<PAGE>
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 April 30, 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 0-21342
WIND RIVER SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 94-2873391
(State of incorporation) (I.R.S. Employer Identification No.)
500 WIND RIVER WAY, ALAMEDA, CALIFORNIA 94501
(Address of principal executive office)
(510) 748-4100
(Telephone number)
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
----- -----
Indicate the number of shares outstanding of each of the issuer's classes of
Common Stock, as of the latest practicable date.
40,504,131 shares of Common Stock, $.001 par value, as of May 31, 1999
<PAGE>
WIND RIVER SYSTEMS, INC.
FORM 10-Q
QUARTER ENDED APRIL 30, 1999
INDEX
Part I: FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Statements of
Income for the three month periods
ended April 30, 1999 and 1998.
Condensed Consolidated Balance Sheets
at April 30, 1999 and January 31, 1999
Condensed Consolidated Statements of
Cash Flows for the three month periods
ended April 30, 1999 and 1998.
Notes to the Condensed Consolidated
Financial Statements
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of
Operations
Item 3. Quantitative and Qualitative Disclosures
about Market Risk
Part II: OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
Signature
2
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WIND RIVER SYSTEMS, INC.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
WIND RIVER SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
Three months ended
April 30,
1999 1998
------------- --------------
<S> <C> <C>
Revenues:
Products $ 22,708 $ 19,322
Services 9,892 7,078
------------- --------------
Total revenues 32,600 26,400
------------- --------------
Cost of revenues:
Products 1,713 1,968
Services 4,198 2,821
------------- --------------
Total cost of revenues 5,911 4,789
------------- --------------
Gross margin 26,689 21,611
------------- --------------
Operating expenses:
Selling and marketing 12,286 9,876
Product development and engineering 5,731 3,774
General and administrative 2,538 1,704
------------- --------------
Total operating expenses 20,555 15,354
------------- --------------
Operating income 6,134 6,257
------------- --------------
Other income (expense):
Interest expense (2,213) (2,134)
Interest income and other, net 3,226 3,082
Write off of investment (500) --
------------- --------------
Total other income 513 948
------------- --------------
Income before provision for income taxes 6,647 7,205
Provision for income taxes 2,493 2,770
------------- --------------
Net income $ 4,154 $ 4,435
------------- --------------
------------- --------------
Net income per share:
Basic $ 0.10 $ 0.11
Diluted $ 0.10 $ 0.11
Weighted average shares:
Basic 40,535 38,796
Diluted 42,586 41,968
</TABLE>
The accompanying notes are an integral part of these condensed
consolidated financial statements.
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WIND RIVER SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
April 30, January 31,
1999 1999
--------------- ---------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 67,567 $ 42,514
Short-term investments 5,407 9,143
Accounts receivable, net 24,575 30,375
Prepaid and other current assets 12,135 10,598
--------------- ---------------
Total current assets 109,684 92,630
Investments 139,587 155,618
Land and equipment, net 32,690 31,350
Other assets 12,754 13,021
Restricted cash 36,044 34,157
--------------- ---------------
Total assets $ 330,759 $ 326,776
--------------- ---------------
--------------- ---------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 4,199 $ 3,389
Accrued liabilities 11,739 10,005
Accrued compensation 6,473 5,950
Income taxes payable 2,330 405
Deferred revenue 16,605 17,062
--------------- ---------------
Total current liabilities 41,346 36,811
Convertible subordinated notes 140,000 140,000
--------------- ---------------
Total liabilities 181,346 176,811
--------------- ---------------
Minority interest in consolidated subsidiary 700 551
--------------- ---------------
Stockholders' equity:
Common stock, par value $.001; 125,000 shares
authorized; 41,770 and 41,718 shares issued;
40,493 and 40,606 shares outstanding 40 41
Additional paid in capital 124,781 124,605
Treasury stock, 1,277 and 1,112 shares, at cost (29,488) (25,491)
Accumulated other comprehensive loss (3,188) (2,155)
Retained earnings 56,568 52,414
--------------- ---------------
Total stockholders' equity 148,713 149,414
--------------- ---------------
Total liabilities and
stockholders' equity $ 330,759 $ 326,776
--------------- ---------------
--------------- ---------------
</TABLE>
The accompanying notes are an integral part of these condensed
consolidated financial statements.
4
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WIND RIVER SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
Three months ended
April 30,
1999 1998
-------------- --------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 4,154 $ 4,435
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 2,232 1,802
Minority interest in consolidated subsidiary 149 112
Write-off of investment 500 -
Change in assets and liabilities:
Accounts receivable, net 5,800 2,533
Prepaid and other assets (2,485) 172
Accounts payable 810 (166)
Accrued liabilities 1,734 (2,452)
Accrued compensation 523 (1,133)
Income taxes payable 1,925 580
Deferred revenue (457) (1,268)
-------------- --------------
Net cash provided by operating activities 14,885 4,615
-------------- --------------
Cash flows from investing activities:
Acquisition of land and equipment (2,857) (3,048)
Purchases of investments (48,772) (129,910)
Sales and maturities of investments 67,902 87,599
Restricted cash (1,887) (7,856)
-------------- --------------
Net cash provided by (used in) investing activities 14,386 (53,215)
-------------- --------------
Cash flows from financing activities:
Proceeds from issuance of Common Stock, net 175 3,228
Purchase of treasury stock (3,997) (2,503)
-------------- --------------
Net cash provided by (used in) financing activities (3,822) 725
-------------- --------------
Effect of exchange rate changes on cash and cash equivalents (396) (485)
-------------- --------------
Net increase (decrease) in cash and cash equivalents 25,053 (48,360)
Cash and cash equivalents at beginning of period 42,514 100,633
-------------- --------------
Cash and cash equivalents at end of period $ 67,567 $ 52,273
-------------- --------------
-------------- --------------
</TABLE>
The accompanying notes are an integral part of these condensed
consolidated financial statements.
5
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WIND RIVER SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation
The accompanying condensed consolidated financial statements and related
notes of Wind River Systems, Inc. ("Wind River") are unaudited. However, in
the opinion of management, all adjustments (consisting only of normal
recurring adjustments) which are necessary for a fair presentation of the
financial position, results of operations and cash flows for the interim
period have been included. These condensed consolidated financial statements
should be read in conjunction with the audited consolidated financial
statements and notes thereto for the fiscal year ended January 31, 1999
included in Wind River's Annual Report on Form 10-K. The results of
operations for the three months ended April 30, 1999 are not necessarily
indicative of results to be expected for the entire fiscal year, which ends
on January 31, 2000.
In accordance with the rules and regulations of the Securities and Exchange
Commission, unaudited condensed consolidated financial statements may omit or
condense certain information and disclosures normally required for a complete
set of financial statements prepared in accordance with generally accepted
accounting principles. However, Wind River believes that the notes to the
condensed consolidated financial statements contain disclosures adequate to
make the information presented not misleading.
The condensed consolidated financial statements include the accounts of Wind
River and its wholly-owned and majority-owned subsidiaries. All significant
inter-company accounts and transactions have been eliminated in consolidation.
Certain amounts in the fiscal 1999 condensed consolidated financial
statements have been reclassified to conform to the fiscal 2000 presentation.
2. Write off of Investment
During the fiscal year ended January 31, 1999, Wind River paid $500,000 for a
10% interest in the common stock of Xact, Inc. ("XACT") that was accounted
for under the cost method. During April 1999, Wind River entered into an
asset purchase agreement with XACT pursuant to which Wind River acquired
certain office and other equipment from XACT and revised the terms of an
existing distribution agreement with XACT. Subsequently but not pursuant to
the asset purchase agreement, Wind River hired a significant number of XACT
employees. As a result of these events, Wind river believes the future
operations and cash flows of XACT have become uncertain and that its original
investment is not recoverable. Accordingly, Wind River has recognized a
charge totaling $500,000 for the difference between the carrying amount of
its investment and the net realizable value.
3. Revenue Recognition
Wind River adopted the provisions of Statement of Position ("SOP") 97-2,
"Software Revenue Recognition," as amended by SOP 98-4, "Deferral of the
Effective Date of Certain Provisions of SOP 97-2," effective February 1,
6
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1998. SOP 97-2 and SOP 98-4 provide guidance on recognizing revenue on
software transactions and supersede SOP 91-1.
In December 1998, the American Institute of Certified Public Accountants
("AICPA") released SOP 98-9, "Modification of SOP 97-2, `Software Revenue
Recognition' with Respect to Certain Transactions." SOP 98-9 amends SOP 97-2
to require that an entity recognize revenue for multiple element arrangements
by means of the "residual method" when (1) there is Vendor-Specific Objective
Evidence ("VSOE") of the fair values of all the undelivered elements that are
not accounted for by means of long-term contract accounting, (2) VSOE of fair
value does not exist for one or more of the delivered elements, and (3) all
revenue recognition criteria of SOP 97-2 (other than the requirement for VSOE
of the fair value of each delivered element) are satisfied. The provisions of
SOP 98-9 that extend the deferral of certain paragraphs of SOP 97-2 became
effective December 15, 1998. These paragraphs of SOP 97-2 and SOP 98-9 will
be effective for transactions that are entered into in fiscal years beginning
after March 15, 1999. Retroactive application is prohibited. We are
evaluating the requirements of SOP 98-9 and the effects, if any, on our
current revenue recognition policies.
4. Cash and Cash Equivalents, Investments and Restricted Cash
Cash equivalents consist of highly liquid investments with an original
maturity of three months or less. These investments consist of fixed income
securities, which are readily convertible to cash and are stated at cost,
which approximates fair value. Fair value is determined based upon the quoted
market prices of the securities as of the balance sheet date.
Investments with maturities greater than three months and less than one year
are classified as short-term investments. Investments with maturities greater
than one year are classified as long-term investments. Wind River accounts
for its investments, including money market funds, municipal bonds, U.S.
government and agency obligations, corporate bonds and other debt securities,
in accordance with Statement of Financial Accounting Standards No. ("SFAS")
115, "Accounting for Certain Investments in Debt and Equity Securities." Wind
River determines the appropriate classification of its marketable securities
at the time of purchase and re-evaluates such classification as of each
balance sheet date. Wind River has classified all of its investments as
available-for-sale and carries such investments at fair value, with
unrealized gains and losses reported in stockholders' equity until
disposition. Fair value is determined based upon the quoted market prices of
the securities as of the balance sheet date. The cost of securities sold is
based on the specific identification method. Realized gains or losses and
declines in value, if any, judged to be other than temporary on
available-for-sale securities are reported in other income or expense.
Restricted cash consists of the investments held as collateral under the
operating lease of Wind River's headquarters and an accreting interest rate
swap agreement.
5. Comprehensive Income
In February 1998, Wind River adopted SFAS 130, "Reporting Comprehensive
Income." Comprehensive income is defined as the change in equity of a company
during a period from transactions and other events and circumstances
excluding transactions resulting from investments by owners and distributions
to owners. The primary difference between net income and comprehensive
income, for Wind River, results from foreign currency translation adjustments
and unrealized losses on available-for-sale securities.
7
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Comprehensive income for the three months ended April 30, 1999 and 1998 is as
follows:
<TABLE>
<CAPTION>
Three Months Ended
April 30,
------------------------
(In thousands) 1999 1998
---------- -----------
<S> <C> <C>
Net income $ 4,154 $ 4,435
---------- -----------
Other comprehensive loss, net of tax
Foreign currency translation adjustments (248) (315)
Unrealized loss on investments (398) (510)
---------- -----------
Other comprehensive loss (646) (825)
---------- -----------
Total comprehensive income $ 3,508 $ 3,610
---------- -----------
---------- -----------
</TABLE>
6. Net Income Per Share
Net income per share is calculated in accordance with the provisions of SFAS
128, "Earnings Per Share". SFAS 128 requires Wind River to report both basic
net income per share, which is based on the weighted-average number of common
shares outstanding, and diluted net income per share, which is based on the
weighted-average number of common shares outstanding, and all dilutive
potential common shares outstanding. Dilutive potential common shares consist
of stock options and warrants (using the treasury stock method) and
convertible subordinated notes (using the if converted method).
In accordance with SFAS 128, the calculation of basic and diluted net income
per share is presented below:
<TABLE>
<CAPTION>
Three Months Ended
April 30,
--------------------------
(In thousands, except per share information) 1999 1998
------------ -----------
<S> <C> <C>
Basic computation:
Net income $ 4,154 $ 4,435
Weighted-average common shares 40,535 38,796
------------ -----------
Basic net income per share $ 0.10 $ 0.11
------------ -----------
------------ -----------
Diluted computation:
Net income $ 4,154 $ 4,435
Weighted-average common shares 40,535 38,796
Assumed incremental shares from:
Stock options and warrants 2,051 3,172
Convertible subordinated notes - -
------------ -----------
Dilutive potential common shares 2,051 3,172
------------ -----------
Total dilutive weighted-average common shares 42,586 41,968
------------ -----------
Diluted net income per share $ 0.10 $ 0.11
------------ -----------
------------ -----------
</TABLE>
The effect of assumed conversion of the convertible subordinated notes is
anti-dilutive and is therefore excluded from the above computations. Options
to purchase approximately 4.5 million and 2.4 million shares which were
outstanding at April 30, 1999 and 1998, respectively, were not included in
the calculation because the exercise prices were greater than the average
market price of common shares in each respective quarter and the effect would
be anti-dilutive. The exercise prices of these options ranged from $19.00 to
$31.92 and $24.96 to $30.68 at April 30, 1999 and 1998, respectively.
8
<PAGE>
7. Treasury Stock
During the quarter Wind River repurchased 165,000 shares of its common stock
at an aggregate cost of $4.0 million, in accordance with the criteria
specified in its stock repurchase program.
In April 1999, Wind River announced a stock repurchase program under which
Wind River is authorized to purchase up to $25 million of its common stock.
The purchases are authorized to be made from time to time on the open market
at prevailing market prices or in negotiated transactions off the market.
These repurchases if made will supplement Wind River's ongoing repurchases of
$4.0 million per quarter. Wind River has not made any repurchases under the
new authorization.
8. Derivative Financial Instruments
Wind River enters into foreign currency forward exchange contracts to manage
exposure related to certain foreign currency transactions. Wind River does
not enter into derivative financial instruments for trading purposes. All
outstanding forward contracts at the end of a period are marked-to-market with
unrealized gains and losses included in other income, net, and thus are
recognized in income in advance of the actual foreign currency cash flows. Wind
River may, from time to time, adjust its foreign currency hedging position by
taking out additional contracts or by terminating or offsetting existing forward
contracts. These adjustments may result from changes in the underlying foreign
currency exposures or from fundamental shifts in the economics of particular
exchange rates. Gains and losses on terminated forward contracts, or on
contracts that are offset, are recognized in income in the period of contract
termination or offset. At April 30, 1999, Wind River had outstanding forward
contracts with notional amounts totaling approximately $2.2 million. These
contracts, which mature in less than ninety days, are hedges of certain foreign
currency transaction exposures primarily in Japanese yen. The difference between
cost and estimated fair value at April 30, 1999 was negligible.
On March 18, 1998, Wind River entered into an accreting interest rate swap
agreement (the "Swap Agreement") to reduce the impact of changes in interest
rates on its floating rate operating lease for its new corporate
headquarters. The Swap Agreement effectively changes Wind River's interest
rate exposure on its operating lease which is at one month LIBOR to a fixed
rate of 5.9%. At April 30, 1999, the notional amount of the accreting
interest rate swap was $28.5 million. The differential to be paid or received
under the Swap Agreement will be recognized as an adjustment to rent expense
related to the operating lease. The Swap Agreement matures at the same time
as the operating lease expires. The amounts potentially subject to credit
risk (arising from the possible inability of the counterparties to meet the
term of their contracts) are generally limited to the amounts, if any, by
which the counterparties' obligations exceed the obligations of Wind River.
9. Recent Accounting Pronouncements
In June 1998, the FASB issued SFAS 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS 133 requires companies to record
derivatives on the balance sheet as assets or liabilities, measured at fair
value. Gains or losses resulting from changes in the fair values of those
derivatives would be accounted for in current earnings unless specific hedge
criteria are met. The key criterion for hedge accounting is that the hedging
relationship must be highly effective in achieving offsetting changes in fair
value or cash flows. Wind River must formally document, designate, and assess
the effectiveness of transactions that receive hedge accounting. SFAS 133
will be effective for Wind River's consolidated financial statements for the
fiscal year ending January 31, 2001. Wind River has not yet determined the
impact, if any, of adopting this statement.
9
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10. Segment and Geographic Information
Wind River operates in one industry segment -- technology for embedded
operating systems. Management uses one measurement of profitability for its
business.
Wind River markets its products and related services to customers in the
United States, Canada, Europe and the Asia Pacific region. Internationally,
Wind River markets its products and services primarily through its
subsidiaries and various distributors. Revenues are attributed to geographic
areas based on the country in which the customer is domiciled. The
distribution of revenues and assets by geographic location is as follows:
<TABLE>
<CAPTION>
Revenue Assets
- --------------------------------------------------- --------------------------------
Three months ended
(In thousands) April 30, April 30, January 31,
- --------------------------------------------------- --------------------------------
<S> <C> <C> <C> <C>
1999 1998 1999 1999
------- ------- -------- --------
United States $19,329 $17,522 $303,988 $295,802
Japan 5,772 4,107 10,509 12,043
Other International 7,499 4,771 16,262 18,931
- -------------------------- ---------------------- ----------------------------
Consolidated $32,600 $26,400 $330,759 $326,776
- -------------------------- ---------------------- ----------------------------
</TABLE>
Other International consists of the revenues and assets of operations in
Europe and Asia Pacific excluding Japan.
10
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WIND RIVER SYSTEMS, INC.
This report contains forward-looking statements. In some cases, these statements
may be identified by terminology such as "may", "will", "should", "expects",
"plans", "anticipates", "believes", "estimates", "predicts", "potential", or
"continue" or the negative of such terms and other comparable expressions. These
statements involve known and unknown risks and uncertainties that may cause the
results, levels of activity, performance or achievements of Wind River Systems
Inc. or its industry to be materially different from those expressed or implied
by the forward-looking statements. Factors that may cause or contribute to such
differences include, but are not limited to, Wind River's ability to compete
successfully in its industry, to continue to develop products for new and
rapidly changing markets, to integrate acquired business and technologies and
others discussed below in Wind River's Annual Report on Form 10-K for the fiscal
year ended January 31, 1999. Wind River disclaims any obligation to update any
of the forward-looking statements contained in this report to reflect any
future events or developments. The following discussions should be read in
conjunction with the unaudited condensed consolidated financial statements and
notes included elsewhere herein.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
OVERVIEW
Wind River develops, markets, supports and provides consulting services for
advanced software operating systems and development tools that allow
customers to create complex, robust, real-time software applications for
embedded computers. An embedded computer is a microprocessor that is
incorporated into a larger device and is dedicated to responding to external
events by performing specific tasks quickly, predictably and reliably. Wind
River's flagship product, Tornado II-TM-, enables customers to enhance
product performance, standardize designs across projects, reduce research and
development costs and shorten product development cycles.
RESULTS OF OPERATIONS
REVENUES
Total revenues for the three months ended April 30, 1999 were $32.6 million,
compared to $26.4 million for the same period in fiscal 1999. The increase in
revenues of 23% for the three month period ended April 30, 1999 is due to
increases in both product revenues and service revenues.
Revenue from the sale of products increased 18% to $22.7 million for the
three months ended April 30, 1999, compared to $19.3 for the same period in
fiscal 1999. Product revenues primarily consist of development license fees
and run-time license fees. Wind River typically charges a one-time fee for
development licenses and OEM licenses and a run-time license fee for each
copy of Wind River's operating system embedded in the customer's product. The
increase in product revenues was due primarily to continued acceptance of
Wind River's products and an increase in run-time license revenues.
Services revenue increased 40% to $9.9 million for the three months ended
April 30, 1999, compared to $7.1 million for the same period in the prior
fiscal year. The increase was primarily due to increases in revenue from (1)
engineering services required to port our VxWorks operating system to
specific customer semiconductor chip sets; (2) maintenance support
agreements, both new and recurring, and training resulting from the increase
in Wind River's installed base of Tornado-TM- software development
environment and software applications provided to customers; and (3)
professional services.
11
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Total revenues from international sales for the three months ended April 30,
1999 were $13.3 million, compared to $8.9 million for the same period in the
prior fiscal year. The increase of 49% for the three months ended April 30,
1999 was primarily due to increased demand for our products and services in
Japan and Europe. International revenues accounted for 41% total revenues for
the three months ended April 30, 1999, compared to 34% for the same period in
the prior fiscal year. Wind River expects international sales to continue to
represent a significant portion of revenues, although the actual percentage
may fluctuate from period to period. Wind River's international sales are
denominated in the local currencies, and an increase in the relative value of
the dollar against such currencies would reduce Wind River's revenues and
backlog in dollar terms or make Wind River's products more expensive and,
therefore, potentially less competitive in foreign markets. Wind River
actively monitors its foreign currency exchange exposure and to date such
exposures have not had a material impact on Wind River's results of
operations. Wind River enters into forward contracts to hedge the short-term
impact of foreign currency fluctuations. In recent years, economic
uncertainty and related weakening of foreign currencies against the dollar
has occurred. As a result, Wind River's future sales may be adversely
affected, which could have a material adverse effect on Wind River's
business, results of operations and financial condition. Revenues from Asia
Pacific sources including Japan represented 55% of international revenues for
the three months ended April 30, 1999, compared to 52% for the same period in
the prior fiscal year. See "Additional Risk Factors that may affect Future
Results of Operations-Risks Associated with International Operations".
COSTS OF REVENUES
The overall cost of products and services as a percentage of total revenues
was at 18% for each of the three month periods ended April 30, 1999 and 1998.
Product-related cost of sales as a percentage of product revenues decreased
to 8% for the three month period ended April 30, 1999, compared to 10% for
the corresponding period of the prior fiscal year. Product-related costs
consist primarily of salaries and benefits for production employees; product
media; royalty payments to third parties for the use of their software;
documentation and packaging. The decrease in product costs as a percentage of
total revenues is attributable to the increase in run-time royalties and a
decrease in royalty payments to third parties as a percentage of product
revenues. Wind River's cost of revenue as a percentage of product revenues
may be affected in the future by the amortization of purchased technology and
distribution rights related to the introduction of new products including
Tornado II, Tornado for Embedded Internet products and Tornado for Managed
Switches and by the royalty payments to other third parties for sales related
to their products.
Service related cost of revenue as a percentage of service revenue was 42 %
for the three month period ended April 30, 1999, compared to 40% for the same
period in fiscal 1999. Service related costs consist primarily of personnel
related costs associated with providing services to customers and the
infrastructure to manage a services organization as well as costs to recruit,
develop, and retain services professionals. The increase in costs of service
revenues is due to investment in developing new services offerings and the
addition of its new professional services organization. Wind River expects
that customer services costs will increase in absolute dollars as Wind River
continues to increase its customer support staff, customer support
capabilities and professional services organization.
OPERATING EXPENSES
Selling and marketing expenses were $12.3 million for the three months ended
April 30, 1999, compared to $9.9 million for the same period in the prior
fiscal year. As a percentage of total revenue, selling and marketing expenses
were 38% for the three months ended April 30, 1999, compared to 37% for the
corresponding period in the prior fiscal year. The increase in absolute
dollars resulted primarily from the growth in the number of sales and
marketing personnel and field engineers and related costs and increases in
expenses related to marketing and advertising programs including third party
marketing costs for product introductions and promotions. During the
12
<PAGE>
first quarter of fiscal 2000, Wind River continued its
introduction of Tornado II to the marketplace while first customer shipment
took place in second quarter of fiscal 2000. Wind River expects that sales
and marketing expenses will continue to increase in absolute dollars as Wind
River continues to expand its sales and marketing staff.
Product development and engineering expenses were $5.7 million for the three
months ended April 30, 1999, or 18% of total revenue for the period compared
to $3.8 million or 14% of total revenue for the same period in the prior
fiscal year. The increase in product development and engineering expenses is
primarily due to the increase in staff and associated support for engineers
to expand and enhance Wind River's product line, including the costs
associated with integrating the XACT engineering team Wind River hired in
April 1999. Wind River believes that product development and engineering
expenses will continue to increase in absolute dollars as it continues to
invest in the development of new products, applications and product
enhancements.
General and administrative expenses were $2.5 million or 8% of total revenue
for the three months ended April 30, 1999, compared to $1.7 million or 6% of
total revenue for the corresponding period in the prior fiscal year. The
increase was primarily due to: (1) the growth in worldwide staff and
infrastructure investments in the areas of information systems, finance and
administration; (2) the write off of a distribution agreement with XACT in
which XACT is unable to complete the development of their product that is
subject to the distribution agreement; and (3) the costs associated with
hiring XACT employees, acquiring equipment and other assets of XACT and
revising a second distribution agreement for another product with XACT. Wind
River believes that general and administrative expenses will continue to
increase in absolute dollars as it continues to invest in worldwide staff and
infrastructure in the areas of information systems, finance and
administration.
OTHER INCOME AND EXPENSES
Interest expense was $2.2 million for the three months ended April 30, 1999,
compared to $2.1 million for the same period in the prior fiscal year. Wind
River pays interest on the 5.0% Convertible Subordinated Notes, due in 2002
and maturities of certain issuance costs associated with these Notes. The
interest on the Notes is payable on February 1 and August 1 of each year
commencing February 1, 1998. The Notes mature on August 1, 2002.
Interest income and other, net was $3.2 million for the three months ended
April 30, 1999, compared to $3.1 million for the same period in the prior
fiscal year.
During the fiscal year ended January 31, 1999, Wind River paid $500,000 for a
10% interest in the common stock of Xact, Inc. ("XACT") that was accounted
for under the cost method. During April 1999, Wind River entered into an
asset purchase agreement with XACT pursuant to which Wind River acquired
certain office and other equipment from XACT and revised the terms of an
existing distribution agreement with XACT. Subsequently but not pursuant to
the asset purchase agreement, Wind River hired a significant number of XACT
employees. As a result of the events, Wind River believes the future
operations and cash flows of XACT have become uncertain and that its original
investment is not recoverable. Accordingly, Wind River has recognized a
charge totaling $500,000 for the difference between the carrying amount of
its investment and the net realizable value.
PROVISION FOR INCOME TAXES
The effective tax rate for the three months ended April 30, 1999 was 37.5%
compared to 38.4% for the same period in the prior fiscal year. The overall
changes in the effective tax rates result primarily from the difference
between foreign and domestic tax rates and the ratio of foreign taxable
income to domestic taxable income, varying levels of available research and
development credits, and varying levels of tax-exempt interest income.
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LIQUIDITY AND CAPITAL RESOURCES
At April 30, 1999, Wind River had working capital of approximately $68
million and cash and investments of approximately $213 million, which include
investments with maturities greater than one year of $140 million. The
decrease in long-term investments of $16 million from January 31, 1999 is
primarily due to transfer of funds held as long-term securities to cash
equivalents or short-term investments.
During the first three months of fiscal 2000, Wind River's operating
activities provided net cash of $14.9 million due primarily to net income,
depreciation and amortization, and changes in accounts receivable, accrued
liabilities and income taxes payable. These sources of cash were partially
offset by the changes in prepaid and other assets and deferred revenue.
During the first three months of fiscal 2000, investing activities provided
net cash of $14.4 million due primarily to sales of investments. These
sources of cash were partially offset by uses of cash relating to the
acquisition of equipment, purchases of investments and purchases of
investments held as collateral for the operating lease and an accreting
interest rate swap agreements. As Wind River transitioned its investment
portfolio from long-term to short-term investments and cash equivalents, our
long-term investments decreased by $16 million. Restricted cash increased
primarily due to the increased collateral funding for the operating lease of
Wind River's headquarters. The collateral consists of direct obligations of
the United States government, with the majority being long-term securities.
Wind River's financing activities used net cash of $3.8 million due primarily
to stock repurchases. Cash used was partially offset by cash provided by the
issuance of common stock from employee stock option exercises. During the
three months ended April 30, 1999, Wind River repurchased as part of its
systematic stock repurchase program 165,000 shares of its common stock at a
cost of approximately $4 million.
In April 1999, Wind River announced a stock repurchase program under which
Wind River is authorized to purchase up to $25 million of its common stock.
The purchases are authorized to be made from time to time on the open market
at prevailing market prices or in negotiated transactions off the market.
These repurchases if made will supplement Wind River's ongoing repurchases of
$4.0 million per quarter. Wind River has not made any repurchases under the
new authorization.
In fiscal 1998, Wind River entered into an operating lease agreement for a
new headquarters facility being constructed on land owned by Wind River in
Alameda, California. As of April 30, 1999, the lessor has funded a total of
$30.6 million of construction costs and has committed to fund up to a maximum
of $35 million. The operating lease payments will begin upon completion of
construction expected to be in the second quarter of fiscal 2000 and will
vary based on the total construction costs of the property, including
capitalized interest, and the London interbank offering rate ("LIBOR").
On March 18, 1998, Wind River entered into an accreting interest rate swap
agreement to reduce the impact of changes in interest rates on its floating
rate operating lease for its new corporate headquarters. This agreement
effectively changes Wind River's interest rate exposure on its operating
lease, which is based on one month LIBOR to a fixed rate of 5.9%. At April 30,
1999, the notional amount of the accreting interest rate swap was $28.5
million. The differential to be paid or received under this agreement will be
recognized as an adjustment to rent expense related to the operating lease.
The swap agreement matures at the same time as the operating lease expires.
The amounts potentially subject to credit risk (arising from the possible
inability of counterparties to meet the term of their contracts) are generally
limited to the amounts, if any, by which the counterparties' obligations exceed
the obligations of Wind River. Wind River manages potential counterparty credit
risk prior to entering into transactions by requiring that all counterparties
have at least a AA Standard and Poor's, or Moody's equivalent, long-term senior
debt rating.
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In connection with the lease, Wind River is obligated to enter into a lease
of its land in Alameda, California to the lessor of the building at a nominal
rate and for a term of 55 years. If Wind River terminates or does not
negotiate an extension of the building lease, the ground lease converts to a
market rental rate. The lease provides Wind River with the option at the end
of the lease to either acquire the building at the lessor's original cost or
arrange for the building to be acquired. Wind River has guaranteed the
residual value associated with the building to the lessor of approximately
82% of the lessor's $35 million funding obligation. Wind River is also
required, periodically during the construction period, to deposit fixed
income securities with a custodian as a deposit to secure the performance of
its obligations under the lease. In addition, under the terms of the lease,
Wind River must maintain compliance with certain financial covenants. As of
April 30, 1999, Wind River was in compliance with these covenants. Management
believes that the contingent liability relating to the residual value
guarantee will not have a material adverse effect on Wind River's financial
condition or results of operations.
Wind River has an investment portfolio of fixed income securities that are
classified as available-for-sale securities. These securities, like all fixed
income instruments, are subject to interest rate risk and will decline in
value if market interest rates increase. Wind River attempts to limit this
exposure by investing primarily in high grade securities.
Management believes that Wind River's working capital and the cash flow
generated from operations are sufficient to meet its working capital
requirements for planned expansion, product development and capital
expenditures for the next twelve months.
"YEAR 2000" ISSUES
Many currently installed computer systems and software products include
coding to accept only two digit entries in the date code field. These date
code fields will need to accept four digit entries to distinguish dates prior
to January 1, 2000, from dates on and after January 1, 2000. As a result, in
approximately six months, computer systems and/or software used by many
companies will need to be upgraded to comply with such "Year 2000"
requirements. Systems that do not properly recognize such information could
generate erroneous data or cause a system to fail. Significant uncertainty
exists in the software industry concerning the potential effects associated
with such compliance.
Wind River has conducted Year 2000 compliance reviews for current versions of
its products. The review includes assessment, implementation, validation
testing and contingency planning. Although Wind River believes the most
current releases of its products will neither cease to perform nor generate
incorrect or ambiguous data or results solely due to a change in date on 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 on or before December 31, 1999 (collectively
"Year 2000 Compliance"), Wind River provides no assurance that its software
products contain all the necessary software routines and programs for the
accurate calculation, display, storage and manipulation of data involving
dates. Failure of Wind River's software products to contain all the necessary
software routines and programs for the accurate calculation, display, storage
and manipulation of data involving dates would have a material adverse effect
on Wind River's business, financial condition and results of operation. The
majority of Wind River's products are combined by its customers with other
software programs or hardware devices not provided by Wind River. Such
combination with other products that are not Year 2000 Compliant or
modifications of Wind River's products by its customers may introduce Year
2000 Compliance issues for its customers. Wind River's customers' inability
to remedy their own Year 2000 Compliance issues could affect their demand for
Wind River's products, which may materially and adversely affect Wind River's
business, financial condition and results of operations. Wind River continues
to respond to customer concerns about prior versions of Wind River's products
on a case-by-case basis. For certain older versions of Wind River's products
which may not be Year 2000 compliant, Wind River is providing a patch to
bring the product into compliance. With respect to certain third party
products included in Wind River's product offerings that may not be Year 2000
compliant, Wind River is working with software vendors to bring the products
into compliance.
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To address Year 2000 issues, Wind River has initiated a program designed to
address the most critical Year 2000 items that would affect its products, its
worldwide business systems, and the operations of research and development,
finance, sales and marketing, manufacturing, and human resources. Assessment
and remediation efforts regarding these critical items are proceeding in
parallel.
Wind River has tested software obtained from third parties that is integrated
into or with Wind River's products, and seeks assurances from vendors that
licensed software is Year 2000 Compliant. Despite testing by Wind River,
current customers and potential customers, and assurances from developers of
products incorporated into Wind River's products, such products may contain
undetected errors or defects associated with Year 2000 date functions. Known
or unknown errors or defects in Wind River's products or third party products
may result in delay or loss of revenue, diversion of development resources,
damage to Wind River's reputation, or increased service and warranty costs.
The occurrence of any of the foregoing could materially adversely affect Wind
River's business, financial condition and results of operations.
Wind River is working with critical suppliers to determine that such
suppliers' operations and the products and services they provide Wind River
are Year 2000 Compliant or to monitor their progress towards Year 2000
Compliance. Wind River has requested its critical suppliers to complete a
questionnaire that provides information regarding Year 2000 Compliance. The
suppliers rate themselves as currently Year 2000 Compliant or are engaged in
programs to become Year 2000 Compliant. Wind River will continue to monitor
the status of suppliers who have not completed their Year 2000 Compliance
programs. Wind River has received information from its largest customers
regarding Year 2000 Compliance. The customers state that they will not incur
any business interruptions related to Year 2000 Compliance issues. As is the
case with other software companies, if its current or future outside
customers or suppliers fail to achieve Year 2000 Compliance or if they divert
technology expenditures to address their own Year 2000 Compliance problems,
Wind River's business, financial condition or results of operations could be
materially adversely affected.
In 1997, Wind River commenced a worldwide financial business and production
systems replacement project that uses software primarily from Oracle. The new
systems are targeted at bringing Wind River's business and production
computer systems into Year 2000 Compliance. Wind River anticipates its
financial and production systems will be operational in the fourth quarter of
1999. In January 1998, Wind River initiated an analysis of the condition of
Year 2000 readiness for the programs it uses for internal development. Wind
River will modify or replace programs that were determined not to be Year
2000 Compliant. Wind River believes the software and hardware it uses
internally or will have installed for internal use will comply with Year 2000
requirements and is not aware of any material operational issues or costs
associated with preparing its internally used software and hardware for the
Year 2000. However, Wind River provides no assurances that it will not
experience serious, unanticipated negative consequences, including material
costs caused by undetected errors or defects in the technology used in its
internal systems. The occurrence of any of the foregoing could have a
material adverse effect on Wind River's business, operating results or
financial condition.
Wind River has funded its Year 2000 Compliance review from operating cash
flows and, except for its new financial reporting system, has not separately
accounted for these costs. Wind River will incur additional amounts related
to the Year 2000 Compliance review including administrative personnel to
manage the review, outside contractors to provide technical advice and
technical support for its products, product engineering and customer
satisfaction. Excluding the implementation of its financial reporting system,
Wind River believes it has completed approximately 85% of the work required
to obtain Year 2000 Compliance. Wind River expects to incur costs of
approximately $4.0 million to implement its financial reporting system. As of
April 30, 1999, Wind River has incurred $1.8 million for the implementation.
Wind River's Year 2000 budget will be modified as necessary to address
correction of any additional systems identified to be non-compliant. However,
management does not anticipate that Wind River will incur other significant
operating expenses or be required to invest heavily in computer systems
improvements to be Year 2000 Compliant.
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Wind River is currently developing contingency plans to be implemented as
part of its efforts to identify and correct Year 2000 problems affecting its
internal systems. Wind River expects to complete its contingency plans by the
second quarter of 1999. Depending on the systems affected, these plans could
include accelerated replacement of affected equipment or software, short to
medium-term use of backup equipment and software, increased work hours for
Company personnel or use of contract personnel to correct (on an accelerated
schedule) any Year 2000 problems that arise or to provide manual workarounds
for information systems, and similar approaches. If Wind River is required to
implement any of these contingency plans, it could have a material adverse
effect on Wind River's financial condition and results of operations.
Wind River's ability to achieve Year 2000 Compliance and the level of
incremental costs associated therewith, could be adversely impacted by, among
other things, the availability and cost of programming and testing resources,
vendors' ability to modify propriety software, and unanticipated problems
identified in the ongoing compliance review. Such failures could have a
material adverse affect on Wind River's business, financial condition and
results of operations.
EURO CURRENCY
On January 1, 1999, several member countries of the European Union
established fixed conversion rates between their sovereign currencies and
adopted the Euro as their new common legal currency. Since that date, the
Euro has traded on currency exchanges. The legacy currencies will remain
legal tender in the participating countries for a transition period between
January 1999 and January 1, 2002. During the transition period, non-cash
payments can be made in the Euro, and parties can elect to pay for goods and
services and transact business using either the Euro or a legacy currency.
Between January 1, 2002 and July 1, 2002, the participating countries will
introduce Euro notes and coins and withdraw all legacy currencies from
circulation. The Euro conversion may affect cross-border competition by
creating cross-border price transparency. Wind River is assessing its
pricing/marketing strategy in order to insure that it remains competitive in
a broader European market and is reviewing whether certain existing contracts
will need to be modified. Wind River has assessed the ability of information
technology systems to allow for transactions to take place in both the legacy
currencies and the Euro and the eventual elimination of the legacy currencies
and believes that its information technology systems will not be affected by
the transition to the Euro. Wind River does not presently expect that
introduction and use of the Euro will materially affect Wind River's foreign
exchange exposures and hedging activities or will result in any material
increase in costs to Wind River. Wind River's currency risk and risk
management for operations in participating countries may be reduced as the
legacy currencies are converted to the Euro. Final accounting, tax and
governmental, legal and regulatory guidance is not available. Wind River will
continue to evaluate issues involving introduction of the Euro. Based on
current information and Wind River's current assessment, it does not expect
that the Euro conversion will have a material adverse effect on its business,
financial condition or results of operations.
ADDITIONAL RISK FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
WIND RIVER'S BUSINESS FACES SIGNIFICANT RISKS. IF ANY OF THE EVENTS OR
CIRCUMSTANCES DESCRIBED IN THE FOLLOWING RISKS ACTUALLY OCCURS, WIND RIVER'S
BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS COULD BE MATERIALLY
AND ADVERSELY AFFECTED. THESE RISKS SHOULD BE READ IN CONJUNCTION WITH THE
OTHER INFORMATION SET FORTH IN THIS REPORT.
FLUCTUATIONS IN OPERATING RESULTS
Our quarterly revenues and operating results have fluctuated significantly in
the past and may continue to vary from quarter to quarter due to a number of
factors including the volume and timing of orders received during the
quarter; lack of long-term license agreements with our customers, which makes
it difficult to predict the timing of license fees; purchasing patterns of
customers and distributors; length of sales cycle of our product; market
acceptance of
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products sold by our customers and stages of their product cycles, which
affect the license revenues we derive from each product sold with our VxWorks
operating system embedded in our customer products and may result in
unanticipated sales and buyouts of run-time licenses; business cycles
affecting the markets in which our products are sold; general economic
conditions or conditions in specific geographic areas; extraordinary events,
such as acquisitions, including related charges; foreign currency exchange
rates and; the risks inherent in acquisitions of technologies and businesses,
including the timing and successful completion of technology and product
development to production readiness, integration issues, costs and
anticipated expenditures, changing relationships with customers, suppliers
and strategic partners, potential intellectual property or employment issues
and the risks that the acquisition cannot be completed successfully or that
anticipated benefits are not realized.
We have at times recognized a substantial portion of our total revenue from
sales booked and shipped in the latter part of a quarter; thus, the magnitude
of quarterly fluctuations may not become evident until late in a particular
quarter. Revenues are typically higher in the fourth quarter, which ends on
January 31, than in other quarters of the fiscal year primarily as a result of
purchases by customers prior to the calendar year end, as well as by customers
who purchase at the commencement of a new calendar year. The procurement
process of our customers may last for several months or longer from initial
inquiry to order and may involve competing considerations; further, as licensing
of our products increasingly becomes a more strategic decision made at higher
management levels, sales cycles for our product may become longer.
Other factors that may cause significant variations in our operating results
include the introduction, timing and acceptance of new products and product
enhancements by Wind River or our competitors, competitive conditions in the
industry, our ability to continue to develop innovative and competitive
products, international conditions such as changes in foreign currency exchange
rates or weak economic conditions of the respective countries in which we
operate, software "bugs" or other product quality problems, including Year 2000
compliance issues, change in product mix sold, changes in company strategy;
personnel changes; mix of products sold, and our ability to successfully
implement a professional services organization for which the cost of personnel
and certified consultants is high and reduces gross margin. Gross margin
represents the difference between the amount of revenue from the sale of
professional services and Wind River's cost of providing these services. Wind
River must pay high salaries to professional services employees to attract and
retain them and pay high hourly fees to consultants to retain them. This results
in a lower gross margin than in Wind River's product business. In addition, the
high cost of training new professional services personnel and consultants or not
fully utilizing these personnel can significantly lower gross margins.
Software vendors have from time to time experienced price erosion of their
products. As is typical in the software industry, Wind River's fixed costs as
a percentage of revenues are high, and significant price erosion could have a
material adverse effect on Wind River's revenues and operating results. We
intend to continue to increase our operating expenses in fiscal year 2000.
Large portions of our expense levels are relatively fixed and are based, in
part, on our expectations of our future revenue. Consequently, if revenue
levels fall below our expectations, our net income will decrease because only
a small portion of our expenses varies with our revenue. We have been
profitable for the last several years on an annual basis. However, there can
be no assurance that Wind River will be able to continue its growth in
revenue or sustain its profitability on a quarterly or annual basis. Due to
all of the foregoing factors, we believe 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. It is possible that, in
some future quarters, our operating results will be below the expectations of
stock market analysts and investors. In such event, the market price of our
common stock could decrease significantly.
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RELIANCE ON CORE FAMILY OF PRODUCTS
Revenue from sales of the Tornado, VxWorks and IxWorks family of products and
services accounted for substantially all of our revenues in each of the
fiscal years ended January 31, 1999, 1998 and 1997. We typically charge a
one-time fee for development licenses and OEM licences and a run-time license
fee for each copy of our operating system embedded in the customer's
products. One of the key components of Wind River's strategy is to increase
revenue through run-time license fees. Our future results depend heavily on
continued market acceptance of our products in our current markets and
successful application in new markets; conditions of markets for the Tornado,
VxWorks and IxWorks family of products and services; successful negotiation
of run-time license agreements; and successful commercialization by our
customers of the underlying products. To the extent that such customers are
not successful, Wind River may not be able to meet its objectives, and its
business, financial condition and results of operations could be materially
and adversely affected.
COMPETITION
The embedded real-time software industry is highly competitive and is
characterized by rapidly advancing technology. Therefore, Wind River's
ability to obtain such business is dependent upon its ability to offer better
strategic concepts and technical solutions, time-to-market for our customers,
competitive prices, integration into certain capabilities like graphic
interfaces, communication protocols and peripheral controllers, customer
support response time, or a combination of these factors. There can be no
assurance that Wind River will be able to effectively compete in each of
these areas, and any failure to compete in the embedded real-time software
market would have a material adverse effect on Wind River's business,
financial condition and results of operations. In order to maintain or
improve its position in the industry, Wind River must continue to enhance its
current products and rapidly develop new products and product extensions.
Wind River believes that its principal competition comes from companies that
develop real-time embedded software development systems in-house rather than
purchase such systems from independent software vendors such as Wind River,
and that it is thus subject to the customers' "develop versus buy" decisions
in addition to the factors set forth above. Many of these organizations have
substantial internal programming resources with the capability to develop
specific products for their needs. Wind River also competes with other
independent software vendors, including Integrated Systems, Inc., Mentor
Graphics, Inc. (through its acquisition of Microtec/Ready Systems), Microware
Systems Corporation, QNX Software Systems, Ltd., Accelerated Technology, Inc.
and Microsoft Corporation. In addition, hardware or other software vendors
could seek to expand their product offerings by designing and selling
products that directly compete with or adversely affect sales of Wind River's
products. Many of Wind River's existing and potential competitors have
substantially greater financial, technical, marketing and sales resources
than Wind River. As a result, they may be able to respond more quickly to new
or emerging technologies and changes in customer requirements, or to devote
greater resources to the development, promotion, sale and support of their
products. Furthermore, current and potential competitors have established or
may establish cooperative relationships among themselves or with third
parties. Accordingly, it is possible that new competitors or alliances among
competitors may emerge and rapidly acquire significant market share. In
addition, Wind River is aware of ongoing efforts by competitors to emulate
the performance and features of Wind River's products, and there can be no
assurance that competitors will not develop equivalent or superior technology
to that of Wind River. Because substantially all of Wind River's revenues
have been derived from sales of the Tornado, VxWorks and IxWorks family of
products and services, the effects of competition could be more adverse than
would be the case if Wind River had a broader product offering. In addition,
competitive pressures could cause Wind River to reduce the prices of its
products and services, which would result in reduced profit margins. There
can be no assurance that Wind River will be able to compete effectively
against its current and future competitors. If Wind River is unable to
compete successfully, its business, financial condition and results of
operations would be materially and adversely affected.
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RAPID TECHNOLOGICAL CHANGE; DEPENDENCE ON NEW PRODUCTS
The embedded real-time software industry is characterized by a fragmented
market characterized by ongoing technological developments; evolving industry
standards; and rapid changes in customer requirements. Our success depends
and will continue to depend upon our ability to continue to develop and
introduce in a timely manner new products that take advantage of
technological advances; identify and adhere to emerging standards; continue
to improve the functionality of our Tornado development environment and the
scalability and functionality of the VxWorks product; offer products across a
spectrum of microprocessor families used in the embedded systems market; and
respond promptly to customers' requirements. Wind River 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 our existing products obsolete. Wind River has from time to time
experienced delays in the development of new products and the enhancement of
existing products. Such delays are commonplace in the software industry.
There can be no assurance that we will be able to develop and market on a
timely basis or at all competitive products, product enhancements and new
products that respond to technological change, changes in customer
requirements and emerging industry standards; or our enhanced or new products
will adequately address the changing needs of the marketplace. Failure to
develop and introduce new products and product enhancements in a timely
manner would materially and adversely affect Wind River's business, financial
condition and results of operations.
RISKS ASSOCIATED WITH NEW AND CHANGING MARKETS
Wind River is continuously engaged in product development for new or changing
markets. In particular, Wind River has invested significant time and effort,
together with a consortium of industry participants, in the development of
I2O, a new specification that is intended to create an open standard set of
interface specifications for high performance I/O systems. The specification
is intended to be used by system, network and peripheral interface card and
operating systems vendors to simplify the task of building and maintaining
high-performance I/O subsystems. Wind River also has developed IxWorks, a
real-time operating system for use in conjunction with the I2O specification.
The success of the I2O specification and the IxWorks product line depends
heavily on its adoption by a broad segment of the industry. Wind River also
has expended, and continues to expend, substantial time and financial
resources to develop embedded operating software and development tools for
Internet applications. The commercial Internet market has only recently begun
to develop, is rapidly changing and is characterized by an increasing number
of new entrants with competitive products. Moreover, there is an increasing
number of new Internet protocols to which Wind River's products must be
ported. It is unclear which of these competing protocols ultimately will
achieve market acceptance. If the protocols upon which Wind River's Internet
products are based ultimately fail to be widely adopted, Wind River's
business, financial condition and results of operations may be materially and
adversely affected. It is difficult to predict with any assurance whether
demand for any of these products will develop or increase in the future. If
these markets, or any other new market targeted by Wind River in the future,
fail to develop, develop more slowly than anticipated or become saturated
with competitors, if Wind River's products are not developed in a timely
manner, or if Wind River's products and services do not achieve or sustain
market acceptance, Wind River's business, financial condition and results of
operations would be materially and adversely affected.
RISKS OF PRODUCT DEFECTS; PRODUCT AND OTHER LIABILITY
As a result of their complexity, software products entail certain risks.
Products may contain undetected errors or compatibility issues, particularly
when first introduced or as new versions are released. Errors may be found in
new products after commencement of commercial shipments. The occurrence of
such errors could result in loss of or delay in market acceptance of our
products, which could have a material adverse effect on Wind River's
business, financial condition and results of operations. The increasing use
of Wind River's products for applications in systems that interact directly
with the general public, particularly applications in transportation,
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medical systems and other markets where the failure of the embedded system
could cause substantial property damage or personal injury, could expose Wind
River to significant product liability claims. Our products may be used for
applications in mission-critical business systems where the failure of the
embedded system could be linked to substantial economic loss. In order to
mitigate adverse effects from such errors or liability claims, we perform
testing and request certain customers to test pre-release versions. Our
license and other agreements with our customers typically contain provisions
designed to limit our exposure to potential product liability and other
claims; these provisions may not be effective in all circumstances and in all
jurisdictions. We carry insurance against product liability risks and errors
or omissions coverage. However, there can be no assurance that such insurance
will continue to be available to Wind River on commercially reasonable terms
or at all. A product liability claim or claim for economic loss brought
against Wind River in excess of or outside the limits of its insurance
coverage, or a product recall involving Wind River's software, could
materially and adversely affect Wind River's business, financial condition
and results of operations.
RISKS ASSOCIATED WITH ACQUISITIONS
As part of our business strategy, we have completed the acquisitions of
Objective Software Technology, Ltd., Zinc Software Incorporated, and have
acquired equity interests in Emultek, Ltd., 3Soft GmbH and Liberate
Technologies, Inc. We have also licensed certain technologies from Liberate
Technologies, Inc. and acquired certain distribution rights from XACT. We
expect to make additional acquisitions of, or significant investments in,
businesses that offer complementary products, services and technologies. Any
acquisitions or investments will be accompanied by the risks commonly
encountered in acquisitions of businesses and technologies including, among
other things, the difficulty of assimilating the operations and personnel of
the acquired businesses; the potential disruption of Wind River's ongoing
business; the inability to complete and integrate acquired technologies into
new and existing products; the inability of management to maximize the
financial and strategic position of Wind River; the potential for
unidentified liabilities to disrupt the ongoing operations of Wind River; the
maintenance of uniform standards, controls, procedures and policies; the
impairment of relationships with employees, customers and suppliers as a
result of any integration of new management personnel; and the charges
related to acquisitions such as one-time write-offs, transaction expenses,
increased debt and contingent liabilities, substantial depreciation or
deferred compensation changes or the amortization of expenses related to
goodwill or other intangible assets. These factors could materially and
adversely affect Wind River's business, results of operations or financial
condition. Consideration paid for future acquisitions, if any, could be in
the form of cash, stock, debt and rights to purchase stock or a combination
thereof. Dilution to existing stockholders and to earnings per share may
result to the extent that shares of stock or other rights to purchase stock
are issued in connection with any such future acquisitions.
DEPENDENCE ON VME MARKET
A significant amount of Wind River's revenues historically has been derived
from sales of systems built to the VME (versabus module eurocard) standard.
These systems typically are used in high cost, low volume applications,
including military, telecommunications, space and research applications.
Although Wind River believes that revenues from sales of products designed
for embedded systems applications will account for an increasing percentage
of Wind River's revenues in the future, Wind River expects revenues from the
VME market to continue to be significant for the foreseeable future. Academic
institutions and defense industry participants, which generate a significant
portion of Wind River's VME revenues, are dependent on government funding,
the continued availability of which is uncertain. Typically, Wind River's VME
customers have received government funding prior to placing its product
orders with Wind River. Any unanticipated future termination of government
funding of VME customers could have a material adverse effect on Wind River's
business, financial condition and results of operations.
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MANAGEMENT OF GROWTH; DEPENDENCE ON KEY PERSONNEL; NEED FOR ADDITIONAL
PERSONNEL
Wind River has experienced, and expects to continue to experience,
significant growth in the number of employees, the scope and complexity of
its operations and financial systems and the geographic area of its
operations. Wind River's continued success will depend significantly on its
ability to integrate new operations and new personnel. Wind River's ability
to manage future expansion of its operations, if any, will require Wind River
to continue to improve its financial and management controls, reporting
systems and procedures on a timely basis and expand, train and manage its
employee work force efficiently. There can be no assurance that Wind River
will be able to do so successfully. Wind River's failure to do so could have
a material adverse effect on Wind River's business, operating results and
financial condition.
During fiscal 1999, we relocated our principal administrative, sales,
marketing, product development and engineering facilities to the new
headquarters facility. We entered into an operating lease agreement under which
we will pay approximately $160,000 per month through September 2004. The
operating lease payment will vary based on the total construction costs of the
property, including capitalized interest, and LIBOR. Wind River's future
performance depends to a significant degree upon the continued contributions of
its key management, product development, marketing, sales, customer support and
operations personnel, several of whom have joined Wind River only recently. In
addition, Wind River believes its future success will depend in large part upon
its ability to attract and retain highly-skilled managerial, product
development, marketing, sales, customer support and operations personnel, many
of whom are in great demand. Competition for such personnel is particularly
intense in the San Francisco Bay Area, where Wind River is headquartered, and
there can be no assurance that Wind River will be successful in attracting and
retaining such personnel. The failure of Wind River to attract, integrate and
retain the necessary personnel could have a material adverse effect on Wind
River's business, financial condition and results of operations.
RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS
During the three month period ended April 30, 1999 and the fiscal year ended
January 31, 1999, Wind River derived approximately 41% and 34%, respectively,
of its total revenue from sales outside of North America. We expect that
international sales will continue to generate a significant percentage of its
total revenue in the foreseeable future. We also expect to continue to make
investments to expand further its international operations and to increase
its direct sales force in Europe and Asia. There can be no assurance that
these investments will result in commensurate increases in Wind River's
international sales. International operations are subject to certain risks,
including, foreign government regulation; more prevalent software piracy;
longer payment cycles; unexpected changes in, or imposition of, regulatory
requirements, tariffs, import and export restrictions and other barriers and
restrictions; greater difficulty in accounts receivable collection;
potentially adverse tax consequences including restrictions on repatriation
of earnings; the burdens of complying with a variety of foreign laws;
staffing and managing foreign operations; political and economic instability;
changes in diplomatic and trade relationships; possible recessionary
environments in economies outside the United States; and other factors beyond
the control of Wind River. There can be no assurance that such factors will
not have a material adverse effect on Wind River's international sales and
consequently, Wind River's business, operating results and financial
condition. Sales by Wind River's foreign subsidiaries are denominated in the
local currency, and an increase in the relative value of the dollar against
such currencies would reduce Wind River's revenues in dollar terms or make
Wind River's products more expensive and, therefore, potentially less
competitive in foreign markets. Wind River enters into forward contracts to
hedge the short-term impact of foreign currency fluctuations. Although Wind
River attempts to reduce the impact of foreign currency fluctuations, there
can be no assurance that foreign currency fluctuations will not have a
material adverse effect on Wind River's business, financial condition and
results of operations. Wind River relies on distributors for sales of its
products in certain foreign countries and, accordingly, is dependent on their
ability to promote and support Wind River's products and, in some cases, to
translate them into
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foreign languages. Wind River's international distributors generally offer
products of several different companies, including in some cases products
that are competitive with Wind River's products, and such distributors are
not subject to any minimum purchase or resale requirements. There can be no
assurance that Wind River's international distributors will continue to
purchase Wind River's products or provide them with adequate levels of
support. Any changes in the relationships Wind River has with its
international distributors may have a material adverse effect on Wind River's
business, operating results and financial condition.
IMPACT OF THE YEAR 2000
Many currently installed computer systems and software products include
coding to accept only two-digit entries in the date code field. These date
code fields will need to accept four digit entries to distinguish dates prior
to January 1, 2000, from dates on and after January 1, 2000. As a result, in
approximately six months, computer systems and/or software used by many
companies will need to have been upgraded to comply with such "Year 2000"
requirements. Systems that do not properly recognize such information could
generate erroneous data or fail. Significant uncertainty exists in the
software industry concerning the potential effects associated with such
compliance. Although Wind River believes its most current releases of its
products, including third party software integrated into certain products,
will neither 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
on or before December 31, 1999 ("Year 2000 Compliance"), Wind River provides
no assurance that its software products contain all the necessary software
routines and programs for the accurate calculation, display, storage and
manipulation of data involving dates. Failure of Wind River's software
products to contain all the necessary software routines and programs for the
accurate calculation, display, storage and manipulation of data involving
dates would have a material adverse effect on its business, financial
condition and results of operations.
The majority of Wind River's products are combined by its customers with
other software programs or hardware devices not provided by Wind River. Such
combination with other products that are not Year 2000 Compliant or
modifications of Wind River's products by its customers may introduce Year
2000 Compliance issues for its customers. Wind River's customers' inability
to remedy their own Year 2000 Compliance issues could affect their demand for
Wind River's products, which could materially and adversely affect Wind
River's business, financial condition and results of operations.
LIMITED PROTECTION OF PROPRIETARY TECHNOLOGY; RISKS OF INFRINGEMENT
Wind River's success is heavily dependent upon its proprietary technology. To
protect its proprietary rights, Wind River relies on a combination of
copyright, trade secret, patent and trademark laws, nondisclosure and other
contractual restrictions on copying, distribution and technical measures.
Wind River seeks to protect its software, documentation and other written
materials through trade secret and copyright laws, which provide only limited
protection. In addition, Wind River has one registered U.S. patent. There can
be no assurance that the claims allowed will be of sufficient scope or
strength (or be issued in all countries where Wind River's products can be
sold) to provide meaningful protection or any commercial advantage to Wind
River. As a part of its confidentiality procedures, Wind River generally
enters into nondisclosure agreements with its employees, consultants,
distributors and corporate partners and limits access to and distribution of
its software, documentation and other proprietary information. End user
licenses of Wind River's software are frequently in the form of shrink wrap
license agreements, which are not signed by licensees, and therefore may be
unenforceable under the laws of many jurisdictions. Despite Wind River's
efforts to protect its proprietary rights, it may be possible for
unauthorized third parties to copy Wind River's products or to reverse
engineer or obtain and use information that Wind River regards as
proprietary. There can be no assurance that Wind River's competitors will not
independently develop technologies that are substantially equivalent or
superior to Wind River's technologies. Policing unauthorized use of
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Wind River's products is difficult, and while Wind River is unable to
determine the extent to which software piracy of its products exists,
software piracy can be expected to be a persistent problem. In addition,
effective protection of intellectual property rights may be unavailable or
limited in certain countries. The status of U.S. patent protection in the
software industry is not well defined and is likely to evolve as the U.S.
Patent and Trademark Office grants additional patents. Patents have been
granted on fundamental technologies in software, and patents may issue in the
future that relate to fundamental technologies incorporated into Wind River's
products.
As the number of patents, copyrights, trademarks, trade secrets and other
intellectual property rights in Wind River's industry increases, products
based on Wind River's technology may increasingly become the subject of
infringement claims. Wind River has received in the past and may receive in
the future letters from third parties asserting infringement claims against
Wind River. There can be no assurance that third parties will not assert
infringement claims against Wind River in the future. Any such claims,
whether with or without merit, could be time consuming, result in costly
litigation, cause product shipment delays or require Wind River to enter into
royalty or licensing agreements. Such royalty or licensing agreements, if
required, may not be available on terms acceptable to Wind River, or at all,
which could have a material adverse effect on Wind River's business,
financial condition and results of operations. In the event of an adverse
ruling in any such litigation, Wind River might be required to pay
substantial damages, discontinue the use and sale of infringing products,
expend significant resources to develop non-infringing technology or obtain
licenses to infringing technology. In addition, Wind River may initiate
claims or litigation against third parties for infringement of Wind River's
proprietary rights or to establish the validity of Wind River's proprietary
rights. Litigation to determine the validity of any claims, whether or not
such litigation is determined in favor of Wind River, could result in
significant expense to Wind River and divert the efforts of Wind River's
technical and management personnel from productive tasks.
LEVERAGE
In connection with the sale of 5% Convertible Subordinated Notes in fiscal
1998, Wind River incurred $140 million in debt which resulted in an increase
in its ratio of long-term debt to total capitalization. As a result of this
additional indebtedness, Wind River's principal and interest obligations have
increased substantially. The degree to which Wind River will be leveraged
could materially and adversely affect Wind River's ability to obtain
financing for working capital, acquisitions or other purposes and could make
it more vulnerable to industry downturns and competitive pressures. Wind
River's ability to meet its debt service obligations will be dependent upon
Wind River's future performance, which will be subject to financial, business
and other factors affecting operations of Wind River, many of which are
beyond its control.
VOLATILITY OF STOCK PRICE
The market price of Wind River's common stock has fluctuated in the past, and
is likely to fluctuate in the future. Wind River believes that various
factors, including quarterly fluctuations in results of operations,
announcements of new products by Wind River or by its competitors, changes in
the software industry in general, Wind River's performance, market
fluctuations, general economic, political and market conditions such as
recessions may significantly affect the market price of its common stock.
In recent years the stock market in general, and the shares of technology
companies in particular, have experienced extreme price fluctuations. This
volatility has had a substantial effect on the market prices of securities
issued by Wind River and other high technology companies, often for reasons
unrelated to the operating performance of the specific companies. In
addition, the market prices of many high technology companies' stocks are at
or near their historical highs and reflect price/earning ratios substantially
above historical norms. There can be no assurance that the market price of
the common stock will remain at or near its current level or that it will not
experience significant volatility. In the past, following periods of
volatility in the market price of a company's securities, securities class
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action litigation has often been instituted against that company. Such
litigation, if instituted against Wind River, could result in substantial
costs and a diversion of management attention and resources, which would have
a material adverse effect on Wind River's business, financial condition and
results of operations, even if Wind River is successful in such suits, it may
adversely affect the market price of Wind River's common stock.
25
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE SENSITIVITY
Wind River's exposure to market risk for changes in interest rates relates
primarily to its investment portfolio and long-term debt obligations.
Wind River places its investments with high quality credit issuers and, by
policy, limits the amount of credit exposure to any one issuer. As stated in
its policy, Wind River's first priority is to reduce the risk of principal
loss. Consequently, Wind River seeks to preserve its invested funds by
limiting default risk, market risk and reinvestment risk. Wind River
mitigates default risk by investing in only high quality credit securities
that it believes to be low risk and by positioning its portfolio to respond
appropriately to a significant reduction in a credit rating of any investment
issuer or guarantor. The portfolio includes only marketable securities with
active secondary or resale markets to ensure portfolio liquidity.
Wind River believes that an immediate 100 basis point move in interest rates
affecting Wind River's floating and fixed rate financial instruments as of
January 31, 1999 would have an immaterial effect on Wind River's pretax
earnings. Wind River also believes that the immediate 100 basis point move in
interest rates would have an immaterial effect on the fair value of Wind
River's financial instruments.
FOREIGN CURRENCY RISK
Wind River transacts business in various foreign currencies, primarily in
Japanese yen and certain European currencies. Wind River has established a
foreign currency hedging program, utilizing foreign currency exchange
contracts for its foreign currency transaction exposures in Japan and certain
European countries. Under this program, increases or decreases in Wind
River's foreign currency transactions are partially offset by gains and loses
on the forward contracts, so as to mitigate the possibility of foreign
currency transaction gains and losses. Wind River does not use forward
contracts for trading purposes. All outstanding forward contracts at the end
of a period are marked-to-market with unrealized gains and losses included in
other income, net, and thus are recognized in income in advance of the actual
foreign currency cash flows. As these forward contracts mature, the realized
gains and losses are recorded and are included in net income as a component
of other income, net. Wind River's ultimate realized gain or loss with
respect to currency fluctuations will depend on the currency exchange rates
and other factors in effect as the contracts mature. At April 30, 1999, Wind
River had outstanding forward contracts to hedge Japanese Yen and certain
European currencies with notional amounts totaling approximately $2.2 million.
The unrealized gains and losses on the outstanding forward contracts at April
30, 1999 were immaterial to Wind River's consolidated financial statements.
Due to the short-term nature of the forward contracts, the fair value at
April 30, 1999 was negligible. The realized gains and losses on these
contracts as they matured were not material to the consolidated operations of
Wind River.
INTEREST RATE SWAP RISK
Wind River entered into a 5.9% accreting interest rate swap to reduce the
impact of changes in interest rates on its floating interest rate operating
lease for its new headquarters. At April 30, 1999, the notional amount of the
accreting interest rate swap was $28.5 million. The estimated fair value at
April 30, 1999 was negligible.
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EQUITY PRICE RISK
Wind River owns 633,752 shares of common stock of Emultek, Inc., an Israeli
corporation. Wind River purchased the common stock prior to Emultek's public
offering at a price of $7.50 per share. Emultek went public in July 1998, and
at April 30, 1999, the closing price of Emultek's stock was $5.06 per share.
Wind River values this investment using the closing price of the stock at the
end of each month. As a result, Wind River reflects this investment on our
balance sheet at April 30, 1999 at its market value of approximately $3.2
million, with the unrealized gains and losses excluded from earnings and
reported in the accumulated other comprehensive income component of
stockholders' equity.
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PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
27.1 Financial Data Schedule
(b) REPORTS ON FORM 8-K
On May 3, 1999, the Registrant filed a current report on Form 8-K,
reporting under Item 5 thereof, that Ronald A. Ablemann, the
Registrant's President and Chief Executive Officer, had announced
his intention to relinquish his responsibilities as President and
Chief Executive Officer on June 24, 1999.
SIGNATURE
Pursuant to the Securities Exchange Act of 1934, the Registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto
authorized.
WIND RIVER SYSTEMS, INC.
Date: June 14, 1999 \s\ RICHARD W. KRABER
-----------------------------
Richard W. Kraber
Vice President and Chief Financial Officer
28
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM CONSOLIDATED
BALANCE SHEET AS OF APRIL 30, 1999 AND THE CONSOLIDATED STATEMENTS OF INCOME FOR
THE THREE MONTH PERIOD ENDED APRIL 30, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCES TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JAN-31-2000
<PERIOD-START> FEB-01-1999
<PERIOD-END> APR-30-1999
<CASH> 67,567
<SECURITIES> 5,407
<RECEIVABLES> 26,081
<ALLOWANCES> 1,506
<INVENTORY> 0
<CURRENT-ASSETS> 109,684
<PP&E> 49,801
<DEPRECIATION> 17,111
<TOTAL-ASSETS> 330,759
<CURRENT-LIABILITIES> 41,346
<BONDS> 140,000
0
0
<COMMON> 40
<OTHER-SE> 148,673
<TOTAL-LIABILITY-AND-EQUITY> 330,759
<SALES> 22,708
<TOTAL-REVENUES> 32,600
<CGS> 1,713
<TOTAL-COSTS> 5,911
<OTHER-EXPENSES> 20,253
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 2,213
<INCOME-PRETAX> 6,647
<INCOME-TAX> 2,493
<INCOME-CONTINUING> 4,154
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