SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
Date of Report (Date of earliest event reported): January 26, 1996
INTEGRATED SYSTEMS, INC.
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(Exact name of Registrant as specified in its charter)
California
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(State or other jurisdiction of incorporation)
0-18268 94-2658153
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(Commission (IRS Employer
File Number) Identification No.)
3260 Jay Street, Santa Clara, California 95054-3309
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(Address of principal executive offices) (Zip code)
(408) 980-1500
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(Registrant's telephone number, including area code)
Not Applicable
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(Former name or former address, if changed since last report)
ITEM 2: ACQUISITION OR DISPOSITION OF ASSETS.
On January 26, 1996, Integrated Systems, Inc., a California
corporation ("Registrant" or "ISI"), acquired control of Doctor Design, Inc., a
California corporation ("DDI"), pursuant to the merger (the "Merger") of ISI
Purchasing Corporation, a Delaware corporation and a wholly owned subsidiary of
ISI ("Sub") with and into DDI. The Merger was effected pursuant to an Agreement
of Merger dated as of January 26, 1996 by and between Sub and DDI and an
Agreement and Plan of Reorganization dated as of December 14, 1995, as amended
January 26, 1996 (the "Plan"), by and among ISI, Sub and DDI. The Merger was
accounted for as a pooling of interests and was structured to be a "tax-free"
reorganization for federal income tax purposes. The directors and executive
officers of Registrant were not changed as a result of the Merger. Prior to the
Merger, DDI was a provider of high-end design services to the computer and
communications industries, specializing in the area of embedded multimedia.
After completion of the Merger, DDI will continue its historical business as a
wholly owned subsidiary of ISI.
Pursuant to the terms of the Plan, each share of DDI Common
Stock ("DDI Common Stock") issued and outstanding immediately before the
effective time of the Merger was exchanged for approximately .148612 shares of
Registrant's Common Stock. Pursuant to this exchange ratio, in the Merger a
total of 371,607 shares of Registrant's Common Stock were issued in exchange for
all of the outstanding DDI Common Stock. In addition, Registrant assumed each
option to purchase DDI Common Stock outstanding immediately before the effective
time of the Merger. Each DDI option is exercisable for that number of shares of
Registrant's Common Stock equal to .148612 multiplied by the number of shares of
DDI Common Stock purchasable under the DDI options immediately before the
effective time of the Merger. Pursuant to this exchange ratio, Registrant may
issue up to 131,862 shares of its Common Stock upon exercise of the assumed
options. Assuming exercise of all assumed options, Registrant may ultimately
issue a total of up to 503,469 shares of its Common Stock. The exchange ratio
was determined on the basis of, among other things (i) a comparison of certain
financial and stock market information for Registrant and certain financial
information for DDI with similar types of information for certain other
companies in businesses similar to those of Registrant and DDI and (ii)
discussions between senior management of Registrant and DDI regarding the
business and prospects of their respective companies.
The shares of Registrant's Common Stock received by the former
DDI shareholders have not been registered under the Securities Act of 1933, as
amended (the "1933 Act"), in reliance upon the exemption from registration
provided by Section 3(a)(10) thereof.
In connection with the Merger, ISI, Chemical Trust Company of
California, as escrow agent, and the former DDI shareholders entered into an
escrow agreement (the "Escrow Agreement") under which ISI deposited into escrow
stock certificates representing 10% of the shares of Registrant's Common Stock
issuable pursuant to the Merger and will deposit 10% of the shares of
Registrant's Common Stock issued upon exercise of the DDI options assumed by
Registrant (the "Escrow Shares"). The Escrow Shares will be held in escrow as
collateral for the indemnification obligations of DDI under the Plan. The
indemnification obligations of DDI will expire (i) for items expected to be
encountered in the audit process, when ISI receives audited financial statements
together with a report thereon from its independent auditors covering the
combined results of ISI and DDI for the ISI fiscal year ending February 29, 1996
(but no later than one year from the closing of the Merger), provided that ISI
has a reasonable period of time, not to exceed 90 days, to review the audit
results to determine if any claim exists and must provide notice of any claim
within the 90 day period and (ii) for all other items, 12 months after the
closing of the Merger.
Contemporaneously with the Merger, Marco Thompson, the
President and Chief Executive Officer of DDI, entered into employment and
noncompetition agreements with Registrant. The employment agreement provides for
a three-year term of employment at a minimum salary of $150,000 per year and a
target bonus of $125,000, payable upon achievement of certain agreed upon goals.
Upon termination of the employment agreement by ISI for cause as defined in the
agreement, all compensation and benefits payable under the employment agreement
are payable through the date of termination. The noncompetition agreement
provides that Mr. Thompson will not compete with Registrant for a period of
three years following the Merger.
- 2 -
In connection with the Merger, Mr. Thompson also transferred
to ISI ownership of the building in which a portion of the DDI business is
located and terminated DDI's lease of the premises, in consideration of ISI
paying the outstanding debt on the property. The number of shares issued to Mr.
Thompson in the Merger in exchange for his DDI Common Stock was reduced by 8,199
shares or $280,406, which is the amount that the outstanding debt on the
property exceeded the appraised current fair market value of the property.
ITEM 7: FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS.
(a) Financial Statements of Businesses Acquired.
The following Financial Statements of Doctor Design, Inc. are filed
herewith:
Report of Independent Auditors
Balance Sheets as of June 30, 1995 and 1994
Statements of Income for the years ended June 30, 1995 and 1994
Statements of Shareholders' Equity for the years ended June 30, 1995
and 1994
Statements of Cash Flows for the years ended June 30, 1995 and 1994
Notes to Financial Statements
Note to Unaudited Financial information
Unaudited Balance Sheets as of September 30, 1995 and June 30, 1995
Unaudited Statements of Income for the three-month period ended
September 30, 1995 and 1994
Unaudited Statements of Cash Flows for the three-month period ended
September 30, 1995 and 1994
(b) Pro Forma Financial Information.
The following unaudited pro forma combined financial information is
filed herewith:
Pro Forma Combined Balance Sheet as of November 30, 1995
Pro Forma Combined Statements of Income for the nine-month period ended
November 30, 1995 and 1994 and the years ended February 28, 1995, 1994
and 1993
Notes to Unaudited Pro Forma Combined Financial Statements
(c) Exhibits.
The following exhibits are filed herewith:
2.01 Agreement and Plan of Reorganization dated as of December 14, 1995, as
amended as of January 26, 1996, by and among Registrant, ISI Purchasing
Corporation and Dr. Design, Inc. and related documents.
2.02 Agreement of Merger dated as of January 26, 1996 by and between ISI
Purchasing Corporation and Dr. Design, Inc.
23.01 Consent of McGladrey & Pullen, LLP
- 3 -
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of
1934, Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
INTEGRATED SYSTEMS, INC.
Date: February 8, 1996 By: /s/ Steven Sipowicz
---------------------
Steven Sipowicz
Chief Financial Officer
- 4 -
ITEM 7(A): FINANCIAL STATEMENTS OF BUSINESS ACQUIRED.
Report of Independent Auditors
To the Board of Directors
Doctor Design, Inc.
San Diego, California
We have audited the accompanying balance sheets of Doctor Design, Inc. as of
June 30, 1995 and 1994, and the related statements of income, shareholders'
equity, and cash flows for the years then ended. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Doctor Design, Inc. as of June
30, 1995 and 1994, and the results of its operations and its cash flows for the
years then ended in conformity with generally accepted accounting principles.
/s/ McGladrey & Pullen, LLP
San Diego, California
November 17, 1995
DOCTOR DESIGN, INC.
BALANCE SHEETS
JUNE 30, 1995 AND 1994
ASSETS (NOTE 5) 1995 1994
- ---------------------------------------------------------------------------------------------
Current Assets
Cash and cash equivalents $ 104,182 $ 10,566
Contract receivables, net of allowance for doubtful
accounts of $14,000 in 1995 and $14,609 in 1994 (Note 7) 1,982,061 499,933
Royalty receivables (Note 11) 190,337 95,938
Costs and estimated earnings in excess of billings
on uncompleted contracts (Note 2) 234,782 107,476
Prepaid expenses and other 95,494 61,942
------------------------
Total current assets 2,606,856 775,855
------------------------
Property and Equipment, net (Note 3) 562,715 196,803
------------------------
Software Development Costs, net of accumulated
amortization of $735,486 in 1994 213,677
------------------------
$3,169,571 $1,186,335
========================
<FN>
See Notes to Financial Statements.
</FN>
-2-
LIABILITIES AND SHAREHOLDERS EQUITY 1995 1994
- ----------------------------------------------------------------------------------------------------
Current Liabilities
Current maturities of long-term debt (Note 5) $ 116,688 $ 180,113
Accounts payable 539,811 56,811
Accrued liabilities (Note 4) 419,566 211,598
Billings in excess of costs and estimated earnings on
uncompleted contracts (Note 2) 31,840 81,800
Income taxes payable 73,200
Deferred income taxes (Note 6) 627,000 40,000
---------------------------
Total current liabilities 1,808,105 570,322
---------------------------
Deferred Revenue (Note 7) 77,942
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Deferred Income Taxes (Note 6) 65,000
---------------------------
Long-term Debt, less current maturities (Note 5) 115,253
---------------------------
Commitments (Note 9)
Shareholders' Equity (Note 8)
Preferred, no par value, 3,000,000 shares authorized;
no shares issued and outstanding
Common:
Class A, voting common stock, no par value, 5,000,000
shares authorized; 2,555,720 shares issued and outstanding 173,942 173,942
Class B, nonvoting common stock, no par value, 1,000,000 shares
authorized; no shares issued and outstanding
Note receivable from shareholder (15,320) (15,320)
Retained earnings 1,202,844 199,196
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1,361,466 357,818
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$ 3,169,571 $ 1,186,335
===========================
-3-
DOCTOR DESIGN, INC.
STATEMENTS OF INCOME
YEARS ENDED JUNE 30, 1995 AND 1994
1995 1994
- --------------------------------------------------------------------------------------
Contract revenue (Note 7) $ 8,814,615 $ 4,280,969
Royalty and other revenue (Note 11) 684,103 210,281
--------------------------
Total revenue 9,498,718 4,491,250
--------------------------
Cost of revenue 5,744,878 2,808,217
--------------------------
Gross profit 3,753,840 1,683,033
--------------------------
Selling, general and administrative expenses:
General and administrative (including related party
rental payments of $144,000 for 1995 and 1994) 1,520,752 703,905
Selling and marketing 507,068 230,345
Research and development 26,556 55,930
--------------------------
2,054,376 990,180
--------------------------
Operating income 1,699,464 692,853
--------------------------
Nonoperating income (expense):
Interest income 22,218 3,076
Interest expense (including related party payments
of $10,000 for 1994) (22,034) (55,175)
Other 15,332
--------------------------
184 (36,767)
--------------------------
Income before provision for income taxes 1,699,648 656,086
Provision for income taxes (Note 6) 696,000 100,784
--------------------------
Net income $ 1,003,648 $ 555,302
==========================
<FN>
See Notes to Financial Statements.
</FN>
-4-
DOCTOR DESIGN, INC.
STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED JUNE 30, 1995 AND 1994
Common Stock Note
Class A Voting Receivable Retained
------------------------------- from Earnings
Shares Amount Shareholder (Deficit) Totals
- -----------------------------------------------------------------------------------------------------------------
Balance, June 30, 1993 2,079,618 $ 78,722 $ $ (356,106) $(277,384)
Net income 555,302 555,302
Stock options exercised 476,102 95,220 (15,320) 79,900
--------------------------------------------------------------------------------------
Balance, June 30, 1994 2,555,720 173,942 (15,320) 199,196 357,818
Net income 1,003,648 1,003,648
--------------------------------------------------------------------------------------
Balance, June 30, 1995 2,555,720 $173,942 $(15,320) $1,202,844 $1,361,466
======================================================================================
<FN>
See Notes to Financial Statements.
</FN>
-5-
DOCTOR DESIGN, INC.
STATEMENTS OF CASH FLOWS
YEARS ENDED JUNE 30, 1995 AND 1994
1995 1994
- ----------------------------------------------------------------------------------------------------------------
Cash Flows from Operating Activities
Net income $1,003,648 $555,302
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 404,019 293,958
Gain on lease assignment (10,208)
Deferred income taxes 522,000 99,984
(Increase) decrease in:
Contract receivables (1,482,128) (354,300)
Royalty receivables (94,399) (95,938)
Costs and estimated earnings in excess of billings on
uncompleted contracts (127,306) (77,592)
Prepaid expenses and other (33,552) 7,354
Increase (decrease) in:
Accounts payable 483,000 (205,754)
Accrued liabilities 207,968 (51,430)
Income taxes payable 73,200
Billings in excess of costs and estimated earnings on
uncompleted contracts (49,960) 62,211
Deferred revenue (77,942) (53,978)
-------------------------------------
Net cash provided by operating activities 828,548 169,609
-------------------------------------
Cash Flows from (used in) Investing Activities
Purchases of property and equipment (556,254) (108,571)
-------------------------------------
Cash (used in) investing activities (556,254) (108,571)
-------------------------------------
Cash Flows from (used in) Financing Activities
Principal payments on long-term debt (178,678) (231,526)
Proceeds from exercise of stock options 79,900
-------------------------------------
Net cash (used in) investing activities (178,678) (151,626)
-------------------------------------
<FN>
See Notes to Financial Statements.
</FN>
-6-
DOCTOR DESIGN, INC.
STATEMENTS OF CASH FLOWS (CONTINUED)
YEARS ENDED JUNE 30, 1995 AND 1994
1995 1994
- -----------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents $ 93,616 $ (90,588)
Cash and cash equivalents:
Beginning 10,566 101,154
-------------------------------------
Ending $104,182 $ 10,566
=====================================
Supplemental Disclosures of Cash Flow Information
Cash payments for:
Interest $ 23,820 $ 59,257
Income taxes $100,800 $ 42,800
Supplemental Schedule of Noncash Investing and
Financing Activities
Capital lease obligations incurred for the use of equipment $ $ 19,737
<FN>
See Notes to Financial Statements.
</FN>
-7-
NOTE 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
NATURE OF BUSINESS
Doctor Design, Inc. (the "Company") provides engineering design services to
manufacturers of high technology products. For certain design service contracts,
the Company retains commercialization or proprietary rights to the technology it
has developed for the customer. The Company is also involved in the sale of high
technology products to design service customers which include internally
developed software applications.
A summary of the Company's significant accounting policies follows:
REVENUE RECOGNITION
Revenue is recognized based on the type of contract. Revenue earned under time
and material contracts is recognized on the basis of hours of work performed and
hourly rates provided under the contract. Revenue from fixed-price contracts is
recognized on the percentage-of-completion method, measured by the percentage of
total hours incurred to date to estimated total hours of each contract.
Management believes that these methods provide the best available measure of
progress on these contracts.
Contract costs include all direct material and labor costs and those indirect
costs related to contract performance, such as indirect labor and supplies.
Selling, general and administrative costs are charged to expense as incurred.
Provisions for estimated losses on uncompleted contracts are made in the period
in which such losses are determined. Changes in contract performance, contract
conditions, and estimated profitability may result in revisions to costs and
income and are recognized in the period in which the revisions are determined.
The asset, "Costs and estimated earnings in excess of billings on uncompleted
contracts," represents revenue recognized in excess of amounts billed. The
liability, "Billings in excess of costs and estimated earnings on uncompleted
contracts," represents billings in excess of revenue recognized.
Revenue is deferred for future recognition when a contractual obligation to
provide services or a third party's right to developed assets exists. Such
revenue is recognized as the contractual obligation or third party right is
satisfied.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include highly liquid investments with original
maturities of three months or less.
The Company maintains its cash accounts in two commercial banks and a brokerage
account located in San Diego, California. The two commercial bank accounts are
insured by Federal Deposit Insurance Corporation (FDIC) up to $100,000 each. At
June 30, 1995, the Company had balances of approximately $422,000 that were
either uninsured or in excess of the FDIC insurance limit.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. Depreciation of property and equipment
used in production of the Company's hand-held computer product is computed using
the units-of-production method over the estimated number of units which can be
produced with the assets. Depreciation of other property and equipment is
computed using the straight-line method over estimated useful lives of three to
five years. Maintenance and repair costs are expensed as incurred.
-8-
SOFTWARE DEVELOPMENT COSTS
Software development costs, as an integral part of the development of the
Company's hand-held computer and graphics display controller, were capitalized
once the technological feasibility of the specific software projects was
established. Capitalization of such costs ceased when the final product was
fully tested and available for general distribution to customers. Amortization
of capitalized software development costs began when the product was ready for
general distribution to customers. Amortization is computed based on the number
of units delivered compared with the number of estimated units to be delivered
or the straight-line method over the remaining estimated economic life of the
product, whichever provides a shorter amortization period. The estimated
economic life of the hand-held computer was five years. All software development
costs have been fully amortized at June 30, 1995.
Other research and development costs are charged to expense when incurred.
INCOME TAXES
Deferred taxes are provided on a liability method whereby deferred tax assets
are recognized for deductible temporary differences and operating loss and tax
credit carryforwards and deferred tax liabilities are recognized for taxable
temporary differences. Temporary differences are the differences between the
reported amounts of assets and liabilities and their tax bases. Deferred tax
assets are reduced by a valuation allowance when, in the opinion of management,
it is more likely than not that some portion or all of the deferred tax assets
will not be realized. Deferred tax assets and liabilities are adjusted for the
effects of changes in tax laws and rates on the date of enactment.
NOTE 2. COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS
Costs and estimated earnings on uncompleted contracts at June 30, 1995 and 1994
consist of the following:
1995 1994
---------------------------
Costs incurred on uncompleted contracts $ 587,877 $ 2,462,776
Estimated earnings 250,782 947,960
---------------------------
838,659 3,410,736
Less billings to date (748,399) (3,385,060)
---------------------------
90,260 25,676
Net under billings on time and material prototype contracts 112,682
---------------------------
$ 202,942 $ 25,676
===========================
Included in the accompanying balance sheets under
the following captions:
Cost and estimated earnings in excess of billings on
uncompleted contracts $ 234,782 $ 107,476
Billings in excess of costs and estimated earnings on
uncompleted contracts (31,840) (81,800)
---------------------------
$ 202,942 $ 25,676
===========================
-9-
NOTE 3. PROPERTY AND EQUIPMENT
Property and equipment at June 30, 1995 and 1994 consist of the following:
1995 1994
------------------------------
Computer equipment $ 766,136 $ 257,256
Office furniture and equipment 232,651 185,277
Product tooling and molds 166,990
------------------------------
998,787 609,523
Less accumulated depreciation and amort 436,072 412,720
------------------------------
$ 562,715 $ 196,803
==============================
NOTE 4. ACCRUED LIABILITIES
Accrued liabilities at June 30, 1995 and 1994 consist of the following:
1995 1994
------------------------------------
Accrued employee costs and benefits $191,115 $166,379
Accrued contract losses 138,321 5,600
Customer advances 16,700 16,885
Sales tax payable 35,545 15,426
Other 37,885 7,308
------------------------------------
$419,566 211,598
====================================
NOTE 5. LONG-TERM DEBT
The Company has a note payable to a bank, $30,773 and $128,227 at June 30, 1995
and 1994, respectively, due in monthly principal payments of $8,120 plus
interest at the bank's prime rate (9.0% at June 30, 1995) plus 3.75% through
September 1995. The note is collateralized by the Company's assets and
guaranteed by the majority shareholder.
The Company has a note payable to a bank, $12,908 and $48,471 at June 30, 1995
and 1994, respectively, due in monthly payments of $3,315, including interest at
13.0%, through November 1995. The note is collateralized by the Company's assets
and guaranteed by the majority shareholder.
The Company has a note payable $73,007 and $66,771 at June 30, 1995 and 1994,
respectively, bearing interest at 8.5%, principal and interest payments based
upon 50% of certain royalties received by the Company. Subsequent to year-end,
the note was renegotiated and the remaining balance due of $45,000 was paid in
full by October 31, 1995.
The Company also had various other arrangements, totaling $51,897 at June 30,
1994 which were paid off during the year ended June 30, 1995.
NOTE 6. INCOME TAXES
The income tax provision charged to continuing operations for the years ended
June 30, 1995 and 1994 was as follows:
1995 1994
-------------------------------
Current:
U.S. federal $ 132,000 $ 24,000
State 42,000 15,000
Deferred:
U.S. federal 400,000 48,000
State 122,000 13,784
-------------------------------
$ 696,000 $ 100,784
===============================
-10-
The income tax provision differs from the amount of income tax determined by
applying the U.S federal income tax rate to pretax income from continuing
operations for the years ended June 30, 1995 and 1994 due to the following:
1995 1994
-------------------------------
Computed "expected" tax expense $ 578,000 $ 223,000
Increase (decrease) in income taxes resulting from:
Reduction in valuation allowance (153,000)
Nondeductible expenses 5,000 3,000
State income taxes, net of federal tax benefit 104,000 40,000
Other 9,000 (12,216)
-------------------------------
$ 696,000 $ 100,784
===============================
Net deferred tax liabilities consist of the following components as of June 30,
1995 and 1994:
1995 1994
------------------------------
Deferred tax liabilities:
Accrual to cash basis $ 635,000 $ 167,000
Software development costs 86,000
Deferred tax assets:
Allowance for doubtful accounts (6,000)
Depreciation (8,000) (20,000)
Net operating loss carryforward (38,000)
Tax credits (84,000)
------------------------------
$ 627,000 $ 105,000
==============================
The components giving rise to the net deferred tax liabilities described above
have been included in the accompanying balance sheets as of June 30, 1995 and
1994 as follows:
1995 1994
---------------------------------
Current (liabilities) $ (627,000) $ (40,000)
Noncurrent (liabilities) (65,000)
---------------------------------
$ (627,000) $(105,000)
=================================
NOTE 7. MAJOR CUSTOMERS
Contract revenue and receivables for the years ended June 30, 1995 and 1994
include revenue and receivables from the following major customers, each of
which accounted for 10% or more of total contract revenue of the Company during
at least one of the years.
1995 1994
- ----------------------------------------------------------------------------------------
Contract Contract
Contract Receivables Contract Receivables
Revenue Balance Revenue Balance
- ----------------------------------------------------------------------------------------
Customer A $ 2,495,000 $ 443,000 $ * $ *
Customer B 2,324,000 564,000 1,850,000 71,000
Customer C 1,183,000 239,000 * *
Customer D 964,000 389,000 * *
-----------------------------------------------------------------------
$ 6,966,000 $1,635,000 $1,850,000 $ 71,000
=======================================================================
<FN>
*Contract revenue accounted for less than 10% of total contract revenue for
1994.
</FN>
-11-
Customer B also provided funding for and holds certain contractual rights to
assets developed by the Company, consisting mainly of tooling and molds for the
production of its hand-held computer. Accordingly, the Company had deferred
recognition of revenue representing the depreciated value of the associated
assets. At June 30, 1995, the assets were fully depreciated and all revenue has
been recognized.
The Company retains the right to further commercialize the software technology
developed in connection with this arrangement for application in certain other
industries.
NOTE 8. EMPLOYEE STOCK OPTIONS
The Company has a stock option plan (the "Plan") which provides for the granting
of both qualified and non-qualified options to employees, directors and outside
consultants of the Company. Options are exercisable at various dates through
June 2003. The terms of the Plan provide for the granting of options at an
exercise price approximating the fair market value of the Company's common
stock, as determined by the Option Committee of the Board of Directors, on the
date of the grant of such options. Under the Plan options for 1,500,000 shares
may be granted. The options vest over periods ranging from 0 to 4 years and at
June 30, 1995 and 1994, options for 431,959 and 347,925 shares, respectively,
were exercisable and options for 234,205 and 530,705 shares, respectively, were
available for future grant. Subsequent to June 30, 1995, an additional 134,000
options were granted at $0.40 per share.
In November 1993, the Company accepted a nonrecourse note receivable as payment
for stock options exercised. This note is non interest bearing and is due and
payable on December 31, 1996. At June 30, 1995, the 76,602 shares related to the
exercise were issuable and included in the shares outstanding.
Transactions for the years ended June 30, 1995 and 1994 comprise the following:
1995 1994
------------------------------
Options outstanding, beginning of year 456,943 832,553
Granted 308,500 357,000
Exercised (476,102)
Expired (12,000) (256,508)
------------------------------
Options outstanding, end of year 753,443 456,943
==============================
Options price range at June 30, 1995 and 1994 $.20 to 0.40 0.20
NOTE 9. COMMITMENTS
OPERATING LEASES
The Company leases its main office facility from the majority shareholder under
a noncancelable operating lease agreement. The term of the lease, which
commenced in January 1989, is ten years with two five-year options. The Company
has guaranteed the payment of the majority shareholder's note payable to a bank;
balance of $403,538 at June 30, 1995, which is secured by the second trust deed
on this facility. The balance of the debt subject to the guaranty is included in
the minimum lease payments shown below for 1999.
The Company also leases four other office facilities under separate operating
lease agreements. The aggregate monthly rental payment for these leases is
approximately $8,800. The lease agreements expire in September 1996 and include
options to extend the terms of the leases. Rental expense was $189,000 and
$144,000 for the years ended June 30, 1995 and 1994, respectively.
-12-
Future minimum lease payments for operating leases at June 30, 1995 are as
follows:
YEAR ENDING JUNE 30,
- -------------------------------------------------------------
1996 $ 247,836
1997 185,803
1998 144,000
1999 417,500
--------------------
Total minimum lease payments $ 995,139
====================
NOTE 10. PROFIT SHARING PLAN
The Company has a deferred compensation and profit sharing plan as defined under
section 401(k) of the Internal Revenue Code. Under the terms of the Plan,
employees may defer a portion of their compensation each year based on
provisions as outlined in the Plan. The Plan was amended in the current year to
implement an employer matching contribution equal to a discretionary percentage
to be determined by the employer. Current matching contributions are $0.50 for
every $1.00 contributed by all eligible participants beginning January 1, 1995
and ending September 30, 1995. Total employer contributions for the year ended
June 30, 1995 were $15,372.
NOTE 11. ROYALTY AGREEMENTS
The Company has entered into a royalty agreement with a customer for the design
and development of certain products. Under the terms of the agreement, the
Company receives a percentage of the net selling price of products sold to
third-parties utilizing this technology Royalties are calculated on a sliding
scale as a percentage of total revenues ranging from 4% to 2%. In addition, the
Company has numerous other royalty agreements with other customers under similar
arrangements. Royalty revenue totaled $606,161 and $163,361, respectively, for
the years ending June 30, 1995 and 1994.
NOTE 12. SUBSEQUENT EVENT
On November 10, 1995, Integrated Systems, Inc. (ISI) and the Company signed a
Letter of Intent for the acquisition of the Company by ISI. The principal terms
of the Letter of Intent stipulate that the Company will become a wholly-owned
subsidiary of ISI as the Company will exchange all of its outstanding capital
stock and stock options for ISI common stock.
The Letter of Intent does not constitute an offer, it is not binding and is not
a definitive agreement. All rights and obligations of the parties are subject to
execution of definitive mutually satisfactory agreements and obtaining all
required corporate and regulatory approvals. The Letter of Intent will
automatically terminate if a definitive agreement is not entered into by
December 25, 1995.
-13-
UNAUDITED FINANCIAL STATEMENTS.
Note to Unaudited Financial Information
The condensed interim financial statements included herein have been
prepared by Doctor Design, Inc. without audit. The June 30, 1995 condensed
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 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 are not necessarily indicative of the results
to be expected for the full year.
DOCTOR DESIGN INCORPORATED
UNAUDITED BALANCE SHEETS
AS OF SEPTEMBER 30, 1995 AND JUNE 30, 1995
September 30, June 30,
1995 1995
----------- -----------
ASSETS
Current assets:
Cash and cash equivalents $ 950,366 $ 104,182
Accounts receivable, net of reserve 1,345,991 2,172,398
Costs and profits in excess of billings 490,328 234,782
Other current assets 78,660 95,494
----------- -----------
Total current assets 2,865,345 2,606,856
Property and equipment, net 609,913 562,715
----------- -----------
$ 3,475,258 $ 3,169,571
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 644,562 $ 539,811
Billings in excess of costs and profits 16,173 31,840
Notes payable 18,278 116,688
Income taxes payable 458,000 73,200
Deferred income taxes payable 297,000 627,000
Other current liabilities 463,730 419,566
----------- -----------
Total current liabilities 1,897,743 1,808,105
Shareholders' equity:
Common stock 173,942 173,942
Note receivable from shareholder (15,320) (15,320)
Retained earnings 1,418,893 1,202,844
----------- -----------
Total shareholders' equity 1,577,515 1,361,466
----------- -----------
Total liabilities and shareholders' equity $ 3,475,258 $ 3,169,571
=========== ===========
DOCTOR DESIGN INCORPORATED
UNAUDITED STATEMENTS OF INCOME
FOR THE THREE-MONTH PERIOD ENDED
SEPTEMBER 30, 1995 AND 1994
1995 1994
----------- -----------
Revenues $ 2,410,828 $ 1,064,511
Costs and expenses:
Cost of revenues 1,518,329 704,767
Selling and marketing 113,494 66,060
General and administrative 470,605 190,015
----------- -----------
Total costs and expenses 2,101,428 960,842
Income from operations 309,400 103,669
Interest income (expense) and other, net 41,449 (6,985)
----------- -----------
Income before provision for income taxes 350,849 96,684
Provision for income taxes 134,800 41,000
----------- -----------
Net income $ 216,049 $ 55,684
=========== ===========
DOCTOR DESIGN INCORPORATED
UNAUDITED STATEMENTS OF CASH FLOWS
FOR THE THREE-MONTH PERIOD ENDED
SEPTEMBER 30, 1995 AND 1994
1995 1994
----------- -----------
Cash flows from operating activities:
Net income $ 216,049 $ 55,684
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 65,007 37,044
Deferred income taxes (330,000) 41,000
Gain on early debt extinguishment (28,007)
Changes in operating accounts:
Accounts receivable 826,407 (110,167)
Costs and profits in excess of billings (255,546) (25,560)
Other current assets 28,545 (5,732)
Accounts payable 104,751 156,271
Billings in excess of costs and profits (15,667) (28,588)
Income taxes payable 384,800
Other current liabilities 44,165 (4,796)
----------- -----------
Net cash provided by operating activities 1,040,504 115,156
Cash flows used for investing activities:
Purchases of property and equipment (112,205) (10,866)
Increase in deposits and other assets (11,712)
----------- -----------
Net cash used for investing activities (123,917) (10,866)
Cash flows used for financing activities:
Payments on long-term debt (70,403) (43,856)
----------- -----------
Net cash used for financing activities (70,403) (43,856)
Net cash flow 846,184 60,434
Cash at begining of period 104,182 10,566
----------- -----------
Cash at end of period $ 950,366 $ 71,000
=========== ===========
ITEM 7 (B): PRO FORMA FINANCIAL INFORMATION.
Unaudited Pro Forma Combined Financial Statements
The following unaudited pro forma condensed data, including the notes
thereto, are qualified in their entirety by reference to, and should be read in
conjunction with, the historical financial statements of Doctor Design Inc.
included elsewhere in this Form 8-K and the consolidated financial statements of
Integrated Systems, Inc. The unaudited pro forma combined statements of
operations combine Doctor Design's results of operations and Integrated Systems'
results of operations for the nine months ended November 30, 1995 and 1994 and
the three years ended February 28, 1995, giving effect to the acquisition as if
it had occurred at March 1, 1992. The unaudited pro forma combined balance sheet
data combine Doctor Design's and Integrated System's balance sheets as of
November 30 1995, giving effect to the acquisition as if it had occurred on
November 30, 1995.
The Pro Forma Financial Information is presented for illustrative
purposes only and is not necessarily indicative of the operating results or
financial position that would have occurred had the acquisition been consummated
at the beginning of the periods presented, nor is it necessarily indicative of
future operating results or financial position.
PRO FORMA STATEMENT
INTEGRATED SYSTEMS, INC. AND DOCTOR DESIGN, INC.
STATEMENT #1
PRO FORMA COMBINED BALANCE SHEET
AS OF NOVEMBER 30, 1995
Includes Doctor Design as of September 30, 1995 and
Integrated Systems, Inc. as of November 30, 1995
(in thousands)
Doctor Pro Forma Pro Forma
Design ISI Adjustments Combined
-------- -------- ----------- --------
Current assets:
Cash and cash equivalents $ 950 $ 10,162 $ 11,112
Marketable securities 16,192 16,192
Accounts receivable, net 1,836 17,100 18,936
Deferred income taxes 852 852
Other current assets 79 2,334 2,413
-------- -------- -------- --------
Total current assets 2,865 46,640 49,505
Marketable securities 19,590 19,590
Property and equipment 610 3,578 838 5,026
Other assets 790 790
Intangible assets 1,994 1,994
-------- -------- -------- --------
Total assets $ 3,475 $ 72,592 $ 838 $ 76,905
-------- -------- -------- --------
Current liabilities:
Accounts payable $ 645 $ 2,222 $ 2,867
Accrued payroll and related expenses 464 2,124 2,588
Deferred revenue 16 7,466 7,482
Notes payable 18 18
Income taxes payable 458 2,852 3,310
Deferred income taxes 297 297
Other current liabilities 3,491 500 3,991
-------- -------- -------- --------
Total current liabilities 1,898 18,155 500 20,553
-------- -------- -------- --------
Other liabilities 451 781 1,232
Common stock 174 37,780 37,954
Note receivable from shareholder (15) (15)
Unrealized holding gain 341 341
Retained earnings 1,418 15,865 (443) 16,840
-------- -------- -------- --------
Total shareholders' equity 1,577 53,986 (443) 55,120
-------- -------- -------- --------
Total liabilities and shareholders' equity $ 3,475 $ 72,592 $ 838 $ 76,905
======== ======== ======== ========
PRO FORMA STATEMENTS
INTEGRATED SYSTEMS, INC. AND DOCTOR DESIGN, INC.
STATEMENT #2
COMBINED STATEMENTS OF INCOME FOR THE NINE-MONTH PERIOD
ENDED NOVEMBER 30, 1995 AND 1994
Includes Doctor Design for the nine months ended September 30, 1995 and 1994 and Integrated Systems, Inc. for the nine months ended
November 30, 1995 and 1994
1995 1994
------------------------------------------- ------------------------------------------
(in thousands) Doctor Pro Forma Pro Forma Doctor Pro Forma Pro Forma
Design ISI Adjustments Combined Design ISI Adjustments Combined
-------- -------- -------- --------- ------- -------- -------- --------
Revenue $ 8,314 $ 50,648 $ 58,962 $ 2,930 $ 36,266 $ 39,196
Costs and expenses:
Cost of revenue 5,215 11,978 17,193 1,814 8,230 10,044
Selling and marketing 475 18,478 18,953 146 14,332 14,478
Research and development 8,229 8,229 30 5,874 5,904
General and administrative 1,422 4,178 (74) 5,526 570 2,678 (74) 3,174
Amortization 449 449 1,123 1,123
Merger related expenses 3,601 3,601
-------- -------- -------- -------- -------- -------- -------- --------
Total costs and expenses 7,112 46,913 (74) 53,951 2,560 32,237 (74) 34,723
-------- -------- -------- -------- -------- -------- -------- --------
Income from operations 1,202 3,735 74 5,011 370 4,029 74 4,473
Interest and other income 52 1,727 (60) 1,719 (23) 1,302 (60) 1,219
-------- -------- -------- -------- -------- -------- -------- --------
Pretax income 1,254 5,462 14 6,730 347 5,331 14 5,692
Income taxes 512 1,748 2 2,262 141 1,706 2 1,849
-------- -------- -------- -------- -------- -------- -------- --------
Net income $ 742 $ 3,714 $ 12 $ 4,468 $ 206 $ 3,625 $ 12 $ 3,843
======== ======== ======== ======== ======== ======== ======== ========
Earnings per share $ 1.50 $ 0.35 $ 0.41 $ 0.42 $ 0.38 $ 0.38
======== ======== ======== ======== ======== ========
Shares 496 10,494 10,990 496 9,492 9,988
======== ======== ======== ======== ======== ========
PRO FORMA STATEMENTS
INTEGRATED SYSTEMS, INC. AND DOCTOR DESIGN, INC.
STATEMENT #3
COMBINED RESULTS FOR THE YEAR ENDED FEBRUARY 28, 1995
Includes Doctor Design for the year ended December 31, 1994 and
Integrated Systems, Inc. for the year ended February 28, 1995
(in thousands) Doctor Pro Forma Pro Forma
Design ISI Adjustments Combined
-------- -------- -------- --------
Revenue $ 5,460 $ 51,979 $ 57,439
Costs and expenses:
Cost of revenue 3,158 11,754 14,912
Selling and marketing 233 20,269 20,502
Research and development 52 8,294 8,346
General and administrative 947 3,601 (98) 4,450
Amortization 1,311 1,311
-------- -------- -------- --------
Total costs and expenses 4,390 45,229 (98) 49,521
-------- -------- -------- --------
Income from operations 1,070 6,750 98 7,918
Interest and other income (expense) (24) 1,712 (80) 1,608
-------- -------- -------- --------
Pretax income 1,046 8,462 18 9,526
Income taxes 418 2,708 3 3,129
-------- -------- -------- --------
Net income $ 628 $ 5,754 $ 15 $ 6,397
======== ======== ======== ========
Earnings per share $ 1.27 $ 0.60 $ 0.63
======== ======== ========
Shares 496 9,583 10,079
======== ======== ========
PRO FORMA STATEMENTS
INTEGRATED SYSTEMS, INC. AND DOCTOR DESIGN, INC.
STATEMENT #4
COMBINED RESULTS FOR THE YEAR ENDED FEBRUARY 28, 1994
Includes Doctor Design for the year ended June 30, 1994 and
Integrated Systems, Inc. for the year ended February 28, 1994
(in thousands) Doctor Pro Forma Pro Forma
Design ISI Adjustments Combined
-------- -------- -------- --------
Revenue $ 4,491 $ 41,701 $ 46,192
Costs and expenses:
Cost of revenue 2,808 10,409 13,217
Selling and marketing 230 16,225 16,455
Research and development 56 5,865 5,921
General and administrative 704 2,916 (98) 3,522
Amortization 1,764 1,764
-------- -------- -------- --------
Total costs and expenses 3,798 37,179 (98) 40,879
-------- -------- -------- --------
Income from operations 693 4,522 98 5,313
Interest and other income (expense) (40) 1,409 (80) 1,289
-------- -------- -------- --------
Pretax income 653 5,931 18 6,602
Income taxes 101 1,898 3 2,002
-------- -------- -------- --------
Net income $ 552 $ 4,033 $ 15 $ 4,600
======== ======== ======== ========
Earnings per share $ 1.11 $ 0.44 $ 0.47
======== ======== ========
Shares 496 9,228 9,724
======== ======== ========
PRO FORMA STATEMENTS
INTEGRATED SYSTEMS, INC. AND DOCTOR DESIGN, INC.
STATEMENT #5
COMBINED RESULTS FOR THE YEAR ENDED FEBRUARY 28, 1993
Includes Doctor Design for the year ended June 30, 1993 and
Integrated Systems, Inc. for the year ended February 28, 1993
(in thousands) Doctor Pro Forma Pro Forma
Design ISI Adjustments Combined
-------- -------- -------- --------
Revenue $ 2,863 $ 32,388 $ 35,251
Costs and expenses:
Cost of revenue 2,162 7,391 9,553
Selling and marketing 334 11,564 11,898
Research and development 108 6,133 6,241
General and administrative 672 2,468 (98) 3,042
Amortization 1,199 1,199
-------- -------- -------- --------
Total costs and expenses 3,276 28,755 (98) 31,933
-------- -------- -------- --------
Income (loss) from operations (413) 3,633 98 3,318
Interest and other income 218 1,575 (83) 1,710
-------- -------- -------- --------
Pretax income (loss) (195) 5,208 15 5,028
Income taxes 1 1,771 1,772
-------- -------- -------- --------
Net income (loss) ($ 196) $ 3,437 $ 15 $ 3,256
======== ======== ======== ========
Earnings per share ($ 0.40) $ 0.37 $ 0.33
======== ======== ========
Shares 496 9,318 9,814
======== ======== ========
NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The Doctor Design, Inc. statements of operations for the years ended
June 30, 1993 and 1994 and December 31, 1994 and the Integrated Systems, Inc.
consolidated statements of income for the three years ended February 28, 1995
have been combined. The combined financial statements include pro forma
adjustments to include the effect of ownership of a building in which Doctor
Design is located. This building was owned by a majority shareholder of Doctor
Design during the periods reported. Additionally, the Doctor Design statements
of operations for the nine months ended September 30, 1995 and 1994 and the
Integrated Systems consolidated statements of income for the nine months ended
November 30, 1994 and 1995 have been combined. This method of combining the two
companies is for the presentation of unaudited pro forma condensed combined
financial statements only. The unaudited pro forma condensed combined financial
statements, including the notes thereto, should be read in conjunction with the
historical consolidated financial statements of Doctor Design included herein
and those of Integrated Systems.
No adjustments have been made to conform the accounting policies of the
combining companies. The nature and extent of such adjustments, if any, will be
based upon further study and analysis and are not expected to be significant.
2. UNAUDITED PRO FORMA COMBINED NET INCOME PER SHARE
The unaudited pro forma combined statements of operations for Doctor
Design and Integrated Systems have been prepared as if the acquisition were
completed at the beginning of the earliest periods presented. The unaudited pro
forma combined net income per share is based on the combined weighted average
number of common and common equivalent shares of Doctor Design common stock and
Integrated Systems common stock for each period, based upon the acquisition
exchange ratio.
3. PRO FORMA UNAUDITED COMBINED SHARES OUTSTANDING
These unaudited pro forma combined financial statements reflect the
issuance of approximately 372,000 shares of Integrated Systems common stock in
exchange for an aggregate of approximately 2,501,000 shares of Doctor Design
common stock in connection with the acquisition based on the acquisition
exchange ratio of 0.1486 shares of Integrated Systems common stock for every one
share of Doctor Design common stock.
The following table details the pro forma share issuances in connection with the
acquisition:
Doctor Design Integrated Systems
Common Shares Exchange Common Shares
Outstanding Ratio Outstanding
---------------- ------------ -------------
Doctor Design shares outstanding as of November 30, 1995 2,501,000 0.1486 372,000
Integrated Systems shares outstanding as of November 30 1995 10,190,000
----------
Total number of shares of Integrated Systems common stock
outstanding after completion of the acquisition 10,562,000
----------
In addition, Integrated Systems assumed all options to purchase Doctor
Design common stock outstanding immediately before the effective time of the
acquisition. Each Doctor Design option is exercisable for that number of
Integrated Systems' common stock equal to 0.1486 multiplied by the number of
shares of Doctor Design purchasable under the Doctor Design option. Pursuant to
this exchange ratio, Integrated Systems may issue up to approximately 132,000
shares of common stock upon exercise of the assumed options. Assuming exercise
of all assumed options, Integrated Systems may ultimately issue a total of up to
approximately 504,000 shares of Common Stock.
4. MERGER RELATED EXPENSES
Doctor Design and Integrated Systems estimate they will incur direct
transaction costs of approximately $500,000 associated with the acquisition
consisting of transaction fees for attorneys and accountants. These nonrecurring
transaction costs will be charged to operations primarily during the quarter
ended February 29, 1996.
The Unaudited Pro Forma Condensed Combined Balance Sheet gives effect
to estimated direct transaction costs as if such costs had been incurred as of
November 30, 1995. These costs are not reflected in the Unaudited Pro Forma
Condensed Combined Statements of Operations.
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ------- -----------------------
2.01 Agreement and Plan of Reorganization dated as of December
14, 1995, as amended as of January 26, 1996, by and among
Registrant, ISI Purchasing Corporation and Dr. Design,
Inc. and related documents.
2.02 Agreement of Merger dated as of January 26, 1996 by and
between ISI Purchasing Corporation and Dr. Design, Inc.
23.01 Consent of McGladrey & Pullen, LLP