Novell's First Quarter Goes into the Red

Published: May 29, 2007

by Timothy Prickett Morgan

Last week, just as the Western economies were gearing down for the Memorial Day holiday, commercial Linux distributor Novell announced that it has completed its lengthy and voluntary review of stock-based compensation for the past decade and can now report its financial results for the first quarter. The good news is that the errors that it found in its stock grants were small enough to not force it to substantially restate financial results for the past decade. The bad news is that Novell posted a loss in the quarter.

In the first quarter of fiscal 2007 ended January 31, Novell said that software license sales amounted to $38.5 million, down 9 percent, while sales of maintenance contracts, software subscriptions (which are really for support, not for the open source software itself), and other services came to $191.2 million, down 4 percent. Total sales for the quarter came in at $229.6 million, down 5 percent. While Novell has kept a tight rein on costs relating to the products themselves, the company has increased spending on sales, marketing, development, and general costs; it has also booked a $7.4 million restructuring charge in the quarter and written off $10.8 million in assets. These factors pushed Novell to a $31.3 million operating loss. Because Novell has over $1 billion in cash in the bank and $790 million in short-term investments, it was able to post a $20.7 million gain in investments and it also sold some venture capital funds for another $3.6 million. When all the math was done and the taxes paid, that worked out to a $19.9 million net loss, or about 6 cents per share, compared to a net profit of $1.9 million in the year ago quarter, or 1 cent a share.

Starting last quarter, Novell has increased the transparency of its financials and now breaks out its financial results in five different categories. The company's Open Platform group, which means SUSE Linux products and services, accounted for $23.6 million in sales, up 37 percent, and had an operating profit of $2.7 million--a far cry better than the $1.1 million operating loss the Linux-related products had a year ago. Novell's Workgroup group is still the economic engine of Novell, which includes NetWare, Open Enterprise Server (the hybrid NetWare-Linux product), and GroupWise groupware. This unit posted sales of $104.9 million, down 11 percent, but it had an operating profit of $74.5 million, down 8 percent. You can see now why Novell hangs onto its NetWare and Groupwise business. Novell's Systems and Resource Management group is also no slouch when it comes to revenue and operating profits, with $42.3 million in sales in the first fiscal quarter (down a smidgen) and an operating profit of $26.4 million. Novell's Identity and Security Management group had sales of $47.6 million, down 5 percent; operating profits in this group came in at $3.9 million, and were almost cut in half. Novell's Business Consulting group had sales of $11.2 million, down 20 percent, and operating profits were cut in half to $1.4 million.

The questions that Novell's top brass and investors must be asking themselves is how far Novell can push Linux sales and will it be fast enough to keep pace with the declines in Netware-related sales? The evidence so far would suggest that Novell cannot do it, but the reality is that Novell has very little choice but to make an attempt to grow Linux services as fast as it can to offset inevitable declines in NetWare license sales. With nearly $1.8 billion in cash and short-term investments--or about two year's worth of revenue--Novell certainly has the capital to ride out the transition. The question will be whether or not Wall Street has the patience to ride out that transition, and whether investors believe that Novell can be as profitable delivering Linux services as it was selling proprietary NetWare licenses for two decades. With a market capitalization of $2.6 billion right now, Novell could take itself private if it borrowed some dough. The odds that someone would try to do a hostile takeover of Novell should the company decide to borrow $770 million to do this are very, very small. Such a tactic might be the second smartest thing Novell ever did, after buying German Linux distributor SUSE nearly four years ago.

As for the stock-based compensation review, Novell said that the cumulative after tax hit to its financials from errors in stock grants came to $19 million from fiscal 1997 through 2005, and in fiscal 2005 and 2006 the results were not changed materially.

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