10-K 1 doc1.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, 2001 COMMISSION FILE NUMBER: 0-26109 _________________ NETTAXI.COM (Exact name of registrant as specified in its charter) _________________ NEVADA 82-0486102 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 1875 S. Bascom Avenue; No. 116, Campbell, CA 95008 (Address of Principal Executive Offices Including Zip Code) (408) 879-9880 (Registrant's telephone number, including area code) _________________ SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: None SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: Common Stock, $.001 par value Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by a check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [_] As of February 12, 2002, the approximate aggregate market value of voting stock held by non-affiliates of the registrant was $7,584,917 (based upon the closing price for shares of the registrant's common stock as reported by the O-T-C Bulletin Board on that date). Shares of common stock held by each officer, director, and holder of 5% or more of the outstanding common stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. As of February 12, 2002, the registrant had 43,124,586 shares of common stock, $.001 par value per share, outstanding. NETTAXI.COM FORM 10-K TABLE OF CONTENTS PART I ------ ITEM 1. Description of Business 4 ITEM 1A. Risk Factors 15 ITEM 2. Properties 22 ITEM 3. Legal Proceedings 22 ITEM 4. Submission Of Matters To A Vote Of Security Holders 23 PART II ------- ITEM 5. Market For The Registrant's Common Stock And Related Stockholder Matters 24 ITEM 6. Selected Consolidated Financial Data 26 ITEM 7. Management's Discussion And Analysis Of Financial Condition And Results Of Operations 26 ITEM 7A. Quantitative And Qualitative Disclosures About Market Risk 37 ITEM 8. Financial Statements And Supplementary Data 37 ITEM 9. Changes In And Disagreements With Accountants On Accounting And Financial Disclosure 37 PART III -------- ITEM 10. Directors And Executive Officers Of The Registrant 38 ITEM 11. Executive Compensation 42 ITEM 12. Security Ownership Of Certain Beneficial Owners And Management 48 ITEM 13. Certain Relationships And Related Transactions 49 PART IV ------- ITEM 14. Exhibits, Financial Statement Schedules, And Reports On Form 8-K 51 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 content and Internet based services for consumers and businesses. Our web site at www.nettaxi.com serves as a gathering place for people with shared topics of interest, as well as an entry point, referred to as a portal, to the Internet. Through our web site, we provide content addressing a number of targeted affinity categories such as news, sports, entertainment, health, politics, finances, lifestyle, and other areas of interest. Visitors to our web site are provided with this content. Subscribers to our web site are also provided with access to enhanced content such as broadband video clips, email accounts and personal web pages. Our original revenue model included access to web site hosting services and a broad range of content for our individual subscribers, or "citizens", and access to a population of Internet users for affiliated businesses for advertising and promotional purposes. During 2000, we focused our efforts on improving the quality of content available on our web site, implementing our web site hosting services and reducing our operating costs by eliminating unprofitable services . We devoted significant resources to developing our content and our services, including developing an infrastructure and building a management team. We also focused on developing consumer loyalty and increasing our overall level of traffic and citizenship. In 2001, we faced the challenges of an overall downturn in the Internet industry and the economy in general. The bankruptcy and liquidation of many of our Internet-based customers and suppliers caused us to re-evaluate our business model. Since the Internet infrastructure is unstable and customer base 4 financially weak, we first took corrective action to significantly decrease our cash burn. Beginning in May 2001, we reduced the salaries of our employees and the number of personnel, marketing expenses and costs associated with our hosting activities. At the same time, we re-evaluated the viability of our web site hosting and Internet connectivity services. Prior to June 2001, we provided these services to corporate customers through a state-of-the-art Internet data center located in Southern California using a high-performance Internet backbone network. Customers paid monthly fees for the professional services utilized, one-time installation fees, and connectivity charges. These "hosting" revenues were recognized in the period the services were provided. Hosting revenues were variable, based upon bandwidth usage and services used, and resulted in operating losses from time to time. As a result of our evaluation, we terminated our significant co-hosting customer contracts effective July 7, 2001. We also discontinued the purchase of bandwidth and premium services from our third party provider, further reducing monthly expenditures. Beginning in the third quarter of 2001, the terminations have reduced our operating expenses, but have also materially affected our revenues. As of December 31, 2001 we had incurred losses of approximately $36.2 million. In spite of our cost cutting measures, there can be no assurance that our operating losses will not increase in the future. We continue to operate our website, however, we have focused our energies on our acquisition strategy and therefore have not pursued any revenue generating activities in the last six months of 2001. While curtailing operations in 2001, we also undertook an analysis to determine the best course of action to maintain and enhance the value of our company. Given the challenges facing Internet-based business models, including but not limited to the decline in advertising, we decided that our then-current business model would not support future growth. We implemented an acquisition strategy pursuant to which we sought to identify an appropriate entity with which to merge, acquire or restructure our current business. Since the announcement of our acquisition strategy in May 2001, we have evaluated a number of potential merger candidates in a wide variety of industries. RECENT DEVELOPMENTS On January 9, 2002 we entered into a merger agreement under which we agreed to merge with RAE Systems Inc., a California corporation that designs and manufactures portable gas detection instruments and wireless monitoring and communications equipment. If the merger is consummated, we will abandon our business model and adopt the business model of RAE Systems. The merger is subject to the approval of our stockholders. Further information regarding the merger will be filed with the Securities and Exchange Commission relating to our solicitation of proxies from our stockholders with respect to the merger. Mergers carry numerous risks and uncertainties and we cannot guarantee that we will be able to successfully integrate any businesses, products, technologies or personnel that might be acquired in the future. 5 INDUSTRY BACKGROUND The Internet has been a significant medium for global communications. Millions of people around the world use the Internet to send and receive information, for entertainment, current events and to purchase products and services. Nevertheless, companies in the Internet industry struggled in 2001. "The Internet downturn casts a wide arc mowing down the strong, the weak and the in-between." The Industry Standard, Layoffs, Losses and Closures Continue in Telecom Sector August 2, 2001. The downturn in the industry particularly hurt companies that advertise on the Internet. The Industry Standard, At Online Ad Conference, More Questions Than Answers August 10, 2001. PORTALS. Portal web sites, such as ours, provide a single online location where users can interact and find and share pertinent information, products and services related to their particular interests or needs. Portal sites generally offer free services including access to e-mail accounts, chat rooms, message boards, news and entertainment. These features tend to increase user loyalty towards particular portal web sites. Users with an email account with a particular web site are likely to repeat visits to the web site on a regular basis to check email and gather other information. ADVERTISING. Prior to 2001, the Internet was an attractive medium for advertisers. The Internet has allowed advertisers to demographically target their messages to groups of Internet users with particular interests, in a manner not available through the means of traditional media. The Internet has also provided to advertisers a unique level of interactivity and measurability. Advertisers can use the Internet to display messages on certain web pages. These messages are referred to as impressions. Consumers wishing for more information on the advertised topic can use their computers to click, or click-through, on those impressions and move through to other web pages which provide the information sought. Using the Internet, advertisers can change their advertisements frequently in response to market factors, current events and consumer feedback. Advertisers can also track the effectiveness of their advertising messages by receiving reports of the number of advertising impressions delivered to consumers and the corresponding number of times that consumers click on those impressions and move through to the advertised web page. CONTENT. The Internet offers content providers mechanisms that combine cost advantages with practices designed to generate revenue. The Internet provides information dissemination at a materially lower cost than do other forms of media, notably, both printed paper and private networks. The Internet also offers the potential for easier access to content, which can expand market coverage. MARKETING PLANS & PROGRAMS Prior to May 2001, we focused our efforts on marketing, improving the quality of content and hosting services available on our web site, and reducing our operating costs by eliminating many of the services which were not profitable. In this regard, we developed a number of new promotions designed to generate new sources of revenue and build customer loyalty. These tools and services included: 6 BROADBAND CONTENT. We developed relationships with content publishers to assist in generating revenue through distribution, branding, awareness, and promotions. In 2000 we added sources of new content that allow users to view videos covering music, sports and other subjects. Users are required to register as subscribers to our web site prior to viewing the content. Advertisements are also displayed to users while progressing through the registration process. Although we continue to offer these services to subscribers to our web site, the revenues generated from these services in 2001 were not significant. TARGETED AFFINITY CATEGORIES. We have organized information on our web site into an extensive network of communities with a wide variety of themes, including entertainment, government, home living, sports, finance, society and culture. Users interested in particular themes can access those themes quickly and easily. This creates marketing opportunities for media companies, Internet service providers, and Internet content companies. IMPROVED SEARCH METHODOLOGY. We had developed a metasearch engine that enabled users to search multiple sites simultaneously and return the results to one web page. This feature drove users to our web site, but did not generate sufficient revenue. We have revised our search methodology to provide context driven searches where advertisers purchase their placement in the search engine. For example, a user of our web site may choose the subject "music" to search. After the choice is made, the results of the search are presented in a list on a new web page. Advertisers pay for premium placement at the top of the list. This allows advertisers to bid for product placement on our web site and increases revenue generated from our search services. Although we continue to offer these services, the revenues generated from these services in 2001 were not significant. SEASONAL PROMOTIONS. During 2000, we implemented seasonal promotions designed to drive Internet users to our e-commerce affiliates. For example, in December 2000 we launched a promotion for Storerunner Network, Inc. Storerunner.com placed advertisements for products it was selling as part of a holiday sale on our web site. Users of our web site could click on the Storerunner advertisements and move to the Storerunner.com web site and purchase the products. Our agreement provided that we receive revenue for each user that accessed the Storerunner.com site from our web site. Although this promotion successfully increased the amount of traffic on our site, we discontinued further services with Storerunner.com after they filed for protection under Chapter 11 of the United States Bankruptcy Code in February 2001. SUBSCRIBER SERVICES. During 2000, we revised the scope of services offered to users of our web site to eliminate many of the free services which were available. Currently, users are offered access to free services such as email accounts and a limited variety of content such as video clips and information. Users desiring additional services such as video clips may become subscribers. Despite the implementation of these tools and services, our revenues failed to keep pace with the costs associated with their implementation. We believe this was the result of a downturn in the Internet industry and the economy in general. As a result, in May 2001, in connection with the adoption of our acquisition strategy, we reduced our marketing efforts significantly. 7 BUSINESS SERVICES OUR WEB SITE Information on our web site at www.nettaxi.com is divided into topic areas which we refer to as affinity groups. We refer the registered users of our web site as citizens. Our web site provides access to information on news, sports, entertainment and other areas of interest. Citizens also have access to Internet related services such as chat services and free e-mail accounts. When users first arrive at www.nettaxi.com, they find hyperlinks to the information categories we provide, such as: - Member services and registration; - Information sorted by topical areas of interest; and - Content such as movies, sports clips and other broadband content. Upon selecting one of the links, for example entertainment, a web page containing articles and information about entertainment appears along with an extensive list of categories, or more specific search topics, such as music and television. Choosing the more specific search topic will further focus your search to uncover more specific information. APPLICATIONS AND FEATURES We offer a range of applications and features to our citizens through our web site, including the following: OUR SEARCH ENGINE. Users of our web site can access our specially configured search engine, which we refer to as our taxi, located in all areas and levels of our web site. Users may use the search engine by typing in a search topic such as sports, and they are quickly presented with a list of hyperlinks to web pages carrying sports related information. Advertisers on our site compete for placement in the search results by paying fees to us. The advertisers that pay the highest fees are brought to the top of the list of search results. Although we continue to offer these services on a limited basis, the revenues generated from these services in 2001 were not significant. E-MAIL SERVICES. Our e-mail services allow users to access their accounts, through both Post Office Protocol, POP, and the Internet, IMAP. POP e-mail is the type most commonly used by Internet service providers. Its primary advantage for users is that messages are sent and received quickly and with more privacy, because they do not stay resident on a server for any length of time. Its greatest disadvantage is that e-mail messages, once delivered to a user, are generally no longer available for download again, so that a user who downloads e-mail to a home computer, for example, will generally not be able to download the same mail at a later time to another computer, such as one at work. IMAP, or web-based e-mail, most commonly used by portal services, allows users to 8 retrieve e-mail messages from any location that offers access to the Internet and a specific web site. Sending and receiving messages may be a bit slower than POP services, but messages are stored on a server, can be retrieved multiple times, and remain available until they are either specifically deleted by the user, or a set amount of time has passed. CONTENT. Prior to May 2001, we developed relationships with providers of premium content in a variety of categories. The purpose of these relationships was not to directly generate revenue, but rather to enhance the quantity and quality of information and content on our web site so that visitors would be drawn to our web site. During 2001, we had formal relationships with the three premium content providers described below and they provided substantially all of the content on our web site that is provided by outside parties. The providers are listed in order by the amount of content they provided to us. - SCREAMINGMEDIA. In April 2000, we entered into a license agreement with ScreamingMedia, an aggregator of a broad range of content such as current events, daily horoscopes, world news, travel, medicine and health for syndication to Internet portals and destination sites. The license agreement has a one year term and automatically renews for successive one-year periods unless terminated. We paid a monthly license fee of $5,000 for use of ScreamingMedia's content, which constituted the majority of our outside party content. In connection with our acquisition strategy, we terminated our agreement with ScreamingMedia, effective in February 2002. - ACTIVEWORLDS. In March 2001, we launched a new area within our web site pursuant to an agreement we entered into in August 2000 with ActiveWorlds.com, Inc., a Delaware corporation. Users that visited our web site, downloaded the appropriate software and paid a monthly fee could access a series of web pages complete with three dimensional graphics. The graphics were designed so that the area had the look and feel of an urban environment. In connection with our acquisition strategy, we have terminated our agreement with ActiveWorlds. Although we were to receive a portion of the fees collected by ActiveWorlds from users of our site that subscribed to the service, revenues from this agreement were not significant in 2001. - STORERUNNER.COM. In September 2000, we entered into an agreement with StoreRunner Network, Inc. under which we placed Storerunner advertisements on our web site and were to be compensated based on the number of visitors to our site that visited the Storerunner site. Although this agreement resulted in increased traffic on our web site, we discontinued further services with Storerunner.com after it filed for protection under Chapter 11 of the United States Bankruptcy Code in February 2001. WEB SITE HOSTING SERVICES Prior to the adoption of our acquisition strategy in May 2001, we offered our registered users web site hosting services. Using these services, we hosted the web sites of over 300 individuals or businesses. These services generally fell into two categories. First, we hosted web pages for subscribers to our web site for a monthly fee. The minimum fee for the services was $19.95 per month. Subscribers to these services were provided with storage space and bandwidth to support their web 9 sites. The fee increased depending on the amount of bandwidth and storage space used by the subscriber. At times, hosting revenues failed to keep pace with the costs of bandwidth and other related costs. We terminated these hosting services following the adoption of our acquisition strategy in May 2001. Second, we provided Internet hosting and connectivity for larger corporate customers. These services involved our maintenance of the servers which hosted the web sites of these customers. For example, we had an agreement with White Sand Communications, Inc. pursuant to which we hosted its web site servers and provided support for the overall operation of the servers. Our services were delivered through Alchemy Communications at its Internet data center located in Los Angeles, California. Customers paid monthly fees for the professional services utilized, one-time installation fees, and monthly connectivity charges. These hosting revenues were recognized in the period the services were provided. Hosting revenues were variable, based upon bandwidth usage and services used, and resulted in operating losses from time to time. In connection with our acquisition strategy, we terminated our significant co-hosting customer contracts effective July 7, 2001. In connection with this, we also discontinued the purchase of bandwidth and premium services from our third party provider. The terminations have reduced our operating expenses, and materially affected our revenues beginning in the third quarter of 2001. SUBSCRIBER SERVICE PLANS AND ASSISTANCE Prior to the adoption of our acquisition strategy in May 2001, we offered both free and premium accounts, on a tiered basis: (i) free citizen accounts, which provided e-mail service for one personal account and access to chat sessions, message boards, shopping and premium content; and (ii) premium account, which allowed subscribers to build premium accounts from a menu of options including unlimited e-mail accounts, disk space for web page hosting and access to promotional opportunities. We ceased offering premium accounts to users following the adoption of our acquisition strategy in May 2001. If we consummate the merger with RAE Systems, the free account services will be terminated. CUSTOMERS ADVERTISING CUSTOMERS. In 2000 we attracted both mass market consumer product companies and technology-related businesses advertising on the Internet. However, due to a variety of factors including the downturn in the Internet industry and the economy in general, we failed to generate substantial revenues from the sale of advertising. In May 2001, in connection with our acquisition strategy, we ceased aggressively marketing our advertising services. Although we continue to operate our web site and to sell advertising on our web site, advertising revenues have declined substantially. No advertising customer accounted for more than ten percent of our revenues in 2001. Advertisers and advertising agencies enter into short-term agreements, on average one to two months with us, pursuant to which they receive a guaranteed number of impressions for a fixed fee. If the guaranteed number of impressions is not delivered, the term of the agreements are extended until the impressions can be delivered. Advertising on our site currently consists of banner-style 10 advertisements that are prominently displayed at the top of pages on a rotating basis throughout the web pages in our web site. From each banner advertisement, viewers can hyperlink directly to the advertiser's own web site, thus providing the advertiser an opportunity to directly interact with an interested customer. Our standard cost per thousand impressions depends upon a number of factors including the location of the advertisement, its size and the extent to which it is targeted for a particular audience. Discounts from standard cost per thousand impressions rates may be provided for higher volume, longer-term advertising contracts. We also received advertising revenue as a result of the adoption of our revised search methodology. Our search methodology uses context driven searches where advertisers purchase their placement in the search engine. For example, a user of our web site may choose the subject "music" to search. After the choice is made, the results of the search are presented in a list on a new web page. Advertisers pay for premium placement at the top of the list. This allows advertisers to bid for product placement on our web site. WEB SITE HOSTING CUSTOMERS. Prior to the adoption of our acquisition strategy in May 2001, we offered our registered users web site hosting services. Using these services, we hosted the web sites of over 300 individuals or businesses. These services generally fell into two categories. First, we hosted web pages for subscribers to our web site for a monthly fee. The minimum fee for these services was $19.95 per month. We also provided Internet hosting and connectivity for larger corporate customers. These services involved our maintenance of the servers which host the web sites of these customers. For the twelve months ended December 31, 2001, web hosting revenues accounted for approximately 90% of total revenues. We terminated all of our web site hosting services following the adoption of our acquisition strategy in May 2001 and revenues declined substantially. In August 1999, we entered into a Data Center Service Agreement with White Sand Communications, Inc. We provided White Sand Communications with space in our Data Center and provided support for the overall operation of the their web servers. The fee for this agreement was a monthly recurring fee which included charges for use and occupancy of the Data Center, connectively fee, power charges, and where applicable, technical support and system administration fees. The term of the agreement was one year. This agreement accounted for 19% of our revenues in 2001, 11% of our revenue in 2000 and 17% of our revenue in 1999. We terminated this agreement as of July 7, 2001. In July 1999, we entered into a Data Center Service Agreement with Babenet, Ltd, a California corporation. We provided Babenet with space in our Data Center for their web servers and provide support for the overall operation of the their web servers. The fee for this agreement was a monthly recurring fee which included charges for use and occupancy of the Data Center, connectively fee, power charges, and where applicable, technical support and system administration fees. The term of this agreement was one year and continued on a monthly basis thereafter. This agreement accounted for 47% of our revenues in 2001 and 20% of our revenue in 2000. We terminated this agreement as of July 7, 2001. In July 1999, we entered into a Data Center Service Agreement with Whitehorn Ventures , Ltd, a California corporation. We provided Whitehorn Ventures with space in our Data Center for their web servers and provide support for the overall operation of the their web servers. The fee for this agreement was a monthly recurring fee which included charges for use and occupancy of the Data Center, connectively fee, power charges, and where applicable, technical support and system administration fees. The term of this agreement was one year and continued on a monthly basis thereafter. This agreement accounted for 25% of our revenues in 2001 and 8% of our revenue in 2000. We terminated this agreement as of July 7, 2001. 11 ADVERTISING SALES AND DESIGN Prior to May 2001, we focused our efforts on creating advertising opportunities designed to build brand loyalty for our corporate sponsors by seamlessly integrating their advertising messages into our content. Following the adoption of our acquisition strategy in May 2001, we terminated substantially all of our efforts in this regard. SALES AND MARKETING Prior to the adoption of our acquisition strategy in May 2001, we committed substantial resources to sales and marketing activities, including offline and online media advertising. Our sales and marketing efforts were focused on: - Generating additional traffic to our site; - Building and defining a desirable online destination for consumers and businesses; and - Creating and enhancing our brand within the Internet and online industries. These efforts were costly and not consistent with our acquisition strategy adopted in May 2001. As a result we terminated substantially all of our efforts in this regard. OPERATING INFRASTRUCTURE At this time, the basic components of our technology infrastructure are in place and operational. Our UNIX-based electronic network for Nettaxi.com operates on a one terabyte Ethernet backbone, with two Cisco Systems Ethernet switches that prevent collisions on the network. Traffic direction for the web servers is handled by Arrowpoint's CS-100, which tracks server load conditions in real time and sends traffic to the most appropriate server to spread around and balance the load. The network is comprised primarily of Sun Microsystems high-capacity servers, and include a mix of Enterprise 450s, Ultra 1, and Ultra 5 models, all running the newest version of Sun's Solaris operating environment for network systems. These servers collectively provide approximately 1.6 terabytes of hard drive space for subscriber capacities. In addition, the network currently includes NT servers to handle registration and selected other database functions, using Microsoft's SQL database software. 12 Our electronic network was located at Alchemy Communications in Los Angeles, California. We had a Gigabit Data Services Agreement with Alchemy Communications pursuant to which they provided us with a secure location for our network servers, multiple high-speed Internet connections, and access to 24-hour-a-day, 7-day-a-week technical support personnel and services. Alchemy Communications also provided routing, redundancy, streaming media and maintenance services for the network and its Internet connections, as well as a back-up power supply capable of continuing network operations for up to a week in the event of a power failure. We paid monthly fees for these services. In 2002, in connection with the adoption of our acquisition strategy and the termination of our web hosting services, we terminated our agreement with Alchemy. COMPETITION The markets in which our web site is engaged are new, rapidly evolving and intensely competitive, and we expect competition to intensify further in the future. Barriers to entry are relatively low, and current and new competitors can launch new sites at a relatively low cost using commercially-available software. Our web site competes with a number of other companies for users, advertisers and electronic commerce marketers, including a number of large online communities and services that have expertise in developing online commerce, and a number of other small services, including those that serve specialty markets. Other companies that offer web site hosting, email, and content services include MegaGo.com, theglobe.com, Yahoo!, Homestead.com, Angelfire, Fortune City, Lycos, and Talk City and, in the future, Internet communities may be developed or acquired by companies currently operating Internet directories, search engines, shareware archives, content sites, Internet Service Providers and other entities, which may have more resources than ours. In addition, our web site faces competition from traditional media companies, a number of which, including CBS, Fox and NBC, have made significant acquisitions or investments in Internet companies. Furthermore, we compete for users and advertisers with other content providers and with thousands of web sites operated by individuals, the government and educational institutions. Such providers and sites include AOL, Angelfire, CNET, CNN/Time Warner, Excite, Hotmail, Infoseek, Lycos, Microsoft, Netscape, Switchboard, ESPN.com, ZDNet.com and Yahoo! Many of our competitors have longer operating histories, larger customer bases, greater brand recognition in other business and Internet markets and significantly greater financial, marketing, technical and other resources than us. In addition, other online services may be acquired by, receive investments from or enter into other commercial relationships with larger, well-established and well-financed companies as use of the Internet and other online services increases. Many of our competitors have continued to devote substantial resources to marketing and promotional campaigns, adopting more aggressive pricing policies and enhancing web site and systems development. These competitors may have gained a significant advantage over us while we have limited our similar expenditures in connection with the adoption of our acquisition strategy. This advantage may prevent our web site's ability to attract users in the future. 13 INTELLECTUAL PROPERTY We currently have pending applications before the United States Patent and Trademark Office for trademark and service mark protection for "Nettaxi" and "NetroNews". If these applications are approved, protection will be available for the periods prescribed by law. The protection of our copyrights, service marks, trademarks, trade dress and trade secrets are were important to the success of our web site, but are not necessarily important in connection with our acquisition strategy. We have entered into confidentiality and invention assignment agreements with our employees and contractors in order to limit access to and disclosure of our proprietary information. There can be no assurance that these contractual arrangements or the other steps taken by us to protect our intellectual property will prove sufficient to prevent misappropriation of our technology or to deter independent third-party development of similar technologies. Our web site also relies upon on technologies that we license from third parties, such as the suppliers of key database technology, the operating system and specific hardware components for our products and services. These licenses extend for terms ranging from one year to perpetuity and are subject to satisfaction of conditions laid out in the specific licensing agreements. There can be no assurance that these third-party technology licenses will continue to be available to us on commercially reasonable terms. Although we do not believe that we infringe the proprietary rights of third parties, there can be no assurance that third parties will not claim infringement by us with respect to past, current or future technologies. We expect that participants in our markets will be increasingly subject to infringement claims as the number of services and competitors in our industry segment grows. Any such claim, whether meritorious or not, could be time-consuming, result in costly litigation and could prevent our ability to enter into an acquisition. As a result, any such claim could have a material adverse effect upon our business, results of operations and financial condition. GOVERNMENT REGULATION Our company, operations and products and services are all subject to regulations set forth by various federal, state and local regulatory agencies. We take measures to ensure our compliance with all such regulations as promulgated by these agencies from time to time. The Federal Communications Commission sets standards and regulations regarding communications and related equipment. There are currently few laws and regulations directly applicable to the Internet. It is possible that a number of laws and regulations may be adopted with respect to the Internet covering issues such as user privacy, pricing, content, copyrights, distribution, antitrust and characteristics and quality of products and services. The growth of the market for online commerce may prompt calls for more stringent consumer protection laws that may impose additional burdens on those companies conducting business online. Tax authorities in a number of states are currently reviewing the appropriate tax treatment of companies engaged in online commerce, and new state tax regulations may subject us to additional state sales and income taxes. 14 In addition, because our web site is accessible worldwide, other jurisdictions may claim that we are required to qualify to do business as a foreign corporation in a particular state or foreign country. Our failure to qualify as a foreign corporation in a jurisdiction where it is required to do so could subject us to taxes and penalties for the failure to qualify and could result in our inability to enforce contracts in such jurisdictions. Any such new legislation or regulation, or the application of laws or regulations from jurisdictions whose laws do not currently apply to our business, could have a material adverse effect on our business, results of operations and financial condition. EMPLOYEES As of December 31, 2001, we had four employees, all of whom were involved in administration and finance. Technical assistance with our limited web site operations have been provided by consultants. We have never had a work stoppage, and no employees are represented under collective bargaining agreements. We consider our relations with our employees to be good. ITEM 1A. RISK FACTORS Our business, financial condition or results of operations could be materially and adversely affected by any of the following risks. WE HAVE INCURRED LOSSES SINCE OUR INCEPTION, AND EXPECT LOSSES FOR THE FORESEEABLE FUTURE. Since our inception, we have incurred net losses, resulting primarily from costs related to developing our web site, attracting users to our web site and establishing the Nettaxi.com brand. At December 31, 2001, we had an accumulated deficit of $36,238,200. Losses have continued to grow faster than our revenues during our limited operating history. Because of the bankruptcy and liquidation of many of our Internet based customers and suppliers and because of the reduction of our operating activities and expenditures in connection with our acquisition strategy, we expect to incur significant net losses for the foreseeable future. We may never achieve profitability. ACQUISITIONS IN CONNECTION WITH OUR ACQUISITION STRATEGY MAY DISRUPT OR OTHERWISE HAVE A NEGATIVE IMPACT ON THE VALUE OF OUR BUSINESS. We are seeking to acquire a businesses that we believe will enhance the value of our company. In this regard, we have agreed to merger with RAE Systems Inc. The merger remains subject to certain conditions to closing as well as the approval of our shareholders. If the Merger is consummated, Nettaxi's current business model will be terminated and the company will implement the current business model of RAE Systems. There can be no assurance that the business model of RAE Systems will be profitable or successful. There can be no assurance that the business model of RAE Systems will enhance the value of the combined company or that the business model of RAE Systems will be any more successful than the business model currently employed by Nettaxi. Additionally, there can be no assurance that the Internet industry will not improve in the future. 15 If the merger with RAE Systems does not take place, we may be unable to identify any other business which could potentially enhance the value of our company. Additionally, we may be unable to negotiate terms for an acquisition which would be favorable to our shareholders. If we were to acquire a company, the amount of time and level of resources required to successfully transition our operations could be substantial. There can be no assurance that new management would be able to successfully operate the business going forward. Furthermore, in making an acquisition, we may have to incur debt or issue equity securities to finance the acquisition, the issuance of which could dilute the holdings of our existing shareholders. WE CURRENTLY HAVE NO REVENUES, WHICH MAY CAUSE THE TRADING PRICE OF OUR COMMON STOCK TO DECLINE. We had revenues of approximately $2,069,500, $9,418,400 and $5,032,800 for the years ended December 31, 2001, 2000 and 1999, respectively. While our growth rate in prior years has been strong, revenues have substantially declined in 2001. We expect current market conditions and the adoption of our acquisition strategy to have a continued material adverse effect on our revenues. We continue to operate our website, however, we have focused our energies on our acquisition strategy and therefore have not pursued any revenue generating activities in the last six months of 2001. We terminated our significant co-hosting customer contracts on`` July 7, 2001, which materially decreased our revenues beginning in the third quarter of 2001. Approximately $1.28 million of the revenues for the year ended December 31, 1999 were derived from credit card transaction processing fees, a revenue stream that has declined significantly and that we do not believe will be material in future periods. In the year 2000, we generated approximately $2.22 million in revenue from reciprocal advertising transactions. These transactions were terminated in year 2000. If our operating results fall below the expectations of investors in future periods, then our stock price may decline. OUR ADVERTISERS ARE EMERGING INTERNET COMPANIES THAT REPRESENT CREDIT RISKS. Some of our advertisers have limited operating histories, are operating at a loss, have limited cash reserves or have limited access to capital. If any significant part of our customer base experiences financial difficulties, is not commercially successful or is unable to pay our advertising fees for any reason, our business, operating results and financial condition may be materially and adversely affected. SHARES ELIGIBLE FOR FUTURE SALE BY OUR CURRENT STOCKHOLDERS MAY ADVERSELY AFFECT OUR STOCK PRICE. As of December 31, 2001, approximately 28 million shares of our common stock were immediately eligible for sale in the public market without restriction or further restriction under the Securities Act of 1933, unless purchased by or issued to any "affiliate" of ours, as that term is defined in 16 Rule 144 promulgated under that Act. Additionally, approximately 14 million shares of common stock were eligible for sale under Rule 144. If our stockholders sell substantial amounts of our common stock, the market price of our common stock could be adversely affected and our ability to raise additional capital at that time through the sale of our securities could be impaired. WE MAY NEED TO UPDATE OUR REGISTRATION STATEMENTS We have filed a registration statement on Form S-1 (File No. 333-36826), declared effective by the Securities and Exchange Commission on June 12, 2000, registering 32,730,849 shares issued and issuable pursuant to recent private placement transactions. Additionally, we have filed a registration statement on Form S-1 (File No. 333-38538), declared effective by the Securities and Exchange Commission on September 21, 2000, registering 4,219,692 shares of common stock issued and issuable pursuant to recent private placement transactions. These registration statements may need to be updated in order to maintain their effectiveness. Although we anticipate updating these registration statements in the near future, we may face liability from shareholders who are unable to sell their shares under the registration statements before they are updated. FUTURE EXERCISE OF WARRANTS OR ISSUANCES OF SECURITIES MAY SIGNIFICANTLY DILUTE YOUR HOLDINGS. There are currently warrants to purchase 18,525,816 shares of our common stock outstanding and exercisable over the next four to five years having exercise prices ranging from $1.50 to $12.38, subject to adjustment. The shares underlying these warrants have been included in the registration statements referenced above. There are also warrants to purchase 1,850,000 shares of our common stock outstanding having exercise prices ranging from of $0.13 to $0.35 per share. Additionally, there are options to purchase 5,578,000 shares of our common stock outstanding under our 1998 and 1999 Stock Option Plans. These shares have been registered pursuant to our registration statement on Form S-8 (File No. 333-32678). As a result, shares issued upon exercise of stock options are eligible for resale in the public market without restriction. If the holders of our outstanding options, warrants and other convertible securities were to exercise their rights, holders of our common stock could experience substantial dilution of their investment. It is possible that we will need to raise additional funds in the future in order to execute a transaction pursuant to our acquisition strategy or if we are to execute our strategic growth plan. If additional funds are raised through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders will be reduced, stockholders may experience additional dilution and such securities may have rights, preferences and privileges senior to those of our common stock. This may make an investment in our common stock less attractive to other investors, thereby weakening the trading market for our common stock. WE MAY FACE THE INTERRUPTION OF OUR SERVICES AND THE DELAY IN THE IMPLEMENTATION OF OUR ACQUISITION STRATEGY DUE TO INCREASED SECURITY MEASURES IN RESPONSE TO TERRORISM. 17 Our business depends on the free flow of products and services through the channels of commerce. Recently, in response to terrorists' activities and threats aimed at the United States, transportation, mail, financial and other services have been slowed or stopped altogether. Further delays or stoppages in transportation, mail, financial or other services could have a material adverse effect on our business, results of operations and financial condition and our ability to complete an acquisition consistent with our acquisition strategy. Furthermore, we may experience an increase in operating costs, such as costs for transportation, insurance and security as a result of the activities and potential activities. We may also experience delays in receiving payments from payers that have been affected by the terrorist activities and potential activities. The U.S. economy in general is being adversely affected by the terrorist activities and potential activities and any economic downturn could adversely impact our results of operations, impair our ability to raise capital or otherwise adversely affect our ability to operate our business and pursue our acquisition strategy. OUR PROJECTED BROADBAND SERVICES AND ENHANCED CONTENT MAY NOT BE LAUNCHED ON A TIMELY BASIS AND MAY NOT GENERATE THE ANTICIPATED LEVEL OF REVENUES. During the first half of 2001, our strategic growth plan called for the development and implementation of broadband services and enhanced content for our subscribers. We have put our strategic growth plan on hold so that we may attempt to execute our acquisition strategy. Should we choose to implement our strategic growth plan in the future, the availability of many of these broadband services will be dependent on our ability to enter into satisfactory contractual relationships with parties offering related content and services which can be made available to our subscribers, as well as relationships with parties seeking to make online sales to our subscribers and other visitors to our web site. To date, our revenues from broadband services and enhanced content have not been material. In light of the reduction of our operating activities and expenditures in connection with our acquisition strategy, we may not be able to commence those services on a timely basis, and there can be no assurance that the services will generate the anticipated amount of revenues. WE RELY HEAVILY ON THIRD PARTIES FOR DEVELOPMENT OF SOFTWARE AND CONTENT AND FOR ESSENTIAL BUSINESS OPERATIONS AND MAY BE ADVERSELY AFFECTED BY OUR FAILURE TO MAINTAIN SATISFACTORY RELATIONSHIPS WITH SUCH PARTIES. We depend on third parties for important aspects of our business, including the development of software and access to the Internet. We have limited control over these third parties, and we are not their only client. We may not be able to maintain satisfactory relationships with any of them on acceptable commercial terms, and there is no guarantee that we will be able to renew these agreements at all. Further, we cannot be sure that the quality of products and services that they provide may remain at the levels needed to enable us to conduct our business effectively. WE ARE VULNERABLE TO POSSIBLE DAMAGE TO OUR OPERATING SYSTEMS. Our web site is dependent in part on our ability to protect our operating systems against physical damage from fire, floods, earthquakes, power loss, telecommunications failures, break-ins or other similar events. Our servers are 18 vulnerable to computer viruses, break-ins and similar disruptive problems. The occurrence of any of these events could result in interruptions, delays or cessations in service to our users and result in a decrease in the number of visitors to our site. Sustained or repeated system failures or interruptions of our web site connection services would reduce the attractiveness of our web site to customers and advertisers, and could therefore have a material and adverse effect on our business due to the loss of membership and advertising revenues. WE DEPEND ON OUR KEY PERSONNEL TO OPERATE OUR BUSINESS AND CARRY OUT OUR ACQUISITION STRATEGY. Our performance is substantially dependent on the continued services and on the performance of our executive officers. The loss of the services of any of our executive officers could materially and adversely affect our business due to their ability to help identify appropriate acquisition target companies, their experience with our business plan and the disruption in the conduct of our day-to-day operations. INTENSE COMPETITION FROM OTHER INTERNET-BASED BUSINESSES MAY REDUCE OUR MARGINS AND MARKET SHARE AND CAUSE OUR STOCK PRICE TO DECLINE. The markets in which our web site operates are new, rapidly evolving and intensely competitive. Barriers to entry are relatively low, and current and new competitors can launch new sites at a relatively low cost using commercially available software. Competition could result in price reductions for our products and services, reduced margins or loss of market share. Consolidation within the online commerce industry may also increase competition. We currently or potentially compete with a number of other companies including a number of large online communities and services that have expertise in developing online commerce, and a number of other small services, including those that serve specialty markets. Many of our potential competitors have longer operating histories, larger customer bases, greater brand recognition and significantly greater financial, marketing, technical and other resources than us. WE MAY FAIL TO ESTABLISH AND MAINTAIN STRATEGIC RELATIONSHIPS WITH OTHER WEB SITES TO INCREASE NUMBERS OF WEB SITE USERS AND INCREASE OUR REVENUES. We have attempted to establish numerous strategic relationships with popular web sites to increase the number of visitors to our web site. These efforts have been substantially slowed by the reduction of our operating activities and expenditures in connection with our acquisition strategy. There is intense competition for placements on these sites, and we may not be able to enter into these relationships on commercially reasonable terms or at all. Even if we enter into relationships with other web sites, they themselves may not attract significant numbers of users. Therefore, our site may not receive additional users from these relationships. Moreover, we may have to pay significant fees to establish these relationships. Our inability to enter into new distribution relationships and expand our existing ones could have a material and adverse effect on our business due to our inability to increase the number of users of our site. 19 WE ARE VULNERABLE TO ADDITIONAL TAX OBLIGATIONS THAT COULD BE IMPOSED ON ONLINE COMMERCE TRANSACTIONS. We do not expect to collect sales or other similar taxes in respect of transactions engaged in by customers on our web site. However, various states or foreign countries may seek to impose sales tax obligations on us and other e-commerce and direct marketing companies. A number of proposals have been made at the state and local levels that would impose additional taxes on the sale of goods and services through the Internet. A successful assertion by one or more states that we should have collected or be collecting sales taxes on the sale of products could have a material and adverse effect on our business due to the imposition of fines or penalties or the requirement that we pay for the uncollected taxes. WE MAY NOT BE ABLE TO TAKE FULL ADVANTAGE OF POTENTIAL TAX BENEFITS FROM OUR NET OPERATING LOSS CARRYFORWARDS. At December 31, 2001 we had Federal net operating loss carryforwards available to reduce future Federal taxable income that aggregated approximately $26.7 million for Federal income tax purposes. These benefits will begin to expire in 2017. Our ability to utilize the net operating loss carryforwards are dependent upon our ability to generate taxable income in future periods and may be limited due to restrictions imposed under Federal and state laws upon change in ownership. If we complete an acquisition consistent with our acquisition strategy, we may be unable to apply these net operating loss carryforwards at all. WE COULD FACE LIABILITY FOR INFORMATION DISPLAYED ON AND COMMUNICATIONS THROUGH OUR WEB SITE. We may be subjected to claims for defamation, negligence, copyright or trademark infringement or based on other theories relating to the information we publish on our web site. These types of claims have been brought, sometimes successfully, against Internet companies as well as print publications in the past. Based on links we provide to other web sites, we could also be subjected to claims based upon online content we do not control that is accessible from our web site. Claims may also be based on statements made and actions taken as a result of participation in our chat rooms or as a result of materials posted by members on bulletin boards at our web site. We also offer e-mail services, which may subject us to potential risks, such as: - liabilities or claims resulting from unsolicited e-mail; - lost or misdirected messages; - illegal or fraudulent use of e-mail; or - interruptions or delays in e-mail service. These claims could result in substantial costs and a diversion of our management's attention and resources. WE COULD FACE ADDITIONAL BURDENS ASSOCIATED WITH GOVERNMENT REGULATION OF AND LEGAL UNCERTAINTIES SURROUNDING THE INTERNET. 20 Any new law or regulation pertaining to the Internet, or the application or interpretation of existing laws, could have a material and adverse effect on our business, results of operations and financial condition due to increased costs of doing business. Laws and regulations directly applicable to Internet communications, commerce and advertising are becoming more prevalent. The law governing the Internet, however, remains largely unsettled, even in areas where there has been some legislative action. It may take years to determine whether and how existing laws governing intellectual property, copyright, privacy, obscenity, libel and taxation apply to the Internet. In addition, the growth and development of e-commerce may prompt calls for more stringent consumer protection laws, both in the United States and abroad. We also may be subject to future regulation not specifically related to the Internet, including laws affecting direct marketers. WE COULD INCUR MONETARY DAMAGES FROM LITIGATION ARISING OUT OF OUR BUSINESS ACTIVITIES. On May 1, 2001 seven shareholders of Nettaxi filed an action against Nettaxi in the United States District Court for the Central District of California (Case No. SACV 01-459 AHS). The complaint also names Robert Rositano, Jr. its Chief Executive Officer, Dean Rositano, its President, and Glenn Goelz its former Chief Financial Officer as additional defendants. The complaint alleged that Nettaxi violated securities laws in connection with its February 2000 private placement. Six of the plaintiffs purchased shares of Nettaxi common stock in the February 2000 private placement. Prior to filing the complaint, the plaintiffs demanded the refund of all of the money invested in Nettaxi and demanded that the exercise price of the warrants issued in the private placement be reduced from $4.00 to $0.25 per share. Additionally, prior to the filing the complaint, Nettaxi was asked to invest capital in a company affiliated with one of the plaintiffs. In the complaint, the plaintiffs seek compensatory damages, injunctive relief and fees and interest. Due to factual misrepresentations in the complaint, Nettaxi anticipated that an amended complaint would be filed. The complaint was amended on May 23, 2001. The amendment added three new plaintiffs to the lawsuit. Shortly after filing the amended complaint, Nettaxi, pursuant to the rules of the District Court, met with plaintiffs and pointed out further factual inaccuracies and deficiencies. Plaintiffs then chose to attempt to amend their complaint for a second time. On October 1, 2001 Nettaxi filed a motion to dismiss the complaint filed by Plaintiffs. In response, Plaintiffs have filed an opposition to Nettaxi's motion to dismiss and have sought leave to amend their complaint for a third time. The District Court has informed the parties that it will rule on the papers, and there will be no hearing. Although we believe the allegations made in the complaint are without merit and will defend the action vigorously, there can be no assurance that we will prevail in this dispute. If the plaintiffs successfully prosecute any of their claims against us, the resulting monetary damages and reduction in our working capital could significantly harm our business. ANTI-TAKEOVER PROVISIONS AND OUR RIGHT TO ISSUE PREFERRED STOCK COULD MAKE A THIRD PARTY ACQUISITION OF US DIFFICULT. We are a Nevada corporation. Anti-takeover provisions of Nevada law could make it more difficult for a third party to acquire control of us, even if such change in control would be beneficial to stockholders. Our articles of 21 incorporation provide that our board of directors may issue preferred stock without stockholder approval. The issuance of preferred stock could make it more difficult for a third party to acquire us. All of the foregoing could adversely affect prevailing market prices for our common stock. OUR COMMON STOCK PRICE IS LIKELY TO BE HIGHLY VOLATILE AS IS TYPICAL OF INTERNET COMPANIES. The market price of our common stock has been, and is likely to continue to be, highly volatile as the stock market in general, and the market for Internet-related and technology companies in particular, has been highly volatile. Investors may not be able to resell their shares of our common stock following periods of volatility because of the market's adverse reaction to volatility. The trading prices of many technology and Internet-related companies' stocks have decreased substantially within the last 18 months. The market downturn and adjustment for the high valuations for internet companies may not return to the levels of late 1999 and early 2000. We cannot assure you that our stock will trade at the same levels of other Internet stocks or that Internet stocks in general will regain their prior market prices. The per share closing price of Nettaxi's common stock in 2001 ranged from a high of $0.46 as of June 11, 2001 to a low of $0.085 as of September 21, 2001. In addition, an active public market for our common stock may not continue. ITEM 2. PROPERTIES Our headquarters are currently located in a leased facility in Campbell, California, consisting of approximately 1,790 square feet of office space to accommodate management, operations, and research and development functions, which is under a lease that expires at the end of May 2002. We believe that our current facilities are appropriate to carry out our acquisition strategy and maintain our limited operations. ITEM 3. LEGAL PROCEEDINGS We previously announced that, on May 1, 2001 seven shareholders of Nettaxi filed an action against Nettaxi in the United States District Court for the Central District of California (Case No. SACV 01-459 AHS). The complaint also names Robert Rositano, Jr. our Chief Executive Officer, Dean Rositano, our President, and Glenn Goelz our former Chief Financial Officer as additional defendants. The complaint alleged that we violated securities laws in connection with our February 2000 private placement. Six of the plaintiffs purchased shares of Nettaxi common stock in the February 2000 private placement. Prior to filing the complaint, the plaintiffs demanded the refund of all of the money invested in Nettaxi and demanded that the exercise price of the warrants issued in the private placement be reduced from $4.00 to $0.25 per share. Additionally, prior to the filing the complaint, Nettaxi was asked to invest capital in a company affiliated with one of the plaintiffs. In the complaint, the plaintiffs seek compensatory damages, injunctive relief and fees and interest. Due to factual misrepresentations in the complaint, we anticipated that an amended complaint would be filed. The complaint was amended on May 23, 2001. The amended complaint added three new plaintiffs to the lawsuit. Shortly after filing the amended complaint, we, pursuant to the rules of the District Court, met with plaintiffs and pointed out further factual inaccuracies and deficiencies. Plaintiffs then chose to attempt to amend their complaint for a second time. On October 1, 2001 22 we filed a motion to dismiss the complaint filed by Plaintiffs. In response, Plaintiffs have filed an opposition to Nettaxi's motion to dismiss and have sought leave to amend their complaint for a third time. The District Court has informed the parties that it will rule on the papers, and there will be no hearing on the motion. We believe that the allegations made in the complaint are completely without merit and that this law suit reflects shareholder frustration over the recent downturn in the stock market. We will defend the action vigorously. On July 31, 2001 Envision Media filed suit against Nettaxi in the Superior Court of California, Santa Cruz County (Case No. CV-141408). The complaint alleges breach of contract and misrepresentation in connection with a Stock Option and Release Agreement entered into between the parties on January 31, 2000. Under the Stock Option and Release Agreement, Envision Media was given the option to convert approximately $900,000 in receivables due from Nettaxi into stock valued at $2.00 per share and also to receive warrants to purchase stock having an exercise price of $2.76. The agreement provided that Nettaxi was to file a registration statement registering the shares issuable under the agreement within 15 days of the execution of the agreement. The agreement also provided that each party would release the other from any claims arising out of or in connection with the conversion of Nettaxi's debt and that the portion of the debt converted was to be deemed paid in full. Nettaxi was unable to file the registration statement before February 15, 2000. Nevertheless, on March 31, 2000 Envision Media converted the entire balance of the amount due into shares and warrants. On May 12, 2000 Nettaxi filed a registration statement on Form S-1 (File No. 333-36826) which included shares and warrants held by Envision Media. On June 8, 2000 the SEC declared the registration statement Form S-1 effective. Nettaxi filed its answer to the complaint on September 17, 2001. Nettaxi believes that the allegations made in the complaint are completely without merit and intends to defend its position vigorously. From time to time, we are involved in legal proceedings incidental to our business. We believe that these pending actions, individually and in the aggregate, will not have a material adverse effect on our financial condition, and that adequate provision has been made for the resolution of such actions and proceedings. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 23 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS Our common stock has been traded on the NASD O-T-C Market Bulletin Board under the trading symbol "NTXY" since October 12, 1998. Prior to that date, our common stock was not actively traded in the public market. After consummation of the merger, we anticipate that such common stock will continue to trade in the over-the-counter market. The following table sets forth, for the periods indicated, the high and low bid prices for our common stock as reported by various Bulletin Board market makers. The quotations do not reflect adjustments for retail mark-ups, mark-downs, or commissions and may not necessarily represent actual transactions.
Period Low Bid High Bid -------------------------------------------------------------------- FISCAL YEAR ENDED DECEMBER 31, 1998: Fourth Quarter (October 12 - December 31, 1998) $ 4.375 $ 8.875 FISCAL YEAR ENDED DECEMBER 31, 1999: First Quarter (January 1 - March 31, 1999) $ 6.187 $ 18.750 Second Quarter (April 1 - June 30, 1999) $ 11.500 $ 34.500 Third Quarter (July 1 - September 30, 1999) $ 7.375 $ 16.500 Fourth Quarter (October 1 - December 31, 1999) $ 1.843 $ 7.875 FISCAL YEAR ENDED DECEMBER 31, 2000: First Quarter (January 1 - March 31, 2000) $ 1.406 $ 9.062 Second Quarter (April 1 - June 30, 2000) $ 0.940 $ 5.968 Third Quarter (July 1 - September 30, 2000) $ 0.420 $ 1.420 Fourth Quarter (October 1 - December 31, 2000) $ 0.125 $ 0.520 FISCAL YEAR ENDED DECEMBER 31, 2001 First Quarter (January 1 - March 31, 2001) $ 0.125 $ 0.295 Second Quarter (April 1 - June 30, 2001) $ 0.095 $ 0.495 Third Quarter (July 1 - September 30, 2001) $ 0.080 $ 0.360 Fourth Quarter (October 1 - December 31, 2001) $ 0.190 $ 0.085 FISCAL YEAR ENDING DECEMBER 31, 2002 First Quarter (January 1 - February 12, 2001) $ 0.280 $ 0.110
On February 12, 2002, the high and low bid prices per share for our common stock on the Bulletin Board were $0.225 and $0.200 respectively. As of February 12, 2002, there were 386 stockholders of record who held shares of our common stock. DIVIDEND POLICY To date, no dividends have been declared or paid on any of our capital stock. We currently intend to retain earnings, if any, to fund the development and growth of our business and do not anticipate paying cash dividends in the 24 foreseeable future. Payment of future dividends, if any, will be at the discretion of our Board of Directors after taking into account various factors, including our financial condition, operating results, current and anticipated cash needs and plans for expansion. RECENT SALES OF UNREGISTERED SECURITIES Set forth in chronological order is information regarding shares of common stock issued and options and warrants and other convertible securities granted by the Company during the year ended December 31, 2001. Also included is the consideration, if any, received by the Company for such shares and options and information relating to the section of the Securities Act of 1933, or rule of the Securities and Exchange Commission under which exemption from registration was claimed. (1) From January to December, 2001 the Company under its 1998 and 1999 Stock Option Plans issued options to purchase up to 3,005,000 shares of common stock to employees, with exercise prices ranging from $0.13 to $0.24 per share, which was not less than the fair market value of the shares on the date of grant. Options to purchase 1,705,000 of these shares have expired as of December 31, 2001. The issuances were made in reliance on Section 4(2) of the Securities Act of 1933 and/or Rule 701 promulgated under the Securities Act of 1933 and were made without general solicitation or advertising. The purchasers were sophisticated investors with access to all relevant information necessary to evaluate the investments, and who represented to the Company that the shares were being acquired for investment. (2) In April 2001, we issued warrants to purchase up to 1,500,000 shares of common stock to a consultant at an exercise price of $0.13 per share, which was not less than the fair market value of the shares on the date of grant. The issuance was made in reliance on Section 4(2) of the Securities Act of 1933 and/or Regulation D promulgated under the Securities Act of 1933 and was made without general solicitation or advertising. The purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment, and who represented to the Company that the shares were being acquired for investment. 25 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA Summary Financial Data Set forth below are summary statements of operations data for the period from October 23, 1997, the date of incorporation to December 31, 1997, the years ended December 31, 1998, 1999, 2000 and 2001, and summary balance sheet data as of December 31, 1997, 1998, 1999, 2000 and 2001. This information should be read in conjunction with the Consolidated Financial Statements and Notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations", appearing elsewhere in this Form.
1997 1998 1999 2000 2001 ----------- ------------ ------------ ------------- ------------ STATEMENT OF OPERATIONS DATA: Net revenues $ 144,900 $ 258,000 $ 5,032,800 $ 9,418,400 $ 2,069,500 Gross profit $ 57,500 $ 18,200 $ 1,029,000 $ 2,110,700 $(2,188,600) Loss from operations $ (142,100) $(3,082,300) $(9,402,500) $(10,367,900) $(8,986,500) Net loss $ (159,700) $(3,113,600) $(9,880,400) $(14,351,400) $(8,550,400) Net loss available to common $ (327,200) $(3,127,900) $(9,880,400) $(14,351,400) $(8,550,400) shareholders Basic loss per share $ (0.06) $ (0.32) $ (0.46) $ (0.36) $ (0.20) Diluted loss per share $ (0.06) $ (0.32) $ (0.46) $ (0.36) $ (0.20) WEIGHTED-AVERAGE COMMON SHARES: Basic outstanding shares 5,483,500 9,724,781 21,274,203 39,381,211 43,124,586 Diluted outstanding shares 5,483,500 9,724,781 21,274,203 39,381,211 43,124,586 Balance Sheet Data: Working capital (Deficiency) $ (222,900) $ 300,400 $(2,053,000) $ 14,144,500 $ 8,525,200 Total Assets $2,082,300 $ 1,652,700 $ 6,031,200 $ 18,123,600 $ 8,791,700 Long-term Liabilities $ 773,500 $ 5,400 $ 3,200,000 $ 0 $ 0 Total stockholders' equity $ 973,400 $ 1,332,100 $(2,000,300) $ 16,563,300 $ 8,607,800 (Deficiency)
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and section 21E of the Securities Exchange Act of 1934, including, without limitation, statements regarding the 26 company's expectations, beliefs, intentions or future strategies that are signified by the words "expects", "anticipates", "intends", "believes", or similar language. These forward-looking statements involve risks, uncertainties and other factors. All forward-looking statements included in this document are based on information available to the company on the date hereof and speak only as of the date hereof. The factors discussed below under "Risk Factors" and elsewhere in this Annual Report on Form 10-K are among those factors that in some cases have affected the company's results and could cause the actual results to differ materially from those projected in the forward-looking statements. The following discussion should be read in conjunction with the condensed consolidated financial statements and notes thereto. OVERVIEW Nettaxi.com is an Internet marketing portal that provides content and Internet based services for consumers and businesses. Our web site at www.nettaxi.com serves as a gathering place for people with shared topics of interest, as well as an entry point, referred to as a portal, to the Internet. Through our web site, we provide content addressing a number of targeted categories. Subscribers to our web site are also provided with access to enhanced content such as broadband video clips and email accounts. In 1999, we developed a diversified revenue model under which we provided subscribers with access to web site hosting services and a broad range of content, and we provided affiliated businesses with access to a large population of Internet users for advertising and promotional purposes. In 2001, Nettaxi faced the challenges of an overall downturn in the Internet industry and the economy in general. As of December 31, 2001, we had incurred losses of approximately $36.2 million. The bankruptcy and liquidation of many of our Internet based customers and suppliers caused us to re-evaluate our business model. Since the Internet infrastructure is unstable and customer base financially weak, we took corrective action to significantly decrease our cash burn and determine the best course of action to maintain and enhance the value of our company. In this regard, we implemented an acquisition strategy pursuant to which we sought to identify an appropriate entity with which to merge, acquire or restructure our current business. Since the announcement of our acquisition strategy in May 2001, we have evaluated a number of potential Merger candidates in a wide variety of industries. Of all of these companies, we believe RAE Systems presents the best fit for our shareholders. We believe the Merger with RAE Systems is the fruit of our acquisition strategy and that the Merger will provide us with a new direction that avoids the pitfalls that have crippled so many Internet businesses. In June 2001, we reduced our overhead and burn rate by reducing the salaries of our employees and reducing the number of personnel, marketing expenses and costs associated with our hosting activities. Our current management team, consisting of finance and administrative employees is in place to maintain our operations and consummate the proposed Merger with RAE Systems. We continue to operate our website, however, we have focused our energies on our acquisition strategy and therefore have not pursued any revenue generating activities in the last six months of 2001. 27 Prior to June 2001, we provided web site hosting and Internet connectivity services for corporate customers. Our services were delivered through a state-of-the-art Internet data center located in Southern California using a high-performance Internet backbone network. Customers paid monthly fees for the professional services utilized, one-time installation fees, and connectivity charges. These "hosting" revenues were recognized in the period the services were provided. Hosting revenues were variable, based upon bandwidth usage and services used, and resulted in operating losses from time to time. In June 2001, we terminated our significant co-hosting customer contracts effective July 7, 2001. In connection with this, we also discontinued the purchase of bandwidth and premium services from our third party provider, further reducing monthly expenditures. The terminations have reduced our operating expenses, and materially affected our revenues beginning in the third quarter of 2001. Acquisitions carry numerous risks and uncertainties and we cannot guarantee that we will be able to successfully integrate any businesses, products, technologies or personnel that might be acquired in the future. RESULTS OF OPERATIONS; COMPARISON OF THE TWELVE MONTHS ENDED DECEMBER 31, 2001 AND 2000 NET REVENUES. Net revenues for the twelve months ended December 31, 2001 were $2.1 million compared with $9.4 million for the twelve months in 2000. The significant decrease is primarily the result of the substantial reduction of our operating activities and expenditures in connection with the adoption of our acquisition strategy and the current economic climate in the Internet industry. In June 2001, we terminated our significant co-hosting customer contracts effective July 7, 2001, which materially decreased our revenues beginning in the third quarter of 2001. The substantial decrease was also the result of significantly lower advertising revenues recognized in the twelve months ended December 31, 2001. For the twelve months ended December 31, 2001, three customers each accounted for greater than 10% of total net revenues for a total of approximately $1.9 million or 90% of the total revenues. These customers, Babenet, Whitesand Communications, and Whitehorn Ventures Limited, accounted for 47%, 19%, and 25%, respectively of our total revenues. All three of these customers were co-hosting customers. For the twelve months ended December 31, 2000, four customers, Babenet, Whitesand Communications, Hearme.com, Spinrecords.com, each accounted for greater than 10% of total net revenues for a total of approximately $5.1 million or 54% of the total revenues. In June 2001, we terminated our significant co-hosting customer contracts effective July 7, 2001, which has materially affected revenues beginning in the third quarter of 2001. ADVERTISING REVENUES. Advertising revenues for the twelve months ended December 31, 2001 and 2000 were approximately $0.2 million and approximately $5.7 million, respectively, which represented 10% and 60%, respectively, of total net revenues. The decline in absolute dollars resulted from the substantial reduction of our operating activities and expenditures in connection with the adoption of our acquisition strategy and the current economic climate in the Internet industry. The decline was also attributable to the discontinued use of reciprocal advertising transactions and decreases in the number of 28 advertisers and the decrease in the average rate paid by these advertisers. As a result of the increased bankruptcy and liquidation trend in the marketplace, we further tightened our credit terms and loss many of our customers. Also, we initiated several cost savings strategies in the first quarter of 2001, which resulted in cancellation of advertising arrangements by our customers that decided that these new strategies did not meet their criteria for advertising promotions. Also, in the first quarter of 2001, we terminated our free hosting arrangements for our citizens, which resulted in decreased page views and therefore decreased the number of banner advertisements served. We believe that the revenues from the sale of banner advertisements can no longer justify the cost of purchasing bandwidth. Reciprocal advertising arrangements accounted for approximately 0% and 28% of total revenues for the twelve months ended December 31, 2001 and 2000, respectively. Reciprocal arrangements were used in our strategy in developing strategic relationships with other advertisers or service providers for non-cash media advertising. We no longer utilize these agreements as the return on investment for these agreements no longer benefits us. We continue to operate our website and sell advertising products, but these revenues will be significantly lower than prior periods. We do not expect these revenues to grow in light of the changing market conditions and the recent actions taken by us. HOSTING REVENUES. Our hosting revenues were approximately $1.9 million and $3.7 million for the twelve months ended December 31, 2001 and 2000, which represented 90% and 40%, of total net revenues, respectively. The decline in absolute dollars resulted from the substantial reduction of our operating activities and expenditures in connection with the adoption of our acquisition strategy and the current economic climate in the Internet industry. For the twelve months ended December 31, 2001, hosting revenues were a higher percentage of total net revenue as advertising revenues significantly decreased in the twelve months ended December 31, 2001. Our services are delivered through a state-of-the-art Internet data center located in Southern California using a high-performance Internet backbone network. Customers pay monthly fees for the professional services utilized, one-time installation fees, and monthly connectivity charges. These hosting revenues were recognized in the period the services were provided. We did not receive any one-time installation fees in the twelve months ended December 31, 2001 and 2000, respectively. In June 2001, we terminated our significant co-hosting customer contracts effective July 7, 2001, which materially affected revenues beginning in the third quarter of 2001. COST OF OPERATIONS. Cost of operations were approximately $4.3 million and $7.3 million for the twelve months ended December 31, 2001 and 2000, respectively. Cost of operations decreased as a result of the substantial reduction of our operating activities and expenditures in connection with the adoption of our acquisition strategy. The decline was also attributable to the termination of our co-hosting customer contracts which required our purchasing of bandwidth and services from a third party provider. We have also experienced a substantial decrease in traffic to our website which resulted in the offset to the cost of purchasing bandwidth. Beginning in February 2001 we changed our web hosting provider to Alchemy Communications, a carrier in Southern California. This new provider provides similar services but at substantial cost saving to us. We entered into traffic directive arrangements whereas selected web traffic or page views are diverted to interest specific areas of our website and advertisements. These arrangements require special tools and costs to third 29 parties. We began these new arrangements in the fourth quarter of 2000, but as result of our acquisition strategy we terminated these arrangements in July 2001. There were no similar costs in the twelve months ended December 31, 2001. SALES AND MARKETING EXPENSES. Sales and marketing expenses were approximately $0.9 million and $5.9 million for the twelve months ended December 31, 2001 and 2000, respectively. The decline in sales and marketing expenses was attributable to the substantial reduction of our operating activities and expenditures in connection with the adoption of our acquisition strategy. The decline was also attributable to the discontinued use of reciprocal online advertising arrangements to increase brand awareness and traditional print and media marketing advertising. We recorded reciprocal advertising expenses in relation to the reciprocal advertising revenues of approximately $2.2 million for the twelve months ended December 31, 2000. There were no similar expenses in 2001. RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses were approximately $0.4 million and $1.6 million for the twelve months ended December 31, 2001 and 2000, respectively. The decline in expense was primarily attributable to the decrease in salaries expense for personnel as the result of decreased personnel. We terminated all research and development personnel in the beginning of the second quarter 2001. Currently, we have no hiring plan in effect for replacement of these individuals. We plan to utilize consultants for any technical projects. As of October 2001, we have engaged two technical consultants for short-term projects. GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses were approximately $5.5 million and $5.0 million for the twelve months ended December 31, 2001 and 2000, respectively. General and administrative costs consisted primarily of salaries and related costs for executives, administrative, and finance personnel, as well as legal, accounting and other professional service fees. In addition to the above we recognized in 2001 a write-down of approximately $823,000 due to impairment of equipment, purchased technology and other intangibles, and a loss on disposal of certain equipment of $327,600 related to our move to smaller facilities in the June 2001. Due to the market conditions, we were unable to sell the capital equipment and the costs for storage and moving the equipment would have exceeded any gain realized on the sale. In June 2001 we negotiated an early termination of our facilities lease and recognized a one-time charge of approximately $94,000, which included the forfeited deposit. This fee was necessary as a result of the market conditions in the San Francisco Bay Area. We entered into a facilities lease of smaller space in Campbell, California. We believe that this space will be sufficient to conduct our current activities. We also recognized approximately $141,000 in one-time costs associated with the termination of our intended acquisition with LookupGuide.com. The above additional expenses were offset with decreases in personnel costs as a result of termination of personnel in the first and second quarter of 2001. INTEREST INCOME. Interest income was approximately $447,900 and $703,800 for the twelve months ended December 31, 2001 and 2000, respectively. The higher average cash balance in the twelve months ended December 31, 2000, was the result of the issuance of common stock in a private placement offering in February 2000 for which cash proceeds became available in March 2000. 30 INTEREST EXPENSE. Interest expense was approximately $9,400 and $4.7 million for the twelve months ended December 31, 2001 and 2000, respectively. For the year 2000 period, the interest expense was primarily the result of non-cash deemed interest expense related to the implied beneficial conversion feature and the value of warrants issued in connection with the settlement agreement that we reached with the holder of the convertible debentures issued on March 31, 1999. The convertible note was fully converted in the second quarter of 2000 and therefore no interest expense was recorded on this note in 2001. INCOME TAXES. The provision for income taxes for the years ended December 31, 2001 and 2000 consisted of minimum state taxes of $2,400 and $1,600, respectively. At December 31, 2001, we had net operating loss carryforwards available to reduce future taxable income that aggregate approximately $26.7 million for Federal income tax purposes. These benefits begin to expire in 2017. We also had California net operation loss carryforwards in the amount of $14.2 million, which may be applied to future taxable income until these benefits begin to expire in 2002. Our ability to utilize the net operating loss carryforwards is dependent upon our ability to generate taxable income in future periods and may be limited due to restrictions imposed under Federal and state laws upon change in ownership. If we complete an acquisition consistent with our acquisition strategy, we may be unable to apply these net operating loss carryforwards at all. RESULTS OF OPERATIONS; COMPARISON OF THE TWELVE MONTHS ENDED DECEMBER 31, 2000 AND 1999 NET REVENUES. Net revenues for the year ended December 31, 2000 increased 87% to approximately $9.4 million from $5.0 million for the year ended December 31, 1999. The absolute dollar increase is the result of an increase in revenues from the corporate web hosting and the increase in advertising revenues. Advertising revenues included third party revenues from both traditional and internet related advertisers which also includes reciprocal arrangements. For the year ended December 31, 2000, four customers each accounted for greater than 10% of total net revenues for a total of approximately $5.1 million or 54% of the total revenues. These customers, Babenet, SpinRecords.com, Whitesand Communications, and Hearme.com, accounted for 20%, 13%, 11% and 10%, respectively of our total revenues. For the year ended December 31, 1999, one customer, Whitesand Communications, accounted for greater than 10% of total net revenues. The loss of any one of all of these customers could have a material adverse affect on our revenue. ADVERTISING REVENUES. Advertising revenues for the year ended December 31, 2000 and 1999 were approximately $5.7 million and approximately $2.7 million, respectively, which represented 60% and 53%, respectively, of total net revenues. The year over year increase in absolute dollars resulted from an increase in reciprocal advertising transactions and increases in the number of advertisers as well as the increase in average contract commitments of these advertisers as a result of increased web traffic to our web site. Reciprocal advertising arrangements are exchanges of similar services between the Company and the advertisers. These arrangements accounted for approximately 28% and 7% of total revenues for the twelve months ended December 31, 2000 and 1999, respectively. Reciprocal arrangements for the twelve months ended December 31, 2000 are the result of the Company's strategy in developing strategic relationships with other advertisers or service providers for non-cash media advertising. 31 TRANSACTION PROCESSING FEES. There were no transaction processing fees for the year ended December 31, 2000. Transaction processing fees were approximately $1.29 million for the year ended December 31, 1999, which represented 26%, of total net revenues. Transactions fees consisted of revenue derived from credit card evaluations and from the processing of on-line credit card transactions. The 1999 revenue is attributable to the Merger with Plus Net, Inc. in May 1999. The contract through which these fees have been derived terminated in December, 1999 and we do not expect revenues of this type to be significant in future periods. HOSTING REVENUES. Our hosting revenues were approximately $3.7 million and $945,000 for the years ended December 31, 2000 and 1999, respectively, which represented 40% and 19%, of total net revenues, respectively. For the year ended December 31, 2000, we recognized hosting revenues for the twelve months as compared to only six months in the year ended December 31, 1999. In the third quarter of 1999, we began providing internet hosting and connectivity services for corporate customers. Our services are delivered through a state-of-the-art Internet data center located in Southern California using a high-performance Internet backbone network. Customers pay monthly fees for the professional services utilized, one-time installation fees, and monthly connectivity charges. These "hosting" revenues were recognized in the period the services were provided. The Company has experienced strong revenue growth in the internet web hosting for corporate customers, but does not expect this growth to continue at the current rate, or that the Company will sustain profitability from this business segment. Additionally, the Company cannot assure that it can increase the number of corporate customers or maintain the current customer base. As previously described, two web-hosting customers accounted for more than 10% of total net revenues for the twelve months ended December 31, 2000. COST OF OPERATIONS. Cost of operations were approximately $7.3 million and $4.0 million for the years ended December 31, 2000 and 1999, respectively. Cost of operations increased 83%. Approximately 85% of the increase is the result of additional expenses related to costs for co-location (Internet connection charges) expenses. In the third quarter of 1999, we began providing Internet connectivity services to corporate customers and required purchases of additional bandwidth to service these customers. These costs are expected to continue to increase as our web traffic increases and our corporate customer require additional bandwidth for our "citizens". For the year ended December 31, 2000, the Company recognized hosting expenses for twelve months as compared to only six months in the year ended December 31, 1999. Approximately 6% of the increase is related to increased depreciation expense for capital purchased in 1999. Approximately 6% of the increase is related to the costs for consultants to improve our website. Separately, during the third quarter ended September 30, 2000, we also initiated cost effective measurement tools to limit the use of unauthorized excessive bandwidth or charging the individual users for the use of additional bandwidth. These cost measures resulted in cost savings to the Company in the third and fourth quarter of year 2000. We cannot be assured that these cost saving measures will continue to result in substantial savings or any savings at all. SALES AND MARKETING EXPENSES. Sales and marketing expenses were approximately $5.9 million and $4.8 million for the twelve month periods ended December 31, 2000 and 1999, respectively. Sales and marketing expenses 32 consisted primarily of advertising, including co-branding and reciprocal, salaries of our sales and marketing personnel and related costs, marketing, and promotion costs. Approximately $1.9 million of the net increase is the result of the redirected marketing approach for brand awareness implemented in the third quarter of 2000. This consisted of using reciprocal online advertising arrangements to increase brand awareness rather than the traditional print and media marketing approach. The Company recorded reciprocal advertising expenses in relation to the reciprocal advertising revenues of $2.2 million for the year ended December 31, 2000 compared to approximately $0.3 million for the year ended December 31, 1999. The Company utilizes reciprocal advertising arrangements as an inexpensive advertising media for increasing brand awareness. There can be no assurance that these increased expenditures will result in increased visitors to our web site or additional revenues in the future. This increase was offset by a reduction of approximately $0.8 million reduction in spending on traditional marketing media expenditures. RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses were $1.6 million and $2.2 million for the twelve months ended December 31, 2000 and 1999, respectively. The 28% decrease was primarily attributable to the lower utilization of consultants by the Company and decrease in average number of technical personnel during the year 2000. Approximately $0.6 million of the decrease was related to the lower utilization of consultants and $0.2 million of the decrease was related to the decrease in recruiting fees paid to hire new employees. The above two costs were offset by an approximately $0.3 million increase which was related to increased depreciation expense for capital equipment. The Company has experienced a difficulty in its ability to recruit and retain technical personnel as a result of the current economic prosperity and high cost of living in Silicon Valley and expects this condition to have a continuous impact on the ability of the Company to retain and hire additional technical personnel. GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses were $5.0 million and $3.5 million for the twelve months ended December 31, 2000 and 1999, respectively. General and administrative costs consisted primarily of salaries and related costs for executives, administrative, and finance personnel, as well as legal, accounting and other professional service fees. Approximately $0.6 million of the increase in general and administrative expenses were primarily attributable to amortization of deferred compensation expense related to stock, warrants and options granted during the year to various consultants for the services. Approximately $0.4 million of the increase was the result of additional salaries and personnel costs. Approximately $0.4 million of the increase is related to higher insurance costs associated with being a public company. Also, the increase is the result of legal fees related to the settlement agreement with the holder of convertible debentures. The Company also recorded approximately $500,000 provision for uncollectible accounts receivable. The Company expects that due to the highly volatile market conditions for internet related and other advertising companies, the provision for bad debt may be higher in the future. The above increases were offset by the decrease in expenditures related to the Merger with Plus Net, Inc. in 1999. INTEREST EXPENSE. Net interest expense was $4.0 million and $0.4 million for the years ended December 31, 2000 and 1999, respectively. For the year 1999 period the net interest expense was primarily due to the convertible promissory 33 note that was issued on March 31, 1999 and to amortization of deferred interest related to warrants issued in conjunction with the convertible promissory note, offset by interest income. For the year 2000 period, the net interest expense was primarily the result of deemed interest expense related to the convertible debenture issued on March 31, 1999. We recognized deemed interest expense of approximately $3.9 million in the second quarter of 2000. This non-cash interest expense resulted from the implied beneficial conversion feature and the value of warrants issued in connection with the settlement agreement that we reached with the holder of the convertible debenture. INCOME TAXES. The provision for income taxes for the year ended December 31, 2000 consisted of minimum state taxes. For the year ended December 31, 1999 we recorded a tax provision which related to earnings made by PlusNet, Inc. during its fiscal period before our merger. At December 31, 2000, we had net operating loss carryforwards available to reduce future taxable income that aggregate approximately $25.1 million for Federal income tax purposes. These benefits begin to expire in 2017. The Company also had a California net operation loss carryforwards in the amount of $13.4 million which may be applied to future taxable income until these benefits begin to expire in 2002. Our ability to utilize the net operating loss carryforwards are dependent upon our ability to generate taxable income in future periods and may be limited due to restrictions imposed under Federal and state laws upon change in ownership. LIQUIDITY AND CAPITAL RESOURCES As of December 31, 2001, the Company had cash and cash equivalents of approximately $8.6 million, compared to approximately $13.9 million at December 31, 2000. Net cash used in operating activities equaled approximately $5.3 million and $8.4 million for the twelve month periods ended December 31, 2001 and 2000, respectively. The decline in cash used was related to the decrease of approximately $5.8 million in net loss for the twelve months ended December 31, 2001 compared to the same twelve months ended December 31, 2000. However, in 2000 we incurred approximately $4.6 million of non-cash interest expense relating to a settlement agreement and issuance of warrants. Net adjustment related to customer receivables amounted to approximately $1.7 million. Net cash used in investing activities was approximately $26,400 and $744,100 for the twelve months ended December 31, 2001 and 2000, respectively. Substantially all of the cash used in investing activities for both periods was primarily related to the purchase of capital equipment. Net cash provided by financing activities was approximately $0 and $22.0 million for the twelve months period ended December 31, 2001 and 2000, respectively. Net cash provided by financing activities in 2000 consisted primarily of net proceeds from the issuance of our common stock. We incurred net losses of approximately $8.6 million and $11.4 million for the twelve months ended December 31, 2001, and 2000, respectively. At December 31, 2001, we had an accumulated deficit of approximately $36.2 million. The net losses and accumulated deficit resulted from the significant operational, 34 infrastructure and other costs incurred in the development and marketing of our services and the fact that revenues failed to keep pace with such costs. Beginning in the fourth quarter of 2000, we initiated cost reductions in all areas of operations. We are continuing to review and reduce all non-essential expenditures while we pursue our acquisition strategy. We do not have any long-term commitments that currently require a specified capital budget other than normal operations. We believe that current cash, and cash equivalents would be sufficient to meet our anticipated operating cash needs for at least the next 12 months if the Merger with RAE Systems were not to take place. The obligations of RAE Systems to close the Merger are subject to, among other things, our net cash being at least $7,500,000. If we do not have $7,500,000 we may be forced to seek additional capital from outside sources. There can be no assurance that financing will be available in amounts or on terms acceptable to us, if at all. The sale of additional equity or convertible debt securities could result in additional dilution to our stockholders. RECENT ACCOUNTING PRONOUNCEMENTS In December 1999, the staff of the Securities and Exchange Commission issued its Staff Accounting Bulletin No. 101, "Revenue Recognition". Staff Accounting Bulletin No. 101 provides the SEC staff's views in applying generally accepted accounting principles to selected revenue recognition issues. Staff Accounting Bulletin No. 101 is effective for the fourth fiscal quarter of fiscal years beginning after December 15, 1999. We believe our current revenue recognition policies comply with the provisions of Staff Accounting Bulletin No. 101. In March 2000, the Financial Accounting Standards Board issued Interpretation (Interpretation) No. 44, "Accounting for Certain Transactions involving Stock Compensation, an Interpretation of ABP Opinion No. 25", which became effective July 1, 2000. Interpretation No. 44 clarifies (a) the definition of employee for purposes of applying Opinion 25, (b) the criteria for determining whether a stock compensation plan qualifies as a noncompensatory plan, (c) the accounting consequences of various modifications to the terms of a previously fixed stock option or award, and (d) the accounting for an exchange of stock compensation awards in a business combination. Adoption of the provisions of the Interpretation had no significant impact on our financial statements. In June 1999, the FASB issued SFAS No. 137, Accounting for Derivative Instrument and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133, which amends SFAS No. 133 to be effective for all fiscal years beginning after June 15, 2000. In June 2000, SFAS No. 133 was amended by SFAS No. 138, Accounting for Certain Derivative Instruments and Hedging Activities, which amended or modified certain issues discussed in SFAS No. 133. SFAS No. 138 is also effective for all fiscal years beginning after June 15, 2000. SFAS No. 133 and SFAS No. 138 establish accounting and reporting standards requiring that every derivative instrument be recorded in the balance sheet as either an asset or liability measured at its fair value. The statements also require that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. The Company does not engage in derivative instruments or hedging activities. Accordingly, there was no impact on the Company's financial statements from the adoption of SFAS No. 133 and SFAS No. 138. 35 In July 2001, the FASB issued SFAS No. 141 (SFAS 141), Business Combinations, which supersedes Accounting Principles Board (APB) Opinion No. 16, Business Combinations. SFAS 141 eliminates the pooling-of-interests method of accounting for business combinations and modifies the application of the purchase accounting method. The elimination of the pooling-of-interests method is effective for transactions initiated after June 30, 2001. The remaining provision of SFAS 141 will be effective for transactions accounted for using the purchase method that are completed after June 30, 2001. In July 2001, the FASB also issued SFAS No. 142 (SFAS 142), Goodwill and Intangible Assets, which supersedes APB Opinion No. 17, Intangible Assets. Under SFAS 142, goodwill and intangible assets with indefinite lives are not amortized but are tested for impairment annually using the fair value approach, except in certain circumstances, and whether there is an impairment indicator, other intangible assets will continue to be valued and amortized over their estimated lives; in-process research and development will continue to be written off immediately; all acquired goodwill must be assigned to reporting units for purposes of impairment testing and segment reporting and existing goodwill will no longer be subject to amortization. The provisions of SFAS No. 142 are required to be applied starting with fiscal years beginning after December 15, 2001. In August 2001, the FASB issued SFAS No. 143 (SFAS 143) Accounting for Obligations Associated with the Retirement of Long-Lived Assets. SFAS 143 addresses financial accounting and reporting for the retirement obligation of an asset. SFAS 143 states that companies should recognize the asset retirement cost, at its fair value, as part of the cost asset and classify the accrued amount as a liability in the balance sheet. The asset retirement liability is then accreted to the ultimate payout as interest expense. The initial measurement of the liability would be subsequently updated for revised estimates of the discounted cash outflows. SFAS 143 will be effective for fiscal years beginning after June 15, 2002. The Company has not yet determined the effect SFAS 143 will have on its financial position, results of operations, or cash flows. In October 2001, the FASB issued SFAS No. 144 (SFAS 144) Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS 144 supersedes the SFAS No. 121 by requiring that one accounting model to be used for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired, and by broadening the presentation of discontinued operation to include more disposal transactions. SFAS 144 will be effective for fiscal years beginning after December 15, 2001. The Company has not yet determined the effect SFAS 144 will have on its financial position, results of operations, or cash flows. 36 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK MARKET RISK As of December 31, 2001, we did not have any long term debt obligations. Therefore, an immediate 10% increase in market interest rates would not have a material adverse effect on our financial position. We currently do not have any material market rate risks. We could be exposed to market risk related to any debt obligations for financing working capital and capital equipment requirements in the future. Historically, we have financed such requirements from the issuance of both preferred and common stock. We continue to consider financing alternatives, which may include the incurrence of long term indebtedness. Actual capital requirements may vary based upon the timing and success of the expansion of our operations. We believe that based on the terms and maturities of any future debt obligations that the market risk would be minimal. EFFECTS OF INFLATION Due to relatively low levels of inflation in 1997, 1998, 1999, 2000 and 2001, inflation has not had a significant effect on our results of operations. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Our financial statements, schedules and supplementary data, as listed under Item 14, appear in a separate section of this report beginning on page F-1. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE NONE. 37 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES Our directors, executive officers and other key employees, and their ages, as of December 31, 2001 are as follows:
NAME AGE POSITION -------------------------- --- ------------------------------------------------- Robert A. Rositano, Jr.(1) 32 Chief Executive Officer, Secretary and Director Dean Rositano (1) 29 President, Chief Operating Officer, Interim Chief Financial Officer and Director Andrew Garroni (2) 45 Director (1) Messrs. Robert A. Rositano, Jr. and Dean Rositano are brothers. (2) Mr. Andrew Garroni is currently the sole member of our Compensation Committee and our Audit Committee and is not an employee of Nettaxi.com.
Each director holds office until the next annual meeting on the stockholders and until his successor is elected and qualified. Executive officers are appointed by and serve at the pleasure of our board of directors. Set forth below is certain information regarding the business experience during the last five years of each of the above named persons. ROBERT A. ROSITANO, JR. Mr. Rositano Jr. co-founded Nettaxi Online Communities, Inc., a Delaware corporation , in October, 1997. He has served as Chief Executive Officer and Secretary of Nettaxi since the reorganization with Swan Valley and prior to that served in the same capacities with Nettaxi Online Communities from its inception. He has over seven years of experience in the Internet service provider and Internet industry. In February 1995, he co-founded Simply Interactive, Inc. , an Internet/intranet software company, and served as Executive Vice President in the areas of Inside Sales, Customer Service and Product Development until he co-founded Nettaxi Online Communities. In January 1994, he co-founded Digital Data Express, a company focused on beginner level Internet users, and served as Chief Executive Officer until February 1995 when Digital Data Express was acquired by Simply Interactive. From 1992 to 1994, Mr. Rositano was hired on as the third employee at Netcom On-line Communications in 1992 and served as a senior sales and account manager until 1993. DEAN ROSITANO. Mr. Rositano co-founded Nettaxi Online Communities in October, 1997. He has served as President of Nettaxi since the reorganization with Swan Valley and prior to that served in the same capacities with Nettaxi Online Communities. He has over seven years of experience in the ISP and Internet industry. In February 1995, he co-founded Simply Interactive, Inc., an 38 Internet/intranet software company, and served as Vice President of Technology until he co-founded Nettaxi Online Communities. While at Simply Interactive, he assembled a digital production studio and produced the Internet the City CD-ROM in a three month time frame on three platforms, Windows 3.1, Windows 95, and Macintosh. In January 1994, he co-founded Digital Data Express and served as President and Chief Executive Officer until February 1995 when Digital Data Express was acquired by Simply Interactive. At Digital Data Express, Mr. Rositano co-produced and directed the world's first Internet training video "Introduction to the Internet." ANDREW GARRONI. Mr. Garroni has served as a director since completion of our merger with Plus Net in May 1999. Under the terms of our merger agreement with Plus Net, Mr. Garroni was appointed as a member of the board of directors. Mr. Garroni has over 20 years experience in the development and management of start-up entertainment companies. He currently serves as Executive Producer of Showtime's movie series "Naked City," a position he has held since January, 1998. From 1990 to September, 1998 he served as President of Axis Films International, Inc. supplying films to cable television networks such as Home Box Office, Showtime Networks and DBS providers like Direct TV. He began his career in New York as a principal partner in the motion picture Production Company Cinerex Associates, Inc. whose clients included Twentieth Century Fox and Orion Pictures. While in New York, he helped create Magnum Motion Pictures and Magnum Entertainment. Mr. Garroni has a Bachelor's degree in Marketing from Fairleigh Dickinson University. EMPLOYMENT AGREEMENTS AND TERMINATION OF EMPLOYMENT AND CHANGE OF CONTROL ARRANGEMENTS EXECUTIVE EMPLOYMENT AGREEMENTS. On August 1, 1998 Nettaxi Online Communities, Inc. entered into executive employment agreements with Robert A. Rositano, Jr. and Dean Rositano, and these agreements continued in effect after the reorganization with Swan Valley Snowmobiles, 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 connection with the adoption of our acquisition strategy in May 2001, each executive officer voluntarily agreed to accept reduced base salaries of $150,000. 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 2001, each executive received the minimum bonus compensation payable. 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 39 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. 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 40 only member of the audit committee. We are currently seeking qualified individuals to join our board of directors and serve on our audit committee. 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. 41 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, 2000 and 2001:
SUMMARY COMPENSATION TABLE (1) ANNUAL COMPENSATION LONG-TERM ---------------------------- COMPENSATION NAME AND PRINCIPAL NUMBER OF SECURITIES POSITION YEAR SALARY BONUS ($) 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 2001 184,818 50,000 380,000 Dean Rositano, 1998(2) 95,917 - 1,012,347 President 1999 156,550 132,500 600,000 2000 214,933 150,000 640,000 2001 184,818 50,000 380,000 Robert Speicher, Vice 2000 179,229 50,000 250,000 President of Sales and 2001 320,869 - - Marketing (3) (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. Speicher was hired in 1999, but did not earn in excess of $100,000 in 1999. Mr. Speicher is no longer employed by Nettaxi. The amount of 42 compensation shown for Mr. Speicher in 2001 includes a payment of $260,000 which was made in connection with the cessation of his employment with Nettaxi.
WARRANT AND OPTION GRANTS IN LAST YEAR The following table sets forth information concerning warrants and options granted to the named executives during 2001.
Warrant And Option Grants During Year Ended December 31, 2001(1) ------------------------------------------------------------------------------------------------------------------ Name Number of % of Total Exercise Expiration Potential Realizable Value at Securities Warrants/ Price Per Date Assumed Annual Rates of Stock Underlying Options Granted Share Price Appreciation for Option Term Warrants/ to Employees in ($/Sh) (3) Options 2001 -------------------------------------------- Granted (#) 5% 10% ------------------------------------------------------------------------------------------------------------------ Robert A. 380,000 29% 0.13 1/2010 $ 76,635.61 $ 116,482.62 Rositano, Jr. (2) ------------------------------------------------------------------------------------------------------------------ Dean 380,000 29% 0.13 1/2010 $ 76,635.61 $ 116,482.62 Rositano (2) ------------------------------------------------------------------------------------------------------------------ 43 (1) No SARs were granted to either of the named executives during 2001. Each warrant and option represents the right to purchase one share of our common stock. In 2001, we granted employees options to purchase an aggregate of 1,300,000 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. and Dean Rositano were each granted options to purchase 380,000 shares of our common stock under two option agreements. Under each agreement, the options expire in twelve equal quarterly installments. (3) 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.
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 2001 and exercisable and unexercisable stock options held by them as of December 31, 2001.
AGGREGATE WARRANT AND OPTION EXERCISES IN 2001 AND YEAR END OPTION VALUES ------------------------------------------------------------------------------------------------ NAME Shares Value Number of Unexercised Value of Unexercised In-the-Money Acquired On Realized Options at Year End(#) Options at Year End($) (1) Exercise(#) ($) -------------------------- ---------------------------- Exercisable Unexercisable Exercisable Unexercisable ------------------------------------------------------------------------------------------------ Robert A. 0 0.00 326,667 1,660,000 $ 316.67 $ 1,583.33 Rositano, Jr. ------------------------------------------------------------------------------------------------ Dean Rositano 0 0.00 326,667 1,660,000 $ 316.67 $ 1,583.33 ------------------------------------------------------------------------------------------------ Robert Speicher 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 $0.135 at December 31, 2001, 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.
44 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 has not been presented to our stockholders for ratification. 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 this annual report on Form 10-K. 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. However, options granted under the plan may not qualify as incentive stock options because our plan was not presented for shareholder ratification. The number of shares available for options under the 1999 Stock Option Plan was initially 3,300,000. The board of directors amended the plan to increase the number of shares available for options to 8,900,000. As of December 31, 2001, 8,333 shares had been issued as a result of the exercise of options previously granted under the 1999 Stock Option Plan, 3,053,000 shares of common stock were subject to outstanding options and 5,838,667 shares were available for future grants. The exercise prices of the outstanding options ranged from $0.13 to $2.44. We have registered 3,300,000 of 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 45 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. 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, 2,525,000 shares were subject to outstanding options and 470,002 shares were available for future grants. The exercise prices of the outstanding options ranged from $0.13 to $14.875. 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. 46 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. 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 47 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. 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 certain information regarding the beneficial ownership of Nettaxi's common stock as of February 12, 2002 (i) by each of Nettaxi's directors; (ii) by each person known by Nettaxi to own beneficially more than five percent of our common stock; (iii) by our executive officers; and (iv) by all directors and executive officers of Nettaxi as a group. 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 12, 2002, 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 voting 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, 1875 S. Bascom Ave., No. 116, Campbell, California 95008.
-------------------------------------------------------------------------------- NAME OF BENEFICIAL OWNER BENEFICIAL OWNERSHIP OF COMMON STOCK OF NETTAXI PRIOR TO THE MERGER -------------------------------------------------------------------------------- EXECUTIVE OFFICERS AND DIRECTORS OF NUMBER OF SHARES PERCENT OF CLASS NETTAXI: BENEFICIALLY OWNED (2) -------------------------------------------------------------------------------- Robert A. Rositano, Jr., Chief 1,736,078 4.0% Executive Officer, Secretary and Director (3) -------------------------------------------------------------------------------- Dean Rositano, President, Chief 2,097,134 4.8% Operating Officer, Interim Chief Financial Officer and Director (4) -------------------------------------------------------------------------------- Andrew Garroni, Director (5) 225,000 * All directors and executive officers as 4,058,210 8.8% a group (three persons) ------------------- ----------------- -------------------------------------------------------------------------------- OTHER 5% STOCKHOLDERS: -------------------------------------------------------------------------------- Michael Gardner (6) 2,914,600 6.5% -------------------------------------------------------------------------------- HBK Investments L. P. (7) 3,000,000 6.5% -------------------------------------------------------------------------------- 48 * Less than one percent. (1) Amounts calculated pursuant to the exchange ration; actual numbers may differ. (2) 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 12, 2002 are deemed outstanding. Such shares, however, are not deemed outstanding for the purposes of computing the percentage ownership of each other person. (3) The number of shares shown for Robert A. Rositano, Jr. includes 365,000 shares of common stock subject to options that are currently exercisable within 60 days of February 12, 2002. Robert A. and Dean Rositano are brothers. (4) The number of shares shown for Dean Rositano includes 365,000 shares of common stock subject to options that are exercisable within 60 days of February 12, 2002. Robert A. and Dean Rositano are brothers. (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. 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. The Company 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 currently 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. Nettaxi obtained this information from HBK Investments L.P.'s 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. In March 2000, we granted Robert Speicher, our former Vice President of Sales and Marketing, 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 49 less than the fair market value on the date of grant. The right to purchase the shares accrued in 12 equal quarterly installments. Mr. Speicher's employment with Nettaxi ceased in 2001 and he received a payment in the amount of $260,000. 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. On May 7, 2001 Nettaxi entered into an additional consulting agreement with Baytree Capital Associates, LLC under which Baytree identified and evaluated acquisition candidates, conducted due diligence and otherwise advised the company with respect to the structuring of a transaction with acquisition candidates. Mr. Michael Gardner is a principal member of Baytree. This agreement was superceded in August 2001 when Nettaxi entered into a new agreement with Baytree for the same purposes. To date, Baytree has not received compensation under this agreement. 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 50 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: CONTENTS ================================================================================ REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS F-1 CONSOLIDATED FINANCIAL STATEMENTS Consolidated balance sheets F-2 Consolidated statements of operations F-3 Consolidated statements of shareholders' equity F-4 Consolidated statements of cash flows F-5 Notes to consolidated financial statements F-6 - F-30 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)) 2.3 Merger Agreement and Plan of Reorganization dated January 9, 2002 by and between RAE Systems Inc., RAES Acquisition Corporation and the Company. (Incorporated by reference to exhibit 2.1filed with the Registrant's Periodic Report on Form 8-K filed on January 10, 2002) 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)) 51 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) 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. 4.4 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)) 10.3 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)) 52 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)) 10.19 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)) 53 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)) 10.23 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)) 10.34 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)) 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)) 10.46 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)) 10.52 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) 10.53 Letter Of Intent Agreement dated as of February 29, 2000 between PPC Racing and the Company. (Previously filed with this registration statement) 54 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. (Incorporated by reference to Exhibit 10.57 filed with the Registrant's annual report on Form 10-K for the year ended December 31, 2000) 10.58 Online Advertising Insertion Order dated as of April 3, 2000 by and between the Company and Hearme.com. (Incorporated by reference to Exhibit 10.58 filed with the Registrant's annual report on Form 10-K for the year ended December 31, 2000) 10.59 Content License Agreement dated April 27, 2000 by and between the Company and ScreamingMedia. (Incorporated by reference to Exhibit 10.59 filed with the Registrant's annual report on Form 10-K for the year ended December 31, 2000) 10.60 Development and Revenue Sharing Agreement dated August 23, 2000 by and between the Company and Activeworlds.com, Inc. (Incorporated by reference to Exhibit 10.60 filed with the Registrant's annual report on Form 10-K for the year ended December 31, 2000) 10.61 GoTo.com Search Services Order dated as of September 1, 2000 by and between the Company and GoTo.com. (Incorporated by reference to Exhibit 10.61 filed with the Registrant's annual report on Form 10-K for the year ended December 31, 2000) 10.62 WebMall Co-Branded Web Page Agreement dated as of September 7, 2000 by and between the Company and StoreRunner Network, Inc. (Incorporated by reference to Exhibit 10.62 filed with 55 the Registrant's annual report on Form 10-K for the year ended December 31, 2000) 10.63 Software License Agreement dated as of September 29, 2000 by and between the Company and Annuncio Software, Inc. (Incorporated by reference to Exhibit 10.63 filed with the Registrant's annual report on Form 10-K for the year ended December 31, 2000) 10.64 Consulting Services Agreement dated as of October 11, 2000 by and between the Company and Annuncio Software, Inc. (Incorporated by reference to Exhibit 10.64 filed with the Registrant's annual report on Form 10-K for the year ended December 31, 2000) 10.65 Online Advertising Services Contract dated as of February 1, 2001 by and between the Company Fastclick.com, Inc. (Incorporated by reference to Exhibit 10.65 filed with the Registrant's annual report on Form 10-K for the year ended December 31, 2000) 10.66 Gigabit Data Services Agreement dated as of March 2001 by and between the Company and Alchemy Communications, Inc. (Incorporated by reference to Exhibit 10.66 filed with the Registrant's annual report on Form 10-K for the year ended December 31, 2000) 10.67 Exit Traffic Agreement dated as of January 1, 2000 by and between the Company and Internet Fuel.com, Inc. (Incorporated by reference to Exhibit 10.67 filed with the Registrant's annual report on Form 10-K for the year ended December 31, 2000) 10.68 Consulting Agreement dated as of April 7, 2001 by and between the Company and Innovative Networks, Inc. (Incorporated by reference to Exhibit 10.68 filed with the Registrant's quarterly report on Form 10-Q for the quarterly period ended June 30, 2001) 10.69 Letter Agreement dated as of August 1, 2001 by and among the Company and Baytree Capital Associates, LLC (Incorporated by reference to Exhibit 10.69 filed with the Registrant's quarterly report on Form 10-Q for the quarterly period ended June 30, 2001) 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. 56 On December 11, 2001 we filed a report on Form 8-K to announce that we had entered into a non-binding letter of intent to merger with RAE Systems Inc. On January 10, 2002 we filed a report on Form 8-K to announce that we had entered into an agreement to merge with RAE Systems Inc. 57 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: February 21, 2002 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, February 21, 2002 ----------------------------------- Secretary and Director Robert A. Rositano, Jr. (principal executive officer) /s/Dean Rositano President Chief Financial Officer February 21, 2002 ----------------------------------- and Director Dean Rositano (principal accounting officer) /s/Andrew Garroni Director February 21, 2002 ----------------------------------- Andrew Garroni
58 NETTAXI.COM CONTENTS ================================================================================ REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS F-1 CONSOLIDATED FINANCIAL STATEMENTS Consolidated balance sheets F-2 Consolidated statements of operations F-3 Consolidated statements of shareholders' equity F-4 Consolidated statements of cash flows F-5 Notes to consolidated financial statements F-6 - F-30 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, 2001 and 2000, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended December 31, 2001. 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 of America. 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. As discussed in Note 1 to the financial statements, on January 9, 2002, Nettaxi.com entered into a merger agreement under which Nettaxi.com, subject to shareholder approval, agreed to merge with RAE Systems, Inc. If the merger is consummated, Nettaxi.com will abandon its business model and adopt the business model of RAE Systems, Inc. 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, 2001 and 2000, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America. /s/ BDO Seidman, LLP San Jose, California January 11, 2002 F-1
NETTAXI.COM Consolidated Balance Sheets ============================================================================================== December 31, 2001 2000 ---------------------------------------------------------------------------------------------- ASSETS Current Assets: Cash and cash equivalents (Note 9) $ 8,586,800 $13,894,700 Accounts receivable, net of allowance for doubtful accounts of $114,100 and $433,000, respectively (Note 9) - 775,100 Prepaid expenses and other assets (Note 7) 122,300 1,035,000 ---------------------------------------------------------------------------------------------- TOTAL CURRENT ASSETS 8,709,100 15,704,800 ---------------------------------------------------------------------------------------------- PROPERTY AND EQUIPMENT, net (Note 2) 77,000 1,748,300 PURCHASED TECHNOLOGY, net (Note 3) - 319,000 OTHER INTANGIBLES, net (Note 3) - 55,000 DEFERRED EXPENSE (Note 7) - 272,500 DEPOSITS 5,600 24,000 ---------------------------------------------------------------------------------------------- $ 8,791,700 $18,123,600 ============================================================================================== LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 49,200 $ 1,162,400 Accrued expenses (Note 4) 134,700 397,900 ---------------------------------------------------------------------------------------------- TOTAL CURRENT LIABILITIES 183,900 1,560,300 ---------------------------------------------------------------------------------------------- COMMITMENTS AND CONTINGENCIES (Notes 5, 9, and 12) SHAREHOLDERS' EQUITY (Notes 6 and 7): 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 shares issued and outstanding 43,100 43,100 Additional paid-in capital 44,897,900 44,732,900 Deferred compensation - (429,900) Accumulated deficit (36,238,200) (27,687,800) ---------------------------------------------------------------------------------------------- TOTAL SHAREHOLDERS' EQUITY 8,607,800 16,563,300 ---------------------------------------------------------------------------------------------- $ 8,791,700 $18,123,600 ============================================================================================== See accompanying notes to consolidated financial statements.
F-2
NETTAXI.COM Consolidated Statements of Operations (Note 1) =================================================================================== Years ended December 31, 2001 2000 1999 ----------------------------------------------------------------------------------- NET REVENUES (Notes 9 and 10) $ 2,069,500 $ 9,418,400 $ 5,032,800 OPERATING EXPENSES: Cost of operations 4,258,100 7,307,700 4,003,800 General and administrative 5,482,900 5,007,300 3,456,000 Sales and marketing 933,700 5,908,300 4,788,800 Research and development 381,300 1,563,000 2,186,700 ----------------------------------------------------------------------------------- TOTAL OPERATING EXPENSES 11,056,000 19,786,300 14,435,300 ----------------------------------------------------------------------------------- LOSS FROM OPERATIONS (8,986,500) (10,367,900) (9,402,500) OTHER INCOME (EXPENSE): Interest income 447,900 703,800 75,100 Interest expense (Notes 6 and 7) (9,400) (4,685,700) (426,200) ----------------------------------------------------------------------------------- LOSS BEFORE INCOME TAXES (8,548,000) (14,349,800) (9,753,600) INCOME TAXES (Note 8) (2,400) (1,600) (126,800) ----------------------------------------------------------------------------------- NET LOSS $(8,550,400) $(14,351,400) $(9,880,400) =================================================================================== BASIC AND DILUTED LOSS PER COMMON SHARE $ (0.20) $ (0.36) $ (0.46) =================================================================================== WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING 43,124,586 39,381,211 21,274,203 =================================================================================== See accompanying notes to consolidated financial statements.
F-3
NETTAXI.COM Consolidated Statements of Shareholders' Equity (Notes 6 and 7) ============================================================================================================================== Common Stock Common Additional -------------------- Stock Paid-in Deferred Accumulated Shares Amount Subscribed Capital Compensation Deficit Total ------------------------------------------------------------------------------------------------------------------------------ BALANCES, December 31, 1998 14,110,000 $14,100 $(95,000) $ 4,868,800 $ - $ (3,455,800) $ 1,332,100 Issuance of common stock in connection with pooling 7,000,000 7,000 - - - (200) 6,800 (Note 1) Deferred compensation related - - - 702,700 (702,700) - - to stock options Amortization of deferred - - - - 211,300 - 211,300 compensation Interest related to issuance - - - 361,200 - - 361,200 of warrants Warrants exercised for 150,000 100 - 1,181,200 - - 1,181,300 common stock Exchange of convertible notes payable and accrued interest 802,223 800 - 1,862,500 - - 1,863,300 Proceeds from the issuance of 802,223 800 - 1,862,500 - - 1,863,300 common stock Issuance of common stock 350,000 400 - 1,060,400 - - 1,060,800 for services Net loss - - - - - (9,880,400) (9,880,400) ------------------------------------------------------------------------------------------------------------------------------ BALANCES, December 31, 1999 23,214,446 23,200 (95,000) 11,899,300 (491,400) (13,336,400) (2,000,300) Exchange of convertible notes payable and accrued interest 2,382,472 2,400 - 3,317,500 - - 3,319,900 Proceeds from the issuance of 632,472 600 - 834,300 - - 834,900 common stock Deemed interest on settlement - - - 3,896,000 - - 3,896,000 agreement Deferred compensation related - - - 512,200 (512,200) - - to stock options Amortization of deferred - - - - 573,700 - 573,700 Compensation Conversion of trade payables to 778,982 800 - 1,557,200 - - 1,558,000 common stock Warrants issued in conjunction with conversion of trade payables - - - 541,400 - - 541,400 Issuance of common stock 686,250 700 - 947,800 - - 948,500 for services Warrants issued for services - - - 84,000 - - 84,000 Proceeds from sale of common stock, net of costs of $1,831,600 15,416,633 15,400 - 21,127,200 - - 21,142,600 Issuance of common stock due to the exercise of stock options 13,331 - - 16,000 - - 16,000 Net loss - - - - - (14,351,400) (14,351,400) ------------------------------------------------------------------------------------------------------------------------------ BALANCES, December 31, 2000 43,124,586 43,100 (95,000) 44,732,900 (429,900) (27,687,800) 16,563,300 Amortization of deferred - - - - 429,900 - 429,900 compensation Options granted for services - - - 165,000 - - 165,000 Net loss - - - - (8,550,400) (8,550,400) ------------------------------------------------------------------------------------------------------------------------------ BALANCES, December 31, 2001 43,124,586 $43,100 $(95,000) $44,897,900 $ - $(36,238,200) $ 8,607,800 ============================================================================================================================== See accompanying notes to consolidated financial statements.
F-4
NETTAXI.COM Consolidated Statements of Cash Flows (Note 11) =================================================================================================== Years Ended December 31, 2001 2000 1999 --------------------------------------------------------------------------------------------------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS CASH FLOWS FROM OPERATING ACTIVITIES: Net Loss $(8,550,400) $(14,351,400) $(9,880,400) Adjustments to reconcile net loss to net cash used in operating activities: Loss on disposal of equipment 327,600 - - Depreciation and amortization 939,500 1,195,300 595,900 Write-down of assets 823,000 - - Allowance for doubtful accounts (318,900) 349,400 52,400 Issuance of common stock for interest on convertible notes - 119,900 63,300 Issuance of common stock for services (Note 7) 955,700 1,019,400 34,200 Compensation expense related to options and warrants granted 595,600 615,700 211,300 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 1,094,000 57,100 (1,100,300) Prepaid expenses and other assets 228,800 (231,000) (62,700) Accounts payable (1,113,200) (1,321,000) 3,854,500 Accrued expenses (265,600) (262,800) 585,100 Deferred revenue - - (47,000) Income taxes payable 2,400 (124,000) 125,600 --------------------------------------------------------------------------------------------------- NET CASH USED IN OPERATING ACTIVITIES (5,281,500) (8,337,000) (5,365,900) --------------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Deposits 18,400 26,900 (50,900) Proceeds from sale of equipment 28,500 - - Capital expenditures (73,300) (771,000) (2,105,400) --------------------------------------------------------------------------------------------------- NET CASH USED IN INVESTING ACTIVITIES (26,400) (744,100) (2,156,300) --------------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Payment on obligations under capital lease - (5,400) (7,300) Proceeds from convertible notes payable - - 5,000,000 Net proceeds from issuance of common stock - 21,993,500 3,051,400 --------------------------------------------------------------------------------------------------- NET CASH PROVIDED BY FINANCING ACTIVITIES - 21,988,100 8,044,100 --------------------------------------------------------------------------------------------------- NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (5,307,900) 12,907,000 521,900 CASH AND CASH EQUIVALENTS, beginning of year 13,894,700 987,700 465,800 --------------------------------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS, end of year $ 8,586,800 $ 13,894,700 $ 987,700 =================================================================================================== See accompanying notes to consolidated financial statements.
F-5 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. Nettaxi.com is an Internet marketing portal that provides a wide range of content and Internet based services for consumers and businesses. Subscribers to the Company's web site, www.nettaxi.com, are also provided with access to enhanced content such as broadband video clips and e-mail accounts. In 1999, the Company developed a diversified revenue model under which it provided subscribers with access to web site hosting services an a broad range of content, and provided affiliated businesses with access to a large population of Internet users for advertising and promotional purposes. The Company also provided web site hosting and Internet connectivity services for corporate customers. The Company's principal executive offices are located in Campbell, California. Beginning in April 2001, the bankruptcy and liquidation of many of the Company's Internet based customers and suppliers caused management to re-evaluate the Company's business model. Since the Internet infrastructure was unstable and customer base financially weak, management began to take corrective action to significantly decrease cash burn and determine the best course of action to maintain and enhance the value of the Company. In this regard, management implemented an acquisition strategy pursuant to which it has been seeking to identify an appropriate entity with which to merge, acquire or restructure the Company's current business. F-6 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ Beginning in May 2001, management reduced the Company's overhead and burn rate by reducing the salaries of employees and reducing the number of personnel, marketing expenses and costs associated with the Company's hosting activities. Effective July 7, 2001, the Company terminated its significant co-hosting customer contracts. In connection with this, it also discontinued the purchase of bandwidth and premium services from its third party provider. The terminations reduced operating expenses, and materially affected the Company's revenues beginning in the third quarter of 2001. The Company continues to operate its website, however, following the implementation of an acquisition strategy, the Company has not pursued any revenue generating activities in the last six months of 2001. The Company's current management team, consisting of finance and administrative employees is in place to maintain operations and enable ongoing review and analysis of acquisition candidates and to assist in the consummation of an appropriate transaction. Management has also engaged the services of an investment banker, to assist in this process (see Note 12). Current Developments On January 9, 2002 Nettaxi.com executed a definitive merger agreement which contemplates the merger of RAES Acquisition Corporation, a California corporation and wholly owned subsidiary of Nettaxi.com with RAE Systems, Inc., a California corporation that designs and manufacturers portable gas detection instruments and wireless monitoring and communications equipment. Under the terms of the merger agreement, unanimously approved by both Boards of Directors, RAE Systems shareholders will receive approximately 80% of the outstanding shares of the combined entity. Subject to the approval of shareholders, Nettaxi.com shares will be reverse split at the ratio of 5.67 to 1 prior to the closing of the merger. The management and Board of Directors of Nettaxi will resign at the closing of the merger and be replaced with the Board of Directors and management team of RAE Systems. It is the understanding of the respective parties that upon completion of the merger the going-forward operating activities of the combined company will be that of RAE Systems, Inc. The transaction, which is expected to be tax-free to shareholders of both companies for U.S. Federal income tax purposes is subject to the approval of each party's shareholders(see Note 12). Upon completion of the merger, the new company will be known as RAE Systems Inc. F-7 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ Consolidation The accompanying consolidated financial statements include the accounts of Nettaxi.com and its wholly-owned subsidiaries, Nettaxi OnLine Communities, Inc. and RAES Acquisition Corporation. All intercompany accounts and transactions have been eliminated in the consolidated financial statements. Use of Estimates The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. 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. F-8 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ Property and Equipment Property and equipment are stated at cost. Depreciation is provided using the straight-line method over the estimated economic useful lives of the assets, as follows: Estimated useful lives ------------------------------------------------------------- Furniture and fixtures 5 years Office equipment 5 years Computers and equipment 3 years ------------------------------------------------------------- Assets held under capital leases are amortized on a straight-line basis over the shorter of the lease term or the estimated useful lives of the related assets. Purchased Technology and Other Intangibles The Company amortizes, on a straight-line basis, the cost of purchased technology and other intangibles over the shorter of five (5) years or the useful life of the related technology or underlying asset. 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. F-9 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ 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, 2001, 2000, and 1999 were approximately $0, $2,224,800, and $343,400, respectively, representing 0%, 28%, and 7% of 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. 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 payments 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 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. F-10 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ 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. In accordance with Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition 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. 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. 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, 2001, 2000, and 1999, were approximately $74,700, $2,365,600, and $2,831,300, respectively. F-11 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. 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. 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. Stock-Based Incentive Program SFAS No. 123, Accounting for Stock-Based Compensation, encourages entities to recognize compensation costs for stock-based employee compensation plans using the fair value based method of accounting defined in SFAS No. 123, but allows for the continued use of the intrinsic value based method of accounting prescribed by Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees. The Company continues to use the accounting prescribed by APB Opinion No. 25 and as such is required to disclose pro forma net income (loss) and earnings (loss) per share as if the fair value based method of accounting had been applied (Note 7). F-12 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ In March 2000, the Financial Accounting Standards Board (FASB) issued Interpretation (Interpretation) No. 44, Accounting for Certain Transactions involving Stock Compensation, an Interpretation of APB 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. 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 25,953,816, 23,994,732, and 3,838,679, for the years ended December 31, 2001, 2000, and 1999, respectively. All share and per share information has been adjusted for the shares exchanged for the common stock of Plus Net, Inc. F-13 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ Adoption of New Accounting Pronouncements In June 1999, the FASB issued SFAS No. 137, Accounting for Derivative Instrument and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133, which amends SFAS No. 133 to be effective for all fiscal years beginning after June 15, 2000. In June 2000, SFAS No. 133 was amended by SFAS No. 138, Accounting for Certain Derivative Instruments and Hedging Activities, which amended or modified certain issues discussed in SFAS No. 133. SFAS No. 138 is also effective for all fiscal years beginning after June 15, 2000. SFAS No. 133 and SFAS No. 138 establish accounting and reporting standards requiring that every derivative instrument be recorded in the balance sheet as either an asset or liability measured at its fair value. The statements also require that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. The Company does not engage in derivative instruments or hedging activities. Accordingly, there was no impact on the Company's financial statements from the adoption of SFAS No. 133 and SFAS No. 138. In July 2001, the FASB issued SFAS No. 141 (SFAS 141), Business Combinations, which supersedes Accounting Principles Board (APB) Opinion No. 16, Business Combinations. SFAS 141 eliminates the pooling- of-interests method of accounting for business combinations and modifies the application of the purchase accounting method. The elimination of the pooling-of-interests method is effective for transactions initiated after June 30, 2001. The remaining provision of SFAS 141 will be effective for transactions accounted for using the purchase method that are completed after June 30, 2001. In July 2001, the FASB also issued SFAS No. 142 (SFAS 142), Goodwill and Intangible Assets, which supersedes APB Opinion No. 17, Intangible Assets. Under SFAS 142, goodwill and intangible assets with indefinite lives are not amortized but are tested for impairment annually using the fair value approach, except in certain circumstances, and whether there is an impairment indicator, other intangible assets will continue to be valued and amortized over their estimated lives; in-process research and development will continue to be written off immediately; all acquired goodwill must be assigned to reporting units for purposes of impairment testing and segment reporting and existing goodwill will no longer be subject to amortization. The provisions of SFAS No. 142 are required to be applied starting with fiscal years beginning after December 15, 2001. F-14 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ In August 2001, the FASB issued SFAS No. 143 (SFAS 143) Accounting for Obligations Associated with the Retirement of Long-Lived Assets. SFAS 143 addresses financial accounting and reporting for the retirement obligation of an asset. SFAS 143 states that companies should recognize the asset retirement cost, at its fair value, as part of the cost asset and classify the accrued amount as a liability in the balance sheet. The asset retirement liability is then accreted to the ultimate payout as interest expense. The initial measurement of the liability would be subsequently updated for revised estimates of the discounted cash outflows. SFAS 143 will be effective for fiscal years beginning after June 15, 2002. The Company has not yet determined the effect SFAS 143 will have on its financial position, results of operations, or cash flows. In October 2001, the FASB issued SFAS No. 144 (SFAS 144) Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS 144 supersedes the SFAS No. 121 by requiring that one accounting model to be used for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired, and by broadening the presentation of discontinued operation to include more disposal transactions. SFAS 144 will be effective for fiscal years beginning after December 15, 2001. The Company has not yet determined the effect SFAS 144 will have on its financial position, results of operations, or cash flows. 2. PROPERTY AND Property and equipment consisted of the following: EQUIPMENT
December 31, 2001 2000 ----------------------------- ---------- ---------- Computers and equipment $1,470,900 $2,721,100 Furniture and fixtures 55,200 203,600 Office equipment 55,100 55,100 ----------------------------- ---------- ---------- 1,581,200 2,979,800 Less accumulated depreciation 1,504,200 1,231,500 ----------------------------- ---------- ---------- $ 77,000 $1,748,300 =====================================================
In the fourth quarter of 2001, the Company had a third-party appraisal carried out of its property and equipment. As a result of this appraisal the Company recorded asset impairment charges of $551,000. F-15 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ 3. PURCHASED Purchased technology and other intangibles consisted of the TECHNOLOGY AND following: OTHER INTANGIBLES December 31, 2001 2000 ----------------------------- -------- -------- Purchased technology $870,000 $870,000 Less accumulated amortization 870,000 551,000 ----------------------------- -------- -------- $ -- $319,000 Other intangibles $150,000 $150,000 Less accumulated amortization 150,000 95,000 ----------------------------- -------- -------- $ -- $ 55,000 ================================================= As a result of the decision taken by management in mid-2001 to implement an acquisition strategy and to terminate the Company's significant co-hosting customer contracts, the projected undiscounted cash flows to support the value of the purchased technology and other intangibles were no longer deemed adequate. In 2001, the Company wrote-down its purchased technology and other intangibles by $232,000 and $40,000, respectively. 4. ACCRUED Accrued expenses consisted of the following: EXPENSES
December 31, 2001 2000 ---------------------------- -------- -------- Professional fees $109,300 $157,300 Payroll and related expenses 2,300 97,800 Marketing - 83,800 Other 23,100 59,000 ---------------------------- -------- -------- $134,700 $397,900 ================================================
5. LEASE The Company leases its facility under an operating lease, COMMITMENTS which expires on May 31, 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, 2001, 2000, and 1999, was $245,300, $281,600, and $178,000, respectively. F-16 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ In 1999, the Company entered into operating leases on certain vehicles. For the years ended December 31, 2001, 2000, and 1999, rent expense related to the vehicle leases aggregated $5,300, $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 Year Ending December 31, Leases -------------------------------------------- ---------- 2002 $ 23,800 -------------------------------------------- ---------- $ 23,800 ========================================================
6. CONVERTIBLE On March 31, 1999 the Company entered into a $5,000,000 NOTES PAYABLE, Convertible Debt Financing Agreement (the Agreement) with RELATED PARTY 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. F-17 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ 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' COMMON STOCK EQUITY 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. The merger constituted a tax-free reorganization and was 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. 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. 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. F-18 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ 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 amortized the aggregate consideration given over the term of the agreement and fully recognized the unamortizated portion in the second quarter of 2001. Included in prepaid expenses and deferred expenses was as of December 31, 2000, $926,500, representing the then unamortized portion of the consideration given for these consulting services. 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. F-19 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ 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. 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 2001, 2000, and 1999: dividend yield of 0%; expected volatility of 94%, 138%, and 69%; risk-free interest rate of 5.5%, 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. F-20 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ 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. 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 exercise 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. F-21 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ 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, was amortized over a four months period. In 2001 and 2000, the Company recognized $42,000 and $42,000 of this amount, respectively. In April 2001, the Company issued warrants, which vested immediately, to purchase 1,500,000 shares of common stock at an exercise price of $0.13 for financial consulting services. The aggregate value of these warrants amounted to $165,000. Included in prepaid expenses as of December 31, 2001, is $41,200 representing the unamortized portion of the consideration given for these consulting services. 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 shareholders. 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. F-22 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ A summary of the status of the Company's stock option plan as of December 31, 2001, 2000, and 1999, and changes during the years then ended is presented in the following table:
Options Outstanding ---------------------------------------------------------------------------- December 31, 2001 December 31, 1999 December 31, 2000 ------------------------- ------------------------ ----------------------- Weighted- Weighted- Weighted- Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price -------------------------------------------------------------------------------------------- Beginning 5,293,916 $ 4.83 2,580,166 $ 9.47 280,000 $ 0.80 Granted 3,005,000 $ 0.16 3,931,600 $ 1.88 2,614,000 $ 10.40 Exercised -- $ -- (13,331) $ 1.20 -- $ -- Forfeited (2,720,916) $ 2.45 (1,204,519) $ 5.19 (313,834) $ 9.45 ------------ ------------ ----------- Ending 5,578,000 $ 3.47 5,293,916 $ 4.83 2,580,166 $ 9.47 ========= ============ =========== ============ ========== =========== ========== Exercisable at year-end 4,521,734 2,368,750 640,499 ============ ============ =========== Weighted-average fair value of options granted during the period: $ 0.11 $ 1.34 $ 5.71 =========== =========== ==========
The following table summarizes information about stock options outstanding as of December 31, 2001:
Options Outstanding --------------------------------------- Options Exercisable Weighted- ------------------------- Average Weighted- Weighted- Range of Remaining Average Average Exercise Number Contractual Exercise Number Exercise Prices Outstanding Life (Years) Prices Exercisable Prices -------------------------------------------------------------------------------- $0.01-0.75 1,408,000 7.53 $ 0.16 593,826 $ 0.17 $0.76-1.00 165,000 3.50 $ 0.80 165,000 $ 0.80 $1.01-2.00 1,199,000 6.46 $ 1.50 1,221,894 $ 1.48 $2.01-5.00 1,396,000 7.76 $ 2.44 921,894 $ 2.44 $5.01-10.00 1,200,000 7.61 $ 9.08 1,200,000 $ 9.08 $10.01-15.00 210,000 6.87 $ 13.91 205,528 $ 13.96 -------------------------------------- ----------- 5,578,000 $ 3.47 4,521,734 $ 4.13 =========== ============= =========== ============
F-23 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ During the years ended December 31, 2001, 2000, and 1999, the Company recorded deferred compensation of approximately $0, $512,200, and $702,700, respectively, relating to the issuance of 0, 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 was charged to operations over the term of the related consulting agreements. In 2001, 2000, and 1999, such amortization amounted to approximately $429,900, $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. 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 2001, 2000, and 1999: dividend yield of 0%; expected volatility of 96%, 124%, and 112%; risk-free interest rate of 5.0%, 6.2%, and 6.2%; 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:
2001 2000 1999 --------------------------------------------------------------- Net income (loss): As reported $ (8,550,400) $(14,351,400) $ (9,880,400) Pro forma $(11,905,200) $(19,426,800) $(11,516,600) Basic and diluted earnings (loss) per share: As reported $ (0.20) $ (0.36) $ (0.46) Pro forma $ (0.28) $ (0.49) $ (0.54)
F-24 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ 8. INCOME TAXES The provision for income taxes for the year ended December 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, 2001 and 2000 consisted of minimum state taxes. 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, 2001, 2000, and 1999:
2001 2000 1999 --------------------------------------------------------------------- Federal income tax benefit at statutory rate $(2,720,000) $(4,675,000) $(3,316,200) State income taxes, net of federal benefit (466,000) (799,000) (566,500) Nondeductible book expenses 555,000 2,308,000 - Tax benefit not currently recognizable 2,404,000 2,992,900 3,884,100 Other 229,400 174,700 125,400 --------------------------------------------------------------------- Provision for income taxes $ 2,400 $ 1,600 $ 126,800 =====================================================================
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. F-25 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ Temporary differences and carryforwards which gave rise to significant portions of deferred tax assets and liabilities as of December 31, 2001, 2000, and 1999 are as follows:
December 31, 2001 2000 1999 ---------------------------------------------------------------------- Net operating loss carryforward $ 9,994,000 $ 7,375,000 $ 4,558,900 Depreciation and amortization 280,000 (36,000) (216,800) Accrued compensation and benefits - 37,000 562,700 Reserves not currently deductible 61,000 555,000 33,300 ---------------------------------------------------------------------- Net deferred tax asset 10,335,000 7,931,000 4,938,100 Valuation allowance (10,335,000) (7,931,000) (4,938,100) ---------------------------------------------------------------------- Reported deferred tax asset $ - $ - $ - ======================================================================
As of December 31, 2001, the Company had a federal net operating loss (NOL) carryforward in the amount of $26,754,000 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 $14,200,600 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. F-26 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ 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 2001, three customers accounted for approximately 47%, CUSTOMERS 25%, and 19% of revenues, respectively, with related account receivable as of December 31, 2001 of $0, $0, and $0, respectively. In 2000, four customers accounted for approximately 20%, 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. 11. SUPPLEMENTAL The following is supplemental disclosure for the statements DISCLOSURE of cash flows. OF CASH FLOW INFORMATION
Years Ended December 31, 2001 2000 1999 -------------------------------------------------------------------- CASH PAID: Income taxes $ - $ 127,200 $ 1,600 Interest $9,400 $ - $ 3,000 NONCASH INVESTING AND FINANCING ACTIVITIES: Issuance of common stock for convertible notes payable plus accrued interest $ - $3,319,900 $1,863,300 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 ====================================================================
F-27 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ 12. COMMITMENTS On May 1, 2001 seven shareholders of Nettaxi filed an action AND CONTINGENCIES against the Company. The complaint also names the Company's Chief Executive Officer, President and former Chief Financial Officer as additional defendants. The complaint alleged that the Company violated securities laws in connection with its February 2000 private placement. The complaint was amended on May 23, 2001. The amendment addressed factual matters and added three new plaintiffs to the lawsuit. Shortly after filing the amended complaint, the Company, pursuant to the rules of the District Court, met with plaintiffs and pointed out further factual inaccuracies and deficiencies. Plaintiffs, then, chose to attempt to amend their complaint for a second time. Six of the plaintiffs purchased shares of Nettaxi common stock in the February 2000 private placement. Prior to filing the complaint the plaintiffs demanded the refund of all of the money invested in Nettaxi and demanded that the exercise price of the warrants issued in the private placement be reduced from $4.00 to $0.25 per share. Additionally, prior to filing the complaint, Nettaxi was asked to invest capital in a company affiliated with one of the plaintiffs. In the complaint, the plaintiffs seek compensatory damages, injunctive relief and fees and interest. On October 1, 2001, the Company filed a motion to dismiss the complaint filed by Plaintiffs. In response, Plaintiffs have given notice that they intend to seek court permission to file a third amended complaint to attempt to recharacterize their claims and to remove some claims which Plaintiffs concede are contrary to the law. 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. F-28 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ In May 2001, the Company entered into an agreement with an investment banker to provide, on a semi-exclusive basis, services in connection with identifying a potential merger candidate and to assist in negotiating and effecting a transaction. The terms of the agreement provide for compensation to be paid to the investment banker upon the successful closing of a transaction in the amount of 5% of the total amount of the transaction up to $3 million and 2% of the remaining amount of the transaction, payable, at the election of the investment banker, in cash or common stock of the Company and a warrant exercisable to purchase up to 5% of the Company's common stock at a purchase price as defined in the agreement On January 9, 2002, the Company entered into a merger agreement under which the Company, subject to shareholder approval, agreed to merge with RAE Systems, Inc. If the Company's shareholders do not approve of the merger, the Company shall pay RAE Systems, Inc., within five days of the date of the termination of the merger agreement, an amount equal to $250,000. If the merger is consummated, with a change in control of the Company as a result, the two officers of the Company will each be entitled to receive a severance package consisting of a cash payment of $150,000; accelerated vesting on outstanding options to purchase 67,020 shares of common stock (after taking into account the 5.67 to 1 reverse split) at an exercise price of $0.737 per share, and a cash bonus of an amount necessary to exercised price of $0.737 per share, and a cash bonus of an amount necessary to exercise the options; and warrants to purchase up to 176,366 shares of common stock (after taking into account the 5.67 to 1 reverse split) at an exercise price of $1.134 per share.
13. VALUATION AND Additions QUALIFYING Balance Charged to Balance ACCOUNTS as of Beginning Costs and as of End Description of Period Expenses Deductions of Period ------------------------------------------------------------------------------ 2001: Allowance for doubtful accounts $ 433,000 $ 2,600 $ (321,500) $ 114,100 2000: Allowance for doubtful accounts $ 83,600 $ 504,900 $ (155,500) $ 433,000 1999: Allowance for doubtful accounts $ 31,200 $ 52,400 $ - $ 83,600 ==============================================================================
F-29 NETTAXI.COM NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ 14. 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. Effective July 7, 2001, the Company terminated its significant co-hosting customer contracts and effectively ceased all revenue generating activities.
Year Ended First Second Third Fourth December 31, Quarter Quarter Quarter Quarter 2001 ----------------------------------------------------------------------------------------- Net revenues $ 1,192,500 $ 869,700 $ 7,000 $ 300 $ 2,069,500 Gross profit (loss) (761,300) (1,282,200) (145,400) 300 (2,188,600) Operating (loss) (2,533,800) (4,408,100) (914,500) (1,130,100) (8,986,500) Net (loss) (2,361,300) (4,286,200) (826,500) (1,076,400) (8,550,400) Basic and diluted (loss) per common share (0.05) (0.10) (0.02) (0.02) (0.20) ========================================================================================= 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 (loss) 991,400 1,063,100 600,600 (544,400) 2,110,700 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) =========================================================================================
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