<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 July 31, 2000.
[ ] 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.
72,757,460 shares of Common Stock, $.001 par value, as of September 8, 2000
<PAGE>
WIND RIVER SYSTEMS, INC.
FORM 10-Q
QUARTER ENDED JULY 31, 2000
INDEX
<TABLE>
<S> <C> <C>
Part I: FINANCIAL INFORMATION
Item 1. Financial Statements
3 Condensed Consolidated Statements of
Operations for the three and six month
periods ended July 31, 2000 and 1999
4 Condensed Consolidated Balance Sheets at
July 31, 2000 and January 31, 2000
5 Condensed Consolidated Statements of
Cash Flows for the six month periods
ended July 31, 2000 and 1999
6 Notes to the Condensed Consolidated
Financial Statements
15 Item 2. Management's Discussion and Analysis of
Financial Condition and Results of
Operations
33 Item 3. Quantitative and Qualitative Disclosures
about Market Risk
Part II: OTHER INFORMATION
35 Item 4. Submission of Matters to a Vote of
Security Holders
36 Item 6. Exhibits and Reports on Form 8-K
37 Signature
</TABLE>
2
<PAGE>
WIND RIVER SYSTEMS, INC.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
WIND RIVER SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
Three months ended Six months ended
July 31, July 31,
2000 1999 2000 1999
-------------- ---------------- -------------- ---------------
<S> <C> <C> <C> <C>
Revenues:
Products $ 67,806 $ 47,978 $ 131,064 $ 90,906
Services 33,455 24,746 61,835 50,100
-------------- ---------------- -------------- ---------------
Total revenues 101,261 72,724 192,899 141,006
-------------- ---------------- -------------- ---------------
Cost of revenues:
Products 7,966 7,514 17,124 13,189
Services 16,148 10,247 29,156 20,048
-------------- ---------------- -------------- ---------------
Total cost of revenues 24,114 17,761 46,280 33,237
-------------- ---------------- -------------- ---------------
Gross margin 77,147 54,963 146,619 107,769
-------------- ---------------- -------------- ---------------
Operating expenses:
Selling and marketing 41,974 28,147 80,206 54,371
Product development and engineering 19,196 12,609 37,457 24,241
General and administrative 9,441 7,217 19,040 13,628
Amortization of intangibles 26,751 763 36,331 1,046
Acquisition-related and other 1,049 7,254 31,748 7,556
-------------- ---------------- -------------- ---------------
Total operating expenses 98,411 55,990 204,782 100,842
-------------- ---------------- -------------- ---------------
Operating income (loss) (21,264) (1,027) (58,163) 6,927
-------------- ---------------- -------------- ---------------
Other income (expense):
Interest income 5,370 4,660 10,447 9,380
Realized gain (loss) on investments 2,360 12 8,716 (627)
Interest expense and other, net (2,017) (2,111) (4,279) (4,276)
-------------- ---------------- -------------- ---------------
Total other income 5,713 2,561 14,884 4,477
-------------- ---------------- -------------- ---------------
Income (loss) before provision for income taxes (15,551) 1,534 (43,279) 11,404
Provision for income taxes 1,795 2,603 6,500 6,092
-------------- ---------------- -------------- ---------------
Net income (loss) $ (17,346) $ (1,069) $ (49,779) $ 5,312
============== ================ ============== ===============
Net income (loss) per share:
Basic $ (0.24) $ (0.02) $ (0.71) $ 0.09
Diluted $ (0.24) $ (0.02) $ (0.71) $ 0.08
Weighted average shares:
Basic 72,557 62,253 69,748 62,208
Diluted 72,557 62,253 69,748 65,319
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
<PAGE>
WIND RIVER SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PAR VALUE)
<TABLE>
<CAPTION>
July 31, January 31,
2000 2000
------------------- -----------------
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 73,735 $ 77,929
Short-term investments 41,753 28,683
Accounts receivable, net 83,275 79,586
Prepaid and other current assets 39,150 35,375
------------------ ------------------
Total current assets 237,913 221,573
Investments 147,453 205,945
Land and equipment, net 60,441 56,331
Intangibles 411,524 35,728
Other assets 11,844 9,769
Restricted cash 48,144 39,744
------------------ ------------------
Total assets $ 917,319 $ 569,090
================== ==================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 15,455 $ 10,551
Line of credit -- 5,094
Accrued liabilities 28,645 22,287
Accrued compensation 16,405 17,910
Income taxes payable 15,019 9,581
Deferred revenue 56,851 49,401
------------------ ------------------
Total current liabilities 132,375 114,824
Deferred taxes payable 8,388 11,574
Long-term debt 141,076 140,598
------------------ ------------------
Total liabilities 281,839 266,996
------------------ ------------------
Minority interest in consolidated subsidiary 507 878
------------------ ------------------
Stockholders' equity:
Common stock, par value $.001; 125,000 shares authorized;
74,574 and 66,230 shares issued; 73,297 and 64,953
shares outstanding [see note 2] 74 66
Additional paid in capital 619,186 216,149
Loan to stockholder (1,979) (1,900)
Treasury stock, 1,277 shares, at cost (29,488) (29,488)
Accumulated other comprehensive income (loss) (2,931) 16,499
Retained earnings 50,111 99,890
------------------ ------------------
Total stockholders' equity 634,973 301,216
------------------ ------------------
Total liabilities and stockholders' equity $ 917,319 $ 569,090
================== ==================
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
<PAGE>
WIND RIVER SYSTEMS, INC.,
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
Six months ended
July 31,
2000 1999
---------------- ----------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ (49,779) $ 5,312
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 44,787 8,807
Deferred income taxes (1,405) (1,412)
Minority interest in consolidated subsidiary (371) 102
Write-off of investment -- 500
Acquired in-process research and development 4,700 6,300
Changes in assets and liabilities:
Accounts receivable, net 2,932 11,634
Prepaid and other assets 496 860
Accounts payable 1,379 847
Accrued liabilities 1,750 (9,164)
Accrued compensation (3,231) 2,063
Income taxes payable 5,438 3,173
Deferred revenue 5,907 (1,044)
Other assets and liabilities (701) (1,381)
---------------- ----------------
Net cash provided by operating activities 11,902 26,597
---------------- ----------------
Cash flows from investing activities:
Acquisition of equipment (9,287) (8,688)
Capitalized software development costs -- (819)
Purchases of investments (39,530) (80,094)
Sales and maturities of investments 55,262 107,607
Acquisitions, net of cash acquired (29,055) (24,872)
Restricted cash (8,400) (1,722)
---------------- ----------------
Net cash used in investing activities (31,010) (8,588)
---------------- ----------------
Cash flows from financing activities:
Proceeds from issuance of Common Stock, net 21,929 4,969
Repayment of bank borrowings (2,524) --
Repayment of line of credit (5,094) --
Purchase of treasury stock -- (7,371)
Repayment of loan to stockholder 1,652 --
---------------- ----------------
Net cash provided by (used in) financing activities 15,963 (2,402)
---------------- ----------------
Effect of exchange rate changes on cash and cash equivalents (1,049) (686)
---------------- ----------------
Effect of changing fiscal year of acquired subsidiary -- (4,816)
---------------- ----------------
Net increase (decrease) in cash and cash equivalents (4,194) 10,105
Cash and cash equivalents at beginning of period 77,929 61,916
---------------- ----------------
Cash and cash equivalents at end of period $ 73,735 $ 72,021
================ ================
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
<PAGE>
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" or the "Company") are
unaudited. However, in the opinion of management, all adjustments (consisting
only of normal recurring adjustments) that 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, 2000 which are included in Wind River's Annual Report on Form
10-K. The results of operations for the three and six months ended July 31,
2000 are not necessarily indicative of results to be expected for the entire
fiscal year, which ends on January 31, 2001, or for any future period.
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.
All historical financial information has been restated to reflect the
acquisition of Integrated Systems, Inc. ("Integrated Systems") in the first
quarter of fiscal 2001, and Routerware, Inc. ("Routerware") in the second
quarter of fiscal 2000, each of which were accounted for as poolings of
interests.
The condensed consolidated financial statements include the accounts of Wind
River and its wholly owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated. Wind River has a fiscal year
end of January 31. Its international subsidiaries have fiscal year ends of
December 31. The condensed consolidated financial statements for the three
and six months ended July 31, 2000 and 1999, include the international
subsidiaries' financial information for the three and six months ended June
30, 2000 and 1999, respectively. Acquisitions that have been accounted for as
purchase transactions, which include Embedded Support Tools Corporation
("Embedded Support Tools") in the first quarter of fiscal 2001, AudeSi
Technologies ("AudeSi") in the second quarter of fiscal 2001 and Software
Development Systems, Inc. ("Software Development Systems") in the second
quarter of fiscal 2000, have been included in the condensed consolidated
results from the date of their acquisition.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the recorded amounts reported in the unaudited condensed consolidated
financial statements and accompanying notes. A change in the facts and
circumstances surrounding these estimates could result in a change to the
estimates and affect future operating results.
Certain amounts in the fiscal 2000 condensed consolidated financial statements
have been reclassified to conform to the fiscal 2001 presentation.
6
<PAGE>
2. Acquisitions
Pooling of Interest Combinations
On June 30, 1999, Wind River completed the acquisition of RouterWare, Inc. In
connection with the merger: (a) each outstanding share of RouterWare common
stock was exchanged for 1.82731 shares of Wind River common stock, resulting
in the issuance of an aggregate of 730,923 shares of Wind River common stock
for all outstanding shares of RouterWare common stock, and (b) all options to
purchase shares of RouterWare common stock outstanding immediately prior to
the consummation of the merger were converted into options to purchase
634,065 shares of Wind River common stock. The merger has been accounted for
as a pooling of interests, and all financial data of Wind River has been
restated to include the historical financial information of RouterWare. In
connection with the acquisition of RouterWare, Wind River incurred
approximately $930,000 in merger related expenses consisting primarily of
transaction fees.
On February 15, 2000, Wind River completed its acquisition of Integrated
Systems, Inc. in a stock-for-stock merger transaction. In connection with the
merger: (a) each outstanding share of Integrated Systems common stock was
exchanged for .92 of a share of Wind River common stock, resulting in the
issuance of an aggregate of 22,499,895 shares of Wind River common stock for
all outstanding shares of Integrated Systems common stock, and (b) all
options to purchase shares of Integrated Systems common stock outstanding
immediately prior to the consummation of the merger were converted into
options to purchase 4,133,128 shares of Wind River common stock. The merger
has been accounted for as a pooling of interests, and all financial data of
Wind River has been restated to include the historical financial information
of Integrated Systems. Wind River and Integrated Systems incurred
approximately $27.0 million of costs associated with the merger, including
$11.1 million for investment banking fees, $7.2 million in severance
payments, $4.5 million for office closure and other costs, $3.6 million for
legal, accounting and other professional fees, and $0.6 million for general
integration costs.
The results of operations for the three and six months ended July 31, 1999,
incorporating businesses acquired as poolings of interests are summarized as
follows:
<TABLE>
<CAPTION>
Three months ended Six months ended
July 31, 1999 July 31, 1999
(In thousands) Revenues Net Income/(Loss) Revenues Net Income/(Loss)
-------------- ---------------- -------------- ---------------
<S> <C> <C> <C> <C>
Wind River $ 39,178 $ 5,243 $ 71,778 $ 9,397
RouterWare 426 (1,001) 1,302 (887)
-------------- ---------------- -------------- ---------------
Combined 39,604 4,242 73,080 8,510
Integrated Systems 33,120 (5,311) 67,926 (3,198)
-------------- ---------------- -------------- ---------------
Combined $ 72,724 $ (1,069) $ 141,006 $ 5,312
-------------- ---------------- -------------- ---------------
</TABLE>
Purchase Combinations
Wind River has made a number of acquisitions accounted for as purchases. The
condensed consolidated financial statements include the operating results of
each business from the date of acquisition. The purchase price for each
acquisition is allocated to tangible and identifiable intangible assets
acquired and liabilities assumed on the basis of their estimated fair values
on the effective date of their acquisition. For acquisitions that occurred
during fiscal 2001, Wind River is still refining its purchase price
allocation and there may be some resulting adjustments in future periods.
In connection with its purchase acquisitions, Wind River has expensed various
amounts related to in-process research and development. The amount allocated
to in-process research and development represents the purchased in-process
technology for projects that, as of the date of the acquisition, had not yet
reached technological feasibility and had no alternative future use. Based on
preliminary assessments from an analysis performed by an independent
appraiser, the value of these projects was determined by estimating the
resulting net cash flows from the sale of the products resulting from the
completion of the projects, reduced by the portion of the revenue
attributable to core technology and the percentage completion of the project.
The
7
<PAGE>
resulting net cash flows were then discounted back to their present value at
appropriate discount rates.
The discount rate selected for estimating future cash flows was 25%. In
selection of the appropriate discount rate, consideration was given to the
Company's estimated weighted-average return on working capital and the Company's
estimated weighted average-return on assets. The discount rate used was
determined to be higher than the Company's estimated weighted average return on
working capital due to the fact that the technology had not yet reached
technological feasibility as of the date of the valuation. In utilizing a
discount rate greater that the Company's weighted-average return on working
capital, the Company has reflected the risk premium associated with achieving
and sustaining growth rates and improved profitability as well as the increased
rates of return associated with intangible assets. To date, the Company is
not aware of any significant variations between costs and estimates made.
On March 31, 2000, Wind River completed its acquisition of Embedded Support
Tools Corporation in a stock-for-stock merger transaction. Embedded Support
Tools is a leading provider of integrated hardware and software for
programming, testing and debugging embedded systems. In connection with the
acquisition: (a) each outstanding share of Embedded Support Tools common
stock was exchanged for .4246 of a share of Wind River common stock,
resulting in the issuance of an aggregate of 5,474,788 shares of Wind River
common stock for all outstanding shares of Embedded Support Tools common
stock, and (b) all options to purchase shares of Embedded Support Tools
common stock outstanding immediately prior to the consummation of the
acquisition were converted into options to purchase 1,122,855 shares of Wind
River common stock. The total purchase price of $335.4 million consisted of
common stock with a fair market value of $275.7 million, options assumed with
a fair market value of $51.5 million, assumed liabilities of $6.2 million and
merger costs of $2.0 million.
Wind River recorded an expense of $3.7 million for the in-process research and
development, which was charged against earnings in the first quarter of fiscal
year 2001. There was one project included in the in-process research and
development for Embedded Support Tools. The applications from this process will
be integrated into Wind River's products. The efforts required to complete the
acquired in-process technology include the completion of all planning, designing
and testing activities that are necessary to establish that the product can be
produced to meet its design requirements.
The allocation of the purchase price is summarized below (in thousands):
<TABLE>
<S> <C>
Completed technology $ 15,150
In-process research and development 3,700
Trademark 650
Workforce 5,650
Net tangible assets 3,206
Deferred tax liability (9,325)
Goodwill 316,368
--------
Total purchase price $335,399
========
</TABLE>
8
<PAGE>
During the three and six months ended July 31, 2000, Wind River amortized $21.0
million and $28.0 million of goodwill and other intangible assets acquired from
Embedded Support Tools. The goodwill and other intangible assets are being
amortized over a four-to-five year period.
The following pro forma summary presents the consolidated results of
operations as if the acquisitions had occurred at the beginning of each of the
periods presented and does not purport to be indicative of the results that
would have been achieved had the acquisition been made as of those dates nor of
the results which may occur in the future.
<TABLE>
<CAPTION>
Three months ended Six months ended
July 31, July 31,
(In thousands, except per share data) 2000 1999 2000 1999
------------------------------------------------------------
<S> <C> <C> <C> <C>
Net revenue $ 101,088 $ 79,219 $ 195,446 $ 152,897
Net loss $ (16,733) $ (30,028) $ (65,172) $ (44,826)
Net loss per share - basic & diluted $ (0.23) $ (0.44) $ (0.95) $ (0.66)
</TABLE>
On May 1, 2000, Wind River acquired AudeSi Technologies in a transaction
involving Canadian exchangeable shares. AudeSi Technologies is a supplier of
Java(-TM-) based tools and other components, for building flexible,
multi-application consumer devices. In connection with the acquisition: (a)
each outstanding share of AudeSi common stock was exchanged for .0927 of an
exchangeable share in AudeSi and each such exchangeable share is or will be
by its terms, exchangeable on a share-for-share basis for a share of Wind
River common stock (the exchange of all such exchangeable shares requiring
the ultimate issuance of an aggregate of 957,169 shares of Wind River common
stock), and (b) all options to purchase AudeSi common stock immediately prior
to the consummation of the acquisition were converted into options to
purchase 119,488 shares of Wind River common stock. The total purchase price
of $52.9 million consisted of common stock with a fair market value of $ 47.2
million, options assumed with a fair market value of $4.7 million and merger
costs of $1.0 million.
In connection with the acquisition, Wind River recorded an expense of $1.0
million for in-process research and development, which was charged against
earnings in the second quarter of fiscal year 2001.
The preliminary allocation of the purchase price is summarized below (in
thousands):
<TABLE>
<CAPTION>
<S> <C>
Completed technology $ 1,100
In-process research and development 1,000
Workforce 850
Net tangible assets 813
Long term deferred tax liability (318)
Goodwill 49,426
-------
Total purchase price $52,871
=======
</TABLE>
9
<PAGE>
During the three months ended July 31, 2000, Wind River amortized $3.2 million
of goodwill and other intangible assets acquired from AudeSi. The goodwill and
other intangible assets are being amortized over a four-to-five year period.
On July 15, 2000, Wind River acquired ICESoft AS ("ICESoft"), which is a
developer of innovative embedded internet browsing technologies for
intelligent devices. In connection with the acquisition, Wind River paid cash
of approximately $24.5 million for ICESoft. The company is located in Norway
and is considered an international entity; therefore the results of its
operations will be included from the date of acquisition in the third quarter
of fiscal 2001. In the condensed consolidated balance sheet as of July 31,
2000, the purchase price has been allocated entirely to goodwill. The company
is currently calculating the purchase price allocation. The purchase price
will be allocated to the tangible and identifiable intangible assets acquired
and liabilities assumed on the basis of their estimated fair values as of the
effective date of the acquisition. An independent appraiser will determine
the valuation of the intangible assets acquired. Such valuations and studies
are not yet complete. Accordingly, the final allocation may be different from
that reflected below. Assuming that the acquisition of ICESoft had occurred
on June 30, 2000 the purchase price allocation would have been as follows:
<TABLE>
<S> <C>
Fair value of assets acquired and liabilities assumed $ 370
Intangible assets 24,080
-------
Total purchase price $24,450
-------
-------
</TABLE>
Pro forma results of operations for AudeSi Technologies and ICESoft have not
been presented because the effects of these acquisitions were not material on
either an individual or an aggregate basis.
3. Revenue Recognition
Wind River recognizes revenue in accordance with 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, 1998. SOP 97-2 and SOP
98-4 provide guidance on recognizing revenue on software transactions and
supersede SOP 91-1. The adoption of SOP 97-2 and SOP 98-4 did not have a
material impact on Wind River's existing licensing or revenue recognition
practices.
In December 1999, the SEC issued Staff Accountin Bulletin ("SAB") 101,
"Revenue Recognition," which outlines the basic criteria that must be met to
recognize revenue and provides guidance for presentation of revenue and for
disclosure related to revenue recognition policies in financial statements
filed with the SEC. The Company believes the adoption of SAB 101 will not
have a material impact on the Company's financial position and results of
operations.
Product revenues consist of licensing fees from operating system and software
development tool products and fees from embedded system run-time licenses.
Service revenues are derived from fees from professional services, software
porting and development contracts, software maintenance and support
contracts, and customer training and consulting. Maintenance contracts are
generally sold separately from the products. Wind River's customers consist
of end users, distributors, original equipment manufacturers, system
integrators and value-added resellers.
Product revenues are generally recognized at the time of shipment or upon the
delivery of a product master in satisfaction of non-cancelable contractual
agreements provided that collection of the resulting receivable is probable,
the fee is fixed or determinable and vendor-specific objective evidence
("VSOE") exists to allocate the total fee to all delivered and undelivered
elements of the arrangement. Any maintenance included in these arrangements
is deferred based on VSOE and recognized ratably over the term of the
arrangement. Service revenues from engineering services contracts are
generally recognized on the percentage-of-completion basis. Service revenues
from software maintenance, support and update fees (post-contract support)
are recognized ratably over the contract period. Services revenue from
training and consulting are recognized when the services are provided.
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.
4. Cash and Cash Equivalents, Investments and Restricted Cash
10
<PAGE>
Cash equivalents consist of highly liquid investments with remaining maturity at
the date of purchase 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 equity securities, 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.
115, "Accounting for Certain Investments in Debt and Equity Securities." Wind
River determines the appropriate classification of its investments 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 the accumulated other comprehensive income component of
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
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 difference between net income and comprehensive income for Wind River
results from foreign currency translation adjustments and unrealized gains and
losses on available-for-sale securities, net of taxes.
Comprehensive income for the three and six months ended July 31, 2000 and 1999
is as follows:
<TABLE>
<CAPTION>
Three months ended Six months ended
July 31, July 31,
---------------------------- ----------------------------
(In thousands) 2000 1999 2000 1999
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Net income (loss) $ (17,346) $ (1,069) $ (49,779) $ 5,312
------------- ------------- ------------- -------------
Other comprehensive income (loss):
Foreign currency translation adjustments (961) (332) (876) (1,003)
Unrealized gain (loss) on investments 1,656 3,876 (18,554) 3,336
------------- ------------- ------------- -------------
Other comprehensive income (loss) 695 3,544 (19,430) 2,333
------------- ------------- ------------- -------------
Total comprehensive income (loss) $ (16,651) $ 2,475 $ (69,209) $ 7,645
============= ============= ============= =============
</TABLE>
6. Net Income Per Share
Wind River reports both basic net income (loss) per share, which is based on the
weighted-average number of common shares outstanding and diluted net income
(loss) per share, which is based on the weighted-average number of common shares
outstanding and all dilutive potential common shares outstanding. Potential
dilutive common shares consist of stock options and warrants (using the treasury
stock method) and convertible subordinated notes (using the if converted
method).
11
<PAGE>
The following is a reconciliation of the number of shares used in the basic and
diluted earnings per share computations for the periods presented:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
July 31, July 31,
--------------------------- -------------------------
(In thousands, except per share information) 2000 1999 2000 1999
------------- ------------ ----------- ------------
<S> <C> <C> <C> <C>
Shares used in basic net income (loss)
per share computation 72,557 62,253 69,748 62,208
Effect of dilutive potential common shares -- -- -- 3,111
------------- ------------ ----------- ------------
Shares used in diluted net income (loss)
per share computation 72,557 62,253 69,748 65,319
============= ============ =========== ============
</TABLE>
Dilutive potential common shares totaling approximately 5.1 million, 5.7
million, and 2.7 million were excluded from the computation of the number of
shares used in the diluted net loss per share calculation for the three and six
months ended July 31, 2000 and the three months ended July 31, 1999,
respectively, as their inclusion would be anti-dilutive. The effect of assumed
conversion of the convertible subordinated notes is anti-dilutive and is
therefore excluded from both the above computations. In addition, options to
purchase approximately 1.2 million, 4.5 million, 300,000, and 4.5 million common
shares which were outstanding for the three months ended July 31, 2000 and 1999,
and for the six months ended July 31, 2000 and 1999, respectively, were not
included in the calculation because the exercise prices were greater than the
average market price of common shares in each respective period and the effect
would be anti-dilutive. The exercise prices of these options ranged from $37.13
to $60.50, $16.75 to $31.92, $40.63 to $60.50, and $17.94 to $31.92 for the
three months ended July 31, 2000 and 1999, and the six months ended July 31,
2000 and 1999, respectively.
7. Commitments and Contingencies
In fiscal 2000, Wind River entered into a second operating lease agreement for
the construction of two additional buildings at its headquarters facility. As of
July 31, 2000, the lessor has funded a total of $12 million of construction
costs and has committed to fund up to a maximum of $26.0 million. Construction
of the buildings is currently expected to be completed in January 2001. The
operating lease payments will vary based upon the total construction costs of
the property, including capitalized interest and London interbank offering rate
("LIBOR").
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. 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 July 31, 2000, Wind River
had outstanding forward contracts to hedge certain foreign currency
transaction exposures in Japanese Yen and certain European currencies. The
difference between cost and estimated fair value at July 31, 2000 was
immaterial.
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. The swap
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<PAGE>
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 July
31, 2000, 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 Financial Accounting Standards Board ("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. In July 1999, the FASB issued SFAS 137, "Accounting for
Derivative Instruments and Hedging Activities - Deferral of the Effective Date
of SFAS No. 133." SFAS 137 deferred the effective date of SFAS 133 until the
first fiscal year beginning after June 15, 2000. In June 2000, the FASB issued
SFAS 138, "Accounting for Certain Derivative Instruments and Certain Hedging
Activities an Amendment of SFAS 133". SFAS 138 amends SFAS 133 to permit limited
use of central treasury "netting" of intercompany derivatives for foreign
currency cash flow hedges. SFAS 138 must be adopted concurrently with SFAS 133.
Wind River has not yet determined the impact, if any, of adopting this
statement.
In March 2000, the FASB issued Interpretation No. 44, ("FIN 44"), "Accounting
for Certain Transactions Involving Stock Compensation - an Interpretation of APB
25". This Interpretation clarifies: (a) the definition of employee for purposes
of applying Opinion 25, (b) the criteria for determining whether a plan
qualifies as a noncompensatory plan, (c) the accounting consequence of various
modifications to the terms of a previously fixed stock option or award, and (d)
the accounting for an exchange of stock compensation awards in a business
combination. This Interpretation is effective July 1, 2000, but certain
conclusions in this Interpretation cover specific events that occur after either
December 15, 1998, or January 12, 2000. The adoption of certain of the
conclusions of FIN 44 covering events occurring during the period after December
15, 1998 or January 12, 2000 did not have a material effect on the Company's
financial position and results of operations. Wind River does not expect that
the adoption of the remaining conclusion will have a material effect on the
financial position or results of operations.
10. Segment and Geographic Information
Wind River operates in one industry segment --technology for embedded operating
systems, and management uses one measurement of revenue and profitability for
its business.
13
<PAGE>
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 Six months ended
(In thousands) July 31, July 31, July 31, January 31,
------------------------ -------------------------- ---------------- ---------------
2000 1999 2000 1999 2000 2000
------------ ----------- ------------ ------------- ---------------- ---------------
<S> <C> <C> <C> <C> <C> <C>
United States $ 67,536 $ 45,095 $ 126,536 $ 86,075 $ 832,949 $ 470,998
Japan 9,910 9,429 19,177 19,749 36,028 31,717
Other International 23,815 18,200 47,186 35,182 48,342 66,375
------------ ----------- ------------ ------------- ---------------- ---------------
Consolidated $ 101,261 $ 72,724 $ 192,899 $ 141,006 $ 917,319 $ 569,090
============ =========== ============ ============= ================ ===============
</TABLE>
Other International consists of the revenues and assets of operations in
Europe and Asia Pacific excluding Japan.
11. Special Charges
During the second quarter of fiscal year 2000, Wind River incurred
approximately $1.2 million associated with the retirement package of its
former chief executive officer, who relinquished his responsibilities as
president and chief executive officer as of June 24, 1999. This non-recurring
charge is included in general and administrative expenses for the three
months ended July 31, 1999.
12. Secured Promissory Notes with Stockholders
At July 31, 2000, the Company's Chief Executive Officer had outstanding a
secured promissory note for $2.0 million from the Company to purchase shares
of our common stock. The note accrues interest at the rate of 5.98% per year,
and is due on September 7, 2008. This loan is full recourse and is secured by
a pledge of personal property. The loan amount outstanding as of July 31,
2000 is reflected as a reduction of equity in the accompanying consolidated
balance sheet.
14
<PAGE>
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 businesses and technologies and others are discussed in
Wind River's Annual Report on Form 10-K for the fiscal year ended January 31,
2000. Wind River does not intend to update any of the forward-looking
statements contained in this report to reflect any future events or
developments unless required by law. 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. Embedded systems provide an
immediate, predictable response to an unpredictable sequence of external events.
Wind River's products enable customers to enhance product performance,
standardize designs across projects, reduce research and development costs and
shorten product development cycles.
All historical financial information has been restated to reflect the
acquisition of Integrated Systems, Inc. ("Integrated Systems") in the first
quarter of fiscal 2001 and Routerware, Inc. ("Routerware") in the second
quarter of fiscal 2000, each of which was accounted for as a pooling of
interests. Acquisitions that have been accounted for as purchase
transactions, which include Embedded Support Tools Corporation ("Embedded
Support Tools") in the first quarter of fiscal 2001, AudeSi Technologies
("AudeSi") in the second quarter of fiscal 2001 and Software Development
Systems, Inc. ("Software Development Systems") in the second quarter of
fiscal 2000, have been included in the condensed consolidated financial
results from the dates of their purchase.
On July 15, 2000, Wind River acquired ICESoft AS ("ICESoft"), which is a
developer of innovative embedded internet browsing technologies for
intelligent devices. In connection with the acquisition, Wind River paid cash
of approximately $24.5 million for ICESoft. The company is located in Norway
and is considered an international entity; therefore the results of its
operations will be included from the date of acquisition in the third quarter
of fiscal 2001. In the condensed consolidated balance sheet as of July 31,
2000, the purchase price has been allocated entirely to goodwill. The company
is currently calculating the purchase price allocation. The purchase price
will be allocated to the tangible and identifiable intangible assets acquired
and liabilities assumed on the basis of their estimated fair values as of the
effective date of the acquisition. An independent appraiser will determine
the valuation of the intangible assets acquired. Such valuations and studies
are not yet complete. Accordingly, the final allocation may be different from
that reflected below. Assuming that the acquisition of ICESoft had occurred
on June 30, 2000 the purchase price allocation would have been as follows:
<TABLE>
<S> <C>
Fair value of assets acquired and liabilities assumed $ 370
Intangible assets 24,080
-------
Total purchase price $24,450
-------
-------
</TABLE>
15
<PAGE>
Results of Operations
Operating results as a percentage of revenue for the three and six month periods
ended July 31, 2000 and 1999 are summarized in the following table:
<TABLE>
<CAPTION>
Three months ended Six months ended
July 31, July 31,
2000 1999 2000 1999
-------------- -------------- -------------- -------------
<S> <C> <C> <C> <C>
Revenues:
Products 67 % 66 % 68 % 65 %
Services 33 34 32 35
-------------- -------------- -------------- -------------
Total revenues 100 100 100 100
-------------- -------------- -------------- -------------
Cost of revenues:
Products 8 10 9 10
Services 16 14 15 14
-------------- -------------- -------------- -------------
Total cost of revenues 24 24 24 24
-------------- -------------- -------------- -------------
Gross margin 76 76 76 76
-------------- -------------- -------------- -------------
Operating expenses:
Selling and marketing 42 39 42 38
Product development and engineering 19 17 19 17
General and administrative 9 10 10 10
Amortization of intangibles 26 1 19 1
Acquisition-related and other 1 10 16 5
-------------- -------------- -------------- -------------
Total operating expenses 97 77 106 71
-------------- -------------- -------------- -------------
Operating income (loss) (21) (1) (30) 5
-------------- -------------- -------------- -------------
Other income (expense):
Interest income 5 6 5 7
Realized gain (loss) on investments 2 - 4 (1)
Interest expense and other, net (1) (3) (2) (3)
-------------- -------------- -------------- -------------
Total other income 6 3 7 3
-------------- -------------- -------------- -------------
Income (loss) before provision for income taxes (15) 2 (23) 8
Provision for income taxes (2) (4) (3) (4)
-------------- -------------- -------------- -------------
Net income (loss) (17) % (2) % (26) % 4 %
============== ============== ============== =============
</TABLE>
(1) The Condensed Consolidated Statements of Operations for the three and six
months ended July 31, 2000 includes charges of 1% ($1.0 million) and 16%
($31.7 million), respectively, in acquisition-related and other charges
associated with the acquisition and integration of Integrated Systems,
Embedded Support Tools and AudeSi Technologies and 26% (26.8 million) and
19% ($36.3 million), respectively, of amortization of goodwill, purchased
technology and other intangibles.
(2) The Condensed Consolidated Statements of Operations for the three and six
months ended July 31, 1999 includes charges of 10% ($ 7.3 million) and 5%
($7.6 million), respectively, of acquisition-related and other charges
associated with the acquisition and integration of Software Development
Systems and Routerware, CEO retirement costs and, in the first
16
<PAGE>
quarter, $500,000 related to the write-off of an investment in XACT, as
well as 1% ($0.8 million) and 1% ($1.0 million), respectively, of
amortization of goodwill, purchased technology and other intangibles.
REVENUES
Total revenues for the three and six month periods ended July 31, 2000 were
$101.3 million and $192.9 million, respectively, compared to $72.7 million
and $141.0 million for the same periods in fiscal 2000. Product revenues
consist of licensing fees from operating system and software development tool
products, fees from embedded system run-time licenses, and programming,
testing, and debugging tools. Service revenues are derived from software
maintenance and support contracts, professional services or consulting,
customer training, and software development and porting contracts. Software
maintenance and support contracts are generally sold separately from the
software licenses and tools. The increase in total revenues of 39% and 37%
for the three and six month periods ended July 31, 2000 is due to increases
in the volume of revenues from both products and services.
Product revenue increased 41% and 44% to $67.8 million and $131.1 million,
respectively, for the three and six month periods ended July 31, 2000,
compared to $48.0 million and $90.9 million for the same periods in fiscal
2000. Product revenues primarily consist of development, OEM and run-time
license fees, and fees from programming, testing, and debugging tools. Wind
River typically charges a one-time fee for development licenses, a separate
OEM license fee for each customer development project and a run-time license
fee for each copy of Wind River's operating system embedded in the customer's
product. For hardware shipments, Wind River recognizes revenue upon shipment
of the product. The increase in product revenues was due primarily to
increases in development, OEM and run-time license revenues, as well as
programming, testing, and debugging revenue, as Wind River's products
continue to be purchased by customers for their product development projects,
customer developed products continue to be accepted by end-users, and as we
expand our product lines through research and development and integrated
products from acquired companies. Product revenues are generally recognized
at the time of shipment or upon the delivery of a product master in
satisfaction of non-cancelable contractual agreements providing that
collection of the resulting receivable is probable, the fee is fixed or
determinable and vendor specific objective evidence exists to allocate the
total fee to all delivered and undelivered elements of the arrangement.
Services revenue increased 35% and 23% to $33.5 million and $61.8 million,
respectively, for the three and six month periods ended July 31, 2000,
compared to $24.7 million and $50.1 million for the same periods in fiscal
2000. The increase was primarily due to increases in revenue from
professional services related to long-term application development, as well
as shorter field consulting assignments, maintenance support agreements, both
new and recurring, and training resulting from the increase in Wind River's
installed base software applications provided to customers. These increases
were partially offset by a decline in revenues from engineering services.
Wind River believes that the decline in engineering services revenue is the
result of many of those contracts moving into our professional services group.
Deferred revenue results primarily from customer prepayments under software
maintenance contracts, which are recognized ratably over the life of the
contracts, certain run-time agreements, which are recognized as target licenses
are delivered, and professional services and engineering services contracts or
training arrangements, which are recognized as the services are performed.
Total revenues from international sales for the three and six month periods
ended July 31, 2000 were $33.7 million and $66.4 million, respectively,
compared to $27.6 million and $54.9 million for the same periods in fiscal
2000. The increases of 22% and 21% for each period, respectively, were due to
increased demand for our products and services in Europe and the Asia Pacific
region. International revenues accounted for 33% and 34%, respectively, of
total revenues for the three and six month periods ended July 31, 2000,
compared to 38% and 39% for the same periods in fiscal
17
<PAGE>
2000. The decrease in international revenue as a percentage of revenue is due
to domestic revenue increasing at a faster rate than international revenue.
The decrease is also related to a decrease in revenues from Japan as a result
of the transition to a new distribution model in which Wind River will sell
directly to its customers in Japan. Due to this transition, we expect that
revenues in Japan will grow at a lesser rate than the other geographic
regions and may even decline. We expect 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 our revenues and backlog in
dollar terms or make our 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 our results of operations. We enter into forward contracts to hedge
the short-term impact of foreign currency fluctuations. In recent years,
economic uncertainty and related fluctuations of certain foreign currencies
against the dollar have occurred. These factors could adversely affect our
future sales and operating expenses. See "Additional Risk Factors that may
affect Future Results of Operations-Our International Business Activities
Subject Us to Risks That Could Adversely Affect Our Business."
COSTS OF REVENUES
The overall cost of products and services as a percentage of total revenues was
24% for the three and six month periods ended July 31, 2000, and 1999.
Product-related cost of sales as a percentage of product revenues was 12% and
13%, respectively, for the three and six month periods ended July 31, 2000,
compared to 16% and 15% for the same periods in fiscal 2000. 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 and documentation and packaging and the cost of material and labor
for hardware shipped. The decrease in this percentage is primarily due to an
increase in production efficiencies as more development, OEM and run-time
licenses move through our production cycle, as well as a reduction in our
product costs. 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 and by royalty payments to other third parties for sales related to
their products.
Service related cost of revenues as a percentage of service revenues was 48%
and 47%, respectively, for the three and six month periods ended July 31,
2000, compared to 41% and 40% for the same periods in fiscal year 2000.
Service related cost of revenues consists primarily of personnel related
costs associated with providing services, including consulting 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 our continued investment in developing
new professional services offerings and the addition of new personnel and
certified third party contractors to our professional services organization.
We expect that the cost of service revenues will increase in absolute dollars
as we continue to increase our professional services organization, customer
support staff, and customer support capabilities.
OPERATING EXPENSES
Selling and marketing expenses were $42.0 million and $80.2 million,
respectively, for the three and six month periods ended July 31, 2000,
compared to $28.1 million and $54.4 million for the same periods in fiscal
2000. As a percentage of total revenue, selling and marketing expenses were
42% for the three and six month periods ended July 31, 2000, compared to 39%
and 38% for the same periods in fiscal 2000. The increase resulted primarily
from the growth in the number of sales and marketing personnel and related
costs, including the costs associated with quarterly commission payments and
increases in expenses related to marketing and
18
<PAGE>
advertising programs, including costs for new product introductions,
promotions and trade shows. In addition, for the six month period ended July
31, 2000, we incurred costs associated with integrating Integrated Systems,
Embedded Support Tools, and AudeSi into Wind River. The selling and marketing
integration costs include reprinting marketing collateral, sales meetings,
trade show promotions, advertisements and web-site development. The increase
is also attributable to the inclusion of sales and marketing expenses related
to the Embedded Support Tools and AudeSi acquisitions accounted for as
purchase transactions during the first and second quarters of fiscal 2001. We
expect that sales and marketing expenses will continue to increase in
absolute dollars as we continue to expand our sales and marketing staff and
programs.
Product development and engineering expenses were $19.2 million and $37.5
million for the three and six month periods ended July 31, 2000, compared to
$12.6 million and $24.2 million for the same periods in fiscal 2000. As a
percentage of total revenue, product development and engineering expenses
were 19% for the three and six month periods ended July 31, 2000, compared to
17% for the same periods in fiscal 2000. 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
lines, including acquisition costs, and with the additional engineering staff
as a result of acquisitions. We believe that product development and
engineering expenses will continue to increase in absolute dollars as we
continue to invest in the development of new products, technologies,
applications and product enhancements.
General and administrative expenses were $9.4 million and $19.0 million for the
three and six month periods ended July 31, 2000, compared to $7.2 million and
$13.6 million for the same periods in fiscal 2000. As a percentage of total
revenue, general and administrative expenses were 9% and 10% for the three and
six month periods ended July 31, 2000 compared to 10% for the same periods in
fiscal 2000. The increase in absolute dollars was due to the growth in worldwide
staff and infrastructure investments in the areas of information systems,
finance, legal and administration to support the growth of Wind River and to
integrate the companies we have acquired. In addition, during the first and
second quarters of fiscal 2001, we include the administrative expenses related
to the acquisitions accounted for as purchase transactions. We believe that
general and administrative expenses will continue to increase in absolute
dollars as we continue to invest in worldwide staff and infrastructure in the
areas of information systems, finance and administration and consolidate the
financial, manufacturing, customer relations management and customer support
information systems of acquired companies.
Amortization of intangibles totaled $26.8 million and $36.3 million,
respectively, for the three and six month periods ended July 31, 2000,
compared to $800,000 and $1.0 million for the same periods in fiscal 2000.
The increase in amortization of intangibles is due to the amortization of
identifiable intangibles and goodwill related to the Embedded Support Tools
acquisition during the first quarter of fiscal 2001 and the AudeSi
Technologies acquisition during the second quarter of fiscal 2001. During the
three and six month periods ended July 31, 2000, Wind River amortized $24.0
million and $31.7 million of goodwill and $2.8 and $4.6 of identifiable
intangible assets. As a result of the Embedded Support Tools and AudeSi
acquisitions, Wind River expects to amortize $337.8 million and $51.4
million, respectively, of goodwill and identifiable intangibles over
approximately 4 years or a total of, approximately, $24.4 million per quarter.
Acquisition-related and other expenses were $1.0 million and $31.7 million,
respectively, for the three and six month periods ended July 31, 2000,
compared to $7.3 million and $7.6 million for the same periods in fiscal
2000. For the three month period ended July 31, 2000, acquisition-related and
other expenses are comprised of $1.0 million related to the write-off of
in-process research and development costs of AudeSi Technologies. For the six
month period ended July 31, 2000, acquisition-related and other expenses are
comprised of $27.0 million in costs associated with the acquisition of
Integrated Systems and $3.7 million relating to the write-off of in-
19
<PAGE>
process research and development costs of Embedded Support Tools, and $1.0
million related to the write-off of in-process research and development costs of
AudeSi Technologies.
The Integrated Systems acquisition costs of $27.0 million include: (a) $11.1
million for investment banking fees, (b) $7.2 million in severance payments, (c)
$4.5 million for office closure and other costs for surplus sales offices in the
USA, Europe and Japan, (d) $3.6 million for legal, accounting and other
professional fees which relate primarily to the acquisition process for
Integrated Systems and with the elimination of acquired legal entities in the
USA, Europe and Japan, and, (e) $0.6 million for general integration costs.
Severance costs of $2.3 million and $3.7 million were paid during the three and
six month periods of fiscal 2001, respectively. The remaining severance costs
are expected to be paid during the third and fourth quarters of fiscal 2001. In
total, 87 employees have been terminated including 40 general and administrative
employees, 33 sales and marketing employees and 14 employees from other areas.
Employees have been terminated if their roles or functions were duplicated
following the acquisition of Integrated Systems. The office closure costs relate
to remaining lease payments on vacant offices extending to October 31, 2004.
Wind River recognized in-process research and development charges of $1.0
million relating to AudeSi Technologies and $3.7 million relating to Embedded
Support Tools during the second and first quarters of fiscal 2001,
respectively. Wind River also recognized an in-process research and
development charge of $6.4 million relating to Software Development Systems
during the second quarter of fiscal 2000. The amounts related to in-process
technology represent purchased in-process technology for projects that have
not yet reached technological feasibility and have no alternative future use.
The value of the in-process research and development was determined by
estimating the net cash flows resulting from the completion of the projects
reduced by the percentage of completion of the projects. Net cash flows were
tax-effected using estimated income taxes consistent with Wind River's
anticipated tax rate for the foreseeable future and then discounted back to
their present value at a discount rate based on Wind River's required risk
adjusted weighted average rate of return. Wind River's estimated revenues,
margins and operating costs are based upon historical information about
similar product development cycles combined with projections of future
revenue and cost patterns, including projections used when initially
evaluating the acquisition of Embedded Support Tools, AudeSi Technologies and
Software Development Systems. Wind River cannot guarantee that it will
realize revenue from these in-process projects in the amounts estimated or
that the costs incurred will be materially consistent with estimates made.
However, to date, the Company is not aware of any significant variations
between costs incurred and estimates made.
The nature of the efforts to develop all purchased in-process technology into
commercially viable products principally relates to the completion of all
planning, designing, prototyping, verification and testing activities that are
necessary to establish that the resulting products can meet their design
specification, including function, features and technical performance
requirements.
Due to the fact that the projects were in-process, there is uncertainty
regarding whether they can be successfully finished and result in the net
cash flows that were originally estimated at the time of the acquisitions. It
is reasonably possible that the development of the acquired technology could
fail because of either prohibitive costs, Wind River's inability to perform
the required completion efforts or other factors outside Wind River's control
such as a change in the market for the resulting developed products. If the
development of the technology is unsuccessful, the technology may be
abandoned during the development phase. Should Wind River's development
efforts fail or encounter significant delay, then Wind River's future returns
may be significantly reduced. In such case, Wind River may be unable to
recover its investment in this project, may be less well positioned to
benefit from new product markets in these areas and Wind River's future
operating results could be adversely affected.
OTHER INCOME AND EXPENSES
20
<PAGE>
Interest income was $5.4 million and $10.4 million, respectively, for the
three and six month periods ended July 31, 2000, compared to $4.7 million and
$9.4 million for the same periods in the prior fiscal year. The increase in
interest income was primarily due to higher interest rates on invested
balances. Total cash and cash equivalents, investments and restricted cash at
July 31, 2000 and 1999 was approximately $311.1 million and $352.3 million,
respectively.
The realized gain on investments was $2.4 million and $8.7 million for the
three and six month periods ended July 31, 2000 compared to a realized gain
of $12,000 and realized loss of $627,000 for the same periods in fiscal 2000.
The increase is due primarily to a gain of $2.5 million and $8.9 million
related to the disposition of equity securities of Liberate Technologies,
Inc. and e-Sim, Inc. during the three and six month periods ended July 31,
2000, respectively. Wind River sold 105,000 common shares of Liberate at
prices ranging from $26.94 to $28.96 per share during the second quarter of
fiscal year 2001, and sold 44,922 common shares of Liberate at $108.00 per
share and 95,100 common shares of e-Sim at prices ranging from $18.38 to
$36.99 per share during the first quarter of fiscal year 2001. During the
first quarter of fiscal year 2000, Wind River recognized a charge totaling
$500,000 relating to the difference between the carrying amount of our
investment in XACT and management's assessment of the net realizable value of
the investment.
Interest expense and other, net was $2.0 million and $4.3 million for the three
and six month periods ended July 31, 2000, compared to $2.1 million and $4.3
million for the same periods in the prior fiscal year. Wind River pays interest
on its outstanding 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.
PROVISION FOR INCOME TAXES
Net income for the three and six month periods ended July 31, 2000 was
negatively impacted by $1.0 million and $31.7 million, respectively, in
acquisition related and other charges, including, $1.0 million and $4.7
million, respectively, of in-process research and development and $26.8
million and $36.3 million, respectively, in amortization of goodwill,
purchased technology and other intangibles. Despite the occurence of a net
loss in the three and six month periods ended July 31, 2000, a tax provision
resulted due to the exclusion of amortization of goodwill and other
intangibles, and the exclusion of in-process research and development and
other acquisition charges, which are non-deductible for income tax purposes.
The effective tax rate for the three and six months ended July 31, 2000
excluding amortization of goodwill and intangibles and acquisition charges
was 37.5% compared to 36.7% and 36.2% for the same periods in the prior
fiscal year. The change in the effective tax rate excluding amortization of
goodwill and intangibles and acquisition charges is attributed to the change
in the ratio of foreign taxable income to domestic taxable income and
carryforward tax attributes.
LIQUIDITY AND CAPITAL RESOURCES
At July 31, 2000, Wind River had working capital of approximately $105.5
million and cash and investments, excluding restricted cash of $48.1 million,
of approximately $262.9 million, which include investments with maturities
greater than one year of $147.5 million. Wind River invests primarily in
instruments that are highly liquid and of investment grade. Cash flows for
the six month period ended July 31, 2000 include cash flows for Embedded
Support Tools from the date of its acquisition on March 31, 2000, and cash
flows for AudeSi Technologies from the date of its acquisition on May 1, 2000.
During the first six months of fiscal 2001, Wind River's operating activities
provided net cash of $11.9 million due primarily to changes in assets and
liabilities including accounts receivable, accounts payable and accrued
liabilities, income taxes payable and deferred revenue offset by a reduction
in accrued compensation. The net loss for the first six months of fiscal 2001
was primarily offset by the adjustments for depreciation and amortization of
intangibles and the write-off of in-process research and development arising
from the acquisitions of Embedded Support Tools and AudeSi Technologies.
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During the first six months of fiscal 2001, investing activities used net
cash of $31.0 million primarily for purchases of investments, the settlement
of liabilities assumed in connection with the acquisition of Embedded Support
Tools, the acquisition of equipment, and changes in restricted cash. These
uses of cash were partially offset by cash provided relating to the sales of
investments. Restricted cash increased primarily due to the increased
collateral funding required for the operating lease of Wind River's
headquarter development. The collateral consists of direct obligations of the
United States government.
During the first six months of fiscal 2001, financing activities provided net
cash of $16.0 million primarily from the sale of common stock in connection
with employee stock option exercises. These proceeds were substantially
offset by cash used for repayment of amounts due under a line of credit at
Wind River's Japanese subsidiary and repayment of Embedded Support Tools'
bank loans following its acquisition. During the six months ended July 31,
1999, Wind River repurchased as part of its systematic stock repurchase
program, 165,000 shares of its common stock at a cost of approximately $4.0
million. Integrated Systems also repurchased 261,000 shares of its common
stock. In June 1999, the Board of Directors rescinded all stock repurchase
authorizations. We have not made any repurchases since March 17, 1999.
In fiscal year 1998, Wind River entered into an operating lease for its current
headquarters facility constructed on land owned by Wind River in Alameda,
California. Construction was completed in the second quarter of fiscal year
2000. The lease was finalized in August 1999 and the lessor has funded a total
of $32.4 million of construction costs. The operating lease payments began in
August 1999 and are based on the total construction costs of the property,
including capitalized interest and LIBOR.
In fiscal year 2000, Wind River entered into a second operating lease agreement
for the construction of two additional buildings at its headquarters facility.
As of July 31, 2000, the lessor has funded a total of $12 million of
construction costs and has committed to fund up to a maximum of $26.0 million.
Construction of the buildings is currently expected to be completed in January
2001. The operating lease payments will vary based upon the total construction
costs of the property, which include capitalized interest and LIBOR. In
connection with the lease of Wind River's new headquarters, Wind River is
obligated to enter into a ground lease of its land in Alameda, California with
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 ground lease provides Wind
River with the option at the end of the lease terms to either acquire the
buildings at the lessor's original cost or arrange for the buildings to be
acquired. Wind River has guaranteed the residual value associated with the
buildings under the first operating lease and second operating lease to the
lessor of approximately 82% and 84.5%, respectively, of the lessor's actual
funding of $32.4 million on the first operating lease and obligated funding of
$26.0 million on the second operating lease, respectively. Wind River is also
required 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 July 31, 2000, 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. 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 the one month
LIBOR to a fixed rate of 5.9%. 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 agreement matures at the same time as the operating
lease expires. The amounts potentially subject to credit risk (arising from the
possible inability of counterparty to meet the term of the contract) are
generally limited to the amounts, if any, by which the counterparty's
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
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Standard and Poor's, or Moody's equivalent, long-term senior debt rating.
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 in high-grade fixed income securities.
Management believes Wind River's working capital and the cash flow from
operations will be sufficient to meet its operating requirements for
planned expansion, product development and capital expenditures for the next
twelve months; however, Wind River may sell additional equity or debt securities
or obtain credit facilities to further enhance its liquidity position. The sale
of additional securities could result in additional dilution to Wind River's
stockholders.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("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. In July 1999, the FASB issued SFAS 137, "Accounting for
Derivative Instruments and Hedging Activities - Deferral of the Effective Date
of SFAS No. 133." SFAS 137 deferred the effective date of SFAS 133 until the
first fiscal year beginning after June 15, 2000. In June 2000, the FASB issued
SFAS 138, "Accounting for Certain Derivative Instruments and Certain Hedging
Activities - an Amendment of SFAS 133". SFAS 138 amends SFAS 133 to permit
limited use of central treasury "netting" of intercompany derivatives for
foreign currency cash flow hedges. SFAS 138 must be adopted concurrently with
SFAS 133. Wind River has not yet determined the impact, if any, of adopting this
statement.
In March 2000, the FASB issued Interpretation No. 44, ("FIN 44"), "Accounting
for Certain Transactions Involving Stock Compensation - an Interpretation of APB
25". This Interpretation clarifies (a) the definition of employee for purposes
of applying Opinion 25, (b) the criteria for determining whether a plan
qualifies as a noncompensatory plan, (c) the accounting consequence of various
modifications to the terms of a previously fixed stock option or award, and (d)
the accounting for an exchange of stock compensation awards in a business
combination. This Interpretation is effective July 1, 2000, but certain
conclusions in this Interpretation cover specific events that occur after either
December 15, 1998, or January 12, 2000. The adoption of certain of the
conclusions of FIN 44 covering events occurring during the period after December
15, 1998 or January 12, 2000 did not have a material effect on the Company's
financial position and results of operations. Wind River does not expect that
the adoption of the remaining conclusion will have a material effect on the
financial position or results of operations.
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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 OCCUR, 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.
NUMEROUS FACTORS MAY CAUSE OUR REVENUES AND OPERATING RESULTS TO FLUCTUATE
SIGNIFICANTLY FROM PERIOD TO PERIOD.
Our revenues and operating results have fluctuated significantly in the past and
may continue to do so in the future. If our quarterly or annual operating
results do not meet the expectations of securities analysts and investors, the
market price of our common stock could decline significantly. A number of
factors, many of which are outside our control, may cause or contribute to these
fluctuations, including:
- the amount and timing of orders we receive;
- changes in the length of our products' sales cycles, which increase as our
customers' purchase decisions become more strategic and are made at higher
management levels;
- the success of our customers' products from which we derive our royalty
revenues;
- the mix of our revenues from the sale of services (which have lower margins
than our revenue from the sale of products) as compared to products;
- our ability to control our operating expenses, which we anticipate will
continue to increase during the current fiscal year;
- our ability to continue to develop, introduce and ship competitive new
products and product enhancements quickly;
- announcements, new product introductions and price reductions by our
competitors;
- our ability to manage costs for fixed-price consulting engagements;
- changes in business cycles that affect the markets in which we sell our
products;
- economic conditions generally and in international markets, which
historically have provided a significant portion of our revenues; and
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- foreign currency exchange rates.
In addition, we often recognize a significant portion of our quarterly revenues
from orders we receive and ship in the last month of the quarter and, as a
result, we may not be able to forecast our revenues until late in the period.
Further, our customers historically have purchased more of our products in our
fourth fiscal quarter than in other quarters. A decrease in orders is likely to
adversely and disproportionately affect our operating results, because a
significant portion of our expenses are fixed and are based, in part, on our
expectations of future revenues. Therefore, we have a limited ability to reduce
expenses in response to a shortfall in anticipated revenues. We believe that
period-to-period comparisons of our operating results may not be meaningful, and
should not be relied on as an indication of our future performance.
IF WE DO NOT INTEGRATE OUR PRODUCTS WITH THOSE OF COMPANIES WE HAVE ACQUIRED, WE
MAY LOSE CUSTOMERS AND FAIL TO ACHIEVE OUR FINANCIAL OBJECTIVES.
We recently completed two significant business acquisitions. In February and
March 2000, we acquired Integrated Systems, Inc., and Embedded Support Tools
Corporation in merger transactions. Achieving the benefits of the mergers
depends in part on the integration of Wind River's, Integrated Systems' and
Embedded Support Tools', as well as our other acquired companies, products in a
timely and efficient manner. In order for us to provide enhanced and more
valuable products to our customers since the mergers, we will need to integrate
our product lines and development organizations. This will be difficult and
unpredictable because our products are highly complex, have been developed
independently and were designed without regard to such integration. If we cannot
successfully integrate our products and continue to provide customers with
products and new product features in the future on a timely basis, we may lose
customers and our business and results of operations may be seriously harmed.
IF WE ARE NOT SUCCESSFUL IN INTEGRATING OUR ORGANIZATIONS, WE WILL NOT BE ABLE
TO OPERATE EFFICIENTLY.
Achieving the benefits of the mergers also depends in part on the successful
integration of Wind River's, Integrated Systems', Embedded Support Tools',
AudeSi's and other acquisitions' operations and personnel in a timely and
efficient manner. Such integration requires coordination of different
development and engineering teams. This, too, will be difficult and
unpredictable because of possible cultural conflicts and different opinions on
technical decisions and product roadmaps. If we cannot successfully integrate
our operations and personnel, we will not realize the expected benefits of the
mergers.
INTEGRATING OUR COMPANIES MAY DIVERT MANAGEMENT'S ATTENTION AWAY FROM OUR
OPERATIONS.
Successful integration of Wind River's, Integrated Systems', Embedded Support
Tools', AudeSi's and other acquisitions' operations, products and personnel may
place a significant burden on our management and our internal resources. The
diversion of management attention and any difficulties encountered in the
transition and integration process could have a material adverse effect on the
combined company's business, financial condition and operating results.
IF WE DO NOT SUCCESSFULLY INTEGRATE THE COMPANIES INTO A SINGLE BUSINESS AND
REALIZE THE EXPECTED BENEFITS OF THE MERGERS, WE WILL HAVE INCURRED SIGNIFICANT
COSTS WHICH MAY HARM OUR BUSINESS.
Wind River expects to incur costs from integrating Integrated Systems', Embedded
Support Tools', AudeSi's and other acquisitions' operations, products and
personnel. These costs may be substantial and may include costs for
- employee redeployment, relocation or severance;
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- conversion of information systems;
- combining research and development teams and processes;
- reorganization or closures of facilities; and
- relocation or disposition of excess equipment.
We do not know whether Wind River will be successful in these integration
efforts and cannot assure you that we will realize the expected benefits of the
mergers.
FAILURE TO RETAIN KEY EMPLOYEES COULD DIMINISH THE BENEFITS OF THE MERGERS.
The successful combination of Wind River, Integrated Systems, Embedded Support
Tools, AudseSi and other acquisitions depends in part on the retention of key
personnel. There can be no assurance that Wind River will be able to retain
Integrated Systems', Embedded Support Tools', AudeSi's and other acquisitions'
key management, technical, sales and customer support personnel, or that Wind
River will realize the anticipated benefits of the mergers.
IF CUSTOMER RELATIONSHIPS ARE DISRUPTED BY THE MERGERS, OUR SALES COULD DECLINE.
Customers may not continue their buying patterns in place prior to the
mergers. Any significant delay or reduction in orders for Wind River's,
Integrated Systems' or Embedded Support Tools', as well as our other
acquisitions' and subsidiaries' products could have a material adverse effect
on the combined company's business, financial condition and results of
operations. Customers may defer purchasing decisions as they evaluate the
likelihood of successful integration of Wind River's, Integrated Systems',
Embedded Support Tools' and other acquisitions' products and the combined
company's future product strategy. Customers may also consider purchasing
products of competitors. In addition, by increasing the breadth of Wind
River's, Integrated Systems', Embedded Support Tools' and other acquisitions'
business, the mergers may make it more difficult for the combined company to
enter into relationships, including customer relationships, with strategic
partners, some of whom may view the combined company as a more direct
competitor than Wind River, Integrated Systems, Embedded Support Tools or
other acquisitions as an independent company.
WE FACE INTENSE COMPETITION, WHICH COULD DECREASE DEMAND FOR OUR PRODUCTS OR
CAUSE US TO REDUCE OUR PRICES.
The embedded real-time software industry is highly competitive. We believe
that our principal competition comes from companies that develop real-time
operating systems in-house rather than purchase these systems from
independent software vendors such as Wind River. We also compete with other
independent software vendors, including
- Accelerated Technology, Inc.
- ENEA Data Systems
- Mentor Graphics, Inc.
- Microsoft Corporation
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- Microware Systems Corporation
- Motorola, Inc.
- QNX Software Systems, Ltd.
- Sun Microsystems, Inc.; and
- Symbian Inc.
Recently, a number of companies, including RedHat, Inc. and Lynx Real-Time
Systems, Inc. have promoted Linux, an open source licensing model, as an
operating system for use in embedded applications. The open source licensing
model provides readily available source code and a royalty-free operating
system. Because Linux is royalty free, Wind River may be forced to reduce the
prices of run time royalties, which could result in reduced profit margins.
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 our products. Many of our existing and potential
competitors have substantially greater financial, technical, marketing and sales
resources than we do. 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. Moreover, our competitors may foresee the course of market
developments more accurately than we do and could in the future develop new
technologies that compete with our products or even render our products
obsolete. Although we believe we presently have certain technological and other
advantages over our competitors, maintaining these advantages will require a
continued high level of investment in research and development, marketing and
customer service and support. In addition, competitive pressures could cause us
to reduce the prices of our products, run-time royalties and services, which
would result in reduced profit margins.
OUR FAILURE TO RESPOND QUICKLY TO RAPID TECHNOLOGICAL CHANGE WITH PRODUCT
OFFERINGS WILL ADVERSELY AFFECT OUR ABILITY TO COMPETE.
The market for embedded real-time software is characterized by ongoing
technological developments, evolving industry standards and rapid changes in
customer requirements. Our success depends upon our ability to adapt and respond
to these changes. We must continuously update our existing products to keep them
current with customer needs, and must develop new products to take advantage of
new technologies, for example, our new Cirrus technologies, emerging standards,
and expanding customer requirements that could render our existing products
obsolete. Because customers often defer purchases between the time a new product
is announced and its availability, our operating results may fluctuate if we do
not provide new products rapidly. We have from time to time experienced delays
in the development of new technologies, new products and the enhancement of
existing products, including, most recently, a delay in the development of our
recently introduced product Tornado for Managed Switches. Such delays are
commonplace in the software industry. We must achieve design wins with key
customers because once a customer has designed a product with a particular
operating system, that customer typically is reluctant to change its supplier,
due to the significant costs associated with selecting a new supplier. If we
cannot adapt or respond in a cost effective and timely manner to new
technologies and new customer requirements, the market for our products would
suffer.
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BECAUSE OUR OPERATING RESULTS DEPEND UPON SALES OF A SMALL NUMBER OF PRODUCTS, A
REDUCTION IN DEMAND FOR A SINGLE PRODUCT MAY DISPROPORTIONATELY DECREASE OUR
OPERATING RESULTS.
Revenue from sales of our Tornado and VxWorks family of products and services
has historically accounted for substantially all of our revenue, and we expect
this concentration will continue in the foreseeable future. Although we have
added new products to our offering as a result of the mergers, any decline in
price or reduction in the demand for our Tornado or VxWorks family of products
and services could materially adversely affect our operating results and cause
the price of our common stock to decline.
IF WE DO NOT CONTINUE TO SUCCESSFULLY ADDRESS NEW AND RAPIDLY CHANGING MARKETS,
OUR REVENUES WILL DECLINE.
We are continuously engaged in product development for new or rapidly changing
markets. It is difficult to predict whether demand for any of these products
will develop or increase in the future.
In particular, we have invested significant time and effort, together with a
consortium of industry participants, in the development of a new specification
that is intended to create an open standard set of interface specifications for
high-performance input/output (I/O) systems. In parallel with this effort, we
have developed IxWorks, a real-time operating system for use in conjunction with
the new specification. The success of the new specification and the IxWorks
product line depends heavily on its adoption by a broad segment of the industry.
We have also spent, and continue to spend, substantial time and financial
resources, through two new business units, to develop software solutions for
Internet appliances and Internet infrastructure, including Tornado for Managed
Switches and the consumer market place. These products must be ported to an
increasing number of Internet protocols and semiconductor architectures designed
specifically for the Internet. If the protocols and semiconductors upon which
our Internet products are based ultimately fail to be widely adopted, our
products based on those protocols and architectures will fail to achieve market
acceptance. If our products fail to achieve market acceptance or if their
targeted markets fail to develop, our revenues will decline.
A SIGNIFICANT PORTION OF OUR REVENUE IS DERIVED FROM ROYALTIES, WHICH ARE
DEPENDENT UPON THE EFFORTS OF OUR CUSTOMERS WHICH ARE OUTSIDE OUR CONTROL.
Our operating systems are embedded in customers' end-user products, and we
receive royalty fees for each copy of our operating system embedded in those
products. Our royalty revenues depend upon our ability to successfully negotiate
royalty agreements with our customers and, in turn, their successful
commercialization of the underlying products. We cannot control their product
development or predict its success. If our customers are not successful, our
royalty revenues will decline significantly.
WE HAVE RECENTLY BEGUN TO OFFER SOFTWARE CONSULTING SERVICES, WHICH HAVE LOWER
MARGINS THAN OUR CORE BUSINESS.
Our new professional services business is characterized by fixed-price
commitments and high costs for personnel and consultants. If this business is
not successful, or if it grows more slowly than anticipated, our gross margin
will suffer. In addition, we may enter into contracts with development schedules
in excess of a year. Failure to manage these contracts efficiently could put
additional pressure on our gross margin.
ACQUISITIONS MAY DISRUPT OUR BUSINESS, DILUTE OUR STOCKHOLDERS AND INCREASE OUR
INDEBTEDNESS.
As part of our business strategy, we anticipate that we will continue to acquire
or make investments in businesses, products and technologies that complement
ours. We have incurred significant costs in connection with completed and
pending transactions, and may incur significant costs in connection with future
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transactions whether or not they actually occur. The transactions may not be
completed in a timely manner or at all. We may experience difficulties
integrating an acquired company's operations into ours. As a result, we may
divert management attention to the integration that would otherwise be available
for the ongoing development of our business. In particular, if we are unable to
combine our financial and customer databases, we will be unable to operate
efficiently. Acquisitions have additional inherent risks, including:
- difficulties assimilating acquired operations, technologies or products;
- unanticipated costs; and
- adverse effects on relationships with customers, suppliers and employees.
We may not be successful in integrating the businesses, products, technologies
or personnel we acquire. Similarly, we cannot guarantee that our investments
will yield a significant return if any. To finance acquisitions, we may issue
equity securities, which may dilute our earnings per share, or incur significant
indebtedness and related interest expense.
FAILURE OF OUR CURRENT AND PLANNED SYSTEMS, PROCEDURES AND CONTROLS TO
ADEQUATELY MANAGE AND SUPPORT OUR ANTICIPATED GROWTH AND FUTURE OPERATIONS,
COULD DISRUPT OUR BUSINESS.
We have experienced, and expect to continue to experience, both through
acquisitions and internal expansion, significant growth in our headcount and in
the scope, complexity and geographic reach of our operations. To support this
expansion, we must continue to improve our management controls, reporting
systems and procedures. To implement those improvements, we must purchase,
develop and maintain complex and expensive systems, such as our enterprise
resource planning system and our planned sales force automation system. Our
current and planned systems, procedures and controls may not be adequate to
support our future operations. Failure of these systems to meet our needs could
disrupt our operations.
IF WE ARE UNABLE TO ATTRACT AND RETAIN QUALIFIED EMPLOYEES IN AN INCREASINGLY
COMPETITIVE ENVIRONMENT, OUR BUSINESS MAY SUFFER.
Our future success depends, and will continue to depend, on our ability to hire,
train, motivate and retain additional highly skilled managerial, product
development, marketing, sales, customer support and operations personnel to
support our growing business. Competition for these personnel is intense,
especially for engineers and especially in the San Francisco Bay Area where we
maintain our headquarters and principal engineering facilities. We cannot be
certain that we will be successful in recruiting and retaining such personnel.
Our failure to do so could impair our ability to compete successfully.
OUR SIGNIFICANT INTERNATIONAL BUSINESS ACTIVITIES SUBJECT US TO ECONOMIC RISKS.
During the six months ended July 31, 2000 and fiscal years ended January 31,
2000 and 1999, we derived approximately 34%, 33% and 32%, respectively, of our
total revenue from sales outside of North America. We expect that international
sales will continue to generate a significant percentage of our total revenue in
the foreseeable future, and we also expect to continue to make investments to
further expand our international operations and to increase our direct sales
force in Europe and Asia. Wind River is in the process of changing its
distribution model in Japan to a model in which Wind River interfaces with and
sells to its customers more directly. We believe that this model will improve
our understanding of and relationships with our customers. During this
transition period, we expect to see a decline in revenues in Japan. Risks
inherent in international operations include:
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- the imposition of governmental controls and regulatory requirements;
- the costs and risks of localizing products for foreign countries;
- unexpected changes in tariffs, import and export restrictions and other
barriers and restrictions;
- greater difficulty in accounts receivable collection;
- the restrictions of repatriation of earnings;
- the burdens of complying with a variety of foreign laws; and
- difficulties in staffing and managing foreign subsidiaries and branch
operations.
Any of these events could reduce our international sales and increase our costs
of doing business internationally.
GAINS AND LOSSES RESULTING FROM FLUCTUATIONS IN FOREIGN CURRENCY EXCHANGE RATES
COULD HARM OUR INTERNATIONAL BUSINESS AND OUR OVERALL OPERATING RESULTS.
As a business with significant international operations, we face exposure to
adverse movements in foreign currency exchange rates. Sales by our foreign
subsidiaries are denominated in the local currency, and an increase in the
relative value of the dollar against such currencies would reduce our revenues
in dollar terms or make our products more expensive and, therefore, potentially
less competitive in foreign markets. Gains and losses on the conversion to
dollars of accounts receivable, accounts payable and other monetary assets and
liabilities arising from international operations may contribute to fluctuations
in our results of operations.
OUR INTERNATIONAL BUSINESS DEPENDS ON THE EFFORTS OF THIRD-PARTY DISTRIBUTORS
OUTSIDE OUR CONTROL.
We rely on distributors for sales of our products in certain foreign countries.
Accordingly, we are dependent on their ability to promote and support our
products and, in some cases, to translate them into 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. We cannot predict that our international distributors will
continue to market our products or provide them with adequate levels of support.
If our international distributors do not promote our products effectively, our
international revenues could decline.
WE SELL A PORTION OF OUR PRODUCTS TO CUSTOMERS DEPENDENT UPON GOVERNMENT
FUNDING, WHICH MAY NOT CONTINUE TO BE AVAILABLE.
We have derived a portion of our revenues historically 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 we believe that
revenues from sales of products designed for embedded systems applications
(non-VME customers) will account for an increasing percentage of our revenues in
the future, we do expect revenues from the VME market to continue to be
significant for the foreseeable future. Academic institutions and defense
industry participants, which generate most of our VME revenues, are dependent on
government funding. Any unanticipated future termination of government funding
of VME customers would reduce our revenues.
IF WE LOSE THIRD-PARTY LICENSE RIGHTS, WE MAY NOT BE ABLE TO SELL SOME OF OUR
PRODUCTS.
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We license software products from other companies to distribute with some of our
products. These third parties may not be able to provide competitive products
with adequate features and high quality on a timely basis or to provide sales
and marketing cooperation. In addition, our products compete with products
produced by some of our licensors. When these licenses terminate or expire,
continued license rights might not be available to us on reasonable terms. In
addition, we might not be able to obtain similar products to substitute into our
tool suites.
THE RIGHTS WE RELY UPON TO PROTECT THE INTELLECTUAL PROPERTY UNDERLYING OUR
PRODUCTS MAY NOT BE ADEQUATE, WHICH COULD ENABLE THIRD PARTIES TO USE OUR
TECHNOLOGY AND REDUCE OUR ABILITY TO COMPETE IN THE MARKET.
Our success is partially dependent upon the proprietary technology contained in
our products. We currently rely on a combination of patents, copyrights,
trademarks, trade secret laws, and contractual provisions to establish and
protect our intellectual property rights in our products. We cannot be certain
that the steps we take to protect our intellectual property will adequately
protect our rights, that others will not independently develop or otherwise
acquire equivalent or superior technology, or that we can maintain such
technology as trade secrets. For example, end user licenses of our software are
frequently in the form of shrink wrap or click wrap license agreements, which
are not signed by licensees, and these may be unenforceable in some cases. In
addition, policing unauthorized use of our products is difficult, and while we
are unable to determine the extent to which software piracy of our products
exists, software piracy can be expected to be a persistent problem, particularly
in foreign countries, where the laws may not protect our intellectual property
as fully as in the United States. Employees, consultants, and others who
participate in the development of our products may breach their agreements with
us regarding our intellectual property, and we may not have adequate remedies
for any such breach.
IF WE ENFORCE OUR INTELLECTUAL PROPERTY RIGHTS THROUGH LITIGATION, THE COSTS
COULD BE SIGNIFICANT.
We may initiate claims or litigation against third parties for infringement of
our proprietary rights or to establish the validity of our proprietary rights.
Litigation to determine the validity of any claims, whether or not such
litigation is determined in our favor, could result in significant expense to us
and divert the efforts of our technical and management personnel from productive
tasks.
THIRD-PARTY CLAIMS OF PATENT INFRINGEMENT COULD RESULT IN SUBSTANTIAL COSTS.
We occasionally receive communications from third parties alleging patent
infringement, and there is always the chance that third parties may assert
infringement claims against us. Any such claims, with or without merit, could
result in costly litigation, expense of significant resources to develop
non-infringing technology, cause product shipment delays or require us to enter
into royalty or licensing agreements. We cannot be certain that the necessary
licenses will be available or that they can be obtained on commercially
reasonable terms. If we were to fail to obtain such royalty or licensing
agreements in a timely manner and on reasonable terms, our business, financial
condition and results of operations would be materially adversely affected. We
believe that our products and technology do not infringe on the intellectual
property rights of others or upon intellectual property rights that may be
granted in the future pursuant to pending applications. We also believe that we
will not be required to obtain licenses of technology owned by other parties.
DEFECTS IN OUR PRODUCTS COULD HURT OUR OPERATING RESULTS AND EXPOSE US TO
SIGNIFICANT PRODUCT LIABILITY CLAIMS.
Because of their complexity, software products, including Wind River's, have in
the past and may in the future contain undetected or unresolved errors,
particularly when first introduced or as new versions are released.
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Despite extensive testing, errors may be found in our current or future products
or enhancements after commencement of commercial shipments. If this occurs, we
may experience delay in or loss of market acceptance and sales, product returns,
diversion of development resources, injury to our reputation, and increased
service and warranty costs.
Our products are increasingly used in applications, such as network
infrastructure, transportation, medical and mission-critical business systems,
in which the failure of the embedded system could cause property damage,
personal injury or economic loss resulting in product liability claims against
us. Although our agreements with our customers typically contain provisions
intended to limit our exposure to liability claims, these provisions may not be
effective in doing so in all circumstances or in all jurisdictions. We maintain
product liability insurance covering certain damages arising from use of our
products, however such insurance may not adequately cover claims brought against
us. Liability claims against us could require us to spend significant time and
money in litigation and, if successful, to pay significant damages.
THE YEAR 2000 PROBLEM MAY ADVERSELY AFFECT OUR BUSINESS, FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
Although we have not experienced any significant Year 2000 problems in our own
or third party software or with our suppliers, it is possible that such problems
still exist. If so, we could face unexpected expenses to fix such problems or
suffer unexpected outages, either of which would harm our business.
WE HAVE SUBSTANTIAL DEBT SERVICE AND PRINCIPAL REPAYMENT OBLIGATIONS, WHICH
COULD MAKE IT DIFFICULT FOR US TO OBTAIN FINANCING.
We sold $140 million of 5% convertible subordinated notes in 1997, which mature
in 2002. This debt financing increased significantly both the ratio of our
long-term debt to our total capitalization and our interest expenses. The degree
to which we are leveraged could impair our ability to obtain financing for
working capital or acquisitions, should we need to do so. The notes are
convertible into our common stock at a price of $32.33 per share, and no notes
have been converted to date. On August 1, 2002, we will be required either to
pay off or refinance any unconverted notes. We do not know if we will be able to
refinance the notes on favorable terms or at all. If a significant amount of the
notes remains unconverted at maturity and we are unable to refinance the notes,
the repayment would deplete our cash reserves significantly.
OUR STOCK PRICE HAS BEEN AND MAY CONTINUE TO BE VOLATILE; A SIGNIFICANT DECREASE
IN OUR STOCK PRICE MAY INCREASE OUR EXPOSURE TO SECURITIES LITIGATION.
The trading price of our common stock has been and is likely to be volatile. It
could fluctuate widely in response to a variety of factors, including:
- actual or anticipated variations in our operating results;
- announcements of new products or significant events or transactions by us
or our competitors;
- changes in our industry;
- changes in financial estimates by securities analysts;
- pricing pressures;
- general market conditions;
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- events affecting other companies that investors believe to be comparable to
us; and
- other events or factors that may be beyond our control.
In recent years, the stock markets in general and the shares of technology
companies in particular have experienced extreme price fluctuations. These
fluctuations often have been unrelated or disproportionate to the operating
performance of the companies affected. Any change in investors' perception of
our prospects could depress our stock price regardless of our results. Other
broad market and industry factors may decrease our stock price, as may general
political or economic conditions such as recessions or interest rate or currency
fluctuations. In the past, following declines in the market price of a company's
securities, securities class action litigation often has been instituted against
the company. Litigation of this type, even if ultimately unsuccessful, could
result in substantial costs and a diversion of management's time and focus.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
INTEREST RATE SENSITIVITY
Wind River's exposure to market risk for changes in interest rates relate
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 an immediate 100 basis point move in interest rates
affecting Wind River's floating and fixed rate financial instruments as of July
31, 2000 would have an immaterial effect on Wind River's pretax earnings. Wind
River also believes 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 losses 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
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July 31, 2000, Wind River had outstanding forward contracts with notional
amounts totaling approximately $5.4 million.
The net unrealized gains and losses on the outstanding forward contracts at
July 31, 2000 were immaterial to Wind River's consolidated financial
statements. Due to the short-term nature of the forward contracts, the fair
value at July 31, 2000 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
In March 1998, 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 July 31, 2000, the notional amount
of the accreting interest rate swap was $28.5 million. The estimated fair value
at July 31, 2000 was negligible.
EQUITY PRICE RISK
Wind River owns 338,652 shares of common stock of e-Sim, Inc., an Israeli
corporation. Wind River purchased the common stock prior to e-Sim's public
offering of $7.50 per share. e-Sim went public in July 1998, and at July 31,
2000, the closing price of e-Sim's stock was $8.00 per share. In addition, Wind
River owns 266,744 shares of common stock of Liberate Technologies, Inc., a
Delaware corporation. Wind River purchased the stock prior to Liberate's public
offering. Liberate went public in July 1999 at $16.00 per share, and at July 31,
2000, the closing price of Liberate's stock was $22.94 per share. Wind River
values these investments using the closing price of the stock at the end of each
month. As a result, Wind River reflects these investments on its balance sheet
at July 31, 2000 at their market value of approximately $8.8 million in
aggregate, with the unrealized gains and losses excluded from earnings and
reported in the accumulated other comprehensive income component of
stockholders' equity. At September 8, 2000, the closing prices of e-Sim's and
Liberate's stock were $10.25 and $30.00, respectively.
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PART II - OTHER INFORMATION
Item 4. Submission of Matters to a vote of Security Holders
At the Annual Meeting of stockholders held July 26, 2000, the following matters
were submitted to a vote of the security holders:
(1) To elect the following to serve as directors of Wind River:
<TABLE>
<CAPTION>
NAME FOR WITHHELD
<S> <C> <C>
Jerry L. Fiddler 53,053,369 213,585
Narendra K. Gupta 53,053,319 213,635
Thomas St. Dennis 53,053,469 213,485
John C. Bolger 53,053,142 213,812
William B. Elmore 53,053,219 213,735
Grant M. Inman 53,053,319 213,635
David B. Pratt 53,053,259 213,695
</TABLE>
(2) To approve an amendment to Wind River's 1993 Employee Stock
Purchase Plan to increase the number of shares of common stock
available under such Plan by 1,500,000 shares:
<TABLE>
<S> <C>
Votes for 52,396,455
Votes against 758,872
Votes abstaining 111,627
</TABLE>
(3) To approve an amendment to Wind River's Amended and Restated
Certificate of Incorporation, as amended, to increase the
authorized number of shares of common stock by 200,000,000.
<TABLE>
<C> <C>
Votes for 50,382,133
Votes against 2,750,541
Votes abstaining 134,280
</TABLE>
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(4) To ratify the selection of PricewaterhouseCoopers LLP as Wind
River's independent accountants for the fiscal year ending January
31, 2001:
<TABLE>
<S> <C>
Votes for 53,153,732
Votes against 51,186
Votes abstaining 62,036
</TABLE>
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
27.1 Financial Data Schedule
(b) Reports on Form 8-K
The Company filed a report on Form 8-K/A, dated June 7, 2000, filing
certain financial information in connection with its acquisition of
Embedded Support Tools Corporation.
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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: September 14, 2000 /s/ RICHARD W. KRABER
---------------------
Richard W. Kraber
Vice President and Chief Financial Officer
37
