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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNESEPTEMBER 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 0-22967
NETWORK SOLUTIONS, INC.
(Exact name of Registrant as specified in its charter)(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 52-1146119
(State or other jurisdiction(STATE OR OTHER JURISDICTION (I.R.S. Employer
of incorporation or organization) Identification No.EMPLOYER
OF INCORPORATION OR IDENTIFICATION NO.)
ORGANIZATION)
505 HUNTMAR PARK DRIVE
HERNDON, VIRGINIA 20170
(703)742-0400
(Address, including zip code, and telephone number,
including area code, of Registrant's principal executive offices)(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
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[X] No --- ---[ ]
As of August 7,November 6, 1998, the Registrant had 4,122,9384,168,202 shares of Class A
common stock, $0.001 par value per share, issued and outstanding, and 11,925,000
shares of Class B common stock, $0.001 par value per share, issued and
outstanding.
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PAGE
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PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Statements of Financial Position as of December
31, 1997 and JuneSeptember 30, 1998 (unaudited)................................................ 3
Unaudited Condensed Statements of Operations for the three
and sixnine months ended JuneSeptember 30, 1997 and 1998.......................1998......... 4
Unaudited Condensed Statements of Changes in Stockholders'
Equity for the sixnine months ended JuneSeptember 30, 1998........................1998....... 5
Unaudited Condensed Statements of Cash Flows for the sixnine
months ended JuneSeptember 30, 1997 and 1998....................................1998.................. 6
Notes to Condensed Financial Statements...............................Statements..................... 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of
Operations.................................Operations................................................ 9
Item 3. Quantitative and Qualitative Disclosures About Market
Risk...................................................... 1827
PART II OTHER INFORMATION
Item 1. Legal Proceedings........................................... 1828
Item 2. Changes in Securities and Use of Proceeds................... 20
Item 4. Submission of Matters to a Vote of Security Holders......... 2029
Item 6. Exhibits and Reports on Form 8-K............................ 21
Signature............................................................ 2230
Signature ............................................................ 31
Index to Exhibits.................................................... 23Exhibits..................................................... 32
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PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
NETWORK SOLUTIONS, INC.
CONDENSED STATEMENTS OF FINANCIAL POSITION
DECEMBER 31, JUNESEPTEMBER 30,
1997 1998
------------ -------------------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents................................. $ 41,146,000 $ 17,928,0009,124,000
Short-term investments, marketable securities............. 40,200,000 79,516,000107,876,000
Accounts receivable, net.................................. 5,792,000 11,226,00013,922,000
Prepaids and other assets................................. 1,005,000 2,365,0001,512,000
Deferred tax asset........................................ 20,153,000 26,219,00030,941,000
Restricted assets......................................... 25,873,000 39,764,000627,000
------------ ------------
Total current assets........................................ 134,169,000 177,018,000164,002,000
Furniture and equipment, net................................ 6,146,000 8,872,0009,579,000
Long-term investments, marketable securities................ -- 6,374,0006,272,000
Deferred tax asset.......................................... 8,128,000 9,416,00011,292,000
Goodwill, net............................................... 1,177,000 905,000770,000
------------ ------------
Total Assets................................................ $149,620,000 $202,585,000$191,915,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities.................. $ 6,426,000 $ 11,198,00015,565,000
Due to parent............................................. 1,250,000 2,358,0002,587,000
Income taxes payable...................................... 5,042,000 529,0003,090,000
Current portion of capital lease obligations.............. 842,000 868,000861,000
Deferred revenue, net..................................... 43,789,000 64,977,00077,766,000
Internet fund liability................................... 25,873,000 39,764,000627,000
------------ ------------
Total current liabilities................................... 83,222,000 119,694,000100,496,000
Capital lease obligations................................... 1,081,000 643,000436,000
Long-term deferred revenue, net............................. 17,662,000 23,974,00028,964,000
------------ ------------
Total liabilities........................................... 101,965,000 144,311,000129,896,000
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.001 par value, authorized 10,000,000
shares; none issued and outstanding in 1997 and 19981998... -- --
Class A common stock, $.001 par value; authorized
100,000,000 shares;
3,795,000 and 4,083,2634,139,838 issued and outstanding in 1997
and 1998...........................1998............................................... 4,000 4,000
Class B common stock, $.001 par value; authorized
30,000,000 shares;
11,925,000 issued and outstanding in 1997 and 1998..........................................1998..... 12,000 12,000
Additional paid-in capital................................ 56,451,000 62,336,00063,147,000
Accumulated deficit....................................... (8,812,000) (4,300,000)(1,295,000)
Accumulated other comprehensive income.................... -- 222,000151,000
------------ ------------
Total stockholders' equity.................................. 47,655,000 58,274,00062,019,000
------------ ------------
Total Liabilities and Stockholders' Equity.................. $149,620,000 $202,585,000$191,915,000
============ ============
The accompanying notes are an integral part of these financial statements.
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NETWORK SOLUTIONS, INC.
CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED SIXNINE MONTHS ENDED
JUNESEPTEMBER 30, JUNESEPTEMBER 30,
------------------------- -------------------------
1997 1998 1997 1998
----------- ----------- ----------- -----------
Net revenue............................... $10,069,000 $20,476,000 $18,724,000 $36,968,000$12,172,000 $25,427,000 $30,896,000 $62,395,000
Cost of revenue........................... 6,141,000 8,791,000 11,435,000 16,139,0007,033,000 10,312,000 18,468,000 26,451,000
----------- ----------- ----------- -----------
Gross profit.............................. 3,928,000 11,685,000 7,289,000 20,829,0005,139,000 15,115,000 12,428,000 35,944,000
Research and development expenses......... 407,000 815,000 718,000 1,540,000377,000 1,353,000 1,095,000 2,893,000
Selling, general and administrative
expenses................................ 2,487,000 8,008,000 4,788,000 14,190,0003,105,000 10,248,000 7,893,000 24,438,000
Interest income........................... (335,000) (1,416,000) (484,000) (2,743,000)(570,000) (1,680,000) (1,054,000) (4,423,000)
Other expenses............................ -- 32,00026,000 -- 67,00093,000
----------- ----------- ----------- -----------
Income before income taxes................ 1,369,000 4,246,000 2,267,000 7,775,0002,227,000 5,168,000 4,494,000 12,943,000
Provision for income taxes................ 629,000 1,783,000 1,011,000 3,263,000995,000 2,163,000 2,006,000 5,426,000
----------- ----------- ----------- -----------
Net income................................ $ 740,0001,232,000 $ 2,463,0003,005,000 $ 1,256,0002,488,000 $ 4,512,0007,517,000
=========== =========== =========== ===========
Earnings per common share:
Basic................................... $ 0.06 $ 0.15 $ 0.10 $ 0.290.19 $ 0.20 $ 0.47
=========== =========== =========== ===========
Diluted................................. $ 0.06 $ 0.15 $ 0.10 $ 0.270.18 $ 0.20 $ 0.45
=========== =========== =========== ===========
The accompanying notes are an integral part of these financial statements.
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NETWORK SOLUTIONS, INC.
CONDENSED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(UNAUDITED)
CLASS A CLASS B ACCUMULATED
COMMON STOCK COMMON STOCK ADDITIONAL COMPRE-OTHER RETAINED TOTAL
------------------ -------------------- PAID-IN HENSIVECOMPREHENSIVE EARNINGS STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT CAPITAL INCOME (DEFICIT) EQUITY
--------- ------ ---------- ------- ----------- --------------------- ----------- -------------
Balance, December 31,
1997..................1997.................... 3,795,000 $4,000 11,925,000 $12,000 $56,451,000 $ -- $(8,812,000) $47,655,000
Issuance of common stock
pursuant to stock
plans................. 288,263 3,767,000 3,767,000plans................... 344,838 4,456,000 4,456,000
Tax benefit associated
with
stock plans...... 2,118,000 2,118,000plans............. 2,240,000 2,240,000
Unrealized gain on
securities............ 222,000 222,000securities.............. $151,000 151,000
Net income for the sixnine
months ended JuneSeptember
30, 1998.................. 4,512,000 4,512,0001998................ 7,517,000 7,517,000
--------- ------ ---------- ------- ----------- -------- ----------- -----------
Balance, JuneSeptember 30,
1998.................. 4,083,2631998.................... 4,139,838 $4,000 11,925,000 $12,000 $62,336,000 $222,000 $(4,300,000) $58,274,000$63,147,000 $151,000 $(1,295,000) $62,019,000
========= ====== ========== ======= =========== ======== =========== ===========
The accompanying notes are an integral part of these financial statements.
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NETWORK SOLUTIONS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
SIXNINE MONTHS ENDED
JUNESEPTEMBER 30,
-----------------------------------------------------
1997 1998
----------------------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................ $ 1,256,0002,488,000 $ 4,512,0007,517,000
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization.......................... 1,017,000 1,459,0001,635,000 2,613,000
Provision for uncollectible accounts receivable........ 3,624,0005,577,000 2,168,000
Deferred income taxes.................................. (2,415,000) (7,499,000)(9,649,000) (14,061,000)
Tax benefit associated with stock plans................ -- 2,240,000
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable........... 2,576,000 (7,602,000)348,000 (10,298,000)
Increase in prepaids and other assets................ (425,000) (1,045,000)(896,000) (507,000)
Increase in accounts payable and accrued
liabilities......................................... 1,378,000 4,908,000liabilities....................................... 1,811,000 9,139,000
Decrease in income taxes payable..................... -- (4,513,000)(1,952,000)
Increase in deferred revenue......................... 16,276,000 27,500,000
-----------25,156,000 45,279,000
------------ ------------
Net cash provided by operating activities......... 23,287,000 19,888,000
-----------activities............ 26,470,000 42,138,000
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of furniture and equipment....................... (317,000) (4,364,000)(1,254,000) (5,639,000)
Purchase of short-term investments, net................... (3,625,000) (39,316,000)(28,321,000) (67,676,000)
Purchase of long-term investments......................... -- (6,007,000)
-----------(6,012,000)
------------ ------------
Net cash used in investing activities............. (3,942,000) (49,687,000)
-----------activities................ (29,575,000) (79,327,000)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net transactions with SAIC................................ (8,729,000) 1,108,0006,627,000 1,337,000
Repayment of capital lease obligations.................... (189,000) (412,000)-- (626,000)
Issuance of common stock pursuant to stock plans.......... -- 3,767,000
Tax benefit associated with stock plans................... -- 2,118,000
-----------4,456,000
------------ ------------
Net cash provided by (used in) financing activities..................................... (8,918,000) 6,581,000
-----------activities............ 6,627,000 5,167,000
------------ ------------
Net increase (decrease) in cash and cash equivalents........ 10,427,000 (23,218,000)3,522,000 (32,022,000)
Cash and cash equivalents, beginning of period.............. 15,540,000 41,146,000
----------------------- ------------
Cash and cash equivalents, end of period.................... $25,967,000 $ 17,928,000
===========19,062,000 $ 9,124,000
============ ============
The accompanying notes are an integral part of these financial statements.
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NETWORK SOLUTIONS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
NOTE 1 -- ORGANIZATION AND BUSINESS
Since 1993, Network Solutions, Inc. ("the Company") currently actshas acted as the
exclusive registrar and registry of Internet domain names within the .com, .org,
.net and .edu top level domains ("TLDs") pursuant tounder a cooperative agreement (the(as
amended, the "Cooperative Agreement") with the National Science Foundation
("NSF") and, currently, the Department of Commerce's National Telecommunications
and Information Administration ("NTIA"). Domain names are used to identify a
unique site or presence on the Internet. As registrar ofand registry for these
TLDs, the Company registers new domain names and is responsible for the
maintenance and dissemination of the master file of domain names includingthrough daily
updates to the Internet. The Company also provides enterprise network consulting
services to large companies, focusing on network engineering, network and
systems security and network management solutions for commercial customers.management.
NOTE 2 -- SIGNIFICANT ACCOUNTING POLICIES
INTERIM FINANCIAL STATEMENTS
The interim financial statements have been prepared by the Company, without
audit, pursuant to the rules and regulations of the Securities and Exchange
Commission.Commission ("SEC"). In the opinion of management, financial statements included
in this report reflect all normal recurring adjustments which the Company
considers necessary for fair presentation of the results of operations for the
interim periods covered and of the financial position of the Company at the date
of the interim balance sheet. Certain information and footnote disclosures
normally included in the annual financial statements prepared in accordance with
generally accepted accounting principles have been condensed or omitted pursuant
to such rules and regulations. However, the Company believes that the
disclosures are adequate for understanding the information presented. The
operating results for interim periods are not necessarily indicative of the
operating results for the entire year. These interim financial statements should
be read in conjunction with the Company's December 31, 1997 audited financial
statements and notes thereto included in the Company's Form 10-K annual report
for the year ended December 31, 1997. Prior periods have been restated for
comparative purposes.
NOTE 3 -- COMPUTATION OF EARNINGS PER SHARE
The following is a reconciliation of the numerator and denominator used in
the basic and diluted EPS computations for continuing operations:earnings per share computations:
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
Three Months Ended JuneTHREE MONTHS ENDED SEPTEMBER 30, 1998
- --------------------------------------------------
Basic............................................. $2,463,000 15,895,000 $0.15Basic.................................. $3,005,000 16,041,000 $0.19
=====
Dilutive securities:
Outstanding options.............................options.................. -- 848,000705,000
---------- ----------
Diluted........................................... $2,463,000 16,743,000 $0.15Diluted................................ $3,005,000 16,746,000 $0.18
========== ========== =====
Three Months Ended JuneTHREE MONTHS ENDED SEPTEMBER 30, 1997
- --------------------------------------------------
Basic............................................. $ 740,000 12,500,000 $0.06Basic.................................. $1,232,000 12,502,000 $0.10
=====
Dilutive securities:
Outstanding options.............................options.................. -- 91,000118,000
---------- ----------
Diluted........................................... $ 740,000 12,591,000 $0.06Diluted................................ $1,232,000 12,620,000 $0.10
========== ========== =====
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NOTE 3 -- COMPUTATION OF EARNINGS PER SHARE -- (CONTINUED)
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
Six Months Ended JuneNINE MONTHS ENDED SEPTEMBER 30, 1998
- --------------------------------------------------
Basic............................................. $4,512,000 15,811,000 $0.29Basic.................................. $7,517,000 15,888,000 $0.47
=====
Dilutive securities:
Outstanding options.............................options.................. -- 632,000656,000
---------- ----------
Diluted........................................... $4,512,000 16,443,000 $0.27Diluted................................ $7,517,000 16,544,000 $0.45
========== ========== =====
Six Months Ended JuneNINE MONTHS ENDED SEPTEMBER 30, 1997
- --------------------------------------------------
Basic............................................. $1,256,000 12,500,000 $0.10Basic.................................. $2,488,000 12,501,000 $0.20
=====
Dilutive securities:
Outstanding options.............................options.................. -- 91,00099,000
---------- ----------
Diluted........................................... $1,256,000 12,591,000 $0.10Diluted................................ $2,488,000 12,600,000 $0.20
========== ========== =====
Common shares issued are weighted for the period the shares were
outstanding and incremental shares assumed issued under the treasury stock
method for diluted EPSearnings per share are weighted for the period the underlying
options were outstanding.
NOTE 4 -- ACCUMULATED OTHER COMPREHENSIVE INCOME BALANCES
Effective January 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income," which established standards for reporting and displaying
comprehensive income and its components in a financial statement that is
displayed with the same prominence as other financial statements. The changes in
the components of accumulated other comprehensive income are reported net of
income taxes for the sixnine months ended JuneSeptember 30, 1998 as follows:
ACCUMULATED
OTHER
UNREALIZED GAINS COMPREHENSIVE
ON SECURITIES INCOME
---------------- -------------
Pre-tax amount........................................... $367,000 $367,000amount.......................... $260,000 $260,000
Income tax............................................... 145,000 145,000tax.............................. 109,000 109,000
-------- --------
Net of tax amount........................................ $222,000 $222,000amount....................... $151,000 $151,000
======== ========
NOTE 5 -- RESTRICTED ASSETS
Under the terms of the September 14, 1995 amendment to the Cooperative
Agreement, 30% of the registration fees collected by the Company is required to
be set aside for the enhancement of the intellectual infrastructure of the
Internet ("set aside funds") and, as such, is not recognized as revenue by the
Company. The Company has reflected these set aside funds, along with the
appropriate percentage of net accounts receivable as restricted assets, and has
recorded an equivalent, related current liability. The Company maintains the
cash received relating to the set aside funds in a separate interest bearing
account. The set aside funds, plus any interest earned, are intended to be
disbursed at the direction of the NSF. In September 1998, the Company disbursed
$39.2 million out of this fund to the NSF at its direction, bringing cumulative
disbursements since September 14, 1995 to $62.2 million.
On March 12, 1998, the NSF and the Company amended the Cooperative
Agreement to eliminate the 30% set aside requirement effective April 1, 1998.
Future disbursement of these set aside funds will have no significant effect on
the Company's business, financial condition or results of operations. For
purposes of the Company's statements of cash flows, amounts relating to these
restricted assets and the Internet fund liability have been excluded in their
entirety.
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NOTE 6 -- COMMITMENTS AND CONTINGENCIES
INTERNET GOVERNANCE
OnWithin the U.S. Government, leadership for the continued privatization of
Internet administration is currently provided by the NTIA. After a series of
draft proposals and public comment periods, on June 5,10, 1998, the U.S. governmentNTIA published
in the Federal Register a statementplan referred to as the Statement of policy entitled "ManagementPolicy or "White
Paper," calling for the formation of Internet Names and Addresses,"
informally calleda not-for-profit corporation to assume
responsibility for administration of the "White Paper" (the "Statementdomain name system ("DNS"), but which
is not expected to perform actual registration of Policy").domain names either as a
registrar or registry. The Statement of Policy invites private sector Internet
stakeholders to work together to form a new private, not-for-profit corporation
to oversee policy for the Internet name and address system. FollowingThe Statement of
Policy calls for a separation of the publicationregistry and registrar functions of the
DNS, both of which functions are currently performed exclusively by the Company
in the .com, .org, .net and .edu TLDs.
As part of the process initiated by the Statement of Policy, several
proposals were put forward to the International Forum forNTIA on the White Paper (the "IFWP"), an ad hoc coalition of
Internet stakeholders, was initiated to coordinate international meetings for
stakeholders to discuss the transitionestablishment and governance of
the domain name systemnot-for-profit corporation. A newly-formed U.S. based private not-for-profit
corporation denoted the Internet Corporation for Assigned Names and Numbers
("DNS"ICANN") administration tohas submitted a series of proposals which is forming the basis of
public discussion at a series of meetings one of which was held on November 14,
1998.
As a result of these and other meetings and private sector. The IFWP is seeking to establish a
consensus amongnegotiations, the
stakeholders on a framework under whichprocess initiated by the new corporation
will be formed and operate. The Statement of Policy states thatmay result in U.S. Government
recognition of ICANN as the U.S.
government andnot-for-profit corporation under the Company will hold discussions aboutStatement of
Policy. The NTIA plan calls for a phased transition of its responsibilities for
the terms and conditions
of the ramp down of the Cooperative Agreement and sets forth certain of the
government's expectations with regardDNS to the Company's actions that will be
requirednot-for-profit corporation over the period ending on September
30, 2000. Despite the significant efforts undertaken to permit the development of competition in domain name registration.
Itdate, it is impossible
to predict at this time whether or when the process initiated by the Statement
of Policy will result in the transition of DNS administration to the
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NOTE 5 -- COMMITMENTS AND CONTINGENCIES -- (CONTINUED)
private sector and, if it does,
the effect on the Company of such transition and private sector
administration oftransition.
In October 1998, the Cooperative Agreement was amended (the "October 1998
Amendment") to extend its term through September 30, 2000. As the U.S.
Government transitions its authority over the DNS onto the not-for-profit
corporation, corresponding obligations under the Cooperative Agreement may be
terminated and, as appropriate, covered in a contract between the not-for-profit
corporation and the Company. It is also impossible to predict at
this timeIn the outcome of discussions betweenOctober 1998 Amendment, the Company and the
government
concerningNTIA agreed to a plan for the terms and conditionstransition to a shared registration system, in
which multiple registrars may register domain names with the single registry for
each TLD, in a phased approach, the first phase of the ramp down of the Cooperative
Agreement.which is scheduled to be
completed by March 31, 1999.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
This quarterly report on Form 10-Q contains forward-looking statements. For
this purpose, any statements contained herein that are not statements of
historical fact may be deemed to be forward-looking statements. Statements
regarding the intent, belief or current expectations of the Company are intended
to be forward-looking statements which may involve risk and uncertainty. There
are a number of factors that could cause the Company's actual results to differ
materially from those indicated by such forward-looking statements, including,
but not limited to, those discussed in "Part I -- Item 1 -- Business -- Risk
Factors" and "Part II -- Item 7 -- Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Factors Affecting Operating
Results" contained in the Company's 1997 Form 10-K, as filed with the Securities
and Exchange CommissionSEC on
March 31, 1998. In addition, set forth below under the heading "Factors
Affecting Operating Results" is a further discussion of certain of those risks
as they relate to the period covered by this report, the Company's near term
outlook with respect thereto, and the forward-looking statements set forth
herein; however, the absence in this quarterly report of a complete recitation
of or update to all risk factors identified in the 1997 Form 10-K should not be
interpreted as modifying or superseding any such risk factors, except to the
extent set forth below. Investors should review this quarterly report in
combination with the Company's 1997 Form 10-K in order to have a more complete
understanding of the principal risks associated with an investment in the
Company's common stock.
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OVERVIEW
The Company currently acts as the exclusive registrar and registry of
Internet domain names within the .com, .org, .net and .edu TLDs pursuant to the
Cooperative Agreement with the NSF.NTIA. Domain names are used to identify a unique
site or presence on the Internet. As registrar toand registry for these TLDs, the
Company registers new domain names and is responsible for the maintenance through daily updatesand
dissemination of the master file of domain names. A pioneer in Internet technology since 1979,names through daily updates to the
Internet.
The Company also providesdelivers enterprise network consulting services focusing onto large
companies that desire to establish or enhance their Internet presence or
re-engineer legacy network infrastructures to accommodate the integration of
both Internet connectivity and internal enterprise network ("Intranet"),
technology into their information technology base. The Company's consulting
services include network engineering, network and systems security and network
management
solutions for commercial customers. The Company's consulting services division
delivers full life cycle network engineering and consulting for a broad range of
companies including major financial institutions and multinational oil and gas
corporations. The Company also develops internally and together with other
companies new technology, products and services that may be offered in
conjunction with the Company's domain name registration and consulting services.management.
Registration Services. In December 1992, the Company entered into the
Cooperative Agreement with the NSF under which the Company was to provide
Internet domain name registration services for five TLDs: .com, .org, .net, .edu
and .gov. These "registration services"registration services include domain name registration and
renewal,annual re-registration, and, throughout the registration term, maintenance of,
and unlimited modifications to, individual domain name records and updates to
the master file of domain names. The Cooperative Agreement became effective
January 1, 1993. It includes a three-month phase-in period, a five-year
operational period (commencing April 1, 1993 and ending March 31, 1998), and a
six-month "flexibility period"flexibility period through September 30, 1998. TheEffective September 9,
1998, the NTIA took over the administration of the Cooperative Agreement is
subject to review byfrom
the NSFNSF. In October 1998, the Cooperative Agreement was amended and may be terminated by the NSF at any time at its
discretion or by mutual agreement. The NSF has stated that it will not be
re-awarding a cooperative agreement at the end of the flexibility period.extended
until September 30, 2000.
The original terms of the Cooperative Agreement provided for a cost
reimbursement plus fixed-fee contract (with aan initial fee of 8%). Effective
September 14, 1995, the NSF and the Company amended the Cooperative Agreement to
require the Company to begin charging end users a services fee of $50 per year
for each domain name in the .com, .org and .net TLDs. Prior to April 1, 1998,
registrants paid a services fee of $100 for two years of domain name services
upon each initial registration and an annual renewalre-registration fee of $50 per
9
10 year
thereafter (collectively "registration fees"). The NSF paid the registration
fees for domain names within the .edu and .gov TLDs through March 31, 1997.
Commencing April 1, 1997, the Company agreed with the NSF to provide domain name
services within the .edu and .gov TLDs free of charge. As of October 1, 1997,
the Company no longer registers or administers domain names in the .gov TLD.
Under the terms of the September 14, 1995 amendment to the Cooperative
Agreement, 30% of the registration fees collected by the Company iswas required to
be set aside for the enhancement of the intellectual infrastructure of the
Internet and, as such, iswas not recognized as revenue by the Company. The Company
has reflected these funds, along with the appropriate percentage of net accounts
receivable, as restricted assets and has recorded an equivalent, related current
liability. The Company maintains the cash received relating to the set aside
funds in a separate interest bearing account. This restricted cash at December
31, 1997 and June 30, 1998 was approximately $23,512,000 and $39,564,000,
respectively. The set aside funds, plus any
interest earned, are intended to be
disbursed at the direction of the NSF. Future collection or disbursementTo date, the Company
has disbursed $62.2 million to the NSF at their direction, and as of these set aside funds will have no significant effect on the Company's business,
net financial position or resultsSeptember
30, 1998, has a remaining restricted cash balance of operations.approximately $627,000.
On March 12, 1998, the NSF and the Company amended the Cooperative
Agreement to eliminate the 30% set aside requirement effective April 1, 1998 and
to reduce the registration fees by a corresponding amount. Initial registrations
on and after April 1, 1998 are charged $70 for two years of registration
services and an annual renewalre-registration fee of $35 per year thereafter. This
amendment will havehas no effect on the revenue currently recognized on each registration
($70 for initial registrations and $35 for renewals)re-registrations), since the Company
previously did not recognize revenue on the 30% set aside funds. Accordingly,
while the revenue to the Company on a per registration basis does not change,
the amount charged to customers will decline.declined.
In order to provide prompt access to new domain names on the Internet, the
Company generally invoices customers and permits them to pay their registration
fees after their domain names are registered. The Company's experience has been
that, for the period from September 1995 through JuneSeptember 1998, approximately
30% of new registrations have ultimately been deactivated for non-payment. The
Company
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believes that this level of uncollectible receivables is due to, among other
factors, the large number of individuals and corporations that have registered
multiple domain names with the apparent intention of transferring registration
for such names at a profit. Such transferorsresellers have a greater tendency than other
customers to default on their registration fees. As a consequence, the Company
has recorded a comparable provision for uncollectible accounts in determining
net registration revenue. This 30% provision has been consistently applied for
the period from September 1995 through JuneSeptember 1998 and is considered adequate
by the Company.
Registration fees charged to end userscustomers for registration services net of
any 30% set aside funds, are
recognized as revenue evenly over the registration term. For example, the
Company recognizes $70 (for registrations prior to April
1, 1998 this represents the $100 fee less $30 set aside) on a straight-line basis over the two-year servicesservice period
for each $70 initial domain name registration, equivalent to $35 per year.
RenewalsAnnual re-registrations of domain name registrationsnames are recorded as revenue based upon $35 (for renewals prior to April 1, 1998 this
represents the $50 fee less $15 set aside)
recognized on a straight-line basis over the one-year servicesservice period. This
"subscription-based"subscription-based model defers revenue recognition until the Company provides
the registration services, including maintenance of and unlimited modifications
to individual domain name records, over the respective registration terms. At
JuneSeptember 30, 1998, the Company had net deferred revenue of $89.0$106.7 million.
Enterprise Network Consulting Services. Substantially all of the Company's
enterprise network consulting services revenue is derived from professional
services which are generally provided to clients on a "timetime and expense"expense basis and
is recognized as services are performed.
NationsBanc Services, Inc. ("NationsBanc")The majority of the Company's enterprise network consulting services are
provided to customers in the financial services industry. Bank America (formerly
NationsBanc) is currently the Company's largest consulting services customer.client,
accounting for 49% of the Company's enterprise network consulting services
business net revenue and 3.7% of the Company's total net revenue in the nine
months ended September 30, 1998. NationsBanc originally contracted with the
Company in 1993 to provide ongoing analysis, design, implementation and support
engineering for its enterprise network. Thethe Company currently provides network design and
engineering services as well as a variety of project specific services for NationsBanc. The Company's current contract with NationsBanc is a
three-year contract which commenced January 1, 1997 and is a requirements
contract under which the Company's services are ordered by task orders issued by
NationsBanc. The NationsBanc contract may be terminated by NationsBanc at any
time upon 30-days' prior written notice to
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the Company. There can be no assurance that the Company will obtain any
additional task orders under the NationsBanc
contract.
RESULTS OF OPERATIONS
Net Revenue. Net revenue increased 103%109% from $10.1$12.2 million for the three
months ended JuneSeptember 30, 1997 to $20.5$25.4 million for the three months ended
JuneSeptember 30, 1998. This increase in net revenue was primarily attributable to
the increase in the number of domain name registrations, principally in the .com
TLD. Net revenue from registration services increased 121%116% from $8.6$10.7 million
for the three months ended JuneSeptember 30, 1997 to $19.0$23.1 million for the three
months ended JuneSeptember 30, 1998. Net new registrations increased 91%89% from
232,000269,000 for the three months ended JuneSeptember 30, 1997 to 443,000507,000 for the three
months ended JuneSeptember 30, 1998. This also represents a 30%14% increase over the
340,000443,000 net new registrations for the three months ended March 31,June 30, 1998. Growth
in net registrations continues to be driven by the widespread use and adoption
by businesses of the Internet and Intranets on a global basis. Cumulative net
registrations as of JuneSeptember 30, 1997 were 1,040,0001,296,000 as compared to 2,289,0002,777,000
as of JuneSeptember 30, 1998, for a 120%114% increase. In addition, this growth in
cumulative net registrations is a 23%21% increase in the Company's entire customer
base since March 31,June 30, 1998.
Net revenue from enterprise network consulting services wasincreased 53% from
$1.5 million for the three months ended JuneSeptember 30, 1998 and 1997. While flat in comparison1997 to the same period in the
prior year, this represents a 50% increase in net revenue from consulting
services from$2.3 million for
the three months ended March 31,September 30, 1998. This also represents a 53% increase
over the $1.5 million in enterprise network consulting services revenue for the
three months ended June 30, 1998. NationsBanc accounted for $497,000$305,000 or 4.9%2.5% of
the Company's total net revenue for the three months ended JuneSeptember 30, 1997
and $561,000$1.2 million or 2.7%4.7% of the Company's total net revenue for the three months
ended JuneSeptember 30, 1998.
Net revenue increased 97%102% from $18.7$30.9 million for the sixnine months ended
JuneSeptember 30, 1997 to $37.0$62.4 million for the sixnine months ended JuneSeptember 30,
1998. This increase in net revenue was primarily attributable to the increase in
the number of domain name registrations, principally in the .com TLD. Net
revenue from registration services increased 127%123% from $15.2$25.9 million for the
sixnine months ended JuneSeptember 30, 1997 to $34.5$57.7 million for the sixnine months ended
JuneSeptember 30, 1998. Net new registrations increased 85% from 698,000 for the
nine months ended September 30, 1997 to 1,290,000 for the nine months ended
September 30,
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1998. The provision for uncollectible accounts used in determining net new
registration revenue for the sixnine months ended JuneSeptember 30, 1997 and 1998 was
consistently applied at a rate of 30%.
Net registrations increased 81%revenue from 413,000enterprise network consulting services decreased 6% from
$5.0 million for the sixnine months ended JuneSeptember 30, 1997 to 748,000 for the six months ended June 30, 1998.
Net revenue from consulting services decreased 29% from $3.5$4.7 million for
the sixnine months ended June 30, 1997 to $2.5 million for the six months ended JuneSeptember 30, 1998. This was primarily attributable to a reduction in business from
NationsBanc which accounted for $1.5$1.7 million
or 7.8%5.5% of the Company's total net revenue for the sixnine months ended JuneSeptember
30, 1997 and $1.1$2.3 million or 3.0%3.7% for the sixnine months ended JuneSeptember 30, 1998, as well as the completion of other fixed period
contracts in late 1997.1998.
During the three and sixnine months ended JuneSeptember 30, 1998, the consulting
services division continued to add new leadership in sales and operations and
retainedhired additional technical consultants. In addition, the division continued to
emphasize its efforts targeted at lead generation and regional sales and
marketing programs by opening offices in New York City and Atlanta, Georgia.
Consulting services' proposal activities remain strong although the sales
closure cycle has been longer than anticipated.
Cost of Revenue. Cost of revenue consists primarily of salaries and
employee benefits, fees paid to subcontractors for work performed in connection
with revenue producing projects, depreciation and equipment costs, lease costs
of the operations infrastructure and the associated operating overhead. Cost of
revenue increased 43% from $6.1$7.0 million for the three months ended JuneSeptember 30,
1997 to $8.8$10.3 million for the three months ended JuneSeptember 30, 1998. TheThis 47%
increase was primarily driven by the growth of the Company's registration
business which experienced additional outsourcing costs of $1.4$1.2 million in
support of the Company's invoicing, collection and processing activities and
additional depreciationdirect labor charges of $795,000 related to systems engineering and
equipment expenditures of $766,000. In June 1997, the
Company opened a 31,200 square foot facility to support its Internet business
operations and in January 1998, the Company signed an agreement to lease an
additional 9,100 square feet at the same location. The Company continues to
invest in improvements to the back office component of its domain name
registration business including investments in additional hardware, software,
staffing and
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facilities and currently anticipates that it will continue to make significant
investments in its back office for the foreseeable future.operations.
As a percentage of net revenue, cost of revenue decreased from 61.0%57.8% for
the three months ended JuneSeptember 30, 1997 to 42.9%40.6% for the three months ended
JuneSeptember 30, 1998. This decrease primarily reflects economies of scale that the
Company has continued to achieve due to the growth of its subscription-based
domain name registration business. In the near term, the continued need for back
office investments is expected to partially offset future margin improvements
arising from economies of scale.
Cost of revenue increased 41% from $11.4$18.5 million for the sixnine months ended
JuneSeptember 30, 1997 to $16.1$26.5 million for the sixnine months ended JuneSeptember 30,
1998. This 43% increase was driven by a $2.5$1.8 million increase in labor, a $3.7
million increase in outsourcing costs and $1.8$2.6 million in additional
depreciation charges and equipment expenditures primarily associated with
supporting the growth of the Company's registration services business.
As a percentage of net revenue, cost of revenue decreased from 61.1%59.8% for
the sixnine months ended JuneSeptember 30, 1997 to 43.7%42.4% for the sixnine months ended
JuneSeptember 30, 1998 reflecting economies of scale achieved in the Company's
registration business.
Research and Development Expenses. Research and development expenses
consist primarily of compensation and consultant expenses to support the
creation, development and enhancement of the Company's products, services and
technologies. Research and development expenses increased 100%259% from $407,000$377,000 for
the three months ended JuneSeptember 30, 1997 to $815,000$1.4 million for the three months
ended JuneSeptember 30, 1998. To date, all
significant research and development costs have been
expensed as incurred. The Company expects that the level of research and
development expenses will continue to increase in the near future in terms of
absolute dollars as the Company invests in developing new product and service
offerings. As a percentage of net revenue, research and development expenses
were 4.0%increased from 3.1% for the three months ended JuneSeptember 30, 1997 andto 5.3% for
the three months ended September 30, 1998.
Research and development expenses increased 114%164% from $718,000$1.1 million for the
sixnine months ended JuneSeptember 30, 1997 to $1.5$2.9 million for the sixnine months ended
JuneSeptember 30, 1998. As a percentage of net revenue, research and development
expenses increased from 3.8%3.5% for the sixnine months ended JuneSeptember 30, 1997 to
4.2%4.6% for the sixnine months ended JuneSeptember 30, 1998.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses consist primarily of salaries of business development,
general management, administrative and financial personnel, marketing expenses,
corporate services from Science Applications International Corporation ("SAIC"),
legal and other professional costs and amortization of goodwill associated with
the Company's 1995 acquisition by
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SAIC. Selling, general and administrative expenses increased 222%230% from $2.5$3.1
million for the three months ended JuneSeptember 30, 1997 to $8.0$10.2 million for the
three months ended JuneSeptember 30, 1998. The increase is primarily attributable to
increases in marketing and business development expenses of $3.7$5.0 million
including television, and on-lineInternet banner advertising and a targeted direct mail
campaign.campaigns. The Company expects that the level of marketing and business
development expenses will increase in the near future as the Company continues
to promote the value of a dot com.com Web address futureand other new Internet-based
value-added services,services. The Company also plans to continue to develop its
distribution channels, both domestically and international channel development.internationally.
As a percentage of net revenue, selling, general and administrative
expenses increased from 24.7%25.5% for the three months ended JuneSeptember 30, 1997 to
39.1%40.3% for the three months ended JuneSeptember 30, 1998.
Selling, general and administrative expenses increased 196%210% from $4.8$7.9
million for the sixnine months ended JuneSeptember 30, 1997 to $14.2$24.4 million for the
sixnine months ended JuneSeptember 30, 1998. The increase was attributable to a $5.0$10.2
million increase in marketing and business development expenses, increased
staffing expenses of $1.7$1.5 million and an increase in legal and other
professional costs of $1.8$2.7 million.
As a percentage of net revenue, selling, general and administrative
expenses increased from 25.6%25.5% for the sixnine months ended JuneSeptember 30, 1997 to
38.4%39.2% for the sixnine months ended JuneSeptember 30, 1998.
Interest Income. The Company had net interest income of $335,000$570,000 for the three
months ended JuneSeptember 30, 1997 as compared to $1.4$1.7 million for the three months
ended JuneSeptember 30, 1998.
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The Company had net interest income of $484,000$1.1 million for the sixnine months ended
JuneSeptember 30, 1997 as compared to $2.7$4.4 million for the sixnine months ended
JuneSeptember 30, 1998. The increase for both the three month and sixnine month
comparisons is attributable to the investment of the net proceeds of the
Company's stockinitial public offering as well as positive cash flow resulting from
increasing domain name registrations.
Income Taxes. The provision for income taxes was 46%45% of pretax earnings,
or $629,000$995,000 for the three months ended JuneSeptember 30, 1997, and 42% or $1.8$2.2
million for the three months ended JuneSeptember 30, 1998.
The provision for income taxes was 45% of pretax earnings, or $1.0$2.0 million
for the sixnine months ended JuneSeptember 30, 1997, and 42%, or $3.3$5.4 million for the
sixnine months ended JuneSeptember 30, 1998. The difference between the effective rates
for both periods presented is principally attributable to the relative impact
that non-deductible goodwill had on pretax operating income. Goodwill is being
amortized by the Company over five years and is associated with the acquisition
of the Company by SAIC in 1995.
LIQUIDITY AND CAPITAL RESOURCES
At JuneSeptember 30, 1998, the Company's principal source of liquidity was its
cash and cash equivalents of $17.9$9.1 million and its short-term investments of
$79.5$107.9 million, which when combined represent an increase of $16.1$35.7 million from
the December 31, 1997 balance in those accounts. The Company also has $6.4$6.3
million of marketable securities held as long term investments as of JuneSeptember
30, 1998.
At JuneSeptember 30, 1998, the Company's cumulative net obligation to SAIC for
intercompany activity was $2.4$2.6 million, a net increase of $1.1$1.3 million from
December 31, 1997. Intercompany activity is primarily comprised of salaries and
benefits paid by SAIC on behalf of the Company. The Company currently reimburses
SAIC for intercompany activity on a monthly basis. Pursuant to the Tax Sharing
Agreement dated September 26, 1997, the Company now generally remits income tax
payments directly to tax authorities as it no longer is part of SAIC's
consolidated group for federal income tax purposes.
Cash provided by operations was $19.9$42.1 million for the sixnine months ended
JuneSeptember 30, 1998. This amount is principally attributed to net income plus the
increase in deferred revenue reflecting cash collected in advance of
registration services revenue recognition ratably over the two- and one-year
registration terms. Partially offsetting this amount is an increase in deferred
tax assets resulting from accelerated revenue recognition for tax purposes and
the subsequent tax liabilities.
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Investing activities totalled $49.7totaled $79.3 million for the sixnine months ended
JuneSeptember 30, 1998, of which $39.3$67.7 million was net purchases of short-term
investments and $6.0 million of long-term investments. These investments are
primarily comprised of commercial investment grade securities.
The Company believes that its existing cash balance, investments and cash
flows expected from future operations will be sufficient to meet the Company's
capital requirements for at least the next 12 to 18 months.
FACTORS AFFECTING OPERATING RESULTS
Limited Operating History.RESULTS.
Ongoing Privatization of Internet Administration. The CompanyInternet is not
bound by geography, and neither the U.S. Government nor any single organization
or entity currently has only a limited operating
history under its current subscription-based pricing model for its domain name
registration business upon which an evaluationformal authority over all aspects of the Company and its prospects
can be based. The Company's prospects must be considered in lightInternet. There
is, however, a need for central policy decisions surrounding the coordination of
the risks
frequently encountered by companies in their early stagesadministrative services required for the registration, allocation and use of
development,
particularly companies in newTLDs and rapidly evolving markets. There can be no
assurance thatInternet Protocol ("IP") numbers, and for the Company will be successful in addressing such risks or thateffective global
operation of the Company will continue to obtain new registrationsInternet. This role has been filled through mutual cooperation
and interrelated informal agreements, historical leadership from an
unincorporated entity called the Internet Assigned Numbers Authority (the
"IANA") and growing involvement from the U.S. Government. With the onset of
increased commercial growth of the Internet, the U.S. Government has initiated
an activity directed at current rates or obtain
renewals from a significant portionincreased privatization of its customers.
Quarterly salesthe policy making and operating results generally depend oncentral
administration of the volume of and
ability to fulfill registration requests and consulting services contract
awards, which areInternet. Without authoritative policy making, it is
becoming increasingly more difficult to forecast.achieve consensus in the historical
manner. Failure to achieve consensus among the various groups who now informally
administer the Internet could disrupt Internet operations or delay
infrastructure improvements or changes in operations needed to maintain and
expand the Internet. The Company may be unable to adjust its
variable or fixed spending in a timely manner to compensate for any unexpected
revenue shortfall. Accordingly, any significant shortfall of demand for the
Company's services in relation to the Company's expectations may have an
immediate adverse impact on the Company's business, operating results and
financial condition. In addition, the Company expects a significant increase in
its operating expenses as it
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funds greater levels of product and services development, increases its sales
and marketing operations, updates systems and infrastructure, expands its
facilities, develops new distribution channels and broadens its customer support
capabilities. While no individual expenditure is anticipated to have a material
impact on the Company's operating results, the combined effect could be
significant and cannot be reasonably estimated at this time. To the extent that
such expenses precede or are not subsequently followed by an increase in
revenue, the Company's business, financial condition and results of
operations will be materially and adversely affected.
Potential Fluctuations in Quarterly Results. The Company believes that
future operating results will be subject to quarterly fluctuations due to a
variety of factors, many of which are beyond the Company's control. Such factors
may include, but are not limited to, developments in Internet governance,
increased competition, through the introduction of competing TLDs or competing
registrars in .com, .org or .net or otherwise, variations in the number of
requests for domain name registrations, demand for the Company's services,
introduction or enhancements of services by the Company or its competitors,
market acceptance of new service offerings, costs associated with providing
domain name registration services, litigation costs, adverse results of
litigation, termination or completion of contracts in the Company's consulting
services business or failure to obtain additional contracts in its consulting
services business, patterns of growth in the use of and interest in the Internet
and general economic conditions. Operating results would be adversely affected
by a downturn in the market for domain name registrations or a failure to
maintain existing or obtain anticipated contracts in its consulting services
business. Because the Company expects an increase in its operating expenses for
personnel, back office infrastructure and marketing and business development,
the Company wouldcould be materially and adversely affected if its revenues did not
correspondingly increase.
Uncertaintyby such a failure.
Within the U.S. Government, leadership for the further privatization of
Internet Governanceadministration is currently provided by the NTIA. After a series of
draft proposals and Regulation. On February 20,public comment periods, on June 10, 1998, the U.S. governmentNTIA published
in the Federal Register "A Proposal to Improve
Technical Management of Internet Names and Addresses" (the "Proposed Rule") to
provide notice and seek public comment on a proposal to improve the technical
management of Internet names and addresses. The proposal suggested the creation
of a representative not-for-profit corporation to manage those functions that
should be coordinated. The proposal also suggested that steps be taken, in an
orderly fashion, to move to more competitive markets in those functional areas
that can be market driven. Comments on the proposed rule revealed substantial
differences regarding how the domain name system ("DNS") should evolve and
elicited competing proposals concerning DNS management. Because of the public
comment and "the continued rapid technological development of the Internet," the
U.S. government determined that it should issue a general statement of policy
rather than define or impose a substantive regulatory regime for the DNS.
Accordingly, on June 10, 1998, the U.S. government published in the Federal
Register a statement of policy entitled "Management of Internet Names and
Addresses," informally called the "White Paper" (the "Statement of Policy").
Several proposals advanced in the Proposed Rule were eliminated in the Statement of Policy, including, but not limited to, proposals relating to
specific requirementscalling for the membershipformation of a
not-for-profit corporation to assume responsibility for administration of the
new corporation, the creation
duringDNS, but which is not expected to perform actual registration of domain names
either as a transition period of a specified number of new generic TLDs and minimum
dispute resolution and other procedures related to trademarks.registrar or registry. The Statement of Policy invites private
sector Internet stakeholders to work together to form a new private,
not-for-profit corporation to oversee policy for the Internet name and address
system. The Statement of Policy states
thatcalls for a separation of the new corporation should be headquarteredregistry and
incorporated in the United
States and have a Board of Directors from around the world. The Statement of
Policy provides that in making a decision to enter into an agreement to
establish a process to transfer U.S. government oversightregistrar functions of the DNS, toboth of which functions are currently performed
exclusively by the new
entity,Company in the U.S. government will be guided by,.com, .org .net, and consider the entity's
commitment to, the principles of stability, competition, private bottom-up
coordination and representation. The Statement of Policy provides that to the
extent that the new corporation is established and operationally stable,
September 30, 2000 is the "outside date" for the transition to the private
sector of DNS administration to be complete.
The Statement of Policy provides that the new corporation ultimately should
have the authority to (1) set policy for and direct allocation of Internet
Protocol number blocks to regional Internet number registries; (2) oversee
operation.edu TLDs.
As part of the authoritative Internet root server system; (3) oversee policy
for determining the
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circumstances under which any new TLDs are added to the root system; and (4)
coordinate the assignment of other Internet technical parameters as needed to
maintain universal connectivity on the Internet.
Following the publication ofprocess initiated by the Statement of Policy, the International
Forum for the White Paper (the "IFWP"), an ad hoc coalition of Internet
stakeholders including internet service providers, content developers, trademark
owners, networkers, intergovernmental groups, policy experts, end-users and
others, was initiated to coordinate international meetings for stakeholders to
discuss the transition of DNS administrationseveral
proposals were put forward to the NTIA on the establishment and governance of
the not-for-profit corporation. ICANN has submitted a series of proposals which
is forming the basis of public discussion at a series of meetings one of which
was held on November 14, 1998.
As a result of these and other meetings and private sectornegotiations, the
process initiated by the Statement of Policy may result in U.S. Government
recognition of ICANN as outlined
inthe not-for-profit corporation under the Statement of
Policy. The IFWP is seekingNTIA plan calls for a phased transition of its responsibilities for
the DNS to establish a consensus among
the stakeholdersnot-for-profit corporation over the period ending on a framework under whichSeptember
30, 2000.
There are several risks associated with the new corporation will be formed
and operate. The IFWP has held three meetings to date, in which the Company has
been an active participant. The U.S. government has stated that if therecognition of private sector
does not demonstrate by September 30, 1998, sufficient progress towards
implementingDNS administration and the recommendationsestablishment of, the Statement of Policy, the government may
assume a more active role in defining the futureand transfer of DNS administration. There is
a risk thatadministration
from the NTIA to, the not-for-profit corporation. Some of those risks include:
- failure to achieve consensus throughon the IFWP processmany issues relating to the
establishment and governance of the not-for-profit corporation could among
other things,
prevent or delay the implementationtransition and thereby result in instability in DNS
administration,
- the not-for-profit corporation could fail to achieve consensus or gain
legitimacy resulting in instability in the operation of a coordinated processthe Internet,
- the U.S. Government could refuse to transfer some responsibilities for
transitioning
DNS administration to the private sector. There is also a risknot-for-profit corporation thereby resulting in
fragmentation or other instability in DNS administration,
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- the Company might not succeed in establishing an acceptable contractual
agreement with the not-for-profit corporation, and
- the not-for-profit corporation could adopt or promote policies,
procedures or programs that any consensus that is reachedare unfavorable to the Company's role in the
registration of domain names or if no consensus is reached, any action
taken by the government, could produce consequences that are not favorable to
the Companyconsistent with, or
not consistent withpreclude, the Company's current or future plans.
There
is a further risk that any consensus that is reached, any policies or programs
adopted byDespite the new corporation or any actions taken by the government could be
challenged. If the new corporation is formed, there is a risk that the U.S.
government will not agreesignificant efforts undertaken to transfer todate, it oversight of DNS policy. There is
also a risk that the new corporation will adopt or promote policies or programs
that are not favorable to the Company or not consistent with the Company's
current or future plans. Any of such events could have a material adverse effect
on the Company's business, financial condition and results of operations through
a direct effect on the Company's operations or through continued uncertainty
about future Internet governance or a disruption to the administration,
effective operation, or maintenance and expansion of the Internet, in general,
or the domain name registration system, in particular.
The Statement of Policy states that the U.S. government and the Company
will hold discussions about the terms and conditions of the ramp down of the
Cooperative Agreement and sets forth certain of the government's expectations
with regard to the Company's actions that will be required to permit the
development of competition in domain name registration. There is a risk that an
agreement may not be reached between the Company and the government or that any
such agreement may contain provisions that are not favorable to the Company or
not consistent with the Company's current or future plans. Any of such events
could have a material adverse effect on the Company's business, financial
condition and results of operations.
It is impossible to
predict at this time whether or when the process initiated by the Statement of
Policy will result in the transition of DNS administration to the private sector and, if it does, the
effect on the Company of such transitiontransition. The Company's business, financial
condition and private sector administrationresults of operations could be materially and adversely affected
by any of these events and the uncertainty regarding authoritative sources for
domain name registration policies.
Status of Cooperative Agreement. On January 1, 1993, the Company initiated
phase-in of the Cooperative Agreement. The three-month phase-in was followed by
a five year operations period (commencing April 1, 1993 and ending March 31,
1998) and a six-month "flexibility period" through September 30, 1998. Effective
in September 1998, the responsibility for the Cooperative Agreement was
transferred to the NTIA. In October 1998, the Cooperative Agreement was amended
to extend its term through September 30, 2000. As the U.S. Government
transitions its responsibilities for the DNS onto the not-for-profit corporation,
corresponding obligations under the Cooperative Agreement may be terminated and,
as appropriate, covered in a contract between the not-for-profit corporation and
the Company. It is
also impossible to predict at this timeIn the outcome of discussions betweenOctober 1998 Amendment, the Company and the government concerningNTIA agreed to a
plan for the transition to a shared registration system, in which multiple
registrars may register domain names with the single registry for each TLD, in a
phased approach, the first phase of which is scheduled to be completed by March
31, 1999.
While the Cooperative Agreement by its terms expires in September 2000, it
may be terminated earlier by the NTIA. The Company's business, financial
condition and conditionsresults of operations could be materially and adversely affected
by a termination or a change in the ramp downterms of the Cooperative Agreement. AnyThere is
also a risk that the U.S. Government's interpretation of certain provisions of
the Cooperative Agreement could differ from the Company's. Certain aspects of
implementation of the Cooperative Agreement also remain to be negotiated. If the
Company is unsuccessful in negotiating acceptable terms of implementation, the
costs of implementation of the Cooperative Agreement, the Company's relationship
with the not-for-profit corporation and other matters affecting the Company's
position in a more competitive DNS environment could all be materially and
adversely affected.
There is a risk that withdrawal of or challenges to the government's
sponsorship or authorization of certain functions that the Company performs
could create a public perception or result in a legal finding that the Company
lacks authority to continue in the Company's current role as registry or
registrar within the .com, .org, .net and .edu TLDs. The legal authority
underlying the roles of NTIA and the not-for-profit corporation with regard to
the DNS system also could be challenged. The impact, if any, of any such eventspublic
perception or finding is unknown but it could have a material adverse
effect onmaterially and adversely affect
the Company's business, financial condition and results of operations.
Competition.Increased Competition in Domain Name Registration Business. A principal
objective expressed inof the Statement of Policy is the introduction ofto introduce additional competition intoand
global participation in the technical management of Internet names and addresses. This could include, among other things,addresses,
including competition among registrars within a single TLD and competition among
existing and new TLDs. The October 1998 Amendment reflects this objective with
the transition to a shared registration system in a phased approach, the first
phase of which is scheduled to be completed by March 31, 1999. Many aspects of
how competition will work in the DNS, however, remain unsettled and could be
impacted by, among other things, actions of the not-for-profit corporation.
Although the Statement of Policy contemplates establishment of additional
competition, the Company currently faces competition in the domain name
registration business from registries for country codes, third level domain name
providers such as Internet access providers and registries of TLDs other than
those TLDs which the Company currently being registered by the Company.registers. A number of entities have
already begun to offer competing registration services using other TLDs and when
the shared registration system takes effect the Company will no longer be the
exclusive registrar in .com, .org and .net TLDs.
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Future competition in the Company's domain name registration business could
come from many different companies, including, but not limited to,including:
- domain name registration resellers,
- Internet access providers,
- major telecommunications firms, and
- cable companies and Internet access providers. Suchcompanies.
Many of these entities have core capabilities to deliver registration
services, such as help desks, billing services and network management, along
with strong name recognition and Internet industry experience. Other companies with some or all of these capabilities may also enter the
registration business. Also emerging is a growing contingent of domain name
resellers. The
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16 Company's
position as the leading registrar of domain names could be materially and
adversely affected by the emergence of any of the foregoingthese competitors and potential
competitors, many of which have longer operating histories and significantly
greater name recognition and greater financial, technical, marketing,
distribution and other resources than the Company. In addition, theThe Company's revenue andfrom
registration fees could be reduced due to increased competition, pricing
pressures or pricing pressures.a modification of billing practices. For example, other entities
may bundle domain name registrations with other products or services, effectively providing such
registration services for free.services. The Company believes that it is well positioned
to succeed in a more competitive environment. However, the
introduction of additional competition into the domain name registration
business could have a material adverse effect on the Company's business,
financial condition and results of operations.
In addition,Limited Service Offerings to Date; Reliance on Domain Name Registration
Services for a Significant Portion of Revenues. The Company's domain name
registration services business generates over 90% of the Company's revenue and
is expected to continue to account for a very significant portion of the
Company's revenue in at least the near term. The Company's future success will
depend largely on:
- the continued increase in domain name registrations,
- re-registration rates of the Company's customers,
- the Company's ability to maintain its current position as a leading
registrar of domain names, and
- the successful development, introduction and market acceptance of new
services that address the demands of Internet users.
Although the Company faces substantial competitionhas experienced revenue growth in its consulting services businessrecent periods, the
Company may not be able to sustain it and in the development and distributionsuch growth may not be indicative of
future products and services for the Internet-based services markets.
Litigation. The Company is a party in a number of legal proceedings as
described in "Part II -- Item 1 -- Legal Proceedings." Whileoperating results. For example, the Company cannot
reasonably estimate the potential impact of the claims advancedmay not be able to maintain
its current position in the PG Media
suit described therein, a successful claim against the Companyproviding domain name registration services or develop
or market additional services. The Company's failure to do so could have a
material adverse effect onmaterially
and adversely affect the Company's business, financial condition and results of
operations.
Limited Operating History. Prior to September 14, 1995, the Company was
paid directly by the NSF for providing registration services on a cost
reimbursement plus fixed fee basis. Accordingly, the Company has only a limited
operating history for its current domain name registration business upon which
to base an evaluation of the Company and its prospects. The Company's prospects
must be considered in light of the risks frequently encountered by companies in
their early stages of development, particularly companies in new and rapidly
evolving markets. To address these risks, the Company must, among other things:
- respond to competitive developments,
- increase its sales and marketing operations,
- continue to identify, attract, retain and motivate qualified persons, and
- continue to upgrade and integrate technologies, products and services.
Due to the rapidly evolving nature of Internet technologies, the Company's
enterprise network consulting services business faces similar risks. The Company
may not be successful in addressing such risks.
Evolving Sales and Marketing Organization and Distribution Channels. The
Company will need to effectively manage its growing sales and marketing
organization if the Company wants to achieve future
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revenue growth. The Company does not know if it will be able to identify,
attract and retain experienced sales and marketing personnel with relevant
experience. Further, the Company's sales and marketing organization may not be
able to successfully compete against the significantly more extensive and
well-funded sales and marketing operations of its current or potential
competitors.
In addition whileto establishing direct sales channels, the Company cannot predict what
relief, if any, might be sought, awarded or imposedis also
developing multiple distribution channels. The Company's ability to achieve
future revenue growth will also depend on its establishing and maintaining
relationships with Internet access providers and other third parties and on
effective use of the Internet as a resultmedium of any civil
action which could be filed bydistribution.
If the DepartmentCompany fails to manage and grow its new sales and marketing
organization, develop and expand its distribution channels or effectively use
the Internet as a medium of Justice arising from its
investigation regarding Internet registration products and services, any such
relief could have a material adverse effect ondistribution, the Company's business, financial
condition and results of operations. Moreover, litigationoperations could be materially and adversely affected.
Reliance on Third Parties. The functioning of the DNS is facilitated
through a hierarchy of domain name servers (specialized software programs
resident in network computers). The top level of this hierarchy consists of 13
globally distributed servers (ten in the United States, two in Europe and one in
Asia), which together are referred to as the Root Server System. These root
servers function as the equivalent of master "white pages" of the Internet. The
Company administers and operates two of the 13 root servers (designated by the
letters A and J). Root Server A has special significance. Every night the
Company updates the Root Server A database by adding the newly registered second
level domain names and updating existing domain name records. The 12 other root
servers then copy the updated database.
All 13 root servers contain information with respect to all TLDs, including
country code TLDs. Also, nine of the 13 root servers currently are populated
with the domain names registered by the Company. When communication with a
particular host within a domain name is involvedrequired and the IP address of that host
is not known locally, the root servers make that information available or
"point" to a direct or indirect source of the information. Multiple root servers
are required for purposes of load balancing and redundancy.
The location and control of these root servers historically has resultedbeen
determined by consensus of various members of the Internet community. The eleven
root servers that the Company does not maintain and likely will result in,control are maintained and
controlled by independent operators on a volunteer basis. If these volunteer
operators at any future litigation
cantime, for any reason, fail to properly maintain such servers or
abandon such servers, the Company's business, financial condition and results of
operations could be expectedmaterially and adversely affected.
Further, as no single organization or entity currently has formal authority
over all aspects of the Internet, neither the U.S. Government nor any
organization or entity has clear legal authority to result in, substantial legal and other expensesdirect root server
operations including where the root servers are to be pointed. If any or all of
the root servers fail to include or provide accessibility to the CompanyCompany's data,
the Internet and a diversion of the Company's personnel. See "Part II -- Item
1 -- Legal Proceedings."business, financial condition and results of
operations would be materially and adversely affected.
The Company's success and ability to compete also depend upon its
relationships with Internet service providers ("ISPs") worldwide. The Company's
business, financial condition and results of operations would be materially and
adversely affected if enough ISPs decided not to route Internet communications
to or from domain names registered by the Company or if enough ISPs decided to
provide routing to a set of accepted root servers which did not point to the
Company's TLD servers.
System Interruption and Security Risks. A failure in the operation of the
Company's registration system could result in deletion of one or more domain
names from the Internet for a period of time. A failure in the
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operation or update of Root Server A could result in deletion of one or more
TLDs from the Internet and the discontinuation of domain names in those TLDs for
a period of time.
The Company's operations are
dependent upondepend on its ability to maintain its computer and
telecommunications equipment in effective working order and to reasonably
protect its systems against damage frominterruption. Such interruptions could result from:
- fire, natural disaster, sabotage, power loss, telecommunication failure,
human error or similar events. In addition,events,
- computer viruses, hackers or similar disruptive problems caused by
employees, customers or other Internet users, and
- systems strain caused by the growth of the Company's customer base may put strain on the capacity of its computers and
telecommunications systems and
the Company's inability to sufficiently maintain or upgrade its systemssystems.
The Company's business, financial condition and results of operations could
lead to degradation in performance or system
failure. Anybe materially and adversely affected by any damage, failure or delay that causes
significant interruptions in the Company's systems wouldsystems.
Regulation. In the United States, apart from the Company's obligations
under the Cooperative Agreement, the Company is not currently subject to direct
regulation other than federal and state regulation applicable to businesses
generally. However, if there are changes in the regulatory environment, the
Company could become subject to direct regulation by U.S. regulatory agencies.
For example, the Company is aware that certain industry requests have been made
to the Federal Communications Commission (the "FCC") to review the impact of
Internet usage on the U.S. telecommunications service providers, in particular,
the generally lower cost for data transmission versus voice. In addition, as the
Internet becomes more widespread internationally, international regulation
becomes more likely. The Company cannot predict whether or to what extent any
such new regulation will occur; however, such regulation could have a material
adverse effect on the Company's business, financial condition and results of
operations.
Year 2000.Additionally, the Company is not certain how existing laws governing issues
such as intellectual property ownership would be applied to it. The Company also
is not certain how courts will interpret the obligation of domain name
registration providers to prevent trademark infringement and other legal issues.
See "-- Legal Proceedings."
Legal Proceedings. The Company is involved in several legal proceedings.
As of November 1, 1998, the Company was named as a defendant in two active
lawsuits involving domain name disputes between trademark owners and domain name
holders. In addition, on March 20, 1997, PG Media, Inc., a New York-based
corporation, filed a lawsuit (the "PG Media suit"), alleging that the Company
had violated the Sherman Act by restricting access to the Internet by not adding
PG Media's requested TLDs to the Internet root zone system. In its complaint, PG
Media has, in addition to requesting damages, asked that the Company be ordered
to include reference to PG Media's TLDs and name servers in the root zone file
that the Company administers under the Cooperative Agreement. The Company
received written direction from the NSF not to take any action which would
create additional TLDs or to add any new TLDs to the Internet root zone until
the NSF provides further guidance. On September 17, 1997, PG Media filed a
Second Amended Complaint adding the NSF as a defendant. On May 14, 1998, PG
Media served the Company with a motion for a preliminary injunction against both
defendants. The motion sought a hearing before the court on June 8, 1998 to
compel both defendants to add PG Media's TLDs to the Internet root zone within
30 days. In response, both the Company and the NSF filed cross motions for
summary judgment against PG Media. On July 20, 1998, all motions were heard. The
basic issue before the court was the NSF's authority to control the Internet's
root zone system. The court has taken the issue under advisement and no date has
been indicated for the issuance of a decision.
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On October 17, 1997, a group of six plaintiffs filed a lawsuit (the "Thomas
suit") against the Company and the NSF. The lawsuit:
- challenged the legality of fees charged by the Company for domain name
registration services; and
- sought restitution of fees collected from domain name registrants in an
amount in excess of $100 million.
The plaintiffs alleged violations of the Administrative Procedures Act,
Independent Offices Appropriations Act, the Sherman Act and the U.S.
Constitution. In August 1998, the court dismissed all of the plaintiffs' claims
against the Company. In October 1998, however, the plaintiffs appealed the
court's dismissal of their claims.
While the Company cannot reasonably estimate the potential impact of the
claims advanced in the PG Media or Thomas suits, a successful claim against the
Company in either of these proceedings could have a material adverse effect on
the Company's business, financial condition and results of operations.
In addition, on June 27, 1997, SAIC received a Civil Investigative Demand
("CID") from the U.S. Department of Justice ("DOJ") issued in connection with an
investigation regarding possible antitrust violations under the Sherman Act
relating to Internet registration products and services. The Company cannot
reasonably estimate the potential impact of the investigation nor can the
Company predict whether a civil action will ultimately be filed by the DOJ or
the form of relief that might be sought. Any such relief could have a material
adverse effect on the Company's business, financial condition and results of
operations.
On August 17, 1998, the Company received notice from the Commission of the
European Communities (the "EC") of an investigation concerning the Company's
Premier Domain Registration Service Program ("Premier Program") in Europe. The
EC requested production of these agreements and related materials for review.
The Company cannot reasonably estimate the potential impact of the investigation
nor can the Company predict whether an action will ultimately be brought by the
EC or the form of relief that might be sought. Any such relief could have a
material adverse effect on the Company's business, financial condition and
results of operations.
Legal proceedings in which the Company is involved have resulted and likely
will result in, and any future legal proceedings can be expected to result in,
substantial legal and other expenses to the Company and a diversion of the
efforts of the Company's personnel.
Technological Change and Additional Technology, Products and Services. The
Company's future financial success will depend upon its ability to develop,
integrate or commercialize in a timely manner new technology, products and
services that can be offered with the Company's current domain name registration
and enterprise network consulting services and that can meet the changing
requirements of the Company's current and future customers. The market for such
technology, products and services is characterized by rapidly changing
technology and evolving industry standards. Generally, the successful
development and commercialization of new technology, products and services
involves many risks, including:
- identifying opportunities for new products or services,
- identifying, hiring and retaining appropriate research and development
personnel,
- successfully completing the development process, and
- customer acceptance of the product or service.
Uncollectible Receivables; Modifications to Billing Practices. Currently,
the Company invoices a majority of its customers and permits them to pay their
services fee after the domain name is registered. The Company believes it has
experienced a high level of uncollectible receivables due to, among other
factors, the large number of individuals and corporations that have registered
multiple domain names with the apparent intention of reselling such names at a
profit. The Company's experience has been that such resellers have a greater
tendency than other customers to default on their services fees. The Company has
established a
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provision for uncollectible accounts which the Company believes to be adequate
to cover anticipated uncollectible receivables; however, actual results could
differ from the Company's estimates.
The Company continually reviews its billing practices for modification to
respond to market conditions and to implement operational improvements. These
modifications could have unanticipated consequences which could materially and
adversely affect the Company's business, financial condition and results of
operations.
Competition in Internet-Based Businesses and Enterprise Network Consulting
Services. In developing and distributing products and services for the
Internet-based services markets, the Company faces intense competition and
expects to have multiple competitors for each of the products or services the
Company develops or sells. Many of the Company's potential competitors for these
products have longer operating histories, greater name recognition and
significantly greater financial, technical, marketing, distribution and other
resources than the Company does. In addition, the Company's industry is
characterized by rapid changes and frequent product and service introductions.
To the extent a competitor introduces a competitive product or service before
the Company introduces the same or similar product or service, market acceptance
of the competitor's product or service may adversely affect the Company's
competitive position.
The Company's current and potential competitors in its enterprise network
consulting services business are companies with Internet expertise including
systems integrators and consulting firms, such as Andersen Consulting, IBM
Global Services and International Network Services. The Company also competes
with certain companies that have developed products that automate the management
of IP addresses and name maps throughout enterprise-wide networks and with
companies with internally-developed systems integration efforts. Many of these
competitors and potential competitors have longer operating histories, greater
name recognition and significantly greater financial, technical, marketing,
distribution and other resources than the Company does.
Management of Growth; Dependence on Key Personnel. The Company continues
to experience growth in the number of its employees and in the scope of its
operating and financial systems. This growth has increased the responsibilities
for both existing and new management personnel. To manage growth, the Company
will have to successfully integrate its management team, continue to implement
and improve its operational, financial and management information systems and to
train, motivate, manage and retain its employees. If the Company cannot manage
its growth, its business, financial condition and results of operations could be
materially and adversely affected. In addition, growth of the Company's customer
base may strain the capacity of its computers and telecommunications systems.
Therefore, the Company must maintain or upgrade its systems or risk degradation
in performance or system failure.
The Company's future success also depends on the continued service of its
key engineering, sales, marketing, executive and administrative personnel, and
its ability to identify, hire and retain additional personnel. On November 16,
1998, the Company announced the resignation of Gabriel A. Battista from his
positions as Chief Executive Officer and Director of the Company. While the
Company conducts a search for a new Chief Executive Officer, Michael A. Daniels,
Chairman of the Board, will assume the executive responsibilities previously
performed by Mr. Battista. In addition, Robert J. Korzeniewski, Chief Financial
Officer, will also be acting as the Company's Chief Operating Officer, assuming
responsibility for day-to-day operations. In addition, the future success of the
Company's enterprise network consulting services business depends in large part
on its ability to hire, train and retain engineers who have expertise in a wide
array of network and computer systems and a broad understanding of the
industries the Company serves. If the Company fails to hire, train and retain a
sufficient number of qualified engineers, the Company's ability to adequately
manage and complete its existing projects or to obtain new projects, as well as
expanding its business, could be impaired. Competition for engineering, sales,
marketing and executive personnel is intense. The Company cannot be certain that
it will be able to retain existing personnel or identify, hire or retain
additional qualified personnel. It is impossible to reasonably estimate the
potential financial impact of hiring a new Chief Executive Officer at this time.
Intellectual Property Rights. As required under the Cooperative Agreement,
on or before November 6, 1998, the Company submitted to the U.S. Government an
electronic copy of all software and data generated
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under the Cooperative Agreement through September 30, 1998. By December 6, 1998,
the Company must submit to the U.S. Government a copy of all existing
documentation for that software and data generated through September 30, 1998.
The U.S. Government is required to take appropriate measures to protect the
confidentiality of such data, software and documentation. The Company's
business, financial condition and results of operations could be materially and
adversely affected if:
- the Company's ownership rights in its data, software and documentation
were to be successfully challenged,
- the Company cannot protect such rights,
- the Company is required to share its data, software and documentation
with potential competitors, or
- the Company's potential competitors were otherwise able to obtain its
data, software or documentation.
The Company relies on a combination of nondisclosure and other contractual
arrangements with its employees and third parties, privacy and trade secret laws
to protect its proprietary rights and limit the distribution of its proprietary
information. Although these actions are considered reasonable and adequate, no
controls can guarantee the protection of the Company's proprietary rights.
Furthermore, even if these steps are successful, other companies may develop
technologies that are similar or superior to the Company's proprietary
technology. Although the Company believes that its services do not infringe on
the intellectual property rights of others and that the Company has all rights
needed to use the intellectual property employed in its business, it is possible
that the Company could become subject to claims alleging infringement of third
party intellectual property rights. Any claims could subject the Company to
costly litigation, and may require the Company to pay damages and develop
non-infringing intellectual property or acquire licenses to the intellectual
property that is the subject of the alleged infringement. If the Company fails
to adequately protect its proprietary rights or if the Company becomes involved
in litigation relating to intellectual property rights, the Company's business,
financial condition and results of operations could be materially and adversely
affected.
Dependence on Future Growth of the Internet and Internet
Infrastructure. The Company's future success substantially depends on the
continued growth in the use of the Internet. If the use of and interest in the
Internet does not continue to grow at its current pace, the Company's business,
financial condition and results of operations would be materially and adversely
affected. Continued growth of the Internet could be slowed by:
- inadequate infrastructure,
- lack of availability of cost-effective, high speed systems and service,
- failure to maintain a reliable network system,
- delays in developing or adopting new standards and protocols to handle
increased levels of Internet activity, or
- government regulation.
If the use of the Internet does not continue to grow, if the necessary
infrastructure or complementary products are not developed or do not effectively
support growth that may occur, or if the Internet does not become a viable
information medium or commercial marketplace, the Company's business, financial
condition and results of operations would be materially and adversely affected.
Uncertainty of Future Acquisitions and Investments. The Company evaluates
potential acquisitions and investments on an ongoing basis. The Company may not
be able to compete successfully for available acquisition candidates, complete
future acquisitions and investments or accurately estimate the financial effect
on the Company of any businesses the Company acquires or investments the Company
makes. Future acquisitions and investments may require the Company to spend
significant cash amounts or decrease operating income, either of which could
have a material adverse effect on the Company's business, financial
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condition and results of operations. The Company's failure to implement
successfully its acquisition and investment strategy could materially and
adversely affect the Company's business, financial condition and results of
operations. The Company may also make future acquisitions or investments in
companies which are in the early stages of development. To the extent that any
of these companies fail, it could have a material adverse effect on the
Company's financial condition.
Potential Fluctuations in Quarterly Results. The Company's quarterly
operating results may fluctuate significantly in the future due to a variety of
factors, many of which are beyond the Company's control. Such factors may
include, but are not limited to:
- developments in Internet governance including establishment of the
not-for-profit corporation and the effect of the October 1998 Amendment,
- increased competition, through the introduction of competing TLDs or
competing registrars in .com, .net or .org,
- variations in the number of requests for domain name registrations or
demand for the Company's services,
- introduction or enhancements of services by the Company or its
competitors,
- market acceptance of new service offerings,
- costs associated with developing or providing domain name registration or
other services,
- litigation costs,
- adverse results of litigation,
- termination or completion of contracts in the Company's enterprise
network consulting services business or failure to obtain additional
contracts in that business,
- patterns of growth in the use of and interest in the Internet, or
- general economic conditions.
In addition, the Company expects a significant increase in its operating
expenses as it:
- increases sales and marketing operations,
- updates systems and infrastructure,
- funds greater levels of product and services development,
- develops new distribution channels,
- broadens customer support capabilities, and
- expands facilities.
If the increase in the Company's expenses is not followed by an increase in
revenue, the Company's business, financial condition and results of operations
could be materially and adversely affected.
In addition, a majority of the Company's enterprise network consulting
services operating expenses, particularly personnel and related costs,
depreciation and rent, are substantially fixed before any particular quarter. As
a result, any under-utilization of engineers may cause the Company's operating
results to vary significantly in any particular quarter and could result in
losses for such quarter.
Control by SAIC. As of November 6, 1998, SAIC owned 100% of the Company's
outstanding Class B Common Stock, representing approximately 74.1% of the
Company's outstanding Common Stock and approximately 96.6% of the combined
voting power of the Company's outstanding Common Stock. The Class B Common Stock
is convertible into Class A Common Stock, subject to certain limitations set
forth in the Company's Second Amended and Restated Certificate of Incorporation
(the "Certificate of Incorporation"). As a result, SAIC effectively controls all
matters requiring approval by the Company's stockholders
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including the election of members of the Company's Board of Directors, changes
in the size and composition of the Board of Directors and a change in control.
The Company does not have an agreement with SAIC which restricts its rights to
convert, distribute or sell its shares of the Company's Common Stock and there
can be no assurance that SAIC will maintain its ownership of the Company's Class
B Common Stock.
Reliance on SAIC for Certain Corporate Services. The Company has entered
into certain intercompany agreements with SAIC, including an agreement pursuant
to which SAIC will provide various corporate services to the Company that may be
material to the conduct of the Company's business (the "Corporate Services
Agreement"). These services include certain routine and ordinary corporate
services, including business insurance, accounting systems, employee benefits,
payroll, tax and legal services as well as assistance in government relations
and corporate quality assurance services as described in the Corporate Services
Agreement. With respect to matters covered by the Corporate Services Agreement,
the Company's relationship with SAIC is intended to continue in a manner
generally consistent with past practices. If SAIC's ownership of the Company's
outstanding Common Stock drops below 50%, the Corporate Services Agreement will
be terminable by either party upon 180 days' prior written notice. Certain
individual services are also terminable by either party upon 180 days' prior
written notice, regardless of SAIC's ownership interests. Although neither the
Company nor SAIC currently intends to terminate the Corporate Services
Agreement, if SAIC did elect to terminate the Corporate Services Agreement, the
Company may not be able to secure alternative sources for such services within
180 days or such services may only be available at prices higher than those
charged by SAIC.
Certain Charter Provisions and Limitations on Liability. The Company's
Certificate of Incorporation includes provisions relating to competition by SAIC
with the Company, allocations of corporate opportunities, transactions with
interested parties and intercompany agreements and provisions limiting the
liability of certain people. It is unclear whether such provisions are
enforceable under Delaware corporate law. The Company's Certificate of
Incorporation provides that any person purchasing or acquiring an interest in
shares of the Company's capital stock shall be deemed to have consented to the
provisions in the Certificate of Incorporation relating to competition with
SAIC, conflicts of interest, corporate opportunities and intercompany
agreements, and such consent may restrict such person's ability to challenge
transactions carried out in compliance with such provisions. The corporate
charter of SAIC does not include similar provisions. Therefore, persons who are
directors and/or officers of the Company and who are also directors and/or
officers of SAIC may choose to take action in reliance on such provisions rather
than act in a manner that might be favorable to the Company but adverse to SAIC.
Under the Company's Certificate of Incorporation, the personal monetary
liability of the Company's directors for breach of their fiduciary duty of care,
including actions involving gross negligence, is eliminated to the fullest
extent permitted under Delaware law.
International Revenues. While substantially all of the Company's
operations, facilities, and personnel are located within the United States, the
Company's revenues from sources outside the U.S. have increased significantly
and may continue to increase in the future. As a result, the Company is subject
to the risks of conducting business internationally, including unexpected
changes in regulatory requirements, fluctuations in the U.S. dollar, tariffs and
other barriers and restrictions and the burdens of complying with a variety of
foreign laws. The Company does not know what the impact of such regulatory,
geopolitical and other factors will be on its business in the future or if the
Company will have to modify its business practice. In addition, the laws of
certain foreign countries may not protect the Company's proprietary rights to
the same extent as do the laws of the United States.
Possible Volatility of Stock Price. The market price of the Company's
Class A Common Stock has been and is likely to continue to be highly volatile
and may be significantly affected by factors such as actual or anticipated
fluctuations in the Company's quarterly operating results, announcements of
technological innovations, industry conditions and trends, changes in or the
Company's failure to meet the expectations of securities analysts and investors,
general market conditions and other factors. It is possible that in some future
quarter, the Company's operating results may be below the expectations of
securities analysts and investors. If this occurs, the price of the Company's
Class A Common Stock would likely decline, perhaps substantially. In
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addition, the stock market has experienced significant price and volume
fluctuations that have particularly affected the market prices of the stocks of
technology companies, including Internet-related companies. These broad market
fluctuations may adversely affect the market price of the Company's Class A
Common Stock. In the past, following periods of volatility in the market price
of a particular company's securities, securities class action litigation has
often been brought. Such litigation could result in substantial costs and a
diversion of management's attention and resources, which could have a material
adverse effect on the Company's business, financial condition and results of
operations.
YEAR 2000 COMPLIANCE
The Company is in the process of assessing the potential effects of the
"Year 2000" milleniumYear 2000 millennium change on the Company's internal computer
software applications andbusiness systems and processes,
including the Internet root servers under the Company's control,
telecommunications systems, facilities, data-networking infrastructure,
commercial-off-the-shelf hardware, software and components used by its employees
and its outsourcing vendors. The Company's Year 2000 project is proceeding on
schedule. The project goal is to ensure that the Company's business is not
impacted by the date transitions associated with the Year 2000.
The Company's Year 2000 project plan is coordinated by a team that reports
directly to senior management. The project team is evaluating the Year 2000
compliance of the Company's business systems and processes, including the
Internet root servers under the Company's control, telecommunications systems,
facilities, data-networking infrastructure, commercial-off-the-shelf hardware,
software and components used by its employees and its outsourcing vendors whom
provide services relating to the Company's domain name registration business.
The Company's Year 2000 project is comprised of the following phases:
- Phase 1 -- Inventory all of the Company's business systems and processes,
including the Internet root servers under the Company's control,
telecommunications systems, facilities, data-networking infrastructure,
commercial-off-the-shelf hardware, software and components used by its
employees in general.order to assign priorities to potentially impacted systems
and services. This phase is expected to be completed in November 1998;
- Phase 2 -- Assess the Year 2000 compliance of all inventoried business
systems and processes, including the Internet root servers under the
Company's control, telecommunications systems, facilities,
data-networking infrastructure, commercial-off-the-shelf hardware,
software and components used by its employees and determine whether to
renovate or replace any non-Year 2000 compliant systems and services.
This phase is expected to be completed by December 1998;
- Phase 3 -- Complete remediation, if any is required, of any non-Year 2000
compliant business systems and processes, including the Internet root
servers under the Company's control, telecommunications systems,
facilities, data-networking infrastructure, commercial-off-the-shelf
hardware, software and components used by its employees. Conduct
procurements to replace any other non-Year 2000 compliant business
systems and processes, telecommunications systems, facilities,
data-networking infrastructure, commercial-off-the-shelf hardware,
software and components used by its employees that won't be remediated.
All remediation efforts, if any are required, are expected to be
completed by April 30, 1999;
- Phase 4 -- Test and validate remediated and replacement systems, if any
such remediation or replacement is required, to ensure inter-system
compliance and mission critical system functionality. The testing and
validation efforts, if any are required, are expected to be completed by
May 31, 1999;
- Phase 5 -- Deploy and implement remediated and replacement systems, if
any deployment or implementation is required, after the completion of
successful testing and validation. The deployment and implementation of
the remediated or replacement systems, if any is required, are expected
to be completed by October 31, 1999; and
- Phase 6 -- Design contingency and business continuation plans in the
event of the failure of business systems and processes,
telecommunications systems, facilities, data-networking infrastructure,
commercial-off-the-shelf hardware, software and components used by the
Company's employees due to the
24
25
Year 2000 millennium change. The initial contingency and business
continuation plan is expected to be in place by December 31, 1998.
Based on its initialinventory and assessment to date, the Company believes that
its internal mission critical systems are Year 2000 compliant. The Company, in
its normal course of business, anticipates replacing or upgrading, prior to the
milleniummillennium change, portions of these systems with new systems which will also be
Year 2000 compliant. Currently, the Company is enhancing its back-office and
registration-related systems and the software relating to its core domain name
registration services business. When complete in 1999, this enhancement effort
will result in replacing portions of the existing registration-related systems
which will be procured from vendors as Year 2000 compliant and will be subjected
to both component and end-to-end testing and validation to ensure the Year 2000
compliance of such systems prior to acceptance and deployment in the Company's
business. This enhancement effort is a function of the Company's business growth
and not a Year 2000 remediation effort.
Based on its inventory and assessment to date, the Company believes that
its facilities and telecommunications systems are Year 2000 compliant. The
Company has conducted detailed assessments of the components of its
telecommunications infrastructure and is working to identify appropriate system
testing guidelines. In addition, the Company is seeking assurances from its
facilities' landlords and telecommunications equipment vendors and data circuit
providers regarding the Year 2000 compliance of their facilities and equipment.
In the event of electrical power interruption outside of the Company's control,
the Company has deployed back-up power systems capable of operating its core
business indefinitely.
At this time, the Company believes that its incremental remediation costs,
if any, needed to make its current business systems and processes, including the
Internet root servers under the Company's control, telecommunications systems,
facilities, data-networking infrastructure, commercial-off-the-shelf hardware,
software and components used by its employees Year 2000 compliant are not
material. Failure ofWhile the Company is incurring some incremental costs directly
relating to staff augmentation for the Year 2000 program management and
technical assessment, the costs expended by the Company through October 31, 1998
are less than $100,000. The Company's expected total costs, including
remediation and replacement costs, if any, new systemare estimated to be between $500,000
and $1,000,000 over the life of the Year 2000 compliant despiteproject. Since portions of the
vendors'
assurances, ormission critical back office and domain name registration-related systems will
generally be replaced as a failurefunction of business growth, the labor and capital
costs associated with such replacement systems are not directly attributed to
fully identify or remediate anyachieving Year 2000 problems
in the Company's systems which are not being replaced or upgraded could have a
material adverse effect on the Company's business, financial condition or
results of operations.
In addition, thecompliance.
The Company is contacting its other hardware and software suppliers
andvendors, other
significant suppliers, outsourcing service providers outsourcing vendors and other contracting
parties to determine the extent to which the Company is vulnerable to any such
third parties'
systems and products are or will beparty's failure to achieve Year 2000 compliant.compliance for their own systems. At
the present time, the Company does not expect Year 2000 issues of any such third
parties to materially affect the Company's services.business. Furthermore, the Company's
business depends on the continued operation of, and widespread access to, the
Internet. This, in turn, depends to a large extent on the software applications and systems of
third parties on which the
Company's systems rely or to which they are connected includingor of other
Internet-related companies, such asincluding Internet web hosting companies, Internet
access providers and Internet root server operators and
the companies that maintain the Internet "backbone."operators. The Company can give no
assurances that the systems of such companies will be Year 2000 compliant or
that the failure of such third parties to achieve Year 2000 compliance will not
have a material adverse effect on the Company. To the extent that the normal
16
17
operation of the Internet is disrupted by the Year 2000 milleniummillennium change, the
Company's business, financial condition or results of operations could be
materially and adversely affected.
Technological ChangeShould the Company fail to solve a Year 2000 compliance problem to its
mission critical business systems and Additional Technology, Productsprocesses, including the Internet root
servers under the Company's control, telecommunications systems, facilities,
data-networking infrastructure, commercial-off-the-shelf hardware, software and
Services.components used by its employees the result could be a failure or interruption
to normal business operations. The Company believes that, with the deployment of
the new back office and domain name registration related systems in 1999, the
potential for significant interruptions to normal operations should be
minimized. The
25
26
Company's future financial success will be highly dependent uponprimary risks with regard to Year 2000 failures are those which impact
its domain name registration business. The reasonably likely worst case risks
inherent in the Company's business are as follows:
- Significant and protracted interruption of electrical power to data and
call-center operations in the Company's engineering facility could
materially and negatively impact the Company's ability to developprovide data
and commercializecall-center operations. To mitigate this risk, the Company has
deployed back-up power systems capable of operating indefinitely.
However, electrical power interruptions that impact Internet connectivity
providers could adversely impact the Company because of the Company's
reliance upon Internet-based operations for its day to day business.
- Significant and protracted interruption of telecommunications and data
network services in either of the Company's headquarters or engineering
facilities could materially and negatively impact the Company's ability
to provide data and call-center operations. The Company has conducted
detailed assessments of the components of its telecommunications
infrastructure and is working to identify appropriate system testing
guidelines. As part of the technical assessment scheduled for completion
by the end of 1998, the Company will have identified the compliance
status of its data networking infrastructure and developed plans for
remediation, if necessary. Finally, the Company has plans to seek
additional assurances and a timely mannerbetter understanding of the compliance
programs of its telecommunications and data circuit providers.
- The failure of components of the Company's current back office and domain
name registration related systems could materially and negatively impact
the Company's business. However, as a function of business growth, these
systems are planned to be retired before the end of 1999. As a
contingency planning measure, the Company is conducting a technical
assessment of the current systems and their software applications in the
event that the deployment of the new technology,systems is delayed beyond December
1999.
- Despite the assurances of the Company's third-party suppliers, hardware
and software vendors, and outsourcing service providers regarding the
Year 2000 compliance of their products and services, the potential exists
that can be offered in conjunction with the Company's current domain
name registrationa Year 2000 problem relating to such third-party suppliers, vendors
and consulting services and that can meet the changing
requirements of its current and future customers. The market for such
technology,outsourcing service providers products and services is characterized by rapidly changing
technology, evolving industry standards and frequent introductions of new
Intranet and Internet-related products and services. Generally, the successful
development and commercialization of new technology, products and services
involves many risks, including the identification of new Intranet and
Internet-related product and service opportunities, the successful completion of
the development process, and the identification, retention and hiring of
appropriate research, development and technical personnel. There can be no
assurance that the Company can successfully identify new product and service
opportunities and develop and bring to market in a timely manner new
technologies, products or services, or that technologies, products or services
developed by others will not render those of the Company noncompetitive or
obsolete. Failure by the Company to develop new technologies, products or
services and bring them to market in a timely manner could have a
material adverse effectimpact on the Company's business, financial conditionbusiness. The Company is conducting
monthly discussions with its mission critical outsourcing service
providers to determine the progress of their Year 2000 compliance
programs.
Despite the Company's belief that its mission critical computer software
applications and results of
operations.
Intellectual Property Rights. If it were determinedsystems are Year 2000 compliant and the expectation that the Company does
not have ownership rightsits
enhancement effort will result in its database of informationYear 2000 compliant back-office and
registration-related systems and software relating to customers
in its core domain name
registration services business, or if the Company is unablecurrently developing a business
continuation contingency plan and is performing a test on the existing core
registration-related systems that are being replaced. The Company expects to
protect such rights
in this database orfinalize its initial contingency plan and to complete the testing of all
existing systems by December 31, 1998.
Although the Company is requiredtaking appropriate steps relative to share the database with potential
competitors, there could be a material adverse effect onensuring that
the Company's business financial condition and resultsis not impacted by the date transitions associated with
the Year 2000, the Company has no responsibility for, nor control over other
Internet root server operators or tens of operations. The U.S. government states inthousands of lower level domain name
system server operators that are critical to the Statement of Policy that "the U.S. Government expects [the Company] to agree to
make available on an ongoing basis appropriate databases, software,
documentation thereof, technical expertise, and other intellectual property for
DNS management and shared registration of domain names." If certainefficient operation of the
Company'sInternet. The Company has no way of knowing whether such root server operators
or other server operators have hardware, software or firmware that is Year 2000
compliant. The Company is notifying various federal government authorities of
this issue and data generatedrequesting that the necessary steps be taken to ensure the
uninterrupted and efficient operation of the Internet.
Forward-Looking Statements
The foregoing Year 2000 discussion contains "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995. Such
statements, including without limitation, anticipated costs and the dates by
which is proprietary to the Company expects to complete certain actions, are based on management's
best current estimates, which were to be provided toderived utilizing numerous assumptions about
future events, including the new corporation and in turn provided to competing
registries or registrars, the Company's business, financial condition and
resultscontinued availability of operations could be materially and adversely affected.
The Company relies upon a combination of nondisclosure and other
contractual arrangements with its employees andcertain resources,
representations received from third parties and trade secret
laws to protect its proprietary rights and limit the distribution of its
proprietary information. There can be no assurance that the steps taken by the
Company in this regard will be adequate to deter misappropriation of proprietary
information or that the Company will be able to detect unauthorized use of its
proprietary information and take appropriate steps to enforce its intellectual
property rights. Furthermore, even if these steps are successful,other factors.
26
27
However, there can be no assuranceguarantee that othersthese estimates will be achieved, and
actual results could differ materially from those anticipated. Specific factors
that might cause such material differences include, but are not develop technologies that are similar or
superiorlimited to, the
Company's proprietary technology. Althoughability to identify and remediate all relevant systems, results of Year 2000
testing, adequate resolution of Year 2000 issues by governmental agencies,
businesses and other third parties who are outsourcing service providers,
suppliers, and vendors of the Company, believes
that its services do not infringeunanticipated system costs, the adequacy
of and ability to implement contingency plans and similar uncertainties. The
"forward-looking statements" made in the foregoing Year 2000 discussion speak
only as of the date on the intellectual property rights of otherswhich such statements are made, and that it has all rights necessary to utilize the intellectual property
employed in its business, the Company
undertakes no obligation to update any forward-looking statement to reflect
events or circumstances after the date on which such statement is subjectmade or to
reflect the riskoccurrence of claims alleging
infringement of third party intellectual property rights. Any such claims could
require the Company to spend significant sums in litigation, pay damages and
develop noninfringing intellectual property or acquire licenses to the
intellectual property that is the subject of asserted infringement. Failure by
the Company to adequately protect its proprietary rights or litigation relating
to intellectual property rights could have a material adverse effect on the
Company's business, financial condition and results of operations.
Shares Eligible for Future Sale. SAIC owns 100% of the Company's
outstanding Class B common stock, which, as of August 7, 1998, represented
approximately 74.3% of the outstanding common stock of the Company. A decision
by SAIC to sell such shares could materially and adversely affect the market
price of the Class A common stock. The Company and SAIC have entered into a
registration rights agreement which requires the Company to effect a
registration statement covering some or all of the shares of Class A common
stock to be owned by SAIC upon conversion of the Class B common stock owned by
SAIC and any other shares of Class A common stock otherwise acquired by SAIC,
subject to certain terms and conditions. The Company has agreed to indemnify
SAIC in connection with any such registration.
17
18
In certain circumstances, including without limitation, a public offering
or distribution of Class B common stock by SAIC, the Class B common stock would
trade separately from the Class A common stock in the public market. Separate
trading of the Class B common stock in the public market or the perception that
such trading could occur, could materially and adversely affect the market price
of the Class A common stock.
Possible Volatility of Stock Price. The market price of the shares of
Class A common stock at times has been highly volatile and may be significantly
affected by factors such as actual or anticipated fluctuations in the Company's
results of operations, announcements of technological innovations, developments
in Internet governance, announcement of additional competing registries,
registrars or TLDs, litigation costs, results of litigation, introduction of new
products or services by the Company or its competitors, developments with
respect to patents, copyrights or proprietary rights, conditions and trends in
the networking and other technology industries, changes in or failure by the
Company to meet securities analysts' expectations, general market conditions and
other factors. In addition, the stock market has from time to time experienced
significant price and volume fluctuations that have particularly affected the
market prices for the common stocks of technology companies. These broad market
fluctuations may adversely affect the market price of the Company's Class A
common stock. In the past, following periods of volatility in the market price
of a particular company's securities, securities class action litigation has
often been brought against that company. There can be no assurance that such
litigation will not occur in the future with respect to the Company. Such
litigation could result in substantial costs and a diversion of management's
attention and resources, which could have a material adverse effect upon the
Company's business, financial condition and results of operations.unanticipated events.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not Applicable.
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PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
As of AugustNovember 1, 1998, the Company was a defendant in threetwo active lawsuits
involving domain name disputes between trademark owners and domain name holders.
The Company is drawn into such disputes, in part, as a result of claims by
trademark owners that the Company is legally required, upon request by a
trademark owner, to terminate the right the Company granted to a domain name
holder to register a domain name which is alleged to be similar to the trademark
in question. Further, trademark owners also have alleged that the Company should
be required to monitor future domain name registrations and to reject
registrations of domain names which are identical or allegedly similar to the
trademark owners' federally registered trademarks. The holders of the domain name registrations in dispute have, in
turn, questioned the Company's right, absent a court order, to take any action
which suspends their use of the domain names in question. Although 43 out of
approximately 4,000 of these situations have resulted in suits actually naming
the Company as a defendant, as of AugustNovember 1, 1998, no adverse judgment has been
rendered and no award of damages has ever been made against the Company. The
Company believes that it has meritorious defenses and vigorously defends itself
against these claims from both sides.
On June 27, 1997, SAIC received a Civil Investigative Demand ("CID") from
the U.S. Department of Justice ("DOJ") issued in connection with an
investigation to determine whether there is, has been, or may be an antitrust
violation under the Sherman Act relating to Internet registration products and
services. The CID seeks documents and information from SAIC and the Company
relating to their Internet registration business. The Company cannot reasonably
estimate the potential impact of the investigation nor can it predict whether a
civil action may ultimately be filed by the DOJ, or the form of relief that
might be sought. Any such relief from such a suit could have a material adverse
effect on the Company's business, financial condition and results of operations.claims.
On March 20, 1997, PG Media, Inc., a New York-based corporation ("PG
Media"), filed a lawsuit against the Company in the United States District
Court, Southern District of New York alleging that the
18
19 Company had restricted
access to the Internet by not adding PG Media's requested TLDs to the Internet
root zone system in violation of the Sherman Act. In its complaint, PG Media
has, in addition to requesting damages, asked that the Company be ordered to
include reference to PG Media's TLDs and name servers in the root zone file
administered by the Company under the Cooperative Agreement. The Company
answered the complaint. In June 1997, the Company received written direction
from the NSF not to take any action which would create additional TLDs or to add
any new TLDs to the Internet root zone until the NSF provides further guidance.
On September 17, 1997, PG Media filed a Second Amended Complaint adding the NSF
as a defendant. On May 14, 1998, PG Media served the Company with a motion for a
preliminary injunction against both defendants. The motion sought a hearing
before the court on June 8, 1998 to compel both defendants to add PG Media's
TLDs to the Internet root zone within 30 days. On July 20, 1998, a hearing on
all parties' motions occurred. The Company believes that
itbasic issue before the court is the NSF's
authority to control the Internet's root zone system. The court has meritorious defensestaken the
issue under advisement and intends to vigorously defend itself against such
motion andno date has been indicated for the claimsissuance of PG Media.a
decision. Although the Company cannot reasonably estimate the potential impact
of such claims, a successful claim under the plaintiff's theory could have a
material adverse effect on the Company's business, financial condition and
results of operations. On July 20, 1998, a
hearing on all parties' cross-motions for summary judgment occurred. The issue
before the Court is the NSF's authority to control the Internet's root zone
system. The Court has taken the issue under advisement and no date has been
indicated for the issuance of the decision.
On October 17, 1997, a group of six plaintiffs filed a lawsuit (the "Thomas
suit") against the Company and the NSF in the United States District Court,
District of Columbia, challenging the legality of fees defendants charge for the
registration of domain names on the Internet and seeking restitution of fees
collected from domain name registrants in an amount in excess of $100 million,
damages, and injunctive and other relief. Plaintiffs originally alleged
violations of the Competition in Contracting Act ("CICA"), the Sherman Act and
the U.S. Constitution. Following the filing of motions to dismiss by the
defendants, the plaintiffs filed an amended complaint on January 30, 1998,
dropping the cause of action based upon CICA, but adding alleged violations of
the Administrative Procedures Act and the Independent Offices Appropriations
Act. The plaintiffs also filed a motion for preliminary injunctive relief
against the NSF concerning the "Intellectual Infrastructure Fund." On February
2, 1998, the United States District Court, District of Columbia, issued an order
granting the plaintiffs' motion for a preliminary injunction, enjoining the NSF
from spending any of the money collected by the Company for the Intellectual
Infrastructure Fund. On February 10, 1998, the plaintiffs filed a motion for
preliminary injunction against the Company seeking several items of relief. On
February 24, 1998, the Company and the NSF filed motions to dismiss the amended
complaint. Also on February 24, the plaintiffs filed a motion for partial
summary judgment concerning the Intellectual Infrastructure Fund. The
plaintiffs' motion for preliminary injunction against the Company and partial
summary judgment against the NSF, and both motions to dismiss were heard before
the Court on March 17, 1998. On April 6, 1998, the Court issued its opinion
granting summary judgment in favor of the plaintiffs on the Intellectual
Infrastructure Fund, ruling it an "unlawful tax." The Courtcourt also granted the
Company's motion to dismiss all other counts (II through X) and simultaneously
denied the plaintiffs' preliminary injunction motion against the Company.
Subsequently, the NSF appealed the February 2, 1998 preliminary injunction
against it. On April 30, 1998, Congress passed H.R. 3579 which was signed into
law by
28
29
the President on May 1, 1998. Section 8003 of H.R. 3579 legalized, ratified and
confirmed the entire Intellectual Infrastructure Fund and authorized and
directed the NSF to deposit the entire fund into the U.S. Treasury. On May 5,
1998, the NSF filed a motion to vacate the preliminary injunction and to dismiss
the case. On June 4, 1998, the plaintiffs filed a Noticenotice of Appealappeal on the
Court's dismissal of counts II through X and on the Court's denial of plaintiffs'plaintiff's motion for
preliminary injunction against the Company. On JulyJune 27, 1998, the United States
Court of Appeals for the District of Columbia Circuit dismissed the plaintiffs'
appeal of the Court's dismissal of counts II through X at this juncture in the
case. Currently,On August 28, 1998, the District Court dismissed the entire case, issuing
a final judgment in the matter. Following that decision, the plaintiffs
dismissed all motionspending appeals in the Court of Appeals. The plaintiffs, however,
on October 23, 1998, filed a new notice of appeal from the final order filed by
the District Court on August 28, 1998.
On June 27, 1997, SAIC received a CID from the DOJ issued in connection
with an investigation to determine whether there is, has been, or may be any
antitrust violation under the Sherman Act relating to Internet registration
products and services. The CID seeks documents and information from SAIC and the
plaintiffs' remaining appeal are pending.Company relating to their Internet registration business. The Company cannot
reasonably estimate the potential impact of the investigation nor can it predict
whether a civil action may ultimately be filed by the DOJ or the form of relief
that might be sought. Any such relief from such a suit could have a material
adverse effect on the Company's business, financial condition and results of
operations.
On August 17, 1998, the Company received notice from the Commission of the
European Communities of an investigation concerning the Company's Premier
Program agreements in Europe. The EC requested production of these agreements
and related materials for review. The Company cannot reasonably estimate the
potential impact of the investigation nor can the Company predict whether an
action will ultimately be brought by the EC or the form of relief that might be
sought. Any such relief could have a material adverse effect on the Company's
business, financial condition and results of operations.
The Company is involved in various other investigations, claims and
lawsuits arising in the normal conduct of its business, none of which, in the
opinion of the Company's management, will have a material adverse effect on its
financial position, results of operations, cash flows or its ability to conduct
business.
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20
Litigation in which the Company is involved has resulted and likely will
result in, and any future litigation can be expected to result in, substantial
legal and other expenses to the Company and a diversion of the efforts of the
Company's personnel.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
The Company's Registration Statement on Form S-1 (Registration No.
333-30705) was declared effective September 25, 1997 by the Securities and
Exchange Commission. The managing underwriters of the Class A common stock
offering commencing September 26, 1997 were Hambrecht & Quist, J.P. Morgan & Co.
and PaineWebber Incorporated. The Company registered and sold 3,220,000 shares
for its own account at an aggregate price of $57,960,000 and the selling
stockholder (SAIC) registered and sold 575,000 shares for its account at an
aggregate price of $10,350,000, for a combined total of 3,795,000 shares at an
aggregate price of $68,310,000. The offering has since terminated.
The total amount of expenses incurred for the Company's account in
connection with the offering were $5,555,200, which is comprised of $4,057,200
for underwriting discounts and commissions and $1,498,000 of other expenses. No
expenses were paid to directors, officers or persons owning more than ten
percent of any class of the Company's equity securities. The resultant Company's
net offering proceeds were $52,404,800. The net proceeds to SAIC for its account
were $9,625,500 after deducting the associated underwriting discounts and
commissions of $724,500.
On October 1, 1997, the Company received the offering proceeds from which a
$10,000,000 dividend was paid to SAIC. SAIC owns ten percent or more of a class
of the Company's equity securities and is an affiliate of the Company. The
remaining proceeds have been invested in investment grade government discount
notes, commercial paper and corporate bonds.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The Company's Annual Meeting of Stockholders was held on May 19, 1998 (the
"Annual Meeting"). At the Annual Meeting, stockholders voted on four matters:
(i) the election of nine directors; (ii) the approval of the Company's 1997
Employee Stock Purchase Plan; (iii) the approval of the Company's 1996 Stock
Incentive Plan, as amended; and (iv) the ratification of the appointment of
Price Waterhouse LLP (effective July 1, 1998, PricewaterhouseCoopers LLP) as the
Company's independent accountants for the period ending December 31, 1998. The
stockholders elected management's nominees as the directors in an uncontested
election, approved the Company's 1997 Employee Stock Purchase Plan and 1996
Stock Incentive Plan and ratified the appointment of Price Waterhouse LLP as the
Company's independent accountants by the following votes, respectively:
(i) Election of directors:
DIRECTOR VOTES FOR VOTES WITHHELD
-------- ----------- --------------
Gabriel A. Battista....................................... 122,306,075 5,150
Michael A. Daniels........................................ 122,306,275 4,950
Donald N. Telage.......................................... 122,305,975 5,250
J. Robert Beyster......................................... 122,305,575 5,650
Craig I. Fields........................................... 122,305,375 5,850
John E. Glancy............................................ 122,304,775 6,450
J. Dennis Heipt........................................... 122,304,775 6,450
William A. Roper, Jr...................................... 122,305,075 6,150
Stratton D. Sclavos....................................... 122,305,375 5,850
(ii) Approval of 1997 Employee Stock Purchase Plan ("1997 Plan"):
VOTES FOR VOTES AGAINST ABSTENTIONS
----------- ------------- -----------
1997 Plan........................................ 120,563,069 154,815 11,120
2029
21
(iii) Approval of 1996 Stock Incentive Plan ("1996 Plan"):
VOTES FOR VOTES AGAINST ABSTENTIONS
----------- ------------- -----------
1996 Plan........................................ 120,094,202 652,187 11,825
(iv) Ratify Appointment of Price Waterhouse LLP:
VOTES FOR VOTES AGAINST ABSTENTIONS
----------- ------------- -----------
Ratify Appointment............................... 122,302,333 4,400 4,492
For further discussion of these matters, see the Company's definitive Proxy
Statement for the May 19, 1998 Annual Meeting of Stockholders, which was filed
with the Commission on April 14, 1998.30
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits -- See Exhibit Index
(b) ReportsThe Company filed a report on Form 8-K -- None
21on October 6, 1998 announcing
that it had entered into an amendment to its Cooperative Agreement with
the United States Department of Commerce (the "Amendment"). A copy of
the Amendment and a press release related thereto were filed as
exhibits to the Form 8-K.
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2231
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NETWORK SOLUTIONS, INC.
Date: August 14, 1998 ByBy: /s/ ROBERT J. KORZENIEWSKI
------------------------------------
Robert J. Korzeniewski
Chief Financial Officer, Acting
Chief Operating Officer and
Authorized Signatory
22Date: November 16, 1998
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EXHIBIT INDEX
NETWORK SOLUTIONS, INC.
EXHIBIT
NO. DESCRIPTION OF EXHIBITS
- - ------- -----------------------
10.22 Amendment No. 10 to the Cooperative Agreement dated
September 29, 1998
27.1 Financial Data Schedule
2332