UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1997
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 October
31, 1997 was 32,275,683.
INTERNATIONAL NETWORK SERVICES
INDEX
PART I -- FINANCIAL INFORMATION
Page No.
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets
as of September 30, 1997 (unaudited) and June 30, 1997 2
Condensed Consolidated Statements of Income (unaudited)
for the three month periods ended September 30, 1997 and 1996 3
Condensed Consolidated Statements of Cash Flows (unaudited)
for the three month periods ended September 30, 1997 and 1996 4
Notes to Condensed Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 7
Item 3. Not applicable
PART II -- OTHER INFORMATION
Items 1-5. Not applicable
Item 6. Exhibits and Reports on Form 8-K 14
Signature 15
-2-
PART I -- FINANCIAL INFORMATION
-------------------------------
ITEM 1. FINANCIAL STATEMENTS.
--------------------
INTERNATIONAL NETWORK SERVICES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
Sept 30, June 30,
1997 1997
--------- ---------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $13,761 $19,455
Short-term investments 19,295 12,075
Accounts receivable, net 31,601 23,949
Deferred income taxes 1,150 1,150
Prepaid expenses and other assets 1,322 2,991
------- -------
Total current assets 67,129 59,620
Property and equipment, net 8,057 8,073
Deferred income taxes 803 803
Investments 7,771 9,240
------- -------
Total assets $83,760 $77,736
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable 3,317 $ 3,208
Accrued expenses 8,435 7,736
Income taxes payable 1,582 -
Deferred revenue 474 554
------- -------
Total current liabilities 13,808 11,498
------- -------
Shareholders' equity:
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;
32,043,234 and 32,076,600 shares issued and outstanding
at September 30, 1997 and June 30, 1997, respectively 60,451 60,897
Notes receivable from shareholders (833) (1,937)
Retained earnings 10,334 7,278
------- -------
Total shareholders' equity 69,952 66,238
------- -------
Total liabilities and shareholders' equity $83,760 $77,736
======= =======
See accompanying notes to condensed consolidated financial statements.
-3-
INTERNATIONAL NETWORK SERVICES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
Three Months Ended
September 30,
-----------------
1997 1996
------- --------
Revenue $33,714 $18,888
------- -------
Operating expenses:
Professional personnel 15,356 8,446
Sales and marketing 4,447 2,534
General and administrative 3,936 2,805
Other costs 5,233 3,143
------- -------
Total operating expenses 28,972 16,928
------- -------
Income from operations 4,742 1,960
Interest and other, net 352 (20)
------- -------
Income before income taxes 5,094 1,940
Provision for income taxes 2,038 757
------- -------
Net income $ 3,056 $ 1,183
======= =======
Net income per share $ 0.09 $ 0.04
======= =======
Shares used to compute net income
per share 33,901 31,124
====== ======
See accompanying notes to condensed consolidated financial statements.
-4-
INTERNATIONAL NETWORK SERVICES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
Three Months Ended
September 30,
--------------------
1997 1996
--------- ---------
Cash flows from operating activities:
Net income $ 3,056 $ 1,183
Adjustments to reconcile net income to net
cash provided by (used for) operating activities:
Depreciation and amortization 1,388 722
Changes in operating assets and liabilities:
Accounts receivable (7,652) (4,446)
Prepaid expenses and other assets 1,669 (48)
Accounts payable 109 2,102
Accrued expenses 699 (748)
Income taxes payable 1,582 (109)
Deferred revenue (80) 68
------- --------
Net cash provided by (used for)
operating activities 771 (1,276)
------- --------
Cash flows from investing activities:
Purchases of investments (5,751) (8,407)
Purchases of property and equipment (1,372) (1,734)
------- --------
Net cash used for investing activities (7,123) (10,141)
------- --------
Cash flows from financing activities:
Repayments of notes payable - (715)
Repayment of borrowings under line of credit - (1,000)
Repayments of shareholder notes receivable 390 -
Proceeds from issuance of Common Stock, net 268 41,889
------- --------
Net cash provided by financing activities 658 40,174
------- --------
Net change in cash and cash equivalents (5,694) 28,757
Cash and cash equivalents at beginning of period 19,455 869
------- --------
Cash and cash equivalents at end of period $13,761 $ 29,626
======= ========
Supplemental disclosure of noncash invseting and
financing activities:
Repurchase of Common Stock in exchange for
cancellation of notes receivable from shareholders $ 714 $
See accompanying notes to condensed consolidated financial statements.
-5-
INTERNATIONAL NETWORK SERVICES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS)
(UNAUDITED)
Note 1 - Basis of Presentation
The accompanying unaudited condensed consolidated 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 disclosure, 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 condensed consolidated
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, 1997, 1996 and 1995
included in the Company's Annual Report on Form 10-K.
For purposes of presentation, the Company has indicated the first three months
of fiscal 1998 and 1997 as ending on September 30, 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 months ended September 30, 1997 are not
necessarily indicative of the results that may be expected for the year ending
June 30, 1998 or any other future interim period, and the Company makes no
representations related thereto.
Note 2 - Balance Sheet Components
SEPT 30 JUNE 30
------------ -----------
1997 1997
------------ -----------
(UNAUDITED)
------------
Accounts receivable:
Trade $32,207 $24,537
Less: allowance for doubtful (606) (588)
accounts ------- -------
$31,601 $23,949
======= =======
Property and equipment:
Computer equipment and software $13,547 $12,389
Furniture, fixtures and leasehold 2,703 2,489
improvements ------- -------
16,250 14,878
Less: accumulated depreciation (8,193) (6,805)
------- -------
$ 8,057 $ 8,073
======= =======
Accrued expenses:
Accrued compensation and employee $ 7,402 $ 6,935
benefits
Other liabilities 1,033 801
------- -------
$ 8,435 $ 7,736
======= =======
-6-
INTERNATIONAL NETWORK SERVICES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS)
(UNAUDITED)
(CONTINUED)
Note 3 - Cash, Cash Equivalents and 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. 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 September 30, 1997, the
estimated fair value approximated cost.
Note 4 - Revenue Recognition
Substantially all of the Company's revenue is derived from professional services
which are generally provided to clients on a "time and expense" basis. The
Company also performs a limited of number of fixed-price engagements under which
revenue is recognized using the percentage-of-completion method (based on the
ratio of costs incurred to total estimated project costs). Provision for
estimated losses on engagements is made during the period in which the loss
becomes probable and can be reasonably estimated. To date, such losses have been
insignificant. The Company reports revenue net of reimbursable expenses which
are billed to and collected from clients. In addition, the Company derives a
portion of its revenue from electronic services. The Company's clients
purchase electronic services as a service or separately as a software
license, software subscription and support services. Service and software
subscription revenue is recognized over the term of the contract, installation
revenue is recognized when installation is complete and software license
revenue is recognized upon shipment of the product, provided no significant
obligations remain and collection of the resulting receivable is probable. In
instances where a significant obligation remains, revenue recognition is
delayed until the obligation is satisfied. Payments received in advance of
revenue recognition are recorded as deferred revenue.
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. 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). Common equivalent shares are excluded from
the computation if their effect is antidilutive, except that pursuant to the
requirements of the Securities and Exchange Commission, common and common
equivalent shares issued one year prior to the initial public offering date have
been included in the computations as if they were outstanding for all periods
presented, even if antidilutive (using the treasury stock method and the assumed
initial public offering price).
-7-
INTERNATIONAL NETWORK SERVICES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS)
(UNAUDITED)
(CONTINUED)
Note 6 - Recent Accounting Pronouncement
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128 ("SFAS 128"), "Earnings per Share." The
Statement redefines earnings per share (EPS) under generally accepted accounting
principles. Under the new standard, primary (EPS) is replaced by basic EPS and
fully diluted EPS is replaced by diluted EPS. It also requires dual
presentation of basic and diluted EPS on the face of the financial statements.
Basic EPS is computed by dividing income available to common shareholders by the
weighted-average number of common shares outstanding for the period. Diluted
EPS is computed similar to fully diluted EPS under APB Opinion 15. SFAS 128
must be adopted for the second quarter of fiscal 1998. The following table
represents unaudited, pro forma disclosures of basic and diluted EPS in
accordance with SFAS 128 assuming the standard was applied during all periods
presented below:
THREE MONTHS ENDED
---------------------
SEPTEMBER 30,
---------------------
1997 1996
---------- ---------
Net income per common share - as reported $0.09 $0.04
Basic net income per common share - pro forma $0.10 $0.09
Diluted net income per common share - pro forma $0.09 $0.04
-8-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
---------------------------------------------------------------
RESULTS OF OPERATIONS.
---------------------
OVERVIEW
International Network Services ("INS" or "the Company") is a worldwide 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 multivendor 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 provides electronic services for certain network
management tasks. The Company's current offering, EnterprisePRO, provides
clients with network monitoring and network performance reporting. Prior to
the quarter ended September 30, 1997, the Company offered it's electronic
services to clients only as a service which resulted in revenue recognition
over the contract term. During the quarter ended September 30, 1997, the
Company also began to allow clients to separately purchase a software license,
software subscription and support services as an alternative to the service
contract. When the client purchases electronic services in components, the
Company recognizes service and software subscription revenue over the term of
the contract, installation revenue when installation is complete and software
license revenue when software is shipped.
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
September 30,
1997 1996
------------------
Revenue 100.0% 100.0%
Operating expenses:
Professional personnel 45.5 44.7
Sales and marketing 13.2 13.4
General and administrative 11.7 14.9
Other costs 15.5 16.6
----- -----
Total operating expenses 85.9 89.6
----- -----
Income from operations 14.1 10.4
Interest and other, net 1.0 (0.1)
----- -----
Income before income taxes 15.1 10.3
Provision for income taxes 6.0 4.0
----- -----
Net income 9.1 6.3
===== =====
-9-
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 79% to $33.7
million in the three months ended September 30, 1997 from $18.9 million in the
same period of 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.
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 $15.4 million and $8.4 million for the three month periods ended September
30, 1997 and 1996, respectively. This increase is attributable primarily to an
increase in the number of network system engineers. Professional personnel
expenses as a percent of revenue were 45.5% and 44.7% for the three month
periods ended September 30, 1997 and 1996, respectively. Professional
personnel expenses increased as a percent of revenue in the three month period
ended September 30, 1997 due to lower utilization of professional personnel.
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
$4.4 million and $2.5 million for the three month periods ended September 30,
1997 and 1996, respectively. The increase was due primarily to the growth in the
number of sales and marketing employees and to commissions resulting from
increased revenues. Sales and marketing expenses were 13.2% and 13.4% of revenue
for the three month periods ended September 30, 1997 and 1996, respectively.
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 $3.9 million and $2.8 million for the three month periods ended
September 30, 1997 and 1996, respectively. General and administrative expenses
have increased as the Company has continued to add personnel to support the
Company's growth in operations. General and administrative expenses were 11.7%
and 14.9% of revenue for the three month periods ended September 30, 1997 and
1996, respectively. The decrease, on a percentage basis, was due primarily to
an increase in revenue.
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 $5.2 million and $3.1
million for the three month periods ended September 30, 1997 and 1996,
respectively. 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. Other costs were 15.5% and 16.6% of revenue for the
three month periods ended September 30, 1997 and 1996, respectively. Other
costs, as a percent of revenue, fluctuate primarily due to the timing of
training and recruiting expenses.
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 investments and notes receivable from shareholders. Interest
expense consists of interest associated with bank borrowings. Net interest
income was $352,000 for the three month period ended September 30, 1997
compared to net interest expense of $20,000 for the three month period ended
September 30, 1996. The increase in net interest income for the three month
period ended September 30, 1997 is primarily a result of higher average
investment balances during the period as compared to the three month period
ended September 30, 1996.
Provision for Income Taxes. Income tax expense represents combined federal,
state and foreign taxes at an effective rate of 40% and 39% for fiscal 1998 and
fiscal 1997, respectively.
-10-
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1997, the Company had $40.8 million in cash, cash equivalents
and investments, relatively unchanged from June 30, 1997.
Net cash provided by operations for the three month period ended September 30,
1997 was $771,000 compared to net cash used in operations of $1.3 million for
the comparable period of the prior year. Increases in cash provided by
operations were offset by an increase in accounts receivable of $7.7 million.
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
$1.4 million in the three months ended September 30, 1997 compared to $1.7
million for the comparable period of the prior year. The Company currently
has no material capital commitments.
The Company has a $10 million line of credit with a bank which expires in June
1998. Borrowings under the line of credit bear interest at the bank's prime
rate. There were no borrowings under the line of credit at September 30, 1997.
Borrowings outstanding at June 30, 1998 that have been used to fund capital
equipment purchases, up to a maximum of $5 million, may be converted to a 36-
month loan which bears interest at the bank's prime rate plus .5%. The line of
credit is secured by substantially all of the Company's assets and requires the
Company to comply with certain financial covenants. At September 30, 1997, the
Company was in compliance with these financial covenants.
The Company believes that its current cash and investment balances and cash flow
from operations, will be sufficient to meet its working capital and capital
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, an
inability to hire and retain sufficient numbers of network systems engineers,
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 development and introduction of new services and general
economic conditions. The Company's operating results may also fluctuate based
upon the ongoing market acceptance of EnterprisePRO (see "Risks Associated
with Electronic Services") and the timing and size of orders, which are
difficult to forecast. In addition, the Company recently began offering
EnterprisePRO software licenses as an alternative to a service contract. The
Company recognizes software license revenue upon the shipment of software
rather than as services over the contract period. As a result, if an
unanticipated order shortfall for electronic services occurs, the Company's
operating results could be materially adversely affected. In addition, the
Company plans to continue to expand its operations by hiring
-11-
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. Although, no one client accounted for
more than 10% of the Company's revenues for the three month period ended
September 30, 1997, there can be no assurance that revenue from 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
any of its clients. Any significant reduction in the scope of the work performed
for any 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. The Company
has experienced, and may in the future experience, increasing compensation costs
for its network systems engineers. Any inability of the Company to recover
increases in compensation of network systems engineers through higher billing
rates or to reduce other expenses to offset such increases, 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 experienced periods 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 and
its ability to maintain its current level of revenues.
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
-12-
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 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.
Risks Associated With Potential Acquisitions. As part of its business strategy,
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 International Expansion. A component of the Company's
long-term strategy is to expand into international markets. During the quarter
ended September 30, 1997, the Company opened an office in the United Kingdom to
serve its client base in Europe. To date, revenue generated from international
operations has not been significant. There is no assurance that the revenue
generated from international operations will be adequate to offset the expense
of establishing and maintaining these foreign operations, and if revenue does
not materialize as anticipated, the Company's business, operating results and
financial condition could be materially adversely affected. To date, the Company
has provided limited professional services to certain of its United States
clients in foreign locations. 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.
Relationship with Cisco Systems. Although the Company is a vendor-independent
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
-13-
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 officer 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 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 expended, and expects
to continue to expend, substantial amounts in the development and marketing of
its electronic services. 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 significant
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
significant market acceptance on a timely basis could have a material adverse
effect on the Company's business, operating results and financial condition.
-14-
PART II -- OTHER INFORMATION
----------------------------
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
--------------------------------
(a) EXHIBITS
11.1 STATEMENT OF COMPUTATION OF NET INCOME PER SHARE
27.1 FINANCIAL DATA SCHEDULE
(b) REPORTS ON FORM 8-K
NO REPORTS ON FORM 8-K WERE FILED DURING THE QUARTER ENDED
SEPTEMBER 30, 1997.
-15-
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: November 12, 1997
-16-
EXHIBIT INDEX
EXHIBIT 11.1 STATEMENT OF COMPUTATION OF NET INCOME PER SHARE
EXHIBIT 27.1 FINANCIAL DATA SCHEDULE
-17-