SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
/X/ Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended April 30, 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.
72,423,814 shares of Common Stock, $.001 par value, as of June 9, 2000
WIND RIVER SYSTEMS, INC.
FORM 10-Q
QUARTER ENDED APRIL 30, 2000
INDEX
Part I: FINANCIAL INFORMATION
Item 1. Financial Statements 3
Condensed Consolidated Statements of Operations
for the three month periods ended April 30,
2000 and 1999 3
Condensed Consolidated Balance Sheets at
April 30, 2000 and January 31, 2000 4
Condensed Consolidated Statements of Cash
Flows for the three month periods ended
April 30, 2000 and 1999 5
Notes to the Condensed Consolidated
Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 15
Item 3. Quantitative and Qualitative Disclosures
about Market Risk 32
Part II: OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds 34
Item 6. Exhibits and Reports on Form 8-K 34
Signature 35
2
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)
Three months ended
April 30,
2000 1999
-------------- ---------------
Revenues:
Products $ 63,258 $ 42,928
Services 28,380 25,354
-------------- ---------------
Total revenues 91,638 68,282
-------------- ---------------
Cost of revenues:
Products 9,158 5,675
Services 13,008 9,801
-------------- ---------------
Total cost of revenues 22,166 15,476
-------------- ---------------
Gross margin 69,472 52,806
-------------- ---------------
Operating expenses:
Selling and marketing 38,232 26,224
Product development and engineering 18,261 11,632
General and administrative 9,599 6,411
Amortization of intangibles 9,580 283
Acquisition-related and other 30,699 302
-------------- ---------------
Total operating expenses 106,371 44,852
-------------- ---------------
Operating income (loss) (36,899) 7,954
-------------- ---------------
Other income (expense):
Interest income 5,077 4,720
Realized gain (loss) on investments 6,356 (639)
Interest expense and other, net (2,262) (2,165)
-------------- ---------------
Total other income 9,171 1,916
-------------- ---------------
Income (loss) before provision for income taxes (27,728) 9,870
Provision for income taxes 4,705 3,489
-------------- ---------------
Net income (loss) $ (32,433) $ 6,381
============== ===============
Net income (loss) per share:
Basic $ (0.48) $ 0.10
Diluted $ (0.48) $ 0.10
Weighted average shares:
Basic 66,939 62,162
Diluted 66,939 65,557
The accompanying notes are an integral part of these
condensed consolidated financial statements.
3
WIND RIVER SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PAR VALUE)
April 30, January 31,
2000 2000
------------------- -----------------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 87,227 $ 77,929
Short-term investments 39,663 25,711
Accounts receivable, net 81,353 79,586
Prepaid and other current assets 40,096 35,375
------------------ ------------------
Total current assets 248,339 218,601
Investments 168,281 208,917
Land and equipment, net 58,289 56,331
Intangibles 363,301 35,728
Other assets 9,701 9,769
Restricted cash 41,844 39,744
--------------------------------------
Total assets $ 889,755 $ 569,090
================== ==================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 26,449 $ 10,551
Line of credit -- 5,094
Accrued liabilities 28,280 22,287
Accrued compensation 20,871 17,910
Income taxes payable 13,234 9,581
Deferred revenue 55,712 49,401
------------------ ------------------
Total current liabilities 144,546 114,824
Deferred taxes payable 20,617 11,574
Long-term debt 140,515 140,598
------------------ ------------------
Total liabilities 305,678 266,996
------------------ ------------------
Minority interest in consolidated subsidiary 712 878
------------------ ------------------
Stockholders' equity:
Common stock, par value $.001; 125,000 shares authorized;
72,167 and 66,230 shares issued; 70,890 and 64,953
shares outstanding 72 66
Additional paid in capital 552,031 216,149
Loan to stockholders (3,081) (1,900)
Treasury stock, 1,277 shares, at cost (29,488) (29,488)
Accumulated other comprehensive income (loss) (3,626) 16,499
Retained earnings 67,457 99,890
------------------ ------------------
Total stockholders' equity 583,365 301,216
------------------ ------------------
Total liabilities and stockholders' equity $ 889,755 $ 569,090
================== ==================
The accompanying notes are an integral part of these
condensed consolidated financial statements.
4
WIND RIVER SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
Three months ended
April 30,
2000 1999
---------------- ----------------
Cash flows from operating activities:
Net income (loss) $ (32,433) $ 6,381
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 13,561 3,695
Deferred income taxes (432) (366)
Minority interest in consolidated subsidiary (166) 149
Write-off of investment -- 500
Acquired in-process research and development 3,700 --
Change in assets and liabilities:
Accounts receivable, net 4,296 15,221
Prepaid and other assets (450) (3,517)
Accounts payable 12,751 885
Accrued liabilities 2,356 (7,201)
Accrued compensation 1,235 520
Income taxes payable 3,653 531
Deferred revenue 4,866 (1,674)
Other assets and liabilities 1,417 (655)
---------------- ----------------
Net cash provided by operating activities 14,354 14,469
---------------- ----------------
Cash flows from investing activities:
Acquisition of equipment (3,850) (3,877)
Capitalized software development costs -- (267)
Purchases of investments (21,553) (55,772)
Sales and maturities of investments 28,466 73,078
Acquisitions, net of cash acquired (5,474) --
Restricted cash (2,100) (1,887)
---------------- ----------------
Net cash provided by (used in) investing activities (4,511) 11,275
---------------- ----------------
Cash flows from financing activities:
Proceeds from issuance of Common Stock, net 6,672 1,338
Repayment of bank borrowings (2,584) --
Repayment of line of credit (5,094) --
Purchase of treasury stock -- (4,781)
Repayment of loan by stockholder 550 --
---------------- ----------------
Net cash used in financing activities (456) (3,443)
---------------- ----------------
Effect of exchange rate changes on cash and cash equivalents (89) (520)
---------------- ----------------
Effect of changing fiscal year of acquired subsidiary -- (4,816)
---------------- ----------------
Net increase in cash and cash equivalents 9,298 16,965
Cash and cash equivalents at beginning of period 77,929 61,916
---------------- ----------------
Cash and cash equivalents at end of period $ 87,227 $ 78,881
================ ================
The accompanying notes are an integral part of these
condensed consolidated financial statements.
5
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
months ended April 30, 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.
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.
On March 31, 2000, Wind River completed its acquisition of Embedded Support
Tools Corporation in a stock-for-stock merger transaction. 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 acquisition
has been accounted for as a purchase.
Wind River's fiscal year ends on January 31. Prior to its acquisition by Wind
River, Integrated Systems' fiscal year ended on the last day of February.
Integrated Systems changed its fiscal year-end to January 31 to conform to Wind
River's fiscal year-end. Prior to its acquisition by Wind River, Embedded
Support Tools' fiscal year ended on the last day of December. The condensed
consolidated statement of operations for the quarters ended April 30, 2000 and
1999 reflect the combined results of operations of Wind River and Integrated
Systems for the quarters ended April 30, 2000 and 1999, respectively, which
include the results of operations for the quarters ended March 31, 2000 and
1999, respectively, of Wind River's and Integrated Systems' international
subsidiaries. The condensed consolidated statement of operations for the quarter
ended April 30, 2000 also includes the results subsequent to the acquisition
date of Embedded Support Tools, which incorporates the results of domestic
operations for the month ended April 30, 2000.
The condensed consolidated balance sheets as of January 31, 2000, combine the
assets, liabilities and stockholders' equity of Wind River at January 31, 2000
with the assets, liabilities and stockholders' equity of Integrated Systems as
of January 31, 2000. The condensed consolidated balance sheets as of April 30,
2000, combine the assets, liabilities and stockholders' equity of Wind River,
Integrated Systems, and Embedded Support Tools as of April 30, 2000.
6
The condensed consolidated financial statements include the accounts of Wind
River and its wholly-owned and majority-owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated in consolidation.
The accompanying consolidated financial statements have been presented to
reflect acquisitions accounted for as pooling of interests for all periods
presented.
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
circumstance surrounding these estimates could result in a change to the
estimates and affect future operating results.
Certain amounts in the fiscal 1999 condensed consolidated financial statements
have been reclassified to conform to the fiscal 2000 presentation.
2. Acquisitions
On June 30, 1999, Wind River completed the acquisition of RouterWare, Inc.
RouterWare developed and marketed a suite of software modules used in data
communications products such as bridges, routers, gateways, and remote access
servers. 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.
7
The results of operations for the three months ended April 30, 1999, are
summarized as follows:
Three Months Ended
April 30,
(In thousands) 1999
----------------------------------------------
Revenues Net income
Wind River $ 32,600 $ 4,154
RouterWare 876 114
---------------------- --------------------
Combined 33,476 4,268
Integrated Systems 34,806 2,113
---------------------- --------------------
Combined $ 68,282 $ 6,381
---------------------- --------------------
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.
On March 31, 2000, Wind River completed its acquisition of Embedded Support
Tools Corporation in a stock-for-stock merger transaction. 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. The fair market value of the exchanged options
to purchase 1,122,855xv shares was valued using the Black-Scholes option
pricing model with the following assumptions: (a) expected volatility of 70%;
(b) weighted-average risk-free interest rate of 6.5%; (c) expected option
life of approximately 3 years; (d) no expected dividends. Wind River's
operating results for the three months ended April 30, 2000 include the
results of Embedded Support Tools from the date of acquisition, March 31,
2000. The acquisition was accounted for as a purchase.
Wind River's consolidated balance sheet as of April 30, 2000 reflects a
preliminary allocation of the purchase price of Embedded Support Tools, which
resulted in a change of accounts receivable, prepaid and other current assets,
long term investments, fixed assets, and current and long term liabilities.
Identifiable intangible assets include completed technology, trade name and
workforce. 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.
The amount allocated to the 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 resulting cash flows were then discounted back to their present
value at appropriate discount rates.
The discount rate selected for estimating future cash flows was 20%. 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 has not yet reached
technological feasibility as of the date of the valuation. In utilizing a
discount rate greater than 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.
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.
8
The allocation of the purchase price is summarized below (in thousands):
Completed technology $15,150
In-process research and development 3,700
Trademark 650
Workforce 5,650
Assumed net assets/liabilities 3,206
Deferred tax liability (9,325)
Goodwill 316,368
--------
Total purchase price $335,399
========
The Company is still refining its purchase price allocation and there may be
some resulting adjustments in future periods.
During the three months ended April 30, 2000, Wind River amortized $7.0 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 unaudited pro forma summary presents the consolidated results
of operations as if the acquisition 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.
Three Months Ended
April 30,
-----------------------
2000 1999
-------- --------
(in thousands, except per share data)
Net revenue $107,179 $ 73,678
======== ========
Net income (loss) $(48,503) $(14,798)
======== ========
Earnings (loss) per share - basic & diluted $ (0.72) $ (0.24)
======== ========
9
3. Revenue Recognition
Revenues are derived from software licenses and related services, which
include implementation and integration, technical support, training and
consulting. For contracts with multiple elements, and for which
vendor-specific objective evidence of fair value for the undelivered elements
exists, revenue is recognized for the delivered elements based upon the
residual contract value as prescribed by Statement of Position No. 98-9,
"Modification of SOP No. 97-2 with Respect to Certain Transactions".
Revenue from license fees is recognized when persuasive evidence of an agreement
exists, delivery of the product has occurred, no significant Company obligations
with regard to implementation or integration exist, the fee is fixed or
determinable and collectibility is probable. Provisions for sales returns are
provided at the time of revenue recognition based upon estimated returns.
Services revenue from consulting and training is recognized as the services
are performed. Services revenue primarily comprises revenue from consulting
fees, maintenance contracts and training. A provision for estimated losses on
engagements is made in the period in which the loss becomes probable and can
be reasonably estimated. To date, no provision has been necessary.
Maintenance contracts include the right to unspecified updates, upgrades and
ongoing support. Maintenance revenue is deferred and recognized on a
straight-line basis as services revenue over the life of the related contract,
which is typically one year.
Customer billing occurs in accordance with contract terms. Customer advances and
amounts billed to customers in excess of revenue recognized are recorded as
deferred revenue. Amounts recognized as revenue in advance of billing (typically
under percentage-of-completion accounting) are recorded as unbilled receivables.
4. Cash and Cash Equivalents, Investments and Restricted Cash
Cash equivalents consist of highly liquid investments with a 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.
10
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.
Comprehensive income for the three months ended April 30, 2000 and 1999 is as
follows:
Three Months Ended
April 30,
-----------------------------
(In thousands) 2000 1999
------------- --------------
Net income (loss) $ (32,433) $ 6,381
------------- --------------
Other comprehensive income
Foreign currency translation adjustments 57 ( 671)
Unrealized loss on investments (20,182) ( 540)
------------- --------------
Other comprehensive loss (20,125) (1,211)
------------- --------------
Total comprehensive income (loss) $ (52,558) $ 5,170
============= ==============
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).
The following is a reconciliation of the number of shares used in the basic and
diluted earnings per share computations for the periods presented:
Three Months Ended
April 30,
-----------------------------
(In thousands, except per share information) 2000 1999
------------- --------------
Shares used in basic net income (loss)
per share computation 66,939 62,162
Effect of dilutive potential common shares - 3,395
------------- --------------
Shares used in diluted net income (loss)
per share computation 66,939 65,557
------------- --------------
11
Dilutive potential common shares totaling approximately 6.1 million were
excluded from the computation of the number of shares used in the diluted net
income (loss) per share calculation for the three months ended April 30, 2000 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
51,000 and 4.5 million common shares which were outstanding at April 30, 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 quarter and the effect would be anti-dilutive. The exercise
prices of these options ranged from $42.75 to $60.50 and $19.00 to $31.92 at
April 30, 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
April 30, 2000, the lessor has funded a total of $6 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 April 30, 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 April 30, 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 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 October 31,
1999, the notional amount of the accreting interest rate swap was $28.5
million. The differential to be paid or received under the swap agreement
will be recognized as an adjustment to rent expense related to the operating
lease. The swap agreement matures at the same time as the operating lease
expires. The amounts potentially subject to credit risk (arising from the
possible inability of the counterparties to meet the term of their contracts)
are generally limited to the amounts, if any, by which the counterparties'
obligations exceed the obligations of Wind River.
9. Recent Accounting Pronouncements
In June 1998, the 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
12
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 quarter beginning after June 15, 2000. Wind River has not yet
determined the impact, if any, of adopting this statement.
In December 1999, the SEC issued Staff Accounting 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.
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. To the extent that this
Interpretation covers events occurring during the period after December 15,
1998, or January 12, 2000, but before the effective date of July 1, 2000, the
effects of applying this Interpretation are recognized on a prospective basis
from July 1, 2000. Wind River has not yet determined the impact, if any, of
adopting this interpretation.
10. Segment and Geographic Information
Wind River operates in one industry segment --technology for embedded operating
systems, and management uses one measurement of profitability for its business.
Wind River markets its products and related services to customers in the United
States, Canada, Europe and the Asia Pacific region. Internationally, Wind River
markets its products and services primarily through its subsidiaries and various
distributors. Revenues are attributed to geographic areas based on the country
in which the customer is domiciled. The distribution of revenues and assets by
geographic location is as follows:
Revenues Assets
------------------------ ---------------------------------
Three months ended
(In thousands) April 30, April 30, January 31,
------------------------ ---------------------------------
2000 1999 2000 2000
------------ ----------- ----------------- ---------------
United States $ 59,000 $ 40,980 $ 817,625 $ 471,199
Japan 9,267 10,320 31,603 31,717
Other International 23,371 16,982 40,527 66,174
------------ ----------- ----------------- ---------------
Consolidated $ 91,638 $ 68,282 $ 889,755 $ 569,090
============ =========== ================= ===============
Other International consists of the revenues and assets of operations in
Europe and Asia Pacific excluding Japan.
13
11. Special Charges
During the three months ended April 30, 1999, Wind River recognized a charge
totaling $500,000 for the difference between the carrying amount of its
investment in XACT, Inc. and its net realizable value. This charge is
included in interest expense and other for the three months ended April 30,
1999. In addition, the Company expensed $302,000 in connection with the costs
associated with hiring the XACT employees, acquiring equipment and other
assets of XACT and revising a second distribution agreement for a certain
product with XACT. This charge is included in general and administrative
expenses for the three months ended April 30, 1999.
12. Secured Promissory Notes with Stockholders
On September 7, 1999, the Company's Chief Executive Officer signed a secured
promissory note to borrow up to $2.4 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. As of April 30, 2000, Mr. St.
Dennis had borrowed $1.9 million against the note. This loan is full recourse
and is secured by a pledge of personal property. The loan amount outstanding
as of April 30, 2000 is reflected as a reduction of equity in the
accompanying consolidated balance sheet.
On December 15, 1999 and March 31, 2000 Embedded Support Tools issued promissory
notes to seven stockholders totaling approximately $1.2 million, collateralized
by common stock. The notes are due no later than April 1, 2005 and bear interest
at the rate of 6.5% per year. Following the acquisition of Embedded Support
Tools, the notes are secured by Wind River common stock and are reflected as a
reduction of equity in the accompanying balance sheet.
13. Subsequent Events
On May 1, 2000, Wind River acquired AudeSi Technologies, which is a supplier
of embedded 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 a
share of Wind River common stock resulting in the 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 acquisition was accounted for as a purchase. AudeSi's staff
members of approximately 50, including its senior management team, will
become part of Wind River's Consumer business unit and remain located in
Calgary, Alberta, Canada.
14
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 disclaims any obligation to update any
of the forward-looking statements contained in this report to reflect any future
events or developments. The following discussions should be read in conjunction
with the unaudited condensed consolidated financial statements and notes
included elsewhere herein.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
Wind River develops, markets, supports and provides consulting services for
advanced software operating systems and development tools that allow customers
to create complex, robust, real-time software applications for embedded
computers. An embedded computer is a microprocessor that is incorporated into a
larger device and is dedicated to responding to external events by performing
specific tasks quickly, predictably and reliably. 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.
On June 30, 1999, Wind River completed the acquisition of RouterWare, Inc.
RouterWare developed and marketed a suite of software modules used in data
communications products such as bridges, routers, gateways, and remote access
servers. 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
15
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.
On March 15, 2000, Wind River announced its strategic investment in Highlander
Engineering, Inc., a privately held company. A member of Wind River management
will join the Highlander board of directors.
On March 31, 2000, Wind River completed its acquisition of Embedded Support
Tools Corporation in a stock-for-stock merger transaction. 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 acquisition
has been accounted for as a purchase. Wind River's operating results for the
three months ended April 30, 2000 include the results of Embedded Support Tools
from the date of acquisition. Wind River's consolidated balance sheet, as of
April 30, 2000, reflects a preliminary allocation of the purchase price of
Embedded Support Tools, of $335.4 million. Identifiable intangible assets
include completed technology, trade name and workforce. Wind River recorded an
expense for the in-process research and development of $3.7 million, which was
charged against earnings in the first quarter of fiscal year 2001.
On May 1, 2000, Wind River acquired AudeSi Technologies, which is a supplier
of embedded 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 a
share of Wind River common stock resulting in the 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 acquisition was accounted for as a purchase.
16
Results of Operations
Operating results as a percentage of revenue for the three month periods ended
April 30, 2000 and 1999 are summarized in the following table:
Three months ended
April 30,
2000 1999
-------------- --------------
Revenues:
Products 69% 63%
Services 31 37
-------------- --------------
Total revenues 100 100
-------------- --------------
Cost of revenues:
Products 10 8
Services 14 15
-------------- --------------
Total cost of revenues 24 23
-------------- --------------
Gross margin 76 77
-------------- --------------
Operating expenses:
Selling and marketing 42 39
Product development and engineering 20 17
General and administrative 10 9
Amortization of intangibles 10 --
Acquisition-related and other 34 --
-------------- --------------
Total operating expenses 116 65
-------------- --------------
Operating income (loss) (40) 12
-------------- --------------
Other income (expense):
Interest income 6 7
Realized gain (loss) on investments 7 (1)
Interest expense and other, net (3) (3)
-------------- --------------
Total other income 10 3
-------------- --------------
Income (loss) before provision for income taxes (30) 15
Provision for income taxes 5 5
-------------- --------------
Net income (loss) (35)%(1) 10%(2)
============== ==============
(1) The Condensed Consolidated Statements of Income for the first quarter of
fiscal 2001 includes charges of 34% ($30.7 million) in acquisition-related
and other charges associated with the acquisition and integration of
Integrated Systems and Embedded Support Tools and 10% ($9.6 million) of
amortization of goodwill, purchased technology and other intangibles.
(2) The first quarter of fiscal 2000 includes $283,000 of amortization of
goodwill, purchased technology and other intangibles, $302,000 of
acquisition-related and other charges and $500,000 related to the write-off
of an investment in XACT.
17
REVENUES
Total revenues for the three month period ended April 30, 2000 were $91.6
million, compared to $68.3 million for the same period in fiscal 2000. 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 software development and porting contracts,
software maintenance and support contracts, and customer training and
consulting. Software maintenance and support contracts are generally sold
separately from the software licenses and tools. The increase in total revenues
of 34% for the three month period ended April 30, 2000 is due to increases in
the volume of revenues from both products and services.
Revenues from the sale of products increased 47% to $63.3 million for the three
month period ended April 30, 2000, compared to $42.9 million for the same period
in fiscal 2000. Product revenues primarily consist of development, OEM and
run-time license fees. 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. The increase in product revenues was
due primarily to increases in development, OEM and run-time license revenues, as
Wind River's products continue to be purchased by customers for their product
development projects, customer developed products continuing to be accepted by
end-users, and from the expansion of our product lines resulting from research
and development and the integration of products from acquired companies,
including Embedded Support Tools, which was acquired on March 31, 2000. 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 12% to $28.4 million for the three month period ended
April 30, 2000, compared to $25.4 million for the same period in the prior
fiscal year. The increase was primarily due to increases in revenue from
maintenance support agreements, both new and recurring, professional services
related to long-term application development, as well as shorter field
consulting assignments, and training resulting from the increase in Wind River's
installed base of Tornado-TM- software development environment and 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 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 month period ended
April 30, 2000 were $32.6 million, compared to $27.3 million for the same
period in the prior fiscal year. The increase of 20% for the three months
ended April 30, 2000 was due to increased demand for our products and
services in Europe and the Asia Pacific region. International revenues
accounted for 36% of total revenues for the three month period ended April
30, 2000, compared to 40% for the same period in the prior fiscal year. The
decrease is due to domestic sales increasing at a faster rate than
international sales. 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. We expect
international sales to continue to represent a significant
18
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, which could have a material adverse effect on
our business, results of operations and financial condition. 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 month period ended April 30, 2000, compared to 23% for the
same period of fiscal 2000.
Product-related cost of sales as a percentage of product revenues was 14% for
the three month period ended April 30, 2000, compared to 13% for the
corresponding period of the prior fiscal year. Product-related costs consist
primarily of salaries and benefits for production employees, product media,
royalty payments to third parties for the use of their software and
documentation and packaging and the cost of material and labor for hardware
shipped. The increase in this percentage is primarily due to a reduction in the
net realizable value of prepaid royalties to Liberate Technologies, Inc. of
approximately $1.0 million, as Wind River moved to a different technology to
support its Java applications. Wind River's cost of revenue as a percentage of
product revenues may be affected in the future by the amortization of purchased
technology and distribution rights related to the introduction of new products,
including Tornado II, as well as future versions and configurations, Tornado for
Embedded Internet products and Tornado for Managed Switches 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 46%
for the three month period ended April 30, 2000, compared to 39% for the same
period 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 investment in developing new services offerings and the addition of new
personnel and certified third party contractors to our professional services
organization. We expect that cost of service revenues will increase in
absolute dollars as we continue to increase our customer support staff,
customer support capabilities and professional services organization.
OPERATING EXPENSES
Selling and marketing expenses were $38.2 million for the three month period
ended April 30, 2000, compared to $26.2 million for the same period in the
prior fiscal year. As a percentage of total revenue, selling and marketing
expenses were 42% for the three month period ended April 30, 2000, compared
to 39% for the corresponding period in the prior fiscal year. The increase
resulted primarily from the growth in the number of sales and marketing
personnel and related costs, including the costs associated with a new sales
commission plan, increases in expenses related to marketing and advertising
programs including costs for new product introductions, promotions and trade
shows, and the costs associated with integrating Integrated Systems with Wind
River. The integration costs include reprinting marketing collateral, sales
meetings,
19
trade show promotions, advertisements and web-site development. The increase
is also attributable to the inclusion of sales and marketing expenses related
to Embedded Support Tools from the date of its acquisition on March 31, 2000.
We expect that sales and marketing expenses will continue to increase in
absolute dollars as we continue to expand our sales and marketing staff.
Product development and engineering expenses were $18.3 million for the three
month period ended April 30, 2000, compared to $11.6 million for the same period
in the prior fiscal year. As a percentage of total revenue, product development
and engineering expenses were 20% for the three month period ended April 30,
2000, compared to 17% for the corresponding period in the prior fiscal year. The
increase in product development and engineering expenses is primarily due to the
increase in staff and associated support for engineers to expand and enhance
Wind River's product line, including the costs associated with the XACT
engineering team Wind River hired in April 1999 and with the additional
engineering staff as a result of the acquisitions of RouterWare on June 30,
1999, Integrated Systems on February 15, 2000 and Embedded Support Tools on
March 31, 2000. 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 $9.6 million for the three month
period ended April 30, 2000, compared to $6.4 million for the corresponding
period in the prior fiscal year. As a percentage of total revenue, general
and administrative expenses were 10% for the three month period ended April
30, 2000 compared to 9% for the corresponding period in the prior fiscal
year. The increase of $3.2 million was due primarily to the growth in
worldwide staff and infrastructure investments in the areas of information
systems, finance and administration to support the growth of Wind River and
to integrate the companies we acquire. During the remainder of fiscal year
2001, we expect to incur expenses related to our enterprise resource planning
system as we integrate data from the Integrated Systems and the Embedded
Support Tools acquisitions. 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 $9.6 million for the three month period
ended April 30, 2000 compared to $0.3 million for the same period ended April
30, 1999. The increase in amortization of intangibles is due to the amortization
of identifiable intangibles and goodwill related to the Embedded Support Tools
acquisition on March 31, 2000. During the three month period ended April 30,
2000, Wind River amortized $6.6 million of goodwill and $421,000 of identifiable
intangible assets. As a result of the Embedded Support Tools acquisition, Wind
River expects to amortize $330.8 million of goodwill and identifiable
intangibles over approximately 4 years or approximately $21.0 million per
quarter.
Acquisition-related and other expenses were $30.7 million for the three month
period ended April 30, 2000 compared to $0.3 million for the same period in
the prior fiscal year. For the three month period ended April 30, 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-process research and development costs of
Embedded Support Tools, as discussed below. 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. 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, (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 professional costs associated with the acquisition process for
Integrated Systems and professional fees associated with eliminating surplus
legal entities existing in the USA, Europe and Japan as a result of the
acquisition, and, (e) $0.6 million for general integration costs. The
majority of the investment banking fees and legal, accounting and other
professional fees are expected to be paid in the second quarter of fiscal
2001. Severance costs of $1.4 million were paid during the first quarter of
fiscal 2001. The remaining severance costs are expected to be paid during the
second and third quarters of fiscal 2001. The office closure costs relate to
remaining lease payments on vacant offices extending to October 31, 2004.
Wind River recognized an in-process research and development charge of $3.7
million relating to the Embedded Support Tools acquisition during the first
quarter of fiscal 2001. The amount related to in-
20
process technology represents purchased in-process technology for a project
that has not yet reached technological feasibility and has no alternative
future use. The value of the in-process project research and development was
determined by estimating the net cash flows resulting from the completion of
the project reduced to the percentage of completion of the project. Net cash
flows were tax effected using estimated income taxes consistent with Wind
River's anticipated tax rate for 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 developments combined with projections of future revenue and
cost patterns, including projections used when initially evaluating the
acquisition of Embedded Support Tools. Wind River cannot guarantee that it
will realize revenue from this in-process project in the amounts estimated or
that the costs incurred will be materially consistent with 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 project is in-process, there is uncertainty whether it
can be successfully finished and result in the net cash flows that were
originally estimated at the time of acquisition. It is reasonably possible that
the development of this 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
Interest income was $5.1 million for the three month period ended April 30,
2000, compared to $4.7 million for the same period in the prior fiscal year. The
increase in interest income was primarily due higher interest rates on invested
balances. Total cash and cash equivalents, investments and restricted cash at
April 30, 2000 and 1999 was approximately $337.0 million and $352.3 million,
respectively.
Realised gain (loss) on investments was a gain of $6.4 million for the three
month period ended April 30, 2000 compared to a loss of $639,000 for the same
period in the prior fiscal year. The increase of $7.0 million is due
primarily to a gain of $6.4 million related to the disposition of shares of
Liberate Technologies, Inc. and e-Sim, Inc. Wind River 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 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 $2.3 million for the three month period
ended April 30, 2000, compared to $2.2 million for the same period 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
21
The effective tax rate for the three month period ended April 30, 2000 was
(17.0%) compared to 35.3% for the same period in the prior fiscal year. The
overall changes in the effective tax rate results primarily from certain
non-deductible acquisition costs related to the acquisition of Embedded
Support Tools. The effective tax rate for the three months ended April 30,
2000 excluding amortization of goodwill and intangibles and acquisition
charges was 37.5% compared to 35.6% for the same period 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 April 30, 2000, Wind River had working capital of approximately $103.8
million and cash and investments, excluding restricted cash of $41.8 million, of
approximately $295.2 million, which include investments with maturities greater
than one year of $168.3 million. Wind River invests primarily in instruments
that are highly liquid and of investment grade. Cash flows for the three
month period ended April 30, 2000 include cash flows for Embedded Support
Tools from the date of its acquisition on March 31, 2000.
During the first three months of fiscal 2001, Wind River's operating
activities provided net cash of $14.4 million due primarily to net loss
adjusted for depreciation and amortization and the write off of in-process
research and development arising from the acquisition of Embedded Support
Tools. Changes in assets and liabilities including changes in accounts
receivable, accounts payable, accrued liabilities, income taxes payable and
deferred revenue also contributed significantly to the net cash provided by
operating activities. The change in accounts payable relates primarily to
investment banking fees of approximately $9.3 million associated with the
acquisition of Integrated Systems.
During the first three months of fiscal 2001, investing activities used net
cash of $4.5 million due primarily to 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 three months of fiscal 2001, financing activities used net
cash of $456,000 primarily 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 their acquisition. These uses of cash were
substantially offset by cash provided by the issuance of common stock from
employee stock option exercises. During the three months ended April 30,
1999, Wind River repurchased as part of its systematic stock repurchase
program, 165,000 shares of its common stock at a cost of approximately $4.0
million. Integrated Systems also repurchased 65,500 shares of its common
stock at a cost of approximately $700,000 during the same period. 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 April 30, 2000, the lessor has funded a total of $6 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.
22
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 April 30, 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 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 primarily in high-grade securities.
Management believes Wind River's working capital and the cash flow from
operations will be sufficient to meet its working capital requirements for
planned expansion, product development and capital expenditures for at least
the next twelve months.
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 quarter beginning after June 15, 2000. Wind River has not yet
determined the impact, if any, of adopting this statement.
In December 1999, the SEC issued Staff Accounting 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.
23
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. To the extent that this
Interpretation covers events occurring during the period after December 15,
1998, or January 12, 2000, but before the effective date of July 1, 2000, the
effects of applying this Interpretation are recognized on a prospective basis
from July 1, 2000. Wind River has not yet determined the impact, if any, of
adopting this interpretation.
ADDITIONAL RISK FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
WIND RIVER'S BUSINESS FACES SIGNIFICANT RISKS. IF ANY OF THE EVENTS OR
CIRCUMSTANCES DESCRIBED IN THE FOLLOWING RISKS ACTUALLY OCCURS, WIND RIVER'S
BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS COULD BE MATERIALLY AND
ADVERSELY AFFECTED. THESE RISKS SHOULD BE READ IN CONJUNCTION WITH THE OTHER
INFORMATION SET FORTH IN THIS REPORT.
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
- - 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
24
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' 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' and Embedded Support Tools'
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' and Embedded
Support Tools' 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' and
Embedded Support Tools' operations, products and personnel. These costs may
be substantial and may include costs for:
- - employee redeployment, relocation or severance;
- - 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 and Embedded
Support Tools depends in part on the retention of key personnel. There can be
no assurance that Wind River will be able to
25
retain Integrated Systems' and Embedded Support Tools' 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' 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' and Embedded Support Tools' 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' and Embedded Support Tools' 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 or Embedded Support Tools 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.
- - Mentor Graphics, Inc.
- - Microsoft Corporation
- - 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
26
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, 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 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.
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 I2o, 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 I2o specification. The success of the I2o
specification and the IxWorks product line depends heavily on its adoption by
a broad segment of the industry. 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. 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 THIRD PARTIES 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.
27
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 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 three months ended April 30, 2000 and fiscal years ended January
31, 2000 and 1999, we derived approximately 36%, 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
28
our customers. During this transition period, we expect to see a decline in
revenues in Japan. Risks inherent in international operations include:
- - 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 SIGNIFICANT 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.
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
29
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. 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.
30
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;
- - 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.
31
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 April
30, 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 April 30, 2000, Wind
River had outstanding forward contracts with notional amounts totaling
approximately $1.7 million.
The unrealized gains and losses on the outstanding forward contracts at April
30, 2000 were immaterial to Wind River's Consolidated Financial Statements. Due
to the short-term nature of the forward contracts, the fair value at April 30,
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 April 30, 2000, the notional amount
of the accreting interest rate swap was $28.5 million. The estimated fair value
at April 30, 2000 was negligible.
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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 April 30,
2000, the closing price of e-Sim's stock was $17.13 per share. In addition, Wind
River owns 371,744 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 April
30, 2000, the closing price of Liberate's stock was $39.13 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 April 30, 2000 at their market value of approximately $20.3 million in
aggregate, with the unrealized gains and losses excluded from earnings and
reported in accumulated other comprehensive income component of stockholders'
equity. At May 31, 2000, the closing prices of e-Sim's and Liberate's stock were
$6.44 and $23.31, respectively.
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PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On March 31, 2000, in connection with its acquisition of Embedded Support Tools
Corporation, a privately-held company, Wind River issued an aggregate of
5,474,788 unregistered shares of its common stock to the stockholders of
Embedded Support Tools. The transaction was exempt from registration under the
Securities Act of 1933, as amended, under Section 4(2) and Rule 506 thereof, as
a transaction not involving a public offering.
On May 1, 2000, in connection with its acquisition of AudeSi Technologies, a
privately-held Canadian company, Wind River issued an aggregate of 957,169
unregistered shares of its common stock for the benefit of the stockholders
of AudeSi. The transaction was exempt from registration under the Securities
Act of 1933, as amended, under Section 4(2) thereof, as a transaction not
involving a public offering.
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, dated February 15, 2000,
reporting the acquisition of Integrated Systems, Inc.
The Company filed a report on Form 8-K, dated February 28, 2000,
reporting the definitive merger agreement with Embedded Support Tools
Corporation.
The Company filed a report on Form 8-K/A, dated February 15, 2000,
filing certain financial information in connection with its acquisition
of Integrated Systems, Inc.
The Company filed a report on Form 8-K, dated March 31, 2000, reporting
the 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: June 14, 2000 /s/ RICHARD W. KRABER
----------------------------
Richard W. Kraber
Vice President and Chief Financial Officer
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