-----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, Ohp+KG0sDqQSZlTbd1aJivVHmvoDnQBT69blotqJOZ0cyNypeKKj3+9Lx3mglthk /hACiNZnIBJ4vy+SGMPDXw== 0001047469-99-027648.txt : 19990716 0001047469-99-027648.hdr.sgml : 19990716 ACCESSION NUMBER: 0001047469-99-027648 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990531 FILED AS OF DATE: 19990715 FILER: COMPANY DATA: COMPANY CONFORMED NAME: INTEGRATED SYSTEMS INC CENTRAL INDEX KEY: 0000775163 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 942658153 STATE OF INCORPORATION: CA FISCAL YEAR END: 0228 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-18268 FILM NUMBER: 99665249 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 10-Q 1 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------- FORM 10-Q (Mark One) /X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the quarterly period ended May 31, 1999 OR / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the transition period from __________ to __________ Commission file number: 0-18268 ------------------------------- INTEGRATED SYSTEMS, INC. (Exact name of Registrant as specified in its charter) CALIFORNIA 94-2658153 (State or other jurisdiction (I.R.S. employer of incorporation or organization) identification no.) ------------------------------ 201 MOFFETT PARK DRIVE SUNNYVALE, CA 94089 (408) 542-1500 (Address, including zip code, of Registrant's principal executive offices and telephone number, including area code) ------------------------------ Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes __X___ No _____ The number of shares outstanding of the Registrant's Common Stock on June 30, 1999 was 22,591,912 shares. Page 1 of 22 pages. INTEGRATED SYSTEMS, INC. FORM 10-Q QUARTER ENDED MAY 31, 1999
INDEX PAGE PART I - FINANCIAL INFORMATION ---- - ------------------------------ Item 1. Financial Statements 3 Condensed Consolidated Balance Sheets as of May 31, 1999 and February 28, 1999 4 Condensed Consolidated Statements of Income and Comprehensive Income (loss) for the Three Months Ended May 31, 1999 and 1998 5 Condensed Consolidated Statements of Cash Flows for the Three Months Ended May 31, 1999 and 1998 6 Notes to Condensed Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10 Item 3. Quantitative and Qualitative Disclosures About Market Risks 19 PART II - OTHER INFORMATION - --------------------------- Item 6. Exhibits and Reports on Form 8-K 20 SIGNATURES 21 - ----------
============================================================================= This Form 10-Q contains forward-looking statements (as defined in the Private Securities Litigation Reform Act of 1995), including but not limited to statements regarding ISI's expectations, hopes or intentions regarding the future. Actual results and trends could differ materially from those discussed in the forward-looking statements. In addition, past trends should not be perceived as indicators of future performance. Among the factors that could cause actual results to differ from the forward-looking statements are those detailed elsewhere in this Report in Management's Discussion and Analysis of Financial Condition and Results of Operations and in ISI's Securities and Exchange Commission reports. ============================================================================= -2- PART I - FINANCIAL INFORMATION ------------------------------ ITEM 1. FINANCIAL STATEMENTS The condensed consolidated interim financial statements included herein have been prepared by Integrated Systems, Inc. ("ISI"), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Although certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, ISI believes that the disclosures made are adequate to make the information presented not misleading. It is suggested that the condensed consolidated interim financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in ISI's Annual Report on Form 10-K for the year ended February 28, 1999. The February 28, 1999 condensed consolidated balance sheet data was derived from the audited financial statements, but does not include all disclosures required by generally accepted accounting principles. The accompanying condensed consolidated interim financial statements have been prepared in all material respects in conformity with the standards of accounting measurements set forth in Accounting Principles Board Opinion No. 28 and, in the opinion of management, reflect all adjustments, consisting only of normal recurring adjustments, necessary to summarize fairly the financial position, results of operations, and cash flows for the periods indicated. The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for the full year. -3- INTEGRATED SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands) MAY 31, FEBRUARY 28, 1999 1999 ------------- -------------- (unaudited) ASSETS Current assets: Cash and cash equivalents $ 26,131 $ 19,079 Marketable securities 2,382 9,554 Accounts receivable, net 25,377 28,431 Deferred income taxes 2,490 2,360 Prepaid expenses and other 4,729 5,255 ------------- -------------- Total current assets 61,109 64,679 Marketable securities 45,078 49,698 Property and equipment, net 18,574 18,633 Intangible assets, net 3,411 3,503 Deferred income taxes 5,322 5,322 Other assets 1,781 1,200 ------------- -------------- Total assets $ 135,275 $ 143,035 ============= ============== LIABILITIES Current liabilities: Accounts payable $ 3,730 $ 4,761 Accrued payroll and related expenses 5,931 6,250 Other accrued liabilities 5,610 10,668 Income taxes payable 1,906 2,562 Deferred revenue 18,139 18,003 ------------- -------------- Total current liabilities 35,316 42,244 ------------- -------------- SHAREHOLDERS' EQUITY Common Stock, no par value, 50,000 shares authorized: 22,755 and 22,686 shares issued and outstanding at May 31, 1999 and February 28, 1999, respectively 59,647 59,848 Accumulated other comprehensive loss, net (1,561) (759) Retained earnings 41,873 41,702 ------------- -------------- Total shareholders' equity 99,959 100,791 ------------- -------------- Total liabilities and shareholders' equity $ 135,275 $ 143,035 ============= ==============
The accompanying notes are an integral part of these condensed consolidated financial statements. -4- INTEGRATED SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (LOSS) (in thousands, except per share data) (unaudited) THREE MONTHS ENDED MAY 31, -------------------------------- 1999 1998 --------------- --------------- Revenue: Product $18,949 $ 17,161 Services 13,643 14,321 --------------- --------------- Total revenue 32,592 31,482 --------------- --------------- Costs and expenses: Cost of product revenue 4,909 3,133 Cost of services revenue 5,994 5,933 Marketing and sales 14,025 12,105 Research and development 5,309 5,441 General and administrative 3,503 3,356 --------------- --------------- Total costs and expenses 33,740 29,968 --------------- --------------- (Loss) income from operations (1,148) 1,514 Interest and other income 1,400 913 --------------- --------------- Income before income taxes 252 2,427 Provision (benefit) for income taxes 81 (1,623) --------------- --------------- Net income $ 171 $ 4,050 =============== =============== Other comprehensive (loss), net of tax: Foreign currency translation adjustments (401) (97) Unrealized loss on investments (401) (39) --------------- --------------- Other comprehensive (loss) (802) (136) --------------- --------------- Total comprehensive income (loss) $ (631) $ 3,914 =============== =============== Earnings per share - basic $ 0.01 $ 0.17 =============== =============== Earnings per share - diluted $ 0.01 $ 0.17 =============== =============== Shares used in per share calculations - basic 22,775 23,426 =============== =============== Shares used in per share calculations - diluted 23,470 24,436 =============== ===============
The accompanying notes are an integral part of these condensed consolidated financial statements. -5- INTEGRATED SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) (unaudited) THREE MONTHS ENDED MAY 31, ------------------------------ 1999 1998 -------------- -------------- Cash flows from operating activities: Net income $ 171 $ 4,050 Adjustments to reconcile net income to net cash (used in) provided by operating activities: Depreciation and amortization 2,171 1,414 Deferred income taxes 137 (1,852) Deduction for doubtful accounts receivable (110) (270) Changes in assets and liabilities: Accounts receivable 3,016 4,414 Prepaid expenses and other 526 (763) Accounts payable, accrued payroll and other accrued liabilities (6,408) 237 Income taxes payable (656) (1,445) Deferred revenue 136 (558) Other assets and liabilities (602) 215 -------------- -------------- Net cash (used in) provided by operating activities (1,619) 5,442 -------------- -------------- Cash flows from investing activities: Maturities of marketable securities 11,124 4,712 Additions to property and equipment (1,599) (1,209) Capitalized software development costs (400) (80) -------------- -------------- Net cash provided by investing activities 9,125 3,423 -------------- -------------- Cash flows from financing activities: Repurchase of common stock (1,492) -- Proceeds from exercise of common stock options and purchases under the Employee Stock Purchase Plan 1,291 1,806 -------------- -------------- Net cash (used in) provided by financing activities (201) 1,806 -------------- -------------- Effect of exchange rate fluctuations on cash and cash equivalents (253) (594) Net increase in cash and cash equivalents 7,052 10,077 Cash and cash equivalents at beginning of period 19,079 14,454 -------------- -------------- Cash and cash equivalents at end of period $ 26,131 $ 24,531 ============== ============== Supplemental disclosure of cash flow information: Cash paid during the period for income taxes $ 607 $ 1,662 Supplemental schedule of noncash investing activities: Unrealized loss on marketable securities $ (668) $ (27)
The accompanying notes are an integral part of these condensed consolidated financial statements. -6- INTEGRATED SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Information for the three months ended May 31, 1999 and 1998 is unaudited) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The condensed consolidated financial statements include the accounts of Integrated Systems, Inc. and its wholly owned subsidiaries, after elimination of all significant intercompany accounts and transactions, and should be read in conjunction with ISI's Annual Report on Form 10-K for the year ended February 28, 1999. These condensed consolidated financial statements do not include all disclosures normally required by generally accepted accounting principles. Certain amounts in the fiscal year 1999 condensed consolidated financial statements have been reclassified to conform to the fiscal year 2000 presentation. These reclassifications had no effect on previously reported results of operations or shareholders' equity. 2. EARNINGS PER SHARE Earnings per share is computed in accordance with the provisions of Financial Accounting Standards Board Statement of Financial Accounting Standards No. 128 ("SFAS 128"), "Earnings Per Share." Basic earnings per share is computed using the weighted average numbers of common shares outstanding during the period. Diluted earnings per share is computed using the weighted average number of common and common equivalent shares outstanding during the period. Common equivalent shares result from the assumed exercise of outstanding stock options that have a dilutive effect when applying the treasury stock method. The following table sets forth the calculations of earnings per share: THREE MONTHS ENDED MAY 31, ----------------------- (in thousands, except per share data) 1999 1998 ---------- ----------- (unaudited) Basic: Net income $ 171 $ 4,050 ========== =========== Weighted average number of common shares outstanding 22,775 23,426 ========== =========== Earnings per share - basic $ 0.01 $ 0.17 ========== =========== Diluted: Net income $ 171 $ 4,050 ========== =========== Weighted average number of common shares outstanding 22,775 23,426 Dilutive effect of stock options, net 695 1,010 ---------- ----------- Weighted average number of common and common equivalent shares outstanding 23,470 24,436 ========== =========== Earnings per share- diluted $ 0.01 $ 0.17 ========== ===========
Certain options to purchase common stock were not included in the above calculations as their exercise prices were greater than the average market price of common stock in each respective period and their inclusion would be anti-dilutive. The number of such options excluded was approximately 1,264,000 and 581,000 for the three months ended May 31 1999 and 1998, respectively. -7- 3. BUSINESS SEGMENT INFORMATION ISI has two reportable segments, Software and Engineering Services. The Software segment includes design and development tools, real-time operating systems software and components, and provides related maintenance, training and consulting services for the embedded software market. The Engineering Services segment provides design expertise to the embedded software and other markets, and comprises Doctor Design. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. ISI evaluates performance based on profit or loss from operations before income taxes, excluding non-recurring gains and losses, acquisition-related and other costs, and interest and other income. ISI accounts for intersegment sales and transfers as if the sales or transfers were to third parties, that is, at current market prices. Corporate costs, such as those related to ISI's headquarters, are recorded in the Software segment. ISI's reportable segments are strategic business units that offer different products and services. They are managed separately because each business requires different technology and marketing strategies. The Engineering Services business was acquired as a unit and the management at the time of the acquisition has been retained. The following tables summarize revenue and operating profit before acquisition-related and other costs and before interest and other income for each segment. For the three months ended May 31, 1998 (in thousands):
ENGINEERING SOFTWARE SERVICES TOTAL ------------ --------------- ------------ Revenues from external customers.................................. $ 26,403 $ 5,079 $ 31,482 Intersegment revenue.............................................. - $ 1,242 $ 1,242 Depreciation...................................................... $ 785 $ 159 $ 944 Operating profit before acquisition-related and other costs and before interest and other income.................................. $ 1,012 $ 502 $ 1,514
For the three months ended May 31, 1999 (in thousands):
ENGINEERING SOFTWARE SERVICES TOTAL ------------ --------------- ------------ Revenues from external customers.............................. $ 25,191 $ 7,401 $ 32,592 Intersegment revenue.......................................... - - - Depreciation.................................................. $ 1,452 $ 206 $ 1,658 Operating profit (loss) before acquisition-related and other costs and before interest and other income.......... $ (1,429) $ 281 $ (1,148)
The following table summarizes property and equipment and capital expenditures, by segment, for the three months ended May 31, 1998 and 1999 (in thousands):
THREE MONTHS ENDED MAY 31, --------------------------- 1998 1999 ------------ ------------ Software: Property and equipment ........................ $ 17,209 $ 17,216 Capital expenditures .......................... $ 1,033 $ 1,478 Engineering Services: Property and equipment ........................ $ 1,424 $ 1,358 Capital expenditures .......................... $ 176 $ 121
-8- Revenue to non-affiliated customers analyzed on a geographical basis were as follows (in thousands):
THREE MONTHS ENDED MAY 31, -------------------------- 1998 1999 ------------ ------------- North America................................ $17,429 $18,951 Europe....................................... 7,954 8,759 Asia/Pacific................................. 6,099 4,882 ------------ ------------- Total................................... $31,482 $32,592 ============ =============
No customer accounted for 10% or more of total revenue in the reported periods. 4. COMPREHENSIVE INCOME (LOSS) The accumulated balances of other comprehensive income (loss), net of taxes, as of May 31, 1999 and 1998 are as follows (in thousands):
MAY 31, 1999 MAY 31, 1998 ------------------------------------------- ----------------------------------------- FOREIGN FOREIGN CURRENCY UNREALIZED CURRENCY UNREALIZED TRANSLATION GAINS/ TOTAL TRANSLATION GAINS/ TOTAL ADJUSTMENTS (LOSSES) OTHER ADJUSTMENTS (LOSSES) OTHER --------------- ------------- ------------- -------------- ------------ ------------ Beginning balance $ (967) $ 208 $ (759) $ (1,438) $ 148 $ (1,290) Current-period change (401) (401) (802) (97) (39) (136) --------------- ------------- ------------- -------------- ------------ ------------ Ending balance $ (1,368) $ (193) $ (1,561) $ (1,535) $ 109 $ (1,426) =============== ============= ============= ============== ============ ============
5. DERIVATIVE FINANCIAL INSTRUMENTS ISI's total contracted foreign currency forward exchange contracts as at May 31, 1999 and 1998 were as follows (in thousands):
MAY 31, 1999 MAY 31, 1998 -------------------------- -------------------------- UNREALIZED UNREALIZED GAINS/ GAINS/ COST (LOSSES) COST (LOSSES) ------------ ------------ ------------ ------------ Japanese Yen $ 1,327 $ (15) $ 5,200 $ 366 British Pound 807 6 - - French Franc 829 30 - - Italian Lira 330 14 - - German Mark 500 15 - - ------------ ------------ ------------ ------------ TOTAL $ 3,793 $ 50 $ 5,200 $ 366 ============ ============ ============ ============
ISI enters into foreign currency forward exchange contracts to hedge the value of recorded foreign currency denominated transactions against fluctuations in exchange rates. The purpose of ISI's foreign exchange exposure management policy and practices is to attempt to minimize the impact of exchange rate fluctuations on the value of the foreign currency denominated assets and liabilities being hedged. All foreign currency forward exchange contracts entered into by ISI have maturities of 360 days or less. -9- 6. RECENT ACCOUNTING PRONOUNCEMENTS In April 1998, the American Institute of Certified Public Accountants ("AICPA") issued Statement of Position 98-1 ("SOP 98-1"), "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." SOP 98-1 provides guidance for determining whether computer software is internal-use software and on the accounting for the proceeds of computer software originally developed or obtained for internal use and then subsequently sold to the public. It also provides guidance on capitalization of the costs incurred for computer software developed or obtained for internal use. ISI has adopted SOP 98-1 effective March 1, 1999, and the statement is not expected to have a significant impact on ISI's operating results, financial position or cash flows. In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities", which supercedes and amends a number of existing standards. The statement is effective for ISI's fiscal year 2001, but earlier application is permitted. The impact of the adoption of this statement, if any, on the financial statements of ISI has not yet been determined. In December 1998, the AICPA issued Statement of Position 98-9 ("SOP 98-9"), "Modification of SOP 97-2, Software Revenue Recognition with Respect to Certain Transactions". This statement supercedes SOP 98-4 and clarifies one of the provisions of SOP 97-2. SOP 98-9 is effective for all transactions entered into by ISI in fiscal year 2001. The adoption of this statement is not expected to have a material impact on ISI's operating results, financial position or cash flows. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following information should be read in conjunction with the condensed consolidated interim financial statements and the notes thereto included in Item 1 of this Quarterly Report and with Management's Discussion and Analysis of Financial Condition and Results of Operations contained in ISI's Annual Report on Form 10-K for the year ended February 28, 1999, as filed with the Securities and Exchange Commission on May 28, 1999. OVERVIEW Integrated Systems, Inc. provides solutions for embedded software development consisting of real-time operating systems and software components for embedded microprocessors; tools for designing, developing and optimizing embedded applications; networking products for device connectivity and management; and engineering design services for accelerated co-sourced product development. ISI's products help users accelerate the design, development, debugging, implementation and maintenance of embedded software. ISI's products and services are intended to reduce the expense associated with embedded software and system development and enable customers to develop systems featuring greater functionality, enhanced performance, improved reliability and ease-of-use. ISI markets and supports its products and provides services on a worldwide basis to a variety of users in a broad range of industries, including telecommunications, data communications, automotive, consumer electronics, office products and point-of-sale, and aerospace. Founded in 1980, ISI is headquartered in Sunnyvale, California, with a worldwide sales and service presence extending throughout Asia, Europe, and the Americas. FORWARD-LOOKING INFORMATION IS SUBJECT TO RISK AND UNCERTAINTY Except for the historical information contained in this Quarterly Report, the matters herein contain "forward-looking" statements and information. All forward-looking statements included in this document are based on information available to ISI on the date hereof, and ISI assumes no obligation to update any such forward-looking statements. ISI's actual results could differ materially from those discussed herein. Factors that could cause or contribute to such differences include, but are not limited to those discussed below, and to other risk factors detailed in ISI's Annual report on Form 10-K for the year ended February 28, 1999, and other documents filed by ISI with the Securities and Exchange Commission. -10- RESULTS OF OPERATIONS The following table sets forth for the periods presented the percentage of total revenue represented by each line item in ISI's condensed consolidated statements of income and the percentage change in each line item from the prior year period:
PERCENTAGE OF PERIOD-TO-PERIOD TOTAL REVENUE PERCENTAGE CHANGE ------------------------- ----------------------------- THREE MONTHS ENDED THREE MONTHS ENDED MAY 31, MAY 31, 1999 1998 1999 COMPARED TO 1998 ----------- ----------- ----------------------------- Revenue: Product 58 % 55 % 10 % Services 42 45 (5) ----------- ----------- Total revenue 100 100 4 ----------- ----------- Costs and expenses: Cost of product revenue 15 10 57 Cost of services revenue 18 19 1 Marketing and sales 43 38 16 Research and development 16 17 (2) General and administrative 11 11 4 ----------- ----------- Total costs and expenses 103 95 13 ----------- ----------- (Loss)income from operations (3) 5 NM Interest and other income 4 3 53 ----------- ----------- Income before income taxes 1 8 NM Provision(benefit) for income taxes - (5) NM ----------- ----------- Net income 1 % 13 % (96)% ----------- ----------- ----------- -----------
NM = Not Meaningful REVENUE Revenue consists of fees from the licensing of software products ("Product Revenue") and from the maintenance and support of software products, customer training, and engineering services ("Services Revenue"). Total revenue increased by 4% from $31.5 million in the first quarter of fiscal year 1999 to $32.6 million in the first quarter of fiscal year 2000. ISI operates in two business segments, the Software segment and the Engineering Services segment, each of which contribute Product Revenue and Services Revenue. The Software segment includes design and development tools, RTOS software and components, and also provides related maintenance, training and consulting services for the embedded software market. The Engineering Services segment provides design expertise to the embedded software and other markets. This segment is managed separately as ISI's subsidiary, Doctor Design. -11- Components of ISI's revenue by segment for the first quarter of fiscal years 1999 and 2000 were as follows: THREE MONTHS ENDED MAY 31, 1998:
Engineering Software Services Total -------- ----------- ------- Product ..................... $16,792 $ 369 $17,161 Services .................... 9,611 4,710 $14,321 ------- ------- ------- Total ....................... $26,403 $ 5,079 $31,482 ======= ======= =======
THREE MONTHS ENDED MAY 31, 1999:
Engineering Software Services Total -------- ----------- ------- Product ..................... $16,430 $ 2,519 $18,949 Services .................... 8,761 4,882 $13,643 ------- ------- ------- Total ....................... $25,191 $ 7,401 $32,592 ======= ======= =======
Product revenue increased 10% from $17.2 million in the first quarter of fiscal year 1999 to $18.9 million in the first quarter of fiscal 2000. The percentage of ISI's total revenue attributable to product revenue increased from 55% in the first quarter of fiscal year 1999 to 58% in the first quarter of fiscal 2000 due primarily to a Doctor Design product sale of $2.5 million, partially offset by a slight decline in licensing of ISI's MATRIXx-Registered Trademark- products. Services revenue decreased 5% from $14.3 million in the first quarter of fiscal year 1999 to $13.6 million in the first quarter of fiscal year 2000. The decrease was due primarily to ISI's decision to shift away from lower margin, fixed-price government contracts, which contributed $1.6 million in the first quarter of fiscal year 1999, and no revenue in the first quarter of fiscal year 2000, offset by continued growth of the installed customer base and the renewal of maintenance and support contracts, and by growth in consulting and engineering services revenue at Doctor Design. Price increases were not a material factor in ISI's revenue growth in the periods presented. The percentage of ISI's total revenue from customers located internationally was 45% of total revenue in the first quarter of fiscal year 1999 and 42% of total revenue in the first quarter of fiscal year 2000. The decrease in international revenue as a percentage of total revenue in the first quarter of fiscal year 2000 was due primarily to a decline in revenue in the Asia/Pacific region. COSTS AND EXPENSES Cost of product revenue includes third-party royalties, costs of product packaging, documentation, amortization of capitalized software development costs, and the costs related to equipment hardware. Cost of product revenue as a percentage of product revenue was 18% in the first quarter of fiscal year 1999 and 26% in the first quarter of fiscal year 2000. The increase in cost of product revenue as a percentage of product revenue is due primarily to the Doctor Design product sale discussed above, which had a low margin. Excluding the effect of this sale, cost of product revenue was 19% of product revenue in the first quarter of fiscal year 2000. Cost of services revenue includes personnel and related direct costs associated with providing training, maintenance, engineering and consulting services to customers and the infrastructure to manage a services organization. In general, there are two primary reasons for cost of services revenue as a percentage of services revenue to fluctuate: first, due to shifts in the services revenue mix between higher margin maintenance and support revenues and lower margin engineering services revenues, and secondly, the cost of services revenue as a percentage of services revenue can fluctuate due to shifts in the proportion of fixed price versus time and material engineering contracts. Fixed price engineering and consulting contracts generally have lower gross margins than time and material contracts. ISI's cost of services revenue as a percentage of services revenue was 41% in the first quarter of fiscal year 1999 and 44% in the first quarter of fiscal year 2000. There were two contributing factors to the change in ISI's cost of services revenue as a percentage of services revenue. Despite the absence of low margin fixed-price government contracts in the first quarter of fiscal year 2000, there was shift in engineering services revenue mix at Doctor Design. -12- Marketing and sales expenses increased by 16% from $12.1 million in the first quarter of fiscal year 1999 to $14.0 million in the first quarter of fiscal year 2000 and represented 38% of total revenue in the first quarter of fiscal year 1999 and 43% of total revenue in the first quarter of fiscal year 2000. The dollar increase in marketing and sales expenses in the first quarter of fiscal year 2000 was due to continued growth of the domestic and international sales and support infrastructure. ISI believes that investment in product research and development is essential to product and technical leadership. Research and development expenses decreased slightly from $5.4 million in the first quarter of fiscal year 1999 to $5.3 million in the first quarter of fiscal year 2000. ISI's investment in product research and development actually increased in the first quarter of fiscal year 2000 over the first quarter of fiscal year 1999, but was partially offset by an increase in capitalization of software product development costs from $80,000 in the first quarter of fiscal year 1999 to $400,000 in the first quarter of fiscal year 2000. ISI anticipates that it will continue to devote substantial resources to product research and development throughout fiscal year 2000. General and administrative expenses were $3.4 million in the first quarter of fiscal year 1999 compared to $3.5 million in the first quarter of fiscal year 2000 and represented 11% of total revenue in both periods. Interest and other income increased from $0.9 million in the first quarter of fiscal year 1999 to $1.4 million in the first quarter of fiscal year 2000 due primarily to more favorable interest rates on interest-bearing cash equivalents and marketable securities and to increased rental income in the first quarter of fiscal year 2000. Net income in the first quarter of fiscal year 1999 was positively impacted by a $2.4 million one-time federal tax benefit related to a tax election made during the quarter. Excluding this tax benefit, the effective tax rate for the first quarter of fiscal year 1999 was 32%. The effective tax rate for the first quarter of fiscal year 2000 was also 32%. RECENT ACCOUNTING PRONOUNCEMENTS In April 1998, the American Institute of Certified Public Accountants ("AICPA") issued Statement of Position 98-1 ("SOP 98-1"), "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." SOP 98-1 provides guidance for determining whether computer software is internal-use software and on the accounting for the proceeds of computer software originally developed or obtained for internal use and then subsequently sold to the public. It also provides guidance on capitalization of the costs incurred for computer software developed or obtained for internal use. ISI has adopted SOP 98-1 effective March 1, 1999, and the statement is not expected to have a significant impact on ISI's operating results, financial position or cash flows. In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities", which supercedes and amends a number of existing standards. The statement is effective for ISI's fiscal year 2001, but earlier application is permitted. The impact of the adoption of this statement, if any, on the financial statements of ISI has not yet been determined. In December 1998, the AICPA issued Statement of Position 98-9 ("SOP 98-9"), "Modification of SOP 97-2, Software Revenue Recognition with Respect to Certain Transactions". This statement supercedes SOP 98-4 and clarifies one of the provisions of SOP 97-2. SOP 98-9 is effective for all transactions entered into by ISI in fiscal year 2001. The adoption of this statement is not expected to have a material impact on ISI's operating results, financial position or cash flows. "YEAR 2000" ISSUES ISI believes that all of its most current product releases will not cease to perform nor generate incorrect or ambiguous data or results solely due to a change in date to or after January 1, 2000, and will calculate any information dependent on such dates in the same manner, and with the same functionality, data integrity, and performance, as such products do on or before December 31, 1999 (collectively, "Year 2000 Compliance"). However, there can be no assurance that all of ISI's customers will implement the Year 2000 compliant release of ISI's products in a timely manner, which could lead to failure of customer systems and product liability claims against ISI. Even if ISI's products are Year 2000 compliant, ISI may, in the future, be subject to claims based on Year 2000 issues in the products of other companies or issues arising from the integration of multiple products within a system. The costs of defending and resolving Year 2000-related disputes, and any liability of ISI for Year 2000-related damages, including consequential damages, could have a material adverse effect on ISI's business, financial condition and results of operations. Such failure could also affect the perceived performance of ISI's products, which could have a negative effect on ISI's competitive position. -13- ISI is reviewing its operations for Year 2000 Compliance and has identified three categories of risk: internal business software, internal non-financial software and embedded chip technology, and external noncompliance by suppliers. With respect to internal business software, ISI is 80% towards being fully compliant and expects to be in full compliance before the year 2000. Accordingly, ISI has not developed formal contingency plans and feels there is minimal risk that the systems will not be compliant before Year 2000. All financial, order processing and manufacturing software is fully Year 2000 Compliant. With respect to internal non-financial software and embedded chip technology, ISI is currently gathering data to assess the impact of the Year 2000 on systems such as security equipment and telephones, with Year 2000 Compliance scheduled for late 1999. Assessment and implementation plans are already being executed in approximately 50% of these areas. If ISI is unable to achieve Year 2000 Compliance for its major non-financial systems, the year 2000 could have a material impact on the operations of ISI. It is estimated that ISI is 50% towards being in full compliance. ISI does not currently have a contingency plan in place for its internal non-financial software and embedded chip technology. With respect to external noncompliance by suppliers, ISI is in the process of identifying and contacting its critical suppliers, service providers and contractors to determine the extent to which ISI's interface systems are vulnerable to those third parties' failure to remedy their own Year 2000 issues. It is expected that full identification will be completed by late 1999. To the extent that responses to Year 2000 readiness are unsatisfactory, ISI intends to change suppliers, service providers or contractors to those who have demonstrated Year 2000 readiness but cannot be assured that it will be successful in finding such alternative suppliers, service providers and contractors. ISI currently has formal information concerning the Year 2000 Compliance status of about 50% of its suppliers including most of its critical suppliers. In the event that any of ISI's critical suppliers do not successfully and timely achieve Year 2000 Compliance, and ISI is unable to replace them with new or alternate suppliers, ISI's business or operations could be adversely affected. All costs associated with carrying out ISI's plan for the Year 2000 Compliance are being expensed as incurred, and are being funded from cash provided from operations. As of May 31, 1999 it is estimated that costs associated with preparation for the Year 2000 were approximately $900,000 and that a further $1.0 million will be incurred to complete the above plans. Of these amounts, approximately $500,000 is to cover new/replacement technologies, and $1.4 million is of a repair or upgrade nature. LIQUIDITY AND CAPITAL RESOURCES ISI funds its operations principally through cash flows from operations. As of May 31, 1999, ISI had $73.6 million of cash, cash equivalents and marketable securities. This represents a decrease of $4.7 million from February 28, 1999. Net cash used in operating activities was $1.6 million during the first quarter of fiscal year 2000. This represents a decrease of $7.1 million from the amount generated in the first quarter of fiscal year 1999. Net cash from operating activities decreased in the first quarter of fiscal year 2000, due primarily to a large decrease in accrued liabilities related to the Green Hills legal settlement. Net cash provided by investing activities was $9.1 million in the first quarter of fiscal year 2000. This compares to net cash provided by investing activities of $3.4 million in the first quarter of fiscal year 1999. The difference between the two comparative quarters is due primarily to the timing of purchases and maturities of marketable securities. Net cash used in financing activities totaled $0.2 million in the first quarter of fiscal year 2000 compared to net cash provided of $1.8 million in the first quarter of fiscal year 1999. The difference was due primarily to the repurchase of approximately 116,000 shares of common stock, combined with a decrease in the proceeds from the exercise of options to purchase common stock and purchases under the employee Stock Purchase Plan. ISI believes that the cash flows from operations, together with existing cash and investment balances, will be adequate to meet ISI's cash requirements for working capital, capital expenditures and stock repurchases for at least the next 12 months. -14- RISK FACTORS THIS SECTION ON "RISK FACTORS" INCLUDES FORWARD-LOOKING STATEMENTS THAT REFLECT ISI'S CURRENT VIEWS WITH RESPECT TO FUTURE MATTERS. THE FOLLOWING DISCUSSION ALSO CONTAINS CAUTIONARY STATEMENTS THAT IDENTIFY IMPORTANT FACTORS, INCLUDING CERTAIN RISKS AND UNCERTAINTIES, THAT MAY CAUSE ACTUAL RESULTS OR OUTCOMES TO DIFFER MATERIALLY FROM THOSE IN THE FORWARD-LOOKING STATEMENTS. FLUCTUATIONS IN QUARTERLY RESULTS MAKE PERIOD-TO-PERIOD COMPARISONS DIFFICULT. ISI's quarterly operating results can vary significantly depending on a number of factors. These factors include: - the volume and timing of orders received during the quarter; - the mix of and changes in customers to whom ISI's products are sold; - the timing and acceptance of new products and product enhancements by ISI or its competitors; - changes in pricing; - buyouts of run-time licenses; - product life cycles; - the level of ISI's sales of third party products; - mix of engineering and support services; - purchasing patterns of customers; - competitive conditions in the industry; - foreign currency exchange rate fluctuations; - business cycles affecting the markets in which ISI's products are sold; - extraordinary events, such as litigation or acquisitions, including related charges; and - economic conditions generally or in various geographic areas. All of these factors are difficult to forecast. The future operating results of ISI may fluctuate as a result of these and other factors, including ISI's ability to continue to develop innovative and competitive products. ISI historically has operated with insignificant product backlog because its products are generally shipped as orders are received. As a result, product revenue in any quarter depends on the volume and timing of orders received in that quarter. In addition, ISI generally recognizes a substantial portion of its total quarterly revenue from sales orders received and shipped in the last two weeks of the quarter. Thus, the magnitude of quarterly fluctuations may not become evident until very late in, or after the end of, a particular quarter. In addition, a significant amount of ISI's sales orders involve products and services that yield revenue over multiple quarters or upon completion of performance. If license agreements entered into during a quarter do not meet ISI's revenue recognition criteria, even if ISI meets or exceeds its forecast of aggregate licensing and other contracting activity, it is possible that ISI's revenues would not meet expectations. Because ISI's staffing and operating expenses are based on anticipated total revenue levels, and a high percentage of ISI's costs are fixed in the short term and do not vary with revenue, small variations between anticipated orders and actual orders, as well as non-recurring or large orders, can cause disproportionate variations in ISI's operating results from quarter to quarter. The procurement process of ISI's customers typically ranges from a few weeks to several months or longer from initial inquiry to order, making the timing of sales and license fees difficult to predict. Moreover, as licensing of ISI's products increasingly becomes a more strategic decision made at higher management levels, ISI believes that sales cycles for ISI's products will lengthen. In addition, a portion of ISI's revenues from services are earned pursuant to fixed price contracts. Variances in costs associated with those contracts could have a material adverse effect on ISI's business and results of operations. ISI's results of operations may also be affected by seasonal trends. While ISI's revenues are not generally seasonal in nature, ISI's total revenue and net income during the first fiscal quarter have historically been lower than the previous fourth fiscal quarter for a variety of reasons, including customer purchase cycles related to expiration of budgetary authorizations. Due to all of the foregoing factors, ISI believes that period-to-period comparisons of its results of operations are not necessarily meaningful and should not be relied upon as an indication of future performance. During previous fiscal years, ISI has experienced actual performance that did not meet financial market expectations. It is possible that, in some future quarters, ISI's operating results will again be below the expectations of stock market analysts and investors. ISI'S ABILITY TO REMAIN COMPETITIVE DEPENDS ON ITS ABILITY TO INTRODUCE PRODUCT ENHANCEMENTS AND NEW PRODUCTS QUICKLY THAT MEET CUSTOMER DEMANDS. The market for embedded applications is fragmented and is characterized by ongoing technological developments, evolving industry standards and rapid changes in customer requirements. -15- ISI's success depends upon its ability to continue to develop and introduce in a timely manner new products that take advantage of technological developments, to continue to enhance its existing product lines, to offer its products across a spectrum of microprocessor families used in the embedded systems market and to respond promptly to customers' requirements and preferences. ISI must continuously update its existing products to keep them current with changing technology and must develop new products to take advantage of new technologies that could render ISI's existing products obsolete. Development delays are commonplace in the software industry. ISI has experienced delays in the development of new products and the enhancement of existing products in the past and is likely to experience delays in the future. If the results of product development efforts are inadequate or delayed, ISI's business, financial condition and results of operations would be materially adversely affected. ISI may not be successful in developing and marketing, on a timely basis or at all, competitive products, product enhancements and new products that respond to technological change, changes in customer requirements and emerging industry standards. In addition, ISI's enhanced or new products may not adequately address the changing needs of the marketplace. The inability of ISI, due to resource constraints or technological or other reasons, to develop and introduce new products or product enhancements in a timely manner could have a material adverse effect on ISI's business, financial condition or results of operations. From time to time, ISI or its competitors may announce new products, capabilities or technologies that have the potential to replace or shorten the life cycles of ISI's existing products. Announcements of currently planned or other new products may cause customers to defer purchasing existing ISI products. Any failure by ISI to anticipate or respond adequately to changing market conditions, or any significant delays in product development or introduction, would have a material adverse effect on ISI's business, financial condition and results of operations. COMPETITION CAN LEAD TO PRICING PRESSURES. The market for commercially available software tools and embedded operating systems is fragmented, highly competitive and is characterized by pressures to incorporate new features and accelerate the release of new product versions. As the industry continues to develop, ISI expects competition to increase in the future from existing competitors and from other companies that may enter ISI's existing or future markets with similar or substitute solutions that may be less costly or provide better performance or functionality than ISI's products. Some of ISI's existing and many of its potential competitors have substantially greater financial, technical, marketing and sales resources than ISI and ISI might not be able to compete successfully against these companies. In the event that price competition increases significantly, competitive pressures could cause ISI to reduce the prices of its products, which would result in reduced profit margins and could negatively affect the ability of ISI to provide adequate service to its customers. Prolonged price competition would have a material adverse effect on ISI's business, financial condition and results of operations. Also, run-time licenses, which provide for per-unit royalty payments for each embedded system that incorporates ISI's real-time operating systems, may be subject to significant pricing pressures, including buy-out arrangements. A variety of other potential actions by ISI's competitors, including increased promotion and accelerated introduction of new or enhanced products, could have a material adverse effect on ISI's business, financial condition and results of operations. In addition, ISI's pricing model for software licenses may be subject to market pressure. The pricing model for ISI's embedded software products is based on a range of mid-priced development license packages, combined with low-priced per-unit production (run-time) licenses. In the future, the market may demand alternative pricing models. This may result in a material adverse effect on ISI's business, financial condition and results of operations. ISI MUST EFFECTIVELY INTEGRATE ACQUIRED BUSINESSES. ISI has completed a number of acquisitions in recent years and may complete additional acquisitions in the future. The process of integrating an acquired company's business into ISI's operations may result in unforeseen operating difficulties and expenditures and may absorb significant management attention that would otherwise be available for the ongoing development of ISI's business. Moreover, the anticipated benefits of an acquisition might not be realized. Future acquisitions by ISI could result in potentially dilutive issuances of equity securities, debt-obligations and contingent liabilities, the use of cash reserves, and amortization expenses related to goodwill and other intangible assets, which could have a material adverse effect on ISI's business, financial condition and results of operations. In addition, acquisitions involve numerous risks, including difficulties in the assimilation of the operations, technologies and products of the acquired companies, difficulties in managing diverse geographic sales and research and development operations, the diversion of management attention from other business concerns, risks of entering markets in which ISI has no or limited direct prior experience and the potential loss of key employees of the acquired company. ISI IS SUBJECT TO THE BUSINESS AND ECONOMIC RISKS OF INTERNATIONAL OPERATIONS. In fiscal years 1998 and 1999 and in the first quarter of fiscal year 2000, ISI derived approximately 41%, 42% and 42%, respectively, of its total revenue from sales outside of North America. ISI expects that international sales will continue to generate a significant percentage of its total revenue in the foreseeable future. International operations are subject to a number of special risks. These risks include: -16- - foreign government regulation; - reduced protection of intellectual property rights in some countries where ISI does business; - longer receivable collection periods and greater difficulty in accounts receivable collection; - unexpected changes in, or imposition of, regulatory requirements, tariffs, import and export restrictions and other barriers and restrictions; - potentially adverse tax consequences; - the burdens of complying with a variety of foreign laws and staffing and managing foreign operations; - exchange rate fluctuations; - general geopolitical risks, such as political and economic instability, hostilities with neighboring countries and changes in diplomatic and trade relationships; and - possible recessionary environments in economies outside the United States. ISI generally denominates sales to and by foreign subsidiaries in local currency. An increase in the relative value of the dollar against local currencies would reduce ISI's revenue in dollar terms or make ISI's products more expensive and, therefore, potentially less competitive in foreign markets. For example, revenue from sales in Japan during fiscal years 1998 and 1997 was adversely affected by the weakness of the yen against the dollar. Similarly, the currencies of many other countries in the Asia/Pacific region have recently lost significant value against the dollar, notably the currencies of Korea and Taiwan. ISI's future results of operations could be adversely affected by currency fluctuations. More generally, recent instability in Asian currency and stock market economies could adversely affect the economic health of the entire region and could have an adverse effect on ISI's results of operations. For example, in many countries in the Asia/Pacific region, during fiscal years 1998 and 1999 there was little or no growth in investment in product development infrastructure by manufacturing companies. In the first quarter of fiscal year 2000, ISI experienced a decline in total revenue in the Asia/Pacific region. ISI relies on distributors and representatives for sales of its products in some foreign countries and, accordingly, depends on their ability to promote and support ISI's products and, in some cases, to translate them into foreign languages. ISI's international distributors and representatives generally offer products of several different companies, including in some cases products that are competitive with ISI's products, and these distributors and representatives are not subject to any minimum purchase or resale requirements. ISI's international distributors and representatives may not continue to purchase ISI's products or provide them with adequate levels of support. PRODUCT DEFECTS CAN BE EXPENSIVE TO FIX AND CAN CAUSE ISI TO LOSE CUSTOMERS. As a result of their complexity, software products may contain undetected errors or compatibility issues, particularly when first introduced or as new versions are released. Despite testing by ISI and testing and use by current and potential customers, errors might be found in new products after commencement of commercial shipments. The occurrence of errors could result in loss of or delay in market acceptance of ISI's products, which could have a material adverse effect on ISI's business, financial condition and results of operations. The increasing use of ISI's products for applications in systems that interact directly with the general public, particularly applications in transportation, medical systems and other markets where the failure of the embedded system could cause substantial property damage or personal injury, could expose ISI to significant product liability claims. In addition, ISI's products are used for applications in business systems where the failure of the embedded system could be linked to substantial economic loss. ISI's license and other agreements with its customers typically contain provisions designed to limit ISI's exposure to potential product liability and other claims. It is likely, however, that the limitation of liability provisions contained in ISI's agreements are not effective in all circumstances and in all jurisdictions. ISI does not have insurance against product liability risks and insurance may not be available to ISI on commercially reasonable terms. ISI has errors and omissions insurance; however, this insurance may not be adequate to cover claims. A product liability claim or claim for economic loss brought against ISI, or a product recall involving ISI's software, could have a material adverse effect on ISI's business, financial condition and results of operations. ISI's operations depend on its ability to protect its computer equipment and the information stored in its databases against damage by fire, natural disaster, power loss, telecommunications failure, unauthorized intrusion and other catastrophic events. ISI believes it has taken prudent measures to reduce the risk of interruption in its operations. However, these measures might not be sufficient. Any damage or failure that causes interruption in ISI's operations could have a material adverse effect on its business, financial condition, and results of operations. ISI FACES INTENSE COMPETITION FOR QUALIFIED EMPLOYEES. ISI's future performance depends to a significant degree upon the continued contributions of its key management, product development, sales, marketing and operations personnel. In addition, ISI believes its future success will also depend in large part upon its ability to attract and retain highly skilled managerial, engineering, sales, marketing and operations personnel, many of whom are in great demand. Competition for qualified personnel is intense in Santa Clara County, California, where ISI is headquartered, and there can be no assurance that ISI will be successful in attracting and retaining personnel. The -17- failure of ISI to attract, assimilate and retain the necessary personnel could have a material adverse effect on ISI's business, financial condition and results of operations. ISI DEPENDS ON ITS INTELLECTUAL PROPERTY RIGHTS, AND IS SUBJECT TO THE RISKS OF INFRINGEMENT. ISI depends on its proprietary technology. Despite ISI's efforts to protect its proprietary rights, it may be possible for unauthorized third parties to copy ISI's products or to reverse engineer or obtain and use information that ISI regards as proprietary. Policing unauthorized use of ISI's products is difficult, and while ISI is unable to determine the extent to which software piracy of its products exists, software piracy can be expected to be a persistent problem. In addition, effective protection of intellectual property rights may be unavailable or limited in foreign countries. The status of United States patent protection in the software industry is not well defined and will evolve as the United States Patent and Trademark Office grants additional patents. Patents have been granted on fundamental technologies in software, and patents may be issued that relate to fundamental technologies incorporated into ISI's products. As the number of patents, copyrights, trademarks and other intellectual property rights in ISI's industry increases, products based on its technology may increasingly become the subject of infringement claims. Third parties could assert infringement claims against ISI in the future. Infringement claims with or without merit could be time consuming, result in costly litigation, cause product shipment delays or require ISI to enter into royalty or licensing agreements. Royalty or licensing agreements, if required, might not be available on terms acceptable to ISI, or at all, which could have a material adverse affect on ISI's business, financial condition and results of operations. In addition, ISI may initiate claims or litigation against third parties for infringement of ISI's proprietary rights or to establish the validity of ISI's proprietary rights. Litigation to determine the validity of any claims, whether or not the litigation is resolved in favor of ISI, could result in significant expense to ISI and divert the efforts of ISI's technical and management personnel from productive tasks. In the event of an adverse ruling in any litigation, ISI might be required to pay substantial damages, discontinue the use and sale of infringing products and expend significant resources to develop non-infringing technology or obtain licenses to infringing technology. The failure of ISI to develop or license a substitute technology could have a material adverse affect on ISI's business, financial condition and results of operations. ISI RELIES ON THIRD-PARTY LICENSES FOR SOME OF ITS PRODUCTS. ISI licenses software development tool products from other companies to distribute with its own products. The inability of these third parties to provide competitive products with adequate features and high quality on a timely basis or to provide sales and marketing cooperation could have a material adverse effect on ISI's business, financial condition and results of operations. In addition, ISI's products compete with products produced by some of ISI's licensors. When these licenses terminate or expire, continued license rights might not be available to ISI on reasonable terms. In addition, ISI might not be able to obtain similar products to substitute into the tool suites. The inability to license these products could have a material adverse effect on ISI's business, financial condition and results of operations. THE MARKET PRICE OF ISI'S STOCK HAS BEEN VOLATILE. The prices for ISI's common stock have fluctuated widely in the past. During the 12 months ended February 28, 1999, the closing price of a share of ISI common stock ranged from a high of $19.31 to a low of $6.25. The management of ISI believes that stock price fluctuations may have been caused by actual or anticipated variations in ISI's operating results, announcements of technical innovations or new products or services by ISI or its competitors, changes in earnings estimates by securities analysts and other factors, including changes in conditions of the software and other technology industries in general. Stock markets have experienced extreme price volatility in recent years. This volatility has had a substantial effect on the market prices of securities issued by ISI and other high technology companies, often for reasons unrelated to the operating performance of the specific companies. In the past, following periods of volatility in the market price of a company's securities, securities class action litigation has often been instituted against the company. Litigation, if instituted, could result in substantial costs and a diversion of management attention and resources, which would have a material adverse effect on ISI's business, financial condition and results of operations even if ISI is successful in any suits. These market fluctuations, as well as general economic, political and market conditions such as recessions, may adversely affect the market price of the common stock. FINANCIAL STATEMENTS ARE BASED ON ESTIMATES AND ASSUMPTIONS. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the recorded amounts of assets and liabilities at the date of the financial statements and the recorded amounts of revenues and expenses during the reporting period. A change in the facts and circumstances surrounding these estimates could result in a change to the estimates and impact future operating results. -18- ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS ISI enters into foreign currency forward exchange contracts to reduce the impact of currency exchange rate fluctuations on monetary asset and liability positions. The objective of these contracts is to minimize the impact of exchange rate fluctuations on ISI's operating results. Gains and losses associated with exchange rate fluctuations on foreign currency forward exchange contracts are recorded in income as they offset corresponding gains and losses on the foreign currency denominated assets and liabilities being hedged. The costs of the foreign currency forward exchange contracts are also recorded in income. All foreign currency forward exchange contracts entered into by ISI have maturities of less than one year. At May 31, 1999, ISI had approximately $3.8 million of foreign currency forward exchange contracts outstanding, in Japanese yen and numerous European currencies. At May 31, 1998 ISI had approximately $5.2 million of foreign currency forward exchange contracts outstanding, all in Japanese yen. Unrealized gains on foreign currency forward exchange contracts at May 31, 1999 and May 31, 1998 were approximately $50,000 and $366,000, respectively. ISI believes that the fair market value of its portfolio of marketable securities or related income would not be significantly impacted by increases or decreases in interest rates due mainly to the short-term nature of the portfolio. However, an increase in interest rates could have a material adverse effect on the fair value of the portfolio. Conversely, declines in interest rates could harm interest income from the portfolio. -19- PART II - OTHER INFORMATION --------------------------- ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (A) EXHIBITS.
The following exhibit is filed herewith: Exhibit Page Number Title Number ------- ----- ------ 27.01 Financial Data Schedule 22
(B) REPORTS ON FORM 8-K. No reports on Form 8-K were filed by Registrant during the three months ended May 31, 1999. -20- SIGNATURES ---------- Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Dated: July 15, 1999 INTEGRATED SYSTEMS, INC. (Registrant) /s/ CHARLES M. BOESENBERG ------------------------------------- CHARLES M. BOESENBERG President and Chief Executive Officer /s/ WILLIAM C. SMITH ------------------------------------- WILLIAM C. SMITH Vice President, Finance and Chief Financial Officer -21- EX-27.1 2 EX-27.1
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM Q1 FY00 FORM 10-Q FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 3-MOS FEB-28-2000 MAR-01-1999 MAY-31-1999 26,131 2,382 25,377 0 0 61,109 18,574 0 135,275 35,316 0 0 0 59,647 40,312 135,275 18,949 32,592 4,909 10,903 22,837 0 0 252 81 171 0 0 0 171 0.01 0.01
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