[Updated Sep. 8] — Embedded software powerhouse Wind River on Aug. 31 reported strong preliminary Q2 results, highlighted by growing Linux-based platform “dominance.” However, an ongoing, voluntary audit of the company's stock option program, as well as “erratic” historical performance, has investment magazine Motley Fool advising a “hands-off” approach to the stock, for now.

During its earnings call last week, Wind River CEO Ken Klein and CFO Mike Zellner said the company expects accounting firm KPMG to complete the company's stock option program audit in time for the company to meet its Q-10 report deadline, which seems to be set for later this week or early next week. Klein and Zellner said the audit was initiated on May 31, by the audit committee of Wind's board of directors, on a pro-active basis, rather than in response to any kind of external investigation or inquiry. Many publicly traded companies in the technology market are undertaking such audits, the two noted.

For example, chipmaker Broadcom undertook a similar voluntary stock option program audit, and announced plans on Sep. 8 to re-state its results from 2000 through the first two quarters of 2006, in order to account for upwards of $1.5B worth of previously mis-reported stock options. The news appears to have had minimal initial effect on the company's stock valuation, however.

The Wind River audit aims to determine whether the company is obliged to record any “non-cash adjustments to compensation expense or adjustments to the related tax effects of previous stock option grants,” the company said. It has already found the program to be free of “systemic” reporting problems, through 2003, according to Zellner.

Wind's preliminary Q2 report

Because of the ongoing audit, Wind River's preliminary Q2 report discloses only revenue, rather than both revenue and earnings. However, revenue was up 10 percent, to $73.4M — significantly higher than the company had forecast.

The growth was driven by the maturation of the subscription-based licensing model the company initiated in 2003, Klein said. Subscription-based revenue grew 34 percent, year-over-year, to account for a full third of the company's revenue, Klein said.

At the same time, Wind River continues to offer “shared success,” or royalty based licensing. And, where high-volume devices are produced using only a few developer seats, the company appears to levy “technology access fees.”

Average deal size was another bright spot, Klein reported. The company completed 130 transactions valued at $100K or above, for the quarter.

Embedded Linux success story

Wind River's transition to Linux has been another success story, Klein said, with Linux products and services now accounting for a full ten percent of the company's income, in terms of bookings. Linux-related bookings of $7.34M for the quarter make Wind River the embedded Linux revenue leader, Klein said.

In terms of specific Linux design wins, Klein cited high-end Danish stereo equipment vendor Bang & Olufsen, which reportedly licensed Wind River's Platform for Consumer Electronics, Linux Edition (PCE-LE), in part because of PCD-LE's interesting remote management capabilities.

Asked if Wind River's commercial success with Linux in the embedded market had come as a surprise to the company, Klein replied, “What has surprised us has been how innocuous the competitive market is. How ready the market is for commercial solutions! Customers have gone through the pain of doing it on their own, and they're coming to us.”

Competitive displacement has been especially strong for Wind River in the network equipment market, Klein said. Noting that Wind River is now the largest commercial supplier of embedded Linux, he said, “As we've achieved dominance in the marketplace with Linux-based platforms, we're seeing partners come to us based on end-user demand. In the case of Sun, there was a large set of customers demanding the move to Wind River Linux.”

Professional services represented yet another bright spot, growing to nearly 10 percent of the company's revenue, Klein said. Zellner noted that despite the danger to margins represented by services growth, Wind River still hopes to eclipse a margins goal of 20 percent once it begins hitting $80M quarters with regularity.

Early market reaction

Based on Wind River's preliminary revenue reporting for Q2, the company's stock price has increased about seven percent, closing at $11/share on Sept. 5. However, investment magazine Motley Fool has advised a “hands-off” approach, in light of the company's historically “erratic” stock, and the ongoing audit.

Wind River, for one, is bullish on the value of its own stock, and in fact repurchased 1.1 million shares of its own stock, at an average price of $10.83, during the quarter.

Additional details can be found in Motley Fool's coverage of the preliminary call, here.

 
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