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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
---------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2002
[ ] 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 1-15831
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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, California 94111
Address of Principal Executive Offices) (Zip Code)
(415) 274-5650
(Registrant's Telephone Number, Including Area Code)
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 [ ]
As of July 30, 2002, 20,875,859 shares of the registrant's common
stock, $0.0001 par value, were outstanding.
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Ratexchange Corporation
Form 10-Q
For the Three Months Ended June 30, 2002
Page No.
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PART I FINANCIAL INFORMATION
ITEM 1. Financial Statements (unaudited)
Condensed Consolidated Statements of Operations for the three months and
six months ended June 30, 2002 and 2001...................................................... 2
Condensed Consolidated Statements of Financial Condition as of
June 30, 2002 and December 31, 2001.......................................................... 3
Condensed Consolidated Statements of Cash Flows for the six months
ended June 30, 2002 and 2001................................................................. 4
Notes to Condensed Consolidated Financial Statements........................................... 5
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.......... 7
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk..................................... 20
PART II OTHER INFORMATION
ITEM 1. Legal Proceedings.............................................................................. 21
ITEM 6. Exhibits and Reports on Form 8-K............................................................... 21
Signatures............................................................................................. 22
1
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
RATEXCHANGE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
Three Months Ended Six Months Ended
--------------------------- ---------------------------
June 30, June 30, June 30, June 30,
2002 2001 2002 2001
------------ ------------ ------------ ------------
Revenue:
Commissions ................................. $ 1,678,516 $ 59,066 $ 2,201,101 $ 94,394
Principal transactions ...................... 106,168 -- 124,776 --
Investment banking .......................... 220,743 -- 246,416 --
Other ....................................... 3,300 11,450 28,827 15,950
------------ ------------ ------------ ------------
Total revenue .......................... 2,008,727 70,516 2,601,120 110,344
------------ ------------ ------------ ------------
Operating expenses:
Compensation and benefits
(inclusive of non-cash expenses of
$97,250, $990,939, $446,530 and $2,535,513) 1,478,743 2,534,645 2,682,818 5,399,344
Brokerage and clearing fees ................... 238,030 -- 395,572 --
Professional services ......................... 129,917 515,507 270,036 749,809
Occupancy and equipment ....................... 44,797 1,679,407 125,220 3,784,302
Communications and technology ................. 57,008 65,793 88,292 183,714
Depreciation and amortization ................. 100,281 458,803 199,375 854,797
Other ......................................... 358,180 431,347 537,965 2,300,446
------------ ------------ ------------ ------------
Total operating expenses ................... 2,406,956 5,685,502 4,299,278 13,272,412
------------ ------------ ------------ ------------
Operating loss ................................... (398,229) (5,614,986) (1,698,158) (13,162,068)
Interest income .................................. 12,221 121,893 27,717 272,170
Interest expense ................................. (363,848) (11,512) (727,620) (11,512)
Other expense .................................... -- (199,923) -- (744,197)
------------ ------------ ------------ ------------
Loss from continuing operations .................. (749,856) (5,704,528) (2,398,061) (13,645,607)
Income from discontinued operations .............. -- 29,360 32,641 329,360
------------ ------------ ------------ ------------
Net loss ......................................... $ (749,856) $ (5,675,168) $ (2,365,420) $(13,316,247)
============ ============ ============ ============
Basic and diluted net loss per share ............. $ (0.04) $ (0.32) $ (0.12) $ (0.75)
============ ============ ============ ============
Weighted average number of common shares ......... 20,292,922 17,783,000 20,111,950 17,783,000
The accompanying notes are an integral part of these condensed
consolidated financial statements
2
RATEXCHANGE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(unaudited)
June 30, December 31,
2002 2001
------------ ------------
ASSETS
Cash and cash equivalents ............................................. $ 3,100,689 $ 4,358,091
Securities owned:
Marketable, at fair value ........................................ 232,096 --
Not readily marketable, at estimated fair value .................. 7,150 --
Due from clearing broker .............................................. 726,540 --
Accounts receivable, net .............................................. 67,500 --
Equipment and fixtures, net ........................................... 478,352 674,618
Debt issuance costs ................................................... 646,874 658,434
Prepaid expenses and other assets ..................................... 150,832 212,050
Assets of discontinued operations ..................................... -- 1,603,588
------------ ------------
Total assets .................................................... $ 5,410,033 $ 7,506,781
============ ============
LIABILITIES AND STOCKHOLDERS' DEFICIT
Accounts payable ...................................................... $ 551,519 $ 401,505
Commissions payable ................................................... 436,896 --
Accrued liabilities ................................................... 1,281,097 1,164,866
Due to clearing and other brokers ..................................... 89,640 --
Deferred revenue ...................................................... 30,833 --
Convertible notes payable, net ........................................ 8,343,671 8,141,704
Liabilities of discontinued operations ................................ -- 1,240,439
------------ ------------
Total liabilities ................................................ 10,733,656 10,948,514
------------ ------------
Commitments and contingencies
Stockholders' deficit:
Preferred stock, $0.0001 par value; 60,000,000 shares authorized;
806,366 and 2,000,000 shares issued and outstanding as of June 30,
2002 and December 31, 2001, respectively; aggregate liquidation
preference of $2,618,184 as of June 30, 2002 ..................... 81 200
Common stock, $0.0001 par value; 300,000,000 shares authorized;
20,875,859 and 18,328,204 shares issued and outstanding
as of June 30, 2002 and December 31, 2001, respectively .......... 2,088 1,833
Additional paid-in capital ......................................... 84,906,051 84,516,375
Accumulated deficit ................................................ (90,231,843) (87,730,641)
Deferred compensation .............................................. -- (229,500)
------------ ------------
Total stockholders' deficit ...................................... (5,323,623) (3,441,733)
------------ ------------
Total liabilities and stockholders' deficit .................... $ 5,410,033 $ 7,506,781
============ ============
The accompanying notes are an integral part of these condensed
consolidated financial statements.
3
RATEXCHANGE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Six Months Ended June 30,
--------------------------
2002 2001
----------- ------------
Cash flows from operating activities:
Net loss ........................................................... $(2,365,420) $(13,316,247)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization ................................... 199,375 854,797
Common stock issued for services ................................ 83,338 --
Stock-based compensation ........................................ 363,192 2,535,513
Note payable issued in connection with employee severance ....... -- 400,000
Amortization of discounts on convertible notes payable .......... 201,967 --
Amortization of debt issuance costs ............................. 34,060 --
(Gain) loss on securities ....................................... (7,298) 744,197
Common stock received for advisory services ..................... (11,000) --
Changes in operating assets and liabilities:
Assets and liabilities of discontinued operations ............. 63,149 (464,359)
Due from clearing broker ...................................... (726,540) --
Receivables ................................................... (67,500) 52,064
Prepaid expenses and other assets ............................. 61,218 97,609
Accounts payable and accrued liabilities ...................... 303,245 (336,835)
Commissions payable ........................................... 436,896 --
Due to clearing and other brokers ............................. 89,640 --
Deferred revenue .............................................. 30,833 --
----------- ------------
Net cash used in operating activities ..................... (1,310,845) (9,433,261)
Cash flows from investing activities:
Purchase of equipment and fixtures .............................. (3,109) (588,768)
Purchase of short-term investments .............................. (1,925,517) --
Proceeds from sale of short-term investments .................... 1,704,569 12,094,951
Proceeds from sale of discontinued operations ................... 300,000 --
----------- ------------
Net cash provided by investing activities ................. 75,943 11,506,183
Cash flows from financing activities:
Debt issuance costs ............................................. (22,500) --
----------- ------------
Net cash used in financing activities ...................... (22,500) --
----------- ------------
Increase (decrease) in cash and cash equivalents .................... (1,257,402) 2,072,922
Cash and cash equivalents at beginning of period .................... 4,358,091 2,115,152
----------- ------------
Cash and cash equivalents at end of period .......................... $ 3,100,689 $ 4,188,074
=========== ============
Supplementary disclosure of cash flow information:
Cash paid during the period:
Interest ...................................................... $ 282,770 $ --
Income taxes .................................................. $ 7,200 $ 2,400
Non-cash investing and financing activities:
Preferred stock issued to purchase software assets ............ $ -- $ 4,383,800
Stock dividend accrued for preferred stock .................... $ 135,782 $ 26,869
Note issued to purchase software assets ....................... $ -- $ 500,000
Common stock issued to settle accrued liabilities ............. $ 37,000 $ --
The accompanying notes are an integral part of these condensed
consolidated financial statements
4
RATEXCHANGE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. Basis of Presentation
The interim statements included herein for Ratexchange Corporation, or
Ratexchange, have been prepared, without audit, pursuant to the rules and
regulations of the Securities and Exchange Commission. In our opinion, the
financial statements included in this report reflect all normal recurring
adjustments that we consider necessary for the fair presentation of the results
of operations for the interim periods covered and the financial position at the
date of the interim statement of financial condition. Certain information and
footnote disclosures normally included in annual financial statements prepared
in accordance with accounting principles generally accepted in the United States
have been condensed or omitted pursuant to such rules and regulations. However,
we believe that the disclosures are adequate to understand the information
presented. The operating results for interim periods are not necessarily
indicative of the operating results for the entire year. These financial
statements should be read in conjunction with our December 31, 2001 audited
consolidated financial statements and notes thereto included in our Annual
Report on Form 10-K for the year ended December 31, 2001.
Certain prior year amounts have been reclassified to conform to current
year consolidated financial statement presentation.
2. 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 21,269,316 and
16,575,079 shares of common stock as of June 30, 2002 and 2001, and 806,366 and
2,000,000 shares of convertible preferred stock at June 30, 2002 and 2001,
respectively, were not included in computing diluted loss per share because
their effects were anti-dilutive.
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- ---------------------------
2002 2001 2002 2001
------------ ------------ ------------ ------------
Net loss .................................. $ (749,856) $ (5,675,168) $ (2,365,420) $(13,316,247)
Preferred stock dividends ................. (53,282) (26,869) (135,782) (26,869)
------------ ------------ ------------ ------------
Net loss available to common stockholders . (803,138) (5,702,037) (2,501,202) (13,343,116)
Weighted-average number of common shares .. 20,292,922 17,783,000 20,111,950 17,783,000
------------ ------------ ------------ ------------
Basic and diluted net loss per common share $ (0.04) $ (0.32) $ (0.12) $ (0.75)
============ ============ ============ ============
3. 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.
Three Months Ended June 30, Six Months Ended June 30,
----------------------- --------------------------
2002 2001 2002 2001
--------- ----------- ----------- ------------
Net loss .............................. $(749,856) $(5,675,168) $(2,365,420) $(13,316,247)
Change in unrealized loss on securities -- -- -- 1,050
--------- ----------- ----------- ------------
Comprehensive loss ............... $(749,856) $(5,675,168) $(2,365,420) $(13,315,197)
========= =========== =========== ============
5
RATEXCHANGE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(unaudited)
4. Discontinued Operations
In 2001, we formed RMG Partners Corporation, or RMG, as a wholly owned
subsidiary to provide risk management solutions through the use of derivative
trading strategies. An affiliate of the principals of RMG, BL Partners, LLC, had
the right to purchase our interest in RMG for $300,000. In April 2002, BL
Partners, LLC exercised its right to purchase RMG in accordance with the terms
of the agreement.
RMG represented a component of our business. Pursuant to SFAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets, we have
reclassified the balances pertaining to RMG in our condensed consolidated
financial statements to reflect the disposition of this subsidiary. The
revenues, expenses, assets and liabilities, and cash flows of these operations
have been segregated in our condensed consolidated financial statements for all
periods presented and have been separately reported as "discontinued
operations."
Income from discontinued operations is comprised of the following revenue
and expenses:
Three Months Ended June 30, Six Months Ended June 30,
-------------------- ------------------------
2002 2001 2002 2001
------ --------- ---------- -----------
Revenue of discontinued operations ..... $ -- $ 300,000 $ 729,946 $ 600,000
Expenses of discontinued operations .... -- (270,640) (697,305) (270,640)
------ --------- ---------- ---------
Income from discontinued operations $ -- $ 29,360 $ 32,641 $ 329,360
====== ========= ========== =========
The major classes of assets and liabilities of discontinued operations as
of December 31, 2001 are as follows:
December 31,
2001
-------------
Assets:
Cash and cash equivalents..................... $ 1,448,634
Investments................................... 125,000
Other......................................... 29,954
-------------
Total.................................... $ 1,603,588
=============
Liabilities:
Accrued liabilities........................... $ 1,166,973
Other......................................... 73,466
-------------
Total.................................... $ 1,240,439
=============
5. Equity Capital
In April 2002, we issued 1,149,876 shares of common stock in connection
with RMG achieving specified revenue milestones during the twelve months ended
April 2002. We did not receive any proceeds from this transaction. Additionally,
in May 2002, stockholders of our preferred stock converted 1,193,634 of their
shares into common stock. We did not receive any proceeds from this transaction.
6. Regulatory Requirements
Our broker-dealer subsidiary, RTX Securities Corporation, or RTX Securities, is
subject to Rule 15c3-1 of the Securities and Exchange Commission, which
specifies uniform minimum net capital requirements, as defined, for their
registrants. As of June 30, 2002, RTX Securities had regulatory net capital, as
defined, of $1,007,000, which exceeded the amount required by $880,000. RTX
Securities is exempt from Rules 15c3-3 and 17a-13 under the Securities Act of
1934 because it does not carry customer accounts, nor does it hold customer
securities or cash.
6
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This Management's Discussion and Analysis of Financial Condition and Results of
Operations contains certain forward-looking statements that involve risks and
uncertainties. We have set forth in our Form 10-K Item 7 "Management's
Discussion and Analysis of Financial Condition and Results of Operations-Risk
Factors," as filed with the Securities and Exchange Commission on March 28,
2002, a detailed statement of risks and uncertainties relating to our business.
In addition, set forth below under the heading "Risk Factors" is a further
discussion of certain of those risks as they relate to the period covered by
this report, our near-term outlook with respect thereto, and the forward-looking
statements set forth herein. Investors should review this quarterly report in
combination with the Form 10-K in order to have a more complete understanding of
the principal risks associated with an investment in our common stock.
Overview
We are a brokerage services firm that combines our 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 provide valuable and marketable information to
clients of RTX Securities.
We recognize revenue 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, capital markets services fees, and merger and acquisition
advisory fees. We believe that our consulting and information services may, in
the future, generate revenues in the form of subscription fees, transaction
fees, professional services fees and management fees.
In 2001, we formed RMG Partners Corporation as a wholly owned subsidiary to
provide risk management solutions through the use of derivative trading
strategies. An affiliate of the principals of RMG, BL Partners, LLC, had the
right to purchase our interest in RMG for $300,000. In April 2002, BL Partners,
LLC exercised its right to purchase RMG in accordance with the terms of the
agreement. The Chairman of RMG obtained control over 1,149,876 shares of our
common stock by attaining certain revenue goals set forth in the agreement.
These shares of common stock were issued to RMG in April 2002.
Critical Accounting Policies and Estimates
The condensed consolidated financial statements are prepared in accordance
with accounting principles generally accepted in the United States, which
require us to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses, and related disclosure of contingent
assets and liabilities. On an on-going basis, we evaluate our estimates,
including those related to bad debts, stock-based compensation, income taxes,
and contingencies and litigation. We base our estimates on historical experience
and on various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results could differ from those estimates. We believe the
following critical accounting policies affect our more significant judgments and
estimates used in the preparation of our consolidated financial statements.
We recognize brokerage revenue once the trade is consummated and the
earnings process is complete. Fees for investment banking advisory services and
consulting assignments are recognized when services for the transactions are
substantially completed under the terms of the engagement, fees from such
services are fixed or determinable, and their collection is probable.
Transaction-related expenses to date have been expenses as incurred.
We maintain an allowance for doubtful accounts for estimated losses
resulting from the inability of our customers to make required payments. If the
financial condition of our customers were to deteriorate, resulting in an
impairment of their ability to make payments, additional allowances may be
required.
7
We utilize the Black-Scholes option pricing model to estimate the fair
value of stock options and warrants granted to non-employees. 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. We use projected
volatility rates, which are based upon historical volatility rates trended into
future years. Our stock options and warrants have characteristics significantly
different from those of traded options, and changes in the subjective input
assumptions can materially affect the fair value estimates.
We have concluded that it is more likely than not that our deferred tax
assets as of June 30, 2002 will not be realized based on the scheduling of
deferred tax liabilities and projected taxable income. The amount of the
deferred tax assets actually realized, however, could vary if there are
differences in the timing or amount of future reversals of existing deferred tax
liabilities or changes in the actual amounts of future taxable income. Should we
determine that we will be able to realize all or part of our deferred tax asset
in the future, an adjustment to the deferred tax asset will be recorded in the
period such determination is made.
Results of Operations
Overview
Our results of operations for the three and six months ended June 30, 2002
are significantly different from those of the comparable periods in 2001. We
transitioned our strategy during 2001 away from the hardware-intensive
facilitation of brokering telecommunications bandwidth through our own network
hubs to operating a securities broker-dealer and aggregating price and market
data related to bandwidth and other emerging commodities for sale to third
parties. We began operating RTX Securities Corporation, a wholly-owned
subsidiary, in January 2002 by offering sales and trading services to
institutions and private clients, as well as, advisory and investment banking
services to our corporate clients. The overall level of our expenditures has
decreased as a result of this change in our business strategy.
Additionally, the results of our continuing operations for the three months
and six months ended June 30, 2002 and 2001 exclude the revenue and expenses
attributed to RMG. The results of operations related to RMG have been separately
reported as discontinued operations.
Three Months ended June 30, 2002 Compared to Three Months ended June 30, 2001
Revenue
Revenue from continuing operations was $2,009,000 and $71,000 during the
three months ended June 30, 2002 and 2001, respectively. The increase in revenue
of approximately $1,938,000, or 2,730%, from 2001 to 2002 was attributed to our
securities broker-dealer operations. Commissions for buying and selling
securities on our customer's behalf amounted to $1,679,000, or 84%, of our
revenue during the three months ended June 30, 2002. This represented a 221%
sequential increase over the $523,000 recognized during the three months ended
March 31, 2002. The higher revenue was primarily attributed to an increase in
the number of active client accounts during the second quarter 2002, and first
quarter brokerage activity did not begin until February 2002. Principal
transaction revenue, including proprietary trading for our own account, amounted
to $106,000, or 5%, of our revenue during the three months ended June 30, 2002.
This represented a 471% sequential increase over the $19,000 recognized during
the three months ended March 31, 2002. Investment banking revenue amounted to
$221,000, or 11%, of our revenue during the three months ended June 30, 2002.
This represented a 760% sequential increase over the $26,000 recognized during
the three months ended March 31, 2002. Investment banking revenue resulted
primarily from advisory service fees in connection with the closing of three
initial fund raising transactions.
Revenue from continuing operations during the three months ended June 30,
2001 consisted mostly of telecommunications bandwidth trading fees. We did not
transact any of these services during 2002. During the three months ended June
30, 2002, one customer accounted for 38% of our revenue from continuing
operations, while no single customer accounted for more than 10% of our revenue
from continuing operations during the three months ended June 30, 2001.
8
Compensation and Benefits
Compensation and benefits expense was $1,479,000 and $2,535,000 during the
three months ended June 30, 2002 and 2001, respectively. The decrease of
approximately $1,056,000, or 42%, from 2001 to 2002 was due to a decrease in
non-cash stock-based compensation of $828,000 and a decrease in headcount from
34 in June 2001 to 26 in June 2002, partially offset by higher commissions and
variable compensation. Compensation and benefits expense increased 23%
sequentially from $1,204,000 during the first quarter 2002 to $1,479,000 during
the second quarter 2002. The increase was due to higher headcount and
commissions and variable compensation.
Brokerage and Clearing Fees
Brokerage and clearing fees were $238,000 and $0 during the three months
ended June 30, 2002 and 2001, respectively. RTX Securities is a fully-disclosed
broker-dealer, which has engaged a third party clearing broker to perform all of
the clearance functions. The clearing broker-dealer processes and settles the
customer transactions for RTX Securities and maintains the detailed customer
records. Additionally, security trades are executed by third-party
broker-dealers and electronic trading systems. We did not incur these expenses
during the three months ended June 30, 2001 since RTX Securities was formed in
December 2001. Brokerage and clearing fees increased 51% sequentially from
$158,000 during the first quarter 2002 to $238,000 during the second quarter
2002. The increase was directly related to the higher securities brokerage
activities.
Professional Services
Professional services expense was $130,000 and $516,000 during the three
months ended June 30, 2002 and 2001, respectively. The decrease of approximately
$386,000, or 75%, from 2001 to 2002 was primarily attributed to outside
consulting services incurred in connection with our bandwidth trading business.
Professional services expense decreased 7% sequentially from $140,000 during the
first quarter 2002 to $130,000 during the second quarter 2002. The higher
professional services expense in the first quarter was due primarily to
consulting costs incurred in establishing the broker-dealer operations.
Occupancy and Equipment
Occupancy and equipment expense was $45,000 and $1,679,000 during the three
months ended June 30, 2002 and 2001, respectively. The decrease of approximately
$1,634,000, or 97%, from 2001 to 2002 was the result of costs related to
transporting telecommunications bandwidth through our own network hubs during
2001. Occupancy and equipment expense incurred in 2001 included $919,000 for
equipment rental, $260,000 for hub disposal costs, $150,000 for equipment
expense, $95,000 for co-location costs, $91,000 for equipment delivery costs and
$90,000 for office rents. Occupancy and equipment expense decreased 44%
sequentially from $80,000 during the first quarter 2002 to $45,000 during the
second quarter 2002. The higher occupancy and equipment expense in the first
quarter was due mostly to equipment cost incurred to support the securities
brokerage activities.
Communications and Technology
Communications and technology expense was $57,000 and $66,000 during the
three months ended June 30, 2002 and 2001, respectively. The decrease of
approximately $9,000, or 14%, from 2001 to 2002 was due to accounting software
licenses fees in 2001 that were not incurred in 2002. Communications and
technology expense increased 82% sequentially from $31,000 during the first
quarter 2002 to $57,000 during the second quarter 2002. The sequential increase
was due to higher telephone and data charges resulting from the securities
brokerage activities.
Depreciation and Amortization
Depreciation and amortization expense was $100,000 and $459,000 during the
three months ended June 30, 2002 and 2001, respectively. The decrease of
approximately $359,000, or 78%, from 2001 to 2002 was due mostly to depreciation
expense recorded in 2001 for certain software assets that were disposed of in
late 2001.
9
Depreciation and amortization expense increased 1% sequentially from $99,000
during the first quarter 2002 to $100,000 during the second quarter 2002. We
purchased $3,000 of equipment during the second quarter 2002. We did not dispose
of any equipment or fixtures during the second quarter 2002.
Other Operating Expenses
Other operating expense was $358,000 and $431,000 during the three months
ended June 30, 2002 and 2001, respectively. The decrease of approximately
$73,000, or 17%, from 2001 to 2002 was primarily attributed to lower travel and
entertainment costs. Other operating expense increased 99% sequentially from
$180,000 during the first quarter 2002 to $358,000 during the second quarter
2002. The sequential increase resulted primarily from the write-down of a
minority equity investment in the amount of $75,000 and higher insurance
expense.
Interest Income
Interest income was $12,000 and $122,000 during the three months ended June
30, 2002 and 2001, respectively. The decrease of approximately $110,000, or 90%,
from 2001 to 2002 was due to a lower average balance of interest earning assets,
which was significantly lower during the three months ended June 30, 2002 as
compared to the similar period in 2001. Interest income decreased 21%
sequentially from $15,000 during the first quarter 2002 to $12,000 during the
second quarter 2002. The sequential decrease was due to a lower average balance
of interest earning assets.
Interest Expense
Interest expense was $364,000 and $12,000 during the three months ended
June 30, 2002 and 2001, respectively. The 2002 amount consisted of $246,000 and
$118,000 for interest expense and amortization of discounts and debt issuance
costs related to the convertible notes payable issued during the fourth quarter
2001, respectively. Interest expense was unchanged from the first quarter 2002.
Other Expense
Other expense was $0 and $200,000 during the three months ended June 30,
2002 and 2001, respectively. The 2001 amount represented the write-down of a
minority equity investment.
Income from Discontinued Operations
Income from discontinued operations was $0 and $29,000 during the three
months ended June 30, 2002 and 2001, respectively. Income from discontinued
operations in 2001 was comprised of revenue, expenses and interest income in the
amount of $300,000, $273,000 and $2,000, respectively. The discontinued
operations were sold in April 2002.
Six Months ended June 30, 2002 Compared to Six Months ended June 30, 2001
Revenue
Revenue from continuing operations was $2,601,000 and $110,000 during the
six months ended June 30, 2002 and 2001, respectively. The increase in revenue
of approximately $2,491,000, or 2,265%, from 2001 to 2002 was attributed to our
securities broker-dealer operations. Commissions for buying and selling
securities on our customer's behalf amounted to $2,201,000, or 85%, of our
revenue during the six months ended June 30, 2002. Principal transaction
revenue, including proprietary trading for our own account, amounted to
$125,000, or 5%, of our revenue during the six months ended June 30, 2002.
Investment banking revenue amounted to $246,000, or 9%, of our revenue during
the six months ended June 30, 2002. Investment banking revenue resulted
primarily from advisory service fees in connection with the closing of three
initial transactions.
Revenue from continuing operations during the six months ended June 30,
2001 consisted mostly of telecommunications bandwidth trading fees. We did not
transact any of these services during 2002. During the six months ended June 30,
2002, one customer accounted for 37% of our revenue from continuing operations,
while no single customer accounted for more than 10% of our revenue from
continuing operations during the six months ended June 30, 2001.
10
Compensation and Benefits
Compensation and benefits expense was $2,683,000 and $5,399,000 during the
six months ended June 30, 2002 and 2001, respectively. The decrease of
approximately $2,716,000, or 50%, from 2001 to 2002 was due to a decrease in
non-cash stock-based compensation of $2,089,000 and a decrease in headcount from
34 in June 2001 to 26 in June 2002, partially offset by higher commissions and
variable compensation.
Brokerage and Clearing Fees
Brokerage and clearing fees were $396,000 and $0 during the six months
ended June 30, 2002 and 2001, respectively. RTX Securities is a fully-disclosed
broker-dealer, which has engaged a third party clearing broker to perform all of
the clearance functions. The clearing broker-dealer processes and settles the
customer transactions for RTX Securities and maintains the detailed customer
records. Additionally, security trades are executed by third-party
broker-dealers and electronic trading systems. We did not incur these expenses
during the six months ended June 30, 2001 since RTX Securities was formed in
December 2001.
Professional Services
Professional services expense was $270,000 and $750,000 during the six
months ended June 30, 2002 and 2001, respectively. The decrease of approximately
$480,000, or 64%, from 2001 to 2002 was primarily attributed to outside
consulting services incurred in connection with our bandwidth trading business
and lower legal fees. Legal costs during 2001 resulted in part from the
preparation of our registration statement in connection with an uncompleted
secondary equity offering.
Occupancy and Equipment
Occupancy and equipment expense was $125,000 and $3,784,000 during the six
months ended June 30, 2002 and 2001, respectively. The decrease of approximately
$3,659,000, or 97%, from 2001 to 2002 was the result of costs related to the
transporting telecommunications bandwidth through our own network hubs during
2001. Occupancy and equipment expense incurred in 2001 included $1,378,000 for
equipment rental, $1,168,000 for co-location costs, $443,000 for equipment
expense, $260,000 for hub disposal costs, $190,000 for development of our
electronic trading system, $91,000 for equipment delivery costs and $90,000 for
office rents. Occupancy and equipment expense incurred in 2002 consisted
primarily of office rents.
Communications and Technology
Communications and technology expense was $88,000 and $184,000 during the
six months ended June 30, 2002 and 2001, respectively. The decrease of
approximately $96,000, or 52%, from 2001 to 2002 was due to accounting software
licenses fees in 2001 that were not incurred in 2002.
Depreciation and Amortization
Depreciation and amortization expense was $199,000 and $855,000 during the
six months ended June 30, 2002 and 2001, respectively. The decrease of
approximately $656,000, or 77%, from 2001 to 2002 was due mostly to depreciation
expense recorded in 2001 for certain software assets that were disposed of in
late 2001.
Other Operating Expenses
Other operating expense was $538,000 and $2,300,000 during the six months
ended June 30, 2002 and 2001, respectively. The decrease of approximately
$1,762,000, or 77% from 2001 to 2002 was primarily attributed to lower outside
services, travel and entertainment costs, marketing expenses and property taxes.
Interest Income
Interest income was $28,000 and $272,000 during the six months ended June
30, 2002 and 2001, respectively. The decrease of approximately $244,000, or 90%,
from 2001 to 2002 was due to a lower average
11
balance of interest earning assets, which was significantly lower during the
three months ended June 30, 2002 as compared to the similar period in 2001.
Interest Expense
Interest expense was $728,000 and $12,000 during the six months ended June
30, 2002 and 2001, respectively. The 2002 amount consisted of $492,000 and
$236,000 for interest expense and amortization of discounts and debt issuance
costs related to the convertible notes payable issued during the fourth quarter
2001, respectively.
Other Expense
Other expense was $0 and $744,000 during the six months ended June 30, 2002
and 2001, respectively. The 2001 amount represented the write-down of a minority
equity investment.
Income from Discontinued Operations
Income from discontinued operations was $33,000 and $329,000 during the six
months ended June 30, 2002 and 2001, respectively. Income from discontinued
operations in 2002 was comprised of revenue and expenses in the amount of
$730,000 and $697,000, respectively. Income from discontinued operations in 2001
was comprised of revenue, expenses and interest income in the amount of
$600,000, $273,000 and $2,000, respectively. The discontinued operations were
sold in April 2002.
Liquidity and Capital Resources
As of June 30, 2002, our principal source of liquidity was our cash and
cash equivalents and marketable securities, amounting to $3,101,000 and
$232,000, respectively.
Cash used in our operating activities during the six months ended June 30,
2002 and 2001 was $1,311,000 and $9,433,000, respectively. Cash used in our
operations in 2002 was primarily attributable to a net loss adjusted for
non-cash charges related to stock-based compensation, amortization of discounts
on convertible notes payable, amortization of debt issuance costs, depreciation
and amortization, loss on securities and changes in operating assets and
liabilities.
Cash provided by our investing activities during the six months ended June
30, 2002 was $76,000, while cash provided by our investing activities during the
six months ended June 30, 2001 was $11,506,000. Investment activities include
the purchase of short-term investments of $1,926,000 in 2002, purchase of
equipment and fixtures of $3,000 and $589,000 in 2002 and 2001, respectively,
proceeds from the sale of short-term investments of $1,705,000 and $12,095,000
in 2002 and 2001, respectively, and proceeds from the sale of discontinued
operations of $300,000 in 2002.
Cash used in our financing activities during the six months ended June 30,
2002 and 2001 was $23,000 and $0, respectively. Financing activities consist of
additional debt issuance costs paid in 2002 related to our issuance of
convertible notes payable during the fourth quarter of 2001.
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 limited 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.
Risk Factors
Investing in our securities involves a high degree of risk. In addition to
the other information contained in this quarterly report, including reports we
incorporate by reference, you should consider the following factors before
investing in our securities.
12
It is difficult to evaluate our business and prospects because we have a limited
operating history in a new and rapidly changing industry.
In December 2001 we acquired a securities broker-dealer firm and created a
wholly-owned subsidiary, RTX Securities Corporation, that began actively
engaging in providing securities brokerage and investment banking services in
January 2002. 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. We cannot assure you 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 our
securities brokerage 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 supporting our
securities brokerage and investment banking business;
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 the cash flow and profits necessary to sustain our business
expectations, 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. In
addition, the emerging commodities part of our business is in an industry that
is new and rapidly changing. For these and other reasons, we cannot assure you
that we will not require higher gross revenues, and an increased number of
clients, securities brokerage and investment banking transactions, emerging
commodity transactions and/or more time in order for us to complete the
development of our business that we believe we need to be able to cover our
operating expenses, or obtain the funds necessary to finance this development.
It is more likely than not that our estimates will prove to be inaccurate
because actual events more often than not differ from anticipated events.
Furthermore, in the event that financing is needed in addition to the amount
that is required for this development, we cannot assure you that such financing
will be available on acceptable terms, if at all. Accordingly, we can neither
assure nor represent to you that our business will ever generate a positive cash
flow or be profitable.
We have a history of operating losses and negative cash flow and we anticipate
losses and negative cash flow to continue 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 since our inception and financed our operations
primarily through sales of equity and debt securities. We incurred net losses of
$30,072,000, $44,729,000 and $9,299,000 for the years ended December 31, 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. We
have incurred net losses and negative cash flows from operations of $2,365,000
and $1,311,000 for the six months ended March 31, 2002. At June 30, 2002, our
accumulated deficit since inception was $90,232,000. We expect operating losses
and negative cash flow to continue for the foreseeable future. We may never
achieve a positive cash flow and
13
profitability and even if we do, we may not sustain or increase them on a
quarterly or annual basis in the future. If we are unable to achieve and sustain
a positive cash flow and profitability, we may be unable to continue our
operations.
The markets for securities brokerage and investment banking services are highly
competitive. If we are not able to compete successfully against current and
future competitors, our business and results of operations will be adversely
affected.
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 customers for our securities brokerage and
investment banking services and participants for the RateXchange Trading System.
Increased pressure created by any current or future competitors, or by our
competitors collectively, could materially and adversely affect our business and
results of operations. Increased competition may result in reduced revenue 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 materially and adversely
affect our business and results of operations. We cannot assure you that we will
be able to compete successfully against current and future competitors. In
addition, new technologies and the expansion of existing technologies may
increase the competitive pressures on us.
We have registered one of our subsidiaries as a securities broker-dealer and, as
such, are subject to substantial regulations. If we fail to comply with these
regulations, our business will be adversely affected.
Because we have registered RTX Securities Corporation, our wholly owned
subsidiary, with the Securities and Exchange Commission and the National
Association of Securities Dealers, Inc., or NASD, as a securities broker-dealer,
we 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 Securities and Exchange
Commission 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 Securities
and Exchange Commission approval, 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 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
Securities and Exchange Commission 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 may be materially and adversely
affected.
Our business may suffer if we lose the services of our executive officers, or if
we cannot recruit and retain additional skilled personnel.
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. The agreement
contains provisions that obligate us to make certain payments to Mr. Merriman
and substantially reduce vesting periods of options granted to him if we should
terminate him without cause or certain events resulting in a change of control
of our board were to occur. Pursuant to an amendment to the agreement, which
became effective as of September 28, 2001, Mr. Merriman reduced his annual
salary from $300,000 to $1.00. Upon the consummation of the sale of the assets
of our futures trading subsidiary and the consummation of our recent private
financing, Mr. Merriman's annual salary has increased to $150,000.
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
14
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. Our business could be harmed if any key
officer or employee were unable or unwilling to continue in his or her current
position. From time to time we have experienced, and we expect to continue to
experience, difficulty in hiring and retaining highly skilled employees.
Competition for employees in our industry is intense. 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 have a number of revenue producers employed by our securities brokerage
and investment banking subsidiary. We do not have employment contracts with
these employees. The loss of one or more of these employees could adversely
affect 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 and, accordingly,
adversely affect our business.
We plan to expand our operations. Our growth, if it occurs, will impose
significant demands on our management, financial, technical and other resources.
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 in
order to manage our future growth. Furthermore, we may acquire technologies or
products or enter into strategic alliances, in order to achieve rapid growth.
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. We may be required
to maintain and expand our relationships with various software vendors, Internet
and other online service providers and other third parties necessary to our
business in order for us to succeed. We may be unable to implement our business
plan if we fail to manage any of the above growth challenges successfully. Our
financial results may suffer and we could be materially and adversely affected
if that occurs.
We may not be able to protect and enforce our intellectual property rights
relating to our RateXchange Trading System, which could result in the loss of
these rights, loss of business or increased costs.
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. 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 materially adversely affect 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 RateXchange Trading System business is dependent on the development and
maintenance of the Internet infrastructure.
15
Our RateXchange Trading System 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 for our broker-dealer and emerging commodities
businesses. Our business, results of operations and financial condition could be
materially and adversely affected if any of these events occur.
Our business and operations would suffer in the event of system failures.
Our success, in particular our ability to successfully facilitate
securities brokerage transactions 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. Any
of the foregoing problems could materially adversely affect our business or
future results of operations.
We may incur liability for information retrieved from or transmitted over the
Internet because our business involves the transmission of information.
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 general liability insurance with $1 million coverage per occurrence
and $2 million in the aggregate, an umbrella policy with $5 million of coverage
and 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. Our business, results of
operations and financial condition could be materially and adversely affected if
any of these events occur.
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.
Your ability to sell your shares may be restricted because there is a limited
trading market for our common stock.
Although our common stock is currently traded on the American Stock
Exchange, a trading market in our stock has been sporadic. Accordingly, you may
not be able to sell your shares when you want or at the price you want.
Our common stock price may be volatile, which could adversely affect the value
of your shares.
16
The market price of our common stock has in the past been, and may in the
future continue to be, volatile. A variety of events may cause the market price
of our common stock to fluctuate significantly, including:
o variations in quarterly operating results;
o our announcements of significant contracts, milestones, acquisitions;
o our relationships with other companies;
o our ability to obtain needed capital commitments;
o additions or departures of key personnel;
o sales of common stock or termination of stock transfer restrictions;
o general economic conditions, including conditions in the securities
brokerage and investment banking and telecommunications markets;
o changes in financial estimates by securities analysts; and
o fluctuations in stock market price and volume.
The last four factors are beyond our control. Any one of the factors noted
herein could have an adverse effect on the value of our common stock.
In addition, the stock market in recent years has experienced significant
price and volume fluctuations that have particularly affected the market prices
of equity securities of many companies and that often have been unrelated to the
operating performance of such companies. These market fluctuations have
adversely impacted the price of our common stock and may do so in the future.
In the past, following periods of volatility in the market price of a
company's securities, securities class action litigation often has been
instituted against that company. Such litigation is expensive and diverts
management's attention and resources. We cannot assure you that we will not be
subject to such litigation.
Your ability to sell your shares could be significantly adversely affected
because our common stock could be delisted from trading on the American Stock
Exchange.
Although our common stock is listed for trading on the American Stock
Exchange, it could be delisted because we may be unable to satisfy certain
American Stock Exchange listing guidelines including earnings per share, market
price and stockholders' equity criteria. We cannot assure you that we will be
able to satisfy these guidelines on a continuing basis. Accordingly, although we
have received no communication from the American Stock Exchange with respect to
this matter, we cannot represent to you that our common stock will continue to
be listed. If the listing is not retained and our common stock is thereafter
quoted only on the OTC Electronic Bulletin Board, a significantly less liquid
market than the American Stock Exchange, a stockholder may find it even more
difficult to dispose of, or to obtain accurate quotations as to the price of,
the common stock. In addition, depending on several factors including, among
others, the future market price of our common stock, these securities could
become subject to the so-called "penny stock" rules that impose additional sales
practice and market making requirements on broker-dealers who sell and/or make a
market in such securities. These factors could affect the ability or willingness
of broker-dealers to sell and/or make a market in our common stock and the
ability of purchasers of our common stock to sell their shares in the secondary
market. A delisting could also negatively affect our ability to raise additional
capital in the future.
Anti-takeover provisions of the Delaware General Corporation Law could
discourage a merger or other type of corporate reorganization or a change in
control even if it could be favorable to the interests of our stockholders.
The Delaware General Corporation Law contains provisions that may enable
our management to retain control and resist our takeover. These provisions
generally prevent us from engaging in a broad range of business combinations
with an owner of 15% or more of our outstanding voting stock for a period of
three years from the date that such person acquires his or her stock.
Accordingly, these provisions could discourage or make more difficult a change
in control or a merger or other type of corporate reorganization even if it
could be favorable to the interests of our stockholders.
Because our board can issue common stock without stockholder approval, you could
experience substantial dilution.
17
Our board of directors has the authority to issue up to 300,000,000 shares
of common stock and to issue options and warrants to purchase shares of our
common stock without stockholder approval. Future issuance of our additional
shares of common stock could be at values substantially below the price at which
you may purchase our stock and, therefore, could represent further substantial
dilution to investors in this offering. In addition, our board could issue large
blocks of our common stock to fend off unwanted tender offers or hostile
takeovers without further stockholder approval.
Our ability to issue preferred stock may adversely affect your rights as a
common stockholder and be used as an anti take-over device.
Our Articles of Incorporation authorize our board of directors to issue up
to 60,000,000 shares of preferred stock without approval from our stockholders.
If you purchase our common stock, this means that the board of directors has the
right, without your approval as a common stockholder, to fix the relative rights
and preferences of the preferred stock. This would affect your rights as a
common stockholder regarding, among other things, dividends and liquidation. We
could also use the preferred stock to deter or delay a change in control of our
company that may be opposed by our management even if the transaction might be
favorable to you as a common stockholder.
Our officers and directors exercise significant control over our affairs, which
could result in their taking actions of which other stockholders do not approve.
Our executive officers and directors, current and past, and entities
affiliated with them, currently control approximately 25% of our outstanding
common stock prior to any conversion of any outstanding notes and/or exercise of
options and warrants. These stockholders, if they act together, will be able to
exercise substantial influence over all matters requiring approval by our
stockholders, including the election of directors and approval of significant
corporate transactions. This concentration of ownership may also have the effect
of delaying or preventing a change in control of us and might affect the market
price of our common stock.
Any exercise of outstanding options and warrants will dilute then-existing
stockholders' percentage of ownership of our common stock.
We have a significant number of outstanding options and warrants. Shares
issuable upon the exercise of these options and warrants, at prices ranging
currently from approximately $0.25 to $14.40 per share, represent approximately
71% of our total outstanding stock on a fully diluted basis. The exercise of all
of the outstanding options and warrants would dilute the then-existing
stockholders' percentage ownership of our common stock. Any sales resulting from
the exercise of options and warrants in the public market, such as sales by the
selling stockholders pursuant to this prospectus, could adversely affect
prevailing market prices for our common stock. Moreover, our ability to obtain
additional equity capital could be adversely affected since the holders of
outstanding options and warrants may exercise them at a time when we would also
wish to enter the market to obtain capital on terms more favorable than those
provided by such options and warrants. We lack control over the timing of any
exercise or the number of shares issued or sold if exercises occur.
Members of our Advisory Board may have conflicting interests and may disclose
data and technical knowledge to our competitors.
Some of our Advisory Board members are employed by other entities, which
may include our competitors. Although we require each of our Advisory Board
members to sign a non-disclosure and non-competition agreement with respect to
the data and information that he or she receives from us, we cannot assure you
that members will abide by them. If a member were to reveal this information to
outside sources, accidentally or otherwise, our operations could be negatively
affected. Since our business depends in large part on our ability to keep our
know-how confidential, any revelation of this information to a competitor or
other source could have an adverse effect on our operations.
18
Forward-Looking Statements
Some of the statements contained, or incorporated by reference, in this
quarterly report discuss future expectations, contain projections of results of
operations or financial condition or state other "forward-looking" information.
Those statements are subject to known and unknown risks, uncertainties and other
factors that could cause the actual results to differ materially from those
contemplated by the statements. The "forward-looking" information is based on
various factors and was derived using numerous assumptions. In some cases, you
can identify these so-called "forward-looking statements" by words like "may,"
"will," "should," "expects," "plans," "anticipates," "believes," "estimates,"
"predicts," "potential" or "continue" or the negative of those words and other
comparable words. You should be aware that those statements only reflect our
predictions. Actual events or results may differ substantially. Important
factors that could cause our actual results to be materially different from the
forward-looking statements are disclosed throughout this report, particularly
under the heading "Risk Factors".
19
Item 3. 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 equity prices, interest rates and foreign currency
exchange rates. We do not use derivative financial instruments for speculative
or trading purposes.
Equity Price Risk
The potential for changes in the market value of our trading positions is
referred to as "market risk." Our trading positions result from proprietary
trading activities. Equity price risks result from exposures to changes in
prices and volatilities of individual equities and equity indices. We seek to
manage this risk exposure through diversification and limiting the size of
individual positions within the portfolio. We do not establish hedges in related
securities or derivatives.
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 rate. 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.
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PART II. OTHER INFORMATION
Item 1. 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 a Washington State court. That matter was dismissed following a
settlement in May of 1999. Mr. Martin revived his claim against Ratexchange. The
revived Federal court complaint was settled in July 2002. Ratexchange will pay
Mr. Martin $65,000 in exchange for a release of all claims. We have recorded the
estimated loss exposure in the consolidated balance sheet as of June 30, 2002.
Additionally, from time to time, we are involved in ordinary routine
litigation incidental to our business.
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibits
None
(b) Reports on Form 8-K
None
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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
July 30, 2002 By: /s/ D. JONATHAN MERRIMAN
----------------------------
D. Jonathan Merriman,
Chairman of the Board and Chief Executive Officer
(Duly Authorized Officer)
July 30, 2002 By: /s/ GREGORY S. CURHAN
-------------------------
Gregory S. Curhan
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)
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