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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 SEPTEMBER 30, 1998MARCH 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________ TO ________
COMMISSION FILE NUMBER: 0-22967
NETWORK SOLUTIONS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 52-1146119
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR IDENTIFICATION NO.)
ORGANIZATION)
505 HUNTMAR PARK DRIVE
HERNDON, VIRGINIA 20170
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(703)742-0400
(ADDRESS, INCLUDING ZIP CODE, AND(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)CODE)
Indicate by check mark whether the Registrant: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
Registrantregistrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
As of November 6, 1998,May 10, 1999, the Registrant had 4,168,20218,424,134 shares of Class A common
stock, $0.001 par value per share, issued and outstanding, and 11,925,00014,850,000 shares
of Class B common stock, $0.001 par value per share, issued and outstanding.
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PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Statements of Financial Position as of December
31, 19971998 and September 30, 1998 (unaudited)...............March 31, 1999 (Unaudited)................... 3
Unaudited Condensed Statements of Operations for the three
and nine months ended September 30, 1997March 31, 1998 and 1998.........1999...................... 4
Unaudited Condensed Statements of Changes in Stockholders'
Equity for the ninethree months ended September 30, 1998.......March 31, 1999.......... 5
Unaudited Condensed Statements of Cash Flows for the ninethree
months ended September 30, 1997March 31, 1998 and 1998..................1999...................... 6
Notes to Condensed Financial Statements..................... 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of
Operations................................................ 9
Item 3. Quantitative and Qualitative Disclosures About Market
Risk...................................................... 2725
PART II OTHER INFORMATION
Item 1. Legal Proceedings........................................... 2826
Item 2. Changes in Securities and Use of Proceeds................... 2927
Item 6. Exhibits and Reports on Form 8-K............................ 3027
Signature ............................................................ 31........................................................... 29
Index to Exhibits..................................................... 32Exhibits.................................................... 30
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PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
NETWORK SOLUTIONS, INC.
CONDENSED STATEMENTS OF FINANCIAL POSITION
DECEMBER 31, SEPTEMBER 30,
1997MARCH 31,
1998 1999
------------ -------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents................................. $ 41,146,00012,862,000 $ 9,124,00026,954,000
Short-term investments, marketable securities............. 40,200,000 107,876,000investments.................................... 118,808,000 121,544,000
Accounts receivable, net.................................. 5,792,000 13,922,00022,628,000 35,745,000
Prepaids and other assets................................. 1,005,000 1,512,0004,001,000 5,889,000
Deferred tax asset........................................ 20,153,000 30,941,000
Restricted assets......................................... 25,873,000 627,00040,508,000 56,954,000
------------ ------------
Total current assets........................................ 134,169,000 164,002,000198,807,000 247,086,000
Furniture and equipment, net................................ 6,146,000 9,579,00016,005,000 31,224,000
Long-term investments, marketable securities................ -- 6,272,000investments....................................... 13,590,000 53,223,000
Deferred tax asset.......................................... 8,128,000 11,292,00014,831,000 7,466,000
Goodwill, net............................................... 1,177,000 770,000634,000 498,000
------------ ------------
Total Assets................................................ $149,620,000 $191,915,000$243,867,000 $339,497,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities.................. $ 6,426,00028,287,000 $ 15,565,00029,350,000
Due to parent............................................. 1,250,000 2,587,000SAIC............................................... 4,766,000 4,578,000
Income taxes payable...................................... 5,042,000 3,090,0005,409,000 29,345,000
Current portion of capital lease obligations.............. 842,000 861,000834,000 761,000
Deferred revenue, net..................................... 43,789,000 77,766,000
Internet fund liability................................... 25,873,000 627,00093,720,000 119,912,000
------------ ------------
Total current liabilities................................... 83,222,000 100,496,000133,016,000 183,946,000
Capital lease obligations................................... 1,081,000 436,000247,000 100,000
Long-term deferred revenue, net............................. 17,662,000 28,964,00035,474,000 48,450,000
------------ ------------
Total liabilities........................................... 101,965,000 129,896,000168,737,000 232,496,000
Commitments and contingencies -- --
Stockholders' equity:
Preferred stock, $.001 par value, authorized 10,000,000
shares; none issued and outstanding in 19971998 and 1998...1999... -- --
Class A common stock, $.001 par value; authorized
100,000,000 shares; 3,795,0009,140,372 and 4,139,83818,390,684 issued and
outstanding in 19971998 and 1998............................................... 4,000 4,0001999........................... 9,000 18,000
Class B common stock, $.001 par value; authorized
30,000,000 shares; 11,925,00023,850,000 and 14,850,000 issued and
outstanding in 19971998 and 1998..... 12,000 12,0001999........................... 24,000 15,000
Additional paid-in capital................................ 56,451,000 63,147,000
Accumulated deficit....................................... (8,812,000) (1,295,000)72,331,000 77,046,000
Retained earnings......................................... 2,407,000 7,205,000
Accumulated other comprehensive income.................... -- 151,000359,000 22,717,000
------------ ------------
Total stockholders' equity.................................. 47,655,000 62,019,00075,130,000 107,001,000
------------ ------------
Total Liabilities and Stockholders' Equity.................. $149,620,000 $191,915,000$243,867,000 $339,497,000
============ ============
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
NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,MARCH 31,
-------------------------
-------------------------
1997 1998 1997 1998
----------- -----------1999
----------- -----------
Net revenue............................... $12,172,000 $25,427,000 $30,896,000 $62,395,000revenue................................................. $16,492,000 $38,132,000
Cost of revenue........................... 7,033,000 10,312,000 18,468,000 26,451,000
----------- -----------revenue............................................. 7,348,000 14,541,000
----------- -----------
Gross profit.............................. 5,139,000 15,115,000 12,428,000 35,944,000profit................................................ 9,144,000 23,591,000
Research and development expenses......... 377,000 1,353,000 1,095,000 2,893,000expenses........................... 725,000 2,035,000
Selling, general and administrative expenses................................ 3,105,000 10,248,000 7,893,000 24,438,000expenses................ 6,182,000 15,265,000
Interest income........................... (570,000) (1,680,000) (1,054,000) (4,423,000)income............................................. (1,327,000) (1,930,000)
Other expenses............................ -- 26,000 -- 93,000
----------- -----------expenses.............................................. 35,000 19,000
----------- -----------
Income before income taxes................ 2,227,000 5,168,000 4,494,000 12,943,000taxes.................................. 3,529,000 8,202,000
Provision for income taxes................ 995,000 2,163,000 2,006,000 5,426,000
----------- -----------taxes.................................. 1,480,000 3,404,000
----------- -----------
Net income................................income.................................................. $ 1,232,0002,049,000 $ 3,005,000 $ 2,488,000 $ 7,517,000
=========== ===========4,798,000
=========== ===========
Earnings per common share:
Basic...................................Basic..................................................... $ 0.100.07 $ 0.19 $ 0.20 $ 0.470.14
=========== ===========
=========== ===========
Diluted.................................Diluted................................................... $ 0.100.06 $ 0.18 $ 0.20 $ 0.45
=========== ===========0.14
=========== ===========
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 OTHER
RETAINED TOTAL
-------------------------------------- -------------------- PAID-IN COMPREHENSIVE EARNINGS STOCKHOLDERS'RETAINED COMPREHENSIVE
SHARES AMOUNT SHARES AMOUNT CAPITAL INCOME (DEFICIT) EQUITY
--------- ------EARNINGS INCOME
---------- ------- ---------- ------- ----------- ------------- --------------------- -------------
Balance, December 31,
1997.................... 3,795,000 $4,000 11,925,000 $12,000 $56,451,000 $(8,812,000) $47,655,0001998.................. 9,140,000 $9,000 23,850,000 $24,000 $72,331,000 $ 359,000 $2,407,000 $ --
Issuance of common
stock pursuant to
stock plans................... 344,838 4,456,000 4,456,000plans........... 251,000 -- -- -- 1,809,000 -- -- --
Tax benefit associated
with stock plans............. 2,240,000 2,240,000
Unrealized gain on
securities.............. $151,000 151,000plans...... -- -- -- -- 2,906,000 -- -- --
Conversion of Class B
Common Stock.......... 9,000,000 9,000 (9,000,000) (9,000) -- -- -- --
Comprehensive income:
Net income for the
nine
monthsperiod ended September
30, 1998................ 7,517,000 7,517,000
--------- ------March 31,
1999.................. -- -- -- -- -- -- 4,798,000 4,798,000
Other comprehensive
income, net of tax:
Unrealized gains on
securities............ -- -- -- -- -- 22,358,000 -- 22,358,000
-----------
Comprehensive income... -- -- -- -- -- -- -- $27,156,000
---------- ------- ---------- ------- ----------- -------- ----------- --------------------- ===========
Balance, September 30,
1998.................... 4,139,838 $4,000 11,925,000 $12,000 $63,147,000 $151,000 $(1,295,000) $62,019,000
========= ======March 31,
1999.................. 18,391,000 $18,000 14,850,000 $15,000 $77,046,000 $22,717,000 $7,205,000
========== ======= ========== ======= =========== ======== =========== =====================
TOTAL
STOCKHOLDERS'
EQUITY
-------------
Balance, December 31,
1998.................. $ 75,130,000
Issuance of common
stock pursuant to
stock plans........... 1,809,000
Tax benefit associated
with stock plans...... 2,906,000
Conversion of Class B
Common Stock.......... --
Comprehensive income:
Net income for the
period ended March 31,
1999.................. 4,798,000
Other comprehensive
income, net of tax:
Unrealized gains on
securities............ 22,358,000
Comprehensive income... --
------------
Balance, March 31,
1999.................. $107,001,000
============
The accompanying notes are an integral part of these financial statements.
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NETWORK SOLUTIONS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINETHREE MONTHS ENDED
SEPTEMBER 30,MARCH 31,
---------------------------
1997 1998 1999
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................ $ 2,488,0002,049,000 $ 7,517,0004,798,000
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization.......................... 1,635,000 2,613,000717,000 1,474,000
Provision for uncollectible accounts receivable........ 5,577,000 2,168,000 --
Deferred income taxes.................................. (9,649,000) (14,061,000)(4,603,000) (25,271,000)
Tax benefit associated with stock plans................ -- 2,240,000
Changes2,906,000
Change in operating assets and liabilities:
Decrease (increase)Increase in accounts receivable........... 348,000 (10,298,000)receivable...................... (4,092,000) (13,117,000)
Increase in prepaids and other assets................ (896,000) (507,000)(126,000) (1,888,000)
Increase in accounts payable and accrued
liabilities....................................... 1,811,000 9,139,000
Decrease579,000 1,063,000
Increase in income taxes payable..................... -- (1,952,000)2,202,000 23,936,000
Increase in deferred revenue......................... 25,156,000 45,279,00011,069,000 39,168,000
------------ ------------
Net cash provided by operating activities............ 26,470,000 42,138,0009,963,000 33,069,000
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of furniture and equipment....................... (1,254,000) (5,639,000)(622,000) (16,557,000)
Purchase of short-term investments, net................... (28,321,000) (67,676,000)(38,681,000) (1,821,000)
Purchase of long-term investments......................... -- (6,012,000)(6,152,000) (2,000,000)
------------ ------------
Net cash used in investing activities................ (29,575,000) (79,327,000)(45,455,000) (20,378,000)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net transactions with SAIC................................ 6,627,000 1,337,0001,129,000 (188,000)
Repayment of capital lease obligations.................... -- (626,000)(205,000) (220,000)
Issuance of common stock pursuant to stock plans.......... -- 4,456,000253,000 1,809,000
------------ ------------
Net cash provided by financing activities............ 6,627,000 5,167,0001,177,000 1,401,000
------------ ------------
Net increase (decrease) in cash and cash equivalents........ 3,522,000 (32,022,000)(34,315,000) 14,092,000
Cash and cash equivalents, beginning of period.............. 15,540,000 41,146,000 12,862,000
------------ ------------
Cash and cash equivalents, end of period.................... $ 19,062,0006,831,000 $ 9,124,00026,954,000
============ ============
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") has actedcurrently acts as the exclusive registrarregistry and registryregistrar of
Internet domain names within the .com, .org, .net and .edu top level domains
("TLDs") under a cooperative agreement (as
amended,pursuant to the "Cooperative Agreement")Cooperative Agreement with the National Science Foundation
("NSF") and, currently, the Department of Commerce's National Telecommunications
and Information Administration ("NTIA").Commerce. Domain
names are used to identify a unique site or presence on the Internet. As
registrarregistry and registryregistrar for these TLDs, the Companytop level domains, Network Solutions registers
new domain names and is responsible for the maintenance and dissemination of the master file of
domain names through daily updates to the Internet. The CompanyNetwork Solutions also
provides enterprise network consultingInternet Technology Services, focusing on architecture, implementation
and support services to help large companies, focusing on network engineering, networkenterprises and systems security and network management.Internet service providers
improve their operational effectiveness.
NOTE 2 -- SIGNIFICANT ACCOUNTING POLICIES
INTERIM FINANCIAL STATEMENTS
The interim financial statements have been prepared by the Company,Network Solutions
without audit, pursuant to the rules and regulations of the Securities and
Exchange Commission ("SEC"). In the opinion of management, financial statements
included in this report reflect all normal recurring adjustments which the CompanyNetwork
Solutions considers necessary for fair presentation of the results of operations
for the interim periods covered and of the financial position of the CompanyNetwork
Solutions 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 CompanyNetwork
Solutions 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'sNetwork
Solutions' December 31, 19971998 audited financial statements and notes thereto
included in the Company'sNetwork Solutions' Form 10-K annual report for the year ended
December 31, 1997.1998. Prior periods have been restated for comparative purposes.
NOTE 3 -- STOCK SPLIT AND SECONDARY STOCK OFFERING
STOCK SPLIT
On December 31, 1998, Network Solutions' board of directors approved a
two-for-one stock split of the shares of Class A common stock and Class B common
stock, to be effected in the form of a 100% stock dividend on shares of Class A
common stock and Class B common stock outstanding on February 26, 1999. The
stock dividend was distributed on March 23, 1999. Share and per share
information for all periods presented in the accompanying financial statements
have been adjusted to reflect the two-for-one stock split.
SECONDARY STOCK OFFERING
On February 12, 1999, Network Solutions completed a secondary stock
offering in which a total of 9,160,000 shares of Class A common stock were sold.
Concurrent with the offering, Science Applications International Corporation,
commonly known as "SAIC", converted 9,000,000 shares of Class B common stock
into 9,000,000 shares of Class A common stock sold in the offering. The
remaining 160,000 shares of Class A common stock were sold by other selling
stockholders after they exercised the applicable stock options simultaneously
with the closing of the offering. Network Solutions was not a selling
stockholder, and, therefore, did not receive any proceeds from the stock
offering other than proceeds from options exercised as part of the offering.
After the offering, SAIC owns approximately 89% of the combined voting power and
approximately 45% of the economic interest of the outstanding common stock.
By May 31, 1999, SAIC intends to convert all of the remaining Class B
common stock into an identical number of shares of Class A common stock. After
that conversion, Class A common stock will be the only
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class of common stock outstanding and SAIC will own approximately 45% of the
voting power and economic interest of Network Solutions' outstanding common
stock.
NOTE 4 -- COMPUTATION OF EARNINGS PER SHARE
The following is a reconciliation of the numerator and denominator used in
the basic and diluted earnings per share computations:
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
THREE MONTHS ENDED SEPTEMBER 30,MARCH 31, 1998
Basic.................................. $3,005,000 16,041,000 $0.19$2,049,000 31,453,000 $0.07
=====
Dilutive securities:
Outstanding options.................. -- 705,000824,000
---------- ----------
Diluted................................ $3,005,000 16,746,000 $0.18$2,049,000 32,277,000 $0.06
========== ========== =====
THREE MONTHS ENDED SEPTEMBER 30, 1997MARCH 31, 1999
Basic.................................. $1,232,000 12,502,000 $0.10$4,798,000 33,121,000 $0.14
=====
Dilutive securities:
Outstanding options.................. -- 118,0001,614,000
---------- ----------
Diluted................................ $1,232,000 12,620,000 $0.10
========== ========== =====
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INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
NINE MONTHS ENDED SEPTEMBER 30, 1998
Basic.................................. $7,517,000 15,888,000 $0.47
=====
Dilutive securities:
Outstanding options.................. -- 656,000
---------- ----------
Diluted................................ $7,517,000 16,544,000 $0.45
========== ========== =====
NINE MONTHS ENDED SEPTEMBER 30, 1997
Basic.................................. $2,488,000 12,501,000 $0.20
=====
Dilutive securities:
Outstanding options.................. -- 99,000
---------- ----------
Diluted................................ $2,488,000 12,600,000 $0.20$4,798,000 34,735,000 $0.14
========== ========== =====
Common shares issued are weighted for the period the shares were
outstanding and incremental shares assumed issued under the treasury stock
method for diluted earnings per shareEPS are weighted for the period the underlying options were
outstanding.
NOTE 45 -- ACCUMULATED OTHER COMPREHENSIVE INCOME 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.BALANCES
The changes in the components of accumulated other comprehensive income are
reported net of income taxes for the ninethree months ended September 30, 1998March 31, 1999 as
follows:
ACCUMULATED
OTHER
UNREALIZED GAINS COMPREHENSIVE
ON SECURITIES INCOME
---------------- -------------
Pre-tax amount.......................... $260,000 $260,000$38,547,000 $38,547,000
Income tax.............................. 109,000 109,000
-------- --------taxes............................ 16,189,000 16,189,000
----------- -----------
Net of tax amount....................... $151,000 $151,000
======== ========$22,358,000 $22,358,000
=========== ===========
NOTE 56 -- RESTRICTED ASSETS
UnderSUBSEQUENT EVENTS
LITIGATION
On May 14, 1999, the termsU.S. Court of Appeals for the District of Columbia
Circuit unanimously affirmed Federal District Court Judge Thomas F. Hogan's
decision in Thomas v. Network Solutions and the National Science Foundation,
thus affirming the validation of Network Solutions' role in providing domain
name registration services and charging fees for such services. The lawsuit,
which had been filed in October 1997, named the National Science Foundation and
Network Solutions as defendants, and alleged that the National Science
Foundation lacked authority to permit Network Solutions to charge for Internet
registration services, and to set aside 30 percent of all fees for the
preservation and enhancement of the Internet's infrastructure. The suit further
had charged that the National Science Foundation had created an illegal monopoly
in Internet registration services and that Network Solutions had illegally
precluded competition.
On May 7, 1999, in the case of Bruce Watts v. Network Solutions, Inc., U.S.
District Court Judge Hamilton of the Southern District of Indiana granted
Network Solutions' motion to dismiss allegations of
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antitrust liability under the Sherman Act and also granted Network Solutions'
motion for summary judgment on allegations of contributory trademark
infringement under the Lanham Act. Watts had challenged Network Solutions'
first-come, first-served domain name registration policy, alleging that Network
Solutions failed to stop cybersquatting and violated the Sherman Act and Lanham
Act and the common law of unfair uncompetition.
On April 26, 1999, the Pennsylvania Attorney General dismissed Network
Solutions from a suit brought by the Pennsylvania Attorney General's Office
against a domain holder who was alleged to have used his domain name in
connection with a web site promoting white supremacy and threatening certain
state employees. Named in the suit were all of the communications companies in
any way connected with the domain name or web site.
STATUS OF COOPERATIVE AGREEMENT
On January 1, 1993, we initiated phase-in of a Cooperative Agreement with
the National Science Foundation. 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 14, 1995 amendment to1998. Effective in
September 1998, the responsibility for 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 relatingwas transferred
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 directionDepartment 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
Within 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 10, 1998, the NTIA published
in the Federal Register a plan referred to as the Statement of Policy or "White
Paper," calling for the formation of a not-for-profit corporation to assume
responsibility for administration of the domain name system ("DNS"), but which
is not expected to perform actual registration of 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. The Statement of
Policy calls for a separation of the registry 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 NTIA on the establishment and governance of
the not-for-profit corporation. A newly-formed U.S. based private not-for-profit
corporation denoted the Internet Corporation for Assigned Names and Numbers
("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 negotiations, the
process initiated by the Statement of Policy may result in U.S. Government
recognition of ICANN as the not-for-profit corporation under the Statement of
Policy. The NTIA plan calls for a phased transition of its responsibilities for
the DNS to the not-for-profit corporation over the period ending on September
30, 2000. Despite the significant efforts undertaken to date, 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 and, if it does,
the effect on the Company of such transition.Commerce. In October 1998, the Cooperative Agreement was
amended (the "October 1998
Amendment") to extend its termthe flexibility period through September 30, 2000. As the U.S.
Government transitions its authority over the DNS2000 and to 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. In the October 1998 Amendment, the Company and the
NTIA agreed to a plan for the
transition to a shared registration system,system.
In accordance with the terms of the October 1998 amendment to the
Cooperative Agreement, as amended in March 1999, we have developed a protocol
and associated software to support a Shared Registration System which will
permit multiple registrars may register domain namesto provide registration services within the top level
domains for which we will act as registry. Network Solutions has deployed its
proprietary Shared Registration System on schedule by establishing a test bed to
support actual registrations by five new registrars. We have entered into
license agreements with the singlefive new registrars to provide access to the Shared
Registration System, permitting them to directly register and maintain actual
domain names.
During the current 60-day test bed period, we have agreed to charge the new
registrars an interim registry fee of $18 for each TLD,new two-year registration. To
date, none of the new test bed registrars have completed their systems
development and testing to enable them to register actual names within the
Shared Registration System.
Network Solutions continues to work with the U.S. Government in
establishing the post-test bed registry price and other issues surrounding the
registry operations in a phased approach, the first phase of which is scheduled to be
completed by March 31, 1999.competitive environment.
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 CompanyNetwork Solutions are
intended to be forward-looking statements which may involve risk and
uncertainty. There are a number of factors that could cause the Company'sNetwork Solutions
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 1997Network Solutions' 1998 Form 10-K, as
filed with the SECSecurities and Exchange Commission on March 31, 1998.30, 1999. 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'sNetwork Solutions' 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 19971998 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 1997Network
Solutions' 1998 Form 10-K in order to have a more
9
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complete understanding of the principal risks associated with an investment in
the
Company'sNetwork Solutions' common stock.
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OVERVIEW
The CompanyNetwork Solutions currently acts as the registry and exclusive registrar and registry of
Internet domain names within the .com, .net, .org .net and .edu TLDstop level domains
pursuant to the Cooperative Agreement with the NTIA.Department of Commerce. Domain
names are used to identify a unique site or presence on the Internet. As
registrarregistry and registryregistrar for these TLDs, the
Companytop level domains, Network Solutions registers
new domain names, and is responsible for the maintenance and
dissemination ofmaintains the master file of domain names through dailyand updates that
master file to the Internet.
The CompanyInternet daily. Network Solutions also delivers enterprise network consulting services to large
companies that desire to establish or enhance theirprovides 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 includeTechnology Services, focusing on network engineering, network and systems
security and network management.management solutions.
Registration Services. In December 1992, the CompanyNetwork Solutions entered into
the Cooperative Agreement with the NSFNational Science Foundation under which
the CompanyNetwork Solutions was to provide Internet domain name registration services for
five TLDs:top level domains: .com, .org, .net, .edu and .gov. These registration
services include the initial two year domain name registration and 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 includesincluded a three-month phase-in period, a five-year operational
period, (commencingcommencing April 1, 1993 and ending March 31, 1998),1998, and a six-month
flexibility period through September 30, 1998. Effective September 9, 1998, the
NTIADepartment of Commerce took over the administration of the Cooperative Agreement
from the NSF. In October 1998, the Cooperative Agreement was amended and extendedto extend
the flexibility period until September 30, 2000.2000 and to transition to a shared
registration system.
The original terms of the Cooperative Agreement provided for a cost
reimbursement plus fixed-fee contract (with an initial fee of 8%).contract. Effective September 14, 1995, the
NSFNational Science Foundation and the CompanyNetwork Solutions amended the Cooperative
Agreement to require the CompanyNetwork Solutions to begin charging end users a services
fee of $50 per year for each domain name in the .com, .org and .net TLDs.top level
domains. 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 re-registrationre-
registration fee of $50 per year thereafter (collectively "registration fees").thereafter. The NSFNational Science Foundation
paid the registration fees for domain names within the .edu and .gov TLDstop level
domains through March 31, 1997. Commencing April 1, 1997, the CompanyNetwork Solutions
agreed with the NSFNational Science Foundation to provide domain name services
within the .edu and .gov TLDstop level domains free of charge. As of October 1,
1997, the CompanyNetwork Solutions no longer registers or administers domain names in the
.gov TLD.top level domain.
Under the terms of the September 14, 1995 amendment to the Cooperative
Agreement, 30% of the registration fees collected by the CompanyNetwork Solutions was
required to be set aside for the enhancement of the intellectual infrastructure
of the Internet and, as such, was 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.Network
Solutions. The set aside funds, plus any interest earned, arewere disbursed at the
direction of the NSF. To date,National Science Foundation. As of December 31, 1998, the
Company hashad cumulatively disbursed $62.2all set aside funds collected and associated
interest earned for a total of $62.3 million to the NSFNational Science Foundation
at their direction, and as of September
30, 1998, has a remaining restricted cash balance of approximately $627,000.direction.
On March 12, 1998, the NSF and the CompanyNetwork Solutions 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 re-registrationrenewal fee of $35 per year thereafter. This amendment
hashad no effect on the revenue currently recognized on each registration ($70 for initial
registrations and $35 for re-registrations)renewals), since the CompanyNetwork Solutions previously did not
recognize revenue on the 30% set aside funds. Accordingly, while the revenue to
the CompanyNetwork Solutions on a per registration basis doesdid not change, the amount charged
to customers declined.
In order to provide prompt access to new domain names on the Internet,
the
CompanyNetwork Solutions generally invoices customers and permits them to pay their
registration fees after their domain names are registered. The Company'sNetwork Solutions'
experience has been that, for the period from September 1995 through September 1998,March 1999,
approximately 30%34% of new registrations have ultimately been deactivated for
non-payment. The
CompanyNetwork Solutions
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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
forreselling such names at a
profit. Such resellers have a greater tendency than other customers to default
on their registration fees. As a consequence, the CompanyNetwork Solutions 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 September 1998 and is considered adequate
by the Company.
Registration fees charged to customersend users for registration services, net of
any 30% set aside funds, are recognized as revenue evenly over the registration
term. For example, the
CompanyAccordingly, Network Solutions recognizes $70 on a straight-line basis
over the two-year serviceservices period for each $70 initial domain name registration,
equivalent to $35 per year. Annual re-registrations of domain namesname registrations
are recorded as revenue based upon $35 recognized on a straight-line basis over
the one-year serviceservices period. This subscription-based model defers revenue
recognition until the CompanyNetwork Solutions provides the registration services,
including maintenance of and unlimited modifications to individual domain name
records, over the respective registration terms. At September 30, 1998, the CompanyMarch 31, 1999, Network
Solutions had net deferred revenue of $106.7$168.4 million.
Enterprise Network ConsultingInternet Technology Services. Substantially all of the Company's
enterprise network consulting servicesNetwork Solutions'
Internet Technology Services revenue is derived from professional services which
are generally provided to clients on a time and expense basis and is recognized
as services are performed.
The majority of the Company's enterprise network consulting servicesNetwork Solutions' Internet Technology Services are
provided to customers in the financial services industry. Bank America (formerly
NationsBanc)Citicorp is currently
the Company'sNetwork Solutions' largest consulting servicesInternet Technology Services client, accounting for
49%45.2% of the Company's enterprise network consulting servicesNetwork Solutions' Internet Technology Services business net revenue
and 3.7%3.9% of the Company'sNetwork Solutions' total net revenue infor the ninethree months ended
September 30, 1998. NationsBancMarch 31, 1999. Citicorp originally contracted with the
CompanyNetwork Solutions in 1993August
1998 and the CompanyNetwork Solutions currently provides network design and engineering
services as well as a variety of project specific services under the contract.
RESULTS OF OPERATIONS
Net Revenue. Net revenue increased 109%131% from $12.2$16.5 million for the three
months ended September 30, 1997March 31, 1998 to $25.4$38.1 million for the three months ended September 30, 1998.March
31, 1999. This increase in net revenue was primarily attributable to the
increase in the number of domain name registrations, principally in the .com TLD.top
level domain. Net revenue from registration services increased 116%125% from $10.7$15.5
million for the three months ended September 30, 1997March 31, 1998 to $23.1$34.8 million for the three
months ended September 30, 1998.March 31, 1999. Net new registrations increased 89%171% from 269,000340,000
for the three months ended September 30, 1997March 31, 1998 to 507,000922,000 for the three months ended
September 30, 1998.March 31, 1999. This also represents a 14%49% increase over the 443,000621,000 net new
registrations for the three months ended June 30,December 31, 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 September 30, 1997March 31, 1998 were 1,296,0001,862,000 as compared to 2,777,0004,225,000 as of
September 30, 1998,March 31, 1999, for a 114%127% increase. In addition, this growth in cumulative net
registrations is a 21%26% increase in the Company'sNetwork Solutions' entire customer base since
June 30,December 31, 1998.
Net revenue from enterprise network consulting servicesInternet Technology Services increased 53%230% from $1.5$1.0
million for the three months ended September 30, 1997March 31, 1998 to $2.3$3.3 million for the three
months ended September 30, 1998. This also represents a 53% increase
over theMarch 31, 1999. Citicorp accounted for $1.5 million in enterprise network consulting services revenue for the
three months ended June 30, 1998. NationsBanc accounted for $305,000 or 2.5%3.9% of
the Company'sNetwork Solutions' total net revenue for the three months ended September 30, 1997
and $1.2 million or 4.7% of the Company's total net revenue for the three months
ended September 30, 1998.
Net revenue increased 102% from $30.9 million for the nine months ended
September 30, 1997 to $62.4 million for the nine months ended September 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 123% from $25.9 million for the
nine months ended September 30, 1997 to $57.7 million for the nine months ended
September 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 nine months ended September 30, 1997 and 1998 was
consistently applied at a rate of 30%.
Net revenue from enterprise network consulting services decreased 6% from
$5.0 million for the nine months ended September 30, 1997 to $4.7 million for
the nine months ended September 30, 1998. NationsBanc accounted for $1.7 million
or 5.5% of the Company's total net revenue for the nine months ended September
30, 1997 and $2.3 million or 3.7% for the nine months ended September 30, 1998.
During the three and nine months ended September 30, 1998, the consulting
services division continued to add new leadership in sales and operations and
hired 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.March 31, 1999.
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 98% from $7.0$7.3 million for the three months ended September 30,
1997March 31,
1998 to $10.3$14.5 million for the three months ended September 30, 1998. This 47%March 31, 1999. The increase
was primarily driven by the growth of the Company'sNetwork Solutions' registration business
which experienced additional outsourcing costs of $1.2$3.5 million in support of the Company's
invoicing, collection and processing activities and additional direct labor
charges of $795,000$1.3 million related to systems engineering and operations. Further,
direct labor and subcontractor costs attributable to Internet Technology
Services increased $1.4 million.
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As a percentage of net revenue, cost of revenue decreased from 57.8%44.6% for
the three months ended September 30, 1997March 31, 1998 to 40.6%38.1% for the three months ended September 30, 1998.March
31, 1999. This decrease primarily reflects economies of scale that the
CompanyNetwork
Solutions 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 from $18.5 million for the nine months ended
September 30, 1997 to $26.5 million for the nine months ended September 30,
1998. This 43% increase was driven by a $1.8 million increase in labor, a $3.7
million increase in outsourcing costs and $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 59.8% for
the nine months ended September 30, 1997 to 42.4% for the nine months ended
September 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'sNetwork Solutions' products services and technologies. Research and
development expenses increased 259%181% from $377,000$725,000 for the three months ended
September 30, 1997March 31, 1998 to $1.4 million$2,035,000 for the three months ended September 30, 1998. To date, all research and development costs have been
expensed as incurred. The CompanyMarch 31, 1999. Network
Solutions expects that the level of research and development expenses will
continue to increase in the near future in terms of
absolute dollars as the CompanyNetwork Solutions
invests in developing new product and service offerings. As a percentage of net
revenue, research and development expenses increased from 3.1%were 4.4% for the three months ended
September 30, 1997 toMarch 31, 1998 and 5.3% for the three months ended September 30, 1998.
Research and development expenses increased 164% from $1.1 million for the
nine months ended September 30, 1997 to $2.9 million for the nine months ended
September 30, 1998. As a percentage of net revenue, research and development
expenses increased from 3.5% for the nine months ended September 30, 1997 to
4.6% for the nine months ended September 30, 1998.March 31, 1999.
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"),SAIC, legal and other professional costs and
amortization of goodwill associated with the Company'sNetwork Solutions' 1995 acquisition by
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SAIC. Selling, general and administrative expenses increased 230%147% from $3.1$6.2
million for the three months ended September 30, 1997March 31, 1998 to $10.2$15.3 million for the three
months ended September 30, 1998.March 31, 1999. The increase is primarilywas attributable to increasesa $7.3 million
increase in marketing and business development expenses of $5.0 million including television,
Internet banner advertising and targeted direct mail campaigns. The Company expects that the level of marketingcampaigns, and business
development expenses will increase in the near future as the Company continues
to promote the value of a .com Web address and other new Internet-based
value-added services. The Company also plans to continue to develop its
distribution channels, both domestically and internationally.
As a percentage of net revenue, selling, general and administrative
expenses increased from 25.5% for the three months ended September 30, 1997 to
40.3% for the three months ended September 30, 1998.
Selling, general and administrative expenses increased 210% from $7.9
million for the nine months ended September 30, 1997 to $24.4 million for the
nine months ended September 30, 1998. The increase was attributable to a $10.2
million increase in marketing and business development expenses, increased
staffing expenses of $1.5 million and an increase in legal and other
professional costs of $2.7$1.0 million. As a percentage of net revenue, selling,
general and administrative expenses increased from 25.5% for the nine months ended September 30, 1997 to
39.2% for the nine months ended September 30, 1998.
Interest Income. The Company had interest income of $570,00037.5% for the three months
ended September 30, 1997March 31, 1998 to 40.0% for the three months ended March 31, 1999. Network
Solutions expects that the level of selling, general and administrative expenses
will continue to increase significantly in the near future in terms of absolute
dollars as comparedoperations continue to $1.7expand. In particular, sales, marketing and
business development expenses will increase as Network Solutions continues to
promote the value of a .com web address and other new Internet-based value-added
services. Network Solutions also plans to continue to develop and enhance its
distribution channels, both domestically and internationally.
Interest Income. Network Solutions had net interest income of $1.3 million
for the three months ended September 30, 1998.
The Company had interest income of $1.1March 31, 1998 as compared to $1.9 million for the
ninethree months ended September 30, 1997 as compared to $4.4 million for the nine months ended
September 30, 1998.March 31, 1999. The increase for both the three month and nine month
comparisons is attributable to the
investment of the net proceeds of the
Company's initial public offering as well as positive cash flow resulting primarily from increasing domain
name registrations.
Income Taxes. The provision for income taxes was 45%42% of pretax earnings,
or $995,000 for the three months ended September 30, 1997, and 42% or $2.2$1.5 million for the three months ended September 30, 1998.
The provision for income taxes was 45% of pretax earnings,March 31, 1998, and 42% or $2.0$3.4
million for the ninethree months ended September 30, 1997, and 42%, or $5.4 million for the
nine months ended September 30, 1998.March 31, 1999. The difference between the
effective ratesrate for both periods presented and the statutory rate is principally
attributable to the relative impact that non-deductible goodwill had on pretax
operating income. Goodwill is being amortized by the CompanyNetwork Solutions over five
years and is associated with the acquisition of the CompanyNetwork Solutions by SAIC in
1995.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1998, the Company'sMarch 31, 1999, Network Solutions' principal source of liquidity was its
cash and cash equivalents of $9.1$26.9 million and its short-term investments of
$107.9$121.5 million, which when combined represent an increase of $35.7$16.8 million from
theits December 31, 1997 balance1998 balances in those accounts.
The Company also has $6.3
million of marketable securities held as long term investments as of September
30, 1998.
At September 30, 1998, the Company'sMarch 31, 1999, Network Solutions' cumulative net obligation to SAIC for
intercompany activity was $2.6$4.6 million, a net increasedecrease of $1.3$0.2 million from
December 31, 1997.for the
quarter. Intercompany activity is primarily comprised of salaries and benefits
paid by SAIC on behalf of the Company. The CompanyNetwork Solutions. Network Solutions currently
reimburses SAIC for intercompany activity on a monthly basis. Pursuant to the
Tax Sharing Agreement dated September 26, 1997, the CompanyNetwork Solutions 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.
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Cash provided by operations was $42.1$33.0 million for the ninethree months ended
September 30, 1998.March 31, 1999. This amount is principally attributed to net income plus the
increase in deferred revenue reflecting cash collected in advance of
registration services revenue recognition which occurs 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 subsequentassociated tax liabilities.
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14liabilities, generally paid on a quarterly
basis.
Investing activities totaled $79.3$20.4 million for the ninethree months ended September 30, 1998,March
31, 1999, of which $67.7$3.8 million was net purchases of short-term
investmentsshort and $6.0 million of long-term
investments. TheseIncluded in the investments arepurchased during the period was a $2.0
million investment in a strategic business partner which subsequently
consummated its initial public offering during the three month period ended
March 31, 1999.
Capital expenditures were $16.6 million for the quarter, primarily comprisedfor
computer equipment and software. Network Solutions will continue to invest in
the back office infrastructure in advance of commercial investment grade securities.
The Companycontinued growth in domain name
registrations and as Network Solutions designs and builds the shared
registration system in accordance with the Cooperative Agreement.
Network Solutions believes that its existing cash balance, investments and
cash flows expected from future operations will be sufficient to meet the Company'sNetwork
Solutions' capital requirements for at least the next 12 months.
FACTORS AFFECTING OPERATING RESULTS.RESULTS
INDUSTRY RISKS
Ongoing Privatizationprivatization of Internet Administration. The Internet is not
bound by geography, and neither the U.S. Government nor any single organization
or entity currently has formal authority over all aspects of the Internet. There
is, however, a need for central policy decisions surrounding the coordination of
the administrative services required for theadministration could harm our registration
allocation and use of
TLDs and Internet Protocol ("IP") numbers, and for the effective global
operation of the Internet. 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 increased privatization of the policy making and central
administration of the Internet. Without authoritative policy making, it is
becoming increasingly more difficult to 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's business financial condition and results of
operations could be materially and adversely affected by such a failure.
Within the U.S. Government, leadership for the furthercontinued privatization of
Internet administration is currently provided by the NTIA.Department of Commerce.
After a series of draft proposals and public comment periods, on June 10, 1998,
the NTIADepartment of Commerce published in the Federal Register a plan referred to
as the Statement of Policy or "White Paper," calling for the formation of a
not-for-profit corporation to assume responsibility for administration ofcertain responsibilities relating to the
DNS,domain name system, but which is not expected to perform actual registration of domain names
either as a registrar or registry. The Statement of Policy invitescalled for increased
competition and invited 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 calls for a separation ofdistinguished between the registry and registrar
functions of the DNS,domain name system, both of which functions are currently
performed exclusively by the Companyus in the .com, .org, .net and .edu TLDs.top level domains.
The technical structure of the Internet only permits one registry for each top
level domain. A registrar acts as the interface between the registry and the
end-user domain name holders. Registrars submit to the registry certain limited
information for each of their customers that has a second level domain name in
that top level domain. A registrar can provide value-added products and services
in addition to its basic registration service. Numerous registrars will be able
to operate within each top level domain.
As part of the process initiated by the Statement of Policy, several
proposals were put forward to the NTIADepartment of Commerce on the establishment
and governance of the not-for-profit corporation. ICANN hasThe proposals differed in
several respects including, among others, their approaches to the following
issues: place and form of incorporation; method for selection of the interim and
permanent board of directors; who should be eligible to become a member and on
what questions should the members vote; what authority should be granted to the
board of directors and what authority should be reserved to the members, if any;
and whether there should be separate supporting organizations and, if so, what
authority these organizations should have. A U.S. based private not-for-profit
corporation with an international board of directors, denoted the Internet
Corporation for Assigned Names and Numbers, or "ICANN," submitted a series ofvarious
proposals which is formingformed the basis of public discussion at a seriesnumber of meetings one of which
was held on November 14, 1998.public and private
meetings. As a result of these and other meetings and private negotiations, the
process initiated by the Statement of Policy may resulthas resulted in the entry by the
U.S. Government recognitioninto a Memorandum of Understanding, or "MOU," with ICANN. Under
the MOU, the parties will jointly design, develop and test the mechanisms,
methods and procedures that should be in place
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and the steps necessary to transition management responsibility for certain
domain name system functions to a private-sector not-for-profit entity. The MOU
provides that once testing is successfully completed, it is contemplated that
management of certain domain name system functions will be transitioned to the
mechanisms, methods and procedures designed and developed in this joint project.
The U.S. Government has sent us a letter directing us to treat ICANN as the
not-for-profit corporation identified in the October amendment to the
Cooperative Agreement, in the performance of ICANN's obligations under the MOU
and until such time as the MOU is terminated. We have not yet responded to that
letter.
ICANN's bylaws call for the creation of supporting organizations that will
select some ICANN board members and provide policy recommendations in particular
areas. ICANN called for submission by February 5, 1999 of applications from
groups urging "recognition" of a domain name supporting organization that would
be charged with developing recommendations for policies ICANN might apply when,
and if, it begins exercising responsibility over certain domain name system
functions. Those responsibilities could include entering into contracts with
registries for all top level domains and adding new top level domains. We
submitted comments regarding the structure and function of such a domain name
supporting organization. On March 4, 1999, the ICANN Board adopted a domain name
supporting organization formation concept statement reflecting some, but not all
of our comments. On March 15, 1999, ICANN released a staff draft of amendments
to its bylaws based on the formation concept statement to establish a domain
name supporting organization that will first meet in May 1999. On March 31,
1999, the ICANN Board adopted bylaw changes to govern establishment of the
domain name supporting organization. We have proposed to organize a global top
level domain registry constituency for the domain name supporting organization
and may join other constituencies. We believe that further organizational steps
are planned for the next ICANN meeting in late May 1999.
We cannot be sure that ICANN will take positions favorable to us in the
process of implementing the final bylaws, recognizing domain name supporting
constituencies or in its further policy development or contract formation.
The Statement of Policy. The NTIA planPolicy calls for a phased transition of itsthe Department of
Commerce's responsibilities for the DNSdomain name system to thea not-for-profit
corporation over the period ending onby September 30, 2000. There are severalWe face risks associated with the recognition of private sector
DNS administration and the establishment of, and transfer of DNS administration
from the NTIA to, the not-for-profit corporation. Some of those risks include:this transition,
including:
- failure to achieve consensus on the many issues relating to the
establishmentfunctioning and governance of the not-for-profit corporation could prevent or delay the transition and thereby result
in instability in DNSdomain name system administration,
- the not-for-profit corporation could fail to achieve consensus or gain legitimacy resulting in
instability in the operation of the Internet,domain name system administration,
- the U.S. Government could refuse to transfer somecertain responsibilities for
DNSdomain name system administration to the not-for-profit corporation therebydue
to security, stability or other reasons resulting in fragmentation or
other instability in DNSdomain name system 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 are unfavorable to the Company'sour role in the
registration of domain names or that are not consistent with or
preclude, the Company'sour current
or future plans.
Despite the significant efforts undertaken to date, it is impossible to
predict at this time whether or when the process initiated by the Statement of
Policy will result in the full transition to the not-for-profit corporation of
DNS administrationdomain name system responsibilities as and to the extent contemplated in the
Statement of Policy and, if it does, the effect on the Companyus of such transition.
The Company'sOperations under, changes to or disputes under the cooperative agreement could
harm our business financial
condition and results 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 itscertain responsibilities for the DNSdomain name
system administration to 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
us. The U.S. Government sent us a letter directing us to treat ICANN as the
Company.not-for-profit corporation identified in the amended
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Cooperative Agreement in the performance of ICANN's obligations under the MOU
and until such time as the MOU is terminated. We have not yet responded to that
letter. We have not yet reached agreement with the U.S. Government or ICANN with
respect to the terms of the transition. We may not be able to reach agreement
and either ICANN or the U.S. Government may take positions that adversely affect
us.
We held two meetings of a technical advisory group to comment on and
participate in testing of our shared registration system and a third meeting is
scheduled for late May 1999. The group included members suggested by ICANN to
the Department of Commerce and other individuals.
In the October 1998 Amendment, the Company and the NTIA agreed to a
plan for the transition to a shared registration system under the Cooperative
Agreement, we are operationally separating our registry business from our
registrar business. Additional, competing registrars will be able to market
registration services in which multiple
registrars may registerthe .com, .net and .org top level domains, with the
domain names registered through the registry that we maintain for each of those
top level domains. Accordingly, persons registering second level domain names
will be able to choose among a number of different registrars, including us. We
began this transition on schedule, with the singlelaunch of a testbed phase involving
the following five registrars accredited by ICANN: America Online, Inc., CORE or
"Internet Council of Registrars", France Telecom/ Oleane, Melbourne IT and
Register.com. As the registry, we have contracts with each of these registrars
allowing them to directly register names through our registry services division
using our proprietary Shared Registration System. Registrations of domain names
by these five testbed registrars have not as yet commenced. ICANN also
accredited 29 additional registrars to begin offering registration services
after the testbed. The proposed accreditation contract between the registrars
and ICANN would require payment of fees to ICANN and would impose special
restrictions on a registrar also acting as the registry. We filed substantial
comments with ICANN objecting to various aspects of the proposed accreditation
approach. Our registry services under the Cooperative Agreement will be subject
to a price cap. During the testbed phase, the cap was set at $18 for each TLD,a two-year
registration and $9 for a one-year re-registration and our Registrar License and
Agreement under which we, as the registry, grant a license to use the Shared
Registration System, was approved for use by agreement with the Department of
Commerce under Amendment 13 to the Cooperative Agreement. Registrar services,
once competitive, may be priced in different ways by us and competing
registrars.
Termination, or a phased approach,change in the first phaseterms, of which is scheduled to be completed by March
31, 1999.the Cooperative Agreement could
harm our business. While the Cooperative Agreement by its terms expires in
September 2000, it may be terminated earlier byearlier. We are currently in discussions
with the NTIA. The Company's business, financial
conditionU.S. Government regarding adequate testing and results of operations could be materially and adversely affected
by a termination or a change in the termsfull implementation of
the Cooperative Agreement. There is
alsoShared Registration System and a risk that the U.S. Government'swide range of contractual issues. The
Department of Commerce's interpretation of certain provisions of the Cooperative
Agreement could differ from ours. For example, the Company's.Department of Commerce has
publicly expressed concerns about our use of the WHOIS service, the internic.net
website and our access policy to our top level domain name zone file. We have
reached agreements with the U.S. Government concerning the temporary provision
of access to the top level domain zone file, operation of the WHOIS service and
use of the internic.net website. Nevertheless, some differences of opinion or
interpretation remain to be addressed. These differences in interpretation or
opinion could lead to disputes between us and the Department of Commerce or the
not-for-profit corporation, which may or may not be resolved in our favor.
Certain aspects of implementation of the Cooperative Agreement also remain to be
negotiated.fully negotiated, including the maximum price we will charge after the testbed
period for registry services in the top level domains for which we now act as
registry. If the
Company iswe are unsuccessful in negotiating acceptable terms of
implementation, the costs of implementation of the Cooperative Agreement, the Company'sour
relationship with the not-for-profit corporation and other matters affecting the Company'sour
position in a more competitive DNSdomain name system environment could all be materially and
adversely affected.
There is a risk that withdrawalharmed.
Challenges to authority over domain name administration could harm our business
Withdrawal of or challenges to the government'sU.S. Government's sponsorship or
authorization of certain functions that the Company performswe perform could create a public
perception or result in a legal finding that the Company
lackswe lack authority to continue in
the Company'sour current role as registry or registrar within the .com, .org, .net and .edu
TLDs.top level domains. The legal authority underlying the roles of NTIAthe Department of
Commerce and the not-for-profit corporation with regard
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16
to the DNSdomain name system also could be challenged. The impact, if any, of any
such public perception or finding is unknown, but it could materially and adversely affectbe harmful to our
business.
We may not be able to compete effectively due to increased competition in the
Company'sdomain name registration business
financial condition and resultsThe introduction of operations.
Increased Competition in Domain Name Registration Business. A principal
objective of the Statement of Policy is to introduce additional competition and
global participationinto the domain name
registration business could be harmful to our business. This includes, in
the management of Internet names and addresses,
includingparticular, competition among registrars within a single TLDtop level domain, like
.com, and competition among registrars and registries of existing and potential
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 facestop level domains. We already face competition in the domain name
registration business from registries for country codes,code top level domains, third
level domain name providers such as Internet access providers and registrars and
registries of TLDstop level domains other than those TLDstop level domains which the Companywe
currently registers.register. A number of entities have already begun to offer competing
registration services using other TLDs and when
thetop level domains. Our shared registration
system takes effectis now available to the Company will no longer befive testbed registrars in the
exclusive registrar in .com, .org and
.net TLDs.
15
16top level domains. More competing registrars are scheduled to offer
competing registration services in these top level domains in the near future.
Future competition in the Company's domain name registration business as a registry
or registrar could come from many different companies, including:
- domain name registration resellers,
- country code registries,
- Internet access providers, and
- major telecommunications firms, and
- cable companies.firms.
Many of these entities have core capabilities to deliver registrationregistry and/or
registrar services, such as help desks, billing services and network management,
along with strong name recognition and Internet industry experience. The Company's
position as the leading registrar of domain names could be materially and
adversely affected by the emergence of any of these 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. The Company'sOur revenue from
registration fees
could be reduced due to increased competition, pricing pressures or a
modification of billing practices. For example, other entities may bundle domain
name registrations with other products or services.
The
introductionWe depend on future growth of additional competition into the domain name registration
business could have a material adverse effectInternet and Internet infrastructure
Our future success substantially depends on the Company's business,
financial condition and results of operations.
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 has experienced revenue growth in recent periods, the
Company may not be able to sustain it and such growth may not be indicative of
future operating results. For example, the Company may not be able to maintain
its current position in providing domain name registration services or develop
or market additional services. The Company's failure to do so could materially
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
16
17
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 to establishing direct sales channels, the Company is 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 medium of distribution.Internet. If the Company fails to manageuse of and grow its new sales and marketing
organization, develop and expand its distribution channels or effectively useinterest in the Internet as a mediumdoes not continue to
grow, our business would be harmed. Continued growth of distribution, the Company's business, financial
condition and results of operationsInternet could be
materiallyslowed by:
- inadequate infrastructure,
- lack of availability of cost-effective, high speed systems and adversely affected.
Relianceservice,
- delays in developing or adopting new standards and protocols to handle
increased levels of Internet activity, or
- government regulation.
We rely on Third Parties. The functioning of the DNS is facilitated
through a hierarchy of domain name servers (specialized software programs
resident in network computers). Thethird parties who maintain and control root zone and top level of this hierarchy consists of 13
globally distributeddomain
zone servers
(ten in the United States, two in EuropeWe currently administer 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 operatesoperate only two of the 13 root zone 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 secondfour top level domain nameszone servers. The others are administered 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 required 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 been
determined by consensus of various members of the Internet community. The eleven
root servers that the Company does not maintain and control are maintained and
controlledoperated
by independent operators on a volunteer basis. IfBecause of the importance to the
functioning of the Internet of these root zone servers and top level domain zone
servers, our registration business could be harmed if these volunteer operators at any time, for any reason,
fail to properly maintain such servers or abandon such servers, the Company'sservers.
Further, our registration business financial condition and results of
operations could be materially and adversely affected.
Further, as no single organization or entity currently has formal authority
over all aspectsharmed if any of the Internet, neither the U.S. Government nor any
organization or entity has clear legal authority to direct root server
operations including where the root servers are to be pointed. If any or all of
the root serversthese
volunteer operators fail to include or provide accessibility to the Company's data that we
maintain in the Internetroot zone servers and the Company's 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 withtop level domain zone servers that we
control.
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17
We rely on Internet service providers
("ISPs") worldwide. The Company'sOur registration business financial condition and results of operations wouldcould be materially and
adversely affectedharmed if enough ISPsInternet service
providers decided not to route Internet communications to or from domain names
registered by the Companyus or if enough ISPsInternet service providers decided to provide
routing to a set of accepted rootdomain name servers which did not point to the
Company's TLDour top level
domain zone servers.
System Interruption and Security Risks.failure or interruption, security breaches or our failure to meet
increasing demands on our systems could harm our business
Any significant problem with our systems or operations could result in lost
revenue, customer dissatisfaction or lawsuits against us. A failure in the
operation of the
Company'sour registration system or other events could result in deletion of
one or more domain names from the Internet for a period of time. A failure in
the 17
18
operation or update of Root Server Athe master database that we maintain could result in
deletion of one or more TLDstop level domains from the Internet and the
discontinuation of second level domain names in those TLDstop level domains for a
period of time. The Company'sinability of our registration system, including our back
office billing and collections infrastructure, and telecommunications systems to
meet the demands of the increasing number of domain name registration requests
and corresponding customer e-mails and telephone calls could result in
substantial degradation in our customer support service and our ability to
process, bill and collect registration requests in a timely manner.
Our operations depend on itsour ability to maintain itsour computer and
telecommunications equipment in effective working order and to reasonably
protect itsour systems against interruption. Such interruptionsThe root zone servers and top level
domain zone servers that we operate are critical hardware to our operations.
Interruptions could result from:
- fire, natural disaster, sabotage, power loss, telecommunication failure,
human error or similar 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'sour customer base and the Company'sour
inability to sufficiently maintain or upgrade itsour systems.
We may lose revenue or incur significant costs if Year 2000 compliance issues
are not properly addressed
Our failure, or the failure of third parties on which we rely, to
adequately address Year 2000 compliance issues may cause us to lose revenue or
to incur significant costs. The Company'sprimary risks that we face with regard to Year
2000 failures are those which impact our domain name registration business.
These risks include:
- significant and protracted interruption of electrical power to data and
systems in our engineering and customer service facilities,
- significant and protracted interruption of telecommunications and data
network services in any of our headquarters, engineering or customer
service facilities,
- the failure of components of our current back office and domain name
registration related systems, and
- the occurrence of a Year 2000 problem with respect to third-party
suppliers', vendors' and outsourcing service providers' products and
services.
If we fail to solve a Year 2000 compliance problem with our mission
critical business financial conditionsystems and results of operationsprocesses, including the domain name servers under
our control, telecommunications systems, facilities, data-networking
infrastructure, commercial-off-the-shelf hardware or software and components
used by our employees, the result could be materiallya failure of or interruption to
normal business operations. Furthermore, our business depends on the continued
operation of, and adversely affectedwidespread access to, the Internet. This, in turn, depends to
a large extent on the software and systems of third parties on which our systems
rely or to which they are connected. These third parties include, among others,
Internet-related companies, including Internet web hosting companies, Internet
access providers and Internet domain name server operators.
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18
We have no responsibility for, nor control over, other Internet domain name
server operators that are critical to the efficient operation of the Internet.
We do not know whether such domain name server operators have hardware, software
or firmware that is Year 2000 compliant.
COMPANY RISKS
Our search for a new chief executive officer presents risks and uncertainties
On November 16, 1998, we announced the resignation of Gabriel A. Battista
from his positions as Chief Executive Officer and director. We cannot reasonably
estimate at this time the potential impact on us of the hiring of a new Chief
Executive Officer. While we conduct a search for a new Chief Executive Officer,
Michael A. Daniels, our Chairman of the Board, is acting as the Chief Executive
Officer and assuming the executive responsibilities previously performed by Mr.
Battista. In addition, Robert J. Korzeniewski, our Chief Financial Officer, is
also acting as our Chief Operating Officer, assuming responsibility for
day-to-day operations. We cannot be certain of the timing of our hiring of a new
Chief Executive Officer or the effect of any damage, failuredelays in our hiring of a new Chief
Executive Officer on the development or delay that causes
significant interruptionsimplementation of our strategic plan.
We must attract, integrate, train and retain key personnel knowledgeable about
our business
Given the relative "newness" and rapid growth of the Internet, there is
intense competition for the limited supply of people qualified to work for us.
Our future success depends on the continued service of key engineering, sales,
marketing, executive and administrative personnel, and our ability to attract,
hire, integrate, train and retain such personnel. Competition for engineering,
sales, marketing and executive personnel is intense, particularly in the
Company's systems.
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 federaltechnology and state regulation applicable to businesses
generally. However, if there are changesInternet sectors and in the regulatory environment,regions where our facilities are
located. We cannot be certain that we will be able to retain existing personnel
or attract, hire or retain additional qualified personnel. The loss of the
Companyservices of any of our senior management team or other key employees or our
failure to attract, integrate, train and retain additional key employees 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 usageharm our business.
Our near term success depends on the U.S. telecommunications service providers,growth of our domain name registration
business
We may not be able to sustain the revenue growth we have experienced in
particular,
the generally lower cost for data transmission versus voice.recent periods. In addition, past revenue growth may not be indicative of future
operating results. If we do not successfully maintain our current position 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.
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 obligationleading provider of domain name registration providersservices or develop or market
additional services, our business could be harmed.
Our domain name registration services business generates over 90% of our
revenue and is expected to prevent trademark infringement and other legal issues.
See "-- Legal Proceedings."
Legal Proceedings. The Company is involvedcontinue to account for a very significant portion of
our revenue in several legal proceedings.
Asat least the near term. Our future success will depend largely
on:
- the continued increase in domain name registrations,
- re-registration rates of November 1, 1998, the Company was namedour customers,
- our ability to maintain our current position as a defendant in two active
lawsuits involvingleading registrar of
domain name disputes between trademark ownersnames, 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- the successful development, introduction and market acceptance of new
services that address the Company
had violateddemands of Internet users.
We must effectively manage our marketing organization and establish and maintain
distribution channels
We will need to effectively manage our growing sales and marketing
organization if we want to achieve future revenue growth. We do not know if we
will be able to identify, attract and retain experienced sales and marketing
personnel with relevant experience. Further, our sales and marketing
organization may not be able to successfully compete against 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 TLDssignificantly
more extensive 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 TLDswell-funded sales and marketing operations of our current 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 motionpotential competitors 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.registration or consulting services.
18
19
On October 17, 1997,Our ability to achieve future revenue growth will also depend on our
ability to continue to establish direct sales channels and to develop multiple
distribution channels. To do this we must maintain relationships with Internet
access providers and other third parties.
We have a grouphigh level of six plaintiffs fileduncollectible receivables
Because of our high level of uncollectible receivables, we continually
review our billing practices. Any modifications that we implement as 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 eitherresult of
these proceedingsreviews 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
relatingunanticipated harmful consequences 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 couldour business. We
believe we 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 resellingtransferring
such names at a profit. The Company'sOur experience has been that such resellers have a
greater tendency than other customers to default on their services fees. The Company hasWe have
established a
19
20 provision for uncollectible accounts which the Company believeswe believe to be
adequate to cover anticipated uncollectible receivables; however, actual results
could differ from the Company'sour estimates.
The Company continually reviews its billing practices for modificationWe are party to respond to market conditions and to implement operational improvements. These
modificationsseveral legal proceedings which could have unanticipated consequences which could materially and
adversely affect the Company's business,a negative financial
condition and results of
operations.
Competitionimpact on us
We are involved 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 Companyseveral legal proceedings. We 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 copyany of all softwarethese proceedings. An adverse determination in
any of these proceedings, however, could harm our business. Legal proceedings in
which we are involved are expensive and data generated
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21
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 measuresdivert our personnel. See
"Part II -- Item 1 -- Legal Proceedings."
We may not be able to protect the
confidentiality of such data, softwareour intellectual property rights 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 reliesproprietary
information
We rely on a combination of nondisclosure and other contractual
arrangements with itsthe U.S. government, our employees, and third parties, as well
as privacy and trade secret laws, to protect its proprietary rights and limit the distribution of itsour
proprietary data, computer software, documentation, and processes used in
conducting our domain name registration business. If we fail to adequately
protect our intellectual property rights and proprietary information, or if we
are subject to adverse results in litigation relating to our intellectual
property rights and proprietary information, our business could be harmed. Any
actions we take may not be adequate to protect our intellectual property rights
and 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, otherOther companies may develop technologiescompeting technology
that areis similar or superior to the Company'sour technology. The U.S. government could take
positions adverse to our claims regarding proprietary technology.rights and/or could
attempt to require us to enter into agreements limiting such claims. Although the Company believeswe
have no reason to believe that its services do notour domain name registration business activities
infringe on the intellectual property rights of others, and we believe that the Company haswe
have all rights needed to use the intellectual property employed in itsconduct our business, it is possible that the Companywe could
become subject to claims alleging infringement of third party intellectual
property rights. Any such claims could subject the Companyus to costly litigation, and mayany
adverse final rulings on any such claims could require the Companyus to pay damages, andseek
to develop non-infringing intellectual property alternative technology, and/or seek to acquire licenses to the
intellectual property that is the subject of theany such alleged infringement. If the Company fails
to adequately protect its proprietary rightsinfringement, and
any such rulings could have a material adverse effect on our business.
Unsuccessful future acquisitions and investments could decrease operating
income, cause operational problems or if the Company becomes involved
in litigation relating to intellectual property rights, the Company'sotherwise disrupt our 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 evaluatesWe evaluate potential acquisitions and investments on an ongoing basis. The Companybasis for
various reasons including, among others, diversification of our domain name
registration and consulting businesses. Our acquisition and investment strategy
poses many risks, including:
- we may not be able to compete successfully for available acquisition
candidates, complete future acquisitions and investments or accurately
estimate the financial effect on the Companyour company of any businesses the Company acquireswe acquire
or investments the Company
makes. Futurewe make,
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- future acquisitions and investments may require the Companyus to spend significant
cash amounts or may decrease our operating income,
either of which could- we may have a material adverse effect ontrouble integrating the Company'sacquired 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 futureretaining
personnel,
- acquisitions or investments in
companies which are in the early stages of development. Tomay disrupt our business and distract our
management from other responsibilities, and
- to the extent that any of thesethe companies which we acquire or in which we
invest fail, itour business could be harmed.
Whether or when pooling of interests accounting for acquisitions might
become available to us depends on many factors beyond our control.
We face increasing risks associated with our international business
While substantially all of our operations, facilities, and personnel are
located within the United States, our revenues from sources outside the U.S.
have increased significantly and may continue to increase in the future. As a
material adverse effectresult, we are subject to the risks of conducting business internationally,
including unexpected changes in regulatory requirements, competition from
foreign companies, fluctuations in the U.S. dollar, tariffs and other barriers
and restrictions and the burdens of complying with a variety of foreign laws. We
do not know what the impact of such regulatory, geopolitical and other factors
will be on our business in the Company's financial condition.
Potential Fluctuations in Quarterly Results. The Company'sfuture or if we will have to modify our business
practice. In addition, the laws of certain foreign countries may not protect our
proprietary rights to the same extent as do the laws of the United States.
Our quarterly operating results may fluctuate; our future revenue and
profitability are uncertain
Our quarterly operating results may fluctuate significantly in the future
due to a variety of factors, manysome of which are beyond the Company'sour control. Such factorsFactors that
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,affect our revenue include:
- variations in the number of requests for domain name registrations or
demand for the Company'sour services,
- introduction or enhancements of servicessuccessful competition 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,others,
- termination or completion of contracts in the Company's enterprise
network consulting servicesour Internet Technology
Services business or failure to obtain additional contracts in that
business, and
- patternsmarket acceptance of growth in the use of and interest in the Internet, or
- general economic conditions.new service offerings.
In addition, the Company expectswe expect a significant increase in itsour operating expenses as
it:we:
- increasesincrease our sales and marketing operations and activities, and
- updatescontinue to update our systems and infrastructure,
- funds greater levels of product and services development,
- develops new distribution channels,
- broadens customer support capabilities, and
- expands facilities.infrastructure.
If the increase in the Company'sour expenses is not followed by an increase in our
revenue, our operating results will be harmed. The fact that in the Company's business, financial conditionpast our
revenues have increased and we have been profitable on a quarterly and annual
basis is not indicative of whether our revenues will increase or whether we will
be profitable on a quarterly or annual basis in the future.
INVESTMENT RISKS
Our stock price, like that of many Internet companies, is highly volatile
The market price of our Class A common stock has been and is likely to
continue to be highly volatile and significantly affected by factors such as:
- general market and economic conditions and market conditions affecting
technology and Internet stocks generally,
- actual or anticipated fluctuations in our quarterly or annual
registrations or operating results,
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- announcements of operations
could be materiallytechnological innovations, acquisitions or investments,
developments in Internet governance or corporate actions such as stock
splits, and
adversely affected.
In addition, a majority- industry conditions and trends.
The stock market has experienced significant price and volume fluctuations
that have particularly affected the market prices of the Company's enterprise network consulting
services operating expenses, particularly personnelstocks of technology
companies, especially Internet-related companies. These broad market or
technology or Internet sector fluctuations may adversely affect the market price
of our Class A common stock. Recently, the market price of our Class A common
stock, like that of many Internet-related companies, has experienced significant
fluctuations. For instance, from January 1, 1999 through May 10, 1999, the
reported sales price for our Class A common stock ranged from $60 per share to
$144 per share. On May 10, 1999, the reported last sale price of our Class A
common stock was $67.688 per share.
The market price of our Class A common stock also has been and related costs,
depreciationis likely to
continue to be significantly affected by expectations of analysts and rent, are substantially fixed before anyinvestors.
Reports and statements of analysts do not necessarily reflect our views. The
fact that we have in the past met or exceeded analyst or investor expectations
does not necessarily mean that we will do so in the future.
In the past, following periods of volatility in the market price of a
particular quarter. As
a result, any under-utilization of engineers may cause the Company's operating
results to vary significantly in any particular quarter andcompany's securities, securities class action litigation has often
been brought. Such litigation could result in losses for such quarter.
Control by SAIC. Assubstantial costs and a diversion
of November 6, 1998,our management's attention and resources.
Future sales of common stock could affect our stock price
SAIC owned 100%owns 14,850,000 of the Company's
outstanding shares of our common stock. A
decision by SAIC to sell such stock could depress the market price of the Class
A common stock.
SAIC may maintain significant influence over us
Because it holds a significant number of shares of our Class B Common Stock, representing approximately 74.1% of the
Company's outstanding Common Stock and approximately 96.6%common
stock, which have ten votes per share, SAIC controls 89% of the combined voting
power of the Company's outstanding Common Stock. TheClass A and Class B Common Stock
is convertible into Class A Common Stock, subject to certain limitations set
forth in the Company's Second Amendedcommon stock and, Restated Certificate of Incorporation
(the "Certificate of Incorporation"). As a result, SAICtherefore, effectively
controls all matters requiring approval by the Company'sour stockholders
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23 including the
election of members of the Company's Boardour board of Directors,directors, changes in the size and
composition of the Boardboard of Directorsdirectors and a change in control. The Company doesWe do not have an
agreement with SAIC which restricts its rights to convert, distribute or sell
its shares of our common stock.
If SAIC converts all of its remaining shares of Class B common stock into
Class A common stock its economic interest and voting power will be below 50% of
the Company's Common Stocktotal economic interest and there
can be no assurance thatvoting power of our common stock after such
conversion. Nonetheless, SAIC will maintain its ownershipremain our largest stockholder and may be
able to exercise significant influence over us.
Certain directors may have conflicts of the Company's Class
B Common Stock.
Relianceinterest
Certain of our directors currently serve as directors, officers and
employees of SAIC. Therefore, there may be various conflicts of interest or
conflicting duties for these individuals. Since our directors and officers may
also own stock of SAIC, there may be conflicts of interest when directors and
officers are faced with decisions that could have different implications for us
and SAIC.
We rely on SAIC for Certain Corporate Services. The Company has entered
into certain intercompany agreements with SAIC, includingcorporate services and employee benefits
We currently receive corporate services under an agreement pursuant
to whichwith SAIC. Were
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
Companythese services, we may not be able to secure alternative
sources for such services within
180 days or such services may only be available to us at prices
higher than those charged by SAIC.
Certain Charter Provisions and Limitations on Liability. The Company's
CertificateOur employees are currently eligible to participate in certain SAIC
employee benefit plans. If SAIC converts its remaining shares of IncorporationClass B common
stock to Class A common stock, we will have to establish certain employee
benefit plans of our own which could result in incremental costs to us.
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Our certificate of incorporation contains provisions relating to SAIC that may
adversely affect us or our stockholders
Our certificate of incorporation includes provisions relating to
competition by SAIC with the Company,us, 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 CertificateOur certificate of Incorporationincorporation
provides that any person purchasing or acquiring an interest in shares of the Company'sour
capital stock shall be deemed to have consented to the provisions in the
Certificatecertificate of Incorporationincorporation 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 Companyours
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 Companyus 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 CompanyNetwork Solutions is in the process ofcontinually assessing the potential effects of the
Year 2000"Year 2000" millennium change on the Company'sNetwork Solutions' business systems and
processes, including the Internet rootdomain name servers under the Company'sNetwork Solutions'
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'sNetwork Solutions' Year 2000 project is proceeding
on schedule. The project goal is to ensure that the Company'sNetwork Solutions' business is
not impacted by the date transitions associated with the Year 2000.
The Company'sNetwork Solutions' 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'sNetwork Solutions' business systems and processes, including
the Internet rootdomain name servers under the Company'sNetwork Solutions' 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'sNetwork Solutions'
domain name registration business. The Company'sNetwork Solutions' Year 2000 project is
comprised of the following parallel phases:
- Phase 1 -- Inventory all of the Company'sNetwork Solutions' business systems and
processes, including the Internet rootdomain name servers under the Company'sNetwork
Solutions' control, telecommunications systems, facilities,
data-networking infrastructure, commercial-off-the-shelf hardware,
software and components used by its employees in order to assign
priorities to potentially impacted systems and services. This phase is expected to be completed in November 1998;has
been completed;
- Phase 2 -- Assess the Year 2000 compliance of all inventoried business
systems and processes, including the Internet rootdomain name servers under
the
Company'sNetwork Solutions' 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;The
assessment of mission critical systems has been completed; however,
assessment continues as a life cycle development activity;
- Phase 3 -- Complete remediation if any is required, of any non-Year 2000 compliant business
systems and processes, including the Internet rootdomain name servers under
the Company'sNetwork Solutions' 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'twill not be remediated. All remediation efforts if any are required, are
expected to be completed by AprilJune 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 towill
begin in parallel as software is remediated. As remediated
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code is successfully tested, it will be completed by
May 31,released into production
incrementally, a process which will last until October 30, 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 31,30, 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'sNetwork Solutions' employees due to the
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25 Year 2000 millennium change. The
initial contingency and business continuation plan is expected tohas been developed.
The final contingency plan will be in place by December 31, 1998.completed during the second quarter of
1999 and it will be updated throughout the year as appropriate.
Based on its inventory and assessment, to date,Network Solutions has found that
less than one-half of one percent of the Company believes thatsoftware code of its internal mission critical
systems areneeds to be remediated to be made Year 2000 compliant. The Company,However, Network
Solutions, in its normal course of business, anticipates replacing or upgrading,
prior to the millennium change, portions of these systems with new systems which
will also be Year 2000 compliant. Currently, the CompanyNetwork Solutions is enhancing its
back-office"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 ensuredetermine the Year 2000 compliance of such systems prior to
acceptance and deployment in the Company'sNetwork Solutions' business. This enhancement
effort is a function of the Company'sNetwork Solutions' business growth and not a Year 2000
remediation effort.
Based on its inventory and assessment, to date, the Company believes thatNetwork Solutions has found no
material Year 2000 problems with its facilities and telecommunications systems are Year 2000 compliant. The
Companysystems.
Network Solutions has conducted detailed assessments of the components of its
telecommunications infrastructure and is working to identify appropriate system
testing guidelines. In addition, the CompanyNetwork Solutions 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'sNetwork
Solutions' control, the CompanyNetwork Solutions has deployed back-up power systems capable
of operating its core business indefinitely.
Network Solutions is now in the remediation and testing phases of its
project cycle. At this time, the CompanyNetwork Solutions believes that its incremental
remediation costs
if any, needed to make its current business systems and processes,
including the Internet rootdomain name servers under the Company'sNetwork Solutions' 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. While the CompanyNetwork Solutions is incurring some
incremental costs directly relating to staff augmentation for the Year 2000
program management and technical assessment, the costs expended by the CompanyNetwork
Solutions through OctoberMarch 31, 19981999 are less than $100,000. The Company's$500,000. Network Solutions'
expected total costs, including remediation and replacement costs, if any, are estimated
to be between $500,000$2,000,000 and $1,000,000$2,375,000 over the life of the Year 2000 project.
Since portions of the mission critical back office"back office" and domain name
registration-related systems will generally be replaced as a function of
business growth, the labor and capital costs associated with such replacement
systems are not directly attributed to achieving Year 2000 compliance. The CompanyNetwork
Solutions will also incur costs for extending its software testing architecture
which, in addition to testing remediated systems, will be used as a normal
component of Network Solutions quality assurance infrastructure. As such these
costs are not directly categorized as Year 2000 project costs but as normal
business development and engineering costs.
Network Solutions is contacting its other hardware and software vendors, other
significant suppliers, outsourcing service providers and other contracting parties to
determine the extent to which the CompanyNetwork Solutions is vulnerable to any such third
party's failure to achieve Year 2000 compliance for their own systems. At the
present time, the CompanyNetwork Solutions does not expect Year 2000 issues of any such
third parties to materially affect the Company'sNetwork Solutions' business. Furthermore,
the Company'sNetwork Solutions' business depends on the continued operation of, and
widespread access to, the Internet. This, in turn, depends to a large extent on
the software and systems of third
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parties on which the
Company'sNetwork Solutions' systems rely or to which they are connected or of otherconnected.
These third parties include, among others, Internet-related companies, including
Internet web hosting companies, Internet access providers and Internet rootdomain
name server operators. The CompanyNetwork Solutions can give no assurances that the
software or systems of such companiesthird parties 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.Network Solutions. To the extent that the normal
operation of the Internet is disrupted by the Year 2000 millennium change,
the
Company'sNetwork Solutions' business, financial condition or results of operations could
be materially and adversely affected.
Should the CompanyNetwork Solutions fail to solve a Year 2000 compliance problem to
its mission critical business systems and processes, including the Internet
rootdomain name servers under the Company'sNetwork Solutions' control, telecommunications
systems, facilities, data-networking infrastructure, commercial-off-the-shelf
hardware, software and components used by its employees, the result could be a
failure or interruption to normal business operations. The CompanyNetwork Solutions
believes that, with the deployment of the new back office"back office" and domain name
registration related systems in 1999, the potential for significant
interruptions to normal operations should be minimized. The
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Company'sNetwork Solutions'
primary 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'sNetwork Solutions' business are as follows:
- Significant and protracted interruption of electrical power to data and
call-center operationssystems in the Company'sNetwork Solutions' engineering facilityand customer support facilities
could materially and negatively impact the Company'sNetwork Solutions' ability to
provide data and call-center operations. To mitigate this risk, the CompanyNetwork
Solutions has deployed back-up power systems capable of operating
indefinitely. However, electrical power interruptions that impact
Internet connectivity providers could adversely impact the CompanyNetwork Solutions
because of the Company'sNetwork Solutions' reliance upon Internet-based operations for
its day to day business.
- Significant and protracted interruption of telecommunications and data
network services in eitherany of the Company'sNetwork Solutions' headquarters, engineering
or engineeringcustomer support facilities could materially and negatively impact
the Company'sNetwork Solutions' ability to provide data and call-center operations.
The CompanyNetwork Solutions has conducted detailed assessments of the components of
its telecommunications infrastructure and is working to identify
appropriate system testing guidelines. As part of theits technical
assessment, scheduled for completion
by the end of 1998, the Company will haveNetwork Solutions identified the compliance status of its
data networking infrastructure and developed plans for remediation, if necessary.remediation.
Finally, the CompanyNetwork Solutions has plans to seek additional assurances and a
better understanding of the compliance programs of its telecommunications
and data circuit providers.
- The failure of components of the Company'sNetwork Solutions' current back office"back office" and
domain name registration related systems could materially and negatively
impact the Company'sNetwork Solutions' 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 conductingNetwork Solutions has conducted a
technical assessment of the current systems and their software
applications in the
event that the deployment of the new systemsand is delayed beyond December
1999.currently remediating and testing such systems.
- Despite the assurances of the Company'sNetwork Solutions' 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 a Year 2000 problem relating to such third-party
suppliers, vendors and outsourcing service providersproviders' products and
services could have a material impact on the Company'sNetwork Solutions' business.
The CompanyNetwork Solutions 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 beliefAlthough Network Solutions has found that it only has to remediate a small
portion of its software code in its internal mission critical computer software
applicationssystems and
systems are Year 2000 compliant and thedespite Network Solutions' expectation that its enhancement effort will result
in Year 2000 compliant back-office"back-office" and registration-related systems and
software relating to its core domain name registration services business,
the CompanyNetwork Solutions is currently 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
finalizeNetwork Solutions finalized its initial contingency
plan and to complete thecompleted testing of all existing systems by December 31, 1998.systems. The final business
continuation plan will be completed during the second quarter of 1999 and will
be updated as appropriate throughout the year.
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Although the CompanyNetwork Solutions is taking appropriate steps relative to ensuringso that the Company'sNetwork
Solutions' business is not impacted by the date transitions associated with the
Year 2000, the CompanyNetwork Solutions has no responsibility for, nor control over other
Internet rootdomain name server operators or tens of thousands of lower level domain
name system server operators that are critical to the efficient operation of the
Internet. The CompanyNetwork Solutions has no way of knowingnot determined whether such rootdomain name server
operators or other server operators have hardware, software or firmware that is
Year 2000 compliant. The Company is notifying various federal government authoritiesNetwork Solutions has notified the Department of Commerce
of this issue and requesting that the necessary steps be taken to ensure the
uninterrupted and efficient operation of the Internet.issue.
Forward-Looking Statements
The foregoing Year 2000 discussion and the information contained herein is
provided as a "Year 2000 Readiness Disclosure" as defined in the Year 2000
Information and Readiness Disclosure Act of 1998 (Public Law 105-271, 112 Stat.
2386) enacted on October 19, 1998 and 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 the CompanyNetwork Solutions expects to complete certain actions, are based on
management's best current estimates, which were derived utilizing numerous
assumptions about future events, including the continued availability of certain
resources, representations received from third parties and other factors.
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However, there can be no guarantee that these 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 limited to, the
ability 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,Network Solutions, unanticipated 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 which such statements are made, and
the CompanyNetwork Solutions undertakes no obligation to update any forward-looking
statement to reflect events or circumstances after the date on which such
statement is made or to reflect the occurrence of unanticipated events.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not Applicable.
27Network Solutions is exposed to the impact of interest rate changes and
change in the market values of its investments.
Interest Rate Risk. Network Solutions' exposure to market rate risk for
changes in interest rates relates primarily to the Company's investment
portfolio. Network Solutions has not used derivative financial instruments in
its investment portfolio. Network Solutions invests its excess cash in debt
instruments of the U.S. Government and its agencies, and in high-quality
corporate issuers and, by policy, limits the amount of credit exposure to any
one issuer. The Company protects and preserves its invested funds by limiting
default, market and reinvestment risk.
Investments in both fixed rate and floating rate interest earning
instruments carries a degree of interest rate risk. Fixed rate securities may
have their fair market value adversely impacted due to a rise in interest rates,
while floating rate securities may produce less income than expected if interest
rates fall. Due in part to these factors, the Company's future investment income
may fall short of expectations due to changes in interest rates or the Company
may suffer losses in principal if forced to sell securities which have declined
in market value due to changes in interest rates.
Investment Risk. The Company has invested in the equity instruments of a
privately-held, information technology company for business and strategic
purposes. This investment is included in other long-term assets and is accounted
for under the cost method which approximates fair value. Network Solutions is
also exposed to equity price risks on the marketable portion of its equity
securities. Network Solutions' available-for-sale securities include investments
in publicly-held companies in the Internet industry sector, many of which have
experienced significant historical volatility in their stock prices.
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PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.PROCEEDINGS
As of November 1, 1998, the Company wasApril 30, 1999, we were a defendant in two active lawsuits involving
domain name disputes between trademark owners and domain name holders. The Company isWe are
drawn into such disputes, in part, as a result of claims by trademark owners
that the Company iswe are legally required, upon request by a trademark owner, to terminate
the right the Companywe granted to a domain name holder to register a domain name which is
alleged to be similar to the trademark in question. The holders of the domain
name registrations in dispute have, in turn, questioned the Company'sour right, absent a
court order, to take any action which suspends their use of the domain names in
question. Although 4349 out of approximately 4,0006,000 of these situations have
resulted in suits actually naming the Companyus as a defendant, as of November 1, 1998,April 30, 1999, no
adverse judgment has been rendered and no award of damages has ever been made
against the Company. The
Company believesus. We believe that it haswe have meritorious defenses and vigorously defends itselfdefend
ourselves against these claims.
On March 20, 1997, PG Media, Inc., a New York-based corporation ("PG
Media"), filed a
lawsuit against the Companyus in the United States District Court, Southern District of New
York alleging that the Companywe had restricted access to the Internet by not adding PG
Media's requested TLDstop level domains 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 Companywe be ordered to include reference to PG Media's
TLDstop level domains and name servers in the root zone file administered by the Companyus
under the Cooperative Agreement. The Company
answered the complaint. In June 1997, the Companywe received written direction
from the NSFNational Science Foundation not to take any action which would create
additional TLDstop level domains or to add any new TLDstop level domains to the Internet
root zone until the NSFNational Science Foundation provides further guidance. On
September 17, 1997, PG Media filed a Second Amended Complaint adding the
NSFNational Science Foundation as a defendant. On May 14, 1998, PG Media served the Companyus
with a motion for a preliminary injunction against both defendants. The motion sought a hearing
before the court on June 8, 1998defendants to compel
both defendants to add PG Media's TLDstop level domains to the Internet root zone
within 30 days. In response, both defendants filed cross-motions for summary
judgment against PG Media. On July 20, 1998, a hearing on all parties' motions
occurred. The basic issue before the court is the NSF'sNational Science Foundation's
authority to control the Internet's root zone system. TheOn March 16, 1999, the
court has takengranted both our and the issueNational Science Foundation's motions for summary
judgment, holding that the National Science Foundation does have authority over
the root zone system and that the federal instrumentality immunity doctrine
immunizes us against liability under advisementboth sections 1 and no date has been indicated for2 of the issuance of a
decision. Although the CompanySherman Act.
PG Media noticed its appeal on April 15, 1999. While we cannot reasonably
estimate the potential impact of suchthe claims advanced in this lawsuit, 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.harm our business.
On October 17, 1997, a group of six plaintiffs filed a lawsuit (the "Thomas
suit")the Thomas suit
against the Companyus and the NSFNational Science Foundation 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 ofConstitution, 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 Companyus 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 court also granted the
Company'sour 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.us. 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 NSFNational Science Foundation 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 notice of appeal on the
Court's dismissal of counts II through X and on the plaintiff's motion for
preliminary injunction against the Company. On June 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. On August 28, 1998, the District Court dismissed
the entire case, issuing a final judgment in the matter. Following that decision,In October 1998, the
plaintiffs dismissed all pending appeals inappealed the court's dismissal of their claims, and oral argument
occurred on February 25, 1999. On May 14, 1999, the Court of Appeals. The plaintiffs, however,
onAppeals ruled in
favor of Network Solutions by unanimously affirming the District Court's
decision.
On October 23,20, 1998, filedwe were included as a new notice of appeal from the final order fileddefendant in a suit brought by
the District CourtPennsylvania Attorney General's office against a domain name holder who was
alleged to have used his domain name in connection with a web site promoting
white supremacy and threatening certain state employees. The Pennsylvania
26
27
Attorney General named all of the communications companies in any way connected
with the domain name or web site. The Pennsylvania Attorney General seeks to
permanently enjoin these entities, including us, from providing services to this
domain name holder in the event that the domain name holder fails to comply with
the order of the court. We have answered the complaint denying any knowledge or
participation in the actions of the primary defendant. The Attorney General
dismissed the case against us on August 28, 1998.April 26, 1999.
On June 27, 1997, SAIC received a CIDCivil Investigative Demand, or "CID,"
from the DOJU.S. Department of Justice 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
seekssought documents and information from SAIC and the
Companyus relating to theirour Internet
registration business. The CompanyOn April 29, 1999, we received a second CID seeking
additional information and documents relating to our ownership rights in,
policies relating to access to, and our use of, data that we compile in the
course of operating our Internet registration business. We are providing
information responsive to the CID. Because the investigation, as currently
focused, is still at a preliminary stage, we cannot reasonably estimate the
potential impact of the investigation nor can itwe predict whether a civil action
maymight ultimately be filed by the DOJDepartment of Justice or the form of relief
that might be sought. Any such relief from such a suit could have a material
adverseharmful
effect on the Company's business, financial condition and results of
operations.our business.
On August 17, 1998, the Companywe received notice from the Commission of the European
Communities, or "EC," 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 Companyreview and we complied. We cannot reasonably estimate
the potential impact of the investigation nor can the Companywe 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 isharm our business.
We are involved in various other investigations, claims and lawsuits
arising in the normal conduct of itsour business, none of which, in theour 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 conductharm our business.
LitigationLegal proceedings in which the Company iswe are involved hashave resulted and likely will
result in, and any future litigationlegal proceedings can be expected to result in,
substantial legal and other expenses to the Company and a diversion of the efforts of the
Company'sour
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.
29
30
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits -- See Exhibit Index
27
28
(b) Reports on Form 8-K --
The Companyfollowing reports on Form 8-K were filed during the quarter ended March
31, 1999:
On January 15, 1999, we filed a report on Form 8-K, pursuant to Item 5 of
such form, to report that our Board of Directors had approved a two-for-one
split of our Class A Common Stock and Class B Common Stock, to be effected in
the form of a 100% stock dividend.
On February 9, 1999, we filed a report on October 6, 1998 announcingForm 8-K, pursuant to Item 5 of
such form, to report that itthe Internet Corporation for Assigned Names and
Numbers had entered into an amendmentissued, in preliminary form, its "Guidelines for Accreditation of
Internet Domain Name Registrars and for Selection of Registrars for the Shared
Registry System TestBed for .com, .net and .org Domains."
On February 11, 1999, we filed a report on Form 8-K, pursuant to its Cooperative Agreement with
the United States DepartmentItem 5 of
Commerce (the "Amendment"). A copysuch form, to report our issuance of
the Amendment and a press release related thereto were filed as
exhibits to the Form 8-K.
30announcing our 1998 fourth
quarter and annual revenue and earnings.
28
3129
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.
By: /s/ ROBERT J. KORZENIEWSKI
Robert J. Korzeniewski
Chief Financial Officer, Acting
Chief Operating Officer and
Authorized Signatory
Date: November 16, 1998
31May 17, 1999
29
32
EXHIBIT30
INDEX TO EXHIBITS
NETWORK SOLUTIONS, INC.
THREE MONTHS ENDED MARCH 31, 1999
EXHIBIT SEQUENTIAL
NO. DESCRIPTION OF EXHIBITS -PAGE NO.
- ------- ----------------------- ----------
10.22
10.25 Amendment No. 1013 to the Cooperative Agreement dated September 29, 1998May 6,
1999
10.26 Lease Agreement By and Between Corporate Oaks LP and Network
Solutions dated March 11, 1999
27.1 Financial Data Schedule
27.2 Restated Financial Data Schedule
3230