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 October 31, 2000.
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the transition period from ____to ____.
Commission file number 0-21342
WIND RIVER SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 94-2873391
(State of incorporation) (I.R.S. Employer Identification No.)
500 WIND RIVER WAY, ALAMEDA, CALIFORNIA 94501
(Address of principal executive office)
(510) 748-4100
(Telephone number)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
---- ----
Indicate the number of shares outstanding of each of the issuer's classes of
Common Stock, as of the latest practicable date.
74,304,438 shares of Common Stock, $.001 par value, as of December 7, 2000
WIND RIVER SYSTEMS, INC.
FORM 10-Q
QUARTER ENDED OCTOBER 31, 2000
INDEX
Part I: FINANCIAL INFORMATION
Item 1. Financial Statements ............................................. 3
Condensed Consolidated Statements of Operations for the
three and nine month periods ended October 31, 2000 and 1999 ..... 3
Condensed Consolidated Balance Sheets at October 31, 2000
and January 31, 2000 ............................................. 4
Condensed Consolidated Statements of Cash Flows for the nine
month periods ended October 31, 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 ........................................ 16
Item 3. Quantitative and Qualitative Disclosures about Market Risk ....... 34
Part II: OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds ........................ 36
Item 6. Exhibits and Reports on Form 8-K ................................. 36
Signature ........................................................ 37
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 Nine months ended
October 31, October 31,
2000 1999 2000 1999
-------------- ---------------- -------------- ---------------
Revenues:
Products $ 82,621 $ 56,143 $ 213,685 $ 147,049
Services 32,217 27,698 94,052 77,798
-------------- ---------------- -------------- ---------------
Total revenues 114,838 83,841 307,737 224,847
-------------- ---------------- -------------- ---------------
Cost of revenues:
Products 9,250 6,277 26,374 19,466
Services 16,573 10,853 45,729 30,901
-------------- ---------------- -------------- ---------------
Total cost of revenues 25,823 17,130 72,103 50,367
-------------- ---------------- -------------- ---------------
Gross margin 89,015 66,711 235,634 174,480
-------------- ---------------- -------------- ---------------
Operating expenses:
Selling and marketing 45,246 31,305 125,452 85,676
Product development and engineering 22,357 14,506 59,814 38,747
General and administrative 10,547 8,937 29,587 22,565
Amortization of intangibles 28,449 2,527 64,780 3,573
Acquisition-related and other 100 1,740 31,848 9,296
-------------- ---------------- -------------- ---------------
Total operating expenses 106,699 59,015 311,481 159,857
-------------- ---------------- -------------- ---------------
Operating income (loss) (17,684) 7,696 (75,847) 14,623
-------------- ---------------- -------------- ---------------
Other income (expense):
Interest income 4,965 4,278 15,412 13,658
Realized gain (loss) on investments 1,510 (256) 10,226 (883)
Interest expense and other, net (1,785) (2,024) (6,064) (6,300)
-------------- ---------------- -------------- ---------------
Total other income 4,690 1,998 19,574 6,475
-------------- ---------------- -------------- ---------------
Income (loss) before provision for income taxes (12,994) 9,694 (56,273) 21,098
Provision for income taxes 3,000 3,495 9,500 9,587
-------------- ---------------- -------------- ---------------
Net income (loss) $ (15,994) $ 6,199 $ (65,773) $ 11,511
============== ================ ============== ===============
Net income (loss) per share:
Basic $ (0.22) $ 0.10 $ (0.92) $ 0.18
Diluted $ (0.22) $ 0.09 $ (0.92) $ 0.18
Weighted average shares:
Basic 74,195 63,477 71,230 62,631
Diluted 74,195 65,976 71,230 65,538
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)
October 31, January 31,
2000 2000
------------------- -----------------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 85,621 $ 77,929
Short-term investments 48,036 28,683
Accounts receivable, net 102,992 79,586
Prepaid and other current assets 41,902 35,375
------------------ ------------------
Total current assets 278,551 221,573
Investments 137,479 205,945
Land and equipment, net 63,893 56,331
Intangibles 437,848 35,728
Other assets 18,564 9,769
Restricted cash 56,494 39,744
--------------------------------------
Total assets $ 992,829 $ 569,090
================== ==================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 14,811 $ 10,551
Line of credit 6,504 5,094
Accrued liabilities 30,095 22,287
Accrued compensation 29,068 17,910
Income taxes payable 19,884 9,581
Deferred revenue 54,930 49,401
------------------ ------------------
Total current liabilities 155,292 114,824
Deferred taxes payable 5,869 11,574
Long-term debt 140,047 140,598
------------------ ------------------
Total liabilities 301,208 266,996
------------------ ------------------
Minority interest in consolidated subsidiary 98 878
------------------ ------------------
Stockholders' equity:
Common stock, par value $.001; 125,000 shares authorized;
77,120 and 66,230 shares issued; 75,843 and 64,953
shares outstanding [see note 2] 76 66
Additional paid in capital 693,877 216,149
Loan to stockholder (2,009) (1,900)
Treasury stock, 1,277 shares, at cost (29,488) (29,488)
Accumulated other comprehensive income (loss) (5,050) 16,499
Retained earnings 34,117 99,890
------------------ ------------------
Total stockholders' equity 691,523 301,216
------------------ ------------------
Total liabilities and stockholders' equity $ 992,829 $ 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)
Nine months ended
October 31,
2000 1999
---------------- ----------------
Cash flows from operating activities:
Net income (loss) $ (65,773) $ 11,511
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 76,725 16,312
Deferred income taxes (1,684) (4,394)
Minority interest in consolidated subsidiary (780) 269
Write-off of investment -- 500
Acquired in-process research and development 4,800 6,300
Changes in assets and liabilities:
Accounts receivable, net (16,785) (1,028)
Prepaid and other assets (2,256) (2,340)
Accounts payable 735 1,442
Accrued liabilities 2,441 (6,146)
Accrued compensation 9,432 5,068
Income taxes payable 10,303 8,938
Deferred revenue 3,986 3,359
Other assets and liabilities (7,421) (2,035)
---------------- ----------------
Net cash provided by operating activities 13,723 37,756
---------------- ----------------
Cash flows from investing activities:
Acquisition of equipment (16,228) (14,815)
Capitalized software development costs -- (1,383)
Purchases of investments (86,983) (116,519)
Sales and maturities of investments 104,564 131,598
Acquisitions, net of cash acquired (28,670) (24,872)
Restricted cash (16,353) (1,387)
---------------- ----------------
Net cash used in investing activities (43,670) (27,378)
---------------- ----------------
Cash flows from financing activities:
Proceeds from issuance of Common Stock, net 40,429 9,127
Repayment of bank borrowings (3,553) --
Borrowings against line of credit 1,410 --
Purchase of treasury stock -- (10,362)
(Loan to) repayment of loan by stockholder 1,622 (1,000)
---------------- ----------------
Net cash provided by (used in) financing activities 39,908 (2,235)
---------------- ----------------
Effect of exchange rate changes on cash and cash equivalents (2,269) (539)
---------------- ----------------
Effect of changing fiscal year of acquired subsidiary -- (4,816)
---------------- ----------------
Net increase in cash and cash equivalents 7,692 2,788
Cash and cash equivalents at beginning of period 77,929 61,916
---------------- ----------------
Cash and cash equivalents at end of period $ 85,621 $ 64,704
================ ================
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/A. The results of operations for the three
and nine months ended October 31, 2000 are not necessarily indicative of results
to be expected for the entire fiscal year, which ends on January 31, 2001, or
for any future period.
In accordance with the rules and regulations of the Securities and Exchange
Commission, unaudited condensed consolidated financial statements may omit or
condense certain information and disclosures normally required for a complete
set of financial statements prepared in accordance with generally accepted
accounting principles. However, Wind River believes that the notes to the
condensed consolidated financial statements contain disclosures adequate to make
the information presented not misleading.
All historical financial information has been restated to reflect the
acquisition of Integrated Systems, Inc. ("Integrated Systems") in the first
quarter of fiscal 2001, and Routerware, Inc. ("Routerware") in the second
quarter of fiscal 2000, each of which was accounted for as a pooling of
interests.
The condensed consolidated financial statements include the accounts of Wind
River and its wholly owned subsidiaries. All significant intercompany accounts
and transactions have been eliminated. Wind River has a fiscal year end of
January 31. Its international subsidiaries have fiscal year ends of December 31.
The condensed consolidated financial statements for the three and nine months
ended October 31, 2000 and 1999 include the international subsidiaries'
financial information for the three and nine months ended September 30, 2000 and
1999, respectively. Acquisitions that have been accounted for as purchase
transactions, which include Embedded Support Tools Corporation ("Embedded
Support Tools") in the first quarter of fiscal 2001, AudeSi Technologies
("AudeSi") in the second quarter of fiscal 2001, ICESoft AS ("ICESoft") and
Rapid Logic, Inc. ("Rapid Logic") in the third quarter of fiscal 2001 and
Software Development Systems, Inc. ("Software Development Systems") in the
second quarter of fiscal 2000, have been included in the condensed consolidated
results from the date of their acquisition.
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the recorded amounts reported in the unaudited
condensed consolidated financial statements and accompanying notes. A change in
the facts and circumstances surrounding these estimates could result in a change
to the estimates and affect future operating results.
Certain amounts in the fiscal 2000 condensed consolidated financial statements
have been reclassified to conform to the fiscal 2001 presentation.
6
2. ACQUISITIONS
POOLING OF INTERESTS COMBINATIONS
On June 30, 1999, Wind River completed the acquisition of RouterWare, Inc.. In
connection with the merger: (a) each outstanding share of RouterWare common
stock was exchanged for 1.82731 shares of Wind River common stock, resulting in
the issuance of an aggregate of 730,923 shares of Wind River common stock for
all outstanding shares of RouterWare common stock, and (b) all options to
purchase shares of RouterWare common stock outstanding immediately prior to the
consummation of the merger were converted into options to purchase 634,065
shares of Wind River common stock. The merger has been accounted for as a
pooling of interests, and all financial data of Wind River has been restated to
include the historical financial information of RouterWare. In connection with
the acquisition of RouterWare, Wind River incurred approximately $930,000 in
merger related expenses consisting primarily of transaction fees.
On February 15, 2000, Wind River completed its acquisition of Integrated
Systems, Inc. in a stock-for-stock merger transaction. In connection with the
merger: (a) each outstanding share of Integrated Systems common stock was
exchanged for .92 of a share of Wind River common stock, resulting in the
issuance of an aggregate of 22,499,895 shares of Wind River common stock for all
outstanding shares of Integrated Systems common stock, and (b) all options to
purchase shares of Integrated Systems common stock outstanding immediately prior
to the consummation of the merger were converted into options to purchase
4,133,128 shares of Wind River common stock. The merger has been accounted for
as a pooling of interests, and all financial data of Wind River has been
restated to include the historical financial information of Integrated Systems.
Wind River and Integrated Systems incurred approximately $27.0 million of costs
associated with the merger, including $11.1 million for investment banking fees,
$7.2 million in severance payments, $4.5 million for office closure and other
costs, $3.6 million for legal, accounting and other professional fees, and $0.6
million for general integration costs.
The results of operations for the three and nine months ended October 31, 1999,
incorporating businesses acquired as poolings of interests are summarized as
follows:
Three months ended Nine months ended
October 31, 1999 October 31, 1999
(In thousands) Revenues Net Income Revenues Net Income/(Loss)
-------------- -------------------- --------------- --------------------
Wind River 44,601 5,894 116,379 15,291
Routerware - - 1,302 (887)
-------------- -------------------- --------------- --------------------
Combined 44,601 5,894 117,681 14,404
Integrated Systems 39,240 305 107,166 (2,893)
-------------- -------------------- --------------- --------------------
Combined $ 83,841 $ 6,199 $ 224,847 $ 11,511
-------------- -------------------- --------------- --------------------
The RouterWare acquisition completed on June 30, 1999 and all results subsequent
to the second quarter of fiscal year 2000 are included within the original
reported results of operations.
PURCHASE COMBINATIONS
Wind River has made a number of acquisitions accounted for as purchase
transactions. The condensed consolidated financial statements include the
operating results of each business from the date of acquisition. The purchase
price for each acquisition is allocated to tangible and identifiable
intangible assets acquired and liabilities assumed on the basis of the
estimated fair values on the effective date of their acquisition. For
acquisitions that occurred during fiscal 2001, Wind River is still refining
its purchase price allocation and there may be some resulting adjustments in
future periods.
In connection with its purchase acquisitions, Wind River has expensed various
amounts related to in-process research and development. The amount allocated to
in-process research and development represents the purchased in-process
technology for projects that, as of the date of the acquisition, had not yet
reached technological feasibility and had no alternative future use. Based on
preliminary assessments from an analysis performed by an independent appraiser,
the value of these projects was determined by estimating the resulting net cash
flows from the sale of the products resulting from the completion of the
projects, reduced by the portion of the revenue attributable to core technology
and the percentage completion of the project. The
7
resulting net cash flows were then discounted back to their present value at
appropriate discount rates.
The discount rate selected for estimating future cash flows was 25%. In
selection of the appropriate discount rate, consideration was given to the
Company's estimated weighted-average return on working capital and the Company's
estimated weighted-average return on assets. The discount rate used was
determined to be higher than the Company's estimated weighted-average return on
working capital due to the fact that the technology had not yet reached
technological feasibility as of the date of the valuation. In utilizing a
discount rate greater 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.
Regarding Wind River's purchase acquisitions completed during fiscal 2001 and
2000, actual results to date have been consistent, in all material respects,
with our assumptions at the time of the acquisitions. The assumptions primarily
consist of an expected completion date for the in-process projects, estimated
costs to complete the projects, and revenue and expense projections once the
products have entered the market. Failure to achieve the expected levels of
revenue and net income from these products during their entire life cycle will
negatively impact the return on investment expected at the time that the
acquisitions were completed and potentially result in impairment of any other
assets related to the development activities.
On March 31, 2000, Wind River completed its acquisition of Embedded Support
Tools in a stock-for-stock merger transaction. Embedded Support Tools is a
provider of integrated hardware and software for programming, testing and
debugging embedded systems. In connection with the acquisition: (a) each
outstanding share of Embedded Support Tools common stock was exchanged for
.4246 of a share of Wind River common stock, resulting in the issuance of an
aggregate of 5,474,788 shares of Wind River common stock for all outstanding
shares of Embedded Support Tools common stock, and (b) all options to
purchase shares of Embedded Support Tools common stock outstanding
immediately prior to the consummation of the acquisition were converted into
options to purchase 1,122,855 shares of Wind River common stock. The total
purchase price of $335.3 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 $1.9 million.
Wind River recorded an expense of $3.7 million for the in-process research and
development, which was charged against earnings in the first quarter of fiscal
year 2001. There was one project included in the in-process research and
development for Embedded Support Tools. The applications from this process will
be integrated into Wind River's products. The efforts required to complete the
acquired in-process technology include the completion of all planning, designing
and testing activities that are necessary to establish that the product can be
produced to meet its design requirements.
The allocation of the purchase price is summarized below (in thousands):
Completed technology $15,150
In-process research and development 3,700
Trademark 650
Workforce 5,650
Net tangible assets 3,206
Deferred tax liability (8,043)
8
Goodwill 315,026
-------
Total purchase price $335,339
========
During the three and nine months ended October 31, 2000, Wind River amortized
$20.8 million and $48.9 million of goodwill and other intangible assets acquired
from Embedded Support Tools. The goodwill and other intangible assets are being
amortized over a four year period.
The following pro forma summary presents the consolidated results of
operations as if the acquisition of Embedded Support Tools 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 Nine months ended
October 31, October 31,
(In thousands, except per share data) 2000 1999 2000 1999
--------------------------------------------------------------
Net revenue $ 114,278 $ 91,360 $ 309,724 $ 244,257
Net loss $ (15,540) $ (13,095) $ (80,712) $ (58,101)
Loss per share - basic & diluted $ (0.22) $ (0.19) $ (1.17) $ (0.85)
On May 1, 2000, Wind River acquired AudeSi Technologies in a transaction
involving Canadian exchangeable shares. AudeSi Technologies is a supplier of
Java(TM) based tools and other components, for building flexible,
multi-application consumer devices. In connection with the acquisition: (a) each
outstanding share of AudeSi common stock was exchanged for .0927 of an
exchangeable share in AudeSi and each such exchangeable share is or will be by
its terms, exchangeable on a share-for-share basis for a share of Wind River
common stock (the exchange of all such exchangeable shares requiring the
ultimate issuance of an aggregate of 957,169 shares of Wind River common stock),
and (b) all options to purchase AudeSi common stock immediately prior to the
consummation of the acquisition were converted into options to purchase 119,488
shares of Wind River common stock. The total purchase price of $52.4 million
consisted of common stock with a fair market value of $47.2 million, options
assumed with a fair market value of $4.7 million and merger costs of $500,000.
In connection with the acquisition, Wind River recorded an expense of $1.0
million for in-process research and development, which was charged against
earnings in the second quarter of fiscal year 2001.
The preliminary allocation of the purchase price is summarized below (in
thousands):
Completed technology $1,100
In-process research and development 1,000
Workforce 850
Net tangible assets 871
Long term deferred tax liability (731)
9
Goodwill 49,330
------
Total purchase price $52,420
=======
During the three and nine months ended October 31, 2000, Wind River amortized
$3.2 million and $6.4 million of goodwill and other intangible assets acquired
from AudeSi. The goodwill and other intangible assets are being amortized over a
four year period.
On July 15, 2000, Wind River completed its acquisition of ICESoft in a cash
transaction of $24.6 million. ICESoft is a developer of innovative embedded
internet browsing technologies for intelligent devices. The total purchase price
of $24.6 million consisted of cash consideration of $24.5 million and
acquisition costs of $100,000.
In connection with the acquisition, Wind River recorded an expense of $100,000
for in-process research and development, which was charged against earnings in
the third quarter of fiscal year 2001.
The preliminary allocation of the purchase price is summarized below (in
thousands):
Completed technology $ 750
In-process research and development 100
Workforce 400
Net tangible assets 225
Deferred tax liability (431)
Goodwill 23,561
------
Total purchase price $24,605
======
During the three and nine months ended October 31, 2000, Wind River amortized
$1.8 million of goodwill and other intangible assets acquired from ICESoft.
The goodwill and other intangible assets are being amortized over a four year
period.
On October 24, 2000, Wind River completed its acquisition of Rapid Logic,
Inc. in a stock-for-stock merger transaction. Rapid Logic is the provider of
advanced device management technologies for networking equipment and other
intelligent devices. In connection with the acquisition: (a) each outstanding
share of Rapid Logic common stock was exchanged for .0730 of a share of Wind
River common stock, resulting in the issuance of an aggregate of 1,244,940
shares of Wind River common stock for all outstanding shares of Rapid Logic
common stock, and (b) all options to purchase shares of Rapid Logic common
stock outstanding immediately prior to the consummation of the acquisition
were converted into fully-vested options to purchase 126,298 shares of Wind
River common stock. The total purchase price of approximately $57.5 million
consisted of common stock with a fair market value of $51.8 million, options
assumed with a fair market value of $5.0 million and merger costs of
$700,000. In the condensed consolidated balance sheet as of October 31, 2000,
the purchase price has been allocated entirely to goodwill. The Company is
currently calculating the purchase price allocation. The purchase price will
be allocated to the tangible and identifiable intangible assets acquired and
liabilities assumed on the basis of their estimated fair values as of the
effective date of the acquisition. An independent appraiser will determine
the valuation of the intangible assets acquired. Such valuations and
10
studies are not yet complete.
Pro forma results of operations for AudeSi Technologies, ICESoft, and Rapid
Logic have not been presented because the effects of these acquisitions were not
material on either an individual or an aggregate basis.
3. REVENUE RECOGNITION
Wind River recognizes revenue in accordance with SOP 97-2, "Software Revenue
Recognition," as amended by SOP 98-4, "Deferral of the Effective Date of Certain
Provisions of SOP 97-2", effective February 1, 1998 and by SOP 98-9,
"Modification of SOP 97-2, 'Software Revenue Recognition' with Respect to
Certain Transactions."
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.
Product revenues consist of licensing fees from operating system and software
development tool products and fees from embedded system run-time licenses.
Service revenues are derived from fees from professional services, software
porting and development contracts, software maintenance and support contracts,
and customer training and consulting. Maintenance contracts are generally sold
separately from the products. Wind River's customers consist of end users,
distributors, original equipment manufacturers, system integrators and
value-added resellers.
Product revenues are recognized at the time of shipment or upon the delivery
of a product master in satisfaction of non-cancelable contractual agreements
provided that collection of the resulting receivable is probable, the fee is
fixed or determinable and vendor-specific objective evidence ("VSOE") exists
to allocate the total fee to all delivered and undelivered elements of the
arrangement. Any maintenance included in these arrangements is deferred based
on VSOE and recognized ratably over the term of the arrangement. Service
revenues from engineering services contracts are generally recognized on the
percentage-of-completion basis. Service revenues from software maintenance,
support and update fees (post-contract support) are recognized ratably over
the contract period. Services revenue from training and consulting are
recognized when the services are provided.
4. CASH AND CASH EQUIVALENTS, INVESTMENTS AND RESTRICTED CASH
Cash equivalents consist of highly liquid investments with remaining maturity at
the date of purchase of three months or less. These investments consist of fixed
income securities, which are readily convertible to cash and are stated at cost,
which approximates fair value. Fair value is determined based upon the quoted
market prices of the securities as of the balance sheet date.
11
Investments with maturities greater than three months and less than one year are
classified as short-term investments. Investments with maturities greater than
one year are classified as long-term investments. Wind River accounts for its
investments, including equity securities, money market funds, municipal bonds,
U.S. government and agency obligations, corporate bonds and other debt
securities, in accordance with Statement of Financial Accounting Standards No.
115, "Accounting for Certain Investments in Debt and Equity Securities." Wind
River determines the appropriate classification of its investments at the time
of purchase and re-evaluates such classification as of each balance sheet date.
Wind River has classified all of its investments as available-for-sale and
carries such investments at fair value, with unrealized gains and losses
reported in the accumulated other comprehensive income component of
stockholders' equity until disposition. Fair value is determined based upon the
quoted market prices of the securities as of the balance sheet date. The cost of
securities sold is based on the specific identification method. Realized gains
or losses and declines in value, if any, judged to be other than temporary on
available-for-sale securities are reported in other income or expense.
Restricted cash consists of the investments held as collateral under the
operating lease of Wind River's headquarters and an accreting interest rate swap
agreement.
5. OTHER BORROWINGS
In October 2000, Wind River borrowed approximately $6.5 million from its
$17.3 million credit line through a subsidiary. The amount borrowed bears an
annual interest rate of 0.95%. There is $10.8 million still available through
the line of credit.
6. COMPREHENSIVE INCOME
Comprehensive income is defined as the change in equity of a company during a
period from transactions and other events and circumstances excluding
transactions resulting from investments by owners and distributions to owners.
The difference between net income and comprehensive income for Wind River
results from foreign currency translation adjustments and unrealized gains and
losses on available-for-sale securities, net of taxes.
Comprehensive income for the three and nine months ended October 31, 2000 and
1999 is as follows:
Three months ended Nine months ended
October 31, October 31,
---------------------------- ----------------------------
(In thousands) 2000 1999 2000 1999
------------- ------------- ------------- -------------
Net income (loss): $ (15,994) $ 6,199 $ (65,773) $ 11,511
------------- ------------- ------------- -------------
Other comprehensive income (loss)
Foreign currency translation adjustments (1,218) 262 (2,094) (610)
Unrealized gain (loss) on investments (901) 6,830 (19,455) 10,035
------------- ------------- ------------- -------------
Other comprehensive income (loss) (2,119) 7,092 (21,549) 9,425
------------- ------------- ------------- -------------
Total comprehensive income (loss) $ (18,113) $ 13,291 $ (87,322) $ 20,936
============= ============= ============= =============
7. 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
12
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 Nine Months Ended
October 31, October 31,
--------------------------- -------------------------
(In thousands) 2000 1999 2000 1999
------------- ------------ ----------- ------------
Shares used in basic net income (loss)
per share computation 74,195 63,477 71,230 62,631
Effect of dilutive potential common shares -- 2,499 -- 2,907
----------- --------- --------- ----------
Shares used in diluted net income (loss)
per share computation 74,195 65,976 71,230 65,538
============= ============ =========== ============
Dilutive potential common shares totaling approximately 5.0 million and 5.5
million were excluded from the computation of the number of shares used in the
diluted net loss per share calculation for the three and nine months ended
October 31, 2000, respectively, as their inclusion would be anti-dilutive. The
effect of assumed conversion of the convertible subordinated notes is
anti-dilutive and is therefore excluded from both the above computations. In
addition, options to purchase approximately 624,000, 4.5 million, 441,000, and
4.5 million common shares which were outstanding for the three months ended
October 31, 2000 and 1999, and for the nine months ended October 31, 2000 and
1999, respectively, were not included in the calculation because the exercise
prices were greater than the average market price of common shares in each
respective period and the effect would be anti-dilutive. The exercise prices of
these options ranged from $40.13 to $60.50, $17.44 to $31.92, $40.13 to $60.50,
and $17.94 to $31.92 for the three months ended October 31, 2000 and 1999, and
the nine months ended October 31, 2000 and 1999, respectively.
8. 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
October 31, 2000, the lessor has funded a total of $19 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"). In addition, under the terms of the lease, Wind River must
maintain compliance with certain financial covenants, tangible net worth and
fixed charge ratio.
9. 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 October 31, 2000, Wind River had outstanding forward
contracts to hedge certain foreign currency transaction exposures in Japanese
Yen and certain European currencies. The difference between cost and estimated
fair value at October 31, 2000 was immaterial.
13
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 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, 2000, the notional
amount of the accreting interest rate swap was $28.5 million. The differential
to be paid or received under the swap agreement will be recognized as an
adjustment to rent expense related to the operating lease. The swap agreement
matures at the same time as the operating lease expires. The amounts potentially
subject to credit risk (arising from the possible inability of the
counterparties to meet the term of their contracts) are generally limited to the
amounts, if any, by which the counterparties' obligations exceed the obligations
of Wind River.
10. RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
133, "Accounting for Derivative Instruments and Hedging Activities." SFAS 133
requires companies to record derivatives on the balance sheet as assets or
liabilities, measured at fair value. Gains or losses resulting from changes
in the fair values of those derivatives would be accounted for in current
earnings unless specific hedge criteria are met. The key criterion for hedge
accounting is that the hedging relationship must be highly effective in
achieving offsetting changes in fair value or cash flows. Wind River must
formally document, designate, and assess the effectiveness of transactions
that receive hedge accounting. In July 1999, the FASB issued SFAS 137,
"Accounting for Derivative Instruments and Hedging Activities - Deferral of
the Effective Date of SFAS No. 133." SFAS 137 deferred the effective date of
SFAS 133 until the first fiscal year beginning after June 15, 2000. In June
2000, the FASB issued SFAS 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities - an Amendment of SFAS 133." SFAS
138 amends SFAS 133 to permit limited use of central treasury "netting" of
intercompany derivatives for foreign currency cash flow hedges. SFAS 138 must
be adopted concurrently with SFAS 133. Wind River is in the process of
determining the impact, if any, the adoption of this statement will have on
its financial statements.
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 non-compensatory 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. Wind River has adopted
the provisions of FIN 44, which has not had a material effect on the
financial position or results of operations.
In July 2000, the EITF issued EITF Issue No. 00-15 "Classification in the
Statement of Cash Flows of the Income Tax Benefit Realized by a Company upon
Employee Exercise of a Non-qualified Stock Option." EITF 00-15 addresses the
cash flow statement presentation of the tax benefit associated with
non-qualified stock options. Wind River receives an income tax deduction for
the difference between the exercise price and the market price of a
non-qualified stock option upon exercise by the employee. EITF 00-15
concludes that the income tax benefit realized by us upon employee exercise
should be classified in the operating section of the cash flow statement. The
EITF is effective for all quarters ending after July 31, 2000. Wind River has
adopted EITF 00-15 and such adoption did not have a material impact on its
consolidated financial statements.
14
11. SEGMENT AND GEOGRAPHIC INFORMATION
Wind River operates in one industry segment -- technology for embedded operating
systems, and management uses one measurement of revenue and profitability for
its business.
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 long-lived
assets by geographic location is as follows:
Revenue Long-Lived Assets
--------------------------------------------------- ---------------------------------
(In thousands) Three months ended Nine months ended October 31, January 31,
October 31, October 31,
------------------------ -------------------------- ---------------- ---------------
2000 1999 2000 1999 2000 2000
------------ ----------- ------------ ------------- ---------------- ---------------
North America $ 82,128 $ 50,632 $ 208,664 $ 137,262 $ 501,397 $ 91,823
Japan 11,322 12,704 30,499 32,453 5,736 3,086
Other International 21,388 20,505 68,574 55,132 6,122 5,419
---------- --------- ---------- ----------- ------------ ------------
Consolidated $ 114,838 $ 83,841 $ 307,737 $ 224,847 $ 513,255 $ 100,328
============ =========== ============ ============= ================ ===============
Other International consists of the revenues and long-lived assets of
operations in Europe and Asia Pacific excluding Japan. Long-lived assets
exclude marketable securities and private investments as well as deferred tax
assets.
12. SECURED PROMISSORY NOTE WITH STOCKHOLDER
At October 31, 2000, the Company's Chief Executive Officer had outstanding a
secured promissory note for $2.0 million from the Company to purchase shares of
our common stock. The note accrues interest at the rate of 5.98% per year, and
is due on September 7, 2008. This loan is full recourse and is secured by a
pledge of personal property. The loan amount outstanding as of October 31, 2000
is reflected as a reduction of equity in the accompanying consolidated balance
sheet.
15
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/A for the fiscal
year ended January 31, 2000. Wind River does not intend to update any of the
forward-looking statements contained in this report to reflect any future events
or developments unless required by law. The following discussions should be read
in conjunction with the unaudited condensed consolidated financial statements
and notes included elsewhere herein.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
Wind River develops, markets, supports and provides consulting services for
advanced software operating systems and software and hardware development
tools that allow customers to create complex, robust, real-time software
applications for embedded computers. An embedded computer is a microprocessor
that is incorporated into a larger device and is dedicated to responding to
external events by performing specific tasks quickly, predictably and
reliably. Embedded systems provide an immediate, predictable response to an
unpredictable sequence of external events. Wind River's products enable
customers to enhance product performance, standardize designs across
projects, reduce research and development costs and shorten product
development cycles.
All historical financial information has been restated to reflect the
acquisition of Integrated Systems, Inc. ("Integrated Systems") in the first
quarter of fiscal 2001 and Routerware, Inc. ("Routerware") in the second quarter
of fiscal 2000, each of which was accounted for as a pooling of interests.
Acquisitions that have been accounted for as purchase transactions, which
include Embedded Support Tools Corporation ("Embedded Support Tools") in the
first quarter of fiscal 2001, AudeSi Technologies ("AudeSi") in the second
quarter of fiscal 2001, ICESoft AS ("ICESoft") and Rapid Logic, Inc. ("Rapid
Logic") in the third quarter of fiscal 2001 and Software Development Systems,
Inc. ("Software Development Systems") in the second quarter of fiscal 2000, have
been included in the condensed consolidated financial results from the dates of
their purchase.
16
RESULTS OF OPERATIONS
Operating results as a percentage of revenue for the three and nine month
periods ended October 31, 2000 and 1999 are summarized in the following table:
Three months ended Nine months ended
October 31, October 31,
2000 1999 2000 1999
-------------- -------------- -------------- -------------
Revenues:
Products 72 % 67 % 69 % 65 %
Services 28 33 31 35
-------------- -------------- -------------- -------------
Total revenues 100 100 100 100
-------------- -------------- -------------- -------------
Cost of revenues:
Products 8 8 9 9
Services 14 13 15 14
-------------- -------------- -------------- -------------
Total cost of revenues 22 21 24 23
-------------- -------------- -------------- -------------
Gross margin 78 79 76 77
-------------- -------------- -------------- -------------
Operating expenses:
Selling and marketing 39 37 41 38
Product development and engineering 20 17 19 17
General and administrative 9 11 10 10
Amortization of intangibles 25 3 21 2
Acquisition-related and other - 2 10 4
-------------- -------------- -------------- -------------
Total operating expenses 93 70 101 71
-------------- -------------- -------------- -------------
Operating income (loss) (15) 9 (25) 6
------------ ----------- ------------ ------------
Other income (expense):
Interest income 4 5 5 6
Realized gain (loss) on investments 2 - 4 -
Interest expense and other, net (2) (3) (2) (3)
-------------- -------------- -------------- -------------
Total other income 4 2 7 3
-------------- -------------- -------------- -------------
Income (loss) before provision for income taxes (11) 11 (18) 9
Provision for income taxes (3) (4) (3) (4)
-------------- -------------- -------------- -------------
Net income (loss) (14) % 7 % (21) % 5 %
============== ============== ============== =============
(1) The Condensed Consolidated Statements of Operations for the three and nine
months ended October 31, 2000 includes charges of 0% ($100,000) and 10%
($31.8 million), respectively, in acquisition-related and other charges
associated with the acquisition and integration of ICESoft and of
Integrated Systems, Embedded Support Tools and AudeSi Technologies,
respectively, and 25% ($28.4 million) and 21% ($64.8 million),
respectively, of amortization of goodwill, purchased technology and other
intangibles.
(2) The Condensed Consolidated Statements of Operations for the three and nine
months ended October 31, 1999 includes charges of 2% ($1.7 million) and 4%
($9.3 million), respectively, of acquisition-related and other charges
associated with the acquisition and integration of Software Development
Systems and Routerware, CEO retirement costs, CEO recruitment and hiring
costs and, in the first quarter, $500,000 related to the write-off of an
investment in XACT, as well as 3% ($2.5 million) and 2% ($3.5 million),
respectively, of amortization of goodwill, purchased technology and other
intangibles.
17
REVENUES
Total revenues for the three and nine month periods ended October 31, 2000
were $114.8 million and $307.7 million, respectively, compared to $83.8
million and $224.8 million for the same periods in fiscal 2000. Product
revenues consist of licensing fees from operating system and software
development tool products, fees from embedded system run-time licenses, and
programming, testing, and debugging tools. Service revenues are derived from
software maintenance and support contracts, professional services or
consulting, customer training, and software development and porting
contracts. Software maintenance and support contracts are generally sold
separately from the software licenses and tools. The increase in total
revenues of 37% for each of the three and nine month periods ended October
31, 2000 is due to increases in the volume of revenues from both products and
services.
Product revenue increased 47% and 45% to $82.6 million and $213.7 million,
respectively, for the three and nine month periods ended October 31, 2000,
compared to $56.1 million and $147.0 million for the same periods in fiscal
2000. Product revenues primarily consist of development, OEM and run-time
license fees, and fees from programming, testing, and debugging tools. Wind
River typically charges a one-time fee for development licenses, a separate OEM
license fee for each customer development project and a run-time license fee for
each copy of Wind River's operating system embedded in the customer's product.
The increase in product revenues was due primarily to increases in development,
OEM and run-time license revenues, as well as programming, testing, and
debugging revenue, as Wind River's products continue to be purchased by
customers for their product development projects, customer developed products
continue to be accepted by end-users, and as we expand our product lines through
research and development and integrated products from acquired companies.
Product revenues are generally recognized at the time of shipment or upon the
delivery of a product master in satisfaction of non-cancelable contractual
agreements providing that collection of the resulting receivable is probable,
the fee is fixed or determinable and vendor specific objective evidence exists
to allocate the total fee to all delivered and undelivered elements of the
arrangement.
Services revenue increased 16% and 21% to $32.2 million and $94.1 million,
respectively, for the three and nine month periods ended October 31, 2000,
compared to $27.7 million and $77.8 million for the same periods in fiscal 2000.
The increase was primarily due to increases in revenue from professional
services related to long-term application development, as well as shorter field
consulting assignments, maintenance support agreements, both new and recurring,
and training resulting from the increase in Wind River's installed base software
applications provided to customers.
Deferred revenue results primarily from customer prepayments under software
maintenance contracts, which are recognized ratably over the life of the
contracts, certain run-time agreements, which are recognized as target licenses
are delivered, and professional services and engineering services contracts or
training arrangements, which are recognized as the services are performed.
Total revenues from international sales for the three and nine month periods
ended October 31, 2000 were $32.7 million and $99.1 million, respectively,
compared to $33.2 million and $87.6 million for the same periods in fiscal
2000. Revenues decreased slightly as compared to the same quarter last fiscal
year, due to a decrease in sales in Japan which were offset by an increase in
Other International sales. The increase of 13% for the year was due to
increased demand for our products and services in Europe and the Asia Pacific
region. International revenues accounted for 28% and 32% of total revenues
for the three and nine month periods ended October 31, 2000, compared to 40%
and 39% for the same periods in fiscal 2000. The decrease in international
revenue as a percentage of revenue is due to domestic revenue increasing at a
faster rate than international revenue. The decrease is also related to a
decrease in revenues from Japan as a result of the transition to a new
distribution model in which Wind River will sell directly to its customers in
Japan. Due to this transition, we expect that revenues in Japan will grow at
a lesser rate than the other geographic regions and may even decline. We
18
expect international sales to continue to represent a significant portion of
revenues, although the actual percentage may fluctuate from period to period.
Wind River's international sales are denominated in the local currencies, and an
increase in the relative value of the dollar against such currencies would
reduce our revenues and backlog in dollar terms or make our products more
expensive and, therefore, potentially less competitive in foreign markets. Wind
River actively monitors its foreign currency exchange exposure and to date such
exposures have not had a material impact on our results of operations. We enter
into forward contracts to hedge the short-term impact of foreign currency
fluctuations. In recent years, economic uncertainty and related fluctuations of
certain foreign currencies against the dollar have occurred. These factors could
adversely affect our future sales and operating expenses. See "Additional Risk
Factors That May Affect Future Results of Operations-Our International Business
Activities Subject Us to Risks That Could Adversely Affect Our Business".
COSTS OF REVENUES
The overall cost of products and services as a percentage of total revenues was
22% and 24% for the three and nine month periods ended October 31, 2000,
compared to 21% and 23% for the same periods in fiscal 2000.
Product-related cost of sales as a percentage of product revenues was 11% and
12%, respectively, for the three and nine month periods ended October 31, 2000,
compared to 11% and 13% for the same periods in fiscal 2000. Product-related
costs consist primarily of salaries and benefits for production employees,
product media, royalty payments to third parties for the use of their software
and documentation and packaging and the cost of material and labor for hardware
shipped. The decrease in this percentage is primarily due to an increase in
production efficiencies as more development, OEM and run-time licenses move
through our production cycle, as well as a reduction in our product costs. Wind
River's cost of revenue as a percentage of product revenues may be affected in
the future by the amortization of purchased technology and distribution rights
related to the introduction of new products and by royalty payments to other
third parties for sales related to their products.
Service related cost of revenues as a percentage of service revenues was 51% and
49%, respectively, for the three and nine month periods ended October 31, 2000,
compared to 39% and 40% for the same periods in fiscal year 2000. Service
related cost of revenues consists primarily of personnel related costs
associated with providing services, including consulting services, to customers
and the infrastructure to manage a services organization as well as costs to
recruit, develop, and retain services professionals. The increase in costs of
service revenues is due to our continued investment in developing new
professional services offerings and the addition of new personnel and certified
third party contractors to our professional services organization. We expect
that the cost of service revenues will increase in absolute dollars as we
continue to increase our professional services organization, customer support
staff, and customer support capabilities.
OPERATING EXPENSES
Selling and marketing expenses were $45.2 million and $125.5 million,
respectively, for the three and nine month periods ended October 31, 2000,
compared to $31.3 million and $85.7 million for the same periods in fiscal 2000.
As a percentage of total revenue, selling and marketing expenses were 39% and
41% for the three
19
and nine month periods ended October 31, 2000, compared to 37% and 38% for
the same periods in fiscal 2000. The increase resulted primarily from the
growth in the number of sales and marketing personnel and related costs,
including the costs associated with quarterly commission payments and
increases in expenses related to marketing and advertising programs,
including costs for new product introductions, promotions and trade shows. In
addition, for the nine month period ended October 31, 2000, we incurred costs
associated with integrating Integrated Systems, Embedded Support Tools,
AudeSi and ICESoft into Wind River. The selling and marketing integration
costs include reprinting marketing collateral, sales meetings, trade show
promotions, and advertisements. The increase is also attributable to the
inclusion of sales and marketing expenses related to the Embedded Support
Tools, AudeSi and ICESoft acquisitions accounted for as purchase transactions
during the first, second and third quarters of fiscal 2001. We expect that
sales and marketing expenses will continue to increase in absolute dollars as
we continue to expand our sales and marketing staff and programs.
Product development and engineering expenses were $22.4 million and $59.8
million for the three and nine month periods ended October 31, 2000, compared to
$14.5 million and $38.7 million for the same periods in fiscal 2000. As a
percentage of total revenue, product development and engineering expenses were
20% and 19% for the three and nine month periods ended October 31, 2000,
compared to 17% for the same periods in fiscal 2000. The increase in product
development and engineering expenses is primarily due to the increase in staff
and associated support for engineers to expand and enhance Wind River's product
lines, including acquisition costs, and with the additional engineering staff as
a result of acquisitions. We believe that product development and engineering
expenses will continue to increase in absolute dollars as we continue to invest
in the development of new products, technologies, applications and product
enhancements.
General and administrative expenses were $10.5 million and $29.6 million for
the three and nine month periods ended October 31, 2000, compared to $8.9
million and $22.6 million for the same periods in fiscal 2000. As a
percentage of total revenue, general and administrative expenses were 9% and
10% for the three and nine month periods ended October 31, 2000 compared to
11% and 10% for the same periods in fiscal 2000. The decrease of general and
administrative expenses as a percent of revenue was due to the $1.3 million
in expenses related to the hiring of our new CEO in the third quarter of
fiscal 2000. The increase in absolute dollars was due to the growth in
worldwide staff and infrastructure investments in the areas of information
systems, finance, legal and administration to support the growth of Wind
River and to integrate the companies we have acquired. In addition, the
administrative expenses related to the acquisitions accounted for as purchase
transactions are included, from the date of acquisition, in Wind River's
results for the first, second and third quarters of fiscal 2001. 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 $28.4 million and $64.8 million,
respectively, for the three and nine month periods ended October 31, 2000,
compared to $2.5 million and $3.6 million for the same periods in fiscal
2000. The increase in amortization of intangibles is due to the amortization
of identifiable intangibles and goodwill related to purchase transactions
completed this year, including Embedded Support Tools, AudeSi Technologies,
and ICESoft. During the three and nine month periods ended October 31, 2000,
Wind River amortized $25.2 million and $57.1 million of goodwill and $2.9
million and $7.5 million of identifiable intangible assets, respectively. As
a result of acquisitions accounted for as purchases, Wind River expects to
amortize $385.1 million and $62.5 million, respectively, of goodwill and
identifiable intangibles over approximately 4 years or a total of
approximately $31.9 million per quarter.
Acquisition-related and other expenses were $100,000 and $31.8 million,
respectively, for the three and nine month periods ended October 31, 2000,
compared to $1.7 million and $9.3 million for the same periods in fiscal 2000.
For the three month period ended October 31, 2000, acquisition-related and other
expenses are
20
comprised of $100,000 related to the write-off of in-process research and
development costs of ICESoft. For the nine month period ended October 31,
2000, acquisition-related and other expenses are comprised of $27.0 million
in costs associated with the acquisition of Integrated Systems and $3.7
million relating to the write-off of in-process research and development
costs of Embedded Support Tools, $1.0 million related to the write-off of
in-process research and development costs of AudeSi Technologies and $100,000
related to the write-off of in-process research and development costs of
ICESoft.
The Integrated Systems acquisition costs of $27.0 million include: (a) $11.1
million for investment banking fees, (b) $7.2 million in severance payments,
(c) $4.5 million for office closure and other costs for surplus sales offices
in the USA, Europe and Japan, (d) $3.6 million for legal, accounting and
other professional fees which relate primarily to the acquisition process for
Integrated Systems and with the elimination of acquired legal entities in the
USA, Europe and Japan, and, (e) $0.6 million for general integration costs.
Severance costs of $1.2 million and $4.9 million were paid during the three
and nine month periods ended October 31, 2000, respectively. The remaining
severance costs are expected to be paid during the fourth quarter of fiscal
2001. In total, 87 employees have been terminated, including 40 general and
administrative employees, 33 sales and marketing employees and 14 employees
from other areas. Employees have been terminated if their roles or functions
were duplicated following the acquisition of Integrated Systems. The office
closure costs relate to remaining lease payments on vacant offices extending
to October 31, 2004.
Wind River recognized in-process research and development charges of $100,000
relating to ICESoft, $1.0 million relating to AudeSi Technologies and $3.7
million relating to Embedded Support Tools during the third, second and first
quarters of fiscal 2001, respectively. Wind River also recognized an in-process
research and development charge of $6.4 million relating to Software Development
Systems during the second quarter of fiscal 2000. The amounts related to
in-process technology represent purchased in-process technology for projects
that have not yet reached technological feasibility and have no alternative
future use. The value of the in-process research and development was determined
by estimating the net cash flows resulting from the completion of the projects
reduced by the percentage of completion of the projects. Net cash flows were
tax-effected using estimated income taxes consistent with Wind River's
anticipated tax rate for the foreseeable future and then discounted back to
their present value at a discount rate based on Wind River's required risk
adjusted weighted average rate of return. Wind River's estimated revenues,
margins and operating costs are based upon historical information about similar
product development cycles combined with projections of future revenue and cost
patterns, including projections used when initially evaluating the acquisition
of Embedded Support Tools, AudeSi Technologies and Software Development Systems.
Wind River cannot guarantee that it will realize revenue from these in-process
projects in the amounts estimated or that the costs incurred will be materially
consistent with estimates made. However, to date, the Company is not aware of
any significant variations between costs incurred and estimates made.
The nature of the efforts to develop all purchased in-process technology into
commercially viable products principally relates to the completion of all
planning, designing, prototyping, verification and testing activities that are
necessary to establish that the resulting products can meet their design
specification, including function, features and technical performance
requirements.
Due to the fact that the projects were in-process, there is uncertainty
regarding whether they can be successfully finished and result in the net cash
flows that were originally estimated at the time of the acquisitions. It is
reasonably possible that the development of the acquired technology could fail
because of either prohibitive costs, Wind River's inability to perform the
required completion efforts or other factors outside Wind River's control such
as a change in the market for the resulting developed products. If the
development of the technology is unsuccessful, the technology may be abandoned
during the development phase. Should Wind River's development efforts fail or
encounter significant delay, then Wind River's future returns may be
significantly reduced. In such case, Wind River may be unable to recover its
investment in this
21
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 $5.0 million and $15.4 million, respectively, for the three
and nine month periods ended October 31, 2000, compared to $4.3 million and
$13.7 million for the same periods in the prior fiscal year. The increase in
interest income was primarily due to higher interest rates on invested balances.
Total cash and cash equivalents, investments and restricted cash at October 31,
2000 and 1999 was approximately $327.6 million and $352.3 million, respectively.
The realized gain on investments was $1.5 million and $10.2 million for the
three and nine month periods ended October 31, 2000 compared to realized
losses of $256,000 and $883,000 for the same periods in fiscal 2000. The
increase is due primarily to a gain of $1.7 million and $10.5 million related
to the disposition of equity securities of Liberate Technologies, Inc. and
e-Sim, Inc. during the three and nine month periods ended October 31, 2000,
respectively. Wind River sold 58,411 common shares of Liberate at prices
ranging from $33.13 to $33.86 during the third quarter. Wind River sold
105,000 common shares of Liberate at prices ranging from $26.94 to $28.96 per
share during the second quarter of fiscal year 2001 and sold 44,922 common
shares of Liberate at $108.00 per share and 95,100 common shares of e-Sim at
prices ranging from $18.38 to $36.99 per share during the first quarter of
fiscal year 2001. During the first quarter of fiscal year 2000, Wind River
recognized a charge totaling $500,000 relating to the difference between the
carrying amount of our investment in XACT and management's assessment of the
net realizable value of the investment.
Interest expense and other, net was $1.8 million and $6.1 million for the three
and nine month periods ended October 31, 2000, compared to $2.0 million and $6.3
million for the same periods in the prior fiscal year. Wind River pays interest
on its outstanding 5.0% convertible subordinated notes due in 2002 and
maturities of certain issuance costs associated with these notes. The interest
on the notes is payable on February 1 and August 1 of each year commencing
February 1, 1998. The notes mature on August 1, 2002.
PROVISION FOR INCOME TAXES
Net income for the three and nine month periods ended October 31, 2000 was
negatively impacted by $100,000 and $31.8 million, respectively, in acquisition
related and other charges, including, $100,000 and $4.8 million, respectively,
of in-process research and development and $28.4 million and $64.8 million,
respectively, in amortization of goodwill, purchased technology and other
intangibles. Despite the occurrence of a net loss in the three and nine month
periods ended October 31, 2000, a tax provision resulted due to the exclusion of
amortization of goodwill and other intangibles, and the exclusion of in-process
research and development and other acquisition charges, which are non-deductible
for income tax purposes. The effective tax rate for the three and nine months
ended October 31, 2000 excluding amortization of goodwill and intangibles and
acquisition charges was 37.5% compared to 35.4% and 35.9% for the same periods
in the prior fiscal year. The change in the effective tax rate excluding
amortization of goodwill and intangibles and acquisition charges is attributed
to the change in the ratio of foreign taxable income to domestic taxable income
and carryforward tax attributes.
22
LIQUIDITY AND CAPITAL RESOURCES
At October 31, 2000, Wind River had working capital of approximately $123.3
million and cash and investments, excluding restricted cash of $56.5 million, of
approximately $271.1 million, which include investments with maturities greater
than one year of $137.5 million. Wind River invests primarily in instruments
that are highly liquid and of investment grade. Cash flows for the nine month
period ended October 31, 2000 include cash flows for companies acquired as a
purchase transaction from the date of their acquisition.
During the first nine months of fiscal 2001, Wind River's operating
activities provided net cash of $13.7 million as compared to $37.8 million
for the same period in fiscal 2000. The decrease is due primarily to changes
in assets and liabilities including accrued liabilities, accrued
compensation, income taxes payable and deferred revenue offset by an increase
in accounts receivable, prepaid and other assets, and other assets and
liabilities. The net loss for the first nine months of fiscal 2001 was
primarily offset by the adjustments for depreciation and amortization of
intangibles and the write-off of in-process research and development arising
from the acquisitions of Embedded Support Tools, AudeSi Technologies and
ICESoft.
During the first nine months of fiscal 2001, investing activities used net
cash of $43.7 million as compared to $27.4 million for the same period in
fiscal 2000. During fiscal 2001, the primary uses of cash were for purchases
of investments, the settlement of liabilities assumed in connection with the
acquisition of Embedded Support Tools, the acquisition of ICESoft, the
acquisition of equipment, and changes in restricted cash. These uses of cash
were partially offset by cash provided relating to the sales and maturities
of investments. Restricted cash increased primarily due to the increased
collateral funding required for the operating lease of Wind River's
headquarters development. The collateral consists of direct obligations of
the United States Government.
During the first nine months of fiscal 2001, financing activities provided
net cash of $39.9 million as compared to use of $2.2 million in the same
period in fiscal 2000. During fiscal 2001, the primary source of cash was
from the sale of common stock in connection with employee stock option
exercises. These proceeds were substantially offset by cash repayment of
Embedded Support Tools' bank loans following its acquisition. During the nine
months ended October 31, 1999, Wind River repurchased as part of its
systematic stock repurchase program, 165,000 shares of its common stock at a
cost of approximately $4.0 million. Integrated Systems also repurchased
261,000 shares of its common stock. In June 1999, the Board of Directors
rescinded all stock repurchase authorizations. We have not made any
repurchases since March 17, 1999.
In fiscal year 1998, Wind River entered into an operating lease for its current
headquarters facility constructed on land owned by Wind River in Alameda,
California. Construction was completed in the second quarter of fiscal year
2000. The lease was finalized in August 1999 and the lessor has funded a total
of $32.4 million of construction costs. The operating lease payments began in
August 1999 and are based on the total construction costs of the property,
including capitalized interest and LIBOR.
In fiscal year 2000, Wind River entered into a second operating lease agreement
for the construction of two additional buildings at its headquarters facility.
As of October 31, 2000, the lessor has funded a total of $19 million of
construction costs and has committed to fund up to a maximum of $26.0 million.
Construction of the buildings is currently expected to be completed in January
2001. The operating lease payments will vary based upon the total construction
costs of the property, which include capitalized interest and LIBOR. In
connection with the lease of Wind River's new headquarters, Wind River is
obligated to enter into a ground lease of its land in Alameda, California with
the lessor of the building at a nominal rate and for a term of 55 years. If Wind
River terminates or does not negotiate an extension of the building lease the
ground lease converts to a market rental rate. The ground lease provides Wind
River with the option at the end of the lease terms to either acquire the
buildings at the lessor's original cost or arrange for the buildings to be
acquired. Wind River has guaranteed the residual value associated with the
buildings under the first operating lease and
23
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,
tangible net worth and fixed charge ratio. As of October 31, 2000, Wind River
was in compliance with these covenants. Management believes that the
contingent liability relating to the residual value guarantee will not have a
material adverse effect on Wind River's financial condition or results of
operations.
On March 18, 1998, Wind River entered into an accreting interest rate swap
agreement to reduce the impact of changes in interest rates on its floating rate
operating lease for its 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 in high-grade fixed income securities.
Management believes Wind River's working capital and the cash flow from
operations will be sufficient to meet its operating requirements for planned
expansion, product development and capital expenditures for the next twelve
months; however, Wind River may sell additional equity or debt securities or
obtain credit facilities to further enhance its liquidity position. The sale of
additional securities could result in additional dilution to Wind River's
stockholders.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS 133
requires companies to record derivatives on the balance sheet as assets or
liabilities, measured at fair value. Gains or losses resulting from changes in
the fair values of those derivatives would be accounted for in current earnings
unless specific hedge criteria are met. The key criterion for hedge accounting
is that the hedging relationship must be highly effective in achieving
offsetting changes in fair value or cash flows. Wind River must formally
document, designate, and assess the effectiveness of transactions that receive
hedge accounting. In July 1999, the FASB issued SFAS 137, "Accounting for
Derivative Instruments and Hedging Activities - Deferral of the Effective Date
of SFAS No. 133." SFAS 137 deferred the effective date of SFAS 133 until the
first fiscal year beginning after June 15, 2000. In June 2000, the FASB issued
SFAS 138, "Accounting for Certain Derivative Instruments and Certain Hedging
Activities - an Amendment of SFAS 133." SFAS 138 amends SFAS 133 to permit
limited use of central treasury "netting" of intercompany derivatives for
foreign currency cash flow hedges. SFAS 138 must be adopted concurrently with
SFAS 133. Wind River in the process of determining the impact, if any, the
adoption of this statement will have on its financial statements.
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
24
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. Wind
River has adopted FIN 44, which has not had a material effect on the
financial position or results of operations.
In July 2000, the EITF issued EITF Issue No. 00-15 "Classification in the
Statement of Cash Flows of the Income Tax Benefit Realized by a Company upon
Employee Exercise of a Non-qualified Stock Option." EITF 00-15 addresses the
cash flow statement presentation of the tax benefit associated with
non-qualified stock options. Wind River receives an income tax deduction for
the difference between the exercise price and the market price of a
non-qualified stock option upon exercise by the employee. EITF 00-15
concludes that the income tax benefit realized by us upon employee exercise
should be classified in the operating section of the cash flow statement. The
EITF is effective for all quarters ending after July 31, 2000. Wind River has
adopted EITF 00-15 and such adoption did not have a material impact on its
consolidated financial statements.
In July 2000, the EITF issued EITF Issue No. 00-16 "Recognition and Measurement
of Employer Payroll Taxes on Employee Stock-Based Compensation." This Issue
addresses how an entity should account for employer payroll taxes on stock-based
compensation under Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" and SFAS No. 123, "Accounting for Stock-Based
Compensation." This Issue addresses Wind River's timing for recognizing when the
tax obligation is triggered. This Issue is effective MMMM DD, 2000. Wind River
has not yet determined the impact, if any, of adopting this Issue.
ADDITIONAL RISK FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
WIND RIVER'S BUSINESS FACES SIGNIFICANT RISKS. IF ANY OF THE EVENTS OR
CIRCUMSTANCES DESCRIBED IN THE FOLLOWING RISKS ACTUALLY OCCUR, WIND RIVER'S
BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS COULD BE MATERIALLY AND
ADVERSELY AFFECTED. THESE RISKS SHOULD BE READ IN CONJUNCTION WITH THE OTHER
INFORMATION SET FORTH IN THIS REPORT.
NUMEROUS FACTORS MAY CAUSE OUR REVENUES AND OPERATING RESULTS TO FLUCTUATE
SIGNIFICANTLY FROM PERIOD TO PERIOD.
Our revenues and operating results have fluctuated significantly in the past and
may continue to do so in the future. If our quarterly or annual operating
results do not meet the expectations of securities analysts and investors, the
market price of our common stock could decline significantly. A number of
factors, many of which are outside our control, may cause or contribute to these
fluctuations, including:
- - the amount and timing of orders we receive;
- - changes in the length of our products' sales cycles, which increase as our
customers' purchase decisions become more strategic and are made at higher
management levels;
25
- - 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 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.
During this fiscal year, we completed four major business acquisitions. In
February, March, May, and October 2000, we acquired Integrated Systems, Inc.,
Embedded Support Tools Corporation, AudeSi Technologies, Inc., and Rapid
Logic, Inc., respectively. Achieving the benefits of the mergers depends in
part on the integration of Wind River's and its acquired companies' products
in a timely and efficient manner. In order for us to provide enhanced and
more valuable products to our customers since the acquisitions, we will need
to integrate our product lines and development organizations of Wind River
and the acquired companies. This will be difficult and unpredictable because
these 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 acquisitions also depends in part on the
successful integration of Wind River's and its acquired companies' 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
26
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 and its acquired companies' 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 ACQUISITIONS, WE WILL HAVE INCURRED
SIGNIFICANT COSTS, WHICH MAY HARM OUR BUSINESS.
Wind River expects to incur costs from integrating its acquired companies'
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 ACQUISITIONS.
The successful combination of Wind River and its acquired companies depends
in part on the retention of key personnel. There can be no assurance that
Wind River will be able to retain its acquired companies' key management,
technical, sales and customer support personnel, or that Wind River will
realize the anticipated benefits of the acquisitions.
IF CUSTOMER RELATIONSHIPS ARE DISRUPTED BY THE ACQUISITIONS, OUR SALES COULD
DECLINE.
Customers may not continue their buying patterns in place prior to the
acquisitions. Any significant delay or reduction in orders for Wind River's
and its acquired companies' 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 and its acquired
companies' 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 and its acquired companies'
business, the acquisitions 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 and its acquired companies 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
27
comes from companies that develop real-time operating systems in-house rather
than purchase these systems from independent software vendors such as Wind
River. We also compete with other independent software vendors, including
- - Accelerated Technology, Inc.;
- - ENEA OSE Systems AB;
- - Mentor Graphics, Inc.
- - Microsoft Corporation;
- - Microware Systems Corporation;
- - Motorola, Inc.;
- - QNX Software Systems, Ltd.;
- - Sun Microsystems, Inc.; and
- - Symbian Inc.
A number of companies, including RedHat, Inc. and Lynx Real-Time Systems,
Inc., have been promoting Linux, an open source licensing model, as an
operating system for use in embedded applications. The open source licensing
model provides readily available source code and a royalty-free operating
system. Because Linux is royalty free, Wind River may be forced to reduce the
prices of run time royalties, which could result in reduced profit margins.
In addition, hardware or other software vendors could seek to expand their
product offerings by designing and selling products that directly compete with
or adversely affect sales of our products. Many of our existing and potential
competitors have substantially greater financial, technical, marketing and sales
resources than we do. As a result, they may be able to respond more quickly to
new or emerging technologies and changes in customer requirements, or to devote
greater resources to the development, promotion, sale and support of their
products. Moreover, our competitors may foresee the course of market
developments more accurately than we do and could in the future develop new
technologies that compete with our products or even render our products
obsolete. Although we believe we presently have certain technological and other
advantages over our competitors, maintaining these advantages will require a
continued high level of investment in research and development, marketing and
customer service and support. In addition, competitive pressures could cause us
to reduce the prices of our products, run-time royalties, and services, which
would result in reduced profit margins.
OUR FAILURE TO RESPOND QUICKLY TO RAPID TECHNOLOGICAL CHANGE WITH PRODUCT
OFFERINGS WILL ADVERSELY AFFECT OUR ABILITY TO COMPETE.
The market for embedded real-time software is characterized by ongoing
technological developments, evolving industry standards and rapid changes in
customer requirements. Our success depends upon our ability to adapt and respond
to these changes. We must continuously update our existing products to keep them
current with customer needs, and must develop new products to take advantage of
new technologies, for
28
example, our new VxWorks AE technologies, emerging standards, and expanding
customer requirements that could render our existing products obsolete.
Because customers often defer purchases between the time a new product is
announced and its availability, our operating results may fluctuate if we do
not provide new products rapidly. We have from time to time experienced
delays in the development of new technologies, new products and the
enhancement of existing products, including, most recently, a delay in the
development of our recently introduced product Tornado for Managed Switches
and VxWorks AE. 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 Vx Works, pSOS and pRISM+ 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
acquisitions, any decline in price or reduction in the demand for our Tornado or
Vx Works, pSOS and pRISM+ family of products and services could materially
adversely affect our operating results and cause the price of our common stock
to decline.
IF WE DO NOT CONTINUE TO SUCCESSFULLY ADDRESS NEW AND RAPIDLY CHANGING MARKETS,
OUR REVENUES WILL DECLINE.
We are continuously engaged in product development for new or rapidly changing
markets. It is difficult to predict whether demand for any of these products
will develop or increase in the future.
In particular, we have invested significant time and effort, together with a
consortium of industry participants, in the development of a new specification
that is intended to create an open standard set of interface specifications for
high-performance input/output (I/O) systems. In parallel with this effort, we
have developed IxWorks, a real-time operating system for use in conjunction with
the new specification. The success of the new specification and the IxWorks
product line depends heavily on its adoption by a broad segment of the industry.
We have also spent, and continue to spend, substantial time and financial
resources, through two new business units, to develop software solutions for
Internet appliances and Internet infrastructure, including Tornado for Managed
Switches and the consumer market place. These products must be ported to an
increasing number of Internet protocols and semiconductor architectures designed
specifically for the Internet. If the protocols and semiconductors upon which
our Internet products are based ultimately fail to be widely adopted, our
products based on those protocols and architectures will fail to achieve market
acceptance. If our products fail to achieve market acceptance or if their
targeted markets fail to develop, our revenues will decline.
A SIGNIFICANT PORTION OF OUR REVENUE IS DERIVED FROM ROYALTIES, WHICH ARE
DEPENDENT UPON THE EFFORTS OF OUR CUSTOMERS WHICH ARE OUTSIDE OUR CONTROL.
Our operating systems are embedded in customers' end-user products, and we
receive royalty fees for each copy of our operating system embedded in those
products. Our royalty revenues depend upon our ability to successfully negotiate
royalty agreements with our customers and, in turn, their successful
commercialization of the underlying products. We cannot control their product
development or predict its success. If our customers are not successful, our
royalty revenues will decline significantly.
29
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 transactions
completed in this fiscal year, 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
30
failure to do so could impair our ability to compete successfully.
OUR SIGNIFICANT INTERNATIONAL BUSINESS ACTIVITIES SUBJECT US TO ECONOMIC RISKS.
During the nine months ended October 31, 2000 and fiscal years ended January 31,
2000 and 1999, we derived approximately 32%, and 37%, respectively, of our total
revenue from sales outside of North America. We expect that international sales
will continue to generate a significant percentage of our total revenue in the
foreseeable future, and we also expect to continue to make investments to
further expand our international operations and to increase our direct sales
force in Europe and Asia. Wind River is in the process of changing its
distribution model in Japan to a model in which Wind River interfaces with and
sells to its customers more directly. We believe that this model will improve
our understanding of and relationships with our customers. During this
transition period, we expect to see a decline in revenues in Japan. Risks
inherent in international operations include:
- - 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.
31
If our international distributors do not promote our products effectively, our
international revenues could decline.
WE SELL A PORTION OF OUR PRODUCTS TO CUSTOMERS DEPENDENT UPON GOVERNMENT
FUNDING, WHICH MAY NOT CONTINUE TO BE AVAILABLE.
We have derived a portion of our revenues historically from sales of systems
built to the VME (versabus module eurocard) standard. These systems typically
are used in high cost, low volume applications, including military,
telecommunications, space and research applications. Although we believe that
revenues from sales of products designed for embedded systems applications
(non-VME customers) will account for an increasing percentage of our revenues in
the future, we do expect revenues from the VME market to continue to be
significant for the foreseeable future. Academic institutions and defense
industry participants, which generate most of our VME revenues, are dependent on
government funding. Any unanticipated future termination of government funding
of VME customers would reduce our revenues.
IF WE LOSE THIRD-PARTY LICENSE RIGHTS, WE MAY NOT BE ABLE TO SELL SOME OF OUR
PRODUCTS.
We license software products from other companies to distribute with some of our
products. These third parties may not be able to provide competitive products
with adequate features and high quality on a timely basis or to provide sales
and marketing cooperation. In addition, our products compete with products
produced by some of our licensors. When these licenses terminate or expire,
continued license rights might not be available to us on reasonable terms. In
addition, we might not be able to obtain similar products to substitute into our
tool suites.
THE RIGHTS WE RELY UPON TO PROTECT THE INTELLECTUAL PROPERTY UNDERLYING OUR
PRODUCTS MAY NOT BE ADEQUATE, WHICH COULD ENABLE THIRD PARTIES TO USE OUR
TECHNOLOGY AND REDUCE OUR ABILITY TO COMPETE IN THE MARKET.
Our success is partially dependent upon the proprietary technology contained in
our products. We currently rely on a combination of patents, copyrights,
trademarks, trade secret laws, and contractual provisions to establish and
protect our intellectual property rights in our products. We cannot be certain
that the steps we take to protect our intellectual property will adequately
protect our rights, that others will not independently develop or otherwise
acquire equivalent or superior technology, or that we can maintain such
technology as trade secrets. For example, end user licenses of our software are
frequently in the form of shrink wrap or click wrap license agreements, which
are not signed by licensees, and these may be unenforceable in some cases. In
addition, policing unauthorized use of our products is difficult, and while we
are unable to determine the extent to which software piracy of our products
exists, software piracy can be expected to be a persistent problem, particularly
in foreign countries, where the laws may not protect our intellectual property
as fully as in the United States. Employees, consultants, and others who
participate in the development of our products may breach their agreements with
us regarding our intellectual property, and we may not have adequate remedies
for any such breach.
IF WE ENFORCE OUR INTELLECTUAL PROPERTY RIGHTS THROUGH LITIGATION, THE COSTS
COULD BE SIGNIFICANT.
We may initiate claims or litigation against third parties for infringement of
our proprietary rights or to establish the validity of our proprietary rights.
Litigation to determine the validity of any claims, whether or not such
litigation is determined in our favor, could result in significant expense to us
and divert the efforts of our technical and management personnel from productive
tasks.
THIRD-PARTY CLAIMS OF PATENT INFRINGEMENT COULD RESULT IN SUBSTANTIAL COSTS.
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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.
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 a small
portion of the notes has 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;
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- - 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.
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
October 31, 2000 would have an immaterial effect on Wind River's pretax
earnings. Wind River also believes the immediate 100 basis point move in
interest rates would have an immaterial effect on the fair value of Wind River's
financial instruments.
FOREIGN CURRENCY RISK
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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 comprehensive 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 October 31,
2000, Wind River had outstanding forward contracts with notional amounts
totaling approximately $8.2 million.
The net unrealized gains and losses on the outstanding forward contracts at
October 31, 2000 were immaterial to Wind River's consolidated financial
statements. Due to the short-term nature of the forward contracts, the fair
value at October 31, 2000 was negligible. The realized gains and losses on these
contracts as they matured were not material to the consolidated operations of
Wind River.
INTEREST RATE SWAP RISK
In March 1998, Wind River entered into a 5.9% accreting interest rate swap to
reduce the impact of changes in interest rates on its floating interest rate
operating lease for its new headquarters. At October 31, 2000, the notional
amount of the accreting interest rate swap was $28.5 million. The estimated fair
value at October 31, 2000 was negligible.
EQUITY PRICE RISK
Wind River owns 338,652 shares of common stock of e-Sim, Inc., an Israeli
corporation. Wind River purchased the common stock prior to e-Sim's public
offering of $7.50 per share. e-Sim went public in July 1998, and at October
31, 2000, the closing price of e-Sim's stock was $3.69 per share. In
addition, Wind River owns 208,333 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 October 31, 2000, the closing price of Liberate's
stock was $19.06 per share. Wind River also owns 90,909 shares of TVIA, Inc.,
a Delaware corporation. TVIA went public in August 2000 at $11.00 per share,
and at October 31, 2000, the closing price was $16.38 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 October 31, 2000 at their market value of approximately $6.5 million
in aggregate, with the unrealized gains and losses excluded from earnings and
reported in the accumulated other comprehensive income component of
stockholders' equity. At December 7, 2000, the closing prices of e-Sim's,
Liberate's and TVIA's stock were $3.09, $14.31 and $10.75, respectively. In
addition to the publicly traded stock, Wind River owns stock in some
privately held companies. Wind River monitors the value of these investments
continuously and has not found any material differences to the carrying value
of the investments.
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PART II - OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds
On October 24, 2000, in connection with its acquisition of Rapid Logic, Inc.,
a privately-held company, Wind River issued an aggregate of 1,244,940
unregistered shares of its common stock for the benefit of the stockholders
of Rapid Logic. The transaction was exempt from registration under the
Securities Act of 1933, as amended, under Regulation D thereof, as a
transaction not involving a public offering.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
3.1(a) Certificate of Incorporation, as amended October 15, 1993
3.1(b) Certificate of Incorporation, as amended July 23, 1996
3.1(c) Certificate of Incorporation, as amended June 26, 1998
3.1(d) Certificate of Incorporation, as amended September 7, 2000
27.1 Financial Data Schedule
(b) Reports on Form 8-K
The Company filed a report on Form 8-K, dated October 25, 2000, filing the press
release announcing its acquisition of Rapid Logic, Inc.
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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: December 15, 2000 /s/ MICHAEL ZELLNER
--------------------------
Michael Zellner
Vice President and Chief Financial Officer
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