-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, MAxiRNZbsgmcnRalgPlZndJu5ERs+cNXLMdZeaO1DiOsXlA5FQIzPdtqqQN1QG26 w+fLxnBvikeOVd3WnMgVgA== 0000950005-98-000013.txt : 19980115 0000950005-98-000013.hdr.sgml : 19980115 ACCESSION NUMBER: 0000950005-98-000013 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19971130 FILED AS OF DATE: 19980114 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: INTEGRATED SYSTEMS INC CENTRAL INDEX KEY: 0000775163 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 942658153 STATE OF INCORPORATION: CA FISCAL YEAR END: 0228 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-18268 FILM NUMBER: 98506879 BUSINESS ADDRESS: STREET 1: 3260 JAY ST CITY: SANTA CLARA STATE: CA ZIP: 95054-3309 BUSINESS PHONE: 4089801500 MAIL ADDRESS: STREET 1: 3260 JAY STREET CITY: SANTA CLARA STATE: CA ZIP: 95054-3309 10-Q 1 FORM 10-Q 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 November 30, 1997 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 December 31, 1997 was 23,380,390 shares. The Exhibit Index is located on page 14. Page 1 of 16 pages. INTEGRATED SYSTEMS, INC. INDEX
Page PART I - FINANCIAL INFORMATION Item 1. Financial Statements 3 Condensed Consolidated Balance Sheets as of November 30, 1997 and February 28, 1997 4 Condensed Consolidated Statements of Operations for the Three and Nine Months Ended November 30, 1997 and 1996 5 Condensed Consolidated Statements of Cash Flows for the Nine Months Ended November 30, 1997 and 1996 6 Notes to Condensed Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 9 PART II - OTHER INFORMATION Item 1. Legal Proceedings 14 Item 6. Exhibits and Reports on Form 8-K 14 SIGNATURES 15
pRISM+, SNiFF+ and MATRIXx are either trademarks or registered trademarks of Integrated Systems, Inc. ======================================================================= 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 the Company'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 the Company's Securities and Exchange Commission reports. ======================================================================= -2- PART I - FINANCIAL INFORMATION Item 1. Financial Statements The condensed consolidated interim financial statements included herein have been prepared by Integrated Systems, Inc. ("the Company"), 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, the Company 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 the Company's Annual Report on Form 10-K for the year ended February 28, 1997. The February 28, 1997 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- INTEGRATED SYSTEMS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands) November 30, February 28, 1997 1997 ------------- ------------- (unaudited) ASSETS Current assets: Cash and cash equivalents $ 12,945 $ 25,585 Marketable securities 5,908 4,483 Accounts receivable, net 26,098 28,266 Deferred income taxes 2,063 1,676 Prepaid expenses and other 4,892 4,136 ------------- ------------- Total current assets 51,906 64,146 Marketable securities 44,752 24,627 Property and equipment, net 18,772 17,956 Intangible assets, net 2,779 3,136 Deferred income taxes 1,293 1,293 Other assets 1,078 1,344 ------------- ------------- Total assets $ 120,580 $ 112,502 ============= ============= LIABILITIES Current liabilities: Accounts payable $ 4,182 $ 4,143 Accrued payroll and related expenses 4,083 3,407 Other accrued liabilities 5,529 4,514 Income taxes payable 984 1,442 Deferred revenue 13,834 12,621 ------------- ------------- Total current liabilities 28,612 26,127 Other liabilities 7 203 ------------- ------------- Total liabilities 28,619 26,330 ------------- ------------- SHAREHOLDERS' EQUITY Common Stock, no par value, 50,000 shares authorized: 23,378 and 23,039 shares issued and outstanding at November 30, 1997 and February 28, 1997, respectively 64,568 61,158 Unrealized holding gain on marketable 84 148 securities, net Translation adjustment (1,455) (1,130) Retained earnings 28,764 25,996 ------------- ------------- Total shareholders' equity 91,961 86,172 ------------- ------------- Total liabilities and shareholders' equity $ 120,580 $ 112,502 ============= ============= The accompanying notes are an integral part of these condensed consolidated financial statements. -4- INTEGRATED SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data) (unaudited)
Three Months Ended Nine Months Ended November 30, November 30, ------------------------------------------- 1997 1996 1997 1996 --------- --------- --------- --------- Revenue: Product $ 19,150 $ 18,515 $ 51,344 $ 49,340 Services 10,752 8,288 35,316 26,719 --------- --------- --------- --------- Total revenue 29,902 26,803 86,660 76,059 --------- --------- --------- --------- Costs and expenses: Cost of product revenue 3,182 2,681 9,567 6,778 Cost of services revenue 5,853 4,223 19,670 12,289 Marketing and sales 12,105 9,999 33,407 28,662 Research and development 4,672 4,149 14,221 12,270 General and administrative 2,738 2,154 8,465 6,309 Acquisition-related and other -- 4,750 -- 5,676 --------- --------- --------- --------- Total costs and expenses 28,550 27,956 85,330 71,984 --------- --------- --------- --------- Income (loss) from operations 1,352 (1,153) 1,330 4,075 Interest and other income 1,090 1,008 2,864 3,200 --------- --------- --------- --------- Income (loss) before income taxes 2,442 (145) 4,194 7,275 Provision (benefit) for income taxes 830 (51) 1,426 2,546 --------- --------- --------- --------- Net income (loss) $ 1,612 $ (94) $ 2,768 $ 4,729 ========= ========= ========= ========= Earnings per share 0.07 0.00 0.12 0.20 ========= ========= ========= ========= Shares used in per share calculations 24,349 22,909 24,057 23,385 ========= ========= ========= ========= The accompanying notes are an integral part of these condensed consolidated financial statements.
-5- INTEGRATED SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) (unaudited)
Nine Months Ended November 30, ------------------------ 1997 1996 ----------- ----------- Cash flows from operating activities: Net income $ 2,768 $ 4,729 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization 4,255 3,002 Write-down of intangible assets -- 616 Deferred income taxes (354) 474 Net income from unconsolidated subsidiary -- (604) Changes in assets and liabilities: Accounts receivable 2,063 (7,000) Prepaid expenses and other (756) (706) Accounts payable, accrued payroll and other accrued liabilities 1,730 (263) Income taxes payable (458) (4,379) Deferred revenue 1,213 935 Other assets and liabilities (3) (315) -------- -------- Net cash provided by (used in) operating activities 10,458 (3,511) -------- -------- Cash flows from investing activities: Purchases of marketable securities, net (21,647) (13,050) Additions to property and equipment (3,816) (15,423) Capitalized software development costs (825) (1,085) Other -- 3,150 -------- -------- Net cash used in investing activities (26,288) (26,408) -------- -------- Cash flows from financing activities: Repurchase of common stock (187) -- Proceeds from issuance of common stock -- 12,790 Proceeds from exercise of common stock options and purchases under the Employee Stock Purchase Plan 2,679 2,935 Tax benefit from disqualifying dispositions of common stock 918 3,708 -------- -------- Net cash provided by financing activities 3,410 19,433 -------- -------- Effect of exchange rate fluctuations on cash and cash equivalents (220) (15) Net decrease in cash and cash equivalents (12,640) (10,501) Cash and cash equivalents at beginning of period 25,585 21,822 -------- -------- Cash and cash equivalents at end of period $ 12,945 $ 11,321 ======== ======== Supplemental disclosure of cash flow information: Cash paid during the period for income taxes $ 1,353 $ 2,607 Supplemental schedule of noncash investing activities: Unrealized gain (loss) on marketable securities $ (97) $ 428 The accompanying notes are an integral part of these condensed consolidated financial statements.
-6- INTEGRATED SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Information for the three and nine months ended November 30, 1997 and 1996 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 the Company's Annual Report on Form 10-K for the year ended February 28, 1997. These condensed consolidated financial statements do not include all disclosures normally required by generally accepted accounting principles. 2. Earnings Per Share Earnings per share is computed using the weighted average number of common and common equivalent shares outstanding during the period. Common equivalent shares result from the assumed exercise of outstanding stock options that have a dilutive effect when applying the treasury stock method. The following table sets forth the calculation of earnings per share for purposes of this report:
Three Months Ended Nine Months Ended November 30, November 30, ------------------------------------------------ (in thousands, except per share data) 1997 1996 1997 1996 --------- --------- --------- --------- Primary: Net income (loss) $ 1,612 $ (94) $ 2,768 $ 4,729 ======== ======== ======== ======== Number of shares: Weighted average number of common shares outstanding 23,291 22,909 23,198 22,250 Dilutive effect of stock options, net 1,058 -- 859 1,135 -------- -------- -------- -------- 24,349 22,909 24,057 23,385 ======== ======== ======== ======== Earnings per share 0.07 0.00 0.12 0.20 ======== ======== ======== ========
Fully diluted earnings per share, for all periods presented, were not materially different from the amounts shown above. 3. Contingencies In January 1997, a former employee filed a complaint against the Company and certain of its officers, alleging claims for, among other things, breach of contract, fraud, negligent misrepresentation and labor code violations. The complaint sought general and specific damages of no less than $1.5 million plus exemplary damages, attorney's fees and costs of suit. The Company filed answers to the complaint denying all of the allegations and asserting various affirmative defenses. In October 1997, the Company reached an agreement with the plaintiff to settle all outstanding legal disputes between the two parties resulting in an immaterial charge in the quarter ended November 30, 1997. In fiscal 1997, a distributor for the Company's sales and service subsidiary in Paris, France filed a complaint against the subsidiary alleging breach of contract. The complaint sought damages of approximately $850,000. An answer to the complaint was filed denying the allegations. In September 1997, the Court in Paris ruled in favor of the Company in all material aspects of the complaint. As such, the dispute was resolved with an immaterial cost to the Company. In November 1997, the Company and one of its customers reached an agreement to resolve a previous contract dispute. The settlement resolved all disagreements between the parties and all associated costs were covered by reserves established in prior periods. In October 1997, Greenhills Software, Inc. ("Greenhills"), a supplier, filed a demand for arbitration against the Company, alleging among other things, breach of contract, fraud, negligent misrepresentation and misappropriation of trade name. Greenhills seeks damages of approximately $30 million plus unspecified punitive and exemplary damages. In December 1997, the Company responded to the arbitration demand, and filed a counter-claim against Greenhills. The Company believes it has meritorious defenses to all claims against the Company and intends to defend the claims vigorously. This dispute, however, is subject to inherent uncertainties and thus, there can be no assurance that it will be resolved favorably to the Company or that it will not have a material adverse effect on the Company's financial position or results of operations. -7- The Company is subject to various other 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 the Company's consolidated financial position, there can be no assurance that these matters will be resolved favorably to the Company. 4. Recent Accounting Pronouncements In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128 ("SFAS No. 128"), "Earnings per Share," which specifies the computation, presentation and disclosure requirements for earnings per share. SFAS No. 128 supersedes Accounting Principles Board Opinion No. 15, is effective for financial statements issued for periods ending after December 15, 1997, and requires that prior periods be restated. In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130 ("SFAS No. 130"), "Reporting Comprehensive Income," which establishes standards of disclosure and financial statement presentation for reporting total comprehensive income in individual components. SFAS No. 130 is effective for fiscal years beginning after December 15, 1997, and will require earlier periods to be restated to reflect application of the provisions of SFAS No. 130. In June 1997, the Financial Accounting Standard Board issued Statement of Financial Accounting Standards No. 131 ("SFAS No. 131"), "Disclosures About Segments of an Enterprise and Related Information," which specifies disclosure requirements for segment reporting. The statement supersedes SFAS No. 14 and SFAS No. 18 and is effective for fiscal years beginning after December 15, 1997, and requires earlier years to be restated if practicable. In November 1997, the American Institute of Certified Public Accountants issued Statement of Position ("SOP") 97-2 "Software Revenue Recognition," which supersedes SOP 91-1. The Statement is effective for fiscal years beginning after December 15, 1997 and therefore will be effective for the Company's fiscal year 1999. The impact of the adoption of the above statements on the financial statements of the Company has not yet been determined. -8- 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 the Company's Annual Report on Form 10-K for the year ended February 28, 1997, as filed with the Securities and Exchange Commission on May 29, 1997. Overview Integrated Systems, Inc. ("the Company") designs, develops, markets and supports software products and provides related engineering services principally for embedded microprocessor-based applications. The Company currently derives substantially all of its revenues from licensing these products and providing related maintenance and engineering and consulting services. In July 1996, the Company acquired Epilogue Technology Corporation ("Epilogue"), a New Mexico corporation in the business of developing network management and embedded Internet software for telecommunications and data communications equipment manufacturers, embedded software suppliers and networking related integrated circuit manufacturers. The combination was accounted for as a pooling of interests. The results of operations for Epilogue have been included only since the date of acquisition, as previous results were not significant. In November 1996, the Company amended the terms of the acquisition of Diab Data, Inc. ("Diab Data") 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 Company to consolidate the results of Diab Data from the fourth quarter of fiscal year 1997 forward. Forward-Looking Information is Subject to Risk and Uncertainty; Additional Risks and Uncertainties Except for the historical information contained in this Quarterly Report, the matters herein contain "forward-looking" statements and information (as defined in the Private Securities Litigation Reform Act of 1995) that involve risk and uncertainty. These forward-looking statements include, but are not limited to, the Company's liquidity and capital needs and various business environment and trend information. Actual future results and trends may differ materially depending on a variety of factors, including the volume and timing of orders received during the quarter, the mix of and changes in distribution channels through which the Company's products are sold, the timing and acceptance of new products and product enhancements by the Company or its competitors, changes in pricing, buyouts of run-time licenses, product life cycles, the level of the Company's sales of third party products, purchasing patterns of distributors and customers, competitive conditions in the industry, business cycles affecting the markets in which the Company's products are sold, extraordinary events, such as litigation or acquisitions, including related charges, and economic conditions generally or in various geographic areas. In particular, the economic conditions in certain countries in Asia have worsened significantly in recent months. The majority of the Company's Asian business is derived in Japan, where the down-turn has been less significant, but the impact on the Company's future results is uncertain. All of the foregoing factors are difficult to forecast. The future operating results of the Company may fluctuate as a result of these and the other risk factors detailed in the Company's Annual Report on Form 10-K for the year ended February 28, 1997, and other documents filed by the Company with the Securities and Exchange Commission. Due to all of the foregoing factors, the Company believes that period-to-period comparisons of its results of operations are not necessarily meaningful and should not be relied upon as an indication of future performance. During the previous fiscal year, the Company's actual performance did not meet market expectations. It is likely that, in some future quarters, the Company's operating results will be below the expectations of stock market analysts and investors. Consequently, the purchase or holding of the Company's Common Stock involves an extremely high degree of risk. -9- Results of Operations The following tables set forth for the periods presented the percentage of total revenue represented by each line item in the Company's condensed consolidated statements of operations and the percentage change in each line item from the prior year period:
Percentage of Period-to-Period Total Revenue Percentage Change --------------------- ------------------------ Three Months Ended Three Months Ended November 30, November 30, 1997 1996 1997 compared to 1996 -------- ------- ------------------------ Revenue: Product 64 % 69 % 3 % Services 36 31 30 -------- ------- Total revenue 100 100 12 -------- ------- Costs and expenses: Cost of product revenue 11 10 19 Cost of services revenue 19 16 39 Marketing and sales 40 37 21 Research and development 16 15 13 General and administrative 9 8 27 Acquisition-related and other -- 18 N/M -------- ------- Total costs and expenses 95 104 2 -------- ------- Income (loss) from operations 5 (4) N/M Interest and other income 3 4 8 -------- ------- Income (loss) before income taxes 8 -- N/M Provision (benefit) for income taxes 3 -- N/M ======== ======= Net income (loss) 5 % -- % N/M ======== ======= N/M = Not Meaningful
-10-
Percentage of Period-to-Period Total Revenue Percentage Change ---------------------------------------------- Nine Months Ended Nine Months Ended November 30, November 30, 1997 1996 1997 compared to 1996 ------- ------- ----------------------- Revenue: Product 59 % 65 % 4 % Services 41 35 32 ------- ------- Total revenue 100 100 14 ------- ------- Costs and expenses: Cost of product revenue 11 9 41 Cost of services revenue 23 16 60 Marketing and sales 38 38 17 Research and development 16 16 16 General and administrative 10 8 34 Acquisition-related and other -- 8 N/M ------- ------- Total costs and expenses 98 95 19 ------- ------- Income from operations 2 5 (67) Interest and other income 3 4 (10) ------- ------- Income before income taxes 5 9 (42) Provision for income taxes 2 3 (44) ------- ------- Net income 3 % 6 % (41) % ======= ======= N/M = Not Meaningful
Revenue The Company's total revenue increased 12% to $29.9 million in the third quarter of fiscal year 1998 from $26.8 million in the third quarter of fiscal year 1997 and 14% to $86.7 million in the first nine months of fiscal year 1998 from $76.1 million in the first nine months of fiscal year 1997. Product revenue increased 3% to $19.2 million in the third quarter of fiscal year 1998 from $18.5 million in the third quarter of fiscal year 1997, and 4% to $51.3 million in the first nine months of fiscal year 1998 from $49.3 million in the first nine months of fiscal year 1997. The dollar increase in product revenue in the third quarter of fiscal year 1998 is primarily due to sales of the pRISM+(TM) development environment, which was released in the second quarter of fiscal year 1998. The increase in product revenue in the nine month period of fiscal year 1998 is due to sales of pRISM+ and the inclusion of product revenue from Diab Data and Epilogue in fiscal year 1998, plus increased unit shipments of SNiFF+(TM). Services revenue increased 30% to $10.8 million in the third quarter of fiscal year 1998 from $8.3 million in the third quarter of fiscal year 1997, and 32% to $35.3 million in the first nine months of fiscal year 1998 from $26.7 million in the first nine months of fiscal year 1997. These dollar increases are the result of both an increase in maintenance revenue from a growing installed base of customers, and from an increase in engineering services and consulting activities at Doctor Design, Inc. ("Doctor Design"), an engineering services subsidiary specializing in multimedia hardware, software and application specific integrated circuit technology. The percentage of the Company's total revenue from customers located internationally was 44% and 36% in the third quarters of fiscal years 1998 and 1997, respectively, and 39% and 37% in the first nine months of fiscal years 1998 and 1997, respectively. These percentage increases are primarily due to growth in product and services revenue in Asia, particularly in Japan. Costs and Expenses The Company's cost of product revenue as a percentage of product revenue increased from 14% in the third quarter of fiscal year 1997 to 17% in the third quarter of fiscal year 1998, and from 14% in the first nine months of fiscal year 1997 to 19% in the first nine months of fiscal year 1998. These percentage increases were due to a higher proportion of product revenue being subject to third party royalty costs. The increase from the first nine months of fiscal year 1997 to fiscal year 1998 was also due to the write-off of certain prepaid royalties in the second quarter of fiscal year 1998. -11- The Company's cost of services revenue as a percentage of services revenue increased from 51% in the third quarter of fiscal year 1997 to 54% in the third quarter of fiscal year 1998, and from 46% in the first nine months of fiscal year 1997 to 56% in the first nine months of fiscal year 1998. These percentage increases were due, in part, to an increase in the proportion of services revenue derived from fixed price contracts, which generally have lower gross margins than time and material consulting contracts. In particular, the cost of services revenue as a percentage of services revenue increased in the first nine months of fiscal year 1998 as the Company was required to procure a significant amount of hardware for integration, which had no associated gross margin, under the terms of a large engineering services contract completed in the second quarter of fiscal year 1998. Excluding this anomaly, cost of services revenue as a percentage of services revenue was 52% for the first nine months of fiscal year 1998. Marketing and sales expenses were $12.1 million and $10.0 million in the third quarters of fiscal years 1998 and 1997, respectively, representing 40% and 37% of total revenue, respectively, and $33.4 million and $28.7 million in the first nine months of fiscal years 1998 and 1997, respectively, representing 38% of total revenue in both nine month periods. The dollar increases for all periods presented were primarily due to the increased marketing activity associated with the introduction of pRISM+ and the Company's continued investment in its sales and support infrastructure. Research and development expenses were $4.7 million and $4.1 million in the third quarters of fiscal years 1998 and 1997, respectively, representing 16% and 15%, respectively, of total revenue, and $14.2 million and $12.3 million in the first nine months of fiscal years 1998 and 1997, respectively, representing 16% of total revenue in both nine month periods. The dollar increases for all periods presented were primarily the result of increased personnel and consulting expenses to support the Company's continued emphasis on developing new products, including pRISM+ and MATRIXx(R) version 6.0, and enhancing existing products. Costs that are required to be capitalized under Statement of Financial Accounting Standards No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed" ("SFAS No. 86") were $575,000 in the third quarter of fiscal year 1998 compared to $350,000 in the third quarter of fiscal year 1997, and $825,000 in the first nine months of fiscal year 1998 compared to $1,085,000 in the first nine months of fiscal year 1997. The amounts capitalized represent approximately 11% of total research and development expenditures for the third quarter of fiscal year 1998 compared to 8% in the third quarter of the previous fiscal year, and 5% in the first nine months of fiscal year 1998 compared to 8% in the first nine months of fiscal year 1997. 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 on a straight line basis over three years. Amortization for the third quarter of fiscal year 1998 was $139,000 compared to $238,000 for the third quarter of fiscal year 1997, and $652,000 in the first nine months of fiscal year 1998 compared to $673,000 in the first nine months of fiscal year 1997. General and administrative expenses were $2.7 million and $2.2 million in the third quarters of fiscal years 1998 and 1997, respectively, representing 9% and 8% of total revenue, respectively, and $8.5 million and $6.3 million in the first nine months of fiscal years 1998 and 1997, respectively, representing 10% and 8% of total revenue, respectively. The dollar increases for all periods presented were primarily the result of increased headcount, related in part to the acquisition of Epilogue and the consolidation of Diab Data, combined with significant growth at Doctor Design. Acquisition-related and other costs in the third quarter of fiscal year 1997 comprised a one-time payment to the executives of a previously acquired company, Diab Data, made in conjunction with a revision to the original acquisition agreement. Acquisition-related and other costs for the nine-month period of fiscal year 1997 also include the write-off of intangible assets related to a prior acquisition and direct costs related to the acquisition of Epilogue. Interest and other income was $1.1 million in the third quarter of fiscal 1998 compared to $1.0 million in the third quarter of fiscal year 1997. The increase is primarily due to higher interest earned from increased holdings of cash and marketable securities in fiscal year 1998. Interest and other income was $2.9 million in the first nine months of fiscal year 1998 compared to $3.2 million in the first nine months of fiscal year 1997. This decrease is due to the inclusion in fiscal year 1997 of net operating income of $680,000 from Diab Data which was required to be accounted for under the equity method of accounting until the fourth quarter of fiscal year 1997, offset, in part, by increased interest income in fiscal year 1998. The effective income tax rate for the three and nine months ended November 30, 1997 was 34% compared to an effective income tax rate of 35% in the prior year's comparable periods. The lower rate in fiscal year 1998 is primarily attributable to an increase in federal R&D credits available in fiscal year 1998. -12- Liquidity and Capital Resources The Company funds its operations and capital expenditures principally through cash flows from operations. As of November 30, 1997, the Company had $63.6 million of cash, cash equivalents and marketable securities. This represents an increase of $8.9 million from February 28, 1997. In April 1997, the Company announced that the Board of Directors had authorized a new common stock repurchase program allowing the Company 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 although the Company is restricted to certain periods in which shares may be purchased. In April 1997, the Company repurchased 20,000 shares of common stock for $187,500. Net cash provided by operating activities during the first nine months of fiscal year 1998 totaled $10.5 million, as compared to net cash used of $3.5 million in the first nine months of fiscal year 1997. Net cash provided by operating activities increased, in spite of a decrease in net income, due mainly to an improvement in the management of accounts receivable and accounts payable, and changes in accrued payroll and other accrued liabilities and income taxes payable. Net cash used in investing activities totaled $26.3 million in the first nine months of fiscal year 1998 compared to $26.4 million in fiscal year 1997. Net purchases of marketable securities increased significantly in fiscal year 1998 as the Company continued to invest excess cash in interest-bearing securities. Additions to property and equipment were higher in fiscal year 1997 due primarily to the purchase of a building in March 1996. Net cash provided by financing activities totaled $3.4 million in the first nine months of fiscal year 1998 compared to $19.4 million in the first nine months of fiscal year 1997. Net cash provided by financing activities was significantly higher in the first nine months of fiscal 1997 due to the issuance of common stock in May 1996. The first nine months of fiscal year 1997 also benefited from a large tax benefit from disqualifying dispositions of common stock. The Company believes that cash flows from operations, together with existing cash balances, will be adequate to meet the Company's cash requirements for working capital, stock repurchase and capital expenditures for the next 12 months and the foreseeable future. Recent Accounting Pronouncements In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128 ("SFAS No. 128"), "Earnings per Share," which specifies the computation, presentation and disclosure requirements for earnings per share. SFAS No. 128 supersedes Accounting Principles Board Opinion No. 15, is effective for financial statements issued for periods ending after December 15, 1997, and requires that prior periods be restated. In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130 ("SFAS No. 130"), "Reporting Comprehensive Income," which establishes standards of disclosure and financial statement presentation for reporting total comprehensive income in individual components. SFAS No. 130 is effective for fiscal years beginning after December 15, 1997, and will require earlier periods to be restated to reflect application of the provisions of SFAS No. 130. In June 1997, the Financial Accounting Standard Board issued Statement of Financial Accounting Standards No. 131 ("SFAS No. 131"), "Disclosures About Segments of an Enterprise and Related Information," which specifies disclosure requirements for segment reporting. The above statements supersedes SFAS No. 14 and SFAS No. 18 and is effective for fiscal years beginning after December 15, 1997, and requires earlier years to be restated if practicable. In November 1997, the American Institute of Certified Public Accountants issued Statement of Position ("SOP") 97-2 "Software Revenue Recognition," which supersedes SOP 91-1. The Statement is effective for fiscal years beginning after December 15, 1997 and therefore will be effective for the Company's fiscal year 1999. The impact of the adoption of the above statements on the financial statements of the Company has not yet been determined. -13- PART II - OTHER INFORMATION Item 1. Legal Proceedings Information with respect to this item is incorporated by reference to Note 3 of Notes to Condensed Consolidated Financial Statements included herein on page 7 of the Form 10-Q. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits. The following exhibit is filed herewith: Exhibit Page Number Title Number 27.00 Financial Data Schedule 16 (b) Reports on Form 8-K. No reports on Form 8-K were filed by Registrant during the three months ended November 30, 1997. -14- 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: January 13, 1998 INTEGRATED SYSTEMS, INC. (Registrant) /S/ DAVID P. ST. CHARLES ------------------------- DAVID P. ST. CHARLES President and Chief Executive Officer /S/ WILLIAM C. SMITH --------------------- WILLIAM C. SMITH Vice President, Finance and Chief Financial Officer -15- EX-27 2 FINANCIAL DATA SCHEDULE
5 THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM Q3 FY98 FORM 10-Q FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1000 9-MOS FEB-28-1998 MAR-01-1997 NOV-30-1997 12,945 5,908 26,098 0 0 51,321 18,772 0 119,995 28,945 0 0 0 63,650 27,393 119,995 51,344 86,660 9,567 29,237 56,093 0 0 4,194 1,426 2,768 0 0 0 2,768 0.12 0.12
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