SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[ X ] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended July 31, 1998 or
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from ____ to ____.
Commission file number 0-21342
WIND RIVER SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 94-2873391
(State of incorporation) (I.R.S. Employer Identification No.)
1010 ATLANTIC AVENUE, 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.
26,335,155 shares of Common Stock; $.001 par value as of August 31, 1998
WIND RIVER SYSTEMS, INC.
FORM 10-Q
QUARTER ENDED JULY 31, 1998
INDEX
Part I: FINANCIAL INFORMATION
Item 1. Financial Statements Condensed
Consolidated Income Statements for the
three and six month periods ended July 31,
1998 and 1997
Condensed Consolidated Balance Sheets at
July 31, 1998 and January 31, 1998
Condensed Consolidated Statements of Cash
Flows for the six month periods ended July
31, 1998 and 1997
Notes to the Condensed Consolidated
Financial Statements
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of
Operations
Part II: OTHER INFORMATION
Item 1. Legal Proceedings
Item 4. Submission of Matters to the Vote of
Security Holders
Item 6. Exhibits and Reports on Form 8-K
Signature
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WIND RIVER SYSTEMS, INC.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
WIND RIVER SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
Three months ended Six months ended
July 31, July 31,
1998 1997 1998 1997
------- ------- ------- -------
Revenues:
Products
$23,169 $15,926 $42,491 $29,183
Services 8,031 6,074 15,109 11,217
------- ------- ------- -------
Total revenues 31,200 22,000 57,600 40,400
------- ------- ------- -------
Cost of revenues:
Products 2,337 1,601 4,305 3,007
Services 3,231 2,362 6,052 4,300
------- ------- ------- -------
Total cost of revenues 5,568 3,963 10,357 7,307
------- ------- ------- -------
Gross margin 25,632 18,037 47,243 33,093
------- ------- ------- -------
Operating expenses:
Selling and marketing 11,035 8,346 20,911 15,601
Product development and engineering 4,287 3,005 8,061 5,439
General and administrative 1,904 1,565 3,608 3,102
------- ------- ------- -------
Total operating expenses 17,226 12,916 32,580 24,142
------- ------- ------- -------
Operating income 8,406 5,121 14,663 8,951
------- ------- ------- -------
Other income (expense):
Interest expense (2,223) 10 (4,357) 43
Interest income and other, net 3,447 916 6,529 1,663
------- ------- ------- -------
Total other income 1,224 926 2,172 1,706
------- ------- ------- -------
Income before income taxes 9,630 6,047 16,835 10,657
Provision for income taxes 3,699 2,177 6,469 3,837
------- ------- ------- -------
Net income $ 5,931 $ 3,870 $10,366 $ 6,820
------- ------- ------- -------
------- ------- ------- -------
Net income per share:
Basic $ 0.23 $ 0.15 $ 0.40 $ 0.27
Diluted $ 0.21 $ 0.14 $ 0.37 $ 0.24
Weighted average shares:
Basic 26,335 25,384 26,099 25,374
Diluted 28,330 28,196 28,155 28,127
The accompanying notes are an integral part of these condensed consolidated
financial statements.
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WIND RIVER SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNT)
(UNAUDITED)
July 31, January 31,
1998 1998
-------- -----------
ASSETS
Current assets:
Cash and cash equivalents $ 39,805 $100,633
Short-term investments 14,366 61,107
Accounts receivable, net of allowances of $1,535 and $1,460 20,977 18,076
Other current assets 4,987 5,210
-------- --------
Total current assets 80,135 185,026
Investments 156,542 60,329
Property and equipment, net of accumulated
depreciation of $13,309 and $10,962 27,950 24,496
Other assets 31,529 17,957
-------- --------
Total assets $296,156 $287,808
-------- --------
-------- --------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 4,220 $ 3,806
Accrued liabilities 5,936 9,733
Accrued compensation 4,681 5,441
Income taxes payable 4,769 1,415
Deferred revenue 15,559 15,027
-------- --------
Total current liabilities 35,165 35,422
Convertible subordinated notes 140,000 140,000
-------- --------
Total liabilities 175,165 175,422
-------- --------
Minority interest in consolidated subsidiary 558 400
-------- --------
Stockholders' equity:
Common stock, par value $.001, 125,000 authorized,
26,953 and 26,166 shares issued; 26,329 and 25,689
shares outstanding 27 26
Additional paid in capital 106,707 101,154
Treasury stock, 624 and 477 shares, at cost (20,482) (15,485)
Cumulative translation adjustments (1,598) (1,700)
Unrealized gain (loss) on investments (950) 503
Retained earnings 36,729 27,488
-------- --------
Total stockholders' equity 120,433 111,986
-------- --------
Total liabilities and stockholders' equity $296,156 $287,808
-------- --------
-------- --------
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)
Six months ended
July 31,
1998 1997
--------- --------
Cash flows from operating activities:
Net income $ 10,366 $ 6,820
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 3,485 1,896
Unrealized loss on investments (1,453) -
Minority interest in consolidated subsidiary 158 (8)
Change in assets and liabilities:
Accounts receivable (2,778) 752
Other assets (14,446) (1,720)
Accounts payable 261 864
Accrued liabilities (4,304) 729
Accrued compensation (860) 58
Income taxes payable 3,351 1,467
Deferred revenue 532 5,152
--------- --------
Net cash provided by (used in) operating activities (5,688) 16,010
--------- --------
Cash flows from investing activities:
Acquisition of property and equipment (5,745) (5,426)
Purchase of investments (150,664) (36,166)
Sales and maturities of investments 101,192 34,591
--------- --------
Net cash used in investing activities (55,217) (7,001)
--------- --------
Cash flows from financing activities:
Proceeds from issuance of Common Stock, net 4,972 2,223
Purchase of treasury stock (4,997) (5,832)
Long-term debt issuance - 135,225
--------- --------
Net cash provided by (used in) financing activities (25) 131,616
--------- --------
Effect of exchange rate changes on cash and cash equivalents 102 (320)
--------- --------
Net increase (decrease) in cash and cash equivalents (60,828) 140,305
Cash and cash equivalents at beginning of period 100,633 9,848
--------- --------
Cash and cash equivalents at end of period $ 39,805 $150,153
--------- --------
--------- --------
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 are unaudited. However, in the opinion of management, all adjustments
(consisting only of normal recurring adjustments) which are necessary for a
fair presentation of the financial position, results of operations and cash
flows for the interim period have been included. These condensed
consolidated financial statements should be read in conjunction with the
audited consolidated financial statements and notes thereto for the fiscal
year ended January 31, 1998 included in the Company's Annual Report on Form
10-K. The results of operations for the three and six months ended July 31,
1998 are not necessarily indicative of results to be expected for the entire
fiscal year, which ends on January 31, 1999.
The condensed consolidated financial statements include the accounts of Wind
River Systems, Inc. ("Wind River" or "the Company") and its wholly-owned and
majority-owned subsidiaries. All significant inter-company accounts and
transactions have been eliminated in consolidation.
In accordance with the rules and regulations of the Securities and Exchange
Commission, the unaudited condensed consolidated financial statements omit or
condense certain information and footnote disclosures normally required for
complete financial statements prepared in accordance with generally accepted
accounting principles. However, the Company believes that the disclosures
are adequate to make the information presented not misleading.
Certain amounts in the fiscal 1998 condensed consolidated financial
statements have been reclassified to conform to the fiscal 1999 presentation.
2. ZINC SOFTWARE INCORPORATED ACQUISITION
In May 1998, the Company acquired Zinc Software, Inc. ("Zinc"), a privately
held company that develops, markets and supports graphical application
software. In connection therewith, the Company issued 226,611 shares of
common stock for all of the outstanding stock of Zinc. The acquisition was
accounted for as a pooling of interests, however, as the operations of Zinc
were not material to the Company's consolidated operations and financial
position, the financial statements of Zinc have been recorded in the
Company's consolidated financial statements as of May 1, 1998.
6
3. REVENUE RECOGNITION
The Company has adopted the provisions of Statement of Position 97-2,
"Software Revenue Recognition" ("SOP 97-2"), as amended by Statement of
Position 98-4, "Deferral of the Effective Date of Certain Provisions of SOP
97-2" ("SOP 98-4"), effective February 1, 1998. SOP 97-2 and SOP 98-4
provide guidance on recognizing revenue on software transactions and
supersede SOP 91-1. The adoption of SOP 97-2 and SOP 98-4 did not have a
material impact on the Company's current licensing or revenue recognition
practices. However, should Wind River adopt new or change its existing
licensing practices, the Company's revenue recognition practices may be
subject to change to comply with the accounting guidance provided in SOP 97-2
and SOP 98-4.
4. CASH AND CASH EQUIVALENTS AND INVESTMENTS
Cash equivalents consist of highly liquid investments with an original
maturity of three months or less. These investments consist of fixed income
securities, which are readily convertible to cash and are stated at cost,
which approximates fair value. 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. The Company has classified all of its investments as
available-for-sale and carries such investments at fair value, with
unrealized gains and losses reported as a 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.
5. COMPREHENSIVE INCOME
In February 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" ("FAS 130").
Comprehensive income is defined as the change in equity of a company during a
period from transactions and other events and circumstances excluding
transactions resulting from investments by owners and distributions to
owners. The primary difference between net income and comprehensive income,
for the Company, results from foreign currency translation adjustments and
unrealized gains and losses on available-for-sale securities.
7
Comprehensive income for the three and six month periods ended July 31, 1998
and 1997 is as follows:
Three Months Ended Six Months Ended
July 31, July 31,
(In thousands) 1998 1997 1998 1997
------ ------ ------- ------
Net income $5,931 $3,870 $10,366 $6,820
------ ------ ------- ------
------ ------ ------- ------
Other comprehensive income, net of tax
Foreign currency translation adjustments 381 (104) 66 (208)
Unrealized loss on investments (434) (27) (944) (91)
------ ------ ------- ------
Other comprehensive income (53) (131) (878) (299)
------ ------ ------- ------
Total comprehensive income $5,878 $3,739 $ 9,488 $6,521
------ ------ ------- ------
------ ------ ------- ------
6. NET INCOME PER SHARE
Net income per share is calculated in accordance with the provisions of
Statement of Financial Accounting Standards No. 128, "Earnings Per Share"
("FAS 128"). FAS 128 requires the Company to report both basic net income
per share, which is based on the weighted-average number of common shares
outstanding, and diluted net income per share, which is based on the
weighted-average number of common shares outstanding and all dilutive
potential common shares outstanding. Dilutive potential common shares consist
of stock options and warrants (using the treasury stock method) and
convertible subordinated notes (using the if converted method).
In accordance with FAS 128, the calculation of basic and diluted net income
per share is presented below:
Three Months Ended Six Months Ended
July 31, July 31,
(In thousands, except per share information) 1998 1997 1998 1997
------- ------- ------- -------
Basic computation:
Net income $ 5,931 $ 3,870 $10,366 $ 6,820
Weighted-average common shares 26,335 25,384 26,099 25,374
------- ------- ------- -------
Basic net income per share $ 0.23 $ 0.15 $ 0.40 $ 0.27
------- ------- ------- -------
------- ------- ------- -------
Diluted computation:
Net income $ 5,931 $ 3,870 $10,366 $ 6,820
Weighted-average common shares 26,335 25,384 26,099 25,374
Assumed incremental shares from:
Stock options and warrants 1,995 2,812 2,056 2,753
Convertible subordinated notes - - - -
------- ------- ------- -------
Dilutive potential common shares 1,995 2,812 2,056 2,753
------- ------- ------- -------
Total dilutive weighted-average
common shares 28,330 28,196 28,155 28,127
------- ------- ------- -------
------- ------- ------- -------
Diluted net income per share $ 0.21 $ 0.14 $ 0.37 $ 0.24
------- ------- ------- -------
------- ------- ------- -------
The effect of assumed conversion of the convertible subordinated notes is
anti-dilutive and is therefore excluded from the above computations. Options
to purchase approximately 1.8 million and 364,000 shares which were
outstanding at
8
July 31, 1998 and 1997, respectively, were not included in the calculation
because the exercise prices were greater than the average market price of
common shares in each respective quarter. The exercise price ranges of these
options were $34.50 to $46.02 and $35.50 to $41.87 at July 31, 1998 and 1997,
respectively.
7. COMMON STOCK TRANSACTIONS
The Company currently repurchases approximately $2.5 million of its common
stock per quarter on the open market at prevailing market prices or in
negotiated transactions off the market. The current program is expected to
continue through the quarter ending October 31, 1998 unless extended or
shortened by the Board of Directors. The Company repurchased and holds as
treasury stock 68,500 shares and 79,300 shares of common stock in the first
and second quarters of fiscal year 1999, respectively, at a cost of $5.0
million.
8. RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 131 "Disclosures about
Segments of an Enterprise and Related Information" ("FAS 131"). This
statement establishes standards for the method companies use to report
information about operating segments in annual financial statements. It also
establishes standards for related disclosures about products and services,
geographic areas, and major customers. The disclosures prescribed by FAS 131
will be effective for the Company's consolidated financial statements for the
fiscal year ending January 31, 1999. FAS 131's interim reporting disclosures
are not required until the Company's fiscal quarter ending April 30, 1999.
In April 1998, the American Institute of Certified Public Accountants issued
Statement of Position 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use" ("SOP 98-1"). SOP 98-1 provides
guidance for determining whether computer software is internal-use software
and on accounting for the proceeds of computer software originally developed
or obtained for internal use and then subsequently sold to the public. It
also provides guidance on capitalization of the costs incurred for computer
software developed or obtained for internal use. The Company has not yet
determined the impact, if any, of adopting this statement. The disclosures
prescribed by SOP 98-1 will be effective for the Company's consolidated
financial statements for the fiscal year ending January 31, 2000.
In June 1998, the FASB issued Statement of Financial Accounting Standards No.
133 "Accounting for Derivative Instruments and Hedging Activities" ("FAS
133"). FAS 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
9
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. The Company must formally document, designate,
and assess the effectiveness of transactions that receive hedge accounting.
The Company has not yet determined the impact, if any, of adopting this
statement. FAS 133 will be effective for the Company's consolidated
financial statements for the fiscal year ending January 31, 2001.
9. LEGAL PROCEEDINGS
The Company is a party to litigation arising in the normal course of its
business. The Company believes that such litigation, even if resolved
adversely to the Company, would not have a material effect on its business,
financial condition or results of operations.
10
WIND RIVER SYSTEMS, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
Except for the historical information contained herein, the following
discussion contains forward-looking statements that involve risks and
uncertainties. All forward-looking statements included in this document are
based on information available to the Company on the date hereof, and the
Company assumes no obligation to update any such forward-looking statements.
The Company's actual results could differ materially from those discussed
herein. Factors that could cause or contribute to such differences include,
but are not limited to, those discussed below, in the Company's Annual Report
on Form 10-K for the fiscal year ended January 31, 1998, as well as in other
of the Company's Securities and Exchange Commission filings. The following
discussions should be read in conjunction with the unaudited consolidated
financial statements and notes included elsewhere herein.
In May 1998, the Company acquired Zinc Software, Inc. ("Zinc"), a privately
held company that develops, markets and supports graphical application
software. In connection therewith, the Company issued 226,611 shares of
common stock for all of the outstanding stock of Zinc. The acquisition was
accounted for as a pooling of interests, however, as the operations of Zinc
were not material to the Company's consolidated operations and financial
position, the financial statements of Zinc have been recorded in the
Company's consolidated financial statements as of May 1, 1998.
Wind River Systems, Inc. ("Wind River" or "the Company") develops, markets
and supports advanced software operating systems and software 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. The Company's flagship product, Tornado-TM-,
enables customers to enhance product performance, standardize designs across
projects, reduce research and development costs and shorten product
development cycles.
RESULTS OF OPERATIONS
REVENUES
Total revenues for the three and six months ended July 31, 1998 were $31.2
million and $57.6 million, respectively, compared to $22 million and $40.4
million for the same periods in fiscal 1998. The increase in revenues of 42%
and 43% for the three
11
and six month periods ended July 31, 1998, respectively, is due to increases
in both the Company's product revenue and services revenues.
Revenue from the sale of products increased 45% and 46% to $23.2 million and
$42.5 million for the three and six months ended July 31, 1998, compared to
$15.9 million and $29.2 million for the same periods in fiscal 1998. Product
revenues primarily consist of development license fees and run-time license
fees. The Company typically charges a one-time fee for a development license
and a run-time license fee for each copy of the Company's operating system
embedded in the customer's product. The increases were due primarily to the
continued acceptance of the Company's products and increased run-time license
revenues.
Service revenues increased 32% and 35% to $8.0 million and $15.1 million for
the three and six months ended July 31, 1998, compared to $6.1 million and
$11.2 million for the same periods in the prior fiscal year. The increases
were primarily due to an increase in maintenance support agreements resulting
from the increase in the Company's installed base of Tornado-TM- software
development environment and software applications provided to customers.
Total revenues from international sales for the three and six months ended
July 31, 1998 were $9.5 million and $18.4 million, compared to $6.3 million
and $12.6 million for the same periods in the prior fiscal year. The
increase of 50% and 46% for the three and six month periods ended July 31,
1998 were primarily due to increased sales in Japan and Europe.
International revenues accounted for 31% and 32% of total revenues for the
three and six month periods ended July 31, 1998, compared to 29% and 31% for
the same periods in the prior fiscal year. The Company expects international
sales to continue to represent a significant portion of net product revenues
although the percentage may fluctuate from period to period. The Company's
international sales are denominated in the local currencies and an increase
in the relative value of the dollar against such currencies would reduce the
Company's revenues in dollar terms or make the Company's products more
expensive and, therefore, potentially less competitive in foreign markets.
The Company actively monitors its foreign currency exchange exposure; and to
date such exposures have not had a material impact on the Company's results
of operations. To date, the Company has not utilized derivative instruments
to manage such exposure. Revenues from Asia Pacific sources including Japan
represented 40% and 46% of international revenues for the three and six
months ended July 31, 1998, compared to 31% and 38% for the same periods in
the prior fiscal year.
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COSTS OF REVENUES
The overall cost of products and services as a percentage of total revenues
was 18% for both the three and six month periods ended July 31, 1998, the
same as for the corresponding periods in fiscal 1998. Product-related cost
of sales as a percentage of product revenues was 10% for both the three and
six month periods ended July 31, 1998, respectively, the same as for the
corresponding periods of the prior fiscal year. Product-related costs consist
primarily of product media, documentation and packaging.
Service related cost of revenues as a percentage of service revenues was 40%
for both the three and six month periods of fiscal 1999, compared to 39% and
38% for the same periods in fiscal 1998. Service related costs consist
primarily of personnel related costs associated with providing services to
customers and the infrastructure to manage a services organization as well as
costs to research, develop, and retain services professionals. The increase
in costs of service revenues is due to investment in developing new services
offerings and the addition of service professionals. The Company expects that
customer support costs will increase in absolute dollars as the Company
continues to increase customer support staff and customer support
capabilities.
OPERATING EXPENSES
Selling and marketing expenses were $11.0 million and $20.9 million for the
three and six months ended July 31, 1998, compared to $8.3 million and $15.6
million for the same periods in the prior fiscal year. As a percentage of
total revenue, selling and marketing expenses decreased to 35% and 36% for
the three and six months ended July 31, 1998 from 38% and 39% for the
corresponding periods in the prior fiscal year. The increase in absolute
dollars resulted primarily from the growth of sales and marketing personnel
and field engineers and related costs and increases in expenses related to
marketing and advertising programs. The Company expects that sales and
marketing expenses will increase in absolute dollars as the Company continues
to expand its sales and marketing staff.
Product development and engineering expenses were $4.3 million and $8.1
million for the three and six months ended July 31, 1998 or 14% of total
revenues for each period, compared to $3.0 million and $5.4 million or 14%
and 13% of total revenue, respectively for the same periods in the prior
fiscal year. The dollar increase in product development and engineering
expense is primarily due to the increase in staff and associated support for
engineers to expand and enhance the Company's product line. The Company
believes that product development and engineering expenses will increase in
absolute dollars as it continues to invest in developing new products,
applications and product enhancements.
13
General and administrative expenses were $1.9 million and $3.6 million or 6%
of total revenues for the three and six month periods ended July 31, 1998,
compared to $1.6 million and $3.1 million or 7% and 8% of total revenues for
the corresponding periods in the prior fiscal year. The increase in absolute
dollars was primarily due to the growth in worldwide staff and infrastructure
investments in the areas of information systems, finance and administration.
The Company believes that general and administrative expenses will increase
in absolute dollars as it continues to invest in worldwide staff and
infrastructure in the areas of information systems, finance and
administration.
OTHER INCOME AND EXPENSES
Interest expense was $2.2 million and $4.4 million for the three and six
month period ended July 31, 1998. No interest expense was incurred during
the same periods in the prior fiscal year. The increase in interest expense
is primarily related to the interest paid on the 5.0% Convertible
Subordinated Notes, due in 2002 (the "Notes") and amortization of certain
issuance costs associated with the Notes. The interest on the Notes is
payable on February 1 and August 1 of each year commencing February 1, 1998.
The Notes mature on August 1, 2002.
Interest income and other, net was $3.4 million and $6.5 million for the
three and six month periods ended July 31, 1998 compared to $0.9 million and
$1.7 million for the same periods in the prior fiscal year. The increase of
$2.5 million and $4.9 million for the three and six months, respectively, is
primarily due to higher average cash and cash equivalent and investment
balances and to the transition of the Company's investment portfolio from
tax-free investments to taxable investments.
PROVISION FOR INCOME TAXES
The effective tax rate for the three and six month periods ended July 31,
1998 was 38.4% compared to 36% for the same periods in the prior fiscal year.
The increase in the effective tax rate between the second quarters of fiscal
1999 and 1998 was due to the transition of the Company's investment portfolio
from tax-free investments to taxable investments. The provision for income
taxes is an estimate based on the Company's anticipated effective tax rate
for the full fiscal year.
LIQUIDITY AND CAPITAL RESOURCES
At July 31, 1998, the Company had working capital of approximately $45
million and cash and investments of approximately $211 million, which include
investments with maturities of greater than one year of $157 million. The
increase in long term investments of $96 million from January 31, 1998 is
primarily due to the transfer of funds held as cash equivalents or short term
investments as of January 31, 1998 to longer term securities.
14
Net cash used in operating activities was $5.7 million in the first six
months of fiscal 1999. In the first six months of fiscal 1999, the changes in
accounts receivable, other assets, accrued liabilities, and accrued
compensation were partially offset by net income, depreciation and
amortization, and changes in income taxes payable. Other assets increased
primarily due to the increased collateral funding for the operating lease of
the Company's future headquarters. The collateral consists of direct
obligations of the United States government, with the majority being
long-term securities. Accrued liabilities decreased as the Company made a
final payment for certain technologies purchased from Network Computer, Inc.
in the quarter ended January 31, 1998.
Net cash used in investing activities in the first six months of fiscal 1999
totaled $55.2 million. In the first six months of fiscal 1999, uses of cash
relating to the acquisition of equipment and purchases of investments were
partially offset by cash provided from the sales of investments. As the
Company transitioned its investment portfolio from short-term to long-term
investments, its long-term investments increased by $96 million.
Net cash used in financing activities in the first six months of fiscal year
1999 totaled $25,000. In the first six months of fiscal 1999, cash provided
by the issuance of common stock from employee stock option exercises was
offset by cash used in the repurchase of treasury stock. During the six
months ended July 31, 1998, the Company repurchased and holds as treasury
stock 147,800 shares of common stock at a cost of approximately $5.0 million.
In fiscal 1998, the Company entered into an operating lease agreement for its
new headquarters facility being constructed on the land the Company purchased
in Alameda, California. As of July 31, 1998, the lessor has funded a total
of $17.5 million of construction costs and has committed to fund up to a
maximum of $35 million. The operating lease payments will begin upon
completion of construction and will vary based on the total construction
costs of the property, including capitalized interest, and the London
interbank offering rate ("LIBOR").
On March 18, 1998, the Company entered into an accreting interest rate swap
agreement (the "Agreement") to reduce the impact of changes in interest rates
on its floating rate operating lease for its new corporate headquarters.
This Agreement effectively changes the Company's interest rate exposure on
its operating lease which is based on one month LIBOR to a fixed rate of
5.9%. The notional amount of the swap under the Agreement is scheduled to
increase in relation to the funds used to construct the Company's new
headquarters. 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 their contracts) are
generally limited to the amounts, if any, by which the counterparty's
obligations exceed the obligations of the Company. The Company 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.
15
Construction of the building is currently expected to be completed in
December 1998. In connection with the lease, the Company is obligated to
enter into a lease of its land in Alameda, California to the lessor of the
building at a nominal rate and for a term of 55 years. If the Company
terminates or does not negotiate an extension of the building lease, the
ground lease converts to a market rental rate. The lease provides the
Company with the option at the end of the lease of either acquiring the
building at the lessor's original cost or arranging for the building to be
acquired. The Company has guaranteed the residual value associated with the
building to the lessor of approximately 82% of the lessor's $35 million
funding obligation. The Company is also required, periodically during the
construction period, to deposit fixed income securities with a custodian as a
deposit to secure the performance of its obligations under the lease. In
addition, under the terms of the lease, the Company must maintain compliance
with certain financial covenants. As of July 31, 1998, the Company 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 the Company's financial condition or results of operations.
The Company 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. The Company attempts to limit
this exposure by investing primarily in high grade securities.
Management believes that the Company's working capital and the cash flow
generated from operations are sufficient to meet its working capital
requirements for planned expansion, product development and capital
expenditures for the next twelve months.
"YEAR 2000" ISSUES
The Company is aware of the issues associated with the programming code in
existing computer systems as the year 2000 approaches. The "Year 2000"
problem is pervasive and complex, as many computer systems will be affected
in some way by the rollover of the two-digit year value to 00. Systems that
do not properly recognize such information could generate erroneous data or
cause a system to fail. The "Year 2000" issue creates risk for the Company
from unforeseen problems in its own computer systems and from third parties
with whom the Company deals on transactions worldwide. Failures of the
Company's and/or third parties' computer systems could have a material
adverse impact on the Company's ability to conduct its business.
The "Year 2000" issue also could affect the products that the Company sells.
The Company believes that its most current releases of its products will
neither cease to perform nor generate incorrect or ambiguous data or results
solely due to a change in date to or after January 1, 2000, and will
calculate any information dependent on such dates in the same manner, and
with the same functionality, data integrity and
16
performance, as such products do on or before December 31, 1999
(collectively, "Year 2000 Compliance"). The Company will continue to analyze
and review its products for Year 2000 Compliance. The majority of the
Company's products are combined or used by its customers with other software
programs or hardware devices not provided by the Company. Such combination
with other products that are not Year 2000 compliant or modifications of the
Company's products by its customers may introduce Year 2000 Compliance issues
for its customers. The Company's customers' inability to remedy their Year
2000 issues could affect their demand for the Company's products, which may
have a material adverse effect on the Company's business, operating results,
and financial condition.
The Company is currently upgrading its financial information systems. The
Company believes it will complete the upgrade during fiscal 2000. These
upgraded financial information systems are believed to be "Year 2000"
compliant. The Company is analyzing its remaining computer systems to
identify any potential "Year 2000" issues and will take appropriate
corrective action based on the results of such analysis. Management does not
believe the costs related to achieving "Year 2000" compliance will be
material.
The Company has initiated communications with its significant suppliers to
determine the extent to which the Company's operations are vulnerable to
those third parties' failure to solve their own "Year 2000" issues. Specific
factors that might cause suppliers to be vulnerable to "Year 2000" issues
include, but are not limited to, the availability and cost of personnel
trained in this area, the ability to locate and correct all relevant computer
codes, and similar uncertainties. There can be no assurance that the systems
of other companies on which the Company relies will be converted on a timely
basis and will not have a material adverse effect on the Company's financial
position or results of operations.
ADDITIONAL RISK FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
FLUCTUATIONS IN OPERATING RESULTS
The Company has experienced from time to time significant period-to-period
fluctuations in revenues and operating results and anticipates that such
fluctuations will occur in the future. These fluctuations may be attributable
to a number of factors, including the volume and timing of orders received
during the quarter, the timing and acceptance of new products and product
enhancements by the Company or its competitors, unanticipated sales and
buyouts of run-time licenses, stages of product life cycles, purchasing
patterns of customers and distributors, market acceptance of products sold by
the Company's customers, competitive conditions in the industry, business
cycles affecting the markets in which the Company's products are sold,
extraordinary events, such as acquisitions, including related charges, and
economic conditions generally or in specific geographic areas. The future
operating results of
17
the Company may fluctuate as a result of these and other factors, including
the Company's ability to continue to develop innovative and competitive
products. In addition, the Company generally does not enter into long-term
agreements with its customers, and the timing of license fees is difficult to
predict. The procurement process of the Company's customers is often several
months or longer from initial inquiry to order and may involve competing
considerations. Further, as licensing of the Company's products increasingly
becomes a more strategic decision made at higher management levels, there can
be no assurance that sales cycles for the Company's product will not
lengthen. Product revenue in any quarter depends primarily on the volume and
timing of orders received in that quarter. The Company has at times
recognized a substantial portion of its total revenue from sales booked and
shipped in the latter part of the quarter; thus, the magnitude of quarterly
fluctuations may not become evident until late in a particular quarter.
Because the Company's staffing and operating expenses are based on
anticipated total revenue levels, and a high percentage of the Company's
costs are fixed in the short term, small variations between anticipated
orders and actual orders, as well as non-recurring or large orders, could
cause disproportionate variations in the Company's operating results from
quarter to quarter. Revenues also are typically higher in the fourth quarter
than in other quarters of the fiscal year, which ends on January 31,
primarily as a result of purchases by customers prior to the calendar year
end, as well as by customers who purchase at the commencement of a new
calendar year. These trends are expected to continue.
Because the software industry is intensely competitive, software vendors have
from time to time experienced price erosion on their products. As is typical
in the software industry, the Company's fixed costs as a percentage of
revenues are high, and significant price erosion could have a material
adverse effect on the Company's revenues and operating results. A number of
additional factors may in the future cause the Company's revenues and
operating results to vary significantly from period to period. These factors
include: software "bugs" or other product quality problems; changes in
operating expenses; changes in Company strategy; personnel changes; foreign
currency exchange rates; and mix of products sold. Although the Company has
been profitable for the last several years on an annual basis, there can be
no assurance that the Company will be able to continue its growth in revenue
or sustain its profitability on a quarterly or annual basis. Due to all of
the foregoing factors, the Company believes that period-to-period comparisons
of its results of operations are not necessarily meaningful and should not be
relied upon as an indication of future performance. It is possible that, in
some future quarters, the Company's operating results will be below the
expectations of stock market analysts and investors. In such event, the price
of the Common Stock could be materially and adversely affected.
RELIANCE ON CORE FAMILY OF PRODUCTS
Revenue from sales of the Tornado-TM- and VxWorks-Registered Trademark-
family of products and services accounted for a significant majority of the
Company's revenues in each of the fiscal
18
years ended January 31, 1998, 1997 and 1996 and the six months ended July 31,
1998. The Company's future results depend heavily on continued market
acceptance of these products in the Company's current markets and successful
application in new markets. Any factor adversely affecting the market for
the Tornado and VxWorks family of products and services could have a material
adverse affect on the Company's business, financial condition and results of
operations. The Company typically charges a one-time fee for a development
license and a run-time license fee for each copy of the Company's operating
system embedded in the customer's products. A key component of the Company's
strategy is to increase revenue through run-time license fees. Any increase
in the percentage of revenues attributable to run-time licenses will depend
on the Company's successful negotiation of run-time license agreements and on
the successful commercialization by the Company's customers of the underlying
products. To the extent that such customers are not successful, the Company
may not be able to meet its objectives, and its business, financial condition
and results of operations could be materially and adversely affected.
COMPETITION
The embedded real-time software industry is highly competitive and is
characterized by rapidly advancing technology. Therefore, the Company's
ability to obtain such business is dependent upon its ability to offer better
strategic concepts and technical solutions, competitive prices, a quicker
response or a combination of these factors. There can be no assurance that
the Company will be able to effectively compete in each of these areas, and
any failure to compete in the embedded real-time software market would have a
material adverse effect on the Company's business, financial condition and
results of operations. In order to maintain or improve its position in the
industry, the Company must continue to enhance its current products and
rapidly develop new products and product extensions. The Company believes
that its principal competition comes from companies that develop real-time
embedded software development systems in-house rather than purchasing such
systems from independent software vendors such as the Company and the Company
is thus subject to the customers' "develop versus buy" decisions in addition
to the factors set forth above. Many of these organizations have substantial
internal programming resources with the capability to develop specific
products for their needs. The Company also competes with other independent
software vendors, including Integrated Systems, Inc., Mentor Graphics, Inc.
(through its acquisition of Microtec/Ready Systems), Microware Systems
Corporation, and Microsoft Corporation. In addition, hardware or other
software vendors could seek to expand their product offerings by designing
and selling products that directly compete with or adversely affect sales of
the Company's products. Many of the Company's existing and potential
competitors have substantially greater financial, technical, marketing and
sales resources than the Company. 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 than the Company. Furthermore, current and
potential
19
competitors have established or may establish cooperative relationships among
themselves or with third parties. Accordingly, it is possible that new
competitors or alliances among competitors may emerge and rapidly acquire
significant market share. In addition, the Company is aware of ongoing
efforts by competitors to emulate the performance and features of the
Company's products, and there can be no assurance that competitors will not
develop equivalent or superior technology to that of the Company. Because a
substantial percentage of the Company's revenues has been derived from sales
of the Tornado and VxWorks family of products and services, the effects of
competition could be more adverse than would be the case if the Company had a
broader product offering. In addition, competitive pressures could cause the
Company to reduce the prices of its products, which would result in reduced
profit margins. There can be no assurance that the Company will be able to
compete effectively against its current and future competitors. If the
Company is unable to compete successfully, its business, financial condition
and results of operations would be materially and adversely affected.
RISKS ASSOCIATED WITH NEW AND CHANGING MARKETS
The Company is continuously engaged in product development for new or
changing markets. In particular, the Company has invested significant time
and effort, together with a consortium of industry participants, in the
development of I(2)O, a new specification that is intended to create an open
standard set of interface specifications for high performance I/O systems.
The specification is intended to be used by system, network and peripheral
interface card and operating systems vendors to simplify the task of building
and maintaining high-performance I/O subsystems. The Company also has
developed IxWorks, a real-time operating system for use in conjunction with
the I(2)O specification. The success of the I(2)O specification and the
IxWorks product line depends heavily on its adoption by a broad segment of
the industry. The Company also has expended, and continues to expend,
substantial time and financial resources to develop embedded operating
software and development tools for Internet applications. The commercial
Internet market has only recently begun to develop, is rapidly changing and
is characterized by an increasing number of new entrants with competitive
products. Moreover, there is an increasing number of new Internet protocols
to which the Company's products must be ported. It is unclear which of these
competing protocols ultimately will achieve market acceptance. If the
protocols upon which the Company's Internet products are based ultimately
fail to be widely adopted, the Company's business, financial condition and
results of operations may be materially and adversely affected. It is
difficult to predict with any assurance whether demand for any of these
products will develop or increase in the future. If these markets, or any
other new market targeted by the Company in the future, fail to develop,
develop more slowly than anticipated or become saturated with competitors, if
the Company's products are not developed in a timely manner, or if the
Company's products and services do not achieve or sustain market acceptance,
the Company's business, financial condition and results of operations would
be materially and adversely affected.
20
RAPID TECHNOLOGICAL CHANGE; DEPENDENCE ON NEW PRODUCTS
The embedded real-time software industry faces a fragmented market
characterized by ongoing technological developments, evolving industry
standards and rapid changes in customer requirements. The introduction of
products embodying new technologies and the emergence of new industry
standards could render the Company's existing products obsolete and
unmarketable. The Company's success depends and will continue to depend upon
its ability to continue to develop and introduce in a timely manner new
products, including new releases, applications and enhancements, that take
advantage of technological advances, to identify and adhere to emerging
standards, to continue to improve the functionality of its Tornado
development environment and the scalability and functionality of the VxWorks
operating system, to offer its products across a spectrum of microprocessor
families used in the embedded systems market and to respond promptly to
customers' requirements. The Company has from time to time experienced delays
in the development of new products and the enhancement of existing products.
Such delays are commonplace in the software industry. There can be no
assurance that the Company will be successful in developing and marketing, on
a timely basis or at all, competitive products, product enhancements and new
products that respond to technological change, changes in customer
requirements and emerging industry standards, or that the Company's enhanced
or new products will adequately address the changing needs of the
marketplace. The inability of the Company, due to resource constraints or
technological or other reasons, to develop and introduce new products or
product enhancements in a timely manner could have a material adverse effect
on the Company's business, financial condition or results of operations.
From time to time, the Company or its competitors may announce new products,
capabilities or technologies that have the potential to replace or shorten
the life cycles of the Company's existing products. There can be no assurance
that announcements of currently planned or other new products by the Company
or others will not cause customers to defer purchasing existing Company
products. Any failure by the Company to anticipate or respond adequately to
changing market conditions, or any significant delays in product development
or introduction, would have a material adverse effect on the Company's
business, financial condition and results of operations.
DEPENDENCE ON VME MARKET
A significant amount of the Company's revenues historically has been derived
from sales of systems built to the VME (versabus module eurocard) standard.
These systems typically are used in high cost, low volume applications,
including military, telecommunications, space and research applications.
Although the Company believes that revenues from sales of products designed
for embedded systems applications will account for an increasing percentage
of the Company's revenues in the future, the Company expects revenues from
the VME market to continue to be significant for the foreseeable future.
Academic institutions and defense industry participants, which generate a
significant portion of the Company's VME revenues,
21
are dependent on government funding, the continued availability of which is
uncertain. Although the Company's VME customers typically have received
government funding prior to placing its product orders with Wind River, any
unanticipated future termination of government funding of VME customers could
have a material adverse effect on the Company's business, financial condition
and results of operations.
MANAGEMENT OF GROWTH; DEPENDENCE ON KEY PERSONNEL; NEED FOR ADDITIONAL PERSONNEL
The Company has experienced, and expects to continue to experience,
significant growth in the number of employees, the scope and complexity of
its operations and financial systems and the geographic area of its
operations. The Company's continued success will depend significantly on its
ability to integrate new operations and new personnel. The Company's ability
to manage future expansion of its operations, if any, will require the
Company to continue to improve its financial and management controls,
reporting systems and procedures on a timely basis and expand, train and
manage its employee work force efficiently. There can be no assurance that
the Company will be able to do so successfully. The Company's failure to do
so could have a material adverse effect on the Company's business, operating
results and financial condition. In addition, the Company anticipates the
need to relocate its management, product development, marketing, sales,
customer support and operations functions to a new facility within the next
year. During fiscal 1998, the Company purchased real property in the City of
Alameda, California for $11.4 million. In fiscal 1998, the Company entered
into an operating lease agreement for its new headquarters facility being
constructed on such property. As of July 31, 1998, the lessor has funded a
total of $17.5 million of construction costs and has committed to fund up to
a maximum of $35 million. The operating lease payments will begin upon
completion of construction. The property is being developed to construct the
Company's new headquarters facility. There can be no assurance that any such
relocation will be accomplished efficiently, or that the Company's operations
will not be materially and adversely affected by such relocation. The
Company's future performance depends to a significant degree upon the
continued contributions of its key management, product development,
marketing, sales, customer support and operations personnel, several of whom
have joined the Company only recently. In addition, the Company believes its
future success will depend in large part upon its ability to attract and
retain highly-skilled managerial, product development, marketing, sales,
customer support and operations personnel, many of whom are in great demand.
Competition for such personnel is particularly intense in the San Francisco
Bay Area, where the Company is headquartered, and there can be no assurance
that the Company will be successful in attracting and retaining such
personnel. The failure of the Company to attract, integrate and retain the
necessary personnel could have a material adverse effect on the Company's
business, financial condition and results of operations.
22
RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS
During the six month period ended July 31, 1998 and the fiscal years ended
January 31, 1998, the Company derived approximately 32% and 29%,
respectively, of its total revenue from sales outside of North America. The
Company expects that international sales will continue to generate a
significant percentage of its total revenue in the foreseeable future. The
Company also expects to make substantial investments to expand further its
international operations and to increase its direct sales force in Europe and
Asia. There can be no assurance that these investments will result in
commensurate increases in the Company's international sales. International
operations are subject to certain risks, including foreign government
regulation; more prevalent software piracy; longer payment cycles; unexpected
changes in, or imposition of, regulatory requirements, tariffs, import and
export restrictions and other barriers and restrictions; greater difficulty
in accounts receivable collection; potentially adverse tax consequences
including restrictions on repatriation of earnings; the burdens of complying
with a variety of foreign laws; staffing and managing foreign operations;
political and economic instability; changes in diplomatic and trade
relationships; possible recessionary environments in economies outside the
United States; and other factors beyond the control of the Company. There can
be no assurance that such factors will not have a material adverse effect on
the Company's international sales and consequently, the Company's business,
operating results and financial condition. Sales by the Company's foreign
subsidiaries are denominated in the local currency, and an increase in the
relative value of the dollar against such currencies would reduce the
Company's revenues in dollar terms or make the Company's products more
expensive and, therefore, potentially less competitive in foreign markets.
There can be no assurance that the Company's future results of operations
will not be adversely affected by currency fluctuations. A portion of the
Company's international revenues are derived from the Asia Pacific region
including Japan. In recent months, economic uncertainty and related
weakening of foreign currencies, particularly the Japanese yen, against the
dollar, has occurred. As a result, the Company's future sales in this region
may be adversely affected which could have a material adverse effect on the
Company's business, results of operations and financial condition. The
Company relies on distributors for sales of its products in certain foreign
countries and, accordingly, is dependent on their ability to promote and
support the Company's products and, in some cases, to translate them into
foreign languages. The Company's international distributors generally offer
products of several different companies, including in some cases products
that are competitive with the Company's products, and such distributors are
not subject to any minimum purchase or resale requirements. There can be no
assurance that the Company's international distributors will continue to
purchase the Company's products or provide them with adequate levels of
support. Any changes in the relationships the Company has with its
international distributors may have a material adverse effect on the
Company's business, operating results and financial condition.
23
RISKS ASSOCIATED WITH ACQUISITIONS
As part of its business strategy, the Company has recently completed the
acquisitions of Objective Software Technology, Ltd. and Zinc Software
Incorporated, has acquired equity interests in Emultek, Ltd. and 3Soft GmbH
and has also licensed certain technologies from Network Computer, Inc. The
Company expects to make additional acquisitions of, or significant
investments in, businesses that offer complementary products, services and
technologies. Any acquisitions or investments will be accompanied by the
risks commonly encountered in acquisitions of businesses and technologies
including, among other things, the difficulty of assimilating the operations
and personnel of the acquired businesses, the potential disruption of the
Company's ongoing business, the inability to integrate acquired technologies
into new and existing products, the inability of management to maximize the
financial and strategic position of the Company, the maintenance of uniform
standards, controls, procedures and policies and the impairment of
relationships with employees and customers as a result of any integration of
new management personnel. These factors could have a material adverse effect
on the Company's business, results of operations or financial condition.
Consideration paid for future acquisitions, if any, could be in the form of
cash, stock, debt, rights to purchase stock or a combination thereof.
Dilution to existing stockholders and to earnings per share may result to the
extent that shares of stock or other rights to purchase stock are issued in
connection with any such future acquisitions.
RISKS OF PRODUCT DEFECTS; PRODUCT AND OTHER LIABILITY
As a result of their complexity, software products may contain undetected
errors or compatibility issues, particularly when first introduced or as new
versions are released. There can be no assurance that, despite testing by the
Company and testing and use by current and potential customers, errors will
not be found in new products after commencement of commercial shipments. The
occurrence of such errors could result in loss of or delay in market
acceptance of the Company's products, which could have a material adverse
effect on the Company's business, financial condition and results of
operations. The increasing use of the Company's products for applications in
systems that interact directly with the general public, particularly
applications in transportation, medical systems and other markets where the
failure of the embedded system could cause substantial property damage or
personal injury, could expose the Company to significant product liability
claims. In addition, the Company's products may be used for applications in
mission-critical business systems where the failure of the embedded system
could be linked to substantial economic loss. Although the Company has not
experienced material adverse effects resulting from any such errors to date,
there can be no assurance that, despite testing by the Company and testing
and use by current and potential customers, errors will not be found in new
products after commencement of commercial shipments, resulting in loss of or
delay in market acceptance, which could have a material adverse effect upon
the Company's business, operating results and financial condition. Although
the Company's license and other agreements with its customers typically
contain provisions designed to limit the Company's exposure to potential
24
product liability and other claims, these provisions may not be effective in
all circumstances and in all jurisdictions. Although the Company has not
experienced any product liability or economic loss claims to date, the sale
and support of the Company's products entails the risk of such claims. The
Company carries insurance against product liability risks and errors or
omissions coverage, although there can be no assurance that such insurance
will continue to be available to the Company on commercially reasonable terms
or at all. A product liability claim or claim for economic loss brought
against the Company in excess of or outside the limits of its insurance
coverage, or a product recall involving the Company's software, could have a
material adverse effect on the Company's business, financial condition and
results of operations.
IMPACT OF THE YEAR 2000
Many older computer software programs use two digits in their date fields,
identifying years by the last two digits only. Such programs may interpret
the year 2000 as 1900 instead, causing such systems to fail after 1999.
Although the Company believes its products will not have such date-related
failures, it has not yet performed the testing and analysis necessary to
permit identification and correction of Year 2000 issues in its internal
computer and information systems and office equipment. There can be no
assurance that the Company will be able to identify and correct any such
problems successfully and in the requisite time frame. Year 2000 issues also
could affect the Company's suppliers and customers. Unresolved Year 2000
issues within the Company, its significant suppliers or customers could have
a material adverse effect on the Company's business, results of operations
and financial condition.
LIMITED PROTECTION OF PROPRIETARY TECHNOLOGY; RISKS OF INFRINGEMENT
The Company's success is heavily dependent upon its proprietary technology.
To protect its proprietary rights, the Company relies on a combination of
copyright, trade secret, patent and trademark laws, nondisclosure and other
contractual restrictions on copying, distribution and technical measures. The
Company seeks to protect its software, documentation and other written
materials through trade secret and copyright laws, which provide only limited
protection. In addition, the Company has two United States patent
applications pending. There can be no assurance that patents will issue from
the Company's pending applications or that any claims allowed will be of
sufficient scope or strength (or be issued in all countries where the
Company's products can be sold) to provide meaningful protection or any
commercial advantage to the Company. As a part of its confidentiality
procedures, the Company generally enters into nondisclosure agreements with
its employees, consultants, distributors and corporate partners and limits
access to and distribution of its software, documentation and other
proprietary information. End user licenses of the Company's software are
frequently in the form of shrink wrap license agreements, which are not
signed by licensees, and therefore may be unenforceable under the laws of
many jurisdictions. Despite the Company's efforts to protect its proprietary
rights, it may be possible for unauthorized third parties to copy the
Company's products or to reverse engineer or obtain and use information that
the
25
Company regards as proprietary. There can be no assurance that the Company's
competitors will not independently develop technologies that are
substantially equivalent or superior to the Company's technologies. Policing
unauthorized use of the Company's products is difficult, and while the
Company is unable to determine the extent to which software piracy of its
products exists, software piracy can be expected to be a persistent problem.
In addition, effective protection of intellectual property rights may be
unavailable or limited in certain countries. The status of U.S. patent
protection in the software industry is not well defined and is likely to
evolve as the U.S. Patent and Trademark Office grants additional patents.
Patents have been granted on fundamental technologies in software, and
patents may issue in the future that relate to fundamental technologies
incorporated into the Company's products.
As the number of patents, copyrights, trademarks, trade secrets and other
intellectual property rights in the Company's industry increases, products
based on the Company's technology may increasingly become the subject of
infringement claims. The Company has received in the past and may receive in
the future letters from third parties asserting infringement claims against
the Company. There can be no assurance that third parties will not assert
infringement claims against the Company in the future. Any such claims,
whether with or without merit, could be time consuming, result in costly
litigation, cause product shipment delays or require the Company to enter
into royalty or licensing agreements. Such royalty or licensing agreements,
if required, may not be available on terms acceptable to the Company, or at
all, which could have a material adverse effect on the Company's business,
financial condition and results of operations. In addition, the Company may
initiate claims or litigation against third parties for infringement of the
Company's proprietary rights or to establish the validity of the Company's
proprietary rights. Litigation to determine the validity of any claims,
whether or not such litigation is determined in favor of the Company, could
result in significant expense to the Company and divert the efforts of the
Company's technical and management personnel from productive tasks. In the
event of an adverse ruling in any such litigation, the Company might be
required to pay substantial damages, discontinue the use and sale of
infringing products, expend significant resources to develop non-infringing
technology or obtain licenses to infringing technology.
LEVERAGE
In connection with the sale of Convertible Subordinated Notes in fiscal 1998,
the Company incurred $140 million in debt which resulted in an increase in
its ratio of long-term debt to total capitalization. As a result of this
additional indebtedness, the Company's principal and interest obligations
have increased substantially. The degree to which the Company will be
leveraged could materially and adversely affect the Company's ability to
obtain financing for working capital, acquisitions or other purposes and
could make it more vulnerable to industry downturns and competitive
pressures. The Company's ability to meet its debt service obligations will be
dependent upon the Company's future performance, which will be subject to
26
financial, business and other factors affecting operations of the Company,
many of which are beyond its control.
VOLATILITY OF STOCK PRICE
The market price of the Company's Common Stock has fluctuated in the past,
and is likely to fluctuate in the future. The Company believes that various
factors, including quarterly fluctuations in results of operations,
announcements of new products by the Company or by its competitors, and
changes in the software industry in general may significantly affect the
market price of the Common Stock. In addition, in recent years the stock
market in general, and the shares of technology companies in particular, have
experienced extreme price fluctuations. This volatility has had a substantial
effect on the market prices of securities issued by the Company and other
high technology companies, often for reasons unrelated to the operating
performance of the specific companies. The market prices of many high
technology companies' stocks are at or near their historical highs and
reflect price/earning ratios substantially above historical norms. There can
be no assurance that the market price of the Common Stock will remain at or
near its current level. In the past, following periods of volatility in the
market price of a company's securities, securities class action litigation
has often been instituted against that company. Such litigation, if
instituted against the Company, could result in substantial costs and a
diversion of management attention and resources, which would have a material
adverse effect on the Company's business, financial condition and results of
operation, even if the Company is successful in such suits. These market
fluctuations, as well as general economic, political and market conditions
such as recessions, may adversely affect the market price of the Common
Stock.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is a party to litigation arising in the normal course of
its business. The Company believes that such litigation, even if
resolved adversely to the Company, would not have a material effect
on its business, financial condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO THE VOTE OF SECURITY HOLDERS
The Company's Annual Meeting of Shareholders was held on June 25,
1998 in Alameda, California. Of the 26,074,460 shares outstanding as
of the record date, 23,663,963 were present or represented by proxy
at the meeting. The following matters were submitted to a vote of
the security holders:
(1) To elect the following to serve as Directors of the Company:
Name For Withheld
---- --- --------
Jerry L. Fiddler 23,518,248 145,715
Ronald A. Abelmann 23,518,398 145,565
David Wilner 23,518,398 145,565
William B. Elmore 23,518,398 145,565
David B. Pratt 23,518,398 145,565
(2) To approve an amendment to the Company's Certificate of Incorporation
to increase the number of shares of Common Stock that the Company is
authorized to issue from 75,000,000 to 125,000,000:
Votes for: 22,550,483
Votes against: 1,085,558
Votes abstaining: 27,922
(3) To approve an amendment to the Company's 1998 Equity Incentive Plan
and the issuance of 1,000,000 shares of Common Stock:
Votes for: 18,246,218
Votes against: 5,372,623
Votes abstaining: 45,122
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(4) To ratify the Company's appointment of PricewaterhouseCoopers LLP as
the Company's independent accountants for the fiscal year ending
January 31, 1999:
Votes for: 23,631,838
Votes against: 10,076
Votes abstaining: 22,049
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
10.22 1998 Equity Incentive Plan
10.23 Form of Option Agreement
27.1 Financial Data Schedule
(b) REPORTS ON FORM 8-K
None.
No other items.
SIGNATURE
Pursuant to the Securities Exchange Act of 1934, the Registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto
authorized.
WIND RIVER SYSTEMS, INC.
Date: September 14, 1998 \s\ RICHARD W. KRABER
----------------------------
Richard W. Kraber
Chief Financial Officer
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