UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 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
of incorporation or organization) Identification No.)
1875 S. Bascom Avenue; No. 116, Campbell, CA 95008
(Address of Principal Executive Offices Including Zip Code)
(408) 879-9880
(Registrant's telephone number, including area code)
_________________
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock, $.001 par value
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 [ ]
Indicate by a check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [_]
As of February 12, 2002, the approximate aggregate market value of voting stock
held by non-affiliates of the registrant was $7,584,917 (based upon the closing
price for shares of the registrant's common stock as reported by the O-T-C
Bulletin Board on that date). Shares of common stock held by each officer,
director, and holder of 5% or more of the outstanding common stock have been
excluded in that such persons may be deemed to be affiliates. This determination
of affiliate status is not necessarily a conclusive determination for other
purposes.
As of February 12, 2002, the registrant had 43,124,586 shares of common stock,
$.001 par value per share, outstanding.
NETTAXI.COM
FORM 10-K
TABLE OF CONTENTS
PART I
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ITEM 1. Description of Business 4
ITEM 1A. Risk Factors 15
ITEM 2. Properties 22
ITEM 3. Legal Proceedings 22
ITEM 4. Submission Of Matters To A Vote Of Security Holders 23
PART II
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ITEM 5. Market For The Registrant's Common Stock
And Related Stockholder Matters 24
ITEM 6. Selected Consolidated Financial Data 26
ITEM 7. Management's Discussion And Analysis Of
Financial Condition And Results Of Operations 26
ITEM 7A. Quantitative And Qualitative Disclosures
About Market Risk 37
ITEM 8. Financial Statements And Supplementary Data 37
ITEM 9. Changes In And Disagreements With Accountants
On Accounting And Financial Disclosure 37
PART III
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ITEM 10. Directors And Executive Officers Of The Registrant 38
ITEM 11. Executive Compensation 42
ITEM 12. Security Ownership Of Certain Beneficial Owners
And Management 48
ITEM 13. Certain Relationships And Related Transactions 49
PART IV
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ITEM 14. Exhibits, Financial Statement Schedules,
And Reports On Form 8-K 51
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PART I
This Form 10-K contains forward-looking statements. These forward-looking
statements are subject to significant risks and uncertainties, including
information included under Items 1 and 1A of this Form 10-K, which may cause
actual results to differ materially from those discussed in such forward-looking
statements. The forward-looking statements within this Form 10-K are identified
by words such as "believes," "anticipates," "expects," "intends," "may," "will"
and other similar expressions regarding our intent, belief and current
expectations. However, these words are not the exclusive means of identifying
such statements. In addition, any statements that refer to expectations,
projections or other characterizations of future events or circumstances and
statements made in the future tense are forward-looking statements. Readers are
cautioned that actual results may differ materially from those projected in the
forward-looking statements as a result of various factors, many of which are
beyond our control. We undertake no obligation to publicly release the results
of any revisions to these forward-looking statements which may be made to
reflect events or circumstances occurring subsequent to the filing of this Form
10-K with the Securities and Exchange Commission. Readers are urged to carefully
review and consider the various disclosures made by us in this Form 10-K,
including those set forth under "Risk Factors" in Item 1A.
ITEM 1. DESCRIPTION OF BUSINESS
OUR BUSINESS
Nettaxi.com is an Internet marketing portal that provides 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 number of targeted
affinity categories such as news, sports, entertainment, health, politics,
finances, lifestyle, and other areas of interest. Visitors to our web site are
provided with this content. Subscribers to our web site are also provided with
access to enhanced content such as broadband video clips, email accounts and
personal web pages. Our original revenue model included access to web site
hosting services and a broad range of content for our individual subscribers, or
"citizens", and access to a population of Internet users for affiliated
businesses for advertising and promotional purposes.
During 2000, we focused our efforts on improving the quality of content
available on our web site, implementing our web site hosting services and
reducing our operating costs by eliminating unprofitable services . We devoted
significant resources to developing our content and our services, including
developing an infrastructure and building a management team. We also focused on
developing consumer loyalty and increasing our overall level of traffic and
citizenship.
In 2001, we faced the challenges of an overall downturn in the Internet
industry and the economy in general. 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
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financially weak, we first took corrective action to significantly decrease our
cash burn. Beginning in May 2001, we reduced the salaries of our employees and
the number of personnel, marketing expenses and costs associated with our
hosting activities.
At the same time, we re-evaluated the viability of our web site hosting and
Internet connectivity services. Prior to June 2001, we provided these services
to corporate customers 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. As a result of our evaluation, we terminated
our significant co-hosting customer contracts effective July 7, 2001. We also
discontinued the purchase of bandwidth and premium services from our third party
provider, further reducing monthly expenditures. Beginning in the third quarter
of 2001, the terminations have reduced our operating expenses, but have also
materially affected our revenues. As of December 31, 2001 we had incurred
losses of approximately $36.2 million. In spite of our cost cutting measures,
there can be no assurance that our operating losses will not increase in the
future.
We continue to operate our website, however, we have focused our energies
on our acquisition strategy and therefore have not pursued any revenue
generating activities in the last six months of 2001.
While curtailing operations in 2001, we also undertook an analysis to
determine the best course of action to maintain and enhance the value of our
company. Given the challenges facing Internet-based business models, including
but not limited to the decline in advertising, we decided that our then-current
business model would not support future growth. We implemented an acquisition
strategy pursuant to which we sought to identify an appropriate entity with
which to merge, acquire or restructure our current business. Since the
announcement of our acquisition strategy in May 2001, we have evaluated a number
of potential merger candidates in a wide variety of industries.
RECENT DEVELOPMENTS
On January 9, 2002 we entered into a merger agreement under which we agreed
to merge with RAE Systems Inc., a California corporation that designs and
manufactures portable gas detection instruments and wireless monitoring and
communications equipment. If the merger is consummated, we will abandon our
business model and adopt the business model of RAE Systems. The merger is
subject to the approval of our stockholders. Further information regarding the
merger will be filed with the Securities and Exchange Commission relating to our
solicitation of proxies from our stockholders with respect to the merger.
Mergers 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.
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INDUSTRY BACKGROUND
The Internet has been a significant medium for global communications.
Millions of people around the world use the Internet to send and receive
information, for entertainment, current events and to purchase products and
services. Nevertheless, companies in the Internet industry struggled in 2001.
"The Internet downturn casts a wide arc mowing down the strong, the weak and the
in-between." The Industry Standard, Layoffs, Losses and Closures Continue in
Telecom Sector August 2, 2001. The downturn in the industry particularly hurt
companies that advertise on the Internet. The Industry Standard, At Online Ad
Conference, More Questions Than Answers August 10, 2001.
PORTALS. Portal web sites, such as ours, provide a single online location
where users can interact and find and share pertinent information, products and
services related to their particular interests or needs. Portal sites generally
offer free services including access to e-mail accounts, chat rooms, message
boards, news and entertainment. These features tend to increase user loyalty
towards particular portal web sites. Users with an email account with a
particular web site are likely to repeat visits to the web site on a regular
basis to check email and gather other information.
ADVERTISING. Prior to 2001, the Internet was an attractive medium for
advertisers. The Internet has allowed advertisers to demographically target
their messages to groups of Internet users with particular interests, in a
manner not available through the means of traditional media. The Internet has
also provided to advertisers a unique level of interactivity and measurability.
Advertisers can use the Internet to display messages on certain web pages. These
messages are referred to as impressions. Consumers wishing for more information
on the advertised topic can use their computers to click, or click-through, on
those impressions and move through to other web pages which provide the
information sought. Using the Internet, advertisers can change their
advertisements frequently in response to market factors, current events and
consumer feedback. Advertisers can also track the effectiveness of their
advertising messages by receiving reports of the number of advertising
impressions delivered to consumers and the corresponding number of times that
consumers click on those impressions and move through to the advertised web
page.
CONTENT. The Internet offers content providers mechanisms that combine cost
advantages with practices designed to generate revenue. The Internet provides
information dissemination at a materially lower cost than do other forms of
media, notably, both printed paper and private networks. The Internet also
offers the potential for easier access to content, which can expand market
coverage.
MARKETING PLANS & PROGRAMS
Prior to May 2001, we focused our efforts on marketing, improving the
quality of content and hosting services available on our web site, and reducing
our operating costs by eliminating many of the services which were not
profitable. In this regard, we developed a number of new promotions designed to
generate new sources of revenue and build customer loyalty. These tools and
services included:
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BROADBAND CONTENT. We developed relationships with content publishers to
assist in generating revenue through distribution, branding, awareness, and
promotions. In 2000 we added sources of new content that allow users to view
videos covering music, sports and other subjects. Users are required to
register as subscribers to our web site prior to viewing the content.
Advertisements are also displayed to users while progressing through the
registration process. Although we continue to offer these services to
subscribers to our web site, the revenues generated from these services in 2001
were not significant.
TARGETED AFFINITY CATEGORIES. We have organized information on our web site
into an extensive network of communities with a wide variety of themes,
including entertainment, government, home living, sports, finance, society and
culture. Users interested in particular themes can access those themes quickly
and easily. This creates marketing opportunities for media companies, Internet
service providers, and Internet content companies.
IMPROVED SEARCH METHODOLOGY. We had developed a metasearch engine that
enabled users to search multiple sites simultaneously and return the results to
one web page. This feature drove users to our web site, but did not generate
sufficient revenue. We have revised our search methodology to provide context
driven searches where advertisers purchase their placement in the search engine.
For example, a user of our web site may choose the subject "music" to search.
After the choice is made, the results of the search are presented in a list on a
new web page. Advertisers pay for premium placement at the top of the list.
This allows advertisers to bid for product placement on our web site and
increases revenue generated from our search services. Although we continue to
offer these services, the revenues generated from these services in 2001 were
not significant.
SEASONAL PROMOTIONS. During 2000, we implemented seasonal promotions
designed to drive Internet users to our e-commerce affiliates. For example, in
December 2000 we launched a promotion for Storerunner Network, Inc.
Storerunner.com placed advertisements for products it was selling as part of a
holiday sale on our web site. Users of our web site could click on the
Storerunner advertisements and move to the Storerunner.com web site and purchase
the products. Our agreement provided that we receive revenue for each user that
accessed the Storerunner.com site from our web site. Although this promotion
successfully increased the amount of traffic on our site, we discontinued
further services with Storerunner.com after they filed for protection under
Chapter 11 of the United States Bankruptcy Code in February 2001.
SUBSCRIBER SERVICES. During 2000, we revised the scope of services offered
to users of our web site to eliminate many of the free services which were
available. Currently, users are offered access to free services such as email
accounts and a limited variety of content such as video clips and information.
Users desiring additional services such as video clips may become subscribers.
Despite the implementation of these tools and services, our revenues failed to
keep pace with the costs associated with their implementation. We believe this
was the result of a downturn in the Internet industry and the economy in
general. As a result, in May 2001, in connection with the adoption of our
acquisition strategy, we reduced our marketing efforts significantly.
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BUSINESS SERVICES
OUR WEB SITE
Information on our web site at www.nettaxi.com is divided into topic areas
which we refer to as affinity groups. We refer the registered users of our web
site as citizens. Our web site provides access to information on news, sports,
entertainment and other areas of interest. Citizens also have access to Internet
related services such as chat services and free e-mail accounts.
When users first arrive at www.nettaxi.com, they find hyperlinks to the
information categories we provide, such as:
- Member services and registration;
- Information sorted by topical areas of interest; and
- Content such as movies, sports clips and other broadband content.
Upon selecting one of the links, for example entertainment, a web page
containing articles and information about entertainment appears along with an
extensive list of categories, or more specific search topics, such as music and
television. Choosing the more specific search topic will further focus your
search to uncover more specific information.
APPLICATIONS AND FEATURES
We offer a range of applications and features to our citizens through our
web site, including the following:
OUR SEARCH ENGINE. Users of our web site can access our specially
configured search engine, which we refer to as our taxi, located in all areas
and levels of our web site. Users may use the search engine by typing in a
search topic such as sports, and they are quickly presented with a list of
hyperlinks to web pages carrying sports related information. Advertisers on our
site compete for placement in the search results by paying fees to us. The
advertisers that pay the highest fees are brought to the top of the list of
search results. Although we continue to offer these services on a limited
basis, the revenues generated from these services in 2001 were not significant.
E-MAIL SERVICES. Our e-mail services allow users to access their accounts,
through both Post Office Protocol, POP, and the Internet, IMAP. POP e-mail is
the type most commonly used by Internet service providers. Its primary advantage
for users is that messages are sent and received quickly and with more privacy,
because they do not stay resident on a server for any length of time. Its
greatest disadvantage is that e-mail messages, once delivered to a user, are
generally no longer available for download again, so that a user who downloads
e-mail to a home computer, for example, will generally not be able to download
the same mail at a later time to another computer, such as one at work. IMAP, or
web-based e-mail, most commonly used by portal services, allows users to
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retrieve e-mail messages from any location that offers access to the Internet
and a specific web site. Sending and receiving messages may be a bit slower than
POP services, but messages are stored on a server, can be retrieved multiple
times, and remain available until they are either specifically deleted by the
user, or a set amount of time has passed.
CONTENT. Prior to May 2001, we developed relationships with providers of
premium content in a variety of categories. The purpose of these relationships
was not to directly generate revenue, but rather to enhance the quantity and
quality of information and content on our web site so that visitors would be
drawn to our web site. During 2001, we had formal relationships with the three
premium content providers described below and they provided substantially all of
the content on our web site that is provided by outside parties. The providers
are listed in order by the amount of content they provided to us.
- SCREAMINGMEDIA. In April 2000, we entered into a license agreement
with ScreamingMedia, an aggregator of a broad range of content such as current
events, daily horoscopes, world news, travel, medicine and health for
syndication to Internet portals and destination sites. The license agreement
has a one year term and automatically renews for successive one-year periods
unless terminated. We paid a monthly license fee of $5,000 for use of
ScreamingMedia's content, which constituted the majority of our outside party
content. In connection with our acquisition strategy, we terminated our
agreement with ScreamingMedia, effective in February 2002.
- ACTIVEWORLDS. In March 2001, we launched a new area within our web
site pursuant to an agreement we entered into in August 2000 with
ActiveWorlds.com, Inc., a Delaware corporation. Users that visited our web
site, downloaded the appropriate software and paid a monthly fee could access a
series of web pages complete with three dimensional graphics. The graphics were
designed so that the area had the look and feel of an urban environment. In
connection with our acquisition strategy, we have terminated our agreement with
ActiveWorlds. Although we were to receive a portion of the fees collected by
ActiveWorlds from users of our site that subscribed to the service, revenues
from this agreement were not significant in 2001.
- STORERUNNER.COM. In September 2000, we entered into an agreement with
StoreRunner Network, Inc. under which we placed Storerunner advertisements on
our web site and were to be compensated based on the number of visitors to our
site that visited the Storerunner site. Although this agreement resulted in
increased traffic on our web site, we discontinued further services with
Storerunner.com after it filed for protection under Chapter 11 of the United
States Bankruptcy Code in February 2001.
WEB SITE HOSTING SERVICES
Prior to the adoption of our acquisition strategy in May 2001, we offered
our registered users web site hosting services. Using these services, we hosted
the web sites of over 300 individuals or businesses. These services generally
fell into two categories.
First, we hosted web pages for subscribers to our web site for a monthly
fee. The minimum fee for the services was $19.95 per month. Subscribers to these
services were provided with storage space and bandwidth to support their web
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sites. The fee increased depending on the amount of bandwidth and storage space
used by the subscriber. At times, hosting revenues failed to keep pace with the
costs of bandwidth and other related costs. We terminated these hosting services
following the adoption of our acquisition strategy in May 2001.
Second, we provided Internet hosting and connectivity for larger corporate
customers. These services involved our maintenance of the servers which hosted
the web sites of these customers. For example, we had an agreement with White
Sand Communications, Inc. pursuant to which we hosted its web site servers and
provided support for the overall operation of the servers. Our services were
delivered through Alchemy Communications at its Internet data center located in
Los Angeles, California. Customers paid 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.
Hosting revenues were variable, based upon bandwidth usage and services used,
and resulted in operating losses from time to time. In connection with our
acquisition strategy, we terminated our significant co-hosting customer
contracts effective July 7, 2001.
In connection with this, we also discontinued the purchase of bandwidth and
premium services from our third party provider. The terminations have reduced
our operating expenses, and materially affected our revenues beginning in the
third quarter of 2001.
SUBSCRIBER SERVICE PLANS AND ASSISTANCE
Prior to the adoption of our acquisition strategy in May 2001, we offered
both free and premium accounts, on a tiered basis: (i) free citizen accounts,
which provided e-mail service for one personal account and access to chat
sessions, message boards, shopping and premium content; and (ii) premium
account, which allowed subscribers to build premium accounts from a menu of
options including unlimited e-mail accounts, disk space for web page hosting and
access to promotional opportunities. We ceased offering premium accounts to
users following the adoption of our acquisition strategy in May 2001. If we
consummate the merger with RAE Systems, the free account services will be
terminated.
CUSTOMERS
ADVERTISING CUSTOMERS. In 2000 we attracted both mass market consumer
product companies and technology-related businesses advertising on the Internet.
However, due to a variety of factors including the downturn in the Internet
industry and the economy in general, we failed to generate substantial revenues
from the sale of advertising. In May 2001, in connection with our acquisition
strategy, we ceased aggressively marketing our advertising services. Although
we continue to operate our web site and to sell advertising on our web site,
advertising revenues have declined substantially. No advertising customer
accounted for more than ten percent of our revenues in 2001.
Advertisers and advertising agencies enter into short-term agreements, on
average one to two months with us, pursuant to which they receive a guaranteed
number of impressions for a fixed fee. If the guaranteed number of impressions
is not delivered, the term of the agreements are extended until the impressions
can be delivered. Advertising on our site currently consists of banner-style
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advertisements that are prominently displayed at the top of pages on a rotating
basis throughout the web pages in our web site. From each banner advertisement,
viewers can hyperlink directly to the advertiser's own web site, thus providing
the advertiser an opportunity to directly interact with an interested customer.
Our standard cost per thousand impressions depends upon a number of factors
including the location of the advertisement, its size and the extent to which it
is targeted for a particular audience. Discounts from standard cost per
thousand impressions rates may be provided for higher volume, longer-term
advertising contracts.
We also received advertising revenue as a result of the adoption of our
revised search methodology. Our search methodology uses context driven searches
where advertisers purchase their placement in the search engine. For example, a
user of our web site may choose the subject "music" to search. After the choice
is made, the results of the search are presented in a list on a new web page.
Advertisers pay for premium placement at the top of the list. This allows
advertisers to bid for product placement on our web site.
WEB SITE HOSTING CUSTOMERS. Prior to the adoption of our acquisition
strategy in May 2001, we offered our registered users web site hosting services.
Using these services, we hosted the web sites of over 300 individuals or
businesses. These services generally fell into two categories. First, we
hosted web pages for subscribers to our web site for a monthly fee. The minimum
fee for these services was $19.95 per month. We also provided Internet hosting
and connectivity for larger corporate customers. These services involved our
maintenance of the servers which host the web sites of these customers. For the
twelve months ended December 31, 2001, web hosting revenues accounted for
approximately 90% of total revenues. We terminated all of our web site hosting
services following the adoption of our acquisition strategy in May 2001 and
revenues declined substantially.
In August 1999, we entered into a Data Center Service Agreement with White
Sand Communications, Inc. We provided White Sand Communications with space in
our Data Center and provided support for the overall operation of the their web
servers. The fee for this agreement was a monthly recurring fee which included
charges for use and occupancy of the Data Center, connectively fee, power
charges, and where applicable, technical support and system administration fees.
The term of the agreement was one year. This agreement accounted for 19% of our
revenues in 2001, 11% of our revenue in 2000 and 17% of our revenue in 1999. We
terminated this agreement as of July 7, 2001.
In July 1999, we entered into a Data Center Service Agreement with Babenet,
Ltd, a California corporation. We provided Babenet with space in our Data
Center for their web servers and provide support for the overall operation of
the their web servers. The fee for this agreement was a monthly recurring fee
which included charges for use and occupancy of the Data Center, connectively
fee, power charges, and where applicable, technical support and system
administration fees. The term of this agreement was one year and continued on a
monthly basis thereafter. This agreement accounted for 47% of our revenues in
2001 and 20% of our revenue in 2000. We terminated this agreement as of July 7,
2001.
In July 1999, we entered into a Data Center Service Agreement with
Whitehorn Ventures , Ltd, a California corporation. We provided Whitehorn
Ventures with space in our Data Center for their web servers and provide support
for the overall operation of the their web servers. The fee for this agreement
was a monthly recurring fee which included charges for use and occupancy of the
Data Center, connectively fee, power charges, and where applicable, technical
support and system administration fees. The term of this agreement was one year
and continued on a monthly basis thereafter. This agreement accounted for 25%
of our revenues in 2001 and 8% of our revenue in 2000. We terminated this
agreement as of July 7, 2001.
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ADVERTISING SALES AND DESIGN
Prior to May 2001, we focused our efforts on creating advertising
opportunities designed to build brand loyalty for our corporate sponsors by
seamlessly integrating their advertising messages into our content. Following
the adoption of our acquisition strategy in May 2001, we terminated
substantially all of our efforts in this regard.
SALES AND MARKETING
Prior to the adoption of our acquisition strategy in May 2001, we committed
substantial resources to sales and marketing activities, including offline and
online media advertising. Our sales and marketing efforts were focused on:
- Generating additional traffic to our site;
- Building and defining a desirable online destination for consumers
and businesses; and
- Creating and enhancing our brand within the Internet and online
industries.
These efforts were costly and not consistent with our acquisition strategy
adopted in May 2001. As a result we terminated substantially all of our efforts
in this regard.
OPERATING INFRASTRUCTURE
At this time, the basic components of our technology infrastructure are in
place and operational. Our UNIX-based electronic network for Nettaxi.com
operates on a one terabyte Ethernet backbone, with two Cisco Systems Ethernet
switches that prevent collisions on the network. Traffic direction for the web
servers is handled by Arrowpoint's CS-100, which tracks server load conditions
in real time and sends traffic to the most appropriate server to spread around
and balance the load. The network is comprised primarily of Sun Microsystems
high-capacity servers, and include a mix of Enterprise 450s, Ultra 1, and Ultra
5 models, all running the newest version of Sun's Solaris operating environment
for network systems. These servers collectively provide approximately 1.6
terabytes of hard drive space for subscriber capacities.
In addition, the network currently includes NT servers to handle
registration and selected other database functions, using Microsoft's SQL
database software.
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Our electronic network was located at Alchemy Communications in Los
Angeles, California. We had a Gigabit Data Services Agreement with Alchemy
Communications pursuant to which they provided us with a secure location for
our network servers, multiple high-speed Internet connections, and access to
24-hour-a-day, 7-day-a-week technical support personnel and services. Alchemy
Communications also provided routing, redundancy, streaming media and
maintenance services for the network and its Internet connections, as well as a
back-up power supply capable of continuing network operations for up to a week
in the event of a power failure. We paid monthly fees for these services. In
2002, in connection with the adoption of our acquisition strategy and the
termination of our web hosting services, we terminated our agreement with
Alchemy.
COMPETITION
The markets in which our web site is 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. Our web site competes with a number of other companies for users,
advertisers and electronic commerce marketers, 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.
Other companies that offer web site hosting, email, and content services
include MegaGo.com, theglobe.com, Yahoo!, Homestead.com, Angelfire, Fortune
City, Lycos, and Talk City and, in the future, Internet communities may be
developed or acquired by companies currently operating Internet directories,
search engines, shareware archives, content sites, Internet Service Providers
and other entities, which may have more resources than ours. In addition, our
web site faces competition from traditional media companies, a number of which,
including CBS, Fox and NBC, have made significant acquisitions or investments in
Internet companies. Furthermore, we compete for users and advertisers with
other content providers and with thousands of web sites operated by individuals,
the government and educational institutions. Such providers and sites include
AOL, Angelfire, CNET, CNN/Time Warner, Excite, Hotmail, Infoseek, Lycos,
Microsoft, Netscape, Switchboard, ESPN.com, ZDNet.com and Yahoo!
Many of our 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. In addition, other online services may be acquired by, receive investments
from or enter into other commercial relationships with larger, well-established
and well-financed companies as use of the Internet and other online services
increases. Many of our competitors have continued to devote substantial
resources to marketing and promotional campaigns, adopting more aggressive
pricing policies and enhancing web site and systems development. These
competitors may have gained a significant advantage over us while we have
limited our similar expenditures in connection with the adoption of our
acquisition strategy. This advantage may prevent our web site's ability to
attract users in the future.
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INTELLECTUAL PROPERTY
We currently have pending applications before the United States Patent and
Trademark Office for trademark and service mark protection for "Nettaxi" and
"NetroNews". If these applications are approved, protection will be available
for the periods prescribed by law. The protection of our copyrights, service
marks, trademarks, trade dress and trade secrets are were important to the
success of our web site, but are not necessarily important in connection with
our acquisition strategy. We have entered into confidentiality and invention
assignment agreements with our employees and contractors in order to limit
access to and disclosure of our proprietary information. There can be no
assurance that these contractual arrangements or the other steps taken by us to
protect our intellectual property will prove sufficient to prevent
misappropriation of our technology or to deter independent third-party
development of similar technologies.
Our web site also relies upon on technologies that we license from third
parties, such as the suppliers of key database technology, the operating system
and specific hardware components for our products and services. These licenses
extend for terms ranging from one year to perpetuity and are subject to
satisfaction of conditions laid out in the specific licensing agreements. There
can be no assurance that these third-party technology licenses will continue to
be available to us on commercially reasonable terms.
Although we do not believe that we infringe the proprietary rights of third
parties, there can be no assurance that third parties will not claim
infringement by us with respect to past, current or future technologies. We
expect that participants in our markets will be increasingly subject to
infringement claims as the number of services and competitors in our industry
segment grows. Any such claim, whether meritorious or not, could be
time-consuming, result in costly litigation and could prevent our ability to
enter into an acquisition. As a result, any such claim could have a material
adverse effect upon our business, results of operations and financial condition.
GOVERNMENT REGULATION
Our company, operations and products and services are all subject to
regulations set forth by various federal, state and local regulatory agencies.
We take measures to ensure our compliance with all such regulations as
promulgated by these agencies from time to time. The Federal Communications
Commission sets standards and regulations regarding communications and related
equipment.
There are currently few laws and regulations directly applicable to the
Internet. It is possible that a number of laws and regulations may be adopted
with respect to the Internet covering issues such as user privacy, pricing,
content, copyrights, distribution, antitrust and characteristics and quality of
products and services. The growth of the market for online commerce may prompt
calls for more stringent consumer protection laws that may impose additional
burdens on those companies conducting business online. Tax authorities in a
number of states are currently reviewing the appropriate tax treatment of
companies engaged in online commerce, and new state tax regulations may subject
us to additional state sales and income taxes.
14
In addition, because our web site is accessible worldwide, other
jurisdictions may claim that we are required to qualify to do business as a
foreign corporation in a particular state or foreign country. Our failure to
qualify as a foreign corporation in a jurisdiction where it is required to do so
could subject us to taxes and penalties for the failure to qualify and could
result in our inability to enforce contracts in such jurisdictions. Any such
new legislation or regulation, or the application of laws or regulations from
jurisdictions whose laws do not currently apply to our business, could have a
material adverse effect on our business, results of operations and financial
condition.
EMPLOYEES
As of December 31, 2001, we had four employees, all of whom were involved
in administration and finance. Technical assistance with our limited web site
operations have been provided by consultants. We have never had a work
stoppage, and no employees are represented under collective bargaining
agreements. We consider our relations with our employees to be good.
ITEM 1A. 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, 2001, we had an accumulated
deficit of $36,238,200. 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 and because of the
reduction of our operating activities and expenditures in connection with our
acquisition strategy, we expect to incur significant net losses for the
foreseeable future. We may never achieve profitability.
ACQUISITIONS IN CONNECTION WITH OUR ACQUISITION STRATEGY MAY DISRUPT OR
OTHERWISE HAVE A NEGATIVE IMPACT ON THE VALUE OF OUR BUSINESS.
We are seeking to acquire a businesses that we believe will enhance the
value of our company. In this regard, we have agreed to merger with RAE Systems
Inc. The merger remains subject to certain conditions to closing as well as the
approval of our shareholders. If the Merger is consummated, Nettaxi's current
business model will be terminated and the company will implement the current
business model of RAE Systems. There can be no assurance that the business
model of RAE Systems will be profitable or successful. There can be no
assurance that the business model of RAE Systems will enhance the value of the
combined company or that the business model of RAE Systems will be any more
successful than the business model currently employed by Nettaxi. Additionally,
there can be no assurance that the Internet industry will not improve in the
future.
15
If the merger with RAE Systems does not take place, we may be unable to
identify any other business which could potentially enhance the value of our
company. Additionally, we may be unable to negotiate terms for an acquisition
which would be favorable to our shareholders. If we were to acquire a company,
the amount of time and level of resources required to successfully transition
our operations could be substantial. There can be no assurance that new
management would be able to successfully operate the business going forward.
Furthermore, in making an acquisition, we may have to incur debt or issue equity
securities to finance the acquisition, the issuance of which could dilute the
holdings of our existing shareholders.
WE CURRENTLY HAVE NO REVENUES, WHICH MAY CAUSE THE TRADING PRICE OF OUR COMMON
STOCK TO DECLINE.
We had revenues of approximately $2,069,500, $9,418,400 and $5,032,800 for
the years ended December 31, 2001, 2000 and 1999, respectively. While our growth
rate in prior years has been strong, revenues have substantially declined in
2001. We expect current market conditions and the adoption of our acquisition
strategy to have a continued material adverse effect on our revenues. We
continue to operate our website, however, we have focused our energies on our
acquisition strategy and therefore have not pursued any revenue generating
activities in the last six months of 2001. We terminated our significant
co-hosting customer contracts on`` July 7, 2001, which materially decreased our
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. These transactions were
terminated in year 2000.
If our operating results fall below the expectations of investors in future
periods, then our stock price may decline.
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.
As of December 31, 2001, approximately 28 million shares of our common
stock were 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
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Rule 144 promulgated under that Act. Additionally, approximately 14 million
shares of common stock were eligible for sale under Rule 144. If our
stockholders sell substantial amounts of our common stock, 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.
WE MAY NEED TO UPDATE OUR REGISTRATION STATEMENTS
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 32,730,849 shares issued and issuable pursuant to recent 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 September 21, 2000, registering 4,219,692 shares of common stock
issued and issuable pursuant to recent private placement transactions. These
registration statements may need to be updated in order to maintain their
effectiveness. Although we anticipate updating these registration statements in
the near future, we may face liability from shareholders who are unable to sell
their shares under the registration statements before they are updated.
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 these warrants have been included in the registration statements
referenced 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. Additionally, there are options to purchase 5,578,000 shares of our
common stock outstanding under our 1998 and 1999 Stock Option Plans. These
shares have been registered pursuant to our registration statement on Form S-8
(File No. 333-32678). As a result, shares issued upon exercise of stock options
are eligible for resale in the public market without restriction. If the holders
of our outstanding options, warrants and other convertible securities were to
exercise their rights, holders of our common stock could experience substantial
dilution of their investment.
It is possible that we will need to raise additional funds in the future in
order to execute a transaction pursuant to our acquisition strategy or if we are
to execute our strategic growth 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 MAY FACE THE INTERRUPTION OF OUR SERVICES AND THE DELAY IN THE IMPLEMENTATION
OF OUR ACQUISITION STRATEGY DUE TO INCREASED SECURITY MEASURES IN RESPONSE TO
TERRORISM.
17
Our business depends on the free flow of products and services through the
channels of commerce. Recently, in response to terrorists' activities and
threats aimed at the United States, transportation, mail, financial and other
services have been slowed or stopped altogether. Further delays or stoppages in
transportation, mail, financial or other services could have a material adverse
effect on our business, results of operations and financial condition and our
ability to complete an acquisition consistent with our acquisition strategy.
Furthermore, we may experience an increase in operating costs, such as costs for
transportation, insurance and security as a result of the activities and
potential activities. We may also experience delays in receiving payments from
payers that have been affected by the terrorist activities and potential
activities. The U.S. economy in general is being adversely affected by the
terrorist activities and potential activities and any economic downturn could
adversely impact our results of operations, impair our ability to raise capital
or otherwise adversely affect our ability to operate our business and pursue our
acquisition strategy.
OUR PROJECTED BROADBAND SERVICES AND ENHANCED CONTENT MAY NOT BE LAUNCHED ON A
TIMELY BASIS AND MAY NOT GENERATE THE ANTICIPATED LEVEL OF REVENUES.
During the first half of 2001, our strategic growth plan called for the
development and implementation of broadband services and enhanced content for
our subscribers. We have put our strategic growth plan on hold so that we may
attempt to execute our acquisition strategy. Should we choose to implement our
strategic growth plan in the future, the availability of many of these broadband
services will be 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. In light of the reduction of our operating activities and expenditures
in connection with our acquisition strategy, 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.
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
the development of software and access to the Internet. 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.
WE ARE VULNERABLE TO POSSIBLE DAMAGE TO OUR OPERATING SYSTEMS.
Our web site is 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. Our servers are
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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. 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 the loss of membership and advertising revenues.
WE DEPEND ON OUR KEY PERSONNEL TO OPERATE OUR BUSINESS AND CARRY OUT OUR
ACQUISITION STRATEGY.
Our performance is substantially dependent on the continued services and on
the performance of our executive officers. The loss of the services of any of
our executive officers could materially and adversely affect our business due to
their ability to help identify appropriate acquisition target companies, their
experience with our business plan and the disruption in the conduct of our
day-to-day operations.
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 our web site operates are new, rapidly evolving and
intensely competitive. 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 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 have attempted to establish numerous strategic relationships with
popular web sites to increase the number of visitors to our web site. These
efforts have been substantially slowed by the reduction of our operating
activities and expenditures in connection with our acquisition strategy. 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.
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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. 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, 2001 we had Federal net operating loss carryforwards
available to reduce future Federal taxable income that aggregated approximately
$26.7 million 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. If we complete an acquisition consistent with our acquisition
strategy, we may be unable to apply these net operating loss carryforwards at
all.
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.
These claims could result in substantial costs and a diversion of our
management's attention and resources.
WE COULD FACE ADDITIONAL BURDENS ASSOCIATED WITH GOVERNMENT REGULATION OF AND
LEGAL UNCERTAINTIES SURROUNDING THE INTERNET.
20
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 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. its Chief Executive Officer, Dean Rositano, its President, and Glenn Goelz
its former Chief Financial Officer as additional defendants. The complaint
alleged that Nettaxi violated securities laws in connection with its 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 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, Nettaxi anticipated that an amended complaint would be filed. The
complaint was amended on May 23, 2001. The amendment added three new plaintiffs
to the lawsuit. Shortly after filing the amended complaint, Nettaxi, 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. On October 1, 2001 Nettaxi filed a motion to
dismiss the complaint filed by Plaintiffs. In response, Plaintiffs have filed an
opposition to Nettaxi's motion to dismiss and have sought leave to amend their
complaint for a third time. The District Court has informed the parties that it
will rule on the papers, and there will be no hearing.
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
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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 18 months. 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 Nettaxi's common stock in 2001 ranged from a high of $0.46 as
of June 11, 2001 to a low of $0.085 as of September 21, 2001. In addition, an
active public market for our common stock may not continue.
ITEM 2. PROPERTIES
Our headquarters are currently located in a leased facility in Campbell,
California, consisting of approximately 1,790 square feet of office space to
accommodate management, operations, and research and development functions,
which is under a lease that expires at the end of May 2002. We believe that our
current facilities are appropriate to carry out our acquisition strategy and
maintain our limited operations.
ITEM 3. LEGAL PROCEEDINGS
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
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 complaint
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. On October 1, 2001
22
we filed a motion to dismiss the complaint filed by Plaintiffs. In response,
Plaintiffs have filed an opposition to Nettaxi's motion to dismiss and have
sought leave to amend their complaint for a third time. The District Court has
informed the parties that it will rule on the papers, and there will be no
hearing on the motion.
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.
On July 31, 2001 Envision Media filed suit against Nettaxi in the Superior
Court of California, Santa Cruz County (Case No. CV-141408). The complaint
alleges breach of contract and misrepresentation in connection with a Stock
Option and Release Agreement entered into between the parties on January 31,
2000. Under the Stock Option and Release Agreement, Envision Media was given the
option to convert approximately $900,000 in receivables due from Nettaxi into
stock valued at $2.00 per share and also to receive warrants to purchase stock
having an exercise price of $2.76. The agreement provided that Nettaxi was to
file a registration statement registering the shares issuable under the
agreement within 15 days of the execution of the agreement. The agreement also
provided that each party would release the other from any claims arising out of
or in connection with the conversion of Nettaxi's debt and that the portion of
the debt converted was to be deemed paid in full. Nettaxi was unable to file
the registration statement before February 15, 2000. Nevertheless, on March 31,
2000 Envision Media converted the entire balance of the amount due into shares
and warrants. On May 12, 2000 Nettaxi filed a registration statement on Form
S-1 (File No. 333-36826) which included shares and warrants held by Envision
Media. On June 8, 2000 the SEC declared the registration statement Form S-1
effective. Nettaxi filed its answer to the complaint on September 17, 2001.
Nettaxi believes that the allegations made in the complaint are completely
without merit and intends to defend its position 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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS
Our common stock has been traded on the NASD O-T-C Market Bulletin Board
under the trading symbol "NTXY" since October 12, 1998. Prior to that date, our
common stock was not actively traded in the public market. After consummation
of the merger, we anticipate that such common stock will continue to trade in
the over-the-counter market. The following table sets forth, for the periods
indicated, the high and low bid prices for our common stock as reported by
various Bulletin Board market makers. The quotations do not reflect adjustments
for retail mark-ups, mark-downs, or commissions and may not necessarily
represent actual transactions.
Period Low Bid High Bid
- --------------------------------------------------------------------
FISCAL YEAR ENDED DECEMBER 31, 1998:
Fourth Quarter (October 12 - December 31, 1998) $ 4.375 $ 8.875
FISCAL YEAR ENDED DECEMBER 31, 1999:
First Quarter (January 1 - March 31, 1999) $ 6.187 $ 18.750
Second Quarter (April 1 - June 30, 1999) $ 11.500 $ 34.500
Third Quarter (July 1 - September 30, 1999) $ 7.375 $ 16.500
Fourth Quarter (October 1 - December 31, 1999) $ 1.843 $ 7.875
FISCAL YEAR ENDED DECEMBER 31, 2000:
First Quarter (January 1 - March 31, 2000) $ 1.406 $ 9.062
Second Quarter (April 1 - June 30, 2000) $ 0.940 $ 5.968
Third Quarter (July 1 - September 30, 2000) $ 0.420 $ 1.420
Fourth Quarter (October 1 - December 31, 2000) $ 0.125 $ 0.520
FISCAL YEAR ENDED DECEMBER 31, 2001
First Quarter (January 1 - March 31, 2001) $ 0.125 $ 0.295
Second Quarter (April 1 - June 30, 2001) $ 0.095 $ 0.495
Third Quarter (July 1 - September 30, 2001) $ 0.080 $ 0.360
Fourth Quarter (October 1 - December 31, 2001) $ 0.190 $ 0.085
FISCAL YEAR ENDING DECEMBER 31, 2002
First Quarter (January 1 - February 12, 2001) $ 0.280 $ 0.110
On February 12, 2002, the high and low bid prices per share for our common
stock on the Bulletin Board were $0.225 and $0.200 respectively. As of February
12, 2002, there were 386 stockholders of record who held shares of our common
stock.
DIVIDEND POLICY
To date, no dividends have been declared or paid on any of our capital
stock. We currently intend to retain earnings, if any, to fund the development
and growth of our business and do not anticipate paying cash dividends in the
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foreseeable future. Payment of future dividends, if any, will be at the
discretion of our Board of Directors after taking into account various factors,
including our financial condition, operating results, current and anticipated
cash needs and plans for expansion.
RECENT SALES OF UNREGISTERED SECURITIES
Set forth in chronological order is information regarding shares of common
stock issued and options and warrants and other convertible securities granted
by the Company during the year ended December 31, 2001. Also included is the
consideration, if any, received by the Company for such shares and options and
information relating to the section of the Securities Act of 1933, or rule of
the Securities and Exchange Commission under which exemption
from registration was claimed.
(1) From January to December, 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 1,705,000 of these shares have expired as of December 31,
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.
25
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
Summary Financial Data
Set forth below are summary statements of operations data for the period
from October 23, 1997, the date of incorporation to December 31, 1997, the years
ended December 31, 1998, 1999, 2000 and 2001, and summary balance sheet data as
of December 31, 1997, 1998, 1999, 2000 and 2001. This information should be
read in conjunction with the Consolidated Financial Statements and Notes thereto
and "Management's Discussion and Analysis of Financial Condition and Results of
Operations", appearing elsewhere in this Form.
1997 1998 1999 2000 2001
----------- ------------ ------------ ------------- ------------
STATEMENT OF OPERATIONS DATA:
Net revenues $ 144,900 $ 258,000 $ 5,032,800 $ 9,418,400 $ 2,069,500
Gross profit $ 57,500 $ 18,200 $ 1,029,000 $ 2,110,700 $(2,188,600)
Loss from operations $ (142,100) $(3,082,300) $(9,402,500) $(10,367,900) $(8,986,500)
Net loss $ (159,700) $(3,113,600) $(9,880,400) $(14,351,400) $(8,550,400)
Net loss available to common $ (327,200) $(3,127,900) $(9,880,400) $(14,351,400) $(8,550,400)
shareholders
Basic loss per share $ (0.06) $ (0.32) $ (0.46) $ (0.36) $ (0.20)
Diluted loss per share $ (0.06) $ (0.32) $ (0.46) $ (0.36) $ (0.20)
WEIGHTED-AVERAGE COMMON
SHARES:
Basic outstanding shares 5,483,500 9,724,781 21,274,203 39,381,211 43,124,586
Diluted outstanding shares 5,483,500 9,724,781 21,274,203 39,381,211 43,124,586
Balance Sheet Data:
Working capital (Deficiency) $ (222,900) $ 300,400 $(2,053,000) $ 14,144,500 $ 8,525,200
Total Assets $2,082,300 $ 1,652,700 $ 6,031,200 $ 18,123,600 $ 8,791,700
Long-term Liabilities $ 773,500 $ 5,400 $ 3,200,000 $ 0 $ 0
Total stockholders' equity $ 973,400 $ 1,332,100 $(2,000,300) $ 16,563,300 $ 8,607,800
(Deficiency)
ITEM 7. 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 the
26
company's 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 the company on the date hereof and speak only
as of the date hereof. The factors discussed below under "Risk Factors" and
elsewhere in this Annual Report on Form 10-K are among those factors that in
some cases have affected the company's 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 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 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.
In 2001, Nettaxi faced the challenges of an overall downturn in the
Internet industry and the economy in general. As of December 31, 2001, we had
incurred losses of approximately $36.2 million. 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 took corrective action to significantly decrease our
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 sought to identify an appropriate entity with which to
merge, acquire or restructure our current business. Since the announcement of
our acquisition strategy in May 2001, we have evaluated a number of potential
Merger candidates in a wide variety of industries. Of all of these companies, we
believe RAE Systems presents the best fit for our shareholders. We believe the
Merger with RAE Systems is the fruit of our acquisition strategy and that the
Merger will provide us with a new direction that avoids the pitfalls that have
crippled so many Internet businesses.
In June 2001, we reduced our overhead and burn rate by reducing the
salaries of our employees and reducing the number of 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 consummate the proposed Merger with RAE Systems.
We continue to operate our website, however, we have focused our energies
on our acquisition strategy and therefore have not pursued any revenue
generating activities in the last six months of 2001.
27
Prior to June 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 also discontinued the purchase of bandwidth
and premium services from our third party provider, further reducing monthly
expenditures. The terminations have reduced our operating expenses, and
materially affected our revenues beginning in the third quarter of 2001.
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.
RESULTS OF OPERATIONS; COMPARISON OF THE TWELVE MONTHS ENDED DECEMBER 31, 2001
AND 2000
NET REVENUES. Net revenues for the twelve months ended December 31, 2001
were $2.1 million compared with $9.4 million for the twelve months in 2000. The
significant decrease is primarily the result of the substantial reduction of our
operating activities and expenditures in connection with the adoption of our
acquisition strategy and the current economic climate in the Internet industry.
In June 2001, we terminated our significant co-hosting customer contracts
effective July 7, 2001, which materially decreased our revenues beginning in the
third quarter of 2001. The substantial decrease was also the result of
significantly lower advertising revenues recognized in the twelve months ended
December 31, 2001.
For the twelve months ended December 31, 2001, three customers each
accounted for greater than 10% of total net revenues for a total of
approximately $1.9 million or 90% of the total revenues. These customers,
Babenet, Whitesand Communications, and Whitehorn Ventures Limited, accounted for
47%, 19%, and 25%, respectively of our total revenues. All three of these
customers were co-hosting customers. For the twelve months ended December 31,
2000, four customers, Babenet, Whitesand Communications, Hearme.com,
Spinrecords.com, each accounted for greater than 10% of total net revenues for a
total of approximately $5.1 million or 54% of the total revenues. In June 2001,
we terminated our significant co-hosting customer contracts effective July 7,
2001, which has materially affected revenues beginning in the third quarter of
2001.
ADVERTISING REVENUES. Advertising revenues for the twelve months ended
December 31, 2001 and 2000 were approximately $0.2 million and approximately
$5.7 million, respectively, which represented 10% and 60%, respectively, of
total net revenues. The decline in absolute dollars resulted from the
substantial reduction of our operating activities and expenditures in connection
with the adoption of our acquisition strategy and the current economic climate
in the Internet industry. The decline was also attributable to the discontinued
use of reciprocal advertising transactions and decreases in the number of
28
advertisers and the decrease in the average rate paid by these advertisers. As a
result of the increased bankruptcy and liquidation trend in the marketplace, we
further tightened our credit terms and loss many of our customers. Also, we
initiated several cost savings strategies in the first quarter of 2001, which
resulted in cancellation of advertising arrangements by our customers that
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 28% of total revenues for the twelve months ended December
31, 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 $1.9 million and
$3.7 million for the twelve months ended December 31, 2001 and 2000, which
represented 90% and 40%, of total net revenues, respectively. The decline in
absolute dollars resulted from the substantial reduction of our operating
activities and expenditures in connection with the adoption of our acquisition
strategy and the current economic climate in the Internet industry. For the
twelve months ended December 31, 2001, hosting revenues were a higher percentage
of total net revenue as advertising revenues significantly decreased in the
twelve months ended December 31, 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
twelve months ended December 31, 2001 and 2000, respectively. In June 2001, we
terminated our significant co-hosting customer contracts effective July 7, 2001,
which materially affected revenues beginning in the third quarter of 2001.
COST OF OPERATIONS. Cost of operations were approximately $4.3 million and
$7.3 million for the twelve months ended December 31, 2001 and 2000,
respectively. Cost of operations decreased as a result of the substantial
reduction of our operating activities and expenditures in connection with the
adoption of our acquisition strategy. The decline was also attributable to the
termination of our co-hosting customer contracts which required our purchasing
of bandwidth and services from a third party provider. We have also experienced
a substantial decrease in traffic to our website which resulted in the offset to
the cost of purchasing bandwidth. 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
29
parties. We began these new arrangements in the fourth quarter of 2000, but as
result of our acquisition strategy we terminated these arrangements in July
2001. There were no similar costs in the twelve months ended December 31, 2001.
SALES AND MARKETING EXPENSES. Sales and marketing expenses were
approximately $0.9 million and $5.9 million for the twelve months ended December
31, 2001 and 2000, respectively. The decline in sales and marketing expenses was
attributable to the substantial reduction of our operating activities and
expenditures in connection with the adoption of our acquisition strategy. The
decline was also attributable to the discontinued use of reciprocal online
advertising arrangements to increase brand awareness and traditional print and
media marketing advertising. We recorded reciprocal advertising expenses in
relation to the reciprocal advertising revenues of approximately $2.2 million
for the twelve months ended December 31, 2000. There were no similar expenses in
2001.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses were
approximately $0.4 million and $1.6 million for the twelve months ended December
31, 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 October 2001, we have engaged two technical
consultants for short-term projects.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
were approximately $5.5 million and $5.0 million for the twelve months ended
December 31, 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. In addition to the above we recognized in 2001 a
write-down of approximately $823,000 due to impairment of equipment, purchased
technology and other intangibles, and a loss on disposal of certain equipment of
$327,600 related to 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
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 additional expenses were offset with
decreases in personnel costs as a result of termination of personnel in the
first and second quarter of 2001.
INTEREST INCOME. Interest income was approximately $447,900 and $703,800
for the twelve months ended December 31, 2001 and 2000, respectively. The higher
average cash balance in the twelve months ended December 31, 2000, 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.
30
INTEREST EXPENSE. Interest expense was approximately $9,400 and $4.7
million for the twelve months ended December 31, 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.
INCOME TAXES. The provision for income taxes for the years ended December
31, 2001 and 2000 consisted of minimum state taxes of $2,400 and $1,600,
respectively. At December 31, 2001, we had net operating loss carryforwards
available to reduce future taxable income that aggregate approximately $26.7
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 $14.2
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 is 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. If we complete an acquisition consistent with
our acquisition strategy, we may be unable to apply these net operating loss
carryforwards at all.
RESULTS OF OPERATIONS; COMPARISON OF THE TWELVE MONTHS ENDED DECEMBER 31, 2000
AND 1999
NET REVENUES. Net revenues for the year ended December 31, 2000 increased
87% to approximately $9.4 million from $5.0 million for the year ended December
31, 1999. The absolute dollar increase is the result of an increase in revenues
from the corporate web hosting and the increase in advertising revenues.
Advertising revenues included third party revenues from both traditional and
internet related advertisers which also includes reciprocal arrangements. For
the year ended December 31, 2000, four customers each accounted for greater than
10% of total net revenues for a total of approximately $5.1 million or 54% of
the total revenues. These customers, Babenet, SpinRecords.com, Whitesand
Communications, and Hearme.com, accounted for 20%, 13%, 11% and 10%,
respectively of our total revenues. For the year ended December 31, 1999, one
customer, Whitesand Communications, accounted for greater than 10% of total net
revenues. The loss of any one of all of these customers could have a material
adverse affect on our revenue.
ADVERTISING REVENUES. Advertising revenues for the year ended December 31,
2000 and 1999 were approximately $5.7 million and approximately $2.7 million,
respectively, which represented 60% and 53%, respectively, of total net
revenues. The year over year increase in absolute dollars resulted from an
increase in reciprocal advertising transactions and increases in the number of
advertisers as well as the increase in average contract commitments of these
advertisers as a result of increased web traffic to our web site. Reciprocal
advertising arrangements are exchanges of similar services between the Company
and the advertisers. These arrangements accounted for approximately 28% and 7%
of total revenues for the twelve months ended December 31, 2000 and 1999,
respectively. Reciprocal arrangements for the twelve months ended December 31,
2000 are the result of the Company's strategy in developing strategic
relationships with other advertisers or service providers for non-cash media
advertising.
31
TRANSACTION PROCESSING FEES. There were no transaction processing fees for
the year ended December 31, 2000. Transaction processing fees were approximately
$1.29 million for the year ended December 31, 1999, which represented 26%, of
total net revenues. Transactions fees consisted of revenue derived from credit
card evaluations and from the processing of on-line credit card transactions.
The 1999 revenue is attributable to the Merger with Plus Net, Inc. in May 1999.
The contract through which these fees have been derived terminated in December,
1999 and we do not expect revenues of this type to be significant in future
periods.
HOSTING REVENUES. Our hosting revenues were approximately $3.7 million and
$945,000 for the years ended December 31, 2000 and 1999, respectively, which
represented 40% and 19%, of total net revenues, respectively. For the year
ended December 31, 2000, we recognized hosting revenues for the twelve months as
compared to only six months in the year ended December 31, 1999. In the third
quarter of 1999, we began providing internet hosting and connectivity services
for corporate customers. 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. The Company has experienced strong revenue growth in the internet web
hosting for corporate customers, but does not expect this growth to continue at
the current rate, or that the Company will sustain profitability from this
business segment. Additionally, the Company cannot assure that it can increase
the number of corporate customers or maintain the current customer base. As
previously described, two web-hosting customers accounted for more than 10% of
total net revenues for the twelve months ended December 31, 2000.
COST OF OPERATIONS. Cost of operations were approximately $7.3 million and
$4.0 million for the years ended December 31, 2000 and 1999, respectively. Cost
of operations increased 83%. Approximately 85% of the increase is the result of
additional expenses related to costs for co-location (Internet connection
charges) expenses. In the third quarter of 1999, we began providing Internet
connectivity services to corporate customers and required purchases of
additional bandwidth to service these customers. These costs are expected to
continue to increase as our web traffic increases and our corporate customer
require additional bandwidth for our "citizens". For the year ended December
31, 2000, the Company recognized hosting expenses for twelve months as compared
to only six months in the year ended December 31, 1999. Approximately 6% of the
increase is related to increased depreciation expense for capital purchased in
1999. Approximately 6% of the increase is related to the costs for consultants
to improve our website. Separately, during the third quarter ended September
30, 2000, we also initiated cost effective measurement tools to limit the use of
unauthorized excessive bandwidth or charging the individual users for the use of
additional bandwidth. These cost measures resulted in cost savings to the
Company in the third and fourth quarter of year 2000. We cannot be assured that
these cost saving measures will continue to result in substantial savings or any
savings at all.
SALES AND MARKETING EXPENSES. Sales and marketing expenses were
approximately $5.9 million and $4.8 million for the twelve month periods ended
December 31, 2000 and 1999, respectively. Sales and marketing expenses
32
consisted primarily of advertising, including co-branding and reciprocal,
salaries of our sales and marketing personnel and related costs, marketing, and
promotion costs. Approximately $1.9 million of the net increase is the result
of the redirected marketing approach for brand awareness implemented in the
third quarter of 2000. This consisted of using reciprocal online advertising
arrangements to increase brand awareness rather than the traditional print and
media marketing approach. The Company recorded reciprocal advertising expenses
in relation to the reciprocal advertising revenues of $2.2 million for the year
ended December 31, 2000 compared to approximately $0.3 million for the year
ended December 31, 1999. The Company utilizes reciprocal advertising
arrangements as an inexpensive advertising media for increasing brand awareness.
There can be no assurance that these increased expenditures will result in
increased visitors to our web site or additional revenues in the future. This
increase was offset by a reduction of approximately $0.8 million reduction in
spending on traditional marketing media expenditures.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses were
$1.6 million and $2.2 million for the twelve months ended December 31, 2000 and
1999, respectively. The 28% decrease was primarily attributable to the lower
utilization of consultants by the Company and decrease in average number of
technical personnel during the year 2000. Approximately $0.6 million of the
decrease was related to the lower utilization of consultants and $0.2 million of
the decrease was related to the decrease in recruiting fees paid to hire new
employees. The above two costs were offset by an approximately $0.3 million
increase which was related to increased depreciation expense for capital
equipment. The Company has experienced a difficulty in its ability to recruit
and retain technical personnel as a result of the current economic prosperity
and high cost of living in Silicon Valley and expects this condition to have a
continuous impact on the ability of the Company to retain and hire additional
technical personnel.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
were $5.0 million and $3.5 million for the twelve months ended December 31, 2000
and 1999, 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 $0.6 million of the increase in general and administrative
expenses were primarily attributable to amortization of deferred compensation
expense related to stock, warrants and options granted during the year to
various consultants for the services. Approximately $0.4 million of the
increase was the result of additional salaries and personnel costs.
Approximately $0.4 million of the increase is related to higher insurance costs
associated with being a public company. Also, the increase is the result of
legal fees related to the settlement agreement with the holder of convertible
debentures. The Company also recorded approximately $500,000 provision for
uncollectible accounts receivable. The Company expects that due to the highly
volatile market conditions for internet related and other advertising companies,
the provision for bad debt may be higher in the future. The above increases
were offset by the decrease in expenditures related to the Merger with Plus Net,
Inc. in 1999.
INTEREST EXPENSE. Net interest expense was $4.0 million and $0.4 million
for the years ended December 31, 2000 and 1999, respectively. For the year 1999
period the net interest expense was primarily due to the convertible promissory
33
note that was issued on March 31, 1999 and to amortization of deferred interest
related to warrants issued in conjunction with the convertible promissory note,
offset by interest income. For the year 2000 period, the net interest expense
was primarily the result of deemed interest expense related to the convertible
debenture issued on March 31, 1999. We recognized deemed interest expense of
approximately $3.9 million in the second quarter of 2000. This non-cash
interest expense resulted from 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 debenture.
INCOME TAXES. The provision for income taxes for the year ended December
31, 2000 consisted of minimum state taxes. For the year ended December 31, 1999
we recorded a tax provision which related to earnings made by PlusNet, Inc.
during its fiscal period before our merger. 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. The Company also had a 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 December 31, 2001, the Company had cash and cash equivalents of
approximately $8.6 million, compared to approximately $13.9 million at December
31, 2000. Net cash used in operating activities equaled approximately $5.3
million and $8.4 million for the twelve month periods ended December 31, 2001
and 2000, respectively. The decline in cash used was related to the decrease of
approximately $5.8 million in net loss for the twelve months ended December 31,
2001 compared to the same twelve months ended December 31, 2000. However, in
2000 we incurred approximately $4.6 million of non-cash interest expense
relating to a settlement agreement and issuance of warrants. Net adjustment
related to customer receivables amounted to approximately $1.7 million.
Net cash used in investing activities was approximately $26,400 and
$744,100 for the twelve months ended December 31, 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 $22.0
million for the twelve months period ended December 31, 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 $8.6 million and $11.4 million for
the twelve months ended December 31, 2001, and 2000, respectively. At December
31, 2001, we had an accumulated deficit of approximately $36.2 million. The net
losses and accumulated deficit resulted from the significant operational,
34
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. We are continuing to review and reduce all non-essential
expenditures while we pursue our acquisition strategy.
We do not have any long-term commitments that currently require a specified
capital budget other than normal operations. We believe that current cash, and
cash equivalents would be sufficient to meet our anticipated operating cash
needs for at least the next 12 months if the Merger with RAE Systems were not to
take place. The obligations of RAE Systems to close the Merger are subject to,
among other things, our net cash being at least $7,500,000. If we do not have
$7,500,000 we may be forced to seek additional capital from outside sources.
There can be no assurance that financing will be available in amounts or on
terms acceptable to us, if at all. The sale of additional equity or convertible
debt securities could result in additional dilution to our stockholders.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 1999, the staff of the Securities and Exchange Commission
issued its Staff Accounting Bulletin No. 101, "Revenue Recognition". Staff
Accounting Bulletin No. 101 provides the SEC staff's views in applying generally
accepted accounting principles to selected revenue recognition issues. Staff
Accounting Bulletin No. 101 is effective for the fourth fiscal quarter of fiscal
years beginning after December 15, 1999. We believe our current revenue
recognition policies comply with the provisions of Staff Accounting Bulletin No.
101.
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 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 our financial
statements.
In June 1999, the FASB issued SFAS No. 137, Accounting for Derivative Instrument
and Hedging Activities - Deferral of the Effective Date of FASB Statement No.
133, which amends SFAS No. 133 to be effective for all fiscal years beginning
after June 15, 2000. In June 2000, SFAS No. 133 was amended by SFAS No. 138,
Accounting for Certain Derivative Instruments and Hedging Activities, which
amended or modified certain issues discussed in SFAS No. 133. SFAS No. 138 is
also effective for all fiscal years beginning after June 15, 2000. SFAS No. 133
and SFAS No. 138 establish accounting and reporting standards requiring that
every derivative instrument be recorded in the balance sheet as either an asset
or liability measured at its fair value. The statements also require that
changes in the derivative's fair value be recognized currently in earnings
unless specific hedge accounting criteria are met. The Company does not engage
in derivative instruments or hedging activities. Accordingly, there was no
impact on the Company's financial statements from the adoption of SFAS No. 133
and SFAS No. 138.
35
In July 2001, the FASB issued SFAS No. 141 (SFAS 141), Business Combinations,
which supersedes Accounting Principles Board (APB) Opinion No. 16, Business
Combinations. SFAS 141 eliminates the pooling-of-interests method of accounting
for business combinations and modifies the application of the purchase
accounting method. The elimination of the pooling-of-interests method is
effective for transactions initiated after June 30, 2001. The remaining
provision of SFAS 141 will be effective for transactions accounted for using the
purchase method that are completed after June 30, 2001.
In July 2001, the FASB also issued SFAS No. 142 (SFAS 142), Goodwill and
Intangible Assets, which supersedes APB Opinion No. 17, Intangible Assets. Under
SFAS 142, goodwill and intangible assets with indefinite lives are not amortized
but are tested for impairment annually using the fair value approach, except in
certain circumstances, and whether there is an impairment indicator, other
intangible assets will continue to be valued and amortized over their estimated
lives; in-process research and development will continue to be written off
immediately; all acquired goodwill must be assigned to reporting units for
purposes of impairment testing and segment reporting and existing goodwill will
no longer be subject to amortization. The provisions of SFAS No. 142 are
required to be applied starting with fiscal years beginning after December 15,
2001.
In August 2001, the FASB issued SFAS No. 143 (SFAS 143) Accounting for
Obligations Associated with the Retirement of Long-Lived Assets. SFAS 143
addresses financial accounting and reporting for the retirement obligation of an
asset. SFAS 143 states that companies should recognize the asset retirement
cost, at its fair value, as part of the cost asset and classify the accrued
amount as a liability in the balance sheet. The asset retirement liability is
then accreted to the ultimate payout as interest expense. The initial
measurement of the liability would be subsequently updated for revised estimates
of the discounted cash outflows. SFAS 143 will be effective for fiscal years
beginning after June 15, 2002. The Company has not yet determined the effect
SFAS 143 will have on its financial position, results of operations, or cash
flows.
In October 2001, the FASB issued SFAS No. 144 (SFAS 144) Accounting for the
Impairment or Disposal of Long-Lived Assets. SFAS 144 supersedes the SFAS No.
121 by requiring that one accounting model to be used for long-lived assets to
be disposed of by sale, whether previously held and used or newly acquired, and
by broadening the presentation of discontinued operation to include more
disposal transactions. SFAS 144 will be effective for fiscal years beginning
after December 15, 2001. The Company has not yet determined the effect SFAS 144
will have on its financial position, results of operations, or cash flows.
36
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK
As of December 31, 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.
EFFECTS OF INFLATION
Due to relatively low levels of inflation in 1997, 1998, 1999, 2000 and
2001, inflation has not had a significant effect on our results of operations.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our financial statements, schedules and supplementary data, as listed under
Item 14, appear in a separate section of this report beginning on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
NONE.
37
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES
Our directors, executive officers and other key employees, and their ages,
as of December 31, 2001 are as follows:
NAME AGE POSITION
- -------------------------- --- -------------------------------------------------
Robert A. Rositano, Jr.(1) 32 Chief Executive Officer, Secretary and Director
Dean Rositano (1) 29 President, Chief Operating Officer, Interim Chief
Financial Officer and Director
Andrew Garroni (2) 45 Director
(1) Messrs. Robert A. Rositano, Jr. and Dean Rositano are brothers.
(2) Mr. Andrew Garroni is currently the sole member of our Compensation
Committee and our Audit Committee and is not an employee of Nettaxi.com.
Each director holds office until the next annual meeting on the
stockholders and until his successor is elected and qualified. Executive
officers are appointed by and serve at the pleasure of our board of directors.
Set forth below is certain information regarding the business experience
during the last five years of each of the above named persons.
ROBERT A. ROSITANO, JR. Mr. Rositano Jr. co-founded Nettaxi Online
Communities, Inc., a Delaware corporation , in October, 1997. He has served as
Chief Executive Officer and Secretary of Nettaxi since the reorganization with
Swan Valley and prior to that served in the same capacities with Nettaxi Online
Communities from its inception. He has over seven years of experience in the
Internet service provider and Internet industry. In February 1995, he co-founded
Simply Interactive, Inc. , an Internet/intranet software company, and served as
Executive Vice President in the areas of Inside Sales, Customer Service and
Product Development until he co-founded Nettaxi Online Communities. In January
1994, he co-founded Digital Data Express, a company focused on beginner level
Internet users, and served as Chief Executive Officer until February 1995 when
Digital Data Express was acquired by Simply Interactive. From 1992 to 1994, Mr.
Rositano was hired on as the third employee at Netcom On-line Communications in
1992 and served as a senior sales and account manager until 1993.
DEAN ROSITANO. Mr. Rositano co-founded Nettaxi Online Communities in
October, 1997. He has served as President of Nettaxi since the reorganization
with Swan Valley and prior to that served in the same capacities with Nettaxi
Online Communities. He has over seven years of experience in the ISP and
Internet industry. In February 1995, he co-founded Simply Interactive, Inc., an
38
Internet/intranet software company, and served as Vice President of Technology
until he co-founded Nettaxi Online Communities. While at Simply Interactive, he
assembled a digital production studio and produced the Internet the City CD-ROM
in a three month time frame on three platforms, Windows 3.1, Windows 95, and
Macintosh. In January 1994, he co-founded Digital Data Express and served as
President and Chief Executive Officer until February 1995 when Digital Data
Express was acquired by Simply Interactive. At Digital Data Express, Mr.
Rositano co-produced and directed the world's first Internet training video
"Introduction to the Internet."
ANDREW GARRONI. Mr. Garroni has served as a director since completion of
our merger with Plus Net in May 1999. Under the terms of our merger agreement
with Plus Net, Mr. Garroni was appointed as a member of the board of directors.
Mr. Garroni has over 20 years experience in the development and management of
start-up entertainment companies. He currently serves as Executive Producer of
Showtime's movie series "Naked City," a position he has held since January,
1998. From 1990 to September, 1998 he served as President of Axis Films
International, Inc. supplying films to cable television networks such as Home
Box Office, Showtime Networks and DBS providers like Direct TV. He began his
career in New York as a principal partner in the motion picture Production
Company Cinerex Associates, Inc. whose clients included Twentieth Century Fox
and Orion Pictures. While in New York, he helped create Magnum Motion Pictures
and Magnum Entertainment. Mr. Garroni has a Bachelor's degree in Marketing from
Fairleigh Dickinson University.
EMPLOYMENT AGREEMENTS AND TERMINATION OF EMPLOYMENT AND CHANGE OF CONTROL
ARRANGEMENTS
EXECUTIVE EMPLOYMENT AGREEMENTS. On August 1, 1998 Nettaxi Online
Communities, Inc. entered into executive employment agreements with Robert A.
Rositano, Jr. and Dean Rositano, and these agreements continued in effect after
the reorganization with Swan Valley Snowmobiles,