We monitor and analyze our financial results on a segment basis for reporting and management purposes, as presented in Note 64 to the accompanying condensed consolidated financial statements. Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessingassess performance.
Cost of services includes the ongoing third-party costs to acquire original content, translate and localize content for our Brands segment from English to Portuguese and Chinese, as well as costs incurred to support our web platform services businessContent and Platform Services segment including labor, content and third party platform support services. These costs were $0.77 millionAs we did not generate revenues from the Content and $1.70 millionPlatform Services segment, we did not have any cost of sales charges during the first quarter of 2012. Cost of services for the three months ended September 30,March 31, 2011 and 2010, respectively, and $2.67 million and $3.96 million for the nine months ended September 30, 2011 and September 30, 2010, respectively. Our cost of services decreased by $0.93 million and $1.29 million in the three and nine months ended September 30, 2011 as compared to the three and nine months ended September 30, 2010, respectively, as newer projects under the web platform segment had higher profit margins than projects in the prior periods.was $1.1 million.
We account for our investment in Sharecare under the equity method of accounting. During the three months and nine months ended September 30, 2011,March 31, 2012, we recognizedrecorded a gain of $2.2 million as a result of the change in interest ownership in Sharecare. Additionally, we recorded a loss of $0.9 million which represents our share in Sharecare’s loss in the equity investment of $0.74 million and $1.22 million, net of taxes, respectively. Sharecare’s website was launched in the fourthfirst quarter of 2010 and has experienced meaningful traffic growth on2012. For the website due to its quality content, media partnerships and array of experts answering the questions of health and wellness. The early losses reflected herein represent infrastructure and marketing investments to build the newly launched website and position itthree months ended March 31, 2011, our loss in the market place for future growth.Sharecare was 0.4 million. We continually evaluate the facts and circumstances related to our investment in Sharecare to assess the need for change in our accounting method in future periods.
Recent accounting pronouncements are summarized in Note 2 to the accompanying notes to the condensed consolidated financial statements.
Cash flows from investing activities
During the ninethree months ended September 30, 2011,March 31, 2012, our net cash used in investing activities was approximately $0.32$0.3 million compared to $0.11$0.2 million infor the same period in 2011. The cash used in investing activities in the first quarter of 2010. The increase2012 was duerelated to costs of website development activities. For the first quarter of 2011, the cash used in investing activities was related to the use of tenant improvement allowances specifically forrelated to the acquisition of $0.23 million of office assets and leasehold improvements in 2011 in addition to a restricted cash balance of $0.10 million received as a deposit in advance of the closelease of our ongoing capital funding activities.corporate headquarters.
Cash flows from financing activities
For the ninethree months ended September 30, 2011,March 31, 2012, the net cash provided by financing activities was $0.08 million which consists of escrowed receiptsthe cash proceeds of $4.25 million provided through the equity financing transaction completed in connection with our ongoing capital raise efforts of $0.10 millionFebruary 2012 partially offset by debtpayments of stock issuance costs of $0.02 million$0.4 million. For the three months ended March 31, 2011, net cash used in financing activities was $20,000 for debt issuance costs related to our revolving credit agreement. For the nine months ended September 30, 2010, there was no net cash provided by or used in financing activities.
Non - CashNon-cash financing and investing activities
For the ninethree months ended September 30,March 31, 2012, the Company issued warrants to the placement agent as part of the stock issuance costs associated with the issuance of capital for cash completed in February 2012. The fair value of these warrants was $0.1 million at the date of issuance and was reported under non-cash investing and financing activities in the statement of cash flows. For the three months ended March 31, 2011, there was approximately $0.13 million in non-cash financing activities related to the warrants issued in conjunction with the revolving credit agreement.
Liquidity Considerationsagreement entered into in March 2011 and Critical Need For Capitalexpired in March 2012.
On February 27, 2012, the Company entered into definitive equity financing agreements with accredited and institutional investors to raise funds in the amount of $4.25 million through a private placement. In connection with our strategic and spending plan, we consistently monitor our cash positionthe transaction, the Company issued to make adjustments as we believe necessaryinvestors common stock priced at $4.50 per share. Investors also received warrants to maintain our objectivesacquire shares of funding ongoing operations and continue to make technological investments to fulfill our customer needscommon stock at an exercise price of $6.81 per share, in the web platform services segment. . Our management and directors continue to evaluate the progress and likelihood of success in each of our markets, our ability to raise additional capital, and the relative value of our resources and other opportunities. We implemented cost saving measures in our Brazil operations in February 2011, and in our China operations in September 2011 to bring costs in line with expected revenues while searching for strategic media partners in both countries and consideration of other strategic alternatives. Our short and long-term plans require additional capital to support the development of our business initiatives utilizing our next generation platform. We are evaluating and pursuing various methods to raise this capital, which may include a public or private debt or equity financing, strategic relationships or other arrangements, or the sale of non-strategic assets.
We are seeking to raise capital through private placement transactions to by selling newly issued securities of the Company. If our efforts are successful, proceeds will be used to fund our operations and the development of new business opportunities. There is no certainty that we will be successful at raising capital, nor is there certainty around the amount of funds25% of the number of shares of common stock that may be raised. In addition, the successinvestors purchased. On February 29, 2012, the Company received $4.25 million in cash and issued to the investors a total of our efforts944,777 shares of common stock and warrants to acquire an additional 236,194 shares of common stock. The warrants have a term of five years and six months and are not exercisable during the first six months after issuance. We determined the fair value of the warrants at $4.87 per share using the Black-Scholes method. Because the common shares were issued in conjunction with the warrants in exchange for the proceeds received, and both securities were classified as equity, we were required to allocate the proceeds between the common shares and the warrants based on their relative fair values. As a result, we allocated $0.67 million to the value of the warrants and $3.58 million to the value of the common shares. The Company also paid a placement agent fee of 7% of the proceeds of the offering or approximately $0.3 million, and issued a three-year warrant to the placement agent to purchase up to an aggregate of 35,429 shares of Common Stock at an exercise price of $7.46 per share. The warrants were valued using the Black-Scholes method at $3.77 per share and classified as equity. The stock issuance costs which amounted $0.4 million along with the value of the warrants issued to the placement agent of $0.13 million were charged to additional paid in capital.
As of March 31, 2012, the Company’s total cash and cash equivalents balance was approximately $4.2 million. The Company believes that its cash balance will be subjectsufficient to performancemeet its cash requirements for at least the next twelve months. The Company has incurred net losses in the three months ended March 31, 2012 and in each fiscal year since its inception and has an accumulated deficit of the markets and investor sentiment regarding the macro and micro economic conditions under which we operate including stock market volatility. Based upon our present cash resources and cash flow projections, we believe that our current liquidity level will provide sufficient funds to enable us to operate our businesses through the first quarter$99 million as of March 31, 2012. However,The Company had minimal revenues in order to ensure our financial viability beyond the first quarter of 2012 we believe that we must raise additional capital and successfully implement a strategic business plan focused on expanding our web platform services business segment while continuingas it continues to reduce our costs and operating losses currently incurred by our digital online publishing business segment. To address our liquidity needs, we are considering options that may include the sale or other strategic alternatives for certain businesses or components of businesses, including the sale of certain technologies or other long-term assets, and further reduction of operating costs through realigning of our business. The amount of capital required to be raised by the Company will be dependent upon our performance in executing our current and future business plans, as measured principally by the time period needed to begin generating positive consolidated cash flows. We currently have access to a line of credit that can be used to meet our short-term liquidity needs. The line of credit expires in March 2012 and is subject to renewal by the lender, at its sole discretion, for one additional year. There can be no assurance that we will be able to raise additional capital, renew our line of credit, generate more revenues, implement cost savings measures or obtain short-term financing from other sources in the future. In addition, any financing that could be obtained would dilute existing shareholders. If we are unable to raise additional capital, we may decide to reallocate our resources or suspend our activities in one or more of our markets in order to focus our limited resources in other opportunities. The aforementioned uncertainties regarding the liquidity indicate that there is a substantial doubt that we will be able to continue as a going concern.
Our current web platform services agreement with Sharecare, our largest customer, which accounted for approximately 74% of revenues during the nine months ended September 30, 2011, expires in December 2011. Given that we do not expect that the Company and Sharecare will extend the term or enter into a new services agreement, there can be no assurance that the revenues generated from service agreements will be sufficient to cover our future liquidity needs. We currently do not have any material commitments for capital expenditures. As discussed above, we continue to explore various business initiatives that could generate additional sources of revenuepursue development and growth to replace revenues from Sharecare, which is not expected to recurfor its new portfolio of websites in 2012. To the extent we are unable to redeploy our resources related to the Sharecare agreement against new revenue generating opportunities, we may decide to suspend or reduce these resources and the related costs as part of our cash management strategy.
On March 4, 2011, we entered into a senior revolving credit agreement with Theorem Capital, LLC (the "Lender"“Lender”) pursuant to which the Lender agreedextended to extend HSWIus a line of credit of up to $1.0 million which expiresexpiring on March 3, 2012, subject to renewal by the Lender, at its sole discretion, for an additional one-year period. UnderThe Lender received a warrant to purchase 65,359 shares of our common stock with an exercise price of $3.06 per share in connection with entering into the termscredit agreement. We recorded the fair value of the credit agreement, HSWI may,warrants using the Black-Scholes valuation technique in its sole discretion, borrow from the Lender up to $1.0amount of $0.13 million from time to timeas debt issuance costs in the first quarter of 2011 and was amortized during the term of the credit agreement, in minimum loan amounts of $200,000. We entered into this senior revolving credit agreement to support our operating business activities and provide flexibility to fund growth.
agreement. As of September 30, 2011, our total cash and cash equivalents balance was approximately $2.57 million and we had nosuch, the debt issuance costs were fully amortized at March 31, 2012. The Company did not have any outstanding balance under our lineat March 31, 2012 and no interest expense was incurred during the term of credit. We have incurred net lossesthe agreement. On March 3, 2012, the agreement expired and the Company chose not to request an additional one-year extension. The warrants were exercised on April 2, 2012. As a result, we issued 32,405 common shares in connection with the nine months ended September 30, 2011Lender’s cashless exercise of the warrants and in each fiscal year since the Company’s inception and have an accumulated deficit of $96.8 million as of September 30, 2011. We continuesubsequently no warrants remain outstanding related to incur substantial net losses and management believes that we will continue to be
unprofitable and use existing funds to support our operations for the near-term. We expect that our customer agreements in the web platform services segment will continue to generate revenues us through December 2011. However, we do not expect that these agreements will be renewed or that we will enter into new services agreements with existing customers in 2012. We continue to pursue new services agreements with new customers for 2012.this agreement.
Off Balance Sheet Arrangements
None.
We translate the foreign currency financial statements of our international operations into U.S. dollars at current exchange rates, except revenue and expenses, which we translate at average exchange rates during each reporting period. We accumulate net exchange gains or losses resulting from the translation of assets and liabilities under accumulatedin a separate caption of stockholders’ equity titled “accumulated other comprehensive income included as a separate line item under stockholders’ equity.(loss)”. Generally, our foreign currency expenses are denominated in the same currency as the associated foreign currency revenue, and at this stage of our 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 September 30,December 31, 2011, 98%99% of our cash was denominated in U.S. dollars. The remaining 2%1% was denominated in Brazilian Reals,Reais, Chinese Renminbi or Hong Kong Dollars. AllThe majority of our cash is placed with financial institutions we believe are of high credit quality. Our cash is maintained in bank deposit accounts, which, at times, exceed federally insured limits. We have not experienced any losses in such accounts and do not believe our cash is exposed to any significant credit risk.
We do not use financial instruments to hedge our foreign exchange exposure because the effects of the foreign exchange rate fluctuations are not currently insignificant.significant. We do not use financial instruments for trading purposes. We do not use any derivative financial instruments to mitigate any of our currency risks. The net assets of our foreign operations at September 30, 2011,March 31, 2012, were approximately $0.37$0.1 million.
In March 2011, the Company entered into a Revolving Credit Agreement for $1.0 million over a 12-month term. Amounts borrowed under the line of credit bear an annual interest rate of 8%. We expect to draw on this line of credit should our other liquidity strategies fail to fulfill our cash needs for the short-term. The line of credit requires that we maintain minimum assets and can be renewed annually at Theorem Capital’s discretion. There are no outstanding balances under the line of credit as of September 30, 2011.
As required by Rule 13a-15 underEvaluation of Disclosure Controls and Procedures
Our management, with the Securities Exchange Actparticipation of 1934, as amended, Ourour Chief Executive Officer, and Chiefor CEO, (Principal Executive Officer, Principal Financial Officer in conjunction with management, haveand Principal Accounting Officer) evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act) as of the end of the period covered by this report. Disclosure controls and procedures refer to controls and other procedures designed to ensure that information required to be disclosed in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission (“SEC”).March 31, 2012. Disclosure controls and procedures are controls and procedures designed to ensure that information required to be disclosed in the Company’s reports filed or submitted under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in SEC’s rules and forms and include, without limitation, controls and procedures designed to ensure that information required to be disclosed in such reports is accumulated and communicated to management, including the Company’s CEO (Principal Executive Officer, Principal Financial and CFO,Principal Accounting Officer), as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, our management acknowledgesrecognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and our management necessarily applied its judgment in evaluating the desired control objectives.
Pursuant tocost-benefit relationship of possible controls and procedures. Based on this evaluation, our CEO (Principal Executive Officer, Principal Financial and CFOPrincipal Accounting Officer) concluded that as of September 30, 2011, the end of the period covered by this report, our disclosure controls and procedures were not effective at the reasonable assurance level as a result of the material weakness that management identifiedMarch 31, 2012.
Changes in Internal Control over Financial Reporting
There have been no changes in our internal control over financial reporting as described below. Notwithstanding this material weakness, our management concluded, based upon(as defined in Rules 13a-15(f) and 15d-15(f) under the supplementary review procedures ofSecurities Exchange Act) during the condensed consolidated financial statements and reliance on existing controls not impacted by this error,quarter ended March 31, 2012 that the condensed consolidated financial statements included in this Form 10-Q fairly present in all material respects, the Company's financial position, results of operations and cash flows for the periods presented in conformity with generally accepted accounting principles.
In June 2011, HSWI’s investee, Sharecare, acquired the assets and assumed the liabilities of HFPN and dotFit in exchange for its common stock. The Company did not receive sufficient evidence at the time regarding the transaction from its investee. Accordingly, the Company did not record an adjustment to reflect the transaction. During the third quarter 2011, the Company received information from its investee, related to the fair value of Sharecare’s common shares. Based on this information, the Company determined that this issuance of common stock by our investee generated a noncash gain of $0.4 million resulting from the change in our interest ownership which should have been included in losses on equity-method investments and investment in unconsolidated affiliate as of and for the three months and six months ended June 30, 2011. Consequently, our CEO and CFO concluded that we did not maintain effective controls over the accounting for a nonmonetary change of interest ownership gain or loss. This control deficiency also resulted in the restatement of our condensed consolidated financial statements originally reported in our Quarterly report on Form 10-Q for the period ended June 30, 2011. Accordingly, our CEO and CFO have determined that this control deficiency constitutes a material weakness as of September 30, 2011.
Our CEO, CFO and management have taken appropriate measures to remediate this material weakness noted above. The Company has emphasized to its investee the need for preparing all financial information going forward in accordance with generally accepted accounting principles and the importance of providing documentation of key events or unusual transactions with the Company on a timely basis. Our management, CEO and CFO believe that the enhanced control procedures over unusual investee transactions and related process improvements, as implemented and when validated, will remediate this material weakness.
Other than the material weakness and the corrective measures noted above, there has been no change in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Exchange Act Rules 13a-15 or 15d-15 that occurred during our last fiscal quarter that has materially affected, or isare reasonably likely to materially affect, our internal control over financial reporting.
PART II – OTHER INFORMATION
None.
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 may not have sufficient liquidity to support our operations.
We currently operate atFor a loss since inception with a substantial negative cash flow from operations. The current services agreements which generate the majoritydiscussion of the Company’s revenues will expirerisk factors, see “Item 1A. – Risk Factors” in December 2011 and we do not expect to renew the term of the agreements or enter into new agreements with our existing customers.
Based upon our present cash resources and cash flow projections, we believe that our current liquidity level will provide sufficient funds to enable us to operate our businesses on a going concern basis through the first quarter of 2012. However, in order to ensure our financial viability beyond the first quarter of 2012, we believe that we must raise additional capital and successfully implement a strategic business plan focused on expanding our web platform services business segment while continuing to reduce our costs and operating losses currently incurred by our digital online publishing business segment. To address our liquidity needs, we are considering options that may include the sale or other strategic alternatives for certain businesses or components of businesses, including the sale of certain technologies or other long-term assets, and further reduction of operating costs through restructuring of our business. The amount of capital required to be raised by the Company will be dependent upon our performance in executing our current and future business plans, as measured principally by the time period needed to begin generating positive consolidated cash flows. We currently have access to a line of credit that can be used to meet our short-term liquidity needs. The line of credit expires in March 2012 and is subject to renewal by the lender, at its sole discretion, for one additional year. There can be no assurance that we will be able to raise additional capital, renew our line of credit or obtain short-term financing from other sources in the future. In addition, any financing that could be obtained would dilute existing shareholders. The aforementioned uncertainties regarding the liquidity indicate that there is a substantial doubt that the Company will be able to continue as a going concern.
We are seeking to raise capital through private placement transactions to sell newly issued securities of the Company. If our efforts are successful, proceeds will be used to fund our operations and to fund development of new business opportunities. There is no certainty that we will be successful at raising capital, nor is there certainty around the amount of funds that may be raised. In addition, the success of our efforts will be subject to performance of the markets and investor sentiment regarding the macro and micro economic conditions under which we operate including stock market volatility. While we believe that our cash resources on hand together with our line of credit are sufficient to fund our existing businesses for a period of at least six months from the end of the third quarter of 2011, our cash resources are not sufficient to fund these businesses for an extended period beyond that unless we are successful at raising capital, revenues increase significantly, or costs decrease significantly. There can be no assurance that we will be successful at raising capital, generating more revenues or implementing restructuring plans and cost saving measures sufficient to support our business. If we are unable to raise additional capital, we may decide to reallocate our resources or suspend our activities in one or more of our markets in order to focus our limited resources in other opportunities.
We may not be able to raise additional funds when needed for our business or to exploit opportunities.
We need to raise additional capital in the near term to support our operations, 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 such as the revolving credit agreement entered into in March 2011 and further described in the Liquidity and Capital Resources section of this Form 10-Q. If we are unable to maintain compliance with the debt covenants, funds may not be available under our revolving credit agreement. In addition to this revolving credit agreement, there can be no assurance that such financing will be available on acceptable terms, if at all. Any such financing may be dilutive to our stockholders.
We continue to develop our business and prospects are difficult to evaluate.
We have a limited operating history and our business strategy is evolving, so we have limited experience in the web platform, vertical website and international Internet markets. We are in varying development stages of our business,
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 our assets; |
· | finance our operations; |
· | successfully attract advertisers for our websites and clients for our web platform services; |
· | 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 and Dodd-Frank Acts; |
· | manage the anticipated rise in operating expenses; |
· | manage and implement successfully new business strategies; |
· | 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 emerge and affect our business, especially with respect to the web platform and 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.
If we default on our credit facility, we might incur substantial penalties and impair our ability to raise additional capital.
In March 2011, we entered into a senior revolving credit agreement with Theorem Capital, LLC under which Theorem Capital extended us a line of credit of up to $1.0 million for a period of one year, subject to renewal. Our credit agreement contains covenants that we consider usual and customary for an agreement of this type, including restrictions on incurring additional indebtedness, maximum trade obligations and accrued expenses and other current liabilities, use of loan proceeds and payment of dividends. Upon the occurrence of an event of default, including payment defaults, breaches of covenants, insolvency proceedings and events having a material adverse effect on our financial condition, business assets, operations or property, Theorem Capital may declare all outstanding obligations under the credit agreement due and payable and the aggregate unpaid principal balance of any borrowings, and any other obligations under the credit agreement will bear interest at a default rate of 11% per annum until the event of default is waived or cured or all outstanding obligations are paid in full. Additionally, if we were to default on the credit agreement, it could subject us to lawsuits, deplete our cash reserves, and hinder our ability to raise additional capital in the future. If we breach our covenants or otherwise default on this credit agreement, it could have an adverse impact on our financial condition, which could in turn have an adverse affect on the price of our stock.
Our web platform services line of business may not prove to be profitable.
We intend to offer web platform services to other customers, but we have limited sales, marketing and other resources and may not be successful in obtaining those customers. Because Sharecare and Discovery Communications, the customers generating virtually all of our web platform services revenue to date, are related parties, the pricing and other terms included in those current agreements may not be indicative of the terms we can successfully obtain in arms-length transactions with other customers. We have limited experience in this line of business, and will be subject to competition with companies with greater resources and experience. Due to these factors, we may be unable to achieve profitability in this new line of business.
We may not be able to successfully establish a personal finance content vertical website.
We intend to develop, launch and operate a personal finance content vertical website leveraging best of breed technology to build and develop platform. We have limited experience in personal finance, limited cash resources, and
limited sales, marketing, and other resources related to the operations and revenue generation for a United States-based website. Additionally, we expect steep competition from established sources for financial information on the Internet.
Our services agreement with Sharecare, which provided the vast majority of our 2011 revenue to date, will expire at the end of the year.
We currently provide web development, design and management services to Sharecare under a services agreement which provided approximately 74% of our revenues during the nine months ended September 30, 2011. This agreement will expire in December 2011, and we do not expect the Company and Sharecare to extend the term or enter into a new services agreement. As Sharecare has developed its operations and grown, it has made the strategic decision to transition these web development, design and management services in-house. This expiration will cause us to lose a significant source of revenue, which would hurt our financial results and condition if the revenue is not replaced by other sources.
We generate revenue on our international sites from advertising, and the reduction in spending by or loss of advertisers could seriously harm our business.
Economic uncertainty as well as the risk associated with an emerging market have had and might continue to have a direct impact on our revenue. We cannot predict the timing, strength or duration of the current economic issues or the subsequent economic recovery generally or in the online advertising market. If the economy or markets in which we operate worsen, our business, financial condition and results of operations will likely be materially and adversely affected. 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.
We may not succeed in marketing and monetizing our international 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 still relatively new and unproven. Moreover, we will have limited experience in determining the pricing of the products and services that we plan to develop. 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 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.
We could incur asset impairment charges for intangible assets or other long-lived assets.
We have intangible assets and other long-lived assets, therefore future financial performance lower than anticipated or changes in estimates and assumptions, which in many cases require significant judgment, could result in impairment charges. We test intangible assets that are determined to have an indefinite life for impairment on a reporting unit basis during the fourth quarter of each fiscal year, and assess whether factors or indicators, such as unfavorable variances from established business plans, significant changes in forecasted results or volatility inherent to external markets and industries, become apparent that would require an interim test. Adverse changes in the operating environment and related key assumptions used to determine the fair value of our indefinite lived intangible assets or declines in the value of our common stock may result in future impairment charges for a portion or all of these assets. In December 2010, we recorded an impairment charge of $0.5 million, primarily because of changes in our assumptions as to the time and cost required to obtain licenses to operate in China similar to the ones we currently hold. In addition, in September 2011, we recorded an impairment charge of $0.38 million resulting from our analysis of a triggering event tied to the strategic reductions in the number of personnel supporting our China business operations to better align expenses to the revenues being generated at this time. If any of the assumptions used in the analysis change in the future, an impairment charge for a portion or all of the assets may be required. An additional impairment charge could have a material adverse effect on our business, financial position and results of operations, but would not be expected to have an impact on our cash flows or liquidity.
The growth we seek is difficult to achieve and would limit our resources and may inhibit our ability to grow.
We currently operate at a loss. However, to the extent we are capable of growing our business in the future; we expect that such growth will place a significant strain on our limited 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 and web platform services markets are highly competitive. We encounter significant competition across our business lines and in each market in which we offer our products and services. In the online publishing market, we expect that our competitors include (i) national Internet portals in China such as Baidu, Shanda Interactive Entertainment, Sina, sohu.com and tom.com, and (ii) national websites in Brazil such as Terra and UOL, all of which compete with us for online advertising revenue and end users. Many of our competitors have more experience, resources and website visitors than us. In the vertical website and web platform services markets, many of our competitors have been providing similar services for an extended period of time, and have developed established brands, reputations, offerings, and client bases. Most of our vertical website and web platform services competitors have more experience and resources than we do.
Resales of our common stock and additional obligations to issue our common stock may cause the market price of our stock to fall.
As of September 30, 2011, there were approximately 5,424,455 shares of our common stock outstanding, and options and warrants to purchase another approximately 1,035,179 shares outstanding. At September 30, 2011, we also had reserved an additional 7,818 shares for future issuance under our equity compensation plans. Resales of outstanding shares or issuance of new shares could depress the market price for our common stock.
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, including the recent U.S. credit rating downgrade, resulting market volatility and economic certainty; |
· | 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 are payable to HowStuffWorks’ former shareholders in three semi-annual installments. The installments were planned to begin in October 2008; however, the shareholder representative had not authorized payment as of September 30, 2011. 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 Discovery owns in the future may fall due to a combination of reasons. All of our rights to publish HowStuffWorks content will remain effective regardless of the number of shares HowStuffWorks owns in the future. If Discovery and HowStuffWorks’ former 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. These factors could also affect our common stock, and depress the market price for our common stock or limit the market for resale of our common stock. The market price of our common stock has been volatile, particularly in the recent stock market turmoil, and is also based on other factors outside of our control.
We might not be able to remain listed on The NASDAQ Stock Market.
In September 2009, we received a notice from The NASDAQ Stock Market indicating that we no longer complied with the continued listing requirement that our shares of common stock maintain a minimum closing bid price of $1.00. In response, we conducted a reverse stock split and regained compliance with continued listing standards. In March 2010, the Company received a notice from The NASDAQ Stock Market indicating that we were not in compliance with the continued listing requirement that the publicly held shares of the Company, which is calculated by subtracting all shares held by officers, directors or beneficial owners of 10% or more from the total shares outstanding, maintain a minimum market value of $5,000,000. In July 2010, the Company received a notice from The NASDAQ Stock Market indicating that it had regained compliance with this rule. In April 2011, HSWI received notification from
The NASDAQ Stock Market indicating that the Company no longer complied with the requirements for continued listing on the NASDAQ Global Market because the Company's stockholders' equity has fallen below $10 million as reported on our Annual Report on Form 10-K for the fiscal year ended December 31, 2010. HSWI’s stockholders’ equity as of December 31, 2010 was $8,775,882. The Company was allowed until May 19, 2011, to submit a plan to NASDAQ to regain compliance. Rather than submit a plan, we elected to move our listing to2011. There have been no material changes from the NASDAQ Capital Market. We are currently in compliance with the standards of the NASDAQ Capital Market. However, there can be no assurance that we will be able to continue to satisfy the requirements to maintain a continued listing on The NASDAQ Capital Market. In addition, we are considering a voluntary delisting as a potential cost-cutting measure.
Our internal control over financial reporting and our disclosure controls and procedures may not prevent all possible errors that could occur.
A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be satisfied. Internal control over financial reporting and disclosure controls and procedures are designed to give a reasonable assurance that they are effective to achieve their objectives. We cannot provide absolute assurance that all of our possible future control issues will be detected. These inherent limitations include the possibility that judgmentsrisk factors previously disclosed in our decision making can be faulty, and that isolated breakdowns can occur because of simple human error or mistake. The design of our system of controls is based in part upon assumptions about the likelihood of future events, and there can be no assurance that any design will succeed absolutely in achieving our stated goals under all potential future or unforeseeable conditions. Because of the inherent limitations in a cost effective control system, misstatements due to error could occur and not be detected.
As disclosed in item 4, our CEO and CFO concluded that we did not maintain effective controls over the accounting for a nonmonetary change of interest ownership gain. This control deficiency resulted in the restatement of our condensed consolidated financial statements originally reported in our QuarterlyAnnual Report on Form 10-Q10-K for the periodfiscal year ended June 30, 2011. Accordingly, our CEO and CFO have determined that this control deficiency constitutes a material weakness as of September 30, 2011.
Our CEO, CFO and management have taken appropriate measures to remediate the material weakness noted above. The Company has emphasized to its investee the need for preparing all financial information going forward in accordance with generally accepted accounting principles and will require documentation of key events or unusual transactions at the investee to be provided to the Company on a timely basis. Our management, CEO and CFO believe that the enhanced control procedures over unusual investee transactions and related process improvements, as implemented and when validated, will remediate this material weakness.
We may have additional tax liabilities if tax positions we have taken in prior years are challenged.
Although the Company has not been a substantial tax payer to date, we and our subsidiaries are subject to taxes in the United States and various foreign jurisdictions. We believe that our tax returns appropriately reflected our tax liability when those tax returns were filed. However, applicable tax authorities may challenge our tax positions. Any successful challenge to one or more of our prior tax positions could result in a material tax liability to us or to one or more of our subsidiaries, including INTAC, for one or more prior years.
The state of the Internet infrastructure in China and Brazil may limit our growth.
We rely on the Internet for 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 makes us vulnerable to disruptions or failures in service, without sufficient access to alternative networks and services. Such disruptions or failures could reduce our user satisfaction. 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 which poses site redundancy risk. Although our site is a Tier 4 data center, which is composed of multiple active power and cooling distribution paths, has redundant components, and is fault tolerant, we do not have a documented disaster recovery plan in the event of damage from fire, flood, typhoon, earthquake, power loss, telecommunications failure, break-in or similar events. If any of the foregoing occurs, we may
experience a temporary system shutdown. If there is significant disruption or damage to the data center hosting our web servers, our ability to provide access to our websites would be interrupted. We do not carry any business interruption insurance. Although we carry property insurance, our coverage may not be adequate to compensate us for all losses, particularly with respect to loss of business and reputation that may occur.
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. If our security measures are breached as a result of third-party action, employee error or otherwise, we could incur liability and our reputation would be damaged, which could lead to the loss of current and potential customers. If we experience any breaches of our network security or sabotage, we might be required to expend significant capital and other resources to remedy, protect against or alleviate these and related problems, and we may not be able to remedy these problems in a timely manner, or at all. Because techniques used by outsiders to obtain unauthorized network access or to sabotage systems change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques or implement adequate preventative measures. We cannot 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 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.
Our sublicensed content is subject to the terms and conditions of agreements between HowStuffWorks and third parties.
Under the terms of our contribution agreements, HowStuffWorks transferred and contributed to us all rights, but only those rights, that belong to and are held by HowStuffWorks pursuant to third-party licenses. Some of those licenses, including those with Publications International, Ltd., contain restrictions on the use of content and termination provisions for breaches of the license agreements. Accordingly, a breach of any third party license by HowStuffWorks may cause us to lose our license with such third party, which could have a material adverse effect on the implementation of our business plan, value of our content offering 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.
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 have reduced spending on marketing and advertising. As a result, a slowdown in overall economic growth, an economic downturn or recession or other adverse economic developments in China or Brazil may materially reduce the demand for our services and materially and adversely affect our business.
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 Ministry of Information Industry, or 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.
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:
· | 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 based in China. |
Any of these actions could have a material adverse effect on our financial condition and results of operations.
A 2006 regulation establishes more complex procedures in the PRC for acquisitions conducted by foreign investors, which could make it more difficult for us to pursue growth through acquisitions.
In August 2006, six PRC regulatory agencies - the PRC Ministry of Commerce, or the MOC, the State Assets Supervision and Administration Commission, the State Administration for Taxation, the State Administration for Industry and Commerce, the China Securities Regulatory Commission and the Chinese State Administration for Foreign Exchange, or SAFE, jointly adopted the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign
Investors, which became effective in September 2006. Among other things, the new regulations established additional procedures and requirements that could make merger and acquisition activities by foreign investors more time-consuming and complex, including requiring in some instances that the MOC be notified in advance of any change-of-control transaction in which a foreign investor takes control of a PRC domestic enterprise. Additional regulations adopted in February 2011 provide for national security review of merger and acquisition transactions. We may grow our business in part by directly acquiring complementary businesses in China. Complying with the requirements of the new regulations could be time-consuming, and any required approval processes, including obtaining approval from the MOC, may delay or inhibit our ability to complete such transactions, which could affect our ability to expand our business or maintain our market share.
We face risks related to health epidemics and other outbreaks, particularly in the PRC.
Our business could be adversely affected by outbreaks of avian influenza, SARS or other widespread diseases. Many users of our Websites, especially in China, access the Internet at public cafes. Any prolonged recurrence of avian influenza, SARS or other widespread disease in China could prompt the government to restrict people’s movements, limit gathering in public places, or otherwise prevent our users from accessing Internet cafes. If our users cannot access Internet cafes, or we are unable to staff our office in China, our business operations could be materially affected. We have not adopted any written preventive measures or contingency plans to combat any future outbreak of avian influenza, SARS or any other epidemic.
We may incur administrative and staffing cost due to the PRC’s new labor contract law.
In 2007, the Standing Committee of the National People’s Congress of China enacted the Labor Contract Law, which became effective in January 2008. The Labor Contract Law’s goal is to improve job security and to protect the rights and interests of employees. In order to fully comply with the legal requirements under the Labor Contract Law, we may incur administrative and staffing cost, which could adversely affect our 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.
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 regulations 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 we expect a substantial amount of our business to be within China in the long term, 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:
· | 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; |
· | 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. |
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 accounts receivable collections, difficulties in managing distributors or representatives, difficulties in staffing and managing international operations, difficulties in protecting our intellectual property overseas, seasonality of sales and potentially adverse tax consequences. Any of these factors could materially and adversely affect our revenues and profits.
Restrictions on currency exchange may limit our ability to utilize our revenues effectively.
Some of our revenues and operating expenses are denominated in Chinese Renminbi. Currently, we may purchase foreign exchange for settlement of “current account transactions” without the approval of the SAFE. We may also retain foreign exchange in our current account (subject to a ceiling approved by the SAFE) to satisfy foreign exchange liabilities or to pay dividends. However, the relevant PRC governmental authorities may limit or eliminate our ability to purchase and retain foreign currencies in the future.
Additionally, some of our revenues and operating expenses are denominated in Brazilian Reals. Brazilian law allows the Brazilian government to impose restrictions on the conversion of the Real into foreign currencies and on the remittance to foreign investors of proceeds from their investments in Brazil. The government may impose such restrictions whenever there is a serious imbalance in Brazil’s balance of payments or there are reasons to foresee a serious imbalance. The Brazilian government last imposed remittance restrictions for approximately six months in 1989 and early 1990. The likelihood that the Brazilian government would impose such restrictions again depends on the extent of Brazil’s foreign currency reserves, the availability of foreign currency in the foreign exchange markets on the date a payment is due, the size of Brazil’s debt service burden relative to the economy as a whole, Brazil’s policy toward the International Monetary Fund and other factors.
Since a portion of our revenues 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 Reals, any future restrictions on the exchange of Reals 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 Reals 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 are not readily converted into Euros or U.S. dollars (or other “hard currencies”) or are only converted at government controlled rates, and, in some countries, the transfer of hard currencies offshore has been restricted from time to time. Very limited hedging transactions are available in China to reduce its exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions in an effort to reduce our exposure to foreign currency exchange risk. While we may decide to enter into hedging transactions in the future, the availability and effectiveness of these hedges may be limited and we may not be able to successfully hedge our exposure, if at all. Our revenues as expressed in our U.S. dollar financial statements will decline in value if Renminbi or Reals 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 Reals into U.S. dollars.
China recently announced that it will allow its currency to trade more freely and no longer carry a value as closely associated with that of the U.S. Dollar as it has in the past. It is possible that such de-coupling will increase the relative value of the Renminbi to the U.S. Dollar, resulting in our incurring higher costs in China due to the higher cost of exchanging U.S. Dollars for Renminbi and our funding our China operations from U.S. Dollars held in our treasury.
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 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 will 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 could 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 could 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, aspects of our business plan could no longer be viable and our business would thus be adversely affected.
Potential additional Chinese regulations could affect our business in China.
The Ministry of Information Industry, the Chinese governmental agency that regulates the Internet in China, promulgated a directive effective January 31, 2008, providing that online videos can only be broadcast or streamed by state-owned or controlled companies. Subsequently, the Ministry of Information Industry acted to provide exceptions for certain non-state-owned or controlled companies. While it is possible that our Chinese website would not be permitted to display online videos, which could have a material effect on the content provided on such website, it is not yet clear what, if any, effect this regulation has upon our business in China.
Political and economic policies of the PRC government could affect our business.
A portion of our business, assets and operations are located in China and a 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:
· | level of government involvement; |
· | level of capital reinvestment; |
· | 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, 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 Brazil and 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 a portion of their assets may be located outside the United States (principally in Brazil and 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 Brazil and the PRC, in original actions or in actions for enforcement of judgments of United States courts, of civil liabilities predicated solely upon the federal securities laws of the United States or the securities laws of any state of the United States.
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. The loss of the service of any of the key members of our senior management may significantly delay or prevent the integration of the contributed assets and other business objectives. Our ability to attract and retain qualified personnel, consultants and advisors will be critical to our success. We may not be able to attract and retain these individuals, and our failure to do so would adversely affect our business.
The concentration of our stock ownership will likely limit your ability to influence corporate matters.
HowStuffWorks, a subsidiary of Discovery, beneficially owns a significant percentage of our outstanding common stock and is party to a stockholders agreement. The stockholders agreement entitles HowStuffWorks to designate nominees to our Board of Directors. As a result, Discovery 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 interests of Discovery and its affiliates may materially conflict with the interests of other shareholders. For as long as they exert a significant influence over our business affairs, they will have the ability to cause us to take actions that may be adverse to the interests of other shareholders or inconsistent with other shareholders’ investment objectives.
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 September 30, 2011, Discovery owned over 40% of our outstanding shares of common stock through its HowStuffWorks subsidiary. As a result, it will be difficult for our other stockholders to approve a takeover of us without the cooperation of Discovery.
Furthermore, our Amended and Restated Certificate of Incorporation and Amended and Restated Bylaws contain anti-takeover provisions, including but not limited to the following provisions:
· | 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 have authorized undesignated preferred stock, the terms of which may be established and shares of which may be issued without stockholder approval; |
· | SEC Rule 14a-8 requires that we receive notice of stockholder proposals at least 120 days prior to the date of our proxy statement for the previous year’s annual meeting or we do not have to include them in our proxy materials; and |
· | for stockholder proposals not requested to be included in our proxy materials under Rule 14a-8, we require advance notice of not less than 60 nor more than 90 days prior to a meeting for the proposal to be introduced and considered. |
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 desire.
Section 203 of the Delaware General Corporation Law may also delay, defer or prevent a change in control that our stockholders might consider to be in their best interest. We are subject to Section 203 of the Delaware General Corporation Law which, subject to certain exceptions, prohibits “business combinations” between a publicly-held Delaware corporation and an “interested stockholder,” which is generally defined as a stockholder who becomes a beneficial owner of 15% or more of a Delaware corporation’s voting stock for a three-year period following the date that such stockholder became an interested stockholder. Section 203 could have the effect of delaying, deferring or preventing a change in control of us that our stockholders consider to be in their best interest.
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, if any, into our existing operations may result in unforeseen difficulties and liabilities and may require a disproportionate amount of resources and management attention. Difficulties that we encounter in integrating the operations of acquired businesses could have a material adverse effect on our 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 could 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 or preferred 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. |
Our investment in Sharecare’s equity securities involves a substantial degree of risk.
Our investment in Sharecare’s equity securities is illiquid and might fail to appreciate and might decline in value or become worthless. Our Sharecare equity securities likely will not pay current dividends, and our ability to realize a return on our investment, as well as to recover our investment, will be dependent on the success of Sharecare. Sharecare is a recently-formed company with limited history of operations. Its prospects must be considered in light of the many risks, uncertainties, expenses, delays and difficulties encountered by companies in their early stages of development. Moreover, Sharecare operates in the highly competitive internet industry and might not achieve profitability or consumer acceptance in the near-term, if ever.
Even if Sharecare is successful, our ability to realize the value of our investment might be limited. Because it is a private company, there is no public market for Sharecare’s securities, and the Sharecare securities are subject to restrictions on resale that might prevent us from selling these securities during periods in which it would be advantageous to do so. As a result, we might have to wait for a liquidity event, such as a public offering or the sale of Sharecare, to realize the value of our investment, if any. It is likely to take a significant amount of time before a liquidity event occurs.
We account for our investment in Sharecare under the equity method of accounting and we record our proportionate share of Sharecare’s net income or loss. Sharecare may need to raise additional capital, and our equity position in Sharecare may be diluted if Sharecare issues additional equity, options, or warrants. If Sharecare makes a capital call of its existing equity holders, our position may be diluted if we choose not to contribute additional capital. We continually evaluate the facts and circumstances related to our investment in Sharecare to assess the need for change in accounting method. We had an option to acquire 13,089 shares in Sharecare which was to expire on July 30, 2011. HSWI decided not to exercise this option.
Two of our stockholders also have substantial Sharecare investments, and potential conflicts of interests could harm us.
Jeff Arnold, a member of our Board of Directors until June 2010 and Chief of Global Digital Strategy for Discovery, the parent company of HowStuffWorks, together with Discovery beneficially own over 40% of our common stock. Both Mr. Arnold and Discovery own significant interests in Sharecare and serve on the board of directors of Sharecare, and Mr. Arnold is also Chairman and Chief Architect of Sharecare. As a result, Mr. Arnold and Discovery have the ability to significantly influence and manage the affairs of both HSWI and Sharecare and determine the outcome of matters submitted for approval to stockholders of each company. If HSWI and Sharecare’s interests diverge, there is a risk that Mr. Arnold or Discovery will favor actions by Sharecare that are adverse to HSWI.
31,2011.
On February 27, 2012, the Company entered into definitive equity financing agreements with accredited and institutional investors to raise funds in the amount of $4.25 million through a private placement. In connection with the transaction, the Company issued to investors common stock priced at $4.50 per share. Investors also received warrants to acquire shares of common stock at an exercise price of $6.81 per share, in the amount of 25% of the number of shares of common stock that the investors purchased. On February 29, 2012, the Company received $4.25 million in cash and issued to the investors a total of 944,777 shares of common stock and warrants to acquire an additional 236,194 shares of common stock. The Company also paid a placement agent fee of 7% of the proceeds of the offering, approximately $0.3 million, and issued a three-year warrant to the placement agent to purchase up to an aggregate of 35,429 shares of Common Stock at an exercise price of $7.46 per share. The warrants were valued using the Black-Scholes method at $3.77 per share and classified as equity. The Company also paid an additional $0.1 million for stock issuance costs. The stock issuance costs which amounted to $0.4 million along with the value of the warrants issued to the placement agent of $0.13 million were charged to additional paid in capital.
All shares of common stock and warrants were issued pursuant to exemptions under Section 4(2) of the Securities Act of 1933, as amended, and Rule 506 of Regulation D promulgated thereunder.
None.
None.Not applicable.
None.
Exhibit | | |
Number | | Description of Document |
| | |
| | |
31.1 | | Certification by the Principal Executive Officer, pursuant to Section 240.13a-14 or section 240.15d-14 of the Securities and Exchange Act of 1934, as amended |
| | |
31.2 | | Certification by the Principal Financial Officer and Principal Accounting Officer pursuant to Section 240.13a-14 or section 240.15d-14 of the Securities and Exchange Act of 1934, as amended |
| | |
32*32.1* | | Certification by the Principal Executive Officer, and Certification by the Principal Financial and Principal Accounting Officer pursuant to 18 U.S.C. 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| | |
101.INS* | | XBRL Instance Document |
| | |
101.SCH* | | XBRL Taxonomy Extension Schema |
| | |
101.CAL* | | XBRL Taxonomy Extension Calculation Linkbase |
| | |
101.LAB* | | XBRL Taxonomy Extension Label Linkbase |
| | |
101.PRE* | | XBRL Taxonomy Extension Presentation Linkbase |
| | |
_________________________
| * | This exhibit isThese exhibits are furnished to the SEC as accompanying documentdocuments and isare not to be deemed “filed” for purposes of Sections 11 and 12 of the Securities Act of 1933, as amended, and Section 18 of the Securities Exchange Act of 1934 or otherwise subject to the liabilities of these Sections nor shall itthey be deemed incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934. |
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| HSW INTERNATIONAL,REMARK MEDIA, INC. |
| |
| |
Date: November 21, 2011May 14, 2012 | By: | /s/ Shawn G. MeredithCarrie B. Ferman | |
| | Shawn G. MeredithCarrie B. Ferman |
| | Chief Executive Officer, Principal Financial Officer and Principal Accounting Officer |