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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR FISCAL YEAR ENDED FEBRUARY 28, 1999 OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 0-18268
INTEGRATED SYSTEMS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN IT'S CHARTER)
CALIFORNIA 94-2658153
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
201 MOFFETT PARK DRIVE
SUNNYVALE, CA 94089
(408) 542-1500
(ADDRESS,INCLUDING ZIP CODE, OF REGISTRANT'S
PRINCIPAL EXECUTIVE OFFICES AND
REGISTRANT'S TELEPHONE NUMBER,
INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
None
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
Common Stock
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. /X/
As of April 30, 1999, the aggregate market value of the voting stock of the
Registrant held by non-affiliates of the Registrant was $242,430,497. The
aggregate market value was computed by reference to the closing price of the
common stock on the Nasdaq National Market on April 30, 1999.
As of April 30, 1999, there were 22,808,780 shares of Registrant's common
stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Registrant's definitive Proxy Statement for its Annual Meeting of
Shareholders to be held August 3, 1999 are incorporated by reference in Part III
hereof.
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INTEGRATED SYSTEMS, INC.
1999 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PART I
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Item 1. Business......................................................................... 1
Item 2. Properties....................................................................... 9
Item 3. Legal Proceedings................................................................ 9
Item 4. Submission of Matters to a Vote of Security Holders.............................. 9
Item 4a. Executive Officers of the Registrant............................................. 9
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters........ 12
Item 6. Selected Financial Data.......................................................... 12
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations.................................................................... 13
Item 7a. Quantitative and Qualitative Disclosures About Market Risks ..................... 24
Item 8. Financial Statements and Supplementary Data...................................... 24
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosures................................................................... 24
PART III
Item 10. Directors and Executive Officers of the Registrant............................... 25
Item 11. Executive Compensation........................................................... 25
Item 12. Security Ownership of Certain Beneficial Owners and Management................... 25
Item 13. Certain Relationships and Related Transactions................................... 25
PART IV
Item 14. Exhibits, Financial Statements, Schedule, and Reports on Form 8-K................ 25
Signatures................................................................................... 51
Index to Exhibits............................................................................ 52
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PART I
This Report contains forward-looking statements (within the meaning of
Section 27A of the Securities Act of 1933, as amended (the "Securities Act") and
Section 21E of the Securities Exchange act of 1934, as amended (the "Exchange
Act") regarding Integrated Systems, Inc. ("ISI") and its business, financial
condition, results of operations and prospects. Words such as "expects,"
"anticipates," "intends," "plans," "believes," "seeks," "estimates" and similar
expressions or variations of these words are intended to identify
forward-looking statements, but are not the exclusive means of identifying
forward-looking statements in this Report. Additionally, statements concerning
future matters such as the features, benefits and advantages of ISI's products,
trends in ISI's target markets, ISI's business and sales strategies, the
development of new products, product enhancements or new technologies, matters
relating to proprietary rights, competition and facilities needs and other
statements regarding matters that are not historical are forward-looking
statements.
Although forward-looking statements in this Report reflects the good faith
judgment of ISI's management, these statements can only be based on facts and
factors currently known by ISI. Consequently, forward-looking statements are
inherently subject to risks and uncertainties, and actual results and outcomes
may differ materially from the results and outcomes discussed in the
forward-looking statements. Factors that could cause or contribute to such
differences in results and outcomes include without limitation those discussed
below as well as those discussed elsewhere in the Report. Readers are urged not
to place undue reliance on these forward-looking statements, which speak only as
of the date of the Report. Readers are urged to review and consider carefully
the various disclosures made by ISI in this Report, which attempts to advise
interested parties of the risks and factors that may affect ISI's business,
financial condition and results of operations.
ITEM 1. BUSINESS
OVERVIEW
Integrated Systems, Inc. provides solutions for embedded software
development consisting of real-time operating systems and software components
for embedded microprocessors; tools for designing, developing and optimizing
embedded applications; networking products for device connectivity and
management; and engineering design services for accelerated co-sourced product
development. ISI's products help users accelerate the design, development,
debugging, implementation and maintenance of embedded software. ISI's products
and services are intended to reduce the expense associated with embedded
software and system development and enable customers to develop systems
featuring greater functionality, enhanced performance, improved reliability and
ease-of-use. ISI 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, data communications, automotive, consumer electronics,
office products and point-of-sale, and aerospace. Founded in 1980, ISI is
headquartered in Sunnyvale, California, with a worldwide sales and service
presence extending throughout Asia, Europe, and the Americas.
INDUSTRY BACKGROUND
Embedded systems are found in telecommunications and data communications
products such as routers, access devices, and switches; in automotive products
such as engine controllers and anti-lock braking systems; in consumer
electronics such as digital cameras and security systems; in office products
such as printers, copiers and point-of-sale terminals; and in aerospace products
such as aircraft and spacecraft control systems.
Embedded systems applications are written to automatically perform highly
specialized tasks in the products that contain them. Given the limited memory
resources of specialized embedded microprocessors and microcontrollers, the
embedded system software must be compact and efficient. Because it functions
independently, the software must also be precise, reliable, and able to respond
in real-time to external events.
Today's embedded systems developers face increasingly complex requirements.
The market is rapidly expanding, driven by the increasing demand of
manufacturers for low-cost, high-performance devices that give their products
enhanced functionality. In addition, advanced technology and time-to-market
pressures
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are dictating shorter cycle times and faster development processes. Developers
are also placing a heightened degree of importance on high quality development
environments and operating systems, and in having access to strong technical
support resources.
As a result, many embedded systems developers are seeking to improve
engineering productivity and decreasing time to market by standardizing on
off-the-shelf third-party software, and are evaluating embedded software
development environments with real-time operating system ("RTOS") technology.
ISI believes that more organizations will choose to replace internally developed
tools with commercial products and standardize on integrated enterprise-wide
solutions that are reliable, intuitive, scalable for simple and complex
application development, suited for small to large development teams, and
available on the industry leading platforms and targets.
THE INTEGRATED SYSTEMS' SOLUTION
ISI's technologies allow customers to develop systems with greater
functionality, enhanced performance, and improved reliability and ease-of-use,
while reducing the expense associated with embedded software and system
development. ISI's products, services, and tools provide technology solutions
that address every aspect of the product development cycle.
The ISI solution is built upon pRISM+(TM), a software development
environment optimized for each critical phase of embedded systems development,
bringing up target hardware platforms, developing real-time application
software, and implementing networking support for embedded devices. Tools within
pRISM+ cover each aspect of embedded application development; including handling
team development across mixed UNIX and PC platforms; SCM (Software Configuration
Management) interfaces; source code comprehension tools for effective reuse of
legacy code; highly optimized compilers and debuggers; and real-time systems
analysis tools. pRISM+ speeds time-to-market by providing network development
teams with a comprehensive set of out-of-the-box pSOSystem(R) integrated
protocol products for the majority of embedded networking needs.
pSOSystem is a modular, high-performance, real-time operating system
designed specifically for embedded microprocessors. It provides a complete
multi-tasking environment, and offers performance, reliability, and ease-of-use
on both custom and commercial hardware. ISI's pOSEK(TM) operating system is a
very small, scalable RTOS. Targeted for automotive applications, pOSEK complies
with OSEK/VDX specifications and provides the automotive industry with an RTOS
that meets its specific requirements while supporting popular automotive
microcontrollers.
ISI's engineering services group offers core competencies in areas such
as embedded software design and implementation, drivers and board support
package development, rapid system prototyping, Application Specific Integrated
Circuit ("ASIC") design and development, sophisticated application programming,
test and certification, production engineering, cost reduction, and customized
hands-on training. These services have allowed ISI to offer its customers
complete turnkey solutions.
ISI's extensive resources and industry-specific expertise help
customers in a wide range of industries that include:
o THE TELECOMMUNICATIONS MARKET: As demand for new services and
interoperability within the telecommunications market continues to expand,
many manufacturers are choosing ISI technology to create devices such as
robust telecom switches and peripherals.
o THE DATA COMMUNICATIONS MARKET: In the highly competitive and fast-growing
data communications market, the small footprint and compact code of ISI's
embedded solutions, along with its industry-leading SNMP(TM) (Simple Network
Management Protocol) products, help manufacturers build better
high-performance, high throughput devices such as modems, routers, switches,
hubs, head end equipment, and wireless communications equipment.
o THE AUTOMOTIVE MARKET: Customers in the automotive market use ISI technology
to develop mission-critical applications such as anti-lock brakes and engine
controls, and in-cockpit applications, including navigation and heads-up
display features.
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o THE CONSUMER ELECTRONICS MARKET: ISI technology is instrumental in the
development of a wide range of next-generation consumer products, including
information appliances, set-top boxes, high-definition television, digital
video and cameras, and custom data terminals.
o THE OFFICE PRODUCTS & POINT-OF-SALE MARKETS: ISI technology aids the
development of competitive and highly efficient office products such as
printers, scanners, copiers, and automated mail equipment. Customers in the
point-of-sale market use ISI technology in the development of lottery
terminals and automated gas pumps.
o THE AEROSPACE MARKET: ISI technology supports the development of reliable,
high performance applications for aircraft and spacecraft control systems,
unmanned flight systems, flight simulators, and space station test
equipment.
BUSINESS STRATEGY
As a worldwide embedded systems technology leader with nearly two decades of
broad industry experience, ISI provides best-of-breed technology for embedded
systems development and engineering. Because sophisticated project requirements
and time-to-market pressures demand that embedded development teams work smarter
and faster than ever, ISI has furthered embedded application development by
integrating enabling software technology with a comprehensive set of software
components, tools, and services. Helping customers accelerate the design,
development, debugging, implementation, and maintenance of embedded systems, ISI
provides both the technology and the methodology to deliver a superior product
to market. ISI's objective is to maintain a leadership position in each of its
key markets, as well as to leverage its experience in embedded applications to
enter new and emerging markets. To achieve this objective, ISI is pursuing the
following business strategy:
MAINTAIN TECHNOLOGY LEADERSHIP. ISI's extensive expertise in embedded
software design and development tools and real-time operating systems has
enabled it to be a technology leader in the embedded software development
market. ISI seeks to capitalize on this existing technology base to accelerate
the development of new products that leverage the features of its existing
product line. ISI 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 software development environment and operating
system software.
OFFER COMPREHENSIVE SOLUTIONS. ISI'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 ISI's technology into customers' products and allows ISI's
products to be used effectively by less-experienced engineers. ISI expects to
continue to expand and refine its solution through internal development
activities and strategic acquisitions.
MAINTAIN MARKET FOCUS. ISI's products and services are suitable for a wide
variety of applications and are sold to a broad range of customers across key
markets comprising telecommunications, data communications, automotive, office
products and point-of-sale, consumer electronics, and aerospace. ISI has
developed a complete suite of products to address these markets, as well as to
provide products that reduce the time and expense associated with system
development. ISI 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 ISI's products.
ADDRESS EMERGING MARKET OPPORTUNITIES. From time to time, ISI evaluates
strategic opportunities and applies its technology to develop products for new
markets more quickly. ISI believes its products and services are suitable for
emerging markets because its products are scalable, reliable and rapidly
re-configurable.
PROVIDE PORTABILITY AND SUPPORT FOR INDUSTRY LEADING EMBEDDED
MICROPROCESSORS AND HOST PLATFORMS. ISI has expended significant resources to
make its products available on a broad range of host platforms and 32-bit
embedded microprocessors. This has allowed ISI to sell into a wide 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
ISI's solution.
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PRODUCTS AND SERVICES
By providing a comprehensive range of tools and utilities that include
custom solutions for fast-growing consumer electronics and communications
markets along with the industry's broadest set of target-based networking
capabilities and features, ISI helps customers meet demanding production
schedules while staying on budget. Workgroup-based distributed engineering
enables development across multiple units, corporations, and even continents,
while engineering productivity tools provide design, graphical simulation,
automated code and document generation, and real-time hardware test capability
for dynamic and control system designers. ISI solutions support the entire
product lifecycle by: enhancing manufacturers' productivity; reducing
time-to-market; lowering hardware device costs; and providing remote device
management and field upgrade capabilities. ISI's wide range of solutions
include:
OPERATING SYSTEMS FOR EMBEDDED MICROPROCESSORS: PSOSYSTEM, POSEK.
With more than 38 million installations worldwide, ISI's pSOSystem is a
widely adopted solution for embedded systems products. pSOSystem is a
priority-based, interrupt-oriented multi-tasking kernel requiring as little as
16K of storage, operating on either tightly or loosely coupled microprocessors.
With companion software components such as a remote procedure call library, a
file system manager, and an ANSI C library, as well as third-party products from
members of ISI's pRISM+ pARTNERS(TM) program, this feature-rich operating system
gives developers a full palette of options, tools, and support that extends far
beyond the kernel.
ISI's pOSEK operating system is a customizable, standards-based, real-time
operating system for the auto industry, providing increased functionality with a
smaller capacity footprint than possible with proprietary real-time operating
systems. pOSEK offers the automotive industry a compliant RTOS that meets the
exacting requirements of the automotive industry and supports popular automotive
microcontrollers.
TOOLS TO DESIGN, DEVELOP, AND ANALYZE EMBEDDED APPLICATIONS: PRISM+, SNIFF+(TM),
DIAB DATA, BETTERSTATE(TM), MATRIXX(R)
pRISM+ is a best-of-class integrated development environment (IDE) that
provides embedded developers a comprehensive set of tools supporting the entire
development process, from concept to completion. The pRISM+ environment is
reliable, intuitive, scalable for simple and complex application development,
suited for small to large development teams, and available on leading platforms
and targets. pRISM+ includes source-level debuggers, optimized compilers,
run-time analyzers, a source code comprehension tool, interfaces to
configuration managers, and version control tools. Based on the Common Object
Request Broker Architecture (CORBA) standard for maximum flexibility and
expandability, pRISM+ also allows developers to plug any third-party tool
seamlessly into the pSOSystem development environment. Providing critical
functionality across all development platforms and target processors through
common facilities, pRISM+ supports Microsoft(R) Windows(R) NT(TM), Windows 95
and UNIX Solaris and HP host platforms and the embedded industry leading
Motorola 68xxx ("68K") and PowerPC, MIPS, ARM, Intel x86, and Mitsubishi M32R
target processors. The pSOSystem operating system is also supported on Intel
i960, Hitachi SH, ColdFire, Fujitsu Sparclite, NEC V8xx, and ST-20. ISI will
continue to port new architectures to pRISM+ as powerful new microprocessors
come to market.
ISI's subsidiary, TakeFive Software GmbH, provides SNiFF+, an integrated
object-oriented development environment for UNIX and Windows programmers working
with C, C++, Java(TM), Fortran, CORBA, IDL, and other programming languages.
Available as part of pRISM+ for pSOSystem, SNiFF+ provides advanced,
object-oriented comprehensive source code analysis capabilities, such as symbol,
hierarchy and class browsers, component analyzers and cross-referencing tools to
assist the developer in developing application code. The SNiFF+ tool is ideally
suited for large teams and complex application development with its SCM
interface, which provides a centralized API (Application Programming Interface)
to interface easily to standard SCM packages such as ClearCase, PVS, RCS or even
proprietary systems. SNiFF+ supports reverse engineering, configuration
management, workspaces and build management, and provides a comprehensive set of
browsers and parsers. With its open architecture, SNiFF+ for Windows is the only
environment that gives developers the flexibility to integrate their choice of
editors, compilers, debuggers, and source code
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managers with a consistent GUI. SNiFF+ also provides a language sensitive editor
with semantic navigation, a documentation builder for code reuse, and a
Unix-like make system.
Through its subsidiary, Diab Data, Inc. ("Diab Data"), ISI provides
high-performance power compiling solutions for 32-bit embedded processors. A
pioneer since 1986 in innovative CISC and RISC compiler technology, Diab Data
has developed highly reliable, ultra high-performance C/C++ compiler suites for
the most demanding embedded applications. Its new highly optimizing cross
compiler, FastJ(TM), enables developers to use the Java language in a manner
similar to C/C++ while offering the performance and code size required for both
high performance and deeply embedded applications. Drawing on information
generated by the compiler suites, Diab Data's RTA Suite provides visual run-time
analysis tools for enhancing program performance, reliability, and memory usage
in embedded applications, enabling developers to create faster, higher quality
code in less time. Diab Data joined forces with ISI in 1995 as an independent
operating subsidiary. With an advanced program optimization technology, Diab
Data's power compiling solutions allow developers to maximize the power of their
design.
BetterState provides powerful graphical programming capabilities based on
graphical constructs such as Statecharts and Flowcharts. With support for
pSOSystem and OSEK/VDX operating systems, BetterState offers developers
significant benefits by simplifying maintenance, reducing design iterations and
facilitating design reuse. Once designs have been drawn, BetterState
automatically generates consistent, maintainable, and accurate ready-to-use code
in any of a wide range of programming languages, including C/C++, Java, C++ for
MFC, Visual Basic, Perl, CGI, and more. BetterState also eases the debugging
process through full-featured visual debugging facilities.
Widely used by customers in the aerospace and automotive industries, ISI's
MATRIXx product family is a complete solution for graphical design, simulation,
automatic code and document generation, and testing of real-time dynamic
systems. Using these tools, applications are developed, analyzed, validated,
implemented, and documented by way of a single graphical representation. The
product family features SystemBuild(TM), for graphical modeling and simulation;
Xmath(R) for object-oriented mathematical analysis and visualization;
AutoCode(TM) for automatic C and Ada source code generation; DocumentIt(TM) for
automatic document generation; and the RealSim(TM) AC-104 rapid prototyping
computer.
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 hierarchial block diagram editor which
supports high-fidelity process behavioral modeling, visual software
specification, simulation based verification and validation, application of
advanced analysis and design techniques, an open architecture environment and
seamless integration with AutoCode (the MATRIXx automated code generator).
XMATH is a mathematically-based engineering analysis, visualization and
scripting 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. Xmath complements the SystemBuild tool.
AUTOCODE automatically generates programming code from SystemBuild diagrams
in the C or Ada languages. AutoCode is optimized for size, speed and
calibration, and can be implemented on a real-time operating system (pSOSystem
or others), a microcontroller or other targets using the customizable template
programming capability.
DOCUMENTIT software further accelerates the design process by automatically
incorporating information about a design into a documentation format.
REALSIM SERIES prototyping tools complete the MATRIXx 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 the RealSim Series hardware.
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NETWORKING PRODUCTS TO MANAGE AND CONNECT EMBEDDED DEVICES
ISI's networking application enablers let developers create applications in
the areas of network and web management, security, monitoring and routing
technologies. ISI's comprehensive solution supports the development of
communications devices with networked management and security functionality,
integrating the pRISM+ IDE and the pSOSystem RTOS with SNMP, TCP/IP, and HTTP
functionality.
ISI's networking products provide users with portable RMON network
monitoring, Web/HTTP and SNMP browser management, TCP/IP protocol stacks,
OSFP2/RIP2/BGP4 routing, and SNMP management technology. These networking
enablers are available in binary or portable source code formats for use with
pRISM+ for pSOSystem and other real-time operating systems. ISI follows a policy
of partnering with industry leading vendors, through the ISI pRISM+ pARTNERS
program, to provide a broad range of application enablers for ISI's target
markets.
A DESIGN GROUP FOR CO-SOURCING OF ENGINEERING SERVICES
ISI's subsidiary, Doctor Design, Inc., ("DDI"), is a source of specialist
engineering design expertise for companies that seek particular technical
skill-sets and exceptional project management capability. Operating within the
framework of the converging computer, communications and consumer electronics
markets, DDI has helped bring to market many products, each with its own
combination of hardware, software and ASIC challenges.
DDI has refined the concept of outsourcing and taken it to the next level.
Co-sourcing is a philosophy that maximizes the effective use of specific skills
within the customers' organization and amplifies those skills with team-oriented
consulting expertise drawn from the ranks of DDI's 100+ staff. Skillful
management of this interface between the two organizations provides a true
concurrent engineering environment, leading to solutions that optimize
time-to-market, and minimize development and manufacturing costs.
SALES AND SUPPORT
ISI markets its products primarily through a direct sales force augmented by
distributors and sales representatives. ISI believes that use of a direct sales
force allows ISI to influence customer purchasing decisions, to provide superior
support to its customers, and to better understand evolving customer needs. ISI
currently uses a direct sales force in the United States, Austria, Canada,
France, Germany, Italy, Sweden, England, Israel, Japan, India, and Korea.
ISI's direct sales organization in North America operates through 18 United
States sales offices. Direct sales managers are supported by field application
engineers who are experts in the embedded market, and ISI's products and
technologies. In addition, an inside sales organization focuses on selling
maintenance, renewal, and royalty contracts, as well as licensing software
upgrades to existing customers.
ISI's software development environment is generally licensed on a per-seat
basis, with the real-time operating system licensed on a per-project basis.
Run-time license fees are typically charged on a per-unit basis when the
customer's application is deployed. List prices for ISI's software development
tools and real-time operating systems development licenses generally range from
less than $5,000 to over $100,000, with a typical development license averaging
between $15,000 and $20,000. Prices for run-time license fees generally range
from less than $1 per-unit to over $100 per-unit depending, in part, on
production quantities.
Approximately 38%, 41%, and 42% of ISI's total revenue was derived from
sales outside North America in fiscal years 1997, 1998 and 1999, respectively.
No single customer accounted for more than 10% of ISI's total revenue in fiscal
years 1997, 1998, and 1999, respectively.
PRODUCT DEVELOPMENT.
ISI's product development activities address the needs of the market
segments upon which ISI focuses by providing an open, industry standard software
development environment for embedded applications. ISI seeks to continue to
enhance the functionality and performance of its pRISM+ for pSOSystem product
lines, while increasingly targeting specific vertical markets and providing
tailored market solutions. In addition to
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the pRISM+ focus, ISI's product development seeks to port pSOSystem to emerging
high volume microprocessors, to continue to target pOSEK to the automotive
market, to add new products and modules to ISI's existing product lines, to
create interfaces between ISI's products and other design and software
development tools, and to provide the end user with comprehensive development
solutions.
ISI releases upgrades and introduces new products or modules on a regular
basis. In connection with each release, ISI works closely with its customers to
define improvements and enhancements that are incorporated into future releases
of the product. This approach includes customer feedback in ISI's product design
process, as well as in ISI's evaluation stage, thereby permitting customers to
influence functionality early in the product's life-cycle.
ISI believes that its engineering services group provides ISI 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, 1999, ISI employed 147 engineers in the product
development group and 82 in the engineering services group. ISI's engineers
include experts in software engineering, software development tools, multimedia,
telecommunications, real-time controls and operating systems technology.
COMPETITION
The market for commercially available software tools and embedded operating
systems is highly competitive and is characterized by pressures to incorporate
new features and accelerate the release of new product versions. ISI'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 products for their specific needs. Many of these
companies have significant investments in their existing software and there can
be no assurance that ISI will be able to persuade existing and potential
customers to replace or augment their internally developed real-time operating
systems with ISI's products.
ISI's principal competitors for third-party embedded software development
and related tools are Wind River Systems, Inc., Microsoft Corporation through
its introduction of Windows CE, and Sun Microsystems, Inc. with its acquisition
of Chorus. 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. ISI 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, ISI expects competition to increase in
the future from existing competitors and from other companies that may enter
ISI's existing or future markets with similar or substitute solutions that may
be less costly or provide better performance or functionality than ISI's
products. Some of ISI's existing and many of its potential competitors have
substantially greater financial, technical, marketing and sales resources than
ISI and there can be no assurance that ISI will be able to compete successfully
against these companies. In the event that price competition increases
significantly, competitive pressures could cause ISI to reduce the prices of its
products, which would result in reduced profit margins. Prolonged price
competition would have a material adverse effect on ISI'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 ISI's
real-time operating systems, may be subject to significant pricing pressures. A
variety of other potential actions by ISI's competitors, including increased
promotion and accelerated introduction of new or enhanced products, could have a
material adverse effect on ISI's business, financial condition and results of
operations.
ISI believes that the principal bases for a customer's decision to license
ISI's products are product functionality and performance, degree of integration,
ease of product use, quality of support services and corporate reputation. ISI
believes that it competes favorably in these areas.
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PROPRIETARY RIGHTS
ISI's success is heavily dependent upon its proprietary technology. To
protect its proprietary rights, ISI relies on a combination of copyright, trade
secret, patent and trademark laws, nondisclosure and other contractual
restrictions on copying and distribution and technical measures. ISI seeks to
protect its software, documentation and other written materials through trade
secret and copyright laws, which provide only limited protection. There can be
no assurance that patents held by ISI will not be challenged and invalidated,
that patents will issue from any of ISI'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 ISI's products can be sold) to
provide meaningful protection or any commercial advantage to ISI. As part of its
confidentiality procedures, ISI 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 ISI'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
ISI's products is also protected as a trade secret and, except for Networking
Components, is generally not licensed to customers. Despite ISI's efforts to
protect its proprietary rights, it may be possible for unauthorized third
parties to copy ISI's products or to reverse engineer or obtain and use
information that ISI regards as proprietary. There can be no assurance that
ISI's competitors will not independently develop technologies that are
substantially equivalent or superior to ISI's technologies. Policing
unauthorized use of ISI's products is difficult, and while ISI 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 be issued that relate to
fundamental technologies incorporated into ISI's products.
As the number of patents, copyrights, trademarks and other intellectual
property rights in ISI's industry increases, products based on its technology
may increasingly become the subject of infringement claims. Third parties could
assert infringement claims against ISI in the future. Infringement claims with
or without merit could be time consuming, result in costly litigation, cause
product shipment delays or require ISI to enter into royalty or licensing
agreements. Royalty or licensing agreements, if required, might not be available
on terms acceptable to ISI, or at all, which could have a material adverse
effect on ISI's business, financial condition and results of operations. In
addition, ISI may initiate claims or litigation against third parties for
infringement of ISI's proprietary rights or to establish the validity of ISI's
proprietary rights. Litigation to determine the validity of any claims, whether
or not such litigation is determined in favor of ISI, could result in
significant expense to ISI and divert the efforts of ISI's technical and
management personnel from productive tasks. In the event of an adverse ruling in
any such litigation, ISI might be required to pay substantial damages,
discontinue the use and sale of infringing products, and expend significant
resources to develop non-infringing technology or obtain licenses to infringing
technology. The failure of ISI to develop or license a substitute technology
could have a material adverse affect on ISI's business, financial condition and
results of operations.
ISI 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 ISI's business, financial condition and results of operations.
In addition, ISI's products compete with products produced by certain of ISI's
licensors. When these licenses terminate or expire, continued license rights
might not be available to ISI on reasonable terms. The inability to license such
products could have a material adverse effect on ISI's business, financial
condition and results of operations.
BACKLOG
ISI generally ships its products within 30 days after acceptance of a
customer purchase order and, therefore, has insignificant product backlog.
Engineering services backlog, consisting of orders for engineering services
scheduled to be performed within the following twelve months, was approximately
$10.4 million, $4.3 million, and $5.2 million at February 28, 1997, 1998 and
1999, respectively. Most of the contracts with ISI's engineering services
customers are terminable at the convenience of the customer. ISI has experienced
terminations in the past and expects terminations to continue to occur in the
future.
8
<PAGE>
EMPLOYEES
As of February 28, 1999, ISI employed 650 persons, including 310 in sales,
marketing and support services, 229 in engineering (82 in engineering services
and 147 in product development) and 111 in management, administration and
finance. Of these employees, 491 are located in the United States and 159 are
located at ISI's subsidiaries and sales offices outside of the United States. In
addition, from time to time ISI employs temporary employees and consultants.
None of ISI's employees are represented by a labor union or is the subject of a
collective bargaining agreement. ISI has never experienced a work stoppage and
believes that its employee relations are good. ISI 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 continues to be intense in
Santa Clara County, California, where ISI is headquartered, and there can be no
assurance that the Company will be successful in attracting and retaining such
personnel.
ITEM 2. PROPERTIES.
ISI owns a building in Sunnyvale, California with approximately 150,000
square feet. ISI leases a number of offices in North America, Europe, Asia and
Israel.
ITEM 3. LEGAL PROCEEDINGS.
In October 1997, Green Hills Software, Inc., a supplier, filed a demand for
arbitration against ISI, alleging among other things, breach of contract, fraud,
negligent misrepresentation and misappropriation of trade name in connection
with a VAR licensing agreement the companies entered into in 1993. In December
1997, ISI responded to the arbitration demand, and filed a counter-claim against
Green Hills. In February 1999, the arbitration panel found both parties to be in
breach of contract. As a result of the panel's findings, the VAR licensing
agreement between the two companies was terminated effective January 31, 1999,
and ISI was ordered to pay Green Hills $3.5 million, plus legal costs. These
arbitration related expenses were recognized in the fourth quarter of fiscal
year 1999.
ISI is subject to various legal proceedings and claims, either asserted or
unasserted, which arise in the ordinary course of business. While management
does not believe that the outcome of any of the legal matters will have a
material adverse effect on ISI's consolidated financial position, legal matters
are subject to inherent uncertainties and thus, there can be no assurance that
these matters will be resolved favorably to ISI.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT.
<TABLE>
<CAPTION>
NAME AGE POSITION
<S> <C> <C>
Joseph Addiego...................... 43 Vice President, Marketing
Charles M. Boesenberg............... 50 President, Chief Executive Officer and Director
Martin Caniff....................... 46 President, Doctor Design, Inc.
Narendra K. Gupta................... 50 Chairman of the Board of Directors and Secretary
Scot J. Morrison.................... 36 Vice President and General Manager, Design Automation
Solutions
William C. Smith.................... 60 Vice President, Finance and Chief Financial Officer
David E. Stepner.................... 54 Vice President, Research and Development
Marco J. Thompson................... 40 Chief Technology Officer
Janice Waterman..................... 39 Vice President, Operations
</TABLE>
Executive officers are chosen by and serve at the discretion of the Board of
Directors of the Company.
9
<PAGE>
Mr. Addiego joined ISI in April 1986. He was appointed Vice President,
Marketing in March 1998. Prior to this position, he was President of TakeFive
Software GmbH (a wholly-owned subsidiary of ISI) since June 1, 1996. From March
1994 to May 1996, he was Vice President, North American Sales. Prior to March
1994, he held a variety of positions in marketing and sales, including Vice
President, Sales, Design Automation Group from January 1992 until February 1994.
Mr. Addiego holds a B.S. in Business from San Francisco State University.
Mr. Boesenberg joined ISI in December 1998 as President, Chief Executive
Officer and a director. From December 1997 to December 1998 he was President
and Chief Executive Officer of Magellan Corporation, a satellite-access
products company based in Santa Clara, California. From January 1995 until it
merged with Magellan Corporation in December 1997, Mr. Boesenberg was
President and Chief Executive Officer of Ashtech, Inc., a
business-to-business GPS company. Previously, he was President, Chief
Executive Officer and Chairman of Central Point Software, Inc., President of
MIPS Computer Systems, Inc., and Senior Vice President of Apple Computers,
Inc. Mr. Boesenberg is on the Board of Directors of Symantec Corporation, a
developer of application and system software products and holds a B.S. in
Mechanical Engineering from Rose Hulman Institute of Technology and an M.S.
in Business Administration from Boston University.
Mr. Caniff joined Doctor Design, Inc. in 1994 as General Manager, Set Top
Box and was promoted to President of Doctor Design in March 1999. Previously he
was the Vice President of Engineering at Docufile, Inc. from 1990 through 1993
and at Optigraphics Corp. from 1983 to 1987. Mr. Caniff holds a B.S. in
Mathematics and a B.S. in Physics from Harvey Mudd College.
Dr. Gupta is a founder of ISI and has been a director of ISI since its
formation in 1980. He has been the Chairman of the Board of ISI since March 1993
and Secretary since September 1989. Dr. Gupta was Chief Executive Officer from
1987 to May 1994 and President from ISI's formation in 1980 to May 1994. He was
elected a Fellow of the Institute of Electrical and Electronic Engineers in
November 1991. Dr. Gupta serves on the board 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.
Mr. Morrison joined ISI in 1986 as a Research Scientist and has held
numerous positions at ISI, including Senior Director of the Design Automation
Solutions business unit. He was promoted to Vice President and General Manager
of this business unit in April 1999. Mr. Morrison holds a B.S. in Applied
Science from the University of Toronto and a M.S. in Aerospace Engineering from
M.I.T.
Mr. Smith joined ISI in January 1997 as the Chief Financial Officer and Vice
President, Finance. From June 1995 to October 1996, Mr. Smith was the Chief
Financial Officer and Vice President, Finance for Meta Software, Inc., an
electronic design automation company. From March 1993 to June 1995, he was the
Chief Financial Officer and Vice President, Finance of Bell Microproducts, Inc.,
a distributor of semiconductor and computer products. Mr. Smith also served as
the Chief Financial Officer of Wadsworth, Inc, from 1983 to 1992. Mr. Smith
holds a B.S. in Financial Management from San Jose State University and an M.B.A
from Gonzaga University.
Dr. Stepner has been Vice President, Research and Development since he
joined ISI 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.
Mr. Thompson founded Doctor Design, Inc. in 1984 and was Doctor Design's
President until March 1999. In June 1998 he was promoted to Chief Technology
Officer of ISI in addition to his role of President of Doctor Design. From 1978
to 1984, Mr. Thompson held various positions at Syte Information Technology and
Megatek Corporation. Mr. Thompson holds a B.S. in Electrical Engineering from
the University of San Diego.
10
<PAGE>
Ms. Waterman joined ISI in July 1995 as Vice President, Human Resources and
has served as Vice President, Human Resources and Operations 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, she served as 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.
11
<PAGE>
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
ISI's common stock is listed on the Nasdaq National Market under the trading
symbol "INTS". The range of high and low sale prices for ISI's common stock on
that market for each of the four quarters during the last two fiscal years are
as follows:
<TABLE>
<CAPTION>
Q1 Q2 Q3 Q4
------- ------ ------ -------
<S> <C> <C> <C> <C> <C>
FY99 High................................... $23.125 $19.313 $13.000 $17.688
Low.................................... $16.125 $7.063 $6.250 $10.000
FY98 High................................... $24.500 $18.000 $25.000 $18.125
Low.................................... $8.750 $11.063 $15.063 $12.188
</TABLE>
As of April 30, 1999, there were 195 holders of record of ISI's common
stock.
ISI has never declared or paid cash dividends on its capital stock and
anticipates that, for the foreseeable future, it will continue to retain any
earnings for use in the operation of its business.
ITEM 6. SELECTED 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
income data set forth below with respect to the years ended February 28, 1997,
1998, and 1999 and the consolidated balance sheet data at February 28, 1998 and
1999 are derived from, and are qualified by reference to, the audited
consolidated financial statements and notes thereto included in this Annual
Report. The consolidated statement of income data set forth below with respect
to the years ended February 28, 1995 and 1996 and the consolidated balance sheet
data at February 28, 1995, 1996, and 1997 are derived from audited consolidated
financial statements not included in this Annual Report. During fiscal year
1996, ISI acquired TakeFive Software GmbH and Doctor Design, Inc. in
transactions accounted for as poolings of interests. Fiscal year 1995 and 1996
annual financial information includes the combined results of ISI and Doctor
Design. Fiscal year 1997 and 1998 annual financial information includes the
results of ISI, Doctor Design, and TakeFive. The annual financial information
has not been restated for earlier years because such financial information was
not material to ISI.
During fiscal year 1997, ISI acquired Epilogue Technology Corporation in a
transaction accounted for as a pooling of interests. The results of Epilogue
have been combined with the results of ISI since the date of acquisition. Prior
period information has not been restated for the results of Epilogue because
such financial information was not material. Also during fiscal year 1997, ISI
revised the terms of the acquisition of Diab Data, Inc. which was acquired in
fiscal year 1996 in a transaction accounted for under the equity method of
accounting. Beginning December 1, 1996 the operating results of Diab Data have
been consolidated with those of ISI.
<TABLE>
<CAPTION>
YEAR ENDED FEBRUARY 28,
1995 1996 1997 1998 1999
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF INCOME DATA:
Total revenue ...................................................... $ 58,054 $ 84,442 $105,463 $120,469 $133,504
Income from operations ............................................. $ 7,999 $ 6,464 $ 6,939 $ 5,293 $ 5,674
Net income ......................................................... $ 6,490 $ 5,283 $ 7,254 $ 6,073 $ 9,633
Earnings per share - diluted ....................................... $ 0.33 $ 0.24 $ 0.31 $ 0.25 $ 0.40
Earnings per share - diluted, before
acquisition-related
and other costs and a one-time tax benefit in fiscal year 1999 (1) $ 0.33 $ 0.50 $ 0.47 $ 0.25 $ 0.55
Shares used in diluted per share calculations ...................... 19,964 22,088 23,508 24,078 23,840
</TABLE>
12
<PAGE>
<TABLE>
<CAPTION>
FEBRUARY 28,
1995 1996 1997 1998 1999
-------- -------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and marketable securities $ 36,517 $ 49,476 $ 54,695 $ 67,446 $ 78,331
Working capital ................................ $ 17,783 $ 31,431 $ 38,019 $ 23,036 $ 22,435
Total assets ................................... $ 66,101 $ 85,264 $112,502 $128,120 $143,035
Total shareholders' equity ..................... $ 47,948 $ 58,276 $ 86,172 $ 94,426 $100,791
</TABLE>
- -------------------
(1) Fiscal years 1996, 1997 and 1999 exclude acquisition-related and other costs
of $7.3 million, $5.7 million and $8.5 million, including related tax
effects, respectively, and a one-time tax benefit of $2.4 million in fiscal
year 1999.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
This Management's Discussion and Analysis of Financial Condition and Results
of Operations includes forward-looking statements that reflect Integrated
Systems, Inc.'s ("ISI's") current views with respect to future matters such as
international operations, including the effect of fluctuations in foreign
currency exchange rates and economic conditions in Asia, certain operating
expense levels, capital needs, and year 2000 compliance. Actual results may
differ materially from the results and outcomes discussed in the forward-looking
statements. Factors that could cause or contribute to such differences in
results and outcomes include those discussed below under "Risk Factors."
OVERVIEW
Integrated Systems, Inc. provides solutions for embedded software
development consisting of real-time operating systems (RTOS) and software
components for embedded microprocessors; tools for designing, developing and
optimizing embedded applications; networking products for device connectivity
and management; and engineering design services for accelerated co-sourced
product development. ISI's products help users accelerate the design,
development, debugging, implementation and maintenance of embedded software.
ISI's products and services reduce the expense associated with embedded
software and system development and enable customers to develop systems
featuring greater functionality, enhanced performance, improved reliability
and ease-of-use. ISI 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, data communications, automotive, consumer
electronics, office products and point-of-sale, and aerospace. Founded in
1980, ISI is headquartered in Sunnyvale, California, with a worldwide sales
and service presence extending throughout Asia, Europe, and the Americas.
In July 1996, ISI acquired Epilogue Technology Corporation, a New Mexico
corporation which develops and distributes network management and embedded
Internet software for telecommunications and data communications equipment
manufacturers, embedded software suppliers and networking related integrated
circuit manufacturers. This business combination has been accounted for as a
pooling of interests; however, the results of operations for Epilogue have been
included only since the date of acquisition, as previous results were not
significant. In November 1996, ISI revised the terms of the acquisition of Diab
Data, Inc. which was acquired in fiscal year 1996 in a transaction accounted for
under the equity method of accounting. Revising the terms of the original
acquisition agreement requires the consolidation of the results of Diab Data
from the fourth quarter of fiscal year 1997 onwards.
RESULTS OF OPERATIONS
The following table sets forth for the periods presented the percentage of
total revenue represented by each line item in ISI's consolidated statements of
income and the percentage change in each line item from the prior period.
13
<PAGE>
<TABLE>
<CAPTION>
Period-to-period
Percentage of Total Revenue Percentage Changes hanges
-------------------------------- --------------------------------
Year Ended February 28,
--------------------------------
Fiscal 1997 Fiscal 1998
1997 (1) 1998 1999 (1) to Fiscal 1998 to Fiscal 1999
-------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Revenue:
Product ................................. 63 % 57 % 57 % 3 % 12 %
Services ................................ 37 43 43 33 10
--------------------------------
Total revenue ...................... 100 100 100 14 11
================================
Costs and Expenses:
Cost of product revenue ................. 9 12 12 63 13
Cost of services revenue ................ 18 23 17 44 (19)
Marketing and sales ..................... 37 35 36 10 14
Research and development ................ 16 16 14 9 (1)
General and administrative .............. 8 9 10 33 16
Amoritization of intangible ass-ts....... -- -- -- 97 (24)
--------------------------------
Total costs and expenses ........... 88 95 89 24 4
--------------------------------
Income from operations .......... 12 5 11 (58) 168
Interest and other income .................... 4 3 3 (7) 27
--------------------------------
Income before income taxes ...... 16 8 14 (45) 108
Provision for income taxes ................... 6 3 4 (47) 96
--------------------------------
Net income ...................... 10 % 5 % 10 % (45)% 114 %
================================
</TABLE>
- -------------------------
(1) The table excludes acquisition-related and other costs of $5.7 million and
$8.5 million, including related tax effects, in fiscal years 1997 and 1999,
respectively, and a one-time tax benefit of $2.4 million in fiscal year
1999, since inclusion of these items would render year-to-year comparisons
less meaningful.
Certain prior year amounts have been reclassified to conform to the
current year presentation.
REVENUE. Revenue consists of fees from the licensing of software products
("Product Revenue") and from the maintenance and support of software products,
customer training, and engineering services ("Services Revenue"). Total revenue
increased by 14% from $105.5 million in fiscal year 1997 to $120.5 million in
fiscal year 1998, and by 11% to $133.5 million in fiscal year 1999. The
percentage of ISI's total revenue attributable to Product Revenue decreased from
63% in fiscal year 1997 to 57% in fiscal year 1998, due primarily to engineering
services at Doctor Design growing faster than overall Product Revenue. The mix
of Product and Services Revenues in fiscal years 1998 and 1999 was relatively
constant.
ISI operates in two business segments, the Software segment and the
Engineering Services segment, each of which contribute Product Revenue and
Services Revenue. The Software segment includes design and development tools,
RTOS software and components, and also provides related maintenance, training
and consulting services for the embedded software market. The Engineering
Services segment provides design expertise to the embedded software and other
markets. This segment is managed separately as ISI's subsidiary, Doctor Design.
Components of ISI's revenue by segment for fiscal years 1997, 1998 and 1999 were
as follows (IN THOUSANDS):
<TABLE>
<CAPTION>
YEAR ENDED FEBRUARY 28, 1997:
Engineering
Software Services Total
-------- ----------- --------
<S> <C> <C> <C>
Product..... $65,508 $ 1,038 $ 66,546
Services.... 23,849 15,068 38,917
------- ------- --------
Total....... $89,357 $16,106 $105,463
======= ======= ========
</TABLE>
14
<PAGE>
<TABLE>
<CAPTION>
YEAR ENDED FEBRUARY 28, 1998:
Engineering
Software Services Total
-------- ----------- --------
<S> <C> <C> <C>
Product..... $66,050 $ 2,569 $ 68,619
Services.... 28,208 23,642 51,850
------- ------- --------
Total....... $94,258 $26,211 $120,469
======= ======= ========
<CAPTION>
YEAR ENDED FEBRUARY 28, 1999:
Engineering
Software Services Total
-------- ----------- --------
<S> <C> <C> <C>
Product..... $ 73,219 $ 3,403 $ 76,622
Services.... 33,686 23,196 56,882
-------- ------- --------
Total....... $106,905 $26,599 $133,504
======== ======= ========
</TABLE>
Product Revenue increased 3% from $66.5 million in fiscal year 1997 to
$68.6 million in fiscal year 1998 and by 12% to $76.6 million in fiscal year
1999. The increase in Product Revenue from fiscal year 1997 to fiscal year
1998 was due primarily to the following factors: an increase in the sales
volume of Doctor Design's Bit Stream Generator product; an increase in the
number of licenses of ISI's pRISM+ product, which was released in the second
quarter of fiscal year 1998; an increase in the number of licenses of ISI's
SNiFF+ product; and the inclusion of revenues from Diab Data and Epilogue
(both impacting revenue in fiscal year 1997) for the full fiscal year. These
increases were partially offset by a decrease in revenue from licenses of
ISI's MATRIXx product. The increase in Product Revenue from fiscal year 1998
to fiscal year 1999 was due primarily to increased licensing of the pRISM+,
SNiFF+ and Diab Data products. Revenue from licensing of the MATRIXx product
was essentially flat between fiscal year 1998 and fiscal year 1999.
Services Revenue increased 33% from $38.9 million in fiscal year 1997 to
$51.9 million in fiscal year 1998, and by 10% to $56.9 million in fiscal year
1999. These increases are due to growth in ISI's base of installed software and
the associated increase in maintenance and support and customer training
revenue, and in fiscal year 1998 from growth in engineering services at Doctor
Design. Services Revenue from ISI's Engineering Services segment was essentially
flat from fiscal year 1998 to fiscal year 1999 as Doctor Design focused on
improving margins over growing revenue.
Price increases were not a material factor in ISI's revenue growth in the
periods presented.
The percentage of ISI's total revenue from customers located
internationally was 38%, 41% and 42% in fiscal years 1997, 1998 and 1999,
respectively. The increase in international revenue as a percentage of total
revenue from fiscal year 1997 to fiscal year 1998, was due primarily to the
growth of Product Revenue in Europe and Asia/Pacific being greater than the
growth of Product Revenue in the United States. This increase was partially
offset by the increase in engineering services revenue at Doctor Design, which
has a predominately domestic customer base. In fiscal year 1999, the percentage
of revenue from international customers increased slightly from fiscal year 1998
due to growth in Europe, offset in part, by a slight decline in revenue from the
Asia/Pacific region.
In Europe and the Asia/Pacific region, revenues and expenses are primarily
denominated in local currencies. In fiscal year 1998, the U.S. dollar
strengthened against many foreign currencies, which resulted in relatively lower
revenues when translated into U.S. dollars. ISI estimates that the movement in
exchange rates from fiscal year 1997 to fiscal year 1998 resulted in a decrease
in total revenue of approximately 12%, and that the movement in exchange rates
from fiscal year 1998 to fiscal year 1999 resulted in a decrease in total
revenue of approximately 1%. ISI's operating and pricing strategies take into
account changes in exchange rates over time, however, results of operations may
be significantly affected in the short term by fluctuations in foreign currency
exchange rates.
15
<PAGE>
COSTS AND EXPENSES. Cost of Product Revenue includes the costs of product
packaging and documentation, third-party royalties, amortization of capitalized
software development costs, and the cost related to hardware. Cost of Product
Revenue as a percentage of Product Revenue was 13%, 21% and 21% in fiscal years
1997, 1998 and 1999, respectively. The increase in cost of Product Revenue as a
percentage of Product Revenue from fiscal year 1997 to fiscal year 1998 was due
primarily to the increase in product sales at Doctor Design, which have a lower
gross margin, an increase in the proportion of product sales subject to
third-party royalties and from the write-off of certain prepaid royalties in the
second quarter of fiscal year 1998. In fiscal year 1999, ISI's product mix
remained relatively constant with fiscal year 1998.
Cost of Services Revenue includes personnel and related direct costs
associated with providing software support, customer training, and engineering
services for customers. ISI's cost of Services Revenue as a percentage of
Services Revenue was 49%, 53% and 39% in fiscal years 1997, 1998 and 1999,
respectively. Cost of Services Revenue as a percentage of Services Revenue can
fluctuate due to shifts in the Services Revenue mix between higher margin
maintenance and support revenues and lower margin engineering services revenues.
In addition, the cost of Services Revenue as a percentage of Services Revenue
can fluctuate due to shifts in the proportion of fixed price versus time and
material engineering contracts. Fixed price engineering and consulting contracts
generally have lower gross margins than time and material contracts. In fiscal
year 1998, cost of Services Revenue as a percentage of Services Revenue was
significantly higher than fiscal years 1997 and 1999. This was due to a higher
percentage of total Services Revenue being derived from engineering contracts as
opposed to maintenance and support contracts. In addition, in fiscal year 1998
there was a higher proportion of fixed price engineering services contracts than
in fiscal years 1997 and 1999. In particular, in the second quarter of fiscal
year 1998, ISI was required to procure a significant amount of hardware, which
had no associated gross margin, under the terms of a large fixed price
engineering services contract.
Marketing and sales expenses increased by 10% from $39.0 million in fiscal
year 1997 to $42.7 million in fiscal year 1998, and by 14% to $48.7 million in
fiscal year 1999. Marketing and sales expenses represented 37%, 35%, and 36% of
total revenue in fiscal years 1997, 1998 and 1999, respectively. Marketing and
sales expenses increased in absolute terms in fiscal year 1998 due primarily to;
additional headcount, increased marketing activity associated with the release
of pRISM+ and other new products and product enhancements, and the full-year
effect of the acquisition of Epilogue and the consolidation of Diab Data. The
increase in marketing and sales expenses in fiscal year 1999 reflects ISI's
continued investment in its sales infrastructure and the promotion of its
expanding product range.
Research and development expenses increased 9% from $17.3 million in fiscal
year 1997 to $18.8 million in fiscal year 1998 and decreased by 1% from fiscal
year 1998 to $18.6 million in fiscal year 1999. Research and development
expenses in fiscal years 1997, 1998 and 1999 were 16%, 16%, and 14%,
respectively, of total revenue. The dollar increase in research and development
expenses from fiscal year 1997 to fiscal year 1998, was attributable primarily
to increased personnel and consulting costs associated with ISI's continued
emphasis on developing new products and enhancing existing products, including
pRISM+, and MATRIXx version 6.0, which were released in the second and fourth
quarters of fiscal year 1998, respectively. The decrease in research and
development expenses from fiscal year 1998 to fiscal year 1999 was due to an
increase in the amount of expenses capitalized (see below), offset by an
increase in personnel and consulting costs from ISI's continued investment in
product development. ISI believes that significant investment for product
research and development is essential to product and technical leadership. ISI
anticipates that it will continue to devote substantial resources to product
research and development throughout fiscal year 2000.
Costs that are required to be capitalized under Statement of Financial
Accounting Standards No. 86 ("SFAS No. 86"), "Accounting for the Costs of
Computer Software to be Sold, Leased or Otherwise Marketed" were $1.5 million in
fiscal year 1997, $1.3 million in fiscal year 1998 and $2.5 million in fiscal
year 1999. In fiscal year 1999, the amount of capitalized research and
development expense increased, primarily due to the development of pRISM+
version 2.0 and MATRIXx version 6.1. 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 to the
total of current and anticipated future gross revenues for that product, or
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on a straight-line basis over two years. Amortization for fiscal year 1997 was
$968,000, compared to $949,000 for fiscal year 1998 and $1.4 million for fiscal
year 1999.
General and administrative expenses increased 33% and 16% in fiscal years
1998 and 1999, respectively, and represented 8%, 9% and 10% of total revenue in
fiscal years 1997, 1998 and 1999, respectively. Expenses increased in each
fiscal year due primarily to a combination of increases in personnel and
personnel-related expenses and higher legal fees and outside service costs. In
addition, general and administrative expenses increased in fiscal year 1998 due
to the acquisition of Epilogue and the consolidation of Diab Data.
Acquisition-related and other costs in fiscal year 1997 totaled $5.7
million and related to a one-time payment to the executives and employees of
Diab Data, the write-off of intangible assets related to a prior acquisition,
and direct costs related to the acquisition of Epilogue. Other costs in fiscal
year 1999 of $8.5 million consist of arbitration-related expenses and executive
transition costs. See Note 9 to Notes to Consolidated Financial Statements.
Interest and other income was $4.2 million, $3.9 million and $5.0 million
in fiscal years 1997, 1998 and 1999, respectively. Interest and other income in
fiscal year 1998 declined from fiscal year 1997 as the fiscal year 1997 amount
included the net operating income from Diab Data during the period it was
accounted for under the equity method of accounting. See Note 2 to Notes to
Consolidated Financial Statements. Interest and other income increased 27% from
fiscal year 1998 to fiscal year 1999 due primarily to increased rental income
from leasing a portion of ISI's corporate facility. In addition, interest income
increased in fiscal year 1999 due to an increase in the amount of
interest-bearing cash equivalents and marketable securities.
The effective tax rate was 35%, 34% and 9% in fiscal years 1997, 1998 and
1999, respectively. Non-deductible acquisition-related costs in fiscal year 1997
resulted in an effective tax rate of 35% in fiscal year 1997. As a result, in
fiscal year 1998, the effective tax rate decreased slightly to 34%. The 9%
effective tax rate in fiscal year 1999 resulted from a $2.4 million federal tax
benefit related to a tax election in the first quarter of fiscal year 1999.
Excluding this tax benefit, the effective tax rate for fiscal year 1999 was 32%.
The decrease in the effective tax rate from fiscal year 1998 was due primarily
to increased benefits from ISI's Foreign Sales Corporation.
LIQUIDITY AND CAPITAL RESOURCES
ISI has funded its operations to date principally through cash flows from
operations. As of February 28, 1999, ISI had $78.3 million of cash, cash
equivalents and marketable securities. This represents an increase of $10.9
million from February 28, 1998. In April 1997, ISI announced that the Board of
Directors had authorized a common stock repurchase program allowing ISI to
repurchase up to 1,000,000 shares of common stock for cash, from time-to-time at
market prices. No time limit was set for the completion of the program. In
September 1998, the Board of Directors authorized an additional 1,000,000 shares
of common stock to be repurchased under this program. As of February 28, 1999,
ISI had repurchased 1,206,000 shares of common stock for $10.4 million under
this program.
Net cash provided by operating activities was $21.9 million during fiscal
year 1999, an increase of $5.9 million over the amount generated in fiscal year
1998. Net cash provided by operating activities increased in fiscal year 1999,
due to higher net income than in fiscal year 1998, and the fact that accounts
receivable decreased by $1.0 million from February 28, 1998 to February 28,
1999. In addition, increases in accounts payable, accrued payroll, other accrued
liabilities and deferred revenue in fiscal year 1999 contributed to the increase
in cash provided by operating activities. Net cash provided by operating
activities was $16.0 million in fiscal year 1998, an increase of $15.8 million
over the amount provided in fiscal year 1997. This increase was due to a smaller
increase in accounts receivable, the inclusion in fiscal year 1997 of net income
from a subsidiary accounted for under the equity method of accounting, decreases
in current liabilities and income taxes payable, and a larger increase in
deferred revenue.
Net cash used in investing activities was $13.1 million in fiscal year 1999
compared to $29.4 million in fiscal year 1998 and $16.7 million in fiscal year
1997. The decrease in net cash used in investing activities in fiscal year 1999
was due primarily to a decrease in the net purchases of marketable securities,
offset in part by an increase in the amount of capitalized software development
costs. The increase in net cash used in investing activities in fiscal year 1998
compared to fiscal year 1997 was due to an increase in the net
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purchases of marketable securities offset, in part, by a decrease in additions
to property and equipment.
Net cash used in financing activities totaled $4.3 million in fiscal year
1999. This compares to net cash provided by financing activities of $2.5 million
in fiscal year 1998 and $20.6 million in fiscal year 1997. The net use of cash
for financing activities in fiscal year 1999 was due to the repurchase of 1.1
million shares of common stock for $8.7 million. This use of cash was offset, in
part, by proceeds from the exercise of stock options and employee stock
purchases. In fiscal year 1998, ISI repurchased 135,000 shares of common stock
for $1.7 million and received proceeds from the exercise of stock options and
employee stock purchases of $3.1 million. In fiscal year 1997, ISI issued and
sold 500,000 shares of common stock for net proceeds of $12.8 million.
ISI believes that the cash flows from operations, together with existing
cash and investment balances, will be adequate to meet cash requirements for
working capital, capital expenditures and stock repurchases for the next 12
months.
RECENT ACCOUNTING PRONOUNCEMENTS
In April 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position 98-1 ("SOP 98-1"), "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use." SOP 98-1
provides guidance for determining whether computer software is internal-use
software and on the accounting for the proceeds of computer software originally
developed or obtained for internal use and then subsequently sold to the public.
It also provides guidance on capitalization of the costs incurred for computer
software developed or obtained for internal use. ISI is currently evaluating the
impact, if any, of adopting this statement. The disclosures prescribed by SOP
98-1 will be effective for ISI's fiscal year ending February 29, 2000.
Also in April 1998, the AICPA issued Statement of Position 98-5 ("SOP
98-5"), "Reporting on the Costs of Start-Up Activities". SOP 98-5 provides
guidance on the financial reporting of start-up costs and organization costs and
requires such costs to be expensed as incurred. This statement will be effective
for ISI's fiscal year ending February 29, 2000. ISI has not yet determined the
impact, if any, of adopting SOP 98-5.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 ("SFAS 133"), "Accounting for Derivative
Instruments and Hedging Activities", which supercedes and amends a number of
existing standards. The statement is effective for ISI's fiscal year 2001, but
earlier application is permitted. The impact of the adoption of this statement,
if any, on the financial statements of ISI has not yet been determined.
In December 1998, the AICPA issued Statement of Position 98-9 ("SOP 98-9"),
"Modification of SOP 97-2, Software Revenue Recognition with Respect to Certain
Transactions". This statement supercedes SOP 98-4 and clarifies one of the
provisions of SOP 97-2. SOP 98-9 is effective for all transactions entered into
by ISI in fiscal year 2001. The adoption of this statement is not expected to
have a material impact on ISI's operating results, financial position or cash
flows.
"YEAR 2000" ISSUES
ISI believes that all of its most current product releases will not cease to
perform nor generate incorrect or ambiguous data or results solely due to a
change in date to or after January 1, 2000, and will calculate any information
dependent on such dates in the same manner, and with the same functionality,
data integrity, and performance, as such products do on or before December 31,
1999 (collectively, "Year 2000 Compliance"). However, there can be no assurance
that all of ISI's customers will implement the Year 2000 compliant release of
ISI's products in a timely manner, which could lead to failure of customer
systems and product liability claims against ISI. Even if ISI's products are
Year 2000 compliant, ISI may, in the future, be subject to claims based on Year
2000 issues in the products of other companies or issues arising from the
integration of multiple products within a system. The costs of defending and
resolving Year 2000-related disputes, and any liability of ISI for Year
2000-related damages, including consequential damages, could have a material
adverse effect on ISI's business, financial condition and results of operations.
Such failure could also affect the perceived performance of ISI's products,
which could have a negative effect on ISI's competitive position.
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ISI is reviewing its operations for Year 2000 Compliance and has
identified three categories of risk: internal business software, internal
non-financial software and embedded chip technology, and external
noncompliance by suppliers. With respect to internal business software, ISI
is 80% towards being fully compliant and expects to be in full compliance
before the year 2000. Accordingly, ISI has not developed formal contingency
plans and feels there is minimal risk that the systems will not be compliant
before Year 2000. All financial, order processing and manufacturing software
is fully Year 2000 Compliant.
With respect to internal non-financial software and embedded chip
technology, ISI is currently gathering data to assess the impact of the Year
2000 on systems such as security equipment and telephones, with Year 2000
Compliance scheduled for late 1999. Assessment and implementation plans are
already being executed in approximately 50% of these areas. If ISI is unable
to achieve Year 2000 Compliance for its major non-financial systems, the Year
2000 could have a material impact on the operations of ISI. It is estimated
that ISI is 50% towards being in full compliance. ISI does not currently have
a contingency plan in place for its internal non-financial software and
embedded chip technology.
With respect to external noncompliance by suppliers, ISI is in the
process of identifying and contacting its critical suppliers, service
providers and contractors to determine the extent to which ISI's interface
systems are vulnerable to those third parties' failure to remedy their own
Year 2000 issues. It is expected that full identification will be completed
by mid-1999. To the extent that responses to Year 2000 readiness are
unsatisfactory, ISI intends to change suppliers, service providers or
contractors to those who have demonstrated Year 2000 readiness but cannot be
assured that it will be successful in finding such alternative suppliers,
service providers and contractors. ISI currently has formal information
concerning the Year 2000 Compliance status of about 50% of its suppliers
including most of its critical suppliers. In the event that any of ISI's
critical suppliers do not successfully and timely achieve Year 2000
Compliance, and ISI is unable to replace them with new or alternate
suppliers, ISI's business or operations could be adversely affected.
All costs associated with carrying out ISI's plan for the Year 2000
Compliance are being expensed as incurred, and are being funded from cash
provided from operations. As of February 28, 1999 it is estimated that
costs associated with preparation for the Year 2000 were approximately
$800,000 and that a further $1.0 million will be incurred to complete the
above plans. Of these amounts, approximately $500,000 is to cover
new/replacement technologies, and $1.3 million is of a repair or upgrade
nature.
RISK FACTORS
THIS SECTION ON "RISK FACTORS" INCLUDES FORWARD-LOOKING STATEMENTS THAT
REFLECT ISI'S CURRENT VIEWS WITH RESPECT TO FUTURE MATTERS. THE FOLLOWING
DISCUSSION ALSO CONTAINS CAUTIONARY STATEMENTS THAT IDENTIFY IMPORTANT FACTORS,
INCLUDING CERTAIN RISKS AND UNCERTAINTIES, THAT MAY CAUSE ACTUAL RESULTS OR
OUTCOMES TO DIFFER MATERIALLY FROM THOSE IN THE FORWARD-LOOKING STATEMENTS.
FLUCTUATIONS IN QUARTERLY RESULTS MAKE PERIOD-TO-PERIOD COMPARISONS
DIFFICULT. ISI's quarterly operating results can vary significantly depending on
a number of factors. These factors include:
o the volume and timing of orders received during the quarter;
o the mix of and changes in customers to whom ISI's products are sold;
o the timing and acceptance of new products and product enhancements by ISI
or its competitors;
o changes in pricing;
o buyouts of run-time licenses;
o product life cycles;
o the level of ISI's sales of third party products;
o purchasing patterns of customers;
o competitive conditions in the industry;
o foreign currency exchange rate fluctuations;
o business cycles affecting the markets in which ISI's products are sold;
o extraordinary events, such as litigation or acquisitions, including related
charges; and
o economic conditions generally or in various geographic areas.
All of these factors are difficult to forecast. The future operating results
of ISI may fluctuate as a result of these and other factors, including ISI's
ability to continue to develop innovative and competitive products.
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ISI 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, ISI generally recognizes a substantial portion of its
total quarterly revenue from sales orders received and shipped in the last two
weeks of the quarter. Thus, the magnitude of quarterly fluctuations may not
become evident until very late in, or after the end of, a particular quarter. In
addition, a significant amount of ISI's sales orders involve products and
services that yield revenue over multiple quarters or upon completion of
performance. If license agreements entered into during a quarter do not meet
ISI's revenue recognition criteria, even if ISI meets or exceeds its forecast of
aggregate licensing and other contracting activity, it is possible that ISI's
revenues would not meet expectations. Because ISI's staffing and operating
expenses are based on anticipated total revenue levels, and a high percentage of
ISI's costs are fixed in the short term and do not vary with revenue, small
variations between anticipated orders and actual orders, as well as
non-recurring or large orders, can cause disproportionate variations in ISI's
operating results from quarter to quarter.
The procurement process of ISI'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 ISI's
products increasingly becomes a more strategic decision made at higher
management levels, ISI believes that sales cycles for ISI's products will
lengthen. In addition, a portion of ISI's revenues from services are earned
pursuant to fixed price contracts. Variances in costs associated with those
contracts could have a material adverse effect on ISI's business and results of
operations. ISI's results of operations may also be affected by seasonal trends.
While ISI's revenues are not generally seasonal in nature, ISI's total revenue
and net income during the first fiscal quarter have historically been lower than
the previous fourth fiscal quarter for a variety of reasons, including customer
purchase cycles related to expiration of budgetary authorizations.
Due to all of the foregoing factors, ISI 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. During
previous fiscal years, ISI has experienced actual performance that did not meet
financial market expectations. It is possible that, in some future quarters,
ISI's operating results will again be below the expectations of stock market
analysts and investors.
ISI'S ABILITY TO REMAIN COMPETITIVE DEPENDS ON ITS ABILITY TO QUICKLY
INTRODUCE PRODUCT ENHANCEMENTS AND NEW PRODUCTS THAT MEET CUSTOMER DEMANDS.
The market for embedded applications is fragmented and is characterized by
ongoing technological developments, evolving industry standards and rapid
changes in customer requirements. ISI's success depends upon its ability to
continue to develop and introduce in a timely manner new products that take
advantage of technological developments, 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 and preferences. ISI 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
ISI's existing products obsolete. Development delays are commonplace in the
software industry. ISI has experienced delays in the development of new
products and the enhancement of existing products in the past and is likely
to experience delays in the future. If the results of product development
efforts are inadequate or delayed, ISI's business, financial condition and
results of operations would be materially adversely affected. ISI may not 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. In addition, ISI's enhanced or new products may not adequately
address the changing needs of the marketplace. The inability of ISI, 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 ISI's business, financial condition or results
of operations. From time to time, ISI or its competitors may announce new
products, capabilities or technologies that have the potential to replace or
shorten the life cycles of ISI's existing products. Announcements of
currently planned or other new products may cause customers to defer
purchasing existing ISI products. Any failure by ISI 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
ISI's business, financial condition and results of operations.
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COMPETITION CAN LEAD TO PRICING PRESSURES. The market for commercially
available software tools and embedded operating systems is fragmented, highly
competitive and is characterized by pressures to incorporate new features and
accelerate the release of new product versions. As the industry continues to
develop, ISI expects competition to increase in the future from existing
competitors and from other companies that may enter ISI's existing or future
markets with similar or substitute solutions that may be less costly or provide
better performance or functionality than ISI's products. Some of ISI's existing
and many of its potential competitors have substantially greater financial,
technical, marketing and sales resources than ISI and ISI might not be able to
compete successfully against these companies. In the event that price
competition increases significantly, competitive pressures could cause ISI to
reduce the prices of its products, which would result in reduced profit margins
and could negatively affect the ability of ISI to provide adequate service to
its customers. Prolonged price competition would have a material adverse effect
on ISI'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 ISI's real-time operating systems, may be subject to
significant pricing pressures, including buy-out arrangements. A variety of
other potential actions by ISI's competitors, including increased promotion and
accelerated introduction of new or enhanced products, could have a material
adverse effect on ISI's business, financial condition and results of operations.
In addition, ISI's pricing model for software licenses may be subject to market
pressure. The pricing model for ISI's embedded software products is based on a
range of mid-priced development license packages, combined with low-priced
per-unit production (run-time) licenses. In the future, the market may demand
alternative pricing models. This may result in a material adverse effect on
ISI's business, financial condition and results of operations.
ISI MUST EFFECTIVELY INTEGRATE ACQUIRED BUSINESSES. ISI has completed a
number of acquisitions in recent years and may complete additional acquisitions
in the future. The process of integrating an acquired company's business into
ISI'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 ISI's business. Moreover,
the anticipated benefits of an acquisition might not be realized. Future
acquisitions by ISI could result in potentially dilutive issuances of equity
securities, debt-obligations and contingent liabilities, the use of cash
reserves, and amortization expenses related to goodwill and other intangible
assets, which could have a material adverse effect on ISI'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 ISI has no or limited direct prior experience and the potential loss of
key employees of the acquired company.
ISI IS SUBJECT TO THE BUSINESS AND ECONOMIC RISKS OF INTERNATIONAL
OPERATIONS. In fiscal years 1997, 1998 and 1999, ISI derived approximately 38%,
41%, and 42%, respectively, of its total revenue from sales outside of North
America. ISI expects that international sales will continue to generate a
significant percentage of its total revenue in the foreseeable future.
International operations are subject to a number of special risks. These risks
include:
o foreign government regulation;
o reduced protection of intellectual property rights in some countries where
ISI does business;
o longer receivable collection periods and greater difficulty in accounts
receivable collection;
o unexpected changes in, or imposition of, regulatory requirements, tariffs,
import and export restrictions and other barriers and restrictions;
o potentially adverse tax consequences;
o the burdens of complying with a variety of foreign laws and staffing and
managing foreign operations;
o exchange rate fluctuations;
o general geopolitical risks, such as political and economic instability,
hostilities with neighboring countries and changes in diplomatic and trade
relationships; and
o possible recessionary environments in economies outside the United States.
ISI generally denominates sales to and by foreign subsidiaries in local
currency. An increase in the relative value of the dollar against local
currencies would reduce ISI's revenue in dollar terms or make ISI's
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products more expensive and, therefore, potentially less competitive in foreign
markets. For example, revenue from sales in Japan during fiscal years 1998 and
1997 was adversely affected by the weakness of the yen against the dollar.
Similarly, the currencies of many other countries in the Asia Pacific region
have recently lost significant value against the dollar, notably the currencies
of Korea and Taiwan. ISI's future results of operations could be adversely
affected by currency fluctuations. More generally, recent instability in Asian
currency and stock market economies could adversely affect the economic health
of the entire region and could have an adverse effect on ISI's results of
operations. For example, in many countries in the Asia Pacific region, during
fiscal years 1998 and 1999 there was little or no growth in investment in
product development infrastructure by manufacturing companies. ISI relies on
distributors and representatives for sales of its products in some foreign
countries and, accordingly, depends on their ability to promote and support
ISI's products and, in some cases, to translate them into foreign languages.
ISI's international distributors and representatives generally offer products of
several different companies, including in some cases products that are
competitive with ISI's products, and these distributors and representatives are
not subject to any minimum purchase or resale requirements. ISI's international
distributors and representatives may not continue to purchase ISI's products or
provide them with adequate levels of support.
PRODUCT DEFECTS CAN BE EXPENSIVE TO FIX AND CAN CAUSE ISI TO LOSE CUSTOMERS.
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. Despite testing by ISI and testing and use by current and
potential customers, errors might be found in new products after commencement of
commercial shipments. The occurrence of errors could result in loss of or delay
in market acceptance of ISI's products, which could have a material adverse
effect on ISI's business, financial condition and results of operations. The
increasing use of ISI'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 ISI to
significant product liability claims. In addition, ISI's products are used for
applications in business systems where the failure of the embedded system could
be linked to substantial economic loss. ISI's license and other agreements with
its customers typically contain provisions designed to limit ISI's exposure to
potential product liability and other claims. It is likely, however, that the
limitation of liability provisions contained in ISI's agreements are not
effective in all circumstances and in all jurisdictions. ISI does not have
insurance against product liability risks and insurance may not be available to
ISI on commercially reasonable terms. ISI has errors and omissions insurance;
however, this insurance may not be adequate to cover claims. A product liability
claim or claim for economic loss brought against ISI, or a product recall
involving ISI's software, could have a material adverse effect on ISI's
business, financial condition and results of operations.
ISI's operations depend on its ability to protect its computer equipment and
the information stored in its databases against damage by fire, natural
disaster, power loss, telecommunications failure, unauthorized intrusion and
other catastrophic events. ISI believes it has taken prudent measures to reduce
the risk of interruption in its operations. However, these measures might not be
sufficient. Any damage or failure that causes interruption in ISI's operations
could have a material adverse effect on its business, financial condition, and
results of operations.
ISI FACES INTENSE COMPETITION FOR QUALIFIED EMPLOYEES. ISI's future
performance depends to a significant degree upon the continued contributions of
its key management, product development, sales, marketing and operations
personnel. In addition, ISI 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 qualified personnel is intense in Santa Clara
County, California, where ISI is headquartered, and there can be no assurance
that ISI will be successful in attracting and retaining personnel. The failure
of ISI to attract, assimilate and retain the necessary personnel could have a
material adverse effect on ISI's business, financial condition and results of
operations.
ISI DEPENDS ON ITS INTELLECTUAL PROPERTY RIGHTS, AND IS SUBJECT TO THE RISKS
OF INFRINGEMENT. ISI depends on its proprietary technology. Despite ISI's
efforts to protect its proprietary rights, it may be possible for unauthorized
third parties to copy ISI's products or to reverse engineer or obtain and use
information that ISI regards as proprietary. Policing unauthorized use of ISI's
products is difficult, and while ISI is unable to
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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
foreign 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 be issued that relate to
fundamental technologies incorporated into ISI's products.
As the number of patents, copyrights, trademarks and other intellectual
property rights in ISI's industry increases, products based on its technology
may increasingly become the subject of infringement claims. Third parties could
assert infringement claims against ISI in the future. Infringement claims with
or without merit could be time consuming, result in costly litigation, cause
product shipment delays or require ISI to enter into royalty or licensing
agreements. Royalty or licensing agreements, if required, might not be available
on terms acceptable to ISI, or at all, which could have a material adverse
affect on ISI's business, financial condition and results of operations. In
addition, ISI may initiate claims or litigation against third parties for
infringement of ISI's proprietary rights or to establish the validity of ISI's
proprietary rights. Litigation to determine the validity of any claims, whether
or not the litigation is resolved in favor of ISI, could result in significant
expense to ISI and divert the efforts of ISI's technical and management
personnel from productive tasks. In the event of an adverse ruling in any
litigation, ISI might be required to pay substantial damages, discontinue the
use and sale of infringing products and expend significant resources to develop
non-infringing technology or obtain licenses to infringing technology. The
failure of ISI to develop or license a substitute technology could have a
material adverse affect on ISI's business, financial condition and results of
operations.
ISI RELIES ON THIRD-PARTY LICENSES FOR SOME OF ITS PRODUCTS. ISI licenses
software development tool products from other companies to distribute with its
own products. The inability of these 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 ISI's
business, financial condition and results of operations. In addition, ISI's
products compete with products produced by some of ISI's licensors. When these
licenses terminate or expire, continued license rights might not be available to
ISI on reasonable terms. In addition, ISI might not be able to obtain similar
products to substitute into the tool suites. The inability to license these
products could have a material adverse effect on ISI's business, financial
condition and results of operations.
THE MARKET PRICE OF ISI'S STOCK HAS BEEN VOLATILE. The prices for ISI's
common stock have fluctuated widely in the past. During the 12 months ended
February 28, 1999, the closing price of a share of ISI common stock ranged from
a high of $23.13 to a low of $6.25. The management of ISI believes that stock
price fluctuations may have been caused by actual or anticipated variations in
ISI's operating results, announcements of technical innovations or new products
or services by ISI 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 ISI and other
high technology companies, often for reasons unrelated to the operating
performance of the specific companies. 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 the company. Litigation, if
instituted, could result in substantial costs and a diversion of management
attention and resources, which would have a material adverse effect on ISI's
business, financial condition and results of operations even if ISI is
successful in any 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.
FINANCIAL STATEMENTS ARE BASED ON ESTIMATES AND ASSUMPTIONS. The preparation
of financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions that affect the
recorded amounts of assets and liabilities at the date of the financial
statements and the recorded amounts of revenues and expenses during the
reporting period. A change in the facts and circumstances surrounding these
estimates could result in a change to the estimates and impact future operating
results.
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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS.
ISI enters into foreign currency forward exchange contracts to reduce the
impact of currency exchange rate fluctuations on monetary asset and liability
positions. The objective of these contracts is to minimize the impact of
exchange rate fluctuations on ISI's operating results. Gains and losses
associated with exchange rate fluctuations on foreign currency forward exchange
contracts are recorded in income as they offset corresponding gains and losses
on the foreign currency denominated assets and liabilities being hedged. The
costs of the foreign currency forward exchange contracts are also recorded in
income. All foreign currency forward exchange contracts entered into by ISI have
maturities of less than one year. At February 28, 1999, ISI had approximately
$3.4 million of foreign currency forward exchange contracts outstanding, all in
Japanese yen. There were no foreign currency forward exchange contracts at
February 28, 1998. Unrealized gains on foreign currency forward exchange
contracts at February 28, 1999 were approximately $112,000.
ISI believes that the fair market value of its portfolio of marketable
securities or related income would not be significantly impacted by increases or
decreases in interest rates due mainly to the short-term nature of the
portfolio. However, an increase in interest rates could have a material adverse
effect on the fair value of the portfolio. Conversely, declines in interest
rates could harm interest income from the portfolio.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
QUARTERLY FINANCIAL DATA
The following table sets forth selected unaudited quarterly financial data
for ISI's last eight fiscal quarters. This unaudited information has been
prepared on the same basis as the audited information and, in management's
opinion, reflects all adjustments (which include only normal recurring
adjustments) necessary for the fair presentation of the information for the
periods presented. Based on ISI'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 1998
-------------------------------
Q1 Q2 Q3 Q4
-------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Total revenue ................................. $ 24,588 $32,170 $29,902 $33,809
Income (loss) from operations ................. $ (449) $ 427 $ 1,352 $ 3,963
Net income .................................... $ 221 $ 935 $ 1,612 $ 3,305
Earnings per share - basic .................... $ 0.01 $ 0.04 $ 0.07 $ 0.14
Earnings per share - diluted .................. $ 0.01 $ 0.04 $ 0.07 $ 0.14
Shares used in per share calculations - basic . 23,121 23,182 23,291 23,355
Shares used in per share calculations - diluted 23,852 23,969 24,349 24,143
<CAPTION>
FISCAL YEAR 1999
-------------------------------
Q1 Q2 Q3 Q4
-------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Total revenue ................................. $ 31,482 $32,005 $34,962 $35,055
Income (loss) from operations ................. $ 1,514 $ 2,145 $ 3,310 $(1,295)
Net income .................................... $ 4,050 $ 2,348 $ 3,172 $ 63
Earnings per share - basic .................... $ 0.17 $ 0.10 $ 0.14 $ 0.00
Earnings per share - diluted .................. $ 0.17 $ 0.10 $ 0.14 $ 0.00
Shares used in per share calculations - basic . 23,426 23,501 22,969 22,657
Shares used in per share calculations - diluted 24,436 24,276 23,241 23,408
</TABLE>
The financial statements required by this item are submitted as a separate
section of this Form 10-K. See Item 14.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURES.
None.
24
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by Item 10 as to directors is incorporated by
reference from the section entitled "Election of Directors" in ISI's definitive
Proxy Statement for its Annual Meeting of Shareholders to be held August 3,
1999. The information required by this Item as to executive officers is included
in Part I under "Executive Officers of the Registrant."
The information required by this item as to compliance with Section 16(a) of
the Securities Exchange Act of 1934 is incorporated by reference from "Section
16(a) Beneficial Ownership Reporting Compliance" in ISI's definitive Proxy
Statement for its Annual Meeting of Shareholders to be held August 3, 1999.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this item is incorporated by reference from
"Election of Directors- Board of Directors' Meetings and Committees," "Executive
Compensation" and "Compensation Committee Interlocks and Insider Participation"
in ISI's definitive Proxy Statement for its Annual Meeting of Shareholders to be
held August 3, 1999.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this item is incorporated by reference from
"Security Ownership of Certain Beneficial Owners and Management" in ISI's
definitive Proxy Statement for its Annual Meeting of Shareholders to be held
August 3, 1999.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this item is incorporated by reference from
"Certain Transactions" in ISI's definitive Proxy Statement for its Annual
Meeting of Shareholders to be held August 3, 1999.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULE, AND REPORTS ON FORM 8-K.
(a)(1) FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
<S> <C>
Report of Independent Accountants 28
Consolidated Balance Sheets at February 28, 1998 and 1999 29
Consolidated Statements of Income for the years ended February 28, 1997, 1998 and
1999 30
Consolidated Statements of Shareholders' Equity for the years ended February 28,
1997, 1998 and 1999 31
Consolidated Statements of Cash Flows for the years ended February 28, 1997, 1998
and 1999 32
Notes to Consolidated Financial Statements 33
(a)(2) FINANCIAL STATEMENT SCHEDULE. Registrant's financial statement schedule filed
herewith is as follows:
SCHEDULE:
Report of Independent Accountants on Schedule
Schedule II: Valuation and Qualifying Accounts for the years ended February 28,
1997, 1998 and 1999
</TABLE>
25
<PAGE>
(a)(3) EXHIBITS. The following exhibits are filed herewith or incorporated
herein by reference:
<TABLE>
<CAPTION>
EXHIBIT
-------
<S> <C>
3.01(i) Registrant's Articles of Incorporation, as amended to date
(incorporated by reference to Exhibit Number 3.01(i) to the
Registrant's Form 10-K for the fiscal year ended February 28,
1996).
3.01(ii) Registrant's Bylaws, as amended June 12, 1996 (incorporated
by reference to Exhibit Number 4.02 to Registrant's
Registration Statement on Form S-8 under the Securities Act
of 1933, as amended, filed September 27, 1996, Registration
No. 333-12799).
4.01 Registration Rights Agreement dated as of April 13, 1987
(incorporated by reference to Exhibit 4.02 to Registrant's
Registration Statement on Form S-1 under the Securities Act
of 1933, as amended, filed January 26, 1990, Registration No.
33-33219 (the "S-1 Registration Statement")).
10.02* Registrant's 1983 Incentive Stock Option Plan, as amended to
date, and related documents (incorporated by reference to
Exhibit Number 10.02 to the S-1 Registration Statement).
10.03* Registrant's 1988 Stock Option Plan, as amended to date
(incorporated by reference to Exhibit Number 4.01 to the
Registrant's Form S-8 filed with the Securities and Exchange
Commission on August 5, 1994, registration No.
33-82438).
10.04* Registrant's 1990 Stock Purchase Plan, as amended to date
(incorporated by reference to Exhibit Number 4.03 to the
Registrant's Form S-8 filed with the Securities and Exchange
Commission on October 18, 1993).
10.05* Dr. Design, Inc. 1991 Stock Option Plan, as amended to date
(incorporated by reference to Exhibit Number 4.03 to the
Registrant's Form S-8 filed with the Securities and Exchange
Commission on February 22, 1996).
10.06* Form of Indemnity Agreement with Directors (incorporated by
reference to Exhibit Number 10.06 to the S-1 Registration
Statement).
10.07* Form of Stock Option Grant and Stock Option Exercise Form
used in connection with Registrant's 1988 Stock Option Plan,
as amended to date (incorporated by reference to Exhibit
Number 19.01 to Registrant's Form 10-Q for the quarter ended
August 31, 1990).
10.08* Form of Option Modification Agreement (incorporated by
reference to Exhibit Number 19.01 to the Registrant's Form
10-Q for the quarter ended August 31, 1991).
10.09* Registrant's 1994 Directors Stock Option Plan (incorporated
by reference to Exhibit Number 10.10 to the Registrant's Form
10-Q for the fiscal year ended February 28, 1994).
10.10* Form of Stock Option Grant and Stock Option Exercise Form
used in connection with Registrant's 1994 Directors Stock
Option Plan (incorporated by reference to Exhibit Number
10.11 to the Registrant's Form 10-K for the fiscal year ended
February 28, 1994).
</TABLE>
26
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
-------
<S> <C>
10.11 Agreement of Purchase and Sale between Connecticut General
Life Insurance Company and the Registrant dated February 9,
1996 (incorporated by reference to Exhibit Number 10.14 to
the Registrant's Form 10-K for fiscal year ended February 28,
1996).
10.12* Form of Stock Option Exercise Form used in connection with
Registrant's 1988 Stock Option Plan, as amended to date
(incorporated by reference to Exhibit Number 10.13 to the
Registrant's Form 10-Q for the quarter ended May 31, 1995).
10.13* Epilogue Technology Corporation 1994 Stock Option Plan, as
amended to date (incorporated by reference to Exhibit Number
4.03 to the Registrant's Form S-8 filed with the Securities
and Exchange Commission on September 27, 1996, Registration
No. 333-12799).
10.14* Registrant's 1998 Equity Incentive Plan (incorporated by
reference to the Registrant's Form S-8 filed with the
Securities and Exchange Commission on September 29, 1998,
Registration No. 333-64673).
10.15* Form of Stock Option Grant used in connection with
Registrant's 1998 Equity Incentive Plan.
10.16* Employment Agreement for Charles M. Boesenberg
10.17 Registrant's Shareholders Rights Plan dated as of
September 24, 1998 (incorporated by reference to the
Registrant's Form 8-K filed with the Securities and Exchange
Commission on October 6, 1998.
10.18* Employment Termination Agreement for David St. Charles
21.01 List of Registrant's Subsidiaries.
23.01 Consent of Independent Accountants.
27.01 Financial Data Schedules
27.02 Financial Data Schedules (Restated)
27.03 Financial Data Schedules (Restated)
</TABLE>
- -------------------
* Represents a management contract or compensatory plan or arrangement.
(b) REPORTS ON FORM 8-K.
No reports on Form 8-K were filed during the last quarter of the fiscal year
covered by this Report.
(c) EXHIBITS. See (a)(3) above.
(d) FINANCIAL STATEMENT SCHEDULES. See (a)(2) above.
27
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders
Integrated Systems, Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income and comprehensive income, of cash flows, and
of shareholders' equity present fairly, in all material respects, the financial
position of Integrated Systems, Inc. and its subsidiaries at February 28, 1999
and 1998, and the results of their operations and their cash flows for each of
the three years in the period ended February 28, 1999, in conformity with
generally accepted accounting principles. These financial statements are the
responsibility of the company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards, which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
San Jose, California
March 25, 1999
28
<PAGE>
INTEGRATED SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
FEBRUARY 28,
-----------------------
1998 1999
--------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ............................................... $ 14,454 $ 19,079
Marketable securities ................................................... 6,670 9,554
Accounts receivable, net of allowance for doubtful accounts of $2,182 and
$1,610 in 1998 and 1999, respectively ................................ 29,455 28,431
Deferred income taxes .................................................. 1,603 2,360
Prepaid expenses and other ............................................. 4,548 5,255
--------- ---------
Total current assets ............................................ 56,730 64,679
Marketable securities ..................................................... 46,322 49,698
Property and equipment, net ............................................... 18,428 18,633
Intangible assets, net .................................................... 2,867 3,503
Deferred income taxes ..................................................... 2,363 5,322
Other assets .............................................................. 1,410 1,200
--------- ---------
Total assets .................................................... $ 128,120 $ 143,035
========= =========
LIABILITIES
Current liabilities:
Accounts payable ........................................................ $ 5,073 $ 4,761
Accrued payroll and related expenses .................................... 4,321 6,250
Other accrued liabilities (Note 9) ...................................... 5,372 10,668
Income taxes payable .................................................... 2,747 2,562
Deferred revenue ........................................................ 16,181 18,003
--------- ---------
Total current liabilities ....................................... 33,694 42,244
--------- ---------
Commitments and contingencies (Note 6)
SHAREHOLDERS' EQUITY
Preferred stock, no par value, 5,000 shares authorized:
Issued and outstanding: none in 1998 and 1999
Common stock, no par value, 50,000 shares authorized:
Issued and outstanding: 23,339 and 22,686 shares in 1998 and 1999,
respectively ............................................................ 63,647 59,848
Accumulated other comprehensive loss ...................................... (1,290) (759)
Retained earnings ......................................................... 32,069 41,702
--------- ---------
Total shareholders' equity
94,426 100,791
--------- ---------
Total liabilities and shareholders' equity ...................... $ 128,120 $ 143,035
========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
29
<PAGE>
INTEGRATED SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED FEBRUARY 28,
1997 1998 1999
--------- --------- --------
<S> <C> <C> <C>
Revenue:
Product ................................................................. $ 66,546 $ 68,619 $ 76,622
Services ................................................................ 38,917 51,850 56,882
--------- --------- --------
Total revenue ......................................................... 105,463 120,469 133,504
--------- --------- --------
Costs and expenses:
Cost of product revenue ................................................. 8,824 14,373 16,169
Cost of services revenue ................................................ 19,071 27,430 22,323
Marketing and sales ..................................................... 38,963 42,701 48,743
Research and development ................................................ 17,264 18,823 18,625
General and administrative .............................................. 8,377 11,161 12,940
Acquisition-related and other ........................................... 5,676 -- 8,507
Amortization of intangible assets ....................................... 349 688 523
--------- --------- --------
Total costs and expenses .............................................. 98,524 115,176 127,830
--------- --------- --------
Income from operations .............................................. 6,939 5,293 5,674
Interest and other income .................................................. 4,220 3,908 4,962
--------- --------- --------
Income before income taxes .......................................... 11,159 9,201 10,636
Provision for income taxes ................................................. 3,905 3,128 1,003
--------- --------- --------
Net income .......................................................... $ 7,254 $ 6,073 $ 9,633
========= ========= ========
Other comprehensive income (loss), net of taxes:
Unrealized gain (loss) on marketable securities ......................... $ (185) -- $ 60
Foreign currency translation adjustments ................................ $ (1,130) $ (308) 471
--------- --------- --------
Comprehensive income ....................................................... $ 5,939 $ 5,765 $ 10,164
========= ========= ========
Earnings per share - basic ................................................. $ 0.32 $ 0.26 $ 0.42
========= ========= ========
Earnings per share - diluted ............................................... $ 0.31 $ 0.25 $ 0.40
========= ========= ========
Shares used in per share calculations - basic .............................. 22,437 23,237 23,138
========= ========= ========
Shares used in per share calculations - diluted ............................ 23,508 24,078 23,840
========= ========= ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
30
<PAGE>
INTEGRATED SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
UNREALIZED
HOLDING
COMMON STOCK GAIN (LOSS), TRANSLATION RETAINED
SHARES AMOUNT NET ADJUSTMENTS EARNINGS TOTAL
------ -------- -------- ------- -------- ---------
<S> <C> <C> <C> <C> <C>
BALANCES, MARCH 1, 1996 ................................. 21,206 $ 40,283 $ 333 -- $ 17,660 $ 58,276
Exercise of common stock options ...................... 651 2,344 2,344
Common stock issued under Employee
Stock Purchase Plan ................................ 51 975 975
Tax benefit from disqualifying
dispositions of common stock ....................... 4,908 4,908
Pooling of interests with Epilogue .................... 631 26 1,082 1,108
Issuance of common stock in connection
with secondary offering ............................ 500 12,774 12,774
Foreign currency translation adjustments, net ......... $ (1,130) (1,130)
Purchase of Doctor Design common stock for cash ....... (152) (152)
Unrealized holding loss on marketable securities, net . (185) (185)
Net income ............................................ 7,254 7,254
-------- -------- -------- ------- -------- ---------
BALANCES, FEBRUARY 28, 1997 ............................. 23,039 61,158 148 (1,130) 25,996 86,172
Exercise of common stock options ...................... 291 1,408 1,408
Common stock issued under Employee
Stock Purchase Plan ................................ 144 1,660 1,660
Tax benefit from disqualifying
dispositions of common stock ....................... 1,093 1,093
Repurchase of common stock ............................ (135) (1,672) (1,672)
Foreign currency translation adjustments, net ......... (308) (308)
Unrealized holding gain (loss) on marketable
securities, net ..................................... -- --
Net income ............................................ 6,073 6,073
-------- -------- -------- ------- -------- ---------
BALANCES, FEBRUARY 28, 1998 ............................. 23,339 63,647 148 (1,438) 32,069 94,426
Exercise of common stock options ...................... 298 1,835 1,835
Common stock issued under Employee
Stock Purchase Plan ................................ 120 1,446 1,446
Tax benefit from disqualifying
dispositions of common stock ....................... 1,129 1,129
Repurchase of common stock ............................ (1,071) (8,744) (8,744)
Compensation charge from common stock options ......... 535 535
Foreign currency translation adjustments, net ......... 471 471
Unrealized holding gain on marketable securities, net . 60 60
Net income ............................................ 9,633 9,633
-------- -------- -------- ------- -------- ---------
BALANCES, FEBRUARY 28, 1999 ............................. 22,686 $ 59,848 $ 208 $ (967) $ 41,702 $ 100,791
======== ======== ======== ======= ======== =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
31
<PAGE>
INTEGRATED SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED FEBRUARY 28,
1997 1998 1999
-------- -------- --------
Cash flows from operating activities:
<S> <C> <C> <C>
Net income .............................................................. $ 7,254 $ 6,073 $ 9,633
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization .......................................... 4,955 5,594 6,192
Write-downs of intangible assets ....................................... 616 -- --
Deferred income taxes................................................... (399) (997) (3,756)
Provisions for doubtful accounts receivable ............................ 900 2,955 326
Net income from unconsolidated subsidiary .............................. (604) -- --
Compensation charge related to common stock options .................... -- -- 535
Changes in assets and liabilities:
Accounts receivable (8,960) (4,222) 962
Prepaid expenses and other (257) (412) (707)
Accounts payable, accrued payroll and other accrued liabilities ...... (1,448) 2,702 6,913
Income taxes payable ................................................. (3,397) 1,305 (185)
Deferred revenue ..................................................... 2,326 3,560 1,822
Other assets and liabilities ......................................... (779) (553) 126
-------- -------- --------
Net cash provided by operating activities ........................ 207 16,005 21,861
-------- -------- --------
Cash flows from investing activities:
Purchases of marketable securities...................................... (24,836) (52,354) (26,036)
Maturities of marketable securities .................................... 14,374 3,763 5,864
Sales of marketable securities ......................................... 8,697 24,709 14,012
Additions to property and equipment .................................... (16,012) (4,268) (4,424)
Disposals of property and equipment .................................... 805 99 --
Capitalized software development costs ................................. (1,540) (1,344) (2,525)
Net cash acquired in acquisitions ...................................... 2,868 -- --
Other .................................................................. (1,042) -- --
-------- -------- --------
Net cash used in investing activities ............................ (16,686) (29,395) (13,109)
-------- -------- --------
Cash flows from financing activities:
Repurchase of common stock ............................................. -- (1,672) (8,744)
Proceeds from issuance of common stock ................................. 12,774 -- --
Proceeds from exercise of common stock options and purchases under
Employee Stock Purchase Plan ......................................... 3,319 3,068 3,281
Tax benefit from disqualifying dispositions of common stock ............ 4,908 1,093 1,129
Other .................................................................. (374) -- --
-------- -------- --------
Net cash provided by (used in) financing activities .............. 20,627 2,489 (4,334)
======== ======== ========
Effect of exchange rate fluctuations on cash and cash equivalents ......... (385) (230) 207
Net increase (decrease) in cash and cash equivalents ...................... 3,763 (11,131) 4,625
Cash and cash equivalents at beginning of year ............................ 21,822 25,585 14,454
-------- -------- --------
Cash and cash equivalents at end of year .................................. $ 25,585 $ 14,454 $ 19,079
======== ======== ========
Supplemental disclosure of cash flow information:
Cash paid during the year for income taxes, net ........................ $ 2,346 $ 1,243 $ 3,293
Supplemental schedule of noncash investing activities:
Unrealized holding gain (loss) on marketable securities, before tax
effects .............................................................. $ (309) $ -- $ 100
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
32
<PAGE>
INTEGRATED SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS
Integrated Systems, Inc. provides solutions for embedded software
development consisting of real-time operating systems and software components
for embedded microprocessors; tools for designing, developing and optimizing
embedded applications; networking products for device connectivity and device
management; and engineering design services for accelerated co-sourced product
development. ISI's products help users accelerate the design, development,
debugging, implementation and maintenance of embedded software. ISI's products
and services reduce the expense associated with embedded software and system
development and enable customers to develop systems featuring greater
functionality, enhanced performance, improved reliability and ease-of-use. ISI
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,
data communications, automotive, consumer electronics, office products and
point-of-sale, and aerospace. Founded in 1980, ISI is headquartered in
Sunnyvale, California, with a sales and service presence extending throughout
Asia, Europe, and the Americas.
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 ISI's equity in
undistributed earnings since acquisition.
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 date of the financial
statements and the reported amounts of revenues and expenses during the
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. ISI has not experienced any material losses
relating to any investment instruments.
FAIR VALUE OF FINANCIAL INSTRUMENTS AND CONCENTRATIONS OF RISK
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, 1999. The fair
values of ISI's marketable securities are set forth in Note 3.
Financial instruments that potentially subject ISI to concentrations of
credit risks comprise, principally, cash, cash equivalents, investments in
marketable securities and accounts receivable. ISI 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. With respect to accounts
receivable, ISI's customer base is dispersed across many different geographic
areas. ISI performs ongoing evaluations of its customers' financial condition
and generally does not require collateral. ISI maintains allowances for
potential credit losses.
33
<PAGE>
INTEGRATED SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
FAIR VALUE OF FINANCIAL INSTRUMENTS AND CONCENTRATIONS OF RISK - (CONTINUED)
In the normal course of business, ISI has exposures to foreign currency
fluctuations arising from foreign currency-denominated sales, purchases and
intercompany transactions. ISI uses foreign currency forward exchange contracts
to limit its exposure to exchange losses arising from foreign currency payables
and receivables. ISI evaluates its net exposure therefrom and enters into
forward contracts to hedge the net exposure. These contracts are executed with
credit-worthy financial institutions and are denominated in currencies of major
industrial nations. Gains and losses on these contracts serve as hedges in that
they offset fluctuations that would otherwise impact ISI's results. Costs
associated with entering into such contracts are expensed as incurred and are
not material to ISI's financial results. ISI's outstanding contracts at February
28, 1999 are set forth in Note 4.
ISI licenses software development tool products from other companies to
distribute with its own products. The inability of these 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 ISI's business, financial condition and results of operations.
In addition, ISI's products compete with those produced by certain of ISI's
licensors. When these licenses terminate or expire, continued license rights
might not be available to ISI on reasonable terms. In addition, ISI might not be
able to obtain similar products to substitute into the tool suites. The
inability to license such products could have a material adverse effect on ISI's
business, financial condition and results of operations.
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 in 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
Effective March 1, 1998, ISI adopted Statement of Position 97-2
("SOP 97-2"), "Software Revenue Recognition", as amended by SOP 98-4,
"Deferral of the Effective Date of Certain Provisions of SOP 97-2". SOP 97-2
and SOP 98-4 provide guidance on applying generally accepted accounting
principles in recognizing revenue on software transactions. The adoption of
SOP 97-2 and SOP 98-4 did not have a material impact on ISI's financial
position, results of operations or cash flows.
PRODUCT REVENUE. Product revenue consists principally of fees from the
licenses and sale of software products. 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 fee
is fixed and determinable, the software has been shipped and collection of the
resulting account receivable is probable.
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 is recognized ratably over the related service
period. License renewal fees, which are substantially less than the initial
license, are recognized ratably over the license term. Revenue from separately
sold maintenance contracts is recognized ratably over the related service
period. The basis for revenue recognition on engineering and consulting services
contracts depends on the contractual terms. 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.
34
<PAGE>
INTEGRATED SYSTEMS. INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
REVENUE RECOGNITION - (CONTINUED)
For contracts with multiple elements (e.g., deliverable and undeliverable
products, maintenance and other services), ISI allocates revenue to each
component of the contract based on objective evidence of its fair value, which
is specific to ISI, or for products not yet being sold separately, the price
established by management. ISI recognizes revenue allocated to maintenance fees
for ongoing customer support and product updates ratably over the period of the
maintenance contract. For revenue allocated to training and consulting services,
ISI recognizes revenue as the related services are performed.
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. The
cost and accumulated depreciation of assets sold or retired are removed from the
accounts and any resulting gain or loss is reflected in results of operations.
SOFTWARE DEVELOPMENT COSTS
ISI capitalizes certain costs to develop computer software to be licensed or
otherwise marketed to customers. Capitalization of software development costs
begins upon the establishment of technical feasibility of the product.
Technological feasibility is established at the completion of detailed program
design and testing. Capitalized software development 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. ISI evaluates
the estimated net realizable value of each software product at each balance
sheet date and records write-downs to net realizable value for any products for
which the net book value is in excess of net realizable value. Software
development costs included in intangible assets at February 28, 1998 and 1999,
were $2,144,000 and $3,297,000, respectively, net of accumulated amortization of
$3,660,000 and $5,032,000, respectively. Capitalized software development costs
were $1,540,000, $1,344,000, and $2,525,000 in fiscal years 1997, 1998 and 1999,
respectively. Amortization, which is included in cost of product revenue, was
$968,000, $949,000, and $1,372,000 in fiscal years 1997, 1998 and 1999,
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. ISI
periodically evaluates the recoverability of goodwill and purchased software
based upon estimated undiscounted future cash flows from the related products
and businesses acquired.
EMPLOYEE STOCK PLANS
ISI accounts for its stock option plans and its Employee Stock Purchase Plan
in accordance with provisions of the Accounting Principles Board's Opinion No.
25 ("APB 25"), "Accounting for Stock Issued to Employees." In 1995, the
Financial Accounting Standards Board issued Statement of Financial Accounting
Standards No. 123 ("SFAS No. 123"), "Accounting for Stock-Based Compensation."
SFAS No. 123 establishes a fair value based method of accounting for stock-based
plans and became effective in ISI's fiscal year 1997. ISI is continuing to
account for its employee stock plans in accordance with the provisions of APB
25, and has provided pro-forma disclosure in Note 7 as if the measurement
provisions of SFAS No. 123 had been adopted.
35
<PAGE>
INTEGRATED SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
INCOME TAXES
ISI'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
ISI expenses advertising costs as they are incurred. Advertising expense for
fiscal years 1997, 1998 and 1999 was $1,566,000, $2,643,000, and $2,195,000,
respectively.
COMPUTATION OF EARNINGS PER SHARE
Basic earnings per share is computed using the weighted average number of
common shares outstanding during the period. Diluted 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
Assets and liabilities of foreign operations, where the functional currency
is the local currency, are translated into U.S. dollars at the fiscal year end
exchange rate. Revenues and expenses are translated at the average rates
prevailing during the year. The related gains and losses from translation are
recorded as translation adjustments in shareholders' equity. Foreign currency
transaction gains and losses, as well as translation adjustments for assets and
liabilities of foreign operations where the functional currency is the U.S.
dollar, are included in results of operations, and have been immaterial.
COMPREHENSIVE INCOME
ISI has adopted the provisions of the Financial Accounting Standards Board
Statement of Financial Accounting Standards No. 130, "Accounting for
Comprehensive Income". ISI's unrealized gains and losses on marketable
securities and foreign currency translation adjustments represent the only
components of comprehensive income that are excluded from net income. The
components of ISI's other comprehensive income are reported, net of tax, in the
Consolidated Statements of Income and Comprehensive Income and in the
Consolidated Statements of Shareholders' Equity. For fiscal years 1997, 1998 and
1999, the tax effect on ISI's unrealized gains and losses on marketable
securities was $124,000, nil and $40,000, respectively. The tax effect on
foreign currency translation adjustments was nil in fiscal years 1997 and 1998,
and $521,000 in fiscal year 1999.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the current
year presentation. These reclassifications had no effect on previously reported
income from operations, net income, or shareholders' equity.
36
<PAGE>
INTEGRATED SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
RECENT ACCOUNTING PRONOUNCEMENTS
In April 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position 98-1 ("SOP 98-1"), "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use." SOP 98-1
provides guidance for determining whether computer software is internal-use
software and on accounting for the proceeds of computer software originally
developed or obtained for internal use and then subsequently sold to the public.
It also provides guidance on capitalization of the costs incurred for computer
software developed or obtained for internal use. ISI is currently evaluating the
impact, if any, of adopting this statement. The disclosures prescribed by SOP
98-1 will be effective for ISI's fiscal year ending February 29, 2000.
Also in April 1998, the AICPA issued Statement of Position 98-5 ("SOP
98-5"), "Reporting on the Costs of Start-Up Activities". SOP 98-5 provides
guidance on the financial reporting of start-up costs and organization costs and
requires such costs to be expensed as incurred. This statement will be effective
for ISI's fiscal year ending February 29, 2000. ISI has not yet determined the
impact, if any, of adopting SOP 98-5.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 ("SFAS 133"), "Accounting for Derivative
Instruments and Hedging Activities", which supercedes and amends a number of
existing standards. The statement is effective for ISI's fiscal year 2001, but
earlier application is permitted. The impact of the adoption of this statement,
if any, on the financial statements of ISI has not yet been determined.
In December 1998, the AICPA issued Statement of Position 98-9 ("SOP 98-9"),
"Modification of SOP 97-2, Software Revenue Recognition with Respect to Certain
Transactions". This statement supercedes SOP 98-4 and clarifies one of the
provisions of SOP 97-2. SOP 98-9 is effective for all transactions entered into
by ISI in fiscal year 2001. The adoption of this statement is not expected to
have a material impact on ISI's operating results, financial position or cash
flows.
2. ACQUISITIONS
MERGER WITH EPILOGUE
In July 1996, ISI acquired Epilogue Technology Corporation, by issuing
630,963 shares of common stock in exchange for all outstanding Epilogue common
and preferred stock. ISI also assumed stock options that converted into options
to purchase 69,033 shares of ISI's common stock. The business combination was
accounted for as a pooling of interests. Results of operations of Epilogue have
been included from the date of acquisition. Prior period results have not been
restated to include Epilogue operations as such operations were insignificant.
Prior to the business combination, Epilogue was a developer and distributor of
network management and embedded Internet software for telecommunications and
datacommunications equipment manufacturers, embedded software suppliers and
networking related integrated circuit manufacturers. ISI has integrated the
business of Epilogue with that of ISI.
ACQUISITION OF DIAB DATA
In November 1996, ISI revised the terms of the acquisition of Diab Data and paid
bonuses to management and employees of Diab Data of $4.8 million. In addition,
as a result of the revision in terms, ISI was required to consolidate the
results of this subsidiary, which previously had been accounted for under the
equity method of accounting. Accordingly, the operating results of Diab Data
have been consolidated with those of ISI beginning December 1, 1996.
37
<PAGE>
INTEGRATED SYSTEMS. INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
3. MARKETABLE SECURITIES
Marketable securities at February 28, 1998 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 . $ 49,235 $49,014 $ 288 $ (67) $221
Municipal securities ....... 3,757 3,731 26 -- 26
-------- ------- ----- ----- ----
$ 52,992 $52,745 $ 314 $ (67) 247
======== ======= ===== ===== ====
Related deferred taxes ..... (99)
----
Unrealized holding gain, net $148
====
<CAPTION>
Marketable securities at February 28, 1999 are summarized below (in
thousands):
FAIR COST UNREALIZED UNREALIZED UNREALIZED
VALUE BASIS GAINS LOSSES NET GAINS
-------- ------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
U.S. Government securities . $ 58,515 $58,176 $ 437 $ (98) $ 339
Municipal securities ....... 737 730 7 0 7
-------- ------- ----- ----- -----
$ 59,252 $58,906 $ 444 $ (98) 346
======== ======= ===== ===== =====
Related deferred taxes ..... (138)
-----
Unrealized holding gain, net $ 208
=====
</TABLE>
At February 28, 1999, 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. Gross realized gains on sales of available-for-sale securities were
$424,000, $450,000 and zero in fiscal years 1997, 1998 and 1999, respectively.
4. DERIVATIVE FINANCIAL INSTRUMENTS
ISI enters into foreign currency forward exchange contracts to hedge the
value of recorded foreign currency denominated transactions against fluctuations
in exchange rates. The purpose of ISI's foreign exchange exposure management
policy and practices is to attempt to minimize the impact of exchange rate
fluctuations on the value of the foreign currency denominated assets and
liabilities being hedged. All foreign currency forward exchange contracts
entered into by ISI have maturities of 360 days or less. ISI's total contracted
foreign currency forward exchange contracts, all in Japanese yen, at February
28, 1999 cost approximately $3.4 million and had associated unrealized exchange
gains of $112,000. ISI had no foreign currency forward exchange contracts at
February 28, 1998.
5. PROPERTY AND EQUIPMENT, NET (IN THOUSANDS):
<TABLE>
<CAPTION>
FEBRUARY 28,
---------------------
1998 1999
-------- --------
<S> <C> <C>
Building ...................................................................... $ 6,587 $ 6,587
Building improvements ......................................................... 586 706
Furniture and fixtures ........................................................ 2,527 2,207
Computer equipment ............................................................ 17,785 21,715
Leasehold improvements ........................................................ 129 418
-------- --------
27,614 31,633
Less accumulated depreciation and amortization ................................ (14,586) (18,400)
-------- --------
13,028 13,233
Land .......................................................................... 5,400 5,400
-------- --------
$ 18,428 $ 18,633
======== ========
</TABLE>
Depreciation expense was $3,131,000, $3,697,000 and $4,219,000 in fiscal years
1997, 1998 and 1999, respectively.
38
<PAGE>
INTEGRATED SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
6. LEASEHOLD COMMITMENTS AND CONTINGENCIES
OPERATING LEASES
Future minimum lease payments under all noncancelable operating leases
amount to approximately $2,463,000, $1,987,000, $891,000, $181,000, $105,000 and
$477,000 for fiscal years 2000, 2001, 2002, 2003, 2004 and thereafter,
respectively. Rent expense for fiscal years 1997, 1998 and 1999 was $1,633,000,
$2,372,000, and $2,577,000, respectively.
CONTINGENCIES
ISI is subject to various legal proceedings and claims, either asserted or
unasserted, which arise in the ordinary course of business. While management
does not believe that the outcome of any of the legal matters will have a
material adverse effect on ISI's consolidated financial position, legal matters
are subject to inherent uncertainties and thus, there can be no assurance that
these matters will be resolved favorably to ISI.
7. SHAREHOLDERS' EQUITY
COMMON STOCK SPLIT AND COMMON STOCK REPURCHASE PROGRAM
On March 4, 1996 ISI's Board of Directors authorized a two-for-one stock
split which was 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.
In April 1997, ISI announced that the Board of Directors had authorized the
repurchase of up to 1,000,000 shares of common stock for cash from time-to-time
at market prices pursuant to a repurchase program. During fiscal year 1998 ISI
repurchased 135,000 shares of common stock in open market transactions for
approximately $1.7 million under this stock repurchase program. In September
1998, the Board of Directors approved the repurchase of an additional 1,000,000
shares of common stock under this program. During fiscal year 1999, ISI
repurchased 1,071,000 shares of common stock in open market transactions for
approximately $8.7 million, bringing the total number of shares repurchased
under this program to 1,206,000 shares.
COMMON STOCK OPTION PLANS
At February 28, 1999, ISI had reserved 5,387,527 shares of common stock for
issuance under various stock option plans. The plans provide for the granting of
incentive stock options to officers and employees of ISI and nonqualified stock
options to officers, employees, directors and consultants of ISI
("Participants") 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 four or five years and expire in ten
years.
In September 1998, ISI's 1988 Stock Option Plan expired. On March 30,
1998, the Board of Directors of ISI approved the adoption of the 1998 Equity
Incentive Plan, which provides for awards of options to purchase shares of
common stock, restricted stock and stock bonuses (collectively "Awards"). The
number of shares of common stock issuable under the 1998 Plan was initially set
at 1,000,000 shares. The 1998 Plan was approved by shareholders in July 1998,
and became effective in September 1998. All equity awards previously granted
under the 1988 Plan continue to be governed by the terms of the 1988 Plan and
the individual option grants. Shares that become available due to cancellations
or forfeiture of equity awards outstanding under the 1988 Plan will become
available for issuance under the 1998 Plan. The 1998 Plan is administered by the
Compensation Committee of the Board of Directors.
39
<PAGE>
INTEGRATED SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
7. SHAREHOLDERS' EQUITY - (CONTINUED)
COMMON STOCK OPTION PLANS - (CONTINUED)
The 1998 Plan permits the granting of options that are intended to
qualify either as Incentive Stock Options ("ISOs") or Nonqualified Stock Options
("NQSOs"). ISOs may be granted only to employees (including officers and
directors who are also employees) of ISI or any parent or subsidiary of ISI. The
exercise price for each ISO share must be no less than 100% of the "fair market
value" (as defined in the 1998 Plan) of a share of common stock at the time of
grant. The exercise price of an ISO granted to a 10% shareholder must be no less
than 110% of the fair market value of a share of common stock at the time of
grant. The exercise price for each NQSO share must be no less than 85% of the
fair market value of a share of common stock at the time of grant. Options
granted under the 1998 Plan will have a term of up to ten years, except for ISOs
granted to 10% shareholders, which will have a term of up to five years.
The Committee may grant Participants Restricted Stock Awards to
purchase stock under the 1998 Plan, under such terms, conditions and
restrictions as the Committee may determine. These restrictions may be based
upon completion of a specified number of years of service with ISI or upon
completion of performance goals as determined by the Committee on the date of
the Award. The purchase price of shares sold pursuant to a Restricted Stock
Award will be determined by ISI on the date of the Award (and in the case of an
Award granted to a 10% shareholder, the purchase price shall be 100% of fair
market value).
In addition, the Committee may grant Stock Bonus Awards under the 1998
Plan, with such terms, conditions and restrictions as the Committee may
determine. A Stock Bonus Award may be awarded upon satisfaction of such
performance goals as determined by the Committee at the date of the Award.
Unless terminated earlier as provided in the 1998 Plan, the 1998 Plan
will expire in March 2008, ten years after the date the Board adopted the 1998
Plan.
Activity under these plans is as follows (in thousands, except share and per
share amounts):
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
----------------------------------------------
SHARES NUMBER OF WEIGHTED
AVAILABLE SHARES UNDER AVERAGE EXERCISE
FOR GRANT OPTION PRICE PER SHARE TOTAL
---------- ------------ -------------------- --------
<S> <C> <C> <C> <C>
BALANCES, MARCH 1, 1996 ........ 2,042,840 2,525,920 $ 7.40 $ 18,704
Assumption of Epilogue Options -- 69,033 $ 7.50 518
Options granted .............. (1,051,798) 1,051,798 $ 23.64 24,867
Options exercised ............ -- (651,390) $ 3.60 (2,344)
Options canceled ............. 184,453 (194,701) $ 12.85 (2,501)
---------- ---------- --------
BALANCES, FEBRUARY 28, 1997 .... 1,175,495 2,800,660 $ 14.01 39,244
Options granted .............. (2,238,990) 2,238,990 $ 10.70 23,948
Options exercised ............ -- (290,661) $ 4.84 (1,408)
Options canceled ............. 1,823,273 (1,823,273) $ 18.22 (33,218)
Shares added to 1988 Plan .... 1,000,000 -- --
---------- ---------- --------
BALANCES, FEBRUARY 28, 1998 .... 1,759,778 2,925,716 $ 9.76 28,566
Options granted .............. (1,859,950) 1,859,950 $ 14.39 26,770
Options exercised ............ -- (297,967) $ 6.16 (1,835)
Options canceled ............. 281,192 (281,192) $ 14.65 (4,118)
Adoption of 1998 Plan ........ 1,000,000 -- --
---------- ---------- --------
BALANCES, FEBRUARY 28, 1999 .... 1,181,020 4,206,507 $ 11.74 $ 49,383
========== ========== ========
</TABLE>
40
<PAGE>
INTEGRATED SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
7. SHAREHOLDERS' EQUITY - (CONTINUED)
COMMON STOCK OPTION PLANS - (CONTINUED)
The following table summarizes information with respect to stock options
outstanding at February 28, 1999:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------------------- ------------------------------
WEIGHTED
NUMBER AVERAGE NUMBER
OUTSTANDING AT REMAINING WEIGHTED EXERCISABLE AT WEIGHTED
FEBRUARY 28, CONTRACTUAL AVERAGE FEBRUARY 28, AVERAGE
RATIO OF EXERCISE PRICE PER SHARE 1999 LIFE (YEARS) EXERCISE PRICE 1999 EXERCISE PRICE
- --------------------------------- -------------- ------------ -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
$0.67 - $1.35 52,931 4.54 $ 1.05 46,547 $ 1.01
$3.06 - $3.88 117,255 4.27 $ 3.32 117,255 $ 3.32
$4.50 - $6.88 299,703 5.06 $ 5.09 287,455 $ 5.11
$7.40 - $10.88 2,514,707 8.55 $ 9.78 725,518 $ 9.58
$11.13 - $15.38 287,709 8.29 $ 13.49 127,370 $ 13.29
$17.23 - $24.00 928,202 8.32 $ 20.22 144,011 $ 19.72
$28.25 - $35.63 6,000 7.36 $ 29.48 3,762 $ 29.29
---------- ----------
4,306,507 8.06 $ 11.74 1,451,918 $ 9.30
========== ==========
</TABLE>
In April 1997, ISI offered employees the right to cancel certain outstanding
stock options and receive new options with a new exercise price. The new
exercise prices range from $8.75 to $10.50 per share, based on the closing price
of the common stock on the date individual employees agreed to cancel their
original outstanding stock options. Options to purchase a total of 1,222,132
shares at original exercise prices ranging from $14.625 to $35.625 per share
were canceled and new options issued in April 1997. Vesting under the new
options commenced on the date the individual employees agreed to cancel their
original options, and occurs over a four year period. Total options exercisable
at February 28, 1997 and 1998 were 833,000 and 767,000, respectively.
EMPLOYEE STOCK PURCHASE PLAN
At February 28, 1999, ISI had reserved a total of 288,801 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 ISI with a means of
acquiring common stock of ISI through payroll deductions. The purchase price of
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 years 1997, 1998 and 1999, approximately 51,000 shares, 144,000
shares, and 120,000 shares, respectively, were sold through the ESPP. The
aggregate fair value and weighted average fair value per share of purchase
rights under the ESPP in fiscal years 1997, 1998 and 1999 were $667,000,
$757,000, and $728,000, and $11.09, $6.26 and $4.16, respectively.
41
<PAGE>
INTEGRATED SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
7. SHAREHOLDERS' EQUITY - (CONTINUED)
PRO FORMA STOCK-BASED COMPENSATION
ISI has elected to continue to follow the provisions of APB No. 25,
"Accounting for Stock Issued to Employees", for financial reporting purposes and
has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for
Stock-Based Compensation". Accordingly, compensation cost has not been
recognized in ISI's Consolidated Statements of Income for ISI's stock option
plans or ESPP. Had compensation cost for ISI's stock option plans and ESPP been
determined under the fair value provisions of SFAS No. 123 for awards granted
subsequent to February 28, 1995, ISI's net income and net income per share for
the years ended February 28, 1997, 1998 and 1999 would have been reduced to the
pro-forma amounts indicated below (in thousands, except per share amounts):
<TABLE>
<CAPTION>
YEAR ENDED
FEBRUARY 28,
---------------------------
1997 1998 1999
------ ------ ------
<S> <C> <C> <C>
Net income - as reported........................................... $7,254 $6,073 $9,633
Net income - pro forma............................................. $4,497 $2,447 $5,085
Basic net income per share - as reported........................... $ 0.32 $ 0.26 $ 0.42
Basic net income per share - pro forma............................. $ 0.20 $ 0.11 $ 0.22
Diluted net income per share - as reported......................... $ 0.31 $ 0.25 $ 0.40
Diluted net income per share - pro forma........................... $ 0.19 $ 0.11 $ 0.21
</TABLE>
The above pro-forma disclosures are not necessarily representative of the
effects on reported net income for future years.
The aggregate fair value and weighted average fair value per share of options
granted in fiscal years 1997, 1998 and 1999 were $17.0 million, $8.8 million and
$15.5 million, and $16.15, $3.92 and $8.31 per share, respectively. The fair
value of each option grant is estimated on the date of grant using the
Black-Scholes Option Pricing Model with the following weighted average
assumptions:
<TABLE>
<CAPTION>
YEAR ENDED
FEBRUARY 28,
--------------------------------
1997 1998 1999
--------- --------- ---------
<S> <C> <C> <C>
Expected volatility................................................ 79.67% 71.18% 72.51%
Risk-free interest rate............................................ 6.15% 6.28% 4.90%
Expected life ..................................................... 5.0 years 4.5 years 4.0 years
Expected dividend yield............................................ 0.00% 0.00% 0.00%
</TABLE>
ISI has also estimated the fair value for the purchase rights under the Employee
Stock Purchase Plan using the Black-Scholes Option Pricing Model, with the
following assumptions for rights granted in 1997, 1998 and 1999:
<TABLE>
<CAPTION>
YEAR ENDED
FEBRUARY 28,
--------------------------------
1997 1998 1999
--------- --------- ---------
<S> <C> <C> <C>
Expected volatility................................................ 83.16% 69.65% 86.59%
Risk-free interest rate............................................ 5.81% 5.56% 4.68%
Expected life ..................................................... 0.5 years 0.5 years 0.5 years
Expected dividend yield............................................ 0.00% 0.00% 0.00%
</TABLE>
42
<PAGE>
INTEGRATED SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
7. SHAREHOLDERS' EQUITY - (CONTINUED)
PRO FORMA STOCK-BASED COMPENSATION - (CONTINUED)
In September 1998, ISI's Board of Directors adopted a shareholder rights
plan declaring a dividend of one preferred share purchase right for each share
of ISI's common stock outstanding on October 15, 1998 (the "Record Date") and
further directing the issuance of one such right with respect to each share of
ISI's common stock that is issued after the Record Date, except in certain
circumstances. The rights will expire on September 30, 2008.
The rights are initially attached to ISI's common stock and will not trade
separately. If a person or a group acquires 20 percent or more of ISI's common
stock (an "Acquiring Person"), or announces an intention to make a tender offer
for ISI's common stock, the consummation of which would result in a person or
group acquiring 20 percent or more of ISI's common stock, then the rights will
be distributed and will thereafter trade separately from the common stock.
In the event rights are distributed, each right may be exercised for 1/200th
of a share of a newly designated Series A Junior Participating Preferred Stock
at an exercise price of $55.00. The preferred stock has been structured so that
the value of 1/200th of a share of such preferred stock will approximate the
value of one share of common stock.
Upon a person or group becoming an Acquiring Person, holders of the rights
(other than the Acquiring Person) will have the right to acquire shares of ISI's
common stock at a substantially discounted price. Additionally, if a person or
group becomes an Acquiring Person and ISI is acquired in a merger or other
business combination, or 50 percent or more of its assets are sold in a
transaction with an Acquiring Person, the holders of rights (other than the
Acquiring Person) will have the right to receive shares of common stock of the
acquiring corporation at a substantially discounted price.
Subsequent to a person or group becoming an Acquiring Person, ISI's Board of
Directors may, at its option, require the exchange of outstanding rights (other
than those held by the Acquiring Person) for common stock at an exchange ratio
of one share of ISI's common stock per right.
The Board of Directors may redeem outstanding rights at any time prior to a
person or group becoming an Acquiring Person at a price of $0.001 per right.
Prior to such time, the terms of the rights may be amended by the Board.
8. 401(K) AND PENSION PLANS
ISI has two 401(k) Plans ("the Plans") that cover essentially all domestic
employees. Each eligible employee may elect to contribute to the Plans, through
payroll deductions, up to 15% of their compensation, subject to certain
limitations. ISI 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
ISI prior to December 1, 1994, ISI contributions are fully vested on the date of
contribution. For individuals who became employed subsequent to November 30,
1994, ISI contributions vest ratably over a six-year period. ISI's contributions
charged against income totaled approximately $410,000, $481,000, and $569,000 in
fiscal years 1997, 1998 and 1999, respectively. ISI also has a number of defined
contribution pension plans, primarily to cover international employees, which
are not material to ISI's results of operations.
43
<PAGE>
INTEGRATED SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
9. ACQUISITION-RELATED AND OTHER COSTS
In association with the acquisition of Epilogue and the revision of the
terms of the Diab Data acquisition (see Note 2), ISI incurred costs in fiscal
year 1997 as set forth below. In addition, in fiscal year 1999, ISI incurred
costs related to the settlement of an arbitration and the transition of its
Chief Executive Officer.
In October 1997, Green Hills Software, Inc., a supplier, filed a demand for
arbitration against ISI, alleging among other things, breach of contract, fraud,
negligent misrepresentation and misappropriation of trade name in connection
with a VAR licensing agreement the companies entered into in 1993. In December
1997, ISI responded to the arbitration demand, and filed a counter-claim against
Green Hills. In February 1999, the arbitration panel found both parties to be in
breach of contract. As a result of the panel's findings, the VAR licensing
agreement between the two companies was terminated effective January 31, 1999,
and ISI was ordered to pay Green Hills $3.5 million, plus legal costs. These
arbitration-related expenses were recognized in the fourth quarter of fiscal
year 1999.
Acquisition-related and other costs for fiscal years 1997, 1998 and 1999
consisted of (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED FEBRUARY 28,
--------------------------
1997 1998 1999
------ ------ ------
<S> <C> <C> <C>
Arbitration award and related legal costs................ -- -- $6,264
Executive transition costs............................... -- -- 2,243
Bonus payments to management and employees of acquired
company.................................................. $4,750 -- --
Purchased software written off........................... 616 -- --
Professional fees and other acquisition costs ........... 310 -- --
------ ------ ------
$5,676 -- $8,507
====== ====== ======
</TABLE>
As of February 28, 1999, arbitration-related costs of $4.8 million were
included in Other Accrued Liabilities.
10. INCOME TAXES
The provision for income taxes included the following (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED FEBRUARY 28,
---------------------------
1997 1998 1999
------ ------ -------
<S> <C> <C> <C>
Federal:
Current........................................ $2,546 $2,691 $ 2,577
Deferred....................................... 245 (955) (2,951)
2,791 1,736 (374)
------ ------ -------
State:
Current........................................ 884 463 276
Deferred....................................... 43 (88) (810)
------ ------ -------
927 375 (534)
------ ------ -------
Foreign.......................................... 187 1,017 1,911
------ ------ -------
$3,905 $3,128 $ 1,003
====== ====== =======
</TABLE>
44
<PAGE>
INTEGRATED SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
10. INCOME TAXES - (CONTINUED)
The reconciliation between the effective tax rates and statutory federal
income tax rates is shown in the following table:
<TABLE>
<CAPTION>
YEAR ENDED FEBRUARY 28,
---------------------------
1997 1998 1999
------ ------ -------
<S> <C> <C> <C>
Statutory federal income tax rate.................... 35.0% 34.0% 35.0%
State taxes, net of federal income tax benefit....... 5.5 5.0 4.6
Acquisition-related costs............................ 1.0 -- --
Research and development tax credit and credit carry
forwards............................................. (4.0) (5.4) (4.7)
Foreign sales corporation tax benefit................ (1.5) (1.6) (3.7)
Changes in tax status of foreign subsidiary.......... -- -- (22.6)
Other................................................ (1.0) 2.0 0.8
----- ----- ------
Effective tax rate................................... 35.0% 34.0% 9.4%
===== ===== ======
</TABLE>
In May 1998, ISI made an election to treat ISI's Austrian subsidiary,
TakeFive Software GmbH, as a foreign branch of ISI in its United States federal
tax return. For financial statement purposes, this election resulted in a
one-time tax benefit of $2.4 million in the first quarter of fiscal year 1999.
Domestic and foreign components of income before income taxes were (in
thousands):
<TABLE>
<CAPTION>
YEAR ENDED FEBRUARY 28,
---------------------------
1997 1998 1999
------- ------ -------
<S> <C> <C> <C>
Domestic................................................ $ 9,493 $5,788 $ 6,814
Foreign................................................. 1,666 3,413 3,822
------- ------ -------
$11,159 $9,201 $10,636
======= ====== =======
</TABLE>
The significant components of deferred tax assets and liabilities consist of
the following (in thousands):
<TABLE>
<CAPTION>
FEBRUARY 28,
-----------------
1998 1999
------ ------
<S> <C> <C>
Deferred tax assets:
Purchased intangibles.......................................... $1,128 $3,389
Tax credit carryforwards....................................... 1,527 2,019
Accelerated depreciation....................................... 432 801
Accrued vacation and holiday................................... 431 507
Deferred revenue .............................................. 547 753
Allowance for doubtful accounts................................ 572 383
Other.......................................................... 373 1,373
------ ------
$5,010 $9,225
====== ======
Deferred tax liabilities:
Software development costs..................................... $ 604 $1,296
Marketable securities.......................................... 99 138
Cash to accrual adjustment and other........................... 341 109
------ ------
$1,044 $1,543
====== ======
</TABLE>
ISI 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.
45
<PAGE>
INTEGRATED SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
11. EARNINGS PER SHARE
The calculation of basic and diluted earnings per share is provided as
follows (in thousands, except per share amounts):
<TABLE>
<CAPTION>
YEAR ENDED FEBRUARY 28,
-----------------------------
1997 1998 1999
------- ------- -------
<S> <C> <C> <C>
Basic:
Net Income ...................... $ 7,254 $ 6,073 $ 9,633
======= ======= =======
Weighted average number of common
shares outstanding ........... 22,437 23,237 23,138
======= ======= =======
Earnings per share .............. $ 0.32 $ 0.26 $ 0.42
======= ======= =======
Diluted:
Net Income ...................... $ 7,254 $ 6,073 $ 9,633
======= ======= =======
Weighted average number of common
shares outstanding ........... 22,437 23,237 23,138
Dilutive effect of options ...... 1,071 841 702
------- ------- -------
23,508 24,078 23,840
======= ======= =======
Earnings per share .............. $ 0.31 $ 0.25 $ 0.40
======= ======= =======
</TABLE>
Certain options to purchase common stock were not included in the above
calculations as their exercise prices were greater than the average market price
of common stock in each respective period and their inclusion would be
anti-dilutive. The number of such options excluded was approximately 68,000,
379,000 and 987,000 in fiscal years 1997, 1998 and 1999, respectively.
12. BUSINESS SEGMENT INFORMATION
ISI has two reportable segments, Software and Engineering Services. The
Software segment includes design and development tools, real-time operating
systems software and components, and provides related maintenance, training and
consulting services for the embedded software market. The Engineering Services
segment provides design expertise to the embedded software and other markets,
and comprises Doctor Design.
The accounting policies of the segments are the same as those described in
the summary of significant accounting policies. ISI evaluates performance based
on profit or loss from operations before income taxes, excluding non-recurring
gains and losses, acquisition-related and other costs, and interest and other
income.
ISI accounts for intersegment sales and transfers as if the sales or
transfers were to third parties, that is, at current market prices. Corporate
costs, such as those related to ISI's headquarters, are recorded in the Software
segment.
ISI's reportable segments are strategic business units that offer different
products and services. They are managed separately because each business
requires different technology and marketing strategies. The Engineering Services
business was acquired as a unit and the management at the time of the
acquisition has been retained.
46
<PAGE>
INTEGRATED SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
12. BUSINESS SEGMENT INFORMATION - (CONTINUED)
The following tables summarize revenue and operating profit before
acquisition-related and other costs and before interest and other income for
each segment.
For the year ended February 28, 1997 (in thousands):
<TABLE>
<CAPTION>
ENGINEERING
SOFTWARE SERVICES TOTAL
-------- ----------- --------
<S> <C> <C> <C>
Revenues from external customers .................... $ 89,357 $16,106 $105,463
Intersegment revenue ................................ -- $ 1,816 $ 1,816
Depreciation ........................................ $ 2,695 $ 436 $ 3,131
Operating profit before acquisition-related and other
costs and before interest and other income .......... $ 9,083 $ 3,532 $ 12,615
</TABLE>
For the year ended February 28, 1998 (in thousands):
<TABLE>
<CAPTION>
ENGINEERING
SOFTWARE SERVICES TOTAL
-------- ----------- --------
<S> <C> <C> <C>
Revenues from external customers .................... $ 94,258 $26,211 $120,469
Intersegment revenue ................................ -- $ 2,645 $ 2,645
Depreciation ........................................ $ 3,035 $ 662 $ 3,697
Operating profit before acquisition-related and other
costs and before interest and other income .......... $ 2,586 $ 2,707 $ 5,293
</TABLE>
For the year ended February 28, 1999 (in thousands):
<TABLE>
<CAPTION>
ENGINEERING
SOFTWARE SERVICES TOTAL
-------- ----------- --------
<S> <C> <C> <C>
Revenues from external customers .................... $106,905 $26,599 $133,504
Intersegment revenue ................................ -- $ 1,466 $ 1,466
Depreciation ........................................ $ 3,414 $ 805 $ 4,219
Operating profit before acquisition-related and other
costs and before interest and other income .......... $ 8,961 $ 5,220 $ 14,181
</TABLE>
The following is a reconciliation of consolidated operating income for fiscal
years 1997, 1998 and 1999 (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED FEBRUARY 28,
-------------------------------
1997 1998 1999
-------- ------- --------
<S> <C> <C> <C>
Software ............................................ $ 9,083 $ 2,586 $ 8,961
Engineering service ................................. 3,532 2,707 5,220
Acquisition related and other costs ................. (5,676) -- (8,507)
-------- ------- --------
$ 6,939 $ 5,293 $ 5,674
======== ======= ========
</TABLE>
47
<PAGE>
INTEGRATED SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
12. BUSINESS SEGMENT INFORMATION - (CONTINUED)
The following table summarizes property and equipment and capital expenditures,
by segment, for fiscal years 1997, 1998 and 1999 (in thousands):
YEAR ENDED FEBRUARY 28,
-------------------------------------
1997 1998 1999
------- ------- -------
Software:
Property and equipment ........ $17,009 $17,069 $17,198
Capital expenditures .......... $15,178 $ 3,102 $ 3,544
Engineering Services:
Property and equipment ........ $ 947 $ 1,359 $ 1,435
Capital expenditures .......... $ 834 $ 1,166 $ 880
Revenues to non-affiliated customers analyzed on a geographical basis were as
follows (in thousands):
YEAR ENDED FEBRUARY 28,
--------------------------------------------
1997 1998 1999
-------- -------- --------
North America ............ $ 65,640 $ 70,559 $ 77,063
Europe ................... 20,763 26,979 35,583
Japan .................... 14,378 18,473 16,916
Asia/Pacific ............. 4,682 4,458 3,942
-------- -------- --------
Total ............... $105,463 $120,469 $133,504
======== ======== ========
Long-lived assets, excluding marketable securities and deferred tax assets, on a
geographical basis were as follows (in thousands):
FEBRUARY 28,
--------------------
1998 1999
------- -------
North America $21,597 $22,059
Europe ...... 892 1,068
Japan ....... 216 209
------- -------
$22,705 $23,336
======= =======
No customer accounted for 10% or more of total revenue in the reported periods.
48
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS ON SCHEDULE
To the Board of Directors
Integrated Systems, Inc.
Our report on the consolidated financial statements of Integrated
Systems, Inc. is included in this Form 10-K. In connection with our audits of
such financial statements, we have also audited the related financial
statement schedule listed in Item 14(a)(2) of this Form 10-K.
In our opinion, the financial statement schedule presents fairly, in all
material respects, the information set forth therein when read in conjunction
with the related consolidated financial statements.
PricewaterhouseCoopers LLP
San Jose, California
March 25, 1999
49
<PAGE>
SCHEDULE II
INTEGRATED SYSTEMS, INC.
VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
-------- -------- -------------------- ---------- --------
CHARGED
BALANCE AT TO COSTS CHARGED BALANCE
BEGINNING AND TO OTHER AT END
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS WRITE-OFFS OF PERIOD
----------- --------- -------- -------- ---------- ---------
<S> <C> <C> <C> <C> <C>
For the year ended February 28, 1997:
Allowance for doubtful accounts $852,000 $750,000 $150,000 $212,000 $1,540,000
For the year ended February 28, 1998:
Allowance for doubtful accounts $1,540,000 $1,257,000 $1,698,000 $2,313,000 $2,182,000
For the year ended February 28, 1999:
Allowance for doubtful accounts $2,182,000 $65,000 $261,000 $898,000 $1,610,000
</TABLE>
50
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on May 26, 1999.
INTEGRATED SYSTEMS, INC.
By: /s/ NARENDRA K. GUPTA
-----------------------------------
Narendra K. Gupta,
Chairman of the Board and Secretary
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Name Title Date
---- ----- ----
<S> <C> <C>
Principal Executive Officer:
/s/ CHARLES M. BOESENBERG President, Chief Executive Officer May 26, 1999
- ---------------------------------------- and Director
Charles M. Boesenberg
Principal Financial and Accounting
Officer:
/s/ WILLIAM C. SMITH Vice President, Finance and Chief May 26, 1999
- ---------------------------------------- Financial Officer
William C. Smith
Additional Directors:
/s/ NARENDRA K. GUPTA Chairman of the Board and May 26, 1999
- ---------------------------------------- Secretary
Narendra K. Gupta
/s/ JOHN C. BOLGER Director May 26, 1999
- ----------------------------------------
John C. Bolger
/s/ MICHAEL A. BROCHU Director May 26, 1999
- ----------------------------------------
Michael A. Brochu
/s/ VINITA GUPTA Director May 26, 1999
- ----------------------------------------
Vinita Gupta
/s/ THOMAS KAILATH Director May 26, 1999
- ----------------------------------------
Thomas Kailath
/s/ RICHARD C. MURPHY Director May 26, 1999
- ----------------------------------------
Richard C. Murphy
</TABLE>
51
<PAGE>
INDEX TO EXHIBITS
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER EXHIBIT PAGE
- ------ ------- ------------
10.15 Form of Stock Option Grant used in connection with
Registrant's 1998 Equity Incentive Plan
10.16 Employment Agreement for Charles M. Boesenberg
10.18 Employment Termination Agreement for David St. Charles
21.01 List of Registrant's Subsidiaries
23.01 Consent of Independent Accountants
27.01 Financial Data Schedule
27.02 Financial Data Schedule (Restated)
27.03 Financial Data Schedule (Restated)
52
<PAGE>
EXHIBIT 10.15
1998 EQUITY INCENTIVE PLAN
STOCK OPTION AGREEMENT
This Stock Option Agreement (this "Agreement") is made and entered into as
of the date of grant set forth below (the "Date of Grant") by and between
Integrated Systems, Inc., a California corporation (the "Company"), and the
participant named below ("Participant"). Capitalized terms not defined herein
shall have the meaning ascribed to them in the Company's 1998 Equity Incentive
Plan (the "Plan").
PARTICIPANT: participantname
PARTICIPANT'S ADDRESS: address1
address2
GRANT NUMBER: GRANTNUMBER
TOTAL OPTIONS GRANTED: totalgranted
EXERCISE PRICE PER SHARE: EXERCSEPRICE
DATE OF GRANT: grantdate
VESTING COMMENCEMENT DATE: vestdate1
EXPIRATION DATE: expirationdate
TYPE OF STOCK OPTION: NONQUALIFIED
1. GRANT OF OPTION. The Company hereby grants to the Participant named
above an option (this "Option") to purchase up to the total number of shares of
Common Stock of the Company set forth above (collectively, the "Shares") at the
Exercise Price Per Share set forth above (the "Exercise Price"), subject to all
of the terms and conditions of this Agreement and the Plan. If designated as an
Incentive Stock Option above, this Option is intended to qualify as an
"incentive stock option" ("ISO") within the meaning of Section 422 of the
Internal Revenue Code of 1986, as amended (the "Code").
2. VESTING AND EXERCISE PERIOD.
2.1 VESTING OF RIGHT TO EXERCISE OPTION. This Option shall
become exercisable as to portions of the Shares as follows: (a) this Option
shall not be exercisable with respect to any of the Shares until [VESTDATE2]
(the "First Vesting Date"); (b) on the First Vesting Date this Option shall
become exercisable as to 25% of the Shares, if Participant has continuously
provided services to the Company or any Subsidiary or Parent of the Company from
the Date of Grant through the First Vesting Data and has not been Terminated on
or before the First Vesting Date; (c) this Option shall become exercisable as to
an additional 2.083% of the Shares upon the expiration of each successive full
month after the First Vesting Date, so long as Participant continuously provides
services to the Company or any Subsidiary or Parent of the Company and is not
Terminated; PROVIDED that this Option shall in no event ever become exercisable
with respect to more than 100% of the Shares.
2.2 EXPIRATION. This Option shall expire on the Expiration Date
set forth above and must be exercised, if at all, on or before the earlier of
the Expiration Date or the date on which this Option is earlier terminated in
accordance with the provisions of Section 3.
1
<PAGE>
3. TERMINATION.
3.1 TERMINATION FOR ANY REASON EXCEPT DEATH, DISABILITY OR
CAUSE. If Participant is Terminated for any reason, except Participant's death,
Disability or Cause, then this Option, to the extent (and only to the extent)
that it would have been exercisable by Participant on the date of Termination,
may be exercised by Participant no later than three (3) months after the date of
Termination, but in any event no later than the Expiration Date.
3.2 TERMINATION BECAUSE OF DEATH OR DISABILITY. If Participant
is Terminated because of death or Disability of Participant (or Participant dies
within three (3) months after a Termination other than for Cause or due to
Disability), then this Option, to the extent that it is exercisable by
Participant on the date of Termination, may be exercised by Participant (or
Participant's legal representative) no later than twelve (12) months after the
date of Termination, but in no event no later than the Expiration Date
3.3 TERMINATION FOR CAUSE. If Participant is terminated for
Cause, this Option will expire on Participant's Termination Date.
3.4 NO OBLIGATION TO EMPLOY. Nothing in the Plan or this
Agreement shall confer on Participant any right to continue in the employ of, or
other relationship with, the Company or any Parent or Subsidiary of the Company,
or limit in any way the right of the Company or any Parent or Subsidiary of the
Company to terminate Participant's employment or other relationship at any time,
with or without cause.
4. MANNER OF EXERCISE.
4.1 STOCK OPTION EXERCISE AGREEMENT. To exercise this Option,
Participant (or in the case of exercise after Participant's death, Participant's
executor, administrator, heir or legatee, as the case may be) must deliver to
the Company an executed stock option exercise agreement in the form attached
hereto as EXHIBIT A, or such other documentation reasonably acceptable to the
Company (the "Exercise Agreement"), which shall set forth, INTER ALIA,
Participant's election to exercise this Option, the number of Shares being
purchased, any restrictions imposed on the Shares and any representations,
warranties and agreements regarding Participant's investment intent and access
to information as may be required by the Company to comply with applicable
securities laws. If someone other than Participant exercises this Option, then
such person must submit documentation reasonably acceptable to the Company that
such person has the right to exercise this Option.
4.2 LIMITATIONS ON EXERCISE. This Option may not be exercised
unless such exercise is in compliance with all applicable federal and state
securities laws, as they are in effect on the date of exercise.
4.3 PAYMENT. The Exercise Agreement shall be accompanied by full
payment of the Exercise Price for the Shares being purchased in cash (by check),
or where permitted by law:
(a) provided that a public market for the Company's stock
exists: (1) through a "same day sale" commitment from
Participant and a broker-dealer that is a member of the
National Association of Securities Dealers (an "NASD
Dealer") whereby Participant irrevocably elects to
exercise this Option and to sell a portion of the Shares
so purchased to pay for the exercise price and whereby
the NASD Dealer irrevocably commits upon receipt of such
Shares to forward the exercise price directly to the
Company; OR (2) through a "margin" commitment from
Participant and a NASD Dealer whereby Participant
irrevocably elects to exercise this Option and to pledge
the Shares so purchased to the NASD Dealer in a margin
account as security for a loan from the NASD Dealer in
the amount of the exercise price, and whereby the NASD
Dealer irrevocably commits upon receipt of such Shares
to forward the exercise price directly to the Company;
2
<PAGE>
(b) or by any combination of the foregoing.
4.4 TAX WITHHOLDING. Prior to the issuance of the Shares upon
exercise of this Option, Participant must pay or provide for any applicable
federal or state withholding obligations of the Company. If the Committee
permits, Participant may provide for payment of withholding taxes upon exercise
of this Option by requesting that the Company retain Shares with a Fair Market
Value equal to the minimum amount of taxes required to be withheld. In such
case, the Company shall issue the net number of Shares to the Participant by
deducting the Shares retained from the Shares issuable upon exercise.
4.5 ISSUANCE OF SHARES. Provided that the Exercise Agreement and
payment are in form and substance satisfactory to counsel for the Company, the
Company shall issue the Shares registered in the name of Participant,
Participant's authorized assignee, or Participant's legal representative, and
shall deliver certificates representing the Shares with the appropriate legends
affixed thereto.
5. NOTICE OF DISQUALIFYING DISPOSITION OF ISO SHARES. If this Option is
an ISO, and if Participant sells or otherwise disposes of any of the Shares
acquired pursuant to the ISO on or before the later of (a) the date two (2)
years after the Date of Grant, and (b) the date one (1) year after transfer of
such Shares to Participant upon exercise of this Option, then Participant shall
immediately notify the Company in writing of such disposition.
6. COMPLIANCE WITH LAWS AND REGULATIONS. The exercise of this Option
and the issuance and transfer of Shares shall be subject to compliance by the
Company and Participant with all applicable requirements of federal and state
securities laws and with all applicable requirements of any stock exchange on
which the Company's Common Stock may be listed at the time of such issuance or
transfer. Participant understands that the Company is under no obligation to
register or qualify the Shares with the Securities and Exchange Commission, any
state securities commission or any stock exchange to effect such compliance.
7. NONTRANSFERABILITY OF OPTION. This Option may not be transferred in
any manner other than by will or by the laws of descent and distribution and may
be exercised during the lifetime of Participant only by Participant. The terms
of this Option shall be binding upon the executors, administrators, successors
and assigns of Participant.
8. TAX CONSEQUENCES. Set forth below is a brief summary as of the date
the Board adopted the Plan of some of the federal and California tax
consequences of exercise of this Option and disposition of the Shares. THIS
SUMMARY IS NECESSARILY INCOMPLETE, AND THE TAX LAWS AND REGULATIONS ARE SUBJECT
TO CHANGE. OPTIONEE SHOULD CONSULT A TAX ADVISOR BEFORE EXERCISING THIS OPTION
OR DISPOSING OF THE SHARES.
8.1 EXERCISE OF INCENTIVE STOCK OPTION. To the extent this Option
qualifies as an ISO, there will be no regular federal or California income tax
liability upon the exercise of this Option, although the excess, if any, of the
fair market value of the Shares on the date of exercise over the Exercise Price
will be treated as a tax preference item for federal income tax purposes and may
subject the Optionee to the alternative minimum tax in the year of exercise.
8.2 EXERCISE OF NONQUALIFIED STOCK OPTION. To the extent this
Option does not qualify as an ISO, there may be a regular federal and California
income tax liability upon the exercise of this Option. Optionee will be treated
as having received compensation income (taxable at ordinary income tax rates)
equal to the excess, if any, of the fair market value of the Shares on the date
of exercise over the Exercise Price. The Company may be required to withhold
from Optionee's compensation or collect from Optionee and pay to the applicable
taxing authorities an amount equal to a percentage of this compensation income
at the time of exercise.
3
<PAGE>
8.3 DISPOSITION OF SHARES. The following tax consequences may
apply upon disposition of the Shares:
(a) INCENTIVE STOCK OPTIONS. If the Shares are
held for more than twelve (12) months after the date of the transfer of the
Shares pursuant to the exercise of an ISO and are disposed of more than two (2)
years after the Date of Grant, any gain realized on disposition of the Shares
will be treated as long-term capital gain for federal and California income tax
purposes. If Shares purchased under an ISO are disposed of within the applicable
one (1) year or two (2) year period, any gain realized on such disposition will
be treated as compensation income (taxable at ordinary income rates) to the
extent of the excess, if any, of the fair market value of the Shares on the date
of exercise over the Exercise Price.
(b) NONQUALIFIED STOCK OPTIONS. If the Shares are
held for more than twelve (12) months after the date of the transfer of the
Shares pursuant to the exercise of an NQSO, any gain realized on disposition of
the Shares will be treated as long-term capital gain.
9. PRIVILEGES OF STOCK OWNERSHIP. Participant shall not have any of the
rights of a shareholder with respect to any Shares until Participant exercises
this Option and pays the Exercise Price.
10. INTERPRETATION. Any dispute regarding the interpretation of this
Agreement shall be submitted by Participant or the Company to the Committee for
review. The resolution of such a dispute by the Committee shall be final and
binding on the Company and Participant.
11. ENTIRE AGREEMENT. The Plan is incorporated herein by reference.
This Agreement and the Plan and the Exercise Agreement constitute the entire
agreement and understanding of the parties hereto with respect to the subject
matter hereof and supersede all prior understandings and agreements with respect
to such subject matter.
12. NOTICES. Any notice required to be given or delivered to the
Company under the terms of this Agreement shall be in writing and addressed to
the Corporate Secretary of the Company at its principal corporate offices. Any
notice required to be given or delivered to Participant shall be in writing and
addressed to Participant at the address indicated above or to such other address
as such party may designate in writing from time to time to the Company. All
notices shall be deemed to have been given or delivered upon: personal delivery;
three (3) days after deposit in the United States mail by certified or
registered mail (return receipt requested); one (1) business day after deposit
with any return receipt express courier (prepaid); or one (1) business day after
transmission by rapifax or telecopier.
13. SUCCESSORS AND ASSIGNS. The Company may assign any of its rights or
duties under this Agreement. This Agreement shall be binding upon and inure to
the benefit of the successors and assigns of the Company. Subject to the
restrictions on transfer set forth herein, this Agreement shall be binding upon
Participant and Participant's heirs, executors, administrators, legal
representatives, successors and assigns.
14. GOVERNING LAW. This Agreement shall be governed by and construed in
accordance with the internal laws of the State of California, without regard to
that body of law pertaining to choice of law or conflict of law.
15. ACCEPTANCE. Participant hereby acknowledges receipt of a copy of
the Plan and this Agreement. Participant has read and understands the terms and
provisions thereof, and accepts this Option subject to all the terms and
conditions of the Plan and this Agreement. Participant acknowledges that there
may be adverse tax consequences upon exercise of this Option or disposition of
the Shares and that the Company has advised Participant to consult a tax advisor
prior to such exercise or disposition.
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IN WITNESS WHEREOF, the Company has caused this Agreement to be
executed in duplicate by its duly authorized representative and Participant has
executed this Agreement in duplicate as of the Date of Grant.
INTEGRATED SYSTEMS, INC. PARTICIPANT
By:
---------------------------------- -----------------------------------
Charles M. Boesenberg [participant name]
President and CEO
GRANT NO.: [GRANT NUMBER]
DATED: [grant date]
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EXHIBIT 10.16
November 30, 1998
Mr. Charles M. Boesenberg
13936 Albar Court
Saratoga, CA 95070
Re: EMPLOYMENT WITH INTEGRATED SYSTEMS, INC.
Dear Chuck:
Integrated Systems, Inc. ("ISI" or the "Company") is pleased to offer you a
position as Chief Executive Officer & President of the Company and a seat on its
Board of Directors, on the terms set forth in this letter agreement.
1. REPORTING DUTIES AND RESPONSIBILITIES. This offer is for a full-time
position, located at the offices of the Company, except as travel to
other locations may be necessary to fulfill your responsibilities. In
this position you will report to the Board of Directors of the Company.
Upon your becoming the Company's Chief Executive Officer & President,
the Board of Directors will elect you to fill a vacancy on the Company's
Board of Directors, and while you remain the Chief Executive Officer &
President of the Company, the Board of Directors will continue to
nominate you for a position on the Board of Directors of the Company.
2. SALARY AND BONUS. Your initial base salary will be at an annualized rate
of $400,000, payable in accordance with the Company's customary payroll
practice as in effect from time to time, subject to future adjustment by
the Company's Board of Directors. You will also be eligible to earn an
annual bonus in the amount of $300,000, payable yearly, based on the
achievement of objectives which you and the Company's Board of Directors
will mutually determine in good faith. Both your initial salary and
bonus as described above will apply for the Company's fiscal year,
beginning on March 1, 1999 and ending on February 29, 2000. For the
period of time from your start date to February 28, 1999, your salary
and bonus will be paid on a pro rata basis.
3. ONE-TIME BONUS. After your start date, you will receive a one-time cash
bonus payment of $750,000 on or before January 31, 1999. In the event
that you are terminated for cause (as defined in paragraph 9 below) or
you voluntarily resign from ISI at any time within your first twelve
months of employment, without good reason, (as defined in paragraph 9)
ISI would be entitled to a full refund from you of the $750,000 bonus
payment.
4. BENEFITS. You will also receive the Company's standard benefits package
and will be subject to the Company's vacation policy, as such package
and policy are in effect from time to time.
5. STOCK OPTIONS. Effective within two weeks of your start date and subject
to the Board of Directors' approval, the Company will grant you a
nonqualified option to purchase 700,000 shares of the Company's Common
Stock pursuant to the Company's 1998 Stock Option Plan and standard
Stock Option Agreement. All options will have an exercise price that
will be equal to the fair market value of the Company's Common Stock at
the date of grant. The options will become exercisable over a four-year
exercise schedule with 25% of the shares vesting at the end of your
first twelve months of service, and with an additional 2.083% vesting
per month thereafter, at the close of each month during which you remain
employed with the Company. In the event that a change of control
(defined in paragraph 6 below) occurs, the vesting period of these
options held by you will be accelerated by twenty-four months as long as
you continue to fulfill your duties until the effective date of the
change of control and you assist the Company to facilitate a smooth
transition following the change of control over a reasonable period that
will not exceed six months.
6. CHANGE OF CONTROL PROVISION. "Change of Control" shall mean, (i) the
sale, lease, conveyance or other disposition of all or substantially all
of the Company's assets as an entirety or substantially as an entirety
to any person, entity or group of persons acting in concert other than
in the ordinary course of business; (ii) any transaction or series of
related transactions (as a result of a tender offer, merger,
consolidation or otherwise) that results in any Person (as defined in
Section 13(h)(8)(E) under the Securities Exchange Act of 1934) becoming
the beneficial owner (as defined in Rule 13d-3 under the Securities
Exchange Act of 1934), directly or indirectly, of more than 50% of the
aggregate voting power of all classes of common equity of the Company,
except if such Person is (A) a subsidiary of the Company, (B) an
employee stock ownership plan for employees
<PAGE>
of the Company or (C) a company formed to hold the Company's common
equity securities and whose shareholders constituted, at the time such
company became such holding company, substantially all the shareholders
of the Company; or, (iii) a change in the composition of the Company's
Board of Directors over a period of thirty-six (36) consecutive months
or less such that a majority of the then current Board members ceases to
be comprised of individuals who either (a) have been Board members
continuously since the beginning of such period, or (b) have been
elected or nominated for election as Board members during such period by
at least a majority of the Board members described in clause (a) who
were still in office at the time such election or nomination was
approved by the Board.
7. EXCISE TAX PROVISION. In the event that the severance and other benefits
provided to you under this Agreement (i) constitute "parachute payments"
within the meaning of Section 280G of the Internal Revenue Code of 1986,
as amended (the "Code") and (ii) but for this Section 5, such severance
and benefits would be subject to the excise tax imposed by Section 4999
of the Code, then your severance benefits under this Paragraph 7 shall
be payable either:
(a) in full,
(b) as to such lesser amount which would result in no
portion of such severance and other benefits being
subject to excise tax under Section 4999 of the Code,
whichever of the foregoing amounts, taking into account
the applicable federal, state and local income taxes and
the excise tax imposed by Section 4999, results in the
receipt by you on an after-tax basis, of the greatest
amount of severance benefits under this Agreement.
Unless the Company and you otherwise agree in writing,
any determination required under this Paragraph 7 shall
be made in writing by independent public accountants
agreed to by the Company and you (the "Accountants"),
whose determination shall be conclusive and binding upon
you and the Company for all purposes. For purposes of
making the calculations required by this Paragraph 7,
the Accountants may make reasonable assumptions and
approximations concerning applicable taxes and may rely
on reasonable, good faith interpretations concerning the
application of Sections 280G and 4999 of the Code. The
Company and you shall furnish to the Accountants such
information and documents as the Accountants may
reasonably request in order to make a determination
under this Paragraph 7. The Company shall bear all costs
the Accountants may reasonably incur in connection with
any calculations contemplated by this Paragraph 7.
8. CONFIDENTIAL INFORMATION. As an employee of the Company, you will have
access to certain Company confidential information and you may, during
the course of your employment, develop certain information or inventions
which will be the property of the Company. To protect the interest of
the Company, you will need to sign the Company's standard "Employee
Inventions and Confidentiality Agreement" as a condition of your
employment. We wish to impress upon you that we do not wish you to bring
with you any confidential or proprietary material of any former employer
or to violate any other obligation to your former employers.
9. SEVERANCE PAYMENTS/ACCELERATION UPON TERMINATION. If the Board of
Directors terminates your employment with the Company for any reason
without cause ("cause" being defined as conviction of a felony, fraud or
willful malfeasance, (or similar wrongful acts), or after notice willful
and neglect of duties) or you resign for good reason, the Company will
pay you a severance amount equal to your then base salary for the period
of twelve months. You agree that the payments set forth in this offer
letter constitute all payments that you shall be entitled to, and under
any theory, in the event of any termination of employment. In the event
you are terminated without cause or if you resign for good reason (as
defined below) at any time prior to your first year anniversary date,
other than following a change of control, (as defined in paragraph 6)
85,000 shares of the Company's Common Stock will immediately vest. "Good
reason" shall mean a material reduction in your title or duties or if
your principal office is moved by the Company to a location more than
sixty miles away from Sunnyvale, California.
10. AT-WILL EMPLOYMENT. While we look forward to a long-term relationship,
should you decide to accept our offer, you will be an at-will employee
of the Company, which means the employment relationship can be
terminated by either of us for any reason at any time. Any statements or
representations to the contrary (and, indeed, any statements
contradicting any provision in this letter) should be regarded by you as
ineffective. Further, your participation in any stock option or benefit
program is not to be regarded as assuring you of continuing employment
for any particular period of time.
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11. AUTHORIZATION TO WORK. Because of Federal regulations adopted in the
Immigration Reform and Control Act of 1986, you will need to present
documentation demonstrating that you have authorization to work in the
United States. If you have any questions about this requirement, which
applies to U.S. citizens and non-U.S. citizens alike, please contact our
human resources department.
12. ARBITRATION PROVISION. The Company and you agree that any dispute
regarding the interpretation or enforcement of this Agreement shall be
decided by confidential, final and binding arbitration conducted by
Judicial Arbitration and Mediation Services ("JAMS") under the
then-existing JAMS rules, rather than by litigation in court, trial by
jury, administrative proceeding, or in any other forum.
13. TERM OF OFFER. This offer will remain open until November 30, 1998. If
you decide to accept our offer, and I hope that you will, please sign
the enclosed copy of this letter in the space indicated and return it to
me. Upon your signature below, this will become our binding agreement
with respect to the subject matter of this letter, superseding in their
entirety all other or prior agreements by you with the Company as to the
specific subjects of this letter, will be binding upon and inure to the
benefit of our respective successors and assigns, and your heirs,
administrators and executors, will be governed by California law, and
may only be amended in a writing signed by you and the Company.
14. START DATE. This offer is made with the understanding that you will be
available to start employment with Integrated Systems, Inc. on or about
December 14, 1998 (the "start date").
Chuck, we are excited and pleased to have you join the ISI team. I am confident
that we will successfully capitalize on our enormous market opportunity.
Sincerely,
/s/ NAREN K. GUPTA
- --------------------------
Naren K. Gupta
Chairman
Acknowledged, Accepted and Agreed:
/s/ CHARLES M. BOESENBERG November 30, 1998
- -------------------------- ------------------
Charles M. Boesenberg Date
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EXHIBIT 10.18
AGREEMENT
THIS AGREEMENT (the "AGREEMENT") dated as of June 15, 1998 is between
David St. Charles ("EMPLOYEE") and Integrated Systems, Inc. ("COMPANY"), a
California corporation. As used in this Agreement, Company refers to Integrated
Systems, Inc. and all parents, subsidiaries, divisions, predecessors, and
successors of Integrated Systems, Inc.
THE PARTIES AGREE AS FOLLOWS:
1. EMPLOYMENT TERMINATION. EMPLOYEE's employment with Company shall
terminate effective upon the earlier of (i) December 15, 1998, or (ii) the date
a new President and Chief Executive Officer commences employment with Company
(the "TERMINATION DATE").
2. PRE-TERMINATION OBLIGATIONS. Employee's employment as President and
Chief Executive Officer of Company shall continue until the Termination Date.
EMPLOYEE shall receive his current monthly base salary and benefits through the
Termination Date (less applicable withholding). EMPLOYEE will be paid his
accrued vacation pay on the Termination Date. EMPLOYEE will be paid an incentive
compensation bonus of $100,000 on June 30, 1998. This payment is in lieu of any
and all other bonuses for the Company's 1999 fiscal year and EMPLOYEE shall not
have any right to any other bonus of any type whatsoever. EMPLOYEE shall
continue to be a nominee for reelection as a member of the Board of Directors of
Company at the Company's annual meeting of shareholders on July 15, 1998.
3. POST TERMINATION OBLIGATIONS. EMPLOYEE shall serve as a consultant
reporting to the new President and Chief Executive Officer or to the Board of
Directors for one (1) year following the Termination Date (the "TRANSITION
PERIOD").
4. OBLIGATIONS OF COMPANY.
a. In exchange for the release of claims and other promises
set forth in this Agreement, Company agrees to provide EMPLOYEE with the
following benefits during the Transition Period:
(1) Company will pay EMPLOYEE a one time
payment of his base salary of $300,000 (less applicable withholding) within
ninety (90) days of the Release Date (as defined in Section 16). EMPLOYEE shall
not participate in Company's bonus plans or continue to accrue vacation or sick
time during the Transition Period.
(2) Company will provide EMPLOYEE with all of
his existing Employee health benefit insurance coverage until the Termination
Date. During the Transition Period, Company will pay EMPLOYEE's monthly COBRA
premium at the same level of coverage in effect prior to the Termination Date.
For the six (6) months thereafter, Company will pay EMPLOYEE's same monthly
COBRA premium unless EMPLOYEE has comparable health benefit insurance coverage
from a subsequent employer in which case Company's obligation under this Section
4.a.(2) will cease.
(3) Employee's stock options shall continue to
vest during the Transition Period in accordance with the 1988 Stock Option Plan
(the "PLAN") and related documents. Vesting will stop at the end of the
Transition Period. Pursuant to Section 8(d)(iii) of the Plan, the Committee has
determined that the Transition Period activity is considered "employment" for
purposes of vesting and such determination is irrevocable. Notwithstanding the
provisions of the Plan, EMPLOYEE may exercise his stock options for a period of
twelve (12) months after the end of the Transition Period.
(4) EMPLOYEE will be provided standard Company
out placement services and reasonable office space and administrative and
support services at the Company's offices during the Transition Period.
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(5) Company will transfer and assign to EMPLOYEE
all of EMPLOYEE's personally used computer equipment (lap top, monitor,
peripherals), fax machine and mobile phone. EMPLOYEE will be responsible for all
expenses and costs related to any such items following the transfer
b. EMPLOYEE understands and acknowledges that EMPLOYEE will
not be entitled to any compensation or benefits from Company other than those
expressly set forth in this Section 3.
5. OBLIGATIONS OF EMPLOYEE. In exchange for the benefits described in
Section 4, EMPLOYEE agrees to the following:
a. EMPLOYEE will continue to be bound by and comply with the
terms of that certain Employee Invention Assignment and Confidentiality
Agreement ("CONFIDENTIALITY AGREEMENT") effective August 10, 1993, a copy of
which is attached to this Agreement as "EXHIBIT A." EMPLOYEE will return all
Company property (unless otherwise agreed in writing) and all confidential and
proprietary information in Employee's possession to Company within five business
days of the end of the Transition Period.
b. For a period of one (1) year from the end of the Transition
Period, EMPLOYEE will not directly or indirectly solicit or take away employees
or consultants of the Company which results in any detriment to the Company.
c. Employee will not directly or indirectly solicit or take
away suppliers or customers of the Company if such solicitation results in any
detriment to the Company and if the identity of the supplier or customer or
supplier or customer contact is a trade secret within the meaning of California
law.
d. During the Transition Period, upon the request of the Board
of Directors or the new President and Chief Executive Officer of the Company,
EMPLOYEE will provide to the Company, marketing, sales and other consulting
services within EMPLOYEE's level of experience and knowledge, not to exceed
eight (8) hours per month. During the Transition Period, EMPLOYEE will not
accept full-time employment or consult with any of the following companies: Wind
River, Sun Microsystems, MicroSoft, Mathworks or Green Hills.
6. RELEASE. In exchange for their respective benefits described in
Sections 4 and 5, each party agrees to execute the release (the "RELEASE")
attached to this Agreement as "EXHIBIT B" on the Termination Date.
7. ARBITRATION. Any claim, dispute, or controversy arising out of or in
any way relating to this Agreement or the alleged breach of this Agreement will
be submitted by the parties to binding arbitration in Santa Clara County,
California pursuant to Sections 1280 through Section 1294 of the California Code
of Civil Proceeding except that discovery shall be limited to a reasonable
number of document requests, depositions and interrogatories as determined by
the arbitrator. This Section 7 will not prevent either party from seeking
injunctive relief (or any other provisional remedy) from any court having
jurisdiction over the parties and the subject matter of their dispute relating
to Employee's obligations under Employee's Confidentiality Agreement and
Employee's obligations under Section 9 hereof.
8. ATTORNEYS' FEES. Each party agrees to pay their own legal fees
incurred in reviewing and negotiating this Agreement except that Company will
pay EMPLOYEE's legal fees for such purposes in an amount not to exceed $2500.
The prevailing party will be entitled to recover from the losing party its
attorneys' fees and costs (including expert witness fees) incurred in any
arbitration, lawsuit or other proceeding brought to enforce any right arising
out of this Agreement.
9. CONFIDENTIALITY. EMPLOYEE acknowledges that EMPLOYEE has not
disclosed any of the terms of this Agreement to anyone other than Employee's
counsel and/or spouse/domestic partner. EMPLOYEE agrees, on behalf of EMPLOYEE
and Employee's agents, not to disclose, or to take every reasonable precaution
to prevent disclosure of, any of the terms of this Agreement or consideration
for this
2
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Agreement (the "SETTLEMENT INFORMATION") to third parties, and agrees that there
will be no publicity, directly or indirectly, concerning any Settlement
Information. EMPLOYEE agrees to take every reasonable precaution to disclose
Settlement Information only to Employee's attorney, accountant, tax authorities,
and Employee's spouse/domestic partner, if and only if these individuals have a
reasonable and justifiable need to know of such Settlement Information,
provided, however, that any person or entity to whom such disclosure is made
will, prior to disclosure and to the extent permitted by law, acknowledge the
confidentiality of such information and agree to keep such information
confidential. EMPLOYEE acknowledges that the confidentiality of the terms of
this Agreement is a material inducement to Company in entering into it. Except
for SEC reporting and disclosure requirements, and as otherwise required by law,
Company agrees to take every reasonable precaution to prevent disclosure of any
of the terms of this Agreement or consideration for this Agreement (the
"SETTLEMENT INFORMATION") to third parties.
10. NON-DISPARAGEMENT. EMPLOYEE agrees to refrain from disparagement,
criticism, defamation or slander of Company or any of its Employees, officers,
directors, agents, products or services to anyone, including but not limited to
other Employees and any past, present or prospective customers. Company agrees
to provide supportive references in regard to EMPLOYEE.
11. NO ADMISSION OF LIABILITY. Company and EMPLOYEE understand and
acknowledge that this Agreement constitutes a compromise and settlement. No
action taken by the parties hereto, or either of them, either previously or in
connection with this Agreement will be deemed or construed to be (a) an
admission of the truth or falsity of any claims or (b) an acknowledgment or
admission by a party of any fault or liability whatsoever to the other party or
to any third party.
12. NO KNOWLEDGE OF WRONGDOING. EMPLOYEE has no knowledge of any
wrongdoing involving improper or false claims against a federal or state
governmental agency, or other wrongdoing, that involves EMPLOYEE or other
present or former Company employees.
13. SUCCESSORS. The provisions of this Agreement will extend and inure
to the benefit of, and be binding upon the respective legal successors and
assigns of Company and EMPLOYEE in addition to Company and EMPLOYEE.
14. NO ORAL MODIFICATION. This Agreement may not be altered or amended
except by a written document executed by EMPLOYEE and Company.
15. GOVERNING LAW. This Agreement will in all respects be governed by
the laws of the State of California as applied to agreements entered into and to
be performed entirely within California between California residents.
16. RELEASE DATE. This Agreement is effective as of June 15, 1998,
provided that the Release, and Company's obligations pursuant to Section 4
above, shall become effective on the eighth day after the Termination Date and
the Release has been signed by both parties (the "RELEASE DATE"), unless sooner
revoked by EMPLOYEE in which case this Agreement will terminate immediately upon
such revocation. If EMPLOYEE desires to revoke the Release, EMPLOYEE must
deliver or cause to be delivered a written statement of revocation from EMPLOYEE
prior to the Release Date to the Company's Human Resources Department. If
EMPLOYEE has signed the Release and has not revoked such Release by the eighth
day after the Termination Date and the date of his signature but Company does
not sign the Release, EMPLOYEE shall be entitled to the consideration specified
in Section 4.a.
17. NO REPRESENTATIONS. Each party represents that it has had the
opportunity to consult with an attorney, and has carefully read and understands
the scope and effect of the provisions of this Agreement. Neither party has
relied upon any representations or statements made by the other party hereto
which are not specifically set forth in this Agreement.
18. COUNTERPARTS. This Agreement may be executed in counterparts, and
each counterpart will have the same force and effect as an original and will
constitute an effective, binding agreement on the part of each of the
undersigned.
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19. SEVERABILITY. In the event that any one or more of the provisions
contained herein will for any reason be held to be unenforceable in any respect
under any statute, rule or law of any state or of the United States of America,
such unenforceability will not affect any other provision of this Agreement,
but, with respect only to the jurisdiction holding the provision to be
unenforceable, this Agreement will then be construed as if such unenforceable
provision or provisions had never been contained herein.
20. INTEGRATION. This Agreement, including the exhibits hereto and Stock
Option Documents, constitutes the entire agreement between the parties with
respect to the subject matter of this Agreement and supersedes all prior
negotiations and agreements, whether written or oral.
EMPLOYEE: INTEGRATED SYSTEMS, INC.
David P. St. Charles /s/ NARENDRA K. GUPTA
------------------------
By: Narendra K. Gupta
Title: Chairman of the Board
/s/ DAVID P. ST.CHARLES
- ------------------------
Signature
Date: December 17, 1998 Date: December 17, 1998
EXHIBIT B
THIS GENERAL RELEASE OF CLAIMS ( "RELEASE") is between David St.
Charles ("EMPLOYEE") and Integrated Systems, Inc. ("Company"), a California
corporation, in accordance with Section 6 of the Agreement entered into by the
parties as of June 15, 1998, (the "AGREEMENT"). Unless otherwise defined herein,
the terms defined in the Agreement shall have the same defined meanings in this
Release.
1. PAYMENT OF SALARY. The parties acknowledge and agree that as of the
Effective Date, all salary, and any and all other benefits, or other such sums
due EMPLOYEE were paid to EMPLOYEE. In light of the payment by Company of all
wages due, or to become due to EMPLOYEE, California Labor Code Section 206.5 is
not applicable to the parties hereto. Said section provides in pertinent part:
No employer will require the execution of any release of any claim or
right on account of wages due, or to become due, or made as an advance
on wages to be earned, unless payment of such wages has been made.
2. RELEASE. EMPLOYEE and Company, on behalf of themselves and their
respective heirs, family members, executors, investors, Employees, officers,
directors, agents, attorneys, legal successors, and assigns, hereby fully and
forever release each other and their respective heirs, family members,
executors, shareholders, from and agree not to sue concerning, any and all
claims, actions, obligations, duties, causes of action, whether now known or
unknown, suspected or unsuspected, that either of them may possess based upon or
arising out of any matter, cause, fact, thing, act, or omission whatsoever
occurring or existing at any time to and including the Effective Date
(collectively, the "RELEASED MATTERS"), including without limitation,
(1) any and all claims relating to or arising from Employee's
employment relationship with Company and the termination of that relationship;
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(2) any and all claims relating to, or arising from,
Employee's right to purchase, or actual purchase of, shares of stock of Company,
including, without limitation, any claims of fraud, misrepresentation, breach of
fiduciary duty, breach of duty under applicable state corporate law, and
securities fraud under any state or federal law;
(3) any and all claims for wrongful discharge of employment;
termination in violation of public policy; discrimination; breach of contract,
both express and implied; breach of a covenant of good faith and fair dealing,
both express and implied; promissory estoppel; negligent or intentional
infliction of emotional distress; negligent or intentional misrepresentation;
negligent or intentional interference with contract or prospective economic
advantage; unfair business practices; defamation; libel; slander; negligence;
personal injury; assault; battery; invasion of privacy; false imprisonment; and
conversion.
(4) any and all claims for violation of any federal, state or
municipal statute, including, but not limited to, Title VII of the Civil Rights
Act of 1964, the Civil rights Act of 1991, the Age Discrimination in Employment
Act of 1967, the Americans with Disabilities Act of 1990, the Fair Labor
Standards Act, the Employee Retirement Income Security Act of 1974, the Worker
Adjustment and Retraining Notification Act, Older Workers Benefit Protection
Act, and the California Fair Employment and Housing Act, and Labor Code section
201, ET. SEQ.;
(5) any and all claims for violation of the federal, or any
state, constitution;
(6) any and all claims arising out of any other laws and
regulations relating to employment or employment discrimination;
(7) any and all claims for attorneys' fees and costs;
(8) any and all acts or omissions done by EMPLOYEE on behalf
of the Company; and
(9) any and all claims either Company or EMPLOYEE may have
against the other for any acts by either occurring at any time prior to the
execution of this Release.
Each of the parties agrees that the foregoing enumeration of claims released is
illustrative, and the claims hereby released are in no way limited by the above
recitation of specific claims, it being the intent of the parties to fully and
completely release all claims whatsoever in any way relating to the Employee's
employment with Company and to the termination of such employment. Each of the
parties agrees that the release set forth in this section will be and remain in
effect in all respects as a complete general release as to the matters released.
This Release does not extend to any obligations incurred under this Agreement or
any future obligations under the Confidentiality Agreement. This Release shall
remain in effect in the event of any breach of the Agreement.
a. EMPLOYEE represents that Employee has no
lawsuits, claims or actions pending in Employee's name, or on behalf of any
other person or entity, against Company or any other person or entity referred
to herein. EMPLOYEE also represents that EMPLOYEE does not intend to bring any
claims on Employee's own behalf against Company or any other person or entity
referred to herein.
b. Each party represents that it is not aware
of any claim by it other than the claims that are released by this Release. Each
party acknowledges that it has been advised by legal counsel and is familiar
with Section 1542 of the Civil Code of the State of California, which states:
A GENERAL RELEASE DOES NOT EXTEND TO CLAIMS WHICH THE
CREDITOR DOES NOT KNOW OR SUSPECT TO EXIST IN HIS
FAVOR AT THE TIME OF EXECUTING THE RELEASE, WHICH IF
KNOWN BY HIM MUST HAVE
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MATERIALLY AFFECTED HIS SETTLEMENT WITH THE DEBTOR.
Each party expressly waives any right or benefit which it has or may have under
Section 1542 of the California Civil Code or any similar provision of the
statutory or non-statutory law of any other jurisdiction, including Delaware, to
the full extent that each party may lawfully waive those rights and benefits
pertaining to the subject matter of this Release. The parties acknowledge that
in the future they may discover claims or facts in addition to or different from
those that they now know or believe to exist with respect to the subject matter
of this Release, and that each of EMPLOYEE and Company intend to fully, finally,
and forever settle all of the Released matters in exchange for the benefits set
forth in this Release and in the Agreement. This release will remain in effect
as a full and complete release notwithstanding the discovery or existence of any
additional claims or facts.
3. INDEMNIFICATION. This Release shall not apply with respect to any
claims arising under Employee's existing rights to indemnification and defense
pursuant to the articles and bylaws of Company and existing indemnification
agreement for acts as a director and/or officer or to Employee's rights of
insurance under any director and officer or other liability policy in effect
covering Company's directors and officers. Company agrees to maintain any such
director and officer liability policy and any other liability policy in effect
with respect to Employee's for services performed by him as a director and
officer to the same extent as other Company directors and officers.
4. ACKNOWLEDGMENT OF WAIVER OF CLAIMS UNDER ADEA. EMPLOYEE acknowledges
that EMPLOYEE is waiving and releasing any rights Employee's may have under the
Age Discrimination in Employment Act of 1967 ("ADEA") and that this waiver and
release is knowing and voluntary. EMPLOYEE and Company agree that this waiver
and release does not apply to any rights or claims that may arise under ADEA
after the Effective Date of this Release, EMPLOYEE acknowledges that the
consideration given for this waiver and release agreement in addition to
anything of value to which EMPLOYEE was already entitled. EMPLOYEE further
acknowledges that EMPLOYEE has been advised by this writing that:
a. EMPLOYEE should consult with an attorney PRIOR to
executing this Release;
b. EMPLOYEE has at least twenty-one (21) days within which to
consider this Release, although EMPLOYEE may accept the terms of this Release at
any time within those 21 days;
c. EMPLOYEE has at least seven (7) days following the
execution of this Release by the parties to revoke this Release; and
d. This Release will not be effective until the
revocation period has expired.
5. VOLUNTARY EXECUTION OF AGREEMENT. This Release is executed
voluntarily and without any duress or undue influence on the part or behalf of
the parties hereto, with the full intent of releasing all claims. The parties
acknowledge that:
a. they have read this Release;
b. they have been represented in the preparation, negotiation,
and execution of this Release by legal counsel of their own choice or that they
have voluntarily declined to seek such counsel;
c. they understand the terms and consequences of this
Release and of the releases it contains;
d. they are fully aware of the legal and binding effect
of this Release.
EMPLOYEE UNDERSTANDS THAT EMPLOYEE MAY CONSULT WITH
AN ATTORNEY BEFORE SIGNING THIS RELEASE AND
UNDERSTANDS THAT EMPLOYEE IS GIVING UP ANY
6
<PAGE>
LEGAL CLAIMS EMPLOYEE HAS AGAINST COMPANY BY
SIGNING THIS RELEASE. EMPLOYEE FURTHER
ACKNOWLEDGES THAT EMPLOYEE DOES SO KNOWINGLY,
WILLINGLY, AND VOLUNTARILY IN EXCHANGE FOR THE
BENEFITS DESCRIBED IN SECTION 3 OF THE AGREEMENT.
6. INTEGRATION. This Release together with the Agreement constitutes
the entire agreement between the parties with respect to the subject matter of
this Agreement and supersedes all prior negotiations and agreements, whether
written or oral.
EMPLOYEE: INTEGRATED SYSTEMS, INC.
David P. St. Charles /s/ NARENDRA K. GUPTA
------------------------
By: Narendra K. Gupta
Title: Chairman of the Board
/s/ DAVID P. ST.CHARLES
- ------------------------
Signature
Date: December 17, 1998 Date: December 17, 1998
7
<PAGE>
EXHIBIT 21.01
INTEGRATED SYSTEMS, INC.
LIST OF REGISTRANT'S SUBSIDIARIES
STATE OR JURISDICTION OF
INCORPORATION OR
NAME ORGANIZATION
- ----------------------------------------- ------------------------
Integrated Systems, Inc. F.S.C U.S. Virgin Islands
Integrated Systems, Inc. Limited United Kingdom
Integrated Systems, Inc. S.A. France
Integrated Systems, GmbH Germany
Integrated Systems, Inc. A.B. Sweden
Integrated Systems (Israel) Ltd. Israel
Integrated Systems, Inc. GmbH Austria
TakeFive Software GmbH Austria
TakeFive Software AG Switzerland
TakeFive Software, Inc. California
TakeFive Software, Ltd. United Kingdom
TakeFive Software GmbH Germany
Doctor Design, Inc. California
ISICAN Integrated Systems (Canada) Inc. Canada
Integrated Systems Japan K.K. Japan
Integrated Systems, Inc. Italia SRL Italy
Epilogue Technology Corporation New Mexico
Diab Data, Inc. California
Diab Data GmbH Germany
<PAGE>
EXHIBIT 23.01
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the
Registration Statements on Form S-8 (File Nos. 33-35281, 33-48626, 33-70494,
33-82438, 333-1145, 333-12799, 333-64673) of Integrated Systems, Inc. of our
reports dated March 25, 1999, relating to the consolidated financial
statements and financial statement schedule which appear in this Form 10-K.
PricewaterhouseCoopers LLP
San Jose, California
May 26, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE FY99 FORM
10-K FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> FEB-28-1999
<PERIOD-START> MAR-01-1998
<PERIOD-END> FEB-28-1999
<CASH> 19,079
<SECURITIES> 9,554
<RECEIVABLES> 28,431
<ALLOWANCES> 1,610
<INVENTORY> 0
<CURRENT-ASSETS> 64,679
<PP&E> 37,033
<DEPRECIATION> 18,400
<TOTAL-ASSETS> 143,035
<CURRENT-LIABILITIES> 42,244
<BONDS> 0
0
0
<COMMON> 59,848
<OTHER-SE> 40,943
<TOTAL-LIABILITY-AND-EQUITY> 143,035
<SALES> 76,622
<TOTAL-REVENUES> 133,504
<CGS> 16,169
<TOTAL-COSTS> 38,492
<OTHER-EXPENSES> 89,338
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 10,636
<INCOME-TAX> 1,003
<INCOME-CONTINUING> 9,633
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 9,633
<EPS-BASIC> 0.42
<EPS-DILUTED> 0.40
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION ETRACTED FROM THE FY98 FORM
10-K FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> FEB-28-1998 FEB-28-1997
<PERIOD-START> MAR-01-1997 MAR-01-1996
<PERIOD-END> FEB-28-1998 FEB-28-1997
<CASH> 14,454 25,585
<SECURITIES> 6,670 4,483
<RECEIVABLES> 29,455 29,806
<ALLOWANCES> 2,182 1,540
<INVENTORY> 0 0
<CURRENT-ASSETS> 56,730 65,439
<PP&E> 33,014 29,073
<DEPRECIATION> 14,586 11,117
<TOTAL-ASSETS> 128,120 112,502
<CURRENT-LIABILITIES> 33,694 26,127
<BONDS> 0 0
0 0
0 0
<COMMON> 63,647 61,158
<OTHER-SE> 30,779 25,014
<TOTAL-LIABILITY-AND-EQUITY> 128,120 112,502
<SALES> 68,619 66,546
<TOTAL-REVENUES> 120,469 105,463
<CGS> 14,373 8,824
<TOTAL-COSTS> 41,803 27,895
<OTHER-EXPENSES> 73,373 70,629
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 0 0
<INCOME-PRETAX> 9,201 11,159
<INCOME-TAX> 3,128 3,905
<INCOME-CONTINUING> 6,073 7,254
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 6,073 7,254
<EPS-BASIC> 0.26 0.32
<EPS-DILUTED> 0.25 0.31
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM Q1 FY98 FORM
10-Q FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C> <C>
<PERIOD-TYPE> 3-MOS 6-MOS 9-MOS
<FISCAL-YEAR-END> FEB-28-1998 FEB-28-1998 FEB-28-1998
<PERIOD-START> MAR-01-1997 MAR-01-1997 MAR-01-1997
<PERIOD-END> MAY-31-1997 AUG-31-1997 NOV-30-1997
<CASH> 20,506 20,868 12,945
<SECURITIES> 5,292 4,813 5,908
<RECEIVABLES> 26,114 26,843 26,098
<ALLOWANCES> 0 0 0
<INVENTORY> 0 0 0
<CURRENT-ASSETS> 59,834 58,451 51,321
<PP&E> 18,325 18,771 18,772
<DEPRECIATION> 0 0 0
<TOTAL-ASSETS> 119,894 118,932 119,995
<CURRENT-LIABILITIES> 32,352 30,259 28,945
<BONDS> 0 0 0
0 0 0
0 0 0
<COMMON> 62,030 62,488 63,650
<OTHER-SE> 25,431 25,936 27,393
<TOTAL-LIABILITY-AND-EQUITY> 119,894 118,932 119,995
<SALES> 13,758 29,260 46,897
<TOTAL-REVENUES> 24,588 56,758 86,660
<CGS> 2,729 6,250 9,458
<TOTAL-COSTS> 8,304 21,371 31,169
<OTHER-EXPENSES> 16,733 35,409 54,161
<LOSS-PROVISION> 0 0 0
<INTEREST-EXPENSE> 0 0 0
<INCOME-PRETAX> 346 1,752 4,194
<INCOME-TAX> 125 596 1,426
<INCOME-CONTINUING> 221 1,156 2,768
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> 221 1,156 2,768
<EPS-BASIC> 0.01 0.05 0.12
<EPS-DILUTED> 0.01 0.05 0.12
</TABLE>
