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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington,WASHINGTON, D.C. 20549
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FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)15(D) OF THE SECURITIES EXCHANGE ACT
OF 1934
(No Fee Required)
For the Fiscal Year Ended DecemberFOR THE FISCAL YEAR ENDED DECEMBER 31, 19971998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
(No Fee Required)
For the Transition Period from to
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Commission File NumberFOR THE TRANSITION PERIOD FROM ________ TO ________
COMMISSION FILE NUMBER 0-22967
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NETWORK SOLUTIONS, INC.
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(Exact name of registrant as specified in its charter)
DelawareDELAWARE 52-1146119
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(StateState or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)organization
505 Huntmar Park Drive, Herndon, VirginiaHUNTMAR PARK DRIVE 20170
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(Address of principal executive offices)HERNDON, VIRGINIA (Zip Code)
(703) 742-0400
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(Registrant's telephone number,
including area code)(Address of principal executive offices)
(703) 742-0400
Registrant's telephone number, including area code
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Class A Common Stock, $.001 Par Value
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for at least the past 90 days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ][X]
The aggregate market value of the voting stock held by non-affiliates of
the registrant was approximately $82,025,402.50$2,029,595,706 on March 13, 199812, 1999 based on the
last sale price as reported by the Nasdaq National Market System.
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The aggregate numberAs of outstandingMarch 12, 1999, the registrant had 18,384,634 shares of Class A
Common Stock,
$.001common stock, $0.001 par value per share, issued and outstanding, and 14,850,000
shares of the registrant was 3,813,063 shares as of March 13, 1998.Class B common stock, $0.001 par value per share, issued and
outstanding which is not publicly traded.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement for the annual
meeting of shareholders to be held on May 19, 1998,18, 1999, which will be filed with the
Commission within 120 days after the end of the registrant's fiscal year ended
December 31, 1997,1998, are incorporated by reference into Part III of this Form
10-K.
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TABLE OF CONTENTS
PagePAGE
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PART I
ITEMItem 1. BUSINESS ................................................................................... 4
ITEMBusiness.................................................... 1
Item 2. PROPERTIES..................................................................................33
ITEMProperties.................................................. 20
Item 3. LEGAL PROCEEDINGS...........................................................................33
ITEMLegal Proceedings........................................... 20
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.........................................34Submission of Matters to a Vote of Security Holders......... 22
PART II
ITEMItem 5. MARKET FOR REGISTRANT'S COMMON STOCK AND
RELATED STOCKHOLDER MATTERS.................................................................36
ITEMMarket for Registrant's Common Equity Stock and Related
Stockholder Matters......................................... 24
Item 6. SELECTED FINANCIAL DATA.....................................................................38
ITEMSelected Financial Data..................................... 25
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS...............................................40
ITEMManagement's Discussion and Analysis of Financial Condition
and Results of Operation.................................... 28
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK...........................................................................53
ITEMQuantitative and Qualitative Disclosures About Market
Risk........................................................ 42
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.................................................53
ITEMFinancial Statements and Supplementary Data................. 42
Item 9. CHANGES IN AND DISAGREEMENTS WITH
ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE..................................................................................53Changes In and Disagreements With Accountants on Accounting
and Financial Disclosure.................................... 43
PART III
ITEMItem 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT..........................................53
ITEMDirectors and Executive Officers of the Registrant.......... 43
Item 11. EXECUTIVE COMPENSATION......................................................................53
ITEMExecutive Compensation...................................... 43
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT..............................54
ITEMSecurity Ownership of Certain Beneficial Owners and
Management.................................................. 43
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS..............................................54Certain Relationships and Related Transactions.............. 43
PART IV
ITEMItem 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K............................54
SIGNATURES....................................................................................................56Exhibits, Financial Statement Schedules, and Reports on Form
8-K......................................................... 44
Signatures.................................................. 46
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PART I
THIS ANNUAL REPORT ON FORM 10-K CONTAINS FORWARD-LOOKING STATEMENTS THAT
HAVE BEEN MADE PURSUANT TO THE PROVISIONS OF THE PRIVATE SECURITIES LITIGATION
REFORM ACT OF 1995. SUCHTHESE FORWARD-LOOKING STATEMENTS ARE BASED ON MANAGEMENT'S
CURRENT EXPECTATIONS, ESTIMATES AND PROJECTIONS, BELIEFS AND ASSUMPTIONS. WORDS
SUCH AS "ANTICIPATES," "EXPECTS," "INTENDS," "PLANS," "BELIEVES," "SEEKS,"
"ESTIMATES," VARIATIONS OF SUCH WORDS AND SIMILAR EXPRESSIONS ARE INTENDED TO
IDENTIFY SUCH FORWARD-LOOKING STATEMENTS. THESE STATEMENTS ARE NOT GUARANTEES OF
FUTURE PERFORMANCE AND ARE SUBJECT TO CERTAIN RISKS, UNCERTAINTIES AND
ASSUMPTIONS THAT ARE DIFFICULT TO PREDICT; THEREFORE, ACTUAL RESULTS MAY DIFFER
MATERIALLY FROM THOSE EXPRESSED OR FORECASTED IN ANY SUCH FORWARD-LOOKING
STATEMENTS. SUCHTHESE RISKS AND UNCERTAINTIES INCLUDE THOSE SET FORTH HEREINDISCUSSED BELOW UNDER
"BUSINESS-RISK"BUSINESS -- RISK FACTORS" ON PAGES 1911 THROUGH 3220 AND ELSEWHERE IN THIS FORM
10-K. UNLESS REQUIRED BY LAW, THE COMPANY UNDERTAKESWE UNDERTAKE NO OBLIGATION TO UPDATE PUBLICLY ANY
FORWARD-LOOKING STATEMENTS, WHETHER AS A RESULT OF NEW INFORMATION, FUTURE
EVENTS OR OTHERWISE. HOWEVER, READERS SHOULD CAREFULLY REVIEW THE FACTORS
SET
FORTHDISCUSSED IN OTHER REPORTS OR DOCUMENTS THE COMPANY FILESTHAT WE FILE FROM TIME TO TIME WITH THE
SECURITIES AND EXCHANGE COMMISSION, PARTICULARLY THE QUARTERLY REPORTS ON FORM
10-Q AND ANY CURRENT REPORTS ON FORM 8-K.
ITEM 1. BUSINESS.BUSINESS
OVERVIEW
Network Solutions, Inc. (the "Company" or "Network Solutions") isWe are the leading Internet domain name registration servicesservice provider
worldwide. The
CompanyWe currently actsact as the exclusive registry and registrar for second
level domain names within the .com, .org, .net and .edu top-leveltop level domains ("TLDs") pursuant tounder
a cooperative agreement (the "Cooperative Agreement") with the National Science
Foundation (the "NSF"). The Cooperative Agreement became effective January 1,
1993. It includes a three-month phase-in period, a five-year operational period
(commencing April 1, 1993 and ending March 31, 1998), and a six-month
"flexibility period" through September 30, 1998.Department of Commerce. We also facilitate
global registration of domain names in other existing top level domains
including country code top level domains.
By registering Internet domain names, the Company enableswe enable businesses, other
organizations and individuals to establish a unique Internet identitypresence from which
to communicate and conduct commerce. The Company also is responsible for maintaining the .com, .org, .net,
and .edu TLD zone files, which contain the second-levelAn Internet domain name is made up of a top
level domain and its
corresponding Internet Protocol ("IP") numeric address. In this capacity,a second level domain. For example, in the Company enablesdomain name
"companyX.com," "companyX" is the efficient operationsecond level domain and ".com" is the top
level domain. As a registry, we maintain the master database of the Internet by supplying or making
available to the Internet root servers located around the world an identical
copy of the file for all second level
domain names registered in these TLDs.
On February 20, 1998,for our top level domains. As a registrar, we enter new second
level domain names into the National Telecommunicationsmaster database maintained by us, as registry, and
Information
Administration ofprocess modifications, transfers, re-registrations and deletions for existing
second level domain names.
We have agreed with the Department of Commerce (the "NTIA") published for commentto transition to a shared,
or competitive, registration system in the Federal Register a proposed rule which if issued, would provide, among
other things, (i) that additional companies could act asmultiple registrars formay register
second level domain names withinwith us, as registry, in the .com, .net and .org and .net TLDs and (ii) that
additional TLDs would be permittedtop
level domains. This transition will occur in a phased approach with limited
competition scheduled to be added to the Internet's root zone
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system. See "Relationship with the NSF; Recent Developments in Internet
Governance" and "Competition."
Through its Consulting Services Division, the Company provides enterprise
network consulting services to large businesses that desire to establish or
enhance their Internet presence or "re-engineer" legacy network infrastructures
to accommodate the integration of both Internet connectivity and Intranet
network technology into their information technology base. The Division's
service offerings have evolved from the Company's Internet pioneering efforts
that date back to 1979 and presently include: (i) network engineering; (ii)
network and systems security; and (iii) network management.begin April 26, 1999.
In addition, the Company intends to offer1998, we introduced a portfolio of Internet-based products and services.
We also provide Internet technology consulting services that will draw upon its positionfocus on network
engineering, network and systems security and network management.
On December 31, 1998, our Board of Directors approved a two-for-one stock
split of the shares of our Class A common stock and Class B common stock, that
was effected in the registration
businessform of a 100%
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stock dividend distributed on March 23, 1999 on shares of our Class A common
stock and make proper use ofClass B common stock outstanding on February 26, 1999. Except as noted
otherwise, all share or per share information in this Annual Report on Form 10-K
has been adjusted to reflect the customer data that the Company collects.
The Company wastwo-for-one stock split.
We were incorporated in Washington, D.C. in 1979 as Network Solutions
Incorporated. The Company wasWe were acquired by Science Applications International
Corporation, ("SAIC"),or SAIC, an employee-owned, diversified professional and technical
services company that designs, develops and manufactures high-technology
products, on March 10, 1995, and waswere reincorporated as Network Solutions, Inc.
in Delaware in November 1996. The CompanyWe completed itsour initial public offering ("IPO") of
3,795,000 shares (pre-split) of itsour Class A common stock, $.001 par value, ("Class A Common Stock"), on
October 1, 1997. As of March 13,
1998,12, 1999, SAIC owned 100% of the Company'sour Class B common
stock, $.001 par value, ("Class B Common Stock"), representing approximately 75.8%45% of the Company'seconomic interest
of our outstanding common stock, $.001 par value, ("Common Stock"), and 96.9%approximately 89% of the
combined voting power of the Company'sour outstanding Class A and Class B Common
Stock. The Company'scommon stock. Our
principal executive offices are located at 505 Huntmar Park Drive, Herndon,
Virginia 20170, itsour telephone number is (703)742-0400 and itsour Class A Common Stockcommon
stock is traded on the Nasdaq National Market under the ticker symbol NSOL.
INDUSTRY BACKGROUND
The Internet is a global network of millions of interconnected computers
and computer networks that allow businesses, other organizations and individuals
to communicate. Historically,OUR BUSINESS
We provide the Internet had been used by a limited number of
academic institutions, defense contractors and government agencies to facilitate
remote access to host computers and transmit electronic mail. However, use of
the Internet has now become dominated by a broad range of commercial
organizations and individuals who utilize the Internet to communicate
electronically, to distribute and retrieve information and to conduct commerce.
Advances in technology, low-cost Internet access and an increasing corporate
reliance on distributed information environments have fueled the rapid growth of
the Internet.
The Company believes that in order to support the demands placed on this
evolving and rapidly growing medium of commerce and information exchange, a wide
range offollowing:
- Domain name registration services,
- Internet-based products and services, will need to be developed and
enhanced,
including: (i) domain name registration services; (ii) Internet-based products
and services; and (iii) enterprise network consulting- Internet technology services.
Domain Name Registration Services. All communication on the Internet
requires a unique numerical electronic address called an IP address. However,
since IP addresses are hard to remember, the Internet functions through the
establishment of a unique Internet identity (a "domain name") that correlates to
an IP address and the proliferation of such domain names in the global Internet
root servers. Currently, there are 13 root servers, ten of which are located in
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the United States, two of which are located in Europe and one of which is
located in Asia. When communication with a particular domain name is required
and the IP address of that domain name's host is not known locally, the root
servers "point" to a direct or indirect source of the information. See "Risk
Factors - Reliance on Third Parties."
An Internet domain name is made up of a TLD, such as .com, .org, .net or
.edu, and additional domain levels consisting of at least one additional domain
level, referred to as a second level domain name. For example, in the domain
name "companyX.com," "companyX" is the second level domain name. With the
increased commercialization of the Internet, second level domain names are being
utilized not only by large corporations but also increasingly by other users,
including small businesses, organizations and individuals. Particularly within
the .com TLD, users are also registering domain names to establish Internet
identities for other purposes such as trademarks, products and events. The most
common TLDs include .com, .org, .net, .edu and .gov, as well as country code
TLDs represented by "." followed by two letter country codes (e.g., .us for the
United States, .uk for the United Kingdom and .de for Germany).
The Internet is not bound by geography or lines of business and
coordination and administration services are required for the registration,
allocation and use of TLDs and for the effective operation of the Internet. In
1992, the NSF entered into the Cooperative Agreement with the Company for the
performance of these functions for the .com, .org, .net, .edu and .gov TLDs.
Internet-Based Products and Services. The proliferation of Internet users
provides businesses, other organizations and individuals with new means by which
to conduct business. To facilitate business-to-business and business-to-consumer
transactions, Internet users are seeking important Internet-based products and
services, such as transaction security services, electronic payment mechanisms
and directory, communications, data and research and identity promotion
services.
Consulting Services. Many businesses are developing enterprise networks
that employ Internet data formats and communications protocols. Internal
enterprise networks ("Intranets") enhance user productivity and connectivity
allowing users controlled access to internal information while also accessing
and exchanging information on the Internet. As more businesses, organizations
and individuals establish an Internet presence and begin to deploy Intranets,
the Company believes there will be an increasing demand for Intranet development
and enterprise network consulting services. In addition, the Company believes
that Intranets are becoming increasingly sophisticated and are allowing users
increased capabilities and improved access to information. As a result,
businesses are increasingly seeking experienced enterprise network consulting
firms to enable all of these services.
PRINCIPAL SERVICES
A. Registration Services.Services
Registration services are the Company'sour core business. The Company registersWe have been performing these
services since 1993 under the Cooperative Agreement. We register second level
domain names in the .com, .org, .net and .edu TLDs, enabling registrants to establish a unique identity on the
Internet. The Company'stop level domains. Our customers
apply to register second level domain names either directly through the Company'sour web
sites and e-mail-based registration templates or indirectly through Internet
access providers which are the largest source of customers for the Company.
Prior to September 14, 1995, the Company was reimbursed under the
Cooperative Agreement by the NSF for providingand others.
Our InterNIC registration services on a cost
reimbursement plus fixed-fee basis. Effective September 14, 1995, the NSF and
the Company amended the Cooperative
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Agreement to authorize the Company to begin charging customers a service fee of
$50 per year for each second level domain name registered. Customers in the
.com, .org and .net TLDs have paid a two-year services fee of $100 for initial
registrations and $50 per year foris an e-mail based registration renewals. Under the terms of the
amendment to the Cooperative Agreement, 30% of the services fees collected have
been required to be set aside to be disbursed in a manner approved by the NSF
for the enhancement of the intellectual infrastructure of the Internet. These
funds have not been recognized as revenue by the Company. With regard to
registrations on or after April 1, 1998, the NSF and the Company have further
amended the Cooperative Agreement to provide that (i) the Company will no longer
charge or set aside a portion of the services fee for the enhancement of the
intellectual infrastructure of the Internet and (ii) the Company's fees will be
reduced to a two-year services fee of $70 for initial registrations and $35 per
year for renewals.
Through the internic web site, Network Solutions provides a domain name
registrationtemplate
application process for the registration of second level domain names. The
Company'sOur
customers submit registration applications to the Company via e-mail through the Internet. The Company processesWe
process the application and either registersregister the requested domain name in the
requested TLDtop level domain or rejectsreject the application. Upon registration or
rejection, the Company notifieswe notify the customer via e-mail. For domain names which are
registered, the Company invoiceswe invoice the customers and permitspermit them to pay the registration
services fee after the domain name is registered. The Company performsWe perform internally (i.e., it does not outsource) itsour core
proprietary automated registration process and associated security functions.
On December 1, 1997, Network Solutions announced its new WorldNIC(TM)
Services brand,we began to offer a suite of enhanced domain name
registration services geared toward businesses building their online identities.small businesses. On January 14, 1998, Network Solutions unveiled RegistrationPlus(TM),we
introduced RegistrationPlus, the first such service. The RegistrationPlus
service offering under the WorldNIC(TM) Services brand. RegistrationPlus(TM) is a serviceweb-based transaction process that provides a way for small businessesis intended to establish themselves onsimplify
the Internet.
RegistrationPlus(TM)'sregistration process. The RegistrationPlus five step registration process
minimizes technical and
procedural barriers for new users seeking to gain an entry point on the
Internet. RegistrationPlus(TM) allows users to register or reserve a second level domain name, in real-time whether or not they have a computer,and activate it later by
providing domain name record hosting, either through Network Solutions' WorldNIC(TM) Servicesour web site or by calling
a toll-free number. As part of RegistrationPlus(TM),The RegistrationPlus service also validates and accepts
credit card payments, providing a customer confirmation number, via our secure
web-based online payment system.
On March 20, 1999, we consolidated into a single web site our InterNIC
informational web site and our RegistrationPlus web site. Now, through the Company offers the
option of reservingnew
web site, users can reserve a name and activating it later by providingsecond level
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domain name record hosting. In addition tothrough our RegistrationPlus service or register a second level
domain name through our InterNIC service using the Company'ssame processes that were
available under the separate web sites. Our customers currently pay a two-year
servicesservice fee for initial
registrations, as of March 13, 1998, RegistrationPlus(TM) customers pay $10$119 for the Company's enhanced registration services or, if applicable, $49 forinitial reservation of a domain name.
The RegistrationPlus(TM) service offering isname and $70 for the
initial registration of a web based transaction
process that is intended to make the registration process easier, more
streamlined and more accessible. The Company believes that ease of use is
becoming increasingly important as the Internet is being more widely adopted by
users who are less technically sophisticated. To facilitate payment of
registration and renewal fees, the Company, as part of its RegistrationPlus(TM)
service, implemented an electronic payment mechanism through which a user pays
for its domain name via credit or debit card through an Internet-based on-line
payment system. The Company believes that a streamlined registration process
and on-line payment system will make it easier$35 per year for customers to registerre-registrations of a
domain name.
As partThrough our 1998 acquisition of Internet Domain Names, Inc., or idNames, we
now offer search and registration services for domain names in country code top
level domains around the world.
Internet-Based Products and Services
We have introduced a portfolio of Internet-based products and services and
intend to develop additional Internet-based products and services, which may
include directory and other Internet identity services. In 1998, we introduced
the following Internet-based products and services:
- DOT COM MAIL. In August 1998, we launched dot com mail, a portable,
personalized e-mail service designed primarily for small businesses. The
dot com mail service is hosted by our outsourcing vendor, Critical Path,
Inc., and enables a business to use its unique domain name for its e-mail
address instead of the domain name of its registration services offering,Internet access provider.
Currently, the Company provides the
following services and support:
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1. Customer Support Services. The Company believes that high quality
customer supportdot com mail service is vitalavailable only to client satisfaction. The domain name registration
services fee provides the customer access to the Company's customer support
services, including a telephone help desk, an on-line processing facility for
account information updates and other services. The Company's customer service
representatives in its Herndon, Virginia facility provide such support services.
As part of its WorldNIC(TM) Services launch, the Company recently outsourced
toll free telephone help desk support for its RegistrationPlus(TM) services to a
large, experienced call center support entity. The outsourcing contractor is
providing 24 hour 7 days a week support with customer service representatives
trained by the Company's training staff. The help desks and on-line processing
facility are important to the success of the Company's registration business
because they are the front line to the customer and provide initial and ongoing
customer service and support.
At the end of 1996, the Company entered into arrangements to outsource
certain back office operations, including invoicing, check processing and
credit card processing. In addition, in December 1997, the Company introduced a
new Oracle-based billing and accounts receivable system (BARS), an
Internet-based transaction billing system. BARS improves tracking capabilities
for billing information and enhances the speed and accuracy with which the
Company's customer service representatives handle payment inquiries. The
outsourcing efforts, in conjunction with BARS, have improved customer service
and account handling and expanded the Company's capacity to service larger
volumes of registrants.
2. Domain Name Dispute Policy Administration. The Company's established
domain name dispute policy is an integral part of the maintenance and
administration of the Company's domain name registration business. This policy
seeks to take a neutral position with regard to domain name disputes between
trademark owners and domain name holders and is designed to address claims thatcustomers who
reserve a domain name registeredwhich we host.
- DOT COM TOOLKIT. In September 1998, we launched the dot com toolkit, a
small business resource center that provides access to tools and services
for setting up a web site and conducting business on the Internet. The
dot com toolkit resource center is available on our web site and offers
tools and services categorized into four areas:
- starting a business on-line,
- setting up an Internet presence,
- managing a business online, and
- promoting a business online.
Within each category, the resource center visitor has the ability to
purchase services from a select group of companies that have contracted with us
to be included in the resource center. We receive referral fees from certain
purchases made by our customers from links in the Company infringesdot com toolkit resource
center.
- DOT COM PROMOTIONS. In August 1998, we launched our dot com promotions
service through a third party's federal
trademark. As of March 13, 1998, the Company had receivedjoint marketing agreement with LinkExchange, Inc.
Through dot com promotions, a domain name registrant can link to and
subscribe to various LinkExchange services which include:
- registering a web site with over 3,600 written
objections400 Internet search engines by
subscribing to the registrationSubmit It! Service,
- monitoring its rank in the search engines through the PositionAgent
service,
- participating in a competitive advertising network that allows users
to promote their web sites and use oftrack success through the Banner
Network service, and
- buying targeted advertising space on affordable web sites through
the LinkExchange Express service.
We receive referral fees from certain domain names. Of these,
approximately 1,960 were disputes in which the Company's domain name dispute
policy was involved. Although 42 out of these situations have resulted in
litigation involving the Company, as of March 13, 1998, no payments have beenpurchases made by our customers from
links from the Company to any plaintiff and only four of these cases are pending.
The Company expends considerable management and legal resources in the
development, refinement and administration of its domain name dispute policy.
See "Itemdot com promotions service.
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- Legal Proceedings."
3. Technical Infrastructure Support. The Company is investing
significant technical and financial resources to improve and to operate its
domain name registration business. A substantial portion of the Company's
software is custom-developed and proprietary. The Company's internally
developed and proprietary software includes an automated registration
capability that currently processes in excess of 90% of all new registration
requests without human intervention. The Company believes that significant
engineering talent is required to create a registration services capability and
that knowledge of 6
Internet domain name system ("DNS") structures,Technology Services
We deliver Internet security, data routing and routing protocols is critical to creating and
enhancing registration service capabilities. The Company developed RWhois, a
standard open protocol, which is used in the registration services business.
The Company's engineering staff has significant expertise in the RWhois
protocol. The Company believes that engineers skilled in protocol development
are difficult to identify, hire and retain and thus its staff of engineers
represents a valuable resource. See "Operations."
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The Company currently maintains in excess of one and one-half million
unique second level domain name registrations. The Company has realized
significant scale efficiencies throughout its registration process as a result
of its large customer base and technical infrastructure.
B. Consulting Services. The Company delivers enterprise networktechnology consulting services to some of the world's leading businesses that are
utilizing Internet technologies for their internal enterprise networks, (i.e., Intranets),
connecting securely with their key partners through Extranets and accessing the
Internet. The Company's engineers have extensive knowledge and experience in
network engineering, network security and network management. The engineers have
a broad base of expertise in such areas as local area network ("LAN")/wide area
network ("WAN") protocols; routing, switching and remote access technologies;
virtual private networks; IP addressing; domain name architecture; and UNIX, NT
and other network operating systems. By leveraging this knowledge and
experience, the Company is able to provide solutions to clients' complex network
needs.
The Company sells and markets its consulting services primarily to large
companies that utilize their enterprise networks for a strategic advantage.
During 1997, the Company provided consulting services to more than 35 individual
companies. Ten of the Consulting Services Division's clients accounted for
approximately 80% of its revenues. Each of these clients was in either the
financial services industry or
the oil and gas industry. Companies within these
two industry groups will continue to be a primary focus for future business
opportunities. The Company provides requirements analysis, design and
implementation services within the following service offerings:
1. Network Engineering. The Company offersintranets.
- NETWORK ENGINEERING. We offer a line of services to help develop optimize, and
integrate enterprise network solutions in a manner tailored to individual
clients' needs.
All of these services are focused on
building a strong network foundation for the enterprise. This includes service
level analysis of IP address space engineering; DNS and dynamic host
configuration protocol ("DHCP") architecture engineering; routing and switching
architecture engineering; Extranet architecture engineering; virtual private
network architecture engineering; and electronic messaging architecture
engineering.
2. Network Security. The Company provides- NETWORK AND SYSTEM SECURITY. We provide a range of security consulting
services to allow clients to protect the integrity of their data and systems. The enterprise network's security architecture establishes theWe develop
access and protection controls that will permit internal and remote users to
access computer systems, databases and applications on the network, while
protecting against unauthorized or inadvertent access to information or misuse of
systems
services. The Company's methods to secure the backbone, LAN-to-WAN access,
remote access and facilities can supplement or replace existing systems security
measures. The Company maintains resident expertise in emerging network
protocols, encryption and key technologies, firewalls, packet filters, proxy
services, secure remote access strategies and secure Intranet servers.
3. Network Management. The Company providessystems.
- NETWORK MANAGEMENT. We provide a range of services tothat allow clients to
monitor, control and improve their mission-critical network performance. Such
services include developing network capacity plans and performance management
tools, conducting baseline assessments, performing network optimization and
tuning, integrating new technology, and implementing complex network management
centers. The CompanyWe also providesprovide
planning and analysis to implement disaster recovery and contingencies
for network system failures.
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The Company'sDuring 1998, we provided Internet technology consulting services to more
than 20 large companies. Our Internet technology consulting services are
generally provided to clients on a time and expense basis. The CompanyWe also performsperform a
limited number of engagements on a fixed-price basis.
Many of the Company's consulting services
clients have been developed through direct contact or referrals from SAIC. The
Company intends to continue to rely on its relationship with SAIC and its
subsidiary, Bell Communications Research, Inc. ("Bellcore"), to attempt to
access SAIC's and Bellcore's major customers and strategic partners. The
Company's Consulting Services Division is establishing its own dedicated sales
team with account executives assigned to key clients in regional territories.
In January 1998, Network Solutions and Informatica, Negocios, y
Technologia, S.A. ("INTESA"), a joint venture between Petroleos de Venezuela
S.A. (PDVSA) and SAIC, headquartered in Caracas, Venezuela, entered into an
agreement under which the Company will provide consulting services to INTESA.
The Company will provide expertise in Internet connectivity, messaging services,
network security and wide area network (WAN) re-engineering to INTESA under a
broad umbrella contract. As part of SAIC's joint venture agreement with PDVSA,
the Company is currently subject to a noncompetition arrangement pursuant to
which the Company has agreed to provide, with certain limited exceptions,
consulting services to other companies in the Latin American market solely
through INTESA.
C. Internet-Based and Other Services. The Company intends to offer a portfolio
of Internet-based products and services that will draw upon the Company's
position in the registration business and makes proper use of the customer data
that it collects. These products and services could include directory,
communications, data and research, identity promotion and other services. Some
of these products and services could include distribution of third party
offerings through on-line enrollment for such products and services from the
Company's domain name registration web site. Some of these products and services
are currently in the process of development. See "Risk Factors - Technological
Change and Additional Technology, Products and Services and - Evolving Sales
and Marketing Organization and Distribution Channels."
D. Strategic Acquisitions. The Company will seek to identify and, where
appropriate, pursue acquisition opportunities which would provide businesses,
products, services or technology complementary to the Company's current
business. See "Risk Factors - Uncertainty of Future Acquisitions."
RELATIONSHIP WITH THE NSF; RECENT DEVELOPMENTS IN INTERNET GOVERNANCE
The Internet is not bound by geography or lines of business and
coordination and administrative services are required for the registration,
allocation and use of TLDs and for the effective operation of the Internet. The
Internet historically has been loosely administered by government agencies which
were involved in the creation of its infrastructure, initially the Department of
Defense's Advanced Research Projects Agency ("ARPA") and, more recently, the
NSF. Since the original role of the Internet was to link computers at
governmental and academic institutions to facilitate communication and research,
the Internet was historically administered by entities which were involved in
sponsoring research rather than by any of the traditional federal or state
regulatory agencies.
In 1992, the Company entered into the Cooperative Agreement with the NSF,
which had been funding the Defense Information Systems Agency ("DISA"), to
perform registration services for second level domain names within the .com,
.org, .net, .edu and .gov TLDs. Under the Cooperative Agreement, the Company was
given the responsibility for ensuring the quality, timeliness and effective
management of registration services to non-military Internet users and networks.
The registration services provided by the Company under the Cooperative
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Agreement included second level domain name registration, domain name server
registration and network number assignment, as well as autonomous system number
assignment and IP address mapping and allocation for North and South America,
the Caribbean and parts of Africa.
The Cooperative Agreement became effective January 1, 1993. It includes a
three-month phase-in period, a five-year operational period (commencing April
1, 1993 and ending March 31, 1998), and a six-month "flexibility period"
through September 30, 1998. The Cooperative Agreement is subject to review by
the NSF and may be terminated by the NSF at any time at its discretion or by
mutual agreement. The NSF has stated that it will not be re-awarding a
cooperative agreement at the end of the flexibility period.
On July 1, 1997, as part of the Clinton Administration's "Framework for
Global Electronic Commerce," the President directed the Secretary of Commerce
to privatize, increase competition in, and promote international participation
in the DNS. Accordingly, on July 2, 1997, the NTIA issued a Request for
Comments on administration of Internet domain names, on behalf of an
inter-agency working group previously formed to explore the appropriate future
role of the U.S. government in the DNS. This request appeared in the form of
the Notice of Inquiry ("NOI") in the U.S. Federal Register. The NOI requested
specific input in five broad areas: general principles, general/organizational
framework issues, creation of new TLDs, policy issues for new registrars and
trademark dispute issues. During the comment period, over 430 comments,
including those of the Company, were received by the NTIA.
On January 30, 1998, the NTIA issued a discussion draft, entitled "A
Proposal to Improve Technical Management of Internet Names and Addresses" (the
"Proposed Rule"). The following is a summary of the principal features of the
Proposed Rule, and is not intended to be a complete description thereof. This
summary is subject to and qualified in its entirety by reference to the
Proposed Rule, which was published pursuant to the Administrative Procedures
Act in the U.S. Federal Register on February 20, 1998.
The Proposed Rule provides notice and seeks public comment on a proposal
to transfer over time the administration of the DNS to a new private,
not-for-profit corporation and increase competition in the administration of
TLDs and the registration of second level domain names. The Proposed Rule
states the view that the U.S. government should end its management role in the
Internet number and name address systems in a responsible manner that ensures
the stability of the Internet. The Proposed Rule covers generic TLDs and does
not address country-code TLDs, which are administered by the corresponding
governments or by private entities with the appropriate government's
acquiescence.
Under the new Proposed Rule, administration of the DNS would be transferred
over time to a new private, not-for-profit corporation. After a transition
period, the corporation would have authority: (i) to set policy for and direct
the allocation of IP address number blocks to regional number registries for
the assignment of Internet addresses; (ii) to oversee the operation of the root
server system; (iii) to oversee policy for determining the circumstances under
which new TLDs are added to the root system; and (iv) to coordinate the
development of other technical protocol parameters to maintain universal
connectivity on the Internet.
The Proposed Rule provides that the new corporation would be headquartered
in the United States and incorporated under U.S. law. The Proposed Rule states
that the board of directors of the new corporation should represent membership
associations of key stakeholders, including IP number registries, domain name
registries, domain name registrars, the technical community
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and Internet users (commercial, not-for-profit and individuals). The Proposed
Rule provides that the corporation should hire a Chief Executive Officer with a
background in the corporate sector. The new corporation would be funded by
domain name registries and regional IP registries.
The Proposed Rule provides that the transition would commence as soon as
possible, with operational responsibility moved to the new corporation by
September 30, 1998. The U.S. government would participate in policy oversight to
assure stability until the new corporation is established and stable, phasing
out as soon as possible, but in no event later than September 30, 2000. The
Commerce Department would coordinate the U.S. government policy role.
The Proposed Rule distinguishes between "registries" and "registrars". A
"registry" is responsible for maintaining a TLD's zone files, which contain each
second level domain name in that TLD and the corresponding IP addresses of its
name servers. Each registry would establish minimum dispute resolution and other
procedures relating to trademark considerations and would be required to
indemnify the new corporation for costs incurred in connection with trademark
disputes. A "registrar" acts as an interface between domain-name holders and the
registry, providing registration and value-added services. The registrar submits
zone file information for each of its customers in a single TLD to the registry.
Currently, the Company acts as both the exclusive registry and as the exclusive
registrar for the .com, .net, .org and .edu TLDs.
During the transition to private administration of the DNS, the Proposed
Rule provides for the addition of up to five new registries, each of which, at
least initially, would be limited to a single TLD. During the transition, the
first five entities to meet the technical, managerial and site criteria provided
in the Proposed Rule would be allowed to establish a domain name registry. The
Proposed Rule does not specify whether the pool of eligible applicants would be
unlimited or limited, and, if limited, on what basis. Neutral accounting and
technical consultancy firms would be engaged to evaluate a proposed registry
under the criteria and certify an applicant as qualified. Qualified registries
would, in the order of their qualification, select a TLD from a list of
available TLDs or propose another TLD. The Proposed Rule states that such list
of TLDs would be proposed based on input received and market data. The Proposed
Rule provides that any entity would be permitted to provide registrar services
within a TLD so long as it met certain specified minimum qualifications.
Registries could set additional requirements for registrars with which they
wished to do business. The Proposed Rule provides that if a registry wishes to
act both as registry and registrar for the same TLD, it must do so through
separate subsidiaries, and appropriate accounting and confidentiality safeguards
shall be used to ensure that the registry subsidiary's business is not utilized
in any manner to benefit the registrar subsidiary to the detriment of any other
registrar. Each TLD database will be maintained by only one registry. The
Internet Assigned Number Authority ("IANA"), which is headed by Dr. Jon Postel
of the Information Sciences Institute at the University of Southern California
and which currently provides IP address allocation, would be involved in many of
the functions during the transition period to the new corporation.
The Proposed Rule provides that during the transition period, the new
corporation should evaluate the effects that the addition of new TLDs has on the
operation of the Internet, on users and on trademark holders. After the
transition, the new corporation would determine whether or when the introduction
of additional TLDs was desirable and would have authority over the terms and
conditions for the admission of new TLDs.
The Proposed Rule provides that the U.S. government would phase out the
Cooperative Agreement by the end of
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September 1998. In addition, the Proposed Rule provides that, as the U.S.
government is seeking to end its role in the DNS, the provision in the
Cooperative Agreement requiring allocation of 30% of the registration fee to
the Internet Intellectual Infrastructure Fund should terminate on April 1,
1998, the beginning of the flexibility period. The Proposed Rule provides that
the Company and the U.S. government would negotiate an agreement that should
contain the following terms designed to promote competition in domain name
registration:
(1) the Company would effectively separate and maintain a clear division
between its current "registry" and "registrar" functions;
(2) the Company would continue to operate the .com, .org and .net
registries and to act as a registrar for those TLDs, but other
companies would be permitted to act as registrar for those TLDs;
(3) the .edu TLD would be transferred to a not-for-profit entity;
(4) the Company's registry would treat all registrars on a
nondiscriminatory basis and price registry services according to an
agreed upon formula for a period of time;
(5) as part of the transition, the Company would develop (or license) and
implement the technical capability to share the registrar functions in
the .com, .org, and .net TLDs with competing registrars as soon as
possible, by an agreed upon date;
(6) the Company would provide the U.S. government with "a copy and
documentation of all the data, software, and appropriate licenses to
other intellectual property generated under the Cooperative Agreement,
for use by the new corporation for the benefit of the Internet";
(7) the Company would turn over control of the A-root server and the
management of the root server system when instructed to do so by the
U.S. government; and
(8) the Company would be required to meet the requirements, set forth in
the Proposed Rule, for registrars and registries.
The Proposed Rule also provides that as part of the transition, an
agreement would need to be reached between the U.S. government and IANA on the
transfer of IANA functions to the new corporation.
The formal comment period for the Proposed Rule ended on March 23, 1998.
The NTIA expresses in the Proposed Rule its hope that a reasonable consensus can
be found and that, after appropriate modifications, implementation of a final
rule can begin in April 1998. Numerous comments have been received on the
Proposed Rule, including comments from the Company. Some of the comments are
critical of certain of the Proposed Rule's provisions. The Commerce Department
has indicated that a final rule will be issued shortly after review of the
comments received. It is impossible to predict at this time whether or when a
final rule will be issued and, if issued, the timing of its implementation, the
exact nature of its provisions or of any terms negotiated by the U.S.
government and the Company or the precise effect of such provisions or terms on
the Company. In addition, any final rule that is issued or any negotiated terms
could be challenged by persons or entities who disagree therewith.
See "Risk Factors - Uncertainty of Internet Governance and Regulation."
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On October 1, 1997, the Company, pursuant to the NSF's directive,
transferred its registration functions for the .gov TLD to the General Services
Administration ("GSA"). The Company was released from all of its obligations
under the Cooperative Agreement relating to the .gov TLD upon such transfer. On
December 22, 1997, the Company, pursuant to the NSF's directive, transferred the
allocation and administration of IP addresses for North and South America, the
Caribbean and parts of Africa to a not-for-profit organization named the
American Registry for Internet Numbers ( "ARIN"). The Company has agreed with
the NSF to provide financial support to ARIN through the end of the first
quarter of 1998. The Company believes that the amount of such support to the
ARIN in the first quarter of 1998 will not be material.
MARKETING AND DISTRIBUTION The Company has designed itsRELATIONSHIPS
We are establishing and expanding marketing and distribution strategy to
increase the use of the .com, .net and .org TLDs worldwide and to address the
particular requirements of its diverse international customer base. The Company
has begun and intends to continue to promote the use of the .com, .net and .org
TLDs.
The Company is working to expand its domain name registration business by:
(i) building on relationships
with Internet access providers; (ii) developing
co-marketing programs with channel partners; (iii) working with major platform
providers to provide the registration function; (iv) increasing its advertising
and direct sales efforts; (v) establishing international alliances; (vi) working
with server software application providers to develop an automated registration
function; and (vii) establishing relationships with Internet-based product and
service providers.companies worldwide.
Strategic AgreementsPrograms with Internet Access Providers. The Company hasProviders and Others
We have entered into agreements to provide specializedenhanced services to certain
Internet access providers, including Internet service providers, ("ISPs"),or "ISPs," both
in the United States and in other countries, who register a significant number
of second-level domain names with the Companyus on behalf of such providers'their customers.
This- PREMIER PROGRAM. Our Premier Domain Registration ServicesService Program
("Premier Program") provides suchparticipating Internet access providers with customized
registration services, personalized
account management, customized billing and financial reports, private
e-mail boxes and other customized features and
provides the Company with a multi-year registration stream from such providers.features. As of March 13, 1998, the Company12, 1999, we had
entered into agreements with 49165 companies including: MCI, Inc., America Online, Incorporated (PrimeHost Division), TABNet,
MindSpring Enterprises, Inc., BBN Corporation (a subsidiaryunder the Premier Program
which include agreements with 71 companies located in the United States
and 94 companies located in Canada, Australia, New Zealand and the
European, South American and Asia-Pacific regions.
- ALLIANCE PROGRAM. The Alliance Program is available to members of GTE
Internetworking), Earthlink Network, Inc., NETCOM Interactive, UUNET
Technologies, Inc., Sprint Communications Company L.P.the
Premier Program who have participated in the program for a minimum of one
year and Rapidsite, Inc.
(Hiway).who have registered a significant number of second-level domain
names with us. The Company intendsAlliance Program is designed to build upon its current relationships with
certainenable us and our
participating companies to provide reciprocal links and referrals to the
other party's distribution channels for each other's complementary
services.
- AFFILIATE PROGRAM. In September 1998, we launched our Affiliate Program.
This program provides a way for small Internet access providers that have agreedand other
companies and individuals to participate in the Premierestablish a link to our RegistrationPlus
domain name registration process. The Affiliate Program and intends to pursue relationships with additionalis designed for
participation by Internet access providers. Through these relationships,providers, web hosting companies, and
web site design companies that currently register their customers' domain
names through us, as well as other companies and individuals who could
benefit from providing this service to their customers. As of March 12,
1999, approximately 4,375 Affiliates were part of the Company seeks to deliver enhanced
registration services and identify additional opportunities to expand its
registration services business.program.
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Distribution Channel Marketing Agreements
with Channel Partners. The Company has developedWe are developing co-marketing programs with channel partners designed to take advantage of their
complementary marketing capabilities.partners.
DOMESTIC AGREEMENTS. In January 1998, the Companywe entered into
strategic agreements with Dun &
Bradstreet Corporation, ("D&B") and Inc. Online, ("Inc.")infoUSA and Centraal Corporation for the
marketing and development of products and services to meet the
future needs of the business marketplace. Theservices.
- Our agreement with D&B makes it possible for businesses to register an
Internet domain name and apply for a D&B D-U-N-S(R)D-U-N-S Number from either the
D&B web site or the Company's WorldNIC(TM)
Servicesour web site. As part of the agreement, Network Solutionswe and D&B placed
a hyper linkhyperlink on each other's Internet
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home pageweb site that will allow businesses and
individuals registering for a domain name to complete that task and then
apply for their D&B D-U-N-S(R)D-U-N-S Number or vice versa.
The Company's- Under our agreement with Inc. is intended to help small businesses
establish a unique identity and grow a brand on the Internet. Network Solutions
is, we are sponsoring Inc.'s "Guide to the
Internet" web site. In the "Guide to the Internet," Inc. helps
small-to-midsize companies navigate through the information and decisions
needed to choose systems, tie them together, get employees to embrace
them and apply them to strategic goals. From Inc.'s web site, small
businesses and individuals can hyper linkhyperlink to the Company's
WorldNIC(TM) Servicesour web site where they can
register or reserve a domain name within minutes using our RegistrationPlus services.
- Under our agreement with infoUSA, we and infoUSA are providing reciprocal
links and referrals to each other's products and services so that our
customers can purchase infoUSA's sales leads and mailing lists services
and receive information on businesses for marketing or credit purposes.
InfoUSA's customers can register a domain name through our
RegistrationPlus service from the Company's RegistrationPlus(TM)infoUSA home page or purchase any other
service offered through our web site.
- Under our agreement with Centraal, we market, sell and service Centraal's
"RealName" subscription orders to domain name holders, directly and
through our channels worldwide. The RealName service is a web navigation
service that enables users to navigate to specific Web pages and is
complementary to our domain name registration services. See "International Alliances.As part of the
agreement, Centraal placed a hyperlink on its web site that allows
Centraal customers to register a domain name with us.
INTERNATIONAL AGREEMENTS. We have also established distribution channels
in Beijing, China through the Computer Network Information Center, or "CNIC,"
Agreementsand in Japan through ASCII Corporation, or "ASCII".
- Under our agreement with Major Platform Providers to Provide the Registration
Function. The Company intends to seek to expand itsCNIC, CNIC is promoting in China our domain name
registration services business through agreements with major platform providers (i.e., operating
system manufacturers or hardware vendors who provide bundled operating system
software) to provide an automated registration functionin the .com, .org and .net top level domains
through a "point-and-click" interface directly intojoint marketing campaign with us in Chinese publications, web
sites and other media, and by providing seminars in China on registering
domain names with us. Under the software installation procedures.
Advertising.agreement, we are promoting domain name
registration in .cn, the China country code top-level domain, under which
CNIC is the registry.
- In October 1998, we launched a Japanese language version of our
RegistrationPlus service, through a strategic agreement with ASCII.
Through this relationship, we will make our RegistrationPlus service
available to Japanese Internet users in the Japanese language, with a
Japanese call center customer support help desk and through an
advertising and marketing campaign in Japanese publications, Japanese web
sites and through other media.
Advertising
In December 1997, the Companywe launched our first significant marketing campaign, a
targeted print and on-line advertising campaign for itsour registration services with the
announcement of its new corporate logo and its WorldNIC(TM) Services brand.services.
This the Company's first significant marketing campaign iswas focused on small
businesses5
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businesses. We also launched several major multi-piece direct mail, print and
their needweb site banner advertising campaigns announcing our new products and services,
such as RegistrationPlus and dot com mail. In addition, we have run two national
cable television ad campaigns.
In December 1998, we entered into two separate global marketing agreements
with Yahoo Inc. and Netscape Communications Corporation under which we purchased
advertising to establish their own unique identity and to grow a
brand on the Internet. The Company is currently developing additional campaigns
in thispromote our domain name registration services and other services
on certain Yahoo! and Netscape web sites during 1999.
Direct Sales
We market segments.
Direct Sales. The Company'sand distribute our services are marketed and distributed directly through itsour Internet home
pages. In addition, the Company iswe are continuing to develop itsour product management,
marketing and sales force to target channel and distribution partners to offer
the Company'sour registration services electronically through existing Internet web sites and through
other direct channels, such as direct mail and telemarketing.
ONGOING PRIVATIZATION OF INTERNET ADMINISTRATION
The CompanyInternet is seekingnot bound by geography and neither the U.S. Government nor
any organization or entity currently has formal authority over all aspects of
the Internet. There is, however, a requirement for central policy decisions
surrounding the coordination of the administrative services required for the
registration, allocation and use of top level domains and Internet Protocol
numbers, and for the effective global operation of the Internet. This role has
been generally filled through mutual cooperation and interrelated informal
agreements, historical leadership from an unincorporated entity called the
Internet Assigned Numbers Authority and involvement from the U.S. Government.
With the onset of increased commercial growth of the Internet, the U.S.
Government initiated an activity directed at increased privatization of the
policy making and central administration of the Internet. Without authoritative
policy making, it has become more difficult to achieve consensus in the
historical manner. Failure to achieve consensus among the various groups who now
informally administer the Internet could disrupt Internet operations or delay
infrastructure improvements or changes in operations needed to maintain and
expand the numberInternet.
Within the U.S. Government, leadership for the continued privatization of
registrations in targeted customer segments both
domesticallyInternet administration is currently provided by the Department of Commerce.
After a series of draft proposals and internationally. The Company is targeting customer segments
such as small business users, individuals, holderspublic comment periods, on June 10, 1998,
the Department of trademarks, service marks
and product marks and event sponsors.
International Alliances. The Company intends to establish distribution
alliances for registration services in selected international countries. These
could include remarketing agreements with channel partners. In addition, the
Company intends to offer "ease of use" solutions for entities worldwide for
registrationCommerce published in the various TLDs, including country code TLDs.
Agreements with Server Software Application Providers.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 responsibilities relating to the domain
name system, but not to perform actual registration of domain names either as a
registrar or registry. The Company has
entered into an agreement with Microsoft Corporation ("Microsoft")Statement of Policy invites private sector Internet
stakeholders to providework together to form a "point-and-click" interfacenew private, not-for-profit corporation
to oversee policy for an automated registration function. This
interface is designedthe Internet name and address system and provides that:
- the not-for-profit corporation should be headquartered and incorporated
in the United States and have a board of directors from around the world;
- in making a decision to facilitate the easedevolve U.S. government oversight of the registration processdomain
name system to the not-for-profit corporation, the U.S. government will
be guided by, and consider the entity's commitment to, the principles of
stability, competition, private bottom-up coordination and
representation;
- to the extent that the not-for-profit corporation is established and
operationally stable, transition to the private sector of domain name
system administration will be phased in by September 30, 2000; and
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- the not-for-profit corporation ultimately should have the authority to:
- set policy for usersand direct allocation of Internet protocol number
blocks to regional Internet number registries;
- oversee operation of the authoritative Internet root server software andsystem;
- oversee policy for determining the circumstances under which any new
top level domains are added to allow for the Company to have a preferred
provider position on the registration wizard screen that appears during the
server initialization process.
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Agreements with Internet-Based Product and Services Providers. The Company
has entered into an agreement with VeriSign, Inc. ("VeriSign") pursuant to which
the Company provides its customers with direct access to VeriSign's server
security certificates through the Company's domain name registration process.
The Company will receive a portionsystem; and
- coordinate the assignment of VeriSign's subscription fees for providing
such accessother Internet technical parameters as
needed to VeriSign subscribers. The Company may enter into other agreements
designed to allow the Company to build upon its strategy of becoming an
Internet-based business center where a business or individual can have access to
companies which provide the enabling products and services to conduct businessmaintain universal connectivity on the Internet.
The Company sellsStatement of Policy distinguishes between the registry and marketsregistrar
functions of the domain name system, both of which functions are currently
performed exclusively by us in the .com, .org, .net and .edu top level domains,
and calls for increased competition. The current technical structure of the
Internet will permit only one registry for each top level domain. A registrar
acts as the interface between the registry and the end-user domain name holders.
Registrars submit to the registry information and other data 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 consultingbasic
registration service. Numerous registrars will be able to operate within each
top level domain.
As part of the process initiated by the Statement of Policy, several
proposals were put forward to the Department of Commerce on the establishment
and governance of the not-for-profit corporation. The proposals differed in
several respects including, among others, their approaches to the following
issues: place and form of incorporation; method for selection of the interim and
permanent board of directors; who should be eligible to become a member and on
what questions should the members vote; what authority should be granted to the
board of directors and what authority should be reserved to the members, if any;
and whether there should be separate supporting organizations and, if so, what
authority these organizations should have. A U.S. based private not-for-profit
corporation with an international board of directors, denoted the Internet
Corporation for Assigned Names and Numbers, or "ICANN," submitted various
proposals which formed the basis of discussion at a number of public and private
meetings. As a result of these and other meetings and private negotiations, the
process initiated by the Statement of Policy has resulted in the entry by the
U.S. Government into a Memorandum of Understanding, or "MOU," with ICANN. Under
the MOU, the parties will jointly design, develop and test the mechanisms,
methods and procedures that should be in place and the steps necessary to
transition management responsibility for certain domain name system functions to
a private-sector not-for-profit entity. The MOU provides that once testing is
successfully completed, it is contemplated that management of certain domain
name system functions will be transitioned to the mechanisms, methods and
procedures designed and developed in this joint project. The U.S. Government has
sent us a letter directing us to treat ICANN as the not-for-profit corporation
identified in the October amendment to the Cooperative Agreement described below
under "-- Status of Cooperative Agreement," in the performance of ICANN's
obligations under the MOU and until such time as the MOU is terminated. We have
not yet responded to that letter.
ICANN's bylaws call for the creation of supporting organizations that will
select some ICANN board members and provide policy recommendations in particular
areas. ICANN called for submission by February 5, 1999 of applications from
groups urging "recognition" of a domain name supporting organization that would
be charged with developing recommendations for policies ICANN might apply when,
and if, it begins exercising responsibility over certain domain name system
matters. Those responsibilities could include entering into contracts with
registries for all top level domains and eventually adding new top level
domains. We submitted comments regarding the structure and function of such a
domain name supporting organization. On March 4, 1999, the ICANN Board adopted a
domain name supporting organization formation concept statement reflecting some,
but not
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all of our comments. On March 15, 1999, ICANN released a staff draft of
amendments to its bylaws based on the formation concept statement to establish a
domain name supporting organization that will first meet in May 1999.
We cannot be sure that ICANN will take positions favorable to us in the
adoption or implementation of the final bylaws or in its further policy
development or contract formation.
STATUS OF COOPERATIVE AGREEMENT
On January 1, 1993, we initiated phase-in of a Cooperative Agreement with
the National Science Foundation. The three-month phase-in was followed by a
five-year operations period, commencing April 1, 1993 and ending March 31, 1998,
and a six-month flexibility period through September 1998. Effective in
September 1998, the responsibility for the Cooperative Agreement was transferred
to the Department of Commerce. In October 1998, the Cooperative Agreement was
amended to extend the flexibility period through September 30, 2000 and to
transition to a shared registration system.
In this transition, we will operationally separate our registry business
from our registrar business. Additional, competing registrars will be able to
market registrations in the .com, .net and .org top level domains through the
registry that we maintain for each of those top level domains. Accordingly,
persons registering second level domain names will be able to choose among a
number of different registrars, including us. As the registry, we will have
contracts with these competing registrars allowing them to register names in our
registry database. Our registry services will be subject to large companiesa price cap, the
details of which are currently under discussion with the Department of Commerce.
Registrar services, once competitive, may be priced in different ways by us and
competing registrars.
On March 12, 1999, the Cooperative Agreement was amended to, among other
things, delay the schedule for the development and deployment of the shared
registration system, due to the fact that utilize their enterprise networkthe MOU was not signed until November
25, 1998, or 25 days later than had been assumed when the milestones were
established. The following summarizes certain terms of the October 1998
amendment to the Cooperative Agreement, as amended by the March amendment:
- We will develop a protocol and associated software to support a shared
registration system which will permit multiple registrars to provide
registration services within the top level domains for which we now act
as exclusive registry and registrar. Implementation of the shared
registration system will reflect an agreed-upon time line, which assumes
that the U.S. Government does not request changes in the specifications,
including the following dates:
- By April 26, 1999, we will initially deploy the shared registration
system by establishing a test bed supporting actual registrations in
.com, .org and .net by five registrars accredited by the
not-for-profit corporation;
- By June 25, 1999, we will deploy the shared registration system and
make it available to support multiple licensed and accredited
registrars within the top level domains for which we act as registry;
- By October 25, 1999, we will complete reengineering of our
registry/registrar interface and back end systems so as to assure that
we, acting as registry, will give all licensed and accredited
registrars equivalent access to registry services through the shared
registration system;
- We and other accredited entities will function as domain name registrars
through the shared registration system. The shared registration system
will, among other things, permit second level domain name holders to
change registrars within the same registry without changing domain names;
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- We will also continue in our role as the registry of .com, .org and .net
top level domains. Commencing upon the initial deployment of the shared
registration system, our price for registry services in the top level
domains for which we now act as registry will be no more than a dollar
amount per registration, per year, agreed upon with the U.S. Government
and reflecting our costs and a reasonable return on our investment;
- Commencing upon the initial deployment of the shared registration system,
for a strategic advantage, including
financialperiod of 18 months, we will permit any customer with whom we have
an exclusive contract as registrar to obtain registration services companies, banks, oilfrom
other registrars;
- From the date of the October 1998 amendment and gas companiesfor a period of 18 months
after initial deployment of the shared registration system, we may not
enter into any agreement that limits a party's ability to serve as a
registrar or operate a registry;
- We agreed to submit to the U.S. Government an electronic copy of all
software and telecommunications companies.data, and a copy of documentation therefor, generated under
the Cooperative Agreement through September 30, 1998. The Company believes that these organizations have
a substantial installed base of enterprise networks and additional requirements
for network engineering, networkU.S. Government
agreed to take appropriate measures to protect the security and
network management consulting
services. In addition, the Company intendsconfidentiality of such data, software and documentation; and
- We have agreed to continue to rely on its
relationshipfunction as the administrator and operator
for root zone servers A and J until such time as the U.S. Government
instructs us to transfer either or both of those functions to the
not-for-profit corporation or a specific alternate entity.
As the U.S. Government transitions certain responsibilities for the domain
name system to the not-for-profit corporation, corresponding obligations under
the Cooperative Agreement may be terminated and, as appropriate, covered in a
contract between the not-for-profit corporation and us. The U.S. Government has
directed us to treat ICANN as the not-for-profit corporation for the purposes
described above, but we have not yet reached agreement with SAICthe U.S. Government
or ICANN with respect to the terms of such transition. We may not be able to
reach agreement and Bellcore to attempt to access SAIC's and Bellcore's
major customers and strategic partners. The Company's Consulting Services
Division is also establishing a direct sales force with account executives
assigned to key customers in regional territories. See "Competition."
See "Risk Factors - Evolving Sales and Marketing Organization and
Distribution Channels and - Technological Change and Additional Technology,
Products and Services."
OPERATIONS
On June 16, 1997,either ICANN or the Company leased 31,247 square feetU.S. Government may take positions that
adversely affect us.
We have held two meetings of a 53,136 square
foot facilityfocused technical advisory group to support itscomment
on and participate in testing of our shared registration system. The group
included members suggested by ICANN to the Department of Commerce and other
individuals. ICANN has issued accreditation standards for competing registrars
and methods for selection of the initial five registrars to participate in the
test bed under the shared registration system. Under the ICANN approach each
accredited registrar will enter into an accreditation contract with ICANN. The
proposed accreditation contract would require payment of fees to ICANN and would
impose special restrictions on a registrar also acting as the registry. We filed
substantial comments with ICANN objecting to various aspects of the proposed
accreditation approach. We are currently in discussions with ICANN and the U.S.
Government regarding implementation of the shared registration system and a wide
range of contractual issues. We cannot be sure that these discussions will
result in agreements or outcomes that are favorable to us.
OPERATIONS
The functioning of the domain name registration business operations.
Effective February 1, 1998,system depends on a hierarchy of
specialized software programs resident in network computers called domain name
servers. The top level of this hierarchy consists of 13 globally distributed
domain name servers, called root zone servers. The root zone servers contain the
Company leased an additional 9,059 square feetmaster directory of all top level domains in the same facility to expand its operations. This leased facility is designed
to meetInternet. Below the root zone
servers in the hierarchy are the top level domain zone servers. The top level
domain zone servers contain the database of active second-level domain names and
corresponding Internet protocol numbers registered in each top level domain.
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The location and control of the root zone and top level domain zone servers
historically has been determined by consensus of various members of the Internet
community. We currently administer and operate two of the 13 root zone servers,
specifically root zone servers A and J, and four top level domain zone servers.
The other root zone and top level domain zone servers that we do not administer
and operate are administered and operated by independent operators on a
volunteer basis. Every night we update root zone server A with a file that
contains the current registration services customer support needs as well as to
provide expansion capability for future business. It includes: (i) a call
center; (ii) a training center equipped for both computerlist of top level domains and telephone
training, including a simulated operations environment; and (iii) a new computer
room with expanded systems and telecommunications services.the Internet protocol numbers
of the top level domain zone servers. The Company believesother top level domain zone servers
then copy that this new facility with the accompanying system enhancements provides the
environment and tools that are essential for quality customer support.file.
To register a domain name within the .com, .org, .net and .edu TLDs, the
Company'stop level
domains, our customer or the customer's Internet access provider (i)on behalf of
the customer, completes a registration application which is submitted to the Companyus via
e-mail or (ii) submits a web-based registration application through the Company's
WorldNIC(TM) Servicesour web site.
Once the customer is registered, the Company
loads the domain name intois included in the A-root zone server, which contains the Internet's
definitive global listing of addresses and which Network Solutions manages under
authority from the NSF. Ittop level
domain master database that is from the A-root zone server that the Internet root
server administrators obtain their nightly updates of the zone files maintained
by the Company. In January 1998, the Company installed a back-up facility in
Charlotte, North Carolina to provide redundancy and enhanced reliability for its
Internet root zone administration.
Seven T1 and one T3 (high-speedupdated nightly.
Eleven high-speed data communications line)line links connected to five ISPseight
Internet service providers support the Company'sour registration services. The aggregate capacity
of the Company's T1 links is 10.5 megabits per second and the capacity of the T3
link is 45 megabits per second. Thus the aggregate capacity of the T1 and T3
links is 55.5 megabits per second. By connecting to
fiveeight different ISPs, the
Company seeksInternet service providers, we seek redundancy to ensuremaintain
constant access to the Internet should 16
17
any given ISPInternet service provider or
link develop complications. The Company believes itsWe believe our current network is adequate and that
any additional capacity will be available in the future as needed.
Substantial portionsPortions of the Company'sour internally developed registration software have been
custom-developed and are proprietary. The Company'sOur internally developed registration
software includes an automated registration capability that currently processes
in excess of 90% of all new registration requests without human intervention.
The Company has a capital lease/purchase process for its computer equipment
that allows the Company to use the latest technology within itsWe have an operating infrastructure. The Company has over 300 NT workstations providing customer
service and approximately 150 UNIX servers running a variety of applications to
evenly distribute operational load. Additionally, the Company utilizes several
large network file serversfacility to support its directoryour current registration
operations and registrationcustomer support needs. The facility includes a call center, a
training center equipped for both computer and telephone training and a new
computer room with expanded systems and telecommunications services. These serversWe contract
for a back-up facility at a third party's secure facility in California to
provide a mirrored file system forredundancy and enhanced reliability for our Internet root zone
administration.
Recently, our systems have been subject to unusually large numbers of
speculative and back-up coverage. The Company isrepetitive e-mail domain name registration and modification
requests from domain name speculators and other abusers. Such abuses of our
systems have resulted in processing delays. We have taken, and are continuing to
take, actions to combat these delays and abusive e-mails by accelerating the
processimplementation of implementing a
state-of-the-art network management technology that will improve overall
operational efficienciesplanned hardware upgrades to our systems and by taking other
actions, including imposing certain restrictions on access to our customer
quality.database, to minimize the impact of such system abuses.
RESEARCH AND DEVELOPMENT
All research and development expenses incurred in 1995 were reimbursed to
the Company by direct charges to contracts, including the Cooperative Agreement.
In 1996, our research and development expenses were $680,000 or 3.6% of net
revenue. In 1997, our research and development expenses were $1,653,000 or 3.6%
of net revenues. The Company believesIn 1998, our research and development expenses were $4,821,000
or 5.1% of net revenues. We expect that significantthe level of research and continuing investmentsdevelopment
expenses will continue to increase in productsthe near future in terms of absolute
dollars as we invest in developing new service offerings.
COMPETITION
COMPETITION IN THE REGISTRATION BUSINESS
A principal objective expressed in the Statement of Policy is the
introduction of competition and services developmentglobal participation in the management of
Internet names and addresses including, among other things, competition among
registrars within a single top level domain and competition among existing
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and new top level domains. This objective is embodied, in part, in the October
1998 amendment to the Cooperative Agreement. Many aspects of how competition
will be required to maintain its position as
the leaderwork in the domain name registration businesssystem, however, remain unsettled and to achieve its strategycould be
impacted by, among other things, actions of leveraging its registration services business to offer and distribute other
enabling services.
COMPETITION
The Companythe not-for-profit corporation. We
currently is the leading provider of domain name registration
services. It currently is the exclusive registry and registrar for second level
domain names within the .com, .org, .net, and .edu TLDs. The Company currently
facesface competition in the domain name registration business from
registries for country code TLDs,top level domains, third level domain name providers
such as Internet access providers and registrars and registries of TLDstop level
domains other than those TLDstop level domains that we currently being
registered by the Company.administer. A
number of entities have already begun to offer competing registration services
using other TLDs.
On July 1, 1997, President Clinton directedtop level domains.
In developing and distributing future products and services for the
Commerce DepartmentInternet-based services markets, we face intense competition and expect to privatize, increase competition in, and promote international participation inhave
multiple competitors for each of the DNS. On February 20, 1998, the NTIA published the Proposed Rule in the
Federal Register for comment. The Proposed Rule, if issued, would provide,
among other things, (i) that additional companies could act as registrars for
second level domain names within the .com, .org and .net TLDs and (ii) that
additional TLDs would be permitted to be added to the Internet's root zone
system.
The Company believes that additional competition will be forthcoming in the
domain name registration services business. The exact timing and nature of that
competition is, at this time, however, uncertain. Additional competition could
result through the emergence of competing
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registrars in the .com, .org and .net TLDs and/or the emergence of additional
registries with responsibility for new TLDs. In the event that a final rule is
issued that results in additional competition in the DNS business or additional
competition is introduced through some other means, there could be a material
adverse effect on the Company's business, financial condition and results of
operations.
Future competition in the Company's domain name registration business could
come from many different companies, including, but not limited to, major
telecommunications firms, cable companies and Internet access providers. Such
entities have core capabilities to deliver registration services, such as help
desks, billing services and network management, along with strong name
recognition and Internet industry experience. Other companies with some or all
of these capabilities may also enter the registration business. Also emerging is
a growing contingent of domain name resellers.
In addition, the Company's revenue and registration fees could be reduced
due to increased competition or pricing pressures. For example, other registrars
may bundle domain name registrations with other products or services, effectively providing such registrationif any, which we
develop or sell. Furthermore, the industry in which we intend to compete is
characterized by rapid changes and frequent product and service introductions.
If a competitor were to successfully introduce certain products or services
for free.
The Company believes that competition in the domain name registration
servicesbefore us, it could cause our business is in the best interests of the Internet community. The
Company believes that it is well positioned to be successful in a competitive
environment by virtue of (i) its existing customer base; (ii) global recognition
of the .com, .net and .org TLDs; (iii) its agreements with Internet access
providers; (iv) its established technical infrastructure; (v) its experience in
the administration of a domain name dispute policy; and (vi) its skilled
technical personnel who are experienced in the domain name registration
business. In addition, a substantial portion of the Company's registration
software has been custom-developed and is proprietary. Additionally, the
Company's internally-developed registration software includes an automated
registration capability that currently processes in excess of 90% of all new
registration requests without human intervention.
See "Relationship With the NSF; Recent Developments in Internet
Governance."suffer.
COMPETITION IN THE INTERNET TECHNOLOGY SERVICES BUSINESS
Companies with Internet expertise are current or potential competitors to
the Company's consulting servicesour Internet Technology Services business. SuchThese companies include systems
integrators and consulting firms, such as Andersen Consulting, IBM Global
Services and International Network Services. The CompanyWe also competescompete with certain
companies that have developed products that automate the management of IP
addresses and name maps throughout enterprise-wide Intranets,intranets, and with companies
with internally-developed systems integration efforts. An IP address
allows a router, a computer which connects networks together, to determine the
network to which the router should send the data it receives. A number of these
competitors and potential competitors have longer operating histories and
greater name recognition and significantly greater financial, technical,
marketing, distribution and other resources than the Company. There can be no
assurance that the Company willwe do. We may not be able to
successfully compete in the consulting services business. Failure by the Company to successfully compete in
the consulting services business could have a material adverse effect on the
Company's business, financial condition and results of operations.
In developing and distributing future products and services for the
Internet-based services markets, the Company faces intense competition and
expects to have multiple competitors for each of the products or services, if
any, which it develops or sells. Many of the Company's
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potential competitors have longer operating histories, greater name recognition
and significantly greater financial, technical, marketing, distribution and
other resources than the Company. Furthermore, the industry in which the Company
intends to compete is characterized by rapid changes and frequent product and
service introductions. To the extent a competitor introduces a competitive
product or service prior to introduction of the same or similar product or
service by the Company, market acceptance of the competitor's product or service
may adversely affect the Company's competitive position.
See "Risk Factors - Competition."Internet Technology Services area.
INTELLECTUAL PROPERTY RIGHTS
The Company'sOur principal intellectual property consists of, and itsour success is
dependent upon, the Company'sour proprietary software utilizedused in itsour registration service
business and certain methodologies and technical expertise it utilizeswe use in both the
design and planned implementation of itsour current and future registration serviceservices and
proposed Internet-enablingInternet-based products and services businesses. Some of the software and
protocols used by the Companywe use in itsour registration service and proposed Internet-enabling businessesservices are in the public domain or are
otherwise available to the Company'sour competitors. The CompanyWe also hashave compiled a database of
information relating to customers in itsour registration business. While a portion
of this database is available to the public in the Company believesform of a directory service,
we believe that it haswe have certain ownership rights in this database and intendswe intend
to protect such rights. The Company's engineersWe have in-depth technical
knowledge and unique processes that are critical to the Company's consulting
services business, in which a full range of consulting and systems integration
services are offered in order to transition organizations from private, legacy
networks to more scalable and efficient enterprise networks. The Company has no patents but itsour proprietary materials are
protected by trade secret laws. The
CompanyWe also has registeredown or have rights to various
copyrights, trademarks and trade names in certain of its proprietary software
and the Company owns several trademarks. See "Risk Factors - Intellectual
Property Rights."our business.
EMPLOYEES
As of December 31, 1997, the Company1998, we had approximately 260385 full-time employees. None
of the Company'sour employees are covered by collective bargaining agreements. The Company believesWe believe
that itsour relations with itsour employees are good.
RISK FACTORS
IN ADDITION TO OTHER INFORMATION IN THIS FORM 10-K, THE FOLLOWING RISK
FACTORS SHOULD BE CAREFULLY CONSIDERED IN EVALUATING THE COMPANYUS AND ITSOUR BUSINESS BECAUSE
SUCH FACTORS CURRENTLY HAVE A SIGNIFICANT IMPACT OR MAY HAVE A SIGNIFICANT
IMPACT ON THE COMPANY'SOUR BUSINESS, OPERATING
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RESULTS OR FINANCIAL CONDITION. ACTUAL RESULTS COULD DIFFER MATERIALLY FROM
THOSE PROJECTED IN THE FORWARD-LOOKING STATEMENTS CONTAINED IN THIS FORM 10-K AS
A RESULT OF THE FOLLOWING RISK FACTORS SET FORTHDISCUSSED BELOW AND ELSEWHERE IN THIS FORM 10-K.
Limited Operating History. Prior to September 14, 1995,INDUSTRY RISKS
Ongoing privatization of Internet administration could harm our registration
business
The Statement of Policy or "White Paper," calls for a phased transition of
the Company was
paid directly byDepartment of Commerce's responsibilities for the NSF for providing registration services on a cost
reimbursement plus fixed fee basis. Accordingly, the Company has only a limited
operating history under its current subscription-based pricing model for its domain name registration business upon which an evaluation of the Company and
its prospects can be based.
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The Company's prospects must be considered in light of the risks frequently
encountered by companies in their early stages of development, particularly
companies in new and rapidly evolving markets. To address these risks, the
Company must, among other things, respond to competitive developments, increase
its sales and marketing organization, continue to identify, attract, retain and
motivate qualified persons and continue to upgrade its technologies and
commercialize products and services incorporating such technologies. While the
Company has been involved in network consulting services since its inception,
due to the rapidly evolving nature of Internet technologies, the Company's
consulting services business faces similar risks. There can be no assurance that
the Company will be successful in addressing such risks or that the Company will
continue to obtain new registrations at current rates or obtain renewals from a
significant portion of its customers.
The Company's expense levels are based in part on its expectations as to
future revenue andsystem to a
large extent are fixed. As a result, quarterly sales and
operating results generally depend on the volume of and ability to fulfill
registration requests, which are difficult to forecast. The Company may be
unable to adjust spending in a timely manner to compensate for any unexpected
revenue shortfall. Accordingly, any significant shortfall of demand for the
Company's services in relation to the Company's expectations would have an
immediate adverse impact on the Company's business, financial condition and
results of operations. In addition, the Company expects a significant increase
in its operating expenses as it funds greater levels of product and services
development, increases its sales and marketing operations, upgrades systems and
infrastructure, opens new offices, develops new distribution channels and
broadens its customer support capabilities. To the extent that such expenses
precede or are not subsequently followednot-for-profit corporation by an increase in revenue, the
Company's business, financial condition and results of operations will be
materially and adversely affected.
Uncertainty of Internet Governance and Regulation. The Internet
historically has been loosely administered by government agencies which were
involved in the creation of its infrastructure, initially ARPA and, more
recently, the NSF. No single organization or entity (including the NSF)
currently has formal authority over all aspects of the Internet and it currently
operates under a system of mutual cooperation. Since the original role of the
Internet was to link computers at governmental and academic institutions to
facilitate communication and research, the Internet was historically
administered by entities which were involved in sponsoring research rather than
by any of the traditional federal or state regulatory agencies. With the
commercialization and internationalization of the Internet, the role of these
entities in Internet administration has become less clear and private parties
have begun to assume a larger role in the enhancement and maintenance of the
Internet's infrastructure.
The Cooperative Agreement became effective January 1, 1993. It includes a
three-month phase-in period, a five-year operational period (commencing April
1, 1993 and ending March 31, 1998), and a six-month "flexibility period"
through September 30, 1998.2000. The Cooperative Agreementdomain name system is subject to reviewthe
system by the NSFwhich Internet names and may be terminated by the NSF at any time at its discretion or by
mutual agreement. The NSF has stated that it will not be re-awarding a
cooperative agreement at the end of the flexibility period.
The U.S. government has issued the Proposed Rule to provide noticeaddresses are registered, allocated and seek
public comment on a proposal to transfer over time the administration of the DNS
to a private, U.S. not-for-profit corporation and increase competition in the
administration of TLDs and the registration of second level domain names. The
Proposed Rule states that the "U.S. government seeks as much consensus as
possible before acting." See "Relationship with the NSF; Recent Developments in
Internet Governance."
Comments on the Proposed Rule have revealed substantial differences
regarding how the DNS should evolve and competing proposals concerning DNS
management to those set forth in the Proposed Rule have been advancedused.
We face risks from time
to time. There is a risk thatthis transition, including:
- failure to achieve consensus could, among other
things, prevent or delay the issuance of a final rule. In addition, any rule
that is issued could be challenged by persons or entities who disagree with its
provisions. Any of such events could have a material adverse effect on the Company's business, financial condition and results of operations through
continued uncertainty about
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future Internet governance or a disruptionmany issues relating to the
administration, effective
operation or maintenancefunctioning and expansiongovernance of the Internet,not-for-profit corporation could result
in general, orinstability in domain name system administration,
- the DNS,not-for-profit corporation could fail to gain legitimacy resulting in
particular. Additionally, any final rule could be different, perhaps
substantially, from the Proposed Rule. Any final rule or any terms negotiated byinstability in domain name system administration,
- the U.S. government and the CompanyGovernment could contain provisions which are not
favorablerefuse to transfer certain responsibilities for
domain name system administration to the Companynot-for-profit corporation due
to security, stability or other reasons resulting in fragmentation or
other instability in domain name system administration, and
- the not-for-profit corporation could adopt or promote policies,
procedures or programs that are unfavorable to our role in the
registration of domain names or that are not consistent with the Company'sour current
or future plans.
ItAs the U.S. Government transitions certain responsibilities for domain name
system administration to the not-for-profit corporation, corresponding
obligations under our Cooperative Agreement with the Department of Commerce may
be terminated and, as appropriate, covered in a contract between the
not-for-profit corporation and us. We might not reach an acceptable contractual
agreement with the not-for-profit corporation for our continuing role in the
registration of domain names.
The U.S. Government has sent us a letter directing us to treat ICANN as the
not-for-profit corporation identified in the October amendment to the
Cooperative Agreement described above, in the performance of its obligations
under the MOU and until such time as the MOU is terminated. We have not yet
responded to that letter. We are currently in discussions with ICANN and the
U.S. Government regarding implementation of the shared registration system and a
wide range of contractual issues. We cannot be sure that these discussions will
result in agreements favorable to us.
Despite the significant efforts undertaken to date, it is impossible to
predict at this time whether or when a final rulethe process initiated by the Statement of
Policy will be issuedresult in the full transition to the not-for-profit corporation of
domain name system responsibilities as and to the extent contemplated in the
White Paper and, if issued,it does, the timing of its implementation, the exact
nature of its provisions or any terms negotiated by the U.S. government and the
Company or the precise effect on us of such provisionstransition. See
"-- Ongoing Privatization of Internet Administration."
Changes to or disputes under the cooperative agreement could harm our business
Termination, or a change in the terms, onof the Company. It is
possible thatCooperative Agreement could
harm our business. While the Cooperative Agreement by its terms expires in
September 2000, it may be terminated earlier. The Department of Commerce's
interpretation of certain provisions of any final rule or certain of such terms
could have a material adverse effect on the Company's business, financial
condition and results of operations. See "Competition."
In the United States, apart from its obligations under the Cooperative Agreement the Company is not currently subject to direct regulation other than
federal and state regulation applicable to businesses generally. However,
changes in the regulatory environment could result in the Company being subject
to direct regulation by other U.S. regulatory agencies, such as the Federal
Communications Commission (the "FCC").differ
from ours. For example, the Company is awareDepartment of Commerce has publicly expressed
concerns about our consolidation into a single web site the web sites through
which our InterNIC registration services and our RegistrationPlus services were
offered. These differences in interpretation
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could lead to disputes between us and the Department of Commerce or the
not-for-profit corporation, which may or may not be resolved in our favor.
Certain aspects of implementation of the Cooperative Agreement also remain to be
fully negotiated, including the maximum price we will charge for registry
services in the top level domains for which we now act as registry. If we are
unsuccessful in negotiating acceptable terms of implementation, the costs of
implementation of the Cooperative Agreement, our relationship with the
not-for-profit corporation and other matters affecting our position in a more
competitive domain name system environment could be harmed. See "-- Status of
Cooperative Agreement."
Challenges to authority over domain name administration could harm our business
Withdrawal of or challenges to the U.S. Government's sponsorship or
authorization of certain industry requestsfunctions that we perform could create a public
perception or result in a legal finding that we lack authority to the FCC to review the impact of Internet usage on
the U.S. telecommunications service providers,continue in
particular, the generally
lower cost structure for data transmission versus voice. In addition,our current role as Internet usage becomes more widespread internationally, there is an increased
likelihood of international regulation. The Company cannot predict whetherregistry or to
what extent any such new regulation will occur; however, such regulation could
have a material adverse effect on the Company's business, financial condition
and results of operations.
Additionally, the applicability to the Company of existing laws governing
issues such as intellectual property ownership is uncertain. Courts have
indicated that, under certain circumstances, ISPs could be held responsible for
the failure to prevent the distribution of material that infringes on others'
copyrights and other intellectual property. The future interpretation by the
courts of the obligation of domain name registrars to prevent trademark
infringement and other legal issues is uncertain. See "Item 3 - Legal
Proceedings."
Costs incurred or decisions rendered as a result of government actions,
including enactment of new laws or adoption of new regulations, investigations
or lawsuits relating to any of the foregoing, could have a material adverse
effect on the Company's business, financial condition and results of operations.
Competition. The Company currently is the exclusive registrar for second
level domain names inwithin the .com, .org.,.org, .net and .edu
TLDs. Multiple registrars
dotop level domains. The legal authority underlying the roles of the Department of
Commerce and the not-for-profit corporation with regard to the domain name
system also could be challenged. The impact, if any, of any such public
perception or finding is unknown, but it could be harmful to our business.
We may not currently register namesbe able to compete effectively due to increased competition in the
same TLD, but this may changedomain name registration business
The introduction of additional competition into the domain name
registration business could be harmful to our business. This includes, in
the
future. The Companyparticular, 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. In addition, we currently facesface competition in the domain
name registration business from registries for country codes,code top level domains,
third level domain name providers such as Internet access providers and
registrars and registries of TLDstop level domains other than those TLDstop level
domains which we currently being registered by the Company.register. A number of entities have already begun to
offer competing registration services using other TLDs.top level domains and when the
shared registration system takes effect we will no longer be the exclusive
registrar in the .com, .org and .net top level domains.
Future competition in the Company's domain name registration business as a registry
or registrar could come from many different companies, including, but not limited to,including:
- domain name registration resellers,
- country code registries,
- Internet access providers, and
- major telecommunications firms, cable companies and Internet access providers. Suchfirms.
Many of these entities have core capabilities to deliver registrationregistry and/or
registrar services, such as help desks, billing services and network management,
along with strong name recognition and Internet industry experience. Other companies with some or all
of these capabilities may also enter the registration business. Also emerging is
a growing contingent of domain name resellers. The Company's position as the
leading registrar of domain names could be materially and adversely affected by
the emergence of any of the foregoing competitors and potential
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competitors, many of which have longer operating histories and significantly
greater name recognition and greater financial, technical, marketing,
distribution and other resources than the Company. In addition, the Company'sOur revenue and registration fees
could be reduced due to increased competition, pricing pressures or pricing pressures.a
modification of billing practices. For example, other entities may bundle domain
name registrations with other products or services, effectively providing such
registration services for free.
Various governmental technical and Internet groups have been discussing for
some time ways of introducing more competition into the domain name
registration business. On February 20, 1998, the NTIA published the Proposed
Ruleservices. See "-- Competition in the
Federal Register to provide notice and seek public commentRegistration Business."
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We depend on a
proposal to increase competition in the administration of TLDs and the
registration of domain names. Under the Proposed Rule, the Company would
continue to operate the .com, .org, and .net registries and to act as a
registrar for those TLDs, but other companies would be permitted to act as
registrar for those TLDs. The Proposed Rule also provides for additional new
TLDs. The Company believes that it is well positioned to succeed in a more
competitive environment. However, the adoption of the Proposed Rule or a
similar rule or the introduction of additional competition into the domain name
registration business in some other manner could have a material adverse effect
on the Company's business, financial condition and results of operations. See
"Relationship with the NSF; Recent Developments in Internet Governance" and
"Competition."
In addition, the Company faces substantial competition in its consulting
services business and in the development and distribution of future products and
services for the Internet-based services markets. See "Competition."
Reliance on Third Parties. Reliable communications over the Internet are
dependent upon the Internet root servers, which serve as the authoritative
source of Internet locations and which allow the resolution of IP addresses from
domain names on the Internet. Currently, there are 13 root servers, ten of which
are located in the United States, two of which are located in Europe and one of
which is located in Asia. Nine of the root servers currently are populated with
the domain names registered by the Company, while these nine and the other four
also contain information with respect to other TLDs, including country TLDs.
When communication with a particular domain name is required and the IP address
of that domain name's host is not known locally, the root servers "point" to a
direct or indirect source of the information. Multiple root servers are required
for purposes of load balancing and redundancy.
The location and control of these root servers has been determined by
consensus of various membersgrowth of the Internet community. The Companyand 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 controlsadminister and operate only onetwo of thesethe 13 root zone servers
and temporarily administers one other
root server.four top level domain zone servers. The other eleven root serversothers are maintainedadministered and controlledoperated
by independent operators on a volunteer basis. TheseBecause 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 may at
any time, for any reason,
fail to properly maintain such servers or abandon such servers.
The occurrenceFurther, our registration business could be harmed if any of any such events could have a material adverse
effect on the Company's business, financial condition and results of
operations.
Further, no single organization or entity currently has formal authority
over all aspects of the root zone system. Somethese
volunteer root server operators have questioned which organization or entity has the legal authority to direct
where the root servers are to be pointed. The operators of the root servers have
historically taken guidance from the IANA. Therefore, it is possible that IANA
could direct the root servers not to accept information updates from the Company
or that the operators of the root servers could choose to no longer carry the
Company's information. In the event that the root servers were changed to
exclude the information maintained by the Company, all domain names registered
by the Company in
22
23
TLDs for which the Company acts as the registry would no longer be accessible by
other users of the Internet. This could cause widespread disruption of the
Internet. If some, but not all, of the root servers were changed to exclude the
Company's data, the multiple root servers would contain inconsistent
information. The failure by any or all of the root serversfail to include or provide accessibility to the Company's data would materially and adversely affectthat we
maintain in the Internetroot zone servers and the Company'stop level domain zone servers that we
control. See "-- Operations."
We rely on Internet service providers
Our registration business financial condition and results of
operations.
The Proposed Rule provides that a new corporation wouldcould be established to
oversee the operation of an authoritative root server system. Under the Proposed
Rule, IANA and the U.S. government, in cooperation with the Company, theharmed if enough Internet Architecture Board and other relevant organizations, would undertake a
review of the root server system to recommend means to increase the security and
professional management of the system. However, no assurance can be given that
this provision will be part of any final rule or that, if this provision is
adopted, it would eliminate the risks in this area.
The Company's success and ability to compete also are dependent upon the
relationships between the Company and ISPs worldwide. Thus, if ISPs were to
electservice
providers decided not to route Internet communications to or from domain names
registered by the Companyus or if enough ISPs were to electInternet service providers decided to provide
routing to a set of accepted rootdomain name servers which did not point to the Company's TLD servers, the
Company'sour 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
financial condition and results ofAny significant problem with our systems or operations would be
materially and adversely affected.
Year 2000. Network Solutions, like many other companies, iscould result in the process
of assessing its computer software applications and systems to ensure their
functionality with respect to the "Year 2000" millenium change. At this time,
the Company believes that the remediation costs, if any, needed to make all of
its internal applications and systems Year 2000 compliant are not material.
Although the Company believes that its internal mission critical systems
are Year 2000 compliant, thelost
revenue, customer dissatisfaction or lawsuits against us. A failure of the software applications or internal
systems of other companies on which the Company's systems rely or to which they
are connected or of other Internet-related companies, including Internet web
hosting companies, Internet access providers, or Internet root server operators,
none of which the Company controls, to be Year 2000 compliant upon January 1,
2000 could have a material adverse effect onin the
operation of our registration system could result in deletion of one or more
domain names from the Internet and/for a period of time. A failure in the operation
or a material adverse effect on the Company's business, financial condition
and results of operations.
Litigation. The Company is involved in several legal proceedings as
described in "Item 3 - Legal Proceedings." As of March 13, 1998, the Company was
a defendant in 6 lawsuits involving domain name disputes between trademark
owners and domain name holders in which
23
24
the Company has been named as a defendant. On March 20, 1997, PG Media, Inc., a
New York-based corporation, filed a lawsuit (the "PG Media suit"), alleging that
the Company had restricted access to the Internet by not adding PG Media's
requested TLDs in violationupdate of the Sherman Act. On October 17, 1997, a groupmaster database that we maintain could result in deletion of
six plaintiffs filed a lawsuit (the "Thomas suit") against the Company and the
NSF challenging the legality of fees defendants charge for the registration and
renewal of domain names onone or more top level domains from the Internet and seeking restitutionthe discontinuation of
fees
collected fromsecond level domain names in those top level domains for a period of time. The
inability of our registration system and telecommunications systems to meet the
demands of the increasing number of domain name registrants in an amount in excess of $100 million,
damages,registration requests and
injunctivecorresponding customer e-mails and other relief. The plaintiffs allege violations of
the Administrative Procedures Act, the Independent Offices Appropriations Act,
the Sherman Act and the U.S. Constitution. In each of these cases, the Company
believes it has meritorious defenses and intends to defend itself vigorously.
While the Company cannot reasonably estimate the potential impact of the claims
advanced in the PG Media or Thomas suits, a successful claim against the
Company in either of these proceedingstelephone calls could have a material adverse effect on
the Company's business, financial condition and results of operations.
In addition, on June 27, 1997, SAIC received a Civil Investigative Demand
from the U.S. Department of Justice issued in connection with an investigation
to determine whether there is, has been, or may be an antitrust violation under
the Sherman Act relating to Internet registration products and services. The
Company cannot reasonably estimate the potential impact of the investigation nor
can it predict whether a civil action will ultimately be filed by the Department
of Justice. The Company is unable to predict the form of relief that might be
sought in such an action or that might be awarded by a court or imposed as a
result of any settlement. Any such relief could have a material adverse effect
on the Company's business, financial condition and results of operations.
Litigation in which the Company is involved has resulted and likely will
result in, and any future litigation can be expected to result in substantial
legaldegradation in our customer support service and other expensesour ability to the Company andprocess
registration requests in a diversion of the efforts of the
Company's personnel.
System Interruption and Security Risks. The Company'stimely manner.
Our operations are
dependent upon itsdepend on our ability to maintain itsour computer and
telecommunications equipment in effective working order and to reasonably
protect itsour systems against interruption frominterruption. 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. The vast majority of
the Company's computer and telecommunications equipment is located in a single
facility. Although the Company has established back-up facilities at its
Charlotte, North Carolina site, this measure will not eliminate the significant
risk to the Company's operations from a natural disaster or system failure at
its principal site. Despite the implementation of security measures and standard
operating procedures, the Company's infrastructure may also be vulnerable toevents,
- computer viruses, hackers human error or similar disruptive problems caused by
its employees, customers or other Internet users. Computer break-insusers, and
other
disruptions may jeopardize14
17
- systems strain caused by the security of information stored in and transmitted
through the computer systems of the Company and may deter potential customers
from utilizing the Company's services. In addition, growth of the Company'sour customer base may put strain on the capacity of its computers and telecommunications systems and the Company'sour
inability to sufficiently maintain or upgrade its systems could lead to degradation in performanceour systems.
See "-- Operations."
We may lose revenue or system
failure. Any damage,incur significant costs if Year 2000 compliance issues
are not properly addressed
Our failure, or delaythe 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 causes significant interruptions in
the Company's systems would have a material adverse effect on the Company's
business, financial condition and results of operations.
On July 17, 1997, during a routine update of the root serverwe face with regard to Year
2000 failures are those which impact our domain name files,registration business.
These risks include:
- significant and protracted interruption of electrical power to data and
call-center operations in our engineering facility,
- significant and protracted interruption of telecommunications and data
network services in either of our headquarters or engineering facilities,
- the Company inadvertently released corrupted database files forfailure of components of our current back office and domain name
registration related systems, and
- the .comoccurrence of a Year 2000 problem with respect to third-party
suppliers', vendors' and .net TLDs, causing disruption throughout the Internet. The originaloutsourcing service providers' products and
services.
If we fail to solve a Year 2000 compliance problem which was caused by a database error, was compounded when the normal quality
control mechanisms used to validate the .comwith our mission
critical business systems and 24
25
.net TLD files were incorrectly overridden by Company personnel and the
corrupted files were released. As a result, certain Internet users were unable
to access certain web sites. The database error was subsequently fixed and the
corrected files were regenerated and re-released by the Company within four
hours, although the length of time during which certain Internet users
experienced disruption in accessing the Internet varied.
The Company has taken several steps to avoid any future occurrences of this
or similar problems,processes, including but not limited to, adding software code to make
it more difficult to transmit a problematic file and additional quality checks
by a senior level person prior to each file transmission. There can be no
assurance, however, that the Company's standard operating procedure or the
additional measures implemented by the Company will prevent or mitigate a
similar occurrence in the future.
Separately, in July 1997, an entity which offers competing registration
services using other TLDs exploited a security vulnerability in the Berkeley
Internet Name Domain ("BIND") software, a third-party Internet name server
software used by Internet companies' Unix systems, to redirect traffic intended
for the Company's web site. The Company's systems were not impacted by the
exploitation. However, Internet users that were relying on systems that had not
upgraded to a more current version of BIND were redirected from the Company's
web site which impacted the Company's business.
If any of these or similar problems should recur or occur in the future, it
could result in, among other things, damage to the Company's reputation and
credibility, increased intervention by governmental entities or reduced customer
confidence, which could in turn materially and adversely affect the Company's
business, financial condition and results of operations.
Uncollectible Receivables; Modifications to Billing Practices. Currently,
the Company invoices a majority of its customers and permits them to pay the
services fee after the domain name servers under
our control, telecommunications systems, facilities, data-networking
infrastructure, commercial-off-the-shelf hardware, 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 registered.Year 2000 compliant.
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Year 2000 Compliance."
COMPANY RISKS
Our search for a new chief executive officer presents risks and uncertainties
On November 16, 1998, we announced the resignation of Gabriel A. Battista
from his positions as Chief Executive Officer and director. We cannot reasonably
estimate at this time the potential impact on us of the hiring of a new Chief
Executive Officer. While we conduct a search for a new Chief Executive Officer,
Michael A. Daniels, our Chairman of the Board, is acting as the Chief Executive
Officer and assuming the executive responsibilities previously performed by Mr.
Battista. In addition, Robert J. Korzeniewski, our Chief Financial Officer, is
also acting as our Chief Operating Officer, assuming responsibility for
day-to-day operations. We cannot be certain of the timing of our hiring of a new
Chief Executive Officer or the effect of any delays in our hiring of a new Chief
Executive Officer on the development or implementation of our strategic plan.
15
18
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 Company believes it hasloss 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.
Our near term success depends on the growth of our domain name registration
business
We may not be able to sustain the revenue growth we have experienced in
recent periods. In addition, past revenue growth may not be indicative of future
operating results. If we do not successfully maintain our current position as a
leading provider of domain name registration services or develop or market
additional services, our business could be harmed.
Our domain name registration services business generates over 90% of our
revenue and is expected to continue to account for a very significant portion of
our revenue in at least the near term. Our future success will depend largely
on:
- the continued increase in domain name registrations,
- re-registration rates of our customers,
- our ability to maintain our current position as a leading registrar of
domain names, and
- the successful development, introduction and market acceptance of new
services that address the demands of Internet users.
We must effectively manage our marketing organization and establish and maintain
distribution channels
We will need to effectively manage our growing sales and marketing
organization if we want to achieve future revenue growth. We do not know if we
will be able to identify, attract and retain experienced sales and marketing
personnel with relevant experience. Further, our sales and marketing
organization may not be able to successfully compete against the significantly
more extensive and well-funded sales and marketing operations of our current or
potential competitors for registration or consulting services.
Our ability to achieve future revenue growth will also depend on our
ability to continue to establish direct sales channels and to develop multiple
distribution channels. To do this we must maintain relationships with Internet
access providers and other third parties.
We have a high level of uncollectible receivables
Because of our high level of uncollectible receivables, we continually
review our billing practices. Any modifications that we implement as a result of
these reviews 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 resellingtransferring
such registrationsnames at a profit. The Company'sOur experience has been that such resellers have a
greater tendency than other customers to default on their services fees. The Company hasWe have
established a provision for uncollectible accounts that it
believeswhich we believe to be
adequate to cover anticipated uncollectible receivables; however, actual results
could differ from
the Company's estimate and could have a
material adverse effect on the Company's business, financial condition and
results of operations.16
19
our estimates. See "Item 7 -- Management's"Management's Discussion and Analysis of Financial Condition
and Results of Operations" and Note 43 of Notes to Financial Statements.
The Company continually reviews its billing practices for modificationWe are party to respond to market conditions and to implement operational improvements. Any such
modificationseveral legal proceedings which could have unanticipated consequencesa 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 could result in a
material adverse effect on the Company's business, financial conditionwe are involved are expensive and results of operations.
Limited Service Offerings to Date; Reliance on Domain Name Registration
Services and Consulting Services for Substantially All Revenue. The Company's
domain name registration services and consulting services businesses have in the
past generated substantially all of the Company's revenue from continuing
operations and are expected to continue to account for substantially all of the
Company's revenue from continuing operations in the near term. The Company's
future success will be highly dependent upon the continued increase in domain
name registrations with the Company, renewal rates of its customers, the ability
of the Company to maintain its current position both as a registrar of domain
names and as the leading
25
26
registrar of domain names within the .com TLD and the successful development,
introduction and market acceptance of new services that address the demands of
Internet users. Although the Company has experienced revenue growth in recent
periods, such growthdivert our personnel. See "Item
3 -- Legal Proceedings."
We may not be sustainable and may not be indicative of future
operating results. There can be no assurance that the Company will be able to successfully retain its current leading position in providing domain name
registration services or develop or market additional services. Failure to do
so would materially and adversely affect the Company's business, financial
condition and results of operations.
The Company's future success will also be dependent on its ability to
maintain and expand its consulting services business. In 1997, ten clients of
the Company's Consulting Services Division accounted for 80% of the division's
revenues. There is no guarantee that the Company will be able to maintain or
expand its consulting services business.
Technological Change and Additional Technology, Products and Services. The
development of RWhois, a Company-developed, standard open protocol, and the
associated technology, allows remote registration by others. The Company's
efforts to standardize and proliferate RWhois as the registration standard may
result in a material adverse effect on the Company's future competitive position
by enabling others to become competing registrars more easily. RWhois is also
the protocol that the Company may utilize for any global directory services that
the Company might offer. The successful introduction of such directory services
may blur the distinction between directory services and domain name
registration. Should this or another global directory service become widely
proliferated, domain name registration may be subsumed into such a service. In
that case, should the Company fail to secure a leadership position in providing
such a global directory service or establish a system for charging for such
service, the Company's business, financial condition and results of operations
would be materially and adversely affected.
The Company's future financial success will be highly dependent upon its
ability to develop and commercialize in a timely manner new technology, products
and services that can be offered in conjunction with the Company's current
domain name registration and consulting services and that can meet the changing
requirements of its current and future customers. The market for such
technology, products and services is characterized by rapidly changing
technology, evolving industry standards and frequent introductions of new
Intranet and Internet-related products and services. Generally, the successful
development and commercialization of new technology, products and services
involves many risks, including the identification of new Intranet and
Internet-related product and service opportunities, the successful completion of
the development process, and the identification, retention and hiring of
appropriate research, development and technical personnel. There can be no
assurance that the Company can successfully identify new products and service
opportunities and develop and bring to market in a timely manner new
technologies, products or services, or that technologies, products or services
developed by others will not render those of the Company noncompetitive or
obsolete. Failure by the Company to develop new technologies, products or
services and bring them to market in a timely manner could have a material
adverse effect on the Company's business, financial condition and results of
operations.
Dependence on Future Growth of the Internet and Internet Infrastructure.
The Company's future success is substantially dependent upon continued growth in
the use of the Internet. Rapid growth in the use of and interest in the Internet
is a relatively recent phenomenon and there can be no assurance that use of the
Internet will continue to grow at its current pace. Even if the Internet
continues to experience significant growth in the number of users and level of
use, there can be no assurance that the Internet infrastructure will continue to
be able to support the demands placed upon it by such growth. The Company's
success and the viability of the
26
27
Internet as an information medium and commercial marketplace will depend in
large part upon the development of a robust infrastructure for providing
Internet access and carrying Internet traffic. Failure to develop a reliable
network system, or timely development of complementary products, such as high
speed modems, could have a material adverse effect on the Company's business,
financial condition and results of operations. In addition, the Internet could
lose its viability due to delays in the development or adoption of new standards
and protocols required to handle increased levels of Internet activity or due to
changes in government regulation. The lack of Internet governance or changes in
governance or regulation could adversely affect the growth of the use of the
Internet and have a material adverse effect on the Company's business, financial
condition and results of operations.
Because global commerce and on-line exchange of information on the Internet
are new and evolving, it is difficult to predict with any assurance that the
infrastructure or complementary products will be developed, or, if developed,
that the Internet will become a viable information medium or commercial
marketplace. If the use of the Internet does not continue to grow, if the
necessary infrastructure or complementary products are not developed or do not
effectively support growth that may occur, or if the Internet does not become a
viable information medium or commercial marketplace, the Company's business,
financial condition and results of operations would be materially and adversely
affected.
Intellectual Property Rights. If it were determined that the Company does
not have ownership rights in its database of information relating to customers
in its registration business or if the Company is unable to protect such rights
in this database or is required to share the database with potential
competitors, there could be a material adverse effect on the Company's
business, financial condition and results of operations. The Proposed Rule
would require the Company to provide the U.S. government with "a copy and
documentation of all the data, software, and appropriate licenses to otherour intellectual property generated under the [C]ooperative [A]greement, for use by
the new corporation for the benefit of the Internet." If certain of the
Company's softwarerights and data generated which is proprietary
to the Company were
to be provided to the new corporation under the Proposed Rule and in turn
provided to competing registries or registrars, the Company's business,
financial condition and results of operations could be materially and adversely
affected.
The Company relies uponinformation
We rely on a combination of nondisclosure and other contractual
arrangements with itsthe U.S. Government, our employees and third parties, and
privacy and trade secret laws to protect its proprietary rights and limit the distribution of itsour
proprietary information. There cancustomer data, software, documentation and processes we have
developed in connection with our domain name registration business. If we fail
to adequately protect our intellectual property rights and proprietary
information or if we become involved in litigation relating to our intellectual
property rights, proprietary information or access to our customer data, our
business could be no assurance that the steps taken by the
Company in this regard willharmed. Any actions we take may not be adequate to deter misappropriation ofprotect our
proprietary information or that the Company will be able to detect unauthorized use of its
proprietary informationrights and take appropriate steps to enforce its intellectual
property rights. Furthermore, even if these steps are successful, there can be
no assurance that others will notother companies may develop technologies that are similar
or superior to the Company'sour proprietary technology. The U.S. Government or ICANN could
take positions adverse to our claims regarding proprietary rights or could
attempt to require us to enter into agreements limiting such claims. Although the Company believeswe
believe that itsour services do not infringe on the intellectual property rights of
others and that it haswe have all rights necessaryneeded to utilizeuse the intellectual property
employed in itsour business, the Companyit is possible that we could become subject to the risk of claims
alleging infringement of third party intellectual property rights. Any such claims
could subject us to costly litigation, and may require the Companyus to spend significant sums in litigation, pay damages and
develop non-infringing intellectual property or acquire licenses to the
intellectual property that is the subject of assertedthe alleged infringement.
Failure by
the Company to adequately protect its proprietary rightsUnsuccessful future acquisitions and investments could decrease operating
income, cause operational problems or litigation relating
to intellectual property rights could have a material adverse effectotherwise disrupt our business
We evaluate potential acquisitions and investments on the
Company's business, financial condition and resultsan ongoing basis for
various reasons including, among others, diversification of operations.
27
28
Potential Fluctuations in Quarterly Results. The Company believes that
future operating results will be subject to quarterly fluctuations due to a
variety of factors, many of which are beyond the Company's control. Such
factors may include, but are not limited to, developments in Internet
governance, the announcement of additional competing registries, registrars or
TLDs, variations in the number of requests for domain name registrations or
demand for the Company's services, introduction or enhancements of services by
the Company or its competitors, market acceptance of new service offerings,
increased competition, costs associated with developing or providingour domain name
registration or other services, litigation costs, results of litigation,
patterns of growth in the use of and interest in the Internetconsulting businesses. Our acquisition and general
economic conditions. The Company is continuing to increase its operating
expenses for personnel, facilities and new services development and, if its
revenues doinvestment strategy
poses many risks, including:
- we may not correspondingly increase, the Company's business, financial
condition and results of operations would be materially and adversely affected.
Since the Company recognizes consulting services revenue only when
engineers are engaged on client projects, the relative utilization of engineers
directly affects the Company's operating results. In addition, a majority of
the Company's consulting services operating expenses, particularly personnel
and related costs, depreciation and rent, are substantially fixed in advance of
any particular quarter. As a result, any under-utilization of engineers may
cause significant variations in operating results in any particular quarter and
could result in losses for such quarter. Termination or completion of contracts
in the Company's consulting services business or failure to obtain additional
contracts in its consulting services business could have a material adverse
effect on the Company's business, financial condition and results of operation.
See "Item 7 -- Management's Discussion and Analysis of Financial Condition and
Results of Operations."
Uncertainty of Future Acquisitions. The Company evalutes potential
acquisitions on an ongoing basis. No assurance can be given as to the Company's
abilityable to compete successfully for available acquisition
candidates, or to
complete future acquisitions and investments or as toaccurately
estimate the financial effect on the Companyour company of any acquired businesses. Futurebusinesses we acquire
or investments we make,
- future acquisitions by the Companyand investments may involverequire us to spend significant
cash expenditures andamounts or may result in decreaseddecrease our operating income,
either- 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 could have a material adverse effect on the Company'swe acquire or in which we
invest fail, our business
financial condition and results of operations. Should the Company be unable to
implement successfully its acquisition strategy, its business, financial
condition and results of operations could be materially and adversely affected.
Managementharmed.
Whether or when pooling of Growth; Dependenceinterests accounting for acquisitions might
become available to us depends on Key Personnel. The Company has recently
experienced growth in the number of its employees and in the scope of its
operating and financial systems. This growth has resulted in an increase in
responsibilities for both existing and new management personnel. The Company's
ability to manage growth effectively will require it to successfully integrate
its management team, continue to implement and improve its operational,
financial and management information systems and to train, motivate, manage and
retain its employees. There can be no assurance that the Company will be able to
manage its expansion effectively and a failure to do so could have a material
adverse effect on the Company'smany factors beyond our control.
17
20
We face increasing risks associated with our international business
financial condition and results of
operations. In addition, growth of the Company's customer base may strain the
capacity of its computers and telecommunications systems, and the Company's
inability to sufficiently maintain or upgrade its systems could lead to
degradation in performance or system failure.
The Company's future success depends in part on the continued service of
its key engineering, sales, marketing, executive and administrative personnel,
and its ability to identify, hire and retain additional personnel. In addition,
the future success of the Company's consulting services will depend in large
part on its ability to hire, train and retain engineers who have expertise in a
wide array of network and computer systems and a broad understanding of the
industries the Company serves. An inability of the Company to identify, hire,
train and retain a sufficient number of qualified engineers could impair the
Company's ability to adequately manage and complete its existing projects or to
obtain new projects, which, in turn, could have a material adverse effect on the
Company's business, financial condition and results of operations and could
impair the Company's expansion of its business. Competition for engineering,
sales, marketing and executive personnel is intense and there can be no
assurance that the Company can retain existing personnel or identify, hire or
retain additional qualified
28
29
personnel.
Evolving Sales and Marketing Organization and Distribution Channels. The
Company has had limited experience in marketing and selling its services under
its current subscription-based pricing model. The Company's ability to achieve
revenue growth in the future will depend in large part on its ability to manage
and grow its new sales and marketing organization. There can be no assurance
that the Company will be able to successfully manage this organization or
identify, attract and retain experienced sales and marketing personnel with
relevant experience, that the cost of such personnel will not exceed the revenue
generated or that the Company's sales and marketing organization will be able to
successfully compete against the significantly more extensive and well-funded
sales and marketing operations of the Company's current or potential
competitors.
In addition to establishing its direct sales channels, the Company's
distribution strategy is to develop multiple distribution channels. Accordingly,
the Company's ability to achieve revenue growth in the future will also depend
in large part on establishing and maintaining relationships with Internet access
providers and other third parties and on effectively using the Internet as a
medium of distribution. There can be no assurance that the Company will be able
to successfully develop third party distribution channels, develop its own
capabilities to distribute services using the Internet or that any such
development will result in an increase in revenue.
Any failure by the Company to manage and grow its new sales and marketing
organization, develop and expand its distribution channels or use the Internet
as a medium of distribution could materially and adversely affect the Company's
business, financial condition and results of operations.
Control by SAIC. As of March 13, 1998, SAIC owned 100% of the Company's
outstanding Class B Common Stock, representing approximately 75.8% of the
outstanding Common Stock of the Company and approximately 96.9% of the combined
voting power of the Company's outstanding Common Stock. The Class B Common Stock
is convertible into Class A Common Stock, subject to certain limitations set
forth in the Company's Second Amended and Restated Certificate of Incorporation
(the "Certificate of Incorporation"). As a result, SAIC effectively controls all
matters requiring approval by the stockholders of the Company, including the
election of members of the Company's Board of Directors, changes in the size and
composition of the Board of Directors and a change in control of the Company.
SAIC does not have an agreement with the Company restricting its rights to
convert, distribute or sell its shares of the Company's Common Stock and there
can be no assurance that SAIC will maintain its ownership of the Company's Class
B Common Stock.
The Internal Revenue Code of 1986, as amended (the "Code"), requires
beneficial ownership by SAIC of at least 80% of the total voting power and 80%
of each class of nonvoting capital stock of the Company in order for SAIC to be
able to effect a tax-free spin-off of the Company under the Code. As of March
13, 1998, SAIC owned approximately 96.9% of the total voting power of the
Company. Because SAIC may seek to maintain its beneficial ownership of the
Company for tax planning purposes or otherwise and may not desire to acquire
additional shares of Common Stock in connection with a future issuance of shares
by the Company, the Company may be constrained in its ability to raise equity
capital in the future or to issue Common Stock or other equity securities in
connection with acquisitions.
Reliance on SAIC for Certain Corporate Services. SAIC and the Company have
entered into certain intercompany agreements, including an agreement pursuant to
which SAIC will
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30
provide various corporate services to the Company that may be material to the
conduct of the Company's business (the "Corporate Services Agreement"). These
services include certain routine and ordinary corporate services, including
business insurance, accounting systems, employee benefits, payroll, tax and
legal services as well as assistance in government relations and corporate
quality assurance services as described in the Corporate Services Agreement.
With respect to matters covered by the Corporate Services Agreement, the
relationship between SAIC and the Company is intended to continue in a manner
generally consistent with past practices. If SAIC's ownership of the Company's
Common Stock drops below 50% of the Company's issued and outstanding Common
Stock, the Corporate Services Agreement will be terminable by either party upon
180 days' prior written notice. Certain individual services are also terminable
by either party upon 180 days' prior written notice, regardless of SAIC's stock
holdings. In the event that SAIC elects to terminate the Corporate Services
Agreement, there can be no assurance that the Company would be able to secure
alternative sources for such services within 180 days or that such services
could be obtained for costs comparable to costs to be charged by SAIC.
Control of Tax Matters; Tax and ERISA Liability. By virtue of its
controlling ownership and the terms of a tax sharing agreement (the "Tax
Sharing Agreement") entered into between the Company and SAIC, SAIC will
effectively controlWhile substantially all of our operations, facilities, and personnel are
located within the Company's tax decisions for taxable periods
during which SAIC and the Company file, for federal purposes, a consolidated
income tax return or, for state and local purposes, a consolidated, combined or
unitary tax return. Under the Tax Sharing Agreement, SAIC has sole authority to
respond to and conduct all tax proceedings (including tax audits) relating to
the Company, to file federal, state and local returns on behalf of the Company
and to calculate the amount of the Company's liability to SAIC under the Tax
Sharing Agreement. Upon completion of the IPO, the Company is no longer part of
SAIC's consolidated group for federal income tax purposes. Given the Company's
past participation in SAIC's consolidated group for tax purposes and pursuant
to the terms of the Tax Sharing Agreement, upon such deconsolidation, the
Company's ability to recognize a benefit for future tax losses it may incur is
subject to SAIC's approval. SAIC may also choose to contest, compromise or
settle any adjustment or deficiency proposed by taxing authorities in a manner
that may be beneficial to SAIC and detrimental to the Company.
Each member of a consolidated group for federal income tax purposes is
jointly and severally liable for the federal income tax liability of each other
member of the consolidated group. In addition, under the Employee Retirement
Income Security Act of 1974, as amended ("ERISA"), and federal income tax law,
each member of the controlled group is jointly and severally liable for funding
and termination liabilities of tax qualified defined benefit retirement plans as
well as certain plan taxes. Accordingly, during the period in which the Company
was included in SAIC's consolidated or controlled group, the Company could be
liable if such liability or tax is incurred, and not discharged, by any other
member of SAIC's consolidated or controlled group.
Potential Conflicts of Interest. Various conflicts of interest between the
Company and SAIC could arise and persons serving as directors, officers and
employees of both the Company and SAIC may have conflicting duties to each.
Currently, Michael A. Daniels, the Company's Chairman of the Board, also serves
as a Sector Vice President and Sector Manager of SAIC, and Donald N. Telage, the
Company's Senior Vice President, Internet Relations and one of the Company's
directors, also serves as a Group Senior Vice President of SAIC. Further, J.
Robert Beyster, a director of the Company, is also the Chief Executive Officer
and Chairman of the Board of SAIC, John E. Glancy, a director of the Company,
is also a Corporate Executive Vice President and a director of SAIC, J. Dennis
Heipt, a director of the Company, is also the Senior Vice President -
Administration of SAIC and William A. Roper, Jr., a director of the Company, is
also Senior Vice President and Chief Financial Officer of
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31
SAIC. Ownership interests of directors or officers of the Company in the common
stock of SAIC could also create or appear to create potential conflicts of
interest when directors and officers are faced with decisions that could have
different implications for the Company and SAIC. In addition, for financial
reporting purposes, the Company's financial results will be included in SAIC's
consolidated financial statements. The members of the Board of Directors of the
Company and the executive officer of the Company who are affiliated with SAIC
will consider not only the short-term and long-term impact of financial and
operating decisions on the Company, but also the impact of such decisions on
SAIC's consolidated financial results. In some instances, the impact of such
decisions could be disadvantageous to the Company while advantageous to SAIC.
Certain Charter Provisions and Limitations on Liability. The Company's
Certificate of Incorporation includes provisions relating to competition by SAIC
with the Company, allocations of corporate opportunities, transactions with
interested parties and intercompany agreements and provisions limiting the
liability of certain persons. The enforceability under Delaware corporate law of
such provisions which eliminate certain rights that might have been available to
stockholders under Delaware law had such provisions not been included has not
been established. The Company's Certificate of Incorporation provides that any
person purchasing or acquiring an interest in shares of capital stock of the
Company shall be deemed to have consented to the provisions in the Certificate
of Incorporation relating to competition by SAIC with the Company, conflicts of
interest, corporate opportunities and intercompany agreements, and such consent
may restrict such person's ability to challenge transactions carried out in
compliance with such provisions. The corporate charter of SAIC does not include
comparable provisions and, as a result, persons who are directors and/or
officers of the Company and who are also directors and/or officers of SAIC may
choose to take action in reliance on such provisions rather than act in a manner
that might be favorable to the Company but adverse to SAIC.
Under the Company's Certificate of Incorporation, the personal monetary
liability of the directors of the Company for breach of their fiduciary duty of
care, including actions involving gross negligence, is eliminated to the fullest
extent permitted under Delaware law.
International Operations. The Company'sUnited States, our revenues from sources outside the U.S.
have increased significantly and may continue to increase in the future. As a
result, the Company will increasingly bewe are subject to the risks of conducting business internationally,
including unexpected changes in regulatory requirements, fluctuations in the
U.S. dollar, tariffs and other barriers and restrictions and the burdens of
complying with a variety of foreign laws. In
addition,We do not know what the Company will increasingly be subject to general geo-political
risks, such as political and economic instability and changes in diplomatic and
trade relationships, in connection with its international operations. There can
be no assurance thatimpact of such
regulatory, geopolitical and other factors will not
adversely impact the Company's operationsbe on our business in the future
or require the Companyif we will have to modify itsour business practice. In addition, the laws of
certain foreign countries may not protect the Company'sour proprietary rights to the same
extent as do the laws of the United States.
Shares Eligible for Future Sale. SAIC owns 100% of the Company's
outstanding Class B Common Stock, which, as of March 13, 1998, represented
approximately 75.8% of the outstanding Common Stock of the Company. A decision
by SAIC to sell such shares could materiallyOur quarterly operating results may fluctuate; our future revenue and
adversely affect the market
price of the Class A Common Stock. The Company and SAIC have entered into a
registration rights agreement (the "Registration Rights Agreement") which
requires the Company to effect a registration statement covering some or all of
the shares of Class A Common Stock to be owned by SAIC upon conversion of the
Class
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32
B Common Stock owned by SAIC and any other shares of Class A Common Stock
otherwise acquired by SAIC, subject to certain terms and conditions. The Company
has agreed to indemnify SAIC in connection with any such registration.
In certain circumstances, including without limitation, a public offering
or distribution of Class B Common Stock by SAIC, the Class B Common Stock would
trade separately from the Class A Common Stockprofitability are uncertain
Our quarterly operating results may fluctuate significantly in the public market. Separate
tradingfuture
due to a variety of the Class B Common Stockfactors, some of which are beyond our control. Factors that
may affect our revenue include:
- variations in the publicnumber of requests for domain name registrations or
demand for our services,
- termination or completion of contracts in our Internet Technology
Services business or failure to obtain additional contracts in that
business, and
- market acceptance of new service offerings.
In addition, we expect a significant increase in our operating expenses as
we:
- increase our sales and marketing operations and activities, and
- continue to update our systems and infrastructure.
If the increase in our expenses is not followed by an increase in our
revenue, our operating results will be harmed. The fact that in the past our
revenues have increased and we have been profitable on a quarterly and annual
basis is not indicative of whether our revenues will increase or whether we will
be profitable on a quarterly or annual basis in the perceptionfuture. See "Item 7 --
Management's Discussion and Analysis of Financial Condition and Results of
Operations."
INVESTMENT RISKS
Our stock price, like that such trading could occur, could materially and adversely affect the market price
of the Class A Common Stock.
Possible Volatility of Stock Price.many Internet companies, is highly volatile
The market price of the shares ofour Class A Common Stock at timescommon stock has been and is likely to
continue to be highly volatile and may be significantly affected by factors such asas:
- general market conditions and market conditions affecting technology and
Internet stocks generally,
- actual or anticipated fluctuations in the Company'sour quarterly or annual
registrations or operating results,
of operations,- announcements of technological innovations, acquisitions or investments,
developments in Internet governance announcement of additional competing registries,
registrars or TLDs, litigation costs, results of litigation, introduction of new
products or services by the Company or its competitors, developments with
respect to patents, copyrights or proprietary rights,corporate actions such as stock
splits, and
- industry conditions and trends in
the networking and other technology industries, changes in or failure by the
Company to meet securities analysts' expectations, general market conditions and
other factors. In addition, thetrends.
The stock market has from time to time experienced significant price and volume fluctuations
that have particularly affected the market prices forof the common stocks of technology
companies, especially Internet-related companies. These broad market or
technology or Internet sector fluctuations may adversely affect the market price
of the Company'sour Class A Common Stock.common stock. Recently, the market price of our Class A common
stock, like that of many Internet-related companies, has experienced significant
fluctuations. For instance, from January 1, 1999 through March 12, 1999, the
reported sales price for our Class A
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21
common stock ranged from $128.0625 per share to $260.375 per share on a
pre-split basis. On March 12, 1999, the reported last sale price of our Class A
common stock was $222 per share on a pre-split basis.
The market price of our Class A 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 against that company. There can be no assurance that such
litigation will not occur in the future with respect to the Company.brought. Such litigation could result in substantial costs and a diversion
of our management's attention and resources, whichresources.
See "Item 5 -- Market for Registrant's Common Equity and Related
Stockholder Matters."
Future sales of common stock could have a material adverse effect uponaffect our stock price
SAIC owns 14,850,000 of the Company's business, financial condition and resultsoutstanding shares of operations.
Effectour common stock. A
decision by SAIC to sell such stock could depress the market price of Certain Charter Provisions; Anti-takeover Effects of Certificate
of Incorporation and Delaware Law. The holders ofthe Class
A Common Stock are
entitled to one votecommon stock.
SAIC may maintain significant influence over us
Because it holds a significant number of shares of our Class B common
stock, which have ten votes per share, SAIC controls 89% of the combined voting
power of the Class A and holdersClass B common stock and, therefore, effectively
controls all matters requiring approval by our stockholders including the
election of members of our board of directors, changes in the size and
composition of the board of directors and a change in control. We do not have an
agreement with SAIC which restricts its rights to convert, distribute or sell
its shares of our common stock.
If SAIC converts all of its remaining shares of Class B Common Stock are entitled
to ten votes per share. Holders of Class A Common Stock and Class B Common Stock
generally vote together as a single class. The Class B Common Stock held by SAIC
is convertiblecommon stock into
Class A Common Stock under certain conditions set forth in
the Company's Certificate of Incorporation. The Company's Board of Directorscommon stock its economic interest and voting power will have the authority to issue up to 10,000,000 shares of preferred stock and
to determine the price, rights, preferences, privileges and restrictions,
including voting rights of such shares, without any further vote or action by
the Company's stockholders. Such charter provisions could have the effect of
delaying or preventing a change of controlbe below 50% of
the Company. The rightstotal economic interest and voting power of the
holders of Common Stockour common stock after such
conversion. Nonetheless, SAIC will be subject to,remain our largest stockholder and may be
adversely affectedable to exercise significant influence over us.
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 the rightsSAIC.
Our employees are currently eligible to participate in certain SAIC
employee benefit plans. If SAIC converts its remaining shares of the holdersClass B common
stock to Class A common stock, we will
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22
have to establish certain employee benefit plans of any preferred stockour 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 issueddeemed to have consented to the provisions in the
future.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 issuancecorporate charter of preferred stock, while providing desirable flexibilitySAIC 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
connection with possible acquisitions and other corporate purposes, could
have the effect of making it more difficult forreliance on such provisions rather than act in a third partymanner that might be favorable
to acquire a
majority of the outstanding voting stock of the Company. The Company has no
current plansus but adverse to issue shares of preferred stock. Further, certain provisions of
the Company's Certificate of Incorporation and of Delaware law could delay or
make more difficult a merger, tender offer or proxy contest involving the
Company.
32
33SAIC.
ITEM 2. PROPERTIES.
The Company'sPROPERTIES
Our principal executive office is located in 45,000 square feet of a
facility in Herndon, Virginia, under a space usage arrangement with SAIC. SAIC's
lease for this facility expires in November 2002. The CompanyWe also leaseslease an additional
40,30640,000 square feet in a facility in Herndon, Virginia under a lease expiring in
July 2002. The CompanyWe also hashave offices located in a 10,000 square foot facility, also
in Herndon, under a space usage arrangement with SAIC. SAIC's lease for this
facility expires in October 1999. Additionally, the Companyour Internet Technology Services
division has offices located inin: approximately 9,3002,900 square feet in a facility
in Charlotte, North Carolina, under twoa space usage arrangementsarrangement with SAIC.SAIC;
approximately 3,700 square feet in a facility in Duluth, Georgia, under a
sublease; approximately 220 square feet in a facility in Thousand Oaks,
California, under a space usage arrangement with SAIC; and, approximately 5,000
square feet in a facility located in New York, New York. SAIC's two leases with
respect to this facilitythe Charlotte and Thousand Oaks facilities expire in August 1998July 2002 and
July 2002. The Company believesMay 1999, respectively. Our sublease in Duluth and our lease in New York expire
in January 2000 and December 2002, respectively. We recently entered into a
lease to rent an additional 60,000 square foot facility in Herndon, Virginia
commencing April 1, 1999 and ending March 31, 2004. We believe that itsour current
facilities will be adequate for the next 12 months and that any additional
facilities will be available in the future as needed on commercially reasonable
terms.
ITEM 3. LEGAL PROCEEDINGS
As of March 13, 1998, the Company was12, 1999, we were a defendant in 6two active lawsuits involving
domain name disputes between trademark owners and domain name holders. The
Company isWe are
drawn into such disputes, in part, as a result of claims by trademark owners
that the Company iswe are legally required, upon request by a trademark owner, to terminate
the right the Companywe granted to an alleged trademark infringera domain name holder to register thea domain name in question. Further, trademark owners have alsowhich is
alleged that the Company shouldto be required to monitor future domain name
registrations and reject registrations of domain names which are identical or similar to their federally registered trademark.the trademark in question. The holders of the domain
name registrations in dispute have, in turn, questioned the Company'sour right, absent a
court order, to take any action which suspends their registration or use of the domain names in
question. Although 4248 out of approximately 3,6006,000 of these situations have
resulted in litigation involving the Company,suits actually naming us as a defendant, as of March 13,
1998,12, 1999, no
payments haveadverse judgment has been rendered and no award of damages has ever been made
by the Company to any plaintiff and only four
of these cases are pending. The Company believesagainst us. We believe that it haswe have meritorious defenses and intends to vigorously defend
itselfourselves against these claims.
On June 27, 1997, SAIC received a Civil Investigative Demand ("CID") from
the U.S. Department of Justice ("DOJ") issued in connection with an
investigation to determine whether there is, has been, or may be an antitrust
violation under the Sherman Act relating to Internet registration products and
services. The CID seeks documents and information from SAIC and the Company
relating to their Internet registration business. The Company cannot reasonably
estimate the potential impact of the investigation nor can it predict whether a
civil action will ultimately be filed by the DOJ. The Company is unable to
predict the form of relief that might be sought in such an action or that might
be awarded by a court or imposed as a result of any settlement. Any such relief
could have a material adverse effect on the Company's business, financial
condition and results of operations.
On March 20, 1997, PG Media, Inc., a New York-based corporation ("PG
Media"), filed a
lawsuit against the Companyus in the United States District Court, Southern District of New
York alleging that the Companywe had restricted
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23
access to the Internet by not adding PG Media's requested TLDstop level domains to
the Internet root zone system in violation of the Sherman Act. In its complaint,
PG Media, has, in addition to requesting damages, asked that the Companywe be ordered to include
reference to PG Media's TLDstop level domains and name servers in the root zone file
administered by the Companyus under the Cooperative Agreement. The Company has answered the complaint, but no
motions are pending. In addition, in June 1997, the Companywe received
written direction from the NSFNational Science Foundation not to take any action
towhich would create additional TLDstop level domains or to add any new TLDstop level
domains to the Internet root zone until the NSFNational Science Foundation provides
further guidance. On September 17, 1997, PG Media filed a Second Amended
Complaint adding the NSFNational Science Foundation as a defendant. The Company believes that it has
33
34
meritorious defenses and intendsOn May 14,
1998, PG Media served us with a motion for a preliminary injunction against both
defendants to vigorously defend itselfcompel 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 the claims
of PG Media. AlthoughOn July 20, 1998, a hearing
on all parties' motions occurred. The basic issue before the Company cannot reasonably estimatecourt is the
potential
impactNational 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 such claims, a successful claim under the plaintiff's theory could
have a material adverse effect on the Company's business, financial condition
and results of operations.Sherman Act.
On October 17, 1997, a group of six plaintiffs filed a lawsuit (the "Thomas
suit")the Thomas suit
against the Companyus and the NSFNational Science Foundation in the United States District
Court, District of Columbia, challenging the legality of fees defendants charge
for the registration and renewal of domain names on the Internet and seeking restitution of
fees collected from domain name registrants in an amount in excess of $100
million, damages, and injunctive and other relief. Plaintiffs originally alleged violations
of the Competition in Contracting Act ("CICA"), the Sherman Act, and
the U.S. Constitution. Following the filing of motions to dismiss by the
defendants, the plaintiffs filed an amended complaint on January 30, 1998,
dropping the cause of action based upon CICA, but adding alleged violations ofConstitution, the Administrative Procedures Act and
the Independent Offices Appropriations Act. The plaintiffs also filed a motion for preliminary injunctive relief
against the NSF concerning the "Intellectual Infrastructure Fund." On February
2, 1998, the United States District Court, District of Columbia, issued an order
granting the plaintiffs' motion for a preliminary injunction, enjoining the NSF
from spending any of the money collected by the Company for the Intellectual
Infrastructure Fund. On February 10, 1998, the plaintiffs
filed a motion for preliminary injunction against the Companyus seeking several items of
relief. On February 24,April 6, 1998, the Company and the NSF filed motions to dismiss the amended
complaint. Also on February 24,Court issued its opinion granting summary judgment
in favor of the plaintiffs filed a motion for partial
summary judgment concerningon the Intellectual Infrastructure Fund.Fund, ruling it an
"unlawful tax." The plaintiffs'court also granted our motion forto 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 CompanyPresident on May 1, 1998. Section 8003 of H.R. 3579 legalized,
ratified and partial
summaryconfirmed 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 againstin the NSF,matter. In October 1998, the
plaintiffs appealed the court's dismissal of their claims, and both motions to dismiss were heard beforeoral argument
occurred on February 25, 1999. We are awaiting the decision of the Court on March 17,of
Appeals.
On October 20, 1998, we were included as a defendant in a suit brought by
the Pennsylvania Attorney General's office against a domain name holder who was
alleged to have used his domain name in connection with a web site promoting
white supremacy and threatening certain state employees. The Pennsylvania
Attorney General named all of the Court has takencommunications companies in any way connected
with the matters under
advisement.domain name or web site. The Company believes that it has meritorious defenses and intendsPennsylvania Attorney General seeks to
vigorously defend itself against the claimspermanently enjoin these entities, including us, from providing services to this
domain name holder in the Thomas suit.event that the domain name holder fails to comply with
the order of the court. We have answered the complaint denying any knowledge or
participation in the actions of the primary defendant. No motions are pending
and we expect to be dismissed from the matter.
While the
Companywe cannot reasonably estimate the potential impact of suchthe claims
advanced in the PG Media, Thomas or Pennsylvania Attorney General suits, a
successful claim against us in any of these proceedings could harm our business.
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,
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has been, or may be any antitrust violation under the plaintiffs' theoriesSherman Act relating to
Internet registration products and services. The CID seeks documents and
information from SAIC and us relating to our Internet registration business. We
cannot reasonably estimate the potential impact of the investigation nor can we
predict whether a civil action may 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 material adverseharmful 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 business, financial conditionPremier
Program agreements in Europe. The EC requested production of these agreements
and resultsrelated materials for review and we complied. We cannot reasonably estimate
the potential impact of operations.
The Company isthe 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 itsour business, none of which, in theour opinion
of the Company's management, will have a material adverse effect on its
financial position, results of operations, cash flows or its ability to conductharm our business.
LitigationLegal proceedings in which the Company iswe are involved hashave resulted and likely will
result in, and any future litigationlegal proceedings can be expected to result in,
substantial legal and other expenses to the Company and a diversion of the efforts of the
Company'sour
personnel.
See "Item 1 --- Business --- Risk Factors - Litigation.-- We are Party to Several Legal
Proceedings Which Could Have a Negative Financial Impact on Us."
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of 1997.1998.
EXECUTIVE OFFICERS OF THE REGISTRANT
Pursuant to General Instruction G(3) of the General Instructions to Form
10-K, the following information is included as an unnumbered Item in Part I of
this Form 10-K. Set forth below is a list of the names and ages (as of March 30,
1998)12,
1999) of all executive officers of Network Solutions, all positions and offices
with the Company held by each such person and
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35 each such person's principal
occupation or employment during at least the past five years. All such persons
have been appointed to serve until their successors are appointed or until their
earlier resignation or retirement.
Name Age Position
-NAME AGE POSITION
---- --- --------
GabrielMichael A. BattistaDaniels................ 53 Chairman of the Board and Acting Chief Executive
Officer
Robert J. Korzeniewski............ 42 Chief Financial Officer and DirectorActing Chief
Operating Officer
Bruce L. Chovnick 38Chovnick................. 39 Senior Vice President and General Manager,
ConsultingInternet Technology Services
Jonathan W. Emery................. 47 Senior Vice President, General Counsel and
Secretary
David H. Holtzman 41Holtzman................. 42 Senior Vice President, Engineering
Robert J. Korzeniewski 41 Chief Financial Officer
Donald N. Telage 53Telage.................. 54 Senior Vice President, Internet Relations and
Special Programs and Director
Douglas L. Wolford 36Wolford................ 37 Senior Vice President, Marketing and Sales
Charles A. Gomes.................. 52 Vice President, MarketingCustomer Programs
Michael G. Voslow................. 39 Vice President, Finance and Treasurer
Gabriel22
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MICHAEL A. BattistaDANIELS has served as Chairman of the Board of Network Solutions
since 1995 and as Acting Chief Executive Officer of Network Solutions since
November 1998. Since 1986, Mr. Daniels has served in various positions with SAIC
and has served as a directorSector Vice President and Sector Manager for the Technology
Applications Sector of SAIC since 1993. Prior thereto, Mr. Daniels served as a
Group Senior Vice President of SAIC from 1991 to 1993. Mr. Daniels received a
B.S. and an M.A. from Northwestern University and received a J.D. from the
CompanyUniversity of Missouri School of Law.
ROBERT J. KORZENIEWSKI has served as Chief Financial Officer of Network
Solutions since NovemberMarch 1996 and as Chief Executive Officer of the Company since October 1996. From
September 1995 to October 1996, Mr. Battista served as President and Chief
Executive Officer of Cable & Wireless, Inc., a telecommunications company and
U.S. subsidiary of Cable & Wireless, P.L.C. From 1991 to 1995, Mr. Battista
served as President andActing Chief Operating Officer of Cable & Wireless, Inc.Network
Solutions since November 1998. From 1987 until October 1997, Mr. Korzeniewski
held a variety of senior financial positions with SAIC and
from 1987 to 1991, he served as the Chief Operating Officera Corporate
Vice President for Administration of National
Telephone Services,SAIC from 1989 until 1997. Mr. Korzeniewski
is a long distance operator service company. Mr. Battista also
serves as a director of Axent Technologies, Inc.Certified Public Accountant and Systems & Computer
Technology Corporation. Mr. Battista received a B.S.E.E.B.S. in Business Administration
from Villanova
University, a M.S.E.E. from Drexel University and an M.B.A. from Temple
University.
BruceSalem State College.
BRUCE L. ChovnickCHOVNICK has served as Senior Vice President and General Manager,
ConsultingInternet Technology Services of the CompanyNetwork Solutions since OctoberSeptember 1997. From
October 1993 until September 1997, heMr. Chovnick served as Vice President of Global Internet Solutions forin various executive
leadership roles with General Electric Information Services, Inc., an electronic
commerce company.company, and, most recently, he served as Vice President of its Global
Internet Solutions business. Prior to that he was a Senior Manager of IBM
Corporation, a computer systems, software, networking systems and storage
devices manufacturer, from January 1984 to September 1993. Mr. Chovnick received
a B.S. in Computer Science from the University of Florida.
DavidJONATHAN W. EMERY has served as Senior Vice President, General Counsel and
Secretary of Network Solutions since December 1997. From 1986 until 1997, Mr.
Emery held a variety of positions with Tambrands Inc., a consumer products
company, most recently as Vice President, Senior Counsel and Assistant
Secretary. Prior thereto, from 1977 until 1986, Mr. Emery was an Associate with
the law firm of Brown & Wood. Mr. Emery received a B.A. from Trinity College,
Hartford, Connecticut, and a J.D. from Boston University School of Law.
DAVID H. HoltzmanHOLTZMAN has served as Senior Vice President, Engineering of
the
CompanyNetwork Solutions since February 1997. From September 1995 until January 1997,
he served as Business Development Manager, Development Manager and Chief
Scientist, IBM Internet Information Technology (InfoMarket) group of IBM
Corporation, a computer systems, software, networking systems and storage
devices manufacturer. Prior thereto, from May 1992 to 1994, he served as a
Senior Associate at Booz-Allen & Hamilton, a management consulting firm. Mr.
Holtzman received a B.A. in Philosophy from the University of Pittsburgh and a
B.S. in Computer Science from the University of Maryland.
Robert J. Korzeniewski has served as Chief Financial Officer of the Company
since March 1996. From 1987 until October 1997, Mr. Korzeniewski held a variety
of senior financial positions with SAIC and served as a Corporate Vice President
for Administration of SAIC from 1989 until 1997. Mr. Korzeniewski is a Certified
Public Accountant and received a B.S. in Business Administration from Salem
State College.
35
36
DonaldDONALD N. TelageTELAGE has served as a director of the CompanyNetwork Solutions since May
1995 and as Senior Vice President, Internet Relations and Special Programs of
the CompanyNetwork Solutions since February 1997. Dr. Telage also served as President and
Chief Operating Officer of the CompanyNetwork Solutions from May 1995 to February 1997.
Since 1986, Dr. Telage has served in various positions with SAIC and has served
as a Group Senior Vice President of SAIC since 1993. Prior thereto, Dr. Telage
served as a Corporate Vice President of SAIC from 1992 to 1993. Dr. Telage
received his B.A. in Psychology from the University of Connecticut and received
an M.A. and a Ph.D. in Mathematics from Clark University.
DouglasDOUGLAS L. WolfordWOLFORD has served as Senior Vice President, Marketing and Sales
of the
CompanyNetwork Solutions since December 1997. From December 1994 to November 1997,
Mr. Wolford was General Manager, Marketing foremployed by General Electric Information Services, Inc., an
electronic commerce company.company, during which tenure he progressed to the position
of General Manager -- Marketing (Americas). Prior thereto, he servedwas employed from
March 1989 to December 1994 by the National Academy of
23
26
Engineering, most recently as Director, Development and Public Affairs for the National Academy of Engineering, from
March 1989 to December 1994.Affairs. Mr.
Wolford received a B.S. in Mechanical Engineering from North Carolina State
University, a Certificat de Langue Francaise from Sorbonne University and an
M.B.A. in Marketing from the University of Maryland.
CHARLES A. GOMES has served as Vice President, Customer Programs of Network
Solutions since March 1998. Mr. Gomes has been part of Network Solutions'
management team since 1984. From October 1995 to March 1998, Mr. Gomes served as
Director of Customer Programs. Prior to assuming his current responsibilities,
Mr. Gomes managed various programs and projects at Network Solutions involving
delivery of technical services to various federal and state government agencies.
Mr. Gomes received a B.A. in Mathematics from the University of California,
Davis, and a Master's of Education from Boston University.
MICHAEL G. VOSLOW has served as Vice President, Finance and Treasurer since
March 1998 and as Treasurer of Network Solutions since January 1997. From
January 1995 to January 1997, Mr. Voslow was Vice President and Corporate
Controller for MAXM Systems Corporation, a worldwide provider of computer
software and professional services. Prior to joining MAXM, Mr. Voslow was a
Senior Manager at Price Waterhouse where he served from August 1983 to January
1995. Mr. Voslow is a Certified Public Accountant and received a B.S. in
Business Administration from Miami University (Ohio) and an M.B.A. in Finance
from Duke University.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCKEQUITY AND RELATED STOCKHOLDER MATTERS
The Company'sOur Registration Statement on Form S-1 (Registration No. 333-30705) was
declared effective on September 25, 1997 by the Securities and Exchange Commission.
TheOur Class A Common Stock of the Companycommon stock began trading publicly on the Nasdaq National Market on
September 26, 1997 under the symbol NSOL. Prior to that date, there was no
public market for the Class A Common
Stock.common stock.
The Companymanaging underwriters of the Class A common stock offering commencing
September 26, 1997 were Hambrecht & Quist, J.P. Morgan & Co. and PaineWebber
Incorporated. We registered and sold 3,220,000 shares on a pre-split basis for
itsour own account at an aggregate price of $57,960,000 and the selling stockholder (SAIC)SAIC registered and
sold 575,000 shares on a pre-split basis for its account at an aggregate price
of $10,350,000, for a combined total of 3,795,000 shares on a pre-split basis at
an aggregate price of $68,310,000. The offering is now completed. After subtractinghas since terminated.
The total amount of expenses incurred for the
Company'sour account in connection with
the offering the Company'swas $5,555,200, which was 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 our equity securities. Our resultant net offering proceeds were $52,405,000.$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 Companywe 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 our equity securities and is an affiliate of ours. The remaining proceeds
have been invested in short-term investment grade government discount notes, commercial
paper and commercial paper.corporate bonds.
On December 31, 1998, our Board of Directors approved a 2-for-1 stock split
of the shares of our Class A common stock and Class B common stock, that was
effected in the form of a 100% stock dividend on March 23, 1999 on shares of our
Class A common stock and Class B common stock outstanding on February 26, 1999.
The following table sets forth the range of high and low last reported last
sales prices of the Class A common stock on the Nasdaq National Market, adjusted
to
24
27
retroactively reflect the stock split, for the period from September 26, 1997
through December 31, 1998.
HIGH LOW
---- ---
Year Ended December 31, 1997:
Fourth Quarter from September 26, 1997.................... $13 3/8 $ 5 7/8
Year Ended December 31, 1998:
First Quarter............................................. 18 9/16 6 15/32
Second Quarter............................................ 27 1/2 16 1/4
Third Quarter............................................. 23 5/32 12 7/8
Fourth Quarter............................................ 82 23/64 14 3/16
As of March 19, 1999, there were 105 holders of record of Network Solutions
Class A common stock. Because many of our shares of common stock are held by
brokers and other institutions on behalf of beneficial stockholders, we are
unable to determine the exact number of beneficial stockholders represented by
these record holders.
With the exception of the $10,000,000 dividend paid to SAIC on October 1,
1997, the Company haswe have neither declared nor paid cash dividends on its Common Stock. The Companyour common stock. We
currently intendsintend to retain itsour earnings, if any, for future growth and doesdo not
anticipate paying any dividends in the foreseeable future. ItsOur Board of
Directors will determine the Company'sour future dividend policy on the basis of various
factors, including the Company'sour results of operations, financial condition, capital
requirements and investment opportunities.
The following table provides the high and low sale prices of the Class A
Common Stock on the Nasdaq National Market for the period from September 26,
1997 through December 31, 1997.
High Low
---- ---
$26.75 $11.75
As of March 20, 1998, there were 47 holders of record of Network Solutions
Class A Common Stock. Because many of the Company's shares of Common Stock are
held by brokers and other institutions on behalf of beneficial stockholders,
the Company is unable to determine the exact number of beneficial stockholders
represented by these record holders.
36
37
Since January 1, 1995, the Company has issued and sold (without payment of
any selling commission to any person) the unregistered securities described
below:
1. From October 14, 1996 to December 31, 1997, the Company granted
incentive stock options to purchase an aggregate of 100,900 shares of the
Company's Class A Common Stock to employees, officers and directors of the
Company under its 1996 Stock Incentive Plan at exercise prices ranging from
$11.25 to $14.00 per share. All of these options vest over a period of time
following their respective dates of grant pursuant to the Company's 1996
Stock Incentive Plan.
2. From October 14, 1996 to December 31, 1997, the Company granted
nonstatutory stock options to purchase an aggregate of 1,725,325 shares of the
Company's Class A Common Stock to employees, officers and directors of the
Company under its 1996 Stock Incentive Plan at exercise prices ranging form
$11.25 to $14.875 per share. All of these options vest over a period of time
following their respective dates of grant pursuant to the Company's 1996
Stock Incentive Plan.
The sales of the above securities were deemed to be exempt from
registration under the Securities Act in reliance on Section 4(2) of the
Securities Act, or Regulation D promulgated thereunder, or Rule 701 promulgated
under Section 3(b) of the Securities Act, as transactions by an issuer not
involving a public offering or transactions pursuant to compensatory benefit
plans and contracts relating to compensation as provided under such Rule 701.
The recipients of securities in each such transaction represented their
intention to acquire the securities for investment only and not with a view to
or for sale in connection with any distribution thereof and appropriate legends
were affixed to the share certificates and instruments issued in such
transactions. All recipients had access, through their relationship with the
Company, to information about the Company.
37
38
ITEM 6. SELECTED FINANCIAL DATA.
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------
1993 1994 1995 (1) 1996 1997
-------- -------- -------- -------- --------
(in thousands, except per share data)
STATEMENT OF OPERATIONS DATA:
Net revenue $ 4,369 $ 5,029 $ 6,486 $ 18,862 $ 45,326
Cost of revenue 2,924 3,073 5,704 14,666 25,798
-------- -------- -------- -------- --------
Gross profit 1,445 1,956 782 4,196 19,528
Research and development expenses - - - 680 1,653
Selling, general and administrative expenses 1,401 1,544 2,394 6,280 12,268
Interest expense (income), net 120 109 61 (496) (2,095)
-------- -------- -------- -------- --------
Income (loss) from continuing
operations before income taxes and
cumulative effect of a change in
accounting principle (76) 303 (1,673) (2,268) 7,702
Provision (benefit) for income taxes 34 114 (239) (643) 3,471
-------- -------- -------- -------- --------
Income (loss) from continuing operations (110) 189 (1,434) (1,625) 4,231
Loss from discontinued
operations, net of income taxes (2) (936) (1,169) (1,403) - -
Cumulative effect of change in accounting
for income taxes 660 - - - -
-------- -------- -------- -------- --------
Net income (loss) $ (386) $ (980) $ (2,837) $ (1,625) $ 4,231
======== ======== ======== ======== ========
Basic earnings per share:
- -------------------------
Income (loss) from continuing operations $ (0.10) $ 0.18 $ (0.14) $ (0.13) $ 0.32
Loss from discontinued operations (0.90) (1.12) (0.13) - -
Cumulative effect of accounting change 0.63 - - - -
-------- -------- -------- -------- --------
Net income (loss) $ (0.37) $ (0.94) $ (0.27) $ (0.13) $ 0.32
======== ======== ======== ======== ========
Weighted average shares 1,048 1,042 10,335 12,500 13,305
Diluted earnings per share:
- ---------------------------
Income (loss) from continuing operations $ (0.10) $ 0.18 $ (0.14) $ (0.13) $ 0.31
Loss from discontinued operations (0.90) (1.12) (0.13) - -
Cumulative effect of accounting change 0.63 - - - -
-------- -------- -------- -------- --------
Net income (loss) $ (0.37) $ (0.94) $ (0.27) $ (0.13) $ 0.31
======== ======== ======== ======== ========
Weighted average shares 1,048 1,047 10,335 12,500 13,483
38
39
Year Ended December 31,
----------------------------------------------------
1993 1994 1995 1996 1997
------ ------ ------ ------ ------
OTHER OPERATING DATA (3):
Net new registrations 13 24 141 489 960
Less: Registrations not renewed - - (1) (39) (46)
------ ------ ------ ------ ------
Net registrations as of year end 13 37 177 627 1,541
====== ====== ====== ====== ======
Year Ended December 31,
----------------------------------------------------
1993 1994 1995 1996 1997
------ ------ ------ ------ ------
BALANCE SHEET DATA:
Cash and cash equivalents $ - $ 136 $ 5 $15,540 $ 41,146
Working capital (4) (179) (1,340) (559) 1,362 50,947
Total assets (5) 3,124 2,448 11,748 66,118 149,620
Deferred revenue, net 73 137 3,346 29,352 61,451
Long-term obligations,
excluding current portion 344 81 1,353 9,440 18,743
Total stockholders' equity 1,221 252 3,062 1,437 47,655
- --------------------------
(1)
The Selectedfollowing table sets forth selected financial and operating data of
Network Solutions for the periods indicated and should be read in conjunction
with "Management's Discussion and Analysis of Financial DataCondition and Results of
Operations," the Financial Statements and the Notes related thereto included
elsewhere and incorporated by reference in this Form 10-K. The selected
financial data for the years ended December 31, 1996, 1997 and 1998 were derived
from Network Solutions' audited financial statements included elsewhere in this
Form 10-K. The information for the year ended December 31, 1994 is derived from
Network Solutions' unaudited financial statements which, in the opinion of
management, reflect all adjustments (consisting only of normal recurring items)
necessary to present fairly the financial position and results of operations for
the periods then ended. The selected financial data for the year ended December
31, 1995 waswere derived by combining the Company's resultsNetwork Solutions' Results of operationsOperations for
the period January 1, 1995 through March 10, 1995 and the period March 11, 1995
through December 31, 1995, which, respectively, areboth as derived from Network Solutions' audited
financial statements. Comparability of pre-acquisition periods before
and afterto
post-acquisition periods is
25
28
limited because the date of the SAIC acquisition. The data for these two
periods werefinancial statements have been prepared on differing bases
of accounting and,
accordingly, the comparability of such data with other periods is
limited, primarily as a result of goodwill amortization, new corporate
services agreementsthe acquisition by SAIC.
YEAR ENDED DECEMBER 31,
-----------------------------------------------
1994 1995 1996 1997 1998
------- ------- ------- ------- -------
IN THOUSANDS, EXCEPT PER SHARE DATA
STATEMENT OF OPERATIONS DATA:
Net revenue................................. $ 5,029 $ 6,486 $18,862 $45,326 $93,652
Cost of revenue............................. 3,073 5,704 14,666 25,798 38,530
------- ------- ------- ------- -------
Gross profit................................ 1,956 782 4,196 19,528 55,122
Research and development expenses........... -- -- 680 1,653 4,821
Selling, general and administrative
expenses.................................. 1,544 2,394 6,280 12,268 37,144
Interest income............................. -- -- (496) (2,211) (6,303)
Other expenses.............................. 109 61 -- 116 116
------- ------- ------- ------- -------
Income (loss) from continuing operations
before income taxes....................... 303 (1,673) (2,268) 7,702 19,344
Provision (benefit) for income taxes........ 114 (239) (643) 3,471 8,109
------- ------- ------- ------- -------
Income (loss) from continuing operations.... 189 (1,434) (1,625) 4,231 11,235
Loss from discontinued operations, net of
income taxes.............................. (1,169) (1,403) -- -- --
------- ------- ------- ------- -------
Net income (loss)........................... $ (980) $(2,837) $(1,625) $ 4,231 $11,235
======= ======= ======= ======= =======
Basic earnings per share(1):
Income (loss) from continuing
operations............................. $ 0.09 $ (0.07) $ (0.07) $ 0.16 $ 0.35
Loss from discontinued operations......... (0.56) (0.07) -- -- --
------- ------- ------- ------- -------
Net income (loss)......................... $ (0.47) $ (0.14) $ (0.07) $ 0.16 $ 0.35
======= ======= ======= ======= =======
Weighted average shares..................... 2,084 20,670 25,000 26,610 31,957
Diluted earnings per share(1):
Income (loss) from continuing
operations............................. $ 0.09 $ (0.07) $ (0.07) $ 0.16 $ 0.34
Loss from discontinued operations......... (.56) (0.07) -- -- --
------- ------- ------- ------- -------
Net income (loss)......................... $ (0.47) $ (0.14) $ (0.07) $ 0.16 $ 0.34
======= ======= ======= ======= =======
Weighted average shares..................... 2,084 20,670 25,000 26,966 33,397
YEAR ENDED DECEMBER 31,
----------------------------------
1994 1995 1996 1997 1998
---- ---- ---- ----- -----
IN THOUSANDS
OTHER OPERATING DATA (2):
Net new registrations.............................. 24 141 489 960 1,911
Registrations not renewed.......................... -- 1 39 46 90
Net registrations as of period end................. 37 177 627 1,541 3,362
26
29
YEAR ENDED DECEMBER 31,
------------------------------------------------
1994 1995 1996 1997 1998
------ ------- ------- -------- --------
IN THOUSANDS
BALANCE SHEET DATA:
Cash and cash equivalents.......................... $ 136 $ 5 $15,540 $ 41,146 $ 12,862
Total marketable securities........................ -- -- -- 40,200 128,098
Working capital.................................... 1,340 (559) 1,362 50,947 65,791
Total assets....................................... 2,448 11,748 66,118 149,620 243,867
Restricted assets included in total assets......... -- 1,408 17,453 25,873 -0-
Deferred revenue, net.............................. 137 3,346 29,352 61,451 129,194
Long-term obligations, excluding current portion... 81 1,353 9,440 18,743 35,721
Total stockholders' equity......................... 252 3,062 1,437 47,655 75,130
- ---------------
(1) All share and per share data reflect the repayment of outstanding debt balances. See
Notes 1 and 11 of Notes to Financial Statements for a discussion of the
presentation for each of these periods.two-for-one stock split in March
1999.
(2) See Note 13 of Notes to Financial Statements for a discussion of
discontinued operations.
(3) Net new registrations for each period include gross new registrations less
an estimate of registrations that are uncollectible. Net registrations
include net new registrations less an estimate of registrations not renewed.
Prior to September 14, 1995, net registrations equaled gross registrations
because the CompanyNetwork Solutions was reimbursed by the NSFNational Science Foundation
for all registrations under a cost plus fixed-fee contract.
(4) Working capital calculation includes $73, $137, $1,993, $19,912 and
$43,789 of current deferred revenue as of December 31, 1993, 1994,
1995, 1996 and 1997, respectively.
(5) Total assets include $0, $0, $1,408, $17,453 and $25,873 of restricted
assets as of December 31, 1993, 1994, 1995, 1996 and 1997,
respectively.
3927
4030
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.OPERATION
The following discussion and analysis should be read in conjunction with
"Item 6 -- Selected Financial Data" and Network Solutions' Financial Statements
and Notes thereto included elsewhere and incorporated by reference in this Form
10-K. Except for the Company's accompanying financial
statementshistorical information contained herein and notes thereto. Certain informationincorporated
herein by reference, the discussion in this Form 10-K contains certain
forward-looking statements. For this purpose, any statements contained herein
that are notinvolve risks and uncertainties, such as
statements of historical fact mayNetwork Solutions' plans, objectives, expectations and intentions.
The cautionary statements made in this Form 10-K should be deemedread as being
applicable to be forward-looking
statements. Statements regarding the intent, belief or current expectations of
the Company are intended to beall related forward-looking statements which may involve
risk and uncertainty. There are a number of factors that could cause the
Company'swherever they appear in
this Form 10-K. Network Solutions' actual results tomay differ materially from those indicated by suchthe
results discussed in the forward-looking statements as a result of certain
factors, including, but not limited to, those discussed in "Factors Affecting Operating Results" as well as those discussed"Item
1 -- Business -- Risk Factors" and elsewhere in this Form 10-K and the Company's subsequent SEC filings.from time to
time in Network Solutions' periodic reports.
OVERVIEW
The Company. The CompanyNetwork Solutions currently acts as the exclusive registry and registrar of
Internet domain names within the .com, .org, .net and .edu TLDstop level domains
pursuant to athe Cooperative Agreement with the NSF.Department of Commerce. Domain
names are used to identify a unique site or presence on the Internet. As
registry and registrar tofor these TLDs, the Companytop level domains, Network Solutions registers
new domain names and is responsible for the maintenance and
dissemination of the master file of
domain names through daily updates to the Internet. The CompanyNetwork Solutions also
provides enterprise network consulting services,Internet Technology Services, focusing on network engineering, network
and systems security and network management solutions for commercial customers.solutions.
Cumulative net registrations (gross registrations less management's
estimate of uncollectible registrations and of non-renewals)non-re-registrations) within the
TLDs
maintainedtop level domains administered by the CompanyNetwork Solutions increased by 146%118%, from 627,000 domain names registered
at December 31, 1996 to
1,541,000 domain names registered at December 31, 1997.1997 to 3,362,000 domain names
registered at December 31, 1998. Net registrations in the .com TLDtop level domain
represent 87%84% of the Company'sNetwork Solutions' total net registrations at December 31,
1997. Out of1998. Of the 1,541,0003,362,000 cumulative net registrations at December 31, 1997, 598,0001998,
1,453,000 registrations will be up for annual renewalre-registration during 1998the next
twelve months based upon their respective anniversaries of initial registration.
International registrations continued to increase as a percentageaccounted for 28% of net new registrations averaging 27% during
1997 with fourth quarter 1997
international registrations at 34%1998 and 26% of net new registrations as compared to 18%
in the same quarter of 1996.during 1997. Net revenue from registration
services accounted for 85.6%91.5% of the Company'sNetwork Solutions' net revenue for the year
ended December 31, 1997.
The Company's consulting services division1998.
Network Solutions delivers full life cycleInternet Technology Services to large companies
that desire to establish or enhance their Internet presence or re-engineer
legacy network engineeringinfrastructures to accommodate the integration of both Internet
connectivity and consulting for a broad range of companies including
multinational oil and gas corporations and major financial institutions. A
pioneer ininternal enterprise network, or intranet, technology into their
information technology base. Our Internet technology since 1979, the Company has built an
international reputation in enterpriseTechnology Services include network
engineering, network and systems security and network operations center deployment.management. During the
year ended December 31, 1998, Network Solutions provided Internet Technology
Services to more than 20 companies. Net revenue from consulting
servicesInternet Technology
Services accounted for 14.4%8.5% of the Company'sNetwork Solutions' net revenue for the year ended
December 31, 1997.1998.
Registration Services.Services
In December 1992, the CompanyNetwork Solutions entered into the Cooperative Agreement
with the NSFNational Science Foundation under which the CompanyNetwork Solutions was to
provide Internet domain name registration services for five TLDs:top level domains:
.com, .org, .net, .edu and .gov. These "registration
40
41
services"registration services include the initial
two year domain name registration and renewal,annual re-registration, and throughout the
registration term, maintenance of and unlimited modifications to individual
domain name records and dissemination of records through updates to the Internet.master file of domain names. The
Cooperative Agreement became
28
31
effective January 1, 1993. It includesincluded a three-month phase-in period, a
five-year operational period, (commencingcommencing April 1, 1993 and ending March 31,
1998),1998, and a six-month "flexibility period"flexibility period through September 30, 1998. TheEffective
September 9, 1998, the Department of Commerce took over the administration of
the Cooperative Agreement is
subjectfrom the National Science Foundation. In October 1998,
the Cooperative Agreement was amended to review by the NSF and may be terminated by the NSF at any time at
its discretion or by mutual agreement. The NSF has stated that it will not be
re-awarding a cooperative agreement at the end ofextend the flexibility period.period until
September 30, 2000.
The original terms of the Cooperative Agreement provided for a cost
reimbursement plus fixed-fee contract (with aan initial fee of 8%). Effective
September 14, 1995, the NSFNational Science Foundation and the CompanyNetwork Solutions
amended the Cooperative Agreement to require the CompanyNetwork Solutions to begin charging
end users a services fee of $50 per year for each domain name in the .com, .org
and .net TLDs. Registrants paytop level domains. Until April 1, 1998, registrants paid a services fee
of $100 for two years of domain name services upon each initial registration and
an annual renewalre-registration fee of $50 per year thereafter (collectively "registration
fees").thereafter. The NSFNational Science
Foundation paid the registration fees for domain names within the .edu and .gov
TLDstop level domains through March 31, 1997. Commencing April 1, 1997, the CompanyNetwork
Solutions agreed with the NSFNational Science Foundation to provide domain name
services within the .edu and .gov TLDstop level domains free of charge. As of
October 1, 1997, the CompanyNetwork Solutions no longer registers or administers domain
names in the .gov TLD. Historical registrations in the .edu
and .gov TLDs represent less than 0.1% of cumulative net registrations at
December 31, 1997 and less than 0.1% of net new registrations during the period
from April 1, 1997 to December 31, 1997, and did not have a significant impact
on the Company's net revenues or costs of services.top level domain.
Under the terms of the September 14, 1995 amendment to the Cooperative
Agreement, 30% of the registration fees collected by the Company isNetwork Solutions was
required to be set aside for the enhancement of the intellectual infrastructure
of the Internet (set aside funds) and, as such, iswas not recognized as revenue by
the Company. The CompanyNetwork Solutions has reflected these set aside funds, along with
the appropriate percentage of net accounts receivable, as restricted assets and
has recorded an equivalent, related current liability. The Company maintainsNetwork Solutions
maintained the cash received relating to the set aside funds in a separate
interest bearing account. This restricted cash at December
31, 1996 and 1997 was approximately $13,049,000 and $23,512,000, respectively.
The set aside funds, plus any interest earned, are intended to bewere
disbursed at the direction of the NSF. In November 1997,National Science Foundation. As of December
31, 1998, the Company had cumulatively disbursed $23 million
out of the fund to the NSF at its direction. Future collection or disbursement
of theseall set aside funds will have no significant effect oncollected
and associated interest earned for a total of $62.3 million to the Company's
business, net financial position or results of operations.National
Science Foundation at their direction. The restricted cash at December 31, 1997
and 1998 was approximately $23,512,000 and $0, respectively.
On March 12, 1998, the NSFNational Science Foundation and the CompanyNetwork Solutions
amended the Cooperative Agreement to eliminate the 30% set aside requirement
effective April 1, 1998 and to reduce the registration fees by a corresponding
amount. Initial registrations on and after April 1, 1998 will beare charged $70 for two
years of registration services and an annual renewalre-registration fee of $35 per year
thereafter. This amendment will havehad no effect on the revenue currently recognized on
each registration, ($70$70 for initial registrations and $35 for renewals),re-registrations,
since the CompanyNetwork Solutions previously did not recognize revenue on the 30% set
aside funds. Accordingly, while the revenue to the CompanyNetwork Solutions on a per
registration basis does not change, the amount charged to customers will decline. The impact of this price change on
new registrations during the first quarter of 1998 is not expected to be
material and the potential increase in demand for domain names for the remainder
of 1998 due to the lower price point is uncertain.declined.
In order to provide prompt access to new domain names on the Internet,
the CompanyNetwork Solutions generally invoices customers and permits them to pay their
registration fees after their domain names are registered. The Company'sNetwork Solutions'
experience has been that, for the period from September 1995 to
41
42through December
1997,1998, approximately 30%31% of new registrations have ultimately been deactivated
for non-payment. The CompanyNetwork 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 resellingtransferring registration for such names at a profit. Such
resellers have a greater tendency than other customers to default on their
registration fees. As a consequence, the CompanyNetwork Solutions has recorded a comparable
provision for uncollectible accounts in determining net registration revenue.
This provision averaged 30% provision has been
consistently applied for the period from September 1995 to Decemberin 1996 and 1997 and 32% in 1998 and is considered
adequate by the Company.Network Solutions.
29
32
Registration fees charged to end userscustomers for registration services net of
the 30% set aside funds, are
recognized as revenue evenly over the registration term. Accordingly, the CompanyFor example, Network
Solutions recognizes $70 ($100 fee less $30 set aside) on a straight-line basis over the two-year servicesservice
period for each $70 initial domain name registration, equivalent to $35 per
year. RenewalsAnnual re-registrations of domain name
registrationsnames are recorded as revenue based upon
$35 ($50 fee less $15 set
aside) recognized on a straight-line basis over the one-year servicesservice period. This
"subscription-based"subscription-based model defers revenue recognition until the CompanyNetwork Solutions
provides the registration services, including daily updates to the Internet and maintenance of and unlimited
modifications to individual domain name records, over the respective
registration terms. At December 31, 1997, the Company1998, Network Solutions had net deferred
revenue of $61.5 million,$129.2 million.
Expenses for Network Solutions increased each quarter during 1996, 1997 and
1998 as a result of which $43.8 millionincreased business activities, primarily attributable to
subscriber growth for Network Solutions' registration services business. Network
Solutions believes continued investments in its back office infrastructure as
well as significant expansion of its sales and marketing and product development
activities are critical to the achievement of its goals and anticipates that
costs and expenses will be recognized
as revenuecontinue to increase in 1998.
Consulting Services.each quarter for the foreseeable
future.
Internet Technology Services
Substantially all of the Company's consulting servicesNetwork Solutions' Internet Technology Services
revenue is derived from professional services which are generally provided to
clients on a "timetime and expense"expense basis and is recognized as services are performed.
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 Inc. ("NationsBanc") is the Company's largest
consulting services customerclient, accounting for 40% of Network Solutions' Internet
Technology Services business net revenue and accounted for 29%3% of the Company's consulting
servicesNetwork Solutions' total net
revenue for the year ended December 31, 1997.1998. NationsBanc originally contracted
with the CompanyNetwork Solutions in 1993 to provide ongoing analysis, design,
implementation and support engineering for its enterprise network. The CompanyNetwork Solutions currently provides network
design and engineering services as well as a variety of project specific
services for NationsBanc. The Company's current contract
with NationsBanc is a three-year contract which commenced January 1, 1997 and is
a requirements contract under which the Company's services are ordered by task
orders issued by NationsBanc. The NationsBanc contract may be terminated by
NationsBanc at any time upon 30-days' prior written notice to the Company.
During 1997, task orders for a number of services the Company had historically
performed for NationsBanc were not renewed. The Company believes this reflects
NationsBanc's focus on increasing its internal information technology staff as
well as its continued efforts to integrate information technology staff from
recent acquisitions. There can be no assurance that the Company will obtain any
additional task orders under the NationsBanc contract.
Financial Presentation. The accompanying historical financial statements
for all periods presented reflect the results of continuing operations related
to the commercial activities of the Company only. The operating results of both
the minority-based government contracts business, which was transferred into a
separate entity prior to the acquisition of the Company by SAIC, and the
remaining government-based business, which was transferred to SAIC effective
February 1996, are reflected as discontinued operations in the Company's
financial statements. See Notes 1 and 9 to the Company's Financial Statements
for a discussion of transactions with SAIC.
42
43
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage
relationship to net revenue of certain items in the Company'sNetwork Solutions' Statements of
Operations.
The percentage relationships
YEAR ENDED DECEMBER 31,
------------------------------------
1996 1997 1998
-------- -------- --------
PERCENTAGE OF NET REVENUE:
Net revenue............................................. 100.0% 100.0% 100.0%
Cost of revenue......................................... 77.8 56.9 41.1
----- ----- -----
Gross profit............................................ 22.2 43.1 58.9
Research and development expenses....................... 3.6 3.6 5.1
Selling, general and administrative expenses............ 33.3 27.1 39.7
Interest and other expense (income)..................... (2.7) (4.6) (6.6)
----- ----- -----
Income (loss) before income taxes....................... (12.0) 17.0 20.7
Provision (benefit) for income taxes.................... (3.4) 7.7 8.7
----- ----- -----
NET INCOME (LOSS)....................................... (8.6)% 9.3% 12.0%
===== ===== =====
30
33
COMPARISON OF YEARS ENDED DECEMBER 31, 1997 AND 1998
Net Revenue
Net revenue increased 107% from $45.3 million for the year ended December
31, 1995
were derived by combining the Company's results of operations1997 to $93.7 million for the period
January 1, 1995 through March 10, 1995year ended December 31,1998. 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 121% from $38.8 million for the year ended
December 31, 1997 to $85.7 million for the year ended December 31, 1998. Net new
registrations increased 99% from 960,000 for the year ended December 31, 1997 to
1,911,000 for the year ended December 31, 1998. Growth in net registrations
continues to be driven by the widespread use and adoption by businesses of the
Internet and intranets on a global basis. Cumulative net registrations as of
December 31, 1997 were 1,541,000 as compared to 3,362,000 as of December 31,
1998 for a 118% increase.
Additionally, net new registrations increased 137% from 262,000 for the
three months ended December 31, 1997 to 621,000 for the three months ended
December 31, 1998. This also represents a 23% increase over the 507,000 net new
registrations for the three months ended September 30, 1998. The growth in
cumulative net registrations was a 21% increase in Network Solutions' entire
customer base since September 30, 1998.
Net revenue from Internet Technology Services increased 22% from $6.5
million for the year ended December 31, 1997 to $8.0 million for the year ended
December 31, 1998. Further, the fourth quarter reflected an increase of 117%
over the same quarter last year and a 47% increase over the third quarter of
1998. NationsBanc accounted for $1.9 million or 4% of Network Solutions' total
net revenue for the year ended December 31, 1997 and $3.2 million or 3% for the
year ended December 31, 1998.
During the year ended December 31, 1998, the Internet Technology Services
division added new leadership in sales and operations and hired additional
technical consultants. In addition, the division continued to emphasize its
efforts targeted at lead generation and regional sales and marketing programs by
opening offices in New York City and Atlanta, Georgia.
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 period March 11, 1995 throughassociated operating overhead. Cost of revenue increased
from $25.8 million for the year ended December 31, 1997 to $38.5 million for the
year ended December 31, 1998. This 49% increase was driven by a $3.0 million
increase in labor, a $6.4 million increase in outsourcing costs and $2.7 million
in additional depreciation charges and equipment expenditures primarily
associated with supporting the growth of Network Solutions' registration
services business. In the near term, the continued investment in the back office
infrastructure and provision of customer service is expected to partially offset
future margin improvements arising from economies of scale.
As a percentage of net revenue, cost of revenue decreased from 56.9% for
the year ended December 31, 1997 to 41.1% for the year ended December 31, 1998
principally reflecting economies of scale and other operational efficiencies
achieved in Network Solutions' registration business.
Research and Development Expenses
Research and development expenses consist primarily of compensation and
consultant expenses to support the creation, development and enhancement of
Network Solutions' products, services and technologies. Research and development
expenses increased 192% from $1.7 million for the year
31
34
ended December 31, 1997 to $4.8 million for the year ended December 31, 1998. As
a percentage of net revenue, research and development expenses increased from
3.6% for the year ended December 31, 1997 to 5.1% for the year ended December
31, 1998. 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 terms of absolute
dollars as Network Solutions invests in developing new service offerings.
Selling, General and Administrative Expenses
Selling, general and administrative expenses consist primarily of salaries
of business development, general management, administrative and financial
personnel, marketing expenses, corporate services from SAIC, legal and other
professional costs and amortization of goodwill associated with Network
Solutions' 1995 which, respectively, are periods beforeacquisition by SAIC. Selling, general and afteradministrative
expenses increased 203% from $12.3 million for the dateyear ended December 31, 1997
to $37.1 million for the year ended December 31, 1998. The increase was
attributable to a $16.9 million increase in marketing and business development
expenses including television, Internet banner advertising and targeted direct
mail campaigns, increased staffing expenses of $1.8 million and an increase in
legal and other professional costs of $2.6 million. As a percentage of net
revenue, selling, general and administrative expenses increased from 27.1% for
the year ended December 31, 1997 to 39.7% for the year ended December 31, 1998.
Network Solutions expects that the level of selling, general and administrative
expenses will continue to increase significantly in the near future in terms of
absolute dollars as operations continue to expand. In particular, sales,
marketing and business development expenses will increase as Network Solutions
continues to promote the value of a .com web address and other new
Internet-based value-added services. Network Solutions also plans to continue to
develop its distribution channels, both domestically and internationally.
Interest Income
Network Solutions had net interest income of $2.2 million for the year
ended December 31, 1997 as compared to $6.3 million for the year ended December
31, 1998. The increase is attributable to the investment of the SAIC acquisition. Accordingly, the data for these two periodspositive cash
flow resulting primarily from increasing domain name registrations and the net
proceeds of Network Solutions' initial public offering.
Income Taxes
The provision for income taxes was 45% of pretax earnings, or $3.5 million
for the year ended December 31, 1997, and 42%, or $8.1 million for the year
ended December 31, 1998. The difference between the effective rates for both
periods precedingpresented 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 followingis associated with the
acquisition were prepared on differing bases
of accounting and, as a result, the comparability of such percentage relations
with other periods is limited primarily as a result of the goodwill
amortization, corporate services agreements and interest expense related to
outstanding debt balances.
Percentage of Net Revenue
-------------------------------
Fiscal Year
Ended December 31,
-------------------------------
1995 1996 1997
------- ------- ------
Net revenue 100.0% 100.0% 100.0%
Cost of revenue 87.9 77.8 56.9
------- ------- ------
Gross profit 12.1 22.2 43.1
Research and development expenses - 3.6 3.6
Selling, general and administrative expenses 36.9 33.3 27.1
Interest expense (income), net 0.9 (2.7) (4.6)
------- ------- ------
Income (loss) from continuing operations (25.7) (12.0) 17.0
Provision (benefit) for income taxes (3.6) (3.4) 7.7
------- ------- ------
Income (loss) from continuing operations,
net of income taxes (22.1%) (8.6%) 9.3%
======= ======= ======
43
44Network Solutions by SAIC in 1995.
COMPARISON OF YEARS ENDED DECEMBER 31, 1996 AND 1997
Net Revenue.Revenue
Net revenue increased 140% from $18.9 million in 1996 to $45.3 million in
1997. This increase in net revenue was primarily attributable to the increase in
the number of domain name registrations, principally in the .com TLD.top level
domain. Net revenue from registration services increased 246% from $11.2 million
in 1996 to $38.8 million in 1997. Net new registrations increased 96% from
489,000 during 1996 to 960,000 during 1997. Growth in registrations has beenwas driven
by the widespread use and adoption by businesses of the Internet and Intranetsintranets
on a global basis. Cumulative net registrations as
32
35
of December 31, 1996 were 627,000 as compared to 1,541,000 as of December 31,
1997, for a 146% increase.
Net revenue from consulting servicesInternet Technology Services decreased 16% from $7.7
million in 1996 to $6.5 million in 1997. This decrease was primarily
attributable to a decrease in business from NationsBanc. NationsBanc, the Company'sNetwork
Solutions' largest consulting servicesInternet Technology Services client, accounted for $3.7
million or 20% of the Company'sNetwork Solutions' total net revenue in 1996 and $1.9 million
or 4% of the Company'sNetwork Solutions' total net revenue in 1997.
The Company believes NationsBanc will continue to be a
significant customer of its consulting services business, but to a lesser extent
than in previous years, both in terms of dollars and as a percentage of the
Company's total net revenue.
Cost of Revenue. Cost of revenue consists primarily of salaries and
employee benefits, fees paid to subcontractors for work performed in connection
with revenue producing projects, depreciation, lease costs of the operations
infrastructure and the associated operating overhead.Revenue
Cost of revenue increased 76% from $14.7 million in 1996 to $25.8 million
in 1997. The increase was primarily driven by the growth of the Company'sNetwork Solutions'
registration business which experienced additional labor costs of $4.2 million
and additional outsourcing costs of $1.6 million in support of the Company'sNetwork
Solutions' invoicing, collection and processing activities. In June 1997,
the CompanyNetwork Solutions opened a 31,200 square foot facility to support its Internet
business operations and in January 1998, the
CompanyNetwork Solutions signed an agreement
to lease an additional 9,100 square feet at the same location. This leased facility is designed to meet current registration
services customer support needs as well as to provide expansion capability for
future business. The Company continues to invest in improvements to the back
office component of its domain name registration business including investments
in additional hardware, software, staffing and facilities and currently
anticipates that it will continue to make significant investments in its back
office for the foreseeable future.
As a percentage of net revenue, cost of revenue decreased from 77.8% in
1996 to 56.9% in 1997. This decrease primarily reflects economies of scale that
the Company has begun to achieveNetwork Solutions achieved due to the growth of its subscription-based domain
name registration business.
In the near term, the continued need for back
office investments is expected to partially offset future margin improvements
arising from economies of scale.
Research and Development Expenses. Research and development expenses
consist primarily of compensation expenses to support the development and
enhancement of the Company's technologies.Expenses
Research and development expenses increased 150% from $680,000 in 1996 to
$1.7 million in 1997. To date, allAll of the Company'sNetwork Solutions' research and development costs
have been expensed as incurred. The
Company expects that the level of research and development expenses will
increase significantly in the near future in absolute dollars as the Company
invests in developing new product and service offerings. As a percentage of net revenue, research and
development expenses were 3.6% for both 1996 and 1997.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses consist primarily of salaries of business development,
general management,
44
45
administrative and financial personnel, corporate services from SAIC, legal
costs and amortization of goodwill associated with the Company's acquisition by
SAIC.Expenses
Selling, general and administrative expenses increased 95% from $6.3
million in 1996 to $12.3 million in 1997. The increase is primarily attributable
to increased management and administrative labor expenses of $1.8 million,
business development expenses of $1.3 million and an increase in legal costs of
$1.0 million.
As a percentage of net revenue, selling, general and administrative
expenses decreased from 33.3% in 1996 to 27.1 %27.1% in 1997. The decrease in
percentage of net revenue reflects economies the Company has begun to achieveof scale Network Solutions achieved
due primarily to the growth of its domain name registration business.
The
Company expects that the level of selling, general and administrative expenses
will increase significantly in the near future in terms of absolute dollars as
operations continue to expand. In particular, sales, marketing and business
development expenses will increase as the Company introduces new enhanced
registration and other services and begins to actively promote the use of the
.com TLD.
Interest Income
Net. The CompanyNetwork Solutions had net interest income of $496,000 in 1996 as compared
to $2.1 million in 1997. The increase is attributable to the investment of the
net proceeds of the Company'sNetwork Solutions' stock offering as well as improved cash flow
resulting from the increase in domain name registrations.
Income Taxes (Benefit).
The income tax benefit was $643,000 in 1996 as compared to an income tax
expense of $3.5 million in 1997. The effective tax rate changed from 28% in 1996
to 45% in 1997. The difference between the effective rates is principally
attributable to the relative impact that non-deductible goodwill had on pretax
operating income or loss for the year. Goodwill is being amortized by the CompanyNetwork
Solutions over five years and is associated with the acquisition of the CompanyNetwork
Solutions by SAIC in 1995.
COMPARISON OF YEARS ENDED DECEMBER 31, 1995 AND 1996
Net Revenue. Net revenue increased 191%33
36
FACTORS AFFECTING OPERATING RESULTS
The Department of Commerce has adopted a plan, referred to as the Statement
of Policy or "White Paper," calling for a phased transition of the Department's
responsibilities for the domain name system to a not-for-profit corporation by
September 30, 2000. The domain name system is the system by which Internet names
and addresses are registered, allocated and used. We face risks from $6.5 million in 1995 to $18.9
million in 1996. This increase in net revenue was primarily attributablethis
transition. As the U.S. Government transitions certain responsibilities for
domain name system administration to the increasenot-for-profit corporation,
corresponding obligations under our Cooperative Agreement with the Department of
Commerce may be terminated and, as appropriate, covered in a contract between
the not-for-profit corporation and us. We might not reach an acceptable
contractual agreement with the not-for-profit corporation for our continuing
role in the numberregistration of domain name registrations, principallynames. The U.S. Government has sent us a
letter directing us to treat ICANN as the not-for-profit corporation identified
in the .com
TLD, as well as the Company's shift to a subscription-based pricing model. Net
revenue from registration services increased 600% from $1.6 million in 1995 to
$11.2 million in 1996. Net revenue in 1995 primarily reflects the cost
reimbursement plus fixed-fee contract with the NSF whereas net revenue for 1996
reflects the Company's subscription-based pricing model. Net new registrations
increased 247% from 141,000 during the year ended December 31, 1995 to 489,000
during the year ended December 31, 1996. Cumulative net registrations increased
254% from 177,000 at December 31, 1995 to 627,000 at December 31, 1996.
Net revenue from consulting services increased 57% from $4.9 million in
1995 to $7.7 million in 1996, including an increase in net revenue from
NationsBanc, the Company's largest consulting services customer, which increased
42% from $2.6 million in 1995 to $3.7 million in 1996. This growth was primarily
attributable to increased funding within NationsBanc to support internal network
integration and expansion. The Company also experienced growth from a number of
new consulting services customers, many of which were obtained through
subcontracting with and utilizing leads from SAIC.
NationsBanc accounted for 19.6% of total net revenue in 1996. NationsBanc
accounted for 40.0% of total net revenue and the NSF (under the cost
reimbursement plus fixed-fee contract) accounted for 20.8% of total net revenue
in 1995. No other source of revenue accounted for
45
46
more than 7.1% of total net revenue in either year.
Cost of Revenue. Cost of revenue increased 157% from $5.7 million in 1995
to $14.7 million in 1996. The increase in cost was related primarily to an
increase in the cost of labor of $3.7 million as a result of the Company's rapid
growth. Effective with the September 14, 1995October amendment to the Cooperative Agreement which implementeddescribed above, in the
subscription-based pricing model, the Company
established and continued to develop its back office capability. This required
the Company to make significant investments in hardware and software as well as
to utilize a number of third-party vendors in support of back office
requirements. In particular, the Company began to outsource portionsperformance of its back
office operations duringobligations under the fourth quarterMOU and until such time as the MOU is
terminated. We have not yet responded to that letter. We are currently in
discussions with ICANN and the U.S. Government regarding implementation of 1996. A principal benefit of
outsourcing was to increase the
capacity and efficiency of its back office
operations; however, such action alone did not significantly impact operating
margins.
As a percentage of net revenue, cost of revenue decreased from 87.9% in
1995 to 77.8% in 1996. This decrease reflects economies of scale that the
Company has begun to achieve due to the growth of its domain name registration
business.
Research and Development Expenses. There were no research and development
expenses in 1995, in large part becauseshared registration system enhancements were
reimbursable under the Cooperative Agreement. In 1996, research and development
expenses were $680,000 or 3.6%a wide range of net revenue. Through December 31, 1996, all of
the Company's research and development costs have been expensed as incurred.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased 162% from $2.4 million in 1995 to $6.3 million
in 1996. This increase was primarily attributable to increases in management,
administrative and business development staff, as well as increased legal costs
associated with the administration of the Company's domain name dispute policy.
Selling, general and administrative expenses include $237,000 in 1995 and
$822,000 in 1996 of expenses allocated from SAIC in accordance with the then
current intercompany agreement. If the expenses were based on the fee of 2.5% of
net revenue under the intercompany agreement in effect during 1997, such
expenses would have been $133,000 and $472,000, respectively.
As a percentage of net revenue, selling, general and administrative
expenses decreased from 36.9% in 1995 to 33.3% in 1996, reflecting the generally
fixed nature of certain general and administrative expenses as well as
management's control of such costs.
Interest Expense (Income). The Company had net interest expense of $61,000
in 1995 as compared to interest income of $496,000 in 1996. The change is
primarily attributable to positive cash flow in 1996 associated with the
Company's domain name registration business.
Income Taxes (Benefit). The income tax benefit was $239,000 in 1995 as
compared to $643,000 in 1996. The effective tax rate increased from 14.3% in
1995 to 28.4% in 1996. The difference between the effective tax rates was
primarily attributable to non-deductible goodwill comprising a higher percentage
of the Company's net loss in 1995.
Discontinued Operations. Immediately prior to the acquisition of the
Company by SAIC, the portion of the Company's business relating to the
minority-based government business had been transferred into a separately-owned
entity. In November 1995, SAIC adopted a plan to transfer the Company's
remaining government-based business to SAIC in order to enable the Company to
focus on the growth of its commercial business, which includes registration and
consulting services. This transfer was effective as of February 1996. November
1995 was the
46
47
measurement date for discontinued operations for accounting purposes. The
activities of both the minority-based government business and the remaining
government-based business are reflected as discontinued operations. Net income
(loss) from discontinued operations excludes general corporate overhead of the
Company. No gain or loss was incurred as a consequence of the transfer of these
businesses.
In 1995, discontinued operations incurred a net loss of $1.4 million. The
loss was primarily attributable to the Company's remaining government business,
which increased the Company's provision for uncollectible accounts associated
with the bankruptcy of a prime contractor, high interest costs associated with
payment issues from other prime contractors and over-runs of fixed-price and
fixed-rate contracts. As mentioned above, this business was transferred to SAIC
effective as of February 1996.
FACTORS AFFECTING OPERATING RESULTS
The Company's expense levels are based in part on its expectations as to
future revenue and to a large extent are fixed. As a result, quarterly sales and
operating results generally depend on the volume of and ability to fulfill
registration requests and consulting services contract awards, which are
difficult to forecast. The Company may be unable to adjust spending in a timely
manner to compensate for any unexpected revenue shortfall. Accordingly, any
significant shortfall of demand for the Company's services in relation to the
Company's expectations would have an immediate adverse impact on the Company's
business, operating results and financial condition. In addition, the Company
expects a significant increase in its operating expenses as it funds greater
levels of product and services development, increases its sales and marketing
operations, updates systems and infrastructure, expands its facilities, develops
new distribution channels and broadens its customer support capabilities. While
no individual expenditure is anticipated to have a material impact on the
Company's operating results, the combined effect could be significant andcontractual issues. We cannot be
reasonably estimated at this time. To the extentsure that such expenses precede
or are not subsequently followed by an increasethese discussions will result in revenue, the Company's
business, financial condition and results of operations will be materially and
adversely affected.
The Company believes that future operating results will be subject to
quarterly fluctuations due to a variety of factors, many of which are beyond the
Company's control. Such factors may include, but are not limited to,
developments in Internet governance, increased competition, through the
introduction of competing TLDs or competing registrars in .com, .org or .net or
otherwise, variations in the number of requests for domain name registrations,
demand for the Company's services, introduction or enhancements of services by
the Company or its competitors, market acceptance of new service offerings,
costs associated with providing domain name registration services, litigation
costs, adverse results of litigation, termination or completion of contracts in
the Company's consulting services business or failure to obtain additional
contracts in its consulting services business, patterns of growth in the use of
and interest in the Internet and general economic conditions. Operating results
would be adversely affected by a downturn in the market for domain name
registrations or a failure to maintain existing or obtain anticipated contracts
in its consulting services business. Because the Company expects an increase in
its operating expenses for personnel and new services development, the Company
would be materially and adversely affected if its revenues did not
correspondingly increase. See "Item 1 - Business - Risk Factors - Potential
Fluctuations in Quarterly Results."
47
48
On February 20, 1998, the U.S. government published in the Federal
Register the Proposed Rule to provide notice and seek public comment on a
proposal to transfer over time the administration of the Internet domain name
system from the U.S. government and the NSF to a new private, not-for-profit
corporation and to increase competition in the administration of TLDs and the
registration of second level domain names. Comments on the Proposed Rule have
revealed substantial differences regarding how the DNS should evolve and
competing proposals concerning DNS management to those set forth in the Proposed
Rule have been advanced from time to time. There is a risk that failure to
achieve consensus could, among other things, prevent or delay the issuance of a
final rule. In addition, any rule that is issued could be challenged by persons
or entities who disagree with its provisions. Any of such events could have a
material adverse effect on the Company's business, financial condition and
results of operation through continued uncertainty about future Internet
governance or a disruption to the administration, effective operation or
maintenance and expansion of the Internet, in general, or the domain name
registration system, in particular. Additionally, any final rule could be
different, perhaps substantially, from the Proposed Rule. Any final rule or any
terms negotiated thereunder by the U.S. government and the Company could contain
provisions which are notagreements favorable to us. Despite
the Company or not consistent with the
Company's current or future plans. Itsignificant efforts undertaken to date, it is impossible to predict at this
time whether or when a final rulethe process initiated by the Statement of Policy will
be issuedresult in the full transition to the not-for-profit corporation of domain name
system responsibilities as and to the extent contemplated in the White Paper
and, if issued,it does, the exact nature of
its provisions or of any such terms, the timing of implementation or the precise
effect on us of such provisionstransition. See "Business -- Ongoing
Privatization of Internet Administration."
Termination, or a change in the terms, onof the Company. It is possible thatCooperative Agreement could
harm our business. While the Cooperative Agreement by its terms expires in
September 2000, it may be terminated earlier. The Department of Commerce's
interpretation of certain provisions of any final rulethe Cooperative Agreement could differ
from ours. For example, the Department of Commerce has publicly expressed
concerns about our consolidation into a single web site the web sites through
which our InterNIC registration services and our RegistrationPlus services were
offered. These differences in interpretation could lead to disputes between us
and the Department of Commerce or certainthe not-for-profit corporation, which may or
may not be resolved in our favor. Certain aspects of suchimplementation of the
Cooperative Agreement also remain to be fully negotiated, including the maximum
price we will charge for registry services in the top level domains for which we
now act as registry. If we are unsuccessful in negotiating acceptable terms could have a material
adverse effect onof
implementation, the Company's business, financial condition and resultscosts of operations. See "Item 1-Business-Relationshipimplementation of the Cooperative Agreement, our
relationship with the NSF; Recent Developments
in Internet Governancenot-for-profit corporation and -Risk Factors-Uncertainty of Internet Governance and
Regulation."
Under the Proposed Rule, the Company would continue to operate the .com,
.org and .net registries and to act as a registrar for those TLDs, but other companies would be permitted to act as registrar for those TLDs. The Proposed
Rule also provides for additional new TLDs. The Company believes that it is well
positioned to succeedmatters affecting our
position in a more competitive environment. However,domain name system environment could be harmed.
See "Business -- Status of Cooperative Agreement."
Withdrawal of or challenges to the adoptionU.S. Government's sponsorship or
authorization of certain functions that we perform could create a public
perception or result in a legal finding that we lack authority to continue in
our current role as registry or registrar within the .com, .org, .net and .edu
top level domains. The legal authority underlying the roles of the Proposed RuleDepartment of
Commerce and the not-for-profit corporation with regard to the domain name
system also could be challenged. The impact, if any, of any such public
perception or a similar rule or thefinding is unknown, but it could be harmful to our business.
The introduction of additional competition into the domain name
registration business could be harmful to our business. This includes, in
someparticular, 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. In addition, we currently face competition in the domain
name registration business from registries for country code top level domains,
third level domain name providers such as Internet access providers and
registrars and registries of top level domains other mannerthan those top level
domains which we currently register. A number of entities have already begun to
offer
34
37
competing registration services using other top level domains and when the
shared registration system takes effect we will no longer be the exclusive
registrar in the .com, .org and .net top level domains. Our revenue could havebe
reduced due to increased competition, pricing pressures or a material adverse effectmodification of
billing practices. For example, other entities may bundle domain name
registrations with other products or services. See "Business -- Competition in
the Registration Business."
Our future success substantially depends on the Company'scontinued growth in the use
of the Internet. If the use of and interest in the Internet does not continue to
grow, our business financial
conditionwould be harmed.
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 could result in deletion of one or more
domain names from the Internet 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 resultsthe discontinuation of
operations. See "Item 1-Business-Competitionsecond level domain names in those top level domains for a period of time. The
inability of our registration system and -Risk
Factors-Competition."
The Company'stelecommunications 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
registration requests in a timely manner. Our operations are dependent upon itsdepend on our ability
to maintain itsour computer and telecommunications equipment in effective working
order and to reasonably protect itsour systems against damageinterruption. The root zone
servers and top level domain zone servers that we operate are critical hardware
to our operations.
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. 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, software and components used by our
employees, the result could be a failure of or interruption to normal business
operations.
On November 16, 1998, we announced the resignation of Gabriel A. Battista
from fire, natural disaster,
sabotage, power loss, telecommunication failure, human errorhis positions as Chief Executive Officer and Director. We cannot reasonably
estimate at this time the potential impact on us of the hiring of a new Chief
Executive Officer. We cannot be certain of the timing of our hiring of a new
Chief Executive Officer or similar events.
In addition,the effect of any delays in our hiring of a new Chief
Executive Officer on the development or implementation of our strategic plan.
Given the relative "newness" and rapid growth of the Company's customer base may put strainInternet, there is
intense competition for the limited supply of people qualified to work for us.
Our future success depends on the capacitycontinued service of its computerskey engineering, sales,
marketing, executive and telecommunications systemsadministrative personnel, and our ability to attract,
hire, integrate, train and retain such personnel. The loss of the Company's
inabilityservices of
any of our senior management team or other key employees or our failure to
sufficientlyattract, integrate, train and retain additional key employees could harm our
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 upgrade its systemsdevelop or market
additional services, our business could leadbe harmed.
Our domain name registration services business generates over 90% of our
revenue and is expected to degradationcontinue to account for a very significant portion of
our revenue in performance or system failure.at least the near term. 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.
35
38
Because of our high level of uncollectible receivables, we continually
review our billing practices. Any damage, failure or delaymodifications that causes significant interruptionswe implement as a result of
these reviews could have unanticipated harmful consequences to our business. 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 involved in the Company's systems would have a material
adverse effect on the Company's business, financial condition and results of
operations.
The Company is a party in a number ofseveral legal proceedings. While the
CompanyWe cannot reasonably estimate
the potential impact of the claims advancedany of these proceedings. An adverse determination in
the PG Media or Thomas suits, a successful claim against the Company in
eitherany of these proceedings, however, could have a material adverse effect on the
Company's business, financial condition and results of operation. In addition,
while the Company cannot predict what relief, if any, might be sought, awarded
or imposed as a result of any civil action filed by the Department of Justice
arising from its investigation regarding Internet registration products and
services, any such relief could have a material adverse effect on the Company's
business,
48
49
financial condition and results of operation. Moreover, litigationharm our business. Legal proceedings in
which the
Company iswe are involved has resultedare expensive and likely will result in, and any future
litigation can be expected to result in, substantial legal and other expenses to
the Company and a diversion of the Company'sdivert our personnel. See "Item
3 --- Legal Proceedings."
The Company isOur quarterly operating results may fluctuate significantly in the processfuture
due to a variety of assessing its computer software
applications and systems to ensure their functionality with respect to the
"Year 2000" millenium change. At this time, the Company believes that the
remediation costs, if any, needed to make all of its internal applications and
systems Year 2000 compliant are not material. Although the Company believes
that its internal mission critical systems are Year 2000 compliant, the failure
of the software applications or internal systems of other companies on which
the Company's systems rely or to which they are connected or of other
Internet-related companies, including Internet web hosting companies, Internet
access providers, or Internet root server operators, nonefactors, some of which are beyond our control. In addition,
we expect a significant increase in our operating expenses. If the Company
controls, toincrease in
our expenses is not followed by an increase in our revenue, our operating
results will be Year 2000 compliant upon January 1, 2000 couldharmed. The fact that in the past our revenues have increased
and we have been profitable on a material
adverse effectquarterly 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 operation of the Internet and/or a material adverse
effect on the Company's business, financial condition and results of operation.
See "Item 1-Business-Risk Factors - Year 2000."future.
SELECTED QUARTERLY RESULTS OF OPERATIONS
The following tables set forth certain unaudited quarterly financial
information for 1996each of the eight quarters in the years ended December 31, 1997
and 1997.1998. In the opinion of management, this information has been presented on
the same basis as the audited financial statements referenced in this Form 10-K,
and all necessary adjustments (consisting only of normal recurring adjustments)
have been included in the amounts stated below to present fairly the selected
unaudited
quarterly results when read in conjunction with the audited financial statements
of the CompanyNetwork Solutions and notes thereto. The operating results of operations for any quarter
are not necessarily indicative of results for any future periods.
49
50period.
Quarter Ended
--------------------------------------------------------------------------------------------
Mar.QUARTER ENDED
---------------------------------------------------------------------------------------
MAR. 31, Jun.JUNE 30, Sep.SEPT. 30, Dec.DEC. 31, Mar.MAR. 31, Jun.JUNE 30, Sep.SEPT. 30, Dec.DEC. 31,
1996 1996 1996 1996
1997 1997 1997 1997 1998 1998 1998 1998
-------- -------- --------- -------- -------- -------- --------- --------
-------- -------- -------- --------
(in thousands, except per share data)(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net revenue $ 2,333 $ 4,496 $ 5,180 $ 6,853 $ 8,655 $ 10,069 $ 12,172 $ 14,430revenue................. $8,655 $10,069 $12,172 $14,430 $16,492 $20,476 $25,427 $31,257
Cost of revenue 2,950 3,571 3,719 4,426revenue............. 5,294 6,141 7,033 7,330 -------- -------- -------- -------- -------- -------- -------- --------7,348 8,791 10,312 12,079
------ ------- ------- ------- ------- ------- ------- -------
Gross profit (617) 925 1,461 2,427profit................ 3,361 3,928 5,139 7,100 9,144 11,685 15,115 19,178
Research and development
expenses - 58 226 396expenses.................. 311 407 377 558 725 815 1,353 1,928
Selling, general and
administrative expenses 921 1,449 1,932 1,978expenses... 2,301 2,487 3,105 4,375 6,182 8,008 10,248 12,706
Interest expense (income), net - (86) (288) (122)income............. (149) (335) (570) (1,041) -------- -------- -------- -------- -------- -------- -------- --------(1,292) (1,384) (1,654) (1,857)
------ ------- ------- ------- ------- ------- ------- -------
Income (loss) before income
taxes (1,538) (496) (409) 175taxes..................... 898 1,369 2,227 3,208 3,529 4,246 5,168 6,401
Provision (benefit) for income
(436) (140) (116) 49taxes..................... 382 629 995 1,465 taxes -------- -------- -------- -------- -------- -------- -------- --------1,480 1,783 2,163 2,683
------ ------- ------- ------- ------- ------- ------- -------
Net income (loss) $ (1,102) $ (356) $ (293) $ 126income.................. $ 516 $ 740 $ 1,232 $ 1,743 ======== ======== ======== ======== ======== ======== ======== ========$ 2,049 $ 2,463 $ 3,005 $ 3,718
====== ======= ======= ======= ======= ======= ======= =======
Basic and diluted EPS(1)EPS (1)............... $ (0.09)0.02 $ (0.03)0.03 $ (0.02) $ 0.01 $ 0.040.05 $ 0.06 $ 0.100.07 $ 0.08 $ 0.09 $ 0.11
======== ======== ======== ======== ======== ======== ======== ============== ======= ======= ======= ======= ======= ======= =======
Diluted EPS (1)............. $ 0.02 $ 0.03 $ 0.05 $ 0.05 $ 0.06 $ 0.07 $ 0.09 $ 0.11
====== ======= ======= ======= ======= ======= ======= =======
- ---------------
(1) All per share data reflect the two-for-one stock split in March, 1999. Since
there are changes in the weighted average number of shares outstanding each
quarter, the sum of the quarterly basic and diluted EPS amounts may not
equal the basic and diluted EPS for calendar years 19961997 and 1997.
501998.
36
5139
Quarter Ended
-----------------------------------------------------------------------------
Mar.QUARTER ENDED
---------------------------------------------------------------------------------------
MAR. 31, Jun.JUNE 30, Sep.SEPT. 30, Dec.DEC. 31, Mar.MAR. 31, Jun.JUNE 30, Sep.SEPT. 30, Dec.DEC. 31,
1996 1996 1996 1996
1997 1997 1997 1997 1998 1998 1998 1998
-------- -------- --------- -------- -------- -------- --------- --------
-------- -------- -------- --------
(as a percentage of revenue)(AS A PERCENTAGE OF NET REVENUE)
Net revenuerevenue.................. 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of revenue 126.4 79.4 71.8 64.6revenue.............. 61.2 61.0 57.8 50.8 44.6 42.9 40.6 38.6
----- ----- ----- ----- ----- ----- ----- -----
Gross profit (26.4) 20.6 28.2 35.4profit................. 38.8 39.0 42.2 49.2 55.4 57.1 59.4 61.4
Research and development
expenses - 1.3 4.4 5.8expenses................... 3.5 4.0 3.1 3.9 4.4 4.0 5.3 6.1
Selling, general and
administrative expenses 39.5 32.2 37.3 28.9expenses.... 26.6 24.7 25.5 30.3 37.4 39.1 40.3 40.7
Interest expense (income), net - (1.9) (5.6) (1.8)income.............. (1.7) (3.2) (4.7) (7.2) (7.8) (6.7) (6.5) (5.9)
----- ----- ----- ----- ----- ----- ----- -----
Income (loss)
before income taxes (65.9) (11.0) (7.9) 2.5taxes... 10.4 13.5 18.3 22.2 21.4 20.7 20.3 20.5
Provision (benefit) for income taxes (18.7) (3.1) (2.2) 0.7taxes... 4.4 6.2 8.2 10.1 9.0 8.7 8.5 8.6
----- ----- ----- ----- ----- ----- ----- -----
Net income (loss) (47.2)% (7.9)% (5.7)% 1.8%income................... 6.0% 7.3% 10.1% 12.1% 12.4% 12.0% 11.8% 11.9%
===== ===== ===== ===== ===== ===== ===== =====
The CompanyNetwork Solutions has experienced quarterly fluctuations in operating
results and anticipates that such fluctuations will continue. These fluctuations
may be caused by, among other things, increases in legal and marketing expenses,
market acceptance of new products, competitive pricing pressures and general
economic conditions. As a result of the foregoing and other factors, the
CompanyNetwork
Solutions believes that period-to-period comparisons of its results of
operations are not necessarily meaningful and should not be relied on as
indications of future performance. See "Factors Affecting Operating Results" and
"Item 1 --- Business --- Risk Factors - Potential Fluctuations in-- Our Quarterly Results.Operating Results May
Fluctuate; Our Future Revenue and Profitability are Uncertain."
The Company'sNetwork Solutions' net revenue increased each quarter presented primarily
due to an increase in the number of cumulative net registrations in each of
those quarters. The CompanyNetwork Solutions currently expects registration services
revenue for the first quarter of 19981999 to show continued growth based upon its
existing registration base and net new registrations during the quarter.
However, there can be no assurance that net registration revenue will continue
to increase at historical rates, or at all, or not decrease in the future,
especially when the Cooperative Agreement is terminated or if there is a change
in the Company'sNetwork Solutions' status as the exclusive registry and registrar for domain
names in the .com, TLD,.net and .org top level domains, particularly as a
significant portion of the Company'sNetwork Solutions' net revenue is attributable to
registrations in the .com TLD.top level domains. Notwithstanding the $61.5$129.2 million
of deferred revenue at December 31, 1997,1998, of which $43.8$93.7 million will be
recognized as revenue in 1998, the Company's1999, Network Solutions' revenue is dependent in large
part on the continued growth of the Internet, the Company'sNetwork Solutions' ability to
maintain its position as the leading Internet domain name registration service
provider worldwide and the evolving nature of the Company'sNetwork Solutions' services,
products and other factors.
Operating expenses have generally increased in absolute dollars in each
quarter shown as the CompanyNetwork Solutions has increased staffing and related
infrastructure costs in its back office, selling and marketing, and
administrative functions. Quarter-to-quarter growth in cost of revenue was
primarily attributable to increased staffing levels and increased outsourcing
costs which are a function of the number of registrants. Quarter-to-quarter
growth in selling, general and administrative expenses are attributable to
increased staffing at the management level, continuing legal expenses and
marketing costs associated with the introduction of new services and products.
51
52
LIQUIDITY AND CAPITAL RESOURCES
From the time of its acquisition by SAIC in March 1995 until December 1996,
the CompanyNetwork Solutions participated in SAIC's centralized cash management system
whereby cash received from operations was transferred to SAIC's centralized cash
accounts and cash disbursements were funded
37
40
from such centralized cash accounts. Accordingly, cash requirements for
operating purposes and for capital expenditures were met from this source.
Beginning in 1997, the CompanyNetwork Solutions implemented its own cash management system.
At December 31, 1998, Network Solutions' principal source of liquidity was
its cash and cash equivalents of $12.9 million and its short-term investments of
$118.8 million, which when combined represent an increase of $50.3 million from
the December 31, 1997 the Company'sbalance in those accounts. Network Solutions also has $9.4
million of marketable securities held as long term investments as of December
31, 1998.
At December 31, 1998, Network Solutions' cumulative net obligation to SAIC
for intercompany activity was $1.3$4.8 million, a decreasenet increase of $14.0$3.5 million for the year
then ended.from
December 31, 1997. Intercompany activity is primarily comprised of corporate income tax
payments made by SAIC on behalf of the Company in accordance with the companies'
tax sharing arrangement and salaries and
benefits paid by SAIC on behalf of the
Company. Effective with the second quarter of 1997, corporate taxes were paid toNetwork Solutions. Network Solutions
currently reimburses SAIC on a quarterly basis, with all otherfor intercompany balances between SAIC and
the Company paidactivity on a monthly basis. Pursuant
to the Tax Sharing Agreementa tax sharing agreement with SAIC dated September 26, 1997, the Company willNetwork Solutions
now generally remitremits income tax payments directly to tax authorities as it no
longer is part of SAIC's consolidated group for federal income tax purposes.
The Company completed its initial public offering on October 1, 1997,
raising $52.4 million for the Company. From these net proceeds, the Company
paid a $10 million dividend to SAIC on October 1, 1997.
Cash provided by operations was $41.1$63.4 million in 1997.for the year ended December
31, 1998. This amount is principally attributed to net income plus the increase
in deferred revenue reflecting cash collected in advance of registration
services revenue recognition which occurs ratably over the two- andtwo-and one-year
registration terms. Partially offsetting this amount is an increase in deferred
tax assets resulting from accelerated revenue recognition for tax purposes and
the subsequentassociated tax liabilities.
The net repayment of $14.0 million to SAIC during 1997 effectively
reduces the cash provided by operations to $27.1 million.
Investing activities used $43.4totaled $104.7 million in 1997,for the year ended December 31,
1998, of which $40.2$78.0 million was net purchases of short-term investments and
$13.6 million of long-term investments. These investments are primarily
comprised of commercial short-term investment grade securities.
Purchases of furniture and equipment ofCapital expenditures were $3.2 million and $13.1 million for the years
ended December 31, 1997 represents an increaseand December 31, 1998, respectively. These expenditures
were primarily for computer equipment. Network Solutions will continue to invest
in the back office infrastructure in advance of $1.3 million from 1996. In addition,
the Company acquired $2.4 million of equipment through a capital lease
transaction. The majority of current and anticipated future capital acquisitions
are to supportcontinued growth in the domain name
registrations and as Network Solutions designs and builds the shared
registration business and are expected
to be acquired through capital purchases as well as financed under various
operating and capital lease agreements ranging from 24 to 36 months.
The Companysystem in accordance with the Cooperative Agreement.
Network Solutions believes that the net proceeds from its IPO, combined with its existing cash balance, short-term investments and
cash flows expected from future operations will be sufficient to meet the Company'sNetwork
Solutions' capital requirements for at least the next 12 months.
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 18 months.
52ensure 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
38
5341
provide services relating to Network Solutions' domain name registration
business. Network Solutions' Year 2000 project is comprised of the following
parallel phases:
- Phase 1 -- Inventory all of Network Solutions' business systems and
processes, including the Internet domain name servers under Network
Solutions' control, telecommunications systems, facilities,
data-networking infrastructure, commercial-off-the-shelf hardware,
software and components used by its employees in order to assign
priorities to potentially impacted systems and services. This phase has
been completed;
- Phase 2 -- Assess the Year 2000 compliance of all inventoried business
systems and processes, including the Internet domain name servers under
Network Solutions' control, telecommunications systems, facilities,
data-networking infrastructure, commercial-off-the-shelf hardware,
software and components used by its employees and determine whether to
renovate or replace any non-Year 2000 compliant systems and services. The
assessment of mission critical systems has been completed however,
assessment continues as a life cycle development activity;
- Phase 3 -- Complete remediation of any non-Year 2000 compliant business
systems and processes, including the Internet domain name servers under
Network Solutions' control, telecommunications systems, facilities,
data-networking infrastructure, commercial-off-the-shelf hardware,
software and components used by its employees. Conduct procurements to
replace any other non-Year 2000 compliant business systems and processes,
telecommunications systems, facilities, data-networking infrastructure,
commercial-off-the-shelf hardware, software and components used by its
employees that won't be remediated. All remediation efforts are expected
to be completed by June 30, 1999;
- Phase 4 -- Test and validate remediated and replacement systems, if any
such remediation or replacement is required, to ensure inter-system
compliance and mission critical system functionality. The testing and
validation efforts, if any are required, are expected to be completed by
August 31, 1999;
- Phase 5 -- Deploy and implement remediated and replacement systems after
the completion of successful testing and validation. The deployment and
implementation of the remediated or replacement systems are expected to
be completed by October 30, 1999; and
- Phase 6 -- Design contingency and business continuation plans in the
event of the failure of business systems and processes,
telecommunications systems, facilities, data-networking infrastructure,
commercial-off-the-shelf hardware, software and components used by
Network Solutions' employees due to the Year 2000 millennium change. The
initial contingency and business continuation plan has been developed.
The final contingency plan will be completed during the second quarter of
1999 and it will be updated throughout the year as appropriate.
Based on its inventory and assessment, Network Solutions has found that
less than one-half of one percent of the software code of its mission critical
systems needs 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. When complete in 1999, this
enhancement effort will result in replacing portions of the existing
registration-related systems which will be procured from vendors as Year 2000
compliant and will be subjected to both component and end-to-end testing and
validation to determine the Year 2000 compliance of such systems prior to
acceptance and deployment in Network Solutions' business. This enhancement
effort is a function of Network Solutions' business growth and not a Year 2000
remediation effort.
39
42
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 of the components of its
telecommunications infrastructure and is working to identify appropriate system
testing guidelines. 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 is now in the remediation and testing phases of its
project cycle. At this time, Network Solutions believes that its incremental
remediation costs needed to make its current business systems and processes,
including the Internet domain name servers under Network Solutions' control,
telecommunications systems, facilities, data-networking infrastructure,
commercial-off-the-shelf hardware, software and components used by its employees
Year 2000 compliant are not material. While Network Solutions is incurring some
incremental costs directly relating to staff augmentation for the Year 2000
program management and technical assessment, the costs expended by Network
Solutions through December 31, 1998 are less than $250,000. Network Solutions'
expected total costs, including remediation and replacement costs, are estimated
to be between $1,000,000 and $1,500,000 over the life of the Year 2000 project.
Since portions of the mission critical "back office" and domain name
registration-related systems will generally be replaced as a function of
business growth, the labor and capital costs associated with such replacement
systems are not directly attributed to achieving Year 2000 compliance. Network
Solutions will also incur costs for extending its software testing architecture
which, in addition to testing remediated systems, will be used as a normal
component of Network Solutions quality assurance infrastructure. As such these
costs are not directly categorized as Year 2000 project costs but as normal
business development and engineering costs.
Network Solutions is contacting its hardware and software vendors,
significant suppliers, outsourcing service providers and contracting parties to
determine the extent to which Network Solutions is vulnerable to any such third
party's failure to achieve Year 2000 compliance for their 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 to
its mission critical business systems and processes, including the Internet
domain name servers under Network Solutions' control, telecommunications
systems, facilities, data-networking infrastructure, commercial-off-the-shelf
hardware, software and components used by its employees, the result could be a
failure or interruption to normal business operations. Network Solutions
believes that, with the deployment of the new "back office" and domain name
registration related systems in 1999, the potential for significant
interruptions to normal operations should be minimized. Network Solutions'
primary risks
40
43
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
call-center operations in Network Solutions' engineering facility 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 either of Network Solutions' headquarters or
engineering facilities could materially and negatively impact Network
Solutions' ability to provide data and call-center operations. Network
Solutions has conducted detailed assessments of the components of its
telecommunications infrastructure and is working to identify appropriate
system testing guidelines. As part of its technical assessment, Network
Solutions identified the compliance status of its data networking
infrastructure and developed plans for 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 are planned to be retired before the end of 1999.
As a contingency planning measure, Network Solutions has conducted a
technical assessment of the current systems and their software
applications in the event that the deployment of the new systems is
delayed beyond December 1999.
- Despite the assurances of Network Solutions' third-party suppliers,
hardware and software vendors, and outsourcing service providers
regarding the Year 2000 compliance of their products and services, the
potential exists that a Year 2000 problem relating to such third-party
suppliers, vendors and outsourcing service providers products and
services could have a material impact on Network Solutions' business.
Network Solutions is conducting monthly discussions with its mission
critical outsourcing service providers to determine the progress of their
Year 2000 compliance programs.
Although Network Solutions has found that it only has to remediate a small
portion of its software code in its internal mission critical systems and
despite Network Solutions' expectation that its enhancement effort will result
in Year 2000 compliant "back-office" and registration-related systems and
software relating to its core domain name registration services business,
Network Solutions is currently developing a business continuation contingency
plan and is performing a test on the existing core registration-related systems
that are being replaced. Network Solutions finalized its initial contingency
plan and completed testing of all existing systems. The final business
continuation plan will be completed during the second quarter of 1999 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.
41
44
Forward-Looking Statements
The foregoing Year 2000 discussion and the information contained herein is
provided as a "Year 2000 Readiness Disclosure" as defined in the Year 2000
Information and Readiness Disclosure Act of 1998 (Public Law 105-271, 112 Stat.
2386) enacted on October 19, 1998 and contains "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995. Such
statements, including without limitation, anticipated costs and the dates by
which Network Solutions expects to complete certain actions, are based on
management's best current estimates, which were derived utilizing numerous
assumptions about future events, including the continued availability of certain
resources, representations received from third parties and other factors.
However, there can be no guarantee that these estimates will be achieved, and
actual results could differ materially from those anticipated. Specific factors
that might cause such material differences include, but are not limited to, the
ability to identify and remediate all relevant systems, results of Year 2000
testing, adequate resolution of Year 2000 issues by governmental agencies,
businesses and other third parties who are outsourcing service providers,
suppliers, and vendors of Network Solutions, unanticipated system costs, the
adequacy of and ability to implement contingency plans and similar
uncertainties. The "forward-looking statements" made in the foregoing Year 2000
discussion speak only as of the date on which such statements are made, and
Network Solutions undertakes no obligation to update any forward-looking
statement to reflect events or circumstances after the date on which such
statement is made or to reflect the occurrence of unanticipated events.
ITEM 7A. 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. Not applicable.Network Solutions' exposure to market rate risk for
changes in interest rates relates primarily to the Company's investment
portfolio. Network Solutions has not used derivative financial instruments in
its investment portfolio. Network Solutions invests its excess cash in debt
instruments of the U.S. Government and its agencies, and in high-quality
corporate issuers and, by policy, limits the amount of credit exposure to any
one issuer. The Company protects and preserves its invested funds by limiting
default, market and reinvestment risk.
Investments in both fixed rate and floating rate interest earning
instruments carries a degree of interest rate risk. Fixed rate securities may
have their fair market value adversely impacted due to a rise in interest rates,
while floating rate securities may produce less income than expected if interest
rates fall. Due in part to these factors, the Company's future investment income
may fall short of expectations due to changes in interest rates or the Company
may suffer losses in principal if forced to sell securities which have declined
in market value due to changes in interest rates.
INVESTMENT RISK. The Company has invested in the equity instruments of a
privately-held, information technology company for business and strategic
purposes. This investment is included in other long-term assets and is accounted
for under the cost method which approximates fair value.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.DATA
The financial statements required by this item are set forth in a separate
section of this Annual Report on Form 10-K as indicated in the "Index to
Financial Information" appearing on page F-1 and is incorporated herein by
reference.
The supplementary data required by this item are set forth under the "Item
7 -- Management's Discussion and Analysis of Financial Condition and Results of
Operations" beginning on page 4028 hereof and are incorporated herein by
reference.
42
45
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.REGISTRANT
As permitted by General Instruction G(3) to Form 10-K, the information
relating to nominees for election as directors of Network Solutions set forth
under the caption "Election of Directors" in Network Solutions' definitive Proxy
Statement for the annual meeting of stockholders to be held on May 19, 1998,18, 1999,
which Proxy Statement will be filed with the Commission within 120 days after
the end of the Company's fiscal year ended December 31, 1997,1998, is incorporated by
reference.
The information on executive officers set forth under the caption
"Executive Officers of the Registrant" beginning on page 3422 hereof is
incorporated herein by reference.
The information relating to compliance with Section 16(a) of the Securities
Exchange Act of 1934, as amended, set forth under the caption "Security
Ownership of Certain Beneficial Owners and Management --- Section 16(a)
Beneficial Ownership Reporting Compliance" in Network Solutions' definitive
Proxy Statement for the annual meeting of stockholders to be held on May 19, 1998,18,
1999, which Proxy Statement will be filed with the Commission within 120 days
after the end of the Company's fiscal yearYear ended December 31, 1997,1998, is
incorporated by reference.
ITEM 11. EXECUTIVE COMPENSATION.COMPENSATION
As permitted by General Instruction G(3) to Form 10-K, the information
called for by this Item is incorporated by reference from the Sections entitled
"Proposal Number 1 --- Election of Directors --- Compensation of Directors,"
"Executive Compensation" and "Compensation Committee Interlocks and Insider
Participation" in Network Solutions' definitive Proxy Statement for the annual
meeting of stockholders to be held on May 19, 1998,18, 1999, which Proxy Statement will
be filed with the Commission within 120 days after the end of the Company's
fiscal year ended December 31, 1997.
53
541998.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.MANAGEMENT
As permitted by General Instruction G(3) to Form 10-K, the information
called for by this Item is incorporated by reference from the Section entitled
"Security Ownership of Certain Beneficial Owners and Management" in Network
Solutions' definitive Proxy Statement for the annual meeting of stockholders to
be held on May 19, 1998,18, 1999, which Proxy Statement will be filed with the Commission
within 120 days after the end of the Company's fiscal year ended December 31,
1997.1998.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.TRANSACTIONS
As permitted by General Instruction G(3) to Form 10-K, the information
called for by this Item is incorporated by reference from the Section entitled
"Relationship with SAIC and Certain Transactions" in the Company's definitive
Proxy Statement for the annual meeting of stockholders to be held on May 19,
1998,18,
1999, which Proxy Statement will be filed with the Commission with 120 days
after the end of the Company's fiscal year ended December 31, 1997.1998.
43
46
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.8-K
(a) Documents filed as part of this report
1. Financial Statements.
The list of financial statements set forth under the caption "Index to
Financial Information" on page F-1 is incorporated herein by reference.
2. Financial Statement Schedules.
The list of financial statement schedules set forth under the caption
"Index to Financial Information" on page F-1 is incorporated herein by
reference. All other schedules have been omitted, as the required information is
inapplicable or the information is presented in the financial statements or
related notes.
3. Exhibits
Exhibit
Number Description of DocumentEXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- ----------------- -----------------------
3(i)**3(i) Second Amended and Restated Certificate of Incorporation.
**3(ii) Second Amended and Restated Bylaws of Network Solutions,
Inc., as amended February 9,May 1, 1998.
4.1**4.1 Form of Common Stock Certificate.
4.2**4.2 Reference is made to Exhibits 3(i) and 3(ii).
10.1**10.1 Cooperative Agreement between the National Science
Foundation and Network Solutions, Inc., as amended by
Amendments Nos. 1, 2, 3 and 5.
10.2**10.2 Amendment No. 4 to the Cooperative Agreement dated September
13, 1995.
10.3**10.3 Master Services Agreement for System Management Services
dated January 21, 1997 by and between NationsBanc Services,
Inc. and Network Solutions, Inc.
10.4*+ 1996 Stock Incentive Plan and forms of agreements thereunder.
54
55
10.5**+10.4 1996 Stock Incentive Plan and forms of agreements
thereunder.
*10.5 Corporate Services Agreement between Network Solutions, Inc.
and Science Applications International Corporation.
10.6**10.6 Tax Sharing Agreement between Network Solutions, Inc. and
Science Applications International Corporation.
10.7**10.7 Registration Rights Agreement between Network Solutions,
Inc. and Science Applications International Corporation.
10.8**10.8 Noncompetition and Corporate Opportunities Agreement between
Network Solutions, Inc. and Science Applications
International Corporation.
10.9*+*+10.9 Letter Agreement dated September 16, 1996 between the
Company and Gabriel A. Battista, as amended as of September
23, 1996.
10.10**10.10 Science Applications International Corporation Employee
Stock Ownership Plan and amendments thereto.
10.11**10.11 Science Applications International Corporation 1995 Stock
Option Plan.
10.12**10.12 Letter dated September 13, 1995 regarding Amendment No. 4 to
the Cooperative Agreement.
10.13**10.13 Asset Transfer Agreement between Network Solutions, Inc. and
Science Applications International Corporation.
10.14**10.14 Amendment No. 6 to the Cooperative Agreement dated June 23,
1997.
10.15****+10.15 1997 Employee Stock Purchase Plan.
******10.16 Amendment No. 7 to the Cooperative Agreement dated December
3, 1997.
44
47
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- ----------- -----------------------
******10.17 Amendment No. 8 to the Cooperative Agreement dated February
20, 1998.
******10.18 Amendment No. 9 to the Cooperative Agreement dated March 12,
1998.
10.19++10.19 Form of Indemnification Agreement entered into by the
Company and each of its directors and officers at the Vice
President level or above.
******10.20 Deed of Lease By and Between Sugarland Business Park Limited
Partnership and Network Solutions, Inc. dated May 30, 1997
("Lease Agreement").
******10.21 Amendment No. 1 to Lease Agreement dated January 31, 1998.
****10.22 Amendment No. 10 to the Cooperative Agreement dated
September 29, 1998.
*****10.23 Amendment No. 11 to the Cooperative Agreement dated October
6, 1998.
10.24 Amendment No. 12 to the Cooperative Agreement dated March
12, 1999.
23.1 Consent of Price WaterhousePricewaterhouseCoopers LLP.
27.1 Financial Data Schedule (in electronic format only).
27.2 Restated Financial Data Schedule (in electronic format
only).
27.3 Restated Financial Data Schedule (in electronic format
only).
- ---------------
* Incorporated by reference from Network Solutions, Inc.'s Registration
Statement on Form S-1 (Registration No. 333-30705).
** Incorporated by reference from Network Solutions, Inc.'s Quarterly
Report on Form 10-Q for the quarterly period ended March 31, 1998.
*** Incorporated by reference from Network Solutions, Inc.'s Registration
Statement on Form S-8 (Registration No. 333-43821).
**** Incorporated by reference from Network Solutions, Inc.'s Quarterly Report
on Form 10-Q for the quarterly period ended September 30, 1998.
***** Incorporated by reference from Network Solutions, Inc.'s Report on Form
8-K dated October 9, 1998.
****** Incorporated by reference from Network Solutions, Inc.'s Annual Report on
Form 10-K for the fiscal year ended December 31, 1997.
+ Executive Compensation Plans and Arrangements.
We own or have rights to various copyrights, trademarks and trade names
used in our business. These include Network Solutions, Inc.(R), WorldNIC(TM),
RegistrationPlus(TM), dot com mail(TM), dot com toolkit(TM), dot com
promotions(TM), dot com people(TM) and RegistrationPlus(TM) aredot com family(TM). This Annual Report on
Form 10-K also includes trademarks, service marks and trade names of the Company.other
companies.
(b)Reports on Form 8-K
NoThe following reports on Form 8-K were filed during the last quarter ended
December 31, 1998:
On October 9, 1998, we filed a report on Form 8-K, pursuant to Item 5 on
such form, to report our entering into Amendment 11 to our Cooperative Agreement
with the United States Department of fiscal
year 1997.
55
56
SIGNATURES
Pursuant toCommerce. Amendment 11, among other things,
extends the requirements of Section 13 or 15(d)flexibility period of the Securities Exchange
ActCooperative Agreement through September
30, 2000.
On November 20, 1998, we filed a report on Form 8-K, pursuant to Item 5 on
such form, to report the resignation of our Chief Executive Officer and
Director, Gabriel A. Battista.
45
48
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934, the Company has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
Dated: March 31, 1998THE COMPANY HAS DULY CAUSED THIS REPORT TO BE SIGNED ON
ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
NETWORK SOLUTIONS, INC.
By: /s/ GABRIELMICHAEL A. BATTISTA
----------------------------
GabrielDANIELS
------------------------------------
MICHAEL A. Battista
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act ofDANIELS
CHAIRMAN OF THE BOARD AND ACTING
CHIEF EXECUTIVE OFFICER
Dated: March 30, 1999
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, as
amended, this report has been signed below by the following persons on behalf of
the Registrant and in the capacities indicated on the dates set forth below.THIS
REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT AND IN THE CAPACITIES INDICATED ON THE DATES INDICATED.
Name Title DateNAME TITLE DATE
---- ----- ----
/s/ GABRIELMICHAEL A. BATTISTADANIELS Chairman of the Board and Acting Chief March 30, 1999
- -------------------------- Chief---------------------------------- Executive Officer
and Director March 31, 1998
GabrielMICHAEL A. BattistaDANIELS
/s/ ROBERT J. KORZENIEWSKI - -------------------------- Chief Financial Officer (Principal Financial March 31, 1998
Robert30, 1999
- ---------------------------------- Officer) and Acting Chief Operating Officer
ROBERT J. Korzeniewski Financial Officer)KORZENIEWSKI
/s/ MICHAEL G. VOSLOW
- -------------------------- Vice President, Finance and Treasurer March 31, 1998
Michael G. Voslow30, 1999
- ---------------------------------- (Principal Accounting Officer)
/s/ MICHAEL A. DANIELS
- -------------------------- Chairman of the Board March 31, 1998
Michael A. DanielsG. VOSLOW
/s/ J. ROBERT BEYSTER - -------------------------- Director March 31, 199830, 1999
- ----------------------------------
J. Robert BeysterROBERT BEYSTER
/s/ CRAIG I. FIELDS - -------------------------- Director March 31, 1998
Craig30, 1999
- ----------------------------------
CRAIG I. FieldsFIELDS
/s/ JOHN E. GLANCY - -------------------------- Director March 31, 1998
John30, 1999
- ----------------------------------
JOHN E. GlancyGLANCY
/s/ J. D. HEIPT Director March 30, 1999
- ----------------------------------
J. DENNIS HEIPT
- --------------------------/s/ W. A. ROPER, JR. Director March 31, 1998
J. Dennis Heipt
/s/30, 1999
- ----------------------------------
WILLIAM A. ROPER, JR.
- -------------------------- Director March 31, 1998
William A. Roper, Jr.
/s/ STRATTON D. SCLAVOS - -------------------------- Director March 31, 1998
Stratton30, 1999
- ----------------------------------
STRATTON D. Sclavos
56
57
Name Title Date
---- ----- ----
SCLAVOS
/s/ DonaldDONALD N. Telage
- --------------------------TELAGE Director March 31, 1998
Donald30, 1999
- ----------------------------------
DONALD N. TelageTELAGE
5746
5849
INDEX TO FINANCIAL INFORMATION
Page
ReferencePAGE
REFERENCE
---------
Report of Independent Accountants......................................................... F-2, F-3Accountants........................... F- 2
1. Financial Statements:
Statements of Financial Position as of December 31, 19961997
and 1997................ F-41998............................................... F- 3
Statements of Operations for the Periods from January 1, 1995 to March
10, 1995 and March 11, 1995 to December 31, 1995, and for the Years Ended December 31,
1996, 1997 and 1997................................................. F-51998.................................... F- 4
Statements of Changes in Stockholders' Equity for the
Periods from
January 1, 1995 to March 10, 1995 and March 11, 1995 toYears Ended December 31, 1995,1996, 1997 and 1998........... F- 5
Statements of Cash Flows for the Years Ended December 31,
1996, 1997 and 1997......................... F-6
Statements of Cash Flows for the Periods from January 1, 1995 to March
10, 1995 and March 11, 1995 to December 31, 1995, and for the Years
Ended December 31, 1996 and 1997................................................. F-71998.................................... F- 6
Notes to Financial Statements.................................................... F-8Statements............................ F- 7
2. Financial Statement Schedule:
Valuation and Qualifying Accounts and Reserves................................... F-24Reserves........... F-23
F-1
59
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Stockholders of Network Solutions, Inc.
In our opinion, the financial statements listed in the index appearing on page
F-1 present fairly, in all material respects, the results of operations and cash
flows for Network Solutions, Inc. ("Predecessor") for the period from January 1,
1995 to March 10, 1995 in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audit. We conducted our audit of these statements in
accordance with generally accepted auditing standards which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for the opinion expressed
above.
As discussed in Note 1 to the financial statements, on March 10, 1995 Science
Applications International Corporation acquired the outstanding stock of the
Company. The financial statements for the periods subsequent to March 10, 1995
have been prepared on the basis of accounting arising from this acquisition. The
financial statements for the period from January 1, 1995 to March 10, 1995 are
presented on the Company's previous basis of accounting.
/s/ PRICE WATERHOUSE LLP
PRICE WATERHOUSE LLP
Falls Church, VA
February 6, 1998
F-2
6050
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of Network Solutions, Inc.
In our opinion, the financial statements listed in the index appearing on
page F-1 present fairly, in all material respects, the financial position of
Network Solutions, Inc. (a majority-owned subsidiary of Science Applications
International Corporation) at December 31, 19971998 and 1996,1997 and the results of its
operations and its cash flows for each of the yearthree years in the period ended
December 31, 1997 and 1996 and for
the period from March 11, 1995 to December 31, 19951998 in conformity with generally accepted accounting principles.
These financial statements are the responsibility of the Company's management;
our responsibility is to express an opinion on these financial statements based
on our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
As discussed in Note 1 to the financial statements, on March 10, 1995 Science
Applications International Corporation acquired the outstanding stock of the
Company. The financial statements for the periods subsequent to March 10, 1995
have been prepared on the basis of accounting arising from this acquisition. The
financial statements for the period from January 1, 1995 to March 10, 1995 are
presented on the Company's previous basis of accounting.
/s/ PRICE WATERHOUSEPRICEWATERHOUSECOOPERS LLP
PRICE WATERHOUSEPRICEWATERHOUSECOOPERS LLP
Falls Church,McLean, VA
February 6, 1998
F-35, 1999
F-2
6151
NETWORK SOLUTIONS, INC.
STATEMENTS OF FINANCIAL POSITION
DECEMBER 31, DECEMBER 31,
1996 1997 ------------- -------------
ASSETS1998
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents $ 15,540,000equivalents................................. $ 41,146,000 $ 12,862,000
Short-term investments -investments.................................... 40,200,000 118,808,000
Accounts receivable, net 12,587,000net.................................. 5,792,000 22,628,000
Prepaids and other assets 936,000assets................................. 1,005,000 4,001,000
Deferred tax asset 10,087,000asset........................................ 20,153,000 40,508,000
Restricted assets 17,453,000assets......................................... 25,873,000 ------------- ---------------
------------ ------------
Total current assets 56,603,000assets.............................. 134,169,000 198,807,000
Furniture and equipment, net 2,266,000net................................ 6,146,000 16,005,000
Long-term investments....................................... -- 13,590,000
Deferred tax asset 4,968,000asset.......................................... 8,128,000 14,831,000
Goodwill, net 2,281,000net............................................... 1,177,000 ------------- -------------634,000
------------ ------------
Total Assets $ 66,118,000 $ 149,620,000
============= =============
Assets...................................... $149,620,000 $243,867,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities $ 2,581,000liabilities.................. $ 6,426,000 $ 28,287,000
Due to parent 15,295,000parent............................................. 1,250,000 4,766,000
Income taxes payable -payable...................................... 5,042,000 5,409,000
Current portion of capital lease obligations -obligations.............. 842,000 834,000
Deferred revenue, net 19,912,000net..................................... 43,789,000 93,720,000
Internet fund liability 17,453,000liability................................... 25,873,000 ------------- ---------------
------------ ------------
Total current liabilities 55,241,000liabilities......................... 83,222,000 133,016,000
Capital lease obligations -obligations................................... 1,081,000 247,000
Long-term deferred revenue, net 9,440,000net............................. 17,662,000 ------------- -------------35,474,000
------------ ------------
Total liabilities 64,681,000liabilities................................. 101,965,000 168,737,000
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.001 par value, authorized 10,000,000
shares; none issued and outstanding in 19961997 and 19971998... -- --
Class A common stock, $.001 par value; authorized
100,000,000 shares; 3,795,0007,590,000 and 9,140,372 issued and
outstanding in 1997 -and 1998........................... 4,000 9,000
Class B common stock, $.001 par value; authorized
30,000,000 shares; 12,500,000 and 11,925,00023,850,000 issued and outstanding in
19961997 and 19971998.......................................... 12,000 12,00024,000
Additional paid-in capital 4,468,000capital................................ 56,451,000 72,331,000
Retained earnings (accumulated deficit)................... (8,812,000) 2,407,000
Accumulated deficit (3,043,000) (8,812,000)
------------- -------------other comprehensive income.................... -- 359,000
------------ ------------
Total stockholders' equity 1,437,000equity........................ 47,655,000 ------------- -------------75,130,000
------------ ------------
Total Liabilities and Stockholders' Equity $ 66,118,000 $ 149,620,000
============= =============
The accompanying notes are an integral part of these financial statements.
F-4
62
NETWORK SOLUTIONS, INC.
STATEMENTS OF OPERATIONS
PREDECESSOR COMPANY
--------------- --------------------------------------------------
JANUARY 1, 1995 MARCH 11, 1995 YEAR ENDED YEAR ENDED
TO MARCH 10, TO DECEMBER 31, DECEMBER 31, DECEMBER 31,
1995 1995 1996 1997
--------------- ---------------- ------------ ------------
Net revenue $ 1,177,000 $ 5,309,000 $ 18,862,000 $ 45,326,000
Cost of revenue 884,000 4,820,000 14,666,000 25,798,000
------------ ------------ ------------ ------------
Gross profit 293,000 489,000 4,196,000 19,528,000
Research and development expenses - - 680,000 1,653,000
Selling, general and administrative expenses 280,000 2,114,000 6,280,000 12,268,000
Interest income - - (496,000) (2,211,000)
Other expenses 9,000 52,000 - 116,000
------------ ------------ ------------ ------------
Income (loss) before income taxes 4,000 (1,677,000) (2,268,000) 7,702,000
Provision (benefit) for income taxes 48,000 (287,000) (643,000) 3,471,000
------------ ------------ ------------ ------------
Income (loss) from continuing operations (44,000) (1,390,000) (1,625,000) 4,231,000
Loss from discontinued operations,
net of income taxes (1,375,000) (28,000) - -
------------ ------------ ------------ ------------
Net income (loss) $ (1,419,000) $ (1,418,000) $ (1,625,000) $ 4,231,000
============ ============ ============ ============
BASIC EARNINGS PER SHARE:
- -------------------------
Income (loss) from continuing operations $ (0.04) $ (0.11) $ (0.13) $ 0.32
Loss from discontinued operations (1.32) - - -
------------ ------------ ------------ ------------
Net income (loss) $ (1.36) $ (0.11) $ (0.13) $ 0.32
============ ============ ============ ============
DILUTED EARNINGS PER SHARE:
- ---------------------------
Income (loss) from continuing operations $ (0.04) $ (0.11) $ (0.13) $ 0.31
Loss from discontinued operations (1.32) - - -
------------ ------------ ------------ ------------
Net income (loss) $ (1.36) $ (0.11) $ (0.13) $ 0.31
============ ============Equity........ $149,620,000 $243,867,000
============ ============
The accompanying notes are an integral part of these financial statements.
F-5statements
F-3
6352
NETWORK SOLUTIONS, INC.
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITYOPERATIONS
CLASS A CLASS B
COMMON STOCK COMMON STOCK TREASURY STOCK
--------------------------- -------------------------- ---------------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
--------------------------- -------------------------- ---------------------------YEAR ENDED DECEMBER 31,
---------------------------------------
1996 1997 1998
----------- ----------- -----------
PREDECESSOR
Balance, December 31, 1994 1,159,000 $ 12,000 110,000 $ (628,000)
PurchaseNet revenue....................................... $18,862,000 $45,326,000 $93,652,000
Cost of treasury stock - - 7,000 (30,000)
Net loss for the period from
January 1 to March 10, 1995 - - - -
---------- ----------- ---------- -----------
Balance, March 10, 1995 1,159,000 $ 12,000 117,000 $ (658,000)
========== =========== ========== ===========
- ------------------------------------------------------------------------------------------------------------------------------------
COMPANY
Purchase of outstanding common
stock by SAIC on March 10, 1995 - - 12,500,000 $ 12,000
Net loss for the period from
March 11 to December 31, 1995 - - - -
---------- ----------- ---------- ----------
Balance, December 31, 1995 - - 12,500,000 12,000
Net loss for the year ended
December 31, 1996 - - - -
---------- ----------- ---------- ----------
Balance, December 31, 1996 - - 12,500,000 12,000
Declaration of Class B dividend - - - -
Conversion of Class B Common Stock 575,000 - (575,000) -
Issuance of Class A Common Stock 3,220,000 $ 4,000 - -
Net income for the year ended
December 31, 1997 - - - -
---------- ----------- ---------- ----------
Balance, December 31, 1997 3,795,000 $ 4,000 11,925,000 $ 12,000
========== =========== ========== ==========
ADDITIONAL RETAINED TOTAL
PAID-IN EARNINGS STOCKHOLDERS'
CAPITAL (DEFICIT) EQUITY
----------- ----------- -------------
PREDECESSOR
Balance, December 31, 1994 $ 1,241,000 $ (373,000) $ 252,000
Purchase of treasury stock - - (30,000)
Net loss for the period from
January 1 to March 10, 1995 - (1,419,000) (1,419,000)revenue................................... 14,666,000 25,798,000 38,530,000
----------- ----------- -----------
Balance, March 10, 1995Gross profit...................................... 4,196,000 19,528,000 55,122,000
Research and development expenses................. 680,000 1,653,000 4,821,000
Selling, general and administrative expenses...... 6,280,000 12,268,000 37,144,000
Interest income................................... (496,000) (2,211,000) (6,303,000)
Other expenses.................................... -- 116,000 116,000
----------- ----------- -----------
Income (loss) before income taxes................. (2,268,000) 7,702,000 19,344,000
Provision (benefit) for income taxes.............. (643,000) 3,471,000 8,109,000
----------- ----------- -----------
Net income (loss)................................. $(1,625,000) $ 1,241,000 $(1,792,000) $(1,197,000)4,231,000 $11,235,000
=========== =========== ===========
- ----------------------------------------------------------------------------------------
COMPANY
Purchase of outstandingEarnings (loss) per common stock by SAIC on March 10, 1995share:
Basic........................................... $ 4,468,000 -(0.07) $ 4,480,000
Net loss for the period from
March 11 to December 31, 1995 - $(1,418,000) (1,418,000)
----------- ----------- -----------
Balance, December 31, 1995 4,468,000 (1,418,000) 3,062,000
Net loss for the year ended
December 31, 1996 - (1,625,000) (1,625,000)
----------- ----------- -----------
Balance, December 31, 1996 4,468,000 (3,043,000) 1,437,000
Declaration of Class B dividend - (10,000,000) (10,000,000)
Conversion of Class B Common Stock - - -
Issuance of Class A Common Stock 51,983,000 - 51,987,000
Net income for the year ended
December 31, 1997 - 4,231,000 4,231,000
----------- ----------- -----------
Balance, December 31, 1997 $56,451,000 $(8,812,000) $47,655,0000.16 $ 0.35
=========== =========== ===========
Diluted......................................... $ (0.07) $ 0.16 $ 0.34
=========== =========== ===========
The accompanying notes are an integral part of these financial statements.
F-6statements
F-4
6453
NETWORK SOLUTIONS, INC.
STATEMENTS OF CASH FLOWSCHANGES IN STOCKHOLDERS' EQUITY
PREDECESSOR COMPANY
--------------- --------------------------------------------
JANUARY 1, 1995 MARCH 11, 1995 YEAR ENDED YEAR ENDED
TO MARCH 10, TO DECEMBER 31 DECEMBER 31, DECEMBER 31,
1995 1995 1996 1997
--------------- --------------ACCUMULATED
CLASS A CLASS B OTHER
COMMON STOCK COMMON STOCK ADDITIONAL COMPRE- RETAINED
------------------ -------------------- PAID-IN HENSIVE EARNINGS
SHARES AMOUNT SHARES AMOUNT CAPITAL INCOME (DEFICIT)
--------- ------ ---------- ------- ----------- ----------- ------------ -------------
Cash flows from operating activities:
Balance, December 31, 1995............... -- $ -- 12,500,000 $12,000 $ 4,468,000 $ -- $ (1,418,000)
Net loss for the year ended December 31,
1996................................... -- -- -- -- -- -- (1,625,000)
--------- ------ ---------- ------- ----------- -------- ------------
Balance, December 31, 1996............... -- -- 12,500,000 12,000 4,468,000 -- (3,043,000)
Declaration of Class B dividend.......... -- -- -- -- -- -- (10,000,000)
Conversion of Class B Common Stock....... 575,000 -- (575,000) -- -- -- --
Issuance of Class A Common Stock......... 3,220,000 4,000 -- -- 51,983,000 -- --
Net income (loss) $ (1,419,000) $ (1,418,000) $ (1,625,000) $for the year ended December
31, 1997............................... -- -- -- -- -- -- 4,231,000
Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities:
Net loss from discontinued operations 1,376,000 28,000 - -
Depreciation and amortization 68,000 765,000 1,417,000 2,432,000
Provision for uncollectible accounts receivable - 124,000 3,597,000 8,082,000
Deferred income taxes - (2,221,000) (12,834,000) (13,226,000)
Change in operating assets and liabilities: - - - -
Increase in accounts receivable (161,000) (3,385,000) (12,144,000) (1,287,000)
(Increase) decrease in prepaids and other assets (36,000) 45,000 (925,000) (69,000)
(Increase) decrease in deposits (49,000) 1,053,000 - -
Increase in accounts payable and accrued liabilities 233,000 282,000 1,226,000 3,845,000
Increase (decrease) in other liabilities 8,000 (89,000) - -
Increase in income taxes payable - - - 5,042,000
Increase (decrease) in deferred revenue (30,000) 3,239,000 26,006,000 32,099,000--------- ------ ---------- ------- ----------- -------- ------------
------------ ------------ ------------
Net cash provided by (used in) operating activities (10,000) (1,577,000) 4,718,000 41,149,000
------------ ------------ ------------ ------------
Cash flows from investing activities:
Purchase of furniture and equipment (134,000) (518,000) (1,901,000) (3,240,000)
Purchase of short-term investments - - - (40,200,000)
Net investment in net assets of discontinued operations 331,000 563,000 (208,000) -
------------ ------------ ------------ ------------
Net cash provided by (used in) investing activities 197,000 45,000 (2,109,000) (43,440,000)
------------ ------------ ------------ ------------
Cash flows from financing activities:
Repayment of bank borrowings (293,000) (834,000) - -
Dividend paid - - - (10,000,000)
Capital lease obligations - - - (463,000)
Proceeds from issuanceBalance, December 31, 1997............... 3,795,000 4,000 11,925,000 12,000 56,451,000 -- (8,812,000)
Issuance of common stock - - - 52,405,000
Purchasepursuant to
stock plans............................ 775,000 1,000 -- -- 10,273,000 -- --
Tax benefit associated with stock
plans.................................. -- -- -- -- 5,607,000 -- --
Two-for-one common stock split effected
in the form of treasurya 100% stock (30,000) - -dividend... 4,570,000 4,000 11,925,000 12,000 -- -- (16,000)
Comprehensive Income:
Net transactionsincome for the year ended December
31, 1998............................. -- -- -- -- -- -- 11,235,000
Other comprehensive income, net of tax;
unrealized gains on securities....... -- -- -- -- -- 359,000 --
Comprehensive income..................... -- -- -- -- -- -- --
--------- ------ ---------- ------- ----------- -------- ------------
Balance, December 31, 1998............... 9,140,000 $9,000 23,850,000 $24,000 $72,331,000 $359,000 $ 2,407,000
========= ====== ========== ======= =========== ======== ============
COMPRE- TOTAL
HENSIVE STOCKHOLDERS'
INCOME EQUITY
----------- -------------
Balance, December 31, 1995............... $ -- $ 3,062,000
Net loss for the year ended December 31,
1996................................... -- (1,625,000)
----------- ------------
Balance, December 31, 1996............... -- 1,437,000
Declaration of Class B dividend.......... -- (10,000,000)
Conversion of Class B Common Stock....... -- --
Issuance of Class A Common Stock......... -- 51,987,000
Net income for the year ended December
31, 1997............................... -- 4,231,000
----------- ------------
Balance, December 31, 1997............... -- 47,655,000
Issuance of common stock pursuant to
stock plans............................ -- 10,274,000
Tax benefit associated with SAIC - 2,371,000 12,926,000 (14,045,000)stock
plans.................................. -- 5,607,000
Two-for-one common stock split effected
in the form of a 100% stock dividend... -- --
Comprehensive Income:
Net income for the year ended December
31, 1998............................. 11,235,000 11,235,000
Other comprehensive income, net of tax;
unrealized gains on securities....... 359,000 359,000
-----------
Comprehensive income..................... $11,594,000 --
=========== ------------
------------ ------------ ------------
Net cash provided by (used in) financing activities (323,000) 1,537,000 12,926,000 27,897,000
------------ ------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents (136,000) 5,000 15,535,000 25,606,000
Cash and cash equivalents, beginning of period 136,000 - 5,000 15,540,000
------------ ------------ ------------ ------------
Cash and cash equivalents, end of periodBalance, December 31, 1998............... $ - $ 5,000 $ 15,540,000 $ 41,146,000
============ ============ ============75,130,000
============
The accompanying notes are an integral part of these financial statements.
F-7statements
F-5
65
Network Solutions, Inc.
Notes to Financial Statements54
NETWORK SOLUTIONS, INC.
STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
-------------------------------------------
1996 1997 1998
------------ ------------ -------------
Cash flows from operating activities:
Net income (loss)........................... $ (1,625,000) $ 4,231,000 $ 11,235,000
Adjustments to reconcile net income (loss)
to net cash provided by operating
activities:
Depreciation and amortization............ 1,417,000 2,432,000 3,754,000
Provision for uncollectible accounts
receivable............................. 3,597,000 8,082,000 2,247,000
Deferred income taxes.................... (12,834,000) (13,226,000) (27,317,000)
Tax benefit associated with stock
plans.................................. -- -- 5,607,000
Changes in operating assets and
liabilities:
Increase in accounts receivable........ (12,144,000) (1,287,000) (19,083,000)
Increase in prepaids and other
assets.............................. (925,000) (69,000) (2,996,000)
Increase in accounts payable and
accrued liabilities................. 1,226,000 3,845,000 21,861,000
Increase in income taxes payable....... -- 5,042,000 367,000
Increase in deferred revenue........... 26,006,000 32,099,000 67,743,000
------------ ------------ -------------
Net cash provided by operating
activities....................... 4,718,000 41,149,000 63,418,000
------------ ------------ -------------
Cash flows from investing activities:
Purchase of furniture and equipment......... (1,901,000) (3,240,000) (13,070,000)
Purchase of short-term investments, net..... -- (40,200,000) (77,990,000)
Purchase of long-term investments........... -- -- (13,590,000)
Net investment in net assets of discontinued
operations............................... (208,000) -- --
------------ ------------ -------------
Net cash used in investing
activities....................... (2,109,000) (43,440,000) (104,650,000)
------------ ------------ -------------
Cash flows from financing activities:
Net transactions with SAIC.................. 12,926,000 (14,045,000) 3,516,000
Proceeds from issuance of common stock...... -- 52,405,000 --
Dividend paid............................... -- (10,000,000) --
Issuance of common stock pursuant to stock
plans.................................... -- -- 10,274,000
Repayment of capital lease obligations...... -- (463,000) (842,000)
------------ ------------ -------------
Net cash provided by financing
activities....................... 12,926,000 27,897,000 12,948,000
------------ ------------ -------------
Net increase (decrease) in cash and cash
equivalents................................. 15,535,000 25,606,000 (28,284,000)
Cash and cash equivalents, beginning of
year........................................ 5,000 15,540,000 41,146,000
------------ ------------ -------------
Cash and cash equivalents, end of year........ $ 15,540,000 $ 41,146,000 $ 12,862,000
============ ============ =============
The accompanying notes are an integral part of these financial statements
F-6
55
NETWORK SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 1 - ORGANIZATION-- COMPANY AND BASISSUMMARY OF PRESENTATIONSIGNIFICANT ACCOUNTING POLICIES
Network Solutions Inc. ("the Company") currently acts as the exclusive registry and registrar of
Internet domain names within the .com, .org, .net and .edu top level domains
("TLDs") pursuant to athe Cooperative Agreement with the National
Science Foundation ("NSF") (Note 3).Department of Commerce. Domain
names are used to identify a unique site or presence on the Internet. As
registry and registrar tofor these TLDs, the Companytop level domains, Network Solutions registers
new domain names and is responsible for the maintenance and
dissemination of the master file of
domain names through daily updates to the Internet. The CompanyNetwork Solutions also
provides enterprise network consulting services,Internet Technology Services, focusing on network engineering, network
and systems security and network management solutions for commercial customers.
The Company was acquired by Science Applications International Corporation
("SAIC") on March 10, 1995 (the "acquisition"). Prior to the acquisition of the
Company by SAIC, the Company's business included commercial and government
contracts awarded to the Company on a competitive basis, including government
contracts that were awarded to the Company partially upon the Company's then
minority-owned status. The contracts which had been awarded to the Company based
partially on the Company's then minority-owned status were transferred into a
separately-owned entity prior to the acquisition of the Company by SAIC.
In November 1995, SAIC adopted a plan to transfer the Company's remaining
government-based business to SAIC in order to enable the Company to focus on the
growth of its commercial business, which includes registration and consulting
services. This transfer was effective as of February 1996. The operating results
of both the minority-based government contract business and the remaining
government-based business, are reflected as discontinued operations in the
financial statements of the Company for all periods presented (Note 13). The
commercial operations, as defined, are reflected as continuing operations in the
financial statements of the Company for all periods presented.
The financial statements for periods subsequent to March 10, 1995 are presented
on the new basis of accounting arising from the acquisition (Note 9). The
financial statements for the period from January 1, 1995 to March 10, 1995 are
presented on the Company's previous basis of accounting. Subsequent to the
acquisition, the results of continuing and discontinued operations include
allocations by SAIC of: (i) costs for administrative functions and services
performed on behalf of the continuing and discontinued operations of the Company
by centralized staff groups within SAIC, (ii) SAIC's general corporate expenses,
(iii) pension and other retirement benefit costs, and (iv) cost of capital
(Notes 8, 9 and 12). Only costs directly attributable to the Company's
government-based business that were not incurred by the Company subsequent to
the transfer of this business to SAIC have been included in discontinued
operations.
F-8
66
NOTE 2 - RECAPITALIZATION AND INITIAL PUBLIC OFFERING
On June 26, 1997, the Board of Directors amended the Certificate of
Incorporation to provide for two classes of common stock, designated as Class A
and Class B. The holders of Class A and Class B common stock generally have
identical rights except that holders of Class A common stock are entitled to one
vote per share while holders of Class B common stock are entitled to ten votes
per share. Each share of Class B common stock is convertible at the holder's
option into one share of Class A common stock.
On October 1, 1997, the Company completed an initial public offering (the "IPO")
of 3,795,000 shares of its $.001 par value Class A common stock, including
495,000 shares resulting from the exercise of certain overallotment provisions.
The Company's net proceeds from the IPO, including overallotment, were $52.4
million based on the Company's direct sale of 3,220,000 shares of Class A common
stock.
Prior to the offering, the Company was a wholly-owned subsidiary of SAIC. In
conjunction with the IPO, SAIC converted 575,000 shares (including 75,000
overallotment shares) of Class B common stock into 575,000 shares of Class A
common stock and directly sold the shares as a selling stockholder. Upon
completion of the offering, SAIC owned 100% of the outstanding Class B common
stock representing 75.9% of the Company's equity and 96.9% of the combined
voting power of the Company's outstanding Class B and Class A common stock.
On August 21, 1997, the Company's Board of Directors declared a $10,000,000
dividend to be paid to SAIC upon consummation of the IPO. This dividend was paid
to SAIC on October 1, 1997.
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NSFsolutions.
Cooperative Agreement
In December 1992, the CompanyNetwork Solutions entered into the Cooperative Agreement
with the NSFNational Science Foundation under which the CompanyNetwork Solutions was to
provide Internet domain name registration services for five TLDs:top level domains:
.com, .org, .net, .edu and .gov. These "registration
services"registration services include the initial
two year domain name registration and renewal,annual re-registration, and throughout the
registration term, maintenance of and unlimited modifications to individual
domain name records and dissemination of records through updates to the Internet.master file of domain names. The
Cooperative Agreement became effective January 1, 1993. It includesincluded a
three-month phase-in period, a five-year operational period, (commencingcommencing April 1,
1993 and ending March 31, 1998),1998, and a six-month "flexibility period"flexibility period through
September 30, 1998. TheEffective September 9, 1998, the Department of Commerce took
over the administration of the Cooperative Agreement is
subjectfrom the National Science
Foundation. In October 1998, the Cooperative Agreement was amended to review by the NSF and may be terminated by the NSF at any time at
its discretion or by mutual agreement. The NSF has stated that it will not be
re-awarding a cooperative agreement at the end ofextend the
flexibility period.period until September 30, 2000.
The original terms of the Cooperative Agreement provided for a cost
reimbursement plus fixed-fee contract (with aan initial fee of 8%). Effective
September 14, 1995, the NSFNational Science Foundation and the CompanyNetwork Solutions
amended the Cooperative Agreement to require the CompanyNetwork Solutions to begin charging
end users a services fee of $50 per year for each domain name in the .com, .org
and .net TLDs. Registrants paytop level domains. Until April 1, 1998, registrants paid a services fee
of $100 for two years of domain name services upon each initial registration and
an annual renewalre-registration fee of $50 per year thereafter (collectively "registration
fees").thereafter. The NSFNational Science
Foundation paid the registration fees to the Company for domain names within the .edu and .gov
TLDstop level domains through March 31, 1997. Commencing April 1, 1997, the CompanyNetwork
Solutions agreed with the NSFNational Science Foundation to provide domain name
services within the .edu and .gov TLDstop level domains free of charge. As of
October 1, 1997, the CompanyNetwork Solutions no longer registers or administers domain
names in the .gov TLD.
F-9
67top level domain.
Under the terms of the September 14, 1995 amendment to the Cooperative
Agreement, 30% of the registration fees collected by the Company isNetwork Solutions was
required to be set aside for the enhancement of the intellectual infrastructure
of the Internet ("set(set aside funds")funds) and, as such, iswas not recognized as revenue by
the
Company. The CompanyNetwork Solutions. Network Solutions has reflected these set aside funds, along
with the appropriate percentage of net accounts receivable (Note 4)3), as
restricted assets and has recorded an equivalent, related current liability.
The Company maintainsNetwork Solutions maintained the cash received relating to the set aside funds
in a separate interest bearing account. This restricted cash at December 31, 1996 and 1997 was approximately
$13,049,000 and $23,512,000, respectively. The set aside funds, plus any interest
earned, are intended to bewere disbursed at the direction of the NSF. In
November 1997, the CompanyNational Science Foundation. As
of December 31, 1998, Network Solutions had cumulatively disbursed $23 million out of this fund to the NSF at
its direction.
Future collection or disbursement of theseall set aside
funds will havecollected and associated interest earned for a total of $62.3 million to
the National Science Foundation at their direction. The restricted cash at
December 31, 1997 and 1998 was approximately $23,512,000 and $0, respectively.
F-7
56
NETWORK SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 1 -- COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
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 re-registration fee of $35 per year
thereafter. This amendment had no
significant effect on the Company's business, net financial position, or results
of operations (Note 15).revenue currently recognized on
each registration, $70 for initial registrations and $35 for re-registrations,
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 does not change, the amount charged to customers declined.
For purposes of the Company'sNetwork Solutions' statements of cash flows, amounts
relating to these restricted assets and the Internet fund liability have been
excluded in their entirety.
Revenue Recognition
Prior to September 14, 1995, net revenue was recognized under the Cooperative
Agreement on the basis of direct cost plus allowable indirect costs and the
earned portion of the fee. Since September 14, 1995, registrationRegistration fees charged to end users for registration services provided
by the Company have beenNetwork Solutions are recognized on a straight-line basis over the life of
the registration term, two years for initial registrations and one year for
renewals. The Companyre-registrations. Network Solutions records revenue net of an estimated
provision for uncollectible accounts receivable (Note 4)3).
Substantially all of the Company's consulting servicesNetwork Solutions' Internet Technology Services
revenue is derived from professional services which are generally provided to
clients on a "timetime and expense"expense basis and is recognized as services are performed.
NetOne Internet Technology Services' customer contributed approximately 20% of
net revenue from two customers approximated 45% and 21% for the period from
January 1, 1995 to March 10, 1995; 40% and 21% for the period from March 11,
1995 to December 31, 1995, and 20% and 0% for the year ended December 31, 1996. One of these customers was the NSF, whose impact on the above percentages of
revenue was reflective of activity prior to the September 14, 1995 amendment of
the Cooperative Agreement. During the yearyears ended
December 31, 1997 and 1998, there were no customers which individually
represented more than 5%4% of net revenues.
Deferred Revenue
Deferred revenue primarily represents the unearned portion of revenue
related to the unexpired term of registration fees, net of an estimate for
uncollectible accounts receivable (Note 4)3).
Cash and Cash Equivalents
The CompanyNetwork Solutions considers all highly liquid investments with an original
maturitiesmaturity of ninety daysthree months or less to be cash equivalents.
F-10Short and Long-Term Investments
Short and long-term investments in marketable securities are classified as
available-for-sale. All long-term investments in marketable securities mature
within two years. At December 31, 1997 and 1998, the fair value of short and
long-term investments approximated cost. Fair value is determined based upon the
quoted market prices of the securities as of the balance sheet date.
At December 31, 1998, Network Solutions also held equity interests in a
privately-held, information technology company totaling $4,200,000. This
investment is included in other long-term assets and is accounted for under the
cost method which approximates fair value.
F-8
6857
NETWORK SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 1 -- COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
Financial Instruments
The recorded value of the Company'sNetwork Solutions' financial instruments, which
include short-termshort and long-term investments, accounts receivable and accounts
payable, approximates market value. Concentration of credit risks with respect
to registration receivables is limited due to the wide variety and number of
customers, as well as their dispersion across geographic areas. The CompanyNetwork
Solutions has no derivative financial instruments.
Furniture and Equipment
Furniture and equipment are stated at cost. Depreciation on furniture,
office and computer equipment is calculated principally using a
declining-balance method over the useful lives of three to seven years.
Equipment under capital leases is amortized using a declining-balance method
over the shorter of the assets' useful lives or lease term, ranging from two to
three years. Leasehold improvements are amortized using the straight-line method
over the shorter of the lease term or the estimated useful lives of the assets,
generally six years.
Goodwill
Goodwill represents the excess of the purchase cost over the fair value of
net assets acquired in theNetwork Solutions' acquisition by Science Applications
International Corporation, or SAIC, in 1995 and is amortized over five years
using the straight-line method. Amortization expense of $580,000, $715,000, $686,000 and
$686,000$543,000 for the period from March 11, 1995 to December 31, 1995, and the years ended December 31, 1996, 1997 and 1997,1998, respectively, was
included in selling, general and administrative expenses. In connection with
Network Solutions' initial public offering during 1997, SAIC sold a portion of
its interest in Network Solutions resulting in a corresponding reduction of
goodwill in the amount of $418,000 which was charged to additional paid-in
capital.
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 will be 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.
Software Development Costs
Effective January 1, 1996, researchResearch and development costs are expensed as incurred. Research and development costs incurred for all periods presented
prior to January 1, 1996 were reimbursed to the Company by direct charges to
contracts and are included in cost of revenue for those periods. In accordance with
Statement of Financial Accounting Standards ("SFAS")(SFAS) No. 86, "Accounting for the
Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed", the CompanyNetwork
Solutions has not capitalized any significant software development costs as of
December 31, 1997.1998.
Income Taxes
Deferred taxes are accounted for under SFAS No. 109, "Accounting for Income
Taxes," whereby deferred tax assets and liabilities are recognized for the
expected future tax consequences of
F-9
58
NETWORK SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 1 -- COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
temporary differences between financial statement reporting and income tax
purposes. A valuation allowance is recorded if it is "more likely than not" that
some portion of or all of a deferred tax asset will not be realized.
For the period from the acquisition until the IPO, the CompanyUntil Network Solutions' initial public offering, Network Solutions filed
tax returns as part of SAIC's consolidated tax group. Tax expense during this
period has been determined as if the CompanyNetwork Solutions was a separate taxpayer and
was charged to the
CompanyNetwork Solutions by SAIC. Effective October 1, 1997, the CompanyNetwork
Solutions is no longer part of SAIC's consolidated tax group for federal income
tax purposes and will prepareprepares its income tax returns as a separate entity.
F-11
69
Stock Based Compensation
The CompanyNetwork Solutions accounts for its stock option and employee stock purchase
plans in accordance with the provisions of Accounting Principles Board Opinion
("APB")(APB) No. 25, "Accounting for Stock Issued to Employees". No compensation cost
has been recognized by the CompanyNetwork Solutions for its employee stock plans. The SFAS
No. 123, "Accounting for Stock-Based Compensation", provides an alternative
accounting method to APB No. 25 and requires additional pro forma disclosures
(Note 12)11). The CompanyNetwork Solutions expects to continue to account for its employee
stock plans in accordance with the provisions of APB No. 25.
Segment Data
During 1998, Network Solutions adopted SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information". SFAS No. 131 supersedes SFAS
No. 14, "Financial Reporting for Segments of a Business Enterprise", replacing
the "industry segment" approach with the "management" approach. The management
approach designates internal reporting that is used by management for making
operating decisions and assessing performance as the source of an entity's
reportable segments. SFAS No. 131 also requires disclosures about products and
services, geographic areas and major customers. The adoption of SFAS No. 131 did
not affect results of operations, financial position or segment information
disclosures of Network Solutions due to the nature and relative magnitude of its
business activities.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make reasonable estimates
and assumptions, based upon all known facts and circumstances that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements. Actual results could
differ from those estimates.
Newly Issued Accounting Standards
Effective December 31, 1997, the Company adopted SFAS No. 128, "Earnings per
Share", which replaces the presentation of primary earnings per share ("EPS")
with a presentation of basic EPS and necessitates the dual presentation of basic
and diluted EPS on the face of the statement of operations. In addition, during
FebruaryMarch 1998, the Company adopted Securities and Exchange Staff Accounting
Bulletin ("SAB") No. 98,American Institute of Certified Public Accountants
issued Statement of Position 98-1 (SOP 98-1), "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use." This standard
requires companies to capitalize qualifying computer software costs which among other things, rescinded SAB No. 83 and
thus eliminates the impact of common share equivalents granted by the Company at
prices below the IPO offering priceare
incurred during the twelve months precedingapplication development stage and amortize them over the
initial IPO filing and through the filing's effective date. All prior period EPS
data have been restated as required by SFAS No. 128 and SAB No. 98. See Note 11
for the reconciliation of the numerator and denominator used in the basic and
diluted EPS computations.
In June 1997, SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information" was issued. SFAS No. 131 establishes standards for
reporting information about operating segments in annual and interim financial
statements issued to stockholders. It also establishes standards for related
disclosures about products and services, geographic areas, and major customers.
SFAS No. 131software's estimated useful life. SOP 98-1 is effective for fiscal years
beginning after December 15, 1998.
F-10
59
NETWORK SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 1 -- COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
Network Solutions is currently evaluating the impact of SOP 98-1 on its
financial statements and related disclosures.
NOTE 2 -- RECAPITALIZATION AND INITIAL PUBLIC OFFERING
On June 26, 1997, the Board of Directors amended the Certificate of
Incorporation to provide for two classes of common stock, designated as Class A
and willClass B. The holders of Class A and Class B common stock generally have
no impactidentical rights except that holders of Class A common stock are entitled to one
vote per share while holders of Class B common stock are entitled to ten votes
per share. Each share of Class B common stock is convertible at the holder's
option into one share of Class A common stock.
On October 1, 1997, Network Solutions completed an initial public offering
of 7,590,000 shares of its $.001 par value Class A common stock, including
990,000 shares resulting from the exercise of certain overallotment provisions.
Network Solutions' net proceeds from the initial public offering, including
overallotment, were $52.5 million based on Network Solutions' direct sale of
6,440,000 shares of Class A common stock.
Prior to the Company's resultsoffering, Network Solutions was a wholly-owned subsidiary of
operations, financial position
or cash flows.SAIC. In conjunction with the initial public offering, SAIC converted 1,150,000
shares (including 150,000 overallotment shares) of Class B common stock into
1,150,000 shares of Class A common stock and directly sold the shares as a
selling stockholder. Upon completion of the offering, SAIC owned 100% of the
outstanding Class B common stock representing 75.9% of Network Solutions' equity
and 96.9% of the combined voting power of Network Solutions' outstanding Class B
and Class A common stock.
On August 21, 1997, Network Solutions' Board of Directors declared a
$10,000,000 dividend to be paid to SAIC upon consummation of the initial public
offering. This dividend was paid to SAIC on October 1, 1997.
NOTE 4 -3 -- ACCOUNTS RECEIVABLE
Accounts receivable consist of the following amounts as of December 31:
1996 1997 ----------------- -----------------1998
----------- -----------
Billed $ 27,430,000Billed................................................ $24,483,000 Unbilled 5,000,000$42,679,000
Unbilled.............................................. 1,526,000 ----------------- -----------------5,695,000
----------- -----------
Total accounts receivable before
allowances 32,430,000allowances............................... 26,009,000 48,374,000
Less --- Allowance for doubtful accounts (15,439,000)uncollectible accounts.......... (17,856,000) -(25,746,000)
-- Accounts receivable allocable to 30% NSF set
aside (Note 3) (4,404,000)1).............................. (2,361,000) ----------------- -------------------
----------- -----------
Accounts receivable, net $ 12,587,000net.............................. $ 5,792,000 ================= =================$22,628,000
=========== ===========
F-12
70
Unbilled receivables consist of registration fees and time and material
contract costs which have been incurred but which have not yet been billed.
Under the
Cooperative Agreement, 30% of collected registration fees will be set aside for
disbursement at the direction of the NSF.
In accounting for registration fees, the CompanyNetwork Solutions initially records
the gross amount of the registration fee to accounts receivable and deferred
revenue. The allowance for estimated uncollectible accounts is recorded against
both accounts receivable and deferred revenue balances (see Note 1 for
F-11
60
NETWORK SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 3 for-- ACCOUNTS RECEIVABLE -- (CONTINUED)
treatment of the 30% NSFNational Science Foundation set aside). From the deferred
revenue and allowance balances, Network Solutions records revenue and its
provision for uncollectible accounts on a straight-line basis over the
registration term. Effective April 1, 1998, Network Solutions consolidates and
then amortizes only the net deferred revenue balance the Company recordsas net revenue on a straight-line basis over the
registration term.
The provision for uncollectible accounts receivable, which iswas separately
recorded on a
straight-line basis over the registration term and deducted from gross registration fees in determining net
registration revenue, was $124,000 for the
period from March 11, 1995 to December 31, 1995$3,597,000, $7,782,000 and $3,597,000 and $7,782,000,$2,168,000, respectively,
for the years ended December 31, 1996, 1997 and 1997.1998. An additional $300,000 and
$79,000 of bad debt expense was recorded in 1997 and 1998, respectively, for the
write-off of consulting servicesInternet Technology Services receivables. The Company'sNetwork Solutions'
allowance for uncollectible accounts receivable is associated solely with its
registration services business. The Company believes it has been necessary to establish its provision for uncollectible accounts
receivable is primarily due to the large number of individuals and corporations
that have registered multiple domain names with the apparent intention of
resellingtransferring registration for such names at a profit. The Company'sNetwork Solutions'
experience has been that, in contrast to other registrants, such speculative
resellers have a higher tendency ofto default on their registration fees.fees,
returning the names into the available pool for subsequent registration.
NOTE 5 -4 -- FURNITURE AND EQUIPMENT
Furniture and equipment consist of the following amounts as of December 31:
1996 1997 1998
----------- -----------
Furniture and office equipment $ 879,000equipment........................ $ 476,000 $ 833,000
Computer equipment 4,033,000equipment.................................... 8,619,000 19,400,000
Leasehold improvements 234,000improvements................................ 288,000 2,018,000
----------- -----------
Furniture and equipment, at cost 5,146,000cost.................... 9,383,000 22,251,000
Less: Accumulated depreciation and amortization (2,880,000)amortization....... (3,237,000) (6,246,000)
----------- -----------
Furniture and equipment, netnet.......................... $ 2,266,000 $ 6,146,000 $16,005,000
=========== ===========
The above tableFurniture and equipment includes $2,386,000 of computer equipment acquired
during 1997 under capital lease agreements. Amortization expense related to
capital leases totaled $915,000 and $1,028,000 in 1997.1997 and 1998, respectively.
Total depreciation and amortization expense for the periods from January 1, 1995 to March 10, 1995 and March 11, 1995 to December
31, 1995 and the years ended December 31,
1996, 1997 and 19971998 was $68,000, $185,000,
$702,000, $1,746,000 and $1,746,000,$3,211,000, respectively.
F-13
71
NOTE 6 -5 -- ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses consist of the following amounts as
of December 31:
1996 1997 1998
---------- ---------------------
Accounts payable $1,054,000payable........................................ $1,896,000 $ 7,647,000
Accrued expenses 1,412,000expenses........................................ 2,384,000 16,717,000
Accrued payroll 115,000payroll......................................... 2,146,000 3,923,000
---------- ---------------------
Total accounts payable and accrued expenses $2,581,000expenses... $6,426,000 $28,287,000
========== =====================
F-12
61
NETWORK SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 7 -6 -- LEASES
Future minimum lease payments, including fixed escalation increases for
office space and equipment under capital and operating leases with initial or
remaining noncancelable lease terms in excess of one year as of December 31,
19971998 are:
Capital Operating
Year Ending DecemberCAPITAL OPERATING
YEAR ENDING DECEMBER 31: Leases Leases
- ------------------------------------------------------------------------------------------------LEASES LEASES
------------------------ ---------- -----------
19981999.................................................... $ 957,000885,000 $ 3,437,000
1999 885,000 3,438,000
20003,778,000
2000.................................................... 252,000 2,806,000
2001 - 1,818,000
2002 - 1,427,000
-----------3,099,000
2001.................................................... -- 1,935,000
2002.................................................... -- 1,452,000
---------- -----------
Total minimum lease payments 2,094,000 $12,926,000payments.................. 1,137,000 $10,264,000
===========
Less: Amounts representing interest (171,000)
-----------interest..................... (56,000)
----------
Present value of minimum lease payments 1,923,000payments................. 1,081,000
Less: Current portion (842,000)
-----------portion................................... (834,000)
----------
Long-term portion of capital lease obligationsobligations.......... $ 1,081,000
===========247,000
==========
In December 1992, the CompanyNetwork Solutions entered into a lease agreement for
the Company'sNetwork Solutions' headquarters in Herndon, Virginia. Subsequent to the
acquisition, SAIC re-negotiated the lease with the landlord whereby SAIC posted a $1,000,000
letter of credit and then subleased the facilities to the CompanyNetwork Solutions under a lease
expiring November 2002. During 1997, the CompanyNetwork Solutions leased a second facility
in Herndon whose lease term expires in July 2002.
LeaseOperating lease expense related to the continuing operations for the periods from January
1, 1995 to March 10, 1995 and March 11, 1995 to December 31, 1995, and for the
years ended December 31,1996 and 1997 was $36,000, $342,000, $924,000 and
$2,188,000, respectively. Lease expense incurred by the discontinued operations
for the periods from January 1, 1995 to March 10, 1995 and March 11, 1995 to
December 31, 1995 was $208,000 and $328,000, respectively. Subsequent to March
10, 1995, the Company generated rental income from subleases in 1995 of
$135,000, and $187,000 and $291,000 for the years ended December 31, 1996, 1997 and
1998 was $924,000, $2,188,000 and $3,533,000, respectively. Network Solutions
generated rental income from subleases of $187,000, $291,000 and $215,000 for
the years ended December 31, 1996, 1997 and 1998, respectively.
F-14
72
NOTE 8 -7 -- INTEREST EXPENSE AND INCOME
Interest expense reflected in continuing operations and discontinued operations
for the period January 1, 1995 to March 10, 1995 was $9,000 and $51,000,
respectively. Interest charges prior to the acquisition have been reflected in
continuing and discontinued operations based on the debt balances associated
with each of the continuing and discontinued operations. In addition, interest
expense of $52,000 and $164,000 for the period from March 11, 1995 to December
31, 1995 was allocated by SAIC to the Company's continuing operations and
discontinued operations, respectively, based upon SAIC's cost of capital
calculation.
For the year ended December 31, 1996, interest income of $496,000 was
allocated by SAIC based upon the cost of capital calculation. From its
acquisition by SAIC in March 1995 until December 1996, the CompanyNetwork Solutions
participated in SAIC's centralized cash management system whereby cash received
from operations was transferred to SAIC's centralized cash accounts and cash
disbursements were funded from such centralized cash accounts. Accordingly, the
SAIC cost of capital formula provided for charges and credits to the CompanyNetwork
Solutions based upon management of certain assets, including accounts receivable
and fixed assets. Such amounts are not necessarily indicative of the cost that
would have been incurred if the CompanyNetwork Solutions had been operated as a separate
entity.
Effective January 1, 1997, the CompanyNetwork Solutions was no longer subject to
SAIC's cost of capital calculation in connection with the CompanyNetwork Solutions
fulfilling its own treasury function. Interest paid for the periods from January 1, 1995 to March 10, 1995
and March 11, 1995 to December 31,1995 and for the years ended December
31, 1996, 1997 and 19971998 was $0, $103,000, $0$116,000 and $116,000, respectively.
NOTE 9 -8 -- TRANSACTIONS WITH SAIC
Under the terms of the acquisition agreement, the CompanyNetwork Solutions was acquired by SAIC on March 10, 1995 in a
stock-for-stock transaction accounted for as a purchase.
The fair market value of theF-13
62
NETWORK SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 8 -- TRANSACTIONS WITH SAIC stock exchanged for the outstanding stock of
the Company was approximately $3.9 million. The acquisition agreement provided
for certain purchase adjustments and related additional stock issuance payments
of approximately $600,000. After reflecting certain purchase accounting
adjustments, the net assets included on the opening balance sheet were as
follows:
Current assets $ 929,000
Furniture and equipment 734,000
Goodwill 3,576,000
Other non-current assets 1,047,000
----------
6,286,000
Current liabilities 1,625,000
Net liabilities of discontinued operations 181,000
----------
Net assets acquired at March 11, 1995 $4,480,000
==========
-- (CONTINUED)
The financial statements as of and for the period from March 11, 1995 to
December 31, 1995 and for the years ended December 31, 1996, 1997 and
19971998 include significant transactions with other SAIC business units involving
functions and services (such as cash management, tax administration, accounting,
legal, data processing and employee benefit plans) that were provided to the CompanyNetwork
Solutions by centralized SAIC organizations. The costs of these functions and
services have been directly charged and/or allocated to the CompanyNetwork Solutions using
methods that SAIC management believes are reasonable; primarily a percentage of
budgeted administrative and overhead costs. Such charges and allocations are not
necessarily indicative of the costs that would have been incurred if the CompanyNetwork
Solutions had been a separate entity. Through August 9, 1996, the amounts
allocated by SAIC to the CompanyNetwork Solutions included both administrative and overhead
costs which are included in selling, general and
F-15
73 administrative expenses and
cost of revenue, respectively. Effective August 10, 1996, SAIC stopped
allocating costs based generally upon pro rata labor and began assessing the CompanyNetwork
Solutions for corporate services provided by SAIC at a fee equal to 2.5% of
annual net revenue. The corporate services fee is negotiated annually and was
2.5% and 1.5% during 1997 and 1998, respectively. The agreement may be
terminated by either party upon 180 daysdays' prior written notice.
Amounts charged and allocated to the CompanyNetwork Solutions for these functions and
services for the period from March 11, 1995 to December 31, 1995 and the years ended December 31, 1996, 1997 and 19971998 were $516,000, $1,196,000,
$1,126,000 and $1,126,000,$1,447,000, respectively, and are principally included in
selling, general and administrative expenses. Additionally, certain interest
charges/credits were allocated by SAIC to the CompanyNetwork Solutions (Note 8)7).
Sales as a subcontractor to SAIC for the period from March 11, 1995 to December
31, 1995 and the years ended December 31, 1996,
1997 and 19971998 were $509,000,
$1,505,000, $2,445,000 and $2,445,000,$525,000, respectively. In
addition, because the CompanyNetwork Solutions was included in SAIC's consolidated tax
returns for periods from acquisition until the IPO, the Companyinitial public offering, Network
Solutions was obligated to make payment for its tax liability to SAIC in
accordance with the tax sharing arrangement (Note 10)9). The due to parent balance
represents the cumulative net activity of all transactions between the
CompanyNetwork
Solutions and SAIC. The CompanyNetwork Solutions reflects this activity in the statementstatements
of cash flows on a net basis because of the quick turnover, the large amounts
and the short maturities of these related party cash transactions.
NOTE 10 -9 -- PROVISION FOR INCOME TAXES
The results of the CompanyNetwork Solutions since its acquisition by SAIC until its
IPO are to
beinitial public offering were included in SAIC's consolidated tax returns.
The tax expense allocation is
set forth in Note 3. Subsequent to the IPO, the Companyinitial public offering, Network Solutions is no longer part
of SAIC's consolidated tax group for federal income tax purposes and will prepareprepares
its income tax returns as a separate entity.
F-14
63
NETWORK SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 9 -- PROVISION FOR INCOME TAXES -- (CONTINUED)
The provision for (benefit) from income taxes charged to continuing operations
consists of the following:
For the Period
1995
------------------------------ Year Ended Year Ended
January 1 to March 11 to DecemberYEAR ENDED DECEMBER 31,
December 31,
March 10 December 31------------------------------------------
1996 1997 ------------1998
------------ ------------ ------------
Current:
Federal $ 40,000 $ 1,521,000Federal.............................. $ 10,171,000 $ 13,931,000 State 8,000 311,000$ 29,559,000
State................................ 2,020,000 2,766,000 ------------5,867,000
------------ ------------ ------------
Total current provision 48,000 1,832,000provision...... 12,191,000 16,697,000 ------------35,426,000
------------ ------------ ------------
Deferred:
Federal - (1,759,000)Federal.............................. (10,716,000) (11,035,000) State - (360,000)(22,792,000)
State................................ (2,118,000) (2,191,000) ------------(4,525,000)
------------ ------------ ------------
Total deferred (benefit) - (2,119,000)..... (12,834,000) (13,226,000) ------------(27,317,000)
------------ ------------ ------------
Provision for (benefit) from income
taxes $ 48,000 $ (287,000)taxes................................ $ (643,000) $ 3,471,000 ============$ 8,109,000
============ ============ ============
F-16
74
Deferred tax assets are comprised of the following temporary differences as
of December 31:
1996 1997 1998
----------- -----------
Deferred Revenue $13,846,000revenue...................................... $26,295,000 $46,943,000
Provision for uncollectible accounts receivable 1,091,000receivable....... 1,841,000 Other 118,0008,409,000
Other................................................. 145,000 (13,000)
----------- -----------
Total deferred tax asset $15,055,000asset.................... $28,281,000 $55,339,000
=========== ===========
Tax valuation allowances were provided through March 10, 1995 against the net
deferred tax assets of both continuing operations and discontinued operations.
In connection with the acquisition purchase accounting, a determination was made
that tax valuation allowances were no longer required.
Although the Company hadNetwork Solutions has a past history of net losses, it has not
established a current valuation allowance for its deferred tax assets since, in
the opinion of management, it is more likely than not that all of the deferred
tax assets will be realized. The deferred tax assets relate primarily to
registration fees which are taxable upon initial registration but are recognized
in the financial statements over the next 12 to 24 months, the registration
term.
A reconciliation of the provision for income taxes to the amount computed
by applying the statutory federal income tax rate of 35% to income before income
taxes is provided below. The statutory federal income tax rate used was 34% for the
periods during 1995 and 35% for the years ended December 31, 1996 and 1997.below:
For the period
1995
---------------------------- Year ended Year ended
January 1 to March 11 to DecemberYEAR ENDED DECEMBER 31,
December 31,
March 10 December 31-----------------------------------
1996 1997 ----------- ----------- ------------ ------------1998
--------- ---------- ----------
Federal tax at statutory rate $ 1,000 $ (570,000) $ (794,000)rate................. $(794,000) $2,696,000 $6,771,000
State income taxes, net of Federalfederal tax
benefit - (68,000)benefit..................................... (96,000) 374,000 1,015,000
Nondeductible goodwill amortization - 348,000amortization........... 281,000 240,000 Other 1,000 3,000213,000
Other......................................... (34,000) 161,000 Valuation allowance 46,000 - - -
---------- ----------110,000
--------- ---------- ----------
Provision for (benefit) from income taxes $ 48,000 $ (287,000) $ (643,000)taxes..... $(643,000) $3,471,000 ========== ==========$8,109,000
========= ========== ==========
The CompanyNetwork Solutions paid income taxes of $119,000 for$31,235,000 during the period from January 1, to
Marchyear ended
December 31, 1998.
F-15
64
NETWORK SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 10 1995.
F-17
75
NOTE 11 --- COMPUTATION OF EARNINGS (LOSS) PER SHARE
The following is a reconciliation of the numerator and denominator used in
the basic and diluted EPS computations for continuing operations:earnings per share computations:
Income (Loss) Shares Per Share
(Numerator) (Denominator) AmountINCOME (LOSS) SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
------------- ------------- -------------------
January 1, 1995 to March 10, 1995
- ---------------------------------
Loss Per Share:
- ---------------
Basic $ (44,000) 1,046,000 $ (0.04)
=========1996 LOSS PER SHARE:
Basic..................................... $(1,625,000) 25,000,000 $(0.07)
======
Dilutive securities:
Outstanding options - -options..................... --
----------- -----------
Diluted----------
Diluted................................... $(1,625,000) 25,000,000 $(0.07)
=========== ========== ======
1997 EARNINGS PER SHARE:
Basic..................................... $ (44,000) 1,046,0004,231,000 26,610,000 $ (0.04)
=========== =========== =========
March 11, 1995 to December 31, 1995
- -----------------------------------
Loss Per Share:
- ---------------
Basic $(1,390,000) 12,500,000 $ (0.11)
=========0.16
======
Dilutive securities:
Outstanding options - -options..................... 356,000
----------- -----------
Diluted $(1,390,000) 12,500,000----------
Diluted................................... $ (0.11)4,231,000 26,966,000 $ 0.16
=========== =========== =========
1996 Loss Per Share:
- --------------------
Basic $(1,625,000) 12,500,000========== ======
1998 EARNINGS PER SHARE:
Basic..................................... $11,235,000 31,957,000 $ (0.13)
=========0.35
======
Dilutive securities:
Outstanding options - -options..................... 1,440,000
----------- -----------
Diluted $(1,625,000) 12,500,000----------
Diluted................................... $11,235,000 33,397,000 $ (0.13)0.34
=========== =========== =========
1997 Earnings Per Share:
- ------------------------
Basic $ 4,231,000 13,305,000 $ 0.32
=========
Dilutive securities:
Outstanding options - 178,000
----------- -----------
Diluted $ 4,231,000 13,483,000 $ .031
=========== =========== =================== ======
Common shares issued are weighted for the period the shares were
outstanding and incremental shares assumed issued under the treasury stock
method for dilutive EPSearnings per share are weighted for the period the
underlying options were outstanding. Options outstanding in 1995 and 1996 are not
reflected in the computation of diluted EPSearnings per share because the effects
are antidilutiveanti-dilutive and would increase diluted EPS.
F-18
76earnings per share.
NOTE 12 -11 -- EMPLOYEE BENEFIT PLANS
1996 Stock Incentive Plan
The 1996 Stock Incentive Plan, (the "Incentive Plan")or Incentive Plan, of the CompanyNetwork Solutions was
adopted by the Board of Directors on September 18, 1996. The Incentive Plan
provides for awards in the form of restricted shares, stock units, stock
appreciation rights, and stock options (including incentive stock options ("ISOs") and
nonstatutory stock options ("NSOs"))options). A total of 2,306,2504,612,500 shares of Class A Common Stock
have been initially reserved for issuance under the Incentive Plan. The number
of shares are increased by 2% of the total number of common shares of the
CompanyNetwork
Solutions outstanding at the end of the most recent calendar year, subject to a
cumulative limit of 1,000,0002,000,000 shares. Through December 31, 1997,1998, an additional
564,4001,789,000 shares were eligible for issuance and have subsequently been reserved
for a combined total of 2,870,6506,401,000 eligible shares under the Incentive Plan.
F-16
65
NETWORK SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 11 -- EMPLOYEE BENEFIT PLANS -- (CONTINUED)
Following is a summary of activity pursuant to the Company'sNetwork Solutions' Incentive
Plan:
Weighted Average
Shares Exercise PriceWEIGHTED AVERAGE
SHARES EXERCISE PRICE
---------- ----------------
Balance at December 31, 1995 - -
Granted 1,225,725 $12.97
Exercised - -
Cancelled - -January 1, 1996........................... -- --
Granted.............................................. 2,451,000 $ 6.49
Exercised............................................ -- --
Cancelled............................................ -- --
----------
Balance at December 31, 1996 1,225,725 $12.97
Granted 600,500 $14.21
Exercised - -
Cancelled (36,500) $14.001996......................... 2,451,000 $ 6.49
Granted.............................................. 1,201,000 $ 7.11
Exercised............................................ -- --
Cancelled............................................ (73,000) $ 7.00
----------
Balance at December 31, 1997 1,789,725 $13.361997......................... 3,579,000 $ 6.68
Granted.............................................. 1,359,000 $21.95
Exercised............................................ (1,520,000) $ 6.51
Cancelled............................................ (707,000) $ 9.26
----------
Balance at December 31, 1998......................... 2,711,000 $13.74
==========
Granted stock options generally become exercisable one year after the date
of the grant, vest 30%, 30%, 20% and 20%, respectively, on each anniversary date
of the grant and have a term of five years. The number of options exercisable at December 31,
1997 are 360,821 with an exercise price range of $11.25 to $14.00 and a weighted
average exercise price of $12.95. The weighted average contractual life of all
options outstanding at December 31, 1997 is 4.10 years. All options granted to date have
been NSOsnonstatutory stock options except for 100,900 ISOs202,000 incentive stock options
granted in 1996. No restricted shares, stock units or SARsstock appreciation rights
have been granted to date.
The following table summarizes the status of Network Solutions' stock
options outstanding and exercisable at December 31, 1998:
STOCK OPTIONS STOCK OPTIONS
OUTSTANDING EXERCISABLE
---------------------- ------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF CONTRACTUAL EXERCISE EXERCISE
EXERCISE PRICES SHARES LIFE PRICE SHARES PRICE
--------------- --------- ----------- -------- ------- --------
$ 7.00-$ 9.25.................. 1,712,000 3.31 $ 7.29 252,000 $7.16
$15.88-$34.25.................. 918,000 4.58 $21.20 -- --
$65.44-$69.50.................. 81,000 5.00 $65.59 -- --
--------- ---- ------ ------- -----
$ 7.00-$69.50.................. 2,711,000 3.79 $13.74 252,000 $7.16
========= ==== ====== ======= =====
Employee Stock Purchase Plan
Effective January 7, 1998, the CompanyNetwork Solutions adopted an Employee Stock
Purchase Plan to provide substantially all full time employees an opportunity to
purchase shares of its Class A common stock through payroll deductions of up to
10% of eligible compensation. Semiannually, on June 30
F-17
66
NETWORK SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 11 -- EMPLOYEE BENEFIT PLANS -- (CONTINUED)
and December 31, participant account balances are used to purchase stock at the
lesser of 85 percent of the fair market value on the trading day before the
participation period starts or the trading day preceding the day on which the
participation period ends. A total of 250,000500,000 shares are availablewere initially reserved for
purchase under the plan. During the year ended December 31, 1998, a total of
30,000 shares were purchased under this plan.
SAIC Benefit Plans
Employees of the CompanyNetwork Solutions participate in various SAIC benefit plans,
including stock, bonus and retirement plans, subject to the applicable
eligibility requirements. SAIC charges the CompanyNetwork Solutions directly for the costs
of such employee benefit plans. Charges related to the administration of the
SAIC benefit plans in which employees of the CompanyNetwork Solutions participate are
included within SAIC general corporate allocations (Notes 1 and 9)(Note 8).
F-19
77
SAIC has one principal Cash or Deferred Arrangement ("CODA")plan which allows
eligible participants to defer a portion of their income through payroll
contributions. Such deferrals are fully vested, are not taxable to the
participant until distributed from the CODACash or Deferred Arrangement plan upon
termination, retirement, permanent disability or death and may be matched by
SAIC. SAIC also has an SAIC Employee Stock Purchase Plan which allows eligible
employees to purchase shares of SAIC's Class A common stock, with SAIC currently
contributing 10% of the existing fair market value.
SAIC has a Bonus Compensation Plan which provides for bonuses to reward
outstanding performance. Bonuses are paid in the form of cash, fully vested
shares of SAIC Class A common stock or vesting shares of SAIC Class A common
stock. The CompanyNetwork Solutions participated in this plan during the period from
acquisition until December 31, 1996.
During the period from March 11, 1995 to December 31, 1995 and during the years ended December 31, 1996 and 1997, a total of 24,450, 53,04053,000 and
11,45011,000 SAIC options were granted to the Company'sNetwork Solutions' employees, respectively,
with exercise prices ranging from $15.72 to $17.79, $19.33 to $22.83 and $25.96 to $34.78 per
share, respectively, with a weighted average price of $16.17, $20.51 and $28.13,
respectively. These options were granted under the SAIC 1995 Stock Option Plan
to purchase SAIC Class A common stock and vest 20%, 20%, 20% and 40%,
respectively, on each anniversary of the date of grant and have a term of five
years. There were no SAIC options granted to Network Solutions' employees during
1998.
Pro Forma Disclosures
The weighted average fair value of the options granted during the period from
March 11, 1995 to December 31,1995 and during the years
ended December 31, 1996 and 1997 under the SAIC Bonus Compensation Plan were
estimated at $3.66, $4.30 and $7.56, respectively, and $2.76$1.38, $2.34 and $4.68,$14.91, during
1996, 1997 and 1998, respectively, for the options
granted during the years ended December 31, 1996 and 1997 under the Company'sNetwork
F-18
67
NETWORK SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 11 -- EMPLOYEE BENEFIT PLANS -- (CONTINUED)
Solutions' Incentive Plan using the Black-Scholes model. The following weighted
average assumptions were used in calculating the option fair values:values.
NETWORK SOLUTIONS
SAIC Stock Options Company Stock Options
----------------------------------------------------- ----------------------------------
March 11,
1995 to Year ended Year ended Year ended Year ended
DecemberSTOCK OPTIONS STOCK OPTIONS
---------------------------- ----------------------------
YEAR ENDED DECEMBER 31, DecemberYEAR ENDED DECEMBER 31,
December 31, December 31, December 31,
1995---------------------------- ----------------------------
1996 1997 1998 1996 1997 --------------- --------------- --------------- --------------- ---------------1998
---- ---- ---- ---- ----- -----
Expected life (years)......... 4.0 5.0 -- 4.0 5.0 4.0 4.0
Risk-free interest rate 6.45%rate....... 5.91% 6.30% -- 5.98% 6.25% Volatility5.1%
Volatility.................... 0.00% 0.00% -- 0.00% 20.79% 90.73%
Dividend yield................ 0.00% 0.00% 20.79%
Dividend yield 0.00% 0.00%-- 0.00% 0.00% 0.00%
F-20
78
Under the above models, the total value of SAIC stock options granted
during 1995, 1996 and 1997 was approximately $89,000, $228,000 and $87,000, respectively, and
$3,379,000, $2,809,000 and $2,809,000,$20,322,000, respectively, for the Company'sNetwork Solutions'
employee stock purchase program and stock options granted in 1996, 1997 and
1997,1998, all of which would be amortized ratably on a pro forma basis over their
respective option terms. Had the CompanyNetwork Solutions recorded compensation costs for
these plans in accordance with SFAS No. 123, the
Company'sNetwork Solutions' pro forma income
(loss) would have been ($1,430,000) for the period
March 11,1995 to December 31,19951,763,000), $3,510,000 and ($1,763,000) and $3,510,000,$9,236,000, respectively,
for the years ended December 31,199631, 1996, 1997 and 1997.1998. Pro forma basic earnings (loss)
per share on a diluted basis would have been ($0.14)0.07), $0.13 and $0.26,$0.28,
respectively, for the years ended December 31,199631, 1996, 1997 and 1997.1998.
NOTE 13 - DISCONTINUED OPERATIONS
As discussed12 -- COMPREHENSIVE INCOME
The changes in Note 1, in November 1995 SAIC adopted a plan to transfer the Company's government-based business to SAIC in ordercomponents of accumulated other comprehensive income are
reported net of income taxes for the Company to focus on
the growth of the commercial business. Such transfer was substantially completed
as of February 1996. Prior to SAIC's acquisition of the Company, the portion of
the Company's business relating to the minority-based government business had
been transferred into a separately-owned entity. The activities of both the
minority-based government business and the government-based business are
reflected as discontinued operations in the financial statements of the Company
for all periods presented. Net income (loss) from discontinued operations
exclude general corporate overhead of the Company. No gain or loss was incurred
as a consequence of the transfer of these businesses.
Summary operating results of the discontinued operations wereyear ended December 31, 1998 as follows:
For the Period
1995
----------------------------
January 1 to March 11 to
March 10 December 31
------------ -----------UNREALIZED GAINS ACCUMULATED OTHER
ON SECURITIES COMPREHENSIVE INCOME
---------------- --------------------
Revenues $ 4,270,000 $ 7,882,000
Costs and expenses (5,478,000) (7,773,000)
----------- -----------
(Loss) income from discontinued
operations before income taxes (1,208,000) 109,000
Provision for income taxes 167,000 137,000
=========== ===========
Loss from discontinued operations,
netPre-tax amount............................... $618,000 $618,000
Income tax................................... 259,000 259,000
-------- --------
Net of income taxes $(1,375,000) $ (28,000)
=========== ===========tax amount............................ $359,000 $359,000
======== ========
NOTE 14 -13 -- COMMITMENTS AND CONTINGENCIES
As of December 31, 1997, the Company1998, Network Solutions was a defendant in 5two active
lawsuits involving domain name disputes between trademark owners and domain name
holders. The
CompanyNetwork Solutions is drawn into such disputes, in part, as a result of
claims by trademark owners that the CompanyNetwork Solutions is legally required, upon
request by a trademark owner, to terminate the right the CompanyNetwork Solutions granted
to an alleged trademark infringera domain name holder to register thea domain name in question. Further, trademark owners have alsowhich is alleged that the Company shouldto be required to monitor future domain name
registrations and reject registrations of domain names which are identical or similar
to their federally registered trademark.the trademark in question. The holders of the domain name registrations in
dispute have, in turn, questioned the Company'sNetwork Solutions' right, absent a court
order, to take any action which suspends their registration or use of the domain names in
question. Although 4146 out of F-21
79approximately 4,500 of these objectionssituations have
resulted in litigation involving the Company,suits actually naming us as a defendant, as of December 31, 1997,1998, no
adverse judgment has been rendered and no award of damages have been awardedmade
against the Company to any
plaintiff in the 36 cases that have been resolved. The CompanyNetwork Solutions.
F-19
68
NETWORK SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 13 -- COMMITMENTS AND CONTINGENCIES -- (CONTINUED)
Network Solutions believes that it has meritorious defenses and intends to vigorously
defenddefends itself against these claims.
On March 20, 1997, PG Media, Inc., a New York-based corporation (PG Media),
filed a lawsuit against Network Solutions in the United States District Court,
Southern District of New York alleging that Network Solutions had restricted
access to the Internet by not adding PG Media's requested top level domains to
the Internet root zone system in violation of the Sherman Act. In its complaint,
PG Media, in addition to requesting damages, asked that Network Solutions be
ordered to include reference to PG Media's top level domains and name servers in
the root zone file administered by Network Solutions under the Cooperative
Agreement. In June 1997, Network Solutions 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 provided 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 Network Solutions
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 is the National Science Foundation's
authority to control the Internet's root zone system. The court has taken the
issue under advisement and no date has been indicated for the issuance of a
decision. With the transition of the Cooperative Agreement from the National
Science Foundation to the Department of Commerce, Network Solutions is still
required to request written direction from the U.S. Government before making or
rejecting any modifications, additions or deletions to the root zone file, in
accordance with the October 1998 amendment to the Cooperative Agreement.
On October 17, 1997, a group of six plaintiffs filed a lawsuit (the "Thomas
suit") against the CompanyNetwork Solutions and the NSFNational Science Foundation in the
United States District Court, District of Columbia, challenging the legality of
fees defendants charge for the registration and renewal of domain names on the
Internet and seeking restitution of fees collected from domain name registrants
in an amount in excess of $100 million, damages, and injunctive and other
relief. Plaintiffs originally alleged violations of the Competition in Contracting Act ("CICA"), the Sherman Act, and
the U.S. Constitution. Following the filing of motions to dismiss by the
defendants, the plaintiffs filed an amended complaint on January 30, 1998,
dropping the cause of action based upon CICA, but adding alleged violations ofConstitution,
the Administrative Procedures Act and the Independent Offices Appropriations
Act. TheOn February 10, 1998, the plaintiffs also filed a motion for preliminary
injunctive reliefinjunction against the NSF concerning the "Intellectual Infrastructure Fund."Network Solutions seeking several items of relief. On February
2,April
6, 1998, the United States District Court District of Columbia, issued an orderits opinion granting the plaintiffs' motion for a preliminary injunction, enjoining the NSF
from spending anysummary judgment in favor of the
money collected by the Company forplaintiffs on the Intellectual Infrastructure Fund.Fund, ruling it an "unlawful tax."
The Companycourt also granted Network Solutions' motion to dismiss all other counts (II
through X) and simultaneously denied the plaintiffs' preliminary injunction
motion against Network Solutions. 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, with oral
argument scheduled for February 25, 1999.
On October 20, 1998, Network Solutions was included as a defendant in a
suit brought by the Pennsylvania Attorney General's office against a domain name
holder who has alleged to have used
F-20
69
NETWORK SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 13 -- COMMITMENTS AND CONTINGENCIES -- (CONTINUED)
his domain name in connection with a web site promoting white supremacy and
threatening certain state employees. The Pennsylvania Attorney General named all
of the communications companies in any way connected with the domain name or web
site. The Pennsylvania Attorney General seeks to permanently enjoin these
entities, including Network Solutions, from providing services to this domain
name holder in the event that the domain name holder fails to comply with the
order of the court. Network Solutions has answered the complaint denying any
knowledge or participation in the actions of the primary defendant. No motions
are pending and Network Solutions expects to be dismissed from the matter.
Network Solutions believes that it has meritorious defenses and intends to vigorously
defenddefends itself against the claims advanced in the PG Media, Thomas suit.or
Pennsylvania Attorney General suits. While the Companymanagement cannot reasonably estimate
the potential impact of such claims, a successful claim under the plaintiffs' theoriesagainst Network
Solutions in any of these proceedings could have a material adverse effect on
the Company'sNetwork Solutions' business, financial condition and results of operations.
See Note 15.
On June 27, 1997, SAIC received a Civil Investigative Demand, ("CID")or "CID" from
the U.S. Department of Justice ("DOJ") issued in connection with an investigation to
determine whether there is, has been, or may be an antitrust violation under the
Sherman Act relating to Internet registration products and services. The CID
seeks documents and information from SAIC and the CompanyNetwork Solutions relating to
their Internet registration business. The CompanyNetwork Solutions cannot reasonably
estimate the potential impact of the investigation nor can it predict whether a
civil action will ultimately be filed by the DOJ. The Company is unable to predictDepartment of Justice or the form
of relief that might be sought in such an action or that might be awarded by a
court or imposed as a result of any settlement.sought. Any such relief could have a material adverse
effect on the Company'sNetwork Solutions' business, financial condition and results of
operations.
On March 20, 1997, PG Media, Inc., a New York-based corporation ("PG Media"),
filed a lawsuit againstAugust 17, 1998, Network Solutions received notice from the Company in the United States District Court,
Southern District of New York alleging that the Company had restricted access to
the Internet by not adding PG Media's requested TLDs in violationCommission
of the Sherman
Act. In its complaint, PG Media has,European Communities, or "EC," of an investigation concerning Network
Solutions' Premier Program agreements in addition to requesting damages, asked
that the Company be ordered to include reference to PG Media's TLDsEurope. The EC requested production of
these agreements and name
servers in the root zone file administered by the Company under the Cooperative
Agreement. The Company has answered the complaint. In addition, in June 1997,
the Company received written direction from the NSF not to take any action to
create additional TLDs or to add any new TLDs to the Internet root zone until
the NSF provides further guidance. On September 17, 1997, PG Media filed a
Second Amended Complaint adding the NSF as a defendant. No motions are pending
as of December 31, 1997. The Company believes that it has meritorious defenses
and intends to vigorously defend itself against the claims of PG Media. Although
the Companyrelated materials for review. Network Solutions cannot
reasonably estimate the potential impact of the investigation nor can Network
Solutions predict whether an action will ultimately be brought by the EC or the
form of relief that might be sought. Any such claims, a
successful claim under the plaintiff's theoryrelief could have a material adverse
effect on the Company's business, financial condition and results of operations.
F-22
80
The Companyharm Network
Solutions' business.
Network Solutions is involved in various other investigations, claims and
lawsuits arising in the normal conduct of its business, none of which, in
themanagement's opinion will harm Network Solutions' business.
Legal proceedings in which Network Solutions is involved have resulted and
likely will result in, and any future legal proceedings can be expected to
result in, substantial legal and other expenses and a diversion of the Company's management, will have a material adverse effect on its financial
position, resultsefforts
of operations, cash flows or its ability to conduct business.Network Solutions' personnel.
NOTE 15 -14 -- SUBSEQUENT EVENTS (UNAUDITED)
Proposed RuleSecondary Stock Offering
On January 30, 1998,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, 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
F-21
70
NETWORK SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 14 -- SUBSEQUENT EVENTS (UNAUDITED) -- (CONTINUED)
proceeds from the stock offering other than proceeds from options exercised as
part of the offering. After the offering, SAIC owns approximately 89% of the
combined voting power and approximately 45% of the economic interest of the
outstanding common stock.
By May 31, 1999, SAIC intends to convert all of the remaining Class B
common stock into an identical number of shares of Class A common stock. After
that conversion, Class A common stock will be the only class of common stock
outstanding and SAIC will own approximately 45% of the voting power and economic
interest of Network Solutions' outstanding common stock.
Litigation
On March 16, 1999, the United States District Court ruled in favor of
Network Solutions' and the National Telecommunications and Information
AdministrationScience Foundation's motions for summary
judgment in the PG Media antitrust lawsuit. In the decision, Network Solutions
was found to be immune to antitrust violations of the Department of Commerce issued a discussion draft,
entitled "A Proposal to Improve Technical Management of Internet Names and
Addresses" which was published in the U.S. Federal Register on February 20,
1998 (the "Proposed Rule"). The Proposed Rule provides notice and seeks public
comment on a proposal to, among other things, increase competition in the
administration of TLDs and the registration of domain names. The Company
supports the transition of domain name services toward a self-regulatory
commercial environment. It is impossible to predict at this time whether or
when a final rule will be issued and, if issued, the exact nature ofSherman Act for its
provisions or the precise effect of such provisions on the Company.
Litigation
On February 10, 1998, the plaintiffs in the Thomas suit filed a motion for
preliminary injunction against the Company seeking several items of relief. On
February 24, 1998, the Company and the NSF filed motions to dismiss the amended
complaint. Also on February 24, the plaintiffs filed a motion for partial
summary judgment concerning the set aside fund. The plaintiffs' motion for
preliminary injunction against the Company and partial summary judgment against
the NSF and both motions to dismiss were heard before the Court on March 17,
1998 and the Court hasactions taken the matters under advisement.
NSF Cooperative Agreement
Pursuant to an amendmentpursuant to the Cooperative Agreement, on March 12, 1998, the
NSF directed the Company to begin charging end users $70 upon each initial
registration for domain names registered April 1, 1998 or later and $35 for each
renewal with an anniversary date of April 1, 1998 or later. In conjunction with
this amendment to the Cooperative Agreement, the Company will no longer set
aside 30% of the collected registration fees for the enhancement of the
intellectual infrastructure of the Internet. This amendment does not alter the
Company's existing revenue per net registration since the 30% set aside funds
were previously not recognized as revenue.
F-23Agreement.
F-22
8171
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
================================================================================================================
COLUMN A COLUMN B COLUMN C ADDITIONS COLUMN D COLUMN E
ADDITIONS
--------------------------------- ----------- ------------------------ ------------ -----------
CHARGED TO
BALANCE AT CHARGED TO OTHER
BEGINNING COSTS AND ACCOUNTS-- DEDUCTIONS-- BALANCE AT
DESCRIPTION OF YEAR EXPENSES DESCRIBE DESCRIBE END OF YEAR
- --------------------------------------------------------------------------------------------------------------------------- ----------- ---------- ----------- ------------ -----------
For the period from January 1, 1995 to
March 10, 1995Year ended December 31,
1996
Allowance for
uncollectible
accounts, continuing
operations............ $ 2,118,000 $3,597,000 $19,270,000(1) $ 9,546,000(2) $15,439,000
Allowance for
uncollectible
accounts, included in
net assets
(liabilities) of
discontinued
operations...................... 809,000 344,000 -- -- 1,153,000
Deferred tax valuation allowance,
continuing operations........... 56,000 46,000 -- -- 102,000(1)
Deferred tax valuation allowance,
discontinued operations......... 512,000 276,000 -- -- 788,000(1)
- ----------------------------------------------------------------------------------------------------------------
For the period from March 11, 1995 to
December 31, 1995
Allowance for uncollectible
accounts, continuing
operations...................... $ -- $ 124,000 $ 1,994,000(2) $ -- $ 2,118,000
Allowance for uncollectible
accounts, included in net assets
(liabilities) of discontinued
operations...................... 1,153,000 465,000 -- -- 1,618,000
Year ended December 31, 1996
Allowance for uncollectible
accounts, continuing
operations...................... 2,118,000 3,597,000 19,270,000(2) 9,546,000(3) 15,439,000
Allowance for uncollectible
accounts, included in net assets
(liabilities) of discontinued
operations......................operations............ 1,618,000 -- -- 1,618,000(4)1,618,000(3) --
Year ended December 31,
1997
Allowance for
uncollectible
accounts, continuing
operations......................operations............ 15,439,000 8,082,000 35,368,000(2) 41,033,000(3)35,368,000(1) 41,033,000(2) 17,856,000
Year ended December 31,
1998
Allowance for
uncollectible
accounts, continuing
operations............ $17,856,000 $2,247,000 $68,480,000(1) $62,837,000(2) $25,746,000
- ---------------
(1) In connection with the acquisition purchase accounting, a determination
was made that the tax valuation allowances were no longer required. (See
Note 10 of Notes to Financial Statements.)
(2) Charged to allowance for deferred revenue (See Notes 31 and 43 of Notes to
Financial Statements).
(3)(2) Amounts are write-offs of uncollectible accounts receivable.
(4) Disposition associated with discontinued operations (See Note 13(3) In November 1995 SAIC adopted a plan to transfer Network Solutions'
government-based business to SAIC in order for Network Solutions to focus on
the growth of Notes to
Financial Statements).
F-24the commercial business. Such transfer was substantially
completed as of February 1996.
F-23
8272
INDEX TO EXHIBITS
Exhibit
Number DescriptionEXHIBIT
NUMBER DESCRIPTION
- ------------- -----------
3(ii) Bylaws of Network Solutions, Inc., as amended February 9, 1998.
10.1610.24 Amendment No. 7 to the Cooperative Agreement dated December 3, 1997.
10.17 Amendment No. 8 to the Cooperative Agreement dated February 20, 1998.
10.18 Amendment No. 912 to the Cooperative Agreement dated March
12, 1998.
10.19 Form of Indemnification Agreement entered into by the Company and each of its
directors and officers at the Vice President level or above.
10.20 Deed of Lease By and Between Sugarland Business Park Limited Partnership and
Network Solutions, Inc. dated May 30, 1997 ("Lease Agreement").
10.21 Amendment No. 1 to Lease Agreement dated January 31, 1998.1999.
23.1 Consent of Price WaterhousePricewaterhouseCoopers LLP.
27.1 Financial Data Schedule (in electronic format only).
27.2 Restated Financial Data Schedule (in electronic format
only).
27.3 Restated Financial Data Schedule (in electronic format
only).