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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1997MARCH 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 0-22967
NETWORK SOLUTIONS, INC.
(Exact name of registrantRegistrant as specified in its charter)
DELAWARE 52-1146119
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
505 HUNTMAR PARK DRIVE
HERNDON, VIRGINIA 20170
(703) 742-0400
(Address, including zip code, and telephone number,
including area code, of Registrant's principal executive offices)
Indicate by check mark whether the RegistrantRegistrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
(1) Yes X No
--- ---
(2) Yes No X
--- ---
As of October 31, 1997,May 8, 1998, the Registrant had 3,795,0004,039,213 shares of Class A common
stock, $0.001 par value per share, issued and outstanding, and 11,925,000 shares
of Class B common stock, $0.001 par value per share, issued and outstanding.
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PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Statements of Financial Position as of December 31, 19961997 and
September 30, 1997March 31, 1998 (unaudited)............................................................................ 3
Unaudited Statements of Operations for the three and nine months
ended
September 30, 1996March 31, 1997 and 1997...............................................1998................................... 4
Unaudited Statements of Changes in Stockholder's Equity for the
nine months ended September 30, 1997...................................... 5
Unaudited Statements of Cash Flows for the ninethree months
ended
September 30, 1996March 31, 1997 and 1997............................................... 61998................................... 5
Notes to Financial Statements............................................... 7Statements............................... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................................... 9Operations................................. 8
Item 3. Quantitative and Qualitative Disclosures About Market
Risk.................. 12Risk...................................................... 15
PART II OTHER INFORMATION
Item 1. Legal Proceedings........................................................... 12Proceedings........................................... 15
Item 2. Changes in Securities and Use of Proceeds................................... 13Proceeds................... 16
Item 6. Exhibits.................................................................... 14
Signature.............................................................................. 15Exhibits and Reports on Form 8-K............................ 17
Signature............................................................ 18
Index to Exhibits...................................................................... 16Exhibits.................................................... 19
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PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
NETWORK SOLUTIONS, INC.
STATEMENTS OF FINANCIAL POSITION
DECEMBER 31, SEPTEMBER 30,
1996MARCH 31,
1997 1998
------------ -------------------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents....................................... $15,540,000equivalents................................. $ 19,062,00041,146,000 $ 6,831,000
Short-term investments.......................................... -- 28,321,000investments.................................... 40,200,000 78,881,000
Accounts receivable, net........................................ 12,587,000 6,662,000net.................................. 5,792,000 7,716,000
Prepaids and other assets....................................... 936,000 1,832,000
Restricted assets............................................... 17,453,000 40,135,000assets................................. 1,005,000 1,131,000
Deferred tax asset.............................................. 10,087,000 17,350,000asset........................................ 20,153,000 24,312,000
Restricted assets......................................... 25,873,000 37,400,000
------------ -------------------------
Total current assets.............................................. 56,603,000 113,362,000assets........................................ 134,169,000 156,271,000
Furniture and equipment, net...................................... 2,266,000 4,812,000net................................ 6,146,000 6,187,000
Long-term investments....................................... -- 6,352,000
Deferred tax asset................................................ 4,968,000 7,354,000asset.......................................... 8,128,000 8,572,000
Goodwill, net..................................................... 2,281,000 1,740,000net............................................... 1,177,000 1,041,000
------------ -------------------------
Total Assets...................................................... $66,118,000 $ 127,268,000
=========== =============Assets................................................ $149,620,000 $178,423,000
============ ============
LIABILITIES AND STOCKHOLDER'SSTOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities........................liabilities.................. $ 2,581,0006,426,000 $ 4,392,000
Dividend payable................................................ -- 10,000,0007,005,000
Due to parent................................................... 15,295,000 21,922,000
Deferred revenue, net........................................... 19,912,000 38,281,000parent............................................. 1,250,000 2,379,000
Income taxes payable...................................... 5,042,000 7,244,000
Current portion of capital lease obligations.................... -- 1,284,000obligations.............. 842,000 858,000
Deferred revenue, net..................................... 43,789,000 53,381,000
Internet fund liability......................................... 17,453,000 40,135,000liability................................... 25,873,000 37,400,000
------------ -------------------------
Total current liabilities......................................... 55,241,000 116,014,000liabilities................................... 83,222,000 108,267,000
Capital lease obligations......................................... -- 1,102,000obligations................................... 1,081,000 860,000
Long-term deferred revenue, net................................... 9,440,000 16,227,000net............................. 17,662,000 19,139,000
------------ -------------------------
Total liabilities................................................. 64,681,000 133,343,000
Stockholder'sliabilities........................................... 101,965,000 128,266,000
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.001 par value, authorized 10,000,000
shares; noneNone issued and outstanding in 19961997 and 1997.................1998
Class A common stock, $.001 par;par value; authorized
100,000,000 shares; none3,795,000 and 3,813,063 issued and
outstanding..................................outstanding in 1997 and 1998........................... 4,000 4,000
Class B common stock, $.001 par;par value; authorized
30,000,000 shares; 12,500,00011,925,000 issued and outstanding............................outstanding in
1997 and 1998.......................................... 12,000 12,000
Additional paid-in capital...................................... 4,468,000 4,468,000capital................................ 56,451,000 56,704,000
Accumulated deficit............................................. (3,043,000) (10,555,000)deficit....................................... (8,812,000) (6,763,000)
Accumulated other comprehensive income.................... -- 200,000
------------ -------------------------
Total stockholder's equity........................................ 1,437,000 (6,075,000)
Commitments and contingenciesstockholders' equity.................................. 47,655,000 50,157,000
------------ -------------------------
Total Liabilities and Stockholder's Equity........................ $66,118,000 $ 127,268,000
=========== =============Stockholders' Equity.................. $149,620,000 $178,423,000
============ ============
The accompanying notes are an integral part of these financial statements.
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NETWORK SOLUTIONS, INC.
STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED
NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- --------------------------
1996MARCH 31,
------------------------
1997 1996 1997
----------- ----------- -----------1998
---------- -----------
Net revenue............................... $ 5,180,000 $12,172,000 $12,009,000 $30,896,000revenue................................................. $8,655,000 $16,492,000
Cost of revenue........................... 3,719,000 7,033,000 10,240,000 18,468,000
----------- ----------- -----------revenue............................................. 5,294,000 7,348,000
---------- -----------
Gross profit.............................. 1,461,000 5,139,000 1,769,000 12,428,000profit................................................ 3,361,000 9,144,000
Research and development expenses......... 226,000 377,000 284,000 1,095,000expenses........................... 311,000 725,000
Selling, general and administrative expenses................. 1,932,000 3,105,000 4,302,000 7,893,000expenses................ 2,301,000 6,182,000
Interest income, net...................... (288,000) (570,000) (374,000) (1,054,000)
----------- ----------- -----------income............................................. (149,000) (1,327,000)
Other expenses.............................................. -- 35,000
---------- -----------
Income (loss) before income taxes......... (409,000) 2,227,000 (2,443,000) 4,494,000taxes.................................. 898,000 3,529,000
Provision (benefit) for income taxes...... (116,000) 995,000 (692,000) 2,006,000
----------- ----------- -----------taxes.................................. 382,000 1,480,000
---------- -----------
Net income (loss).........................income.................................................. $ (293,000)516,000 $ 1,232,000 $(1,751,000)2,049,000
========== ===========
Basic and diluted EPS....................................... $ 2,488,000
=========== =========== =========== ===========
Pro forma net income (loss) per share.....0.04 $ (0.02) $ 0.09 $ (0.13) $ 0.19
=========== =========== =========== ===========
Shares used in computing pro forma net
income (loss) per share................. 13,487,000 13,161,000 13,487,000 13,373,000
=========== =========== ===========0.13
========== ===========
The accompanying notes are an integral part of these financial statements.
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NETWORK SOLUTIONS, INC.
STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITYCASH FLOWS
(UNAUDITED)
CLASS B
COMMON STOCK ADDITIONAL RETAINED TOTAL
--------------------- PAID-IN EARNINGS STOCKHOLDER'S
SHARES AMOUNT CAPITAL (DEFICIT) EQUITY
---------- ------- ----------THREE MONTHS ENDED
MARCH 31,
---------------------------
1997 1998
------------ -------------------------
Balance, December 31, 1996....... 12,500,000 $12,000 $4,468,000CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................ $ (3,043,000)516,000 $ 1,437,0002,049,000
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization.......................... 365,000 717,000
Provision for uncollectible accounts receivable........ 2,163,000 2,168,000
Deferred income taxes.................................. 904,000 (4,603,000)
Change in operating assets and liabilities:
Decrease (increase) in accounts receivable........... 816,000 (4,092,000)
Decrease (increase) in prepaids and other assets..... (380,000) (126,000)
Increase in accounts payable and accrued
liabilities....................................... 317,000 579,000
Increase in income taxes payable..................... -- 2,202,000
Increase in deferred revenue......................... 7,548,000 11,069,000
------------ ------------
Net income for the nine months
ended September 30, 1997....... 2,488,000 2,488,000
Declarationcash provided by operating activities......... 12,249,000 9,963,000
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of Class B
dividend....................... (10,000,000) (10,000,000)
---------- ------- ----------furniture and equipment....................... (159,000) (622,000)
Purchase of short-term investments........................ -- (38,681,000)
Purchase of long-term investments......................... -- (6,152,000)
------------ -------------
Balance, September 30, 1997...... 12,500,000 $12,000 $4,468,000 $(10,555,000)------------
Net cash used in investing activities............. (159,000) (45,455,000)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net transactions with SAIC................................ (15,147,000) 1,129,000
Repayment of capital lease obligations.................... -- (205,000)
Issuance of common stock pursuant to stock plans.......... -- 253,000
------------ ------------
Net cash provided by (used in) financing
activities...................................... (15,147,000) 1,177,000
------------ ------------
Net decrease in cash and cash equivalents................... (3,057,000) (34,315,000)
Cash and cash equivalents, beginning of period.............. 15,540,000 41,146,000
------------ ------------
Cash and cash equivalents, end of period.................... $ (6,075,000)
========== ======= ==========12,483,000 $ 6,831,000
============ =========================
The accompanying notes are an integral part of these financial statements.
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NETWORK SOLUTIONS, INC.
STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------------
1996 1997
------------ -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)............................................... $ (1,751,000) $ 2,488,000
Adjustments to reconcile net income (loss) to net cash provided
by (used in) operating activities:
Depreciation and amortization................................ 768,000 1,635,000
Provision for uncollectible accounts receivable.............. 2,677,000 5,577,000
Deferred income taxes........................................ (10,282,000) (9,649,000)
Change in operating assets and liabilities:
Decrease (increase) in accounts receivable................. (14,062,000) 348,000
Increase in prepaid and other assets....................... (466,000) (896,000)
Increase in accounts payable and accrued liabilities....... 1,190,000 1,811,000
Increase in deferred revenue............................... 18,665,000 25,156,000
------------ -----------
Net cash provided by (used in) operating activities..... (3,261,000) 26,470,000
------------ -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of furniture and equipment............................. (1,844,000) (1,254,000)
Purchase of short-term investments, net......................... -- (28,321,000)
Net investment in net assets of discontinued operations......... (208,000) --
------------ -----------
Net cash used in investing activities................... (2,052,000) (29,575,000)
------------ -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net transactions with SAIC...................................... 7,298,000 6,627,000
------------ -----------
Net cash provided by financing activities............... 7,298,000 6,627,000
------------ -----------
Net increase in cash and cash equivalents......................... 1,985,000 3,522,000
Cash and cash equivalents, beginning of period.................... 5,000 15,540,000
------------ -----------
Cash and cash equivalents, end of period.......................... $ 1,990,000 $19,062,000
============ ===========
The accompanying notes are an integral part of these financial statements.
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NETWORK SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 1 -- ORGANIZATION AND BUSINESS
Network Solutions, Inc. (the Company) was incorporated in ("the District of
Columbia in 1979 and was reincorporated in Delaware in 1996. The CompanyCompany") currently acts as the exclusive
registrar of Internet domain names within the .com, .org, .net and .edu top
level domains (TLDs)("TLDs") pursuant to a Cooperative
Agreementcooperative agreement (the "Cooperative
Agreement") with the National Science Foundation (NSF)("NSF"). Domain names are used
to identify a unique site or presence on the Internet. As registrar for these
TLDs, the Company registers new domain names and is responsible for the
maintenance and dissemination of the master file of domain names through daily
updates to the Internet. The Company also provides Intranetenterprise network consulting
services, focusing on network engineering, network and systems security and
network design and implementation services to large
companies that desire to establish or enhance their Internet presence or to
"re-engineer" legacy network infrastructures to accommodate the integration of
both Internet connectivity and Intranet network technology into their
information technology base.management solutions for commercial customers.
NOTE 2 -- SIGNIFICANT ACCOUNTING POLICIES
INTERIM FINANCIAL STATEMENTS
The interim financial statements have been prepared by the Company, without
audit, pursuant to the rules and regulations of the Securities and Exchange
Commission. In the opinion of management, financial statements included in this
report reflect all normal recurring adjustments which the Company considers
necessary for fair presentation of the results of operations for the interim
periods covered and of the financial position of the Company at the date of the
interim balance sheet. Certain information and footnote disclosures normally
included in the annual financial statements prepared in accordance with
generally accepted accounting principles have been condensed or omitted pursuant
to such rules and regulations. However, the Company believes that the
disclosures are adequate for understanding the information presented. The
operating results for interim periods are not necessarily indicative of the
operating results for the entire year. These interim financial statements should
be read in conjunction with the Company's December 31, 1997 audited financial
statements and notes thereto included in the Company's Form S-1 Registration Statement
declared effective on September 25,10-K annual report
for the year ended December 31, 1997.
NOTE 3 -- INITIAL PUBLIC OFFERING
On October 1, 1997,COMPUTATION OF EARNINGS PER SHARE
The following is a reconciliation of 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 proceeds from the IPO, including overallotment, were
$54 million based on the direct sale of 3,220,000 shares of Class A common
stock. This transaction is not reflectednumerator and denominator used in
the interim financial statements
dated as of September 30, 1997.
Prior tobasic and diluted EPS computations for continuing operations:
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
Three Months Ended March 31, 1997
- --------------------------------------------------
Basic............................................. $ 516,000 12,500,000 $0.04
=====
Dilutive securities:
Outstanding options............................. -- 91,000
---------- ----------
Diluted........................................... $ 516,000 12,591,000 $0.04
========== ========== =====
Three Months Ended March 31, 1998
- --------------------------------------------------
Basic............................................. $2,049,000 15,726,000 $0.13
=====
Dilutive securities:
Outstanding options............................. -- 413,000
---------- ----------
Diluted........................................... $2,049,000 16,139,000 $0.13
========== ========== =====
Common shares issued are weighted for the offering, the Company was a wholly-owned subsidiary of Science
Applications International Corporation, a Delaware corporation ("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 Class A common
stock and directly soldperiod the shares as a selling stockholder. Upon completion ofwere
outstanding and incremental shares assumed issued under the offering, SAIC owns 100% oftreasury stock
method for diluted EPS are weighted for the outstanding Class B common stock
representing 75.9% ofperiod the Company's equity and 96.9% of the combined voting
power of the Company's outstanding Class B and Class A common stock.
NOTE 4 -- DIVIDEND
On August 21, 1997, the 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.underlying options were
outstanding.
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NETWORK SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS--STATEMENTS -- (CONTINUED)
NOTE 4 -- ACCUMULATED OTHER COMPREHENSIVE INCOME BALANCES
Effective January 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income", which established standards for reporting and displaying
comprehensive income and its components in a financial statement that is
displayed with the same prominence as other financial statements. The changes in
the components of accumulated other comprehensive income are reported net of
income taxes as follows:
ACCUMULATED
OTHER
UNREALIZED GAINS COMPREHENSIVE
ON SECURITIES INCOME
---------------- -------------
Pre-tax amount........................................... $345,000 $345,000
Income tax............................................... 145,000 145,000
-------- --------
Net of tax amount........................................ $200,000 $200,000
======== ========
NOTE 5 -- COMPUTATION OF PRO FORMA NET INCOME (LOSS) PER SHARE
Pro forma net income (loss) per share is computed usingCOMMITMENTS AND CONTINGENCIES
PROPOSED RULE
On January 30, 1998, the pro forma
weighted average number of commonNational Telecommunications and common equivalent shares outstanding. Pro
forma weighted average common and common equivalent shares include common stock
and stock options using the treasury stock method.
Pursuant to the requirementsInformation
Administration of the SecuritiesDepartment of Commerce issued a discussion draft, entitled
"A Proposal to Improve Technical Management of Internet Names and Exchange Commission,
common stockAddresses"
which was published in the U.S. Federal Register on February 20, 1998 (the
"Proposed Rule"). The Proposed Rule provides notice and stock optionsseeks public comment on
a proposal to, among other things, increase competition in the administration of
TLDs and the registration of domain names. The Company supports the transition
of domain name services toward a self-regulatory commercial environment. It is
impossible to predict at this time whether or when a final rule will be issued
and, if issued, the exact nature of its provisions or the precise effect of such
provisions on the Company.
LITIGATION
On April 6, 1998, the Court in the Thomas suit issued its opinion, granting
summary judgment in favor of the plaintiffs on the Intellectual Infrastructure
Fund, ruling it an "unlawful tax." The Court also granted the Company's motion
to dismiss all other counts and, simultaneously, denied the plaintiffs'
preliminary injunction motion against the Company.
On April 30, 1998, Congress passed H.R. 3579, which was signed into law by
the Company duringPresident on May 1, 1998. Section 8003 of H.R. 3579 legalized, ratified and
confirmed the twelve months
immediately precedingentire Intellectual Infrastructure Fund and authorized and
directed the filing ofNSF to deposit the initial registration statement and
throughentire fund into the effective date of such registration statement have been included inU.S. Treasury. On May 5,
1998 the calculation ofNSF filed a motion to vacate the pro forma weighted average shares outstanding using the
treasury stock method basedFebruary 2, 1998 preliminary
injunction on the IPO price. Additionally, as required byIntellectual Infrastructure Fund and to dismiss the Securities and Exchange Commission, the pro forma per share data presented
treats as outstanding for purposes of the calculation the number of shares from
the public offering necessary to fund the amount of the $10,000,000 dividend
payable to SAIC in excess of the Company's net income for the twelve months
ended June 30, 1997.
The Company will adopt Statement of Financial Accounting Standards No. 128,
"Earnings Per Share" ("FAS 128") in the fourth quarter of 1997, as required. The
Company will continue to apply Accounting Principles Board Opinion No. 15,
"Earnings Per Share" ("APB 15") until the adoption of FAS 128. Based on a
preliminary evaluation of FAS 128, the Company does not expect the per share
amounts reported under FAS 128 to be materially different from those calculated
and presented under APB 15.case.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
OVERVIEW
This Quarterly Reportquarterly report on Form 10-Q contains forward-looking statements. For
this purpose, any statements contained herein that are not statements of
historical fact may be deemed to be forward-looking statements. Statements
regarding the intent, belief or current expectations of the Company are intended
to be forward-looking statements which may involve risk and uncertainty. There
are a number of factors that could cause the Company's actual results to differ
materially from those indicated by such forward-looking statements, including,
but not limited to, those discussed in "Part I -- Item 1 -- Business -- Risk
Factors" and "Part II -- Item 7 -- Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Factors Affecting Operating
Results" contained in the Company's 1997 Form S-1 Registration
Statement10-K, as declared effective byfiled with the Securities
and Exchange Commission on March 31, 1998. In addition, set forth below under
the heading "Factors Affecting Operating Results" is a further discussion of
certain of those risks as they relate to the period covered by this report, the
Company's near term outlook with respect thereto, and the forward-looking
statements set forth herein; however, the absence in this quarterly report of a
complete recitation of or update to all risk factors identified in the 1997 Form
10-K should not be interpreted as modifying or superseding any such risk
factors, except to the extent set forth below. Investors should review this
quarterly report in combination with the Company's 1997 Form 10-K in order to
have a more complete understanding of the principal risks associated with an
investment in the Company's common stock.
OVERVIEW
The Company currently acts as the exclusive registrar of Internet domain
names within the .com, .org, .net and .edu TLDs pursuant to the Cooperative
Agreement with the NSF. Domain names are used to identify a unique site or
presence on the Internet. As registrar for these TLDs, the Company registers new
domain names and is responsible for the maintenance and dissemination of the
master file of domain names through daily updates to the Internet. A pioneer in
Internet technology since 1979, the Company also provides enterprise network
consulting services, focusing on network engineering, network and systems
security and network management solutions for commercial customers. The
Company's consulting services division delivers full life cycle network
engineering and consulting for a broad range of companies including
multinational oil and gas corporations and major financial institutions.
Registration Services. In December 1992, the Company entered into the
Cooperative Agreement with the NSF under which the Company was to provide
Internet domain name registration services for five TLDs: .com, .org, .net, .edu
and .gov. These "registration services" include domain name registration and
renewal, and throughout the registration term, maintenance of and unlimited
modifications to individual domain name records and dissemination of records
through updates to the Internet. The Cooperative Agreement became effective
January 1, 1993. It includes a three-month phase-in period, a five-year
operational period (commencing April 1, 1993 and ending March 31, 1998), and a
six-month "flexibility period" through September 25,30, 1998. The Cooperative
Agreement is subject to review by the NSF and may be terminated by the NSF at
any time at its discretion or by mutual agreement. The NSF has stated that it
will not be re-awarding a cooperative agreement at the end of the flexibility
period.
The original terms of the Cooperative Agreement provided for a cost
reimbursement plus fixed-fee contract (with a fee of 8%). Effective September
14, 1995, the NSF and the Company amended the Cooperative Agreement to require
the Company to begin charging end users a services fee of $50 per year for each
domain name in the .com, .org and .net TLDs. Prior to April 1, 1998, registrants
paid a services fee of $100 for two years of domain name services upon each
initial registration and an annual renewal fee of $50 per year thereafter
(collectively "registration fees"). The NSF paid the registration fees for
domain names within the .edu and .gov TLDs through March 31, 1997. Commencing
April 1, 1997, the Company agreed with the NSF to provide domain name services
within the .edu and .gov TLDs free of charge. As of October 1, 1997, the Company
no longer registers or administers domain names in the .gov TLD.
Under the terms of the September 14, 1995 amendment to the Cooperative
Agreement, 30% of the registration fees collected by the Company is required to
be set aside for the enhancement of the intellectual infrastructure of the
Internet and, as such, is not recognized as revenue by the Company. The Company
has
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reflected these funds, along with the appropriate percentage of net accounts
receivable, as restricted assets and has recorded an equivalent, related current
liability. The Company maintains the cash received relating to the set aside
funds in a separate interest bearing account. This restricted cash at December
31, 1997 and incorporated hereinMarch 31, 1998 was approximately $23,512,000 and $34,452,000
respectively. The set aside funds, plus any interest earned, are intended to be
disbursed at the direction of the NSF. Future collection or disbursement of
these set aside funds will have no significant effect on the Company's business,
net financial position or results of operations.
On March 12, 1998, the NSF and the Company amended the Cooperative
Agreement to eliminate the 30% set aside requirement effective April 1, 1998 and
to reduce the registration fees by reference.a corresponding amount. Initial registrations
on and after April 1, 1998 are charged $70 for two years of registration
services and an annual renewal fee of $35 per year thereafter. This amendment
will have no effect on the revenue currently recognized on each registration
($70 for initial registrations and $35 for renewals), since the Company
previously did not recognize revenue on the 30% set aside funds. Accordingly,
while the revenue to the Company on a per registration basis does not change,
the amount charged to customers will decline.
In order to provide prompt access to new domain names on the Internet, the
Company generally invoices customers and permits them to pay their registration
fees after their domain names are registered. The Company's experience has been
that, for the period from September 1995 through March 1998, approximately 30%
of registrations have ultimately been deactivated for non-payment. The Company
believes that this level of uncollectible receivables is due to, among other
factors, the large number of individuals and corporations that have registered
multiple domain names with the apparent intention of reselling such names at a
profit. Such resellers have a greater tendency than other customers to default
on their registration fees. As a consequence, the Company has recorded a
comparable provision for uncollectible accounts in determining net registration
revenue. This 30% provision has been consistently applied for the period from
September 1995 through March 1998 and is considered adequate by the Company.
Registration fees charged to end users for registration services, net of
the 30% set aside funds, are recognized as revenue evenly over the registration
term. Accordingly, the Company recognizes $70 ($100 fee less $30 set aside) on a
straight-line basis over the two-year services period for each initial domain
name registration, equivalent to $35 per year. Renewals of domain name
registrations are recorded as revenue based upon $35 ($50 fee less $15 set
aside) recognized on a straight-line basis over the one-year services period.
This "subscription-based" model defers revenue recognition until the Company
provides the registration services, including daily updates to the Internet and
maintenance of and unlimited modifications to individual domain name records,
over the respective registration terms. At March 31, 1998, the Company had net
deferred revenue of $72.5 million.
Consulting Services. Substantially all of the Company's consulting
services revenue is derived from professional services which are generally
provided to clients on a "time and expense" basis and is recognized as services
are performed.
NationsBanc Services, Inc. ("NationsBanc") is the Company's largest
consulting services customer. NationsBanc originally contracted with the Company
in 1993 to provide ongoing analysis, design, implementation and support
engineering for its enterprise network. The Company currently provides network
design and engineering services as well as a variety of project specific
services for NationsBanc. The Company's current contract with NationsBanc is a
three-year contract which commenced January 1, 1997 and is a requirements
contract under which the Company's services are ordered by task orders issued by
NationsBanc. The NationsBanc contract may be terminated by NationsBanc at any
time upon 30-days' prior written notice to the Company. There can be no
assurance that the Company will obtain any additional task orders under the
NationsBanc contract.
RESULTS OF OPERATIONS
Net Revenue. Net revenue increased 135%90% from $5.2$8.7 million for the three
months ended September 30, 1996March 31, 1997 to $12.2$16.5 million for the three months ended September 30, 1997.March
31, 1998. This increase in net revenue was primarily attributable to the
increase in the number of domain name subscriptions,registrations, principally in the .com
TLD. Subscription growth has beenNet
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revenue from registration services increased 131% from $6.7 million for the
three months ended March 31, 1997 to $15.5 million for the three months ended
March 31, 1998. Net new registrations increased 73% from 197,000 for the three
months ended March 31, 1997 to 340,000 for the three months ended March 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 March 31, 1997 were 818,000 as compared to
1,862,000 as of March 31, 1998, for a 128% increase.
Net revenue from registrationconsulting services increased 215%decreased 50% from $3.4$2.0 million for
the three months ended September 30, 1996March 31, 1997 to $10.7$1.0 million for the three months ended
September
30, 1997. The provision for uncollectible accounts used in determining net
registration revenue for the three months ended September 30, 1996 and 1997 was
consistently applied at a rate of 30%. Net registrations increased 112% from
121,000 for the three months ended September 30, 1996 to 256,000 for the three
months ended September 30, 1997. Cumulative net registrations as of September
30, 1996 were 461,000 as compared to 1,296,000 as of September 30, 1997.
Net revenue from Intranet services decreased 17% from $1.8 million for the
three months ended September 30, 1996 to $1.5 million for the three months ended
September 30, 1997.March 31, 1998. This decrease was primarily attributable to a decreasethe conclusion of
certain engagements in business fromDecember 1997 coupled with slower than expected signing
and commencement of new business. NationsBanc Services, Inc. ("NationsBanc"). NationsBanc, the
Company's largest Intranet services client, accounted for $904,000$972,000 or 17.5%11.2% of
the Company's total net revenue for the three months ended September 30, 1996March 31, 1997 and
$305,000$499,000 or 2.5%3.0% of the Company's total net revenue for the three months ended
September 30, 1997.March 31, 1998.
During the first quarter of 1997, task orders for a
number of services that the Company had historically performed for NationsBanc
were not renewed. Though these actions will have an impact on the Company's
Intranet services revenue for the balance of 1997, the Company believes
NationsBanc will continue to be a significant customer of its Intranet 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.
Net revenue increased 158% from $12.0 million for the ninethree months ended September 30, 1996March 31, 1998, the consulting services
division continued to $30.9 million foradd new leadership in sales and operations and retained
additional technical consultants. In addition, the nine months ended September 30,
1997. This increase in net revenue was primarily attributabledivision continued to
emphasize its efforts targeted at lead generation and regional sales and
marketing programs. Consulting services' proposal activities remain strong
although the increase in
the number of domain name subscriptions, principally in the .com TLD. Net
revenue from registration services increased 318% from $6.2 million for the nine
months ended September 30, 1996 to $25.9 million for the nine months ended
September 30, 1997. The provision for uncollectible accounts used in determining
net registration revenue for the nine months ended September 30, 1996 and 1997
was consistently applied at a rate of 30%.
Net registrations increased 136% from 284,000 for the nine months ended
September 30, 1996 to 669,000 for the nine months ended September 30, 1997.
Net revenue from Intranet services decreased 14% from $5.8 million for the
nine months ended September 30, 1996 to $5.0 million for the nine months ended
September 30, 1997. The decrease was attributable to a reduction in business
from NationsBanc which accounted for $2.7 million for the nine months ended
September 30, 1996 and $1.7 million for the nine months ended September 30,
1997. The
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remaining Intranet services business experienced growth for the nine months
ended September 30, 1997, primarily through leveraging opportunities with SAIC
customers.sales closure cycle has been longer than anticipated.
Cost of Revenue. Cost of revenue consists primarily of salaries and
employee benefits, fees paid to subcontractors for work performed in connection
with revenue producing projects, depreciation and equipment costs, lease costs
of the operations infrastructure and the associated operating overhead. Cost of
revenue increased 89%38% from $3.7$5.3 million for the three months ended September 30, 1996March 31,
1997 to $7.0$7.3 million for the three months ended September 30, 1997.March 31, 1998. The increase was
primarily driven by the growth of the Company's registration business which
experienced additional labor
costs of $1.4 million and additional outsourcing costs of $1.1 million to vendors in support of the
Company's invoicing, collection and processing activities.activities and additional
depreciation charges and equipment expenditures of $918,000. In June 1997, the
Company opened a 31,200 square foot facility to support its Internet business
operations and in January 1998, the Company signed an agreement to lease an
additional 9,100 square feet at the same location. This leased facility is
designed to meet current registration services customer support needs as well as
to provide expansion capability for future business. The Company continues to
invest in improvements to the back office component of its domain name
registration business including investments in additional hardware, software,
staffing and facilities and currently anticipates that it will continue to make
significant investments in its back office for the foreseeable future.
In June 1997, the Company opened a
31,000 square foot facility to support its Internet business operations. This
leased facility is designed to meet current registration services customer
support needs as well as to provide expansion capacity for future business.
As a percentage of net revenue, cost of revenue decreased from 71.8%60.9% for
the three months ended September 30, 1996March 31, 1997 to 57.8%44.2% for the three months ended September 30, 1997.March
31, 1998. This decrease primarily reflects economies of scale that the Company
has beguncontinued to achieve due to the growth of its subscription-based domain name
registration business. In the near term, the continued need for back office
investments is expected to partially offset future margin improvements arising
from economies of scale.
Cost of revenue increased 81% from $10.2 million for the nine months ended
September 30, 1996 to $18.5 million for the nine months ended September 30,
1997. This increase was driven by $5.0 million in additional labor costs
primarily associated with supporting the growth of the Company's registration
services business.
As a percentage of net revenue, cost of revenue decreased from 85.3% for
the nine months ended September 30, 1996 to 59.8% for the nine months ended
September 30, 1997.
Research and Development Expenses. Research and development expenses
consist primarily of compensation expenses to support the creation, development
and enhancement of the Company's products and technologies. Research and
development expenses increased 67%133% from $226,000$311,000 for the three months ended
September 30, 1996March 31, 1997 to $377,000$725,000 for the three months ended September 30, 1997.March 31, 1998. To date,
all of the Company's research and development costs have been expensed as
incurred. The Company expects that the level of research and development
expenses will continue to 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 decreased fromwere 3.6% for the three months
ended March 31, 1997 and 4.4% for the three months ended September 30, 1996 to
3.1% for the three months ended September 30, 1997.
Research and development expenses increased 287% from $284,000 for the nine
months ended September 30, 1996 to $1.1 million for the nine months ended
September 30, 1997. As a percentage of net revenue, research and development
expenses increased from 2.4% for the three months ended September 30, 1996 to
3.5% for the three months ended September 30, 1997.March 31, 1998.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses consist primarily of salaries of marketing, business
development, general management, administrative and financial personnel,
corporate services from SAIC,Science Applications International Corporation ("SAIC"),
legal costs and amortization of goodwill associated with the Company's
acquisition by SAIC. Selling, general and administrative expenses increased 63%170%
from $1.9$2.3 million for the three months ended September 30, 1996March 31, 1997 to $3.1$6.2 million for
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the three months ended September 30, 1997.March 31, 1998. The increase wasis primarily attributable to
increasedincreases in marketing and business development expenses of $979,000, management
and administrative labor expenses of $841,000 and an increase in legal costs associated with the administration of the Company's domain dispute
policy. These expenses include $263,000 of expenses allocated from SAIC during
the three months
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ended September 30, 1996 and $304,000 of expenses which were charged by SAIC
during the three months ended September 30, 1997.$716,000.
As a percentage of net revenue, selling, general and administrative
expenses decreasedincreased from 37.3%26.4% for the three months ended September 30, 1996March 31, 1997 to 25.5%37.6%
for the three months ended September 30, 1997. The decrease in percentage
of net revenue reflects economies the Company has begun to achieve due primarily
to the growth of its domain name registration business.March 31, 1998. The Company 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. Selling, generalIn
particular, it is anticipated that sales, marketing and administrative expenses increased 84% from $4.3
million for the nine months ended September 30, 1996 to $7.9 million for the
nine months ended September 30, 1997. The increase was attributable to increased
management and administrative labor of $1.7 million and an increase in legal
costs of $405,000 associated with the administration of the Company's domain
dispute policy. These expenses include $588,000 of expenses allocated from SAIC
during the nine months ended September 30, 1996 and $770,000 of expenses which
were charged by SAIC during the nine months ended September 30, 1997.
As a percentage of net revenue, selling, general and administrative
expenses decreased from 35.8% for the nine months ended September 30, 1996 to
25.6% for the nine months ended September 30, 1997. The decrease in percentage
of net revenue reflects economies the Company has begun to achieve due primarily
to the growth of its domain name registration business. The Company expects that
the level of selling, general and administrativebusiness development
expenses will increase significantly inas the near future in termsCompany introduces new enhanced registration and
other services and begins to actively promote the use of absolute dollars as operations
continue to expand.the .com TLD.
Interest Income. The Company had net interest income of $288,000$149,000 for the
three months ended September 30, 1996March 31, 1997 as compared to $570,000$1.3 million for the three
months ended September 30, 1997.March 31, 1998. The Company had net interest income of $374,000 for the nine months ended
September 30, 1996 as compared to $1.1 million for the nine months ended
September 30, 1997. The change for both the three month and nine month
comparisonsincrease is attributable to increasedthe investment of
the net proceeds of the Company's stock offering as well as improved cash flow
associated withresulting from the Company's
registration services business.increase in domain name registrations.
Income Taxes (Benefit).Taxes. The provision for income tax benefittaxes was $116,00043% of pretax earnings,
or $382,000 for the three months ended September 30, 1996 as compared to an income tax expense of $995,000March 31, 1997, and 42%, or $1.5 million
for the three months ended September 30, 1997. The effective tax rate changed
from 28% for the three months ended September 30, 1996 to 45% for the three
months ended September 30, 1997.
The income tax benefit was $692,000 for the nine months ended September 30,
1996 as compared to an income tax expense of $2,006,000 for the nine months
ended September 30, 1997. The effective tax rate changed from 28% for the nine
months ended September 30, 1996 to 45% for the nine months ended September 30,
1997.March 31, 1998. The difference between the effective
rates for both the three month and
nine month comparisons is principally attributable to the relative impact that non-deductible
goodwill had on pretax operating income or loss for the quarter.
The goodwill amountyear. Goodwill is being
amortized by the Company over five years and is associated with the acquisition
of the Company by SAIC in 1995.
LIQUIDITY AND CAPITAL RESOURCES
FromAt March 31, 1998, the Company's principal source of liquidity was its acquisition by SAIC in March 1995 until December 1996, the Company
participated in SAIC's centralized cash management system whereby cash received
from operations was transferred to SAIC's centralized cash accounts
and cash disbursements were fundedequivalents of $6.8 million and its short-term investments of $78.9
million, which when combined represent an increase of $4.4 million from such centralized cashits
December 31, 1997 balances in those accounts.
Accordingly, cash
requirements for operating purposes and for capital expenditures were met from
this source. Beginning in 1997, the Company implemented its own cash management
system.
At September 30, 1997,March 31, 1998, the Company's cumulative net obligation to SAIC for
intercompany activity was $21.9$2.4 million, an increase of $6.6$1.1 million for the
nine months then ended.quarter. Intercompany activity is primarily comprised of
corporate income tax payments made by SAIC on behalf of the
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Company in accordance with the companies' tax sharing arrangement and salaries and benefits
paid by SAIC on behalf of the Company. Effective with the second
quarter of 1997, corporate taxes were paid to SAIC on a quarterly basis, with
all other intercompany balances between SAICCompany and the Company paid on a monthly
basis.is settled monthly. Pursuant to the
Tax Sharing Agreement dated September 26, 1997, the Company will now generally
remit income tax payments directly to tax authorities as it no longer is part of
SAIC's consolidated group for federal income tax purposes.
The Company completed its initial public offering on October 1, 1997
raising $54 million for the Company. From these proceeds, the Company paid the
$10 million dividend to SAIC on October 1, 1997. In addition, the Company made
its quarterly tax and intercompany activity payments to SAIC totaling $10.5
million by October 3, 1997 with the remaining $11.4 million to be paid by
November 15, 1997.
Cash provided by operations was $26.5$10.0 million for the ninethree months ended
September 30, 1997.March 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 24-two- and
12-monthone-year registration periods.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.liabilities, generally paid on a quarterly
basis.
Investing activities used $29.6$45.5 million for the ninethree months ended September
30, 1997March
31, 1998, of which $28.3$38.7 million was net purchases of short-term investments and
$6.0 million was purchases of long-term investments. These investments are
primarily comprised of commercial short-term investment grade securities. Purchases of
furniture and equipment of $1.2 million for the period represents a decrease
from the nine months ended September 30, 1996 as a result of the utilization of
lease arrangements during 1997. The majority of capital acquisitions are to
support growth in the domain name registration business and are expected to
continue to be financed under lease agreements ranging from 24 to 36 months.
The Company believes that the net proceeds from its IPO, combined with its existing cash balance, short-termbalances and investments and
expected cash flows expected from future operations will be sufficient to meet the
Company's capital requirements for at least the next 12 to 18 months.
FACTORS AFFECTING OPERATING RESULTS
Limited Operating History. 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. 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. There can be no
assurance that the Company will be successful in addressing such risks or that
the Company will continue to 24 months.obtain new registrations at current rates or obtain
renewals from a significant portion of its customers.
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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 its
variable or fixed 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 may have an
immediate adverse impact on the Company's business, operating results and
financial condition. In addition, the Company expects a significant increase in
its operating expenses as it funds greater levels of product and services
development, increases its sales and marketing operations, updates systems and
infrastructure, expands its facilities, develops new distribution channels and
broadens its customer support capabilities. While no individual expenditure is
anticipated to have a material impact on the Company's operating results, the
combined effect could be significant and cannot be reasonably estimated at this
time. To the extent that such expenses precede or are not subsequently followed
by an increase in revenue, the Company's business, financial condition and
results of operations will be materially and adversely affected.
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,
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.
Uncertainty of Internet Governance and Regulation. On February 20, 1998,
the U.S. government published in the Federal Register "A Proposal to Improve
Technical Management of Internet Names and Addresses" (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 ("DNS") 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 operations through continued uncertainty about future Internet
governance or a disruption to the administration, effective operation or
maintenance and expansion of the Internet, in general, or the domain name
registration system, in particular. Additionally, any final rule could be
different, perhaps substantially, from the Proposed Rule. Any final rule or any
terms negotiated thereunder by the U.S. government and the Company could contain
provisions which are not favorable to the Company or not consistent with the
Company's current or future plans. It is impossible to predict at this time
whether or when a final rule will be issued and, if issued, the exact nature of
its provisions or of any such terms, the timing of implementation or the precise
effect of such provisions or terms on the Company. It is possible that certain
provisions of any final rule or certain of such terms could have a material
adverse effect on the Company's business, financial condition and results of
operations.
Competition. 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 currently
faces competition in the domain name registration business from registries for
country codes, third level domain
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name providers such as Internet access providers and registries of TLDs other
than those TLDs currently being registered by the Company. A number of entities
have already begun to offer competing registration services using other TLDs.
Future competition in the Company's domain name registration business could come
from many different companies, including, but not limited to, major
telecommunications firms, cable companies and Internet access providers. Such
entities have core capabilities to deliver registration services, such as help
desks, billing services and network management, along with strong name
recognition and Internet industry experience. Other companies with some or all
of these capabilities may also enter the registration business. Also emerging is
a growing contingent of domain name resellers. The Company's position as the
leading registrar of domain names could be materially and adversely affected by
the emergence of any of the foregoing competitors and potential competitors,
many of which have longer operating histories and significantly greater name
recognition and greater financial, technical, marketing, distribution and other
resources than the Company. In addition, the Company's revenue and registration
fees could be reduced due to increased competition or pricing pressures. For
example, other entities may bundle domain name registrations with other products
or services, effectively providing such registration services for free. 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. 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.
Litigation. The Company is a party in a number of legal proceedings as
described in "Part II -- Item 1 -- Legal Proceedings." While the Company cannot
reasonably estimate the potential impact of the claims advanced in the PG Media
suit described therein, a successful claim against the Company could have a
material adverse effect on the Company's business, financial condition and
results of operations. In addition, while the Company cannot predict what
relief, if any, might be sought, awarded or imposed as a result of any civil
action which could be 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, financial
condition and results of operations. Moreover, litigation in which the Company
is involved has resulted and likely will result in, and any future litigation
can be expected to result in, substantial legal and other expenses to the
Company and a diversion of the Company's personnel. See "Part II -- Item
1 -- Legal Proceedings."
System Interruption and Security Risks. The Company's operations are
dependent upon its ability to maintain its computer and telecommunications
equipment in effective working order and to reasonably protect its systems
against damage from fire, natural disaster, sabotage, power loss,
telecommunication failure, human error or similar events. In addition, growth of
the Company's customer base may put strain on the capacity of its computers and
telecommunications systems and the Company's inability to sufficiently maintain
or upgrade its systems could lead to degradation in performance or system
failure. Any damage, failure or delay that causes significant interruptions in
the Company's systems would have a material adverse effect on the Company's
business, financial condition and results of operations.
Year 2000. The Company is in the process of assessing its computer
software applications and systems to ensure their functionality with respect to
the "Year 2000" millenium change. At this time, the Company believes that the
remediation costs, if any, needed to make all of its internal applications and
systems Year 2000 compliant are not material. Although the Company believes that
its internal mission critical systems are Year 2000 compliant, the failure of
the software applications or internal systems of other companies on which the
Company's systems rely or to which they are connected or of other
Internet-related companies, including Internet web hosting companies, Internet
access providers, or Internet root server operators, none of which the Company
controls, to be Year 2000 compliant upon January 1, 2000 could have a material
adverse effect on the operation of the Internet and/or a material adverse effect
on the Company's business, financial condition and results of operations.
Technological Change and Additional Technology, Products and Services. The
Company's future financial success will be highly dependent upon its ability to
develop and commercialize in a timely manner
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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.
Intellectual Property Rights. If it were determined that the Company does
not have ownership rights in its database of information relating to customers
in its registration business or if the Company is unable to protect such rights
in this database or is required to share the database with potential
competitors, there could be a material adverse effect on the Company's business,
financial condition and results of operations. The Proposed Rule would require
the Company to provide the U.S. government with "a copy and documentation of all
the data, software, and appropriate licenses to other intellectual property
generated under the [C]ooperative [A]greement, for use by the new corporation
for the benefit of the Internet." If certain of the Company's software and data
generated which is proprietary to the Company were to be provided to the new
corporation under the Proposed Rule and in turn provided to competing registries
or registrars, the Company's business, financial condition and results of
operations could be materially and adversely affected.
The Company relies upon a combination of nondisclosure and other
contractual arrangements with its employees and third parties and trade secret
laws to protect its proprietary rights and limit the distribution of its
proprietary information. There can be no assurance that the steps taken by the
Company in this regard will be adequate to deter misappropriation of proprietary
information or that the Company will be able to detect unauthorized use of its
proprietary information and take appropriate steps to enforce its intellectual
property rights. Furthermore, even if these steps are successful, there can be
no assurance that others will not develop technologies that are similar or
superior to the Company's proprietary technology. Although the Company believes
that its services do not infringe on the intellectual property rights of others
and that it has all rights necessary to utilize the intellectual property
employed in its business, the Company is subject to the risk of claims alleging
infringement of third party intellectual property rights. Any such claims could
require the Company to spend significant sums in litigation, pay damages and
develop noninfringing intellectual property or acquire licenses to the
intellectual property that is the subject of asserted infringement. Failure by
the Company to adequately protect its proprietary rights or litigation relating
to intellectual property rights could have a material adverse effect on the
Company's business, financial condition and results of operations.
Shares Eligible for Future Sale. SAIC owns 100% of the Company's
outstanding Class B common stock, which, as of May 8, 1998, represented
approximately 74.7% of the outstanding common stock of the Company. A decision
by SAIC to sell such shares could materially and adversely affect the market
price of the Class A common stock. The Company and SAIC have entered into a
registration rights agreement 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 B common stock owned by
SAIC and any other shares of Class A common stock otherwise acquired by SAIC,
subject to certain terms and conditions. The Company has agreed to indemnify
SAIC in connection with any such registration.
In certain circumstances, including without limitation, a public offering
or distribution of Class B common stock by SAIC, the Class B common stock would
trade separately from the Class A common stock in the public market. Separate
trading of the Class B common stock in the public market or the perception that
such trading could occur, could materially and adversely affect the market price
of the Class A common stock.
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Possible Volatility of Stock Price. The market price of the shares of
Class A common stock at times has been highly volatile and may be significantly
affected by factors such as actual or anticipated fluctuations in the Company's
results of operations, announcements of technological innovations, developments
in Internet governance, announcement of additional competing registries,
registrars or TLDs, litigation costs, results of litigation, introduction of new
products or services by the Company or its competitors, developments with
respect to patents, copyrights or proprietary rights, conditions and trends in
the networking and other technology industries, changes in or failure by the
Company to meet securities analysts' expectations, general market conditions and
other factors. In addition, the stock market has from time to time experienced
significant price and volume fluctuations that have particularly affected the
market prices for the common stocks of technology companies. These broad market
fluctuations may adversely affect the market price of the Company's Class A
common stock. In the past, following periods of volatility in the market price
of a particular company's securities, securities class action litigation has
often been brought against that company. There can be no assurance that such
litigation will not occur in the future with respect to the Company. Such
litigation could result in substantial costs and a diversion of management's
attention and resources, which could have a material adverse effect upon the
Company's business, financial condition and results of operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not Applicable.
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
As of October 31, 1997,May 8, 1998, the Company was a defendant in ninefour lawsuits involving
domain name disputes between trademark owners and domain name holders. The
Company is drawn into such disputes, in part, as a result of claims by trademark
owners that the Company is legally required, upon request by a trademark owner,
to terminate the right the Company granted to an alleged trademark infringer to
register the domain name in question. Further, trademark owners also have also
alleged that the Company should be required to monitor future domain name
registrations and reject registrations of domain names which are identical or
similar to their federally registered trademark. The holders of the domain name
registrations in dispute have, in turn, questioned the Company's right, absent a
court order, to take any action which suspends their registration or use of the
domain names in question. Such litigation hasAlthough 43 out of approximately 3,900 of these
situations have resulted in and any future litigation can be expected to result in, substantial
legal and other expenses tosuits actually naming the Company as a defendant, as
of May 8, 1998, no award of damages has ever been made against the Company. The
Company believes that it has meritorious defenses and a diversion of the efforts of the
Company's personnel.intends to vigorously
defend itself against these claims.
On June 27, 1997, SAIC received a Civil Investigative Demand ("CID") from
the U.S. Department of Justice ("DOJ") issued in connection with an
investigation to determine whether there is, has been, or may be aan antitrust
violation of
antitrust laws 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 is in the process
of producing the documents and
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information requested. Neither SAIC nor the Company is aware of the scope or
nature of the investigation. The Company cannot reasonably
estimate the potential impact of the investigation ornor can it predict whether a
civil action willmay ultimately be filed by the DOJ or by private litigants as a result of the
DOJ investigation or, if filed, what such action would entail.DOJ. The Company is unable to
predict the form of relief that might be sought in such an action or
that mightto be
awarded by a court or imposed as a result of any settlement
between the Company and the DOJ or private litigants.instituted. Any such relief from such a suit could have a material adverse
effect on the Company's business, financial condition and results of operations.
On March 20, 1997, PG Media, Inc., a New York-based corporation ("PG
Media"), filed a lawsuit against the Company in the United States District
Court, Southern District of New York alleging that the Company had restricted
access to the Internet by not adding PG Media's requested TLDs 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 Company be ordered to
amend the root zone configuration file so that the file
includesinclude reference to PG Media's TLDs and nameservers.name servers in the root zone file
administered by the Company under the Cooperative Agreement. The Company has
answered the complaint. In addition,June 1997, the Company recently received written direction
from the National Science Foundation ("NSF")NSF not to take any action
to15
16
which would create additional TLDs or to add any new TLDs to the Internet root
serverszone until the NSF provides further guidance is provided by the NSF.guidance. On September 17, 1997, PG Media
filed a Second Amended Complaint adding the NSF as a defendant. On May 14, 1998,
PG Media served the Company with a motion for a preliminary injunction against
both defendants. The motion seeks a hearing before the court on June 8, 1998 to
compel both defendants to add PG Media's TLDs to the Internet root zone within
30 days. The Company believes that it has meritorious defenses and intends to
vigorously defend itself against such motion and the claims of PG Media.
WhileAlthough the Company cannot reasonably estimate the potential impact of such
claims, a successful claim under the plaintiff's theory could have a material
adverse effect on the Company's business, financial condition and results of
operations.
On October 17, 1997, a group of six plaintiffs filed a lawsuit (the "Thomas
suit") against the Company and the NSF in the United States District Court,
District of Columbia, alleging violationschallenging the legality of fees defendants charge for the
Competition in Contracting Act,registration of domain names on the Sherman ActInternet and the Fifth Amendment. Relief sought includesseeking restitution of fees
collected from domain name registrants in an amount in excess of $100 million,
damages, and injunctive and other relief. Plaintiffs originally alleged
violations of the Competition in Contracting Act ("CICA"), the Sherman Act and
the U.S. Constitution. Following the filing of motions to dismiss by the
defendants, the plaintiffs filed an amended complaint on January 30, 1998,
dropping the cause of action based upon CICA, but adding alleged violations of
the Administrative Procedures Act and the Independent Offices Appropriations
Act. The Company
believes that it has meritorious defenses and intends to vigorously defend
itselfplaintiffs also filed a motion for preliminary injunctive relief
against these claims. Whilethe 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 cannot reasonably estimatefor the potential impactIntellectual
Infrastructure Fund. On February 10, 1998, the plaintiffs filed a motion for
preliminary injunction against the Company seeking several items of such claims,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 successful claim undermotion for partial
summary judgment concerning the Intellectual Infrastructure Fund. The
plaintiffs' motion for preliminary injunction against the Company and partial
summary judgment against the NSF, and both motions to dismiss were heard before
the Court on March 17, 1998. On April 6, 1998, the Court issued its opinion,
granting summary judgment in favor of the plaintiffs on the Intellectual
Infrastructure Fund, ruling it an "unlawful tax." The Court also granted the
Company's motion to dismiss all other counts and, simultaneously, denied the
plaintiffs' theory
could havepreliminary injunction motion against the Company. Subsequently, the
NSF appealed the February 2, 1998 preliminary injunction against it. 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 NSF to
deposit the entire fund into the U.S. Treasury. On May 5, 1998 the NSF filed a
material adverse effect onmotion to vacate the Company's business, financial
conditionpreliminary injunction and results of operations.to dismiss the case.
The Company is involved in various other investigations, claims and
lawsuits arising in the normal conduct of its business, none of which, in the
opinion of the Company's management, will have a material adverse effect on its
consolidated financial position, results of operations, cash flows or its ability to conduct
business.
Litigation in which the Company is involved has resulted and likely will
result in, and any future litigation can be expected to result in, substantial
legal and other expenses to the Company and a diversion of the efforts of the
Company's personnel.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
The Company's Registration Statement on Form S-1 (Registration No.
333-30705) was declared effective September 25, 1997 by the Securities and
Exchange Commission. The managing underwriters of the Class A Common Stockcommon stock
offering commencing September 26, 1997 were Hambrecht & Quist, J.P. Morgan & Co.
and PaineWebber Incorporated. The Company registered and sold 3,220,000 shares
for its own account at an aggregate price of $57,960,000 and the selling
stockholder (SAIC) registered and sold 575,000 shares for its account at an
aggregate price of $10,350,000, for a combined total of 3,795,000 shares at an
aggregate price of $68,310,000. The offering has since terminated.
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17
The total amount of expenses incurred for the Company's account in
connection with the offering is estimated at $5,457,200,were $5,555,200, which is comprised of $4,057,200
for underwriting discounts and commissions and $1,400,000$1,498,000 of other expenses. No
expenses were paid to directors, officers or persons owning more than ten
percent of any class of the Company's equity securities. The resultant Company's
net offering proceeds were $52,502,800.$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.
As of September 30, 1997, the Company had not received the proceeds from
the offering. On October 1, 1997, the Company received the offering proceeds from which thea
$10,000,000 dividend was
13
14 paid to SAIC. SAIC owns ten percent or more of a class
of the Company's equity securities and is an affiliate of the Company. The
remaining proceeds have been invested in short-term investment grade government discount
notes, commercial paper and commercial
paper.corporate bonds.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits -- See Exhibit Index
(b) Reports on Form 8-K:8-K -- None
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NETWORK SOLUTIONS, INC.
Date: November 14, 1997 BYMay 15, 1998 By /s/ ROBERT J. KORZENIEWSKI
------------------------------------
Robert J. Korzeniewski
Chief Financial Officer 15and
Authorized Signatory
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EXHIBIT INDEX
NETWORK SOLUTIONS, INC.
QUARTERTHREE MONTHS ENDED SEPTEMBER 30, 1997MARCH 31, 1998
EXHIBIT SEQUENTIAL
NO. DESCRIPTION OF EXHIBITS PAGE NO.
- -------- --------------------------------------------------------------------------------- ----------------------- ----------
3(i)*3(ii) Second Amended and Restated CertificateBy-Laws of Incorporation..................
3(ii)* BylawsNetwork Solutions,
Inc., Effective as of the Registrant, as amended......................................
4.1* Form of Common Stock Certificate..........................................
4.2 Reference is made to Exhibits 3(i) and 3(ii)..............................May 1, 1998.........................
27.1 Financial Data Schedule...................................................
11 Statement of Computation of Pro Forma Net Income (Loss) Per Share
(Unaudited)............................................................. 17Schedule.....................................
- ---------------
* Incorporated by reference to exhibit of the same number to the Registrant's
Registration Statement on Form S-1 (Registration No. 333-30705), originally
filed with the Securities and Exchange Commission on July 3, 1997.
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