UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 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 October
30, 1998 was 33,346,831.
INTERNATIONAL NETWORK SERVICES
INDEX
PART I - FINANCIAL INFORMATION
Page No
Item 1 Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets as of September 30, 1998 (unaudited) and 3
June 30, 1998
Condensed Consolidated Statements of Income (unaudited) for the three month
periods ended September 30, 1998 and 1997 4
Condensed Consolidated Statements of Cash Flows (unaudited) for the three month
periods ended September 30, 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
Item 3 Quantitative and Qualitative Disclosures about Market Risk 15
PART II - OTHER INFORMATION
Items 1-5 Not applicable 16
Item 6 Exhibits and Reports on Form 8-K 16
Signature 17
2
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INTERNATIONAL NETWORK SERVICES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
September 30, June 30,
1998 1998
(Unaudited)
----------------- ---------------
ASSETS
Current assets:
Cash and cash equivalents...................................................... $ 26,141 $ 28,262
Short-term investments......................................................... 15,977 25,319
Accounts receivable, net....................................................... 53,656 42,717
Deferred income taxes.......................................................... 2,172 2,172
Prepaid expenses and other assets.............................................. 3,001 3,806
-------------- --------------
Total current assets....................................................... 100,947 102,276
Property and equipment, net........................................................ 12,838 11,092
Deferred income taxes.............................................................. 1,071 1,071
Investments........................................................................ 24,220 15,148
-------------- --------------
$ 139,076 $ 129,587
============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable............................................................... $ 5,686 $ 3,564
Accrued compensation and employee benefits .................................... 12,947 12,195
Accrued liabilities............................................................ 1,079 4,009
Income taxes payable........................................................... 3,169 --
Deferred revenue............................................................... 11,169 11,882
-------------- --------------
Total current liabilities.................................................. 34,050 31,650
-------------- --------------
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; 33,035,336 and
32,919,060 shares issued and outstanding at September 30, 1998 and June 30,
1998, respectively.......................................................... 76,291 75,259
Notes receivable from shareholders............................................. (678) (675)
Cumulative translation adjustments............................................. (37) (35)
Retained earnings ............................................................. 29,450 23,388
-------------- --------------
Total shareholders' equity................................................. 105,026 97,937
============== ==============
$139,076 $ 129,587
============== ==============
See accompanying notes to condensed consolidated financial statements.
3
INTERNATIONAL NETWORK SERVICES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
Three Months Ended
September 30,
---------------------------
1998 1997
------------ -----------
Revenue..................................... $62,452 $33,714
----------- -----------
Operating expenses:
Professional personnel................. 26,758 15,356
Sales and marketing.................... 9,271 4,447
General and administrative............. 7,418 3,936
Other costs............................ 9,557 5,233
------------ -----------
Total operating expenses.......... 53,004 28,972
------------ -----------
Income from operations...................... 9,448 4,742
Interest and other, net..................... 656 352
------------ -----------
Income before provision for income taxes.... 10,104 5,094
Provision for income taxes.................. 4,042 2,038
============ ===========
Net income.................................. $6,062 $3,056
============ ===========
Net income per share - Basic................ $0.19 $0.10
============ ===========
Shares used to compute net income per
share - Basic............................... 32,505 30,797
============ ===========
Net income per share - Diluted.............. $0.17 $0.09
============ ===========
Shares used to compute net income per
share - Diluted............................. 35,972 33,901
============ ===========
See accompanying notes to condensed consolidated financial statements.
4
INTERNATIONAL NETWORK SERVICES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
Three Months Ended
September 30,
----------------------------------
1998 1997
--------------- ---------------
Cash flows from operating activities:
Net income....................................... $ 6,062 $ 3,056
Adjustments to reconcile net income
to net cash provided by (used for)
operating activities:
Depreciation and amortization................. 1,206 1,388
Changes in operating assets and
liabilities:
Accounts receivable....................... (10,939) (7,652)
Prepaid expenses and other assets......... 805 1,669
Accounts payable.......................... 2,122 109
Accrued expenses.......................... (2,178) 699
Income taxes payable...................... 3,169 1,582
Deferred revenue.......................... (713) (80)
--------------- ---------------
Net cash provided by (used for)
operating activities................. (466) 771
--------------- ---------------
Cash flows from investing activities:
Purchases of investments........................ (12,669) (5,751)
Sales of investments............................ 12,939 --
Purchases of property and equipment, net......... (2,952) (1,372)
--------------- ---------------
Net cash used for investing
activities........................... (2,682) (7,123)
--------------- ---------------
Cash flows from financing activities:
Repayment (borrowing) of shareholder notes
receivable....................................... (3) 390
Proceeds from issuance of Common Stock, net...... 1,032 268
--------------- ---------------
Net cash provided by financing
activities............................ 1,029 658
--------------- ---------------
Effect of exchange rate changes on cash and cash
equivalents............................................. (2) --
--------------- ---------------
Net change in cash and cash equivalents................. (2,121) (5,694)
Cash and cash equivalents at beginning of period........ 28,262 19,455
--------------- ---------------
Cash and cash equivalents at end of period.............. $26,141 $13,761
=============== ===============
See accompanying notes to condensed consolidated financial statements.
5
INTERNATIONAL NETWORK SERVICES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(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, 1998, 1997 and 1996 included in the Company's Annual
Report on Form 10-K.
For purposes of presentation, the Company has indicated the first
quarter of fiscal 1999 and 1998 as ending on September 30, respectively;
whereas, in fact the Company's fiscal quarters end on the Sunday nearest the end
of the calendar quarter.
The results of operations for the three months ended September 30, 1998
are not necessarily indicative of the results that may be expected for the year
ending June 30, 1999 or any other future interim period, and the Company makes
no representations related thereto.
NOTE 2--BALANCE SHEET COMPONENTS (IN THOUSANDS)
September 30, June 30,
1998 1998
------------------ -----------------
Accounts receivable:.......
Trade........................................... $56,245 $44,185
Less: allowance for doubtful accounts.......... (2,589) (1,468)
------- -------
$53,656 $42,717
======= =======
Property and equipment:....
Computer equipment and software................. $17,260 $15,616
Furniture, fixtures & leasehold improvements.... 6,606 5,394
------- -------
23,866 21,010
Less: accumulated depreciation................. (11,028) (9,918)
------- -------
$12,838 $ 11,092
======= =======
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 September 30, 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 software
solutions. The Company's clients can purchase software solutions as a service or
separately as a software license, software subscription and support services.
Service and software subscription revenue is recognized ratably over the term of
the contract. Revenue from sales of software licenses to end users is recognized
when a signed contract or other persuasive evidence of an arrangement exists,
the software has been shipped or electronically delivered, the license fee is
fixed or determinable, and collection of the resulting receivable is probable.
For contracts with multiple elements/obligations (e.g. software products,
upgrades/enhancements maintenance, and services), revenue is allocated to each
element of the arrangement based on the Company's objective evidence of the fair
value as determined by the amount charged when the element is sold separately.
Revenue from support services (i.e. providing product updates and customer
support) is deferred and recognized ratably over the service period.
Effective June 29, 1998, the Company adopted Statement of Position
(SOP)97-2, "Software Revenue Recognition." SOP 97-2 provides guidance on
applying generally accepted accounting principles in recognizing revenue on
software transactions. The adoption of SOP 97-2 did not have a material impact
on the Company's consolidated financial position or results of operations.
Payments received in advance of revenue recognition are recorded as
deferred revenue.
NOTE 5--EARNINGS PER SHARE
Basic net income per share is computed by dividing net income
(numerator) by the weighted average number of common shares outstanding
(denominator) during the period and excludes the dilutive effect of stock
options. Diluted net income per share gives effect to all dilutive potential
common shares outstanding during a period. In computing diluted net income per
share, the average stock for the period is used in determining the number of
shares to be purchased from the exercise of stock options. All prior period net
income per share data presented has been restated in accordance with Statement
of Financial Accounting Standards No. 128 ("SFAS 128"), "Earnings per Share."
Three Months Ended
September 30,
-------------------
1998 1997
---- ----
(Unaudited)
Numerator:
Net income $ 6,062 $ 3,056
======= =======
Denominator:
Denominator for basic earnings per
Share--weighted-average shares 32,505 30,797
Effect of dilutive securities:
Common stock equivalents 2,995 1,845
Common stock subject to repurchase 472 1,259
------- -------
Denominator for diluted earnings per
Share 35,972 33,901
======= =======
Net income per share--Basic $ .19 $ .10
======= =======
Net income per share--Diluted $ .17 $ .09
======= =======
7
Antidilutive Options. Options to purchase 114,809 shares of common stock were
outstanding during the three-month period ended September 30, 1997 but were not
included in the computation of diluted EPS because the options' exercise price
was greater than the average market price of the common shares. There were no
options to purchase shares of common stock not included in the computation of
diluted EPS.
NOTE 6 - COMPREHENSIVE INCOME
In 1997, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive
Income," which was adopted by the Company in the first quarter of 1999. SFAS No.
130 requires companies to report a new, additional measure of income on the
income statement or to create a new financial statement that has the new measure
of income on it. "Comprehensive income" includes foreign currency translation
gains and losses and other unrealized gains and losses that have been previously
excluded from net income and reflected instead in equity. The components of
comprehensive income, which are excluded from net income, are not significant
individually or in the aggregate, and therefore, no separate statement of
comprehensive income has been presented.
NOTE 7--SUBSEQUENT EVENTS
On October 9, 1998, the Company entered into a definitive merger
agreement to acquire VitalSigns Software ("VitalSigns"). Under the terms of the
definitive merger agreement, the Company will acquire all of the outstanding
stock and assume all of the outstanding employee stock options of VitalSigns in
exchange for 4.2 million shares of the Company's common stock. The Merger, which
is intended to be accounted for as a pooling of interests, is subject to the
approval of the VitalSigns shareholders as well as other standard closing
conditions and there can be no assurance that the Merger will close in a timely
manner, or at all.
On October 29, 1998 at the Annual Meeting of Shareholders of the Company,
the shareholders approved a change in the state of incorporation of the Company
from California to Delaware.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
OVERVIEW
International Network Services ("INS" or "the Company") is a global
provider of solutions 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 service 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 has leveraged its expertise in complex networks
to develop software solutions for certain repetitive network management tasks.
The Company's current offering, EnterprisePRO, provides clients with network and
application monitoring and network performance reporting. Prior to fiscal 1998,
the Company offered its software solutions 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. The Company
recognizes revenue from sales of software licenses to end users upon persuasive
evidence of an arrangement, delivery of the software to a customer, and
collection of a fixed or determinable license fee is considered probable.
Service and software subscription revenue is recognized ratably over the term of
the contract.
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."
8
RECENT DEVELOPMENTS
On October 9, 1998, the Company entered into a definitive merger
agreement to acquire VitalSigns. Under the terms of the definitive merger
agreement, the Company will acquire all of the outstanding stock and assume
all of the outstanding employee stock options of VitalSigns in exchange for
4.2 million shares of the Company's common stock. The Merger, which is
intended to be accounted for as a pooling of interests, is subject to the
approval of the VitalSigns shareholders as well as other standard closing
conditions and there can be no assurance that the Merger will close in a
timely manner, or at all.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain
financial data as a percent of revenue:
Three Months Ended
September 30,
---------------------
1998 1997
---- ----
Revenue 100.0% 100.0%
Operating expenses:
Professional personnel......................... 42.8 45.5
Sales and marketing............................ 14.8 13.2
General and administrative..................... 11.9 11.7
Other costs.................................... 15.4 15.5
----- -----
Total operating expenses................. 84.9 85.9
----- -----
Income from operations................................ 15.1 14.1
Interest and other, net............................... 1.1 1.0
----- -----
Income before provision for income taxes.............. 16.2 15.1
Provision for income taxes............................ 6.5 6.0
----- -----
Net income............................................ 9.7% 9.1%
===== =====
REVENUE
Substantially all of the Company's revenue is derived from fees for
professional services. The Company also derives revenue from software solutions;
however, such revenue has not been significant to date. Revenue increased 85% to
$62.5 million for the three-month period ended September 30, 1998 from $33.7
million in the same period of 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 12% of the Company's revenue for the
three-month period ended September 30, 1998. No one client accounted for more
than 10% of the Company's revenue for the three-month period ended September 30,
1997.
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 software solutions. Professional personnel
expenses were $26.8 million and $15.4 million for the three-month periods ended
September 30, 1998 and 1997, respectively. 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 42.8% at
September 30, 1998 from 45.5% for the same period in fiscal 1998. Professional
personnel expenses decreased as a percent of revenue 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
$9.3 million and $4.4 million for the three-month periods ended September 30,
1998 and 1997, respectively. As a percent of revenue, sales and marketing
expenses increased to 14.8% at September 30, 1998 from 13.2% for the same period
in fiscal 1998. The increase was due primarily to the growth in the number of
sales and marketing employees and a significant increase in marketing spending,
primarily for advertising.
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 $7.4 million and $3.9 million for the three-month
periods ended September 30,
9
1998 and 1997, respectively. As a percent of revenue, general and administrative
expenses increased to 11.9% at September 30, 1998 from 11.7% for the same period
in fiscal 1998. General and administrative expenses have increased as the
Company has continued to add personnel to support the Company's growth in
operations.
Other costs. Other costs consist of expenses related to professional
personnel (other than compensation and benefits), including travel and
entertainment, certain recruiting and professional development expenses, field
facilities, depreciation, expensed equipment and supplies, and research and
development expenses related to software solutions. Other costs were $9.6
million and $5.2 million for the three-month periods ended September 30, 1998
and 1997, respectively. Other costs increased primarily as a result of increases
in the number of professional personnel employed, and to a lesser extent, the
costs of field offices established. Other costs decreased slightly as a percent
of revenue to 15.4% at September 30, 1998 from 15.5% for the same period in
fiscal 1998.
Interest and other, net. Interest and other, net, consists of interest
income. Interest income consists primarily of interest on cash, cash equivalents
and short-term investments and notes receivable from shareholders. Net interest
income was $656,000 and $352,000 for the three-month periods ended September 30,
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 1999 and 1998.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1998, the Company had $66.3 million in cash, cash
equivalents and investments, representing a decrease of $2.4 million from June
30, 1998.
Net cash used by operations for the first three months of fiscal 1999
was $466,000 compared to net cash provided by operations of $771,000 for the
comparable period of the prior year. Cash used in operating activities was
primarily used to fund increasing accounts receivable, payment of accrued
liabilities, and partially offset by increasing payables. 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 $3.0 million during the three
months ended September 30, 1998 compared to $1.4 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 February 2000. Borrowings under the line of credit bear interest at the
bank's prime rate less one half of one percent, or the Company has the option to
borrow at a fixed rate at one and one half percent above the bank's LIBOR for a
fixed term of up to three months. Balances outstanding at February 2000 that
have been used to fund capital equipment may be converted to a three-year term
loan, which provides for the same interest rate option. There were no borrowings
under the line of credit at September 30, 1998. The line of credit requires the
Company to comply with certain financial covenants. At September 30, 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.
10
Variability of Quarterly Operating Results. INS derives substantially
all of its revenue from professional services, which are generally provided on a
"time and expenses" basis. INS recognizes professional services revenue only
when network systems engineers are engaged on client projects. In addition, a
majority of INS' 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 INS' 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.
INS' 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 INS' failure to meet its clients' expectations;
* claims by INS' clients for the actions of INS' employees arising from
damages to clients' business or otherwise;
* competition;
* the development and introduction of new services;
* corporate acquisitions;
* decrease or slowdown in the growth of the networking industry as a
whole; and
* general economic conditions.
INS' operating results may also fluctuate based upon the ongoing
market acceptance and the timing and size of orders for -- electronic services
which consist primarily of software solutions, which are difficult to
forecast. See "Risks Associated with Software Solutions." An unanticipated
order shortfall for software solutions could materially adversely affect INS'
operating results, particularly because margins are higher on software
solutions than professional services. INS has entered into a definitive merger
agreement with VitalSigns, a company that manufactures and develops software
products that monitor and measure network and application performance. If the
proposed acquisition of VitalSigns closes, INS' electronic services offerings
will include a greater percentage of sales of software products. Sales of
software products are subject to numerous risks including: product life
cycles, undetected product errors or failures (product "bugs") and dependence
on proprietary technology. In addition, INS 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 materially adversely affect INS' operating results if revenue does not
increase as much as forecasted.
INS believes that quarterly revenue and operating results are likely to
vary significantly in the future and that period-to-period comparisons of INS'
operating results are not necessarily meaningful. You should not rely on period-
to-period comparisons as indications of future performance. In some future
quarter, INS' revenue or operating results will likely be below the expectations
of public market analysts or investors. In such event, the price of INS Common
Stock would likely be materially adversely affected.
Risks Associated with Client Concentration; Absence of Long-Term
Agreements. INS has derived a significant portion of its revenue from a limited
number of large clients and expects this concentration to continue. In the
quarter ended September 30, 1998, one client accounted for approximately 12% of
revenue and ten clients accounted for approximately 44% of revenue. No one
client accounted for more than 10% of revenue for the quarter ended September
30, 1997. There can be no assurance that revenue from clients that have
accounted for significant revenue in past periods, individually or as a group,
will continue, or if continued will reach or exceed historical levels in any
future period. INS has, in the past, experienced declines in revenue from
clients that have accounted for significant revenue.
11
In addition, INS generally does not have a long-term services contract
with any of its clients. INS' clients are generally able to reduce or cancel
their use of INS' professional services without penalty and with little or no
notice. As a result, INS believes that the number and size of INS' existing
projects are not reliable indicators or measures of future revenue. When a
client defers, modifies or cancels a project, INS 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 INS' operating
results. In addition, INS' 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, the following could have a
material adverse effect on INS' business, operating results and financial
conditions:
* 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.
Need to Attract and Retain Qualified Network Systems Engineers. INS'
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 INS
serves. Competition for network systems engineers is intense, and there can be
no assurance that INS 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. INS has experienced,
and may in the future experience, high rates of turnover among its network
systems engineers. INS' inability to hire, train and retain a sufficient number
of qualified network systems engineers could impair its ability to adequately
manage and complete its existing projects or to obtain new projects, which, in
turn, could have a material adverse effect on INS' business, operating results
and financial condition.
INS has experienced, and may in the future experience, increasing
compensation costs for its network systems engineers. INS' inability 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 INS' business, operating results and financial
condition. In addition, INS' inability to attract and retain a sufficient number
of qualified network systems engineers in the future could impair INS' planned
expansion of its business.
Dependence on New Business Development. INS' future success will also
depend in large part on the development of new business by INS' account
managers, who solicit new business and manage relationships with existing
clients. As a result, INS' success will depend on its ability to attract and
retain qualified account managers who have an understanding of INS' business and
the industry it serves. Competition for account managers is intense and INS has
experienced, and may in the future experience, high rates of turnover among its
account managers. In addition, integration of new account managers into INS'
business can be lengthy. INS' inability to attract and retain a sufficient
number of account managers or to integrate new account managers into INS'
operations on a timely basis would impair its ability to obtain projects from
new and existing clients which could have a material adverse effect on INS'
business, operating results and financial condition.
Risks Associated with Software Solutions. INS' long-term strategy is
to derive a significant portion of its revenue from the sale of software
solutions. INS has expended, and expects to continue to expend, substantial
amounts of money and management time in the development and marketing of its
software solutions. The introduction of software solutions is subject to risks
generally associated with new product and service introductions, including
delays in development, testing or introduction, or the failure to satisfy
clients' requirements.
Management of Growth. INS has recently experienced a period of rapid
revenue and client growth and an increase in the number of employees and offices
and in the scope of its supporting infrastructure. INS 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 INS' management and operating and financial systems. INS
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 its operations and any introduction of new products and services. There can
be no assurance that INS' management or systems will be adequate to support its
existing or future operations. Any failure to implement and improve INS' systems
or to hire and retain appropriate personnel to manage its operations would have
a material adverse effect on INS' business, operating results and financial
condition.
12
Intense Competition. The network industry is comprised of a large
number of participants and is subject to rapid change and intense competition.
With respect to professional services, INS faces competition from system
integrators, 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 INS
does. With respect to software solutions, INS also faces competition from
software vendors. INS 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 have a material adverse effect on INS'
business, operating results and financial condition. There can be no assurance
that INS will be able to compete successfully against current or future
competitors. INS' failure to compete successfully would have a material adverse
effect on INS' business, operating results and financial condition.
Risks Associated with Acquisitions. In addition to the proposed
acquisition of VitalSigns, INS 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 INS' ongoing business,
* the distraction of management and other resources,
* the inability of management to maximize INS' financial and strategic
position 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 INS 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 INS'
long-term strategy is to expand into international markets. INS provides
professional services to certain of its United States clients in foreign
locations. INS has opened offices in the United Kingdom, the Netherlands and
Canada. 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, INS' business, operating results and financial condition could be
materially adversely affected. There can be no assurance that INS will be able
to successfully market, sell and deliver its services in international markets.
In addition to the uncertainty as to INS' ability to expand into
international markets, there are certain risks inherent in conducting business
on an international level, any of which could adversely impact the success of
INS' international operations. These risks include:
* 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.
There can be no assurance that one or more of these factors will not
have a material adverse effect on INS' future international operations and,
consequently, on INS' business, operating results and financial condition. There
can be no assurance that INS will be able to compete effectively in these
markets.
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Relationship with Cisco Systems. Although INS is a vendor independent
provider of network services, INS has a significant relationship with Cisco and
believes that maintaining and enhancing this relationship is important to INS'
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. INS has entered into direct relationships with clients
as a result of referrals from Cisco and provides services directly to Cisco,
primarily as a subcontractor.
INS has 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 INS
and an officer of Cisco is a member of INS' Board of Directors. Although INS
believes that its relationship with Cisco is good, there can be no assurance
that INS will be able to maintain or enhance its relationship with Cisco. Any
deterioration in INS' relationship with Cisco could have a material adverse
effect on INS' business, operating results and financial condition. In addition,
should INS' relationship with Cisco be perceived as compromising its ability to
provide unbiased solutions, INS' relationship with existing or potential clients
could be materially adversely affected.
Year 2000. The year 2000 issue is the result of computer programs
having been written using two digits, rather than four, to define the applicable
year. Any of the Company's computers, computer programs, and administration
equipment or products that have date-sensitive software may recognize a date
using "00" as the year 1900 rather than the year 2000. If any of the Company's
systems that have date-sensitive software use only two digits, system failures
or miscalculations may result causing disruptions of operations, including,
among other things, a temporary inability to process transactions or send and
receive electronic data with third parties or engage in similar normal business
activities.
The Company believes its current software solutions offering, EnterprisePro, is
year 2000 compliant. However, there can be no assurances that the Company's
current products do not contain undetected errors or defects associated with
year 2000 date functions that may result in material cost to the Company.
With respect to its internal information technology systems (including
information technology-based office facilities such as data and voice
communications, building management and security systems), the Company has
formed an ongoing internal review team to address the Year 2000. A team of
professionals has been engaged in a process to identify and resolve significant
Year 2000 issues in a timely manner. The process includes an assessment of
issues, testing of systems and development of remediation plans, where
necessary, as they relate to internally used software, computer hardware and use
of computer applications in the Company's products. Further, based on the
exposures found as a result of this review, the team will assess the need to
develop a contingency planning effort necessary to support critical business
operations. Executive management regularly monitors the status of the Company's
Year 2000 remediation plans.
The Company is in the process of contacting its key suppliers and other key
third parties to certify their year 2000 readiness and conducting ongoing risk
analysis. To the extent such third parties are materially adversely affected by
the Year 2000 issue, this could disrupt the Company's operations. There can be
no assurance that the company's key contractors will have successful conversion
programs, and that any such Year 2000 compliance failures will not have a
material adverse effect on the Company's business, results of operation or
financial condition.
Based on information available to date, the Company plans to substantially
complete its Year 2000 assessment and remediation in the summer of 1999. To
date, the Company has not incurred any material costs related to the assessment
of, and preliminary efforts in connection with, its Year 2000 issues. The
Company further believes that such review and modification, if any, will not
require material charge to operating expenses over the next several years. The
costs of the project and the date on which the Company plans to complete its
Year 2000 assessment and remediation are based on management's estimates, which
were derived utilizing numerous assumptions of future events including the
continued availability of certain resources, third party modification plans and
other factors. However, there can be no guarantee that these estimates will be
achieved and actual results could differ significantly from those plans.
Specific factors that might cause differences from management's estimates
include, but are not limited to, the availability and cost of personnel trained
in this area, and similar uncertainties. Management believes that the Company is
devoting the necessary resources to identify and resolve significant Year 2000
issues in a timely manner.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Quantitative and qualitative information about market risk was addressed in Item
7 of the Company's Form 10-K for the fiscal year ended June 30, 1998. There has
been no material change to that information required to be disclosed in this
Form 10-Q filing.
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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 September 30, 1998.
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SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934,
THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE
UNDERSIGNED THEREUNTO DULY AUTHORIZED.
INTERNATIONAL NETWORK SERVICES
By: /s/ Kevin J.Laughlin
----------------------------------------
Kevin J. Laughlin
Vice President, Chief Financial Officer
and Secretary
(Principal Financial and Accounting
Officer and Duly Authorized Officer)
Date: November 12, 1998
17