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Wind River Systems, Inc. (WIND)

F4Q08 Earnings Call

March 6, 2008 5:00 pm ET

Executives

Anne Marie McCauley - VP, Investor Relations

Ken Klein - Chairman, President, and CEO

Ian Halifax – CFO, Senior Vice President of Finance and Administration

Analysts

Matt Petkun - D.A. Davidson & Company

Michael Huang - ThinkEquity Partners LLC

Brendan Barnicle - Pacific Crest Securities

Kevin Buttigieg - Stanford Group Company

John Walsh - Citigroup

Aaron Schwartz - JPMorgan

Richard Williams – Cross Research

Operator

Good afternoon. My name is Jason, and I will be your conference operator today. At this time, I would like to welcome everyone to the Wind River Q4 fiscal year 2008 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. (Operator Instructions) Thank you. I would now like to turn the conference over to Wind River, Vice President of Investor Relations, Ms. Anne Marie McCauley. Maam, you may begin.

Anne Marie McCauley

Thank you, Jason. Good afternoon and welcome to Wind River's Q4 in fiscal year 2008 conference call. Joining me today is Ken Klein, our Chairman, 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 in a fourth quarter update presentation can be accessed on the Wind River Investor Relation’s 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 information regarding Q4 and fiscal 2008; however, some of our comments and responses to your questions will include forward-looking statements, such as statements regarding our estimated revenue, GAAP net loss for share, non-GAAP net income per share, and estimated expenses, margins, cash flows, and tax rates for the upcoming quarter or full fiscal year 2009.

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 investments we are making in 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. In 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, 2007 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 supplemental 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 description of non-GAAP financial measures and reconciliations of these non-GAAP financial measures to the most directly comparable financial measures, please see the section of Wind River’s earnings release issued today entitle “about non-GAAP financial measures” and supplemental information posted on the Wind River Investor Relation’s 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 fourth quarter sales performance was Wind River’s strongest in seven years. Revenue for the quarter was $84.3 million dollars, an increase of 11% over Q4 last year. Deferred revenue was $134.6 million dollars, an increase of 6% over Q4 last year and an increase of $18.7 million dollars or 16% sequentially. Q4 GAAP net loss per share was 2 cents and non-GAAP earnings per diluted share were 9 cents, exceeding our guidance.

Revenue for fiscal year 2008 was $328.6 million dollars, an increase of 15% over FY2007. GAAP loss per share for 2008 was 3 cents and non-GAAP ranks per share for the year were 33 cents. Our strong performance in Q4 and solid finish to fiscal year 2008 indicate the investments we have made during the year in products, the sales force, and alliance partnerships are driving success for Wind River.

We are seeing returns in our key targeted verticals. Aerospace defense, networking equipment, industrial and automotive, and the mobile handset marketplace. Let me give you an example. Annual bookings in our aerospace and defense business grew 23% year-over-year. Our results are in stark contrast to the overall A&D market, which is growing in single digits. The growth drivers for us in this market are based upon strong execution across all three investment areas—product, sales, and partnerships. Our A&D products are significantly better and highly differentiated from competitive offerings. We are winning most avionic steels we compete for, including two major safety certified wins last quarter. A classified U.S. defense program and the neuron program, a multi-country project to develop an unmanned air vehicle or UAV.

In addition, our customers are engaging with Wind River to provide a complete certifiable application development platform, including an innovative way to deliver certification evidence. This unique approach allows our customers to certified their applications much faster and at significantly lower costs than other alternatives.

Strong partnerships with companies like Curtiss-Wright and GE Fanuc are providing us market leverage. Curtiss-Wright helped us win a $2.8 million dollar deal at Rafeon on a Silent Night program in a highly competitive deal. Today, over 95% of Curtiss-Wright’s board shipped with the X works on them.

We are ramping up our product in channel investments in an emerging, yet strategic segment of the A&D market called multiple independent levels of security or MILLS. MILLS is fast becoming the architecture of choice for applications that require multiple levels of secure con-activity. I believe that our MILLS investment will fuel measurable segment growth for us in the coming year.

We also are very pleased with our Linux business and the traction we are garnering in each of our targeted verticals. In Q4, Linux bookings grew 66% over last year. We expect this business to be well in excess of $50 million dollars in FY09. Our vertical strategy for entry and expansion in high growth Linux-based markets falls a consistent approach. First we identify and partner with a industry-leading manufacturer to define the specifications for a vertical Linux solution. We then utilize our professional services capability to deliver the initial solution. Finally, we have an efficient handoff between professional services and engineering to develop a vertical industry offering leveraging the work that was started on a specific customer engagement. Let me give you an example of how we implemented this strategy to drive Linux growth in the high end networking equipment marketplace. As we mentioned, we entered this segment through a services-led engagement with Nortel almost two years ago. The technology assets from this initial effort led to our platform for networking equipment Linux edition. We continue to evolve this platform and recently announced that we are the first commercial software company to support Carrier Grade Linux or CGL 4.0. This quarter Carrier Grade Linux customers for this product included new design wins at Nokia Siemens Networks and Ericsson. We have Linux wins in the networking equipment market that include a per unit fee as part of the commercial pricing terms. The strong market adoption of our Carrier Grade Linux product has led to the expansion of other relationships with our partners in this vertical segment. Emerson, RadiSys, Contron, and Sun have each made us part of their product plan of record. We expect increase demand to come from these efforts.

Let me give you a second example. The automotive marketplace. On the last two conference calls, I’ve highlighted Wind River’s opportunity based on the segment’s need to address rapid cycle times, as well as design flexibility, to integrate both current and future applications and services. Linux is fast becoming the market’s solution of choice.

In Q2, we announced a strategic partnership with Intel to develop an automotive grade Linux distribution that the industry will consolidate around. We are on target to deliver the solution in Q2.

The first customer for the solution was BMW. In Q3, we completed the design win with a European tier one automotive supplier. Since then, we’ve had multiple transactions with tier one automotive suppliers, including another top tier European supplier and a large Detroit based supplier as well.

Shifting to mobile handsets, one year ago we were brand new to the Linux-based mobile handset market. Today, we well positioned to benefit from the huge momentum shift to Linux-based phones. On previous conference calls, I’ve told you about our leadership positions in the Lima Foundation and the open handset alliance, as well as our strong partnerships with Texas Instruments and other leading semi-conductor partners. At this year’s Mobile World Congress, the world’s largest mobile handset event, demonstrated five Google android-based reference designs. We also announced our partnership with Access, a leading middleware provide in the handset market. In addition to extending our tools opportunity inside of Limo, the Access partnership gives us new leverage in the Japan market. In Q4, we had our very first android-based design win with the largest U.S. manufacturer. This quarter, we expect to complete several more android-based design wins with handset manufacturers, based on referrals from Google and T.I. We’re negotiating these deals incorporating pricing, based on a per unit fee model.

Now let me shift gears and update you on the progress we are making with VX Works product line. We saw very strong results in Q4 with VX Works bookings, which were off over 60% year-over-year. In addition to growth in the aerospace and defense market, we also saw strength for VX Works in the non-cost networking equipment space. The network equipment segment represents almost 25% of the VX Works business. We completed very large transactions with several network equipment providers, including Walway, Nortel, and Alcatel Lucent. There were two key growth drivers for us in this segment of the networking market. First, the adoption of multi-core technologies and second, four G wireless, specifically Wymax. Multi-core enables higher performance and more efficient power utilization at a significantly lower cost; however, software complexities are preventing manufacturers from realizing these gains. This quarter Wind River launched several new run-time products and tools to help solve the multi-core problem. We were working very closely with several partners, including Cavium and Freescale to expand our multi-core solution. You’ll be hearing about some new innovations from these partnerships in the coming quarters.

Wymax is emerging as an important con-activity standard in this market. This quarter Wind River launched products to integrate Wymax with our VX Works platforms, will be one of several designs based on these products, including bay stations, voice over IP modems, and phones.

Finally, our device management product line delivered another record quarter. We added 24 new customers during the quarter, bringing the install base to nearly 100 customers. Device management gives customers the ability to remotely identify, diagnose and fix device software problems both in the quality assurance lab or in deploy devices. Device management has a compelling and differentiated value proposition. Not only were we successful selling it on a stand alone basis, but we also saw several examples where device management pulled through sizable VX Works transactions.

At the beginning of February, Wind River announced a reorganization of the company. The biggest change was in how we build and manage our products. Wind River is made up of a multiple businesses. Each has different operating characteristics, in terms of scale, profitability and growth. Each requiring different kinds of investment. The more we thought about this, the more we realized it made sense to organize ourselves as a company around these businesses. So now we are organizing four product divisions. This will allow us to focus on new technology and market opportunities, be nimble and agile with both customers and partners, operate more efficiently and drive and measure return on investments.

Before I turn the call over to Ian, I would like to summarize. I believe the confluence of three market conditions create a unique opportunity for Wind River growth in fiscal year 2009. Device complexity—software, not hardware, is the differentiator in devices. Applications and device services are converging on a single device. The number of lines of code is doubling on average every 24 months. Multi-core is making it harder and harder to develop and debug applications. Customers need the products and services we deliver to reduce this complexity. Number two, industry disruption. Supply chains have been in place for generations are being scrutinized. Dif intermediation is happening in many industries we serve. Our customers’ customers are becoming sales opportunities for us. Number three, mild or moderate recession. Real or not, customers are taking a cautious view towards our engineering spend in the current economy. This is accelerating customers’ openness to buy versus build decisions.

Fiscal year 2008 was a year of investment for us. Our investments are bearing fruit. Our customers are adopting our new products. Our sales force execution is much improved. Our alliances are creating significant incremental opportunities for us and we are reaching critical mass in key high growth vertical markets. As we head into 2009, I believe Wind River is well positioned to see returns from our 2008 investments. Thank you very much.

Ian Halifax

Thank you, Ken. Good afternoon. I would now like to review our fourth quarter and fiscal year 2008 financial performance, as well as review guidance for both the first quarter and fiscal year 2009. For the fourth quarter, the fiscal year 2008, net revenues were $84.3 million dollars, reflecting an 11% increase over the fourth fiscal quarter of 2007. Subscription revenue for the quarter was up 18% year-on-year to $32.9 million dollars. Revenue, including project-based perpetual licenses and production licenses was $27.3 million dollars compared to $29.2 million dollars in the fourth fiscal quarter of 2007. Services revenue, including maintenance, professional services and training, was $24.1 million dollars, up 26% over the same quarter a year ago.

Deferred revenue for the quarter ended at a record $134.6 million dollars, representing a 6% increase over the fourth quarter of fiscal year 2007, and a sequential increase of $18.7 million dollars or 16% over the third quarter of 2008.

At the end of the fourth quarter, we had services backlog of approximately $19 million dollars. This represents an increase of over 80%, compared to the same quarter a year ago. As a reminder, this metric is intended to provide a gauge of the underlying demand for our products and services. The combination of deferred revenue and services backlog this quarter is approximately $153 million dollars, representing an increase of 11% over the same quarter a year ago.

In terms of geographers, America is representing 52% of total revenue for the fourth quarter. EMEA contributed 27% and Asia Pacific, including Japan, contributed 21%. In terms of bookings, our top customers in the quarter included Alcatel Lucent, BAE Systems, Direct TV, Ericsson, [Pen Mecanica], Harris Corporation, Honeywell, Nortel Networks, Northrup Grumman, and Rafeon. We had more than 180 deals, greater than $100,00 dollars during the quarter. Our bookings profile by end market for the quarter was as follows: Network infrastructure accounted for 27% . Aerospace and defense, 34%. Industrial and automotive, 19%, and digital consumer, 20%.

Gross margin on a non-GAAP basis for the fourth fiscal quarter of 2008 was 76% compared to 79% for the same quarter a year ago. The decrease is due to a continued high proportion of professional services revenue and associated cost. As anticipated, non-GAAP operating expenses increased slightly in Q4 from Q3 levels. The sequential increase was $9.3 million or 1%. Non-GAAP operating income in the fourth quarter was $6 million compared to $7.9 million in the same quarter a year ago. This translates into fourth quarter non-GAAP operating margins of 7%. Interest and other income on a non-GAAP basis was $2.4 million dollars for the quarter. The impacts of [unclear 123] are expensing of stock-brace compensation in the quarter was $5.2 million dollars. We incurred impairments expense of $2.8 million dollars related to a previous acquisition and a $9.4 million dollar impairment expense related to small components of our investment portfolio.

Net loss on a GAAP basis in the fourth fiscal quarter of 2008 was $2 million, compared to net income of $9.2 million dollars in the same quarter a year ago. Non-GAAP net income in the fourth fiscal quarter of 2008 was $8.1 million dollars, compared to $8.7 million dollars in the same quarter a year ago. GAAP net loss per share in the fourth quarter was 2 cents on a diluted share base of 87.4 million shares. Non-GAAP earnings per share in the fourth quarter were 9 cents, based on diluted share account of 88.6 million shares.

Q4 of FY08 ended with $244.1 million dollars in cash, cash equivalents, and investments. Cash flow from operations were $19.3 million dollars for the quarter, an increase of 22% over the same quarter a year ago. As a reminder, we have two primary uses for our cash. The first and preferred for growing your business is acquisition activity. As mentioned previously, we regularly explore technology and our services taking acquisitions. The second is to repurchase shares and we have a $50 million dollar authorized program in place. During Q4, we explored an acquisition for which the proposed purchase price precluded us from repurchasing stock during the quarter. We elected not to proceed with this transaction, due to potential earnings dilution. Hence, we intend to buy back shares in the first quarter. The account receivable balance as of January 31st, 2008, was $87 million dollars. Days sales outstanding was 94 days, due primarily to strong Q4 bookings and related invoicing. This seasonal increase in days sales outstanding is consistent with Q4 a year ago. Depreciation in the fourth quarter was $2.2 million dollars. Capital expenditures were $2.8 million dollars, including approximately $9.6 million dollars for internal use software projects.

At the end of January, our total head count was 1,490, including sales head counts of 428. Following the recent reorganization, at the end of February, our head count was 1,441. Revenue for fiscal year 2008 was $328.6 million dollars, an increase of 15% over fiscal year 2007. GAAP loss per share for 2008 was 3 cents and non-GAAP earnings per share for the year were 33 cents. Operating cash flow for the year was $42.6 million dollars.

As stated in today’s earnings press release, we provide the following outlook for Q1 and for fiscal year 2009. For fiscal year 2009, we anticipate revenues in a range of $365 to $375 million dollars with strong growth anticipated in the second half of the year. As we see return from our investments in products, our sales organization underlines this. As noted earlier, we have deferred revenue on services backlog of approximately $153 million dollars. This represents approximately 40% of projected fiscal year 2009 revenues and is consistent with the level at which we entered fiscal year 2008. We expect gross margins on a non-GAAP basis to be in the range of 75 to 76% of revenues, depending on the proportion of professional services revenues. We continue to see a strong pipeline for products enabling professional services engagements in new vertical markets.

We anticipate research and development expense to be between 21 and 22% of revenues below historic levels. We expect sales and marketing expense to be 35 to 36% of revenues and general administration expense to be 7 to 8% of revenues consistent with fiscal year 2008.

We anticipate operating margins for the year to exceed 10% with a strong ramp in the second half of the year. We intend to exit Q4 fiscal year 2009 with operating margins in excess of 15% of revenues. We project interest and other income to be in the $6 to $7 million dollar range on a non-GAAP basis and a non-GAAP tax rate of approximately 15% for the year. [unclear] expense for the year is projected at $22 to $24 million dollars. We expect other one time or non-cash operating items, such as restructuring expense or amortization from acquisitions to be in the $10 to $11 million dollar range.

We anticipate non-GAAP earnings to be in the $39 to $42 million dollar range. Hence, GAAP net income per share is projected at 4 to 6 cents. Non-GAAP income per share is forecast to be 43 to 46 cents. This is consistent with comments made on prior earnings calls. It is also important to emphasize that revenues operating margins and non-GAAP earnings per share are expected to ramp strongly in the second half of the year. Revenue growth will drive operating leverage.

Operating cash flow for FY09 is anticipated to be in the $45 to $50 million dollar range. For the first fiscal quarter of 2009, we anticipate revenues in the $80 to $81 million dollar range. GAAP net loss of 11 to 12 cents per share and non-GAAP net income per share of 1 to 3 cents.

Wind River concluded FY08 on a strong note. We believe we are positioned to build on this momentum and the investments we have made as we enter FY09. We have reorganized the company into product divisions following extensive strategic review and tailored our cost structure to allow us to continue to make critical investments while simultaneously expanding operating margins.

We believe we have significant opportunities in our targeted marketing segments. Aerospace and defense, networking, automotive, and mobile device market. Continued and consistent execution will be key in translating these opportunities into revenues and earnings per share in FY09. We’ll update guidance for the year each quarter and provide guidance for each ensuing quarter.

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

Question-and-Answer Session

Operator

At this time, I would like to remind everyone that in order to ask a question, please press star, then the number 1 on your telephone keypad. Your first question comes from Matt Petkum, from D.A. Davidson & Company.

Matt Petkun - D.A. Davidson & Company

Hi, good afternoon. Just in the Q1 guidance, are you expecting, and I would assume just based on the results that you put up in Q4, higher percentage of the business coming from services and, therefore, that’s why the relative profitability is down, because you’ve put up quarters with similar revenue numbers and much better earnings in the past.

Ian Halifax

That’s a good question, Matt. I think if you look back to what we saw in Q1 last year, you’ll note that Q1 tends to be a heavy quarter for us in sales and marketing expense. It tends to be a seasonable high quarter due to our sales rally and for a number of trade shows we’ve run in the first quarter. So it’s less revenue mix as a typical seasonal spend issue.

Matt Petkun - D.A. Davidson & Company

Okay, and then the growth in the subscription bookings was pretty astounding and very nice to see after a couple of quarters of slower growth. Can you really describe what led to that growth this quarter and whether or not we should expect continued growth in that line item through this year or are we running higher booking rates and this is kind of what we should see for the next couple of quarters.

Ken Klein

Obviously we had a strong bookings quarter if you look at the net change in deferred revenue, we are in excess of $100 million dollars and we’re very proud about that. In terms of specific revenue components were very strong. We saw particular strength in Linux, as we mentioned, and VX Works 6. So we’re seeing a great return on investments we made and VX Works 6 we saw strength in key vertical markets, specifically aerospace and defense. We saw strength in industrial and in consumer. Again, I think it just is really manifestation of the investments that we’ve been making in both the products, the partnerships, and in the sales force. Terms of a go forward, we’re not providing breakdowns of specific revenue components at this time. Again, Ian has already provided guidance for Q1.

Operator

Your next question is from Michael Huang, from ThinkEquity Partners LLC

Michael Huang - ThinkEquity Partners LLC

A couple of questions for you guys. First of all, your comment about the macro economy accelerating decision to buy versus build. Just wondering, have you seen it impact sales or is this something that we should expect to see in ’09.

Ken Klein

In terms of the pipeline, we see a very robust pipeline going into the year and specifically relative to Q1. I can point to a number of transactions where customers had to effectively do more with less and as a result they are buying solutions from us as opposed to building them on their own. I think that one great example of that or a couple of examples of that are our Linux business where we’re really taking share away from the roll your own market as opposed to just competitive wins, which obviously we’re getting market share there as well, but that, I think is a great data point, because these are customers that just don’t have engineers sitting around to be able to handcraft device software platforms. They purchase them, and a second example is what we’re seeing in the aerospace and defense market, which we’ve been seeing for quite some time, which is a shift from a roll your own to purchasing cots or commercial off-the-shelf stuff, that’s a good cross to what we’re seeing in all of our markets.

Michael Huang - ThinkEquity Partners LLC

Just to follow up on that, when you look at sales cycles and the length of sales cycles, are you expecting that to compress somewhat in ’09 and I guess traditionally the sales cycles have been pretty lengthy, so any improvement there would be positive.

Ken Klein

Yeah, I think that we see no material change in the sales cycle duration yet. I will say though that because we are developing a much strong position, the competitors, the amount, and the time spent going through evaluations, I would expect to decrease over time as we become more and more of a standard go to partner for device software.

Michael Huang - ThinkEquity Partners LLC

Then in terms of royalty performance, obviously there was some under-execution in royalty collection in FY07 and so I would imagine that FY08 benefited from some catch-up royalties to some extent. Can you comment and talk about in FY09, is this a tougher hurdle to clear from a growth perspective or do you finally start seeing the benefit of VX Works 6 starting to shift more notably in FY09?

Ken Klein

First of all, we’re not getting any kind of guidance relative to the components of revenue relative to production licenses, we have multiple sources of those, clearly over 2,000 wins the last couple of years. Many of those, of course, being VX Works 6, we would expect to come online, produce volumes, and thus produce production license royalties to us. As I mentioned during my call script, we are doing deals today in the Linux marketplace that are paying a per unit or will pay a per unit fee and so that will be another source of production, license royalties to us. Again, the guidance that we provide anticipates revenue from multiple sources, including of course production license.

Michael Huang - ThinkEquity Partners LLC

Last question, just to clarify on that point. So with respect to royalties being attached to somebody’s handset, so are you guys also selling platforms two tiers as well. So it’s both the selling, the developer, plus the royalties when they ship?

Ken Klein

Yeah, it’s only three things. It’s selling per developer, access fee for our technology, and a per unit fee.

Michael Huang - ThinkEquity Partners LLC

Right, thanks very much.

Operator

Your next question comes Bill Fryex, from Radnor Wood Capital.

Bill Fryex, from Radnor Wood Capital

Good afternoon. Can you hear me? Okay. Ken, just sitting back and accounting this, it sounds to me like in terms of revenue, you’ve got a business that’s growing at about a 11% clip and then in the change in the growth and deferred and then the additional off balance sheet backlog. That’s grown at about 11% too. So all end, the business is growing about 11%. Is that a good way to look at it?

Ken Klein

Well if you look at the high end of our range that Ian has provided, our current forecasts indicate that revenue growth is going to be similarly situated to what we grew last year, which overall was a 15% growth for the year.

Bill Fryex, from Radnor Wood Capital

So you’re not anticipating any kind of decline or nothing?

Ken Klein

No. This year or I should say last year, FY08 was a year of investment for us. I think we’ve mentioned a number of times that we’ve invested heavily in the sales force, in products and partnerships. Clearly, Q4 was a great punctuation mark that we’re realizing a nice return on those investments and we expect those returns to continue to materialize in FY09.

Bill Fryex, from Radnor Wood Capital

Okay. So at the end of the year, we’re looking at a 15% grower with a 15% operating margin, is that right?

Ken Klein

That’s not the guidance that Ian gave specifically.

Ian Halifax

Our guidance range for revenue was in the 11 to 14% range if you do the math where we ended FY08. What I also said was that we expect to exit Q4 of FY09 with operating margins at or above 15%. For the full year, we expect operating margins to be north of 10%.

Bill Fryex, from Radnor Wood Capital

Let me ask you this. Are you making money off these service contracts?

Ken Klein

Absolutely. We measure the services very, very carefully and in general we’re seeking gross margins on professional services and this is exclusive trading in the mid-30%.

Bill Fryex, from Radnor Wood Capital

Okay and you can get that.

Ken Klein

We are getting that.

Bill Fryex, from Radnor Wood Capital

Okay good. Thanks a lot.

Ken Klein

Thank you.

Operator

Your next question comes from Brendan Barnicle, from Pacific Crest Securities

Brendan Barnicle - Pacific Crest Securities

I want to follow up on the service backlog, which came in at $19 million dollars and I think it had been a $20 million the prior two quarters. So I wanted to try and understand why the decline there.

Ian Halifax

We delivered a lot of service in Q4. Services such as revenue grew I think in the low to mid-20’s, from the top of my head. So it’s a case of simply fulfilling contracts.

Ken Klein

Basically grew at 24% and we delivered $16 million dollars worth of services.

Ian Halifax

I think where you’re heading, Brandan, is it demands slowing down for service and I think we said in our prepared remarks that our pipeline for services engagements off-scale in our new markets is very, very high. So we’re very encouraged by momentum in these new markets being led by a very profitable services business.

Brendan Barnicle - Pacific Crest Securities

Great, and can you talk a little more about the investments in the first half driving sort of the acceleration in the second half. Can you get more specific in what we should be watching in the first half to make sure that we do see that kind of leverage and follow through in the second half.

Ian Halifax

I think the best way to be able to qualitatively predict solely, you know, very strong growth is to see announcements we make in terms of wins over first half of the year, because those announcements will be leading indicators of future revenue steams from services from product from per unit fees.

Ken Klein

The other point is from a quantitative perspective, you know, evaluate our results in Q1 and Q2.

Brendan Barnicle - Pacific Crest Securities

And then the reorg, as part of that, obviously there’s some personnel that’s gone as part of that, what other disruptions may that involve? Where are those changes occurring, the biggest changes?

Ken Klein

First of all, to maybe give you some perspective, our view that the company is operating really quite well right now. I would say that there’s absolutely no downside, if you will, from the reorganization we went through. In fact, we’re seeing a lot of positives as we’ve gone through the changes around either the fact that we have more eyes on the critical business lines. We have integrated sale or other engineering and marketing, which makes for a much faster decision loops, a more agile organization. Clearly, we drove cost deficiencies as we went through the reorganization, and with the type of focus and oversight that we have, this is the way we believe to accelerate growth and to do a better job of measuring ROI. So I’m thrilled with the outcome of the reorg and just anecdotally, there have been numerous examples how things are happening faster and better around Wind River as a result of reorg.

Brendan Barnicle - Pacific Crest Securities

Great. Thank you.

Operator

Your next question comes from Kevin Buttigieg, from the Stanford Group

Kevin Buttigieg - Stanford Group

Thank you. Ian, you had mentioned about passing an acquisition in the fourth quarter and then consequently resuming a buy back in the first quarter of this year. Just kind of wondering, does that mean that you intend to buy stock back so that you could pursue this acquisition so that the total net effect is neutral or could you just clarify what your intention was with those comments?

Ian Halifax

My comment was I think there was an expectation that we would buy back stock in Q4. We did not do so. No. It was because we were looking at this acquisition. Now that’s history. We have passed on that transaction we think for very reasonable reasons; therefore, we intend to deploy a reasonable amount of cash on buying back stock.

Kevin Buttigieg - Stanford Group

Fine. Then on the guidance for FY09, that’s positive. The cash flow guidance that you put up for this year, just sort of turning back into a bookings number for that, in my model would sort of suggest a slower bookings growth rate then or revenue growth rate in ’09. Just wondering if that’s qualitatively correct and sort of what your cash flow guidance would be implying then.

Ian Halifax

No. I would say that I would agree with your model in the sense that that’s not our assumption.

Kevin Buttigieg - Stanford Group

Is it actually faster then or is it in line with the revenue growth?

Ian Halifax

Again, we don’t give bookings guidance, but I think it to be fairly certain that the revenue is projected, you need bookings of at least that level or somewhat above and that’s all I’m going to say.

Kevin Buttigieg - Stanford Group

Thank you.

Operator

Your next question comes from John Walsh, from Citigroup.

John Walsh - Citigroup

Ian, just following up on that question on cash flows only up about $5 million I think year-over-year at the midpoint. What’s the dynamics of that?

Ian Halifax

I just guess we’re taking a somewhat cautious view. It’s the first time we ever forecast cash flow for fiscal year and I don’t think it’s a surprise if we get it completely wrong.

John Walsh - Citigroup

Okay, and then on the handset side, Ken, could you maybe delve in our walk us through kind of your position with both the Limo and the OHA foundations, just what your role is and maybe a little bit on the timing of when you expect, you know, you mentioned that you’re confident that you get the per device fee and just on timing of when you think either those agreements would be in place or when you’d start to see revenue from that.

Ken Klein

As you mentioned, we are active with both the Google handset alliance and with Limo. Just to recap on our roles, we are currently the only commercialization partner on OHA relative to operating systems and so we have a lead role there and as I mentioned that the Mobile World Congress, we participated in actually helping Google and their partners deploy five reference designs, three based on TI silicon, one in ST Micro and one in AEC. So we’re really proud of our results there. In addition to that, we are a board member of the Limo foundation and Limo has elected to standardize on Wyndever’s technology, specifically our layer built system and their common integration environment. So what is this doing for our business? Well first of all it’s getting us a tremendous cache in the consumer segment and I think one of the reasons that you see in our results that consumer was up was due to this halo effect from the relationships in both of these camps. It’s actually, in fact, helping us in other segments outside of the mobile handset marketplace. So obviously that’s tremendous for us. In terms of predicting when design wins are actually going to consummate as I mentioned in my prepared remarks, we have a number of transactions that we’re negotiating. At Mobile World Congress, we had 58 customer meetings there and so part of this is what makes the most sense for us to do, you know, what’s going to provide, if you will, the greatest contribution margin? What’s going to be the most strategic, etcetera. Again, just to reiterate, we fully expect to book Linux business that pays on a per unit basis. We’ve done it in networking equipment. We plan to do it in this space and when those deals are done and we’re able to talk about them, we will.

John Walsh - Citigroup

Is there any push back from the handset makers on the per device. I know obviously they pay it too. For instance, Microsoft and the one with windows mobile side of things, but is there any pushback, because that’s one of the things they want to get away from or do you think as long as if it’s competitive or maybe lower than what Microsoft charges. Do you think the conversations have been pretty constructive?

Ken Klein

None whatsoever.

John Walsh - Citigroup

As far as pushback?

Ken Klein

No.

John Walsh - Citigroup

My final question. Device management, you mentioned over 100 customers now. Any run rate or revenue expectation? How should we think of that as far as a revenue driver?

Ken Klein

We obviously have some very, very aggressive goals for this division. It is a division within Wind River. We call it our device management division, but the numbers are still relatively modest and don’t move the needle too much in terms of our posted numbers. What I will say though that device management is a clear differentiator for us both in terms of field diagnostics and also for lab and test products and we think this is going to be a very big growth area for us in the coming years and that’s one of the reasons that we’re investing in it and as I alluded to it actually helped through a number of transactions for our VX Works product line and it’s been helpful in the Linux product line in the past as well.

John Walsh - Citigroup

Okay, great. Thanks a lot.

Ken Klein

Sure.

Operator

Your next question comes from Aaron Schwartz, from JPMorgan

Aaron Schwartz - JPMorgan

Good afternoon. Just had a question on the seasonality in revenues for the year being stronger in the second half. Is there some assumption to give you a little more confidence or whether it be some contracts you already signed on design when it should start to contribute royalty revenues second half or can walk through what gives you the dynamics of it and seasonality to see that ramp up stronger in the second half.

Ian Halifax

I would say we do historically tend to see Q4 being by some distance our strongest quarter for both sales activity on revenue. This quarter is a good example of that. I’m encouraged by the fact that we have in our combination of deferred revenue, such as backlog, 40% of our midpoint of our guidance already committed. I think what’s going to be key on seasonality is translating some of our services wins into long-term product and per unit fee generating and it will take some time to convert some of those. Hence, the revenue being forecast most strongly second half of the year.

Aaron Schwartz - JPMorgan

Okay, and then a question on the balance sheet backlog, the $19 million dollars. If we think about that, it’s service engagements you’re using to see the market in some higher growth opportunities for you. As you get more into those markets and start to generate more product revenue, would you naturally expect that off balance sheet amount to decline as it comes more onto the financials or how do you think about that longer term if you do get into these markets?

Ian Halifax

I would say no, because we will continue to leverage our technology and services capability into other new verticals. We’re already seeing very small pockets of that already. We see the services capability as being a very important vertical with which to penetrate and develop and grow new markets.

Aaron Schwartz - JPMorgan

Okay, and then the last question I had was just on the first quarter earnings. I know you had talked about seasonally higher sales and marketing expenses related to conferences, etcetera, but you’re also coming off I guess a reinvestment period and you did take some costs early on in the quarter. I’m just wondering why that wouldn’t offset some of the seasonality around market expenses more to why earnings is at the level you got it to?

Ian Halifax

Well, the seasonal one-time expenses around our sales rally, I think three industry conferences are substantial. The 2 to 3 plus pennies per share and we believe they’re very important investments to make.

Aaron Schwartz - JPMorgan

Thanks for taking my questions.

Operator

Unfortunately, we only have time for one more question. Our final question comes from Richard Williams, from Cross Research

Richard Williams – Cross Research

Thank you. Congrats on the quarter. I wonder if you could give us products breakout as you have in past quarters and perhaps a little color on it as well?

Ian Halifax

Yes, I will break out by revenues. Give me a moment here. There’s an echo on the phone. Much better. Thank you. Products, $7.9 million dollars. Production licenses, $19.4 million dollars. Bankments, $8 million dollars. Professional services, $15 million dollars. Training, $1.1. Subscriptions, $33. That should round to $84.3 if I’ve done the math correctly.

Richard Williams – Cross Research

Last quarter you had mentioned on the call that there was a good chance that you would have two significant announcements in automotive and also in Linux handsets. It sounds like you actually had three flavors in the automotive. Is that correct and what’s happening on the handset side?

Ken Klein

That’s correct and in my prepared remarks I mentioned significant handset win in the United States from the largest handset manufacturer in our country.

Richard Williams – Cross Research

Excellent. So that leads us to think that there may be another one coming, another announcement in the handset market?

Ken Klein

Again, as I’d mentioned, we are negotiating a number of different things in this space and it’s the correct conclusion to take that there’ll be more wins that we’ll be able to announce.

Richard Williams – Cross Research

Okay, great. Final question. On the consulting that you’ve done relating to Linux, kind of the front end loading of the consulting business trying to land deals. How has that progressed? Have you gotten the traction that you were hoping to see?

Ken Klein

Really, really well. Actually in the networking equipment space, I described our experience with Nortel and that’s resulted in numerous wins that Nokea Siemens Networks, Alcatel Lucent, and Ericsson, and many others. We have seen similar phenomena occur in the automotive space, based on our work with BFW, jointly with Intel and we’ve seen that also occur in the consumer space. Our work with Google and resulting in the handset win that we described that occurred last quarter.

Richard Williams – Cross Research

Ian, for the last three quarters, you’ve I guess you can interpret it that you’ve underguided for quarterly results and come out and matched or beaten consensus. Is it fair to conclude that that’s the same MO as we go forward this year?

Ian Halifax

Well I would say with a straight face that we [unclear] performed, but all I will say is I get asked this question every quarter and it’s clear to me that there are no prizes if you miss guidance.

Anne Marie McCauley

Thank you for joining us today. As a reminder, we will be hosting an analysis day here on March 26th. Again, thank you for joining us.

Operator

That concludes this evening’s teleconference. You may now disconnect.

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Source: Wind River Systems, Inc. F4Q08 (01/3108) Earnings Call Transcript
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