<PAGE>
                                 EXHBIIT 13.1

 
                            Selected Financial Data

The following selected financial data should be read in conjunction with the
Consolidated Financial Statements and related notes thereto and "Management's
Discussion And Analysis Of Financial Condition And Results Of Operations"
appearing elsewhere in this Annual Report.
<TABLE>
<CAPTION>
 
(in thousands, except per share data)                                                              Year Ended June 30,
STATEMENT OF OPERATIONS DATA                                                          1998      1997     1996      1995      1994
----------------------------------------------------------------------------------------------------------------------------------
<S>                                                                                  <C>      <C>      <C>      <C>       <C>
 Revenue                                                                             $169,678  $99,275  $44,092  $15,549   $ 7,565
 Operating expenses:
  Professional personnel                                                               75,659   44,826   19,892    6,654     3,319
  Sales and marketing                                                                  23,479   14,440    7,990    3,843     2,774
  General and administrative                                                           19,106   13,435    5,049    1,890     1,588
  Other costs                                                                          26,504   14,711    6,447    2,346     1,248
                                                                                     ---------------------------------------------
   Total operating expenses                                                           144,748   87,412   39,378   14,733     8,929
                                                                                     ---------------------------------------------
 Income (loss) from operations                                                         24,930   11,863    4,714      816    (1,364)
 Interest and other, net                                                                1,909    1,059        3       17       (30)
                                                                                     ---------------------------------------------
 Income (loss) before income taxes                                                     26,839   12,922    4,717      833    (1,394)
 Provision for income taxes                                                            10,729    5,040    1,840       58        --
                                                                                     ---------------------------------------------
 Net income (loss)                                                                     16,110    7,882    2,877      775    (1,394)
 Accretion of Mandatorily Redeemable Convertible Preferred Stock                           --      270    1,135      883       403
                                                                                     ---------------------------------------------
 Net income (loss) attributable to Common Stock                                      $ 16,110  $ 7,612  $ 1,742  $  (108)  $(1,797)
                                                                                     =============================================
 Net income (loss) attributable to Common Stock per share:
  Basic                                                                                 $0.51    $0.30    $0.21   $(0.02)   $(0.26)
  Diluted                                                                               $0.47    $0.23    $0.06   $(0.02)   $(0.26)
 Shares used to compute net income (loss) attributable to Common Stock
  per share(1):
  Basic                                                                                31,457   25,477    8,469    7,053     6,793
  Diluted                                                                              34,323   32,923   28,974    7,053     6,793
</TABLE>

 (1) See Note 1 of Notes to Consolidated Financial Statements for an explanation
     of shares used to compute net income (loss) per share.
<PAGE>

                           Selected Financial Data
                                 (continued)

The following table sets forth, for the periods indicated, certain financial
data as a percent of revenue:
<TABLE>
<CAPTION>
                                                          Year Ended June 30,
                                              1998       1997       1996       1995       1994
<S>                                         <C>        <C>        <C>        <C>        <C>
Revenue                                      100.0%     100.0%     100.0%     100.0%     100.0%
Operating expenses:                                                                  
 Professional personnel                       44.6       45.2       45.1       42.8       43.9
 Sales and marketing                          13.8       14.6       18.1       24.7       36.6
 General and administrative                   11.3       13.5       11.5       12.1       21.0
 Other costs                                  15.6       14.8       14.6       15.1       16.5
                                              ------------------------------------------------
  Total operating expenses                    85.3       88.1       89.3       94.7      118.0
                                              ------------------------------------------------
Income (loss) from operations                 14.7       11.9       10.7        5.3      (18.0)
Interest and other, net                        1.1        1.1         --        0.1       (0.4)
                                              ------------------------------------------------
Income (loss) before income taxes             15.8       13.0       10.7        5.4      (18.4)
Provision for income taxes                     6.3        5.1        4.2        0.4         --
                                              ------------------------------------------------
Net income (loss)                              9.5        7.9        6.5        5.0      (18.4) 
Accretion of Mandatory Redeemable
 Convertible Preferred Stock                    --        0.2        2.5        5.7        5.3
                                              ------------------------------------------------
Net income (loss) attributable
 to Common Stock                               9.5%       7.7%       4.0%      (0.7)%    (23.7)%
                                              ================================================
<CAPTION>                                  
(in thousands)                                                 June 30,
BALANCE SHEET DATA                            1998       1997       1996       1995       1994
<S>                                         <C>        <C>        <C>        <C>        <C>
Cash, cash equivalents and investments    $ 68,729    $40,770    $   869     $4,161    $ 2,414
Working capital                             70,626     48,122      6,060      6,103      2,850
Total assets                               129,587     77,736     18,072      9,967      5,112
Notes payable, less current portion             --         --        316        732        447
Shareholders' equity(2)                     97,937     66,238      9,883      6,897      3,117
</TABLE>

(2)  Includes Mandatorily Redeemable Convertible Preferred Stock which converted
     to Common Stock upon the consummation of the Company's initial public
     offering on September 18, 1996.
<PAGE>
 

                      Management's Discussion and Analysis
                of Financial Condition and Results of Operations


The following discussion contains forward-looking statements that involve risks
and uncertainties. The Company's actual results could differ materially from
those anticipated in these forward-looking statements as a result of certain
factors, including those set forth below in "Future Results Subject to Risks"
and under "Risk Factors" in the Company's Annual Report on Form 10-K.

ANNUAL RESULTS OF OPERATIONS

Revenue

Substantially all of the Company's revenue is derived from fees for professional
services. The Company also derives revenue from electronic services; however,
such revenue has not been significant to date. Revenue was $44.1 million, $99.3
million and $169.7 million in fiscal 1996, 1997 and 1998, respectively,
representing increases over the prior fiscal year of 183.6%, 125.2% and 70.9%,
respectively. Revenue increased primarily due to an increase in the number and
size of professional services projects and secondarily due to an increase in
average billing rates per hour. One client accounted for approximately 17.0% of
revenue in fiscal 1996. No one client accounted for more than 10% of revenue in
fiscal 1997 or 1998.

Operating Expenses

Professional Personnel    Professional personnel expenses consist primarily of
compensation and benefits of the Company's employees engaged in the delivery of
professional services and electronic services. Professional personnel expenses
were $19.9 million, $44.8 million and $75.7 million in fiscal 1996, 1997 and
1998, respectively, representing increases over the prior fiscal year of 198.9%,
125.3% and 68.8%, respectively. These increases were attributable primarily to
an increase in the number of network systems engineers. The number of network
systems engineers included in professional personnel was 344, 651 and 1,053 at
the end of fiscal 1996, 1997 and 1998, respectively. Professional personnel
expenses were 45.1%, 45.2% and 44.6% of revenue in fiscal 1996, 1997 and 1998,
respectively. Professional personnel expenses were lower as a percent of revenue
in fiscal 1998 than fiscal 1996 and 1997 due primarily to an increase in billing
rates for professional services, and to a lesser extent, an increase in
electronic services revenue as a percent of sales.

Sales and Marketing    Sales and marketing expenses consist primarily of
compensation, including commissions and benefits of sales and marketing
personnel as well as outside marketing expenses. Sales and marketing expenses
were $8.0 million, $14.4 million and $23.5 million in fiscal 1996, 1997 and
1998, respectively, representing increases over the prior fiscal year of 107.9%,
80.7% and 62.6%, respectively. The increase in each year was due primarily to
the growth in the number of sales and marketing employees and to commissions
resulting from increased revenue. Sales and marketing expenses were 18.1%, 14.6%
and 13.8% of revenue in fiscal 1996, 1997 and 1998, respectively. The decreases,
on a percentage basis, were due primarily to leverage of the field management
organization and changes in compensation plans.

General and Administrative    General and administrative expenses consist of
expenses associated with executive staff, finance, corporate facilities,
information systems and human resources. General and administrative expenses
were $5.0 million, $13.4 million and $19.1 million in fiscal 1996, 1997 and
1998, 
<PAGE>
 
respectively, representing increases over the prior fiscal year of 167.1%,
166.1% and 42.2%, respectively. The increase in each year was due primarily to
the growth in the number of personnel necessary to support the Company's growth
in operations. General and administrative expenses were 11.5%, 13.5%, and 11.3%
of revenue in fiscal 1996, 1997 and 1998, respectively. The increase from fiscal
1996 to fiscal 1997 on a percentage basis was due primarily to expanding the
Company's infrastructure to support the growth in operations. The decrease from
fiscal 1997 to fiscal 1998 on a percentage basis was due primarily to the
leverage of infrastructure.

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 electronic services. Other costs also include research
and development expenses related to electronic services. Other costs were $6.4
million, $14.7 million and $26.5 million in fiscal 1996, 1997 and 1998,
respectively, representing increases over the prior fiscal year of 174.8%,
128.2% and 80.2%, respectively. Other costs increased each year due primarily to
increases in the number of professional personnel employed, and to a lesser
extent, to the costs of field offices. Other costs were 14.6%, 14.8%, and 15.6%
of revenue in fiscal 1996, 1997 and 1998, respectively. Other costs, as a
percent of revenue, increased primarily due to increases in recruiting,
professional development and travel and entertainment expenses. Research and
development expenses were $879,000, $1.4 million, and $1.7 million in fiscal
1996, 1997 and 1998, respectively. Research and development expenses were 2.0%,
1.4%, and 1.0% of revenue in fiscal 1996, 1997 and 1998, respectively. These
increases in absolute dollars were a result of the development of, and
enhancements to, the Company's electronic services.

Interest and Other, Net

Interest and other, net consists of interest income and expense. Interest income
consists primarily of interest on cash, cash equivalents, investments and notes
receivable from shareholders. Interest expense consists of interest associated
with bank borrowings. Interest expense was $108,000 and $85,000, in fiscal 1996
and 1997, respectively. Interest and other, net were $3,000, $1.1 million, and
$1.9 million in fiscal 1996, 1997 and 1998, respectively. The increase in fiscal
1997 to $1.1 million or 1.1% of revenue compared to $3,000 or less than 0.1% of
revenue in fiscal 1996 was due primarily to increases in funds available for
investment and the pay-off of all outstanding debt as a result of the Company
completing its initial public offering in September 1996. The increase in fiscal
1998 to $1.9 million was due primarily to an increase in funds available for
investment.

Provision for Income Taxes

The Company provides for income taxes using an asset and liability approach that
recognizes deferred tax assets and liabilities for expected future tax
consequences of temporary differences between the book and tax bases of assets
and liabilities. The effective tax rates for fiscal 1996, 1997 and 1998 were
39%, 39% and 40%, respectively. The Company's effective tax rates approximated
the combined federal and state statutory rates, net of federal benefits.

LIQUIDITY AND CAPITAL RESOURCES

Since inception, the Company has financed its operations primarily through a
combination of cash generated from operations, the sale of equity and debt
securities and bank borrowings. In September 1996, the Company completed its
initial public offering of 2,875,000 shares of Common Stock at $16 per share,
which resulted in net proceeds to the Company of approximately $41.7 million. At
June 30, 1998, the Company had $68.7 million in cash, cash equivalents and
investments. The Company had a revolving line of credit with a bank that
provided for borrowings up to $10 million which expired in August 1998. Advances
under the revolving line of credit bore interest at the bank's prime rate. As of
June 30, 1998, there were no borrowings under 
<PAGE>
 
the revolving line of credit, and the Company was in compliance with all
covenants and restrictions. In August 1998, the Company entered into an
unsecured revolving line of credit agreement with another bank which provides
for borrowings up to $10 million. Borrowings under the revolving line of credit
bear interest at the bank's prime rate less 1/2%. The credit facility expires in
February 2000 and contains customary covenants and restrictions.

Net cash provided by operations was $347,000, $4.5 million and $25.2 million in
fiscal 1996, 1997 and 1998, respectively. The increase in cash provided by
operations each year primarily reflects the Company's increased profitability
offset by increases in accounts receivable. Although the Company believes its
collections experience is within industry standards, the Company's inability to
collect for its services on a timely basis in the future could have a material
adverse effect on the Company's business, operating results and financial
condition. In fiscal 1998, cash provided by operations also resulted from
prepayments for services resulting in an increase in deferred revenue of $11.3
million. Net cash used in investing activities was $4.4 million, $29.1 million
and $27.9 million in fiscal 1996, 1997 and 1998, respectively. Cash used in
investing activities in fiscal 1997 and 1998 primarily reflected net investment
activity and, to a lesser extent, purchases of computer equipment and software.
Cash used in fiscal 1996 reflected purchases of equipment and software. Net cash
provided by financing activities in fiscal 1996 of $760,000 primarily reflected
borrowings under the Company's credit facility, which were principally offset by
repayments on long-term debt. Net cash provided by financing activities in
fiscal 1997 and 1998 of $43.2 million and $11.6 million, respectively, primarily
resulted from the issuance of Common Stock and a warrant to purchase Common
Stock.

The Company believes that existing cash and investment balances combined with
cash generated from operations and amounts available under the credit facility,
will be sufficient to meet its capital requirements for at least the next twelve
months. The Company may also utilize cash to acquire or invest in complementary
businesses or to obtain the right to use complementary technologies. The Company
may sell additional equity or debt securities or obtain additional credit
facilities. The sale of additional equity or convertible debt securities will
result in additional dilution to the Company's shareholders.

FUTURE RESULTS SUBJECT TO RISKS

Since professional services revenue is recognized by the Company only when
network systems engineers are engaged on client projects, the utilization of
network systems engineers is important in determining the Company's operating
results. In addition, a substantial majority of the Company's operating
expenses, particularly personnel and related costs, depreciation and rent, are
relatively fixed in advance of any particular quarter. As a result, any
underutilization of network systems engineers may cause significant variations
in operating results in any particular quarter and could result in losses for
such quarter. Factors which would cause such underutilization include: the
reduction in size, delay in commencement, interruption or termination of one or
more significant projects; the completion during a quarter of one or more
significant projects; the inability to obtain new projects; the overestimation
of resources required to complete new or ongoing projects; and the timing and
extent of training, weather related shut-downs, vacation days and holidays. The
Company's clients are generally able to reduce or cancel their use of the
Company's professional services without penalty and with little or no notice.
The Company generally provides services to clients without a long-term
commitment. The Company's revenue and earnings may also fluctuate from quarter
to quarter based on a variety of factors including the loss of key employees, an
inability to hire and retain sufficient numbers of network systems engineers and
account managers, reductions in billing rates, write-offs of billings, or
services performed at no charge as a result of the Company's failure to meet
it's client's expectations, competition, the development and introduction of new
services, decrease or slowdown in the growth of the networking industry as a
whole and general economic conditions. The Company's operating results may also
fluctuate based upon the ongoing market acceptance and the timing and size of
orders for electronic 

<PAGE>
 
services which are difficult to forecast. If an unanticipated order shortfall
for electronic services occurs, the Company's operating results could be
materially adversely affected, particularly because margins are higher on
electronic services than professional services. In addition, the Company plans
to continue to expand its operations based on sales forecasts by hiring
additional network systems engineers, account managers and other employees, and
adding new offices, systems and other infrastructure. The resulting increase in
operating expenses would have a material adverse effect on the Company's
operating results if revenue were not to increase to support such expenses.
Based upon all of the foregoing, the Company believes that quarterly revenue and
operating results may vary significantly in the future and that period-to-period
comparisons of its operating results are not necessarily meaningful and should
not be relied on as indications of future performance. Furthermore, it is likely
that in some future quarter the Company's revenue or operating results will be
below the expectations of public market analysts or investors. In such event,
the price of the Company's Common Stock would likely be materially adversely
affected.

The Company's future success will depend in large part on its ability to hire,
train and retain network systems engineers who together have expertise in a wide
array of network and computer systems and a broad understanding of the
industries the Company serves. Competition for network systems engineers is
intense, and there can be no assurance that the Company will be successful in
attracting and retaining such personnel. In particular, competition is intense
for the limited number of qualified managers and senior network systems
engineers. The Company has experienced, and may in the future experience, high
rates of turnover among its network systems engineers. Any inability of the
Company to hire, train and retain a sufficient number of qualified network
systems engineers could impair the Company's ability to adequately manage and
complete its existing projects or to obtain new projects, which, in turn, could
have a material adverse effect on the Company's business, operating results and
financial condition. The Company has experienced, and may in the future
experience increasing compensation costs for its network systems engineers. Any
inability of the Company to offset such increases in compensation of network
systems engineers through higher billing rates or reduction of other expenses to
offset such increases, could have a material adverse effect on the Company's
business, operating results and financial condition. In addition, any inability
of the Company to attract and retain a sufficient number of qualified network
systems engineers in the future could impair the Company's planned expansion of
its business.

The Company's future success will also depend in large part on the development
of new business by the Company's account managers, who solicit new business and
manage relationships with existing clients. As a result, the Company's success
will depend on its ability to attract and retain qualified account managers who
have an understanding of the Company's business and the industry it serves.
Competition for account managers is intense and the Company has experienced, and
may in the future experience, high rates of turnover among its account managers.
In addition, integration of new account managers into the Company's business can
be lengthy. Any inability of the Company to attract and retain a sufficient
number of account managers or to integrate new account managers into the
Company's operations on a timely basis, would impair the Company's ability to
obtain projects from new and existing clients which could have a material
adverse effect on the Company's business, operating results and financial
condition.

Furthermore, the network services industry is comprised of a large number of
participants and is subject to rapid change and intense competition. With
respect to professional services, the Company faces competition from system
integrators, value added resellers ("VARs"), local and regional network services
firms, telecommunications providers, network equipment vendors, software vendors
and computer systems vendors, many of which have significantly greater
financial, technical and marketing resources and greater name recognition, and
generate greater service revenue than does the Company. With respect to
electronic services, the Company faces competition primarily from software
vendors. The Company has faced, and 
<PAGE>
 
expects to continue to face, additional competition from new entrants into its
markets. Increased competition could result in price reductions, fewer client
projects, underutilization of employees, reduced operating margins and loss of
market share, any of which could materially adversely affect the Company's
business, operating results and financial condition. There can be no assurance
that the Company will be able to compete successfully against current or future
competitors. The failure of the Company to compete successfully would have a
material adverse effect on the Company's business, operating results and
financial condition.

In addition, the Company has a significant relationship with Cisco Systems
("Cisco") and believes that maintaining and enhancing this relationship is
important to the Company's business. Although the Company believes that its
relationship with Cisco is good, there can be no assurance that the Company will
be able to maintain or enhance its relationship with Cisco. Any deterioration in
the Company's relationship with Cisco could have a material adverse effect on
the Company's business, operating results and financial condition.

Year 2000

The year 2000 problem is the result of computer programs being written using two
digits rather than four to define the applicable year. Computer programs that
have time-sensitive software may recognize a date using "00" as the year 1900
rather than the year 2000. This could result in a major system failure or
miscalculations. The year 2000 issue creates risk for the Company from
unforeseen problems in its own computer systems and from third parties. Failure
of the Company's and/or third parties' computer systems could have a material
adverse impact on the Company's ability to conduct its business. The Company is
currently reviewing its products, its internal computer systems and systems of
third parties on which the Company relies for handling the year 2000. Based on
information available to date, the Company believes that it will be able to
complete its year 2000 compliance review and make any necessary modifications to
its products and internal systems prior to the end of 1999. The Company further
believes that such review and modification, if any, will not require the Company
to incur any material charge to operating expenses over the next several years.
The Company is also seeking confirmation from third parties that their systems
are year 2000 compliant or that plans are being developed to address the year
2000 problem. However, there can be no assurance that such third-party systems
will be year 2000 compliant or that the failure of such systems to be year 2000
compliant would not have a material adverse effect on the Company's financial
position or results of operations. The Company believes its current electronic
service offering, EnterprisePro, is year 2000 compliant.

Market Risk

The Company invests in marketable securities in accordance with its investment
policy. The primary objectives of the Company's investment policy are to
preserve principal, maintain proper liquidity to meet operating needs and
maximize yields. The Company's investment policy specifies credit quality
standards for the Company's investments and limits the amount of credit exposure
to any single issue, issuer or type of investment. The maximum allowable
maturity of a single issue is two years and the maximum allowable average
maturity of the portfolio is one year.

At the end of fiscal 1998, the Company had an investment portfolio of fixed
income securities totaling $40.5 million, excluding those classified as cash and
cash equivalents. The Company's investments consist primarily of money market
funds and various municipal obligations. These securities are classified as
available for sale and are recorded on the balance sheet at fair market value
with unrealized gains or losses reported as a separate component of
shareholders' equity. Unrealized losses are charged against income when a
decline in fair market value is determined to be other than temporary. The
specific identification method is used to determine the cost of securities sold.
Gains and losses on marketable securities are included in net interest income
when realized.
<PAGE>
 
The investment portfolio is subject to interest rate risk and will fall in value
in the event market interest rates increase. If market interest rates were to
increase immediately and uniformly by 50 basis points (approximately 10% of
current rates in the portfolio) from levels as of June 30, 1998, the fair market
value of the portfolio would decline by approximately $200,000. However, the
Company has the ability to hold its fixed income securities to maturity and may
avoid recognizing a decline in income or cash flows.

To date, revenue from foreign sources and operations in foreign locations have
not been material. In addition, substantially all of the revenue has been
received in U.S. dollars. As such, the current foreign exchange rate risk is
considered minimal, and the Company believes that sudden significant changes in
foreign currency exchange rates would not have a material impact on its
operating results or financial position. However, a component of the Company's
long-term strategy is to expand into international markets. As a result,
fluctuations in currency exchange rates in the future could have a material
adverse effect on the Company's business, operating results and financial
condition.
<PAGE>
 
                          Consolidated Balance Sheets
<TABLE>
<CAPTION>
(in thousands, except share data)                                                                 June 30,
ASSETS                                                                                        1998       1997
<S>                                                                                         <C>        <C>
 Current assets:
  Cash and cash equivalents                                                                 $ 28,262   $19,455
  Short-term investments                                                                      25,319    12,075
  Accounts receivable, net                                                                    42,717    23,949
  Deferred income taxes                                                                        2,172     1,150
  Prepaid expenses and other assets                                                            3,806     2,991
                                                                                            --------   -------
     Total current assets                                                                    102,276    59,620
                                                                                            --------   -------
 Property and equipment, net                                                                  11,092     8,073
 Deferred income taxes                                                                         1,071       803
 Investments                                                                                  15,148     9,240
                                                                                            --------   -------
                                                                                            $129,587   $77,736
                                                                                            ========   =======
 LIABILITIES AND SHAREHOLDERS' EQUITY
 Current liabilities:
  Accounts payable                                                                          $  3,564   $ 3,208
  Accrued compensation and employee benefits                                                  12,195     6,935
  Accrued liabilities                                                                          4,009       801
  Deferred revenue                                                                            11,882       554
                                                                                            --------   -------
     Total current liabilities                                                                31,650    11,498
 Commitments and contingencies (Note 8)
 Shareholders' equity:
  Preferred Stock, no par value, 5,000,000 shares
   authorized; none issued and outstanding                                                        --        --
  Common Stock, no par value, 75,000,000 shares
   authorized; 32,919,060 and 32,076,600 shares issued
   and outstanding                                                                            75,259    60,897
  Notes receivable from shareholders                                                            (675)   (1,937)
  Cumulative translation adjustments                                                             (35)       --
  Retained earnings                                                                           23,388     7,278
                                                                                            --------   -------
     Total shareholders' equity                                                               97,937    66,238
                                                                                            --------   -------
                                                                                            $129,587   $77,736
                                                                                            ========   =======
</TABLE> 
The accompanying notes are an integral part of these consolidated financial 
statements.
<PAGE>
 
                       Consolidated Statements of Income
<TABLE>
<CAPTION>
                                                                                                Year Ended June 30,
(in thousands, except per share data)                                                         1998     1997     1996
<S>                                                                                         <C>       <C>      <C>
 Revenue                                                                                    $169,678  $99,275  $44,092
 Operating expenses:
  Professional personnel                                                                      75,659   44,826   19,892
  Sales and marketing                                                                         23,479   14,440    7,990
  General and administrative                                                                  19,106   13,435    5,049
  Other costs                                                                                 26,504   14,711    6,447
                                                                                            --------  -------  -------
     Total operating expenses                                                                144,748   87,412   39,378
                                                                                            --------  -------  -------
 Income from operations                                                                       24,930   11,863    4,714
 Interest and other, net                                                                       1,909    1,059        3
                                                                                            --------  -------  -------
 Income before income taxes                                                                   26,839   12,922    4,717
 Provision for income taxes                                                                   10,729    5,040    1,840
                                                                                            --------  -------  -------
 Net income                                                                                   16,110    7,882    2,877
  Accretion of Mandatorily Redeemable
   Convertible Preferred Stock                                                                    --      270    1,135
                                                                                            --------  -------  -------
 Net income attributable to
  Common Stock                                                                              $ 16,110  $ 7,612  $ 1,742
                                                                                            --------  -------  -------
 Net income attributable to
  Common Stock per share:
   Basic                                                                                       $0.51    $0.30    $0.21
   Diluted                                                                                     $0.47    $0.23    $0.06
                                                                                            --------------------------
 Shares used to compute net income
  attributable to Common Stock
  per share:
   Basic                                                                                      31,457   25,477    8,469
   Diluted                                                                                    34,323   32,923   28,974
                                                                                            --------------------------

The accompanying notes are an integral part of these consolidated financial statements.
</TABLE> 
<PAGE>
 
                Consolidated Statements of Shareholders' Equity
<TABLE>
<CAPTION>
                                                                                  Accretion
                                                                    Notes       of Mandatorily
                                                                 Receivable       Redeemable      Cumulative    Retained
                                         Common Stock               From         Convertible     Translation   Earnings/
   (in thousands, except share data)        Shares     Amount   Shareholders   Preferred Stock   Adjustments   (Deficit)    Total
____________________________________________________________________________________________________________________________________
<S>                                      <C>           <C>      <C>            <C>               <C>           <C>         <C>
 Balance at June 30, 1995                   8,394,320  $   435       $   (30)          $(1,319)         $ --     $(3,481)  $(4,395)
  Accretion of Mandatorily Redeemable
   Convertible
   Preferred Stock                                 --       --            --            (1,135)           --          --    (1,135)
  Issuance of Common Stock upon
   exercise of
   stock options and warrants, net          3,032,555    1,959        (1,850)               --            --          --       109
  Net income                                       --       --            --                --            --       2,877     2,877
                                        --------------------------------------------------------------------------------------------
 Balance at June 30, 1996                  11,426,875    2,394        (1,880)           (2,454)           --        (604)   (2,544)
  Accretion of Mandatorily Redeemable
   Convertible
   Preferred Stock                                 --       --            --              (270)           --          --      (270)
  Issuance of Common Stock in public
   offering, net of
   issuance costs                           2,875,000   41,709            --                --            --          --    41,709
  Conversion of Mandatorily Redeemable
   Convertible
   Preferred Stock in connection with
    IPO                                    16,734,889    9,973            --             2,724            --          --    12,697
  Issuance of Common Stock upon
   exercise of stock
   options and warrants, net                  824,479      244           (57)               --            --          --       187
  Issuance of Common Stock under
   employee stock
   purchase plan                              215,357    2,983            --                --            --          --     2,983
  Income tax benefit related to stock
   option exercises                                --    3,594            --                --            --          --     3,594
  Net income                                       --       --            --                --            --       7,882     7,882
                                        --------------------------------------------------------------------------------------------
 Balance at June 30, 1997                  32,076,600   60,897        (1,937)               --            --       7,278    66,238
  Issuance of Common Stock upon
   exercise of stock
   options and warrants, net                  423,093    1,079            --                --            --          --     1,079
  Issuance of Common Stock under
   employee stock
   purchase plan                              419,367    6,047            --                --            --          --     6,047
  Repayment of Shareholders' Notes                 --       --         1,262                --            --          --     1,262
  Issuance of Warrant                              --    3,188            --                --            --          --     3,188
  Translation adjustments                          --       --            --                --           (35)         --       (35)
  Income tax benefit related to stock
   option exercises                                --    4,048            --                --            --          --     4,048
  Net income                                       --       --            --                --            --      16,110    16,110
                                        --------------------------------------------------------------------------------------------
 Balance at June 30, 1998                  32,919,060  $75,259       $  (675)          $    --          $(35)    $23,388   $97,937
                                        --------------------------------------------------------------------------------------------
</TABLE>

The accompanying notes are an integral part of these consolidated financial 
statements.

<PAGE>
 
                     Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
                                                                             Year Ended June 30,
(in thousands)                                                       1998            1997          1996
<S>                                                              <C>             <C>             <C>
Cash flows from operating activities:                                                      
  Net income                                                      $ 16,110         $ 7,882       $ 2,877
Adjustments to reconcile net income to net cash                                            
 provided by operating activities:                                                         
  Depreciation                                                       5,776           3,821         1,786
  Deferred income taxes                                             (1,290)         (1,096)         (857)
  Tax benefit from employee stock plans                              4,048           3,594            --
  Changes in assets and liabilities:                                                       
    Accounts receivable                                            (18,768)        (12,128)       (7,657)
    Prepaid expenses and other assets                                 (815)         (2,605)         (270)
    Accounts payable                                                   356           1,300         1,256
    Accrued liabilities                                              8,468           3,782         2,942
    Deferred revenue                                                11,328             (58)          270
                                                                  --------------------------------------
      Net cash provided by operating activities                     25,213           4,492           347
                                                                  --------------------------------------
Cash flows from investing activities:                                        
  Purchases of property and equipment, net                          (8,795)         (7,755)       (4,399)
  Purchases of investments                                         (38,884)        (25,414)           --
  Sales of investments                                              19,732           4,099            --
                                                                  --------------------------------------
      Net cash used for investing activities                       (27,947)        (29,070)       (4,399)
                                                                  --------------------------------------
Cash flows from financing activities:                                                       
  Borrowings (payments) under line of credit                            --          (1,000)        1,000
  Payments on notes payable                                             --            (715)         (349)
  Proceeds from issuance of Common Stock, net                       10,314          44,879           109
  Repayment of shareholder notes receivable                          1,262              --            --
                                                                  --------------------------------------
      Net cash provided by financing activities                     11,576          43,164           760
                                                                  --------------------------------------
Effect of exchange rate changes on cash and                                                 
 cash equivalents                                                      (35)             --            --
                                                                  --------------------------------------
Increase (decrease) in cash and cash equivalents                     8,807          18,586        (3,292)
Cash and cash equivalents at beginning of period                    19,455             869         4,161
                                                                  --------------------------------------
Cash and cash equivalents at end of period                        $ 28,262         $19,455       $   869
                                                                  ======================================
Supplemental disclosure of cash flow information:                                           
  Cash paid for interest                                           $    --         $    97       $   103
  Cash paid for income taxes                                       $ 8,177         $ 7,599       $ 2,470  
Non-cash transactions:                                                                      
  Issuance of Common Stock in exchange for notes                                            
   receivable from shareholders                                    $    --        $     57       $ 1,850
  Conversion of Mandatorily Redeemable Convertible                                          
   Preferred Stock to Common Stock                                 $    --        $  9,973       $    --
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements.

<PAGE>
 
                   Notes to Consolidated Financial Statements

1. THE COMPANY AND ITS SIGNIFICANT ACCOUNTING POLICIES

The Company

International Network Services (the "Company") was incorporated in California in
August 1991. The Company is a leading provider of services for complex
enterprise networks. The Company provides services for the full life cycle of a
network and maintains expertise in the most complex network technologies and
multivendor environments. The Company operates in one industry segment. To date,
the Company has provided limited professional services to certain of its United
States based clients in foreign locations.

Significant accounting policies

Fiscal year    The Company's fiscal year is composed of four 13-week quarters,
each of which ends on the last Sunday of the final fiscal month of the quarter,
with the fiscal year ending on the Sunday closest to June 30. For financial
statement presentation purposes, each fiscal year end is titled June 30th.

Principles of consolidation    The consolidated financial statements include the
accounts of the Company and its wholly-owned subsidiaries in the United Kingdom
and Canada. All intercompany accounts and transactions have been eliminated.

Foreign currency translation    The functional currency of the Company's wholly-
owned foreign subsidiaries are the local currencies. Assets and liabilities of
these subsidiaries are translated into U.S. dollars at exchange rates in effect
at the balance sheet date. Income and expense items are translated at average
exchange rates for the period. Accumulated net translation adjustments are
recorded in shareholders' equity. Foreign exchange transaction gains and losses
were not material in all periods presented and are included in the results of
operations.

Cash equivalents and marketable securities    Cash equivalents consist of highly
liquid investments with original maturities of three months or less. The
company's marketable securities are classified as available-for-sale and, at the
balance sheet date, are reported at fair market value which approximates cost.

Property and equipment    Property and equipment are stated at cost.
Depreciation is computed using the straight-line method over the estimated
useful lives of the respective assets, ranging from two to five years.

Revenue recognition    Substantially all of the Company's revenue is derived
from professional services which are generally provided to clients on a "time
and expenses" basis. Revenue is recognized as services are performed. Payments
received in advance of services performed are recorded as deferred revenue. The
Company also performs a limited number of fixed-price engagements under which
revenue is recognized using the percentage-of-completion method (based on the
ratio of costs incurred to total estimated project costs). Provision for
estimated losses on engagements is made during the period in which the loss
becomes probable and can be reasonably estimated. To date, such losses have been
insignificant. The Company reports revenue net of reimbursable expenses which
are billed to and collected from clients. The Company also derives revenue from
electronic services. Prior to the quarter ended September 30, 1997, the Company
offered its electronic services to clients only as a service which resulted in
revenue recognition over the contract term. The Company currently allows clients
to separately purchase a software license, software subscription and support
services as an alternative to the service contract. When the client purchases
electronic services in components, the Company recognizes service and software
subscription revenue over the term of the contract, installation revenue when
installation is complete and software license revenue when software is shipped,
there are no significant obligations remaining, and collection is probable.
<PAGE>
 
Operating expenses

Professional personnel    Professional personnel expenses consist primarily of
compensation and benefits of the Company's employees engaged in the delivery of
professional and electronic 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 electronic services. Other costs also include research
and development expenses related to electronic services. Research and
development expenses were $1.7 million, $1.4 million, and $879,000 for fiscal
years 1998, 1997 and 1996, respectively. 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 electronic services have not been
significant. Accordingly, the Company has not capitalized any software
development costs.

Income taxes

The Company provides for income taxes using an asset and liability approach that
recognizes deferred tax assets and liabilities for expected future tax
consequences of temporary differences between the book and tax bases of assets
and liabilities.

Concentration of credit risk

The Company's financial instruments that are exposed to concentrations of credit
risk consist primarily of cash, cash equivalents, short-term and long-term
investments, and accounts receivable. The Company's investments consist of
investment grade securities managed by qualified professional investment
managers. The investment policy limits the Company's exposure to concentration
of credit risk. The Company's accounts receivable is derived from revenue earned
from customers primarily located in the United States. The Company maintains an
allowance for potential credit losses based upon the expected collectibility of
all accounts receivable; historically, such losses have been immaterial. In
fiscal 1998 and 1997, no one customer accounted for more than 10% of revenues.
In fiscal 1996, one customer accounted for 17% of revenue.

Net income per share

Basic net income per share is computed by dividing net income available to
common shareholders (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 price 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."
<PAGE>
 
The following is a reconciliation of the numerators and denominators of the
basic and diluted earnings per share ("EPS") computations for the years ended
June 30 (in thousands):
<TABLE>
<CAPTION>
                                                                                                                         
                                             1998                                1997                             1996 
                                 Net                     Per       Net                       Per       Net                     Per
                               Income       Shares      Share     Income        Shares      Share     Income      Shares      Share
                             (Numerator) (Denominator)  Amount  (Numerator)  (Denominator)  Amount  (Numerator) (Denominator) Amount
------------------------------------------------------------------------------------------------------------------------------------
<S>                          <C>          <C>            <C>     <C>          <C>          <C>     <C>          <C>            <C>
 Basic EPS:
  Net income available for
   common shareholders          $16,110       31,457      $0.51    $7,612        25,477      $0.30      $1,742        8,469    $0.21
 Effects of dilutive
  securities:
  Common stock equivalents           --        1,947         --        --         2,023         --          --        1,873       --
  Common stock subject to
   repurchase                        --          919         --        --         1,937         --          --        1,897       --
  Preferred stock                    --           --         --        --         3,486         --          --       16,735       --
 Diluted EPS:
  Net income available for
   common shareholders
                                ----------------------------------------------------------------------------------------------------
   assuming dilution            $16,110       34,323      $0.47    $7,612        32,923      $0.23      $1,742       28,974    $0.06
                                ====================================================================================================
</TABLE>

Antidilutive Options    Options to purchase 380,883, 151,141 and 30,593 shares
of common stock were outstanding during fiscal 1998, 1997 and 1996,
respectively, but were not included in the computations of diluted EPS because
the options' exercise price was greater than the average market price of the
common shares.

Stock-based compensation

The Company accounts for stock-based compensation using the intrinsic value
method prescribed by APB Opinion No. 25, "Accounting for Stock Issued to
Employees." The Company's policy is to grant options with an exercise price
equal to the quoted market price of the Company's stock on the grant date.
Accordingly, no compensation cost has been recognized in the Company's
consolidated statements of income. The Company has provided additional pro forma
disclosures as required under Statement of Financial Accounting Standards No.
123 ("SFAS 123"), "Accounting for Stock-Based Compensation" (see Note 6).

Management estimates and assumptions

The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, the disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenue and expenses during the reporting period. Actual
results could differ from those estimates.

Recently issued accounting pronouncements

In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 130 ("SFAS 130"), "Reporting Comprehensive
Income," which establishes standards for reporting and displaying comprehensive
income and its components in a full set of general-purpose statements. The
disclosure requirements of SFAS 130 are first expected to be reflected in the
Company's first quarter of fiscal 1999 interim statements. In June 1997, the
FASB issued Statement of Financial Accounting Standards No. 131 ("SFAS 131"),
"Disclosures about Segments of an Enterprise and Related Information," which
establishes annual and interim reporting standards for an enterprise's business
segments and related disclosures about its products, services, geographic areas
and major customers. SFAS 131 will be first reflected in the Company's fiscal
1999 Annual Report. Adoption of SFAS 130 and SFAS 131 will not impact the
Company's consolidated financial position, results of operations or cash flows.
<PAGE>
 
In October 1997 and March 1998, the American Institute of Certified Public
Accountants (AICPA) issued Statement of Position (SOP) 97-2, "Software Revenue
Recognition" and 98-4, "Deferral of Effective Date of a Provision of SOP 97-2,
Software Revenue Recognition," which the Company is required to adopt for
transactions entered into in the fiscal year beginning July 1, 1998. SOP 97-2
and SOP 98-4 provide guidance on recognizing revenue on software transactions
and supercede SOP 91-1. The Company believes that the adoption of SOP 97-2 and
SOP 98-4 will not have a significant impact on its current licensing or revenue
recognition practices.

In April 1998, the AICPA issued SOP 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use." SOP 98-1 provides guidance for
determining whether computer software is internal-use software and on accounting
for the proceeds of computer software originally developed or obtained for
internal use and then subsequently sold to the public. It also provides guidance
on capitalization of the costs incurred for computer software developed or
obtained for internal use. The Company is required to adopt SOP 98-1 by July 1,
2000 and does not expect it to have a material effect on the Company's
consolidated financial position, results of operations or cash flows.

<TABLE>
<CAPTION>
2. BALANCE SHEET COMPONENTS

                                                June 30,
(in thousands)                               1998      1997
<S>                                        <C>       <C>
 Accounts receivable:
  Trade                                    $44,185   $24,537
  Less: allowance for doubtful accounts     (1,468)     (588)
                                           -----------------
                                           $42,717   $23,949
                                           -----------------
 Property and equipment:
  Computer equipment and software          $15,616   $12,389
  Furniture, fixtures, and other             5,394     2,489
                                           -----------------                                        
                                            21,010    14,878
  Less: accumulated depreciation            (9,918)   (6,805)
                                           -----------------
                                           $11,092   $ 8,073
                                           =================
</TABLE> 
<PAGE>
 
3. INVESTMENTS

The carrying value of the Company's investment portfolio approximated fair value
at June 30, 1998. Cash equivalents and investments consist of the following:

<TABLE>
<CAPTION>
                                                            June 30,
(in thousands)                                        1998           1997
--------------------------------------------------------------------------------
<S>                                             <C>                <C>
 Money market fund                              $  10,284           $    850
 Municipal bonds                                   56,677             33,386 
                                                ---------           -------- 
 Total available-for-sale securities               66,961             34,236  
 Less amounts classified as cash equivalents      (26,494)           (12,921)
                                                ---------           --------  
 Total Investments                              $  40,467           $ 21,315
                                                ---------           -------- 
</TABLE>

The contractual maturities of marketable securities at June 30, 1998, regardless
of their balance sheet classification, was as follows:

<TABLE>
<CAPTION>

(in thousands)
--------------------------------------------------------------------------------
<S>                                             <C>
 Due in 1 year or less                           $25,319
 Due in 1-2 years                                 15,148
                                                 -------
 Total investments                               $40,467
                                                 =======
</TABLE>

Gross realized gains and losses from the sale of securities classified as
available-for-sale were not material for the years ended June 30, 1998, 1997 and
1996. For the purpose of determining gross realized gains and losses, the cost
of securities is based upon specific identification.

At June 30, 1998, marketable securities totaling $26.5 million were classified
as cash equivalents and included money market funds of $10.3 million and
municipal bonds of $16.2 million. At June 30, 1997, marketable securities
totaling $12.9 million were classified as cash equivalents and included money
market funds of $.9 million and municipal bonds of $12.0 million.
<PAGE>
 
4. MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK

Prior to the initial public offering in September 1996, the Company had
authorized 17,000,000 shares of Mandatorily Redeemable Convertible Preferred
Stock ("Preferred Stock"), of which 2,848,000, 6,849,000 and 7,037,967 shares
were designated as Series A, B and C, respectively. The Preferred Stock was
mandatorily redeemable anytime after May 19, 1998, at a per share price equal to
the original issue price plus a 10% accretion per year, compounded annually.
Accretion of Preferred Stock was $270,000 and $1.1 million in fiscal 1997 and
1996, respectively. All issued and outstanding shares of Preferred Stock were
converted into 16,734,889 shares of Common Stock upon the closing of the public
offering.

5. COMMON STOCK

Certain Common Stock option holders (see Note 6) have the right to exercise
unvested options, subject to a repurchase right held by the Company. At June 30,
1998, 549,992 of the shares issued on the exercise of options were subject to
repurchase by the Company at the original purchase price in the event of
employee termination.

In September 1996, the Company completed its initial public offering of
2,875,000 shares of Common Stock at $16 per share, which resulted in net
proceeds to the Company of approximately $41.7 million.

During 1998, in conjunction with a services agreement with a client, the Company
received aggregate proceeds of approximately $3.2 million from the client for a
warrant to purchase up to 263,000 shares of Common Stock at $29.59 per share.
The warrant, which is exercisable immediately, expires on May 1, 2005. The
warrant was issued at fair market value.

At June 30, 1998, the Company had reserved 263,000, 565,276, and 9,895,802
shares of Common Stock for future issuance under a warrant purchase agreement,
its stock purchase plan and its stock option plans, respectively.

Notes receivable from shareholders
In exchange for the issuance of Common Stock upon exercise of options, the
Company has from time to time received notes receivable from shareholders which
bear interest at rates varying from 5.33% to 5.91% per annum. Principal and
interest are due and payable at different dates between 1998 and 1999. The
outstanding balance of such notes receivable has been included in shareholders'
equity.

6. EMPLOYEE BENEFIT PLANS

Stock option plan
On July 18, 1996, the Company's Board of Directors adopted the 1996 Stock Option
Plan (the "1996 Plan") as a successor to its 1992 Stock Option Plan (the "1992
Plan"). In addition to the 8,000,000 shares of Common Stock authorized for
issuance under the 1992 Plan, the Board of Directors authorized an additional
5,500,000 shares for issuance under the 1996 Plan. As of July 18, 1996, no
further option grants or stock issuances were made under the 1992 Plan, and all
option grants and stock issuances made during the remainder of fiscal 1997 were
made under the 1996 Plan. All outstanding options under the 1992 Plan were
incorporated into the 1996 Plan. The 1996 Plan provides for granting to
employees (including officers and directors) incentive stock options and for the
granting to employees, directors (including non-employee directors) and
consultants nonstatutory stock options and stock purchase rights.

On April 24, 1998, the Company's Board of Directors adopted the 1998
Nonstatutory Stock Option Plan (the "1998 Plan") and authorized 2,000,000 shares
for issuance under this plan. The 1998 Plan provides for granting nonstatutory
stock options to employees and consultants, excluding officers and directors.

Incentive stock options must be granted at fair market value at the date of
grant, and nonstatutory stock options and stock appreciation rights may be
granted at not less than 85% of fair market value on the date of grant. Options
generally vest 24% on the first anniversary from the date of grant, and ratably
each month over the remaining thirty-eight months. Options expire over terms not
exceeding ten years from the date of grant.

On April 25, 1997, the Board of Directors approved a plan to offer all
employees, excluding Executive Officers, the opportunity to exchange their
outstanding stock options with exercise prices greater than $23.00 per share for
new options that would be exercisable at the fair market value of the Company's
Common Stock as of the closing of the stock market on May 5, 1997 ($19.75).
These new options were otherwise identical to the old options.
<PAGE>
 
The following table summarizes stock option activity under the Company's 1992,
1996 and 1998 Plans:
<TABLE>
<CAPTION>
                                       1998                                 1997                               1996
                                               Weighted                             Weighted                             Weighted
                               Option           Average             Option           Average            Option            Average
                               Shares       Exercise Price          Shares        Exercise Price        Shares        Exercise Price
------------------------------------------------------------------------------------------------------------------------------------
<S>                          <C>          <C>                  <C>                <C>             <C>                  <C>
 Outstanding at beginning
  of year                     3,328,289            $     9.40         2,169,460           $ 1.41           2,676,975          $ 0.06
  Granted                     4,754,100                 24.61         2,594,794            18.66           3,486,350            1.64
  Exercised                    (620,996)                 2.84          (544,937)            0.43          (3,016,445)           0.65
  Canceled                     (608,996)                16.61          (891,028)           22.65            (977,420)           0.61
 Outstanding at end of year   6,852,397            $    19.97         3,328,289           $ 9.40           2,169,460          $ 1.41
                              ------------------------------------------------------------------------------------------------------
 Options exercisable at
  year end                    1,034,639            $     8.59           779,900           $ 1.29             720,910          $ 0.04
                              ------------------------------------------------------------------------------------------------------
</TABLE> 

The following table summarizes information about stock options outstanding and
exercisable at June 30, 1998:
                                          Options Outstanding 
<TABLE>
<CAPTION>
                                                                         Options Exercisable

                                                        Weighted          Weighted                             Weighted
                                      Shares             Average           Average            Shares            Average
 Range of                         Outstanding at        Remaining          Exercise       Exercisable at        Exercise
 Exercise Price                   June 30, 1998     Contractual Life       Price         June 30, 1998          Price
------------------------------------------------------------------------------------------------------------------------
<S>                               <C>               <C>                   <C>            <C>                  <C> 
 $  .01 to $  .08                   165,397              6 years           $ 0.07             129,907          $ 0.07
 $  .25 to $ 1.50                   358,043              7 years           $ 0.90             205,749          $ 0.90
 $ 2.50 to $ 8.00                   538,512              7 years           $ 5.70             278,160          $ 5.30
 $12.00 to $17.75                 1,016,533              9 years           $15.02             217,718          $14.06
 $19.75 to $23.62                 2,628,882              9 years           $21.06             200,925          $20.43
 $26.44 to $34.00                 2,145,030             10 years           $29.28               2,180          $27.01
                                  ------------------------------------------------------------------------------------
 $  .01 to $34.00                 6,852,397              9 years           $19.97           1,034,639          $ 8.59
                                  ------------------------------------------------------------------------------------
</TABLE>
Employee stock purchase plan

On July 18, 1996, the Company's Board of Directors adopted an Employee Stock
Purchase Plan (the "Purchase Plan"), which was approved by shareholders in
September 1996. Under the Purchase Plan, eligible employees can have up to 15%
of their earnings withheld through payroll deductions for the purchase of shares
of Common Stock at 85% of the lower of the fair market value of the Common Stock
on the commencement date of each offering period or the specified purchase date.
Each offering period is divided into four consecutive semi-annual purchase
periods. The initial offering period commenced on the effectiveness of the
Company's initial public offering in September 1996. A total of 1,200,000 shares
of Common Stock have been reserved for issuance under the Purchase Plan. There
were 419,367 and 215,357 shares issued under the Purchase Plan in fiscal 1998
and 1997, respectively.

Stock-based compensation

At June 30, 1998, the Company has three stock-based compensation plans, as
described above. The Company has elected to continue to apply APB Opinion 25 and
related Interpretations in accounting for its plans (see Note 1). Accordingly,
no compensation cost has been recognized for the 1992, 1996 and 1998 Plans or
Purchase Plan. Pro forma information regarding net income and earnings per
share is required by SFAS 123 for awards granted after June 30, 1994, as if
the Company had accounted for its stock-based awards to employees under the
fair value method of SFAS 123. The fair value of the Company's stock-based
awards to employees was estimated using a Black-Scholes option pricing model.
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options 
<PAGE>
 
that have no vesting restrictions and are fully transferable. The Black-
Scholes model requires the input of highly subjective assumptions including
the expected stock price volatility. Because the Company's stock-based awards
to employees have characteristics significantly different from those of traded
options, and because changes in the subjective input assumptions can
materially affect the fair value estimate, in management's opinion, the
existing models do not necessarily provide a reliable single measure of the
fair value of its stock-based awards to employees. The fair value of the
Company's stock-based awards to employees was estimated assuming no expected
dividends and the following weighted-average assumptions:

                                   Options                Purchase Plan
                            1998     1997     1996        1998      1997
 ------------------------------------------------------------------------
 Expected life (years)      4.50      4.50     4.50       0.50      0.50
 Expected volatility          55%       55%      55%        70%       75%
 Risk-free interest rate    5.47%     6.32%    5.92%       5.23%    5.82%
 Dividend yield               --        --       --          --       --


The weighted average estimated fair value of options granted under the 1998,
1996 and 1992 Plans during 1998, 1997 and 1996 was $12.48, $8.23 and $0.81,
respectively. The weighted average estimated fair value of purchase rights
granted under the Purchase Plan during 1998 and 1997 was $7.94 and $7.65,
respectively. For pro forma purposes, the estimated fair value of the Company's
stock-based awards to employees is generally amortized over the options' vesting
period (for options) and the six-month purchase period (for stock purchases
under the Purchase Plan). The Company's pro forma information follows:
<TABLE>
<CAPTION>
                                                                                               Year Ended June 30,
(In thousands, except per share data)                                             1998                 1997          1996
--------------------------------------------------------------------------------------------------------------------------
<S>                                                     <C>                     <C>                   <C>           <C>
 Net Income (loss)                                      As reported             $16,110               $7,612        $1,742
                                                        Pro forma               $ 2,484               $ (895)       $1,580

 Basic income (loss) per share                          As reported             $  0.51               $ 0.30        $ 0.21
                                                        Pro forma               $  0.08               $(0.04)       $ 0.19

 Diluted income (loss) per share                        As reported             $  0.47               $ 0.23        $ 0.06
                                                        Pro forma               $  0.07               $(0.04)       $ 0.05
</TABLE>

The above pro forma disclosures are not likely to be representative of pro
forma disclosures of future years.

<PAGE>
 
7. INCOME TAXES

The provision for income taxes for the years ended June 30, 1998, 1997 and 1996
consists of the following (in thousands):

                        Year Ended June 30,
                    1998        1997       1996
------------------------------------------------
 Current:                               
  Federal         $ 9,437     $ 4,705     $1,940
  State             2,351       1,266        757
  Foreign             231         165         --
                   12,019       6,136      2,697
------------------------------------------------
 Deferred:                              
  Federal          (1,140)       (963)      (757)
  State              (150)       (133)      (100)
------------------------------------------------
                   (1,290)     (1,096)      (857)
------------------------------------------------
                  $10,729     $ 5,040     $1,840
------------------------------------------------

The provision for income taxes differs from the amount determined by applying
the U.S. statutory income tax rate to income before income taxes as summarized
below (in thousands).

                                                  Year Ended June 30,
                                                1998     1997     1996
-----------------------------------------------------------------------
Tax provision at statutory rate               $ 9,393   $4,523   $1,604
State income taxes, net of federal benefit      1,528      736      370
Change in valuation allowance                      --       --     (309)
Tax exempt interest                              (528)    (271)      --
Nondeductible expenses                            235       83       98
Other                                             101      (31)      77
-----------------------------------------------------------------------
                                              $10,729   $5,040   $1,840
-----------------------------------------------------------------------

Deferred income taxes reflect the tax effects of temporary differences between
carrying amounts of assets and liabilities for financial reporting and income
tax purposes. The Company provides a valuation allowance for deferred tax
assets when it is more likely than not, based on available evidence, that some
portion or all of the deferred tax assets will not be realized. Based on a
reevaluation of the realizability of future tax benefits based on income
earned in fiscal 1996, creating available tax carrybacks, the Company reversed
the previously established valuation allowance during fiscal 1996. Significant
components of the Company's deferred tax assets are as follows (in thousands):

                                      June 30,
                                    1998    1997
-------------------------------------------------
Depreciation                       $1,071  $  964
State income taxes                    375     201
Allowance for doubtful accounts       594     225
Reserves and other accruals         1,203     563
-------------------------------------------------
                                   $3,243  $1,953
-------------------------------------------------

<PAGE>
 
8. COMMITMENTS AND CONTINGENCIES

The Company leases office space for its corporate headquarters and various field
offices and certain computer equipment. Future annual minimum lease payments
under all noncancellable operating leases as of June 30, 1998 are as follows (in
thousands):
<TABLE>
<CAPTION>
Fiscal year
<S>            <C>
 1999                                                                   $ 4,890
 2000                                                                     3,850
 2001                                                                     2,667
 2002                                                                     1,683
 2003                                                                     2,246
 Thereafter                                                                 867
                                                                        -------
                                                                        $15,336
                                                                        =======
</TABLE>

Total rent expense for the years ended June 30, 1998, 1997 and 1996 was
approximately $3.0 million, $1.3 million, and $545,000, respectively.

During 1998, the Company entered into an agreement with a client under which the
Company is required to pay royalties to the client, if and when revenue from
specified services exceeds a predetermined base of revenue for those services.
No royalties have been recorded under this agreement in fiscal 1998.

9. LINES OF CREDIT

The Company had a $10 million line of credit with a bank which expired in August
1998. Borrowings under the line of credit bore interest at the bank's prime rate
(8.5% at June 30, 1998). There were no borrowings under the line of credit at
June 30, 1998. The line of credit was secured by substantially all of the
Company's assets and required the Company to comply with certain financial
covenants. At June 30, 1998, the Company was in compliance with these financial
covenants.

In August 1998, the Company entered into an unsecured revolving line of credit
agreement with another bank which provides for borrowings up to $10 million.
Borrowings under the revolving line of credit bear interest at the bank's prime
rate less 1/2%, or the Company has the option to borrow at a fixed rate at 
1 1/2% above the bank's LIBOR for a fixed term of up to three months. Balances
outstanding at February 14, 2000 that have been used to fund capital equipment
may be converted to a 3-year term loan which provides for the same interest rate
options. The line of credit expires in February 2000 and requires the Company to
comply with certain financial convenants.
<PAGE>
 
                       Report of Independent Accountants



TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF
INTERNATIONAL NETWORK SERVICES

In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income, of shareholders' equity and of cash flows
present fairly, in all material respects, the financial position of
International Network Services and its subsidiaries at June 30, 1998 and 1997,
and the results of their operations and their cash flows for each of the three
years in the period ended June 30, 1998, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.

/s/ PricewaterhouseCoopers LLP
------------------------------

San Jose, California
July 24, 1998,
except for Note 9 which is
as of August 25, 1998
<PAGE>
 
                              Stock Price History

The Company's Common Stock is traded on the NASDAQ National Market under the
symbol INSS. The Company completed its initial public offering in September
1996. The following table sets forth the high and low sales prices for the
Common Stock during the quarter indicated:

                                          High       Low
 ---------------------------------------------------------
 June 30, 1998                           $40.63     $27.50
 March 31, 1998                          $29.88     $21.00
 December 31, 1997                       $24.00     $16.00
 September 30, 1997                      $28.75     $19.38
 June 30, 1997                           $27.75     $15.50
 March 31, 1997                          $39.00     $17.94
 December 31, 1996                       $51.88     $26.13
 September 30, 1996                      $39.75     $28.00

The Company had 243 shareholders of record as of September 1, 1998.

No dividends have been paid on the Common Stock and the Company has no plans to
pay dividends in the future.
<PAGE>
 
                        Quarterly Results of Operations
                                  (unaudited)
<TABLE>
<CAPTION>
                                             Three Months Ended Fiscal 1998                   Three Months Ended Fiscal 1997
                                 June 30,          Mar. 31,      Dec. 31,   Sept. 30,   June 30,   Mar. 31,   Dec. 31,   Sept. 30,
                                   1998              1998          1997        1997       1997       1997       1996        1996
-----------------------------------------------------------------------------------------------------------------------------------
<S>                          <C>               <C>               <C>        <C>         <C>        <C>        <C>        <C>
 Revenue                             $52,458           $45,241    $38,265     $33,714    $30,511    $26,539    $23,337     $18,888
 Operating expenses:
  Professional personnel              22,906            19,989     17,408      15,356     13,569     12,366     10,445       8,446
  Sales and marketing                  7,316             6,280      5,436       4,447      4,243      3,950      3,713       2,534
  General and
   administrative                      5,840             5,092      4,238       3,936      3,723      3,520      3,387       2,805
  Other costs                          8,355             7,217      5,699       5,233      4,841      3,568      3,159       3,143
                                     ----------------------------------------------------------------------------------------------
     Total operating
      expenses                        44,417            38,578     32,781      28,972     26,376     23,404     20,704      16,928
 Income from operations                8,041             6,663      5,484       4,742      4,135      3,135      2,633       1,960
 Interest and other, net                 548               531        478         352        355        350        374         (20)
                                     ----------------------------------------------------------------------------------------------
 Income before income taxes            8,589             7,194      5,962       5,094      4,490      3,485      3,007       1,940
 Provision for income taxes            3,438             2,874      2,379       2,038      1,751      1,359      1,173         757
                                     ----------------------------------------------------------------------------------------------
 Net income                            5,151             4,320      3,583       3,056      2,739      2,126      1,834       1,183
 Accretion of Mandatorily
  Redeemable Convertible
  Preferred Stock                         --                --         --          --         --         --         --         270
 Net income attributable
  to Common Stock                    $ 5,151           $ 4,320    $ 3,583     $ 3,056    $ 2,739    $ 2,126    $ 1,834     $   913
                                     =============================================================================================
 Net income attributable
  to Common Stock per
  share:
  Basic                              $  0.16           $  0.14    $  0.11     $  0.10    $  0.09    $  0.07    $  0.06     $  0.07
  Diluted                            $  0.15           $  0.13    $  0.11     $  0.09    $  0.08    $  0.06    $  0.05     $  0.03
                                     ---------------------------------------------------------------------------------------------
 Shares used to compute
  net income attributable
  to Common Stock per
  share:
  Basic                               32,154            31,637     31,241      30,797     30,351     29,757     29,317      12,481
  Diluted                             35,267            34,417     33,705      33,901     33,809     33,687     33,743      30,452
                                     ---------------------------------------------------------------------------------------------
 AS A PERCENT OF REVENUE
 Revenue                               100.0%            100.0%     100.0%      100.0%     100.0%     100.0%     100.0%      100.0%
  Operating expenses:
  Professional personnel                43.7              44.2       45.5        45.5       44.5       46.6       44.8        44.7
  Sales and marketing                   14.0              13.9       14.2        13.2       13.9       14.9       15.9        13.4
  General and
   administrative                       11.1              11.2       11.1        11.7       12.2       13.3       14.5        14.9
  Other costs                           15.9              16.0       14.9        15.5       15.9       13.4       13.5        16.6
                                     ---------------------------------------------------------------------------------------------
     Total operating
      expenses                          84.7              85.3       85.7        85.9       86.4       88.2       88.7        89.6
 Income from operations                 15.3              14.7       14.3        14.1       13.6       11.8       11.3        10.4
 Interest and other, net                 1.0               1.2        1.3         1.0        1.2        1.3        1.6        (0.1)
                                     ---------------------------------------------------------------------------------------------
 Income before income taxes             16.3              15.9       15.6        15.1       14.8       13.1       12.9        10.3
 Provision for income taxes              6.5               6.4        6.2         6.0        5.7        5.1        5.0         4.0
                                     ---------------------------------------------------------------------------------------------
 Net income                              9.8               9.5        9.4         9.1        9.1        8.0        7.9         6.3 
 Accretion of Mandatory
  Redeemable Preferred Stock              --                --         --          --         --         --         --        15
                                     ---------------------------------------------------------------------------------------------
 Net income attributable 
  to Common Stock                        9.8%              9.5%       9.4%        9.1%       9.1%       8.0%       7.9%        4.8%
                                     =============================================================================================
</TABLE>

<PAGE>
 
                                     Corporate Information
<TABLE> 
<CAPTION> 

BOARD OF DIRECTORS                                                             ANNUAL MEETING                   
------------------                                                             --------------                   
<S>                                   <C>                                      <C> 
Donald K. McKinney                    Fred Farinacci                           The Annual Meeting of            
Chairman of the Board                 Vice President,                          Shareholders will be held        
                                      Northwest Central                        on Thursday, October 29,         
Vernon Anderson                       Operations                               1998 at 1 p.m., local time,      
Investor                                                                       at the Company's headquarters,   
                                      Ruth Gaines                              located at: 1213 Innsbruck Drive,
David Carlick                         Vice President,                          Sunnyvale, California 94089.     
President,                            Mid-Atlantic Operations                                                   
Power Agent                                                                    FORM 10-K                        
                                      Tom Holt                                 ---------                        
John L. Drew                          Vice President and                       The Company's Form 10-K as filed 
Director, President and               Chief Information Officer                with the Securities and Exchange 
Chief Executive Officer                                                        Commission, is available, without 
                                      Kevin J. Laughlin                        charge upon written request to:  
Larry Finch                           Vice President and                       Investor Relations               
Partner, Sigma Partners               Chief Financial Officer                  International Network Services   
                                                                               1213 Innsbruck Drive             
Douglas Allred                        Peter Licata                             Sunnyvale, CA 94089              
Senior Vice President,                Vice President,                          Telephone: (408) 542-0182        
Customer Advocacy                     Business Development                                                      
World Wide Systems,                                                            TRANSFER AGENT AND               
Support, Services                     Alan Roach                               REGISTRAR                        
Cisco Systems, Inc.                   Vice President,                          ------------------               
                                      United Kingdom                           ChaseMellon Shareholder          
MANAGEMENT                            Operations                               Services                         
----------                                                                     85 Challenger Road               
John L. Drew                          Ross Roesner                             Overpeck Centre                  
President and                         Vice President,                          Ridgefield Park, NJ 07660        
Chief Executive Officer               Electronic Services Development                                           
                                      and Engineering                          INDEPENDENT ACCOUNTANTS          
Elvin Ambler                                                                   -----------------------          
Vice President,                       Ralph Troupe                             PricewaterhouseCoopers LLP       
Marketing                             Vice President,                          150 Almaden Boulevard            
                                      Eastern Operations                       San Jose, CA 95113               
David Butze                                                                                                     
Vice President,                       Steve Umphreys                           LEGAL COUNSEL                    
North American Field                  Vice President,                          -------------                    
Operations                            Human Resources                          Wilson Sonsini Goodrich          
                                                                               & Rosati                         
Ted Case                                                                       650 Page Mill Road               
Vice President,                                                                Palo Alto, CA 94034               
Southwest Central
Operations
</TABLE> 

<PAGE>
 
                                    Offices

HEADQUARTERS                    GEORGIA                 OHIO                 
1213 Innsbruck Dr.,             Atlanta                 Cleveland            
Sunnyvale, CA 94089                                     Columbus             
Phone: (408) 542-0100           ILLINOIS                                     
Fax: (408) 542-0101             Chicago                 OKLAHOMA             
                                                        Tulsa                
ARIZONA                         KANSAS                                       
Phoenix                         Kansas City             PENNSYLVANIA         
                                                        Philadelphia         
CALIFORNIA                      MASSACHUSETTS                                
Costa Mesa                      Boston                  TEXAS                
Los Angeles                     Burlington              Austin               
Sacramento                                              Dallas               
San Diego                       MICHIGAN                Houston              
San Mateo                       Detroit                 San Antonio          
San Ramon                                                                    
Woodland Hills                  MINNESOTA               WASHINGTON           
                                Minneapolis             Seattle              
COLORADO                                                                     
Denver                          NEW JERSEY              WASHINGTON D.C.      
                                Iselin                                       
CONNECTICUT                     Parsippany              EUROPE               
Hartford                                                London               
                                NEW YORK                                     
FLORIDA                         New York City           CANADA               
Jacksonville                                            Toronto               
Ft. Lauderdale                  NORTH CAROLINA      
Tampa                           Charlotte           
                                Raleigh              


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