UNITED STATES 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, 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 January
30, 1998 was 32,399,223.
INTERNATIONAL NETWORK SERVICES
INDEX
PART I -- FINANCIAL INFORMATION
PAGE NO.
---------
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets as of December 31, 1997 (unaudited) and June 30, 1997........ 3
Condensed Consolidated Statements of Income (unaudited) for the three and six month periods ended
December 31, 1997 and 1996..................................................................... 4
Condensed Consolidated Statements of Cash Flows (unaudited) for the six month periods ended
December 31, 1997 and 1996..................................................................... 5
Notes to Condensed Consolidated Financial Statements............................................... 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations............................................................ 8
Item 3 Not Applicable
PART II -- OTHER INFORMATION
Items 1-3. Not applicable
Item 4. Submission of Matters to a Vote of Security Holders................................................ 14
Item 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)
December 31, 1997 JUNE 30, 1997
----------------- -------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents.......................................................................... $20,623 $19,455
Short-term investments............................................................................. 23,323 12,075
Accounts receivable, net........................................................................... 30,737 23,949
Deferred income taxes.............................................................................. 1,150 1,150
Prepaid expenses and other assets.................................................................. 1,675 2,991
------- -------
Total current assets.......................................................................... 77,508 59,620
Property and equipment, net............................................................................. 7,849 8,073
Deferred income taxes................................................................................... 803 803
Investments............................................................................................. 5,964 9,240
------- -------
Total assets.................................................................................. $92,124 $77,736
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable................................................................................... $ 3,202 $ 3,208
Accrued expenses................................................................................... 10,260 7,736
Income taxes payable............................................................................... 93 --
Deferred revenue................................................................................... 1,660 554
------- -------
Total current liabilities..................................................................... 15,215 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;
32,338,370 and 32,076,600 shares issued and outstanding
at December 31, 1997 and June 30, 1997, respectively......................................... 63,702 60,897
Notes receivable from shareholders................................................................. (710) (1,937)
Retained earnings.................................................................................. 13,917 7,278
------- -------
Total shareholders' equity.................................................................... 76,909 66,238
------- -------
Total liabilities and shareholders' equity.................................................... $92,124 $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 SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------ ----------------
1997 1996 1997 1996
-------- -------- ------- -------
Revenue................................................. $38,265 $23,337 $71,979 $42,225
Operating expenses:
Professional personnel........................... 17,408 10,445 32,764 18,891
Sales and marketing.............................. 5,436 3,713 9,883 6,247
General and administrative....................... 4,238 3,387 8,174 6,192
Other costs...................................... 5,699 3,159 10,932 6,302
------- ------- ------- -------
Total operating expenses................. 32,781 20,704 61,753 37,632
------- ------- ------- -------
Income from operations.................................. 5,484 2,633 10,226 4,593
Interest and other, net................................. 478 374 830 354
------- ------- ------- -------
Income before income taxes.............................. 5,962 3,007 11,056 4,947
Provision for income taxes.............................. 2,379 1,173 4,417 1,930
------- ------- ------- -------
Net income.............................................. $ 3,583 $ 1,834 $ 6,639 $ 3,017
======= ======= ======= =======
Net income per share - Basic............................ $0.11 $0.06 $0.21 $0.14
======= ======= ======= =======
Shares used to compute net income per share - Basic.... 32,220 31,404 32,138 22,235
Net income per share - Diluted.......................... $0.11 $0.05 $0.20 $0.09
======= ======= ======= =======
Shares used to compute net income per share - Diluted.. 33,705 33,743 33,803 32,434
See accompanying notes to condensed consolidated financial statements.
4
INTERNATIONAL NETWORK SERVICES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
SIX MONTHS ENDED
DECEMBER 31,
1997 1996
-------- --------
Cash flows from operating activities:
Net income................................................................................... $ 6,639 $ 3,017
Adjustments to reconcile net income
to net cash provided by (used for) operating activities:
Depreciation and amortization............................................................... 2,500 1,239
Changes in operating assets and liabilities:
Accounts receivable....................................................................... (8,076) (6,964)
Prepaid expenses and other assets......................................................... 1,316 (276)
Accounts payable.......................................................................... (6) 1,097
Accrued expenses.......................................................................... 2,524 2,106
Income taxes payable...................................................................... 93 (250)
Deferred revenue.......................................................................... 2,394 (8)
-------- --------
Net cash provided by (used for) operating activities..................................... 7,384 (39)
-------- --------
Cash flows from investing activities:
Purchases of investments.................................................................... (9,542) (15,508)
Purchases of property and equipment, net.................................................... (2,276) (4,473)
-------- --------
Net cash used for investing activities..................................................... (11,818) (19,981)
-------- --------
Cash flows from financing activities:
Repayments of notes payable................................................................. --- (715)
Repayment of borrowings under line of credit................................................ --- (1,000)
Repayment of shareholder notes receivable................................................... 513 ---
Proceeds from issuance of Common Stock, net................................................. 3,519 41,891
-------- --------
Net cash provided by financing activities.................................................. 4,032 40,176
-------- --------
Net change in cash and cash equivalents........................................................ (402) 20,156
Cash and cash equivalents at beginning of period............................................... 21,025 869
-------- --------
Cash and cash equivalents at end of period..................................................... $ 20,623 $ 21,025
======== ========
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING 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 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, 1997, 1996 and 1995 included in the Company's Annual
Report on Form 10-K.
For purposes of presentation, the Company has indicated the second quarter and
the first six months of fiscal 1998 and 1997 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, 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
DEC 31, JUNE 30,
1997 1997
----------- ----------
(UNAUDITED)
Accounts receivable:
Trade........................................ $31,756 $24,537
Less: allowance for doubtful accounts........ (1,019) (588)
------- -------
$30,737 $23,949
======= =======
Property and equipment:
Computer equipment and software.............. $13,768 $12,389
Furniture, fixtures & leasehold improvements 3,386 2,489
------- ------
17,154 14,878
Less: accumulated depreciation............... (9,305) (6,805)
------- -------
$ 7,849 $ 8,073
======= =======
Accrued expenses:
Accrued compensation and employee
benefits.................................... $ 8,994 $ 6,935
Other liabilities............................ 1,266 801
------- -------
$10,260 $ 7,736
======= =======
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 and demand notes. 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, 1997, the estimated fair
value approximated cost.
6
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 - EARNINGS PER SHARE
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 was adopted
for the second quarter of fiscal 1998. The following table represents unaudited,
disclosures of basic and diluted EPS in accordance with SFAS 128 assuming the
standard was applied during all periods presented below:
Three Months Ended
December 31, 1997 December 31, 1996
Per-Share Per-Share
Income Shares Amount Income Shares Amount
-----------------------------------------------------------
BASIC EPS
Net income available to common
shareholders $ 3,583 32,220 $ 0.11 $ 1,834 31,404 $ 0.06
====== ======
EFFECT OF DILUTIVE SECURITIES
Common stock equivalents --- 1,485 --- 2,339
------- ------ ------- ------
DILUTED EPS
Net income available to common
shareholders and assumed conversions $ 3,583 33,705 $ 0.11 $ 1,834 33,743 $ 0.05
======= ====== ====== ======= ====== ======
Six Months Ended
December 31, 1997 December 31, 1996
Per-Share Per-Share
Income Shares Amount Income Shares Amount
-----------------------------------------------------------
BASIC EPS
Net income available to common
shareholders $ 6,639 32,138 $ 0.21 $ 3,017 22,235 $ 0.14
====== ======
EFFECT OF DILUTIVE SECURITIES
Common stock equivalents --- 1,665 --- 10,199
------- ------ ------- ------
DILUTED EPS
Net income available to common
shareholders and assumed conversions $ 6,639 33,803 $ 0.20 $ 3,017 32,434 $ 0.09
======= ====== ====== ======= ====== ======
Antidilutive Options. Options to purchase 946,850 and 84,000 shares of common
stock were outstanding during the three month period ended December 31, 1997 and
1996, respectively and 954,450 and 250,750 during the six month period ended
December 31, 1997 and 1996, respectively but were not included in the
computations of diluted EPS because the options' exercise price was greater than
the average market price of the common shares.
7
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 and products 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.
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 its electronic services to clients only
as a service which resulted in revenue recognition over the contract term. The
Company currently allows 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 SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------ ------------
1997 1996 1997 1996
---- ---- ---- ----
Revenue............................. 100.0% 100.0% 100.0% 100.0%
Operating expenses:
Professional personnel......... 45.5 44.8 45.5 44.7
Sales and marketing............ 14.2 15.9 13.7 14.8
General and administrative..... 11.1 14.5 11.4 14.7
Other costs.................... 14.9 13.5 15.2 14.9
----- ----- ----- -----
Total operating expenses.. 85.7 88.7 85.8 89.1
----- ----- ----- -----
Income from operations.............. 14.3 11.3 14.2 10.9
Interest and other, net............. 1.2 1.6 1.2 .8
----- ----- ----- -----
Income before income taxes.......... 15.5 12.9 15.4 11.7
Provision for income taxes.......... 6.2 5.0 6.1 4.6
----- ----- ----- -----
Net income.......................... 9.3% 7.9% 9.3% 7.1%
===== ===== ===== =====
8
REVENUE
Substantially all of the Company's revenue is derived from fees for
professional services. The Company also derives revenue from electronic
services. Revenue increased 64.0% to $38.3 million for the three months ended
December 31, 1997 from $23.3 million in the same period of the prior year.
Revenue increased 70.5% to $72.0 million in the six months ended December 31,
1997 from $42.2 million in the same period in the prior year. The Company does
not believe that these rates of growth are sustainable in future periods.
Revenue increased primarily due to an increase in the number and size of
professional service projects as well as an increase in EnterprisePRO sales and,
to a lesser extent, an increase in average billing rates per hour per engineer
from the same period of the prior year.
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 $17.4 million and $32.8 million for the three-month and six-month periods
ended December 31, 1997, respectively, compared to $10.4 million and $18.9
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 increased to 45.5% for both the three-month and six-month periods ended
December 31, 1997, compared to 44.8% and 44.7% for the same respective periods
in the prior year. Professional personnel expenses increased as a percent of
revenue in the three month and six month periods ended December 31, 1997 due
primarily to changes in the use of estimates for payroll taxes.
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 $5.4
million and $9.9 million for the three-month and six-month periods ended
December 31, 1997, respectively, compared to $3.7 million and $6.2 million,
respectively, for the same periods in the prior year. 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 revenue. As a percent of
revenue, sales and marketing expenses decreased to 14.2% and 13.7% for the
three-month and six-month periods ended December 31, 1997, respectively, from
15.9% and 14.8%, respectively, in the same periods of the prior year. 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 $4.2 million and $8.2 million for the three-month and six-month
periods ended December 31, 1997, respectively, compared to $3.4 million and $6.2
million, respectively, for the same periods in the prior year. 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 decreased to 11.1% and
11.4% for the three-month and six-month periods ended December 31, 1997,
respectively, from 14.5% and 14.7%, respectively, in the same periods of the
prior year. General and administrative expenses decreased as a percent of
revenue in the three-month and six-month periods ended December 31, 1997 as a
result of the Company's increased 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 $5.7 million and $10.9
million for the three-month and six-month periods ended December 31, 1997,
respectively, compared to $3.2 million and $6.3 million, respectively, for the
same periods in the prior year. 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. As a percent of revenue, other
costs increased to 14.9% and 15.2% for the three-month and six-month periods
ended December 31, 1997, respectively, from 13.5% and 14.9%, respectively, for
the same periods in the prior year, due primarily to an increase in unbilled
travel and entertainment expenses. Other costs also fluctuate due to the timing
of training and recruiting expenses.
9
Interest and other, net. Interest and other, net, consists of interest income
and expense. Interest income consists primarily of interest on cash, cash
equivalents, investments and notes receivable from shareholders. Interest
expense consists of interest associated with bank borrowings. Net interest
income was $478,000 and $374,000 for the three-month periods ended December 31,
1997 and 1996, respectively and $830,000 and $354,000 for the six-month periods
ended December 31, 1997 and 1996, respectively. The increase in net interest
income reflects higher average investment balances during the three and six
month periods ended December 31, 1997 as compared to the same periods of the
prior year.
Provision for Income Taxes. Income tax expense represents combined federal,
state and foreign taxes at an effective rate of 40% for fiscal 1998 and 39% for
fiscal 1997.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1997, the Company had $49.9 million in cash, cash equivalents
and investments, representing an increase of $9.1 million from June 30, 1997.
Net cash provided by operations for the six months ended December 31, 1997 was
$7.4 million compared to net cash used in operations of $39,000 for the
comparable period of the prior year. Increases in cash provided by operations
were due primarily to an increase in net income offset by an increase in
accounts receivable of $8.1 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 $2.3 million during the six months ended
December 31, 1997 compared to $4.5 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 December 31, 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 0.5%. 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 December 31, 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
inability to obtain new 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 and account managers, 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, decrease slowdown in
the growth of the networking industry as a whole and general economic
10
conditions. The Company's operating results may also fluctuate based upon the
ongoing market acceptance and the timing and size of orders for of EnterprisePRO
(see "Risks Associated with Electronic Services") which are difficult to
forecast. and the timing and size of orders, which are difficult to forecast If
an unanticipated order shortfall for electronic services occurs, the Company's
operating results could be materially adversely affected, particularly because
margins are higher on electronic services than professional services. In
addition, the Company plans to continue to expand its operations based on sales
forecasts by hiring additional network systems engineers, account managers 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. In addition, in the short-term, a significant portion of the Company's
operating expenses are relatively fixed, and planned expenditures are based on
sales forecasts. 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; Absence of Long-Term Agreements.
The Company has derived a significant portion of its revenue from a limited
number of large clients and expects this concentration to continue. 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 has, in the past, experienced declines in revenue from clients that have
accounted for significant revenue. In addition, the Company generally does not
have a long-term services contract with any of its clients. 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. 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 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.
Dependence on New Business Development. The Company's future success will also
depend in large part on the development of new business by the Company's account
managers, who solicit new business and manage relationships with existing
clients. As a result, the Company's success will depend on its ability to
attract and retain qualified account managers who have an understanding of the
Company's business and the industry it serves. Competition for account managers
is intense and the Company has experienced, and may in the future experience,
high rates of turnover among its account managers. In addition, integration of
new account managers into the Company's business can be lengthy. Any inability
of the Company to attract and retain a sufficient number of account managers or
to integrate new account managers into the Company's operations on a timely
basis, would impair the Company's ability to obtain projects from new and
existing clients which could have a material, adverse effect on the Company's
business, operating results and financial condition.
Risks Associated with Electronic Services. The Company's long-term strategy is
to derive a significant portion of its revenue from electronic services. The
Company has expended, and expects to continue to expend, substantial amounts in
the
11
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.
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 hire management personnel
and improve its systems on a timely basis and in such a manner as is necessary
to accommodate any increase in the number of transactions and clients, any
increase in the size of the Company's operations and any introduction of new
products and services. 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.
Intense Competition. The network services industry is comprised of a large
number of participants and is subject to rapid change and intense competition.
With respect to professional services, the Company faces competition from system
integrators, value-added resellers ("VARs"), local and regional network services
firms, telecommunications providers, network equipment 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. With respect to electronic services, the
Company faces competition from software vendors. 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. The Company provides
professional services to certain of its United States clients in foreign
locations and during the quarter ended September 30, 1997, opened an office in
the United Kingdom to serve clients 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. There
can be no assurance that the Company will be able to successfully market, sell
and deliver its services in international 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.
12
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 relationships with clients as a result of
referrals from Cisco and provides to Cisco, primarily as a subcontractor. In
addition, during the quarter ended December 31, 1997, the Company entered into a
resale agreement with Cisco, whereby Cisco's sales organization will market
EnterprisePRO to its customers and INS will deliver and administer the
service. 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.
13
PART II -- OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
-----------------------------------------------------
The following matters were submitted to the shareholders at the Company's
Annual Meeting of Shareholders held October 30, 1997. Each of these matters was
approved by a majority of shares present at the meeting.
1. The uncontested election of six directors to serve a one-year until their
successors are duly elected and qualified. The following is a summary of the
nominees and voting results:
Votes For Votes Withheld
---------- --------------
Donald K. McKinney 26,125,139 98,017
John L. Drew 26,124,103 99,053
Douglas C. Allred 26,122,300 100,856
Vernon R. Anderson 26,124,627 98,529
David Carlick 26,171,242 51,914
Lawrence G. Finch 26,171,242 51,914
2. The ratification of the appointment of Price Waterhouse, LLP as the
independent accountants of the Company for the fiscal year ending June 30, 1998.
Results of the voting included 26,215,926 shares for, 5,493 against and 1,737
shares abstained.
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
DECEMBER 31, 1997.
14
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 11, 1998
15
EXHIBIT INDEX
EXHIBIT 11.1 STATEMENT OF COMPUTATION OF NET INCOME PER SHARE
EXHIBIT 27.1 FINANCIAL DATA SCHEDULE
16