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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 (No Fee Required)
For the Fiscal Year Ended December 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 (No Fee Required)
For the Transition Period from to
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Commission File Number 0-22967
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NETWORK SOLUTIONS, INC.
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(Exact name of registrant as specified in its charter)
Delaware 52-1146119
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(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
505 Huntmar Park Drive, Herndon, Virginia 20170
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(Address of principal executive offices) (Zip Code)
(703) 742-0400
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(Registrant's telephone number,
including area code)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Class A Common Stock, $.001 Par Value
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for at least the past 90 days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates
of the registrant was approximately $82,025,402.50 on March 13, 1998 based on
the last sale price as reported by the Nasdaq National Market System.
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The aggregate number of outstanding shares of Class A Common Stock,
$.001 par value, of the registrant was 3,813,063 shares as of March 13, 1998.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement for the annual
meeting of shareholders to be held on May 19, 1998, which will be filed with the
Commission within 120 days after the end of the registrant's fiscal year ended
December 31, 1997, are incorporated by reference into Part III of this Form
10-K.
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TABLE OF CONTENTS
Page
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PART I
ITEM 1. BUSINESS ................................................................................... 4
ITEM 2. PROPERTIES..................................................................................33
ITEM 3. LEGAL PROCEEDINGS...........................................................................33
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.........................................34
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND
RELATED STOCKHOLDER MATTERS.................................................................36
ITEM 6. SELECTED FINANCIAL DATA.....................................................................38
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS...............................................40
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK...........................................................................53
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.................................................53
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH
ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE..................................................................................53
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT..........................................53
ITEM 11. EXECUTIVE COMPENSATION......................................................................53
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT..............................54
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS..............................................54
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K............................54
SIGNATURES....................................................................................................56
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PART I
THIS ANNUAL REPORT ON FORM 10-K CONTAINS FORWARD-LOOKING STATEMENTS THAT
HAVE BEEN MADE PURSUANT TO THE PROVISIONS OF THE PRIVATE SECURITIES LITIGATION
REFORM ACT OF 1995. SUCH FORWARD-LOOKING STATEMENTS ARE BASED ON MANAGEMENT'S
CURRENT EXPECTATIONS, ESTIMATES AND PROJECTIONS, BELIEFS AND ASSUMPTIONS. WORDS
SUCH AS "ANTICIPATES," "EXPECTS," "INTENDS," "PLANS," "BELIEVES," "SEEKS,"
"ESTIMATES," VARIATIONS OF SUCH WORDS AND SIMILAR EXPRESSIONS ARE INTENDED TO
IDENTIFY SUCH FORWARD-LOOKING STATEMENTS. THESE STATEMENTS ARE NOT GUARANTEES OF
FUTURE PERFORMANCE AND ARE SUBJECT TO CERTAIN RISKS, UNCERTAINTIES AND
ASSUMPTIONS THAT ARE DIFFICULT TO PREDICT; THEREFORE, ACTUAL RESULTS MAY DIFFER
MATERIALLY FROM THOSE EXPRESSED OR FORECASTED IN ANY SUCH FORWARD-LOOKING
STATEMENTS. SUCH RISKS AND UNCERTAINTIES INCLUDE THOSE SET FORTH HEREIN UNDER
"BUSINESS-RISK FACTORS" ON PAGES 19 THROUGH 32 AND ELSEWHERE IN THIS FORM 10-K.
UNLESS REQUIRED BY LAW, THE COMPANY UNDERTAKES NO OBLIGATION TO UPDATE PUBLICLY
ANY FORWARD-LOOKING STATEMENTS, WHETHER AS A RESULT OF NEW INFORMATION, FUTURE
EVENTS OR OTHERWISE. HOWEVER, READERS SHOULD CAREFULLY REVIEW THE FACTORS SET
FORTH IN OTHER REPORTS OR DOCUMENTS THE COMPANY FILES FROM TIME TO TIME WITH THE
SECURITIES AND EXCHANGE COMMISSION, PARTICULARLY THE QUARTERLY REPORTS ON FORM
10-Q AND ANY CURRENT REPORTS ON FORM 8-K.
ITEM 1. BUSINESS.
OVERVIEW
Network Solutions, Inc. (the "Company" or "Network Solutions") is the
leading Internet domain name registration services provider worldwide. The
Company currently acts as the exclusive registrar for second level domain names
within the .com, .org, .net, and .edu top-level domains ("TLDs") pursuant to a
cooperative agreement (the "Cooperative Agreement") with the National Science
Foundation (the "NSF"). The Cooperative Agreement became effective January 1,
1993. It includes a three-month phase-in period, a five-year operational period
(commencing April 1, 1993 and ending March 31, 1998), and a six-month
"flexibility period" through September 30, 1998. By registering Internet domain
names, the Company enables businesses, other organizations and individuals to
establish a unique Internet identity from which to communicate and conduct
commerce. The Company also is responsible for maintaining the .com, .org, .net,
and .edu TLD zone files, which contain the second-level domain name and its
corresponding Internet Protocol ("IP") numeric address. In this capacity, the
Company enables the efficient operation of the Internet by supplying or making
available to the Internet root servers located around the world an identical
copy of the file for all second level domain names registered in these TLDs.
On February 20, 1998, the National Telecommunications and Information
Administration of the Department of Commerce (the "NTIA") published for comment
in the Federal Register a proposed rule which, if issued, would provide, among
other things, (i) that additional companies could act as registrars for second
level domain names within the .com, .org, and .net TLDs and (ii) that
additional TLDs would be permitted to be added to the Internet's root zone
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system. See "Relationship with the NSF; Recent Developments in Internet
Governance" and "Competition."
Through its Consulting Services Division, the Company provides enterprise
network consulting services to large businesses that desire to establish or
enhance their Internet presence or "re-engineer" legacy network infrastructures
to accommodate the integration of both Internet connectivity and Intranet
network technology into their information technology base. The Division's
service offerings have evolved from the Company's Internet pioneering efforts
that date back to 1979 and presently include: (i) network engineering; (ii)
network and systems security; and (iii) network management.
In addition, the Company intends to offer a portfolio of Internet-based
products and services, that will draw upon its position in the registration
business and make proper use of the customer data that the Company collects.
The Company was incorporated in Washington, D.C. in 1979 as Network
Solutions Incorporated. The Company was acquired by Science Applications
International Corporation ("SAIC"), an employee-owned, diversified professional
and technical services company, on March 10, 1995, and was reincorporated as
Network Solutions, Inc. in Delaware in November 1996. The Company completed its
initial public offering ("IPO") of 3,795,000 shares of its Class A common stock,
$.001 par value ("Class A Common Stock"), on October 1, 1997. As of March 13,
1998, SAIC owned 100% of the Company's Class B common stock, $.001 par value
("Class B Common Stock"), representing approximately 75.8% of the Company's
outstanding common stock, $.001 par value ("Common Stock"), and 96.9% of the
combined voting power of the Company's outstanding Class A and Class B Common
Stock. The Company's principal executive offices are located at 505 Huntmar Park
Drive, Herndon, Virginia 20170, its telephone number is (703)742-0400 and its
Class A Common Stock is traded on the Nasdaq National Market under the ticker
symbol NSOL.
INDUSTRY BACKGROUND
The Internet is a global network of millions of interconnected computers
and computer networks that allow businesses, other organizations and individuals
to communicate. Historically, the Internet had been used by a limited number of
academic institutions, defense contractors and government agencies to facilitate
remote access to host computers and transmit electronic mail. However, use of
the Internet has now become dominated by a broad range of commercial
organizations and individuals who utilize the Internet to communicate
electronically, to distribute and retrieve information and to conduct commerce.
Advances in technology, low-cost Internet access and an increasing corporate
reliance on distributed information environments have fueled the rapid growth of
the Internet.
The Company believes that in order to support the demands placed on this
evolving and rapidly growing medium of commerce and information exchange, a wide
range of products and services will need to be developed and enhanced,
including: (i) domain name registration services; (ii) Internet-based products
and services; and (iii) enterprise network consulting services.
Domain Name Registration Services. All communication on the Internet
requires a unique numerical electronic address called an IP address. However,
since IP addresses are hard to remember, the Internet functions through the
establishment of a unique Internet identity (a "domain name") that correlates to
an IP address and the proliferation of such domain names in the global Internet
root servers. Currently, there are 13 root servers, ten of which are located in
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the United States, two of which are located in Europe and one of which is
located in Asia. When communication with a particular domain name is required
and the IP address of that domain name's host is not known locally, the root
servers "point" to a direct or indirect source of the information. See "Risk
Factors - Reliance on Third Parties."
An Internet domain name is made up of a TLD, such as .com, .org, .net or
.edu, and additional domain levels consisting of at least one additional domain
level, referred to as a second level domain name. For example, in the domain
name "companyX.com," "companyX" is the second level domain name. With the
increased commercialization of the Internet, second level domain names are being
utilized not only by large corporations but also increasingly by other users,
including small businesses, organizations and individuals. Particularly within
the .com TLD, users are also registering domain names to establish Internet
identities for other purposes such as trademarks, products and events. The most
common TLDs include .com, .org, .net, .edu and .gov, as well as country code
TLDs represented by "." followed by two letter country codes (e.g., .us for the
United States, .uk for the United Kingdom and .de for Germany).
The Internet is not bound by geography or lines of business and
coordination and administration services are required for the registration,
allocation and use of TLDs and for the effective operation of the Internet. In
1992, the NSF entered into the Cooperative Agreement with the Company for the
performance of these functions for the .com, .org, .net, .edu and .gov TLDs.
Internet-Based Products and Services. The proliferation of Internet users
provides businesses, other organizations and individuals with new means by which
to conduct business. To facilitate business-to-business and business-to-consumer
transactions, Internet users are seeking important Internet-based products and
services, such as transaction security services, electronic payment mechanisms
and directory, communications, data and research and identity promotion
services.
Consulting Services. Many businesses are developing enterprise networks
that employ Internet data formats and communications protocols. Internal
enterprise networks ("Intranets") enhance user productivity and connectivity
allowing users controlled access to internal information while also accessing
and exchanging information on the Internet. As more businesses, organizations
and individuals establish an Internet presence and begin to deploy Intranets,
the Company believes there will be an increasing demand for Intranet development
and enterprise network consulting services. In addition, the Company believes
that Intranets are becoming increasingly sophisticated and are allowing users
increased capabilities and improved access to information. As a result,
businesses are increasingly seeking experienced enterprise network consulting
firms to enable all of these services.
PRINCIPAL SERVICES
A. Registration Services. Registration services are the Company's core
business. The Company registers second level domain names in the .com, .org,
.net, and .edu TLDs, enabling registrants to establish a unique identity on the
Internet. The Company's customers apply to register second level domain names
either directly through the Company's web sites or indirectly through Internet
access providers, which are the largest source of customers for the Company.
Prior to September 14, 1995, the Company was reimbursed under the
Cooperative Agreement by the NSF for providing registration services on a cost
reimbursement plus fixed-fee basis. Effective September 14, 1995, the NSF and
the Company amended the Cooperative
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Agreement to authorize the Company to begin charging customers a service fee of
$50 per year for each second level domain name registered. Customers in the
.com, .org and .net TLDs have paid a two-year services fee of $100 for initial
registrations and $50 per year for registration renewals. Under the terms of the
amendment to the Cooperative Agreement, 30% of the services fees collected have
been required to be set aside to be disbursed in a manner approved by the NSF
for the enhancement of the intellectual infrastructure of the Internet. These
funds have not been recognized as revenue by the Company. With regard to
registrations on or after April 1, 1998, the NSF and the Company have further
amended the Cooperative Agreement to provide that (i) the Company will no longer
charge or set aside a portion of the services fee for the enhancement of the
intellectual infrastructure of the Internet and (ii) the Company's fees will be
reduced to a two-year services fee of $70 for initial registrations and $35 per
year for renewals.
Through the internic web site, Network Solutions provides a domain name
registration process for the registration of second level domain names. The
Company's customers submit registration applications to the Company via e-mail
through the Internet. The Company processes the application and either registers
the requested domain name in the requested TLD or rejects the application. Upon
registration or rejection, the Company notifies the customer via e-mail. For
domain names which are registered, the Company invoices the customers and
permits them to pay the registration services fee after the domain name is
registered. The Company performs internally (i.e., it does not outsource) its
core proprietary automated registration process and associated security
functions.
On December 1, 1997, Network Solutions announced its new WorldNIC(TM)
Services brand, a suite of enhanced domain name registration services geared
toward businesses building their online identities. On January 14, 1998,
Network Solutions unveiled RegistrationPlus(TM), the first service offering
under the WorldNIC(TM) Services brand. RegistrationPlus(TM) is a service that
provides a way for small businesses to establish themselves on the Internet.
RegistrationPlus(TM)'s five step registration process minimizes technical and
procedural barriers for new users seeking to gain an entry point on the
Internet. RegistrationPlus(TM) allows users to register or reserve a second
level domain name in real-time whether or not they have a computer, either
through Network Solutions' WorldNIC(TM) Services web site, or by calling a
toll-free number. As part of RegistrationPlus(TM), the Company offers the
option of reserving a name and activating it later by providing domain name
record hosting. In addition to the Company's two-year services fee for initial
registrations, as of March 13, 1998, RegistrationPlus(TM) customers pay $10 for
the Company's enhanced registration services or, if applicable, $49 for
reservation of a domain name.
The RegistrationPlus(TM) service offering is a web based transaction
process that is intended to make the registration process easier, more
streamlined and more accessible. The Company believes that ease of use is
becoming increasingly important as the Internet is being more widely adopted by
users who are less technically sophisticated. To facilitate payment of
registration and renewal fees, the Company, as part of its RegistrationPlus(TM)
service, implemented an electronic payment mechanism through which a user pays
for its domain name via credit or debit card through an Internet-based on-line
payment system. The Company believes that a streamlined registration process
and on-line payment system will make it easier for customers to register a
domain name.
As part of its registration services offering, the Company provides the
following services and support:
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1. Customer Support Services. The Company believes that high quality
customer support is vital to client satisfaction. The domain name registration
services fee provides the customer access to the Company's customer support
services, including a telephone help desk, an on-line processing facility for
account information updates and other services. The Company's customer service
representatives in its Herndon, Virginia facility provide such support services.
As part of its WorldNIC(TM) Services launch, the Company recently outsourced
toll free telephone help desk support for its RegistrationPlus(TM) services to a
large, experienced call center support entity. The outsourcing contractor is
providing 24 hour 7 days a week support with customer service representatives
trained by the Company's training staff. The help desks and on-line processing
facility are important to the success of the Company's registration business
because they are the front line to the customer and provide initial and ongoing
customer service and support.
At the end of 1996, the Company entered into arrangements to outsource
certain back office operations, including invoicing, check processing and
credit card processing. In addition, in December 1997, the Company introduced a
new Oracle-based billing and accounts receivable system (BARS), an
Internet-based transaction billing system. BARS improves tracking capabilities
for billing information and enhances the speed and accuracy with which the
Company's customer service representatives handle payment inquiries. The
outsourcing efforts, in conjunction with BARS, have improved customer service
and account handling and expanded the Company's capacity to service larger
volumes of registrants.
2. Domain Name Dispute Policy Administration. The Company's established
domain name dispute policy is an integral part of the maintenance and
administration of the Company's domain name registration business. This policy
seeks to take a neutral position with regard to domain name disputes between
trademark owners and domain name holders and is designed to address claims that
a domain name registered by the Company infringes a third party's federal
trademark. As of March 13, 1998, the Company had received over 3,600 written
objections to the registration and use of certain domain names. Of these,
approximately 1,960 were disputes in which the Company's domain name dispute
policy was involved. Although 42 out of these situations have resulted in
litigation involving the Company, as of March 13, 1998, no payments have been
made by the Company to any plaintiff and only four of these cases are pending.
The Company expends considerable management and legal resources in the
development, refinement and administration of its domain name dispute policy.
See "Item 3 - Legal Proceedings."
3. Technical Infrastructure Support. The Company is investing
significant technical and financial resources to improve and to operate its
domain name registration business. A substantial portion of the Company's
software is custom-developed and proprietary. The Company's internally
developed and proprietary software includes an automated registration
capability that currently processes in excess of 90% of all new registration
requests without human intervention. The Company believes that significant
engineering talent is required to create a registration services capability and
that knowledge of Internet domain name system ("DNS") structures, Internet
security, data routing and routing protocols is critical to creating and
enhancing registration service capabilities. The Company developed RWhois, a
standard open protocol, which is used in the registration services business.
The Company's engineering staff has significant expertise in the RWhois
protocol. The Company believes that engineers skilled in protocol development
are difficult to identify, hire and retain and thus its staff of engineers
represents a valuable resource. See "Operations."
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The Company currently maintains in excess of one and one-half million
unique second level domain name registrations. The Company has realized
significant scale efficiencies throughout its registration process as a result
of its large customer base and technical infrastructure.
B. Consulting Services. The Company delivers enterprise network consulting
services to some of the world's leading businesses that are utilizing Internet
technologies for their internal enterprise networks (i.e., Intranets),
connecting securely with their key partners through Extranets and accessing the
Internet. The Company's engineers have extensive knowledge and experience in
network engineering, network security and network management. The engineers have
a broad base of expertise in such areas as local area network ("LAN")/wide area
network ("WAN") protocols; routing, switching and remote access technologies;
virtual private networks; IP addressing; domain name architecture; and UNIX, NT
and other network operating systems. By leveraging this knowledge and
experience, the Company is able to provide solutions to clients' complex network
needs.
The Company sells and markets its consulting services primarily to large
companies that utilize their enterprise networks for a strategic advantage.
During 1997, the Company provided consulting services to more than 35 individual
companies. Ten of the Consulting Services Division's clients accounted for
approximately 80% of its revenues. Each of these clients was in either the
financial services industry or the oil and gas industry. Companies within these
two industry groups will continue to be a primary focus for future business
opportunities. The Company provides requirements analysis, design and
implementation services within the following service offerings:
1. Network Engineering. The Company offers a line of services to
help develop, optimize, and integrate enterprise network solutions in a manner
tailored to individual clients' needs. All of these services are focused on
building a strong network foundation for the enterprise. This includes service
level analysis of IP address space engineering; DNS and dynamic host
configuration protocol ("DHCP") architecture engineering; routing and switching
architecture engineering; Extranet architecture engineering; virtual private
network architecture engineering; and electronic messaging architecture
engineering.
2. Network Security. The Company provides a range of security
consulting services to allow clients to protect the integrity of their data and
systems. The enterprise network's security architecture establishes the access
and protection controls that will permit internal and remote users to access
computer systems, databases and applications on the network, while protecting
against unauthorized or inadvertent access to information or misuse of systems
services. The Company's methods to secure the backbone, LAN-to-WAN access,
remote access and facilities can supplement or replace existing systems security
measures. The Company maintains resident expertise in emerging network
protocols, encryption and key technologies, firewalls, packet filters, proxy
services, secure remote access strategies and secure Intranet servers.
3. Network Management. The Company provides a range of services to
allow clients to control their mission-critical network performance. Such
services include developing network capacity plans and performance management
tools, conducting baseline assessments, performing network optimization and
tuning, integrating new technology, and implementing complex network management
centers. The Company also provides planning and analysis to implement disaster
recovery and contingencies for network system failures.
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The Company's consulting services are generally provided to clients on a
time and expense basis. The Company also performs a limited number of
engagements on a fixed-price basis. Many of the Company's consulting services
clients have been developed through direct contact or referrals from SAIC. The
Company intends to continue to rely on its relationship with SAIC and its
subsidiary, Bell Communications Research, Inc. ("Bellcore"), to attempt to
access SAIC's and Bellcore's major customers and strategic partners. The
Company's Consulting Services Division is establishing its own dedicated sales
team with account executives assigned to key clients in regional territories.
In January 1998, Network Solutions and Informatica, Negocios, y
Technologia, S.A. ("INTESA"), a joint venture between Petroleos de Venezuela
S.A. (PDVSA) and SAIC, headquartered in Caracas, Venezuela, entered into an
agreement under which the Company will provide consulting services to INTESA.
The Company will provide expertise in Internet connectivity, messaging services,
network security and wide area network (WAN) re-engineering to INTESA under a
broad umbrella contract. As part of SAIC's joint venture agreement with PDVSA,
the Company is currently subject to a noncompetition arrangement pursuant to
which the Company has agreed to provide, with certain limited exceptions,
consulting services to other companies in the Latin American market solely
through INTESA.
C. Internet-Based and Other Services. The Company intends to offer a portfolio
of Internet-based products and services that will draw upon the Company's
position in the registration business and makes proper use of the customer data
that it collects. These products and services could include directory,
communications, data and research, identity promotion and other services. Some
of these products and services could include distribution of third party
offerings through on-line enrollment for such products and services from the
Company's domain name registration web site. Some of these products and services
are currently in the process of development. See "Risk Factors - Technological
Change and Additional Technology, Products and Services and - Evolving Sales
and Marketing Organization and Distribution Channels."
D. Strategic Acquisitions. The Company will seek to identify and, where
appropriate, pursue acquisition opportunities which would provide businesses,
products, services or technology complementary to the Company's current
business. See "Risk Factors - Uncertainty of Future Acquisitions."
RELATIONSHIP WITH THE NSF; RECENT DEVELOPMENTS IN INTERNET GOVERNANCE
The Internet is not bound by geography or lines of business and
coordination and administrative services are required for the registration,
allocation and use of TLDs and for the effective operation of the Internet. The
Internet historically has been loosely administered by government agencies which
were involved in the creation of its infrastructure, initially the Department of
Defense's Advanced Research Projects Agency ("ARPA") and, more recently, the
NSF. Since the original role of the Internet was to link computers at
governmental and academic institutions to facilitate communication and research,
the Internet was historically administered by entities which were involved in
sponsoring research rather than by any of the traditional federal or state
regulatory agencies.
In 1992, the Company entered into the Cooperative Agreement with the NSF,
which had been funding the Defense Information Systems Agency ("DISA"), to
perform registration services for second level domain names within the .com,
.org, .net, .edu and .gov TLDs. Under the Cooperative Agreement, the Company was
given the responsibility for ensuring the quality, timeliness and effective
management of registration services to non-military Internet users and networks.
The registration services provided by the Company under the Cooperative
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Agreement included second level domain name registration, domain name server
registration and network number assignment, as well as autonomous system number
assignment and IP address mapping and allocation for North and South America,
the Caribbean and parts of Africa.
The Cooperative Agreement became effective January 1, 1993. It includes a
three-month phase-in period, a five-year operational period (commencing April
1, 1993 and ending March 31, 1998), and a six-month "flexibility period"
through September 30, 1998. The Cooperative Agreement is subject to review by
the NSF and may be terminated by the NSF at any time at its discretion or by
mutual agreement. The NSF has stated that it will not be re-awarding a
cooperative agreement at the end of the flexibility period.
On July 1, 1997, as part of the Clinton Administration's "Framework for
Global Electronic Commerce," the President directed the Secretary of Commerce
to privatize, increase competition in, and promote international participation
in the DNS. Accordingly, on July 2, 1997, the NTIA issued a Request for
Comments on administration of Internet domain names, on behalf of an
inter-agency working group previously formed to explore the appropriate future
role of the U.S. government in the DNS. This request appeared in the form of
the Notice of Inquiry ("NOI") in the U.S. Federal Register. The NOI requested
specific input in five broad areas: general principles, general/organizational
framework issues, creation of new TLDs, policy issues for new registrars and
trademark dispute issues. During the comment period, over 430 comments,
including those of the Company, were received by the NTIA.
On January 30, 1998, the NTIA issued a discussion draft, entitled "A
Proposal to Improve Technical Management of Internet Names and Addresses" (the
"Proposed Rule"). The following is a summary of the principal features of the
Proposed Rule, and is not intended to be a complete description thereof. This
summary is subject to and qualified in its entirety by reference to the
Proposed Rule, which was published pursuant to the Administrative Procedures
Act in the U.S. Federal Register on February 20, 1998.
The Proposed Rule provides notice and seeks public comment on a proposal
to transfer over time the administration of the DNS to a new private,
not-for-profit corporation and increase competition in the administration of
TLDs and the registration of second level domain names. The Proposed Rule
states the view that the U.S. government should end its management role in the
Internet number and name address systems in a responsible manner that ensures
the stability of the Internet. The Proposed Rule covers generic TLDs and does
not address country-code TLDs, which are administered by the corresponding
governments or by private entities with the appropriate government's
acquiescence.
Under the new Proposed Rule, administration of the DNS would be transferred
over time to a new private, not-for-profit corporation. After a transition
period, the corporation would have authority: (i) to set policy for and direct
the allocation of IP address number blocks to regional number registries for
the assignment of Internet addresses; (ii) to oversee the operation of the root
server system; (iii) to oversee policy for determining the circumstances under
which new TLDs are added to the root system; and (iv) to coordinate the
development of other technical protocol parameters to maintain universal
connectivity on the Internet.
The Proposed Rule provides that the new corporation would be headquartered
in the United States and incorporated under U.S. law. The Proposed Rule states
that the board of directors of the new corporation should represent membership
associations of key stakeholders, including IP number registries, domain name
registries, domain name registrars, the technical community
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and Internet users (commercial, not-for-profit and individuals). The Proposed
Rule provides that the corporation should hire a Chief Executive Officer with a
background in the corporate sector. The new corporation would be funded by
domain name registries and regional IP registries.
The Proposed Rule provides that the transition would commence as soon as
possible, with operational responsibility moved to the new corporation by
September 30, 1998. The U.S. government would participate in policy oversight to
assure stability until the new corporation is established and stable, phasing
out as soon as possible, but in no event later than September 30, 2000. The
Commerce Department would coordinate the U.S. government policy role.
The Proposed Rule distinguishes between "registries" and "registrars". A
"registry" is responsible for maintaining a TLD's zone files, which contain each
second level domain name in that TLD and the corresponding IP addresses of its
name servers. Each registry would establish minimum dispute resolution and other
procedures relating to trademark considerations and would be required to
indemnify the new corporation for costs incurred in connection with trademark
disputes. A "registrar" acts as an interface between domain-name holders and the
registry, providing registration and value-added services. The registrar submits
zone file information for each of its customers in a single TLD to the registry.
Currently, the Company acts as both the exclusive registry and as the exclusive
registrar for the .com, .net, .org and .edu TLDs.
During the transition to private administration of the DNS, the Proposed
Rule provides for the addition of up to five new registries, each of which, at
least initially, would be limited to a single TLD. During the transition, the
first five entities to meet the technical, managerial and site criteria provided
in the Proposed Rule would be allowed to establish a domain name registry. The
Proposed Rule does not specify whether the pool of eligible applicants would be
unlimited or limited, and, if limited, on what basis. Neutral accounting and
technical consultancy firms would be engaged to evaluate a proposed registry
under the criteria and certify an applicant as qualified. Qualified registries
would, in the order of their qualification, select a TLD from a list of
available TLDs or propose another TLD. The Proposed Rule states that such list
of TLDs would be proposed based on input received and market data. The Proposed
Rule provides that any entity would be permitted to provide registrar services
within a TLD so long as it met certain specified minimum qualifications.
Registries could set additional requirements for registrars with which they
wished to do business. The Proposed Rule provides that if a registry wishes to
act both as registry and registrar for the same TLD, it must do so through
separate subsidiaries, and appropriate accounting and confidentiality safeguards
shall be used to ensure that the registry subsidiary's business is not utilized
in any manner to benefit the registrar subsidiary to the detriment of any other
registrar. Each TLD database will be maintained by only one registry. The
Internet Assigned Number Authority ("IANA"), which is headed by Dr. Jon Postel
of the Information Sciences Institute at the University of Southern California
and which currently provides IP address allocation, would be involved in many of
the functions during the transition period to the new corporation.
The Proposed Rule provides that during the transition period, the new
corporation should evaluate the effects that the addition of new TLDs has on the
operation of the Internet, on users and on trademark holders. After the
transition, the new corporation would determine whether or when the introduction
of additional TLDs was desirable and would have authority over the terms and
conditions for the admission of new TLDs.
The Proposed Rule provides that the U.S. government would phase out the
Cooperative Agreement by the end of
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September 1998. In addition, the Proposed Rule provides that, as the U.S.
government is seeking to end its role in the DNS, the provision in the
Cooperative Agreement requiring allocation of 30% of the registration fee to
the Internet Intellectual Infrastructure Fund should terminate on April 1,
1998, the beginning of the flexibility period. The Proposed Rule provides that
the Company and the U.S. government would negotiate an agreement that should
contain the following terms designed to promote competition in domain name
registration:
(1) the Company would effectively separate and maintain a clear division
between its current "registry" and "registrar" functions;
(2) the Company would continue to operate the .com, .org and .net
registries and to act as a registrar for those TLDs, but other
companies would be permitted to act as registrar for those TLDs;
(3) the .edu TLD would be transferred to a not-for-profit entity;
(4) the Company's registry would treat all registrars on a
nondiscriminatory basis and price registry services according to an
agreed upon formula for a period of time;
(5) as part of the transition, the Company would develop (or license) and
implement the technical capability to share the registrar functions in
the .com, .org, and .net TLDs with competing registrars as soon as
possible, by an agreed upon date;
(6) the Company would provide the U.S. government with "a copy and
documentation of all the data, software, and appropriate licenses to
other intellectual property generated under the Cooperative Agreement,
for use by the new corporation for the benefit of the Internet";
(7) the Company would turn over control of the A-root server and the
management of the root server system when instructed to do so by the
U.S. government; and
(8) the Company would be required to meet the requirements, set forth in
the Proposed Rule, for registrars and registries.
The Proposed Rule also provides that as part of the transition, an
agreement would need to be reached between the U.S. government and IANA on the
transfer of IANA functions to the new corporation.
The formal comment period for the Proposed Rule ended on March 23, 1998.
The NTIA expresses in the Proposed Rule its hope that a reasonable consensus can
be found and that, after appropriate modifications, implementation of a final
rule can begin in April 1998. Numerous comments have been received on the
Proposed Rule, including comments from the Company. Some of the comments are
critical of certain of the Proposed Rule's provisions. The Commerce Department
has indicated that a final rule will be issued shortly after review of the
comments received. It is impossible to predict at this time whether or when a
final rule will be issued and, if issued, the timing of its implementation, the
exact nature of its provisions or of any terms negotiated by the U.S.
government and the Company or the precise effect of such provisions or terms on
the Company. In addition, any final rule that is issued or any negotiated terms
could be challenged by persons or entities who disagree therewith.
See "Risk Factors - Uncertainty of Internet Governance and Regulation."
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On October 1, 1997, the Company, pursuant to the NSF's directive,
transferred its registration functions for the .gov TLD to the General Services
Administration ("GSA"). The Company was released from all of its obligations
under the Cooperative Agreement relating to the .gov TLD upon such transfer. On
December 22, 1997, the Company, pursuant to the NSF's directive, transferred the
allocation and administration of IP addresses for North and South America, the
Caribbean and parts of Africa to a not-for-profit organization named the
American Registry for Internet Numbers ( "ARIN"). The Company has agreed with
the NSF to provide financial support to ARIN through the end of the first
quarter of 1998. The Company believes that the amount of such support to the
ARIN in the first quarter of 1998 will not be material.
MARKETING AND DISTRIBUTION
The Company has designed its marketing and distribution strategy to
increase the use of the .com, .net and .org TLDs worldwide and to address the
particular requirements of its diverse international customer base. The Company
has begun and intends to continue to promote the use of the .com, .net and .org
TLDs.
The Company is working to expand its domain name registration business by:
(i) building on relationships with Internet access providers; (ii) developing
co-marketing programs with channel partners; (iii) working with major platform
providers to provide the registration function; (iv) increasing its advertising
and direct sales efforts; (v) establishing international alliances; (vi) working
with server software application providers to develop an automated registration
function; and (vii) establishing relationships with Internet-based product and
service providers.
Strategic Agreements with Internet Access Providers. The Company has
entered into agreements to provide specialized services to certain Internet
access providers, including Internet service providers ("ISPs"), who register a
significant number of second-level domain names with the Company on behalf of
such providers' customers. This Premier Domain Registration Services Program
("Premier Program") provides such Internet access providers with customized
registration services, personalized account management, customized billing and
financial reports, private e-mail boxes and other customized features and
provides the Company with a multi-year registration stream from such providers.
As of March 13, 1998, the Company had entered into agreements with 49 companies,
including: MCI, Inc., America Online, Incorporated (PrimeHost Division), TABNet,
MindSpring Enterprises, Inc., BBN Corporation (a subsidiary of GTE
Internetworking), Earthlink Network, Inc., NETCOM Interactive, UUNET
Technologies, Inc., Sprint Communications Company L.P. and Rapidsite, Inc.
(Hiway). The Company intends to build upon its current relationships with
certain Internet access providers that have agreed to participate in the Premier
Program and intends to pursue relationships with additional Internet access
providers. Through these relationships, the Company seeks to deliver enhanced
registration services and identify additional opportunities to expand its
registration services business.
Marketing Agreements with Channel Partners. The Company has developed
co-marketing programs with channel partners designed to take advantage of their
complementary marketing capabilities. In January 1998, the Company entered into
strategic agreements with Dun & Bradstreet Corporation ("D&B") and Inc. Online
("Inc.") for the marketing and development of products and services to meet the
future needs of the business marketplace. The agreement with D&B makes it
possible for businesses to register an Internet domain name and apply for a D&B
D-U-N-S(R) Number from either the D&B web site or the Company's WorldNIC(TM)
Services web site. As part of the agreement, Network Solutions and D&B placed a
hyper link on each other's Internet
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home page that will allow businesses and individuals registering for a domain
name to complete that task and then apply for their D&B D-U-N-S(R) Number or
vice versa.
The Company's agreement with Inc. is intended to help small businesses
establish a unique identity and grow a brand on the Internet. Network Solutions
is sponsoring Inc.'s "Guide to the Internet" web site. In the "Guide to the
Internet," Inc. helps small-to-midsize companies navigate through the
information and decisions needed to choose systems, tie them together, get
employees to embrace them and apply them to strategic goals. From Inc.'s web
site, small businesses and individuals can hyper link to the Company's
WorldNIC(TM) Services web site where they can register or reserve a domain name
within minutes using the Company's RegistrationPlus(TM) services.
See "International Alliances."
Agreements with Major Platform Providers to Provide the Registration
Function. The Company intends to seek to expand its registration services
business through agreements with major platform providers (i.e., operating
system manufacturers or hardware vendors who provide bundled operating system
software) to provide an automated registration function through a
"point-and-click" interface directly into the software installation procedures.
Advertising. In December 1997, the Company launched a targeted print and
on-line advertising campaign for its registration services with the
announcement of its new corporate logo and its WorldNIC(TM) Services brand.
This, the Company's first significant marketing campaign, is focused on small
businesses and their need to establish their own unique identity and to grow a
brand on the Internet. The Company is currently developing additional campaigns
in this and other market segments.
Direct Sales. The Company's services are marketed and distributed directly
through its Internet home pages. In addition, the Company is continuing to
develop its product management, marketing and sales force to target channel and
distribution partners to offer the Company's registration services
electronically through existing Internet web sites and through other direct
channels, such as direct mail and telemarketing. The Company is seeking to
expand the number of registrations in targeted customer segments both
domestically and internationally. The Company is targeting customer segments
such as small business users, individuals, holders of trademarks, service marks
and product marks and event sponsors.
International Alliances. The Company intends to establish distribution
alliances for registration services in selected international countries. These
could include remarketing agreements with channel partners. In addition, the
Company intends to offer "ease of use" solutions for entities worldwide for
registration in the various TLDs, including country code TLDs.
Agreements with Server Software Application Providers. The Company has
entered into an agreement with Microsoft Corporation ("Microsoft") to provide a
"point-and-click" interface for an automated registration function. This
interface is designed to facilitate the ease of the registration process for
users of the server software and to allow for the Company to have a preferred
provider position on the registration wizard screen that appears during the
server initialization process.
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Agreements with Internet-Based Product and Services Providers. The Company
has entered into an agreement with VeriSign, Inc. ("VeriSign") pursuant to which
the Company provides its customers with direct access to VeriSign's server
security certificates through the Company's domain name registration process.
The Company will receive a portion of VeriSign's subscription fees for providing
such access to VeriSign subscribers. The Company may enter into other agreements
designed to allow the Company to build upon its strategy of becoming an
Internet-based business center where a business or individual can have access to
companies which provide the enabling products and services to conduct business
on the Internet.
The Company sells and markets its consulting services to large companies
that utilize their enterprise network for a strategic advantage, including
financial services companies, banks, oil and gas companies and
telecommunications companies. The Company believes that these organizations have
a substantial installed base of enterprise networks and additional requirements
for network engineering, network security and network management consulting
services. In addition, the Company intends to continue to rely on its
relationship with SAIC and Bellcore to attempt to access SAIC's and Bellcore's
major customers and strategic partners. The Company's Consulting Services
Division is also establishing a direct sales force with account executives
assigned to key customers in regional territories. See "Competition."
See "Risk Factors - Evolving Sales and Marketing Organization and
Distribution Channels and - Technological Change and Additional Technology,
Products and Services."
OPERATIONS
On June 16, 1997, the Company leased 31,247 square feet of a 53,136 square
foot facility to support its domain name registration business operations.
Effective February 1, 1998, the Company leased an additional 9,059 square feet
in the same facility to expand its operations. This leased facility is designed
to meet current registration services customer support needs as well as to
provide expansion capability for future business. It includes: (i) a call
center; (ii) a training center equipped for both computer and telephone
training, including a simulated operations environment; and (iii) a new computer
room with expanded systems and telecommunications services. The Company believes
that this new facility with the accompanying system enhancements provides the
environment and tools that are essential for quality customer support.
To register a domain name within the .com, .org, .net, and .edu TLDs, the
Company's customer or the customer's Internet access provider (i) completes a
registration application which is submitted to the Company via e-mail or (ii)
submits a web-based registration application through the Company's
WorldNIC(TM) Services web site. Once the customer is registered, the Company
loads the domain name into the A-root zone server, which contains the Internet's
definitive global listing of addresses and which Network Solutions manages under
authority from the NSF. It is from the A-root zone server that the Internet root
server administrators obtain their nightly updates of the zone files maintained
by the Company. In January 1998, the Company installed a back-up facility in
Charlotte, North Carolina to provide redundancy and enhanced reliability for its
Internet root zone administration.
Seven T1 and one T3 (high-speed data communications line) links connected
to five ISPs support the Company's registration services. The aggregate capacity
of the Company's T1 links is 10.5 megabits per second and the capacity of the T3
link is 45 megabits per second. Thus the aggregate capacity of the T1 and T3
links is 55.5 megabits per second. By connecting to five different ISPs, the
Company seeks redundancy to ensure constant access to the Internet should
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any given ISP or link develop complications. The Company believes its current
network is adequate and that any additional capacity will be available in the
future as needed.
Substantial portions of the Company's internally developed registration
software have been custom-developed and are proprietary. The Company's
internally developed registration software includes an automated registration
capability that currently processes in excess of 90% of all new registration
requests without human intervention.
The Company has a capital lease/purchase process for its computer equipment
that allows the Company to use the latest technology within its operating
infrastructure. The Company has over 300 NT workstations providing customer
service and approximately 150 UNIX servers running a variety of applications to
evenly distribute operational load. Additionally, the Company utilizes several
large network file servers to support its directory and registration services.
These servers provide a mirrored file system for enhanced reliability and
back-up coverage. The Company is in the process of implementing a
state-of-the-art network management technology that will improve overall
operational efficiencies and customer quality.
RESEARCH AND DEVELOPMENT
All research and development expenses incurred in 1995 were reimbursed to
the Company by direct charges to contracts, including the Cooperative Agreement.
In 1996, research and development expenses were $680,000 or 3.6% of net revenue.
In 1997, research and development expenses were $1,653,000 or 3.6% of net
revenues. The Company believes that significant and continuing investments in
products and services development will be required to maintain its position as
the leader in the domain name registration business and to achieve its strategy
of leveraging its registration services business to offer and distribute other
enabling services.
COMPETITION
The Company currently is the leading provider of domain name registration
services. It currently is the exclusive registry and registrar for second level
domain names within the .com, .org, .net, and .edu TLDs. The Company currently
faces competition in the domain name registration business from registries for
country code TLDs, third level domain name providers such as Internet access
providers and registries of TLDs other than those TLDs currently being
registered by the Company. A number of entities have already begun to offer
competing registration services using other TLDs.
On July 1, 1997, President Clinton directed the Commerce Department to
privatize, increase competition in, and promote international participation in
the DNS. On February 20, 1998, the NTIA published the Proposed Rule in the
Federal Register for comment. The Proposed Rule, if issued, would provide,
among other things, (i) that additional companies could act as registrars for
second level domain names within the .com, .org and .net TLDs and (ii) that
additional TLDs would be permitted to be added to the Internet's root zone
system.
The Company believes that additional competition will be forthcoming in the
domain name registration services business. The exact timing and nature of that
competition is, at this time, however, uncertain. Additional competition could
result through the emergence of competing
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registrars in the .com, .org and .net TLDs and/or the emergence of additional
registries with responsibility for new TLDs. In the event that a final rule is
issued that results in additional competition in the DNS business or additional
competition is introduced through some other means, there could be a material
adverse effect on the Company's business, financial condition and results of
operations.
Future competition in the Company's domain name registration business could
come from many different companies, including, but not limited to, major
telecommunications firms, cable companies and Internet access providers. Such
entities have core capabilities to deliver registration services, such as help
desks, billing services and network management, along with strong name
recognition and Internet industry experience. Other companies with some or all
of these capabilities may also enter the registration business. Also emerging is
a growing contingent of domain name resellers.
In addition, the Company's revenue and registration fees could be reduced
due to increased competition or pricing pressures. For example, other registrars
may bundle domain name registrations with other products or services,
effectively providing such registration services for free.
The Company believes that competition in the domain name registration
services business is in the best interests of the Internet community. The
Company believes that it is well positioned to be successful in a competitive
environment by virtue of (i) its existing customer base; (ii) global recognition
of the .com, .net and .org TLDs; (iii) its agreements with Internet access
providers; (iv) its established technical infrastructure; (v) its experience in
the administration of a domain name dispute policy; and (vi) its skilled
technical personnel who are experienced in the domain name registration
business. In addition, a substantial portion of the Company's registration
software has been custom-developed and is proprietary. Additionally, the
Company's internally-developed registration software includes an automated
registration capability that currently processes in excess of 90% of all new
registration requests without human intervention.
See "Relationship With the NSF; Recent Developments in Internet
Governance."
Companies with Internet expertise are current or potential competitors to
the Company's consulting services business. Such companies include 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 Intranets, and with
companies with internally-developed systems integration efforts. An IP address
allows a router, a computer which connects networks together, to determine the
network to which the router should send the data it receives. A number of these
competitors and potential competitors have longer operating histories and
greater name recognition and significantly greater financial, technical,
marketing, distribution and other resources than the Company. There can be no
assurance that the Company will be able to successfully compete in the
consulting services business. Failure by the Company to successfully compete in
the consulting services business could have a material adverse effect on the
Company's business, financial condition and results of operations.
In developing and distributing future 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, if
any, which it develops or sells. Many of the Company's
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potential competitors have longer operating histories, greater name recognition
and significantly greater financial, technical, marketing, distribution and
other resources than the Company. Furthermore, the industry in which the Company
intends to compete is characterized by rapid changes and frequent product and
service introductions. To the extent a competitor introduces a competitive
product or service prior to introduction of the same or similar product or
service by the Company, market acceptance of the competitor's product or service
may adversely affect the Company's competitive position.
See "Risk Factors - Competition."
INTELLECTUAL PROPERTY RIGHTS
The Company's principal intellectual property consists of, and its success
is dependent upon, the Company's proprietary software utilized in its
registration service business and certain methodologies and technical expertise
it utilizes in both the design and planned implementation of its current and
future registration service and proposed Internet-enabling services businesses.
Some of the software and protocols used by the Company in its registration
service and proposed Internet-enabling businesses are in the public domain or
are otherwise available to the Company's competitors. The Company also has
compiled a database of information relating to customers in its registration
business. While a portion of this database is available to the public, the
Company believes that it has certain ownership rights in this database and
intends to protect such rights. The Company's engineers have in-depth technical
knowledge and unique processes that are critical to the Company's consulting
services business, in which a full range of consulting and systems integration
services are offered in order to transition organizations from private, legacy
networks to more scalable and efficient enterprise networks. The Company has no
patents but its proprietary materials are protected by trade secret laws. The
Company also has registered copyrights in certain of its proprietary software
and the Company owns several trademarks. See "Risk Factors - Intellectual
Property Rights."
EMPLOYEES
As of December 31, 1997, the Company had approximately 260 full-time
employees. None of the Company's employees are covered by collective bargaining
agreements. The Company believes that its relations with its employees are good.
RISK FACTORS
IN ADDITION TO OTHER INFORMATION IN THIS FORM 10-K, THE FOLLOWING RISK
FACTORS SHOULD BE CAREFULLY CONSIDERED IN EVALUATING THE COMPANY AND ITS
BUSINESS BECAUSE SUCH FACTORS CURRENTLY HAVE A SIGNIFICANT IMPACT OR MAY HAVE A
SIGNIFICANT IMPACT ON THE COMPANY'S BUSINESS, OPERATING RESULTS OR FINANCIAL
CONDITION. ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE PROJECTED IN THE
FORWARD-LOOKING STATEMENTS CONTAINED IN THIS FORM 10-K AS A RESULT OF THE
FOLLOWING RISK FACTORS SET FORTH BELOW AND ELSEWHERE IN THIS FORM 10-K.
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 under its current subscription-based pricing model for its
domain name registration business upon which an evaluation of the Company and
its prospects can be based.
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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 organization, continue to identify, attract, retain and
motivate qualified persons and continue to upgrade its technologies and
commercialize products and services incorporating such technologies. While the
Company has been involved in network consulting services since its inception,
due to the rapidly evolving nature of Internet technologies, the Company's
consulting services business faces similar risks. There can be no assurance that
the Company will be successful in addressing such risks or that the Company will
continue to obtain new registrations at current rates or obtain renewals from a
significant portion of its customers.
The Company's expense levels are based in part on its expectations as to
future revenue and to a large extent are fixed. As a result, quarterly sales and
operating results generally depend on the volume of and ability to fulfill
registration requests, which are difficult to forecast. The Company may be
unable to adjust spending in a timely manner to compensate for any unexpected
revenue shortfall. Accordingly, any significant shortfall of demand for the
Company's services in relation to the Company's expectations would have an
immediate adverse impact on the Company's business, financial condition and
results of operations. In addition, the Company expects a significant increase
in its operating expenses as it funds greater levels of product and services
development, increases its sales and marketing operations, upgrades systems and
infrastructure, opens new offices, develops new distribution channels and
broadens its customer support capabilities. To the extent that such expenses
precede or are not subsequently followed by an increase in revenue, the
Company's business, financial condition and results of operations will be
materially and adversely affected.
Uncertainty of Internet Governance and Regulation. The Internet
historically has been loosely administered by government agencies which were
involved in the creation of its infrastructure, initially ARPA and, more
recently, the NSF. No single organization or entity (including the NSF)
currently has formal authority over all aspects of the Internet and it currently
operates under a system of mutual cooperation. Since the original role of the
Internet was to link computers at governmental and academic institutions to
facilitate communication and research, the Internet was historically
administered by entities which were involved in sponsoring research rather than
by any of the traditional federal or state regulatory agencies. With the
commercialization and internationalization of the Internet, the role of these
entities in Internet administration has become less clear and private parties
have begun to assume a larger role in the enhancement and maintenance of the
Internet's infrastructure.
The Cooperative Agreement became effective January 1, 1993. It includes a
three-month phase-in period, a five-year operational period (commencing April
1, 1993 and ending March 31, 1998), and a six-month "flexibility period"
through September 30, 1998. The Cooperative Agreement is subject to review by
the NSF and may be terminated by the NSF at any time at its discretion or by
mutual agreement. The NSF has stated that it will not be re-awarding a
cooperative agreement at the end of the flexibility period.
The U.S. government has issued the Proposed Rule to provide notice and seek
public comment on a proposal to transfer over time the administration of the DNS
to a private, U.S. not-for-profit corporation and increase competition in the
administration of TLDs and the registration of second level domain names. The
Proposed Rule states that the "U.S. government seeks as much consensus as
possible before acting." See "Relationship with the NSF; Recent Developments in
Internet Governance."
Comments on the Proposed Rule have revealed substantial differences
regarding how the DNS should evolve and competing proposals concerning DNS
management to those set forth in the Proposed Rule have been advanced from time
to time. There is a risk that failure to achieve consensus could, among other
things, prevent or delay the issuance of a final rule. In addition, any rule
that is issued could be challenged by persons or entities who disagree with its
provisions. Any of such events could have a material adverse effect on the
Company's business, financial condition and results of operations through
continued uncertainty about
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future Internet governance or a disruption to the administration, effective
operation or maintenance and expansion of the Internet, in general, or the DNS,
in particular. Additionally, any final rule could be different, perhaps
substantially, from the Proposed Rule. Any final rule or any terms negotiated by
the U.S. government and the Company could contain provisions which are not
favorable to the Company or not consistent with the Company's current or future
plans. It is impossible to predict at this time whether or when a final rule
will be issued and, if issued, the timing of its implementation, the exact
nature of its provisions or any terms negotiated by the U.S. government and the
Company or the precise effect of such provisions or terms on the Company. It is
possible that certain provisions of any final rule or certain of such terms
could have a material adverse effect on the Company's business, financial
condition and results of operations. See "Competition."
In the United States, apart from its obligations under the Cooperative
Agreement, the Company is not currently subject to direct regulation other than
federal and state regulation applicable to businesses generally. However,
changes in the regulatory environment could result in the Company being subject
to direct regulation by other U.S. regulatory agencies, such as the Federal
Communications Commission (the "FCC"). For example, the Company is aware of
certain industry requests to the FCC to review the impact of Internet usage on
the U.S. telecommunications service providers, in particular, the generally
lower cost structure for data transmission versus voice. In addition, as
Internet usage becomes more widespread internationally, there is an increased
likelihood of international regulation. 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 applicability to the Company of existing laws governing
issues such as intellectual property ownership is uncertain. Courts have
indicated that, under certain circumstances, ISPs could be held responsible for
the failure to prevent the distribution of material that infringes on others'
copyrights and other intellectual property. The future interpretation by the
courts of the obligation of domain name registrars to prevent trademark
infringement and other legal issues is uncertain. See "Item 3 - Legal
Proceedings."
Costs incurred or decisions rendered as a result of government actions,
including enactment of new laws or adoption of new regulations, investigations
or lawsuits relating to any of the foregoing, could have a material adverse
effect on the Company's business, financial condition and results of operations.
Competition. The Company currently is the exclusive registrar for second
level domain names in the .com, .org., .net and .edu TLDs. Multiple registrars
do not currently register names in the same TLD, but this may change in the
future. The Company currently faces competition in the domain name registration
business from registries for country codes, third level domain name providers
such as Internet access providers and registries of TLDs other than those TLDs
currently being registered by the Company. A number of entities have already
begun to offer competing registration services using other TLDs. Future
competition in the Company's domain name registration business could come from
many different companies, including, but not limited to, major
telecommunications firms, cable companies and Internet access providers. Such
entities have core capabilities to deliver registration services, such as help
desks, billing services and network management, along with strong name
recognition and Internet industry experience. Other companies with some or all
of these capabilities may also enter the registration business. Also emerging is
a growing contingent of domain name resellers. The Company's position as the
leading registrar of domain names could be materially and adversely affected by
the emergence of any of the foregoing competitors and potential
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competitors, many of which have longer operating histories and significantly
greater name recognition and greater financial, technical, marketing,
distribution and other resources than the Company. In addition, the Company's
revenue and registration fees could be reduced due to increased competition or
pricing pressures. For example, other entities may bundle domain name
registrations with other products or services, effectively providing such
registration services for free.
Various governmental technical and Internet groups have been discussing for
some time ways of introducing more competition into the domain name
registration business. On February 20, 1998, the NTIA published the Proposed
Rule in the Federal Register to provide notice and seek public comment on a
proposal to increase competition in the administration of TLDs and the
registration of domain names. Under the Proposed Rule, the Company would
continue to operate the .com, .org, and .net registries and to act as a
registrar for those TLDs, but other companies would be permitted to act as
registrar for those TLDs. The Proposed Rule also provides for additional new
TLDs. The Company believes that it is well positioned to succeed in a more
competitive environment. However, the adoption of the Proposed Rule or a
similar rule or the introduction of additional competition into the domain name
registration business in some other manner could have a material adverse effect
on the Company's business, financial condition and results of operations. See
"Relationship with the NSF; Recent Developments in Internet Governance" and
"Competition."
In addition, the Company faces substantial competition in its consulting
services business and in the development and distribution of future products and
services for the Internet-based services markets. See "Competition."
Reliance on Third Parties. Reliable communications over the Internet are
dependent upon the Internet root servers, which serve as the authoritative
source of Internet locations and which allow the resolution of IP addresses from
domain names on the Internet. Currently, there are 13 root servers, ten of which
are located in the United States, two of which are located in Europe and one of
which is located in Asia. Nine of the root servers currently are populated with
the domain names registered by the Company, while these nine and the other four
also contain information with respect to other TLDs, including country TLDs.
When communication with a particular domain name is required and the IP address
of that domain name's host is not known locally, the root servers "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 has been determined by
consensus of various members of the Internet community. The Company currently
controls only one of these root servers and temporarily administers one other
root server. The other eleven root servers are maintained and controlled by
independent operators on a volunteer basis. These volunteer operators may at
any time, for any reason, fail to properly maintain such servers or abandon
such servers. The occurrence of any such events could have a material adverse
effect on the Company's business, financial condition and results of
operations.
Further, no single organization or entity currently has formal authority
over all aspects of the root zone system. Some volunteer root server operators
have questioned which organization or entity has the legal authority to direct
where the root servers are to be pointed. The operators of the root servers have
historically taken guidance from the IANA. Therefore, it is possible that IANA
could direct the root servers not to accept information updates from the Company
or that the operators of the root servers could choose to no longer carry the
Company's information. In the event that the root servers were changed to
exclude the information maintained by the Company, all domain names registered
by the Company in
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TLDs for which the Company acts as the registry would no longer be accessible by
other users of the Internet. This could cause widespread disruption of the
Internet. If some, but not all, of the root servers were changed to exclude the
Company's data, the multiple root servers would contain inconsistent
information. The failure by any or all of the root servers to include or provide
accessibility to the Company's data would materially and adversely affect the
Internet and the Company's business, financial condition and results of
operations.
The Proposed Rule provides that a new corporation would be established to
oversee the operation of an authoritative root server system. Under the Proposed
Rule, IANA and the U.S. government, in cooperation with the Company, the
Internet Architecture Board and other relevant organizations, would undertake a
review of the root server system to recommend means to increase the security and
professional management of the system. However, no assurance can be given that
this provision will be part of any final rule or that, if this provision is
adopted, it would eliminate the risks in this area.
The Company's success and ability to compete also are dependent upon the
relationships between the Company and ISPs worldwide. Thus, if ISPs were to
elect not to route Internet communications to or from domain names registered by
the Company or if enough ISPs were to elect to provide routing to a set of
accepted root servers which did not point to the Company's TLD servers, the
Company's business, financial condition and results of operations would be
materially and adversely affected.
Year 2000. Network Solutions, like many other companies, is in the process
of assessing its computer software applications and systems to ensure their
functionality with respect to the "Year 2000" millenium change. At this time,
the Company believes that the remediation costs, if any, needed to make all of
its internal applications and systems Year 2000 compliant are not material.
Although the Company believes that its internal mission critical systems
are Year 2000 compliant, the failure of the software applications or internal
systems of other companies on which the Company's systems rely or to which they
are connected or of other Internet-related companies, including Internet web
hosting companies, Internet access providers, or Internet root server operators,
none of which the Company controls, to be Year 2000 compliant upon January 1,
2000 could have a material adverse effect on the operation of the Internet
and/or a material adverse effect on the Company's business, financial condition
and results of operations.
Litigation. The Company is involved in several legal proceedings as
described in "Item 3 - Legal Proceedings." As of March 13, 1998, the Company was
a defendant in 6 lawsuits involving domain name disputes between trademark
owners and domain name holders in which
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the Company has been named as a defendant. On March 20, 1997, PG Media, Inc., a
New York-based corporation, filed a lawsuit (the "PG Media suit"), alleging that
the Company had restricted access to the Internet by not adding PG Media's
requested TLDs in violation of the Sherman Act. On October 17, 1997, a group of
six plaintiffs filed a lawsuit (the "Thomas suit") against the Company and the
NSF challenging the legality of fees defendants charge for the registration and
renewal 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. The plaintiffs allege violations of
the Administrative Procedures Act, the Independent Offices Appropriations Act,
the Sherman Act and the U.S. Constitution. In each of these cases, the Company
believes it has meritorious defenses and intends to defend itself vigorously.
While the Company cannot reasonably estimate the potential impact of the claims
advanced in the PG Media or Thomas suits, a successful claim against the
Company in either of these proceedings could have a material adverse effect on
the Company's business, financial condition and results of operations.
In addition, on June 27, 1997, SAIC received a Civil Investigative Demand
from the U.S. Department of Justice issued in connection with an investigation
to determine whether there is, has been, or may be an antitrust violation under
the Sherman Act relating to Internet registration products and services. The
Company cannot reasonably estimate the potential impact of the investigation nor
can it predict whether a civil action will ultimately be filed by the Department
of Justice. The Company is unable to predict the form of relief that might be
sought in such an action or that might be awarded by a court or imposed as a
result of any settlement. Any such relief could have a material adverse effect
on the Company's business, financial condition and results of operations.
Litigation in which the Company is involved has resulted and likely will
result in, and any future litigation can be expected to result in, substantial
legal and other expenses to the Company and a diversion of the efforts of the
Company's personnel.
System Interruption and Security Risks. The Company's operations are
dependent upon its ability to maintain its computer and telecommunications
equipment in effective working order and to reasonably protect its systems
against interruption from fire, natural disaster, sabotage, power loss,
telecommunication failure, human error or similar events. The vast majority of
the Company's computer and telecommunications equipment is located in a single
facility. Although the Company has established back-up facilities at its
Charlotte, North Carolina site, this measure will not eliminate the significant
risk to the Company's operations from a natural disaster or system failure at
its principal site. Despite the implementation of security measures and standard
operating procedures, the Company's infrastructure may also be vulnerable to
computer viruses, hackers, human error or similar disruptive problems caused by
its employees, customers or other Internet users. Computer break-ins and other
disruptions may jeopardize the security of information stored in and transmitted
through the computer systems of the Company and may deter potential customers
from utilizing the Company's services. In addition, growth of the Company's
customer base may put strain on the capacity of its computers and
telecommunications systems and the Company's inability to sufficiently maintain
or upgrade its systems could lead to degradation in performance or system
failure. Any damage, failure or delay that causes significant interruptions in
the Company's systems would have a material adverse effect on the Company's
business, financial condition and results of operations.
On July 17, 1997, during a routine update of the root server domain name
files, the Company inadvertently released corrupted database files for the .com
and .net TLDs, causing disruption throughout the Internet. The original problem,
which was caused by a database error, was compounded when the normal quality
control mechanisms used to validate the .com and
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.net TLD files were incorrectly overridden by Company personnel and the
corrupted files were released. As a result, certain Internet users were unable
to access certain web sites. The database error was subsequently fixed and the
corrected files were regenerated and re-released by the Company within four
hours, although the length of time during which certain Internet users
experienced disruption in accessing the Internet varied.
The Company has taken several steps to avoid any future occurrences of this
or similar problems, including, but not limited to, adding software code to make
it more difficult to transmit a problematic file and additional quality checks
by a senior level person prior to each file transmission. There can be no
assurance, however, that the Company's standard operating procedure or the
additional measures implemented by the Company will prevent or mitigate a
similar occurrence in the future.
Separately, in July 1997, an entity which offers competing registration
services using other TLDs exploited a security vulnerability in the Berkeley
Internet Name Domain ("BIND") software, a third-party Internet name server
software used by Internet companies' Unix systems, to redirect traffic intended
for the Company's web site. The Company's systems were not impacted by the
exploitation. However, Internet users that were relying on systems that had not
upgraded to a more current version of BIND were redirected from the Company's
web site which impacted the Company's business.
If any of these or similar problems should recur or occur in the future, it
could result in, among other things, damage to the Company's reputation and
credibility, increased intervention by governmental entities or reduced customer
confidence, which could in turn materially and adversely affect the Company's
business, financial condition and results of operations.
Uncollectible Receivables; Modifications to Billing Practices. Currently,
the Company invoices a majority of its customers and permits them to pay the
services fee after the domain name is registered. The Company believes it has
experienced a high level of uncollectible receivables due to, among other
factors, the large number of individuals and corporations that have registered
multiple domain names with the apparent intention of reselling such
registrations at a profit. The Company's experience has been that such resellers
have a greater tendency than other customers to default on their services fees.
The Company has established a provision for uncollectible accounts that it
believes to be adequate to cover anticipated uncollectible receivables; however,
actual results could differ from the Company's estimate and could have a
material adverse effect on the Company's business, financial condition and
results of operations. See "Item 7 -- Management's Discussion and Analysis of
Financial Condition and Results of Operations" and Note 4 of Notes to Financial
Statements.
The Company continually reviews its billing practices for modification to
respond to market conditions and to implement operational improvements. Any such
modification could have unanticipated consequences which could result in a
material adverse effect on the Company's business, financial condition and
results of operations.
Limited Service Offerings to Date; Reliance on Domain Name Registration
Services and Consulting Services for Substantially All Revenue. The Company's
domain name registration services and consulting services businesses have in the
past generated substantially all of the Company's revenue from continuing
operations and are expected to continue to account for substantially all of the
Company's revenue from continuing operations in the near term. The Company's
future success will be highly dependent upon the continued increase in domain
name registrations with the Company, renewal rates of its customers, the ability
of the Company to maintain its current position both as a registrar of domain
names and as the leading
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registrar of domain names within the .com TLD 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, such growth may not be sustainable and may not be indicative of future
operating results. There can be no assurance that the Company will be able to
successfully retain its current leading position in providing domain name
registration services or develop or market additional services. Failure to do
so would materially and adversely affect the Company's business, financial
condition and results of operations.
The Company's future success will also be dependent on its ability to
maintain and expand its consulting services business. In 1997, ten clients of
the Company's Consulting Services Division accounted for 80% of the division's
revenues. There is no guarantee that the Company will be able to maintain or
expand its consulting services business.
Technological Change and Additional Technology, Products and Services. The
development of RWhois, a Company-developed, standard open protocol, and the
associated technology, allows remote registration by others. The Company's
efforts to standardize and proliferate RWhois as the registration standard may
result in a material adverse effect on the Company's future competitive position
by enabling others to become competing registrars more easily. RWhois is also
the protocol that the Company may utilize for any global directory services that
the Company might offer. The successful introduction of such directory services
may blur the distinction between directory services and domain name
registration. Should this or another global directory service become widely
proliferated, domain name registration may be subsumed into such a service. In
that case, should the Company fail to secure a leadership position in providing
such a global directory service or establish a system for charging for such
service, the Company's business, financial condition and results of operations
would be materially and adversely affected.
The Company's future financial success will be highly dependent upon its
ability to develop and commercialize in a timely manner new technology, products
and services that can be offered in conjunction with the Company's current
domain name registration and consulting services and that can meet the changing
requirements of its current and future customers. The market for such
technology, products and services is characterized by rapidly changing
technology, evolving industry standards and frequent introductions of new
Intranet and Internet-related products and services. Generally, the successful
development and commercialization of new technology, products and services
involves many risks, including the identification of new Intranet and
Internet-related product and service opportunities, the successful completion of
the development process, and the identification, retention and hiring of
appropriate research, development and technical personnel. There can be no
assurance that the Company can successfully identify new products and service
opportunities and develop and bring to market in a timely manner new
technologies, products or services, or that technologies, products or services
developed by others will not render those of the Company noncompetitive or
obsolete. Failure by the Company to develop new technologies, products or
services and bring them to market in a timely manner could have a material
adverse effect on the Company's business, financial condition and results of
operations.
Dependence on Future Growth of the Internet and Internet Infrastructure.
The Company's future success is substantially dependent upon continued growth in
the use of the Internet. Rapid growth in the use of and interest in the Internet
is a relatively recent phenomenon and there can be no assurance that use of the
Internet will continue to grow at its current pace. Even if the Internet
continues to experience significant growth in the number of users and level of
use, there can be no assurance that the Internet infrastructure will continue to
be able to support the demands placed upon it by such growth. The Company's
success and the viability of the
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Internet as an information medium and commercial marketplace will depend in
large part upon the development of a robust infrastructure for providing
Internet access and carrying Internet traffic. Failure to develop a reliable
network system, or timely development of complementary products, such as high
speed modems, could have a material adverse effect on the Company's business,
financial condition and results of operations. In addition, the Internet could
lose its viability due to delays in the development or adoption of new standards
and protocols required to handle increased levels of Internet activity or due to
changes in government regulation. The lack of Internet governance or changes in
governance or regulation could adversely affect the growth of the use of the
Internet and have a material adverse effect on the Company's business, financial
condition and results of operations.
Because global commerce and on-line exchange of information on the Internet
are new and evolving, it is difficult to predict with any assurance that the
infrastructure or complementary products will be developed, or, if developed,
that the Internet will become a viable information medium or commercial
marketplace. 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.
Intellectual Property Rights. If it were determined that the Company does
not have ownership rights in its database of information relating to customers
in its registration business or if the Company is unable to protect such rights
in this database or is required to share the database with potential
competitors, there could be a material adverse effect on the Company's
business, financial condition and results of operations. The Proposed Rule
would require the Company to provide the U.S. government with "a copy and
documentation of all the data, software, and appropriate licenses to other
intellectual property generated under the [C]ooperative [A]greement, for use by
the new corporation for the benefit of the Internet." If certain of the
Company's software and data generated which is proprietary to the Company were
to be provided to the new corporation under the Proposed Rule and in turn
provided to competing registries or registrars, the Company's business,
financial condition and results of operations could be materially and adversely
affected.
The Company relies upon a combination of nondisclosure and other
contractual arrangements with its employees and third parties and trade secret
laws to protect its proprietary rights and limit the distribution of its
proprietary information. There can be no assurance that the steps taken by the
Company in this regard will be adequate to deter misappropriation of proprietary
information or that the Company will be able to detect unauthorized use of its
proprietary information and take appropriate steps to enforce its intellectual
property rights. Furthermore, even if these steps are successful, there can be
no assurance that others will not develop technologies that are similar or
superior to the Company's proprietary technology. Although the Company believes
that its services do not infringe on the intellectual property rights of others
and that it has all rights necessary to utilize the intellectual property
employed in its business, the Company is subject to the risk of claims alleging
infringement of third party intellectual property rights. Any such claims could
require the Company to spend significant sums in litigation, pay damages and
develop non-infringing intellectual property or acquire licenses to the
intellectual property that is the subject of asserted infringement. Failure by
the Company to adequately protect its proprietary rights or litigation relating
to intellectual property rights could have a material adverse effect on the
Company's business, financial condition and results of operations.
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Potential Fluctuations in Quarterly Results. The Company believes that
future operating results will be subject to quarterly fluctuations due to a
variety of factors, many of which are beyond the Company's control. Such
factors may include, but are not limited to, developments in Internet
governance, the announcement of additional competing registries, registrars or
TLDs, variations in the number of requests for domain name registrations or
demand for the Company's services, introduction or enhancements of services by
the Company or its competitors, market acceptance of new service offerings,
increased competition, costs associated with developing or providing domain
name registration or other services, litigation costs, results of litigation,
patterns of growth in the use of and interest in the Internet and general
economic conditions. The Company is continuing to increase its operating
expenses for personnel, facilities and new services development and, if its
revenues do not correspondingly increase, the Company's business, financial
condition and results of operations would be materially and adversely affected.
Since the Company recognizes consulting services revenue only when
engineers are engaged on client projects, the relative utilization of engineers
directly affects the Company's operating results. In addition, a majority of
the Company's consulting services operating expenses, particularly personnel
and related costs, depreciation and rent, are substantially fixed in advance of
any particular quarter. As a result, any under-utilization of engineers may
cause significant variations in operating results in any particular quarter and
could result in losses for such quarter. Termination or completion of contracts
in the Company's consulting services business or failure to obtain additional
contracts in its consulting services business could have a material adverse
effect on the Company's business, financial condition and results of operation.
See "Item 7 -- Management's Discussion and Analysis of Financial Condition and
Results of Operations."
Uncertainty of Future Acquisitions. The Company evalutes potential
acquisitions on an ongoing basis. No assurance can be given as to the Company's
ability to compete successfully for available acquisition candidates or to
complete future acquisitions or as to the financial effect on the Company of
any acquired businesses. Future acquisitions by the Company may involve
significant cash expenditures and may result in decreased operating income,
either of which could have a material adverse effect on the Company's business,
financial condition and results of operations. Should the Company be unable to
implement successfully its acquisition strategy, its business, financial
condition and results of operations could be materially and adversely affected.
Management of Growth; Dependence on Key Personnel. The Company has recently
experienced growth in the number of its employees and in the scope of its
operating and financial systems. This growth has resulted in an increase in
responsibilities for both existing and new management personnel. The Company's
ability to manage growth effectively will require it 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. There can be no assurance that the Company will be able to
manage its expansion effectively and a failure to do so could have a material
adverse effect on the Company's business, financial condition and results of
operations. In addition, growth of the Company's customer base may strain the
capacity of its computers and telecommunications systems, and the Company's
inability to sufficiently maintain or upgrade its systems could lead to
degradation in performance or system failure.
The Company's future success depends in part on the continued service of
its key engineering, sales, marketing, executive and administrative personnel,
and its ability to identify, hire and retain additional personnel. In addition,
the future success of the Company's consulting services will depend 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. An inability of the Company to identify, hire,
train and retain a sufficient number of qualified engineers could impair the
Company's ability to adequately manage and complete its existing projects or to
obtain new projects, which, in turn, could have a material adverse effect on the
Company's business, financial condition and results of operations and could
impair the Company's expansion of its business. Competition for engineering,
sales, marketing and executive personnel is intense and there can be no
assurance that the Company can retain existing personnel or identify, hire or
retain additional qualified
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personnel.
Evolving Sales and Marketing Organization and Distribution Channels. The
Company has had limited experience in marketing and selling its services under
its current subscription-based pricing model. The Company's ability to achieve
revenue growth in the future will depend in large part on its ability to manage
and grow its new sales and marketing organization. There can be no assurance
that the Company will be able to successfully manage this organization or
identify, attract and retain experienced sales and marketing personnel with
relevant experience, that the cost of such personnel will not exceed the revenue
generated or that the Company's sales and marketing organization will be able to
successfully compete against the significantly more extensive and well-funded
sales and marketing operations of the Company's current or potential
competitors.
In addition to establishing its direct sales channels, the Company's
distribution strategy is to develop multiple distribution channels. Accordingly,
the Company's ability to achieve revenue growth in the future will also depend
in large part on establishing and maintaining relationships with Internet access
providers and other third parties and on effectively using the Internet as a
medium of distribution. There can be no assurance that the Company will be able
to successfully develop third party distribution channels, develop its own
capabilities to distribute services using the Internet or that any such
development will result in an increase in revenue.
Any failure by the Company to manage and grow its new sales and marketing
organization, develop and expand its distribution channels or use the Internet
as a medium of distribution could materially and adversely affect the Company's
business, financial condition and results of operations.
Control by SAIC. As of March 13, 1998, SAIC owned 100% of the Company's
outstanding Class B Common Stock, representing approximately 75.8% of the
outstanding Common Stock of the Company and approximately 96.9% of the combined
voting power of the Company's outstanding Common Stock. The Class B Common Stock
is convertible into Class A Common Stock, subject to certain limitations set
forth in the Company's Second Amended and Restated Certificate of Incorporation
(the "Certificate of Incorporation"). As a result, SAIC effectively controls all
matters requiring approval by the stockholders of the Company, including the
election of members of the Company's Board of Directors, changes in the size and
composition of the Board of Directors and a change in control of the Company.
SAIC does not have an agreement with the Company restricting its rights to
convert, distribute or sell its shares of the Company's Common Stock and there
can be no assurance that SAIC will maintain its ownership of the Company's Class
B Common Stock.
The Internal Revenue Code of 1986, as amended (the "Code"), requires
beneficial ownership by SAIC of at least 80% of the total voting power and 80%
of each class of nonvoting capital stock of the Company in order for SAIC to be
able to effect a tax-free spin-off of the Company under the Code. As of March
13, 1998, SAIC owned approximately 96.9% of the total voting power of the
Company. Because SAIC may seek to maintain its beneficial ownership of the
Company for tax planning purposes or otherwise and may not desire to acquire
additional shares of Common Stock in connection with a future issuance of shares
by the Company, the Company may be constrained in its ability to raise equity
capital in the future or to issue Common Stock or other equity securities in
connection with acquisitions.
Reliance on SAIC for Certain Corporate Services. SAIC and the Company have
entered into certain intercompany agreements, including an agreement pursuant to
which SAIC will
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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
relationship between SAIC and the Company is intended to continue in a manner
generally consistent with past practices. If SAIC's ownership of the Company's
Common Stock drops below 50% of the Company's issued and outstanding Common
Stock, 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 stock
holdings. In the event that SAIC elects to terminate the Corporate Services
Agreement, there can be no assurance that the Company would be able to secure
alternative sources for such services within 180 days or that such services
could be obtained for costs comparable to costs to be charged by SAIC.
Control of Tax Matters; Tax and ERISA Liability. By virtue of its
controlling ownership and the terms of a tax sharing agreement (the "Tax
Sharing Agreement") entered into between the Company and SAIC, SAIC will
effectively control all of the Company's tax decisions for taxable periods
during which SAIC and the Company file, for federal purposes, a consolidated
income tax return or, for state and local purposes, a consolidated, combined or
unitary tax return. Under the Tax Sharing Agreement, SAIC has sole authority to
respond to and conduct all tax proceedings (including tax audits) relating to
the Company, to file federal, state and local returns on behalf of the Company
and to calculate the amount of the Company's liability to SAIC under the Tax
Sharing Agreement. Upon completion of the IPO, the Company is no longer part of
SAIC's consolidated group for federal income tax purposes. Given the Company's
past participation in SAIC's consolidated group for tax purposes and pursuant
to the terms of the Tax Sharing Agreement, upon such deconsolidation, the
Company's ability to recognize a benefit for future tax losses it may incur is
subject to SAIC's approval. SAIC may also choose to contest, compromise or
settle any adjustment or deficiency proposed by taxing authorities in a manner
that may be beneficial to SAIC and detrimental to the Company.
Each member of a consolidated group for federal income tax purposes is
jointly and severally liable for the federal income tax liability of each other
member of the consolidated group. In addition, under the Employee Retirement
Income Security Act of 1974, as amended ("ERISA"), and federal income tax law,
each member of the controlled group is jointly and severally liable for funding
and termination liabilities of tax qualified defined benefit retirement plans as
well as certain plan taxes. Accordingly, during the period in which the Company
was included in SAIC's consolidated or controlled group, the Company could be
liable if such liability or tax is incurred, and not discharged, by any other
member of SAIC's consolidated or controlled group.
Potential Conflicts of Interest. Various conflicts of interest between the
Company and SAIC could arise and persons serving as directors, officers and
employees of both the Company and SAIC may have conflicting duties to each.
Currently, Michael A. Daniels, the Company's Chairman of the Board, also serves
as a Sector Vice President and Sector Manager of SAIC, and Donald N. Telage, the
Company's Senior Vice President, Internet Relations and one of the Company's
directors, also serves as a Group Senior Vice President of SAIC. Further, J.
Robert Beyster, a director of the Company, is also the Chief Executive Officer
and Chairman of the Board of SAIC, John E. Glancy, a director of the Company,
is also a Corporate Executive Vice President and a director of SAIC, J. Dennis
Heipt, a director of the Company, is also the Senior Vice President -
Administration of SAIC and William A. Roper, Jr., a director of the Company, is
also Senior Vice President and Chief Financial Officer of
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SAIC. Ownership interests of directors or officers of the Company in the common
stock of SAIC could also create or appear to create potential conflicts of
interest when directors and officers are faced with decisions that could have
different implications for the Company and SAIC. In addition, for financial
reporting purposes, the Company's financial results will be included in SAIC's
consolidated financial statements. The members of the Board of Directors of the
Company and the executive officer of the Company who are affiliated with SAIC
will consider not only the short-term and long-term impact of financial and
operating decisions on the Company, but also the impact of such decisions on
SAIC's consolidated financial results. In some instances, the impact of such
decisions could be disadvantageous to the Company while advantageous to SAIC.
Certain Charter Provisions and Limitations on Liability. The Company's
Certificate of Incorporation includes provisions relating to competition by SAIC
with the Company, allocations of corporate opportunities, transactions with
interested parties and intercompany agreements and provisions limiting the
liability of certain persons. The enforceability under Delaware corporate law of
such provisions which eliminate certain rights that might have been available to
stockholders under Delaware law had such provisions not been included has not
been established. The Company's Certificate of Incorporation provides that any
person purchasing or acquiring an interest in shares of capital stock of the
Company shall be deemed to have consented to the provisions in the Certificate
of Incorporation relating to competition by SAIC with the Company, 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
comparable provisions and, as a result, persons who are directors and/or
officers of the Company and who are also directors and/or officers of SAIC may
choose to take action in reliance on such provisions rather than act in a manner
that might be favorable to the Company but adverse to SAIC.
Under the Company's Certificate of Incorporation, the personal monetary
liability of the directors of the Company for breach of their fiduciary duty of
care, including actions involving gross negligence, is eliminated to the fullest
extent permitted under Delaware law.
International Operations. 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 will increasingly be 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. In
addition, the Company will increasingly be subject to general geo-political
risks, such as political and economic instability and changes in diplomatic and
trade relationships, in connection with its international operations. There can
be no assurance that such regulatory, geopolitical and other factors will not
adversely impact the Company's operations in the future or require the Company
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.
Shares Eligible for Future Sale. SAIC owns 100% of the Company's
outstanding Class B Common Stock, which, as of March 13, 1998, represented
approximately 75.8% of the outstanding Common Stock of the Company. A decision
by SAIC to sell such shares could materially and adversely affect the market
price of the Class A Common Stock. The Company and SAIC have entered into a
registration rights agreement (the "Registration Rights Agreement") which
requires the Company to effect a registration statement covering some or all of
the shares of Class A Common Stock to be owned by SAIC upon conversion of the
Class
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B Common Stock owned by SAIC and any other shares of Class A Common Stock
otherwise acquired by SAIC, subject to certain terms and conditions. The Company
has agreed to indemnify SAIC in connection with any such registration.
In certain circumstances, including without limitation, a public offering
or distribution of Class B Common Stock by SAIC, the Class B Common Stock would
trade separately from the Class A Common Stock in the public market. Separate
trading of the Class B Common Stock in the public market or the perception that
such trading could occur, could materially and adversely affect the market price
of the Class A Common Stock.
Possible Volatility of Stock Price. The market price of the shares of Class
A Common Stock at times has been highly volatile and may be significantly
affected by factors such as actual or anticipated fluctuations in the Company's
results of operations, announcements of technological innovations, developments
in Internet governance, announcement of additional competing registries,
registrars or TLDs, litigation costs, results of litigation, introduction of new
products or services by the Company or its competitors, developments with
respect to patents, copyrights or proprietary rights, conditions and trends in
the networking and other technology industries, changes in or failure by the
Company to meet securities analysts' expectations, general market conditions and
other factors. In addition, the stock market has from time to time experienced
significant price and volume fluctuations that have particularly affected the
market prices for the common stocks of technology companies. These broad market
fluctuations may adversely affect the market price of the Company's Class A
Common Stock. In the past, following periods of volatility in the market price
of a particular company's securities, securities class action litigation has
often been brought against that company. There can be no assurance that such
litigation will not occur in the future with respect to the Company. Such
litigation could result in substantial costs and a diversion of management's
attention and resources, which could have a material adverse effect upon the
Company's business, financial condition and results of operations.
Effect of Certain Charter Provisions; Anti-takeover Effects of Certificate
of Incorporation and Delaware Law. The holders of Class A Common Stock are
entitled to one vote per share and holders of Class B Common Stock are entitled
to ten votes per share. Holders of Class A Common Stock and Class B Common Stock
generally vote together as a single class. The Class B Common Stock held by SAIC
is convertible into Class A Common Stock under certain conditions set forth in
the Company's Certificate of Incorporation. The Company's Board of Directors
will have the authority to issue up to 10,000,000 shares of preferred stock and
to determine the price, rights, preferences, privileges and restrictions,
including voting rights of such shares, without any further vote or action by
the Company's stockholders. Such charter provisions could have the effect of
delaying or preventing a change of control of the Company. The rights of the
holders of Common Stock will be subject to, and may be adversely affected by,
the rights of the holders of any preferred stock that may be issued in the
future. The issuance of preferred stock, while providing desirable flexibility
in connection with possible acquisitions and other corporate purposes, could
have the effect of making it more difficult for a third party to acquire a
majority of the outstanding voting stock of the Company. The Company has no
current plans to issue shares of preferred stock. Further, certain provisions of
the Company's Certificate of Incorporation and of Delaware law could delay or
make more difficult a merger, tender offer or proxy contest involving the
Company.
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ITEM 2. PROPERTIES.
The Company's principal executive office is located in 45,000 square feet
of a facility in Herndon, Virginia, under a space usage arrangement with SAIC.
SAIC's lease for this facility expires in November 2002. The Company also
leases an additional 40,306 square feet in a facility in Herndon, Virginia
under a lease expiring in July 2002. The Company also has offices located in a
10,000 square foot facility, also in Herndon, under a space usage arrangement
with SAIC. SAIC's lease for this facility expires in October 1999.
Additionally, the Company has offices located in approximately 9,300 square
feet in a facility in Charlotte, North Carolina, under two space usage
arrangements with SAIC. SAIC's two leases with respect to this facility
expire in August 1998 and July 2002. The Company believes that its current
facilities will be adequate for the next 12 months and that any additional
facilities will be available in the future as needed on commercially reasonable
terms.
ITEM 3. LEGAL PROCEEDINGS
As of March 13, 1998, the Company was a defendant in 6 lawsuits involving
domain name disputes between trademark owners and domain name holders. The
Company is drawn into such disputes, in part, as a result of claims by trademark
owners that the Company is legally required, upon request by a trademark owner,
to terminate the right the Company granted to an alleged trademark infringer to
register the domain name in question. Further, trademark owners have also
alleged that the Company should be required to monitor future domain name
registrations and reject registrations of domain names which are identical or
similar to their federally registered trademark. The holders of the domain name
registrations in dispute have, in turn, questioned the Company's right, absent a
court order, to take any action which suspends their registration or use of the
domain names in question. Although 42 out of approximately 3,600 of these
situations have resulted in litigation involving the Company, as of March 13,
1998, no payments have been made by the Company to any plaintiff and only four
of these cases are pending. The Company believes that it has meritorious
defenses and intends to vigorously defend itself against these claims.
On June 27, 1997, SAIC received a Civil Investigative Demand ("CID") from
the U.S. Department of Justice ("DOJ") issued in connection with an
investigation to determine whether there is, has been, or may be an antitrust
violation under the Sherman Act relating to Internet registration products and
services. The CID seeks documents and information from SAIC and the Company
relating to their Internet registration business. The Company cannot reasonably
estimate the potential impact of the investigation nor can it predict whether a
civil action will ultimately be filed by the DOJ. The Company is unable to
predict the form of relief that might be sought in such an action or that might
be awarded by a court or imposed as a result of any settlement. Any such relief
could have a material adverse effect on the Company's business, financial
condition and results of operations.
On March 20, 1997, PG Media, Inc., a New York-based corporation ("PG
Media"), filed a lawsuit against the Company in the United States District
Court, Southern District of New York alleging that the Company had restricted
access to the Internet by not adding PG Media's requested TLDs in violation of
the Sherman Act. In its complaint, PG Media has, in addition to requesting
damages, asked that the Company be ordered to include reference to PG Media's
TLDs and name servers in the root zone file administered by the Company under
the Cooperative Agreement. The Company has answered the complaint, but no
motions are pending. In addition, in June 1997, the Company received written
direction from the NSF not to take any action to create additional TLDs or to
add any new TLDs to the Internet root zone until the NSF provides further
guidance. On September 17, 1997, PG Media filed a Second Amended Complaint
adding the NSF as a defendant. The Company believes that it has
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meritorious defenses and intends to vigorously defend itself against the claims
of PG Media. Although the Company cannot reasonably estimate the potential
impact of such claims, a successful claim under the plaintiff's theory could
have a material adverse effect on the Company's business, financial condition
and results of operations.
On October 17, 1997, a group of six plaintiffs filed a lawsuit (the "Thomas
suit") against the Company and the NSF in the United States District Court,
District of Columbia, challenging the legality of fees defendants charge for the
registration and renewal of domain names on the Internet and seeking restitution
of fees collected from domain name registrants in an amount in excess of $100
million, damages, and injunctive and other relief. Plaintiffs originally alleged
violations of the Competition in Contracting Act ("CICA"), the Sherman Act and
the U.S. Constitution. Following the filing of motions to dismiss by the
defendants, the plaintiffs filed an amended complaint on January 30, 1998,
dropping the cause of action based upon CICA, but adding alleged violations of
the Administrative Procedures Act and the Independent Offices Appropriations
Act. The plaintiffs also filed a motion for preliminary injunctive relief
against the NSF concerning the "Intellectual Infrastructure Fund." On February
2, 1998, the United States District Court, District of Columbia, issued an order
granting the plaintiffs' motion for a preliminary injunction, enjoining the NSF
from spending any of the money collected by the Company for the Intellectual
Infrastructure Fund. On February 10, 1998, the plaintiffs filed a motion for
preliminary injunction against the Company seeking several items of relief. On
February 24, 1998, the Company and the NSF filed motions to dismiss the amended
complaint. Also on February 24, the plaintiffs filed a motion for partial
summary judgment concerning the Intellectual Infrastructure Fund. The
plaintiffs' motion for preliminary injunction against the Company and partial
summary judgment against the NSF, and both motions to dismiss were heard before
the Court on March 17, 1998 and the Court has taken the matters under
advisement. The Company believes that it has meritorious defenses and intends
to vigorously defend itself against the claims in the Thomas suit. While the
Company cannot reasonably estimate the potential impact of such claims, a
successful claim under the plaintiffs' theories could have a material adverse
effect on the Company's business, financial condition and results of
operations.
The Company is involved in various other investigations, claims and
lawsuits arising in the normal conduct of its business, none of which, in the
opinion of the Company's management, will have a material adverse effect on its
financial position, results of operations, cash flows or its ability to conduct
business.
Litigation in which the Company is involved has resulted and likely will
result in, and any future litigation can be expected to result in, substantial
legal and other expenses to the Company and a diversion of the efforts of the
Company's personnel.
See "Item 1 - Business - Risk Factors - Litigation."
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of security holders during the fourth
quarter of 1997.
EXECUTIVE OFFICERS OF THE REGISTRANT
Pursuant to General Instruction G(3) of the General Instructions to Form
10-K, the following information is included as an unnumbered Item in Part I of
this Form 10-K. Set forth below is a list of the names and ages (as of March 30,
1998) of all executive officers of Network Solutions, all positions and offices
with the Company held by each such person and
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each such person's principal occupation or employment during at least the past
five years. All such persons have been appointed to serve until their successors
are appointed or until their earlier resignation or retirement.
Name Age Position
- ---- --- --------
Gabriel A. Battista 53 Chief Executive Officer and Director
Bruce L. Chovnick 38 Senior Vice President and General Manager,
Consulting Services
David H. Holtzman 41 Senior Vice President, Engineering
Robert J. Korzeniewski 41 Chief Financial Officer
Donald N. Telage 53 Senior Vice President, Internet Relations and
Director
Douglas L. Wolford 36 Senior Vice President, Marketing
Gabriel A. Battista has served as a director of the Company since November
1996 and as Chief Executive Officer of the Company since October 1996. From
September 1995 to October 1996, Mr. Battista served as President and Chief
Executive Officer of Cable & Wireless, Inc., a telecommunications company and
U.S. subsidiary of Cable & Wireless, P.L.C. From 1991 to 1995, Mr. Battista
served as President and Chief Operating Officer of Cable & Wireless, Inc. and
from 1987 to 1991, he served as the Chief Operating Officer of National
Telephone Services, a long distance operator service company. Mr. Battista also
serves as a director of Axent Technologies, Inc. and Systems & Computer
Technology Corporation. Mr. Battista received a B.S.E.E. from Villanova
University, a M.S.E.E. from Drexel University and an M.B.A. from Temple
University.
Bruce L. Chovnick has served as Senior Vice President and General Manager,
Consulting Services of the Company since October 1997. From October 1993 until
September 1997, he served as Vice President of Global Internet Solutions for
General Electric Information Services, Inc., an electronic commerce company.
Prior to that he was a Senior Manager of IBM Corporation, a computer systems,
software, networking systems and storage devices manufacturer, from January 1984
to September 1993. Mr. Chovnick received a B.S. in Computer Science from the
University of Florida.
David H. Holtzman has served as Senior Vice President, Engineering of the
Company since February 1997. From September 1995 until January 1997, he served
as Chief Scientist, IBM Internet Information Technology (InfoMarket) group, a
computer systems, software, networking systems and storage devices manufacturer.
Prior thereto, from May 1992 to 1994, he served as a Senior Associate at
Booz-Allen & Hamilton, a management consulting firm. Mr. Holtzman received a
B.A. in Philosophy from the University of Pittsburgh and a B.S. in Computer
Science from the University of Maryland.
Robert J. Korzeniewski has served as Chief Financial Officer of the Company
since March 1996. From 1987 until October 1997, Mr. Korzeniewski held a variety
of senior financial positions with SAIC and served as a Corporate Vice President
for Administration of SAIC from 1989 until 1997. Mr. Korzeniewski is a Certified
Public Accountant and received a B.S. in Business Administration from Salem
State College.
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Donald N. Telage has served as a director of the Company since May 1995 and
as Senior Vice President, Internet Relations of the Company since February 1997.
Dr. Telage also served as President and Chief Operating Officer of the Company
from May 1995 to February 1997. Since 1986, Dr. Telage has served in various
positions with SAIC and has served as a Group Senior Vice President of SAIC
since 1993. Prior thereto, Dr. Telage served as a Corporate Vice President of
SAIC from 1992 to 1993. Dr. Telage received his B.A. in Psychology from the
University of Connecticut and received an M.A. and a Ph.D. in Mathematics from
Clark University.
Douglas L. Wolford has served as Senior Vice President, Marketing of the
Company since December 1997. From December 1994 to November 1997, Mr. Wolford
was General Manager, Marketing for General Electric Information Services, Inc.,
an electronic commerce company. Prior thereto, he served as Director,
Development and Public Affairs for the National Academy of Engineering, from
March 1989 to December 1994. Mr. Wolford received a B.S. from North Carolina
State University, a Certificat de Langue Francaise from Sorbonne University and
an M.B.A. in Marketing from the University of Maryland.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company's Registration Statement on Form S-1 (Registration No.
333-30705) was declared effective on September 25, 1997 by the Securities and
Exchange Commission. The Class A Common Stock of the Company began trading
publicly on the Nasdaq National Market on September 26, 1997 under the symbol
NSOL. Prior to that date, there was no public market for the Class A Common
Stock. 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 is now completed. After subtracting expenses incurred for the
Company's account in connection with the offering, the Company's net offering
proceeds were $52,405,000. On October 1, 1997, the Company received the offering
proceeds, from which a $10,000,000 dividend was paid to SAIC. The remaining
proceeds have been invested in short-term investment grade government discount
notes and commercial paper. With the exception of the $10,000,000 dividend paid
to SAIC on October 1, 1997, the Company has neither declared nor paid cash
dividends on its Common Stock. The Company currently intends to retain its
earnings, if any, for future growth and does not anticipate paying any dividends
in the foreseeable future. Its Board of Directors will determine the Company's
future dividend policy on the basis of various factors, including the Company's
results of operations, financial condition, capital requirements and investment
opportunities.
The following table provides the high and low sale prices of the Class A
Common Stock on the Nasdaq National Market for the period from September 26,
1997 through December 31, 1997.
High Low
---- ---
$26.75 $11.75
As of March 20, 1998, there were 47 holders of record of Network Solutions
Class A Common Stock. Because many of the Company's shares of Common Stock are
held by brokers and other institutions on behalf of beneficial stockholders,
the Company is unable to determine the exact number of beneficial stockholders
represented by these record holders.
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Since January 1, 1995, the Company has issued and sold (without payment of
any selling commission to any person) the unregistered securities described
below:
1. From October 14, 1996 to December 31, 1997, the Company granted
incentive stock options to purchase an aggregate of 100,900 shares of the
Company's Class A Common Stock to employees, officers and directors of the
Company under its 1996 Stock Incentive Plan at exercise prices ranging from
$11.25 to $14.00 per share. All of these options vest over a period of time
following their respective dates of grant pursuant to the Company's 1996
Stock Incentive Plan.
2. From October 14, 1996 to December 31, 1997, the Company granted
nonstatutory stock options to purchase an aggregate of 1,725,325 shares of the
Company's Class A Common Stock to employees, officers and directors of the
Company under its 1996 Stock Incentive Plan at exercise prices ranging form
$11.25 to $14.875 per share. All of these options vest over a period of time
following their respective dates of grant pursuant to the Company's 1996
Stock Incentive Plan.
The sales of the above securities were deemed to be exempt from
registration under the Securities Act in reliance on Section 4(2) of the
Securities Act, or Regulation D promulgated thereunder, or Rule 701 promulgated
under Section 3(b) of the Securities Act, as transactions by an issuer not
involving a public offering or transactions pursuant to compensatory benefit
plans and contracts relating to compensation as provided under such Rule 701.
The recipients of securities in each such transaction represented their
intention to acquire the securities for investment only and not with a view to
or for sale in connection with any distribution thereof and appropriate legends
were affixed to the share certificates and instruments issued in such
transactions. All recipients had access, through their relationship with the
Company, to information about the Company.
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ITEM 6. SELECTED FINANCIAL DATA.
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------
1993 1994 1995 (1) 1996 1997
-------- -------- -------- -------- --------
(in thousands, except per share data)
STATEMENT OF OPERATIONS DATA:
Net revenue $ 4,369 $ 5,029 $ 6,486 $ 18,862 $ 45,326
Cost of revenue 2,924 3,073 5,704 14,666 25,798
-------- -------- -------- -------- --------
Gross profit 1,445 1,956 782 4,196 19,528
Research and development expenses - - - 680 1,653
Selling, general and administrative expenses 1,401 1,544 2,394 6,280 12,268
Interest expense (income), net 120 109 61 (496) (2,095)
-------- -------- -------- -------- --------
Income (loss) from continuing
operations before income taxes and
cumulative effect of a change in
accounting principle (76) 303 (1,673) (2,268) 7,702
Provision (benefit) for income taxes 34 114 (239) (643) 3,471
-------- -------- -------- -------- --------
Income (loss) from continuing operations (110) 189 (1,434) (1,625) 4,231
Loss from discontinued
operations, net of income taxes (2) (936) (1,169) (1,403) - -
Cumulative effect of change in accounting
for income taxes 660 - - - -
-------- -------- -------- -------- --------
Net income (loss) $ (386) $ (980) $ (2,837) $ (1,625) $ 4,231
======== ======== ======== ======== ========
Basic earnings per share:
- -------------------------
Income (loss) from continuing operations $ (0.10) $ 0.18 $ (0.14) $ (0.13) $ 0.32
Loss from discontinued operations (0.90) (1.12) (0.13) - -
Cumulative effect of accounting change 0.63 - - - -
-------- -------- -------- -------- --------
Net income (loss) $ (0.37) $ (0.94) $ (0.27) $ (0.13) $ 0.32
======== ======== ======== ======== ========
Weighted average shares 1,048 1,042 10,335 12,500 13,305
Diluted earnings per share:
- ---------------------------
Income (loss) from continuing operations $ (0.10) $ 0.18 $ (0.14) $ (0.13) $ 0.31
Loss from discontinued operations (0.90) (1.12) (0.13) - -
Cumulative effect of accounting change 0.63 - - - -
-------- -------- -------- -------- --------
Net income (loss) $ (0.37) $ (0.94) $ (0.27) $ (0.13) $ 0.31
======== ======== ======== ======== ========
Weighted average shares 1,048 1,047 10,335 12,500 13,483
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Year Ended December 31,
----------------------------------------------------
1993 1994 1995 1996 1997
------ ------ ------ ------ ------
OTHER OPERATING DATA (3):
Net new registrations 13 24 141 489 960
Less: Registrations not renewed - - (1) (39) (46)
------ ------ ------ ------ ------
Net registrations as of year end 13 37 177 627 1,541
====== ====== ====== ====== ======
Year Ended December 31,
----------------------------------------------------
1993 1994 1995 1996 1997
------ ------ ------ ------ ------
BALANCE SHEET DATA:
Cash and cash equivalents $ - $ 136 $ 5 $15,540 $ 41,146
Working capital (4) (179) (1,340) (559) 1,362 50,947
Total assets (5) 3,124 2,448 11,748 66,118 149,620
Deferred revenue, net 73 137 3,346 29,352 61,451
Long-term obligations,
excluding current portion 344 81 1,353 9,440 18,743
Total stockholders' equity 1,221 252 3,062 1,437 47,655
- --------------------------
(1) The Selected Financial Data for the year ended December 31, 1995
was derived by combining the Company's results of operations for the
period January 1, 1995 through March 10, 1995 and the period March 11,
1995 through December 31, 1995, which, respectively, are periods before
and after the date of the SAIC acquisition. The data for these two
periods were prepared on differing bases of accounting and,
accordingly, the comparability of such data with other periods is
limited, primarily as a result of goodwill amortization, new corporate
services agreements and the repayment of outstanding debt balances. See
Notes 1 and 11 of Notes to Financial Statements for a discussion of the
presentation for each of these periods.
(2) See Note 13 of Notes to Financial Statements for a discussion of
discontinued operations.
(3) Net new registrations for each period include gross new registrations
less an estimate of registrations that are uncollectible. Net
registrations include net new registrations less an estimate of
registrations not renewed. Prior to September 14, 1995, net
registrations equaled gross registrations because the Company was
reimbursed by the NSF for all registrations under a cost plus fixed-fee
contract.
(4) Working capital calculation includes $73, $137, $1,993, $19,912 and
$43,789 of current deferred revenue as of December 31, 1993, 1994,
1995, 1996 and 1997, respectively.
(5) Total assets include $0, $0, $1,408, $17,453 and $25,873 of restricted
assets as of December 31, 1993, 1994, 1995, 1996 and 1997,
respectively.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.
The following discussion and analysis should be read in conjunction with
"Item 6 -- Selected Financial Data" and the Company's accompanying financial
statements and notes thereto. Certain information in this Form 10-K contains
forward-looking statements. For this purpose, any statements contained herein
that are not statements of historical fact may be deemed to be forward-looking
statements. Statements regarding the intent, belief or current expectations of
the Company are intended to be forward-looking statements which may involve
risk and uncertainty. There are a number of factors that could cause the
Company's actual results to differ materially from those indicated by such
forward-looking statements, including, but not limited to, those discussed in
"Factors Affecting Operating Results" as well as those discussed elsewhere in
this Form 10-K and the Company's subsequent SEC filings.
OVERVIEW
The Company. The Company currently acts as the exclusive registrar of
Internet domain names within the .com, .org, .net, and .edu TLDs pursuant to a
Cooperative Agreement with the NSF. Domain names are used to identify a unique
site or presence on the Internet. As registrar to these TLDs, the Company
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 Company also provides enterprise network consulting services,
focusing on network engineering, network and systems security and network
management solutions for commercial customers.
Cumulative net registrations (gross registrations less management's
estimate of uncollectible registrations and of non-renewals) within the TLDs
maintained by the Company increased by 146% from 627,000 domain names registered
at December 31, 1996 to 1,541,000 domain names registered at December 31, 1997.
Net registrations in the .com TLD represent 87% of the Company's total net
registrations at December 31, 1997. Out of the 1,541,000 cumulative net
registrations at December 31, 1997, 598,000 registrations will be up for annual
renewal during 1998 based upon their respective anniversaries of initial
registration. International registrations continued to increase as a percentage
of net new registrations, averaging 27% during 1997 with fourth quarter 1997
international registrations at 34% of net new registrations as compared to 18%
in the same quarter of 1996. Net revenue from registration services accounted
for 85.6% of the Company's net revenue for the year ended December 31, 1997.
The Company's consulting services division delivers full life cycle network
engineering and consulting for a broad range of companies including
multinational oil and gas corporations and major financial institutions. A
pioneer in Internet technology since 1979, the Company has built an
international reputation in enterprise network engineering, network and systems
security, and network operations center deployment. Net revenue from consulting
services accounted for 14.4% of the Company's net revenue for the year ended
December 31, 1997.
Registration Services. In December 1992, the Company entered into the
Cooperative Agreement with the NSF under which the Company was to provide
Internet domain name registration services for five TLDs: .com, .org, .net, .edu
and .gov. These "registration
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services" include domain name registration and renewal, and throughout the
registration term, maintenance of and unlimited modifications to individual
domain name records and dissemination of records through updates to the
Internet. The Cooperative Agreement became effective January 1, 1993. It
includes a three-month phase-in period, a five-year operational period
(commencing April 1, 1993 and ending March 31, 1998), and a six-month
"flexibility period" through September 30, 1998. The Cooperative Agreement is
subject to review by the NSF and may be terminated by the NSF at any time at
its discretion or by mutual agreement. The NSF has stated that it will not be
re-awarding a cooperative agreement at the end of the flexibility period.
The original terms of the Cooperative Agreement provided for a cost
reimbursement plus fixed-fee contract (with a fee of 8%). Effective September
14, 1995, the NSF and the Company amended the Cooperative Agreement to require
the Company to begin charging end users a services fee of $50 per year for each
domain name in the .com, .org and .net TLDs. Registrants pay a services fee of
$100 for two years of domain name services upon each initial registration and
an annual renewal fee of $50 per year thereafter (collectively "registration
fees"). The NSF paid the registration fees for domain names within the .edu and
.gov TLDs through March 31, 1997. Commencing April 1, 1997, the Company agreed
with the NSF to provide domain name services within the .edu and .gov TLDs free
of charge. As of October 1, 1997, the Company no longer registers or
administers domain names in the .gov TLD. Historical registrations in the .edu
and .gov TLDs represent less than 0.1% of cumulative net registrations at
December 31, 1997 and less than 0.1% of net new registrations during the period
from April 1, 1997 to December 31, 1997, and did not have a significant impact
on the Company's net revenues or costs of services.
Under the terms of the September 14, 1995 amendment to the Cooperative
Agreement, 30% of the registration fees collected by the Company is required to
be set aside for the enhancement of the intellectual infrastructure of the
Internet and, as such, is not recognized as revenue by the Company. The Company
has reflected these funds, along with the appropriate percentage of net accounts
receivable, as restricted assets and has recorded an equivalent, related current
liability. The Company maintains the cash received relating to the set aside
funds in a separate interest bearing account. This restricted cash at December
31, 1996 and 1997 was approximately $13,049,000 and $23,512,000, respectively.
The set aside funds, plus any interest earned, are intended to be disbursed at
the direction of the NSF. In November 1997, the Company disbursed $23 million
out of the fund to the NSF at its direction. Future collection or disbursement
of these set aside funds will have no significant effect on the Company's
business, net financial position or results of operations.
On March 12, 1998, the NSF and the Company amended the Cooperative
Agreement to eliminate the 30% set aside requirement effective April 1, 1998 and
to reduce the registration fees by a corresponding amount. Initial registrations
on and after April 1, 1998 will be charged $70 for two years of registration
services and an annual renewal fee of $35 per year thereafter. This amendment
will have no effect on the revenue currently recognized on each registration
($70 for initial registrations and $35 for renewals), since the Company
previously did not recognize revenue on the 30% set aside funds. Accordingly,
while the revenue to the Company on a per registration basis does not change,
the amount charged to customers will decline. The impact of this price change on
new registrations during the first quarter of 1998 is not expected to be
material and the potential increase in demand for domain names for the remainder
of 1998 due to the lower price point is uncertain.
In order to provide prompt access to new domain names on the Internet,
the Company invoices customers and permits them to pay their registration fees
after their domain names are registered. The Company's experience has been
that, for the period from September 1995 to
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December 1997, approximately 30% of registrations have ultimately been
deactivated for non-payment. The Company 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 reselling such names at a profit. Such resellers have a
greater tendency than other customers to default on their registration fees. As
a consequence, the Company has recorded a comparable provision for uncollectible
accounts in determining net registration revenue. This 30% provision has been
consistently applied for the period from September 1995 to December 1997 and is
considered adequate by the Company.
Registration fees charged to end users for registration services, net of
the 30% set aside funds, are recognized as revenue evenly over the registration
term. Accordingly, the Company recognizes $70 ($100 fee less $30 set aside) on a
straight-line basis over the two-year services period for each initial domain
name registration, equivalent to $35 per year. Renewals of domain name
registrations are recorded as revenue based upon $35 ($50 fee less $15 set
aside) recognized on a straight-line basis over the one-year services period.
This "subscription-based" model defers revenue recognition until the Company
provides the registration services, including daily updates to the Internet and
maintenance of and unlimited modifications to individual domain name records,
over the respective registration terms. At December 31, 1997, the Company had
net deferred revenue of $61.5 million, of which $43.8 million will be recognized
as revenue in 1998.
Consulting Services. Substantially all of the Company's consulting 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.
NationsBanc Services, Inc. ("NationsBanc") is the Company's largest
consulting services customer and accounted for 29% of the Company's consulting
services revenue for the year ended December 31, 1997. NationsBanc originally
contracted with the Company in 1993 to provide ongoing analysis, design,
implementation and support engineering for its enterprise network. The Company
currently provides network design and engineering services as well as a variety
of project specific services for NationsBanc. The Company's current contract
with NationsBanc is a three-year contract which commenced January 1, 1997 and is
a requirements contract under which the Company's services are ordered by task
orders issued by NationsBanc. The NationsBanc contract may be terminated by
NationsBanc at any time upon 30-days' prior written notice to the Company.
During 1997, task orders for a number of services the Company had historically
performed for NationsBanc were not renewed. The Company believes this reflects
NationsBanc's focus on increasing its internal information technology staff as
well as its continued efforts to integrate information technology staff from
recent acquisitions. There can be no assurance that the Company will obtain any
additional task orders under the NationsBanc contract.
Financial Presentation. The accompanying historical financial statements
for all periods presented reflect the results of continuing operations related
to the commercial activities of the Company only. The operating results of both
the minority-based government contracts business, which was transferred into a
separate entity prior to the acquisition of the Company by SAIC, and the
remaining government-based business, which was transferred to SAIC effective
February 1996, are reflected as discontinued operations in the Company's
financial statements. See Notes 1 and 9 to the Company's Financial Statements
for a discussion of transactions with SAIC.
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RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage
relationship to net revenue of certain items in the Company's Statements of
Operations. The percentage relationships for the year ended December 31, 1995
were derived by combining the Company's results of operations for the period
January 1, 1995 through March 10, 1995 and the period March 11, 1995 through
December 31, 1995 which, respectively, are periods before and after the date of
the SAIC acquisition. Accordingly, the data for these two periods and the
periods preceding and following the acquisition were prepared on differing bases
of accounting and, as a result, the comparability of such percentage relations
with other periods is limited primarily as a result of the goodwill
amortization, corporate services agreements and interest expense related to
outstanding debt balances.
Percentage of Net Revenue
-------------------------------
Fiscal Year
Ended December 31,
-------------------------------
1995 1996 1997
------- ------- ------
Net revenue 100.0% 100.0% 100.0%
Cost of revenue 87.9 77.8 56.9
------- ------- ------
Gross profit 12.1 22.2 43.1
Research and development expenses - 3.6 3.6
Selling, general and administrative expenses 36.9 33.3 27.1
Interest expense (income), net 0.9 (2.7) (4.6)
------- ------- ------
Income (loss) from continuing operations (25.7) (12.0) 17.0
Provision (benefit) for income taxes (3.6) (3.4) 7.7
------- ------- ------
Income (loss) from continuing operations,
net of income taxes (22.1%) (8.6%) 9.3%
======= ======= ======
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COMPARISON OF YEARS ENDED DECEMBER 31, 1996 AND 1997
Net Revenue. Net revenue increased 140% from $18.9 million in 1996 to $45.3
million in 1997. 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 246% from $11.2 million in
1996 to $38.8 million in 1997. Net new registrations increased 96% from 489,000
during 1996 to 960,000 during 1997. Growth in registrations has been driven by
the widespread use and adoption by businesses of the Internet and Intranets on a
global basis. Cumulative net registrations as of December 31, 1996 were 627,000
as compared to 1,541,000 as of December 31, 1997, for a 146% increase.
Net revenue from consulting services decreased 16% from $7.7 million in
1996 to $6.5 million in 1997. This decrease was primarily attributable to a
decrease in business from NationsBanc. NationsBanc, the Company's largest
consulting services client, accounted for $3.7 million or 20% of the Company's
total net revenue in 1996 and $1.9 million or 4% of the Company's total net
revenue in 1997. The Company believes NationsBanc will continue to be a
significant customer of its consulting services business, but to a lesser extent
than in previous years, both in terms of dollars and as a percentage of the
Company's total net revenue.
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, lease costs of the operations
infrastructure and the associated operating overhead. Cost of revenue increased
76% from $14.7 million in 1996 to $25.8 million in 1997. The increase was
primarily driven by the growth of the Company's registration business which
experienced additional labor costs of $4.2 million and additional outsourcing
costs of $1.6 million in support of the Company's invoicing, collection and
processing activities. In June 1997, the Company opened a 31,200 square foot
facility to support its Internet business operations and in January 1998, the
Company signed an agreement to lease an additional 9,100 square feet at the
same location. This leased facility is designed to meet current registration
services customer support needs as well as to provide expansion capability for
future business. The Company continues to invest in improvements to the back
office component of its domain name registration business including investments
in additional hardware, software, staffing and facilities and currently
anticipates that it will continue to make significant investments in its back
office for the foreseeable future.
As a percentage of net revenue, cost of revenue decreased from 77.8% in
1996 to 56.9% in 1997. This decrease primarily reflects economies of scale that
the Company has begun 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.
Research and Development Expenses. Research and development expenses
consist primarily of compensation expenses to support the development and
enhancement of the Company's technologies. Research and development expenses
increased 150% from $680,000 in 1996 to $1.7 million in 1997. To date, all of
the Company's research and development costs have been expensed as incurred. The
Company expects that the level of research and development expenses will
increase significantly in the near future in absolute dollars as the Company
invests in developing new product and service offerings. As a percentage of net
revenue, research and development expenses were 3.6% for both 1996 and 1997.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses consist primarily of salaries of business development,
general management,
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administrative and financial personnel, corporate services from SAIC, legal
costs and amortization of goodwill associated with the Company's acquisition by
SAIC. Selling, general and administrative expenses increased 95% from $6.3
million in 1996 to $12.3 million in 1997. The increase is primarily
attributable to increased management and administrative labor expenses of $1.8
million, business development expenses of $1.3 million and an increase in legal
costs of $1.0 million.
As a percentage of net revenue, selling, general and administrative
expenses decreased from 33.3% in 1996 to 27.1 % in 1997. The decrease in
percentage of net revenue reflects economies the Company has begun to achieve
due primarily to the growth of its domain name registration business. The
Company expects that the level of selling, general and administrative expenses
will increase significantly in the near future in terms of absolute dollars as
operations continue to expand. In particular, sales, marketing and business
development expenses will increase as the Company introduces new enhanced
registration and other services and begins to actively promote the use of the
.com TLD.
Interest Income, Net. The Company had net interest income of $496,000 in
1996 as compared to $2.1 million in 1997. The increase is attributable to the
investment of the net proceeds of the Company's stock offering as well as
improved cash flow resulting from the increase in domain name registrations.
Income Taxes (Benefit). The income tax benefit was $643,000 in 1996 as
compared to an income tax expense of $3.5 million in 1997. The effective tax
rate changed from 28% in 1996 to 45% in 1997. The difference between the
effective rates is principally attributable to the relative impact that
non-deductible goodwill had on pretax operating income or loss for the year.
Goodwill is being amortized by the Company over five years and is associated
with the acquisition of the Company by SAIC in 1995.
COMPARISON OF YEARS ENDED DECEMBER 31, 1995 AND 1996
Net Revenue. Net revenue increased 191% from $6.5 million in 1995 to $18.9
million in 1996. This increase in net revenue was primarily attributable to the
increase in the number of domain name registrations, principally in the .com
TLD, as well as the Company's shift to a subscription-based pricing model. Net
revenue from registration services increased 600% from $1.6 million in 1995 to
$11.2 million in 1996. Net revenue in 1995 primarily reflects the cost
reimbursement plus fixed-fee contract with the NSF whereas net revenue for 1996
reflects the Company's subscription-based pricing model. Net new registrations
increased 247% from 141,000 during the year ended December 31, 1995 to 489,000
during the year ended December 31, 1996. Cumulative net registrations increased
254% from 177,000 at December 31, 1995 to 627,000 at December 31, 1996.
Net revenue from consulting services increased 57% from $4.9 million in
1995 to $7.7 million in 1996, including an increase in net revenue from
NationsBanc, the Company's largest consulting services customer, which increased
42% from $2.6 million in 1995 to $3.7 million in 1996. This growth was primarily
attributable to increased funding within NationsBanc to support internal network
integration and expansion. The Company also experienced growth from a number of
new consulting services customers, many of which were obtained through
subcontracting with and utilizing leads from SAIC.
NationsBanc accounted for 19.6% of total net revenue in 1996. NationsBanc
accounted for 40.0% of total net revenue and the NSF (under the cost
reimbursement plus fixed-fee contract) accounted for 20.8% of total net revenue
in 1995. No other source of revenue accounted for
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more than 7.1% of total net revenue in either year.
Cost of Revenue. Cost of revenue increased 157% from $5.7 million in 1995
to $14.7 million in 1996. The increase in cost was related primarily to an
increase in the cost of labor of $3.7 million as a result of the Company's rapid
growth. Effective with the September 14, 1995 amendment to the Cooperative
Agreement which implemented the subscription-based pricing model, the Company
established and continued to develop its back office capability. This required
the Company to make significant investments in hardware and software as well as
to utilize a number of third-party vendors in support of back office
requirements. In particular, the Company began to outsource portions of its back
office operations during the fourth quarter of 1996. A principal benefit of
outsourcing was to increase the capacity and efficiency of its back office
operations; however, such action alone did not significantly impact operating
margins.
As a percentage of net revenue, cost of revenue decreased from 87.9% in
1995 to 77.8% in 1996. This decrease reflects economies of scale that the
Company has begun to achieve due to the growth of its domain name registration
business.
Research and Development Expenses. There were no research and development
expenses in 1995, in large part because registration system enhancements were
reimbursable under the Cooperative Agreement. In 1996, research and development
expenses were $680,000 or 3.6% of net revenue. Through December 31, 1996, all of
the Company's research and development costs have been expensed as incurred.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased 162% from $2.4 million in 1995 to $6.3 million
in 1996. This increase was primarily attributable to increases in management,
administrative and business development staff, as well as increased legal costs
associated with the administration of the Company's domain name dispute policy.
Selling, general and administrative expenses include $237,000 in 1995 and
$822,000 in 1996 of expenses allocated from SAIC in accordance with the then
current intercompany agreement. If the expenses were based on the fee of 2.5% of
net revenue under the intercompany agreement in effect during 1997, such
expenses would have been $133,000 and $472,000, respectively.
As a percentage of net revenue, selling, general and administrative
expenses decreased from 36.9% in 1995 to 33.3% in 1996, reflecting the generally
fixed nature of certain general and administrative expenses as well as
management's control of such costs.
Interest Expense (Income). The Company had net interest expense of $61,000
in 1995 as compared to interest income of $496,000 in 1996. The change is
primarily attributable to positive cash flow in 1996 associated with the
Company's domain name registration business.
Income Taxes (Benefit). The income tax benefit was $239,000 in 1995 as
compared to $643,000 in 1996. The effective tax rate increased from 14.3% in
1995 to 28.4% in 1996. The difference between the effective tax rates was
primarily attributable to non-deductible goodwill comprising a higher percentage
of the Company's net loss in 1995.
Discontinued Operations. Immediately prior to the acquisition of the
Company by SAIC, the portion of the Company's business relating to the
minority-based government business had been transferred into a separately-owned
entity. In November 1995, SAIC adopted a plan to transfer the Company's
remaining government-based business to SAIC in order to enable the Company to
focus on the growth of its commercial business, which includes registration and
consulting services. This transfer was effective as of February 1996. November
1995 was the
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measurement date for discontinued operations for accounting purposes. The
activities of both the minority-based government business and the remaining
government-based business are reflected as discontinued operations. Net income
(loss) from discontinued operations excludes general corporate overhead of the
Company. No gain or loss was incurred as a consequence of the transfer of these
businesses.
In 1995, discontinued operations incurred a net loss of $1.4 million. The
loss was primarily attributable to the Company's remaining government business,
which increased the Company's provision for uncollectible accounts associated
with the bankruptcy of a prime contractor, high interest costs associated with
payment issues from other prime contractors and over-runs of fixed-price and
fixed-rate contracts. As mentioned above, this business was transferred to SAIC
effective as of February 1996.
FACTORS AFFECTING OPERATING RESULTS
The Company's expense levels are based in part on its expectations as to
future revenue and to a large extent are fixed. As a result, quarterly sales and
operating results generally depend on the volume of and ability to fulfill
registration requests and consulting services contract awards, which are
difficult to forecast. The Company may be unable to adjust spending in a timely
manner to compensate for any unexpected revenue shortfall. Accordingly, any
significant shortfall of demand for the Company's services in relation to the
Company's expectations would have an immediate adverse impact on the Company's
business, operating results and financial condition. In addition, the Company
expects a significant increase in its operating expenses as it funds greater
levels of product and services development, increases its sales and marketing
operations, updates systems and infrastructure, expands its facilities, develops
new distribution channels and broadens its customer support capabilities. While
no individual expenditure is anticipated to have a material impact on the
Company's operating results, the combined effect could be significant and cannot
be reasonably estimated at this time. To the extent that such expenses precede
or are not subsequently followed by an increase in revenue, the Company's
business, financial condition and results of operations will be materially and
adversely affected.
The Company believes that future operating results will be subject to
quarterly fluctuations due to a variety of factors, many of which are beyond the
Company's control. Such factors may include, but are not limited to,
developments in Internet governance, increased competition, through the
introduction of competing TLDs or competing registrars in .com, .org or .net or
otherwise, variations in the number of requests for domain name registrations,
demand for the Company's services, introduction or enhancements of services by
the Company or its competitors, market acceptance of new service offerings,
costs associated with providing domain name registration services, litigation
costs, adverse results of litigation, termination or completion of contracts in
the Company's consulting services business or failure to obtain additional
contracts in its consulting services business, patterns of growth in the use of
and interest in the Internet and general economic conditions. Operating results
would be adversely affected by a downturn in the market for domain name
registrations or a failure to maintain existing or obtain anticipated contracts
in its consulting services business. Because the Company expects an increase in
its operating expenses for personnel and new services development, the Company
would be materially and adversely affected if its revenues did not
correspondingly increase. See "Item 1 - Business - Risk Factors - Potential
Fluctuations in Quarterly Results."
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On February 20, 1998, the U.S. government published in the Federal
Register the Proposed Rule to provide notice and seek public comment on a
proposal to transfer over time the administration of the Internet domain name
system from the U.S. government and the NSF to a new private, not-for-profit
corporation and to increase competition in the administration of TLDs and the
registration of second level domain names. Comments on the Proposed Rule have
revealed substantial differences regarding how the DNS should evolve and
competing proposals concerning DNS management to those set forth in the Proposed
Rule have been advanced from time to time. There is a risk that failure to
achieve consensus could, among other things, prevent or delay the issuance of a
final rule. In addition, any rule that is issued could be challenged by persons
or entities who disagree with its provisions. Any of such events could have a
material adverse effect on the Company's business, financial condition and
results of operation through continued uncertainty about future Internet
governance or a disruption to the administration, effective operation or
maintenance and expansion of the Internet, in general, or the domain name
registration system, in particular. Additionally, any final rule could be
different, perhaps substantially, from the Proposed Rule. Any final rule or any
terms negotiated thereunder by the U.S. government and the Company could contain
provisions which are not favorable to the Company or not consistent with the
Company's current or future plans. It is impossible to predict at this time
whether or when a final rule will be issued and, if issued, the exact nature of
its provisions or of any such terms, the timing of implementation or the precise
effect of such provisions or terms on the Company. It is possible that certain
provisions of any final rule or certain of such terms could have a material
adverse effect on the Company's business, financial condition and results of
operations. See "Item 1-Business-Relationship with the NSF; Recent Developments
in Internet Governance and -Risk Factors-Uncertainty of Internet Governance and
Regulation."
Under the Proposed Rule, the Company would continue to operate the .com,
.org and .net registries and to act as a registrar for those TLDs, but other
companies would be permitted to act as registrar for those TLDs. The Proposed
Rule also provides for additional new TLDs. The Company believes that it is well
positioned to succeed in a more competitive environment. However, the adoption
of the Proposed Rule or a similar rule or the introduction of additional
competition into the domain name registration business in some other manner
could have a material adverse effect on the Company's business, financial
condition and results of operations. See "Item 1-Business-Competition and -Risk
Factors-Competition."
The Company's operations are dependent upon its ability to maintain its
computer and telecommunications equipment in effective working order and to
reasonably protect its systems against damage from fire, natural disaster,
sabotage, power loss, telecommunication failure, human error or similar events.
In addition, growth of the Company's customer base may put strain on the
capacity of its computers and telecommunications systems and the Company's
inability to sufficiently maintain or upgrade its systems could lead to
degradation in performance or system failure. Any damage, failure or delay that
causes significant interruptions in the Company's systems would have a material
adverse effect on the Company's business, financial condition and results of
operations.
The Company is a party in a number of legal proceedings. While the
Company cannot reasonably estimate the potential impact of the claims advanced
in the PG Media or Thomas suits, a successful claim against the Company in
either of these proceedings could have a material adverse effect on the
Company's business, financial condition and results of operation. In addition,
while the Company cannot predict what relief, if any, might be sought, awarded
or imposed as a result of any civil action filed by the Department of Justice
arising from its investigation regarding Internet registration products and
services, any such relief could have a material adverse effect on the Company's
business,
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financial condition and results of operation. Moreover, litigation in which the
Company is involved has resulted and likely will result in, and any future
litigation can be expected to result in, substantial legal and other expenses to
the Company and a diversion of the Company's personnel. See "Item 3 - Legal
Proceedings."
The Company is in the process of assessing its computer software
applications and systems to ensure their functionality with respect to the
"Year 2000" millenium change. At this time, the Company believes that the
remediation costs, if any, needed to make all of its internal applications and
systems Year 2000 compliant are not material. Although the Company believes
that its internal mission critical systems are Year 2000 compliant, the failure
of the software applications or internal systems of other companies on which
the Company's systems rely or to which they are connected or of other
Internet-related companies, including Internet web hosting companies, Internet
access providers, or Internet root server operators, none of which the Company
controls, to be Year 2000 compliant upon January 1, 2000 could have a material
adverse effect on the operation of the Internet and/or a material adverse
effect on the Company's business, financial condition and results of operation.
See "Item 1-Business-Risk Factors - Year 2000."
SELECTED QUARTERLY RESULTS OF OPERATIONS
The following tables set forth certain unaudited quarterly financial
information for 1996 and 1997. In the opinion of management, this information
has been presented on the same basis as the audited financial statements and all
necessary adjustments (consisting only of normal recurring adjustments) have
been included in the amounts stated below to present fairly the selected
unaudited quarterly results when read in conjunction with the audited financial
statements of the Company and notes thereto. The results of operations for any
quarter are not necessarily indicative of results for any future periods.
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Quarter Ended
--------------------------------------------------------------------------------------------
Mar. 31, Jun. 30, Sep. 30, Dec. 31, Mar. 31, Jun. 30, Sep. 30, Dec. 31,
1996 1996 1996 1996 1997 1997 1997 1997
-------- -------- -------- -------- -------- -------- -------- --------
(in thousands, except per share data)
Net revenue $ 2,333 $ 4,496 $ 5,180 $ 6,853 $ 8,655 $ 10,069 $ 12,172 $ 14,430
Cost of revenue 2,950 3,571 3,719 4,426 5,294 6,141 7,033 7,330
-------- -------- -------- -------- -------- -------- -------- --------
Gross profit (617) 925 1,461 2,427 3,361 3,928 5,139 7,100
Research and development
expenses - 58 226 396 311 407 377 558
Selling, general and
administrative expenses 921 1,449 1,932 1,978 2,301 2,487 3,105 4,375
Interest expense (income), net - (86) (288) (122) (149) (335) (570) (1,041)
-------- -------- -------- -------- -------- -------- -------- --------
Income (loss)
before income taxes (1,538) (496) (409) 175 898 1,369 2,227 3,208
Provision (benefit) for income (436) (140) (116) 49 382 629 995 1,465
taxes -------- -------- -------- -------- -------- -------- -------- --------
Net income (loss) $ (1,102) $ (356) $ (293) $ 126 $ 516 $ 740 $ 1,232 $ 1,743
======== ======== ======== ======== ======== ======== ======== ========
Basic and diluted EPS(1) $ (0.09) $ (0.03) $ (0.02) $ 0.01 $ 0.04 $ 0.06 $ 0.10 $ 0.11
======== ======== ======== ======== ======== ======== ======== ========
(1) Since there are changes in the weighted average number of shares outstanding
each quarter, the sum of the quarterly basic and diluted EPS amounts may not
equal the basic and diluted EPS for calendar years 1996 and 1997.
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Quarter Ended
-----------------------------------------------------------------------------
Mar. 31, Jun. 30, Sep. 30, Dec. 31, Mar. 31, Jun. 30, Sep. 30, Dec. 31,
1996 1996 1996 1996 1997 1997 1997 1997
-------- -------- -------- -------- -------- -------- -------- --------
(as a percentage of revenue)
Net revenue 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of revenue 126.4 79.4 71.8 64.6 61.2 61.0 57.8 50.8
----- ----- ----- ----- ----- ----- ----- -----
Gross profit (26.4) 20.6 28.2 35.4 38.8 39.0 42.2 49.2
Research and development
expenses - 1.3 4.4 5.8 3.5 4.0 3.1 3.9
Selling, general and
administrative expenses 39.5 32.2 37.3 28.9 26.6 24.7 25.5 30.3
Interest expense (income), net - (1.9) (5.6) (1.8) (1.7) (3.2) (4.7) (7.2)
----- ----- ----- ----- ----- ----- ----- -----
Income (loss)
before income taxes (65.9) (11.0) (7.9) 2.5 10.4 13.5 18.3 22.2
Provision (benefit) for income
taxes (18.7) (3.1) (2.2) 0.7 4.4 6.2 8.2 10.1
----- ----- ----- ----- ----- ----- ----- -----
Net income (loss) (47.2)% (7.9)% (5.7)% 1.8% 6.0% 7.3% 10.1% 12.1%
===== ===== ===== ===== ===== ===== ===== =====
The Company has experienced quarterly fluctuations in operating results and
anticipates that such fluctuations will continue. These fluctuations may be
caused by, among other things, increases in legal and marketing expenses,
market acceptance of new products, competitive pricing pressures and general
economic conditions. As a result of the foregoing and other factors, the
Company believes that period-to-period comparisons of its results of operations
are not necessarily meaningful and should not be relied on as indications of
future performance. See "Factors Affecting Operating Results" and "Item 1 -
Business - Risk Factors - Potential Fluctuations in Quarterly Results."
The Company's net revenue increased each quarter presented primarily due to
an increase in the number of cumulative net registrations in each of those
quarters. The Company currently expects registration services revenue for the
first quarter of 1998 to show continued growth based upon its existing
registration base and net new registrations during the quarter. However, there
can be no assurance that net registration revenue will continue to increase at
historical rates, or at all, or not decrease in the future, especially when the
Cooperative Agreement is terminated or if there is a change in the Company's
status as the exclusive registrar for domain names in the .com TLD, particularly
as a significant portion of the Company's net revenue is attributable to
registrations in the .com TLD. Notwithstanding the $61.5 million of deferred
revenue at December 31, 1997, of which $43.8 million will be recognized as
revenue in 1998, the Company's revenue is dependent in large part on the
continued growth of the Internet, the Company's ability to maintain its position
as the leading Internet domain name registration service provider worldwide and
the evolving nature of the Company's services, products and other factors.
Operating expenses have generally increased in absolute dollars in each
quarter shown as the Company has increased staffing and related infrastructure
costs in its back office, selling and marketing, and administrative functions.
Quarter-to-quarter growth in cost of revenue was primarily attributable to
increased staffing levels and increased outsourcing costs which are a function
of the number of registrants. Quarter-to-quarter growth in selling, general and
administrative expenses are attributable to increased staffing at the management
level, continuing legal expenses and marketing costs associated with the
introduction of new services and products.
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LIQUIDITY AND CAPITAL RESOURCES
From its acquisition by SAIC in March 1995 until December 1996, the Company
participated in SAIC's centralized cash management system whereby cash received
from operations was transferred to SAIC's centralized cash accounts and cash
disbursements were funded from such centralized cash accounts. Accordingly, cash
requirements for operating purposes and for capital expenditures were met from
this source. Beginning in 1997, the Company implemented its own cash management
system.
At December 31, 1997, the Company's cumulative net obligation to SAIC for
intercompany activity was $1.3 million, a decrease of $14.0 million for the year
then ended. Intercompany activity is primarily comprised of corporate income tax
payments made by SAIC on behalf of the Company in accordance with the companies'
tax sharing arrangement and salaries and benefits paid by SAIC on behalf of the
Company. Effective with the second quarter of 1997, corporate taxes were paid to
SAIC on a quarterly basis, with all other intercompany balances between SAIC and
the Company paid on a monthly basis. Pursuant to the Tax Sharing Agreement dated
September 26, 1997, the Company will now generally remit income tax payments
directly to tax authorities as it no longer is part of SAIC's consolidated group
for federal income tax purposes.
The Company completed its initial public offering on October 1, 1997,
raising $52.4 million for the Company. From these net proceeds, the Company
paid a $10 million dividend to SAIC on October 1, 1997.
Cash provided by operations was $41.1 million in 1997. This amount is
principally attributed to net income plus the increase in deferred revenue
reflecting cash collected in advance of registration services revenue
recognition ratably over the two- and one-year registration terms. Partially
offsetting this amount is an increase in deferred tax assets resulting from
accelerated revenue recognition for tax purposes and the subsequent tax
liabilities. The net repayment of $14.0 million to SAIC during 1997 effectively
reduces the cash provided by operations to $27.1 million.
Investing activities used $43.4 million in 1997, of which $40.2 million was
net purchases of short-term investments, primarily commercial short-term
investment grade securities. Purchases of furniture and equipment of $3.2
million for 1997 represents an increase of $1.3 million from 1996. In addition,
the Company acquired $2.4 million of equipment through a capital lease
transaction. The majority of current and anticipated future capital acquisitions
are to support growth in the domain name registration business and are expected
to be acquired through capital purchases as well as financed under various
operating and capital lease agreements ranging from 24 to 36 months.
The Company believes that the net proceeds from its IPO, combined with its
existing cash balance, short-term investments and cash flows expected from
future operations, will be sufficient to meet the Company's capital requirements
for at least the next 12 to 18 months.
52
53
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial statements required by this item are set forth in a separate
section of this Annual Report on Form 10-K as indicated in the "Index to
Financial Information" appearing on page F-1 and is incorporated herein by
reference.
The supplementary data required by this item are set forth under the
"Item 7 -- Management's Discussion and Analysis of Financial Condition and
Results of Operations" beginning on page 40 hereof and are incorporated herein
by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
As permitted by General Instruction G(3) to Form 10-K, the information
relating to nominees for election as directors of Network Solutions set forth
under the caption "Election of Directors" in Network Solutions' definitive Proxy
Statement for the annual meeting of stockholders to be held on May 19, 1998,
which Proxy Statement will be filed with the Commission within 120 days after
the end of the Company's fiscal year ended December 31, 1997, is incorporated by
reference.
The information on executive officers set forth under the caption
"Executive Officers of the Registrant" beginning on page 34 hereof is
incorporated herein by reference.
The information relating to compliance with Section 16(a) of the Securities
Exchange Act of 1934, as amended, set forth under the caption "Security
Ownership of Certain Beneficial Owners and Management - Section 16(a) Beneficial
Ownership Reporting Compliance" in Network Solutions' definitive Proxy Statement
for the annual meeting of stockholders to be held on May 19, 1998, which Proxy
Statement will be filed with the Commission within 120 days after the end of the
Company's fiscal year ended December 31, 1997, is incorporated by reference.
ITEM 11. EXECUTIVE COMPENSATION.
As permitted by General Instruction G(3) to Form 10-K, the information
called for by this Item is incorporated by reference from the Sections entitled
"Proposal Number 1 - Election of Directors - Compensation of Directors,"
"Executive Compensation" and "Compensation Committee Interlocks and Insider
Participation" in Network Solutions' definitive Proxy Statement for the annual
meeting of stockholders to be held on May 19, 1998, which Proxy Statement will
be filed with the Commission within 120 days after the end of the Company's
fiscal year ended December 31, 1997.
53
54
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
As permitted by General Instruction G(3) to Form 10-K, the information
called for by this Item is incorporated by reference from the Section entitled
"Security Ownership of Certain Beneficial Owners and Management" in Network
Solutions' definitive Proxy Statement for the annual meeting of stockholders to
be held on May 19, 1998, which Proxy Statement will be filed with the Commission
within 120 days after the end of the Company's fiscal year ended December 31,
1997.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
As permitted by General Instruction G(3) to Form 10-K, the information
called for by this Item is incorporated by reference from the Section entitled
"Relationship with SAIC and Certain Transactions" in the Company's definitive
Proxy Statement for the annual meeting of stockholders to be held on May 19,
1998, which Proxy Statement will be filed with the Commission with 120 days
after the end of the Company's fiscal year ended December 31, 1997.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) Documents filed as part of this report
1. Financial Statements.
The list of financial statements set forth under the caption
"Index to Financial Information" on page F-1 is incorporated herein by
reference.
2. Financial Statement Schedules.
The list of financial statement schedules set forth under the
caption "Index to Financial Information" on page F-1 is incorporated herein by
reference. All other schedules have been omitted, as the required information is
inapplicable or the information is presented in the financial statements or
related notes.
3. Exhibits
Exhibit
Number Description of Document
- ------ -----------------------
3(i)* Second Amended and Restated Certificate of Incorporation.
3(ii) Bylaws of Network Solutions, Inc., as amended February 9, 1998.
4.1* Form of Common Stock Certificate.
4.2* Reference is made to Exhibits 3(i) and 3(ii).
10.1* Cooperative Agreement between the National Science Foundation and
Network Solutions, Inc., as amended by Amendments Nos. 1, 2, 3 and 5.
10.2* Amendment No. 4 to the Cooperative Agreement dated September 13, 1995.
10.3* Master Services Agreement for System Management Services dated
January 21, 1997 by and between NationsBanc Services, Inc. and
Network Solutions, Inc.
10.4*+ 1996 Stock Incentive Plan and forms of agreements thereunder.
54
55
10.5* Corporate Services Agreement between Network Solutions, Inc. and Science
Applications International Corporation.
10.6* Tax Sharing Agreement between Network Solutions, Inc. and Science Applications
International Corporation.
10.7* Registration Rights Agreement between Network Solutions, Inc. and Science
Applications International Corporation.
10.8* Noncompetition and Corporate Opportunities Agreement between Network
Solutions, Inc. and Science Applications International Corporation.
10.9*+ Letter Agreement dated September 16, 1996 between the Company and
Gabriel A. Battista, as amended as of September 23, 1996.
10.10* Science Applications International Corporation Employee Stock Ownership Plan
and amendments thereto.
10.11* Science Applications International Corporation 1995 Stock Option Plan.
10.12* Letter dated September 13, 1995 regarding Amendment No. 4 to the Cooperative
Agreement.
10.13* Asset Transfer Agreement between Network Solutions, Inc. and Science
Applications International Corporation.
10.14* Amendment No. 6 to the Cooperative Agreement dated June 23, 1997.
10.15**+ 1997 Employee Stock Purchase Plan.
10.16 Amendment No. 7 to the Cooperative Agreement dated December 3, 1997.
10.17 Amendment No. 8 to the Cooperative Agreement dated February 20, 1998.
10.18 Amendment No. 9 to the Cooperative Agreement dated March 12, 1998.
10.19+ Form of Indemnification Agreement entered into by the Company and each of its
directors and officers at the Vice President level or above.
10.20 Deed of Lease By and Between Sugarland Business Park Limited Partnership and
Network Solutions, Inc. dated May 30, 1997 ("Lease Agreement").
10.21 Amendment No. 1 to Lease Agreement dated January 31, 1998.
23.1 Consent of Price Waterhouse LLP.
27.1 Financial Data Schedule (in electronic format only).
27.2 Restated Financial Data Schedule (in electronic format only).
* Incorporated by reference from Network Solutions, Inc.'s Registration Statement on
Form S-1 (Registration No. 333-30705).
** Incorporated by reference from Network Solutions, Inc.'s Registration Statement on
Form S-8 (Registration No. 333-43821).
+ Executive Compensation Plans and Arrangements.
WorldNIC(TM) and RegistrationPlus(TM) are trademarks of the Company.
(b)Reports on Form 8-K
No reports on Form 8-K were filed during the last quarter of fiscal
year 1997.
55
56
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Company has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
Dated: March 31, 1998
NETWORK SOLUTIONS, INC.
By: /s/ GABRIEL A. BATTISTA
----------------------------
Gabriel A. Battista
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this report has been signed below by the following persons on behalf of
the Registrant and in the capacities indicated on the dates set forth below.
Name Title Date
---- ----- ----
/s/ GABRIEL A. BATTISTA
- -------------------------- Chief Executive Officer and Director March 31, 1998
Gabriel A. Battista
/s/ ROBERT J. KORZENIEWSKI
- -------------------------- Chief Financial Officer (Principal March 31, 1998
Robert J. Korzeniewski Financial Officer)
/s/ MICHAEL G. VOSLOW
- -------------------------- Vice President, Finance and Treasurer March 31, 1998
Michael G. Voslow (Principal Accounting Officer)
/s/ MICHAEL A. DANIELS
- -------------------------- Chairman of the Board March 31, 1998
Michael A. Daniels
/s/ J. ROBERT BEYSTER
- -------------------------- Director March 31, 1998
J. Robert Beyster
/s/ CRAIG I. FIELDS
- -------------------------- Director March 31, 1998
Craig I. Fields
/s/ JOHN E. GLANCY
- -------------------------- Director March 31, 1998
John E. Glancy
/s/ J. DENNIS HEIPT
- -------------------------- Director March 31, 1998
J. Dennis Heipt
/s/ WILLIAM A. ROPER, JR.
- -------------------------- Director March 31, 1998
William A. Roper, Jr.
/s/ STRATTON D. SCLAVOS
- -------------------------- Director March 31, 1998
Stratton D. Sclavos
56
57
Name Title Date
---- ----- ----
/s/ Donald N. Telage
- -------------------------- Director March 31, 1998
Donald N. Telage
57
58
INDEX TO FINANCIAL INFORMATION
Page
Reference
---------
Report of Independent Accountants......................................................... F-2, F-3
1. Financial Statements:
Statements of Financial Position as of December 31, 1996 and 1997................ F-4
Statements of Operations for the Periods from January 1, 1995 to March
10, 1995 and March 11, 1995 to December 31, 1995, and for the Years
Ended December 31, 1996 and 1997................................................. F-5
Statements of Changes in Stockholders' Equity for the Periods from
January 1, 1995 to March 10, 1995 and March 11, 1995 to December 31,
1995, and for the Years Ended December 31, 1996 and 1997......................... F-6
Statements of Cash Flows for the Periods from January 1, 1995 to March
10, 1995 and March 11, 1995 to December 31, 1995, and for the Years
Ended December 31, 1996 and 1997................................................. F-7
Notes to Financial Statements.................................................... F-8
2. Financial Statement Schedule:
Valuation and Qualifying Accounts and Reserves................................... F-24
F-1
59
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Stockholders of Network Solutions, Inc.
In our opinion, the financial statements listed in the index appearing on page
F-1 present fairly, in all material respects, the results of operations and cash
flows for Network Solutions, Inc. ("Predecessor") for the period from January 1,
1995 to March 10, 1995 in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audit. We conducted our audit of these statements in
accordance with generally accepted auditing standards which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for the opinion expressed
above.
As discussed in Note 1 to the financial statements, on March 10, 1995 Science
Applications International Corporation acquired the outstanding stock of the
Company. The financial statements for the periods subsequent to March 10, 1995
have been prepared on the basis of accounting arising from this acquisition. The
financial statements for the period from January 1, 1995 to March 10, 1995 are
presented on the Company's previous basis of accounting.
/s/ PRICE WATERHOUSE LLP
PRICE WATERHOUSE LLP
Falls Church, VA
February 6, 1998
F-2
60
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Stockholders of Network Solutions, Inc.
In our opinion, the financial statements listed in the index appearing on page
F-1 present fairly, in all material respects, the financial position of Network
Solutions, Inc. (a majority-owned subsidiary of Science Applications
International Corporation) at December 31, 1997 and 1996, and the results of its
operations and cash flows for the year ended December 31, 1997 and 1996 and for
the period from March 11, 1995 to December 31, 1995 in conformity with generally
accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
As discussed in Note 1 to the financial statements, on March 10, 1995 Science
Applications International Corporation acquired the outstanding stock of the
Company. The financial statements for the periods subsequent to March 10, 1995
have been prepared on the basis of accounting arising from this acquisition. The
financial statements for the period from January 1, 1995 to March 10, 1995 are
presented on the Company's previous basis of accounting.
/s/ PRICE WATERHOUSE LLP
PRICE WATERHOUSE LLP
Falls Church, VA
February 6, 1998
F-3
61
NETWORK SOLUTIONS, INC.
STATEMENTS OF FINANCIAL POSITION
DECEMBER 31, DECEMBER 31,
1996 1997
------------- -------------
ASSETS
Current assets:
Cash and cash equivalents $ 15,540,000 $ 41,146,000
Short-term investments - 40,200,000
Accounts receivable, net 12,587,000 5,792,000
Prepaids and other assets 936,000 1,005,000
Deferred tax asset 10,087,000 20,153,000
Restricted assets 17,453,000 25,873,000
------------- -------------
Total current assets 56,603,000 134,169,000
Furniture and equipment, net 2,266,000 6,146,000
Deferred tax asset 4,968,000 8,128,000
Goodwill, net 2,281,000 1,177,000
------------- -------------
Total Assets $ 66,118,000 $ 149,620,000
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities $ 2,581,000 $ 6,426,000
Due to parent 15,295,000 1,250,000
Income taxes payable - 5,042,000
Current portion of capital lease obligations - 842,000
Deferred revenue, net 19,912,000 43,789,000
Internet fund liability 17,453,000 25,873,000
------------- -------------
Total current liabilities 55,241,000 83,222,000
Capital lease obligations - 1,081,000
Long-term deferred revenue, net 9,440,000 17,662,000
------------- -------------
Total liabilities 64,681,000 101,965,000
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.001 par value, authorized 10,000,000 shares;
none issued and outstanding in 1996 and 1997
Class A common stock, $.001 par value; authorized 100,000,000 shares;
3,795,000 issued and outstanding in 1997 - 4,000
Class B common stock, $.001 par value; authorized 30,000,000 shares;
12,500,000 and 11,925,000 issued and outstanding in 1996 and 1997 12,000 12,000
Additional paid-in capital 4,468,000 56,451,000
Accumulated deficit (3,043,000) (8,812,000)
------------- -------------
Total stockholders' equity 1,437,000 47,655,000
------------- -------------
Total Liabilities and Stockholders' Equity $ 66,118,000 $ 149,620,000
============= =============
The accompanying notes are an integral part of these financial statements.
F-4
62
NETWORK SOLUTIONS, INC.
STATEMENTS OF OPERATIONS
PREDECESSOR COMPANY
--------------- --------------------------------------------------
JANUARY 1, 1995 MARCH 11, 1995 YEAR ENDED YEAR ENDED
TO MARCH 10, TO DECEMBER 31, DECEMBER 31, DECEMBER 31,
1995 1995 1996 1997
--------------- ---------------- ------------ ------------
Net revenue $ 1,177,000 $ 5,309,000 $ 18,862,000 $ 45,326,000
Cost of revenue 884,000 4,820,000 14,666,000 25,798,000
------------ ------------ ------------ ------------
Gross profit 293,000 489,000 4,196,000 19,528,000
Research and development expenses - - 680,000 1,653,000
Selling, general and administrative expenses 280,000 2,114,000 6,280,000 12,268,000
Interest income - - (496,000) (2,211,000)
Other expenses 9,000 52,000 - 116,000
------------ ------------ ------------ ------------
Income (loss) before income taxes 4,000 (1,677,000) (2,268,000) 7,702,000
Provision (benefit) for income taxes 48,000 (287,000) (643,000) 3,471,000
------------ ------------ ------------ ------------
Income (loss) from continuing operations (44,000) (1,390,000) (1,625,000) 4,231,000
Loss from discontinued operations,
net of income taxes (1,375,000) (28,000) - -
------------ ------------ ------------ ------------
Net income (loss) $ (1,419,000) $ (1,418,000) $ (1,625,000) $ 4,231,000
============ ============ ============ ============
BASIC EARNINGS PER SHARE:
- -------------------------
Income (loss) from continuing operations $ (0.04) $ (0.11) $ (0.13) $ 0.32
Loss from discontinued operations (1.32) - - -
------------ ------------ ------------ ------------
Net income (loss) $ (1.36) $ (0.11) $ (0.13) $ 0.32
============ ============ ============ ============
DILUTED EARNINGS PER SHARE:
- ---------------------------
Income (loss) from continuing operations $ (0.04) $ (0.11) $ (0.13) $ 0.31
Loss from discontinued operations (1.32) - - -
------------ ------------ ------------ ------------
Net income (loss) $ (1.36) $ (0.11) $ (0.13) $ 0.31
============ ============ ============ ============
The accompanying notes are an integral part of these financial statements.
F-5
63
NETWORK SOLUTIONS, INC.
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
CLASS A CLASS B
COMMON STOCK COMMON STOCK TREASURY STOCK
--------------------------- -------------------------- ---------------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
--------------------------- -------------------------- ---------------------------
PREDECESSOR
Balance, December 31, 1994 1,159,000 $ 12,000 110,000 $ (628,000)
Purchase of treasury stock - - 7,000 (30,000)
Net loss for the period from
January 1 to March 10, 1995 - - - -
---------- ----------- ---------- -----------
Balance, March 10, 1995 1,159,000 $ 12,000 117,000 $ (658,000)
========== =========== ========== ===========
- ------------------------------------------------------------------------------------------------------------------------------------
COMPANY
Purchase of outstanding common
stock by SAIC on March 10, 1995 - - 12,500,000 $ 12,000
Net loss for the period from
March 11 to December 31, 1995 - - - -
---------- ----------- ---------- ----------
Balance, December 31, 1995 - - 12,500,000 12,000
Net loss for the year ended
December 31, 1996 - - - -
---------- ----------- ---------- ----------
Balance, December 31, 1996 - - 12,500,000 12,000
Declaration of Class B dividend - - - -
Conversion of Class B Common Stock 575,000 - (575,000) -
Issuance of Class A Common Stock 3,220,000 $ 4,000 - -
Net income for the year ended
December 31, 1997 - - - -
---------- ----------- ---------- ----------
Balance, December 31, 1997 3,795,000 $ 4,000 11,925,000 $ 12,000
========== =========== ========== ==========
ADDITIONAL RETAINED TOTAL
PAID-IN EARNINGS STOCKHOLDERS'
CAPITAL (DEFICIT) EQUITY
----------- ----------- -------------
PREDECESSOR
Balance, December 31, 1994 $ 1,241,000 $ (373,000) $ 252,000
Purchase of treasury stock - - (30,000)
Net loss for the period from
January 1 to March 10, 1995 - (1,419,000) (1,419,000)
----------- ----------- -----------
Balance, March 10, 1995 $ 1,241,000 $(1,792,000) $(1,197,000)
=========== =========== ===========
- ----------------------------------------------------------------------------------------
COMPANY
Purchase of outstanding common
stock by SAIC on March 10, 1995 $ 4,468,000 - $ 4,480,000
Net loss for the period from
March 11 to December 31, 1995 - $(1,418,000) (1,418,000)
----------- ----------- -----------
Balance, December 31, 1995 4,468,000 (1,418,000) 3,062,000
Net loss for the year ended
December 31, 1996 - (1,625,000) (1,625,000)
----------- ----------- -----------
Balance, December 31, 1996 4,468,000 (3,043,000) 1,437,000
Declaration of Class B dividend - (10,000,000) (10,000,000)
Conversion of Class B Common Stock - - -
Issuance of Class A Common Stock 51,983,000 - 51,987,000
Net income for the year ended
December 31, 1997 - 4,231,000 4,231,000
----------- ----------- -----------
Balance, December 31, 1997 $56,451,000 $(8,812,000) $47,655,000
=========== =========== ===========
The accompanying notes are an integral part of these financial statements.
F-6
64
NETWORK SOLUTIONS, INC.
STATEMENTS OF CASH FLOWS
PREDECESSOR COMPANY
--------------- --------------------------------------------
JANUARY 1, 1995 MARCH 11, 1995 YEAR ENDED YEAR ENDED
TO MARCH 10, TO DECEMBER 31 DECEMBER 31, DECEMBER 31,
1995 1995 1996 1997
--------------- -------------- ------------ -------------
Cash flows from operating activities:
Net income (loss) $ (1,419,000) $ (1,418,000) $ (1,625,000) $ 4,231,000
Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities:
Net loss from discontinued operations 1,376,000 28,000 - -
Depreciation and amortization 68,000 765,000 1,417,000 2,432,000
Provision for uncollectible accounts receivable - 124,000 3,597,000 8,082,000
Deferred income taxes - (2,221,000) (12,834,000) (13,226,000)
Change in operating assets and liabilities: - - - -
Increase in accounts receivable (161,000) (3,385,000) (12,144,000) (1,287,000)
(Increase) decrease in prepaids and other assets (36,000) 45,000 (925,000) (69,000)
(Increase) decrease in deposits (49,000) 1,053,000 - -
Increase in accounts payable and accrued liabilities 233,000 282,000 1,226,000 3,845,000
Increase (decrease) in other liabilities 8,000 (89,000) - -
Increase in income taxes payable - - - 5,042,000
Increase (decrease) in deferred revenue (30,000) 3,239,000 26,006,000 32,099,000
------------ ------------ ------------ ------------
Net cash provided by (used in) operating activities (10,000) (1,577,000) 4,718,000 41,149,000
------------ ------------ ------------ ------------
Cash flows from investing activities:
Purchase of furniture and equipment (134,000) (518,000) (1,901,000) (3,240,000)
Purchase of short-term investments - - - (40,200,000)
Net investment in net assets of discontinued operations 331,000 563,000 (208,000) -
------------ ------------ ------------ ------------
Net cash provided by (used in) investing activities 197,000 45,000 (2,109,000) (43,440,000)
------------ ------------ ------------ ------------
Cash flows from financing activities:
Repayment of bank borrowings (293,000) (834,000) - -
Dividend paid - - - (10,000,000)
Capital lease obligations - - - (463,000)
Proceeds from issuance of common stock - - - 52,405,000
Purchase of treasury stock (30,000) - -
Net transactions with SAIC - 2,371,000 12,926,000 (14,045,000)
------------ ------------ ------------ ------------
Net cash provided by (used in) financing activities (323,000) 1,537,000 12,926,000 27,897,000
------------ ------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents (136,000) 5,000 15,535,000 25,606,000
Cash and cash equivalents, beginning of period 136,000 - 5,000 15,540,000
------------ ------------ ------------ ------------
Cash and cash equivalents, end of period $ - $ 5,000 $ 15,540,000 $ 41,146,000
============ ============ ============ ============
The accompanying notes are an integral part of these financial statements.
F-7
65
Network Solutions, Inc.
Notes to Financial Statements
NOTE 1 - ORGANIZATION AND BASIS OF PRESENTATION
Network Solutions, Inc. ("the Company") currently acts as the exclusive
registrar of Internet domain names within the .com, .org, .net, and .edu top
level domains ("TLDs") pursuant to a Cooperative Agreement with the National
Science Foundation ("NSF") (Note 3). Domain names are used to identify a unique
site or presence on the Internet. As registrar to these TLDs, the Company
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 Company also provides enterprise network consulting services,
focusing on network engineering, network and systems security and network
management solutions for commercial customers.
The Company was acquired by Science Applications International Corporation
("SAIC") on March 10, 1995 (the "acquisition"). Prior to the acquisition of the
Company by SAIC, the Company's business included commercial and government
contracts awarded to the Company on a competitive basis, including government
contracts that were awarded to the Company partially upon the Company's then
minority-owned status. The contracts which had been awarded to the Company based
partially on the Company's then minority-owned status were transferred into a
separately-owned entity prior to the acquisition of the Company by SAIC.
In November 1995, SAIC adopted a plan to transfer the Company's remaining
government-based business to SAIC in order to enable the Company to focus on the
growth of its commercial business, which includes registration and consulting
services. This transfer was effective as of February 1996. The operating results
of both the minority-based government contract business and the remaining
government-based business, are reflected as discontinued operations in the
financial statements of the Company for all periods presented (Note 13). The
commercial operations, as defined, are reflected as continuing operations in the
financial statements of the Company for all periods presented.
The financial statements for periods subsequent to March 10, 1995 are presented
on the new basis of accounting arising from the acquisition (Note 9). The
financial statements for the period from January 1, 1995 to March 10, 1995 are
presented on the Company's previous basis of accounting. Subsequent to the
acquisition, the results of continuing and discontinued operations include
allocations by SAIC of: (i) costs for administrative functions and services
performed on behalf of the continuing and discontinued operations of the Company
by centralized staff groups within SAIC, (ii) SAIC's general corporate expenses,
(iii) pension and other retirement benefit costs, and (iv) cost of capital
(Notes 8, 9 and 12). Only costs directly attributable to the Company's
government-based business that were not incurred by the Company subsequent to
the transfer of this business to SAIC have been included in discontinued
operations.
F-8
66
NOTE 2 - RECAPITALIZATION AND INITIAL PUBLIC OFFERING
On June 26, 1997, the Board of Directors amended the Certificate of
Incorporation to provide for two classes of common stock, designated as Class A
and Class B. The holders of Class A and Class B common stock generally have
identical rights except that holders of Class A common stock are entitled to one
vote per share while holders of Class B common stock are entitled to ten votes
per share. Each share of Class B common stock is convertible at the holder's
option into one share of Class A common stock.
On October 1, 1997, the Company completed an initial public offering (the "IPO")
of 3,795,000 shares of its $.001 par value Class A common stock, including
495,000 shares resulting from the exercise of certain overallotment provisions.
The Company's net proceeds from the IPO, including overallotment, were $52.4
million based on the Company's direct sale of 3,220,000 shares of Class A common
stock.
Prior to the offering, the Company was a wholly-owned subsidiary of SAIC. In
conjunction with the IPO, SAIC converted 575,000 shares (including 75,000
overallotment shares) of Class B common stock into 575,000 shares of Class A
common stock and directly sold the shares as a selling stockholder. Upon
completion of the offering, SAIC owned 100% of the outstanding Class B common
stock representing 75.9% of the Company's equity and 96.9% of the combined
voting power of the Company's outstanding Class B and Class A common stock.
On August 21, 1997, the Company's Board of Directors declared a $10,000,000
dividend to be paid to SAIC upon consummation of the IPO. This dividend was paid
to SAIC on October 1, 1997.
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NSF Cooperative Agreement
In December 1992, the Company entered into the Cooperative Agreement with the
NSF under which the Company was to provide Internet domain name registration
services for five TLDs: .com, .org, .net, .edu and .gov. These "registration
services" include domain name registration and renewal, and throughout the
registration term, maintenance of and unlimited modifications to individual
domain name records and dissemination of records through updates to the
Internet. The Cooperative Agreement became effective January 1, 1993. It
includes a three-month phase-in period, a five-year operational period
(commencing April 1, 1993 and ending March 31, 1998), and a six-month
"flexibility period" through September 30, 1998. The Cooperative Agreement is
subject to review by the NSF and may be terminated by the NSF at any time at
its discretion or by mutual agreement. The NSF has stated that it will not be
re-awarding a cooperative agreement at the end of the flexibility period.
The original terms of the Cooperative Agreement provided for a cost
reimbursement plus fixed-fee contract (with a fee of 8%). Effective September
14, 1995, the NSF and the Company amended the Cooperative Agreement to require
the Company to begin charging end users a services fee of $50 per year for each
domain name in the .com, .org and .net TLDs. Registrants pay a services fee of
$100 for two years of domain name services upon each initial registration and
an annual renewal fee of $50 per year thereafter (collectively "registration
fees"). The NSF paid the registration fees to the Company for domain names
within the .edu and .gov TLDs through March 31, 1997. Commencing April 1, 1997,
the Company agreed with the NSF to provide domain name services within the .edu
and .gov TLDs free of charge. As of October 1, 1997, the Company no longer
registers or administers domain names in the .gov TLD.
F-9
67
Under the terms of the September 14, 1995 amendment to the Cooperative
Agreement, 30% of the registration fees collected by the Company is required to
be set aside for the enhancement of the intellectual infrastructure of the
Internet ("set aside funds") and, as such, is not recognized as revenue by the
Company. The Company has reflected these set aside funds, along with the
appropriate percentage of net accounts receivable (Note 4), as restricted assets
and has recorded an equivalent, related current liability. The Company maintains
the cash received relating to the set aside funds in a separate interest bearing
account. This restricted cash at December 31, 1996 and 1997 was approximately
$13,049,000 and $23,512,000, respectively. The set aside funds, plus any
interest earned, are intended to be disbursed at the direction of the NSF. In
November 1997, the Company disbursed $23 million out of this fund to the NSF at
its direction.
Future collection or disbursement of these set aside funds will have no
significant effect on the Company's business, net financial position, or results
of operations (Note 15). 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.
Revenue Recognition
Prior to September 14, 1995, net revenue was recognized under the Cooperative
Agreement on the basis of direct cost plus allowable indirect costs and the
earned portion of the fee. Since September 14, 1995, registration fees charged
to end users for registration services provided by the Company have been
recognized on a straight-line basis over the life of the registration term, two
years for initial registrations and one year for renewals. The Company records
revenue net of an estimated provision for uncollectible accounts receivable
(Note 4).
Substantially all of the Company's consulting 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.
Net revenue from two customers approximated 45% and 21% for the period from
January 1, 1995 to March 10, 1995; 40% and 21% for the period from March 11,
1995 to December 31, 1995, and 20% and 0% for the year ended December 31, 1996.
One of these customers was the NSF, whose impact on the above percentages of
revenue was reflective of activity prior to the September 14, 1995 amendment of
the Cooperative Agreement. During the year ended December 31, 1997, there were
no customers which individually represented more than 5% of net revenues.
Deferred Revenue
Deferred revenue primarily represents the unearned portion of revenue related to
the unexpired term of registration fees, net of an estimate for uncollectible
accounts receivable (Note 4).
Cash and Cash Equivalents
The Company considers all highly liquid investments with original maturities of
ninety days or less to be cash equivalents.
F-10
68
Financial Instruments
The recorded value of the Company's financial instruments, which include
short-term investments, accounts receivable and accounts payable, approximates
market value. Concentration of credit risks with respect to registration
receivables is limited due to the wide variety and number of customers, as well
as their dispersion across geographic areas. The Company has no derivative
financial instruments.
Furniture and Equipment
Furniture and equipment are stated at cost. Depreciation on furniture, office
and computer equipment is calculated principally using a declining-balance
method over the useful lives of three to seven years. Equipment under capital
leases is amortized using a declining-balance method over the shorter of the
assets' useful lives or lease term, ranging from two to three years. Leasehold
improvements are amortized using the straight-line method over the shorter of
the lease term or the estimated useful lives of the assets, generally six years.
Goodwill
Goodwill represents the excess of the purchase cost over the fair value of net
assets acquired in the acquisition and is amortized over five years using the
straight-line method. Amortization expense of $580,000, $715,000 and $686,000
for the period from March 11, 1995 to December 31, 1995, and the years ended
December 31, 1996 and 1997, respectively, was included in selling, general and
administrative expenses.
Software Development Costs
Effective January 1, 1996, research and development costs are expensed as
incurred. Research and development costs incurred for all periods presented
prior to January 1, 1996 were reimbursed to the Company by direct charges to
contracts and are included in cost of revenue for those periods.
In accordance with Statement of Financial Accounting Standards ("SFAS") No. 86
"Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise
Marketed", the Company has not capitalized any significant software development
costs as of December 31, 1997.
Income Taxes
Deferred taxes are accounted for under SFAS No. 109 "Accounting for Income
Taxes," whereby deferred tax assets and liabilities are recognized for the
expected future tax consequences of temporary differences between financial
statement reporting and income tax purposes. A valuation allowance is recorded
if it is "more likely than not" that some portion of or all of a deferred tax
asset will not be realized.
For the period from the acquisition until the IPO, the Company filed tax returns
as part of SAIC's consolidated tax group. Tax expense during this period has
been determined as if the Company was a separate taxpayer and was charged to the
Company by SAIC. Effective October 1, 1997, the Company is no longer part of
SAIC's consolidated tax group for federal income tax purposes and will prepare
its income tax returns as a separate entity.
F-11
69
Stock Based Compensation
The Company accounts for its stock option and employee stock purchase plans in
accordance with the provisions of Accounting Principles Board Opinion ("APB")
No. 25, "Accounting for Stock Issued to Employees". No compensation cost has
been recognized by the Company for its employee stock plans. SFAS No. 123,
"Accounting for Stock-Based Compensation", provides an alternative accounting
method to APB No. 25 and requires additional pro forma disclosures (Note 12).
The Company expects to continue to account for its employee stock plans in
accordance with the provisions of APB No. 25.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make reasonable estimates and
assumptions, based upon all known facts and circumstances that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements. Actual results could
differ from those estimates.
Newly Issued Accounting Standards
Effective December 31, 1997, the Company adopted SFAS No. 128, "Earnings per
Share", which replaces the presentation of primary earnings per share ("EPS")
with a presentation of basic EPS and necessitates the dual presentation of basic
and diluted EPS on the face of the statement of operations. In addition, during
February 1998, the Company adopted Securities and Exchange Staff Accounting
Bulletin ("SAB") No. 98, which, among other things, rescinded SAB No. 83 and
thus eliminates the impact of common share equivalents granted by the Company at
prices below the IPO offering price during the twelve months preceding the
initial IPO filing and through the filing's effective date. All prior period EPS
data have been restated as required by SFAS No. 128 and SAB No. 98. See Note 11
for the reconciliation of the numerator and denominator used in the basic and
diluted EPS computations.
In June 1997, SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information" was issued. SFAS No. 131 establishes standards for
reporting information about operating segments in annual and interim financial
statements issued to stockholders. It also establishes standards for related
disclosures about products and services, geographic areas, and major customers.
SFAS No. 131 is effective for fiscal years beginning after December 15, 1997 and
will have no impact on the Company's results of operations, financial position
or cash flows.
NOTE 4 - ACCOUNTS RECEIVABLE
Accounts receivable consist of the following amounts as of December 31:
1996 1997
----------------- -----------------
Billed $ 27,430,000 $24,483,000
Unbilled 5,000,000 1,526,000
----------------- -----------------
Total accounts receivable before allowances 32,430,000 26,009,000
Less - Allowance for doubtful accounts (15,439,000) (17,856,000)
- Accounts receivable allocable to 30% NSF
set aside (Note 3) (4,404,000) (2,361,000)
----------------- -----------------
Accounts receivable, net $ 12,587,000 $ 5,792,000
================= =================
F-12
70
Unbilled receivables consist of registration fees and time and material contract
costs which have been incurred but which have not yet been billed. Under the
Cooperative Agreement, 30% of collected registration fees will be set aside for
disbursement at the direction of the NSF.
In accounting for registration fees, the Company initially records the gross
amount of the registration fee to accounts receivable and deferred revenue. The
allowance for estimated uncollectible accounts is recorded against both accounts
receivable and deferred revenue balances (see Note 3 for treatment of the 30%
NSF set aside). From the net deferred revenue balance, the Company records
revenue on a straight-line basis over the registration term.
The provision for uncollectible accounts receivable, which is recorded on a
straight-line basis over the registration term and deducted from gross
registration fees in determining net registration revenue, was $124,000 for the
period from March 11, 1995 to December 31, 1995 and $3,597,000 and $7,782,000,
respectively, for the years ended December 31, 1996 and 1997. An additional
$300,000 of bad debt expense was recorded in 1997 for the write-off of
consulting services receivables. The Company's allowance for uncollectible
accounts receivable is associated solely with its registration services
business. The Company believes it has been necessary to establish its provision
for uncollectible accounts receivable due to the large number of individuals and
corporations that have registered multiple domain names with the intention of
reselling such names at a profit. The Company's experience has been that, in
contrast to other registrants, such resellers have a higher tendency of default
on their registration fees.
NOTE 5 - FURNITURE AND EQUIPMENT
Furniture and equipment consist of the following amounts as of December 31:
1996 1997
----------- -----------
Furniture and office equipment $ 879,000 $ 476,000
Computer equipment 4,033,000 8,619,000
Leasehold improvements 234,000 288,000
----------- -----------
Furniture and equipment, at cost 5,146,000 9,383,000
Less: Accumulated depreciation and amortization (2,880,000) (3,237,000)
----------- -----------
Furniture and equipment, net $ 2,266,000 $ 6,146,000
=========== ===========
The above table includes $2,386,000 of computer equipment acquired during 1997
under capital lease agreements. Amortization expense related to capital leases
totaled $915,000 in 1997. Total depreciation and amortization expense for the
periods from January 1, 1995 to March 10, 1995 and March 11, 1995 to December
31, 1995 and the years ended December 31, 1996 and 1997 was $68,000, $185,000,
$702,000 and $1,746,000, respectively.
F-13
71
NOTE 6 - ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses consist of the following amounts as of
December 31:
1996 1997
---------- ----------
Accounts payable $1,054,000 $1,896,000
Accrued expenses 1,412,000 2,384,000
Accrued payroll 115,000 2,146,000
---------- ----------
Total accounts payable and accrued expenses $2,581,000 $6,426,000
========== ==========
NOTE 7 - LEASES
Future minimum lease payments, including fixed escalation increases, for office
space and equipment under capital and operating leases with initial or remaining
noncancelable lease terms in excess of one year as of December 31, 1997 are:
Capital Operating
Year Ending December 31: Leases Leases
- ------------------------------------------------------------------------------------------------
1998 $ 957,000 $ 3,437,000
1999 885,000 3,438,000
2000 252,000 2,806,000
2001 - 1,818,000
2002 - 1,427,000
----------- -----------
Total minimum lease payments 2,094,000 $12,926,000
===========
Less: Amounts representing interest (171,000)
-----------
Present value of minimum lease payments 1,923,000
Less: Current portion (842,000)
-----------
Long-term portion of capital lease obligations $ 1,081,000
===========
In December 1992, the Company entered into a lease agreement for the Company's
headquarters in Herndon, Virginia. Subsequent to the acquisition, SAIC
re-negotiated the lease with the landlord whereby SAIC posted a $1,000,000
letter of credit and then subleased the facilities to the Company under a lease
expiring November 2002. During 1997, the Company leased a second facility in
Herndon whose lease term expires in July 2002.
Lease expense related to the continuing operations for the periods from January
1, 1995 to March 10, 1995 and March 11, 1995 to December 31, 1995, and for the
years ended December 31,1996 and 1997 was $36,000, $342,000, $924,000 and
$2,188,000, respectively. Lease expense incurred by the discontinued operations
for the periods from January 1, 1995 to March 10, 1995 and March 11, 1995 to
December 31, 1995 was $208,000 and $328,000, respectively. Subsequent to March
10, 1995, the Company generated rental income from subleases in 1995 of
$135,000, and $187,000 and $291,000 for the years ended December 31, 1996 and
1997, respectively.
F-14
72
NOTE 8 - INTEREST EXPENSE AND INCOME
Interest expense reflected in continuing operations and discontinued operations
for the period January 1, 1995 to March 10, 1995 was $9,000 and $51,000,
respectively. Interest charges prior to the acquisition have been reflected in
continuing and discontinued operations based on the debt balances associated
with each of the continuing and discontinued operations. In addition, interest
expense of $52,000 and $164,000 for the period from March 11, 1995 to December
31, 1995 was allocated by SAIC to the Company's continuing operations and
discontinued operations, respectively, based upon SAIC's cost of capital
calculation. For the year ended December 31, 1996, interest income of $496,000
was allocated by SAIC based upon the cost of capital calculation. From its
acquisition by SAIC in March 1995 until December 1996, the Company participated
in SAIC's centralized cash management system whereby cash received from
operations was transferred to SAIC's centralized cash accounts and cash
disbursements were funded from such centralized cash accounts. Accordingly, the
SAIC cost of capital formula provided for charges and credits to the Company
based upon management of certain assets, including accounts receivable and fixed
assets. Such amounts are not necessarily indicative of the cost that would have
been incurred if the Company had been operated as a separate entity.
Effective January 1, 1997, the Company was no longer subject to SAIC's cost of
capital calculation in connection with the Company fulfilling its own treasury
function. Interest paid for the periods from January 1, 1995 to March 10, 1995
and March 11, 1995 to December 31,1995 and for the years ended December 31, 1996
and 1997 was $0, $103,000, $0 and $116,000, respectively.
NOTE 9 - TRANSACTIONS WITH SAIC
Under the terms of the acquisition agreement, the Company was acquired by SAIC
on March 10, 1995 in a stock-for-stock transaction accounted for as a purchase.
The fair market value of the SAIC stock exchanged for the outstanding stock of
the Company was approximately $3.9 million. The acquisition agreement provided
for certain purchase adjustments and related additional stock issuance payments
of approximately $600,000. After reflecting certain purchase accounting
adjustments, the net assets included on the opening balance sheet were as
follows:
Current assets $ 929,000
Furniture and equipment 734,000
Goodwill 3,576,000
Other non-current assets 1,047,000
----------
6,286,000
Current liabilities 1,625,000
Net liabilities of discontinued operations 181,000
----------
Net assets acquired at March 11, 1995 $4,480,000
==========
The financial statements as of and for the period from March 11, 1995 to
December 31, 1995 and for the years ended December 31, 1996 and 1997 include
significant transactions with other SAIC business units involving functions and
services (such as cash management, tax administration, accounting, legal, data
processing and employee benefit plans) that were provided to the Company by
centralized SAIC organizations. The costs of these functions and services have
been directly charged and/or allocated to the Company using methods that SAIC
management believes are reasonable; primarily a percentage of budgeted
administrative and overhead costs. Such charges and allocations are not
necessarily indicative of the costs that would have been incurred if the Company
had been a separate entity. Through August 9, 1996, the amounts allocated by
SAIC to the Company included both administrative and overhead costs which are
included in selling, general and
F-15
73
administrative expenses and cost of revenue, respectively. Effective August 10,
1996, SAIC stopped allocating costs based generally upon pro rata labor and
began assessing the Company for corporate services provided by SAIC at a fee
equal to 2.5% of annual net revenue. The agreement may be terminated by either
party upon 180 days prior written notice.
Amounts charged and allocated to the Company for these functions and services
for the period from March 11, 1995 to December 31, 1995 and the years ended
December 31, 1996 and 1997 were $516,000, $1,196,000 and $1,126,000,
respectively, and are principally included in selling, general and
administrative expenses. Additionally, certain interest charges/credits were
allocated by SAIC to the Company (Note 8).
Sales as a subcontractor to SAIC for the period from March 11, 1995 to December
31, 1995 and the years ended December 31, 1996 and 1997 were $509,000,
$1,505,000 and $2,445,000, respectively. In addition, because the Company was
included in SAIC's consolidated tax returns for periods from acquisition until
the IPO, the Company was obligated to make payment for its tax liability to SAIC
in accordance with the tax sharing arrangement (Note 10). The due to parent
balance represents the cumulative net activity of all transactions between the
Company and SAIC. The Company reflects this activity in the statement of cash
flows on a net basis because of the quick turnover, the large amounts and the
short maturities of these related party cash transactions.
NOTE 10 - PROVISION FOR INCOME TAXES
The results of the Company since its acquisition by SAIC until its IPO are to
be included in SAIC's consolidated tax returns. The tax expense allocation is
set forth in Note 3. Subsequent to the IPO, the Company is no longer part of
SAIC's consolidated tax group for federal income tax purposes and will prepare
its income tax returns as a separate entity.
The provision for (benefit) from income taxes charged to continuing operations
consists of the following:
For the Period
1995
------------------------------ Year Ended Year Ended
January 1 to March 11 to December 31, December 31,
March 10 December 31 1996 1997
------------ ------------ ------------ ------------
Current:
Federal $ 40,000 $ 1,521,000 $ 10,171,000 $ 13,931,000
State 8,000 311,000 2,020,000 2,766,000
------------ ------------ ------------ ------------
Total current provision 48,000 1,832,000 12,191,000 16,697,000
------------ ------------ ------------ ------------
Deferred:
Federal - (1,759,000) (10,716,000) (11,035,000)
State - (360,000) (2,118,000) (2,191,000)
------------ ------------ ------------ ------------
Total deferred (benefit) - (2,119,000) (12,834,000) (13,226,000)
------------ ------------ ------------ ------------
Provision for (benefit) from income
taxes $ 48,000 $ (287,000) $ (643,000) $ 3,471,000
============ ============ ============ ============
F-16
74
Deferred tax assets are comprised of the following temporary differences as of
December 31:
1996 1997
----------- -----------
Deferred Revenue $13,846,000 $26,295,000
Provision for uncollectible
accounts receivable 1,091,000 1,841,000
Other 118,000 145,000
----------- -----------
Total deferred tax asset $15,055,000 $28,281,000
=========== ===========
Tax valuation allowances were provided through March 10, 1995 against the net
deferred tax assets of both continuing operations and discontinued operations.
In connection with the acquisition purchase accounting, a determination was made
that tax valuation allowances were no longer required.
Although the Company had a past history of net losses, it has not established a
current valuation allowance for its deferred tax assets since, in the opinion of
management, it is more likely than not that all of the deferred tax assets will
be realized. The deferred tax assets relate primarily to registration fees which
are taxable upon initial registration but are recognized in the financial
statements over the next 12 to 24 months, the registration term.
A reconciliation of the provision for income taxes to the amount computed by
applying the statutory federal income tax rate to income before income taxes is
provided below. The statutory federal income tax rate used was 34% for the
periods during 1995 and 35% for the years ended December 31, 1996 and 1997.
For the period
1995
---------------------------- Year ended Year ended
January 1 to March 11 to December 31, December 31,
March 10 December 31 1996 1997
----------- ----------- ------------ ------------
Federal tax at statutory rate $ 1,000 $ (570,000) $ (794,000) $2,696,000
State income taxes, net of Federal
tax benefit - (68,000) (96,000) 374,000
Nondeductible goodwill amortization - 348,000 281,000 240,000
Other 1,000 3,000 (34,000) 161,000
Valuation allowance 46,000 - - -
---------- ---------- ---------- ----------
Provision for (benefit) from income taxes $ 48,000 $ (287,000) $ (643,000) $3,471,000
========== ========== ========== ==========
The Company paid income taxes of $119,000 for the period from January 1, to
March 10, 1995.
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75
NOTE 11 - COMPUTATION OF EARNINGS (LOSS) PER SHARE
The following is a reconciliation of the numerator and denominator used in the
basic and diluted EPS computations for continuing operations:
Income (Loss) Shares Per Share
(Numerator) (Denominator) Amount
------------- ------------- ----------
January 1, 1995 to March 10, 1995
- ---------------------------------
Loss Per Share:
- ---------------
Basic $ (44,000) 1,046,000 $ (0.04)
=========
Dilutive securities:
Outstanding options - -
----------- -----------
Diluted $ (44,000) 1,046,000 $ (0.04)
=========== =========== =========
March 11, 1995 to December 31, 1995
- -----------------------------------
Loss Per Share:
- ---------------
Basic $(1,390,000) 12,500,000 $ (0.11)
=========
Dilutive securities:
Outstanding options - -
----------- -----------
Diluted $(1,390,000) 12,500,000 $ (0.11)
=========== =========== =========
1996 Loss Per Share:
- --------------------
Basic $(1,625,000) 12,500,000 $ (0.13)
=========
Dilutive securities:
Outstanding options - -
----------- -----------
Diluted $(1,625,000) 12,500,000 $ (0.13)
=========== =========== =========
1997 Earnings Per Share:
- ------------------------
Basic $ 4,231,000 13,305,000 $ 0.32
=========
Dilutive securities:
Outstanding options - 178,000
----------- -----------
Diluted $ 4,231,000 13,483,000 $ .031
=========== =========== =========
Common shares issued are weighted for the period the shares were outstanding and
incremental shares assumed issued under the treasury stock method for dilutive
EPS are weighted for the period the underlying options were outstanding. Options
outstanding in 1995 and 1996 are not reflected in the computation of diluted EPS
because the effects are antidilutive and would increase diluted EPS.
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76
NOTE 12 - EMPLOYEE BENEFIT PLANS
1996 Stock Incentive Plan
The 1996 Stock Incentive Plan (the "Incentive Plan") of the Company was adopted
by the Board of Directors on September 18, 1996. The Incentive Plan provides for
awards in the form of restricted shares, stock units, stock appreciation rights,
and stock options (including incentive stock options ("ISOs") and nonstatutory
stock options ("NSOs")). A total of 2,306,250 shares of Class A Common Stock
have been initially reserved for issuance under the Incentive Plan. The number
of shares are increased by 2% of the total number of common shares of the
Company outstanding at the end of the most recent calendar year, subject to a
cumulative limit of 1,000,000 shares. Through December 31, 1997, an additional
564,400 shares were eligible for issuance and have subsequently been reserved
for a combined total of 2,870,650 eligible shares under the Incentive Plan.
Following is a summary of activity pursuant to the Company's Incentive Plan:
Weighted Average
Shares Exercise Price
---------- ----------------
Balance at December 31, 1995 - -
Granted 1,225,725 $12.97
Exercised - -
Cancelled - -
----------
Balance at December 31, 1996 1,225,725 $12.97
Granted 600,500 $14.21
Exercised - -
Cancelled (36,500) $14.00
----------
Balance at December 31, 1997 1,789,725 $13.36
==========
Granted stock options generally become exercisable one year after the date of
the grant, vest 30%, 30%, 20% and 20% on each anniversary date of the grant and
have a term of five years. The number of options exercisable at December 31,
1997 are 360,821 with an exercise price range of $11.25 to $14.00 and a weighted
average exercise price of $12.95. The weighted average contractual life of all
options outstanding at December 31, 1997 is 4.10 years. All options granted to
date have been NSOs except for 100,900 ISOs granted in 1996. No restricted
shares, stock units or SARs have been granted to date.
Employee Stock Purchase Plan
Effective January 7, 1998, the Company adopted an Employee Stock Purchase Plan
to provide substantially all full time employees an opportunity to purchase
shares of its Class A common stock through payroll deductions of up to 10% of
eligible compensation. Semiannually, on June 30 and December 31, participant
account balances are used to purchase stock at the lesser of 85 percent of the
fair market value on the trading day before the participation period starts or
the trading day preceding the day on which the participation period ends. A
total of 250,000 shares are available for purchase under the plan.
SAIC Benefit Plans
Employees of the Company participate in various SAIC benefit plans, including
stock, bonus and retirement plans, subject to the applicable eligibility
requirements. SAIC charges the Company directly for the costs of such employee
benefit plans. Charges related to the administration of the SAIC benefit plans
in which employees of the Company participate are included within SAIC general
corporate allocations (Notes 1 and 9).
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77
SAIC has one principal Cash or Deferred Arrangement ("CODA") which allows
eligible participants to defer a portion of their income through payroll
contributions. Such deferrals are fully vested, are not taxable to the
participant until distributed from the CODA upon termination, retirement,
permanent disability or death and may be matched by SAIC. SAIC also has an SAIC
Employee Stock Purchase Plan which allows eligible employees to purchase shares
of SAIC's Class A common stock, with SAIC currently contributing 10% of the
existing fair market value.
SAIC has a Bonus Compensation Plan which provides for bonuses to reward
outstanding performance. Bonuses are paid in the form of cash, fully vested
shares of SAIC Class A common stock or vesting shares of SAIC Class A common
stock. The Company participated in this plan during the period from acquisition
until December 31, 1996.
During the period from March 11, 1995 to December 31, 1995 and during the years
ended December 31, 1996 and 1997, a total of 24,450, 53,040 and 11,450 SAIC
options were granted to the Company's employees, respectively, with exercise
prices ranging from $15.72 to $17.79, $19.33 to $22.83 and $25.96 to $34.78 per
share, respectively, with a weighted average price of $16.17, $20.51 and $28.13,
respectively. These options were granted under the SAIC 1995 Stock Option Plan
to purchase SAIC Class A common stock and vest 20%, 20%, 20% and 40% on each
anniversary date of grant and have a term of five years.
Pro Forma Disclosures
The weighted average fair value of the options granted during the period from
March 11, 1995 to December 31,1995 and during the years ended December 31, 1996
and 1997 under the SAIC Bonus Compensation Plan were estimated at $3.66, $4.30
and $7.56, respectively, and $2.76 and $4.68, respectively, for the options
granted during the years ended December 31, 1996 and 1997 under the Company's
Incentive Plan using the Black-Scholes model. The following weighted average
assumptions were used in calculating the option fair values:
SAIC Stock Options Company Stock Options
----------------------------------------------------- ----------------------------------
March 11,
1995 to Year ended Year ended Year ended Year ended
December 31, December 31, December 31, December 31, December 31,
1995 1996 1997 1996 1997
--------------- --------------- --------------- --------------- ---------------
Expected life (years) 4.0 4.0 5.0 4.0 4.0
Risk-free interest rate 6.45% 5.91% 6.30% 5.98% 6.25%
Volatility 0.00% 0.00% 0.00% 0.00% 20.79%
Dividend yield 0.00% 0.00% 0.00% 0.00% 0.00%
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78
Under the above models, the total value of SAIC stock options granted during
1995, 1996 and 1997 was approximately $89,000, $228,000 and $87,000,
respectively, and $3,379,000 and $2,809,000, respectively, for the Company's
stock options granted in 1996 and 1997, all of which would be amortized ratably
on a pro forma basis over their respective option terms. Had the Company
recorded compensation costs for these plans in accordance with SFAS No. 123, the
Company's pro forma income (loss) would have been ($1,430,000) for the period
March 11,1995 to December 31,1995 and ($1,763,000) and $3,510,000, respectively
for the years ended December 31,1996 and 1997. Pro forma basic earnings (loss)
per share would have been ($0.14) and $0.26, respectively, for the years ended
December 31,1996 and 1997.
NOTE 13 - DISCONTINUED OPERATIONS
As discussed in Note 1, in November 1995 SAIC adopted a plan to transfer the
Company's government-based business to SAIC in order for the Company to focus on
the growth of the commercial business. Such transfer was substantially completed
as of February 1996. Prior to SAIC's acquisition of the Company, the portion of
the Company's business relating to the minority-based government business had
been transferred into a separately-owned entity. The activities of both the
minority-based government business and the government-based business are
reflected as discontinued operations in the financial statements of the Company
for all periods presented. Net income (loss) from discontinued operations
exclude general corporate overhead of the Company. No gain or loss was incurred
as a consequence of the transfer of these businesses.
Summary operating results of the discontinued operations were as follows:
For the Period
1995
----------------------------
January 1 to March 11 to
March 10 December 31
------------ -----------
Revenues $ 4,270,000 $ 7,882,000
Costs and expenses (5,478,000) (7,773,000)
----------- -----------
(Loss) income from discontinued
operations before income taxes (1,208,000) 109,000
Provision for income taxes 167,000 137,000
=========== ===========
Loss from discontinued operations,
net of income taxes $(1,375,000) $ (28,000)
=========== ===========
NOTE 14 - COMMITMENTS AND CONTINGENCIES
As of December 31, 1997, the Company was a defendant in 5 lawsuits involving
domain name disputes between trademark owners and domain name holders. The
Company is drawn into such disputes, in part, as a result of claims by trademark
owners that the Company is legally required, upon request by a trademark owner,
to terminate the right the Company granted to an alleged trademark infringer to
register the domain name in question. Further, trademark owners have also
alleged that the Company should be required to monitor future domain name
registrations and reject registrations of domain names which are identical or
similar to their federally registered trademark. The holders of the domain name
registrations in dispute have, in turn, questioned the Company's right, absent a
court order, to take any action which suspends their registration or use of the
domain names in question. Although 41 of
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these objections have resulted in litigation involving the Company, as of
December 31, 1997, no damages have been awarded against the Company to any
plaintiff in the 36 cases that have been resolved. The Company believes that it
has meritorious defenses and intends to vigorously defend itself against these
claims.
On October 17, 1997, a group of six plaintiffs filed a lawsuit (the "Thomas
suit") against the Company and the NSF in the United States District Court,
District of Columbia, challenging the legality of fees defendants charge for the
registration and renewal of domain names on the Internet and seeking restitution
of fees collected from domain name registrants in an amount in excess of $100
million, damages, and injunctive and other relief. Plaintiffs originally alleged
violations of the Competition in Contracting Act ("CICA"), the Sherman Act and
the U.S. Constitution. Following the filing of motions to dismiss by the
defendants, the plaintiffs filed an amended complaint on January 30, 1998,
dropping the cause of action based upon CICA, but adding alleged violations of
the Administrative Procedures Act and the Independent Offices Appropriations
Act. The plaintiffs also filed a motion for preliminary injunctive relief
against the NSF concerning the "Intellectual Infrastructure Fund." On February
2, 1998, the United States District Court, District of Columbia, issued an order
granting the plaintiffs' motion for a preliminary injunction, enjoining the NSF
from spending any of the money collected by the Company for the Intellectual
Infrastructure Fund. The Company believes that it has meritorious defenses and
intends to vigorously defend itself against the claims in the Thomas suit. While
the Company cannot reasonably estimate the potential impact of such claims, a
successful claim under the plaintiffs' theories could have a material adverse
effect on the Company's business, financial condition and results of operations.
See Note 15.
On June 27, 1997, SAIC received a Civil Investigative Demand ("CID") from the
U.S. Department of Justice ("DOJ") issued in connection with an investigation to
determine whether there is, has been, or may be an antitrust violation under the
Sherman Act relating to Internet registration products and services. The CID
seeks documents and information from SAIC and the Company relating to their
Internet registration business. The Company cannot reasonably estimate the
potential impact of the investigation nor can it predict whether a civil action
will ultimately be filed by the DOJ. The Company is unable to predict the form
of relief that might be sought in such an action or that might be awarded by a
court or imposed as a result of any settlement. Any such relief could have a
material adverse effect on the Company's business, financial condition and
results of operations.
On March 20, 1997, PG Media, Inc., a New York-based corporation ("PG Media"),
filed a lawsuit against the Company in the United States District Court,
Southern District of New York alleging that the Company had restricted access to
the Internet by not adding PG Media's requested TLDs in violation of the Sherman
Act. In its complaint, PG Media has, in addition to requesting damages, asked
that the Company be ordered to include reference to PG Media's TLDs and name
servers in the root zone file administered by the Company under the Cooperative
Agreement. The Company has answered the complaint. In addition, in June 1997,
the Company received written direction from the NSF not to take any action to
create additional TLDs or to add any new TLDs to the Internet root zone until
the NSF provides further guidance. On September 17, 1997, PG Media filed a
Second Amended Complaint adding the NSF as a defendant. No motions are pending
as of December 31, 1997. The Company believes that it has meritorious defenses
and intends to vigorously defend itself against the claims of PG Media. Although
the Company cannot reasonably estimate the potential impact of such claims, a
successful claim under the plaintiff's theory could have a material adverse
effect on the Company's business, financial condition and results of operations.
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The Company is involved in various other investigations, claims and lawsuits
arising in the normal conduct of its business, none of which, in the opinion of
the Company's management, will have a material adverse effect on its financial
position, results of operations, cash flows or its ability to conduct business.
NOTE 15 - SUBSEQUENT EVENTS (UNAUDITED)
Proposed Rule
On January 30, 1998, the National Telecommunications and Information
Administration of the Department of Commerce issued a discussion draft,
entitled "A Proposal to Improve Technical Management of Internet Names and
Addresses" which was published in the U.S. Federal Register on February 20,
1998 (the "Proposed Rule"). The Proposed Rule provides notice and seeks public
comment on a proposal to, among other things, increase competition in the
administration of TLDs and the registration of domain names. The Company
supports the transition of domain name services toward a self-regulatory
commercial environment. It is impossible to predict at this time whether or
when a final rule will be issued and, if issued, the exact nature of its
provisions or the precise effect of such provisions on the Company.
Litigation
On February 10, 1998, the plaintiffs in the Thomas suit filed a motion for
preliminary injunction against the Company seeking several items of relief. On
February 24, 1998, the Company and the NSF filed motions to dismiss the amended
complaint. Also on February 24, the plaintiffs filed a motion for partial
summary judgment concerning the set aside 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 and the Court has taken the matters under advisement.
NSF Cooperative Agreement
Pursuant to an amendment to the Cooperative Agreement, on March 12, 1998, the
NSF directed the Company to begin charging end users $70 upon each initial
registration for domain names registered April 1, 1998 or later and $35 for each
renewal with an anniversary date of April 1, 1998 or later. In conjunction with
this amendment to the Cooperative Agreement, the Company will no longer set
aside 30% of the collected registration fees for the enhancement of the
intellectual infrastructure of the Internet. This amendment does not alter the
Company's existing revenue per net registration since the 30% set aside funds
were previously not recognized as revenue.
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SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
================================================================================================================
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
ADDITIONS
-------------------------
CHARGED TO
BALANCE AT CHARGED TO OTHER
BEGINNING COSTS AND ACCOUNTS-- DEDUCTIONS-- BALANCE AT
DESCRIPTION OF YEAR EXPENSES DESCRIBE DESCRIBE END OF YEAR
- ----------------------------------------------------------------------------------------------------------------
For the period from January 1, 1995 to
March 10, 1995
Allowance for uncollectible
accounts, included in net assets
(liabilities) of discontinued
operations...................... 809,000 344,000 -- -- 1,153,000
Deferred tax valuation allowance,
continuing operations........... 56,000 46,000 -- -- 102,000(1)
Deferred tax valuation allowance,
discontinued operations......... 512,000 276,000 -- -- 788,000(1)
- ----------------------------------------------------------------------------------------------------------------
For the period from March 11, 1995 to
December 31, 1995
Allowance for uncollectible
accounts, continuing
operations...................... $ -- $ 124,000 $ 1,994,000(2) $ -- $ 2,118,000
Allowance for uncollectible
accounts, included in net assets
(liabilities) of discontinued
operations...................... 1,153,000 465,000 -- -- 1,618,000
Year ended December 31, 1996
Allowance for uncollectible
accounts, continuing
operations...................... 2,118,000 3,597,000 19,270,000(2) 9,546,000(3) 15,439,000
Allowance for uncollectible
accounts, included in net assets
(liabilities) of discontinued
operations...................... 1,618,000 -- -- 1,618,000(4) --
Year ended December 31, 1997
Allowance for uncollectible
accounts, continuing
operations...................... 15,439,000 8,082,000 35,368,000(2) 41,033,000(3) 17,856,000
- ---------------
(1) In connection with the acquisition purchase accounting, a determination
was made that the tax valuation allowances were no longer required. (See
Note 10 of Notes to Financial Statements.)
(2) Charged to allowance for deferred revenue (See Notes 3 and 4 of Notes to
Financial Statements).
(3) Amounts are write-offs of uncollectible accounts receivable.
(4) Disposition associated with discontinued operations (See Note 13 of Notes to
Financial Statements).
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INDEX TO EXHIBITS
Exhibit
Number Description
- ------ -----------
3(ii) Bylaws of Network Solutions, Inc., as amended February 9, 1998.
10.16 Amendment No. 7 to the Cooperative Agreement dated December 3, 1997.
10.17 Amendment No. 8 to the Cooperative Agreement dated February 20, 1998.
10.18 Amendment No. 9 to the Cooperative Agreement dated March 12, 1998.
10.19 Form of Indemnification Agreement entered into by the Company and each of its
directors and officers at the Vice President level or above.
10.20 Deed of Lease By and Between Sugarland Business Park Limited Partnership and
Network Solutions, Inc. dated May 30, 1997 ("Lease Agreement").
10.21 Amendment No. 1 to Lease Agreement dated January 31, 1998.
23.1 Consent of Price Waterhouse LLP.
27.1 Financial Data Schedule (in electronic format only).
27.2 Restated Financial Data Schedule (in electronic format only).