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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
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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
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Transition Period from __________________ to ___________________
Commission File Number 33-19139-NY
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RATEXCHANGE CORPORATION
(Exact Name of Registrant as Specified in its Charter)
Delaware 11-2936371
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
100 Pine Street, Suite 500
San Francisco, CA 94111
(Address of Principal Executive Offices) (Zip Code)
(415) 274-5650
(Registrant's Telephone Number, Including Area Code)
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Securities Registered Pursuant to Section 12(b) of the Act:
Common Stock, $0.0001 per share
Securities Registered Pursuant to Section 12(g) of the Act: None
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 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. |_|
The aggregate market value of the 17,669,449 shares of common stock of the
Registrant issued and outstanding as of March 28, 2002, excluding 742,900 shares
of common stock held by affiliates of the Registrant was $6,361,002. This amount
is based on the closing price of the common stock on the American Stock Exchange
of $0.36 per share on March 28, 2002.
DOCUMENTS INCORPORATED BY REFERENCE
Part III of this Form 10-K incorporates by reference certain portions of
the Registrant's proxy statement for its 2002 annual meeting of stockholders to
be filed with the Commission not later than 120 days after the end of the fiscal
year covered by this report.
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Ratexchange Corporation
Form 10-K
for the Year Ended December 31, 2001
PART I
ITEM 1. Business............................................... 3
ITEM 2. Properties............................................. 5
ITEM 3. Legal Proceedings...................................... 5
ITEM 4. Submission of Matters to a Vote of Security Holders.... 6
PART II
ITEM 5. Market for Registrant's Common Stock and Related
Stockholder Matters.................................... 7
ITEM 6. Selected Consolidated Financial Data................... 7
ITEM 7 Management's Discussion and Analysis of Financial
Condition and Results of Operations.................... 9
ITEM 7A. Quantitative and Qualitative Disclosures About
Market Risk............................................ 18
ITEM 8. Financial Statements and Supplementary Data............ 19
Consolidated Balance Sheets............................ 21
Consolidated Statements Of Operations.................. 22
Consolidated Statements Of Stockholders' Equity
(Deficit).............................................. 23
Consolidated Statements of Cash Flows.................. 24
Notes to Consolidated Financial Statements............. 25
PART III
ITEM 9. Changes in and Disagreements With Accountants On
Accounting and Financial Disclosure.................... 40
ITEM 10. Directors and Executive Officers of the Registrant..... 40
ITEM 11. Executive Compensation................................. 42
ITEM 12. Security Ownership of Certain Beneficial
Owners and Management.................................. 42
ITEM 13. Certain Relationships and Related Transactions......... 42
PART IV
ITEM 14. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K.................................... 43
Certain statements contained in this Annual Report on Form 10-K (Report),
including, without limitation, statements containing the words "believes,"
"anticipates," "estimates," "expects," "projections," and words of similar
import, constitute "forward-looking statements." Readers should not place undue
reliance on these forward-looking statements. Ratexchange's actual results could
differ materially from those anticipated in these forward-looking statements for
many reasons, including risks faced by the Company described in this Report,
including the "Risk Factors" section contained in Item 7, and the other
documents Ratexchange files with the Securities and Exchange Commission (SEC),
including its most recent reports on Form 8-K and Form 10-Q, and amendments
thereto.
PART I
ITEM 1. BUSINESS
Overview
Ratexchange is an innovative brokerage services firm that combines its
expertise in bandwidth and other emerging commodity markets with securities
brokerage and investment banking activities. Our RTX Securities Corporation
subsidiary is a NASD licensed, fully disclosed broker-dealer offering sales and
trading services to institutions and private clients, as well as advisory and
investment banking services to our corporate clients. Through our emerging
commodities division, we are developing channels to maximize profits by
providing valuable and marketable information to RTX Securities.
Ratexchange Corporation expects to generate revenues from brokerage and
investment banking activities through RTX Securities and to a lesser extent from
consulting and information services through our emerging commodities division.
We get paid for our investment banking and brokerage services in the form of
commissions, transaction fees, merger and acquisition advisory fees and capital
markets services fees. We also believe that our consulting and information
services will begin to generate revenues in the form of subscription fees,
transaction fees, professional services fees and management fees.
RTX Securities
The consolidation and downsizing of investment banks serving emerging
growth companies, particularly in San Francisco, has created a timely
opportunity for Ratexchange to enter this voided market through its RTX
Securities subsidiary. It is contemplated that the potential products and
services that we will focus on within RTX Securities will include
trading/execution services, market making, private placement services for public
companies (PIPEs), initial public offerings, secondary offerings, mergers and
acquisitions advisory, soft dollar services and asset management.
In addition, given the telecommunications sector bankruptcies and the
market volatility in telecommunications debt and equity securities, Ratexchange
has seen considerable interest in bandwidth pricing and other telecommunications
related data from asset managers and corporations. We believe that the need for
information in the distressed telecommunications sector has never been greater
and our brokerage operation is an additional channel to derive revenues from
providing that information. A key aspect to the value proposition for our
growing brokerage and investment banking businesses is specialized, in-depth
information. We intend to leverage our internal capabilities to analyze that
information with an eye to creating marketable research products. Additional
market sectors for our investment banking services and research focus include
technology, telecommunications, life sciences, consumer growth and financial
services.
Emerging Commodities
We believe that opportunity will arise from the chaos experienced in the
telecommunications and energy merchant sectors during 2001, punctuated by the
unraveling of Enron, Winstar, and Global Crossing, among many others. Even in
the face of these company and market disruptions, there appears to be increasing
demand for bandwidth from both the residential and commercial sectors, which we
believe will provoke a reordering of the telecommunications sector and
subsequent market conditions which will, over time, reinvigorate the awareness
and trading of bandwidth that was beginning to show higher daily volumes during
the summer and early fall of 2001. We believe that the market for the brokering
of bandwidth will eventually take hold as has been demonstrated in the markets
for other recently commoditized products such as natural gas and electricity.
Despite the uncertainty relative to the timing of marketplace adoption and the
magnitude of eventual trading volumes for bandwidth, we believe that our
investment to date in technology and brand presence has positioned us to
capitalize on that investment. We are not currently brokering bandwidth, but
when market activity rebounds we are positioned to resume brokering of
bandwidth. We have shifted our focus to aggregating price and market data
related to bandwidth and other emerging commodities for sale to third parties.
3
Data Aggregation Model
Through the investment in a flexible design and architecture of the
Ratexchange Trading System (RTS), we now have the capability to aggregate
pricing and market data not only related to bandwidth, but in other
telecommunications and non-telecommunications arenas as well. Information
service providers, telecommunications companies, energy merchants and financial
institutions need real time access to current market data and pricing
information to be able to effectively manage risk and maximize a return on their
assets. In response to this need, we intend to make this type of data available
to the marketplace through the Specialist Data Agreement we signed with Reuters
Limited in 2001. We intend to develop relationships with operating companies and
other data providers who would be interested in leveraging the business and
technical infrastructure we have developed with Reuters. By working with
Ratexchange to channel their data through the RTS, we are providing our data
aggregation partners a cost-effective and rapid solution for tapping into a
potential new global customer base represented by Reuters' significant installed
subscriber base worldwide. Ratexchange will earn a percentage of the
subscription fees that Reuters charges to its Specialist Data customers who pay
for the Ratexchange data. Our data aggregation partners then share a portion of
the fees we receive from Reuters.
Ratexchange Trading System
Proprietary Ratexchange trading software powers the trading system,
designed with input from energy merchants, telecommunication companies,
commodity traders and brokers. The RTS is analogous to trading platforms in the
on-line natural gas and electricity commodity markets. The RTS enables market
participants to buy and sell fiber optic, Internet and satellite bandwidth
capacity globally. The RTS serves not only as a platform for bandwidth trading,
but for the aggregation of data from third parties as well. We have developed
the technical infrastructure, using the RTS as a platform, to execute inbound
and outbound data transfers from our data aggregation partners and Reuters,
effectively converting the RTS into a data aggregation hub as well as a trading
platform. We believe we have developed intellectual property with regard to our
RTS, including certain processes and innovations that we believe can be
patented.
Trades executed on the RTS can be delivered between any two city-pairs
globally. Market participants can trade any number of city pairs. As the
bandwidth trading market evolves, notwithstanding the year-end 2001 market
turmoil, participants will likely adopt a standardized contract, similar to the
evolution that occurred in other commodity markets. Trading will utilize the
Master Bandwidth Purchase and Sale Agreement (MBPSA)--made available by the
Bandwidth Trading Organization (BTO)--as well as other supplier and buyer
contracts.
OffXchange Trading
In addition to trading directly over the Ratexchange Trading System,
Ratexchange, in an agreement with Amerex Bandwidth, Ltd. (Amerex), also executed
transactions using traditional voice brokerage. We believe that voice brokerage
is critical to establishing liquidity in early markets such as bandwidth. Amerex
is the world's largest over-the-counter energy broker, providing customers with
voice and electronic brokerage services, market liquidity, price discovery and
data services around the globe.
Consulting Services
In the context of declining bandwidth prices and current financial
pressures on the telecommunications market, there has been increasing emphasis
on the monetization of bandwidth-related assets. Institutions within the
financial community have become aware of the opportunities presented by the
evolving telecommuncations and bandwidth markets and are actively seeking to
educate and position themselves. Furthermore, network providers are aware of the
need to effectively manage risk in the face of volatile market conditions. Based
on our management team and professional staff drawn from the financial services,
energy, commodity and telecommunications industries, we are qualified to provide
a wide range of consulting services to existing and prospective market
participants.
Commodity/Risk Management
Current volatile energy prices provide strong evidence that companies
should consider utilizing risk management tools. We currently provide hedging,
trading and analytical expertise that will help bandwidth trading customers
manage the risk associated with bandwidth price volatility. Our areas of
expertise include:
o Hedging, as well as price and risk management
o Asset valuation
o Purchase and liquidation provisioning
o Structured swaps and derivative products
4
Analytics
With increasing liquidity and resulting price discovery in the bandwidth
market, buyers and sellers are able to identify and build forward price curves.
We offer, through our RateXlabs consulting service, pricing strategy and develop
analytical tools, such as custom-made indices, that enable customers to make
more effective decisions with respect to their bandwidth assets. RateXlabs has
presented its work on bandwidth pricing strategy and other analytical
information to numerous current and potential market participants.
Risk Management Group
RMG Partners Corporation (RMG) is a wholly owned Delaware subsidiary which
provides risk management solutions through the use of derivative trading
strategies. RMG designs solutions to manage financial risk for a variety of
clients including corporations, money managers and hedge funds. The management
team at RMG has extensive experience in structuring fixed income and equity
derivative products.
By utilizing derivative instruments, RMG offers customized investment
products and trade ideas. The following list identifies a few basic strategies
that have been executed for clients of RMG:
o Arbitrage Trades
o Covered Call-Write Option Strategies
o Fund Redemption Strategies
o Directional Exposure with Defined Risk/Reward Profiles
o Variable Rate Prepay Forwards
o Structured Notes
As noted in Item 7. "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and Item 8. "Financial Statements and
Supplemental Data", we intend to sell the RMG subsidiary in April 2002 and
discontinue the offering of these consulting services.
Employees
Ratexchange and its subsidiaries employed seventeen (17) persons as of
December 31, 2001.
ITEM 2. PROPERTIES
Not applicable.
ITEM 3. LEGAL PROCEEDINGS
Martin v. Ratexchange - On October 3, 2001, Gregory Martin and Patricia
Whitney filed a lawsuit against Ratexchange Corporation in the United States
District Court for the Western District of Washington, C01-1565R alleging breach
of contract. In 1998, Mr. Martin was the President and CEO of NetAmerica
International Corporation (NAMI), a predecessor of Ratexchange Corporation. In
December of 1998, Mr. Martin was terminated from his employment with NAMI. The
claims allege breach of agreements associated with Mr. Martin's employment. The
complaint asks for damages of approximately $150,000. Mr. Martin had filed suit
previously in the Washington State court. That matter was dismissed following a
settlement in May of 1999. Mr. Martin has now revived his claim against
Ratexchange. The matter is being defended by Ratexchange and is in the
preliminary stages of litigation. We have recorded the estimated loss exposure
in the consolidated balance sheet as of December 31, 2001.
YellowBrix, Inc. v. Ratexchange Corporation - On October 2, 2001,
YellowBrix, Inc. filed a lawsuit against Ratexchange Corporation in the Circuit
Court for the City of Alexandria, Virginia alleging breach of contract.
YellowBrix, Inc. provided news wire information to us in 2001. In January 2002,
we settled this case for a cash payment of $19,250. We have recorded the
settlement in the consolidated balance sheet as of December 31, 2001.
5
Ratexchange I, Inc. v. PWREF/MCC-China Basin, LLC - In September 2001,
Ratexchange I, Inc., one of our Delaware subsidiaries, terminated its lease and
filed a lawsuit against PWREF/MCC-China Basin, LLC, its previous landlord,
alleging constructive eviction and seeking declaratory relief. The allegations
of the complaint arise from the lease for commercial space between the parties
for the property located at 185 Berry Street, in San Francisco, California.
PWREF/MCC-China Basin, LLC responded to the complaint and filed a
cross-complaint against Ratexchange I, Inc. In March 2002, we settled the
cross-complaint and dismissed our action. We paid $195,937 and issued 50,000
shares of our restricted common stock to PWREF/MCC-China Basin, LLC. We have
recorded the settlement in the consolidated balance sheet as of December 31,
2001.
Additionally, from time to time, we are involved in ordinary routine
litigation incidental to our business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of 2001.
6
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
Our common stock trades on the American Stock Exchange under the symbol
"RTX." The following table sets forth the range of the high and low sales prices
per share of our common stock for the fiscal quarters indicated.
High Low
---- ---
2001
Fourth Quarter...................... $ 0.75 $ 0.20
Third Quarter....................... 1.40 0.20
Second Quarter ..................... 2.05 0.70
First Quarter....................... 3.05 1.15
2000
Fourth Quarter...................... $ 4.00 $ 1.19
Third Quarter....................... 6.38 3.00
Second Quarter ..................... 22.13 5.19
First Quarter....................... 43.25 5.63
The closing sale price for our common stock on March 28, 2002 was $0.36.
The market price of our common stock has fluctuated significantly and may be
subject to significant fluctuations in the future. See Item 7. "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
As of March 28, 2002, there were approximately 273 stockholders of record
of our common stock and 18,412,349 shares of common stock outstanding.
Ratexchange has never paid cash dividends on its capital stock. We
currently intend to retain earnings for use in our business and do not
anticipate paying any cash dividends in the foreseeable future.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with Item 7. "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the consolidated financial statements
and the notes thereto included in Item 8. "Financial Statements and
Supplementary Data."
As of December 31,
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
Balance Sheet Data:
Cash and cash equivalents .................. $ 5,806,725 $ 2,115,152 $ 536,615 $ 528,516 $ --
Working capital ............................ 3,339,174 12,001,202 (48,367) 700,654 (200)
Total assets ............................... 7,506,781 16,263,816 3,043,885 830,154 --
Long-term obligations ...................... 8,375,892 -- -- -- --
Stockholders' equity (deficit) ............. $(3,441,733) $13,662,946 $ 318,829 $ 700,654 $ (200)
7
Year ended December 31,
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
Statement of Operations Data:
Revenue .................................. $ 2,194,811 $ 91,223 $ -- $ -- $ --
Operating expenses:
Selling, general and
administrative ..................... 18,967,242 41,969,950 7,491,447 2,161,253 200
Depreciation and amortization .......... 1,570,622 222,115 18,676 -- --
Settlement of lease obligations ........ 7,315,360 -- -- -- --
Write-down of software assets .......... 3,010,371 -- -- -- --
Acquisition of subsidiary .............. -- -- 1,507,408 89,710 --
Write-off of advances to
potential investee ................. -- -- 413,681 885,000 --
------------ ------------ ------------ ------------ ------------
Total operating expenses ........ 30,863,595 42,192,065 9,431,212 3,135,963 200
------------ ------------ ------------ ------------ ------------
Operating loss ........................... (28,668,784) (42,100,842) (9,431,212) (3,135,963) (200)
Interest income .......................... 330,772 1,017,482 151,496 2,214 --
Interest expense ......................... (265,089) (164,671) (19,073) (10,773) --
Interest expense (non-cash) .............. (74,124) (1,657,988) -- -- --
Loss on securities ....................... (744,197) -- -- -- --
Other expense, net ....................... (650,754) (1,822,875) -- -- --
------------ ------------ ------------ ------------ ------------
Net loss ................................. $(30,072,176) $(44,728,894) $ (9,298,789) $ (3,144,522) $ (200)
============ ============ ============ ============ ============
Basic and diluted net loss per
common share ....................... $ (1.69) $ (2.69) $ (0.72) $ (1.92) $--
============ ============ ============ ============ ============
Weighted average number of
common shares outstanding .......... 17,913,546 16,633,611 12,863,020 1,639,919 200,000
Adjusted Statement of Operations Data:
Ratexchange provides adjusted net loss and adjusted net loss per share data
to assist readers in understanding our operating results. These adjustments are
not in accordance with, or an alternative to, generally accepted accounting
principles and may be different for the presentation of financial information
provided by other companies. See Item 8. "Financial Statements and Supplementary
Data" for Ratexchange's complete financial statements presented under generally
accepted accounting principles.
Year ended December 31,
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
Net loss ................................. $(30,072,176) $(44,728,894) $ (9,298,789) $ (3,144,522) $ (200)
Adjustments:
Stock-based compensation ................. 5,218,971 23,107,832 3,158,415 2,020,376 --
Settlement of leases and obligations ..... 7,575,892 -- -- -- --
Write-off of property and equipment ...... 3,235,454 -- -- -- --
Depreciation and amortization ............ 1,570,622 222,115 -- -- --
Loss on write-down of security ........... 744,197 -- -- -- --
Employee severance ....................... 400,000 -- -- -- --
Interest expense (non-cash) .............. 74,124 1,657,988 -- -- --
------------ ------------ ------------ ------------ ------------
Adjusted net loss ........................ $(11,252,916) $(19,740,959) $ (6,140,374) $ (1,124,146) $ (200)
============ ============ ============ ============ ============
Basic and diluted adjusted net
loss per common share .............. $ (0.64) $ (1.19) $ (0.48) $ (0.69) $ (0.00)
============ ============ ============ ============ ============
Weighted average number of
common shares outstanding .......... 17,913,546 16,633,611 12,863,020 1,639,919 200,000
8
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction with
"Selected Consolidated Financial Data" and our consolidated financial statements
and notes thereto included elsewhere in this Annual Report on Form 10-K.
Overview
Ratexchange is an innovative brokerage services firm that combines its
expertise in bandwidth and other emerging commodity markets with securities
brokerage and investment banking activities. Our RTX Securities Corporation
subsidiary is a NASD licensed, fully disclosed broker-dealer offering sales and
trading services to institutions and private clients, as well as advisory and
investment banking services to our corporate clients. Through our emerging
commodities division, we are developing channels to maximize profits by
providing valuable and marketable information to RTX Securities.
In December 2001, we completed a private offering of convertible notes, in
an aggregate principal amount of $3.5 million, due December 31, 2011. The notes
bear interest at 12% per annum and may be converted into shares of common stock
on election of the holder anytime before their maturity or their prior
redemption or repurchase by Ratexchange. The net proceeds from this offering
were approximately $3.1 million, after deducting offering expenses. Pending the
use of the net proceeds, we have invested them in interest bearing money market
accounts.
In December 2001, we acquired an inactive broker-dealer and changed the
name of the entity to RTX Securities Corporation (RTX Securities), a California
corporation and wholly owned subsidiary of Ratexchange. RTX Securities is a
registered, fully disclosed broker-dealer with the Securities Exchange
Commission and is a member of the National Association of Securities Dealers
(NASD). The membership agreement with the NASD allows RTX Securities to engage
in various business activities including private placement of securities,
trading equity securities over-the-counter and selling corporate debt
securities. In 2002, RTX Securities intends to apply for a change in its
membership agreement allowing RTX Securities to engage additional business
activities including proprietary trading, options trading and making markets in
corporate securities over-the-counter.
During 2001, management revised our business plan concerning the delivery
of telecommunications bandwidth through our own network hubs. It was determined
that we did not have an alternative use for the network equipment in our ongoing
operations. As a result, we recorded a $6.4 million charge for the acceleration
of remaining contractual obligations and costs associated with the Forsythe
McArthur & Associates (Forsythe) lease arrangement.
In November 2001, Forsythe agreed to forego all amounts owed by Ratexchange
under the lease obligation in exchange for a convertible note payable and stock
warrants. We issued a convertible note in an aggregate principal amount of $5.9
million, due August 31, 2006. The note bears interest at 9% per annum and may be
paid in cash or our common stock at our discretion. The note may be converted
into shares of common stock on election of Forsythe on August 31, 2006 with a
conversion price equal to 80% of the closing market price of the common stock at
that date.
In March 2001, we acquired Xpit.com, Inc. and merged it into our newly
created subsidiary Xpit Corporation. The acquisition enabled us to offer trading
and risk management systems to the futures industry. Under the terms of the
transaction, we acquired the outstanding common shares of Xpit.com, Inc. in
exchange for $500,000 in cash, a $500,000 two-year note bearing interest at 7%
per year, 2,000,000 shares of Series A convertible preferred stock with a
cumulative dividend of 6% based on a share price of $2.75 per share and $4.9
million in future royalty payments tied to the achievement of Xpit Corporation's
projected revenues from 2001 through 2003. The Series A preferred stock is
convertible on a one-for-one basis into common stock at the discretion of the
holders. The acquisition price was allocated primarily to the software
technology acquired.
In October 2001, we sold all of the material assets of our Xpit Corporation
subsidiary, including the Ratexchange Futures System (RFS), to CQG, Inc. (CQG),
a privately-held quotation services company. The assets were sold to CQG in
exchange for $1.5 million in cash. Additionally, we can earn royalties of up to
$650,000 over the next four years if CQG achieves future revenue targets via the
RFS platform. In connection with the sale to CQG, we recorded a $3.0 million
non-cash charge in the third quarter to reflect the impairment in the value of
the Xpit Corporation assets, principally the carrying value of the RFS platform.
Additionally, the $500,000 note payable associated with the original Xpit.com,
Inc. purchase price was paid in full, plus accrued interest. Net cash proceeds,
after payment of the note and expenses associated with the transaction, were
$902,000.
9
In April 2001, we formed RMG Partners Corporation (RMG) as a wholly owned
subsidiary which provides risk management solutions through the use of
derivative trading strategies. Ratexchange committed to capitalize the newly
formed company with $300,000 and 2.2 million shares of Ratexchange's common
stock. RMG principals receive 85% of revenue, which is used to cover payroll and
operating expenses of RMG. An affiliate of the principals of RMG, BL Partners,
LLC, has the right to purchase all of our interest in RMG, except for the
portion of Ratexchange common stock used to capitalize RMG that is not
"controlled" by the Chairman of RMG, for $300,000 commencing in April 2002. The
Chairman of RMG obtains control over the Ratexchange common stock based on the
achievement of revenue targets. As of December 31, 2001, the Chairman of RMG had
achieved control over approximately 1.1 million shares of the Ratexchange common
stock used to capitalize RMG.
In February 2002, we received notice from BL Partners, LLC, that it intends
to exercise its right to purchase RMG in April 2002 in accordance with the terms
of the agreement. Our consolidated financial statements for 2001 properly
reflect the activity of RMG. The following adjustments to our consolidated
financial statements would be appropriate to reflect our results "as if" we did
not own RMG during 2001. Our consolidated balance sheet as of December 31, 2001
would have reflected the following decreases: (i) cash and cash equivalents by
$1,149,000, (ii) prepaid expenses and other current assets by $16,000, (iii)
other investments and deposits by $139,000, and (iv) accounts payable and
accrued liabilities by $1,304,000. The consolidated statement of income for the
year ended December 31, 2001 would have reflected a decrease in revenue of
$1,993,000 and a decrease in operating expenses of $1,832,000 in 2001.
Results of Operations
Revenue
We recognized $2,195,000 and $91,000 in revenue during 2001 and 2000,
respectively. We did not recognize revenue during 1999. The increase in revenue
of approximately $2,104,000, or 2,312% from 2000 to 2001 was due primarily to
consulting revenue attributed to the activity of RMG. During 2001, a single
customer accounted for 29% of our total revenue. During 2000, no customer
accounted for more than 10% of our revenue. Consulting revenue attributed to the
activity of RMG represented 91% of the consolidated revenue during 2001. As
discussed above, we expect to sell the RMG subsidiary during the second quarter
of 2002 and will likely lose this source of revenue. We anticipate our revenue
for 2002 will increase sequentially over the revenue recognized in 2001 related
primarily to activities of our RTX Securities broker-dealer subsidiary.
Selling, General and Administrative Expense
Selling, general and administrative expenses were $18,967,000, $41,970,000
and $7,491,000 in 2001, 2000 and 1999, respectively. The increase of
approximately $34,479,000, or 460% from 1999 to 2000 was due to an increase in
(i) non-cash stock-based compensation of $19,949,000, (ii) outside services
mostly related to business development and marketing activity of $4,159,000,
(iii) payroll costs of $3,994,000, and (iv) network equipment installation costs
of $3,970,000. The decrease of approximately $23,003,000, or 55% from 2000 to
2001 related to a decrease in (i) non-cash stock-based compensation of
$17,489,000 and (ii) outside services of $4,503,000. We anticipate selling,
general and administrative expense, both non-cash and in the aggregate, to be
lower in 2002 as compared to 2001.
Depreciation and Amortization
Depreciation and amortization costs were $1,571,000, $222,000 and $19,000
in 2001, 2000 and 1999, respectively. The increase of approximately $203,000, or
1,068% from 1999 to 2000 was due mostly to depreciation of the trading platform
software purchased and developed in 2000. The increase of approximately
$1,349,000, or 608% from 2000 to 2001 resulted primarily from depreciation of
the software assets acquired in the purchase of Xpit.com, Inc. during March
2001. We expect depreciation and amortization to decrease in absolute dollars
during 2002 because we sold the software assets acquired in the purchase of
Xpit.com, Inc. during October 2001.
Write-Down of Software Assets
In March 2001, we acquired Xpit.com, Inc. for approximately $5.5 million in
preferred stock, notes payable and cash. The acquisition price was allocated
primarily to the software technology acquired, the Ratexchange Futures System
trading platform. In October 2001, we sold the RFS trading platform for $1.5
million in cash. We recorded a $3.0 million non-cash charge in the third quarter
of 2001 to reflect the impairment in the value of the RFS software.
10
Settlement of Lease Obligations
We have entered into various operating leases associated with our delivery
hubs, including various telecommunications routing equipment and other
infrastructure. In addition, we have entered into various leases for office
space and related office equipment, including computers and software. During
2001, we revised our business plan concerning the delivery of telecommunications
bandwidth through our own network hubs. It was determined that we did not have
an alternative use for the network equipment in our ongoing operations. We
recorded a $6.4 million charge for the acceleration of remaining contractual
obligations and costs associated with the lease arrangement with Forsythe. We
recorded expenses of approximately $900,000 in connection with the settlement or
restructure of the various operating leases.
Acquisition of Subsidiary
In 1999, the Company purchased all the outstanding common stock of Rate
Exchange, Inc. seeking to develop new exchange services for the
telecommunications market. The purchase price included 574,998 shares of common
stock, valued at $920,000, and a $450,000 promissory note. On the date of
purchase, Rate Exchange, Inc. had negative net worth of $112,408. The Company
recorded an expense of $1,507,408 representing the amount by which the
consideration provided exceeded the net assets of Rate Exchange, Inc. at the
date of acquisition plus expenses associated with the transaction of $25,000.
Write-off of Advances to Potential Investee
In September 1998, the Company, then known as Venture World, Ltd., began
negotiations to acquire NetAmerica, Inc., subsequently renamed A1 Internet, Inc.
The acquisition was never closed and negotiations were terminated in March 1999.
Between the time the Company negotiated to purchase NetAmerica, Inc and the time
the deal was terminated in March 1999, the Company advanced $1,738,769 to
NetAmerica, Inc. During 1999, the Company determined that $1,507,408 of the
amount advanced to NetAmerica, Inc. was uncollectible and charged this amount to
expense.
Interest Income
Interest income was $331,000, $1,017,000 and $151,000 in 2001, 2000 and
1999, respectively. The increase of approximately $866,000, or 574% from 1999 to
2000 was due to interest earned on cash, cash equivalents and investment
securities acquired with the proceeds from the issuance of common stock in 2000.
The decrease of approximately $686,000, or 67% from 2000 to 2001 resulted from a
decrease in cash, cash equivalents and investment securities in 2001 as compared
to 2000. We expect interest income to be lower in 2002 as compared to 2001
because cash, cash equivalents and investment securities will be lower.
Interest Expense
Interest expense was $265,000, $165,000 and $19,000 in 2001, 2000 and 1999,
respectively. The increase of approximately $146,000, or 768% from 1999 to 2000
was due primarily to the $2 million bridge loan issued in February 2000 and
converted to common stock later in 2000. The increase of approximately $100,000,
or 61% from 2000 to 2001 was due to the convertible notes payable issued in late
2001 with an aggregate balance of approximately $8.4 million. We anticipate
interest expense will increase in 2002 as a result of a full year of interest
expense associated with our convertible notes payable.
Interest Expense (Non-Cash Amortization)
Interest expense (non-cash amortization) was $74,000, $1,658,000 and $0 in
2001, 2000 and 1999, respectively. The 2000 non-cash expense represented the
fair value charge in connection with the conversion of our bridge loan into
common stock and stock warrants. The 2001 non-cash expense represented
amortization of discounts and debt issuance costs related to the convertible
notes payable issued during the fourth quarter 2001. We expect non-cash interest
expense to increase during 2002 as we continue to amortize these discounts and
debt issuance costs and record a full year affect of such amortization.
Loss on Securities
As noted above in the discussion concerning the write-off of advances to
potential investee, we advanced to A1 Internet, Inc. amounts which were
determined to be uncollectible. A1 Internet, Inc. agreed to repay certain of the
costs incurred by the Company prior to the termination. A1 Internet, Inc. was
subsequently sold to Halo Holdings of Nevada, Inc. (Halo), a privately held
company. We received 100,000 shares of Halo common stock in our settlement with
Halo. During 2001, we sold a portion of the Halo common stock for a realized
loss and recorded an impairment loss for the remaining shares of common stock.
The loss attributed to the Halo investment was $744,000 in 2001.
11
Other Expenses, net
Other expenses were $651,000, $1,823,000 and $0 in 2001, 2000 and 1999,
respectively. The 2000 expenses primarily represented a charge for common stock
and stock warrants issued as settlement of a dispute. The 2001 expenses
consisted of $225,000 for the write-off of fixed assets not utilized and
$426,000 for the settlement of legal obligations.
Liquidity and Capital Resources
As of December 31, 2001, our principal source of liquidity was our cash and
cash equivalents, amounting to $5.8 million. As noted in "Overview", we expect
to sell RMG during the second quarter of 2002 for $300,000. Cash and cash
equivalents in the RMG subsidiaries as of December 31, 2001 was $1,449,000.
Cash used in our operating activities was $11,762,000, $17,161,000 and
$3,070,000 in 2001, 2000 and 1999, respectively. Cash used in our operations in
2001 was primarily attributable to a net loss adjusted for the non-cash charges
of stock-based compensation, loss on settlement of lease obligations, write-down
of software assets, loss on securities, write-off of fixed assets, amortization
of discounts on convertible notes payable, amortization of debt issuance costs,
an increase in interest payable, decreases in interest receivable, other
advances and deposits, offset by decreases in accounts payable and accrued
liabilities.
Cash provided by our investing activities in 2001 was $12,349,000, while
cash used by our investing activities in 2000 and 1999 was $13,643,000 and
$914,000, respectively. Investment activities include the purchase of short-term
investments of $32,975,000 in 2000, sale of short-term investments of
$20,767,000 in 2000 and $12,095,000 in 2001, purchase of property and equipment
of $208,000 in 1999, $1,435,000 in 2000 and $1,043,000 in 2001, sale of software
assets of $1,422,000 in 2001, and investment in private companies of $706,000 in
1999 and $125,000 in 2001.
Cash provided by our financing activities was $3,105,000, $32,382,000 and
$3,992,000 in 2001, 2000 and 1999, respectively. Financing activities include
the issuance of common stock of $3,582,000 in 1999 and $31,726,000 in 2000,
issuance of convertible notes payable and other debt of $410,000 in 1999,
$1,090,000 in 2000 and $3,605,000 in 2001, the repayment of notes payable of
$500,000 in 2001 and a loan to our employee stock purchase program of $434,000
in 2000.
We believe that our existing cash balances and investments will be
sufficient to meet our liquidity and capital spending requirements at least
through the end of the first quarter 2003. However, we have been unprofitable
since inception, have incurred net losses in each year, and to date, we have
generated only nominal revenues. Furthermore, our funding of working capital and
current and future operating losses may require additional capital investment.
We cannot be certain that additional debt or equity financing will be available
when required or, if available, that we can secure it on terms satisfactory to
us.
Effects of Recent Accounting Pronouncements
In July 2001, the Financial Accounting Standards Board issued SFAS No. 141,
Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets.
SFAS No. 141 addresses financial accounting and reporting for business
combinations. This statement requires the purchase method of accounting to be
used for all business combinations, and prohibits the pooling-of-interests
method of accounting. This statement is effective for all business combinations
initiated after June 30, 2001 and supercedes APB Opinion No. 16, Business
Combinations, as well as SFAS No. 38, Accounting for Preacquisition
Contingencies of Purchased Enterprises.
SFAS No. 142 addresses how intangible assets that are acquired individually
or with a group of other assets should be accounted for in financial statements
upon their acquisition. This statement requires goodwill amortization to cease
and for goodwill to be periodically reviewed for impairment, for fiscal years
beginning after October 31, 2001. SFAS No. 142 supercedes APB Opinion No. 17,
Intangible Assets. We will adopt the provisions of this standard for its first
quarter of fiscal 2002, and do not expect the adoption to have a material effect
on our financial condition or results of operations.
In August 2001, the Financial Accounting Standards Board issued SFAS No.
143, Accounting for Asset Retirement Obligation. SFAS No. 143 is effective for
fiscal years beginning after June 15, 2002, and will require companies to record
the fair value of a liability for asset retirement obligations in the period in
which they are incurred, which typically could be upon completion or shortly
thereafter. The effect of adoption of this standard on our results of operations
and financial positions is being evaluated.
In October 2001, the Financial Accounting Standards Board issued SFAS No.
144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No.
144 is effective for fiscal years beginning after December 15, 2001. It provides
a single accounting model for long-lived assets to be disposed of and replaces
SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and Long-Lived
Assets to Be Disposed Of. The effect of adoption of this standard on our results
of operations and financial positions is being evaluated.
12
Risk Factors
Investing in our securities involves a high degree of risk. In addition to
the other information contained in this annual Report, including reports we
incorporate by reference, you should consider the following factors before
investing in our securities.
We are a company with a limited operating history in a changing industry,
it is difficult to evaluate our business and prospects.
Our activities to date have concentrated primarily on planning and
developing our electronic trading system for brokering telecommunications
bandwidth and other telecommunications products. In September 2000, we began
operating the Ratexchange Trading System for trading telecommunications
bandwidth and in December 2001 we established a securities broker-dealer and
investment bank, RTX Securities Corporation. Accordingly, we have a limited
operating history on which to base an evaluation of our business and prospects.
Our prospects must be considered in light of the risks, expenses and
difficulties frequently encountered by companies in their early stage of
development, particularly companies in new and rapidly evolving markets. There
can be no assurance that we will be successful in addressing these risks and our
failure to do so could have a material adverse effect on our business and
results of operations.
Our ability to attain a positive cash flow and become profitable depends on
our ability to generate and maintain greater revenues while incurring reasonable
expenses. This, in turn, depends, among other things, on the development of
telecommunications bandwidth trading as a viable commercial market, development
of securities trading and investment banking business as well as our ability to:
o establish, maintain and increase our client base;
o manage the quality of services delivered by us and third party brokers
and customers supporting our trading system, securities and banking
businesses;
o compete effectively with existing and potential competitors;
o further develop our business model;
o manage expanding operations; and
o attract and retain qualified personnel.
If we do achieve a positive cash flow and profitability, we cannot be
certain that we will be able to sustain or increase them on a quarterly or
annual basis in the future. Our inability to achieve or maintain profitability
or positive cash flow could result in disappointing financial results, impede
implementation of our growth strategy or cause the market price of our common
stock to decrease. Accordingly, we cannot assure you that we will be able to
generate profits, which makes our ability to implement successfully our business
plan uncertain.
Because we are a developing company, the factors upon which we are able to
base our estimates as to the gross revenues and the number of participating
clients that will be required for us to attain a positive cash flow and any
additional financing that may be needed for this purpose, are unpredictable and
extremely limited. In addition, the business in which we operate is new and
rapidly changing. For these and other reasons, we can give no assurance that we
will not require higher gross revenues, a greater number of clients, a greater
numbers of securities and banking transactions, a greater number of emerging
commodity transactions and/or more time in order for us to complete the
development that we believe we need to be able to cover our operating expenses,
or obtain the funds necessary to finance this development. In fact, because
actual events more often than not differ from anticipated events, it is more
likely than not that our estimates will prove to be inaccurate. Furthermore, in
the event that financing is needed in addition to the amount that is required
for this development, we cannot assure that such financing will be available on
acceptable terms, if at all. Accordingly, we can neither assure nor represent
that our business will ever generate a positive cash flow or be profitable.
We have a history of operating losses and we anticipate losses and negative cash
flow for the foreseeable future. Unless we are able to generate profits and
positive cash flow we may not be able to continue operations.
We have incurred net losses and generated only nominal revenues from
operations since our inception and financed our operations primarily through
sales of equity and debt securities. We incurred net loss of $30,072,000,
$44,729,000 and $9,299,000 in 2001, 2000 and 1999, respectively, and negative
cash flow from operations of $11,762,000, $17,161,000 and $3,070,000 in 2001,
2000 and 1999, respectively. As of December 31, 2001, our accumulated deficit
since inception was $87,731,000. We expect net losses and negative cash flow to
continue, at least into the fourth quarter of 2002. We may never achieve
profitability and even if we do, we may not sustain or increase it on a
quarterly or annual basis in the future. If we are unable to achieve or sustain
profitability, we may be unable to continue our operations.
13
We may require additional funding in the event our revenues do not meet our
projections, our expenses are greater than we anticipate, or to finance the
further development of our business. Our inability to obtain additional
financing, if required, would have an adverse effect on our business.
We expect that our current liquidity, together with our existing resources
will be sufficient to meet our cash requirements for at least the next twelve
months. However, if our actual costs are higher than projected or our
contemplated future revenues fall below our current expectations, we may require
additional financing before the expiration of twelve months. In such event, we
will be forced to seek additional financing, most likely from one or more public
or private equity or debt offerings. We currently have no commitments for any of
such additional funding and may not be able to raise needed cash on terms
acceptable to us or at all. Financings may be on terms that are dilutive or
potentially dilutive to our stockholders. Further, our lack of tangible assets
to pledge could prevent us from establishing a source of financing. If sources
of financing are required, but are insufficient or unavailable, we will need to
modify our growth and operating plans to the extent of available funding, which
would have an adverse effect on the successful implementation of our planned
business development.
We may not be able to compete successfully against current and future
competitors.
The markets for securities brokerage, investment banking and data
aggregation for emerging commodities are highly competitive. Our ability to
compete with other companies will depend largely upon our ability to capture
market share by obtaining sufficient participants for the Ratexchange Trading
System and customers for our brokerage and banking services.
Increased pressure created by any current or future competitors, or by our
competitors collectively, could have a material adverse effect on our business
and results of operations. Increased competition may result in reduced
commissions and fees and loss of market share. Further, as a strategic response
to changes in the competitive environment, we may from time to time make certain
pricing, service or marketing decisions or acquisitions that also could have a
material adverse effect on our business and results of operations. We cannot
assure that we will be able to compete successfully against current and future
competitors. In addition, new technologies, services and the expansion of
existing technologies or services may increase the competitive pressures on us.
We may become subject to regulation by the Commodity Futures Trading Commission,
depending on the types of products and services we eventually introduce.
We have developed an electronic trading system for trading futures
contracts, options on futures contracts and swaps for the purchase or sale of
bandwidth and other emerging commodity products. Futures contracts and options
on futures contracts are within the jurisdiction of the Commodity Futures
Trading Commission (CFTC). Currently, the Commodity Exchange Act provides that
futures contracts may be entered into only on a board of trade that has been
designated by the CFTC as a contract market. The CFTC has never determined
whether some or all swap agreements are futures or options contracts subject to
regulation under the Commodity Exchange Act and the CFTC's regulations. The CFTC
has, however, issued a policy statement stating that most swap transactions are
not appropriately regulated as futures or options contracts under the Commodity
Exchange Act or the CFTC's regulations. The CFTC has also issued rules exempting
swap agreements from most provisions of the Commodity Exchange Act and the
CFTC's regulations provided certain conditions are satisfied. These exemptive
rules do not permit swaps to be traded on traditional exchanges. Neither the
CFTC's policy statement, which is limited in its application to cash-settled
swaps, nor the CFTC's exemptive rules permit swaps to be cleared, and both
impose other restrictions on swaps. As a result, under the current statutory and
regulatory scheme applicable to swaps, should we elect in the future to list for
trading or clearing of swap agreements, we may need to request an exemption from
the CFTC to do so. The CFTC is under no obligation to reach a decision within a
certain period or to grant an exemption.
We have registered as a securities broker-dealer and, as such, are subject to
substantial regulations. Our failure to comply with these regulations may
adversely affect our business.
We registered our wholly owned subsidiary with the SEC and the NASD as a
securities broker-dealer in December 2001 and are subject to extensive
regulation under federal and state laws. The principal purpose of regulation and
discipline of broker-dealers is the protection of customers and the securities
markets rather than protection of creditors and stockholders of broker-dealers.
The SEC is the federal agency charged with administration of the federal
securities laws. Much of the regulation of broker-dealers, however, has been
delegated to self-regulatory organizations, such as the NASD and national
securities exchanges. The NASD is our primary self-regulatory organization.
These self-regulatory organizations adopt rules (which are subject to approval
by the SEC) that govern the industry and conduct periodic examinations of member
broker-dealers. Broker-dealers are also subject to regulation by state
securities commissions in the states in which they are registered. The
regulations to
14
which broker-dealers are subject cover all aspects of the securities business,
including net capital requirements, sales methods, trading practices among
broker-dealers, capital structure of securities firms, record keeping and the
conduct of directors, officers and employees. The SEC and the self-regulatory
bodies may conduct administrative proceedings, which can result in censure,
fine, suspension or expulsion of a broker-dealer, its officers or employees. If
we fail to comply with these rules and regulations, our business would be
materially and adversely affected.
If we lose the services of our executive officers, or if we cannot recruit and
retain additional skilled personnel, our business may suffer.
We depend on the continued services and performance of D. Jonathan
Merriman, our Chairman and Chief Executive Officer, for our future success. We
currently have an employment agreement with Mr. Merriman, which ends on October
8, 2003 but can be terminated by either party on 60 day's notice.
In addition to Mr. Merriman, we are currently managed by a small number of
key management and operating personnel. We do not maintain "key man" insurance
on any employee. Our future success depends, in part, on the continued service
of our key executive, management and technical personnel, many of whom have only
recently been hired, and our ability to attract highly skilled employees. If any
key officer or employee were unable or unwilling to continue in his or her
current position, our business could be harmed. From time to time we have
experienced, and we expect to continue to experience, difficulty in hiring and
retaining highly skilled employees. If we are unable to retain our key employees
or attract, integrate or retain other highly qualified employees in the future,
such failure may have a material adverse effect on our business and results of
operations.
We may be unable to effectively manage rapid growth that we may experience,
which could place a continuous strain on our resources.
We plan to expand our operations. Our growth, if it occurs, will impose
significant demands on our management, financial, technical and other resources.
To manage our future growth we must adapt to changing business conditions and
improve existing systems or implement new systems for our financial and
management controls, reporting systems and procedures and expand, train and
manage a growing employee base. Furthermore, in order to achieve rapid growth,
we may acquire technologies or products or enter into strategic alliances. For
us to succeed we must make our existing technology, business and systems work
effectively with those of any strategic partners without undue expense,
management distraction or other disruptions to our business. In addition, we may
be required to maintain and expand our relationships with various hardware and
software vendors, Internet and other online service providers and other third
parties necessary to our business. If we fail to manage any of the above growth
challenges successfully, we may be unable to implement our business plan. If
that occurs, our financial results may suffer and we could be materially
adversely affected.
We may not be able to protect and enforce our intellectual property rights,
which could result in the loss of our rights, loss of business or increased
costs.
Our performance and ability to compete is dependent to a degree on our
proprietary technology, including, but not limited to the design of the trading
and data aggregation capabilities of the Ratexchange Trading System. We regard
our copyrighted material, software design, trade secrets and similar
intellectual property as necessary to our success, and we rely on trademark and
copyright laws, trade secret protection and confidentiality and/or license
agreements with our employees, customers, partners and others to protect our
proprietary rights. We cannot assure you that we will be able to secure
significant protection for any of our intellectual property. If we are unable to
secure or protect our marks and systems, it could result in the loss of our
rights to our marks and systems, or the loss of business. In addition, it is
possible that our competitors or others will adopt product or service names
similar to our marks, thereby inhibiting our ability to build brand identity and
possibly leading to customer confusion.
We generally have entered into agreements containing confidentiality and
non-disclosure provisions with our employees and consultants who have limited
access to and distribution of our software, documentation and other proprietary
information. We cannot assure you that the steps we take will prevent
misappropriation of our technology or that agreements entered into for that
purpose will be enforceable. Notwithstanding the precautions we have taken, it
might be possible for a third party to copy or otherwise obtain and use our
software independently. Policing unauthorized use of our technology is
difficult, particularly because the global nature of the Internet makes it
difficult to control the ultimate destination or security of software or other
data transmitted. The laws of other countries may afford us little or no
effective protection of our intellectual property.
15
Effective trademark, service mark, copyright and trade secret protection
may not be available in every country where our services are made available
online. In the future, we may also need to file lawsuits to enforce our
intellectual property rights, protect our trade secrets and determine the
validity and scope of the proprietary rights of others. Such litigation, whether
successful or unsuccessful, could result in substantial costs and diversion of
resources, which could have a material adverse effect on our business and
results of operations.
Third parties may claim that our business activities infringe upon their
proprietary rights. From time to time in the ordinary course of business we may
be subject to claims of infringement of third parties' trademarks and other
intellectual property rights. Such claims could subject us to significant
liability and result in invalidation of our proprietary rights. These claims
could also be time-consuming and expensive to defend, even if we ultimately are
not found liable. In addition, these claims could divert our management's time
and attention from the operation of our business.
Our business is dependent on the development and maintenance of the Internet
infrastructure.
Our success will depend, in part, upon the development and maintenance of
the Internet infrastructure as a reliable network backbone with the necessary
speed, data capacity and security, and timely development of enabling products,
such as high-speed modems, for providing reliable Internet access and services.
We cannot assure you that the Internet infrastructure will continue to
effectively support the demands placed on it as the Internet continues to
experience increased numbers of users, greater frequency of use or increased
bandwidth requirements of users. Even if the necessary infrastructure or
technologies are developed, we may have to expend considerable resources to
adapt our offerings accordingly. Furthermore, in the past, the Internet has
experienced a variety of outages and other delays. Any future outages or delays
could affect our ability to use the Internet as a successful trading medium. If
any of these events occur, our business, results of operations and financial
condition could be materially and adversely affected.
Critical issues concerning the commercial use of the Internet, such as ease
of access, security, reliability, cost and quality of service, remain unresolved
and may affect the growth of Internet use or the attractiveness of conducting
commerce online. In addition, the Internet and online services may not be
accepted as a viable commercial marketplace for a number of reasons, including
potentially inadequate development of the necessary network infrastructure or
delayed development of enabling technologies and performance improvements. To
the extent that the Internet and online services continue to experience
significant growth, there can be no assurance that the infrastructure of the
Internet and online services will prove adequate to support increased user
demands. In addition, the Internet or online services could lose their viability
due to delays in the development or adoption of new standards and protocols
required to handle increased levels of Internet or online service activity.
Changes in or insufficient availability of telecommunications services to
support the Internet or online services could also result in slower response
times and adversely affect usage of the Internet and online services generally
and our services in particular. We would be materially and adversely affected
if:
o use of the Internet and online services does not continue to grow, or
grows more slowly than expected;
o the infrastructure for the Internet and online services does not
effectively support growth that may occur; or
o the Internet and online services do not become a viable commercial
marketplace.
We may be adversely affected by government regulations and legal uncertainties
associated with the Internet.
Laws and regulations directly applicable to Internet communications,
commerce and advertising are becoming more prevalent, but the legislative and
regulatory treatment of the Internet remains largely unsettled. The U.S.
Congress has adopted Internet laws regarding copyright, taxation and the
protection of children.
16
In addition, a number of other legislative and regulatory proposals under
consideration by federal, state, local and foreign governments could lead to
additional laws and regulations affecting, among other things:
o the right to collect and use personally identifiable information;
o pricing;
o intellectual property;
o online content;
o user privacy;
o taxation;
o access charges;
o distribution;
o liability for third-party activities; and
o characteristics and quality of products and services.
For example, the growth and development of the market for Internet commerce
may prompt calls for more stringent consumer protection laws in the United
States that may impose additional burdens on companies conducting business over
the Internet.
The adoption of any additional laws or regulations may decrease the growth
of the Internet or other online services, which could, in turn, reduce the
demand for our products and services and increase our cost of doing business, or
otherwise have an adverse effect on our business and results of operations.
Moreover, courts may seek to apply existing laws not explicitly relating to the
Internet in ways that could impact the Internet, and it may take years to
determine whether and how laws such as those governing intellectual property,
privacy, libel and taxation will affect the Internet and our use of it.
We plan to facilitate transactions between numerous customers residing in
various states and foreign countries, and such jurisdictions may claim that we
are required to qualify to do business as a foreign corporation in each such
state and 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. Any new legislation or regulation, the application of laws and
regulations from jurisdictions whose laws do not currently apply to our
business, or the application of existing laws and regulations to the Internet
and other online services could have a material adverse effect on our business
and results of operations.
Our business and operations would suffer in the event of system failures.
Our success, in particular our ability to successfully facilitate bandwidth
and securities brokerage and provide high-quality customer service, largely
depends on the efficient and uninterrupted operation of our computer and
communications hardware systems. Our systems and operations are vulnerable to
damage or interruption from fire, flood, power loss, telecommunication failures,
break-ins, earthquake and similar events. Despite the implementation of network
security measures, our servers are vulnerable to computer viruses, physical or
electronic break-ins and similar disruptions, which could lead to interruptions,
delays, loss of data or the inability to accept and fulfill customer orders.
If we do not respond effectively to technological change, our service could
become obsolete and our business could suffer.
To remain competitive, we must continue to enhance and improve the
responsiveness, functionality and features of the Ratexchange Trading System.
The Internet and the online commerce industry are characterized by rapid
technological change, changes in user and customer requirements and preferences,
frequent new product and service introductions embodying new technologies and
the emergence of new industry standards and practices that could render our
existing proprietary technology and systems obsolete. Our success will depend,
in part, on our ability to license leading technologies useful in our business,
enhance our existing services, develop new services and technology that address
the increasingly sophisticated and varied needs of our prospective customers,
and respond to technological advances and emerging industry standards and
practices on a cost-effective and timely basis.
The development of our other proprietary technology entails significant
technical and business risks. There can be no assurance that we will
successfully use new technologies effectively or adapt proprietary technology to
user requirements or emerging industry standards. Our failure to adapt in a
timely manner to changing market conditions or customer requirements, whether
for technical, legal, financial or other reasons, could have a material adverse
effect on our business and results of operations.
17
Because our business involves the transmission of information, we may incur
liability for information retrieved from or transmitted over the Internet.
We may be subject to claims relating to information that is posted or made
available on our web site, including claims for defamation, obscenity,
negligence or copyright or trademark infringement. We also may be subject to
claims based on the nature, publication or distribution of our content or based
on errors or false or misleading information provided on our web site. These
types of claims have been brought, sometimes successfully, against online
services in the past. We could also be sued for the content that is accessible
from our web site through links to other Internet sites. Although we have
commercial liability insurance with $2 million coverage, a $5 million umbrella,
errors and omissions and directors and officers coverage, awards may exceed
these amounts. Our insurance may not provide for coverage for certain of these
types of claims and, therefore, may not adequately protect us against them. In
addition, we could incur significant costs in investigating and defending such
claims, even if we ultimately are not found liable. If any of these events
occur, our business, results of operations and financial condition could be
materially and adversely affected.
Computer viruses may cause our systems to incur delays or interruptions and may
increase our expenses or liabilities.
Computer viruses may cause our systems to incur delays or other service
interruptions, which may cause us to incur additional operating expenses to
correct problems we may experience. In addition, the inadvertent transmission of
computer viruses could expose us to a material risk of loss or litigation and
possible liability. Moreover, if a computer virus affecting our system is
publicly disclosed, our reputation could be materially damaged and our visitor
traffic may decrease.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following discussion about market risk disclosures involves
forward-looking statements. Actual results could differ materially from those
projected in the forward-looking statements. We may be exposed to market risks
related to changes in interest rates and foreign currency exchange rates. We do
not use derivative financial instruments for speculative or trading purposes.
Interest Rate Risk
Our exposure to market risk resulting from changes in interest rates
relates primarily to our investment portfolio and long term debt obligations.
Our interest income and cash flows may be impacted by changes in the general
level of U.S. interest rates. We do not hedge this exposure because we believe
that we are not subject to any material market risk exposure due to the
short-term nature of our investments. We would not expect an immediate 10%
increase or decrease in current interest rates to have a material effect on the
fair market value of our investment portfolio.
Our long term debt obligations bear interest at a fixed fate. Accordingly,
an immediate 10% increase or decrease in current interest rates would not have
an impact on our interest expense or cash flows. The fair market value of our
long term fixed interest rate debt is subject to interest rate risk. Generally,
the fair market value of fixed interest rate debt will increase as interest
rates fall and decrease as interest rates rise. We would not expect an immediate
10% increase or decrease in current interest rates to have a material impact on
the fair market value of our long term debt obligations.
Foreign Currency Risk
We do not have any foreign currency denominated assets or liabilities or
purchase commitments and have not entered into any foreign currency contracts.
Accordingly, we are not exposed to fluctuations in foreign currency exchange
rates.
18
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following financial statements are included in this report:
o Report of Independent Public Accountants
o Consolidated Balance Sheets
o Consolidated Statements of Operations
o Consolidated Statements of Stockholders' Equity (Deficit)
o Consolidated Statements of Cash Flows
o Notes to Consolidated Financial Statements
Schedules other than those listed above are omitted because of the absence
of conditions under which they are required or because the required information
is presented in the financial statements or notes thereto.
19
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders
of Ratexchange Corporation and Subsidiaries:
We have audited the accompanying consolidated balance sheets of Ratexchange
Corporation (a Delaware corporation) and Subsidiaries as of December 31, 2001
and 2000 and the related consolidated statements of operations, stockholders'
equity (deficit) 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. 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 that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Ratexchange Corporation and
Subsidiaries as of December 31, 2001 and 2000, and the results of their
operations and their 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.
Arthur Andersen LLP
San Francisco, California
February 26, 2002
20
RATEXCHANGE CORPORATION
CONSOLIDATED BALANCE SHEETS
December 31,
-----------------------------
2001 2000
---- ----
ASSETS
Current assets:
Cash and cash equivalents .................................................................... $ 5,806,725 $ 2,115,152
Short-term investments ....................................................................... -- 12,124,635
Accounts receivable (net of allowance of $4,960) ............................................. -- 41,170
Notes receivable ............................................................................. 6,197 --
Interest receivable .......................................................................... -- 204,755
Prepaid expenses and other current assets .................................................... 98,874 116,360
------------ ------------
Total current assets ..................................................................... 5,911,796 14,602,072
Property and equipment, net ...................................................................... 674,618 1,401,888
Debt issuance costs .............................................................................. 658,434 --
Other investments ................................................................................ 200,000 75,000
Deposits ......................................................................................... 61,933 184,856
------------ ------------
Total assets ............................................................................. $ 7,506,781 $ 16,263,816
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ............................................................................. $ 474,971 $ 1,538,910
Accrued liabilities .......................................................................... 2,097,651 1,061,960
------------ ------------
Total current liabilities ................................................................ 2,572,622 2,600,870
Convertible notes payable, net ................................................................... 8,375,892 --
------------ ------------
Total liabilities ........................................................................ 10,948,514 2,600,870
------------ ------------
Commitments and contingencies (Note 9)
Stockholders' equity (deficit):
Preferred stock, $0.0001 par value; 60,000,000 shares authorized;
2,000,000 shares issued and outstanding as of December 31, 2001;
aggregate liquidation preference of $5,764,917 ........................................... 200 --
Common stock, $0.0001 par value; 300,000,000 shares authorized;
18,328,204 and 17,783,204 shares issued and outstanding
as of December 31, 2001 and 2000, respectively ........................................... 1,833 1,778
Additional paid-in capital ................................................................... 84,516,375 72,132,890
Accumulated deficit .......................................................................... (87,730,641) (57,393,548)
Deferred compensation ........................................................................ (229,500) --
Notes receivable from stockholders ........................................................... -- (363,661)
Accumulated other comprehensive loss ......................................................... -- (714,513)
------------ ------------
Total stockholders' equity (deficit) ..................................................... (3,441,733) 13,662,946
------------ ------------
Total liabilities and stockholders' equity ............................................... $ 7,506,781 $ 16,263,816
============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
21
RATEXCHANGE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
Year ended December 31,
------------------------------------------------------
2001 2000 1999
---- ---- ----
Brokerage and consulting revenue ................................. $ 2,194,811 $ 91,223 $ --
Operating expenses:
Selling, general and administrative
(inclusive of non-cash expenses of
$5,618,971 in 2001, $23,107,832 in
2000 and $3,158,414 in 1999) ......................... 18,967,242 41,969,950 7,491,447
Depreciation and amortization .............................. 1,570,622 222,115 18,676
Write-down of software assets .............................. 3,010,371 -- --
Settlement of lease obligations ............................ 7,315,360 -- --
Acquisition of subsidiary .................................. -- -- 1,507,408
Write-off of advances to potential investee ................ -- -- 413,681
------------ ------------ ------------
Total operating expenses ................................ 30,863,595 42,192,065 9,431,212
------------ ------------ ------------
Operating loss ................................................... (28,668,784) (42,100,842) (9,431,212)
Interest income .................................................. 330,772 1,017,482 151,496
Interest expense ................................................. (265,089) (164,671) (19,073)
Interest expense (non-cash amortization) ......................... (74,124) (1,657,988) --
Loss on securities ............................................... (744,197) -- --
Other expenses, net .............................................. (650,754) (1,822,875) --
------------ ------------ ------------
Net loss ......................................................... $(30,072,176) $(44,728,894) $ (9,298,789)
============ ============ ============
Basic and diluted net loss per share ............................. $ (1.69) $ (2.69) $ (0.72)
============ ============ ============
Weighted average number of common shares ......................... 17,913,546 16,633,611 12,863,020
The accompanying notes are an integral part of these consolidated financial
statements.
22
RATEXCHANGE CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
Preferred Stock Common Stock Additional
---------------------------- ---------------------------- Paid-in
Shares Amount Shares Amount Capital
------------ ------------ ------------ ------------ ------------
Balance, December 31, 1998 .................. -- $ -- 7,243,023 $ 724 $ 4,065,795
Net loss .................................... -- -- -- -- --
Change in unrealized loss on securities ..... -- -- -- -- --
Comprehensive loss ..........................
Common stock issued ......................... -- -- 6,844,402 685 7,711,588
Stock options and warrants granted .......... -- -- -- -- 1,448,441
------------ ------------ ------------ ------------ ------------
Balance, December 31, 1999 .................. -- $ -- 14,087,425 $ 1,409 $ 13,225,824
Net loss .................................... -- -- -- -- --
Change in unrealized loss on securities ..... -- -- -- -- --
Comprehensive loss ..........................
Common stock and warrants issued in
connection with financing ............. -- -- 3,128,329 313 33,839,873
Common stock and warrants issued in
connection with settlement of dispute . -- -- 227,000 22 2,028,372
Repurchase of common stock for stock
purchase loan program ................. -- -- (80,000) (8) (433,881)
Common stock issued to employees pursuant
to stock purchase loan program ........ -- -- 102,712 10 487,183
Repurchase of common stock from employees
pursuant to stock purchase loan program -- -- (22,712) (2) (123,530)
Exercise of stock options and warrants ...... -- -- 340,450 34 1,216
Stock warrants issued in connection with
Amerex transaction .................... -- -- -- -- 7,368,000
Stock warrants issued for services .......... -- -- -- -- 2,170,704
Stock options modified for terminated
employees ............................. -- -- -- -- 1,046,458
Amortization of stock options granted to
employees, Directors and consultants .. -- -- -- -- 12,522,671
------------ ------------ ------------ ------------ ------------
Balance, December 31, 2000 .................. -- $ -- 17,783,204 $ 1,778 $ 72,132,890
Net loss .................................... -- -- -- -- --
Change in unrealized loss on securities ..... -- -- -- -- --
Comprehensive loss ..........................
Preferred stock issued ...................... 2,000,000 200 -- -- 4,383,600
Preferred stock dividend .................... -- -- -- -- 264,917
Common stock issued for services ............ -- -- 545,000 55 259,645
Repurchase of common stock from employees
pursuant to stock purchase loan program -- -- -- -- (363,661)
Stock options and warrants granted .......... -- -- -- -- 733,277
Warrants issued in connection with
modification of lease obligations ..... -- -- -- -- 1,654,564
Stock options modified for terminated
employees ............................. -- -- -- -- 546,875
Amortization of stock options granted to
employees and Directors ............... -- -- -- -- 1,433,919
Deferred compensation ....................... -- -- -- -- 1,163,117
Amortization of deferred compensation ....... -- -- -- -- --
Beneficial conversion feature and stock
warrants issued in connection with
convertible notes payable ............. -- -- -- -- 2,307,232
------------ ------------ ------------ ------------ ------------
Balance, December 31, 2001 .................. 2,000,000 $ 200 18,328,204 $ 1,833 $ 84,516,375
============ ============ ============ ============ ============
Accumulated Total
Receivable Other Stockholders'
Accumulated Deferred From Comprehensive Equity
Deficit Compensation Stockholders Loss (Deficit)
------------ ------------ ------------ ------------ ------------
Balance, December 31, 1998 .................. $ (3,365,865) $ -- $ -- $ -- $ 700,654
Net loss .................................... (9,298,789) -- -- -- (9,298,789)
Change in unrealized loss on securities ..... -- -- -- (243,750) (243,750)
------------
Comprehensive loss .......................... (9,542,539)
------------
Common stock issued ......................... -- -- -- -- 7,712,273
Stock options and warrants granted .......... -- -- -- -- 1,448,441
------------ ------------ ------------ ------------ ------------
Balance, December 31, 1999 .................. $(12,664,654) $ -- $ -- $ (243,750) $ 318,829
Net loss .................................... (44,728,894) -- -- -- (44,728,894)
Change in unrealized loss on securities ..... -- -- -- (470,763) (470,763)
------------
Comprehensive loss .......................... (45,199,657)
------------
Common stock and warrants issued in
connection with financing ............. -- -- -- -- 33,840,186
Common stock and warrants issued in
connection with settlement of dispute . -- -- -- -- 2,028,394
Repurchase of common stock for stock
purchase loan program ................. -- -- -- -- (433,889)
Common stock issued to employees pursuant
to stock purchase loan program ........ -- -- (487,193) -- --
Repurchase of common stock from employees
pursuant to stock purchase loan program -- -- 123,532 -- --
Exercise of stock options and warrants ...... -- -- -- -- 1,250
Stock warrants issued in connection with
Amerex transaction .................... -- -- -- -- 7,368,000
Stock warrants issued for services .......... -- -- -- -- 2,170,704
Stock options modified for terminated
employees ............................. -- -- -- -- 1,046,458
Amortization of stock options granted to
employees, Directors and consultants .. -- -- -- -- 12,522,671
------------ ------------ ------------ ------------ ------------
Balance, December 31, 2000 .................. $(57,393,548) $ -- $ (363,661) $ (714,513) $ 13,662,946
Net loss .................................... (30,072,176) -- -- -- (30,072,176)
Change in unrealized loss on securities ..... -- -- -- 714,513 714,513
------------
Comprehensive loss .......................... (29,357,663)
------------
Preferred stock issued ...................... -- -- -- -- 4,383,800
Preferred stock dividend .................... (264,917) -- -- -- --
Common stock issued for services ............ -- -- -- -- 259,700
Repurchase of common stock from employees
pursuant to stock purchase loan program -- -- 363,661 -- --
Stock options and warrants granted .......... -- -- -- -- 733,277
Warrants issued in connection with
modification of lease obligations ..... -- -- -- -- 1,654,564
Stock options modified for terminated
employees ............................. -- -- -- -- 546,875
Amortization of stock options granted to
employees and Directors ............... -- -- -- -- 1,433,919
Deferred compensation ....................... -- (1,163,117) -- -- --
Amortization of deferred compensation ....... -- 933,617 -- -- 933,617
Beneficial conversion feature and stock
warrants issued in connection with
convertible notes payable ............. -- -- -- -- 2,307,232
------------ ------------ ------------ ------------ ------------
Balance, December 31, 2001 .................. $(87,730,641) $ (229,500) $ -- $ -- $ (3,441,733)
============ ============ ============ ============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
23
RATEXCHANGE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31,
--------------------------------------------
2001 2000 1999
------------ ------------ ------------
Cash flows from operating activities:
Net loss ....................................................................... $(30,072,176) $(44,728,894) $ (9,298,789)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization .............................................. 1,570,622 222,115 18,676
Common stock issued for services ........................................... 259,700 -- --
Stock options and warrants granted to service
providers and strategic partners ....................................... 390,296 13,770,883 3,158,415
Stock warrants issued in connection with
modification of lease obligations ...................................... 1,654,564 -- --
Amortization of stock options granted to employees,
Directors and consultants .............................................. 1,433,919 10,391,432 --
Stock options modified for terminated employees ............................ 546,875 1,046,458 --
Stock warrants issued in relation to bridge financing ...................... -- 1,657,988 --
Amortization of deferred compensation ...................................... 933,617 -- --
Note payable issued in connection with employee severance .................. 400,000 -- --
Loss on settlement of lease obligations .................................... 7,315,360 -- --
Acquisition of subsidiary .................................................. -- -- 1,507,408
Write-down of software assets .............................................. 3,010,371 -- --
Write-off of property and equipment ........................................ 225,083 -- --
Write-off of advances to potential investee ................................ -- -- 206,898
Loss on securities ......................................................... 744,197 -- --
Amortization of discounts on convertible notes payable ..................... 68,637 -- --
Amortization of debt issuance costs ........................................ 5,487 -- --
Increase in interest payable on debt ....................................... 234,188 -- --
Changes in operating assets and liabilities:
Interest receivable and other advances ................................. 257,214 (200,030) (160,617)
Deposits ............................................................... 122,923 (81,551) (103,305)
Accounts payable and accrued expenses .................................. (863,309) 760,814 1,601,241
------------ ------------ ------------
Net cash used in operating activities ............................... (11,762,432) (17,160,785) (3,070,073)
Cash flows from investing activities:
Purchase of property and equipment ............................................. (1,042,900) (1,435,112) (207,568)
Proceeds from sale of software assets .......................................... 1,422,179 -- --
Investment in Halo common stock ................................................ -- -- (631,251)
Purchase of short-term investments ............................................. -- (32,975,313) --
Proceeds from sale of short-term investments ................................... 12,094,951 20,767,415 --
Other investments .............................................................. (125,000) -- (75,000)
------------ ------------ ------------
Net cash provided by (used in) investing activities ........................ 12,349,230 (13,643,010) (913,819)
Cash flows from financing activities:
Proceeds from issuance of common stock, net ................................ -- 30,135,902 3,581,991
Convertible notes payable and other debt, net .............................. 3,604,775 1,090,000 410,000
Proceeds from notes receivable ............................................. -- 1,590,319 --
Repayment of promissory notes .............................................. (500,000) -- --
Loan to employee stock purchase program .................................... -- (433,889) --
------------ ------------ ------------
Net cash provided by financing activities .......................................... 3,104,775 32,382,332 3,991,991
------------ ------------ ------------
Increase in cash and cash equivalents .............................................. 3,691,573 1,578,537 8,099
Cash and cash equivalents at beginning of year ..................................... 2,115,152 536,615 528,516
------------ ------------ ------------
Cash and cash equivalents at end of year ........................................... $ 5,806,725 $ 2,115,152 $ 536,615
============ ============ ============
Supplementary disclosure of cash flow information:
Cash paid during the year:
Interest ................................................................... $ 22,151 $ 164,671 $ --
Income taxes ............................................................... $ -- $ -- $ --
Non-cash investing and financing activities:
Preferred stock issued to purchase software assets ......................... $ 4,383,800 $ -- $ --
Preferred stock dividends .................................................. $ 264,917 $ -- $ --
Warrants issued in connection with debt issuance ........................... $ 268,696 $ -- $ --
Stock options issued for purchase of software assets ....................... $ 74,285 $ -- $ --
Beneficial conversion feature and stock warrants issued
in connection with convertible notes payable ........................... $ 2,307,232 $ -- $ --
Stock issued in connection with settlement of bridge loan .................. $ -- $ 1,975,000 $ --
Purchase of outstanding shares of Ratexchange .............................. $ -- $ -- $ 920,000
Stock issued in connection with commission on stock sales .................. $ -- $ -- $ 196,029
The accompanying notes are an integral part of these consolidated financial
statements.
24
RATEXCHANGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Description of Business
Ratexchange Corporation is a brokerage services firm that combines its
knowledge of bandwidth and other emerging commodity markets with securities
brokerage and investment banking activities. The Company's RTX Securities
Corporation subsidiary is a NASD licensed, fully disclosed broker-dealer
offering sales and trading services to institutions and private clients, as well
as advisory and investment banking services to corporate clients. Through the
Company's emerging commodities division, we are developing channels to maximize
profits by providing valuable and marketable information to RTX Securities.
Ratexchange Corporation (Ratexchange or the Company), formerly
NetAmerica.com Corporation and formerly Venture World, Ltd., is a Delaware
corporation organized on May 6, 1987. NetAmerica.com Corporation acquired Rate
Exchange, Inc., a Colorado corporation, in June 1999. On April 24, 2000 the
Company changed its name from NetAmerica.com to Ratexchange Corporation to
better reflect its focus as an online trading system for bandwidth. In July
2000, the Company's common stock was listed on the American Stock Exchange and
currently trades under the symbol "RTX". The Company had no operations or
business before September 30, 1998. The Company is located in San Francisco,
California.
From inception, the Company has been primarily engaged in organizational
activities, including recruiting personnel, developing its electronic trading
platform, developing its broker-dealer operations, establishing office
facilities, developing infrastructure, designing and developing its website,
raising capital, and establishing its marketing plan and service offerings to
seek meaningful revenue generating capacity. The Company began recognizing
revenue in 2000 and achieved the bulk of its revenue in 2001 from consulting
activities of RMG. As discussed in Note 13, the Company plans to sell RMG during
the second quarter of 2002. The Company expects to generate most of its revenue
in 2002 from its RTX Securities broker-dealer.
Since inception, the Company has generated significant recurring losses.
Successful completion of the Company's development activities and, ultimately,
the attainment of profitable operations is dependent upon future events,
implementing and successfully executing its business and marketing strategy,
increasing its customer base, and hiring and retaining qualified personnel.
Negative developments in any of these conditions could have a material adverse
effect on the Company's business, financial condition and results of operations.
2. Summary of Significant Accounting Policies
Principles of Consolidation
Ratexchange has four wholly owned U.S. subsidiaries which have been
consolidated in the accompanying financial statements. The subsidiaries include
Ratexchange I, Inc., RMG Partners Corporation (RMG), Xpit Corporation (Xpit),
and RTX Securities Corporation (RTX Securities). PolarCap was a wholly owned
subsidiary of the Company but has since been dissolved in 2001. The consolidated
financial statements include the accounts of Ratexchange Corporation and its
wholly owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated.
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with original
maturities of ninety days or less to be cash equivalents.
Investments
Ratexchange's short-term and long-term investments are classified as
available-for-sale and are reported at fair value, with unrealized gains and
losses, net of tax, recorded in accumulated other comprehensive loss. Realized
gains or losses and declines in value determined to be other than temporary, if
any, on available-for-sale securities will be reported in other income or
expense as incurred. As of December 31, 2001, Ratexchange did not have any
short-term or long-term investments.
Ratexchange also has certain other minority equity investments in
non-publicly traded companies. These investments are generally carried at cost
as the Company owns less than 20% of the voting equity and does not have the
ability to exercise significant influence over these companies. As of December
31, 2001 and 2000, $200,000 and $75,000 of these investments are included in
long-term other investments, respectively. The Company monitors these
investments for impairment and makes appropriate reductions in carrying values
when necessary. No write-downs were recorded during 2001 or 2000.
25
RATEXCHANGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Property and Equipment
Property and equipment are recorded at cost. Depreciation and amortization
are computed using the straight-line method over useful lives of three to five
years.
Internal use software and web site development costs are capitalized in
accordance with Statement of Position (SOP) No. 98-1, Accounting for the Costs
of Computer Software Developed or Obtained for Internal Use, and Emerging Issues
Task Force (EITF) Issue No. 00-02, Accounting for Web Site Development Costs.
Qualifying costs incurred during application development stage, which consist
primarily of outside services and purchased software license costs, are
capitalized and amortized over the estimated useful life of the asset.
Long-Lived Assets
The Company evaluates its long-lived assets for impairment whenever events
or changes in circumstances indicate that the carrying amount of such assets may
not be recoverable. Recoverability of assets to be held and used is measured by
a comparison of the carrying amount of an asset to future net cash flows
expected to be generated by the assets. If such assets are considered to be
impaired, the impairment to be recognized is measured as the amount by which the
carrying amount of the assets exceeds the fair value of the assets. Assets to be
disposed of are reported at the lower of the carrying amount or fair value less
costs to sell.
Revenue Recognition
The Company recognizes brokerage revenue once a trade is consummated and
the earnings process is complete. Consulting and advertising revenue is
recognized when the related services are performed, fees for such services are
fixed or determinable, and its collection is probable.
Income Taxes
The Company uses the asset and liability method of accounting for income
taxes. Deferred tax assets and liabilities are recognized for the estimated
future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. A valuation
allowance is recorded to reduce deferred tax assets to an amount whose
realization is more likely than not. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in the consolidated
statements of operations in the period that includes the enactment date.
Stock-Based Compensation
The Company uses the intrinsic value-based method in accordance with
Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to
Employees, to account for employee stock-based compensation. Accordingly,
compensation cost is recorded on the date of grant to the extent the fair value
of the underlying share of common stock exceeds the exercise price for a stock
option or the purchase price for a share of common stock. Such compensation cost
is amortized on a straight-line basis over the vesting period of the individual
award. Pursuant to Statement of Financial Accounting Standards (SFAS) No. 123,
Accounting for Stock-Based Compensation, the Company discloses the pro forma
effect of using the fair value method of accounting for employee stock-based
compensation.
Stock-based awards granted to nonemployees are accounted for pursuant to
the fair value method in SFAS No. 123 and Issue No. 96-18 of the Emerging Issues
Task Force. The associated expense is measured and recognized by the Company
over the period the services are performed by the nonemployee.
Net Loss Per Share
The Company computes net loss per share in accordance with SFAS No. 128,
Earnings per Share, and SEC Staff Accounting Bulletin (SAB) No. 98. Under the
provisions of SFAS No. 128 and SAB No. 98 basic net loss per share excludes
dilution and is computed by dividing net loss available to common stockholders
(net loss after subtracting dividends due on preferred stock) by the weighted
average number of common shares outstanding for the period. Diluted net loss per
common share was the same as basic net loss per common share for all periods
presented since the effect of any potentially dilutive securities is excluded as
they are anti-dilutive because of the Company's net losses.
26
RATEXCHANGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Comprehensive loss
Comprehensive loss includes the net loss reported on the consolidated
statements of operations and changes in the fair value of investments classified
as available for sale, which is reported as a component of stockholders' equity
(deficit).
Concentrations
Substantially all of the Company's cash and cash equivalents are held at
three major U.S. financial institutions. The majority of the Company's cash
equivalents consist of short-term marketable securities. Deposits held with
banks may exceed the amount of insurance provided on such deposits. Generally
these deposits may be redeemed upon demand.
Historically, Ratexchange has relied on a limited number of customers for a
substantial portion of its consulting revenue. During 2001, a single customer
accounted for 29% of the Company's total revenue. During 2000, no customers
accounted for more than 10% of the Company's revenue. Consulting revenue
attributed to the activities of RMG, a wholly owned subsidiary of Ratexchange,
represented 91% of the consolidated revenue during 2001. Pursuant to the
agreement between Ratexchange and BL Partners, LLC, an affiliate of the
principals of RMG, which is more fully described in Note 13, the Company expects
to sell RMG during the second quarter of 2002 and will likely lose this source
of revenue.
Fair Value of Financial Instruments
The carrying amounts of the Company's financial instruments, which include
short-term and long-term investments, accounts receivable, accounts payable, and
other accrued expenses, approximate their fair values due to their short
maturities. The fair value of the Company's long-term convertible notes payable
is estimated based on the current rates offered to the Company for debt of the
same remaining maturities.
Segment Reporting
The Company has adopted the provisions of SFAS No. 131, Disclosures about
Segments of an Enterprise and Related Information. SFAS No. 131 establishes
annual and interim reporting standards for operating segments of a company. It
also requires entity-wide disclosures about the products and services an entity
provides, the material countries in which it holds assets and reports revenues,
and its major customers. The Company is not organized by multiple operating
segments for the purpose of making operating decisions or assessing performance.
Accordingly, the Company operates in one reportable operating segment in the
United States.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates, judgments and assumptions that affect the reported amounts of assets,
liabilities, revenue and expenses. Actual results could differ from those
estimates.
Reclassification
Certain prior year amounts have been reclassified to conform with current
year consolidated financial statement presentation. These reclassifications had
no impact on previously reported net loss or total stockholders' equity.
New Accounting Standards
In July 2001, the Financial Accounting Standards Board issued SFAS No. 141,
Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets.
SFAS No. 141 addresses financial accounting and reporting for business
combinations. This statement requires the purchase method of accounting to be
used for all business combinations, and prohibits the pooling-of-interests
method of accounting. This statement is effective for all business combinations
initiated after June 30, 2001 and supercedes APB Opinion No. 16, Business
Combinations, as well as SFAS No. 38, Accounting for Preacquisition
Contingencies of Purchased Enterprises.
27
RATEXCHANGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
SFAS No. 142 addresses how intangible assets that are acquired individually
or with a group of other assets should be accounted for in financial statements
upon their acquisition. This statement requires goodwill amortization to cease
and for goodwill to be periodically reviewed for impairment, for fiscal years
beginning after October 31, 2001. SFAS No. 142 supercedes APB Opinion No. 17,
Intangible Assets. The company will adopt the provisions of this standard for
its first quarter of fiscal 2002, and does not expect the adoption to have a
material effect on its financial condition or results of operations.
In August 2001, the Financial Accounting Standards Board issued SFAS No.
143, Accounting for Asset Retirement Obligation. SFAS No. 143 is effective for
fiscal years beginning after June 15, 2002, and will require companies to record
the fair value of a liability for asset retirement obligations in the period in
which they are incurred, which typically could be upon completion or shortly
thereafter. The effect of adoption of this standard on our results of operations
and financial positions is being evaluated.
In October 2001, the Financial Accounting Standards Board issued SFAS No.
144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No.
144 is effective for fiscal years beginning after December 15, 2001. It provides
a single accounting model for long-lived assets to be disposed of and replaces
SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and Long-Lived
Assets to Be Disposed Of. The effect of adoption of this standard on our results
of operations and financial positions is being evaluated.
3. Short-Term Investments
Short-term investments as of December 31, 2000 are comprised of the
following:
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Loss Value
----------- ----------- ----------- -----------
US Government agencies ................ $ 4,628,382 $ 5,057 $ -- $ 4,633,439
Corporate bonds ....................... 7,452,920 21,161 -- 7,474,081
Corporate stocks ...................... 757,846 -- (740,731) 17,115
----------- ----------- ----------- -----------
Available for sale .................... $12,839,148 $ 26,218 $ (740,731) $12,124,635
=========== =========== =========== ===========
The Company did not have any short-term investments as of December 31,
2001.
4. Property and Equipment
Property and equipment consisted of the following:
December 31,
-------------------------------
2001 2000
----------- -----------
Furniture and fixtures ................. $ 7,913 $ 38,097
Computer equipment and software ........ 1,223,142 1,604,582
----------- -----------
1,231,055 1,642,679
Less: Accumulated depreciation ......... (556,437) (240,791)
----------- -----------
$ 674,618 $ 1,401,888
=========== ===========
The Company purchased software assets amounting to $5.5 million during 2001
and later sold these assets during the same year (see Note 12). Depreciation
expense related to the software assets during 2001 amounted to $1,026,000.
Additionally, the Company disposed of property and equipment not utilized during
2001 with a cost basis of $455,000 and accumulated depreciation of $230,000.
28
RATEXCHANGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
5. Convertible Notes Payable
In November and December 2001, Ratexchange completed private offerings of
convertible notes, in an aggregate principal amount of $3.5 million, due
December 31, 2011. The notes bear interest at 12% per annum payable on January
1, April 1, July 1 and October 1 of each year beginning January 1, 2002. The
notes may be converted into shares of Ratexchange's common stock on election of
the holder anytime before their maturity or their prior redemption or repurchase
by the Company. The conversion rate is 2,703 shares of the Company's common
stock per each $1,000 principal amount of notes, subject to adjustment in
certain circumstances. The Company has the option to redeem all or a portion of
the notes that have not been previously converted subsequent to (i) the
registration under the Securities Act of 1933 of the common stock underlying the
notes and (ii) the common stock achieving a closing price at or above $1.59 for
20 consecutive trading days.
In connection with this financing transaction, the Company granted to the
convertible note investors warrants to purchase a total of 1,000,000 shares of
common stock at $0.37 per share. The convertible notes are presented on the
consolidated balance sheets net of discounts resulting from the relative fair
value of the stock warrants and beneficial conversion feature in the amount of
$242,000 and $333,000, respectively. The discounts are being amortized over the
ten-year term using the effective interest method. The discount amortization is
included in the consolidated statements of operations as interest expense which
amounted to approximately $2,000 in 2001. Debt issuance costs amounting to
$664,000, includes the fair value of warrants issued to the placement agent to
purchase a combination of the Company's convertible notes or common stock, plus
stock warrants. The debt issuance costs are being amortized over a ten-year term
using the straight-line method. Amortization of debt issuance costs during 2001
was approximately $5,000.
As discussed in Note 9, Forsythe McArthur & Associates (Forsythe) agreed to
forego all amounts owed by Ratexchange under the lease obligation in exchange
for a convertible note payable and stock warrants. The Company issued a
convertible note dated September 1, 2001, in an aggregate principal amount of
$5.9 million, due August 31, 2006. The note bears interest at 9% per annum
payable March 31, June 30, September 30 and December 31 of each year beginning
March 31, 2002 and may be paid in cash or Ratexchange's common stock at the
discretion of the Company. The note may be converted into shares of common stock
on election of Forsythe at August 31, 2006 with a conversion price equal to 80%
of the closing market price of the common stock.
In connection with the convertible note, the Company granted to Forsythe a
warrant to purchase 520,833 shares of common stock at $0.48 per share. The
convertible note is presented on the consolidated balance sheets net of
discounts resulting from the relative fair value of the stock warrant and
beneficial conversion feature in the amount of $122,000 and $1,078,000,
respectively. The discounts are being amortized over the five-year term using
the effective interest method. The discount amortization included with interest
expense amounted to approximately $67,000 in 2001.
During 2001, the Company renegotiated the terms of the severance included
in its employment agreement with Donald Sledge, the former Chairman and CEO of
Ratexchange. Upon his leaving the Company in May 2001, the Company issued to Mr.
Sledge a 7% convertible note, in an aggregate principal amount of $400,000, due
April 2003. Interest is payable at the maturity of the two-year term. The notes
may be converted into shares of Ratexchange's common stock on election of Mr.
Sledge anytime before their maturity or their prior repurchase by the Company.
The conversion rate is 364 shares per each $1,000 principal amount of notes,
subject to adjustment in certain circumstances.
Interest payable in connection with the convertible notes described above
is included with the convertible notes payable balance in the consolidated
balance sheets. As of December 31, 2001, interest payable amounted to $234,000.
29
RATEXCHANGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
6. Stockholders' Equity (Deficit)
Preferred Stock
In April 2001, the Company issued 2,000,000 shares of Series A convertible
preferred stock at a price of $2.19 per share in connection with the purchase of
Xpit.com, Inc. (see note 12). The rights, preferences, and privileges of the
holders of Series A convertible preferred stock are as follows:
o Each share of preferred stock is convertible into one share of common
stock on election of the holders, subject to certain antidilutive
adjustments;
o Shares of preferred stock automatically convert to common stock on the
first date after which all of the following conditions are satisfied
(i) the fourth anniversary of the Xpit purchase has occurred, (ii) the
Company's common stock is publicly traded on a national exchange, and
(iii) the closing price of the Company's common stock is equal to or
exceeds $6.00 per share for ten consecutive trading days;
o Series A convertible preferred stock is not redeemable by the Company;
o Holders of preferred stock are entitled to dividends of additional
shares of Series A convertible preferred stock at the rate of 6% per
annum;
o Preferred stock votes equally with the shares of common stock on an
"as-if-converted" basis; and
o Holders of preferred stock have a liquidation preference of $2.75 per
share, or $5.5 million, plus all declared but unpaid dividends.
Common Stock
Nonmonetary transactions for which no cash was exchanged and for which
shares of common stock were exchanged for goods and services are recorded at the
fair market value of the common stock issued at the time of the transaction and
reported in the statements of operations as services are rendered.
During 2001, the Company issued common stock in connection with the
following transactions:
o 170,000 shares issued for $71,700 to employees in lieu of salaries;
and
o 375,000 shares issued for $188,000 for services rendered and to settle
lease obligations.
During 2000, the Company issued common stock in connection with the
following transactions:
o The Company raised $2 million in short-term bridge loans between
December 1999 and February 2000. In 2000, the Company granted the
investors in the bridge loan the right to convert their loans into
Ratexchange's common stock at a conversion rate of $5.00 per share.
Additionally, the Company issued the investors warrants to purchase an
aggregate of 493,750 shares of common stock at $5.00 per share.
Investors who declined this offer were entitled to rescind their
original investment and receive their principal back in full,
including accrued interest. As a result, $1,975,000 of loans plus
$128,000 of interest payable were converted into 395,000 shares of
common stock. The warrants were valued at $1,602,000 which was
included with additional paid-in capital.
o In March 2000, the Company issued 2,733,329 shares of restricted
common stock in a private placement for $32,799, 948. After deducting
$2,665,000 for costs associated with the offering, the Company
received $30,135,000;
o 227,000 shares issued for $1,334,760 to settle third party claims;
o 315,450 shares issued for the cashless exercise of 325,000 warrants at
$.05 and $2 per share.
o 25,000 shares issued for $1,250 from exercise of an option; and
o 80,000 shares repurchased and subsequently issued to employees under
stock purchase loan program;
30
RATEXCHANGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
During 1999, the Company issued common stock in connection with the
following transactions:
o 916,574 shares issued for $91,657 to related parties. The shares were
issued with restrictions so that the stock cannot be sold, traded,
assigned, transferred or pledged until the Company achieves gross
revenue of $10 million in a one-year period. As these shares were
issued below fair market value, the Company recorded an expense and
increased additional paid-in capital by $886,053;
o 322,500 shares issued for $32,250 as cost reimbursement. As these
shares were issued below fair market value, the Company recorded an
expense and increased additional paid-in capital by $311,761;
o 758,438 shares issued for $728,100, net of $80,900 for commissions;
o 3,112,500 shares issued for $3,320,000 to related parties and other
investors;
o 268,500 shares issued for $287,233 in exchange for legal and
consulting services;
o 193,186 shares issued for $206,917 to repay debt to creditors of A1
Internet;
o 30,000 shares issued for $32,001 to repay outstanding note payable;
o 30,000 shares issued for $32,001 in exchange for services rendered;
o 515,188 shares issued for $628,272, net of $196,029 in commissions
paid with 122,518 shares;
o 122,518 shares issued for $196,029 as payment for commissions on
private placement; and
o 574,998 shares issued for $920,000 to purchase Rate Exchange, Inc.
(see note 16).
7. Stock-Based Compensation
Stock Options
The 1999 Stock Option Plan and the 2000 Stock Option and Incentive Plan
(Option Plans) permit the Company to grant employees, outside directors, and
consultants qualified stock options, nonstatutory stock options or stock
purchase rights to purchase shares of the Company's common stock. The Option
Plans do not permit the exercise of non-vested stock options, and therefore as
of December 31, 2001 and 2000 there were no shares subject to repurchase.
As of December 31, 2001, there were 3,000,000 and 5,000,000 shares
authorized for issuance under the 1999 Stock Option Plan and 2000 Stock Option
Plan, respectively, and 4,290,000 shares authorized for issuance outside of the
Option Plans. As of December 31, 2001, 964,943 shares were available for future
option grants under the Option Plans. There were no shares available for future
option grants outside of the Options Plans.
The Company uses the intrinsic-value method in accounting for its
stock-based compensation arrangements for employees, whereby compensation cost
is measured to the extent that the fair value of the underlying common stock
exceeds the exercise price of the stock options at the date of grant. In 2000,
the Company granted to employees stock options to purchase 4,015,000 shares with
intrinsic value. These amounts are being amortized on a straight-line basis over
the vesting period, generally one year or four years. Compensation expense
resulting from option grants with intrinsic value amounted to $1.4 million and
$12.5 million in 2001 and 2000, respectively. As of December 31, 2001, the
unamortized expense attributed to option grants with intrinsic value was
$406,000.
During 2001 and 2000, certain employees who were terminated received an
extension to the period of time their vested stock options were exercisable.
This modification to the stock options grants resulted in additional
compensation expense for the Company in the amount of $547,000 and $1,046,000 in
2001 and 2000, respectively.
31
RATEXCHANGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
A summary of stock option activity is as follows:
2001 2000 1999
--------------------- --------------------- ---------------------
Wtd-Avg Wtd-Avg Wtd-Avg
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
---------- -------- ---------- -------- ---------- --------
Outstanding at beginning of year ................. 10,582,772 $4.62 2,990,000 $2.23 -- $ --
Granted .......................................... 2,267,590 1.60 8,516,900 5.47 3,050,000 2.24
Exercised ........................................ -- -- 25,000 0.05 -- --
Canceled ......................................... 3,089,262 4.79 899,128 4.84 60,000 2.50
---------- ----- ---------- ----- ---------- -----
Outstanding at end of year ....................... 9,761,100 3.76 10,582,772 4.62 2,990,000 2.23
========== ===== ========== ===== ========== =====
Exercisable at end of year ....................... 7,558,137 3.97 4,819,767 4.12 1,287,500 1.96
========== ===== ========== ===== ========== =====
Stock Warrants
In September 2000, the Company entered into an alliance agreement with
Amerex Bandwidth, Ltd. Under this agreement, Amerex brokers will execute trades
for the sales or purchase of telecommunications capacity and/or other
telecommunications-related products over the Company's electronic trading system
and Ratexchange will share in the revenues generated by the electronic trading
system. In connection with this agreement, the Company issued to Amerex warrants
to purchase an aggregate of 2,300,000 shares of common stock with a fair market
value of $7,368,000, which was charged to expense in 2000. Two warrants, one for
300,000 shares and one for 500,000 shares, with exercise prices of $4.47 and
$4.70 per share, are currently exercisable by Amerex. The remaining three
warrants each for 500,000 shares and with exercise prices of $4.92 per share,
$5.14 per share and $5.37 per share, will become exercisable upon the earlier of
September 2005 or Amerex executing cumulative value of transactions over the
Company's online electronic trading system of $2 million, $5 million and $10
million, respectively. The warrants expire in September 2005.
During 2001, 2000 and 1999, the Company issued warrants to third-party
service providers and in connection with the settlement of contractual
obligations. Stock-based awards granted to nonemployees are accounted for
pursuant to the fair value method in SFAS No. 123 and EITF Issue No. 96-18. The
associated expense is measured and recognized by the Company over the period the
services are performed by the nonemployee. During 2001, 2000 and 1999, the
expense resulting from the issuance of these warrants was $2,388,000, $2,171,000
and $1,448,000, respectively.
As discussed in note 5, the Company also issued warrants to purchase its
common stock in connection with the convertible notes payable to Forsythe and
the private financing investors during 2001. Warrants were also issued to the
placement agent of the private financing. Such amounts are charged to expense as
discussed in Note 5.
A summary of stock warrant activity is as follows:
2001 2000 1999
--------------------- --------------------- ---------------------
Wtd-Avg Wtd-Avg Wtd-Avg
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
--------- -------- --------- -------- --------- --------
Outstanding at beginning of year ................... 5,472,043 $8.41 625,000 $1.74 100,000 $2.00
Granted ............................................ 2,582,333 0.94 5,172,043 8.58 525,000 1.69
Exercised .......................................... -- -- 325,000 0.80 -- --
Canceled ........................................... -- -- -- -- -- --
--------- ----- --------- ----- --------- -----
Outstanding at end of year ......................... 8,054,376 5.91 5,472,043 8.41 625,000 1.74
========= ===== ========= ===== ========= =====
Exercisable at end of year ......................... 6,554,376 6.09 3,955,043 9.67 625,000 1.74
========= ===== ========= ===== ========= =====
32
RATEXCHANGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Stock Options and Warrants Outstanding
Summary of the outstanding stock options and warrants issued to employees
and non-employees as of December 31, 2001 were as follows:
Outstanding Exercisable
--------------------------------------------------- ---------------------------------
Weighted
Weighted Average Weighted
Average Remaining Average
Warrants/ Exercise Contractual Warrants/ Exercise
Range of exercise prices Options Price Life (years) Options Price
- ------------------------ ------------- ------------ ------------ ------------ ------------
Employees
$ 0.34-$ 2.00 1,690,949 $ 1.19 8.90 1,272,449 $ 1.17
$ 2.01-$ 4.00 3,687,842 $ 2.96 8.49 2,179,525 $ 2.86
$ 4.01-$ 6.00 422,539 $ 5.54 9.53 341,810 $ 5.51
$ 6.01-$ 7.00 2,451,043 $ 7.00 9.30 2,315,626 $ 7.00
--------- ---------
Employees 8,252,373 6,109,410
Non-employees
$ 0.33-$ 4.00 4,215,284 $ 1.39 4.09 4,155,284 $ 1.39
$ 4.01-$ 7.00 3,294,146 $ 5.13 5.12 1,794,146 $ 5.13
$ 7.01-$12.00 -- $ -- -- -- $ --
$12.01-$14.40 2,053,673 $ 14.18 3.39 2,053,673 $ 14.18
--------- ---------
Non-employees 9,563,103 8,003,103
--------- ---------
Total 17,815,476 14,112,513
========== ==========
Pro Forma Stock-Based Compensation
Had compensation cost for the Company's stock options been determined based
on the fair value at the grant date for awards in 2001, 2000 and 1999 consistent
with the provisions of SFAS No. 123, the Company's net loss and net loss per
common share would have increased to the pro forma amounts indicated below:
2001 2000 1999
---- ---- ----
Net loss
As reported ........................... $ (30,072,176) $ (44,728,894) $ (9,298,789)
============== ============== ==============
Pro forma ............................. $ (32,954,415) $ (56,341,485) $ (10,275,351)
============== ============== ==============
Net loss per common share (basic and diluted)
As reported ........................... $ (1.69) $ (2.69) $ (0.72)
============== ============== ==============
Pro forma ............................. $ (1.85) $ (3.39) $ (0.80)
============== ============== ==============
The above pro forma disclosures are not necessarily representative of the
effects on reported net income or loss for future years.
The weighted average fair value of each option and warrant granted in 2001
was $0.86 and $0.51, respectively. The weighted average fair value of each
option and warrant granted in 2000 was $2.94 and $4.35, respectively. The
weighted average fair value of each option and warrant granted in 1999 was $0.73
and $1.04, respectively. The fair value of each option grant is estimated on the
date of grant using the Black-Scholes option pricing model with the following
weighted average assumptions for 2001, 2000 and 1999:
2001 2000 1999
---- ---- ----
Risk-free interest rate............. 3.94% 6.23% 5.70%
Dividend yield...................... -- -- --
Volatility.......................... 100% 100% 100%
Average expected term (years)....... 2.0 2.0 2.0
33
RATEXCHANGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
The Black-Scholes option pricing model was developed for use in estimating
the fair value of traded options that have no vesting restrictions and are fully
transferable. In addition, option pricing models require the input of highly
subjective assumptions including the expected stock price volatility. The
Company uses projected volatility rates, which are based upon historical
volatility rates trended into future years. The Company's employee stock options
have characteristics significantly different from those of traded options, and
changes in the subjective input assumptions can materially affect the fair value
estimates.
Common Stock Controlled by RMG
As discussed in Note 13, RMG was entitled to approximately 1.1 million
shares of common stock used to capitalize RMG as of December 31, 2001. The fair
value of the 1.1 million shares of common stock amounting to $1.2 million was
recorded as deferred compensation. Amortization of deferred compensation was
$934,000 in 2001.
8. Employee Benefit Plans
During 2000, the Company implemented a Stock Purchase Loan Program (SPLP)
for employees. The SPLP permitted employees to purchase, subject to specified
limits, common stock of the Company in exchange for a two-year note payable to
the Company. The face amount of the notes was non-recourse, while interest,
which accrued at 9% per year, was with recourse to the employee. During 2000,
the Company purchased 80,000 of its common stock and immediately sold them to
employees under the SPLP for notes totaling $487,193. Also during 2000, the
Company acquired 22,712 shares of common stock from certain employees who repaid
their notes totaling $123,532 and subsequently sold these shares to other
employees at the then current market price totaling $53,302. During 2001, all
participating employees relinquished their ownership claim to the common stock
to extinguish the related loans outstanding.
During the year ended December 31, 2000, the Company adopted a 401(k) plan.
The 401(k) plan allows eligible employees to contribute up to 15% of their
compensation, subject to a statutory prescribed annual limit. Employee
contributions and earnings thereon vest immediately. Although the Company may
make discretionary contributions to the 401(k) plan, none have been made during
2001 and 2000.
9. Commitments and Contingencies
The Company leases its facilities under a noncancelable operating lease
which expires in June 2003. Future annual minimum lease payments related to this
operating lease as of December 31, 2001 are $93,600 in 2002 and $23,400 in 2003.
Rent expense was $459,000, $2,024,000 and $42,000 in 2001, 2000 and 1999,
respectively.
The Company had entered into various operating leases associated with its
delivery hubs, including various telecommunications routing equipment and other
infrastructure. In addition, it had entered into various leases for office space
and related office equipment, including computers and software. These operating
leases have since been settled or restructured, as described below.
During 2001, management revised its business plan concerning the delivery
of telecommunications bandwidth through its own network hubs. It was determined
that the Company did not have an alternative use for the network equipment in
its ongoing operations. As a result, the Company recorded a $6.4 million charge
for the acceleration of remaining contractual obligations and costs associated
with the Forsythe lease arrangement.
In June 2001, the Company and Forsythe McArthur & Associates entered into a
restructure agreement with respect to an equipment lease of delivery hub
equipment. The terms of the restructure agreement required twelve monthly
payments of $74,056 beginning on May 1, 2001, twelve monthly payments of
$148,113 beginning on May 1, 2002 followed by one payment of $4,184,544 on May
1, 2003. In September 2001, Forsythe agreed to allow Ratexchange to withhold
scheduled payments through December 31, 2001, subject to a proposed further
restructuring of the lease. In November 2001, Forsythe agreed to forego all
amounts owed by Ratexchange under the lease obligation in exchange for a
convertible note and stock warrants. In November 2001, the Company agreed to
issue the convertible note and stock warrants as described more fully in Note 5.
34
RATEXCHANGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
During 2001, the Company also settled claims and additional outstanding
lease obligations related to assets and facilities that no longer fit with the
revised operating plan. In August 2001, the Company settled its outstanding
litigation with Switch and Data Facilities Company. The settlement had a value
of $368,000, including a cash payment of $250,000 and Ratexchange common stock
valued at $118,000. In August 2001, the Company settled its co-location lease
with Telecity by providing consideration of $275,000 in cash and an agreement to
pay $95,000 over six months in return for elimination of all liabilities related
to the lease, which totaled approximately $1.2 million. In November 2001, the
Company settled an obligation to Science Applications International Corp. for
goods and services associated with delivery hub equipment. The settlement had a
value of $158,000, including a cash payment of $50,000 and 175,000 shares of
restricted Ratexchange common stock valued at $108,000. The Company had a lease
for accounting software that it no longer utilizes. As of December 31, 2001, the
Company has recorded an accrued liability for the amount due under the original
lease term.
The Company is involved in the following lawsuits:
Martin v. Ratexchange - On October 3, 2001, Gregory Martin and Patricia
Whitney filed a lawsuit against Ratexchange Corporation in the United States
District Court for the Western District of Washington, C01-1565R alleging breach
of contract. In 1998, Mr. Martin was the President and CEO of NetAmerica
International Corporation (NAMI), a predecessor of Ratexchange Corporation. In
December of 1998 Mr. Martin was terminated from his employment with NAMI. The
claims allege breach of agreements associated with Mr. Martin's employment. The
complaint asks for damages of approximately $150,000. Mr. Martin had filed suit
previously in the Washington State court. That matter was dismissed following a
settlement in May of 1999. Mr. Martin has now revived his claim against
Ratexchange. The matter is being defended by Ratexchange and is in the
preliminary stages of litigation. The Company has recorded the estimated loss
exposure in the consolidated balance sheet as of December 31, 2001.
YellowBrix, Inc. v. Ratexchange Corporation - On October 2, 2001,
YellowBrix, Inc. filed a lawsuit against Ratexchange Corporation in the Circuit
Court for the City of Alexandria, Virginia alleging breach of contract.
YellowBrix, Inc. provided news wire information to the Company in 2001. In
January 2002, the Company settled this case for a cash payment of $19,250. The
Company has recorded the settlement in the consolidated balance sheet as of
December 31, 2001.
Ratexchange I, Inc. v. PWREF/MCC-China Basin, LLC - In September of 2001,
Ratexchange I, Inc., one of the Company's Delaware subsidiaries, terminated its
lease and filed a lawsuit against PWREF/MCC-China Basin, LLC, its previous
landlord, alleging constructive eviction and seeking declaratory relief. The
allegations of the complaint arise from the lease for commercial space between
the parties for the property located at 185 Berry Street, in San Francisco,
California. PWREF/MCC-China Basin, LLC responded to the complaint and filed a
cross-complaint against Ratexchange I, Inc. In March 2002, the Company settled
the cross-complaint and dismissed the action. The Company paid $195,937 and
issued 50,000 shares of restricted common stock to PWREF/MCC-China Basin, LLC.
The Company has recorded the settlement in the consolidated balance sheet as of
December 31, 2001.
10. Income Taxes
No provision for federal income taxes was recorded during the three years
ended December 31, 2001 as the Company incurred net operating losses during the
period.
Actual income tax expense differs from expected tax benefit computed by
applying the statutory federal income tax rate of approximately 34% for the
three years ended December 31, 2001, primarily as a result of the change in
valuation allowance and stock based compensation.
35
RATEXCHANGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
The tax effect of temporary differences that give rise to significant
portions of the deferred tax assets as of December 31, 2001 and 2000 is
presented as follows:
December 31,
-----------------------------
2001 2000
---- ----
Deferred tax assets:
Net operating loss carryforward ....... $ 12,330,095 $ 5,450,910
Stock options and warrants for services 13,177,848 10,948,508
Start-up expenses ..................... 6,612,170 8,265,212
Write-down of equipment ............... 2,107,872 --
Reserves and accruals ................. 212,391 --
Unrealized loss on securities ......... -- 290,092
------------ ------------
Deferred tax assets ............. 34,440,376 24,954,722
Valuation allowance ............. (34,440,376) (24,954,722)
------------ ------------
Net deferred tax asset .... $ -- $ --
============ ============
The net change in the valuation allowance for the years ended December 31,
2001 and 2000 was an increase of $9,485,654 and $18,752,626, respectively. The
Company has established a valuation allowance against that portion of deferred
tax assets where management has determined that it is more likely than not that
the asset will not be realized.
As of December 31, 2001, the Company had a net operating loss carryforward
of approximately $30,519,828. If not earlier utilized, the federal net operating
loss carryforward will expire in 2022 and the state loss carryforward will
expire in 2006.
Under the Tax Reform Act of 1986, the amounts of and the benefit from net
operating losses that can be carried forward may be limited in certain
circumstances. Events that may cause limitations in the utilization of net
operating losses include a cumulative stock ownership change of more than 50%
over a three year period and other events. Ratexchange has not yet determined
the extent that its net operating loss benefit will be limited.
11. Net Loss per Share
Basic loss per share is computed by dividing the net loss, less accrued
dividends on preferred stock, by the weighted average number of common shares
outstanding. Stock options and warrants outstanding to purchase 17,815,476
shares of common stock and 2,000,000 shares of convertible preferred stock at
December 31, 2001 were not included in computing diluted loss per share because
their effects were anti-dilutive.
For the Years ended December 31,
2001 2000 1999
---- ---- ----
Net loss .......................................... $(30,072,176) $(44,728,894) $ (9,298,789)
Preferred stock dividends ......................... (264,917) -- --
------------ ------------ ------------
Net loss available to common stockholders ......... (30,337,093) (44,728,894) (9,298,789)
Weighted-average number of common shares .......... 17,913,546 16,633,611 12,863,020
------------ ------------ ------------
Basic and diluted net loss per common share ....... $ (1.69) $ (2.69) $ (0.72)
============ ============ ============
12. Acquisition of Xpit Corporation
On March 12, 2001, the Company acquired Xpit.com, Inc., a privately held
Idaho Corporation for approximately $5.5 million in a transaction recorded under
the purchase accounting method as a purchase of assets. The acquisition enabled
the Company to offer trading and risk management systems to the futures
industry. Xpit Corporation was a wholly owned subsidiary of Ratexchange. Under
the terms of the transaction, the Company acquired the outstanding common shares
of Xpit.com, Inc. in exchange for $500,000 in cash, a $500,000 two-year note
bearing interest at 7% per year, 2,000,000 shares of convertible preferred stock
with a cumulative dividend of 6% based on a share price of $2.75 per share, and
$4.9 million in future royalty payments tied to the achievement of Xpit
Corporation's projected revenues from 2001 through 2003. The preferred stock is
convertible on a one-for-one basis into common stock of the Company at the
discretion of the holders. The acquisition price was allocated primarily to the
software technology acquired.
36
RATEXCHANGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
On October 29, 2001, the Company sold all of the material assets of the
Company's Xpit Corporations subsidiary, including the Ratexchange Futures System
(RFS), to CQG, Inc. (CQG), a privately-held quotation services company. The
assets were sold to CQG in exchange for $1.5 million in cash. Additionally, the
Company can earn royalties of up to $650,000 over the next four years if CQG
achieves future revenue targets via the RFS platform. In view of the sale to
CQG, the Company recorded a $3.0 million non-cash charge in the third quarter to
reflect the impairment in the value of the Xpit Corporation assets, principally
the carrying value of the RFS platform. Additionally, the $500,000 note payable
associated with the original Xpit.com, Inc. purchase price was paid in full,
plus accrued interest. Net cash proceeds to the Company, after payment of the
note and expenses associated with the transaction, were $902,000.
13. Formation of RMG Partners Corporation
In April 2001, the Company formed RMG Partners Corporation as a wholly
owned subsidiary which provides risk management solutions through the use of
derivative trading strategies. Ratexchange committed to capitalize the newly
formed company with $300,000 and 2.2 million shares of Ratexchange's common
stock. RMG principals receive 85% of revenue, which is used to cover payroll and
operating expenses of RMG.
An affiliate of the principals of RMG, BL Partners, LLC, has the right to
purchase all of the Company's interest in RMG, except for the portion of
Ratexchange common stock used to capitalize RMG that is not "controlled" by the
Chairman of RMG, for $300,000 commencing in April 2002. The Chairman of RMG
obtains control over the Ratexchange common stock based on the achievement of
revenue targets. The accumulation of control of Ratexchange common stock by RMG
is accounted for as deferred compensation in the balance sheet and is being
amortized over a period of twelve months. As of December 31, 2001, RMG was
entitled to approximately 1.1 million shares of the Ratexchange common stock
used to capitalize RMG. These shares were not issued or outstanding at December
31, 2001. The fair value of the 1.1 million shares of common stock amounting to
$1.2 million was recorded as deferred compensation in 2001. Amortization of
deferred compensation was $934,000 in 2001.
See Note 20 for subsequent events involving RMG.
14. Acquisition of Spider Securities, Inc.
In December 2001, the Company acquired Spider Securities, Inc. (Spider) for
$50,000 in a transaction recorded as organization costs and expensed in 2001.
The Company changed the name of the entity to RTX Securities Corporation and
contributed $1,000,000 of capital to RTX Securities. RTX Securities is a
California corporation and a wholly owned subsidiary of Ratexchange.
RTX Securities Corporation is a registered broker-dealer with the
Securities Exchange Commission and is a member of the National Association of
Securities Dealers. The Company is a licensed broker-dealer in all fifty states
and Washington, D.C. and is located in San Francisco, California.
15. Acquisition of Rate Exchange, Inc.
In 1999, the Company purchased all the outstanding common stock of Rate
Exchange, Inc., a Colorado corporation, seeking to develop new exchange services
for the telecommunications market. The purchase price included 574,998 shares of
common stock, valued at $920,000, and a $450,000 promissory note. Under the
terms of the transaction, two of the owners/employees of Rate Exchange, Inc.
became employees of the Company responsible for exploring the development of the
business. On the date of purchase, Rate Exchange, Inc. had negative net worth of
$112,408. The Company recorded an expense of $1,507,408 representing the amount
by which the consideration provided exceeded the net assets of Rate Exchange,
Inc. at the date of acquisition plus expenses associated with the transaction of
$25,000.
37
RATEXCHANGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
16. Advances to Potential Investee
In September 1998, the Company, then known as Venture World, Ltd., began
negotiations to acquire NetAmerica, Inc., subsequently renamed A1 Internet, Inc.
The acquisition was never closed and negotiations were terminated in March 1999.
Between the time the Company negotiated to purchase NetAmerica, Inc and the time
the deal was terminated in March 1999, the Company advanced $1,738,769 to
NetAmerica, Inc. During 1999, the Company determined that $1,507,408 of the
amount advanced to NetAmerica, Inc. was uncollectible and charged this amount to
expense. A1 Internet, Inc. agreed to repay certain of the costs incurred by the
Company prior to the termination. A1 Internet, Inc. was subsequently sold to
Halo Holdings of Nevada, Inc. (Halo), a privately held company. The Company
received 100,000 shares of Halo common stock and retained certain rights to the
name "NetAmerica" in its settlement with Halo. During 2001, the Company sold a
portion of the Halo common stock for a realized loss and recorded an impairment
loss for the remaining shares of common stock. The loss attributed to the Halo
investment was $744,000 in 2001.
17. Agreement with Amerex Bandwidth, Ltd.
As discussed in Note 7, the Company entered into an alliance agreement with
Amerex Bandwidth, Ltd. In July 2001, the Company began negotiations to acquire
Amerex Bandwidth, Ltd. (ABL), however since this time these negotiations have
ceased. As of February 2002, the Company has no plans to acquire ABL. During
2001, Ratexchange paid to ABL approximately $650,000 to cover certain expenses
in accordance with the alliance agreement of September 2000.
18. Net Capital Requirements of RTX Securities Corporation
RTX Securities Corporation, a wholly owned subsidiary of the Company, is
subject to the Uniform Net Capital Rule (Rule 5c3-1) of the SEC, which requires
both the maintenance of minimum net capital and requires that the ratio of
aggregate indebtedness to net capital, both as defined, shall not exceed 15 to
1. As of December 31, 2001, RTX Securities had net capital of $891,099, which
was $883,834 in excess of its required net capital of $7,265. RTX Securities'
ratio of aggregate indebtedness to net capital was 0.12 to 1, which was less
than the 15.00 to 1 maximum ratio required of a broker-dealer.
RTX Securities does not carry customer accounts, nor does it hold customer
securities or cash. It is exempt from Rules 15c3-3 and 17a-13 under the
Securities Act of 1934.
19. Related Party Transactions
During 1998, the Company entered into a consulting contract with a major
shareholder that pays a monthly consulting fee plus an incentive bonus for (i)
any successful acquisition of business enterprises, or (ii) successful capital
funding of at least $5 million in 1998 or 1999. The incentive awards are
$250,000 in cash, warrants to purchase 250,000 shares of common stock at $1.00,
and a merger and acquisition fee for any acquisition during 1998 or 1999. During
1999, the Company recorded $315,800 in cash fees relating to completed
financing, mergers or acquisitions based on the value of the Rate Exchange, Inc.
acquisition. During 2000, the Company recorded $259,266 in connection with
financing activities and securing various operating leases.
In January 1999, the Company sold 916,574 shares in exchange for $91,657 in
notes payable to a related party and other investors at a price of $0.10 per
share. In March 1999, the Company sold 3,112,500 shares to a related party and
other investors in exchange for $3,320,000 in notes payable at a price of $1.07
per share. Of the total subscriptions receivable/note receivable issued during
1999 of $3,411,657 and $300,000 issued in 1998, $1,924,126 was collected prior
to December 31, 1999. Interest was assessed at 6.5% and accrued interest on the
subscription receivable was $150,608 at December 31, 1999. The Company
determined that $197,212 of the receivables were un-collectible and the Company
wrote them off. The remaining receivables were collected in 2000. In 2000, the
Board of Directors of the Company waived the interest due amounting to $132,240
on the purchase of 3,112,500 shares when the notes were collected in full by
February 25, 2000. The notes were originally due by March 31, 2001.
In October 2001, the Company successfully completed the process of
obtaining a broker-dealer license for RMG, a wholly owned subsidiary. Prior to
obtaining this broker-dealer license, RMG completed certain of its consulting
and risk management transactions through a registered broker-dealer affiliated
with the principals of RMG.
38
RATEXCHANGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
20. Subsequent Events
As discussed in Note 13, an affiliate of the principals of RMG has the
right to purchase all of the Company's interest in RMG, except for the portion
of the Ratexchange common stock used to capitalize RMG that is not "controlled"
by the Chairman of RMG, for $300,000 commencing in April 2002. In February 2002,
the Company received notice from BL Partners, LLC, that it intends to exercise
its right to purchase RMG in April 2002 in accordance with the terms of the
agreement. The Company's consolidated financial statements for 2001 properly
reflect the activity of RMG. The following adjustments to the consolidated
financial statements would be appropriate to reflect the Company's results "as
if" Ratexchange did not own RMG during 2001. The consolidated balance sheets as
of December 31, 2001 would have reflected the following decreases: (i) cash and
cash equivalents by $1,149,000, (ii) prepaid expenses and other current assets
by $16,000, (iii) other investments and deposits by $139,000, and (iv) accounts
payable and accrued liabilities by $1,304,000. The consolidated statements of
income for the year ended December 31, 2001 would have reflected a decrease in
revenue of $1,993,000 and a decrease in operating expenses of $1,832,000 in
2001.
39
PART III
ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The table below sets forth certain information concerning each of the
Directors and executive officers of Ratexchange:
Name Age Position
----- ---- -------
D. Jonathan Merriman 41 Chairman of the Board of Directors
and Chief Executive Officer
Patrick Arbor 64 Director
Dean S. Barr 41 Director
E. Russell Braziel 51 Director
Gregory S. Curhan 40 Executive Vice President
and Chief Financial Officer
Robert E. Ford 41 President and Chief Operating Officer
John E. McConnaughy, Jr. 72 Director
Donald H. Sledge 61 Director
Ronald E. Spears 52 Director
Steven W. Town 41 Director
D. Jonathan Merriman has served as our Chief Executive Officer since
October 2000 and served as our President from October 2000 through June 2001. He
has served as a Director since February 2000 and became Chairman of the Board in
June 2001. In June 1998, Mr. Merriman became Managing Director and Head of the
Equity Capital Markets Group and member of the Board of Directors at First
Security Van Kasper. In this capacity, he oversaw the Research, Institutional
Sales, Equity Trading, Syndicate and Derivatives Trading departments. He is
currently on the Boards of Directors of Leading Brands, Inc., and Fiberstars,
Inc. From June 1997, Mr. Merriman served as Managing Director and head of
Capital Markets at The Seidler Companies in Los Angeles, where he also served on
the firm's Board of Directors. Before Seidler, Mr. Merriman was Director of
Equities for Dabney/Resnick/Imperial, LLC. In 1989, Mr. Merriman co-founded the
hedge fund company Curhan, Merriman Capital Management, Inc., which managed
money for high net worth individuals and corporations. Before Curhan, Merriman
Capital Management, Inc., he worked in the Risk Arbitrage Department at Bear
Stearns & Co. as a trader/analyst. He has completed coursework at New York
University's Graduate School of Business. Mr. Merriman received his Bachelor of
Arts in Psychology from Dartmouth College.
Patrick Arbor has served as Director of Ratexchange since February 2001 and
has served as a member of the audit committee since April 2001. Currently an
independent futures trader, Mr. Arbor is a principal of the trading firm of
Shatkin, Arbor, Karlov & Co. He is a longtime member of the Chicago Board of
Trade (CBOT), the world's oldest derivatives exchange, serving as the
organization's Chairman from 1993 to 1999. During that period, Mr. Arbor also
served on the Board of Directors of the National Futures Association. Prior to
that, he served as Vice Chairman of the CBOT for three years and ten years as a
Director. Mr. Arbor's other exchange memberships include the Chicago Board
Options Exchange, the Mid-America Commodity Exchange and the Chicago Stock
Exchange. Mr. Arbor received his undergraduate degree in business and economics
from Loyola University.
Dean S. Barr has served as one of our Directors since November 2000. Mr.
Barr is currently the Global Chief Investment Officer of Deutsche Asset
Management, a position he has held since 1999. In this role, Mr. Barr is
responsible for $600 billion in investment assets worldwide for Deutsche Bank.
Before joining Deutsche Bank, Mr. Barr served as Global Chief Investment Officer
of Active Strategies and Global Director of Research at State Street Global
Advisors where he was responsible for $120 billion in active investment assets.
Mr. Barr co-founded and served from 1988 to 1997 as Chief Executive Officer of
Advanced Investment Technology, a quantitative asset manager with $1 billion in
assets under
40
management, until State Street Global Advisors purchased Advanced Investment
Technology. Mr. Barr began his career in 1984 at Goldman Sachs where he worked
on early trading applications for computer program trading. Mr. Barr received
his undergraduate degree from Cornell University and received his Masters in
Business Administration from New York University.
E. Russell "Rusty" Braziel has served as a Director of Ratexchange since
February 2001 and has served as a member of the audit committee since April
2001. Mr. Braziel is founder and CEO of Netrana, LLC, a consulting and software
venture that brings innovative market services, software solutions and liquidity
formation methodologies to a broad range of vertical electronic markets.
Previously, in 1996, Mr. Braziel founded Altra Energy Technologies, a world
leader in enterprise-wide business solutions, delivering electronic trading
platforms, transaction management products and integration services for the
energy industry. Under Mr. Braziel's leadership, Altra grew from a small project
team to a company conducting billions in e-commerce each month. Mr. Braziel
serves on various Boards of Directors and advisory boards, providing insight
into the development of a number of B2B exchanges, professional services firms,
and software companies. Mr. Braziel received his undergraduate degree in finance
and his Masters in Business Administration from Stephen F. Austin University.
Gregory S. Curhan is our Executive Vice President and Chief Financial
Officer. Previously he served as Chief Financial Officer of WorldRes.com from
May 1999 through June 2001. Prior to joining WorldRes.com, Mr. Curhan served as
Director of Global Technology Research Marketing and Managing Director Specialty
Technology Institutional Equity Sales at Merrill Lynch & Co. from May 1998 to
May 1999. Prior to joining Merrill Lynch, Mr. Curhan was a partner in the
investment banking firm of Volpe Brown Whelan & Co., serving in various
capacities including Internet research analyst and Director of Equities from May
1993 to May 1998. Mr. Curhan was a founder and principal of the investment
advisor Curhan, Merriman Capital Management from July 1998 through December
1992. Prior to founding Curhan, Merriman, Mr. Curhan was a Vice President
institutional equity sales for Montgomery Securities from June 1985 through June
1988. From August 1983 to May 1985, Mr. Curhan was a financial analyst in the
investment banking group at Merrill Lynch. Mr. Curhan earned his Bachelor of
Arts degree from Dartmouth College.
Robert E. Ford serves as President and Chief Operating Officer for
Ratexchange. He brings 18 years of executive and operations experience to the
Company. Prior to joining Ratexchange, Mr. Ford was a co-Founder and CEO of
Metacat, Inc., a content management ASP that specializes in enabling supplier
catalogs for Global 2000 private exchanges and eMarketplaces. Previously, he was
President/COO and on the founding team of JobDirect.com, a leading resume and
job matching service for university students, now a wholly-owned subsidiary of
Korn Ferry International. Previously, Mr. Ford co-founded and managed an
education content company. Prior to that, he headed up a turnaround and merger
as General Manager of a 65 year-old manufacturing and distribution company. Mr.
Ford started his career as VP of Business Development at Lazar Enterprises, a
technology-consulting firm. He earned his Masters in International Business and
Law from the Fletcher School of Law and Diplomacy at Tufts University and a BA
with high distinction from Dartmouth College.
John E. "Jack" McConnaughy, Jr. has served as one of our Directors since
December 2001. Mr. McConnaughy is currently Chairman and Chief Executive Officer
of JEMC Corporation. He was Chairman and CEO of Peabody International
Corporation from 1969 and in addition Chairman and Chief Executive Officer of
GEO International Corporation when it spun off in 1981. He retired from the
former in 1986 and the latter in 1992. He was named outstanding Chief Executive
Officer in his industry for the years 1975, 1976 and1978 by Financial World
Magazine. Prior to joining Peabody, Mr. McConnaughy served as Vice
President-European Consumer Products with the Singer Company where he was
responsible for operations in sixteen countries. A graduate of the Denison
University with a B.A. in economics, Mr. McConnaughy earned his Masters in
Business Administration in marketing and finance at Harvard's Graduate School of
Business Administration.
Donald H. Sledge has served as one of our Directors since September 1999
and Chairman of our Board of Directors from February 2000 to June 2001. He has
served as a member of the compensation committee since April 2001. He also
served as Chief Executive Officer from February 2000 until October 2000. From
September 1999 until February of 2000 he served as President, Chief Executive
Officer and Chairman of our subsidiary Ratexchange I, Inc. Mr. Sledge is
currently a general partner in Fremont Communications, a venture capital fund,
based in San Francisco. From 1996 to September 1999, Mr. Sledge was president
and Chief Executive Officer of TeleHub Communications Corporation, a next
generation ATM-based telecommunications company. From 1994 to 1995, Mr. Sledge
served as President and Chief Operating
41
Officer of WCT, a $160-million long distance telephone company that was one of
Fortune Magazine's 25 fastest growing public companies before it was acquired by
Frontier Corporation. From 1993 to 1994, Mr. Sledge was head of operations for
New T&T, a Hong Kong-based start-up. He was Chairman and Chief Executive Officer
of New Zealand Telecom International from 1991 to 1993 and a member of the
executive board of TCNZ, where he led privatization and public offerings and
served as managing director of New Zealand's largest operating telephone
company, Telecom Auckland Ltd. One of the subsidiaries of Telehub
Communications,Telehub Network Services Corporation, filed for bankruptcy
several months after Mr. Sledge resigned from Telehub. Mr. Sledge also served as
president and Chief Executive Officer of Pacific Telesis International. Since
November 1997, Mr. Sledge also has served on the Board of Directors of eGlobe,
Inc., a voice-based applications services provider. Mr. Sledge holds a Masters
of Business Administration and Batchelor of Arts degree in industrial management
from Texas Technological University.
Ronald E. Spears has served as one of our Directors since March 2000 and
has served as a member of the audit committee since April 2001. Throughout his
20-year career, he has managed telecommunications and professional service
start-ups, as well as established long distance powerhouses. Since June 2000,
Mr. Spears has led the formulation and implementation of corporate-wide
development related to strategic planning, marketing and communications,
business alliances as Vaultus', formerly MobileLogic, President and Chief
Executive Officer. Mr. Spears joined Vaultus after serving as the President and
Chief Executive Officer of CMGI Solutions, an enterprise focused Internet
solutions provider from April 1999 to May 2000. Before joining CMGI Solutions,
Mr. Spears served as president and COO of e.spire Communications, one of the
nation's fastest growing integrated communications providers, from February 1998
to April 1999 where he managed day-to-day business operations and saw
significant growth in revenue and market share. From June 1995 to January 1998
he was corporate vice president at Citizens Utilities, managing that company's
independent telephone company operations in 13 states. He also served as
President of MCI WorldCom, Inc.'s Midwest Division from 1984 to 1990. A pioneer
of the competitive long distance industry, Mr. Spears began his career in
telecommunications as a manager of AT&T Longlines in 1978, following eight years
as an officer in the U.S. Army. He is a graduate of the United Military Academy
at West Point and also holds a Master's Degree in Public Service from Western
Kentucky University.
Steven W. Town has served as one of our Directors since October 2000 and
has served as a member of the compensation committee since April 2001. Mr. Town
currently serves as Co-Chief Executive Officer of the Amerex Natural Gas, Amerex
Power and Amerex Bandwidth, Ltd. Mr. Town began his commodities career in 1987
in the retail futures industry prior to joining the Amerex Group of Companies.
He began the Amerex futures and forwards brokerage group in natural gas in 1990,
in Washington D.C., and moved this unit of Amerex to Houston in 1992. During Mr.
Town's tenure as Co-Chief Executive Officer, the Amerex companies have become
the leading brokerage organizations in their respective industries. Amerex
currently provides energy, power and bandwidth brokerage services to many of the
energy companies. Mr. Town is a graduate of Oklahoma State University.
There is no family relationship among any of the foregoing officers or
between any of the foregoing executive officers and any Director of the Company.
The information set forth under the caption "Section 16(a) Beneficial
Ownership Reporting Compliance" is incorporated by reference to the Company's
definitive 2002 Proxy Statement.
ITEM 11. EXECUTIVE COMPENSATION
The information is incorporated by reference to the Company's definitive
2002 Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information is incorporated by reference to the Company's definitive
2002 Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information is incorporated by reference to the Company's definitive
2002 Proxy Statement.
42
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. The information required by this item is included in Item 8 of Part II
of this Annual Report on Form 10-K.
2. Financial Statement Schedules
The required schedules are omitted because of the absence of
conditions under which they are required or because the required
information is presented in the financial statements or notes thereto.
3. Exhibits
The exhibits listed in the accompanying index to exhibits are filed or
incorporated by reference as part of this Annual Report on Form 10-K.
(b) Reports on Form 8-K
Form 8-K (item 5 reported) filed on November 28, 2001.
43
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.
RATEXCHANGE CORPORATION
March 28, 2002 By: /s/ D. JONATHAN MERRIMAN
---------------------------------------------
D. Jonathan Merriman,
Chairman of the Board and Chief Executive Officer
Pursuant to the requirements of the Securities and Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ D. JONATHAN MERRIMAN Chairman of the Board and March 28, 2002
- -------------------------- Chief Executive Officer
D. Jonathan Merriman
/s/ GREGORY CURHAN Chief Financial Officer March 28, 2002
- --------------------------
Gregory Curhan
/s/ PATRICK ARBOR Director March 28, 2002
- --------------------------
Patrick Arbor
DEAN BARR Director March 28, 2002
- --------------------------
Dean Barr
E. RUSSELL BRAZIEL Director March 28, 2002
- --------------------------
E. Russell Braziel
JOHN MCCONNAGHY, JR. Director March 28, 2002
- --------------------------
John E. McConnaghy, Jr.
/s/ DONALD SLEDGE Director March 28, 2002
- --------------------------
Donald Sledge
/s/ RONALD SPEARS Director March 28, 2002
- --------------------------
Ronald Spears
/s/ STEVEN TOWN Director March 28, 2002
- --------------------------
Steven Town
44
EXHIBIT INDEX
Exhibit
No. Description
------- -----------
2.1 Acquisition agreement between Ratexchange and Xpit.com Inc.,
date March 12, 2001.
3.1 Certificate of Incorporation, as amended (incorporated herein
by reference to Exhibit 3.1 to Ratexchange's Registration
Statement on Form S-1 (Reg. No. 333-37004)).
3.3 Amended and Restated Bylaws, as amended. (incorporated by
reference to Exhibit 10.3 to Ratexchange's Registration
Statement on Form S-1 (Reg. No. 333-53316)).
4.1 Form of Convertible Subordinated Note related to Ratexchange
private financing, dated November 26, 2001.
4.2 Form of Class A Redeemable Warrant to Purchase Common Stock of
Ratexchange related to Ratexchange Corporation private
financing, dated November 26, 2001.
10.1+ Employment Agreement between Ratexchange and Edward Mooney
dated April 1, 1999 (incorporated by reference to Exhibit 10.3
to Ratexchange's Form 10-Q for the quarter ended September 30,
1999).
10.2 Promissory Note of Edward Mooney dated December 18, 1998
(incorporated herein by reference to Exhibit 10.4 to
Ratexchange's Registration Statement on Form S-1 (Reg. No.
333-53316)).
10.3+ Form of Severance Agreement between Ratexchange and Edward
Mooney (incorporated herein by reference to Exhibit 10.5 to
Ratexchange's Registration Statement on Form S-1
(Reg.No.333-53316)).
10.4+ Employment Agreement between Ratexchange and Douglas Cole dated
April 1, 1999 (incorporated herein by reference to Exhibit 10.6
to Ratexchange's Registration Statement on Form S-1 (Reg. No.
333-53316)).
10.5+ Form of Severance Agreement between Ratexchange and Douglas
Cole (incorporated herein by reference to Exhibit 10.7 to
Ratexchange's Registration Statement on Form S-1 (Reg. No.
333-53316)).
10.6+ Employment Agreement between Ratexchange I, Inc. and Donald H.
Sledge dated September 15, 1999 (incorporated herein by
reference to Exhibit 10.8 to Ratexchange's Registration
Statement on Form S-1 (Reg. No. 333-53316)).
10.7+ Amendment No. 1 to Employment Agreement of Donald H. Sledge
dated October 5, 2000 (incorporated herein by reference to
Exhibit 10.9 to Ratexchange's Registration Statementon Form S-1
(Reg.No.333-53316)).
10.8+ Employment Agreement between Ratexchange and Ross Mayfield
dated July 2, 1999 (incorporated herein by reference to Exhibit
10.10 to Ratexchange's Registration Statement on Form S-1 (Reg.
No. 333-53316)).
10.9+ Separation Agreement between Ratexchange and Ross Mayfield
dated August 18, 2000 (incorporated herein by reference to
Exhibit 10.11 to Ratexchange's Registration Statement on Form
S-1 (Reg. No. 333-53316)).
10.10+ Employment Agreement between Ratexchange and Paul Wescott dated
July 5,2000 (incorporated herein by reference to Exhibit 10.12
to Ratexchange's Registration Statement on Form S-1 (Reg. No.
333-53316)).
10.11+ Separation Agreement between Ratexchange and Paul Wescott dated
August 28, 2000 (incorporated herein by reference to Exhibit
10.13 to Ratexchange's Registration Statement on Form S-1 (Reg.
No. 333-53316)).
10.12+ Employment Agreement between Ratexchange and Philip Rice dated
February 29, 2000 (incorporated herein by reference to Exhibit
10.14 to Ratexchange's Registration Statement on Form S-1
(Reg.No.333-53316)).
10.13+ Employment Agreement between Ratexchange and D. Jonathan
Merriman dated October 5, 2000 (incorporated herein by
reference to Exhibit 10.15 to Ratexchange's Registration
Statement on Form S-1 (Reg. No. 333-53316)).
45
10.14+ 1998 Employee/Consultant Stock Compensation Plan (incorporated
herein by reference to Exhibit 10.1 to Ratexchange's
Registration Statement on Form S-8 (Reg. No. 333-65729)).
10.15+ 1999 Stock Option Plan (incorporated herein by reference to
Exhibit 4.1 to Ratexchange's Registration Statement on Form S-8
(Reg. No.333-43776)).
10.16+ Form of Non-Qualified, Non-Plan Stock Option Agreement dated
February 24, 2000 between Ratexchange and Phillip Rice, Nick
Cioll, Paul Wescott, Ross Mayfield, Russ Matulich, Terry Ginn,
Donald Sledge, Christopher Vizas, Douglas Cole, Ronald Spears
and Jonathan Merriman (incorporated by reference to Exhibit 4.2
to Ratexchange's Registration Statement on Forms S-8 (Reg. No.
333-43776)).
10.17+ Schedule of non-plan option grants made under Non-Qualified,
Non-Plan Stock Option Agreements to directors and executive
officers (incorporated herein by reference to Exhibit 10.19 to
Ratexchange's Registration Statement on Form S-1 (Reg. No.
333-53316)).
10.18+ 2000 Stock Option and Incentive Plan, as amended (incorporated
herein by reference to Exhibit 10.20 to Ratexchange's
Registration Statement on Form S-1 (Reg. No. 333-53316)).
10.19 Advisory Agreement between Ratexchange and Maroon Bells Capital
Partners, Inc. dated December 15, 1998 (incorporated by
reference to Exhibit 10.12 to Ratexchange's Form 10-K/A for the
year ended December 31, 1999).
10.20 Promissory Note of Theodore Swindells dated March 30,
1999(incorporated by reference to Exhibit 10.13 to
Ratexchange's Form 10-K/A for the year ended December 31,
1999).
10.21 Term Sheet dated July 23, 1999 between Ratexchange I, Inc. and
Ultimate Markets, Inc. (incorporated by reference to Exhibit
10.14 to Ratexchange's Form 10-K/A for the year ended December
30, 1999)
10.22 Settlement Agreement and Full General Mutual Release by and
between Ratexchange and Ultimate Markets, Inc., dated August
28, 2000 (incorporated by reference to Exhibit 10.6 to
Ratexchange's Form 10-Q for the quarter ended September 30,
2000).
10.23 Master Equipment Lease Agreement dated March 16, 2000
(incorporated by reference to Exhibit 10.6 to Ratexchange's
Registration Statement on Form S-1 (Reg. No. 333-37004)).
10.24* Agreement between Ratexchange and Amerex Bandwidth, Ltd. dated
September 17, 2000, including Warrants (incorporated by
reference to Ratexchange's Form 10K for the year ended December
31, 2000).
10.25 Multi Site Colocation Commitment Agreement by and between
Ratexchange and COLO.com dated February 17, 2000 (incorporated
by reference to Ratexchange's Form 10K for the year ended
December 31, 2000).
10.26 Co-location License by and between Ratexchange and Switch &
Data Facilities Company dated March 1, 2000 (incorporated by
reference to Ratexchange's Form 10K for the year ended December
31, 2000).
10.27 Facilities Management Agreement between Ratexchange and
Telecity UK Limited dated July 11, 2000 (incorporated by
reference to Exhibit 10.2 to Ratexchange's Form 10-Q for the
quarter ended September 30, 2000).
10.28 Master Agreement between Ratexchange and Science Applications
International Corporation dated February 2, 2000 (incorporated
by reference to Ratexchange's Form 10K for the year ended
December 31, 2000).
10.29 Agreement between Ratexchange and BL Partners related to RMG
Partners Corporation, dated April 8, 2001 (incorporated by
reference to Exhibit 10.1 to Ratexchange's Form 10-Q for the
quarter ended June 30, 2001).
10.30+ Offer of Employment Agreement between Ratexchange Corporation
and Robert E. Ford, dated February 19, 2001, is Exhibit 10.2 to
Form 10-Q for the quarter ended June 30, 2001, and is hereby
incorporated by reference.
10.31 Ratexchange Placement Agreement with Murphy & Durieu, dated
November 28, 2001, for private financing transaction.
10.32 Form of Placement Agent Warrant to Murphy & Durieu, dated
November 28, 2001.
10.33 Convertible Promissory Note held by Forsythe/McArthur
Associates, Inc., dated September 1, 2001, related to
restructure of Master Equipment Lease Agreement that is Exhibit
10.23 to Form 10K for the year ended December 31, 2000.
10.34+ Employment Agreement between Ratexchange and Gregory S. Curhan,
dated January 9, 2002.
10.35+ Employment Agreement between Ratexchange Corporation and Robert
E. Ford, dated January 1, 2002.
10.36 Lease Termination and Settlement Agreement by and between
Ratexchange and PWREF/MCC-China Basin, LLC, dated February 25,
2001.
10.37 Stock Purchase Agreement by and among Ratexchange and Instream
Securities, Inc, (formerly known as Spider Securities, Inc.)
and Independent Advantage Financial & Insurance Services, Inc.,
dated December 7, 2001.
10.38 Asset Purchase Agreement by and among Xpit Acquisition, LLC,
CQG, Inc., Xpit Corporation, Ratexchange and certain Related
Parties, dated October 24, 2001.
21.1 List of Subsidiaries of Ratexchange.
22.1 Ratexchange Proxy Statement pursuant to Section 14(a) of the
Securities Exchange Act of 1934, for the stockholders' meeting
held on May 31, 2001 in San Francisco, California.
99.1 Letter to Commission pursuant to Temporary Note 3T, dated March
28, 2002.
+ Represents management contract or compensatory plan or
arrangement.
* Certain confidential portions of this Exhibit were omitted by
means of redacting a portion of the text. This Exhibit has been
filed separately with the Secretary of the Securities and
Exchange Commission without such redaction pursuant to our
Application Requesting Confidential Treatment under Rule 406 of
the Securities Act, which request has been granted by the
Securities Exchange Commission
46