UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 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)
Delaware 77-0289509
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1213 Innsbruck Drive, Sunnyvale, CA 94089
(Address of principal executive offices) (zip code)
Registrant's telephone number, including area code: (408) 542-0100
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [_]
The number of shares outstanding of the registrant's Common Stock as of January
29, 1999 was 37,575,481.
INTERNATIONAL NETWORK SERVICES
INDEX
PART I - FINANCIAL INFORMATION
Page No
--------------
Item 1 Condensed Consolidated Financial Statements:
Condensed Consolidated Balance Sheets as of December 31, 1998 (unaudited)
and June 30, 1998 3
Condensed Consolidated Statements of Income (unaudited) for the three and six
month periods ended December 31, 1998 and 1997 4
Condensed Consolidated Statements of Cash Flows (unaudited) for the six month
periods ended December 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 10
Operations
Item 3 Quantitative and Qualitative Disclosures about Market Risk 19
PART II OTHER INFORMATION
Item 1 Not applicable 21
Item 2 Changes in Securities 20
Item 3 Not applicable 20
Item 4 Submission of Matters to a Vote of Security Holders 20
Item 5 Not applicable 21
Item 6 Exhibits and Reports on Form 8-K 21
Signature 22
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INTERNATIONAL NETWORK SERVICES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
December 31, June 30,
1998 1998
------------------ ------------------
ASSETS (Unaudited)
Current assets:
Cash and cash equivalents....................................................... $ 15,092 $ 32,484
Short-term investments.......................................................... 33,056 25,319
Accounts receivable, net........................................................ 73,598 47,035
Deferred income taxes........................................................... 3,758 3,758
Prepaid expenses and other assets............................................... 4,942 3,926
------------------ ------------------
Total current assets.......................................................... 130,446 112,522
Property and equipment, net....................................................... 16,118 11,495
Deferred income taxes............................................................. 1,071 1,071
Investments....................................................................... 22,468 15,198
------------------ ------------------
$170,103 $140,286
================== ==================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable................................................................ $ 14,530 $ 3,816
Accrued compensation and employee benefits...................................... 18,662 12,638
Accrued liabilities............................................................. 1,130 4,530
Income taxes payable............................................................ 831 --
Deferred revenue................................................................ 10,768 16,995
------------------ ------------------
Total current liabilities..................................................... 45,921 37,979
------------------ ------------------
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; 37,416,456 and
36,956,120 shares issued and outstanding at December 31, 1998 and June 30,
1998, respectively............................................................. 98,488 83,648
Notes receivable from shareholders.............................................. (506) (685)
Cumulative translation adjustments.............................................. (35) (35)
Deferred compensation........................................................... (1,379) (1,443)
Retained earnings............................................................... 27,614 20,822
------------------ ------------------
Total shareholders' equity.................................................... 124,182 102,307
------------------ ------------------
$170,103 $140,286
================== ==================
See accompanying notes to condensed consolidated financial statements.
INTERNATIONAL NETWORK SERVICES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
(UNAUDITED)
Three Months Ended Six Months Ended
December 31, December 31,
---------------------------------- ---------------------------------
1998 1997 1998 1997
-------------- -------------- -------------- -------------
Revenue:
Services.............................................. $66,597 $36,944 $126,012 $70,462
License............................................... 7,249 1,894 12,230 2,322
-------------- -------------- -------------- -------------
Total revenue........................................ 73,846 38,838 138,242 72,784
-------------- -------------- -------------- -------------
Operating expenses:
Professional personnel................................ 30,329 17,408 57,071 32,764
Other costs............................................ 9,935 5,289 18,861 10,162
Cost of license revenue................................ 205 42 353 73
Research and development............................... 1,481 1,163 2,762 1,919
Sales and marketing................................... 11,198 6,161 21,565 11,063
General and administrative............................ 8,747 4,413 16,467 8,446
Acquisition related charges........................... 7,176 - 7,176 -
-------------- -------------- -------------- -------------
Total operating expenses.............................. 69,071 34,476 124,255 64,427
-------------- -------------- -------------- -------------
Income from operations.................................. 4,775 4,362 13,987 8,357
Interest and other, net................................. 764 593 1,454 1,002
-------------- -------------- -------------- -------------
Income before provision for income taxes................ 5,539 4,955 15,441 9,359
Provision for income taxes.............................. 4,688 1,982 8,649 3,744
-------------- -------------- -------------- -------------
Net income.............................................. $ 851 $ 2,973 $ 6,792 $ 5,615
============== ============== ============== =============
Net income per share - Basic............................ $0.02 $0.09 $0.19 $0.17
Shares used to compute net income per share Basic...... 35,962 33,453 35,508 33,172
============== ============== ============== =============
Net income per share - Diluted.......................... $0.02 $0.08 $0.17 $0.15
Shares used to compute net income per share - Diluted... 41,043 37,419 40,555 37,414
============== ============== ============== =============
See accompanying notes to condensed consolidated financial statements.
INTERNATIONAL NETWORK SERVICES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(UNAUDITED)
Six Months Ended
December 31,
------------------
1998 1997
------------------ -------------------
Cash flows from operating activities:
Net income.................................................................. $ 6,792 $ 5,615
Adjustments to reconcile net income
to net cash provided by (used for) operating activities:
Depreciation and amortization........................................... 3,296 2,546
Changes in operating assets and liabilities:
Accounts receivable.................................................. (26,563) (7,629)
Prepaid expenses and other assets.................................... (1,016) 1,234
Accounts payable..................................................... 10,714 1
Accrued expenses..................................................... 2,624 3,039
Income taxes payable................................................. 831 (590)
Deferred revenue..................................................... (6,227) 2,297
------------------ -------------------
Net cash provided by (used for) operating activities.................... (9,549) 6,513
------------------ -------------------
Cash flows from investing activities:
Purchases of investments................................................... (36,264) (8,022)
Sales of investments....................................................... 21,257 --
Purchases of property and equipment, net.................................... (7,855) (2,522)
------------------ -------------------
Net cash used for investing activities.................................. (22,862) (10,544)
------------------ -------------------
Cash flows from financing activities:
Repayment of shareholder notes receivable................................... 179 1,163
Proceeds from issuance of Common Stock, net................................. 14,840 2,981
------------------ -------------------
Net cash provided by financing activities............................... 15,019 4,144
------------------ -------------------
Net change in cash and cash equivalents........................................ (17,392) 113
Cash and cash equivalents at beginning of period............................... 32,484 24,550
------------------ -------------------
Cash and cash equivalents at end of period..................................... $ 15,092 $ 24,663
================== ===================
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.
INTERNATIONAL NETWORK SERVICES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1--BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have
been prepared by International Network Services (the "Company" or "INS" ) in
accordance with the rules and regulations of the Securities and Exchange
Commission. Certain information and footnote disclosures normally included in
consolidated 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 annual audited consolidated
financial statements and notes as of and for the year ended June 30, 1998
included in the Company's Form 8-K dated December 17, 1998.
For purposes of presentation, the Company has indicated the second quarter and
the first six months of fiscal 1999 and 1998 as ending on December 31,
respectively; whereas, in fact the Company's fiscal quarters end on the Sunday
nearest the end of the calendar quarter.
The results of operations for the three and six months ended December 31, 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.
Reclassification
Certain reclassifications have been made to the prior period condensed
consolidated financial statements to conform to the current year presentation.
Acquisition
On November 20, 1998, the Company completed the acquisition of VitalSigns
Software Inc. ("VitalSigns") in a transaction accounted for as a pooling of
interests. As a result, the Company's previously issued financial statements for
the periods presented in this Form 10-Q have been restated to include the
assets, liabilities and operating results of VitalSigns in accordance with
generally accepted accounting principles and the instructions in Regulation S-X.
VitalSigns manufactures and develops software products that monitor and
measure network and application performance.
NOTE 2--BALANCE SHEET COMPONENTS (in thousands)
December 31, June 30,
1998 1998
-------------------- ------------------
Accounts receivable:
Trade............................................................... $ 76,955 $ 48,503
Less: allowance for doubtful accounts.............................. (3,357) (1,468)
-------------------- ------------------
$ 73,598 $ 47,035
==================== ==================
Property and equipment:
Computer equipment and software..................................... $ 22,464 $ 15,885
Furniture, fixtures & leasehold improvements........................ 6,526 5,664
-------------------- ------------------
28,990 21,549
Less: accumulated depreciation..................................... (12,872) (10,054)
-------------------- ------------------
$ 16,118 $ 11,495
==================== ==================
NOTE 3--CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
The Company considers all highly liquid investments purchased with original
maturities of three months or less to be cash equivalents. Cash equivalents
include commercial paper, U.S. Treasury Bills and demand notes. Short-term
investments, all of which are classified as "available for sale", consist of
high quality debt securities with original maturity dates greater than 90 days.
In accordance with Statement of Financial Accounting Standards No. 115,
"Accounting for Certain Investments in Debt and Equity Securities," investments
in securities classified as available-for-sale are reported at fair value with
unrealized gains and losses, net of related taxes, reported as a separate
component of shareholders' equity. At December 31, 1998, the estimated fair
value approximated cost.
NOTE 4--REVENUE RECOGNITION
Services revenue consists primarily of revenues earned from professional
services. Professional services are generally performed on a "time and expenses"
basis and revenue is recognized as the services are performed. The Company also
performs a limited number of fixed-price engagements under which revenue is
recognized using the percentage-of-completion method of accounting. Provision
for estimated losses on such 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 professional services revenue net of
reimbursable expenses, which are billed to and collected from clients. Services
revenue also includes software services revenue. Software services revenue
consists of all inclusive service contracts, which include the right to use
software combined with installation, maintenance and support, as well as
services for installation, maintenance and support of software licenses sold
separately. Prior to fiscal 1998, the Company only offered its EnterprisePRO
solution as an all inclusive contract. Revenue from all inclusive software
service contracts is recognized ratably over the term of the agreement. Service
revenue related to installation is generally recognized when the services are
complete. Maintenance revenue, which consists of fees for providing updates and
user documentation and support services, which provide access to INS' Technical
Assistance Center and field support staff, are recognized ratably over the term
of the agreement. Payments received in advance of services performed are
recorded as deferred revenue.
License revenue consists principally of revenue earned under software license
agreements and under royalty agreements with OEMs. License revenue is generally
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 subscription license agreements, which include
software, rights to future products and maintenance, is recognized ratably over
the term of the subscription period. Revenue on shipments to resellers, which is
generally subject to certain rights of return and price protection, is
recognized when the products are sold by the resellers to the end-user customer.
Royalty revenues that are contingent upon sale to an end user by OEMs are
recognized upon receipt of a report by the Company from the OEM.
Effective in fiscal 1999, 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 and supercedes the previous guidance provided by SOP 91-1. The
adoption of SOP 97-2 did not have a material impact on the Company's licensing
practices or consolidated financial position or results of operations.
NOTE 5--ACQUISITIONS
On November 20, 1998, the Company completed its acquisition of VitalSigns,
which has been accounted for as a pooling of interests, pursuant to the terms of
the Agreement and Plan of Reorganization, as amended and restated as of October
30, 1998. Each issued and outstanding share of VitalSigns Common Stock was
converted into 0.3160826 shares of INS Common Stock; and each outstanding option
to acquire VitalSigns Common Stock was assumed by INS and became an equivalent
option with respect to INS Common Stock, on the same terms of the original
option adjusted to reflect the exchange ratio. The Company issued approximately
3,955,000 shares of INS Common Stock in the acquisition and assumed options that
can be exercised for approximately 280,000 shares of INS Common Stock.
The transaction was accounted for as a pooling-of-interests and accordingly,
the accompanying condensed consolidated financial statements have been restated
to reflect the merger as if it occurred at the beginning of the first period
presented. VitalSigns' fiscal year ends on December 31. The condensed
consolidated income statements combine VitalSigns' results for the three months
and six months ended December 31, 1998 and 1997. The condensed balance sheets as
of June 30, 1998 and December 31, 1998 include VitalSigns' balance sheets as of
June 30, 1998 and December 31, 1998, respectively.
The results of operations previously reported by the separate companies and
the combined amounts in the accompanying consolidated financial statements are
summarized below (in thousands):
Period from
July 1, 1998 to Year Ended June 30,
November 20, -------------------------------------------------
1998 1998 1997
------------------------ --------------------- ---------------------
Revenue:
INS......................................... $109,533 $169,678 $99,275
VitalSigns.................................. 3,655 3,120 238
------------------------ --------------------- ---------------------
Combined $113,188 $172,798 $99,513
======================== ===================== =====================
Net income (loss) attributable to Common Stock:
INS......................................... $ 10,778 $ 16,110 $ 7,612
VitalSigns.................................. 314 (1,706) (860)
------------------------ --------------------- ---------------------
Combined $ 11,092 $ 14,404 $ 6,752
======================== ===================== =====================
This combined financial information is provided for comparative
purposes only and does not purport to be indicative of the results which
actually would have been obtained if the acquisition had been effected for the
periods indicated, or of the results which may be obtained in the future.
The Company incurred approximately $7.2 million in acquisition-related
charges, principally in the three month period ending December 31, 1998. These
charges include direct transaction costs primarily for financial advisory
services, legal and consulting fees and costs associated with combining the
operations of the two companies.
Prior to the acquisition, VitalSigns' fiscal year end ended on December 31.
The condensed consolidated financial statements for the year ended June 30, 1998
reflect the results of operations of INS for the year ended June 30,
1998 combined with the results of operations of VitalSigns for the twelve months
ended June 30, 1998. The financial statements for the year ended June 30, 1997
reflect the results of operations of INS for the year ended June 30, 1997
combined with the results of operations of VitalSigns for the period from August
15, 1996 (inception) through June 30, 1997.
NOTE 6--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."
Reconciliation between basic and diluted earnings per share is as follows for
the three and six month periods ended December 31, 1998 and 1997 (in thousands,
except per share data):
Three Months
Ended Six Months Ended
December 31, December 31,
--------------------------------- ---------------------------------
1998 1997 1998 1997
------------- ------------- ------------ ------------
Net income $ 851 $ 2,973 $ 6,792 $ 5,615
------- -------- -------- --------
Weighted-average commons shares -
Basic earnings per share 35,962 33,453 35,508 33,172
Effect of dilutive securities:
Common stock equivalents 3,815 2,054 3,565 2,191
Common stock subject to repurchase 1,266 1,912 1,482 2,051
Weighted-average commons shares -
Diluted earnings per share 41,043 37,419 40,555 37,414
======= ======== ======== ========
Net income per share--Basic $ .02 $ 0.09 $ .19 $ 0.17
======= ======== ======== ========
Net income per share--Diluted $ .02 $ 0.08 $ .17 $ 0.15
======= ======== ======== ========
Antidilutive Options. Options to purchase 395,743 and 892,439 shares of
common stock were outstanding during the three month period ended December 31,
1998 and 1997, respectively, and 197,872 and 503,624 during the six month
period ended December 31, 1998 and 1997, respectively, 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.
NOTE 7--RECENT ACCOUNTING STANDARDS
In 1998, the Company adopted Statement of Financial Accounting Standards
(SFAS) No. 129, "Disclosure of Information About Capital Structure," which
requires companies to disclose certain information about their capital
structure. SFAS No. 129 did not have a material impact on the Company's
consolidated financial statement disclosures.
The Company adopted SFAS No. 130, "Reporting Comprehensive Income" 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.
The Company complies with the provisions of Emerging Issues Task Force Issue
No. 96-18 ("EITF 96-18") with respect to stock options granted to non-employees
who are consultants to the Company. EITF 96-18 requires variable
plan accounting with respect to such non-employee stock options, whereby
compensation associated with such options is measured on the date such options
vest, and incorporates the current fair market value of the Company's common
stock into the option valuation model. Compensation expenses associated with
such non-employee stock options granted to date have not been significant.
NOTE 8--SUBSEQUENT EVENT
Effective December 28, 1998 (the first day of the Company's third fiscal
quarter), the Company changed its state of incorporation from California to
Delaware. As a result of the change, the par value of the Company's stock was
changed from no par value to $0.001 per share. There was no impact on the
Company's financial condition or results of operations as a result of the
reincorporation. The reincorporation proposal had been approved by the
Company's shareholders at the Company's annual meeting of shareholders. An
increase in the number of authorized shares of the Company's stock from
75,000,000 to 150,000,000 was also approved by the shareholders.
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 enterprise network professional services and software solutions. The Company
provides professional services for the full life cycle of a network, including
planning, design, implementation, operations and optimization, and maintains
expertise in the most complex network technologies and multi-vendor
environments. Through its INSoft division, INS offers industry leading software
products and software services for managing and optimizing application-ready
networks. The Company's core software solutions include EnterprisePRO, which was
introduced in June 1996, and VitalSuite, which was introduced in November 1997.
Services revenue consists primarily of revenues earned from professional
services. Professional services are generally performed on a "time and
expenses" basis and revenue is recognized as the services are performed. The
Company also performs a limited number of fixed-price engagements under which
revenue is recognized using the percentage-of-completion method of accounting.
Provision for estimated losses on such 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 professional services
revenue net of reimbursable expenses, which are billed to and collected from
clients. Services revenue also includes software services revenue. Software
services revenue consists of all inclusive service contracts, which include the
right to use software combined with installation, maintenance and support, as
well as services for installation, maintenance and support of software licenses
sold separately. Prior to fiscal 1998, the Company only offered its
EnterprisePRO solution as an all inclusive contract. Revenue from all inclusive
software service contracts is recognized ratably over the term of the agreement.
Service revenue related to installation is generally recognized when the
services are complete. Maintenance revenue, which consists of fees for
providing updates and user documentation and support services, which provide
access to INS' Technical Assistance Center and field support staff, are
recognized ratably over the term of the agreement. Payments received in advance
of services performed are recorded as deferred revenue.
License revenue consists principally of revenue earned under software license
agreements and under royalty agreements with OEMs. License revenue is generally
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 subscription license agreements, which include
software, rights to future products and maintenance, is recognized ratably over
the term of the subscription period. Revenue on shipments to distributors and
retailers, which is generally subject to certain rights of return and price
protection, is recognized when the products are sold by the distributor or
retailer to the end-user customer. Royalty revenues that are contingent upon
sale to an end user by OEMs are recognized upon receipt of a report by the
Company from the OEM.
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."
ACQUISITION
On November 20, 1998, the Company completed the acquisition of VitalSigns in a
transaction accounted for as a pooling of interests and, as a result, the
Company's previously issued financial statements for the periods presented in
this Form 10-Q have been restated to include the assets, liabilities and
operating results of VitalSigns in accordance with generally accepted accounting
principles and the instructions in Regulation S-X.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain financial
data as a percent of revenue:
Three Months Ended Six Months Ended
December 31, December 31,
---------------------------------- --------------------------------
1998 1997 1998 1997
--------------- ---------------- --------------- --------------
Revenue:
Services............................................. 90.2% 95.1% 91.2% 96.8%
License.............................................. 9.8 4.9 8.8 3.2
-----------------------------------------------------------------------
Total revenue....................................... 100.0 100.0 100.0 100.0
-----------------------------------------------------------------------
Operating expenses:
Professional personnel............................... 41.1 44.8 41.3 45.0
Other costs.......................................... 13.4 13.6 13.6 14.0
Cost of license revenue.............................. 0.3 0.1 0.3 0.1
Research and development............................. 2.0 3.0 2.0 2.6
Sales and marketing.................................. 15.2 15.9 15.6 15.2
General and administrative........................... 11.8 11.4 11.9 11.6
Acquisition related charges 9.7 5.2
-----------------------------------------------------------------------
Total operating expenses........................... 93.5 88.8 89.9 88.5
-----------------------------------------------------------------------
Income from operations................................ 6.5 14.3 10.1 11.5
Interest and other, net............................... 1.0 1.5 1.1 1.4
-----------------------------------------------------------------------
Income before provision for income taxes.............. 7.5 12.8 11.2 12.9
Provision for income taxes............................ 6.3 5.1 6.3 5.1
-----------------------------------------------------------------------
Net income............................................ 1.2 7.7 4.9 7.7
=======================================================================
REVENUE
Total Revenue. The Company's total revenue increased 90.1 % to $73.8 million
for the three-month period ended December 31, 1998 from $38.8 million in the
same period of the prior year. Total revenue increased 89.9% to $138.2 million
for the six-month period ended December 31, 1998 from $72.8 million in the same
period of the prior year. Total revenue increased primarily due to an increase
in services revenue. The Company does not believe that these rates of growth are
sustainable in future periods.
Services. Substantially all of the Company's services revenue is derived from
fees for professional services. The Company also derives revenue from software
services. Software services revenue consists of all inclusive service contracts,
which include the right to use software combined with installation, maintenance
and support, as well as services for installation, maintenance and support of
software licenses sold separately. Services revenue increased 80.3%
to $66.6 million for the three-month period ended December 31, 1998 from $36.9
million in the same period of the prior year. Services revenue increased 78.8 %
to $126.0 million for the six-month period ended December 31, 1998 from $70.5
million in the same period of the prior year. Services revenue increased
primarily due to an increase in the number and size of professional service
projects and, to a lesser extent, due to an increase in average billing rates,
and increases in software services.
License. License revenue consists principally of revenue earned under
software license agreements and under royalty agreements with OEMs. License
revenue increased 282.7 % to $7.2 million for the three-month period ended
December 31, 1998 from $1.9 million in the same period of the prior year.
License revenue increased 426.7 % to $12.2 million for the six-month period
ended December 31, 1998 from $2.3 million in the same period of the prior year.
The increase in license revenues resulted from increased sales to new customers
and sales to existing customers for new products.
One client accounted for 10% and 11% of the Company's revenue for the three-
month and six-month periods ended December 31, 1998, respectively. No one client
accounted for more than 10% of the Company's revenue for the three-month and
six-month periods ended December 31, 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 $30.3 million and $57.1 million for the three-month and six-month periods
ended December 31, 1998, respectively, compared to $17.4 million and $32.8
million, respectively, for the same periods of the prior year. The increase is
primarily due to an increase in the number of network system engineers. As a
percent of revenue, professional personnel decreased to 41.1% and 41.3% for the
three-month and six-month periods ended December 31, 1998, respectively, from
44.8% and 45.0%, respectively, in the same periods of the prior year.
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 software revenue as a percent of total revenue.
Other costs. Other costs consist primarily of travel and entertainment,
certain recruiting and professional development expenses, field facilities,
depreciation, expensed equipment and supplies related to the delivery of
professional services and software solutions. Other costs were $9.9 million and
$18.9 million for the three-month and six-month periods ended December 31, 1998,
respectively, compared to $5.3 million and $10.2 million, respectively, for the
same periods of the prior year. The increase is primarily due to the increase in
the number of employees and to a lesser extent, to the costs of field offices.
As a percent of revenue, other costs decreased to 13.4 % and 13.6 % for the
three-month and six-month periods ended December 31, 1998, respectively, from
13.6% and 14.0%, respectively, in the same periods of the prior year.
Cost of license revenue. Cost of license revenue consists primarily of the
cost of product components, product duplication, shipping and reproduction of
manuals. Cost of license revenue was $205,000 and $353,000 for the three-month
and six-month periods ended December 31, 1998, respectively, compared to $42,000
and $73,000, respectively, for the same periods of the prior year. The increase
was due primarily to an increase in the number of software licenses shipped. As
a percent of revenue, cost of license revenue increased to 0.3% for both the
three-month and six-month periods ended December 31, 1998, respectively, from
0.1% in the same periods of the prior year.
Research and development. Research and development expenses consist of
personnel and related costs for product development, enhancements, upgrades,
quality assurance and testing. All research and development expenses, including
software development costs, are charged to expense as incurred. Statement of
Financial Accounting Standards No. 86 ("SFAS 86"), "Accounting for the Costs of
Computer Software to be Sold, Leased, or Otherwise Marketed," requires the
capitalization of certain software development costs once technological
feasibility is established, which the Company defines as the completion of a
working model. The capitalized costs are then amortized on a straight line basis
over the estimated product life, or based on the ratio of current revenues to
total projected product revenues, whichever is greater. To date, costs incurred
subsequent to achieving technological feasibility and prior to the general
commercial release of the software have not been significant. Accordingly, the
Company has not capitalized any software development costs.
Research and development expenses were $1.5 million and $2.8 million for the
three-month and six-month periods ended December 31, 1998, respectively,
compared to $1.2 million and $1.9 million, respectively, for the same periods of
the prior year. The increase was a result of increased headcount to support the
development of, and enhancements to, software products. As a percent of revenue,
research and development expenses decreased to 2.0% for both the three-month and
six-month periods ended December 31, 1998, respectively, from 3.0% and 2.6%,
respectively, in the same periods of the prior year.
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
$11.2 million and $21.6 million for the three-month and six-month periods ended
December 31, 1998, respectively, compared to $6.2 million and $11.1 million,
respectively, for the same periods in the prior year. 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. As a
percent of revenue, sales and marketing expenses were 15.2% and 15.6% for the
three-month and six-month period ended December 31, 1998, respectively, compared
to 15.9% and 15.2% in the same periods of the prior year.
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 $8.7 million and $16.5 million for the three-month and six -month
periods ended December 31,1998, respectively, compared to $4.4 million and $8.5
million, respectively, for the same periods in the prior year. The increase is
due primarily to the addition of personnel to support the Company's growth in
operations. As a percent of revenue, general and administrative expenses
increased to 11.8 % and 11.9 % for the three-month and six-month periods ended
December 31, 1998, respectively, from 11.4% and 11.6%, respectively, in the same
periods of the prior year.
Acquisition related charges. The Company incurred approximately $7.2 million
in acquisition-related charges, principally in the three-month period ending
December 31, 1998. These charges include direct transaction costs primarily for
financial advisory services, legal and consulting fees and costs associated with
combining the operations of the two companies.
Interest and other, net. Interest and other, net, consists of interest
income. Net interest income was $764,000 and $1.5 million for the three-month
and six-month periods ended December 31,1998, respectively, compared to $593,000
and $1.0 million, respectively, for the same periods in the prior year. Interest
income consists primarily of interest on cash, cash equivalents and short-term
investments and notes receivable from shareholders. Net interest income was
$764,000 and $593,000 for the three-month periods ended December 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 1999 and 1998.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1998, the Company had cash, cash equivalents and investments
as follows (in thousands):
December 31, June 30,
1998 1998
------------------- ------------------
Cash and cash equivalents............................. $15,092 $32,484
Short-term investments................................ 33,056 25,319
Long term investments................................. 22,468 15,198
------------------- ------------------
Total............................................... $70,616 $73,001
=================== ==================
Net cash used by operations for the six months ended December 31, 1998 was
$9.6 million compared to net cash provided by operations of $6.5 million for the
comparable period of the prior year. Cash used in operating activities of $9.6
million resulted primarily from the increase in accounts receivable, the
decrease in deferred revenue and the
reduction of net income resulting from the acquisition-related charges. The
Company's accounts receivable increased by $26.6 million from June 30, 1998 to
December 31, 1998. This increase was primarily due to delays in invoicing
during the quarter resulting from the implementation of a new financial
system. Although the Company believes its cash collections experience remains
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 $7.9 million during the six months ended December 31, 1998
compared to $2.5 million for the comparable period of the prior year. Capital
expenditures were primarily related to the installation of new internal
software as well as capital expenditures related to new office facilities.
Cash flow from investing activities of $15.0 million resulted primarily from
the proceeds from issuance of common stock related to the exercise of stock
options and employee stock purchases under the Company's Employee Stock
Purchase Plan. 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 December 31, 1998. The line of credit requires the Company to
comply with certain financial covenants. At December 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 our future
operating results and could cause actual events to differ materially from those
predicted in our forward-looking statements related to our business.
Variability of Quarterly Operating Results. We derive the majority all of
our revenue from professional services, which are generally provided on a "time
and expenses" basis. We recognize professional services revenue only when
network systems engineers are engaged on client projects. In addition, a
majority of our 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 our 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.
Our 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 employees, including
network systems engineers, account managers and software engineers;
. reductions in billing rates or product pricing;
. write-offs of billings or services performed at no charge as a result of
our failure to meet client expectations;
. product returns and undetected product errors or failures;
. the timing of new product announcements and changes in pricing policies by
INS and our competitors;
. claims by our clients for the actions of our employees arising from damages
to our clients' business or otherwise;
. competition;
. the development and introduction of new services and products;
. corporate acquisitions;
. decrease or slowdown in the growth of the networking industry as a whole;
. general economic conditions;
. ongoing market acceptance; and
. the timing and size of orders for software solutions.
We recently acquired VitalSigns, a company that manufactures and develops
software products that monitor and measure network and application performance.
As a result, our revenues will include a greater percentage of sales from
software solutions. See "Risks Associated With Software Solutions." An
unanticipated shortfall for our software solutions could materially adversely
affect our operating results, particularly because margins are higher on
software than professional services.
In addition, we plan to continue to expand our operations based on sales
forecasts by hiring additional network systems engineers, account managers and
other employees, investing in new product development and adding new offices,
systems and other infrastructure. The resulting increase in operating expenses
would materially adversely affect our operating results if revenue does not
increase as much as forecasted.
We believe that quarterly revenue and operating results are likely to vary
significantly in the future and that period-to-period comparisons of our
operating results are not necessarily meaningful. You should not rely on period-
to-period comparisons as indications of future performance. In some future
quarter, our 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.
We have historically derived a significant portion of our revenue from a limited
number of clients and expect this concentration to continue. In the quarter
ended December 31, 1998, one client accounted for approximately 10% of revenue
and ten clients accounted for approximately 44% of revenue. One client accounted
for approximately 11% of revenue for the six month period ended December 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. We have, in the past, experienced declines in revenue from clients that
have accounted for significant revenue.
In addition, we generally do not have a long-term services contract with any
of our clients. Our clients are generally able to reduce or cancel their use of
our professional services without penalty and with little or no notice. As a
result, we believe that the number and size of our existing projects are not
reliable indicators or measures of future revenue. When a client defers,
modifies or cancels a project, we 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 our operating results. In
addition, our 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 our 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; or
. the failure of anticipated projects to materialize.
Need to Attract and Retain Qualified Network Systems Engineers. Our future
success will depend in large part on our 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 we serve.
Competition for network systems engineers is intense, and there can be no
assurance that we 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. We have experienced, and may in
the future experience, high rates of turnover among our network systems
engineers. Our inability to hire, train and retain a sufficient number of
qualified network systems engineers could impair our ability to adequately
manage and complete our existing projects or to obtain new projects, which, in
turn, could have a material adverse effect on our business, operating results
and financial condition.
We have experienced, and may in the future experience, increasing compensation
costs for our network systems engineers. Our 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 our business, operating
results and financial condition. In addition, our inability to attract and
retain a sufficient number of qualified network systems engineers in the future
could impair our planned expansion of our business.
Dependence on New Business Development. Our future success will also depend in
large part on the development of new business by our account managers, who
solicit new business and manage relationships with existing clients. As a
result, our success will depend on our ability to attract and retain qualified
account managers who have an understanding of our business and the industry it
serves. Competition for account managers is intense and we have experienced, and
may in the future experience, high rates of turnover among our account managers.
In addition, integration of new account managers into our business can be
lengthy. Our inability to attract and retain a sufficient number of account
managers or to integrate new account managers into our operations on a timely
basis could have a material adverse effect on our business, operating results
and financial condition.
Risks Associated with Software Solutions. Our long-term strategy is to
derive a significant portion of our revenue from the sale of software
solutions. We have devoted and expect to continue to devote, substantial
amounts of money and employees in the development and marketing of our
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.
If we introduce products embodying new technologies or if new industry
standards emerge, our existing software products could become obsolete and
unmarketable. The life cycles of our software products are difficult to
estimate. Our future success depends upon our ability to enhance our current
products and to develop and introduce new products on a timely basis that keep
pace with technological developments and emerging industry standards and address
the increasingly sophisticated needs of our customers. We may not be successful
in developing and marketing product enhancements or new products that respond to
technological change or evolving industry standards. We could experience
difficulties that could delay or prevent the successful development,
introduction and marketing of these products. Our new products and product
enhancements may not adequately meet the requirements of our current or
potential customers or achieve market acceptance. If we cannot, for
technological or other reasons, develop and introduce new products or
enhancements of existing products in a timely manner in response to changing
market conditions or customer requirements, our business, operating results and
financial condition could be materially adversely affected. If these products
are not accepted in the marketplace, our operating results and financial
condition will be adversely affected.
Dependence on Growth in an Emerging Market. We currently expect our
VitalAnalysis and VitalHelp application performance management software products
to account for a significant portion of our future software product revenue.
Although demand for VitalHelp and VitalAnalysis has grown recently, the
application performance management market is still an emerging market. Our
future software product financial performance will largely depend on continued
growth in the number of organizations adopting application performance
management environments from the end user's perspective. If the application
performance management market fails to grow or grows more slowly than we
currently anticipate, our operating results could be adversely affected.
Dependence on Proprietary Technology; Risks of Infringement. Our success
depends in part on our information technology, only some of which is proprietary
to us, and other intellectual property rights. We rely on a combination of
nondisclosure and other contractual arrangements, technical measures, copyrights
and trade secret and trademark laws to protect our proprietary rights. We also
try to protect our software, documentation and other written materials under
trade secret and copyright laws. In addition, we presently have eight patent
applications pending, fourteen applications for federal trademark rights pending
and one federal trademark issued. There can be no assurance that such patent and
trademarks applications will be granted. We have in the past entered into
services contracts with clients that assign rights to certain of the work
performed under such contracts to such clients. We do not believe that these
contracts will limit our ability to render services to other clients, although
we can not assure you that this will be the case. In selling certain products,
we rely on "end user" licenses that are not signed by licensees and, therefore,
such licenses may be unenforceable under the laws of certain jurisdictions. The
laws of some foreign countries do not protect our proprietary rights to the same
extent as the laws of the United States. There can be no assurance that the
steps we have taken to protect our proprietary rights will be adequate or that
third parties will not infringe or misappropriate our patents, copyrights,
trademarks, trade dress and similar proprietary rights.
We enter into confidentiality arrangements with our employees and attempt
to limit access to and distribution of proprietary information. There can be no
assurance that the steps we have taken in this regard will be adequate to deter
misappropriation of proprietary information and that we will be able to detect
unauthorized use or take appropriate steps
to enforce intellectual property rights. We expect software piracy to be a
persistent problem. Policing unauthorized use of our products is difficult, and
we cannot determine the extent to which piracy of our software exists.
We may receive communication in the future from third parties or clients
asserting that we have infringed or misappropriated the proprietary rights of
such parties. We expect that software developers will increasingly be subject to
infringement claims as the number of products and the number of competitors in
our industry segment grows and the functionality of products in other industry
segments overlap. Any such claims, with or without merit, could be time
consuming, result in costly litigation and divert technical and management
personnel, result in delays of product shipments, require us to develop non-
infringing technology or require us to enter into royalty or licensing
agreements. Such royalty or licensing agreements, if required, may not be
available on terms acceptable to us or at all. If a claim of infringement or
misappropriation against us is successful and we fail to or cannot develop non-
infringing technology or license the infringed, misappropriated, or similar
technology, our business, operating results and financial condition could be
materially adversely affected.
Management of Growth. We have experienced a period of rapid revenue and client
growth and an increase in the number of employees and offices and in the scope
of our supporting infrastructure. We do 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 our management and operating and financial systems. We will be required to
continue to hire management personnel and improve our 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 our operations and any
introduction of new products and services. There can be no assurance that our
management or systems will be adequate to support our existing or future
operations. Any failure to implement and improve our systems or to hire and
retain appropriate personnel to manage our operations would have a material
adverse effect on our business, operating results and financial condition.
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, we face 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 we do. With respect
to software solutions, we face competition from companies such as Hewlett
Packard, Tivoli, Computer Associates, Network Associates, Concord
Communications, Desktalk Systems and Compuware, some of which have significantly
greater financial, technical and marketing resources and greater name
recognition, and generate greater service revenue than we do. We have faced, and
expect to continue to face, additional competition from new entrants into our
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 our business,
operating results and financial condition. There can be no assurance that we
will be able to compete successfully against current or future competitors. Our
failure to compete successfully would have a material adverse effect on our
business, operating results and financial condition.
Risks Associated with Acquisitions. We may make acquisitions of, or
significant investments in, complementary companies, products or technologies.
We recently completed the acquisition of VitalSigns. This acquisition, as well
as any future acquisitions, will 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 our ongoing business,
. the distraction of management and other resources,
. the inability of management to maximize our 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, partners and clients as a
result of the acquisition.
There can be no assurance that we will be successful in overcoming these risks
or any other problems encountered in connection with the acquisition of
VitalSigns or any future acquisitions. Any such problems encountered in the
transition and integration process could have a material adverse effect on our
business, operating results and financial condition.
Risks Associated With International Expansion. A component of our long-term
strategy is to expand into international markets. We provide professional
services to certain of our United States clients in foreign locations, and have
opened offices in the United Kingdom, the Netherlands, Germany 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, our
business, operating results and financial condition could be materially
adversely affected. There can be no assurance that we will be able to
successfully market, sell and deliver our services in international markets.
In addition to the uncertainty as to our ability to expand into international
markets, there are certain risks inherent in conducting business on an
international level, any one of which could adversely impact the success of our
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 and 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 our future international operations and,
consequently, on our business, operating results and financial condition. There
can be no assurance that we will be able to compete effectively in these
markets.
Relationship with Cisco Systems. Although we are a vendor independent provider
of network services, we have a significant relationship with Cisco and believe
that maintaining and enhancing this relationship is important to our 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. We have entered into direct relationships with clients as a result of
referrals from Cisco and provide services directly to Cisco, primarily as a
subcontractor.
Cisco is a shareholder of ours, and an officer of Cisco is a member of our
Board of Directors. Although we believe that our relationship with Cisco is
good, there can be no assurance that we will be able to maintain or enhance our
relationship with Cisco. Any deterioration in our relationship with Cisco could
have a material adverse effect on our business, operating results and financial
condition. In addition, should our relationship with Cisco be perceived as
compromising our ability to provide unbiased solutions, our relationship with
existing or potential clients could be materially adversely affected.
Risk of Product "Bugs." Software products as complex as ours may contain
undetected errors or failures when first introduced or when new versions are
released. Although we have not experienced material adverse effects resulting
from any such errors to date, errors could be found in new products or releases
after they have been sold, despite testing by us and by current and potential
customers, which would result in loss of or delay in market acceptance.
Product Liability. Our software product license agreements with customers
typically contain provisions designed to limit our exposure to potential product
liability claims. In selling certain products, we rely on "end user" licenses
that are not signed by licensees and, therefore, it is possible that such
licenses may be unenforceable under the laws of certain jurisdictions. For these
and other reasons, the limitation of liability provisions contained in our
license agreements may not be effective. Although we have not had any product
liability claims to date, the sale and support of products may result in such
claims in the future. A successful product liability claim brought against us
could have an adverse effect upon our operating results.
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 our 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 our 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.
We believe that our current software products are year 2000 compliant.
However, there can be no assurance that our current products do not contain
undetected errors or defects associated with year 2000 date functions that may
result in material cost to us.
With respect to our internal information technology systems (including
information technology-based office facilities such as data and voice
communications, building management and security systems), we have 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 our 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 our Year 2000 remediation plans.
We are in the process of contacting our 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 our operations. There can be no
assurance that our key contractors will have successful conversion programs, and
that any such Year 2000 compliance failures will not have a material adverse
effect on our business, results of operation or financial condition. Based on
information available to date, we plan to substantially complete our Year 2000
assessment and remediation in the summer of 1999. To date, we have not incurred
any material costs related to the assessment of, and preliminary efforts in
connection with, our Year 2000 issues. We further believe that such review and
modification, if any, will not require material charge to operating expenses.
The costs of the project and the date on which we plan to complete our Year 2000
assessment and remediation are based on our 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 our estimates include, but
are not limited to, the availability and cost of personnel trained in this area,
and similar uncertainties. We believe that we are devoting the necessary
resources to identify and resolve significant Year 2000 issues in a timely
manner.
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.
PART II -- OTHER INFORMATION
ITEM 1 NOT APPLICABLE
ITEM 2 CHANGES IN SECURITIES
In November 1998, in connection with the Company's acquisition of VitalSigns,
the Company issued approximately 3,995,000 shares of the Company's Common Stock
to the existing shareholders of VitalSigns in exchange for all of the
outstanding shares of capital stock of VitalSigns. Such shares were not
registered under the Securities Act of 1933, as amended (the "Securities
Act"), and such issuance was deemed to be exempt from registration in reliance
on Regulation D under Section 4(2) of the Securities Act as a transaction by
an issuer not involving a public offering. The recipients of the securities
represented their intentions to acquire the securities for investment only,
had access to all relevant information regarding the Company necessary to
evaluate the investment and were either accredited investors or relied upon a
purchaser representative.
ITEM 3 NOT APPLICABLE
ITEM 4 SUBMISSION OF MATTER TO A VOTE OF SECURITY HOLDERS
The following matters were submitted to the shareholders at the Company's
Annual Meeting of Shareholders held October 29, 1998. Each of these matters was
approved by a majority of shares present at the meeting.
1. The uncontested election of six directors to serve a one-year until their
successors are duly elected and qualified. The following is a summary of the
nominees and voting results:
Votes For Votes Withheld
---------- --------------
Donald K. McKinney 30,954,760 55,546
John L. Drew 30,503,260 507,046
Douglas C. Allred 25,566,301 5,444,005
Vernon R. Anderson 30,951,715 58,951
David Carlick 30,956,315 53,991
Lawrence G. Finch 30,956,215 54,091
2. The approval of the amendment to 1996 stock plan. Results of the voting
included 20,925,920 shares for 8,285,938 against and 27,627 shares abstained.
3. The approval of the amendment to 1996 employee stock purchase plan.
Results of the voting included 28,223,818 shares for 986,979 against and 26,688
shares abstained.
4. The approval of the adoption of the 1998 director option plan. Results
of the voting included 21,632,587shares for 7,594,420 against and 67,602 shares
abstained.
5. The approval of the reincorporation in Delaware. Results of the voting
included 21,963,271 shares for 7,264,632 against and 11,582 shares abstained.
6. The approval of the increase in the number of authorized shares. Results
of the voting included 30,292,002 shares for 699,824 against and 18,480 shares
abstained.
7. The ratification of the appointment of PricewaterhouseCoopers, LLP as
the independent accountants of the Company for the fiscal year ending June 30,
1999. Results of the voting included 30,985,323 shares for 7,390 against and
17,593 shares abstained.
ITEM 5. NOT APPLICABLE
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
10.8 1998 NonStatutory Stock Option Plan, as amended
27.1 Financial Data Schedule
(b) Reports on Form 8-K:
The Company filed the following Reports on Form 8-K during
the quarter ended December 31, 1998:
On November 30, 1998, the Company filed a Report
on Form 8-K dated November 20, 1998 in connection
with the acquisition of VitalSigns.
On December 17, 1998, the Company filed a Report
on Form 8-K dated December 17, 1998 to restate
certain financial information to give effect to the
VitalSigns acquisition.
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: February 9, 1999