August 25, 1999 - 5:15pm
Hambrecht & Quist
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Company: Wind River Systems
Price: 15.5
Recommendation: Market Perform
Notes: a, b,f
Date: 8/25/99
1 of 2 Wind Reports Mixed July Quarter. Maintain Market Perform.
* Wind reported July quarter results with EPS of 14¢ below the consensus of 16¢.
* Near-term we remain cautious as Wind has embarked on a significant internal
reorganization, continues to seek a CEO, and continues to invest in
infrastructure and new product initiatives.
* Management did take a strong step forward towards improving visibility by
revealing the revenue contribution of many products (i.e. I20, Tornado for
Managed Switches) in the qtr.
* We believe the shares will trade horizontally, or at a modest discount to
the expected 25% growth rate, until visibility improves and the near-term
transition risk subsides.
* We maintain our Market Perform.
1999 A 2000 E 2001 E
Q1 EPS $0.11 $0.11a $
Q2 EPS 0.14 0.14a
Q3 EPS 0.17 0.17
Q4 EPS 0.20 0.22
FY EPS 0.61 0.63 0.85
FY REVS (M) 129.4 161.6 190.0
CY EPS 0.63 0.85 --
CY P/E 25 18 --
FY Ends Jan Current Price $15.50
52-Week Range $11-34 Market Cap (M) $677
Shares Out (M) 43.74 Book Value $3.83
Net Cash/Share $1.96 3-Year EPS Growth 25%
CY00 P/E-to-Growth 92%
Summary Wind reported mixed July quarter results with revenues of $39.6
million ahead of the consensus estimate and earnings of 14¢ short of the
consensus 16¢ and our original estimate of 17¢. Recall we lowered our
estimates to 12¢ for the quarter and 63¢ for fiscal 2000 when we downgraded
the shares on July 8. Following the July quarter, we continue to remain
concerned with the lack of visibility and transition risk associated with many
of Wind's new vertical initiatives and a vacant CEO post. Wind also announced
a formal reorganization along business units which adds to the near-term risk
but represents a logical step forward as the company seeks to lay the
foundation for growth reacceleration into fiscal 2001 and beyond. Now that
the Street has lowered fiscal 2000 estimates to our 63¢ range, we believe the
shares will likely trade horizontally through the remainder of this transition
period. Management did take a strong step forward towards improving visibility
by revealing the revenue contribution of many products (i.e. I20, Tornado for
Managed Switches) in the quarter. While this provides a snapshot of the
business today, management did not commit to providing such details in the
future which is a step back in our opinion.
Hunting for the Next Leg of Growth As we discussed in previous reports, we
believe Wind River is at a crossroads in the embedded market. Over the past
three years, the market opportunity has matured from 40%+ growth to a more
ambient 25% level due to a confluence of events including greater competition,
increasing device complexity (i.e. the need for more customization), overall
softness in semiconductor demand, weakness in Asia, and slower than
anticipated ramp in consumer demand for embedded devices. In an effort to
reaccelerate growth, Wind and other vendors like Integrated Systems have
focused on several key verticals that comprise the bulk of the embedded growth
opportunity including telecom, transportation, consumer, and office
automation. Over the past three years, building on acquisitions and internal
development, Wind has released several subsets of its flagship Tornado
development environment tailored for many of these verticals. Specifically
those are :
Product Announced First Shipment
Tornado for I2O February 1996 October 1997
Tornado for Embedded Internet June 1997 Third Quarter 1997
Tornado for Java July 1997 March 1998
Tornado for DSP September 1997 Fourth Quarter 1997
Tornado for PersonalJava March 1998 Second Quarter 1998
Tornado for Digita April 1998 April 1998
Tornado for TrueFFS July 1998 July 1998
Tornado for Automotive Control February 1999 February 1999
Tornado for Managed Switches October 1998 Second Quarter 1999
Gauging Wind's Vertical Success Traditionally Wind management has been
tight-lipped about the performance of these products so gauging Wind's
vertical success has been a qualitative and challenging exercise. The July
quarter marks the first in which management unveiled some details on these
initiatives and recent acquisitions. In general we believe it is still too
early to say which verticals will ultimately drive the reacceleration in
growth Wind management is hoping for. Clearly some have shown success while
others lag expectations considerably. To the degree management is willing to
provide details on vertical performance, we believe the next several quarters
will be most critical in assessing Wind's growth potential and investment
merit over the next several years.
Tornado for I2O has been a huge moving target since its initial release in
1996, fueling much speculation as to when and if a significant ramp in
royalties would ever occur. In the July quarter, I2O royalties were reported
at $1.5 million (5.2% of total license sales). I2O royalties are generated
from multiple streams, the most substantial of which is Intel. Due to an
acceleration in Intel's accounting of i960 shipments in the June quarter, Wind
recognized royalties for both the March ($363k) and June ($408k) periods in
the July quarter ($745k total). The other two royalty-bearing relationships
are with Symbios and StrongArm (formerly DEC, now Intel). StrongArm and
Symbios contributed $745k in aggregate, reflecting guaranteed prepaids that
extend into Q1 of 2000 rather than actual royalties. As a result, it is
plausible that Wind may experience a rather significant (at least half) drop-
off in I2O royalties in the second quarter of fiscal 2001 unless end-market
demand ramps up on these platforms.
Tornado for Managed Switches underperformed as we had suspected in our recent
downgrade. While Wind announced the product in October 1998 and has more or
less maintained roughly $2 million in bookings since that time. In the first
quarter, roughly $300k was recognized as the product was delayed and the bulk
of bookings carried over into Q2. Yet despite shipping "on-time", only $326k
in revenues were recognized in the second quarter, essentially flat on a
sequential basis. The confusion here relates to two different versions of
TMS. TMS version 1 was released June 30 and we believe is most appropriately
described as a prerelease. While the product is fully functional, it does not
incorporate all the functionality originally promised when the $2 million in
booking were logged. That incremental release is version 2, which as we had
expected, will not be available until sometime next month. As a result, Wind
cannot recognize the remaining bookings until that time. In addition,
management mentioned that 3 customers require functionality that will not be
available until TMS version 3, though the company has yet to commit to a
release date for that product. Despite these near-term speed bumps, we
believe the longer-term prospects for TMS are impressive given that the
product carries a significantly higher ASP than that of the stand-alone
Tornado offering (up to 5x) and considering that initial customers include MMC
Networks, Ardent, Cerent, Broadcom and PMC-Sierra.
Routerware turned in a decent quarter considering the usual disruption caused
by acquisitions and personnel integration. Revenues grew 100% year over year
to $1.2 million, (4.2% of total license sales). Through both the Routerware
and Xact acquisitions, Wind has added an incremental 50 engineers with
expertise in the telecom vertical which will likely prove valuable in
establishing the new Wind Networking unit.
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