10-K 1 0001.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000 COMMISSION FILE NUMBER: 0-26109 _________________ NETTAXI.COM (Exact name of registrant as specified in its charter) _________________ NEVADA 82-0486102 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 1696 DELL AVENUE, CAMPBELL, CA 95008 (Address of Principal Executive Offices Including Zip Code) (408) 374-1168 (Registrant's telephone number, including area code) _________________ SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: None SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: Common Stock, $.001 par value Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by a check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [_] As of February 28, 2001, the approximate aggregate market value of voting stock held by non-affiliates of the registrant was $6,871,860 (based upon the closing price for shares of the registrant's common stock as reported by the O-T-C Bulletin Board on that date). Shares of common stock held by each officer, director, and holder of 5% or more of the outstanding common stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. As of February 28, 2001, the registrant had 43,049,486 shares of common stock, $.001 par value per share, outstanding. 2
NETTAXI.COM FORM 10-K TABLE OF CONTENTS PART I -------- ITEM 1. Description of Business 4 ITEM 1A. Risk Factors 22 ITEM 2. Properties 34 ITEM 3. Legal Proceedings 34 ITEM 4 . Submission Of Matters To A Vote Of Security Holders 36 PART II -------- ITEM 5. Market For The Registrant's Common Stock And Related Stockholder Matters 37 ITEM 6. Selected Consolidated Financial Data 40 ITEM 7. Management's Discussion And Analysis Of Financial Condition And Results Of Operations 41 ITEM 7A. Quantitative And Qualitative Disclosures About Market Risk 52 ITEM 8. Financial Statements And Supplementary Data 52 ITEM 9. Changes In And Disagreements With Accountants On Accounting And Financial Disclosure 52 PART III -------- ITEM 10. Directors And Executive Officers Of The Registrant 53 ITEM 11. Executive Compensation 58 ITEM 12. Security Ownership Of Certain Beneficial Owners And Management 65 ITEM 13. Certain Relationships And Related Transactions 67 PART IV -------- ITEM 14. Exhibits, Financial Statement Schedules, And Reports On Form 8-K 71
3 PART I This Form 10-K contains forward-looking statements. These forward-looking statements are subject to significant risks and uncertainties, including information included under Items 1 and 1A of this Form 10-K, which may cause actual results to differ materially from those discussed in such forward-looking statements. The forward-looking statements within this Form 10-K are identified by words such as "believes," "anticipates," "expects," "intends," "may," "will" and other similar expressions regarding our intent, belief and current expectations. However, these words are not the exclusive means of identifying such statements. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances and statements made in the future tense are forward-looking statements. Readers are cautioned that actual results may differ materially from those projected in the forward-looking statements as a result of various factors, many of which are beyond our control. We undertake no obligation to publicly release the results of any revisions to these forward-looking statements which may be made to reflect events or circumstances occurring subsequent to the filing of this Form 10-K with the Securities and Exchange Commission. Readers are urged to carefully review and consider the various disclosures made by us in this Form 10-K, including those set forth under "Risk Factors" in Item 1A. ITEM 1. DESCRIPTION OF BUSINESS OUR BUSINESS Nettaxi.com is an Internet marketing portal that provides a range of content and Internet based services for consumers and businesses. Our web site at www.nettaxi.com serves as a gathering place for people with shared topics of interest, as well as an entry point, referred to as a portal, to the Internet. Through our web site, we provide content addressing a large number of targeted categories. The content is organized into affinity categories such as news, sports, entertainment, health, politics, finances, lifestyle, and other areas of interest. Visitors to our web site are provided with comprehensive information and content. Subscribers to our web site, which we call citizens, are also provided with access to enhanced content such as broadband video clips, email accounts and personal web pages. We have developed a diversified revenue model under which we provide our citizens with access to web site hosting services and a broad range of content, and we provide affiliated businesses with access to a large population of Internet users for advertising and promotional purposes. In 2000, we focused our efforts on improving the quality of content available on our web site, implementing our web site hosting services and reducing our operating costs by eliminating many of the services which were not profitable. 4 We have devoted significant resources to developing our content and our services, including developing an infrastructure and building a management team. We have also focused on developing consumer loyalty and subsequently increasing our overall level of traffic and citizenship. While we have incurred losses of approximately $27,687,800 since our site was launched in October 1997, traffic to our site has increased consistently. In December 1998, we had 60,000 registered citizens. As of December 31, 2000, there were over 800,000 registered citizens in our community and we had a membership base of 1.8 million. We have also enjoyed increases in traffic on our web site which is documented by PC Data Online and their measurements of unique visitors to our web site comparing all Internet properties. PC Data Online is an independent research firm which produces comprehensive lists of the top web sites on the Internet on a monthly and weekly basis. Our site had over 1,760,000 unique visitors during the month of December 1999, causing PC Data Online to rank us as 281st among all Internet properties for the month. As a result of an aggressive marketing campaign we conducted during the month of December 2000, PC Data Online ranked nettaxi.com as the 94th most visited site on the Internet. We had 6,800,000 unique visitors to our web site in December 2000. In the two months that followed, we curtailed much of our marketing efforts due to changes in the Internet industry and, as a result, our ranking by PC Data Online fell to 636 for the month of February 2001. In March 2001, we again launched a redesigned marketing program. By March 24, 2001 PC Data Online had ranked us as the 213th most visited site on the Internet with 1,176,000 unique visitors for the week. INDUSTRY BACKGROUND The Internet is a significant medium for global communications. Millions of people around the world use the Internet to send and receive information, for entertainment, current events and to purchase products and services. The emergence of portals, such as ours, has been an important development on the Internet. These web sites provide an online location where users of the Internet can gain access to a wide variety of information quickly. Traditionally, portal sites have offered free services to users of the Internet including access to e-mail accounts, message boards, news and entertainment. Through these services, portals have attempted to develop consumer loyalty with users of the Internet, while increasing the level of traffic on their web sites. PORTALS. Portals provide a single online location where users can interact and find and share pertinent information, products and services related to their particular interests or needs. Portal sites generally offer free services including access to e-mail accounts, chat rooms, message boards, news and entertainment. These features tend to increase user loyalty towards particular portal web sites. Users with an email account with a particular web site are likely to repeat visits to the web site on a regular basis to check email and gather other information. As a result, we believe that users tend to be loyal to and spend more time online at portal sites. Booze Allen & Hamilton, in a study titled "The Great Portal Payoff: Matching Internet Marketing to Consumer Behavior" shows that portals are a mainstream destination site for Internet users. This study shows that sixty percent (60%) of all Internet user sessions include a visit to a portal. As the Internet grows, users seek sources of aggregated and user defined information and services that portals have historically provided. 5 As a result, portals provide advertisers an attractive means of promoting their products and services and allow businesses to reach the growing number of users who will be purchasing goods or services over the Internet in the future. Portals also offer content providers with an attractive means of disseminating their content to users with particular interests. ADVERTISING. The Internet is an attractive medium for advertisers. The Internet has often allowed advertisers to demographically target their messages to groups of Internet users with particular interests, in a manner not available through the means of traditional media. The Internet also allows advertisers a unique level of interactivity and measurability. Advertisers can use the Internet to display messages on certain web pages. These messages are referred to as impressions. Consumers wishing for more information on the advertised topic can use their computers to click, or click-through, on those impressions and move through to other web pages which provide the information sought. Using the Internet, advertisers can change their advertisements frequently in response to market factors, current events and consumer feedback. Advertisers can also track the effectiveness of their advertising messages by receiving reports of the number of advertising impressions delivered to consumers and the corresponding number of times that consumers click on those impressions and move through to the advertised web page. To date, Internet advertising has primarily taken the form of banner advertisements, which are comprised of advertising messages displayed on a portion of a web page viewed by visitors to the site. Like traditional media advertising banners are typically priced by advertisers who pay for exposures to potential consumers. However, this approach, which is called impression-based advertising, does not take full advantage of the Internet's direct marketing potential, resulting in low consumer click-through rates, the rate at which consumers click on advertisements to move to the advertised web sites. Advertisers, therefore are paying for exposure to many viewers who are not interested in the product or service advertised. According to the Internet Advertising Bureau (IAD), banner ads accounted for half of all Internet advertising in the second quarter of 2000, while click through rates (CTR's) for banner ads fell more than 40 percent between October 1999 and October 2000. We believe advertiser's are considering alternatives to banner advertising. We also believe that advertisers will focus on more targeted marketing opportunities as they recognize they can offer a level of targetability, interactivity and measurability not generally available in other media. CONTENT. The Internet offers content providers significant and attractive economic mechanisms that combine cost advantages with practices that are conducive to revenue generation or premiums. Significantly, the Internet provides information dissemination at a materially lower cost than do other forms of media, notably, both printed paper and private networks. The Internet also offers the potential for easier access to content, which can expand market coverage. We believe that by using the capabilities of the Internet to enrich the convenience, utility, time, or entertainment value of content, Internet content providers can garner significant and even premium revenues. 6 CURRENT MARKETING PLANS & PROGRAMS We have focused our efforts on marketing, improving the quality of content and hosting services available on our web site, and reducing our operating costs by eliminating many of the services which were not profitable. In this regard, we have developed a number of new promotions designed to generate new sources of revenue and build customer loyalty. Some of the powerful business tools and resources that are part of our solution include: BROADBAND CONTENT. We are continually seeking to develop relationships with content publishers to assist in generating revenue through distribution, branding, awareness, and promotions. In 2000 we added sources of new content that allow users to view videos covering music, sports and other subjects. Users are required to register as citizens of our web site prior to viewing the content. Advertisements are also displayed to users while progressing through the registration process. DIRECT MARKETING. Jupiter Communications forecasts email marketing will be a $7.3 billion business by 2005, a boost from $164 million in 1999. The volume of messages will swell to 268 billion promotional email messages by 2005. We have been collecting registrations for all our citizens since 1998 and maintaining a large, accurate, opt-in database that allows targeted communications based upon gender, age, income, interest and many other demographic variables. We have a consulting services agreement with Annuncio Software, Inc. under which they are to provide us with access to their direct email marketing system. We believe, the campaign management system, Annuncio, is one of the most sophisticated direct email marketing systems available today. We will incorporate our direct email marketing capability into promotional offers from companies that we affiliate with, daily emails to registered players of our Internet games, and communications to generate additional activity and transactions with our customer base. TARGETED AFFINITY CATEGORIES. We have organized information on our web site into an extensive network of communities with a wide variety of themes, including entertainment, government, home living, sports, finance, society and culture. Users interested in particular themes can access those themes quickly and easily. This creates marketing opportunities for media companies, Internet service providers, and Internet content companies. IMPROVED SEARCH METHODOLOGY. We had developed a metasearch engine that enabled users to search multiple sites simultaneously and return the results to one web page. This feature drove users to our web site, but did not generate sufficient revenue. We have revised our search methodology to enhance the revenue generated from our search services. Our current search methodology uses context driven searches where advertisers purchase their placement in the search engine. For example, a user of our web site may choose the subject "music" to search. After the choice is made, the results of the search are presented in a list on a new web page. Advertisers pay for premium placement at the top of the list. This allows advertisers to bid for product placement on our web site and increases revenue generated from our search services. SEASONAL PROMOTIONS. During 2000, we successfully implemented seasonal promotions designed to drive Internet users to our e-commerce affiliates. For example, in December 2000 we launched a promotion for Storerunner Network, Inc. Storerunner.com placed advertisements for products it was selling as part of a holiday sale on our web site. Users of our web site could click on the Storerunner advertisements and move to the Storerunner.com web site and purchase the products. Our agreement provided that we receive revenue for each user that accessed the Storerunner.com site from our web site. Although this promotion successfully increased the amount of traffic on our site, we discontinued further services with Storerunner.com after they filed for protection under Chapter 11 of the United States Bankruptcy Code in February 2001. 7 CITIZEN SERVICES. During 2000, we revised the scope of services offered to users of our web site to eliminate many of the free services which were available. Currently, users are offered access to free services such as email accounts and a limited variety of content such as video clips or sweepstakes offerings. Nevertheless, we have expanded the range of services available to users that subscribe to our web site. Such subscribers are provided with web site hosting services, personal home pages, access to an expanded variety of video clips, and permission based promotional offers. These services are provided in exchange for a monthly subscription fee. The minimum subscription fee is currently $19.95. NETTAXI'S 3D WORLD. In March 2000 we launched a new area within our web site pursuant to an agreement with ActiveWorlds. Users that visit our web site, download the appropriate software and pay a monthly fee can access a series of web pages complete with three dimensional graphics. The graphics are designed so that the area has the look and feel of an urban environment. Users are offered the opportunity to design a personalized Avatar. An Avatar is a three dimensional figure that represents the identity of the user. This Avatar can then walk through the urban environment and engage in online chat with other Avatars. Businesses can set up storefronts within the urban environment and advertise products on billboards within the urban environment. We believe this experience will change the way people chat online. OUR STRATEGY We are now poised to build on our early success and implement a growth strategy that leverages our infrastructure, marketing expertise, traffic and brand. In 2001, we intend to focus our marketing efforts on generating multiple sources of revenue while enhancing our advertising products and services. Key elements of our strategic growth plan are listed below. EXPAND SUBSCRIBER ACQUISITION PROGRAM We intend to embark on aggressive programs to expand our citizen base, which we believe will increase our advertising revenues. We also plan to design programs tailored to increasing the number of paying subscribers to our web site. To this end, we may offer discounted subscription rates to new subscribers and offer new subscribers access to music, video, and other entertainment content unavailable to users that do not subscribe to our web site. We believe these efforts will increase our revenues from subscription fees for our premium account services. The program will include a concerted effort to refine our offering of products and services to expand demand and an aggressive marketing campaign to create real excitement about our site. We hope to raise additional capital for brand development and expansion of our operations. 8 DEVELOP OUR INFRASTRUCTURE; BUILD PREMIUM CONTENT Over the next 12 months, we are looking to further develop our managerial and technical infrastructure, enhance the quality and depth of our content by developing new relationships with premium content providers and improve the quantity and quality of our broadband content. We expect these improvements will create several distinct revenues streams for us from the following sources: - Subscription fees paid by end users for access to broadband and enhanced content; and - Advertising revenues paid by advertisers seeking exposure to Internet users accessing our broadband and enhanced content. INCREASE ADVERTISING REVENUES To date, our revenues have been derived principally from the sale of advertisements. We intend to increase our advertising revenue by focusing on a number of key strategies, including: - expanding the quantity and quality of content available on our web site in order to increase interest in and traffic on our web site and increase the number of searches conducted on our web site; - expanding our advertising customer base; - increasing the cost of advertising placement charged to our advertising customers through enhanced targeting and rich media programs; - further improving the sophistication of our search methodology; - increasing the average size and length of our advertising contracts; - increasing the number of our direct sales representatives; and - continuing to invest in improving advertising serving and advertising targeting technology. GAIN SIGNIFICANT MARKET SHARE AND CONSOLIDATE COMPETITORS We hope to gain significant market share and consolidate our competitive position by acquiring strategic online community companies and continue an aggressive plan of infrastructure expansion. In May 1999 we acquired Plus Net, Inc., a California corporation which operated a portal site with a range of Internet related tools, including a robust search engine and e-commerce capabilities which supported consumer buying opportunities and programs designed to prevent credit card fraud. The Plus Net merger also provided us with access to a pool of approximately 1,000,000 potential subscribers and provided us with an opportunity to substantially increase the citizenship base within our portal. We are currently in the process of acquiring the assets of LookUpGuide.com, a California corporation, and broadband portal design and development company. In March 2001, we entered into an Asset Purchase Agreement with LookupGuide.com pursuant to which we will issue 2,200,000 shares of common stock in exchange for the assets of LookupGuide.com upon completion of the transaction. We have not completed this transaction and there can be no assurance that we will complete this transaction. We believe these acquisitions will accelerate our research and development efforts, and will enrich the Internet experience of our subscribers. 9 BUSINESS SERVICES OUR WEB SITE Our web site at www.nettaxi.com is designed to appear as a virtual urban environment. Information on our web site is divided into topic areas which we refer to as affinity groups. We refer the registered users of our web site as citizens. Our web site provides access to information on news, sports, entertainment and other areas of interest. Citizens also have access to Internet related services such as personal home pages, chat services and free e-mail accounts. When users first arrive at www.nettaxi.com, they view the broad urban environment, where they find hyperlinks to the information categories we provide, such as: - Member services, registration, and web hosting; - Community information links such as message boards; - Information sorted by topical areas of interest; and - Content such as movies, sports clips and other broadband content. Upon selecting one of the links, for example entertainment, a web page containing articles and information about entertainment appears along with an extensive list of categories, or more specific search topics, such as music and television. Choosing the more specific search topic will further focus your search to uncover more specific information. APPLICATIONS AND FEATURES We offer a wide range of applications and features to our citizens through our web site, including the following: OUR SEARCH ENGINE. Users of our web site can access our specially configured search engine, which we refer to as our taxi, located in all areas and levels of our web site. Users may use the search engine by typing in a search topic such as sports, and they are quickly presented with a list of hyperlinks to web pages carrying sports related information. Advertisers on our site compete for placement in the search results by paying fees to us. The advertisers that pay the highest fees are brought to the top of the list of search results. We believe our search engine provides greater value to our users since it presents small, manageable groups of choices in response to a search, as opposed to an overwhelming volume of listings turned up by many other search engines. E-MAIL SERVICES. Our e-mail services allow users to access their accounts, through both Post Office Protocol, POP, and the Internet, IMAP. POP e-mail is the type most commonly used by Internet service providers. Its primary advantage for users is that messages are sent and received quickly and with more privacy, because they do not stay resident on a server for any length of time. Its greatest disadvantage is that e-mail messages, once delivered to a user, are generally no longer available for download again, so that a user who downloads e-mail to a home computer, for example, will generally not be able to download the same mail at a later time to another computer, such as one at work. IMAP, or web-based e-mail, most commonly used by portal services, allows users to retrieve e-mail messages from any location that offers access to the Internet and a specific web site. Sending and receiving messages may be a bit slower than POP services, but messages are stored on a server, can be retrieved multiple times, and remain available until they are either specifically deleted by the user, or a set amount of time has passed. 10 Our e-mail service also allows subscribers to our premium services to offer a free web-based email service with a unique domain name, such as me@you.com, giving the domain name free promotion with every email sent. There is no software for the user to download and we provide all mail and maintenance with no added inconvenience to the webmaster. The look and feel can be customized to look like the subscriber's home page. CONTENT A key component of our current and future plans is the continued development of relationships with providers of premium content in a variety of categories. The purpose of these relationships is not to directly generate revenue, but rather to enhance the quantity and quality of information and content on our web site. We believe that enhanced information and content may lead to increased visitors to our site as well as increased subscriptions to our services. During 2000, we had formal relationships with the five premium content providers described below. The companies listed below provide substantially all of the content on our web site that is currently provided by outside parties. The providers are listed in order by the amount of content they provide to us. - SCREAMINGMEDIA. In April 2000 we entered into a license agreement with ScreamingMedia, an aggregator of a broad range of content such as current events, daily horoscopes, world news, travel, medicine and health for syndication to Internet portals and destination sites. The term of the agreement is one year and automatically renews for successive one year periods unless terminated. We pay a monthly license fee of $5,000 for use of ScreamingMedia's content. ScreamingMedia currently provides the majority of our outside party content. - ACTIVEWORLDS. In March 2001 we launched a new area within our web site pursuant to an agreement we entered into in August 2000 with ActiveWorlds.com, Inc., a Delaware corporation. Users that visit our web site, download the appropriate software and pay a monthly fee can access a series of web pages complete with three dimensional graphics. The graphics are designed so that the area has the look and feel of an urban environment. Users are offered the opportunity to design a personalized Avatar. An Avatar is a three dimensional figure that represents the identity of the user. This Avatar can they walk through the urban environment and engage in online chat with other Avatars. Businesses can set up storefronts within the urban environment and advertise products on billboards within the urban environment. We believe this experience will change the way people chat online. We are to receive a portion of the fees collected by ActiveWorlds from users of our site that subscribe to the service. The agreement has term of one year and automatically renews for successive periods of one year unless terminated prior to the extension. 11 - NETOPIA, INC. In March 1999, we entered into a nonexclusive agreement with Netopia, a provider of next generation products including web site services and high-speed connectivity to the Internet, under which Netopia provides us with technology that enhances our ability to provide services to our subscribers. The term of the agreement is two years. This agreement is an expense sharing agreement and generates less than one percent of our revenues. - SOLUTIONS MEDIA, INC. In November 1999, we entered into a non-exclusive agreement with Solutions Media, Inc., the operator of the web site, SpinRecords.com to co-brand its content, which includes digital audio/video music files in the MP3 format, which SpinRecords.com has licensed from independent artists. This audio and video content was downloadable by our subscribers from SpinRecords.com. The term of this agreement was one year with an option to renew the agreement for successive periods of one year. We received 50% ad revenue for banner advertisements shown on these co-branded content pages from Solutions Media, Inc. We also received 5% of gross sales from our citizens who purchase licensed content or merchandise from these co-branded web pages. This agreement had a term of one year, and accounted for approximately 13% of our revenue in 2000. We do not expect this relationship to continue in 2001 because Solutions Media, Inc. is no longer in business. - STORERUNNER.COM. In September 2000, we entered into an agreement with StoreRunner Network, Inc. under which we placed Storerunner advertisements on our web site and were to be compensated based on the number of visitors to our site that visited the Storerunner site. This agreement resulted in increased traffic on our web site and was part of the reason PC Data Online ranked nettaxi.com as the 94th most visited site on the Internet in December 2000. Although, this promotion was very successful, we have discontinued further services with Storerunner.com after they filed for protection under Chapter 11 of the United States Bankruptcy Code in February 2001. Under our agreements, we provide co-branding services to the content providers listed above. The content included on our web site is branded with the logo and similar brand features of the relevant providers. We also increase the traffic to their own web sites by linking our sites so that end users can easily move from our web site to theirs. We are also working to identify and develop a selection of relationships with providers of proprietary information content, particularly individuals and organizations with archives and databases that could be easily rendered into digital format. We believe that a carefully developed selection of such databases, would act as a powerful attraction to the type and volume of subscribers that our advertisers find desirable. WEB SITE HOSTING SERVICES One of the key features that we offer our registered users is our web site hosting services. Using these services, we currently host the web sites of over 300 individuals or businesses. These services generally fall into two categories. First, we host web pages for subscribers to our web site for a monthly fee. The minimum fee for these services is currently $19.95 per month. Subscribers to these services are provided with storage space and bandwidth to support their web sites. The fee increases depending on the amount of bandwidth and storage space used by the subscriber. 12 Second, we provide Internet hosting and connectivity for larger corporate customers. These services involve our maintenance of the servers which host the web sites of these customers. For example, we have an agreement with White Sand Communications, Inc. pursuant to which we host its web site servers and provide support for the overall operation of the servers. Our services are delivered through Alchemy Communications at its Internet data center located in Los Angeles, California. 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 were provided. In conjunction with these services, our customers are able to purchase advertising packages within their communities to help market web sites, as well as email tools that will provide them the capability to direct market to their customer base. Our subscribers also provide personal or entrepreneurial and commercial content that is available on our web site. We offer paying subscribers 25 megabytes of server space to use for a home page and e-mail. In addition, subscribers have access to free, easy-to-use web site design software to build their web home page, and they can designate the community and street where they would like to have their home page located. We are currently developing technologies that we believe will improve the quality of the hosting services we provide. SUBSCRIBER SERVICE PLANS AND ASSISTANCE In order to provide subscribers with choices that suit their individual needs, we offer both free and premium accounts, on a tiered basis similar to the way that cable systems do. Premium accounts are configured from a large menu of options, to attract subscribers and address the needs and desires of particular segments of online users. In each case, subscribers are provided with free, easy-to-use software for designing and building their web page, tips and techniques for making their web sites attractive and exciting to visit, and our search engine to drive traffic to their web site. We also adhere to the principle that providing excellent customer service is integral to attracting and, more importantly, retaining subscribers. To that end, we have focused on development of a customer service organization keenly focused on satisfying demand and creating customer loyalty. BASIC FREE CITIZEN ACCOUNT. Like most portals, we offer a free basic service package, which we call the free citizen account, to attract a large number of subscribers. This account offers the following package of features and services: - E-mail service for one personal e-mail account; and - Access to chat sessions, message boards, and shopping, as well as premium content such as broadband video clips, news information and other information. PREMIUM ACCOUNTS. Our premium accounts are especially attractive. Citizens can build premium accounts from a menu of options, allowing them the ability to pick and choose which items they are interested in. Options can be added for additional fees. In addition to the services which are provided to free service account subscribers, premium account holders are provided with the following options: 13 - E-mail service for unlimited e-mail accounts, each with a distinct @nettaxi.com address or a unique domain and customized look and feel; - Disk space for web page hosting; and - Access to advertising and banner ads, and other cross-promotional opportunities. One of the key features that we offer premium account subscribers is our web site hosting services. Using these services, we currently host the web sites of over 300 individuals or businesses. We host web pages for subscribers to our web site for a monthly fee. The minimum fee for these services is currently $19.95 per month. The fee increases depending on the amount of bandwidth and memory used by the subscriber. Premium subscribers are provided with professional web site services to assist with the design and launch of a web site as well as easy-to-use software for updating the site at any time. In addition, subscribers are provided with special tips and techniques for making their web sites attractive and exciting to visit, as well as mechanisms to drive traffic to their web site, including our search engine and strategically placed, highly visible links to the site from other desirable web sites on the Internet. Subscribers wishing to have their own domain are charged a one-time fee to register the domain for a two-year period. CUSTOMER ASSISTANCE. In order to maintain nettaxi.com as a portal that truly serves its subscribers and reflects their interests and needs, we invite and encourage subscribers and visitors to send in their comments and suggestions. We track visitor and subscriber activities, and carefully monitor the nature and content of their comments, as part of our strategy for continuing product refinement and development. Regardless of the type of account selected, subscribers have access to free online help at any time by simply clicking on our Help icon and by visiting the message boards, where they can review information posted by other subscribers, or post a query of their own. Subscribers can also find information on billing matters, special promotions, upcoming events, etc., quickly and easily on the Nettaxi.com home page. If they are unable to find what they are looking for, or if the information they find is confusing, subscribers can submit queries, to which we will actively and promptly respond with appropriate information or guidance. We are also establishing and deploying subscriber-to-subscriber support services, which are provided by online volunteers in exchange for free account upgrades or other premiums. 14 INTERNET TRAINING CD-ROM We had developed a CD-ROM product, called "Nettaxi.com; The Experience", which was a comprehensive, interactive training tool that enabled new and intermediate users of computers to learn about and begin using the many powerful capabilities and features of the Internet. The CD-ROM product was also designed to direct people to our web site once they began using the Internet. During 2000 we ceased distribution of our the CD-ROM product due to the substantial costs associated with its maintenance, development and distribution. CUSTOMERS ADVERTISING CUSTOMERS. In 2000 we attracted both mass market consumer product companies as well as technology-related businesses advertising on the Internet. Due to our advantages as an Internet marketing portal, we believe that we are well positioned to capture a portion of the growing number of consumer product and service companies seeking to advertise on the Internet. Currently, advertisers and advertising agencies enter into short-term agreements, on average one to two months, pursuant to which they receive a guaranteed number of impressions for a fixed fee. If the guaranteed number of impressions is not delivered, the term of the agreements are extended until the impressions can be delivered. Advertising on our site currently consists of banner-style advertisements that are prominently displayed at the top of pages on a rotating basis throughout the web pages in our web site. From each banner advertisement, viewers can hyperlink directly to the advertiser's own web site, thus providing the advertiser an opportunity to directly interact with an interested customer. Our standard cost per thousand impressions depends upon a number of factors including the location of the advertisement, its size and the extent to which it is targeted for a particular audience. Discounts from standard cost per thousand impressions rates may be provided for higher volume, longer-term advertising contracts. We have also implemented a search methodology to enhance the advertising revenue generated from our search services. Our current search methodology uses context driven searches where advertisers purchase their placement in the search engine. For example, a user of our web site may choose the subject "music" to search. After the choice is made, the results of the search are presented in a list on a new web page. Advertisers pay for premium placement at the top of the list. This allows advertisers to bid for product placement on our web site and increases revenue generated from our search services. We have entered into an agreement with GoTo.com, under which we use its search services to provide recommended web sites based upon a listing of the top search categories and user defined keywords. We are to receive a percentage of the revenue generated from users of our site using the search services. The agreement has a one year term commencing in September 2000 and automatically renews for periods of one year unless terminated. In April 2000 we placed the advertising of Hearme.com on our web site pursuant to an Online Advertising Insertion Order. Under the agreement, we received between $18.00 and $25.00 per million impressions delivered. A portion of the revenue received from this agreement was reciprocal revenue. This agreement accounted for 10% of our revenue in 2000. The agreement had a term of three months. 15 In July 1999, we entered into an Advertising Impression Network Contract with White Sand Communications, Inc. White Sand Communications engaged us to deliver banner advertising, sponsorship advertising and exit traffic advertising. The term of the agreement was initially six months and thereafter continued on a month-to-month basis. White Sand Communications pays us a minimum monthly guaranteed payment for exclusive use of banner advertising impressions. This agreement accounted for 6% of our revenue in 1999. WEB SITE HOSTING CUSTOMERS. In 2000, we focused on the development of our web site hosting services. We currently host the web sites of over 300 individuals and businesses. These services generally fall into two categories. First, we host web pages for subscribers to our web site for a monthly fee. The minimum fee for these services is currently $19.95 per month. Subscribers to these services are provided with storage space and bandwidth to support their web sites. The fee increases depending on the amount of bandwidth and memory used by the subscriber. We also provide Internet hosting and connectivity for larger corporate customers. These services involve our maintenance of the servers which host the web sites of these customers. For the twelve months ended December 31, 2000, web hosting revenues accounted for 40% of total revenues. In August 1999, we entered into a Data Center Service Agreement with White Sand Communications, Inc. We provide White Sand Communications with space in our Data Center and provide support for the overall operation of the their web servers. The fee for this agreement is a monthly recurring fee which includes charges for use and occupancy of the Data Center, connectively fee, power charges, and where applicable, technical support and system administration fees. The term of this agreement is one year. This agreement accounted for 11% of our revenue in 2000 and 4% of our revenue in 1999. In July 1999, we entered into a Data Center Service Agreement with Babenet, Ltd, a California corporation. We provide Babenet with space in our Data Center for their web servers and provide support for the overall operation of the their web servers. The fee for this agreement is a monthly recurring fee which includes charges for use and occupancy of the Data Center, connectively fee, power charges, and where applicable, technical support and system administration fees. The term of this agreement is one year and continues on a monthly basis thereafter. This agreement accounted for 20% of our revenue in 2000. ADVERTISING SALES AND DESIGN We seek to distinguish ourselves from our competition through the creation of advertising and sponsorship opportunities that are designed to build brand loyalty for our corporate sponsors by seamlessly integrating their advertising messages into our content. Sponsorship programs involve other business advertising particular programs on web pages within our web site which are branded with both our brand features and the brand features of the advertiser. We have used sponsorship programs to advertise holiday sales of particular types of merchandise. This is distinguished from advertising opportunities in which business display general messages about their products or services on our web site. 16 Through our close relationship with our subscribers, we have the ability to deliver advertising to specific targets within our site's theme content areas, allowing advertisers to single out and effectively deliver their messages to their respective target audiences. For example, an advertiser can target its message solely to women with an interest in recreation and sports. We believe that such sophisticated targeting is a critical element for capturing worldwide advertising budgets for the Internet. In the next twelve months, we intend to expand the amount and type of demographic information our site collects from our members, which will allow us to offer specific data to our advertising clients. In 2001 we intend to enter into arrangements with a number of third-party advertising sales representatives pursuant to short-term agreements that in general may be terminated by either party, without notice or penalty. The sales organization would consult regularly with advertisers and agencies on design and placement of their web-based advertising, provide customers with advertising measurement analysis and focus on providing a high level of customer service and satisfaction. During 2001, we also intend to implement special software on our web site in the immediate future. The software allows us to track a user surfing through the overall web site, follow the user's patterns of activity, present ads that are targeted and relevant to the user's interests, and recommend particular products or services, based on the user's activity profile. In addition, the software will be able to track the particular banner and other advertising to which the user has been exposed while visiting our site. This will provide us with a record of the number and type of advertisement views accessed by users over a specified period of time, useful for determining rates for outside advertisers wishing to have a presence on our web site. It will also provide us with the opportunity to rotate the particular ads it presents to a user to keep the ads fresh and appropriate in context. Eventually, we hope to expand our activity tracking functions to include serving content to users based on their preferences. The result will be content that is customized for a user, automatically and seamlessly. We have also licensed advertisement management software from Accipiter Technology, and written some custom code to extend the software's capabilities. The software tracks how many ads are served on the web site, which areas and which pages to which they were served, and how many people have clicked on them. The software allows us to manage advertisement selection and placement by providing an accurate advertisement count on both a real-time and a compiled-over-a-specified-time basis, information crucial to billing an advertiser. The software also provides advertisers with the ability to audit their advertisement performance on our web site on a real-time basis. We provide a user identification and password to the advertiser, who can then come onto the web site and track their ads at any time. SALES AND MARKETING In 2000, we committed approximately $5.9 million to sales and marketing activities, including offline and online media advertising. Our sales and marketing efforts are focused on: 17 - Generating additional traffic to our site; - Building and defining a desirable online destination for consumers and businesses; and - Creating and enhancing our brand within the Internet and online industries. Among the key elements of our sales and marketing strategy are the following: ADVERTISING PROGRAMS. We plan to invest in online advertising to drive traffic to our site by placing advertisements on selected high volume sites, as well as purchasing targeted keywords on several popular search engines such as Yahoo!, Excite, Lycos, and others. We also plan to advertise in traditional media such as print, radio and broadcast, on a selective, highly targeted basis, to increase the awareness of our site. PUBLIC RELATIONS SUPPORT. By virtue of its broad appeal and focus, we anticipate that a targeted public relations campaign will yield material results in building both national and targeted local and regional awareness for Nettaxi. We do not currently have an agreement with a national public relations professional, but are seeking to enter into an arrangement with a suitable public relations company in 2001. OPERATING INFRASTRUCTURE At this time, the basic components of our technology infrastructure are in place and operational. Our UNIX-based electronic network for Nettaxi.com operates on a one terabyte Ethernet backbone, with two Cisco Systems Ethernet switches that prevent collisions on the network. Traffic direction for the web servers is handled by Arrowpoint's CS-100, which tracks server load conditions in real time and sends traffic to the most appropriate server to spread around and balance the load. The network is comprised primarily of Sun Microsystems high-capacity servers, and include a mix of Enterprise 450s, Ultra 1, and Ultra 5 models, all running the newest version of Sun's Solaris operating environment for network systems. These servers collectively provide approximately 1.6 terabytes of hard drive space for subscriber capacities. In addition, the network currently includes NT servers to handle registration and selected other database functions, using Microsoft's SQL database software. Our electronic network is located at Alchemy Communications in Los Angeles, California. We have a Gigabit Data Services Agreement with Alchemy Communications pursuant to which they provide a secure location for our network servers, multiple high-speed Internet connections, and access to 24-hour-a-day, 7-day-a-week technical support personnel and services. Alchemy Communications also provides critically important routing, redundancy, streaming media and maintenance services for the network and its Internet connections, as well as a back-up power supply capable of continuing network operations for up to a week in the event of a power failure. We pay monthly fees for the services and the agreement has a term of 1 year. COMPETITION 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. We currently or potentially compete with a number of other companies for users, advertisers and electronic commerce marketers, including a number of large online communities and services that have expertise in developing online commerce, and a number of other small services, including those that serve specialty markets. 18 Other companies that offer web site hosting, email, and content services include MegaGo.com, theglobe.com, Yahoo!, Xoom, Homestead.com, WBS.net, Angelfire, Fortune City, Lycos and Talk City and, in the future, Internet communities may be developed or acquired by companies currently operating Internet directories, search engines, shareware archives, content sites, Internet Service Providers and other entities, which may have more resources than ours. In addition, we currently and in the future face competition from traditional media companies, a number of which, including CBS, Fox and NBC, have recently made significant acquisitions or investments in Internet companies. Furthermore, we compete for users and advertisers with other content providers and with thousands of web sites operated by individuals, the government and educational institutions. Such providers and sites include AOL, Angelfire, CNET, CNN/Time Warner, Excite, Hotmail, Infoseek, Lycos, Microsoft, Netscape, Switchboard, Xoom, ESPN.com, ZDNet.com and Yahoo! We believe that the following are the principal competitive factors for companies seeking to create online communities on the Internet: - community cohesion and interaction; - customer service; - brand recognition; - web site convenience and accessibility; - price; - quality of search tools; and - system reliability. We also compete with companies in the online commerce market. This market is new, rapidly evolving and intensely competitive. Current and new competitors can launch new web sites at relatively low cost. The products and services that might be offered through our site will compete with other retailers and direct marketers, some of which may specifically target our potential customers. We anticipate that we will compete with various mail-order and web-based retailers; various traditional retailers, either in their physical or online stores; various online service providers that offers products of interest to our potential customers, including AOL, Microsoft, and other providers mentioned above;. We believe that the following are the principal competitive factors in the online commerce market: - brand recognition; - quality of site content; 19 - merchandise selection; - convenience; - price; - customer service; and - reliability and speed of fulfillment. Many of our current and 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. In addition, other online services may be acquired by, receive investments from or enter into other commercial relationships with larger, well-established and well-financed companies as use of the Internet and other online services increases. Therefore, our competitors with other revenue sources may be able to devote greater resources to marketing and promotional campaigns, adopt more aggressive pricing policies and devote substantially more resources to web site and systems development than us or may try to attract traffic by offering services for free. Increased competition may result in reduced operating margins, loss of market share and diminished value of our brand. INTELLECTUAL PROPERTY We currently have pending applications before the United States Patent and Trademark Office for trademark and service mark protection for "Nettaxi" and "NetroNews". If these applications are approved, protection will be available for the periods prescribed by law. We regard the protection of our copyrights, service marks, trademarks, trade dress and trade secrets as critical to our future success and rely on a combination of copyright, trademark, service mark and trade secret laws and contractual restrictions to establish and protect our proprietary rights in products and services. We have entered into confidentiality and invention assignment agreements with our employees and contractors, and nondisclosure agreements with our suppliers in order to limit access to and disclosure of our proprietary information. There can be no assurance that these contractual arrangements or the other steps taken by us to protect our intellectual property will prove sufficient to prevent misappropriation of our technology or to deter independent third-party development of similar technologies. While we intend to pursue registration of our trademarks and service marks in the U.S. and internationally, effective trademark, service mark, copyright and trade secret protection may not be available in every country in which our services are made available online. 20 We also rely on technologies that we license from third parties, such as the suppliers of key database technology, the operating system and specific hardware components for our products and services. These licenses extend for terms ranging from one year to perpetuity and are subject to satisfaction of conditions laid out in the specific licensing agreements. There can be no assurance that these third-party technology licenses will continue to be available to us on commercially reasonable terms. The loss of such technology could require us to obtain substitute technology of lower quality or performance standards or at greater cost, which could materially adversely affect our business, results of operations and financial condition. Although we do not believe that we infringe the proprietary rights of third parties, there can be no assurance that third parties will not claim infringement by us with respect to past, current or future technologies. We expect that participants in our markets will be increasingly subject to infringement claims as the number of services and competitors in our industry segment grows. Any such claim, whether meritorious or not, could be time-consuming, result in costly litigation, cause service upgrade delays or require us to enter into royalty or licensing agreements. Such royalty or licensing agreements might not be available on terms acceptable to us or at all. As a result, any such claim could have a material adverse effect upon our business, results of operations and financial condition. GOVERNMENT REGULATION Our company, operations and products and services are all subject to regulations set forth by various federal, state and local regulatory agencies. We take measures to ensure our compliance with all such regulations as promulgated by these agencies from time to time. The Federal Communications Commission sets standards and regulations regarding communications and related equipment. There are currently few laws and regulations directly applicable to the Internet. It is possible that a number of laws and regulations may be adopted with respect to the Internet covering issues such as user privacy, pricing, content, copyrights, distribution, antitrust and characteristics and quality of products and services. The growth of the market for online commerce may prompt calls for more stringent consumer protection laws that may impose additional burdens on those companies conducting business online. Tax authorities in a number of states are currently reviewing the appropriate tax treatment of companies engaged in online commerce, and new state tax regulations may subject us to additional state sales and income taxes. Several states have also proposed legislation that would limit the uses of personal user information gathered online or require online services to establish privacy policies. The Federal Trade Commission has also initiated action against at least one online service regarding the manner in which personal information is collected from users and provided to third parties. Changes to existing laws or the passage of new laws intended to address these issues, including some recently proposed changes, could create uncertainty in the marketplace that could reduce demand for our products and services or increase the cost of doing business as a result of litigation costs or increased service delivery costs, or could in some other manner have a material adverse effect on our business, results of operations and financial condition. In addition, because our services are accessible worldwide and we facilitate sales of goods to users worldwide, other jurisdictions may claim that we are required to qualify to do business as a foreign corporation in a particular state or foreign country. Our failure to qualify as a foreign corporation in a jurisdiction where it is required to do so could subject us to taxes and penalties for the failure to qualify and could result in our inability to enforce contracts in such jurisdictions. Any such new legislation or regulation, or the application of laws or regulations from jurisdictions whose laws do not currently apply to our business, could have a material adverse effect on our business, results of operations and financial condition. 21 EMPLOYEES As of December 31, 2000, we had 19 employees, including: - 1 in customer support; - 3 in product development; - 10 in sales, marketing and business development; and - 5 in administration. We believe that our future success will depend in part on our continued ability to attract, integrate, retain and motivate highly qualified technical and managerial personnel, and upon the continued service of our senior management and key technical personnel. The competition for qualified personnel in our industry and geographical location is intense, and there can be no assurance that we will be successful in attracting, integrating, retaining and motivating a sufficient number of qualified personnel to conduct our business in the future. From time to time, we also engage independent contractors to support our research and development, marketing, sales and support and administrative organizations. We have never had a work stoppage, and no employees are represented under collective bargaining agreements. We consider our relations with our employees to be good. ITEM 1A. RISK FACTORS Our business, financial condition or results of operations could be materially and adversely affected by any of the following risks. WE HAVE 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 December 31, 2000, we had an accumulated deficit of $27,687,800. Losses have continued to grow faster than our revenues during our limited operating history. 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. 22 WE REQUIRE FURTHER CAPITAL TO PURSUE OUR BUSINESS OBJECTIVES. We currently believe that we have sufficient cash to fund our current operations through December 2002. However, to fully execute our business plan, we will be required to seek additional capital. We expect to generate a portion of the necessary cash flow through advertising and hosting revenues, but will also need to obtain capital through other sources such as equity or debt financing. We cannot assure you that we will be able to achieve and sustain positive cash flow or profitability or that we will have other sources available to provide the financial resources necessary to continue our operations. No assurances can be given that we will be able to obtain such additional resources. If we are unsuccessful in generating anticipated resources from one or more of the anticipated sources, and unable to replace the shortfall with resources from another source, we may be able to extend the period for which available resources would be adequate by deferring the creation or satisfaction of various commitments, deferring the introduction of various services or entry into various markets, and otherwise scaling back operations. If we are unable to generate the required resources, our ability to meet our obligations and to continue our operations would be adversely affected. SHARES ELIGIBLE FOR FUTURE SALE BY OUR CURRENT STOCKHOLDERS MAY ADVERSELY AFFECT OUR STOCK PRICE. As of February 28, 2001, 18,091,516 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. Additionally, we have filed a registration statement on Form S-8 (File No. 333-32678) to register 6,300,000 shares of common stock issuable upon exercise of options granted or to be granted under our 1998 and 1999 stock option plans. As a result, shares issued upon exercise of stock options are eligible for resale in the public market without restriction. We also intend to file a registration statement on Form S-8 to register the additional 5,600,000 shares of common stock under our 1999 Stock Option Plan, as amended. We have also filed a registration statement on Form S-1 (File No. 333-36826), declared effective by the Securities and Exchange Commission on June 12, 2000 registering 32,730,849 shares issued and issuable pursuant to recent private placement transactions. Additionally, we have filed a registration statement on Form S-1 (File No. 333-38538), declared effective by the Securities and Exchange Commission on September 21, 2000, registering 4,219,692 shares of common stock issued and issuable pursuant to recent private placement transactions. As of February 28, 2001 approximately 7 million additional shares of common stock were eligible for sale under Rule 144. If our stockholders sell substantial amounts of our common stock under Rule 144 or pursuant to the aforementioned registration statements, the market price of our common stock could be adversely affected and our ability to raise additional capital at that time through the sale of our securities could be impaired. FUTURE EXERCISE OF WARRANTS OR ISSUANCES OF SECURITIES MAY SIGNIFICANTLY DILUTE YOUR HOLDINGS. There are currently warrants to purchase 18,650,816 shares of our common stock outstanding and exercisable over the next four to five years having exercise prices ranging from $1.50 to $12.38, subject to adjustment. The shares underlying all of these warrants have been registered pursuant to our registration statements on Form S-1 filed with the Securities and Exchange Commission. There are also warrants to purchase 350,000 shares of our common stock outstanding having an exercise price of $0.35 per share. If the holders of our outstanding warrants and other convertible securities were to exercise their rights, purchasers of our common stock could experience substantial dilution of their investment. 23 It is likely that we will need to raise additional funds in the future in order to execute our business plan. If additional funds are raised through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders will be reduced, stockholders may experience additional dilution and such securities may have rights, preferences and privileges senior to those of our common stock. This may make an investment in our common stock less attractive to other investors, thereby weakening the trading market for our common stock. WE ARE SUBJECT TO THE RISKS AND UNCERTAINTIES FREQUENTLY ENCOUNTERED BY EARLY STAGE COMPANIES IN NEW AND RAPIDLY EVOLVING MARKETS. Due to our limited operating history, we are subject to many of the risks and uncertainties frequently encountered by early stage companies in new and rapidly evolving markets, such as 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 $9,418,400, $5,032,800 and $258,000 for the years ended December 31, 2000, 1999 and 1998, respectively. While our growth rate has been strong, it is unlikely that revenue will continue to grow at this rate in the future and our performance during these periods should not be taken as being indicative of future trends. In addition, approximately 24 $1,285,000 of the revenues for the year ended December 31, 1999 were derived from credit card transaction processing fees, a revenue stream that has declined significantly and that we do not believe will be material in future periods. In the year 2000, we generated approximately $2,200,000 in revenue from reciprocal advertising transactions. We anticipate that these arrangements will not be significant in the future. Accurate predictions regarding our revenues in the future are difficult and should be considered in light of our limited operating history and rapid changes in the ever evolving Internet market. For example, our ability to generate revenues in the future is dependent in part on the success of our capital-raising efforts and the investments that we intend to make in sales and marketing, infrastructure, and content development. Our revenues for the foreseeable future will remain primarily dependent on the number of customers that we are able to attract to our web site, and secondarily on web hosting, sponsorship and advertising revenues. We cannot forecast with any degree of certainty the number of visitors to our web site, the number of visitors who will become customers, or the amount of sponsorship and advertising revenues. 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. OUR QUARTERLY OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY, THEREBY INCREASING THE VOLATILITY OF OUR STOCK PRICE We anticipate that our operating results will fluctuate significantly from quarter to quarter. These fluctuations may be due to seasonal and cyclical patterns that have emerged in Internet related spending. For example, the use of our web site is somewhat lower during periods of the year during the first and third calendar quarters because of the summer vacation period and post winter holiday season slowdown. This results in lower revenues for us during periods of the year. Quarterly results may also vary because it is difficult to predict the long-term revenue growth of our business. 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. 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. 25 - 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 ten 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. OUR PROJECTED BROADBAND SERVICES AND ENHANCED CONTENT MAY NOT BE LAUNCHED ON A TIMELY BASIS AND MAY NOT GENERATE THE ANTICIPATED LEVEL OF REVENUES Our strategic growth plan calls for development and implementation of broadband services and enhanced content for our subscribers. The availability of many of these tools is dependent on our ability to enter into satisfactory contractual relationships with parties offering related content and services which can be made available to our subscribers, as well as relationships with parties seeking to make online sales to our subscribers and other visitors to our web site. To date, our revenues from broadband services and enhanced content have not been material, and we have yet to launch a number of the services that we hope to provide to our subscribers. We may not be able to commence those services on a timely basis, and there can be no assurance that the services will generate the anticipated amount of revenues. OUR LONG-TERM SUCCESS DEPENDS ON THE DEVELOPMENT OF THE BROADBAND SERVICES MARKET, WHICH IS UNCERTAIN Our future revenues and profits substantially depend upon the widespread acceptance and use of the Internet as an effective medium for the distribution and viewing of broadband content. The use of the Internet for these services is a recent phenomenon. Demand for recently introduced services and products over the Internet and online services is subject to a high level of uncertainty. For example, the distribution and viewing of broadband content over the Internet is at an early stage and buyers may be unwilling to shift their purchasing from traditional vendors of such content to online vendors. If the demand for broadband services does not develop or increase rapidly, this could have a material adverse effect on our results of operations. 26 WE RELY HEAVILY ON THIRD PARTIES FOR DEVELOPMENT OF SOFTWARE AND CONTENT AND FOR ESSENTIAL BUSINESS OPERATIONS AND MAY BE ADVERSELY AFFECTED BY OUR FAILURE TO MAINTAIN SATISFACTORY RELATIONSHIPS WITH SUCH PARTIES. We depend on third parties for important aspects of our business, including: - Internet access; - development of software for new web site features; - content; and - telecommunications. We have limited control over these third parties, and we are not their only client. We may not be able to maintain satisfactory relationships with any of them on acceptable commercial terms, and there is no guarantee that we will be able to renew these agreements at all. Further, we cannot be sure that the quality of products and services that they provide may remain at the levels needed to enable us to conduct our business effectively. WE ARE HEAVILY RELIANT ON THIRD PARTIES TO HOUSE AND SERVICE OUR WEB SITE AND ARE VULNERABLE TO POSSIBLE DAMAGE TO OUR OPERATING SYSTEMS. We maintain substantially all of our computer systems at our Campbell, California site and the Los Angeles, California site of Alchemy Communications. We are heavily reliant on the ability of Alchemy Communications to house and service our web site. This system's continuing and uninterrupted performance is critical to our success. Growth in the number of users accessing our web site may strain its capacity, and we rely on Alchemy Communications to upgrade our system's capacity in the face of this growth. Alchemy Communications also provides our connection to the Internet. Sustained or repeated system failures or interruptions of our web site connection services would reduce the attractiveness of our web site to customers and advertisers, and could therefore have a material and adverse effect on our business due to loss of membership and advertising revenues. In addition, our operations are dependent in part on our ability to protect our operating systems against physical damage from fire, floods, earthquakes, power loss, telecommunications failures, break-ins or other similar events. Furthermore, our servers are vulnerable to computer viruses, break-ins and similar disruptive problems. The occurrence of any of these events could result in interruptions, delays or cessations in service to our users and result in a decrease in the number of visitors to our site. 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. 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. 27 WE DEPEND ON OUR KEY PERSONNEL TO OPERATE OUR BUSINESS, AND WE MAY NOT BE ABLE TO HIRE ENOUGH ADDITIONAL MANAGEMENT AND OTHER PERSONNEL AS OUR BUSINESS GROWS. Our performance is substantially dependent on the continued services and on the performance of our executive officers and other key employees, particularly Robert A. Rositano, Jr., our Chief Executive Officer, and Dean Rositano, our President and Chief Operating Officer. The loss of the services of any of our executive officers could materially and adversely affect our business due to their experience with our business plan and the disruption in the conduct of our day-to-day operations. Additionally, we believe we will need to attract, retain and motivate talented management and other highly skilled employees to be successful. Competition for employees that possess knowledge of both the Internet industry and our target market is intense. We may be unable to retain our key employees or attract, assimilate and retain other highly qualified employees in the future. 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. 28 OUR ADVERTISERS ARE EMERGING INTERNET COMPANIES THAT REPRESENT CREDIT RISKS. Some of our advertisers have limited operating histories, are operating at a loss, have limited cash reserves or have limited access to capital. If any significant part of our customer base experiences financial difficulties, is not commercially successful or is unable to pay our advertising fees for any reason, our business, operating results and financial condition may be materially and adversely affected. WE MAY NOT BE ABLE TO ADAPT AS INTERNET TECHNOLOGIES AND CUSTOMER DEMANDS CONTINUE TO EVOLVE. To be successful, we must adapt to rapidly changing Internet technologies and continually enhance the features and services provided on our web site. We could incur substantial, unanticipated costs if we need to modify our web site, software and infrastructure to incorporate new technologies demanded by our audience. We may use new technologies ineffectively or we may fail to adapt our 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. 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. We do not have any present understanding relating to any such acquisition or investment. If we were to buy a content, service or technology company, the amount of time and level of resources required to successfully integrate their business operation could be substantial. The challenges in assimilating their people and organizational structure, and in encountering potential unforeseen technical issues in integrating their content, service or technology into ours, could cause 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. Further, states have attempted to impose sales taxes on catalog sales from businesses such as ours. A successful assertion by one or more states that we should have collected or be collecting sales taxes on the sale of products could have a material and adverse effect on our business due to the imposition of fines or penalties or the requirement that we pay for the uncollected taxes. WE MAY NOT BE ABLE TO TAKE FULL ADVANTAGE OF POTENTIAL TAX BENEFITS FROM OUR NET OPERATING LOSS CARRYFORWARDS. At December 31, 2000 we had Federal net operating loss carryforwards available to reduce future Federal taxable income that aggregated approximately $25,143,000 for Federal income tax purposes. These benefits will begin to expire in 2017. 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. web usage may be inhibited for a number of reasons, including: - inadequate Internet infrastructure; - security concerns; - inconsistent quality of service; - unavailability of cost-effective, high-speed service; - imposition of transactional taxes; or - limitation of third party service provider's ability and willingness to invest in new or updated equipment to handle traffic volume. 30 If Internet usage grows, the Internet infrastructure may not be able to support the demands placed on it by this growth, or its performance and reliability may decline. We are highly dependant on third party service providers. Any interruption experienced by these service providers may have a material impact on our business due to our inability to serve our advertising customers or end users. In addition, web sites, including ours, have experienced a variety of interruptions in their service as a result of outages and other delays occurring throughout the Internet network infrastructure. If these outages or delays frequently occur in the future, web usage, including usage of our web site, could grow slowly or decline. This may have a material impact on future revenues. WE RELY ON A CONTINUOUS POWER SUPPLY TO CONDUCT OUR OPERATIONS, AND CALIFORNIA'S CURRENT ENERGY CRISIS COULD DISRUPT OUR OPERATIONS AND INCREASE OUR EXPENSES. California is in the midst of an energy crisis that could disrupt our operations and increase our expenses. In the event of an acute power shortage, that is, when power reserves for the State of California fall below 1.5%, California has on some occasions implemented, and may in the future continue to implement, rolling blackouts throughout California. Our computer systems are supplied primary power by power companies in California. In addition, the systems are connected to battery backup systems. This alternative source of power is provided by our hosting provider and is subject to upkeep and maintenance. Our current insurance does not provide coverage for any damages our customers or we may suffer as a result of any interruption in our power supply. If blackouts interrupt our third party power supply, we would be temporarily unable to continue operations at our affected facilities. Any such interruption in our ability to continue operations at our facilities could damage our reputation and could result in lost revenue, which could have a material adverse effect on our business, operating results and financial condition. 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. 31 BREACHES OF SECURITY ON THE INTERNET MAY SLOW THE GROWTH OF E-COMMERCE AND WEB ADVERTISING AND SUBJECT US TO LIABILITY. The need to securely transmit confidential information, such as credit card and other personal information, over the Internet has been a significant barrier to e-commerce and communications over the web. Any well-publicized compromise of security could deter more people from using the web or from using it to conduct transactions that involve transmitting confidential information, such as purchases of goods or services. Furthermore, decreased traffic and e-commerce sales as a result of general security concerns could cause advertisers to reduce their amount of online spending. To the extent that our activities or the activities of third party contractors involve the storage and transmission of proprietary information, such as credit card numbers, security breaches could disrupt our business, damage our reputation and expose us to a risk of loss or litigation and possible liability. We could be liable for claims based on unauthorized purchases with credit card information, impersonation or other similar fraud claims. Claims could also be based on other misuses of personal information, such as for unauthorized marketing purposes. We may need to spend a great deal of money and use other resources to protect against the threat of security breaches or to alleviate problems caused by security breaches. WE COULD FACE LIABILITY FOR INFORMATION DISPLAYED ON AND COMMUNICATIONS THROUGH OUR WEB SITE. We may be subjected to claims for defamation, negligence, copyright or trademark infringement or based on other theories relating to the information we publish on our web site. These types of claims have been brought, sometimes successfully, against Internet companies as well as print publications in the past. Based on links we provide to other web sites, we could also be subjected to claims based upon online content we do not control that is accessible from our web site. Claims may also be based on statements made and actions taken as a result of participation in our chat rooms or as a result of materials posted by members on bulletin boards at our web site. We also offer e-mail services, which may subject us to potential risks, such as: - liabilities or claims resulting from unsolicited e-mail; - lost or misdirected messages; - illegal or fraudulent use of e-mail; or - interruptions or delays in e-mail service. 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. 32 WE COULD FACE ADDITIONAL BURDENS ASSOCIATED WITH GOVERNMENT REGULATION OF AND LEGAL UNCERTAINTIES SURROUNDING THE INTERNET. Any new law or regulation pertaining to the Internet, or the application or interpretation of existing laws, could have a material and adverse effect on our business, results of operations and financial condition due to increased costs of doing business. Laws and regulations directly applicable to Internet communications, commerce and advertising are becoming more prevalent. The law governing the Internet, however, remains largely unsettled, even in areas where there has been some legislative action. It may take years to determine whether and how existing laws governing intellectual property, copyright, privacy, obscenity, libel and taxation apply to the Internet. In addition, the growth and development of e-commerce may prompt calls for more stringent consumer protection laws, both in the United States and abroad. We also may be subject to future regulation not specifically related to the Internet, including laws affecting direct marketers. WE COULD INCUR MONETARY DAMAGES FROM LITIGATION ARISING OUT OF OUR BUSINESS ACTIVITIES. On July 9, 1999, we were named as one of several defendants in a lawsuit filed by four disaffected shareholders in Simply Interactive, Inc. The lawsuit arises out of a series of events relating to certain assets our operating company, Nettaxi Online Communities, purchased from SSN Properties in October 1997. The complaint alleges that we owed, and either intentionally or negligently breached, fiduciary duties to the plaintiffs. The suit also claims that we either intentionally or negligently interfered with the plaintiffs' contract or prospective advantage. A Case Management Conference is currently scheduled for April 13, 2001 at which time the parties must represent to the court whether or not this matter is ready to be set for trial. 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. ANTI-TAKEOVER PROVISIONS AND OUR RIGHT TO ISSUE PREFERRED STOCK COULD MAKE A THIRD PARTY ACQUISITION OF US DIFFICULT. We are a Nevada corporation. Anti-takeover provisions of Nevada law could make it more difficult for a third party to acquire control of us, even if such change in control would be beneficial to stockholders. Our articles of incorporation provide that our board of directors may issue preferred stock without stockholder approval. The issuance of preferred stock could make it more difficult for a third party to acquire us. All of the foregoing could adversely affect prevailing market prices for our common stock. 33 OUR COMMON STOCK PRICE IS LIKELY TO BE HIGHLY VOLATILE AS IS TYPICAL OF INTERNET COMPANIES. The market price of our common stock has been, and is likely to continue to be, highly volatile as the stock market in general, and the market for Internet-related and technology companies in particular, has been highly volatile. Investors may not be able to resell their shares of our common stock following periods of volatility because of the market's adverse reaction to volatility. The trading prices of many technology and Internet-related companies' stocks have decreased substantially within the last 52 weeks. The market downturn and adjustment for the high valuations for internet companies may not return to the levels of late 1999 and early 2000. We cannot assure you that our stock will trade at the same levels of other Internet stocks or that Internet stocks in general will regain their prior market prices. The per share closing price of our common stock in 2000 ranged from a high of $8.09 as of March 13, 2000 to a low of $0.14 as of December 29, 2001. In addition, an active public market for our common stock may not continue. Factors that could cause such volatility may include, among other things: - actual or anticipated fluctuations in our quarterly operating results; - announcements of technological innovations; - conditions or trends in the Internet industry; and - changes in the market valuations of other Internet companies. ITEM 2. PROPERTIES Our headquarters are currently located in a leased facility in Campbell, California, consisting of approximately 8,600 square feet of office space to accommodate management, operations, and research and development functions, which is under a lease that expires at the end of April 2002. We are currently evaluating our need for the current accommodations and believe that the current market conditions will allow the Company to either renew the current lease space or find additional space if needed. ITEM 3. LEGAL PROCEEDINGS On July 9, 1999, after our public announcement of the filing of our registration statement on Form S-1, (Registration No. 333-78129) four disaffected shareholders in Simply Interactive, Inc., led by Ronald Ventre, filed an action in the Santa Clara County Superior Court against Warren J. Kaplan, Frank McGrath, Bruno Henry, Alan K. Fetzer, Robert Divenere, Robert A. Rositano, Sr., Robert A. Rositano, Jr., Dean Rositano, Glenn Goelz, Nettaxi.com, Nettaxi Online Communities, Inc., SSN Properties, LLC and others. In August 1999 this claim was consolidated with another claim filed by Carlo Bruno, et al., on September 17, 1998. The case number is CV 783127. Mr. Kaplan was formerly the chief executive officer and a director of Simply Interactive. He also became a member of SSN Properties and is currently the chief operating officer of AboveNet Communications, Inc. Mr. McGrath was a director of Simply Interactive. He also became a member of SSN Properties and is currently a vice president of MCI WorldCom. Messrs. Henry, Fetzer, and DiVenere were all former officers of Simply Interactive, and Mr. Henry also served as a director of Simply Interactive. Robert A. Rositano, Sr. was a director of Simply Interactive and became the managing member of SSN Properties. He currently owns more than 5% of the outstanding shares of our common stock following a distribution by SSN Properties to its members in March 1999. Robert A. Rositano, Jr. was formerly an executive vice president of Simply Interactive and served as a director until May 1996. He is currently chief executive officer, secretary and a director of Nettaxi. Dean Rositano was formerly an executive vice president of Simply Interactive and served as a director until May 1996. He is currently president, chief operating officer and a director of Nettaxi. Mr. Goelz was the chief financial officer of Simply Interactive from August 1996 to July 1997 and was our chief financial officer from April 1999 to April 2000. All individual defendants held shares, or options to purchase shares, of Simply Interactive. 34 Distinctions can be made between the claims that the Ventre group is pursuing against us and the other defendants. As to us, the suit claims that we owed, and either intentionally or negligently breached, fiduciary duties to the Ventre group. The suit also claims that we either intentionally or negligently interfered with the Ventre group's contract or prospective advantage. The Ventre group is seeking the following relief against us: - an unstated amount of compensatory and special damages in the sum of their investments in Simply Interactive, plus prejudgment interest; - an accounting of profits; - punitive damages; and - costs of suit, including attorney fees as permitted by law. The Ventre group's claims against the other defendants, while not clear, include all of the claims described above with respect to us as well as other claims of ineffective management, waste of assets and similar claims. In addition to the relief described above with respect to us, the Ventre group seeks the following from the other defendants: - declaratory relief concerning the validity of the election of the board of directors of Simply Interactive; and - orders for the inspection of corporate records in, and the holding of shareholder meetings for, Simply Interactive. The factual basis for the proceedings as alleged by the Ventre group can be summarized as follows. The Ventre group alleges that between February and April 1996, they made a series of investments in Simply Interactive and thereby became minority shareholders. Thereafter, according to the complaint, the board of directors of Simply Interactive, without due diligence and disclosure to the minority shareholders, increased the debts and expenses of Simply Interactive. The Ventre group then alleges that the defendants raised capital through the sale of $5.5 million principal amount of convertible notes, secured by all the assets and properties of Simply Interactive, to three of the defendants, that the minority shareholders were not given notice of the proposed financing and an opportunity to participate, and that the entire transaction is void or voidable because the board of directors of Simply Interactive was improperly constituted at the time. The Ventre group goes on to allege that SSN Properties, which acquired the notes from the original purchaser, foreclosed on the assets of Simply Interactive without reason in August 1997. Finally, the complaint alleges that the assets formerly used by Simply Interactive were transferred to us through a series of transactions in violation of fiduciary obligations owed by the defendants to the minority shareholders of Simply Interactive. 35 Our officers and directors believe that the Ventre group's claims are without merit and that significant issues of proof exist with regard to the relevant facts as alleged in the complaint. For example, the individual defendants have advised that the issuance of the notes followed numerous failed attempts to raise additional funds from outside sources, and that foreclosure occurred only after Simply Interactive's default in its obligations to make required interest payments. Moreover, while the complaint does include us as defendants with respect to the allegations arising out of the events described above, our current operating company, Nettaxi Online Communities, was not launched until September 1997. In fact, Nettaxi Online Communities did purchase certain assets from SSN Properties in October 1997, including the original Internet the City CD-ROM product; a domain name; furniture, fixtures, and equipment; plus other assets which have since been abandoned. However, the assets acquired by Nettaxi Online Communities from SSN Properties at that time represented less than 50% of the value of the foreclosed assets. As described in the notes to our financial statements, the aggregate value of the assets acquired by Nettaxi Online Communities from SSN Properties was $2,000,000, which amount was verified by an independent appraiser. In 1998, we experienced several significant functional problems with portions of a purchased technology program, namely the web to database software application, due to those components incompatability with subsequent releases of upgraded versions of its operating system. Following attempts to make these components of the acquired technology compatible, we decided, in December 1998, not to spend additional monies on these components but to replace them. We wrote off the unamortized portion of this impaired technology that reduced the value of the assets by approximately $700,000. As of December 31, 2000, the unamortized cost of the remaining assets purchased from SSN Properties as a percentage of our total assets was less than 5%. Moreover, the role of these assets, which were intended to be revenue-generating products in Simply Interactive's business model, is substantially different for us in that we view them primarily as a tool to drive traffic to our site and not necessarily as an independent revenue source. It should also be noted that our business model for an online community is substantially different than Simply Interactive's objective of licensing, distribution, and sale of the CD-ROM product and marketing and sales of the impaired software application described above. A Case Management Conference is currently scheduled for April 13, 2001 at which time the parties must represent to the court whether or not this matter is ready to be set for trial. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 36 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS Our common stock has been traded on the NASD O-T-C Market Bulletin Board under the trading symbol "NTXY" since October 12, 1998. Prior to that date, our common stock was not actively traded in the public market. The following table sets forth, for the periods indicated, the high and low bid prices for our common stock as reported by various Bulletin Board market makers. The quotations do not reflect adjustments for retail mark-ups, mark-downs, or commissions and may not necessarily represent actual transactions.
Period Low Bid High Bid ------------------------------------------------------------------ FISCAL YEAR ENDED DECEMBER 31, 1998: Fourth Quarter (October 12 - December 31, 1998) $ 4.375 $ 8.875 FISCAL YEAR ENDED DECEMBER 31, 1999: First Quarter (January 1 - March 31, 1999) $ 6.187 $18.750 Second Quarter (April 1 - June 30, 1999) $11.500 $34.500 Third Quarter (July 1 - September 30, 1999) $ 7.375 $16.500 Fourth Quarter (October 1 - December 31, 1999) $ 1.843 $ 7.875 FISCAL YEAR ENDED DECEMBER 31, 2000: First Quarter (January 1 - March 31, 2000) $ 1.406 $ 9.062 Second Quarter (April 1 - June 30, 2000) $ 0.940 $ 5.968 Third Quarter (July 1 - September 30, 2000) $ 0.420 $ 1.420 Fourth Quarter (October 1 - December 31, 2000) $ 0.125 $ 0.520 FISCAL YEAR ENDING DECEMBER 31, 2001 First Quarter (January 1 - March 16, 2001) $ 0.130 $ 0.240
On March 16, 2001, the high and low bid prices per share for our common stock on the Bulletin Board were $0.240 and $0.180, respectively. As of February 28, 2001, there were 434 stockholders of record who held shares of our common stock DIVIDEND POLICY To date, no dividends have been declared or paid on any of our capital stock. We currently intend to retain earnings, if any, to fund the development and growth of our business and do not anticipate paying cash dividends in the foreseeable future. Payment of future dividends, if any, will be at the discretion of our board of directors after taking into account various factors, including our financial condition, operating results, current and anticipated cash needs and plans for expansion. RECENT SALES OF UNREGISTERED SECURITIES Set forth in chronological order is information regarding shares of common stock issued and options and warrants and other convertible securities granted by the Company during the year ended December 31, 2000. Also included is the consideration, if any, received by the Company for such shares and options and information relating to the section of the Securities Act of 1933, or rule of the Securities and Exchange Commission under which exemption from registration was claimed. 37 (1) In January 2000, we issued options to purchase up to 1,508,800 shares of common stock under our 1999 stock option plan to three current and one former member of our board of directors who were not employees of the Company, 5 officers and 23 key employees with an exercise price of $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 1933 and/or Rule 701 promulgated under the Securities Act of 1933 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. (2) In January, 2000, the Company issued options to purchase 230,000 shares of common stock to 8 vendors and consultants, with an exercise price of $2.44 per share. These issuances were made in reliance on Section 4(2) of the Securities Act of 1933 and/or Rule 701 promulgated under the Securities Act of 1933 and were made without general solicitation or advertising. The purchasers were sophisticated investors with access to all relevant information necessary to evaluate these investments, and who represented to the Company that the shares were being acquired for investment. (3) In February 2000 we issued 6,250 shares of common stock, having a value of $9,700, to PPC Racing in settlement of cancellation of a letter of intent to provide sponsorship. The issuance was made in reliance on Section 4(2) of the Securities Act of 1933 and/or Regulation D promulgated under the Securities Act of 1933 and was made without general solicitation or advertising. The purchaser was a sophisticated investor with access to all relevant information necessary to evaluate these investments, and who represented to the Company that the shares were being acquired for investment. (4) In February 2000 we issued 175,000 shares of Common Stock to Sinclair Davis Trading Corp. in exchange for consulting services. The issuance was made in reliance on Section 4(2) of the Securities Act of 1933 and/or Regulation D promulgated under the Securities Act of 1933 and was made without general solicitation or advertising. The purchaser was a sophisticated investor with access to all relevant information necessary to evaluate these investments, and who represented to the Company that the shares were being acquired for investment. (5) In February 2000 we issued approximately 15.4 million shares of Common Stock and warrants to purchase up to an equal number of shares of common stock in exchange for approximately $23 million. 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 accredited 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. 38 (6) In February, 2000, the Company issued options to purchase 150,000 shares of common stock to Fontanelle, LLC, with an exercise price of $1.88 per share. These issuances were made in reliance on Section 4(2) of the Securities Act of 1933 and/or Rule 701 promulgated under the Securities Act of 1933 and were made without general solicitation or advertising. The purchasers were sophisticated investors with access to all relevant information necessary to evaluate these investments, and who represented to the Company that the shares were being acquired for investment. (7) In February 2000, we issued options to purchase up to 1,850,800 shares of common stock under our 1999 stock option plan to, 5 officers and 17 key employees with an exercise price of $1.44 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 1933 and/or Rule 701 promulgated under the Securities Act of 1933 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. (8) In March and April 2000, the Company issued warrants to purchase 389,491 shares of common stock and 778,982 shares of common stock to 2 vendors, with an exercise price of $2.76 per share in exchange for the conversion of certain accounts payable. The issuance was made in reliance on Section 4(2) of the Securities Act of 1933 and/or Regulation D promulgated under the Securities Act of 1933 and was made without general solicitation or advertising. The purchaser was a sophisticated investor with access to all relevant information necessary to evaluate these investments, and who represented to the Company that the shares were being acquired for investment. (9) From March, 2000 to December, 2000, the Company pursuant to its 1999 Stock Option Plan, issued options to purchase 192,000 shares of common stock to its employees, with exercise prices ranging from $0.37 to $6.812 per share. These issuances were made in reliance on Section 4(2) of the Securities Act of 1933 and/or Rule 701 promulgated under the Securities Act of 1933 and were made without general solicitation or advertising. The purchasers were sophisticated investors with access to all relevant information necessary to evaluate these investments, and who represented to the Company that the shares were being acquired for investment. (10) In July 2000 we issued 80,000 shares of Common Stock to James Stubler in exchange for consulting services. The issuance was made in reliance on Section 4(2) of the Securities Act of 1933 and/or Regulation D promulgated under the Securities Act of 1933 and was made without general solicitation or advertising. The purchaser was a sophisticated investor with access to all relevant information necessary to evaluate these investments, and who represented to the Company that the shares were being acquired for investment. (11) In July 2000 we issued 100,000 shares of Common Stock to Newport Capital Consultants, Inc. in exchange for consulting services. The issuance was made in reliance on Section 4(2) of the Securities Act of 1933 and/or Regulation D promulgated under the Securities Act of 1933 and was made without general solicitation or advertising. The purchaser was a sophisticated investor with access to all relevant information necessary to evaluate these investments, and who represented to the Company that the shares were being acquired for investment. 39 (12) In August 2000 we issued 250,000 shares of Common Stock to Robert Shatles in exchange for consulting services. The issuance was made in reliance on Section 4(2) of the Securities Act of 1933 and/or Regulation D promulgated under the Securities Act of 1933 and was made without general solicitation or advertising. The purchaser was a sophisticated investor with access to all relevant information necessary to evaluate these investments, and who represented to the Company that the shares were being acquired for investment. (13) In September 2000 we issued 75,000 shares of Common Stock to Sinclair Davis Trading Corp. in consideration of our failure to execute on the demand registration rights exercised by Sinclair Davis in a timely manner. The issuance was made in reliance on Section 4(2) of the Securities Act of 1933 and/or Regulation D promulgated under the Securities Act of 1933 and was made without general solicitation or advertising. The purchaser was a sophisticated investor with access to all relevant information necessary to evaluate these investments, and who represented to the Company that the shares were being acquired for investment. (14) In October 2000 we issued warrants to purchase up to 350,000 shares of Common Stock to Mr. Michael Gardner in exchange for consulting services. The exercise price for the warrants is $0.35 per share. The issuance was made in reliance on Section 4(2) of the Securities Act of 1933 and/or Regulation D promulgated under the Securities Act of 1933 and was made without general solicitation or advertising. The purchaser was a sophisticated investor with access to all relevant information necessary to evaluate these investments, and who represented to the Company that the shares were being acquired for investment. ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA SUMMARY FINANCIAL DATA Set forth below are summary statements of operations data for the period from October 23, 1997, date of incorporation, to December 31, 1997 and for the years ended December 31, 1998, 1999 and 2000, and summary balance sheet data as of December 31, 1997, 1998, 1999 and 2000. This information should be read in conjunction with the Consolidated Financial Statements and Notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations", appearing elsewhere in this Form.
------------------------------------------- ----------- ------------ ------------ ------------- 1997 1998 1999 2000 ------------------------------------------- ----------- ------------ ------------ ------------- ------------------------------------------- ----------- ------------ ------------ ------------- STATEMENT OF OPERATIONS DATA(1): ------------------------------------------- ----------- ------------ ------------ ------------- Net revenues $ 144,900 $ 258,000 $ 5,032,800 $ 9,418,400 ------------------------------------------- ----------- ------------ ------------ ------------- Gross profit $ 57,500 $ 18,200 $ 1,029,000 $ 2,110,700 ------------------------------------------- ----------- ------------ ------------ ------------- Loss from operations $ (142,100) $(3,082,300) $(9,402,500) $(10,367,900) ------------------------------------------- ----------- ------------ ------------ ------------- Net loss $ (159,700) $(3,113,600) $(9,880,400) $(14,351,400) ------------------------------------------- ----------- ------------ ------------ ------------- Net loss available to common shareholders $ (327,200) $(3,127,900) $(9,880,400) $(14,351,400) ------------------------------------------- ----------- ------------ ------------ ------------- Basic loss per share $ (0.06) $ (0.32) $ (0.46) $ (0.36) ------------------------------------------- ----------- ------------ ------------ ------------- Diluted loss per share $ (0.06) $ (0.32) $ (0.46) $ (0.36) ------------------------------------------- ----------- ------------ ------------ ------------- WEIGHTED-AVERAGE COMMON SHARES: ------------------------------------------- ----------- ------------ ------------ ------------- Basic outstanding shares 5,483,500 9,724,781 21,274,203 39,381,211 ------------------------------------------- ----------- ------------ ------------ ------------- Diluted outstanding shares 5,483,500 9,724,781 21,274,203 39,381,211 ------------------------------------------- ----------- ------------ ------------ ------------- ------------------------------------------- ----------- ------------ ------------ ------------- Balance Sheet Data: ------------------------------------------- ----------- ------------ ------------ ------------- Working capital (Deficiency) $ (222,900) $ 300,400 $(2,053,000) $ 14,144,500 ------------------------------------------- ----------- ------------ ------------ ------------- Total Assets $2,082,300 $ 1,652,700 $ 6,031,200 $ 18,123,600 ------------------------------------------- ----------- ------------ ------------ ------------- Long-term Liabilities $ 773,500 $ 5,400 $ 3,200,000 $ 0 ------------------------------------------- ----------- ------------ ------------ ------------- Total stockholders' equity (Deficiency) $ 973,400 $ 1,332,100 $(2,000,300) $ 16,563,300 ------------------------------------------- ----------- ------------ ------------ -------------
(1) We have not given effect to the possible liability arising from the litigation with the Ventre group described in the section of this annual report entitled, Legal Proceedings. At this time, in the opinion of management, there are no pending claims, the outcome of which is expected to result in a material adverse effect on our financial position. 40 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and section 21E of the Securities Exchange Act of 1934, including, without limitation, statements regarding the company's expectations, beliefs, intentions or future strategies that are signified by the words "expects", "anticipates", "intends", "believes", or similar language. These forward-looking statements involve risks, uncertainties and other factors. All forward-looking statements included in this document are based on information available to the company on the date hereof and speak only as of the date hereof. The factors discussed below under "Risk Factors" and elsewhere in this Annual Report on Form 10-K are among those factors that in some cases have affected the company's results and could cause the actual results to differ materially from those projected in the forward-looking statements. The following discussion should be read in conjunction with the condensed consolidated financial statements and notes thereto. OVERVIEW Nettaxi.com is an Internet marketing portal that provides a wide range of content and Internet based services for consumers and businesses. Our web site at www.nettaxi.com serves as a gathering place for people with shared topics of interest, as well as an entry point, referred to as a portal, to the Internet. Through our web site, we provide content addressing a large number of targeted categories The content is organized into affinity categories such as news, sports, entertainment, health, politics, finances, lifestyle, and other areas of interest. Visitors to our web site are provided with comprehensive information and content. Subscribers to our web site, which we call citizens, are also provided with access to enhanced content such as broadband video clips, email accounts and personal web pages. We have developed a diversified revenue model under which we provide our citizens with access to web site hosting services and a broad range of content, and we provide affiliated businesses with access to a large population of Internet users for advertising and promotional purposes. 41 In 2000, we focused our efforts on improving the quality of content available on our web site, implementing our web site hosting services and reducing our operating costs by eliminating many of the services which were not profitable. During the year we developed a number of new promotions designed to generate new sources of revenue. 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. The loss or reduction of revenue from this customer may have a material impact on total net revenues. The Company also receives other revenues from premium account membership subscriptions. 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 that enables the acceptance and processing of online credit card transactions. We believe this merger also enhanced 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. In February 2000, we completed our private placement, which raised approximately $23 million in exchange for issuance of the Company's common stock and warrants, to purchase shares of our common, which, if fully exercised by all investors, will result in an additional $62 million in equity funding to Nettaxi.com. The acquisition of this new capital will provide Nettaxi.com the ability to become a more aggressive competitor in the community portal arena. The Company plans to use the funds raised to increase our ability to develop new community content and commerce relationships, and enhance each Nettaxi.com citizen's experience within our communities. This funding will also facilitate potential acquisitions, mergers, and other strategic partnerships which fit into the company's overall long-term business strategy. 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. During the fourth quarter ended September 30, 2000, we entered into a contract with Screaming Media to provide content for users of our website. We expect this new content to increase brand awareness to our web site. We also entered into a contract with Annuncio Software, Inc. to enhance our marketing efforts for direct marketing to our citizens that may enhance their time spent online with other products and services for purchase. 42 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. RESULTS OF OPERATIONS; COMPARISON OF THE TWELVE MONTHS ENDED DECEMBER 31, 2000 AND 1999 NET REVENUES. Net revenues for the year ended December 31, 2000 increased 87% to approximately $9.4 million from $5.0 million for the year ended December 31, 1999. The absolute dollar increase is the result of an increase in revenues from the corporate web hosting and the increase in advertising revenues. Advertising revenues included third party revenues from both traditional and internet related advertisers which also includes reciprocal arrangements. For the year ended December 31, 2000, four customers each accounted for greater than 10% of total net revenues for a total of approximately $5.1 million or 54% of the total revenues. These customers, Babenet, SpinRecords.com, Whitesand Communications, and Hearme.com, accounted for 20%, 13%, 11% and 10%, respectively of our total revenues. For the year ended December 31, 1999, one customer, Whitesand Communications, accounted for greater than 10% of total net revenues. The loss of any one of all of these customers could have a material adverse affect on our revenue. ADVERTISING REVENUES. Advertising revenues for the year ended December 31, 2000 and 1999 were approximately $5.7 million and approximately $2.7 million, respectively, which represented 60% and 53%, respectively, of total net revenues. The year over year increase in absolute dollars resulted from an increase in reciprocal advertising transactions and increases in the number of advertisers as well as the increase in average contract commitments of these advertisers as a result of increased web traffic to our web site.Reciprocal advertising arrangements are exchanges of similar services between the Company and the advertisers. These arrangements accounted for approximately 28% and 7% of total revenues for the twelve months ended December 31, 2000 and 1999, respectively. Reciprocal arrangements for the twelve months ended December 31, 2000 are the result of the Company's strategy in developing strategic relationships with other advertisers or service providers for non-cash media advertising. TRANSACTION PROCESSING FEES. There were no transaction processing fees for the year ended December 31, 2000. Transaction processing fees were approximately $1.29 million for the year ended December 31, 1999, which represented 26%, of total net revenues. Transactions fees consisted of revenue derived from credit card evaluations and from the processing of on-line credit card transactions. The 1999 revenue is attributable to the merger with Plus Net, Inc. in May 1999. The contract through which these fees have been derived terminated in December, 1999 and we do not expect revenues of this type to be significant in future periods. HOSTING REVENUES. Our hosting revenues were approximately $3.7 million and $945,000 for the years ended December 31, 2000 and 1999, respectively, which represented 40% and 19%, of total net revenues, respectively. For the year ended December 31, 2000, we recognized hosting revenues for the twelve 43 months as compared to only six months in the year ended December 31, 1999. In the third quarter of 1999, we began providing internet hosting and connectivity services for corporate customers. Our services are delivered through a state-of-the-art Internet data center located in Southern California using a high-performance Internet backbone network. Customers pay monthly fees for the professional services utilized, one-time installation fees, and monthly connectivity charges. These "hosting" revenues were recognized in the period the services were provided. The Company has experienced strong revenue growth in the internet web hosting for corporate customers, but does not expect this growth to continue at the current rate, or that the Company will sustain profitability from this business segment. Additionally, the Company cannot assure that it can increase the number of corporate customers or maintain the current customer base. As previously described, two web-hosting customers accounted for more than 10% of total net revenues for the twelve months ended December 31, 2000. COST OF OPERATIONS. Cost of operations were approximately $7.3 million and $4.0 million for the years ended December 31, 2000 and 1999, respectively. Cost of operations increased 83%, Approximately 85% of the increase is the result of additional expenses related to costs for co-location (Internet connection charges) expenses. In the third quarter of 1999, we began providing Internet connectivity services to corporate customers and required purchases of additional bandwidth to service these customers. These costs are expected to continue to increase as our web traffic increases and our corporate customer require additional bandwidth for our "citizens". For the year ended December 31, 2000, we recognized hosting expenses for twelve months as compared to only six months in the year ended December 31, 1999. Approximately 11% of the increase is related to increased depreciation expense for capital purchased in 1999. Approximately 6% of the increase is related to the costs for consultants to improve our website. Separately, during the third quarter ended September 30, 2000, we also initiated cost effective measurement tools to limit the use of unauthorized excessive bandwidth or charging the individual users for the use of additional bandwidth. These cost measures resulted in cost savings to the Company in the third and fourth quarter of year 2000. We cannot be assured that these cost saving measures will continue to result in substantial savings or any savings at all. SALES AND MARKETING EXPENSES. Sales and marketing expenses were approximately $5.9 million and $4.8 million for the twelve month periods ended December 31, 2000 and 1999, respectively. Sales and marketing expenses consisted primarily of advertising, including co-branding and reciprocal, salaries of our sales and marketing personnel and related costs, marketing, and promotion costs. Approximately $1.9 million of the net increase is the result of the redirected marketing approach for brand awareness implemented in the third quarter of 2000. This consisted of using reciprocal online advertising arrangements to increase brand awareness rather than the traditional print and media marketing approach. The Company recorded reciprocal advertising expenses in relation to the reciprocal advertising revenues of $2.2 million for the year ended December 31, 2000 compared to approximately $0.3 million for the year ended December 31, 1999. The Company utilizes reciprocal advertising arrangements as an inexpensive advertising media for increasing brand awareness. There can be no assurance that these increased expenditures will result in increased visitors to our web site or additional revenues in the future. This increase was offset by a reduction of approximately $0.8 million reduction in spending on traditional marketing media expenditures. 44 RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses were $1.6 million and $2.2 million for the twelve months ended December 31, 2000 and 1999, respectively. The 28% decrease was primarily attributable to the lower utilization of consultants by the Company and decrease in average number of technical personnel during the year 2000. Approximately $0.6 million of the decrease was related to the lower utilization of consultants and $0.2 million of the decrease was related to the decrease in recruiting fees paid to hire new employees. The above two costs were offset by an approximately $0.3 million increase which was related to increased depreciation expense for capital equipment. The Company has experienced a difficulty in its ability to recruit and retain technical personnel as a result of the current economic prosperity and high cost of living in Silicon Valley and expects this condition to have a continuous impact on the ability of the Company to retain and hire additional technical personnel. GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses were $5.0 million and $3.5 million for the twelve months ended December 31, 2000 and 1999, respectively. General and administrative costs consisted primarily of salaries and related costs for executives, administrative, and finance personnel, as well as legal, accounting and other professional service fees. Approximately $0.6 million of the increase in general and administrative expenses were primarily attributable to amortization of deferred compensation expense related to stock, warrants and options granted during the year to various consultants for the services. Approximately $0.4 million of the increase was the result of additional salaries and personnel costs. Approximately $0.4 million of the increase is related to higher insurance costs associated with being a public company. Also, the increase is the result of legal fees related to the settlement agreement with the holder of convertible debentures. The Company also recorded approximately $500,000 provision for uncollectible accounts receivable. The Company expects that due to the highly volatile market conditions for internet related and other advertising companies, the provision for bad debt may be higher in the future. The above increase were offset by the decrease in expenditures related to the merger with Plus Net. INTEREST EXPENSE. Net interest expense was $4.0 million and $0.4 million for the years ended December 31, 2000 and 1999, respectively. For the year 1999 period the net interest expense was primarily due to the convertible promissory note that was issued on March 31, 1999 and to amortization of deferred interest related to warrants issued in conjunction with the convertible promissory note, offset by interest income. For the year 2000 period, the net interest expense was primarily the result of deemed interest expense related to the convertible debenture issued on March 31, 1999. We recognized deemed interest expense of approximately $3.9 million in the second quarter of 2000. This non-cash interest expense resulted from the implied beneficial conversion feature and the value of warrants issued in connection with the settlement agreement that we reached with the holder of the convertible debenture. INCOME TAXES. At December 31, 2000, we had net operating loss carryforwards available to reduce future taxable income that aggregate approximately $25.1 million for Federal income tax purposes. These benefits begin to expire in 2017. The Company also had a California net operation loss carryforwards in the amount of $13.4 million which may be applied to future taxable income until these benefits begin to expire in 2002. Our ability to utilize the net operating loss carryforwards are dependent upon our ability to generate taxable income in future periods and may be limited due to restrictions imposed under Federal and state laws upon change in ownership. The provision for income taxes for the year ended December 31, 2000 consisted of minimum state taxes. For the year ended December 31, 1999 we recorded a tax provision which related to earnings made by PlusNet, Inc. during its fiscal period before our merger. 45 RESULTS OF OPERATIONS; COMPARISON OF THE TWELVE MONTHS ENDED DECEMBER 31, 1999 AND 1998 NET REVENUES. Net revenues for the year ended December 31, 1999 increased 1,851% to approximately $5.03 million from $258,000 in the year ended December 31, 1998. The absolute dollar increase is the result of the increase in the number of advertisers and the average contract duration and value (the result of higher web site traffic to nettaxi.com web pages), an increase in revenues from the corporate web hosting, transaction processing fee revenue, and to a lesser extent, increases in our royalties and customization fees associated with the distribution of our CD ROM product. Barter revenues accounted for approximately 7% of total revenues for the twelve months ended December 31, 1999. One customer, WhiteSand Communications, Inc., accounted for approximately 17% of the total revenues in the twelve months ended December 13, 1999, no other customer accounted for greater than 10% of total revenues. For the year ended December 31, 1998, four customers each accounted accounted for greater than 10% of net revenues, these customers @dventure, Unique Media (Go4Media), Pioneer Technologies, and Flycast Communications, accounted for 28%, 21%, 13%, and 12% of net revenues, respectively. ADVERTISING REVENUES. Advertising revenues for the year ended December 31, 1999 and 1998 were approximately $2.67 million and approximately $177,000, respectively, which represented 53% and 69%, respectively, of total net revenues. The year over year increase in absolute dollars 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. TRANSACTION PROCESSING FEES. Transaction processing fees were approximately $1.29 million for the year ended December 31, 1999, which represented 26%, of total net revenues. There were no transaction processing fees in 1998. 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 May 1999. The contract through which these fees have been derived terminated in December 1999 and we do not expect revenues of this type to be significant in future periods. HOSTING REVENUES. Our hosting revenues were approximately $945,000 for the year ended December 31, 1999, which represented 19%, of total net revenues. There were no hosting revenues in 1998. In the third quarter of 1999, the Company began providing internet hosting and connectivity services for corporate customers. Our services are delivered through a state-of-the-art Internet data center located in Southern California using a high-performance Internet backbone network. Customers pay monthly fees for the professional services utilized, one-time installation fees, and monthly connectivity charges. These "hosting" revenues were recognized in the period the services were provided. COST OF OPERATIONS. Cost of operations were approximately $4.0 million and $240,000 for the years ended December 31, 1999 and 1998, respectively. Approximately 93% of the increases for the twelve month period in 1999 over 1998 is the result of increased costs for co-location expenses (Internet connection charges). Equipment costs and depreciation of equipment, amortization of intangible assets, and expenses for third party content and development accounted for the balance of the increase. In the third quarter of 1999, we began providing Internet connectivity services to corporate customers and required purchases of additional bandwidth to service these customers. These costs are expected to continue to increase as our web traffic increases and our corporate customer require additional bandwidth for our "citizens". 46 SALES AND MARKETING EXPENSES. Sales and marketing expenses consisted primarily of salaries of our sales and marketing personnel, marketing, promotion, advertising and related costs. Sales and marketing expenses were approximately $4.79 million and $746,000 for the twelve month periods ended December 31, 1999 and 1998, respectively. Approximately $2.8 million of the increase was related to expansion of our online and print advertising, public relation and other promotional expenditures, and approximately $0.5 million of the increase was related to the hiring of 10 additional sales and marketing personnel and related expenses required to implement our marketing strategy. In the third quarter of 1999, the Company began to implement 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 expect sales and marketing expenses to increase significantly in future periods. These increases will be principally related to hiring additional sales and marketing personnel and increased spending on advertising in a variety of media to increase brand awareness and attract additional visitors to our web site. There can be no assurance that these increased expenditures will result in increased visitors to our web site or additional revenues. RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses were approximately $2.19 million and $635,000 for the twelve month periods ended December 31, 1999 and 1998, respectively. The absolute dollar increases for both the twelve month period in 1999 over 1998 primarily attributable to ongoing updating of the infrastructure and technological development of our web site. Approximately $0.6 million of the increase includes increased salaries and associated hiring costs that are a result of the highly competitive nature of hiring in the internet software marketplace and the hiring of 7 additional personnel. We experienced substantial costs for engineer consultants during the twelve month period ended December 31, 1999 and expects these increased costs to continue as we continue to recruit and retain personnel to meet the research and development requirements. These costs accounted for approximately $0.7 million of the net increase. GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses consisted primarily of salaries and related costs for our executive, administrative, and finance personnel, as well as legal, accounting and other professional service fees. General and administrative expenses were approximately $3.46 million and $1.05 million for the respective twelve month periods ended December 31, 1999 and 1998, respectively. Approximately $0.6 million of the increase is related to increases in the salaries of general and administrative personnel and related costs as the result of the hiring of key financial personnel in the second quarter of 1999. Approximately $0.6 million of the increase is the costs associated with the amortization of deferred compensation expenses, related to the issuance of common stock and options to consultants. Approximately $0.7 million of the increase is the result of higher legal and accounting fees associated with cost of being a public company. Approximately $0.5 million of the increase is the result of costs associated with the merger with Plus Net, Inc. in 1999. 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 operation as a public company. ASSET IMPAIRMENT. For the year ended December 31, 1998 operating expenses includes a one time adjustment of $667,000 for asset impairment. Asset impairment write down was to adjust the carrying amount of portions of the purchased technology, namely the web to database software application to its net realizable value. For the period ended December 31, 1999, no asset impairment write-down was recorded. 47 INTEREST EXPENSE. Net interest expense was approximately $351,100 and $59,000 for the respective twelve month period ended December 31, 1999 and 1998. The net interest expense for the twelve month periods ended December 31, 1999 and 1998 related to the convertible promissory note that was issued on March 31, 1999 and to amortization of deferred interest related to warrants issued in conjunction with the convertible promissory note. OTHER INCOME. In the twelve months ended December 31, 1998 we realized a gain of $28,500, from the disposal of capital equipment. No gain was realized in 1999. INCOME TAXES. At December 31, 1999, we had net operating loss carry forwards available to reduce future taxable income that aggregate 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 carry forwards may be limited if a cumulative change of ownership of more than 50% occurs over a three-year period. In the twelve months ended December 31, 1999 we recorded a tax provision which relates to earnings made by Plus Net, Inc. during its fiscal period before our merger. RESULTS OF OPERATIONS; COMPARISON OF THE PERIOD OCTOBER 23, 1997, DATE OF INCORPORATION, TO DECEMBER 31, 1997 AND THE TWELVE MONTHS ENDED DECEMBER 31, 1998 NET REVENUES. Net revenues for the twelve months ended December 31, 1998 were approximately $258,000 and for the period ended December 31, 1997 approximately $144,900. The revenues for the 1997 period were principally derived from royalties from the distribution of our CD-ROM tutorial product. Revenues for the twelve months ended December 31, 1998 reflect the shift from the initial start-up phase of the Company to the current business model that derives a majority of its revenue from the sale of banner advertisements. ADVERTISING REVENUES. Advertising revenues for the twelve months ended December 31, 1998 were approximately $177,000 or approximately 69% of total revenues. There were no advertising revenues for the period ended December 31, 1997. The Company began the sale of banner advertising on the Internet in the third quarter of 1998. ROYALTY REVENUES. Our royalty revenues were approximately $61,700 for the twelve months ended December 31, 1998, which represented approximately 24% of total revenues, and approximately $132,300 for the period ended December 31, 1997, which represented approximately 51% of total revenues. The Company initially derived its revenues from the distribution of the CD-ROM tutorial product. COST OF OPERATIONS. Cost of operations were approximately $239,800 for the twelve months ended December 31, 1998 and $87,400 for the period ended December 31, 1997. The substantial absolute dollar is the result of increased costs for co-location expenses (Internet connection charges), software and equipment costs, and depreciation of equipment as a result of build-out of our web site. 48 SALES AND MARKETING EXPENSES. Sales and marketing expenses consisted primarily of salaries of our sales and marketing personnel. Sales and marketing expenses were approximately $745,600 and $3,100 for the twelve month period ended December 31, 1998 and the period ended December 31, 1997, respectively. The absolute dollar increase represents the shift from the early research and development stages of the Company to the current business model as an online community generating revenues from the sales of advertising that required the shift in resources to focus on the sales and marketing efforts to promote the brand awareness of the Company and increased traffic on our web site. We expect sales and marketing expenses to increase significantly in future periods. These increases will be principally related to hiring additional sales and marketing personnel and increased spending on advertising in a variety of media to increase brand awareness and attract additional visitors to our web site. There can be no assurance that these increased expenditures will result in increased visitors to our web site or additional revenues. RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses were approximately $634,700 and $36,500 for the twelve month period ended December 31, 1998 and the period ended December 31, 1997, respectively. The absolute dollar increases in research and development expenses were primarily attributable to ongoing updating of the infrastructure and technological development of our web site, increased salaries that are a result of the highly competitive nature of hiring in the Internet software marketplace. We expect these increased costs to continue as we continue to recruit and retain personnel to meet the research and development requirements of the Company. GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses consisted primarily of salaries and related costs for our executive, administrative, and finance personnel, as well as legal, accounting and other professional service fees. General and administrative expenses were approximately $1.05 million and $160,000 for the twelve month period ended December 31, 1998 and the period ended December 31, 1997, respectively. The increase in absolute dollars in general and administrative expenses was primarily due to increases in the number of general and administrative personnel and the increase in fees for professional services. 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 operation as a public company. ASSET IMPAIRMENT. For the twelve months ended December 31, 1998 operating expenses includes a one time adjustment of $667,000 for asset impairment. Asset impairment write down was to adjust the carrying amount of portions of the purchased technology, namely the web to database software application to its net realizable value. For the period ended December 31, 1997, no asset impairment write-down was recorded. INTEREST INCOME/EXPENSE. Net interest expense for the twelve months ended December 31, 1998 was approximately $59,000 and $17,000 for the period ended December 31, 1997. The net interest expense for both periods was related to the convertible promissory note that was issued on November 1, 1997 which was converted into shares of common stock in September 1998. 49 INCOME TAXES. The provision for income taxes for the year ended December 31, 1998 and the period ended December 31, 1997 consisted of minimum state taxes. At December 31, 1998, we had net operating loss carry forwards available to reduce future taxable income that aggregate approximately $ 1,227,000 for Federal income tax purposes. LIQUIDITY AND CAPITAL RESOURCES As of December 31, 2000, the Company had cash and cash equivalents of approximately $13,900,000, compared to approximately $988,000 at December 31, 1999. Net cash used in operating activities equaled approximately $8.4 million and $5.37 million for the twelve-month periods ended December 31, 2000 and 1999, respectively. We had significant negative cash flows from operating activities for both of the twelve month periods primarily from our net operating losses, adjusted for non-cash items, and in 1999 an increase in accounts receivable balances due to the time lag between revenue recognition and the receipt of payments from advertisers. In 1999, these factors were offset by significant increases in accounts payable and accrued expenses. Non cash adjustments included issuance of common stock for services of $1,019,400 and $34,200 for the years ended December 31,2000 and 1999, respectively and compensation expense related to options and warrants granted for $615,700 and $211,300 for the years ended December 31, 2000 and 1999, respectively. Non cash adjustments in the year ended December 31, 2000 included interest expense related to the settlement agreement and issuance of warrants related to the convertible note issued in 1999. The total expense in 2000 was approximately $4.6 million compared to approximately $200,000 in 1999. Non cash adjustments also included bad debt write-offs of $350,000 and $52,400 for the years ended December 31, 2000 and 1999, respectively. Net cash used in investing activities was approximately $744,000 and $2.16 million for the twelve month periods ended December 31, 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. The Company does not have any outstanding orders for capital equipment and believes that the current capital equipment will sustain the needs for the forthcoming year. The Company does not plan to spend any significant amount in 2001 for capital equipment. Net cash provided by financing activities was approximately $22.0 million and $8.04 million for the twelve month periods ended December 31, 2000 and 1999, respectively. Net cash provided by financing activities in 2000 consisted primarily of net proceeds from the issuance of our common stock in a private placement offering. Net cash provided by financing activities in 1999 consisted of both net proceeds from issuance of common stock and issuance of a convertible promissory note. 50 We incurred net losses of approximately $14.4 million and $9.88 million for the year ended December 31, 2000, and 1999, respectively. At December 31, 2000, we had an accumulated deficit of approximately $27.7 million. The net losses and accumulated deficit resulted from the significant operational, infrastructure and other costs incurred in the development and marketing of our services and the fact that revenues failed to keep pace with such costs. 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. In February 2000, we completed a private placement of our common stock. As a result, we raised approximately $23 million in exchange for approximately 15.4 million shares of common stock issued to investors. The investors also received warrants to purchase up to an equal number of shares of our common stock exercisable at an exercise price of $4.00 per share. We currently believe that we have sufficient cash to fund our current operations through December 2002. However, given our limited resources and our history of losses from operations, we will need to raise additional funds in order to fully execute our business plan and fund expansion of our business, develop new or enhanced services or products, respond to competitive pressures or to acquire complementary products, businesses or technologies. No assurances can be given, however, that we will be able to obtain such additional resources. If we are unsuccessful in generating anticipated resources from one or more of the anticipated sources, and unable to replace the shortfall with resources from another source, we may be able to extend the period for which available resources would be adequate by deferring the creation or satisfaction of various commitments, deferring the introduction of various services or entry into various markets, and otherwise scaling back operations. If we are unable to generate the required resources, our ability to meet our obligations and to continue our operations would be adversely affected. RECENT ACCOUNTING PRONOUNCEMENTS In December 1999, the staff of the Securities and Exchange Commission issued its Staff Accounting Bulletin No. 101, "Revenue Recognition". Staff Accounting Bulletin No. 101 provides the SEC staff's views in applying generally accepted accounting principles to selected revenue recognition issues. Staff Accounting Bulletin No. 101 is effective for the fourth fiscal quarter of fiscal years beginning after December 15, 1999. We believe our current revenue recognition policies comply with the provisions of Staff Accounting Bulletin No. 101. In March 2000, the Financial Accounting Standards Board issued Interpretation (Interpretation) No. 44, "Accounting for Certain Transactions involving Stock Compensation, an Interpretation of ABP Opinion No. 25", which became effective July 1, 2000. Interpretation No. 44 clarifies (a) the definition of employee for purposes of applying Opinion 25, (b) the criteria for determining whether a stock compensation plan qualifies as a noncompensatory plan, (c) the accounting consequences of various modifications to the terms of a previously fixed stock option or award, and (d) the accounting for an exchange of stock compensation awards in a business combination. Adoption of the provisions of the Interpretation had no significant impact on our financial statements. 51 In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities." Statement of Financial Accounting Standards No.133, as amended by Statement of Financial Accounting Standards No. 138, establishes accounting and reporting standards requiring that every derivative instrument be recorded in the balance sheet as either an asset or liability measured at its fair value. Statement of Financial Accounting Standards No. 133 requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. 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 or all fiscal years beginning after June 15, 2000. Historically, we have not entered into derivatives contracts either to hedge existing risks or for speculative purposes. Accordingly, we do not expect adoption of the new standard to have a material impact on our results from operations, financial position or cash flows. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK MARKET RISK As of December 31, 2000, we did not have any long term debt obligations. Therefore, an immediate 10% increase in market interest rates would not have a material adverse effect on our financial position. We currently do not have any material market rate risks. We could be exposed to market risk related to any debt obligations for financing working capital and capital equipment requirements in the future. Historically, we have financed such requirements from the issuance of both preferred and common stock. We continue to consider financing alternatives, which may include the incurrence of long term indebtedness. Actual capital requirements may vary based upon the timing and success of the expansion of our operations. We believe that based on the terms and maturities of any future debt obligations that the market risk would be minimal. EFFECTS OF INFLATION Due to relatively low levels of inflation in 1997, 1998, 1999 and 2000, inflation has not had a significant effect on our results of operations. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Our financial statements, schedules and supplementary data, as listed under Item 14, appear in a separate section of this report beginning on page F-1. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE NONE. 52 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES Our directors, executive officers and other key employees, and their ages, as of March 31, 2001 are as follows:
NAME AGE POSITION -------------------------- --- ------------------------------------------------- Robert A. Rositano, Jr.(1) 32 Chief Executive Officer, Secretary and Director -------------------------- --- ------------------------------------------------- Dean Rositano (1) 29 President, Chief Operating Officer, Interim Chief Financial Officer and Director ------------------------------------------------- Robert Speicher 48 Vice President of Sales and Marketing -------------------------- --- ------------------------------------------------- Andrew Garroni (2) 45 Director -------------------------- --- ------------------------------------------------- (1) Messrs. Robert A. Rositano, Jr. and Dean Rositano are brothers. (2) Mr. Andrew Garroni is currently the sole member of our Compensation Committee and our Audit Committee and is not an employee of Nettaxi.com.
Each director holds office until the next annual meeting on the stockholders and until his successor is elected and qualified. Executive officers are appointed by and serve at the pleasure of our board of directors. Set forth below is certain information regarding the business experience during the last five years of each of the above named persons. ROBERT A. ROSITANO, JR. Mr. Rositano Jr. co-founded Nettaxi Online Communities, Inc., a Delaware corporation , in October, 1997. He has served as Chief Executive Officer and Secretary of Nettaxi since the reorganization with Swan Valley and prior to that served in the same capacities with Nettaxi Online Communities from its inception. He has over seven years of experience in the Internet service provider and Internet industry. In February 1995, he co-founded Simply Interactive, Inc. , an Internet/intranet software company, and served as Executive Vice President in the areas of Inside Sales, Customer Service and Product Development until he co-founded Nettaxi Online Communities. In January 1994, he co-founded Digital Data Express, a company focused on beginner level Internet users, and served as Chief Executive Officer until February 1995 when Digital Data Express was acquired by Simply Interactive. From 1992 to 1994, Mr. Rositano was hired on as the third employee at Netcom On-line Communications in 1992 and served as a senior sales and account manager until 1993. DEAN ROSITANO. Mr. Rositano co-founded Nettaxi Online Communities in October, 1997. He has served as President of Nettaxi since the reorganization with Swan Valley and prior to that served in the same capacities with Nettaxi Online Communities. He has over seven years of experience in the ISP and Internet industry. In February 1995, he co-founded Simply Interactive, Inc., an Internet/intranet software company, and served as Vice President of Technology until he co-founded Nettaxi Online Communities. While at Simply Interactive, he assembled a digital production studio and produced the Internet the City CD-ROM in a three month time frame on three platforms, Windows 3.1, Windows 95, and Macintosh. In January 1994, he co-founded Digital Data Express and served as President and Chief Executive Officer until February 1995 when Digital Data Express was acquired by Simply Interactive. At Digital Data Express, Mr. Rositano co-produced and directed the world's first Internet training video "Introduction to the Internet." 53 ROBERT SPEICHER. Robert Speicher joined Nettaxi in October, 1999 to serve as our Vice President of Sales and Marketing. From November, 1994 through October, 1999; Speicher was Executive Vice President and General Manager at Wood Associates, a marketing and promotions company. Prior to that, he served as President of Plastech Marketing, Inc., a company that introduced biodegradable polymer technologies to the promotional merchandise industry. He has also served as Vice President of Sales at Multidate Corporation, a company dedicated to providing automation solutions for the financial services industry. He earned his Bachelor's degree from San Diego State University and his MBA from Pepperdine University. ANDREW GARRONI. Mr. Garroni has served as a director since completion of our merger with Plus Net in May 1999. Under the terms of our merger agreement with Plus Net, Mr. Garroni was appointed as a member of the board of directors. Mr. Garroni has over 20 years experience in the development and management of start-up entertainment companies. He currently serves as Executive Producer of Showtime's movie series "Naked City," a position he has held since January, 1998. From 1990 to September, 1998 he served as President of Axis Films International, Inc. supplying films to cable television networks such as Home Box Office, Showtime Networks and DBS providers like Direct TV. He began his career in New York as a principal partner in the motion picture Production Company Cinerex Associates, Inc. whose clients included Twentieth Century Fox and Orion Pictures. While in New York, he helped create Magnum Motion Pictures and Magnum Entertainment. Mr. Garroni has a Bachelor's degree in Marketing from Fairleigh Dickinson University. EMPLOYMENT AGREEMENTS AND TERMINATION OF EMPLOYMENT AND CHANGE OF CONTROL ARRANGEMENTS EXECUTIVE EMPLOYMENT AGREEMENTS. On August 1, 1998 Nettaxi Online Communities, Inc. entered into executive employment agreements with Robert A. Rositano, Jr. and Dean Rositano, and these agreements continued in effect after the reorganization with Swan Valley Snowmobiles, Inc. Pursuant to the terms of their individual executive employment agreements, Robert A. Rositano, Jr. is to perform the duties Chief Executive Officer and serve as a member of the board of directors, and Dean Rositano is to perform the duties of President and serve as a member of the board of directors. Each executive employment agreement provides for an annual base salary which may be increased by the board of directors, in its discretion. The base salary also is to increase by ten percent per annum, which increase shall be cumulative for each year. In August 2000, the base salaries for each executive were increased to $220,000. Under the executive employment agreements, each executive is also eligible for annual bonus compensation in the minimum amount of $50,000 up to a maximum amount equal to the base salary then payable. The board of directors is to determine the amount of the annual bonus based upon performance targets established by the board of directors. In August 2000, each executive received bonus compensation of $50,000. 54 Under the executive employment agreements, Robert A. Rositano, Jr. and Dean Rositano each received warrants to purchase up to 883,952 shares of the common stock of Nettaxi Online Communities. The warrants were to vest over three years and vesting was accelerated upon the reorganization with Swan Valley. Robert A. Rositano, Jr. and Dean Rositano each exercised their warrants in September, 1998. They have each been granted registration rights with respect to shares of common stock issued upon exercise of the warrants and they have each waived any such rights with respect to this registration statement. Each executive is eligible to receive three weeks paid vacation for the first year of employment and four weeks per year thereafter. They are also eligible to participate in the health, life insurance, medical, retirement and other benefit programs which we may offer from time to time. Each executive receives a car allowance in an amount not to exceed $600 per month plus insurance and costs of repair and may be reimbursed for other reasonable expenses incurred during the course of performing their duties. The term of the executive employment agreements is four years and they are automatically renewed for successive periods of one year unless terminated prior to such renewal. We may terminate either executive at any time with or without cause. The term "cause" is defined in the executive employment agreements. If any executive is terminated without cause, he is to receive severance pay equal to the base salary for the remainder of the term, minimum bonus plus any pro rata bonus in excess of the minimum bonus, pre payment of all automobile allowance for the remaining period of the term and continued coverage for life, health and disability insurance for the remainder of the term. These amounts shall be due in one lump sum payment three days following the termination of his employment without cause. If there is a "change in control" with respect to Nettaxi, the executives may terminate their executive employment agreements and be entitled to severance in the amount of three years of annual benefits to be realized in accordance with the terms of the executive employment agreements, payable in one lump sum. "Change in control" is defined in the executive employment agreements as any change of equity such that more than 50% of the outstanding shares of our outstanding shares are transferred to a third party, debt ownership such that more than 50% of our outstanding shares are transferred to a third party, or a sale of 70% or more of our assets. The executive employment agreements also contain covenants restricting the disclosure of our confidential information, the solicitation of our employees or agents and the ability of the executives to engage in competing activities with us. In the course of the previous year, as a result of our limited human resources, both executives have performed other responsibilities not necessarily within the scope of the definition of their positions under the executive employment agreements. 55 OTHER EXECUTIVE EMPLOYMENT AGREEMENTS. We have also entered into an employment agreement with Robert Speicher. The agreement has a term of three years and automatically renews for successive periods of one year unless terminated prior to such renewal. We may terminate the executive at any time with or without cause. The term "cause" is defined in the executive employment agreement. Mr. Speicher is eligible to receive severance pay if terminated without cause or if Nettaxi experiences a change in control and the executive elects to terminate the agreement or is terminated. The severance payment would be equal to the base salary for the remainder of the term, minimum bonus plus any pro rata bonus in excess of the minimum bonus and continued coverage for health and other benefits for the remainder of the term. Additionally, the vesting of all options to purchase our common stock would be accelerated immediately. The severance payment would be due in one lump sum three days following the termination of employment. "Change in control" is defined in the employment agreements as any change of equity such that more than 50% of our outstanding shares are transferred to a third party, debt ownership such that more than 50% of our outstanding shares are transferred to a third party, or a sale of substantially all of our assets. The employment agreements also contain covenants regarding the assignment of inventions, restricting the disclosure of our confidential information, the solicitation of our employees or agents and the ability of the executive to engage in competing activities. Our agreement with Mr. Speicher was entered into as of September 1999. Under the agreement, he is employed as Vice President of Sales and Marketing and is expected to perform the duties consistent with the position including the management and supervision of our sales and marketing operations and duties and the hiring of personnel. Mr. Speicher receives an annual base salary of $175,000. He is also eligible for annual bonus compensation in the minimum amount of $50,000 up to a maximum amount equal to the base salary then payable. The board of directors is to determine the amount of the annual bonus based upon performance targets established by the board of directors. He also is to receive options to purchase up to 250,000 shares of our common stock, which vest over three years, under our 1998 Stock Option Plan. He receives three weeks paid vacation for the first year of employment and four weeks per year thereafter. He is also eligible to participate in the health and other benefit program which we may offer from time to time. BOARD COMMITTEES The Compensation Committee of the board of directors determines the salaries and incentive compensation of our officers and provides recommendations for the salaries and incentive compensation of our other employees. The compensation committee also administers our 1998 Stock Option Plan. There is currently one member of the Compensation Committee, Mr. Garroni. We are currently seeking qualified individuals to join our board of directors and serve on our audit committee. The Audit Committee of the board of directors reviews, acts on and reports to the board of directors with respect to various auditing and accounting matters, including the selection of our independent auditors, the scope of the annual audits, fees to be paid to the auditors, the performance of our independent auditors and our accounting practices. Mr. Garroni is currently the only member of the audit committee. We are currently seeking qualified individuals to join our board of directors and serve on our audit committee. 56 The board of directors does not have a nominating committee. DIRECTORS' COMPENSATION Directors who are also our employees receive no compensation for serving on the board of directors. With respect to directors who are not employees, we intend to reimburse such directors for all travel and other expenses incurred in connection with attending meetings of the board of directors and any committees of the board of directors. Non-employee directors are also eligible to receive grants of non-qualified stock options under our 1998 Stock Option Plan and 1999 Stock Option Plan. We intend to grant our non-employee directors, subject to shareholder ratification, options to purchase common stock under our stock option plans to provide us with an effective way to recruit and retain qualified individuals to serve as members of the board of directors. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION We did not have a Compensation Committee or other committee of the board of directors performing similar functions during the fiscal years ending December 31, 1997 and 1998. Messrs. Robert A. and Dean Rositano are each officers of Nettaxi and, as members of the board of directors, participated in deliberations of the board of directors relating to the compensation of our executive officers. As indicated above, the board of directors established a Compensation Committee as of May 3, 1999. COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934 Section 16(a) of the Securities Exchange Act of 1934, as amended, requires our officers and directors, and persons who own more than ten percent of a class of our capital stock, to file reports of ownership and changes in their ownership with the Securities and Exchange Commission. Officers, directors and greater than ten-percent shareholders are required to furnish us with copies of all Section 16(a) forms they file. Based solely on a review of the copies of such forms received by us, or written representations from certain reporting persons that no Forms 5 were required for such persons, we believe that, during the last fiscal year, all filing requirements applicable to our officers, directors and greater than ten percent beneficial owners were complied with except that reports on Form 4 were filed late by Messrs. Robert A. Rositano, Jr. and Dean Rositano. ITEM 11. EXECUTIVE COMPENSATION The following table sets forth information concerning compensation for services in all capacities awarded to, earned by or paid to our Chief Executive Officer and President, collectively, the "named executives" during the years ended December 31, 1998, 1999 and 2000: 57
SUMMARY COMPENSATION TABLE (1) ------------------------------- ------------------------------ --------------------- LONG-TERM ANNUAL COMPENSATION COMPENSATION ------------------------------- ------------------------------ --------------------- NAME AND PRINCIPAL YEAR SALARY ($) BONUS ($) NUMBER OF SECURITIES POSITION UNDERLYING WARRANTS/ OPTIONS (#) ------------------------------- ------- ---------- --------- --------------------- ------------------------------- ------- ---------- --------- --------------------- Robert A. Rositano, Jr. 1998(2) 95,917 - 1,012,347 Chief Executive Officer ------- ---------- --------- --------------------- 1999 156,550 132,500 600,000 ------- ---------- --------- --------------------- 2000 214,933 150,000 640,000 ------------------------------- ------- ---------- --------- --------------------- Dean Rositano, 1998(2) 95,917 - 1,012,347 President ------- ---------- --------- --------------------- 1999 156,550 132,500 600,000 ------- ---------- --------- --------------------- 2000 214,933 150,000 640,000 ------------------------------- ------- ---------- --------- --------------------- Glenn Goelz, Chief Financial 2000 60,230 150,000 280,000 Officer (3) ------------------------------- ------- ---------- --------- --------------------- Robert Speicher, Vice 2000 179,229 50,000 250,000 President of Sales and Marketing (4) ------------------------------- ------- ---------- --------- --------------------- Brian Stroh, Vice President of 2000 106,746 75,000 136,000 Information Services (5) ------------------------------- ------- ---------- --------- --------------------- (1) The columns for "Other Annual Compensation" "Restricted Stock Awards" "LTP Payouts" and "All Other Compensation" have been omitted because there is no compensation required to be reported. No other executive officer received compensation in excess of $100,000 during this period. (2) Information regarding the compensation of Messrs. Robert A. and Dean Rositano earned during 1998 includes services rendered by them while employed by Nettaxi Online Communities, Inc. prior to the reorganization with Swan Valley Snowmobiles, Inc. and by Nettaxi following the reorganization with Swan Valley. The salary earned by each of Messrs. Robert A. and Dean Rositano during 1998 includes $93,000 in cash compensation and 16,574 shares of common stock issued to each of them in February, 1998 in lieu of salary earned in 1998 having an ascribed value of $2,198 as determined by the board of directors. (3) Mr. Glenn Goelz was hired in 1999, but did not earn in excess of $100,000 in 1999. Mr. Goelz resigned as the Chief Financial Officer and as an employee of Nettaxi.com on April 28, 2000. The options to purchase our common stock held by Mr. Goelz expired on July 28, 2000. (4) Mr. Robert Speicher was hired in 1999, but did not earn in excess of $100,000 in 1999. (5) Mr. Brian Stroh was hired in 1999, but did not earn in excess of $100,000 in 1999. Mr. Stroh resigned as the Vice President of Information Services and as an employee of Nettaxi.com on November 9, 2000. Mr. Stroh's options to purchase our common stock expired on February 9, 2001.
58 WARRANT AND OPTION GRANTS IN LAST YEAR The following table sets forth information concerning warrants and options granted to the named executives during 2000.
WARRANT AND OPTION GRANTS DURING YEAR ENDED DECEMBER 31, 2000(1) ------------------------------------------------------------------------------------------------ Name NUMBER OF % OF TOTAL Exercise EXPIRATION Potential Realizable Value at SECURITIES WARRANTS/ Price Per DATE Assumed Annual Rates of Stock UNDERLYING OPTIONS GRANTED Share Price Appreciation for Option WARRANTS/ TO EMPLOYEES IN ($/Sh) Term (7) OPTIONS 2000 ------------------------- GRANTED (#) 5% 10% -------------- ----------- ---------------- ---------- ---------- ----------- ------------ Robert A. 64,000 1.4% 2.44 1/2006 $53,109.34 $120,486.97 Rositano, Jr. (2) ----------- ---------------- ---------- ---------- ----------- ------------ 64,000 1.4% 2.44 1/2007 $63,572.80 $148,151.66 ----------- ---------------- ---------- ---------- ----------- ------------ 64,000 1.4% 2.44 1/2008 $74,559.44 $178,582.83 ----------- ---------------- ---------- ---------- ----------- ------------ 64,000 1.4% 2.44 1/2009 $86,095.41 $212,057.11 ----------- ---------------- ---------- ---------- ----------- ------------ 96,000 2.1% 1.44 1/2006 $47,014.82 $106,660.59 ----------- ---------------- ---------- ---------- ----------- ------------ 96,000 2.1% 1.44 1/2007 $56,277.56 $131,150.65 ----------- ---------------- ---------- ---------- ----------- ------------ 96,000 2.1% 1.44 1/2008 $66,003.44 $158,089.72 ----------- ---------------- ---------- ---------- ----------- ------------ 96,000 2.1% 1.44 1/2009 $76,215.61 $187,722.69 -------------- ----------- ---------------- ---------- ---------- ----------- ------------ Dean 64,000 1.4% 2.44 1/2006 $53,109.34 $120,486.97 Rositano (3) ----------- ---------------- ---------- ---------- ----------- ------------ 64,000 1.4% 2.44 1/2007 $63,572.80 $148,151.66 ----------- ---------------- ---------- ---------- ----------- ------------ 64,000 1.4% 2.44 1/2008 $74,559.44 $178,582.83 ----------- ---------------- ---------- ---------- ----------- ------------ 64,000 1.4% 2.44 1/2009 $86,095.41 $212,057.11 ----------- ---------------- ---------- ---------- ----------- ------------ 96,000 2.1% 1.44 1/2006 $47,014.82 $106,660.59 ----------- ---------------- ---------- ---------- ----------- ------------ 96,000 2.1% 1.44 1/2007 $56,277.56 $131,150.65 ----------- ---------------- ---------- ---------- ----------- ------------ 96,000 2.1% 1.44 1/2008 $66,003.44 $158,089.72 ----------- ---------------- ---------- ---------- ----------- ------------ 96,000 2.1% 1.44 1/2009 $76,215.61 $187,722.69 -------------- ----------- ---------------- ---------- ---------- ----------- ------------ Glenn Goelz 112,000 2.4% 2.44 7/2000 $ 0.00 $ 0.00 (4) -------------- ----------- ---------------- ---------- ---------- ----------- ------------ 168,000 3.6% 1.44 7/2000 $ 0.00 $ 0.00 -------------- ----------- ---------------- ---------- ---------- ----------- ------------ Robert 25,000 0.5% 2.44 1/2006 $20,745.83 $ 47,065.22 Speicher (5) 25,000 0.5% 2.44 1/2007 $24,833.13 $ 57,871.74 ----------- ---------------- ---------- ---------- ----------- ------------ 25,000 0.5% 2.44 1/2008 $29,124.78 $ 69,758.92 ----------- ---------------- ---------- ---------- ----------- ------------ 25,000 0.5% 2.44 1/2009 $33,631.02 $ 82,834.81 ----------- ---------------- ---------- ---------- ----------- ------------ 37,500 0.8% 1.44 1/2006 $18,365.16 $ 41,664.29 ----------- ---------------- ---------- ---------- ----------- ------------ 37,500 0.8% 1.44 1/2007 $21,983.42 $ 51,230.72 ----------- ---------------- ---------- ---------- ----------- ------------ 37,500 0.8% 1.44 1/2008 $25,782.59 $ 61,753.80 ----------- ---------------- ---------- ---------- ----------- ------------ 37,500 0.8% 1.44 1/2009 $29,771.72 $ 73,329.18 -------------- ----------- ---------------- ---------- ---------- ----------- ------------ Brian Stroh 3,000 0.1% 2.44 1/2006 $ 2,489.50 $ 5,647.83 (6) 3,000 0.1% 2.44 1/2007 $ 2,979.98 $ 6,944.61 ----------- ---------------- ---------- ---------- ----------- ------------ 3,000 0.1% 2.44 1/2008 $ 3,494.97 $ 8,371.07 ----------- ---------------- ---------- ---------- ----------- ------------ 3,000 0.1% 2.44 1/2009 $ 4,035.72 $ 9,940.18 ----------- ---------------- ---------- ---------- ----------- ------------ 31,000 0.7% 1.44 1/2006 $15,181.87 $ 34,442.48 ----------- ---------------- ---------- ---------- ----------- ------------ 31,000 0.7% 1.44 1/2007 $18,172.96 $ 42,350.73 ----------- ---------------- ---------- ---------- ----------- ------------ 31,000 0.7% 1.44 1/2008 $21,313.61 $ 51,049.80 ----------- ---------------- ---------- ---------- ----------- ------------ 31,000 0.7% 1.44 1/2009 $24,611.29 $ 60,618.78 -------------- ----------- ---------------- ---------- ---------- ----------- ------------ 59 (1) No SARs were granted to either of the named executives during 2000. Each warrant and option represents the right to purchase one share of our common stock. In 2000, we granted employees options to purchase an aggregate of 4,551,200 shares of our common stock. The options shown may terminate before their expiration dates if the optionee's status as an employee is terminated or upon the optionee's death or disability. (2) Robert A. Rositano, Jr. was granted options to purchase 256,000 and 384,000 shares of our common stock, respectively, under two option agreements. Under each agreement, the options expire in four equal installments on the sixth, seventh, eighth and ninth anniversary's of the grant date of the option. Under the agreements, options to purchase 40,000 shares vest in 12 equal quarterly installments, options to purchase 100,000 shares vest in 12 equal monthly installments and the remaining shares vest upon our achievement of specific business objectives which have been established by the board of directors. (3) Dean Rositano was granted options to purchase 256,000 and 384,000 shares of our common stock, respectively, under two option agreements. Under each agreement, the options expire in four equal installments on the sixth, seventh, eighth and ninth anniversary's of the grant date of the option. Under the agreements, options to purchase 40,000 shares vest in 12 equal quarterly installments, options to purchase 100,000 shares vest in 12 equal monthly installments and the remaining shares vest upon our achievement of specific business objectives which have been established by the board of directors. (4) Mr. Glenn Goelz was granted options to purchase 112,000 and 168,000 shares of our common stock, respectively, under two option agreements during 2000. Mr. Goelz resigned as the Chief Financial Officer and as an employee of Nettaxi.com on April 28, 2000. Therefore, the options to purchase our common stock held by Mr. Goelz expired on July 28, 2000. (5) Mr. Robert Speicher was granted options to purchase 100,000 and 150,000 shares of common stock, respectively, under two option agreements. Under each agreement, the options expire in four equal installments on the sixth, seventh, eighth and ninth anniversary's of the grant date of the option. Under the agreements, the options vest in 12 equal quarterly installments following the date of grant. (6) Mr. Brian Stroh was granted options to purchase 12,000 and 124,000 shares of common stock, respectively, under two option agreements. Under each agreement, the options were to expire in four equal installments on the sixth, seventh, eighth and ninth anniversary's of the grant date of the option. Mr. Stroh resigned as the Vice President of Information Services and as an employee of Nettaxi.com on November 9, 2000. Therefore, Mr. Stroh's options to purchase our common stock expired on February 9, 2001. (7) The amounts indicated in the columns under the heading "Potential Realizable Value at Assumed Annual Rates of Stock Price Appreciation for Option Term" Amounts represent hypothetical gains that could be achieved for the respective warrants and options if exercised at their end of their respective terms. The 5% and 10% assumed annual rates of compounded stock price appreciation are mandated by rules of the Securities and Exchange Commission and do not represent our estimate or projection of the future prices of the common stock. Actual gains, if any, on any exercises of warrants and options are dependent upon the future performance of our common stock and overall stock market conditions. The amounts reflected in the table may not necessarily be achieved.
60 WARRANT AND OPTION EXERCISES AND YEAR-END OPTION VALUES The following table sets forth information with respect to the Named Executives concerning their exercise of warrants during 2000 and exercisable and unexercisable stock options held by them as of December 31, 2000.
AGGREGATE WARRANT AND OPTION EXERCISES IN 2000 AND YEAR END OPTION VALUES ----------------------- ------------ --------- ----------- ------------- ------------ -------------- Shares Value Number of Unexercised Value of Unexercised In-the-Money NAME Acquired On Realized Options at Year End(#) Options at Year End($) (1) Exercise (#) ($) Exercisable Unexercisable Exercisable Unexercisable ----------------------- ------------ --------- ----------- ------------- ------------ -------------- Robert A. Rositano, Jr. 0 0.00 231,000 1,049,000 $ 0.00 $ 0.00 ----------------------- ------------ --------- ----------- ------------- ------------ -------------- Dean Rositano 0 0.00 231,000 1,049,000 $ 0.00 $ 0.00 ----------------------- ------------ --------- ----------- ------------- ------------ -------------- Glenn Goelz 0 0.00 0 0 $ 0.00 $ 0.00 ----------------------- ------------ --------- ----------- ------------- ------------ -------------- Robert Speicher 0 0.00 150,462 517,537 $ 0.00 $ 0.00 ----------------------- ------------ --------- ----------- ------------- ------------ -------------- Brian Stroh 0 0.00 0 0 $ 0.00 $ 0.00 ----------------------- ------------ --------- ----------- ------------- ------------ -------------- (1) The amounts shown in the columns under the heading "Value of Unexercised In-the-Money Options at Year End" are based on a per share fair market value of our common stock equal to $0.140 at December 29, 1999, the closing price for our common stock on that date as reported by various market makers for our common stock on the NASD O-T-C Market Bulletin Board. Neither of the Named Executives have options to purchase shares of common stock which were in the money at year end.
EMPLOYEE BENEFIT PLANS 1999 STOCK OPTION PLAN. Our 1999 Stock Option Plan was adopted by the board of directors in January 2000, and amended the plan to increase the number of shares reserved for issuance under the plan in April, 2000. It will be presented to our stockholders for ratification at our annual meeting of stockholders to be held in the summer of 2001. The following description of our 1999 Stock Option Plan is a summary and qualified in its entirety by the text of the plan, which is filed as an exhibit to the registration statement of which this prospectus is a part. The purpose of the 1999 Stock Option Plan is to enhance our profitability and stockholder value by enabling us to offer stock based incentives to employees, directors and consultants. The 1999 Stock Option Plan authorizes the grant of options to purchase shares of common stock to employees, directors and consultants of Nettaxi and its affiliates. Under the 1999 Stock Option Plan, we may grant incentive stock options within the meaning of Section 422 of the Internal Revenue Code of 1986 and non-qualified stock options. Incentive stock options may only be granted our employees. 61 The number of shares available for options under the 1999 Stock Option Plan was initially 3,300,000. The board of directors recently amended the plan to increase the number of shares available for options to 8,900,000. As of December 31, 2000, 8,333 shares had been issued as a result of the exercise of options previously granted under the 1999 Stock Option Plan, options to purchase up to 3,931,600 shares of common stock had been granted, and options to purchase 4,968,400 shares were available for future grants. The exercise prices of the outstanding options ranged from $0.37 to $6.812. We have registered the shares subject to issuance under our 1999 Stock Option Plan, pursuant to our registration statement filed on Form S-8 (File No. 333-32678). The 1999 Stock Option Plan is administered by the Compensation Committee of the board. Subject to the provisions of the 1999 Stock Option Plan, the Compensation Committee has authority to determine the employees, directors and consultants of Nettaxi who are to be awarded options and the terms of such awards, including the number of shares subject to such option, the fair market value of the common stock subject to options, the exercise price per share and other terms. Incentive stock options must have an exercise price equal to at least 100% of the fair market value of a share on the date of the award and generally cannot have a duration of more than 10 years. If the grant is to a stockholder holding more than 10% of our voting stock, the exercise price must be at least 110% of the fair market value on the date of grant. Terms and conditions of awards are set forth in written agreements between Nettaxi and the respective option holders. Awards under the 1999 Stock Option Plan may not be made after the tenth anniversary of the date of its adoption but awards granted before that date may extend beyond that date. If the employment with Nettaxi of the holder of an incentive stock option is terminated for any reason other than as a result of the holder's death or disability or for "cause" as defined in the 1999 Stock Option Plan, the holder may exercise the option, to the extent exercisable on the date of termination of employment, until the earlier of the option's specified expiration date and 90 days after the date of termination. If an option holder dies or becomes disabled, both incentive and non-qualified stock options may generally be exercised, to the extent exercisable on the date of death or disability, by the option holder or the option holder's survivors until the earlier of the option's specified termination date and one year after the date of death or disability. Optionees have no rights as stockholders with respect to shares subject to option prior to the issuance of shares pursuant to the exercise thereof. Options issued to employees under the 1999 Stock Option Plan shall expire no later than ten years after the date of grant. An option becomes exercisable at such time and for such amounts as determined at the discretion of the board of directors or the Compensation Committee at the time of the grant of the option. An optionee may exercise a part of the option from the date that part first becomes exercisable until the option expires. The purchase price for shares to be issued to an employee upon his exercise of an option is determined by the board of directors or the Compensation Committee on the date the option is granted. The purchase price is payable in full in cash, by promissory note, by net exercise or by delivery of shares of our common stock when the option is exercised. The 1999 Stock Option Plan provides for adjustment as to the number and kinds of shares covered by the outstanding options and the option price therefor to give effect to any stock dividend, stock split, stock combination or other reorganization of or by Nettaxi. 62 1998 STOCK OPTION PLAN. Our 1998 Stock Option Plan was adopted by the board of directors, and ratified and approved by our stockholders, as of September 29, 1998. The following description of our 1998 Stock Option Plan is a summary and qualified in its entirety by the text of the plan, which is filed as an exhibit to the registration statement of which this prospectus is a part. The purpose of the 1998 Stock Option Plan is to enhance our profitability and stockholder value by enabling us to offer stock based incentives to employees, directors and consultants. The 1998 Stock Option Plan authorizes the grant of options to purchase shares of common stock to employees, directors and consultants of Nettaxi and its affiliates. Under the 1998 Stock Option Plan, we may grant incentive stock options within the meaning of Section 422 of the Internal Revenue Code of 1986 and non-qualified stock options. Incentive stock options may only be granted our employees. The number of shares available for options under the 1998 Stock Option Plan is 3,000,000. As of December 31, 2000, 4,998 shares had been issued as the result of the exercise of options previously granted under the 1998 Stock Option Plan, 2,055,000 shares were subject to outstanding options and 940,002 shares were available for future grants. The exercise prices of the outstanding options ranged from $0.80 to approximately $44.00. The options under the 1998 Stock Option Plan vest over varying lengths of time pursuant to various option agreements that we have entered into with the grantees of such options. We have registered the shares subject to issuance under our 1998 Stock Option Plan, pursuant to the Securities Act of 1933, pursuant to our registration statement on Form S-8 (File No. 333-32678). The 1998 Stock Option Plan is administered by the Compensation Committee of the board. Subject to the provisions of the 1998 Stock Option Plan, the Compensation Committee has authority to determine the employees, directors and consultants of Nettaxi who are to be awarded options and the terms of such awards, including the number of shares subject to such option, the fair market value of the common stock subject to options, the exercise price per share and other terms. Incentive stock options must have an exercise price equal to at least 100% of the fair market value of a share on the date of the award and generally cannot have a duration of more than 10 years. If the grant is to a stockholder holding more than 10% of our voting stock, the exercise price must be at least 110% of the fair market value on the date of grant. Terms and conditions of awards are set forth in written agreements between Nettaxi and the respective option holders. Awards under the 1998 Stock Option Plan may not be made after the tenth anniversary of the date of its adoption but awards granted before that date may extend beyond that date. If the employment with Nettaxi of the holder of an incentive stock option is terminated for any reason other than as a result of the holder's death or disability or for "cause" as defined in the 1998 Stock Option Plan, the holder may exercise the option, to the extent exercisable on the date of termination of employment, until the earlier of the option's specified expiration date and 90 days after the date of termination. If an option holder dies or becomes disabled, both incentive and non-qualified stock options may generally be exercised, to the extent exercisable on the date of death or disability, by the option holder or the option holder's survivors until the earlier of the option's specified termination date and one year after the date of death or disability. 63 Optionees have no rights as stockholders with respect to shares subject to option prior to the issuance of shares pursuant to the exercise thereof. Options issued to employees under the 1998 Stock Option Plan shall expire no later than ten years after the date of grant. An option becomes exercisable at such time and for such amounts as determined at the discretion of the board of directors or the Compensation Committee at the time of the grant of the option. An optionee may exercise a part of the option from the date that part first becomes exercisable until the option expires. The purchase price for shares to be issued to an employee upon his exercise of an option is determined by the board of directors or the Compensation Committee on the date the option is granted. The purchase price is payable in full in cash, by promissory note, by net exercise or by delivery of shares of our common stock when the option is exercised. The 1998 Stock Option Plan provides for adjustment as to the number and kinds of shares covered by the outstanding options and the option price therefor to give effect to any stock dividend, stock split, stock combination or other reorganization of or by Nettaxi. 401(K) SAVINGS PLAN. Effective June 1, 1999 we instituted the Nettaxi 401(k) Savings Plan. Eligible employees may begin making deferrals under the 401(k) Savings Plan. The 401(k) Savings Plan is intended to be a qualified plan under Internal Revenue Code Section 401(a), with a cash or deferred option governed by Section 401(k) Savings of the Internal Revenue Code. Employees may elect to defer their eligible current compensation up to the statutorily and 401(k) Savings Plan prescribed limits and have the amount of such deferral contributed to the 401(k) Savings Plan. Contributions to the 401(k) Savings Plan are invested in the investment funds described in the 401(k) Savings Plan. INDEMNIFICATION AGREEMENTS We have entered into indemnification agreements with our directors and officers. These agreements provide, in general, that we shall indemnify and hold harmless such directors and officers to the fullest extent permitted by law against any judgments, fines, amounts paid in settlement, and expenses incurred in connection with, or in any way arising out of, any claim, action or proceeding against, or affecting, such directors and officers resulting from, relating to or in any way arising out of, the service of such persons as our directors and officers. Our directors and officers are entitled to the benefits of the limitation of liability provided under our charter documents and the laws of the State of Nevada. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth information with respect to the beneficial ownership of our common stock as of February 28, 2001 and as adjusted to reflect the sale of the shares of common stock offered by this prospectus, by each person, or group of affiliated persons, who we know beneficially owns 5% or more of our common stock, each of our directors and executive officers, and all of our directors and executive officers as a group. 64 The percentages of total shares of common stock set forth below assume that only the indicated person or group has exercised options and warrants which are exercisable within 60 days of February 28, 2001 and do not reflect the percentage of common stock which would be calculated if all other holders of currently exercisable options or warrants had exercised their securities. Unless otherwise indicated in the paragraphs following the table, the following individuals have sole vesting and sole investment control with respect to the shares they beneficially own. Unless otherwise indicated, the address of each beneficial owner listed below is care of Nettaxi.com, 1696 Dell Avenue, Campbell, California.
---------------------------------------- ------------------- ----------------- NAME OF BENEFICIAL OWNER ---------------------------------------- ------------------- ----------------- EXECUTIVE OFFICERS AND DIRECTORS: NUMBER OF SHARES PERCENT OF CLASS BENEFICIALLY OWNED(1) ---------------------------------------- ------------------- ----------------- Robert A. Rositano, Jr. (2) 1,772,265 4.1% ---------------------------------------- ------------------- ----------------- Dean Rositano (3) 2,130,134 4.9% ---------------------------------------- ------------------- ----------------- Robert Speicher (4) 232,639 * ---------------------------------------- ------------------- ----------------- Andrew Garroni (5) 225,000 * ---------------------------------------- ------------------- ----------------- All directors and executive officers as 4,360,038 9.1% ------------------- ----------------- a group (4 Persons) ---------------------------------------- ------------------- ----------------- OTHER 5% STOCKHOLDERS: ---------------------------------------- ------------------- ----------------- Michael Gardner (6) 2,914,600 6.6% ---------------------------------------- ------------------- ----------------- HBK Investments L. P. (7) 3,000,000 6.6% ---------------------------------------- ------------------- ----------------- * Less than one percent. (1) Beneficial ownership is determined in accordance with rules of the Securities and Exchange Commission. In computing the number of shares beneficially owned by a person and the percentage ownership of that person, shares of common stock and options on exercisable within 60 days of February 28, 2001 are deemed outstanding. Such shares, however, are not deemed outstanding for the purposes of computing the percentage ownership of each other person. (2) The number of shares shown for Robert A. Rositano, Jr. includes 348,000 shares of common stock subject to options that are currently exercisable within 60 days of February 28, 2001. Excludes 932,000 shares of common stock subject to options that will not be exercisable within 60 days of February 28, 2001. Robert A. and Dean Rositano are brothers. (3) The number of shares shown for Dean Rositano includes 348,000 shares of common stock subject to options that are exercisable within 60 days of February 28, 2001. Excludes 932,000 shares of common stock subject to options that will not be exercisable within 60 days of February 28, 2001. Robert A. and Dean Rositano are brothers. 65 (4) The number of shares shown for Robert Speicher includes 232,639 shares of common stock subject to options that are exercisable within 60 days of February 28, 2001. Excludes 435,361 shares of common stock subject to options that will not be exercisable within 60 days of February 28, 2001. (5) The number of shares shown for Andrew Garroni includes 150,000 shares of common stock subject to options that are currently exercisable. (6) The shares shown for Mr. Michael Gardner include 1,429,800 shares of common stock subject to warrants that are currently exercisable. Mr. Gardner's address is care of Baytree Capital Associates, LLC, 40 Wall Street, 58th floor New York, NY 10005. We obtained this information from Mr. Gardner's public filings on Form 13D. (7) The number of shares shown for HBK Investments L.P. includes 3,000,000 shares of common stock subject to warrants that are exercisable. The shares shown for HBK Investments L.P. are held in the name of Montrose Investments, Ltd. HBK Investments L.P. has sole voting and dispositive power over these shares pursuant to an Investment Management Agreement with Montrose Investments, Ltd. Accordingly, Montrose has no beneficial ownership of such shares. The address for HBK Investments L.P. is 300 Crescent Ct. Ste 700, Dallas, Texas 75201. We obtained this information from HBK Investments L.P. public filings on Form 13G.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The following describes transactions to which we were or are a party and in which any of our directors, officers, or significant stockholders, or members of the immediate family of any of the foregoing persons, had or has a direct or indirect material interest. STOCK TRANSACTIONS BY NETTAXI ONLINE COMMUNITIES, INC. On February 12, 1998, Robert A. and Dean Rositano each were issued 66,297 shares of Nettaxi Online Communities common stock in lieu of salary compensation earned by them between October 1997 and January 1998 in the amount of $11,667. In March 1998, Robert A. and Dean Rositano each were issued warrants to purchase 88,395 shares of Nettaxi Online Communities common stock. On August 1, 1998, they were each issued warrants to purchase 883,952 shares of Nettaxi Online Communities common stock pursuant to the executive employment agreements. All the warrants issued to Robert A. and Dean Rositano each were exercised in September 1998. During 1998, Robert A. and Dean Rositano transferred 129,435 and 137,012 shares, respectively, of Nettaxi Online Communities common stock by gift to individuals. All the shares of Nettaxi Online Communities common stock held by Robert A. and Dean Rositano and their donees were converted into shares of our common stock in the reorganization with Swan Valley Snowmobiles, Inc. described below. 66 SSN PROPERTIES, LLC. In October 1997, Nettaxi Online Communities purchased the assets of Simply Interactive, Inc. from SSN Properties LLC pursuant to an asset purchase agreement. The purchase price for the assets was $2,000,000. $1,020,000 was paid pursuant to a convertible interest bearing promissory note and the remainder of the purchase price was paid by the issuance of 2,475,066 shares of Nettaxi Online Communities common stock. In September 1998, SSN Properties converted its promissory note with accrued interest in exchange for 2,792,763 shares of Nettaxi Online Communities common stock. In September, 1998 Nettaxi Online Communities also issued 176,790 shares of its Nettaxi Online Communities common stock to SSN Properties in exchange for the cancellation of a $70,000 accounts payable to SSN Properties. All the shares of Nettaxi Online Communities common stock held by SSN Properties were converted into shares of our common stock in the reorganization with Swan Valley Snowmobiles, Inc. described below. In April, 1999 a pro rata distribution of the shares of common stock held by SSN Properties was made to all of its members. Robert Rositano, Sr., father of Robert A, and Dean Rositano, is a managing member of SSN Properties. REORGANIZATION WITH SWAN VALLEY SNOWMOBILES, INC. In September 1998, Nettaxi Online Communities entered into the reorganization with Swan Valley with a non-operating public company, Swan Valley Snowmobiles, Inc., a Nevada corporation incorporated in October 1995. From its incorporation, Swan Valley engaged in the business of snowmobile repair. During the first half of 1997, Swan Valley determined that this line of business was no longer feasible and discontinued its operations. Under the terms of the reorganization, the Nettaxi Online Communities stockholders received approximately 2.53 shares of common stock of Swan Valley in exchange for each of their shares of Nettaxi Online Communities common stock, and Nettaxi Online Communities became a wholly-owned subsidiary of Swan Valley. An aggregate of 12,000,000 shares were issued to the former Nettaxi Online Communities stockholders in the reorganization with Swan Valley and the Nettaxi Online Communities stockholders owned approximately 85% of Swan Valley immediately after the reorganization. As part of the reorganization, all of the executive officers and directors of Swan Valley resigned and the executive officers and directors of Nettaxi Online Communities became the executive officers and directors of Swan Valley which changed its name to Nettaxi, Inc. (and later changed its name to Nettaxi.com) Immediately prior to the reorganization, Swan Valley completed a limited public offering of its common stock which yielded gross proceeds of $1,000,000 that was available to Nettaxi once the reorganization was completed. OTHER AGREEMENTS In October 1998, each of Robert A. Rositano and Dean Rositano were granted options to purchase up to 40,000 shares of our common stock under the 1998 Stock Option Plan. As described above, we have entered into employment agreements and other compensation arrangements with our officers. 67 As described above, in September 1999, we granted Mr. Robert Speicher, our Vice President of Sales and Marketing options to purchase up to 250,000 shares of common stock in accordance with our 1998 Stock Option Plan. The exercise price for the options is equal to their fair market value on the date of grant. Options to purchase up to 6,944 shares were immediately vested on the date of grant and the remaining options vest in 12 equal quarterly installments. As described above, in August 1999 each of Robert A. Rositano, Jr. and Dean Rositano were granted options to purchase up to 600,000 shares of our common stock under the 1998 Stock Option Plan. The exercise price for the options is equal to 110% of their fair market value on the date of grant. Options to purchase 100,000 shares vest in 12 monthly installments and options to purchase the remaining 500,000 shares vest upon our achievement of specific business objectives which have been established by the board of directors. In January 2000, each of Robert A. Rositano and Dean Rositano were granted options to purchase up to 256,000 shares of our common stock under our 1999 Stock Option Plan. The exercise price for these options was not less than 100% of the fair market value on the date of grant. The right to purchase 40,000 of these shares vests in 12 equal quarterly installments. The right to exercise 16,000 of the shares vests in 12 equal monthly installments. The right to purchase the remaining shares vests upon our achievement of certain business objectives. In January 2000, we granted Robert Speicher options to purchase up to 100,000 shares of common stock under our 1999 Stock Option Plan. The exercise price for these options was not less than the fair market value on the date of grant. The right to purchase the shares vests in 12 equal quarterly installments. In January 2000, we granted each of our non employee directors at that time, Andy Garonni, Ron R. Goldie and Steven Antebi, options to purchase up to 150,000 shares of common stock under our 1999 Stock Option Plan. The exercise price for these options was not less than the fair market value on the date of grant. The right to purchase these shares was immediately vested. In February 2000, each of Robert A. Rositano, Jr. and Dean Rositano were granted options to purchase up to 384,000 shares of our common stock under our 1999 stock option plan. The exercise price for these options was not less than 100% of the fair market value on the date of grant. The right to puchase 24,000 of these shares vests in 12 equal quarterly installments. The right to purchase 60,000 of these shares vests in 12 equal monthly installments. The right to purchase the remaining shares vests upon our achievement of certain business objectives. In February 2000, we granted Robert Speicher options to purchase up to 150,000 shares of common stock under our 1999 Stock Option Plan. The exercise price for these options was not less than the fair market value on the date of grant. The right to purchase the shares accrues in 12 equal quarterly installments. 68 In October 1999, we granted Glenn Goelz, our former chief financial officer, options to purchase up to 250,000 shares of common stock under the 1998 Stock Option Plan. In January 2000, we granted Mr. Goelz additional options to purchase up to 112,000 shares of common stock under our 1999 Stock Option Plan. The exercise price for these options was not less than the fair market value on the date of grant. The right to purchase 12,000 of the options issued were vested on the date of grant and the right to purchase the remaining shares vested in 12 equal quarterly installments. In February 2000, we granted Mr. Goelz, additional options to purchase up to 168,000 shares of common stock under our 1999 Stock Option Plan. The exercise price for these options was not less than the fair market value on the date of grant and the remainder accrued in 12 quarterly installments. As of April 30, 2000, Mr. Goelz resigned and any shares not vested on the date of his resignation terminated automatically. Mr. Brian Stroh, our former Vice President of Information Services, was granted options to purchase 12,000 and 124,000 shares of common stock, respectively, under two option agreements. Under each agreement, the options were to vest in 12 equal quarterly installments beginning on the date of grant. Mr. Stroh resigned as the Vice President of Information Services and as an employee of Nettaxi.com on November 9, 2000. Therefore, Mr. Stroh's options to purchase our common stock expired on February 9, 2001. As previously described, we have an agreement with Alchemy Communications, pursuant to which Alchemy Communications hosts the servers that support our web site. Mr. Andrew Garroni, a member of our board of directors, Mr. Garroni is a member of the board of directors of Alchemy Communications and is also the Secretary of Alchemy Communications. On October 30, 2000, we entered into a consulting agreement with Mr. Michael Gardner, the beneficial owner of 6.6% of our outstanding common stock. Under the agreement, Mr. Gardner was to perform certain consulting services specified in the agreement. As compensation for his services, Mr. Gardner received warrants to purchase 350,000 shares of our common stock, having an exercise price of $0.35 per share. We believe that all of the transactions set forth above were made on terms no less favorable to us than could have been obtained from unaffiliated third parties. We intend that all future transactions, including loans, between us and our officers, directors, principal stockholders and their affiliates will be approved by a majority of the board of directors, including a majority of the independent and disinterested outside directors on the board of directors, and be on terms no less favorable to us than could be obtained from unaffiliated third parties. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (A) DOCUMENTS FILED AS PART OF THIS REPORT: 1. Financial Statements. The following financial statements of Nettaxi.com are included in a separate section of this Annual Report on Form 10-K commencing on the pages referenced below: 69 2. Financial Statement Schedules. The financial statement schedules of Nettaxi.com have been omitted because they are not applicable, not required, or the information is included in the consolidated financial statements or notes thereto. 3. Exhibits. The following Exhibits are attached hereto and incorporated herein by reference: Exhibit Number Description of Exhibit --------------- ------------------------ 2.1 Agreement and Plan of Reorganization dated September 24, 1998 by and among Nettaxi Online Communities, Inc., the owners of all the outstanding shares of common stock of Nettaxi Online Communities, Inc. and the Company. (Incorporated by reference to exhibit 2.1 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129) which was declared effective on August 13, 1999) 2.2 Merger Agreement and Plan of Reorganization dated April 1, 1999 by and between Plus Net, Inc. and the Company. (Incorporated by reference to exhibit 2.2 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 3.1 Articles of Incorporation of the Company. (Incorporated by reference to exhibit 3.1 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 3.2 Certificate of Amendment to the Articles of Incorporation of the Company. (Incorporated by reference to exhibit 3.2 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 3.3 By-Laws of the Company (Incorporated by reference to exhibit 3.3 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 3.4 Certificate of Amendment to the Articles of Incorporation of the Company. (Incorporated by reference to Exhibit 3.4 filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1999) 3.5 Certificate of Amendment to the Articles of Incorporation of the Company. (Previously filed with this registration statement) 70 4.1 Specimen Common Stock Certificate of the Company. (Incorporated by reference to exhibit 4.1 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 4.2 See Exhibits 3.1, 3.2 and 3.3 for provisions of the Articles of Incorporation and By-Laws of the Company defining the rights of holders of Common Stock of the Company. 4.3 Convertible Debenture dated March 31, 1999 in favor of RGC International Investors, LDC. (Incorporated by reference to exhibit 4.3 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 4.4 1999 Stock Option Plan of the Company. (Incorporated by reference to exhibit 4.4 filed with the Registrant's Registration Statement on Form S-8 (File No. 333-32678) which was filed on March 17 2000) 4.5 Form of Stock Option Agreement for options issued pursuant to 199 Stock Option Plan of the Company. (Incorporated by reference to exhibit 4.5 filed with the Registrant's Registration Statement on Form S-8 (File No. 333-32678)) 10.1 Asset Purchase and Sale Agreement dated October 1, 1997 by and between SSN Properties, LLC and the Company. (Incorporated by reference to exhibit 10.1 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.2 Sub Lease dated September 3, 1997 by and between Execustaff and the Company. (Incorporated by reference to exhibit 10.2 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.3 Stock Option Agreement dated March 20, 1998 by and between Robert A. Rositano, Jr. and the Company. (Incorporated by reference to exhibit 10.5 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.4 Stock Option Agreement dated March 20, 1998 by and between Dean Rositano and the Company. (Incorporated by reference to exhibit 10.6 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.5 Employment Agreement dated August 1, 1998 between Dean Rositano and the Company. (Incorporated by reference to exhibit 10.9 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.6 Employment Agreement dated August 1, 1998 between Robert A. Rositano, Jr. and the Company. (Incorporated by reference to exhibit 10.10 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 71 10.7 Stock Option Agreement dated August 1, 1998 by and between Robert A. Rositano, Jr. and the Company. (Incorporated by reference to exhibit 10.11 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.8 Stock Option Agreement dated August 1, 1998 by and between Dean Rositano and the Company. (Incorporated by reference to exhibit 10.12 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.9 Letter Agreement dated September 3, 1998 between Bay Tree Capital Associates, LLC and the Company. (Incorporated by reference to exhibit 10.14 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.10 1998 Stock Option Plan of the Company. (Incorporated by reference to exhibit 10.17 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.11 Form of Stock Option Agreement for options issued pursuant to 1998 Stock Option Plan of the Company. (Incorporated by reference to exhibit 10.18 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.12 Stock Option Agreement under the 1998 Stock Option Plan by and between Dean Rositano and the Company. (Incorporated by reference to exhibit 10.19 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.13 Stock Option Agreement under the 1998 Stock Option Plan by and between Robert A. Rositano, Jr. and the Company. (Incorporated by reference to exhibit 10.20 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.14 Technology Licensing Agreement dated February 3, 1999 by and between Go Hip, Inc. and the Company. (Incorporated by reference to exhibit 10.22 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.15 First Amendment to Technology Licensing Agreement dated as of April 1, 1999 by and between Go Hip, Inc. and the Company. (Incorporated by reference to exhibit 10.23 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 72 10.16 Settlement Agreement dated March 2, 1999 by and among Michael Gardner, Bay Tree Capital Associates, LLP, Wall Street Trading Group, Bruce K. Dorfman, Robert A. Rositano, Jr., Dean Rositano and the Company. (Incorporated by reference to exhibit 10.28 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.17 Common Stock Purchase Option to Purchase Common Shares of Nettaxi, Inc. dated March 4, 1999 between Wall Street Trading Group and the Company. (Incorporated by reference to exhibit 10.29 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.18 Securities Purchase Agreement dated March 31, 1999 by and among RGC International Investors, LDC and the Company. (Incorporated by reference to exhibit 10.30 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.19 Stock Purchase Warrant dated March 31, 1999 by and among RGC International Investors, LDC and the Company. (Incorporated by reference to exhibit 10.31 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.20 Registration Rights Agreement dated March 31, 1999 by and among RGC International Investors, LDC and the Company. (Incorporated by reference to exhibit 10.32 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.21 Oppenheimer Funds 401K Plan. (Incorporated by reference to exhibit 10.33 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.22 Standard Office Lease- Gross dated March 1999 by and between South Bay Construction and Development Co. III & South Bay Construction and Development Co. VII and the Company. (Incorporated by reference to exhibit 10.34 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.23 Form of Indemnification Agreement between the Company and each of its Directors and Executive Officers. (Incorporated by reference to exhibit 10.35 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.24 Employment Agreement dated April 1, 1999 by and between Mr. Glenn Goelz and the Company. (Incorporated by reference to exhibit 10.37 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.25 Consulting Agreement dated May 10, 1999 by and between Fontenelle LLC and the Company. (Incorporated by reference to exhibit 10.38 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 73 10.26 Lease Agreement dated as of May 27, 1999 by and between H&L Realty and Management Company, Agent for owners Flamingo Fountains and the Registrant. (Incorporated by reference to exhibit 10.41 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.27 Master Software License Bundling and Distribution Agreement dated November 13, 1997 between Apple Computer, Inc. and the Company. (Incorporated by reference to exhibit 10.42 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.28 Master Software License, Bundling and Distribution Agreement dated March 14, 1997 between Fountain Technologies, Inc. and the Company. (Incorporated by reference to exhibit 10.43 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.29 Web Advertising Services Agreement dated June 3, 1998 between Fly Cast Communications Corporation and the Company. (Incorporated by reference to exhibit 10.44 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.30 Sales and Representation Contract dated July 7, 1998 between Michael Weiner dba Unique Media Services and the Company. (Incorporated by reference to exhibit 10.45 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.31 Merchant Services Agreement dated August 3, 1998 by and between eCharge Corporation and the Company. (Incorporated by reference to exhibit 40.46 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.32 Conversion Agreement dated September 4, 1998 by and between SSN Properties, LLC and the Company. (Incorporated by reference to exhibit 10.47 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.33 Internet Infospace Content (World Wide Web Site) Distribution Agreement dated October 8, 1998 by and between InfoSpace.com, Inc., a Delaware corporation and the Company. (Incorporated by reference to exhibit 10.48 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.34 Agreement for Terminal Facility Co-Location Space dated January 18, 1999 between Alchemy Communications, Inc. and the Company. (Incorporated by reference to exhibit 10.49 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 74 10.35 Letter Agreement dated January 15, 1999 between Babenet, Ltd. and the Company. (Incorporated by reference to exhibit 10.50 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.36 License and Distribution Agreement dated March 30, 1999 by and between Netopia, Inc. and the Company. (Incorporated by reference to exhibit 10.51 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.37 Website Linking and Promotion Agreement dated March 5, 1999 between PI Graphix, Inc. and the Company. (Incorporated by reference to exhibit 10.52 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.38 Development Agreement dated as of December 16, 1998 between the Big Network Inc. and the Company. (Incorporated by reference to exhibit 10.53 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.39 Development and License Agreement dated May, 1999 by and between eBay, Inc. and the Company. (Incorporated by reference to exhibit 10.54 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.40 Internet Services Suite Agreement dated May 5, 1999 by and between Wired Digital, Inc., Lycos, Inc. and the Company. (Incorporated by reference to exhibit 10.55 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.41 Financial Consulting Agreement dated June 29, 1999 by and between The Phoenix Group International, LLC and the Company. (Incorporated by reference to exhibit 10.56 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.42 Co-Branded Free ISP Agreement dated November 30, 1999 by and between Spin Media Network, Inc. and the Company. (Incorporated by reference to exhibit 10.57 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.43 Internet Content Distribution Agreement dated December 30, 1999 by and between InfoSpace.com and the Company. (Incorporated by reference to exhibit 10.58 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 75 10.44 Advertising Impression Network Contract dated July 1, 1999 by and between White Sand Communications, Inc. and the Company. (Incorporated by reference to exhibit 10.59 filed with the Registrant's Quarterly Report on Form 10-Q for the period ending September 30, 1999) 10.45 Advertising Impression Network Contract dated July 1, 1999 by and between Multinet Communications Worldwide Limited and the Company(Incorporated by reference to exhibit 10.60 filed with the Registrant's Quarterly Report on Form 10-Q for the period ending September 30, 1999) 10.46 Data Center Service Agreement dated July 15, 1999 by and between Babenet, LTD and the Company. (Incorporated by reference to exhibit 10.61 filed with the Registrant's Quarterly Report on Form 10-Q for the period ending September 30, 1999) 10.47 Data Center Service Agreement dated July 15, 1999 by and between Whitehorn Ventures Limited and the Company. (Incorporated by reference to exhibit 10.62 filed with the Registrant's Quarterly Report on Form 10-Q for the period ending September 30, 1999) 10.48 Data Center Service Agreement dated August 15, 1999 by and between White Sand Communications, Inc. and the Company. (Incorporated by reference to exhibit 10.63 filed with the Registrant's Quarterly Report on Form 10-Q for the period ending September 30, 1999) 10.49 Co-Branded Free ISP Agreement dated November 30, 1999 by and between Spin Media Network, Inc. and the Company (Incorporated by reference to exhibit 10.64 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.50 Internet Content Distribution Agreement dated December 30, 1999 by and between InfoSpace.com and the Company. (Incorporated by reference to exhibit 10.65 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 10.51 Sinclair Davis Trading Group Agreement dated as of December 8, 1999 by and between Sinclair Davis Trading Corp. and the Company. (Incorporated by reference to exhibit 10.66 filed with the Registrant's Annual Report on Form 10-K for the period ending December 31, 1999) 10.52 Form of Subscription Agreement of the Company. (Incorporated by reference to exhibit10.67 filed with the Registrant's Annual Report on Form 10-K for the period ending December 31, 1999) 76 10.53 Letter Of Intent Agreement dated as of February 29, 2000 between PPC Racing and the Company. (Previously filed with this registration statement) 10.54 Registration Rights Agreement dated as of April 28, 2000 by and between RGC International Investors, LDC and the Company. (Incorporated by reference to Exhibit 10.54 filed with the Registrant's registration statement on Form S-1 filed on June 2, 2000) 10.55 Warrant Agreement dated as of April 28, 2000 by and between RGC International Investors, LDC and the Company. (Incorporated by reference to Exhibit 10.54 filed with the Registrant's registration statement on Form S-1 filed on June 2, 2000) 10.56 Settlement Agreement and Mutual General Release dated as of April 28, 2000 by and between RGC International Investors LDC, Rose Glen Capital Management, L.P., RGC General Partner Corporation, Steve Katznelson, Gerald Stahlecker, Chris Hinkel and the Company. (Incorporated by reference to Exhibit 10.54 filed with the Registrant's registration statement on Form S-1 filed on June 2, 2000) 10.57 Consulting Agreement dated as of October 29, 2000 by and between the Company and Michael Gardner. 10.58 Online Advertising Insertion Order dated as of April 3, 2000 by and between the Company and Hearme.com. 10.59 Content License Agreement dated April 27, 2000 by and between the Company and ScreamingMedia. 10.60 Development and Revenue Sharing Agreement dated August 23, 2000 by and between the Company and Activeworlds.com, Inc. 10.61 GoTo.com Search Services Order dated as of September 1, 2000 by and between the Company and GoTo.com 10.62 WebMall Co-Branded Web Page Agreement dated as of September 7, 2000 by and between the Company and StoreRunner Network, Inc. 10.63 Software License Agreement dated as of September 29, 2000 by and between the Company and Annuncio Software, Inc. 10.64 Consulting Services Agreement dated as of October 11, 2000 by and between the Company and Annuncio Software, Inc. 10.65 Online Advertising Services Contract dated as of February 1, 2001 by and between the Company Fastclick.com, Inc. 10.66 Gigabit Data Services Agreement dated as of March 2001 by and between the Company and Alchemy Communications, Inc. 10.67 Exit Traffic Agreement dated as of January 1, 2000 by and between the Company and Internet Fuel.com, Inc. 21.1 Subsidiaries of the Company. (Incorporated by reference to exhibit 10.57 filed with the Registrant's Registration Statement on Form S-1 (File No. 333-78129)) 23.1 Consent of BDO Seidman, LLP (b) Reports on Form 8-K. None. 77 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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: April 3, 2001 By: /s/ Dean Rositano ------------------- Dean Rositano, Chief Financial Officer (Principal Accounting and Financial Officer) Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed by the following persons in the capacities and on the dates indicated: SIGNATURE TITLE DATE ------------------------------ --------------------------------- ------------- /S/ Robert A. Rositano, Jr. Chief Executive Officer, April 3, 2001 ----------------------------- Secretary and Director Robert A. Rositano, Jr. (principal executive officer) /S/ Dean Rositano President Chief Financial Officer April 3, 2001 ----------------------------- and Director Dean Rositano (principal accounting officer) /S/ Andrew Garroni Director April 3, 2001 ----------------------------- Andrew Garroni 78 NETTAXI.COM ================================================================================ CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2000 AND 1999 NETTAXI.COM ================================================================================ CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2000 AND 1999
NETTAXI.COM CONTENTS ================================================================================ REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS 3 CONSOLIDATED FINANCIAL STATEMENTS Consolidated balance sheets 4 Consolidated statements of operations 5 Consolidated statements of shareholders' equity (deficiency) 6 Consolidated statements of cash flows 7 Notes to consolidated financial statements 8 - 33
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS To The Board of Directors and Shareholders of Nettaxi.com We have audited the accompanying consolidated balance sheets of Nettaxi.com as of December 31, 2000 and 1999, and the related consolidated statements of operations, shareholders' equity (deficiency) and cash flows for each of the three years in the period ended December 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Nettaxi.com as of December 31, 2000 and 1999, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States. /s/ BDO Seidman LLP San Jose, California March 8, 2001 3 NETTAXI.COM Consolidated Balance Sheets ================================================================================
December 31, 2000 1999 ------------------------------------------------------------------------------------------------ ASSETS Current Assets: Cash and cash equivalents (Note 9) $ 13,894,700 $ 987,700 Accounts receivable, net of allowance for doubtful accounts of $433,000 and $83,600, respectively (Note 9) 775,100 1,181,600 Prepaid expenses and other assets (Note 7) 1,035,000 609,200 ------------------------------------------------------------------------------------------------ TOTAL CURRENT ASSETS 15,704,800 2,778,500 ------------------------------------------------------------------------------------------------ PROPERTY AND EQUIPMENT, net (Note 2) 1,748,300 1,968,600 PURCHASED TECHNOLOGY, net (Note 3) 319,000 493,000 OTHER INTANGIBLES, net (Note 3) 55,000 85,000 DEFERRED EXPENSE (Note 7) 272,500 655,200 DEPOSITS 24,000 50,900 ------------------------------------------------------------------ ------------- ------------- $ 18,123,600 $ 6,031,200 ============= ============= LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY) CURRENT LIABILITIES: Accounts payable $ 1,162,400 $ 4,041,400 Accrued expenses (Note 4) 397,900 659,100 Income taxes payable (Note 8) 125,600 Current portion of capital lease obligations 5,400 ------------------------------------------------------------------------------------------------ TOTAL CURRENT LIABILITIES 1,560,300 4,831,500 ------------------------------------------------------------------------------------------------ LONG-TERM LIABILITIES Convertible notes payable, related party (Note 6) 3,200,000 ------------------------------------------------------------------------------------------------ TOTAL LIABILITIES 1,560,300 8,031,500 ------------------------------------------------------------------------------------------------ COMMITMENTS AND CONTINGENCIES (Notes 5, 9, and 12) STOCKHOLDERS' EQUITY (DEFICIENCY) (Notes 6, 7, and 13): Preferred stock, $0.001 par value; 1,000,000 shares authorized; no shares issued and outstanding Common stock subscribed (95,000) (95,000) Common stock, $0.001 par value; 200,000,000 shares authorized; 43,124,586 and 23,214,446 shares issued and outstanding, respectively 43,100 23,200 Additional paid-in capital 44,732,900 11,899,300 Deferred compensation (429,900) (491,400) Accumulated deficit (27,687,800) (13,336,400) ------------------------------------------------------------------------------------------------ TOTAL SHAREHOLDERS' EQUITY (DEFICIENCY) 16,563,300 (2,000,300) ------------------------------------------------------------------------------------------------ $ 18,123,600 $ 6,031,200 ================================================================================================
See accompanying notes to consolidated financial statements. 4 NETTAXI.COM Consolidated Statements of Operations ================================================================================
Years ended December 31, 2000 1999 1998 ===================================================================================== NET REVENUES (Notes 9 and 10) $ 9,418,400 $ 5,032,800 $ 258,000 OPERATING EXPENSES: Cost of operations 7,307,700 4,003,800 239,800 Sales and marketing 5,908,300 4,788,800 745,600 Research and development 1,563,000 2,186,700 634,700 General and administrative 5,007,300 3,456,000 1,053,200 Asset impairment (Note 3) - - 667,000 ------------------------------------------------------------------------------------- TOTAL OPERATING EXPENSES 19,786,300 14,435,300 3,340,300 ------------------------------------------------------------------------------------- LOSS FROM OPERATIONS (10,367,900) (9,402,500) (3,082,300) OTHER INCOME (EXPENSE): Interest income 703,800 75,100 9,800 Interest expense (Notes 6 and 7) (4,685,700) (426,200) (68,800) Other income 28,500 ------------------------------------------------------------------------------------- LOSS BEFORE INCOME TAXES (14,349,800) (9,753,600) (3,112,800) INCOME TAXES (Note 8) (1,600) (126,800) (800) ------------------------------------------------------------------------------------- NET LOSS $(14,351,400) $(9,880,400) $(3,113,600) ===================================================================================== PREFERRED STOCK DIVIDEND $ $ $ (14,300) ===================================================================================== NET LOSS AVAILABLE TO COMMON SHAREHOLDERS (14,351,400) (9,880,400) (3,127,900) ===================================================================================== BASIC AND DILUTED LOSS PER COMMON SHARE $ (0.36) $ (0.46) $ (0.32) ===================================================================================== WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING 39,381,211 21,274,203 9,724,781 =====================================================================================
See accompanying notes to consolidated financial statements. 5 NETTAXI.COM Consolidated Statements of Shareholders' Equity (Deficiency) (Notes 6 and 7) ================================================================================
Preferred Stock Common Stock Common Additional =================== =================== Stock Paid-in Shares Amount Shares Amount Subscribed Capital ======================================================================================================================== Balances, December 31, 1997 134,000 $ 100 5,238,991 $ 5,200 $ - $ 1,295,300 Net proceeds from sale of preferred stock 11,400 - - - - 22,900 Net proceeds from sale of common stock - - 1,756,378 1,800 - 1,198,300 Issuance of common stock for services and salaries - - 328,132 300 - 142,500 Exchange of convertible notes payable and accrued interest - - 2,792,763 2,800 - 1,103,000 Exchange of preferred stock for common stock (145,400) (100) 734,438 700 - (600) Compensation expense related to warrants granted - - - - - 855,000 Warrants exchanged for common stock - - 2,399,298 2,400 (95,000) 92,600 Issuance of common stock to Placement Agent - - 200,000 200 - 159,800 Common stock issued in connection with Reorganization - - 660,000 700 - - Net loss available to common shareholders - - - - - - ------------------------------------------------------------------------------------------------------------------------ Balances, December 31, 1998 - - 14,110,000 14,100 (95,000) 4,868,800 Issuance of common stock in connection with pooling (Note 1) - - 7,000,000 7,000 - - Deferred compensation related to stock options - - - - - 702,700 Amortization of deferred compensation - - - - - - Interest related to issuance of warrants - - - - - 361,200 Warrants exercised for common stock - - 150,000 100 - 1,181,200 Exchange of convertible notes payable and accrued interest - - 802,223 800 - 1,862,500 Proceeds from the issuance of common stock - - 802,223 800 - 1,862,500 Issuance of common stock for services - - 350,000 400 - 1,060,400 Net loss available to common shareholders - - - - - - ------------------------------------------------------------------------------------------------------------------------ Balances, December 31, 1999 - - 23,214,446 23,200 (95,000) 11,899,300 Exchange of convertible notes payable and accrued interest - - 2,382,472 2,400 - 3,317,500 Proceeds from the issuance of common stock - - 632,472 600 - 834,300 Deemed interest on settlement agreement - - - - - 3,896,000 Deferred compensation related to stock options - - - - - 512,200 Amortization of deferred compensation - - - - - - Conversion of trade payables to common stock - - 778,982 800 - 1,557,200 Warrants issued in conjunction with conversion of trade payables - - - - - 541,400 Issuance of common stock for services - - 686,250 700 - 947,800 Warrants issued for services - - - - - 84,000 Proceeds from sale of common stock, net of costs of $1,831,600 - - 15,416,633 15,400 - 21,127,200 Issuance of common stock due to the exercise of stock options - - 13,331 - - 16,000 Net loss available to common shareholders - - - - - - ------------------------------------------------------------------------------------------------------------------------ Balances, December 31, 2000 - $ - 43,124,586 $43,100 $ (95,000) $44,732,900 ======================================================================================================================== Deferred Accumulated Compensation Deficit Total ================================================================================================ Balances, December 31, 1997 $ - $ (327,200) $ 973,400 Net proceeds from sale of preferred stock - - 22,900 Net proceeds from sale of common stock - - 1,200,100 Issuance of common stock for services and salaries - - 142,800 Exchange of convertible notes payable and accrued interest - - 1,105,800 Exchange of preferred stock for common stock - - - Compensation expense related to warrants granted - - 855,000 Warrants exchanged for common stock - - - Issuance of common stock to Placement Agent - - 160,000 Common stock issued in connection with Reorganization - (700) - Net loss available to common shareholders - (3,127,900) (3,127,900) ------------------------------------------------------------------------------------------------ Balances, December 31, 1998 - (3,455,800) 1,332,100 Issuance of common stock in connection with pooling (Note 1) - (200) 6,800 Deferred compensation related to stock options (702,700) - - Amortization of deferred compensation 211,300 - 211,300 Interest related to issuance of warrants - - 361,200 Warrants exercised for common stock - - 1,181,300 Exchange of convertible notes payable and accrued interest - - 1,863,300 Proceeds from the issuance of common stock - - 1,863,300 Issuance of common stock for services - - 1,060,800 Net loss available to common shareholders - (9,880,400) (9,880,400) ------------------------------------------------------------------------------------------------ Balances, December 31, 1999 (491,400) (13,336,400) (2,000,300) Exchange of convertible notes payable and accrued interest - - 3,319,900 Proceeds from the issuance of common stock - - 834,900 Deemed interest on settlement agreement - - 3,896,000 Deferred compensation related to stock options (512,200) - - Amortization of deferred compensation 573,700 - 573,700 Conversion of trade payables to common stock - - 1,558,000 Warrants issued in conjunction with conversion of trade payables - - 541,400 Issuance of common stock for services - - 948,500 Warrants issued for services - - 84,000 Proceeds from sale of common stock, net of costs of $1,831,600 - - 21,142,600 Issuance of common stock due to the exercise of stock options - - 16,000 Net loss available to common shareholders - (14,351,400) (14,351,400) Balances, December 31, 2000 $ (429,900) $(27,687,800) $ 16,563,300 ================================================================================================
See accompanying notes to consolidated financial statements. 6 NETTAXI.COM Consolidated Statements of Cash Flows (Note 11) ================================================================================
Years Ended December 31, 2000 1999 1998 ===================================================================================================== INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS CASH FLOWS FROM OPERATING ACTIVITIES: Net Loss $(14,351,400) $(9,880,400) $(3,113,600) Adjustments to reconcile net loss to net cash used in operating activities: Gain on disposal of equipment (28,500) Depreciation and amortization 1,195,300 595,900 433,500 Allowance for doubtful accounts 349,400 52,400 31,200 Issuance of common stock for interest on convertible notes 119,900 63,300 68,800 Issuance of common stock for services (Note 7) 1,019,400 34,200 302,800 Asset impairment (Note 3) 667,000 Compensation expense related to options and warrans granted 615,700 211,300 855,000 Interest expense related to settlement agreement 2,400,000 Interest expense related to issuance of warrants 2,196,400 202,200 Changes in operating assets and liabilities: Accounts receivable 57,100 (1,100,300) (104,800) Prepaid expenses and other assets (231,000) (62,700) (13,200) Accounts payable (1,321,000) 3,854,500 175,900 Accrued expenses (261,200) 585,100 13,700 Deferred revenue (47,000) 47,000 Income taxes payable (125,600) 125,600 (600) ----------------------------------------------------------------------------------------------------- NET CASH USED IN OPERATING ACTIVITIES (8,337,000) (5,365,900) (665,800) ----------------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from disposal of equipment 34,600 Deposits 26,900 (50,900) Capital expenditures (771,000) (2,105,400) (159,200) ----------------------------------------------------------------------------------------------------- NET CASH USED IN INVESTING ACTIVITIES (744,100) (2,156,300) (124,600) ----------------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Payment on obligations under capital lease (5,400) (7,300) (2,000) Proceeds from convertible notes payable 5,000,000 Net proceeds from issuance of preferred stock 8,600 Net proceeds from issuance of common stock 21,993,500 3,051,400 1,200,100 ----------------------------------------------------------------------------------------------------- NET CASH PROVIDED BY FINANCING ACTIVITIES 21,988,100 8,044,100 1,206,700 ----------------------------------------------------------------------------------------------------- NET INCREASE IN CASH AND CASH EQUIVALENTS 12,907,000 521,900 416,300 CASH AND CASH EQUIVALENTS, beginning of year 987,700 465,800 49,500 ----------------------------------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS, end of year $ 13,894,700 $ 987,700 $ 465,800 =====================================================================================================
See accompanying notes to consolidated financial statements. 7 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ 1. SUMMARY OF The Company ACCOUNTING POLICIES Nettaxi.com (formerly Nettaxi, Inc and formerly Swan Valley Snowmobiles, Inc.), the Company, is a Nevada Corporation, which was 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. (now Nettaxi.com). 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 (Note 7). 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. The merger with Plus Net, Inc. allowed the Company to provide its customers with a web based e-mail program and a robust meta search engine. Plus Net, Inc. also had an e-commerce processing engine that enabled the acceptance and processing of online credit card transactions. 8 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ Plus Net, Inc. reported no revenues and a net loss of $200 for the period ended December 31, 1998. For the period from January 1 to May 7, 1999 Plus Net, Inc. had revenues of approximately $700,000 and net income of approximately $413,600. Subsequent to the merger the Company ceased its evaluation and processing of online credit card transactions business. In 1999, this line of business accounted for approximately $1,285,000 of the Company's revenues. 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. The Company's principal executive offices are located in Campbell, California. Consolidation The accompanying 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. 9 NETTAXI.COM NOTES TO 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. 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. 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 =========================================================== 10 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ 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. 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. Advertising revenue 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. Barter revenues and related expenses for the years ended December 31, 2000, 1999, and 1998 were approximately $2,224,800, $343,400, and $0, respectively, representing 28%, 7%, and 0% of net revenues, respectively. 11 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ 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. In December 1999, the staff of the Securities and Exchange Commission (SEC) issued its Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition. SAB No. 101 provides the SEC staff's views in applying generally accepted accounting principles to selected revenue recognition issues. SAB No. 101 is effective for the fourth fiscal quarter of fiscal years beginning after December 15, 1999. The Company believes that its current revenue recognition policies comply with the provisions of SAB No. 101. 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 years ended December 31, 2000, 1999, and 1998, were approximately $2,365,600, $2,831,300, and $3,100, respectively. 12 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ Long-Lived Assets The Company periodically reviews its long-lived assets for impairment. When events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable, the Company writes the asset down to its fair value. 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. 13 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ At December 31, 2000 and 1999, the fair values of the Company's debt instruments approximate their 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 for stock-based compensation to its employees 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 (Note 7). The Company accounts for stock-based compensation to non-employees under SFAS No. 123. In March 2000, the Financial Accounting Standards Board issued Interpretation (Interpretation) No. 44, Accounting for Certain Transactions involving Stock Compensation, an Interpretation of ABP Opinion No. 25, which became effective July 1, 2000. Interpretation No. 44 clarifies (a) the definition of employee for purposes of applying Opinion 25, (b) the criteria for determining whether a stock compensation plan qualifies as a noncompensatory plan, (c) the accounting consequences of various modifications to the terms of a previously fixed stock option or award, and (d) the accounting for an exchange of stock compensation awards in a business combination. Adoption of the provisions of the Interpretation had no significant impact on the Company's financial statements. 14 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ 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. The number of potential common shares not included in diluted earnings per share, due to their being anti-dilutive, are 23,994,732, 3,838,679, and 280,000, for the years ended December 31, 2000, 1999, and 1998, respectively. All share and per share information has been adjusted for the shares exchanged for the common stock of Plus Net, Inc. 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. 15 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ 2. PROPERTY AND Property and equipment consisted of the following: EQUIPMENT December 31, 2000 1999 ============================================================ Furniture and fixtures $ 203,600 $ 196,200 Office equipment 55,100 59,700 Computers and equipment 2,721,100 2,134,400 ------------------------------------------------------------ 2,979,800 2,390,300 Less accumulated depreciation 1,231,500 421,700 ------------------------------------------------------------ $1,748,300 $1,968,600 ============================================================ Depreciation expense amounted to $903,400, $361,800 and $59,800 for the years ended December 31, 200, 1999, and 1998 respectively. 3. PURCHASED In November 1997, the Company issued a convertible secured TECHNOLOGY promissory note in the amount of $1,020,000 (Note 6) and AND OTHER 2,475,066 shares of common stock, valued at $980,000, to a INTANGIBLES 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 ============================================================ 16 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ 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. Purchased technology and other intangibles consisted of the following: December 31, 2000 1999 ============================================================ Purchased technology $870,000 $870,000 Less accumulated amortization 551,000 377,000 ------------------------------------------------------------ $319,000 $493,000 ============================================================ Other intangibles $150,000 $150,000 Less accumulated amortization 95,000 65,000 ------------------------------------------------------------ $ 55,000 $ 85,000 ============================================================ 4. ACCRUED EXPENSES Accrued expenses consisted of the following: December 31, 2000 1999 ============================================================ Payroll and related expenses $ 97,800 $216,200 Professional fees 157,300 135,000 Marketing 83,800 93,000 Accrued interest, related party 125,500 Other 59,000 89,400 ------------------------------------------------------------ $397,900 $659,100 ============================================================ 17 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ 5. LEASE The Company leases its facility under an operating lease, COMMITMENTS which expires on May 1, 2002. The facility lease requires the Company to pay certain maintenance and operating expenses, such as taxes, insurance, and utilities. Rent expense for the years ended December 31, 2000, 1999, and 1998, was $281,600, $178,000, and $35,500, respectively. In 1999, the Company entered into operating leases on certain vehicles. For the years ended December 31, 2000 and 1999, rent expense related to the vehicle leases aggregated $5,300 and $2,600. A summary of the future minimum payments required under noncancelable operating leases with terms in excess of one year follows: Operating Years Ending December 31, Leases ============================================================ 2001 $ 284,400 2002 98,400 ------------------------------------------------------------ $ 382,800 ============================================================ 6. CONVERTIBLE On November 1, 1997, the Company issued a 10% five-year NOTES PAYABLE, convertible secured promissory note in the amount of RELATED PARTY $1,020,000. In September 1998, this note, with accrued interest of $85,800, was converted into 2,792,763 shares of common stock. Interest expense on the note aggregated $68,800 in 1998. 18 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ On March 31, 1999 the Company entered into a $5,000,000 Convertible Debt Financing Agreement (the Agreement) with RGC International Investors, LDC (RGC). The convertible debenture bears interest at 5% and matures on March 31, 2004. The debentures are convertible at the option of the holder into that number of shares of common stock equal to the principal amount of the debentures to be converted including all accrued interest, divided by the conversion price specified in the debentures. The conversion price is the lesser of a variable or fixed conversion price. The variable conversion price is based on the trading price of the Company's common stock over a fixed period to conversion of the debentures, and the fixed conversion price is $11.88. The fixed conversion price represents 120% of the average of the three lowest trades ten days prior to the effective date of the Agreement. In accordance with the terms of the debt agreement, RGC converted, in November and December 1999, $1,800,000 of the debentures, with accrued interest of $63,300, into 802,223 shares of common stock and, in January and February 2000, $800,000 of the debentures, with accrued interest of $34,900 into 632,472 shares of common stock. On April 28, 2000, the Company reached a settlement agreement with RGC for the $2,400,000 remaining principal amount of the convertible debentures, plus accrued interest thereon of approximately $85,000, whereby the Company agreed to issue an aggregate of 1,750,000 shares of common stock "settlement shares" and warrants to purchase an aggregate of 2,200,000 shares of common stock, with an exercise price of $1.50 per share, as discussed further in Note 7. It was also agreed that beginning on the date of the agreement and prior to the delivery of the settlement shares, the debentures would be convertible at a fixed conversion price of $1.42 per share. As the fair market value of the Company's stock on April 28, 2000 was $3.00, the Company recognized a deemed noncash interest expense of $2,400,000 resulting from the implied beneficial conversion feature. 7. SHAREHOLDERS' In October 1997, the Company offered shares of its preferred EQUITY stock through a private placement offering. This offering PREFERRED established a maximum of 150,000 shares of Series A STOCK preferred stock at $0.75 per share, each share convertible into 5.05 shares of the Company's common stock at any time. 19 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ During the year ended December 31, 1998 and the period ended December 31, 1997, the Company issued 11,400 and 134,000 shares of Series A preferred stock in this offering for net cash proceeds of $8,600 and $100,500, respectively. As these shares were issued at a discount from the then fair market value of the stock the Company recorded deemed preferred stock dividends of $14,300 and $167,500 in the year ended December 31, 1998 and for the period ended December 31, 1997, respectively. In September 1998, all of the shares of Series A preferred stock were converted into 734,438 shares of the Company's common stock. COMMON STOCK In October 1997, the Company offered shares of its common stock through a private placement offering. This offering established a maximum of 1,262,650 shares of common stock at $0.40 per share. During 1998, the Company issued 506,378 shares of common stock in this offering for net proceeds of $200,500. During the year ended December 31, 1998, the Company issued 252,045 shares of common stock with an ascribed value of $120,000 as payment for services. The shares issued for services performed were valued at the then fair market value of the share issued in the October 1997 private placement offering. During the year ended December 31, 1998, the Company issued 76,087 shares of common stock with an ascribed value of $22,800 to officers and employees of the Company in lieu of salaries. In September 1998, the Company's Board of Directors declared a 2.53 to 1 stock split, in connection with the Acquisition as discussed in Note 1. All references to number of shares of common stock and per share data in the consolidated financial statements have been adjusted to reflect the stock split on a retroactive basis. 20 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ In September 1998, in connection with the Acquisition, the Company offered shares of its common stock through a private placement offering (the Offering). The Offering established a maximum of 1,250,000 shares of common stock at $0.80 per share. The Placement Agent received 200,000 shares of common stock with a fair market value of $160,000. The Company issued 1,250,000 shares of common stock in the Offering for net proceeds of $999,600. In May 1999, the Company completed a merger in a single transaction with Plus Net, Inc. (as discussed in Note 1) by exchanging 7,000,000 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. In accordance with the Convertible Debt Financing Agreement, entered into between the Company and RGC International Investors, LDC on March 31, 1999, RGC had the option to purchase one additional share of common stock for every share of common stock issuable as a result of a conversion of the debenture, at a price equal to the applicable conversion price. In November and December 1999, RGC exercised this investment option right and purchased 802,223 shares of the Company's common stock for proceeds of $1,863,300 and, in January and February 2000, an additional 632,472 shares of common stock for proceeds of $834,900. In December 1999, the Company issued 350,000 shares of common stock to a consulting group in exchange for a two-year agreement to provide the Company with consulting services. Based on the then fair market value of the shares issued the price of these services was determined to be $1,060,800. In February 2000, the Company issued an additional 175,000 shares of common stock, with a fair market value of $574,200, in consideration for extending the agreement for an additional six months. The Company amortizes the aggregate consideration given over the 30 months term of the agreement. Included in prepaid expenses and deferred expenses are, as of December 31, 2000 and 1999, $926,500 and $1,026,600, respectively, representing the unamortized portion of the consideration given for these consulting services. 21 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ In September 2000, the Company issued 75,000 additional shares of common stock to the consulting group in consideration of failure to execute the demand registration rights in a timely manner pursuant to the agreements. Based on the fair market value of the shares issued, the Company recognized $37,500 in consulting expense for this transaction. In February 2000, the Company offered shares of its common stock, valued at $1.50 per share, and warrants, each expiring on January 31, 2003 and entitling the holder the right to purchase one share of common stock at an exercise price of $4.00 per share, through a private placement offering. The Company issued 15,416,633 shares of common stock and warrants to purchase 15,416,633 shares of common stock in the offering for net proceeds of $21,142,600. In February 2000, the Company issued 6,250 shares of common stock, with a fair market value of $9,700, in settlement for the cancellation of a letter of intent to provide sponsorship. In March and April 2000, the Company issued 778,982 shares of common stock and warrants to purchase 389,491 shares of common stock at an exercise price of $2.76 per share, as discussed further below, in exchange for the conversion of $1,558,000 in trade payables. In July and August 2000, the Company issued an aggregate of 430,000 shares of common stock, with a fair market value of $327,100, in consideration for consulting services. The Company amortizes the aggregate consideration given over the term of the underlying agreements. Included in prepaid expenses is, as of December 31, 2000, $29,200 representing the unamortized portion of the consideration given for these consulting services. In May 2000, the Company's Certificate of Incorporation was amended to increase the number of shares of authorized common stock to 200,000,000. 22 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ WARRANTS In 1998, prior to the adoption of the Stock Option Plan as discussed below, the Company granted warrants to directors and employees of the Company, to purchase 2,399,298 shares of common stock at $0.04. As the exercise price for those warrants was less than the market price of the common stock on the grant date, the Company recorded in accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees, $855,000 of compensation costs associated with these warrants. In September 1998, these warrants were exchanged for 2,399,298 shares of common stock via the issuance of promissory notes for $95,000, concurrent with the reorganization of the Company. The promissory notes have been accounted for as common stock subscribed and are an offset to shareholders' equity until such notes are collected. During the years ended December 31, 2000 and 1999, the Company issued warrants in connection with financing, consulting services, and conversion of trade payables to purchase 3,139,491 and 475,000 shares of common stock, respectively. The Company estimates the fair value of warrants at the grant date by using the Black-Scholes valuation model with the following weighted-average assumptions used for grants in 2000 and 1999: dividend yield of 0%; expected volatility of 138% and 69%; risk-free interest rate of 6.2% and 6.2%; and the expected contractual lives of the warrant. The computed value is charged to operations or interest over the term of the related agreements. In March 1999, the Company issued warrants, which vested immediately to purchase 125,000 shares of common stock at $8.00 per share. These warrants were Issued in connection with a dispute settlement and expire in March 2001. In conjunction with the Agreement, entered into between the Company and RGC on March 31, 1999, the Company issued warrants, which vested immediately, to purchase 150,000 shares of common stock at $12.375. The Company recognized an additional $115,500 of interest expense associated with these warrants. In August 1999, the Company entered into an agreement with RGC pursuant to which it exercised these warrants. 23 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ In consideration for the early exercise of the warrants, the exercise price for the warrants was decreased from $12.375 to $7.875 and the Company issued RGC warrants to purchase an additional 150,000 shares of common stock at $7.875. These warrants were subsequently, due to anti-dilution provisions, issued at an execise price of $4.38 per share, resulting in an increase in the number of shares issuable upon exercise of the warrants to 269,692. The Company recognized an additional $245,700 of interest expense associated with these warrants. In 2000 and 1999, the Company recognized $159,000 and $86,700 of this amount as interest expense respectively. In June 2000, the Company issued warrants, which vested immediately, to purchase 2,200,000 shares of common stock at $1.50 per share, exercisable over five years, in accordance with the settlement agreement entered into between the Company and RGC or April 28, 2000. The Company recognized an additional $1,496,000 of deemed interest expense associated with these warrants. In February 2000, the Company issued warrants, which vested immediately, to purchase 200,000 shares of common stock at an exercise price of $4.00, in addition to previously issued warrants to purchase 50,000 shares of common stock at an exercise price of $12.375 for finders fee in connection with the private placement. In March and April 2000, the Company issued warrants to purchase 389,491 shares of common stock at an exercise price of $2.76 in conjunction with the conversion of trade payables. The Company recognized $541,400 in interest expense associated with these warrants. In October 2000, the Company issued warrants for consulting services, which vested immediately to purchase 350,000 shares of common stock at an exercise price of $0.35 per share. The aggregate value of these warrants, $84,000, is amortized over a four months period. Included in prepaid expenses is, as of December 31, 2000, $42,000 representing the unamortized portion of the consideration given for these consulting services. 24 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ STOCK OPTION PROGRAM In September 1998, the Company adopted the 1998 Stock Option Plan and, in January 2000, the Board of Directors adopted the 1999 Stock Option Plan (collectively "the Plans"), which is subject to its ratification by the stockholders. The Plans authorizes the grant of options to purchase shares of common stock to employees, directors, and consultants of the Company and its affiliates. The options are a combination of both incentive and nonstatutory options. Incentive options may be granted at not less than 100% of the fair market value per share, and nonstatutory options may be granted at not less than 85% of the fair market value per share at the date of grant as determined by the Board of Directors or committee thereof, except for options granted to a person owning greater than 10% of the outstanding stock, for which the exercise price must not be less than 110% of the fair market value. Options granted under the Plans generally vest over three years and are exercisable over ten years. The Company has reserved 3,000,000 shares of common stock for issuance under the 1998 Stock Option Plan and 8,900,000 shares of common stock for issuance under the 1999 Stock Option Plan. 25 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ A summary of the status of the Company's stock option plan as of December 31, 2000, 1999, and 1998, and changes during the years then ended is presented in the following table:
Options Outstanding ----------------------------------------------------------- December 31, 2000 December 31, 1999 December 31, 1998 ------------------- -------------------- ---------------- Weighted- Weighted- Weighted- Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price ---------------------------------------------------------------------- Beginning 2,580,166 $ 9.47 280,000 $ 0.80 - $ - Granted 3,931,600 $ 1.88 2,614,000 $ 10.40 280,000 $ 0.80 Exercised (13,331) $ 1.20 - $ - - $ - Forfeited (1,504,519) $ 4.64 (313,834) $ 9.45 - $ - ----------- ---------- ------- Ending 4,993,916 $ 4.97 2,580,166 $ 9.47 280,000 $ 0.80 ====================================================================== Exercisable at year-end 2,068,750 640,499 23,333 =========== ========== ======= Weighted-average fair value of options granted during the period: $ 1.34 $ 5.71 $ 0.71 ====== ======== =======
26 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ The following table summarizes information about stock options outstanding as of December 31, 2000:
Options Outstanding ---------------------- Options Exercisable Weighted ---------------------- Average Weighted- Weighted- Range of Remaining Average Average Exercise Number Contractual Exercise Number Exercise Prices Outstanding Life Prices Exercisable Prices ========================================================================= 0.01-0.75 154,250 9.67 $ 0.47 14,250 $ 0.49 0.76-1.00 265,000 7.76 $ 0.80 202,500 $ 0.80 1.01-2.00 1,530,533 8.44 $ 1.48 539,900 $ 1.47 2.01-5.00 1,240,133 8.07 $ 2.44 690,266 $ 2.44 5.01-10.00 1,464,000 8.63 $ 8.74 309,334 $ 8.42 10.01-15.00 250,000 5.67 $ 13.96 222,500 $ 14.27 15.01-30.00 45,000 0.50 $ 25.60 45,000 $ 25.60 30.01-45.00 45,000 0.50 $ 40.22 45,000 $ 40.22 -------------------------------------- ----------- 4,993,916 $ 4.97 2,068,750 $ 5.51 =========== ========= =========== =========
During the years ended December 31, 2000 and 1999, the Company recorded deferred compensation of approximately $512,200 and $702,700, respectively, relating to the issuance of 380,000 and 285,000 consultant options, respectively, for administrative and sales and marketing services. These amounts were computed using the Black-Scholes option valuation model. The related amortization will be charged to operations over the term of the related consulting agreements. In 2000 and 1999, such amortization amounted to approximately $573,700 and $211,300, respectively. The weighted-average assumptions used to compute the value of the options granted in 2000 and 1999 were as follows: dividend yield of 0%; expected volatility of 110% and 82%; risk-free interest rate of 6.2% and 6.2%; and expected lives of two years. 27 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ SFAS No. 123, Accounting for Stock-Based Compensation, requires the Company to provide pro forma information regarding net (loss) income and (loss) earnings per share as if compensation cost for the Company's stock option plan had been determined in accordance with the fair value based method prescribed in SFAS No.123. The Company estimates the fair value of stock options at the grant date by using the Black-Scholes option valuation model with the following weighted average assumptions used for grants in 2000, 1999, and 1998: dividend yield of 0%; expected volatility of 124%, 112%, and 180%; risk-free interest rate of 6.2%, 6.2%, and 5.7%; and expected lives of three years for all plan options. Under the accounting provisions of SFAS No. 123, the Company's net loss and the basic and diluted net loss per common share would have been adjusted to the pro forma amounts below:
2000 1999 1998 ============================================================== Net income (loss): As reported $(14,351,400) $ (9,880,400) $(3,127,900) Pro forma $(19,426,800) $(11,516,600) $(3,144,500) Basic and diluted earnings (loss) per share: As reported $ (0.36) $ (0.46) $ (0.32) Pro forma $ (0.49) $ (0.54) $ (0.32)
8. INCOME The provision for income taxes for the year ended December TAXES 31, 1999 relates to the earnings of Plus Net, Inc. prior to the merger. The provision for income taxes for the years ended December 31, 2000, and 1998 consisted of minimum state taxes. 28 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ The following summarizes the differences between income tax expense and the amount computed applying the Federal income tax rate of 34% for the years ended December 31, 2000, 1999, and 1998:
2000 1999 1998 ===================================================================== Federal income tax benefit at statutory rate $(4,675,000) $(3,316,200) $(1,058,400) State income taxes, net of federal benefit (799,000) (566,500) (180,800) Tax benefit not currently recognizable 4,985,900 3,884,100 835,400 Other 489,700 125,400 404,600 --------------------------------------------------------------------- Provision for income taxes $ 1,600 $ 126,800 $ 800 =====================================================================
The Company's effective tax rate differs from the statutory federal income tax principally as a result of federal and state net operating losses for which no deferred benefit is recognized due to a full valuation allowance provided on the resulting deferred tax asset. Temporary differences and carryforwards which gave rise to significant portions of deferred tax assets and liabilities as of December 31, 2000, 1999, and 1998 are as follows:
December 31, 2000 1999 1998 =================================================================== Net operating loss carryforward $ 9,368,000 $ 4,558,900 $ 473,900 Depreciation and amortization (36,000) (216,800) (90,300) Accrued compensation and benefits 37,000 562,700 4,000 Reserves not currently deductible 555,000 33,300 316,200 ------------------------------------------------------------------- Net deferred tax asset 9,924,000 4,938,100 703,800 Valuation allowance (9,924,000) (4,938,100) (703,800) ------------------------------------------------------------------- Reported deferred tax asset $ - $ - $ - ===================================================================
29 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ As of December 31, 2000, the Company had a federal net operating loss (NOL) carryforward in the amount of $25,143,000 which may be applied to future taxable income until these benefits begin to expire in 2017. The Company also had a California NOL carryforward in the amount of $13,395,000 which may be applied to future taxable income until these benefits begin to expire in 2002. The Company's ability to utilize the NOL carryforwards are dependent upon the Company's ability to generate taxable income in future periods and may be limited due to restrictions imposed under Federal and state laws upon a change in ownership. 9. CONCENTRATION Financial instruments, which potentially subject the Company OF CREDIT RISK to concentration of credit risk, consist principally of cash and cash equivalents and trade receivables. The Company places its cash and cash equivalents with high quality financial institutions and, by policy, limits the amounts of credit exposure to any one financial institution. The Company's accounts receivable are derived from many customers in various industries. The Company believes any risk of accounting loss is significantly reduced due to the diversity of its end-customers and geographic sales areas. The Company performs credit evaluation of its customers' financial condition whenever necessary, and generally does not require cash collateral or other security to support customer receivables. 10. MAJOR In 2000, four customers accounted for approximately 20%, CUSTOMERS 13%, 11%, and 10% of revenues, respectively, with related account receivable as of December 31, 2000 of $294,000, $0, $95,200, and $0, respectively. In 1999, one customer accounted for approximately 17% of revenues, with related account receivable as of December 31, 1999 of $250,000. In 1998, four customers accounted for approximately 28%, 21%, 13% and 12% of revenues, respectively, with related accounts receivable as of December 31, 1998 of $52,100, $38,100, $0 and $23,800, respectively. 30 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ 11. SUPPLEMENTAL The following is supplemental disclosure for the statements DISCLOSURE of cash flows. OF CASH FLOW INFORMATION
Years Ended December 31, 2000 1999 1998 ======================================================================== CASH PAID: Income taxes $ 127,200 $ 1,600 $ 1,400 Interest $ $ 3,000 $ 100 NONCASH INVESTING AND FINANCING ACTIVITIES: Purchase of equipment under capital lease $ $ $ 14,700 Issuance of common stock for convertible notes payable plus accrued interest $3,319,900 $1,863,300 $1,020,000 Issuance of common stock for consulting services $ 948,500 $1,060,800 $ Issuance of common stock for trade payables $1,558,000 $ $ Warrants issued in conjunction with debt financing $ $ 361,200 $ Conversion of preferred stock to common stock $ $ $ 109,100 Promissory notes received for common stock subscribed $ $ $ 95,000 ========================================================================
12. CONTINGENCIES Nettaxi.com acquired certain technology from SSN Properties, which in turn, acquired these assets through the foreclosure of convertible notes issued by Simply Interactive, Inc. Certain minority shareholders of Simply Interactive, Inc. are disputing the transfer of these assets to, ultimately, Nettaxi.com. Management believes that the group's claims are without merit and therefore that any settlement relating to these claims will not have a material adverse effect on the financial position of the Company. 31 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ From time to time, in the normal course of business, various claims are made against the Company. At this time, in the opinion of management, there are no pending claims, the outcome of which is expected to result in a material adverse effect on the financial position of the Company. 13. SUBSEQUENT On March 1, 2001, the Company signed an Asset Purchase EVENTS Agreement under which it via its newly formed wholly owned subsidiary, Lookup Guide Acquisition Corporation, a California corporation, will issue 2,200,000 shares of common stock in exchange for substantially all assets of LookupGuide.com, a California corporation. 14. VALUATION AND QUALIFYING ACCOUNTS
Balance Additions as of Charged to Balance Beginning Costs and as of End Description of Period Expenses Deductions of Period ======================================================================= 2000: Allowance for doubtful accounts $ 83,600 $ 504,900 $(155,500) $ 433,000 1999: Allowance for doubtful accounts $ 31,200 $ 52,400 $ $ 83,600 1998: Allowance for doubtful accounts $ $ 31,200 $ $ 31,200 =======================================================================
32 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ 15. QUARTERLY The summarized quarterly financial data presented below INFORMATION reflect all adjustments, which, in the opinion of (UNAUDITED) management, are of a normal and recurring nature necessary to present fairly the results of operations for the periods presented.
Year Ended First Second Third Fourth December 31, Quarter Quarter Quarter Quarter 2000 ---------------------------------------------------------------------------------------- Net revenues $ 2,764,900 $ 2,984,900 $ 2,254,000 $ 1,414,600 $ 9,418,400 Gross profit 991,400 1,063,100 600,600 (544,400) 2,110,700 (loss) Operating (loss) (2,696,500) (2,605,400) (2,360,500) (2,705,500) (10,367,900) Net (loss) (2,769,000) (6,461,600) (2,132,200) (2,988,600) (14,351,400) Basic and diluted (loss) per common share (0.09) (0.15) (0.05) (0.07) (0.36) ========================================================================================
Year Ended First Second Third Fourth December 31, Quarter Quarter Quarter Quarter 1999 -------------------------------------------------------------------------------------- Net revenues $ 689,300 $ 1,189,100 $ 1,102,500 $ 2,051,900 $ 5,032,800 Gross profit 365,900 780,300 (79,900) (37,300) 1,029,000 (loss) Operating (loss) (410,400) (2,022,700) (3,975,200) (2,994,200) (9,402,500) Net (loss) (509,100) (2,137,900) (4,089,100) (3,144,300) (9,880,400) Basic and diluted (loss) per common share (0.02) (0.10) (0.19) (0.14) (0.46) ======================================================================================
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