10-Q 1 0001.txt FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 (Mark One) [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2000 [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________ to ________ Commission file number: 0-26109 NETTAXI.COM (Exact name of registrant as specified in its charter) Nevada 82-0486102 (State or other jurisdiction (I.R.S. Employer Identification No.) of incorporation or organization) 1696 Dell Avenue, Campbell, CA 95008 (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number, including area code: (408) 879-9880 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Applicable Only To Corporate Issuers: As of August 1, 2000, the registrant had 42,619,586 shares of common stock, $.001 par value per share, outstanding.
NETTAXI.COM CONTENTS PART I FINANCIAL INFORMATION Page No. -------- Item 1. Financial Statements Condensed Consolidated Balance Sheets as of June 30, 2000 (unaudited) and December 31, 1999 3 Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2000 (unaudited) and June 30, 1999 (unaudited) 4 Condensed Consolidated Statements of Shareholders' (Deficiency) Equity, June 30, 2000 (unaudited) 5 Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2000 (unaudited) and June 30, 1999 (unaudited) 6 Notes to Condensed Consolidated Financial Statements (unaudited) 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 14 Item 3. Quantitative and Qualitative Disclosures About Market Risk 32 PART II OTHER INFORMATION Item 1. Legal Proceedings 32 Item 2. Changes in Securities and Use of Proceeds 32 Item 3. Defaults Upon Senior Securities 33 Item 4. Submission of Matters to a Vote of Security Holders 33 Item 5. Other Information 34 Item 6. Exhibits and Reports on Form 8-K 34 SIGNATURES 34 EXHIBIT INDEX 35
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PART I. FINANCIAL INFORMATION ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS NETTAXI.COM CONDENSED CONSOLIDATED BALANCE SHEETS December 31, 1999 JUNE 30, 2000 ------------------- --------------- (UNAUDITED) --------------- ASSETS ----------------------------------------------------------------------------------- CURRENT ASSETS: ----------------------------------------------------------------------------------- Cash and cash equivalents $ 987,700 $ 16,734,200 ----------------------------------------------------------------------------------- ------------------- --------------- Accounts receivable, net of allowance for doubtful accounts of $83,600 and $260,600, respectively 1,181,600 1,810,300 ----------------------------------------------------------------------------------- ------------------- --------------- Prepaid expenses and other assets 609,200 920,300 ----------------------------------------------------------------------------------- ------------------- --------------- TOTAL CURRENT ASSETS 2,778,500 19,464,800 ----------------------------------------------------------------------------------- ------------------- --------------- Property and equipment, net 1,968,600 1,888,800 ----------------------------------------------------------------------------------- ------------------- --------------- Intangibles, net 578,000 476,000 ----------------------------------------------------------------------------------- ------------------- --------------- Deferred expenses 706,100 630,800 ----------------------------------------------------------------------------------- ------------------- --------------- TOTAL ASSETS $ 6,031,200 $ 22,460,400 ----------------------------------------------------------------------------------- ------------------- --------------- LIABILITIES AND SHAREHOLDERS' (DEFICIENCY) EQUITY ----------------------------------------------------------------------------------- CURRENT LIABILITIES ----------------------------------------------------------------------------------- Accounts payable $ 4,041,400 $ 1,201,000 ----------------------------------------------------------------------------------- ------------------- --------------- Accrued expenses 664,500 774,700 ----------------------------------------------------------------------------------- ------------------- --------------- Income taxes payable 125,600 - ----------------------------------------------------------------------------------- ------------------- --------------- TOTAL CURRENT LIABILITIES 4,831,500 1,975,700 ----------------------------------------------------------------------------------- ------------------- --------------- LONG-TERM LIABILITIES ----------------------------------------------------------------------------------- Convertible notes payable 3,200,000 - ----------------------------------------------------------------------------------- ------------------- --------------- TOTAL LIABILITIES 8,031,500 1,975,700 ----------------------------------------------------------------------------------- ------------------- --------------- Commitments and contingencies ----------------------------------------------------------------------------------- SHAREHOLDERS' (DEFICIENCY) EQUITY ----------------------------------------------------------------------------------- Preferred stock, $.001 par value; 1,000,000 shares authorized; no shares issued and outstanding Common stock, $.001 par value; 50,000,000 and 200,000,000 shares authorized, respectively, 23,214,446 and 42,619,586 shares issued and outstanding, respectively 20,000 39,200 ----------------------------------------------------------------------------------- ------------------- --------------- Additional paid-in capital 11,807,500 43,737,600 ----------------------------------------------------------------------------------- ------------------- --------------- Deferred compensation (491,400) (725,100) ----------------------------------------------------------------------------------- ------------------- --------------- Accumulated deficit (13,336,400) (22,567,000) ----------------------------------------------------------------------------------- ------------------- --------------- TOTAL SHAREHOLDERS' (DEFICIENCY) EQUITY (2,000,300) 20,484,700 ----------------------------------------------------------------------------------- ------------------- --------------- TOTAL LIABILITIES AND SHAREHOLDERS' (DEFICIENCY) EQUITY $ 6,031,200 $ 22,460,400 ----------------------------------------------------------------------------------- ------------------- --------------- **The accompanying notes are an integral part of these financial statements
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NETTAXI.COM CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS Three Months ended THREE MONTHS ENDED Six Months ended SIX MONTHS ENDED 6/30/99 6/30/00 6/30/99 6/30/00 -------------------- -------------------- ------------------ ------------------ (unaudited) (UNAUDITED) (unaudited) (UNAUDITED) -------------------- -------------------- ------------------ ------------------ Net Revenues $ 1,189,100 $ 2,984,900 $ 1,878,400 $ 5,749,800 --------------------------------------- -------------------- -------------------- ------------------ ------------------ Operating Expenses: --------------------------------------- Cost of operations 408,800 1,921,800 732,200 3,695,300 --------------------------------------- -------------------- -------------------- ------------------ ------------------ Sales and marketing 705,300 2,073,700 841,000 3,837,000 --------------------------------------- -------------------- -------------------- ------------------ ------------------ Research and development 511,900 373,300 729,700 830,400 --------------------------------------- -------------------- -------------------- ------------------ ------------------ General and administrative 1,585,800 1,221,500 2,008,600 2,689,000 --------------------------------------- -------------------- -------------------- ------------------ ------------------ Total Operating Expenses 3,211,800 5,590,300 4,311,500 11,051,700 --------------------------------------- -------------------- -------------------- ------------------ ------------------ Loss From Operations (2,022,700) (2,605,400) (2,433,100) (5,301,900) --------------------------------------- -------------------- -------------------- ------------------ ------------------ Interest income 36,900 221,000 39,500 247,000 --------------------------------------- -------------------- -------------------- ------------------ ------------------ Interest expense (151,300) (181,200) (151,800) (278,900) --------------------------------------- -------------------- -------------------- ------------------ ------------------ Deemed interest on settlement agreement - (3,896,000) - (3,896,000) --------------------------------------- -------------------- -------------------- ------------------ ------------------ Loss before income taxes (2,137,100) (6,461,600) (2,545,400) (9,229,800) --------------------------------------- -------------------- -------------------- ------------------ ------------------ Income tax expense (800) - (101,600) (800) --------------------------------------- -------------------- -------------------- ------------------ ------------------ Net Loss $ (2,137,900) $ (6,461,600) $ (2,647,000) $ (9,230,600) --------------------------------------- -------------------- -------------------- ------------------ ------------------ Basic and diluted loss per common share $ ( 0.10 ) $ (0.15) $ (0.13) $ (0.25) --------------------------------------- -------------------- -------------------- ------------------ ------------------ Weighted average common shares outstanding 21,110,000 41,836,456 21,110,000 36,315,563 --------------------------------------- -------------------- -------------------- ------------------ ------------------ **The accompanying notes are an integral part of these financial statements
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NETTAXI.COM CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS' (DEFICIENCY) EQUITY Common Stock ------------------- Additional Paid-in Deferred Accumulated Shares Amount Capital Compensation Deficit Total ---------- ------- ------------------- -------------- ------------- ------------ Balances, December 31, 1999, (Audited) 23,214,446 $20,000 $ 11,807,500 $ (491,400) $(13,336,400) $(2,000,300) ------------------------------------ ---------- ------- ------------------- -------------- ------------- ------------ Exchange of convertible notes payable and accrued interest 2,382,472 2,300 3,317,600 3,319,900 ------------------------------------ ---------- ------- ------------------- -------------- ------------- ------------ Proceeds from the issuance of common stock 632,472 600 834,300 834,900 ------------------------------------ ---------- ------- ------------------- -------------- ------------- ------------ Deemed interest on settlement agreement 3,896,000 3,896,000 ------------------------------------ ---------- ------- ------------------- -------------- ------------- ------------ Deferred compensation 1,175,400 (1,175,400) - ------------------------------------ ---------- ------- ------------------- -------------- ------------- ------------ Amortization of deferred compensation 941,700 941,700 ------------------------------------ ---------- ------- ------------------- -------------- ------------- ------------ Conversion of trade payables to common stock 778,982 800 1,557,200 1,558,000 ------------------------------------ ---------- ------- ------------------- -------------- ------------- ------------ Issuance of common stock for services 181,250 200 583,800 584,000 ------------------------------------ ---------- ------- ------------------- -------------- ------------- ------------ Proceeds from sale of common stock, net of costs of $2,409,100 15,416,633 15,300 20,549,800 20,565,100 ------------------------------------ ---------- ------- ------------------- -------------- ------------- ------------ Issuance of common stock due to the exercise of stock options 13,331 16,000 16,000 ------------------------------------ ---------- ------- ------------------- -------------- ------------- ------------ Net loss (9,230,600) (9,230,600) ------------------------------------ ---------- ------- ------------------- -------------- ------------- ------------ Balances, June 30, 2000 (unaudited) 42,619,586 $39,200 $ 43,737,600 $ (725,100) $(22,567,000) $20,484,700 ------------------------------------ ---------- ------- ------------------- -------------- ------------- ------------ **The accompanying notes are an integral part of these financial statements ------------------------------------ ---------- ------- ------------------- -------------- ------------- ------------
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NETTAXI.COM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS Six Months Ended SIX MONTHS ENDED June 30, JUNE 30, 1999 2000 (Unaudited) (UNAUDITED) -------------------------------------------------------------------------------------------------------------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $ (2,647,100) $ (9,230,600) Adjustments to reconcile net loss to net cash (used in) provided by operating activities: Depreciation and amortization 195,700 536,200 Allowance for doubtful accounts 119,100 177,000 Issuance of common stock for interest on convertible notes - 119,900 Issuance of common stock for services - 357,100 Compensation expense related to options granted 17,800 364,200 Interest expense related to settlement agreement - 2,400,000 Interest expense related to warrants granted 86,600 1,655,000 Changes in operating assets and liabilities: Accounts receivable (396,800) (805,700) Prepaid expenses and other assets (34,000) (187,500) Accounts payable 1,955,900 (1,282,400) Accrued expenses 564,900 113,800 Deferred revenue 22,900 - Income taxes payable 100,000 (125,600) -------------------------------------------------------------------------------------------------------------- NET CASH USED IN OPERATING ACTIVITIES (14,900) (5,908,600) -------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Deposits (41,100) 19,600 Capital expenditures (1,028,300) (354,400) -------------------------------------------------------------------------------------------------------------- NET CASH USED IN INVESTING ACTIVITIES (1,069,400) (334,800) -------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Payment on obligation under capital lease (3,700) (3,600) Proceeds from issuance of note payable 5,000,000 - Net proceeds from issuance of common stock 6,800 21,993,500 -------------------------------------------------------------------------------------------------------------- NET CASH PROVIDED BY FINANCING ACTIVITIES 5,003,100 21,989,900 -------------------------------------------------------------------------------------------------------------- NET INCREASE IN CASH AND CASH EQUIVALENTS 3,918,800 15,746,500 CASH AND CASH EQUIVALENTS, beginning of period 465,800 987,700 -------------------------------------------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS, end of period $ 4,384,600 $ 16,734,200 ============================================================================================================== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash Paid: Income taxes $ 1,600 $ 97,400 Interest $ 500 $ - Noncash Operating and Financing Activities: Issuance of common stock for accounts payable $ - $ 1,558,000 Issuance of common stock for convertible notes plus accrued interest $ - $ 3,319,900 Issuance of common stock for services $ - $ 584,000 Options granted for finders fee $ - $ 577,500
6 NETTAXI.COM NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF ACCOUNTING POLICIES THE COMPANY Nettaxi.com (formerly Nettaxi, Inc. and formerly Swan Valley Snowmobiles, Inc.), the Company, is a Nevada corporation, incorporated on October 26, 1995. On September 29, 1998, the Company completed the acquisition of 100% of the outstanding common stock of Nettaxi OnLine Communities, Inc., a Delaware corporation, and changed its name to Nettaxi, Inc. The Company changed its name to Nettaxi.com in June, 1999. For accounting purposes, the acquisition has been treated as the acquisition of the Company by Nettaxi OnLine Communities, Inc. with Nettaxi OnLine Communities, Inc. as the acquiror. All shares and per share data prior to the acquisition have been restated to reflect the stock issuance and related stock split. As the former shareholders of Nettaxi OnLine Communities, Inc. received 85% of the shares in the Company immediately after the acquisition, the financial statements for periods prior to the reorganization are those of Nettaxi OnLine Communities, Inc. Effective May 7, 1999, the Company completed a merger in a single transaction with Plus Net, Inc. by exchanging 7 million shares of its common stock for all of the common stock of Plus Net, Inc. Each share of Plus Net was exchanged for 1,000 shares of Nettaxi common stock. The merger constituted a tax-free reorganization and has been accounted for as a pooling of interest under Accounting Principles Board Opinion No. 16. For periods proceeding the merger, there were no intercompany transactions that require elimination from the combined consolidated results of operations and there were no adjustments necessary to conform the accounting practices of the two companies. Nettaxi OnLine Communities, Inc., was incorporated on October 23, 1997 to capitalize on a significant opportunity that exists today through the convergence of the media and entertainment industries with the vast communications power of the Internet. The Company's Web site, http://www.nettaxi.com, is an online community designed to seamlessly integrate content with e-commerce services for the Company's subscribers, providing comprehensive information about news, sports, entertainment, health, politics, finances, lifestyle, and areas of interest to the growing number of Internet users. The Company's mission is to establish Nettaxi.com as an entry point, or portal, to the Internet by continuing to develop premium online communities, which are both content-rich to its subscribers and provide easy-to-use e-commerce services to businesses which reside in these online communities. 7 The Company's principal executive offices are located in Campbell, California. CONSOLIDATION The accompanying condensed consolidated financial statements include the accounts of Nettaxi.com (formerly Nettaxi, Inc. and formerly Swan Valley Snowmobile, Inc.) and its wholly-owned subsidiary, Nettaxi OnLine Communities, Inc. All intercompany accounts and transactions have been eliminated in the consolidated financial statements. USE OF ESTIMATES The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. BASIS OF PRESENTATION The unaudited historical consolidated financial statements of Nettaxi.com included herein have been prepared in accordance with the instructions for Form 10-Q and, therefore, do not include all information and footnotes necessary for a complete presentation of Nettaxi.com results of operations, financial position and cash flows. The unaudited consolidated financial statements included herein reflect all adjustments (which include only normal, recurring adjustments) which are, in the opinion of management, necessary to state fairly the results for the periods presented. The results for the six months ended June 30, 2000 are not necessarily indicative of the results expected for the full fiscal year. CASH AND CASH EQUIVALENTS The Company considers all highly liquid investments having original maturities of 90 days or less to be cash equivalents. ACCOUNTS RECEIVABLE AND ALLOWANCES FOR DOUBTFUL ACCOUNTS The Company grants credit to its customers after undertaking an investigation of credit risk for all significant amounts. An allowance for doubtful accounts is provided for estimated credit losses at a level deemed appropriate to adequately provide for known and inherent risks related to such amounts. The allowance is based on reviews of losses, adjustment history, current economic conditions and other factors that deserve recognition in estimating potential losses. While management uses the best information available in making its determination, the ultimate recovery of recorded accounts receivable is also dependent upon future economic and other conditions that may be beyond management's control. 8 PROPERTY AND EQUIPMENT Property and equipment are stated at cost. Depreciation is provided using the straight-line method over the estimated economic useful lives of the assets, as follows: Estimated useful lives ------------------------ Furniture and fixtures. 5 years Office equipment 5 years Computers and equipment 3 years Assets held under capital leases are amortized on a straight-line basis over the shorter of the lease term or the estimated useful lives of the related assets. PURCHASED TECHNOLOGY AND OTHER INTANGIBLES The Company amortizes, on a straight-line basis, the cost of purchased technology and other intangibles over the shorter of five (5) years or the useful life of the related technology or underlying asset. SOFTWARE DEVELOPMENT COSTS In accordance with Statement of Financial Accounting Standards No. 86, Accounting for the Costs of Computer Software to be Sold, Leased, or otherwise Marketed, software development costs are expensed as incurred until technological feasibility has been established, at which time such costs are capitalized until the product is available for general release to customers. To date, the establishments of technological feasibility of the Company's products and general release of such software have substantially coincided. As a result, software development costs qualifying for capitalization have been insignificant, and therefore, the Company has not capitalized any software development costs. REVENUE RECOGNITION AND DEFERRED REVENUE The Company's revenues are derived principally from the sale of banner advertisements, web hosting services and from products from its online malls. Advertising revenues are recognized in the period in which the advertisement is delivered, provided that collection of the resulting receivable is probable. Advertisers are charged on a per impression or delivery basis up to a maximum as specified in the contract. To date, the duration of the Company's advertising commitments has not exceeded one year. When the Company guarantees a minimum number of impressions or deliveries, revenue is recognized ratably in proportion to the number of impressions or deliveries recorded to the minimum number of impressions and deliveries guaranteed. Web hosting revenues are recognized in the period in which the services are provided. Product revenue is recognized upon shipment, provided no significant obligations remain and collectability is probable. 9 Advertising revenues include barter revenues, which are the exchange by Nettaxi.com of advertising space on Nettaxi.com's web sites for reciprocal advertising space on other web sites. Revenues from these barter transactions are recorded as advertising revenues at the lower of the estimated fair value of the advertisements received or delivered and are recognized when the advertisements are run on Nettaxi.com's web sites. Barter expenses are recorded when Nettaxi.com's advertisements are run on the reciprocal web sites, which is typically in the same period as when advertisements are run on Nettaxi.com's web sites. For the six months ending June 30, 2000, barter revenues represented approximately 22% of gross revenues as compared to 0% for the same time period in 1999. In November 1999, the Financial Accounting Standards Board (FASB) issued Emerging Issues Task Force (EITF) Issue 99-17 "Accounting for Advertising Barter Transactions". Under EITF 99-17, revenues and expenses should be recognized from advertising barter transactions at the fair value of the advertising surrendered or received only when the company has a historical practice of receiving or paying cash for such transactions. As of June 30, 2000, the Company was in compliance with EITF 99-17. INCOME TAXES The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes, which requires an asset and liability approach. This approach results in the recognition of deferred tax assets (future tax benefits) and liabilities for the expected future tax consequences of temporary differences between the book carrying amounts and the tax basis of assets and liabilities. The deferred tax assets and liabilities represent the future tax return consequences of those differences, which will either be deductible or taxable when the assets and liabilities are recovered or settled. Future tax benefits are subject to a valuation allowance when management believes it is more likely than not that the deferred tax assets will not be realized. ADVERTISING COSTS The cost of advertising is expensed as incurred. Advertising costs for the six months ended June 30, 2000 and 1999, were approximately $3.0 million and $234,100, respectively. LONG-LIVED ASSETS The Company periodically reviews its long-lived assets for impairment. When events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable, the Company writes the asset down to its net realizable value. 10 FAIR VALUES OF FINANCIAL INSTRUMENTS The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments: CASH AND CASH EQUIVALENTS: The carrying amount reported in the consolidated balance sheets for cash and cash equivalents approximates fair value. SHORT-TERM DEBT: The fair value of short-term debt approximates cost because of the short period of time to maturity. LONG-TERM DEBT: The fair value of long-term debt is estimated based on current interest rates available to the Company for debt instruments with similar terms and remaining maturities. RELATED PARTY NOTES RECEIVABLE AND PAYABLE: The fair value of the notes receivable and notes payable to shareholders is based on arms-length transactions and bear interest at rates comparable to similar debt obligations. At June 30, 2000 and December 31, 1999, the fair values of the Company's debt instruments approximatedtheir historical carrying amounts. STOCK-BASED INCENTIVE PROGRAM SFAS No. 123, Accounting for Stock-Based Compensation, encourages entities to recognize compensation costs for stock-based employee compensation plans using the fair value based method of accounting defined in SFAS No. 123, but allows for the continued use of the intrinsic value based method of accounting prescribed by Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees. The Company continues to use the accounting prescribed by APB Opinion No. 25 and as such is required to disclose pro forma net income (loss) and earnings (loss) per share as if the fair value based method of accounting had been applied. BASIC AND DILUTED LOSS PER COMMON SHARE In February 1997, the FASB issued SFAS No. 128, Earnings Per Share, which was effective December 28, 1997. Conforming to SFAS No. 128, the Company changed its method of computing earnings per share and restated all prior periods included in the consolidated financial statements. Basic loss per common share is determined by dividing loss available to common shareholders by the weighted average number of common shares outstanding. Diluted per-common-share amounts assume the issuance of common stock for all potentially dilutive equivalent shares outstanding. Anti-dilution provisions of SFAS 128 require consistency between diluted per-common-share amounts and basic per-common-share amounts in loss periods. For the periods reported, there were no differences between basic and diluted earnings per share. All share and per share information has been adjusted for the shares exchanged for the common stock of Plus Net, Inc. 11 ADOPTION OF NEW ACCOUNTING PRONOUNCEMENTS In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133, as amended by SFAS No. 138, requires companies to recognize all derivatives contracts as either assets or liabilities in the balance sheet and to measure them at fair value. If certain conditions are met, a derivative may be specifically designated as a hedge, the objective of which is to match the timing of gain or loss recognition on the hedging derivative with the recognition of (i) the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk or (ii) the earnings effect of the hedged forecasted transaction. For a derivative not designated as a hedging instrument, the gain or loss is recognized in income in the period of change. In June 1999, the FASB issued SFAS No. 137, Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133, which amends SFAS No. 133 to be effective for all fiscal quarters of all fiscal years beginning after June 15, 2000. Historically, the Company has not entered into derivative contracts either to hedge existing risks or for speculative purposes. Accordingly, the Company does not expect adoption of the new standard to have a material impact on the Company's results from operations, financial position or cash flows. 2. PURCHASED TECHNOLOGY AND OTHER INTANGIBLES In November 1997, the Company issued a convertible secured promissory note in the amount of $1,020,000 and 2,475,066 shares of common stock, valued at $980,000, to a related party in exchange for certain fixed assets, liabilities and technology. Core to the technology acquired was a web to database software application and the underlying technology to the Company's Internet The City products. Based on the fair market value of the consideration exchanged, as determined by an independent appraisal service, the aggregate purchase price was $2,000,000, and was allocated to the following respective assets and liabilities based on their fair market value at the time of the transaction: Purchased technology $1,740,000 Other intangibles $ 150,000 Computers and equipment $ 100,000 Office equipment $ 45,000 Furniture and fixtures $ 5,000 Contracts payable and accrued expenses $ (40,000) ------------------------------------------ ----------- $2,000,000 ========================================== =========== 12 In 1998, the Company experienced several functional problems with portions of the purchased technology, namely the web to database software application, due to those components' incompatibility with subsequent releases of upgraded versions of its operating system. Following attempts to make these components compatible, the Company decided, in December 1998, not to spend additional monies on these components but to replace them. As approximately 50% of the components of the acquired technology were no longer technically viable with the upgraded versions of the Company's operating system and provided no alternative future use, the Company wrote off the unamortized portion of the impaired technology, resulting in a charge to expense of $667,000 in the fourth quarter of 1998. 13 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. THIS REPORT CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, INCLUDING, WITHOUT LIMITATION, STATEMENTS REGARDING THE 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 QUARTERLY REPORT ON FORM 10-Q 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 We were incorporated in October 1997 and launched our web site in July 1998. We are a provider of content-rich and commerce-enabled communities that offer subscribers, or "citizens", a place to build their home pages or businesses on the Internet. The Nettaxi.com web site, at http://www.nettaxi.com, is structured as a virtual "urban" environment, populated by citizens, that is divided into thematic "communities," and from there into "streets" and "homes." Nettaxi.com provides access to information on news, sports, entertainment, health, politics, finances, lifestyle, travel and other areas of interest, and services such as free e-mail, personal home pages, chat and messages. To date, our revenues have been derived principally from the sale of advertisements. We sell a variety of advertising packages to clients, including banner advertisements, event sponsorships, and targeted and direct response advertisements. Currently, our advertising revenues are derived principally from short-term advertising arrangements, averaging one to six months, in which we guarantee a minimum number of impressions for a fixed fee. Advertising revenues are recognized ratably in the period in which the advertisement is displayed, provided that we have no significant remaining obligations and that collection of the resulting receivable is probable. Payments received from advertisers prior to displaying their advertisements on the site are recorded as deferred revenues and are recognized as revenue ratably when the advertisement is displayed. To the extent minimum guaranteed impression levels are not met, we defer recognition of the corresponding revenues until guaranteed levels are achieved. We expect to continue to derive the majority of our revenue for the foreseeable future from the sale of advertising space on our web site. 14 In the third quarter of 1999, we began providing web site hosting and Internet 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 connectivity charges. These "hosting" revenues are recognized in the period the services are provided. In addition to advertising revenues, we derive other revenues from royalties from the distribution of our CD-ROM tutorial product and our premium account membership subscriptions. Royalty revenues result from relationships with computer manufacturers that bundle and distribute our CD-ROM product with their products. Our membership programs offer premium services for a monthly fee, providing additional services such as unlimited personal e-mail accounts for family or friends, unlimited Nettaxi Site Builder web pages, themed web page templates, a personal event calendar, discussion groups, and options to customize personal homepages with pictures, colors and content. In May 1999, we completed the merger with Plus Net, Inc., a California corporation, which has allowed us to provide our users with a web based e-mail program and a robust meta search engine. Plus Net also has an e-commerce processing engine which enables the acceptance and processing of online credit card transactions. We believe this merger also enhances our electronic commerce and advertising opportunities. As a result of this merger, we received revenues from credit card processing fees during the first half of 1999, with minimal revenues being earned in the third quarter of 1999. The contract through which these fees have been derived terminated in December 1999 and we anticipate that revenues of this type will be minimal in the foreseeable future. We also receive revenues from e-commerce transactions. Our recent e-commerce arrangements generally provide us with a share of any sales resulting from direct links from our site. Revenues from these programs will be recognized in the month that the service is provided. To date, revenues from e-commerce arrangements have not been material. However, we expect e-commerce derived revenues to become a more significant portion of our total revenues in the foreseeable future, as we increase the number of contractual relationships with parties offering e-commerce related products and services which can be made available to our subscribers and parties seeking to make online sales to our subscribers and other visitors to our site. To date, we have entered into business and technology license arrangements in order to build our web site community, provide community-specific content, generate additional traffic, and provide our subscribers with additional products and services, including e-commerce tools. We intend to continue to investigate potential acquisitions and to seek additional relationships with content providers that fall within the scope of our business strategy, and will serve to increase our subscriber base and overall site traffic. 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. 15 RESULTS OF OPERATIONS - COMPARISON OF THE THREE MONTHS ENDED JUNE 30, 2000 AND 1999. NET REVENUES. Revenues for the second quarter of 2000 increased to approximately $3.0 million compared to $1.2 million during the same period of 1999. The period-to-period growth resulted from additional revenues derived as a result of providing Internet web hosting and connectivity services for corporate customers beginning in the third quarter of 1999. Advertising revenues also increased as a result of the increase in the number of advertisers, the average contract duration, and value offered (higher web site traffic to nettaxi.com web pages). Revenues for the second quarter in 1999 consisted primarily of transaction processing fees derived from credit card evaluations and from the processing of on-line credit card transactions. There were no transaction processing fees in 2000. Barter revenues, which are included in advertising revenues, accounted for approximately 22% of total revenues for the second quarter of 2000. There were no barter revenues for the second quarter of 1999. We believe that barter revenues will continue to be significant for the foreseeable future. Four customers each accounted for in excess of 10% of our net revenues for the three months ended June 30, 2000. There were no customers with revenues greater than or equal to 10% of our net revenues for the three months ended June 30, 1999. ADVERTISING REVENUES. Advertising revenues were approximately $2.1 million for the second quarter of 2000 compared to $0.3 million for the same period in1999, which represented approximately 72% and 28%, respectively, of total net revenues. The absolute dollar increases resulted from an increase 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. We cannot predict whether advertisers will either increase or decrease their activity at the site. TRANSACTION PROCESSING FEES. Transaction processing fees, which consist of revenue derived from credit card evaluations and from the processing of on-line credit card transactions were approximately $0.9 million for the three months ended June 30, 1999. We received no transaction processing fees in the second quarter of 2000. The contract through which we derived these fees transmitted in December 1999, and we do not expect revenues of this type to be significant in future periods. HOSTING REVENUES. Hosting revenues were approximately $0.8 million for the second quarter of 2000 or 28% of total net revenues for the period. There were no hosting revenues in the second quarter of 1999. We began providing internet web hosting and connectivity services for corporate customers in the third quarter of 1999. Web hosting 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 are recognized in the period the services are provided. 16 COST OF OPERATIONS. Cost of operations for the second quarter of 2000 increased to $1.9 million compared to $0.4 million for the second quarter of 1999. The increase was primarily attributed to fees paid to third parties related to increased costs for co-location expenses (Internet connection charges). In the third quarter of 1999, we began providing Internet connectivity services to corporate customers, which demanded purchases of additional bandwidth. These costs are expected to continue to increase, as our web traffic increases and our corporate customers require additional bandwidth for our "citizens". Other items contributing to higher costs were equipment costs and depreciation, amortization of intangible assets, and expenses for third party content and development. SALES AND MARKETING EXPENSES. Sales and marketing expenses for the second quarter of 2000 increased to $2.1 million compared to $0.7 million for the second quarter of 1999. Sales and Marketing expenses consisted primarily of investments in sales and marketing personnel, marketing, promotion, advertising and related costs. The absolute dollar increases in sales and marketing expenses were mostly related to expansion of online and print advertising, public relations and other promotional expenditures, and expenditures related to barter transaction and related expenses required to implement our marketing strategy. We expect sales and marketing expenses to increase significantly in future periods. These increases will be principally related to increased spending on advertising in a variety of media to increase brand awareness and attract additional visitors to the Web site. There can be no assurance that these increased expenditures will result in increased visitors to our Web site or additional revenues. Also to a lesser extent, we expect sales and marketing expenses to increase as a result of increased cost of hiring additional sales and marketing personnel. RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses for the second quarter of 2000 decreased to $0.4 million compared to $0.5 million for the second quarter of 1999. The reduction were attributable to cost savings implemented by us including a decrease in the use of consultants. We will continue to implement cost saving programs but cannot assure that these programs will be effective or that future cost savings will be realized. GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses consisted primarily of salaries and related costs for executives, administrative, and finance personnel, as well as legal, accounting and other professional service fees. General and administrative expenses for the second quarter of 2000 decreased to $1.2 million for the second quarter of 2000 compared to $1.6 million during the same period in 1999. The decreases in absolute dollars were primarily due to our implementation of cost controls throughout the entire company which was partially offset by an increase in legal fees relating to the settlement with the holder of the convertible debentures. We expect general and administrative expenses to grow, however, as we hire additional personnel and incur additional expenses related to the growth of our business and our operations as a public company. 17 INTEREST INCOME AND EXPENSE. Net interest income for the second quarter of 2000 was $39,800 compared to a net interest expense of $114,400 during the same period in 1999. Interest expense was primarily due to the convertible promissory note that we issued on March 31, 1999 and to amortization of deferred interest related to warrants issued in conjunction with this convertible promissory note. For the three months ended June 30, 2000 however, this expense was offset by additional interest income resulting from our higher average cash balance in 2000 compared to 1999. The higher average cash balance resulted from our completion of a private placement of common stock that raised approximately $23 million in the first quarter of 2000. Interest expense also decreased in the second quarter of 2000 as a result of the conversion of the convertible promissory note in that quarter. DEEMED INTEREST EXPENSE. 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 Convertibles debentures. RESULTS OF OPERATIONS - COMPARISON OF THE RESPECTIVE SIX MONTHS ENDED JUNE 30, 2000 AND 1999. NET REVENUES. Revenues for the six months ended June 30, 2000 increased to approximately $5.7 million compared to $1.9 million during the same period of 1999. The period-to-period growth resulted from additional revenues derived as a result of providing Internet web hosting and connectivity services for corporate customers beginning in the third quarter of 1999. Advertising revenues also increased as a result of the increase in the number of advertisers, the average contract duration, and value offered (higher web site traffic to nettaxi.com web pages). Revenues for the six months in 1999 consisted primarily of transaction processing fees derived from credit card evaluations and from the processing of on-line credit card transactions. There were no transaction processing fees in 2000. Barter revenues, which are included in advertising revenues, accounted for approximately 22% of total revenues for the six months of 2000. There were no barter revenues for the six months of 1999. We believe that barter revenues will continue to be significant for the foreseeable future. Four customers each accounted for in excess of 10% of our net revenues for the six months ended June 30, 2000. There were no customers with revenues greater than or equal to 10% of our net revenues for the six months ended June 30, 1999. ADVERTISING REVENUES. Advertising revenues were approximately $3.9 million for the six months of 2000 compared to $0.5 million for the same period of 1999, which represented approximately 68% and 26% of total net revenues. The absolute dollar increases resulted from an increase 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. The Company cannot assure that advertisers will either increase or decrease their activity at the site. Additionally, the Company cannot predict certain factors that could lower the advertising prices currently in effect. 18 TRANSACTION PROCESSING FEES. Transaction processing fees were approximately $1.3 million for the six months ended June 30, 1999. There were no transaction processing fees in 2000. Transactions fees consist 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 1999. The Company does not expect revenues of this type to be significant in the future periods. HOSTING REVENUES. Hosting revenues were approximately $1.8 million for the six months of 2000 or 32% of total net revenues. There were no hosting revenues in the six months of 1999. The Company began providing internet web hosting and connectivity services for corporate customers in the third quarter of 1999. Web hosting 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 are recognized in the period the services are provided. COST OF OPERATIONS. Cost of operations for the six months of 2000 increased approximately $3.0 million to $3.7 million compared to $0.7 million for the six months of 1999. The increase was primarily attributed to fees paid to third parties related to increased costs for co-location expenses (Internet connection charges). In the third quarter of 1999, the Company began providing Internet connectivity services to corporate customers, which demanded purchases of additional bandwidth. These costs are expected to continue to increase, as our web traffic increases and our corporate customer require additional bandwidth for our "citizens". Other items contributing to higher costs were equipment costs and depreciation, amortization of intangible assets, and expenses for third party content and development. SALES AND MARKETING EXPENSES. Sales and marketing expenses for the six months of 2000 increased $3.0 million to $3.8 million compared to $0.8 million for the six months of 1999. Sales and Marketing expenses consisted primarily of investments in sales and marketing personnel, marketing, promotion, advertising and related costs. The absolute dollar increases in sales and marketing expenses were mostly related to expansion of online and print advertising, public relations and other promotional expenditures, expenditures related to barter transactions, and related expenses required to implement our marketing strategy. The Company expects sales and marketing expenses to increase significantly in future periods. These increases will be principally related to increased spending on advertising in a variety of media to increase brand awareness and attract additional visitors to the Web site. There can be no assurance that these increased expenditures will result in increased visitors to our Web site or additional revenues. Also to a lesser extent, we expect sales and marketing expenses to increase as a result of increased cost of hiring additional sales and marketing personnel. RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses for the six months of 2000 increased $0.1 million to $0.8 million compared to $0.7 million for the six months of 1999. The absolute dollar increase were due to investments in web architecture and development costs in the first quarter of 2000 offset by the lower utilization of consultants by the Company and other cost savings implemented by the Company. The Company will continue to implement cost saving programs but cannot assure that these programs will be effective or that future cost savings will be realized. 19 GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses consisted primarily of salaries and related costs for executives, administrative, and finance personnel, as well as legal, accounting and other professional service fees. General and administrative expenses for the six months of 2000 increased approximately $0.7 million to $2.7 million for the six months of 2000 compared to $2.0 million during the same period of 1999 partially due to an increase in legal fees relating to the settlement agreement with the holder of convertible debentures. We expect general and administrative expenses to grow as we hire additional personnel and incur additional expenses related to the growth of our business and our operations as a public company. INTEREST EXPENSE. Net interest expense for the six months of 2000 was $31,900 compared to $112,300 during the same period of 1999. The decrease in net interest expense was primarily the result of the conversion of the note in the second quarter 2000. Also, the Company realized additional interest income as a result of higher average cash balance in the 2000 compared to 1999 as a result of the completion of a private placement of its common stock raising approximately $23 million in the first quarter of 2000. DEEMED INTEREST EXPENSE. We recognized deemed interest expense of approximately $3.9 million for the first six months 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 tha we reached with the holder of the convertible debentures. INCOME TAXES. At December 31, 1999, we had net operating loss carryforwards available to reduce future taxable income that aggregate approximately $11.20 million for Federal income tax purposes. These benefits expire through 2019. Pursuant to a "change in ownership" as defined by the provisions of the Tax Reform Act of 1986, utilization of our net operating loss carryforwards may be limited if a cumulative change of ownership of more than 50% occurs over a three-year period. We have not determined if an ownership change has occurred. LIQUIDITY AND CAPITAL RESOURCES As of June 30, 2000, we had cash and cash equivalents of approximately $16.7 million, compared to approximately $1.0 million at December 31, 1999. The increase in cash was due to the completion of our private placement February 2000. Net cash used in operating activities equaled approximately $5.9 million and $14,900 for the six-month periods ended June 30, 2000 and 1999, respectively. We had significant negative cash flows from operating activities for the six month period ended June 30, 2000, primarily from our net operating losses, adjusted for non-cash items, and increases in accounts receivable balances due to the time lag between revenue recognition and the receipt of payments from advertisers and decreases in accounts payable. Net cash used in investing activities was approximately $0.3 and $1.1 million for the six-month periods ended June 30, 2000 and 1999, respectively. Substantially all of the cash used in investing activities for both periods was primarily related to the purchase of capital equipment in connection with the build out of our web site and infrastructure. We expects to continue to purchase capital equipment to meet our needs. 20 Net cash provided by financing activities was approximately $22.0 million and $5.0 million for the six month periods ended June 30, 2000 and 1999, respectively. Net cash provided by financing activities in 2000 consisted primarily of net proceeds from the February private placement of our common stock and warrants. Net cash provided by financing activities for the six months ended June 30, 1999 consisted of issuance of a promissory note and to a lesser extent the issuance of common stock. We incurred net losses of approximately $9.2 million and $2.6 million for the six months ended June 30, 2000, and 1999, respectively. At June 30, 2000, we had an accumulated deficit of approximately $22.6 million. In the six months ended June 30, 2000, we recognized a non-cash interest expense of approximately $3.9 million resulting 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 debentures. The net losses and accumulated deficit also resulted from the significant operational, infrastructure and other costs incurred in the development and marketing of our services and the fact that revenues failed to keep pace with such costs. As a result of our expansion plans and our expectation that our operating expenses, especially in the areas of sales and marketing, will continue to increase significantly, we expect to incur additional losses from operations for the foreseeable future. To the extent that increases in our operating expenses precede or are not subsequently followed by commensurate increases in revenues, or that we are unable to adjust operating expense levels accordingly, our business, results of operations and financial condition would be materially and adversely affected. There can be no assurance that we will ever achieve or sustain profitability or that our operating losses will not increase in the future. Our cash requirements depend on numerous factors, including market acceptance of our services, the capital required to maintain and grow our web site, the resources required for marketing and selling our services and to increase brand awareness and other factors. We have experienced a substantial increase in our capital expenditures since our inception consistent with the growth in our operations and staffing. Additionally, we continue to evaluate possible investments in businesses, products and technologies, some of which may be material. Since our inception, we have incurred significant operating losses and we believe we will continue to incur operating losses for the foreseeable future. We expect that we will continue to experience negative operating cash flows for the foreseeable future as result of our operating losses. We believe that our current cash and cash equivalents and short-term investments will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for our existing business for the next 12 months. We cannot assure you that we will be able to achieve and sustain positive cash flow or profitability. We may need to raise additional funds during 2001 for future expansion of our business, to develop new or enhanced services or products, to respond to competitive pressures or to acquire complementary products, businesses or technologies. We cannot assure you that additional financing will be available on terms favorable to us, or at all. IMPACT OF THE YEAR 2000 In our previous filings with the Securities and Exchange Commission, we have discussed the nature and progress of our plans to deal with potential Year 2000 problems. These problems arise from the fact that many currently installed computer systems and software products were coded to accept or recognize only two digit entries in the date code field. These systems may recognize a date using "00" as the year 1900 rather than the year 2000. As a result, computer systems and/or software used by many companies and governmental agencies needed to be upgraded to comply with Year 2000 requirements or risk system failure or miscalculations causing disruptions of normal business activities. Prior to December 31, 1999, we completed our assessment of all material information technology and non-information technology systems at our headquarters, as well as our review of Year 2000 compliance by our key vendors, distributors and suppliers. To date, we have experienced no significant disruptions in mission critical information technology and non-information technology systems and we believe those systems successfully responded to the Year 2000 date changes. We are not aware of any material problems resulting from Year 2000 issues, either with our own internal systems or the products and services of third parties. We will continue to monitor our mission critical computer applications and those of our suppliers and vendors throughout the year 2000 to ensure that any latent Year 2000 matters that may arise are addressed promptly. 21 RISK FACTORS WE HAVE A LIMITED OPERATING HISTORY, HAVE INCURRED LOSSES SINCE INCEPTION, AND EXPECT LOSSES FOR THE FORESEEABLE FUTURE We were incorporated in October 1997. Accordingly, we have only a limited operating history upon which you can evaluate our business and prospects. 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 June 30, 2000, we had an accumulated deficit of $22,567,000. Losses have continued to grow faster than our revenues during our limited operating history. This trend is reflective of our continued investments in technology and sales and marketing efforts to grow the business. Because of our plans to continue to invest heavily in marketing and promotion, to hire additional employees, and to enhance our web site and operating infrastructure, we expect to incur significant net losses for the foreseeable future. We believe these expenditures are necessary to strengthen our brand recognition, attract more users to our web site and generate greater online revenues. If our revenue growth is slower than we anticipate or our operating expenses exceed our expectations, our losses will be significantly greater. We may never achieve profitability. If we do achieve profitability, we may be unable to sustain or increase profitability on a quarterly or annual basis. WE MAY REQUIRE FURTHER CAPITAL TO PURSUE OUR BUSINESS OBJECTIVES We currently believe that we have sufficient cash to fund our operations through the next twelve months. After that time, we may be required to seek additional capital to sustain our operations. We have experienced a substantial increase in our capital expenditures since our inception consistent with the growth in our operations and staffing. Additionally, we continue to evaluate possible investments in businesses, products and technologies, some of which may be material. Since our inception, we have incurred significant operating losses and we believe we will continue to incur operating losses for the foreseeable future. We expect that we will continue to experience negative operating cash flows for the foreseeable future as result of our operating losses. We believe that our current cash and cash equivalents and short-term investments will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for our existing business for the next 12 months. We cannot assure you that we will be able to achieve and sustain positive cash flow or profitability or that we will have other sources available to provide the financial resources necessary to continue our operations. We may need to raise additional funds during 2001 for future expansion of our business, to develop new or enhanced services or products, to respond to competitive pressures or to acquire complementary products, businesses or technologies. We cannot assure you that additional financing will be available on terms favorable to us, or at all. If we are unsuccessful in generating anticipated resources from one or more of the anticipated sources, and unable to replace the shortfall with resources from another source, we may be able to extend the period for which available resources would be adequate by deferring the creation or satisfaction of various commitments, deferring the introduction of various services or entry into various markets, and otherwise scaling back operations. If we are unable to generate the required resources, our ability to meet our obligations and to continue our operations would be adversely affected. 22 OUR NEED TO RAISE ADDITIONAL CAPITAL MAY CAUSE OUR STOCKHOLDERS TO EXPERIENCE SIGNIFICANT DILUTION IN THE FUTURE It is likely that we will need to raise additional funds in the future in order to pursue our business objectives. If additional funds are raised through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders will be reduced, stockholders may experience additional dilution and such securities may have rights, preferences and privileges senior to those of our common stock. This may make an investment in our common stock less attractive to other investors, thereby weakening the trading market for our common stock. WE ARE SUBJECT TO THE RISKS AND UNCERTAINTIES FREQUENTLY ENCOUNTERED BY EARLY STAGE COMPANIES IN NEW AND RAPIDLY EVOLVING MARKETS Due to our limited operating history, we are subject to many of the risks and uncertainties frequently encountered by early stage companies in new and rapidly evolving markets, such as e-commerce. Among other things, we are faced with the need to establish our credibility with customers, advertising, content providers, and companies offering e-commerce products and services, and such parties are often understandably reluctant to do business with companies that have not had an opportunity to establish a track record of performance and accountability. For example, our ability to enter into exclusive relationships to provide content over the Internet will be dependent on our ability to demonstrate that we can handle high volumes of traffic through our site. Similarly, early stage companies must devote substantial time and resources to recruiting qualified senior management and employees at all levels, and must also make significant investments to establish brand recognition. If we are unable to overcome some of these obstacles, we may be unable to achieve our business goals and raise sufficient capital to expand our business. OUR REVENUE GROWTH IN PRIOR PERIODS IS NOT INDICATIVE OF FUTURE GROWTH AND WE CANNOT ACCURATELY PREDICT OUR FUTURE REVENUES We had revenues of approximately $5,749,800 and $1,878,400 for the six months ended June 30, 2000 and 1999, respectively. While our growth rate has been strong, it is unlikely that revenue will continue to grow at this rate in the future and our performance during these periods should not be taken as being indicative of future trends. Accurate predictions regarding our revenues in the future are difficult and should be considered in light of our limited operating history and rapid changes in the ever evolving Internet market. For example, our ability to generate revenues in the future is dependent in part on the success of our capital-raising efforts and the investments that we intend to make in sales and marketing, infrastructure, and content development. Our revenues for the foreseeable future will remain primarily dependent on the number of customers that we are able to attract to our web site, and secondarily on sponsorship and advertising revenues. We cannot forecast with any degree of certainty the number of visitors to our web site, the number of visitors who will become customers, or the amount of sponsorship and advertising revenues. Similarly, we cannot provide any guarantees regarding the revenues that will be generated from e-commerce products and services that we intend to make available on our site. 23 OUR QUARTERLY OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY, THEREBY INCREASING THE VOLATILITY OF OUR STOCK PRICE In addition to the uncertainties regarding the rate of growth of our future revenues, we anticipate that our operating results will fluctuate significantly from quarter to quarter. These fluctuations may be due to seasonal and cyclical patterns that may emerge in Internet e-commerce and advertising spending. For example, we believe that the use of our web site will be somewhat lower during periods of the year if the patterns that currently effect traditional media, such as television and radio where advertising sales are lower during the first and third calendar quarters because of the summer vacation period and post winter holiday season slowdown, develop in the Internet industry. It is likely that similar seasonal patterns will develop in the Internet industry and thus result in decreasing revenues for us during periods of the year. Quarterly results may also vary for some of the same reasons and because it is difficult to predict the long-term revenue growth of our business. If investments in marketing and content development are delayed, we may experience corresponding delays in anticipated revenues from such investments, thereby leading to uneven quarterly results. Because of these factors, we believe that quarter-to-quarter comparisons of our results of operations are not good indicators of our future performance. If our operating results fall below the expectations of investors in future periods, then our stock price may decline. SHARES ELIGIBLE FOR FUTURE SALE BY OUR CURRENT STOCKHOLDERS MAY ADVERSELY AFFECT OUR STOCK PRICE As of June 30, 2000, 42,619,586 shares of our common stock were outstanding and 6,163,533 shares of common stock were subject to options granted under our 1998 and 1999 Stock Option Plans and otherwise of the outstanding shares, 11,487,250 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 Rule 144 promulgated under that Act. All other outstanding shares of our common stock are "restricted securities" as such term is defined under Rule 144, in that such shares were issue din private transactions not involving a public offering and may not be sold in the absence of registration other than in accordance with Rules 144, 144(k) or 701 promulgated under the Securities Act of 1933 or another exemption from registration. As of June 30, 2000, approximately 21 million shares of common stock were eligible for sale under Rule 144. If our stockholders sell substantial amounts of our common stock under Rule 144, 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. 24 FUTURE EXERCISE OF WARRANTS OR ISSUANCES OF SECURITIES MAY SIGNIFICANTLY DILUTE YOUR HOLDINGS There are currently warrants to purchase 2,200,000 shares of our common stock outstanding and exercisable over the next five years at an exercise price per share of $1.50, subject to adjustment. There are also warrants to purchase 269,692 shares of common stock outstanding and exercisable over the next four and a half years at an exercise price per share of $4.38, subject to adjustment. The shares underlying these warrants have been registered for resale pursuant to our registration statement on Form S-1 (File No. 333-38538). Pursuant to another registration statement on Form S-1 (File No. 333-36826) we registered shares underlying warrants to purchase 15,567,133 shares of common stock issued having an exercise price per share of $4.00, warrants to purchase 436,351 shares of common stock having an exercise price per share of $2.76 and warrants to purchase 50,000 shares of common stock having an exercise price per share of $12.38. Pursuant to a third registration statement on Form S-1 (File No. 333-30074), we registered warrants to purchase 125,000 shares of common stock having an exercise price of $8.00 per share. If the holders of our outstanding warrants and other convertible securities were to exercise their rights, purchasers of our common stock could experience substantial dilution of their investment. OUR PLANNED ONLINE AND TRADITIONAL MARKETING CAMPAIGNS MAY NOT ATTRACT SUFFICIENT ADDITIONAL VISITORS TO OUR WEB SITE We plan to pursue aggressive marketing campaigns online and in traditional media to promote the Nettaxi.com brand and attract an increasing number of visitors to our web site. We believe that maintaining and strengthening the Nettaxi.com brand will be critical to the success of our business. This investment in increased marketing carries with it significant risks, including the following: - Our advertisements may not properly convey the Nettaxi.com brand image, or may even detract from our image. Advertising in print and broadcast media is expensive and is often typically difficult to modify quickly in order to take into account feedback that may indicate that we have failed to convey the optimal message. If our advertisements fail to positively promote our brand and image, the damage to our business may be long-lasting and costly to repair. - Even if we succeed in creating the right messages for our promotional campaigns, these advertisements may fail to attract new visitors to our web site at levels commensurate with their costs. We may fail to choose the optimal mix of television, radio, print and other media to cost effectively deliver our message. Moreover, if these efforts are unsuccessful, we will face difficult and costly choices in deciding whether and how to redirect our marketing dollars. WE MAY FAIL TO ESTABLISH AN EFFECTIVE INTERNAL SALES ORGANIZATION TO ATTRACT SPONSORSHIP AND ADVERTISING REVENUES To date, we have relied principally on outside advertising agencies to develop sponsorship and advertising opportunities. We believe that the growth of sponsorship and advertising revenues will depend on our ability to establish an aggressive and effective internal sales organization. Our internal sales team currently has nine members. We will need to substantially increase this sales force in the coming year in order to execute our business plan. Our ability to increase our sales force involves a number of risks and uncertainties, including competition and the length of time for new sales employees to become productive. If we do not develop an effective internal sales force, our business will be materially and adversely affected by our inability to attract sponsorship and advertising revenues. 25 WE RELY HEAVILY ON THIRD PARTIES FOR DEVELOPMENT OF SOFTWARE AND CONTENT AND FOR ESSENTIAL BUSINESS OPERATIONS AND MAY BE ADVERSELY AFFECTED BY OUR FAILURE TO MAINTAIN SATISFACTORY RELATIONSHIPS WITH SUCH PARTIES We depend on third parties for important aspects of our business, including Internet access, the development of software for new web site features, content, and telecommunications. We have limited control over these third parties, and we are not their only client. We may not be able to maintain satisfactory relationships with any of them on acceptable commercial terms, and there is no guarantee that we will be able to renew these agreements at all. Further, we cannot be sure that the quality of products and services that they provide may remain at the levels needed to enable us to conduct our business effectively. WE ARE HEAVILY RELIANT ON THIRD PARTIES TO HOUSE AND SERVICE OUR WEB SITE AND ARE VULNERABLE TO POSSIBLE DAMAGE TO OUR OPERATING SYSTEMS We maintain substantially all of our computer systems at our Campbell, California site and the Santa Clara, California site of Exodus Communications. We are heavily reliant on the ability of Exodus to house and service our web site. This system's continuing and uninterrupted performance is critical to our success. Growth in the number of users accessing our web site may strain its capacity, and we rely on Exodus to upgrade our system's capacity in the face of this growth. Exodus also provides our connection to the Internet. Sustained or repeated system failures or interruptions of our web site connection services would reduce the attractiveness of our web site to customers and advertisers, and could therefore have a material and adverse effect on our business due to loss of membership and advertising revenues. In 1998 and 1999, we experienced several interruptions and degradations of service as a result of our third party service provider's inability to deliver the contractual bandwidth required to handle our traffic volume. These interruptions result in decreased web usage volume and therefore impact our ability to serve advertising impressions for our customers. These interruptions can materially impact our revenues. We estimate that during 1998 we lost approximately $35,000 in revenue because of this, and during 1999 we lost an additional $35,000 in revenues. In addition, our operations are dependent in part on our ability to protect our operating systems against physical damage from fire, floods, earthquakes, power loss, telecommunications failures, break-ins or other similar events. Furthermore, our servers are vulnerable to computer viruses, break-ins and similar disruptive problems. The occurrence of any of these events could result in interruptions, delays or cessations in service to our users and result in a decrease in the number of visitors to our site. Our insurance policies may not adequately compensate us for any losses that may occur due to any failures or interruptions in our systems. 26 WE PLAN TO GROW RAPIDLY, AND EFFECTIVELY MANAGING OUR GROWTH MAY BE DIFFICULT Our business plan contemplates a period of significant expansion. In order to execute our business plan, we must grow significantly. This growth will strain our personnel, management systems and resources. To manage our growth, we must implement operational and financial systems and controls and recruit, train and manage new employees. These individuals have had little experience working with our management team. We cannot be sure that we will be able to integrate new executives and other employees into our organization effectively. In addition, there will be significant administrative burdens placed on our management team as a result of our status as a public company. If we do not manage growth effectively, we will not be able to achieve our financial and business goals. WE DEPEND ON OUR KEY PERSONNEL TO OPERATE OUR BUSINESS, AND WE MAY NOT BE ABLE TO HIRE ENOUGH ADDITIONAL MANAGEMENT AND OTHER PERSONNEL AS OUR BUSINESS GROWS Our performance is substantially dependent on the continued services and on the performance of our executive officers and other key employees, particularly Robert A. Rositano, Jr., our Chief Executive Officer, and Dean Rositano, our Chief Operating Officer. We do not currently maintain "key person" insurance on the lives of Messrs. Rositano. The loss of the services of any of our executive officers could materially and adversely affect our business due to their experience with our business plan and the disruption in the conduct of our day-to-day operations. Additionally, we believe we will need to attract, retain and motivate talented management and other highly skilled employees to be successful. Competition for employees that possess knowledge of both the Internet industry and our target market is intense. We may be unable to retain our key employees or attract, assimilate and retain other highly qualified employees in the future. OUR PROJECTED E-COMMERCE SERVICES MAY NOT BE LAUNCHED ON A TIMELY BASIS AND MAY NOT GENERATE THE ANTICIPATED LEVEL OF REVENUES Our strategic growth plan calls for development and implementation of e-commerce tools for our citizens. The availability of many of these tools is dependent on our ability to enter into satisfactory contractual relationships with parties offering e-commerce related products 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 site. To date, our revenues from e-commerce services have not been material, and we have yet to launch a number of the services that we hope to provide to our citizens and visitors to the our site. We may not be able to commence those services on a timely basis, and there is no assurance that the services will generate the anticipated amount of revenues. 27 INTENSE COMPETITION FROM OTHER INTERNET-BASED BUSINESSES MAY REDUCE OUR MARGINS AND MARKET SHARE AND CAUSE OUR STOCK PRICE TO DECLINE The markets in which we are engaged are new, rapidly evolving and intensely competitive, and we expect competition to intensify further in the future. Barriers to entry are relatively low, and current and new competitors can launch new sites at a relatively low cost using commercially available software. Competition could result in price reductions for our products and services, reduced margins or loss of market share. Consolidation within the online commerce industry may also increase competition. We currently or potentially compete with a number of other companies including a number of large online communities and services that have expertise in developing online commerce, and a number of other small services, including those that serve specialty markets. Many of our potential competitors have longer operating histories, larger customer bases, greater brand recognition in other business and Internet markets and significantly greater financial, marketing, technical and other resources than us. WE MAY FAIL TO ESTABLISH AND MAINTAIN STRATEGIC RELATIONSHIPS WITH OTHER WEB SITES TO INCREASE NUMBERS OF WEB SITE USERS AND INCREASE OUR REVENUES We intend to establish numerous strategic relationships with popular web sites to increase the number of visitors to our web site. There is intense competition for placements on these sites, and we may not be able to enter into these relationships on commercially reasonable terms or at all. Even if we enter into relationships with other web sites, they themselves may not attract significant numbers of users. Therefore, our site may not receive additional users from these relationships. Moreover, we may have to pay significant fees to establish these relationships. Our inability to enter into new distribution relationships and expand our existing ones could have a material and adverse effect on our business due to our inability to increase the number of users of our site. WE MAY NOT BE ABLE TO ADAPT AS INTERNET TECHNOLOGIES AND CUSTOMER DEMANDS CONTINUE TO EVOLVE 28 To be successful, we must adapt to rapidly changing Internet technologies and continually enhance the features and services provided on our web site. We could incur substantial, unanticipated costs if we need to modify our web site, software and infrastructure to incorporate new technologies demanded by our audience. We may use new technologies ineffectively or we may fail to adapt our web site, transaction-processing systems and network infrastructure to user requirements or emerging industry standards. If we fail to keep pace with the technological demands of our web-savvy audience for new services, products and enhancements, our users may not use our web site and instead use those of our competitors. WE MAY NOT BE ABLE TO PROTECT AND ENFORCE OUR TRADEMARKS, WEB ADDRESSES AND PROPRIETARY RIGHTS Our Nettaxi.com brand and our web address, www.nettaxi.com, are critical to our success. We have filed a trademark application for "Nettaxi", among other trademark applications. We cannot guarantee that any of these trademark applications will be granted. In addition, we may not be able to prevent third parties from acquiring web addresses that are confusingly similar to our addresses, which could harm our business. Also, while we have entered into confidentiality agreements with our employees, contractors and suppliers in order to safeguard our trade secrets and other proprietary information, there can be no assurance that technology will not be misappropriated or that others may lawfully develop similar technologies. WE WOULD LOSE REVENUES AND INCUR SIGNIFICANT COSTS IF OUR SYSTEMS OR MATERIAL THIRD PARTY SYSTEMS ARE NOT YEAR 2000-COMPLIANT We have not devised a Year 2000 contingency plan. Although we did not experience any Year 2000-related problems on January 1, 2000, and have not experienced any such problems to date, the failure of our internal systems, or any material third party systems, to be Year 2000-compliant could have a material and adverse effect on our business, results of operations and financial condition if the compliance problems significantly impair access to and use of our web site. In addition, there can be no assurance that governmental agencies, utility companies, Internet access companies, third party service providers and others outside our control will be Year 2000 compliant. The failure by these entities to be Year 2000 compliant could result in a systemic failure beyond our control, including, for example, a prolonged Internet, telecommunications or electrical failure, which could also prevent us from delivering our services to our users, decrease the use of the Internet or prevent users from accessing our services. ACQUISITIONS MAY DISRUPT OR OTHERWISE HAVE A NEGATIVE IMPACT ON OUR BUSINESS We may acquire or make investments in complementary businesses, products, services or technologies on an opportunistic basis when we believe they will assist us in carrying out our business strategy. Growth through acquisitions has been a successful strategy used by other Internet companies. On July 13, 2000, we signed a letter of intent to merge with GoHip, a privately held direct marketing firm and Web Portal, but do not have any present understanding relating to any other such acquisition or investment. If we were to buy a content, service or technology company, the amount of time and level of resources required to successfully integrate their business operation could be substantial. The challenges in assimilating their people and organizational structure, and in encountering potential unforeseen technical issues in integrating their content, service or technology into ours, could cause significant delays in executing other key areas of our business plan. This could include delays in integrating other content, services or technology into our communities, or moving forward on other business development relationships, as management and employees, both of which are time constrained, may be distracted. In addition, the key personnel of the acquired company may decide not to work for us, which could result in the loss of key technical or business knowledge to us. Furthermore, in making an acquisition, we may have to incur debt or issue equity securities to finance the acquisition, the issuance of which could be dilutive to our existing shareholders. 29 WE ARE VULNERABLE TO ADDITIONAL TAX OBLIGATIONS THAT COULD BE IMPOSED ON ONLINE COMMERCE TRANSACTIONS We do not expect to collect sales or other similar taxes in respect of transactions engaged in by customers on our web site. However, various states or foreign countries may seek to impose sales tax obligations on us and other e-commerce and direct marketing companies. A number of proposals have been made at the state and local levels that would impose additional taxes on the sale of goods and services through the Internet. These proposals, if adopted, could substantially impair the growth of e-commerce and cause purchasing through our web site to be less attractive to customers as compared to traditional retail purchasing. The United States Congress has passed legislation limiting for three years the ability of the states to impose taxes on Internet-based transactions. Failure to renew this legislation could result in the imposition by various states of taxes on e-commerce. Further, states have attempted to impose sales taxes on catalog sales from businesses such as ours. A successful assertion by one or more states that we should have collected or be collecting sales taxes on the sale of products could have a material and adverse effect on our business due to the imposition of fines or penalties or the requirement that we pay for the uncollected taxes. WE MAY NOT BE ABLE TO TAKE FULL ADVANTAGE OF POTENTIAL TAX BENEFITS FROM OUR NET OPERATING LOSS CARRYFORWARDS At December 31, 1999 we had net operating loss carryforwards available to reduce future taxable income that aggregated approximately $11,200,000 for Federal income tax purposes. These benefits expire through 2019. Pursuant to a "change in ownership" as defined by the provisions of the Tax Reform Act of 1986, utilization of our net operating loss carryforwards may be limited, if a cumulative change of ownership of more than 50% occurs within a three-year period. We have not determined if an ownership change has occurred. If it has, we may not be able to take full advantage of potential tax benefits from our net operating loss carry forwards. WE ARE DEPENDENT ON THE CONTINUED DEVELOPMENT OF THE INTERNET INFRASTRUCTURE Our industry is new and rapidly evolving. Our business is highly dependant on the growth of the internet industry and would be adversely affected if web usage and e-commerce does not continue to grow. Internet usage may be inhibited for a number of reasons, including inadequate Internet infrastructure, security concerns, inconsistent quality of service, the unavailability of cost-effective, high-speed service, the imposition of transactional taxes, or the limitation of third party service provider's ability and willingness to invest in new or updated equipment to handle traffic volume. 30 If web usage grows, the Internet infrastructure may not be able to support the demands placed on it by this growth, or its performance and reliability may decline. We are highly dependant on third party service providers. Any interruption experienced by these service providers may have a material impact on our business due to our inability to serve our advertising customers or end users. In addition, web sites, including ours, have experienced a variety of interruptions in their service as a result of outages and other delays occurring throughout the Internet network infrastructure. If these outages or delays frequently occur in the future, web usage, including usage of our web site, could grow slowly or decline. This may have a material impact on future revenues. OUR LONG-TERM SUCCESS DEPENDS ON THE DEVELOPMENT OF THE E-COMMERCE MARKET, WHICH IS UNCERTAIN Our future revenues and profits substantially depend upon the widespread acceptance and use of the Internet as an effective medium of commerce by consumers. Rapid growth in the use of the Internet and commercial online services is a recent phenomenon. Demand for recently introduced services and products over the Internet and online services is subject to a high level of uncertainty. The development of the Internet and online services as a viable commercial marketplace is subject to a number of factors. For example, e-commerce is at an early stage and buyers may be unwilling to shift their purchasing from traditional vendors to online vendors, there may be insufficient availability of telecommunication services or changes in telecommunication services could result in slower response times and adverse publicity and consumer concerns about the security of commerce transactions on the Internet could discourage its acceptance and growth. ADOPTION OF THE INTERNET AS AN ADVERTISING MEDIUM IS UNCERTAIN The growth of Internet sponsorships and advertising requires validation of the Internet as an effective advertising medium. This validation has yet to fully occur. In order for us to generate sponsorship and advertising revenues, marketers must direct a significant portion of their budgets to the Internet and, specifically, to our web site. To date, sales of Internet sponsorships and advertising represent only a small percentage of total advertising sales. Also, technological developments could slow the growth of sponsorships and advertising on the Internet. For example, widespread use of filter software programs that limit access to advertising on our web site from the Internet user's browser could reduce advertising on the Internet. Our business, financial condition and operating results would be adversely affected if the market for Internet advertising fails to further develop due to the loss of anticipated revenues. BREACHES OF SECURITY ON THE INTERNET MAY SLOW THE GROWTH OF E-COMMERCE AND WEB ADVERTISING AND SUBJECT US TO LIABILITY The need to securely transmit confidential information, such as credit card and other personal information, over the Internet has been a significant barrier to e-commerce and communications over the Internet. Any well-publicized compromise of security could deter more people from using the Internet or from using it to conduct transactions that involve transmitting confidential information, such as purchases of goods or services. Furthermore, decreased traffic and e-commerce sales as a result of general security concerns could cause advertisers to reduce their amount of online spending. To the extent that our activities or the activities of third party contractors involve the storage and transmission of proprietary information, such as credit card numbers, security breaches could disrupt our business, damage our reputation and expose us to a risk of loss or litigation and possible liability. We could be liable for claims based on unauthorized purchases with credit card information, impersonation or other similar fraud claims. Claims could also be based on other misuses of personal information, such as for unauthorized marketing purposes. We may need to spend a great deal of money and use other resources to protect against the threat of security breaches or to alleviate problems caused by security breaches. 31 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. Efforts to regulate or eliminate the use of mechanisms which automatically collect information on users of our web site may interfere with our ability to target our marketing efforts and tailor our web site offerings to the tastes of our users. Web sites typically place a tracking program on a user's hard drive without the user's knowledge or consent. These programs automatically collect data on anyone visiting a web site. Web site operators use these mechanisms for a variety of purposes, including the collection of data derived from users' Internet activity. Most currently available web browsers allow users to elect to remove these mechanisms at any time or to prevent such information from being stored on their hard drive. In addition, some commentators, privacy advocates and governmental bodies have suggested limiting or eliminating the use of these tracking mechanisms. Any reduction or limitation in the use of this software could limit the effectiveness of our sales and marketing efforts. WE COULD FACE ADDITIONAL BURDENS ASSOCIATED WITH GOVERNMENT REGULATION OF AND LEGAL UNCERTAINTIES SURROUNDING THE INTERNET Any new law or regulation pertaining to the Internet, or the application or interpretation of existing laws, could have a material and adverse effect on our business, results of operations and financial condition due to increased costs of doing business. Laws and regulations directly applicable to Internet communications, commerce and advertising are becoming more prevalent. The law governing the Internet, however, remains largely unsettled, even in areas where there has been some legislative action. It may take years to determine whether and how existing laws governing intellectual property, copyright, privacy, obscenity, libel and taxation apply to the Internet. In addition, the growth and development of e-commerce may prompt calls for more stringent consumer protection laws, both in the United States and abroad. We also may be subject to future regulation not specifically related to the Internet, including laws affecting direct marketers. 32 WE COULD INCUR MONETARY DAMAGES FROM LITIGATION ARISING OUT OF OUR BUSINESS ACTIVITIES On July 9, 1999, we were named as one of several defendants in a lawsuit filed by four disaffected shareholders in Simply Interactive, Inc. The lawsuit arises out of a series of events relating to certain assets our operating company, Nettaxi Online Communities, purchased from SSN Properties in October 1997. The complaint alleges that we owed, and either intentionally or negligently breached, fiduciary duties to the plaintiffs. The suit also claims that we either intentionally or negligently interfered with the plaintiffs' contract or prospective advantage. While our officers and directors believe that the suit is without merit, we cannot provide you with any assurances that we will prevail in this dispute. If the plaintiffs successfully prosecute any of their claims against us, the resulting monetary damages and reduction in our working capital could significantly harm our business. For more information please see the section of our Annual Report on Form 10-K for the year ended December 31, 1999 called "Legal Proceedings". 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. In addition, our articles of incorporation provide that our board of directors may issue preferred stock in one or more series. Our board of directors can fix the price, rights, preferences, privileges and restrictions of the preferred stock without any further vote or action by our stockholders. If our board of directors issues preferred stock, potential acquirers may not make acquisition bids for us, our stock price may fall and the voting rights of existing stockholders may diminish as a result. 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 reached historical highs within the last 52 weeks and have reflected valuations substantially above historical levels. During the same period, these companies' stocks have also been highly volatile and have recorded lows well below historical highs. We cannot assure you that our stock will trade at the same levels of other Internet stocks or that Internet stocks in general will sustain their current market prices. 33 Factors that could cause such volatility may include, among other things actual or anticipated fluctuations in our quarterly operating results, announcements of technological innovations, conditions or trends in the Internet industry, and changes in the market valuations of other Internet companies. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. We could be exposed to market risk related to any and all of our 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. In addition, we have augmented our equity financing activities via the issuance of convertible debt financing. 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. We currently do not have any material market rate risks. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. Please refer to our previous disclosures in our Annual Report on Form 10-K for the year ended December 31, 1999 and on our Form 8-K filed on May 8, 2000 for a description of certain matters. From time to time, we are involved in legal proceedings incidental to our business. We believe that these pending actions, individually and in the aggregate, will not have a material adverse effect on our financial condition, and that adequate provision has been made for the resolution of such actions and proceedings. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. (1) From January to April, 2000 the Company under its 1999 Stock Option Plan issued options to purchase up to 3,257,200 shares of common stock to members of its board of directors who were not employees of the Company, 3 officers, and 33 employees and 7 consultant with exercise prices ranging from $2.44 per share, which was not less than the fair market value of the shares on the date of grant. The issuances were made in reliance on Section 4(2) of the Securities Act of and was 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. 34 (2) In March and April, 2000 we issued 778,982 shares of common stock and warrants to purchase up to 389,491 shares of common stock to consultants in exchange for the conversion of approximately $1.6 million in debt owed to the consultants. The issuances were 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 were made without general solicitation or advertising. The purchasers were sophisticated investors with access to all relevant information necessary to evaluate these investments, and who represented to the Company that the shares were being acquired for investment. ITEM 3. DEFAULTS UPON SENIOR SECURITIES. Please refer to our current Report on Form 8-K filed on May 8, 2000 for a description of certain matters related to convertible debentures held by RGC International Investors, LDC. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. On April 14, 2000, we solicited the consent of our stockholders to an increase in the number of authorized shares of common stock to 200,000,000. We received consents from holders of a majority of the then-outstanding shares of common stock and the amendment to our Articles of Incorporation became effective on May 8, 2000. The number of votes cast for the amendment was 21,620,209. The number of votes cast against the amendment was 518,885. The number of shares abstaining from voting was 26,675. ITEM 5. OTHER INFORMATION. Not applicable. 35 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits Exhibit Number Description of Exhibit --------------- ------------------------ 27.1 Financial Data Schedule (b) Reports on Form 8-K. We filed current Reports on Form 8-K on April 20, 2000 and May 8, 2000 which included descriptions of certain matters related to convertible debentures held by RGC International Investors, LDC. 36 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934,the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. NETTAXI.COM Date: August 14, 2000 By: /S/ Dean Rositano -- ---------------------------------------------- Dean Rositano, President and Interim Chief Financial Officer (Principal Accounting Officer) 37 EXHIBIT INDEX Exhibit Number Description of Exhibit --------------- ------------------------ 27.1 Financial Data Schedule 38