<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------
FORM 10-Q
(Mark One)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended May 31, 1999
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
For the transition period from __________ to __________
Commission file number: 0-18268
-------------------------------
INTEGRATED SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)
CALIFORNIA 94-2658153
(State or other jurisdiction (I.R.S. employer
of incorporation or organization) identification no.)
------------------------------
201 MOFFETT PARK DRIVE
SUNNYVALE, CA 94089
(408) 542-1500
(Address, including zip code, of Registrant's
principal executive offices and telephone
number, including area code)
------------------------------
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes __X___ No _____
The number of shares outstanding of the Registrant's Common Stock on June 30,
1999 was 22,591,912 shares.
Page 1 of 22 pages.
<PAGE>
INTEGRATED SYSTEMS, INC.
FORM 10-Q
QUARTER ENDED MAY 31, 1999
<TABLE>
<CAPTION>
INDEX
PAGE
PART I - FINANCIAL INFORMATION ----
- ------------------------------
<S> <C> <C>
Item 1. Financial Statements 3
Condensed Consolidated Balance Sheets as of May 31, 1999 and February 28, 1999 4
Condensed Consolidated Statements of Income and Comprehensive Income (loss) for
the Three Months Ended May 31, 1999 and 1998 5
Condensed Consolidated Statements of Cash Flows for the Three Months
Ended May 31, 1999 and 1998 6
Notes to Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations 10
Item 3. Quantitative and Qualitative Disclosures About Market Risks 19
PART II - OTHER INFORMATION
- ---------------------------
Item 6. Exhibits and Reports on Form 8-K 20
SIGNATURES 21
- ----------
</TABLE>
=============================================================================
This Form 10-Q contains forward-looking statements (as defined in the Private
Securities Litigation Reform Act of 1995), including but not limited to
statements regarding ISI's expectations, hopes or intentions regarding the
future. Actual results and trends could differ materially from those
discussed in the forward-looking statements. In addition, past trends should
not be perceived as indicators of future performance. Among the factors that
could cause actual results to differ from the forward-looking statements are
those detailed elsewhere in this Report in Management's Discussion and
Analysis of Financial Condition and Results of Operations and in ISI's
Securities and Exchange Commission reports.
=============================================================================
-2-
<PAGE>
PART I - FINANCIAL INFORMATION
------------------------------
ITEM 1. FINANCIAL STATEMENTS
The condensed consolidated interim financial statements included herein
have been prepared by Integrated Systems, Inc. ("ISI"), without audit,
pursuant to the rules and regulations of the Securities and Exchange
Commission. Although certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to
such rules and regulations, ISI believes that the disclosures made are
adequate to make the information presented not misleading. It is suggested
that the condensed consolidated interim financial statements be read in
conjunction with the consolidated financial statements and the notes thereto
included in ISI's Annual Report on Form 10-K for the year ended February 28,
1999. The February 28, 1999 condensed consolidated balance sheet data was
derived from the audited financial statements, but does not include all
disclosures required by generally accepted accounting principles.
The accompanying condensed consolidated interim financial statements
have been prepared in all material respects in conformity with the standards
of accounting measurements set forth in Accounting Principles Board Opinion
No. 28 and, in the opinion of management, reflect all adjustments, consisting
only of normal recurring adjustments, necessary to summarize fairly the
financial position, results of operations, and cash flows for the periods
indicated. The results of operations for the interim periods presented are
not necessarily indicative of the results to be expected for the full year.
-3-
<PAGE>
INTEGRATED SYSTEMS, INC.
<TABLE>
<CAPTION>
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
MAY 31, FEBRUARY 28,
1999 1999
------------- --------------
(unaudited)
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 26,131 $ 19,079
Marketable securities 2,382 9,554
Accounts receivable, net 25,377 28,431
Deferred income taxes 2,490 2,360
Prepaid expenses and other 4,729 5,255
------------- --------------
Total current assets 61,109 64,679
Marketable securities 45,078 49,698
Property and equipment, net 18,574 18,633
Intangible assets, net 3,411 3,503
Deferred income taxes 5,322 5,322
Other assets 1,781 1,200
------------- --------------
Total assets $ 135,275 $ 143,035
============= ==============
LIABILITIES
Current liabilities:
Accounts payable $ 3,730 $ 4,761
Accrued payroll and related expenses 5,931 6,250
Other accrued liabilities 5,610 10,668
Income taxes payable 1,906 2,562
Deferred revenue 18,139 18,003
------------- --------------
Total current liabilities 35,316 42,244
------------- --------------
SHAREHOLDERS' EQUITY
Common Stock, no par value, 50,000 shares authorized:
22,755 and 22,686 shares issued and outstanding at
May 31, 1999 and February 28, 1999, respectively 59,647 59,848
Accumulated other comprehensive loss, net (1,561) (759)
Retained earnings 41,873 41,702
------------- --------------
Total shareholders' equity 99,959 100,791
------------- --------------
Total liabilities and shareholders' equity $ 135,275 $ 143,035
============= ==============
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
-4-
<PAGE>
INTEGRATED SYSTEMS, INC.
<TABLE>
<CAPTION>
CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (LOSS)
(in thousands, except per share data)
(unaudited)
THREE MONTHS ENDED
MAY 31,
--------------------------------
1999 1998
--------------- ---------------
<S> <C> <C>
Revenue:
Product $18,949 $ 17,161
Services 13,643 14,321
--------------- ---------------
Total revenue 32,592 31,482
--------------- ---------------
Costs and expenses:
Cost of product revenue 4,909 3,133
Cost of services revenue 5,994 5,933
Marketing and sales 14,025 12,105
Research and development 5,309 5,441
General and administrative 3,503 3,356
--------------- ---------------
Total costs and expenses 33,740 29,968
--------------- ---------------
(Loss) income from operations (1,148) 1,514
Interest and other income 1,400 913
--------------- ---------------
Income before income taxes 252 2,427
Provision (benefit) for income taxes 81 (1,623)
--------------- ---------------
Net income $ 171 $ 4,050
=============== ===============
Other comprehensive (loss), net of tax:
Foreign currency translation adjustments (401) (97)
Unrealized loss on investments (401) (39)
--------------- ---------------
Other comprehensive (loss) (802) (136)
--------------- ---------------
Total comprehensive income (loss) $ (631) $ 3,914
=============== ===============
Earnings per share - basic $ 0.01 $ 0.17
=============== ===============
Earnings per share - diluted $ 0.01 $ 0.17
=============== ===============
Shares used in per share calculations - basic 22,775 23,426
=============== ===============
Shares used in per share calculations - diluted 23,470 24,436
=============== ===============
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
-5-
<PAGE>
INTEGRATED SYSTEMS, INC.
<TABLE>
<CAPTION>
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
THREE MONTHS ENDED
MAY 31,
------------------------------
1999 1998
-------------- --------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 171 $ 4,050
Adjustments to reconcile net income to net cash
(used in) provided by operating activities:
Depreciation and amortization 2,171 1,414
Deferred income taxes 137 (1,852)
Deduction for doubtful accounts receivable (110) (270)
Changes in assets and liabilities:
Accounts receivable 3,016 4,414
Prepaid expenses and other 526 (763)
Accounts payable, accrued payroll and
other accrued liabilities (6,408) 237
Income taxes payable (656) (1,445)
Deferred revenue 136 (558)
Other assets and liabilities (602) 215
-------------- --------------
Net cash (used in) provided by operating activities (1,619) 5,442
-------------- --------------
Cash flows from investing activities:
Maturities of marketable securities 11,124 4,712
Additions to property and equipment (1,599) (1,209)
Capitalized software development costs (400) (80)
-------------- --------------
Net cash provided by investing activities 9,125 3,423
-------------- --------------
Cash flows from financing activities:
Repurchase of common stock (1,492) --
Proceeds from exercise of common stock options and
purchases under the Employee Stock Purchase Plan 1,291 1,806
-------------- --------------
Net cash (used in) provided by financing activities (201) 1,806
-------------- --------------
Effect of exchange rate fluctuations on cash and cash equivalents (253) (594)
Net increase in cash and cash equivalents 7,052 10,077
Cash and cash equivalents at beginning of period 19,079 14,454
-------------- --------------
Cash and cash equivalents at end of period $ 26,131 $ 24,531
============== ==============
Supplemental disclosure of cash flow information:
Cash paid during the period for income taxes $ 607 $ 1,662
Supplemental schedule of noncash investing activities:
Unrealized loss on marketable securities $ (668) $ (27)
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
-6-
<PAGE>
INTEGRATED SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Information for the three months ended May 31, 1999 and 1998 is unaudited)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The condensed consolidated financial statements include the accounts of
Integrated Systems, Inc. and its wholly owned subsidiaries, after elimination
of all significant intercompany accounts and transactions, and should be read
in conjunction with ISI's Annual Report on Form 10-K for the year ended
February 28, 1999. These condensed consolidated financial statements do not
include all disclosures normally required by generally accepted accounting
principles.
Certain amounts in the fiscal year 1999 condensed consolidated financial
statements have been reclassified to conform to the fiscal year 2000
presentation. These reclassifications had no effect on previously reported
results of operations or shareholders' equity.
2. EARNINGS PER SHARE
Earnings per share is computed in accordance with the provisions of
Financial Accounting Standards Board Statement of Financial Accounting
Standards No. 128 ("SFAS 128"), "Earnings Per Share." Basic earnings per
share is computed using the weighted average numbers 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.
The following table sets forth the calculations of earnings per share:
<TABLE>
THREE MONTHS ENDED
MAY 31,
-----------------------
(in thousands, except per share data) 1999 1998
---------- -----------
(unaudited)
<S> <C> <C>
Basic:
Net income $ 171 $ 4,050
========== ===========
Weighted average number of common shares outstanding 22,775 23,426
========== ===========
Earnings per share - basic $ 0.01 $ 0.17
========== ===========
Diluted:
Net income $ 171 $ 4,050
========== ===========
Weighted average number of common shares outstanding 22,775 23,426
Dilutive effect of stock options, net 695 1,010
---------- -----------
Weighted average number of common and common equivalent shares outstanding 23,470 24,436
========== ===========
Earnings per share- diluted $ 0.01 $ 0.17
========== ===========
</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
1,264,000 and 581,000 for the three months ended May 31 1999 and 1998,
respectively.
-7-
<PAGE>
3. 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.
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 three months ended May 31, 1998 (in thousands):
<TABLE>
<CAPTION>
ENGINEERING
SOFTWARE SERVICES TOTAL
------------ --------------- ------------
<S> <C> <C> <C>
Revenues from external customers.................................. $ 26,403 $ 5,079 $ 31,482
Intersegment revenue.............................................. - $ 1,242 $ 1,242
Depreciation...................................................... $ 785 $ 159 $ 944
Operating profit before acquisition-related and other costs and
before interest and other income.................................. $ 1,012 $ 502 $ 1,514
</TABLE>
For the three months ended May 31, 1999 (in thousands):
<TABLE>
<CAPTION>
ENGINEERING
SOFTWARE SERVICES TOTAL
------------ --------------- ------------
<S> <C> <C> <C>
Revenues from external customers.............................. $ 25,191 $ 7,401 $ 32,592
Intersegment revenue.......................................... - - -
Depreciation.................................................. $ 1,452 $ 206 $ 1,658
Operating profit (loss) before acquisition-related
and other costs and before interest and other income.......... $ (1,429) $ 281 $ (1,148)
</TABLE>
The following table summarizes property and equipment and capital expenditures,
by segment, for the three months ended May 31, 1998 and 1999 (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED MAY 31,
---------------------------
1998 1999
------------ ------------
<S> <C> <C>
Software:
Property and equipment ........................ $ 17,209 $ 17,216
Capital expenditures .......................... $ 1,033 $ 1,478
Engineering Services:
Property and equipment ........................ $ 1,424 $ 1,358
Capital expenditures .......................... $ 176 $ 121
</TABLE>
-8-
<PAGE>
Revenue to non-affiliated customers analyzed on a geographical basis were as
follows (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED MAY 31,
--------------------------
1998 1999
------------ -------------
<S> <C> <C>
North America................................ $17,429 $18,951
Europe....................................... 7,954 8,759
Asia/Pacific................................. 6,099 4,882
------------ -------------
Total................................... $31,482 $32,592
============ =============
</TABLE>
No customer accounted for 10% or more of total revenue in the reported periods.
4. COMPREHENSIVE INCOME (LOSS)
The accumulated balances of other comprehensive income (loss), net of taxes, as
of May 31, 1999 and 1998 are as follows (in thousands):
<TABLE>
<CAPTION>
MAY 31, 1999 MAY 31, 1998
------------------------------------------- -----------------------------------------
FOREIGN FOREIGN
CURRENCY UNREALIZED CURRENCY UNREALIZED
TRANSLATION GAINS/ TOTAL TRANSLATION GAINS/ TOTAL
ADJUSTMENTS (LOSSES) OTHER ADJUSTMENTS (LOSSES) OTHER
--------------- ------------- ------------- -------------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Beginning balance $ (967) $ 208 $ (759) $ (1,438) $ 148 $ (1,290)
Current-period change (401) (401) (802) (97) (39) (136)
--------------- ------------- ------------- -------------- ------------ ------------
Ending balance $ (1,368) $ (193) $ (1,561) $ (1,535) $ 109 $ (1,426)
=============== ============= ============= ============== ============ ============
</TABLE>
5. DERIVATIVE FINANCIAL INSTRUMENTS
ISI's total contracted foreign currency forward exchange contracts as at May 31,
1999 and 1998 were as follows (in thousands):
<TABLE>
<CAPTION>
MAY 31, 1999 MAY 31, 1998
-------------------------- --------------------------
UNREALIZED UNREALIZED
GAINS/ GAINS/
COST (LOSSES) COST (LOSSES)
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Japanese Yen $ 1,327 $ (15) $ 5,200 $ 366
British Pound 807 6 - -
French Franc 829 30 - -
Italian Lira 330 14 - -
German Mark 500 15 - -
------------ ------------ ------------ ------------
TOTAL $ 3,793 $ 50 $ 5,200 $ 366
============ ============ ============ ============
</TABLE>
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.
-9-
<PAGE>
6. 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
has adopted SOP 98-1 effective March 1, 1999, and the statement is not
expected to have a significant impact on ISI's operating results, financial
position or cash flows.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 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.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following information should be read in conjunction with the condensed
consolidated interim financial statements and the notes thereto included in Item
1 of this Quarterly Report and with Management's Discussion and Analysis of
Financial Condition and Results of Operations contained in ISI's Annual Report
on Form 10-K for the year ended February 28, 1999, as filed with the Securities
and Exchange Commission on May 28, 1999.
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.
FORWARD-LOOKING INFORMATION IS SUBJECT TO RISK AND UNCERTAINTY
Except for the historical information contained in this Quarterly Report,
the matters herein contain "forward-looking" statements and information. All
forward-looking statements included in this document are based on information
available to ISI on the date hereof, and ISI assumes no obligation to update any
such forward-looking statements. ISI's actual results could differ materially
from those discussed herein. Factors that could cause or contribute to such
differences include, but are not limited to those discussed below, and to other
risk factors detailed in ISI's Annual report on Form 10-K for the year ended
February 28, 1999, and other documents filed by ISI with the Securities and
Exchange Commission.
-10-
<PAGE>
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 condensed consolidated
statements of income and the percentage change in each line item from the prior
year period:
<TABLE>
<CAPTION>
PERCENTAGE OF PERIOD-TO-PERIOD
TOTAL REVENUE PERCENTAGE CHANGE
------------------------- -----------------------------
THREE MONTHS ENDED THREE MONTHS ENDED
MAY 31, MAY 31,
1999 1998 1999 COMPARED TO 1998
----------- ----------- -----------------------------
<S> <C> <C> <C>
Revenue:
Product 58 % 55 % 10 %
Services 42 45 (5)
----------- -----------
Total revenue 100 100 4
----------- -----------
Costs and expenses:
Cost of product revenue 15 10 57
Cost of services revenue 18 19 1
Marketing and sales 43 38 16
Research and development 16 17 (2)
General and administrative 11 11 4
----------- -----------
Total costs and expenses 103 95 13
----------- -----------
(Loss)income from operations (3) 5 NM
Interest and other income 4 3 53
----------- -----------
Income before income taxes 1 8 NM
Provision(benefit) for income taxes - (5) NM
----------- -----------
Net income 1 % 13 % (96)%
----------- -----------
----------- -----------
</TABLE>
NM = Not Meaningful
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 4% from $31.5 million in the first quarter of
fiscal year 1999 to $32.6 million in the first quarter of fiscal year 2000.
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.
-11-
<PAGE>
Components of ISI's revenue by segment for the first quarter of fiscal years
1999 and 2000 were as follows:
THREE MONTHS ENDED MAY 31, 1998:
<TABLE>
<CAPTION>
Engineering
Software Services Total
-------- ----------- -------
<S> <C> <C> <C>
Product ..................... $16,792 $ 369 $17,161
Services .................... 9,611 4,710 $14,321
------- ------- -------
Total ....................... $26,403 $ 5,079 $31,482
======= ======= =======
</TABLE>
THREE MONTHS ENDED MAY 31, 1999:
<TABLE>
<CAPTION>
Engineering
Software Services Total
-------- ----------- -------
<S> <C> <C> <C>
Product ..................... $16,430 $ 2,519 $18,949
Services .................... 8,761 4,882 $13,643
------- ------- -------
Total ....................... $25,191 $ 7,401 $32,592
======= ======= =======
</TABLE>
Product revenue increased 10% from $17.2 million in the first quarter of
fiscal year 1999 to $18.9 million in the first quarter of fiscal 2000. The
percentage of ISI's total revenue attributable to product revenue increased from
55% in the first quarter of fiscal year 1999 to 58% in the first quarter of
fiscal 2000 due primarily to a Doctor Design product sale of $2.5 million,
partially offset by a slight decline in licensing of ISI's MATRIXx-Registered
Trademark- products.
Services revenue decreased 5% from $14.3 million in the first quarter of
fiscal year 1999 to $13.6 million in the first quarter of fiscal year 2000.
The decrease was due primarily to ISI's decision to shift away from lower
margin, fixed-price government contracts, which contributed $1.6 million in
the first quarter of fiscal year 1999, and no revenue in the first quarter of
fiscal year 2000, offset by continued growth of the installed customer base
and the renewal of maintenance and support contracts, and by growth in
consulting and engineering services revenue at Doctor Design.
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 45% of total revenue in the first quarter of fiscal year
1999 and 42% of total revenue in the first quarter of fiscal year 2000. The
decrease in international revenue as a percentage of total revenue in the first
quarter of fiscal year 2000 was due primarily to a decline in revenue in the
Asia/Pacific region.
COSTS AND EXPENSES
Cost of product revenue includes third-party royalties, costs of product
packaging, documentation, amortization of capitalized software development
costs, and the costs related to equipment hardware. Cost of product revenue
as a percentage of product revenue was 18% in the first quarter of fiscal
year 1999 and 26% in the first quarter of fiscal year 2000. The increase in
cost of product revenue as a percentage of product revenue is due primarily
to the Doctor Design product sale discussed above, which had a low margin.
Excluding the effect of this sale, cost of product revenue was 19% of product
revenue in the first quarter of fiscal year 2000.
Cost of services revenue includes personnel and related direct costs
associated with providing training, maintenance, engineering and consulting
services to customers and the infrastructure to manage a services
organization. In general, there are two primary reasons for cost of services
revenue as a percentage of services revenue to fluctuate: first, due to
shifts in the services revenue mix between higher margin maintenance and
support revenues and lower margin engineering services revenues, and
secondly, 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. ISI's cost of services revenue as a percentage of services
revenue was 41% in the first quarter of fiscal year 1999 and 44% in the first
quarter of fiscal year 2000. There were two contributing factors to the
change in ISI's cost of services revenue as a percentage of services revenue.
Despite the absence of low margin fixed-price government contracts in the
first quarter of fiscal year 2000, there was shift in engineering services
revenue mix at Doctor Design.
-12-
<PAGE>
Marketing and sales expenses increased by 16% from $12.1 million in the
first quarter of fiscal year 1999 to $14.0 million in the first quarter of
fiscal year 2000 and represented 38% of total revenue in the first quarter of
fiscal year 1999 and 43% of total revenue in the first quarter of fiscal year
2000. The dollar increase in marketing and sales expenses in the first quarter
of fiscal year 2000 was due to continued growth of the domestic and
international sales and support infrastructure.
ISI believes that investment in product research and development is
essential to product and technical leadership. Research and development
expenses decreased slightly from $5.4 million in the first quarter of fiscal
year 1999 to $5.3 million in the first quarter of fiscal year 2000. ISI's
investment in product research and development actually increased in the
first quarter of fiscal year 2000 over the first quarter of fiscal year 1999,
but was partially offset by an increase in capitalization of software product
development costs from $80,000 in the first quarter of fiscal year 1999 to
$400,000 in the first quarter of fiscal year 2000. ISI anticipates that it
will continue to devote substantial resources to product research and
development throughout fiscal year 2000.
General and administrative expenses were $3.4 million in the first quarter
of fiscal year 1999 compared to $3.5 million in the first quarter of fiscal year
2000 and represented 11% of total revenue in both periods.
Interest and other income increased from $0.9 million in the first quarter
of fiscal year 1999 to $1.4 million in the first quarter of fiscal year 2000 due
primarily to more favorable interest rates on interest-bearing cash equivalents
and marketable securities and to increased rental income in the first quarter of
fiscal year 2000.
Net income in the first quarter of fiscal year 1999 was positively impacted
by a $2.4 million one-time federal tax benefit related to a tax election made
during the quarter. Excluding this tax benefit, the effective tax rate for the
first quarter of fiscal year 1999 was 32%. The effective tax rate for the first
quarter of fiscal year 2000 was also 32%.
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
has adopted SOP 98-1 effective March 1, 1999, and the statement is not
expected to have a significant impact on ISI's operating results, financial
position or cash flows.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 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.
-13-
<PAGE>
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 late 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 May 31, 1999 it is estimated that costs
associated with preparation for the Year 2000 were approximately $900,000 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 $1.4 million is of a repair or upgrade nature.
LIQUIDITY AND CAPITAL RESOURCES
ISI funds its operations principally through cash flows from operations. As
of May 31, 1999, ISI had $73.6 million of cash, cash equivalents and marketable
securities. This represents a decrease of $4.7 million from February 28, 1999.
Net cash used in operating activities was $1.6 million during the first
quarter of fiscal year 2000. This represents a decrease of $7.1 million from the
amount generated in the first quarter of fiscal year 1999. Net cash from
operating activities decreased in the first quarter of fiscal year 2000, due
primarily to a large decrease in accrued liabilities related to the Green Hills
legal settlement.
Net cash provided by investing activities was $9.1 million in the first
quarter of fiscal year 2000. This compares to net cash provided by investing
activities of $3.4 million in the first quarter of fiscal year 1999. The
difference between the two comparative quarters is due primarily to the timing
of purchases and maturities of marketable securities.
Net cash used in financing activities totaled $0.2 million in the first
quarter of fiscal year 2000 compared to net cash provided of $1.8 million in the
first quarter of fiscal year 1999. The difference was due primarily to the
repurchase of approximately 116,000 shares of common stock, combined with a
decrease in the proceeds from the exercise of options to purchase common stock
and purchases under the employee Stock Purchase Plan.
ISI believes that the cash flows from operations, together with existing
cash and investment balances, will be adequate to meet ISI's cash
requirements for working capital, capital expenditures and stock repurchases
for at least the next 12 months.
-14-
<PAGE>
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:
- the volume and timing of orders received during the quarter;
- the mix of and changes in customers to whom ISI's products are sold;
- the timing and acceptance of new products and product enhancements by
ISI or its competitors;
- changes in pricing;
- buyouts of run-time licenses;
- product life cycles;
- the level of ISI's sales of third party products;
- mix of engineering and support services;
- purchasing patterns of customers;
- competitive conditions in the industry;
- foreign currency exchange rate fluctuations;
- business cycles affecting the markets in which ISI's products are
sold;
- extraordinary events, such as litigation or acquisitions, including
related charges; and
- economic conditions generally or in various geographic areas.
All of 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.
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 INTRODUCE
PRODUCT ENHANCEMENTS AND NEW PRODUCTS QUICKLY 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.
-15-
<PAGE>
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.
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 1998 and 1999 and in the first quarter of fiscal
year 2000, ISI derived approximately 41%, 42% 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:
-16-
<PAGE>
- foreign government regulation;
- reduced protection of intellectual property rights in some countries
where ISI does business;
- longer receivable collection periods and greater difficulty in
accounts receivable collection;
- unexpected changes in, or imposition of, regulatory requirements,
tariffs, import and export restrictions and other barriers and
restrictions;
- potentially adverse tax consequences;
- the burdens of complying with a variety of foreign laws and staffing
and managing foreign operations;
- exchange rate fluctuations;
- general geopolitical risks, such as political and economic
instability, hostilities with neighboring countries and changes in
diplomatic and trade relationships; and
- 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 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. In the first quarter of fiscal year 2000, ISI experienced a
decline in total revenue in the Asia/Pacific region. 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
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<PAGE>
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
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 $19.31 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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<PAGE>
ITEM 3. 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 May 31, 1999, ISI had
approximately $3.8 million of foreign currency forward exchange contracts
outstanding, in Japanese yen and numerous European currencies. At May 31,
1998 ISI had approximately $5.2 million of foreign currency forward exchange
contracts outstanding, all in Japanese yen. Unrealized gains on foreign
currency forward exchange contracts at May 31, 1999 and May 31, 1998 were
approximately $50,000 and $366,000, respectively.
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.
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<PAGE>
PART II - OTHER INFORMATION
---------------------------
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS.
<TABLE>
<CAPTION>
The following exhibit is filed herewith:
Exhibit Page
Number Title Number
------- ----- ------
<S> <C> <C>
27.01 Financial Data Schedule 22
</TABLE>
(B) REPORTS ON FORM 8-K. No reports on Form 8-K were filed by Registrant
during the three months ended May 31, 1999.
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<PAGE>
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: July 15, 1999 INTEGRATED SYSTEMS, INC.
(Registrant)
/s/ CHARLES M. BOESENBERG
-------------------------------------
CHARLES M. BOESENBERG
President and Chief Executive Officer
/s/ WILLIAM C. SMITH
-------------------------------------
WILLIAM C. SMITH
Vice President, Finance and
Chief Financial Officer
-21-
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM Q1 FY00 FORM
10-Q FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> FEB-28-2000
<PERIOD-START> MAR-01-1999
<PERIOD-END> MAY-31-1999
<CASH> 26,131
<SECURITIES> 2,382
<RECEIVABLES> 25,377
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 61,109
<PP&E> 18,574
<DEPRECIATION> 0
<TOTAL-ASSETS> 135,275
<CURRENT-LIABILITIES> 35,316
<BONDS> 0
0
0
<COMMON> 59,647
<OTHER-SE> 40,312
<TOTAL-LIABILITY-AND-EQUITY> 135,275
<SALES> 18,949
<TOTAL-REVENUES> 32,592
<CGS> 4,909
<TOTAL-COSTS> 10,903
<OTHER-EXPENSES> 22,837
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 252
<INCOME-TAX> 81
<INCOME-CONTINUING> 171
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 171
<EPS-BASIC> 0.01
<EPS-DILUTED> 0.01
</TABLE>
