UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1999
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: (650) 318-1000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [_]
The number of shares outstanding of the registrant's Common Stock as of April
26, 1999 was 56,605,585.
1
INTERNATIONAL NETWORK SERVICES
INDEX
PART I FINANCIAL INFORMATION
Page No
-------
Item 1 Condensed Consolidated Financial Statements:
Condensed Consolidated Balance Sheets as of March 31, 1999 (unaudited) and
June 30, 1998 3
Condensed Consolidated Statements of Income (unaudited) for the three and nine
month periods ended March 31, 1999 and 1998 4
Condensed Consolidated Statements of Cash Flows (unaudited) for the nine month
periods ended March 31, 1999 and 1998 5
Notes to Condensed Consolidated Financial Statements 6
Item 2 Management's Discussion and Analysis of Financial Condition and Results of
Operations 10
Item 3 Quantitative and Qualitative Disclosures about Market Risk 21
PART II OTHER INFORMATION
Item 1 5 Not applicable 22
Item 6 Exhibits and Reports on Form 8-K 22
Signature 23
2
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INTERNATIONAL NETWORK SERVICES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
March 31, June 30,
1999 1998
----------------- -----------------
ASSETS (Unaudited)
Current assets:
Cash and cash equivalents.................................................... $ 34,697 $ 32,484
Short-term investments....................................................... 21,013 25,319
Accounts receivable, net..................................................... 69,888 47,035
Deferred income taxes........................................................ 3,758 3,758
Prepaid expenses and other assets............................................ 6,063 3,926
----------------- -----------------
Total current assets....................................................... 135,419 112,522
Property and equipment, net.................................................... 18,106 11,495
Deferred income taxes.......................................................... 1,071 1,071
Investments.................................................................... 30,137 15,198
----------------- -----------------
Total assets............................................................... $184,733 $140,286
================= =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable............................................................. $ 9,991 $ 3,816
Accrued compensation and employee benefits................................... 22,045 12,638
Accrued liabilities.......................................................... 1,519 4,530
Income taxes payable......................................................... 4,293 --
Deferred revenue............................................................. 11,246 16,995
----------------- -----------------
Total current liabilities.................................................. 49,094 37,979
----------------- -----------------
Stockholders' equity:
Preferred Stock, $0.001 par value (no par value June 30, 1998), 5,000 shares
authorized; no shares issued and outstanding................................ -- --
Common Stock and additional paid-in capital, $0.001 par value (no par value -
June 30, 1998), 150,000 and 75,000 shares authorized; 56,517 and 54,797
shares issued and outstanding at March 31, 1999 and June 30, 1998,
respectively................................................................ 100,832 83,648
Notes receivable from stockholders........................................... (488) (685)
Deferred compensation........................................................ (1,271) (1,443)
Unrealized investment gains.................................................. 186 --
Cumulative translation adjustments........................................... 97 (35)
Retained earnings............................................................ 36,283 20,822
----------------- -----------------
Total stockholders' equity................................................. 135,639 102,307
----------------- -----------------
$184,733 $140,286
================= =================
See accompanying notes to condensed consolidated financial statements.
3
INTERNATIONAL NETWORK SERVICES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
(Unaudited)
Three Months Ended Nine Months Ended
March 31, March 31,
------------------------------- -------------------------------
1999 1998 1999 1998
------------- ------------- ------------- -------------
Revenue:
Services.................................................... $74,121 $43,999 $201,289 $114,461
License..................................................... 8,583 2,048 19,657 4,370
------------- ------------- ------------- -------------
Total revenue 82,704 46,047 220,946 118,831
------------- ------------- ------------- -------------
Operating expenses:
Professional personnel...................................... 34,180 19,955 91,251 52,719
Other costs................................................. 10,333 6,740 29,194 16,902
Cost of license revenue..................................... 278 162 631 235
Research and development.................................... 1,676 997 4,438 2,916
Sales and marketing......................................... 11,985 6,962 33,550 18,025
General and administrative.................................. 10,596 5,278 27,063 13,724
Acquisition related charges................................. - - 7,176 -
------------- ------------- ------------- -------------
Total operating expenses................................. 69,048 40,094 193,303 104,521
------------- ------------- ------------- -------------
Income from operations........................................ 13,656 5,953 27,643 14,310
Interest and other, net....................................... 733 577 2,187 1,579
------------- ------------- ------------- -------------
Income before provision for income taxes...................... 14,389 6,530 29,830 15,889
Provision for income taxes.................................... 5,720 2,612 14,369 6,356
------------- ------------- ------------- -------------
Net income.................................................... $ 8,669 $ 3,918 $ 15,461 $ 9,533
============= ============= ============= =============
Net income per share - basic.................................. $0.16 $0.08 $0.29 $0.19
------------- ------------- ------------- -------------
Shares used to compute net income per share - basic........... 55,188 51,013 53,904 50,176
------------- ------------- ------------- -------------
Net income per share - diluted................................ $0.14 $0.07 $0.25 $0.17
------------- ------------- ------------- -------------
Shares used to compute net income per share - diluted......... 63,451 57,409 61,705 56,550
------------- ------------- ------------- -------------
See accompanying notes to condensed consolidated financial statements.
4
INTERNATIONAL NETWORK SERVICES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Nine Months Ended
March 31,
----------------------------------------
1999 1998
----------------- -----------------
Cash flows from operating activities:
Net income................................................................ $ 15,461 $ 9,533
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation and amortization.......................................... 4,579 2,292
Changes in operating assets and liabilities:
Accounts receivable................................................. (22,853) (17,270)
Prepaid expenses and other assets................................... (2,137) 897
Accounts payable.................................................... 6,175 654
Accrued expenses.................................................... 6,396 5,323
Income taxes payable................................................ 4,293 1,248
Deferred revenue.................................................... (5,749) 2,911
----------------- -----------------
Net cash provided by operating activities...................... 6,165 5,588
----------------- -----------------
Cash flows from investing activities:
Purchases of investments.................................................. (46,592) (12,072)
Sales of investments...................................................... 36,145 --
Purchases of property and equipment, net.................................. (11,018) (3,629)
----------------- -----------------
Net cash used in investing activities.......................... (21,465) (15,701)
----------------- -----------------
Cash flows from financing activities:
Repayment of stockholder notes receivable................................. 197 1,177
Proceeds from issuance of Common Stock, net............................... 17,184 3,765
----------------- -----------------
Net cash provided by financing activities...................... 17,381 4,942
----------------- -----------------
Effect of exchange rate changes on cash and cash equivalents................. 132 --
----------------- -----------------
Net change in cash and cash equivalents...................................... 2,213 (5,171)
Cash and cash equivalents at beginning of period............................. 32,484 24,550
----------------- -----------------
Cash and cash equivalents at end of period................................... $ 34,697 $ 19,379
================= =================
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND
FINANCING ACTIVITIES:
Repurchase of Common Stock in exchange for cancellation of notes
receivable from stockholders........................................... $ - $ 714
See accompanying notes to condensed consolidated financial statements.
5
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 third quarter and
the first nine months of fiscal 1999 and 1998 as ending on March 31,
respectively; whereas, in fact the Company's fiscal quarters end on the Sunday
nearest the end of the calendar quarter.
The results of operations for the three and nine months ended March 31, 1999
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.
Stock Split
On March 4, 1999, the Company announced that its Board of Directors approved a
three-for-two split of the Company's common stock that was applicable to
stockholders of record on March 15, 1999. All share and per-share data for all
periods presented have been adjusted to give effect to this three-for-two stock
split that was effected on April 5, 1999.
6
NOTE 2--BALANCE SHEET COMPONENTS (in thousands)
March 31, June 30,
1999 1998
------------------- -----------------
(Unaudited)
Accounts receivable:
Trade............................................................... $ 73,760 $ 48,503
Less: allowance for doubtful accounts............................... (3,872) (1,468)
------------------- -----------------
$ 69,888 $ 47,035
=================== =================
Property and equipment:
Computer equipment and software..................................... $ 24,318 $ 15,885
Furniture, fixtures & leasehold improvements........................ 8,249 5,664
------------------- -----------------
32,567 21,549
Less: accumulated depreciation...................................... (14,461) (10,054)
------------------- -----------------
$ 18,106 $ 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 ("SFAS") 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 stockholders' equity. At March 31, 1999, the net unrealized gain
was approximately $186,000.
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, is
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
7
to the end-user customer. Royalty revenue that is contingent upon sale to an end
user by OEMs is 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 to purchase INS Common Stock, on the same terms as the original option
adjusted to reflect the exchange ratio. The Company issued approximately
5,933,000 shares of INS Common Stock in the acquisition and assumed options that
can be exercised for approximately 420,000 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. 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
======================= ==================== ====================
Prior to the acquisition, VitalSigns' fiscal year 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 VitalSigns for the period from August 15, 1996
(inception) through June 30, 1997.
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 that may be obtained in the future.
The Company incurred approximately $7.2 million in acquisition-related
charges, principally in the three-month period ended 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.
NOTE 6--NET INCOME 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 the
8
effect of potential dilutive common shares under the treasury stock method,
the average stock price for the period is used in determining the number of
shares to be purchased pursuant to the potential exercise of stock options.
All prior period net income per share data presented has been restated in
accordance with SFAS No. 128, "Earnings per Share."
All share and per share data presented reflect a three-for-two stock
split, which was effected on April 5, 1999. (See Note 8).
Reconciliation between basic and diluted net income per share is as
follows for the three and nine month periods ended March 31, 1999 and 1998 (in
thousands, except per share data):
Three Months Ended Nine Months Ended
March 31, March 31,
------------------------------------ --------------------------------
1999 1998 1999 1998
================== =============== ============== ===============
Net income $ 8,669 $ 3,918 $15,461 $ 9,533
================== =============== ============== ===============
Weighted-average common shares used to
compute basic net income per share 55,188 51,013 53,904 50,176
Effect of dilutive securities:
Common stock equivalents 7,087 3,541 5,927 3,371
Common stock subject to repurchase 1,176 2,855 1,874 3,003
Weighted-average common shares used to ------------------ --------------- -------------- ---------------
Compute diluted net income per share 63,451 57,409 61,705 56,550
================== =============== ============== ===============
Net income per share--basic $ 0.16 $ 0.08 $ 0.29 $ 0.19
================== =============== ============== ===============
Net income per share--diluted $ 0.14 $ 0.07 $ 0.25 $ 0.17
================== =============== ============== ===============
Antidilutive Options. Options to purchase 673,451 shares of common stock were
outstanding during the three-month period ended March 31, 1998, and 197,872 and
728,108 during the nine-month periods ended March 31, 1999 and 1998,
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. There were no such options outstanding for the three-month period
ended March 31, 1999.
NOTE 7 RECENT ACCOUNTING STANDARDS
The Company adopted SFAS No. 130, "Reporting Comprehensive Income" in the
first quarter of fiscal 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.
9
NOTE 8 STOCKHOLDERS' EQUITY
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 was approved by the Company's
stockholders at the Company's annual meeting of stockholders. An increase in the
number of authorized shares of the Company's Common Stock from 75,000,000 to
150,000,000 was also approved by the stockholders.
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 network consulting 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 revenue 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.
Services 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, is
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
resellers, which is generally subject to certain rights of return and price
protection, is recognized when the products are sold by the distributor or
reseller to the end-user customer. Royalty revenue that is contingent upon sale
to an end user by OEMs is 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."
10
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 Nine Months Ended
March 31, March 31,
---------- ---------
1999 1998 1999 1998
---- ---- ---- ----
Revenue:
Services............................................. 89.6% 95.6% 91.1% 96.3%
License.............................................. 10.4 4.4 8.9 3.7
-------------------------------------------------------------------
Total revenue 100.0 100.0 100.0 100.0
-------------------------------------------------------------------
Operating expenses:
Professional personnel............................... 41.3 43.3 41.3 44.4
Other costs.......................................... 12.5 14.6 13.2 14.2
Cost of license revenue.............................. 0.4 0.4 0.3 0.2
Research and development............................. 2.0 2.2 2.0 2.5
Sales and marketing.................................. 14.5 15.1 15.2 15.2
General and administrative........................... 12.8 11.5 12.2 11.5
Acquisition related charges.......................... - - 3.3 -
-------------------------------------------------------------------
Total operating expenses........................... 83.5 87.1 87.5 88.0
-------------------------------------------------------------------
Income from operations................................ 16.5 12.9 12.5 12.0
Interest and other, net............................... 0.9 1.3 1.0 1.3
-------------------------------------------------------------------
Income before provision for income taxes.............. 17.4 14.2 13.5 13.3
Provision for income taxes............................ 6.9 5.7 6.5 5.3
-------------------------------------------------------------------
Net income............................................ 10.5% 8.5% 7.0% 8.0%
===================================================================
REVENUE
Total Revenue. The Company's total revenue increased 79.6% to $82.7 million
for the three-month period ended March 31, 1999 from $46.0 million in the same
period of the prior year. Total revenue increased 85.9% to $220.9 million for
the nine-month period ended March 31, 1999 from $118.8 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 68.5%
to $74.1 million for the three-month period ended March 31, 1999 from $44.0
million in the same period of the prior year. Services revenue increased 75.9%
to $201.3 million for the nine-month period ended March 31, 1999 from $114.5
million in the same period of the prior year. Services revenue increased
primarily due to an increase in the number and size of professional services
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 319.1% to $8.6 million for the three-month period ended March
31, 1999 from $2.0 million in the same period of the prior year. License
revenue increased 349.8% to $19.7 million for the nine-month period ended March
31, 1999 from $4.4 million in the same period of the prior year. The
11
increase in license revenue resulted from increased sales to new customers and
sales to existing customers for new products.
One client accounted for 10.6% of the Company's total revenue for the nine-month
period ended March 31, 1999. One client accounted for 10% of the Company's
total revenue for the three-month period ended March 31, 1998.
OPERATING EXPENSES
Professional personnel. Professional personnel expenses consist primarily
of compensation and benefits of the Company's employees engaged in the delivery
of professional services and software solutions. Professional personnel
expenses were $34.2 million and $91.3 million for the three-month and nine-month
periods ended March 31, 1999, respectively, compared to $20.0 million and $52.7
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 total revenue, professional personnel expenses decreased to 41.3% for
both the three-month and nine-month periods ended March 31, 1999, respectively,
from 43.3% and 44.4%, respectively, in the same periods of the prior year.
Professional personnel expenses decreased as a percent of total revenue
primarily due to the increase in software revenue. As a percent of service
revenue, professional personnel expenses increased to 46.1% for the three-month
period ended March 31, 1999, from 45.4% in the same period of the prior year.
This increase was due to increases in compensation and benefits, primarily
matching contributions by the Company under the 401(k) plan, which commenced
during the three-month period ended March 31, 1999. Professional personnel
expenses, as a percent of services revenue, decreased to 45.3% for the nine-
month period ended March 31, 1999, from 46.1% in the same period of the prior
year. This decrease was due primarily to an increase in billing rates for
professional services.
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 $10.3 million
and $29.2 million for the three-month and nine-month periods ended March 31,
1999, respectively, compared to $6.7 million and $16.9 million, respectively,
for the same periods of the prior year. The increase is primarily due to the
increased amount of unbilled travel and entertainment expenses, field facility
costs and equipment expenses. As a percent of revenue, other costs decreased to
12.5% and 13.2% for the three-month and nine-month periods ended March 31, 1999,
respectively, from 14.6% and 14.2%, respectively, in the same periods of the
prior year. This decrease was primarily the result of decreases in recruiting,
equipment, unbilled travel and entertainment and field facility expenses as a
percent of revenue.
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 $278,000 and $631,000 for the three-month
and nine-month periods ended March 31, 1999, respectively, compared to $162,000
and $235,000, 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 was 0.4% and 0.3% for
the three-month and nine-month periods ended March 31, 1999, respectively,
compared to 0.4% and 0.2%, respectively, for the same periods in 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 revenue to
total projected product revenue, 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 $1.7 million and $4.4 million for the three-month and
nine-month periods ended March 31, 1999, respectively, compared to $1.0 million
and $2.9 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 were 2.0% for both the three-month and nine-month periods
ended March 31, 1999, respectively, compared to 2.2% and 2.5% in the same
periods of the prior year.
12
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
$12.0 million and $33.6 million for the three-month and nine-month periods ended
March 31, 1999, respectively, compared to $7.0 million and $18.0 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 an
increase in marketing spending. As a percent of revenue, sales and marketing
expenses were 14.5% and 15.2% for the three-month and nine-month periods ended
March 31, 1999, respectively, compared to 15.1% and 15.2% in the same periods of
the prior year. The decrease resulted from the increased revenue.
General and administrative. General and administrative expenses consist
of expenses associated with executive staff, finance and administration,
corporate facilities, information systems and human resources. General and
administrative expenses were $10.6 million and $27.1 million for the three-
month and nine-month periods ended March 31, 1999, respectively, compared to
$5.3 million and $13.7 million, respectively, for the same periods in the
prior year. As a percent of revenue, general and administrative expenses
increased to 12.8% and 12.2% for the three-month and nine-month periods ended
March 31, 1999, respectively, from 11.5% in each of the same periods of the
prior year. The increase was the result of increases in infrastructure across
finance, human resources and information services to support the Company's
growth.
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 $733,000 and $2.2 million for the three-month
and nine-month periods ended March 31,1999, respectively, compared to $577,000
and $1.6 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 stockholders. 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 March 31, 1999, the Company had cash, cash equivalents and investments as
follows (in thousands):
March 31, June 30,
1999 1998
------------------ -----------------
(Unaudited)
Cash and cash equivalents................................. $34,697 $32,484
Short-term investments.................................... 21,013 25,319
Long-term investments..................................... 30,137 15,198
------------------ -----------------
Total............................................ $85,847 $73,001
================== =================
Net cash provided by operations for the nine months ended March 31,
1999 was $6.2 million compared to net cash provided by operations of $5.6
million for the comparable period of the prior year. Cash provided by operating
activities resulted primarily from net income and increases in accounts payable
and accrued expenses offset by a decrease in deferred revenue and an increase in
accounts receivable. 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 $11.0 million during the nine months ended March 31,
1999 compared to $3.6 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 financing activities of $17.4 million resulted primarily from the
proceeds from issuance of common stock related to the exercise of stock options
and
13
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 March 31, 1999. The line of credit requires the Company to
comply with certain financial covenants. At March 31, 1999, 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.
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 products are 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 issue. 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.
14
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.
Our quarterly operating results are uncertain and are likely to fluctuate
significantly.
The underutilization of our network systems engineers may cause our
operating results to fluctuate. We derive the majority 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.
A shortfall in software revenue could cause our operating results to
decline. We also derive a significant portion of our revenue from the license
of our software solutions. Our revenue from software solutions is hard to
predict because our license fee revenue is substantially dependent on orders
booked and shipped in that quarter and because we generally recognize a
substantial portion of our revenue from software solutions in the last month
of the quarter. An unanticipated shortfall of sales of our software solutions
could harm our operating results, particularly because profit margins are
higher on software solutions than on professional services.
Other factors may cause our operating results to fluctuate. Our revenue and
earnings may also fluctuate from quarter to quarter based on a variety of
factors, including:
. an inability to hire and retain sufficient numbers of employees,
including network systems engineers, account managers and software
engineers;
. changes in billing rates or product pricing;
. market acceptance of current and future products;
. 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;
. claims by our clients arising from actions of our employees which result
in damages to our clients' business or otherwise;
15
. competition;
. the development and introduction of new services and products by us and
our competitors;
. the loss of key employees;
. corporate acquisitions;
. decrease or slowdown in the growth of the networking industry as a whole;
. any slowdown in systems and software spending or in general business
expansion in connection with year 2000 issues; and
. general economic conditions.
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 harm 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 may be below the expectations
of public market analysts or investors. In that event, the price of our common
stock would probably decline.
We depend on a small number of customers for most of our revenues.
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 March 31, 1999, ten clients accounted for approximately 46% of
revenue. For the nine-month period ended March 31, 1999, one client accounted
for approximately 11% of revenue and ten clients accounted for approximately
43% of revenue. We have regularly experienced declines in revenue from clients
that have accounted for significant revenue, and we expect to continue to
experience these declines in the future. When revenue for one or more
significant clients declines in a quarter, we must rapidly redeploy network
systems engineers to other projects in order to minimize the underutilization
of employees. If we are unable to do so, our business, operating results and
financial condition could suffer.
Our customers are generally able to reduce or cancel their contracts.
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, if we are not able to rapidly redeploy network
systems engineers to other projects in order to minimize the underutilization
of employees, our business, operating results and financial condition could
suffer.
We face risks associated with our software solutions.
Development and introduction risks. The market for our software solutions
is characterized by rapid technological change, evolving industry standards,
changes in customer requirements and frequent new product introductions and
enhancements. The introduction of software products embodying new technologies
and the emergence of new industry standards can render existing software
products obsolete and unmarketable. The life cycles of our software solutions
are difficult to estimate. As a result, our future success will depend, in
part, upon our ability to continue to enhance our existing software solutions
and develop and introduce in a timely manner new software solutions that keep
pace with technological developments, satisfy customer requirements and
achieve market acceptance. We cannot be certain that we will successfully
identify new software product
16
opportunities and develop and bring new software products to market in a
timely and cost-effective manner, or that software products, capabilities or
technologies developed by others will not render our software products or
technologies obsolete or noncompetitive or shorten the life cycles of our
software products. If we are unable to develop on a timely and cost-effective
basis new software products or enhancements to our existing products, or if
such new products or enhancements do not achieve market acceptance, our
business, operating results and financial condition will suffer.
Risk of product "bugs." Software products as complex as ours frequently
contain undetected errors or "bugs" when first introduced or when new versions
are released that, despite testing by use, are discovered only after a product
has been installed and used by customers. There can be no assurance that
errors will not be found in our software solutions or that such errors will
not result in delay or loss of revenue, diversion of development resources,
damage to our reputation or impaired market acceptance of these products,
which could harm our business, operating results and financial condition.
Our success depends on our ability 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
we cannot be certain 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 harm our business, operating results and
financial condition. In addition, 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 harm our business, operating results and financial
condition.
Our success depends on our development of new business and our ability to
attract and retain qualified account managers.
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
harm our business, operating results and financial condition.
We must effectively manage the growth of our operations.
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 have to
continue to hire management personnel and improve our systems on a timely
basis and in the manner necessary to accommodate any increase in the number of
our transactions and clients, any increase in the size of our operations and
any introduction of new products and services. Our management or systems may
not be adequate to support our existing or future operations, particularly as
we expand internationally. Any failure to implement and improve our systems or
to hire and retain appropriate personnel to manage our operations would harm
our business, operating results and financial condition.
17
We face intense competition.
Our 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, value-added resellers,
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
Concord Communications, Desktalk Systems and Compuware, some of which have
significantly greater financial, technical and marketing resources and greater
name recognition, and generate greater revenue than we do. We have faced, and
expect to continue to face, additional competition from new entrants into our
markets, many of which are well established in the software industry and have
greater financial resources. 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 harm our
business, operating results and financial condition. We cannot be sure that we
will be able to compete successfully against current or future competitors.
Our failure to compete successfully would harm our business, operating results
and financial condition.
We face risks from expansion of our international operations.
A component of our long-term strategy is to expand into international
markets. We have offices in the United Kingdom, the Netherlands, Germany and
Canada. We expect to generate an increasing proportion of our revenue from
international operations. The revenue generated from international operations
may not 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 suffer. We
cannot be certain 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.
One or more of these factors could harm our future international operations
and our business, operating results and financial condition. In addition, we
may not be able to compete effectively in these markets.
Our relationship with Cisco Systems is subject to risks.
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
18
supports high-performance, multiprotocol internetworking systems that link
geographically dispersed local area networks and wide area networks. 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. We cannot be certain that our relationship with Cisco will
not deteriorate or that Cisco will not establish strategic relationships with
other companies or develop internal capabilities competitive with our
business. Any deterioration in our relationship with Cisco could harm 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
suffer.
We face liability risks from the actions of our employees and the license of
our software products.
We are subject to claims by our clients for the actions of our employees
arising from damages to our clients' business or otherwise. In selling certain
products, we rely on "end user" licenses that are not signed by licensees and
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.
A successful liability claim brought against us as a result of the actions of
our employees or the license of our software products could harm our operating
results.
We may be unable to adequately protect our intellectual property.
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, patents 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 selling
certain products, we rely on "end user" licenses that are not signed by
licensees and 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. The
steps we have taken to protect our proprietary rights may not be adequate to
protect our intellectual property and we cannot be certain that third parties
will not infringe or misappropriate our patents, copyrights, trademarks, trade
dress and similar proprietary rights.
We may be unable to deter misappropriation of our proprietary information and
the proprietary information of our clients.
We enter into confidentiality arrangements with our employees and attempt
to limit access to and distribution of our proprietary information and the
proprietary information of our clients. The steps we have taken in this regard
may not be adequate to deter misappropriation of proprietary information and
we may not be able to detect unauthorized use or take appropriate steps to
enforce intellectual property rights. If we are not successful in our efforts
to protect our proprietary information and the proprietary information of our
clients, our business, financial condition and operating results could suffer.
In addition, policing unauthorized use of our products is difficult, and we
cannot determine the extent to which piracy of our software exists.
We may infringe the intellectual property rights of others.
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 overlaps that of our products. 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
19
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 suffer.
We face risks associated with acquisitions.
We have recently acquired VitalSigns Software, and we may make additional
acquisitions of, or significant investments in, complementary companies,
products or technologies. Any such 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.
We cannot be certain that we will be successful in overcoming these risks
or any other problems encountered in connection with any acquisitions. Any
such problems encountered in the transition and integration process could harm
our business, operating results and financial condition.
We face risks associated with the year 2000.
As a result of the year 2000 issue, we face risks including:
. Demand for our services and products may decrease as current and potential
clients reduce their spending on software and systems during the second
half of 1999 and into the year 2000 due to concerns or issues they
anticipate or experience in connection with the year 2000;
. Our internal systems may experience year 2000-related problems which may
significantly disrupt our operations, including a temporary inability to
process transactions or engage in normal business activities; and
. Our clients who experience year 2000 problems with their systems may claim
that our software products which they use are not Year 2000 compliant or
that our employees who performed services for them are responsible for the
year 2000 problems and, as a result, we could be required to provide
extensive technical support or services or we could become involved in
costly and/or protracted litigation.
The occurrence of any of the above events as well as other year 2000-related
problems could cause significant diversion of our management and financial
resources and could harm our business, financial condition and results of
operations.
20
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.
21
PART II -- OTHER INFORMATION
ITEM 1 - 5 NOT APPLICABLE
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
10.8 1998 Non Statutory 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 March 31, 1999:
On December 29, 1998, the Company filed a Report on Form 8-K
dated December 28, 1998 in connection with the reincorporation of
INS California in the State of Delaware.
On March 11, 1999, the Company filed a Report on Form 8-K
dated March 4, 1999 in connection with the three-for-two stock
split.
22
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THE
REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE
UNDERSIGNED THEREUNTO DULY AUTHORIZED.
INTERNATIONAL NETWORK SERVICES
By: /s/ Kevin J. Laughlin
-----------------------------
Kevin J. Laughlin
Vice President, Chief Financial Officer
and Secretary
(Principal Financial and Accounting
Officer and Duly Authorized Officer)
Date: May 12, 1999
23