Novell Almost Profits on Rising Linux, Stabilizing NetWare

Published: August 30, 2007

by Timothy Prickett Morgan

As Novell's financial results for its fiscal third quarter ended July 31 show, the company's partnership with Microsoft has certainly helped to prop up its revenues and profits for the quarter, and apparently so have some special bundles and pricing actions on the NetWare and Open Enterprise Server side of the Novell house. The end result is that Novell had sales of $243.1 million, up 3 percent, and reported a net loss of $3.4 million, considerably better than the $6.5 million net loss in the year ago quarter.

While Linux was the star of the quarter, the fact that NetWare sales are not plummeting, as they have been doing for many years, is probably equally significant and worthy of some attention. If aggregate NetWare and OES sales declines continue to shrink, as they have done in the past two quarters, and if Linux sales continue to grow, as they have particularly since Novell's distribution deal with Microsoft, then Novell could actually end up being a profitable company again and get some breathing room as it seeks to expand its Linux business.

In the quarter, Novell's Open Platform Solutions unit, which basically means SUSE Linux and related products, accounted for $20.6 million in subscription revenues, up 77. 4 percent compared to the same quarter last year. Other open platform product sales declined by 55.8 percent to $1.5 million. To date, Novell has banked $55 million in Linux subscription fees, according to Dana Russell, Novell's chief financial officer, an increase of 71 percent compared to the prior year. Linux invoicing (which includes unrecognized revenue that will hit in future quarters as subscriptions roll through the quarters) rose by 95 percent in the third fiscal quarter to $38 million, and for the fiscal year to date rose by 243 percent to $163 million. During the quarter, Microsoft represented $14 million of that invoicing, and since the deal was launched last November, Microsoft's customers have activated $105 million of the $240 million in licenses that Microsoft bought. That's about 44 percent of a contract that was supposed to last five years. The Windows base is slowing down, however, and did not invoice nearly as many SUSE licenses as they did immediately following the announcement of the distribution agreement.

Lucky for Novell, the slowing of Linux activations by Microsoft's customers is timed to match an unexpected lull in the crashing of the NetWare-OES product set. Novell's Workgroup unit, which includes the NetWare and OES operating systems, GroupWise groupware, and several other systems software products, had sales of $82.9 million, down only 1.6 percent. OES sales came to $44.6 million, down only 1.3 percent, while NetWare sales came to $5.8 million, down by 39.2 percent. GroupWise accounted for $24.7 million in sales, down 2.3 percent, and other products in the set accounted for $7.7 million in sales, up 86.9 percent. The bright spot was OES licensing, which hit $9.9 million, rising 8.9 percent.

The question everyone wants to answer is whether or not Novell's Workgroup products line will stabilize further once OES 2 is launched; the product, which was contingent on the delivery of Service Pack 1 for SUSE Linux Enterprise Server 10, has been completed and the launch is imminent. OES is, of course, an amalgam of SUSE Linux and NetWare, allowing Linux services to run on NetWare and NetWare services to run on Linux.

In the conference call, Ron Hovsepian, Novell's chief executive officer, cautioned analysts about jumping to conclusions based on these numbers. "It is too early to conclude that this is a trend," Hovsepian said. And when pressed during a question and answer session to provide a little more color about what is going on, he said that Novell had to get through the OES 2 launch and see. "I want to be very careful on this because we have all been burned by this in the past," he said.

During fiscal Q3, Novell Systems and Resource Management unit, which is mostly comprised of its ZENworks product line, had sales of $34.85 million, up 3.7 percent, while the company's Identity and Security Management unit posted sales of $29.8 million, down 1.2 percent. Hovsepian said that he was not happy with what was happening in this unit, and blamed it on sales execution in the Americas region. He said that the company was taking steps to correct the problem.

Novell hit a non-GAAP operating margin of 5 percent in the quarter, and had promised Wall Street during restructurings that occurred last year that it could have an operating margin in the range of 5 percent to 7 percent as it exited the fourth quarter of fiscal 2007. Both executives said that Novell was pretty confident it could hit those numbers. For the full 2007 fiscal year, Novell is sticking to its prior guidance of sales between $925 million and $955 million.

As he did during last quarter's call, Hovsepian did not give any indication about what Novell would do with its $1.8 billion cash and investment hoard. But clearly buying XenSource for $500 million might have been a smart thing to do. Too bad Citrix Systems got to it first.

Hovsepian did get asked about how the XenSource acquisition by Citrix would affect Novell, since it embeds the open source Xen hypervisor inside of SLES 10, its server operating system, and SLED 10, its desktop variant. "From our point of view, Xen is an open source project, and thus we do not anticipate any inhibitors to where we are heading with Xen," he explained. "In terms of broader implications--where Citrix is going with the product [meaning XenEnterprise and how it will use it in its own products, presumably]--I am not familiar with that."

He also said that Novell would fully support the GNU General Public License v3 and that since the new license grandfathered in the Novell-Microsoft agreement, he did not foresee any issues with future SUSE Linux releases or Microsoft's distribution of them. As for the bickering that is going on between Microsoft and the Free Software Foundation about how the GPL v3 license does or does not bind Microsoft, Hovsepian was wise enough to stay out of it.

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