INTEGRATED SYSTEMS INC, 424A, 1996-04-15

INTEGRATED SYSTEMS INC
424A, 1996-04-15
PREPACKAGED SOFTWARE

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<PAGE> 1

INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES
MAY NOT BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE
REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT
CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY
NOR SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH SUCH
OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR
QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.

SUBJECT TO COMPLETION, DATED APRIL 12, 1996
PROSPECTUS Filed Pursuant to Rule 424(a)
- ---------------- Registration No. 333-02449

1,800,000 SHARES

LOGO
COMMON STOCK

Of the 1,800,000 shares of Common Stock offered hereby, 500,000 shares are
being sold by the Company and 1,300,000 shares are being sold by the Selling
Shareholders. The Company will not receive any of the proceeds from the sale of
shares by the Selling Shareholders. See "Selling Shareholders."

The Company's Common Stock is quoted on the Nasdaq National Market under
the symbol INTS. On April 10, 1996, the last reported sale price for the Common
Stock was $24.00 per share. See "Price Range of Common Stock."

------------------

THE SHARES OFFERED HEREBY INVOLVE A HIGH DEGREE OF RISK.
SEE "RISK FACTORS" ON PAGE 4.

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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS
THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS.
ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
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PROCEEDS TO
PRICE TO UNDERWRITING PROCEEDS TO SELLING
PUBLIC DISCOUNT(1) COMPANY(2) SHAREHOLDERS
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Per Share......................... $ $ $ $
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Total(3).......................... $ $ $ $
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</TABLE>

(1) See "Underwriting" for indemnification arrangements with the Underwriters.

(2) Before deducting expenses payable by the Company estimated at $350,000.

(3) One Selling Shareholder has granted to the Underwriters a 30-day option to
purchase up to 270,000 additional shares of Common Stock solely to cover
over-allotments, if any. If all such shares are purchased, the total Price
to Public, Underwriting Discount and Proceeds to Selling Shareholders will
be $ , $ and $ , respectively. See
"Underwriting."

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The shares of Common Stock are offered by the Underwriters subject to prior
sale, receipt and acceptance by them and subject to the right of the
Underwriters to reject any order in whole or in part and certain other
conditions. It is expected that certificates for such shares will be available
for delivery on or about May , 1996, at the office of the agent of Hambrecht &
Quist LLC in New York, New York.

HAMBRECHT & QUIST WESSELS, ARNOLD & HENDERSON

May , 1996
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INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE

The following documents filed with the Securities and Exchange Commission
(the "Commission") by the Company are hereby incorporated by reference into this
Prospectus except as superseded or modified herein: (1) the Company's Annual
Report on Form 10-K for the fiscal year ended February 28, 1996 and (2) the
description of the Company's Common Stock set forth in the Company's
Registration Statement on Form 8-A filed with the Commission on January 29,
1990. All documents filed by the Company with the Commission pursuant to Section
13(a), 13(c), 14 or 15(d) of the Securities Exchange Act of 1934, as amended
(the "Exchange Act"), after the date of this Prospectus and prior to the
termination of the offering of the shares offered hereby shall be deemed to be
incorporated by reference into this Prospectus and to be a part hereof from the
date of filing of such documents. Any statement contained in any document
incorporated or deemed to be incorporated by reference herein shall be deemed to
be modified or superseded for purposes of this Prospectus to the extent that a
statement contained herein modifies or supersedes such statement. Any such
statement so modified or superseded shall not be deemed, except as modified or
superseded, to constitute a part of this Prospectus. The Company will provide
without charge to each person, including any beneficial owner, to whom this
Prospectus is delivered, upon written or oral request of such person, a copy of
any and all of the documents that have been or may be incorporated by reference
herein (other than exhibits to such documents which are not specifically
incorporated by reference into such documents). Such requests should be directed
to Investor Relations, Integrated Systems, Inc., 3260 Jay Street, Santa Clara,
California 95054-3309. The Company's telephone number at that location is (408)
980-1500.

IN CONNECTION WITH THIS OFFERING, CERTAIN UNDERWRITERS AND SELLING GROUP
MEMBERS (IF ANY) OR THEIR RESPECTIVE AFFILIATES MAY ENGAGE IN PASSIVE MARKET
MAKING TRANSACTIONS IN THE COMMON STOCK ON THE NASDAQ NATIONAL MARKET IN
ACCORDANCE WITH RULE 10B-6A UNDER THE SECURITIES EXCHANGE ACT OF 1934. SEE
"UNDERWRITING."

IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK AT
A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH
TRANSACTIONS MAY BE EFFECTED ON THE NASDAQ NATIONAL MARKET, IN THE
OVER-THE-COUNTER MARKET OR OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE
DISCONTINUED AT ANY TIME.

AutoCode(R), MATRIXx(R), pSOS(R) and Xmath(R) are registered trademarks of
the Company. DocumentIt, ESp, FlexOS, pSOSystem, RealSim, SNiFF+, SystemBuild
and Embedded Internet are trademarks of the Company. This Prospectus also
includes trademarks of other companies.

Integrated Systems, Inc. was incorporated in California in February 1980.
As used in this Prospectus, the "Company" and "Integrated Systems" refer to
Integrated Systems, Inc. and its subsidiaries. The Company's principal executive
offices are located at 3260 Jay Street, Santa Clara, California 95054-3309. Its
telephone number is (408) 980-1500.

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PROSPECTUS SUMMARY

The following summary is qualified in its entirety by the more detailed
information, including "Risk Factors" and the consolidated financial statements
and notes thereto, appearing elsewhere in this Prospectus or incorporated by
reference in this Prospectus.
THE COMPANY

Integrated Systems designs, develops, markets and supports software
products for embedded microprocessor-based applications and also provides
related engineering services. Embedded microprocessors are used to add
functionality and intelligence to a variety of products and to operate as an
integral part of these products,
generally without any direct human intervention. The Company offers software
that consists of a real-time operating system and a series of modules and design
tools that aid the development of embedded applications. The Company's products
are designed to enable users to accelerate the design, development, debugging,
implementation and maintenance of embedded software. The Company's products and
services reduce the expense associated with embedded software and system
development and enable customers to develop systems that have greater
functionality, enhanced performance, improved reliability and ease of use.
Integrated Systems markets and supports its products and provides services on a
worldwide basis to a variety of users in a broad range of industries, including
telecommunications and data communications, automotive, multimedia and consumer
and office and industrial automation. Recently, the Company has introduced
embedded operating software and design tools for Internet applications. The
Company markets its products primarily through a direct sales force augmented by
a telemarketing organization, distributors and sales representatives. Integrated
Systems' customers include Alcatel, Daimler-Benz, General Motors,
Hewlett-Packard, Honda, Motorola, Philips, Sharp and Sony.

THE OFFERING

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<S> <C>
Common Stock offered by the Company.................... 500,000 shares
Common Stock offered by the Selling Shareholders....... 1,300,000 shares
Common Stock to be outstanding after the offering...... 21,865,650 shares(1)
Use of proceeds........................................ For general corporate purposes, including working
capital and possible acquisitions.
Nasdaq National Market symbol.......................... INTS
</TABLE>

SUMMARY CONSOLIDATED FINANCIAL INFORMATION(2)
(IN THOUSANDS, EXCEPT PER SHARE DATA)

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<CAPTION>
FISCAL YEAR ENDED FEBRUARY 28,
-------------------------------------------------------
1992 1993 1994 1995 1996
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CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Total revenue......................................................... $24,612 $32,388 $45,783 $58,054 $84,442
Income (loss) from operations......................................... (7,499) 3,633 4,763 7,999 6,464
Net income (loss)..................................................... (7,890) 3,437 4,086 6,490 5,283
Earnings (loss) per share(3).......................................... $ (0.45) $ 0.18 $ 0.21 $ 0.33 $ 0.24
Earnings per share before acquisition and other costs(4).............. $ 0.23 $ 0.18 $ 0.21 $ 0.33 $ 0.50
Shares used in per share calculations(3).............................. 17,478 18,636 19,122 19,964 22,088
</TABLE>

<TABLE>
<CAPTION>
FEBRUARY 28, 1996
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ACTUAL AS ADJUSTED(5)
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CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and marketable securities.................................................. $49,476 $ 60,496
Working capital................................................................................... 31,431 42,451
Total assets...................................................................................... 85,264 96,284
Total shareholders' equity........................................................................ 58,276 69,296
</TABLE>

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(1) Based on the number of shares outstanding at February 28, 1996. Excludes (i)
2,525,920 shares of Common Stock issuable upon exercise of stock options
outstanding at February 28, 1996, with a weighted average exercise price of
$7.40, and (ii) 2,647,210 shares of Common Stock are available for future
issuance under the Company's stock option plans and stock purchase plan. See
Note 7 of Notes to Consolidated Financial Statements.
(2) In October 1995, the Company acquired TakeFive Software GmbH and, in January
1996, the Company acquired Doctor Design, Inc. These acquisitions were
accounted for on a pooling of interests basis. The annual financial
information has been restated to combine the results of the Company and
Doctor Design, Inc. in fiscal 1994 and fiscal 1995. Fiscal 1996 includes the
results of Doctor Design, Inc. and TakeFive Software GmbH. The annual
financial information has not been restated for earlier years because such
financial information was not material to the Company. See Note 2 of Notes
to Consolidated Financial Statements.
(3) See Note 1 of Notes to Consolidated Financial Statements for an explanation
of the determination of the number of shares used in per share calculations.
(4) Fiscal 1992 and 1996 earnings per share before acquisition and other costs
reflect earnings per share as if the Company had not incurred such
acquisition and other costs, net of any tax effects.
(5) Adjusted to give effect to the sale of the 500,000 shares of Common Stock
offered by the Company hereby, at an assumed public offering price of $24.00
per share and after deducting the estimated underwriting discount and
expenses of this offering, and the application of the net proceeds
therefrom. Does not include proceeds to the Company from option exercises by
any Selling Shareholders in connection with shares sold in this offering.
See "Use of Proceeds."
------------------------

Except as otherwise noted, all information in this Prospectus (i) assumes no
exercise of the Underwriters' over-allotment option; (ii) reflects the
two-for-one split of the Company's Common Stock effected on April 5, 1996; and
(iii) assumes that all fiscal years end on February 28.

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RISK FACTORS

The statements contained in this Prospectus that are not purely historical
are forward looking statements, including statements regarding the Company's
expectations, hopes or intentions regarding the future. Actual results could
differ materially from those discussed in the forward-looking statements. Among
the factors that could cause actual results to differ materially are those
discussed below. In addition to the other information in this Prospectus, the
following risk factors should be considered carefully in evaluating the Company
and its business before purchasing the Common Stock offered hereby.

Fluctuations in Quarterly Results. The Company's quarterly operating
results vary significantly depending on a number of factors, including the
volume and timing of orders received during the quarter, the mix of and changes
in distribution channels through which the Company's products are sold, the
timing and acceptance of new products and product enhancements by the Company or
its competitors, changes in pricing, buyouts of run-time licenses, product life
cycles, the level of the Company's sales of third party products, purchasing
patterns of distributors and customers, competitive conditions in the industry,
business cycles affecting the markets in which the Company's products are sold,
extraordinary events, such as litigation or acquisitions, including related
charges, and economic conditions generally or in various geographic areas. All
of the foregoing factors are difficult to forecast. The future operating results
of the Company may fluctuate as a result of these and other factors, including
the Company's ability to continue to develop innovative and competitive
products.

The Company historically has operated with insignificant product backlog
because its products are generally shipped as orders are received. As a result,
product revenue in any quarter depends on the volume and timing of orders
received in that quarter. In addition, the Company has at times recognized a
substantial portion of its total revenue from sales booked and shipped in the
last two weeks of the quarter such that the magnitude of quarterly fluctuations
may not become evident until very late in, or after the end of, a particular
quarter. Because the Company's staffing and operating expenses are based on
anticipated total revenue levels, and a high percentage of the Company's costs
are fixed in the short term, small variations between anticipated orders and
actual orders, as well as non-recurring or large orders, can cause
disproportionate variations in the Company's operating results from quarter to
quarter.

The procurement process of the Company's customers typically ranges from a
few weeks to several months or longer from initial inquiry to order, making the
timing of sales and license fees difficult to predict. Moreover, as licensing of
the Company's products increasingly becomes a more strategic decision made at
higher management levels, there can be no assurance that sales cycles for the
Company's products will not lengthen. The Company's results of operations may
also be affected by seasonal trends. The Company's total revenue and net income
during the first fiscal quarter have been lower than the previous fourth fiscal
quarter for a variety of reasons, including customer purchase cycles related to
expiration of budgetary authorizations, and the Company expects that total
revenue and net income in the first quarter of fiscal 1997 will be lower than
the fourth quarter of fiscal 1996. In addition, in the first quarter of fiscal
1997, the Company shifted from third party distributors to direct sales and
support in Japan and Italy. In the past, the Company's sales declined in the
short term during such transitions. There can be no assurance that declines will
not occur during the current transitions or similar transitions in the future.
Also, the Company's recent acquisitions in fiscal 1996, as well as any future
acquisitions, involve numerous risks and could have a material adverse effect on
the Company's business, financial condition and results of operations. The
Company expects to move its Santa Clara, California operations to Sunnyvale,
California by the end of the first quarter of fiscal 1997. There can be no
assurance that the move will not disrupt the Company's operations or affect the
Company's operating results. Due to all of the foregoing factors, the Company
believes that period-to-period comparisons of its results of operations are not
necessarily meaningful and should not be relied upon as an indication of future
performance. It is likely that, in some future quarters, the Company's operating
results will be below the expectations of stock market analysts and investors.
In such event, the price of the Company's Common Stock would likely be
materially adversely affected. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."

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Rapid Technological Change; Dependence on New Products. The market for
embedded applications is fragmented and is characterized by ongoing
technological developments, evolving industry standards and rapid changes in
customer requirements. The Company's success depends upon its ability to
continue to develop and introduce in a timely manner new products that take
advantage of technological advances, to continue to enhance its existing product
lines, to offer its products across a spectrum of microprocessor families used
in the embedded systems market and to respond promptly to customers'
requirements. The Company must continuously update its existing products to keep
them current with changing technology and must develop new products to take
advantage of new technologies that could render the Company's existing products
obsolete. The Company has in the past experienced delays in the development of
new products and the enhancement of existing products. Such delays are
commonplace in the software industry and are likely to be experienced by the
Company in the future. The Company's future prospects depend upon the Company's
ability to increase the functionality of existing products in a timely manner
and to develop new products that address new technologies and achieve market
acceptance. New products and enhancements must keep pace with competitive
offerings, adapt to evolving industry standards and provide additional
functionality. There can be no assurance that the Company will be successful in
developing and marketing, on a timely basis or at all, competitive products,
product enhancements and new products that respond to technological change,
changes in customer requirements and emerging industry standards, or that the
Company's enhanced or new products will adequately address the changing needs of
the marketplace. The inability of the Company, due to resource constraints or
technological or other reasons, to develop and introduce new products or product
enhancements in a timely manner could have a material adverse effect on the
Company's business, financial condition or results of operations. From time to
time, the Company or its competitors may announce new products, capabilities or
technologies that have the potential to replace or shorten the life cycles of
the Company's existing products. There can be no assurance that announcements of
currently planned or other new products will not cause customers to defer
purchasing existing Company products. Any failure by the Company to anticipate
or respond adequately to changing market conditions, or any significant delays
in product development or introduction, would have a material adverse effect on
the Company's business, financial condition and results of operations. See
"Business--Product Development."

Risks Associated with New or Emerging Markets. From time to time, the
Company embarks on product development for new or emerging markets. Currently,
the Company is expending substantial time and financial resources to develop a
product line for applications that use Internet technology with embedded
microprocessors. The Company has introduced both embedded operating software and
development tools for Internet applications. The commercial Internet market has
only recently begun to develop, is rapidly changing and is characterized by an
increasing number of new entrants with competitive products. It is difficult to
predict with any assurance whether the Internet will prove to be a viable
commercial marketplace, or whether demand for Internet related products and
services will emerge or increase in the future. If the Internet market, or any
other new market targeted by the Company in the future, fails to develop,
develops more slowly than anticipated or becomes saturated with competitors, or
if the Company's products and services do not achieve or sustain market
acceptance, the Company's business, financial condition and results of
operations would be materially adversely affected. See "Business--Product
Development."

Competition. The market for commercially available software tools and
embedded operating systems is fragmented and highly competitive and is
characterized by pressures to incorporate new features and accelerate the
release of new product versions. The Company's products compete with software
developed internally by embedded systems manufacturers and software offered by
other third parties. Many organizations that internally develop and maintain
real-time operating systems have substantial programming resources and can
develop specific products for their needs. Many of these companies have
significant investments in their existing software and there can be no assurance
that the Company will be able to persuade existing and potential customers to
replace or augment their internally developed real-time operating systems with
the Company's products. The Company's principal competitors for third-party
embedded software development and related tools (pSOSystem)

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are Mentor Graphics (through its acquisition of Microtec Research Inc.),
Microware Systems Corporation and Wind River Systems, Inc. The MATRIXx product
family competes with products offered by Mathworks Incorporated and a number of
other companies that provide design and analysis, modeling and simulation, and
code generation products. The Company also competes with a number of other
vendors that address one or more segments of the system design process,
including vendors that have modified general purpose software engineering
products for real-time and control design applications.

As the industry continues to develop, the Company expects competition to
increase in the future from existing competitors and from other companies that
may enter the Company's existing or future markets with similar or substitute
solutions that may be less costly or provide better performance or functionality
than the Company's products. Some of the Company's existing and many of its
potential competitors have substantially greater financial, technical, marketing
and sales resources than the Company and there can be no assurance that the
Company will be able to compete successfully against these companies. In the
event that price competition increases significantly, competitive pressures
could cause the Company to reduce the prices of its products, which would result
in reduced profit margins. Prolonged price competition would have a material
adverse effect on the Company's business, financial condition and results of
operations. Also, run-time licenses, which provide for per-unit royalty payments
for each embedded system that incorporates the Company's real-time operating
systems, may be subject to significant pricing pressures. A variety of other
potential actions by the Company's competitors, including increased promotion
and accelerated introduction of new or enhanced products, could have a material
adverse effect on the Company's business, financial condition and results of
operations. See "Business--Competition."

Acquisition-Related Risks. The Company completed a number of acquisitions
in fiscal 1996 and may complete additional acquisitions in the future. The
process of integrating an acquired company's business into the Company's
operations may result in unforeseen operating difficulties and expenditures and
may absorb significant management attention that would otherwise be available
for the ongoing development of the Company's business. Moreover, there can be no
assurance that the anticipated benefits of an acquisition will be realized.
Future acquisitions by the Company could result in potentially dilutive
issuances of equity securities, the incurrence of debt and contingent
liabilities and amortization expenses related to goodwill and other intangible
assets, which could materially adversely affect the Company's business,
financial condition and results of operations. In addition, acquisitions involve
numerous risks, including difficulties in the assimilation of the operations,
technologies and products of the acquired companies, difficulties in managing
diverse geographic sales and research and development operations, the diversion
of management attention from other business concerns, risks of entering markets
in which the Company has no or limited direct prior experience and the potential
loss of key employees of the acquired company. The inability of the Company's
management to respond to changing business conditions effectively, including the
changes associated with its recent acquisitions, could have a material adverse
effect on the Company's business, financial condition and results of operations.
From time to time, the Company evaluates potential acquisitions of businesses,
products or technologies. The Company has no present understandings, commitments
or agreements with respect to any material acquisition of other businesses,
products or technologies, and no material acquisition is currently being pursued
actively. In the event that such an acquisition were to occur, however, there
can be no assurance that the Company's business, operating results and financial
condition would not be materially adversely affected. See "Use of Proceeds" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."

Risks Associated with International Operations. In fiscal 1994, 1995 and
1996, the Company derived approximately 30%, 28% and 34%, respectively, of its
total revenue from sales outside of North America. The Company expects that
international sales will continue to generate a significant percentage of its
total revenue in the foreseeable future. The Company expects to continue to make
substantial investments in its international operations and to increase its
direct sales force in Europe and Asia. There can be no assurance that these
increases will result in commensurate increases in the Company's international
sales. In addition, international operations are subject to a number of special

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risks, including foreign government regulation, more prevalent software piracy,
longer payment cycles, unexpected changes in, or imposition of, regulatory
requirements, tariffs, import and export restrictions and other barriers and
restrictions, greater difficulty in accounts receivable collection, potentially
adverse tax consequences, the burdens of complying with a variety of foreign
laws, staffing and managing foreign operations, general geopolitical risks, such
as political and economic instability, hostilities with neighboring countries
and changes in diplomatic and trade relationships, possible recessionary
environments in economies outside the United States and other factors beyond the
control of the Company. The Company generally denominates sales to and by
foreign subsidiaries in local currency, and an increase in the relative value of
the dollar against such currencies, as has recently occurred, would reduce the
Company's revenue in dollar terms or make the Company's products more expensive
and, therefore, potentially less competitive in foreign markets. The Company has
little experience in hedging its foreign currency sales and often does not hedge
such sales. There can be no assurance that the Company's future results of
operations will not be adversely affected by currency fluctuations. The Company
relies on distributors for sales of its products in certain foreign countries
and, accordingly, is dependent on their ability to promote and support the
Company's products and, in some cases, to translate them into foreign languages.
The Company's international distributors generally offer products of several
different companies, including in some cases products that are competitive with
the Company's products, and such distributors are not subject to any minimum
purchase or resale requirements. There can be no assurance that the Company's
international distributors will continue to purchase the Company's products or
provide them with adequate levels of support. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."

Risks of Product Defects; Product and Other Liability. As a result of
their complexity, software products may contain undetected errors or
compatibility issues, particularly when first introduced or as new versions are
released. There can be no assurance that, despite testing by the Company and
testing and use by current and potential customers, errors will not be found in
new products after commencement of commercial shipments. The occurrence of such
errors could result in loss of or delay in market acceptance of the Company's
products, which could have a material adverse effect on the Company's business,
financial condition and results of operations. The increasing use of the
Company's products for applications in systems that interact directly with the
general public, particularly applications in transportation, medical systems and
other markets where the failure of the embedded system could cause substantial
property damage or personal injury, could expose the Company to significant
product liability claims. In addition, the Company's products are used for
applications in mission-critical business systems where the failure of the
embedded system could be linked to substantial economic loss. The Company's
license and other agreements with its customers typically contain provisions
designed to limit the Company's exposure to potential product liability and
other claims. It is likely, however, that the limitation of liability provisions
contained in the Company's agreements are not effective in all circumstances and
in all jurisdictions. Although the Company has not experienced any product
liability or economic loss claims to date, the sale and support of the Company's
products may entail the risk of such claims. The Company currently does not have
insurance against product liability risks or errors or omissions coverage and
there can be no assurance that such insurance will be available to the Company
on commercially reasonable terms or at all. A product liability claim or claim
for economic loss brought against the Company, or a product recall involving the
Company's software, could have a material adverse effect on the Company's
business, financial condition and results of operations. See "Business--Product
Development."

Dependence on Key Personnel; Need for Additional Personnel. The Company's
future performance depends to a significant degree upon the continued
contributions of its key management, product development, sales, marketing and
operations personnel. The Company does not have employment agreements with any
of its key personnel and does not maintain any key person life insurance
policies. In addition, the Company believes its future success will also depend
in large part upon its ability to attract and retain highly skilled managerial,
engineering, sales, marketing and operations personnel, many of whom are in
great demand. Competition for such personnel has intensified dramatically over

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the last twelve months in Santa Clara County, California, where the Company is
headquartered, and there can be no assurance that the Company will be successful
in attracting and retaining such personnel. The failure of the Company to
attract, assimilate and retain the necessary personnel could have a material
adverse effect on the Company's business, financial condition and results of
operations. See "Business--Employees" and "Management."

Limited Protection of Proprietary Technology. The Company's success is
heavily dependent upon its proprietary technology. To protect its proprietary
rights, the Company relies on a combination of copyright, trade secret, patent
and trademark laws, nondisclosure and other contractual restrictions on copying
and distribution and technical measures. The Company seeks to protect its
software, documentation and other written materials through trade secret and
copyright laws, which provide only limited protection. In addition, the Company
holds two United States patents and has additional United States patent
applications pending. There can be no assurance that patents held by the Company
will not be challenged and invalidated, that patents will issue from any of the
Company's pending applications or that any claims allowed from existing or
pending patents will be of sufficient scope or strength (or be issued in all
countries where the Company's products can be sold) to provide meaningful
protection or any commercial advantage to the Company. As part of its
confidentiality procedures, the Company generally enters into nondisclosure
agreements with its employees, consultants, distributors and corporate partners
and limits access to and distribution of its software, documentation and other
proprietary information. End user licenses of the Company's software are
frequently in the form of shrink wrap license agreements, which are not signed
by licensees, and therefore may be unenforceable under the laws of many
jurisdictions. The source code of the Company's products is also protected as a
trade secret and is generally not licensed to customers. Despite the Company's
efforts to protect its proprietary rights, it may be possible for unauthorized
third parties to copy the Company's products or to reverse engineer or obtain
and use information that the Company regards as proprietary. There can be no
assurance that the Company's competitors will not independently develop
technologies that are substantially equivalent or superior to the Company's
technologies. Policing unauthorized use of the Company's products is difficult,
and while the Company is unable to determine the extent to which software piracy
of its products exists, software piracy can be expected to be a persistent
problem. In addition, effective protection of intellectual property rights may
be unavailable or limited in certain countries. The status of United States
patent protection in the software industry is not well defined and will evolve
as the United States Patent and Trademark Office grants additional patents.
Patents have been granted on fundamental technologies in software, and patents
may issue that relate to fundamental technologies incorporated into the
Company's products.

As the number of patents, copyrights, trademarks and other intellectual
property rights in the Company's industry increases, products based on its
technology may increasingly become the subject of infringement claims. There can
be no assurance that third parties will not assert infringement claims against
the Company in the future. Any such claims with or without merit could be time
consuming, result in costly litigation, cause product shipment delays or require
the Company to enter into royalty or licensing agreements. Such royalty or
licensing agreements, if required, may not be available on terms acceptable to
the Company, or at all, which could have a material adverse affect on the
Company's business, financial condition and results of operations. In addition,
the Company may initiate claims or litigation against third parties for
infringement of the Company's proprietary rights or to establish the validity of
the Company's proprietary rights. Litigation to determine the validity of any
claims, whether or not such litigation is determined in favor of the Company,
could result in significant expense to the Company and divert the efforts of the
Company's technical and management personnel from productive tasks. In the event
of an adverse ruling in any such litigation, the Company may be required to pay
substantial damages, discontinue the use and sale of infringing products, expend
significant resources to develop non-infringing technology or obtain licenses to
infringing technology. The failure of the Company to develop or license a
substitute technology could have a material adverse affect on the Company's
business, financial condition and results of operations. See
"Business--Proprietary Rights."

8
<PAGE> 9

Dependence on Licenses from Third Parties. The Company licenses certain
software development tool products from other companies to distribute with its
own products. The inability of such third parties to provide competitive
products with adequate features and high quality on a timely basis or to
cooperate in sales and marketing activities could have a material adverse effect
on the Company's business, financial condition and results of operations. In
addition, the Company's products compete with products produced by certain of
the Company's licensors. There can be no assurance that, upon the termination or
expiration of these licenses, such licenses will be available on reasonable
terms or at all, or that similar products could be obtained to substitute into
the tool suites. The inability to license such products could have a material
adverse effect on the Company's business, financial condition and results of
operations.

Volatility of Stock Price. The prices for the Company's Common Stock have
fluctuated widely in the past. The management of the Company believes that such
fluctuations may have been caused by actual or anticipated variations in the
Company's operating results, announcements of technical innovations or new
products or services by the Company or its competitors, changes in earnings
estimates by securities analysts and other factors, including changes in
conditions of the software and other technology industries in general. Stock
markets have experienced extreme price volatility in recent years. This
volatility has had a substantial effect on the market prices of securities
issued by the Company and other high technology companies, often for reasons
unrelated to the operating performance of the specific companies. The trading
prices of many high technology companies' stocks, including the stock of the
Company, are at or near their historical highs and reflect price/earnings ratios
substantially above historical norms. There can be no assurance that the trading
price of the Company's stock will remain at or near its current level. In the
past, following periods of volatility in the market price of a company's
securities, securities class action litigation has often been instituted against
such a company. Such litigation, if instituted, could result in substantial
costs and a diversion of management attention and resources, which would have a
material adverse effect on the Company's business, financial condition and
results of operations even if the Company is successful in such suits. These
market fluctuations, as well as general economic, political and market
conditions such as recessions, may adversely affect the market price of the
Common Stock.

9
<PAGE> 10

USE OF PROCEEDS

The net proceeds to the Company from the sale of the 500,000 shares of
Common Stock offered by the Company hereby at an assumed public offering price
of $24.00 are estimated to be $11,020,000. The Company intends to use the net
proceeds from this offering for general corporate purposes, including working
capital and possible acquisitions. From time to time, in the ordinary course of
business, the Company evaluates potential acquisitions of complementary
businesses, products or technologies, for which a portion of the net proceeds
may be used. However, the Company currently has no understandings, commitments
or agreements with respect to any material acquisition of other businesses,
products or technologies. Pending use of the net proceeds for the above
purposes, the Company intends to invest such funds in interest-bearing,
investment grade obligations. The Company will not receive any proceeds from the
sale of Common Stock by the Selling Shareholders.

PRICE RANGE OF COMMON STOCK

The Common Stock of the Company commenced trading publicly on the Nasdaq
National Market on March 7, 1990 and is traded under the symbol INTS. The
following table sets forth for the periods indicated the high and low sale
prices for the Common Stock.

<TABLE>
<CAPTION>
HIGH LOW
------- -------
<S> <C> <C>
FISCAL YEAR ENDED FEBRUARY 28, 1995
1st Quarter................................................. $ 6.250 $ 4.500
2nd Quarter................................................. 6.500 4.188
3rd Quarter................................................. 8.625 6.125
4th Quarter................................................. 11.750 7.125
FISCAL YEAR ENDED FEBRUARY 28, 1996
1st Quarter................................................. 12.000 9.875
2nd Quarter................................................. 15.375 10.000
3rd Quarter................................................. 21.000 14.625
4th Quarter................................................. 23.875 16.000
FISCAL YEAR ENDING FEBRUARY 28, 1997
1st Quarter (through April 10, 1996)........................ 26.000 22.875
</TABLE>

On April 10, 1996, the reported last sale price for the Common Stock on the
Nasdaq National Market was $24.00 per share. As of February 28, 1996 there were
approximately 147 holders of record of the Common Stock.

DIVIDEND POLICY

The Company has not declared or paid any cash dividends on its capital
stock. The Company currently anticipates that it will retain all future earnings
for use in its business and does not anticipate paying any cash dividends in the
foreseeable future.

10
<PAGE> 11

CAPITALIZATION

The following table sets forth the consolidated capitalization of the
Company as of February 28, 1996 as adjusted to reflect the sale of the 500,000
shares of Common Stock offered by the Company at an assumed public offering
price of $24.00 per share and after deducting the estimated underwriting
discount and estimated offering expenses payable by the Company.

<TABLE>
<CAPTION>
FEBRUARY 28, 1996
--------------------------
ACTUAL AS ADJUSTED(1)
------- --------------
(IN THOUSANDS)
<S> <C> <C>
Long-term debt................................................... $ -- $ --
Shareholders' equity:
Preferred Stock, no par value; 5,000,000 shares authorized;
none outstanding............................................ -- --
Common Stock, no par value; 50,000,000 shares authorized;
21,206,000 shares outstanding; 21,706,000 shares
outstanding, as adjusted(2)................................. 40,283 51,303
Unrealized holding gain on marketable securities, net.......... 333 333
Retained earnings.............................................. 17,660 17,660
------- -------
Total shareholders' equity............................. 58,276 69,296
------- -------
Total capitalization................................. $58,276 $ 69,296
======= =======
</TABLE>

- ---------------

(1) Does not include proceeds to the Company from option exercises by any
Selling Shareholders in connection with shares sold in this offering.

(2) Does not include 2,525,920 authorized but unissued shares of Common Stock
issuable upon exercise of stock options outstanding at February 28, 1996,
with a weighted average exercise price of $7.40 and 2,647,210 shares of
Common Stock available for future issuance under the Company's stock option
plans and stock purchase plan.

11
<PAGE> 12

SELECTED CONSOLIDATED FINANCIAL DATA

The following selected consolidated financial data is qualified by
reference to and should be read in conjunction with the consolidated financial
statements and the notes thereto included elsewhere herein. The consolidated
statement of operations data set forth below with respect to the years ended
February 28, 1994, 1995 and 1996 and the consolidated balance sheet data at
February 28, 1995 and 1996 are derived from, and are qualified by reference to,
the audited consolidated financial statements and notes thereto included in this
Prospectus. The consolidated statement of operations data set forth below with
respect to the years ended February 28, 1992 and 1993 and the consolidated
balance sheet data at February 28, 1992 and 1993 are derived from audited
consolidated financial statements not included in this Prospectus. During fiscal
1996, the Company acquired TakeFive Software GmbH and Doctor Design, Inc. in
transactions accounted for as poolings of interests. The annual financial
information has been restated to combine the results of the Company and Doctor
Design, Inc. in fiscal 1994 and fiscal 1995. Fiscal 1996 includes the results of
Doctor Design, Inc. and TakeFive Software GmbH. The annual financial information
has not been restated for earlier years because such financial information was
not material to the Company.

<TABLE>
<CAPTION>
YEAR ENDED FEBRUARY 28,
-------------------------------------------------------
1992(1) 1993(1) 1994 1995 1996
------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
Revenue:
Product....................................... $13,384 $19,690 $26,350 $34,952 $51,597
Services...................................... 11,228 12,698 19,433 23,102 32,845
------- ------- ------- ------- -------
Total revenue............................ 24,612 32,388 45,783 58,054 84,442
------- ------- ------- ------- -------
Cost and expenses:
Cost of product revenue....................... 1,843 3,221 4,986 5,980 9,046
Cost of services revenue...................... 3,947 4,170 8,262 9,547 15,824
Marketing and sales........................... 7,349 11,564 16,515 20,565 27,209
Research and development...................... 4,537 6,133 5,926 8,341 11,379
General and administrative.................... 1,995 2,468 3,567 4,311 6,637
Amortization of intangible assets............. 600 1,199 1,764 1,311 556
Acquisition and other......................... 11,840 -- -- -- 7,327
------- ------- ------- ------- -------
Total costs and expenses................. 32,111 28,755 41,020 50,055 77,978
------- ------- ------- ------- -------
Income (loss) from operations....... (7,499) 3,633 4,763 7,999 6,464
Interest and other income........................ 1,735 1,575 1,258 1,601 2,331
------- ------- ------- ------- -------
Income (loss) before income taxes... (5,764) 5,208 6,021 9,600 8,795
Provision for income taxes....................... 2,126 1,771 1,935 3,110 3,512
------- ------- ------- ------- -------
Net income (loss)................... $(7,890) $ 3,437 $ 4,086 $ 6,490 $ 5,283
======= ======= ======= ======= =======
Earnings (loss) per share(2)..................... $ (0.45) $ 0.18 $ 0.21 $ 0.33 $ 0.24
======= ======= ======= ======= =======
Earnings per share before acquisition and other
costs(3)...................................... $ 0.23 $ 0.18 $ 0.21 $ 0.33 $ 0.50
======= ======= ======= ======= =======
Shares used in per share calculations(2)......... 17,478 18,636 19,122 19,964 22,088
======= ======= ======= ======= =======
</TABLE>

<TABLE>
<CAPTION>
FEBRUARY 28,
-------------------------------------------------------
1992 1993 1994 1995 1996
------- ------- ------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and marketable
securities.................................... $23,985 $27,150 $33,156 $36,517 $49,476
Working capital.................................. 9,744 13,005 12,298 17,783 31,431
Total assets..................................... 38,417 40,918 52,970 66,101 85,264
Total shareholders' equity....................... 30,946 32,447 38,032 47,948 58,276
</TABLE>

- ------------------------------
(1) Fiscal 1992 and 1993 have not been restated to reflect the annual financial
information for Doctor Design, Inc. as such financial information was not
material to the Company.
(2) See Note 1 of Notes to Consolidated Financial Statements for an explanation
of the determination of the number of shares used in per share calculations.
(3) Fiscal 1992 and 1996 earnings per share before acquisition and other costs
reflect earnings per share as if the Company had not incurred such
acquisition and other costs, net of any tax effects.

12
<PAGE> 13

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion provides an analysis of the Company's financial
condition and results of operations, and should be read in conjunction with the
"Selected Consolidated Financial Data" and the Notes thereto and the
Consolidated Financial Statements and the Notes thereto of the Company.

OVERVIEW

Integrated Systems designs, develops, markets and supports software
products for embedded microprocessor-based applications and provides related
engineering services. The Company currently derives substantially all of its
revenues from licensing of these products and providing related maintenance and
engineering and consulting services. The Company's revenue has grown steadily
through increased licensing of existing and new products and through
acquisitions, and its net income, excluding acquisition and other charges has
also grown steadily. In October 1995, the Company acquired TakeFive Software
GmbH ("TakeFive"), an Austrian corporation in the business of developing and
marketing software tools used in software development, including SNiFF+, an
advanced object-oriented integrated development environment. In January 1996,
the Company completed a merger with Doctor Design, Inc. ("Doctor Design"), a
California corporation that develops multimedia hardware, software and
application specific integrated circuit technology. Each of these business
combinations has been accounted for as a pooling of interests and the results of
operations for fiscal 1996 include the results of TakeFive and Doctor Design for
the whole year. The fiscal 1994 and 1995 results have been restated to include
only the results of Doctor Design, since those of TakeFive were not significant
in those years. See "Risk Factors--Acquisition-Related Risks."

FORWARD-LOOKING INFORMATION IS SUBJECT TO RISK AND UNCERTAINTY

Certain statements in the financial discussion and analysis by management
contain "forward-looking" information (as defined in the Private Securities
Litigation Reform Act of 1995) that involve risk and uncertainty, including
projections for fiscal 1997 and various business environment and trends
projections. Actual future results and trends may differ materially depending on
a variety of factors, including the volume and timing of orders received during
the quarter, the mix of and changes in distribution channels through which the
Company's products are sold, the timing and acceptance of new products and
product enhancements by the Company or its competitors, changes in pricing,
buyouts of run-time licenses, product life cycles, the level of the Company's
sales of third party products, purchasing patterns of distributors and
customers, competitive conditions in the industry, business cycles affecting the
markets in which the Company's products are sold, extraordinary events, such as
litigation or acquisitions, including related charges, and economic conditions
generally or in various geographic areas. All of the foregoing factors are
difficult to forecast. The future operating results of the Company may fluctuate
as a result of these and the other risk factors detailed from time-to-time in
the Company's Securities and Exchange Commission reports and in the section of
this Prospectus entitled "Risk Factors."

Due to all of the foregoing factors, the Company believes that
period-to-period comparisons of its results of operations are not necessarily
meaningful and should not be relied upon as an indication of future performance.
It is likely that, in some future quarters, the Company's operating results will
be below the expectations of stock market analysts and investors. In such event,
the price of the Company's Common Stock would likely be materially adversely
affected. Consequently, the purchase or holding of the Company's Common Stock
involves a high degree of risk.

13
<PAGE> 14

RESULTS OF OPERATIONS

The following table sets forth for the periods presented the percentage of
total revenue represented by each line item in the Company's consolidated
statements of income and the percentage change in each line item from the prior
period.

<TABLE>
<CAPTION>
PERCENTAGE OF
TOTAL REVENUE PERIOD-TO-PERIOD
------------------------- PERCENTAGE CHANGES
---------------------------
YEAR ENDED FEBRUARY 28, FISCAL 1994 FISCAL 1995
------------------------- TO TO
1994 1995 1996(1) FISCAL 1995 FISCAL 1996
---- ---- ------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Revenue:
Product..................................... 58 % 60 % 61% 33% 48%
Services.................................... 42 40 39 19 42
--- --- ---
Total revenue....................... 100 100 100 27 45
--- --- ---
Costs and expenses:
Cost of product revenue..................... 11 10 11 20 51
Cost of services revenue.................... 18 17 19 16 66
Marketing and sales......................... 36 36 32 25 32
Research and development.................... 13 14 13 41 36
General and administrative.................. 8 7 8 21 54
Amortization of intangible assets........... 4 2 1 (26) (58)
--- --- ---
Total costs and expenses............ 90 86 84 22 41
--- --- ---
Income from operations......... 10 14 16 68 72
Interest and other income..................... 3 3 3 27 46
--- --- ---
Income before income taxes..... 13 17 19 59 68
Provision for income taxes.................... 4 6 6 61 66
--- --- ---
Net income..................... 9 % 11 % 13% 59 69
=== === ===
</TABLE>

- ------------------------------
(1) The table excludes acquisition and other costs of $7.3 million, including
related tax effects, in 1996 since inclusion of such costs would render
year-to-year comparisons less meaningful.

Revenue. The Company's total revenue increased 27% from $45.8 million in
fiscal 1994 to $58.1 million in fiscal 1995 and an additional 45% to $84.4
million in fiscal 1996. A majority of the Company's total revenue came from
product revenue, which increased 33% from $26.4 million in fiscal 1994 to $35.0
million in fiscal 1995 and an additional 48% to $51.6 million in fiscal 1996.
The increase in product revenue from fiscal 1994 to fiscal 1995 was primarily
due to increased unit shipments of pSOSystem and new products. The increase in
product revenue from fiscal 1995 to fiscal 1996 was due primarily to increased
unit shipments of pSOSystem and MATRIXx and the inclusion of SNiFF+ product
revenue in fiscal 1996. pSOSystem revenue increased between both comparison
periods as a result of increased unit volume in all geographic regions and the
introduction of new products. MATRIXx revenue was flat from fiscal 1994 to
fiscal 1995 as domestic growth was offset by a decline in international revenue
due, in part, to the transition from independent sales representatives to direct
sales and support organizations in Europe. MATRIXx revenue grew from fiscal 1995
to fiscal 1996 due to increased unit shipments and the introduction of new
products. Services revenue increased 19% from $19.4 million in fiscal 1994 to
$23.1 million in fiscal 1995 and an additional 42% to $32.8 million in fiscal
1996. These increases were the result of increases in the number and size of
consulting contracts and increases in maintenance revenue from the Company's
growing installed base of customers.

The percentage of the Company's total revenue from customers located
internationally was 30%, 28% and 34% in fiscal 1994, 1995 and 1996,
respectively. The Company expects international revenue will continue to grow as
a percentage of total revenue.

14
<PAGE> 15

Costs and Expenses. The Company's cost of product revenue as a percentage
of product revenue was 19%, 17% and 18% in fiscal 1994, 1995 and 1996,
respectively. These fluctuations are due primarily to changes in the mix of
product revenue derived from the sale of higher margin products. The Company's
cost of services revenue as a percentage of services revenue was 43%, 41% and
48% in fiscal 1994, 1995 and 1996, respectively. Fluctuations in these
percentages result from shifts in service revenue mix between higher margin
maintenance revenue and lower margin consulting contract revenue.

Marketing and sales expenses were $16.5 million, $20.6 million and $27.2
million in fiscal 1994, 1995 and 1996, respectively, representing 36%, 36% and
32%, respectively of total revenue. The dollar increases were primarily due to
additional expenses associated with the Company's continued expansion of its
marketing and sales organization both domestically and overseas. The percentage
decrease from fiscal 1995 to fiscal 1996 was the result of pooling the operating
results of several acquired companies whose marketing and sales expenses had
represented a smaller percentage of their total revenue. The Company anticipates
that marketing and sales expenses will increase in fiscal 1997 as a percentage
of total revenue as the Company invests in infrastructure to support certain
acquired products and to continue its expansion into new geographical areas.

Research and development expenses were $5.9 million, $8.3 million and $11.4
million in fiscal 1994, 1995 and 1996, respectively, representing 13%, 14% and
13%, respectively, of total revenue. These dollar increases were primarily the
result of increased activity associated with bringing several products to
market, including increased personnel and consulting expenses, and a decrease in
software cost capitalization. Costs that are required to be capitalized under
Statement of Financial Accounting Standards No. 86, "Accounting for the Costs of
Computer Software to be Sold, Leased or Otherwise Marketed" ("SFAS No. 86") were
$335,000 in fiscal 1996 compared to $492,000 in fiscal 1995 and $1.1 million in
fiscal 1994. The amount capitalized represents approximately 3% of total
research and development expenditures for fiscal 1996 compared to 6% for fiscal
1995 and 16% for fiscal 1994. The amount of research and development
expenditures capitalized in a given time period depends upon the nature of the
development performed and, accordingly, amounts capitalized may vary from period
to period. Capitalized costs are being amortized using the greater of the amount
computed using the ratio that current gross revenues for a product bear the
total of current and anticipated future gross revenues for that product, or on a
straight-line basis over three years. Amortization for fiscal 1996 was $921,000,
compared to $607,000 for fiscal 1995 and $160,000 for fiscal 1994.

General and administrative expenses were $3.6 million, $4.3 million and
$6.6 million in fiscal 1994, 1995 and 1996, respectively, representing 8%, 7%
and 8%, respectively, of total revenue. These dollar increases were primarily
the result of increased headcount, related in part to the acquisitions of Doctor
Design and TakeFive.

Amortization of intangible assets was $1.8 million, $1.3 million and
$556,000 in fiscal 1994, 1995 and 1996, respectively. These dollar amounts
declined as the Company reached the end of the amortization period for software
purchased in an earlier acquisition.

Acquisition and other costs in fiscal 1996 totaled $7.3 million and
comprised direct costs related to the acquisitions of TakeFive and Doctor
Design, the write-off of intangible assets related to a prior acquisition whose
product offering will be replaced by the use of other products, costs associated
with the acquisition of certain technology and related assets to enhance
pSOSystem product offerings, and costs related to the termination of a
distributor relationship in Japan. See Note 2 to Notes to Consolidated Financial
Statements.

Interest and other income was $1.3 million, $1.6 million and $2.3 million
in fiscal 1994, 1995 and 1996, respectively. Interest and other income increased
due to an increase in the amount of cash equivalents and marketable securities
and to higher interest rates.

15
<PAGE> 16

The effective tax rate was 40% in fiscal 1996 compared to 32% in both
fiscal 1995 and fiscal 1994. The increase in the effective rate is due to the
effect of non-deductible acquisition and other costs. After adjusting for such
items, the effective rate for fiscal 1996 is 32%.

QUARTERLY FINANCIAL DATA

The following tables set forth selected unaudited quarterly financial data
for the Company's fiscal year ended February 28, 1996. The unaudited information
has been prepared on the same basis as the audited information and, in the
opinion of management, reflects all adjustments (which include only normal
recurring adjustments) necessary for the fair presentation of the information
for the periods presented. Based on the Company's operating history and factors
that may cause fluctuations in the quarterly results, quarter-to-quarter
comparisons should not be relied upon as indicators of future performance.

<TABLE>
<CAPTION>
FISCAL YEAR ENDED FEBRUARY 28, 1996
--------------------------------------------------
QUARTER ENDED
--------------------------------------------------
MAY 31, AUGUST 31, NOVEMBER 30, FEBRUARY 28,
1995 1995 1995 1996
------- ---------- ------------ ------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Revenue:
Product......................................... $11,622 $ 12,146 $ 12,665 $ 15,164
Services........................................ 6,836 7,705 8,845 9,459
------- ------- ------- -------
Total revenue........................... 18,458 19,851 21,510 24,623
Costs and expenses:
Cost of product revenue......................... 2,466 2,073 2,128 2,379
Cost of services revenue........................ 3,423 3,971 4,147 4,283
Marketing and sales............................. 6,379 6,246 6,761 7,823
Research and development........................ 2,585 2,843 2,827 3,124
General and administrative...................... 1,557 1,604 1,563 1,913
Amortization of intangible assets............... 186 186 77 107
Acquisition and other........................... -- -- 3,601 3,726
------- ------- ------- -------
Total costs and expenses................ 16,596 16,923 21,104 23,355
------- ------- ------- -------
Income from operations............. 1,862 2,928 406 1,268
Interest and other income......................... 525 691 511 604
------- ------- ------- -------
Income before income taxes.............. 2,387 3,619 917 1,872
Provision for income taxes........................ 809 1,185 333 1,185
------- ------- ------- -------
Net income.............................. $ 1,578 $ 2,434 $ 584 $ 687
======= ======= ======= =======
Earnings per share................................ $ 0.07 $ 0.11 $ 0.03 $ 0.03
======= ======= ======= =======
Earnings per share before acquisition and other
costs........................................... $ 0.07 $ 0.11 $ 0.14 $ 0.17
======= ======= ======= =======
Shares used in per share calculations............. 21,714 21,994 22,284 22,362
======= ======= ======= =======
</TABLE>

16
<PAGE> 17

<TABLE>
<CAPTION>
AS A PERCENTAGE OF TOTAL REVENUE(1)
--------------------------------------------------
QUARTER ENDED
--------------------------------------------------
MAY 31, AUGUST 31, NOVEMBER 30, FEBRUARY 28,
1995 1995 1995 1996
------- ---------- ------------ ------------
<S> <C> <C> <C> <C>
Revenue:
Product.......................................... 63% 61% 59% 62%
Services......................................... 37 39 41 38
------- ---- --- ---- --- ---- ---
Total revenue............................ 100 100 100 100
------- ---- --- ---- --- ---- ---
Costs and expenses:
Cost of product revenue.......................... 13 11 10 10
Cost of services revenue......................... 19 20 19 17
Marketing and sales.............................. 35 31 31 32
Research and development......................... 14 14 13 13
General and administrative....................... 8 8 7 8
Amortization of intangible assets................ 1 1 1 --
------- ---- --- ---- --- ---- ---
Total costs and expenses................. 90 85 81 80
------- ---- --- ---- --- ---- ---
Income from operations.............. 10 15 19 20
Interest and other income.......................... 3 3 2 2
------- ---- --- ---- --- ---- ---
Income before income taxes............... 13 18 21 22
Provision for income taxes......................... 4 6 7 7
------- ---- --- ---- --- ---- ---
Net income............................... 9% 12% 14% 15%
======= ======= ======= =======
</TABLE>

- ---------------
(1) The table excludes acquisition and other costs, including the related tax
effects, since inclusion of such costs would render the comparison less
meaningful.

The Company's quarterly operating results vary significantly depending on a
number of factors, including the volume and timing of orders received during the
quarter, the mix of and changes in distribution channels through which the
Company's products are sold, the timing and acceptance of new products and
product enhancements by the Company or its competitors, changes in pricing,
buyouts of run-time licenses, product life cycles, the level of the Company's
sales of third party products, purchasing patterns of distributors and
customers, competitive conditions in the industry, business cycles affecting the
markets in which the Company's products are sold, extraordinary events, such as
litigation or acquisitions, including related charges, and economic conditions
generally or in various geographic areas. All of the foregoing factors are
difficult to forecast. The future operating results of the Company may fluctuate
as a result of these and other factors, including the Company's ability to
continue to develop innovative and competitive products.

17
<PAGE> 18

strategic decision made at higher management levels, there can be no assurance
that sales cycles for the Company's products will not lengthen. The Company's
results of operations may also be affected by seasonal trends. The Company's
total revenue and net income during the first fiscal quarter have been lower
than the previous fourth fiscal quarter for a variety of reasons, including
customer purchase cycles related to expiration of budgetary authorizations, and
the Company expects that total revenue and net income in the first quarter of
fiscal 1997 will be lower than the fourth quarter of fiscal 1996. In addition,
in the first quarter of fiscal 1997, the Company shifted from third party
distributors to direct sales and support in Japan and Italy. In the past, the
Company's sales declined in the short term during such transitions. There can be
no assurance that declines will not occur during the current transitions or
similar transitions in the future. Also, the Company's recent acquisitions in
fiscal 1996, as well as any future acquisitions, involve numerous risks and
could have a material adverse effect on the Company's business, financial
condition and results of operations. The Company expects to move its Santa
Clara, California operations to Sunnyvale, California by the end of the first
quarter of fiscal 1997. There can be no assurance that the move will not disrupt
the Company's operations or affect the Company's operating results. Due to all
of the foregoing factors, the Company believes that period-to-period comparisons
of its results of operations are not necessarily meaningful and should not be
relied upon as an indication of future performance. It is likely that, in some
future quarters, the Company's operating results will be below the expectations
of stock market analysts and investors. In such event, the price of the
Company's Common Stock would likely be materially adversely affected.

RECENT ACCOUNTING PRONOUNCEMENTS

During March 1995, the Financial Accounting Standards Board issued
Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of" (SFAS No. 121), which requires the Company
to review for impairment of long-lived assets, certain identifiable intangibles
and goodwill related to those assets whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. In certain
situations, an impairment loss would be recognized. SFAS No. 121 will be
effective for the Company's fiscal year 1997. The Company has studied the
implications of the statement, and, based on its initial evaluation, does not
expect it to have a material impact on the Company's financial condition or
results of operations.

During October 1995, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standard No. 123, "Accounting for Stock-Based
Compensation" (SFAS No. 123). This accounting standard permits the use of either
a fair value based method or the current Accounting Principals Board Opinion No.
25, "Accounting for Stock Issued to Employees" (APB No. 25) when accounting for
stock-based compensation arrangements. Companies that do not follow the new fair
value based method will be required to disclose pro forma net income and
earnings per share computed as if the fair value based method had been applied.
The disclosure provisions of SFAS No. 123 are effective for fiscal years
beginning after December 15, 1995. Management has not determined whether it will
adopt the fair value based method of accounting for stock-based compensation
arrangements nor the impact of SFAS No. 123 on the Company's consolidated
financial statements.

LIQUIDITY AND CAPITAL RESOURCES

The Company has funded its operations to date principally through cash
flows from operations. As of February 28, 1996, the Company had $49.5 million of
cash, cash equivalents and marketable securities. This represents an increase of
$13.0 million from February 28, 1995. During the first quarter of fiscal 1995,
the Company announced that the Board of Directors had authorized the Company to
repurchase up to an additional 1,000,000 shares of Common Stock for cash, from
time-to-time at market prices, pursuant to a repurchase program announced in
September 1992. In the second quarter of fiscal 1995, under this program, the
Company repurchased 250,000 shares of Common Stock for $1.1 million. The Company
believes that cash flows from operations, together with existing cash balances,
available

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<PAGE> 19

borrowings and the proceeds from this offering, will be adequate to meet the
Company's cash requirements for working capital, capital expenditures and stock
repurchases for the next 12 months and the foreseeable future.

Net cash provided by operating activities during fiscal 1996 totaled $18.5
million, an increase of $10.7 million over the amount generated in fiscal 1995
which increased by $293,000 over fiscal 1994. The increase in net cash provided
by operating activities in fiscal 1996 was due to increases in depreciation and
amortization, current liabilities, income taxes payable and deferred revenue
were offset by increases in accounts receivable and other current assets.

Net cash used in investing activities totaled $6.0 million in fiscal 1996
compared to $9.3 million in fiscal 1995 and $7.0 million in fiscal 1994. The
decrease in net cash used in investing activities in fiscal 1996 was due
primarily to the reduction in net purchases of marketable securities, offset by
increases in additions to property and equipment and net cash paid in
acquisitions. The increase in net cash used in investing activities in fiscal
1995 was due primarily to the acquisition of the FlexOS product line and an
increase in expenditures for property and equipment.

Net cash provided by financing activities totaled $1.6 million in fiscal
1996 compared to $961,000 in fiscal 1995 and $674,000 in fiscal 1994. The
increase in net cash provided by financing activities in fiscal 1996 was due to
an increase in proceeds from the exercise of options to purchase Common Stock
and purchases under the Employee Stock Purchase Plan and the absence of Common
Stock repurchases. The increase in net cash provided by financing activities in
fiscal 1995 was due to an increase in proceeds from the exercise of options to
purchase Common Stock and purchases under the Employee Stock Purchase Plan,
offset by the repurchase of 250,000 shares of Common Stock.

After the end of fiscal 1996, in March 1996, the Company purchased a
building, which will become its principal facility, for cash of approximately
$12.0 million. The Company expects the move to this new facility to be completed
by the end of the first quarter of fiscal 1997.

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<PAGE> 20

BUSINESS

Integrated Systems designs, develops, markets and supports software
products for embedded microprocessor-based applications and also provides
related engineering services. Embedded microprocessors are used to add
functionality and intelligence to a variety of products and to operate as an
integral part of these products, generally without any direct human
intervention. The Company offers software that consists of a real-time operating
system and a series of modules and design tools that aid the development of
embedded applications. The Company's products are designed to enable users to
accelerate the design, development, debugging, implementation and maintenance of
embedded software. The Company's products and services reduce the expense
associated with embedded software and system development and enable customers to
develop systems that have greater functionality, enhanced performance, improved
reliability and ease of use. Integrated Systems markets and supports its
products and provides services on a worldwide basis to a variety of users in a
broad range of industries, including telecommunications and data communications,
automotive, multimedia and consumer and office and industrial automation.
Recently, the Company has introduced embedded operating software and design
tools for Internet applications.

INDUSTRY BACKGROUND

Embedded systems consist of a microprocessor and related software dedicated
to a specialized task or set of tasks and are found in many common products such
as telephones, automobiles, VCRs and facsimile machines. Many of these products
require real-time embedded systems that provide an immediate, predictable
response to unpredictable sequences of external events under severe deadlines.
For example, the embedded system that controls the engine in an automobile must
set airflow, fuel quantity, spark advance and other engine parameters for each
cycle within milliseconds based on engine speed, engine temperature, atmospheric
conditions and accelerator position in order to optimize fuel efficiency,
emissions control and responsiveness.

As more powerful microprocessors have become available and decreased in
price, the use of embedded systems are being used in or with a wider range of
applications. Today, embedded systems are found in telecommunications and data
communications products such as routers, access devices and switches; automotive
products such as engine controllers and anti-lock braking systems; multimedia
and consumer products such as digital video broadcast and security systems; and
office and industrial automation products such as printers, copiers and
point-of-sale terminals. Emerging embedded Internet applications for interactive
entertainment, network computers, remote maintenance and other areas may offer
significant new opportunities for embedded systems.

The development of applications software for embedded systems requires
software development tools and a real-time operating system. Real-time operating
systems and software development tools, including compilers, debuggers and
simulators, are used by developers to create applications software that enables
the embedded system to perform its required functions. Embedded systems are
increasingly based upon 32-bit microprocessors, which run significantly larger
and more sophisticated application software than embedded systems based upon
less powerful microprocessors. In addition, the cost of some 32-bit
microprocessors has decreased substantially to below $10, thereby opening new
markets for high-volume embedded applications that can now be cost justified. As
a result, 32-bit microprocessors represent the fastest growing segment of the
embedded microprocessor industry. The complexity and size of these new software
applications and the proliferation of multiple types of microprocessors require
a more substantial engineering effort, necessitating more sophisticated
development tools and real-time operating systems.

Developers of embedded systems are increasingly replacing internally
developed real-time operating systems with commercially available products as
organizations find in-house development and maintenance costly and a diversion
of core engineering resources. Also, developers of embedded systems often find
that in-house real-time operating systems developed for a single project are not
easily ported to other microprocessors or scalable for different applications
within the organization,

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<PAGE> 21

which increases development time and cost. As a result, organizations are
seeking to improve engineering productivity by standardizing on third-party
software in order to eliminate software incompatibilities and reduce training
and support costs. With productivity becoming a more strategic issue, selection
of tools and real-time operating system technology is increasingly being
evaluated by senior managers for division or company-wide deployment. The
Company believes that more organizations will need to replace in-house tools
with commercial products and to standardize on integrated enterprise-wide
solutions that are highly reliable, easily customizable and scalable so that
they can be used for simple as well as complex applications.

INTEGRATED SYSTEMS' SOLUTION

Integrated Systems provides comprehensive solutions for the development of
highly reliable and sophisticated embedded microprocessor-based applications.
The Company offers operating software that consists of a real-time system, the
pSOSystem, and a series of modules and design tools. The Company's products are
designed to enable users to accelerate the design, development, debugging,
implementation and maintenance of embedded software and to develop systems that
have greater functionality, enhanced performance, improved reliability and ease
of use. The Company also offers a range of consulting services, including
product and system design, training in the use of the Company's products and
development of specialized application code or drivers for incorporation into
customers' applications. These services have allowed the Company to offer
customers complete designs based on the Company's products and have allowed more
rapid use of the Company's technology in customers' product designs. The
Company's solution is used in embedded applications in a broad range of
industries, including telecommunications and data communications, automotive,
multimedia and consumer and office and industrial automation. Recently, the
Company has introduced embedded operating software and design tools for Internet
applications. The solution offered by Integrated Systems provides the following
features and benefits:

High Reliability. The Company's pSOS+ operating system is highly reliable,
making it suitable for deeply embedded applications where human intervention to
remedy software operating problems is not feasible. High reliability reduces
maintenance costs and allows the Company's customers to develop sophisticated
mass market products based on Integrated Systems' solution.

Suitability For High Volume Applications. The Company offers a
full-featured high performance operating system with memory requirements as low
as 16 Kbytes. In addition, the Company's operating system is very efficient,
enabling the Company's customers to minimize hardware costs while increasing the
functionality of their application designs. The Company's solutions are suitable
for low-cost, high-volume applications because of their low memory and other
hardware requirements and for hand-held applications in which less complex
hardware conserves battery power.

Customability and Scalability. The Company's product architecture is
modular, scalable and readily customizable. As a result, the Company's solution
is used in a broad range of industries for a wide array of applications. In
addition, these product features enable the Company to enter new and emerging
markets rapidly. The Company endeavors to be first to market with support for
new applications and microprocessors.

Cross-Development Capabilities. To accelerate the application development
process, Integrated Systems offers a set of tools specifically designed for
embedded software development that fully supports object-oriented methodologies.
The Company's solution provides an integrated development environment ("IDE") to
which individual development tools can be connected. The Company's IDE includes
SNiFF+, which is an advanced, object-oriented environment for the development of
sophisticated applications. The Company offers comprehensive cross-development
capabilities that allow its development tools to operate on a personal computer
or workstation, while the embedded software runs on an embedded processor. The
Company offers MATRIXx, a high-level set of tools for modeling, simulation and
code generation from a graphical description of real-time control software
functionality.

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<PAGE> 22

Application-Specific Modules. The Company offers various application
specific modules that run on top of the Company's operating system and that
allow the operating software to be more easily targeted to specific applications
without degrading performance of the operating system.

BUSINESS STRATEGY

The Company's objective is to maintain its leadership position in the
telecommunications and data communications, automotive, multimedia and consumer
and office and industrial automation markets, and leverage its experience in
embedded applications to enter new markets, such as embedded Internet
applications, in which the Company believes it can establish a leadership
position. To achieve these objectives, the Company is pursuing the following
business strategy:

Maintain Technology Leadership. The Company's extensive expertise in
embedded software development tools and real-time operating systems has enabled
it to be a technology leader in the embedded software development market. The
Company seeks to capitalize on this existing technology base to accelerate the
development of new products that leverage the features of its existing product
line. The Company intends to maintain its technological leadership through rapid
response to emerging opportunities and customer requirements by continuing to
make significant investments in research and development and continuing to
enhance the architecture of its development tools and operating software.

Offer Comprehensive Solutions. The Company's products and services offer a
comprehensive solution to users of embedded microprocessors. This approach
simplifies customers' purchasing decisions, eliminates the need for customers to
integrate products from multiple sources, improves customer support, accelerates
the integration of the Company's technology into customers' products and allows
the Company's products to be used effectively by less experienced engineers. The
Company expects to continue to expand and refine its solution through internal
development activities and strategic acquisitions.

Maintain Market Focus. While the Company's products and services are
suitable for a wide variety of applications and are sold to a broad range of
customers, the Company has focused its development and marketing efforts on the
telecommunications and data communications, automotive, multimedia and consumer
and office and industrial automation markets. The Company has developed a
complete suite of products to address these markets in order to achieve deeper
penetration, as well as to provide products that reduce the time and expense
associated with system development. The Company seeks to participate in the
rapid growth of low-cost, high-volume applications for embedded systems through
run-time license arrangements with its customers based on the number of products
sold that incorporate the Company's products.

Address Emerging Market Opportunities. From time to time, the Company
evaluates strategic opportunities and applies its technology to develop products
for new markets more quickly. The Company recently introduced design tools and
operating software products for the embedded Internet market based in part on
technology obtained through recent acquisitions. The Company believes its
products and services are suitable for emerging markets because its products are
scalable, reliable and rapidly reconfigurable.

Focus on Large Accounts. Integrated Systems markets its software products
and engineering services to large customers to encourage them to use the
Company's products in multiple designs. This strategy has made it possible for
certain large customers to standardize on the Company's products. In addition,
it allows the Company to learn from large customers about future requirements
that the Company may incorporate into its products and services.

Portability and Support for Widely-Used Embedded Microprocessors and Host
Platforms. The Company has expended significant resources to make its products
available on a broad range of host platforms and 32-bit embedded
microprocessors. This has allowed the Company to sell into a broad

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<PAGE> 23

range of markets. Because large companies use a range of host platforms and
microprocessors, it also makes it possible for large customers to standardize on
Integrated Systems' solution.

PRODUCTS AND SERVICES

The Company offers three major families of products to support the embedded
software development market: real-time or embedded operating software, software
development tools and graphical design products.

Embedded Operating Software. Integrated Systems' embedded operating
software consists of the pSOS+ operating system and special purpose modules that
run on the pSOS+ operating system. The combination of real-time operating
software and development tools is marketed and licensed as pSOSystem. pSOS+ is a
priority-based, interrupt-oriented, multitasking operating system that is small
in size (requiring as little as 16 Kbytes of storage) and highly reliable and
efficient. Based on a scalable software component architecture, pSOS+ represents
a complete solution for advanced 32-bit embedded applications development and
run-time. The Company also offers a multiprocessing version, called pSOS+m, that
operates on tightly coupled or loosely coupled microprocessors. pSOS+ operating
system is currently available for the Motorola 68xxx, Intel x86 and i960, Power
PC, MIPS and Hitachi SH product families.

The special purpose modules that run on the pSOS+ operating system are used
to support development of pSOS+ application software, to debug embedded code and
to provide file support for embedded applications. The Company also offers X11
graphical user interface modules for embedded applications. In addition, the
Company offers a number of modules that address networking, telecommunications
and data communications, automotive, multimedia and consumer and embedded
Internet applications. These modules provide complete implementation of certain
aspects of the applications at which they are focused, which improves customers'
time to market and reliability. For example, the TCP/IP module offered by the
Company provides a complete implementation of the TCP/IP communication protocol.

Software Development Tools. The Company offers a broad line of tools to
support the development of embedded software applications. The Company's
development tools consist of an integrated development environment ("IDE"),
which provides sophisticated cross development frameworks, and individual tools
that are connected to these frameworks. The Company's IDE includes SNiFF+, which
is an advanced, object-oriented environment for the development of sophisticated
applications including the development of complex object-oriented desktop and
client-server applications. Individual tools offered by the Company include C
and C++ cross-compilers, source level debuggers, browsers, pSOS+ simulators and
profilers. The Company also offers a visual debugging and analysis tool called
ESp that graphically displays component configurations, memory stack usage and
errors, static and dynamic views of all kernel objects, user specified events
and CPU use graphs. The Company also offers IDE products and individual tools
that are licensed from third parties or that include technology licensed from
third parties. The Company's tools operate on Windows-based personal computers
and workstations manufactured by Sun Microsystems, Hewlett-Packard and IBM.

Graphical Design Products. The Company's graphical design product line,
called MATRIXx, includes control system engineering tools for analysis, design,
simulation and prototyping. Products and modules in the MATRIXx family include
the following:

--Xmath is a mathematically-based engineering analysis tool that
provides analysis capabilities, plot generation facilities and specialized
function libraries for control design, robust control, optimization,
digital signal processing, system identification and model reduction
applications.

--SystemBuild is a system modeling and simulation tool used to create
interactive, dynamic system models that include plant dynamics and
real-time software logic. SystemBuild includes a block diagram editor,
tools to create animated system simulations and state transition diagrams.
In

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<PAGE> 24

addition, customers can order special purpose libraries for a variety of
needs, including fuzzy logic systems. The architecture of SystemBuild
allows the creation of application-specific libraries.

--AutoCode automatically generates programming code from SystemBuild
diagrams in the C or Ada languages. This accelerates application
development by relieving engineers of line-by-line programming and sharply
reducing programming errors committed as projects move from design analysis
to programming phrases.

--DocumentIt software further accelerates the design process by
automatically incorporating information about a design into a documentation
format.

--RealSim Series prototyping tools complete the family by providing
the software and real-time computing hardware to verify an application in
its intended environment. C or Ada code generated in the AutoCode
environment automatically loads and runs on RealSim Series hardware.

Embedded Internet Products. In January 1996, the Company announced the
availability of pSOSystem modules directed at embedded Internet applications.
The first two modules offered by the Company in its Embedded Internet family are
Java support for pSOSystem, which allows developers to build Internet
applications on pSOSystem, and an HTTP server based on pSOS+, which allows the
Company's operating software to be used for embedded Internet servers. For
example, one of the Company's customers has recently demonstrated a network
management capability for global networks based on the Company's product
providing Java support for pSOSystem. The Company has also recently introduced a
SNiFF+ design environment for Java that enables the development of both embedded
and desktop Java-based Internet applications. The Company expects to announce
additional Embedded Internet products during 1996.

Engineering Services. In addition to the products described above, the
Company offers engineering services to its customers. The Company's engineering
services group helps customers design and implement specific solutions typically
using tools provided by the Company. The Company provides engineering services
to develop close relationships with key customers, to accelerate acceptance of
advanced tools in the industry, to demonstrate the effectiveness of the
products, to learn more about specific systems and customer's development needs
and to work with the Company's product development group to incorporate
appropriate features into new versions of products or into new modules or
libraries. Engineering services projects can last from a few weeks to several
years and are generally performed on a time and materials basis.

SALES AND SUPPORT

The Company markets its products primarily through a direct sales force
augmented by a telemarketing organization, distributors and sales
representatives. The Company believes that use of a direct sales force allows
the Company to influence customer purchasing decisions, to provide superior
support to its customers and to understand better evolving customer needs. The
Company has significantly expanded the number of markets where it uses a direct
sales force and expects to continue to do so in the future.

The Company's direct sales organization in North America operates through
14 United States sales offices and a recently-opened subsidiary in Canada.
Direct sales managers are typically supported by field application engineers
that are experts in the Company's technology and products. In addition, a small
telemarketing organization focuses on selling maintenance and renewal contracts,
licensing lower-priced products and licensing to universities.

Sales internationally are supported by a direct sales force that operates
from subsidiaries based in France, Germany, Italy, Sweden, the United Kingdom,
Israel and Japan. In addition, the Company has sales and support offices in
Korea and India. The sales and support personnel in these subsidiaries and
offices are complemented by distributors and sales representatives that address
certain geographical areas, market segments or product families. Sales
representatives market and support the Company's

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<PAGE> 25

products in Australia, China, India, Korea, Taiwan and several other countries
in Asia, while distributors cover the rest of the world. The Company initiated
direct selling operations in Japan and Italy, replacing its existing third party
distributor arrangements, and implemented certain substantial changes to its
direct sales operations in Germany and France in the first quarter of fiscal
1997. These transitions may result in a decline in the Company's sales in those
countries during such transition.

The Company's software development products are typically licensed on a
per-user basis. The Company's real-time operating systems and run-time packages
are also generally licensed for development on a per-user basis. Run-time
license fees are typically charged on a per-unit basis when the customer's
application is deployed. List prices for the Company's software development
tools and real-time operating systems development licenses generally range from
less than $4,000 to over $100,000, with a typical development license averaging
between $25,000 and $50,000.

Approximately 30%, 28% and 34% of the Company's total revenue was derived
from sales outside of North America in fiscal 1994, 1995 and 1996, respectively.
See Note 10 of Notes to Consolidated Financial Statements. The Company has made
significant investments in developing its distribution and support channels
outside North America to increase the percentage of revenue derived from
international sales. There can be no assurance that changes from distribution
sales to direct sales or these additional investments will lead to increased
revenue. See "Risk Factors--Risks Associated with International Operations."

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<PAGE> 26

CUSTOMERS AND APPLICATIONS

The Company markets its products to customers in a variety of industries,
with principal focus on telecommunications and data communications, automotive,
multimedia and consumer and office and industrial automation. Recently, the
Company has introduced embedded operating software and design tools for Internet
applications. No single customer accounted for more than 10% of the Company's
total revenue in fiscal 1995 or fiscal 1996.

The Company's customers include the following:

<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------
<S> <C>
CUSTOMERS SELECTED APPLICATIONS
- ------------------------------------------------------------------------------------
TELECOMMUNICATIONS AND DATA COMMUNICATIONS:
Alcatel Telephone switching equipment
AT&T Central office switching equipment
Cascade Communications Frame relay switch
DSC Communications Interoffice switching equipment
Fujitsu SONET switch
Motorola Corporation Satellite communications system
Northern Telecom PBXs
Samsung Transmission equipment
- ------------------------------------------------------------------------------------
AUTOMOTIVE:
Bosch Automotive components
Daimler-Benz Automotive electronics
Ford Motor Corporation Chassis control
General Motors Powertrain controllers
Honda Engine controllers
Nissan Automotive electronics
Toyota Traction control
- ------------------------------------------------------------------------------------
MULTIMEDIA AND CONSUMER:
Hewlett-Packard Set-top box development
Philips N.V. HDTV and consumer appliances
Sega Corporation Karaoke system
Sony Corporation Digital broadcast satellite system
- ------------------------------------------------------------------------------------
OFFICE AND INDUSTRIAL AUTOMATION:
Eastman Kodak Company Copiers
Sharp Corporation Multifunction devices
Xerox Corporation Copiers and printers
- ------------------------------------------------------------------------------------
EMBEDDED INTERNET:
UB Networks Network management
Xionics Printer maintenance and
management
- ------------------------------------------------------------------------------------
MISCELLANEOUS:
Gilbarco Automated gas pumps
G-TECH Electronic lottery machines
- ------------------------------------------------------------------------------------
</TABLE>

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PRODUCT DEVELOPMENT

The Company's product development activities specifically address the needs
of the market segments upon which the Company focuses, offer customers open
cross-development capability and enhance the capabilities of current products
and modules to address user requirements. In addition, the Company seeks to port
the pSOSystem to additional microprocessors, make the pSOSystem suitable for
additional high-volume applications, add new products and modules to the
Company's product lines, create interfaces between the Company's products and
other key computer-aided design and software development tools and provide the
end user greater flexibility to integrate automatically-generated code with
manually-written code, thereby allowing the end user to accelerate application
development.

The Company attempts to release upgrades and to introduce new products or
modules on a regular basis. In connection with each release, the Company works
closely with its customers to define improvements and enhancements that are
incorporated into the next release of the product. This approach includes
customer feedback in the Company's product design process, as well as in the
evaluation stage, thereby permitting customers to influence functionality early
in the product's life-cycle. The Company believes that its engineering services
group provides the Company with a competitive advantage for product development
by defining needs for new products, guiding future enhancements and testing new
implementations. In addition, this group contracts with customers to research
new methodologies that can serve as prototypes for new features, products or
modules. As of February 28, 1996, the Company employed 127 engineers in the
product development group and 62 in the engineering services group. The
Company's engineers include experts in software engineering, software
development tools, multimedia, telecommunications, real-time controls and
operating systems technology.

For fiscal 1994, 1995 and 1996, the Company's research and development
expenses were approximately $5.9 million, $8.3 million and $11.4 million or 13%,
14% and 13% of its total revenue, respectively. The Company capitalizes certain
costs of developing computer software to be licensed or otherwise marketed to
customers in accordance with Statement of Financial Accounting Standards No. 86,
"Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise
Marketed" ("SFAS No. 86"). The Company capitalized approximately $1.1 million,
$492,000 and $335,000 of research and development expenses related to the
development of software products in fiscal 1994, 1995 and 1996, respectively.
The amounts capitalized represented approximately 16%, 6% and 3%, respectively,
of total research and development expenses for fiscal 1994, 1995 and 1996. Such
capitalized costs are being amortized using the greater of the amount computed
using the ratio that current gross revenues for a product bear to the total of
current and anticipated future gross revenues for that product, or on a
straight-line basis over three years. Amortization of capitalized cost for
fiscal 1994, 1995 and 1996 was $160,000, $607,000 and $921,000, respectively.
The amount of research and development expenses capitalized in a given time
period depends upon the nature of the development performed and, accordingly,
amounts capitalized may vary from period to period.

The market for embedded applications is fragmented and is characterized by
ongoing technological developments, evolving industry standards and rapid
changes in customer requirements. The Company's success depends upon its ability
to continue to develop and introduce in a timely manner new products that take
advantage of technological advances, to continue to enhance its existing product
lines, to offer its products across a spectrum of microprocessor families used
in the embedded systems market and to respond promptly to customers'
requirements. The Company must continuously update its existing products to keep
them current with changing technology and must develop new products to take
advantage of new technologies that could render the Company's existing products
obsolete. The Company has in the past experienced delays in the development of
new products and the enhancement of existing products. Such delays are
commonplace in the software industry and are likely to be experienced by the
Company in the future. The Company's future prospects depend upon the Company's
ability to increase the functionality of existing products in a timely manner
and to develop new products that address new technologies and achieve market
acceptance. New products

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and enhancements must keep pace with competitive offerings, adapt to evolving
industry standards and provide additional functionality. There can be no
assurance that the Company will be successful in developing and marketing, on a
timely basis or at all, competitive products, product enhancements and new
products that respond to technological change, changes in customer requirements
and emerging industry standards, or that the Company's enhanced or new products
will adequately address the changing needs of the marketplace. The inability of
the Company, due to resource constraints or technological or other reasons, to
develop and introduce new products or product enhancements in a timely manner
could have a material adverse effect on the Company's business, financial
condition or results of operations. From time to time, the Company or its
competitors may announce new products, capabilities or technologies that have
the potential to replace or shorten the life cycles of the Company's existing
products. There can be no assurance that announcements of currently planned or
other new products will not cause customers to defer purchasing existing Company
products. Any failure by the Company to anticipate or respond adequately to
changing market conditions, or any significant delays in product development or
introduction, would have a material adverse effect on the Company's business,
financial condition and results of operations. Currently, the Company is
expending substantial time and financial resources to develop a product line for
applications that use Internet technology with embedded microprocessors. If the
Internet market, or any other new market targeted by the Company in the future,
fails to develop, develops more slowly than anticipated or becomes saturated
with competitors, or if the Company's products and services do not achieve or
sustain market acceptance, the Company's business, financial condition and
results of operations would be materially adversely affected. See "Risk
Factors -- Risks Associated with New or Emerging Markets."

COMPETITION

The market for commercially available software tools and embedded operating
systems is fragmented and highly competitive and is characterized by pressures
to incorporate new features and accelerate the release of new product versions.
The Company's products compete with software developed internally by embedded
systems manufacturers and software offered by other third parties. Many
organizations that internally develop and maintain real-time operating systems
have substantial programming resources and can develop specific products for
their needs. Many of these companies have significant investments in their
existing software and there can be no assurance that the Company will be able to
persuade existing and potential customers to replace or augment their internally
developed real-time operating systems with the Company's products.

The Company's principal competitors for third-party embedded software
development and related tools (pSOSystem) are Mentor Graphics (through its
acquisition of Microtec Research Inc.), Microware Systems Corporation and Wind
River Systems, Inc. The MATRIXx product family competes with products offered by
Mathworks Incorporated and a number of other companies that provide design and
analysis, modeling and simulation, and code generation products. The Company
also competes with a number of other vendors that address one or more segments
of the system design process, including vendors that have modified general
purpose software engineering products for real-time and control design
applications.

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systems, may be subject to significant pricing pressures. A variety of other
potential actions by the Company's competitors, including increased promotion
and accelerated introduction of new or enhanced products, could have a material
adverse effect on the Company's business, financial condition and results of
operations.

The Company believes that the principal bases for a customer's decision to
license the Company's products are product functionality and performance, degree
of integration, ease of product use, quality of support services and corporate
reputation. The Company believes that it competes favorably in these areas.

PROPRIETARY RIGHTS

The Company's success is heavily dependent upon its proprietary technology.
To protect its proprietary rights, the Company relies on a combination of
copyright, trade secret, patent and trademark laws, nondisclosure and other
contractual restrictions on copying and distribution and technical measures. The
Company seeks to protect its software, documentation and other written materials
through trade secret and copyright laws, which provide only limited protection.
In addition, the Company holds two United States patents and has additional
United States patent applications pending. There can be no assurance that
patents held by the Company will not be challenged and invalidated, that patents
will issue from any of the Company's pending applications or that any claims
allowed from existing or pending patents will be of sufficient scope or strength
(or be issued in all countries where the Company's products can be sold) to
provide meaningful protection or any commercial advantage to the Company. As
part of its confidentiality procedures, the Company generally enters into
nondisclosure agreements with its employees, consultants, distributors and
corporate partners and limits access to and distribution of its software,
documentation and other proprietary information. End user licenses of the
Company's software are frequently in the form of shrink wrap license agreements
which are not signed by licensees, and therefore may be unenforceable under the
laws of many jurisdictions. The source code of the Company's products is also
protected as a trade secret and is generally not licensed to customers. Despite
the Company's efforts to protect its proprietary rights, it may be possible for
unauthorized third parties to copy the Company's products or to reverse engineer
or obtain and use information that the Company regards as proprietary. There can
be no assurance that the Company's competitors will not independently develop
technologies that are substantially equivalent or superior to the Company's
technologies. Policing unauthorized use of the Company's products is difficult,
and while the Company is unable to determine the extent to which software piracy
of its products exists, software piracy can be expected to be a persistent
problem. In addition, effective protection of intellectual property rights may
be unavailable or limited in certain countries. The status of United States
patent protection in the software industry is not well defined and will evolve
as the United States Patent and Trademark Office grants additional patents.
Patents have been granted on fundamental technologies in software, and patents
may issue that relate to fundamental technologies incorporated into the
Company's products.

As the number of patents, copyrights, trademarks and other intellectual
property rights in the Company's industry increases, products based on its
technology may increasingly become the subject of infringement claims. There can
be no assurance that third parties will not assert infringement claims against
the Company in the future. Any such claims with or without merit could be time
consuming, result in costly litigation, cause product shipment delays or require
the Company to enter into royalty or licensing agreements. Such royalty or
licensing agreements, if required, might not be available on terms acceptable to
the Company, or at all, which could have a material adverse effect on the
Company's business, financial condition and results of operations. In addition,
the Company may initiate claims or litigation against third parties for
infringement of the Company's proprietary rights or to establish the validity of
the Company's proprietary rights. Litigation to determine the validity of any
claims, whether or not such litigation is determined in favor of the Company,
could result in significant expense to the Company and divert the efforts of the
Company's technical and management personnel from productive tasks. In the event
of an adverse ruling in any such litigation, the Company might be required to
pay substantial damages, discontinue the use and sale of infringing products,
expend

29
<PAGE> 30

significant resources to develop non-infringing technology or obtain licenses to
infringing technology. The failure of the Company to develop or license a
substitute technology could have a material adverse affect on the Company's
business, financial condition and results of operations.

The Company licenses certain software development tool products from other
companies to distribute with its own products. The inability of such third
parties to provide competitive products with adequate features and high quality
on a timely basis or to provide sales and marketing cooperation could have a
material adverse effect on the Company's business, financial condition and
results of operations. In addition, the Company's products compete with products
produced by certain of the Company's licensors. There can be no assurance that,
upon the termination or expiration of these licenses, such licenses will be
available on reasonable terms or at all, or that similar products could be
obtained to substitute into the tool suites. The inability to license such
products could have a material adverse effect on the Company's business,
financial condition and results of operations.

BACKLOG

The Company generally ships its products within 30 days after acceptance of
a customer purchase order and, therefore, has insignificant product backlog. The
insignificant product backlog makes it difficult to predict with accuracy
quarterly revenue and quarterly earnings prior to the end of a quarterly
reporting period. Engineering services backlog, consisting of orders for
engineering services scheduled to be performed within the following twelve
months, was approximately $2.1 million, $4.1 million and $7.2 million at
February 28, 1994, 1995 and 1996, respectively. Most of the contracts with the
Company's engineering services customers are terminable at the convenience of
the customer. Although the Company has not experienced any material
cancellations in the past, there can be no assurance that such cancellations
will not occur in the future.

EMPLOYEES

As of February 28, 1996, the Company employed 416 persons, including 155 in
marketing, sales and support services, 189 in engineering (62 in engineering
services and 127 in product development) and 72 in management, administration
and finance. Of these employees, 345 are located in the United States and 71 are
located at the Company's subsidiaries and sales offices outside of the United
States. In addition, from time to time the Company employs temporary employees
and consultants. None of the Company's employees is represented by a labor union
or is the subject of a collective bargaining agreement. The Company has never
experienced a work stoppage and believes that its employee relations are good.
The Company believes its future success will depend in large part upon its
ability to attract and retain highly skilled managerial, engineering, sales,
marketing and operations personnel, many of whom are in great demand.
Competition for such personnel has intensified dramatically over the last twelve
months in Santa Clara County, California, where the Company is headquartered,
and there can be no assurance that the Company will be successful in attracting
and retaining such personnel. See "Risk Factors--Dependence on Key Personnel;
Need for Additional Personnel."

FACILITIES

The Company's principal offices are located in two buildings in Santa
Clara, California covering approximately 60,000 square feet. The Company
occupies this space under lease agreements that expire in September 1996. The
annual base rental payment for this space (not including operating expenses,
insurance, property taxes and assessment) is approximately $700,000. The Company
also leases a number of additional offices in North America, Europe, Asia and
Israel.

In March 1996, the Company purchased for approximately $12.0 million in
cash a building in Sunnyvale, California covering approximately 150,000 square
feet. By the end of the first quarter of fiscal 1997, the Company expects to
move its operations to this space from the two buildings in Santa Clara and
terminate its obligations under the lease agreements. The Company will occupy
approximately 100,000 square feet of this facility and lease the remaining space
for approximately two years. There can be no assurance that the move will not
disrupt the Company's operations or affect the Company's operating results over
the near term.

30
<PAGE> 31

MANAGEMENT

EXECUTIVE OFFICERS AND DIRECTORS

The executive officers and directors of the Company and their respective
ages and positions are as follows:

<TABLE>
<CAPTION>
NAME AGE POSITION
- ---------------------------------------- --- -----------------------------------------------
<S> <C> <C>
Narendra K. Gupta....................... 47 Chairman of the Board of Directors and
Secretary
David P. St. Charles.................... 47 President, Chief Executive Officer and Director
Joseph Addiego.......................... 40 Vice President, North American Sales
Robert M. Dressler...................... 56 Vice President, Advanced Systems Group
Hamid Mirab............................. 34 Vice President, European Operations
Steven Sipowicz......................... 43 Vice President, Finance and Chief Financial
Officer
David E. Stepner........................ 51 Vice President, Research and Development
Tony Tolani............................. 50 Vice President, Far East Operations
Janice Waterman......................... 36 Vice President, Human Resources and Operations
John C. Bolger(1)(2).................... 49 Director
Vinita Gupta(1)......................... 45 Director
Thomas Kailath(1)....................... 60 Director
Richard C. Murphy(2).................... 51 Director
</TABLE>

- ------------------------------
(1) Member of the Compensation Committee.

(2) Member of the Audit Committee.

Each director will hold office until the next Annual Meeting of
Shareholders and until his successor is elected and qualified or until his
earlier resignation or removal. Each officer serves at the discretion of the
Board of Directors.

Dr. Gupta is a founder of the Company and has been a director of the
Company since its formation in 1980. He has been the Chairman of the Board of
the Company since March 1993 and Secretary since September 1989. Dr. Gupta was
Chief Executive Officer from 1988 to May 1994 and President from the Company's
formation in 1980 to May 1994. He was elected a Fellow of the Institute of
Electrical and Electronic Engineers (the "IEEE") in November 1991. Dr. Gupta is
currently also a director of Digital Link Corporation, a data communications and
wide-area networking equipment manufacturer, and Simulation Sciences, Inc., a
developer of chemical simulation software. Dr. Gupta holds an M.S. in
Engineering from the California Institute of Technology and a Ph.D. in
Engineering from Stanford University. He is Vinita Gupta's husband.

Mr. St. Charles joined the Company in August 1993 and was appointed
President and Chief Executive Officer of the Company in May 1994. He has been a
director since he joined the Company in August 1993. From April 1990 until
August 1993, Mr. St. Charles served as President and a director of Wind River
Systems, Inc., a real-time software company. He holds a B.A. in Liberal Arts and
an M.A. in International Economics from Carleton University and an M.S. from the
Sloan School of Management at the Massachusetts Institute of Technology.

Mr. Addiego has been Vice President, North American Sales of the Company
since March 1994. Since joining the Company in April 1986, he has held a variety
of positions in marketing and sales, including Vice President, Sales, Design
Automation Group from January 1992 until March 1994. Prior to joining the
Company, he was employed by Hewlett-Packard and AT&T in technical support and
sales positions. Mr. Addiego holds a B.S. in Computer Engineering from San
Francisco State University.

31
<PAGE> 32

Dr. Dressler has been Vice President, Advanced Systems Group since he
joined the Company in February 1991. Prior to joining the Company, Dr. Dressler
was employed for approximately 16 years by ESL Inc., a defense, aerospace and
electrical systems company, most recently as Manager, Aerospace Systems
Laboratory. He has also been employed by Systems Control Inc., a computer
services company, and Stanford Research Institute in a variety of technical
management and engineering research positions. Dr. Dressler holds a B.S. in
Electrical Engineering from Rensselaer Polytechnic Institute and an M.S. and a
Ph.D., both in Electrical Engineering, from Stanford University.

Dr. Mirab joined the Company in November 1989 and has been Vice President,
European Operations since October 1995. From November 1989 to September 1992,
Dr. Mirab served as Manager, Technical Support in the United Kingdom, and from
September 1992 to February 1995 as Managing Director of the Company's United
Kingdom subsidiary. From February 1995 to October 1995, he served as General
Manager, European Operations. Dr. Mirab holds a B.S. in General Engineering and
a Ph.D. in Control Systems from the University of Glasgow.

Mr. Sipowicz joined the Company in January 1992 and has been Vice
President, Finance of the Company since April 1993 and Chief Financial Officer
of the Company since September 1994. From January 1992 to April 1993, he served
as the Company's Corporate Controller. Prior to joining the Company, Mr.
Sipowicz spent 17 years in various management positions with Coopers & Lybrand,
an accounting firm, in the United Kingdom and United States. He holds a B.S. in
Chemistry from the University of Bristol in the United Kingdom. Mr. Sipowicz is
a certified public accountant.

Dr. Stepner has been Vice President, Research and Development since he
joined the Company in December 1993. From April 1984 until March 1993, he served
as Founder, President and Chief Executive Officer of Greyhawk Systems, Inc., a
manufacturer of high resolution liquid crystal displays. In March 1993, Greyhawk
Systems, Inc. was sold to AmPro Corporation and Dr. Stepner served as Executive
Vice President of AmPro Corporation and General Manager of the AmPro/Greyhawk
Division from March 1993 until December 1993. Dr. Stepner holds a B.S. in
General Engineering from Brown University and an M.S. and a Ph.D., both in
Electrical Engineering, from Stanford University.

Dr. Tolani has been Vice President, Far East Operations since he joined the
Company in December 1994. From 1973 to September 1994, he was employed by
Structural Dynamics Research Corporation, a mechanical design software company,
most recently as Vice President and General Manager, Far East Operations. Dr.
Tolani holds a B.S. in Mechanical Engineering from Birla College of Engineering
in India and an M.S. and a Ph.D., both in Mechanical Engineering, from the
University of Missouri.

Ms. Waterman joined the Company in July 1995 as Vice President, Human
Resources and has served as Vice President, Human Resources and Operations of
the Company since March 1996. From September 1994 to July 1995, she served as
Vice President, Human Resources and Administration for Salick Health Care Inc.,
a health care provider. From May 1991 until September 1994, Ms. Waterman was
Vice President of Human Resources and Administration of Tekelec, Inc., a
telecommunications company. Ms. Waterman holds a B.A. in Sociology and Economics
from the University of California at Davis and an M.S. in Industrial Psychology
from California State University, Hayward.

Mr. Bolger has been a director of the Company since July 1993. He served as
Vice President, Finance and Administration, and Secretary of Cisco Systems,
Inc., a networking software company, from 1989 until his retirement in 1992. Mr.
Bolger is currently also a director of Integrated Device Technology, Inc., a
semiconductor manufacturer, TCSI, a communication software company, and Sanmina
Corporation, a backplane and contract assembly manufacturer. He holds a B.A. in
English Literature from the University of Massachusetts and an M.B.A. from
Harvard University.

32
<PAGE> 33

Mrs. Gupta has been a director of the Company since its formation in 1980.
Since May 1985, she has served as Chairperson of the Board and Chief Executive
Officer of Digital Link Corporation, a data-communications and wide-area
networking equipment manufacturer. Mrs. Gupta holds an M.S. in Electrical
Engineering from the University of California, Los Angeles. She is Narendra K.
Gupta's spouse.

Dr. Kailath is a founder of the Company and has been a director of the
Company since its formation in 1980. He served as Vice Chairman of the Board of
Directors from January 1990 to March 1993 and Chairman of the Board of Directors
from April 1980 to January 1990. He is currently the Hitachi America Professor
of Engineering at Stanford University, where he has been on the faculty since
January 1963. Dr. Kailath is a member of the National Academy of Engineering,
the American Academy of Arts and Sciences and a Fellow of the IEEE. He holds an
M.S. and a Sc.D., both in Electrical Engineering, from the Massachusetts
Institute of Technology.

Mr. Murphy has been a director of the Company since December 1994. He is a
self-employed business consultant. Mr. Murphy is currently also a director of
Objectivity, Inc., an object database software company, and iXOS Software, Inc.,
a distributor of image management software. He holds a B.S. in Mechanical
Engineering from the University of Illinois and an M.B.A. from Northwestern
University.

33
<PAGE> 34

SELLING SHAREHOLDERS

The following table sets forth certain information with respect to
beneficial ownership of the Company's Common Stock as of April 10, 1996, and as
adjusted to reflect the sale of the shares offered by this Prospectus, by each
Selling Shareholder. Except as indicated in the footnotes to this table, the
persons and entities named in the table have sole voting and sole investment
power with respect to all shares beneficially owned by them, subject to
community property laws.

<TABLE>
<CAPTION>
SHARES BENEFICIALLY SHARES BENEFICIALLY
OWNED PRIOR TO OWNED AFTER
OFFERING(1) NUMBER OF OFFERING(1)
------------------- SHARES -------------------
NAME NUMBER PERCENT OFFERED NUMBER PERCENT
- ----------------------------------------------- --------- ------- --------- --------- -------
<S> <C> <C> <C> <C> <C>
Narendra K. and Vinita Gupta(2)................ 6,116,958 28.6% 1,020,000 5,096,958 23.3%
Marco Thompson(3).............................. 377,432 1.8 120,000 257,432 1.2
David P. St. Charles(4)........................ 183,314 * 160,000 23,314 *
</TABLE>

- ------------------------------
* Less than 1%

(1) Percent ownership is based on 21,352,502 shares of Common Stock outstanding
as of April 10, 1996 prior to the offering and 21,865,650 shares outstanding
after the offering. Options to purchase shares of Common Stock that are
exercisable within 60 days of April 10, 1996 are deemed to be outstanding
and to be beneficially owned by the persons holding such options for the
purpose of computing the percentage ownership of such person but are not
deemed to be outstanding for the purpose of the computing the percentage of
ownership of any other person.

(2) Represents (i) 5,090,200 shares of Common Stock held of record by Dr. and
Mrs. Gupta, (ii) 1,000,000 shares held of record by them, together with a
third party, as trustees for their children, as to which they disclaim
beneficial ownership, (iii) 7,800 shares held by Dr. Gupta as custodian for
his daughter under the Uniform Gifts to Minors Act, as to which he disclaims
beneficial ownership and (iv) 18,958 shares subject to options held by Mrs.
Gupta that are exercisable within 60 days of April 10, 1996. Dr. Gupta is
Chairman of the Board and Secretary of the Company and Mrs. Gupta is a
director of the Company. If the Underwriters' over-allotment option to
purchase up to an additional 270,000 shares from Dr. and Mrs. Gupta is
exercised, the total number of shares offered by them will be 1,290,000 and
the shares beneficially owned after the offering will be 4,826,958, or 22.1%
of the shares outstanding after the offering.

(3) Includes 3,922 shares subject to options held by Mr. Thompson that are
exercisable within 60 days of April 10, 1996. Mr. Thompson is President of
Doctor Design.

(4) Includes 179,416 shares subject to options held by Mr. St. Charles that are
exercisable within 60 days of April 10, 1996. In addition, Mr. St. Charles
holds options to purchase 168,084 shares that will vest in the future. Mr.
St. Charles is the President, Chief Executive Officer and a director of the
Company.

34
<PAGE> 35

UNDERWRITING

Subject to the terms and conditions of the Underwriting Agreement,
Hambrecht & Quist LLC and Wessels, Arnold & Henderson, L.L.C. (the
"Underwriters") have severally agreed to purchase from the Company and the
Selling Shareholders the following respective number of shares of Common Stock.

<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITER SHARES
-------------------------------------------------------------------------- ----------
<S> <C>
Hambrecht & Quist LLC.....................................................
Wessels, Arnold & Henderson, L.L.C. ......................................
---------
Total........................................................... 1,800,000
=========
</TABLE>

The Underwriting Agreement provides that the obligations of the
Underwriters are subject to certain conditions precedent, including the absence
of any material adverse change in the Company's business and the receipt of
certain certificates, opinions and letters from the Company and its counsel and
independent auditors. The nature of the Underwriters' obligation is such that
they are committed to purchase all shares of Common Stock offered hereby if any
of such shares are purchased.

The Underwriters propose to offer the shares of Common Stock directly to
the public at the offering price set forth on the cover page of this Prospectus
and to certain dealers at such price less a concession not in excess of $
per share. The Underwriters may allow and such dealers may reallow a concession
not in excess of $ per share to certain other dealers. After the public
offering of the shares, the offering price and other selling terms may be
changed by the Underwriters.

One Selling Shareholder has granted to the Underwriters an option,
exercisable no later than 30 days after the date of this Prospectus, to purchase
up to 270,000 additional shares of Common Stock at the public offering price,
less the underwriting discount, set forth on the cover page of this Prospectus.
To the extent that the Underwriters exercise this option, each of the
Underwriters will have a firm commitment to purchase approximately the same
percentage thereof which the number of shares of Common Stock to be purchased by
it shown in the above table bears to the total number of shares of Common Stock
offered hereby. The Selling Shareholder will be obligated, pursuant to the
option, to sell such shares to the Underwriters to the extent the option is
exercised. The Underwriters may exercise such option only to cover
over-allotments made in connection with the sale of the shares of Common Stock
offered hereby.

The offering of the shares is made for delivery when, as and if accepted by
the Underwriters and subject to prior sale and to withdrawal, cancellation or
modification of the offering without notice. The Underwriters reserve the right
to reject an order for the purchase of shares in whole or in part.

The Company and the Selling Shareholders have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act, and to contribute to payments the Underwriters may be required
to make in respect thereof.

The Selling Shareholders and a director have agreed that they will not,
without the prior written consent of Hambrecht & Quist LLC, sell, offer,
contract to sell, make any short sale, pledge, sell any option or contract to
purchase, purchase any option or contract to sell, grant any option, right or
warrant to purchase or otherwise transfer or dispose of any shares of Common
Stock or any securities convertible into or exchangeable or exercisable for or
any rights to purchase or acquire Common Stock or enter into any swap or other
agreement that transfers, in whole or in part, any of the economic consequences
or ownership of Common Stock owned by them during the 90-day period following
the date of this Prospectus.

35
<PAGE> 36

In general, the rules of the Commission will prohibit the Underwriters from
making a market in the Company's Common Stock during the "cooling off" period
immediately preceding the commencement of sales in the offering. The Commission
has, however, adopted exemptions from these rules that permit passive market
making under certain conditions. These rules permit an underwriter to continue
to make a market subject to the conditions, among others, that its bid not
exceed the highest bid by a market maker not connected with the offering and
that its net purchases on any one trading day not exceed prescribed limits.
Pursuant to these exemptions, the Underwriters, selling group members (if any)
or their respective affiliates intend to engage in passive market making in the
Company's Common Stock during the cooling off period.

LEGAL MATTERS

The validity of the issuance of the shares of Common Stock offered hereby
will be passed upon for the Company and the Selling Shareholders by Fenwick &
West LLP, Palo Alto, California. Certain legal matters in connection with this
offering will be passed upon for the Underwriters by Morrison & Foerster LLP,
Palo Alto, California.

EXPERTS

The consolidated balance sheets of the Company as of February 28, 1995 and
1996, and the consolidated statements of income, shareholders' equity and cash
flows for each of the three years in the period ended February 28, 1996,
included in this Prospectus and Registration Statement, have been included
herein in reliance on the report of Coopers & Lybrand L.L.P., independent
accountants, given upon the authority of that firm as experts in accounting and
auditing.

36
<PAGE> 37

AVAILABLE INFORMATION

The Company is subject to the informational requirements of the Exchange
Act and in accordance therewith files reports, proxy statements and other
information with the Commission. Such reports, proxy statements and other
information can be inspected and copied at the public reference facilities
maintained by the Commission at Room 1024, 450 Fifth Street, N.W., Judiciary
Plaza, Washington, D.C. 20549, and at the Commission's following Regional
Offices: Suite 1400, Northwest Atrium Center, 500 West Madison Street, Chicago,
Illinois 60661; and 13th Floor, Seven World Trade Center, New York, New York
10048. Copies of such material can be obtained at prescribed rates from the
Public Reference Section of the Commission at 450 Fifth Street, N.W., Judiciary
Plaza, Washington, D.C. 20549. The Company's Common Stock is quoted for trading
on the Nasdaq National Market and reports, proxy statements and other
information concerning the Company may also be inspected at the offices of the
National Association of Securities Dealers, 1735 K Street, N.W., Washington,
D.C. 20006.

The Company has filed with the Commission a Registration Statement on Form
S-3 (referred to herein, together with all amendments and exhibits, as the
"Registration Statement") under the Securities Act of 1933, as amended, with
respect to the securities offered by this Prospectus. This Prospectus does not
contain all of the information set forth in the Registration Statement, certain
parts of which have been omitted in accordance with the rules and regulations of
the Commission. For further information with respect to the Company and the
securities offered hereby, reference is made to the Registration Statement.
Statements made in this Prospectus as to the contents of any contract or other
document referred to herein are not necessarily complete and in each instance in
which a copy of such contract is filed as an exhibit to the Registration
Statement, reference is made to such copy, and each such statement shall be
deemed qualified in all respects by such reference. Copies of the Registration
Statement may be inspected, without charge, at the offices of the Commission, or
obtained at prescribed rates from the Public Reference Section of the Commission
at the address set forth above.

37
<PAGE> 38

REPORT OF INDEPENDENT ACCOUNTANTS

The Board of Directors and Shareholders
Integrated Systems, Inc.:

We have audited the accompanying consolidated balance sheets of Integrated
Systems, Inc. as of February 28, 1995 and 1996 and the related consolidated
statements of income, shareholders' equity and cash flows for each of the three
years in the period ended February 28, 1996. 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 in accordance with generally accepted auditing
standards. Those standards 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. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Integrated Systems, Inc. as of February 28, 1995 and 1996, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended February 28, 1996 in conformity with generally accepted accounting
principles.

COOPERS & LYBRAND L.L.P.

San Jose, California
March 27, 1996

F-1
<PAGE> 39

INTEGRATED SYSTEMS, INC.

CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)

<TABLE>
<CAPTION>
FEBRUARY 28,
---------------------
1995 1996
------- -------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents..................................................... $ 7,746 $21,822
Marketable securities......................................................... 6,472 12,231
Accounts receivable, net of allowance for doubtful accounts of $629 and
$852 in 1995 and 1996, respectively........................................ 15,475 19,822
Deferred income taxes......................................................... 1,595 373
Prepaid expenses and other.................................................... 2,793 3,587
------- -------
Total current assets.................................................. 34,081 57,835
Marketable securities........................................................... 22,299 15,423
Property and equipment, net..................................................... 3,613 5,593
Intangible assets, net.......................................................... 5,466 2,106
Deferred income taxes........................................................... 1,906
Other assets.................................................................... 642 2,401
------- -------
Total assets.......................................................... $66,101 $85,264
======= =======
LIABILITIES
Current liabilities:
Accounts payable.............................................................. $ 2,092 $ 4,309
Accrued payroll and related expenses.......................................... 2,331 3,673
Other accrued liabilities..................................................... 3,257 4,842
Income taxes payable.......................................................... 2,354 4,191
Deferred revenue.............................................................. 6,264 9,389
------- -------
Total current liabilities............................................. 16,298 26,404
Deferred income taxes........................................................... 790
Other liabilities............................................................... 1,065 584
------- -------
Total liabilities..................................................... 18,153 26,988
------- -------
Commitments (Note 6).
SHAREHOLDERS' EQUITY
Preferred stock, no par value, 5,000 shares authorized:
Issued and outstanding: none in 1995 and 1996
Common stock, no par value, 50,000 shares authorized:
Issued and outstanding: 19,722 and 21,206 shares in 1995 and 1996,
respectively............................................................... 35,688 40,283
Unrealized holding gain (loss) on marketable securities, net.................... (109) 333
Retained earnings............................................................... 12,369 17,660
------- -------
Total shareholders' equity............................................ 47,948 58,276
------- -------
Total liabilities and shareholders' equity............................ $66,101 $85,264
======= =======
</TABLE>

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

F-2
<PAGE> 40

INTEGRATED SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
YEAR ENDED FEBRUARY 28,
-------------------------------
1994 1995 1996
------- ------- -------
<S> <C> <C> <C>
Revenue:
Product..................................................... $26,350 $34,952 $51,597
Services.................................................... 19,433 23,102 32,845
------- ------- -------
Total revenue....................................... 45,783 58,054 84,442
------- ------- -------
Costs and expenses:
Cost of product revenue..................................... 4,986 5,980 9,046
Cost of services revenue.................................... 8,262 9,547 15,824
Marketing and sales......................................... 16,515 20,565 27,209
Research and development.................................... 5,926 8,341 11,379
General and administrative.................................. 3,567 4,311 6,637
Amortization of intangible assets........................... 1,764 1,311 556
Acquisition and other....................................... 7,327
------- ------- -------
Total costs and expenses............................ 41,020 50,055 77,978
------- ------- -------
Income from operations......................... 4,763 7,999 6,464
Interest and other income..................................... 1,258 1,601 2,331
------- ------- -------
Income before income taxes..................... 6,021 9,600 8,795
Provision for income taxes.................................... 1,935 3,110 3,512
------- ------- -------
Net income..................................... $ 4,086 $ 6,490 $ 5,283
======= ======= =======
Earnings per share............................................ $ 0.21 $ 0.33 $ 0.24
======= ======= =======
Shares used in per share calculations......................... 19,122 19,964 22,088
======= ======= =======
</TABLE>

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

F-3
<PAGE> 41

INTEGRATED SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(IN THOUSANDS)

<TABLE>
<CAPTION>
UNREALIZED
COMMON STOCK HOLDING
------------------ GAIN (LOSS), RETAINED
SHARES AMOUNT NET EARNINGS TOTAL
------ ------- ------------ -------- -------
<S> <C> <C> <C> <C> <C>
Balances, February 28, 1993................. 17,774 $29,699 $ 2,748 $32,447
Exercise of common stock options.......... 469 572 572
Common stock purchased under Employee
Stock Purchase Plan.................... 120 312 312
Amortization of deferred compensation..... 242 242
Tax benefit from disqualifying
dispositions of common stock........... 372 372
Pooling of interests with Doctor Design... 614 79 (291) (212)
Note receivable from shareholder.......... (14) (14)
Unrealized holding gain on marketable
securities, net........................ $ 227 227
Net income................................ 4,086 4,086
------ ------- ----- ------- -------
Balances, February 28, 1994................. 18,977 31,262 227 6,543 38,032
Exercise of common stock options.......... 585 1,858 1,858
Common stock purchased under Employee
Stock Purchase Plan.................... 94 420 420
Amortization of deferred compensation..... 183 183
Tax benefit from disqualifying
dispositions of common stock........... 1,009 1,009
Repurchase of common stock................ (250) (430) (664) (1,094)
Issuance of common stock in connection
with acquisition....................... 316 1,386 1,386
Unrealized holding loss on marketable
securities, net........................ (336) (336)
Net income................................ 6,490 6,490
------ ------- ----- ------- -------
Balances, February 28, 1995................. 19,722 35,688 (109) 12,369 47,948
Exercise of common stock options.......... 540 2,050 2,050
Common stock purchased under Employee
Stock Purchase Plan.................... 72 557 557
Tax benefit from disqualifying
dispositions of common stock........... 2,323 2,323
Pooling of interests with TakeFive
Software............................... 872 50 8 58
Purchase of TakeFive Software common stock
for cash............................... (400) (400)
Payment of note receivable from
shareholder............................ 15 15
Unrealized holding gain on marketable
securities, net........................ 442 442
Net income................................ 5,283 5,283
------ ------- ----- ------- -------
Balances, February 28, 1996................. 21,206 $40,283 $ 333 $ 17,660 $58,276
====== ======= ===== ======= =======
</TABLE>

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

F-4
<PAGE> 42

INTEGRATED SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

<TABLE>
<CAPTION>
YEAR ENDED FEBRUARY 28,
---------------------------------
1994 1995 1996
-------- ------- --------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income.......................................................... $ 4,086 $ 6,490 $ 5,283
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization.................................... 3,868 3,584 4,103
Write-down of intangible assets.................................. 3,083
Deferred income taxes............................................ (2) (558) (1,768)
Changes in assets and liabilities:
Accounts receivable............................................ (1,661) (5,321) (4,347)
Prepaid expenses and other..................................... (658) (1,171) (794)
Accounts payable, accrued payroll and other accrued
liabilities................................................... 844 2,201 5,255
Income taxes payable........................................... 635 1,979 4,160
Deferred revenue............................................... 1,058 640 3,125
Other assets and liabilities................................... (687) (68) 375
-------- ------- --------
Net cash provided by operating activities................... 7,483 7,776 18,475
-------- ------- --------
Cash flows from investing activities:
Purchases of marketable securities.................................. (11,633) (8,041) (16,878)
Maturities of marketable securities................................. 7,234 3,593 18,731
Additions to property and equipment................................. (1,448) (2,089) (4,332)
Disposals of property and equipment................................. 128 46 149
Capitalized software development costs.............................. (1,132) (492) (335)
Net cash paid in acquisitions....................................... (117) (2,081) (2,885)
Other............................................................... (200) (480)
-------- ------- --------
Net cash used in investing activities....................... (6,968) (9,264) (6,030)
-------- ------- --------
Cash flows from financing activities:
Repurchase of common stock.......................................... (1,094)
Proceeds from exercise of common stock options and purchases under
Employee Stock Purchase Plan..................................... 884 2,278 2,607
Other............................................................... (210) (223) (976)
-------- ------- --------
Net cash provided by financing activities................... 674 961 1,631
-------- ------- --------
Net increase (decrease) in cash and cash equivalents.................. 1,189 (527) 14,076
Cash and cash equivalents at beginning of year........................ 7,084 8,273 7,746
-------- ------- --------
Cash and cash equivalents at end of year.............................. $ 8,273 $ 7,746 $ 21,822
======== ======= ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for income taxes, net..................... $ 2,056 $ 1,741 $ 700
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING ACTIVITIES:
Increase in carrying amount of purchased intangible assets upon
adoption of Financial Accounting Standards No. 109, "Accounting
for Income Taxes"................................................ $ 767
Unrealized holding gain (loss) on marketable securities............. $ 379 $ (560) $ 736
SUPPLEMENTAL SCHEDULE OF NONCASH FINANCING ACTIVITIES:
Tax benefit from disqualifying dispositions of common stock......... $ 372 $ 1,009 $ 2,323
Issuance of common stock in connection with acquisition (Note 2).... $ 1,386
</TABLE>

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

F-5
<PAGE> 43

INTEGRATED SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

NATURE OF OPERATIONS

Integrated Systems, Inc. (the Company) designs, develops, markets and
supports software products for embedded microprocessor-based applications and
also provides related engineering services. Embedded microprocessors are used to
add functionality and intelligence to a variety of products and to operate as an
integral part of these products, generally without any direct human
intervention. The Company offers software that consists of a real-time operating
system and a series of modules and design tools that aid the development of
embedded applications. The Company markets and supports its products and
provides services on a worldwide basis to a variety of users in a broad range of
industries, including telecommunications and data communications, automotive,
multimedia and consumer, and office and industrial automation, as well as in the
embedded Internet market, through a direct sales force augmented by a
telemarketing organization, distributors and sales representatives.

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of Integrated
Systems, Inc. and its wholly owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated. Investments in affiliated
companies that are not controlled are carried at cost plus the Company's equity
in undistributed earnings since acquisition (see Note 2).

USE OF ESTIMATES

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 and
disclosure of contingent assets and liabilities at the dates of the financial
statements and the reported amounts of revenues and expenses during a reporting
period. Actual results could differ from those estimates.

CASH AND CASH EQUIVALENTS

Cash and cash equivalents, which are held at a variety of financial
institutions, include demand deposits, money market accounts and all highly
liquid debt instruments with an original or remaining maturity at the date of
purchase of three months or less. The Company has not experienced any material
losses relating to any investment instruments.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The amounts reported for cash equivalents, accounts receivable, accounts
payable and accrued liabilities are considered to approximate fair values based
upon comparable market information available at February 28, 1996. Based upon
interest rates available to the Company for debt with comparable maturities, the
carrying values of the Company's notes payable approximate fair values. The fair
values of the Company's marketable securities are set forth in Note 3.

Financial instruments that potentially subject the Company to
concentrations of credit risks comprise, principally, cash, cash equivalents,
investments and trade accounts receivable. The Company invests its excess cash
in government securities, tax exempt municipal securities, preferred stock,
Eurodollar notes and bonds, time deposits, certificates of deposit, commercial
paper rated Aa or better and other specific money market and corporate
instruments of similar liquidity and credit quality. The Company performs
ongoing evaluations of its customers' financial condition and does not require

F-6
<PAGE> 44

INTEGRATED SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
collateral. The Company maintains allowances for potential credit losses and
such losses have been within management's expectations.

MARKETABLE SECURITIES

All marketable securities are classified as available-for-sale and
therefore are carried at fair value. Marketable securities classified as current
assets have scheduled maturities of less than one year, while marketable
securities classified as noncurrent assets have scheduled maturities of more
than one year. Unrealized holding gains and losses on such securities are
reported net of related taxes as a separate component of shareholders' equity.
Realized gains and losses on sales of all such securities are reported in
interest and other income and computed using the specific identification cost
method.

REVENUE RECOGNITION

Product Revenue

Product revenue consists principally of revenue from product licensing
fees. Product licensing fees, including advanced production royalty payments,
are generally recognized when a customer purchase order has been received, a
license agreement has been executed, the software has been shipped, remaining
obligations are insignificant and collection of the resulting account receivable
is probable. Generally, the Company's distributors do not have the right of
return. Provisions for estimated product returns, warranty costs and
insignificant vendor obligations are recorded at the time products are shipped.

Services Revenue

Services revenue consists principally of maintenance and renewal fees for
providing product updates, technical support and related services for software
products, and engineering and consulting services fees. Software maintenance
revenue bundled with the initial product license revenue is deferred and
recognized ratably over the related service period. The Company unbundles a
portion of its initial product license revenue related to software maintenance
revenue based upon product license renewal amounts, which are substantially less
than the initial product license fee, or based upon the amount charged for such
services when they are sold separately. License renewal fees, which are
substantially less than the initial license, are deferred and recognized ratably
over the license term. Revenue from separately sold maintenance contracts is
recognized ratably over the related service period. Engineering and consulting
services revenue from short-term and long-term contracts is generally recognized
on the percentage-of-completion method. For cost reimbursement and firm fixed
price contracts, revenues are recognized as the work is performed, based on the
ratio of incurred costs to estimated total completion costs. For
time-and-material contracts, revenues are recognized on the basis of direct
labor hours and other direct costs incurred. Provisions for anticipated losses
are made in the period in which they first become determinable.

PROPERTY AND EQUIPMENT

Property and equipment are recorded at cost. Depreciation is computed using
the straight-line method over the estimated useful lives of the respective
assets (three to twenty years). Leasehold improvements are amortized over the
lease term or the estimated useful life of the asset, whichever is shorter.

F-7
<PAGE> 45

INTEGRATED SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
SOFTWARE DEVELOPMENT COSTS

The Company capitalizes certain costs to develop computer software to be
licensed or otherwise marketed to customers. Such costs are amortized using the
greater of the amount computed using the ratio that current gross revenues for a
product bear to the total of current and anticipated future gross revenues for
that product, or on a straight-line basis over three years. Software development
costs included in intangible assets at February 28, 1995 and 1996, were
$1,763,000 and $1,177,000, respectively, net of accumulated amortization of
$822,000 and $1,743,000, respectively. Capitalized software development costs
were $1,132,000, $492,000 and $335,000 in fiscal 1994, 1995 and 1996,
respectively. Amortization, which is included in cost of product revenue, was
$160,000, $607,000 and $921,000 in fiscal 1994, 1995 and 1996, respectively.

INTANGIBLE ASSETS

Intangible assets consist primarily of goodwill, purchased software and
capitalized software development costs. Goodwill and purchased software are
amortized on a straight-line basis over their estimated useful lives. The
Company periodically evaluates the recoverability of these costs based upon
estimated undiscounted future cash flows from the related products and
businesses acquired.

INCOME TAXES

The Company's provision for income taxes is comprised of its current tax
liability and the change in its deferred tax assets and liabilities. Deferred
tax assets and liabilities are determined based on differences between financial
reporting and tax bases of assets and liabilities and are measured using the
enacted tax rates and laws that will be in effect when the differences are
expected to reverse.

ADVERTISING

The Company expenses advertising costs as they are incurred. Advertising
expense for fiscal 1994, 1995 and 1996 was $409,000, $800,000 and $927,000,
respectively.

COMPUTATION OF EARNINGS PER SHARE

Earnings per share is computed using the weighted average number of common
and common equivalent shares outstanding during the period. Common equivalent
shares result from the assumed exercise of outstanding stock options that have a
dilutive effect when applying the treasury stock method.

FOREIGN CURRENCY TRANSLATION

The Company's foreign subsidiaries that operate as sales and marketing
offices for the Company's products, translate their financial statements using
the U.S. dollar as the functional currency. Accordingly, foreign exchange gains
and losses, which have been insignificant, are included in the consolidated
statements of income. The Company's remaining foreign subsidiaries use the local
currency as the functional currency. Accordingly, all assets and liabilities are
recorded at year-end exchange rates and income and expenses are recorded at
average rates. Adjustments resulting from the translation have been
insignificant.

F-8
<PAGE> 46

INTEGRATED SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FISCAL YEAR

Prior to fiscal 1996, the Company's fiscal year was reported on a 52/53
week period ending on the last Saturday in February of each year. Beginning in
fiscal 1996, the Company's fiscal year end is the last day in February.
Accordingly, the fiscal year end for fiscal 1994, 1995 and 1996 was February 26,
25 and 29, respectively. The effect of this change was not material to the
Company's financial statements for the year ended February 29, 1996. For clarity
of presentation herein, all fiscal years are referred to as ending on February
28.

RECLASSIFICATIONS

Certain prior year amounts have been reclassified to conform to the current
year presentation.

RECENT ACCOUNTING PRONOUNCEMENTS

During March 1995, the Financial Accounting Standards Board issued
Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of" (SFAS No. 121), which requires the Company
to review for impairment of long-lived assets, certain identifiable intangibles
and goodwill related to those assets whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. In certain
situations, an impairment loss would be recognized. SFAS No. 121 will be
effective for the Company's fiscal year 1997. The Company has studied the
implications of the statement and, based on its initial evaluation, does not
expect it to have a material impact on the Company's financial condition or
results of operations.

During October 1995, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" (SFAS No. 123). This accounting standard permits the use of either
a fair value based method or the current Accounting Principals Board Opinion No.
25, "Accounting for Stock Issued to Employees" (APB No. 25) when accounting for
stock-based compensation arrangements. Companies that do not follow the new fair
value based method will be required to disclose pro forma net income and
earnings per share computed as if the fair value based method had been applied.
The disclosure provisions of SFAS No. 123 are effective for fiscal years
beginning after December 15, 1995. Management has not determined if it will
adopt the fair value based method of accounting for stock-based compensation
arrangements nor the impact of SFAS No. 123 on the Company's consolidated
financial statements.

2. ACQUISITIONS

MERGER WITH TAKEFIVE

In October 1995, the Company acquired TakeFive Software GmbH (TakeFive), an
Austrian corporation by issuing 871,980 shares of its common stock in exchange
for 97% of the shares of TakeFive. The remaining 3% of the shares of TakeFive
were purchased for cash. The business combination was accounted for as a pooling
of interests and the Company's results of operations for fiscal 1996 include
those of TakeFive. The prior years' results have not been restated to include
TakeFive operations as such operations were insignificant. Prior to the business
combination, TakeFive was in the business of developing, marketing and
supporting software tools used in software development. The Company intends to
continue the business of TakeFive and operate TakeFive as an independent
subsidiary.

F-9
<PAGE> 47

INTEGRATED SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

2. ACQUISITIONS (CONTINUED)
MERGER WITH DOCTOR DESIGN

In January 1996, the Company acquired Doctor Design, Inc. (Doctor Design),
an engineering services company specializing in multimedia hardware, software
and application specific integrated circuit technology. The Company issued
743,214 shares of its common stock for substantially all the outstanding stock
of Doctor Design. The Company also assumed stock options that converted into
options to purchase 263,724 shares of the Company's common stock. The business
combination was accounted for as a pooling of interests and the consolidated
financial statements have been restated as if Doctor Design had been combined
for all periods presented. The Company intends to continue the business of
Doctor Design and operate Doctor Design as an independent subsidiary.

COMBINED AND SEPARATE RESULTS OF MERGERS

Combined and separate results of the Company, Doctor Design and TakeFive
during the periods preceding the mergers were as follows (in thousands):

<TABLE>
<CAPTION>
INTEGRATED DOCTOR
SYSTEMS DESIGN TAKEFIVE COMBINED
---------- ------ -------- --------
<S> <C> <C> <C> <C>
Nine months ended November 30, 1995
(unaudited):
Net revenue.............................. $ 47,455 $9,171 $3,193 $59,819
Net income............................... 3,134 882 580 4,596
Year ended February 28, 1995:
Net revenue.............................. 51,979 6,075 58,054
Net income............................... 5,754 736 6,490
Year ended February 28, 1994:
Net revenue.............................. 41,701 4,082 45,783
Net income............................... 4,033 53 4,086
</TABLE>

OTHER ACQUISITIONS

In September 1994, the Company acquired certain software products and other
assets for a total purchase price of approximately $3,467,000, consisting of
$2,081,000 in cash and non-cash consideration of approximately 316,000 shares of
restricted common stock with a value of approximately $1,386,000. The
acquisition was accounted for using the purchase method of accounting and,
accordingly, its operations have been included with those of the Company since
the date of acquisition. Substantially all of the purchase price was allocated
to purchased software, which prior to the third quarter of fiscal 1996, was
being amortized on a straight-line basis over a seven-year period. During the
third quarter of fiscal 1996, the Company determined that the recoverability of
the purchased software was not probable as the products purchased would be
replaced by the products acquired in the merger with TakeFive. Accordingly,
capitalized purchased software totaling $3,083,000 was charged to acquisition
and other expenses in the consolidated statement of income.

In December 1995, the Company acquired certain technology, related assets
and all of the outstanding common stock of a company for $1,735,000. The
acquisition has been accounted for under the equity method of accounting and is
included in other assets in the accompanying balance sheet. The acquisition cost
exceeded the underlying equity in net assets by $1,395,000, of which $756,000,
$425,000 and $214,000 was allocated to existing software products, which had
reached technological

F-10
<PAGE> 48

INTEGRATED SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

2. ACQUISITIONS (CONTINUED)
feasibility, goodwill and in-process software development, which had not reached
technological feasibility, respectively, based on their respective fair values.
The costs allocated to goodwill and existing products are being amortized over
periods of five and two years, respectively, and the costs allocated to
in-process software development were charged to acquisition and other expenses.
In addition to the purchase price, the Company paid bonuses to non-shareholder
management and employees totaling $1,645,000, which were expensed and are
included as part of acquisition and other expenses in the consolidated statement
of income for fiscal 1996. The operations of the acquired company are not
material to the consolidated financial statements of the Company, and
accordingly, separate financial information for this company has not been
presented.

ACQUISITION AND OTHER EXPENSES

Acquisition and other expenses for fiscal 1996 consist of (in thousands):

<TABLE>
<S> <C>
In-process software development costs written-off......................... $ 214
Bonuses paid to management and employees of acquired company.............. 1,645
Purchased software written-off............................................ 3,083
Professional fees and other acquisition costs............................. 1,585
Termination fees payable to a distributor................................. 800
------
$7,327
======
</TABLE>

The termination fees payable to a distributor relate to amounts payable
resulting from the termination of the Company's reseller arrangement with a
Japanese distributor in February 1996.

3. MARKETABLE SECURITIES

At February 28, 1995 and 1996, marketable securities consisted of
fixed-income U.S. Government securities, primarily treasury notes, municipal
securities and preferred stock, held by two investment banks.

Marketable securities at February 28, 1995 are summarized below (in
thousands):

<TABLE>
<CAPTION>
UNREALIZED
FAIR COST UNREALIZED UNREALIZED NET GAINS
VALUE BASIS GAINS LOSSES (LOSSES)
------- ------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
U.S. Government securities........... $12,911 $13,076 $ 65 $ (230) $ (165)
Municipal securities................. 13,790 13,837 40 (87) (47)
Preferred stock...................... 2,070 2,039 31 31
------- ------- ---- ----- -----
$28,771 $28,952 $136 $ (317) (181)
======= ======= ==== =====
Related deferred taxes............... 72
-----
Unrealized holding loss, net......... $ (109)
=====
</TABLE>

F-11
<PAGE> 49

INTEGRATED SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

3. MARKETABLE SECURITIES (CONTINUED)
Marketable securities at February 28, 1996 are summarized below (in
thousands):

<TABLE>
<CAPTION>
FAIR COST UNREALIZED UNREALIZED UNREALIZED
VALUE BASIS GAINS LOSSES NET GAINS
------- ------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
U.S. Government securities........... $12,678 $12,471 $221 $(14) $ 207
Municipal securities................. 11,550 11,456 94 94
Preferred stock...................... 3,426 3,172 254 254
------- ------- ---- ---- -----
$27,654 $27,099 $569 $(14) 555
======= ======= ==== ====
Related deferred taxes............... (222)
-----
Unrealized holding gain, net......... $ 333
=====
</TABLE>

At February 28, 1996, all marketable debt securities classified as current
assets have scheduled maturities of less than one year. Marketable debt
securities classified as noncurrent assets have scheduled maturities of one to
five years.

4. PROPERTY AND EQUIPMENT, NET (IN THOUSANDS):

<TABLE>
<CAPTION>
FEBRUARY 28,
---------------------
1995 1996
------- -------
<S> <C> <C>
Buildings...................................................... $ 908 $ 908
Furniture and fixtures......................................... 1,150 1,373
Computer equipment............................................. 7,786 11,642
Leasehold improvements......................................... 246 258
------- -------
10,090 14,181
Less accumulated depreciation and amortization................. (6,477) (8,588)
------- -------
$ 3,613 $ 5,593
======= =======
</TABLE>

Depreciation expense amounted to $1,367,000, $1,531,000 and $2,203,000 in
fiscal 1994, 1995 and 1996, respectively.

5. LINE OF CREDIT

At February 28, 1996, the Company had available a $1,000,000 unsecured bank
line of credit and a $5,000,000 foreign exchange contract facility under an
agreement that expires on July 15, 1996. Borrowings under the line of credit
bear interest at the bank's prime rate. The agreement contains certain
restrictive covenants regarding the Company's financial position. The Company
has had no borrowings under this agreement.

6. LEASEHOLD COMMITMENTS

OPERATING LEASES

The Company occupies its principal facilities under an operating lease
agreement that expires in September 1996. Under the agreement, the Company is
responsible for taxes, utilities and insurance expenses. Future minimum lease
payments under all noncancelable operating leases amount to approximately
$973,000, $361,000, $137,000, $102,000, $47,000 and $230,000 for fiscal 1997,
1998, 1999, 2000, 2001 and thereafter, respectively. Rent expense for fiscal
1994, 1995 and 1996 was $875,000, $1,148,000 and $1,455,000, respectively.

F-12
<PAGE> 50

INTEGRATED SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

6. LEASEHOLD COMMITMENTS (CONTINUED)
BUILDING PURCHASE

In March 1996, the Company purchased a building, which will become its
principal facility, for cash of approximately $12,000,000. The Company expects
the move to this new facility to be completed by the end of the first quarter of
fiscal 1997.

7. SHAREHOLDERS' EQUITY

COMMON STOCK SPLIT

On March 4, 1996, the Company's Board of Directors authorized a two-for-one
stock split to be effective on April 5, 1996 for the shareholders of record on
March 18, 1996. All share and per share information in the accompanying
financial statements has been restated to give retroactive recognition to the
stock split for all periods presented.

COMMON STOCK OPTION PLANS

At February 28, 1996, the Company had reserved 6,663,724 shares of common
stock for issuance under various stock option plans, including a plan resulting
from the business combination with Doctor Design (see Note 2). The plans provide
for the granting of incentive stock options to officers and employees of the
Company and nonqualified stock options to officers, employees, directors and
consultants of the Company at prices not less than fair market value (as
determined by the Compensation Committee of the Board of Directors) on the date
of grant. Options are exercisable at times and in increments as specified by the
Compensation Committee. Options generally vest over five years and expire in six
to ten years.

F-13
<PAGE> 51

INTEGRATED SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

7. SHAREHOLDERS' EQUITY (CONTINUED)
Activity under these plans is as follows (in thousands, except share and
per share amounts):

<TABLE>
<CAPTION>
SHARES NUMBER
AVAILABLE OF PRICE PER
FOR GRANT OPTIONS SHARE TOTAL
---------- --------- ------------ -------
<S> <C> <C> <C> <C>
Balances, February 28, 1993................... 2,122,866 1,643,080 $0.32-$ 6.63 $ 4,192
Options granted............................. (1,561,812) 1,561,812 $0.68-$ 5.88 5,577
Options exercised........................... (468,884) $0.32-$ 4.44 (572)
Options canceled............................ 212,912 (216,112) $0.38-$ 6.63 (748)
---------- --------- -------
Balances, February 28, 1994................... 773,966 2,519,896 $0.32-$ 5.88 8,449
Adoption of 1994 Directors Stock Option
Plan..................................... 400,000
Shares added to 1988 Plan................... 2,000,000
Options granted............................. (826,164) 826,164 $0.68-$ 9.38 4,894
Options exercised........................... (584,848) $0.32-$ 5.25 (1,858)
Options canceled............................ 337,344 (337,344) $2.63-$ 5.32 (1,227)
---------- --------- -------
Balances, February 28, 1995................... 2,685,146 2,423,868 $0.32-$ 9.38 10,258
Options granted............................. (882,272) 882,272 $1.35-$19.50 11,915
Options exercised........................... (540,254) $0.39-$ 9.38 (2,050)
Options canceled............................ 239,966 (239,966) $2.88-$14.63 (1,419)
---------- --------- -------
Balances, February 28, 1996................... 2,042,840 2,525,920 $0.32-$19.50 $18,704
========== ========= =======
</TABLE>

At February 28, 1996, options to purchase 799,630 shares of common stock
were exercisable.

EMPLOYEE STOCK PURCHASE PLAN

At February 28, 1996, the Company had reserved a total of 1,000,000 shares
of common stock for issuance under its 1990 Employee Stock Purchase Plan (the
ESPP). The purpose of the ESPP is to provide eligible employees of the Company
with a means of acquiring common stock of the Company through payroll
deductions. The purchase price of such stock under the ESPP cannot be less than
85% of the lower of the fair market value on the specified purchase date or the
beginning of the offering period. During fiscal 1994, 1995 and 1996,
approximately 120,000 shares, 94,000 shares and 72,000 shares, respectively,
were sold through the ESPP.

8. 401(K) PLANS

The Company has two 401(k) Plans (the Plans), including a plan resulting
from the business combination with Doctor Design (see Note 2), that cover
essentially all employees. Each eligible employee may elect to contribute to the
Plans, through payroll deductions, up to 15% of their compensation, subject to
certain limitations. The Company is obligated to make matching contributions on
behalf of each participating employee in an amount equal to 25% of an employee's
contribution, up to 2% of the employee's compensation. For individuals who were
employed by the Company prior to December 1, 1994, Company contributions are
fully vested on the date of contribution. For individuals who became employed
subsequent to November 30, 1994, Company contributions vest ratably over a
six-year period. The Company's contributions charged against income totaled
approximately $170,000, $228,000 and $390,000 in fiscal 1994, 1995 and 1996,
respectively.

F-14
<PAGE> 52

INTEGRATED SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

9. INCOME TAXES

The provision for income taxes included the following (in thousands):

<TABLE>
<CAPTION>
YEAR ENDED FEBRUARY 28,
------------------------------
1994 1995 1996
------- ------ -------
<S> <C> <C> <C>
Federal:
Current.............................................. $ 1,851 $1,838 $ 3,211
Deferred............................................. (1,021) (429) (1,584)
------- ------ -------
830 1,409 1,627
------- ------ -------
State:
Current.............................................. 730 647 1,208
Deferred............................................. (252) (58) (593)
------- ------ -------
478 589 615
------- ------ -------
Foreign................................................ 627 1,112 1,270
------- ------ -------
$ 1,935 $3,110 $ 3,512
======= ====== =======
</TABLE>

The reconciliation between the effective tax rates and statutory federal
income tax rate is shown in the following table:

<TABLE>
<CAPTION>
YEAR ENDED FEBRUARY
28,
----------------------
1994 1995 1996
---- ---- ----
<S> <C> <C> <C>
Statutory federal income tax rate.............................. 34.0% 34.0% 34.0%
State taxes, net of federal income tax benefit................. 5.3 4.6 5.4
Acquisition costs.............................................. 8.0
Research and development tax credit and credit carryforwards... (2.9) (1.2) (2.0)
Foreign sales corporation tax benefit.......................... (3.8) (3.7) (3.5)
Other.......................................................... (0.5) (1.3) (1.9)
---- ---- ----
Effective tax rate............................................. 32.1% 32.4% 40.0%
==== ==== ====
</TABLE>

Domestic and foreign components of income before income taxes were (in
thousands):

<TABLE>
<CAPTION>
YEAR ENDED FEBRUARY 28,
----------------------------
1994 1995 1996
------ ------ ------
<S> <C> <C> <C>
Domestic................................................. $5,410 $8,558 $7,430
Foreign.................................................. 611 1,042 1,365
------ ------ ------
$6,021 $9,600 $8,795
====== ====== ======
</TABLE>

F-15
<PAGE> 53

INTEGRATED SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

9. INCOME TAXES (CONTINUED)
The significant components of deferred tax assets and liabilities consist
of the following (in thousands):

<TABLE>
<CAPTION>
FEBRUARY 28,
-------------------
1995 1996
------ ------
<S> <C> <C>
Deferred tax assets:
Purchased intangibles.......................................... $2,572
Tax credit carryforwards....................................... $ 778
Accelerated depreciation....................................... 207 296
Accrued vacation and holiday................................... 266 262
Allowance for doubtful accounts................................ 243 387
Other.......................................................... 366 58
------ ------
$1,860 $3,575
====== ======
Deferred tax liabilities:
Software development costs..................................... $ 766 $ 510
Marketable securities.......................................... 222
Cash to accrual adjustment..................................... 289 564
------ ------
$1,055 $1,296
====== ======
</TABLE>

The Company has not provided a valuation allowance for its net deferred tax
assets as it expects such amounts to be realized through taxable income from
future operations, or by carryback to prior years' taxable income.

10. BUSINESS SEGMENT INFORMATION

The Company operates in one business segment: the design, marketing and
support of products for automating the process of real-time software development
and system design, including engineering services to assist customers in
implementing specific solutions.

The Company's foreign operations primarily consist of sales and customer
service organizations. Revenue, income and assets of the Company's foreign
subsidiaries were not material to the consolidated financial statements in
fiscal 1994, 1995 and 1996.

Revenue by geographical location of customer is as follows (in thousands):

<TABLE>
<CAPTION>
YEAR ENDED FEBRUARY 28,
--------------------------------
1994 1995 1996
-------- -------- --------
<S> <C> <C> <C>
North America......................................... $ 32,277 $ 41,723 $ 56,109
Europe................................................ 8,734 9,541 17,028
Asia/Pacific.......................................... 4,772 6,790 11,305
------- ------- -------
$ 45,783 $ 58,054 $ 84,442
======= ======= =======
</TABLE>

Export revenue to Europe was $5,213,000, $6,472,000 and $9,458,000 for
fiscal 1994, 1995 and 1996, respectively. Export revenue to Asia/Pacific was
$4,772,000, $6,790,000 and $11,305,000, in fiscal 1994, 1995 and 1996,
respectively.

Revenue from the United States Government, which are primarily engineering
services, was approximately 11% of total revenue for fiscal 1994. No other
customer accounted for 10% or more of total revenue in the reported periods.

F-16
<PAGE> 54

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NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT
BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY, ANY SELLING SHAREHOLDER
OR THE UNDERWRITERS. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY TO ANY PERSON IN ANY JURISDICTION IN WHICH SUCH
AN OFFER OR SOLICITATION WOULD BE UNLAWFUL OR TO ANY PERSON TO WHOM IT IS
UNLAWFUL. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY OFFER OR SALE MADE
HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS
BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY OR THAT THE INFORMATION CONTAINED
HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF.

------------------

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Incorporation of Certain Documents by
Reference................................ 2
Prospectus Summary......................... 3
Risk Factors............................... 4
Use of Proceeds............................ 10
Price Range of Common Stock................ 10
Dividend Policy............................ 10
Capitalization............................. 11
Selected Consolidated Financial Data....... 12
Management's Discussion and Analysis of
Financial Condition and Results of
Operations............................... 13
Business................................... 20
Management................................. 31
Selling Shareholders....................... 34
Underwriting............................... 35
Legal Matters.............................. 36
Experts.................................... 36
Available Information...................... 37
Report of Independent Accountants.......... F-1
Consolidated Financial Statements.......... F-2
</TABLE>

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1,800,000 SHARES
LOGO

COMMON STOCK
----------------------
PROSPECTUS
----------------------
HAMBRECHT & QUIST

WESSELS, ARNOLD & HENDERSON
May , 1996

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