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Technology Stocks : Wind River going up, up, up! -- Ignore unavailable to you. Want to Upgrade?

To: lkj who wrote (9313)	3/8/2001 1:21:27 PM
From: Allen Benn	Read Replies (2) \| Respond to of 10309

What contributed to this lag [in WIND’s reaction to the Asian crisis]? Is there anything in WIND's royalty recognition that could attribute to this? Just prior to the beginning of Asian crisis, WIND was probably on the verge of breaking out seriously to the upside. The crisis slowed new projects to a standstill, but existing projects continued into production heightening royalty revenues. It is likely that WIND’s conservative revenue recognition policies contributed to the lag, as royalty reports lagged actual shipments by one or more quarters, and deferred royalty income kept flowing in irrespective of production activity. As the pace of new designs began to pick up when the crisis was over, royalties served the opposite role of holding revenues back until newer designs were ready for production. Knowing this would happen is why a year ago I called for revenues to accelerate throughout FY 2001. If WIND were to see a similar slowdown as it faced during the Asia Crisis, how many quarters would the "lag" be for today's WindRiver System? I’m not sure investors will notice any impact of the slowdown on WIND’s revenues and earnings, if only because recent company performance emerging from the Asian crisis has been tepid compared to its potential, and because management guidance is conservative. Indeed, by almost any definition, WIND appears to be recession-proof going forward, due to the counter-forces cited above and others cited by management during the recent conference call. It is instructive to review the many counter-cyclical factors that combine to keep WIND recession-proof: 1. The sizeable lag between product license growth changes and royalties, which dampens revenues in good times while increasing them when things slow down. 2. In good times volumes ramp, but volume discounts keep revenues from growing proportionally, with the opposite effect when the economy slows. 3. In bad times, OEMs must get the jump on new products, with staff cut as lean as possible, which forces management to take a stand against in-house OSs and inefficient staff work. In good times, all sorts of inefficiencies are overlooked by management as they worry mostly about keeping engineers happily on-board in a tight labor market. 4. Similarly, small competitors to WIND are suffered during good times, as OEMs are willing to experiment more and use their own resources to fill in for inadequacies – always preferring as much NIH as possible. A slowdown forces a no-nonsense attitude that permeates most organizations. 5. Total, vertical solutions with huge barriers to competition preventing loss of designs and providing pricing power take on more importance during bad times than when everything is foot-loose and fancy-free. (This factor was not present during the Asian crisis). 6. Total market dominance following the ISI merger shores up pricing power during bad times, but is not exercised as much during good times so as to win over powerful partners. (Not only was this factor not present during the Asian crisis, but ISI was a major thorn in WIND's side, as the secondary player tried especially hard to win designs with aggressive pricing.) 7. Semiconductor prices come under extreme pressure during bad times, lowering the breakeven point for 32-bit microprocessor solutions with high hardware content (memory, DSPs, etc.), making designs practical at the margin. Countering this, however, is the higher bar design teams must jump to gain financial approval. 8. Fewer startups in bad times (bad for WIND), but those that do get funding are more focused on getting products developed with the least risk in the shortest time (good for WIND). 9. WIND’s broad market penetration has kept the company from exploding to the high side during bad times, but it enables it to find and emphasize market niches that continue to grow nicely during slowdowns. All it takes is one maturing lily pond and WIND could perform this year at a pace far faster than expected. I can’t begin to forecast the net effects of all these countervailing forces. But what I can predict is that the slowdown will be much less severe on WIND than most technology companies, and there may not be any perceived impact at all. Since WIND’s revenues dropped from 45% growth to 22% during the Asian crisis, I would expect better performance this time because many of the factors above are both powerful and new this time around. This is why I would guess that management’s 30% guidance fairly represents the low end of WIND's performance over the upcoming year. To the extent that there is a noticeable slowdown, I would expect it to start with product license sales and work its way through to royalties in six months to a year. This is why I have started paying closer attention than usual to product license sales and why the issue concerning an appropriate metric for design wins is important. I’ll try to put some color on the issue in another post. Allen