-----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, ACUPdXFIiZbSE5XcGBDVohJlpHbTdHTScWqLDtSSJnxSkxqhgW9GKaUdWbCh8fwt J08zyM+IioJroAO4fLB4NQ== 0000950005-97-000569.txt : 19970530 0000950005-97-000569.hdr.sgml : 19970530 ACCESSION NUMBER: 0000950005-97-000569 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19970228 FILED AS OF DATE: 19970529 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-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-18268 FILM NUMBER: 97615801 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-K 1 ANNUAL REPORT ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR FISCAL YEAR ENDED FEBRUARY 28, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission file number: 0-18268 INTEGRATED SYSTEMS, INC. (Exact name of Registrant as specified in it's charter) California 94-2658153 (State or other jurisdiction of (I.R.S. employer incorporation or organization) identification number) 201 Moffett Park Drive Sunnyvale, CA 94089 (408) 542-1500 (Address,including zip code, of Registrant's principal executive offices and Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] As of April 30, 1997, the aggregate market value of the voting stock of the Registrant held by non-affiliates of the Registrant was $167,432,389. The aggregate market value was computed by reference to the closing price of the common stock on the Nasdaq National Market on April 30, 1997. As of April 30, 1997, there were 23,165,870 shares of Registrant's common stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of Registrant's definitive Proxy Statement for its Annual Meeting of Shareholders to be held July 15, 1997 are incorporated by reference in Part III hereof. The Exhibit Index is located on page 48. ================================================================================ INTEGRATED SYSTEMS, INC. 1997 FORM 10-K ANNUAL REPORT Table of Contents PART I
Page ---- No. --- Item 1. Business......................................................................... 1 Item 2. Properties....................................................................... 14 Item 3. Legal Proceedings................................................................ 14 Item 4. Submission of Matters to a Vote of Security Holders.............................. 14 Item 4a. Executive Officers of the Registrant............................................. 15 PART II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters........ 17 Item 6. Selected Financial Data.......................................................... 17 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.................................................................... 19 Item 7a Quantitative and Qualitative Disclosures About Market Risks...................... 22 Item 8. Financial Statements and Supplementary Data...................................... 23 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures................................................................... 23 PART III Item 10. Directors and Executive Officers of the Registrant............................... 24 Item 11. Executive Compensation........................................................... 24 Item 12. Security Ownership of Certain Beneficial Owners and Management................... 24 Item 13. Certain Relationships and Related Transactions................................... 24 PART IV Item 14. Exhibits, Financial Statements, Schedule, and Reports on Form 8-K ............... 25 Signatures................................................................................... 47 Index to Exhibits............................................................................ 48
PART I Item 1. Business. Integrated Systems, Inc. ("the Company") designs, develops, markets and supports software products and provides related engineering services principally for embedded microprocessor-based applications. Embedded microprocessors are used to add functionality and intelligence to a variety of products and to operate as an integral part of these products, generally without any direct human intervention. The Company offers software that consists of a real-time operating system, a development suite and a series of component modules and design tools that aid software development. The Company's products are designed to enable users to accelerate the design, development, debugging, implementation and maintenance of embedded software. The Company's products and services reduce the expense associated with embedded software and system development and enable customers to develop systems that have greater functionality, enhanced performance, improved reliability and ease of use. Integrated Systems markets and supports its products and provides services on a worldwide basis to a variety of users in a broad range of industries, including telecommunications and data communications, automotive, multimedia and consumer, office and industrial automation and the embedded Internet. The Company was incorporated in California in February 1980. Industry Background Embedded systems consist of a microprocessor and related software dedicated to a specialized task or set of tasks and are found in many common products such as telephones, automobiles, VCRs and facsimile machines. Many of these products require real-time embedded systems that provide an immediate, predictable response to unpredictable sequences of external events under severe deadlines. For example, the embedded system that controls the engine in an automobile must set airflow, fuel quantity, spark advance and other engine parameters for each cycle within milliseconds based on engine speed, engine temperature, atmospheric conditions and accelerator position in order to optimize fuel efficiency, emissions control and responsiveness. As more powerful microprocessors have become available and decreased in price, embedded systems are being used in or with a wider range of applications. Today, embedded systems are found in: telecommunications and data communications products such as routers, access devices and switches; automotive products such as engine controllers and anti-lock braking systems; multimedia and consumer products such as digital video broadcast and security systems; and office and industrial automation products such as printers, copiers and point-of-sale terminals. Emerging embedded Internet applications for interactive entertainment, network computers, remote maintenance and other areas may offer significant new opportunities for embedded systems. The development of applications software for embedded systems requires software development and design tools and a real-time operating system. Real-time operating systems and software development tools, including compilers, debuggers and simulators, are used by developers to create applications software that enables the embedded system to perform its required functions. Embedded systems are increasingly based upon 32-bit microprocessors, which run significantly larger and more sophisticated application software than embedded systems based upon less powerful microprocessors. In addition, the cost of some 32-bit microprocessors has decreased substantially to below $10, thereby opening new markets for high-volume embedded applications that can now be cost justified. As a result, 32-bit microprocessors represent the fastest growing segment of the embedded microprocessor industry. The complexity and size of these new software applications and the proliferation of multiple types of microprocessors require a more substantial engineering effort, necessitating more sophisticated development tools and real-time operating systems. Developers of embedded systems are increasingly replacing internally developed real-time operating systems with commercially available products as organizations find internal development and maintenance to be costly and a diversion of core engineering resources. Also, developers of embedded systems often find that internally developed real-time operating systems designed for a single project are not easily ported to other microprocessors or scalable for different applications within the organization, which increases development time and cost. As a result, organizations are seeking to improve engineering productivity by standardizing on third-party software in order to eliminate software incompatibilities and reduce training and 1 support costs. With productivity becoming a more strategic issue, selection of tools and real-time operating system technology is increasingly being evaluated by senior managers for division or company-wide deployment. The Company believes that more organizations will need to replace internally developed tools with commercial products and to standardize on integrated enterprise-wide solutions that are highly reliable, easily customizable and scalable so that they can be used for simple as well as complex applications. Integrated Systems' Solution Integrated Systems provides comprehensive solutions for the development of highly reliable and sophisticated embedded microprocessor-based applications. The Company offers operating software that consists of a real-time system, the pSOSystem, an integrated development environment, and a series of component modules and design tools. The Company's products are designed to enable users to accelerate the design, development, debugging, implementation and maintenance of embedded software and to develop systems that have greater functionality, enhanced performance, improved reliability and ease of use. The Company also offers a range of consulting services, including product and system design, training in the use of the Company's products and development of specialized application code or drivers for incorporation into customers' applications. These services have allowed the Company to offer customers complete designs based on the Company's products and have allowed more rapid use of the Company's technology in customers' product designs. The solution offered by Integrated Systems provides the following features and benefits: High Reliability. The Company's pSOS+ operating system is highly reliable, making it suitable for deeply embedded applications where human intervention to remedy software operating problems is not feasible. High reliability reduces maintenance costs and allows the Company's customers to develop sophisticated mass market products based on Integrated Systems' solution. Suitability For High Volume Applications. The Company offers a full-featured high performance operating system with memory requirements as low as 16 Kbytes. In addition, the Company's operating system is very efficient, enabling the Company's customers to minimize hardware costs while increasing the functionality of their application designs. The Company's solutions are suitable for low-cost, high-volume applications because of their low memory and other hardware requirements and for hand-held applications in which less complex hardware conserves battery power. Scalability. The Company's product architecture is modular, scalable and readily customizable. As a result, the Company's solution is used in a broad range of industries for a wide array of applications. In addition, these product features enable the Company to enter new and emerging markets rapidly. The Company endeavors to be first to market with support for new applications and microprocessors. Cross-Development Capabilities. To accelerate the application development process, the Company offers a set of tools specifically designed for embedded software development that fully supports object-oriented methodologies. The Company's solution provides an integrated development environment ("IDE"), called pRISM+ to which individual development tools can be connected. Built on the industry-standard CORBA (Common Object Request Broker Architecture) framework, pRISM+ is a graphical programming environment which brings a comprehensive set of application oriented tools to the embedded market. pRISM+ currently operates on certain Unix-based workstations. The Company also offers SNiFF+, which is an advanced, object-oriented environment for the development of sophisticated applications. The Company offers comprehensive cross-development capabilities that allow its development tools to operate on a personal computer or workstation, while the embedded software runs on an embedded processor. The Company offers MATRIXx, a high-level set of tools for modeling, simulation and code generation from a graphical description of real-time control software functionality. Application Specific Modules. While the Company's products are suitable for a broad range of embedded applications, the Company provides additional support for large application areas through the availability of application-specific modules. 2 Business Strategy The Company's objective is to maintain a leadership position in the telecommunications and data communications, automotive, multimedia and consumer and office and industrial automation markets, and leverage its experience in embedded applications to enter new markets, such as embedded Internet applications, in which the Company believes it can establish a leadership position. To achieve these objectives, the Company is pursuing the following business strategy: Maintain Technology Leadership. The Company's extensive expertise in embedded software development tools and real-time operating systems has enabled it to be a technology leader in the embedded software development market. The Company seeks to capitalize on this existing technology base to accelerate the development of new products that leverage the features of its existing product line. The Company intends to maintain its technological leadership through rapid response to emerging opportunities and customer requirements by continuing to make significant investments in research and development and continuing to enhance the architecture of its development tools and operating software. Offer Comprehensive Solutions. The Company's products and services offer a comprehensive solution to users of embedded microprocessors. This approach simplifies customers' purchasing decisions, eliminates the need for customers to integrate products from multiple sources, improves customer support, accelerates the integration of the Company's technology into customers' products and allows the Company's products to be used effectively by less experienced engineers. The Company expects to continue to expand and refine its solution through internal development activities and strategic acquisitions. Maintain Market Focus. While the Company's products and services are suitable for a wide variety of applications and are sold to a broad range of customers, the Company has focused its development and marketing efforts on the telecommunications and data communications, automotive, multimedia and consumer and office and industrial automation markets. The Company has developed a complete suite of products to address these markets in order to achieve deeper penetration, as well as to provide products that reduce the time and expense associated with system development. The Company seeks to participate in the rapid growth of low-cost, high-volume applications for embedded systems through run-time license arrangements with its customers based on the number of products sold that incorporate the Company's products. Address Emerging Market Opportunities. From time to time, the Company evaluates strategic opportunities and applies its technology to develop products for new markets more quickly. The Company believes its products and services are suitable for emerging markets because its products are scalable, reliable and rapidly reconfigurable. Portability and Support for Widely-Used Embedded Microprocessors and Host Platforms. The Company has expended significant resources to make its products available on a broad range of host platforms and 32-bit embedded microprocessors. This has allowed the Company to sell into a broad range of markets. Because large companies use a range of host platforms and microprocessors, it also makes it possible for large customers to standardize on Integrated Systems' solution. Products and Services The Company offers three major families of products to support the embedded software development market: real-time or embedded operating software, software development tools and graphical design products. Embedded Operating Software. Integrated Systems' embedded operating software consists of the pSOS+ operating system and special purpose modules that run on the pSOS+ operating system. The combination of real-time operating software and development tools is marketed and licensed as pSOSystem. pSOS+ is a priority-based, interrupt-oriented, multitasking operating system that is small in size (requiring as little as 16 Kbytes of storage) and highly reliable and efficient. Based on a scalable software component architecture, pSOS+ represents a complete solution for advanced 32-bit embedded applications development and run-time. The Company also offers a multiprocessing version, called pSOS+m, that operates on tightly coupled or 3 loosely coupled microprocessors. pSOS+ operating system is currently available for the Motorola 68xxx, Intel x86 and i960, Power PC, MIPS and Hitachi SH product families. The Company is currently porting pSOS+ for ARM, Sparc and Mitsubishi M32. The special purpose modules that run on the pSOS+ operating system are used to support development of pSOS+ application software, to debug embedded code, to provide file support for embedded applications and to develop user interfaces. In addition, the Company offers a number of modules that address networking, telecommunications and data communications, automotive, multimedia and consumer and embedded Internet applications. These modules provide complete implementation of certain aspects of the applications at which they are focused, which improves customers' time to market and reliability. For example, the TCP/IP module offered by the Company provides a complete implementation of the TCP/IP communication protocol. Software Development Tools. The Company offers a broad line of tools to support the development of embedded software applications. The Company's development tools consist of an integrated development environment ("IDE"), called pRISM+, which provides sophisticated cross development frameworks, and individual tools that are connected to these frameworks. pRISM+ allows tool-to-tool and tool-to-target communications over local and wide-area networks, allowing a project to readily move from a single workstation to a distributed network. pRISM+ is built around an object bus conforming to the CORBA standard. pRISM+ currently operates on Unix-based workstations manufactured by Sun Microsystems and Hewlett-Packard, and is currently being developed to operate on Windows-based personal computers. The Company also offers SNiFF+, which is an advanced, object-oriented environment for the development of sophisticated applications including the development of complex object-oriented desktop and client-server applications. Individual tools offered by the Company include C and C++ cross-compilers, source level debuggers, browsers, pSOS+ simulators and profilers. The Company also offers a visual debugging and analysis tool called ESp that graphically displays component configurations, memory stack usage and errors, static and dynamic views of all kernel objects, user specified events and CPU use graphs. The Company also offers IDE products and individual tools that are licensed from third parties or that include technology licensed from third parties. These tools operate on Windows-based personal computers and workstations manufactured by Sun Microsystems, Hewlett-Packard and IBM. Graphical Design Products. The Company's graphical design product line, called MATRIXx, includes control system engineering tools for analysis, design, simulation and prototyping. Products and modules in the MATRIXx family include the following: --Xmath is a mathematically-based engineering analysis tool that provides analysis capabilities, plot generation facilities and specialized function libraries for control design, robust control, optimization, digital signal processing, system identification and model reduction applications. --SystemBuild is a system modeling and simulation tool used to create interactive, dynamic system models that include plant dynamics and real-time software logic. SystemBuild includes a block diagram editor, tools to create animated system simulations and state transition diagrams. In addition, customers can order special purpose libraries for a variety of needs, including fuzzy logic systems. The architecture of SystemBuild allows the creation of application-specific libraries. --AutoCode automatically generates programming code from SystemBuild diagrams in the C or Ada languages. This accelerates application development by relieving engineers of line-by-line programming and sharply reducing programming errors committed as projects move from design analysis to programming phases. --DocumentIt software further accelerates the design process by automatically incorporating information about a design into a documentation format. 4 --RealSim Series prototyping tools complete the family by providing the software and real-time computing hardware to verify an application in its intended environment. C or Ada code generated in the AutoCode environment automatically loads and runs on RealSim Series hardware. --BetterState is a Statechart modeling, simulation, and automatic code generation tool. BetterState's Statecharts allow developers to model complex software system's reactions to asynchronous external stimulus and to generate production-quality embedded code automatically. It is currently available for the Windows 95 and Windows NT operating systems. Engineering Services. In addition to the products described above, the Company offers engineering services to its customers. The Company's engineering services group helps customers design and implement specific solutions typically using tools provided by the Company. The Company provides engineering services to develop close relationships with key customers, to accelerate acceptance of advanced tools in the industry, to demonstrate the effectiveness of the products, to learn more about specific systems and customer's development needs and to work with the Company's product development group to incorporate appropriate features into new versions of products or into new modules or libraries. Engineering services projects can last from a few weeks to several years and are generally performed on a time and materials basis. Sales and Support The Company markets its products primarily through a direct sales force augmented by a telemarketing organization, distributors and sales representatives. The Company believes that use of a direct sales force allows the Company to influence customer purchasing decisions, to provide superior support to its customers and to understand better evolving customer needs. The Company has significantly expanded the number of markets where it uses a direct sales force and expects to continue to do so in the future. The Company's direct sales organization in North America operates through 19 United States sales offices and a subsidiary in Canada. Direct sales managers are typically supported by field application engineers who are experts in the Company's technology and products. In addition, a small telemarketing organization focuses on selling maintenance and renewal contracts, licensing lower-priced products and licensing to universities. Sales internationally are supported by a direct sales force that operates from subsidiaries based in Austria, Canada, France, Germany, Israel, Japan, Italy, Sweden, and the United Kingdom. In addition, the Company has sales and support offices in Korea and India. The sales and support personnel in these subsidiaries and offices are complemented by distributors and sales representatives that address certain geographical areas, market segments or product families. Sales representatives market and support the Company's products in Australia, China, India, Korea, Taiwan and several other countries in Asia, while distributors cover the rest of the world. In fiscal 1996, the Company initiated direct selling operations in Japan and Italy, replacing its existing third party distributor arrangements, and implemented certain substantial changes to its direct sales operations in Germany and France in the first quarter of fiscal 1997. The Company's software development products are typically licensed on a per-user basis. The Company's real-time operating systems and run-time packages are also generally licensed for development on a per-project basis. Run-time license fees are typically charged on a per-unit basis when the customer's application is deployed. List prices for the Company's software development tools and real-time operating systems development licenses generally range from less than $4,000 to over $100,000, with a typical development license averaging between $25,000 and $50,000. Prices for run-time license fees generally range from less than $1 per-unit to over $100 per-unit depending, in part, on production quantities. Approximately 28%, 34% and 38% of the Company's total revenue was derived from sales outside of North America in fiscal 1995, 1996 and 1997, respectively. No single customer accounted for more than 10% of the Company's total revenue in fiscal 1995, fiscal 1996, and fiscal 1997. The Company has made significant investments in developing its distribution and support channels outside North America to increase the percentage of revenue derived from international sales. There can be no assurance that changes from distribution sales to direct sales or these additional investments will lead to increased revenue. See "--Risk Factors--Risks Associated with International Operations." 5 Product Development The Company's product development activities address the needs of the market segments upon which the Company focuses, offer customers open cross-development capability and enhance the capabilities of current products and modules to address user requirements. In addition, the Company seeks to port the pSOSystem to additional microprocessors, make the pSOSystem suitable for additional high-volume applications, add new products and modules to the Company's product lines, create interfaces between the Company's products and other key computer-aided design and software development tools and provide the end user greater flexibility to integrate automatically-generated code with manually-written code, thereby allowing the end user to accelerate application development. The Company attempts to release upgrades and to introduce new products or modules on a regular basis. In connection with each release, the Company works closely with its customers to define improvements and enhancements that are incorporated into the next release of the product. This approach includes customer feedback in the Company's product design process, as well as in the evaluation stage, thereby permitting customers to influence functionality early in the product's life-cycle. The Company believes that its engineering services group provides the Company with a competitive advantage for product development by defining needs for new products, guiding future enhancements and testing new implementations. In addition, this group contracts with customers to research new methodologies that can serve as prototypes for new features, products or modules. As of February 28, 1997, the Company employed 132 engineers in the product development group and 70 in the engineering services group. The Company's engineers include experts in software engineering, software development tools, multimedia, telecommunications, real-time controls and operating systems technology. For fiscal 1995, 1996 and 1997, the Company's research and development expenses were approximately $8.3 million, $11.4 million, and $17.3 million or 14%, 13%, and 16% of its total revenue, respectively. Research and development expenses increased faster than revenue in fiscal 1997 to support the development of pRISM+. The Company capitalizes certain costs of developing computer software to be licensed or otherwise marketed to customers in accordance with Statement of Financial Accounting Standards No. 86 ("SFAS No. 86"), "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed. The Company capitalized approximately $492,000, $335,000, and $1,540,000 of research and development expenditures related to the development of software products in fiscal 1995, 1996 and 1997, respectively. The amounts capitalized represented approximately 6%, 3%, and 8%, respectively, of total research and development expenditures for fiscal 1995, 1996 and 1997. Such capitalized costs are being amortized using the greater of the amount computed using the ratio that current gross revenues for a product bear to the total of current and anticipated future gross revenues for that product, or on a straight-line basis over three years. Amortization of capitalized cost for fiscal 1995, 1996 and 1997 was $607,000, $921,000, and $968,000, respectively. The amount of research and development expenses capitalized in a given time period depends upon the nature of the development performed and, accordingly, amounts capitalized may vary from period to period. The market for embedded applications is fragmented and is characterized by ongoing technological developments, evolving industry standards and rapid changes in customer requirements. The Company's success depends upon its ability to continue to develop and introduce in a timely manner new products that take advantage of technological advances, to continue to enhance its existing product lines, to offer its products across a spectrum of microprocessor families used in the embedded systems market and to respond promptly to customers' requirements. The Company must continuously update its existing products to keep them current with changing technology and must develop new products to take advantage of new technologies that could render the Company's existing products obsolete. The Company has recently experienced delays in the development of new products and the enhancement of existing products. Specifically, the development of pRISM+ to operate on Windows-based personal computers has been subject to delays. Such delays are commonplace in the software industry and are likely to be experienced by the Company in the future. The Company's future prospects depend upon the Company's ability to increase the functionality of existing products in a timely manner and to develop new products that address new technologies and achieve market acceptance. New products and enhancements must keep pace with competitive offerings, adapt to evolving industry standards and provide additional functionality. There can be no assurance that the Company will be successful in developing and marketing, on a timely basis or at all, competitive products, product enhancements and new products that respond to technological change, changes 6 in customer requirements and emerging industry standards, or that the Company's enhanced or new products will adequately address the changing needs of the marketplace. The inability of the Company, due to resource constraints or technological or other reasons, to develop and introduce new products or product enhancements in a timely manner could have a material adverse effect on the Company's business, financial condition or results of operations. From time to time, the Company or its competitors may announce new products, capabilities or technologies that have the potential to replace or shorten the life cycles of the Company's existing products. There can be no assurance that announcements of currently planned or other new products will not cause customers to defer purchasing existing Company products. Any failure by the Company to anticipate or respond adequately to changing market conditions, or any significant delays in product development or introduction, would have a material adverse effect on the Company's business, financial condition and results of operations. If the results of product development efforts are inadequate or delayed, the Company's business, financial condition and results of operations would be materially adversely affected. See "-- Risk Factors -- Risks Associated with New or Emerging Markets." Competition The market for commercially available software tools and embedded operating systems is fragmented, highly competitive, and is characterized by pressures to incorporate new features and accelerate the release of new product versions. The Company's products compete with software developed internally by embedded systems manufacturers and software offered by other third parties. Many organizations that internally develop and maintain real-time operating systems have substantial programming resources and can develop specific products for their needs. Many of these companies have significant investments in their existing software and there can be no assurance that the Company will be able to persuade existing and potential customers to replace or augment their internally developed real-time operating systems with the Company's products. The Company's principal competitors for third-party embedded software development and related tools (pSOSystem) are Wind River Systems, Inc., Mentor Graphics (through its acquisition of Microtec Research, Inc.), and Microware Systems Corporation. The MATRIXx product family competes with products offered by Mathworks Incorporated and a number of other companies that provide design and analysis, modeling and simulation, and code generation products. The Company also competes with a number of other vendors that address one or more segments of the system design process, including vendors that have modified general purpose software engineering products for real-time and control design applications. As the industry continues to develop, the Company expects competition to increase in the future from existing competitors and from other companies that may enter the Company's existing or future markets with similar or substitute solutions that may be less costly or provide better performance or functionality than the Company's products. Some of the Company's existing and many of its potential competitors have substantially greater financial, technical, marketing and sales resources than the Company and there can be no assurance that the Company will be able to compete successfully against these companies. In the event that price competition increases significantly, competitive pressures could cause the Company to reduce the prices of its products, which would result in reduced profit margins. Prolonged price competition would have a material adverse effect on the Company's business, financial condition and results of operations. Also, run-time licenses, which provide for per-unit royalty payments for each embedded system that incorporates the Company's real-time operating systems, may be subject to significant pricing pressures. A variety of other potential actions by the Company's competitors, including increased promotion and accelerated introduction of new or enhanced products, could have a material adverse effect on the Company's business, financial condition and results of operations. The Company believes that the principal bases for a customer's decision to license the Company's products are product functionality and performance, degree of integration, ease of product use, quality of support services and corporate reputation. The Company believes that it competes favorably in these areas. 7 Proprietary Rights The Company's success is heavily dependent upon its proprietary technology. To protect its proprietary rights, the Company relies on a combination of copyright, trade secret, patent and trademark laws, nondisclosure and other contractual restrictions on copying and distribution and technical measures. The Company seeks to protect its software, documentation and other written materials through trade secret and copyright laws, which provide only limited protection. In addition, the Company holds two United States patents and has additional United States patent applications pending. There can be no assurance that patents held by the Company will not be challenged and invalidated, that patents will issue from any of the Company's pending applications or that any claims allowed from existing or pending patents will be of sufficient scope or strength (or be issued in all countries where the Company's products can be sold) to provide meaningful protection or any commercial advantage to the Company. As part of its confidentiality procedures, the Company generally enters into nondisclosure agreements with its employees, consultants, distributors and corporate partners and limits access to and distribution of its software, documentation and other proprietary information. End user licenses of the Company's software are frequently in the form of shrink wrap license agreements which are not signed by licensees, and therefore may be unenforceable under the laws of many jurisdictions. The source code of the Company's products is also protected as a trade secret and is generally not licensed to customers. Despite the Company's efforts to protect its proprietary rights, it may be possible for unauthorized third parties to copy the Company's products or to reverse engineer or obtain and use information that the Company regards as proprietary. There can be no assurance that the Company's competitors will not independently develop technologies that are substantially equivalent or superior to the Company's technologies. Policing unauthorized use of the Company's products is difficult, and while the Company is unable to determine the extent to which software piracy of its products exists, software piracy can be expected to be a persistent problem. In addition, effective protection of intellectual property rights may be unavailable or limited in certain countries. The status of United States patent protection in the software industry is not well defined and will evolve as the United States Patent and Trademark Office grants additional patents. Patents have been granted on fundamental technologies in software, and patents may issue that relate to fundamental technologies incorporated into the Company's products. As the number of patents, copyrights, trademarks and other intellectual property rights in the Company's industry increases, products based on its technology may increasingly become the subject of infringement claims. There can be no assurance that third parties will not assert infringement claims against the Company in the future. Any such claims with or without merit could be time consuming, result in costly litigation, cause product shipment delays or require the Company to enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, might not be available on terms acceptable to the Company, or at all, which could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, the Company may initiate claims or litigation against third parties for infringement of the Company's proprietary rights or to establish the validity of the Company's proprietary rights. Litigation to determine the validity of any claims, whether or not such litigation is determined in favor of the Company, could result in significant expense to the Company and divert the efforts of the Company's technical and management personnel from productive tasks. In the event of an adverse ruling in any such litigation, the Company might be required to pay substantial damages, discontinue the use and sale of infringing products, expend significant resources to develop non-infringing technology or obtain licenses to infringing technology. The failure of the Company to develop or license a substitute technology could have a material adverse affect on the Company's business, financial condition and results of operations. The Company licenses certain software development tool products from other companies to distribute with its own products. The inability of such third parties to provide competitive products with adequate features and high quality on a timely basis or to provide sales and marketing cooperation could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, the Company's products compete with products produced by certain of the Company's licensors. There can be no assurance that, upon the termination or expiration of these licenses, such licenses will be available on reasonable terms or at all, or that similar products could be obtained to substitute into the tool suites. The inability to license such products could have a material adverse effect on the Company's business, financial condition and results of operations. 8 Backlog The Company generally ships its products within 30 days after acceptance of a customer purchase order and, therefore, has insignificant product backlog. The insignificant product backlog makes it difficult to predict with accuracy quarterly revenue and quarterly earnings prior to the end of a quarterly reporting period. Engineering services backlog, consisting of orders for engineering services scheduled to be performed within the following twelve months, was approximately $4.1 million, $7.2 million, and $10.4 million at February 28, 1995, 1996 and 1997, respectively. Most of the contracts with the Company's engineering services customers are terminable at the convenience of the customer. The Company has experienced termination in the past and expects terminations to continue to occur in the future. Employees As of February 28, 1997, the Company employed 510 persons, including 229 in marketing, sales and support services, 202 in engineering (70 in engineering services and 132 in product development) and 79 in management, administration and finance. Of these employees, 399 are located in the United States and 111 are located at the Company's subsidiaries and sales offices outside of the United States. In addition, from time to time the Company employs temporary employees and consultants. None of the Company's employees is represented by a labor union or is the subject of a collective bargaining agreement. The Company has never experienced a work stoppage and believes that its employee relations are good. The Company believes its future success will depend in large part upon its ability to attract and retain highly skilled managerial, engineering, sales, marketing and operations personnel, many of whom are in great demand. Competition for such personnel has intensified dramatically over the last twelve months in Santa Clara County, California, where the Company is headquartered, and there can be no assurance that the Company will be successful in attracting and retaining such personnel. See "--Risk Factors--Dependence on Key Personnel; Need for Additional Personnel." Risk Factors The statements contained in this Annual Report that are not purely historical are forward looking statements, including statements regarding the Company's expectations, hopes or intentions regarding the future. Actual results could differ materially from those discussed in the forward-looking statements. Among the factors that could cause actual results to differ materially are those discussed below. In addition to the other information in this Annual Report, the following risk factors should be considered carefully in evaluating the Company and its business. Fluctuations in Quarterly Results. The Company's quarterly operating results vary significantly depending on a number of factors, including the volume and timing of orders received during the quarter, the mix of and changes in distribution channels through which the Company's products are sold, the timing and acceptance of new products and product enhancements by the Company or its competitors, changes in pricing, buyouts of run-time licenses, product life cycles, the level of the Company's sales of third party products, purchasing patterns of distributors and customers, competitive conditions in the industry, foreign currency exchange rate fluctuations, business cycles affecting the markets in which the Company's products are sold, extraordinary events, such as litigation or acquisitions, including related charges, and economic conditions generally or in various geographic areas. All of the foregoing factors are difficult to forecast. The future operating results of the Company may fluctuate as a result of these and other factors, including the Company's ability to continue to develop innovative and competitive products. The Company historically has operated with insignificant product backlog because its products are generally shipped as orders are received. As a result, product revenue in any quarter depends on the volume and timing of orders received in that quarter. In addition, the Company has at times recognized a substantial portion of its total revenue from sales booked and shipped in the last two weeks of the quarter such that the magnitude of quarterly fluctuations may not become evident until very late in, or after the end of, a particular quarter. Because the Company's staffing and operating expenses are based on anticipated total revenue levels, and a high percentage of the Company's costs are fixed in the short term, small variations between anticipated orders and actual orders, as well as non-recurring or large orders, can cause disproportionate variations in the Company's operating results from quarter to quarter. 9 The procurement process of the Company's customers typically ranges from a few weeks to several months or longer from initial inquiry to order, making the timing of sales and license fees difficult to predict. Moreover, as licensing of the Company's products increasingly becomes a more strategic decision made at higher management levels, there can be no assurance that sales cycles for the Company's products will not lengthen. The Company's results of operations may also be affected by seasonal trends. The Company's total revenue and net income during the first fiscal quarter have historically been lower than the previous fourth fiscal quarter for a variety of reasons, including customer purchase cycles related to expiration of budgetary authorizations, and the Company expects that total revenue and net income in the first quarter of fiscal 1998 will be lower than the fourth quarter of fiscal 1997. In addition, the Company's acquisitions in fiscal 1996 and 1997, as well as any future acquisitions, involve numerous risks and could have a material adverse effect on the Company's business, financial condition and results of operations. 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 last 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 again be below the expectations of stock market analysts and investors. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Rapid Technological Change; Dependence on New Products. The market for embedded applications is fragmented and is characterized by ongoing technological developments, evolving industry standards and rapid changes in customer requirements. The Company's success depends upon its ability to continue to develop and introduce in a timely manner new products that take advantage of technological advances, to continue to enhance its existing product lines, to offer its products across a spectrum of microprocessor families used in the embedded systems market and to respond promptly to customers' requirements. The Company must continuously update its existing products to keep them current with changing technology and must develop new products to take advantage of new technologies that could render the Company's existing products obsolete. The Company has recently experienced delays in the development of new products and the enhancement of existing products. Specifically, the development of pRISM+ to operate on Windows-based personal computers has been subject to delays. Such delays are commonplace in the software industry and are likely to be experienced by the Company in the future. The Company's future prospects depend upon the Company's ability to increase the functionality of existing products in a timely manner and to develop new products that address new technologies and achieve market acceptance. New products and enhancements must keep pace with competitive offerings, adapt to evolving industry standards and provide additional functionality. There can be no assurance that the Company will be successful in developing and marketing, on a timely basis or at all, competitive products, product enhancements and new products that respond to technological change, changes in customer requirements and emerging industry standards, or that the Company's enhanced or new products will adequately address the changing needs of the marketplace. The inability of the Company, due to resource constraints or technological or other reasons, to develop and introduce new products or product enhancements in a timely manner could have a material adverse effect on the Company's business, financial condition or results of operations. From time to time, the Company or its competitors may announce new products, capabilities or technologies that have the potential to replace or shorten the life cycles of the Company's existing products. There can be no assurance that announcements of currently planned or other new products will not cause customers to defer purchasing existing Company products. Any failure by the Company to anticipate or respond adequately to changing market conditions, or any significant delays in product development or introduction, would have a material adverse effect on the Company's business, financial condition and results of operations. If the results of product development efforts are inadequate or delayed, the Company's business, financial condition and results of operations would be materially adversely affected. See "Business--Product Development." 10 Risks Associated with New or Emerging Markets. From time to time, the Company embarks on product development for new or emerging markets. Currently, the Company is continuing to expend substantial time and financial resources to develop product lines for applications that use Internet technology with embedded microprocessors. The Company has introduced both embedded operating software and development tools for Internet applications. The commercial Internet market has only recently begun to develop, is rapidly changing and is characterized by an increasing number of new entrants with competitive products. It is difficult to predict with any assurance whether the Internet will prove to be a viable commercial marketplace, or whether demand for Internet related products and services will emerge or increase in the future. If the Internet market, or any other new market targeted by the Company in the future, fails to develop or develops more slowly than anticipated or becomes saturated with competitors, or if the Company's products and services do not achieve or sustain market acceptance, the Company's business, financial condition and results of operations would be materially adversely affected. See "Business--Product Development." Competition. The market for commercially available software tools and embedded operating systems is fragmented and highly competitive and is characterized by pressures to incorporate new features and accelerate the release of new product versions. The Company's products compete with software developed internally by embedded systems manufacturers and software offered by other third parties. Many organizations that internally develop and maintain real-time operating systems have substantial programming resources and can develop specific products for their needs. Many of these companies have significant investments in their existing software and there can be no assurance that the Company will be able to persuade existing and potential customers to replace or augment their internally developed real-time operating systems with the Company's products. The Company's principal competitors for third-party embedded software development and related tools (pSOSystem) are Wind River Systems, Inc., Mentor Graphics (through its acquisition of Microtec Research, Inc.), and Microware Systems. The MATRIXx product family competes with products offered by Mathworks Incorporated and a number of other companies that provide design and analysis, modeling and simulation, and code generation products. The Company also competes with a number of other vendors that address one or more segments of the system design process, including vendors that have modified general purpose software engineering products for real-time and control design applications. As the industry continues to develop, the Company expects competition to increase in the future from existing competitors and from other companies that may enter the Company's existing or future markets with similar or substitute solutions that may be less costly or provide better performance or functionality than the Company's products. Some of the Company's existing and many of its potential competitors have substantially greater financial, technical, marketing and sales resources than the Company and there can be no assurance that the Company will be able to compete successfully against these companies. In the event that price competition increases significantly, competitive pressures could cause the Company to reduce the prices of its products, which would result in reduced profit margins. Prolonged price competition would have a material adverse effect on the Company's business, financial condition and results of operations. Also, run-time licenses, which provide for per-unit royalty payments for each embedded system that incorporates the Company's real-time operating systems, may be subject to significant pricing pressures. A variety of other potential actions by the Company's competitors, including increased promotion and accelerated introduction of new or enhanced products, could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business--Competition." Acquisition-Related Risks. The Company completed a number of acquisitions in fiscal 1996 and one in fiscal 1997 and may complete additional acquisitions in the future. The process of integrating an acquired company's business into the Company's operations may result in unforeseen operating difficulties and expenditures and may absorb significant management attention that would otherwise be available for the ongoing development of the Company's business. Moreover, there can be no assurance that the anticipated benefits of an acquisition will be realized. Future acquisitions by the Company could result in potentially dilutive issuances of equity securities, the incurrence of debt and contingent liabilities and amortization expenses related to goodwill and other intangible assets, which could materially adversely affect the Company's business, financial condition and results of operations. In addition, acquisitions involve numerous risks, including difficulties in the assimilation of the operations, technologies and products of the acquired companies, difficulties in managing diverse geographic sales and research and development operations, the diversion of management attention from other business concerns, risks of entering markets in which the Company has no or limited direct prior experience and the potential loss of key employees of the acquired company. The inability of the Company's management to respond to changing business 11 conditions effectively, including the changes associated with its recent acquisitions, could have a material adverse effect on the Company's business, financial condition and results of operations. From time to time, the Company evaluates potential acquisitions of businesses, products or technologies. The Company has no present understandings, commitments or agreements with respect to any material acquisition of other businesses, products or technologies, and no material acquisition is currently being pursued actively. In the event that such an acquisition were to occur, however, there can be no assurance that the Company's business, operating results and financial condition would not be materially adversely affected. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Risks Associated with International Operations. In fiscal 1995, 1996 and 1997, the Company derived approximately 28%, 34%, and 38%, respectively, of its total revenue from sales outside of North America. The Company expects that international sales will continue to generate a significant percentage of its total revenue in the foreseeable future. International operations are subject to a number of special risks, including foreign government regulation, more prevalent software piracy, longer payment cycles, unexpected changes in, or imposition of, regulatory requirements, tariffs, import and export restrictions and other barriers and restrictions, greater difficulty in accounts receivable collection, potentially adverse tax consequences, the burdens of complying with a variety of foreign laws, staffing and managing foreign operations, general geopolitical risks, such as political and economic instability, hostilities with neighboring countries and changes in diplomatic and trade relationships, possible recessionary environments in economies outside the United States and other factors beyond the control of the Company. The Company generally denominates sales to and by foreign subsidiaries in local currency, and an increase in the relative value of the dollar against such currencies, as has recently occurred, would reduce the Company's revenue in dollar terms or make the Company's products more expensive and, therefore, potentially less competitive in foreign markets. The Company has little experience in hedging its foreign currency sales and often does not hedge such sales. There can be no assurance that the Company's future results of operations will not be adversely affected by currency fluctuations. The Company relies on distributors for sales of its products in certain foreign countries and, accordingly, is dependent on their ability to promote and support the Company's products and, in some cases, to translate them into foreign languages. The Company's international distributors generally offer products of several different companies, including in some cases products that are competitive with the Company's products, and such distributors are not subject to any minimum purchase or resale requirements. There can be no assurance that the Company's international distributors will continue to purchase the Company's products or provide them with adequate levels of support. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Risks of Product Defects; Product and Other Liability. As a result of their complexity, software products may contain undetected errors or compatibility issues, particularly when first introduced or as new versions are released. There can be no assurance that, despite testing by the Company and testing and use by current and potential customers, errors will not be found in new products after commencement of commercial shipments. The occurrence of such errors could result in loss of or delay in market acceptance of the Company's products, which could have a material adverse effect on the Company's business, financial condition and results of operations. The increasing use of the Company's products for applications in systems that interact directly with the general public, particularly applications in transportation, medical systems and other markets where the failure of the embedded system could cause substantial property damage or personal injury, could expose the Company to significant product liability claims. In addition, the Company's products are used for applications in mission-critical business systems where the failure of the embedded system could be linked to substantial economic loss. The Company's license and other agreements with its customers typically contain provisions designed to limit the Company's exposure to potential product liability and other claims. It is likely, however, that the limitation of liability provisions contained in the Company's agreements are not effective in all circumstances and in all jurisdictions. Although the Company has not experienced any product liability or economic loss claims to date, the sale and support of the Company's products may entail the risk of such claims. The Company currently does not have insurance against product liability risks or errors or omissions coverage and there can be no assurance that such insurance will be available to the Company on commercially reasonable terms or at all. A product liability claim or claim for economic loss brought against the Company, or a product recall involving the Company's software, could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business--Product Development." 12 Dependence on Key Personnel; Need for Additional Personnel. The Company's future performance depends to a significant degree upon the continued contributions of its key management, product development, sales, marketing and operations personnel. The Company does not have employment agreements with any of its key personnel and does not maintain any key person life insurance policies. In addition, the Company believes its future success will also depend in large part upon its ability to attract and retain highly skilled managerial, engineering, sales, marketing and operations personnel, many of whom are in great demand. Competition for such personnel has intensified dramatically over the last twelve months in Santa Clara County, California, where the Company is headquartered, and there can be no assurance that the Company will be successful in attracting and retaining such personnel. The failure of the Company to attract, assimilate and retain the necessary personnel could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business--Employees." Limited Protection of Proprietary Technology. The Company's success is heavily dependent upon its proprietary technology. To protect its proprietary rights, the Company relies on a combination of copyright, trade secret, patent and trademark laws, nondisclosure and other contractual restrictions on copying and distribution and technical measures. The Company seeks to protect its software, documentation and other written materials through trade secret and copyright laws, which provide only limited protection. In addition, the Company holds two United States patents and has additional United States patent applications pending. There can be no assurance that patents held by the Company will not be challenged and invalidated, that patents will issue from any of the Company's pending applications or that any claims allowed from existing or pending patents will be of sufficient scope or strength (or be issued in all countries where the Company's products can be sold) to provide meaningful protection or any commercial advantage to the Company. As part of its confidentiality procedures, the Company generally enters into nondisclosure agreements with its employees, consultants, distributors and corporate partners and limits access to and distribution of its software, documentation and other proprietary information. End user licenses of the Company's software are frequently in the form of shrink wrap license agreements, which are not signed by licensees, and therefore may be unenforceable under the laws of many jurisdictions. The source code of the Company's products is also protected as a trade secret and is generally not licensed to customers. Despite the Company's efforts to protect its proprietary rights, it may be possible for unauthorized third parties to copy the Company's products or to reverse engineer or obtain and use information that the Company regards as proprietary. There can be no assurance that the Company's competitors will not independently develop technologies that are substantially equivalent or superior to the Company's technologies. Policing unauthorized use of the Company's products is difficult, and while the Company is unable to determine the extent to which software piracy of its products exists, software piracy can be expected to be a persistent problem. In addition, effective protection of intellectual property rights may be unavailable or limited in certain countries. The status of United States patent protection in the software industry is not well defined and will evolve as the United States Patent and Trademark Office grants additional patents. Patents have been granted on fundamental technologies in software, and patents may issue that relate to fundamental technologies incorporated into the Company's products. As the number of patents, copyrights, trademarks and other intellectual property rights in the Company's industry increases, products based on its technology may increasingly become the subject of infringement claims. There can be no assurance that third parties will not assert infringement claims against the Company in the future. Any such claims with or without merit could be time consuming, result in costly litigation, cause product shipment delays or require the Company to enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available on terms acceptable to the Company, or at all, which could have a material adverse affect on the Company's business, financial condition and results of operations. In addition, the Company may initiate claims or litigation against third parties for infringement of the Company's proprietary rights or to establish the validity of the Company's proprietary rights. Litigation to determine the validity of any claims, whether or not such litigation is determined in favor of the Company, could result in significant expense to the Company and divert the efforts of the Company's technical and management personnel from productive tasks. In the event of an adverse ruling in any such litigation, the Company may be required to pay substantial damages, discontinue the use and sale of infringing products, expend significant resources to develop non-infringing technology or obtain licenses to infringing technology. The failure of the Company to develop or license a substitute technology could have a material adverse affect on the Company's business, financial condition and results of operations. See "Business -- Proprietary Rights." 13 Dependence on Licenses from Third Parties. The Company licenses certain software development tool products from other companies to distribute with its own products. The inability of such third parties to provide competitive products with adequate features and high quality on a timely basis or to cooperate in sales and marketing activities could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, the Company's products compete with products produced by certain of the Company's licensors. There can be no assurance that, upon the termination or expiration of these licenses, such licenses will be available on reasonable terms or at all, or that the Company could obtain similar products to substitute into the tool suites. The inability to license such products could have a material adverse effect on the Company's business, financial condition and results of operations. Volatility of Stock Price. The prices for the Company's common stock have fluctuated widely in the past. The management of the Company believes that such fluctuations may have been caused by actual or anticipated variations in the Company's operating results, announcements of technical innovations or new products or services by the Company or its competitors, changes in earnings estimates by securities analysts and other factors, including changes in conditions of the software and other technology industries in general. Stock markets have experienced extreme price volatility in recent years. This volatility has had a substantial effect on the market prices of securities issued by the Company and other high technology companies, often for reasons unrelated to the operating performance of the specific companies. In the past, following periods of volatility in the market price of a company's securities, securities class action litigation has often been instituted against such a company. Such litigation, if instituted, could result in substantial costs and a diversion of management attention and resources, which would have a material adverse effect on the Company's business, financial condition and results of operations even if the Company is successful in such suits. These market fluctuations, as well as general economic, political and market conditions such as recessions, may adversely affect the market price of the common stock. Item 2. Properties. In March 1996, the Company purchased for approximately $12.0 million in cash a building in Sunnyvale, California covering approximately 150,000 square feet. The Company occupies approximately 100,000 square feet of this facility and leases out the remaining space. The Company leases a number of offices in North America, Europe, Asia and Israel. Item 3. Legal Proceedings. In January 1997, a former employee filed a complaint in the Superior Court of the State of California, County of San Diego, 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 seeks general and specific damages of no less than $1.5 million plus exemplary damages, attorney's fees and costs of suit. The Company has filed answers to the complaint denying all of the allegations and asserting various affirmative defenses. 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 seeks damages of approximately $850,000. An answer to the complaint has been filed denying the allegations. The Company believes it has meritorious defenses to these claims and intends to defend these suits vigorously. However, litigation is subject to inherent uncertainties and thus, there can be no assurance that these lawsuits will be resolved favorably to the Company or that they will not have a material adverse effect on the Company's results of operations. Item 4. Submission of Matters to a Vote of Security Holders. Not applicable. 14 Item 4a. Executive Officers of the Registrant.
Name Age Position ---- --- -------- Narendra K. Gupta............ 48 Chairman of the Board of Directors and Secretary Hamid Mirab.................. 35 Vice President, European Operations Greg Olson................... 47 Vice President, Marketing William C. Smith............. 58 Vice President, Finance and Chief Financial Officer David P. St. Charles......... 48 President, Chief Executive Officer and Director David E. Stepner............. 52 Vice President, Research and Development Janice Waterman.............. 37 Vice President, Human Resources and Operations
Executive officers are chosen by and serve at the discretion of the Board of Directors of the Company. Dr. Gupta is a founder of the Company and has been a director of the Company since its formation in 1980. He has been the Chairman of the Board of the Company since March 1993 and Secretary since September 1989. Dr. Gupta was Chief Executive Officer from 1987 to May 1994 and President from the Company's formation in 1980 to May 1994. He was elected a Fellow of the Institute of Electrical and Electronic Engineers ("IEEE") in November 1991. Dr. Gupta serves on the board of Digital Link Corporation, a data communications and wide-area networking equipment manufacturer and Simulation Sciences, Inc., a developer of chemical simulation software. Dr. Gupta holds an M.S. in Engineering from the California Institute of Technology and a Ph.D. in Engineering from Stanford University. Dr. Mirab joined the Company in November 1989 and has been Vice President, European Operations since October 1995. From November 1989 to September 1992, Dr. Mirab served as Manager, Technical Support in the United Kingdom and from September 1992 to February 1995 he served as Managing Director of the Company's United Kingdom subsidiary. From February 1995 to October 1995, Dr. Mirab served as General Manager, European Operations. Dr. Mirab holds a B.S. in General Engineering and a Ph.D. in Control Systems from the University of Glasgow. Mr. Olson has been Vice President, Marketing since he joined the Company in July 1996. From June 1992 to March 1996, Mr. Olson held Vice President positions in product strategy, tools products, and strategic planning at Sybase, Inc., a data-base software company. Mr. Olson holds a B.S. in Information Sciences from the University of California, Santa Cruz. Mr. Smith joined the Company in January 1997 as the Chief Financial Officer and Vice President, Finance. From June 1995 to October 1996, Mr. Smith was the Chief Financial Officer and Vice President, Finance for Meta Software, Inc. From March 1993 to June 1995, Mr. Smith was the Chief Financial Officer and Vice President, Finance of Bell Microproducts, Inc. Mr. Smith also served as the Chief Financial Officer of Wodsworth, Inc, from 1983 to 1992. Mr. Smith holds a B.S. in Financial Management from San Jose State University and an M.B.A from Gonzaga University. Mr. St. Charles joined the Company in August 1993 and was appointed President and Chief Executive Officer of the Company in May 1994. He has been a director since he joined the Company in August 1993. From April 1990 until August 1993, Mr. St. Charles served as President and a director of Wind River Systems, Inc., a real-time software company. He holds a B.A. in Liberal Arts and an M.A. in International Economics from Carleton University and an M.S. from the Sloan School of Management at the Massachusetts Institute of Technology. Dr. Stepner has been Vice President, Research and Development since he joined the Company in December 1993. From April 1984 until March 1993, he served as Founder, President and Chief Executive Officer of Greyhawk Systems, Inc., a manufacturer of high resolution liquid crystal displays. In March 1993, Greyhawk Systems, Inc. was sold to AmPro Corporation and Dr. Stepner served as Executive Vice President of AmPro Corporation and General Manager of the AmPro/Greyhawk Division from March 1993 until December 1993. Dr. Stepner holds a B.S. in General Engineering from Brown University and an M.S. and a Ph.D., both in Electrical Engineering, from Stanford University. 15 Ms. Waterman joined the Company in July 1995 as Vice President, Human Resources and has served as Vice President, Human Resources and Operations of the Company since March 1996. From September 1994 to July 1995, she served as Vice President, Human Resources and Administration for Salick Health Care Inc., a health care provider. From May 1991 until September 1994, she served as Vice President of Human Resources and Administration of Tekelec, Inc., a telecommunications company. Ms. Waterman holds a B.A. in Sociology and Economics from the University of California at Davis and an M.S. in Industrial Psychology from California State University, Hayward. 16 PART II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters. The Company's common stock is listed on the Nasdaq National Market under the trading symbol "INTS". The range of high and low sale prices for the Company's common stock on that market for each of the four quarters during the last two fiscal years are as follows: Q1 Q2 Q3 Q4 ---------------------------------- FY97 High............ $36.750 $40.062 $41.250 $29.625 Low............. $22.750 $25.000 $15.875 $19.625 FY96 High............ $12.000 $15.375 $21.000 $23.875 Low............. $ 9.875 $10.000 $14.625 $16.000 All share prices have been adjusted to reflect the two-for-one split of the Company's common stock effected on April 5, 1996. As of April 30, 1997, there were 242 holders of record of the Company's common stock. The Company has never declared or paid cash dividends on its capital stock and anticipates that, for the foreseeable future, it will continue to retain any earnings for use in the operation of its business. Item 6. Selected Financial Data. The following selected consolidated financial data is qualified by reference to and should be read in conjunction with the consolidated financial statements and the notes thereto included elsewhere herein. The consolidated statement of income data set forth below with respect to the years ended February 28, 1995, 1996, and 1997 and the consolidated balance sheet data at February 28, 1996 and 1997 are derived from, and are qualified by reference to, the audited consolidated financial statements and notes thereto included in this Annual Report. The consolidated statement of income data set forth below with respect to the years ended February 28, 1993 and 1994 and the consolidated balance sheet data at February 28, 1993, 1994, and 1995 are derived from audited consolidated financial statements not included in this Annual Report. During fiscal 1996, the Company acquired TakeFive Software GmbH and Doctor Design, Inc. in transactions accounted for as poolings of interests. Fiscal 1994 and 1995 annual financial information includes the combined results of the Company and Doctor Design, Inc. Fiscal 1996 and 1997 annual financial information includes the results of Doctor Design, Inc. and TakeFive Software GmbH. The annual financial information has not been restated for earlier years because such financial information was not material to the Company. During fiscal 1997, the Company acquired Epilogue Technology Corporation in a transaction accounted for as a pooling of interests. The results of Epilogue Technology Corporation have been combined with the results of the Company since the date of acquisition. Prior period information has not been restated for the results of Epilogue Technology Corporation because such financial information was not material to the Company. Also during fiscal 1997, the Company revised the terms of the acquisition of Diab Data, Inc., which was acquired in fiscal 1996 in a transaction accounted for under the equity method of accounting. 17
Year Ended February 28, ------------------------------------------------------ 1993 (1) 1994 1995 1996 1997 -------- ---- ---- ---- ---- (in thousands, except per share data) Consolidated Statements of Income Data: Revenue: Product.............................. $19,690 $26,350 $34,952 $51,597 $ 69,282 Services............................. 12,698 19,433 23,102 32,845 36.181 ------- ------- ------- ------- --------- Total revenue................... 32,388 45,783 58,054 84,442 105,463 ------- ------- ------- ------- --------- Costs and expenses: Cost of product revenue.............. 3,221 4,986 5,980 9,046 9,755 Cost of services revenue............. 4,170 8,262 9,547 15,824 16,392 Marketing and sales.................. 11,564 16,515 20,565 27,209 40,546 Research and development............. 6,133 5,926 8,341 11,379 17,264 General and administrative........... 2,468 3,567 4,311 6,637 8,891 Amortization of intangible assets 1,199 1,764 1,311 556 -- Acquisition-related and other........ -- -- -- 7,327 5,676 ------- ------- ------- ------- --------- Total costs and expenses........ 28,755 41,020 50,055 77,978 98,524 ------- ------- ------- ------- --------- Income from operations..... 3,633 4,763 7,999 6,464 6,939 Interest and other income............... 1,575 1,258 1,601 2,331 4,220 ------- ------- ------- ------- --------- Income before income taxes. 5,208 6,021 9,600 8,795 11,159 Provision for income taxes.............. 1,771 1,935 3,110 3,512 3,905 ------- ------- ------- ------- --------- Net income................ $ 3,437 $ 4,086 $ 6,490 $ 5,283 $ 7,254 ======= ======= ======= ======= ========= Earnings per share(2)................... $ 0.18 $ 0.21 $ 0.33 $ 0.24 $ 0.31 ======= ======= ======= ======= ========= Earnings per share before acquisition-related and other costs(3)................... $ 0.18 $ 0.21 $ 0.33 $ 0.50 $ 0.47 ======= ======= ======= ======= ========= Shares used in per share calculations(2) 18,636 19,122 19,964 22,088 23,508 ======= ======= ======= ======= ========= February 28, -------------------------------------------------- 1993 1994 1995 1996 1997 ---- ---- ---- ---- ---- (in thousands) Consolidated Balance Sheet Data: Cash, cash equivalents and marketable securities............................ $27,150 $33,156 $36,517 $49,476 $ 54,695 Working capital.......................... 13,005 12,298 17,783 31,431 38,019 Total assets............................. 40,918 52,970 66,101 85,264 112,502 Total shareholders' equity............... 32,447 38,032 47,948 58,276 86,172 - ------------------- (1) Fiscal 1993 has not been restated to reflect the annual financial information for Doctor Design, Inc. as such financial information was not material to the Company. (2) See Note 1 of Notes to Consolidated Financial Statements for an explanation of the determination of the number of shares used in per share calculations. (3) Fiscal 1996 and 1997 earnings per share before acquisition-related and other costs reflect earnings per share as if the Company had not incurred such acquisition-related and other costs, net of any tax effects.
18 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. The following discussion provides an analysis of the Company's financial condition and results of operations, and should be read in conjunction with the "Selected Financial Data" and the Consolidated Financial Statements and the Notes thereto of the Company. Overview Integrated Systems 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 of these products and providing related maintenance and engineering and consulting services. In October 1995, the Company acquired TakeFive Software GmbH ("TakeFive"), an Austrian corporation in the business of developing and marketing software tools used in software development, including SNiFF+, an advanced object-oriented IDE. In January 1996, the Company completed a merger with Doctor Design, Inc. ("Doctor Design"), a California corporation that develops multimedia hardware, software and application specific integrated circuit technology. In July 1996, the Company acquired Epilogue Technology Corporation ("Epilogue"), a New Mexico corporation which develops and distributes network management and embedded Internet software for telecommunications and data communications equipment manufactures, embedded software suppliers and networking related integrated circuit manufactures. Each of these business combinations has been 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. The results of operations for fiscal 1996 include the results of TakeFive and Doctor Design for the whole year. The fiscal 1995 results have been restated to include only the results of Doctor Design, since those of TakeFive were not significant. In November 1996, the Company revised the terms of the acquisition of Diab Data, Inc. ("Diab Data") which was acquired in fiscal 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 1997 onwards. See "Business -- Risk Factors--Acquisition-Related Risks." Forward-Looking Information is Subject to Risk and Uncertainty Except for the historical statements contained herein, this Form 10-K contains "forward-looking" statements and information (as defined in the Private Securities Litigation Reform Act of 1995) that involve risk and uncertainty, including expectations for fiscal 1998 and various business environment and trends. Actual future results and trends may differ materially depending on a variety of factors, including the volume and timing of orders received during the quarter, the mix of and changes in distribution channels through which the Company's products are sold, the timing and acceptance of new products and product enhancements by the Company or its competitors, changes in pricing, buyouts of run-time licenses, product life cycles, the level of the Company's sales of third party products, purchasing patterns of distributors and customers, competitive conditions in the industry, business cycles affecting the markets in which the Company's products are sold, extraordinary events, such as litigation or acquisitions, including related charges, and economic conditions generally or in various geographic areas. All of the foregoing factors are difficult to forecast. The future operating results of the Company may fluctuate as a result of these and the other risk factors detailed from time-to-time in the Company's Securities and Exchange Commission reports and in the section of this Annual Report entitled "Business -- Risk Factors." Due to all of the foregoing factors, the Company believes that period-to-period comparisons of its results of operations are not necessarily meaningful and should not be relied upon as an indication of future performance. During the last 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 again be below the expectations of stock market analysts and investors. 19 Results of Operations The following table sets forth for the periods presented the percentage of total revenue represented by each line item in the Company's consolidated statements of income and the percentage change in each line item from the prior period.
Percentage of Period-to-Period Total Revenue Percentage Changes ------------- ------------------ Year Ended February 28, Fiscal 1995 Fiscal 1996 ----------------------- to to 1995 1996(1) 1997(1) Fiscal 1996 Fiscal 1997 ---- ------- ------- ----------- ----------- Revenue: Product........................... 60% 61% 66% 48% 34% Services.......................... 40 39 34 42 10 -- -- -- Total revenue.................. 100 100 100 45 25 --- --- --- Costs and expenses: Cost of product revenue.......... 10 11 9 51 8 Cost of services revenue......... 17 19 16 66 4 Marketing and sales.............. 36 32 38 32 49 Research and development......... 14 13 16 36 52 General and administrative....... 7 8 9 54 34 Amortization of intangible assets 2 1 -- (58) -- --- --- --- Total costs and expenses....... 86 84 88 41 31 --- --- --- Income from operations....... 14 16 12 72 (9) Interest and other income........... 3 3 4 46 81 --- --- --- Income before income taxes... 17 19 16 68 4 Provision for income taxes.......... 6 6 6 66 11 --- --- --- Net income................... 11% 13% 10% 69% 1% === === === - ------------------------- (1) The table excludes acquisition-related and other costs of $7.3 million, including related tax effects, in 1996 and $5.7 million, including related tax effects, in 1997, since inclusion of such costs would render year-to-year comparisons less meaningful.
Revenue. The Company's total revenue increased 45% from fiscal year 1995 to fiscal year 1996, or from $58.1 million to $84.4 million, and 25% from fiscal year 1996 to fiscal year 1997 to $105.5 million. A majority of the Company's total revenue came from product revenue, which increased 48% from $35.0 million in fiscal year 1995 to $51.6 million in fiscal year 1996 and an additional 34% to $69.3 million in fiscal year 1997. The increase in product revenue from fiscal years 1995 to 1996 was primarily due to increased unit shipments of pSOSystem and MATRIXx and the inclusion of SNiFF+ product revenue in fiscal year 1996. Product revenue increased from fiscal year 1996 to fiscal year 1997 as unit shipments of pSOSystem and SNiFF+ continued to increase in all geographic regions. In addition, fiscal year 1997 product revenue includes revenues from product sales of Epilogue Technology Corporation, which was acquired in July 1996. MATRIXx revenue was flat from fiscal year 1996 to fiscal year 1997. Services revenue increased 42% from $23.1 million in fiscal year 1995 to $32.8 million in fiscal year 1996 as a result of increases in the number and size of consulting contracts and increases in maintenance revenue from the Company's growing installed base of customers. Services revenue increased 10% from fiscal year 1996 to fiscal year 1997 to $36.2 million. The decrease in the rate of services revenue growth in fiscal year 1997 as compared to the fiscal year 1996 growth rate, was due to a decrease in some of the Company's consulting activities. The percentage of the Company's total revenue from customers located internationally was 28%, 34% and 38% in fiscal years 1995, 1996 and 1997, respectively. In Europe and Japan, revenues and expenses are primarily denominated in local currencies. In fiscal year 1997, the U.S. dollar strengthened significantly against the major European currencies and the Japanese Yen, which resulted in lower revenues and expenses when translated into U.S. dollars, as compared to prior years. In fiscal years 1995 and 1996 revenues were less influenced by fluctuations in foreign exchange rates. The Company's operating and pricing strategies take into account changes in exchange rates over time, however, the Company's results of operations may be significantly affected in the short term by fluctuations in foreign currency exchange rates. 20 Costs and Expenses. Cost of product revenue as a percentage of product revenue was 17%, 18%, and 14% in fiscal years 1995, 1996 and 1997, respectively. The decrease in fiscal year 1997 is a result of a lower proportion of product sales subject to third-party royalties. In addition, fiscal year 1997 product revenue has a smaller proportion of lower margin hardware revenue than in fiscal year 1996. The Company's cost of services revenue as a percentage of services revenue was 41%, 48%, and 45% in fiscal years 1995, 1996 and 1997, respectively. Fluctuations in these percentages result from shifts in the services revenue mix between higher margin maintenance revenue and lower margin consulting contract revenue. Marketing and sales expenses in fiscal years 1995, 1996 and 1997, were 36%, 32% and 38%, respectively, of total revenue. The percentage decrease from fiscal year 1995 to fiscal year 1996 was the result of pooling the operating results of several acquired companies whose marketing and sales expenses had represented a smaller percentage of their total revenue. The percentage increase from fiscal year 1996 to fiscal year 1997 was primarily due to additional expenses associated with the Company's continued expansion of its marketing and sales organization both domestically and internationally, as well as increased marketing activity associated with new product introductions. Research and development expenses in fiscal years 1995, 1996 and 1997, were 14%, 13% and 16%, respectively, of total revenue. The increase from fiscal year 1996 to fiscal year 1997 was primarily the result of increased activity associated with the development of several products, including increased personnel and consulting expenses. Costs that are required to be capitalized under Statement of Financial Accounting Standards No. 86 ("SFAS No. 86"), "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed" were $1,540,000 in fiscal year 1997 compared to $335,000 in fiscal year 1996 and $492,000 in fiscal year 1995. The amount capitalized represents approximately 8% of total research and development expenditures for fiscal year 1997 compared to 3% for fiscal year 1996 and 6% for fiscal year 1995. 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 fiscal year 1997 was $968,000, compared to $921,000 for fiscal year 1996 and $607,000 for fiscal year 1995. General and administrative expenses in fiscal years 1995, 1996 and 1997, were 7%, 8%, and 9% respectively, of total revenue. The increases from fiscal year 1995 to fiscal year 1996 and from fiscal year 1996 to fiscal year 1997 were primarily the result of higher personnel-related expenses. Amortization of intangible assets decreased from $1.3 million in fiscal year 1995 to $556,000 in fiscal year 1996, as the Company reached the end of the amortization period for software purchased in an earlier acquisition. For fiscal 1997 amortization of intangible assets was not significant and is included in general and administrative expenses. Acquisition-related and other costs in fiscal year 1996 totaled $7.3 million and comprised direct costs and write-offs related to the acquisitions of TakeFive and Doctor Design. Acquisition-related and other costs in fiscal year 1997 of $5.7 million related to a one-time payment to the executives and employees of Diab Data, the write-off during the year of intangible assets related to a prior acquisition, and direct costs related to the acquisition of Epilogue. See Note 2 to Notes to Consolidated Financial Statements. Interest and other income was $1.6 million, $2.3 million, and $4.2 million in fiscal years 1995, 1996 and 1997, respectively. Interest and other income in fiscal year 1997 increased due to the inclusion of net operating income from Diab Data during the period it was accounted for under the equity method of accounting. In addition, interest and other income increased in both comparative periods due to an increase in the amount of cash equivalents and marketable securities. The effective tax rate was 32% in fiscal year 1995 compared to 40% in fiscal year 1996 and 35% in fiscal year 1997. The increase in the effective rate from fiscal year 1995 to 1996 was due to the effect of non-deductible acquisition-related and other costs. After adjusting for such items, the effective rate for fiscal year 1996 was 32%. Non-deductible acquisition-related costs in fiscal year 1997, combined with a higher statutory federal income tax rate, resulted in an effective tax rate of 35% in fiscal year 1997. 21 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. The impact of the adoption of SFAS No. 128 on the financial statements of the Company has not yet been determined. Liquidity and Capital Resources The Company has funded its operations to date principally through cash flows from operations. As of February 28, 1997, the Company had $54.7 million of cash, cash equivalents and marketable securities. This represents an increase of $5.2 million from February 28, 1996. During the first quarter of fiscal year 1995, the Company announced that the Board of Directors had authorized the Company to repurchase up to an additional 1,000,000 shares of common stock for cash, from time-to-time at market prices, pursuant to a repurchase program announced in September 1992. In the second quarter of fiscal year 1995, under this program, the Company repurchased 250,000 shares of common stock for $1.1 million. During fiscal year 1997, the Board of Directors rescinded this program. Subsequent to fiscal year 1997 year end, the Company announced that the Board of Directors had authorized a new 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. In April 1997, the Company repurchased 20,000 shares of common stock for $187,500. Net cash provided by operating activities during fiscal year 1997 decreased $15.9 million over the amount generated in fiscal year 1996, which increased by $9.4 million over fiscal year 1995. The decrease in net cash provided by operating activities in fiscal year 1997 was due to an increase in accounts receivable, the inclusion of net income from an unconsolidated subsidiary, write-downs of intangible assets and decreases in current liabilities and income taxes payable, offset in part, by an increase in deferred revenue. The increase in net cash provided by operating activities in fiscal year 1996 was due to increases in depreciation and amortization, write-downs of intangible assets, increases in current liabilities, income taxes payable and deferred revenue, partially offset by increases in accounts receivable and other current assets. Net cash used in investing activities totaled $16.7 million in fiscal year 1997 compared to $6.0 million in fiscal year 1996 and $9.3 million in fiscal year 1995. The increase in net cash used in investing activities in fiscal year 1997 was due primarily to the purchase of the corporate headquarters building in Sunnyvale, California in March 1996, for approximately $12.0 million, offset in part, by cash acquired through acquisitions. The decrease in net cash used in investing activities from fiscal year 1995 to fiscal year 1996 was due primarily to a reduction in net purchases of marketable securities, offset by increases in additions to property and equipment and net cash paid in acquisitions. Net cash provided by financing activities totaled $20.6 million in fiscal year 1997 compared to $4.0 million in fiscal year 1996 and $2.0 million in fiscal year 1995. The increase in net cash provided by financing activities in fiscal year 1997 was due primarily to the issuance and sale of 500,000 shares of common stock in April 1996, for net proceeds of $12.8 million, and from an increase in the tax benefits from disqualifying dispositions of common stock. The increase in net cash provided by financing activities from fiscal year 1995 to fiscal year 1996 was due to an increase in proceeds from the exercise of options to purchase common stock and purchases under the Employee Stock Purchase Plan, and the absence of common stock repurchases. The Company believes that the cash flows from operations, together with existing cash and investment balances, will be adequate to meet the Company's cash requirements for working capital, capital expenditures and stock repurchases for the next 12 months and the foreseeable future. Item 7a. Quantitative and Qualitative Disclosures About Market Risks Not applicable. 22 Item 8. Financial Statements and Supplementary Data. Quarterly Financial Data The following table sets forth selected unaudited quarterly financial data for the Company's last eight fiscal quarters. This unaudited information has been prepared on the same basis as the audited information and, in management's opinion, reflects all adjustments (which include only normal recurring adjustments) necessary for the fair presentation of the information for the periods presented. Based on the Company's operating history and factors that may cause fluctuations in the quarterly results, quarter-to-quarter comparisons should not be relied upon as indicators of future performance.
Fiscal 1996 -------------------------------------------- Q1 Q2 Q3 Q4 -- -- -- -- (in thousands, except per share data) Total revenue............................. $18,458 $19,851 $21,510 $24,623 Income from operations.................... 1,862 2,928 406 1,268 Net income................................ 1,578 2,434 584 687 Earnings per share........................ 0.07 0.11 0.03 0.03 Shares used in per share calculations..... 21,714 21,994 22,284 22,362
Fiscal 1997 -------------------------------------------- Q1 Q2 Q3 Q4 -- -- -- -- (in thousands, except per share data) Total revenue............................. $23,151 $26,105 $26,803 $29,404 Income (loss) from operations............. 2,319 2,909 (1,153) 2,864 Net income (loss)......................... 2,451 2,372 (94) 2,525 Earnings per share........................ 0.11 0.10 0.00 0.11 Shares used in per share calculations..... 22,709 23,511 22,909 23,875
The financial statements required by this item are submitted as a separate section of this Form 10-K. See Item 14. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures. None. 23 PART III Item 10. Directors and Executive Officers of the Registrant. The information required by Item 10 as to directors is incorporated by reference from the section entitled "Election of Directors" in the Company's definitive Proxy Statement for its Annual Meeting of Shareholders to be held July 15, 1997. The information required by this Item as to executive officers is included in Part I under "Executive Officers of the Registrant." The information required by this item as to compliance with Section 16(a) of the Securities Exchange Act of 1934 is incorporated by reference from "Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's definitive Proxy Statement for its Annual Meeting of Shareholders to be held July 15, 1997. Item 11. Executive Compensation. The information required by this item is incorporated by reference from "Executive Compensation" and "Compensation Committee Interlocks and Insider Participation" in the Company's definitive Proxy Statement for its Annual Meeting of Shareholders to be held July 15, 1997. Item 12. Security Ownership of Certain Beneficial Owners and Management. The information required by this item is incorporated by reference from "Security Ownership of Certain Beneficial Owners and Management" in the Company's definitive Proxy Statement for its Annual Meeting of Shareholders to be held July 15, 1997. Item 13. Certain Relationships and Related Transactions. The information required by this item is incorporated by reference from "Certain Transactions" in the Company's definitive Proxy Statement for its Annual Meeting of Shareholders to be held July 15, 1997. 24 PART IV Item 14. Exhibits, Financial Statements, Schedule, and Reports on Form 8-K. (a)(1) Financial Statements
Page ---- Report of Independent Accountants 28 Consolidated Balance Sheets at February 28, 1996 and 1997 29 Consolidated Statements of Income for the years ended February 28, 1995, 1996 and 1997 30 Consolidated Statements of Shareholders' Equity for the years ended February 28, 1995, 1996 and 1997 31 Consolidated Statements of Cash Flows for the years ended February 28, 1995, 1996 and 1997 32 Notes to Consolidated Financial Statements 33
(a)(2) Financial Statement Schedule. Registrant's financial statement schedule filed herewith is as follows: Schedule: Report of Independent Accountants on Schedule Schedule II: Valuation and Qualifying Accounts for the years ended February 28, 1995, 1996 and 1997 (a)(3) Exhibits. The following exhibits are filed herewith or incorporated herein by reference: Exhibit 2.01 Stock Exchange Agreement dated as of October 31, 1995 by and between the Registrant and TakeFive Software GmbH and the holders of share interests in TakeFive Software GmbH (incorporated herein by reference to Exhibit 2.01 to the Registrant's Current Report on Form 8-K, dated October 31, 1995). 2.02 Agreement and Plan of Reorganization dated as of December 14, 1995, as amended January 26, 1996, by and among Registrant, ISI Purchasing Corporation and Doctor Design, Inc. and related documents (incorporated herein by reference to Exhibit 2.01 to the Registrant's Current Report on Form 8-K, dated January 26, 1996 (the "January 26, 1996 Form 8-K")). 2.03 Agreement of Merger dated as of January 26, 1996 by and between ISI Purchasing Corporation and Doctor Design, Inc. (incorporated herein by reference to Exhibit 2.02 to the January 26, 1996 Form 8-K). 3.01(i) Registrant's Articles of Incorporation, as amended to date (incorporated by reference to Exhibit Number 3.01(i) to the Registrant's Form 10-K for the fiscal year ended February 28, 1996). 3.01(ii) Registrant's Bylaws, as amended June 12, 1996 (incorporated by reference to Exhibit Number 4.02 to Registrant's Registration Statement on Form S-8 under the Securities Act of 1933, as amended, filed September 27, 1996, Registration No. 333-12799). 4.01 Registration Rights Agreement dated as of April 13, 1987 (incorporated by reference to Exhibit 4.02 to Registrant's Registration Statement on Form S-1 under the Securities Act of 1933, as amended, filed January 26, 1990, Registration No. 33-33219 (the "S-1 Registration Statement")). 25 10.01* Registrant's 401(k) Plan (incorporated by reference to Exhibit Number 10.01 to the S-1 Registration Statement). 10.02* Registrant's 1983 Incentive Stock Option Plan, as amended to date, and related documents (incorporated by reference to Exhibit Number 10.02 to the S-1 Registration Statement). 10.03* Registrant's 1988 Stock Option Plan, as amended to date (incorporated by reference to Exhibit Number 4.01 to the Registrant's Form S-8 filed with the Securities and Exchange Commission on June 16, 1992). 10.04* Registrant's 1990 Stock Purchase Plan, as amended to date (incorporated by reference to Exhibit Number 4.03 to the Registrant's Form S-8 filed with the Securities and Exchange Commission on October 18, 1993). 10.05* Dr. Design, Inc. 1991 Stock Option Plan, as amended to date (incorporated by reference to Exhibit Number 4.03 to the Registrant's Form S-8 filed with the Securities and Exchange Commission on February 22, 1996). 10.06* Form of Indemnity Agreement with Directors (incorporated by reference to Exhibit Number 10.06 to the S-1 Registration Statement). 10.07* Form of Stock Option Grant and Stock Option Exercise Form used in connection with Registrant's 1988 Stock Option Plan, as amended to date (incorporated by reference to Exhibit Number 19.01 to Registrant's Form 10-Q for the quarter ended August 31, 1990). 10.08* Form of Option Modification Agreement (incorporated by reference to Exhibit Number 19.01 to the Registrant's Form 10-Q for the quarter ended August 31, 1991). 10.09* Registrant's 1994 Directors Stock Option Plan (incorporated by reference to Exhibit Number 10.10 to the Registrant's Form 10-Q for the quarter ended August 31, 1991). 10.10* Form of Stock Option Grant and Stock Option Exercise Form used in connection with Registrant's 1994 Directors Stock Option Plan (incorporated by reference to Exhibit Number 10.11 to the Registrant's Form 10-K for the fiscal year ended February 28, 1994). 10.11 Agreement of Purchase and Sale between Connecticut General Life Insurance Company and the Registrant dated February 9, 1996 (incorporated by reference to Exhibit Number 10.14 to the Registrant's Form 10-K for fiscal year ended February 28, 1996). 10.12* Form of Stock Option Exercise Form used in connection with Registrant's 1988 Stock Option Plan, as amended to date (incorporated by reference to Exhibit Number 10.13 to the Registrant's Form 10-Q for the quarter ended May 31, 1995). 10.13* Epilogue Technology Corporation 1994 Stock Option Plan, as amended to date (incorporated by reference to Exhibit Number 4.03 to the Registrant's Form S-8 filed with the Securities and Exchange Commission on September 27, 1996, Registration No. 333-12799). 26 11.01 Statement regarding computation of net income per share. 21.01 List of Registrant's Subsidiaries. 23.01 Consent of Independent Accountants. 27.01 Financial Data Schedule - ------------------- * Represents a management contract or compensatory plan or arrangement. (b) Reports on Form 8-K. No reports on Form 8-K were filed during the last quarter of the fiscal year covered by this Report. (c) Exhibits. See (a)(3) above. (d) Financial Statement Schedules. See (a)(2) above. 27 REPORT OF INDEPENDENT ACCOUNTANTS The Board of Directors and Shareholders Integrated Systems, Inc.: We have audited the accompanying consolidated balance sheets of Integrated Systems, Inc. as of February 28, 1996 and 1997 and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended February 28, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Integrated Systems, Inc. as of February 28, 1996 and 1997, and the consolidated results of its operations and its cash flows for each of the three years in the period ended February 28, 1997 in conformity with generally accepted accounting principles. COOPERS & LYBRAND L.L.P. San Jose, California March 26, 1997, except for Note 6, as to which the date is April 28, 1997 28 INTEGRATED SYSTEMS, INC. CONSOLIDATED BALANCE SHEETS (in thousands)
February 28, ------------ 1996 1997 ---- ---- ASSETS Current assets: Cash and cash equivalents ............................................. $ 21,822 $ 25,585 Marketable securities ................................................. 12,231 4,483 Accounts receivable, net of allowance for doubtful accounts of $852 and $1,540 in 1996 and 1997, respectively .............................. 19,822 28,266 Deferred income taxes ................................................. 373 1,676 Prepaid expenses and other ............................................ 3,587 4,136 --------- --------- Total current assets .......................................... 57,835 64,146 Marketable securities ................................................... 15,423 24,627 Property and equipment, net ............................................. 5,593 17,956 Intangible assets, net .................................................. 2,106 3,136 Deferred income taxes ................................................... 1,906 1,293 Other assets ............................................................ 2,401 1,344 --------- --------- Total assets .................................................. $ 85,264 $ 112,502 ========= ========= LIABILITIES Current liabilities: Accounts payable ...................................................... $ 4,309 $ 4,143 Accrued payroll and related expenses .................................. 3,673 3,407 Other accrued liabilities ............................................. 4,842 4,514 Income taxes payable .................................................. 4,191 1,442 Deferred revenue ...................................................... 9,389 12,621 --------- --------- Total current liabilities ..................................... 26,404 26,127 Other liabilities ....................................................... 584 203 --------- --------- Total liabilities ............................................. 26,988 26,330 --------- --------- Commitments and contingencies (Note 5) SHAREHOLDERS' EQUITY Preferred stock, no par value, 5,000 shares authorized: Issued and outstanding: none in 1996 and 1997 Common stock, no par value, 50,000 shares authorized: Issued and outstanding: 21,206 and 23,039 shares in 1996 and 1997, respectively ....................................................... 40,283 61,158 Unrealized holding gain on marketable securities, net ................... 333 148 Translation adjustment .................................................. -- (1,130) Retained earnings ....................................................... 17,660 25,996 --------- --------- Total shareholders' equity .................................... 58,276 86,172 --------- --------- Total liabilities and shareholders' equity .................... $ 85,264 $ 112,502 ========= ========= The accompanying notes are an integral part of these consolidated financial statements.
29 INTEGRATED SYSTEMS, INC. CONSOLIDATED STATEMENTS OF INCOME (in thousands, except per share data) Year Ended February 28, ----------------------- 1995 1996 1997 ---- ---- ---- Revenue: Product ................................. $ 34,952 $ 51,597 $ 69,282 Services ................................ 23,102 32,845 36,181 -------- -------- -------- Total revenue ......................... 58,054 84,442 105,463 -------- -------- -------- Costs and expenses: Cost of product revenue ................. 5,980 9,046 9,755 Cost of services revenue ................ 9,547 15,824 16,392 Marketing and sales ..................... 20,565 27,209 40,546 Research and development ................ 8,341 11,379 17,264 General and administrative .............. 4,311 6,637 8,891 Amortization of intangible assets ....... 1,311 556 -- Acquisition-related and other ........... -- 7,327 5,676 -------- -------- -------- Total costs and expenses .............. 50,055 77,978 98,524 -------- -------- -------- Income from operations .............. 7,999 6,464 6,939 Interest and other income .................. 1,601 2,331 4,220 -------- -------- -------- Income before income taxes .......... 9,600 8,795 11,159 Provision for income taxes ................. 3,110 3,512 3,905 -------- -------- -------- Net income .......................... $ 6,490 $ 5,283 $ 7,254 ======== ======== ======== Earnings per share ......................... $ 0.33 $ 0.24 $ 0.31 ======== ========= ======== Shares used in per share calculations ...... 19,964 22,088 23,508 ======== ========= ======== The accompanying notes are an integral part of these consolidated financial statements. 30 INTEGRATED SYSTEMS, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (in thousands)
Unrealized Holding Common Stock Gain (Loss), Translation Retained Shares Amount Net Adjustment Earnings Total -------- -------- -------- ---------- -------- -------- Balances, February 28, 1994 ............... 18,977 $ 31,262 $ 227 $ 6,543 $ 38,032 Exercise of common stock options ......... 585 1,858 1,858 Common stock purchased under Employee Stock Purchase Plan ................... 94 420 420 Amortization of deferred compensation .... 183 183 Tax benefit from disqualifying dispositions of common stock .......... 1,009 1,009 Repurchase of common stock ............... (250) (430) (664) (1,094) Issuance of common stock in connection with acquisition ...................... 316 1,386 1,386 Unrealized holding loss on marketable securities, net ....................... (336) (336) Net income ............................... 6,490 6,490 -------- -------- ------- -------- -------- Balances, February 28, 1995 ................ 19,722 35,688 (109) 12,369 47,948 Exercise of common stock options ......... 540 2,050 2,050 Common stock purchased under Employee Stock Purchase Plan ................... 72 557 557 Tax benefit from disqualifying dispositions of common stock .......... 2,323 2,323 Pooling of interests with TakeFive Software .............................. 872 50 8 58 Purchase of TakeFive Software common stock for cash .............................. (400) (400) Payment of note receivable from shareholder ........................... 15 15 Unrealized holding gain on marketable securities, net ....................... 442 442 Net income ............................... 5,283 5,283 -------- -------- ------- -------- -------- Balances, February 28, 1996 ................ 21,206 40,283 333 17,660 58,276 Exercise of common stock options ......... 651 2,344 2,344 Common stock purchased under Employee Stock Purchase Plan ................... 51 975 975 Tax benefit from disqualifying dispositions of common stock .......... 4,908 4,908 Pooling of interests with Epilogue ....... 631 26 1,082 1,108 Issuance of common stock in connection with secondary offering ............... 500 12,774 12,774 Foreign currency translation adjustment ............................ $(1,130) (1,130) Purchase of Doctor Design common stock for cash .............................. (152) (152) Unrealized holding loss on marketable securities, net ....................... (185) (185) Net income ............................... 7,254 7,254 -------- -------- ------- ------- -------- -------- Balances, February 28, 1997 .............. 23,039 $ 61,158 $ 148 $(1,130) $ 25,996 $ 86,172 ======== ======== ======= ======= ======== ======== The accompanying notes are an integral part of these consolidated financial statements.
31 INTEGRATED SYSTEMS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
Year Ended February 28, ----------------------- 1995 1996 1997 -------- -------- -------- Cash flows from operating activities: Net income ....................................................... $ 6,490 $ 5,283 $ 7,254 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization ................................... 3,584 4,103 4,955 Write-downs of intangible assets ................................ -- 3,083 616 Deferred income taxes ........................................... (558) (1,768) (399) Provisions for doubtful accounts receivable ..................... 147 223 688 Net income from unconsolidated subsidiary ....................... -- -- (604) Changes in assets and liabilities: Accounts receivable ........................................... (5,468) (4,570) (8,748) Prepaid expenses and other .................................... (1,171) (794) (257) Accounts payable, accrued payroll and other accrued liabilities 2,201 5,255 (1,448) Income taxes payable .......................................... 970 1,837 (3,397) Deferred revenue .............................................. 640 3,125 2,326 Other assets and liabilities .................................. (68) 375 (779) -------- -------- -------- Net cash provided by operating activities ..................... 6,767 16,152 207 -------- -------- -------- Cash flows from investing activities: Purchases of marketable securities .............................. (8,041) (16,878) (24,836) Maturities of marketable securities ............................. 3,593 18,731 14,374 Sales of marketable securities .................................. -- -- 8,697 Additions to property and equipment ............................. (2,089) (4,332) (16,012) Disposals of property and equipment ............................. 46 149 805 Capitalized software development costs .......................... (492) (335) (1,540) Net cash (paid) acquired in acquisitions ........................ (2,081) (2,885) 2,868 Other ........................................................... (200) (480) (1,042) -------- -------- -------- Net cash used in investing activities .......................... (9,264) (6,030) (16,686) -------- -------- -------- Cash flows from financing activities: Repurchase of common stock ...................................... (1,094) -- -- Proceeds from issuance of common stock .......................... -- -- 12,774 Proceeds from exercise of common stock options and purchases under Employee Stock Purchase Plan ............................ 2,278 2,607 3,319 Tax benefit from disqualifying dispositions of common stock ..... 1,009 2,323 4,908 Other ........................................................... (223) (976) (374) -------- -------- -------- Net cash provided by financing activities ..................... 1,970 3,954 20,627 -------- -------- -------- Effect of exchange rate fluctuations on cash and cash equivalents .. -- -- (385) Net increase (decrease) in cash and cash equivalents ............... (527) 14,076 3,763 Cash and cash equivalents at beginning of year ..................... 8,273 7,746 21,822 -------- -------- -------- Cash and cash equivalents at end of year ........................... $ 7,746 $ 21,822 $ 25,585 ======== ======== ======== Supplemental disclosure of cash flow information: Cash paid during the year for income taxes, net ................. $ 1,741 $ 700 $ 2,346 Supplemental schedule of noncash investing activities: Unrealized holding gain (loss) on marketable securities ......... $ (560) $ 736 $ (309) Supplemental schedule of noncash financing activities: Issuance of common stock in connection with acquisition (Note 2). $ 1,386 -- -- The accompanying notes are an integral part of these consolidated financial statements.
32 INTEGRATED SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Summary of Significant Accounting Policies Nature of Operations Integrated Systems, Inc. ("the Company") designs, develops, markets and supports software products and provides related engineering services principally for embedded microprocessor-based applications. Embedded microprocessors are used to add functionality and intelligence to a variety of products and to operate as an integral part of these products, generally without any direct human intervention. The Company offers software that consists of a real-time operating system, a development suite and a series of component modules and design tools that aid software development. The Company markets and supports its products and provides services on a worldwide basis to a variety of users in a broad range of industries, including telecommunications and data communications, automotive, multimedia and consumer, office and industrial automation, and the embedded Internet, through a direct sales force augmented by a telemarketing organization, distributors and sales representatives. Principles of Consolidation The consolidated financial statements include the accounts of Integrated Systems, Inc. and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. Investments in affiliated companies that are not controlled are carried at cost plus the Company's equity in undistributed earnings since acquisition (see Note 2). Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during a reporting period. Actual results could differ from those estimates. Cash and Cash Equivalents Cash and cash equivalents, which are held at a variety of financial institutions, include demand deposits, money market accounts and all highly liquid debt instruments with an original or remaining maturity at the date of purchase of three months or less. The Company has not experienced any material losses relating to any investment instruments. Fair Value of Financial Instruments and Concentrations The amounts reported for cash equivalents, accounts receivable, accounts payable and accrued liabilities are considered to approximate fair values based upon comparable market information available at February 28, 1997. The fair values of the Company's marketable securities are set forth in Note 3. Financial instruments that potentially subject the Company to concentrations of credit risks comprise, principally, cash, cash equivalents, investments in marketable securities and accounts receivable. The Company invests its excess cash in government securities, tax exempt municipal securities, preferred stock, Eurodollar notes and bonds, time deposits, certificates of deposit, commercial paper rated Aa or better and other specific money market and corporate instruments of similar liquidity and credit quality. With respect to accounts receivable, the Company's customer base is dispersed across many different geographic areas. The Company performs ongoing evaluations of its customers' financial condition and generally does not require collateral. The Company maintains allowances for potential credit losses and such losses have been within management's expectations. 33 INTEGRATED SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) 1. Summary of Significant Accounting Policies - (continued) Fair Value of Financial Instruments and Concentrations - (continued) The Company licenses certain software development tool products from other companies to distribute with its own products. The inability of such third parties to provide competitive products with adequate features and high quality on a timely basis or to cooperate in sales and marketing activities could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, the Company's products compete with products produced by certain of the Company's licensors. There can be no assurance that, upon the termination or expiration of these licenses, such licenses will be available on reasonable terms or at all, or that the Company could obtain similar products as substitutes. The inability to license such products could have a material adverse effect on the Company's business, financial condition and results of operations. Marketable Securities All marketable securities are classified as available-for-sale and therefore are carried at fair value. Marketable securities classified as current assets have scheduled maturities of less than one year, while marketable securities classified as noncurrent assets have scheduled maturities of more than one year. Unrealized holding gains and losses on such securities are reported net of related taxes as a separate component of shareholders' equity. Realized gains and losses on sales of all such securities are reported in interest and other income and computed using the specific identification cost method. Revenue Recognition Product Revenue Product revenue consists principally of revenue from product licensing fees. Product licensing fees, including advanced production royalty payments, are generally recognized when a customer purchase order has been received, a license agreement has been executed, the software has been shipped, remaining obligations are insignificant and collection of the resulting account receivable is probable. Generally, the Company's distributors do not have the right of return. Provisions for estimated product returns, warranty costs and insignificant vendor obligations are recorded at the time products are shipped. Services Revenue Services revenue consists principally of maintenance and renewal fees for providing product updates, technical support and related services for software products, and engineering and consulting services fees. Software maintenance revenue bundled with the initial product license revenue is deferred and recognized ratably over the related service period. The Company unbundles a portion of its initial product license revenue related to software maintenance revenue based upon product license renewal amounts, which are substantially less than the initial product license fee, or based upon the amount charged for such services when they are sold separately. License renewal fees, which are substantially less than the initial license, are deferred and recognized ratably over the license term. Revenue from separately sold maintenance contracts is recognized ratably over the related service period. Engineering and consulting services revenue from short-term and long-term contracts is generally recognized on the percentage-of-completion method. For cost reimbursement and firm fixed price contracts, revenues are recognized as the work is performed, based on the ratio of incurred costs to estimated total completion costs. For time-and-material contracts, revenues are recognized on the basis of direct labor hours and other direct costs incurred. Provisions for anticipated losses are made in the period in which they first become determinable. 34 INTEGRATED SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) 1. Summary of Significant Accounting Policies - (continued) Property and Equipment Property and equipment are recorded at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the respective assets (three to twenty years). Leasehold improvements are amortized over the lease term or the estimated useful life of the asset, whichever is shorter. The cost and accumulated depreciation of assets sold or retired are removed from the accounts and any resulting gain or loss is reflected in results of operations. Software Development Costs The Company capitalizes certain costs to develop computer software to be licensed or otherwise marketed to customers. Such costs are amortized using the greater of the amount computed using the ratio that current gross revenues for a product bear to the total of current and anticipated future gross revenues for that product, or on a straight-line basis over three years. The Company evaluates the estimated net realizable value of each software product at each balance sheet date and records write-downs to net realizable value for any products for which the net book value is in excess of net realizable value. Software development costs included in intangible assets at February 28, 1996 and 1997, were $1,177,000 and $1,749,000, respectively, net of accumulated amortization of $1,743,000 and $2,711,000, respectively. Capitalized software development costs were $492,000, $335,000, and $1,540,000 in fiscal 1995, 1996 and 1997, respectively. Amortization, which is included in cost of product revenue, was $607,000, $921,000, and $968,000 in fiscal 1995, 1996 and 1997, respectively. Intangible Assets Intangible assets consist primarily of goodwill, purchased software and capitalized software development costs. Goodwill and purchased software are amortized on a straight-line basis over their estimated useful lives. The Company periodically evaluates the recoverability of goodwill and purchased software based upon estimated undiscounted future cash flows from the related products and businesses acquired. Employee Stock Plans The Company accounts for its stock option plans and its employee stock purchase plan in accordance with provisions of the Accounting Principles Board's Opinion No. 25 ("APB 25"), "Accounting for Stock Issued to Employees." In 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 ("SFAS No. 123"), "Accounting for Stock-Based Compensation." SFAS No. 123 establishes a fair value based method of accounting for stock-based plans and is effective for fiscal years beginning after December 15, 1995. The Company is continuing to account for its employee stock plans in accordance with the provisions of APB 25, and has provided pro forma disclosure in Note 6 as if the measurement provisions of SFAS No. 123 had been adopted. Income Taxes The Company's provision for income taxes is comprised of its current tax liability and the change in its deferred tax assets and liabilities. Deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Advertising The Company expenses advertising costs as they are incurred. Advertising expense for fiscal 1995, 1996 and 1997 was $800,000, $927,000, and $1,566,000, respectively. 35 INTEGRATED SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) 1. Summary of Significant Accounting Policies - (continued) Computation of Earnings Per Share Earnings per share is computed using the weighted average number of common and common equivalent shares outstanding during the period. Common equivalent shares result from the assumed exercise of outstanding stock options that have a dilutive effect when applying the treasury stock method. Foreign Currency Translation Assets and liabilities of foreign operations where the functional currency is the local currency, are translated into U.S. dollars at the fiscal year end exchange rate. Revenues and expenses are translated at the average rate prevailing during the year. The related gains and losses from translation are recorded as a translation adjustment in a separate component of shareholder's equity. Foreign currency transaction gains and losses, as well as translation adjustments for assets and liabilities of foreign operations where the functional currency is the U.S. dollar, are included in results of operations. Fiscal Year Prior to fiscal 1996, the Company's fiscal year was reported on a 52/53 week period ending on the last Saturday in February of each year. Beginning in fiscal 1996, the Company's fiscal year end is the last day in February. Accordingly, the fiscal year end for fiscal 1995, 1996 and 1997 was February 25, 29 and 28, respectively. The effect of this change was not material to the Company's financial statements for fiscal 1996 or 1997. For clarity of presentation herein, all fiscal years are referred to as ending on February 28. Reclassifications Certain prior year amounts have been reclassified to conform to the current year presentation. Recent Accounting Pronouncements 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. The impact of the adoption of SFAS No. 128 on the financial statements of the Company has not yet been determined. 2. Acquisitions Merger With TakeFive In October 1995, the Company acquired TakeFive Software GmbH ("TakeFive"), an Austrian corporation by issuing 871,980 shares of its common stock in exchange for 97% of the shares of TakeFive. The remaining 3% of the shares of TakeFive were purchased for cash. The business combination was accounted for as a pooling of interests and the Company's results of operations for fiscal 1996 and 1997 include those of TakeFive. The prior years' results have not been restated to include TakeFive operations as such operations were insignificant. Prior to the business combination, TakeFive was in the business of developing, marketing and supporting software tools used in software development. The Company has continued the business of TakeFive and operates TakeFive as an independent subsidiary. 36 INTEGRATED SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) 2. Acquisitions - (continued) Merger With Doctor Design In January 1996, the Company acquired Doctor Design, Inc. ("Doctor Design"), an engineering services company specializing in multimedia hardware, software and application specific integrated circuit technology. The Company issued 743,214 shares of its common stock for substantially all the outstanding stock of Doctor Design. The Company also assumed stock options that converted into options to purchase 263,724 shares of the Company's common stock. The business combination was accounted for as a pooling of interests and the Company's results of operations include those of Doctor Design for all periods presented. The Company has continued the business of Doctor Design and operates Doctor Design as an independent subsidiary. Merger with Epilogue In July 1996, the Company acquired Epilogue Technology Corporation ("Epilogue"), a New Mexico corporation, by issuing 630,963 shares of common stock in exchange for all outstanding Epilogue common and preferred stock. The Company also assumed stock options that converted into options to purchase 69,033 shares of the Company's common stock. The business combination was accounted for as a pooling of interests. Results of operations have been included from the date of acquisition. Prior period results have not been restated to include Epilogue operations as such operations were insignificant. Prior to the business combination, Epilogue was a developer and distributor of network management and embedded Internet software for telecommunications and datacommunications equipment manufacturers, embedded software suppliers and networking related integrated circuit manufacturers. The Company intends to integrate the business of Epilogue with that of the Company. Combined and Separate Results of Mergers Combined and separate results of the Company, Doctor Design and TakeFive during the periods preceding the mergers were as follows (in thousands):
Integrated Doctor Systems Design TakeFive Combined ------- ------ -------- -------- Nine months ended November 30, 1995 (unaudited): Net revenue................................ $47,455 $9,171 $3,193 $59,819 Net income................................. 3,134 882 580 4,596 Year ended February 28, 1995: Net revenue................................ 51,979 6,075 58,054 Net income................................. 5,754 736 6,490
Net revenues and net income of Epilogue for the pre-acquisition periods were insignificant. Acquisition of Diab Data In December 1995, the Company acquired certain technology, related assets and all of the outstanding common stock of Diab Data, Inc. ("Diab Data") for $1,735,000. The acquisition was accounted for under the equity method of accounting and was included in other assets in the balance sheet as at February 28, 1996. The acquisition cost exceeded the underlying equity in net assets by $1,395,000, of which $756,000, $425,000 and $214,000 was allocated to existing software products which had reached technological feasibility, goodwill, and in-process software development which had not reached technological feasibility, respectively, based on their respective fair values. The costs allocated to goodwill and existing products are amortized over periods of five and two years, respectively, and the costs allocated to in-process software development were charged to acquisition-related and other costs. In addition to the purchase price, the Company paid bonuses to non-shareholder management and employees totaling $1,645,000, which were expensed and are included as part of acquisition and other expenses in the consolidated statement of income for fiscal 1996. The operations of Diab Data were not material to the consolidated financial statements of 37 INTEGRATED SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) 2. Acquisitions - (continued) Acquisition of Diab Data - (continued) the Company in fiscal 1996 or fiscal 1997, and accordingly, separate financial information for Diab Data has not been presented. In November 1996, the Company revised the terms of the acquisition of Diab Data and paid bonuses to management and employees of Diab Data of $4.8 million. In addition, as a result of the revision in terms, the Company is now required to consolidate the results of this subsidiary, which previously had been accounted for under the equity method of accounting. Accordingly, the operating results of Diab Data have been consolidated with those of the Company beginning December 1, 1996. Other Acquisitions In September 1994, the Company acquired certain software products and other assets for a total purchase price of approximately $3,467,000, consisting of $2,081,000 in cash and non-cash consideration of approximately 316,000 shares of restricted common stock with a value of approximately $1,386,000. The acquisition was accounted for using the purchase method of accounting and accordingly, its operations were included with those of the Company since the date of acquisition. Substantially all of the purchase price was allocated to purchased software, which prior to the third quarter of fiscal 1996, was being amortized on a straight-line basis over a seven-year period. During the third quarter of fiscal 1996, the Company determined that the recoverability of the purchased software was not probable as the products purchased would be replaced by the products acquired in the merger with TakeFive. Accordingly, capitalized purchased software totaling $3,083,000 was charged to acquisition-related and other costs in the consolidated statement of income. Acquisition-Related and Other Costs Acquisition-related and other costs for fiscal 1996 and 1997 consist of (in thousands): Year Ended February 28, ---------------------- 1996 1997 ------ ------ In-process software development costs written-off ........ $ 214 -- Bonus payments to management and employees of acquired company .................................... 1,645 $4,750 Purchased software written-off ........................... 3,083 616 Professional fees and other acquisition costs ............ 1,585 310 Termination fees payable to a distributor ................ 800 -- ------ ------ $7,327 $5,676 ====== ====== The termination fees payable to a distributor relate to amounts payable resulting from the termination of the Company's reseller arrangement with a Japanese distributor in February 1996. 3. Marketable Securities At February 28, 1996 and 1997, marketable securities consisted of fixed-income U.S. Government securities, primarily treasury notes, municipal securities and preferred stock, held by two investment banks. Marketable securities at February 28, 1996 are summarized below (in thousands):
Fair Cost Unrealized Unrealized Unrealized Value Basis Gains Losses Net Gains ----- ----- ----- ------ --------- U.S. Government securities ............. $ 12,678 $ 12,471 $ 221 $ (14) $ 207 Municipal securities ................... 11,550 11,456 94 -- 94 Preferred stock ........................ 3,426 3,172 254 -- 254 -------- -------- -------- ------ -------- $ 27,654 $ 27,099 $ 569 $ (14) 555 ======== ======== ======== ====== Related deferred taxes ................. (222) -------- Unrealized holding gain, net ........... $ 333 ========
38 INTEGRATED SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) 3. Marketable Securities - (continued) Marketable securities at February 28, 1997 are summarized below (in thousands):
Fair Cost Unrealized Unrealized Unrealized Value Basis Gains Losses Net Gains ----- ----- ----- ------ --------- U.S. Government securities...... $19,818 $19,737 $ 101 $ (20) $ 81 Municipal securities............ 5,832 5,783 49 -- 49 Preferred stock................. 3,460 3,344 135 (19) 116 ------- ------- ----- ----- ------ $29,110 $28,864 $ 285 $ (39) 246 ======= ======= ===== ===== Related deferred taxes.......... (98) ------ Unrealized holding gain, net.... $ 148 ======
At February 28, 1997, all marketable debt securities classified as current assets have scheduled maturities of less than one year. Marketable debt securities classified as noncurrent assets have scheduled maturities of one to five years. 4. Property and Equipment, net (in thousands): February 28, ------------ 1996 1997 ---- ---- Buildings .......................................... $ 908 $ 6,587 Furniture and fixtures ............................. 1,373 1,766 Computer equipment ................................. 11,642 14,724 Leasehold improvements ............................. 258 596 -------- -------- 14,181 23,673 Less accumulated depreciation and amortization ..... (8,588) (11,117) -------- -------- 5,593 12,556 Land ............................................... -- 5,400 -------- -------- $ 5,593 $ 17,956 ======== ======== In March 1996, the Company purchased its principal facility, for cash of approximately $12,000,000. Depreciation expense was $1,531,000, $2,203,000, and $3,131,000 in fiscal 1995, 1996 and 1997, respectively. 5. Leasehold Commitments and Contingencies Operating Leases Future minimum lease payments under all noncancelable operating leases amount to approximately $1,408,000, $1,151,000, $822,000, $130,000, $81,000 and $206,000 for fiscal 1998, 1999, 2000, 2001, 2002 and thereafter, respectively. Rent expense for fiscal 1995, 1996 and 1997 was $1,148,000, $1,455,000, and $1,633,000, respectively. 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 seeks general and specific damages of no less than $1.5 million plus exemplary damages, attorney's fees and costs of suit. The Company has filed answers to the complaint denying all of the allegations and asserting various affirmative defenses. The Company believes it has meritorious defenses to the claims and intends to defend the suit vigorously. 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 seeks damages of approximately $850,000. An answer to the complaint has been filed denying the allegations. The Company believes it has meritorious defenses to the claim and intends to defend the suit vigorously. 39 INTEGRATED SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) 5. Leasehold Commitments and Contingencies - (continued) Contingencies - (continued) The Company is involved in a contract dispute with a customer. Management believes it has meritorious defenses in relation to this dispute. No accrual for the above matters has been made in the accompanying consolidated financial statements as the ultimate outcomes of the litigation and dispute presently are not determinable. The litigation and dispute are subject to inherent uncertainties and thus, there can be no assurance that the litigation or dispute will be resolved favorably to the Company or that they will not have a material adverse effect on the Company's financial position or results of operations. 6. Shareholders' Equity Common Stock Split and Common Stock Repurchase On March 4, 1996, the Company's Board of Directors authorized a two-for-one stock split to be effective on April 5, 1996 for the shareholders of record on March 18, 1996. All share and per share information in the accompanying financial statements has been restated to give retroactive recognition to the stock split for all periods presented. In April 1997, the Company announced that the Board of Directors had authorized the Company to repurchase up to 1,000,000 shares of common stock for cash from time-to-time at market prices. In April 1997, the Company repurchased 20,000 shares of common stock in open market transactions for $187,500 under this stock repurchase program. Common Stock Option Plans At February 28, 1997, the Company had reserved 3,976,155 shares of common stock for issuance under various stock option plans, including plans resulting from the business combinations with Doctor Design and Epilogue (see Note 2). The plans provide for the granting of incentive stock options to officers and employees of the Company and nonqualified stock options to officers, employees, directors and consultants of the Company at prices not less than fair market value (as determined by the Compensation Committee of the Board of Directors) on the date of grant. Options are exercisable at times and in increments as specified by the Compensation Committee. Options generally vest over four or five years and expire in six to ten years. Activity under these plans is as follows (in thousands, except share and per share amounts):
Shares Number Weighted Available of Average for Grant Options Price Per Share Total --------- ------- --------------- ----- Balances, February 28, 1994..................... 773,966 2,519,896 $ 3.35 $ 8,449 Adoption of 1994 Directors Stock Option Plan.. 400,000 Shares added to 1988 Plan..................... 2,000,000 Options granted............................... (826,164) 826,164 $ 5.92 4,894 Options exercised ............................ (584,848) $ 3.18 (1,858) Options canceled.............................. 337,344 (337,344) $ 3.64 (1,227) ---------- --------- ------- Balances, February 28, 1995..................... 2,685,146 2,423,868 $ 4.23 10,258 Options granted............................... (882,272) 882,272 $13.50 11,915 Options exercised............................. (540,254) $ 3.79 (2,050) Options canceled.............................. 239,966 (239,966) $ 5.91 (1,419) ---------- --------- ------- Balances, February 28, 1996..................... 2,042,840 2,525,920 $ 7.40 18,704 Assumption of Epilogue Options ............... 69,033 $ 7.50 518 Options granted............................... (1,051,798) 1,051,798 $23.64 24,867 Options exercised ............................ (651,390) $ 3.60 (2,344) Options canceled ............................. 184,453 (194,701) $12.85 (2,501) ---------- --------- ------- Balances, February 28, 1997..................... 1,175,495 2,800,660 $14.01 $39,244 ========== ========= ====== =======
40 INTEGRATED SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) 6. Shareholders' Equity - (continued) Common Stock Option Plans - (continued) The following table summarizes information with respect to stock options outstanding at February 28, 1997:
(number of options in thousands) Options Outstanding Options Exercisable ------------------------------------------------ ------------------------------ Weighted Number Average Number Outstanding at Remaining Weighted Exercisable at Weighted February 28, Contractual Average February 28, Average Range of Exercise Price 1997 Life (years) Exercise Price 1997 Exercise Price ----------------------- -------------- ------------ -------------- -------------- -------------- $ 0.67 - $ 1.35 92 6.76 $ 1.05 57 $ 0.90 $ 2.46 - $ 3.88 408 5.19 $ 3.25 276 $ 3.19 $ 4.50 - $ 7.41 479 7.22 $ 5.50 246 $ 5.80 $ 7.62 - $11.13 297 7.94 $ 9.07 110 $ 8.95 $14.25 - $20.75 874 8.42 $17.25 139 $16.84 $22.75 - $35.63 651 9.07 $26.14 5 $25.66 ----- --- 2,801 7.79 $14.01 833 $ 6.99 ===== ===
At February 28, 1996, options to purchase 799,630 shares of common stock at a weighted average exercise price of $3.48 were exercisable. In April 1997, the Company offered employees the right to cancel certain outstanding stock options at original exercise prices and receive new options with a new exercise price. The new exercise prices range from $8.75 to $10.50 per share, based on the closing price of the common stock on the date individual employees agreed to cancel their original outstanding stock options. Options to purchase a total of 1,222,132 shares at original exercise prices ranging from $14.625 to $35.625 per share were canceled and new options were issued in April 1997. Vesting under the new options commenced on the date the individual employees agreed to cancel their original options, and occurs over a four year period. Employee Stock Purchase Plan At February 28, 1997, the Company had reserved a total of 553,632 shares of common stock for issuance under its 1990 Employee Stock Purchase Plan ("the ESPP"). The purpose of the ESPP is to provide eligible employees of the Company with a means of acquiring common stock of the Company through payroll deductions. The purchase price of such stock under the ESPP cannot be less than 85% of the lower of the fair market value on the specified purchase date or the beginning of the offering period. During fiscal 1995, 1996 and 1997, approximately 94,000 shares, 72,000 shares, and 51,000 shares, respectively, were sold through the ESPP. The aggregate fair value and weighted average fair value per share of purchase rights under the ESPP in fiscal 1996 and 1997 were $237,000 and $667,000, and $4.41 and $11.09, respectively. 41 INTEGRATED SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) 6. Shareholders' Equity - (continued) Pro Forma Stock-Based Compensation The Company has elected to continue to follow the provisions of APB No. 25, "Accounting for Stock Issued to Employees", for financial reporting purposes and has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123 ("SFAS No. 123"), "Accounting for Stock-Based Compensation". Accordingly, no compensation cost has been recognized for the Company's Stock Option Plans or ESPP. Had compensation cost for the Company's Stock Option Plans and ESPP been determined based on the fair value at the grant date for awards in fiscal 1996 and 1997 consistent with the provisions of SFAS No. 123, the Company's net income and net income per share for the years ended February 28, 1996 and 1997 would have been reduced to the pro forma amounts indicated below (in thousands, except per share amounts): Year Ended February 28, ------------ 1996 1997 ---- ---- Net income - as reported ...................... $5,283 $7,254 Net income - pro forma ........................ 4,704 4,497 Net income per share - as reported ........... 0.24 0.31 Net income per share - pro forma ............. 0.21 0.19 The above pro-forma disclosures are not necessarily representative of the effects on reported net income for future years. The aggregate fair value and weighted average fair value per share of options granted in fiscal 1996 and 1997 were $9.1 million and $17.0 million, and $10.30 and $16.15 per share, respectively. The fair value of each option grant is estimated on the date of grant using the Black-Scholes Option Pricing Model with the following weighted average assumptions: 1996 1997 ---- ---- Expected volatility .......................... 79.47% 79.67% Risk-free interest rate ...................... 6.34% 6.15% Expected life ................................ 5.5 years 5.0 years Expected dividend yield ...................... 0.00% 0.00% The Company has also estimated the fair value for the purchase rights under the Employee Stock Purchase Plan using the Black-Scholes Option Pricing Model, with the following assumptions for rights granted in 1996 and 1997: 1996 1997 ---- ---- Expected volatility .......................... 52.25% 83.16% Risk-free interest rate ...................... 5.81% 5.81% Expected life ................................ 0.5 years 0.5 years Expected dividend yield ...................... 0.00% 0.00% 7. 401(k) Plans The Company has two 401(k) Plans (the Plans), including a plan resulting from the business combination with Doctor Design (see Note 2), that cover essentially all domestic employees. Each eligible employee may elect to contribute to the Plans, through payroll deductions, up to 15% of their compensation, subject to certain limitations. The Company is obligated to make matching contributions on behalf of each participating employee in an amount equal to 25% of an employee's contribution, up to 2% of the employee's compensation. For individuals who were employed by the Company prior to December 1, 1994, Company contributions are fully vested on the date of contribution. For individuals who became employed subsequent to November 30, 1994, Company contributions vest ratably over a six-year period. The Company's contributions charged against income totaled approximately $228,000, $390,000, and $410,000 in fiscal 1995, 1996 and 1997, respectively. 42 INTEGRATED SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) 8. Income Taxes The provision for income taxes included the following (in thousands): Year Ended February 28, ----------------------- 1995 1996 1997 ---- ---- ---- Federal: Current ............................ $ 1,838 $ 3,211 $ 2,546 Deferred ........................... (429) (1,584) 245 ------- ------- ------- 1,409 1,627 2,791 ------- ------- ------- State: Current ............................ 647 1,208 884 Deferred ........................... (58) (593) 43 ------- ------- ------- 589 615 927 ------- ------- ------- Foreign .............................. 1,112 1,270 187 ------- ------- ------- $ 3,110 $ 3,512 $3,905 ======= ======== ======= The reconciliation between the effective tax rates and statutory federal income tax rates is shown in the following table: Year Ended February 28, ----------------------- 1995 1996 1997 ---- ---- ---- Statutory federal income tax rate ................. 34.0% 34.0% 35.0% State taxes, net of federal income tax benefit .... 4.6 5.4 5.5 Acquisition-related costs ......................... -- 8.0 1.0 Research and development tax credit and credit carry forwards ........................... (1.2) (2.0) (4.0) Foreign sales corporation tax benefit ............. (3.7) (3.5) (1.5) Other ............................................. (1.3) (1.9) (1.0) ---- ---- ---- Effective tax rate ................................ 32.4% 40.0% 35.0% ==== ==== ==== Domestic and foreign components of income before income taxes were (in thousands): Year Ended February 28, ----------------------- 1995 1996 1997 ---- ---- ---- Domestic..................................... $8,558 $7,430 $ 9,493 Foreign...................................... 1,042 1,365 1,666 ------ ------ ------- $9,600 $8,795 $11,159 ====== ====== ======= The significant components of deferred tax assets and liabilities consist of the following (in thousands): February 28, ------------ 1996 1997 ---- ---- Deferred tax assets: Purchased intangibles .................................. $2,572 $1,274 Tax credit carryforwards ............................... -- 1,087 Accelerated depreciation ............................... 296 299 Accrued vacation and holiday ........................... 262 368 Allowance for doubtful accounts ........................ 387 574 Other .................................................. 58 359 ------ ------ $3,575 $3,961 ====== ====== Deferred tax liabilities: Software development costs ............................. $ 510 $ 545 Marketable securities .................................. 222 98 Cash to accrual adjustment and other ................... 564 349 ------ ------ $1,296 $ 992 ====== ====== The Company has not provided a valuation allowance for its net deferred tax assets as it expects such amounts to be realized through taxable income from future operations, or by carryback to prior years' taxable income. 43 INTEGRATED SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) 9. Business Segment Information The Company operates in one business segment: the design, marketing and support of products for automating the process of real-time software development and system design, including engineering services to assist customers in implementing specific solutions. The Company's foreign operations primarily consist of an operating subsidiary and sales and customer service organizations. Net revenues, operating income and identifiable assets of the Company's foreign subsidiaries were not material to the consolidated financial statements in fiscal 1995 and 1996. For fiscal 1997 the net revenues, operating income and identifiable assets for the Company's North American, European and Asia/Pacific operations are summarized below:
(in thousands) North America Europe Asia/Pacific Eliminations Total ------- ------ ------------ ------------ ----- 1997: Net revenues $88,870 $20,366 $12,472 $(16,245) $105,463 Operating income 5,944 436 559 0 6,939 Identifiable assets 48,013 8,865 5,234 (4,305) 57,807
Sales and transfers between geographic areas are accounted for at prices which the Company believes are arm's length prices, which in general are in accordance with the rules and regulations of the respective governing tax authorities. Such transfers are eliminated in the consolidated financial statements. Identifiable assets are those that can be directly associated with a particular geographic area. Corporate assets include cash and cash equivalents, short-term investments and long-term investments and totaled $54,695,000 at February 28, 1997. Export revenues consisting of sales from the Company and it's U.S. operating subsidiaries to non-affiliated customers were as follows: Year Ended February 28, ----------------------- (in thousands) 1995 1996 1997 ---- ---- ---- Europe $ 6,472 $ 9,458 $ 1,869 Asia/Pacific 6,790 11,305 6,588 ------- ------- ------- Total $13,262 $20,763 $ 8,457 ======= ======= ======= No customer accounted for 10% or more of total revenue in the reported periods. 44 REPORT OF INDEPENDENT ACCOUNTANTS ON SCHEDULE In connection with our audits of the consolidated financial statements of Integrated Systems, Inc. and Subsidiaries as of February 28, 1996 and 1997, and for the each of the three years in the period ended February 28, 1997, which financial statements are included in the Registrant's Annual Report on Form 10-K, we have also audited the financial statement schedule listed in Item 14 herein. In our opinion, the financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein. COOPERS & LYBRAND L.L.P. San Jose, California March 26, 1997, except for Note 6, as to which the date is April 28, 1997 45 SCHEDULE II INTEGRATED SYSTEMS, INC. VALUATION AND QUALIFYING ACCOUNTS
Column A Column B Column C Column D Column E -------- -------- --------------------- --------- -------- Charged Balance at to Costs Charged Balance Beginning and to Other at End Description of Period Expenses Accounts Write-offs of Period ----------- ---------- ---------- ----------- ---------- ---------- For the year ended February 28, 1995: Allowance for doubtful accounts $482,000 $253,000 -- $106,000 $ 629,000 For the year ended February 28, 1996: Allowance for doubtful accounts $629,000 $286,000 -- $ 63,000 $ 852,000 For the year ended February 28, 1997: Allowance for doubtful accounts $852,000 $750,000 $150,000 $212,000 $1,540,000
46 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on May 28, 1997. INTEGRATED SYSTEMS, INC. By: /s/ NARENDRA K. GUPTA ------------------------- Narendra K. Gupta, Chairman of the Board and Secretary Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Name Title Date ---- ----- ---- Principal Executive Officer: /s/ DAVID P. ST. CHARLES President, Chief Executive Officer May 28, 1997 - ---------------------------------------- and Director David P. St. Charles Principal Financial and Accounting Officer: /s/ WILLIAM C. SMITH Vice President, Finance and Chief May 28, 1997 - ---------------------------------------- Financial Officer William C. Smith Additional Directors: /s/ NARENDRA K. GUPTA Chairman of the Board and May 28, 1997 - ---------------------------------------- Secretary Narendra K. Gupta /s/ JOHN C. BOLGER Director May 28, 1997 - ---------------------------------------- John C. Bolger /s/ VINITA GUPTA Director May 28, 1997 - ---------------------------------------- Vinita Gupta /s/ THOMAS KAILATH Director May 28, 1997 - ---------------------------------------- Thomas Kailath /s/ RICHARD C. MURPHY Director May 28, 1997 - ---------------------------------------- Richard C. Murphy
47 INDEX TO EXHIBITS Sequentially Exhibit Numbered Number Exhibit Page ------ ------- ---- 11.01 Statement Regarding Computation of Net Income Per Share ... 49 21.01 List of Registrant's Subsidiaries ......................... 50 23.01 Consent of Independent Accountants ........................ 51 27.01 Financial Data Schedule ................................... 52 48 EX-11.01 2 COMPUTATION OF NET INCOME PER SHARE EXHIBIT 11.01 INTEGRATED SYSTEMS, INC. COMPUTATION OF NET INCOME PER SHARE (1) (Amounts in thousands, except per share amounts) Year Ended February 28, ----------------------- 1995 1996 1997 ---- ---- ---- Primary: Net income $ 6,490 $ 5,283 $ 7,254 ======= ======= ======= Reconciliation of weighted number of shares outstanding to amount used in net income per share computation: Weighted average number of common shares outstanding 19,318 20,962 22,437 Dilutive effect of options 646 1,126 1,071 ------- ------- ------- 19,964 22,088 23,508 ======= ======= ======= Net income per share $ 0.33 $ 0.24 $ 0.31 ======= ======= ======= Fully Diluted: Net income $ 6,490 $ 5,283 $ 7,254 ======= ======= ======= Reconciliation of weighted number of shares outstanding to amount used in net income per share computation: Weighted average number of common shares outstanding 19,318 20,962 22,437 Dilutive effect of options 936 1,130 1,105 ------- ------- ------- 20,254 22,092 23,542 ======= ======= ======= Net income per share $ 0.32 $ 0.24 $ 0.31 ======= ======= ======= (1) See Note 1 of Notes to Consolidated Financial Statements. 49 EX-21.01 3 LIST OF REGISTRANT'S SUBSIDIARIES EXHIBIT 21.01 INTEGRATED SYSTEMS, INC. LIST OF REGISTRANT'S SUBSIDIARIES State or Jurisdiction of Incorporation or Name Organization ----------------------------------- ------------------------- Integrated Systems, Inc. F.S.C U.S. Virgin Islands Integrated Systems, Inc. Limited United Kingdom Integrated Systems, Inc. S.A. France Integrated Systems, GmbH Germany Integrated Systems, Inc. A.B. Sweden Integrated Systems (Israel) Ltd. Israel Integrated Systems, Inc. GmbH Austria TakeFive Software GmbH Austria TakeFive Software AG Switzerland TakeFive Software, Inc. California TakeFive Software, Ltd. United Kingdom Doctor Design, Inc. California ISICAN Integrated Systems (Canada) Inc. Canada Integrated Systems Japan K.K. Japan Integrated Systems, Inc. Italia SRL Italy Epilogue Technology Corporation New Mexico Diab Data, Inc. California 50 EX-23.01 4 CONSENT OF INDEPENDENT ACCOUNTANTS EXHIBIT 23.01 CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference in the Registration Statements of Integrated Systems, Inc. on Form S-8 (File Nos. 33-35281, 33-48626, 33-70494, 333-1145, 333-12799) of our reports dated March 26, 1997, except for Note 6, as to which the date is April 28, 1997, on our audits of the consolidated financial statements and financial statement schedule of Integrated Systems, Inc. as of February 28, 1996 and 1997, and for each of the three years in the period ended February 28, 1997 which reports are included in this Form 10-K. Coopers & Lybrand L.L.P. San Jose, California May 28, 1997 51 EX-27 5 FINANCIAL DATA SCHEDULE
5 THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE FY97 FORM 10-K FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 12-MOS FEB-28-1997 MAR-01-1996 FEB-28-1997 25,585 4,483 29,806 1,540 0 65,439 29,073 11,117 112,502 26,127 0 0 0 61,158 25,014 112,502 69,282 105,463 9,755 26,147 72,377 0 0 11,159 3,905 7,254 0 0 0 7,254 0.31 0.31
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