Remark Holdings
HSW International, Inc. (Form: 10-K, Received: 03/31/2009 17:05:06)
 


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2008

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _____ to _____

Commission file number 001-33720
________________________________________

HSW INTERNATIONAL, INC.
(Exact name of Registrant as specified in its charter)

Delaware
 
33-1135689
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)  

One Capital City Plaza
3350 Peachtree Road, Suite 1600
Atlanta, Georgia 30326
(Address of principal executive offices, including zip code)

(404) 364-5823
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class
 
Name of each exchange on which registered
Common Stock, $0.001 Par Value
 
NASDAQ Global Market

Securities registered pursuant to Section 12(g) of the Act:  None.

Indicate by check mark if the Registrant is a well-known seasoned issuer (as defined in Rule 405 of the Securities Act).
Yes o   No x

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes o   No x

 
 
 

 

 
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x   No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definition of “large accelerated filer”  “accelerated filer” and smaller reporting company” in Rule 12b-2 of the Act (Check one):

Large accelerated filer o
 
Accelerated filer o
Non-accelerated filer o
 
Smaller reporting company x
(Do not check if a smaller reporting company)
   

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o   No x

At March 30, 2009, 53,698,292 shares of the Registrant’s common stock, $0.001 par value per share, were outstanding.  The aggregate market value of shares of common stock held by nonaffiliates as of June 30, 2008, was $70,617,793.
 



 
 

 
 
 
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PART I

Forward-looking information

Our disclosure and analysis in this report concerning our operations, cash flows and financial position, including, in particular, the likelihood of our success in expanding our business and our assumptions regarding the regulatory environment and international markets, include forward-looking statements.  Statements that are predictive in nature, that depend upon or refer to future events or conditions, or that include words such as “expect,” “anticipate,” “intend,” “plan,” “believe,” “estimate,” “may” and similar expressions are forward-looking statements.  Although these statements are based upon reasonable assumptions, they are subject to risks and uncertainties that are described more fully in this report in the section titled “Part I, Item 1A. Risk Factors”.  These forward-looking statements represent our estimates and assumptions only as of the date of this filing and are not intended to give any assurance as to future results. As a result, you should not place undue reliance on any forward-looking statements.  We assume no obligation to update any forward-looking statements to reflect actual results, changes in assumptions or changes in other factors, except as required by applicable securities laws.


ITEM 1.  BUSINESS
 
Overview
 
HSW International, Inc. (“HSW International”) is an online publishing company that develops and operates Internet businesses focused on providing consumers in the world’s digital economies with locally relevant, high quality information and ways to connect with each other.  Our international websites published under the HowStuffWorks brand provide readers in China and Brazil with thousands of articles about how the world around them works, serving as destinations for credible, easy-to-understand reference information.  HSW International is the exclusive licensee in China and Brazil for the digital publication of translated content from HowStuffWorks.com, a subsidiary of Discovery Communications, Inc., and in China for the digital publication of translated content from World Book Inc., publishers of World Book Encyclopedia.  Our DailyStrength brand, which was acquired on November 26, 2008, helps hundreds of thousands of readers share information and support on www.dailystrength.org , a comprehensive health-related social media website.  The acquisition of DailyStrength was completed in part to diversify our business and to publish another product which offers insight on highly relevant topics.  We generate revenue primarily through the sale of online advertising on our websites. We were incorporated in Delaware in March 2006.  Our headquarters are located at One Capital City Plaza, 3350 Peachtree Road, Suite 1600, Atlanta, Georgia  30326.

Products and Services

ComoTudoFunciona – HowStuffWorks Brazil

We entered the Brazilian online publishing market in March 2007 with the launch of our website ComoTudoFunciona (http://hsw.com.br), utilizing the exclusively licensed HowStuffWorks digital content.  At December 31, 2008, we had published approximately 5,500 articles that were either (i) articles from the HowStuffWorks content database translated from English to Portuguese, or (ii) originally created content.  We are continuing the development of our business strategy in Brazil as we focus on expansion by (i) adding original proprietary digital content designed to meet the information needs of the Brazilian online community, (ii) expanding the amount of translated content from HowStuffWorks, and (iii) refining local marketing strategies.

BoWenWang – HowStuffWorks China

In June 2008, we entered China’s online publishing market utilizing a combination of the contributed assets from HowStuffWorks with the benefit of our predecessor INTAC’s relationships and knowledge of the Chinese markets in obtaining our Internet licenses.  Our Beijing-based website BoWenWang ( http://www.bowenwang.com.cn ) initially launched with a combination of HowStuffWorks content translated from English to Chinese and original content created by our China division, including several hundred articles about the Beijing Olympics.  In September 2008, we entered into an exclusive content partnership with World Book, Inc. to dramatically increase the amount of content published on BoWenWang .  In 2009, World Book will create thousands of original Chinese-language articles providing information on all branches of knowledge, including arts, sciences, history, technology, mathematics, sports, and recreation, exclusively for our Chinese website.  At December 31, 2008, we had published approximately 4,400 articles in China.
 
 
 
 
DailyStrength

In November 2008, we acquired Daily Strength, Inc. (“DS”), publisher of the health social networking website DailyStrength ( http://www.dailystrength.org ).  DailyStrength.org offers content authored by medical professionals based on current topics, support groups, a treatment directory with definitions, private messaging, one-on-one chat forums and personal goal trackers, and primarily serves English-speaking territories such as the United States, Canada, Australia and the United Kingdom.  The medical panel of professionals contributes articles and journals providing insight to a number of topics relevant to the DS user group and communities.  Additionally, DS offers users and members the opportunity to launch a community for a group of like-minded individuals regarding a topic of personal significance using best-of-breed community tools to interact.

DS was founded in 2006 by Internet veterans with more than 20 years of experience conceiving, building, and running communities on the web, including Yahoo, GeoCities, Facebook and more.  DS hosts more than 500 communities focused on issues such as weight loss, divorce, parenting and illnesses.

Our History
 
HSW International was formed on March 14, 2006, as a wholly owned subsidiary of HowStuffWorks, Inc. in order to (i) develop businesses using exclusive digital publishing rights to HowStuffWorks’ content for the countries of China and Brazil, and (ii) effect the INTAC International, Inc. merger (the “INTAC Merger”).  We completed the INTAC Merger to assist in the development of our digital content database exclusively licensed from HowStuffWorks by (i) accelerating our obtaining Internet licenses in China for launching our Internet platform, (ii) obtaining INTAC’s knowledge of the Chinese markets, relationships, and core competencies to accelerate the growth of our Internet platforms in China, and (iii) providing additional cash flow from INTAC’s established businesses.  These established businesses included services related to wireless telephone training and the development and sale of educational software delivered to customers in China (“INTAC Legacy Businesses”).  As discussed below, these legacy businesses were subsequently disposed.

Our initial focus was online publishing of localized, translated Chinese and Brazilian editions of the HowStuffWorks Internet site, utilizing strategies based on those employed by HowStuffWorks, Inc., as tailored to the needs of each localized market.  In November 2008, we acquired Daily Strength, Inc. (“DS”), publisher of the health social networking website DailyStrength ( http://www.dailystrength.org ).  Our acquisition of DS allows us to further leverage our web publishing infrastructure, provides us with an opportunity to diversify our initial focus on the emerging economies, and enter the healthcare digital market.  The online healthcare market in the United States has matured over the past 10 years and now represents a significant market for online advertising.  While the global economic credit market has lowered expectations for near-term growth in the emerging economies, our diversification into the world’s largest online advertising economy – the United States – provides greater access to digital revenues.

The INTAC Merger

The INTAC Merger and related transactions were consummated pursuant to a merger agreement dated April 20, 2006, as amended January 29, 2007.  On October 2, 2007, we completed the INTAC Merger and related transactions pursuant to which:

·  
HowStuffWorks contributed to us, in exchange for shares of our common stock, perpetual, fully paid up, royalty-free, exclusive digital publishing rights to HowStuffWorks’ existing content for the countries of China and Brazil which we are translating and localizing into the predominant languages of China and Brazil.
·  
A wholly owned subsidiary of ours was merged into INTAC, with INTAC surviving as our wholly owned subsidiary, and holders of INTAC common stock received one share of our common stock in exchange for each of their shares of INTAC common stock.
·  
Certain investors (referred to in this report as American investors) purchased or agreed to purchase shares of our common stock having an aggregate value of approximately $39.4 million, of which $22.5 million and $16.9 million (both before expenses) were received in October 2007, and January and February 2008, respectively.  Shelf registration statements covering the resale of these shares were subsequently filed.
·  
Our stock became publicly traded on the NASDAQ Global Market under the symbol “HSWI” in connection with the INTAC Merger.  Prior to the INTAC Merger, INTAC’s common stock was traded on the NASDAQ Capital Market under the symbol “INTN”.


 
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·  
In connection with and as a condition of the INTAC Merger, INTAC sold its wireless handset and prepaid calling cards distribution businesses (“distribution companies”), to an entity controlled by Wei Zhou, CEO, director and significant stockholder of INTAC prior to the INTAC Merger and a member of our Board of Directors from October 2007 to December 2007, in exchange for 3.0 million shares of our common stock held by Mr. Zhou.  The 3.0 million shares of our common stock were recorded as treasury shares valued at cost as determined by a third party valuation.

On January 31 and February 1, 2008, also in connection with the INTAC Merger, certain investors (referred to in this report as the European investors) purchased $5.8 million, before expenses, of our common stock and $11 million of our shares held as treasury stock, respectively, for a price per share of $3.68.  In this transaction, we issued approximately 1.6 million shares of our common stock and sold 3.0 million treasury shares in the aggregate to the European investors.
 
Our Relationship with Discovery Communications, Inc.
 
Following the grant of rights from HowStuffWorks to us, HowStuffWorks merged with Discovery Communications, Inc. (“Discovery”) on December 17, 2007 (the “Discovery Merger”), and became a wholly owned subsidiary of Discovery.  The following summarizes the material agreements between the parties.

·  
We hold a perpetual, fully paid, royalty-free, sublicensable exclusive license to certain of the content published on HowStuffWorks.com in local languages and the HowStuffWorks brand for Brazil and China.
·  
HowStuffWorks provides to us new and updated content published on HowStuffWorks.com, upon our request and pursuant to the same license terms.
·  
We have the right to an exclusive license for the HowStuffWorks trademarks for our Brazil and China websites that display the HowStuffWorks content.
·  
We hold a perpetual, fully paid up, royalty-free, sublicensable license to the software code for HowStuffWorks’ content management platform.
·  
HowStuffWorks has the right to designate three members of our Board of Directors, and the chairperson of the Nominating and Governance Committee.  Additionally, to the extent that HowStuffWorks owns any shares of our common stock in excess of 45% of the outstanding shares, HowStuffWorks is required to vote such excess shares in the exact proportion to the vote of our other shareholders.  HowStuffWorks may vote in its discretion its shares of our common stock up to and including 45% of the outstanding shares of our common stock as of any applicable record date.

The merger agreement between Discovery and HowStuffWorks provided that payment to the former HowStuffWorks shareholders for a significant portion of its ownership of our common stock would not be paid at the October 2007 closing of the transaction, but instead will be available to be paid in three semi-annual installments during a period which began in October 2008.  Such payments will be in the form of cash or shares of HSWI stock now held by HowStuffWorks.  Accordingly, the amount of shares of our common stock indirectly owned by Discovery in the future may fall or rise due to a combination of the potential distributions pursuant to the terms of the Discovery merger or our exercise of the options to publish HowStuffWorks content in local languages in Russia and India.  All of our rights to publish HowStuffWorks content will remain effective regardless of the number of shares owned by HowStuffWorks in the future.  At December 31, 2008, Discovery, through its wholly owned subsidiary HowStuffWorks, owned approximately 42.8% of our outstanding common stock, and had not made any share distributions of our common stock to former HowStuffWorks shareholders.
 
Sale of the INTAC Legacy Businesses and Related Transactions
 
Due to an increased focus of our management and resources on our primary Internet publishing business, a change of control in our majority ownership leading to further refinement in our strategies, and an under-performance of the INTAC Legacy Businesses after the INTAC Merger, in early 2008 we decided to dispose of those businesses.  The INTAC Legacy Businesses were comprised of two lines of business unrelated to our core Internet platform businesses.

We decided that it was critical that all our current resources be fully focused on expanding our Brazilian Internet platform and the June 2008 launch of our Chinese Internet platform.  Although we believe we benefited in the short-term from INTAC’s relationships and knowledge of the Chinese markets in obtaining our Internet licenses, this refined strategic focus did not allow us the time required to realize the expected long-term synergies, embodied in our acquired INTAC goodwill, from INTAC’s knowledge of the Chinese markets, relationships, and core competencies.  In addition, we were provided with and acted on an opportunity to sell the INTAC Legacy Businesses for approximately their stand-alone appraised value, and through simultaneous sale of the treasury stock received, generate significant additional cash to invest into our core Internet businesses.
 
 
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In February and March 2008, we sold the INTAC Legacy Businesses to an entity owned by Mr. Zhou.  We funded the businesses with $4.3 million of cash, net of disposition expenses, and received 5.0 million shares of our stock in exchange.  As of December 31, 2008, all of HSWI’s assets were in our core Internet business and the sole assets we retained from the INTAC Merger were the Internet licenses intangible asset we used to enter the Chinese markets in June 2008.

On February 15, 2008, we entered into a stock purchase agreement where we agreed to sell, and two qualified institutional buyers agreed to purchase, the 5.0 million shares of our common stock received from the INTAC Legacy Businesses disposition at a purchase price of $3.68 per share.  We simultaneously sold 5.0 million shares to institutional buyers in a private placement raising $18.4 million additional cash.
  
Sales & Support
 
We have sales teams in Brazil and the United States to service advertisers and customers for our businesses.  We conduct sales for the websites in Brazil and the U.S. through a direct sales force, as well as strategic relationships with companies that can represent advertising inventory.  We are implementing the same model in China.
 
Marketing
 
The primary business model for our websites is the sale of advertising, sponsorships and related products and services.  By focusing on providing high-quality web properties to end users in Brazil, China and the United States, we aim to establish a user base attractive to advertisers.  We primarily sell advertising based on the quantity of views delivered to advertisers or the success of various advertising-related metrics.
 
Much of our marketing effort is in fostering word-of-mouth momentum by providing high-quality products and services and using public relations efforts.  Additionally, we enter into relationships with existing businesses to provide awareness of and traffic to our products and services.  We also engage in advertising designed to inform potential users and customers about our products and services.
 
Competition
 
The online publishing business is highly competitive.  We encounter significant competition in each market in which we offer our products and services.  Our competitors include national Internet portals in China such as Baidu, NetEase.com, Shanda Interactive Entertainment, Sina, sohu.com and tom.com; national websites in Brazil such as Terra and UOL; and health social media websites like MedHelp.com and trusera.com, which compete with us for online advertising revenue and end users.
 
Intellectual Property

We rely upon patent, trademark, copyright and trade secret laws in various jurisdictions, as well as confidentiality procedures and contractual provisions to protect our proprietary assets and brand.  We do not own any patent or copyright registrations.  We hold various trademarks for our brands, and we have additional applications pending.
 
A number of threats exist to our intellectual property rights.  Effective intellectual property protection may not be available in every country in which we intend to distribute products and services.  Additionally, it may be time consuming and costly for us to protect our intellectual property and even then such steps may not be sufficient or effective.


 
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Government Regulation
 
Our operations in China and Brazil are subject to a number of foreign and domestic laws and regulations that affect companies conducting business on the Internet.  Laws and regulations are being debated and considered for adoption in these countries and others throughout the world in areas relating to user privacy, freedom of expression, content, advertising, information security and intellectual property rights.
 
Additionally, the Internet infrastructures in China and Brazil are subject to regulatory control and, in the case of China, ownership by the Chinese government.  The PRC regulates its Internet sector by enacting legislation or issuing regulations regarding the legality of foreign investment in the PRC Internet sector and the existence and enforcement of content restrictions on the Internet.  We believe that our current ownership structure and localized content complies with PRC laws and regulations.  There are, however, substantial uncertainties regarding the interpretation and enforcement of PRC Internet laws and regulations.  Accordingly, it is possible that the PRC government will ultimately take a view contrary to ours.
 
The PRC Ministry of Information Industry (“MII”), the Chinese governmental agency that regulates the Internet in China, has stated that the activities of Internet content providers are subject to regulation by various PRC government authorities, depending on the specific activities conducted by the Internet content provider.  Various government authorities have stated publicly that they are in the process of preparing new laws and regulations that will govern these activities.  The areas of regulation include, among others, online advertising, online news reporting, online publishing, online securities trading, online community, online video, and the provision of industry specific (e.g., pharmaceutical-related) information over the Internet.  Other aspects of our online operations may be subject to regulation in the future.
 
The MII also promulgated a directive, effective January 31, 2008, providing that online videos can only be broadcast or streamed by state-owned or controlled companies.  Subsequent interpretation was provided to exclude certain websites that existed prior to the directive.  This directive may prevent our Chinese website from displaying online videos, which could have a material effect on the business.
 
Because our services are accessible worldwide, certain foreign jurisdictions may claim that we are required to comply with their laws, even where we have no local entity, employees or infrastructure.  This could also be detrimental to our business.
 
Employees
 
As of December 31, 2008, we had 70 employees, located in Georgia and California, USA; Brazil and China.
 
Seasonality

We expect our business to be affected by seasonal fluctuations in Internet usage and traditional retail seasonality.  Internet usage generally slows during the summer months, and online shopping and related advertising typically increases in the fourth quarter of each year.  These seasonal trends will likely cause fluctuations in quarterly results, including fluctuations in sequential revenue growth rates.
 
Available information
 
Our website address is www.hswinternational.com.  Information on our website is not incorporated by reference herein and should not be considered a part of this report.  We make available free of charge through our website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC.
 

 
 
ITEM 1A.  RISK FACTORS

This report contains forward-looking statements that involve risks and uncertainties.  Our actual results could differ materially from those discussed in this report.  Factors that could cause or contribute to these differences include, but are not limited to, those discussed below and elsewhere in this report and in any documents incorporated in this report by reference.

We are in the early development of our business and prospects are difficult to evaluate.

We have no significant operating history, and limited experience in the Chinese and Brazilian markets.  We are in the early development of our business, including the new strategy of entering the health social networking market with the DailyStrength acquisition in November 2008, with a limited operating history upon which investors and others can evaluate our current business and prospects.  Our prospects must be considered in light of the many risks, uncertainties, expenses, delays, and difficulties frequently encountered by companies in their early stages of development.  Some of the risks and difficulties we expect to encounter include our ability to:

·  
successfully commercialize and monetize the contributed and acquired assets;
·  
continue to raise additional working capital, the lack of which would likely have a significant negative impact on our long term business plan and our ability to take advantage of our strategic alliances and to successfully execute our expansion plan;
·  
manage our expense structure as a U.S. public company including, without limitation, compliance with the Sarbanes Oxley Act;
·  
manage the anticipated rise in operating expenses;
·  
manage and implement successfully new business strategies including, if applicable, new strategies resulting from the Discovery Merger and the accompanying changes to the agreements between HowStuffWorks and us;
·  
adapt and successfully execute our evolving and unpredictable business model, with which we will have only limited experience;
·  
establish and take advantage of contacts and strategic relationships;
·  
adapt to our potential diversification into other industries and geographic regions;
·  
manage and adapt to rapidly changing and expanding operations;
·  
implement and improve operational, financial and management systems and processes;
·  
respond effectively to competitive developments;
·  
attract, retain and motivate qualified personnel; and
·  
manage each of the other risks set forth in this report.
 
Because of our lack of operating history and the early stage of development of our business, we will have limited insight into trends and conditions that may exist or might emerge and affect our business, especially with respect to the online publishing market.  We cannot be certain that our business strategy will be successful or that it will successfully address these risks.  Any failure by us to successfully implement our new business plans could have a material adverse effect on our business, results of operations and financial condition.

We may not have sufficient liquidity to support the time required for our business to fully develop.

The Company is in the process of launching Internet businesses in three different markets, including publishing businesses in two emerging markets.  We believe that our cash resources on hand are sufficient to fund these businesses for less than 24 months unless revenues increase significantly or we find other sources of capital, neither of which can be assured.  Our management and directors continually evaluate our progress and likelihood of success in each of our markets, and our ability to raise additional capital, against the relative value of our resources and other opportunities. Accordingly, we might decide to suspend our activities in one or more of our markets in order to focus our limited resources in the other(s). 


 
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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 Chinese and Brazilian online markets through the Internet are new and unproven.  Moreover, we will have limited experience in determining the pricing of the products and services that we plan to develop.  Because we have never marketed or sold these products and services, we may not be successful in establishing a customer base or strategic partnerships for the distribution of our products and services.  If we are not successful in developing, releasing and marketing these products and services on a profitable basis, our results of operations would be materially and adversely affected.
 
We do not have significant experience in the Brazilian and Chinese marketplaces.  Additionally, we may not have the resources available to simultaneously develop operations in China and Brazil.  Accordingly, there may be a delay in developing such operations or we might decide not to pursue these markets, which could affect our business plan and results of operations.

In addition, any delay in developing our operations in Brazil and China may impact our decision to exercise our option to acquire the exclusive digital publishing rights for the content in India and Russia.  The option expires in May 2009 and our failure to exercise such option may have an adverse affect on our ability to expand our international operations, which could affect our business plan and results of operations.  Exercise of this option requires our issuing additional shares to HowStuffWorks and we will consider the cost of the option and the opportunities of the specific market when considering whether or not to exercise each option. At this time we have made no determination concerning whether these options will be exercised.

The growth we seek is rare.

Substantial future growth will be required in order for us to realize our business objectives.  Growth of this magnitude is rare.  To the extent we are capable of growing our business as necessary, we expect that such growth will place a significant strain on our managerial, operational and financial resources.  We must manage our growth, if any, through appropriate systems and controls in each of these areas.  We must also establish, train and manage a larger work force.  If we do not manage the growth of our business effectively, our business, results of operations and financial condition could be materially and adversely affected.

We face intense competition, which could have an adverse effect on our business, financial condition and results of operations.

The online publishing market is highly competitive.  We encounter significant competition across our business lines and in each market in which we offer our products and services.  In the online publishing market, we expect that our competitors will include national Internet portals in China such as Baidu, NetEase.com, Shanda Interactive Entertainment, Sina, sohu.com and tom.com; national websites in Brazil such as Terra and UOL; and health information websites in the U.S. like MedHelp.com and trusera.com, which will compete with us for online advertising revenue and end users.  Many of our competitors have more experience, resources and visitors than us.

The sale of INTAC’s Legacy Businesses, leaving our strategic focus on the online publishing, could have an adverse effect on our business, financial condition and results of operations.

INTAC’s wireless handset distribution business accounted for approximately 95% of its total revenues for the third quarter of fiscal year 2007, and approximately 92% of its total revenues for the fiscal year ended September 30, 2006.  We sold the INTAC Legacy Businesses in February 2008 which eliminates future revenues from the INTAC Merger.  All future revenue will be derived from online publishing market and other future business strategies.  There is no guarantee that we will be able to offset the sale of the wireless handset distribution business and the INTAC Legacy Businesses through comparable growth in our online publishing businesses.
   
Resales of our common stock and additional obligations to issue our common stock may cause the market price of our stock to fall.
 
We have registered for resale an aggregate of 33,634,192 shares of our common stock held by INTAC affiliates, HowStuffWorks and investors that participated in our equity financings, although HowStuffWorks agreed not to sell or otherwise transfer one-third of its shares until October 2008, one-third of its shares until April 2009 and one-third of its shares until October 2009.  In addition, we granted HowStuffWorks a warrant to purchase 500,000 (250,000 of which are now expired) shares of our common stock.  The issuance of these new shares and the resale of additional shares of our common stock could depress the market price for our common stock.

 
 
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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:
 
·  
general market and economic conditions;
·  
our common stock has been thinly traded; and 
·  
minimal third party research is available regarding our company.

Additionally, the terms of the Discovery merger provided that payment to HowStuffWorks shareholders for a significant portion of HowStuffWorks’ ownership of our common stock would not be paid at the October 2007 closing of the transaction and instead will be paid to HowStuffWorks’ former shareholders in three semi-annual installments beginning on or about October 2008.  Such payments will be in the form of cash or shares of HSWI stock now held by HowStuffWorks.  Accordingly, the amount of shares of our common stock indirectly owned by Discovery in the future may fall or rise due to a combination of the potential distributions pursuant to the terms of the Discovery merger or our exercise of the options to publish HowStuffWorks content in local languages in Russia and India.  All of our rights to publish HowStuffWorks content will remain effective regardless of the number of shares owned by HowStuffWorks in the future.  If Discovery and HowStuffWorks’ former shareholders’ representative elect to distribute shares of our common stock to former HowStuffWorks shareholders, a significant number of shares may be sold by such shareholders relative to the daily market trading volumes for our common stock. While we intend to take reasonable measures aimed to ensure that any such potential sales are not disruptive to the market for our common stock, we cannot be certain as to the outcome.

These factors may similarly affect our common stock, and may have the effect of depressing the market price for our common stock or limiting the market for resale of our common stock.

Our internal control over financial reporting and our disclosure controls and procedures may not prevent all possible errors that could occur.  Internal control over financial reporting and disclosure controls and procedures, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objective will be met.

A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be satisfied.  Internal control over financial reporting and disclosure controls and procedures are designed to give a reasonable assurance that they are effective to achieve their objectives.  We cannot provide absolute assurance that all of our possible future control issues will be detected.  These inherent limitations include the possibility that judgments in our decision making can be faulty, and that isolated breakdowns can occur because of simple human error or mistake.  The design of our system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed absolutely in achieving our stated goals under all potential future or unforeseeable conditions.  Because of the inherent limitations in a cost effective control system, misstatements due to error could occur and not be detected.

We may have additional tax liabilities if tax positions we have taken in prior years are challenged.

We and our subsidiaries are subject to taxes in the United States and various foreign jurisdictions.  We believed that our tax returns appropriately reflected our tax liability when those tax returns were filed.  However, our tax positions may be challenged by the applicable tax authorities.  Any successful challenge to one or more of our prior tax positions could result in a material tax liability to us or to one or more of our subsidiaries, including INTAC, for one or more prior years.


 
8

 


The state of the Internet infrastructure in China and Brazil may limit our growth.

We rely on the Internet for certain aspects of our business, including the publication of content online and our Internet portals.  The Internet infrastructures in China and Brazil are not well developed and are subject to regulatory control and, in the case of China, ownership by the Chinese government.  The cost of Internet access is high relative to the average income in China.  Failure to further develop these infrastructures could limit our ability to grow.  Alternatively, as these infrastructures improve and Internet use increases, we may not be able to scale our systems proportionately.  Our reliance on these infrastructures will make us vulnerable to disruptions or failures in service, without sufficient access to alternative networks and services.  Such disruptions or failures could reduce our user satisfaction.  Should these risks be realized, our ability to increase revenues and profitability would be impaired.

Our operations are vulnerable to natural disasters and other events.

While we believe we have adequate backup systems in place, we could still experience system failures and electrical outages from time to time in the future, which could disrupt our operations.  All of our servers and routers are currently hosted in a single location, a Tier 4 data center.  We do not have a documented disaster recovery plan in the event of damage from fire, floods, typhoons, earthquakes, power loss, and telecommunications failures, break ins and similar events.  If any of the foregoing occurs, we may experience a temporary system shutdown.  If there is significant disruption or damage to the data center hosting our web servers, our ability to provide access to our websites would be interrupted. We do not carry any business interruption insurance.  Although we carry property insurance, our coverage may not be adequate to compensate us for all losses, particularly with respect to loss of business and reputation that may occur.

Our network operations may be vulnerable to hacking, viruses and other disruptions, which may make our products and services less attractive and reliable.

Internet usage of our products could decline if any well publicized compromise of our security occurs.  “Hacking” involves efforts to gain unauthorized access to information or systems or to cause intentional malfunctions or loss or corruption of data, software, hardware or other computer equipment.  Hackers, if successful, could misappropriate proprietary information or cause disruptions in our service.  We may be required to expend capital and other resources to protect our website against hackers.  We cannot assure you that any measures we may take will be effective.  In addition, the inadvertent transmission of computer viruses could expose us to a material risk of loss or litigation and possible liability, as well as materially damage our reputation and decrease our user traffic.

Unauthorized use of our intellectual property by third parties, and the expenses incurred in protecting our intellectual property rights, may adversely affect our business.

We regard our copyrights, service marks, trademarks, trade secrets and other intellectual property as critical to our success.  Unauthorized use of our intellectual property by third parties may adversely affect our business and reputation.  We rely on trademark and copyright law, trade secret protection and confidentiality agreements with our employees, customers, business partners and others to protect our intellectual property rights.  Despite our precautions, it is possible for third parties to obtain and use our intellectual property without authorization.  Furthermore, the validity, enforceability and scope of protection of intellectual property in Internet related industries are uncertain and still evolving.  In particular, the laws of the PRC, Brazil and certain other countries are uncertain or do not protect intellectual property rights to the same extent as do the laws of the United States.  Moreover, litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others.  Future litigation could result in substantial costs and diversion of resources.

We may be subject to intellectual property infringement claims, which may force us to incur substantial legal expenses and, if determined adversely against us, materially disrupt our business.

We cannot be certain that our products and services will not infringe valid patents, copyrights or other intellectual property rights held by third parties.  We may in the future be subject to legal proceedings and claims from time to time relating to the intellectual property of others in the ordinary course of our business.  In particular, if we are found to have violated the intellectual property rights of others, we may be enjoined from using such intellectual property, and may incur licensing fees or be forced to develop alternatives.  We may incur substantial expenses in defending against these third party infringement claims, regardless of their merit.  Successful infringement claims against us may result in substantial monetary liability or may materially disrupt the conduct of our business.


 
9

 


Our sublicensed content is subject to the terms and conditions of agreements between HowStuffWorks and third parties.

Under the terms of our contribution agreements, HowStuffWorks transferred and contributed to us all rights, but only those rights, which belong to and are held by HowStuffWorks pursuant to third-party licenses.  Some of those licenses, including those with Publications International, Inc. contain restrictions on the use of such content and termination provisions for breaches of the license agreements.  Accordingly, a breach of any third party license by HowStuffWorks may cause us to lose our license with such third party, which could have a material adverse effect on the implementation of our business plan, value of our content offering and results of our operations.

A slowdown or other adverse developments in the PRC or Brazil economy may materially and adversely affect our customers, demand for our services and our business.

Although the PRC economy has grown significantly in recent years, we cannot assure you that such growth will continue and we may be sensitive to a slowdown in economic growth or other adverse changes in the PRC and Brazil economies.  This is particularly true in light of current financial and economic uncertainties.  In response to adverse economic developments, companies may reduce spending on marketing and advertising.  As a result, a slowdown in overall economic growth, an economic downturn or recession or other adverse economic developments in China or Brazil may materially reduce the demand for our services and materially and adversely affect our business.

PRC laws and regulations related to the PRC Internet sector are unclear and will likely change in the near future.  If we are found to be in violation of current or future PRC laws or regulations, we could be subject to severe penalties.

The PRC regulates its Internet sector by making pronouncements or enacting regulations regarding the legality of foreign investment in the PRC Internet sector and the existence and enforcement of content restrictions on the Internet.  There are substantial uncertainties regarding the interpretation of current PRC Internet laws and regulations, including those discussed below.

The PRC enacted regulations applying to Internet related services and telecommunications related activities.  While many aspects of these regulations remain unclear, they purport to limit and require licensing of various aspects of the provision of Internet information services.  The MII has also stated that the activities of Internet content providers are subject to regulation by various PRC government authorities, depending on the specific activities conducted by the Internet content provider.  Various government authorities have stated publicly that they are in the process of preparing new laws and regulations that will govern these activities.  The areas of regulation currently include online advertising, online news reporting, online publishing, online securities trading and the provision of industry specific (e.g., drug related) information over the Internet.  Other aspects of our online operations may be subject to regulation in the future.

Under the agreement reached in November 1999 between the PRC and the United States concerning the United States’ support of China’s entry into the World Trade Organization, or the WTO, foreign investment in PRC Internet services was to be liberalized to allow for 30% foreign ownership in key telecommunication services, including PRC Internet ventures, for the first year after China’s entry into the WTO, 49% in the second year and 50% thereafter.  China officially entered the WTO on December 11, 2001.  However, the implementation of China’s WTO accession agreements is still subject to various conditions.

The interpretation and application of existing PRC laws and regulations, the directives of the MII and the possible new laws or regulations have created substantial uncertainties regarding the legality of existing and future foreign investments in, and the businesses and activities of, PRC Internet companies, including us.  Accordingly, it is possible that the relevant PRC authorities could, at any time, assert that any portion or all of our ownership structure and business violate existing or future PRC laws, regulations or policies.  It is also possible that the new laws or regulations governing the PRC Internet sector that have been adopted or may be adopted in the future will prohibit or restrict foreign investment in, or other aspects of, any of our proposed businesses and operations.  In addition, these new laws and regulations may be retroactively applied to us.


 
10

 


If we are found to be in violation of any existing or future PRC laws or regulations, the relevant PRC authorities would have broad discretion in dealing with such violation, including, without limitation, the following:

·  
levying fines;
·  
confiscating our income;
·  
revoking our business licenses;
·  
pursuing criminal sanctions against our business and personnel;
·  
shutting down our servers and/or blocking our websites;
·  
requiring us to restructure our ownership structure or operations; and
·  
requiring us to discontinue any portion or all of our Internet business.
 
Any of these actions could have a material adverse effect on our financial condition and results of operations.

The online advertising markets in China and Brazil are still developing, and present risk to our revenues to be generated from our online publishing business using the contributed assets.

Our online publishing businesses in China and Brazil are expected to derive significant revenue from online advertisements.  The online advertising markets in China and Brazil are still developing, and future growth and expansion of these markets is uncertain.  If these online advertising markets do not grow at expected rates, our results of operations and financial condition will be materially adversely affected.

Our international operations subject us to other significant risks including unpredictable governmental regulation in China and Brazil.

Our international operations expose us to a wide variety of other risks including increased credit risks, customs duties, import quotas and other trade restrictions, potentially greater inflationary pressures, and the risk of failure or material interruption of wireless systems and services.  Changes may occur in foreign trade and investment laws in the territories and countries where we will operate.  U.S. laws and regulations relating to investment and trade in foreign countries could also change to our detriment.  Any of these factors could materially and adversely affect our revenues and profits.  We are subject to risk of political instability and trade sanctions within China.

China has traditionally been a closed market with strict political controls.  As China shifts to a market economy, growing economic and social freedoms may conflict with the more restrictive political and governmental policies.  In addition, democratic countries throughout the world have, from time to time, attempted to use economic and other sanctions to achieve political or social change in other countries.  Each of these factors could result in economic sanctions, economic instability, the disruption of trading and war within China and the Asia Pacific Rim, any of which could result in our inability to conduct business operations in China.  Because a substantial amount of our business is expected to be within China, the disruption of distribution channels into China would have material and adverse consequences to our business.

In the past, the Brazilian government has intervened in the Brazilian economy and occasionally made drastic changes in economic policy.  The Brazilian government’s actions to control inflation and affect other policies have included high interest rates, wage and price controls, currency devaluations, capital controls and limits on exports, among other actions.  Our business, financial condition, revenues, results of operations, prospects and the market price of our securities may be adversely affected by changes in Brazilian government policies, as well as general economic factors, including:

·  
currency fluctuations;
·  
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;
·  
inflation;
·  
price instability;
·  
energy policy;
·  
interest rate increases;
·  
liquidity of domestic capital and lending markets;
·  
changes in tax policy; and
·  
other political, domestic, social and economic developments in or affecting Brazil.
 
 
11

 
 
Also, the President of Brazil has considerable power to determine governmental policies and actions that relate to the Brazilian economy and, consequently, affect the operations and financial performance of businesses operating in Brazil.  We have no control over, and cannot predict what policies or actions the Brazilian government may take in the future.

Further risks relating to international operations include, but are not restricted to, unexpected changes in legal and regulatory requirements, changes in tariffs, exchange rates and other barriers, political and economic instability, possible effects of war and acts of terrorism, difficulties in account receivable collection, difficulties in managing distributors or representatives, difficulties in staffing and managing international operations, difficulties in protecting our intellectual property overseas, seasonality of sales and potentially adverse tax consequences.  Any of these factors could materially and adversely affect our revenues and profits.

Restrictions on currency exchange may limit our ability to utilize our revenues effectively.
 
Some of our operating expenses are denominated in Chinese Renminbi.  Currently, we may purchase foreign exchange for settlement of “current account transactions” without the approval of the Chinese State Administration for Foreign Exchange, or SAFE.  We may also retain foreign exchange in our current account (subject to a ceiling approved by the SAFE) to satisfy foreign exchange liabilities or to pay dividends.  However, the relevant PRC governmental authorities may limit or eliminate our ability to purchase and retain foreign currencies in the future.

Additionally, some of our revenues and operating expenses are denominated in Brazilian Reais .  Brazilian law allows the Brazilian government to impose restrictions on the conversion of the Real into foreign currencies and on the remittance to foreign investors of proceeds from their investments in Brazil.  The government may impose such restrictions whenever there is a serious imbalance in Brazil’s balance of payments or there are reasons to foresee a serious imbalance.  The Brazilian government last imposed remittance restrictions for approximately six months in 1989 and early 1990.  The likelihood that the Brazilian government would impose such restrictions again may depend on the extent of Brazil’s foreign currency reserves, the availability of foreign currency in the foreign exchange markets on the date a payment is due, the size of Brazil’s debt service burden relative to the economy as a whole, Brazil’s policy toward the International Monetary Fund and other factors.

Since a significant amount of our revenues will be denominated in Renminbi, existing and future restrictions on the exchange of Renminbi to other currencies may limit our ability to use revenue generated in Renminbi to fund our business activities outside China, if any, or expenditures denominated in foreign currencies.  Similarly, in the event that a significant amount of our revenues are denominated in Reais , any future restrictions on the exchange of Reais for other currencies or the remittance to foreign investors of proceeds from their investments in Brazil may limit our ability to use revenue generated in Reais to fund our business activities outside Brazil, or expenditures denominated in foreign currencies.

We are subject to risks of currency fluctuations and exchange restrictions.

Currency fluctuations, devaluations and exchange restrictions may adversely affect our liquidity and results of operations.  In some countries, local currencies may not be readily converted into Euros or U.S. dollars (or other “hard currencies”) or may only be converted at government controlled rates, and, in some countries, the transfer of hard currencies offshore has been restricted from time to time.  Very limited hedging transactions are available in China to reduce its exposure to exchange rate fluctuations.  To date, we have not entered into any hedging transactions in an effort to reduce our exposure to foreign currency exchange risk.  While we may decide to enter into hedging transactions in the future, the availability and effectiveness of these hedges may be limited and we may not be able to successfully hedge our exposure, if at all.  Our revenues as expressed in our U.S. dollar financial statements will decline in value if Renminbi or Reais depreciate relative to the U.S. dollar.  In addition, our currency exchange losses may be magnified by PRC exchange control regulations that restrict our ability to convert Renminbi into U.S. dollars or by Brazilian exchange control regulations that restrict our ability to convert Reais into U.S. dollars.


 
12

 


Regulation and censorship of information collection and distribution in China may adversely affect our business.

China has enacted regulations governing Internet access and the distribution of news and other information.  Furthermore, the Propaganda Department of the Chinese Communist Party has been given the responsibility to censor news published in China to ensure, supervise and control a particular political ideology.  In addition, the MII has published implementing regulations that subject online information providers to potential liability for content included on their portals and the actions of subscribers and others using their systems, including liability for violation of PRC laws prohibiting the distribution of content deemed to be socially destabilizing.  Because many PRC laws, regulations and legal requirements with regard to the Internet are relatively new and untested, their interpretation and enforcement may involve significant uncertainty.  In addition, the PRC legal system is a civil law system in which decided legal cases have limited binding force as legal precedents.  As a result, in many cases it is difficult to determine the type of content that may result in liability for a website operator.

Periodically, the Ministry of Public Security has stopped the distribution over the Internet of information which it believes to be socially destabilizing.  The Ministry of Public Security has the authority to cause any local Internet service provider to block any website maintained outside China at its sole discretion.  If the PRC government were to take action to limit or eliminate the distribution of information through our portals or to limit or regulate current or future applications available to users of our portals, our business would be adversely affected.

The State Secrecy Bureau, which is directly responsible for the protection of state secrets of all PRC government and Chinese Communist Party organizations, is authorized to block any website it deems to be leaking state secrets or failing to meet the relevant regulations relating to the protection of state secrets in the distribution of online information.  Under the applicable regulations, we may be held liable for any content transmitted on our portal.  Furthermore, where the transmitted content clearly violates the laws of the PRC, we will be required to delete it, and where the transmitted content is considered suspicious, we are required to report such content.  We must also undergo computer security inspections, and if we fail to implement the relevant safeguards against security breaches, our operations in the PRC may be shut down.

Although the PRC has several laws and regulations relating to the use of the Internet, addressing personal privacy in use of the Internet and the freedom of communications, the PRC government does not restrict online service providers in the collection, transmission and commercial use of personal information or data.  Personal data is protected from unlawful use by general statutes and by any contractual arrangement between the user and the service provider.

Since spring of 2005, the National People’s Congress and the State Council have begun legislative review of a draft Law for Protection of Personal Information which provides a wider scope of information protection than that required to protect the personal privacy of a citizen.  Cellular phone number, home address, medical files and occupational information will all be protected under the draft law.  The draft further provides that usage of such personal information by service providers (excluding the national security authority, research institutions, and news agency) shall be subject to the prior authorization of each individual and violation under this law could result in administrative, civil, and even criminal liabilities.  If regulations are adopted addressing the collection, transmission and commercial use of personal information or data, we could be subject to these penalties, certain aspects of our business plan may no longer be viable and our business would thus be adversely affected.

Potential additional Chinese regulation could affect our business in China.

The Ministry of Information Industry, the Chinese governmental agency which regulates the Internet in China, promulgated a directive effective January 31, 2008, providing that online videos can only be broadcast or streamed by state-owned or controlled companies.  Subsequently, the Ministry of Information Industry acted to provide exceptions for certain non-state-owned or controlled companies.  While it is possible that our Chinese website would not be permitted to display online videos, which could have a material effect on the content provided on such website, it is not yet clear what, if any, effect this regulation has upon our business in China.


 
13

 


Political and economic policies of the PRC government could affect our business.

A significant portion of our business, assets and operations are located in China and a significant portion of our future revenues are expected to be derived from our operations in China.  Accordingly, our business could be adversely affected by changes in political, economic or social conditions in China, adjustments in PRC government policies or changes in laws and regulations.

The economy of China differs from the economies of most countries belonging to the Organization for Economic Cooperation and Development in a number of respects, including:

·  
structure;
·  
level of government involvement;
·  
level of development;
·  
level of capital reinvestment;
·  
growth rate;
·  
control of foreign exchange; and
·  
methods of allocating resources.

Since 1949, China has been primarily a planned economy subject to a system of macroeconomic management.  Although the Chinese government still owns a significant portion of the productive assets in China, economic reform policies since the late 1970s have emphasized decentralization, autonomous enterprises and the utilization of market mechanisms.  We cannot predict what effects the economic reform and macroeconomic measures adopted by the Chinese government may have on our business or results of operations.

The PRC legal system embodies uncertainties which could limit the legal protections available to us.

The PRC legal system is a civil law system based on written statutes.  Unlike common law systems, it is a system in which decided legal cases have little precedential value.  In 1979, the PRC government began to promulgate a comprehensive system of laws and regulations governing economic matters in general.  We are subject to laws and regulations applicable to foreign investment in mainland China.  However, these laws, regulations and legal requirements are relatively recent, and their interpretation and enforcement involve uncertainties.  These uncertainties could limit the legal protections available to us and other foreign investors.  In addition, we cannot predict the effect of future developments in the PRC legal system, particularly with regard to the Internet, our ownership structure and currency exchange, including the promulgation of new laws, changes to existing laws or the interpretation or enforcement thereof, or the preemption of local regulations by national laws.

It may be difficult to enforce any civil judgments against us or our board of directors or officers, because in the future a significant portion of our assets could be located outside of the United States.

Although the combined company is incorporated in the State of Delaware, in the future a substantial portion of our assets could be located in the PRC.  As a result, it may be difficult for investors to enforce outside the United States any actions brought against us in the United States, including actions predicated upon the civil liability provisions of the federal securities laws of the United States or of the securities laws of any state of the United States.  In addition, certain of our directors and officers and all or a substantial portion of their assets may be located outside the United States (principally in the PRC).  As a result, it may not be possible for investors to effect service of process within the United States upon those directors and officers, or to enforce against them or us judgments obtained in United States courts, including judgments predicated upon the civil liability provisions of the federal securities laws of the United States or of the securities laws of any state of the United States.  There is doubt as to the enforceability in the PRC, in original actions or in actions for enforcement of judgments of United States courts, of civil liabilities predicated solely upon the federal securities laws of the United States or the securities laws of any state of the United States.


 
14

 


If we are not able to attract and retain key management and consultants, we may not successfully integrate the contributed assets into our historical business or achieve our other business objectives.

We will depend upon our senior management and consultants for our business success.  Key members of the senior team include Jeff Arnold, a consultant and our current Chairman of the Board.  Our consulting agreement with Mr. Arnold, which commenced in 2006, runs through May 31, 2009.  The loss of the service of any of the key members of our senior management may significantly delay or prevent the integration of the contributed assets and other business objectives.  Our ability to attract and retain qualified personnel, consultants and advisors will be critical to our success.  We may be unable to attract and retain these individuals, and our failure to do so would adversely affect our business.

The concentration of our stock ownership will likely limit your ability to influence corporate matters.
 
HowStuffWorks beneficially owns a significant percentage of our outstanding common stock and entered into a stockholders agreement.  The stockholders agreement entitles HowStuffWorks to designate nominees to our board of directors.  Furthermore, Jeff Arnold, our current Chairman of the Board, is the Chief Executive Officer and Chairman of HowStuffWorks, and another member of our Board of Directors is President-Digital Media and Business Development of its parent company, Discovery.  As a result, HowStuffWorks has the ability to influence our management and affairs and determine the outcome of matters submitted to stockholders for approval, including the election and removal of directors, amendments to the charter, approval of equity-based employee compensation plans and any merger, consolidation or sale of all or substantially all of our assets.

The concentration of our stock ownership, as well as our Amended and Restated Certificate of Incorporation, Amended and Restated Bylaws, stockholders agreement and Delaware law contain provisions that may make our acquisition more difficult without the approval of our board of directors, which could discourage, delay or prevent a transaction involving our change of control.

As of March 30, 2009, HowStuffWorks owned approximately 43% of our outstanding shares of common stock.  As a result, it will be difficult for our other stockholders to approve a takeover of us without the cooperation of HowStuffWorks.

Furthermore, our Amended and Restated Certificate of Incorporation and Amended and Restated Bylaws contain certain anti-takeover provisions, including but not limited to the following provisions:

·  
only our board of directors may call special meetings of our stockholders;
·  
our stockholders may take action only at a meeting of our stockholders and not by written consent;
·  
·  
we require advance notice for stockholder proposals of not less than 60 nor more than 90 days prior to a meeting at which stockholder proposals may be introduced.

In addition, the stockholders agreement gives HowStuffWorks the right to designate nominees to our board of directors.

These anti-takeover defenses could discourage, delay or prevent a transaction involving a change of control of us.  These provisions could also discourage proxy contests and make it more difficult for you and other stockholders to cause us to take other corporate actions you may desire.

Section 203 of the Delaware General Corporation Law may also delay, defer or prevent a change in control that our stockholders might consider to be in their best interest.  We are subject to Section 203 of the Delaware General Corporation Law which, subject to certain exceptions, prohibits “business combinations” between a publicly-held Delaware corporation and an “interested stockholder,” which is generally defined as a stockholder who becomes a beneficial owner of 15% or more of a Delaware corporation’s voting stock for a three-year period following the date that such stockholder became an interested stockholder.  Section 203 could have the effect of delaying, deferring or preventing a change in control of us that our stockholders might consider to be in their best interest.


 
15

 


Acquisitions, business combinations and other transactions present integration risk and may have negative consequences for our business and our stockholders.
 
The process of integrating acquired businesses, like DailyStrength, into our existing operations may result in unforeseen difficulties and liabilities and may require a disproportionate amount of resources and management attention. Difficulties that we may encounter in integrating the operations of acquired businesses could have a material adverse effect on our results of operations and financial position. Moreover, we may not realize any of the anticipated benefits of an acquisition and integration costs may exceed anticipated amounts. We may enter into joint ventures, strategic alliances or similar arrangements with third parties.  These transactions may result in changes in the nature and scope of our operations and changes in our financial condition.  Financing for these transactions may come from cash on hand, proceeds from the issuance of additional common stock or proceeds from debt financing.

The issuance of additional equity or debt securities could:

·  
cause substantial dilution of the percentage ownership of our stockholders at the time of the issuance;
·  
cause substantial dilution of our earnings per share;
·  
subject us to the risks associated with increased leverage;
·  
subject us to restrictive covenants that could limit our flexibility in conducting future business activities; and
·  
adversely affect the prevailing market price for our outstanding securities.
 
We may not be able to raise additional funds when needed for our business or to exploit opportunities.

We may need to raise additional funds to support expansion, develop new or enhanced applications and services, respond to competitive pressures, acquire complementary businesses or technologies or take advantage of unanticipated opportunities.  If required, we may attempt to raise such additional funds through public or private debt or equity financing, strategic relationships or other arrangements.  There can be no assurance that such financing will be available on acceptable terms, if at all, or that such financing will not be dilutive to our stockholders.

We face competition from other social media companies.

We face competition for our DailyStrength website from other social media companies, including start-ups as well as developed companies that are enhancing or developing social media technologies.  Also, we may compete with companies that provide health-focused websites because these companies, like us, are trying to sell advertising for health content on the Internet.  Among the social media and health-focused website companies, there are a number of large, established competitors with significantly greater employees and cash resources than we have.  We expect that some of these companies will increasingly use their resources to compete against us in a variety of ways, including by making acquisitions, investing more aggressively in research and development, and competing more aggressively for advertisers and users.  If our competitors are successful in providing similar or better social media destinations for health, we could experience a decline in user traffic.  Any such decline could negatively affect our revenues and growth opportunities.

We may not be able to successfully grow and monetize our social media business.

Formidable growth of users and revenue is required for our DailyStrength social media business to generate sufficient revenue to cover operating costs.  If we fail to maintain and enhance the “DailyStrength” brand, if we are unable to attract sufficient users for our DailyStrength website, or if we incur excessive expenses in these efforts, our business, operating results and financial condition will be materially and adversely affected.

We generate our revenue almost entirely from advertising, and the reduction in spending by or loss of advertisers could seriously harm our business.

We generated the majority of our revenues in 2008 from our advertisers.  Our advertisers can generally terminate their contracts with us at any time.  Advertisers will not continue to do business with us if their investment in advertising with us does not generate sales leads, and ultimately customers, or if we do not deliver their advertisements in an appropriate and effective manner.  If we are unable to be competitive and provide value to our advertisers, they may stop placing ads with us, which would negatively harm our revenues and business.  In addition, expenditures by advertisers tend to be cyclical, reflecting overall economic conditions and budgeting and buying patterns.  Any decreases in or delays in advertising spending due to general economic conditions could reduce our revenues or negatively impact our ability to grow our revenues.
 
 
16

 
 
ITEM 1B.  UNRESOLVED STAFF COMMENTS

None.


ITEM 2.  PROPERTIES

Our corporate headquarters are located at One Capital City Plaza, 3350 Peachtree Road, Suite 1600, Atlanta, Georgia, which consists of approximately 6,000 square feet of leased space.  At December 31, 2008, we also leased approximately 5,700 square feet in Beijing, China, approximately 700 square feet in Sao Paulo, Brazil, as well as a nominal amount in California.  We do not own any real property. We believe that our existing facilities are adequate to meet our needs in the near term.
 
As of December 31, 2008, our current total remaining lease obligations are U.S. $465,439.

 
ITEM 3.  LEGAL PROCEEDINGS

We are not subject to any material pending legal proceeding, nor are we aware of any material threatened claims against us.

 
ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
No matters were submitted to a vote of our security holders during the fourth quarter of the year ended December 31, 2008.
 
 
 
 
PART II
 
ITEM 5.  MARKET FOR THE REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
Our common stock has been traded on the NASDAQ Global Market under the symbol “HSWI” since October 2, 2007, and INTAC traded on the NASDAQ Capital Market under the symbol “INTN” prior to that time.  The following table sets forth the high and low sales prices of our and INTAC’s common stock, as reported per the appropriate market.

   
High
   
Low
 
Year ended December 31, 2007
           
First Quarter
  $ 8.92     $ 5.65  
Second Quarter
    8.00       6.50  
Third Quarter
    11.48       5.00  
Fourth Quarter
    11.25       4.18  
                 
Year ended December 31, 2008
               
First Quarter
  $ 6.23     $ 3.20  
Second Quarter
    5.30       2.61  
Third Quarter
    3.90       2.05  
Fourth Quarter
    2.74       0.15  

Holders of Record

As of March 30, 2009, the last sale price of our common stock on NASDAQ Global Market was $0.15 per share.  As of March 30, 2009, there were approximately 25 stockholders of record.

Dividend Policy

We have neither paid nor declared dividends on our common stock since our inception and do not plan to pay dividends in the foreseeable future.  Any earnings that we may realize will be returned to finance our growth.


 
18

 

 
ITEM 6.  SELECTED FINANCIAL DATA

The following table sets forth consolidated financial data with respect to us as of and for the years ended December 31, 2008 and 2007.  The selected consolidated financial data below should be read in conjunction with the audited consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in Item 7.  This is particularly true because our historical financial data is difficult to compare from period to period because of the mergers and business dispositions we have recently consummated, as described therein.

The following data, insofar as it relates to the years ended December 31, 2008 and 2007, has been derived from the audited consolidated financial statements, including the consolidated balance sheets at December 31, 2008, and 2007, and the related consolidated statements of operations, cash flows and stockholders’ equity and comprehensive income for the years ended December 31, 2008 and 2007, and notes thereto appearing elsewhere in this report.

As discussed in Notes 1, 2, and 3 to the consolidated financial statements included elsewhere in this report, HSWI merged with INTAC International Inc. on October 2, 2007, and the INTAC Legacy Businesses were subsequently disposed on February 29, 2008.  Following the disposition, the sole asset we retained from INTAC is the indefinite lived Internet Licenses intangible asset and no revenue was realized from this asset in 2008 or 2007.

Consolidated Statement of Operations Data:

   
Years Ended December 31,
 
   
2008
   
2007
 
             
Operating revenue
  $ 457,006     $ 147,535  
Cost of services
    987,266       1,242,252  
Gross loss
    (530,260 )     (1,094,717 )
Operating expenses
    23,751,913       13,768,471  
Loss from operations
    (24,282,173 )     (14,863,188 )
Other income
    515,238       11,842  
Deferred income tax benefit
    1,962,500        
Loss from continuing operations
    (21,804,435 )     (14,851,346 )
Loss from discontinued operations
    (133,526 )     (24,687,959 )
Net loss
  $ (21,937,961 )   $ (39,539,305 )
                 
Per share data:
               
Basic and diluted loss per share from continuing operations
  $ (0.41 )   $ (1.29 )
Basic and diluted loss per share from discontinued operations
          (2.13 )
Basic and diluted loss per share
  $ (0.41 )   $ (3.42 )
Weighted average shares outstanding – basic and diluted
    52,941,525       11,544,818  
 
Consolidated Balance Sheet Data:

   
December 31,
 
   
2008
   
2007
 
             
Cash and cash equivalents
  $ 18,020,159     $ 3,476,673  
Goodwill and other intangibles
    5,799,066       10,021,476  
Total assets
    26,309,653       34,745,160  
Total liabilities
    1,833,231       9,834,723  
Stockholders’ equity
    24,476,422       24,910,437  
 

 
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ITEM 7.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion together with our consolidated financial statements and the related notes and other financial information included elsewhere in this report. The discussion in this report contains forward-looking statements that involve risks and uncertainties, such as statements of our plans, objectives, expectations and intentions. The cautionary statements made in this report should be read as applying to all related forward-looking statements wherever they appear in this report. Our actual results could differ materially from those discussed here.

Business Overview and Recent Events

HSW International is an online publishing company that develops and operates Internet businesses focused on providing consumers in the world’s digital economies with locally relevant, high quality information and ways to connect with each other.  Our international websites published under the HowStuffWorks brand provide readers in China and Brazil with thousands of articles about how the world around them works, serving as destinations for credible, easy-to-understand reference information.  HSW International is the exclusive licensee in China and Brazil for the digital publication of translated content from HowStuffWorks.com, a subsidiary of Discovery Communications, Inc., and in China for the digital publication of translated content from World Book Encyclopedia.  Our DailyStrength business, which was acquired on November 26, 2008, helps hundreds of thousands of readers share information and support on www.dailystrength.org , a comprehensive health-related social media website.  The acquisition of DailyStrength was completed in part to diversify our business and to publish another product which offers insight on highly relevant topics.  We generate revenue primarily through the sale of online advertising on our websites. We were incorporated in Delaware in March 2006.  Our headquarters are located at One Capital City Plaza, 3350 Peachtree Road, Suite 1600, Atlanta, Georgia  30326.

Business Trends

The number of unique visitors, page views and time spent on our Web sites indicates volume of traffic to our sites and are key non-financial metrics we monitor, because they can influence our advertising revenue rates and our overall advertising revenue.  We also monitor overall Internet advertising trends as indicators of our performance.  Because data on Brazil and China is limited, we watch U.S. trends as a proxy, although trends might vary country-by-country.

The advertising market overall declined in 2008 due to the economic slowdown.  This decline affected online advertising expenditures as well.  The result for us has been lower revenue than expected, even in Brazil.

In this tough economy, we are cautious regarding our operating expenses and have cut costs in 2009 to attempt to better align our spending with our expectations for growth within each product line.  We acquired DailyStrength in November 2008 and accordingly have added related operating expenses to our 2009 budget. Since then, we have implemented cost-cutting measures in our headcount and third-party and other professional services to better align our operating costs with our revised growth expectations and partially offset the additional charges related to DailyStrength.  As described above, we expect challenges in our revenue growth and margins for 2009.  As a result, we closely monitor our cash status and our progress and likelihood of success in each of our markets.  Accordingly, we might decide to suspend our activities in one or more of our markets in order to focus our limited resources in the other(s).

The INTAC Merger

We completed the INTAC Merger on October 2, 2007 to assist in the development of our digital content database exclusively licensed from HowStuffWorks by (i) accelerating our obtaining Internet licenses in China for launching our Internet platform, (ii) obtaining INTAC’s knowledge of the Chinese markets, relationships, and core competencies to accelerate the growth of our Internet platforms in China, and (iii) providing additional cash flow from INTAC’s established businesses.  These established businesses included services related to wireless telephone training and the development and sale of educational software delivered to customers in China (“INTAC Legacy Businesses”).  As discussed below, the INTAC Legacy Businesses were subsequently disposed.

Prior to the consummation of the merger with INTAC, we had only limited assets and operations incident to our formation and in preparation for the merger with INTAC and subsequent business.

 
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In conjunction with the INTAC Merger:

·  
HowStuffWorks contributed exclusive digital publishing rights to HowStuffWorks’ content for China and Brazil;
·  
our stock became publicly traded on the NASDQ Global Market under the symbol “HSWI”; and
·  
certain investors contributed $39.4 million (before expenses).

As more fully discussed in Note 2 to the consolidated financial statements included in this Annual Report to Form 10-K, the preliminary allocation of the purchase price of $47.9 million resulted in approximately $29.0 million of goodwill primarily from our expectations that we could utilize INTAC’s knowledge of the Chinese markets, relationships, and core competencies to accelerate the growth of our Internet platforms in China.  However, as discussed below, we disposed of the entire INTAC Legacy Businesses on February 29, 2008.

Business Development

On November 26, 2008, we acquired DailyStrength to diversify our business.  This acquisition provides us with a footprint in the US healthcare market and we believe this addition is synergistic to our existing technology. The DailyStrength acquisition extends HSW International’s proven publishing platform with social networking applications and communities.  DailyStrength hosts more than 500 communities focused on issues such as weight loss, divorce, parenting and illnesses. Users of the site both read and interact with high-quality, reference information. The site features health journals, discussion forums, virtual hugs, member-created groups, and treatment reviews plus unique content provided on a daily basis by physicians and other health professionals.

Our Operations

We entered the Brazilian online publishing market in March 2007.  At December 31, 2008, we had approximately 5,500 articles that were either (i) articles from the HowStuffWorks content database translated from English to Portuguese, or (ii) originally created content.  The web site address is http://hsw.com.br/ .  We are continuing the development of our business strategy in Brazil as we continue to expand by (i) adding original proprietary digital content designed to meet the information needs of the Brazilian online community, (ii) expanding the amount of translated content from HowStuffWorks, and (iii) refining local marketing strategies.  We recognized approximately $405,000 and $148,000 of revenue during the years ended December 31, 2008 and 2007, respectively.

In June 2008, we entered China’s online publishing market utilizing a combination of the contributed assets from HowStuffWorks with the benefit of INTAC’s relationships and knowledge of the Chinese markets in obtaining our Internet licenses. In September 2008, we announced an exclusive content partnership with World Book, Inc. In 2009, World Book will create thousands of original Chinese-language articles providing information on all branches of knowledge, including arts, sciences, history, technology, mathematics, sports, and recreation, exclusively for HSW International's Beijing-based website, BoWenWang ( http://www.bowenwang.com.cn/ ). At December 31, 2008, we had approximately 4,400 articles.

We are developing our business strategy for DailyStrength with emphasis on expanding its offerings, in addition to integrating the best of DailyStrength’s social media technologies into HSW International’s web publishing platform.  DailyStrength.org offers content authored by medical professionals based on current topics, support groups, a treatment directory with definitions, private messaging, one-on-one chat forums and personal goal trackers, and primarily serves English speaking territories, such as the United States, Canada, Australia and the United Kingdom.  The medical panel of professionals contributes articles and journals providing insight to a number of topics relevant to the DS user group and communities.  DailyStrength and its user group create online communities and support services to help people cope with health, stress and other challenges of modern life – issues that people the world over face daily.

Sale of the INTAC Legacy Businesses (Discontinued Operations) and Related Transactions

Due to an increased focus of our management and resources on our primary Internet publishing business, a change of control in our majority ownership leading to further refinement in our strategies, and an under performance of the INTAC Legacy Businesses after the INTAC Merger, in early 2008, we decided to dispose of the INTAC Legacy Businesses.  The INTAC Legacy Businesses were comprised of two lines of business which were both unrelated to our core Internet platform businesses.


 
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We had originally estimated when deciding to acquire the INTAC Legacy Businesses that, in addition to accelerating our obtaining Internet licenses in China for launching our Internet platform, INTAC would provide us (i) further knowledge of the Chinese markets, relationships, and core competencies to accelerate the growth of our Internet platforms in China, and (ii) additional cash flow from its established businesses.  Following the underperformance of the INTAC Legacy Businesses in the fourth quarter of 2007, that resulted in short-term negative cash flow from these operations of $1.1 million, and a change-in-control of our business through the acquisition of our largest shareholder, HowStuffWorks, by Discovery, we reconsidered the potential risk of excessive short-term consumption of cash and management resources by our acquired non-core INTAC Legacy Businesses and refined our strategic direction.

We decided that it was critical that all our current resources be fully focused on expanding our Brazilian platform and the June 2008 launch of our Chinese Internet platform.  Although we believe we have benefited in the short-term from INTAC’s relationships and knowledge of the Chinese markets in obtaining our Internet licenses, this refined strategic focus did not allow us the time required to realize the expected long-term synergies, embodied in our acquired INTAC goodwill, from INTAC’s knowledge of the Chinese markets, relationships, and core competencies.  In addition, we were provided with and acted on an opportunity to sell the unrelated INTAC Legacy Businesses for approximately their stand-alone appraised value, and through simultaneous sale of the treasury stock received, generate significant additional cash resources for investing into our core Internet businesses.

At December 31, 2007, we recognized a loss of $24.7 million related to the February 29, 2008, INTAC legacy disposition and has been recorded as discontinued operations in the accompanying consolidated financial statements. During the year ended December 31, 2008, we recognized a loss of $133,526, which has been recorded as discontinued operations in the accompanying consolidated financial statements.  All the goodwill resulting from the INTAC acquisition was included in the INTAC Legacy Businesses when we determined the potential write off, because such operations had not been integrated with our online publishing segment prior to our decision to dispose of the INTAC Legacy Businesses.

On February 29, 2008, we completed the sale of the INTAC Legacy Businesses.  The INTAC Legacy Businesses were sold to China Trend Holdings Ltd., a British Virgin Islands corporation that is owned by Mr. Zhou, CEO, director and significant stockholder of INTAC prior to the INTAC Merger in October 2007.  Mr. Zhou was also a member of our board of directors from October 2007 to December 2007.  In accordance with the share purchase agreement with China Trend Holdings, we were to receive 5.0 million of our common shares owned by Mr. Zhou.  In addition, as a condition to the February 29, 2008, INTAC Legacy Businesses disposition, the INTAC Legacy Businesses were to include $4.5 million in cash at closing.

At the February 29, 2008, INTAC Legacy Businesses disposition, we received only 4.5 million shares of our common stock from Mr. Zhou and accordingly, we only funded the INTAC Legacy Businesses with $2.7 million in cash.  Mr. Zhou delivered his additional 0.5 million shares of our common stock to us on March 26, 2008, and on March 31, 2008, we released another $1.6 million in cash to the INTAC Legacy Businesses ($1.8 million for the stock received net of an estimated $0.2 million withheld for disposition expenses).  As of December 31, 2008, all of HSWI’s assets were in our core Internet businesses and the sole asset we retained from the INTAC Merger is the Internet licenses intangible we used to enter the Chinese markets in June 2008.

On February 15, 2008, we entered into a stock purchase agreement where we agreed to sell and two qualified institutional buyers agreed to purchase the 5.0 million shares of our common stock received from the INTAC Legacy Businesses disposition at a purchase price of $3.68 per share.  Simultaneously with the February 29, 2008 disposition, we sold the 4.5 million shares we received to the institutional buyers.  Subsequently on March 26, 2008, we sold the additional 0.5 million shares from Mr. Zhou to the institutional buyers.


 
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Results of Operations – Year Ended December 31, 2008 Compared to Year Ended December 31, 2007

The following table sets forth our results of operations for the years ended December 31, 2008 and 2007.   As discussed in Notes 1, 2, and 3 to the consolidated financial statements included in this Annual Report on Form 10-K, HSWI merged with INTAC International Inc. on October 2, 2007, and the INTAC Legacy Businesses were subsequently disposed on February 29, 2008.  Following the disposition, the sole asset we retained from INTAC is the indefinite-lived Internet Licenses intangible asset and no revenue was realized from this asset in 2008 or 2007.  INTAC’s results of operations have been recorded within discontinued operations for both years presented.

HSW INTERNATIONAL, INC. and SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(expressed in U.S. Dollars)
   
Years Ended December 31,
 
   
2008
   
2007
 
             
Operating revenue
           
Digital online publishing
  $ 234,144     $ 147,535  
Sales to affiliates
    222,862        
Total revenue
    457,006       147,535  
                 
Cost of services
    987,266       1,242,252  
                 
Gross margin
    (530,260 )     (1,094,717 )
                 
Operating expenses
               
Selling, general and administrative (including stock-based
               
compensation expense of $4,787,756 and $7,203,738
               
in 2008 and 2007, respectively)
    15,678,365       13,710,723  
Licenses to operate in China impairment
    7,850,000        
Depreciation and amortization
    223,548       57,748  
Total operating expenses
    23,751,913       13,768,471  
                 
Loss from continuing operations before other income
               
(expense) and income taxes
    (24,282,173 )     (14,863,188 )
                 
Other income (expense)
               
Interest income
    515,238       51,754  
Interest expense
          (39,912 )
Total other income (expense)
    515,238       11,842  
                 
Loss from continuing operations before income taxes
    (23,766,935 )     (14,851,346 )
                 
Deferred income tax benefit
    1,962,500        
                 
Loss from continuing operations
    (21,804,435 )     (14,851,346 )
                 
Loss from discontinued operations, net of income taxes
    (133,526 )     (24,687,959 )
                 
Net loss
  $ (21,937,961 )   $ (39,539,305 )
                 
Basic and diluted weighted average shares outstanding
    52,941,525       11,544,818  
                 
Net loss per basic and diluted shares
  $ (0.41 )   $ (3.42 )


 
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Revenues

Revenue for the years ended December 31, 2008 and 2007 of approximately $405,000 and $148,000, respectively, was generated in Brazil, where we launched our website in March 2007.  For the year ended December 31, 2008, approximately 86% of revenue was generated from paid-for-impression advertising and 14% was generated from pay-per-performance ads.  DailyStrength contributed approximately $52,000 of revenue for the year ended December 31, 2008.  There was no China digital online publishing revenue during 2008 or 2007 as the website in China was launched in June 2008.

Cost of Services

Cost of services includes the ongoing third-party costs to translate, localize and enhance articles from English to Portuguese and Mandarin Chinese, as well as costs incurred to acquire original articles written by third parties.  Portuguese article translation costs totaled $777,000 and $719,000 and Chinese translation costs totaled $194,000 and $523,000 for the years ended December 31, 2008 and 2007, respectively.

Operations – Selling, General and Administrative Expenses

Our total selling, general and administrative   expenses increased by $2.0 million for the year ended December 31, 2008 as compared to 2007.  The increase is primarily attributable to increased costs of establishing our operations related to the Brazil website, and launching the China website, as well as additional costs incurred for compliance and operation as a public company.  The increases over 2007 are primarily comprised of $1.8 million in personnel costs, $2.1 million in professional fees related to operating as a public company, as well as continued investment in our platform and technology and $0.5 million associated with directors and officers insurance costs.  The increase is partially offset by a $2.4 million decrease in stock-based compensation expense for the year ended December 31, 2008 as compared to 2007 (see Note 10 to Notes to the Consolidated Financial Statements included in this Annual Report to Form 10-K).  Stock-based compensation expense is a non-cash item, and in 2008 totaled $4.8 million.  This amount was based primarily on vesting during the year of options at exercise prices ranging from $6.50 per share to $7.10 per share, reflecting our higher stock price in earlier periods when the options were granted.

Impairment Loss

We recorded an impairment charge related to the licenses to operate in China intangible asset in the amount of $7.9 million (see Note 6).

Other Income (Expense)

Other income (expense) increased approximately $503,000 for the year ended December 31, 2008 as compared to 2007.  The increase in interest income reflects an increase in cash on hand resulting from the sale of our stock to certain institutional investors during our first quarter.  The decrease in interest expense is due to full payment on an affiliated party loan during the fourth quarter of 2007.

Deferred Income Tax Benefit

We recorded a $2.0 million tax benefit related to the impairment charge against the licenses to operate in China intangible asset.


 
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Discontinued Operations – INTAC Legacy Businesses

The discussion that follows relates to the INTAC Legacy Businesses results of operations for the years ended December 31, 2008 and 2007.  Revenue was for services related to wireless telephone training and the development and sale of educational software in China.  The $0.5 million loss from discontinued operations in 2008 was reduced by a $0.4 million gain upon final disposition on February 29, 2008.  The $24.7 million loss from discontinued operations in 2007 was primarily due to a goodwill write off of approximately $22.5 million related to the February 29, 2008 disposition of the INTAC Legacy Businesses.

   
Years Ended December 31,
 
   
2008
   
2007
 
             
Revenues
  $ 38,849     $ 198,627  
Loss from discontinued operations (before income taxes)
    (133,526 )     (24,687,959 )
Loss from discontinued operations
  $ (133,526 )   $ (24,687,959 )

As discussed above and more fully in Notes 2 and 3 to the Consolidated Financial Statements included in this Annual Report on Form 10-K, the goodwill write off is the result of the subsequent sale of the INTAC Legacy Businesses on February 29, 2008.

Liquidity and Capital Resources

We expect to expend significant resources in expanding and gaining market share for our Internet platforms in Brazil and China and to develop our healthcare social networking strategy, including up-front expenditures to create or acquire content.  These expenditures will be made in the respective markets based on our success and anticipated market conditions and trends.  We expect that most of these expenditures will be paid or under commitment before we begin to realize significant revenues.  We believe that our current cash balance and expected cash generated from future operations will be sufficient to fund operations for longer than the next twelve months.  If cash on hand and generated from operations is insufficient to satisfy our working capital and capital expenditure requirements, we may be required to sell additional equity or obtain bank financing to fund further development and attain profitability.  There is no assurance that such financing will be available or that we will be able to complete financing on satisfactory terms, if at all.

Cash and cash equivalents was $18.0 million at December 31, 2008, compared to $3.5 million at December 31, 2007.  The increase in cash is primarily attributable to the sale of our stock during the first quarter of 2008.

As of December 31, 2008, our cumulative losses were $74.2 million, which included non-cash expenses of $21.8 million for stock-based compensation, $22.5 million goodwill write-off related to the February 29, 2008 INTAC Legacy Businesses disposition and an impairment charge of $5.9 million, net of tax.  We used a significant amount of the $21.0 million net proceeds from the October 2, 2007, sale of stock to pay transaction costs, to pay off advances from HowStuffWorks, and to fund operations.  As previously disclosed, in the first quarter of 2008, we received an additional $33.4 million before expenses from the sale of our stock.

Cash flows from operations

Our net cash used in continuing operating activities during 2008 increased by $4.3 million compared to the prior year.  The increase was due to increased funding requirements to support our operations in Brazil and China while building and maintaining our technology infrastructure.  Net cash used in discontinued operating activities was $0.5 million and $5.1 million for the years ended December 31, 2008 and 2007.

Cash used in investing activities

During the year ended December 31, 2008, net cash used in investing activities was $8.5 million compared to $0.6 million in 2007.  Cash used in investing activities during the year ended December 31, 2008 reflects $4.5 million of cash used in conjunction with the sale of our INTAC Legacy Businesses, $3.2 million of cash used to acquire DailyStrength, as well as the purchases of property and equipment.


 
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Cash flows from financing activities

For the year ended December 31, 2008, net cash provided by financing activities was approximately $35.2 million versus $16.5 million for 2007.  The significant increase in 2008 is a direct result of the proceeds we received from the sale of our common stock during the first quarter.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States.  We believe that of our significant accounting policies, revenue recognition, stock-based compensation and long-lived assets including goodwill and other intangible assets may involve a higher degree of judgment and complexity.

Revenue Recognition

Online publishing revenue is generally recognized as visitors are exposed to or react to advertisements on our website.  Revenue is generated from advertising in the form of sponsored links and image ads.  This includes both pay-per-performance ads and paid-for-impression advertising.  In the pay-per-performance model, we earn revenue based on the number of clicks associated with such ad; in the paid-for-impression model (sponsorships), revenue is derived from the display of ads.

We recognize revenue when the service has been provided, and the other criteria set forth in Staff Accounting Bulletin (“SAB”) 104, Revenue Recognition , have been met; namely, the fees we charge are fixed or determinable, we and our advertisers understand the specific nature and terms of the agreed-upon transactions and the collectability is reasonably assured.

Stock-Based Compensation

Under the 2006 Equity Incentive Plan adopted April 13, 2006 (the “Plan”), HSWI authorized 8,000,000 shares for grant as part of a long term incentive plan to attract, retain and motivate its eligible executives, employees, officers, directors and consultants.  Options to purchase common stock under the Plan have been granted to our officers and employees with an exercise price equal to the fair market value of the underlying shares on the date of grant.  Additionally in 2008, restricted shares were granted to certain members of our Board of Directors and executives at the fair market value on the grant date.  As of December 31, 2008, no options had been exercised under the Plan.

We account for stock-based compensation in accordance with SFAS 123(R) which requires us to recognize expense related to the fair value of our stock-based compensation awards.

SFAS 123(R) requires the use of a valuation model to calculate the fair value of the stock based awards.  We have elected to use the Black-Scholes options pricing model to determine the fair value of stock options on the dates of grant, consistent with that used for pro forma disclosures under SFAS 123.  We measure stock-based compensation based on the fair values of all stock-based awards on the dates of grant, and recognize stock-based compensation expense using the straight-line method over the vesting periods.  Stock-based compensation expense was $4.8 million and $7.2 million for the years ended December 31, 2008 and 2007, respectively.

Long-Lived Assets Including Goodwill and Other Intangible Assets

We review property and equipment and amortizable intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.  Recoverability of property and equipment is measured by a comparison of the carrying amounts to future net cash flows the assets are expected to generate.  The carrying value of the intangible asset is compared to the fair value in order to determine if an impairment exists.  Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.


 
26

 


In accordance with SFAS 142, Goodwill and Other Intangible Assets , we test goodwill and indefinite lived intangible assets for impairment annually at December 31, or more frequently if events or changes in circumstances indicate that this asset may be impaired.  SFAS 142 also requires that intangible assets with definite lives be amortized over their estimated useful lives and reviewed for impairment whenever events or circumstances indicate an asset’s carrying value may not be recoverable in accordance with SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets .  We amortize our acquired intangible assets with definite lives over three to eleven years.  We recorded an impairment charge of $5.9 million, net of tax, of the licenses to operate in China intangible asset due to the results of the December 31, 2008 impairment analysis.

Recent Accounting Pronouncements

In September 2006, the FASB issued SFAS 157, Fair Value Measurements .  SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles in the United States (“GAAP”), and expands disclosures about fair value measurements.  SFAS 157 emphasizes that fair value is a market-based measurement, not an entity-specific measurement.  Therefore, a fair value measurement would be determined based on the assumptions that market participants would use in pricing the asset or liability.  SFAS 157 is effective for fiscal years beginning after November 15, 2007, except for non-financing assets and liabilities.  The adoption of SFAS 157 did not have a material impact on our consolidated financial statements as the Company had no financial assets other than cash and accounts receivable.

In February 2008, the FASB issued FASB Staff Position (“FSP”) 157-2, Partial Deferral of the Effective Date of SFAS 157 , which delayed the effective date of SFAS 157 for all nonrecurring fair value measurements of nonfinancial assets and nonfinancial liabilities until January 1, 2009.  We are currently evaluating the impact FSP 157-2 will have on our consolidated financial statements.

An associated pronouncement, SFAS 159, The Fair Value Option for Financial Assets and Financial Liabilities , was also effective at the beginning of the Company’s 2008 fiscal year.  The Company has elected not to apply the fair value option to measure any of the financial assets and liabilities on its balance sheet not already valued at fair value under other accounting pronouncements.  These other financial assets and liabilities are primarily accounts receivable and accounts payable, which are reported at historical value.  The fair value of these financial assets and liabilities approximate their fair value because of their short duration.

In December 2007, the FASB issued SFAS 141(R), Business Combinations .  SFAS 141(R) expands the definition of a business combination and requires the fair value of the purchase price of an acquisition, including the issuance of equity securities, to be determined on the acquisition date.  SFAS 141(R) also requires that all assets, liabilities, contingent considerations, and contingencies of an acquired business be recorded at fair value at the acquisition date.  In addition, SFAS 141(R) requires that acquisition costs generally be expensed as incurred, restructuring costs generally be expensed in periods subsequent to the acquisition date, and changes in accounting for deferred tax asset valuation allowances and acquired income tax uncertainties after the measurement period impact income tax expense.  SFAS 141(R) is effective for fiscal years beginning after December 15, 2008 with early adoption prohibited.  We are currently evaluating the impact SFAS 141(R) will have on our consolidated financial statements.
  
In December 2007, the FASB issued SFAS 160, Noncontrolling Interests in Consolidated Financial Statements, an Amendment of ARB 51 .  SFAS 160 changes the accounting and reporting for minority interests such that minority interests will be recharacterized as noncontrolling interests and will be required to be reported as a component of equity, and requires that purchases or sales of equity interests that do not result in a change in control be accounted for as equity transactions and, upon a loss of control, requires the interest sold, as well as any interest retained, to be recorded at fair value with any gain or loss recognized in earnings.  SFAS 160 is effective for fiscal years beginning on or after December 15, 2008 with early adoption prohibited.  We do not expect the implementation of SFAS 160 will have a material impact on our consolidated financial statements.

Off-Balance Sheet Arrangements

None.
 

 
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ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The foreign currency financial statements of our international operations are translated into U.S. dollars at current exchange rates, except revenue and expenses, which are translated at average exchange rates during each reporting period.  Net exchange gains or losses resulting from the translation of assets and liabilities are accumulated in a separate section 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 development the exposure to rate changes is minimal.

Financial instruments that potentially subject us to a concentration of credit risk consist principally of cash and accounts receivables. At December 31, 2008, 99% of our cash was denominated in U.S. dollars.  The remaining 1% was denominated in Brazilian Reais, Chinese Renminbi or Hong Kong Dollars.  All our cash is placed with financial institutions we believe are of high credit quality.  Our cash is maintained in bank deposit accounts, which, at times, may exceed federally insured limits.  We have not experienced any losses in such accounts and do not believe our cash is exposed to any significant credit risk.

We do not use financial instruments to hedge our foreign exchange exposure because the effects of the foreign exchange rate fluctuations are not currently significant.  We do not use financial instruments for trading purposes.  The net assets of our foreign operations at December 31, 2008, were approximately $0.5 million.

We have not entered into long-term agreements or borrowing arrangements with third parties under which any amounts were outstanding during 2008.  Therefore, we do not believe we have any material exposure to market risk changes in interest rates.

We do not use any derivative financial instruments to mitigate any of our currency risks.  We do not currently have any credit facilities and therefore are not subject to interest rate risk.  Due to the nature of our short-term investments and our lack of debt, we have concluded that we face no material market risk exposure.
 
 
 
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ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA



INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

CONSOLIDATED FINANCIAL STATEMENTS

30
31
32
33
34
35

For supplemental quarterly financial information, see Note 13, Quarterly Results of Operations (unaudited), of the Notes to Consolidated Financial Statements.

 
 
29

 
 
 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Shareholders
HSW International, Inc. and subsidiaries:

We have audited the accompanying consolidated balance sheets of HSW International, Inc. (a Delaware corporation) and subsidiaries (“the Company”) as of December 31, 2008 and 2007, and the related consolidated statements of operations, stockholders’ equity and comprehensive income, and cash flows for the years then ended.  Our audits of the basic financial statements included the consolidated financial statement schedule listed in the table of contents appearing under Item 15 Schedule II.  These financial statements and financial statement schedule are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting.  Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting.  Accordingly, we express no such opinion.  An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of HSW International, Inc. and subsidiaries as of December 31, 2008 and 2007, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.  Also in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.


/s/ GRANT THORNTON LLP


Atlanta, Georgia
March 25, 2009
 
 

 
HSW INTERNATIONAL, INC. and SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(expressed in U.S. Dollars)

 
   
December 31,
 
   
2008
   
2007
 
             
Assets
           
             
Current assets
           
Cash and cash equivalents
  $ 18,020,159     $ 3,476,673  
Trade accounts receivable (net of allowance for doubtful accounts
               
of $15,343 and $0 at December 31, 2008 and 2007, respectively)
    103,020       23,212  
Prepaid expenses and other current assets
    1,660,097       942,588  
Assets held for sale
          19,988,029  
Total current assets
    19,783,276       24,430,502  
                 
Property and equipment, net
    727,311       293,182  
Licenses to operate in China
    2,150,000       10,000,000  
Goodwill
    1,972,944        
Intangibles, net
    1,676,122       21,476  
                 
Total assets
  $ 26,309,653     $ 34,745,160  
                 
Liabilities and Stockholders’ Equity
               
                 
Current liabilities
               
Accounts payable
  $ 554,673     $ 537,418  
Accrued expenses and other current liabilities
    322,094       561,247  
Advances from shareholder and affiliate
    83,044       72,927  
Liabilities held for sale
          6,163,131  
Total current liabilities
    959,811       7,334,723  
                 
Deferred tax liability
    873,420       2,500,000  
                 
Commitments and contingencies
               
                 
Stockholders’ equity
               
Preferred stock, $.001 par value, 10,000,000 shares authorized, none issued
           
Common stock, $.001 par value, 200,000,000 shares authorized, 53,638,784 issued and
               
outstanding at December 31, 2008, and 49,306,107 issued and 46,306,107 outstanding
               
at December 31, 2007
    53,639       49,306  
Additional paid-in-capital
    98,606,934       85,980,746  
Accumulated other comprehensive income (loss)
    (1,126 )     112,291  
Retained deficit
    (74,183,025 )     (52,245,064 )
Less: cost of treasury stock, 3,000,000 shares in 2007
          (8,986,842 )
Total stockholders’ equity
    24,476,422       24,910,437  
Total liabilities and stockholders’ equity
  $ 26,309,653     $ 34,745,160  

The accompanying notes are an integral part of these consolidated financial statements.




HSW INTERNATIONAL, INC. and SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(expressed in U.S. Dollars)

   
Years Ended December 31,
 
   
2008
   
2007
 
             
Operating revenue
           
Digital online publishing
  $ 234,144     $ 147,535  
Sales to affiliates
    222,862        
Total revenue
    457,006       147,535  
                 
Cost of services
    987,266       1,242,252  
                 
Gross margin
    (530,260 )     (1,094,717 )
                 
Operating expenses
               
Selling, general and administrative (including stock-based
               
compensation expense of $4,787,756 and $7,203,738
               
in 2008 and 2007, respectively)
    15,678,365       13,710,723  
Impairment loss
    7,850,000        
Depreciation and amortization
    223,548       57,748  
Total operating expenses
    23,751,913       13,768,471  
                 
Loss from continuing operations before other income
               
(expense) and income taxes
    (24,282,173 )     (14,863,188 )
                 
Other income (expense)
               
Interest income
    515,238       51,754  
Interest expense
          (39,912 )
Total other income (expense)
    515,238       11,842  
                 
Loss from continuing operations before income taxes
    (23,766,935 )     (14,851,346 )
                 
Deferred income tax benefit
    1,962,500        
                 
Loss from continuing operations
    (21,804,435 )     (14,851,346 )
                 
Loss from discontinued operations, net of income taxes
    (133,526 )     (24,687,959 )
                 
Net loss
  $ (21,937,961 )   $ (39,539,305 )
                 
Basic and diluted loss per share
               
Loss from continuing operations
  $ (0.41 )   $ (1.29 )
Loss from discontinued operations
          (2.13 )
Net loss per share
  $ (0.41 )   $ (3.42 )
                 
Basic and diluted weighted average shares outstanding
    52,941,525       11,544,818  

The accompanying notes are an integral part of these consolidated financial statements.


 
32

 


HSW INTERNATIONAL, INC. and SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT) AND COMPREHENSIVE INCOME
(expressed in U.S. Dollars)

                                 
Accumulated
         
Total
 
               
Additional
               
Other
         
Stockholders’
 
   
Common Stock
   
Paid-in
   
Treasury
   
Comprehensive
   
Accumulated
   
Equity
 
   
Shares
   
Amount
   
Capital
   
Shares
   
Stock
   
Income (Loss)
   
Deficit
   
(Deficit)
 
                                                 
Balance at December 31, 2006
    10     $     $ 9,810,987           $     $     $ (12,705,759 )   $ (2,894,772 )
                                                                 
Comprehensive loss:
                                                               
Net loss
                                        (39,539,305 )     (39,539,305 )
Foreign currency translation
                                  112,291             112,291  
Total comprehensive loss
                                                            (39,427,014 )
                                                                 
Issuance of shares to
                                                               
HowStuffWorks in exchange
                                                               
for digital publishing rights
    22,940,717       22,941       (22,941 )                              
Issuance of shares due to
                                                               
merger with INTAC
    22,940,727       22,941       38,965,425                               38,988,366  
Issuance of shares to
                                                               
investors, net
    3,424,653       3,424       21,036,695                               21,040,119  
Stock-based compensation
                                                               
expense
                7,203,738                               7,203,738  
Treasury stock
                8,986,842       (3,000,000 )     (8,986,842 )                  
                                                                 
Balance at December 31, 2007
    49,306,107       49,306       85,980,746       (3,000,000 )     (8,986,842 )     112,291       (52,245,064 )     24,910,437  
                                                                 
Comprehensive loss:
                                                               
Net loss
                                        (21,937,961 )     (21,937,961 )
Foreign currency translation
                                  (113,417 )           (113,417 )
Total comprehensive loss
                                                            (22,051,378 )
                                                                 
Shares received from sale of
                                                               
   INTAC Legacy Businesses
                      (5,000,000 )     (18,400,000 )                 (18,400,000 )
  Issuance of shares to
                                                               
investors, net
    4,268,812       4,269       7,838,496       8,000,000       27,386,842                   35,229,607  
Restricted stock grants
    63,865       64       (64 )                              
Stock-based compensation
                                                               
expense
                4,787,756                               4,787,756  
                                                                 
Balance at December 31, 2008
    53,638,784     $ 53,639     $ 98,606,934           $     $ (1,126 )   $ (74,183,025 )   $ 24,476,422  

The accompanying notes are an integral part of these consolidated financial statements.

 

 
HSW INTERNATIONAL, INC. and SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(expressed in U.S. Dollars)

   
Years Ended December 31,
 
   
2008
   
2007
 
             
Cash flows from continuing operating activities:
           
Net loss from continuing operations
  $ (21,804,435 )   $ (14,851,346 )
Adjustments to reconcile net loss from continuing operations to net cash used in
               
continuing operating activities:
               
Impairment loss
    7,850,000        
Stock-based compensation
    4,787,756       7,203,738  
Deferred income taxes
    (1,962,500 )      
Depreciation and amortization
    223,548       57,748  
Provision for doubtful accounts
    15,343        
Changes in operating assets and liabilities from continuing operations:
               
Accounts receivable
    (102,430 )     (23,212 )
Prepaid expenses and other current assets
    (822,302 )     (956,169 )
Accounts payable, accrued expenses, and other liabilities
    37,744       1,119,532  
Net cash used in continuing operating activities
    (11,777,276 )     (7,449,709 )
Cash flows from discontinued operating activities:
               
Net loss from discontinued operations
    (133,526 )     (24,687,959 )
Adjustments to reconcile net loss from discontinued operations to net cash used in
               
discontinued operating activities:
               
Goodwill write off related to disposition
          22,518,382  
Provision for doubtful accounts
          1,210,631  
Depreciation and amortization
    170,475       280,103  
Gain on sale of businesses
    (343,990 )      
Changes in operating assets and liabilities from discontinued operations:
               
Accounts receivable
    31,030       374,694  
Prepaid expenses and other current assets
    (56,419 )     371,712  
Accounts payable, accrued expenses, and other liabilities
    (189,000 )     (5,263,987 )
Payable to affiliates
          86,611  
Net cash used in discontinued operating activities
    (521,430 )     (5,109,813 )
Net cash used in operating activities
    (12,298,706 )     (12,559,522 )
                 
Cash flows from continuing investing activities:
               
Purchases of property and equipment
    (644,546 )     (237,103 )
Sale of INTAC Legacy Businesses
    (4,500,000 )      
Daily Strength, Inc. acquisition, net of cash received of $76,880
    (3,215,074 )      
INTAC merger related costs, net
    (107,027 )     (339,892 )
Cash used in continuing investing activities
    (8,466,647 )     (576,995 )
Cash flows from discontinued investing activities:
               
Purchases of property and equipment
          (25,002 )
Cash used in discontinued investing activities
          (25,002 )
Net cash used in investing activities
    (8,466,647 )     (601,997 )
                 
Cash flows from financing activities:
               
Proceeds from issuance of common stock, net
    35,229,607       21,040,119  
Proceeds of advance from shareholder
          4,460,529  
Repayment of advance from shareholder
          (8,716,013 )
Repayment of affiliated party loan
          (280,320 )
Cash provided by financing activities
    35,229,607       16,504,315  
                 
Net change in cash and cash equivalents
    14,464,254       3,342,796  
Impact of currency translation on cash
    (83,926 )     63,773  
Cash and cash equivalents at beginning of period, including $163,158
               
reclassified to assets held for sale
    3,639,831       233,262  
Cash and cash equivalents at end of period
  $ 18,020,159     $ 3,639,831  

The accompanying notes are an integral part of these consolidated financial statements.

 

 
HSW INTERNATIONAL, INC. and SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(continued)
(expressed in U.S. Dollars)

   
Years Ended December 31,
 
   
2008
   
2007
 
             
Supplemental disclosure of cash flow information
           
Cash paid for taxes
  $     $  
Cash paid for interest
          56,208  
                 
Non-cash business acquisition activities
               
Issuance of equity including $100,000 fair value of options assumed
  $     $ 38,988,366  
Deferred tax liabilities
          4,055,000  
Net liabilities assumed, excluding cash
          3,155,656  
                 
Other non-cash financing and investing activities
               
Receipt of shares for sale of INTAC Legacy Businesses
  $ 18,400,000     $  
Receipt of shares for sale of INTAC distribution companies
          8,986,842  
Issuance of shares for digital publishing rights
          22,941  

The accompanying notes are an integral part of these consolidated financial statements.

 
 
35

 

 
HSW INTERNATIONAL, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements
(expressed in U.S. Dollars)

1.  DESCRIPTION OF ORGANIZATION AND BUSINESS OPERATIONS

HSW International (“HSWI”) is an online publishing company that develops and operates Internet businesses focused on providing consumers in the world’s digital economies with locally relevant, high quality information and ways to connect with each other.  Our international websites published under the HowStuffWorks brand provide readers in China and Brazil with thousands of articles about how the world around them works, serving as destinations for credible, easy-to-understand reference information.  HSW International is the exclusive licensee in China and Brazil for the digital publication of translated content from HowStuffWorks.com, a subsidiary of Discovery Communications, Inc., and in China for the digital publication of translated content from World Book Encyclopedia.  Our DailyStrength brand, which was acquired on November 26, 2008, helps hundreds of thousands of readers share information and support on www.dailystrength.org , a comprehensive health-related social media website.  The acquisition of DailyStrength was completed in part to diversify our business and to publish another product which offers insight on highly relevant topics.  We generate revenue primarily through the sale of online advertising on our websites.  We were incorporated in Delaware in March 2006.  Our headquarters are located at One Capital City Plaza, 3350 Peachtree Road, Suite 1600, Atlanta, Georgia  30326.

In June 2008, we entered China’s online publishing market utilizing a combination of the contributed assets from HowStuffWorks with the benefit of INTAC’s relationships and knowledge of the Chinese markets in obtaining our Internet licenses.  We currently maintain offices in China, Brazil, Los Angeles, California and Atlanta, Georgia, our corporate headquarters.

Prior to the INTAC Merger and related financing transactions, our sole shareholder was HowStuffWorks, a privately-held online publishing company founded in 1999 that provides objective and useful information for people to learn about the world around them and make informed decisions.  On December 17, 2007, HowStuffWorks, our largest shareholder, merged with Discovery Communications, Inc. (“Discovery”) becoming a wholly-owned subsidiary of Discovery.  As of December 31, 2008, Discovery, through its wholly owned subsidiary HowStuffWorks, owned approximately 42.8% of our outstanding common stock.  HowStuffWorks remains based in Atlanta, Georgia.

On October 2, 2007, the date of our merger with INTAC, the following occurred:

·  
HowStuffWorks contributed to us in exchange for shares of our common stock, exclusive digital publishing rights to HowStuffWorks’ content for the countries of China and Brazil which we translate and localize into the predominant languages of China and Brazil.
·  
Our stock became publicly traded on the NASDAQ Global Market under the symbol “HSWI” in connection with our merger with INTAC, with INTAC becoming our wholly owned subsidiary.  We were determined to be the accounting acquirer under the applicable guidance.  At the date of the INTAC Merger, holders of INTAC common stock received one share of our common stock in exchange for each of their shares of INTAC common stock. Prior to the INTAC Merger, INTAC’s common stock was traded on the NASDAQ Capital Market under the symbol “INTN”.
·  
Certain investors purchased or agreed to purchase shares of our common stock (equity financings) having an aggregate value of approximately $39.4 million of which $22.5 million and $16.9 million (both before expenses) were received in October 2007, and January and February 2008, respectively (see Notes 3 and 10).
·  
In connection with and as a condition of the INTAC Merger, INTAC sold its wireless handset and prepaid calling cards distribution business (“distribution companies”), to an entity controlled by Wei Zhou, INTAC’s Chief Executive Officer and President, in exchange for 3.0 million shares of our common stock held by Mr. Zhou.  The 3.0 million shares of our common stock were recorded as treasury shares valued at cost as determined by a third party valuation.

On February 29, 2008, based on an increased focus on our Internet based publishing segment, we disposed of all INTAC’s remaining legacy businesses which included services related to wireless telephone training and the development and sale of educational software in China (“INTAC Legacy Businesses”).  Following the disposition the sole asset we retain from the INTAC acquisition is the Internet Licenses intangible we are using to enter the Chinese market.  The operations from the INTAC Legacy Businesses will be reflected as discontinued operations in our consolidated financial statements in subsequent periods.  All intercompany balances and transactions have been eliminated.


 
36

 


We entered the Brazilian online publishing market in March 2007, by utilizing royalty-free and exclusively licensed digital content provided by HowStuffWorks.  At December 31, 2008, we had approximately 5,500 articles that were either (i) articles from the HowStuffWorks content database translated from English to Portuguese, or (ii) originally created content.  The web site address is ( http://hsw.com.br/ ).  We are in the early development of our business strategy in Brazil as we continue to expand by (i) adding original proprietary digital content designed to meet the information needs of the Brazilian online community, (ii) expanding the amount of translated content from HowStuffWorks, and (iii) refining local marketing strategies.

In June 2008, we entered China’s online publishing market utilizing a combination of the contributed assets from HowStuffWorks with the benefit of INTAC’s relationships and knowledge of the Chinese markets in obtaining our Internet licenses. In September 2008, we announced an exclusive content partnership with World Book, Inc.  In 2009, World Book will create thousands of original Chinese-language articles providing information on all branches of knowledge, including arts, sciences, history, technology, mathematics, sports, and recreation, exclusively for HSW International's Beijing-based website, BoWenWang ( http://www.bowenwang.com.cn/ ). At December 31, 2008, we had published approximately 4,400 articles.

In November 2008, we acquired Daily Strength, Inc. (“DS”), publisher of the health social networking website DailyStrength (http://www.dailystrength.org).  DailyStrength was founded in 2006 by internet veterans with more than 20 years of experience conceiving, building, and running communities on the web, including Yahoo Mail, Yahoo Message Boards, Yahoo Groups, GeoCities, Facebook and more. DailyStrength hosts more than 500 communities focused on issues such as weight loss, divorce, parenting and illnesses. Users of the site both read and interact with high-quality, accurate reference information. The site features health journals, discussion forums, virtual hugs, member-created groups, and treatment reviews plus unique content provided on a daily basis by physicians and other health professionals.


2.  ACQUISITION OF INTAC INTERNATIONAL, INC.

On October 2, 2007, the INTAC Merger became effective with INTAC becoming our wholly owned subsidiary.  The results of the INTAC Legacy Businesses have been included in discontinued operations in our consolidated financial statements since that date until their disposition on February 29, 2008 (see Note 3).  At the date of the INTAC Merger, holders of INTAC common stock received one share of our common stock in exchange for each of their shares of INTAC common stock. 

INTAC was acquired to assist in our primary business focus, the development of our digital content database exclusively licensed from HowStuffWorks by (i) accelerating our obtaining Internet licenses in China for launching our Internet platform, (ii) obtaining INTAC’s knowledge of the Chinese markets, relationships, and core competencies and (iii) providing additional cash flow from its established businesses.

In the INTAC acquisition we also obtained two legacy businesses - services related to wireless telephone training and the development and sale of educational software delivered to customers in China. However, due to (i) an increased focus of our management and resources on our primary Internet publishing business, (ii) a change of control in our majority ownership leading to further refinement in our strategies, and (iii) an under performance of the INTAC Legacy Businesses subsequent to the INTAC Merger, we sold these legacy businesses on February 29, 2008 (see Note 3).  Following the disposition, the sole asset we retained from the INTAC acquisition is the Internet Licenses intangible we used to enter the China market in June 2008.

The purchase price at October 2, 2007 consisted of the following (dollars in thousands):
 
Exchange of 19,940,727 HSWI common shares for all INTAC shares
     
outstanding including $100 of fair value for options assumed
  $ 38,988  
Direct acquisition costs
    1,774  
Other
    47  
      40,809  
Net liabilities assumed
    3,037  
Deferred tax liabilities
    4,055  
Total purchase price
  $ 47,901  

For convenience, we designated October 1, 2007, as the effective date for this acquisition.


 
37

 


We noted that SFAS 141, “Business Combinations” states that “the fair value of securities traded in the market is generally more clearly evident than the fair value of the acquired entity” and “that the quoted market price of a security issued to effect a business combination generally should be used to estimate the fair value of an acquired entity after recognizing possible effects of price fluctuations, quantities traded, issues costs and the like.”  However, HSWI as the acquirer was not publicly traded until after the merger with INTAC.  In addition we considered the unique facts and circumstances in the INTAC Merger, including HSWI’s limited historical operations; the transaction being a merger of equals; and lastly, using INTAC’s public stock price, and determined INTAC’s public stock price was also not a fair value of the equity security because, among other reasons, (i) the public stock price was affected by historical performance of the INTAC distribution business which was sold simultaneously with the Merger, (ii) the INTAC stock was thinly traded and (iii) a majority of the stock was held by insiders.  As a result, we obtained an independent valuation, (using recognized valuation techniques) of our enterprise value post-merger to determine the fair value of our common stock issued for the INTAC common shares.

The deferred tax liabilities approximating $4.1 million relate to the non-deductibility (for tax purposes) of the acquired intangibles in China.

As part of the acquisition, we assumed 500,000 INTAC outstanding stock options.  The per share fair value of our stock options issued in exchange for all of INTAC’s outstanding options was estimated using the Black-Scholes options pricing model (see Note 10).  All of the options assumed were either already fully vested at the time of the merger or vested in full as a result of the INTAC Merger.  Therefore, the fair value of the assumed options, $100,000, is treated as part of the purchase price.

The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition (dollars in thousands).

  $ 118  
Trade accounts receivable
    4,584  
Other current assets
    1,683  
Property and equipment
    298  
Other assets
    90  
Licenses to operate in China (indefinite life)
    10,000  
Vendor endorsement in China (indefinite life)
    4,400  
Acquired database (5 year life)
    1,335  
Acquired software (5 year life)
    1,500  
Coursework books (4 year life)
    1,035  
Franchise agreements (4 year life)
    680  
Goodwill
    28,951  
Assets acquired
    54,674  
Accounts payable and other liabilities
    (9,810 )
Deferred tax liabilities
    (4,055 )
Net assets acquired
  $ 40,809  

The purchase price allocation is based on estimates of the fair value of the tangible and intangible assets acquired and liabilities assumed. These estimates were arrived at utilizing recognized valuation techniques with the assistance of an independent valuation firm. Goodwill of approximately $29.0 million resulted primarily from our expectation that we could utilize INTAC’s knowledge of the Chinese markets, relationships, and core competencies to accelerate the growth of our Internet platform in China. However as discussed in Note 3, subsequent to December 31, 2007, we decided to dispose of the entire INTAC Legacy Businesses prior to our integrating INTAC with our online publishing segment. Accordingly all goodwill at December 31, 2007, along with all other intangibles and net assets acquired except for the Internet Licenses intangible was allocated to the INTAC Legacy Businesses in our determination of the appropriate carrying values of our acquired INTAC assets, considering our expected loss on disposition (see Note 3).  Goodwill is not expected to be deductible for tax purposes in the China.

The intangible assets, other than the indefinite lived goodwill, Internet licenses, and the vendor endorsement, are being amortized over their useful lives of 4.0 to 5.0 years with a weighted-average amortization period of 4.62 years. We recorded no in-process research and development related to this acquisition.

Following the February 2008 disposition, the sole assets we retained from the INTAC Legacy Businesses were the Internet Licenses intangible asset that has an indefinite life and is not amortized and from which no revenue has been generated from the date of acquisition to December 31, 2008.  Therefore, any pro forma information assuming the acquisition of this remaining asset as of the beginning of the respective periods would provide no additional useful information.

 
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In connection with and as a condition of the INTAC Merger, INTAC sold its distribution companies to an entity controlled by Mr. Zhou, in exchange for 3.0 million shares of our common stock held by Mr. Zhou.  The 3.0 million shares of our common stock were recorded as treasury shares valued at cost as determined by a third party valuation for similar reasons that an independent valuation was performed to value the INTAC Merger, as discussed above.


3.  DISCONTINUED OPERATIONS – INTAC LEGACY BUSINESSES

Due to an increased focus of our management and resources on our primary Internet publishing business , a change of control in our majority ownership leading to further refinement in our strategies, and an under performance of the INTAC Legacy Businesses after the INTAC Merger, in early 2008, we decided to dispose of the INTAC Legacy Businesses.  The INTAC Legacy Businesses were comprised of two lines of business which were both unrelated to our core Internet platform businesses.

We had originally estimated when deciding to acquire the INTAC Legacy Businesses that, in addition to accelerating our obtaining Internet licenses in China for launching our Internet platform, INTAC would provide us (i) further knowledge of the Chinese markets, relationships, and core competencies to accelerate the growth of our Internet platforms in China and (ii) additional cash flow from its established businesses.  Following the underperformance of the INTAC Legacy Businesses in the fourth quarter of 2007, that resulted in short-term negative cash flow from these operations of $1.1 million, and a change-in-control of our business through the acquisition of our largest shareholder, HowStuffWorks, by Discovery, we reconsidered the potential risk of excessive short-term consumption of cash and management resources by our acquired non-core INTAC Legacy Businesses and refined our strategic direction.

We decided that it was critical that all our current resources be fully focused on expanding our Brazilian platform and the June 2008 launch of our Chinese Internet platform.  Although we believe we have benefited in the short-term from INTAC’s relationships and knowledge of the Chinese markets in obtaining our Internet licenses, this refined strategic focus did not allow us the time required to realize the expected long-term synergies, embodied in our acquired INTAC goodwill, from INTAC’s knowledge of the Chinese markets, relationships, and core competencies.  In addition, we were provided with and acted on an opportunity to sell the unrelated INTAC Legacy Businesses for approximately their stand-alone appraised value, and through simultaneous sale of the treasury stock received, generate significant additional cash resources for investing into our core Internet businesses.

On February 15, 2008, we entered into a share purchase agreement to sell the INTAC Legacy Businesses.  On February 29, 2008, we completed the sale of the subsidiaries that comprised the INTAC Legacy Businesses.  These subsidiaries were sold to China Trend Holdings Ltd., a British Virgin Islands corporation that is owned by Mr. Zhou, CEO, director and significant stockholder of INTAC prior to the INTAC Merger in October 2007.  Mr. Zhou was also on our board of directors from October 2007 to December 2007.  In accordance with the Share Purchase Agreement with China Trend Holdings, we were to receive 5.0 million of our common shares owned by Mr. Zhou.  In addition, as a condition to the February 29, 2008, INTAC Legacy Businesses disposition, the INTAC Legacy Businesses were to include $4.5 million in cash at closing.

At the February 29, 2008, INTAC Legacy Businesses disposition, we received only 4.5 million shares of our common stock from Mr. Zhou and accordingly, we only funded the INTAC Legacy Businesses with $2.7 million in cash.  Mr. Zhou delivered his additional 0.5 million shares of our common stock to us on March 26, 2008, and on March 31, 2008, we released another $1.6 million in cash to the INTAC Legacy Businesses ($1.8 million for the stock received net of an estimated $0.2 million withheld for disposition expenses).  As of December 31, 2008, all of HSWI’s assets were in our core Internet businesses and the sole asset we retained from the INTAC Merger is the Internet Licenses intangible we used to enter the Chinese markets in June 2008.

In the year ended December 31, 2007, we recognized a preliminary goodwill write off of approximately $22.5 million related to the February 29, 2008, INTAC Legacy Businesses disposition.  All goodwill resulting from the INTAC acquisition was included with the INTAC Legacy Businesses when we determined the potential write off, because such operations had not been integrated with our online publishing segment prior to our decision to dispose of the INTAC Legacy Businesses. The goodwill write off due to disposition resulted from the fair value of the expected net proceeds of 5.0 million shares of our common stock valued at $3.68 per share (less estimated disposal costs) being less than the combined cash to be transferred in the disposition plus the carrying value of the net assets and intangibles sold in the disposition. The disposition proceeds of 5.0 million shares of our common stock, 4.5 million at closing with an additional 0.5 million shares delivered to us on March 26, 2008, were recorded to treasury stock at $3.68 per share based on a Stock Purchase Agreement entered into on February 15, 2008 where we agreed to sell and two qualified institutional buyers agreed to purchase 5.0 million shares of our common stock at a purchase price of $3.68 per share.
 
 
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As a result of this disposition, the operations of the INTAC Legacy Businesses have been segregated and reported as discontinued operations for all the periods presented in our consolidated statements of operations.  The results of discontinued operations for the years ended December 31, 2008 and 2007 are as follows:

   
Years Ended December 31,
 
   
2008
   
2007
 
             
Revenues
  $ 38,849     $ 198,627  
Loss from discontinued operations (before income taxes)
    (133,526 )     (24,687,959 )
Loss from discontinued operations
  $ (133,526 )   $ (24,687,959 )

The following table presents (i) the INTAC Legacy Businesses’ carrying value of the assets and liabilities disposed on February 29, 2008, and (ii) the carrying value of the assets and liabilities at December 31, 2007 that have been reclassified as “held for resale” for the consolidated balance sheet at December 31, 2007:

   
At Date of Disposition
       
   
February 29, 2008
   
December 31, 2007
 
             
Cash and cash equivalents
  $     $ 164  
Trade accounts and other receivables
    2,967       2,998  
Prepaid expenses and other
    1,451       1,401  
Property and equipment
    270       291  
Intangible assets
    8,627       8,701  
Goodwill
    6,540       6,433  
Total assets disposed
    19,855       19,988  
Accrued liabilities and other
    4,909       4,633  
Deferred tax liabilities
    1,514       1,530  
Total liabilities disposed
    6,423       6,163  
Net assets disposed before cash transferred to disposed subsidiaries
    13,432       13,825  
Cash to be transferred to disposed subsidiaries
    4,500       4,500  
Net assets disposed
  $ 17,932     $ 18,325  

The estimated goodwill write off due to disposition, based on the expected fair value resulting from disposition was preliminary at December 31, 2007.  Upon final disposition on February 29, 2008 proceeds received of $18.4 million of our common stock (including 500,000 shares received in March 2008) exceeded the net assets carrying value of $17.9 million by $0.5 million partially offset by our estimated disposition costs accrual of $0.1 million, resulting in a net recovery on disposition of $0.4 million in the quarter ended March 31, 2008.  The recovery primarily resulted from our operation of the disposed subsidiaries at a $0.5 million loss through the disposition date resulting in the carrying value of net assets and liabilities decreasing from normal activities such as depreciation and amortization, disbursements and cash receipts on accounts receivable. We recorded this net recovery of $0.4 million on disposition in the Loss from Discontinued Operations that partially offset the discontinued operations operating loss of $0.5 million.

 
 
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4.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The consolidated financial statements from continuing operations include the accounts of (1) HSWI, (2) our subsidiary HSW Brasil - Tecnologia e Informação Ltda. (“HSW Brazil”), (3) HSW (HK) Inc. Limited, (4) Bonet (Beijing) Technology Limited Liability Company, (5) BoWenWang Technology (Beijing) Limited Liability Company, and (6) Daily Strength, Inc.  The equity of certain of these entities is partially or fully held by citizens of the country of incorporation to comply with local laws and regulations.  The operations of the INTAC Legacy Businesses since October 2, 2007, the date of the INTAC Merger, through February 29, 2008, the date of INTAC Legacy Businesses disposition are reflected as discontinued operations, and the assets and liabilities for the year ended December 31, 2007, have been reclassified as “held for sale”.

All intercompany balances and transactions have been eliminated in consolidation.  During the periods reported, our revenue was derived primarily from advertising revenue from our Internet website in Brazil.  Net losses from HSW Brazil and China for the years ended December 31, 2008, and 2007, were $3.3 million and $3.7 million, respectively. 

Revenue Recognition Policies

Online Publishing Revenue

Online publishing revenue is generally recognized as visitors are exposed to or react to advertisements on our website. Revenue is generated from advertising in the form of sponsored links and image ads. This includes both pay-per-performance ads and paid-for-impression advertising. In the pay-per-performance model, we earn revenue based on the number of clicks associated with such ads; in the paid-for-impression model (sponsorships), revenue is derived from the display of ads.

We recognize these revenues when the service have been provided, and the other criteria set forth in Staff Accounting Bulletin (“SAB”) 104, Revenue Recognition, have been met; namely, the fees we charge are fixed or determinable, we and our  advertisers understand the specific nature and terms of the agreed-upon transactions and collectability is reasonably assured.

Cost of Revenues

Online Publishing

The online publishing cost of revenue represents the cost of translating and localizing content and acquiring original articles written by third parties.

Liquidity

Due to the start up nature of the online publishing segment of HSWI, revenue recorded for the years ended December 31, 2008 and 2007, were approximately $457,000 and $148,000, respectively.

As of December 31, 2008, our cumulative losses were $74.2 million which included non cash expenses of $21.8 million for stock-based compensation, $22.5 million goodwill write-off related to the February 29, 2008 INTAC Legacy Businesses disposition and an impairment charge of $5.9 million, net of tax.  We used a significant amount of the $21.0 million net proceeds from the October 2, 2007, sale of stock in the equity financing to pay transaction costs, to pay off advances from HowStuffWorks, and to fund operations.  In the first quarter of 2008, we received an additional $33.4 million from the sale of our stock.  We believe the proceeds from the sale of our stock in our first quarter of 2008 will provide us sufficient working capital to establish our operations in Brazil, China and the US and provide sufficient working capital for at least the next twelve months.


 
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Concentration of Credit Risk and Accounts Receivable
 
Financial instruments that potentially subject us to a concentration of credit risk consist principally of cash and accounts receivables.  At December 31, 2008, 99% of our cash was denominated in U.S. dollars, and 1% represented cash denominated in Brazilian Reais, Chinese Renminbi or Hong Kong dollars.  All our cash is placed with financial institutions we believe are of high credit quality.  Our cash is maintained in bank deposit accounts, which, at times, may exceed federally insured limits.  We have not experienced any losses in such accounts and do not believe our cash is exposed to any significant credit risk.

We believe we are not exposed to a significant concentration of credit or accounts receivable risk.  However, cash is subject to foreign currency fluctuations against the U.S. dollar.  Our risk in foreign currency is somewhat mitigated at this time as U.S. funds are transferred monthly to Brazil and China to fund that month’s operating activity.  If however the U.S. dollar is devalued significantly against the Brazilian Reais or the Chinese Renminbi, the cost to further develop our websites in Brazil and China could exceed our original estimates.

We regularly evaluate the collectability of trade receivable balances based on a combination of factors such as customer credit-worthiness, past transaction history with the customer, current economic industry trends and changes in customer payment patterns.  If we determine that a customer will be unable to fully meet its financial obligation, such as in the case of a bankruptcy filing or other material events impacting its business, we record a specific reserve for bad debt to reduce the related receivable to the amount expected to be recovered.

Cash and Cash Equivalents

We consider all highly liquid investments with original maturities of three months or less to be cash equivalents.  We maintain our cash in financial institutions we believe are of high credit quality and do not believe any undue risk is associated with our cash balances.  A large portion of the cash balance is maintained at one financial institution.

Use of Estimates

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires us 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, we evaluate our estimates, including those related to accounts receivable, intangible assets and goodwill, useful lives of intangible assets, property and equipment, and income taxes, among other things.

Reclassifications

Certain reclassifications have been made to prior year financial information to conform to the current year presentation.

Income Taxes

We recognize income taxes under the asset and liability method.  Deferred income tax assets and liabilities are computed for differences between the financial statement and tax basis of assets and liabilities that will 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.

Effective January 1, 2007, we adopted the provisions of Financial Accounts Standards Board (“FASB”) Interpretation (“FIN”) 48, Accounting for Uncertainty in Income Taxes .  FIN 48 clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with Statement of Financial Accounting Standard (“SFAS”) 109, Accounting for Income Taxes .  FIN 48 requires a company to determine whether it is more-likely-than-not that a tax position will be sustained upon examination based upon the technical merits of the position. If the more-likely-than-not threshold is met, a company must measure the tax position to determine the amount to recognize in the financial statements.

In May 2007, the FASB issued FASB Staff Position (“FSP”) FIN 48-1, Definition of Settlement in FASB Interpretation 48 .  FSP FIN 48-1 amends FIN 48, to provide guidance on how an enterprise should determine whether a tax position is effectively settled for the purposes of recognizing previously unrecognized tax benefits.  We are required to apply the guidance provided in FSP FIN 48-1, the application of which has not had a material effect on our financial position, results of operations, or cash flows.

 
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The application of income tax law is inherently complex.  Laws and regulation in this area are voluminous and are often ambiguous. As such, we are required to make many subjective assumptions and judgments regarding our income tax exposures.  Interpretations of, and guidance surrounding income tax laws and regulations change over time.  As such, changes in our subjective assumptions and judgments can materially affect amounts recognized in the balance sheets and statements of operations.

We intend to classify 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, 2008 and 2007, we had no accrued interest or penalties related to uncertain tax positions.  The tax years 2007, 2006 and 2005 are not or have not been under examination but remain open to examination under IRS statute.

The INTAC Merger and the stock transactions in October 2007, more fully discussed in notes 1, 2, 3 and 10 created an ownership change that may limit our ability to utilize its net operating loss carry forward.

Stock Based Compensation

We account for stock based compensation in accordance with SFAS 123(R), Share-Based Payment , which requires us to recognize expense related to the fair value of our stock-based compensation awards.

SFAS 123(R) requires the use of a valuation model to calculate the fair value of the stock based awards.  We have elected to use the Black-Scholes options pricing model to determine the fair value of stock options on the dates of grant, consistent with that used for pro forma disclosures under SFAS 123, Accounting for Stock-Based Compensation .  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.

Foreign Currency

The functional currency of our international subsidiaries is the local currency, Reais in Brazil, Renminbi in China or Hong Kong dollars.  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.  Both currency translation and transaction losses during 2008 and 2007 were not material to our consolidated financial statements.
 
Capitalized Transaction Costs
 
The Company complies with SFAS 141, “Business Combinations,” which requires all internal costs associated with a merger to be expensed as incurred.  SFAS 141 also requires companies to capitalize and include in the purchase accounting all incremental costs to outside consultants and other professionals directly associated with the merger.  Accordingly, the Company included $1.7 million of vendor costs, principally legal costs, directly associated with the INTAC Merger, in the INTAC Merger purchase price. (See Note 2).
 
The Company also complies with the requirements of the SEC Staff Accounting Bulletin (SAB) Topic 5A — “Expenses of Offering”.  In 2007, we incurred $1.5 million of costs related to the equity financing closed in 2007.  These costs were netted against the proceeds from the transaction and included in additional paid in capital.

Purchase Price Allocations

From time to time, we enter into material business combinations.  In accordance to SFAS 141, Business Combinations, the purchase price is allocated to the various assets acquired and liabilities assumed at their estimated fair value.  Fair values of assets acquired and liabilities assumed are based upon available information and may involve us engaging an independent third party to perform an appraisal of certain tangible and intangible assets.  Estimating fair values can be complex and subject to significant business judgment and most commonly impacts property, plant and equipment and intangible assets, including those with indefinite lives.  Generally, we have, if necessary, up to one year from the date of acquisition to obtain all of the information that we have arranged to obtain and that is known to be obtainable to finalize the purchase price allocation.  Until such time, the purchase price allocation may remain subject to change based on final valuations of assets acquired and liabilities assumed and may be subject to material revision.
 
 
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Property and Equipment

Property and equipment is stated at cost less accumulated depreciation.  Depreciation, recorded within operating expenses in the consolidated statements of operations, is computed 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.  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.

Legal and Auditing Fees

Legal and auditing fees are expensed in the period incurred.

Advertising Expenses

We expense advertising costs in the year in which they are incurred.  Advertising expense for each of the years ended December 31, 2008 and 2007 was $0.2 million.

Commitments and Contingencies

Liabilities for loss contingencies arising from claims, assessments and litigation and other sources are recorded 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, after consultation with legal counsel, there are no claims, assessments and litigation against the Company.

Long-Lived Assets Including Goodwill and Other Intangible Assets

We review property and equipment and amortizable intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.  Recoverability of property and equipment is measured by a comparison of the carrying amounts to future net cash flows the assets are expected to generate.  The carrying value of the intangible asset is compared to the fair value in order to determine if an impairment exists.  Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.

In accordance with SFAS 142, Goodwill and Other Intangible Assets , we test goodwill and indefinite lived intangible assets for impairment annually at December 31, or more frequently if events or changes in circumstances indicate that this asset may be impaired.  SFAS 142 also requires that intangible assets with definite lives be amortized over their estimated useful lives and reviewed for impairment whenever events or circumstances indicate an asset’s carrying value may not be recoverable in accordance with SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets .  We amortize our acquired intangible assets with definite lives over three to eleven years.  We recorded an impairment charge of $5.9 million, net of tax, of the licenses to operate in China intangible asset due to the results of the December 31, 2008 impairment analysis.

Taxes Collected from Customers

Taxes collected from customers and remitted to governmental authorities are presented on a net basis in cost of sales in the accompanying Consolidated Statements of Operations.

Net Loss per Share

We compute net loss per share in accordance with SFAS 129, Earnings per Share , which requires dual presentation of basic and dilu