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Network Solutions Inc/DE – ‘10-Q’ for 9/30/99

On:  Monday, 11/15/99   ·   For:  9/30/99   ·   Accession #:  950133-99-3630   ·   File #:  0-22967

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  As Of                Filer                Filing    For·On·As Docs:Size              Issuer               Agent

11/15/99  Network Solutions Inc/DE          10-Q        9/30/99    6:124K                                   Bowne - DC/FA

Quarterly Report   —   Form 10-Q
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: 10-Q        Quarterly Report                                      31    163K 
 2: EX-10.33    Amendment No. 16 to the Cooperative Agreement          2     15K 
 3: EX-10.34    Amendment No. 17 to Cooperative Agreement              2     14K 
 4: EX-10.35    Amendment No. 18 to the Cooperative Agreement          2     14K 
 5: EX-27.1     Financial Data Schedule                                1      6K 
 6: EX-27.2     Financial Data Schedule                                1      9K 


10-Q   —   Quarterly Report
Document Table of Contents

Page (sequential) | (alphabetic) Top
 
11st Page   -   Filing Submission
3Item 1
10Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
11Net revenue
12Cost of revenue
13Research and development expenses
"Selling, general and administrative expenses
"Interest income
14Factors Affecting Operating Results
26Forward-Looking Statements
27Item 3. Quantitative and Qualitative Disclosures About Market Risk
28Item 1. Legal Proceedings
29Item 2. Changes in Securities and Use of Proceeds
"Item 4. Submission of Matters to A Vote of Security Holders
"Item 6. Exhibits and Reports on Form 8-K
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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 SEPTEMBER 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) [Download Table] 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 November 10, 1999, the Registrant had 33,419,151 shares of common stock, $0.001 par value per share, issued and outstanding. -------------------------------------------------------------------------------- --------------------------------------------------------------------------------
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[Download Table] PAGE ---- PART I FINANCIAL INFORMATION Item 1. Financial Statements Condensed Statements of Financial Position as of December 31, 1998 and September 30, 1999 (Unaudited)............... 3 Unaudited Condensed Statements of Operations for the three and nine months ended September 30, 1998 and 1999......... 4 Unaudited Condensed Statements of Changes in Stockholders' Equity for the nine months ended September 30, 1999....... 5 Unaudited Condensed Statements of Cash Flows for the nine months ended September 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...................................................... 27 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............................ 29 Signature ............................................................ 30 Index to Exhibits..................................................... 31 2
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PART I FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS. NETWORK SOLUTIONS, INC. CONDENSED STATEMENTS OF FINANCIAL POSITION [Enlarge/Download Table] DECEMBER 31, SEPTEMBER 30, 1998 1999 ------------ ------------- (UNAUDITED) ASSETS Current assets: Cash and cash equivalents................................. $ 12,862,000 $ 98,863,000 Short-term investments.................................... 118,808,000 99,090,000 Accounts receivable, net.................................. 22,628,000 45,783,000 Prepaids and other assets................................. 4,001,000 13,415,000 Deferred tax asset........................................ 40,508,000 81,920,000 ------------ ------------ Total current assets........................................ 198,807,000 339,071,000 Furniture and equipment, net................................ 16,005,000 54,688,000 Long-term investments....................................... 13,590,000 36,013,000 Deferred tax asset.......................................... 14,831,000 29,990,000 Goodwill, net............................................... 634,000 226,000 ------------ ------------ Total Assets................................................ $243,867,000 $459,988,000 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accrued liabilities.................. $ 28,287,000 $ 41,850,000 Due to SAIC............................................... 4,766,000 6,578,000 Income taxes payable...................................... 5,409,000 8,767,000 Current portion of capital lease obligations.............. 834,000 436,000 Deferred revenue, net..................................... 93,720,000 200,160,000 ------------ ------------ Total current liabilities................................... 133,016,000 257,791,000 Capital lease obligations................................... 247,000 -- Long-term deferred revenue, net............................. 35,474,000 82,779,000 ------------ ------------ Total liabilities........................................... 168,737,000 340,570,000 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; 33,381,167 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 86,783,000 Retained earnings......................................... 2,407,000 20,278,000 Accumulated other comprehensive income.................... 359,000 12,324,000 ------------ ------------ Total stockholders' equity.................................. 75,130,000 119,418,000 ------------ ------------ Total Liabilities and Stockholders' Equity.................. $243,867,000 $459,988,000 ============ ============ The accompanying notes are an integral part of these financial statements. 3
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NETWORK SOLUTIONS, INC. CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED) [Enlarge/Download Table] THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------- -------------------------- 1998 1999 1998 1999 ----------- ----------- ----------- ------------ Net revenue.............................. $25,427,000 $59,254,000 $62,395,000 $144,885,000 Cost of revenue.......................... 10,312,000 21,788,000 26,451,000 54,040,000 ----------- ----------- ----------- ------------ Gross profit............................. 15,115,000 37,466,000 35,944,000 90,845,000 Research and development expenses........ 1,353,000 2,870,000 2,893,000 7,365,000 Selling, general and administrative expenses............................... 10,248,000 24,921,000 24,438,000 59,581,000 Interest income.......................... (1,680,000) (2,455,000) (4,423,000) (6,312,000) Other expenses........................... 26,000 11,000 93,000 45,000 ----------- ----------- ----------- ------------ Income before income taxes............... 5,168,000 12,119,000 12,943,000 30,166,000 Provision for income taxes............... 2,163,000 4,841,000 5,426,000 12,295,000 ----------- ----------- ----------- ------------ Net income............................... $ 3,005,000 $ 7,278,000 $ 7,517,000 $ 17,871,000 =========== =========== =========== ============ Earnings per common share: Basic.................................. $ 0.09 $ 0.22 $ 0.24 $ 0.54 =========== =========== =========== ============ Diluted................................ $ 0.09 $ 0.21 $ 0.23 $ 0.51 =========== =========== =========== ============ The accompanying notes are an integral part of these financial statements. 4
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NETWORK SOLUTIONS, INC. CONDENSED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED) [Enlarge/Download Table] ACCUMULATED CLASS A CLASS B ADDITIONAL OTHER TOTAL COMMON COMMON COMMON PAID-IN COMPREHENSIVE RETAINED COMPREHENSIVE STOCKHOLDERS' STOCK STOCK STOCK CAPITAL INCOME EARNINGS INCOME EQUITY ------- -------- -------- ----------- ------------- ----------- ------------- ------------- Balance, December 31, 1998................. $ -- $ 9,000 $ 24,000 $72,331,000 $ 359,000 $ 2,407,000 $ -- $ 75,130,000 Issuance of common stock pursuant to stock plans.......... -- -- -- 3,726,000 -- -- -- 3,726,000 Tax benefit associated with stock plans..... -- -- -- 10,726,000 -- -- -- 10,726,000 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 September 30, 1999... -- -- -- -- -- 17,871,000 17,871,000 17,871,000 Other comprehensive income, net of tax: Unrealized gains on securities........... -- -- -- -- 11,965,000 -- 11,965,000 11,965,000 ----------- Comprehensive income... -- -- -- -- -- -- $29,836,000 -- ------- -------- -------- ----------- ----------- ----------- =========== ------------ Balance, September 30, 1999................. $33,000 $ -- $ -- $86,783,000 $12,324,000 $20,278,000 $119,418,000 ======= ======== ======== =========== =========== =========== ============ The accompanying notes are an integral part of these financial statements. 5
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NETWORK SOLUTIONS, INC. CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED) [Enlarge/Download Table] NINE MONTHS ENDED SEPTEMBER 30, --------------------------- 1998 1999 ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income................................................ $ 7,517,000 $ 17,871,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization.......................... 2,613,000 6,440,000 Provision for uncollectible accounts receivable........ 2,168,000 -- Deferred income taxes.................................. (14,061,000) (64,876,000) Tax benefit associated with stock plans................ 2,240,000 10,726,000 Change in operating assets and liabilities: Increase in accounts receivable...................... (10,298,000) (23,155,000) Increase in prepaids and other assets................ (507,000) (9,414,000) Increase in accounts payable and accrued liabilities....................................... 9,139,000 13,563,000 Increase (decrease) in income taxes payable.......... (1,952,000) 3,358,000 Increase in deferred revenue......................... 45,279,000 153,745,000 ------------ ------------ Net cash provided by operating activities............ 42,138,000 108,258,000 ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of furniture and equipment....................... (5,639,000) (44,717,000) Redemption (purchase) of short-term investments, net...... (67,676,000) 21,223,000 Purchase of long-term investments......................... (6,012,000) (11,656,000) Proceeds from maturity of long-term investments, net...... -- 8,000,000 ------------ ------------ Net cash used in investing activities................ (79,327,000) (27,150,000) ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Net transactions with SAIC................................ 1,337,000 1,812,000 Repayment of capital lease obligations.................... (626,000) (645,000) Issuance of common stock pursuant to stock plans.......... 4,456,000 3,726,000 ------------ ------------ Net cash provided by financing activities............ 5,167,000 4,893,000 ------------ ------------ Net increase (decrease) in cash and cash equivalents........ (32,022,000) 86,001,000 Cash and cash equivalents, beginning of period.............. 41,146,000 12,862,000 ------------ ------------ Cash and cash equivalents, end of period.................... $ 9,124,000 $ 98,863,000 ============ ============ The accompanying notes are an integral part of these financial statements. 6
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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 network engineering, network and systems security and network management solutions. 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 changed from 89% to 45%, consistent with the number of Class A shares owned after the conversion. On 7
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NETWORK SOLUTIONS, INC. NOTES TO CONDENSED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 3 -- COMMON STOCK -- (CONTINUED) 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: [Enlarge/Download Table] INCOME SHARES PER SHARE (NUMERATOR) (DENOMINATOR) AMOUNT ----------- ------------- --------- THREE MONTHS ENDED SEPTEMBER 30, 1999 Basic............................................ $ 7,278,000 33,347,000 $0.22 ===== Dilutive securities: Outstanding options............................ -- 1,377,000 ----------- ---------- Diluted.......................................... $ 7,278,000 34,724,000 $0.21 =========== ========== ===== THREE MONTHS ENDED SEPTEMBER 30, 1998 Basic............................................ $ 3,005,000 32,082,000 $0.09 ===== Dilutive securities: Outstanding options............................ -- 1,410,000 ----------- ---------- Diluted.......................................... $ 3,005,000 33,492,000 $0.09 =========== ========== ===== NINE MONTHS ENDED SEPTEMBER 30, 1999 Basic............................................ $17,871,000 33,251,000 $0.54 ===== Dilutive securities: Outstanding options............................ -- 1,476,000 ----------- ---------- Diluted.......................................... $17,871,000 34,727,000 $0.51 =========== ========== ===== NINE MONTHS ENDED SEPTEMBER 30, 1998 Basic............................................ $ 7,517,000 31,776,000 $0.24 ===== Dilutive securities: Outstanding options............................ -- 1,312,000 ----------- ---------- Diluted.......................................... $ 7,517,000 33,088,000 $0.23 =========== ========== ===== 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
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NETWORK SOLUTIONS, INC. NOTES TO CONDENSED FINANCIAL STATEMENTS -- (CONTINUED) 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 nine months ended September 30, 1999 and September 30, 1998 are as follows: [Enlarge/Download Table] UNREALIZED GAINS (LOSSES) UNREALIZED GAINS ON SECURITIES ON SECURITIES THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------- ---------------------- 1998 1999 1998 1999 ---------- ------------ -------- ----------- Pre-tax amount........................ $(107,000) $(7,298,000) $260,000 $20,270,000 Income taxes.......................... (36,000) (3,272,000) 109,000 8,305,000 --------- ----------- -------- ----------- Net of tax amount..................... $ (71,000) $(4,026,000) $151,000 $11,965,000 ========= =========== ======== =========== NOTE 6 -- SUBSEQUENT EVENTS STATUS OF PRIVITIZATION ADMINISTRATION On November 10, 1999, a series of wide-ranging agreements were entered into relating to the domain name system. These agreements consist of the following: - A registry agreement between Network Solutions and the Internet Corporation for Assigned Names and Numbers ("ICANN") under which Network Solutions will continue to act as the exclusive registry for the .com, .net and .org top level domains for at least four more years. - A revised registrar accreditation agreement between ICANN and all registrars registering names in the .com, .net and .org domains. - A revised registrar license and agreement between Network Solutions as registry and all registrars registering names in the .com, .net and .org domains using Network Solutions' proprietary shared registration system. - Amendment 19 to the Cooperative Agreement. - An amendment to the Memorandum of Understanding ("MOU") between the U.S. Government and ICANN. Under these agreements Network Solutions has recognized ICANN as the not-for-profit corporation described in Amendment 11 to the Cooperative Agreement, has become an ICANN-accredited registrar and has agreed to operate the registry in accordance with the provisions of the registry agreement and the consensus policies established by ICANN in accordance with the terms of that agreement. Network Solutions will be an accredited registrar through November 9, 2004 with a right to renew indefinitely. As the registry, Network Solutions will continue to charge registrars $9 per registration-year until January 15, 2000. Thereafter, the fee will be $6 per registration-year unless increased to cover increases in registry costs under the circumstances described in the registry agreement. The term of the registry agreement extends until November 9, 2003, except that if the ownership of Network Solutions' registry and registrar operations is separated within 18 months as described in the agreement, the registry agreement term would be extended for four additional years. Network Solutions has agreed to pay annual fees set by ICANN at levels not to exceed $2 million for Network Solutions registrar and $250,000 for the Network Solutions registry. 9
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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 a series of wide-ranging agreements with ICANN and the Department of Commerce that were entered into on November 10, 1999. 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 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 10
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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 September 1999, approximately 35% 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 September 30, 1999, Network Solutions had net deferred revenue of $283 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 58.8% of Network Solutions' Internet Technology Services business net revenue and 2.8% of Network Solutions' total net revenue for the three months ended September 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 133% from $25.4 million for the three months ended September 30, 1998 to $59.3 million for the three months ended September 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 144% from $23.1 million for the three months ended September 30, 1998 to $56.4 million for the three months ended September 30, 1999. Net new registrations for Network Solutions' Registrar (NSI Registrar) increased 160% from 507,000 for the three months ended September 30, 1998 to 1,318,000 for the three months ended September 30, 1999. This also represents a 12% increase over the 1,180,000 net new registrations for the three months ended June 30, 1999. NSI Registrar new international registrations totaled 406,000 in the third quarter of 1999, up 194% from the 11
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third quarter of 1998 total of 138,000. Non-NSI registrars registered an additional 190,000 names with Network Solutions' registry, bringing the total new registrations for the quarter in .com, .net and .org top level domains to 1.5 million. 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. In addition, value added services were sold to approximately 15% of NSI Registrar's 1,318,000 new registrations in the third quarter. These value added services present potential growth areas for Network Solutions. Cumulative net registrations for the NSI Registrar as of September 30, 1998 were 2,777,000 as compared to 6,528,000 as of September 30, 1999, for a 135% increase. In addition, this growth in cumulative net registrations represents a 23% increase in NSI Registrar's entire customer base since June 30, 1999. Net revenue from Internet Technology Services increased 26% from $2.3 million for the three months ended September 30, 1998 to $2.9 million for the three months ended September 30, 1999. This represents a 7% increase in net revenue from Internet Technology Services from the three months ended June 30, 1999. Bank of America accounted for $1.7 million or 2.8% of Network Solutions' total net revenue for the three months ended September 30, 1999 and $1.2 million or 4.7% for the three months ended September 30, 1998. Net revenue increased 132% from $62.4 million for the nine months ended September 30, 1998 to $144.9 million for the nine months ended September 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 $57.7 million for the nine months ended September 30, 1998 to $136.1 million for the nine months ended September 30, 1999. Net new registrations for NSI Registrar during the nine month period ended September 30, 1999 were 3.4 million as compared to 1.3 million during the nine month period ended September 30, 1998, an increase of 162%. Due in part to the addition of nearly 40 international partners, 1.0 million, or 30%, of net new registrations were international registrations for the nine months ended September 30, 1999. Net revenue from Internet Technology Services increased 89% from $4.7 million for the nine months ended September 30, 1998 to $8.9 million for the nine months ended September 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 $3.5 million or 2.4% of Network Solutions' total net revenue for the nine months ended September 30, 1999, and $2.3 million or 3.7% for nine months ended September 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 112% from $10.3 million for the three months ended September 30, 1998 to $21.8 million for the three months ended September 30, 1999. The increase was primarily driven by the growth of Network Solutions' registration business which experienced additional outsourcing costs of $3.8 million in support of invoicing, collection and processing activities, $3 million in additional depreciation charges and equipment expenditures and additional direct labor charges of $3.2 million related to systems engineering and operations. As a percentage of net revenue, cost of revenue decreased from 40.6% for the three months ended September 30, 1998 to 36.7% for the three months ended September 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 104% from $26.5 million for the nine months ended September 30, 1998 to $54.0 million for the nine months ended September 30, 1999. This increase was driven by a $10.1 million increase in outsourcing costs and $6 million in additional depreciation charges and equipment expenditures and additional direct labor charges of $7.6 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 42.4% for the nine months ended September 30, 1998 to 37.3% for the nine months ended September 30, 1999 reflecting economies of scale achieved in Network Solutions' registration business. 12
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Research and Development Expenses. Research and development expenses consist primarily of compensation expenses to support the creation, development and enhancement of Network Solutions' products and technologies. Research and development expenses increased 107% from $1.4 million for the three months ended September 30, 1998 to $2.9 million for the three months ended September 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 5.3% and 4.8% for the three months ended September 30, 1998 and 1999, respectively. Research and development expenses increased 155% from $2.9 million for the nine months ended September 30, 1998 to $7.4 million for the nine months ended September 30, 1999. As a percentage of net revenue, research and development expenses increased from 4.6% for the nine months ended September 30, 1998 to 5.1% for the nine months ended September 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. Selling, general and administrative expenses increased 144% from $10.2 million for the three months ended September 30, 1998 to $24.9 million for the three months ended September 30, 1999. The increase was primarily attributable to a $8.1 million increase in marketing and business development expenses including Internet banner advertising and targeted direct mail campaigns, increased staffing expenses of $2.3 million and an increase of other professional costs of $2.7 million. As a percentage of net revenue, selling, general and administrative expenses increased from 40.3% for the three months ended September 30, 1998 to 42.1% for the three months ended September 30, 1999. Selling, general and administrative expenses increased 144% from $24.4 million for the nine months ended September 30, 1998 to $59.6 million for the nine months ended September 30, 1999. This increase was primarily attributable to a $22.4 million increase in marketing and business development expenses including Internet banner advertising and targeted direct mail campaigns, increased staffing expenses of $4.3 million and an increase of other professional costs of $5 million. As a percentage of net revenue, selling, general and administrative expenses increased from 39.2% for the nine months ended September 30, 1998 to 41.1% for the nine months ended September 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 NSI Registrar continues to promote the value of a .com web address and other new Internet-based value-added services including web site design and enhanced service offerings. NSI Registrar also plans to continue to develop and enhance its extensive partner and distribution channels, both domestically and internationally in light of the new competitive environment. Interest Income. Network Solutions had net interest income of $1.7 million for the three months ended September 30, 1998 as compared to $2.5 million for the three months ended September 30, 1999. Network Solutions had net interest income of $4.4 million for the nine months ended September 30, 1998 as compared to $6.3 million for the nine months ended September 30, 1999. The increase for both the three month and nine 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 $2.2 million for the three months ended September 30, 1998, and 40%, or $4.8 million for the three months ended September 30, 1999. The provision for income taxes was 42% or $5.4 million for the nine months ended September 30, 1998, and 41% or $12.3 million for the nine months ended September 30, 1999. 13
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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 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 September 30, 1999, Network Solutions' principal source of liquidity was its cash and cash equivalents of $98.9 million and its short-term investments of $99.1 million, which when combined represent an increase of $66.3 million from its December 31, 1998 balances in those accounts. Network Solutions also has $36 million of marketable securities held as long term investments as of September 30, 1999. At September 30, 1999, Network Solutions' cumulative net obligation to SAIC for intercompany activity was $6.6 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 remits income tax payments directly to tax authorities as it no longer is part of SAIC's consolidated group for income tax purposes. Cash provided by operations was $108.3 million for the nine months ended September 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. Cash used in investing activities totaled $27.2 million for the nine months ended September 30, 1999. Capital expenditures of $44.7 million and net long-term investment purchases of $3.7 million were partially offset by the redemption of $21.2 million of short-term investments. Investments during the period include a $2.0 million investment in Critical Path, a strategic business partner, which subsequently consummated its initial public offering during the period. Also during the period, a $9.7 million investment was made in RealNames Corporation, a strategic business partner which filed its S-1 Registration Statement on October 6, 1999. Critical Path provides outsourced email services in support of Network Solutions' value-added email product offerings. RealNames provides an Internet keyword service that Network Solutions promotes in its value-added product offerings. Capital expenditures year to date were $44.7 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 14
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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 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. This process resulted in the entry by the U.S. Government into a Memorandum of Understanding, or "MOU," with 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." 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 recognized ICANN as the not-for-profit corporation described in Amendment 11 to the Cooperative Agreement, in the performance of ICANN's obligations under the MOU and until such time as the MOU is terminated. On November 10, 1999, a series of wide-ranging agreements were entered into relating to the domain name system. These agreements consist of the following: - A registry agreement between us and ICANN under which we will continue to act as the exclusive registry for the .com, .net and .org top level domains for at least four more years. - A revised registrar accreditation agreement between ICANN and all registrars registering names in the .com, .net and .org domains. - A revised registrar license and agreement between us as registry and all registrars registering names in the .com, .net and .org domains using our proprietary shared registration system. - Amendment 19 to the Cooperative Agreement. - An amendment to the MOU. Under these agreements we have recognized ICANN as the not-for-profit corporation described in Amendment 11 to the Cooperative Agreement, have become an ICANN-accredited registrar and have agreed to operate the registry in accordance with the provisions of the registry agreement and the consensus policies established by ICANN in accordance with the terms of that agreement. We will be an accredited registrar through November 9, 2004 with a right to renew indefinitely. On or before March 9, 2000, we are required to implement a system under which we will not accept the registration of a domain name as a registrar unless we are satisfied that we have received a reasonable assurance of payment of the registration fee. We are entitled to establish our own prices for registrar services so long as we do so only for registrations for which we have a reasonable assurance of payment of the registration fee. As the registry, we will continue to charge registrars $9 per registration-year until January 15, 2000. Thereafter, the fee will be $6 per registration-year unless increased to cover increases in registry costs under the circumstances described in the registry agreement. 15
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We have agreed to use our best commercial efforts to implement by January 15, 2000 modifications to the shared registration system that will enable a registrar to (a) accept registrations and renewals in one-year increments and (b) add one year to a registrant's registration period upon transfer of a registration from one registrar to another. The unexpired term of any registration may not exceed ten years. We are contractually obligated to provide equivalent access to the shared registration system to all ICANN-accredited registrars and to ensure that the revenues and assets of the registry are not utilized to advantage our registrar activities to the detriment of other registrars. We have agreed to and have implemented an organizational conflict of interest compliance plan that includes organizational, physical and procedural safeguards in connection with the foregoing. The term of the registry agreement extends until November 9, 2003, except that if the ownership of our registry and registrar operations is separated within 18 months as described in the agreement, the registry agreement term would be extended for four additional years. Department of Commerce approval would be required for the transfer of our registry operations and for the designation of a successor registry by ICANN. Upon expiration of the agreement, ICANN will conduct a process for selecting a successor registry, in which case we may compete on an equal basis. If, during the term of the agreement, we fail to remedy any breach by us of the agreement, we may be terminated as the registry for the .com, .net and .org domains. ICANN is contractually obligated to the registry and to all accredited registrars to comply with specified procedural requirements governing the exercise of its authority. The agreements also explicitly define the subjects within the scope of ICANN's authority with respect to both the registry and registrars. ICANN's authority to set policy for the registry may be terminated if (a) ICANN breaches the registry agreement and fails to remedy that breach; (b) the Department of Commerce withdraws its recognition of ICANN; or (c) the Department of Commerce concludes that ICANN has not made sufficient progress towards entering into agreements with other registries and we are competitively disadvantaged. In the event ICANN's authority is terminated, the Department of Commerce will assume the policy-setting function for registry services for the .com, .net and .org domains. We have agreed to pay annual fees set by ICANN at levels not to exceed $2 million for our registrar and $250,000 for our registry. We have agreed to provide to the Department of Commerce control over the content and use of the internic.net web site, subject to transition arrangements set forth in the agreements. All accredited registrars are obligated to provide query-based access to registration data and are barred from placing conditions upon any legal use of that data, except to prohibit use of the data to enable the transmission of mass unsolicited commercial solicitations via e-mail (spam) or to enable high volume, automated electronic processes that apply to the registrar (or its systems). In addition, all accredited registrars are required to provide third-party bulk access to registration data (subject to the restrictions described above) for an annual fee not to exceed $10,000. This obligation will remain in effect until replaced by a different policy adopted by ICANN or a finding by the Department of Commerce that no individual or entity is able to exercise market power with respect to data used for development of third-party value added products and services. The Statement of Policy calls for a phased transition of the Department of Commerce's responsibilities for the domain name system to ICANN by September 30, 2000. We face risks from this transition, including: - ICANN could adopt or promote policies, procedures or programs that are unfavorable to our role as the registry or as a registrar or that are not consistent with our current or future plans, - Legal, regulatory or other challenges could be made, including challenges to the agreements described above or to the legal authority underlying the roles and actions of the Department of Commerce, ICANN and/or us, - The Department of Commerce or ICANN could assert that we are not continuing to provide equivalent access to all accredited registrars or that we are using the revenues or assets of our registry to advantage our registrar to the detriment of other competing registrars, 16
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- ICANN could declare us in breach of the registry agreement and/or the registrar accreditation agreement and terminate our ability to be the registry and/or a registrar, - The Department of Commerce could declare us in breach of Amendment 19 to the Cooperative Agreement and terminate our ability to be the registry and/or a registrar, - Congress has held two hearings in which various issues about the domain name system have been raised and Congress could take action which is unfavorable to us, - If we do not seek to separate ownership of our registry and registrar businesses within 18 months, as described in the agreements, the term of the registry agreement could expire in four years and we may not be chosen as the successor registry, - The terms of the registrar accreditation contract could change, as a result of an ICANN-adopted policy, in a manner which is unfavorable to us, - The Department of Commerce's interpretation of certain provisions of the Cooperative Agreement could differ from ours, - The Department of Commerce could revoke its recognition of ICANN, as a result of which the Department of Commerce would step into the shoes of ICANN for purposes of the various agreements described above, and could take actions which are harmful to us, - The requirement that we provide bulk access to registrant data could hurt our value-added services, - ICANN could fail to gain legitimacy resulting in instability in domain name system administration, and - The U.S. Government could refuse to transfer certain responsibilities for domain name system administration to ICANN due to security, stability or other reasons resulting in fragmentation or other instability in domain name system administration. 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. As of November 10, 1999, our shared registration system was being used by 17 accredited (in addition to us) 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, as ICANN has accredited 48 additional registrars as of such date. The accredited registrars include large companies such as: America Online, Inc., AT&T, CORE or "Internet Council of Registrars", France Telecom Oleane, Melbourne IT, Register.com, PSINet, Inc., Verio, Inc., iDirections, Inc., NetBenefit, NameSecure.com, and interQ Incorporated. For the quarter ended September 30, 1999, we registered 1.3 million net new domain names and competing accredited registrars registered 190,000 names. 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. 17
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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 billing practices. Some registrars and 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. 18
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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 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
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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 of the registrar and registry 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 in the new competitive environment. 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 have recently been implemented, 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 limit the 20
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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. 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. 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 and profitability include: - variations in the number of requests for domain name registrations or demand for our services, - successful competition by others, 21
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- termination or completion of contracts in our Internet Technology Services business or failure to obtain additional contracts in that business, - market acceptance of new service offerings, and - the success of our recent reorganization into separate business units. 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 November 12, 1999, the reported sales price for our common stock ranged from $51.75 per share to $155.94 per share. On November 12, 1999, the reported last sale price of our common stock was $150.06 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. 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 22
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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 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- 23
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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 for the most critical dates has been completed. As remediated code is successfully tested, it is released into production incrementally, a process which was completed by October 16, 1999. However, should vendors release additional patches related to the Year 2000 millennium change, Network Solutions will continue to deploy changes during regularly scheduled maintenance windows; - 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 was completed by October 16, 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 contingency and business continuation plans have been completed and they 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. Network Solutions has completed the testing phase of its project cycle although Network Solutions will continue to use its test environment to evaluate less critical processes into and through the transition to the Year 2000. 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, 24
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software and components used by its employees Year 2000 compliant are not material. Network Solutions is incurring some incremental costs directly relating to staff augmentation for the Year 2000 program management and technical assessment. Through September 30, 1999, the costs expended by Network Solutions are approximately $2,000,000. Network Solutions' expected total costs, including remediation and replacement costs, are estimated to be between $2,500,000 and $2,750,000 over the life of the Year 2000 project. Since portions of the mission critical "back office" and domain name registration-related systems have been 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 has incurred costs for extending its software testing architecture which, in addition to testing remediated systems, is 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 maintaining contact with its hardware and software vendors, significant suppliers, outsourcing service providers and contracting parties to monitor 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 upgrades to the "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 tested those systems. 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 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 will undergo significant upgrades before the end of 1999. As 25
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a contingency planning measure, Network Solutions has conducted a technical assessment of the current systems and their software applications, taken corrective action where necessary, tested those changes, and deployed into production the remediated software. - 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 follow-up 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' finding that its enhancement effort has resulted 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 has performed a test on the existing core registration-related systems that were upgraded. Such test was performed by conducting end-to-end testing of the existing core registration-related systems in a test environment mirroring the production system environment. 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. Network Solutions is aware that many companies that have their own DNS servers are running older copies of BIND software which are not certified Year 2000 compliant, although the current version of BIND, version 8.x, is so certified. BIND is the most commonly used program for DNS resolution at the server level and is created and distributed by the Internet Software Consortium. Network Solutions has not determined whether the older versions of BIND could present a significant Year 2000 problem. Network Solutions has made available test support materials to aid DNS operators in their evaluation of their local compliance. 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. 26
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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. 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
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PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS As of November 4, 1999, we were a defendant in 9 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 59 out of approximately 8,661 of these situations have resulted in suits actually naming us as a defendant, as of November 4, 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 490 top level domains to the Internet root zone 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. Oral argument on the appeal occurred on November 4, 1999. 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. The plaintiffs have now filed a Petition for a writ of Certiorari with the U.S. Supreme Court on October 12, 1999. We plan to oppose that Petition. 28
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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. None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits -- See Exhibit Index (b) Reports on Form 8-K -- None 29
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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: November 15, 1999 30
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INDEX TO EXHIBITS NETWORK SOLUTIONS, INC. THREE MONTHS ENDED SEPTEMBER 30, 1999 [Download Table] EXHIBIT SEQUENTIAL NO. DESCRIPTION OF EXHIBITS PAGE NO. ------- ----------------------- ---------- 10.33 Amendment No. 16 to the Cooperative Agreement dated August 18, 1999 10.34 Amendment No. 17 to the Cooperative Agreement dated October 11, 1999 10.35 Amendment No. 18 to the Cooperative Agreement dated October 11, 1999 27.1 Financial Data Schedule 27.2 Restated Financial Data Schedule 31

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11/9/04915
11/9/03916
9/30/001016
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1/15/00916
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11/12/9922
11/10/991178-K
11/4/9928
10/16/9924
10/12/9928
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For Period End:9/30/99131
7/20/9928
7/9/9929
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6/17/998298-A12G/A
6/3/997
5/14/9928
4/29/9929
4/15/9928
3/30/991010-K
3/23/997
3/16/9928
2/26/997
2/25/9928
2/12/997SC 13G/A
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4/6/9828
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3/12/9811SC 13G/A
2/10/9828
10/17/9728
10/1/971029
9/26/971429424B1
9/25/9729S-1/A
9/17/9728
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4/1/9710
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