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 DECEMBER 31, 1996
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________________ to ___________________
Commission File Number: 0-21131
--------
INTERNATIONAL NETWORK SERVICES
(Exact name of registrant as specified in its charter)
California 77-0289509
---------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1213 Innsbruck Drive, Sunnyvale, CA 94089
(Address of principal executive offices) (zip code)
Registrant's telephone number, including area code: (408) 542-0100
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 [_]
The number of shares outstanding of the registrant's Common Stock as of January
31, 1997 was 31,445,691.
INTERNATIONAL NETWORK SERVICES
INDEX
PART I -- FINANCIAL INFORMATION
Page No.
Item 1. Condensed Financial Statements
Condensed Balance Sheets
as of December 31, 1996 (unaudited) and June 30, 1996 2
Condensed Statements of Operations (unaudited)
for the three and six month periods ended
December 31, 1996 and 1995 3
Condensed Statements of Cash Flows (unaudited)
for the six month periods ended
December 31, 1996 and 1995 4
Notes to Condensed Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 7
PART II -- OTHER INFORMATION
Items 1-4. Not applicable
Item 5. Other Information 13
Item 6. Exhibits and Reports on Form 8-K 13
Signature 14
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PART I -- FINANCIAL INFORMATION
-------------------------------
ITEM 1. FINANCIAL STATEMENTS.
--------------------
INTERNATIONAL NETWORK SERVICES
CONDENSED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
December 31, 1996 June 30, 1996
----------------- -----------------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $21,025 $ 869
Short-term investments 15,508 -
Accounts receivable 18,785 11,821
Deferred income taxes 857 857
Prepaid expenses and other assets 662 386
----------------- -----------------
Total current assets 56,837 13,933
Property and equipment, net 7,373 4,139
----------------- -----------------
Total assets $64,210 $18,072
================= =================
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable $ 3,005 $ 1,908
Accrued expenses 5,810 3,704
Income taxes payable - 250
Deferred revenue 604 612
Borrowings under line of credit - 1,000
Current portion of notes payable - 399
----------------- -----------------
Total current liabilities 9,419 7,873
----------------- -----------------
Notes payable, less current portion - 316
----------------- -----------------
Mandatorily Redeemable Convertible - 12,427
----------------- -----------------
Preferred Stock
Commitments
Shareholders' equity (deficit):
Preferred Stock, no par value,
5,000,000 shares authorized; no
shares issued and outstanding - -
Common Stock, no par value,
75,000,000 shares authorized;
31,408,471 and 11,426,875
shares issued and outstanding
at December 31, 1996 and June
30, 1996, respectively 54,277 2,394
Accretion of Mandatorily Redeemable
Convertible Preferred Stock - (2,454)
Notes receivable from shareholders (1,899) (1,880)
Retained earnings (deficit) 2,413 (604)
----------------- -----------------
Total shareholders'
equity (deficit) 54,791 (2,544)
----------------- -----------------
Total liabilities and
shareholders' equity $64,210 $18,072
================= =================
See accompanying notes to condensed financial statements.
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INTERNATIONAL NETWORK SERVICES
CONDENSED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------ ----------------
1996 1995 1996 1995
-------- -------- ------- -------
Revenue $23,337 $ 9,610 $42,225 $17,116
Operating expenses:
Professional personnel 10,445 4,448 18,891 7,795
Sales and marketing 3,713 1,701 6,247 3,150
General and administrative 3,387 922 6,192 1,515
Other costs 3,159 1,321 6,302 2,501
-------- -------- ------- -------
Total operating expenses 20,704 8,392 37,632 14,961
-------- -------- ------- -------
Income from operations 2,633 1,218 4,593 2,155
Interest and other, net 374 16 354 23
-------- -------- ------- -------
Income before income taxes 3,007 1,234 4,947 2,178
Provision for income taxes 1,173 481 1,930 849
-------- -------- ------- -------
Net income $ 1,834 $ 753 $ 3,017 $ 1,329
======== ======== ======= =======
Net income per share $0.05 $0.02 $0.09 $0.04
======== ======== ======= =======
Shares used to compute net income per
share 33,743 30,583 32,434 30,484
======== ======== ======= =======
See accompanying notes to condensed financial statements.
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INTERNATIONAL NETWORK SERVICES
CONDENSED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
Six Months Ended
December 31
-------------------------
1996 1995
-------- --------
Cash flows from operating activities:
Net income $ 3,017 $ 1,329
Adjustments to reconcile net income
to net cash used for operating activities:
Depreciation and amortization 1,239 736
Changes in operating assets and liabilities:
Accounts receivable (6,964) (4,187)
Prepaid expenses and other assets (276) (251)
Accounts payable 1,097 675
Accrued expenses 2,106 824
Income taxes payable (250) (58)
Deferred revenue (8) 874
-------- --------
Net cash used for operating activities (39) (58)
-------- --------
Cash flows from investing activities:
Purchases of short-term investments (15,508) -
Purchases of property and equipment (4,473) (1,616)
-------- --------
Net cash used for investing activities (19,981) (1,616)
-------- --------
Cash flows from financing activities:
Repayments of notes payable (715) (150)
Repayment of borrowings under line of credit (1,000)
Proceeds from issuance of Common Stock, net 41,891 48
-------- --------
Net cash provided by (used for)
financing activities 40,176 (102)
-------- --------
Increase (decrease) in cash and cash equivalents 20,156 (1,776)
Cash and cash equivalents at beginning of period 869 4,161
-------- --------
Cash and cash equivalents at end of period $ 21,025 $ 2,385
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 97 $ 64
Cash paid for income taxes $ 2,180 $ 907
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND
FINANCING ACTIVITIES:
Issuance of Common Stock in exchange for notes
receivable from shareholders $ - $ 337
See accompanying notes to condensed financial statements.
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INTERNATIONAL NETWORK SERVICES
NOTES TO CONDENSED FINANCIAL STATEMENTS
(IN THOUSANDS)
(UNAUDITED)
Note 1 - Basis of Presentation
---------------------
The accompanying unaudited financial statements have been prepared by
International Network Services (the "Company") in accordance with the rules and
regulations of the Securities and Exchange Commission. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted in accordance with such rules and regulations. In the opinion of
management, the accompanying unaudited financial statements reflect all
adjustments, consisting only of normal recurring adjustments, necessary to
present fairly the financial position of the Company, and its results of
operations and cash flows. These financial statements should be read in
conjunction with the audited financial statements and notes thereto for the
fiscal years ended June 30, 1996, 1995 and 1994 included in the Company's
Registration Statement on Form S-1 (File No. 333-9287), which was declared
effective by the Securities and Exchange Commission on September 18, 1996.
For purposes of presentation, the Company has indicated the second quarter
and the first six months of fiscal 1997 and 1996 as ending on December 31,
respectively; whereas, in fact the Company's fiscal quarters end on the Sunday
nearest the end of the calendar quarter.
The results of operations for the three and six months ended December 31,
1996 are not necessarily indicative of the results that may be expected for the
year ending June 30, 1997 or any other future interim period, and the Company
makes no representations related thereto.
Note 2 - Balance Sheet Components (in thousands)
---------------------------------------
DEC 31 JUNE 30
1996 1996
----------- --------
(UNAUDITED)
Accounts receivable:
Trade $19,488 $12,375
Less: allowance for doubtful accounts (703) (554)
------- -------
$18,785 $11,821
======= =======
Property and equipment:
Computer equipment $10,141 $ 6,511
Furniture and fixtures 1,455 612
------- -------
11,596 7,123
Less: accumulated depreciation (4,223) (2,984)
------- -------
$ 7,373 $ 4,139
======= =======
Accrued expenses:
Accrued compensation and employee
benefits $ 5,532 $ 3,356
Other liabilities 278 348
------- -------
$ 5,810 $ 3,704
======= =======
-5-
INTERNATIONAL NETWORK SERVICES
NOTES TO CONDENSED FINANCIAL STATEMENTS
(IN THOUSANDS)
(UNAUDITED)
(CONTINUED)
Note 3 - Cash, Cash Equivalents and Short-term Investments
-------------------------------------------------
The Company considers all highly-liquid investments purchased with
original maturities of three months or less to be cash equivalents. Cash
equivalents include commercial paper, U.S. Treasury Bills, demand notes and
government agency bonds. Short-term investments, all of which are
classified as "available-for sale", consist of high quality debt securities
with original maturity dates greater than 90 days. In accordance with
Statement of Financial Accounting Standards No. 115, "Accounting for
Certain Investments in Debt and Equity Securities," investments in
securities classified as available for sale are reported at fair value with
unrealized gains and losses, net of related taxes, reported as a separate
component of shareholders' equity. At December 31, 1996, the estimated
fair value approximated cost.
Note 4 - Initial Public Offering
-----------------------
In September 1996, the Company completed an initial public offering
("IPO") of 2,875,000 shares of Common Stock for $16 per share, which
resulted in proceeds to the Company of approximately $41.9 million, net of
issuance costs of approximately $924,000. All shares of Mandatorily
Redeemable Convertible Preferred Stock outstanding at June 30, 1996 were
automatically converted into 16,734,889 shares of Common Stock on a one for
one basis upon the closing of the IPO.
Note 5 - Net Income per Share
--------------------
Net income per share is computed using the weighted average number of
common and common equivalent shares ("weighted average shares") outstanding
during the period. Pursuant to the requirements of the Securities and
Exchange Commission, common and common equivalent shares issued within one
year prior to the Company's initial public offering date have been included
in the computation as if they were outstanding for all periods presented
prior to the effective date of the Company's initial public offering, even
if anti-dilutive (using the treasury stock method and the assumed initial
public offering price). Common equivalent shares consist of Mandatorily
Redeemable Convertible Preferred Stock (using the if converted method) and
stock options and warrants (using the treasury stock method).
-6-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
---------------------------------------------------------------
RESULTS OF OPERATIONS.
---------------------
OVERVIEW
International Network Services ("INS" or "the Company") is a provider of
services for complex enterprise networks. The Company provides services for the
full life cycle of a network, including planning, design, implementation,
operations and optimization, and maintains expertise in the most complex
technologies and multi-vendor environments. Areas of expertise include WANs,
network management, network and host security and high performance LANs and
VLANs. Substantially all of the Company's revenue is derived from professional
services, which are generally provided to clients on a "time and expenses"
basis. Professional services revenue is recognized as services are performed.
Any payments received in advance of services performed are recorded as deferred
revenue. The Company also performs a limited number of fixed-price projects
under which revenue is recognized using the percentage-of-completion method. In
addition, the Company is leveraging its expertise in complex networks to develop
electronic services for certain repetitive network management tasks, such as
network monitoring and network performance reporting. Revenue derived from
electronic services has not been significant to date. Electronic services
revenue is recognized ratably over the term of the contract. As of December 31,
1996, the Company had 518 network systems engineers.
The following discussion contains forward looking statements within the meaning
of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. Predictions of future events are
inherently uncertain. Actual events could differ materially from those
predicted in the forward looking statements as a result of the risks set forth
in the following discussion, and in particular, the risks discussed below under
the caption "Risk Factors that May Affect Operating Results."
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain financial
data as a percent of revenue:
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------- ------------------
1996 1995 1996 1995
-------- -------- ------- --------
Revenue 100.0 100.0 100.0 100.0
Operating expenses:
Professional personnel 44.8 46.3 44.7 45.5
Sales and marketing 15.9 17.7 14.8 18.4
General and administrative 14.5 9.6 14.7 8.9
Other costs 13.5 13.7 14.9 14.6
-------- -------- ------- --------
Total operating expenses 88.7 87.3 89.1 87.4
-------- -------- ------- --------
Income from operations 11.3 12.7 10.9 12.6
Interest and other, net 1.6 .1 .8 .1
-------- -------- ------- --------
Income before income taxes 12.9 12.8 11.7 12.7
Provision for income taxes 5.0 5.0 4.6 5.0
-------- -------- ------- --------
Net income 7.9 7.8 7.1 7.7
======== ======== ======= ========
REVENUE
- -------
Substantially all of the Company's revenue is derived from fees for professional
services. The Company also derives revenue from electronic services; however,
such revenue has not been significant to date. Revenue increased 143% to $23.3
million for the three months ended December 31, 1996 from $9.6 million in the
same period of the prior year. Revenue increased 147% to $42.2 million in the
six months ended December 31, 1996 from $17.1 million in the same period in the
prior year. Revenue increased primarily due to an increase in the number of
professional service projects and to the increase in the size of projects. The
Company does not believe that these rates of growth are sustainable in future
periods. The Company's revenue is dependent in large part on its ability to
attract, retain and utilize qualified network systems engineers.
-7-
OPERATING EXPENSES
- ------------------
Professional personnel. Professional personnel expenses consist primarily of
- ----------------------
compensation and benefits of the Company's employees engaged in the delivery of
professional services and electronic services. Professional personnel expenses
were $10.4 million and $18.9 million for the three-month and six-month periods
ended December 31, 1996, respectively, compared to $4.4 million and $7.8
million, respectively, for the same periods of the prior year. The increase in
absolute dollars is attributable primarily to an increase in the number of
network system engineers. As a percent of revenue, professional personnel
expenses decreased to 44.8% and 44.7% for the three-month and six-month periods
ended December 31, 1996, respectively, compared to 46.3% and 45.5% for the same
respective periods in the prior year. Professional personnel expenses
decreased as a percent of revenue in the three month and six month periods ended
December 31, 1996 due to a decrease in the use of contract labor.
Sales and marketing. Sales and marketing expenses consist primarily of
- -------------------
compensation (including commissions) and benefits of sales and marketing
personnel and outside marketing expenses. Sales and marketing expenses were $3.7
million and $6.2 million for the three-month and six-month periods ended
December 31, 1996, respectively, compared to $1.7 million and $3.2 million,
respectively, for the same periods in fiscal 1996. The increase in absolute
dollars was due primarily to the growth in the number of sales and marketing
employees and to commissions resulting from increased revenues. As a percent of
revenue, sales and marketing expenses decreased to 15.9% and 14.8% for the
three-month and six-month periods ended December 31, 1996, respectively, from
17.7% and 18.4%, respectively, in the same periods of fiscal 1996. The
decrease, on a percentage basis, was due primarily to a decrease in commission
rates and increased revenue.
General and administrative. General and administrative expenses consist of
- --------------------------
expenses associated with executive staff, finance and administration, corporate
facilities, information systems and human resources. General and administrative
expenses were $3.4 million and $6.2 million for the three-month and six-month
periods ended December 31, 1996, respectively, compared to $922,000 and $1.5
million, respectively, for the same periods in fiscal 1996. General and
administrative expenses have increased in absolute dollars as the Company has
continued to add personnel to support the Company's growth in operations. As a
percent of revenue, general and administrative expenses increased to 14.5% and
14.7% for the three-month and six-month periods ended December 31, 1996,
respectively, from 9.6% and 8.9%, respectively, in the same periods of fiscal
1996. General and administrative expenses increased as a percent of revenue in
the three-month and six-month periods ended December 31, 1996 as a result of the
Company's investment in its infrastructure to support the growth in operations.
Other costs. Other costs consist of expenses related to professional personnel
- -----------
(other than compensation and benefits), including travel and entertainment,
certain recruiting and professional development expenses, field facilities,
depreciation, expensed equipment, supplies, and research and development
expenses related to electronic services. Other costs were $3.2 million and $6.3
million for the three-month and six-month periods ended December 31, 1996,
respectively, compared to $1.3 million and $2.5 million, respectively, for the
same periods in fiscal 1996. Other costs increased primarily as a result of
increases in the number of professional personnel employed, and to a lesser
extent, the costs of field offices established since the first quarter of fiscal
1996. As a percent of revenue, other costs remained fairly constant at 13.5%
and 14.9% for the three-month and six-month periods ended December 31, 1996,
respectively, as compared to 13.7% and 14.6%, respectively, for the same
periods in fiscal 1996.
Interest and Other, Net. Interest and other, net, consists of interest income
- -----------------------
and expense. Interest income consists primarily of interest on cash, cash
equivalents and short term investments and notes receivable from shareholders.
Interest expense consists of interest associated with bank borrowings. Net
interest income was $374,000 and $16,000 for the three-month periods ended
December 31, 1996 and 1995, respectively. Net interest income was $354,000 and
$23,000 for the six-month periods ended December 31, 1996 and 1995,
respectively. The increase in net interest income reflects increased cash
available for investment and a decrease in bank borrowings during the first
quarter of fiscal 1997. All outstanding debt was repaid upon completion of the
initial public offering in September 1996.
Provision for Income Taxes. Income tax expense represents combined federal and
- --------------------------
state taxes at an effective rate of
-8-
39% for fiscal 1997 and fiscal 1996.
LIQUIDITY AND CAPITAL RESOURCES
Prior to its initial public offering, the Company financed its operations and
investments in property and equipment primarily through a combination of cash
generated from operations, the private sale of equity securities, private debt
and bank borrowings. In September 1996, the Company completed an initial public
offering of common stock resulting in net proceeds to the Company of
approximately $41.9 million. The Company has a bank credit facility which
includes a revolving line of credit that provides for borrowings equal to the
lesser of $6.0 million or 80% of eligible accounts receivable and a term
facility that provides for borrowings up to $3.0 million for capital equipment
purchases. Advances under the revolving line and term facility bear interest at
the bank's prime rate plus 1.00% and 1.25%, respectively. As of December 31,
1996, there were no borrowings under these credit facilities. The credit
facility expires in June 1997, is secured by substantially all of the assets of
the Company, and contains customary covenants and restrictions. As of December
31, 1996, the Company was in compliance with all such covenants and
restrictions.
At December 31, 1996, the Company had $36.5 million in cash, cash equivalents
and short-term investments, representing an increase of $35.7 million from June
30, 1996. The increase was primarily due to cash provided as a result of the
completion of the Company's initial public offering.
Net cash used in operations for the first six months of fiscal 1997 was $39,000.
Cash used in operations primarily reflects increases in accounts receivable.
Although the Company believes its collections experience is within industry
standards, the Company's inability to collect for its services on a timely basis
in the future could have a material adverse effect on the Company's business,
operating results and financial condition. Capital expenditures were $4.5
million during the six months ended December 31, 1996. The capital expenditures
were primarily attributable to additional equipment requirements associated with
increases in the number of employees and expenditures for equipment and office
furniture associated with the Company's new corporate headquarters and other
field facilities. The Company currently has no material capital commitments.
The Company believes that the net proceeds of its initial public offering,
together with available funds, will be sufficient to meet its working capital
and capital expenditure requirements for at least the next twelve months. The
Company may also utilize cash to acquire or invest in complementary businesses
or to obtain the right to use complementary technologies.
RISK FACTORS THAT MAY AFFECT OPERATING RESULTS
The following risk factors could materially and adversely affect the Company's
future operating results and could cause actual events to differ materially from
those predicted in the Company's forward-looking statements related to its
business.
Variability of Quarterly Operating Results. Substantially all of the Company's
- ------------------------------------------
revenue is derived from professional services, which are generally provided on a
"time and expenses" basis. Professional services revenue is recognized only when
network systems engineers are engaged on client projects. In addition, a
substantial majority of the Company's operating expenses, particularly personnel
and related costs, depreciation and rent, are relatively fixed in advance of any
particular quarter. As a result, any underutilization of network systems
engineers may cause significant variations in operating results in any
particular quarter and could result in losses for such quarter. Factors which
could cause such underutilization include: the reduction in size, delay in
commencement, interruption or termination of one or more significant projects;
the completion during a quarter of one or more significant projects; the
overestimation of resources required to complete new or ongoing projects; and
the timing and extent of training, weather related shut-downs, vacation days and
holidays. The Company's revenue and earnings may also fluctuate from quarter to
quarter based on a variety of factors including the loss of key employees,
reductions in billing rates, write-offs of billings, or services performed at
no charge as a result of the Company's failure to meet its clients'
expectations, claims by the Company's clients for the actions of the Company's
employees arising from damages to clients' business or otherwise, competition,
timing of employment taxes, the initial or ongoing market acceptance of
EnterprisePRO (see "Uncertainty of Market Acceptance of Electronic Services"),
the development and introduction of new services and general
-9-
economic conditions. In addition, the Company plans to continue to expand its
operations by hiring additional network systems engineers and other employees,
and adding new offices, systems and other infrastructure. The resulting increase
in operating expenses would have a material adverse effect on the Company's
operating results if revenue were not to increase to support such expenses.
Based upon all of the foregoing, the Company believes that quarterly revenue and
operating results are likely to vary significantly in the future and that
period-to-period comparisons of its operating results are not necessarily
meaningful and should not be relied on as indications of future performance.
Furthermore, it is likely that in some future quarter the Company's revenue or
operating results will be below the expectations of public market analysts or
investors. In such event, the price of the Company's Common Stock would likely
be materially adversely affected.
Risks Associated with Client Concentration. The Company has derived a
- ------------------------------------------
significant portion of its revenue from a limited number of large clients and
expects this concentration to continue. The Company's largest client, MCI Corp.
("MCI"), accounted for approximately $7.5 million, or 17.0%, of the Company's
revenue in fiscal 1996. No one customer accounted for more than 10% of the
Company's revenues for the three or six month periods ended December 31, 1996.
There can be no assurance that revenue from MCI or other clients that have
accounted for significant revenue in past periods, individually or as a group,
will continue, or if continued will reach or exceed historical levels in any
future period. The Company does not have a long-term services contract with MCI
or any of its other clients. Any significant reduction in the scope of the work
performed for MCI, any other significant client or a number of smaller clients,
the failure of anticipated projects to materialize, or deferrals, modifications
or cancellations of ongoing projects by any of these clients could have a
material adverse effect on the Company's business, operating results and
financial condition.
Need to Attract and Retain Qualified Network Systems Engineers. The Company's
- --------------------------------------------------------------
future success will depend in large part on its ability to hire, train and
retain network systems engineers who together have expertise in a wide array of
network and computer systems and a broad understanding of the industries the
Company serves. Competition for network systems engineers is intense, and there
can be no assurance that the Company will be successful in attracting and
retaining such personnel. In particular, competition is intense for the limited
number of qualified managers and senior network systems engineers. The Company
has experienced, and may in the future experience, high rates of turnover among
its network systems engineers. Any inability of the Company to hire, train and
retain a sufficient number of qualified network systems engineers could impair
the Company's ability to adequately manage and complete its existing projects or
to obtain new projects, which, in turn, could have a material adverse effect on
the Company's business, operating results and financial condition. In addition,
any inability of the Company to attract and retain a sufficient number of
qualified network systems engineers in the future could impair the Company's
planned expansion of its business.
Management of Growth. The Company has recently experienced a period of rapid
- --------------------
revenue and client growth and an increase in the number of its employees and
offices and the scope of its supporting infrastructure. The Company does not
believe these rates of growth are sustainable. This growth has resulted in new
and increased responsibilities for management personnel and has placed and
continues to place a significant strain on the Company's management and
operating and financial systems. The Company will be required to continue to
implement and improve its systems on a timely basis and in such a manner as is
necessary to accommodate the increased number of transactions and clients and
the increased size of the Company's operations. There can be no assurance that
the Company's management or systems will be adequate to support the Company's
existing or future operations. Any failure to implement and improve the
Company's systems or to hire and retain the appropriate personnel to manage its
operations would have a material adverse effect on the Company's business,
operating results and financial condition.
Absence of Long-Term Agreements. The Company's clients are generally able to
- -------------------------------
reduce or cancel their use of the Company's professional services without
penalty and with little or no notice. As a result, the Company believes that the
number and size of its existing projects are not reliable indicators or measures
of future revenue. The Company has in the past provided, and is likely in the
future to provide, services to clients without a long-term agreement. When a
client defers, modifies or cancels a project, the Company must be able to
rapidly redeploy network systems engineers to other projects in order to
minimize the underutilization of employees and the resulting adverse impact on
operating results. In addition, the Company's operating expenses are relatively
fixed and cannot be reduced on short notice to compensate for unanticipated
variations in the number or size of projects in progress. As a result, any
termination, significant reduction or modification of its business relationships
with any of its significant clients or with a number of
-10-
smaller clients could have a material adverse effect on the Company's business,
operating results and financial condition.
Intense Competition. The network services industry is comprised of a large
- -------------------
number of participants and is subject to rapid change and intense competition.
The Company faces competition from system integrators, value added resellers
("VARs"), local and regional network services firms, telecommunications
providers, network equipment vendors, software vendors and computer systems
vendors, many of which have significantly greater financial, technical and
marketing resources and greater name recognition, and generate greater service
revenue than does the Company. The Company has faced, and expects to continue to
face, additional competition from new entrants into its markets. Increased
competition could result in price reductions, fewer client projects,
underutilization of employees, reduced operating margins and loss of market
share, any of which could materially adversely affect the Company's business,
operating results and financial condition. There can be no assurance that the
Company will be able to compete successfully against current or future
competitors. The failure of the Company to compete successfully would have a
material adverse effect on the Company's business, operating results and
financial condition.
Uncertainty of Market Acceptance of Electronic Services. The Company's long-term
- -------------------------------------------------------
strategy is to derive a portion of its revenue from electronic services,
although such revenue has not been significant to date. The Company has in the
past offered, on a limited basis, an electronic service that has not achieved
significant market acceptance or generated significant revenue. The Company has
expended, and expects to continue to expend, substantial amounts in the
development and marketing of its electronic services. The Company has recently
introduced EnterprisePRO, an enhanced version of the prior electronic service.
The introduction of EnterprisePRO and any other electronic services that the
Company may develop in the future will be subject to risks generally associated
with new service introductions, including delays in development, testing or
introduction, or the failure to satisfy clients' requirements. There can be no
assurance that EnterprisePRO will gain market acceptance on a timely basis or at
all. The failure of EnterprisePRO, or any other new electronic services that the
Company may develop, to gain market acceptance on a timely basis could have a
material adverse effect on the Company's business, operating results and
financial condition.
Relationship with Cisco Systems. Although the Company is a vendor-independent
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provider of network services, the Company has a significant relationship with
Cisco Systems, Inc. ("Cisco") and believes that maintaining and enhancing this
relationship is important to the Company's business due to Cisco's leading
position in the large scale, enterprise internetworking market. Cisco develops,
manufactures, markets and supports high-performance, multiprotocol
internetworking systems that link geographically dispersed LANs and WANs. The
Company has entered into direct relationships with clients as a result of
referrals from Cisco and has from time to time performed pre-sales and post-
sales support services for Cisco. In addition, Cisco is a shareholder of the
Company and an employee of Cisco is a member of the Company's Board of
Directors. Although the Company believes that its relationship with Cisco is
good, there can be no assurance that the Company will be able to maintain or
enhance its relationship with Cisco. Any deterioration in the Company's
relationship with Cisco could have a material adverse effect on the Company's
business, operating results and financial condition. In addition, should the
Company's relationship with Cisco be perceived as compromising the Company's
ability to provide unbiased solutions, the Company's relationship with existing
or potential clients could be materially adversely affected.
Risks Associated With Potential Acquisitions. As part of its business strategy,
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the Company may make acquisitions of, or significant investments in,
complementary companies, products or technologies. Any such future transactions
would be accompanied by the risks commonly encountered in making acquisitions of
companies, products and technologies. Such risks include, among others, the
difficulty associated with assimilating the personnel and operations of acquired
companies, the potential disruption of the Company's ongoing business, the
distraction of management and other resources, the inability of management to
maximize the financial and strategic position of the Company through the
successful integration of acquired personnel, technology and rights, the
maintenance of uniform standards, controls, procedures and policies, and the
impairment of relationships with employees and clients as a result of the
integration of new management personnel. There can be no assurance that the
Company will be successful in overcoming these risks or any other problems
encountered in connection with any such acquisitions.
Risks Associated With Potential International Expansion. A component of the
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Company's long-term strategy is to expand into international markets. If the
Company opens any international offices and the revenue generated by these
offices are not adequate to offset the expense of establishing and maintaining
these foreign operations, the Company's business, operating results and
financial condition could be materially adversely affected. To date, the Company
has
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provided limited professional services to certain of its United States
clients in foreign locations, but has no direct international experience. There
can be no assurance that the Company will be able to successfully market, sell
and deliver its services in these markets. In addition to the uncertainty as to
the Company's ability to expand into international markets, there are certain
risks inherent in conducting business on an international level, such as
unexpected changes in regulatory requirements, export restrictions, tariffs and
other trade barriers, difficulties in staffing and managing foreign operations,
employment laws and practices in foreign countries, longer payment cycles,
problems in collecting accounts receivable, political instability, fluctuations
in currency exchange rates, imposition of currency exchange controls, seasonal
reductions in business activity during the summer months in Europe and certain
other parts of the world, and potentially adverse tax consequences, any of which
could adversely impact the success of the Company's international operations.
There can be no assurance that one or more of these factors will not have a
material adverse effect on the Company's future international operations and,
consequently, on the Company's business, operating results and financial
condition. There can be no assurance that the Company will be able to compete
effectively in these markets.
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PART II -- OTHER INFORMATION
----------------------------
ITEM 5. OTHER INFORMATION.
-----------------
In December 1996, the Board of Directors appointed Douglas Allred as a
director of the Company to fill the vacancy created by the resignation of Donald
LeBeau , formerly an officer of Cisco Systems, Inc. Mr Allred is Senior Vice
President, Customer Advocacy, of Cisco Systems, Inc.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
--------------------------------
(a) EXHIBITS
11.1 STATEMENT OF COMPUTATION OF NET INCOME PER SHARE
27 FINANCIAL DATA SCHEDULE
(b) REPORTS ON FORM 8-K
NO REPORTS ON FORM 8-K WERE FILED DURING THE QUARTER ENDED
DECEMBER 31, 1996.
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SIGNATURES
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.
INTERNATIONAL NETWORK SERVICES
By: /s/ Kevin J. Laughlin
----------------------
Kevin J. Laughlin
Vice President, Finance, Chief
Financial Officer and Secretary
(Principal Financial and Accounting
Officer and Duly Authorized Officer)
Date: February 12 , 1997
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EXHIBIT INDEX
EXHIBIT 11.1 STATEMENT OF COMPUTATION OF NET INCOME PER SHARE
EXHIBIT 27 FINANCIAL DATA SCHEDULE
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