Wind River Systems, Inc. F3Q09 (Qtr End 10/31/08) Earnings Call Transcript

Wind River Systems, Inc. (WIND)

F3Q09 Earnings Call

December 4, 2008 5:00 pm ET

Executives

Anne Marie McCauley – Vice President of Investor Relations

Ken Klein – Chairman, Chief Executive Officer and President

Ian R. Halifax – Chief Financial Officer

Analysts

Matthew Petkun - D. A. Davidson & Co.

Michael Huang - Thinkequity LLC

Nabil Elsheshai - Pacific Crest Securities

Kevin Buttigieg - Stanford Group Co.

Brent Williams - The Benchmark Co.

Richard Williams - Cross Research

Presentation

Operator

Ladies and gentlemen, good afternoon and thank you for joining the Wind River Systems Q3 fiscal year 2009 earnings conference call. After prepared comments by management, the company will host a Q&A session. At this time I will turn the call over to Anne Marie McCauley, Vice President of Investor Relations at Wind River Systems. Ms. McCauley, you may begin.

Anne Marie McCauley

Thank you Christian. Thank you. Good afternoon and welcome to Wind River’s Q3 fiscal 2009 conference call. Joining me today is Ken Klein, our Chairman and CEO and President, and Ian Halifax, our CFO.

Before we start, I’d like to remind you that this call is being webcast. The webcast and the third quarter update presentation can be accessed on the Wind River Investor Relations website at www.windriver.com. A replay will also be available shortly after the conclusion of the call and will remain available for approximately one year.

The purpose of this call is to provide you with information regarding Q3 FY ’09. However, some of our comments and responses to your question will include forward-looking statements such as statements regarding our estimated revenue; GAAP net income per share; non-GAAP income per share; and estimated margins, cash flows and tax rates for the upcoming quarter or full fiscal year 2009; directional commentary on expected financial performance for fiscal year 2010; potential design wins; market opportunities; and expected business and market growth and development; new business models; expected new products or product features; and the benefit of new products and return on investments we have made on our products, sales organization and alliances.

These forward-looking statements are based on certain assumptions and are subject to a number of risks and uncertainties. Actual future results may vary materially. I encourage you to read the risk factors described in the company’s annual report on Form 10-K for the fiscal year ended January 31, 2008 as well as other reports filed with the SEC after that date, including our Form 8-K filed today.

I’d also like to point out that results discussed today include certain supplement, non-GAAP financial measures. We provide these non-GAAP financial measures because we believe that they provide important supplemental information about our core operating results. These non-GAAP financial measures have not been prepared under any comprehensive set of accounting rules. All non-GAAP financial measures should be read in conjunction with the comparable GAAP information.

For a description of non-GAAP financial measures and reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures, please see the section of Wind River’s earnings release issued today entitled About Non-GAAP Financial Measures and supplemental information posted on the Wind River Investor Relations website at www.windriver.com.

With that I’ll turn the call over to Ken Klein.

Ken Klein

Thanks Anne Marie and good afternoon everyone. Our Q3 results demonstrate another quarter of solid execution. Given the difficult economic environment, we are pleased with our performance and remain focused on our strategy of targeting select and diverse vertical markets, enhancing our product portfolio, and optimizing our go to market model and alliance partnerships.

Revenue for the quarter was $91.6 million, an increase of 12% over Q3 last year. Bookings also showed double-digit growth. The combination of deferred revenue and services backlog was approximately $155 million, an increase of 15% over Q3 last year. Q3 GAAP net income per share was $0.08. Non-GAAP earnings per diluted share were $0.14, an increase of 75% over the $0.08 reported in Q3 last year.

Our focus this year is on consistent execution and return on investment. Our Q3 results underscore our ability to deliver on our commitments. While we are by no means immune from the trends in the macro environment, we believe our value proposition of enabling customers and partners to do more with less is increasingly compelling. To that end, we again had solid sales close rates in Q3 and have a robust sales pipeline as we enter Q4.

Let me take a few minutes to review Q3 highlights and to describe the key market trends that are benefiting us. We are encouraged by the success of our sales teams’ ability to sell higher and more broadly into customers organizations, resulting in a higher frequency of larger transactions. This quarter we had ten deals that were $1 million or greater and 144 deals greater than $100,000. These transactions are spread across all our target vertical markets.

We also had another strong design win quarter, with design wins surpassing 300 in Q3. From a product line perspective, VxWorks 6 bookings were up 45% year-over-year. Results were very solid in our aerospace and defense vertical market. In this segment we had a number of key wins, further adoption of our avionics offering and continued interest in our MILS platform. Leveraging the combination of our VxWorks portfolio and professional services, we had a meaningful win in A&D with a major defense prime subcontractor.

This customer was able to preserve and enhance valuable intellectual property by porting a large legacy code base to VxWorks. This resulted in the customer having a solution that was delivered on time and within budget. We continued to expand our presence in the avionics market with bookings for our ARINC 653 solution up 20% over the quarter a year ago. This platform provides customers the proven, safe and reliable solution to their safety critical control systems.

Customer wins in Q3 for the VxWorks 653 platform were geographically focused in the Americas and Asia, with device types ranging from aircraft to helicopters to next generation space launch vehicles. We are also seeing a healthy interest in the VxWorks for the MILS Multiple Independent Layers of Security architecture. As a reminder, MILS enables our defense and commercial customers to build systems with certified high assurance and can securely and concurrently process classified or commercial data from multiple sources.

At the recent MILCOM 2008 event four major defense suppliers, Boeing, Lockheed Martin, Raytheon and Rockwell Collins each demonstrated their own proprietary systems running securely and concurrently on a single hardware system utilizing our VxWorks MILS platform. We continue to see strong demand for our VxWorks based offerings in the industrial vertical market as well. During the quarter, we had a large industrial services win with a global transportation firm. The customer manufactures locomotive equipment and selected our VxWorks based certified solution and services.

In Q3, we had another excellent Linux quarter as bookings grew 115% over last year. We are well positioned to achieve sales in excess of $65 million in FY ’09. We continue to make progress with the execution of our strategy in the mobile handset and mobile internet device or MID Vertical. Participating in each of the leading mobile Linux consortia, the Open Handset Alliance, i.e. Google’s Android, Intel’s Moblin and LiMo positions Wind River to strategically benefit regardless of which mobile Linux approach the market ultimately embraces.

We have multiple opportunities with both handset manufacturers and mobile operators looking to offer Linux based mobile devices. In Q3 with the open source availability of Android, we announced we will offer a commercial Android solution. The commercial platform for Android is expected to include the latest open source Android software, Wind River’s commercial grade Linux including Android specific patches, and pre-integrated third party technologies to help commercialized Android.

As we mentioned on our last earnings call, in Q2 we had a services led Android based design win with a major mobile operator. During Q3 we extended this transaction, leveraging our Android commercialization and integration expertise. In addition, this win has opened the door to negotiations with several OEMs and ODMs within the operator’s supply chain.

During the quarter, we also expanded our system integration business with Kyocera with the development of their next generation, Android based Smartphone. We are now positioned to derive per unit fees from Kyocera tied to their production and volumes. We closed the acquisition MIZI Research during Q3 and are very encouraged by the mobile expertise and customer leverage they bring to our mobile Linux efforts.

Wind River entered the mobile internet device or MID market in partnership with Intel in Q2. We are now developing a commercial, mobile in base, Linux platform for the MID market. While this platform will evolve over the next few quarters, we completed the first generation demonstration platform during Q3, facilitating initial engagements and potential customers in this new market.

We are seeing broader adoption of Linux solutions in the automotive infotainment market. We had a new system integration win with a tier one European supplier to BMW and early adopt of our Linux platform for entertainment. They are now developing an infotainment platform for another large European automotive manufacturer. Q3 marked another quarter of strong growth in our networking equipment vertical with healthy demand for all of our portfolio products; VxWorks, Linux, Tools and Device Management.

In Q3 we had one major network equipment provider broadly adopt our technology in the networking vertical. Additionally, all 20 of the top 20 networking equipment providers are now using our VxWorks solution, our Linux solution or both in their network equipment offerings. Customers purchasing our network solutions in Q3 included Alcatel-Lucent, Ericsson, Motorola, Nokia Siemens, Tellabs, and ZTE.

Finally, our device management product line delivered a record quarter. We added 14 new customers and had a major customer renew and increased our device management business, based on successful adoption over the past year. While still early, our test in diagnostic value proposition is starting to resonate with customers as evidenced by its increasing inclusion in large transactions.

We are seeing continued signs that our DSL strategy, marked by decisions to buy commercial solutions versus build solutions internally, is taking hold within our customer base. Two notable customer wins exemplify this where our solutions were selected to supplant in house solutions. One win was with a global manufacturer of multi-function printers. They extended a multi year agreement to use both our VxWorks and Linux offerings across multiple product lines. They also selected our test management solution for use with a Wind River Linux based, multi-function printer in an effort to improve time to market and reduce costs associated with device testing.

A second is an exemplar build to buy win. The customer, a leading provider of silicon systems and software technologies had been using homegrown tools in conjunction with a small number of VxWorks seats. We were able to significantly expand our relationship with the customer by helping them improve time to market with predictable product releases and increased engineering efficiency.

We leveraged past professional services success and our strong reputation for quality products. In a multi-year transaction, the customer purchased a number of our portfolio products including VxWorks, Workbench and services.

Before I turn the call over to Ian, I would like to summarize. To reiterate, our focus this year has been on continuous execution and driving return on the investments we made in prior years. Year-to-date, we have delivered on these objectives. Given our investments, vertical market focus, targets of strategic initiatives and diversified business across products, industries, and geographies we believe we remain well positioned to continue this momentum. Thank you very much.

Ian R. Halifax

Thank you Ken. Good afternoon. I would now like to review our third quarter fiscal year 2009 financial performance. Additionally, we will review guidance for the fourth quarter and fiscal year 2009, as well as provide directional commentary on fiscal year 2010.

For the third quarter of fiscal year 2009, net revenues were $91.6 million reflecting a 12% increase over the third quarter of fiscal year 2008. Subscription revenue for the quarter was up 3% year on year to $31.8 million. Product revenue, including project based, perpetual and term licenses as well as production licenses was $37.4 million, up 26% compared to $29.7 million in the third quarter in fiscal year 2008.

Perpetual and term licenses contributed $21.3 million to product revenue, reflecting continued strong adoption of our recently implemented term license model. Going forward, we anticipate product revenue to trend above last year’s run rate, due to our shift to term licenses for large, multiple element arrangements. Production license revenue declined 21% to $16.1 million compared with Q3 a year ago.

However, core or run rate production licenses, those attributed to our customers device production last quarter, remained flat. The decline was primarily due to a lower level of compliance activity and one time block purchases in the quarter compared with the same quarter a year ago. We anticipate a low level of compliance revenue going forward and have factored this into our guidance.

Services revenue, including maintenance, professional services and training, was $22.3 million, up 6% compared to the same quarter a year ago. Deferred revenue for the quarter ended at

$125.8 million, representing a 9% increase over the third quarter of fiscal year 2008. It’s important to note our deferred revenue balances include a negative foreign exchange impact of approximately $4.8 million compared to last quarter.

At the end of the third quarter we had services backlog of approximately $29 million. This represents an increase of over 50% compared to the same quarter a year ago. The combination of deferred revenue and services backlog this quarter is approximately $155 million, representing an increase of 15% over the third quarter of fiscal year 2008. As a reminder, this message is intended to provide a gauge of the overall demand for our products and services.

VxWorks revenue for the third quarter fiscal year 2009 was $65.5 million, an increase of 9% compared to the third quarter of fiscal year 2008. Linux revenue this quarter was $13.3 million, an increase of 71% compared to the same quarter a year ago. Other revenue including revenue from non-core products, design services, tools and device management for the third quarter of fiscal year 2009 were $12.7 million, a decrease of 7% compared to the same quarter a year ago.

In certain geographies, the Americas represented 57% of total revenue for the third quarter, EMEA contributed 22%, and Asia-Pacific including Japan contributed 21%. In terms of bookings some of the top customers in the quarter included Ericsson, Kyocera, LSI Wajig, Lockheed, Motorola, Nokia Siemens Networks, Siemens, Tellabs, Xerox and ZTE. We had 144 deals greater than $100,000 during the quarter and we had ten deals that were $1 million or greater during the quarter.

Our bookings profile by end market for the quarter is as follows. Network infrastructure accounted for 35%, aerospace and defense 27%, industrial and automotive 19%, and digital consumer also 19%. Gross margin on a non-GAAP basis for the third quarter fiscal year 2009 was 79%, a slight increase over the third quarter a year ago. This was driven primarily by the increasing revenue from term licenses.

As anticipated, non-GAAP offering expenses increased in Q3 from Q2 levels to $60.7 million. The sequential increase of $2.3 million or 4% was primarily due to compensation expense, sales commissions, and professional services. We remain very focused on managing spend, anticipating quarterly non-GAAP operating expenses slightly in excess of $63 million. Non-GAAP operating income in the third quarter was $11.5 million compared to $5.1 million in the same quarter a year ago. This translates into third quarter non-GAAP operating margin of 13%.

Interest and other income on a non-GAAP basis was $1.2 million for the quarter. The impact of FAS 123R, expensing of stock based compensation in the quarter, was $4.1 million. We incurred a one time acquisition of $0.3 million in the quarter related to the closing of the recent MIZI acquisition. We incurred an impairment expense of $0.4 million relating to a small component of our investment portfolio.

Net income on a GAAP basis in the third quarter of fiscal year 2009 was $5.9 million compared to a net loss of $0.1 million in the same quarter a year ago. Non-GAAP net income in the third quarter fiscal year 2009 was $11.6 million compared to $7.2 million in the same quarter a year ago, an increase of 62%.

On a diluted share base of 78.6 million shares, GAAP net income per share in the third quarter was $0.08. On a diluted share basis of 79.9 million shares, non-GAAP earnings per share in the third quarter were $0.14, an increase of 75% over the same quarter a year ago. Cash flow from operations was $5.1 million for the quarter, up from $0 in the same quarter a year ago. Operating cash flow tends to be seasonally light in Q3, primarily due to bonus payments made in the quarter related to results from operations for the first half of the year.

Q3 FY ’09 ended with $161.2 million in cash, cash equivalents and investments. Our cash balances were negatively impacted by foreign exchange by approximately $7.7 million. During the third quarter 2009, we completed the acquisition of MIZI Research for a total amount of approximately $16 million. Also during the third quarter, we repurchased 2 million shares for a total amount of $20 million. This brings the shares repurchased in FY ’09 to 30 million for a total amount of $105 million. We currently have a balance of $45 million available to buy back shares.

The accounts receivable balance as of October 31, 2008 was $71.8 million. Days sales outstanding was 71 days. Depreciation in the third quarter was $2.3 million. Capital expenditures were $2.4 million, including approximately $1.1 million for internal use software projects. At the end of October, our total headcount was 1,626 including sales headcount of 410. It also includes 62 employees from MIZI who joined the Wind River team during the quarter. We had roughly 165 quota bearing sales personnel at the end of Q3.

I would now like to review the financial outlook we included in today’s earnings press release. We are providing guidance for Q4 for the first time and are raising our earnings per share projections for the full fiscal year 2009. As a brief reminder, guidance for the upcoming quarter and for the year are set with a focus on sales forecasts and pipelines, the conversion that borders into revenue, and our ability to carefully manage spend.

A key challenge is projection the quarter in which large deals will close and convert to revenue. In Q3, we saw a continued rapid adoption of the term license model and some transactions closed earlier than originally forecast. Hence, for fiscal year 2009 we anticipate revenues in the range of $365 to $366 million. GAAP net income per share is now projected at $0.20 to $0.22 and non-GAAP net income per share is now forecast to be $0.51 to $0.53.

For the fourth quarter of fiscal year 2009, we anticipate revenues in the $93 to $95 million range, GAAP net income per share of $0.02 to $0.04 and non-GAAP net income per share of $0.11 to $0.13. As we mentioned last quarter, as our GAAP profitability increases and as it becomes more predictable, we may be in a position to release our valuation allowance related to our U.S. deferred tax assets. The release would result in a one time significant benefit to the GAAP tax charge in the quarter in which the release occurs.

While we are unable to predict if this release will occur later in FY ’09 or in future years, the impact will result in a change to the GAAP tax rate. We do not expect a material impact on the non-GAAP tax rate this year. We remain in the process of assessing longer term tax strategies to manage our overall effective tax rate.

We continue to be encouraged by the momentum in our business, despite a difficult macroeconomic background. As we look into FY ’10, we believe that from the current FY ’09 guidance we can grow revenues at approximately 10% while expanding operating margins by further careful management of our cost infrastructure. If we accomplish this, we will achieve continued bottom line leverage, resulting in non-GAAP earnings per share growth at approximately 20%.

Clearly if the economic environment were to further deteriorate, and have a material impact on our operations, we would reevaluate our financial projections. It is likely that revenue and earnings growth will be modest in the first half of FY ’10, with stronger growth anticipated in the third and fourth quarter.

Wind River has demonstrated solid execution in the first three quarters of fiscal year 2009. Given our investments, organizational structure, vertical market focus and target strategic initiatives, we believe we are positioned to build on our momentum.

At this point, Ken, I would like to open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Matthew Petkun - D. A. Davidson & Co.

Matthew Petkun - D. A. Davidson & Co.

Ian or Ken, could you tell me roughly – it was a nice increase in the term business and a pretty impressive number, what is the rough duration of the term licenses signed in the quarter?

Ian R. Halifax

Yes, most term deals tend to be at a two or three years, so somewhere in the middle of the two to two-and-a-half years.

Matthew Petkun - D. A. Davidson & Co.

So far you guys have done nothing but pretty much execute according to your guidance. I think the only thing that at least we have a little bit of question with is, you know, there’s more term license revenue in the mix and as you just pointed out we’re giving away maybe a couple of years of revenue in exchange for what used to be, at least with some of these contracts, one year subscription deals. What gives you the confidence and the ability to guide roughly in line with what you’ve guided before in terms of 20% bottom line growth next year and 10% top line growth? What types of deals do you still see in the pipeline?

Ken Klein

The way we look at our business is that we’re still, you know, very much scratching the surface here. If you look at the overall penetration that we have within the electronics 300, number one. Number two, if you look at the momentum that we have in terms of design wins, which is up substantially both sequentially and year-over-year. We’re very pleased with that 300 design win number. And you know we have a lot of new products that are coming on line.

We mentioned several of those, you know, our DM product line, our MILS product line, our ability therefore to extract more incremental dollars for those new products. And targeted strategic initiatives to go after new verticals and we’re most excited of course about verticals such as the mobile and the MID marketplace. So all of these gives us tremendous confidence on a go forward basis and underpin our guidance.

Now that’s somewhat meted of course by macroeconomic factors, which we of course have taken into account the extent that we can. And again we factored that into the guidance we’ve given. And again I’d reiterate the point that Ian mentioned also that we are planning to grow EPS at twice the rate of revenue and that’s due to again keeping a very strong hand on expenses, and really leveraging our model. So that’s what gives us the confidence to go along with that guidance.

Matthew Petkun - D. A. Davidson & Co.

One more question for you, Ken, the device management growth that you’re talking about and tests in general, what types of customers are you seeing most traction with in the management side? Are they preexisting Wind customers or are these deals coming about through new engagements that you have maybe on the Linux side with new customers?

Ken Klein

Yes, so in general it’s a combo platter of preexisting customers but in different areas within that customer base. And we also have existing customers that are using other underlying operating systems in certain cases. And in terms of verticals, we’re seeing not surprisingly networking equipment being the most mature and generally the earliest adopter of new technologies, and we’re seeing traction there. And also in the industrial and as it turns out the aerospace and defense market.

In terms of our operating systems we’re seeing uptake across VxWorks and Linux, so it’s very horizontal.

Matthew Petkun - D. A. Davidson & Co.

Ian, on the production license revenue you were referring to something you were calling compliance revenue, I think? What’s going on there? I mean, I think we all understand that device units are likely down in the current environment but what’s going on there and how should we think about this part of your business growing in 2010?

Ian R. Halifax

Yes, compliance revenue stems from – think of it as audit work we do with certain customers who may have under reported production licenses to us. So in any given quarter, we typically can see some capture by from the results of these audits. This revenue can run typically $1 to

$3 million in any given quarter but tends to be very lumpy. And we didn’t see much of that in the third quarter.

Also some customers will make block purchases of production licenses up front, and again we didn’t see much of that in Q3. Over the medium term, I would expect the basic run rate of production licenses to remain fairly flat. I wouldn’t expect substantial growth any time soon.

Ken Klein

And I would add too, Matt, that that doesn’t necessarily imply that the devices shipping with our technology are flat, but due to our L model customers are able to [basically] aggregate their total volume and thus get a lower per unit cost from us. So while, you know, volumes could be up, although that’s going to be somewhat muted by the macroeconomic factors, you know, that may not necessarily, you know, apply to the overall growth rate there. So flat to maybe slight up, you know, we’ll have to wait and see.

Operator

Your next question comes from Michael Huang - Thinkequity LLC.

Michael Huang - Thinkequity LLC

First, so if directionally were you assuming with respect to close rates and numbers of large deals and numbers of design wins in your guidance versus the last couple quarters? And you know given what you’re seeing now, I mean, how would you expect to see trends through next year?

Ian R. Halifax

Well, that’s a hard question in this environment to answer with the level of specificity I think you’re looking for. I think a better way to counter is if I look back at close rates over the last three quarters, our sales force done an excellent job. Close rates have been truly very, very good indeed. Our pipelines even today remain very strong across the globe. I can’t give you a hard number right now on what percentage of all the deals in the pipeline will close. We are hopeful that very slight execution will continue.

Michael Huang - Thinkequity LLC

I guess what I’m trying to get at is, you know, based on your assumptions and, you know, given a pretty tough environment out there I was wondering whether or not you’ve assumed some more conservatism around close rates and maybe the number of design wins as well. Obviously you’ve executed very well, but the market itself is providing some uncertainty I’d imagine.

Ian R. Halifax

Yes, I think if you look at our guidance and compare some of the commentary this quarter with what we talked about last quarter we have factored in some of the things we are seeing in the broad, macroeconomic backdrop.

Michael Huang - Thinkequity LLC

And then just if I’d name some renewals, I’d imagine that Q4 is a pretty strong renewal quarter for you guys. Are you seeing any pressure on pricing or any pick up in attrition? And just remind me again, can any of these renewals of subscriptions could they renew as term license?

Ken Klein

Yes, so first of all I mean we’re very early into Q4 right now and so far knock on wood we haven’t seen any changes or shifts in customer buying behavior relative to renewals. And the second part of your question can those instead be – end up being term arrangements? Absolutely. You know, it kind of depends on what a customer wants to do. And thirdly what we really look to do is up sell, i.e. extend the and grow the amount of value and thus the investment customers are making with us when we come up for a renewal.

Michael Huang - Thinkequity LLC

And then I know you talked about device management, good quarter there. I’m not sure you provided a ton of color around the virtualization hypervisor product. Is that out and steadily available yet or and maybe you can help us understand what kind of early interest that you’re seeing around that product area?

Ken Klein

Yes, it’s not yet in GA although we’ve had a lot of customer interest around it. It will be coming out next year and we’ll be targeting some very specific use cases around areas such as offload, opti performance, around consolidation for customers that want to reduce the number of processors that they have, obviously to drive cost savings. And those are just some examples if you will of where we think that we’re going to see uptake.

In addition, of course, our MILS product is built upon our hypervisor product and so we already have customers that are in the process of implementing that. So we’re getting a lot of experience with it and so far the feel has been excellent.

Michael Huang - Thinkequity LLC

And last question for you, so just with respect to the production licenses obviously some conservative targets next year with respect to growth rates, what would be the biggest driver behind growth in that line? You know, is it an improved economic environment or is it more of the VxWorks 6 adoption manifesting itself in unit volumes? Or is it handset volumes starting to ship? Help us understand where might we ever or when might we see better growth in that non-compliance related.

Ken Klein

Yes, I think it’s really in all three areas. Obviously it would be helpful to have secular improvement in the overall environment. You know, we obviously have booked literally thousands of design wins on VxWorks 6 and so getting those devices into production, ramping in the volume. And thirdly you know continuing to sell Linux in the high volumed devices that command a per unit fee, like what we did with Kyocera, like what we’ve done in the automotive and the network equipment segments with several other customers. That’s going to be helpful to drive revenue on that line item.

Michael Huang - Thinkequity LLC

And so that might not be next year but that would be the year after?

Ken Klein

Well you know the first point has to do with what’s going on with the economy, right? So I think that if you kind of take our commentary, we’re looking at on the one hand to have more design wins, on the other hand we’re contemplating lower volumes due to the economy. So either one could drive that and the guidance anticipates really a combination of those two contra-trends.

Operator

Your next question comes from Nabil Elsheshai - Pacific Crest Securities.

Nabil Elsheshai - Pacific Crest Securities

Guys, a couple of quick questions. One, when you talk to customers about changing from in house development to solutions, presumably that would require something of an upfront investment and then they get their return over time. Are they more resistant to doing that in this environment? What are you hearing from those type of customers?

Ken Klein

Not at all. I would say that that’s one of the key reasons this build to buy sentiment or shift that’s actually driving our business right now. So our customers are very are amenable to that. They’re looking at ways to do that. They’re being literally forced to do that because the amount of work that they have really isn’t necessarily decreasing any of their – they need to innovate. There’s more software that’s required per device. They have fewer engineers to actually build that software. It’s more complex.

Technologies such as multi-core really create inflection points relative to how they’ve been doing things in the past, all of which are really driving this shift to outsourcing or buying platforms – commercial platforms versus doing it internally. So it’s actually benefiting us. So to a certain degree the recession is our friend, you know, however if that becomes steeper or longer obviously that’s not necessarily good. But at one level it’s actually helpful.

Nabil Elsheshai - Pacific Crest Securities

And then I know at least Nokia has been talking about given the Symbian without the production license, does that make it more difficult for you guys to charge production licenses with the Linux wins?

Ken Klein

Not at all. We believe that is actually a defensive move on the part of Symbian and Nokia, and I think it’s an admission that they’re losing ground as is Microsoft for that matter to Linux. And the handset deals that we’ve done so far are per unit fee generating, so we’ve been very successful at really getting our customers to embrace that model.

Nabil Elsheshai - Pacific Crest Securities

I missed the services backlog. I was wondering if I could get that real quick.

Ken Klein

Around $29 million.

Operator

Your next question comes from Kevin Buttigieg - Stanford Group Co.

Kevin Buttigieg - Stanford Group Co.

A question about the professional services business, you – as I recall you signed some big deals earlier this year, and it sounds like those deals are still in backlog and just generally trying to think about how the professional services business, the revenue should flow in that business. It seems just to be very volatile despite the big build up in backlog that you’ve seen over the course of the last couple of quarters.

Ian R. Halifax

Yes, let me answer that one. I think a couple of things, one, yes we have built up a decent backlog over the last several quarters and that’s been very encouraging. It shows there’s great demand for that part of our business. Recognition of revenue can be somewhat lumpy depending on how the deals are structured. So that’s one thing we saw in Q3 where we had some revenue deferred more than we would have perhaps liked.

We also in Q3 had a lot of pre-sales efforts going on as well, so that’s another factor. But I think we expect a very solid Q4 for services from both a bookings and revenue perspective.

Kevin Buttigieg - Stanford Group Co.

And the large deals that you signed this year, they still remain in backlog then it sounds like?

Ian R. Halifax

Oh yes, as in backlog or some parts also in deferred revenue.

Kevin Buttigieg - Stanford Group Co.

And then looking – it looks like this quarter there continue to be the big shift towards term from subscription. Do you have a sense looking out to ‘010 – 2010 for example, if that is something that’s going to kind of stabilize? Or do you expect to see the mix continuing to shift in favor of term licenses?

Ian R. Halifax

I think that the mix will continue to shift, but gradually. I’d point out that in the third quarter, term license revenues were just a little bit above 10% of total revenues. So I don’t want to give the impression this is a wholesale switch from subscription to term. It will – the trend will continue, but it will be a long tail sort of trend.

Operator

Your next question comes from Brent Williams - The Benchmark Co.

Brent Williams - The Benchmark Co.

Just first the simplest housekeeping question imaginable, the breakdown – did you give the breakdown of the service line into perpetual versus consulting? I’ve been trying to do two calls at once, so I think I missed it.

Ian R. Halifax

Let me walk you through all the revenue lines so you have them all at once, if that’s okay. So subscription $31.8 million, product which includes term licenses and perpetual assets $21.3, production licenses $16.1, maintenance $9.0, professional services $12.2, and training $1.2. So it’s in rounding that.

Brent Williams - The Benchmark Co.

If you’re looking at you know given the success that you’ve had with the enterprise selling model, and while I realize that’s sort of more a blanket purchase agreement than a taking down all the product right up front, have you seen any shift towards, you know, are people like they’re doing with some enterprise software products, breaking up large deals into a couple of slugs? Or are they pretty much still really consistent with the sizes that they’ve been talking about on the largest enterprise type deals?

Ken Klein

You know, so far we really haven’t seen any shift in our – in terms of our customer buying behavior or uptake of our technology. And again I really want to draw the distinction here, that we’re selling to R&D, to developers, where even in recessionary times they need to innovate now to be prepared for future products and growth later on. We don’t sell into the IT market where our brethren over there are seeing a lot of deal flippage and deal downsizing.

So again I think part of it is is that we are fundamentally in a different space. And then the other part is just the secular demand for software on devices increasing at a rapid rate. And the ability to meet those needs is limited and therefore there’s a great opportunity for us to provide commercial solutions.

Brent Williams - The Benchmark Co.

As I recall this hasn’t particularly been an issue, but any significant portion of the aerospace and defense business tied to delivery of Boeing’s 787?

Ken Klein

You know, not particularly. That deal was done quite some time ago and although there are per unit fees attached to that, I believe they’re relatively modest in the scheme of things. We’re talking about hundreds as opposed to millions of units. And you know we’re obviously doing everything we can on our side to help Boeing out there, but so far we haven’t received any calls recently from them that I’m aware of.

Operator

Your next question comes from Richard Williams - Cross Research.

Richard Williams - Cross Research

Could you talk a little bit about the geographic conditions and to what extent you’ve seen credit crisis impacting your customers?

Ken Klein

Yes, sure, you know we saw strength in each of the key large geographies, in particular last quarter strength in the Americas, North America, in EMEA and Asia-Pacific. In terms of the credit crisis, I mean thankfully we don’t sell to banking, brokerage or insurance customers and so we’re just only [transentially] affected by that trend.

Richard Williams - Cross Research

And the auto industry with all the headlines and not just domestically, to what extent is that going to be impacted as we look forward over the next few quarters?

Ken Klein

Well, we’re still actually very early days in auto and our focus has been on in-vehicle entertainment, specifically predicated on our Linux based platforms as auto manufacturers move off of proprietary solutions and look to consolidate multiple systems and multiple processors to just a few. And so we’ve seen a lot of interest just around our hypervisor technology and obviously our Linux offering. We entered that market with work that we did with BMW. Since that time we’ve had several really important design wins.

And we haven’t seen any slowdown there. And I mean part of it is that the model years that we’re looking at are out in the 2012 and beyond. Secondly these are initiatives that actually help our customers, our auto customers in specific produce new cars, whether they be more green, fuel efficient, lower cost, etc. So in essence we’re the piece that they need to invest in in order to drive their future business. And so far we just haven’t seen an impact. Again they’re relatively small numbers, too, so it’s not like we have a big legacy business to concern ourselves with.

We don’t have a big per unit fee or unit volume attached to automotive, and again that puts us in a good position.

Richard Williams - Cross Research

How about with the cell phone industry given the recent spate of companies missing their expectations?

Ken Klein

Well, again, we’re same thing – we’re early days into some very new trends within the handset market. If you look at sort of the production license or the per unit fee that we see from handsets is very, very small right now because we’re really a new entry there. And we’re entering on the back of these consortia efforts that we’ve alluded to, you know, with LiMo, with Google and Android and with Intel’s Moblin. And this is really the key to next generation devices, either they’re converge devices that have a lot more capability.

And so we’re really in the high growth area within an overall segment that could be declining, but we’re basically driving a disproportion spend in our direction because that’s really the area of investment. I think the key to all these conversations is we have a very, very diverse set of customers, diverse set of markets, diverse set of geographies, diverse set of products which provide a level of safety relative to the Wind River thesis.

Operator

Your first question comes from Matthew Petkun - D. A. Davidson & Co.

Matthew Petkun - D. A. Davidson & Co.

One follow-up question, Ian on the cash flow it looks like it’ll be up this year over last year assuming you’re cash flow positive in this upcoming quarter. But generally speaking, the last couple of years you’re free cash flow or your cash flow from operations hasn’t really matched your EPS growth. What would you anticipate from a general perspective if indeed you are able to grow EPS at 20% next year?

Ian R. Halifax

Yes, we’re still in the midst of modeling out FY ’10 so I’m a little reluctant at this point to give any color on what we see for next year. I think what I can say is that we said I think in last quarter and the quarter before the expected offer in cash flow this year to be around $60 million. I think we remain pretty comfortable with that at this point.

Matthew Petkun - D. A. Davidson & Co.

So a nice quarter should be coming here in Q4?

Ian R. Halifax

That’s what we’re shooting for, yes.

Anne Marie McCauley

Great. Since there are no more questions that concludes our Q3 earnings conference call. Thank you for joining us today.

Operator

Ladies and gentlemen, this concludes today’s conference call. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: [e-mail]. Thank you!