FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2001
Commission file number: 0-26109
NETTAXI.COM
(Exact name of registrant as specified in its charter)
Nevada 82-0486102
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
1875 South Bascom Ave., No. 116, Campbell, CA 95008
(Address of Principal Executive Offices)
(Zip Code)
Registrant's telephone number, including area code: (408) 879-9880
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 [X] No [ ]
Applicable Only To Corporate Issuers:
As of August 6, 2001, the registrant had 43,124,586 shares of common stock,
$.001 par value per share, outstanding.
NETTAXI.COM
CONTENTS
Page No.
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PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets, as of June 30, 2001 (unaudited) and
and December 31, 2000 3
Condensed Consolidated Statements of Operations for the Three and Six Months Ended
June 30, 2001 (unaudited) and June 30, 2000 (unaudited) 4
Condensed Consolidated Statements of Shareholders' Equity, June 30, 2001 (unaudited) 5
Condensed Consolidated Statements of Cash Flows for the Six Months Ended
June 30, 2001 (unaudited) and June 30, 2000 (unaudited) 6
Notes to Condensed Consolidated Financial Statements (unaudited) 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 11
Item 3. Quantitative and Qualitative Disclosures About Market Risk 32
PART II OTHER INFORMATION
Item 1. Legal Proceedings 32
Item 2. Changes in Securities and Use of Proceeds 33
Item 3. Defaults Upon Senior Securities 33
Item 4. Submission of Matters to a Vote of Security Holders 33
Item 5. Other Information 33
Item 6. Exhibits and Reports on Form 8-K 33
SIGNATURES 35
EXHIBIT INDEX 36
2
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NETTAXI.COM
CONDENSED CONSOLIDATED BALANCE SHEETS
=================================================================================================
December 31, June 30,
2000 2001
- -------------------------------------------------------------------------------------------------
(Unaudited)
ASSETS
Current Assets:
Cash and cash equivalents $ 13,894,700 $ 10,124,800
Accounts receivable, net of allowance for doubtful accounts
of $433,000 and $344,700, respectively 775,100 340,000
Prepaid expenses and other assets 1,035,000 590,500
- -------------------------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 15,704,800 11,055,300
- -------------------------------------------------------------------------------------------------
PROPERTY AND EQUIPMENT, net 1,748,300 988,200
PURCHASED TECHNOLOGY, net 319,000 --
OTHER INTANGIBLES, net 55,000 --
DEFERRED EXPENSE 272,500 --
DEPOSITS 24,000 29,800
- -------------------------------------------------------------------------------------------------
$ 18,123,600 $ 12,073,300
=================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 1,162,400 $ 990,500
Accrued expenses 397,900 572,100
- -------------------------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 1,560,300 1,562,600
- -------------------------------------------------------------------------------------------------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY:
Preferred stock, $0.001 par value; 1,000,000 shares authorized;
no shares issued and outstanding -- --
Common stock, $0.001 par value; 200,000,000 shares
authorized; 43,124,586 shares issued and outstanding 43,100 43,100
Additional paid-in capital 44,637,900 44,802,900
Deferred compensation (429,900) --
Accumulated deficit (27,687,800) (34,335,300)
- -------------------------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY 16,563,300 10,510,700
- -------------------------------------------------------------------------------------------------
$ 18,123,600 $ 12,073,300
=================================================================================================
3
NETTAXI.COM
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
=======================================================================================
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
2000 2001 2000 2001
- ---------------------------------------------------------------------------------------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
NET REVENUES $ 2,984,900 $ 869,700 $ 5,749,800 $ 2,062,200
OPERATING EXPENSES:
Cost of operations 1,921,800 2,151,900 3,695,300 4,105,700
General and administrative 1,221,500 2,508,700 2,689,000 3,585,000
Sales and marketing 2,073,700 489,000 3,837,000 932,100
Research and development 373,300 128,200 830,400 381,300
- ---------------------------------------------------------------------------------------
TOTAL OPERATING EXPENSES 5,590,300 5,277,800 11,051,700 9,004,100
- ---------------------------------------------------------------------------------------
LOSS FROM OPERATIONS (2,605,400) (4,408,100) (5,301,900) (6,941,900)
OTHER INCOME (EXPENSE):
Interest income 221,000 124,500 247,000 303,800
Interest expense (4,077,200) (2,600) (4,174,900) (9,400)
- ---------------------------------------------------------------------------------------
LOSS BEFORE INCOME TAXES (6,461,600) (4,286,200) (9,229,800) (6,647,500)
INCOME TAXES -- -- (800) --
- ---------------------------------------------------------------------------------------
NET LOSS $(6,461,600) $(4,286,200) $(9,230,600) $(6,647,500)
=======================================================================================
BASIC AND DILUTED LOSS PER
COMMON SHARE $ (0.15) $ (0.10) $ (0.25) $ (0.15)
=======================================================================================
WEIGHTED-AVERAGE COMMON SHARES
OUTSTANDING 41,836,456 43,124,586 36,315,563 43,124,586
=======================================================================================
4
NETTAXI.COM
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
==================================================================================================================
Common Stock Additional
------------------------- Paid-in Deferred Accumulated
Shares Amount Capital Compensation Deficit Total
- ------------------------------------------------------------------------------------------------------------------
BALANCES, December 31, 2000
(Audited) 43,124,586 $ 43,100 $44,637,900 $ (429,900) $(27,687,800) $16,563,300
Amortization of deferred
compensation -- -- -- 429,900 -- 429,900
Options granted for services -- -- 165,000 -- -- 165,000
Net loss -- -- -- -- (6,647,500) (6,647,500)
- ------------------------------------------------------------------------------------------------------------------
BALANCES, June 30, 2001
(Unaudited) 43,124,586 $ 43,100 $44,802,900 $ -- $(34,335,300) $10,510,700
5
NETTAXI.COM
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
=================================================================================================
Six Months Ended June 30,
--------------------------
2000 2001
- -------------------------------------------------------------------------------------------------
(Unaudited) (Unaudited)
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Loss $(9,230,600) $(6,647,500)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 536,200 847,000
Loss on disposal of equipment -- 356,100
Allowance for doubtful accounts 177,000 (88,300)
Issuance of common stock for interest on convertible notes 119,900 --
Issuance of common stock for services 357,100 955,700
Compensation expense related to options and warrants granted 364,200 513,100
Interest expense related to settlement agreement 2,400,000 --
Interest expense related to issuance of warrants 1,655,000 --
Changes in operating assets and liabilities:
Accounts receivable (805,700) 523,400
Prepaid expenses and other assets (187,500) (156,900)
Accounts payable (1,282,400) (171,900)
Accrued expenses 113,800 174,200
Income taxes payable (125,600) --
- -------------------------------------------------------------------------------------------------
NET CASH USED IN OPERATING ACTIVITIES (5,908,600) (3,695,100)
- -------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Deposits 19,600 (5,800)
Capital expenditures (354,400) (69,000)
- -------------------------------------------------------------------------------------------------
NET CASH USED IN INVESTING ACTIVITIES (334,800) (74,800)
- -------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment on obligations under capital lease (3,600) --
Net proceeds from issuance of common stock 21,993,500 --
- -------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 21,989,900 --
- -------------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 15,746,500 (3,769,900)
CASH AND CASH EQUIVALENTS, beginning of period 987,700 13,894,700
- -------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, end of period $16,734,200 $10,124,800
=================================================================================================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
CASH PAID:
Income taxes $ 97,400 $ --
Interest $ -- $ 9,400
NONCASH INVESTING AND FINANCING ACTIVITIES:
Issuance of common stock for convertible notes payable
plus accrued interest $ 3,319,900 $ --
Issuance of common stock for consulting services $ 584,000 $ --
Issuance of common stock for trade payables $ 1,558,000 $ --
=================================================================================================
6
NETTAXI.COM
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF ACCOUNTING POLICIES
THE COMPANY
Nettaxi.com is a Nevada Corporation, which was incorporated on October 26, 1995.
The Company's principal executive offices are located in Campbell, California.
CONSOLIDATION
The accompanying condensed consolidated financial statements include the
accounts of Nettaxi.com and its wholly-owned subsidiary, Nettaxi Online
Communities, Inc. All intercompany accounts and transactions have been
eliminated in the consolidated financial statements.
USE OF ESTIMATES
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the consolidated
financial statements and the reported amounts of revenues and expenses during
the reporting period. Acutal results could differ from those estimates.
BASIS OF PRESENTATION
The unaudited condensed consolidated interim financial statements reflect all
adjustments (which include only normal, recurring adjustments), which are, in
the opinion of management, necessary to state fairly the results for the periods
presented. The results for the three and six month periods ended June 30, 2001
are not necessarily indicative of the results expected for the full fiscal year
or for any future period. The unaudited historical financial statements included
herein have been prepared in accordance with instructions for Form 10-Q and,
therefore, do not include all information and footnotes necessary for a complete
presentation of the Company's results of operations, financial position and cash
flows. These financial statements should be read in conjunction with the
consolidated financial statements and related notes included in the Company's
Annual Report on Form 10-K for the fiscal year ended December 31, 2000.
REVENUE RECOGNITION AND DEFERRED REVENUE
The Company's revenues are derived from the sale of banner advertisements, web
hosting services and from products from its online malls. Advertising revenues
are recognized in the period in which the advertisement is delivered, provided
that collection of the resulting receivable is probable. Advertisers are charged
on a per impression or delivery basis up to a maximum as specified in the
contract. To date, the duration of the Company's advertising commitments has not
exceeded one year. When the Company guarantees a minimum number of impressions
or deliveries, revenue is recognized ratably in proportion to the number of
impressions or deliveries recorded to the minimum number of impressions and
7
deliveries guaranteed. Web hosting revenues are recognized in the period in
which the services are provided. Product revenue is recognized upon shipment,
provided no significant obligations remain and collectability is probable.
Advertising revenue include barter transactions, which are the exchange by
Nettaxi.com of advertising space on Nettaxi.com's web sites for reciprocal
advertising space on other web sites or advertising media. Revenues from these
barter transactions are recorded as advertising revenues at the lower of the
estimated fair value of the advertisements received or delivered and are
recognized when the advertisements are run on Nettaxi.com's web sites. Barter
expenses are recorded when Nettaxi.com's advertisements are run on the
reciprocal web sites, which is typically in the same period as when
advertisements are run on Nettaxi.com's web sites. Barter revenues and related
expenses for the three and six months ended June 30, 2000 were approximately
$655,000 and $1.3 million, respectively, representing 22% and 23% of total net
revenues, respectively. There were no Barter revenues and related expenses in
the six months ended June 30, 2001.
In November 1999, the Financial Accounting Standards Board (FASB) issued
Emerging Issues Task Force (EITF) Issue 99-17 "Accounting for Advertising Barter
Transactions". Under EITF 99-17, revenues and expenses should be recognized from
advertising barter transactions at the fair value of the advertising surrendered
or received only when the company has a historical practice of receiving or
paying cash for such transactions. As of June 30, 2001, the Company was in
compliance with EITF 99-17.
Royalty revenues are earned on sales of the Company developed CD-Rom "Internet
the City" by third party distributors. Third party distributors package the
CD-Rom with their products for sale to the end-user. The distributor remits
payment to the Company 90 days after the sales of their product to the end-user
and the end-user does not have a right of return. The Company recognizes these
revenues only upon receipt of payment from the distributor. The Company did not
earn any royalty revenues in the six months ended June 30, 2001.
The Company is in contract with several partners in revenue and expense sharing
agreements. The agreements provide for the Company to earn revenues based on
the sale of third-party suppliers products. For those transactions, where the
Company receives either a percentage of the transaction or a fixed fee, revenues
are recorded net. As of June 30, 2001, the Company has not earned any revenues
or expenses related to these contracts.
The Company charges its co-hosting customers one-time installation fees. Prior
to January 31, 2001, the Company recognized these fees upon completion of the
installation. Upon Issuance of SEC SAB 101 issued on December 3, 1999 one-time
installation fees are to be deferred and systematically recognized as the
products and/or services are delivered and/or performed over the term of the
arrangement or the expected period of performance that the fees are earned. The
Company did not recognize any one-time installation fees in 2001.
Our premium subscribers are charged web-site development fees to develop their
web-site upon request. These fees charged and the costs to develop these sites
8
by the Company are nominal. The Company defers the recognition of the fees
charged over the period of the contract. For the six months ended June 30,
2001, the Company did not earn any web-site development fee.
In December 1999, the staff of the Securities and Exchange Commission (SEC)
issued its Staff Accounting Bulletin (SAB) No. 101, "Revenue Recognition". SAB
No. 101 provides the SEC staff's views in applying generally accepted accounting
principles to selected revenue recognition issues. SAB No. 101 is effective for
the fourth fiscal quarter of fiscal years beginning after December 15, 1999.
The Company believes that its current revenue recognition policies comply with
the provisions of SAB No. 101.
LONG-LIVED ASSETS
The Company periodically reviews its long-lived assets for impairment. When
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable, the Company writes the asset down to its fair value. The
Company periodically reviews other intangible assets to evaluate whether events
or changes have occurred that would suggest an impairment of carrying value. An
impairment would be recognized when expected future operating cash flows are
lower than the carrying value. Property and equipment are stated at cost.
Depreciation is provided using the straight-line method over the estimated
economic useful lives of the assets, generally ranging from three to five years.
The Company amortizes, on a straight-line basis, the cost of purchased
technology and other intangibles over the shorter of five years or the useful
life of the related technology or underlying asset.
ADOPTION OF NEW ACCOUNTING PRONOUNCEMENTS
In September 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities". SFAS No. 133, as amended by SFAS No 138,
requires companies to recognize all derivatives contracts as either assets or
liabilities in the balance sheet and to measure them at fair value. If certain
conditions are met, a derivative may be specifically designated as a hedge, the
objective of which is to match the timing of gain or loss recognition on the
hedging derivative with the recognition of (i) the changes in the fair value of
the hedged asset or liability that are attributable to the hedged risk or (ii)
the earnings effect of the hedged forecasted transaction. For a derivative not
designated as a hedging instrument, the gain or loss is recognized in income in
the period of change. In September 1999, the FASB issued SFAS No. 137,
"Accounting for Derivative Instruments and Hedging Activities - Deferral of the
Effective Date of FASB Statement No. 133", which amends SFAS No. 133 to be
effective for all fiscal quarters of all fiscal years beginning after September
15, 2000. The Company has not entered into derivative contracts either to hedge
existing risks or for speculative purposes. Accordingly, the Company's adoption
of the new standard did not have a material impact on the Company's results from
operations, financial position or cash flows.
In March 2000, the Financial Accounting Standards Board issued Interpretation
(Interpretation) No. 44, "Accounting for Certain Transactions involving Stock
Compensation, an Interpretation of ABP Opinion No. 25", which became effective
July 1, 2000. Interpretation No. 44 clarifies (a) the definition of employee
for purposes of applying Opinion 25, (b) the criteria for determining whether a
stock compensation plan qualifies as a noncompensatory plan, (c) the accounting
consequences of various modifications to the terms of a previously fixed stock
9
option or award, and (d) the accounting for an exchange of stock compensation
awards in a business combination. Adoption of the provisions of the
Interpretation had no significant impact on the Company's financial statements.
In June 2001, the Financial Accounting Standards Board (FASB) finalized
Statement No. 141, Business Combinations (SFAS 141), and No. 142, Goodwill and
Other Intangible Assets (SFAS 142). SFAS 141 requires the use of the purchase
method of accounting and prohibits the use of the pooling-of-interests method of
accounting for business combinations initiated after June 30, 2001. SFAS 141
also requires assets meet certain criteria. SFAS 141 applies to all business
combinations initiated after June 30, 2001 and for purchase business
combinations completed on or after July 1, 2001. It also requires that the
Company, upon adoption of SFAS 142, reclassify the carrying amounts of
intangible assets and goodwill based on the criteria in SFAS 141.
SFAS 142 requires, among other things, that companies no longer amortize
goodwill, but instead test goodwill for impairment at least annually. In
addition, SFAS 142 requires that the Company identify reporting units for the
purposes of assessing potential future impairments of goodwill, reassess the
useful lives of other existing recognized intangible assets, and cease
amortization of intangible assets with an indefinite useful life. An intangible
asset with an indefinite useful life should be tested for impairment in
accordance with the guidance in SFAS 142. SFAS 142 is required to be applied in
fiscal years beginning after December 15, 2001 to all goodwill and other
intangible assets recognized at that date, regardless of when those assets were
initially recognized. SFAS 142 requires the Company to complete a transitional
goodwill impairment test six months from the date of adoption. The Company is
also required to reassess the useful lives of other intangible assets within the
first interim quarter after adoption of SFAS 142.
The Company does not expect the adoption of SFAS 141 and SFAS 142 to have a
material effect on its consolidated results of operations or financial position,
but it is currently assessing and has not yet determined the impact the adoption
will have.
BASIC AND DILUTED LOSS PER COMMON SHARE
Basic loss per common share is determined by dividing loss available to common
shareholders by the weighted average number of common shares outstanding.
Diluted per-common-share amounts assume the issuance of common stock for all
potentially dilutive equivalent shares outstanding. Anti-dilution provisions of
SFAS 128 require consistency between diluted per-common-share amounts and basic
per-common-share amounts in loss periods. For the periods reported, there were
no differences between basic and diluted earnings per share.
COMMITMENTS AND CONTINGENCIES
Nettaxi.com acquired certain technology from SSN Properties, which in turn
acquired these assets through the foreclosure of convertible notes issued by
Simply Interactive, Inc. Certain minority shareholders of Simply Interactive,
Inc. are disputing the transfer of assets to, ultimately, Nettaxi.com.
Management believes that the group's claims are without merit and therefore that
any settlement relating to these claims will not have a material adverse effect
on the financial position of the Company.
10
On May 1, 2001 seven shareholders of Nettaxi filed an action against the
Company. The complaint also names the Company's Chief Executive Officer,
President and former Chief Financial Officer as additional defendants. The
complaint alleged that the Company violated securities laws in connection with
its February 2000 private placement. The complaint was amended on May 23, 2001.
The amendment addressed factual matters and added three new plaintiffs to the
lawsuit. Shortly after filing the amended complaint, The Company, pursuant to
the rules of the District Court, met with plaintiffs and pointed out further
factual inaccuracies and deficiencies. Plaintiffs then chose to attempt to amend
their complaint for a second time. Six of the plaintiffs purchased shares of
Nettaxi common stock in the February 2000 private placement. Prior to filing the
complaint, the plaintiffs demanded the refund of all of the money invested in
Nettaxi and demanded that the exercise price of the warrants issued in the
private placement be reduced from $4.00 to $0.25 per share. Additionally, prior
to filing the complaint, Nettaxi was asked to invest capital in a company
affiliated with one of the plaintiffs. In the complaint, the plaintiffs seek
compensatory damages, injunctive relief and fees and interest. Management
believes that the allegations made in the complaint are without merit and that
this lawsuit reflects shareholder frustration over the recent downturn in the
stock market and will defend the action vigorously.
SUBSEQUENT EVENTS
From time to time, in the normal course of business, various claims are made
against the Company. At this time, in the opinion of management, there are no
pending claims, the outcome of which is expected to result in a material adverse
effect on the financial position of the Company.
In May 2001, the Company entered into an agreement with an investment banker to
provide, on a semi-exclusive basis, services in connection with identifying a
potential merger candidate and to assist in negotiating and effecting a
transaction. The terms of the agreement provide for compensation to be paid to
the investment banker upon the successful closing of a transaction in the amount
of 5% of the total amount of the transaction up to $3 million and 2% of the
remaining amount of the transaction, payable, at the election of the investment
banker, in cash or common stock of the Company and a warrant exercisable to
purchase up to 5% of the Company's common stock at a purchase price as defined
in the agreement.
Effective July 7, 2001, the Company terminated its significant co-hosting
customer contracts and, in connection therewith, discontinued its purchase of
bandwidth. The termination will materially affect the Company's revenues
beginning in the third quarter of 2001.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
THIS REPORT CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF
SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE SECURITIES
EXCHANGE ACT OF 1934, INCLUDING, WITHOUT LIMITATION, STATEMENTS REGARDING OUR
EXPECTATIONS, BELIEFS, INTENTIONS OR FUTURE STRATEGIES THAT ARE SIGNIFIED BY THE
WORDS "EXPECTS", "ANTICIPATES", "INTENDS", "BELIEVES", OR SIMILAR LANGUAGE.
THESE FORWARD-LOOKING STATEMENTS INVOLVE RISKS, UNCERTAINTIES AND OTHER FACTORS.
ALL FORWARD-LOOKING STATEMENTS INCLUDED IN THIS DOCUMENT ARE BASED ON
INFORMATION AVAILABLE TO US ON THE DATE HEREOF AND SPEAK ONLY AS OF THE DATE
HEREOF. THE FACTORS DISCUSSED BELOW UNDER "RISK FACTORS" AND ELSEWHERE IN THIS
11
QUARTERLY REPORT ON FORM 10-Q ARE AMONG THOSE FACTORS THAT IN SOME CASES HAVE
AFFECTED OUR RESULTS AND COULD CAUSE THE ACTUAL RESULTS TO DIFFER MATERIALLY
FROM THOSE PROJECTED IN THE FORWARD-LOOKING STATEMENTS.
The following discussion should be read in conjunction with the condensed
consolidated financial statements and notes thereto.
OVERVIEW
Nettaxi.com is an Internet marketing portal that provides a wide range of
content and Internet based services for consumers and businesses. Our web site
at www.nettaxi.com serves as a gathering place for people with shared topics of
interest, as well as an entry point, referred to as a portal, to the Internet.
Through our web site, we provide content addressing a large number of targeted
categories. Subscribers to our web site are also provided with access to
enhanced content such as broadband video clips and email accounts. In 1999, we
developed a diversified revenue model under which we provided subscribers with
access to web site hosting services and a broad range of content, and we
provided affiliated businesses with access to a large population of Internet
users for advertising and promotional purposes. We also provided web site
hosting and Internet connectivity services for corporate customers.
Beginning in April 2001, the bankruptcy and liquidation of many of our
Internet based customers and suppliers caused us to re-evaluate our business
model. Since the Internet infrastructure is unstable and customer base
financially weak, we have begun to take corrective action to significantly
decrease cash burn and determine the best course of action to maintain and
enhance the value of our company. In this regard, we implemented an acquisition
strategy pursuant to which we have been seeking to identify an appropriate
entity with which to merge, acquire or restructure our current business. We have
been reviewing a number of potential merger candidates in a wide variety of
industries.
Beginning in June 2001, we reduced our overhead and burn rate by reducing
the salaries of our employees, reducing personnel, marketing expenses and costs
associated with our hosting activities. Our current management team, consisting
of finance and administrative employees, is in place to maintain our operations
and enable our ongoing review and analysis of acquisition candidates and to
assist us in the consummation of an appropriate transaction. We have also
engaged the services of an investment banker, to assist us in this process. As
of the date of this quarterly report on Form 10-Q, we have not determined a
suitable candidate with which to complete a transaction and there can be no
assurance that we will be able to identify an appropriate candidate that will
enhance the value of our company.
We continue to operate our website and sell advertising products, but these
revenues will be significantly lower than prior periods. We do not expect these
revenues to grow in light of the changing market conditions and the recent
actions taken by us.
During the six months ended June 30, 2001 we provided web site hosting and
Internet connectivity services for corporate customers. Our services were
delivered through a state-of-the-art Internet data center located in Southern
California using a high-performance Internet backbone network. Customers paid
monthly fees for the professional services utilized, one-time installation fees,
and connectivity charges. These "hosting" revenues were recognized in the period
the services were provided. Hosting revenues were variable, based upon bandwidth
usage and services used, and resulted in operating losses from time to time. In
June 2001, we terminated our significant co-hosting customer contracts effective
July 7, 2001. In connection with this, we have also discontinued the purchase of
bandwidth and premium services from our third party provider, further reducing
monthly expenditures. The terminations will reduce our operating expenses, but
materially affect our revenues beginning in the third quarter of 2001. In spite
of the above, there can be no assurance that our operating losses will not
increase in the future.
12
In February 2000, we completed our private placement, which raised
approximately $23 million in exchange for issuance of our common stock and
warrants to purchase shares of our common stock. The acquisition of this new
capital enabled us to fund our operations and become a more aggressive
competitor in the community portal arena. However, the bankruptcy and
liquidation of many of our Internet based customers and suppliers prevented us
from taking advantage of our efforts. Market conditions forced us to re-evaluate
our business model. Since the Internet infrastructure is unstable and customer
base financially weak, we have begun to take corrective action to significantly
decrease cash burn and determine the best action to become a profitable company.
We plan to continue our operations while seeking potential acquisitions,
mergers, and other strategic partnerships which could enhance the value of our
company. Acquisitions carry numerous risks and uncertainties and we cannot
guarantee that we will be able to successfully integrate any businesses,
products, technologies or personnel that might be acquired in the future. As of
the date of this quarterly report on Form 10-Q, we have not determined a
suitable candidate with which to complete a transaction and there can be no
assurance that we will be able to identify an appropriate candidate that will
enhance the value of our company.
RESULTS OF OPERATIONS - COMPARISON OF THE THREE MONTHS ENDED JUNE 30, 2001 AND
2000.
NET REVENUES. Net revenues for the three months ended June 30, 2001 were
$0.87 million compared with $2.98 million for the three months in 2000. The
substantial decrease is primarily the result of significantly lower advertising
revenues recognized in the year 2001. The decline is also the result of
discontinued utilization of reciprocal advertising agreements. Reciprocal
advertising arrangements are exchanges of similar services between us and the
advertiser. For the three months ended June 30, 2000, we recognized
approximately $655,000 or 22% of net revenues from reciprocal advertising
agreements. There were no reciprocal advertising revenues recognized in 2001.
13
For the three months ended June 30, 2001, three customers each accounted
for greater than 10% of total net revenues for a total of approximately $0.83
million or 95% of the total net revenues. These customers, Babenet, Whitesand
Communications, and Whitehorn Ventures Limited, accounted for 51%, 18%, and 26%,
respectively of our total revenues. All three of these customers are co-hosting
customers. For the three months ended June 30, 2000, four customers, Babenet,
CollegeClub.com, Hearme.com, Spinrecords.com, each accounted for greater than
10% of total net revenues for a total of approximately $1.67 million or 56% of
the total revenues. In June 2001, we terminated our significant co-hosting
customer contracts effective July 7, 2001, which will materially affect revenues
beginning in the third quarter of 2001.
ADVERTISING REVENUES. Advertising revenues for the three months ended June
30, 2001 and 2000 were approximately $41,400 and approximately $2.1 million,
respectively, which represented 5% and 72%, respectively, of total net revenues.
The decline in absolute dollars resulted from the discontinued use of reciprocal
advertising transactions and decreases in the number of advertisers and the
decrease in the average rate paid by these advertisers. The decline also
resulted from the bankruptcy and liquidation of many of our customers. This lead
to the tightening of our credit terms and the loss of many customers. Also, we
initiated several cost savings strategies in the first quarter of 2001, which
resulted in cancellation of advertising arrangements by our customers which
decided that these new strategies did not meet their criteria for advertising
promotions. Also, in the first quarter of 2001, we terminated our free hosting
arrangements for its citizens, which resulted in decreased page views and
therefore decreased the number of banner advertisements served. We believe that
the revenues from the sale of banner advertisements can no longer justify the
cost of purchasing bandwidth. Reciprocal advertising arrangements accounted for
approximately 0% and 22% of total revenues for the three months ended June 30,
2001 and 2000, respectively. Reciprocal arrangements were used in our strategy
in developing strategic relationships with other advertisers or service
providers for non-cash media advertising. We no longer utilize these agreements
as the return on investment for these agreements no longer benefits us. We
continue to operate our website and sell advertising products, but these
revenues will be significantly lower than prior periods. We do not expect these
revenues to grow in light of the changing market conditions and the recent
actions taken by us.
HOSTING REVENUES. Our hosting revenues were approximately $0.83 million for
both the three months ended June 30, 2001 and 2000, which represented 95% and
28%, of total net revenues, respectively. For the three months ended June 30,
2001, hosting revenues were a higher percentage of total net revenue as
advertising revenues significantly decreased in the three months ended June 30,
2001. Our services are delivered through a state-of-the-art Internet data center
located in Southern California using a high-performance Internet backbone
network. Customers pay monthly fees for the professional services utilized,
one-time installation fees, and monthly connectivity charges. These hosting
revenues were recognized in the period the services were provided. We did not
receive any one-time installation fees in the second quarter of 2001 and 2000,
respectively. Hosting revenues were variable, based upon bandwidth usage and
services used, and resulted in operating losses from time to time. In June 2001,
we terminated our significant co-hosting customer contracts effective July 7,
2001, which will materially affect revenues beginning in the third quarter of
2001.
COST OF OPERATIONS. Cost of operations were approximately $2.15 million
and $1.92 million for the three months ended June 30, 2001 and 2000,
respectively. Cost of operations increased as a result of the increased costs
related to the traffic directive arrangements. These contracts were terminated
14
in July 2001. The above increase was offset by lower bandwidth costs.
Beginning in February 2001 we changed our web hosting provider to Alchemy
Communications, a carrier in Southern California. This new provider provides
similar services but at substantial cost saving to us. We entered into traffic
directive arrangements whereas selected web traffic or page views are diverted
to interest specific areas of our website and advertisements. These
arrangements require special tools and costs to third parties. We began these
new arrangements in the fourth quarter 2000. These cost represented
approximately 39% or approximately $844,000 of total cost of operations for the
three months ended June 30, 2001. There were no similar costs in the three
months ended June 30, 2000.
SALES AND MARKETING EXPENSES. Sales and marketing expenses were
approximately $489,000 and $2.07 million for the three months ended June 30,
2001 and 2000, respectively. The decline in sales and marketing expenses was
primarily attributable to the discontinued use of reciprocal online advertising
arrangements to increase brand awareness and traditional print and media
marketing advertising. The decline was also attributable to the decrease in
salaries expense for personnel as the result of decreased personnel which
included an agreement reached with our Vice President of Sales and Marketing,
Mr. Robert Speicher, pursuant to which he voluntarily resigned as an officer of
our company. We recorded reciprocal advertising expenses in relation to the
reciprocal advertising revenues of $655,000 for the three months ended June 30,
2000. There were no similar expenses in 2001. Also, approximately $1.0 million
of the decline in sales and marketing expense was achieved through the reduction
in spending on traditional marketing media expenditures.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses were
approximately $128,200 and $373,300 for the three months ended June 30, 2001 and
2000, respectively. The decline in expense was primarily attributable to the
decrease in salaries expense for personnel as the result of decreased personnel.
We terminated all research and development personnel in the beginning of the
second quarter 2001. Currently, we have no hiring plan in effect for
replacement of these individuals. We plan to utilize consultants for any
technical projects. As of August 2001, we have not engaged any technical
consultants.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
were approximately $2.51 million and $1.22 million for the three months ended
June 30, 2001 and 2000, respectively. General and administrative costs consisted
primarily of salaries and related costs for executives, administrative, and
finance personnel, as well as legal, accounting and other professional service
fees. Approximately $0.9 million of the increase in general and administrative
expenses were primarily attributable to the accelerated amortization of deferred
costs related to the issuance of common stock for services and compensation
expense related to options and warrants granted. In addition to the above we
recognized a write-down of approximately $356,100 on capital equipment that we
have disposed of during our move to smaller facilities in the June 2001. Due to
the market conditions, we were unable to sell the capital equipment and the
costs for storage and moving the equipment would have exceeded any gain realized
on the sale. In June 2001 we negotiated an early termination of our facilities
lease and recognized a one-time charge of approximately $94,000, which included
a forfeited deposit. This fee was necessary as a result of the excessive lease
space that became available in the last several months and because of market
conditions in the San Francisco Bay Area. We entered into a new facilities lease
of smaller space in Campbell, California. We believe that this space will be
sufficient to conduct our current activities. We also recognized approximately
$141,000 in one-time costs associated with the termination of our intended
acquisition with LookupGuide.com.
15
INTEREST EXPENSE. Interest expense was approximately $2,600 and $4,077,200
for the three months ended June 30, 2001 and 2000, respectively. For the year
2000 period, the net interest expense was primarily the result of non-cash
deemed interest expense related to the implied beneficial conversion feature and
the value of warrants issued in connection with the settlement agreement that we
reached with the holder of the convertible debentures issued on June 30, 1999.
The convertible note was fully converted in the second quarter of 2000 and
therefore no interest expense was recorded on this note in 2001.
INTEREST INCOME. Interest income was approximately $124,500 and $221,000
for the three months ended June 30, 2001 and 2000, respectively. The decrease
was the result of the higher average cash and cash equivalents during the three
months ended June 30, 2000. This higher average cash balance was the result of
the issuance of common stock in a private placement offering in February 2000.
INCOME TAXES. At December 31, 2000, we had net operating loss
carryforwards available to reduce future taxable income that aggregate
approximately $25.1 million for Federal income tax purposes. These benefits
begin to expire in 2017. We also had California net operation loss
carryforwards in the amount of $13.4 million, which may be applied to future
taxable income until these benefits begin to expire in 2002. Our ability to
utilize the net operating loss carryforwards are dependent upon our ability to
generate taxable income in future periods and may be limited due to restrictions
imposed under Federal and state laws upon change in ownership.
RESULTS OF OPERATIONS - COMPARISON OF THE SIX MONTHS ENDED JUNE 30, 2001 AND
2000.
NET REVENUES. Net revenues for the six months ended June 30, 2001 were
$2.06 million compared with $5.75 million for the six months in 2000. The
substantial decrease is primarily the result of significantly lower advertising
revenues recognized in the six months ended June 30, 2001. The decline is also
the result of discontinued utilization of reciprocal advertising agreements.
For the six months ended June 30, 2000, we recognized approximately $1.3 million
or 23% of net revenues from reciprocal advertising agreements. There were no
reciprocal advertising revenues recognized in the six months ended June 30,
2001.
For the six months ended June 30, 2001, three customers each accounted for
greater than 10% of total net revenues for a total of approximately $1.86
million or 90% of the total revenues. These customers, Babenet, Whitesand
Communications, and Whitehorn Ventures Limited, accounted for 46%, 19%, and 25%,
respectively of our total revenues. All three of these customers are co-hosting
customers. For the six months ended June 30, 2000, four customers, Babenet,
Internet Fuel.com, Hearme.com, Spinrecords.com, each accounted for greater than
10% of total net revenues for a total of approximately $3.09 million or 54% of
the total revenues. In June 2001, we terminated our significant co-hosting
customer contracts effective July 7, 2001, which will materially affect revenues
beginning in the third quarter of 2001.
16
ADVERTISING REVENUES. Advertising revenues for the six months ended June
30, 2001 and 2000 were approximately $171,800 and approximately $3.91 million,
respectively, which represented 8% and 68%, respectively, of total net revenues.
The decline in absolute dollars resulted from the discontinued use of reciprocal
advertising transactions and decreases in the number of advertisers and the
decrease in the average rate paid by these advertisers. The decline also
resulted from the bankruptcy and liquidation of many of our customers. This lead
to the tightening of our credit terms and the loss of many customers. Also, we
initiated several cost savings strategies in the first quarter of 2001, which
resulted in cancellation of advertising arrangements by our customers which
decided that these new strategies did not meet their criteria for advertising
promotions. Also, in the first quarter of 2001, we terminated our free hosting
arrangements for our citizens, which resulted in decreased page views and
therefore decreased the number of banner advertisements served. We believe that
the revenues from the sale of banner advertisements can no longer justify the
cost of purchasing bandwidth. Reciprocal advertising arrangements accounted for
approximately 0% and 23% of total revenues for the six months ended June 30,
2001 and 2000, respectively. Reciprocal arrangements were used in our strategy
in developing strategic relationships with other advertisers or service
providers for non-cash media advertising. We no longer utilize these agreements
as the return on investment for these agreements no longer benefits us. We
continue to operate our website and sell advertising products, but these
revenues will be significantly lower than prior periods. We do not expect these
revenues to grow in light of the changing market conditions and the recent
actions taken by us.
HOSTING REVENUES. Our hosting revenues were approximately $1.89 million and
$1.82 million for the six months ended June 30, 2001 and 2000, which represented
91% and 32%, of total net revenues, respectively. For the six months ended June
30, 2001, hosting revenues were a higher percentage of total net revenue as
advertising revenues significantly decreased in the six months ended June 30,
2001. Our services are delivered through a state-of-the-art Internet data center
located in Southern California using a high-performance Internet backbone
network. Customers pay monthly fees for the professional services utilized,
one-time installation fees, and monthly connectivity charges. These hosting
revenues were recognized in the period the services were provided. We did not
receive any one-time installation fees in the six months ended June 30, 2001 and
2000, respectively. Hosting revenues were variable, based upon bandwidth usage
and services used, and resulted in operating losses from time to time. In June
2001, we terminated our significant co-hosting customer contracts effective July
7, 2001, which will materially affect revenues beginning in the third quarter of
2001.
COST OF OPERATIONS. Cost of operations were approximately $4.10 million
and $3.7 million for the six months ended June 30, 2001 and 2000, respectively.
Cost of operations increased as a result of the increased costs related to the
traffic directive arrangements. These contracts were terminated in July 2001.
The above increase was offset by lower bandwidth costs. Beginning in February
2001 we changed our web hosting provider to Alchemy Communications, a carrier in
Southern California. This new provider provides similar services but at
substantial cost saving to us. We entered into traffic directive arrangements
whereas selected web traffic or page views are diverted to interest specific
areas of our website and advertisements. These arrangements require special
tools and costs to third parties. We began these new arrangements in the fourth
quarter 2000. These cost represented approximately 25% or approximately $1.0
million of total cost of operations for the six months ended June 30, 2001.
There were no similar costs in the six months ended June 30, 2000.
SALES AND MARKETING EXPENSES. Sales and marketing expenses were
approximately $932,100 and $3.84 million for the six months ended June 30, 2001
and 2000, respectively. The decline in sales and marketing expenses was
17
primarily attributable to the discontinued use of reciprocal online advertising
arrangements to increase brand awareness and traditional print and media
marketing advertising. The decline was also attributable to the decrease in
salaries expense for personnel as the result of decreased personnel which
included an agreement reached with our Vice President of Sales and Marketing,
Mr. Robert Speicher, pursuant to which he voluntarily resigned as an officer of
our company. We recorded reciprocal advertising expenses in relation to the
reciprocal advertising revenues of approximately $1.3 million for the six months
ended June 30, 2000. There were no similar expenses in 2001. Also, approximately
$1.5 million of the decline in sales and marketing expense was achieved through
the reduction in spending on traditional marketing media expenditures.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses were
approximately $381,300 and $830,400 for the six months ended June 30, 2001 and
2000, respectively. The decline in expense was primarily attributable to the
decrease in salaries expense for personnel as the result of decreased personnel.
We terminated all research and development personnel in the beginning of the
second quarter 2001. Currently, we have no hiring plan in effect for
replacement of these individuals. We plan to utilize consultants for any
technical projects. As of August 2001, we have not engaged any technical
consultants.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
were approximately $3.59 million and $2.69 million for the six months ended June
30, 2001 and 2000, respectively. General and administrative costs consisted
primarily of salaries and related costs for executives, administrative, and
finance personnel, as well as legal, accounting and other professional service
fees. Approximately $0.9 million of the increase in general and administrative
expenses were primarily attributable to the acceleration amortization of
deferred costs related to the issuance of common stock for services and
compensation expense related to options and warrants granted. In addition to the
above we recognized a write-down of approximately $356,100 on capital equipment
that we have disposed of during its move to smaller facilities in the June 2001.
Due to the market conditions, we were unable to sell the capital equipment and
the costs for storage and moving the equipment would have exceeded any gain
realized on the sale. In June 2001 we negotiated an early termination of our
facilities lease and recognized a one-time charge of approximately $94,000,
which included the forfeited deposit. This fee was necessary as a result of the
market conditions in the San Francisco Bay Area. We entered into a facilities
lease of smaller space in Campbell, California. We believe that this space will
be sufficient to conduct our current activities. We also recognized
approximately $141,000 in one-time costs associated with the termination of our
intended acquisition with LookupGuide.com. The above increases were offset
decreases in personnel costs as a result of termination of personnel in the
first and second quarter of 2001.
INTEREST EXPENSE. Interest expense was approximately $9,400 and $4,174,900
for the six months ended June 30, 2001 and 2000, respectively. For the year
2000 period, the interest expense was primarily the result of non-cash deemed
interest expense related to the implied beneficial conversion feature and the
value of warrants issued in connection with the settlement agreement that we
reached with the holder of the convertible debentures issued on March 31, 1999.
The convertible note was fully converted in the second quarter of 2000 and
therefore no interest expense was recorded on this note in 2001.
INTEREST INCOME. Interest income was approximately $303,800 and $247,000
for the six months ended June 30, 2001 and 2000, respectively. The increase is
related to a higher average cash balance for the six months ended June 30, 2001,
which yielded a larger return on investment interest income. The higher average
cash balance in the six months ended June 30, 2001, was the result of the
issuance of common stock in a private placement offering in February 2000 for
which cash proceeds became available in March 2000.
18
INCOME TAXES. At December 31, 2000, we had net operating loss
carryforwards available to reduce future taxable income that aggregate
approximately $25.1 million for Federal income tax purposes. These benefits
begin to expire in 2017. We also had California net operation loss
carryforwards in the amount of $13.4 million, which may be applied to future
taxable income until these benefits begin to expire in 2002. Our ability to
utilize the net operating loss carryforwards are dependent upon our ability to
generate taxable income in future periods and may be limited due to restrictions
imposed under Federal and state laws upon change in ownership.
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 2001, the Company had cash and cash equivalents of approximately
$10.1 million, compared to approximately $13.9 million at December 31, 2000.Net
cash used in operating activities equaled approximately $3.7 million and $5.9
million for the six month periods ended June 30, 2001 and 2000, respectively.
The decline in cash used was related to the decrease of approximately $2.6
million in net loss for the six months ended June 30, 2001 compared to the same
six months ended June 30, 2000. We also had significant negative cash flows
from changes in our operating assets and liabilities for the three months ended
June 30, 2000 compared to the same period in 2001.
Net cash used in investing activities was approximately $74,800 and
$334,800 for the six months ended June 30, 2001 and 2000, respectively.
Substantially all of the cash used in investing activities for both periods was
primarily related to the purchase of capital equipment.
Net cash provided by financing activities was approximately $0 and $22
million for the six months period ended June 30, 2001 and 2000, respectively.
Net cash provided by financing activities in 2000 consisted primarily of net
proceeds from the issuance of our common stock.
We incurred net losses of approximately $6.6 million and $9.2 million for
the six months ended June 30, 2001, and 2000, respectively. At June 30, 2001, we
had an accumulated deficit of approximately $34 million. The net losses and
accumulated deficit resulted from the significant operational, infrastructure
and other costs incurred in the development and marketing of our services and
the fact that revenues failed to keep pace with such costs. Beginning in the
fourth quarter of 2000, we initiated cost reductions in all areas of operations.
In the first quarter of 2001, we switched our bandwidth provider and expect
future costs savings of approximately $2.0 million per year. We are continuing
to review and reduce all expenditures that do not contribute toward our
profitability. There can be no assurance that we will ever achieve or sustain
profitability or that our operating losses will not increase in the future.
We do not have any long-term commitments that currently require a specified
capital budget other than normal operations. We believe that current cash, cash
equivalents and marketable securities balances will be sufficient to meet our
anticipated operating cash needs for at least the next 12 months. With the
current control measures implemented in the first and second quarter of 2001, we
believe that we will be able to continue to direct our effort towards
profitability and in pursuit of our acquisition strategy. We have determined
that we may also need to seek additional capital in connection with a potential
19
merger or acquisition transaction, which might impact our liquidity requirements
or cause us to issue additional equity or debt securities. There can be no
assurance that financing will be available in amounts or on terms acceptable to
us, if at all. We continually evaluate opportunities to sell additional equity
or debt securities, obtain credit facilities from lenders for strategic reasons
or to further strengthen our financial position. The sale of additional equity
or convertible debt securities could result in additional dilution to our
stockholders.
We cannot assure you that we will be able to achieve and sustain positive
cash flow or profitability or that we will have other sources available to
provide the financial resources necessary to continue our operations. If we are
unsuccessful in generating resources from one or more of the anticipated sources
and are unable to replace any shortfall with resources from another source, we
may be able to extend the period for which available resources would be adequate
by deferring the creation or satisfaction of various commitments, deferring the
expansion or introduction of various services, and otherwise scaling back
operations. If we were unable to generate the required resources, our ability
to meet our obligations and to continue our operations would be adversely
affected.
We plan to continue our operations while seeking potential acquisitions,
mergers, and other strategic partnerships which could enhance the value of our
company. Acquisitions carry numerous risks and uncertainties and we cannot
guarantee that we will be able to successfully integrate any businesses,
products, technologies or personnel that might be acquired in the future.
RISK FACTORS
Our business, financial condition or results of operations could be
materially and adversely affected by any of the following risks.
WE HAVE INCURRED LOSSES SINCE OUR INCEPTION, AND EXPECT LOSSES FOR THE
FORESEEABLE FUTURE.
Since our inception, we have incurred net losses, resulting primarily from
costs related to developing our web site, attracting users to our web site and
establishing the Nettaxi.com brand. At December 31, 2000, we had an accumulated
deficit of $27,687,800. Losses have continued to grow faster than our revenues
during our limited operating history. Because of the bankruptcy and liquidation
of many of our Internet based customers and suppliers, we expect to incur
significant net losses for the foreseeable future. We may never achieve
profitability.
ACQUISITIONS MAY DISRUPT OR OTHERWISE HAVE A NEGATIVE IMPACT ON OUR BUSINESS.
We are seeking to acquire or make investments in complementary businesses,
products, services or technologies on an opportunistic basis when we believe
they will enhance the value of our business. We do not have any present
understanding relating to any such acquisition or investment. If we were to buy
a content, service or technology company, the amount of time and level of
resources required to successfully integrate their business operation could be
substantial. The challenges in assimilating their people and organizational
structure, and in encountering potential unforeseen technical issues in
integrating their content, service or technology into ours, could cause
20
significant delays in executing other key areas of our business plan. This
could include delays in integrating other content, services or technology into
our communities, or moving forward on other business development relationships,
as management and employees, both of which are time constrained, may be
distracted. In addition, the key personnel of the acquired company may decide
not to work for us, which could result in the loss of key technical or business
knowledge to us. Furthermore, in making an acquisition, we may have to incur
debt or issue equity securities to finance the acquisition, the issuance of
which could be dilutive to our existing shareholders.
OUR ADVERTISERS ARE EMERGING INTERNET COMPANIES THAT REPRESENT CREDIT RISKS.
Some of our advertisers have limited operating histories, are operating at
a loss, have limited cash reserves or have limited access to capital. If any
significant part of our customer base experiences financial difficulties, is not
commercially successful or is unable to pay our advertising fees for any reason,
our business, operating results and financial condition may be materially and
adversely affected.
SHARES ELIGIBLE FOR FUTURE SALE BY OUR CURRENT STOCKHOLDERS MAY ADVERSELY AFFECT
OUR STOCK PRICE.
Approximately twenty million shares of our common stock are immediately
eligible for sale in the public market without restriction or further
restriction under the Securities Act of 1933, unless purchased by or issued to
any "affiliate" of ours, as that term is defined in Rule 144 promulgated under
that Act. We have filed a registration statement on Form S-1 (File No.
333-36826), declared effective by the Securities and Exchange Commission on June
12, 2000 registering 16,577,365 shares of common stock and warrants to purchase
up to 16,053,484 shares of common stock issued pursuant to private placement
transactions. Additionally, we have filed a registration statement on Form S-1
(File No. 333-38538), declared effective by the Securities and Exchange
Commission on June 21, 2000, registering 1,750,000 shares of common stock and
warrants to purchase up to 2,575,245 shares of common stock pursuant to private
placement transactions. We have also filed a registration statement on Form S-8
(File No. 333-32678) to register 6,300,000 shares of common stock issuable upon
exercise of options granted or to be granted under our 1998 and 1999 stock
option plans. As a result, shares issued upon exercise of stock options are
eligible for resale in the public market without restriction. We also intend to
file a registration statement on Form S-8 to register the additional 5,600,000
shares of common stock under our 1999 Stock Option Plan, as amended. As of June
30, 2001 approximately 6 million additional shares of common stock were eligible
for sale under Rule 144. If our stockholders sell substantial amounts of our
common stock under Rule 144 or pursuant to the aforementioned registration
statements, the market price of our common stock could be adversely affected and
our ability to raise additional capital at that time through the sale of our
securities could be impaired.
FUTURE EXERCISE OF WARRANTS OR ISSUANCES OF SECURITIES MAY SIGNIFICANTLY DILUTE
YOUR HOLDINGS.
There are currently warrants to purchase 18,525,816 shares of our common
stock outstanding and exercisable over the next four to five years having
exercise prices ranging from $1.50 to $12.38, subject to adjustment. The shares
underlying all of these warrants have been registered pursuant to our
registration statements on Form S-1 filed with the Securities and Exchange
Commission as described above. There are also warrants to purchase 1,850,000
shares of our common stock outstanding having exercise prices ranging from of
$0.13 to $0.35 per share. If the holders of our outstanding warrants and other
convertible securities were to exercise their rights, purchasers of our common
stock could experience substantial dilution of their investment.
21
It is likely that we will need to raise additional funds in the future in
order to execute our business plan. If additional funds are raised through the
issuance of equity or convertible debt securities, the percentage ownership of
our stockholders will be reduced, stockholders may experience additional
dilution and such securities may have rights, preferences and privileges senior
to those of our common stock. This may make an investment in our common stock
less attractive to other investors, thereby weakening the trading market for our
common stock.
WE ARE SUBJECT TO THE RISKS AND UNCERTAINTIES FREQUENTLY ENCOUNTERED BY EARLY
STAGE COMPANIES IN NEW AND RAPIDLY EVOLVING MARKETS.
Due to our limited operating history, we are subject to many of the risks
and uncertainties frequently encountered by early stage companies in new and
rapidly evolving markets, such as the Internet. Among other things, we are
faced with the need to establish our credibility with customers, advertising,
content providers, and companies offering e-commerce products and services, and
such parties are often understandably reluctant to do business with companies
that have not had an opportunity to establish a track record of performance and
accountability. For example, our ability to enter into exclusive relationships
to provide content over the Internet will be dependent on our ability to
demonstrate that we can handle high volumes of traffic through our site.
Similarly, early stage companies must devote substantial time and resources to
recruiting qualified senior management and employees at all levels, and must
also make significant investments to establish brand recognition. If we are
unable to overcome some of these obstacles, we may be unable to achieve our
business goals and raise sufficient capital to expand our business.
OUR REVENUE GROWTH IN PRIOR PERIODS IS NOT INDICATIVE OF FUTURE GROWTH AND WE
CANNOT ACCURATELY PREDICT OUR FUTURE REVENUES.
We had revenues of approximately $9,418,400, $5,032,800 and $258,000 for
the years ended December 31, 2000, 1999 and 1998, respectively. While our
growth rate has been strong, it is unlikely that revenue will continue to grow
at this rate in the future and our performance during these periods should not
be taken as being indicative of future trends. We expect current market
conditions to have a material adverse effect on our revenues. We continue to
operate our website and sell advertising products, but these revenues will be
significantly lower than prior periods. We do not expect these revenues to grow
in light of the changing market conditions and the recent actions taken by us.
Additionally, in June 2001, we terminated our significant co-hosting customer
contracts effective July 7, 2001, which will materially affect revenues
beginning in the third quarter of 2001. Approximately $1.28 million of the
revenues for the year ended December 31, 1999 were derived from credit card
transaction processing fees, a revenue stream that has declined significantly
and that we do not believe will be material in future periods. In the year
2000, we generated approximately $2.22 million in revenue from reciprocal
advertising transactions. We anticipate that these arrangements will not be
significant in the future. Accurate predictions regarding our revenues in the
future are difficult and should be considered in light of our limited operating
history and rapid changes in the ever evolving Internet market. For example,
our ability to generate revenues in the future is dependent in part on the
success of our capital-raising efforts and the investments that we intend to
make in sales and marketing, infrastructure, and content development. Our
22
revenues for the foreseeable future will remain primarily dependent on the
number of customers that we are able to attract to our web site, and secondarily
on web hosting, sponsorship and advertising revenues. We cannot forecast with
any degree of certainty the number of visitors to our web site, the number of
visitors who will become customers, or the amount of sponsorship and advertising
revenues.
WE REQUIRE FURTHER CAPITAL TO PURSUE OUR BUSINESS OBJECTIVES.
We currently believe that we have sufficient cash to fund our current
operations through June 2002. However, to fully execute our business plan, we
will be required to seek additional capital. We expect to generate a portion of
the necessary cash flow through advertising and hosting revenues, but will also
need to obtain capital through other sources such as equity or debt financing.
We cannot assure you that we will be able to achieve and sustain positive cash
flow or profitability or that we will have other sources available to provide
the financial resources necessary to continue our operations. No assurances can
be given that we will be able to obtain such additional resources. If we are
unsuccessful in generating anticipated resources from one or more of the
anticipated sources, and unable to replace the shortfall with resources from
another source, we may be able to extend the period for which available
resources would be adequate by deferring the creation or satisfaction of various
commitments, deferring the introduction of various services or entry into
various markets, and otherwise scaling back operations. If we are unable to
generate the required resources, our ability to meet our obligations and to
continue our operations would be adversely affected.
OUR QUARTERLY OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY, THEREBY INCREASING
THE VOLATILITY OF OUR STOCK PRICE
We anticipate that our operating results will fluctuate significantly from
quarter to quarter. These fluctuations may be due to seasonal and cyclical
patterns that have emerged in Internet related spending. For example, the use
of our web site is somewhat lower during periods of the year during the first
and third calendar quarters because of the summer vacation period and post
winter holiday season slowdown. This results in lower revenues for us during
periods of the year. Quarterly results may also vary because it is difficult to
predict the long-term revenue growth of our business. Because of these factors,
we believe that quarter-to-quarter comparisons of our results of operations are
not good indicators of our future performance. If our operating results fall
below the expectations of investors in future periods, then our stock price may
decline.
WE MAY FAIL TO ESTABLISH AN EFFECTIVE INTERNAL SALES ORGANIZATION TO ATTRACT
SPONSORSHIP AND ADVERTISING REVENUES.
To date, we have relied principally on outside advertising agencies to
develop sponsorship and advertising opportunities. We believe that the growth
of sponsorship and advertising revenues will depend on our ability to establish
an aggressive and effective internal sales organization. Our internal sales
team currently has two members. Our ability to increase our sales force involves
a number of risks and uncertainties, including whether or not the current market
conditions will
23
improve, competition and the length of time for new sales employees to become
productive. If we do not develop an effective internal sales force, our
business will be materially and adversely affected by our inability to attract
sponsorship and advertising revenues.
OUR PROJECTED BROADBAND SERVICES AND ENHANCED CONTENT MAY NOT BE LAUNCHED ON A
TIMELY BASIS AND MAY NOT GENERATE THE ANTICIPATED LEVEL OF REVENUES
Our strategic growth plan calls for development and implementation of
broadband services and enhanced content for our subscribers. The availability
of many of these tools is dependent on our ability to enter into satisfactory
contractual relationships with parties offering related content and services
which can be made available to our subscribers, as well as relationships with
parties seeking to make online sales to our subscribers and other visitors to
our web site. To date, our revenues from broadband services and enhanced
content have not been material, and we have yet to launch a number of the
services that we hope to provide to our subscribers. We may not be able to
commence those services on a timely basis, and there can be no assurance that
the services will generate the anticipated amount of revenues.
OUR LONG-TERM SUCCESS DEPENDS ON THE DEVELOPMENT OF THE BROADBAND SERVICES
MARKET, WHICH IS UNCERTAIN
Our future revenues and profits substantially depend upon the widespread
acceptance and use of the Internet as an effective medium for the distribution
and viewing of broadband content. The use of the Internet for these services is
a recent phenomenon. Demand for recently introduced services and products over
the Internet and online services is subject to a high level of uncertainty. For
example, the distribution and viewing of broadband content over the Internet is
at an early stage and buyers may be unwilling to shift their purchasing from
traditional vendors of such content to online vendors. If the demand for
broadband services does not develop or increase rapidly, this could have a
material adverse effect on our results of operations.
WE RELY HEAVILY ON THIRD PARTIES FOR DEVELOPMENT OF SOFTWARE AND CONTENT AND FOR
ESSENTIAL BUSINESS OPERATIONS AND MAY BE ADVERSELY AFFECTED BY OUR FAILURE TO
MAINTAIN SATISFACTORY RELATIONSHIPS WITH SUCH PARTIES.
We depend on third parties for important aspects of our business,
including:
- Internet access;
- development of software for new web site features;
- content; and
- telecommunications.
We have limited control over these third parties, and we are not their only
client. We may not be able to maintain satisfactory relationships with any of
them on acceptable commercial terms, and there is no guarantee that we will be
able to renew these agreements at all. Further, we cannot be sure that the
quality of products and services that they provide may remain at the levels
needed to enable us to conduct our business effectively.
24
WE ARE HEAVILY RELIANT ON THIRD PARTIES TO HOUSE AND SERVICE OUR WEB SITE AND
ARE VULNERABLE TO POSSIBLE DAMAGE TO OUR OPERATING SYSTEMS.
We maintain substantially all of our computer systems at our Campbell,
California site and the Los Angeles, California site of Alchemy Communications.
We are heavily reliant on the ability of Alchemy Communications to house and
service our web site. This system's continuing and uninterrupted performance is
critical to our success. Growth in the number of users accessing our web site
may strain its capacity, and we rely on Alchemy Communications to upgrade our
system's capacity in the face of this growth. Alchemy Communications also
provides our connection to the Internet. Sustained or repeated system failures
or interruptions of our web site connection services would reduce the
attractiveness of our web site to customers and advertisers, and could therefore
have a material and adverse effect on our business due to loss of membership and
advertising revenues.
In addition, our operations are dependent in part on our ability to protect
our operating systems against physical damage from fire, floods, earthquakes,
power loss, telecommunications failures, break-ins or other similar events.
Furthermore, our servers are vulnerable to computer viruses, break-ins and
similar disruptive problems. The occurrence of any of these events could result
in interruptions, delays or cessations in service to our users and result in a
decrease in the number of visitors to our site.
OUR BUSINESS PLAN CONTEMPLATES A PERIOD OF SIGNIFICANT EXPANSION , AND
EFFECTIVELY MANAGING OUR GROWTH MAY BE DIFFICULT.
In order to execute our business plan, we may need to grow significantly.
This growth will strain our personnel, management systems and resources. To
manage our growth, we must implement operational and financial systems and
controls and recruit, train and manage new employees. We cannot be sure that we
will be able to integrate new executives and other employees into our
organization effectively. In addition, there will be significant administrative
burdens placed on our management team as a result of our status as a public
company. If we do not manage growth effectively, we will not be able to achieve
our financial and business goals.
WE DEPEND ON OUR KEY PERSONNEL TO OPERATE OUR BUSINESS, AND WE MAY NOT BE ABLE
TO HIRE ENOUGH ADDITIONAL MANAGEMENT AND OTHER PERSONNEL AS OUR BUSINESS GROWS.
Our performance is substantially dependent on the continued services and on
the performance of our executive officers and other key employees, particularly
Robert A. Rositano, Jr., our Chief Executive Officer, and Dean Rositano, our
President and Chief Operating Officer. The loss of the services of any of our
executive officers could materially and adversely affect our business due to
their experience with our business plan and the disruption in the conduct of our
day-to-day operations. Additionally, we believe we will need to attract, retain
and motivate talented management and other highly skilled employees to be
successful. Competition for employees that possess knowledge of both the
Internet industry and our target market is intense. We may be unable to retain
our key employees or attract, assimilate and retain other highly qualified
employees in the future.
25
INTENSE COMPETITION FROM OTHER INTERNET-BASED BUSINESSES MAY REDUCE OUR MARGINS
AND MARKET SHARE AND CAUSE OUR STOCK PRICE TO DECLINE.
The markets in which we are engaged are new, rapidly evolving and intensely
competitive, and we expect competition to intensify further in the future.
Barriers to entry are relatively low, and current and new competitors can launch
new sites at a relatively low cost using commercially available software.
Competition could result in price reductions for our products and services,
reduced margins or loss of market share. Consolidation within the online
commerce industry may also increase competition.
We currently or potentially compete with a number of other companies
including a number of large online communities and services that have expertise
in developing online commerce, and a number of other small services, including
those that serve specialty markets. Many of our potential competitors have
longer operating histories, larger customer bases, greater brand recognition in
other business and Internet markets and significantly greater financial,
marketing, technical and other resources than us.
WE MAY FAIL TO ESTABLISH AND MAINTAIN STRATEGIC RELATIONSHIPS WITH OTHER WEB
SITES TO INCREASE NUMBERS OF WEB SITE USERS AND INCREASE OUR REVENUES.
We intend to establish numerous strategic relationships with popular web
sites to increase the number of visitors to our web site. There is intense
competition for placements on these sites, and we may not be able to enter into
these relationships on commercially reasonable terms or at all. Even if we
enter into relationships with other web sites, they themselves may not attract
significant numbers of users. Therefore, our site may not receive additional
users from these relationships. Moreover, we may have to pay significant fees
to establish these relationships. Our inability to enter into new distribution
relationships and expand our existing ones could have a material and adverse
effect on our business due to our inability to increase the number of users of
our site.
WE MAY NOT BE ABLE TO ADAPT AS INTERNET TECHNOLOGIES AND CUSTOMER DEMANDS
CONTINUE TO EVOLVE.
To be successful, we must adapt to rapidly changing Internet technologies
and continually enhance the features and services provided on our web site. We
could incur substantial, unanticipated costs if we need to modify our web site,
software and infrastructure to incorporate new technologies demanded by our
audience. We may use new technologies ineffectively or we may fail to adapt our
26
web site, transaction-processing systems and network infrastructure to user
requirements or emerging industry standards. If we fail to keep pace with the
technological demands of our web-savvy audience for new services, products and
enhancements, our users may not use our web site and instead use those of our
competitors.
WE MAY NOT BE ABLE TO PROTECT AND ENFORCE OUR TRADEMARKS, WEB ADDRESSES AND
PROPRIETARY RIGHTS.
Our Nettaxi.com brand and our web address, www.nettaxi.com, are critical to
our success. We have filed a trademark application for "Nettaxi", among other
trademark applications. We cannot guarantee that any of these trademark
applications will be granted. In addition, we may not be able to prevent third
parties from acquiring web addresses that are confusingly similar to our
addresses, which could harm our business. Also, while we have entered into
confidentiality agreements with our employees, contractors and suppliers in
order to safeguard our trade secrets and other proprietary information, there
can be no assurance that technology will not be misappropriated or that others
may lawfully develop similar technologies.
WE ARE VULNERABLE TO ADDITIONAL TAX OBLIGATIONS THAT COULD BE IMPOSED ON ONLINE
COMMERCE TRANSACTIONS.
We do not expect to collect sales or other similar taxes in respect of
transactions engaged in by customers on our web site. However, various states
or foreign countries may seek to impose sales tax obligations on us and other
e-commerce and direct marketing companies. A number of proposals have been made
at the state and local levels that would impose additional taxes on the sale of
goods and services through the Internet. These proposals, if adopted, could
substantially impair the growth of e-commerce and cause purchasing through our
web site to be less attractive to customers as compared to traditional retail
purchasing. Further, states have attempted to impose sales taxes on catalog
sales from businesses such as ours. A successful assertion by one or more
states that we should have collected or be collecting sales taxes on the sale of
products could have a material and adverse effect on our business due to the
imposition of fines or penalties or the requirement that we pay for the
uncollected taxes.
WE MAY NOT BE ABLE TO TAKE FULL ADVANTAGE OF POTENTIAL TAX BENEFITS FROM OUR NET
OPERATING LOSS CARRYFORWARDS.
At December 31, 2000 we had Federal net operating loss carryforwards
available to reduce future Federal taxable income that aggregated approximately
$25,143,000 for Federal income tax purposes. These benefits will begin to
expire in 2017. Our ability to utilize the net operating loss carryforwards are
dependent upon our ability to generate taxable income in future periods and may
be limited due to restrictions imposed under Federal and state laws upon change
in ownership
WE ARE DEPENDENT ON THE CONTINUED DEVELOPMENT OF THE INTERNET INFRASTRUCTURE
27
Our industry is new and rapidly evolving. Our business is highly dependant
on the growth of the internet industry and would be adversely affected if web
usage and e-commerce does not continue to grow. web usage may be inhibited for
a number of reasons, including:
- inadequate Internet infrastructure;
- security concerns;
- inconsistent quality of service;
- unavailability of cost-effective, high-speed service;
- imposition of transactional taxes; or
- limitation of third party service provider's ability and willingness
to invest in new or updated equipment to handle traffic volume.
If Internet usage grows, the Internet infrastructure may not be able to
support the demands placed on it by this growth, or its performance and
reliability may decline. We are highly dependant on third party service
providers. Any interruption experienced by these service providers may have a
material impact on our business due to our inability to serve our advertising
customers or end users. In addition, web sites, including ours, have experienced
a variety of interruptions in their service as a result of outages and other
delays occurring throughout the Internet network infrastructure. If these
outages or delays frequently occur in the future, web usage, including usage of
our web site, could grow slowly or decline. This may have a material impact on
future revenues.
WE RELY ON A CONTINUOUS POWER SUPPLY TO CONDUCT OUR OPERATIONS, AND CALIFORNIA'S
CURRENT ENERGY CRISIS COULD DISRUPT OUR OPERATIONS AND INCREASE OUR EXPENSES.
California is in the midst of an energy crisis that could disrupt our
operations and increase our expenses. In the event of an acute power shortage,
that is, when power reserves for the State of California fall below 1.5%,
California has on some occasions implemented, and may in the future continue to
implement, rolling blackouts throughout California. Our computer systems are
supplied primary power by power companies in California. In addition, the
systems are connected to battery backup systems. This alternative source of
power is provided by our hosting provider and is subject to upkeep and
maintenance. Our current insurance does not provide coverage for any damages
our customers or we may suffer as a result of any interruption in our power
supply. If blackouts interrupt our third party power supply, we would be
temporarily unable to continue operations at our affected facilities. Although,
our third party bandwith provider has assured us that alternative energy supply
resources are available, there can be no assurance that such alternative energy
supplies will be adequate. Any interruption may affect our ability to continue
operations at our corporate facilities could damage our reputation and could
result in lost revenue, which could have a material adverse effect on our
business, operating results and financial condition. In addition, our employees
may be personally impacted and unable to commute to or from work during these
rolling blackouts. Any or all of these factors may have adverse impact on our
business.
ADOPTION OF THE INTERNET AS AN ADVERTISING MEDIUM IS UNCERTAIN.
28
The growth of Internet sponsorships and advertising requires validation of
the Internet as an effective advertising medium. This validation has yet to
fully occur. In order for us to generate sponsorship and advertising revenues,
marketers must direct a significant portion of their budgets to the Internet
and, specifically, to our web site. To date, sales of Internet sponsorships and
advertising represent only a small percentage of total advertising sales. Also,
technological developments could slow the growth of sponsorships and advertising
on the Internet. For example, widespread use of filter software programs that
limit access to advertising on our web site from the Internet user's browser
could reduce advertising on the Internet. Our business, financial condition and
operating results would be adversely affected if the market for Internet
advertising fails to further develop due to the loss of anticipated revenues.
BREACHES OF SECURITY ON THE INTERNET MAY SLOW THE GROWTH OF E-COMMERCE AND WEB
ADVERTISING AND SUBJECT US TO LIABILITY.
The need to securely transmit confidential information, such as credit card
and other personal information, over the Internet has been a significant barrier
to e-commerce and communications over the web. Any well-publicized compromise
of security could deter more people from using the web or from using it to
conduct transactions that involve transmitting confidential information, such as
purchases of goods or services. Furthermore, decreased traffic and e-commerce
sales as a result of general security concerns could cause advertisers to reduce
their amount of online spending. To the extent that our activities or the
activities of third party contractors involve the storage and transmission of
proprietary information, such as credit card numbers, security breaches could
disrupt our business, damage our reputation and expose us to a risk of loss or
litigation and possible liability. We could be liable for claims based on
unauthorized purchases with credit card information, impersonation or other
similar fraud claims. Claims could also be based on other misuses of personal
information, such as for unauthorized marketing purposes. We may need to spend
a great deal of money and use other resources to protect against the threat of
security breaches or to alleviate problems caused by security breaches.
WE COULD FACE LIABILITY FOR INFORMATION DISPLAYED ON AND COMMUNICATIONS THROUGH
OUR WEB SITE.
We may be subjected to claims for defamation, negligence, copyright or
trademark infringement or based on other theories relating to the information we
publish on our web site. These types of claims have been brought, sometimes
successfully, against Internet companies as well as print publications in the
past. Based on links we provide to other web sites, we could also be subjected
to claims based upon online content we do not control that is accessible from
our web site. Claims may also be based on statements made and actions taken as
a result of participation in our chat rooms or as a result of materials posted
by members on bulletin boards at our web site. We also offer e-mail services,
which may subject us to potential risks, such as:
- liabilities or claims resulting from unsolicited e-mail;
- lost or misdirected messages;
- illegal or fraudulent use of e-mail; or
- interruptions or delays in e-mail service.
29
These claims could result in substantial costs and a diversion of our
management's attention and resources.
Efforts to regulate or eliminate the use of mechanisms which automatically
collect information on users of our web site may interfere with our ability to
target our marketing efforts and tailor our web site offerings to the tastes of
our users.
Web sites typically place a tracking program on a user's hard drive without
the user's knowledge or consent. These programs automatically collect data on
anyone visiting a web site. Web site operators use these mechanisms for a
variety of purposes, including the collection of data derived from users'
Internet activity. Most currently available web browsers allow users to elect
to remove these mechanisms at any time or to prevent such information from being
stored on their hard drive. In addition, some commentators, privacy advocates
and governmental bodies have suggested limiting or eliminating the use of these
tracking mechanisms. Any reduction or limitation in the use of this software
could limit the effectiveness of our sales and marketing efforts.
WE COULD FACE ADDITIONAL BURDENS ASSOCIATED WITH GOVERNMENT REGULATION OF AND
LEGAL UNCERTAINTIES SURROUNDING THE INTERNET.
Any new law or regulation pertaining to the Internet, or the application or
interpretation of existing laws, could have a material and adverse effect on our
business, results of operations and financial condition due to increased costs
of doing business. Laws and regulations directly applicable to Internet
communications, commerce and advertising are becoming more prevalent. The law
governing the Internet, however, remains largely unsettled, even in areas where
there has been some legislative action. It may take years to determine whether
and how existing laws governing intellectual property, copyright, privacy,
obscenity, libel and taxation apply to the Internet. In addition, the growth
and development of e-commerce may prompt calls for more stringent consumer
protection laws, both in the United States and abroad. We also may be subject
to future regulation not specifically related to the Internet, including laws
affecting direct marketers.
WE COULD INCUR MONETARY DAMAGES FROM LITIGATION ARISING OUT OF OUR BUSINESS
ACTIVITIES.
On July 9, 1999, we were named as one of several defendants in a lawsuit
filed by four disaffected shareholders in Simply Interactive, Inc. The lawsuit
arises out of a series of events relating to certain assets our operating
company, Nettaxi Online Communities, purchased from SSN Properties in October
1997. The complaint alleges that we owed, and either intentionally or
negligently breached, fiduciary duties to the plaintiffs. The suit also claims
that we either intentionally or negligently interfered with the plaintiffs'
contract or prospective advantage. Recently, the parties have engaged in
settlement negotiations which have been productive. There has been no other
material developments with respect to this matter. While our officers and
directors believe that the suit is without merit, we cannot provide you with any
assurances that we will prevail in this dispute. If the plaintiffs successfully
prosecute any of their claims against us, the resulting monetary damages and
reduction in our working capital could significantly harm our business.
30
On May 1, 2001 seven shareholders of Nettaxi filed a law suit against
Nettaxi in the United States District Court for the Central District of
California (Case No. SACV 01-459 AHS). The complaint names Robert Rositano, Jr.
our Chief Executive Officer, Dean Rositano, our President and Glenn Goelz our
former Chief Financial Officer as additional defendants. The complaint alleges
the company violated securities laws in connection with the Company's February
2000 private placement. The complaint was amended on May 23, 2001. The amendment
addressed factual matters and added three new plaintiffs to the lawsuit. Shortly
after filing the amended complaint, we, pursuant to the rules of the District
Court, met with plaintiffs and pointed out further factual inaccuracies and
deficiencies. Plaintiffs then chose to attempt to amend their complaint for a
second time. Six of the plaintiffs purchased shares of Nettaxi common stock in
the February 2000 private placement completed by Nettaxi. Although we believe
the allegations made in the complaint are without merit and will defend the
action vigorously, there can be no assurance that we will prevail in this
dispute. If the plaintiffs successfully prosecute any of their claims against
us, the resulting monetary damages and reduction in our working capital could
significantly harm our business
ANTI-TAKEOVER PROVISIONS AND OUR RIGHT TO ISSUE PREFERRED STOCK COULD MAKE A
THIRD PARTY ACQUISITION OF US DIFFICULT.
We are a Nevada corporation. Anti-takeover provisions of Nevada law could
make it more difficult for a third party to acquire control of us, even if such
change in control would be beneficial to stockholders. Our articles of
incorporation provide that our board of directors may issue preferred stock
without stockholder approval. The issuance of preferred stock could make it
more difficult for a third party to acquire us. All of the foregoing could
adversely affect prevailing market prices for our common stock.
OUR COMMON STOCK PRICE IS LIKELY TO BE HIGHLY VOLATILE AS IS TYPICAL OF INTERNET
COMPANIES.
The market price of our common stock has been, and is likely to continue to
be, highly volatile as the stock market in general, and the market for
Internet-related and technology companies in particular, has been highly
volatile. Investors may not be able to resell their shares of our common stock
following periods of volatility because of the market's adverse reaction to
volatility. The trading prices of many technology and Internet-related
companies' stocks have decreased substantially within the last 52 weeks. The
market downturn and adjustment for the high valuations for internet companies
may not return to the levels of late 1999 and early 2000. We cannot assure you
that our stock will trade at the same levels of other Internet stocks or that
Internet stocks in general will regain their prior market prices. The per share
closing price of our common stock in 2001 ranged from a high of $0.46 as of June
11, 2001 to a low of $0.11 as of April 25, 2001. In addition, an active public
market for our common stock may not continue.
Factors that could cause such volatility may include, among other things:
- actual or anticipated fluctuations in our quarterly operating
results;
31
- announcements of technological innovations;
- conditions or trends in the Internet industry; and
- changes in the market valuations of other Internet companies.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
During the six months ended June 30, 2001, we did not have any long term
debt obligations. Therefore, an immediate 10% increase in market interest rates
would not have a material adverse effect on our financial position. We currently
do not have any material market rate risks. We could be exposed to market risk
related to any debt obligations for financing working capital and capital
equipment requirements in the future. Historically, we have financed such
requirements from the issuance of both preferred and common stock. We continue
to consider financing alternatives, which may include the incurrence of long
term indebtedness. Actual capital requirements may vary based upon the timing
and success of the expansion of our operations. We believe that based on the
terms and maturities of any future debt obligations that the market risk would
be minimal.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
On July 9, 1999, four disaffected shareholders in Simply Interactive, Inc.,
led by Ronald Ventre, filed an action in the Santa Clara County Superior Court
against Nettaxi, our wholly owned subsidiary Nettaxi Online Communities, Inc.,
Robert A. Rositano, Jr., Dean Rositano, Glenn Goelz, Warren J. Kaplan, Frank
McGrath, Bruno Henry, Alan K. Fetzer, Robert Divenere, Robert A. Rositano, Sr.,
SSN Properties, LLC and others. The case number is CV 783127. In August, 1999
this claim was consolidated with another claim filed by Carlo Bruno, et al., on
September 17, 1998. Recently, the parties have engaged in settlement
negotiations which have been productive. There has been no other material
developments with respect to this matter.
We previously announced that, on May 1, 2001 seven shareholders of Nettaxi
filed an action against Nettaxi in the United States District Court for the
Central District of California (Case No. SACV 01-459 AHS). The complaint also
names Robert Rositano, Jr. our Chief Executive Officer, Dean Rositano, our
President, and Glenn Goelz our former Chief Financial Officer as additional
defendants. The complaint alleged that we violated securities laws in connection
with our February 2000 private placement. Six of the plaintiffs purchased shares
of Nettaxi common stock in the February 2000 private placement. Prior to filing
the complaint, the plaintiffs demanded the refund of all of the money invested
in Nettaxi and demanded that the exercise price of the warrants issued in the
private placement be reduced from $4.00 to $0.25 per share. Additionally, prior
32
to the filing the complaint, Nettaxi was asked to invest capital in a company
affiliated with one of the plaintiffs. In the complaint, the plaintiffs seek
compensatory damages, injunctive relief and fees and interest. Due to factual
misrepresentations in the complaint, we anticipated that an amended complaint
would be filed. The complaint was amended on May 23, 2001. The amended added
three new plaintiffs to the lawsuit. Shortly after filing the amended complaint,
we, pursuant to the rules of the District Court, met with plaintiffs and pointed
out further factual inaccuracies and deficiencies. Plaintiffs then chose to
attempt to amend their complaint for a second time.
We believe that the allegations made in the complaint are completely
without merit and that this law suit reflects shareholder frustration over the
recent downturn in the stock market. We will defend the action vigorously.
From time to time, we are involved in legal proceedings incidental to our
business. We believe that these pending actions, individually and in the
aggregate, will not have a material adverse effect on our financial condition,
and that adequate provision has been made for the resolution of such actions and
proceedings.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
(1) From January to June, 2001 the Company under its 1998 and 1999
Stock Option Plans issued options to purchase up to 3,005,000 shares of common
stock to employees, with exercise prices ranging from $0.13 to $0.24 per share,
which was not less than the fair market value of the shares on the date of
grant. Options to purchase 1,702,500 of these shares have expired as of June 30,
2001. The issuances were made in reliance on Section 4(2) of the Securities Act
of 1933 and/or Rule 701 promulgated under the Securities Act of 1933 and were
made without general solicitation or advertising. The purchasers were
sophisticated investors with access to all relevant information necessary to
evaluate the investments, and who represented to the Company that the shares
were being acquired for investment.
(2) In April 2001, we issued warrants to purchase up to 1,500,000 shares of
common stock to a consultant at an exercise price of $0.13 per share, which was
not less than the fair market value of the shares on the date of grant. The
issuance was made in reliance on Section 4(2) of the Securities Act of 1933
and/or Regulation D promulgated under the Securities Act of 1933 and was made
without general solicitation or advertising. The purchaser was a sophisticated
investor with access to all relevant information necessary to evaluate the
investment, and who represented to the Company that the shares were being
acquired for investment.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None
ITEM 5. OTHER INFORMATION.
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
33
None.
(b) Reports on Form 8-K
On May 11, 2001, we filed a report on Form 8-K which described the
litigation described in the section of this quarterly report on Form 10-Q
entitled "Legal Proceedings".
34
SIGNATURES
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.
NETTAXI.COM
Date: August 14, 2001 By: /s/ Dean Rositano
---------------------
Dean Rositano,
President and Interim Chief Financial Officer
(Principal Accounting Officer)
35
EXHIBIT INDEX
Exhibit Number Description of Exhibit
- -------------- ------------------------
10.68 Consulting Agreement dated as of April 7, 2001 by and
between the Company and Innovative Networks, Inc.
10.69 Letter Agreement dated as of August 1, 2001 by and among the
Company and Baytree Capital Associates, LLC
36