Document/Exhibit Description Pages Size
1: 10-Q Network Solutions Form 10-Q 32 177K
2: EX-3 Certificate of Amendment 2 10K
3: EX-10.27 Amendment #14 to the Cooperative Agrmt. of July 13 2 14K
4: EX-10.28 Amendment #15 to the Cooperative Agrmt. of July 16 2 14K
5: EX-10.29 Offer Letter Between James Rutt and Network 5 25K
6: EX-10.30 Separation Agrmt. Between James Rutt & Network 7 29K
7: EX-10.31 Non-Statutory Stock Option Agreement Dated June 7 7 39K
8: EX-10.32 Non-Statutory Stock Option Agreement Dated May 21 7 39K
9: EX-27.1 FDS for Period Ending June 30, 1999 1 7K
10: EX-27.2 FDS for Period Ending June 30, 1998 1 9K
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________ TO ________
COMMISSION FILE NUMBER: 0-22967
NETWORK SOLUTIONS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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DELAWARE 52-1146119
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR IDENTIFICATION NO.)
ORGANIZATION)
505 HUNTMAR PARK DRIVE
HERNDON, VIRGINIA 20170
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(703)742-0400
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
As of August 3, 1999, the Registrant had 33,342,342 shares of common stock,
$0.001 par value per share, issued and outstanding.
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PAGE
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PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Unaudited Condensed Statements of Financial Position as of
December 31, 1998 and June 30, 1999....................... 3
Unaudited Condensed Statements of Operations for the three
and six months ended June 30, 1998 and 1999............... 4
Unaudited Condensed Statements of Changes in Stockholders'
Equity for the six months ended June 30, 1999............. 5
Unaudited Condensed Statements of Cash Flows for the six
months ended June 30, 1998 and 1999....................... 6
Notes to Condensed Financial Statements..................... 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 10
Item 3. Quantitative and Qualitative Disclosures About Market
Risk...................................................... 26
PART II OTHER INFORMATION
Item 1. Legal Proceedings........................................... 28
Item 2. Changes in Securities and Use of Proceeds................... 29
Item 4. Submission of Matters to a Vote of Security Holders......... 29
Item 6. Exhibits and Reports on Form 8-K............................ 30
Signature............................................................ 31
Index to Exhibits.................................................... 32
2
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
NETWORK SOLUTIONS, INC.
CONDENSED STATEMENTS OF FINANCIAL POSITION
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DECEMBER 31, JUNE 30,
1998 1999
------------ -------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents................................. $ 12,862,000 $ 46,099,000
Short-term investments.................................... 118,808,000 114,215,000
Accounts receivable, net.................................. 22,628,000 47,084,000
Prepaids and other assets................................. 4,001,000 6,453,000
Deferred tax asset........................................ 40,508,000 67,212,000
------------ ------------
Total current assets........................................ 198,807,000 281,063,000
Furniture and equipment, net................................ 16,005,000 51,112,000
Long-term investments....................................... 13,590,000 42,060,000
Deferred tax asset.......................................... 14,831,000 20,291,000
Goodwill, net............................................... 634,000 362,000
------------ ------------
Total Assets................................................ $243,867,000 $394,888,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities.................. $ 28,287,000 $ 43,323,000
Due to SAIC............................................... 4,766,000 7,607,000
Income taxes payable...................................... 5,409,000 6,699,000
Current portion of capital lease obligations.............. 834,000 643,000
Deferred revenue, net..................................... 93,720,000 156,906,000
------------ ------------
Total current liabilities................................... 133,016,000 215,178,000
Capital lease obligations................................... 247,000 --
Long-term deferred revenue, net............................. 35,474,000 65,682,000
------------ ------------
Total liabilities........................................... 168,737,000 280,860,000
Commitments and contingencies............................... -- --
Stockholders' equity:
Preferred stock, $.001 par value, authorized 10,000,000
shares; none issued and outstanding in 1998 and 1999... -- --
Common stock, $.001 par value; authorized 210,000,000
shares; 33,319,000 issued and outstanding in 1999...... -- 33,000
Class A common stock, $.001 par value; authorized
100,000,000 shares in 1998; 9,140,000 issued and
outstanding in 1998.................................... 9,000 --
Class B common stock, $.001 par value; authorized
30,000,000 shares in 1998; 23,850,000 issued and
outstanding in 1998.................................... 24,000 --
Additional paid-in capital................................ 72,331,000 84,645,000
Retained earnings......................................... 2,407,000 13,000,000
Accumulated other comprehensive income.................... 359,000 16,350,000
------------ ------------
Total stockholders' equity.................................. 75,130,000 114,028,000
------------ ------------
Total Liabilities and Stockholders' Equity.................. $243,867,000 $394,888,000
============ ============
The accompanying notes are an integral part of these financial statements.
3
NETWORK SOLUTIONS, INC.
CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
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THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------- -------------------------
1998 1999 1998 1999
----------- ----------- ----------- -----------
Net revenue............................... $20,476,000 $47,499,000 $36,968,000 $85,631,000
Cost of revenue........................... 8,791,000 17,711,000 16,139,000 32,252,000
----------- ----------- ----------- -----------
Gross profit.............................. 11,685,000 29,788,000 20,829,000 53,379,000
Research and development expenses......... 815,000 2,460,000 1,540,000 4,495,000
Selling, general and administrative
expenses................................ 8,008,000 19,395,000 14,190,000 34,660,000
Interest income........................... (1,416,000) (1,927,000) (2,743,000) (3,857,000)
Other expenses............................ 32,000 15,000 67,000 34,000
----------- ----------- ----------- -----------
Income before income taxes................ 4,246,000 9,845,000 7,775,000 18,047,000
Provision for income taxes................ 1,783,000 4,050,000 3,263,000 7,454,000
----------- ----------- ----------- -----------
Net income................................ $ 2,463,000 $ 5,795,000 $ 4,512,000 $10,593,000
=========== =========== =========== ===========
Earnings per common share:
Basic................................... $ 0.08 $ 0.17 $ 0.14 $ 0.32
=========== =========== =========== ===========
Diluted................................. $ 0.07 $ 0.17 $ 0.14 $ 0.30
=========== =========== =========== ===========
The accompanying notes are an integral part of these financial statements.
4
NETWORK SOLUTIONS, INC.
CONDENSED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(UNAUDITED)
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ACCUMULATED
ADDITIONAL OTHER
COMMON CLASS A CLASS B PAID-IN COMPREHENSIVE RETAINED COMPREHENSIVE
STOCK COMMON STOCK COMMON STOCK CAPITAL INCOME EARNINGS INCOME
------- ------------ ------------ ----------- ------------- ----------- -------------
Balance, December 31,
1998................. $ -- $ 9,000 $ 24,000 $72,331,000 $ 359,000 $ 2,407,000 $ --
Issuance of common
stock pursuant to
stock plans.......... -- -- -- 2,988,000 -- -- --
Tax benefit associated
with stock plans..... -- -- -- 9,326,000 -- -- --
Conversion of Class B
common stock......... -- 24,000 (24,000) -- -- -- --
Reclassification of
Class A
common stock......... 33,000 (33,000) -- -- -- -- --
Comprehensive income:
Net income for the
period ended June 30,
1999................. -- -- -- -- -- 10,593,000 10,593,000
Other comprehensive
income, net of tax:
Unrealized gains on
securities........... -- -- -- -- 15,991,000 -- 15,991,000
-----------
Comprehensive
income............... -- -- -- -- -- -- $26,584,000
------- -------- -------- ----------- ----------- ----------- ===========
Balance, June 30,
1999................. $33,000 $ -- $ -- $84,645,000 $16,350,000 $13,000,000
======= ======== ======== =========== =========== ===========
TOTAL
STOCKHOLDERS'
EQUITY
-------------
Balance, December 31,
1998................. $ 75,130,000
Issuance of common
stock pursuant to
stock plans.......... 2,988,000
Tax benefit associated
with stock plans..... 9,326,000
Conversion of Class B
common stock......... --
Reclassification of
Class A
common stock......... --
Comprehensive income:
Net income for the
period ended June 30,
1999................. 10,593,000
Other comprehensive
income, net of tax:
Unrealized gains on
securities........... 15,991,000
Comprehensive
income............... --
------------
Balance, June 30,
1999................. $114,028,000
============
The accompanying notes are an integral part of these financial statements.
5
NETWORK SOLUTIONS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
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SIX MONTHS ENDED
JUNE 30,
---------------------------
1998 1999
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................ $ 4,512,000 $ 10,593,000
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization.......................... 1,459,000 3,439,000
Provision for uncollectible accounts receivable........ 2,168,000 --
Deferred income taxes.................................. (7,499,000) (43,743,000)
Tax benefit associated with stock plans................ 2,118,000 9,326,000
Change in operating assets and liabilities:
Increase in accounts receivable...................... (7,602,000) (24,456,000)
Increase in prepaids and other assets................ (1,045,000) (2,452,000)
Increase in accounts payable and accrued
liabilities....................................... 4,908,000 15,036,000
Increase (decrease) in income taxes payable.......... (4,513,000) 1,290,000
Increase in deferred revenue......................... 27,500,000 93,394,000
------------ ------------
Net cash provided by operating activities............ 22,006,000 62,427,000
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of furniture and equipment....................... (4,364,000) (38,274,000)
Sale (purchase) of short-term investments, net............ (39,316,000) 5,693,000
Purchase of long-term investments......................... (6,007,000) (2,000,000)
------------ ------------
Net cash used in investing activities................ (49,687,000) (34,581,000)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net transactions with SAIC................................ 1,108,000 2,841,000
Repayment of capital lease obligations.................... (412,000) (438,000)
Issuance of common stock pursuant to stock plans.......... 3,767,000 2,988,000
------------ ------------
Net cash provided by financing activities............ 4,463,000 5,391,000
------------ ------------
Net increase (decrease) in cash and cash equivalents........ (23,218,000) 33,237,000
Cash and cash equivalents, beginning of period.............. 41,146,000 12,862,000
------------ ------------
Cash and cash equivalents, end of period.................... $ 17,928,000 $ 46,099,000
============ ============
The accompanying notes are an integral part of these financial statements.
6
NETWORK SOLUTIONS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
NOTE 1 -- ORGANIZATION AND BUSINESS
Network Solutions, Inc. ("Network Solutions") currently acts as the
exclusive registry and as a registrar of Internet domain names within the .com,
.org, .net and .edu top level domains pursuant to the Cooperative Agreement with
the Department of Commerce. Domain names are used to identify a unique site or
presence on the Internet. As registry and a registrar for these top level
domains, Network Solutions registers new domain names and is responsible for the
maintenance of the master file of domain names through daily updates to the
Internet. Network Solutions also provides Internet Technology Services, focusing
on architecture, implementation and support services to help large enterprises
and Internet service providers improve their operational effectiveness.
NOTE 2 -- SIGNIFICANT ACCOUNTING POLICIES
INTERIM FINANCIAL STATEMENTS
The interim financial statements have been prepared by Network Solutions
without audit, pursuant to the rules and regulations of the Securities and
Exchange Commission ("SEC"). In the opinion of management, financial statements
included in this report reflect all normal recurring adjustments which Network
Solutions considers necessary for fair presentation of the results of operations
for the interim periods covered and of the financial position of Network
Solutions at the date of the interim balance sheet. Certain information and
footnote disclosures normally included in the annual financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted pursuant to such rules and regulations. However, Network
Solutions believes that the disclosures are adequate for understanding the
information presented. The operating results for interim periods are not
necessarily indicative of the operating results for the entire year. These
interim financial statements should be read in conjunction with Network
Solutions' December 31, 1998 audited financial statements and notes thereto
included in Network Solutions' Form 10-K annual report for the year ended
December 31, 1998. Prior periods have been restated for comparative purposes.
NOTE 3 -- COMMON STOCK
STOCK SPLIT
On December 31, 1998, Network Solutions' board of directors approved a
two-for-one stock split of the shares of Class A common stock and Class B common
stock, to be effected in the form of a 100% stock dividend on shares of Class A
common stock and Class B common stock outstanding on February 26, 1999. The
stock dividend was distributed on March 23, 1999. Share and per share
information for all periods presented in the accompanying financial statements
have been adjusted to reflect the two-for-one stock split.
SECONDARY STOCK OFFERING AND STOCK RECLASSIFICATION
On February 12, 1999, Network Solutions completed a secondary stock
offering in which a total of 9,160,000 shares of Class A common stock were sold.
Concurrent with the offering, Science Applications International Corporation,
commonly known as "SAIC", converted 9,000,000 shares of Class B common stock
into 9,000,000 shares of Class A common stock sold in the offering. The
remaining 160,000 shares of Class A common stock were sold by other selling
stockholders after they exercised the applicable stock options simultaneously
with the closing of the offering. Network Solutions was not a selling
stockholder, and, therefore, did not receive any proceeds from the stock
offering other than proceeds from options exercised as part of the offering.
After the offering, SAIC owned approximately 89% of the combined voting power
and approximately 45% of the economic interest of the outstanding common stock.
On June 3, 1999, SAIC, the sole Class B common stock shareholder, converted
the remaining Class B common stock into an identical number of shares of Class A
common stock. As a result, SAIC's voting power
7
changed from 89% to 45%, consistent with the number of Class A shares owned
after the conversion. On June 17, 1999, Network Solutions filed a Certificate of
Amendment of Second Amended and Restated Certificate of Incorporation whereby
its Class A common stock, par value $0.001 per share, and Class B common stock,
par value $0.001 per share, were reclassified as a single class of common stock,
par value $0.001 per share, the "Common Stock". At the time of the
reclassification of the Class A common stock and Class B common stock to Common
Stock, there were 33,312,594 shares of Class A common stock and no shares of
Class B common stock outstanding.
The Certificate of Amendment also increased the total number of authorized
shares of Network Solutions, Inc. to 220,000,000 of which 210,000,000 shares are
authorized shares of Common Stock and 10,000,000 shares are authorized shares of
preferred stock, par value $0.001 per share. There are no shares of preferred
stock outstanding.
NOTE 4 -- COMPUTATION OF EARNINGS PER SHARE
The following is a reconciliation of the numerator and denominator used in
the basic and diluted earnings per share computations:
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INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
THREE MONTHS ENDED JUNE 30, 1999
Basic.................................. $5,795,000 33,281,000 $0.17
=====
Dilutive securities:
Outstanding options.................. -- 1,440,000
---------- ----------
Diluted................................ $5,795,000 34,721,000 $0.17
========== ========== =====
THREE MONTHS ENDED JUNE 30, 1998
Basic.................................. $2,463,000 31,791,000 $0.08
=====
Dilutive securities:
Outstanding options.................. -- 1,696,000
---------- ----------
Diluted................................ $2,463,000 33,487,000 $0.07
========== ========== =====
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INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
SIX MONTHS ENDED JUNE 30, 1999
Basic................................. $10,593,000 33,202,000 $0.32
=====
Dilutive securities:
Outstanding options................. -- 1,558,000
----------- ----------
Diluted............................... $10,593,000 34,760,000 $0.30
=========== ========== =====
SIX MONTHS ENDED JUNE 30, 1998
Basic................................. $ 4,512,000 31,623,000 $0.14
=====
Dilutive securities:
Outstanding options................. -- 1,262,000
----------- ----------
Diluted............................... $ 4,512,000 32,885,000 $0.14
=========== ========== =====
Common shares issued are weighted for the period the shares were
outstanding and incremental shares assumed issued under the treasury stock
method for diluted earnings per share are weighted for the period the underlying
options were outstanding.
8
NOTE 5 -- ACCUMULATED OTHER COMPREHENSIVE INCOME BALANCES
The changes in the components of accumulated other comprehensive income,
net of income taxes, for the three and six months ended June 30, 1999 and June
30, 1998 are as follows:
[Enlarge/Download Table]
UNREALIZED GAINS (LOSSES) UNREALIZED GAINS
ON SECURITIES ON SECURITIES
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------- -----------------------
1998 1999 1998 1999
-------- ------------- -------- -----------
Pre-tax amount............................. $22,000 $(10,979,000) $367,000 $27,568,000
Income taxes............................... 9,000 (4,612,000) 145,000 11,577,000
------- ------------ -------- -----------
Net of tax amount.......................... $13,000 $ (6,367,000) $222,000 $15,991,000
======= ============ ======== ===========
NOTE 6 -- SUBSEQUENT EVENTS
LITIGATION
On August 17, 1998, we received notice from the Commission of the European
Communities, or "EC," of an investigation concerning the Company's Premier
Program agreements in Europe. The EC requested production of these agreements
and related materials for review and we complied. On June 17, 1999, we received
a second inquiry from the EC concerning our registrar licensing agreements with
the five newly-accredited testbed registrars and we responded to this inquiry on
July 9, 1999. We cannot reasonably estimate the potential impact of the
investigation nor can we predict whether an action will ultimately be brought by
the EC or the form of relief that might be sought. Any such relief could harm
our business.
STATUS OF COOPERATIVE AGREEMENT
On January 1, 1993, Network Solutions initiated phase-in of a Cooperative
Agreement with the National Science Foundation. The three-month phase-in was
followed by a five-year operations period, commencing April 1, 1993 and ending
March 31, 1998, and a six-month flexibility period through September 1998.
Effective in September 1998, the responsibility for the Cooperative Agreement
was transferred to the Department of Commerce. In October 1998, the Cooperative
Agreement was amended to extend the flexibility period through September 30,
2000 and to transition to a shared registration system.
In accordance with the terms of the October 1998 and subsequent amendments
to the Cooperative Agreement, Network Solutions has developed a protocol and
associated software to support a shared registration system which will permit
multiple registrars to provide registration services within the top level
domains for which Network Solutions will act as registry. Network Solutions
deployed its proprietary shared registration system on schedule by establishing
a testbed to support actual registrations by five new registrars. We have
entered into license agreements with the five new registrars to provide access
to the shared registration system, permitting them to directly register and
maintain actual domain names.
During the current testbed period, we have agreed to charge the new
registrars an interim registry fee of $18 for each new two-year registration.
All of the five original new testbed registrars have completed their systems
development and testing, are certified and have begun to register actual names
within the shared registration system.
On August 6, 1999, Network Solutions agreed with the Department of Commerce
to extend the testbed period through September 10, 1999, and to consider
additional accredited registrars eligible to participate in the testbed. Network
Solutions has signed confidentiality agreements with 12 additional testbed
registrars and has shipped these new prospective registrars the software and
documentation to begin developing their system interfaces with the shared
registration system in order to begin providing registration services. These 12
prospective registrars are among the 59 companies accredited, or to be
accredited, by the Internet Corporation for Assigned Names and Numbers. All 59
of these companies may be eligible to participate in the testbed.
9
Network Solutions continues to work with the U.S. Government toward
establishing the post-testbed registry price and toward resolving other issues
surrounding the registry operations in a competitive environment.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
This quarterly report on Form 10-Q contains forward-looking statements. For
this purpose, any statements contained herein that are not statements of
historical fact may be deemed to be forward-looking statements. Statements
regarding the intent, belief or current expectations of Network Solutions are
intended to be forward-looking statements which may involve risk and
uncertainty. There are a number of factors that could cause Network Solutions'
actual results to differ materially from those indicated by such forward-
looking statements, including, but not limited to, those discussed in "Part
I -- Item 1 -- Business -- Risk Factors" and "Part II -- Item 7 -- Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Factors Affecting Operating Results" contained in Network Solutions' 1998 Form
10-K, as filed with the Securities and Exchange Commission on March 30, 1999. In
addition, set forth below under the heading "Factors Affecting Operating
Results" is a further discussion of certain of those risks as they relate to the
period covered by this report, Network Solutions' near-term outlook with respect
thereto, and the forward-looking statements set forth herein; however, the
absence in this quarterly report of a complete recitation of or update to all
risk factors identified in the 1998 Form 10-K should not be interpreted as
modifying or superseding any such risk factors, except to the extent set forth
below. Investors should review this quarterly report in combination with Network
Solutions' 1998 Form 10-K in order to have a more complete understanding of the
principal risks associated with an investment in Network Solutions' common
stock.
OVERVIEW
Network Solutions currently acts as the exclusive registry and as a
registrar of Internet domain names within the .com, .net, .org and .edu top
level domains pursuant to the Cooperative Agreement with the Department of
Commerce. Domain names are used to identify a unique site or presence on the
Internet. As registry and a registrar for these top level domains, Network
Solutions registers new domain names, maintains the master file of domain names
and updates that master file to the Internet daily. Network Solutions also
provides Internet Technology Services, focusing on network engineering, network
and systems security and network management solutions.
Registration Services. In December 1992, Network Solutions entered into
the Cooperative Agreement with the National Science Foundation under which
Network Solutions was to provide Internet domain name registration services for
five top level domains: .com, .org, .net, .edu and .gov. These registration
services include the initial two year domain name registration and annual
re-registration, and throughout the registration term, maintenance of and
unlimited modifications to individual domain name records and updates to the
master file of domain names. The Cooperative Agreement became effective January
1, 1993. It included 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. Effective September 9, 1998, the
Department of Commerce took over the administration of the Cooperative Agreement
from the National Science Foundation. In October 1998, the Cooperative Agreement
was amended to extend the flexibility period until September 30, 2000 and to
transition to a shared registration system.
The original terms of the Cooperative Agreement provided for a cost
reimbursement plus fixed-fee contract. Effective September 14, 1995, the
National Science Foundation and Network Solutions amended the Cooperative
Agreement to require Network Solutions to begin charging end users a services
fee of $50 per year for each domain name in the .com, .org and .net top level
domains. Thus, prior to April 1, 1998, registrants paid a services fee of $100
for two years of domain name services upon each initial registration and an
annual re-registration fee of $50 per year thereafter. The National Science
Foundation paid the registration fees for domain names within the .edu and .gov
top level domains through March 31, 1997. Commencing April 1, 1997, Network
Solutions agreed with the National Science Foundation to provide domain name
10
services within the .edu and .gov top level domains free of charge. As of
October 1, 1997, Network Solutions no longer registers or administers domain
names in the .gov top level domain.
Under the terms of the September 14, 1995 amendment to the Cooperative
Agreement, 30% of the registration fees collected by Network Solutions was
required to be set aside for the enhancement of the intellectual infrastructure
of the Internet and, as such, was not recognized as revenue by Network
Solutions. The set aside funds, plus any interest earned, were disbursed at the
direction of the National Science Foundation. As of December 31, 1998, the
Company had cumulatively disbursed to the National Science Foundation at its
direction all set aside funds collected and associated interest earned for a
total of $62.3 million.
On March 12, 1998, the National Science Foundation and Network Solutions
amended the Cooperative Agreement to eliminate the 30% set aside requirement
effective April 1, 1998 and to reduce the registration fees by a corresponding
amount. Initial registrations on and after April 1, 1998 are charged $70 for two
years of registration services and an annual renewal fee of $35 per year
thereafter. This amendment had no effect on the revenue recognized on each
registration ($70 for initial registrations and $35 for renewals), since Network
Solutions previously did not recognize revenue on the 30% set aside funds.
Accordingly, while the revenue to Network Solutions on a per registration basis
did not change, the amount charged to customers declined.
In order to provide prompt access to new domain names on the Internet,
Network Solutions generally invoices customers and permits them to pay their
registration fees after their domain names are registered. Network Solutions'
experience has been that, for the period from September 1995 through June 1999,
approximately 36% of registrations have ultimately been deactivated for
non-payment. Network Solutions 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 speculative resellers have a
greater tendency than other customers to default on their registration fees. As
a consequence, Network Solutions has recorded a comparable provision for
uncollectible accounts in determining net registration revenue.
Registration fees charged to end users for registration services, net of
any 30% set aside funds, are recognized as revenue evenly over the registration
term. Accordingly, Network Solutions recognizes $70 on a straight-line basis
over the two-year services period for each basic initial domain name
registration, equivalent to $35 per year. Annual re-registrations of basic
domain name registrations are recorded as revenue based upon $35 recognized on a
straight-line basis over the one-year services period. This subscription-based
model defers revenue recognition until Network Solutions provides the
registration services, including maintenance of and unlimited modifications to
individual domain name records, over the respective registration terms. At June
30, 1999, Network Solutions had net deferred revenue of $222.6 million.
Internet Technology Services. Substantially all of Network Solutions'
Internet Technology Services revenue is derived from professional services which
are generally provided to clients on a time and expense basis and is recognized
as services are performed.
The majority of Network Solutions' Internet Technology Services are
provided to customers in the financial services industry. Bank of America,
formerly NationsBanc, is currently Network Solutions' largest Internet
Technology Services client, accounting for 38.8% of Network Solutions' Internet
Technology Services business net revenue and 2.2% of Network Solutions' total
net revenue for the three months ended June 30, 1999. NationsBanc originally
contracted with Network Solutions in 1993 and Network Solutions currently
provides network design and engineering services as well as a variety of project
specific services under the contract.
RESULTS OF OPERATIONS
Net Revenue. Net revenue increased 132% from $20.5 million for the three
months ended June 30, 1998 to $47.5 million for the three months ended June 30,
1999. This increase in net revenue was primarily attributable to the increase in
the number of domain name registrations, principally in the .com top level
domain. Net revenue from registration services increased 136% from $19.0 million
for the three months ended
11
June 30, 1998 to $44.8 million for the three months ended June 30, 1999. Net new
registrations increased 166% from 443,000 for the three months ended June 30,
1998 to 1,180,000 for the three months ended June 30, 1999. This also represents
a 28% increase over the 922,000 net new registrations for the three months ended
March 31, 1999. Growth in net registrations continues to be driven by the
widespread use and adoption by businesses of the Internet and Intranets on a
global basis. Cumulative net registrations as of June 30, 1998 were 2,289,000 as
compared to 5,322,000 as of June 30, 1999, for a 133% increase. In addition,
this growth in cumulative net registrations represents a 28% increase in Network
Solutions' entire customer base since March 31, 1999.
Net revenue from Internet Technology Services increased 82% from $1.5
million for the three months ended June 30, 1998 to $2.7 million for the three
months ended June 30, 1999. This represents a 20% decrease in net revenue from
Internet Technology Services from the three months ended March 31, 1999. Bank of
America accounted for $1.0 million or 2.2% of Network Solutions' total net
revenue for the three months ended June 30, 1999 and $571,000 or 2.8% for the
three months ended June 30, 1998.
Net revenue increased 132% from $37.0 million for the six months ended June
30, 1998 to $85.6 million for the six months ended June 30, 1999. This increase
in net revenue was primarily attributable to the increase in the number of
domain name registrations, principally in the .com top level domain. Net revenue
from registration services increased 131% from $34.5 million for the six months
ended June 30, 1998 to $79.7 million for the six months ended June 30, 1999.
Net new registrations during the six month period ended June 30, 1999 were
2.1 million as compared to 783,000 during the six month period ended June 30,
1998, an increase of 158%.
Net revenue from Internet Technology Services increased 143% from $2.5
million for the six months ended June 30, 1998 to $6.0 million for the six
months ended June 30, 1999. This was primarily attributable to an increase in
business from Bank of America and other financial services customers. Bank of
America accounted for $1.8 million or 2.1% of Network Solutions' total net
revenue for the six months ended June 30, 1999, and $1.1 million or 3.0% for six
months ended June 30, 1998.
Cost of Revenue. Cost of revenue consists primarily of salaries and
employee benefits, fees paid to subcontractors for work performed in connection
with revenue producing projects, depreciation and equipment costs, lease costs
of the operations infrastructure and the associated operating overhead. Cost of
revenue increased 101% from $8.8 million for the three months ended June 30,
1998 to $17.7 million for the three months ended June 30, 1999. The increase was
primarily driven by the growth of Network Solutions' registration business which
experienced additional outsourcing costs of $2.8 million in support of
invoicing, collection and processing activities, $2.0 million in additional
depreciation charges and equipment expenditures and additional direct labor
charges of $3.1 million related to systems engineering and operations.
As a percentage of net revenue, cost of revenue decreased from 42.9% for
the three months ended June 30, 1998 to 37.3% for the three months ended June
30, 1999. This decrease primarily reflects economies of scale that Network
Solutions has continued to achieve due to the growth of its subscription-based
domain name registration business. In the near term, the continued need for back
office investments is expected to partially offset future margin improvements
arising from economies of scale.
Cost of revenue increased 100% from $16.1 million for the six months ended
June 30, 1998 to $32.3 million for the six months ended June 30, 1999. This
increase was driven by a $6.3 million increase in outsourcing costs and $3.0
million in additional depreciation charges and equipment expenditures and
additional direct labor charges of $4.4 million related to systems engineering
and operations primarily associated with supporting the growth of Network
Solutions' registration services business.
As a percentage of net revenue, cost of revenue decreased from 43.7% for
the six months ended June 30, 1998 to 37.7% for the six months ended June 30,
1999 reflecting economies of scale achieved in Network Solutions' registration
business.
Research and Development Expenses. Research and development expenses
consist primarily of compensation expenses to support the creation, development
and enhancement of Network Solutions' products
12
and technologies. Research and development expenses increased 202% from $815,000
for the three months ended June 30, 1998 to $2,460,000 for the three months
ended June 30, 1999. To date, all significant research and development costs
have been expensed as incurred. Network Solutions expects that the level of
research and development expenses will continue to increase in the near future
in absolute dollars as Network Solutions invests in developing new product and
service offerings. As a percentage of net revenue, research and development
expenses were 4.0% and 5.2% for the three months ended June 30, 1998 and 1999,
respectively.
Research and development expenses increased 192% from $1.5 million for the
six months ended June 30, 1998 to $4.5 million for the six months ended June 30,
1999. As a percentage of net revenue, research and development expenses
increased from 4.2% for the six months ended June 30, 1998 to 5.3% for the six
months ended June 30, 1999.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses consist primarily of salaries of business development,
general management, administrative and financial personnel, marketing expenses,
corporate services from SAIC, legal and other professional costs and
amortization of goodwill associated with Network Solutions' 1995 acquisition by
SAIC. Selling, general and administrative expenses increased 142% from $8.0
million for the three months ended June 30, 1998 to $19.4 million for the three
months ended June 30, 1999. The increase was primarily attributable to a $7.0
million increase in marketing and business development expenses including
television, Internet banner advertising and targeted direct mail campaigns,
increased staffing expenses of $900,000 and an increase of other professional
costs of $2.1 million.
As a percentage of net revenue, selling, general and administrative
expenses increased from 39.1% for the three months ended June 30, 1998 to 40.8%
for the three months ended June 30, 1999.
Selling, general and administrative expenses increased 144% from $14.2
million for the six months ended June 30, 1998 to $34.7 million for the six
months ended June 30, 1999. This increase was primarily attributable to a $14.3
million increase in marketing and business development expenses including
television, Internet banner advertising and targeted direct mail campaigns,
increased staffing expenses of $2.0 million and an increase of other
professional costs of $2.3 million.
As a percentage of net revenue, selling, general and administrative
expenses increased from 38.4% for the six months ended June 30, 1998 to 40.5%
for the six months ended June 30, 1999.
Network Solutions expects that the level of selling, general and
administrative expenses will continue to increase significantly in the near
future in terms of absolute dollars as operations continue to expand. In
particular, sales, marketing and business development expenses will increase as
Network Solutions continues to promote the value of a .com web address and other
new Internet-based value-added services. Network Solutions also plans to
continue to develop and enhance its distribution channels, both domestically and
internationally.
Interest Income. Network Solutions had net interest income of $1.4 million
for the three months ended June 30, 1998 as compared to $1.9 million for the
three months ended June 30, 1999.
Network Solutions had net interest income of $2.7 million for the six
months ended June 30, 1998 as compared to $3.9 million for the six months ended
June 30, 1999. The increase for both the three month and six month comparisons
is attributable to the investment of the net proceeds of Network Solutions'
initial public offering as well as positive cash flow resulting from increasing
domain name registrations.
Income Taxes. The provision for income taxes was 42% of pretax earnings,
or $1.8 million for the three months ended June 30, 1998, and 41%, or $4.1
million for the three months ended June 30, 1999.
The provision for income taxes was 42% or $3.3 million for the six months
ended June 30, 1998, and 41% or $7.5 million for the six months ended June 30,
1999.
The difference between the effective rate for both periods presented and
the statutory rate is principally attributable to the relative impact that
non-deductible goodwill had on pretax operating income. Goodwill is
13
being amortized by Network Solutions over five years and is associated with the
acquisition of Network Solutions by SAIC in 1995.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 1999, Network Solutions' principal source of liquidity was its
cash and cash equivalents of $46.0 million and its short-term investments of
$114.2 million, which when combined represent an increase of $28.6 million from
its December 31, 1998 balances in those accounts. Network Solutions also has
$42.1 million of marketable securities held as long term investments as of June
30, 1999.
At June 30, 1999, Network Solutions' cumulative net obligation to SAIC for
intercompany activity was $7.6 million. Intercompany activity is primarily
comprised of salaries and benefits paid by SAIC on behalf of Network Solutions.
Network Solutions currently reimburses SAIC for intercompany activity on a
monthly basis. Pursuant to the Tax Sharing Agreement dated September 26, 1997,
Network Solutions now generally remits income tax payments directly to tax
authorities as it no longer is part of SAIC's consolidated group for federal
income tax purposes.
Cash provided by operations was $62.4 million for the six months ended June
30, 1999. This amount is principally attributed to net income plus the increase
in deferred revenue reflecting cash collected in advance of registration
services revenue recognition which occurs ratably over the two-and one-year
registration terms. Partially offsetting this amount is an increase in deferred
tax assets resulting from accelerated revenue recognition for tax purposes and
the associated tax liabilities, generally paid on a quarterly basis.
Investing activities totaled $34.6 million for the six months ended June
30, 1999, of which $5.7 million was the net sale of short-term investments.
Investments during the period include a $2.0 million investment in a strategic
business partner which subsequently consummated its initial public offering
during the period.
Capital expenditures year to date were $38.3 million, primarily for
computer equipment and software to support Network Solutions' registry and
registrar efforts, as well as costs related to the opening of Network Solutions'
new call center. Network Solutions will continue to invest in the back office
infrastructure in advance of continued growth in domain name registrations and
as Network Solutions designs, builds, and operates the shared registration
system in accordance with the Cooperative Agreement.
Network Solutions believes that its existing cash balance, investments and
cash flows expected from future operations will be sufficient to meet Network
Solutions' capital requirements for at least the next 12 months.
FACTORS AFFECTING OPERATING RESULTS
INDUSTRY RISKS
Ongoing privatization of Internet administration could harm our registration
business
Within the U.S. Government, leadership for the continued privatization of
Internet administration is currently provided by the Department of Commerce.
After a series of draft proposals and public comment periods, on June 10, 1998,
the Department of Commerce published in the Federal Register a plan referred to
as the Statement of Policy or "White Paper," calling for the formation of a
not-for-profit corporation to assume certain responsibilities relating to the
domain name system, but not to perform actual registration of domain names
either as a registrar or registry. The Statement of Policy called for increased
competition and invited private sector Internet stakeholders to work together to
form a new private, not-for-profit corporation to oversee policy for the
Internet name and address system.
The Statement of Policy distinguished between the registry and registrar
functions of the domain name system. We currently are the exclusive registry in
the .com, .org, .net and .edu top level domains and act as the leading registrar
in those domains. The technical structure of the Internet only permits one
registry for each top level domain. A registrar acts as the interface between
the registry and the end-user domain name registrants. Registrars submit to the
registry certain limited information for each of their customers that has a
second level domain name in that top level domain. A registrar can provide
value-added products and services
14
in addition to its basic registration service. Numerous registrars will be able
to operate within each top level domain.
As part of the process initiated by the Statement of Policy, several
proposals were put forward to the Department of Commerce on the establishment
and governance of the not-for-profit corporation. The proposals differed in
several respects including, among others, their approaches to the following
issues: place and form of incorporation; method for selection of the interim and
permanent board of directors; who should be eligible to become a member and on
what questions should the members vote; what authority should be granted to the
board of directors and what authority should be reserved to the members, if any;
and whether there should be separate supporting organizations and, if so, what
authority these organizations should have. A U.S. based private not-for-profit
corporation with an international board of directors, denoted the Internet
Corporation for Assigned Names and Numbers, or "ICANN," submitted various
proposals which formed the basis of discussion at a number of public and private
meetings. As a result of these and other meetings and private negotiations, the
process initiated by the Statement of Policy has resulted in the entry by the
U.S. Government into a Memorandum of Understanding, or "MOU," with ICANN. Under
the MOU, the parties will jointly design, develop and test the mechanisms,
methods and procedures that should be in place and the steps necessary to
transition management responsibility for certain domain name system functions to
a private-sector not-for-profit entity. The MOU provides that once testing is
successfully completed, it is contemplated that management of certain domain
name system functions will be transitioned to the mechanisms, methods and
procedures designed and developed in this joint project. The U.S. Government has
sent us a letter directing us to treat ICANN as the not-for-profit corporation
described in the October amendment to the Cooperative Agreement, in the
performance of ICANN's obligations under the MOU and until such time as the MOU
is terminated. We have taken the position that ICANN will become such not-
for-profit corporation, or "NewCo", only when responsibilities are transferred
to it in compliance with the Statement of Policy and that ICANN will be
"recognized" by us only pursuant to a mutually agreeable, bilateral, agreement.
We are actively negotiating such an agreement.
ICANN's bylaws called for the creation of supporting organizations that
will select some ICANN board members and provide policy recommendations in
particular areas. ICANN called for submission by February 5, 1999 of
applications from groups urging "recognition" of a domain name supporting
organization that would be charged with developing recommendations for policies
ICANN might apply. We submitted comments regarding the structure and function of
such a domain name supporting organization. On March 4, 1999, the ICANN Board
adopted a domain name supporting organization formation concept statement
reflecting some, but not all of our comments. On March 15, 1999, ICANN released
a staff draft of amendments to its bylaws based on the formation concept
statement to establish a domain name supporting organization. On March 31, 1999,
the ICANN Board adopted bylaw changes to govern establishment of the domain name
supporting organization. In May 1999, ICANN recognized a provisional Names
Council and six constituencies. We organized a global top level domain registry
constituency for the domain name supporting organization and may join other
constituencies. On August 12, 1999, ICANN further amended its bylaw provisions
relating to the domain name supporting organization.
We cannot be sure that ICANN will take positions favorable to us in the
process of implementing the final bylaws, recognizing domain name supporting
constituencies or in its further policy development, contract formation or other
actions.
The Statement of Policy calls for a phased transition of the Department of
Commerce's responsibilities for the domain name system to a not-for-profit
corporation by September 30, 2000. We face risks from this transition,
including:
- failure to achieve consensus on the many issues relating to the
functioning and governance of the not-for-profit corporation could result
in instability in domain name system administration,
- the not-for-profit corporation could fail to gain legitimacy resulting in
instability in domain name system administration,
15
- the U.S. Government could refuse to transfer certain responsibilities for
domain name system administration to the not-for-profit corporation due
to security, stability or other reasons resulting in fragmentation or
other instability in domain name system administration, and
- the not-for-profit corporation could adopt or promote policies,
procedures or programs that are unfavorable to our role in the
registration of domain names or that are not consistent with our current
or future plans.
Despite the significant efforts undertaken to date, it is impossible to
predict at this time whether or when the process initiated by the Statement of
Policy will result in the full transition to the not-for-profit corporation of
domain name system responsibilities as and to the extent contemplated in the
Statement of Policy and, if it does, the effect on us of such transition.
Operations under, changes to or disputes under the Cooperative Agreement could
harm our business
As the U.S. Government transitions certain responsibilities for domain name
system administration to the not-for-profit corporation, corresponding
obligations under the Cooperative Agreement may be terminated and, as
appropriate, covered in a contract between the not-for-profit corporation and
us. The U.S. Government sent us a letter directing us to treat ICANN as the
not-for-profit corporation identified in the amended Cooperative Agreement in
the performance of ICANN's obligations under the MOU and until such time as the
MOU is terminated. We have taken the position that ICANN will become such
not-for-profit corporation, or "NewCo", only when responsibilities are
transferred to it in compliance with the Statement of Policy and that ICANN will
be "recognized" by us only pursuant to a mutually agreeable, bilateral,
agreement. We are actively negotiating such an agreement. We have not yet
reached agreement with the U.S. Government or ICANN with respect to the terms of
the transition. We may not be able to reach agreement and either ICANN or the
U.S. Government may take positions that adversely affect us.
In the transition to a shared registration system under the Cooperative
Agreement, we are operationally separating our registry business from our
registrar business. Additional, competing registrars are now able to market
registration services in the .com, .net and .org top level domains, with the
domain names registered into the registry that we maintain for each of those top
level domains. Accordingly, persons registering second level domain names are
now able to choose among a number of different registrars, including us. We
began this transition on schedule, with the launch of a testbed phase involving
the following five registrars accredited by ICANN: America Online, Inc., CORE or
"Internet Council of Registrars", France Telecom/ Oleane, Melbourne IT and
Register.com. As the registry, we have contracts with each of these registrars
allowing them to directly register names into our registry database using our
proprietary shared registration system. Registrations of domain names by these
five testbed registrars have commenced. On August 6, 1999, we agreed with the
Department of Commerce to extend the testbed period through September 10, 1999,
and to consider additional accredited registrars eligible to participate in the
testbed. We have signed confidentiality agreements with 12 additional testbed
registrars and have shipped these new prospective registrars the software and
documentation to begin developing their system interfaces with the shared
registration system in order to begin providing registration services. These 12
prospective registrars are among the 59 companies accredited, or to be
accredited, by the ICANN. All of these companies may be eligible to participate
in the testbed. Our registry services under the Cooperative Agreement will be
subject to a price cap. During the testbed phase, the cap was set at $18 for a
two-year registration and $9 for a one-year re-registration and our Registrar
License and Agreement under which we, as the registry, grant a license to use
the shared registration system, was approved for use by agreement with the
Department of Commerce under Amendment 13 to the Cooperative Agreement.
Registrar services, now competitive, are being priced in different ways than we
price for such services by resellers for at least one of the competing
registrars.
Termination, or a change in the terms, of the Cooperative Agreement could
harm our business. While the Cooperative Agreement by its terms expires in
September 2000, it may be terminated earlier. We are currently in discussions
with the U.S. Government regarding adequate testing and full implementation of
the shared registration system and a wide range of contractual issues. The
Department of Commerce's interpretation of certain provisions of the Cooperative
Agreement differs from ours. For example, the
16
Department of Commerce has publicly expressed concerns about our use of the
WHOIS service, the internic.net website and our access policy to our top level
domain name zone file. The Department of Commerce has asserted a right to
recompete the Cooperative Agreement in certain circumstances and has claimed
government ownership of the intellectual property rights associated with our
performance of the Cooperative Agreement to date, including the WHOIS database.
We have reached agreements with the U.S. Government concerning the temporary
provision of access to the top level domain zone file. We have agreed with the
Department of Commerce to provide access to the WHOIS database, including for
third-party development of value-added products and services, subject to certain
conditions, pending resolution of outstanding issues with the Department of
Commerce and ICANN. Congress has held two hearings in which various issues about
the domain name system have been raised, including our claim of ownership to the
intellectual property associated with our performance under the Cooperative
Agreement, including the WHOIS database, and our dot com directory service
offering. Additionally, we have received letters from members of Congress
regarding these and other subjects, and urging us to promptly resolve issues now
in dispute with the Department of Commerce and ICANN. These differences in
interpretation or opinion have led to disputes between us and the Department of
Commerce and ICANN, which may or may not be resolved in our favor or which may
result in unfavorable action by Congress. Certain aspects of implementation of
the Cooperative Agreement remain to be fully negotiated, including the maximum
price we will charge after the testbed period for registry services in the top
level domains for which we now act as registry. If we are unsuccessful in
negotiating acceptable terms of implementation, the costs of implementation of
the Cooperative Agreement, our relationship with the not-for-profit corporation
and other matters affecting our position in a more competitive domain name
system environment could be harmed.
Challenges to authority over domain name administration could harm our business
Withdrawal of or challenges to the U.S. Government's sponsorship or
authorization of certain functions that we perform could create a public
perception or result in a legal finding that we lack authority to continue in
our current role as registry or registrar within the .com, .org, .net and .edu
top level domains. The legal authority underlying the roles of the Department of
Commerce and the not-for-profit corporation with regard to the domain name
system also could be challenged. The impact, if any, of any such public
perception or finding is unknown, but it could be harmful to our business.
Increased competition could harm our domain name registration business
The introduction of additional competition into the domain name
registration business could be harmful to our business. This includes, in
particular, competition among registrars within a single top level domain, like
.com, and competition among registrars and registries of existing and potential
new top level domains. We already face competition in the domain name
registration business from other registrars in the top level domains for which
we act as registry, third level domain name providers such as Internet access
providers and registrars and registries of top level domains other than those
top level domains for which we act as registry. Our shared registration system
is now being used by the five testbed registrars in the .com, .org and .net top
level domains to register domain names. More competing registrars are
anticipated to offer competing registration services in these top level domains
in the near future.
Future competition in the domain name registration business as a registry
or registrar could come from many different companies, including:
- domain name registration resellers,
- country code registries,
- Internet access providers, and
- major telecommunications firms.
Many of these entities have core capabilities to deliver registry and/or
registrar services, such as help desks, billing services and network management,
along with strong name recognition and Internet industry experience. Our revenue
could be reduced due to increased competition, pricing pressures or a
modification of
17
billing practices. Some resellers for at least one competing registrar in the
.com, .net and .org top level domains are already charging lower prices for
domain name registration services in those domains. In addition, other entities
are bundling and may, in the future bundle domain name registrations with other
products or services.
We depend on future growth of the Internet and Internet infrastructure
Our future success substantially depends on the continued growth in the use
of the Internet. If the use of and interest in the Internet does not continue to
grow, our business would be harmed. Continued growth of the Internet could be
slowed by:
- inadequate infrastructure,
- lack of availability of cost-effective, high speed systems and service,
- delays in developing or adopting new standards and protocols to handle
increased levels of Internet activity, or
- government regulation.
We rely on third parties who maintain and control root zone and top level domain
zone servers
We currently administer and operate only two of the 13 root zone servers
and four top level domain zone servers. The others are administered and operated
by independent operators on a volunteer basis. Because of the importance to the
functioning of the Internet of these root zone servers and top level domain zone
servers, our registration business could be harmed if these volunteer operators
fail to properly maintain such servers or abandon such servers.
Further, our registration business could be harmed if any of these
volunteer operators fail to include or provide accessibility to the data that we
maintain in the root zone servers and the top level domain zone servers that we
control.
We rely on Internet service providers
Our registration business could be harmed if enough Internet service
providers decided not to route Internet communications to or from domain names
registered by us or if enough Internet service providers decided to provide
routing to a set of domain name servers which did not point to our top level
domain zone servers.
System failure or interruption, security breaches or our failure to meet
increasing demands on our systems could harm our business
Any significant problem with our systems or operations could result in lost
revenue, customer dissatisfaction or lawsuits against us. A failure in the
operation of our registration system or other events could result in deletion of
one or more domain names from the Internet for a period of time. A failure in
the operation of our shared registration system could result in the inability of
one or more other registrars to register and maintain domain names for a period
of time. A failure in the operation or update of the master database that we
maintain could result in deletion of one or more top level domains from the
Internet and the discontinuation of second level domain names in those top level
domains for a period of time. The inability of our registration system,
including our back office billing and collections infrastructure, and
telecommunications systems to meet the demands of the increasing number of
domain name registration requests and corresponding customer e-mails and
telephone calls could result in substantial degradation in our customer support
service and our ability to process, bill and collect registration requests in a
timely manner.
Our operations depend on our ability to maintain our computer and
telecommunications equipment in effective working order and to reasonably
protect our systems against interruption and potentially on such maintenance and
protection by other registrars in the shared registration system. The root zone
servers and top
18
level domain zone servers that we operate are critical hardware to our
operations. Interruptions could result from:
- fire, natural disaster, sabotage, power loss, telecommunication failure,
human error or similar events,
- computer viruses, hackers or similar disruptive problems caused by
employees, customers or other Internet users, and
- systems strain caused by the growth of our customer base and our
inability to sufficiently maintain or upgrade our systems.
We may lose revenue or incur significant costs if Year 2000 compliance issues
are not properly addressed
Our failure, or the failure of third parties on which we rely, to
adequately address Year 2000 compliance issues may cause us to lose revenue or
to incur significant costs. The primary risks that we face with regard to Year
2000 failures are those which impact our domain name registration business.
These risks include:
- significant and protracted interruption of electrical power to data and
systems in our engineering and customer service facilities,
- significant and protracted interruption of telecommunications and data
network services in any of our headquarters, engineering or customer
service facilities,
- the failure of components of our current back office and domain name
registration related systems,
- the occurrence of a Year 2000 problem with respect to third-party
suppliers', vendors' and outsourcing service providers' products and
services, and
- the occurrence of a Year 2000 problem with respect to one of the other
registrars in the shared registration system.
If we fail to solve a Year 2000 compliance problem with our mission
critical business systems and processes, including the domain name servers under
our control, telecommunications systems, facilities, data-networking
infrastructure, commercial-off-the-shelf hardware or software and components
used by our employees, the result could be a failure of or interruption to
normal business operations. Furthermore, our business depends on the continued
operation of, and widespread access to, the Internet. This, in turn, depends to
a large extent on the software and systems of third parties on which our systems
rely or to which they are connected. These third parties include, among others,
Internet-related companies, including Internet web hosting companies, Internet
access providers and Internet domain name server operators.
We have no responsibility for, nor control over, other Internet domain name
server operators that are critical to the efficient operation of the Internet.
We do not know whether such domain name server operators have hardware, software
or firmware that is Year 2000 compliant.
COMPANY RISKS
We must attract, integrate, train and retain key personnel knowledgeable about
our business
Given the relative "newness" and rapid growth of the Internet, there is
intense competition for the limited supply of people qualified to work for us.
Our future success depends on the continued service of key engineering, sales,
marketing, executive and administrative personnel, and our ability to attract,
hire, integrate, train and retain such personnel. Competition for engineering,
sales, marketing and executive personnel is intense, particularly in the
technology and Internet sectors and in the regions where our facilities are
located. We cannot be certain that we will be able to retain existing personnel
or attract, hire or retain additional qualified personnel. The loss of the
services of any of our senior management team or other key employees or our
failure to attract, integrate, train and retain additional key employees could
harm our business.
19
Our near term success depends on the growth of our domain name registration
business
We may not be able to sustain the revenue growth we have experienced in
recent periods. In addition, past revenue growth may not be indicative of future
operating results. If we do not successfully maintain our current position as a
leading provider of domain name registration services or develop or market
additional services, our business could be harmed.
Our domain name registration services business generates over 90% of our
revenue and is expected to continue to account for a very significant portion of
our revenue in at least the near term. Our future success will depend largely
on:
- the continued increase in domain name registrations,
- re-registration rates of our customers,
- our ability to maintain our current position as a leading registrar of
domain names,
- the successful development, introduction and market acceptance of new
services that address the demands of Internet users,
- our ability to provide a robust domain name registration system, and
- our ability to provide a superior customer service infrastructure.
We must effectively manage our marketing organization and establish and maintain
distribution channels
We will need to effectively manage our growing sales and marketing
organization if we want to achieve future revenue growth. We do not know if we
will be able to identify, attract and retain experienced sales and marketing
personnel with relevant experience. Further, our sales and marketing
organization may not be able to successfully compete against the significantly
more extensive and well-funded sales and marketing operations of our current or
potential competitors for registration or consulting services.
Our ability to achieve future revenue growth will also depend on our
ability to continue to establish direct sales channels and to develop multiple
distribution channels. To do this we must maintain relationships with Internet
access providers and other third parties.
We have a high level of uncollectible receivables
Because of our high level of uncollectible receivables, we continually
review our billing practices. Any modifications that we may implement as a
result of these reviews, including prepayment or pre-approved credit limits for
new registration orders, which will occur later during 1999, could have
unanticipated harmful consequences to our business. We believe we have
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 transferring such names at
a profit. Our experience has been that such speculative resellers have a greater
tendency than other customers to default on their services fees. We have
established a provision for uncollectible accounts which we believe to be
adequate to cover anticipated uncollectible receivables; however, actual results
could differ from our estimates.
We are party to several legal proceedings which could have a negative financial
impact on us
We are involved in several legal proceedings. We cannot reasonably estimate
the potential impact of any of these proceedings. An adverse determination in
any of these proceedings, however, could harm our business. Legal proceedings in
which we are involved are expensive and divert our personnel. See "Part II --
Item 1 -- Legal Proceedings."
We may not be able to protect our intellectual property rights and proprietary
information
We rely on a combination of nondisclosure and other contractual
arrangements with the U.S. Government, our employees, and third parties, as well
as privacy and trade secret laws, to protect and
20
limit the distribution of our proprietary data, computer software,
documentation, and processes used in conducting our domain name registration
business. If we fail to adequately protect our intellectual property rights and
proprietary information, or if we are subject to adverse results in litigation
relating to our intellectual property rights and proprietary information, our
business could be harmed. Any actions we take may not be adequate to protect our
intellectual property rights and proprietary information. Other companies may
develop competing technology that is similar or superior to our technology. The
U.S. Government has taken positions adverse to our claims regarding proprietary
rights over the WHOIS database and other intellectual property associated with
our performance under the Cooperative Agreement and could attempt to require us
to enter into agreements limiting such claims. In addition, members of Congress
during hearings and otherwise have raised similar issues concerning our claims
of proprietary rights. If these issues are not resolved in our favor, there
could be a material adverse effect on our business. See "-- Operations under,
changes to or disputes under the Cooperative Agreement could harm our business."
Although we have no reason to believe that our domain name registration business
activities infringe on the intellectual property rights of others, and we
believe that we have all rights needed to conduct our business, it is possible
that we could become subject to claims alleging infringement of third party
intellectual property rights. Any such claims could subject us to costly
litigation, and any adverse final rulings on any such claims could require us to
pay damages, seek to develop alternative technology, and/or seek to acquire
licenses to the intellectual property that is the subject of any such alleged
infringement, and any such rulings could have a material adverse effect on our
business.
Unsuccessful future acquisitions and investments could decrease operating
income, cause operational problems
or otherwise disrupt our business
We evaluate potential acquisitions and investments on an ongoing basis for
various reasons including, among others, diversification of our domain name
registration and Internet Technology Services businesses. Our acquisition and
investment strategy poses many risks, including:
- we may not be able to compete successfully for available acquisition
candidates, complete future acquisitions and investments or accurately
estimate the financial effect on our company of any businesses we acquire
or investments we make,
- future acquisitions and investments may require us to spend significant
cash amounts or may decrease our operating income,
- we may have trouble integrating the acquired business and retaining
personnel,
- acquisitions or investments may disrupt our business and distract our
management from other responsibilities, and
- to the extent that any of the companies which we acquire or in which we
invest fail, our business could be harmed.
Whether or when pooling of interests accounting for acquisitions might
become available to us depends on many factors beyond our control.
We face increasing risks associated with our international business
While substantially all of our operations, facilities, and personnel are
located within the United States, our revenues from sources outside the U.S.
have increased significantly and may continue to increase in the future. As a
result, we are subject to the risks of conducting business internationally,
including unexpected changes in regulatory requirements, competition from
foreign companies, fluctuations in the U.S. dollar, tariffs and other barriers
and restrictions and the burdens of complying with a variety of foreign laws. We
do not know what the impact of such regulatory, geopolitical and other factors
will be on our business in the future or if we will have to modify our business
practice. In addition, the laws of certain foreign countries may not protect our
proprietary rights to the same extent as do the laws of the United States.
21
Our quarterly operating results may fluctuate; our future revenue and
profitability are uncertain
Our quarterly operating results may fluctuate significantly in the future
due to a variety of factors, some of which are beyond our control. Factors that
may affect our revenue include:
- variations in the number of requests for domain name registrations or
demand for our services,
- successful competition by others,
- termination or completion of contracts in our Internet Technology
Services business or failure to obtain additional contracts in that
business, and
- market acceptance of new service offerings.
In addition, we expect a significant increase in our operating expenses as
we:
- increase our sales and marketing operations and activities, and
- continue to update our systems and infrastructure.
If the increase in our expenses is not followed by an increase in our
revenue, our operating results will be harmed. The fact that in the past our
revenues have increased and we have been profitable on a quarterly and annual
basis is not indicative of whether our revenues will increase or whether we will
be profitable on a quarterly or annual basis in the future.
INVESTMENT RISKS
Our stock price, like that of many Internet companies, is highly volatile
The market price of our common stock has been and is likely to continue to
be highly volatile and significantly affected by factors such as:
- general market and economic conditions and market conditions affecting
technology and Internet stocks generally,
- actual or anticipated fluctuations in our quarterly or annual
registrations or operating results,
- announcements of technological innovations, acquisitions or investments,
developments in Internet governance or corporate actions such as stock
splits, and
- industry conditions and trends.
The stock market has experienced significant price and volume fluctuations
that have particularly affected the market prices of the stocks of technology
companies, especially Internet-related companies. These broad market or
technology or Internet sector fluctuations may adversely affect the market price
of our common stock. Recently, the market price of our common stock, like that
of many Internet-related companies, has experienced significant fluctuations.
For instance, from January 1, 1999 through August 3, 1999, the reported sales
price for our common stock ranged from $51.75 per share to $144 per share. On
August 3, 1999, the reported last sale price of our common stock was $57 per
share.
The market price of our common stock also has been and is likely to
continue to be significantly affected by expectations of analysts and investors.
Reports and statements of analysts do not necessarily reflect our views. The
fact that we have in the past met or exceeded analyst or investor expectations
does not necessarily mean that we will do so in the future.
In the past, following periods of volatility in the market price of a
particular company's securities, securities class action litigation has often
been brought. Such litigation could result in substantial costs and a diversion
of our management's attention and resources.
22
Future sales of common stock could affect our stock price
SAIC owns 14,850,000 of the outstanding shares of our common stock. A
decision by SAIC to sell such stock could depress the market price of the common
stock.
SAIC may maintain significant influence over us
SAIC owns approximately 45% of our common stock and remains our largest
shareholder. Matters requiring approval by our stockholders, including the
election of members of our board of directors, changes in the size and
composition of the board of directors and a change in control, may need SAIC's
approval to be effected. We do not have an agreement with SAIC which restricts
its rights to convert, distribute or sell its shares of our common stock.
Certain directors may have conflicts of interest
Certain of our directors currently serve as directors, officers and
employees of SAIC. Therefore, there may be various conflicts of interest or
conflicting duties for these individuals. Since our directors and officers may
also own stock of SAIC, there may be conflicts of interest when directors and
officers are faced with decisions that could have different implications for us
and SAIC.
We rely on SAIC for certain corporate services and employee benefits
We currently receive corporate services under an agreement with SAIC. Were
SAIC to terminate these services, we may not be able to secure alternative
sources for such services or such services may only be available to us at prices
higher than those charged by SAIC.
Our employees are currently eligible to participate in certain SAIC
employee benefit plans through the end of calendar year 1999. However, due to
SAIC's sale of some of its shares, SAIC now owns less than 50% of our common
stock and as a result we will have to establish certain employee benefit plans
of our own which could result in incremental costs to us.
Our certificate of incorporation contains provisions relating to SAIC that may
adversely affect us
or our stockholders
Our certificate of incorporation includes provisions relating to
competition by SAIC with us, allocations of corporate opportunities,
transactions with interested parties and intercompany agreements and provisions
limiting the liability of certain people. It is unclear whether such provisions
are enforceable under Delaware corporate law. Our certificate of incorporation
provides that any person purchasing or acquiring an interest in shares of our
capital stock shall be deemed to have consented to the provisions in the
certificate of incorporation relating to competition with SAIC, conflicts of
interest, corporate opportunities and intercompany agreements, and such consent
may restrict such person's ability to challenge transactions carried out in
compliance with such provisions. The corporate charter of SAIC does not include
similar provisions. Therefore, persons who are directors and/or officers of ours
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 us but adverse to SAIC.
YEAR 2000 COMPLIANCE
Network Solutions is continually assessing the potential effects of the
"Year 2000" millennium change on Network Solutions' business systems and
processes, including the Internet domain name servers under Network Solutions'
control, telecommunications systems, facilities, data-networking infrastructure,
commercial-off-the-shelf hardware, software and components used by its employees
and its outsourcing vendors. Network Solutions' Year 2000 project is proceeding
on schedule. The project goal is to ensure that Network Solutions' business is
not impacted by the date transitions associated with the Year 2000.
Network Solutions' Year 2000 project plan is coordinated by a team that
reports directly to senior management. The project team is evaluating the Year
2000 compliance of Network Solutions' business
23
systems and processes, including the Internet domain name servers under Network
Solutions' control, telecommunications systems, facilities, data-networking
infrastructure, commercial-off-the-shelf hardware, software and components used
by its employees and its outsourcing vendors whom provide services relating to
Network Solutions' domain name registration business. Network Solutions' Year
2000 project is comprised of the following parallel phases:
- Phase 1 -- Inventory all of Network Solutions' business systems and
processes, including the Internet domain name servers under Network
Solutions' control, telecommunications systems, facilities, data-
networking infrastructure, commercial-off-the-shelf hardware, software
and components used by its employees in order to assign priorities to
potentially impacted systems and services. This phase has been completed;
- Phase 2 -- Assess the Year 2000 compliance of all inventoried business
systems and processes, including the Internet domain name servers under
Network Solutions' control, telecommunications systems, facilities,
data-networking infrastructure, commercial-off-the-shelf hardware,
software and components used by its employees and determine whether to
renovate or replace any non-Year 2000 compliant systems and services. The
assessment of mission critical systems has been completed; however,
assessment continues as a life cycle development activity;
- Phase 3 -- Complete remediation of any non-Year 2000 compliant business
systems and processes, including the Internet domain name servers under
Network Solutions' control, telecommunications systems, facilities,
data-networking infrastructure, commercial-off-the-shelf hardware,
software and components used by its employees. Conduct procurements to
replace any other non-Year 2000 compliant business systems and processes,
telecommunications systems, facilities, data-networking infrastructure,
commercial-off-the-shelf hardware, software and components used by its
employees that will not be remediated. All remediation efforts have been
completed;
- Phase 4 -- Test and validate remediated systems to ensure inter-system
compliance and mission critical system functionality. The testing has
begun. As remediated code is successfully tested, it is released into
production incrementally, a process which will last until October 30,
1999;
- Phase 5 -- Deploy and implement remediated and replacement systems after
the completion of successful testing and validation. The deployment and
implementation of the remediated or replacement systems are expected to
be completed by October 30, 1999; and
- Phase 6 -- Design contingency and business continuation plans in the
event of the failure of business systems and processes,
telecommunications systems, facilities, data-networking infrastructure,
commercial-off-the-shelf hardware, software and components used by
Network Solutions' employees due to the Year 2000 millennium change. The
business continuation plan has been completed and it will be updated
throughout the year as appropriate.
Based on its inventory and assessment, Network Solutions found that less
than one-half of one percent of the software code of its mission critical
systems needed to be remediated to be made Year 2000 compliant. However, Network
Solutions, in its normal course of business, anticipates replacing or upgrading,
prior to the millennium change, portions of these systems with new systems which
will also be Year 2000 compliant. Currently, Network Solutions is enhancing its
"back-office" and registration-related systems and the software relating to its
core domain name registration services business. This enhancement effort is a
function of Network Solutions' business growth and not a Year 2000 remediation
effort.
Based on its inventory and assessment, Network Solutions has found no
material Year 2000 problems with its facilities and telecommunications systems.
Network Solutions has conducted detailed assessments and tested the components
of its telecommunications infrastructure. In addition, Network Solutions is
seeking assurances from its facilities' landlords and telecommunications
equipment vendors and data circuit providers regarding the Year 2000 compliance
of their facilities and equipment. In the event of electrical power interruption
outside of Network Solutions' control, Network Solutions has deployed back-up
power systems capable of operating its core business indefinitely.
24
Network Solutions is now in the testing phase of its project cycle. Network
Solutions believes that its incremental remediation costs to make its current
business systems and processes, including the Internet domain name servers under
Network Solutions' control, telecommunications systems, facilities, data-
networking infrastructure, commercial-off-the-shelf hardware, software and
components used by its employees Year 2000 compliant are not material. While
Network Solutions is incurring some incremental costs directly relating to staff
augmentation for the Year 2000 program management and technical assessment, the
costs expended by Network Solutions through June 30, 1999 are less than
$1,000,000. Network Solutions' expected total costs, including remediation and
replacement costs, are estimated to be between $2,000,000 and $2,375,000 over
the life of the Year 2000 project. Since portions of the mission critical "back
office" and domain name registration-related systems will generally be replaced
as a function of business growth, the labor and capital costs associated with
such replacement systems are not directly attributed to achieving Year 2000
compliance. Network Solutions will also incur costs for extending its software
testing architecture which, in addition to testing remediated systems, will be
used as a normal component of Network Solutions' quality assurance
infrastructure. As such these costs are not directly categorized as Year 2000
project costs but as normal business development and engineering costs.
Network Solutions is contacting its hardware and software vendors,
significant suppliers, outsourcing service providers and contracting parties to
determine the extent to which Network Solutions is vulnerable to any such third
party's failure to achieve Year 2000 compliance for its own systems. At the
present time, Network Solutions does not expect Year 2000 issues of any such
third parties to materially affect Network Solutions' business. Furthermore,
Network Solutions' business depends on the continued operation of, and
widespread access to, the Internet. This, in turn, depends to a large extent on
the software and systems of third parties on which Network Solutions' systems
rely or to which they are connected. These third parties include, among others,
Internet-related companies, including Internet web hosting companies, Internet
access providers and Internet domain name server operators. Network Solutions
can give no assurances that the software or systems of such third parties will
be Year 2000 compliant or that the failure of such third parties to achieve Year
2000 compliance will not have a material adverse effect on Network Solutions. To
the extent that the normal operation of the Internet is disrupted by the Year
2000 millennium change, Network Solutions' business, financial condition or
results of operations could be materially and adversely affected.
Should Network Solutions fail to solve a Year 2000 compliance problem
related to its mission critical business systems and processes, including the
Internet domain name servers under Network Solutions' control,
telecommunications systems, facilities, data-networking infrastructure,
commercial-off-the-shelf hardware, software and components used by its
employees, the result could be a failure or interruption to normal business
operations. Network Solutions believes that, with the deployment of the new
"back office" and domain name registration related systems in 1999, the
potential for significant interruptions to normal operations should be
minimized. Network Solutions' primary risks with regard to Year 2000 failures
are those which impact its domain name registration business. The reasonably
likely worst case risks inherent in Network Solutions' business are as follows:
- Significant and protracted interruption of electrical power to data and
systems in Network Solutions' engineering and customer support facilities
could materially and negatively impact Network Solutions' ability to
provide data and call-center operations. To mitigate this risk, Network
Solutions has deployed back-up power systems capable of operating
indefinitely. However, electrical power interruptions that impact
Internet connectivity providers could adversely impact Network Solutions
because of Network Solutions' reliance upon Internet-based operations for
its day to day business.
- Significant and protracted interruption of telecommunications and data
network services in any of Network Solutions' headquarters, engineering
or customer support facilities could materially and negatively impact
Network Solutions' ability to provide data and call-center operations.
Network Solutions has conducted detailed assessments of the components of
its telecommunications infrastructure and is working to identify
appropriate system testing guidelines. As part of its technical
assessment, Network Solutions identified the compliance status of its
data networking infrastructure and implemented remediation. Finally,
Network Solutions has plans to seek additional assurances and
25
a better understanding of the compliance programs of its
telecommunications and data circuit providers.
- The failure of components of Network Solutions' current "back office" and
domain name registration related systems could materially and negatively
impact Network Solutions' business. However, as a function of business
growth, these systems are planned to be retired before the end of 1999.
As a contingency planning measure, Network Solutions has conducted a
technical assessment of the current systems and their software
applications and is currently testing such systems.
- Despite the assurances of Network Solutions' third-party suppliers,
hardware and software vendors, and outsourcing service providers
regarding the Year 2000 compliance of their products and services, the
potential exists that a Year 2000 problem relating to such third-party
suppliers, vendors and outsourcing service providers' products and
services could have a material impact on Network Solutions' business.
Network Solutions is conducting monthly discussions with its mission
critical outsourcing service providers to determine the progress of their
Year 2000 compliance programs.
Although Network Solutions found that it only has had to remediate a small
portion of its software code in its internal mission critical systems and
despite Network Solutions' expectation that its enhancement effort will result
in Year 2000 compliant "back-office" and registration-related systems and
software relating to its core domain name registration services business,
Network Solutions has developed a business continuity plan and is performing a
test on the existing core registration-related systems that are being replaced.
The final business continuity plan has been completed and will be updated as
appropriate throughout the year.
Although Network Solutions is taking appropriate steps so that Network
Solutions' business is not impacted by the date transitions associated with the
Year 2000, Network Solutions has no responsibility for, nor control over other
Internet domain name server operators or tens of thousands of lower level domain
name system server operators that are critical to the efficient operation of the
Internet. Network Solutions has not determined whether such domain name server
operators or other server operators have hardware, software or firmware that is
Year 2000 compliant. Network Solutions has notified the Department of Commerce
of this issue.
Forward-Looking Statements
The foregoing Year 2000 discussion and the information contained herein is
provided as a "Year 2000 Readiness Disclosure" as defined in the Year 2000
Information and Readiness Disclosure Act of 1998 (Public Law 105-271, 112 Stat.
2386) enacted on October 19, 1998 and contains "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995. Such
statements, including without limitation, anticipated costs and the dates by
which Network Solutions expects to complete certain actions, are based on
management's best current estimates, which were derived utilizing numerous
assumptions about future events, including the continued availability of certain
resources, representations received from third parties and other factors.
However, there can be no guarantee that these estimates will be achieved, and
actual results could differ materially from those anticipated. Specific factors
that might cause such material differences include, but are not limited to, the
ability to identify and remediate all relevant systems, results of Year 2000
testing, adequate resolution of Year 2000 issues by governmental agencies,
businesses and other third parties who are outsourcing service providers,
suppliers, and vendors of Network Solutions, unanticipated system costs, the
adequacy of and ability to implement contingency plans and similar
uncertainties. The "forward-looking statements" made in the foregoing Year 2000
discussion speak only as of the date on which such statements are made, and
Network Solutions undertakes no obligation to update any forward-looking
statement to reflect events or circumstances after the date on which such
statement is made or to reflect the occurrence of unanticipated events.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Network Solutions is exposed to the impact of interest rate changes and
change in the market values of its investments.
26
Interest Rate Risk. Network Solutions' exposure to market rate risk for
changes in interest rates relates primarily to the Company's investment
portfolio. Network Solutions has not used derivative financial instruments in
its investment portfolio. Network Solutions invests its excess cash in debt
instruments of the U.S. Government and its agencies, and in high-quality
corporate issuers and, by policy, limits the amount of credit exposure to any
one issuer. The Company protects and preserves its invested funds by limiting
default, market and reinvestment risk.
Investments in both fixed rate and floating rate interest earning
instruments carry a degree of interest rate risk. Fixed rate securities may have
their fair market value adversely impacted due to a rise in interest rates,
while floating rate securities may produce less income than expected if interest
rates fall. Due in part to these factors, the Company's future investment income
may fall short of expectations due to changes in interest rates or the Company
may suffer losses in principal if forced to sell securities which have declined
in market value due to changes in interest rates.
Investment Risk. The Company has invested in the equity instruments of a
privately-held, information technology company for business and strategic
purposes. This investment is included in other long-term assets and is accounted
for under the cost method which approximates fair value. Network Solutions is
also exposed to equity price risks on the marketable portion of its equity
securities. Network Solutions' available-for-sale securities include investments
in publicly-held companies in the Internet industry sector, many of which have
experienced significant historical volatility in their stock prices.
27
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
As of August 1, 1999, we were a defendant in four active lawsuits involving
domain name disputes between trademark owners and domain name holders. We are
drawn into such disputes, in part, as a result of claims by trademark owners
that we are legally required, upon request by a trademark owner, to terminate
the right we granted to a domain name holder to register a domain name which is
alleged to be similar to the trademark in question. The holders of the domain
name registrations in dispute have, in turn, questioned our right, absent a
court order, to take any action which suspends their use of the domain names in
question. Although 51 out of approximately 6,600 of these situations have
resulted in suits actually naming us as a defendant, as of August 1, 1999, no
adverse judgment has been rendered and no award of damages has ever been made
against us. We believe that we have meritorious defenses and vigorously defend
ourselves against these claims.
On March 20, 1997, PG Media, Inc., a New York-based corporation, filed a
lawsuit against us in the United States District Court, Southern District of New
York alleging that we had restricted access to the Internet by not adding PG
Media's requested top level domains to the Internet root zone system in
violation of the Sherman Act. In its complaint, PG Media, in addition to
requesting damages, asked that we be ordered to include reference to PG Media's
top level domains and name servers in the root zone file administered by us
under the Cooperative Agreement. In June 1997, we received written direction
from the National Science Foundation not to take any action which would create
additional top level domains or to add any new top level domains to the Internet
root zone until the National Science Foundation provides further guidance. On
September 17, 1997, PG Media filed a Second Amended Complaint adding the
National Science Foundation as a defendant. On May 14, 1998, PG Media served us
with a motion for a preliminary injunction against both defendants to compel
both defendants to add PG Media's top level domains to the Internet root zone
within 30 days. In response, both defendants filed cross-motions for summary
judgment against PG Media. On July 20, 1998, a hearing on all parties' motions
occurred. The basic issue before the court was the National Science Foundation's
authority to control the Internet's root zone system. On March 16, 1999, the
court granted both our and the National Science Foundation's motions for summary
judgment, holding that the National Science Foundation does have authority over
the root zone system and that the federal instrumentality immunity doctrine
immunizes us against liability under both sections 1 and 2 of the Sherman Act.
PG Media noticed its appeal on April 15, 1999. Our brief was filed in the
appellate court on July 26, 1999. No oral argument has yet been scheduled. While
we cannot reasonably estimate the potential impact of the claims advanced in
this lawsuit, a successful claim could harm our business.
On October 17, 1997, a group of six plaintiffs filed the Thomas suit
against us and the National Science Foundation in the United States District
Court, District of Columbia, challenging the legality of fees defendants charge
for the registration of domain names on the Internet and seeking restitution of
fees collected from domain name registrants in an amount in excess of $100
million, damages, and injunctive and other relief. Plaintiffs alleged violations
of the Sherman Act, the U.S. Constitution, the Administrative Procedures Act and
the Independent Offices Appropriations Act. On February 10, 1998, the plaintiffs
filed a motion for preliminary injunction against us seeking several items of
relief. On April 6, 1998, the Court issued its opinion granting summary judgment
in favor of the plaintiffs on the Intellectual Infrastructure Fund, ruling it an
"unlawful tax." The court also granted our motion to dismiss all other counts
(II through X) and simultaneously denied the plaintiffs' preliminary injunction
motion against us. On April 30, 1998, Congress passed H.R. 3579 which was signed
into law by the President on May 1, 1998. Section 8003 of H.R. 3579 legalized,
ratified and confirmed the entire Intellectual Infrastructure Fund and
authorized and directed the National Science Foundation to deposit the entire
fund into the U.S. Treasury. On August 28, 1998, the District Court dismissed
the entire case, issuing a final judgment in the matter. In October 1998, the
plaintiffs appealed the court's dismissal of their claims, and oral argument
occurred on February 25, 1999. On May 14, 1999, the Court of Appeals ruled in
favor of Network Solutions by unanimously affirming the District Court's
decision. The Court of Appeals denied the plaintiffs' motion for reconsideration
and entered final judgment on July 20, 1999.
28
On June 27, 1997, SAIC received a Civil Investigative Demand, or "CID,"
from the U.S. Department of Justice issued in connection with an investigation
to determine whether there is, has been, or may be any antitrust violation under
the Sherman Act relating to Internet registration products and services. The CID
sought documents and information from SAIC and us relating to our Internet
registration business. On April 29, 1999, we received a second CID seeking
additional information and documents relating to our ownership rights in,
policies relating to access to, and our use of, data that we compile in the
course of operating our Internet registration business. We are providing
information responsive to the CID. On June 23, 1999, the Department of Justice
formally notified us that SAIC had been removed as a subject of the
investigation. Because the investigation, as currently focused, is still at a
preliminary stage, we cannot reasonably estimate the potential impact of the
investigation nor can we predict whether a civil action might ultimately be
filed by the Department of Justice or the form of relief that might be sought.
Any such relief from such a suit could have a harmful effect on our business.
On August 17, 1998, we received notice from the Commission of the European
Communities, or "EC," of an investigation concerning the Company's Premier
Program agreements in Europe. The EC requested production of these agreements
and related materials for review and we complied. On June 17, 1999, we received
a second inquiry from the EC concerning our registrar licensing agreements with
the five newly-accredited testbed registrars and we responded to this inquiry on
July 9, 1999. We cannot reasonably estimate the potential impact of the
investigation nor can we predict whether an action will ultimately be brought by
the EC or the form of relief that might be sought. Any such relief could harm
our business.
We are involved in various other investigations, claims and lawsuits
arising in the normal conduct of our business, none of which, in our opinion
will harm our business.
Legal proceedings in which we are involved have resulted and likely will
result in, and any future legal proceedings can be expected to result in,
substantial legal and other expenses and a diversion of the efforts of our
personnel.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
The Company's Registration Statement on Form S-1 (Registration No.
333-30705) was declared effective September 25, 1997 by the Securities and
Exchange Commission. The managing underwriters of the Class A common stock
offering commencing September 26, 1997 were Hambrecht & Quist, J.P. Morgan & Co.
and PaineWebber Incorporated. The Company registered and sold 3,220,000 shares
(pre-split) for its own account at an aggregate price of $57,960,000 and the
selling stockholder (SAIC) registered and sold 575,000 shares (pre-split) for
its account at an aggregate price of $10,350,000, for a combined total of
3,795,000 shares (pre-split) at an aggregate price of $68,310,000. The offering
has since terminated.
The total amount of expenses incurred for the Company's account in
connection with the offering was $5,555,200, which is comprised of $4,057,200
for underwriting discounts and commissions and $1,498,000 of other expenses. No
expenses were paid to directors, officers or persons owning more than ten
percent of any class of the Company's equity securities. The resultant Company's
net offering proceeds were $52,404,800. The net proceeds to SAIC for its account
were $9,625,500 after deducting the associated underwriting discounts and
commissions of $724,500.
On October 1, 1997, the Company received the offering proceeds from which a
$10,000,000 dividend was paid to SAIC. SAIC owns ten percent or more of a class
of the Company's equity securities and is an affiliate of the Company. The
remaining proceeds have been invested in investment grade government discount
notes, commercial paper and corporate bonds.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The Company's Annual Meeting of Stockholders was held on May 18, 1999 (the
"Annual Meeting"). At the Annual Meeting, stockholders voted on three matters:
(i) the election of eight directors; (ii) the approval of a proposal to amend
the Company's Second Amended and Restated Certificate of Incorporation (the
"Certificate of Incorporation") to reclassify the Company's Class A common
stock, par value $0.001 per
29
share, and Class B common stock, par value $0.001 per share, as shares of the
Company's common stock, par value $0.001 per share (the "Common Stock"); and
(iii) the approval of a proposal to amend the Company's Certificate of
Incorporation to increase the number of authorized shares of the Company's
Common Stock from 130,000,000 to 210,000,000. The stockholders elected
management's nominees as the directors in an uncontested election and approved
the amendments to the Certificate of Incorporation by the following votes,
respectively:
(i) Election of directors:
[Enlarge/Download Table]
DIRECTOR VOTES FOR VOTES WITHHELD
-------- ---------- --------------
Michael A. Daniels.......................................... 81,911,557 71,776
Donald N. Telage............................................ 81,914,148 69,185
J. Robert Beyster........................................... 81,908,815 74,518
Craig I. Fields............................................. 81,913,130 70,203
John E. Glancy.............................................. 81,911,257 72,076
J. Dennis Heipt............................................. 81,912,656 70,677
William A. Roper, Jr........................................ 81,913,757 69,576
Stratton D. Sclavos......................................... 81,926,509 56,824
(ii) Approval of a proposal to amend the Company's Certificate of
Incorporation to reclassify the Company's Class A common stock, par value $0.001
per share, and Class B common stock, par value $0.001 per share, as shares of
Common Stock, par value $0.001 per share:
[Enlarge/Download Table]
VOTES FOR VOTES AGAINST ABSTENTIONS
---------- ------------- -----------
Amendment to Reclassify Shares................. 81,905,816 69,345 8,172
(iii) Approval of a proposal to amend the Certificate of Incorporation to
increase the number of authorized shares of Common Stock from 130,000,000 to
210,000,000:
[Enlarge/Download Table]
VOTES FOR VOTES AGAINST ABSTENTIONS
---------- ------------- -----------
Amendment to Increase Authorized Shares........ 81,735,582 241,231 6,520
For further discussion of these matters, see the Company's definitive Proxy
Statement for the May 18, 1999 Annual Meeting of Stockholders, which was filed
with the Commission on April 16, 1999.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits -- See Exhibit Index
(b) Reports on Form 8-K -- None
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NETWORK SOLUTIONS, INC.
By: /s/ ROBERT J. KORZENIEWSKI
------------------------------------
Robert J. Korzeniewski
Chief Financial Officer and
Authorized Signatory
Date: August 16, 1999
31
INDEX TO EXHIBITS
NETWORK SOLUTIONS, INC.
THREE MONTHS ENDED JUNE 30, 1999
[Download Table]
EXHIBIT SEQUENTIAL
NO. DESCRIPTION OF EXHIBITS PAGE NO.
------- ----------------------- ----------
3(iii) Certificate of Amendment of Second Amended and Restated
Certificate of Incorporation
10.27 Amendment No. 14 to the Cooperative Agreement dated July 13,
1999
10.28 Amendment No. 15 to the Cooperative Agreement dated July 16,
1999
10.29 Offer Letter between James Rutt and Network Solutions, Inc.
dated May 18, 1999
10.30 Separation Agreement between James Rutt and Network
Solutions, Inc. dated May 19, 1999
10.31 Non-Statutory Stock Option Agreement Between James Rutt and
Network Solutions, Inc. dated June 7, 1999
10.32 Non-Statutory Stock Option Agreement Between James Rutt and
Network Solutions, Inc. dated May 21, 1999
27.1 Financial Data Schedule
27.2 Restated Financial Data Schedule
32
Dates Referenced Herein and Documents Incorporated by Reference
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