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, 2011
OR
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
________________________________________
REMARK MEDIA, 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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Six Concourse Parkway, Suite 1500 Atlanta, Georgia 30328
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(Address of principal executive offices, including zip code)
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(770) 821-6670
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(Registrant’s telephone number, including area code)
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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 Capital 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 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 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
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.
Indicate by check mark whether the Registrant is 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
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Accelerated filer
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Non-accelerated filer
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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 No x
At March 22, 2012, 6,367,072 shares of the Registrant’s common stock, $0.001 par value per share, were outstanding. The aggregate market value of the common stock held by non-affiliates of the registrant was approximately $12,736,770 as of June 30, 2011, based on the closing price of the Common Stock on that date on the NASDAQ Capital Market. Shares of common stock held by each executive officer and director and by each person who owns 10% or more of the outstanding common stock have been excluded in that such person might be deemed to be an affiliate. This determination of affiliate status might not be conclusive for other purposes.
Documents incorporated by reference:
None
Table of Contents
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Page
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PART I
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PART II
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PART III
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PART IV
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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, undue reliance should not be placed 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
Our Mission
Our mission is to provide digital experiences that deliver content and foster connections so engaging and dynamic as to inform, entertain and inspire the world.
Our fundamentals for immersive digital experiences include: compelling content that fuels engagement, clean and intelligent organization and dynamic presentation that promotes content discovery, and intuitive discussion capabilities that generate content sharing and meaningful conversation.
Who We Are
Remark Media, Inc., formerly HSW International, Inc., (“Remark Media”, “we”, or the "Company") is a global digital media company focused on developing, owning and operating next-generation web publishing platforms that combine traditional web publishing and social media, with the goal of revolutionizing the way people search and exchange information over the Internet. The Company also offers a suite of content and platform services that provide its clients with opportunities to build consumer awareness, promote content engagement and foster brand-customer interactions.
The Company’s current leading brands, BoWenWang (bowenwang.com.cn) and ComoTudoFunciona (hsw.com.br), 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. Remark Media is the exclusive digital publisher in China and Brazil for translated content from HowStuffWorks.com, a subsidiary of Discovery Communications. The Company’s website services business creates innovative content and platform solutions for media and entertainment companies as well as Fortune 500 brands and boutique businesses. The solutions the Company offers center on helping clients generate incremental value by maximizing content utilization, enhancing online engagement and customer experience and by driving online and offline actions. Remark Media is also a founding partner and developer of the U.S.-based product Sharecare, a highly searchable social Q&A healthcare platform organizing and answering health and medical questions. The Company generates revenue primarily through service and licensing fees as well as online advertising sales on its owned and operated websites.
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The Company was incorporated in Delaware in March 2006 and is headquartered in Atlanta with additional operations in New York, Beijing and Sao Paulo.
Corporate Name Change
On December 30, 2011, the Company’s stockholders approved a company name change to Remark Media, Inc. The name Remark Media reflects the Company’s continued dedication to rich, high-quality content, its commitment to deep social media engagement, and its core belief that uniting remarkable content and remarkable people leads to value-added exchanges of information and enriched connections with others.
The Company amended and restated its Certificate of Incorporation with the Delaware Secretary of State on December 30, 2011 to reflect its name change. Effective January 3, 2012, the ticker symbol for the Company’s common stock traded on the NASDAQ Capital Market changed from “HSWI” to “MARK”, and the Cusip for the Company’s common stock changed from “40431N104” to “75954W107”.
History
Remark Media was incorporated in Delaware in March 2006 as a wholly owned subsidiary of HowStuffWorks, Inc. in order to develop businesses using exclusive digital publishing rights to HowStuffWorks’ content in China and Brazil, and effect the merger with INTAC International, Inc. (the “INTAC Merger”). The Company completed the INTAC Merger in 2007 which assisted in the development of its digital content database exclusively licensed from HowStuffWorks by (i) accelerating its obtaining Internet licenses in China for launching its Internet platform, (ii) obtaining INTAC’s knowledge of the Chinese markets, relationships, and core competencies to accelerate the growth of its Internet platforms in China, and (iii) providing additional cash flow from INTAC’s established businesses. In 2007 and 2008, the Company launched Brazilian and Chinese editions, respectively, of HowStuffWorks.com, utilizing strategies based on those employed by HowStuffWorks, Inc., as tailored to the needs of each localized market. Remark Media still owns and operates these businesses.
In 2008, Remark Media decided to further leverage its web publishing infrastructure by expanding its operations into the U.S. market through the acquisition of DailyStrength, Inc. (“DailyStrength”). DailyStrength’s website offered content authored by medical professionals and the ability for users and members to launch health-related discussion groups using leading community tools to interact with others.
In 2009, the Company co-founded Sharecare, a U.S.-based venture between: Dr. Mehmet Oz, a leading cardiac surgeon, health expert and host of “The Dr. Oz Show”; HARPO Productions, producer of “The Oprah Winfrey Show”; Discovery Communications, the world’s largest non-fiction media company; Jeff Arnold, WebMD founder and Discovery Communications’ former Chief of Global Digital Strategy; Sony Pictures Television; and Remark Media. Sharecare was created to build a web-based platform that simplifies the search for health and wellness information by organizing a vast array of health-related questions and providing multiple answers from experts, organizations, publishers, and caregivers representing various points of view. As a part of the transactions, the Company received an equity stake in Sharecare, sold substantially all of the assets of its DailyStrength subsidiary to Sharecare, agreed to provide management and website development services to Sharecare, and received a license to use Sharecare’s web platform for its own businesses. As of December 31, 2011, Remark Media owns approximately 15.8% of Sharecare and has representation on its Board of Directors. Accordingly, the Company considers Sharecare a related party. Further information about Sharecare is available at http://sharecare.com. The Company does not incorporate any information on the Sharecare.com site into this Form 10-K. As Sharecare’s technology development partner, the Company began development of the platform for Sharecare in July 2009, and Sharecare.com was launched in October 2010. The Company continued to provide services to Sharecare through December 31, 2011, at which time its agreement with Sharecare expired. The Company does not expect to provide any further significant development services to Sharecare. Remark Media maintains the licensed rights to use the web publishing and social media platform it built for Sharecare for its own businesses outside of the healthcare industry.
In 2010, Remark Media launched Curiosity Online for Discovery Communications (http://curiosity.com ), and provided website development services for the site through November 2011. The Company’s service agreement with Discovery ended in December 2011.
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Recent Developments
Funding. On February 27, 2012, the Company entered into definitive equity financing agreements with accredited and institutional investors to raise funds in the amount of $4.25 million through a private placement. In connection with the transaction, the Company issued to investors common stock priced at $4.50 per share. Investors also received warrants to acquire shares of common stock at an exercise price of $6.81 per share, in the amount of 25% of the number of shares of common stock that the investors purchased. On February 29, 2012, the Company received $4.25 million in cash and issued to the investors a total of 944,777 shares of common stock and warrants to acquire an additional 236,194 shares of common stock. The Company also paid a placement agent fee of 7% of the proceeds of the offering or approximately $0.3 million, and issued a three-year warrant to the Placement Agent to purchase up to an aggregate of 35,429 shares of Common Stock at an exercise price of $7.46 per share.
Banks.com Merger. On February 26, 2012, the Company entered into an agreement and plan of merger with Banks.com, Inc. (BNNX.PK), pursuant to which Banks.com will become a wholly-owned subsidiary of Remark Media (the “Banks.com Merger”). Banks.com is a leading financial services portal operating a unique breadth and depth of financial products and services. Upon the closing of the merger, which is subject to standard conditions to closing including the approval of the Banks.com shareholders, Remark Media will issue up to 702,784 shares of Common Stock representing approximately 11% of our shares issued and outstanding as of March 22, 2012 to the shareholders of Banks.com, plus $300,000 in cash, as consideration for the merger.
DESCRIPTION OF BUSINESSES
Remark Media has two operating segments: Brands (formerly “Digital online publishing”) and Content and Platform Services (formerly “Web platform services”).
Brands
Our Brands segment consists of those digital media properties that we own and operate. It presently includes our translated and localized editions of HowStuffWorks.com in China and Brazil, and our soon-to-launch personal finance destination, DimeSpring. We intend to expand our Brands segment in the coming year by continuing to develop and launch U.S.-based content and social media websites in a variety of content verticals. Additionally, the digital media businesses we acquire through the expected Banks.com Merger will become a part of our Brands segment.
HowStuffWorks, China and Brazil. ComoTudoFunciona (http://hsw.com.br) is Brazil’s online source for credible, unbiased and easy-to-understand explanations of how the world actually works. The Portuguese-language site is the exclusive digital publisher in Brazil of translated and localized content from the leading Discovery Communications brand HowStuffWorks. ComoTudoFunciona was established in March 2007. Its content is either originally created or translated and localized from HowStuffWorks. BoWenWang (http://www.bowenwang.com.cn) is an information and reference website that provides China with encyclopedic knowledge and easy-to-understand explanations of how the world works. The website is published from Beijing in the Chinese language. Launched in June 2008, BoWenWang features a combination of original content authored by the Company, translated and localized from the leading Discovery Communications brand HowStuffWorks, and content from World Book, Inc. BoWenWang is the exclusive digital publisher in China of translated HowStuffWorks content and has an exclusive content partnership with World Book, Inc.
During 2011, we implemented certain cost-savings measures in our Brazil and China operations in connection with a strategic shift towards operations in the United States. We believe that the value of our international assets will be recognized over a longer term horizon, as online advertising markets develop for Brazil and China and the websites’ traffic fundamentals improve. In the near term, we believe our resources can be better applied to developing and establishing new brands and expending our services business in the United States; and as such, we are managing our costs in Brazil and China while evaluating those opportunities. In connection with these cost cutting measures, we performed an impairment assessment of the license to operate in China which is an indefinite-lived intangible asset. As a result of the assessment, we recorded an impairment loss of $0.38 million in our statement of operations for the third quarter ended September 30, 2011.
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DimeSpring. As of December 31, 2011, we were in the development phase of a new English-language, personal finance website that will utilize rich content and advice from a wide array of professionals to build a community of people interested in managing life’s financial hurdles and opportunities. DimeSpring is part of a larger product strategy to leverage our experience and expertise to create leading destination websites that offer a dynamic online experience around a given topic with access to relevant content and subject matter experts. Assets obtained through the expected Banks.com Merger will complement DimeSpring and serve to build a network of personal finance sites that aim to fulfill consumers’ needs. DimeSpring is expected to launch by the end of March 2012 at www.dimespring.com.
Content and Platform Services
Our Content and Platform Services business provides third-party clients with content, design, and development services for their websites as well as advisory services and custom technology solutions. We also license our proprietary web publishing and social media platforms. Our digital architects, developers and designers aim to construct a seamless connection between content and technology to create solutions that build consumer awareness, promote content engagement and foster multi-dimensional interactions. Our prospective client base includes leading media and entertainment companies as well as Fortune 500 brands and boutique businesses. Recent engagements include the development and launch of Ask Dr. Oz (http://www.doctoroz.com/ask) for Sharecare and the development and launch of Curiosity Online for Discovery Communications (http://www.curiosity.com).
As part of our transition to focusing on our U.S.-based Brands business, our legacy content and platform service agreements with Sharecare and Discovery Communications expired in December 2011. The Content and Platform Services business will have no revenues unless we enter into new services agreements with new customers. Accordingly, we intend to expand our Content & Platform Services business to additional clients in 2012, and we are continuing to evolve our technology platforms with the objective of incorporating the latest in social media and content trends.
Sales & Marketing
The primary business model for our Brands business is the sale of advertising, sponsorships and related products and services. By focusing on providing high-quality digital properties to end users in the United States, Brazil and China 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. We have sales operations in the United States to service our advertisers and intend to conduct sales for our owned and operated websites through a direct sales force and strategic partnerships. The primary business model for our Content and Platform Services business is service fees and platform licensing fees.
Much of our marketing efforts for both segments are in fostering word-of-mouth momentum by providing high-quality brands and services, in addition to using public relations efforts and search engine optimization practices. We also intend to enter into partnerships with local businesses to provide awareness of and traffic to our brands and services. We plan to begin paid marketing activities for our businesses during 2012.
Competition
Online publishing is a rapidly evolving market and we encounter significant competition in each market in which we own and operate websites. Competitors for our Brands business include:
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United States: traditional Internet companies like Yahoo! and AOL, and web portals that focus on specific category verticals such as Demand Media, WebMD and About.com;
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China: national Internet portals such as Baidu, Shanda Interactive Entertainment, Sina, sohu.com and tom.com; and
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Brazil: national websites such as Terra.
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These competitors operate websites that compete with us for both end users and advertising revenue.
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Our Content & Platform Services segment provides a broad range of digital services for third parties, including content, design and development of websites as well as licensing of our proprietary content and social media technology platforms. We are subject to significant competition from other website service providers. Website service providers vary in their offerings and the market is highly competitive due to low barriers to entry and a large number of competitors. With respect to our social media technology platforms, we compete with companies such as Disqus and Jive Software.
Intellectual Property
We license many technologies used in our businesses as well as hold licenses to content owned by HowStuffWorks. We rely upon trademark, copyright and trade secret laws in various jurisdictions, as well as confidentiality procedures and contractual provisions to protect our proprietary assets and brands. We do not own any patent or copyright registrations. We hold various trademarks for our brands, and we have additional applications pending.
Employees
As of December 31, 2011, we had 31 employees.
Our Relationship with Discovery Communications, Inc.
On December 17, 2007, following HowStuffWorks’ contribution of digital publishing rights to the Company, HowStuffWorks merged with Discovery Communications, Inc. (the “Discovery Merger”), and became a wholly owned subsidiary of Discovery. 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 would be available to be paid in three semi-annual installments. The installments were planned to begin in October 2008; however, no payment has occurred as of December 31, 2011. Such payments will be in the form of cash or shares of Remark Media stock now held by HowStuffWorks. Accordingly, the amount of shares of our common stock Discovery indirectly owns in the future may fall due to the potential distributions pursuant to the terms of the Discovery Merger. At December 31, 2011, Discovery, through HowStuffWorks, owned approximately 42% of the Company’s outstanding common stock.
Available Information
Remark Media’s website address is www.remarkmedia.com. Information on our website is not incorporated by reference into this Form 10-K and should not be considered a part of this report. We make available free of charge through our website our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports in addition to other SEC reports as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC.
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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.
RISKS RELATING TO OUR SERVICES & BRANDS
We continue to evolve our business strategy and develop new brands and services, and prospects are difficult to evaluate.
We are in varying development stages of our business, so 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. Additionally, we have limited operating history of our owned websites in the United States market. Some of the risks and difficulties we expect to encounter include our ability to:
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manage and implement new business strategies;
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successfully commercialize and monetize our assets;
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successfully attract advertisers for our owned and operated websites, and clients for our content and platform services;
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continue to raise additional working capital;
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manage our expense structure as a U.S. public company including, without limitation, compliance with the Sarbanes Oxley and Dodd Frank Acts;
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manage the anticipated rise in operating expenses;
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establish and take advantage of contacts and strategic relationships;
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adapt to our potential diversification into other content verticals and service offerings;
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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 in the United States and the early stage of development of our business, 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, financial condition, results of operations and cash flows.
If we do not effectively manage our growth, our operating performance will suffer and our financial condition could be adversely affected.
Substantial future growth will be required in order for us to realize our business objectives. To the extent we are capable of achieving this growth, it will place significant demands on our managerial, operational and financial resources. Additionally, this growth will require us to make significant expenditures, establish, train and manage a larger work force, and allocate valuable management resources. We must manage any such growth through appropriate systems and controls in each of these areas. If we do not manage the growth of our business effectively, our business, financial condition, results of operations and cash flows could be materially and adversely affected.
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The expansion of our Brands segments into new category verticals subjects us to additional business, legal, financial and competitive risks.
A key component of our business strategy is to grow our network of owned and operated websites to cover a variety of category verticals to address consumer interests and needs. In doing so we will encounter a number of risks, including increased capital requirements, growth in our workforce, new competitors and development of new strategic relationships. We cannot ensure that our strategy will result in increased revenue or operating profit. Furthermore, growth into new areas may require changes to our cost structure, modifications to our infrastructure and exposure to new regulatory and legal risks, any of which may require expertise in areas in which we have little or no experience. If we cannot generate revenue as a result of our expansion into new areas that are greater than the cost of such expansion, our operating results could be negatively impacted.
We have and will continue to generate revenue from advertising, and the reduction in spending by or loss of advertisers could seriously harm our business.
As we expand our Brands business, we will become increasingly reliant on online advertising. To date, we have had limited experience in selling online advertising. 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 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 impact our revenues and business. Economic conditions, especially those associated with an emerging market or an industry where our Brands business has a focus such as banking and finance, could have a direct impact on advertising spend which would impact our revenue. We cannot predict the timing, strength or duration of economic issues or a subsequent economic recovery generally or in the online advertising market. 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.
If we are unable to attract and retain visitors to our web business in a cost-effective manner, our business, financial condition and results of operations will be adversely affected.
Our primary strategy for attracting and retaining users to our websites is to provide content and community-focused digital experiences. The success of these efforts depends, in part, upon our ability to create and distribute high-quality content as well as innovate and evolve our content and social media technology platforms at scale in a cost-effective manner. Failure to do so could adversely affect user experiences and reduce traffic to our owned and operated websites, which would adversely affect our business, financial condition, results of operations and cash flows. Additionally, our strategy could be flawed and might not result in the ability to attract and retain users in a cost-effective manner. A second strategy we utilize to attract traffic is the search engine optimization, (“SEO”), of our websites and the content published on them. SEO involves architecting websites with the objective of ranking well in unpaid search engine results. Our ability to successfully manage SEO efforts across our owned and operated websites is dependent on our timely and effective modification of SEO practices implemented in response to periodic changes in search engine algorithms and methodologies and changes in search query trends and our ability to offer websites and content responsive to ever-changing consumer interests and trends. Our failure to successfully manage our SEO strategy could result in a substantial decrease in traffic to our owned and operated websites, or an inability to attract traffic to new websites that we launch which would adversely affect our business, financial condition, results of operations and cash flows.
Even if we succeed in attracting traffic to our owned and operated websites, we may not be successful in monetizing the traffic. Additionally, the costs of attracting and retaining users to our websites may exceed our ability to generate revenues from such activities which would have an adverse effect on our business, financial condition, results of operations and cash flows.
Our services agreements with Sharecare and Discovery, which provided the vast majority of our 2011 revenue, expired at the end of 2011.
During 2011, we provided website development, design and management services to Sharecare and Discovery under services agreements which provided approximately 73% and 24%, respectively, of our revenues for 2011. These agreements expired in December 2011, and we do not expect to extend the terms or enter into new services agreements with either customer. As Sharecare has developed its operations and grown, it has made the strategic decision to
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transition these website development, design and management services in-house. In addition, the website services provided to Discovery were fully transitioned in 2011. The expiration of the two agreements has caused us to lose the majority of our sources of revenue, which will hurt our business, financial condition, results of operations and cash flows if the lost revenues are not replaced with other sources of revenue. Subsequent to December 31, 2011, we will have no service-related revenues generated in our U.S. operations unless we enter into new services agreements with new customers.
As a creator and a distributor of digital content, we face potential liability for legal claims based on the nature and content of the materials that we create or distribute, or that are accessible via our owned and operated websites.
As a creator and distributor of original content and third-party provided content, we face potential liability for legal claims, including defamation, negligence, unlawful practice of a licensed profession, copyright or trademark infringement or other legal theories based on the nature, creation or distribution of this information, and under various laws, including the Lanham Act, the Digital Millennium Copyright Act and the Copyright Act. We may also be exposed to similar liability in connection with content that is posted to our owned and operated websites by users and other third parties through comments, profile pages, discussion forums and other social media features. In addition, it is also possible that visitors to our owned and operated websites could make claims against us for losses incurred in reliance upon information provided on our owned and operated websites. Any of these claims could result in significant costs to investigate and defend, regardless of the merit of the claims. If we are not successful in our defense, we may be forced to pay substantial damages. While we run our content through a rigorous quality control process, there is no guarantee that we will avoid future liability and potential expenses for legal claims, which could affect our business, financial condition, results of operations and cash flows.
Our Content and Platform Services business may not prove to be profitable.
We intend to offer content and platform services to a broad portfolio of customers, but we have newly developed sales and marketing resources and may not be successful in obtaining those customers. Because Sharecare and Discovery Communications, the customers generating virtually all of our Content and Platform services revenue through the end of 2011, are related parties, the pricing and other terms that were included in the agreements with those customers may not be indicative of the terms we can successfully obtain in arms-length transactions with other customers. Additionally, we will be subject to competition with companies with greater resources. Due to these factors, we may be unable to achieve profitability in this new line of business.
We face intense competition, which could have an adverse effect on our business, financial condition and results of operations.
The online publishing and content and platform development services markets are 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 include:
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United States: traditional Internet companies like Yahoo! and AOL, and web portals that focus on specific category verticals such as Demand Media, WebMD and About.com;
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China: national Internet portals such as Baidu, Shanda Interactive Entertainment, Sina, sohu.com and tom.com; and
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Brazil: national websites such as Terra.
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In the content and platform services markets we are subject to competition from other website service providers. Website service providers vary in their offerings and the market is highly competitive due to low barriers to entry and a large number of competitors. With respect to our social media technology platforms, we compete with companies such as Disqus and Jive Software.
Many of our competitors have more experience, resources and website visitors than us. In the online publishing and content and platform services markets, many of our competitors have been providing similar services for an extended period of time, and have developed established brands, reputations, offerings, and client bases.
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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 United States are still relatively new, and we have limited experience in owning and operating websites in the United States. We may not be successful in establishing a customer base of our owned and operated websites or strategic partnerships for our services. If we are not successful in developing, releasing and/or marketing these owned and operated websites and services on a profitable basis, our results of operations would be materially and adversely affected. Moreover, we may not have the resources available to simultaneously continue development of 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, financial condition, results of operations and cash flows.
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, that belong to and are held by HowStuffWorks pursuant to third party licenses. Some of those licenses, including those with Publications International, Ltd., contain restrictions on the use of 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, financial condition, results of our operations and cash flows.
RISKS RELATING TO OUR COMPANY
We have a history of operating losses and if we do not reach profitability, we may not be able to fund and operate our businesses.
Although Remark Media was founded in 2006, our business strategy is still evolving, and we have a limited operating history. We are in varying development stages of our businesses, including content and platform services, online publishing and international and domestic digital markets, with a limited operating history upon which investors and others can evaluate our current business and prospects. We have had operating losses in each year of our operations. If we are not able to reach profitability, we may not be able to fund our operations in the future.
Because of our limited operating history and the ongoing development of our business, we will have limited insight into trends and conditions that may exist or emerge and affect our business, especially with respect to the content and platform services and online publishing market. Our content and platform service agreements with Sharecare and Discovery Communications, which represented approximately 97% of our revenues for 2011, expired in December 2011. The Content and Platform Services business will have no revenues unless we enter into new services agreements with new customers. 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, financial condition, results of operations and cash flows.
Acquisitions, business combinations and other transactions present integration risk and may have negative consequences for our business and our stockholders.
We plan to continuously monitor certain strategic acquisition opportunities. On February 26, 2012, we entered into an agreement and plan of merger with Banks.com, Inc., pursuant to which Banks.com would become a wholly owned subsidiary of Remark Media. The process of integrating acquired businesses 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 encounter in integrating the operations of acquired businesses could have a material adverse effect on our business, financial condition, results of operations and cash flows. 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 result
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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:
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cause substantial dilution of the percentage ownership of our stockholders at the time of the issuance;
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cause substantial dilution of our earnings per share;
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subject us to the risks associated with increased leverage and additional interest costs;
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subject us to restrictive covenants that could limit our flexibility in conducting future business activities; and
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adversely affect the prevailing market price for our outstanding securities.
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Our investment in Sharecare’s equity securities involves a substantial degree of risk.
Sharecare is a recently-formed company with limited history of operations. Its prospects must be considered in light of the many risks, uncertainties, expenses, delays and difficulties encountered by companies in their early stages of development. Moreover, Sharecare operates in the highly competitive internet industry and might not achieve profitability or consumer acceptance in the near term, if ever. Our investment in Sharecare’s equity securities is illiquid and might fail to appreciate and might decline in value or become worthless. It is unlikely our Sharecare equity securities will pay current dividends, and our ability to realize a return on our investment, as well as to recover our investment, will be dependent on the success of Sharecare.
Even if Sharecare is successful, our ability to realize the value of our investment might be limited. Because it is a private company, there is no public market for Sharecare’s securities, and the Sharecare securities are subject to restrictions on resale that might prevent us from selling these securities during periods in which it would be advantageous to do so. As a result, we might have to wait for a liquidity event, such as a public offering or the sale of Sharecare, to realize the value of our investment, if any. A liquidity event is not expected in the near term.
We account for our investment in Sharecare under the equity method of accounting and we record our proportionate share of Sharecare’s net income or loss. It is likely that Sharecare will need to raise additional capital, or make additional acquisitions, and our equity position in Sharecare may be diluted if Sharecare issues additional equity, options, or warrants. If Sharecare makes a capital call of its existing equity holders, our position may be diluted if we choose not to contribute additional capital. We continually evaluate the facts and circumstances related to our investment in Sharecare to assess the need for change in accounting method. In November 2010, we acquired an option to purchase 13,089 shares in Sharecare. The option expired on July 30, 2011. Our interest ownership in Sharecare was 15.8% at December 31, 2011.
We may not have sufficient liquidity to support the ongoing development and growth of our businesses.
The Company is in the process of developing and launching new content vertical websites as well as a website services business. We currently operate at a loss and with a substantial negative cash flow from operations. While we believe that our cash resources on hand at the time of this filing including the proceeds from our recent financing transactions, are sufficient to fund the launch and early growth of these businesses for a period of at least 12 months, our cash resources are not necessarily sufficient to fund these businesses for an extended period beyond that unless revenues increase significantly or we find additional sources of capital, neither of which can be assured. Additionally, the development of new content vertical websites may require additional sources of capital for the Company. Our management and directors continue to 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 implemented cost saving measures in 2011 related to our Atlanta, Brazil and China operations in order to focus our limited resources in building our new content verticals, and we might decide to implement further cost savings measures or suspend our activities in one or more of our markets. We may also need to raise additional funds for our business or the development of new initiatives, which may be dilutive to our stockholders.
We may need to raise additional funds in the future 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 similar to the revolving credit agreement entered into in March 2011 and which expired on March 3, 2012. In addition, 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. For further details regarding our liquidity, refer to our “Liquidity and Capital Resources” section of the “Management’s Discussion and Analysis” included in this Form 10-K.
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If we do not scale and adapt our business to technological needs of increased traffic and technological changes, it could cause inefficiencies or disruptions on our websites and loss of users, contributors, and advertisers.
As our business grows, our technological and network infrastructure must keep in-line with our traffic and advertiser needs. Future demand is difficult to forecast and we may not be adequately able to handle large increases unless we spend substantial amounts to augment our ability to handle increased traffic. Additionally, the implementation of increased network capacity contains some execution risks and may lead to ineffectiveness or inefficiency. This could lead to a diminished experience for our consumers and advertisers and damage our reputation and relationship with them, leading to lower marketability and negative effects on our operating results. Moreover, the pace of innovative change in network technology is fast and if we do not keep up, we may lag behind competitors. The costs of upgrading and improving technology could be substantial and negatively affect our business, financial condition, results of operations and cash flows.
We are vulnerable to failures of third party network and technology providers who may fail to provide adequate services in the future. This could cause technical problems or failure of our websites or traffic which could inhibit our revenues or damage our reputation and relationships with users, advertisers, and content providers.
We rely on many third party businesses for technological, network, and expert services. Our ability to operate successfully depends on the successful operation of these third party businesses, which carry their own risks. If one of our third party vendors fails to deliver expected services, our websites and business could suffer operating problems or temporary failures. If there is a problem or failure with our websites, it could hurt our ability to advertise and damage our reputation with consumers and advertisers.
We utilize third party services to host our websites. If one of these third parties experiences a failure, it could cause the failure of our websites, which may cause material adverse effects to our business. Additionally, a termination of our hosting agreements or failure to renew on favorable terms could affect our business. Shifting hosting services could require management focus and time and potentially disrupt operations of our websites.
In addition, as operators of content websites reliant on user traffic to sell advertising, our users must have adequate and functioning internet access. Technical problems with internet access providers such as cable, DSL satellite or mobile companies may inhibit user access to our websites and slow traffic. Such events as power outages caused by blackouts, brown outs, storm outages or other power issues could also cause loss of user access to our websites.
Our network operations may be vulnerable to hacking, viruses and other disruptions, which may make our products and services less attractive and reliable.
User traffic to our owned and operated websites 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 owned and operated websites against hackers. If our security measures are breached as a result of third party action, employee error or otherwise, we could incur liability and our reputation would be damaged, which could lead to the loss of current and potential customers. If we experience any breaches of our network security or sabotage, we might be required to expend significant capital and other resources to remedy, protect against or alleviate these and related problems, and we may not be able to remedy these problems in a timely manner, or at all. Because techniques used by outsiders to obtain unauthorized network access or to sabotage systems change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques or implement adequate preventative measures. We cannot ensure 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.
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We are subject to many government laws and regulations which could subject us to claims if we do not comply with such laws and regulations which could affect our reputation, business and financial position.
We are subject to a variety of laws and regulations regarding our business both within the United States, and in foreign territories in which we operate. Laws and regulations of particular importance to our business relate to: privacy, information security, intellectual property and other copyright, freedom of expression, domain registration, content distribution, and advertising. In particular, as a content company we may not be particularly protected from the Digital Millennium Copyright Act for infringing content posted on our website if we are not fully in compliance with the statutory requirements of this act.
Our failure to comply with these regulations may result in claims against us or other liabilities. Such liabilities could be substantial and adversely affect our operations, reputation and financial condition. We may incur substantial legal expenses and management resources may be required to defend against such claims, even if meritless.
We are exposed to unique risks from operations in Emerging Market countries, including Brazil and China which could affect our operations in these countries.
Our international operations expose us to a wide variety of 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. United States laws and regulations relating to investment and trade in foreign countries could also change to our detriment. Any of these factors could 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.
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, results of operations, cash flows, 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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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.
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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 accounts receivable collections, 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 adversely affect our revenues and profits. Additional risks include, but are not limited to the following:
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We may not succeed in marketing and monetizing our international assets to potential customers or developing strategic partnerships for the distribution of our websites and services. Our plans to market and monetize our assets in the Chinese and Brazilian online markets through the Internet are still relatively unproven.
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The state of the Internet infrastructure in Emerging Markets may limit our growth in these countries. The Internet infrastructures in Emerging Market countries, including 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 Emerging Market countries. 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 makes 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.
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We may be sensitive to a slowdown in economic growth or other adverse changes in the China and Brazil economies. This is particularly true in light of current financial and economic uncertainties. In response to adverse economic developments, companies have reduced 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.
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Our Emerging Market operations subject us to other regulatory risks including unpredictable governmental regulation in China and Brazil.
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Although Remark Media is incorporated in the State of Delaware, we have operations located in Brazil and the PRC. As a result, it may be difficult for investors to enforce outside the United States any actions brought against us or our officers and directors 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. There is doubt as to the enforceability in Brazil and 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.
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Additional specific risks related to conducting business in China could affect our business operations in that country.
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 affects the economic reform and macroeconomic measures adopted by the Chinese government may have on our business or results of operations. Specific risks which could affect our business in China include:
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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. 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.
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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.
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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. 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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pursuing criminal sanctions against our business and personnel;
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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 based in China.
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A 2006 regulation establishes more complex procedures in the PRC for acquisitions conducted by foreign investors, which could make it more difficult for us to pursue growth through acquisitions.
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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. We do not expect our online publishing businesses in China and Brazil to derive significant revenue from online advertisements in the near term. The online advertising markets in China and Brazil are still developing, and future growth and expansion of these markets is uncertain. In February and September 2011, we implemented certain cost-saving measures in our Brazil and China operations, respectively, to bring costs in line with expected revenues while searching for strategic media partners in both countries and consideration of other strategic alternatives. These measures have also had an impact on our trend of revenues in both countries which would impact our financial condition, results or operations and cash flows generated in these countries.
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Potential additional Chinese regulation could affect our business in China. The Ministry of Information Industry, the Chinese governmental agency that 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.
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New political and economic policies of the PRC government could affect our business.
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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.
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Any of these actions could have an adverse effect on our business, financial condition, results of operations and cash flows.
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We are subject to risks arising from some of our revenue being denominated in currencies other than the U.S. dollar. Restrictions on currency exchange may limit our ability to utilize our revenues effectively. Fluctuations in currency exchange rates may cause our foreign revenues to be unpredictable and fluctuate quarterly and annually.
Some of our revenues and operating expenses may be denominated in Chinese Renminbi. Currently, we may purchase foreign exchange for settlement of “current account transactions” without the approval of the 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 may be 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 depends 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 portion of our revenues may 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.
Currency fluctuations, devaluations and exchange restrictions may adversely affect our liquidity and results of operations. In some countries, local currencies are not readily converted into Euros or U.S. dollars (or other “hard currencies”) or are only 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 to the extent we have revenues in China or Brazil. 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.
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 and Brazil 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 brands 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.
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If we are not able to attract and retain key management, 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 for our business success. 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 not be able to attract and retain these individuals, and our failure to do so would adversely affect our business.
We may have additional tax liabilities if tax positions we have taken in prior years are challenged.
Although the company has not been a substantial tax payer to date, we and our subsidiaries are subject to taxes in the United States and various foreign jurisdictions. We believe that our tax returns appropriately reflected our tax liability when those tax returns were filed. However, applicable tax authorities may challenge our tax positions. 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.
We could incur asset impairment charges for intangible assets or other long-lived assets.
We have intangible assets and other long-lived assets, therefore future lower than anticipated financial performance or changes in estimates and assumptions, which in many cases require significant judgment, could result in impairment charges. We test intangible assets that are determined to have an indefinite life for impairment during the fourth quarter of each fiscal year, and assess whether factors or indicators, such as unfavorable variances from established business plans, significant changes in forecasted results or volatility inherent to external markets and industries, become apparent that would require an interim test. Adverse changes in the operating environment and related key assumptions used to determine the fair value of our indefinite lived intangible assets or declines in the value of our common stock may result in future impairment charges for a portion or all of these assets. In September 2011, we recorded an impairment charge of $0.38 million resulting from our analysis of a triggering event tied to the strategic reductions in investment in our China operations to better align expenses to the revenues being generated at this time. If any of the assumptions used in the analysis change in the future, an impairment charge for a portion or all of the assets may be required. In addition, in December 2010, we recorded an impairment charge of $0.5 million, primarily because of changes in our assumptions as to the time and cost required to obtain licenses to operate in China similar to the ones we currently hold. An additional impairment charge could have a material adverse effect on our business, financial position and results of operations, but would not be expected to have an impact on our cash flows or liquidity. The fair value of the license to operate in China was $0.1 million at December 31, 2011.
Our internal control over financial reporting and our disclosure controls and procedures may not prevent all possible errors that could occur.
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 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.
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In our quarterly report on Form 10-Q for the period ended September 30, 2011, we disclosed that the former Chief Executive Officer (“CEO”) and former Chief Financial Officer (“CFO”) concluded that during the third quarter 2011 we did not maintain effective controls over the accounting for a nonmonetary change of interest ownership gain related to equity method investments. This control deficiency resulted in the restatement of our condensed consolidated financial statements originally reported in our Quarterly Report on Form 10-Q for the period ended June 30, 2011. Accordingly, the CEO and CFO at the time of filing determined that this control deficiency constitutes a material weakness as of September 30, 2011.
Our current CEO and management have taken appropriate measures to remediate the material weakness noted above. These enhanced control procedures over unusual investee transactions and related process improvements, have remediated this material weakness. The Company updated its accounting policies to require recognition of a non-cash change in interest gain or loss upon the issuance of equity in exchange for nonmonetary assets for equity-method investments in the period the equity issuance occurs. If the fair value of nonmonetary assets or the equity issued is not determined at the time of the transaction, the Company will record an estimate to reflect the gain or loss resulting from the change in interest ownership. In addition, the Company updated its procedures to require having periodic communications with its equity-method investees for review of the investees’ financial results and inquiring on key events or unusual transactions and ensuring the financial statements are prepared in accordance with GAAP.
We are not required to have our independent auditors attest to the effectiveness of our internal controls over our financial reporting.
The Sarbanes-Oxley Act of 2002 requires public companies to have and maintain effective internal controls over financial reporting to provide reasonable assurance regarding the reliability of financial reporting and preparation of financial statements, and have management review the effectiveness of those controls on an annual basis. We are required to comply with these requirements, but as a “smaller reporting company,” as defined by SEC rules, we are not required to have our independent auditors attest to the effectiveness of our internal controls over our financial reporting. As a result, we may not have comparable procedures in place as compared to other larger public companies.
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 which poses site redundancy risk. Although our site is a Tier 4 data center, which is composed of multiple active power and cooling distribution paths, has redundant components, is fault tolerant, and provides 99.995% availability, we do not have a documented disaster recovery plan in the event of damage from fire, flood, typhoon, earthquake, power loss, telecommunications failure, break in or 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.
RISKS RELATING TO OUR COMMON STOCK
There is a risk that an active and robust market for our common stock may not be available.
Our common stock is currently listed on the NASDAQ Capital Market, a robust exchange with substantial liquidity. It is not guaranteed that an active and robust market will exist for our common stock. However, if the NASDAQ Capital Market changes its listing requirements or ceases to operate in its current manner, there is no guarantee that we will be able to list on another exchange. This could severely limit the market liquidity of our stock and could adversely affect its price.
Moreover, the market for our common stock will be subject to general market economic conditions. Internet stocks in particular have exhibited extreme price fluctuations and volume volatility. In the event of adverse economic shifts in the Internet and Media stock sectors or the stock market in general, there is a risk that trading liquidity in our stock may not be available.
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The market price of our stock is likely to be volatile and 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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·
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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 stockholders 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 are payable to HowStuffWorks’ former stockholders in three semi-annual installments. The installments were planned to begin in October 2008; however, payment had not occurred as of December 31, 2011. Such payments will be in the form of cash or shares of Remark Media stock now held by HowStuffWorks. Accordingly, the amount of shares of our common stock Discovery owns in the future may fall due to a combination of reasons. All of our rights to publish HowStuffWorks content will remain effective regardless of the number of shares HowStuffWorks owns in the future. If Discovery and HowStuffWorks’ former stockholders’ representative elect to distribute shares of our common stock to former HowStuffWorks stockholders, a significant number of shares may be sold by such stockholders relative to the daily market trading volumes for our common stock. These factors could also affect our common stock, and depress the market price for our common stock or limit the market for resale of our common stock. The market price of our common stock has been volatile, particularly in the recent stock market turmoil, and is also based on other factors outside of our control.
The concentration of our stock ownership may limit individual stockholder ability to influence corporate matters.
HowStuffWorks, a subsidiary of Discovery, beneficially owns a significant percentage of our outstanding common stock and is a party of a stockholders’ agreement. The stockholders’ agreement entitles HowStuffWorks to designate nominees to our Board of Directors. As a result, Discovery may have 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 interests of Discovery and its affiliates may materially conflict with the interests of other stockholders. For as long as they exert a significant influence over our business affairs, they will have the ability to cause us to take actions that may be adverse to the interests of other stockholders or inconsistent with other stockholders’ investment objectives.
Two of our stockholders also have substantial Sharecare investments, and potential conflicts of interests could harm us.
Jeff Arnold, a member of the Board of Directors until June 2010 and former Chief of Global Digital Strategy for Discovery, the parent company of HowStuffWorks, together with Discovery beneficially own approximately 42% of our common stock at December 31, 2011. Both Mr. Arnold and Discovery own significant interests in Sharecare. Mr. Arnold and a representative of Discovery serve on the Board of Directors of Sharecare, and Mr. Arnold is also Chairman and Chief Executive Officer of Sharecare. As a result, Mr. Arnold and Discovery have the ability to significantly influence and manage the affairs of both Remark Media and Sharecare and determine the outcome of matters submitted for approval to stockholders of each company. If Remark Media and Sharecare’s interests diverge, there is a risk that Mr. Arnold or Discovery will favor actions by Sharecare that are adverse to Remark Media.
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.
18
As of December 31, 2011, Discovery owned approximately 42% of our outstanding shares of common stock through its HowStuffWorks subsidiary. As a result, it will be difficult for our other stockholders to approve a takeover of us without the cooperation of Discovery.
Furthermore, our Amended and Restated Certificate of Incorporation and Amended and Restated Bylaws contain 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 have authorized undesignated preferred stock, the terms of which may be established and shares of which may be issued without stockholder approval;
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·
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SEC Rule 14a-8 requires that we receive notice of stockholder proposals at least 120 days prior to the date of our proxy statement for the previous year’s annual meeting or we do not have to include them in our proxy materials; and
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·
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for stockholder proposals not requested to be included in our proxy materials under Rule 14a-8, we require advance notice of not less than 60 nor more than 90 days prior to a meeting for the proposal to be introduced and considered.
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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 individual investors and other stockholders to cause us to take other corporate actions individual investors and other stockholders 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 consider to be in their best interest.
Resales of our common stock and additional obligations to issue our common stock may cause the market price of our stock to fall.
As of December 31, 2011, there were approximately 5,422,295 shares of our common stock outstanding, and options and warrants to purchase another approximately 989,192 shares outstanding. At December 31, 2011, we also had reserved an additional 366,325 shares for future issuance under our equity compensation plans. Resale of outstanding shares or issuance of new shares could depress the market price for our common stock.
If we fail to meet all listing requirements, we might not be able to remain listed on The NASDAQ Stock Market.
In September 2009, we received a notice from The NASDAQ Stock Market indicating that we no longer complied with the continued listing requirement that our shares of common stock maintain a minimum closing bid price of $1.00. In response, we conducted a reverse stock split and regained compliance with continued listing standards. In March 2010, the Company received a notice from The NASDAQ Stock Market indicating that we were not in compliance with the continued listing requirement that the publicly held shares of the Company, which is calculated by subtracting all shares held by officers, directors or beneficial owners of 10% or more from the total shares outstanding, maintain a minimum market value of $5,000,000. In July 2010, the Company received a notice from The NASDAQ Stock Market indicating that it had regained compliance with this rule. In April 2011, Remark Media received notification from the NASDAQ Stock Market indicating that the Company no longer complied with the requirements for continued listing on the NASDAQ Global Market because the Company’s stockholders’ equity has fallen below $10 million as reported on our Annual Report on Form 10-K for the year ended December 31, 2010. The Company’s stockholders’ equity as of December 31, 2010 was $8,775,882. The Company was allowed until May 19, 2011, to submit a plan to NASDAQ to regain compliance. Rather than submit a plan, we elected to move our listing to the NASDAQ Capital Market. Our stockholders’ equity as of December 31, 2011 was $2,693,183. We are currently in compliance with the standards of the NASDAQ Capital Market. However, there can be no assurance that we will be able to continue to satisfy the requirements to maintain a continued listing on The NASDAQ Capital Market.
19
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
Our corporate headquarters are located at Six Concourse Parkway, Suite 1500, Atlanta, Georgia, 30328 which consists of approximately 12,000 square feet of leased space. 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, 2011, our total remaining lease obligations were approximately U.S. $1.1 million. The lease obligations are associated with a lease agreement for our headquarters which will terminate in 2016.
We are not subject to any material pending legal proceeding, nor are we aware of any material threatened claims against us.
Not applicable.
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ITEM 5. MARKET FOR THE REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock has been traded on the NASDAQ Capital Market under the symbol “MARK” since January 3, 2012, following the change of our corporate name to Remark Media, Inc. Previously, our common stock traded under the symbol “HSWI” on the NASDAQ Global Market from October 2, 2007, until May 30, 2011, and on the NASDAQ Capital Market from May 31, 2011 until January 3, 2012. The following table sets forth the high and low sales prices of our common stock, as reported on the NASDAQ Capital Market. See Note 8, “Stockholders’ Equity” of the notes to the financial statements included in this report.
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High
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Low
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|||||||
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Year ended December 31, 2011
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||||||||
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First Quarter
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$ | 4.25 | $ | 2.52 | ||||
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Second Quarter
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6.41 | 2.68 | ||||||
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Third Quarter
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5.99 | 2.41 | ||||||
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Fourth Quarter
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3.74 | 2.00 | ||||||
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Year ended December 31, 2010
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||||||||
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First Quarter
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$ | 2.36 | $ | 1.36 | ||||
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Second Quarter
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2.40 | 1.54 | ||||||
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Third Quarter
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7.49 | 1.77 | ||||||
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Fourth Quarter
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7.38 | 3.76 | ||||||
Holders of Record
As of March 22, 2012, the last sale price of our common stock on the NASDAQ Capital Market was $5.80 per share. As of March 22, 2012, there were approximately 30 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 retained to finance our growth.
Reverse Stock Split
On February 16, 2010, the Company conducted a reverse split of its common stock, par value $0.001, at a ratio of 10-for-1 (the “Reverse Split”), at which time each share of common stock was automatically reclassified as and converted into one-tenth of a share of common stock. Each stockholder’s percentage ownership in the Company and proportional voting power remained unchanged by the Reverse Split, except for those adjustments resulting from stockholders receiving cash in lieu of fractional shares. In connection with the Reverse Split, the number of authorized shares of the Company’s capital stock was reduced accordingly by a ratio of 10-for-1. Any references to Remark’s stock within this document prior to the stock split have been adjusted to reflect the effects of the Reverse Split, unless otherwise indicated.
21
Equity Compensation Plans
The information required by Item 5 of Form 10-K regarding equity compensation plans is incorporated herein by reference to “Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters”.
ITEM 6. SELECTED FINANCIAL DATA
We are a smaller reporting company; as a result, we are not required to report selected financial data disclosures as required by item 301 of Regulation S-K.
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 will likely differ materially from those discussed here.
Business Overview and Recent Developments
Remark Media, Inc., formerly HSW International, Inc., (“Remark Media”, “we”, or the “Company”) is a global digital media company focused on developing, owning and operating next-generation web publishing platforms that combine traditional web publishing and social media, with the goal of revolutionizing the way people search and exchange information over the Internet. The Company also offers a suite of content and platform services that provide its clients with opportunities to build consumer awareness, promote content engagement and foster brand-customer interactions.
The Company’s current leading brands, BoWenWang (bowenwang.com.cn) and ComoTudoFunciona (hsw.com.br), 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. Remark Media is the exclusive digital publisher in China and Brazil for translated content from HowStuffWorks.com, a subsidiary of Discovery Communications, and in China for certain content from World Book, Inc., publisher of World Book Encyclopedia. The Company’s website services business seeks to create innovative content and platform solutions for leading media and entertainment companies as well as Fortune 500 brands and boutique businesses. The solutions the Company offers center on helping clients generate value with the objective of maximizing content utilization, enhancing online engagement and customer experience and by driving online and offline actions. Remark Media is also a founding partner and developer of the U.S.-based product Sharecare, a highly searchable social Q&A healthcare platform organizing and answering health and medical questions. The Company generates revenue primarily through service and licensing fees as well as online advertising sales on its owned and operated websites.
The Company was incorporated in Delaware in March 2006 and is headquartered in Atlanta with additional operations in New York, Beijing and Sao Paulo.
On December 30, 2011, the Company changed its name to Remark Media, Inc. The name Remark Media reflects the Company’s continued dedication to rich, high-quality content, its commitment to deep social media engagement, and its core belief that uniting remarkable content and remarkable people leads to value-added exchanges of information and enriched connections with others. The Company amended and restated its Certificate of Incorporation with the Delaware Secretary of State to reflect its name change. Effective January 3, 2012, the ticker symbol for the Company’s common stock traded on the NASDAQ Capital Market changed from “HSWI” to “MARK”, and the CUSIP for the Company’s common stock changed from “40431N104” to “75954W107”.
22
On February 27, 2012, the Company entered into definitive equity financing agreements with accredited and institutional investors to raise funds in the amount of $4.25 million through a private placement. In connection with the transaction, the Company issued to investors common stock priced at $4.50 per share. Investors also received warrants to acquire shares of common stock at an exercise price of $6.81 per share, in the amount of 25% of the number of shares of common stock that the investors purchased. On February 29, 2012, the Company received $4.25 million in cash and issued to the investors a total of 944,777 shares of common stock and warrants to acquire an additional 236,194 shares of common stock.
On February 26, 2012, the Company entered into an agreement and plan of merger with Banks.com, Inc. (BNNX.PK), pursuant to which Banks.com will become a wholly-owned subsidiary of Remark Media (the “Banks.com Merger”). Banks.com is a leading financial services portal operating a unique breadth and depth of financial products and services. Upon the closing of the merger, which is subject to standard conditions to closing including the approval of the Banks.com shareholders, Remark Media will issue up to 702,784 shares of Common Stock representing approximately 11 percent of our shares issued and outstanding as of March 22, 2012 to the shareholders of Banks.com, plus $300,000 in cash, as consideration for the merger.
Operations
2011 was a transformative year for the Company. We made a strategic decision to shift our management, operational, and financial focus to the U.S. market with the development of new owned and operated websites and the expansion of our services business. We also changed our name to Remark Media. We believe the new name reflects more accurately the entirety of what we aim to be, as opposed to one example of who we are. Concurrent with the name change, we appointed a new executive management team and the Board of Directors elected a new Chairman in December 2011. The new executive management team will support our new strategy and drive the Company towards the future. Additionally, we right-sized the organization, domestically and internationally, to align with the new strategy.
Domestic
Brands. We are developing DimeSpring.com, a new English-language, personal finance website that intends to utilize rich content and advice from a wide array of professionals to build a community of people interested in managing life’s financial hurdles and opportunities. DimeSpring is part of a larger product strategy to leverage our experience and expertise to create leading destination websites that offer a dynamic online experience around a given topic with access to relevant content and subject matter experts. Assets obtained through the expected Banks.com merger will complement DimeSpring and serve to build a network of personal finance digital media businesses. We are investing in technology, editorial staff, sales and marketing to support this initiative. It is our goal to expand into more vertical categories through both the in-house development of new websites and acquisitions of websites and digital products.
Content and Platform Services. During 2011 and 2010, we provided website development services to two affiliated entities, Sharecare and Discovery. 73% and 24% of our revenue generated and recognized in 2011 resulted from the services we performed for Sharecare and Discovery, respectively, and, which represented 100% of our revenue for the Content and Platforms Services reporting segment. Our agreements with Sharecare and Discovery expired in December 2011, and no new revenue from these clients is expected in 2012. We will not have revenues related to the Content and Platforms Services segment unless we enter into new revenue agreements to provide content and platform services. Accordingly, we intend to expand our services business to new clients in 2012. We are investing in sales and marketing to support our growth initiative, and are continuing to evolve our technology platforms to ensure we incorporate the latest in social media and content trends.
Sharecare Investment. Although Remark Media is no longer providing services for Sharecare, the Company maintains equity ownership in the venture. As of December 31, 2011, we own approximately 15.8% of Sharecare and have representation on Sharecare’s board of directors. We account for our investment in Sharecare under the equity method of accounting for investments and we record our proportionate share of Sharecare’s net income or loss in our consolidated statements of operations under income or loss on equity-method investments.
23
International
During 2011, we implemented certain cost-savings measures in our Brazil and China operations in connection with a strategic shift towards operations in the United States. We believe that the value of our international assets will be recognized over a longer term horizon, as online advertising markets develop for Brazil and China and the websites’ traffic fundamentals improve. In the near term, we believe our resources can be better applied to developing and establishing new brands and expanding our services business in the United States; and as a result, are managing our costs in Brazil and China while evaluating our opportunities.
ComoTudoFunciona (http://hsw.com.br) is Brazil’s online source for credible, unbiased and easy-to-understand explanations of how the world actually works. The Portuguese-language site is the exclusive digital publisher in Brazil of translated and localized content from the leading Discovery Communications brand HowStuffWorks, and is published from Remark Media’s São Paulo operations. As a result of our cost cutting measures, the number of page views and unique visitors for ComoTudoFunciona decreased by 15% and 2%, in 2011 as compared to 2010, respectively. We recognized approximately $0.1 million and $0.2 million of revenue from Brazil during the twelve months ended December 31, 2011 and 2010, respectively. Brazil revenues and operating results are included in the Brands reporting segment. We do not expect to see major growth in our Brazil operations in the near term unless we increase investment in the brand.
BoWenWang (http://www.bowenwang.com.cn) is an information and reference website that provides China with encyclopedic knowledge and easy-to-understand explanations of how the world works. The website is published from Beijing in the Chinese language. Launched in June 2008, BoWenWang features a combination of original content authored by the Company, translated and localized articles from the leading Discovery Communications brand HowStuffWorks, and content from World Book, Inc. As a result of our cost cutting measures, the number of page views and unique visitors for BoWenWang decreased by 38% and 33% in 2011 as compared to 2010, respectively. Revenue generated from the operations based in China was approximately $0.03 million and $0.01 million during the twelve months ended December 31, 2011 and 2010, respectively. We performed an impairment assessment of the license to operate in China which is an indefinite-lived intangible asset. As a result of the assessment, we recorded an impairment loss of $0.38 million in our statement of operations for the third quarter ended September 30, 2011. China revenues and operating results are included in the Brands reporting segment. We do not expect to see major growth in our China operations in the near term unless we increase investment in the brand.
24
Results of Operations – Year Ended December 31, 2011, Compared to Year Ended December 31, 2010
The following table sets forth our consolidated results of operations for the years ended December 31, 2011, and 2010.
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(Expressed in U.S. Dollars)
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||||||||
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Year Ended December 31,
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2011
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2010
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Operating revenue
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Brands
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$ | 140,702 | $ | 190,712 | ||||
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Content and platform services from affiliates
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4,851,224 | 6,464,352 | ||||||
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Total revenue
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4,991,926 | 6,655,064 | ||||||
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Cost of services
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3,187,379 | 5,405,128 | ||||||
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Gross margin
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1,804,547 | 1,249,936 | ||||||
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Operating expenses
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||||||||
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Selling general and administrative expenses (including
stock based compensation expense of $615,367 and
$265,990 in 2011 and 2010, respectively)
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5,919,996 | 4,983,981 | ||||||
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Impairment loss
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381,000 | 488,560 | ||||||
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Depreciation and amortization expense
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220,327 | 295,529 | ||||||
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Total operating expenses
|
6,521,323 | 5,768,070 | ||||||
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Operating loss
|
(4,716,776 | ) | (4,518,134 | ) | ||||
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Other income (expense)
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||||||||
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Interest expense
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(123,480 | ) | - | |||||
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Other (expense) income
|
6,769 | 14,514 | ||||||
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Total other (expense) income
|
(116,711 | ) | 14,514 | |||||
|
Loss before income taxes and losses of equity-method investments
|
(4,833,487 | ) | (4,503,620 | ) | ||||
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Losses of equity-method investment, net of taxes
|
(2,066,283 | ) | (1,522,697 | ) | ||||
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Net loss before benefit from income taxes
|
(6,899,770 | ) | (6,026,317 | ) | ||||
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Income tax benefit
|
(95,250 | ) | (121,238 | ) | ||||
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Net loss
|
$ | (6,804,520 | ) | $ | (5,905,079 | ) | ||
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Net loss per share
|
||||||||
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Net loss per share, basic and diluted
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$ | (1.26 | ) | $ | (1.10 | ) | ||
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Basic and diluted weighted average shares outstanding
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5,416,109 | 5,368,419 | ||||||
25
Revenues
For the twelve months ended December 2011 and 2010, we generated revenue of $5.0 million and $6.7 million respectively, of which 97% was generated from our Content and Platform services segment for 2011and 2010. The decrease in revenue is primarily attributable to a decrease in the services provided to Sharecare and Discovery during 2011 as compared to 2010. As Sharecare has developed its operations and grown, it has made the strategic decision to transition the web development, design and management services in-house which was completed in the fourth quarter 2011. In addition, the services agreements with Sharecare and Discovery expired in December 2011 and the content and platform services segment will have no revenues unless we enter into new agreements with new customers. Sharecare and Discovery are related parties and the related revenues are included in our consolidated statements of operations under Content and Platform Services from affiliates. Our Brands segment is comprised of revenue generated from our owned and operated websites, including international website businesses based in Brazil and China. Revenue generated on the two websites relate primarily to paid-for-impression and pay-per-performance ads. In Brazil, we generated revenue for the years ended December 31, 2011 and 2010 of approximately $0.1 million and $0.2 million, respectively. In China, we generated revenue for the years ended December 31, 2011 and 2010, of approximately $0.03 million and $0.01 million, respectively.
Cost of Services
Cost of services includes the costs incurred to support our content and platform services business including labor, content and third party platform support services as well as ongoing third party costs to support our Brands business, including the costs to acquire original content, translate and localize content from English to Portuguese and Chinese. These costs were $3.2 million and $5.4 million for the years ended December 31, 2011 and 2010, respectively. The decrease in cost of services is related to the decrease in revenues in addition to performing platform services projects in 2011 that had higher profitability margins than projects completed in 2010.
Operations – Selling, General and Administrative Expenses
Our total selling, general and administrative expenses (“SG&A”) increased by $0.9 million for the year ended December 31, 2011, as compared to 2010. The increase is primarily related to an increase in stock compensation expense of $0.3 million compared to the same period of 2010. In addition, the Company incurred additional costs related to the cost-saving measures implemented in Brazil, China and United States operations. These costs also included severance payments of $0.3 million.
Impairment Loss
During the quarter ended September 30, 2011, we made reductions in the number of personnel supporting our China business operations to better align with our new strategic direction. This event directly impacted the Company’s expectations of revenues and growth rates. In accordance with ASC 350 – “Intangibles – Goodwill and Other”, we performed an assessment for impairment on our indefinite-lived intangible asset, our license to operate in China, which had a carrying value of $0.5 million prior to performing the assessment. We used the cost approach instead of the discounted cash flow method used in the prior year due to a decrease in projected revenues and cost cutting measures enacted during the third quarter 2011. The reductions prompted a change in our assessment of the highest and best use of the asset from an in-use premise to an in-exchange valuation premise. The cost approach uses the concept of depreciated replacement costs as an indicator of value. As a result of the assessment, we concluded that the asset is impaired and its fair value is $0.1 million at September 30, 2011. Subsequently, we recorded a charge of $0.4 million under the impairment loss line in our statement of operations for the quarter ended September 30, 2011. We believe that the fair value of the China license remained at $0.1 million at December 31, 2011.
26
Depreciation and Amortization
Depreciation and amortization expense was $0.2 million and $0.3 million for the years ended December 31, 2011 and 2010, respectively. The slight decrease is due to certain assets being fully depreciated and amortized during the year 2011.
Interest Expense
Interest expense was $0.1 million during the year ended December 31, 2011 which is related to the amortization of debt issuance costs associated with the credit agreement entered into in March 2011 which expired in March 2012 and we chose not to request a renewal. We had no interest expense in 2010.
Deferred Income Tax Benefit
During the year 2011, we recorded $0.1 million as a tax benefit due to the impairment charge against the license to operate in China.
Loss in Equity Investment
We account for our investment in Sharecare under the equity method of accounting. For the years ended December 31, 2011 and 2010, we recognized a loss in the equity investment of approximately $2.1 million and approximately $1.5 million, respectively, net of taxes. The losses are related to major expenses that Sharecare is incurring as it builds its business strategy.
Liquidity and Capital Resources
On February 27, 2012, the Company entered into definitive equity financing agreements with accredited and institutional investors to raise funds in the amount of $4.25 million through a private placement. In connection with the transaction, the Company issued to investors common stock priced at $4.50 per share. Investors also received warrants to acquire shares of common stock at an exercise price of $6.81 per share, in the amount of 25% of the number of shares of common stock that the investors purchased. On February 29, 2012, the Company received $4.25 million in cash and issued to the investors a total of 944,777 shares of common stock and warrants to acquire an additional 236,194 shares of common stock.
On March 4, 2011, we entered into a senior revolving credit agreement with Theorem Capital, LLC (the “Lender”) pursuant to which the Lender agreed to extend to the Company a line of credit of up to $1.0 million for a period of one year from March 4, 2011, subject to renewal by the Lender, at its sole discretion, for an additional one-year period. Under the terms of the credit agreement, we could, in our sole discretion, borrow from the Lender up to $1.0 million from time to time during the term of the credit agreement, in minimum loan amounts of $200,000. Any borrowings under the credit agreement would be senior unsecured indebtedness of Remark Media and could be used for our working capital and general corporate purposes. Borrowings under the credit agreement bear interest at a fixed rate equal to 8% per annum, payable on or before March 3, 2012, unless the line of credit was renewed and the payment date extended, in which case interest would be payable on or before March 3, 2013. During the term of the credit agreement, any principal amounts repaid by Remark Media could be re-borrowed. As of December 31, 2011, the Company did not have any outstanding balance under the senior revolving credit agreement and no interest was incurred during 2011. Interest expense showing in our consolidated statements of operations is related to the amortization of debt issuance costs associated with the senior revolving credit agreement. The agreement expired on March 3, 2012 and we chose not to request an additional one-year extension.
Our cash balance was approximately $1.5 million as of December 31, 2011. We believe that this balance along with the funds received through the above mentioned equity financing transaction will be sufficient to meet our cash requirements for the next twelve months.
We consistently monitor our cash position, and make operational changes as necessary to maintain our business objective of funding ongoing operations and related growth. Accordingly, we implemented cost savings measures in our Brazil operations in February 2011, and in our China operations in September 2011. It is important to note that all our content and platform service agreements expired in December 2011. The Content and Platform Services business
27
will have no revenues unless we enter into new services agreements with new customers. We are actively seeking to expand our Content & Platform Services business to additional clients in 2012, and we are continuing to evolve our technology platforms and brands to ensure we incorporate the latest in social media and content trends.
The table below summarizes the change in our statement of cash flows for the years ended December 31, 2011 and 2010:
|
Year Ended December 31,
|
||||||||
|
2011
|
2010
|
|||||||
|
Net cash used in operating activities
|
$ | (2,952,840 | ) | $ | (3,663,784 | ) | ||
|
Net cash used in investing activities
|
(323,639 | ) | (215,300 | ) | ||||
|
Net cash used in financing activities
|
(20,000 | ) | 0 | |||||
|
Net decrease in cash and cash equivalents
|
$ | (3,296,479 | ) | $ | (3,879,084 | ) | ||
Our net cash used in operating activities during 2011 decreased by $0.7 million compared to the prior year. The decrease in cash used was related to a decrease in accounts receivable at the end 2011 as compared to 2010 due to higher collections in the current year.
Cash used in investing activities
During the year ended December 31, 2011, net cash used in investing activities was $0.3 million as compared to $0.2 million in 2010. The increase was primarily due to additional capital expenditures for leasehold improvements in connection with relocating our corporate headquarters.
Cash flows from financing activities
For the years ended December 31, 2011, net cash used in financing activities was $0.02 million which was related to payments of debt issuance costs related to our revolving credit agreement. There was no cash used in financing activities during the year 2010.
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 our critical accounting policies, revenue recognition, stock-based compensation and long-lived assets including goodwill, equity investments, and other intangible assets may involve a higher degree of judgment and complexity.
Revenue Recognition
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.
28
We recognize revenue from our owned and operated websites as visitors are exposed to or react to advertisements on our website. We generate revenue 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. These revenues are classified within our Brands segment.
We recognize content and platform services revenue at the time services are performed. All of our services revenue is related to the design, development, hosting and other services required to launch and operate the Sharecare, DailyStrength and Ask Dr. Oz websites through our direct activities and management of third-party vendors. We also recognize content and platform services revenue on certain projects using a percentage of completion method. Sales are calculated based on the percentage that total costs incurred bear to total estimated costs at completion. These revenues are classified within our Content and Platform services segment.
Stock-Based Compensation
Under the 2006 Equity Incentive Plan adopted April 13, 2006, and the 2010 Equity Plan adopted June 15, 2010, as modified on December 30, 2011 (the “Plans”), Remark Media authorized a total of 1,325,000 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 Plans 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, 2009, 2010 and 2011, we granted restricted shares to certain members of our Board of Directors and executives. As of December 31, 2011, no options have been exercised under the Plan.
We account for stock-based compensation in accordance with Codification ASC 718, “Compensation, Stock Compensation” which requires us to recognize expense based on the fair value of our stock-based compensation awards.
ASC 718 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 grant date fair value of stock option awards. 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 $0.6 million and $0.3 million for the years ended December 31, 2011 and 2010, respectively.
Impairment of Property and Equipment
Property and equipment is tested for impairment whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. Such events include significant adverse changes in the business climate, the impact of significant customer losses, unanticipated current period operating or cash flow losses, forecasted continuing losses or a current expectation that an asset group will be disposed of before the end of its useful life. Recoverability of property and equipment is measured by a comparison of the carrying amounts to future net undiscounted cash flows the assets are expected to generate. For purposes of recognition and measurement of an impairment loss, property and equipment are grouped with other assets at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets.
Impairment of Investments
Investments are reviewed to determine if events have occurred which would indicate that a decrease in value has occurred which is other than temporary. Evidence of a loss in value might include, but would not necessarily be limited to, absence of an ability to recover the carrying amount of the investment or inability of the investee to sustain an earnings capacity that would justify the carrying amount of the investment. We monitor our assets for potential impairment on an ongoing basis. No impairment charge has been recognized on our investment balances as of December 31, 2011 or 2010.
29
Impairment of Definite-Lived Intangible Assets
Amortizable intangible assets are tested for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. The carrying amount of an asset or asset group is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use of the asset and its eventual disposition. We monitor our assets for potential impairment on an ongoing basis. We have no definite-lived intangible assets at December 31, 2011 and 2010.
Goodwill and Indefinite-Lived Intangible Assets Impairment
Generally, we perform our annual assessment for impairment for goodwill and indefinite-lived intangible assets during the fourth quarter of the fiscal year, unless facts and circumstances require differently. For goodwill, we determine recoverability by comparing the estimated fair value of the reporting unit to which the goodwill applies to the carrying value, including goodwill, of that reporting unit using a discounted cash flow model. We test indefinite-lived intangible assets, which are licenses to operate in China, for impairment by utilizing discounted cash flow models to estimate their fair values, as appropriate. Estimating the fair value of the reporting unit and our long-lived intangible assets involve uncertainties, because management is required to develop numerous assumptions, including assumptions about the future growth and potential volatility in revenues and costs, capital expenditures, industry economic factors and future business strategy. The variability of the factors that management uses to perform our impairment tests depend on a number of conditions, including uncertainty about future events and cash flows. All such factors are interdependent and, therefore, do not change in isolation. Accordingly, the accounting estimates may materially change from period to period due to changing market factors and other conditions. Significant judgments in this area involve determining whether a triggering event has occurred, determining the future cash flows for the assets involved and determining the proper discount rate to be applied in determining fair value. The discounted cash flow approach was used in 2010. However, in the impairment assessment for 2011, the Company used the cost approach. The change in the approach used in the impairment analysis of 2011 compared to 2010 was due to a major decrease in projected revenues as a result of costs saving measures implemented in September 2011. The reductions prompted a change in our assessment of the highest and best use of the asset from an in-use premise to an in-exchange valuation premise. As a result, the income approach used in 2010 was no longer a valid approach for the 2011 analysis. The cost approach uses the concept of depreciated replacement cost as an indicator of value and is based on the principle of substitution which holds that a prudent investor would pay no more for an asset than the amount for which the asset could be replaced less the effects of physical, functional and external depreciation or obsolescence.
Recent Accounting Pronouncements
We are subject to recent accounting pronouncements, as described in detail in Note 3 to our consolidated financial statements included in Item 8 herein.
Off-Balance Sheet Arrangements
None.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We translate the foreign currency financial statements of our international operations into U.S. dollars at current exchange rates, except revenue and expenses, which we translate at average exchange rates during each reporting period. We accumulate net exchange gains or losses resulting from the translation of assets and liabilities in a separate caption of stockholders’ equity titled “accumulated other comprehensive income (loss)”. Generally, our foreign expenses are denominated in the same currency as the associated foreign revenue, and at this stage of our development, the exposure to rate changes is minimal.
30
Financial instruments that potentially subject us to a concentration of credit risk consist principally of cash and accounts receivables. At December 31, 2011, 99% of our cash was denominated in U.S. dollars. The remaining 1% was denominated in Brazilian Reals, Chinese Renminbi or Hong Kong Dollars. The majority of 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, 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. We do not use any derivative financial instruments to mitigate any of our currency risks. The net assets of our foreign operations at December 31, 2011, were approximately $0.1 million.
31
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
|
33
|
|
|
35
|
|
|
36
|
|
|
37
|
|
|
38
|
|
|
39
|
For supplemental quarterly financial information, see Note 14, Quarterly Financial Data (unaudited), of the Notes to Consolidated Financial Statements.
32
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE
To the Board of Directors and Stockholders of Remark Media, Inc.:
We have audited the accompanying consolidated balance sheet of Remark Media, Inc. and subsidiaries (the Company) as of December 31, 2011, and the related statements of operations, stockholders’ equity, and cash flows for the year ended December 31, 2011. We have also audited the accompanying consolidated financial statement schedule for the year ended December 31, 2011. These consolidated financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audit.
We conducted our audit in accordance with standards of the Public Company Accounting Oversight Board (United States of America). 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 purposes 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 audit provides 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 the Company as of December 31, 2011, and the results of its operations and its cash flows for the year ended December 31, 2011, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related consolidated financial statement schedule for the year ended December 31, 2011, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
As discussed in Notes 2 and 10 to the consolidated financial statements, the Company has entered into significant transactions with Sharecare, Inc. and Discovery Communications, both related parties. The Company’s services agreements with Sharecare, Inc. and Discovery Communications expired at the end of 2011, which will have a significant negative impact on the Company’s future results of operations and financial condition if the lost revenue is not replaced. Management’s plans with regards to these matters are also described in Note 2.
Cherry, Bekaert & Holland, L.L.P.
Atlanta, GA
March 22, 2012
33
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To Board of Directors and Stockholders of HSW International, Inc.:
In our opinion, the accompanying consolidated balance sheet and the related consolidated statements of operations, of stockholders' equity, and cash flows present fairly, in all material respects, the financial position of HSW International, Inc. at December 31, 2010 and the results of their operations and their cash flows for the year ended December 31, 2010 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule for the year ended December 31, 2010 presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. 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 audit. We conducted our audit of these statements 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. An audit 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, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
As discussed in Notes 2 and 10 to the consolidated financial statements, the Company has entered into significant transactions with Sharecare, Inc., a related party.
/s/ PricewaterhouseCoopers LLP
Atlanta, Georgia
March 29, 2011
34
REMARK MEDIA, INC. AND SUBSIDIARIES (formerly HSW INTERNATIONAL, INC.)
CONSOLIDATED BALANCE SHEETS
(Expressed in U.S. Dollars)
|
December 31, 2011
|
December 31, 2010
|
|||||||
|
Assets
|
||||||||
|
Current assets
|
||||||||
|
Cash and cash equivalents
|
$ | 1,531,502 | $ | 4,843,893 | ||||
|
Trade accounts receivable, net
|
21,730 | 42,741 | ||||||
|
Trade accounts receivable due from affiliates
|
302,129 | 658,944 | ||||||
|
Prepaid expenses and other current assets
|
393,989 | 566,174 | ||||||
|
Total current assets
|
2,249,350 | 6,111,752 | ||||||
|
Property, equipment and software, net
|
364,386 | 306,460 | ||||||
|
Investment in unconsolidated affiliate
|
905,852 | 2,972,135 | ||||||
|
Licenses to operate in China
|
100,000 | 481,000 | ||||||
|
Intangibles
|
16,429 | 16,429 | ||||||
|
Other long-term assets
|
100,000 | - | ||||||
|
Total assets
|
$ | 3,736,017 | $ | 9,887,776 | ||||
|
Liabilities and Stockholders’ Equity
|
||||||||
|
Current liabilities
|
||||||||
|
Accounts payable
|
$ | 93,806 | $ | 382,515 | ||||
|
Advances from stockholder
|
85,745 | 85,745 | ||||||
|
Accrued expenses and other current liabilities
|
547,569 | 523,384 | ||||||
|
Total current liabilities
|
727,120 | 991,644 | ||||||
|
Long-term liabilities
|
||||||||
|
Deferred tax liabilities
|
25,000 | 120,250 | ||||||
|
Other long-term liabilities
|
290,714 | - | ||||||
|
Total liabilities
|
1,042,834 | 1,111,894 | ||||||
|
Commitments and contingencies
|
- | - | ||||||
|
Stockholders’ equity
|
||||||||
|
Preferred stock, $0.001 par value; 1,000,000 shares
authorized, none issued
|
- | - | ||||||
|
Common stock, $0.001 par value; 20,000,000 shares
authorized, 5,422,295 and 5,375,455 issued and
outstanding at December 31, 2011 and
2010, respectively
|
5,422 | 5,375 | ||||||
|
Additional paid-in-capital
|
101,444,780 | 100,701,356 | ||||||
|
Accumulated other comprehensive income
|
16,881 | 38,531 | ||||||
|
Accumulated deficit
|
(98,773,900 | ) | (91,969,380 | ) | ||||
|
Total stockholders’ equity
|
2,693,183 | 8,775,882 | ||||||
|
Total liabilities and stockholders’ equity
|
$ | 3,736,017 | $ | 9,887,776 | ||||
The accompanying notes are an integral part of these consolidated financial statements.
35
REMARK MEDIA, INC. AND SUBSIDIARIES (formerly HSW INTERNATIONAL, INC.)
CONSOLIDATED STATEMENTS OF OPERATIONS
(Expressed in U.S. Dollars)
|
Year Ended December 31,
|
||||||||
|
2011
|
2010
|
|||||||
|
Operating revenue
|
||||||||
|
Brands
|
$ | 140,702 | $ | 190,712 | ||||
|
Content and platform services from affiliates
|
4,851,224 | 6,464,352 | ||||||
|
Total revenue
|
4,991,926 | 6,655,064 | ||||||
|
Cost of services
|
3,187,379 | 5,405,128 | ||||||
|
Gross margin
|
1,804,547 | 1,249,936 | ||||||
|
Operating expenses
|
||||||||
|
Selling general and administrative expenses (including
Stock-based compensation expense of $615,367 and
$265,990 in 2011 and 2010, respectively)
|
5,919,996 | 4,983,981 | ||||||
|
Impairment loss
|
381,000 | 488,560 | ||||||
|
Depreciation and amortization expense
|
220,327 | 295,529 | ||||||
|
Total operating expenses
|
6,521,323 | 5,768,070 | ||||||
|
Operating loss
|
(4,716,776 | ) | (4,518,134 | ) | ||||
|
Other income (expense)
|
||||||||
|
Interest expense
|
(123,480 | ) | - | |||||
|
Other income
|
6,769 | 14,514 | ||||||
|
Total other (expense) income
|
(116,711 | ) | 14,514 | |||||
|
Loss before income taxes and loss in equity-method investments
|
(4,833,487 | ) | (4,503,620 | ) | ||||
|
Loss in equity-method investment, net of taxes
|
(2,066,283 | ) | (1,522,697 | ) | ||||
|
Net loss before benefit from income taxes
|
(6,899,770 | ) | (6,026,317 | ) | ||||
|
Income tax benefit
|
(95,250 | ) | (121,238 | ) | ||||
|
Net loss
|
$ | (6,804,520 | ) | $ | (5,905,079 | ) | ||
|
Net loss per share
|
||||||||
|
Net loss per share, basic and diluted
|
$ | (1.26 | ) | $ | (1.10 | ) | ||
|
Basic and diluted weighted average shares outstanding
|
5,416,109 | 5,368,419 | ||||||
The accompanying notes are an integral part of these consolidated financial statements.
36
REMARK MEDIA, INC. AND SUBSIDIARIES (formerly HSW INTERNATIONAL, INC.)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(Expressed in U.S. Dollars)
|
Common Stock
|
Additional Paid-in Capital
|
Accumulated Other Comprehensive Income (Loss)
|
Accumulated Deficit
|
Total Stockholders’ Equity
|
||||||||||||||||||||
|
Shares
|
Amount
|
|||||||||||||||||||||||
|
Balance as of December 31, 2009
|
5,369,829 | $ | 5,369 | $ | 100,435,372 | $ | 40,100 | $ | (86,064,301 | ) | $ | 14,416,540 | ||||||||||||
|
Comprehensive loss:
|
||||||||||||||||||||||||
|
Net loss
|
- | - | - | - | (5,905,079 | ) | (5,905,079 | ) | ||||||||||||||||
|
Foreign currency translation adjustments
|
- | - | - | (1,569 | ) | - | (1,569 | ) | ||||||||||||||||
|
Total comprehensive loss
|
(5,906,648 | ) | ||||||||||||||||||||||
|
Restricted stock grants
|
8,000 | 8 | (8 | ) | - | - | - | |||||||||||||||||
|
Forfeited restricted stock
|
(2,374 | ) | (2 | ) | 2 | - | - | - | ||||||||||||||||
|
Stock-based compensation
|
- | - | 265,990 | - | - | 265,990 | ||||||||||||||||||
|
Balance as of December 31, 2010
|
5,375,455 | $ | 5,375 | $ | 100,701,356 | $ | 38,531 | $ | (91,969,380 | ) | $ | 8,775,882 | ||||||||||||
|
Comprehensive loss:
|
||||||||||||||||||||||||
|
Net loss
|
- | - | - | - | (6,804,520 | ) | (6,804,520 | ) | ||||||||||||||||
|
Foreign currency translation adjustments
|
- | - | - | (21,650 | ) | - | (21,650 | ) | ||||||||||||||||
|
Total comprehensive loss
|
(6,826,170 | ) | ||||||||||||||||||||||
|
Restricted stock grants
|
49,000 | 49 | (49 | ) | - | - | - | |||||||||||||||||
|
Forfeited restricted stock
|
(2,160 | ) | (2 | ) | 2 | - | - | - | ||||||||||||||||
|
Stock-based compensation
|
- | - | 615,367 | - | - | 615,367 | ||||||||||||||||||
|
Warrants issued
|
- | - | 128,104 | - | - | 128,104 | ||||||||||||||||||
|
Balance as of December 31, 2011
|
5,422,295 | $ | 5,422 | $ | 101,444,780 | $ | 16,881 | $ | (98,773,900 | ) | $ | 2,693,183 | ||||||||||||
Outstanding shares at December 31, 2009 have been restated to reflect the Company’s February 2010 10-for-1 Reverse Split. See Note 8: “Stockholders’ Equity”.
The accompanying notes are an integral part of these consolidated financial statements.
37
REMARK MEDIA, INC. AND SUBSIDIARIES (formerly HSW INTERNATIONAL, INC.)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Expressed in U.S. Dollars)
|
Year Ended December 31,
|
||||||||
|
2011
|
2010
|
|||||||
|
Cash Flows from operating activities:
|
||||||||
|
Net loss
|
$ | (6,804,520 | ) | $ | (5,905,079 | ) | ||
|
Adjustments to reconcile net loss to net cash used in operating activities:
|
||||||||
|
Depreciation and amortization
|
220,327 | 295,529 | ||||||
|
Impairment loss
|
381,000 | 488,560 | ||||||
|
Stock-based compensation
|
615,367 | 265,965 | ||||||
|
Deferred income taxes
|
(95,250 | ) | (122,140 | ) | ||||
|
Loss in equity-method investments
|
2,066,283 | 1,522,697 | ||||||
|
Loss on disposal of property, equipment and
software
|
39,648 | 14,095 | ||||||
|
Changes in operating assets and liabilities:
|
||||||||
|
Accounts receivable
|
21,011 | (6,364 | ) | |||||
|
Accounts receivable from affiliates
|
356,815 | (189,759 | ) | |||||
|
Prepaid expenses and other assets
|
220,289 | 221,798 | ||||||
|
Accounts payable, accrued expenses and other
liabilities
|
26,190 | (249,086 | ) | |||||
|
Net cash used in operating activities
|
(2,952,840 | ) | (3,663,784 | ) | ||||
|
Cash flows from investing activities:
|
||||||||
|
Purchases of property, equipment and software
|
(327,404 | ) | (125,772 | ) | ||||
|
Other, net
|
3,765 | (89,528 | ) | |||||
|
Net cash used in investing activities
|
(323,639 | ) | (215,300 | ) | ||||
|
Cash flows from financing activities:
|
||||||||
|
Payments of debt issuance costs
|
(20,000 | ) | - | |||||
|
Net cash used in financing activities
|
(20,000 | ) | - | |||||
|
Net change in cash and cash equivalents
|
(3,296,479 | ) | (3,879,084 | ) | ||||
|
Impact of currency translation on cash
|
(15,912 | ) | (1,569 | ) | ||||
|
Cash and cash equivalents at beginning of year
|
4,843,893 | 8,724,546 | ||||||
|
Cash and cash equivalents at end of year
|
$ | 1,531,502 | $ | 4,843,893 | ||||
|
Supplemental disclosure of cash flow information:
|
||||||||
|
Other non-cash financing and investing activities:
|
||||||||
|
Debt issuance costs in the form of warrants
|
$ | 128,104 | $ | - | ||||
.
38
REMARK MEDIA, INC. AND SUBSIDIARIES (formerly HSW INTERNATIONAL, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in U.S. Dollars)
1. DESCRIPTION OF ORGANIZATION AND BUSINESS OPERATIONS
Remark Media, Inc., formerly HSW International, Inc., (“Remark Media” or the “Company”) is a global digital media company focused on developing, owning and operating next-generation web publishing platforms that combine traditional web publishing and social media, with the goal of revolutionizing the way people search and exchange information over the Internet. The Company also offers a suite of content and platform services that provide its clients with opportunities to build consumer awareness, promote content engagement and foster brand-customer interactions.
Remark Media has two operating segments: Brands (formerly “Digital online publishing”) and Content and Platform Services (formerly “Web platform services”).
The Brands segment consists of those digital media properties that are owned and operated. It presently includes translated and localized editions of HowStuffWorks.com in China and Brazil, and the soon-to-launch personal finance destination DimeSpring. The Company intends to expand its Brands business in the coming year by continuing to develop and launch U.S.-based content and social media websites in a variety of content verticals. Additionally, the digital media businesses acquired through the expected Banks.com Merger will become part of the Brands business.
The Content and Platform Services segment provides third party clients with content, design and development services for their websites as well as advisory services and custom technology solutions. The Company also licenses its proprietary web publishing and social media platforms. Remark Media’s digital architects, developers and designers aim to construct a seamless connection between content and technology to create solutions that help its clients generate incremental value by maximizing content utilization, enhancing online engagement and customer experience and by driving online and offline actions.
The Company was incorporated in Delaware in March 2006 and is headquartered in Atlanta with additional operations in New York, Beijing and Sao Paulo.
The Company amended and restated its Certificate of Incorporation with the Delaware Secretary of State on December 30, 2011, to reflect its name change. Effective January 3, 2012, the ticker symbol for the Company’s common stock traded on the NASDAQ Capital Market changed from “HSWI” to “MARK”, and the Cusip for the Company’s common stock changed from “40431N104” to “75954W107”.
Liquidity Considerations
On February 27, 2012, the Company entered into definitive equity financing agreements with accredited and institutional investors to raise funds in the amount of $4.25 million through a private placement. In connection with the transaction, the Company issued to investors common stock priced at $4.50 per share. Investors also received warrants to acquire shares of common stock at an exercise price of $6.81 per share, in the amount of 25% of the number of shares of common stock that the investors purchased. On February 29, 2012, the Company received $4.25 million in cash and issued to the investors a total of 944,777 shares of common stock and warrants to acquire an additional 236,194 shares of common stock. The Company also paid a placement agent fee of 7% of the proceeds of the offering or approximately $0.3 million, and issued a three-year warrant to the Placement Agent to purchase up to an aggregate of 35,429 shares of Common Stock at an exercise price of $7.46 per share.
On March 4, 2011, the Company entered into a senior revolving credit agreement with Theorem Capital, LLC (the “Lender”) pursuant to which the Lender agreed to extend to the Company a line of credit of up to $1.0 million for a period of one year from March 4, 2011, subject to renewal by the Lender, at its sole discretion, for an additional one-year period. Under the terms of the credit agreement, the Company could, in its sole discretion, borrow from the
39
Lender up to $1.0 million from time to time during the term of the credit agreement, in minimum loan amounts of $200,000. Borrowings under the credit agreement bear interest at a fixed rate equal to 8% per annum, payable on or before March 3, 2012. As of December 31, 2011, the Company did not have any outstanding balance under the senior revolving credit agreement and no interest was incurred during 2011. Interest expense showing in the Company’s consolidated statements of operations is related to the amortization of debt issuance costs associated with the senior revolving credit agreement. The agreement expired on March 3, 2012 and the Company chose not to request an additional one-year extension.
The Company’s cash and cash equivalents were approximately $1.5 million as of December 31, 2011. The Company believes that this balance along with the proceeds received through the above-mentioned equity financing transaction will be sufficient to meet its cash requirements for the next twelve months.
The Company consistently monitors its cash position, and makes operational changes as necessary to maintain its business objective of funding ongoing operations and related growth. Accordingly, the Company implemented cost savings measures in its Brazil operations in February 2011, and in its China operations in September 2011. In addition, all Remark Media Content and Platform Service agreements expired in December 2011. The Content and Platform Services business will have no revenues generated unless the Company enters into new services agreements with new customers. The Company is actively seeking to expand its Content and Platform Services business to additional clients in 2012, and Remark Media is continuing to evolve its technology platforms and brands to ensure it incorporates the latest in social media and content trends.
2. TRANSACTIONS WITH SHARECARE
On October 30, 2009, the Company co-founded Sharecare, Inc. a U.S.-based venture among: Dr. Mehmet Oz, a leading cardiac surgeon, health expert and host of “The Dr. Oz Show”; HARPO Productions, producer of “The Oprah Winfrey Show”; Discovery Communications, the world’s largest non-fiction media company; Jeff Arnold, WebMD founder and Discovery Communications’ former Chief of Global Digital Strategy; and Remark Media. Sharecare was created to build a web-based platform that simplifies the search for health and wellness information by organizing a vast array of the questions of health and providing multiple answers from experts, organizations, publishers, and caregivers representing various points of view.
As a result of these transactions, the Company:
|
·
|
Entered into a subscription agreement for the purchase of 125,000 shares of common stock of Sharecare, representing 20% ownership of Sharecare at the time of purchase;
|
|
·
|
Sold substantially all of the assets of its DailyStrength subsidiary to Sharecare;
|
|
·
|
Agreed to provide management and website development services to Sharecare; and
|
|
·
|
Received a limited license to use the Sharecare web platform for the Company’s own businesses.
|
The Company accounts for its equity interest in Sharecare under the equity method of accounting based on its ability to exercise significant influence over Sharecare due to its ownership percentage and representation on its board of directors. Under this method, the Company recorded its proportionate share of Sharecare’s net income or loss based on Sharecare’s financial results. As of December 31, 2011, Remark Media owned approximately 15.8% of the outstanding common stock of Sharecare.
At December 31, 2011, there was no difference between the carrying amount of Sharecare’s investment balance of $0.9 million and the Company’s proportionate share of Sharecare’s underlying net assets.
In June 2011, Sharecare acquired the assets and assumed the liabilities of HFPN and dotFit in exchange for its common stock. The Company did not receive sufficient evidence at the time regarding the transaction from Sharecare. Accordingly, the Company did not record an adjustment to reflect the transaction. During the third quarter 2011, the Company received information from Sharecare related to the fair value of Sharecare’s common shares. Based on this information, the Company determined that this issuance of common stock by Sharecare generated a non-cash gain of $0.4 million resulting from the change in its interest ownership which should have been recorded in the second
40
quarter 2011. As a result, the Company has restated its financials for the quarter ended June 30, 2011 to reflect the gain. Other than this transaction, there was no other issuance of common stock by Sharecare to any other third party investors in 2011 that would result in recording an adjustment related to a change in interest ownership.
For the year ended December 31, 2010, the Company recorded a non-cash adjustment to loss in equity-method investment of approximately $0.1 million to correct the Company’s investment in unconsolidated affiliate balance. The Company determined this out-of-period adjustment was not material to the consolidated financial statements for the year ended December 31, 2010 or prior period financial statements.
The following table shows selected financial data of Sharecare as well as Remark Media’s proportional share of net loss in Sharecare as reported under the equity method:
|
Year Ended December 31,
|
||||||||
|
2011
|
2010
|
|||||||
|
Revenues
|
$ | 11,839,568 | $ | 4,742,403 | ||||
|
Gross profit
|
9,809,402 | 4,000,091 | ||||||
|
Loss from operations
|
(13,626,988 | ) | (11,863,151 | ) | ||||
|
Net loss
|
(13,862,217 | ) | (12,008,017 | ) | ||||
|
Loss in equity-method investment
|
$ | (2,066,283 | ) | $ | (1,980,122 | ) | ||
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of Remark Media and its subsidiaries (1) HSW Brasil – Tecnologia e Informação Ltda., (2) HSW (HK) Inc. Limited, (3) Bonet (Beijing) Technology Limited Liability Company, and (4) BoWenWang Technology (Beijing) Limited Liability Company. 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.
Equity investments in which the Company exercises significant influence but does not control and is not the primary beneficiary are accounted for using the equity method. In the event of a change in ownership, any gain or loss resulting from an investee share issuance is recorded in earnings. Investments in which the Company is not able to exercise significant influence over the investee are accounted for under the cost method. Controlling interest is determined by majority ownership interest and the ability to unilaterally direct or cause the direction of management and policies of an entity after considering any third-party participatory rights. The Company applies the guidelines set forth in ASC 810, “Consolidations”, in evaluating whether it has interests in variable interest entities (“VIE”) and in determining whether to consolidate any such entities. All inter-company accounts and transactions between consolidated companies are eliminated in consolidation.
The Company uses qualitative analysis to determine whether or not it is the primary beneficiary of a VIE. The Company considers the rights and obligations conveyed by its implicit and explicit variable interest in each VIE and the relationship of these with the variable interests held by other parties to determine whether the variable interests will absorb a majority of a VIE’s expected losses, receive a majority of its expected residual returns, or both. If the
41
Company determines that its variable interests will absorb a majority of the VIE’s expected losses, receive a majority of its expected residual returns, or both, it consolidates the VIE as the primary beneficiary, and if not, the Company does not consolidate.
The Company has determined that Bonet (Beijing) Technology Limited Liability Company is a variable interest entity as defined in ASC 810. Remark Media is the primary beneficiary of this entity and accordingly, the results of this entity have been consolidated along with other subsidiaries.
The Company has determined that its interest in Sharecare is not a VIE. Additionally, the Company believes that it is able to exercise significant influence over Sharecare due to its level of interest ownership and its representation on Sharecares’s Board of Directors. Accordingly, the equity method of accounting is used to account for the investment in Sharecare.
Revenue Recognition
Brands Revenue. The Company generally recognizes Brands revenue as visitors are exposed to or react to advertisements on its websites. Revenue from advertising is generated 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, revenue is generally earned based on the number of clicks or other actions taken associated with such ads; in the paid-for-impression model, revenue is derived from the display of ads.
Content and Platform Services. Revenue from Content and Platform services is recognized during the period services related to the design, development, hosting, and related web services are performed. Revenue is recorded on a gross versus net basis as Remark Media bears the risk of loss related to the services performed, the majority of which relates to services performed by the Company’s resources. The Company is able to recognize all of the revenue generated from this effort when the services have been provided since the Company meets the criteria set forth in Staff Accounting Bulletin (“SAB”) 104, “Revenue Recognition”; namely, the fees the Company charges are fixed or determinable. Remark Media and its customers understand the specific nature and terms of the agreed-upon transactions and collectability is reasonably assured.
The Company may also recognize content and platform services revenue on certain projects using a percentage of completion method. Sales are calculated based on the total costs incurred to date divided by total estimated costs at completion times the contract price.
Cost of Services
Brands. The Brands cost of revenue represents the cost of translating and localizing content and acquiring original content written by third-parties as well as costs associated with design, development, hosting, user acquisition and user retentions.
Content and Platform Services. The Content and Platform Services cost of revenue represents the costs incurred to support the services agreements with the Company’s customers in this segment which include labor, content and third-party support services.
Concentration of Credit Risk and Accounts Receivable
Financial instruments that potentially subject Remark Media to a concentration of credit risk consist principally of cash and accounts receivable. At December 31, 2011, 99% of cash was denominated in U.S. dollars, and 1% was
42
denominated in Brazilian Reais, Chinese Renminbi or Hong Kong dollars. The majority of the Company’s cash and cash equivalents balances are in one financial institution which is believed to have high credit quality. Cash is maintained in bank deposit accounts, which, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts and does not believe its cash is exposed to any significant credit risk. Cash held by non-U.S. subsidiaries is subject to foreign currency fluctuations against the U.S. dollar. However, the risk in foreign currency is somewhat mitigated at this time as U.S. funds are transferred to Brazil and China to fund that subsidiary’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 the Company’s websites in Brazil and China could exceed original estimates.
94% of the Company’s accounts receivable balance as of December 31, 2011, was from Sharecare and Discovery, who are related parties. The Company regularly evaluates 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 the Company determines 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, a specific reserve for bad debt will be recorded to reduce the related receivable to the amount expected to be recovered. The Company’s revenue from Sharecare for the years ended December 31, 2011 and December 31, 2010, was approximately $3.7 million and $6.0 million, respectively. The Company provided content and platform services to Sharecare in 2011, and amounts due from Sharecare represented approximately 56% of accounts receivable balances as of December 31, 2011.
During 2011, the Company also provided services to Discovery Communications, LLC (“Discovery”) to provide website development services to Discovery. The Company’s Content and Platform services revenue from Discovery, an affiliated entity, for the year ended December 31, 2011 totaled approximately $1.2 million, and Discovery represented approximately 38% of accounts receivable balance as of December 31, 2011.
All accounts receivable from affiliates outstanding at the end of 2011, which accounted for 94% of accounts receivable balances at December 31, 2011, were collected in 2012. As such, an allowance for doubtful accounts was not deemed necessary at December 31, 2011.
Cash and Cash Equivalents
The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. A large portion of the cash balance is maintained at one financial institution. Cash denominated in foreign currencies is translated to U.S dollars at the month-end rate of exchange. The impact of foreign currency on cash and cash equivalents is presented in the Company’s statements of cash flows in accordance with accounting principles generally accepted in the United States (“GAAP”).
Use of Estimates
The preparation of consolidated financial statements in conformity with GAAP requires the Company to make estimates and assumptions that affect amounts reported and disclosed in the consolidated financial statements and accompanying notes. Actual results could differ materially from those estimates. On an ongoing basis, the Company evaluates its estimates, including those related to accounts receivable, intangible assets, useful lives of property and equipment, stock-based compensation, equity-method investments, and income taxes, among other things.
Income Taxes
Income taxes are accounted for using the asset and liability method in accordance with ASC 740, “Income Taxes”. Deferred income tax assets and liabilities are computed for differences between the financial statement and tax basis of assets and liabilities that could result in future taxable or deductible amounts, based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized.
43
The application of income tax law is inherently complex. Laws and regulations in this area are voluminous and are often ambiguous. As a result, the Company is required to make many subjective assumptions and judgments regarding income tax exposures, interpretations of, and guidance, surrounding income tax laws and regulations change over time. As a result, changes in the Company’s assumptions and judgments can materially affect amounts recorded in the consolidated financial statements.
The Company classifies interest and penalties arising from unrecognized income tax positions in the statement of operations as general and administrative expenses if they occur. At December 31, 2011, and 2010, the Company had no accrued interest or penalties related to uncertain tax positions. The tax years 2007 through 2010 are not or have not been under examination but remain open to examination under the IRS statute.
Stock-Based Compensation
The Company measures stock-based compensation at the grant date based on the calculated fair value of the award. The Company recognizes the expense over the employee’s requisite service period, generally the vesting period of the award. The Company estimates the fair value of stock options at the grant date using the Black-Scholes option pricing model with weighted average assumptions for the activity under its stock plans. Option pricing model input assumptions such as expected term, expected volatility and risk-free interest rate among others, impact the fair value estimate. These assumptions generally require significant analysis and use of judgment and estimates to develop. Options vest based on meeting a minimum service period or performance condition. Restricted stock grants are recorded using the fair value of the granted shares based on the market value at the grant date. In addition, the forfeiture rate impacts the amount of aggregate compensation. These assumptions are subjective and generally require significant analysis and judgment to develop.
The Company does not recognize a deferred tax asset for unrealized tax benefits associated with the tax deductions in excess of the compensation recorded (excess tax benefit). The Company applies the “with and without” approach for utilization of tax attributes upon realization of net operating losses in the future. This method allocates stock-based compensation benefits last among other tax benefits recognized. In addition, the Company applies the “direct only” method in calculating the amount of windfalls or shortfalls.
Foreign Currency
The functional currency of the Company’s international subsidiaries is the local currency, Reais in Brazil, Renminbi in China or Hong Kong dollars in Hong Kong. The financial statements of these subsidiaries are translated to U.S. dollars using month-end rates of exchange for assets and liabilities, and average rates of exchange for revenue, costs and expenses. Translation gains and losses are recorded in accumulated other comprehensive income (loss) as a component of stockholders’ equity. Net gains and losses resulting from foreign exchange transactions are recorded in selling, general and administrative expenses. Currency translation gains and losses during 2011 and 2010 were immaterial to the Company’s consolidated financial statements.
Purchase Price Allocations
Occasionally, the Company enters into material business combinations. In accordance to ASC 805, “Business Combinations”, the purchase price is allocated to the various assets acquired and liabilities assumed based on their estimated fair value. Fair values of assets acquired and liabilities assumed are based upon available information and may involve engaging an independent third party to perform an appraisal of tangible and intangible assets. Estimating fair values can be complex and subject to significant business judgment and most commonly impacts property, equipment, software, and definite- or indefinite-lived intangible assets.
44
Property, Equipment and Software
Property, equipment and software is stated at cost less accumulated depreciation. Depreciation is recorded within operating expenses in the consolidated statements of operations, using the straight-line method over the estimated useful lives of the assets, generally one to three years for computer equipment and software and three to five years for building improvements and office equipment. Leasehold improvements are depreciated over the shorter of their estimated useful life or lease term. Costs represent the purchase price and any directly attributable costs of bringing the asset to working condition for its intended use. Repairs and maintenance are expensed as incurred. Betterments and capital improvements are capitalized and depreciated over the remaining useful life of the related asset. Gains or losses from disposal of property and equipment are included in selling, general and administrative expenses.
Software Development Costs
In accordance with ASC 350-40, “Internal Use Software” and ASC 350-50, “Web Development Costs”, the Company capitalizes qualifying costs of computer software and website development costs. Costs incurred during the application development stage as well as upgrades and enhancements that result in additional functionality are capitalized. The internally developed software costs capitalized were $0.1 million at December 31, 2011 and are included in “Property, equipment and software” in the consolidated balance sheet. Internally developed software and website development costs will be amortized utilizing the straight-line method over a period of three years, the expected period of the benefit. There was no amortization recorded for these costs during 2011 as these projects were not complete yet at December 31, 2011.
Advertising Expenses
The Company expenses advertising costs in the year in which they are incurred. Advertising expenses for each of the years ended December 31, 2011 and 2010 were minimal.
Commitments and Contingencies
The Company records liabilities for loss contingencies arising from claims, assessments and litigation and other sources when it is probable that a liability has been incurred and the amount of the assessment can be reasonably estimated. In the opinion of management, and after consultation with legal counsel, there were no material claims, assessments and litigation against the Company as of December 31, 2011.
Impairment of Property, Equipment and Software and Definite-Lived Intangible Assets
Property, equipment, software and definite-lived intangible assets are tested for impairment whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. Such events include significant adverse changes in the business climate, the impact of significant customer losses, unanticipated current period operating or cash flow losses, forecasted continuing losses or a current expectation that an asset group will be disposed of before the end of its useful life. Recoverability of these assets is measured by a comparison of the carrying amounts to future net undiscounted cash flows the assets are expected to generate. For purposes of recognition and measurement of an impairment loss, property, equipment, software and definite-lived intangible assets are grouped with other assets at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets.
45
Impairment of Investments
Investments are reviewed to determine if events have occurred which would indicate that a decrease in value has occurred which is other than temporary. Evidence of a loss in value include, but are not limited to, absence of an ability to recover the carrying amount of the investment or inability of the investee to sustain an earnings capacity that would justify the carrying amount of the investment. The Company monitors its assets for potential impairment on an ongoing basis. No impairment charge has been recognized related to investments as of December 31, 2011 or 2010.
Goodwill and Indefinite-Lived Intangible Assets Impairment
Generally, the Company performs its annual assessment of impairment for goodwill and indefinite-lived intangible assets during the fourth quarter of each year, unless facts and circumstances require differently. For goodwill, the Company determines recoverability by comparing the estimated fair value of the reporting unit to which goodwill applies to the carrying value, including goodwill, of that reporting unit using a discounted cash flow model. The Company tests its indefinite-lived intangible assets, which are licenses to operate in China, for impairment by utilizing appropriate valuations techniques to estimate their fair values. Estimating the fair value of the reporting unit and its long-lived intangible assets involve uncertainties, because management is required to develop numerous assumptions, including assumptions about the future growth and potential volatility in revenues and costs, capital expenditures, industry economic factors and future business strategy. The variability of the factors that management uses to perform its impairment tests depends on a number of conditions, including uncertainty about future events and cash flows. All such factors are interdependent and, therefore, do not change in isolation. Accordingly, the accounting estimates may materially change from period to period due to changing market factors and other conditions. Significant judgments in this area involve determining whether a triggering event has occurred, estimating the future cash flows for the assets involved and determining the proper discount rate to be applied in determining fair value.
As of September 30, 2011, and in light of the market conditions and the cost savings measures implemented in the Company’s operations in China, the Company performed an impairment analysis of its indefinite-lived intangible asset which is a license to operate in China. The Company used the cost approach to estimate the fair value. As a result of the assessment, the Company determined that the intangible asset is impaired and recorded in the Company’s statement of operations for the third quarter 2011 an impairment charge of $0.4 million.
As a result of the annual impairment test in the fourth quarter 2010, the Company recorded an impairment charge related to its indefinite-lived intangible asset of $0.5 million during the year ended December 31, 2010, related to the licenses to operate in China. The Company used the discounted cash flow approach to determine the fair value. For further details, refer to Note 5.
46
Fair Value Measurements on a Recurring Basis
The Company applies the guidance in ASC 820, “Fair Value Measurements”, to nonfinancial assets and liabilities that are recognized or disclosed at fair value on a nonrecurring basis. ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). To measure fair value, the Company incorporates assumptions that market participants would use in pricing the asset or liability, and utilizes market data to the maximum extent possible.
As a basis for considering market participant assumptions in fair value measurements, ASC 820 establishes a three-tier fair value hierarchy which prioritizes the inputs used in measuring fair value as follows:
|
·
|
Level 1 – Observable inputs such as quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access;
|
|
·
|
Level 2 – Inputs, other than the quoted market prices included in Level 1, which are observable for the asset or liability, either directly or indirectly; and
|
|
·
|
Level 3 – Unobservable inputs for the asset or liability, which are typically based on an entity’s own assumptions, as there is little, if any, related market data available.
|
In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability.
Debt Issuance Costs
Costs associated with entering into a credit facility are deferred and amortized over the term of the credit facility on a straight-line basis. The amortization is included in interest expense in the consolidated statements of operations.
In connection with the revolving credit agreement entered into in March 2011, the Company deferred debt issuance costs of approximately $0.15 million provided to its lender consisting of $0.02 million paid in cash and $0.13 million in warrants to purchase 65,359 shares of the Company’s common stock.
Net Loss per Share
The Company computes net loss per share in accordance with ASC 260, “Earnings per Share”, which requires dual presentation of basic and diluted earnings or loss per share (“EPS”).
The Company computes basic loss per share by dividing net loss applicable to common stockholders by the weighted-average number of common shares outstanding during the period. The Company calculates diluted loss per share by dividing net loss by the weighted-average number of common shares and dilutive potential common shares, if any, outstanding during the period. Stock options and warrants are not included in the computation of diluted loss per share because their effects are anti-dilutive.
47
Recent Accounting Pronouncements
In September 2011, the Financial Accounting Standards board ("FASB”) issued Accounting Standard update (“ASU”) No. 2011-08, “Intangibles – Goodwill and Other” (Topic 350), (“ASU 2011-08”) which simplifies how entities test goodwill for impairment. This accounting update permits an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in Topic 350. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. ASU 2011-08 will be effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011 with early adoption permitted. The Company will adopt this ASU in the first quarter 2012 and does not expect that the adoption of ASU 2011-08 will have a material impact on the Company’s financial position, results of operations or cash flows.
In June 2011, the FASB issued ASU No. 2011-05, “Comprehensive Income Topic 220” – “Presentation of Comprehensive Income” (ASU 2011-05). ASU 2011-05 requires that all nonowner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. Under either method, adjustments must be displayed for items that are reclassified from other comprehensive income to net income, in both net income and other comprehensive income. The standard does not change the current option for presenting components of other comprehensive income (“OCI”) gross or net of the effect of income taxes, provided that such tax effects are presented in the statement in which OCI is presented or disclosed in the notes to the financial statements. Additionally, the standard does not affect the calculation or reporting of earnings per share. In December 2011, the FASB issued ASU 2011-12 Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05 (“ASU 2011-12”). ASU 2011-12 defers those changes in ASU 2011-05 that relate to the presentation of reclassification adjustments. The FASB has deferred those changes in order to reconsider whether to present on the face of the financial statements the effects of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income for all periods presented. ASU 2011-12 does not impact the requirement of ASU 2011-05 to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements. For public entities, ASU 2011-05 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011 and is to be applied retrospectively, with early adoption permitted. The Company will adopt these updates in the first quarter 2012 and does not expect that the adoption will have any impact on its financial position, results of operations or cash flows.
In May 2011, the FASB issued ASU No. 2011-04, “Fair Value Measurement (Topic 820)” – “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS” (ASU 2011-04). The amendments in this ASU result in common fair value measurement disclosure requirements between U.S. GAAP and International Financial Reporting Standards. Consequently, the amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and disclosing information about fair value measurements. The amendments include a clarification of the FASB’s intent about the application of existing fair value measurement requirements and change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements. The amendments in this guidance are effective prospectively for interim and annual periods beginning after December 15, 2011, with no early adoption permitted. The Company will adopt the update in the first quarter of 2012 and does not expect the adoption to have a material impact on its financial position, results of operations or cash flows.
Effective January 1, 2011, the Company adopted ASU No. 2009-13, “Revenue Recognition (Topic 605)” – “Multiple-deliverables revenue arrangements” (ASU 2009-13). This update provides that, when vendor-specific objective evidence or third party evidence of selling price is not available, a best estimate of the selling price is required to separate deliverables and allocate arrangement consideration based on the relative selling prices of the separate deliverables (the “relative selling price method”). The relative selling price method allocates any discount in the arrangement proportionately to each deliverable on the basis of each deliverable’s selling price. The Company concluded that the adoption of ASU 2009-13 did not have a material impact on its financial position, results of operations or cash flows, as the guidance applied to revenue arrangements with multiple deliverables, which were not significant.
48
In January 2010, the FASB issued authoritative guidance that expands the required disclosures about fair value measurements. This guidance provided for new disclosures requiring the Company to (i) disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers and (ii) present separately information about purchases, sales, issuances and settlements in the reconciliation of Level 3 fair value measurements. This guidance also provides clarification of existing disclosures requiring the Company to (i) determine each class of assets and liabilities based on the nature and risks of the investments rather than by major security type and (ii) for each class of assets and liabilities, disclose the valuation techniques and inputs used to measure fair value for both Level 2 and Level 3 fair value measurements. The adoption of this guidance did not have a material impact on the financial statements.
4. PREPAID EXPENSES AND OTHER CURRENT ASSETS
As of December 31, 2011 and 2010, prepaid expenses and other current assets consisted of the following:
|
December 31,
|
||||||||
|
2011
|
2010
|
|||||||
|
Prepaid insurance
|
$ | 326,482 | $ | 348,936 | ||||
|
Deposits and other current assets
|
67,507 | 217,238 | ||||||
|
Total
|
$ | 393,989 | $ | 566,174 | ||||
5. GOODWILL AND INTANGIBLE ASSETS
In accordance with ASC No. 350, “Intangibles-Goodwill and Other”, goodwill and other intangible assets with indefinite lives are not amortized. Instead, a review for impairment is performed at least annually or more frequently if events and circumstances indicate impairment might have occurred. Intangible assets with indefinite lives are tested by comparing the fair value of the asset to its carrying value. If the carrying value of the asset exceeds its fair value, impairment is recognized. The Company has no goodwill but does have indefinite-lived intangible assets consisting of a license to operate in China and certain site domains related to its operations in Brazil. In the third quarter 2011, the Company made strategic reductions in the number of personnel supporting its China business operations to better align with its new strategic business plans. This event directly impacted the Company’s expectations of revenues and growth rates. As a result, the Company performed an impairment assessment related to its license to operate in China using the cost approach. The Company considered the inputs in this assessment to be level 3 in the fair value hierarchy under ASC 820. As a result of the assessment, the Company determined the China license fair value to be $0.1 million at December 31, 2011 and recorded an impairment loss of $0.4 million which was reported under impairment loss in the Company’s consolidated statement of operations for the third quarter 2011. In performing the analysis, the Company assumed that the time involved to negotiate and obtain the license is approximately 4.5 months and estimated the direct and indirect costs to obtain the license is approximately $0.1 million.
In the fourth quarter of 2010, the Company performed an impairment assessment on its license to operate in China using the income approach. As a result of this assessment, the Company determined the China license’s fair value to be $0.4 million and recorded an impairment charge of $0.5 million, reported under impairment loss in its consolidated statements of operations for the year ended December 31, 2010.
The change in the approach used in the impairment analysis was due to a major decrease in projected revenues as a result of costs saving measures implemented in September 2011. The reductions prompted a change in the
49
Company’s assessment of the highest and best use of the asset from an in-use premise to an in-exchange valuation premise. As a result, the income approach used in 2010 was no longer a valid approach for the 2011 analysis. The cost approach uses the concept of depreciated replacement cost as an indicator of value and is based on the principle of substitution which holds that a prudent investor would pay no more for an asset than the amount for which the asset could be replaced less the effects of physical, functional and external depreciation or obsolescence.
The Company also has indefinite-lived intangible assets related to Brazil website domain names. The Company did not recognize any impairment during 2011 and 2010 related to this asset.
As of December 31, 2011 and 2010 intangible assets consisted of the following:
|
Indefinite-lived Intangible assets:
|
December 31,
|
|||||||
|
2011
|
2010
|
|||||||
|
License to operate in China:
|
||||||||
|
Balance, beginning of year
|
$ | 481,000 | $ | 969,560 | ||||
|
Impairment loss
|
(381,000 | ) | (488,560 | ) | ||||
|
Balance, end of year
|
100,000 | 481,000 | ||||||
|
Site domains:
|
||||||||
|
Balance, end of year
|
16,429 | 16,429 | ||||||
|
Total
|
$ | 116,429 | $ | 497,429 | ||||
The following table presents the range of assumptions the Company used to derive its fair value estimates for the China reporting units during the impairment test conducted in the fourth quarter of 2010.
|
2010 Assumptions
|
||||
|
Weighted-average cost of capital
|
28 | % | ||
|
Long-term growth rates
|
7.0 | % | ||
|
Annual revenue growth rates
|
$0.2 -$25.2 million
|
|||
|
Time required to obtain similar licenses
|
4.5 months
|
|||
Any change in estimates and assumptions related to the operations in China or to the license may lead to further material impairment charges to the remaining carrying amount of the licenses to operate in China.
50
6. PROPERTY, EQUIPMENT AND SOFTWARE
As of December 31, 2011 and 2010, property, equipment and software consisted of the following:
|
December 31,
|
||||||||
|
2011
|
2010
|
|||||||
|
Computer equipment
|
$ | 593,177 | $ | 569,440 | ||||
|
Furniture and fixtures
|
198,231 | 113,071 | ||||||
|
Software
|
359,946 | 267,896 | ||||||
|
Leasehold improvements
|
214,811 | 193,401 | ||||||
|
Total
|
1,366,165 | 1,143,808 | ||||||
|
Less accumulated depreciation and amortization
|
(1,001,779 | ) | (837,348 | ) | ||||
|
Property, equipment and software, net
|
$ | 364,386 | $ | 306,460 | ||||
Depreciation and amortization expense was $0.2 million and $0.3 million for the years ended December 31, 2011, and 2010, respectively. At December 31, 2011, the U.S. operations and Brazil operations own approximately 86% and 14% of Property, equipment and software, net of accumulated depreciation and amortization, respectively.
7. INCOME TAXES
For the years ended December 31, 2011 and 2010, the benefit from income taxes is comprised of the following:
|
Year Ended December 31,
|
||||||||
|
2011
|
2010
|
|||||||
|
Current:
|
||||||||
|
Federal
|
$ | - | $ | - | ||||
|
State
|
- | - | ||||||
|
Foreign
|
- | 902 | ||||||
|
Total
|
- | 902 | ||||||
|
Deferred:
|
||||||||
|
Federal
|
- | - | ||||||
|
State
|
- | - | ||||||
|
Foreign
|
(95,250 | ) | (122,140 | ) | ||||
|
Total
|
(95,250 | ) | (122,140 | ) | ||||
|
Income tax benefit
|
$ | (95,250 | ) | $ | (121,238 | ) | ||
51
The provision for income taxes for the years ended December 31, 2011 and 2010 differs from the amount computed by applying the U.S. income tax rate of 34% to loss before taxes as follows:
|
Year Ended December 31,
|
||||||||
|
2011
|
2010
|
|||||||
|
Computed “expected” tax expense
|
$ | (2,345,921 | ) | $ | (2,048,948 | ) | ||
|
Loss from equity-method investment
|
702,536 | 517,717 | ||||||
|
State taxes, net of federal benefit
|
(223,587 | ) | (167,067 | ) | ||||
|
Change in valuation allowance
|
1,614,792 | 1,356,007 | ||||||
|
Tax effect of losses and rates in non-US jurisdictions
|
113,836 | 169,089 | ||||||
|
Tax effect of other permanent items
|
43,094 | 51,371 | ||||||
|
Other
|
- | 593 | ||||||
|
Total
|
$ | (95,250 | ) | $ | (121,238 | ) | ||
Loss before benefit from income taxes for the years ended December 31, 2011 and 2010, on a domestic versus foreign basis, consisted of the following:
|
Year Ended December 31,
|
||||||||
|
2011
|
2010
|
|||||||
|
Domestic
|
$ | (6,071,414 | ) | $ | (4,830,570 | ) | ||
|
Foreign
|
(828,356 | ) | (1,195,747 | ) | ||||
|
Total
|
$ | (6,899,770 | ) | $ | (6,026,317 | ) | ||
52
Deferred income taxes reflect the tax consequences on future years of temporary differences between the tax basis of assets and liabilities and their financial reporting basis and are reflected as current or non-current depending on the classification of the asset or liability generating the deferred tax. The deferred tax provision for the periods shown represents the effect of changes in the amounts of temporary differences during those periods.
|
December 31,
|
||||||||
|
2011
|
2010
|
|||||||
|
Deferred tax assets:
|
||||||||
|
Net operating loss carryforwards
|
$ | 13,703,132 | $ | 12,434,401 | ||||
|
Amortization
|
11,793 | 66,321 | ||||||
|
Depreciation of property, equipment and software
|
- | |||||||