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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 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 Registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 52-1146119
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
</TABLE>
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 Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
--- ---
As of August 7, 1998, the Registrant had 4,122,938 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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<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Statements of Financial Position as of December 31, 1997 and
June 30, 1998 (unaudited)................................. 3
Unaudited Statements of Operations for the three and six
months ended June 30, 1997 and 1998....................... 4
Unaudited Statements of Changes in Stockholders' Equity for
the six months ended June 30, 1998........................ 5
Unaudited Statements of Cash Flows for the six months ended
June 30, 1997 and 1998.................................... 6
Notes to Financial Statements............................... 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 9
Item 3. Quantitative and Qualitative Disclosures About Market
Risk...................................................... 18
PART II OTHER INFORMATION
Item 1. Legal Proceedings........................................... 18
Item 2. Changes in Securities and Use of Proceeds................... 20
Item 4. Submission of Matters to a Vote of Security Holders......... 20
Item 6. Exhibits and Reports on Form 8-K............................ 21
Signature............................................................ 22
Index to Exhibits.................................................... 23
</TABLE>
2
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PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
NETWORK SOLUTIONS, INC.
STATEMENTS OF FINANCIAL POSITION
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1997 1998
------------ ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 41,146,000 $ 17,928,000
Short-term investments, marketable securities............. 40,200,000 79,516,000
Accounts receivable, net.................................. 5,792,000 11,226,000
Prepaids and other assets................................. 1,005,000 2,365,000
Deferred tax asset........................................ 20,153,000 26,219,000
Restricted assets......................................... 25,873,000 39,764,000
------------ ------------
Total current assets........................................ 134,169,000 177,018,000
Furniture and equipment, net................................ 6,146,000 8,872,000
Long-term investments, marketable securities................ -- 6,374,000
Deferred tax asset.......................................... 8,128,000 9,416,000
Goodwill, net............................................... 1,177,000 905,000
------------ ------------
Total Assets................................................ $149,620,000 $202,585,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities.................. $ 6,426,000 $ 11,198,000
Due to parent............................................. 1,250,000 2,358,000
Income taxes payable...................................... 5,042,000 529,000
Current portion of capital lease obligations.............. 842,000 868,000
Deferred revenue, net..................................... 43,789,000 64,977,000
Internet fund liability................................... 25,873,000 39,764,000
------------ ------------
Total current liabilities................................... 83,222,000 119,694,000
Capital lease obligations................................... 1,081,000 643,000
Long-term deferred revenue, net............................. 17,662,000 23,974,000
------------ ------------
Total liabilities........................................... 101,965,000 144,311,000
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.001 par value, authorized 10,000,000
shares; none issued and outstanding in 1997 and 1998 -- --
Class A common stock, $.001 par value; authorized
100,000,000 shares; 3,795,000 and 4,083,263 issued and
outstanding in 1997 and 1998........................... 4,000 4,000
Class B common stock, $.001 par value; authorized
30,000,000 shares; 11,925,000 issued and outstanding in
1997 and 1998.......................................... 12,000 12,000
Additional paid-in capital................................ 56,451,000 62,336,000
Accumulated deficit....................................... (8,812,000) (4,300,000)
Accumulated other comprehensive income.................... -- 222,000
------------ ------------
Total stockholders' equity.................................. 47,655,000 58,274,000
------------ ------------
Total Liabilities and Stockholders' Equity.................. $149,620,000 $202,585,000
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
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NETWORK SOLUTIONS, INC.
STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------- -------------------------
1997 1998 1997 1998
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net revenue............................... $10,069,000 $20,476,000 $18,724,000 $36,968,000
Cost of revenue........................... 6,141,000 8,791,000 11,435,000 16,139,000
----------- ----------- ----------- -----------
Gross profit.............................. 3,928,000 11,685,000 7,289,000 20,829,000
Research and development expenses......... 407,000 815,000 718,000 1,540,000
Selling, general and administrative
expenses................................ 2,487,000 8,008,000 4,788,000 14,190,000
Interest income........................... (335,000) (1,416,000) (484,000) (2,743,000)
Other expenses............................ -- 32,000 -- 67,000
----------- ----------- ----------- -----------
Income before income taxes................ 1,369,000 4,246,000 2,267,000 7,775,000
Provision for income taxes................ 629,000 1,783,000 1,011,000 3,263,000
----------- ----------- ----------- -----------
Net income................................ $ 740,000 $ 2,463,000 $ 1,256,000 $ 4,512,000
=========== =========== =========== ===========
Earnings per common share:
Basic................................... $ 0.06 $ 0.15 $ 0.10 $ 0.29
=========== =========== =========== ===========
Diluted................................. $ 0.06 $ 0.15 $ 0.10 $ 0.27
=========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
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NETWORK SOLUTIONS, INC.
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(UNAUDITED)
<TABLE>
<CAPTION>
CLASS A CLASS B
COMMON STOCK COMMON STOCK ADDITIONAL COMPRE- RETAINED TOTAL
------------------ -------------------- PAID-IN HENSIVE EARNINGS STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT CAPITAL INCOME (DEFICIT) EQUITY
--------- ------ ---------- ------- ----------- -------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31,
1997.................. 3,795,000 $4,000 11,925,000 $12,000 $56,451,000 $ -- $(8,812,000) $47,655,000
Issuance of common stock
pursuant to stock
plans................. 288,263 3,767,000 3,767,000
Tax benefit associated
with stock plans...... 2,118,000 2,118,000
Unrealized gain on
securities............ 222,000 222,000
Net income for the six
months ended June 30,
1998.................. 4,512,000 4,512,000
--------- ------ ---------- ------- ----------- -------- ----------- -----------
Balance, June 30,
1998.................. 4,083,263 $4,000 11,925,000 $12,000 $62,336,000 $222,000 $(4,300,000) $58,274,000
========= ====== ========== ======= =========== ======== =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
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NETWORK SOLUTIONS, INC.
STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
--------------------------
1997 1998
----------- ------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................ $ 1,256,000 $ 4,512,000
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization.......................... 1,017,000 1,459,000
Provision for uncollectible accounts receivable........ 3,624,000 2,168,000
Deferred income taxes.................................. (2,415,000) (7,499,000)
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable........... 2,576,000 (7,602,000)
Increase in prepaids and other assets................ (425,000) (1,045,000)
Increase in accounts payable and accrued
liabilities......................................... 1,378,000 4,908,000
Decrease in income taxes payable..................... -- (4,513,000)
Increase in deferred revenue......................... 16,276,000 27,500,000
----------- ------------
Net cash provided by operating activities......... 23,287,000 19,888,000
----------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of furniture and equipment....................... (317,000) (4,364,000)
Purchase of short-term investments, net................... (3,625,000) (39,316,000)
Purchase of long-term investments......................... -- (6,007,000)
----------- ------------
Net cash used in investing activities............. (3,942,000) (49,687,000)
----------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net transactions with SAIC................................ (8,729,000) 1,108,000
Repayment of capital lease obligations.................... (189,000) (412,000)
Issuance of common stock pursuant to stock plans.......... -- 3,767,000
Tax benefit associated with stock plans................... -- 2,118,000
----------- ------------
Net cash provided by (used in) financing
activities..................................... (8,918,000) 6,581,000
----------- ------------
Net increase (decrease) in cash and cash equivalents........ 10,427,000 (23,218,000)
Cash and cash equivalents, beginning of period.............. 15,540,000 41,146,000
----------- ------------
Cash and cash equivalents, end of period.................... $25,967,000 $ 17,928,000
=========== ============
</TABLE>
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") currently acts as the exclusive
registrar of Internet domain names within the .com, .org, .net and .edu top
level domains ("TLDs") pursuant to a cooperative agreement (the "Cooperative
Agreement") with the National Science Foundation ("NSF"). Domain names are used
to identify a unique site or presence on the Internet. As registrar of these
TLDs, the Company registers new domain names and is responsible for the
maintenance of the master file of domain names including daily updates to the
Internet. The Company also provides enterprise network consulting services,
focusing on network engineering, network and systems security and network
management solutions for commercial customers.
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 10-K annual report
for the year ended December 31, 1997.
NOTE 3 -- COMPUTATION OF EARNINGS PER SHARE
The following is a reconciliation of the numerator and denominator used in
the basic and diluted EPS computations for continuing operations:
<TABLE>
<CAPTION>
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
<S> <C> <C> <C>
Three Months Ended June 30, 1998
- --------------------------------------------------
Basic............................................. $2,463,000 15,895,000 $0.15
=====
Dilutive securities:
Outstanding options............................. -- 848,000
---------- ----------
Diluted........................................... $2,463,000 16,743,000 $0.15
========== ========== =====
Three Months Ended June 30, 1997
- --------------------------------------------------
Basic............................................. $ 740,000 12,500,000 $0.06
=====
Dilutive securities:
Outstanding options............................. -- 91,000
---------- ----------
Diluted........................................... $ 740,000 12,591,000 $0.06
========== ========== =====
</TABLE>
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NOTE 3 -- COMPUTATION OF EARNINGS PER SHARE -- (CONTINUED)
<TABLE>
<CAPTION>
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
<S> <C> <C> <C>
Six Months Ended June 30, 1998
- --------------------------------------------------
Basic............................................. $4,512,000 15,811,000 $0.29
=====
Dilutive securities:
Outstanding options............................. -- 632,000
---------- ----------
Diluted........................................... $4,512,000 16,443,000 $0.27
========== ========== =====
Six Months Ended June 30, 1997
- --------------------------------------------------
Basic............................................. $1,256,000 12,500,000 $0.10
=====
Dilutive securities:
Outstanding options............................. -- 91,000
---------- ----------
Diluted........................................... $1,256,000 12,591,000 $0.10
========== ========== =====
</TABLE>
Common shares issued are weighted for the period the shares were
outstanding and incremental shares assumed issued under the treasury stock
method for diluted EPS are weighted for the period the underlying options were
outstanding.
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 for the six months ended June 30, 1998 as follows:
<TABLE>
<CAPTION>
ACCUMULATED
OTHER
UNREALIZED GAINS COMPREHENSIVE
ON SECURITIES INCOME
---------------- -------------
<S> <C> <C>
Pre-tax amount........................................... $367,000 $367,000
Income tax............................................... 145,000 145,000
-------- --------
Net of tax amount........................................ $222,000 $222,000
======== ========
</TABLE>
NOTE 5 -- COMMITMENTS AND CONTINGENCIES
INTERNET GOVERNANCE
On June 5, 1998, the U.S. government published in the Federal Register a
statement of policy entitled "Management of Internet Names and Addresses,"
informally called the "White Paper" (the "Statement of Policy"). The Statement
of Policy invites private sector Internet stakeholders to work together to form
a new private, not-for-profit corporation to oversee policy for the Internet
name and address system. Following the publication of the Statement of Policy,
the International Forum for the White Paper (the "IFWP"), an ad hoc coalition of
Internet stakeholders, was initiated to coordinate international meetings for
stakeholders to discuss the transition of the domain name system ("DNS")
administration to the private sector. The IFWP is seeking to establish a
consensus among the stakeholders on a framework under which the new corporation
will be formed and operate. The Statement of Policy states that the U.S.
government and the Company will hold discussions about the terms and conditions
of the ramp down of the Cooperative Agreement and sets forth certain of the
government's expectations with regard to the Company's actions that will be
required to permit the development of competition in domain name registration.
It is impossible to predict at this time whether or when the process initiated
by the Statement of Policy will result in the transition of DNS administration
to the
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NOTE 5 -- COMMITMENTS AND CONTINGENCIES -- (CONTINUED)
private sector and, if it does, the effect of such transition and private sector
administration of the DNS on the Company. It is also impossible to predict at
this time the outcome of discussions between the Company and the government
concerning the terms and conditions of the ramp down of the Cooperative
Agreement.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
This quarterly report on Form 10-Q contains forward-looking statements. For
this purpose, any statements contained herein that are not statements of
historical fact may be deemed to be forward-looking statements. Statements
regarding the intent, belief or current expectations of 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 10-K, as filed 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 to these TLDs, the Company registers new
domain names and is responsible for the maintenance through daily updates of the
master file of domain names. 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 major financial institutions and multinational oil and gas
corporations. The Company also develops internally and together with other
companies new technology, products and services that may be offered in
conjunction with the Company's domain name registration and consulting services.
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 updates to the master file
of domain names. The Cooperative Agreement became effective January 1, 1993. It
includes a three-month phase-in period, a five-year operational period
(commencing April 1, 1993 and ending March 31, 1998), and a six-month
"flexibility period" through September 30, 1998. The Cooperative Agreement is
subject to review by the NSF and may be terminated by the NSF at any time at its
discretion or by mutual agreement. The NSF has stated that it will not be
re-awarding a cooperative agreement at the end of the flexibility period.
The original terms of the Cooperative Agreement provided for a cost
reimbursement plus fixed-fee contract (with a fee of 8%). Effective September
14, 1995, the NSF and the Company amended the Cooperative Agreement to require
the Company to begin charging end users a services fee of $50 per year for each
domain name in the .com, .org and .net TLDs. 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
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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 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 June 30, 1998 was approximately $23,512,000 and $39,564,000,
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 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 June 1998, approximately 30% of
new 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 transferring registration
for such names at a profit. Such transferors 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 June 1998 and is considered adequate by
the Company.
Registration fees charged to end users for registration services, net of
any 30% set aside funds, are recognized as revenue evenly over the registration
term. For example, the Company recognizes $70 (for registrations prior to April
1, 1998 this represents the $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 (for renewals prior to April 1, 1998 this
represents the $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 maintenance of and unlimited modifications to individual domain name
records, over the respective registration terms. At June 30, 1998, the Company
had net deferred revenue of $89.0 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
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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 103% from $10.1 million for the three
months ended June 30, 1997 to $20.5 million for the three months ended June 30,
1998. This increase in net revenue was primarily attributable to the increase in
the number of domain name registrations, principally in the .com TLD. Net
revenue from registration services increased 121% from $8.6 million for the
three months ended June 30, 1997 to $19.0 million for the three months ended
June 30, 1998. Net new registrations increased 91% from 232,000 for the three
months ended June 30, 1997 to 443,000 for the three months ended June 30, 1998.
This also represents a 30% increase over the 340,000 net new registrations 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 June 30, 1997
were 1,040,000 as compared to 2,289,000 as of June 30, 1998, for a 120%
increase. In addition, this growth in cumulative net registrations is a 23%
increase in the Company's entire customer base since March 31, 1998.
Net revenue from consulting services was $1.5 million for the three months
ended June 30, 1998 and 1997. While flat in comparison to the same period in the
prior year, this represents a 50% increase in net revenue from consulting
services from the three months ended March 31, 1998. NationsBanc accounted for
$497,000 or 4.9% of the Company's total net revenue for the three months ended
June 30, 1997 and $561,000 or 2.7% of the Company's total net revenue for the
three months ended June 30, 1998.
Net revenue increased 97% from $18.7 million for the six months ended June
30, 1997 to $37.0 million for the six months ended June 30, 1998. This increase
in net revenue was primarily attributable to the increase in the number of
domain name registrations, principally in the .com TLD. Net revenue from
registration services increased 127% from $15.2 million for the six months ended
June 30, 1997 to $34.5 million for the six months ended June 30, 1998. The
provision for uncollectible accounts used in determining net new registration
revenue for the six months ended June 30, 1997 and 1998 was consistently applied
at a rate of 30%.
Net registrations increased 81% from 413,000 for the six months ended June
30, 1997 to 748,000 for the six months ended June 30, 1998.
Net revenue from consulting services decreased 29% from $3.5 million for
the six months ended June 30, 1997 to $2.5 million for the six months ended June
30, 1998. This was primarily attributable to a reduction in business from
NationsBanc, which accounted for $1.5 million or 7.8% of the Company's total net
revenue for the six months ended June 30, 1997 and $1.1 million or 3.0% for the
six months ended June 30, 1998, as well as the completion of other fixed period
contracts in late 1997.
During the three and six months ended June 30, 1998, the consulting
services division continued to add new leadership in sales and operations and
retained 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.
Consulting services' proposal activities remain strong although the 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 43% from $6.1 million for the three months ended June 30, 1997
to $8.8 million for the three months ended June 30, 1998. The increase was
primarily driven by the growth of the Company's registration business which
experienced additional outsourcing costs of $1.4 million in support of the
Company's invoicing, collection and processing activities and additional
depreciation charges and equipment expenditures of $766,000. 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. 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
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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 61.0% for
the three months ended June 30, 1997 to 42.9% for the three months ended June
30, 1998. This decrease primarily reflects economies of scale that the Company
has continued to achieve due to the growth of its subscription-based domain name
registration business. In the near term, the continued need for back office
investments is expected to partially offset future margin improvements arising
from economies of scale.
Cost of revenue increased 41% from $11.4 million for the six months ended
June 30, 1997 to $16.1 million for the six months ended June 30, 1998. This
increase was driven by a $2.5 million increase in outsourcing costs and $1.8
million in additional depreciation charges and equipment expenditures primarily
associated with supporting the growth of the Company's registration services
business.
As a percentage of net revenue, cost of revenue decreased from 61.1% for
the six months ended June 30, 1997 to 43.7% for the six months ended June 30,
1998 reflecting economies of scale achieved in the Company's registration
business.
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, services and technologies. Research
and development expenses increased 100% from $407,000 for the three months ended
June 30, 1997 to $815,000 for the three months ended June 30, 1998. To date, all
significant research and development costs have been expensed as incurred. The
Company expects that the level of research and development expenses will
continue to increase in the near future in terms of absolute dollars as the
Company invests in developing new product and service offerings. As a percentage
of net revenue, research and development expenses were 4.0% for the three months
ended June 30, 1997 and 1998.
Research and development expenses increased 114% from $718,000 for the six
months ended June 30, 1997 to $1.5 million for the six months ended June 30,
1998. As a percentage of net revenue, research and development expenses
increased from 3.8% for the six months ended June 30, 1997 to 4.2% for the six
months ended June 30, 1998.
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 Science Applications International Corporation ("SAIC"),
legal and other professional costs and amortization of goodwill associated with
the Company's acquisition by SAIC. Selling, general and administrative expenses
increased 222% from $2.5 million for the three months ended June 30, 1997 to
$8.0 million for the three months ended June 30, 1998. The increase is primarily
attributable to increases in marketing and business development expenses of $3.7
million including television and on-line advertising and a targeted direct mail
campaign. The Company expects that the level of marketing and business
development expenses will increase in the near future as the Company continues
to promote the value of a dot com Web address, future value-added services, and
international channel development.
As a percentage of net revenue, selling, general and administrative
expenses increased from 24.7% for the three months ended June 30, 1997 to 39.1%
for the three months ended June 30, 1998.
Selling, general and administrative expenses increased 196% from $4.8
million for the six months ended June 30, 1997 to $14.2 million for the six
months ended June 30, 1998. The increase was attributable to a $5.0 million
increase in marketing and business development expenses, increased staffing
expenses of $1.7 million and an increase in legal and other professional costs
of $1.8 million.
As a percentage of net revenue, selling, general and administrative
expenses increased from 25.6% for the six months ended June 30, 1997 to 38.4%
for the six months ended June 30, 1998.
Interest Income. The Company had net interest income of $335,000 for the
three months ended June 30, 1997 as compared to $1.4 million for the three
months ended June 30, 1998.
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The Company had net interest income of $484,000 for the six months ended
June 30, 1997 as compared to $2.7 million for the six months ended June 30,
1998. The increase for both the three month and six month comparisons is
attributable to the investment of the net proceeds of the Company's stock
offering as well as positive cash flow resulting from increasing domain name
registrations.
Income Taxes. The provision for income taxes was 46% of pretax earnings,
or $629,000 for the three months ended June 30, 1997, and 42% or $1.8 million
for the three months ended June 30, 1998.
The provision for income taxes was 45% of pretax earnings, or $1.0 million
for the six months ended June 30, 1997, and 42%, or $3.3 million for the six
months ended June 30, 1998. The difference between the effective rates for both
periods presented is principally attributable to the relative impact that
non-deductible goodwill had on pretax operating income. 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
At June 30, 1998, the Company's principal source of liquidity was its cash
and cash equivalents of $17.9 million and its short-term investments of $79.5
million, which when combined represent an increase of $16.1 million from the
December 31, 1997 balance in those accounts. The Company also has $6.4 million
of marketable securities held as long term investments as of June 30, 1998.
At June 30, 1998, the Company's cumulative net obligation to SAIC for
intercompany activity was $2.4 million, a net increase of $1.1 million from
December 31, 1997. Intercompany activity is primarily comprised of salaries and
benefits paid by SAIC on behalf of the Company. The Company currently reimburses
SAIC for intercompany activity on a monthly basis. Pursuant to the Tax Sharing
Agreement dated September 26, 1997, the Company now generally remits income tax
payments directly to tax authorities as it no longer is part of SAIC's
consolidated group for federal income tax purposes.
Cash provided by operations was $19.9 million for the six months ended June
30, 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 ratably over the two- and one-year registration
terms. Partially offsetting this amount is an increase in deferred tax assets
resulting from accelerated revenue recognition for tax purposes and the
subsequent tax liabilities.
Investing activities totalled $49.7 million for the six months ended June
30, 1998, of which $39.3 million was net purchases of short-term investments and
$6.0 million of long-term investments. These investments are primarily comprised
of commercial investment grade securities.
The Company believes that its existing cash balance, investments and cash
flows expected from future operations will be sufficient to meet the Company's
capital requirements for at least the next 12 to 18 months.
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 obtain new registrations at current rates or obtain
renewals from a significant portion of its customers.
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
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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, back office infrastructure and marketing and business 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 improve the technical
management of Internet names and addresses. The proposal suggested the creation
of a representative not-for-profit corporation to manage those functions that
should be coordinated. The proposal also suggested that steps be taken, in an
orderly fashion, to move to more competitive markets in those functional areas
that can be market driven. Comments on the proposed rule revealed substantial
differences regarding how the domain name system ("DNS") should evolve and
elicited competing proposals concerning DNS management. Because of the public
comment and "the continued rapid technological development of the Internet," the
U.S. government determined that it should issue a general statement of policy
rather than define or impose a substantive regulatory regime for the DNS.
Accordingly, on June 10, 1998, the U.S. government published in the Federal
Register a statement of policy entitled "Management of Internet Names and
Addresses," informally called the "White Paper" (the "Statement of Policy").
Several proposals advanced in the Proposed Rule were eliminated in the
Statement of Policy including, but not limited to, proposals relating to
specific requirements for the membership of the new corporation, the creation
during a transition period of a specified number of new generic TLDs and minimum
dispute resolution and other procedures related to trademarks.
The Statement of Policy invites private sector Internet stakeholders to
work together to form a new private, not-for-profit corporation to oversee
policy for the Internet name and address system. The Statement of Policy states
that the new corporation should be headquartered and incorporated in the United
States and have a Board of Directors from around the world. The Statement of
Policy provides that in making a decision to enter into an agreement to
establish a process to transfer U.S. government oversight of the DNS to the new
entity, 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. The Statement of Policy provides that to the
extent that the new corporation is established and operationally stable,
September 30, 2000 is the "outside date" for the transition to the private
sector of DNS administration to be complete.
The Statement of Policy provides that the new corporation ultimately should
have the authority to (1) set policy for and direct allocation of Internet
Protocol number blocks to regional Internet number registries; (2) oversee
operation of the authoritative Internet root server system; (3) oversee policy
for determining the
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circumstances under which any new TLDs are added to the root system; and (4)
coordinate the assignment of other Internet technical parameters as needed to
maintain universal connectivity on the Internet.
Following the publication of the Statement of Policy, the International
Forum for the White Paper (the "IFWP"), an ad hoc coalition of Internet
stakeholders including internet service providers, content developers, trademark
owners, networkers, intergovernmental groups, policy experts, end-users and
others, was initiated to coordinate international meetings for stakeholders to
discuss the transition of DNS administration to the private sector as outlined
in the Statement of Policy. The IFWP is seeking to establish a consensus among
the stakeholders on a framework under which the new corporation will be formed
and operate. The IFWP has held three meetings to date, in which the Company has
been an active participant. The U.S. government has stated that if the private
sector does not demonstrate by September 30, 1998, sufficient progress towards
implementing the recommendations of the Statement of Policy, the government may
assume a more active role in defining the future of DNS administration. There is
a risk that failure to achieve consensus through the IFWP process could, among
other things, prevent or delay the implementation of a coordinated process for
transitioning DNS administration to the private sector. There is also a risk
that any consensus that is reached or, if no consensus is reached, any action
taken by the government, could produce consequences that are not favorable to
the Company or not consistent with the Company's current or future plans. There
is a further risk that any consensus that is reached, any policies or programs
adopted by the new corporation or any actions taken by the government could be
challenged. If the new corporation is formed, there is a risk that the U.S.
government will not agree to transfer to it oversight of DNS policy. There is
also a risk that the new corporation will adopt or promote policies or programs
that are not favorable to the Company or not consistent with the Company's
current or future plans. Any of such events could have a material adverse effect
on the Company's business, financial condition and results of operations through
a direct effect on the Company's operations or 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.
The Statement of Policy states that the U.S. government and the Company
will hold discussions about the terms and conditions of the ramp down of the
Cooperative Agreement and sets forth certain of the government's expectations
with regard to the Company's actions that will be required to permit the
development of competition in domain name registration. There is a risk that an
agreement may not be reached between the Company and the government or that any
such agreement may contain provisions that are not favorable to the Company or
not consistent with the Company's current or future plans. Any of such events
could have a material adverse effect on the Company's business, financial
condition and results of operations.
It is impossible to predict at this time whether or when the process
initiated by the Statement of Policy will result in the transition of DNS
administration to the private sector and, if it does, the effect of such
transition and private sector administration of the DNS on the Company. It is
also impossible to predict at this time the outcome of discussions between the
Company and the government concerning the terms and conditions of the ramp down
of the Cooperative Agreement. Any of such events could have a material adverse
effect on the Company's business, financial condition and results of operations.
Competition. A principal objective expressed in the Statement of Policy is
the introduction of competition into the technical management of Internet names
and addresses. This could include, among other things, competition among
registrars within a single TLD and competition among existing and new TLDs. The
Company currently faces competition in the domain name registration business
from registries for country codes, third level domain name providers such as
Internet access providers and registries of TLDs other than those TLDs currently
being registered by the Company. A number of entities have already begun to
offer competing registration services using other TLDs. Future competition in
the Company's domain name registration business could come from many different
companies, including, but not limited to, major telecommunications firms, cable
companies and Internet access providers. Such entities have core capabilities to
deliver registration services, such as help desks, billing services and network
management, along with strong name recognition and Internet industry experience.
Other companies with some or all of these capabilities may also enter the
registration business. Also emerging is a growing contingent of domain name
resellers. The
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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 introduction of
additional competition into the domain name registration business 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 the potential
effects of the "Year 2000" millenium change on the Company's internal computer
software applications and systems and on the Company's business in general.
Based on its initial assessment to date, the Company believes that its internal
mission critical systems are Year 2000 compliant. The Company, in its normal
course of business, anticipates replacing or upgrading, prior to the millenium
change, portions of these systems with new systems which will also be Year 2000
compliant. At this time, the Company believes that its incremental remediation
costs, if any, needed to make its systems Year 2000 compliant are not material.
Failure of any new system to be Year 2000 compliant despite the vendors'
assurances, or a failure to fully identify or remediate any Year 2000 problems
in the Company's systems which are not being replaced or upgraded could have a
material adverse effect on the Company's business, financial condition or
results of operations.
In addition, the Company is contacting its hardware and software suppliers
and other significant suppliers, service providers, outsourcing vendors and
other contracting parties to determine the extent to which such third parties'
systems and products are or will be Year 2000 compliant. At the present time,
the Company does not expect Year 2000 issues of such third parties to materially
affect the Company's services. Furthermore, the Company's business depends on
the continued operation of, and widespread access to, the Internet. This, in
turn, depends to a large extent on the software applications and systems of
third parties on which the Company's systems rely or to which they are
connected, including other Internet-related companies, such as Internet web
hosting companies, Internet access providers, Internet root server operators and
the companies that maintain the Internet "backbone." The Company can give no
assurances that the systems of such companies 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 the Company. To the extent that the normal
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operation of the Internet is disrupted by the Year 2000 millenium change, the
Company's business, financial condition or results of operations could be
materially and adversely affected.
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 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 product 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 U.S. government states in the
Statement of Policy that "the U.S. Government expects [the Company] to agree to
make available on an ongoing basis appropriate databases, software,
documentation thereof, technical expertise, and other intellectual property for
DNS management and shared registration of domain names." If certain of the
Company's software and data generated which is proprietary to the Company were
to be provided to the new corporation 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 August 7, 1998, represented
approximately 74.3% 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.
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In certain circumstances, including without limitation, a public offering
or distribution of Class B common stock by SAIC, the Class B common stock would
trade separately from the Class A common stock in the public market. Separate
trading of the Class B common stock in the public market or the perception that
such trading could occur, could materially and adversely affect the market price
of the Class A common stock.
Possible Volatility of Stock Price. The market price of the shares of
Class A common stock at times has been highly volatile and may be significantly
affected by factors such as actual or anticipated fluctuations in the Company's
results of operations, announcements of technological innovations, developments
in Internet governance, announcement of additional competing registries,
registrars or TLDs, litigation costs, results of litigation, introduction of new
products or services by the Company or its competitors, developments with
respect to patents, copyrights or proprietary rights, conditions and trends in
the networking and other technology industries, changes in or failure by the
Company to meet securities analysts' expectations, general market conditions and
other factors. In addition, the stock market has from time to time experienced
significant price and volume fluctuations that have particularly affected the
market prices for the common stocks of technology companies. These broad market
fluctuations may adversely affect the market price of the Company's Class A
common stock. In the past, following periods of volatility in the market price
of a particular company's securities, securities class action litigation has
often been brought against that company. There can be no assurance that such
litigation will not occur in the future with respect to the Company. Such
litigation could result in substantial costs and a diversion of management's
attention and resources, which could have a material adverse effect upon the
Company's business, financial condition and results of operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not Applicable.
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
As of August 1, 1998, the Company was a defendant in three 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 a domain name
holder to register a domain name which is alleged to be similar to the trademark
in question. Further, trademark owners also have alleged that the Company should
be required to monitor future domain name registrations and to reject
registrations of domain names which are identical or allegedly similar to the
trademark owners' federally registered trademarks. 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 use of the domain
names in question. Although 43 out of approximately 4,000 of these situations
have resulted in suits actually naming the Company as a defendant, as of August
1, 1998, no award of damages has ever been made against the Company. The Company
believes that it has meritorious defenses and vigorously defends itself against
these claims from both sides.
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 may ultimately be filed by the DOJ, or the form of relief that
might be sought. 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
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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 include reference to PG Media's TLDs and name servers in
the root zone file administered by the Company under the Cooperative Agreement.
The Company answered the complaint. In June 1997, the Company received written
direction from the NSF not to take any action which would 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. On May 14, 1998, PG Media served the Company with
a motion for a preliminary injunction against both defendants. The motion sought
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. Although the Company cannot reasonably
estimate the potential impact of such claims, a successful claim under the
plaintiff's theory could have a material adverse effect on the Company's
business, financial condition and results of operations. On July 20, 1998, a
hearing on all parties' cross-motions for summary judgment occurred. The issue
before the Court is the NSF'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 the decision.
On October 17, 1997, a group of six plaintiffs filed a lawsuit (the "Thomas
suit") against the Company and the NSF in the United States District Court,
District of Columbia, challenging the legality of fees defendants charge for the
registration of domain names on the Internet and seeking restitution of fees
collected from domain name registrants in an amount in excess of $100 million,
damages, and injunctive and other relief. Plaintiffs originally alleged
violations of the Competition in Contracting Act ("CICA"), the Sherman Act and
the U.S. Constitution. Following the filing of motions to dismiss by the
defendants, the plaintiffs filed an amended complaint on January 30, 1998,
dropping the cause of action based upon CICA, but adding alleged violations of
the Administrative Procedures Act and the Independent Offices Appropriations
Act. The plaintiffs also filed a motion for preliminary injunctive relief
against the NSF concerning the "Intellectual Infrastructure Fund." On February
2, 1998, the United States District Court, District of Columbia, issued an order
granting the plaintiffs' motion for a preliminary injunction, enjoining the NSF
from spending any of the money collected by the Company for the Intellectual
Infrastructure Fund. On February 10, 1998, the plaintiffs filed a motion for
preliminary injunction against the Company seeking several items of relief. On
February 24, 1998, the Company and the NSF filed motions to dismiss the amended
complaint. Also on February 24, the plaintiffs filed a motion for partial
summary judgment concerning the Intellectual Infrastructure Fund. The
plaintiffs' motion for preliminary injunction against the Company and partial
summary judgment against the NSF, and both motions to dismiss were heard before
the Court on March 17, 1998. 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 (II through X) and, simultaneously,
denied the plaintiffs' preliminary 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 motion to vacate the preliminary
injunction and to dismiss the case. On June 4, 1998, the plaintiffs filed a
Notice of Appeal on the Court's dismissal of counts II through X and on the
Court's denial of plaintiffs' motion for preliminary injunction against the
Company. On July 27, 1998, the United States Court of Appeals for the District
of Columbia Circuit dismissed the plaintiffs' appeal of the Court's dismissal of
counts II through X at this juncture in the case. Currently, all motions and the
plaintiffs' remaining appeal are pending.
The Company is involved in various other investigations, claims and
lawsuits arising in the normal conduct of its business, none of which, in the
opinion of the Company's management, will have a material adverse effect on its
financial position, results of operations, cash flows or its ability to conduct
business.
19
<PAGE> 20
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 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.
The total amount of expenses incurred for the Company's account in
connection with the offering were $5,555,200, which is comprised of $4,057,200
for underwriting discounts and commissions and $1,498,000 of other expenses. No
expenses were paid to directors, officers or persons owning more than ten
percent of any class of the Company's equity securities. The resultant Company's
net offering proceeds were $52,404,800. The net proceeds to SAIC for its account
were $9,625,500 after deducting the associated underwriting discounts and
commissions of $724,500.
On October 1, 1997, the Company received the offering proceeds from which a
$10,000,000 dividend was paid to SAIC. SAIC owns ten percent or more of a class
of the Company's equity securities and is an affiliate of the Company. The
remaining proceeds have been invested in investment grade government discount
notes, commercial paper and corporate bonds.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The Company's Annual Meeting of Stockholders was held on May 19, 1998 (the
"Annual Meeting"). At the Annual Meeting, stockholders voted on four matters:
(i) the election of nine directors; (ii) the approval of the Company's 1997
Employee Stock Purchase Plan; (iii) the approval of the Company's 1996 Stock
Incentive Plan, as amended; and (iv) the ratification of the appointment of
Price Waterhouse LLP (effective July 1, 1998, PricewaterhouseCoopers LLP) as the
Company's independent accountants for the period ending December 31, 1998. The
stockholders elected management's nominees as the directors in an uncontested
election, approved the Company's 1997 Employee Stock Purchase Plan and 1996
Stock Incentive Plan and ratified the appointment of Price Waterhouse LLP as the
Company's independent accountants by the following votes, respectively:
(i) Election of directors:
<TABLE>
<CAPTION>
DIRECTOR VOTES FOR VOTES WITHHELD
-------- ----------- --------------
<S> <C> <C>
Gabriel A. Battista....................................... 122,306,075 5,150
Michael A. Daniels........................................ 122,306,275 4,950
Donald N. Telage.......................................... 122,305,975 5,250
J. Robert Beyster......................................... 122,305,575 5,650
Craig I. Fields........................................... 122,305,375 5,850
John E. Glancy............................................ 122,304,775 6,450
J. Dennis Heipt........................................... 122,304,775 6,450
William A. Roper, Jr...................................... 122,305,075 6,150
Stratton D. Sclavos....................................... 122,305,375 5,850
</TABLE>
(ii) Approval of 1997 Employee Stock Purchase Plan ("1997 Plan"):
<TABLE>
<CAPTION>
VOTES FOR VOTES AGAINST ABSTENTIONS
----------- ------------- -----------
<S> <C> <C> <C>
1997 Plan........................................ 120,563,069 154,815 11,120
</TABLE>
20
<PAGE> 21
(iii) Approval of 1996 Stock Incentive Plan ("1996 Plan"):
<TABLE>
<CAPTION>
VOTES FOR VOTES AGAINST ABSTENTIONS
----------- ------------- -----------
<S> <C> <C> <C>
1996 Plan........................................ 120,094,202 652,187 11,825
</TABLE>
(iv) Ratify Appointment of Price Waterhouse LLP:
<TABLE>
<CAPTION>
VOTES FOR VOTES AGAINST ABSTENTIONS
----------- ------------- -----------
<S> <C> <C> <C>
Ratify Appointment............................... 122,302,333 4,400 4,492
</TABLE>
For further discussion of these matters, see the Company's definitive Proxy
Statement for the May 19, 1998 Annual Meeting of Stockholders, which was filed
with the Commission on April 14, 1998.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits -- See Exhibit Index
(b) Reports on Form 8-K -- None
21
<PAGE> 22
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: August 14, 1998 By /s/ ROBERT J. KORZENIEWSKI
------------------------------------
Robert J. Korzeniewski
Chief Financial Officer
and
Authorized Signatory
22
<PAGE> 23
EXHIBIT INDEX
NETWORK SOLUTIONS, INC.
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION OF EXHIBITS
- ------- -----------------------
<S> <C> <C>
27.1 Financial Data Schedule
</TABLE>
23
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 17,928
<SECURITIES> 79,516
<RECEIVABLES> 26,768
<ALLOWANCES> (15,542)
<INVENTORY> 0
<CURRENT-ASSETS> 177,018
<PP&E> 13,095
<DEPRECIATION> (4,223)
<TOTAL-ASSETS> 202,585
<CURRENT-LIABILITIES> 119,694
<BONDS> 0
0
0
<COMMON> 16
<OTHER-SE> 58,258
<TOTAL-LIABILITY-AND-EQUITY> 202,585
<SALES> 0
<TOTAL-REVENUES> 36,968
<CGS> 0
<TOTAL-COSTS> 16,139
<OTHER-EXPENSES> 12,987
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 67
<INCOME-PRETAX> 7,775
<INCOME-TAX> 3,263
<INCOME-CONTINUING> 4,512
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4,512
<EPS-PRIMARY> 0.29
<EPS-DILUTED> 0.27
</TABLE>
