-----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, QURUUVt0R/JU949Nlj5bnO9+1j9vI3JId12prLgeeBr0ydE5U1uarBVzDZqFkXrE u1MVlBIDGtbOs1lraasyRQ== 0001047469-99-023900.txt : 19990615 0001047469-99-023900.hdr.sgml : 19990615 ACCESSION NUMBER: 0001047469-99-023900 CONFORMED SUBMISSION TYPE: PRE 14A PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19990803 FILED AS OF DATE: 19990611 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: PRE 14A SEC ACT: SEC FILE NUMBER: 000-18268 FILM NUMBER: 99644965 BUSINESS ADDRESS: STREET 1: 201 MOFFETT PARK DIRVE CITY: SUNNYVALE STATE: CA ZIP: 95054-3309 BUSINESS PHONE: 4085421500 MAIL ADDRESS: STREET 1: 201 MOFFETT PARK DRIVE CITY: SUNNYVALE STATE: CA ZIP: 94089 PRE 14A 1 PRE 14A SCHEDULE 14A INFORMATION Proxy Statement Pursuant to Section 14(a) of the Securities Exchange Act of 1934 (Amendment No. ____) Filed by the Registrant |X| Filed by the Party other than the Registrant |_| Check the appropriate box: [X] Preliminary Proxy Statement |_| Confidential, for Use of the [ ] Definitive Proxy Statement Commission Only (as permitted by [ ] Definitive Additional Materials Rule 14a-6(e)(2)) [ ] Soliciting Material Pursuant to Rule 14a-11(c) or Rule 14a-12 INTEGRATED SYSTEMS, INC. (Name of Registrant as Specified In Its Charter) ---------------------------------------------------- (Name of Person(s) Filing Proxy Statement, if other than the Registrant) Payment of Filing Fee (Check the appropriate box): [x] No fee required. [ ] Fee computed on table below per Exchange Act Rules 14a-6(i)(1) and 0-11. 1) Title of each class of securities to which transaction applies: ---------------------------------------------------------------- 2) Aggregate number of securities to which transaction applies: ---------------------------------------------------------------- 3) Per unit price or other underlying value of transaction computed pursuant to Exchange Act Rule 0-11 (set forth the amount on which the filing fee is calculated and state how it was determined): ---------------------------------------------------------------- 4) Proposed maximum aggregate value of transaction: ---------------------------------------------------------------- 5) Total fee paid: ---------------------------------------------------------------- [ ] Fee paid previously with preliminary materials. [ ] Check box if any part of the fee is offset as provided by Exchange Act Rule 0-11(a)(2) and identify the filing for which the offsetting fee was paid previously. Identify the previous filing by registration statement number, or the Form or Schedule and the date of its filing. 1) Amount Previously Paid: ---------------------------------------------------------------- 2) Form, Schedule or Registration Statement No.: ---------------------------------------------------------------- 3) Filing Party: ---------------------------------------------------------------- 4) Date Filed: ---------------------------------------------------------------- [INTEGRATED SYSTEMS LOGO] To Our Shareholders: You are cordially invited to attend the Annual Meeting of Shareholders of Integrated Systems, Inc. to be held at ISI's headquarters located at 201 Moffett Park Drive, Sunnyvale, California, on Tuesday, August 3, 1999, at 2:00 p.m., local time. The matters expected to be acted upon at the meeting are described in detail in the accompanying Notice of Annual Meeting of Shareholders and Proxy Statement. It is important that you use this opportunity to take part in the affairs of your Company by voting on the business to come before this meeting. WHETHER OR NOT YOU PLAN TO ATTEND THE MEETING, PLEASE COMPLETE, DATE, SIGN AND PROMPTLY RETURN THE ACCOMPANYING PROXY IN THE IN THE ENCLOSED POSTAGE-PAID ENVELOPE BEFORE THE MEETING. Returning the Proxy does not deprive you of your right to attend the meeting and to vote your shares in person. We look forward to seeing you at the meeting. Sincerely, Narendra K. Gupta CHAIRMAN OF THE BOARD [INTEGRATED SYSTEMS LOGO] INTEGRATED SYSTEMS, INC. 201 MOFFETT PARK DRIVE SUNNYVALE, CALIFORNIA 94089 NOTICE OF ANNUAL MEETING OF SHAREHOLDERS To Our Shareholders: NOTICE IS HEREBY GIVEN that the Annual Meeting of Shareholders of Integrated Systems, Inc. will be held at ISI's headquarters located at 201 Moffett Park Drive, Sunnyvale, California, on Tuesday, August 3, 1999, at 2:00 p.m., local time, for the following purposes: 1. To elect seven directors, each to serve until the next Annual Meeting of Shareholders and until his successor has been elected and qualified or until his earlier resignation or removal. The Board of Directors intends to present the following nominees for election as directors: Charles M. Boesenberg Vinita Gupta John C. Bolger Thomas Kailath Michael A. Brochu Richard C. Murphy Narendra K. Gupta 2. To approve an amendment to the 1998 Equity Incentive Plan to increase the number of shares of common stock reserved for issuance from 1,000,000 to 2,000,000 shares. 3. To approve the 1999 Employee Stock Purchase Plan, under which 800,000 shares of common stock will be reserved for issuance. 4. To approve an amendment to the Bylaws to change the number of authorized directors to a range of five to nine. 5. To ratify the selection of PricewaterhouseCoopers LLP as the independent accountants for fiscal year 2000. 6. To transact such other business as may properly come before the meeting or any adjournment or postponement of the meeting. The foregoing items of business are more fully described in the Proxy Statement that accompanies this Notice. Only shareholders of record at the close of business on June 7, 1999 are entitled to notice of and to vote at the meeting or any adjournment or postponement of the meeting. By Order of the Board of Directors Narendra K. Gupta Chairman of the Board Sunnyvale, California June 28, 1999 - ------------------------------------------------------------------------------- WHETHER OR NOT YOU EXPECT TO ATTEND THE MEETING, PLEASE COMPLETE, DATE AND SIGN THE ACCOMPANYING PROXY AND RETURN IT PROMPTLY IN THE ENCLOSED POSTAGE-PAID ENVELOPE. - ------------------------------------------------------------------------------- [INTEGRATED SYSTEMS LOGO] INTEGRATED SYSTEMS, INC. 201 MOFFETT PARK DRIVE SUNNYVALE, CALIFORNIA 94089 --------------- PROXY STATEMENT --------------- June 28, 1999 The accompanying proxy is solicited on behalf of the Board of Directors (the "BOARD") of Integrated Systems, Inc., a California corporation, for use at the Annual Meeting of Shareholders to be held at ISI's headquarters, located at 201 Moffett Park Drive, Sunnyvale, California, on Tuesday, August 3, 1999, at 2:00 p.m., local time. This proxy statement and the accompanying form of proxy were first mailed to shareholders on or about June 28, 1999. An annual report for the fiscal year ended February 28, 1999 is enclosed with this proxy statement. VOTING RIGHTS AND SOLICITATION OF PROXIES Only holders of record of ISI's common stock at the close of business on June 7, 1999 (the "RECORD Date") are entitled to vote at the meeting. A majority of the shares outstanding on the Record Date will constitute a quorum for the transaction of business at the meeting. At the close of business on the Record Date, ISI had 22,764,412 shares of common stock outstanding and entitled to vote. Holders of ISI's common stock are entitled to one vote for each share held as of the Record Date. Shares of common stock may not be voted cumulatively. If a broker, bank, custodian, nominee or other record holder of ISI's common stock indicates on a proxy that it does not have discretionary authority to vote certain shares on a particular matter (a "BROKER non-vote"), those shares will not be considered present and entitled to vote with respect to that matter, although they will be counted in determining the presence of a quorum. Directors will be elected by a plurality of the votes of the shares of common stock present in person or represented by proxy at the meeting and entitled to vote on the election of directors. The seven nominees receiving the highest number of affirmative votes will be elected. Abstentions and broker non-votes have no legal effect. Approval of Proposals No. 2, 3, 4 and 5 requires the affirmative vote of the majority of shares of common stock present in person or represented by proxy at the meeting. Abstentions have the effect of a negative vote and broker non-votes do not affect the calculation. All votes will be tabulated by the inspector of elections appointed for the meeting. The proxy accompanying this proxy statement is solicited on behalf of the Board for use at the meeting. Shareholders are requested to complete, date and sign the accompanying proxy card and promptly return it in the enclosed envelope. All signed, returned proxies that are not revoked will be voted in accordance with the instructions contained therein; however, returned signed proxies that give no instructions as to how they should be voted on a particular proposal will be counted as votes "for" such proposal (or, in the case of the election of directors, as a vote "for" election to the Board of all the nominees presented by the Board). In the event that sufficient votes in favor of the proposals are not received by the date of the meeting, the persons named as proxies may propose one or more adjournments of the meeting to permit further solicitations of proxies. Any such adjournment would require the affirmative vote of the majority of the shares present in person or represented by proxy at the meeting. ISI will pay the expenses of soliciting proxies for the meeting. Following the original mailing of the proxies and other soliciting materials, ISI will request that brokers, custodians, nominees and other record holders of ISI's common stock forward copies of the proxy and other soliciting materials to persons for whom they hold shares of common stock and request authority for the exercise of proxies. In such cases, ISI, upon the request of the record holders, will reimburse such holders for their reasonable expenses. The original solicitation of proxies by mail may be supplemented by telephone, telegram or personal solicitation by directors, officers and regular employees of ISI. REVOCABILITY OF PROXIES Any person signing a proxy in the form accompanying this proxy statement has the power to revoke it before the meeting or at the meeting before the vote pursuant to the proxy. A proxy may be revoked by a writing delivered to ISI stating that the proxy is revoked, by a subsequent proxy that is signed by the person who signed the earlier proxy and is presented at the meeting, or by attendance at the meeting and voting in person. Please note, however, that if a shareholder's shares are held of record by a broker, bank or other nominee and that shareholder wishes to vote at the meeting, the shareholder must bring to the meeting a letter from the broker, bank or other nominee confirming that shareholder's beneficial ownership of the shares. -2- PROPOSAL NO. 1 ELECTION OF DIRECTORS The Board consists of seven directors, all of whom are to be elected at the meeting. Each director will be elected to hold office until the next annual meeting of shareholders or until a successor is duly elected and qualified or until the director's earlier resignation or removal. Shares represented by the accompanying proxy will be voted for the election of each of the seven nominees named below unless the proxy is marked in such a manner as to withhold authority so to vote. If any nominee for any reason is unable to serve or for good cause will not serve, the proxies may be voted for such substitute nominee as the proxy holder may determine. ISI is not aware of any nominee who will be unable to or for good cause will not serve as a director. NOMINEES The names of the nominees, each of whom is currently a director of ISI, and certain information about them are set forth below:
NAME OF DIRECTOR AGE PRINCIPAL OCCUPATION DIRECTOR SINCE ---------------- --- -------------------- -------------- Narendra K. Gupta 50 Chairman of the Board and Secretary of ISI 1980 Charles M. Boesenberg 50 President and Chief Executive Officer of ISI 1998 John C. Bolger (1) (2) 52 Retired Chief Financial Officer 1993 Cisco Systems, Inc. Michael A. Brochu (2) 45 President and Chief Executive Officer 1998 Primus, Inc. Vinita Gupta 48 President, Chief Executive Officer and 1980 Chairperson of the Board Digital Link Corporation Thomas Kailath (1) 63 Professor of Engineering, Stanford University 1980 Richard C. Murphy (1) (2) 54 Director and Business Consultant 1994
- -------------------- (1) Member of the Compensation Committee. (2) Member of the Audit Committee. Dr. Gupta is a founder of ISI and has been a director of ISI since its formation in 1980. He has been the Chairman of the Board of ISI since March 1993 and Secretary since September 1989. Dr. Gupta was Chief Executive Officer from 1988 to May 1994 and President from ISI's formation in 1980 to May 1994. He was elected a Fellow of the Institute of Electrical and Electronic Engineers in November 1991. Dr. Gupta serves on the board of Digital Link Corporation, a data communications and wide-area networking equipment manufacturer, and three privately-held companies. Dr. Gupta holds an M.S. in Engineering from the California Institute of Technology and a Ph.D. in Engineering from Stanford University. He is Vinita Gupta's husband. Mr. Boesenberg joined ISI in December 1998 as President, Chief Executive Officer and a director. In June 1999, he was also appointed Vice President of Marketing. From December 1997 to December 1998 he was President and Chief Executive Officer of Magellan Corporation, a satellite-access products company based in Santa Clara, California. From January 1995 until it merged with Magellan Corporation in December 1997, Mr. Boesenberg was President and Chief Executive Officer of Ashtech, Inc., a business-to-business GPS company. Previously, he was President, Chief Executive Officer and Chairman of Central Point Software, Inc., President of MIPS Computer Systems, Inc., and Senior Vice President of Apple Computer, Inc. Mr. Boesenberg holds a B.S. in -3- Mechanical Engineering from Rose Hulman Institute of Technology and an M.S. in Business Administration from Boston University. Mr. Bolger has been a director of ISI since July 1993. He served as Vice President, Finance and Administration, and Secretary of Cisco Systems, Inc., a networking systems company, from 1989 until his retirement in 1992. Mr. Bolger is also a director of Integrated Device Technology, Inc., a semiconductor manufacturer; TCSI, a communication software company; Sanmina Corporation, a contract assembly manufacturer; and Mission West Properties, a REIT. He holds a B.A. in English Literature from the University of Massachusetts and an M.B.A. from Harvard University. Mr. Brochu has been a director of ISI since April 1998. Since November 1997, Mr. Brochu has been President and Chief Executive Officer of Primus, Inc., a developer of problem resolution software. Prior to joining Primus, Mr. Brochu was President, Chief Operating Officer and Chief Financial Officer of Sierra On-line, Inc., a software development company. Mr. Brochu was also appointed Senior Vice President of CUC International, Inc., the parent corporation pursuant to their acquisition of Sierra On-line, Inc. in July 1996. From 1982 to 1994, Mr. Brochu held several executive positions at Burlington Northern, Inc., a hazardous waste management company, as well as several of its subsidiaries. His last position with Burlington Northern, Inc. was that of Chief Financial Officer and Senior Vice President of Burlington Environmental, Inc. Mr. Brochu is a graduate of the University of Texas at El Paso with B.S. degrees in Accounting and Finance. Mrs. Gupta has been a director of ISI since its formation in 1980. In January 1999, she returned as President, Chief Executive Officer and Chairperson of the Board of Digital Link Corporation, a manufacturer of data communications equipment. She has been Chairperson of the Board since 1985 and served as President and Chief Executive Officer between 1985 and 1996. Mrs. Gupta holds an M.S. degree in Electrical Engineering from the University of California, Los Angeles. She is Narendra K. Gupta's spouse. Dr. Kailath is a founder of ISI and has been a director of ISI since its formation in 1980. He served as Vice Chairman of the Board of Directors from January 1990 to March 1993 and Chairman of the Board of Directors from April 1980 to January 1990. He is currently the Hitachi America Professor of Engineering at Stanford University, where he has been on the faculty since January 1963. Dr. Kailath is a member of the National Academy of Engineering, the American Academy of Arts and Sciences and a Fellow of the IEEE. Dr. Kailath holds M.S. and Sc.D. degrees in Electrical Engineering from the Massachusetts Institute of Technology. Mr. Murphy has been a director of ISI since December 1994. He is an independent business consultant. Mr. Murphy was Vice President of Marketing, Sales and Corporate Development of Informix Software, Inc., a relational database software company, from 1983 until he retired in 1988. Mr. Murphy is also a director of Objectivity, Inc., an object database software company; iXOS Software Inc., a distributor of image management software; and Intermax Solutions, Inc., an applications development software tools company. He holds a B.S. in Mechanical Engineering from the University of Illinois and an M.B.A. from Northwestern University. BOARD OF DIRECTORS' MEETINGS AND COMMITTEES The Board met five times, including telephone conference meetings, and acted by unanimous written consent once during the fiscal year ended February 28, 1999. No director attended fewer than 75% of the total number of meetings of the Board and all committees of the Board on which such director served during the year. Standing committees of the Board include an Audit Committee and a Compensation Committee. The Board does not have a nominating committee or a committee performing a similar function. The current members of the Audit Committee are Mr. Bolger, Mr. Brochu and Mr. Murphy. The Audit Committee met twice during fiscal year 1999. The Audit Committee meets with ISI's independent accountants to review the adequacy of ISI's internal control systems and financial reporting procedures; reviews the general scope of ISI's annual audit and the fees charged by the independent accountants; reviews and monitors the performance of non-audit services by ISI's independent accountants; reviews the fairness of any proposed transaction between ISI and any officer, director or other affiliate of ISI, and after such review, makes recommendations to the full Board; and performs such further functions as may be required by any stock exchange or over-the-counter market upon which ISI's common stock may be listed. -4- The current members of the Compensation Committee are Mr. Bolger, Mr. Murphy and Dr. Kailath. The Compensation Committee met four times and acted by unanimous written consent twice during fiscal year 1999. The Compensation Committee determines compensation for officers and employees of ISI, grants options and stock awards under ISI's employee benefit plans and reviews and recommends adoption of and amendments to stock option and employee benefit plans. DIRECTOR COMPENSATION During fiscal year 1999, ISI paid directors fees of $13,500 to Mr. Bolger, Mrs. Gupta, Dr. Kailath and Mr. Murphy and $12,750 to Mr. Brochu. Members of the Board who are not employees, consultants or independent contractors of ISI, or any parent, subsidiary or affiliate of ISI, are eligible to participate in ISI's 1994 Directors Stock Option Plan. In fiscal year 1999, each eligible director was granted an option to purchase 5,000 shares of ISI common stock on the anniversary of such director joining the Board, at the following exercise prices per share: Mr. Bolger, $15.125; Mr. Brochu, $18.8438; Mrs. Gupta, $19.312; Dr. Kailath, $19.312; and Mr. Murphy, $10.500. These options have a term of ten years and become exercisable at the rate of 2.083% of the shares per month, so long as the director continuously remains a director of ISI. THE BOARD RECOMMENDS A VOTE FOR THE ELECTION OF EACH OF THE NOMINATED DIRECTORS. PROPOSAL NO. 2 AMENDMENT OF 1998 EQUITY INCENTIVE PLAN Shareholders are being asked to approve an amendment to ISI's 1998 Equity Incentive Plan (the "INCENTIVE PLAN") to increase the number of shares of common stock reserved for issuance under the Incentive Plan by 1,000,000 shares, from 1,000,000 shares to 2,000,000 shares. The Board believes that the increase in the number of shares reserved for issuance under the Incentive Plan is in the best interests of ISI because of the continuing need to provide stock options to attract and retain quality employees and remain competitive in the industry. The granting of equity incentives under the Incentive Plan plays an important role in ISI's efforts to attract and retain employees of outstanding ability. Competition for skilled engineers and other key employees is intense and the use of significant stock options for retention and motivation of such personnel is pervasive in the high technology industries. The Board believes that the additional reserve of shares with respect to which equity incentives may be granted will provide ISI with adequate flexibility to ensure that ISI can continue to meet those goals and facilitate ISI's expansion of its employee base. The Board approved the proposed amendment in March 1999, to be effective upon shareholder approval. Below is a summary of the principal provisions of the Incentive Plan, assuming shareholder approval of the amendment. The summary is not necessarily complete, and reference is made to the full text of the Incentive Plan. INCENTIVE PLAN HISTORY The Incentive Plan, covering 1,000,000 shares of common stock, was adopted by the Board in March 1998 and approved by the shareholders in July 1998. Together with shares carried forward from ISI's 1988 Stock Option Plan, at February 28, 1999, 2,005,332 shares were available for issuance under the Incentive Plan. The purpose of the Incentive Plan is to provide incentives to attract, retain and motivate eligible persons whose present and potential contributions are important to the success of ISI, by offering them an opportunity to participate in ISI's future performance through awards of stock options, restricted stock and stock bonuses. The Incentive Plan took effect in September 1998, when ISI's 1988 Stock Option Plan terminated by its terms. From the effective date of the Incentive Plan to February 28, 1999, options to purchase a total of 1,011,550 shares of ISI common stock were granted under the Incentive Plan. Of these, options were granted to the Named Executive Officers, as follows: Charles M. Boesenberg, 700,000 shares; Joseph Addiego, 65,000 shares; and Janice Waterman, 25,000 shares. During the same period, ISI's executive officers as of February 28, 1999 as a group (7 persons) had been granted options to purchase a total of 790,000 shares and the current directors or nominees for election as a director who are not executive officers as a group (5 persons) had been granted no options under the -5- Incentive Plan. No options were granted during the period under the Incentive Plan to any associate of any executive officer or director of ISI, and no other person received 5% or more of such options. SHARES SUBJECT TO THE INCENTIVE PLAN The stock subject to issuance under the Incentive Plan consists of shares of ISI's authorized but unissued common stock. After taking into account the proposed amendment, there are reserved for issuance under the Incentive Plan a total of 2,000,000 shares of common stock plus (a) any shares not issued or subject to outstanding options under ISI's 1988 Stock Option Plan (the "PRIOR PLAN") on the effective date of the Incentive Plan; (b) shares that are issuable upon exercise of an option granted under the Prior Plan but cease to be subject to the option for any reason other than exercise of the option; and (c) shares that were issued under the Prior Plan that are repurchased by ISI at the original issue price or forfeited. In addition, (a) shares subject to an option granted under the Incentive Plan that cease to be subject to the option for any reason other than exercise of the option; (b) shares subject to an award granted under the Incentive Plan that are forfeited or are repurchased by ISI at the original issue price; or (c) shares subject to an award granted under the Incentive Plan that otherwise terminates without shares being issued, will again be available for grant and issuance under the Incentive Plan. This number of shares is subject to proportional adjustment to reflect stock splits, stock dividends and other similar events. ELIGIBILITY Employees, officers, directors, consultants, independent contractors and advisors of ISI (and of any subsidiaries and affiliates of ISI) are eligible to receive awards under the Incentive Plan. A participant may be granted more than one award under the Incentive Plan. No participant is eligible to receive more than 200,000 shares of common stock in any calendar year under the Incentive Plan, other than new employees of ISI (including directors and officers who are also new employees) who are eligible to receive up to a maximum of 1,000,000 shares of common stock in the calendar year in which they commence their employment with ISI. As of February 28, 1999, approximately 650 persons were eligible to participate in the Incentive Plan, no shares had been issued upon exercise of options, 1,009,550 shares were subject to outstanding options and no shares had been issued under restricted stock or stock bonus awards. As of that date, 1,995,782 shares were available for future grant under the Incentive Plan, after taking into account the proposed amendment to the Incentive Plan and the shares originally reserved for issuance under the Prior Plan that have become available for distribution under the Incentive Plan. The closing price of ISI's common stock on the Nasdaq National Market was $14.125 per share on June 4, 1999, the last trading day before the Record Date. ADMINISTRATION The Incentive Plan is administered by the Compensation Committee of the Board (the "COMMITTEE"). The members of the Committee are appointed by the Board. The Committee currently consists of John C. Bolger, Richard C. Murphy and Thomas Kailath, all of whom are "NON-EMPLOYEE DIRECTORS," as defined in Rule 16b-3 promulgated under the Securities Exchange Act of 1934, as amended (the "EXCHANGE ACT"), and "OUTSIDE DIRECTORS," as defined in Section 162(m) of the Internal Revenue Code of 1986, as amended (the "CODE"). Subject to the terms of the Incentive Plan, the Committee determines the persons who are to receive awards, the number of shares subject to each award and the terms and conditions of awards. The Committee also has the authority to construe and interpret any of the provisions of the Incentive Plan or any awards granted thereunder. STOCK OPTIONS The Incentive Plan permits the granting of options that are intended to qualify either as Incentive Stock Options ("ISOS") or Nonqualified Stock Options ("NQSOS"). ISOs may be granted only to employees (including officers and directors who are also employees) of ISI or any parent or subsidiary of ISI. The exercise price for each ISO share must be no less than 100% of the "fair market value" (as defined in the Incentive Plan) of a share of common stock at the time of grant. The exercise price of an ISO share granted to a 10% shareholder must be no less than 110% of the fair market value of a share of common stock at the time of grant. The exercise price for each NQSO share must be no less than 85% of the fair market value of a share of common stock at the time of grant. ISI has not granted options under the Incentive Plan at less than fair market value and does not intend to do so in the -6- foreseeable future. All options granted under the Incentive Plan have a term of up to ten years, except for ISOs granted to 10% shareholders, which have a term of up to five years. The exercise price of options granted under the Incentive Plan may be paid as approved by the Committee at the time of grant: (1) in cash (by check); (2) by cancellation of indebtedness of ISI to the participant; (3) by surrender of shares of ISI's common stock owned by the participant for at least six months and having a fair market value on the date of surrender equal to the total exercise price of the option or that were obtained by the participant in the open market; (4) by tender of a full recourse promissory note; (5) by waiver of compensation due to or accrued by the participant for services rendered; (6) by a "same-day sale" commitment from the participant and a National Association of Securities Dealers, Inc. ("NASD") broker; (7) by a "margin" commitment from the participant and an NASD broker; or (8) by any combination of the foregoing. RESTRICTED STOCK AWARDS The Committee may grant restricted stock awards to purchase stock under such terms, conditions and restrictions as the Committee may determine. These restrictions may be based upon completion of a specified number of years of service with ISI or upon completion of performance goals as determined by the Committee on the date of the award. The purchase price of restricted shares sold under the Incentive Plan will be determined by the Committee on the date of the award (and in the case of an award granted to a 10% shareholder, the purchase price must be 100% of fair market value) and can be paid for in any of the forms of consideration listed in items (1) through (5) in "Stock Options" above, as are approved by the Committee at the time of grant. ISI has not granted any restricted stock awards under the Incentive Plan. STOCK BONUS AWARDS The Committee may grant stock bonus awards under the Incentive Plan, with such terms, conditions and restrictions as the Committee may determine. A stock bonus award may be awarded upon satisfaction of such performance goals as determined by the Committee at the date of the award. ISI has not granted any stock bonus awards under the Incentive Plan. MERGERS, CONSOLIDATIONS, CHANGE OF CONTROL In the event of a merger, consolidation, dissolution or liquidation of ISI, the sale of substantially all of the assets of ISI or any other similar corporate transaction, the successor corporation may assume, convert or replace any or all awards outstanding under the Incentive Plan or substitute equivalent awards in exchange for those granted under the Incentive Plan or provide to participants substantially similar consideration, shares or other property as was provided to shareholders of ISI (after taking into account the provisions of the awards). In the event that the successor corporation does not assume, convert, replace or substitute awards, the vesting of the awards will accelerate and options will become exercisable in full before completion of the corporate transaction, at the time and on the conditions as the Committee determines. If the options are not exercised before completion of the corporate transaction, they will terminate in accordance with the provisions of the Incentive Plan. The successor corporation may also issue, in place of outstanding ISI shares held by the participant, substantially similar shares or other property subject to repurchase restrictions no less favorable to the participant. AMENDMENT OF THE INCENTIVE PLAN The Board may at any time terminate or amend the Incentive Plan, including amending any form of award agreement or document to be executed under the Incentive Plan. However, the Board may not amend the Incentive Plan in any manner that requires shareholder approval under the Code or the regulations promulgated under the Code. TERM OF THE INCENTIVE PLAN Unless terminated earlier as provided in the Incentive Plan, the Incentive Plan will expire in March 2008, ten years after the date the Board adopted the Incentive Plan. -7- FEDERAL INCOME TAX INFORMATION THE FOLLOWING IS A GENERAL SUMMARY AS OF THE DATE OF THIS PROXY STATEMENT OF THE FEDERAL INCOME TAX CONSEQUENCES TO ISI AND PARTICIPANTS UNDER THE INCENTIVE PLAN. FEDERAL TAX LAWS MAY CHANGE AND THE FEDERAL, STATE AND LOCAL TAX CONSEQUENCES FOR ANY PARTICIPANT WILL DEPEND UPON HIS OR HER INDIVIDUAL CIRCUMSTANCES. EACH PARTICIPANT HAS BEEN AND IS ENCOURAGED TO SEEK THE ADVICE OF A QUALIFIED TAX ADVISOR REGARDING THE TAX CONSEQUENCES OF PARTICIPATION IN THE INCENTIVE PLAN. INCENTIVE STOCK OPTIONS. A participant will recognize no income upon grant of an ISO and incur no tax on its exercise (unless the participant is subject to the alternative minimum tax ("AMT") as described below). If the participant holds shares acquired upon exercise of an ISO (the "ISO SHARES") for more than one year after the date the option was exercised and for more than two years after the date the option was granted, the participant generally will realize capital gain or loss (rather than ordinary income or loss) upon disposition of the ISO Shares. This gain or loss will be equal to the difference between the amount realized upon such disposition and the amount paid for the ISO Shares. If the participant disposes of ISO Shares prior to the expiration of either required holding period (a "DISQUALIFYING DISPOSITION"), the gain realized upon such disposition, up to the difference between the fair market value of the ISO Shares on the date of exercise (or, if less, the amount realized on a sale of such shares) and the option exercise price, will be treated as ordinary income. Any additional gain will be capital gain, taxed at a rate that depends upon the amount of time the ISO Shares were held by the participant. ALTERNATIVE MINIMUM TAX. The difference between the fair market value of the ISO Shares on the date of exercise and the exercise price is an adjustment to income for purposes of AMT. The AMT (imposed to the extent it exceeds the taxpayer's regular tax) is 26% of an individual taxpayer's alternative minimum taxable income (28% in the case of alternative minimum taxable income in excess of $175,000). A maximum 20% AMT rate applies to the portion of alternative minimum taxable income that would otherwise be taxable as net capital gain. Alternative minimum taxable income is determined by adjusting regular taxable income for certain items, increasing that income by certain tax preference items (including the difference between the fair market value of the ISO Shares on the date of exercise and the exercise price), and reducing this amount by the applicable exemption amount ($45,000 in case of a joint return, subject to reduction under certain circumstances). If a disqualifying disposition of the ISO Shares occurs in the same calendar year as exercise of the ISO, there is no AMT adjustment with respect to those ISO Shares. Also, upon a sale of ISO Shares that is not a disqualifying disposition, alternative minimum taxable income is reduced in the year of sale by the excess of the fair market value of the ISO Shares at exercise over the amount paid for the ISO Shares. NONQUALIFIED STOCK OPTIONS. A participant will not recognize any taxable income at the time an NQSO is granted. However, upon exercise of an NQSO, the participant must include in income as compensation an amount equal to the difference between the fair market value of the shares on the date of exercise and the participant's exercise price. The included amount must be treated as ordinary income by the participant and may be subject to withholding by ISI (either by payment in cash or withholding out of the participant's salary). Upon resale of the shares by the participant, any subsequent appreciation or depreciation in the value of the shares will be treated as capital gain or loss. RESTRICTED STOCK AND STOCK BONUS AWARDS. Restricted stock and stock bonus awards will generally be subject to tax at the time of receipt, unless there are restrictions that enable the participant to defer tax. At the time the tax is incurred, the tax treatment will be similar to that discussed above for NQSOs. MAXIMUM TAX RATES. The maximum tax rate applicable to ordinary income is 39.6%. Long-term capital gain is taxed at a maximum rate of 20%. To receive long-term capital gain treatment, the stock must be held for more than one year. Capital gains may be offset by capital losses and up to $3,000 of capital losses may be offset annually against ordinary income. -8- TAX TREATMENT OF ISI. ISI generally will be entitled to a deduction in connection with the exercise of an NQSO by a participant or the receipt of restricted stock or stock bonuses by a participant to the extent that the participant recognizes ordinary income, provided that ISI timely reports such income to the Internal Revenue Service. ISI will be entitled to a deduction in connection with the disposition of ISO Shares only to the extent that the participant recognizes ordinary income on a disqualifying disposition of the ISO Shares. ERISA. The Incentive Plan is not subject to any of the provisions of the Employee Retirement Income Security Act of 1974 ("ERISA") and is not qualified under Section 401(a) of the Code. NEW PLAN BENEFITS The amounts of future option grants under the Incentive Plan are not determinable because, under the terms of the Incentive Plan, such grants are made in the discretion of the Committee. Future option exercise prices are not determinable because they are based upon the fair market value of ISI's common stock on the date of grant. THE BOARD RECOMMENDS A VOTE FOR THE AMENDMENT OF THE 1998 EQUITY INCENTIVE PLAN PROPOSAL NO. 3 APPROVAL OF 1999 EMPLOYEE STOCK PURCHASE PLAN Shareholders are being asked to approve ISI's 1999 Employee Stock Purchase Plan (the "STOCK PURCHASE Plan"). The Stock Purchase Plan covers a total of 800,000 shares of common stock, plus any shares previously approved by shareholders for issuance under ISI's current employee stock purchase plan that remain unissued when that plan expires. The current stock purchase plan will expire in September 1999, after the end of the current offering period. In March 1999, the Board adopted the Stock Purchase Plan to replace the existing plan. The Board believes that it is in the best interests of ISI to continue to offer employees the benefit of a stock purchase plan because of the need to provide equity participation to attract and retain quality employees and remain competitive in the industry. The Stock Purchase Plan plays an important role in ISI's efforts to attract and retain employees of outstanding ability. Below is a summary of the principal provisions of the Stock Purchase Plan. The summary is not necessarily complete, and reference is made to the full text of the Stock Purchase Plan. STOCK PURCHASE PLAN HISTORY The purpose of the Stock Purchase Plan is to provide employees of ISI and its parents and subsidiaries the Board designates as eligible to participate with a convenient means to acquire an equity interest in ISI through payroll deductions, to enhance their sense of participation in the affairs of ISI and to provide an incentive for continued employment. ISI intends that the Stock Purchase Plan will qualify as an "employee stock purchase plan" under Section 423 of the Code. SHARES SUBJECT TO THE STOCK PURCHASE PLAN The stock subject to issuance under the Stock Purchase Plan consists of shares of ISI's authorized but unissued common stock. The Board has reserved 800,000 shares of common stock for issuance under the Stock Purchase Plan, plus any shares remaining unissued under ISI's current employee stock purchase plan when it expires. The number of shares available under the Stock Purchase Plan is subject to proportional adjustment to reflect stock splits, stock dividends and other similar events. ADMINISTRATION The Stock Purchase Plan is administered by the Committee. The interpretation or construction by the Committee of any provisions of the Stock Purchase Plan will be final and binding on all participants. -9- ELIGIBILITY All employees of ISI, or any parent or subsidiary designated by the Board, are eligible to participate in an Offering Period (as defined below) under the Stock Purchase Plan, except the following: (a) employees who are not employed by ISI three months before the beginning of such Offering Period; (b) employees who are customarily employed for 20 hours or less per week; (c) employees who are customarily employed for five months or less in a calendar year; (d) employees who own stock or hold options to purchase stock or who, as a result of participation in the Stock Purchase Plan, would own stock or hold options to purchase stock, possessing 5% or more of the total combined voting power or value of all classes of stock of ISI; and (e) independent contractors who are reclassified as employees for any reason except for federal income and employment tax purposes. As of February 28, 1999, approximately 456 persons were eligible to participate in the Stock Purchase Plan. The closing price of ISI's common stock on the Nasdaq National Market was $14.125 per share on June 4, 1999, the last trading day before the Record Date. Employees participate in the Stock Purchase Plan through payroll deductions. A participant sets the rate of payroll deductions, which may not be less than 2% nor more than 10% of the participant's compensation, which is defined as base salary, wages, commissions, overtime, shift premiums, bonuses and draws against commissions, before any deductions from the participant's salary under Sections 125 or 401(k) of the Code. No participant is permitted to purchase shares under the Stock Purchase Plan at a rate which, when aggregated with such employee's rights to purchase stock under all similar purchase plans of ISI, exceeds $15,000 in fair market value determined as of the Offering Date for each calendar year. OFFERING PERIODS Each offering of common stock under the Stock Purchase Plan is for a period of 24 months (the "OFFERING PERIOD"). Offering Periods are planned to start on April 1 and October 1 of each year and end on March 31 and September 30. The first Offering Period will begin on October 1, 1999. Each Offering Period consists of four six-month purchase periods (individually, a "PURCHASE PERIOD") during which payroll deductions of the participants are accumulated under the Stock Purchase Plan. On the last day of the Purchase Period the accumulated amounts are used to purchase shares. The Committee has the power to change the duration of Offering Periods without shareholder approval if the change is announced at least 15 days before the scheduled beginning of the first Offering Period to be affected. The first business day of each Offering Period is the "OFFERING Date" and the last business day of each Purchase Period is the "PURCHASE DATE." Employees may elect to participate in any Offering Period by enrolling as provided under the terms of the Stock Purchase Plan. Once enrolled, a participant will automatically participate in each succeeding Offering Period unless the participant withdraws from the Offering Period or the Stock Purchase Plan is terminated. After a participant sets his or her rate of payroll deductions for an Offering Period, that rate is effective for the remainder of the Offering Period (and for all subsequent Offering Periods in which the participant is automatically enrolled) unless the participant increases or decreases the rate of deduction. No more than one change may be made during a single Purchase Period. PURCHASE PRICE The purchase price of shares that may be acquired in any Offering Period under the Stock Purchase Plan is 85% of the lesser of: (a) the fair market value of the shares on the Offering Date; or (b) the fair market value of the shares on the Purchase Date. The fair market value of a share of ISI's common stock is defined as the closing price on the Nasdaq National Market on the date before the Offering Date or Purchase Date as reported by Nasdaq. PURCHASE OF STOCK UNDER THE STOCK PURCHASE PLAN The number of whole shares a participant will be able to purchase in any Purchase Period will be determined by dividing the total payroll amount withheld from the participant during the Purchase Period under the Stock Purchase Plan by the purchase price for each share determined as described above. The purchase will take place automatically on the Purchase Date of such Purchase Period. -10- SUSPENSION OF DEDUCTIONS OR WITHDRAWAL A participant may stop making payroll deductions during an Offering Period. The participant may elect to keep the deductions that have accumulated in the Stock Purchase Plan to purchase shares at the end of the current Purchase Period, or may elect to have the accumulated deductions returned to him or her. If the participant makes his or her election less than 15 days before such Purchase Date, payroll deductions will continue for the remainder of that Purchase Period. No further payroll deductions for the purchase of shares will be made for the succeeding Offering Period unless the participant enrolls in the new Offering Period at least 15 days before the Offering Date. AMENDMENT OF THE STOCK PURCHASE PLAN The Board may at any time amend, terminate or extend the term of the Stock Purchase Plan, except that any such termination cannot affect the terms of shares previously granted under the Stock Purchase Plan, nor may any amendment make any change in the terms of shares previously granted which would adversely affect the right of any participant, nor may any amendment be made without shareholder approval if such amendment would: (a) increase the number of shares that may be issued under the Stock Purchase Plan; or (b) change the designation of the employees (or class of employees) eligible for participation in the Stock Purchase Plan. The Board can amend the Stock Purchase Plan without the above restrictions if the continuation of the Stock Purchase plan or any Offering Period would result in financial accounting treatment different than that in effect at the time the Stock Purchase plan was adopted. TERM OF THE STOCK PURCHASE PLAN The Stock Purchase Plan will continue until the earlier to occur of: (a) termination of the Stock Purchase Plan by the Board; (b) the issuance of all the shares of common stock reserved for issuance under the Stock Purchase Plan; or (c) March 2009, ten years after the date the Board adopted the Stock Purchase Plan. FEDERAL INCOME TAX INFORMATION THE FOLLOWING IS A GENERAL SUMMARY AS OF THE DATE OF THIS PROXY STATEMENT OF THE FEDERAL INCOME TAX CONSEQUENCES TO ISI AND EMPLOYEES PARTICIPATING IN THE STOCK PURCHASE PLAN. FEDERAL TAX LAWS MAY CHANGE AND THE FEDERAL, STATE AND LOCAL TAX CONSEQUENCES FOR ANY PARTICIPANT WILL DEPEND UPON HIS OR HER INDIVIDUAL CIRCUMSTANCES. EACH PARTICIPANT HAS BEEN AND IS ENCOURAGED TO SEEK THE ADVICE OF A QUALIFIED TAX ADVISER REGARDING THE TAX CONSEQUENCES OF PARTICIPATION IN THE STOCK PURCHASE PLAN. The Stock Purchase Plan is intended to qualify as an "employee stock purchase plan" within the meaning of Section 423 of the Code. TAX TREATMENT OF THE PARTICIPANT. Participants will not recognize income for federal income tax purposes either upon enrollment in the Stock Purchase Plan or upon the purchase of shares. All tax consequences are deferred until a participant sells the shares, disposes of the shares by gift or dies. If shares are held for more than one year after the date of purchase and more than two years from the beginning of the applicable Offering Period, or if the participant dies while owning the shares, the participant realizes ordinary income on a sale (or a disposition by way of gift or upon death) to the extent of the lesser of: (a) 15% of the fair market value of the shares at the beginning of the Offering Period; or (b) the actual gain (the amount by which the market value of the shares on the date of sale, gift or death exceeds the purchase price). All additional gain upon the sale of shares is treated as capital gain. If the shares are sold and the sale price is less than the purchase price, there is no ordinary income and the participant has a capital loss for the difference between the sale price and the purchase price. If the shares are sold or are otherwise disposed of including by way of gift (but not death, bequest or inheritance) (in any case, a "DISQUALIFYING DISPOSITION") within either the one-year or the two-year holding periods described above, the participant realizes ordinary income at the time of sale or other disposition, taxable to the extent that the fair market value of the shares at the date of purchase is greater than the purchase price. This excess will constitute ordinary income (not currently subject to withholding) in the year of the sale or other disposition even if no gain is realized on the sale or if a gratuitous transfer is made. The difference, if any, between the -11- proceeds of sale and the aggregate fair market value of the shares at the date of purchase is a capital gain or loss. The maximum tax rate applicable to ordinary income is 39.6%. Long-term capital gain is taxed at a maximum rate of 20%. To receive long-term capital gain treatment, the stock must be held for more than one year. Capital gains may be offset by capital losses and up to $3,000 of capital losses may be offset annually against ordinary income. TAX TREATMENT OF ISI. ISI will be entitled to a deduction in connection with the disposition of shares acquired under the Stock Purchase Plan only to the extent that the participant recognizes ordinary income on a disqualifying disposition of the shares. ISI will treat any transfer of record ownership of shares as a disposition, unless it is notified to the contrary. In order to enable ISI to learn of disqualifying dispositions and ascertain the amount of the deductions to which it is entitled, participants are required to notify ISI in writing of the date and terms of any disposition of shares purchased under the Stock Purchase Plan. ERISA. The Stock Purchase Plan is not subject to any of the provisions of ERISA nor is it qualified under Section 401(a) of the Code. NEW PLAN BENEFITS The amounts of future stock purchases under the Stock Purchase Plan are not determinable because, under the terms of the Stock Purchase Plan, purchases are based upon elections made by participants. Future purchase prices are not determinable because they are based upon the fair market value of ISI's common stock. THE BOARD RECOMMENDS A VOTE FOR APPROVAL OF THE 1999 EMPLOYEE STOCK PURCHASE PLAN PROPOSAL NO. 4 AMENDMENT OF THE BYLAWS Shareholders are being asked to approve an amendment to ISI's Bylaws to change the number of authorized directors. The ISI Bylaws provide that the number of directors must be at least four, but not more than seven. The Board sets the exact number of directors within the limits set by the Bylaws. The Board currently consists of seven directors. The Board approved the proposed amendment in March 1999, to be effective upon shareholder approval. The proposed amendment will increase the size of the Board to a range of at least five, but not more than nine. The Board will retain the authority to determine the exact number of directors within the limits set by the Bylaws. Initially, the Board will set the exact number of directors at seven. The Board has not identified any candidates for the Board. The Board believes that the amendment is in the best interests of ISI because it gives the Board greater flexibility to add directors in the future as qualified candidates are identified. In addition, the amendment gives the Board the flexibility to adjust the number of directors to reflect changing corporate governance practices with respect to board composition and size as well as to adapt the size of the Board to the changing needs of ISI. THE BOARD RECOMMENDS A VOTE FOR THE AMENDMENT OF THE BYLAWS PROPOSAL NO. 5 RATIFICATION OF SELECTION OF INDEPENDENT ACCOUNTANTS ISI has selected PricewaterhouseCoopers LLP as its independent accountants to perform the audit of ISI's financial statements for fiscal year 2000 and the shareholders are being asked to ratify such selection. PricewaterhouseCoopers LLP has been ISI's independent accountant since the inception of ISI. Representatives of PricewaterhouseCoopers LLP will be present at the meeting, will have the opportunity to make a statement at the meeting if they desire to do so, and will be available to respond to appropriate questions. THE BOARD RECOMMENDS A VOTE FOR THE RATIFICATION OF THE SELECTION OF PRICEWATERHOUSECOOPERS LLP -12- SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth certain information, as of June 7, 1999, with respect to the beneficial ownership of ISI's common stock by: (a) each shareholder known by ISI to be the beneficial owner of more than 5% of ISI's common stock; (b) each nominee for director; (c) each Named Executive Officer; and (d) all directors and executive officers as a group. Unless otherwise indicated below, the persons and entities named in the table have sole voting and sole investment power with respect to all shares beneficially owned, subject to community property laws where applicable. Shares of common stock subject to options that are currently exercisable or exercisable within 60 days of June 7, 1999 are deemed to be outstanding and to be beneficially owned by the person holding such options for the purpose of computing the percentage ownership of such person but are not treated as outstanding for the purpose of computing the percentage ownership of any other person.
AMOUNT OF NAME OF BENEFICIAL OWNER BENEFICIAL OWNERSHIP PERCENT OF CLASS - ------------------------ -------------------- ---------------- Narendra K. and Vinita Gupta (1).......................... 4,803,414 21.0% Nevis Capital Management (2) ............................. 2,589,599 11.4% Brown Investment Advisory (3)............................. 2,448,401 10.8% Franklin Advisors, Inc. (4)............................... 2,205,800 9.7% Thomas Kailath (5)........................................ 831,598 3.6% David P. St. Charles (6).................................. 243,282 1.1% Joseph Addiego (7)........................................ 130,189 * Marco J. Thompson (8)..................................... 106,134 * John C. Bolger (9)........................................ 52,936 * Richard C. Murphy (10).................................... 44,895 * William C. Smith (11)..................................... 31,666 * Janice E. Waterman (12)................................... 20,937 * Charles M. Boesenberg (13)................................ 6,000 * Michael A. Brochu (14).................................... 5,999 * Phillip R. Bell (15)...................................... -- * All officers and directors as a group (14 persons) (16)... 6,232,126 27.3%
- ------------------- * Less than 1% (1) Includes 3,730,200 shares held of record by Dr. and Mrs. Gupta in The Narendra and Vinita Gupta Living Trust. Also includes 1,000,000 shares held of record by Dr. and Mrs. Gupta, together with a third party, as trustees for their children, as to which they disclaim beneficial ownership; 7,800 shares held of record by Dr. Gupta as custodian for his daughter, as to which he claims beneficial ownership; 16,666 shares subject to options held by Dr. Gupta that are exercisable within 60 days of June 7, 1999; and 48,748 shares subject to options held by Mrs. Gupta that are exercisable within 60 days of June 7, 1999. Dr. Gupta is the Chairman of the Board and Secretary of ISI. Mrs. Gupta is a director of ISI. The address of Dr. and Mrs. Gupta is 201 Moffett Park Drive, Sunnyvale, California 94089. (2) The address of this shareholder is Nevis Capital Management, Inc., 1119 St. Paul Street, Baltimore, Maryland 21202. Share ownership is as reported on Schedule 13G filed February 2, 1999. (3) The address of this shareholder is Brown Investment Advisory and Trust Co., 19 South Street, Baltimore, Maryland 21202. Share ownership is as reported on Schedule 13G/A filed April 13, 1999. (4) The address of this shareholder is Franklin Advisors, Inc., 901 Mariners Island Blvd., San Mateo, California 94404. Franklin Advisors, Inc. reported on Schedule 13G filed with the SEC on January 28, 1999 that it -13- beneficially owned 2,264,550 shares of ISI common stock. Franklin has since orally informed ISI that as of March 31, 1999, it owned 2,205,800 shares. (5) Includes 382,850 shares held of record by Dr. Kailath and his wife as trustees of a revocable trust and 400,000 shares held of record by them, together with a third party, as trustees for their children and as custodians for their son. Also includes 48,748 shares subject to options exercisable within 60 days of June 7, 1999. Dr. Kailath is a director of ISI. (6) Includes 196,665 shares subject to options exercisable within 60 days of June 7, 1999. Mr. St. Charles is the former President and Chief Executive Officer and a former director of ISI. (7) Includes 86,062 shares subject to options exercisable within 60 days of June 7, 1999. Mr. Addiego is the Vice President of Worldwide Sales of ISI. (8) Includes 41,541 shares subject to options exercisable within 60 days of June 7, 1999. Mr. Thompson is the Chief Technology Officer of ISI. (9) Includes 48,436 shares subject to options exercisable within 60 days of June 7, 1999. Mr. Bolger is a director of ISI. (10) Includes 34,895 shares subject to options exercisable within 60 days of June 7, 1999. Mr. Murphy is a director of ISI. (11) Represents shares subject to options exercisable within 60 days of June 7, 1999. Mr. Smith is the Vice President of Finance and Chief Financial Officer of ISI. (12) Represents shares subject to options exercisable within 60 days of June 7, 1999. Ms. Waterman is the Vice President of Operations of ISI. (13) Mr. Boesenberg is the President, Chief Executive Officer and Vice President of Marketing and a director of ISI. (14) Includes 4,999 shares subject to options exercisable within 60 days of June 7, 1999. Mr. Brochu is a director of ISI. (15) Mr. Bell is the former Vice President of Worldwide Sales of ISI. (16) Includes 768,005 shares subject to options exercisable within 60 days of June 7, 1999, including the options described in footnotes (1), (5), and (7) through (13). -14- EXECUTIVE COMPENSATION The following table sets forth all compensation awarded, earned or paid for services rendered in all capacities to ISI and its subsidiaries during each of fiscal years 1997, 1998 and 1999 to the President and Chief Executive Officer, the four other most highly compensated executive officers who were serving as executive officers at the end of fiscal year 1999 and the former President and Chief Executive Officer and one other former executive officer (together, the "NAMED EXECUTIVE OFFICERS"). This information includes the dollar values of base salaries, bonus awards, the number of shares subject to stock options granted and certain other compensation, if any, whether paid or deferred. ISI does not grant stock appreciation rights and has no long-term compensation benefits other than stock options. SUMMARY COMPENSATION TABLE
LONG-TERM COMPENSATION ANNUAL COMPENSATION AWARDS ----------------------------- ------------------ SECURITIES ALL OTHER NAME AND FISCAL UNDERLYING COMPENSA- PRINCIPAL POSITION YEAR SALARY (1) BONUS (2) OPTIONS (3) TION (4) - ---------------------------------------- ---------- -------------- ------------- ------------------- ------------- Charles M. Boesenberg (5)........... 1999 $102,603 $750,000 700,000 $2,455 President, Chief Executive Officer and 1998 -- -- -- -- Vice President, Marketing 1997 -- -- -- -- Joseph Addiego...................... 1999 $233,910 $74,050 65,000 $2,685 Vice President, Worldwide Sales 1998 $266,470 -- 135,000 $2,623 1997 $274,303 -- 40,000 $2,177 William C. Smith.................... 1999 $211,035 -- 20,000 $2,245 Vice President, 1998 $175,000 $50,000 80,000 $2,423 Finance and Chief Financial Officer 1997 $23,558 -- 80,000 $202 Janice Waterman..................... 1999 $187,615 $15,000 40,000 $2,846 Vice President, Operations 1998 $159,807 $27,000 51,000 $2,577 1997 $160,817 -- 20,000 $1,919 Marco J. Thompson................... 1999 $185,282 -- 20,000 $2,476 Chief Technology Officer 1998 $263,293 $20,000 62,000 $2,631 1997 $301,353 $60,000 16,000 $1,353 David P. St. Charles (6)........... 1999 $252,460 $400,000 80,000 $529 Former President and Chief Executive 1998 $250,000 -- 160,000 $1,154 Officer 1997 $257,462 -- 100,000 $2,113 Phillip R. Bell (7)................. 1999 $240,486 $120,000 -- $2,178 Former Vice President, 1998 $33,846 $40,000 80,000 $677 Worldwide Sales 1997 -- -- -- --
- ----------------- (1) Includes commissions and deferral for 401(k) and Section 125 plans. (2) Represents bonuses earned for services rendered during the fiscal year listed, but does not include bonuses paid during the fiscal year listed for services rendered during a prior fiscal year. -15- (3) Option grants in fiscal year 1998 for the following executive officers include options granted in exchange for outstanding options in connection with a repricing in April 1997: Joseph Addiego, options to purchase 60,000 shares; William C. Smith, options to purchase 80,000 shares; Janice Waterman, options to purchase 50,000 shares; Marco J. Thompson, options to purchase 16,000 shares; and David P. St. Charles, options to purchase 100,000 shares. (4) Represents employer matching contributions to 401(k) plan accounts. (5) Mr. Boesenberg joined ISI in December 1998. His annual salary is $400,000. (6) Mr. St. Charles became a consultant to ISI in December 1998. (7) Mr. Bell left ISI in January 1999. The following table sets forth further information regarding option grants during fiscal year 1999 to each of the Named Executive Officers. In accordance with the rules of the Commission, the table sets forth the hypothetical gains or "option spreads" that would exist for the options at the end of their respective ten-year terms. These gains are based on assumed rates of annual compound stock price appreciation of 5% and 10% from the date the option was granted to the end of the option term. OPTION GRANTS IN FISCAL YEAR 1999
POTENTIAL REALIZABLE VALUE AT ASSUMED ANNUAL NUMBER OF PERCENTAGE OF RATES OF STOCK PRICE SECURITIES TOTAL OPTIONS APPRECIATION FOR OPTION UNDERLYING GRANTED EXERCISE TERM(2) OPTIONS IN FISCAL PRICE EXPIRATION ------- NAME GRANTED(1) YEAR 1999 PER SHARE DATE 5% 10% - ---- ---------- ----------- -------------- -------- -------- -------- Charles M. Boesenberg.... 700,000 37.6% $10.50 12/14/08 $4,622,400 $ 11,714,000 Joseph Addiego........... 40,000 2.2% $10.50 12/14/08 $ 264,100 $ 669,400 25,000 1.3% $ 7.75 10/15/08 $ 121,800 $ 308,800 William C. Smith......... 20,000 1.1% $21.00 3/30/08 $ 264,100 $ 669,400 Janice Waterman.......... 15,000 0.8% $21.00 3/30/08 $ 198,100 $ 502,000 25,000 1.3% $ 7.75 10/15/08 $ 121,800 $ 308,800 Marco J. Thompson........ 20,000 1.1% $21.00 3/30/08 $ 264,100 $ 669,400 David P. St. Charles..... 80,000 4.3% $21.00 3/30/08 $1,056,500 $ 2,667,500 Phillip R. Bell.......... -- -- -- -- -- --
- ----------------- (1) The options shown in the table are incentive stock options (to the extent permitted under the Code). They were granted at fair market value and will expire ten years from the date of grant, subject to earlier termination upon termination of the optionee's employment. The options become exercisable over a four-year period, at a rate of 25% on the first anniversary of the grant date and 1/48 of the shares at the end of each full month thereafter. (2) The 5% and 10% assumed annual compound rates of stock price appreciation are mandated by the rules of the Commission and do not represent ISI's estimate or projection of future common stock prices. -16- The following table sets forth certain information concerning the exercise of options by each of the Named Executive Officers during fiscal year 1999. "Value Realized" represents the fair market value of the shares of common stock underlying the option on the date of exercise less the aggregate exercise price of the option. In addition, the table includes the number of shares covered by both exercisable and unexercisable stock options as of February 28, 1999. Also reported are values of "in-the-money" options. These values, unlike the amounts set forth in the column entitled "Value Realized," have not been, and may never be, realized and are based on the positive spread between the respective exercise prices of outstanding options and $15.875 per share, which was the closing price of ISI's common stock on February 26, 1999. AGGREGATED OPTION EXERCISES IN FISCAL YEAR 1999 AND FISCAL YEAR-END VALUES
NUMBER OF SECURITIES VALUE OF UNEXERCISED IN-THE UNDERLYING UNEXERCISED MONEY OPTIONS AT FISCAL OPTIONS AT FISCAL YEAR-END YEAR-END ------------------------------- ------------------------------ SHARES ACQUIRED ON VALUE NAME EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE - ----------------------------------------- -------------- ------------- ----------------- ------------- --------------- Charles M. Boesenberg.... -- -- -- 700,000 -- $3,762,500 Joseph Addiego........... 13,000 $52,000 68,457 153,543 $ 401,153 $ 564,097 William C. Smith......... 20,000 $172,120 16,166 63,334 $ 93,746 $ 243,754 Janice Waterman.......... 12,750 $123,594 10,624 67,626 $ 71,530 $ 389,126 Marco J. Thompson........ 3,922 $58,340 28,416 53,584 $ 160,298 $ 189,452 David P. St. Charles..... 80,000 $791,250 164,166 181,334 $1,143,403 $ 533,547 Phillip R. Bell.......... -- -- 21,666 -- $ 54,165 --
EMPLOYMENT AND SEVERANCE AGREEMENTS ISI and Mr. Boesenberg are parties to a letter agreement dated November 30, 1998 governing his employment with ISI. Under the agreement, ISI agreed to pay Mr. Boesenberg an initial base salary at an annualized rate of $400,000, with a bonus of up to $300,000 on an annualized basis, depending upon achievement of agreed-upon objectives. Mr. Boesenberg also received a one-time cash bonus of $750,000, subject to refund if, within the first 12 months of his employment, Mr. Boesenberg resigns for other than good reason or if he is terminated for cause. ISI agreed to provide benefits that ISI provides for employees in comparable positions, and to grant an option to purchase 700,000 shares of ISI common stock. The option was granted on December 14, 1998 at an exercise price of $10.50 per share. The option becomes vested over four years, at the rate of 25% of the shares on the first anniversary of the grant date and 2.083% of the shares monthly thereafter, for as long as Mr. Boesenberg remains employed with ISI. Upon a change of control of ISI, the vesting period of the options will be accelerated by 24 months. If Mr. Boesenberg's employment is terminated without cause or he resigns for good reason, then he will be entitled to severance of 12 months base salary and options to purchase 85,000 shares will become vested immediately. Mr. Boesenberg's employment is at-will and may be terminated by either ISI or Mr. Boesenberg at any time. ISI and Mr. St. Charles are parties to an agreement dated as of June 15, 1999 under which Mr. St. Charles agreed to make himself available to ISI as a consultant for 12 months beginning December 15, 1998, in consideration of a one time payment of his base salary of $300,000. During the period of consultancy, Mr. St. Charles' options continue to vest and his options will remain exercisable until December 15, 2000. -17- COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION The Compensation Committee consists of John C. Bolger, Richard C. Murphy and Thomas Kailath. The members of the Compensation Committee are independent outside directors. There is no interlocking relationship between the Board or Compensation Committee and the board of directors or compensation committee of any other company. REPORT ON EXECUTIVE COMPENSATION The Compensation Committee of the Board (the "COMMITTEE") makes all decisions involving the compensation of executive officers of ISI. During fiscal year 1999, the Committee consisted of John C. Bolger, Richard C. Murphy and Thomas Kailath, three independent non-employee directors, none of whom have any interlocking relationships as defined by the Commission. The Committee typically reviews base salary levels and target bonuses for the Chief Executive Officer and other executive officers at or about the beginning of each year. Mr. Boesenberg evaluated the performance of all executive officers and recommended salary adjustments that were reviewed and approved by the Committee. Performance evaluations for individual executive officers are based on predetermined individual goals. For the Chief Executive Officer and Chairman of the Board, these goals are set by the Committee, and for all other officers, these goals are recommended by the Chief Executive Officer and reviewed and approved by the Committee. The Chief Executive Officer and the Chairman of the Board do not participate in any discussion regarding their respective salary adjustments. The Committee administers ISI's incentive and equity plans, including the Incentive Plan and the Stock Purchase Plan. GENERAL COMPENSATION POLICY The Committee's policy in compensating executive officers, including the Chief Executive Officer and the Chairman of the Board, is based upon the philosophy that ISI's long-term success in its marketplace is best achieved through recruitment and retention of the best people in the industry. The Committee applies this philosophy in determining compensation for executive officers in three areas: salary, bonuses and stock options. The Committee believes that the compensation of the Chief Executive Officer, the Chairman of the Board and the other executive officers should relate directly to corporate performance. Thus, ISI's compensation policy, which applies to management and other key employees, relates a portion of each individual's total compensation to corporate management and individual objectives and profit objectives set forth at the beginning of the year. Consistent with this policy, a designated portion of the compensation of each executive is contingent upon corporate performance and, in the case of certain executive officers, adjusted based on the individual officer's performance measured against personal objectives, as determined by the Committee in its discretion. ISI strives to offer salaries to its executive officers that are competitive in its industry for similar positions requiring similar qualifications. In determining executive officer salaries, the Committee considers information provided by the Vice President, Human Resources and Operations, whose recommendations are based upon salary surveys specific to ISI's industry, size and geographic location. These surveys are prepared by an independent organization using information provided from over 300 companies. These surveys summarize information from companies that closely match ISI in terms of product or industry, geography and revenue levels. The base salaries, incentive compensation and stock option grants of the executive officers are determined in part by the Committee after review and evaluation of these data in connection with ISI's corporate goals. To this end, the Committee attempts to compare the compensation of ISI's executive officers with the compensation practices of comparable companies to determine base salary, target bonuses and target total cash compensation. In addition to considering the results of the performance evaluations and information concerning competitive salaries, the Committee places primary weight on the financial condition of ISI in considering salary adjustments. -18- ISI seeks to provide additional incentives and rewards to executives who make contributions of outstanding value to ISI. For this reason, the Committee administers a bonus plan, which can comprise a substantial portion of the total compensation of executive officers when earned and paid. The bonus for the Chief Executive Officer, Chairman of the Board and for other executives is based primarily on ISI's performance. The Committee believes that employee equity ownership provides significant additional motivation to executive officers to maximize value for ISI's shareholders, and therefore recommends to the Board periodic grants of stock options under the Incentive Plan. Stock options are granted by the Committee in its discretion at the prevailing market price. Stock options generally have value for the executive only if the price of ISI's stock increases above the fair market value on the grant date and the executive remains in ISI's employ for the period required for the options to vest. Therefore, the Committee believes that stock options serve to align the interest of executive officers closely with other shareholders because of the direct benefit executive officers receive through improved stock performance. In preparing the performance graph for this Proxy Statement, ISI used the Hambrecht & Quist Technology Index as its published line of business index. The compensation practices of most of the companies in the H&Q Technology Index were not reviewed by ISI when the Committee reviewed the compensation information described above because such companies were determined not to be competitive with ISI for executive talent. 1999 EXECUTIVE COMPENSATION BASE COMPENSATION. The Committee reviewed the recommendations and performance and market data outlined above and established a base salary level to be effective March 1, 1999 for each executive officer, including the Chief Executive Officer and the Chairman of the Board. INCENTIVE COMPENSATION. The Committee determines annually the total amount of cash bonuses available for executive officers. Bonus awards are contingent upon the performance of ISI as a whole, based upon certain revenue and operating profit goals set by the Board annually in consultation with the Chief Executive Officer. The target amounts of bonuses available to each executive officer are set annually by the Committee in its discretion with regard to the Chief Executive Officer and Chairman of the Board and by the Chief Executive Officer, subject to review and approval by the Committee, with regard to executive officers other than the Chief Executive Officer. The relative target amounts for individual officers are based upon the total dollars available for bonuses, and historical and expected future contributions by the individual executive officer. The Chief Executive Officer's subjective judgment of executives' performance (other than his own) is taken into account in determining whether those goals have been satisfied. Executive officers earn a percentage of the target amounts based on ISI's achievement of the performance goals, as determined by the Committee annually in its discretion. Awards are weighted so that proportionately higher awards are received when ISI's performance exceeds targets and proportionately smaller or no awards are made when ISI does not meet targets. In fiscal year 1999, the objectives used as the basis for incentive compensation were based primarily on ISI's performance. STOCK OPTIONS. Stock options are an essential element of ISI's executive compensation package. The Committee believes that equity-based compensation in the form of stock options links the interests of management and shareholders by focusing employees and management on increasing shareholder value. The actual value of such equity-based compensation depends entirely on appreciation of ISI's stock. Approximately 100% of ISI's full-time employees participate in the Incentive Plan. The Committee makes option grants in its discretion after consideration of recommendations from the Chief Executive Officer and other members of the Board. Recommendations for options are based upon relative positions and responsibilities of executive officers, historical and expected contributions of each executive officer to ISI, and previous option grants to such executive officers. Options are recommended with a goal of providing equity compensation for executive officers competitive with that of executive officers of similar rank in other companies in ISI's industry, geographic location and size. Stock options typically have been granted to executive officers when the executive first joins ISI, in connection with a significant change in responsibilities, and, occasionally, to achieve equity within a peer group. The Committee may, however, grant additional stock options to executives for other reasons. The number of shares subject to each stock option granted is within the discretion -19- of the Committee and is based on anticipated future contribution and ability to affect corporate and/or business unit results, past performance or consistency within the executive's peer group. In the discretion of the Committee, executive officers may also be granted stock options to provide greater incentives to continue their employment with ISI and to strive to increase the value of ISI's common stock. In fiscal year 1999, the Committee considered these factors, as well as the number of options held by executive officers as of the date of grant that remained unvested. In fiscal year 1999, stock options were granted to each executive officer. The stock options generally become exercisable over a four-year period and are granted at a price that is equal to the fair market value of ISI's common stock on the date of grant. For fiscal year 2000, the Committee will be considering whether to grant future options under the Incentive Plan to executive officers based on the factors described above, with particular attention to ISI-wide management objectives and the executive officers' success in obtaining specific individual financial and operational objectives established or to be established for fiscal year 2000 and to the number of options currently held by the executive officers that remain unvested. CHIEF EXECUTIVE OFFICER COMPENSATION. Compensation for the Chief Executive Officer is determined through a process similar to that discussed above for other executive officers of ISI. In March 1998, the Committee established a base salary for Mr. St. Charles for fiscal year 1999. This base salary represented an increase over Mr. St. Charles' fiscal year 1998 base salary. The Committee also established a target bonus for Mr. St. Charles under the fiscal year 1999 bonus plan. The fiscal year 1999 base salary level and target bonus were based upon a number of factors, including (a) the Committee's assessment of the fiscal year 1998 performance of ISI and Mr. St. Charles, (b) fiscal year 1999 ISI performance objectives and individual performance objectives and responsibilities for Mr. St. Charles established in March 1998 and (c) the market compensation data for companies in the same industry and geographic location and similar in size to ISI in terms of revenue. These objectives included satisfactorily managing ISI's overall corporate business plan, such as meeting ISI's profitability projections and its sales targets, and strengthening ISI's financial position. In fiscal 1999, the Committee granted Mr. St. Charles a new stock option to purchase 80,000 shares. The number of shares granted was based on Mr. St. Charles' position, fiscal year 1998 performance and expected performance in fiscal year 1999. As set forth in his letter agreement with ISI, Mr. Boesenberg's base salary was established at the time he began employment with ISI at $400,000 per year. The target bonus for the balance of fiscal year 1999 for Mr. Boesenberg was set in his agreement at $300,000, prorated for the period from December 14, 1998 through February 28, 1999. The base salary and target bonus were based, at the Committee's discretion, upon similar factors as described above for Mr. St. Charles' base salary and target bonus, reduced proportionally for the period of time in fiscal year 1999 that Mr. Boesenberg served as the Chief Executive Officer. Mr. Boesenberg also received a one-time cash bonus of $750,000, subject to refund if, within the first 12 months of his employment, Mr. Boesenberg resigns for other than good reason or if he is terminated for cause. The Committee concluded this payment of this award was appropriate to provide a total compensation package for Mr. Boesenberg comparable to that of his former position. Consistent with the terms of his letter agreement, Mr. Boesenberg was awarded a stock option grant for 700,000 shares of ISI common stock on December 14, 1998, when he joined ISI. COMPLIANCE WITH SECTION 162(m) OF THE INTERNAL REVENUE CODE OF 1986. ISI intends to comply with the requirements of Section 162(m) of the Code. The Incentive Plan is already in compliance with Section 162(m) by limiting stock awards to named executive officers. ISI does not expect cash compensation for 1998 to be in excess of $1,000,000 or consequently affected by the requirements of Section 162(m). COMPENSATION COMMITTEE JOHN C. BOLGER RICHARD C. MURPHY THOMAS KAILATH -20- COMPANY STOCK PRICE PERFORMANCE The stock price performance graph below is required by the Commission and shall not be deemed to be incorporated by reference by any general statement incorporating by reference this proxy statement into any filing under the Securities Act of 1933, as amended, or under the Exchange Act, except to the extent that ISI specifically incorporates this information by reference, and shall not otherwise be deemed soliciting material or filed under such Acts. The graph below compares the cumulative total shareholder return on ISI common stock from March 1, 1994 to February 26, 1999 with the cumulative total return of the Nasdaq Composite Index and the Hambrecht & Quist Technology Index over the same period (assuming the investment of $100 in the common stock of ISI and in each of the other indices on March 1, 1994, and reinvestment of all dividends). The comparisons in the graph below are based on historical data and are not intended to forecast the possible future performance of ISI's common stock.
NASDAQ Com H&Q Technology Integrated Systems, Inc. - ------------------------------------------------------------------------------- 2/28/1994 100 100 100 - ------------------------------------------------------------------------------- 8/31/1994 97 101 108 - ------------------------------------------------------------------------------- 2/28/1995 101 116 179 - ------------------------------------------------------------------------------- 8/31/1995 130 163 244 - ------------------------------------------------------------------------------- 2/28/1996 141 174 392 - ------------------------------------------------------------------------------- 8/30/1996 180 187 554 - ------------------------------------------------------------------------------- 2/28/1997 167 227 379 - ------------------------------------------------------------------------------- 8/29/1997 203 298 248 - ------------------------------------------------------------------------------- 2/27/1998 226 311 284 - ------------------------------------------------------------------------------- 8/31/1998 191 252 118 - ------------------------------------------------------------------------------- 2/26/1999 292 411 265 - -------------------------------------------------------------------------------
-21- CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS From March 1, 1998 to the present, there has not been any, and there are no currently proposed, transactions in which the amount involved exceeds $60,000 to which ISI or any of its subsidiaries was (or is to be) a party and in which any executive officer, director, 5% beneficial owner of ISI's common stock or member of the immediate family of any of the foregoing persons had (or will have) a direct or indirect material interest, except for payments set forth under "Election of Directors - Director Compensation" and "Executive Compensation" above and the transactions described below. During fiscal year 1999, Digital Link Corporation purchased products and services totaling approximately $42,000 from ISI. In addition, Digital Link Corporation leased office space from ISI, for total rent payments of approximately $74,000. Dr. Gupta, the Chairman of the Board of Directors and Secretary of ISI, served as a member of the Board of Directors of Digital Link Corporation. Mrs. Gupta, who is a director of ISI and the spouse of Dr. Gupta, is the Chairperson of the Board of Directors of Digital Link Corporation. Dr. and Mrs. Gupta are more than 10% shareholders of both ISI and Digital Link Corporation. SHAREHOLDER PROPOSALS Proposals of shareholders intended to be presented at ISI's 2000 Annual Meeting of Shareholders must be received by ISI at its principal executive offices no later than February 29, 2000 in order to be included in ISI's proxy statement and form of proxy relating to that meeting. Proxies solicited by ISI for its 2000 Annual Meeting of Shareholders will be voted in the discretion of the persons voting them with respect to all proposals presented by shareholders for consideration at such meeting after May 14, 2000. SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Section 16 of the Exchange Act requires ISI's directors and executive officers, and persons who own more than 10% of a registered class of ISI's equity securities, to file initial reports of ownership and reports of changes in ownership with the Commission. Such persons are required by regulation to furnish ISI with copies of all Section 16(a) forms they file. Based solely on its review of the copies of such forms furnished to ISI and written representations from the executive officers and directors of ISI, ISI believes that all Section 16(a) filing requirements were met during fiscal year 1999. OTHER BUSINESS The Board does not intend to bring any other business before the meeting, and, so far as is known to the Board, no matters are to be brought before the meeting except as specified in the notice of the meeting. As to any business that may properly come before the meeting, however, it is intended that proxies, in the form enclosed, will be voted in accordance with the judgment of the persons voting such proxies. WHETHER OR NOT YOU PLAN TO ATTEND THE MEETING, PLEASE COMPLETE, DATE, SIGN AND PROMPTLY RETURN THE ACCOMPANYING PROXY IN THE ENCLOSED POSTAGE-PAID ENVELOPE SO THAT YOUR SHARES WILL BE REPRESENTED AT THE MEETING. -22- INTEGRATED SYSTEMS, INC. 1999 EMPLOYEE STOCK PURCHASE PLAN As Adopted March 24, 1999 1. ESTABLISHMENT OF PLAN. Integrated Systems, Inc., Inc. (the "COMPANY") proposes to grant options for purchase of the Company's Common Stock to eligible employees of the Company and its Participating Subsidiaries (as hereinafter defined) pursuant to this Employee Stock Purchase Plan (this "PLAN"). For purposes of this Plan, "PARENT CORPORATION" and "SUBSIDIARY" shall have the same meanings as "parent corporation" and "subsidiary corporation" in Sections 424(e) and 424(f), respectively, of the Internal Revenue Code of 1986, as amended (the "CODE"). "PARTICIPATING SUBSIDIARIES" are Parent Corporations or Subsidiaries that the Board of Directors of the Company (the "BOARD") designates from time to time as corporations that shall participate in this Plan. The Company intends this Plan to qualify as an "employee stock purchase plan" under Section 423 of the Code (including any amendments to or replacements of such Section), and this Plan shall be so construed. Any term not expressly defined in this Plan but defined for purposes of Section 423 of the Code shall have the same definition herein. A total of 800,000 shares of the Company's Common Stock is reserved for issuance under this Plan plus any shares authorized but not yet issued under the Company's 1990 Employee Stock Purchase Plan (the "PRIOR PLAN") on the First Offering Date (as defined in Section 5 below). Such share numbers shall be subject to adjustments effected in accordance with Section 14 of this Plan. 2. PURPOSE. The purpose of this Plan is to provide eligible employees of the Company and Participating Subsidiaries with a convenient means of acquiring an equity interest in the Company through payroll deductions, to enhance such employees' sense of participation in the affairs of the Company and Participating Subsidiaries, and to provide an incentive for continued employment. 3. ADMINISTRATION. This Plan shall be administered by the Compensation Committee of the Board (the "COMMITTEE"). Subject to the provisions of this Plan and the limitations of Section 423 of the Code or any successor provision in the Code, all questions of interpretation or application of this Plan shall be determined by the Committee and its decisions shall be final and binding upon all participants. Members of the Committee shall receive no compensation for their services in connection with the administration of this Plan, other than standard fees as established from time to time by the Board for services rendered by Board members serving on Board committees. All expenses incurred in connection with the administration of this Plan shall be paid by the Company. 4. ELIGIBILITY. Any employee of the Company or the Participating Subsidiaries is eligible to participate in an Offering Period (as hereinafter defined) under this Plan except the following: (a) employees who are not employed by the Company or a Participating Subsidiary three (3) months before the beginning of such Offering Period; (b) employees who are customarily employed for twenty (20) hours or less per week; (c) employees who are customarily employed for five (5) months or less in a calendar year; (d) employees who, together with any other person whose stock would be attributed to such employee pursuant to Section 424(d) of the Code, own stock or hold options to purchase stock possessing five percent (5%) or more of the total combined voting power or value of all classes of stock of the Company or any of its Participating Subsidiaries or who, as a result of being granted an option under this Plan with respect to such Offering Period, would own stock or hold options to purchase stock possessing five percent (5%) or more of the total combined voting power or value of all classes of stock of the Company or any of its Participating Subsidiaries; and Integrated Systems, Inc. 1999 Employee Stock Purchase Plan As Adopted March 24, 1999 (e) individuals who provide services to the Company or any of its Participating Subsidiaries as independent contractors who are reclassified as common law employees for any reason except for federal income and employment tax purposes. 5. OFFERING DATES. The offering periods of this Plan (each, an "OFFERING PERIOD") shall be of twenty-four (24) months duration commencing on April 1 and October 1 of each year and ending on March 31 and September 30. The first Offering Period under the Plan shall commence on October 1, 1999 (the "FIRST OFFERING DATE"). Each Offering Period shall consist of four (4) six month purchase periods (individually, a "PURCHASE PERIOD") during which payroll deductions of the participants are accumulated under this Plan. The first business day of each Offering Period is referred to as the "OFFERING DATE". The last business day of each Purchase Period is referred to as the "PURCHASE DATE". The Committee shall have the power to change the duration of Offering Periods with respect to offerings without stockholder approval if such change is announced at least fifteen (15) days prior to the scheduled beginning of the first Offering Period to be affected. 6. PARTICIPATION IN THIS PLAN. Eligible employees may become participants in an Offering Period under this Plan on the first Offering Date after satisfying the eligibility requirements by delivering a subscription agreement to the Company's treasury department (the "TREASURY DEPARTMENT") not later than fifteen (15) days before such Offering Date. Notwithstanding the foregoing, the Committee may set a later time for filing the subscription agreement authorizing payroll deductions for all eligible employees with respect to a given Offering Period. An eligible employee who does not deliver a subscription agreement to the Treasury Department by such date after becoming eligible to participate in such Offering Period shall not participate in that Offering Period or any subsequent Offering Period unless such employee enrolls in this Plan by filing a subscription agreement with the Treasury Department not later than fifteen (15) days preceding such subsequent Offering Date. Once an employee becomes a participant in an Offering Period, such employee will automatically participate in the Offering Period commencing immediately following the last day of the prior Offering Period unless the employee withdraws or is deemed to withdraw from this Plan or terminates further participation in the Offering Period as set forth in Section 11 below. Such participant is not required to file any additional subscription agreement in order to continue participation in this Plan. 7. GRANT OF OPTION ON ENROLLMENT. Enrollment by an eligible employee in this Plan with respect to an Offering Period will constitute the grant (as of the Offering Date) by the Company to such employee of an option to purchase on the Purchase Date up to that number of shares of Common Stock of the Company determined by dividing (a) the amount accumulated in such employee's payroll deduction account during such Purchase Period by (b) the lower of (i) eighty-five percent (85%) of the fair market value of a share of the Company's Common Stock on the Offering Date (but in no event less than the par value of a share of the Company's Common Stock), or (ii) eighty-five percent (85%) of the fair market value of a share of the Company's Common Stock on the Purchase Date (but in no event less than the par value of a share of the Company's Common Stock), provided, however, that the number of shares of the Company's Common Stock subject to any option granted pursuant to this Plan shall not exceed the lesser of (x) the maximum number of shares set by the Committee pursuant to Section 10(c) below with respect to the applicable Purchase Date, or (y) the maximum number of shares which may be purchased pursuant to Section 10(b) below with respect to the applicable Purchase Date. The fair market value of a share of the Company's Common Stock shall be determined as provided in Section 8 below. 8. PURCHASE PRICE. The purchase price per share at which a share of Common Stock will be sold in any Offering Period shall be eighty-five percent (85%) of the lesser of: (A) The fair market value on the Offering Date; or (B) The fair market value on the Purchase Date. For purposes of this Plan, the term "FAIR MARKET VALUE" means, as of any date, the value of a share of the Company's Common Stock determined as follows: -2- Integrated Systems, Inc. 1999 Employee Stock Purchase Plan As Adopted March 24, 1999 (a) if such Common Stock is then quoted on the Nasdaq National Market, its closing price on the Nasdaq National Market on the last trading date prior to the date of determination as reported in THE WALL STREET JOURNAL; (b) if such Common Stock is publicly traded and is then listed on a national securities exchange, its closing price on the last trading date prior to the date of determination on the principal national securities exchange on which the Common Stock is listed or admitted to trading as reported in THE WALL STREET JOURNAL; (c) if such Common Stock is publicly traded but is not quoted on the Nasdaq National Market nor listed or admitted to trading on a national securities exchange, the average of the closing bid and asked prices on the last trading date prior to the date of determination as reported in THE WALL STREET JOURNAL; or (d) if none of the foregoing is applicable, by the Board in good faith. 9. PAYMENT OF PURCHASE PRICE; CHANGES IN PAYROLL DEDUCTIONS; ISSUANCE OF SHARES. (a) The purchase price of the shares is accumulated by regular payroll deductions made during each Offering Period. The deductions are made as a percentage of the participant's compensation in one percent (1%) increments not less than two percent (2%), nor greater than ten percent (10%) or such lower limit set by the Committee. Compensation shall mean a participant's base salary or wages, including, commissions, overtime, shift premiums and bonuses, plus draws against commissions, provided, however, that for purposes of determining a participant's compensation, any election by such participant to reduce his or her regular cash remuneration under Sections 125 or 401(k) of the Code shall be treated as if the participant did not make such election. Payroll deductions shall commence on the first payday of the Offering Period and shall continue to the end of the Offering Period unless sooner altered or terminated as provided in this Plan. (b) A participant may increase or decrease the rate of payroll deductions during an Offering Period by filing with the Treasury Department a new authorization for payroll deductions, in which case the new rate shall become effective for the next payroll period commencing more than fifteen (15) days after the Treasury Department's receipt of the authorization and shall continue for the remainder of the Offering Period unless changed as described below. Such change in the rate of payroll deductions may be made at any time during an Offering Period, but not more than one (1) change may be made effective during any Purchase Period. A participant may increase or decrease the rate of payroll deductions for any subsequent Offering Period by filing with the Treasury Department a new authorization for payroll deductions not later than fifteen (15) days before the beginning of such Offering Period. (c) A participant may reduce his or her payroll deduction percentage to zero during an Offering Period by filing with the Treasury Department a request for cessation of payroll deductions. Such reduction shall be effective beginning with the next payroll period commencing more than fifteen (15) days after the Treasury Department's receipt of the request and no further payroll deductions will be made for the duration of the Offering Period. Payroll deductions credited to the participant's account prior to the effective date of the request shall be used to purchase shares of Common Stock of the Company in accordance with Section (e) below. A participant may not resume making payroll deductions during the Offering Period in which he or she reduces his or her payroll deductions to zero. (d) All payroll deductions made for a participant are credited to his or her account under this Plan and are deposited with the general funds of the Company. No interest accrues on the payroll deductions. All payroll deductions received or held by the Company may be used by the Company for any corporate purpose, and the Company shall not be obligated to segregate such payroll deductions. (e) On each Purchase Date, so long as this Plan remains in effect and provided that the participant has not submitted a signed and completed withdrawal form which is effective pursuant to Section 11 before that date which notifies the Company that the participant wishes to withdraw from that Offering Period under this Plan and -3- Integrated Systems, Inc. 1999 Employee Stock Purchase Plan As Adopted March 24, 1999 have all payroll deductions accumulated in the account maintained on behalf of the participant as of that date returned to the participant, the Company shall apply the funds then in the participant's account to the purchase of whole shares of Common Stock reserved under the option granted to such participant with respect to the Offering Period to the extent that such option is exercisable on the Purchase Date. The purchase price per share shall be as specified in Section 8 of this Plan. Any cash remaining in a participant's account after such purchase of shares shall be refunded to such participant in cash, without interest; provided, however that any amount remaining in such participant's account on a Purchase Date which is less than the amount necessary to purchase a full share of Common Stock of the Company shall be carried forward, without interest, into the next Purchase Period or Offering Period, as the case may be. In the event that this Plan has been oversubscribed, all funds not used to purchase shares on the Purchase Date shall be returned to the participant, without interest. No Common Stock shall be purchased on a Purchase Date on behalf of any employee whose participation in this Plan has terminated prior to such Purchase Date. (f) As promptly as practicable after the Purchase Date, the Company shall issue shares for the participant's benefit representing the shares purchased upon exercise of his or her option. (g) During a participant's lifetime, his or her option to purchase shares hereunder is exercisable only by him or her. The participant will have no interest or voting right in shares covered by his or her option until such option has been exercised. 10. LIMITATIONS ON SHARES TO BE PURCHASED. (a) No participant shall be entitled to purchase stock under this Plan at a rate which, when aggregated with his or her rights to purchase stock under all other employee stock purchase plans of the Company or any Subsidiary, exceeds $15,000 in fair market value, determined as of the Offering Date (or such other lesser limit as may be imposed by the Code) for each calendar year in which the employee participates in this Plan. The Company shall automatically suspend the payroll deductions of any participant as necessary to enforce such limit provided that when the Company automatically resumes such payroll deductions, the Company must apply the rate in effect immediately prior to such suspension. (b) No more than two hundred percent (200%) of the number of shares determined by using eighty-five percent (85%) of the fair market value of a share of the Company's Common Stock on the Offering Date as the denominator may be purchased by a participant on any single Purchase Date. (c) No participant shall be entitled to purchase more than the Maximum Share Amount (as defined below) on any single Purchase Date. Not less than thirty (30) days prior to the commencement of any Offering Period, the Committee may, in its sole discretion, set a maximum number of shares which may be purchased by any employee at any single Purchase Date (hereinafter the "MAXIMUM SHARE AMOUNT"). In no event shall the Maximum Share Amount exceed the amounts permitted under Section 10(b) above. If a new Maximum Share Amount is set, then all participants must be notified of such Maximum Share Amount prior to the commencement of the next Offering Period. The Maximum Share Amount shall continue to apply with respect to all succeeding Purchase Dates and Offering Periods unless revised by the Committee as set forth above. (d) If the number of shares to be purchased on a Purchase Date by all employees participating in this Plan exceeds the number of shares then available for issuance under this Plan, then the Company will make a pro rata allocation of the remaining shares in as uniform a manner as shall be reasonably practicable and as the Committee shall determine to be equitable. In such event, the Company shall give written notice of such reduction of the number of shares to be purchased under a participant's option to each participant affected. (e) Any payroll deductions accumulated in a participant's account which are not used to purchase stock due to the limitations in this Section 10 shall be returned to the participant as soon as practicable after the end of the applicable Purchase Period, without interest. -4- Integrated Systems, Inc. 1999 Employee Stock Purchase Plan As Adopted March 24, 1999 11. WITHDRAWAL. (a) Each participant may withdraw from an Offering Period under this Plan by signing and delivering to the Treasury Department a written notice to that effect on a form provided for such purpose. Such withdrawal may be elected at any time at least fifteen (15) days prior to the end of an Offering Period. (b) Upon withdrawal from this Plan, the accumulated payroll deductions shall be returned to the withdrawn participant, without interest, and his or her interest in this Plan shall terminate. In the event a participant voluntarily elects to withdraw from this Plan, he or she may not resume his or her participation in this Plan during the same Offering Period, but he or she may participate in any Offering Period under this Plan which commences on a date subsequent to such withdrawal by filing a new authorization for payroll deductions in the same manner as set forth in Section 6 above for initial participation in this Plan. (c) If the Fair Market Value on the first day of the current Offering Period in which a participant is enrolled is higher than the Fair Market Value on the first day of any subsequent Offering Period, the Company will automatically enroll such participant in the subsequent Offering Period. Any funds accumulated in a participant's account prior to the first day of such subsequent Offering Period will be applied to the purchase of shares on the Purchase Date immediately prior to the first day of such subsequent Offering Period. A participant does not need to file any forms with the Company to automatically be enrolled in the subsequent Offering Period 12. TERMINATION OF EMPLOYMENT. Termination of a participant's employment for any reason, including retirement, death or the failure of a participant to remain an eligible employee of the Company or of a Participating Subsidiary, immediately terminates his or her participation in this Plan. In such event, the payroll deductions credited to the participant's account will be returned to him or her or, in the case of his or her death, to his or her legal representative, without interest. For purposes of this Section 12, an employee will not be deemed to have terminated employment or failed to remain in the continuous employ of the Company or of a Participating Subsidiary in the case of sick leave, military leave, or any other leave of absence approved by the Board; provided that such leave is for a period of not more than ninety (90) days or reemployment upon the expiration of such leave is guaranteed by contract or statute. 13. RETURN OF PAYROLL DEDUCTIONS. In the event a participant's interest in this Plan is terminated by withdrawal, termination of employment or otherwise, or in the event this Plan is terminated by the Board, the Company shall deliver to the participant all payroll deductions credited to such participant's account. No interest shall accrue on the payroll deductions of a participant in this Plan. 14. CAPITAL CHANGES. Subject to any required action by the stockholders of the Company, the number of shares of Common Stock covered by each option under this Plan which has not yet been exercised and the number of shares of Common Stock which have been authorized for issuance under this Plan but have not yet been placed under option (collectively, the "RESERVES"), as well as the price per share of Common Stock covered by each option under this Plan which has not yet been exercised, shall be proportionately adjusted for any increase or decrease in the number of issued and outstanding shares of Common Stock of the Company resulting from a stock split or the payment of a stock dividend (but only on the Common Stock) or any other increase or decrease in the number of issued and outstanding shares of Common Stock effected without receipt of any consideration by the Company; PROVIDED, HOWEVER, that conversion of any convertible securities of the Company shall not be deemed to have been "effected without receipt of consideration". Such adjustment shall be made by the Committee, whose determination shall be final, binding and conclusive. Except as expressly provided herein, no issue by the Company of shares of stock of any class, or securities convertible into shares of stock of any class, shall affect, and no adjustment by reason thereof shall be made with respect to, the number or price of shares of Common Stock subject to an option. Unless otherwise provided by the Committee, the Offering Period will terminate immediately prior to the consummation of any of the following proposed actions: (i) a merger or consolidation in which the Company is not the surviving corporation (other than a merger or consolidation with a wholly-owned subsidiary, a reincorporation of the Company in a different jurisdiction, or other transaction in which there is no substantial change in the stockholders of the Company or their relative stock holdings and the options under this Plan are -5- Integrated Systems, Inc. 1999 Employee Stock Purchase Plan As Adopted March 24, 1999 assumed, converted or replaced by the successor corporation, which assumption will be binding on all participants), (ii) a merger in which the Company is the surviving corporation but after which the stockholders of the Company immediately prior to such merger (other than any stockholder that merges, or which owns or controls another corporation that merges, with the Company in such merger) cease to own their shares or other equity interest in the Company, (iii) the sale of all or substantially all of the assets of the Company; (iv) the acquisition, sale, or transfer of more than 50% of the outstanding shares of the Company by tender offer or similar transaction; or (v) a dissolution or liquidation of the Company. The Committee may, in the exercise of its sole discretion in such instances, declare that this Plan shall terminate as of a date fixed by the Committee and give each participant the right to purchase shares under this Plan prior to such termination. The Committee may, if it so determines in the exercise of its sole discretion, also make provision for adjusting the Reserves, as well as the price per share of Common Stock covered by each outstanding option, in the event that the Company effects one or more reorganizations, recapitalizations, rights offerings or other increases or reductions of shares of its outstanding Common Stock, or in the event of the Company being consolidated with or merged into any other corporation. 15. NONASSIGNABILITY. Neither payroll deductions credited to a participant's account nor any rights with regard to the exercise of an option or to receive shares under this Plan may be assigned, transferred, pledged or otherwise disposed of in any way (other than by will, the laws of descent and distribution or as provided in Section 22 below) by the participant. Any such attempt at assignment, transfer, pledge or other disposition shall be void and without effect. 16. REPORTS. Individual accounts will be maintained for each participant in this Plan. Each participant shall receive promptly after the end of each Purchase Period a report of his or her account setting forth the total payroll deductions accumulated, the number of shares purchased, the per share price thereof and the remaining cash balance, if any, carried forward to the next Purchase Period or Offering Period, as the case may be. 17. NOTICE OF DISPOSITION. Each participant shall notify the Company in writing if the participant disposes of any of the shares purchased in any Offering Period pursuant to this Plan if such disposition occurs within two (2) years from the Offering Date or within one (1) year from the Purchase Date on which such shares were purchased (the "NOTICE PERIOD"). The Company may, at any time during the Notice Period, place a legend or legends on any certificate representing shares acquired pursuant to this Plan requesting the Company's transfer agent to notify the Company of any transfer of the shares. The obligation of the participant to provide such notice shall continue regardless of whether any such legend is placed on the certificates. 18. NO RIGHTS TO CONTINUED EMPLOYMENT. Neither this Plan nor the grant of any option hereunder shall confer any right on any employee to remain in the employ of the Company or any Participating Subsidiary, or restrict the right of the Company or any Participating Subsidiary to terminate such employee's employment. 19. EQUAL RIGHTS AND PRIVILEGES. All eligible employees shall have equal rights and privileges with respect to this Plan so that this Plan qualifies as an "employee stock purchase plan" within the meaning of Code Section 423 or any successor provision of the Code and the related regulations. Any provision of this Plan which is inconsistent with Code Section 423 or any successor provision of the Code shall, without further act or amendment by the Company, the Committee or the Board, be reformed to comply with the requirements of Code Section 423. This Section 19 shall take precedence over all other provisions in this Plan. 20. NOTICES. All notices or other communications by a participant to the Company under or in connection with this Plan shall be deemed to have been duly given when received in the form specified by the Company at the location, or by the person, designated by the Company for the receipt thereof. 21. TERM; STOCKHOLDER APPROVAL. After this Plan is adopted by the Board, this Plan will become effective on the First Offering Date (as defined above). This Plan shall be approved by the stockholders of the Company, in any manner permitted by applicable corporate law, within twelve (12) months after the date this Plan is adopted by the Board. No purchase of shares pursuant to this Plan shall occur prior to such stockholder approval. This Plan shall continue until the earlier to occur of (a) termination of this Plan by the Board (which -6- Integrated Systems, Inc. 1999 Employee Stock Purchase Plan As Adopted March 24, 1999 termination may be effected by the Board at any time), (b) issuance of all of the shares of Common Stock reserved for issuance under this Plan, or (c) ten (10) years from the adoption of this Plan by the Board. 22. DESIGNATION OF BENEFICIARY. (a) A participant may file a written designation of a beneficiary who is to receive any shares and cash, if any, from the participant's account under this Plan in the event of such participant's death subsequent to the end of an Purchase Period but prior to delivery to him of such shares and cash. In addition, a participant may file a written designation of a beneficiary who is to receive any cash from the participant's account under this Plan in the event of such participant's death prior to a Purchase Date. (b) Such designation of beneficiary may be changed by the participant at any time by written notice. In the event of the death of a participant and in the absence of a beneficiary validly designated under this Plan who is living at the time of such participant's death, the Company shall deliver such shares or cash to the executor or administrator of the estate of the participant, or if no such executor or administrator has been appointed (to the knowledge of the Company), the Company, in its discretion, may deliver such shares or cash to the spouse or to any one or more dependents or relatives of the participant, or if no spouse, dependent or relative is known to the Company, then to such other person as the Company may designate. 23. CONDITIONS UPON ISSUANCE OF SHARES; LIMITATION ON SALE OF SHARES. Shares shall not be issued with respect to an option unless the exercise of such option and the issuance and delivery of such shares pursuant thereto shall comply with all applicable provisions of law, domestic or foreign, including, without limitation, the Securities Act of 1933, as amended and the Securities Exchange Act of 1934, as amended, the rules and regulations promulgated thereunder, and the requirements of any stock exchange or automated quotation system upon which the shares may then be listed, and shall be further subject to the approval of counsel for the Company with respect to such compliance. 24. APPLICABLE LAW. The Plan shall be governed by the substantive laws (excluding the conflict of laws rules) of the State of California. 25. AMENDMENT OR TERMINATION OF THIS PLAN. The Board may at any time amend, terminate or extend the term of this Plan, except that any such termination cannot affect options previously granted under this Plan, nor may any amendment make any change in an option previously granted which would adversely affect the right of any participant, nor may any amendment be made without approval of the stockholders of the Company obtained in accordance with Section 21 above within twelve (12) months of the adoption of such amendment (or earlier if required by Section 21) if such amendment would: (a) increase the number of shares that may be issued under this Plan; or (b) change the designation of the employees (or class of employees) eligible for participation in this Plan. Notwithstanding the foregoing, the Board may make such amendments to the Plan as the Board determines to be advisable, if the continuation of the Plan or any Offering Period would result in financial accounting treatment for the Plan that is different from the financial accounting treatment in effect on the date this Plan is adopted by the Board. -7- INTEGRATED SYSTEMS, INC. 1998 EQUITY INCENTIVE PLAN As Adopted March 30, 1998 As Amended March 24, 1999 1. PURPOSE. The purpose of this Plan is to provide incentives to attract, retain and motivate eligible persons whose present and potential contributions are important to the success of the Company, its Parent and Subsidiaries, by offering them an opportunity to participate in the Company's future performance through awards of Options, Restricted Stock and Stock Bonuses. Capitalized terms not defined in the text are defined in Section 23. 2. SHARES SUBJECT TO THE PLAN. 2.1 NUMBER OF SHARES AVAILABLE. Subject to Sections 2.2 and 18, the total number of Shares reserved and available for grant and issuance pursuant to this Plan will be 2,000,000 Shares plus (a) any authorized shares not issued or subject to outstanding grants under the Company's 1988 Stock Option Plan the ("PRIOR PLAN") on the Effective Date (as defined in Section 19 below); (b) shares that are subject to issuance upon exercise of an option granted under the Prior Plan but cease to be subject to such option for any reason other than exercise of such option; and (c) shares that were issued under the Prior Plan which are repurchased by the Company at the original issue price or forfeited. Subject to Sections 2.2 and 18, Shares that are subject to: (x) issuance upon exercise of an Option but cease to be subject to such Option for any reason other than exercise of such Option; (y) an Award granted hereunder but are forfeited or are repurchased by the Company at the original issue price; and (z) an Award that otherwise terminates without Shares being issued, will again be available for grant and issuance in connection with future Awards under this Plan. At all times the Company shall reserve and keep available a sufficient number of Shares as shall be required to satisfy the requirements of all outstanding Options granted under this Plan and all other outstanding but unvested Awards granted under this Plan. 2.2 ADJUSTMENT OF SHARES. In the event that the number of outstanding shares is changed by a stock dividend, recapitalization, stock split, reverse stock split, subdivision, combination, reclassification or similar change in the capital structure of the Company without consideration, then (a) the number of Shares reserved for issuance under this Plan, (b) the Exercise Prices of and number of Shares subject to outstanding Options, and (c) the number of Shares subject to other outstanding Awards will be proportionately adjusted, subject to any required action by the Board or the stockholders of the Company and compliance with applicable securities laws; PROVIDED, HOWEVER, that fractions of a Share will not be issued but will either be replaced by a cash payment equal to the Fair Market Value of such fraction of a Share or will be rounded up to the nearest whole Share, as determined by the Committee. 3. ELIGIBILITY. ISOs (as defined in Section 5 below) may be granted only to employees (including officers and directors who are also employees) of the Company or of a Parent or Subsidiary of the Company. All other Awards may be granted to employees, officers, directors, consultants, independent contractors and advisors of the Company or any Parent or Subsidiary of the Company; PROVIDED such consultants, contractors and advisors render bona fide services not in connection with the offer and sale of securities in a capital-raising transaction. No person will be eligible to receive more than 200,000 Shares in any calendar year under this Plan pursuant to the grant of Awards hereunder, other than new employees of the Company or of a Parent or Subsidiary of the Company (including new employees who are also officers and directors of the Company or any Parent or Subsidiary of the Company), who are eligible to receive up to a maximum of 1,000,000 Shares in the calendar year in which they commence their employment. A person may be granted more than one Award under this Plan. 4. ADMINISTRATION. 4.1 COMMITTEE AUTHORITY. This Plan will be administered by the Committee or by the Board acting as the Committee. Subject to the general purposes, terms and conditions of this Plan, and to the Integrated Systems, Inc. 1998 Equity Incentive Plan direction of the Board, the Committee will have full power to implement and carry out this Plan. Without limitation, the Committee will have the authority to: (a) construe and interpret this Plan, any Award Agreement and any other agreement or document executed pursuant to this Plan; (b) prescribe, amend and rescind rules and regulations relating to this Plan or any Award; (c) select persons to receive Awards; (d) determine the form and terms of Awards; (e) determine the number of Shares or other consideration subject to Awards; (f) determine whether Awards will be granted singly, in combination with, in tandem with, in replacement of, or as alternatives to, other Awards under this Plan or any other incentive or compensation plan of the Company or any Parent or Subsidiary of the Company; (g) grant waivers of Plan or Award conditions; (h) determine the vesting, exercisability and payment of Awards; (i) correct any defect, supply any omission or reconcile any inconsistency in this Plan, any Award or any Award Agreement; (j) determine whether an Award has been earned; and (k) make all other determinations necessary or advisable for the administration of this Plan. 4.2 COMMITTEE DISCRETION. Any determination made by the Committee with respect to any Award will be made in its sole discretion at the time of grant of the Award or, unless in contravention of any express term of this Plan or Award, at any later time, and such determination will be final and binding on the Company and on all persons having an interest in any Award under this Plan. The Committee may delegate to one or more officers of the Company the authority to grant an Award under this Plan to Participants who are not Insiders of the Company. 5. OPTIONS. The Committee may grant Options to eligible persons and will determine whether such Options will be Incentive Stock Options within the meaning of the Code ("ISO") or Nonqualified Stock Options ("NQSOS"), the number of Shares subject to the Option, the Exercise Price of the Option, the period during which the Option may be exercised, and all other terms and conditions of the Option, subject to the following: 5.1 FORM OF OPTION GRANT. Each Option granted under this Plan will be evidenced by an Award Agreement which will expressly identify the Option as an ISO or an NQSO ("STOCK OPTION AGREEMENT"), and will be in such form and contain such provisions (which need not be the same for each Participant) as the Committee may from time to time approve, and which will comply with and be subject to the terms and conditions of this Plan. 5.2 DATE OF GRANT. The date of grant of an Option will be the date on which the Committee makes the determination to grant such Option, unless otherwise specified by the Committee. The Stock Option Agreement and a copy of this Plan will be delivered to the Participant within a reasonable time after the granting of the Option. -2- Integrated Systems, Inc. 1998 Equity Incentive Plan 5.3 EXERCISE PERIOD. Options may be exercisable within the times or upon the events determined by the Committee as set forth in the Stock Option Agreement governing such Option; PROVIDED, HOWEVER, that no Option will be exercisable after the expiration of ten (10) years from the date the Option is granted; and PROVIDED FURTHER that no ISO granted to a person who directly or by attribution owns more than ten percent (10%) of the total combined voting powerof all classes of stock of the Company or of any Parent or Subsidiary of the Company ("TEN PERCENT STOCKHOLDER") will be exercisable after the expiration of five (5) years from the date the ISO is granted. The Committee also may provide for Options to become exercisable at one time or from time to time, periodically or otherwise, in such number of Shares or percentage of Shares as the Committee determines. 5.4 EXERCISE PRICE. The Exercise Price of an Option will be determined by the Committee when the Option is granted and may be not less than 85% of the Fair Market Value of the Shares on the date of grant; provided that: (i) the Exercise Price of an ISO will be not less than 100% of the Fair Market Value of the Shares on the date of grant; and (ii) the Exercise Price of any ISO granted to a Ten Percent Stockholder will not be less than 110% of the Fair Market Value of the Shares on the date of grant. Payment for the Shares purchased may be made in accordance with Section 8 of this Plan. 5.5 METHOD OF EXERCISE. Options may be exercised only by delivery to the Company of a written stock option exercise agreement (the "EXERCISE AGREEMENT") in a form approved by the Committee (which need not be the same for each Participant), stating the number of Shares being purchased, the restrictions imposed on the Shares purchased under such Exercise Agreement, if any, and such representations and agreements regarding Participant's investment intent and access to information and other matters, if any, as may be required or desirable by the Company to comply with applicable securities laws, together with payment in full of the Exercise Price for the number of Shares being purchased. 5.6 TERMINATION. Notwithstanding the exercise periods set forth in the Stock Option Agreement, exercise of an Option will always be subject to the following: (a) If the Participant is Terminated for any reason except death or Disability, then the Participant may exercise such Participant's Options only to the extent that such Options would have been exercisable upon the Termination Date no later than three (3) months after the Termination Date (or such shorter or longer time period not exceeding five (5) years as may be determined by the Committee, with any exercise beyond three (3) months after the Termination Date deemed to be an NQSO), but in any event, no later than the expiration date of the Options. (b) If the Participant is Terminated because of Participant's death or Disability (or the Participant dies within three (3) months after a Termination other than for Cause or because of Participant's Disability), then Participant's Options may be exercised only to the extent that such Options would have been exercisable by Participant on the Termination Date and must be exercised by Participant (or Participant's legal representative or authorized assignee) no later than twelve (12) months after the Termination Date (or such shorter or longer time period not exceeding five (5) years as may be determined by the Committee, with any such exercise beyond (a) three (3) months after the Termination Date when the Termination is for any reason other than the Participant's death or Disability, or (b) twelve (12) months after the Termination Date when the Termination is for Participant's death or Disability, deemed to be an NQSO), but in any event no later than the expiration date of the Options. (c) Notwithstanding the provisions in paragraph 5.6(a) above, if a Participant is terminated for Cause, neither the Participant, the Participant's estate nor such other person who may then hold the Option shall be entitled to exercise any Option with respect to any Shares whatsoever, after termination of service, whether or not after termination of service the -3- Integrated Systems, Inc. 1998 Equity Incentive Plan Participant may receive payment from the Company or Subsidiary for vacation pay, for services rendered prior to termination, for services rendered for the day on which termination occurs, for salary in lieu of notice, or for any other benefits. In making such determination, the Board shall give the Participant an opportunity to present to the Board evidence on his behalf. For the purpose of this paragraph, termination of service shall be deemed to occur on the date when the Company dispatches notice or advice to the Participant that his service is terminated. 5.7 LIMITATIONS ON EXERCISE. The Committee may specify a reasonable minimum number of Shares that may be purchased on any exercise of an Option, provided that such minimum number will not prevent Participant from exercising the Option for the full number of Shares for which it is then exercisable. 5.8 LIMITATIONS ON ISO. The aggregate Fair Market Value (determined as of the date of grant) of Shares with respect to which ISO are exercisable for the first time by a Participant during any calendar year (under this Plan or under any other incentive stock option plan of the Company, Parent or Subsidiary of the Company) will not exceed $100,000. If the Fair Market Value of Shares on the date of grant with respect to which ISO are exercisable for the first time by a Participant during any calendar year exceeds $100,000, then the Options for the first $100,000 worth of Shares to become exercisable in such calendar year will be ISO and the Options for the amount in excess of $100,000 that become exercisable in that calendar year will be NQSOs. In the event that the Code or the regulations promulgated thereunder are amended after the Effective Date of this Plan to provide for a different limit on the Fair Market Value of Shares permitted to be subject to ISO, such different limit will be automatically incorporated herein and will apply to any Options granted after the effective date of such amendment. 5.9 MODIFICATION, EXTENSION OR RENEWAL. The Committee may modify, extend or renew outstanding Options and authorize the grant of new Options in substitution therefor, provided that any such action may not, without the written consent of a Participant, impair any of such Participant's rights under any Option previously granted. Any outstanding ISO that is modified, extended, renewed or otherwise altered will be treated in accordance with Section 424(h) of the Code. The Committee may reduce the Exercise Price of outstanding Options without the consent of Participants affected by a written notice to them; PROVIDED, HOWEVER, that the Exercise Price may not be reduced below the minimum Exercise Price that would be permitted under Section 5.4 of this Plan for Options granted on the date the action is taken to reduce the Exercise Price. 5.10 NO DISQUALIFICATION. Notwithstanding any other provision in this Plan, no term of this Plan relating to ISO will be interpreted, amended or altered, nor will any discretion or authority granted under this Plan be exercised, so as to disqualify this Plan under Section 422 of the Code or, without the consent of the Participant affected, to disqualify any ISO under Section 422 of the Code. 6. RESTRICTED STOCK. A Restricted Stock Award is an offer by the Company to sell to an eligible person Shares that are subject to restrictions. The Committee will determine to whom an offer will be made, the number of Shares the person may purchase, the price to be paid (the "PURCHASE PRICE"), the restrictions to which the Shares will be subject, and all other terms and conditions of the Restricted Stock Award, subject to the following: 6.1 FORM OF RESTRICTED STOCK AWARD. All purchases under a Restricted Stock Award made pursuant to this Plan will be evidenced by an Award Agreement ("RESTRICTED STOCK PURCHASE AGREEMENT") that will be in such form (which need not be the same for each Participant) as the Committee will from time to time approve, and will comply with and be subject to the terms and conditions of this Plan. The offer of Restricted Stock will be accepted by the Participant's execution and delivery of the Restricted Stock Purchase Agreement and full payment for the Shares to the Company within thirty (30) days from the date the Restricted Stock Purchase Agreement is delivered to the person. If such person does not execute and deliver the Restricted Stock Purchase Agreement along with full payment for the Shares to the Company within thirty (30) days, then the offer will terminate, unless otherwise determined by the Committee. -4- Integrated Systems, Inc. 1998 Equity Incentive Plan 6.2 PURCHASE PRICE. The Purchase Price of Shares sold pursuant to a Restricted Stock Award will be determined by the Committee on the date the Restricted Stock Award is granted, except in the case of a sale to a Ten Percent Stockholder, in which case the Purchase Price will be 100% of the Fair Market Value. Payment of the Purchase Price may be made in accordance with Section 8 of this Plan. 6.3 TERMS OF RESTRICTED STOCK AWARDS. Restricted Stock Awards shall be subject to such restrictions as the Committee may impose. These restrictions may be based upon completion of a specified number of years of service with the Company or upon completion of the performance goals as set out in advance in the Participant's individual Restricted Stock Purchase Agreement. Restricted Stock Awards may vary from Participant to Participant and between groups of Participants. Prior to the grant of a Restricted Stock Award, the Committee shall: (a) determine the nature, length and starting date of any Performance Period for the Restricted Stock Award; (b) select from among the Performance Factors to be used to measure performance goals, if any; and (c) determine the number of Shares that may be awarded to the Participant. Prior to the payment of any Restricted Stock Award, the Committee shall determine the extent to which such Restricted Stock Award has been earned. Performance Periods may overlap and Participants may participate simultaneously with respect to Restricted Stock Awards that are subject to different Performance Periods and having different performance goals and other criteria. 6.4 TERMINATION DURING PERFORMANCE PERIOD. If a Participant is Terminated during a Performance Period for any reason, then such Participant will be entitled to payment (whether in Shares, cash or otherwise) with respect to the Restricted Stock Award only to the extent earned as of the date of Termination in accordance with the Restricted Stock Purchase Agreement, unless the Committee will determine otherwise. 7. STOCK BONUSES. 7.1 AWARDS OF STOCK BONUSES. A Stock Bonus is an award of Shares (which may consist of Restricted Stock) for services rendered to the Company or any Parent or Subsidiary of the Company. A Stock Bonus may be awarded for past services already rendered to the Company, or any Parent or Subsidiary of the Company pursuant to an Award Agreement (the "STOCK BONUS AGREEMENT") that will be in such form (which need not be the same for each Participant) as the Committee will from time to time approve, and will comply with and be subject to the terms and conditions of this Plan. A Stock Bonus may be awarded upon satisfaction of such performance goals as are set out in advance in the Participant's individual Award Agreement (the "PERFORMANCE STOCK BONUS AGREEMENT") that will be in such form (which need not be the same for each Participant) as the Committee will from time to time approve, and will comply with and be subject to the terms and conditions of this Plan. Stock Bonuses may vary from Participant to Participant and between groups of Participants, and may be based upon the achievement of the Company, Parent or Subsidiary and/or individual performance factors or upon such other criteria as the Committee may determine. 7.2 TERMS OF STOCK BONUSES. The Committee will determine the number of Shares to be awarded to the Participant. If the Stock Bonus is being earned upon the satisfaction of performance goals pursuant to a Performance Stock Bonus Agreement, then the Committee will: (a) determine the nature, length and starting date of any Performance Period for each Stock Bonus; (b) select from among the Performance Factors to be used to measure the performance, if any; and (c) determine the number of Shares that may be awarded to the Participant. Prior to the payment of any Stock Bonus, the Committee shall determine the extent to which such Stock Bonuses have been earned. Performance Periods may overlap and Participants may participate simultaneously with respect to Stock Bonuses that are subject to different Performance Periods and different performance goals and other criteria. The number of Shares may be fixed or may vary in accordance with such performance goals and criteria as may be determined by the Committee. The Committee may adjust the performance goals applicable to the Stock Bonuses to take into account changes in law and accounting or tax rules and to make such adjustments as the Committee deems necessary or appropriate to reflect the impact of extraordinary or unusual items, events or circumstances to avoid windfalls or hardships. -5- Integrated Systems, Inc. 1998 Equity Incentive Plan 7.3 FORM OF PAYMENT. The earned portion of a Stock Bonus may be paid currently or on a deferred basis with such interest or dividend equivalent, if any, as the Committee may determine. Payment may be made in the form of cash or whole Shares or a combination thereof, either in a lump sum payment or in installments, all as the Committee will determine. 8. PAYMENT FOR SHARE PURCHASES. 8.1 PAYMENT. Payment for Shares purchased pursuant to this Plan may be made in cash (by check) or, where expressly approved for the Participant by the Committee and where permitted by law: (a) by cancellation of indebtedness of the Company to the Participant; (b) by surrender of shares that either: (1) have been owned by Participant for more than six (6) months and have been paid for within the meaning of SEC Rule 144 (and, if such shares were purchased from the Company by use of a promissory note, such note has been fully paid with respect to such shares); or (2) were obtained by Participant in the public market; (c) by tender of a full recourse promissory note having such terms as may be approved by the Committee and bearing interest at a rate sufficient to avoid imputation of income under Sections 483 and 1274 of the Code; PROVIDED, HOWEVER, that Participants who are not employees or directors of the Company will not be entitled to purchase Shares with a promissory note unless the note is adequately secured by collateral other than the Shares; (d) by waiver of compensation due or accrued to the Participant for services rendered; (e) with respect only to purchases upon exercise of an Option, and provided that a public market for the Company's stock exists: (1) through a "same day sale" commitment from the Participant and a broker-dealer that is a member of the National Association of Securities Dealers (an "NASD DEALER") whereby the Participant irrevocably elects to exercise the Option and to sell a portion of the Shares so purchased to pay for the Exercise Price, and whereby the NASD Dealer irrevocably commits upon receipt of such Shares to forward the Exercise Price directly to the Company; or (2) through a "margin" commitment from the Participant and a NASD Dealer whereby the Participant irrevocably elects to exercise the Option and to pledge the Shares so purchased to the NASD Dealer in a margin account as security for a loan from the NASD Dealer in the amount of the Exercise Price, and whereby the NASD Dealer irrevocably commits upon receipt of such Shares to forward the Exercise Price directly to the Company; or (f) by any combination of the foregoing. 8.2 LOAN GUARANTEES. The Committee may help the Participant pay for Shares purchased under this Plan by authorizing a guarantee by the Company of a third-party loan to the Participant. 9. WITHHOLDING TAXES. 9.1 WITHHOLDING GENERALLY. Whenever Shares are to be issued in satisfaction of Awards granted under this Plan, the Company may require the Participant to remit to the Company an amount sufficient to satisfy federal, state and local withholding tax requirements prior to the delivery of any certificate or -6- Integrated Systems, Inc. 1998 Equity Incentive Plan certificates for such Shares. Whenever, under this Plan, payments in satisfaction of Awards are to be made in cash, such payment will be net of an amount sufficient to satisfy federal, state, and local withholding tax requirements. 9.2 STOCK WITHHOLDING. When, under applicable tax laws, a Participant incurs tax liability in connection with the exercise or vesting of any Award that is subject to tax withholding and the Participant is obligated to pay the Company the amount required to be withheld, the Committee may in its sole discretion allow the Participant to satisfy the minimum withholding tax obligation by electing to have the Company withhold from the Shares to be issued that number of Shares having a Fair Market Value equal to the minimum amount required to be withheld, determined on the date that the amount of tax to be withheld is to be determined. All elections by a Participant to have Shares withheld for this purpose will be made in accordance with the requirements established by the Committee and be in writing in a form acceptable to the Committee 10. PRIVILEGES OF STOCK OWNERSHIP. 10.1 VOTING AND DIVIDENDS. No Participant will have any of the rights of a stockholder with respect to any Shares until the Shares are issued to the Participant. After Shares are issued to the Participant, the Participant will be a stockholder and have all the rights of a stockholder with respect to such Shares, including the right to vote and receive all dividends or other distributions made or paid with respect to such Shares; PROVIDED, that if such Shares are Restricted Stock, then any new, additional or different securities the Participant may become entitled to receive with respect to such Shares by virtue of a stock dividend, stock split or any other change in the corporate or capital structure of the Company will be subject to the same restrictions as the Restricted Stock; PROVIDED, FURTHER, that the Participant will have no right to retain such stock dividends or stock distributions with respect to Shares that are repurchased at the Participant's Purchase Price or Exercise Price pursuant to Section 12. 10.2 FINANCIAL STATEMENTS. The Company will provide financial statements to each Participant prior to such Participant's purchase of Shares under this Plan, and to each Participant annually during the period such Participant has Awards outstanding; PROVIDED, HOWEVER, the Company will not be required to provide such financial statements to Participants whose services in connection with the Company assure them access to equivalent information. 11. TRANSFERABILITY. Awards granted under this Plan, and any interest therein, will not be transferable or assignable by Participant, and may not be made subject to execution, attachment or similar process, otherwise than by will or by the laws of descent and distribution or as determined by the Committee and set forth in the Award Agreement with respect to Awards that are not ISOs. During the lifetime of the Participant an Award will be exercisable only by the Participant, and any elections with respect to an Award may be made only by the Participant unless otherwise determined by the Committee and set forth in the Award Agreement with respect to Awards that are not ISOs. 12. RESTRICTIONS ON SHARES. At the discretion of the Committee, the Company may reserve to itself and/or its assignee(s) in the Award Agreement a right to repurchase a portion of or all Unvested Shares held by a Participant following such Participant's Termination at any time within ninety (90) days after the later of Participant's Termination Date and the date Participant purchases Shares under this Plan, for cash and/or cancellation of purchase money indebtedness, at the Participant's Exercise Price or Purchase Price, as the case may be. 13. CERTIFICATES. All certificates for Shares or other securities delivered under this Plan will be subject to such stock transfer orders, legends and other restrictions as the Committee may deem necessary or advisable, including restrictions under any applicable federal, state or foreign securities law, or any rules, regulations and other requirements of the SEC or any stock exchange or automated quotation system upon which the Shares may be listed or quoted. -7- Integrated Systems, Inc. 1998 Equity Incentive Plan 14. ESCROW; PLEDGE OF SHARES. To enforce any restrictions on a Participant's Shares, the Committee may require the Participant to deposit all certificates representing Shares, together with stock powers or other instruments of transfer approved by the Committee, appropriately endorsed in blank, with the Company or an agent designated by the Company to hold in escrow until such restrictions have lapsed or terminated, and the Committee may cause a legend or legends referencing such restrictions to be placed on the certificates. Any Participant who is permitted to execute a promissory note as partial or full consideration for the purchase of Shares under this Plan will be required to pledge and deposit with the Company all or part of the Shares so purchased as collateral to secure the payment of Participant's obligation to the Company under the promissory note; PROVIDED, HOWEVER, that the Committee may require or accept other or additional forms of collateral to secure the payment of such obligation and, in any event, the Company will have full recourse against the Participant under the promissory note notwithstanding any pledge of the Participant's Shares or other collateral. In connection with any pledge of the Shares, Participant will be required to execute and deliver a written pledge agreement in such form as the Committee will from time to time approve. The Shares purchased with the promissory note may be released from the pledge on a pro rata basis as the promissory note is paid. 15. EXCHANGE AND BUYOUT OF AWARDS. The Committee may, at any time or from time to time, authorize the Company, with the consent of the respective Participants, to issue new Awards in exchange for the surrender and cancellation of any or all outstanding Awards. The Committee may at any time buy from a Participant an Award previously granted with payment in cash, Shares (including Restricted Stock) or other consideration, based on such terms and conditions as the Committee and the Participant may agree. 16. SECURITIES LAW AND OTHER REGULATORY COMPLIANCE. An Award will not be effective unless such Award is in compliance with all applicable federal and state securities laws, rules and regulations of any governmental body, and the requirements of any stock exchange or automated quotation system upon which the Shares may then be listed or quoted, as they are in effect on the date of grant of the Award and also on the date of exercise or other issuance. Notwithstanding any other provision in this Plan, the Company will have no obligation to issue or deliver certificates for Shares under this Plan prior to: (a) obtaining any approvals from governmental agencies that the Company determines are necessary or advisable; and/or (b) completion of any registration or other qualification of such Shares under any state or federal law or ruling of any governmental body that the Company determines to be necessary or advisable. The Company will be under no obligation to register the Shares with the SEC or to effect compliance with the registration, qualification or listing requirements of any state securities laws, stock exchange or automated quotation system, and the Company will have no liability for any inability or failure to do so. 17. NO OBLIGATION TO EMPLOY. Nothing in this Plan or any Award granted under this Plan will confer or be deemed to confer on any Participant any right to continue in the employ of, or to continue any other relationship with, the Company or any Parent or Subsidiary of the Company or limit in any way the right of the Company or any Parent or Subsidiary of the Company to terminate Participant's employment or other relationship at any time, with or without cause. 18. CORPORATE TRANSACTIONS. 18.1 ASSUMPTION OR REPLACEMENT OF AWARDS BY SUCCESSOR. In the event of (a) a dissolution or liquidation of the Company, (b) a merger or consolidation in which the Company is not the surviving corporation (other than a merger or consolidation with a wholly-owned subsidiary, a reincorporation of the Company in a different jurisdiction, or other transaction in which there is no substantial change in the stockholders of the Company or their relative stock holdings and the Awards granted under this Plan are assumed, converted or replaced by the successor corporation, which assumption will be binding on all Participants), (c) a merger in which the Company is the surviving corporation but after which the stockholders of the Company immediately prior to such merger (other than any stockholder that merges, or which owns or controls another corporation that merges, with the Company in such merger) cease to own their shares or other equity interest in the Company, (d) the sale of substantially all of the assets of the Company, or (e) the acquisition, sale, or transfer of more than 50% of the outstanding shares of the Company by tender offer or similar transaction, any or all -8- Integrated Systems, Inc. 1998 Equity Incentive Plan outstanding Awards may be assumed, converted or replaced by the successor corporation (if any), which assumption, conversion or replacement will be binding on all Participants. In the alternative, the successor corporation may substitute equivalent Awards or provide substantially similar consideration to Participants as was provided to stockholders (after taking into account the existing provisions of the Awards). In the event such successor or acquiring corporation (if any) does not assume, convert, replace or substitute Awards, as provided above, pursuant to a transaction described in this Section 18.1, then notwithstanding any other provision in this Plan to the contrary, the vesting of such Awards will accelerate and the Options will become exercisable in full prior to the consummation of such event at such times and on such conditions as the Committee determines, and if such Options are not exercised prior to the consummation of the corporate transaction, they shall terminate in accordance with the provisions of this Plan. The successor corporation may also issue, in place of outstanding Shares of the Company held by the Participant, substantially similar shares or other property subject to repurchase restrictions no less favorable to the Participant. The Committee may, in its sole discretion, provide that the vesting of any or all Awards granted pursuant to this Plan will accelerate even if Options would otherwise be assumed, converted, replaced or substituted for. If the Committee exercises such discretion with respect to Options, such Options will become exercisable in full prior to the consummation of such event at such time and on such conditions as the Committee determines, and if such Options are not exercised prior to the consummation of the corporate transaction, they shall terminate at such time as determined by the Committee. 18.2 OTHER TREATMENT OF AWARDS. Subject to any greater rights granted to Participants under the foregoing provisions of this Section 18, in the event of the occurrence of any transaction described in Section 18.1, any outstanding Awards will be treated as provided in the applicable agreement or plan of merger, consolidation, dissolution, liquidation, or sale of assets. 18.3 ASSUMPTION OF AWARDS BY THE COMPANY. The Company, from time to time, also may substitute or assume outstanding awards granted by another company, whether in connection with an acquisition of such other company or otherwise, by either; (a) granting an Award under this Plan in substitution of such other company's award; or (b) assuming such award as if it had been granted under this Plan if the terms of such assumed award could be applied to an Award granted under this Plan. Such substitution or assumption will be permissible if the holder of the substituted or assumed award would have been eligible to be granted an Award under this Plan if the other company had applied the rules of this Plan to such grant. In the event the Company assumes an award granted by another company, the terms and conditions of such award will remain unchanged (except that the exercise price and the number and nature of Shares issuable upon exercise of any such option will be adjusted appropriately pursuant to Section 424(a) of the Code). In the event the Company elects to grant a new Option rather than assuming an existing option, such new Option may be granted with a similarly adjusted Exercise Price. 19. ADOPTION AND STOCKHOLDER APPROVAL. This Plan will become effective upon the expiration date of the Prior Plan (the "EFFECTIVE DATE"). This Plan shall be approved by the stockholders of the Company (excluding Shares issued pursuant to this Plan), consistent with applicable laws, within twelve (12) months before or after the date this Plan is adopted by the Board. Upon the Effective Date, the Committee may grant Awards pursuant to this Plan; PROVIDED, HOWEVER, that: (a) no Option may be exercised prior to initial stockholder approval of this Plan; (b) no Option granted pursuant to an increase in the number of Shares subject to this Plan approved by the Board will be exercised prior to the time such increase has been approved by the stockholders of the Company; and (c) in the event that stockholder approval of such increase is not obtained within the time period provided herein, all Awards granted pursuant to such increase will be canceled, any Shares issued pursuant to any Award granted pursuant to such increase will be canceled, and any purchase of Shares pursuant to such increase will be rescinded. 20. TERM OF PLAN/GOVERNING LAW. Unless earlier terminated as provided herein, this Plan will terminate ten (10) years from the date this Plan is adopted by the Board or, if earlier, the date of -9- Integrated Systems, Inc. 1998 Equity Incentive Plan stockholder approval. This Plan and all agreements thereunder shall be governed by and construed in accordance with the laws of the State of California. 21. AMENDMENT OR TERMINATION OF PLAN. The Board may at any time terminate or amend this Plan in any respect, including without limitation amendment of any form of Award Agreement or instrument to be executed pursuant to this Plan; PROVIDED, HOWEVER, that the Board will not, without the approval of the stockholders of the Company, amend this Plan in any manner that requires such stockholder approval. 22. NONEXCLUSIVITY OF THE PLAN. Neither the adoption of this Plan by the Board, the submission of this Plan to the stockholders of the Company for approval, nor any provision of this Plan will be construed as creating any limitations on the power of the Board to adopt such additional compensation arrangements as it may deem desirable, including, without limitation, the granting of stock options and bonuses otherwise than under this Plan, and such arrangements may be either generally applicable or applicable only in specific cases. 23. DEFINITIONS. As used in this Plan, the following terms will have the following meanings: "AWARD" means any award under this Plan, including any Option, Restricted Stock or Stock Bonus. "AWARD AGREEMENT" means, with respect to each Award, the signed written agreement between the Company and the Participant setting forth the terms and conditions of the Award. "BOARD" means the Board of Directors of the Company. "CAUSE" means the commission of an act of theft, embezzlement, fraud, dishonesty or a breach of fiduciary duty to the Company or a Parent or Subsidiary of the Company. "CODE" means the Internal Revenue Code of 1986, as amended. "COMMITTEE" means the Compensation Committee of the Board. "COMPANY" means Integrated Systems, Inc. or any successor corporation. "DISABILITY" means a disability, whether temporary or permanent, partial or total, as determined by the Committee. "EXCHANGE ACT" means the Securities Exchange Act of 1934, as amended. "EXERCISE PRICE" means the price at which a holder of an Option may purchase the Shares issuable upon exercise of the Option. "FAIR MARKET VALUE" means, as of any date, the value of a share of the Company's Common Stock determined as follows: (a) if such Common Stock is then quoted on the Nasdaq National Market, its closing price on the Nasdaq National Market on the date of determination as reported in THE WALL STREET JOURNAL; (b) if such Common Stock is publicly traded and is then listed on a national securities exchange, its closing price on the date of determination on the principal national -10- Integrated Systems, Inc. 1998 Equity Incentive Plan securities exchange on which the Common Stock is listed or admitted to trading as reported in THE WALL STREET JOURNAL; (c) if such Common Stock is publicly traded but is not quoted on the Nasdaq National Market nor listed or admitted to trading on a national securities exchange, the average of the closing bid and asked prices on the date of determination as reported in THE WALL STREET JOURNAL; (d) in the case of an Award made on the Effective Date, the price per share at which shares of the Company's Common Stock are initially offered for sale to the public by the Company's underwriters in the initial public offering of the Company's Common Stock pursuant to a registration statement filed with the SEC under the Securities Act; or (d) if none of the foregoing is applicable, by the Committee in good faith. "INSIDER" means an officer or director of the Company or any other person whose transactions in the Company's Common Stock are subject to Section 16 of the Exchange Act. "OPTION" means an award of an option to purchase Shares pursuant to Section 5. "PARENT" means any corporation (other than the Company) in an unbroken chain of corporations ending with the Company if each of such corporations other than the Company owns stock possessing 50% or more of the total combined voting power of all classes of stock in one of the other corporations in such chain. "PARTICIPANT" means a person who receives an Award under this Plan. "PERFORMANCE FACTORS" means the factors selected by the Committee from among the following measures to determine whether the performance goals established by the Committee and applicable to Awards have been satisfied: (a) Net revenue and/or net revenue growth; (b) Earnings before income taxes and amortization and/or earnings before income taxes and amortization growth; (c) Operating income and/or operating income growth; (d) Net income and/or net income growth; (e) Earnings per share and/or earnings per share growth; (f) Total shareholder return and/or total shareholder return growth; (g) Return on equity; (h) Operating cash flow return on income; (i) Adjusted operating cash flow return on income; (j) Economic value added; and (k) Individual confidential business objectives. -11- Integrated Systems, Inc. 1998 Equity Incentive Plan "PERFORMANCE PERIOD" means the period of service determined by the Committee, not to exceed five years, during which years of service or performance is to be measured for Restricted Stock Awards or Stock Bonuses. "PLAN" means this Integrated Systems, Inc. 1998 Equity Incentive Plan, as amended from time to time. "RESTRICTED STOCK AWARD" means an award of Shares pursuant to Section 6. "SEC" means the Securities and Exchange Commission. "SECURITIES ACT" means the Securities Act of 1933, as amended. "SHARES" means shares of the Company's Common Stock reserved for issuance under this Plan, as adjusted pursuant to Sections 2 and 18, and any successor security. "STOCK BONUS" means an award of Shares, or cash in lieu of Shares, pursuant to Section 7. "SUBSIDIARY" means any corporation (other than the Company) in an unbroken chain of corporations beginning with the Company if each of the corporations other than the last corporation in the unbroken chain owns stock possessing 50% or more of the total combined voting power of all classes of stock in one of the other corporations in such chain. "TERMINATION" or "TERMINATED" means, for purposes of this Plan with respect to a Participant, that the Participant has for any reason ceased to provide services as an employee, officer, director, consultant, independent contractor, or advisor to the Company or a Parent or Subsidiary of the Company. An employee will not be deemed to have ceased to provide services in the case of (i) sick leave, (ii) military leave, or (iii) any other leave of absence approved by the Committee, provided, that such leave is for a period of not more than 90 days, unless reemployment upon the expiration of such leave is guaranteed by contract or statute or unless provided otherwise pursuant to formal policy adopted from time to time by the Company and issued and promulgated to employees in writing. In the case of any employee on an approved leave of absence, the Committee may make such provisions respecting suspension of vesting of the Award while on leave from the employ of the Company or a Subsidiary as it may deem appropriate, except that in no event may an Option be exercised after the expiration of the term set forth in the Option agreement. The Committee will have sole discretion to determine whether a Participant has ceased to provide services and the effective date on which the Participant ceased to provide services (the "TERMINATION DATE"). "UNVESTED SHARES" means "Unvested Shares" as defined in the Award Agreement. "VESTED SHARES" means "Vested Shares" as defined in the Award Agreement. -12- INTEGRATED SYSTEMS, INC. PROXY SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS FOR THE ANNUAL MEETING OF SHAREHOLDERS TO BE HELD ON AUGUST 3, 1999 The undersigned hereby appoints Narendra K. Gupta and William C. Smith, or either of them, as proxies and attorneys in fact, each with full power of substitution, to represent the undersigned at the Annual Meeting of Shareholders of Integrated Systems, Inc. (the "Company") to be held at the Company, 201 Moffett Park Drive, Sunnyvale, CA, 94089 on August 3, 1999 at 2:00 p.m., and any adjournments or postponements thereof, and to vote the number of shares the undersigned would be entitled to vote if personally present at the meeting. UNLESS A CONTRARY DIRECTION IS INDICATED, THIS PROXY WILL BE VOTED FOR ALL NOMINEES LISTED IN PROPOSAL 1 AND FOR PROPOSALS 2, 3, 4 AND 5 AS MORE SPECIFICALLY DESCRIBED IN THE PROXY STATEMENT. IF SPECIFIC INSTRUCTIONS ARE INDICATED, THIS PROXY WILL BE VOTED IN ACCORDANCE THEREWITH. In their discretion, the proxies are authorized to vote upon such other business as may properly come before the meeting or any adjournment thereof to the extent authorized by Rule 14a-4(c) promulgated by the Securities and Exchange Commission. (Continued and to be signed on the other side.) - ------------------------------------------------------------------------------- - FOLD AND DETACH HERE - Please mark your votes as indicated in this example [X] MANAGEMENT RECOMMENDS A VOTE FOR ALL THE NOMINEES FOR DIRECTOR LISTED BELOW AND A VOTE FOR PROPOSALS 2, 3, 4 AND 5. PROPOSAL 1: To elect directors to hold office until the next Annual Meeting of Shareholders and until their successors are elected. FOR all nominees listed below WITHHOLD AUTHORITY to vote (except as marked to the contrary). FOR ALL nominees listed below. [ ] [ ] Nominees: Charles M. Boesenberg, John C. Bolger, Michael A. Brochu, Narendra K. Gupta, Vinita Gupta, Thomas Kailath and Richard C. Murphy To withhold authority to vote for any nominee(s), write such nominee(s) name(s) below: - ------------------------------------------------------- PROPOSAL 2: To approve an amendment to the 1998 Equity Incentive Plan to increase the number of shares of common stock reserved for issuance. FOR AGAINST ABSTAIN [ ] [ ] [ ] PROPOSAL 3: To approve the adoption of the 1999 Employee Stock Purchase Plan. FOR AGAINST ABSTAIN [ ] [ ] [ ] PROPOSAL 4: To approve an amendment to the Bylaws to change the numbers of authorized directors. FOR AGAINST ABSTAIN [ ] [ ] [ ] PROPOSAL 5: To ratify the selection of PricewaterhouseCoopers LLP as the Company's independent accountants. FOR AGAINST ABSTAIN [ ] [ ] [ ] SIGN EXACTLY AS YOUR NAME(S) APPEARS ON YOUR STOCK CERTIFICATE. IF SHARES OF STOCK STAND OF RECORD IN THE NAMES OF TWO OR MORE PERSONS OR IN THE NAME OF HUSBAND AND WIFE, WHETHER AS JOINT TENANTS OR OTHERWISE, BOTH OR ALL OF SUCH PERSONS SHOULD SIGN THE ABOVE PROXY. IF SHARES OF STOCK ARE HELD OF RECORD BY A CORPORATION, THE PROXY SHOULD BE EXECUTED BY THE PRESIDENT OR VICE PRESIDENT AND THE SECRETARY OR ASSISTANT SECRETARY. EXECUTORS OR ADMINISTRATORS OR OTHER FIDUCIARIES WHO EXECUTE THE ABOVE PROXY FOR A DECEASED SHAREHOLDER SHOULD GIVE THEIR FULL TITLE. PLEASE DATE THE PROXY. WHETHER OR NOT YOU PLAN TO ATTEND THE MEETING IN PERSON, YOU ARE URGED TO SIGN AND PROMPTLY MAIL THIS PROXY IN THE RETURN ENVELOPE SO THAT YOUR STOCK MAY BE REPRESENTED AT THE MEETING. Signature: ________________________________________ Date: ____________________ Signature: ________________________________________ - ------------------------------------------------------------------------------- - FOLD AND DETACH HERE - -----END PRIVACY-ENHANCED MESSAGE-----