HSWI Hsw International, Inc. (MM)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 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)

One Capital City Plaza

3350 Peachtree Road, Suite 1600

Atlanta, GA  30326

(Address of principal executive offices, including zip code)

404-974-2710

(Registrant’s telephone number, including area code)

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

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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  o   No x

At August 14, 2008, the number of common shares outstanding was 53,638,784.

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PART I – FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements.

HSW INTERNATIONAL, INC. and SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(expressed in U.S. Dollars)

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

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HSW INTERNATIONAL, INC. and SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(expressed in U.S. Dollars)

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

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HSW INTERNATIONAL, INC. and SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(expressed in U.S. Dollars)

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

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HSW INTERNATIONAL, INC. and SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(continued)

(expressed in U.S. Dollars)

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

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HSW INTERNATIONAL, INC. and SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2008

(Unaudited)

1.  DESCRIPTION OF ORGANIZATION AND BUSINESS OPERATIONS

HSW International, Inc. (the “Company”, or “HSWI” or “we”, or “our”), is a Delaware corporation that was formed on March 14, 2006, as a wholly owned subsidiary of HowStuffWorks, Inc. (“HSW”) in order to (i) develop businesses using exclusive digital publishing rights to HSW’s content for the countries of China and Brazil, and (ii) to effect the merger with INTAC International, Inc. (“INTAC”) (the “INTAC Merger”).

Our primary focus is to build an international online publishing company that develops and operates Internet businesses focused on providing consumers in the world’s emerging digital economies with locally relevant, high quality content.  We entered the Brazilian online publishing market in March 2007, by utilizing a royalty-free and exclusively licensed digital content database provided by HSW prior to the INTAC Merger.

In June 2008, we entered China’s online publishing market utilizing a combination of the contributed assets from HSW 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, and Atlanta, Georgia, our corporate headquarters.

Prior to the INTAC Merger and related financing transactions our sole shareholder was HSW, 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.  HSW’s website, HowStuffWorks.com, offers in-depth, easy-to-understand explanations, expert product reviews, comprehensive buying guides and informational videos, simplifying thousands of topics in the areas of health, science, travel, automotive, electronics, consumer products and many other areas.  On December 17, 2007, HSW, our largest shareholder, merged with Discovery Communications, LLC (“Discovery”) becoming a wholly-owned subsidiary of Discovery.  As of June 30, 2008, Discovery, through its wholly-owned subsidiary, HSW, owned approximately 42.8% of our outstanding common stock.  HSW remains based in Atlanta, Georgia.

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

·                   HSW contributed to us in exchange for shares of our common stock, exclusive digital publishing rights to HSW’s 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.

·                   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 retained from the INTAC acquisition is the Internet licenses intangible we used to enter the Chinese market.  The operations from the INTAC Legacy Businesses have been reflected as discontinued operations in our consolidated financial statements.  All intercompany balances and transactions have been eliminated.

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Our core Internet publishing platforms in Brazil and China are our only business segment subsequent to the February 29, 2008, disposition of the INTAC Legacy Businesses.  These platforms are in the early development stage.   We launched our Brazilian Internet website in March 2007.  At June 30, 2008, we had approximately 4,600 articles that were either (i) articles from the HSW content database translated from English to Portuguese, or (ii) originally created content.  We will continue to expand the website 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 HSW, and (iii) refining local marketing strategies.

We launched our Internet website in China in June 2008.  We have hired Chinese personnel, received licenses to do business in China through the INTAC Merger and we have translated and localized our content for the China online publishing business.  We also intend to generate revenue by assembling our own library of digital content (including originally authored content and content that has been acquired from third parties) for our own use and for licensing to various customers, including HSW, in territories outside of our markets.

We expect to expend significant resources in launching, expanding and gaining market share for our Internet platforms in these significant, growing markets for our online publishing business.  We believe that with the completed equity financings and the February 29, 2008, INTAC Legacy Businesses disposition (non-core businesses) that our current cash balance and expected cash generated from future operations will be more than sufficient to fund operations for the next twelve months.  If cash from equity financings, dispositions, 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 additional credit facilities.  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.

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 HSW 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 was 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):

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

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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 at 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.  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, was 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).  We are in the process of obtaining third-party valuations of certain assets and liabilities including tax and deferred tax balances; thus the allocation of the purchase price is subject to refinement.

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 all 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.

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Following the disposition, the sole asset we retain from the INTAC Legacy Businesses is the Internet Licenses intangible that has an indefinite life and is not amortized and from which no revenue has been generated from the date of acquisition to June 30, 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.

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, HSW, 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 June 30, 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

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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.

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.  Since we had not acquired INTAC prior to October 2, 2007, comparative quarter discontinued operations is not presented. The results of discontinued operations for the six months ended June 30, 2008 are as follows:

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:

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.

We are continuing to finalize with our external valuation consultants certain tax liabilities and deferred tax assets and liabilities resulting from the initial INTAC subsidiaries acquisition purchase price allocation, which remains preliminary, and as a result, any such changes may affect the final loss on disposition and the final loss on discontinued operations. An adjustment to the estimated loss, if any, based on further refinement of the measurement of the purchase accounting and resulting loss on disposition will be recognized in the subsequent reporting period.

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4.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

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, and (5) BoWenWang Technology (Beijing) Limited Liability Company.  The equity of certain of these entities is partially or fully held by citizens of the country of incorporation to comply with local laws and regulations.  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 three months ended June 30, 2008, and 2007, were $0.8 million and $1.0 million, respectively.  Net losses from HSW Brazil and China for the six months ended June 30, 2008, and 2007, were $1.7 million and $1.6 million, respectively.

The year-end balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America.

The accompanying interim consolidated financial statements for the three and six months ended June 30, 2008, and 2007, are unaudited.  Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America for financial information have been omitted pursuant to the rules and regulations of Article 10 of SEC Regulation S-X.  In the opinion of management, these consolidated financial statements contain all adjustments, consisting of normal recurring adjustments, necessary to present fairly the financial position, results of operations and cash flows for the periods indicated.  Operating results for the three and six months ended June 30, 2008, are not necessarily indicative of results that may be expected for any other future interim period or for the year ending December 31, 2008.  You should read the unaudited consolidated financial statements in conjunction with Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations, as well as with HSWI’s consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007.

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 or other actions associated with such ads; in the paid-for-impression model, revenue is derived from the display of ads.

We recognize revenue 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 the collectability is reasonably assured.

Cost of Revenue:

Online Publishing

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

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Liquidity:

Our core Internet publishing platforms in Brazil and China are our only remaining business segment subsequent to the sale of the INTAC Legacy Businesses.  Our Internet publishing platforms are in the early development of our business (see Note 1).

Due to the start up nature of the online publishing segment of HSWI, revenue recorded for the three and six months ended June 30, 2008 was approximately $128,000 and $173,000, respectively.  Revenue recorded for the three and six months ended June 30, 2007 was approximately $33,000.

As of June 30, 2008, our cumulative losses were $61.4 million which included non cash expenses of $19.9 million for stock-based compensation.  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 HSW, 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 and China and provide sufficient working capital for at least the next twelve months.

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.

Stock Based Compensation:

We account for stock based compensation in accordance with Statement of Financial Accounting Standard (“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 other expense, net.  Both currency translation and transaction losses during 2008 and 2007 were not material to our consolidated financial statements.

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Recent Accounting Pronouncements:

In September 2006, the Financial Accounting Standards Board (“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.

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 effect the implementation of SFAS 141(R) will have on the 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 are currently evaluating the effect the implementation of SFAS 160 will have on the consolidated financial statements.

5.  INCOME TAXES

The Company records income taxes pursuant to SFAS 109, Accounting for Income Taxes .  SFAS 109 uses an asset and liability approach to account for income taxes, wherein deferred taxes are provided for book and tax basis differences for assets and liabilities.   As part of our financial process, we must assess the likelihood that our deferred tax assets can be recovered.  If recovery is not likely, the provision for taxes must be increased by recording a reserve in the form of a valuation allowance for the deferred tax assets that are estimated not to be ultimately recoverable.  In this process, certain relevant criteria are evaluated including the existence of deferred tax liabilities that can be used to absorb deferred tax assets, the taxable income in prior carryback years that can be used to absorb net operating losses and credit carrybacks and taxable income in future years.  Our judgment regarding future taxable income may change due to future market conditions, changes in U.S. tax laws and other factors. These changes, if any, may require material adjustments to these deferred tax assets and an accompanying reduction or increase in net income in the period when such determinations are made.

No income tax benefit was recorded for the three and six months ended June 30, 2008 and 2007.  Our effective rate, which is 0%, differs from the statutory federal rate of 35% and 34% because of our lack of taxable income and because of an increase in the valuation allowance due to net operating losses.

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6.  STOCKHOLDERS’ EQUITY

Common Stock

As discussed in Note 1, on October 2, 2007, we completed the INTAC Merger and related transactions affecting our stockholders’ equity as follows:

·                   We issued 22,940,717 and 22,940,727 million shares of our stock to HSW and to INTAC shareholders, respectively.

·                   Three million shares of common stock were recorded as treasury shares valued at cost, $9.0 million.

·                   We sold 3,424,653 shares of our common stock to certain investors for $22.5 million prior to expenses.  On February 4, 2008, we issued 2,689,464 additional shares to these investors pursuant to an adjustment mechanism provided for in their stock purchase agreement.  The stock purchase agreement with these investors requires shelf registration statements covering the resale of their shares.

·                   We entered into a stock purchase agreement with certain investors who agreed to purchase shares of our common stock, conditioned upon the shares being publicly registered.  Such registration was subsequently declared effective on January 14, 2008.  On January 31, 2008, we issued 1,579,348 shares of our stock in exchange for $5.8 million in cash before expenses and, on February 1, 2008, we sold our 3 million treasury shares for $11.0 million in cash before expenses.

On February 29, 2008, we completed the INTAC Legacy Businesses disposition.  In accordance with the share purchase agreement, we were to receive 5.0 million of our common shares owned by Mr. Zhou and the INTAC Legacy Businesses were to include $4.5 million in cash.  At the February 29, 2008, disposition, we received only 4.5 million of our shares and we only funded the INTAC Legacy Businesses with $2.7 million in cash (see Note 3).  Concurrently, we sold the 4.5 million shares of common stock to two qualified institutional buyers for $16.6 million in cash before expenses.  Our stock purchase agreement with the investors allows them to request registration of resale of their stock within 180 days of the sale, if they are not able to sell their shares under Rule 144 at that time.

We received the additional 0.5 million shares of our stock from Mr. Zhou on March 26, 2008, and released another $1.8 million in cash to the INTAC Legacy Businesses.  The additional shares were sold to the institutional buyers for $1.8 million pursuant to the Stock Purchase Agreement.

Each share of our common stock entitles its holder to one voting right.

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.

On August 23, 2006, we granted stock options covering 6,337,500 shares, (the “2006 Grants”) at an exercise price of $6.50.  Of the 6,337,500 shares subject to the options granted, 2,000,000 vested on the date of grant, 2,000,000 vest on the date of the second anniversary date of the grant date, 600,000 vested over the period from August 23, 2006 to June 4, 2007, and 1,737,500 vest over three years.

On October 10, 2007, we granted stock options covering 730,000 shares, (the “2007 Grants”) at an exercise price of $7.10 per share.   Of the 730,000 shares subject to the options granted, 218,889 vested on the date of grant, 319,444 vest monthly over the period from date of grant through August 23, 2009, 76,667 vest annually over two years ending August 23, 2009, 40,000 vest annually over three years ending April 23, 2010, 50,000 vest annually over three years ending October 10, 2010, and 25,000 vest annually over three years ending November 19, 2010.

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On March 10, 2008, we granted stock options covering 12,000 shares, at an exercise price of $4.26 per share.   These options vest monthly through March 10, 2011.

On May 28, 2008, we granted stock options covering 25,000 shares, at an exercise price of $3.80 per share.  These options vest monthly through May 28, 2011.  The March 10, 2008 and May 28, 2008 stock option grants are collectively the “2008 Grants”.

On March 10, 2008, HSWI granted 33,096 shares of restricted stock to four members of the Board of Directors.  The grant date fair value was $4.26 per share.  As of June 30, 2008, unrecognized compensation expense relating to non-vested restricted stock approximated $87,000 and is expected to be recognized during 2008.  The restricted stock vests on December 31, 2008.

The per share fair value of the stock options granted, estimated on the date of the grant, was $3.37 and $3.78 for the 2006 Grants and 2007 Grants, respectively, and a range of $1.98 to $2.04 for the 2008 Grants.  We use the Black-Scholes options pricing model to value our options, using the assumptions in the following table.  Expected volatilities are based on the historical volatility of the stock combined with other factors.  The expected term of options represents the period of time that the options granted are expected to be outstanding.  The risk-free rate of periods during the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.

In accordance with SFAS 123(R), stock-based compensation cost is measured at the grant date based on the fair value of the award, and is recognized as an expense over the employee’s requisite service period.  Stock-based compensation expense for the three and six months ended June 30, 2008 was approximately $1.6 million and $2.9 million, respectively.  As of June 30, 2008, unrecognized compensation expense relating to non-vested stock options approximated $3.1 million and is expected to be recognized through 2011.  At June 30, 2008, no options had been exercised under this plan.

A summary of stock option activity and related information as of June 30, 2008, and changes during the six months then ended is presented below:

The aggregate intrinsic value in the above tables represents the total pre-tax intrinsic value (the difference between the HSWI closing stock price on the last trading date of the periods presented and the exercise price, multiplied by the number of options).  The amount of aggregate intrinsic value will change based on the fair market value of our stock.

The fair value of options vested during the three and six months ended June 30, 2008, is $0.1 million and $1.4 million, respectively.

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We assumed 500,000 INTAC stock options as part of the INTAC Merger and exchanged them for an equal amount of HSWI options.  All of these options 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 was treated as part of the purchase price and no related expense was recorded (see Note 2).  The per share fair value of our stock options issued in exchange for all of INTAC’s options was estimated using the Black-Scholes options pricing model, resulting in a $0.04 to $0.39 fair value range per option (weighted average fair value options assumed is $0.33).  The fair value of each option grant was estimated on the date of grant using the following assumptions: underlying stock price of $1.95; no dividend yield; expected volatility of 50%; risk-free interest rate of 5.0%; and, expected life of seven years.

In conjunction with the merger, simultaneously with the assumption of the INTAC stock options and as discussed in Note 2, we issued warrants to purchase 500,000 shares of our common stock to HSW on the same terms as the INTAC stock options, with a provision that as the exchanged stock options are forfeited or expire, a similar amount of the warrants expire.  At June 30, 2008, there were 250,000 warrants outstanding.

On May 13, 2008, HSWI entered into a Separation Agreement with the Company’s Chief Financial Officer (“CFO”) in conjunction with the CFO’s desire to retire.  This Agreement provides for the CFO to continue as an employee and officer of HSWI through July 31, 2008, and as a consultant for six months thereafter.  The CFO will be paid a lump sum severance payment of $200,000 upon termination as an employee in accordance with his employment contract, and allow his stock options to remain exercisable for the full 10-year term notwithstanding his termination.  The change in contractual term was accounted for as a modification under SFAS 123(R), which resulted in an additional $43,000 of stock-based compensation expense, which was recognized immediately as the options were fully vested.

On April 3, 2008, the Company extended the stock option term for a member of the Company’s board of directors who was also a former member of INTAC’s board of directors.  The options were extended from a 7-year term to a 10-year term.  The change in contractual term was accounted for as a modification under SFAS 123(R), which resulted in an additional $78,000 of stock-based compensation expense, which was recognized immediately as the options were fully vested.

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Earnings per Share

The following is a reconciliation of the numerators and denominators of our basic and diluted earnings per share computations:

Stock options, restricted stock and warrants are not included in the diluted earnings per share calculation above as they are anti-dilutive.

7.  RELATED PARTY TRANSACTIONS

In August 2006, HSW Brazil entered into a 36 month services agreement with Administradora de Bens Capela (“Capela”), a Brazilian corporation, whereby Capela provides sales, business development, and operations personnel to our Brazilian subsidiary.  Monthly fees for these services are $66,197 (U.S. Dollars).  The terms of the agreement also provided to Capela 800,000 stock options at $6.50, the market value on the contract and grant date vesting over the three year contract period.  These options are included in the options described in Note 6.

During 2006, we entered into six unsecured notes payable with Capela that had various maturity dates in 2007.  Interest on these loans was based on the Interbank Certificate of Deposit rate plus 0.3% through 0.5%.  As of March 31, 2007, the balance of the notes payable outstanding was $195,848, including accrued interest.  The notes payable balance was paid in full in 2007 and accordingly, there is no note payable outstanding at June 30, 2008.

From time to time, Capela purchases advertising space on our Brazilian website “Como Tudo Functiona”.  The revenue associated with these transactions is classified as “Sales to Affiliates” in the accompanying consolidated financial statements.  The Company recognized $97,148 of revenue from affiliates during the six months ended June 30, 2008.

Capela was deemed an affiliate due to an ownership interest it had in HSW, indirectly our largest shareholder.

As of June 30, 2008, the Company has approximately $41,000 payable to China Trend Holdings Ltd., related to the INTAC Legacy Businesses disposition.  China Trend Holdings Ltd. 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, disposition expenses related to this transaction were to be split evenly between the Company and China Trend Holdings Ltd.  The Company withheld $200,000 of the purchase price to cover China Trend Holdings Ltd. estimated portion of disposition expenses.  As the Company makes disposition expense payments, half of those costs offset the advance from affiliate balance on the consolidated balance sheet.  Any remaining funds will be released to China Trend Holdings, Ltd. once all disposition expenses have been paid.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Cautionary Statement Regarding Forward-Looking Information

The following Management’s Discussion and Analysis of our Financial Condition and Results of Operations should be read in conjunction with the consolidated financial statements and notes thereto included as part of this Form 10-Q.  This Form 10-Q contains forward-looking statements that are based upon current expectations.  We sometimes identify forward-looking statements with such words as “may”, “will”, “expect”, “anticipate”, “estimate”, “seek”, “intend”, “believe” or similar words concerning future events. The forward-looking statements contained herein, include, without limitation, statements concerning future revenue sources and concentration, gross profit margins, selling, general and administrative expenses, capital resources, and the effects of general industry and economic conditions and are subject to risks and uncertainties including, but not limited to, those discussed below and elsewhere in this Form 10-Q that could cause actual results to differ materially from the results contemplated by these forward-looking statements.  We also urge you to carefully review the risk factors set forth in other documents we file from time to time with the SEC, including our Annual Report on Form 10-K for the year ended December 31, 2007.

Business Overview and Recent Events

We were formed on March 14, 2006 as a wholly owned subsidiary of HowStuffWorks, Inc. (“HSW”) in order to (i) develop exclusive digital publishing rights to HSW’s content for the countries of China and Brazil, and (ii) effect the INTAC merger.  Our ongoing primary focus is to become an international online publishing company that develops and operates Internet businesses focused on providing consumers in the world’s emerging digital economies with locally relevant, high quality content.

The INTAC Merger

The INTAC Merger was done to assist in the development of our digital content database exclusively licensed from HSW 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.

On October 2, 2007, we completed the INTAC Merger and related transactions pursuant to which:

·                   HSW contributed to us, in exchange for our common stock, perpetual, fully paid up, royalty-free exclusive digital publishing rights to HSW’s 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 with INTAC surviving as a wholly owned subsidiary of ours 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 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.

·                   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”.

·                   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 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.

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As more fully discussed in Note 2 to the consolidated financial statements included in this Form 10-Q, 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 decided to dispose of the entire INTAC Legacy Businesses subsequent to December 31, 2007.

HSW Merger with Discovery Communications, LLC.

In December 2007, HSW was acquired by Discovery Communications, LLC and became a wholly owned subsidiary of Discovery.  As a result, certain of our contributions from HSW were modified.  At June 30, 2008, Discovery, through its wholly owned subsidiary HSW, owned approximately 42.8% of our outstanding common stock.

Our Operations

Our initial focus is online publishing of localized, translated Chinese and Brazilian editions of the HowStuffWorks Internet site, utilizing strategies based on those employed by HSW, as tailored to the needs of each localized market.

We launched our Brazilian website in March 2007.  At June 30, 2008, we had approximately 4,600 articles that were either (i) articles from the HSW 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 HSW, and (iii) refining local marketing strategies.  We recognized $127,989 and $172,826 of revenue during the second quarter and first half of 2008, respectively.

In June 2008, we entered the Chinese online publishing market and utilizing a combination of the licensed and sublicensed content that we recently received from HSW with the benefits of INTAC International, Inc.’s relationships and knowledge of the Chinese markets in obtaining our Internet licenses.  The website address is http://bowenwang.com.cn .  We have hired Chinese personnel, received licenses to conduct certain business in China and translated and localized our content for the China online publishing business.

We also intend to generate revenue by assembling our own library of digital content (including originally authored content and content that has been acquired from third parties) for our own use and for licensing to various customers, including HSW, in territories outside of our markets.  We believe that both China and Brazil represent significant, growing markets for our initial online publishing strategy.

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.

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, HSW, 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.

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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 in loss from operations before income taxes in the statement of operations, a preliminary goodwill write off of approximately $22.5 million related to the February 29, 2008, INTAC Legacy disposition.  During the six months ended June 30, 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 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 June 30, 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.

Results of Operations

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 businesses.

The following table sets forth our operations for the three and six months ended June 30, 2008 and 2007.  As discussed in Notes 1, 2, and 3 to the consolidated financial statements included in this Form 10-Q, 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 primary assets we retained from INTAC were the indefinite-lived Internet Licenses intangible and no revenue was realized from this asset in 2007 or through the six months ended June 30, 2008.

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