Novell Gets Pinched By Rising Costs, Falling Sales

Published: March 6, 2007

by Timothy Prickett Morgan

Commercial Linux distributor Novell reported its financial results for its fiscal quarter of fiscal 2007 last week, and the company continues to struggle to boost sales and profits, as it has in many past quarters. In this quarter, the numbers didn't pan out, and Novell got caught in the pinchers of rising costs and falling sales, pushing it to a loss. Since Novell is in the middle of a review of stock option grants, the results it reported last week were preliminary and subject to revision.

In fiscal Q1, which ended January 31, Novell's sales were $229.6 million, down 6 percent. Despite its monster deal with Microsoft, which is distributed SUSE Linux Enterprise Server 10 by the tens of thousands to its Windows customers, Novell's software licensing sales nonetheless dropped by 9 percent to $38.4 million in the quarter. Maintenance and services sales fell by 4 percent to $191.2 million. While Novell was able to cut the direct costs of providing its software and services in the quarter by 3 percent and chopped general and administrative costs by 10 percent, sales and marketing costs as well as product development costs grew by more. Not helping matters was the fact that Novell wrote off $10.8 million in one of its consulting units, plus $7.4 million in restructuring charges and $5.8 million in costs relating to the stock options review. This pushed Novell to a loss from operations of $31.3 million and a net loss of $19.9 million. In the prior year's first fiscal quarter, Novell brought $1.9 million to the bottom line.

According to Dana Russell, Novell's chief financial officer, Novell has broken its business into five pieces to reflect the way products are organized and sold. The Open Platform Solutions unit is Linux and related products; the Workgroup unit covers Open Enterprise Server, NetWare, and related products. The Systems and Resource Management unit is ZENworks and other tools, while the Identity and Security Management covers eDirectory and related software. A small consulting unit the operates in the United Kingdom and Switzerland is the fifth unit.

The unit to watch going forward, of course, is the Open Platform Solutions piece of Novell. Russell said that Linux sales were up 46 percent to $15 million in the quarter, and that Linux-related invoices booked had grown by more than 650 percent to $91 million in the quarter (The Microsoft partnership accounted for $73 million of this, by the way.) That big batch of invoices will obviously have a big effect in future quarters as those invoices get paid and add to the deferred revenue bucket for SUSE Linux. In fact, this is already starting to happen. Russell said that Novell had $121 million in deferred Linux revenue in the fiscal first quarter on its books, more than four times what it did a year ago. Including services, the Open Platform Solutions unit had sales of $23.6 million, up 37 percent. The Workgroup unit is what is crushing Novell in terms of revenue declines, with sales of only $104.8 million, down 11 percent. The Systems and Resource Management unit had sales of $42.3 million, down a tiny bit, while the Identity and Security unit had sales of $47.6 million, down 5 percent. The Business Consulting unit brought in $11.2 million, down 20 percent.

As these numbers make plain, Linux, while an important part of Novell's business and a keystone of its future, is still a relatively small piece of its overall revenues and profits--about 10 percent of revenues and gross profits, respectively. You can understand why Novell was willing to partner with Microsoft and possibly incur the wrath of parts of the open source community to goose its Linux sales.

Novell is still in pretty good shape cash wise, however, and a partnership with Microsoft was not its only option. Novell exited the quarter with more than $1 billion in cash and equivalents, up by a third compared to the cash on hand at the end of October 2006 (thanks mostly to Microsoft and its Linux distribution deal). Novell also has $790 million in short-term investments, too. So it could clearly afford to ride out the relatively minor (at least compared to this cash pile) ups and downs in its quarterly results for a very long time--provided it was willing to burn cash to do it.

The company said in a conference call with Wall Street analysts that for fiscal 2007, it expected sales to fall between $945 million and $975 million, with operating margins of between 5 percent and 7 percent. The company did not provide revenue guidance for fiscal 2008, but as a carrot to investors, Novell said that it expected operating margins to grow substantially in fiscal 2008, hitting between 12 percent and 15 percent as it exits the fiscal year in October 2008.

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