ||||||
|
Additional
paid-in-capital
|
98,606,934 | 85,980,746 | ||||||
|
Accumulated other comprehensive
income (loss)
|
(1,126 | ) | 112,291 | |||||
|
Retained deficit
|
(74,183,025 | ) | (52,245,064 | ) | ||||
|
Less: cost of treasury stock,
3,000,000 shares in 2007
|
— | (8,986,842 | ) | |||||
|
Total stockholders’
equity
|
24,476,422 | 24,910,437 | ||||||
|
Total liabilities and
stockholders’ equity
|
$ | 26,309,653 | $ | 34,745,160 | ||||
The
accompanying notes are an integral part of these consolidated financial
statements.
31
CONSOLIDATED
STATEMENTS OF OPERATIONS
(expressed
in U.S. Dollars)
|
Years
Ended December 31,
|
||||||||
|
2008
|
2007
|
|||||||
|
Operating
revenue
|
||||||||
|
Digital online
publishing
|
$ | 234,144 | $ | 147,535 | ||||
|
Sales to
affiliates
|
222,862 | — | ||||||
|
Total revenue
|
457,006 | 147,535 | ||||||
|
Cost
of services
|
987,266 | 1,242,252 | ||||||
|
Gross
margin
|
(530,260 | ) | (1,094,717 | ) | ||||
|
Operating
expenses
|
||||||||
|
Selling, general and
administrative (including stock-based
|
||||||||
|
compensation expense of
$4,787,756 and $7,203,738
|
||||||||
|
in 2008 and 2007,
respectively)
|
15,678,365 | 13,710,723 | ||||||
|
Impairment loss
|
7,850,000 | — | ||||||
|
Depreciation and
amortization
|
223,548 | 57,748 | ||||||
|
Total operating
expenses
|
23,751,913 | 13,768,471 | ||||||
|
Loss
from continuing operations before other income
|
||||||||
|
(expense) and income
taxes
|
(24,282,173 | ) | (14,863,188 | ) | ||||
|
Other
income (expense)
|
||||||||
|
Interest income
|
515,238 | 51,754 | ||||||
|
Interest expense
|
— | (39,912 | ) | |||||
|
Total other income
(expense)
|
515,238 | 11,842 | ||||||
|
Loss
from continuing operations before income taxes
|
(23,766,935 | ) | (14,851,346 | ) | ||||
|
Deferred
income tax benefit
|
1,962,500 | — | ||||||
|
Loss
from continuing operations
|
(21,804,435 | ) | (14,851,346 | ) | ||||
|
Loss
from discontinued operations, net of income taxes
|
(133,526 | ) | (24,687,959 | ) | ||||
|
Net
loss
|
$ | (21,937,961 | ) | $ | (39,539,305 | ) | ||
|
Basic
and diluted loss per share
|
||||||||
|
Loss from continuing
operations
|
$ | (0.41 | ) | $ | (1.29 | ) | ||
|
Loss from discontinued
operations
|
— | (2.13 | ) | |||||
|
Net loss per share
|
$ | (0.41 | ) | $ | (3.42 | ) | ||
|
Basic
and diluted weighted average shares outstanding
|
52,941,525 | 11,544,818 | ||||||
The
accompanying notes are an integral part of these consolidated financial
statements.
32
CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT) AND COMPREHENSIVE
INCOME
(expressed
in U.S. Dollars)
|
Accumulated
|
Total
|
|||||||||||||||||||||||||||||||
|
Additional
|
Other
|
Stockholders’
|
||||||||||||||||||||||||||||||
|
Common
Stock
|
Paid-in
|
Treasury
|
Comprehensive
|
Accumulated
|
Equity
|
|||||||||||||||||||||||||||
|
Shares
|
Amount
|
Capital
|
Shares
|
Stock
|
Income
(Loss)
|
Deficit
|
(Deficit)
|
|||||||||||||||||||||||||
|
Balance
at December 31, 2006
|
10 | $ | — | $ | 9,810,987 | — | $ | — | $ | — | $ | (12,705,759 | ) | $ | (2,894,772 | ) | ||||||||||||||||
|
Comprehensive
loss:
|
||||||||||||||||||||||||||||||||
|
Net loss
|
— | — | — | — | — | — | (39,539,305 | ) | (39,539,305 | ) | ||||||||||||||||||||||
|
Foreign currency
translation
|
— | — | — | — | — | 112,291 | — | 112,291 | ||||||||||||||||||||||||
|
Total comprehensive
loss
|
(39,427,014 | ) | ||||||||||||||||||||||||||||||
|
Issuance of shares
to
|
||||||||||||||||||||||||||||||||
|
HowStuffWorks in
exchange
|
||||||||||||||||||||||||||||||||
|
for digital publishing
rights
|
22,940,717 | 22,941 | (22,941 | ) | — | — | — | — | — | |||||||||||||||||||||||
|
Issuance of shares due
to
|
||||||||||||||||||||||||||||||||
|
merger with
INTAC
|
22,940,727 | 22,941 | 38,965,425 | — | — | — | — | 38,988,366 | ||||||||||||||||||||||||
|
Issuance of shares
to
|
||||||||||||||||||||||||||||||||
|
investors, net
|
3,424,653 | 3,424 | 21,036,695 | — | — | — | — | 21,040,119 | ||||||||||||||||||||||||
|
Stock-based
compensation
|
||||||||||||||||||||||||||||||||
|
expense
|
— | — | 7,203,738 | — | — | — | — | 7,203,738 | ||||||||||||||||||||||||
|
Treasury stock
|
— | — | 8,986,842 | (3,000,000 | ) | (8,986,842 | ) | — | — | — | ||||||||||||||||||||||
|
Balance
at December 31, 2007
|
49,306,107 | 49,306 | 85,980,746 | (3,000,000 | ) | (8,986,842 | ) | 112,291 | (52,245,064 | ) | 24,910,437 | |||||||||||||||||||||
|
Comprehensive
loss:
|
||||||||||||||||||||||||||||||||
|
Net loss
|
— | — | — | — | — | — | (21,937,961 | ) | (21,937,961 | ) | ||||||||||||||||||||||
|
Foreign currency
translation
|
— | — | — | — | — | (113,417 | ) | — | (113,417 | ) | ||||||||||||||||||||||
|
Total comprehensive
loss
|
(22,051,378 | ) | ||||||||||||||||||||||||||||||
|
Shares received from sale
of
|
||||||||||||||||||||||||||||||||
|
INTAC
Legacy Businesses
|
— | — | — | (5,000,000 | ) | (18,400,000 | ) | — | — | (18,400,000 | ) | |||||||||||||||||||||
|
Issuance
of shares to
|
||||||||||||||||||||||||||||||||
|
investors, net
|
4,268,812 | 4,269 | 7,838,496 | 8,000,000 | 27,386,842 | — | — | 35,229,607 | ||||||||||||||||||||||||
|
Restricted stock
grants
|
63,865 | 64 | (64 | ) | — | — | — | — | — | |||||||||||||||||||||||
|
Stock-based
compensation
|
||||||||||||||||||||||||||||||||
|
expense
|
— | — | 4,787,756 | — | — | — | — | 4,787,756 | ||||||||||||||||||||||||
|
Balance
at December 31, 2008
|
53,638,784 | $ | 53,639 | $ | 98,606,934 | — | $ | — | $ | (1,126 | ) | $ | (74,183,025 | ) | $ | 24,476,422 | ||||||||||||||||
The
accompanying notes are an integral part of these consolidated financial
statements.
33
(expressed
in U.S. Dollars)
|
Years
Ended December 31,
|
||||||||
|
2008
|
2007
|
|||||||
|
Cash
flows from continuing operating activities:
|
||||||||
|
Net
loss from continuing operations
|
$ | (21,804,435 | ) | $ | (14,851,346 | ) | ||
|
Adjustments
to reconcile net loss from continuing operations to net cash used
in
|
||||||||
|
continuing operating
activities:
|
||||||||
|
Impairment loss
|
7,850,000 | — | ||||||
|
Stock-based
compensation
|
4,787,756 | 7,203,738 | ||||||
|
Deferred income
taxes
|
(1,962,500 | ) | — | |||||
|
Depreciation and
amortization
|
223,548 | 57,748 | ||||||
|
Provision for doubtful
accounts
|
15,343 | — | ||||||
|
Changes in operating assets and
liabilities from continuing operations:
|
||||||||
|
Accounts
receivable
|
(102,430 | ) | (23,212 | ) | ||||
|
Prepaid expenses and other
current assets
|
(822,302 | ) | (956,169 | ) | ||||
|
Accounts payable, accrued
expenses, and other liabilities
|
37,744 | 1,119,532 | ||||||
|
Net
cash used in continuing operating activities
|
(11,777,276 | ) | (7,449,709 | ) | ||||
|
Cash
flows from discontinued operating activities:
|
||||||||
|
Net
loss from discontinued operations
|
(133,526 | ) | (24,687,959 | ) | ||||
|
Adjustments
to reconcile net loss from discontinued operations to net cash used
in
|
||||||||
|
discontinued operating
activities:
|
||||||||
|
Goodwill write off related to
disposition
|
— | 22,518,382 | ||||||
|
Provision for doubtful
accounts
|
— | 1,210,631 | ||||||
|
Depreciation and
amortization
|
170,475 | 280,103 | ||||||
|
Gain on sale of
businesses
|
(343,990 | ) | — | |||||
|
Changes in operating assets and
liabilities from discontinued operations:
|
||||||||
|
Accounts
receivable
|
31,030 | 374,694 | ||||||
|
Prepaid expenses and other
current assets
|
(56,419 | ) | 371,712 | |||||
|
Accounts payable, accrued
expenses, and other liabilities
|
(189,000 | ) | (5,263,987 | ) | ||||
|
Payable to
affiliates
|
— | 86,611 | ||||||
|
Net
cash used in discontinued operating activities
|
(521,430 | ) | (5,109,813 | ) | ||||
|
Net
cash used in operating activities
|
(12,298,706 | ) | (12,559,522 | ) | ||||
|
Cash
flows from continuing investing activities:
|
||||||||
|
Purchases of property and
equipment
|
(644,546 | ) | (237,103 | ) | ||||
|
Sale of INTAC Legacy
Businesses
|
(4,500,000 | ) | — | |||||
|
Daily Strength, Inc. acquisition,
net of cash received of $76,880
|
(3,215,074 | ) | — | |||||
|
INTAC merger related costs,
net
|
(107,027 | ) | (339,892 | ) | ||||
|
Cash
used in continuing investing activities
|
(8,466,647 | ) | (576,995 | ) | ||||
|
Cash
flows from discontinued investing activities:
|
||||||||
|
Purchases of property and
equipment
|
— | (25,002 | ) | |||||
|
Cash
used in discontinued investing activities
|
— | (25,002 | ) | |||||
|
Net
cash used in investing activities
|
(8,466,647 | ) | (601,997 | ) | ||||
|
Cash
flows from financing activities:
|
||||||||
|
Proceeds from issuance of common
stock, net
|
35,229,607 | 21,040,119 | ||||||
|
Proceeds of advance from
shareholder
|
— | 4,460,529 | ||||||
|
Repayment of advance from
shareholder
|
— | (8,716,013 | ) | |||||
|
Repayment of affiliated party
loan
|
— | (280,320 | ) | |||||
|
Cash
provided by financing activities
|
35,229,607 | 16,504,315 | ||||||
|
Net
change in cash and cash equivalents
|
14,464,254 | 3,342,796 | ||||||
|
Impact
of currency translation on cash
|
(83,926 | ) | 63,773 | |||||
|
Cash
and cash equivalents at beginning of period, including
$163,158
|
||||||||
|
reclassified to assets held for
sale
|
3,639,831 | 233,262 | ||||||
|
Cash
and cash equivalents at end of period
|
$ | 18,020,159 | $ | 3,639,831 | ||||
The
accompanying notes are an integral part of these consolidated financial
statements.
34
HSW
INTERNATIONAL, INC. and SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF CASH FLOWS (UNAUDITED)
(continued)
(expressed
in U.S. Dollars)
|
Years
Ended December 31,
|
||||||||
|
2008
|
2007
|
|||||||
|
Supplemental
disclosure of cash flow information
|
||||||||
|
Cash paid for
taxes
|
$ | — | $ | — | ||||
|
Cash paid for
interest
|
— | 56,208 | ||||||
|
Non-cash
business acquisition activities
|
||||||||
|
Issuance of equity including
$100,000 fair value of options assumed
|
$ | — | $ | 38,988,366 | ||||
|
Deferred tax
liabilities
|
— | 4,055,000 | ||||||
|
Net liabilities assumed, excluding
cash
|
— | 3,155,656 | ||||||
|
Other
non-cash financing and investing activities
|
||||||||
|
Receipt of shares for sale of
INTAC Legacy Businesses
|
$ | 18,400,000 | $ | — | ||||
|
Receipt of shares for sale of
INTAC distribution companies
|
— | 8,986,842 | ||||||
|
Issuance of shares for digital
publishing rights
|
— | 22,941 | ||||||
The
accompanying notes are an integral part of these consolidated financial
statements.
35
(expressed
in U.S. Dollars)
1. DESCRIPTION
OF ORGANIZATION AND BUSINESS OPERATIONS
HSW
International (“HSWI”) is an online publishing company that develops and
operates Internet businesses focused on providing consumers in the world’s
digital economies with locally relevant, high quality information and ways to
connect with each other. Our international websites published under
the HowStuffWorks brand provide readers in China and Brazil with thousands of
articles about how the world around them works, serving as destinations for
credible, easy-to-understand reference information. HSW International
is the exclusive licensee in China and Brazil for the digital publication of
translated content from HowStuffWorks.com, a subsidiary of Discovery
Communications, Inc., and in China for the digital publication of translated
content from World Book Encyclopedia. Our DailyStrength brand, which
was acquired on November 26, 2008, helps hundreds of thousands of readers share
information and support on www.dailystrength.org,
a comprehensive health-related social media website. The acquisition
of DailyStrength was completed in part to diversify our business and to publish
another product which offers insight on highly relevant topics. We
generate revenue primarily through the sale of online advertising on our
websites. We were incorporated in Delaware in March
2006. Our headquarters are located at One Capital City Plaza, 3350
Peachtree Road, Suite 1600, Atlanta, Georgia 30326.
In June
2008, we entered China’s online publishing market utilizing a combination of the
contributed assets from HowStuffWorks with the benefit of INTAC’s relationships
and knowledge of the Chinese markets in obtaining our Internet
licenses. We currently maintain offices in China, Brazil, Los
Angeles, California and Atlanta, Georgia, our corporate
headquarters.
Prior to
the INTAC Merger and related financing transactions, our sole shareholder was
HowStuffWorks, a privately-held online publishing company founded in 1999 that
provides objective and useful information for people to learn about the world
around them and make informed decisions. On December 17, 2007,
HowStuffWorks, our largest shareholder, merged with Discovery Communications,
Inc. (“Discovery”) becoming a wholly-owned subsidiary of
Discovery. As of December 31, 2008, Discovery, through its
wholly owned subsidiary HowStuffWorks, owned approximately 42.8% of our
outstanding common stock. HowStuffWorks remains based in Atlanta,
Georgia.
On
October 2, 2007, the date of our merger with INTAC, the following
occurred:
|
·
|
HowStuffWorks
contributed to us in exchange for shares of our common stock, exclusive
digital publishing rights to HowStuffWorks’ content for the countries of
China and Brazil which we translate and localize into the predominant
languages of China and Brazil.
|
|
·
|
Our
stock became publicly traded on the NASDAQ Global Market under the symbol
“HSWI” in connection with our merger with INTAC, with INTAC becoming our
wholly owned subsidiary. We were determined to be the
accounting acquirer under the applicable guidance. At the date
of the INTAC Merger, holders of INTAC common stock received one share of
our common stock in exchange for each of their shares of INTAC common
stock. Prior to the INTAC Merger, INTAC’s common stock was traded on the
NASDAQ Capital Market under the symbol
“INTN”.
|
|
·
|
Certain
investors purchased or agreed to purchase shares of our common stock
(equity financings) having an aggregate value of approximately $39.4
million of which $22.5 million and $16.9 million (both before expenses)
were received in October 2007, and January and
February 2008, respectively (see Notes 3 and
10).
|
|
·
|
In
connection with and as a condition of the INTAC Merger, INTAC sold its
wireless handset and prepaid calling cards distribution business
(“distribution companies”), to an entity controlled by Wei Zhou, INTAC’s
Chief Executive Officer and President, in exchange for 3.0 million shares
of our common stock held by Mr. Zhou. The 3.0 million shares of
our common stock were recorded as treasury shares valued at cost as
determined by a third party
valuation.
|
36
We
entered the Brazilian online publishing market in March 2007, by utilizing
royalty-free and exclusively licensed digital content provided by
HowStuffWorks. At December 31, 2008, we had approximately 5,500
articles that were either (i) articles from the HowStuffWorks content database
translated from English to Portuguese, or (ii) originally created
content. The web site address is (http://hsw.com.br/). We
are in the early development of our business strategy in Brazil as we continue
to expand by (i) adding original proprietary digital content designed to meet
the information needs of the Brazilian online community, (ii) expanding the
amount of translated content from HowStuffWorks, and (iii) refining local
marketing strategies.
In June
2008, we entered China’s online publishing market utilizing a combination of the
contributed assets from HowStuffWorks with the benefit of INTAC’s relationships
and knowledge of the Chinese markets in obtaining our Internet licenses. In
September 2008, we announced an exclusive content partnership with World Book,
Inc. In 2009, World Book will create thousands of original
Chinese-language articles providing information on all branches of knowledge,
including arts, sciences, history, technology, mathematics, sports, and
recreation, exclusively for HSW International's Beijing-based website, BoWenWang
(http://www.bowenwang.com.cn/).
At December 31, 2008, we had published approximately 4,400
articles.
In
November 2008, we acquired Daily Strength, Inc. (“DS”), publisher of the health
social networking website DailyStrength
(http://www.dailystrength.org). DailyStrength was founded in 2006 by
internet veterans with more than 20 years of experience conceiving, building,
and running communities on the web, including Yahoo Mail, Yahoo Message Boards,
Yahoo Groups, GeoCities, Facebook and more. DailyStrength hosts more than 500
communities focused on issues such as weight loss, divorce, parenting and
illnesses. Users of the site both read and interact with high-quality, accurate
reference information. The site features health journals, discussion forums,
virtual hugs, member-created groups, and treatment reviews plus unique content
provided on a daily basis by physicians and other health
professionals.
2. ACQUISITION
OF INTAC INTERNATIONAL, INC.
On
October 2, 2007, the INTAC Merger became effective with INTAC becoming our
wholly owned subsidiary. The results of the INTAC Legacy Businesses have
been included in discontinued operations in our consolidated financial
statements since that date until their disposition on February 29, 2008 (see
Note 3). At the date of the INTAC Merger, holders of INTAC common
stock received one share of our common stock in exchange for each of their
shares of INTAC common stock.
INTAC was
acquired to assist in our primary business focus, the development of our digital
content database exclusively licensed from HowStuffWorks by
(i) accelerating our obtaining Internet licenses in China for launching our
Internet platform, (ii) obtaining INTAC’s knowledge of the Chinese markets,
relationships, and core competencies and (iii) providing additional cash
flow from its established businesses.
In the
INTAC acquisition we also obtained two legacy businesses - services related to
wireless telephone training and the development and sale of educational software
delivered to customers in China. However, due to (i) an increased focus of
our management and resources on our primary Internet publishing business,
(ii) a change of control in our majority ownership leading to further
refinement in our strategies, and (iii) an under performance of the INTAC
Legacy Businesses subsequent to the INTAC Merger, we sold these legacy
businesses on February 29, 2008 (see Note 3). Following the
disposition, the sole asset we retained from the INTAC acquisition is the
Internet Licenses intangible we used to enter the China market in June
2008.
|
Exchange
of 19,940,727 HSWI common shares for all INTAC shares
|
||||
|
outstanding including $100 of fair
value for options assumed
|
$ | 38,988 | ||
|
Direct
acquisition costs
|
1,774 | |||
|
Other
|
47 | |||
| 40,809 | ||||
|
Net
liabilities assumed
|
3,037 | |||
|
Deferred
tax liabilities
|
4,055 | |||
|
Total purchase
price
|
$ | 47,901 | ||
For
convenience, we designated October 1, 2007, as the effective date for this
acquisition.
37
We noted
that SFAS 141, “Business Combinations” states that “the fair value of securities
traded in the market is generally more clearly evident than the fair value of
the acquired entity” and “that the quoted market price of a security issued to
effect a business combination generally should be used to estimate the fair
value of an acquired entity after recognizing possible effects of price
fluctuations, quantities traded, issues costs and the like.” However, HSWI
as the acquirer was not publicly traded until after the merger with
INTAC. In addition we considered the unique facts and circumstances
in the INTAC Merger, including HSWI’s limited historical operations; the
transaction being a merger of equals; and lastly, using INTAC’s public stock
price, and determined INTAC’s public stock price was also not a fair value of
the equity security because, among other reasons, (i) the public stock
price was affected by historical performance of the INTAC distribution business
which was sold simultaneously with the Merger, (ii) the INTAC stock was
thinly traded and (iii) a majority of the stock was held by insiders.
As a result, we obtained an independent valuation, (using recognized valuation
techniques) of our enterprise value post-merger to determine the fair value of
our common stock issued for the INTAC common shares.
The
deferred tax liabilities approximating $4.1 million relate to the
non-deductibility (for tax purposes) of the acquired intangibles in
China.
As part
of the acquisition, we assumed 500,000 INTAC outstanding stock options.
The per share fair value of our stock options issued in exchange for all of
INTAC’s outstanding options was estimated using the Black-Scholes options
pricing model (see Note 10). All of the options assumed were either
already fully vested at the time of the merger or vested in full as a result of
the INTAC Merger. Therefore, the fair value of the assumed options,
$100,000, is treated as part of the purchase price.
The
following table summarizes the estimated fair values of the assets acquired and
liabilities assumed at the date of acquisition (dollars in
thousands).
| $ | 118 | |||
|
Trade
accounts receivable
|
4,584 | |||
|
Other
current assets
|
1,683 | |||
|
Property
and equipment
|
298 | |||
|
Other
assets
|
90 | |||
|
Licenses
to operate in China (indefinite life)
|
10,000 | |||
|
Vendor
endorsement in China (indefinite life)
|
4,400 | |||
|
Acquired
database (5 year life)
|
1,335 | |||
|
Acquired
software (5 year life)
|
1,500 | |||
|
Coursework
books (4 year life)
|
1,035 | |||
|
Franchise
agreements (4 year life)
|
680 | |||
|
Goodwill
|
28,951 | |||
|
Assets acquired
|
54,674 | |||
|
Accounts
payable and other liabilities
|
(9,810 | ) | ||
|
Deferred
tax liabilities
|
(4,055 | ) | ||
|
Net assets
acquired
|
$ | 40,809 |
The
purchase price allocation is based on estimates of the fair value of the
tangible and intangible assets acquired and liabilities assumed. These estimates
were arrived at utilizing recognized valuation techniques with the assistance of
an independent valuation firm. Goodwill of approximately $29.0 million resulted
primarily from our expectation that we could utilize INTAC’s knowledge of the
Chinese markets, relationships, and core competencies to accelerate the growth
of our Internet platform in China. However as discussed in Note 3, subsequent to
December 31, 2007, we decided to dispose of the entire INTAC Legacy
Businesses prior to our integrating INTAC with our online publishing segment.
Accordingly all goodwill at December 31, 2007, along with all other
intangibles and net assets acquired except for the Internet Licenses intangible
was allocated to the INTAC Legacy Businesses in our determination of the
appropriate carrying values of our acquired INTAC assets, considering our
expected loss on disposition (see Note 3). Goodwill is not expected to be
deductible for tax purposes in the China.
The
intangible assets, other than the indefinite lived goodwill, Internet licenses,
and the vendor endorsement, are being amortized over their useful lives of 4.0
to 5.0 years with a weighted-average amortization period of
4.62 years. We recorded no in-process research and development related to
this acquisition.
Following
the February 2008 disposition, the sole assets we retained from the INTAC Legacy
Businesses were the Internet Licenses intangible asset that has an indefinite
life and is not amortized and from which no revenue has been generated from the
date of acquisition to December 31, 2008. Therefore, any pro forma
information assuming the acquisition of this remaining asset as of the beginning
of the respective periods would provide no additional useful
information.
38
In
connection with and as a condition of the INTAC Merger, INTAC sold its
distribution companies to an entity controlled by Mr. Zhou, in exchange for 3.0
million shares of our common stock held by Mr. Zhou. The 3.0 million
shares of our common stock were recorded as treasury shares valued at cost as
determined by a third party valuation for similar reasons that an independent
valuation was performed to value the INTAC Merger, as discussed
above.
3. DISCONTINUED
OPERATIONS – INTAC LEGACY BUSINESSES
Due to an
increased focus of our management and resources on our primary Internet
publishing business , a change of control in our majority ownership leading to
further refinement in our strategies, and an under performance of the INTAC
Legacy Businesses after the INTAC Merger, in early 2008, we decided to dispose
of the INTAC Legacy Businesses. The INTAC Legacy Businesses were
comprised of two lines of business which were both unrelated to our core
Internet platform businesses.
We had
originally estimated when deciding to acquire the INTAC Legacy Businesses that,
in addition to accelerating our obtaining Internet licenses in China for
launching our Internet platform, INTAC would provide us (i) further
knowledge of the Chinese markets, relationships, and core competencies to
accelerate the growth of our Internet platforms in China and
(ii) additional cash flow from its established
businesses. Following the underperformance of the INTAC Legacy
Businesses in the fourth quarter of 2007, that resulted in short-term negative
cash flow from these operations of $1.1 million, and a change-in-control of our
business through the acquisition of our largest shareholder, HowStuffWorks, by
Discovery, we reconsidered the potential risk of excessive short-term
consumption of cash and management resources by our acquired non-core INTAC
Legacy Businesses and refined our strategic direction.
We
decided that it was critical that all our current resources be fully focused on
expanding our Brazilian platform and the June 2008 launch of our Chinese
Internet platform. Although we believe we have benefited in the
short-term from INTAC’s relationships and knowledge of the
Chinese markets in obtaining our Internet licenses, this refined strategic focus
did not allow us the time required to realize the expected long-term synergies,
embodied in our acquired INTAC goodwill, from INTAC’s knowledge of the Chinese
markets, relationships, and core competencies. In addition, we were
provided with and acted on an opportunity to sell the unrelated INTAC Legacy
Businesses for approximately their stand-alone appraised value, and through
simultaneous sale of the treasury stock received, generate significant
additional cash resources for investing into our core Internet
businesses.
On
February 15, 2008, we entered into a share purchase agreement to sell the INTAC
Legacy Businesses. On February 29, 2008, we completed the sale of the
subsidiaries that comprised the INTAC Legacy Businesses. These
subsidiaries were sold to China Trend Holdings Ltd., a British Virgin Islands
corporation that is owned by Mr. Zhou, CEO, director and significant stockholder
of INTAC prior to the INTAC Merger in October 2007. Mr. Zhou was also
on our board of directors from October 2007 to December 2007. In
accordance with the Share Purchase Agreement with China Trend Holdings, we were
to receive 5.0 million of our common shares owned by Mr. Zhou. In
addition, as a condition to the February 29, 2008, INTAC Legacy Businesses
disposition, the INTAC Legacy Businesses were to include $4.5 million in cash at
closing.
At the
February 29, 2008, INTAC Legacy Businesses disposition, we received only 4.5
million shares of our common stock from Mr. Zhou and accordingly, we only funded
the INTAC Legacy Businesses with $2.7 million in cash. Mr. Zhou
delivered his additional 0.5 million shares of our common stock to us on March
26, 2008, and on March 31, 2008, we released another $1.6 million in cash to the
INTAC Legacy Businesses ($1.8 million for the stock received net of an estimated
$0.2 million withheld for disposition expenses). As of December 31,
2008, all of HSWI’s assets were in our core Internet businesses and the sole
asset we retained from the INTAC Merger is the Internet Licenses intangible we
used to enter the Chinese markets in June 2008.
In the
year ended December 31, 2007, we recognized a preliminary goodwill write
off of approximately $22.5 million related to the February 29, 2008, INTAC
Legacy Businesses disposition. All goodwill resulting from the INTAC
acquisition was included with the INTAC Legacy Businesses when we determined the
potential write off, because such operations had not been integrated with our
online publishing segment prior to our decision to dispose of the INTAC Legacy
Businesses. The goodwill write off due to disposition resulted from the fair
value of the expected net proceeds of 5.0 million shares of our common stock
valued at $3.68 per share (less estimated disposal costs) being less than the
combined cash to be transferred in the disposition plus the carrying value of
the net assets and intangibles sold in the disposition. The disposition proceeds
of 5.0 million shares of our common stock, 4.5 million at closing with an
additional 0.5 million shares delivered to us on March 26, 2008, were recorded
to treasury stock at $3.68 per share based on a Stock Purchase Agreement entered
into on February 15, 2008 where we agreed to sell and two qualified
institutional buyers agreed to purchase 5.0 million shares of our common stock
at a purchase price of $3.68 per share.
39
As a
result of this disposition, the operations of the INTAC Legacy Businesses have
been segregated and reported as discontinued operations for all the periods
presented in our consolidated statements of operations. The results
of discontinued operations for the years ended December 31, 2008 and 2007 are as
follows:
|
Years
Ended December 31,
|
||||||||
|
2008
|
2007
|
|||||||
|
Revenues
|
$ | 38,849 | $ | 198,627 | ||||
|
Loss
from discontinued operations (before income taxes)
|
(133,526 | ) | (24,687,959 | ) | ||||
|
Loss
from discontinued operations
|
$ | (133,526 | ) | $ | (24,687,959 | ) | ||
The
following table presents (i) the INTAC Legacy Businesses’ carrying value of the
assets and liabilities disposed on February 29, 2008, and (ii) the carrying
value of the assets and liabilities at December 31, 2007 that have been
reclassified as “held for resale” for the consolidated balance sheet at December
31, 2007:
|
At
Date of Disposition
|
||||||||
|
February
29, 2008
|
December
31, 2007
|
|||||||
|
Cash
and cash equivalents
|
$ | — | $ | 164 | ||||
|
Trade
accounts and other receivables
|
2,967 | 2,998 | ||||||
|
Prepaid
expenses and other
|
1,451 | 1,401 | ||||||
|
Property
and equipment
|
270 | 291 | ||||||
|
Intangible
assets
|
8,627 | 8,701 | ||||||
|
Goodwill
|
6,540 | 6,433 | ||||||
|
Total assets
disposed
|
19,855 | 19,988 | ||||||
|
Accrued
liabilities and other
|
4,909 | 4,633 | ||||||
|
Deferred
tax liabilities
|
1,514 | 1,530 | ||||||
|
Total liabilities
disposed
|
6,423 | 6,163 | ||||||
|
Net
assets disposed before cash transferred to disposed
subsidiaries
|
13,432 | 13,825 | ||||||
|
Cash
to be transferred to disposed subsidiaries
|
4,500 | 4,500 | ||||||
|
Net
assets disposed
|
$ | 17,932 | $ | 18,325 | ||||
The
estimated goodwill write off due to disposition, based on the expected fair
value resulting from disposition was preliminary at December 31,
2007. Upon final disposition on February 29, 2008 proceeds received
of $18.4 million of our common stock (including 500,000 shares received in March
2008) exceeded the net assets carrying value of $17.9 million by $0.5 million
partially offset by our estimated disposition costs accrual of $0.1 million,
resulting in a net recovery on disposition of $0.4 million in the quarter ended
March 31, 2008. The recovery primarily resulted from our operation of
the disposed subsidiaries at a $0.5 million loss through the disposition date
resulting in the carrying value of net assets and liabilities decreasing from
normal activities such as depreciation and amortization, disbursements and cash
receipts on accounts receivable. We recorded this net recovery of $0.4 million
on disposition in the Loss from Discontinued Operations that partially offset
the discontinued operations operating loss of $0.5 million.
40
4. SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES
Principles
of Consolidation
The
consolidated financial statements from continuing operations include the
accounts of (1) HSWI, (2) our subsidiary HSW Brasil - Tecnologia e Informação
Ltda. (“HSW Brazil”), (3) HSW (HK) Inc. Limited, (4) Bonet (Beijing) Technology
Limited Liability Company, (5) BoWenWang Technology (Beijing) Limited Liability
Company, and (6) Daily Strength, Inc. The equity of certain of these
entities is partially or fully held by citizens of the country of incorporation
to comply with local laws and regulations. The operations of the
INTAC Legacy Businesses since October 2, 2007, the date of the INTAC Merger,
through February 29, 2008, the date of INTAC Legacy Businesses disposition are
reflected as discontinued operations, and the assets and liabilities for the
year ended December 31, 2007, have been reclassified as “held for
sale”.
All
intercompany balances and transactions have been eliminated in
consolidation. During the periods reported, our revenue was derived
primarily from advertising revenue from our Internet website in
Brazil. Net losses from HSW Brazil and China for the years ended
December 31, 2008, and 2007, were $3.3 million and $3.7 million,
respectively.
Revenue
Recognition Policies
Online Publishing Revenue
Online
publishing revenue is generally recognized as visitors are exposed to or react
to advertisements on our website. Revenue is generated from advertising in the
form of sponsored links and image ads. This includes both pay-per-performance
ads and paid-for-impression advertising. In the pay-per-performance model, we
earn revenue based on the number of clicks associated with such ads; in the
paid-for-impression model (sponsorships), revenue is derived from the display of
ads.
We
recognize these revenues when the service have been provided, and the other
criteria set forth in Staff Accounting Bulletin (“SAB”) 104, Revenue Recognition, have
been met; namely, the fees we charge are fixed or determinable, we and our
advertisers understand the specific nature and terms of the agreed-upon
transactions and collectability is reasonably assured.
Cost
of Revenues
Online Publishing
The
online publishing cost of revenue represents the cost of translating and
localizing content and acquiring original articles written by third
parties.
Liquidity
Due to
the start up nature of the online publishing segment of HSWI, revenue recorded
for the years ended December 31, 2008 and 2007, were approximately $457,000
and $148,000, respectively.
As of
December 31, 2008, our cumulative losses were $74.2 million which included non
cash expenses of $21.8 million for stock-based compensation, $22.5 million
goodwill write-off related to the February 29, 2008 INTAC Legacy Businesses
disposition and an impairment charge of $5.9 million, net of tax. We used
a significant amount of the $21.0 million net proceeds from the October 2,
2007, sale of stock in the equity financing to pay transaction costs, to pay off
advances from HowStuffWorks, and to fund operations. In the first quarter
of 2008, we received an additional $33.4 million from the sale of our stock.
We believe the proceeds from the sale of our stock in our first quarter of
2008 will provide us sufficient working capital to establish our operations in
Brazil, China and the US and provide sufficient working capital for at least the
next twelve months.
41
Concentration
of Credit Risk and Accounts Receivable
Financial
instruments that potentially subject us to a concentration of credit risk
consist principally of cash and accounts receivables. At December 31,
2008, 99% of our cash was denominated in U.S. dollars, and 1% represented cash
denominated in Brazilian Reais, Chinese Renminbi or Hong Kong dollars. All
our cash is placed with financial institutions we believe are of high credit
quality. Our cash is maintained in bank deposit accounts, which, at
times, may exceed federally insured limits. We have not experienced
any losses in such accounts and do not believe our cash is exposed to any
significant credit risk.
We
believe we are not exposed to a significant concentration of credit or accounts
receivable risk. However, cash is subject to foreign currency
fluctuations against the U.S. dollar. Our risk in foreign currency is
somewhat mitigated at this time as U.S. funds are transferred monthly to Brazil
and China to fund that month’s operating activity. If however the
U.S. dollar is devalued significantly against the Brazilian Reais or the Chinese
Renminbi, the cost to further develop our websites in Brazil
and China could exceed our original estimates.
We
regularly evaluate the collectability of trade receivable balances based on a
combination of factors such as customer credit-worthiness, past transaction
history with the customer, current economic industry trends and changes in
customer payment patterns. If we determine that a customer will be
unable to fully meet its financial obligation, such as in the case of a
bankruptcy filing or other material events impacting its business, we record a
specific reserve for bad debt to reduce the related receivable to the amount
expected to be recovered.
Cash
and Cash Equivalents
We
consider all highly liquid investments with original maturities of three months
or less to be cash equivalents. We maintain our cash in financial
institutions we believe are of high credit quality and do not believe any undue
risk is associated with our cash balances. A large portion of the
cash balance is maintained at one financial institut