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 MARCH 31, 1998
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 April
30, 1998 was 32,849,303.
INTERNATIONAL NETWORK SERVICES
INDEX
PART I FINANCIAL INFORMATION
Page No
--------------
Item 1 Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets as of March 31, 1998 (unaudited) and 3
June 30, 1997
Condensed Consolidated Statements of Operations (unaudited) for the three and
nine month periods ended March 31, 1998 and 1997 4
Condensed Consolidated Statements of Cash Flows (unaudited) for the nine month
periods ended March 31, 1998 and 1997 5
Notes to Condensed Consolidated Financial Statements 6
Item 2 Management's Discussion and Analysis of Financial Condition and Results of
Operations 8
PART II OTHER INFORMATION
Items 1-5 Not applicable 14
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)
(UNAUDITED)
March 31, June 30,
1998 1997
----------------- -----------------
ASSETS
Current assets:
Cash and cash equivalents....................................................... $ 15,574 $19,455
Short-term investments.......................................................... 27,578 12,075
Accounts receivable, net........................................................ 40,728 23,949
Deferred income taxes........................................................... 1,150 1,150
Prepaid expenses and other assets............................................... 2,016 2,991
--------- -------
Total current assets.......................................................... 87,046 59,620
Property and equipment, net....................................................... 9,080 8,073
Deferred income taxes............................................................. 803 803
Investments....................................................................... 5,759 9,240
--------- -------
Total assets.................................................................. $ 102,688 $77,736
========= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable................................................................ $ 3,873 $ 3,208
Accrued expenses................................................................ 12,493 7,736
Income taxes payable............................................................ 2,196 --
Deferred revenue................................................................ 2,296 554
--------- -------
Total current liabilities..................................................... 20,858 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; 34,416,910 and
32,576,338 shares issued and outstanding at March 31, 1998 and June 30,
1997, respectively............................................................. 64,294 60,897
Notes receivable from shareholders.............................................. (695) (1,937)
Retained earnings............................................................... 18,231 7,278
--------- -------
Total shareholders' equity.................................................... 81,830 66,238
--------- -------
Total liabilities and shareholders' equity.................................... $ 102,688 $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 Nine Months Ended
March 31, March 31,
------------------------------- ------------------------------
1998 1997 1998 1997
------------- ------------- ------------- ------------
Revenue........................................................ $45,241 $26,539 $117,220 $68,764
------------- ------------- ------------- ------------
Operating expenses:
Professional personnel..................................... 19,989 12,366 52,753 31,257
Sales and marketing........................................ 6,280 3,950 16,163 10,197
General and administrative................................. 5,092 3,520 13,266 9,712
Other costs................................................ 7,217 3,568 18,149 9,870
------------- ------------- ------------- ------------
Total operating expenses.............................. 38,578 23,404 100,331 61,036
------------- ------------- ------------- ------------
Income from operations......................................... 6,663 3,135 16,889 7,728
Interest and other, net........................................ 531 350 1,361 704
------------- ------------- ------------- ------------
Income before income taxes..................................... 7,194 3,485 18,250 8,432
Provision for income taxes..................................... 2,874 1,359 7,291 3,289
------------- ------------- ------------- ------------
Net income..................................................... $ 4,320 $ 2,126 $ 10,959 $ 5,143
============= ============= ============= ============
Net income per share - Basic................................... $0.14 $0.07 $0.35 $0.22
============= ============= ============= ============
Shares used to compute net income per share - Basic............ 31,637 29,757 31,225 23,278
Net income per share - Diluted................................. $0.13 $0.06 $0.32 $0.16
============= ============= ============= ============
Shares used to compute net income per share - Diluted.......... 34,417 33,687 34,008 32,851
See accompanying notes to condensed consolidated financial statements.
4
INTERNATIONAL NETWORK SERVICES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
Nine Months Ended
March 31,
------------------------------------------
1998 1997
------------------ ------------------
Cash flows from operating activities:
Net income.................................................................. $ 10,959 $ 5,143
Adjustments to reconcile net income
to net cash provided by (used for) operating activities:
Depreciation and amortization............................................ 3,860 2,379
Changes in operating assets and liabilities:
Accounts receivable.................................................... (16,779) (10,923)
Prepaid expenses and other assets...................................... 975 (609)
Accounts payable....................................................... 665 89
Accrued expenses....................................................... 4,757 3,279
Income taxes payable................................................... 2,196 (8)
Deferred revenue....................................................... 1,742 (61)
------------------ ------------------
Net cash provided by (used for) operating activities................. 8,375 (711)
------------------ ------------------
Cash flows from investing activities:
Purchases of investments, net.............................................. (12,022) (18,256)
Purchases of property and equipment, net.................................... (4,867) (6,121)
------------------ ------------------
Net cash used for investing activities............................... (16,889) (24,377)
------------------ ------------------
Cash flows from financing activities:
Repayments of notes payable................................................. -- (715)
Repayment of borrowings under line of credit................................ -- (1,000)
Repayment of shareholder notes receivable................................... 528 --
Proceeds from issuance of Common Stock, net................................. 4,105 41,911
------------------ ------------------
Net cash provided by financing activities............................ 4,633 40,196
------------------ ------------------
Net change in cash and cash equivalents........................................ (3,881) 15,108
Cash and cash equivalents at beginning of period............................... 19,455 869
------------------ ------------------
Cash and cash equivalents at end of period..................................... $ 15,574 $ 15,977
================== ==================
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 third quarter and
the first nine months of fiscal 1998 and 1997 as ending on March 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 nine months ended March 31, 1998
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 (IN THOUSANDS)
March 31, June 30,
1998 1997
----------------- -----------------
Accounts receivable:
Trade................................................................... $42,150 $24,537
Less: allowance for doubtful accounts.................................. (1,422) (588)
------- -------
$40,728 $23,949
======= =======
Property and equipment:......................................................
Computer equipment and software......................................... $14,164 $12,389
Furniture, fixtures & leasehold improvements............................ 4,054 2,489
------- -------
18,218 14,878
Less: accumulated depreciation......................................... (9,138) (6,805)
------- -------
$ 9,080 $ 8,073
======= =======
Accrued expenses:
Accrued compensation and employee benefits.............................. $10,339 $ 6,935
Other liabilities....................................................... 2,154 801
------- -------
$12,493 $ 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 March 31, 1998, 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 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 Nine Months Ended
----------------------------- -----------------------------
March 31, March 31, March 31, March 31,
1998 1997 1998 1997
----------------------------- -----------------------------
(Unaudited)
Numerator:
Net income $ 4,320 $ 2,126 $10,959 $ 5,143
------- ------- ------- -------
Denominator:
Denominator for basic earnings per
share-- weighted-average shares 31,637 29,757 31,225 23,278
Effect of dilutive securities:
Common stock equivalents 1,975 2,140 1,768 7,512
Common stock subject to repurchase 805 1,790 1,105 2,061
------- ------- ------- -------
Denominator for diluted earnings per
share 34,417 33,687 34,008 32,851
======= ======= ======= =======
Net income per share--Basic $ .14 $ .07 $ .35 $ .22
======= ======= ======= =======
Net income per share--Diluted $ .13 $ .06 $ .32 $ .16
======= ======= ======= =======
Antidilutive Options. Options to purchase 448,967 and 227,511 shares of common
stock were outstanding during the three month period ended March 31, 1998 and
1997, respectively and 327,674 and 113,015 during the nine month period ended
March 31, 1998 and 1997, 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 NINE MONTHS ENDED
MARCH 31, MARCH 31,
--------- ---------
1998 1997 1998 1997
---- ---- ---- ----
Revenue 100.0% 100.0% 100.0% 100.0%
Operating expenses:
Professional personnel............................. 44.2 46.6 45.0 45.5
Sales and marketing................................ 13.9 14.9 13.8 14.8
General and administrative......................... 11.3 13.3 11.3 14.1
Other costs........................................ 16.0 13.4 15.5 14.4
----- ----- ----- -----
Total operating expenses....................... 85.4 88.2 85.6 88.8
----- ----- ----- -----
Income from operations................................ 14.6 11.8 14.4 11.2
Interest and other, net............................... 1.2 1.3 1.2 1.0
----- ----- ----- -----
Income before income taxes............................ 15.8 13.1 15.6 12.2
Provision for income taxes............................ 6.4 5.1 6.2 4.8
----- ----- ----- -----
Net income............................................ 9.4% 8.0% 9.4% 7.4%
===== ===== ===== =====
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 71% to $45.2 million for the three months ended March 31, 1998 from
$26.5 million in the same period of the prior year. Revenue increased 70% to
$117.2 million in the nine months ended March 31, 1998 from $68.8 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. One
client accounted for 10% of the Company's revenue for the three month period
ended March 31, 1998. No one client accounted for more than 10% of
8
the Company's revenue for the nine month period ended March 31, 1998.
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 $20.0 million and $52.8 million for the three-month and
nine-month periods ended March 31, 1998, respectively, compared to $12.4 million
and $31.3 million, respectively, for the same periods in fiscal 1997. 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 44.2% and 45.0% for the three-month and nine-
month periods ended March 31, 1998, respectively, compared to 46.6% and 45.5%
for the same periods of fiscal 1997. Professional personnel expenses decreased
as a percent of revenue in the three month and nine month periods ended March
31, 1998 primarily due to an increase in billing rates for professional services
and, to a lesser extent, an increase in EnterprisePRO revenue as a percent of
total revenue.
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
$6.3 million and $16.2 million for the three-month and nine-month periods ended
March 31, 1998, respectively, compared to $4.0 million and $10.2 million,
respectively, for the same periods in fiscal 1997. 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 13.9% and 13.8% for the
three-month and nine-month periods ended March 31, 1998, respectively, from
14.9% and 14.8%, respectively, in the same periods of fiscal 1997. The decrease,
on a percentage basis, was due primarily to leverage of the field management
organization and changes in compensation plans.
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 $5.1 million and $13.3 million for the three-month
and nine-month periods ended March 31, 1998, respectively, compared to $3.5 and
$9.7 million, respectively, for the same periods in fiscal 1997. 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 11.3% for
both the three-month and nine-month periods ended March 31, 1998, from 13.3 %
and 14.1%, respectively, in the same periods of fiscal 1997. General and
administrative expenses decreased as a percent of revenue in the three-month and
nine-month periods ended March 31, 1998 due to the leverage of infrastructure.
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 and supplies, and research and
development expenses related to electronic services. Other costs were $7.2
million and $18.1 million for the three-month and nine-month periods ended March
31, 1998, respectively, compared to $3.6 million and $9.9 million, respectively,
for the same periods in fiscal 1997. 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
1997. Other costs increased as a percent of revenue to 16.0% and 15.5% for the
three-month and nine-month periods ended March 31, 1998, respectively, as
compared to 13.4% and 14.4%, respectively, for the same periods in fiscal 1997.
Other costs, as a percent of revenue, increased primarily due to increases in
recruiting, professional development and travel and entertainment 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 short term investments and notes receivable from
shareholders. Interest expense consists of interest associated with bank
borrowings. Net interest income was $531,000 and $350,000 for the three-month
periods ended March 31, 1998 and 1997, respectively. Net interest income was
$1.4 million and $704,000 for the nine-month periods ended March 31, 1998 and
1997, respectively. The increase in net interest income reflects higher average
investment balances.
Provision for Income Taxes. Income tax expense represents combined
federal and state taxes at an effective rate of 40% for fiscal 1998 and 39% for
fiscal 1997.
9
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 1998, the Company had $48.9 million in cash, cash
equivalents and investments, representing an increase of $8.1 million from June
30, 1997.
Net cash provided by operations for the first nine months of fiscal
1998 was $8.4 million compared to net cash used in operations of $711,000 for
the comparable period of the prior year. Increases in cash provided by
operations were due primarily to an increase in net income. 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 $4.9 million during the nine
months ended March 31, 1998 compared to $6.1 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 March 31, 1998.
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 March 31, 1998, 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 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
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 or slowdown in
the growth of the networking industry as a whole and general economic
conditions. The Company's operating results may also fluctuate based upon the
ongoing market acceptance and the timing and size of orders for electronic
services (see "Risks Associated with Electronic Services") 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
10
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; 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. One
client accounted for 10% of the Company's revenues for the three month period
ended March 31, 1998. No one client accounted for more than 10% of the Company's
revenue for the nine month period ended March 31, 1998. 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 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
11
with new service introductions, including delays in development, testing or
introduction, or the failure to satisfy clients' requirements.
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 this rate of growth is 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.
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 also 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 Potential 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 recently opened an office in the United Kingdom to
serve its 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
12
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 relationships with clients as a
result of referrals from Cisco and provides services directly 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 1-5 NOT APPLICABLE
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
27.1 Financial Data Schedule
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the quarter ended
March 31, 1998.
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, Chief Financial Officer
and Secretary
(Principal Financial and Accounting
Officer and Duly Authorized Officer)
Date: May 11 , 1998
15