<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM 8-K/A
Current Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
JULY 21, 1999
- -------------------------------------------------------------------------------
Date of Report (Date of earliest event reported)
INTEGRATED SYSTEMS, INC.
- -------------------------------------------------------------------------------
(Exact name of Registrant as specified in its charter)
CALIFORNIA 0-18268 94-2658153
- ------------------------ ------------------------ -------------------------
(State of incorporation) (Commission file number) (I.R.S. Employer
Identification No.)
201 MOFFETT PARK DRIVE
SUNNYVALE, CALIFORNIA 94089
- -------------------------------------------------------------------------------
(Address of principal executive offices, including zip code)
(408) 542-1500
- -------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
<PAGE>
ITEM 7: FINANCIAL STATEMENTS AND EXHIBITS
On August 5, 1999, Integrated Systems, Inc. ("ISI") filed a Form 8-K to
report its acquisition of Software Development Systems, Inc. ("SDS"). Pursuant
to Item 7 of Form 8-K, ISI indicated that it would file certain financial
information no later than the date required by Item 7 of Form 8-K. This
Amendment No. 1 is filed to provide the required financial information.
(a) FINANCIAL STATEMENTS OF BUSINESS ACQUIRED.
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and
Stockholders of Software Development Systems, Inc.:
We have audited the accompanying consolidated balance sheet of Software
Development Systems, Inc. and subsidiaries as of December 31, 1998, and the
related consolidated statements of operations, stockholders' equity, and
cash flows for the year then ended. 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 audit.
We conducted our audit 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 audit
provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of
Software Development Systems, Inc. and subsidiaries as of December 31,
1998, and the results of their operations and their cash flows for the
year then ended in conformity with generally accepted accounting
principles.
/s/ KPMG LLP
---------------------
April 30, 1999
2
<PAGE>
SOFTWARE DEVELOPMENT SYSTEMS, INC.
AND SUBSIDIARIES
Consolidated Balance Sheets
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
ASSETS 1998 1999
-------------------- ---------------
(UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 3,033,696 2,008,924
Accounts receivable and unbilled services, net of allowance for
doubtful accounts of $393,900 and $404,340, respectively 2,529,498 2,732,975
Inventories 72,775 141,023
Prepaid expenses and other 360,051 378,280
Refundable income taxes 962,470 890,422
Deferred income taxes 796,053 796,053
-------------------- ---------------
7,754,543 6,947,677
-------------------- ---------------
Property and equipment, at cost less accumulated depreciation 1,854,292 1,818,757
Internally developed software, at cost less accumulated amortization
of $590,714 and $646,740, respectively 187,455 131,429
Other assets 78,000 97,500
Deferred income taxes 94,947 454,282
-------------------- ---------------
$ 9,969,237 9,449,645
-------------------- ---------------
-------------------- ---------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable $ 712,563 554,788
Accrued compensation and related items 661,518 844,558
Other accrued liabilities 1,127,643 944,200
Current portion of long-term debt 527,852 518,327
Deferred revenue 1,738,209 1,951,694
Note payable -- 80,000
-------------------- ---------------
4,767,785 4,893,567
-------------------- ---------------
Long-term liabilities:
Notes payable, including interest payable of $248,324
and $365,564, respectively 5,248,234 5,365,564
Other long-term liabilities 766,490 735,208
-------------------- ---------------
6,014,724 6,100,772
-------------------- ---------------
Stockholders' equity (deficit):
Common stock, no par value:
Authorized - 30,000,000 shares
Issued and outstanding - 7,500,000 shares 1,301,000 1,301,000
Note receivable from shareholder (1,200,000) (1,200,000)
Additional paid in capital from stock based compensation 3,263,872 3,301,849
Deferred compensation on stock options (866,667) (830,076)
Retained earnings (accumulated deficit) (3,327,487) (4,133,102)
Accumulated other comprehensive income 16,010 15,635
-------------------- ---------------
(813,272) (1,544,694)
-------------------- ---------------
$ 9,969,237 9,449,645
-------------------- ---------------
-------------------- ---------------
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
SOFTWARE DEVELOPMENT SYSTEMS, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
<TABLE>
<CAPTION>
YEAR ENDED THREE MONTHS ENDED
DECEMBER 31, MARCH 31,
1998 1998 1999
------------------- --------------- ---------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C>
Revenues:
Products $ 14,720,190 3,553,629 3,729,897
Services 1,801,585 259,666 541,682
------------------- --------------- ---------------
Total revenues 16,521,775 3,813,295 4,271,579
------------------- --------------- ---------------
Operating expenses
Cost of product revenue 3,335,250 561,641 771,333
Cost of services revenue 1,077,043 406,979 175,454
Marketing and sales 8,285,056 1,539,858 2,441,684
Research and development 3,600,004 638,004 958,282
General and administative 6,049,288 2,837,090 996,224
------------------- --------------- ---------------
Total operating expenses 22,346,641 5,983,572 5,342,977
------------------- --------------- ---------------
Operating loss (5,824,866) (2,170,277) (1,071,398)
------------------- --------------- ---------------
Other income (expense):
Interest expense (308,940) (27,261) (144,243)
Interest income 186,053 20,418 41,628
Other 13,229 6,642 9,063
------------------- --------------- ---------------
(109,658) (201) (93,552)
------------------- --------------- ---------------
Loss before income taxes (5,934,524) (2,170,478) (1,164,950)
Income taxes 1,246,902 52,599 359,335
------------------- --------------- ---------------
Net loss $ (4,687,622) (2,117,879) (805,615)
------------------- --------------- ---------------
------------------- --------------- ---------------
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE>
SOFTWARE DEVELOPMENT SYSTEMS, INC.
AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
For the year ended December 31, 1998
<TABLE>
<CAPTION>
ADDITIONAL
NOTES PAID IN DEFERRED
RECEIVABLE CAPITAL FROM COMPENSATION
COMMON FROM STOCK BASED ON
STOCK STOCKHOLDER COMPENSATION STOCK OPTIONS
------------- ------------------------------------- ----------------
<S> <C> <C> <C> <C>
Balance at December 31, 1997 $ 101,000 -- -- --
Comprehensive income
Net loss -- -- -- --
Other comprehensive income - foreign
currency translation adjustment -- -- -- --
Issuance of stock options -- -- 1,114,372 (1,114,372)
Amortization of deferred compensation -- -- -- 247,705
Issuance of stock for note receivable 1,200,000 (1,200,000) 2,149,500 --
------------- ------------------------------------- ----------------
Balance at December 31, 1998 $ 1,301,000 (1,200,000) 3,263,872 (866,667)
------------- ------------------------------------- ----------------
------------- ------------------------------------- ----------------
<CAPTION>
RETAINED ACCUMULATED
EARNINGS/ OTHER
(ACCUMULATED COMPREHENSIVE COMPREHENSIVE
DEFICIT) INCOME TOTAL INCOME (LOSS)
------------------- -------------------- --------------- -------------------
<S> <C> <C> <C> <C>
Balance at December 31, 1997 1,360,135 7,403 1,468,538
Comprehensive income
Net loss (4,687,622) -- (4,687,622) $ (4,687,622)
Other comprehensive income - foreign
currency translation adjustment -- 8,607 8,607 8,607
Issuance of stock options -- -- -- --
Amortization of deferred compensation -- -- 247,705 --
Issuance of stock for note receivable -- -- 2,149,500 --
------------------- -------------------- --------------- -------------------
Balance at December 31, 1998 (3,327,487) 16,010 (813,272) (4,679,015)
------------------- -------------------- --------------- -------------------
------------------- -------------------- --------------- -------------------
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
SOFTWARE DEVELOPMENT SYSTEMS, INC.
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED MARCH 31,
DECEMBER 31, --------------------------------
1998 1998 1999
------------------- --------------- ---------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $ (4,687,622) (2,117,879) (805,615)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Stock based compensation 2,397,205 2,197,761 74,568
Depreciation 735,748 37,713 198,464
Amortization 243,214 86,277 56,026
Deferred income taxes (477,000) -- (359,335)
Loss on disposal of fixed assets 48,297 -- --
Interest accrued on long-term debt 248,234 14,794 117,330
Changes in current assets and current liabilities:
Accounts receivable, net (155,118) 491,092 (203,477)
Inventories (42,329) (185,796) (68,248)
Refundable income taxes (615,168) 52,515 72,048
Other assets (294,823) (142,032) (37,729)
Accounts payable 136,302 111,037 (157,774)
Accrued compensation and related items (135,765) (250,305) 183,040
Other accrued liabilities 776,273 (169,243) (183,443)
Deferred revenue 346,377 56,520 213,485
------------------- --------------- ---------------
Net cash provided by (used in) operating activities (1,476,175) 182,454 (900,660)
------------------- --------------- ---------------
Cash flows from investing activities:
Proceeds from disposition of property, plant and equipment 32,000 -- --
Purchases of property, plant and equipment (1,087,866) (278,707) (93,981)
Capitalized software development costs (148,169) (80,108) --
------------------- --------------- ---------------
Net cash used in investing activities (1,204,035) (358,815) (93,981)
------------------- --------------- ---------------
Cash flows from financing activities:
Capital lease financing 476,683 -- --
Net borrowings (payments) from line of credit (300,000) (300,000) --
Proceeds from long-term debt 5,000,000 3,000,000 --
Payments on capital lease (102,920) -- (64,756)
Payments on long-term debt (180,000) (45,000) (45,000)
Advance to affiliate -- -- 80,000
------------------- --------------- ---------------
Net cash provided by (used in) financing activities 4,893,763 2,655,000 (29,756)
------------------- --------------- ---------------
Effect of exchange rates on cash 8,607 8,295 (375)
Net increase (decrease) in cash and cash equivalents 2,222,160 2,486,934 (1,024,772)
Cash and cash equivalents - beginning of period 811,536 811,536 3,033,696
------------------- --------------- ---------------
Cash and cash equivalents - end of period $ 3,033,696 3,298,470 2,008,924
------------------- --------------- ---------------
------------------- --------------- ---------------
Supplemental disclosures of cash flow information:
Cash paid during the period for interest $ 65,478 12,467 25,614
Cash paid during the period for income taxes 396,436 28,750 --
Cash received for income tax refunds 444,961 -- --
------------------- --------------- ---------------
------------------- --------------- ---------------
Supplemental disclosures of noncash investing and financing activities:
Notes receivable from shareholder for purchase of stock $ 1,200,000 1,200,000 --
Equipment under capital lease 710,579 -- 68,950
Interest accrued on long-term debt 248,234 14,794 117,330
------------------- --------------- ---------------
------------------- --------------- ---------------
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
SOFTWARE DEVELOPMENT SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(1) NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS
Software Development Systems, Inc. and Subsidiaries (the "Company")
develops, markets, and supports a family of specialized integrated
software products, which include microprocessor simulators,
development and debugging tools, and compilers. These products are
utilized by customers in the embedded-systems industry. The Company
focuses product development in two main areas. The first is the
hardware bring-up and hardware-software integration phases where the
problems are most complex in the business. The second is the
application development phase where applications are built on top of
embedded operating systems instead of within a real-time operating
system. Software Development Systems, Inc. and Subsidiaries also
provides product-related maintenance and support services and
non-recurring engineering services to customers for the development of
specific software products. The Company markets and supports its
products and services through its own sales organization, including an
international network of wholly owned subsidiaries, and other
non-direct sales channels.
USE OF ESTIMATES
In preparing the consolidated financial statements in conformity with
generally accepted accounting principles, the Company's management
makes estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting periods. Actual
results could differ from those estimates.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries: Software Development
Systems Limited; Software Development Systems France; and Software
Development Systems Kabushiki Kaisha ("SDS-Japan"). All significant
intercompany accounts and transactions are eliminated in
consolidation.
REVENUE RECOGNITION
Revenue from software product sales of perpetual license agreements is
recognized upon product delivery and customer acceptance, when all
significant contractual obligations are satisfied and the collection
of the resulting receivable is reasonably assured. Related maintenance
and support revenue is recognized ratably over the term of the
maintenance contract, which is usually one to two years. Billings in
excess of earned support revenue are classified as deferred revenues.
Service revenues are derived from the Company's non-recurring
engineering and consulting service business. These revenues are mostly
comprised of fixed-price contracts. Fixed-price contract revenues are
recognized based on the percentage-of-completion method.
CASH EQUIVALENTS
Cash equivalents are comprised of highly liquid investments with
original maturities of three months or less.
2
<PAGE>
SOFTWARE DEVELOPMENT SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
INVENTORIES
Inventories, which consist primarily of third-party hardware, are
stated at cost, cost being determined using specific identification.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost, less accumulated
depreciation and amortization. Depreciation is computed using the
straight-line method based on the estimated useful lives, generally
three to seven years, of the various classes of property and
equipment. Amortization of leasehold improvements is computed over the
shorter of the lease term or the estimate useful life of the asset.
The Company changed the estimated useful lives for certain classes of
equipment from 10 years and 5 years to 3 years. The Company believes
that the shortened useful lives more appropriately reflect the timing
of the economic benefits to be received from these assets. The effect
of this change was to increase 1998 depreciation expense and
accumulated depreciation by $128,480.
PURCHASED AND DEVELOPED SOFTWARE
Software development costs are accounted for in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 86,
"Accounting for the Costs of Computer Software to Be Sold, Leased, or
Otherwise Marketed." Costs associated with the planning and designing
phase of software development, including coding and testing activities
necessary to establish technological feasibility, are classified as
product development and expensed as incurred. Once technological
feasibility has been determined, additional costs incurred in
development, including coding, testing and documentation are
capitalized until the product or enhancement is available for release
to customers. Development costs for certain products may be entirely
expensed as incurred because the costs incurred between technological
feasibility and general release to customers does not materially
affect the Company. Amortization of purchased and developed software
is provided on a product-by-product basis over the estimated economic
life of the software, generally two to three years, using the
straight-line method. This method generally results in greater
amortization expense per year than the method based on the ratio of
current year gross product revenue to current and anticipated future
gross product revenue. Amortization commences when a product is
available for general release to customers. Unamortized capitalized
costs determined to be in excess of the net realizable value of a
product are expensed at the date of such determination. The Company
capitalized $148,169 of software development costs in 1998. The
Company recorded $243,214 of amortization expense in 1998.
INCOME TAXES
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to temporary differences between the
financial statement carrying amounts of existing assets and
liabilities and their respective tax bases and operating loss and
credit carryforwards. Deferred tax assets and liabilities are measured
using the enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are to be recovered or
3
<PAGE>
SOFTWARE DEVELOPMENT SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
settled. The effect on deferred tax assets and liabilities of a change
in tax rates is recognized in earnings in the period of enactment.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair values of the Company's financial instruments were not
materially different from their carrying amounts as of December 31,
1998.
FOREIGN CURRENCY TRANSLATION AND TRANSACTIONS
The financial position and results of operations of the Company's
foreign subsidiaries are measured using the local currency as the
functional currency. Accordingly, assets and liabilities are
translated into U.S. dollars using the current exchange rates as of
the balance sheet date. Revenues and expenses are translated at
average exchange rates prevailing during the year. Translation
adjustments arising from differences in exchange rates are included as
a separate component of stockholders' equity. Gains and losses
resulting from foreign currency transactions are included in the
consolidated statement of operations.
STOCK-BASED COMPENSATION
The Company applies the provisions of Accounting Principles Board
("APB") Opinion No. 25, "Accounting for Stock Issued to Employees,"
and provides pro forma net income disclosures as if the Company had
applied the fair value method defined in SFAS No. 123, "Accounting for
Stock-Based Compensation."
INTERIM FINANCIAL STATEMENTS
The accompanying unaudited interim financial statements reflect all
adjustments which in the opinion of management, are necessary for the
fair presentation of the financial position of the Company as of March
31, 1999, and the results of its operations and its cash flows for the
three month periods ended March 31, 1998 and 1999.
4
<PAGE>
SOFTWARE DEVELOPMENT SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(2) PROPERTY AND EQUIPMENT
Property and equipment as of December 31, 1998 were comprised of the
following:
<TABLE>
<CAPTION>
<S> <C>
Computer hardware $ 1,280,493
Computer software 664,553
Furniture and fixtures 814,772
Other fixed assets 217,545
Leasehold improvements 280,286
---------------
3,257,649
Less - accumulated depreciation 1,403,357
---------------
$ 1,854,292
---------------
---------------
</TABLE>
Included in property and equipment as of December 31, 1998 are
software, hardware and leasehold improvements with costs of $1,174,924
and accumulated depreciation of $173,343, which are under capital
lease.
(3) INCOME TAXES
Loss before income taxes for the year ended December 31, 1998
consisted of the following:
<TABLE>
<CAPTION>
<S> <C>
U.S. $ (5,783,127)
Foreign (151,397)
----------------
Total $ (5,934,524)
----------------
----------------
</TABLE>
5
<PAGE>
SOFTWARE DEVELOPMENT SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The income tax benefit consisted of the following:
<TABLE>
Current:
<S> <C>
Federal $ (847,902)
State --
Foreign 78,000
-----------------
Total current (769,902)
Deferred:
Federal (290,000)
State (187,000)
Foreign --
-----------------
Deferred (477,000)
-----------------
Total income tax benefit $ (1,246,902)
-----------------
-----------------
</TABLE>
A reconciliation of total taxes based on the federal statutory rate and
the Company's actual total provision (benefit) was as follows:
<TABLE>
<S> <C>
Income taxes at the federal statutory rate of 34% $ (2,017,738)
State taxes, net of federal benefit (123,000)
Foreign income at different rates (8,000)
Increase in valuation allowance 962,000
Other, net (60,164)
------------------
$ (1,246,902)
------------------
------------------
</TABLE>
6
<PAGE>
SOFTWARE DEVELOPMENT SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The deferred income tax assets and liabilities were comprised of the
following as of December 31, 1998:
<TABLE>
<CAPTION>
Deferred tax assets:
<S> <C>
Net operating loss $ 123,000
Depreciation 21,000
AMT credits 24,000
Bad debts 153,000
Deferred revenue 546,000
Compensation accruals 912,000
Foreign net operating losses 230,000
-----------------
Total gross deferred tax assets 2,009,000
Less valuation allowance (1,045,000)
-----------------
Net deferred tax assets 964,000
Deferred tax liabilities:
Capitalized software costs (73,000)
-----------------
Total deferred tax liabilities (73,000)
-----------------
Total net deferred taxes $ 891,000
-----------------
-----------------
</TABLE>
The Company has reduced gross deferred tax assets by a valuation
allowance to reflect the estimated amount of deferred tax assets which
will more likely than not, be realized. The net deferred tax asset at
December 31, 1998 reflects management's estimate of the amount that will
be realized as a result of future profitability. The amount of the
deferred tax assets considered realizable could be reduced if estimates
of future taxable income are reduced.
The valuation allowance was increased by $962,000 from December 31, 1997
to December 31, 1998.
As of December 31, 1998, the Company had approximately $2,457,000 of
state net operating losses and approximately $653,000 of foreign net
operating losses, which will begin to expire in 2003 and 2001
respectively.
Undistributed earnings of the Company's corporate foreign subsidiaries
amounted to approximately $408,000 at December 31, 1998. Those earnings
are considered to be indefinitely reinvested, and accordingly, no
provision for U.S. federal and state income taxes and foreign
withholding taxes have been made. Upon distribution of those earnings,
the Company would be subject to U.S. income taxes (subject to a
reduction for foreign tax credits) and withholding taxes payable to the
appropriate foreign countries. Determination of the amount of
unrecognized
7
<PAGE>
SOFTWARE DEVELOPMENT SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
deferred U.S. income tax liability is not practicable; however,
unrecognized foreign tax credit carryovers would be available to reduce
some portion of the U.S. liability.
(4) NOTES PAYABLE AND LONG-TERM DEBT
The bank demand note entered into on June 30, 1997, with maximum
borrowings of $800,000 was paid in full during 1998. On December 31,
1998, the Company entered into a demand note with a principal sum of
$1,500,000 bearing interest at prime. The bank's prime rate at
December 31, 1998 was 7.75%. This demand note replaces the demand note
dated June 30, 1997. As of December 31, 1998, there were no borrowings
against the demand note. The demand note is secured by all assets of the
Company. The amount which the Company may borrow under the note is
determined by the value of eligible accounts receivable as defined, per
the loan and security agreement dated August 14, 1995.
In March 1998, the Company entered into an agreement with a vendor that
provided for two convertible subordinated secured notes. The first note
was executed on March 11, 1998 in the amount of $3,000,000. The second
note was executed on November 16, 1998 in the amount of $2,000,000.
These notes bear interest at a rate of 9%. The notes are secured by the
assets of the Company, subordinate to the interests of senior creditors.
The outstanding principal and unpaid accrued interest under these notes
are convertible into shares of the Company's common stock at a
conversion price equal to $4.06 per share. Certain financial covenants
and reporting requirements are also included in the agreement.
The Company maintains a secured line of credit, which expires in July
1999, under a credit agreement with the Company's main banking facility.
Borrowings under this agreement are specifically for the purchase of
furniture, office and computer equipment, which secure the borrowed
amounts. The line of credit bears interest at 8.35%.
Long-term debt is summarized as follows.
<TABLE>
<CAPTION>
Long-term debt:
<S> <C>
Bank note payable, due February 2000, payable in monthly principal
installments of $15,000 plus interest at the bank's prime rate $ 210,000
Convertible subordinated secured notes including interest at 9%, due
February 28, 2002 5,248,234
Capitalized lease obligations:
Bank lease line funding - 8.35%, due June 2001, secured by certain
office and computer equipment 892,551
Capitalized lease obligations with interest at 6.85% to 21.85%,
secured primarily by telephone systems 191,791
-----------------
6,542,576
Less current portion 527,852
-----------------
Total long-term debt $ 6,014,724
-----------------
-----------------
</TABLE>
8
<PAGE>
SOFTWARE DEVELOPMENT SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
At December 31, 1998, future minimum principal payments on long-term
debt and capitalized lease obligations were as follows:
<TABLE>
<S> <C>
1999 $ 527,852
2000 404,821
2001 286,259
2002 5,289,872
2003 33,772
-------------
$ 6,542,576
-------------
-------------
</TABLE>
(5) COMMITMENTS
The Company has various lease agreements for real and personal property.
These obligations extend through 2003 and in some cases contain renewal
options. As of December 31, 1998, future minimum lease payments for
noncancelable operating leases in excess of one year are as follows:
<TABLE>
<S> <C>
1999 $ 837,506
2000 356,833
2001 92,364
2002 4,292
2003 2,124
---------------
$ 1,293,119
---------------
---------------
</TABLE>
Rental expense on all operating leases totaled $807,486 for the year
ended December 31, 1998.
(6) STOCKHOLDERS' EQUITY
On February 25, 1998, the sole director of the Company and shareholders
approved a 5,000 for 1 stock split of the then issued and outstanding
10,000 shares of $1.00 par value common stock. In addition, the sole
director of the Company and the shareholders approved an increase in the
number of authorized shares of common stock to 30,000,000, and a change
in the par value of the authorized shares to no par value. All common
share information presented in these financial statements reflects the
retroactive recognition of the stock split.
(7) STOCK BASED COMPENSATION
In 1998, the Company adopted the Software Development Systems, Inc.,
Stock Option Plan (the Plan) in order to attract and retain key
employees and key non-employees. The Company applies APB Opinion No. 25
and related interpretations to account for the Plan. During 1998, the
Company recognized $247,705 and $2,149,500 of compensation expense for
stock options granted and employee stock purchases (see note 9),
respectively. Had compensation cost for the Company's stock-based
compensation plan been determined based on the fair value at the grant
dates for awards under the plan consistent with the method prescribed by
SFAS No. 123, the
9
<PAGE>
SOFTWARE DEVELOPMENT SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Company's net income (loss) would have been the pro forma amounts
indicated below:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, 1998
-------------------
<S> <C>
Net loss:
As reported $ (4,687,622)
Pro forma (4,702,807)
-------------------
-------------------
</TABLE>
For purposes of SFAS No. 123, the fair value of each option grant is
estimated on the date of grant using the minimum value method with the
following assumptions used for grants in 1998: no expected dividends,
risk-free interest rate of 6.00%, and expected life of 5 years. The fair
value of options granted in 1998 was $1.78.
As of December 31, 1998, the Company had 1,125,000 options available for
grant under the Plan. During 1998, 727,208 options were granted at an
exercise price of $.60/share and were outstanding as of December 31,
1998. Options exercisable as of December 31, 1998 were 147,555.
(8) EMPLOYEE BENEFITS
The Company has a contributory retirement savings plan (the "401(k)
Plan") which covers eligible U.S. employees who qualify as to age and
length of service. Participants may contribute 1% - 15% of their
salaries, subject to maximum contribution limitations imposed by the
IRS. The expense of the 401(k) Plan, consisting of discretionary Company
contributions, was $54,484 for the year ended December 31, 1998.
(9) RELATED PARTY TRANSACTIONS
On January 1, 1998, the Company issued 1,500,000 shares of common stock
at $0.80 per share. Consideration for the shares issued was in the form
of a $1,200,000 note bearing interest at 6.5% annually due from the
stockholder. The principal and accrued and unpaid interest is due on
December 31, 2007. In connection with the issuance of the common stock,
the Company entered into a subscription agreement with the stockholder.
The agreement provides for additional consideration to be paid to the
stockholder upon a change in control, based on the value of the shares
as defined in the agreement. Subsequent to December 31, 1999, if the
stockholder ceases to be employed by the Company, he may require that
the Company repurchase all of the purchased shares at a price determined
in accordance with the agreement. Additionally, the Company has the
option, but no obligation, to repurchase the shares if the stockholder
ceases his employment. In conjunction with the purchase of the stock,
$2,149,500 of compensation expense was recorded.
(10) CONCENTRATIONS OF CREDIT RISK
Financial instruments that potentially subject the Company to
concentrations of credit risk consist primarily of trade accounts
receivable. The Company performs ongoing credit evaluations of its
customers and maintains an allowance for doubtful accounts to reserve
for potential credit losses.
10
<PAGE>
SOFTWARE DEVELOPMENT SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Management believes that the allowance for doubtful accounts is
adequate to provide for possible credit losses.
Approximately 20% of the Company's revenues in 1998 were generated from
one distribution partner. The Company has successfully renegotiated the
terms of the contract with this distribution partner through December
1999.
(11) SUBSEQUENT EVENT
Subsequent to year-end, the Company entered into promissory notes with
two of its stockholders for $40,000 each. The notes bear interest at
6.5% per annum and are payable on or before December 31, 1999. The notes
may be prepaid in whole or in part without premium or penalty together
with accrued and unpaid interest on the amount being prepaid. If an
event of default, as defined in the agreement, shall occur and be
continuing, the entire principal amount of these notes, together with
the accrued interest, shall become and be immediately due and payable.
11
<PAGE>
PRO FORMA COMBINED FINANCIAL INFORMATION
OVERVIEW
Effective July 21, 1999 Integrated Systems Inc (ISI) acquired all the
outstanding stock and stock rights of Software Development Inc (SDS) which
develops, markets and supports a family of specialized integrated software
products used in the embedded-systems industry. The total purchase price of
approximately $39.2 million consisted of 1,430,046 shares of ISI's common
stock with an estimated fair value of approximately $13.9 million, cash
consideration of $24.3 million and acquisition costs of $1.0 million. The
acquisition has been accounted for using the purchase method of accounting
and accordingly the purchase price has been allocated to the tangible and
intangible assets acquired and liabilities assumed on the basis of their
respective fair values on the acquisition date.
The allocation of the purchase price is summarized below (in thousands):
<TABLE>
<S> <C>
Completed technology $ 6,500
In-process research and development 6,300
OEM relationships 2,800
Non-compete agreement 1,000
Trade name 1,800
Workforce 2,900
Deferred tax liability (4,800)
Assumed net assets/liabilities (293)
Goodwill 23,028
Total purchase price $39,935
</TABLE>
The acquisition has been structured as a tax-free exchange of stock,
therefore, the differences between the recognized fair value of acquired
assets, including tangible assets, and their historical tax bases are not
deductible for tax purposes.
The amount allocated to the in-process research and development represents
the purchased in-process technology for projects that, as of the date of
acquisition, had not yet reached technological feasibility and have no
alternative future use. Based on preliminary assessments, the value of these
projects was determined by estimating the resulting net cash flows from the
sale of the products resulting from the completion of the projects, reduced
by the portion of the revenue attributable to core technology and the
percentage completion of the project. The resulting cash flows were then
discounted back to their present value at appropriate discount rates.
The nature of the efforts to develop the purchased in-process research and
development into commercially viable products principally relates to the
completion of all planning, designing, prototyping and testing activities
that are necessary to establish that the product can be produced to meet its
design specification including function, features and technical performance
requirements. The resulting net cash flows from such products are based on
estimates of revenue, cost of revenue, research and development costs, sales
and marketing costs, and income taxes from such projects.
The amount allocated to these projects identified as in-process research and
development of SDS will be charged to the income statement in the period the
valuation analysis is complete, shortly after the consummation of the
acquisition. Such charges relate to in-process research and development have
not been included in the unaudited pro forma combined statements of
operations since they are non-recurring in nature. However, the charges have
been reflected in the unaudited pro forma combined balance sheet.
The following unaudited pro forma combined balance sheet gives effect to the
transaction as if it had been consummated as of May 31, 1999, by combining
the balance sheet of ISI as at May 31, 1999 with the balance sheet of SDS as
at March 31, 1999.
The following unaudited pro forma combined financial statements of operations
for the year ended February 28, 1999 and the three months ended May 31, 1999
give effect to the acquisition as if it had occurred on March 1, 1998, by
combining the results of operations of ISI for the year ended February 28,
1999 and the three month period ended May 31, 1999 with the results of
operations of SDS for the year ended December 31, 1998 and the three month
period ended March 31, 1999 respectively.
The pro forma information is presented for illustrative purposes only and is
not necessarily indicative of the operating results or financial position
that would have occurred if the merger had been consummated at the beginning
of the earliest period presented, nor is it necessarily indicative of future
operating results or financial position. The pro forma adjustments are based
upon information and assumptions available at the time of the filing of this
Form 8-K/A. The pro forma information should be read in conjunction with the
accompanying notes thereto and with the historical financial statements and
related notes thereto in ISI's Form 10-K, filed in May 1999 and SDS's
financial statements and related notes filed herewith.
12
<PAGE>
INTEGRATED SYSTEMS, INC.
PRO FORMA COMBINED BALANCE SHEET
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
May 31, March 31,
1999 1999 Pro Forma Pro Forma
ISI SDS Adjustments Combined
--- --- ----------- ------------
<S> <C> <C> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 26,131 $ 2,009 $ (24,342)(a) $ 3,798
Marketable securities 2,382 2,382
Accounts receivable, net 25,377 2,733 $ (1,243)(b) 26,867
Deferred income taxes 2,490 1,686 4,176
Prepaid expenses and other 4,729 519 5,248
-------------- ------------ ------------- -------------
Total current assets 61,109 6,947 (25,585) 42,471
Marketable securities 45,078 45,078
Property and equipment, net 18,574 1,819 20,393
Intangible assets, net 3,411 131 32,663 (c) 36,205
Deferred income taxes 5,322 454 (4,800)(d) 976
Other assets 1,781 98 1,879
-------------- ------------ ------------- -------------
Total Assets $ 135,275 $ 9,449 $ 2,278 $ 147,002
-------------- ------------ ------------- -------------
-------------- ------------ ------------- -------------
Liabilities
Current liabilities:
Accounts payable $ 3,730 $ 555 $ 4,285
Accrued payroll and related expenses 5,931 845 6,776
Other accrued liabilities 5,610 944 $ (1,243)(b) 5,311
1,652 (e) 1,652
Current portion of long term debt 598 598
Income taxes payable 1,906 1,906
Deferred revenue 18,139 1,952 (1,952)(f) 20,091
-------------- ------------ ------------- -------------
Total current liabilities 35,316 4,894 (1,543) 38,667
Long - term liabilities
Note payable 5,365 (5,365)(g)
Other long - term liabilities 735 735
-------------- ------------ ------------- -------------
Total liabilities 35,316 10,994 (6,908) 39,402
Shareholder's Equity
Common stock 59,647 13,941 (h) 73,588
1,301 (1,301)(i)
Less - notes receivable from shareholder (1,200) 1,200 (i)
Additional paid in capital from stock based compensation 3,302 (3,302)(i)
Deferred compensation on stock options (830) 830 (i)
Accumulated other comprehensive income (1,561) 15 (18)(i) (1,561)
Retained earnings 41,873 (4,133) 4,133 (i) 41,873
(6,300) (j) (6,300)
-------------- ------------ ------------- -------------
Total shareholder's equity 99,959 (1,545) 9,186 107,600
-------------- ------------ ------------- -------------
Total liabilities and shareholder's equity $135,275 $ 9,449 $ 2,278 $ 147,002
-------------- ------------ ------------- -------------
-------------- ------------ ------------- -------------
</TABLE>
INTEGRATED SYSTEMS, INC.
NOTES TO UNAUDITED PRO FORMA COMBINED BALANCE SHEET
a) To reflect the cash consideration paid for the acquisition of SDS.
b) To reflect the elimination of accounts receivable and payable balances
between ISI and SDS.
c) To reflect the intangible assets resulting from the allocation of the
total amount of the consideration paid for the SDS acquisition.
d) To reflect the deferred tax liability arising on acquisition due to the
change in basis of the acquired assets.
e) To reflect the accrual of direct costs arising from the acquisition of
SDS, estimated at approximately $1,652,000 consisting mainly of legal fees,
appraisal fees, audit fees, and an accrual of for the estimated expense
associated with SDS's deferred revenue.
f) To eliminate SDS's deferred revenue.
g) To reflect the repayment by ISI on acquisition of SDS's note payable.
h) To reflect the issuance of $13,941 in common stock on acquisition of SDS.
i) To reflect the elimination of SDS's equity.
j) To reflect the estimated write-off of in-process research and development
of $6.3 million. The charge related to in-process research and
development has not been included in the unaudited pro forma combined
statements of operations since it is non-recurring in nature. However, the
charge has been reflected in the unaudited pro forma combined balance
sheet.
13
<PAGE>
INTEGRATED SYSTEMS, INC.
PRO FORMA COMBINED STATEMENT OF OPERATIONS
(In thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Year Ended
--------------------------
February 28, December 31,
1999 1998 Pro Forma Pro Forma
ISI SDS Adjustments Combined
--- --- ----------- ---------
<S> <C> <C> <C> <C> <C>
Revenue:
Product $ 76,622 $ 14,720 $ (4,362)(l) $ 86,980
Services 56,882 1,802 (210)(l) 58,474
---------------------------------------------------
Total revenue 133,504 16,522 (4,572) 145,454
Costs and expenses:
Cost of product revenue 13,505 3,335 (4,362)(l) 12,478
Cost of services revenue 24,987 1,077 (210)(l) 25,854
Marketing and sales 48,743 8,285 57,028
Research and development 18,625 3,600 22,225
General and administrative 12,940 6,049 18,989
Acquisition-related and other 8,507 8,507
Amortization of intangibles 523 9,024 (m) 9,547
---------------------------------------------------
Total costs and expenses 127,830 22,346 4,452 154,628
Income (loss) from operations 5,674 (5,824) (9,024) (9,174)
Interest and other income (expense) 4,962 (110) (1,069)(n) 3,783
---------------------------------------------------
Income (loss) before income taxes 10,636 (5,934) (10,093) (5,391)
Provision (benefit) for income taxes 1,003 (1,247) (2,632)(o) (2,876)
---------------------------------------------------
Net income (loss) $ 9,633 $ (4,687) $ (7,461) $ (2,515)
---------------------------------------------------
---------------------------------------------------
Net loss per share - basic & diluted $ (0.10)
---------
---------
Shares used in per share calculations - basic & diluted 23,138 1,430 24,568 (p)
--------- --------- ---------
--------- --------- ---------
</TABLE>
14
<PAGE>
INTEGRATED SYSTEMS, INC.
PRO FORMA COMBINED STATEMENT OF OPERATIONS
(In thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended
-----------------------------
May 31, March 31,
1999 1999 Pro Forma Pro Forma
ISI SDS Adjustments Combined
--- --- ----------- ------------
<S> <C> <C> <C> <C> <C>
Revenue:
Product $ 18,949 $ 3,730 $ (1,036)(l) $ 21,643
Services 13,643 542 (207)(l) 13,978
---------------------------------------------------------
Total revenue 32,592 4,272 (1,243) 35,621
Costs and expenses:
Cost of product revenue 4,909 771 (1,036)(l) 4,644
Cost of services revenue 5,994 176 (207)(l) 5,963
Marketing and sales 14,025 2,442 16,467
Research and development 5,309 958 6,267
General and administrative 3,331 996 4,327
Amortization of intangibles 172 0 2,256 (m) 2,428
---------------------------------------------------------
Total costs and expenses 33,740 5,343 1,013 40,096
Income (loss) from operations (1,148) (1,071) (1,999) (4,475)
Interest and other income (expense) 1,400 (94) (212)(n) 1,094
---------------------------------------------------------
Income (loss) before income taxes 252 (1,165) (2,468) (3,381)
Provision (benefit) for income taxes 81 (359) (531)(o) (809)
---------------------------------------------------------
Net income (loss) $ 171 $ (806) $ (1,937) $ (2,572)
---------------------------------------------------------
---------------------------------------------------------
Earnings per share - basic & diluted $ (0.11)
------------
------------
Shares used in per share calculations - basic & diluted 22,775 1,430 24,405 (p)
--------- --------- ------------
--------- --------- ------------
</TABLE>
INTEGRATED SYSTEMS, INC.
NOTES TO UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS
l) To reflect the elimination of product and services revenue and the related
cost of revenue on transactions between ISI and SDS.
m) To reflect amortization of goodwill and intangible assets associated
with the acquisition as follows:
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------
Amortization Amortization
Amortization expense for 12 expense for 3
Amount period month period month period
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Goodwill $20,118 5 years $4,024 $1,006
- ----------------------------------------------------------------------------------------
OEM relationships,
Trade name, Workforce $7,500 5 years $1,500 $375
- ----------------------------------------------------------------------------------------
Non-compete agreement $1,000 4 years $250 $62
- ----------------------------------------------------------------------------------------
Completed technology $6,500 2 years $3,250 $813
</TABLE>
n) To reflect the loss of interest income ($1.3 million for the year, and
$0.3 million for the three month period), due to the cash portion of the
purchase price and reduction in interest expense ($0.2 million for the
year and $0.1million for the three month period) on the note payable.
o) To reflect the effect of the above adjustments on income tax expense,
excluding the amortization of goodwill which is a non-deductible item.
p) To reflect adjustment to the weighted average shares outstanding of the
1,430,046 issued to the shareholders SDS on acquisition, assuming that
all the shares issued in the purchase were outstanding for the year.
15
<PAGE>
(c) EXHIBITS
The following exhibits are filed herewith:
2.01 Agreement and Plan of Reorganization dated as of July 15, 1999 by and
among ISI, Software Development Systems, Inc., ISI Acquisition
Corporation and certain individual shareholders of Software
Development Systems, Inc. Pursuant to Item 601(b)(2) of Regulation of
S-K, the schedules have been omitted but will be furnished
supplementally to the Commission upon request.*
4.01 Registration Rights Agreement dated as of July 15, 1999 by and among
ISI and the shareholders of Software Development Systems, Inc.*
10.01 Offer of Employment dated July 15, 1999 from ISI to James E.
Challenger.*
10.02 Non-Competition Agreement dated as of July 15, 1999 between ISI and
James E. Challenger.*
23.01 Consent of KPMG LLP, Independent Auditors.
- -------------------------------
*Previously filed.
[REMAINDER OF THE PAGE INTENTIONALLY LEFT BLANK.]
17
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this amendment to report to be signed on its behalf
by the undersigned thereunto duly authorized.
INTEGRATED SYSTEMS, INC.
By: /s/ William C. Smith
------------------------------------
Date: October 4, 1999 William C. Smith
Vice President, Finance and
Chief Financial Officer
18
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
NUMBER DESCRIPTION
- ------ -----------
<S> <C>
2.01 Agreement and Plan of Reorganization dated as of July 15,
1999 by and among ISI, Software Development Systems, Inc.,
ISI Acquisition Corporation and certain individual
shareholders of Software Development Systems, Inc.
Pursuant to Item 601(b)(2) of Regulation of S-K, the
schedules have been omitted but will be furnished
supplementally to the Commission upon request.*
4.01 Registration Rights Agreement dated as of July 15, 1999 by
and among ISI and the shareholders of Software Development
Systems, Inc.*
10.01 Offer of Employment dated July 15, 1999 from ISI to James E.
Challenger.*
10.02 Non-Competition Agreement dated as of July 15, 1999 between ISI
and James E. Challenger.*
23.01 Consent of KPMG LLP, Independent Auditors
</TABLE>
- -----------------------------
*Previously filed.
<PAGE>
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
Software Development Systems, Inc.:
We consent to the inclusion of our report dated April 30, 1999, with respect to
the consolidated balance sheet of Software Development Systems, Inc. and
subsidiaries as of December 31, 1998, and the related consolidated statements of
operations, stockholders' equity, and cash flows for the year then ended, in
this Form 8-K/A of Integrated Systems, Inc.
/s/ KPMG LLP
- --------------
Chicago, Illinois
September 29, 1999
