-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, HrAS0k8+vphtEyUF/X8zw+qan28euCNaud07QhMTv5Ph1grzbtPtVGBNRKx/ytYh 1DmVxBgGvwn4IUwa/IXqyQ== 0001015402-01-501208.txt : 20010516 0001015402-01-501208.hdr.sgml : 20010516 ACCESSION NUMBER: 0001015402-01-501208 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20010331 FILED AS OF DATE: 20010515 FILER: COMPANY DATA: COMPANY CONFORMED NAME: NETTAXI INC CENTRAL INDEX KEY: 0001084876 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-BUSINESS SERVICES, NEC [7389] IRS NUMBER: 820486102 STATE OF INCORPORATION: NV FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-26109 FILM NUMBER: 1637031 BUSINESS ADDRESS: STREET 1: 1696 DELL AVE CITY: CAMPBELL STATE: CA ZIP: 95008 BUSINESS PHONE: 4088799880 10-Q 1 doc1.txt FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 (Mark One) [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2001 Commission file number: 0-26109 NETTAXI.COM (Exact name of registrant as specified in its charter) Nevada 82-0486102 (State or other jurisdiction (I.R.S. Employer Identification No.) of incorporation or organization) 1696 Dell Avenue, Campbell, CA 95008 (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number, including area code: (408) 879-9880 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Applicable Only To Corporate Issuers: As of May 3, 2001, the registrant had 43,124,586 shares of common stock, $.001 par value per share, outstanding. NETTAXI.COM CONTENTS Page No. -------- PART I FINANCIAL INFORMATION Item 1. Financial Statements Condensed Consolidated Balance Sheets, as of March 31, 2001 (unaudited) and and December 31, 2000 3 Condensed Consolidated Statements of Operations, Three Months Ended March 31, 2001 (unaudited) and March 31, 2000 (unaudited) 4 Condensed Consolidated Statements of Cash Flows, Three Months Ended March 31, 2001 (unaudited) and March 31, 2000 (unaudited) 5 Notes to Condensed Consolidated Financial Statements (unaudited) 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10 Item 3. Quantitative and Qualitative Disclosures About Market Risk 28 PART II OTHER INFORMATION Item 1. Legal Proceedings 29 Item 2. Changes in Securities and Use of Proceeds 29 Item 3. Defaults Upon Senior Securities 29 Item 4. Submission of Matters to a Vote of Security Holders 29 Item 5. Other Information 29 Item 6. Exhibits and Reports on Form 8-K 29 SIGNATURES 30 EXHIBIT INDEX 31 2
PART I. FINANCIAL INFORMATION ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS NETTAXI.COM CONDENSED CONSOLIDATED BALANCE SHEET December 31, March 31, 2000 2001 - ------------------------------------------------------------------------------------------------- (Unaudited) ASSETS Current Assets: Cash and cash equivalents $ 13,894,700 $ 12,365,400 Accounts receivable, net of allowance for doubtful accounts of $433,000 and $401,400, respectively 775,100 581,900 Prepaid expenses and other assets 1,035,000 1,376,500 - ------------------------------------------------------------------------------------------------- TOTAL CURRENT ASSETS 15,704,800 14,323,800 - ------------------------------------------------------------------------------------------------- PROPERTY AND EQUIPMENT, net 1,748,300 1,524,300 PURCHASED TECHNOLOGY, net 319,000 212,500 OTHER INTANGIBLES, net 55,000 36,500 DEFERRED EXPENSE 272,500 109,000 DEPOSITS 24,000 24,000 - ------------------------------------------------------------------------------------------------- $ 18,123,600 $ 16,230,100 ================================================================================================= LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 1,162,400 $ 1,398,200 Accrued expenses 397,900 482,300 - ------------------------------------------------------------------------------------------------- TOTAL CURRENT LIABILITIES 1,560,300 1,880,500 - ------------------------------------------------------------------------------------------------- COMMITMENTS AND CONTINGENCIES SHAREHOLDERS' EQUITY: Preferred stock, $0.001 par value; 1,000,000 shares authorized; no shares issued and outstanding - - Common stock, $0.001 par value; 200,000,000 shares authorized; 43,124,586 shares issued and outstanding, 43,100 43,100 Additional paid-in capital 44,637,900 44,637,900 Deferred compensation (429,900) (282,300) Accumulated deficit (27,687,800) (30,049,100) - ------------------------------------------------------------------------------------------------- TOTAL SHAREHOLDERS' EQUITY 16,563,300 14,349,600 - ------------------------------------------------------------------------------------------------- $ 18,123,600 $ 16,230,100 ================================================================================================= **The accompanying notes are an integral part of these condensed consolidated financial statements.
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NETTAXI.COM CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS Three Months Three Months Ended Ended March 31, March 31, 2000 2001 - ----------------------------------------------------------------------------------------------------- (Unaudited) (Unaudited) NET REVENUES $ 2,764,900 $ 1,192,500 OPERATING EXPENSES: Cost of operations 1,773,500 1,953,800 General and administrative 1,467,500 1,076,300 Sales and marketing 1,763,300 443,100 Research and development 457,100 253,100 - ----------------------------------------------------------------------------------------------------- TOTAL OPERATING EXPENSES 5,461,400 3,726,300 - ----------------------------------------------------------------------------------------------------- LOSS FROM OPERATIONS (2,696,500) (2,533,800) OTHER INCOME (EXPENSE): Interest income 26,000 179,300 Interest expense (97,700) (6,800) - ----------------------------------------------------------------------------------------------------- LOSS BEFORE INCOME TAXES (2,768,200) (2,361,300) INCOME TAXES 800 - - ----------------------------------------------------------------------------------------------------- NET LOSS $ (2,769,000) $ (2,361,300) ===================================================================================================== BASIC AND DILUTED LOSS PER COMMON SHARE $ (0.09) $ (0.05) ===================================================================================================== WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING 29,391,784 43,124,586 The accompanying notes are an integral part of these condensed consolidated financial statements.
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NETTAXI.COM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS Three Months Three Months Ended Ended March 31, March 31, 2000 2001 - ----------------------------------------------------------------------------------------------------- (Unaudited) (Unaudited) INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS CASH FLOWS FROM OPERATING ACTIVITIES: Net Loss $ (2,769,000) $ (2,361,300) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 216,900 363,900 Allowance for doubtful accounts 85,000 (31,600) Issuance of common stock for interest on convertible notes 34,900 - Issuance of common stock for services 183,800 192,700 Compensation expense related to options and warrants granted 216,600 189,600 Interest expense related to issuance of warrants 30,700 - Changes in operating assets and liabilities: Accounts receivable (973,900) 224,800 Prepaid expenses and other assets (130,200) (412,700) Accounts payable (999,500) 235,800 Accrued expenses 624,100 84,400 Income taxes payable (123,000) - - ----------------------------------------------------------------------------------------------------- NET CASH USED IN OPERATING ACTIVITIES (3,603,600) (1,514,400) - ----------------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Deposits 18,100 - Capital expenditures (32,100) (14,900) - ----------------------------------------------------------------------------------------------------- NET CASH USED IN INVESTING ACTIVITIES (14,000) (14,900) - ----------------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Payment on obligations under capital lease (1,800) - Net proceeds from issuance of common stock 21,903,300 - - ----------------------------------------------------------------------------------------------------- NET CASH PROVIDED BY FINANCING ACTIVITIES 21,901,500 - - ----------------------------------------------------------------------------------------------------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 18,283,900 (1,529,300) CASH AND CASH EQUIVALENTS, beginning of period 987,700 13,894,700 - ----------------------------------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS, end of period $ 19,271,600 $ 12,365,400 ===================================================================================================== 5 SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: CASH PAID: Income taxes $ 97,400 $ - Interest $ - $ 6,800 NONCASH INVESTING AND FINANCING ACTIVITIES: Issuance of common stock for convertible notes payable plus accrued interest $ 834,900 $ - Issuance of common stock for consulting services $ 583,900 $ - Issuance of common stock for trade payables $ 834,100 $ - The accompanying notes are an integral part of these condensed consolidated financial statements.
6 NETTAXI.COM NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF ACCOUNTING POLICIES THE COMPANY Nettaxi.com is a Nevada Corporation, which was incorporated on October 26, 1995. The Company's principal executive offices are located in Campbell, California. CONSOLIDATION The accompanying condensed consolidated financial statements include the accounts of Nettaxi.com and its wholly-owned subsidiary, Nettaxi Online Communities, Inc. All intercompany accounts and transactions have been eliminated in the consolidated financial statements. USE OF ESTIMATES The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Acutal results could differ from those estimates. BASIS OF PRESENTATION The unaudited condensed consolidated interim financial statements reflect all adjustments (which include only normal, recurring adjustments), which are, in the opinion of management, necessary to state fairly the results for the periods presented. The results for three month period ended March 31, 2001 are not necessarily indicative of the results expected for the full fiscal year or for any future period. The unaudited historical financial statements included herein have been prepared in accordance with instructions for Form 10-Q and, therefore, do not include all information and footnotes necessary for a complete presentation of the Company's results of operations, financial position and cash flows. These financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2000. REVENUE RECOGNITION AND DEFERRED REVENUE The Company's revenues are derived from the sale of banner advertisements, web hosting services and from products from its online malls. Advertising revenues are recognized in the period in which the advertisement is delivered, provided that collection of the resulting receivable is probable. Advertisers are charged on a per impression or delivery basis up to a maximum as specified in the contract. To date, the duration of the Company's advertising commitments has not exceeded one year. When the Company guarantees a minimum number of impressions or deliveries, revenue is recognized ratably in proportion to the number of impressions or deliveries recorded to the minimum number of impressions and 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. 7 Advertising revenue include barter transactions, which are the exchange by Nettaxi.com of advertising space on Nettaxi.com's web sites for reciprocal advertising space on other web sites or advertising media. Revenues from these barter transactions are recorded as advertising revenues at the lower of the estimated fair value of the advertisements received or delivered and are recognized when the advertisements are run on Nettaxi.com's web sites. Barter expenses are recorded when Nettaxi.com's advertisements are run on the reciprocal web sites, which is typically in the same period as when advertisements are run on Nettaxi.com's web sites. Barter revenues and related expenses for the three months ended March 31, 2001 and 2000 were approximately $0 and $651,000, respectively, representing 0% and 23% of total net revenues, respectively. In November 1999, the Financial Accounting Standards Board (FASB) issued Emerging Issues Task Force (EITF) Issue 99-17 "Accounting for Advertising Barter Transactions". Under EITF 99-17, revenues and expenses should be recognized from advertising barter transactions at the fair value of the advertising surrendered or received only when the company has a historical practice of receiving or paying cash for such transactions. As of March 31, 2001, the Company was in compliance with EITF 99-17. Royalty revenues are earned on sales of the Company developed CD-Rom "Internet the City" by third party distributors. Third party distributors package the CD-Rom with their products for sale to the end-user. The distributor remits payment to the Company 90 days after the sales of their product to the end-user and the end-user does not have a right of return. The Company recognizes these revenues only upon receipt of payment from the distributor. The Company did not earn any royalty revenues in the first quarter of 2001. The Company is in contract with several partners in revenue and expense sharing agreements. The agreements provide for the Company to earn revenues based on the sale of third-party suppliers products. For those transactions, where the Company receives either a percentage of the transaction or a fixed fee, revenues are recorded net. As of March 31, 2001, the Company has not earned any revenues or expenses related to these contracts. The Company charges its co-hosting customers one-time installation fees. Prior to January 31, 2001, the Company recognized these fees upon completion of the installation. Upon Issuance of SEC SAB 101 issued on December 3, 1999 one-time installation fees are to be deferred and systematically recognized as the products and/or services are delivered and/or performed over the term of the arrangement or the expected period of performance that the fees are earned. The Company did not recognize any one-time installation fees in 2001. Our premium subscribers are charged web-site development fees to develop their web-site upon request. These fees charged and the costs to develop these sites by the Company are nominal. The Company defers the recognition of the fees charged over the period of the contract. For the three months ended March 31, 2001, the Company did not earn any web-site development fee. 8 In December 1999, the staff of the Securities and Exchange Commission (SEC) issued its Staff Accounting Bulletin (SAB) No. 101, "Revenue Recognition". SAB No. 101 provides the SEC staff's views in applying generally accepted accounting principles to selected revenue recognition issues. SAB No. 101 is effective for the fourth fiscal quarter of fiscal years beginning after December 15, 1999. The Company believes that its current revenue recognition policies comply with the provisions of SAB No. 101. LONG-LIVED ASSETS The Company periodically reviews its long-lived assets for impairment. When events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable, the Company writes the asset down to its fair value. The Company periodically reviews other intangible assets to evaluate whether events or changes have occurred that would suggest an impairment of carrying value. An impairment would be recognized when expected future operating cash flows are lower than the carrying value. Property and equipment are stated at cost. Depreciation is provided using the straight-line method over the estimated economic useful lives of the assets, generally ranging from three to five years. The Company amortizes, on a straight-line basis, the cost of purchased technology and other intangibles over the shorter of five years or the useful life of the related technology or underlying asset. ADOPTION OF NEW ACCOUNTING PRONOUNCEMENTS In September 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities". SFAS No. 133, as amended by SFAS No 138, requires companies to recognize all derivatives contracts as either assets or liabilities in the balance sheet and to measure them at fair value. If certain conditions are met, a derivative may be specifically designated as a hedge, the objective of which is to match the timing of gain or loss recognition on the hedging derivative with the recognition of (i) the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk or (ii) the earnings effect of the hedged forecasted transaction. For a derivative not designated as a hedging instrument, the gain or loss is recognized in income in the period of change. In September 1999, the FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133", which amends SFAS No. 133 to be effective for all fiscal quarters of all fiscal years beginning after September 15, 2000. The Company has not entered into derivative contracts either to hedge existing risks or for speculative purposes. Accordingly, the Company's adoption of the new standard did not have a material impact on the Company's results from operations, financial position or cash flows. In March 2000, the Financial Accounting Standards Board issued Interpretation (Interpretation) No. 44, "Accounting for Certain Transactions involving Stock Compensation, an Interpretation of ABP Opinion No. 25", which became effective July 1, 2000. Interpretation No. 44 clarifies (a) the definition of employee for purposes of applying Opinion 25, (b) the criteria for determining whether a stock compensation plan qualifies as a noncompensatory plan, (c) the accounting consequences of various modifications to the terms of a previously fixed stock 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. 9 BASIC AND DILUTED LOSS PER COMMON SHARE Basic loss per common share is determined by dividing loss available to common shareholders by the weighted average number of common shares outstanding. Diluted per-common-share amounts assume the issuance of common stock for all potentially dilutive equivalent shares outstanding. Anti-dilution provisions of SFAS 128 require consistency between diluted per-common-share amounts and basic per-common-share amounts in loss periods. For the periods reported, there were no differences between basic and diluted earnings per share. CONTINGENCIES Nettaxi.com acquired certain technology from SSN Properties, which in turn acquired these assets through the foreclosure of convertible notes issued by Simply Interactive, Inc. Certain minority shareholders of Simply Interactive, Inc. are disputing the transfer of assets to, ultimately, Nettaxi.com. Management believes that the group's claims are without merit and therefore that any settlement relating to these claims will not have a material adverse effect on the financial position of the Company. On May 1, 2001 seven shareholders of Nettaxi filed an action against the Company. The complaint also names the Company's Chief Executive Officer, President and former Chief Financial Officer as additional defendants. The complaint alleges that the Company violated securities laws in connection with its February 2000 private placement. Only three of the seven plaintiffs actually purchased shares of Nettaxi common stock in the February 2000 private placement. Prior to filing the complaint, the plaintiffs demanded the refund of all of the money invested in Nettaxi and demanded that the exercise price of the warrants issued in the private placement be reduced from $4.00 to $0.25 per share. Additionally, prior to filing the complaint, Nettaxi was asked to invest capital in a company affiliated with one of the plaintiffs. In the complaint, the plaintiffs are seeking compensatory damages, injunctive relief and fees and interest. Management believes that the allegations made in the complaint are without merit and that this lawsuit reflects shareholder frustration over the recent downturn in the stock market and will defend the action vigorously. 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. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. THIS REPORT CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, INCLUDING, WITHOUT LIMITATION, STATEMENTS REGARDING OUR EXPECTATIONS, BELIEFS, INTENTIONS OR FUTURE STRATEGIES THAT ARE SIGNIFIED BY THE WORDS "EXPECTS", "ANTICIPATES", "INTENDS", "BELIEVES", OR SIMILAR LANGUAGE. THESE FORWARD-LOOKING STATEMENTS INVOLVE RISKS, UNCERTAINTIES AND OTHER FACTORS. ALL FORWARD-LOOKING STATEMENTS INCLUDED IN THIS DOCUMENT ARE BASED ON INFORMATION AVAILABLE TO US ON THE DATE HEREOF AND SPEAK ONLY AS OF THE DATE HEREOF. THE FACTORS DISCUSSED BELOW UNDER "RISK FACTORS" AND ELSEWHERE IN THIS QUARTERLY REPORT ON FORM 10-Q ARE AMONG THOSE FACTORS THAT IN SOME CASES HAVE AFFECTED OUR RESULTS AND COULD CAUSE THE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE PROJECTED IN THE FORWARD-LOOKING STATEMENTS. The following discussion should be read in conjunction with the condensed consolidated financial statements and notes thereto. OVERVIEW Nettaxi.com is an Internet marketing portal that provides a wide range of content and Internet based services for consumers and businesses. Our web site at www.nettaxi.com serves as a gathering place for people with shared topics of interest, as well as an entry point, referred to as a portal, to the Internet. Through our web site, we provide content addressing a large number of targeted categories. 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, and email accounts. 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. 10 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. We also provide 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 any one of these customers may have a material impact on total net revenues. We also receive 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. Beginning in the fourth quarter of 2000, we initiated cost reductions in all areas of operations. In the first quarter of 2001, we switched our bandwidth provider and expect future costs savings of approximately $2.0 million per year. We are also in the process of determining our staffing needs in all areas of the organization which may result in reduced headcount. We are continuing to review and reduce all expenditures that do not contribute toward our profitability. There can be no assurance that we will ever achieve or sustain profitability or that our operating losses will not increase in the future. In February 2000, we completed our private placement, which raised approximately $23 million in exchange for issuance of our common stock and warrants to purchase shares of our common stock. The acquisition of this new capital enabled us to fund our operations and become a more aggressive competitor in the community portal arena. We plan to use the remaining funds to improve our online community, content and commerce relationships, and to 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 our overall 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 third quarter ended September 30, 2000, we entered into a contract with ScreamingMedia to provide content for users of our web site. 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. 11 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 NET REVENUES. Net revenues for the three months ended March 31, 2001 declined 57% to $1.19 million compared with $2.76 million for the three months in 2000. The substantial decrease is primarily the result of significantly lower advertising revenues recognized in the year 2001. The decline is also the result of decreased utilization of reciprocal advertising agreements. For the three months ended March 31, 2000, we recognized approximately $651,000 or 23% of net revenues from reciprocal advertising agreements. There were no reciprocal advertising agreements recognized in 2001. For the three months ended March 31, 2001, three customers each accounted for greater than 10% of total net revenues for a total of approximately $1.06 million or 87% of the total revenues. These customers, Babenet, Whitesand Communications, and Whitehorn Ventures Limited, accounted for 43%, 20%, and 24%, respectively of our total revenues. All three of these customers are co-hosting customers. For the three months ended March 31, 2000, three customers, Babenet, Internet Fuel.com, Spinrecords.com, each accounted for greater than 10% of total net revenues for a total of approximately $1.27 million or 46% of the total 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 three months ended March 31, 2001 and 2000 were approximately $130,400 and approximately $1.8 million, respectively, which represented 11% and 64%, respectively, of total net revenues. The decline in absolute dollars resulted from the discontinued use of reciprocal advertising transactions and decreases in the number of advertisers and the decrease in the average rate paid by these advertisers. Also, we initiated several cost savings strategies in the first quarter of 2001, which resulted in cancellation of advertising arrangements by our customers which decided that these new strategies did not meet their criteria for advertising promotions. Also, in the first quarter of 2001, we terminated our free hosting arrangements for its citizens, which resulted in decreased page views and therefore decreased the number of banner advertisements served. We believe that the revenues from the sale of banner advertisements can no longer justify the cost of purchasing bandwidth. Reciprocal advertising arrangements are exchanges of similar services between us and the advertiser. These arrangements accounted for approximately 0% and 23% of total revenues for the three months ended March 31, 2001 and 2000, respectively. Reciprocal arrangements were used in our strategy in developing strategic relationships with other advertisers or service providers for non-cash media advertising. We no longer utilize these agreements as the return on investment for these agreements no longer benefits us. Management expects the advertising revenues to continue to be significantly lower in 2001, as compared to 2000. 12 HOSTING REVENUES. Our hosting revenues were approximately $1.06 million and $985,500 for the three months ended March 31, 2001 and 2000, respectively, which represented 89% and 36%, of total net revenues, respectively. For the three months ended March 31, 2001, hosting revenues were a higher percentage of total net revenue as advertising revenues decreased in the three months ended March 31, 2001. Our services are delivered through a state-of-the-art Internet data center located in Southern California using a high-performance Internet backbone network. Customers pay monthly fees for the professional services utilized, one-time installation fees, and monthly connectivity charges. These hosting revenues were recognized in the period the services were provided. We did not receive any one-time installation fees in the first quarter of 2001 and 2000. We have three major corporate customers, as mentioned above, and the loss of any one of these customers will adversely affect our revenues. We have determined that the current relationship with these customers is in good standing. COST OF OPERATIONS. Cost of operations were approximately $1.95 million and $1.77 million for the three months ended March 31, 2001 and 2000, respectively. Cost of operations remained relatively constant year over year, but the higher costs in relation to total net revenue for the three months ended March 31, 2001 were attributable to a fixed contract for bandwidth that was prematurely terminated in February 2001. Beginning in February 2001 we changed our web hosting provider to Alchemy Communications, a carrier in Southern California. This new provider provides similar services but at substantial cost saving to us. We will begin to recognize this benefit in the second quarter of 2001. We have entered into traffic directive arrangements whereas selected web traffic or page views are diverted to interest specific areas of our website and advertisements. These arrangements require special tools and costs to third parties. We began these new arrangements in the fourth quarter 2000. These cost represented approximately 8% or approximately $163,000 of total cost of operations for the three months ended March 31, 2001. There were no similar costs in the three months ended March 31, 2000. SALES AND MARKETING EXPENSES. Sales and marketing expenses were approximately $443,100 and $1.76 million for the three months ended March 31, 2001 and 2000, respectively. The decline in sales and marketing expenses was primarily attributable to the discontinued use of reciprocal online advertising arrangements to increase brand awareness and traditional print and media marketing advertising. We recorded reciprocal advertising expenses in relation to the reciprocal advertising revenues of $651,000 for the three months ended March 31, 2000. There were no similar expenses in 2001. Also, approximately $600,000 of the decline in sales and marketing expense was achieved through the reduction in spending on traditional marketing media expenditures. RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses were approximately $253,100 and $457,100 for the three months ended March 31, 2001 and 2000, respectively. The decline in expense was primarily attributable to the decrease in salaries and bonuses for research and development personnel. The average number of employees during the three months ended March 31, 2001 were 2 verses 6 during the three months ended March 31, 2000. As a result of the competitive nature of the Silicon Valley, we utilized incentive bonuses to retain and recruit these individuals during the three months ended March 31, 2000. In the three months ended March 31, 2001, we did not pay out any incentive bonuses. This decline was offset by the utilization of consultants in the three months ended March 31, 2001 to offset the decreased number of personnel. We continue to experience difficulty in our ability to recruit and retain technical personnel as a result of the current economic prosperity and high cost of living in Silicon Valley and we expect this condition to have a continuous impact on our ability to retain and hire additional technical personnel. 13 GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses were approximately $1.08 million and $1.47 million for the three months ended March 31, 2001 and 2000, respectively. General and administrative costs consisted primarily of salaries and related costs for executives, administrative, and finance personnel, as well as legal, accounting and other professional service fees. Approximately $0.3 million of the decrease in general and administrative expenses were primarily attributable to the reduction in salaries and related benefits and $0.2 million of the decrease is related to the cost controls implemented for professional fees. We recognized a decrease in salaries and related costs during the three months ended March 31, 2001 as a result of the decrease in personnel and incentive bonuses used to retain employees. The above costs savings were offset by increases in insurance costs associated with operating as a publicly traded company. INTEREST EXPENSE. Interest expense was approximately $6,800 and $97,700 for the three months ended March 31, 2001 and 2000, respectively. 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, and to a lesser extent the amortization of deferred interest related to warrants issued in conjunction with the convertible promissory note. The convertible note was fully converted in the second quarter of 2000 and therefore no interest expense was recorded on this note in the first quarter of 2001. INTEREST INCOME Interest income was approximately $179,300 and $26,000 for the three months ended March 31, 2001 and 2000, respectively. The increase is the result of the higher average cash and cash equivalents during the three months ended March 31, 2001. This higher average cash balance is the result of the issuance of common stock in a private placement offering in February 2000. INCOME TAXES. At December 31, 2000, we had net operating loss carryforwards available to reduce future taxable income that aggregate approximately $25.1 million for Federal income tax purposes. These benefits begin to expire in 2017. We also had California net operation loss carryforwards in the amount of $13.4 million, which may be applied to future taxable income until these benefits begin to expire in 2002. Our ability to utilize the net operating loss carryforwards are dependent upon our ability to generate taxable income in future periods and may be limited due to restrictions imposed under Federal and state laws upon change in ownership. LIQUIDITY AND CAPITAL RESOURCES As of March 31, 2001, the Company had cash and cash equivalents of approximately $12.4 million, compared to approximately $13.9 million at December 31, 2000. Net cash used in operating activities equaled approximately $1.5 million and $3.6 million for the three month periods ended March 31, 2001 and 2000, respectively. The decline in cash used was related to the decrease of approximately $407,700 in net loss for the three months ended March 31, 2001 compared to the same three months ended March 31, 2001. We also had significant 14 negative cash flows from changes in our operating assets and liabilities for the three months ended March 31, 2000 compared to the same period in 2001. Changes in our operating assets were the result of lower number of days outstanding for accounts receivable as we improved our collection process and also the decrease in sales volume. Net cash used in investing activities was approximately $14,900 and $14,000 for the three months ended March 31, 2001 and 2000, respectively. Substantially all of the cash used in investing activities for both periods was primarily related to the purchase of capital equipment. We expect to continue to purchase capital equipment to meet our needs. Net cash provided by financing activities was approximately $0 and $22 million for the three months period ended March 31, 2001 and 2000, respectively. Net cash provided by financing activities in 2000 consisted primarily of net proceeds from the issuance of our common stock. We incurred net losses of approximately $2.4 million and $2.8 million for the three months ended March 31, 2001, and 2000, respectively. At March 31, 2001, we had an accumulated deficit of approximately $30 million. The net losses and accumulated deficit resulted from the significant operational, infrastructure and other costs incurred in the development and marketing of our services and the fact that revenues failed to keep pace with such costs. Beginning in the fourth quarter of 2000, we initiated cost reductions in all areas of operations. In the first quarter of 2001, we switched our bandwidth provider and expect future costs savings of approximately $2.0 million per year. We are continuing to review and reduce all expenditures that do not contribute toward our profitability. There can be no assurance that we will ever achieve or sustain profitability or that our operating losses will not increase in the future. We do not have any long-term commitments that currently require a specified capital budget other than normal operations. We believe that current cash, cash equivalents and marketable securities balances will be sufficient to meet our anticipated operating cash needs for at least the next 12 months. With the current control measures implemented in the first and second quarter of 2001, we believe that we will be able to continue to direct our effort towards profitability. We have determined that we may also need to seek additional capital to sustain our operations, fund expansion of our business, to develop new or enhanced services or products, to respond to competitive pressures or to acquire complementary products, businesses or technologies, which might impact our liquidity requirements or cause us to issue additional equity or debt securities. There can be no assurance that financing will be available in amounts or on terms acceptable to us, if at all. We continually evaluate opportunities to sell additional equity or debt securities, obtain credit facilities from lenders for strategic reasons or to further strengthen our financial position. The sale of additional equity or convertible debt securities could result in additional dilution to our stockholders. We cannot assure you that we will be able to achieve and sustain positive cash flow or profitability or that we will have other sources available to provide the financial resources necessary to continue our operations. If we are unsuccessful in generating resources from one or more of the anticipated sources and are unable to replace any shortfall with resources from another source, we may be able to extend the period for which available resources would be adequate by deferring the creation or satisfaction of various commitments, deferring the expansion or introduction of various services, and otherwise scaling back operations. If we were unable to generate the required resources, our ability to meet our obligations and to continue our operations would be adversely affected. 15 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. 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. 16 As of March 31, 2001, 20,399,711 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 March 31, 2001 approximately 6 million additional shares of common stock were eligible for sale under Rule 144. If our stockholders sell substantial amounts of our common stock under Rule 144 or pursuant to the aforementioned registration statements, the market price of our common stock could be adversely affected and our ability to raise additional capital at that time through the sale of our securities could be impaired. FUTURE EXERCISE OF WARRANTS OR ISSUANCES OF SECURITIES MAY SIGNIFICANTLY DILUTE YOUR HOLDINGS. There are currently warrants to purchase 18,650,816 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. 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. 17 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 $1.28 million of the revenues for the year ended December 31, 1999 were derived from credit card transaction processing fees, a revenue stream that has declined significantly and that we do not believe will be material in future periods. In the year 2000, we generated approximately $2.22 million in revenue from reciprocal advertising transactions. We anticipate that these arrangements will not be significant in the future. Accurate predictions regarding our revenues in the future are difficult and should be considered in light of our limited operating history and rapid changes in the ever evolving Internet market. For example, our ability to generate revenues in the future is dependent in part on the success of our capital-raising efforts and the investments that we intend to make in sales and marketing, infrastructure, and content development. Our 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 18 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. - 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 19 Our strategic growth plan calls for development and implementation of broadband services and enhanced content for our subscribers. The availability of many of these tools is dependent on our ability to enter into satisfactory contractual relationships with parties offering related content and services which can be made available to our subscribers, as well as relationships with parties seeking to make online sales to our subscribers and other visitors to our web site. To date, our revenues from broadband services and enhanced content have not been material, and we have yet to launch a number of the services that we hope to provide to our subscribers. We may not be able to commence those services on a timely basis, and there can be no assurance that the services will generate the anticipated amount of revenues. OUR LONG-TERM SUCCESS DEPENDS ON THE DEVELOPMENT OF THE BROADBAND SERVICES MARKET, WHICH IS UNCERTAIN Our future revenues and profits substantially depend upon the widespread acceptance and use of the Internet as an effective medium for the distribution and viewing of broadband content. The use of the Internet for these services is a recent phenomenon. Demand for recently introduced services and products over the Internet and online services is subject to a high level of uncertainty. For example, the distribution and viewing of broadband content over the Internet is at an early stage and buyers may be unwilling to shift their purchasing from traditional vendors of such content to online vendors. If the demand for broadband services does not develop or increase rapidly, this could have a material adverse effect on our results of operations. WE RELY HEAVILY ON THIRD PARTIES FOR DEVELOPMENT OF SOFTWARE AND CONTENT AND FOR ESSENTIAL BUSINESS OPERATIONS AND MAY BE ADVERSELY AFFECTED BY OUR FAILURE TO MAINTAIN SATISFACTORY RELATIONSHIPS WITH SUCH PARTIES. We depend on third parties for important aspects of our business, including: - Internet access; - development of software for new web site features; - content; and - telecommunications. We have limited control over these third parties, and we are not their only client. We may not be able to maintain satisfactory relationships with any of them on acceptable commercial terms, and there is no guarantee that we will be able to renew these agreements at all. Further, we cannot be sure that the quality of products and services that they provide may remain at the levels needed to enable us to conduct our business effectively. 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. 20 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. 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. 21 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. 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. 22 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. 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. 23 At December 31, 2000 we had Federal net operating loss carryforwards available to reduce future Federal taxable income that aggregated approximately $25,143,000 for Federal income tax purposes. These benefits will begin to expire in 2017. Our ability to utilize the net operating loss carryforwards are dependent upon our ability to generate taxable income in future periods and may be limited due to restrictions imposed under Federal and state laws upon change in ownership WE ARE DEPENDENT ON THE CONTINUED DEVELOPMENT OF THE INTERNET INFRASTRUCTURE Our industry is new and rapidly evolving. Our business is highly dependant on the growth of the internet industry and would be adversely affected if web usage and e-commerce does not continue to grow. web usage may be inhibited for a number of reasons, including: - inadequate Internet infrastructure; - security concerns; - inconsistent quality of service; - unavailability of cost-effective, high-speed service; - imposition of transactional taxes; or - limitation of third party service provider's ability and willingness to invest in new or updated equipment to handle traffic volume. If Internet usage grows, the Internet infrastructure may not be able to support the demands placed on it by this growth, or its performance and reliability may decline. We are highly dependant on third party service providers. Any interruption experienced by these service providers may have a material impact on our business due to our inability to serve our advertising customers or end users. In addition, web sites, including ours, have experienced a variety of interruptions in their service as a result of outages and other delays occurring throughout the Internet network infrastructure. If these outages or delays frequently occur in the future, web usage, including usage of our web site, could grow slowly or decline. This may have a material impact on future revenues. WE RELY ON A CONTINUOUS POWER SUPPLY TO CONDUCT OUR OPERATIONS, AND CALIFORNIA'S CURRENT ENERGY CRISIS COULD DISRUPT OUR OPERATIONS AND INCREASE OUR EXPENSES. California is in the midst of an energy crisis that could disrupt our operations and increase our expenses. In the event of an acute power shortage, that is, when power reserves for the State of California fall below 1.5%, California has on some occasions implemented, and may in the future continue to implement, rolling blackouts throughout California. Our computer systems are supplied primary power by power companies in California. In addition, the systems are connected to battery backup systems. This alternative source of power is provided by our hosting provider and is subject to upkeep and maintenance. Our current insurance does not provide coverage for any damages our customers or we may suffer as a result of any interruption in our power supply. If blackouts interrupt our third party power supply, we would be temporarily unable to continue operations at our affected facilities. Although, our third party bandwith provider has assured us that alternative energy supply resources are available, there can be no assurance that such alternative energy supplies will be adequate. Any interruption may affect our ability to continue operations at our corporate facilities could damage our reputation and could result in lost revenue, which could have a material adverse effect on our business, operating results and financial condition. In addition, our employees may be personally impacted and unable to commute to or from work during these rolling blackouts. Any or all of these factors may have adverse impact on our business. 24 ADOPTION OF THE INTERNET AS AN ADVERTISING MEDIUM IS UNCERTAIN. The growth of Internet sponsorships and advertising requires validation of the Internet as an effective advertising medium. This validation has yet to fully occur. In order for us to generate sponsorship and advertising revenues, marketers must direct a significant portion of their budgets to the Internet and, specifically, to our web site. To date, sales of Internet sponsorships and advertising represent only a small percentage of total advertising sales. Also, technological developments could slow the growth of sponsorships and advertising on the Internet. For example, widespread use of filter software programs that limit access to advertising on our web site from the Internet user's browser could reduce advertising on the Internet. Our business, financial condition and operating results would be adversely affected if the market for Internet advertising fails to further develop due to the loss of anticipated revenues. BREACHES OF SECURITY ON THE INTERNET MAY SLOW THE GROWTH OF E-COMMERCE AND WEB ADVERTISING AND SUBJECT US TO LIABILITY. The need to securely transmit confidential information, such as credit card and other personal information, over the Internet has been a significant barrier to e-commerce and communications over the 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: 25 - liabilities or claims resulting from unsolicited e-mail; - lost or misdirected messages; - illegal or fraudulent use of e-mail; or - interruptions or delays in e-mail service. These claims could result in substantial costs and a diversion of our management's attention and resources. Efforts to regulate or eliminate the use of mechanisms which automatically collect information on users of our web site may interfere with our ability to target our marketing efforts and tailor our web site offerings to the tastes of our users. Web sites typically place a tracking program on a user's hard drive without the user's knowledge or consent. These programs automatically collect data on anyone visiting a web site. Web site operators use these mechanisms for a variety of purposes, including the collection of data derived from users' Internet activity. Most currently available web browsers allow users to elect to remove these mechanisms at any time or to prevent such information from being stored on their hard drive. In addition, some commentators, privacy advocates and governmental bodies have suggested limiting or eliminating the use of these tracking mechanisms. Any reduction or limitation in the use of this software could limit the effectiveness of our sales and marketing efforts. WE COULD FACE ADDITIONAL BURDENS ASSOCIATED WITH GOVERNMENT REGULATION OF AND LEGAL UNCERTAINTIES SURROUNDING THE INTERNET. Any new law or regulation pertaining to the Internet, or the application or interpretation of existing laws, could have a material and adverse effect on our business, results of operations and financial condition due to increased costs of doing business. Laws and regulations directly applicable to Internet communications, commerce and advertising are becoming more prevalent. The law governing the Internet, however, remains largely unsettled, even in areas where there has been some legislative action. It may take years to determine whether and how existing laws governing intellectual property, copyright, privacy, obscenity, libel and taxation apply to the Internet. In addition, the growth and development of e-commerce may prompt calls for more stringent consumer protection laws, both in the United States and abroad. We also may be subject to future regulation not specifically related to the Internet, including laws affecting direct marketers. 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 26 that we either intentionally or negligently interfered with the plaintiffs' contract or prospective advantage. A Case Management Conference is currently scheduled for May 10, 2001 at which time the parties must represent to the court whether or not this matter is ready to be set for trail. 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. On May 1, 2001 seven shareholders of Nettaxi filed a law suit against Nettaxi in the United States District Court for the Central District of California (Case No. SACV 01-459 AHS). The complaint names Robert Rositano, Jr. our Chief Executive Officer, Dean Rositano, our President and Glenn Goelz our former Chief Financial Officer as additional defendants. The complaint alleges the company violated securities laws in connection with the Company's February 2000 private placement. Three of the seven plaintiffs purchased shares of Nettaxi common stock in the February 2000 private placement completed by Nettaxi. Although we believe the allegations made in the complaint are without merit and will defend the action vigorously, there can be no assurance that we will prevail in this dispute. If the plaintiffs successfully prosecute any of their claims against us, the resulting monetary damages and reduction in our working capital could significantly harm our business ANTI-TAKEOVER PROVISIONS AND OUR RIGHT TO ISSUE PREFERRED STOCK COULD MAKE A THIRD PARTY ACQUISITION OF US DIFFICULT. We are a Nevada corporation. Anti-takeover provisions of Nevada law could make it more difficult for a third party to acquire control of us, even if such change in control would be beneficial to stockholders. Our articles of incorporation provide that our board of directors may issue preferred stock without stockholder approval. The issuance of preferred stock could make it more difficult for a third party to acquire us. All of the foregoing could adversely affect prevailing market prices for our common stock. OUR COMMON STOCK PRICE IS LIKELY TO BE HIGHLY VOLATILE AS IS TYPICAL OF INTERNET COMPANIES. The market price of our common stock has been, and is likely to continue to be, highly volatile as the stock market in general, and the market for Internet-related and technology companies in particular, has been highly volatile. Investors may not be able to resell their shares of our common stock following periods of volatility because of the market's adverse reaction to volatility. The trading prices of many technology and Internet-related companies' stocks have decreased substantially within the last 52 weeks. The market downturn and adjustment for the high valuations for internet companies may not return to the levels of late 1999 and early 2000. We cannot assure you that our stock will trade at the same levels of other Internet stocks or that Internet stocks in general will regain their prior market prices. The per share closing price of our common stock in 2001 ranged from a high of $0.28 as of February 6, 2001 to a low of $0.13 as of March 21, 2001. In addition, an active public market for our common stock may not continue. 27 Factors that could cause such volatility may include, among other things: - actual or anticipated fluctuations in our quarterly operating results; - announcements of technological innovations; - conditions or trends in the Internet industry; and - changes in the market valuations of other Internet companies. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. During the three months ended March 31, 2001, we did not have any long term debt obligations. Therefore, an immediate 10% increase in market interest rates would not have a material adverse effect on our financial position. We currently do not have any material market rate risks. We could be exposed to market risk related to any debt obligations for financing working capital and capital equipment requirements in the future. Historically, we have financed such requirements from the issuance of both preferred and common stock. We continue to consider financing alternatives, which may include the incurrence of long term indebtedness. Actual capital requirements may vary based upon the timing and success of the expansion of our operations. We believe that based on the terms and maturities of any future debt obligations that the market risk would be minimal. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. On July 9, 1999, four disaffected shareholders in Simply Interactive, Inc., led by Ronald Ventre, filed an action in the Santa Clara County Superior Court against Nettaxi, our wholly owned subsidiary Nettaxi Online Communities, Inc., Robert A. Rositano, Jr., Dean Rositano, Glenn Goelz, Warren J. Kaplan, Frank McGrath, Bruno Henry, Alan K. Fetzer, Robert Divenere, Robert A. Rositano, Sr., SSN Properties, LLC and others. The case number is CV 783127. In August, 1999 this claim was consolidated with another claim filed by Carlo Bruno, et al., on September 17, 1998. The parties have attended mediation which has proved to be unfruitful. A Case Management Conference is currently scheduled for May 18, 2001, at which time the parties must represent to the court whether or not this matter is ready to be set for trial. A request for production of documents and form interrogatories have been served on Nettaxi; however, the plaintiffs have granted an open extension in which to answer. On May 1, 2001 seven shareholders of Nettaxi filed an action against Nettaxi in the United States District Court for the Central District of California (Case No. SACV 01-459 AHS). The complaint also names Robert Rositano, Jr. our Chief Executive Officer, Dean Rositano, our President, and Glenn Goelz our former Chief Financial Officer as additional defendants. Due to factual misrepresentations in the complaint, we anticipate that an amended complaint will be filed. 28 The complaint alleges that we violated securities laws in connection with our February 2000 private placement. Only three of the seven plaintiffs actually purchased shares of Nettaxi common stock in the February 2000 private placement. Prior to filing the complaint, the plaintiffs demanded the refund of all of the money invested in Nettaxi and demanded that the exercise price of the warrants issued in the private placement be reduced from $4.00 to $0.25 per share. Additionally, prior to the filing the complaint, Nettaxi was asked to invest capital in a company affiliated with one of the plaintiffs. In the complaint, the plaintiffs are seeking compensatory damages, injunctive relief and fees and interest. We believe that the allegations made in the complaint are completely without merit and that this law suit reflects shareholder frustration over the recent downturn in the stock market. We will defend the action vigorously. From time to time, we are involved in legal proceedings incidental to our business. We believe that these pending actions, individually and in the aggregate, will not have a material adverse effect on our financial condition, and that adequate provision has been made for the resolution of such actions and proceedings. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. (1) From January to March, 2001 the Company under its 1999 Stock Option Plan issued options to purchase up to 1,705,000 shares of common stock to employees with exercise prices ranging from $0.14 to $0.185 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 were made without general solicitation or advertising. The purchasers were sophisticated investors with access to all relevant information necessary to evaluate the investments, and who represented to the Company that the shares were being acquired for investment. ITEM 3. DEFAULTS UPON SENIOR SECURITIES. None ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None ITEM 5. OTHER INFORMATION. Not applicable. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. 29 (a) Exhibits None. (b) Reports on Form 8-K No reports on Form 8-K were filed during the quarter ended March 31, 2001. 30 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934,the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. NETTAXI.COM Date: May 15, 2001 By: /s/ Dean Rositano ------------------- Dean Rositano, President and Interim Chief Financial Officer (Principal Accounting Officer) 31 EXHIBIT INDEX Exhibit Number Description of Exhibit - --------------- ------------------------ 32 -----END PRIVACY-ENHANCED MESSAGE-----