UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark one)
[X] Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the Quarterly Period Ended July 31, 2003
or
[ ] Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the transition period from
to
-----------
Commission File Number: 0-13351
NOVELL, INC.
(Exact name of registrant as specified in its charter)
Delaware 87-0393339
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1800 South Novell Place
Provo, Utah 84606
(Address of principal executive offices and zip code)
(801) 861-7000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO __
Indicate by check mark wither the registrant is an accelerated filer (as defined
in Rule 12b-2 of the Exchange Act)
YES X NO __
As of August 29, 2003, there were 373,426,470 shares of the registrant's common
stock outstanding.
Part I. Financial Information
Item 1. Financial Statements
NOVELL, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
July 31, 2003 October 31, 2002
------------- ----------------
In thousands, except share and per share data (Unaudited)
Assets Current assets:
Cash, cash equivalents, and short-term investments $ 738,777 $ 635,858
Receivables (less allowances of $29,539 - July 31,
2003 and $39,676 - October 31, 2002) 217,230 214,827
Prepaid expenses 27,596 24,077
Deferred income taxes 19,677 21,204
Other current assets 22,820 23,572
---------------- ---------------
Total current assets 1,026,100 919,538
Property, plant and equipment, net 258,908 369,189
Goodwill 178,297 179,534
Intangible assets 4,360 36,351
Long-term investments 51,039 73,452
Deferred income taxes 96,245 74,323
Other assets 7,792 12,678
---------------- ---------------
Total assets $ 1,622,741 $ 1,665,065
================ ===============
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 48,263 $ 57,241
Accrued compensation 96,233 87,778
Other accrued liabilities 121,678 134,850
Income taxes payable 24,980 36,294
Deferred revenue 295,786 275,344
---------------- ---------------
Total current liabilities 586,940 591,507
---------------- ---------------
Minority interests 8,016 8,016
---------------- ---------------
Stockholders' equity:
Common stock, par value $.10 per share:
Authorized - 600,000,000 shares;
Issued -371,828,779 shares-July 31, 2003,
367,537,926 shares-October 31, 2002 37,183 36,753
Preferred stock, par value $.10 per share;
Authorized - 500,000 shares, Issued - 0 shares -- --
Additional paid-in capital 304,655 297,139
Retained earnings 685,763 738,663
Accumulated other comprehensive income 4,633 57
Other (4,449) (7,070)
----------------- ----------------
Total stockholders' equity 1,027,785 1,065,542
---------------- ---------------
Total liabilities and stockholders' equity $ 1,622,741 $ 1,665,065
================ ===============
See notes to consolidated unaudited condensed financial statements.
NOVELL, INC.
CONSOLIDATED UNAUDITED CONDENSED STATEMENTS OF OPERATIONS
Three Months Ended
July 31, 2003 July 31, 2002
In thousands, except per share data
Net revenue
New software licenses $ 69,255 $ 82,894
Maintenance and services 213,554 199,379
--------------- ---------------
Net revenue 282,809 282,273
--------------- ---------------
Cost of revenue
New software license costs 5,886 8,098
Maintenance and services 101,591 101,724
--------------- ---------------
Cost of revenue 107,477 109,822
--------------- ---------------
Gross profit 175,332 172,451
--------------- ---------------
Operating expenses:
Sales and marketing 92,470 87,487
Product development 48,178 44,130
General and administrative 28,379 29,566
Purchased in-process research and development -- 3,000
Restructuring 26,350 --
--------------- ---------------
Total operating expenses 195,377 164,183
--------------- ---------------
Income (loss) from operations (20,045) 8,268
--------------- ---------------
Other income (expense), net:
Investment income (expense) (5,016) 5,268
Other, net 1,299 1,962
--------------- ---------------
Other income (expense), net (3,717) 7,230
---------------- ---------------
Income (loss) before taxes (23,762) 15,498
Income tax benefit (11,362) 5,549
---------------- ---------------
Net loss $ (12,400) $ 9,949
================ ===============
Basic and diluted net loss per share $ (0.03) $ 0.03
=============== ==============
Basic weighted average shares outstanding 371,484 364,211
Diluted weighted average shares outstanding 371,484 364,247
See notes to consolidated unaudited condensed financial statements.
NOVELL, INC.
CONSOLIDATED UNAUDITED CONDENSED STATEMENTS OF OPERATIONS
Nine Months Ended
July 31, 2003 July 31, 2002
In thousands, except per share data
Net revenue
New software licenses $ 194,758 $ 224,980
Maintenance and services 623,989 609,005
--------------- ---------------
Net revenue 818,747 833,985
--------------- ---------------
Cost of revenue
New software license costs 17,070 21,711
Maintenance and services 296,742 318,508
--------------- ---------------
Cost of revenue 313,812 340,219
--------------- ---------------
Gross profit 504,935 493,766
--------------- ---------------
Operating expenses:
Sales and marketing 292,512 255,108
Product development 139,454 129,528
General and administrative 86,663 90,946
Purchased in-process research and development -- 3,000
Restructuring 35,025 19,100
--------------- ---------------
Total operating expenses 553,654 497,682
--------------- ---------------
Loss from operations (48,719) (3,916)
--------------- ----------------
Other income (expense), net:
Investment income (expense) (22,615) (9,323)
Other, net 234 8,625
--------------- ---------------
Other income (expense), net (22,381) (698)
---------------- ----------------
Loss before taxes and cumulative effect of accounting change (71,100) (4,614)
Income tax expense (benefit) (18,200) 6,835
---------------- ---------------
Loss before cumulative effect of accounting change (52,900) (11,449)
Cumulative effect of accounting change -- (143,702)
--------------- ----------------
Net loss $ (52,900) $ (155,151)
================ ================
Basic and diluted net loss per share:
Before cumulative effect of accounting change $ (0.14) $ (0.03)
Cumulative effect of accounting change -- (0.40)
--------------- ---------------
Basic and diluted net loss per share $ (0.14) $ (0.43)
=============== ===============
Basic and diluted weighted average shares outstanding 369,435 363,131
See notes to consolidated unaudited condensed financial statements.
NOVELL, INC.
CONSOLIDATED UNAUDITED CONDENSED STATEMENTS OF CASH FLOWS
Nine Months Ended
In thousands July 31, 2003 July 31, 2002
------------- -------------
Cash flows from operating activities:
Net loss $ (52,900) $ (155,151)
Adjustments to reconcile net loss to net cash provided by operating activities:
Gain on sale of property, plant and equipment (25,299) (8,762)
Depreciation and amortization 49,174 49,175
Loss on impaired goodwill and intangible assets, net of tax 13,935 143,702
Loss on impaired investments 32,563 29,839
Non-cash restructuring charges 23,226 16,426
In-process research and development expense -- 3,000
(Increase) decrease in receivables (2,403) 29,346
(Increase) decrease in prepaid expenses (3,519) 4,756
(Increase) decrease in deferred income taxes (10,507) 963
Decrease in other current assets 752 8,372
Decrease in accounts payable (8,978) (21,564)
Decrease in other current liabilities, net (34,476) (78,168)
Increase (decrease) in deferred revenue 20,442 (3,332)
------------- --------------
Net cash provided by operating activities 2,010 18,602
------------- -------------
Cash flows from financing activities:
Issuance of common stock, net 7,805 6,861
------------- -------------
Net cash provided by financing activities 7,805 6,861
------------- -------------
Cash flows from investing activities:
Expenditures for property, plant and equipment (30,605) (18,676)
Proceeds from the sale of property, plant and equipment 125,000 16,050
Purchases of short-term investments (455,719) (1,191,184)
Maturities of short-term investments 72,556 907,134
Sales of short-term investments 265,923 425,534
Cash acquired from acquisition of SilverStream -- 108,286
Cash paid for acquisition of SilverStream -- (210,847)
Cash paid for Volera minority interest shares (1,050) --
Expenditures for long-term investments (11,285) (7,882)
Other 12,055 (2,955)
------------- --------------
Net cash (used for) provided by investing activities (23,125) 25,460
-------------- -------------
Net (decrease) increase in cash and cash equivalents (13,310) 50,923
Cash and cash equivalents - beginning of period 463,987 337,927
------------- -------------
Cash and cash equivalents - end of period 450,677 388,850
Short-term investments - end of period 288,100 218,460
------------- -------------
Cash and short-term investments - end of period $ 738,777 $ 607,310
============= =============
See notes to consolidated unaudited condensed financial statements.
NOVELL, INC.
NOTES TO CONSOLIDATED UNAUDITED CONDENSED FINANCIAL STATEMENTS
A. Quarterly Financial Statements
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to
make estimates and assumptions that affect the amounts reported in the
financial statements and accompanying notes. As discussed under the
subheading "Critical Accounting Policies" in Part I, Item 2, "Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
actual results could differ materially from those estimates. The
accompanying consolidated unaudited condensed financial statements have
been prepared in accordance with the instructions to Form 10-Q but do not
include all of the information and footnotes required by generally accepted
accounting principles and should, therefore, be read in conjunction with
our fiscal 2002 Annual Report on Form 10-K. These financial statements do
include all normal recurring adjustments that we believe are necessary for
a fair presentation of the statements. The interim operating results are
not necessarily indicative of the results for a full year. Certain
reclassifications, none of which affected net loss, have been made to the
prior year's amounts in order to conform to the current year's
presentation.
B. Foreign Currency Translation
Due to increased activity in non-U.S. dollar currencies, beginning November
1, 2002, we have determined the functional currency of all of our
international subsidiaries, except for our Irish subsidiaries, to be the
local currency. These subsidiaries generate and expend cash primarily in
their respective local currency. Assets and liabilities of these
subsidiaries are translated at current month-end exchange rates. Revenue
and expenses are translated monthly at the average monthly exchange rate.
Such translation adjustments are recorded in accumulated other
comprehensive income. Previously, the functional currency of our
international subsidiaries, except Novell Japan, Novell India, and the
international subsidiaries of Cambridge Technology Partners ("Cambridge")
and SilverStream, was the U.S. dollar.
C. Cash, Cash Equivalents, and Short-term Investments
We consider all highly liquid debt instruments purchased with a term to
maturity of three months or less to be cash equivalents. Short-term
investments are widely diversified, consisting primarily of investment
grade securities that either mature within the next 12 months or have other
characteristics of short-term investments. These include:
oVariable rate preferred stock instruments that are publicly traded and
earn dividends periodically at a rate set in an auction. These
instruments have auction dates within 180 days of the prior auction
date.
oFixed income securities, which have contractual maturities ranging from
zero to seven years. These securities are available to be used for
current operations and thus are classified as short-term investments,
even though some maturities may extend beyond one year.
No other short-term investments have contractual maturities. All marketable
debt and equity securities that are included in cash and short-term
investments are considered available-for-sale and are carried at fair
market value. The unrealized gains and losses related to these securities
are included in accumulated other comprehensive income, net of tax, after
any applicable tax valuation allowances (see Note M). Fair market values
are based on quoted market prices when available; if quoted market prices
are not available, the fair market values are based on quoted market prices
of similar instruments of companies that are comparable in size, product
offerings, and market sector. When securities are sold, their cost is
determined based on the specific identification method.
The following is a summary of cash and short-term investments, all of which
are considered available-for-sale.
Gross Gross Fair Market
Cost at Unrealized Unrealized Value at
In thousands July 31, 2003 Gains Losses July 31, 2003
------------- ----- ------ -------------
Cash and cash equivalents:
Cash $ 131,130 $ -- $ -- $ 131,130
Government and agency securities 22,794 -- -- 22,794
Corporate obligations 20,212 -- -- 20,212
Money market funds 276,541 -- -- 276,541
----------- ---------- ---------- -----------
Total cash and cash equivalents 450,677 -- -- 450,677
----------- ---------- ---------- -----------
Short-term investments:
Variable rate instruments 37,500 36 -- 37,536
Government and agency securities 111,950 372 (215) 112,107
Corporate obligations 132,170 1,441 (227) 133,384
Equity securities 4,872 323 (122) 5,073
----------- ---------- ---------- ------------
Total short-term investments 286,492 2,172 (564) 288,100
----------- ---------- ----------- ------------
Total cash and short-term $ 737,169 $ 2,172 $ (564) $ 738,777
=========== ========== =========== ============
investments
Gross Gross Fair Market
Cost at Unrealized Unrealized Value at
In thousands October 31, 2002 Gains Losses October 31, 2002
---------------- ----- ------ ----------------
Cash and cash equivalents:
Cash $ 179,098 $ -- $ -- $ 179,098
Government and agency securities 60,121 -- -- 60,121
Corporate obligations 23,219 -- -- 23,219
Money market funds 201,549 -- -- 201,549
------------- ----------- ---------- ------------
Total cash and cash equivalents 463,987 -- -- 463,987
------------- ----------- ----------- ------------
Short-term investments:
Variable rate instruments 14,499 1 -- 14,500
Government and agency securities 38,025 379 -- 38,404
Corporate obligations 110,746 2,533 (113) 113,166
Equity securities 5,982 368 (549) 5,801
------------- ----------- ---------- ------------
Total short-term investments 169,252 3,281 (662) 171,871
------------- ----------- ---------- ------------
Total cash and short-term investments $ 633,239 $ 3,281 $ (662) $ 635,858
============= =========== ========== --============
During the third quarter of fiscal 2003, we realized gains of $0.6 million
and realized losses of $0.1 million from the sale of short-term
investments. During the third quarter of fiscal 2002, we realized gains of
$1.9 million and realized losses of $0.8 million from the sale of
short-term investments. During the first nine months of fiscal 2003, we
realized gains of $1.7 million and realized losses of $0.4 million from the
sale of short-term investments. During the first nine months of fiscal
2002, we realized gains of $7.4 million and realized losses of $1.0 million
from the sale of short-term investments.
We routinely review all of our investments for impairment. We did not
record any impairment losses on short-term investments during the first
nine months of fiscal 2003 or fiscal 2002.
D. Long-term Investments
The primary components of long-term investments as of July 31, 2003 were
investments made through the Novell Venture account or the Cambridge
Technology Capital Fund I L.P. ("CTC I"), and direct investments we made
for strategic purposes in equity securities of privately-held companies.
Long-term investments are accounted for initially at cost and written down
to fair market value when indicators of impairment are deemed to be other
than temporary.
We routinely review our investments in private securities and venture funds
for impairment. To assess impairment, we analyze forecasted financial
performance of the investees, the liquidation preference value of the stock
we hold, and our estimate of the potential for investment recovery based on
all these factors. During the third quarter and first nine months of fiscal
2003, we recognized impairment losses on long-term investments totaling
$8.0 million and $32.6 million, respectively. During the third quarter of
fiscal 2002, we did not recognize an impairment loss. During the first nine
months of fiscal 2002, we recognized impairment losses of $24.4 million. As
of July 31, 2003 and 2002, there were no unrealized gains or losses on our
long-term equity investments.
E. Goodwill and Intangible Assets
Goodwill includes approximately $126.7 million from the July 2002
acquisition of SilverStream Software, Inc. ("SilverStream"), approximately
$42.5 million from the July 2001 acquisition of Cambridge, and
approximately $9.1 million related to the acquisition of several small
technology-related companies. Beginning November 1, 2002, we reorganized
our operations and began reporting our financial results in four segments;
three are based on geographic area and the fourth being Celerant management
consulting. The geographic segments are Americas, EMEA, and Asia Pacific.
o Americas - includes the United States, Canada, and Latin America
o EMEA - includes Eastern and Western Europe, Middle East, and Africa
o Asia Pacific -includes China, Japan, Southeast Asia, Australia,
New Zealand, and India
Prior to November 1, 2002, we operated and reported financial results based
on three business segments: product, consulting, and Volera, Inc.
The following is a summary of goodwill, which has been reallocated to the
new segments, which we consider to be reporting units for allocating and
evaluating goodwill:
In thousands Americas EMEA Asia Celerant Total
Pacific
-------- ---- ----- -------- -----
Balance as of November 1, 2002 $ 69,842 $ 60,447 $ 6,745 $ 42,500 $ 179,534
Adjustments (623) (552) (62) -- (1,237)
---------- --------- ---------- --------- ----------
Balance as of July 31, 2003 $ 69,219 $ 59,895 $ 6,683 $ 42,500 $ 178,297
========= ======== -======== ========= ==========
Adjustments relate to a true up of SilverStream merger-related liabilities.
The following is a summary of intangible assets:
In thousands July 31, 2003 October 31, 2002
------------- ----------------
Developed technology $ 3,800 $ 32,769
Trade names 560 3,582
------------ ------------
Total intangible assets $ 4,360 $ 36,351
============ ============
Developed technology at October 31, 2002 related primarily to the exteNd
product line that we acquired as a part of our July 2002 acquisition of
SilverStream Software, Inc. Trade names relate to the SilverStream
individual product names, which we continue to use. During the third
quarter of fiscal 2003, we determined that there existed impairment
indicators related to the developed technology and trade names we acquired
from SilverStream as a result of unexpected revenue declines for the exteNd
products. Based on an independent valuation of these assets, we recorded a
$23.6 million charge to write down these assets to fair value.
Because the intangibles were determined to be impaired, we also analyzed
our other long-lived assets for indicators of impairment. This included
goodwill and fixed assets acquired from SilverStream. Goodwill is
reflective of the segment to which it is allocated, not necessarily the
company or technology from which it originated, thus the analysis of
goodwill is performed on geographic segment performance. No indicators of
impairments were noted. Fixed assets consisted mainly of computers and
software, none of which had become impaired. Our annual goodwill impairment
analysis is performed during our fourth fiscal quarter of each year.
Developed technology is being amortized over three years. Amortization for
the third quarter and first nine months of fiscal 2003 was $2.1 million and
$8.5 million, respectively. Amortization for the third quarters and first
nine months of fiscal 2002 was $0.6 million and $2.9 million, respectively.
Trade names have an indefinite life and therefore are not amortized but are
reviewed for impairment at least annually.
F. Income Taxes
Our effective tax rate before investment impairment losses for the third
quarter and first nine months of fiscal 2003 was 30%. The actual tax
benefit rate for the third quarter of fiscal 2003 was 48% and the actual
tax benefit rate for the first nine months of fiscal 2003 was 26%. The
effective tax rate for fiscal 2002 was 12%. The actual rate for the third
quarter and the first nine months of 2003 is after adjusting for the
impairment of the SilverStream intangibles. Furthermore, a portion of the
gain realized on the sale of the San Jose property qualifies as capital
gain and was offset by capital loss carryforwards. The investment
impairment was not realized for tax purposes, and as noted with respect to
earlier periods, corporations can only offset capital gains with capital
losses and Novell could not be assured at quarter end that it could realize
sufficient capital gains during the five-year carry over period for capital
losses. The effective tax rate for the first nine months of fiscal 2003
differed from the fiscal 2002 effective tax rate primarily because of
differences in the amount of non-deductible and non-taxable items in each
period. A valuation allowance has been established against the capital loss
amounts that we may not be able to recognize.
We paid income taxes of $7.6 million in the first nine months of fiscal
2003 and $14.7 million during the same period of fiscal 2002.
G. Line of Credit
We currently have a $15 million unsecured revolving bank line of credit,
which expires on March 3, 2004. The line can be used for either letter of
credit or working capital purposes and is subject to the terms of a loan
agreement containing financial covenants and restrictions, none of which
are expected to significantly affect our operations. At July 31, 2003,
there were $12.9 million of standby letters of credit outstanding under
this agreement.
Our subsidiary in China has a $0.9 million short-term revolving line of
credit, which expires on February 29, 2004. The line is being used for our
China operations, where there are restrictions on transfers of cash into
the country. This line is collateralized by standby letters of credit,
discussed above. At July 31, 2003, there was $0.9 million outstanding under
this revolving line.
H. Restructuring
Third quarter of fiscal 2003
During the third quarter of fiscal 2003, we recorded a pre-tax
restructuring charge of approximately $27.8 million resulting from the
restructuring of our operations in response to changes in general market
conditions, changing customer demands, and the evolution of our business
strategy relative to the identity management and secure web services areas
of our business and our revised strategy. This strategy includes plans to
support the Linux kernel in addition to the NetWare kernel, by offering
Novell products and services that run on both Netware and Linux platforms.
These changes in strategy and company structure were made to address the
current revenue declines. Specific actions taken included reducing our
workforce worldwide by approximately 600 employees (approximately 10%)
across all functions and geographies, with a majority coming from product
development, sales, and general and administrative functions, primarily in
the United States. In addition, we consolidated facilities, and disposed of
excess equipment. By reporting segment, the Americas accounted for $19.4
million, EMEA accounted for $6.0 million, and Asia Pacific accounted for
$2.4 million.
The following table summarizes the activity during the third quarter of
2003 related to this restructuring.
Balance at
Original Cash Non-cash July 31,
Charge Payments Adjustments 2003
-------- --------- ----------- ---------
In thousands
Severance and benefits $ 20,287 $ (11,671) $ -- $ 8,616
Excess facilities and property and equipment 5,778 -- 218 5,996
Other restructuring-related costs 1,729 (67) (261) 1,401
-------- ---------- --------- --------
$ 27,794 $ (11,738) $ (43) $ 16,013
======== ========== ========= ========
As of July 31, 2003, the remaining balance of the third quarter of fiscal
2003 restructuring charge included accrued liabilities related to severance
and benefits, which will be paid out over the remaining severance
obligation period, not to exceed two years, lease costs for redundant
facilities, which will be paid over the respective remaining contract
terms, and various severed employee related costs, which will be paid over
the next four quarters.
During the third quarter of fiscal 2003, we also released approximately
$1.4 million related to excess restructuring reserves related to the second
quarter fiscal 2002 restructuring event. This release is reflected in the
second quarter fiscal 2002 table below. The net impact of the third quarter
fiscal 2003 restructuring and the release of the excess fiscal 2002
reserves was a charge of $26.4 million.
Second quarter of fiscal 2003
During the second quarter of fiscal 2003, we determined that the amount we
had originally accrued for facility-related costs in previous
restructurings was too low and accrued an additional $8.7 million. The
original liability was based on estimated sublease rates and timing, which
have been affected by the decline in the real estate market. This
additional amount, which pertains to three separate restructuring events,
is included in the following tables.
Second quarter of fiscal 2002
During the second quarter of fiscal 2002, we recorded a pre-tax
restructuring charge of approximately $20 million resulting from our
continued migration towards becoming a solutions provider and as a result
of changing business needs. Specific actions taken included reducing our
workforce worldwide by approximately 50 employees (less than 1%),
consolidating facilities, closing offices in unprofitable locations, and
disposing of excess property and equipment.
As noted above, during the second quarter of fiscal 2003, we determined
that the amount we had originally accrued for facility-related costs was
too low and accrued an additional $7.7 million. The original liability for
lease costs was based on estimated sublease rates and timing, which have
been affected by the decline in the real estate market. Additionally,
during the third quarter of fiscal 2003 we released approximately $1.4
million of excess restructuring reserves related to excess severance costs
The following table summarizes the activity during fiscal 2003 related to
the second quarter of fiscal 2002 restructuring.
Balance at Balance at
Original October 31, Cash July 31,
Charge 2002 Payments Adjustments 2003
------ ------ --------- ----------- --------
In thousands
Severance and benefits $ 14,748 $ 4,258 $ (2,851) $ (100) $ 1,307
Excess facilities and property and equipment 5,146 4,221 (2,445) 6,391 8,167
Other restructuring-related costs 492 300 -- -- 300
-------- -------- -------- -------- --------
$ 20,386 $ 8,779 $ (5,296) $ 6,291 $ 9,774
======== ======== ========= ======== ========
As of July 31, 2003, the remaining balance of the second quarter of fiscal
2002 restructuring charge included accrued liabilities related to severance
and benefits, which will be paid out over the remaining severance
obligation period, and lease costs for redundant facilities and other fixed
contracts, which will be paid over the respective remaining contract terms.
Fourth quarter of fiscal 2001
During the fourth quarter of fiscal 2001, we recorded $51 million of
pre-tax restructuring charges resulting from the restructuring of our
operations in light of changes in general market conditions, changing
customer demands, and the evolution of our business strategy. The execution
of this strategy included refining our consulting initiatives, refocusing
research and development efforts, defining sales and marketing efforts to
be more customer and solutions oriented, and adjusting our overall cost
structure given current revenue levels and our direction.
Specific actions included reducing our workforce worldwide by approximately
1,100 employees (approximately 16%), consolidating excess facilities and
disposing of excess property and equipment, terminating a management
consulting contract that no longer fit with our strategic focus, and
abandoning and writing off technologies that no longer fit within our new
strategy. We also realigned our remaining resources to better manage our
business. As noted above, during the second quarter of fiscal 2003, we
determined that the amount we had originally accrued for facility-related
costs was too low and accrued an additional $0.3 million. The original
liability was based on estimated sublease rates and timing, which have been
affected by the decline in the real estate market.
The following table summarizes the costs and activities during fiscal 2003
related to the fourth quarter of 2001 restructuring.
Balance at Balance at
Original October 31, Cash July 31,
Charge 2002 Payments Adjustments 2003
------ ----------- ---------- ------------ --------
In thousands
Severance and benefits $ 32,793 $ 1,117 $ (907) $ -- $ 210
Excess facilities and property and equipment 10,896 4,651 (2,051) 262 2,862
Other restructuring-related costs 6,973 624 (439) -- 185
-------- -------- ---------- -------- -------
$ 50,662 $ 6,392 $ (3,397) $ 262 $ 3,256
======== ======== ========== ======== ========
As of July 31, 2003, the remaining balance of the fourth quarter fiscal
2001 restructuring charge included accrued liabilities largely related to
severance and benefits, which will be paid out during fiscal 2003, and
lease costs for excess facilities, which will be paid over the respective
remaining lease terms.
Third quarter of fiscal 2001
During the third quarter of fiscal 2001, we recorded a pre-tax
restructuring charge of approximately $30 million as a result of our July
2001 acquisition of Cambridge Technology Partners and changes in our
business to move towards a Net business solutions strategy. Specific
actions included reducing our workforce worldwide by approximately 280
employees across all functional areas (approximately 5% before the addition
of Cambridge), consolidating facilities and disposing of excess property
and equipment, abandoning and writing off technologies that no longer fit
within our new strategy, and discontinuing unprofitable product lines. As
noted above, during the second quarter of fiscal 2003, we determined that
the amount we had originally accrued for facility-related costs was too low
and accrued an additional $0.7 million. The original liability was based on
estimated sublease rates and timing, which have been affected by the
decline in the real estate market.
The following table summarizes the activity during fiscal 2003 related to
the third quarter of fiscal 2001 restructuring costs.
Balance at Balance at
Original October 31, Cash July 31,
Charge 2002 Payments Adjustments 2003
-------- ----------- --------- ----------- ---------
Severance and benefits $ 15,978 $ -- $ -- $ -- $ --
Excess facilities and property and equipment 10,740 3,889 (1,778) 678 2,789
Other restructuring-related costs 3,675 137 (137) -- --
-------- -------- --------- -------- ---------
$ 30,393 $ 4,026 $ (1,915) $ 678 $ 2,789
======== ======== ========= ======== =========
As of July 31, 2003, the remaining balance of the third quarter of fiscal
2001 restructuring charge included accrued liabilities related to lease
costs for excess facilities, which will be paid over the respective
remaining lease terms.
I. Guarantees
During the first quarter of fiscal 2002, we sold our subsidiary in the
Czech Republic. As a part of this transaction, we provided a guarantee to
the landlord of the building we lease in the Czech Republic whereby we
agreed to pay any and all monies due under the lease, including legal fees
if the new lessee defaults on the lease. During fiscal 2003, we paid
approximately $0.1 million against this guarantee and have accrued an
additional $0.4 million, which represents our liability exposure if the new
lessee continues in default, excluding legal fees.
As an element of our standard contract terms, we include an indemnification
clause in our agreements with our customers that indemnifies the licensee
against certain liability and damages arising from intellectual property
infringement claims arising from their use or distribution of our software.
These terms are common in the high technology industry. We do not record a
liability for potential litigation claims related to indemnification
agreements with our customers. We do not believe the likelihood of a
material obligation is probable.
We also have some outstanding intercompany guarantees, which guarantee
payment of certain obligations of our subsidiaries.
J. Commitments and Contingencies
In 1997, the Board of Directors established the Novell Venture account
within our investment portfolio for the purpose of promoting our business
and strategic objectives by making investments in privately-held companies,
mainly small capitalization stocks in the high technology industry sector,
and in funds managed by venture capitalists. As of July 31, 2003, we had a
balance of $47.2 million related to investments in various venture capital
funds and had commitments to contribute an additional $57.6 million to
these funds over the next three to four years, upon the request of the fund
managers. As a result of our acquisition of Cambridge, we also own both
limited and general partnership interests in CTC I of approximately 24%. As
of July 30, 2003, we had an investment balance of $0.2 million in CTC I and
had commitments to contribute up to an additional $0.3 million over the
next three to four years. We do not intend to make any new long-term
investments through the Novell Venture account or in venture capital funds.
In May 2002, France Telecom SA and U.S. Philips Corporation, alleged
co-owners of a U.S. patent, filed suit in the U.S. District Court, District
of Delaware, against Novell. The plaintiffs allege that Novell's NetWare
client software infringes the patent. In the suit, the plaintiffs seek
unspecified monetary damages and an injunction prohibiting infringement of
the patent. We intend to vigorously defend ourselves in this suit. Although
there can be no assurance as to the ultimate disposition of the suit, we do
not believe that the resolution of this litigation will have a material
adverse effect on our financial position, results of operations or cash
flows.
SilverStream and several of its former officers and directors, as well as
the underwriters who handled SilverStream's two public offerings, were
named as defendants in several class action complaints that were filed on
behalf of certain former stockholders of SilverStream who purchased shares
of SilverStream common stock between August 16, 1999 and December 6, 2000.
These complaints are closely related to several hundred other complaints
that the same plaintiffs have brought against other issuers and
underwriters. These complaints all allege violations of the Securities
Exchange Act of 1933, as amended, and the Securities Exchange Act of 1934,
as amended. In particular, they allege, among other things, that there was
undisclosed compensation received by the underwriters of the public
offerings of all of these issuers, including SilverStream's. The plaintiffs
are seeking monetary damages, statutory compensation and other relief that
may be deemed appropriate by the court. A Consolidated Amended Complaint
with respect to all of these complaints was filed in the U.S. District
Court, Southern District of New York, on April 19, 2002. All issuers,
including SilverStream, filed a Motion to Dismiss on July 15, 2002. We
believe that SilverStream and its former officers and directors have
meritorious defenses to the claims made in the complaints and intend to
contest the claims against SilverStream and its former directors and
officers vigorously. While there can be no assurance as to the ultimate
disposition of the litigation, we do not believe that its resolution will
have a material adverse effect on our financial position, results of
operations or cash flows.
In February 1998, a suit was filed in the U.S. District Court, District of
Utah, against us and certain of our officers and directors, alleging
violation of federal securities laws by concealing the true nature of our
financial condition and seeking unspecified damages. The lawsuit was
brought as a purported class action on behalf of purchasers of our common
stock from November 1, 1996 through April 22, 1997. After a first dismissal
of the suit on November 3, 2000 and a subsequent amendment to the complaint
filed on February 20, 2001, the U.S. District Court dismissed the amended
complaint with prejudice for failure to state a claim. Much of the District
Court's Order of Dismissal was recently affirmed by the Tenth Circuit Court
of Appeals while certain claims were remanded for the District Court's
further review. Novell believes it has meritorious defenses to these
remaining claims. While there can be no assurance as to the ultimate
disposition of the lawsuit, we do not believe that the resolution of this
litigation will have a material adverse effect on our financial position,
results of operations or cash flows.
We are a party to a number of additional legal claims arising in the
ordinary course of our business. We believe that the ultimate resolution of
these claims will not have a material adverse effect on our financial
position, results of operations or cash flows.
K. Segment Information
Beginning November 1, 2002, we reorganized our operations and began
reporting our financial results in four segments; three are based on
geographic areas and the fourth is Celerant management consulting. The
geographic segments are Americas, EMEA, and Asia Pacific. Performance is
evaluated by our Chief Executive Officer and Worldwide Management
Committee, our chief decision makers, and is based on reviewing revenue and
segment operating income (loss) information for each of the geographic
segments and for the Celerant management consulting segment.
The geographic segments include:
o Americas - includes the United States, Canada, and Latin America
o EMEA - includes Eastern and Western Europe, Middle East, and Africa
o Asia Pacific -includes China, Japan, Southeast Asia, Australia,
New Zealand, and India
All geographic segments sell our software, licenses and services offerings
(except Celerant management consulting services). These offerings are sold
in the U.S. via direct, OEM, reseller, and distributor channels, and
internationally are sold directly and through distributors who sell to
dealers and end users.
Operating results by segment
Three months July 31, 2003 Three months July 31, 2002
-------------------------- --------------------------
Operating Operating
Net Revenue Income (Loss) Net Revenue Income (Loss)
----------- ------------- ----------- -------------
In thousands
Americas $ 135,635 $ 61,671 $ 151,255 $ 64,755
EMEA 87,400 31,512 79,383 29,658
Asia Pacific 23,235 5,667 20,094 4,894
Common unallocated operating costs -- (92,939) -- (89,653)
---------- ---------- ---------- ----------
Total geographic segments 246,270 5,911 250,732 9,654
Celerant management consulting 36,539 894 31,541 1,614
Unallocated integration costs and
restructuring adjustments -- (26,850) -- (3,000)
---------- ----------- ---------- -----------
Total $ 282,809 $ (20,045) $ 282,273 $ 8,268
========== =========== ========== ==========
Nine months ended July 31, 2003 Nine months ended July 31, 2002
------------------------------- -------------------------------
Operating Operating
Net Revenue Income (Loss) Net Revenue Income (Loss)
----------- ------------- ----------- -------------
In thousands
Americas $ 396,979 $ 163,372 $ 448,707 $ 196,446
EMEA 257,800 90,857 233,492 90,080
Asia Pacific 62,000 8,982 59,062 10,535
Common unallocated operating costs -- (277,107) -- (280,279)
---------- ---------- ---------- ----------
Total geographic segments 716,779 (13,896) 741,261 16,782
Celerant management consulting 101,968 3,074 92,723 4,058
Unallocated integration costs and
restructuring adjustments -- (37,897) -- (24,756)
---------- ----------- ---------- -----------
Total $ 818,747 $ (48,719) $ 833,984 $ (3,916)
========== =========== ========== ===========
Common unallocated operating costs include corporate services common to all
segments such as corporate sales and marketing, product development,
corporate general and administrative costs, and corporate infrastructure
costs. Celerant does not utilize these corporate services.
In addition to reviewing geographic and Celerant management consulting
segment results, our chief decision makers review net revenue by solution
category. These solution categories are:
o Identity management and secure web services - solutions that help
customers with their identity management and security issues. Products
include Secure-Login/Single Sign-On, DirXML, iChain, exteNd, and
BorderManager. Products in this category are branded as Nsure and
exteNd.
o Cross platform services - solutions that offer an effective and open
approach to networking and collaboration services, including file,
print, messaging, scheduling, workspace, etc. while using a
cross-platform approach. Products include NetWare, GroupWise, ZEN, and
Novell iFolder. Products in this category are branded as Nterprise.
o Worldwide services - comprehensive worldwide IT consulting, education,
and support services that apply Net business solutions to our customers'
business situations, providing the business knowledge and technical
expertise to help our customers implement our identity management,
secure web services, and cross platform services. Services in this
category are branded as Ngage.
o Celerant management consulting- operational strategy and implementation
consulting services offered to a wide range of customers across various
sectors, worldwide.
Revenue by solution category
Three months ended July 31, Nine months ended July 31,
---------------------------- --------------------------
2003 2002 2003 2002
---- ---- ---- ----
In thousands
Identity management and secure web services $ 26,318 $ 19,576 $ 72,132 $ 53,055
Cross platform services 144,376 153,208 422,242 450,264
---------- ---------- ---------- ----------
Total software licenses and maintenance 170,694 172,784 494,374 503,319
Worldwide services 75,576 77,949 222,406 237,943
---------- ---------- ---------- ----------
Total IT software and solutions 246,270 250,733 716,780 741,262
Celerant management consulting 36,539 31,541 101,969 92,723
----------- ----------- ---------- ----------
Total net revenue $ 282,809 $ 282,274 $ 818,749 $ 833,985
========== ========== ========== ==========
Separate financial information is not evaluated by business segment with
regard to asset allocation. Prior to November 1, 2002, we operated and
reported financial results based on three business segments: product,
consulting, and Volera, Inc.
For the third quarters of fiscal 2003 and fiscal 2002, sales in the U.S.
were $129.3 million and $143.3 million, respectively, and sales to
international customers were approximately $153.5 million and $139.0
million, respectively. In the third quarters of fiscal 2003 and fiscal
2002, 74% of our international sales were in EMEA.
On a year-to-date basis, sales in the U.S. were $378.8 million in fiscal
2003 and $433.8 million in fiscal 2002, and sales to international
customers were $439.9 million in fiscal 2003 and $400.2 million in fiscal
2002. For the first nine months of fiscal 2003 and fiscal 2002,
international sales in EMEA accounted for 75% and 73%, respectively, of our
total international sales.
No single international country accounted for more than 10% of our total
revenue.
L. Net Income (Loss) Per Share
Earnings per share for the third quarters and first nine months of fiscal
2003 and 2002 were calculated as follows:
Three months ended July 31, Nine months ended July 31,
In thousands, except per share data 2003 2002 2003 2002
---- ---- ---- ----
Basic net loss per share:
Net income (loss) $ (12,400) $ 9,949 $ (52,900) $(155,151)
=========== ========= ========== ==========
Weighted average shares outstanding 371,484 364,211 369,435 363,131
Basic net income (loss) per share $ (0.03) $ 0.03 $ (0.14) $ (0.43)
=========== ========= ========== ===========
Diluted net loss per share:
Net income (loss) $ (12,400) $ 9,949 $ (52,900) $(155,151)
=========== ========= ========== ==========
Weighted average shares outstanding 371,484 364,247 369,435 363,131
Diluted net income (loss) per share $ (0.03) $ 0.03 $ (0.14) $ (0.43)
=========== ========= ========== ===========
M. Comprehensive Income (Loss)
The components of comprehensive income (loss), net of tax, for the third
quarters and year-to-date periods of fiscal 2003 and 2002, were as follows:
Three months ended July 31, Nine months ended July 31,
---------------------------- --------------------------
2003 2002 2003 2002
---- ---- ---- ----
In thousands
Net income (loss) $ (12,400) $ 9,949 $ (52,900) $ (155,151)
Change in net unrealized gain/(loss) on
investments (1,022) (672) (757) (4,687)
Change in cumulative translation adjustment 5,004 (843) 5,333 (1,157)
----------- ----------- ----------- -----------
Comprehensive income (loss) $ (8,418) $ 8,434 $ (48,324) $ (160,995)
============ ========== ============ ===========
The components of accumulated other comprehensive income (loss), net of
related tax, at July 31, 2003 and October 31, 2002 are as follows:
July 31, 2003 October 31, 2002
In thousands
Net unrealized gain on investment $ 1,447 $ 2,204
Cumulative foreign currency translation adjustment
3,186 (2,147)
----------- ------------
Accumulated other comprehensive income $ 4,653 $ 57
=========== ===========
N. Stock Option and Other Equity Plans
Pursuant to an Exchange Offer dated May 14, 2003, which was implemented
after our stockholders approved amendments to our stock option plans at our
2003 Annual Meeting held on May 1, 2003, we offered a stock option exchange
program to our non-executive employees giving them the right to exchange
outstanding stock options with an exercise price of $5.03 per share or more
for new options to be issued six months and one day subsequent to the
closing of the tender offer. The closing of the tender offer was on June
12, 2003. The options tendered under the program will be replaced with
options to purchase a fewer number of shares than the original options
would have provided, based upon an exchange ratio primarily dependent upon
the exercise price of the tendered option.
Options to purchase approximately 17 million shares of our common stock
were tendered, representing 64% of the options that were eligible for the
exchange. These options were cancelled and are no longer outstanding. Not
less than six months and one day after the closing of the tender offer, we
estimate we will issue new options at the then-current fair market value on
that date to purchase an aggregate of approximately 9.3 million shares of
our common stock. After the issuance of the new options, we anticipate
retiring approximately 7.7 million options, which would reduce our total
overhang to approximately 28.5%.
The program was structured to comply with current accounting guidelines so
that we will not be subject to variable accounting and thus will not
recognize compensation expense in connection with the grant of the
replacement options. If the current accounting standards or guidelines are
changed prior to the issuance of the new options, we will have to comply
with the changed accounting treatment.
At July 31, 2003, we had authorized stock option and other equity plans
under which options or rights to purchase shares of our common stock and
awards of stock could be granted to employees, consultants and outside
directors. We apply the intrinsic value method in accounting for our stock
option and equity plans. Accordingly, no compensation expense (except
compensation expense related to restricted stock purchase grants,
below-market option grants, and grants to non-employees) has been
recognized for our stock option and other equity plans. If compensation
expense for our stock option and other equity plans had been determined
based on the fair value method of accounting for stock grants, using the
Black-Scholes option pricing model, our net loss and net loss per share
would have been the pro forma amounts indicated in the following table.
Three months ended July 31, Nine months ended July 31,
---------------------------- --------------------------
2003 2002 2003 2002
---- ---- ---- ----
In thousands, except per share data
Net income (loss):
As reported $ (12,400) $ 9,949 $ (52,900) $ (155,151)
Pro forma $ (17,568) $ (2,405) $ (73,383) $ (198,879)
Net income (loss) per share:
As reported basic and diluted $ (0.03) $ 0.03 $ (0.14) $ (0.43)
Pro forma basic and diluted $ (0.05) $ (0.01) $ (0.20) $ (0.55)
During the third quarter and first nine months of fiscal 2003, we
recognized a pre-tax expense of $0.9 million and $2.5 million in
compensation expense compared to $0.9 million and $5.6 million during the
same periods of fiscal 2002. Pro forma amounts have been adjusted to
reflect the impact of additional compensation expense related to our stock
option and other equity plans. For the three months ended July 31, 2003 and
2002, pro-forma compensation expense, pre-tax, was $8.4 million and $20.1
million, respectively. For the nine months ended July 31, 2003 and 2002,
pro-forma compensation expense, pre-tax, was $32.2 million and $72.4
million respectively.
For purposes of the above table, the fair value of each option grant was
estimated as of the date of grant using the Black-Scholes option pricing
model with the following weighted-average assumptions used for grants in
the third quarters of fiscal 2003 and fiscal 2002: a risk-free interest
rate of approximately 2.19% and 3.75%, respectively; a dividend yield of
0.0% for both quarters; a weighted-average expected life of five years for
both quarters, except for the shares to be tendered as a part of a Tender
Offer which has an average expected life of three years; and a volatility
factor of the expected market price of our common stock of 0.81 and 0.87,
respectively. The weighted average fair value of options granted in the
third quarters of fiscal 2003 and fiscal 2002 were $2.02 and $1.51,
respectively.
For the first nine months of fiscal 2003 and fiscal 2002 assumptions
included: a risk-free interest rate of approximately 2.36% and 3.65%,
respectively; a dividend yield of 0.0% for both periods; a weighted-average
expected life of five years for both periods, except for the shares to be
tendered as a part of a Tender Offer which has an average expected life of
three years; and a volatility factor of the expected market price of our
common stock of 0.82 and 0.87, respectively. The weighted average fair
value of options granted in the first nine months of fiscal 2003 and fiscal
2002 were $2.30 and $1.70, respectively.
For purposes of the above table, the Company does not recognize
compensation expense related to employee purchase rights under the Purchase
Plan. Pro forma compensation expense is estimated for the fair value of the
employees' purchase right using the Black-Scholes option pricing model with
the following assumptions for the shares issued in the third quarters of
fiscal 2003 and fiscal 2002: risk-free interest rate of approximately 2.3%
and 1.5%, respectively; a dividend yield of 0.0% for both periods; a
weighted-average expected life of 6 months for both periods; and a
volatility factor of the expected market price of our common stock of 0.88
and 0.87, respectively. The weighted average fair value of the purchase
rights issued in the third quarters of fiscal 2003 and fiscal 2002 was
$0.93 and $1.52.
O. Derivative Instruments
A large portion of our revenue, expense, and capital purchasing activities
are transacted in U.S. dollars. However, we do enter into transactions in
other currencies, primarily the Euro, Japanese yen, and certain other
European, Latin American, and Asian currencies. To protect against
reductions in value caused by changes in foreign exchange rates, we have
established balance sheet and intercompany hedging programs. We hedge
currency risks of some assets and liabilities denominated in foreign
currencies through the use of one-month foreign currency forward contracts.
We enter into these one-month hedging contracts two business days before
the end of each month and settle them at the end of the following month.
Due to the short period of time between entering into the forward contracts
and the quarter-end, the fair value of the derivatives as of July 31, 2003
is insignificant. Gains and losses recognized during the quarter on these
foreign currency contracts are recorded as other income or expense and
would generally be offset by corresponding losses or gains on the related
hedged items, resulting in negligible net exposure to our financial
statements. We do not currently hedge currency risks related to revenue or
expenses denominated in foreign currencies.
P. Subsequent Event
On August 4, 2003, we acquired Ximian, Inc., a privately-held company and
leading provider of desktop and server solutions that enable enterprise
Linux adoption, for approximately $40 million. The acquisition of Ximian
expands Novell's ability to support Linux solutions, providing Novell with
Linux desktop, groupware and management technologies. The acquisition also
brings leaders in the open source community and a strong core of Linux
developers to Novell.
Q. New Accounting Pronouncement
Financial Accounting Standards Board Interpretation No. 46, "Consolidation
of Variable Interest Entities" ("FIN 46"), was issued in January 2003. FIN
46 requires that if an entity is the primary beneficiary of a variable
interest entity, the assets, liabilities and results of operations of the
variable interest entity should be included in the consolidated financial
statements of the entity. The provisions of FIN 46 are effective
immediately for all arrangements entered into after January 31, 2003. We
have not invested in any variable interest entities after January 31, 2003.
For those arrangements entered into prior to January 31, 2003, the
provisions of FIN 46 are required to be adopted at the beginning of the
first interim or annual period beginning after June 15, 2003. We are
reviewing our arrangements with variable interest entities entered into
prior to January 31, 2003. We do not believe that our arrangements with
these entities will require consolidation of their financial information in
our financial statements.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This Management's Discussion and Analysis of Financial Condition and Results of
Operations ("MD&A") and other parts of this Form 10-Q contain forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995 that involve risks and uncertainties. In some cases, such forward-looking
statements may be identified by the use of words such as "may," "will,"
"expects," "plans," "anticipates," "estimates," "potential," or "continue" or
the negative thereof or other comparable words. Such forward-looking statements
include statements regarding, among other things, our revenue expectations,
future business strategies, market conditions and opportunities, and liquidity.
All forward-looking statements are based on management's current expectations
and information available to us on the date hereof, and we assume no obligation
to update any such forward-looking statements. Our actual results may differ
materially from management's expectations and the results discussed in such
forward-looking statements as a result of a number of factors, which include,
but are not limited to, those set forth below in the section titled "Risk
Factors Affecting Future Results of Operations."
Introduction
Novell, Inc. has been a pioneer in the field of computer networking since our
development and release of NetWare in the mid 1980s. As a result of our 20 years
of experience as a leader in the field of computer networking, we have some of
the best networking engineers in the world. These engineers, together with our
consulting force, work to create world-class IT solutions. We are
extraordinarily proud of our people, the skills that they have and the
dedication that they bring to our company. Leveraging this expertise, we expect
to continue our evolution of our cross platform strategy and become a leading
company in providing cross platform solutions, secure Web services, and identity
management. Our solutions leverage our network expertise and the Web to help to
create a world without information boundaries.
Today we provide Net business solutions across a myriad of platforms designed to
secure and empower the networked world, helping organizations solve complex
business challenges, simplify their systems and processes, and capture new
opportunities. Net business solutions include software applications and
consulting services that were developed using open Internet standards and our
own eDirectoryTM network infrastructure products, support highly distributed
network solutions and capitalize on the growth of the Internet. With both
software and services offerings, we can determine how Net business solutions can
be used by an organization and the requirements necessary to ensure proper
security and access. This can then be turned into a Net solutions approach that
helps our customer deliver the right information, to the right individual, at
the right time, and on the right device.
In addition, our Net business solutions include essential network management,
messaging, and collaboration capabilities integrated through our directory
services. Networks are inherently a varied mix of business process,
infrastructure, computer systems, applications, and other devices. Our software
provides the framework and applications for managing, maintaining, and accessing
the information and services of these networks. During fiscal 2003, we announced
our strategy to support the Linux kernel in addition to the NetWare kernel. This
would give our customers a choice by providing Novell products and services that
run on both Netware and Linux platforms.
Our training, service and support, and consulting groups also support our Net
business solutions by providing worldwide consulting, training, developer, and
distribution channel programs that support our product offerings.
Critical Accounting Policies
An accounting policy is deemed to be critical if it requires us to make an
accounting estimate based on assumptions about matters that are highly uncertain
at the time the accounting estimate is made, and if different estimates that
reasonably could have been used, or if changes in the accounting estimate that
are reasonably likely to occur periodically, could materially impact the
financial statements. We consider certain accounting policies related to revenue
recognition, restructuring, impairment of long-lived assets, and valuation of
deferred tax assets to be critical accounting policies due to the estimation
processes involved in each.
Revenue recognition. Revenue from our Celerant management consulting segment and
about half of the revenue from our IT consulting group within our worldwide
services business is derived from fixed-price, fixed-time contracts, which
require the accurate estimation of the cost, scope, and duration of each
engagement. Revenue and the related costs for these projects are recognized
using the percentage-of-completion method, using time-to-completion to measure
the percent complete, with revisions to estimates reflected in the period in
which changes become known. If we do not accurately estimate the resources
required or the scope of work to be performed, or do not manage our projects
properly within the planned periods of time or satisfy our obligations under the
contracts, future consulting margins may be significantly and negatively
affected or losses on existing contracts may need to be recognized. Any such
resulting reductions in margins or contract losses could be material to our
results of operations.
We record a provision against revenue for estimated sales returns and allowances
on product and service related sales in the same period as the related revenues
are recorded. We also record a provision to operating expense for bad debts
resulting from customers' inability to pay for the products or services they
have received due to such factors as bankruptcy. These estimates are based on
historical sales returns and bad debt data, analysis of credit memo data, and
other known factors. If the historical data we use to calculate these estimates
does not properly reflect future returns or bad debts, revenue or net income
could be overstated or understated.
Restructuring Liabilities. From time to time, as business conditions or other
factors change requiring us to change or modify our strategy, we are required to
restructure our business. This typically involves eliminating excess headcount,
consolidating facilities, or exiting or abandoning unprofitable product lines or
geographic areas. When we consolidate facilities or exit or abandon unprofitable
product lines or geographic areas, we must make certain assumptions regarding
the sublease rates and timing for the exited facilities and estimated future
cash flows from products lines or geographic locations. If we do not accurately
estimate these factors, our estimated liabilities may not be fairly stated. Any
such resulting changes in estimates could be material to our results of
operations. For example, during the second quarter of fiscal 2003, we were
required to increase our restructuring reserves by approximately $8.7 million
due to changes in estimated sublease rates and timing, which have been affected
by the decline in the real estate market.
Long-lived Assets. Our long-lived assets include property, plant and equipment,
long-term investments, goodwill and other intangible assets. At July 31, 2003,
our long-lived assets included $258.9 million of net property, plant and
equipment, $51.0 million of long-term investments, $178.3 million of goodwill,
$4.4 million of identifiable intangible assets, and $115.9 million of current
and non-current net deferred tax assets.
Property, Plant and Equipment. We periodically review our property, plant and
equipment for impairment in accordance with Statement of Financial Accounting
Standards No. 144 ("SFAS 144"), "Accounting for the Impairment or Disposal of
Long-Lived Assets." In determining whether an asset is impaired, we must make
assumptions regarding recoverability of costs, estimated future cash flows from
the asset, intended use of the asset, and other related factors. If these
estimates or their underlying assumptions change, we may be required to record
impairment charges for these assets. For example, in the fourth quarter of
fiscal 2002, we determined that our facilities in San Jose, California and a
small building in Provo, Utah had become impaired due to changes in the intended
use of the facilities, as well as changes in the local commercial real estate
market. This resulted in a pre-tax, non-cash impairment charge of $80 million.
Depending upon relevant factors, such as a decision to sell a facility, or a
continuation of the decline in real estate market conditions, we could be
required to record additional impairment charges.
Long-term Investments. The fair value of long-term investments is dependant on
the actual financial performance of the companies and venture funds in which we
have invested, the investee's market value, and the volatility inherent in the
external markets for these investments. In assessing potential impairment for
these privately-held equity investments, we consider these factors as well as
the forecasted financial performance of our investees, liquidation preference
value of the stock we hold, and estimated potential for investment recovery
based on all these factors. If any of these factors indicate that the investment
has become other-than-temporarily impaired, we will have to record additional
impairment charges not previously recognized. During the first nine months of
fiscal 2003, we recognized $32.6 million of impairment losses related to our
long-term investments due to poor performance and general market conditions. If
general market conditions do not improve, or if any of the companies or venture
funds included in long-term investments do not meet performance goals, our
investments could become further impaired on an other-than-temporary basis as
their values decline, causing us to record further investment impairment
charges.
Goodwill and Intangible Assets. In assessing the recoverability of our goodwill
and other intangible assets, we must make assumptions regarding estimated future
cash flows and other factors to determine the fair value of the respective
assets. This process is subjective and requires judgment at many points
throughout the analysis. If these estimates or their related assumptions change
in the future, we may be required to record impairment charges for these assets
not previously recorded.
We periodically review our goodwill and intangibles for indicators of
impairment. We also perform an annual impairment review under Statement of
Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill and Other
Intangible Assets," in the fourth quarter of each fiscal year, based on August 1
balances, to determine whether there are any indicators of impairment as of that
date. Various assumptions will be made as a part of this analysis that could
affect the resulting outcome. For example, to estimate the fair value of our
reporting units, management will make estimates and judgments about future cash
flows based on our fiscal 2003 forecast and current long-range plans used to
manage the business. These long-range estimates could change in the future
depending on changes in the Company as well as external factors. Future changes
in estimates could possibly result in a non-cash goodwill impairment that could
have a material adverse impact on our financial condition and results of
operations.
In connection with our acquisition of SilverStream, we acquired developed
technology related to SilverStream's exteNd products that could be combined with
our products and services. We periodically review our identifiable intangible
assets for impairment in accordance with SFAS No. 144. In determining whether an
intangible asset is impaired, we must make assumptions regarding estimated
future cash flows from the asset, intended use of the asset and other related
factors. If the estimates or the related assumptions used to determine the value
of the intangible assets change, we may be required to record further impairment
charges for these assets. For example, if we were to abandon our products which
integrate the exteNd Web-based technology that we acquired from SilverStream, or
if the sales forecasts for these secure Web services products were to change, we
could be required to record an impairment charge in future periods. During the
third quarter of fiscal 2003, we determined that the developed technology and
trade names we acquired from SilverStream had become impaired. Based on an
independent valuation of these assets, we recorded a $23.6 million dollar charge
as a result of unexpected revenue declines for the exteNd products.
Deferred Tax Assets. The carrying value of our net deferred tax assets assumes
that we will be able to generate sufficient future taxable income in certain tax
jurisdictions based on estimates and assumptions. If these estimates and related
assumptions change in the future, we may be required to record additional
valuation allowances against our deferred tax assets resulting in additional
income tax expense in our consolidated statement of operations. Management
evaluates the realizability of the deferred tax assets quarterly and assesses
the need for additional valuation allowances quarterly. During the nine months
ended July 31, 2003, we recorded an additional $16 million of valuation
allowances related to the increase in our net deferred tax assets, primarily
relating to investment impairments, that we may not be able to recognize in
future periods.
Results of operations
Revenue
Three months ended July 31, Nine months ended July 31,
--------------------------- --------------------------
2003 2002 Change 2003 2002 Change
---- ---- ------ ---- ---- ------
(Dollars in thousands)
New software licenses $ 69,255 $ 82,894 (17)% $ 194,758 $ 224,980 (13)%
Maintenance and services 213,554 199,379 7% 623,989 609,005 3%
---------- ----------- ---------- -----------
Total net revenue $ 282,809 $ 282,273 -% $ 818,747 $ 833,985 (2)%
========== =========== ========== ===========
New software licenses revenue decreased in the third quarter and first nine
months of fiscal 2003 compared to the same periods of fiscal 2002 primarily due
to decreased demand for our solutions in the United States as a result of the
weak economic environment and a continuing decline in the demand for our NetWare
products. Maintenance and services revenue, which includes software maintenance,
technical support, education, and consulting services grew in the third quarter
and first nine months of fiscal 2003 compared to the same periods in fiscal 2002
largely due to growth in software maintenance revenue (increase of 13% and 8%,
respectively), increased Celerant management consulting revenue (increase of 16%
and 10%, respectively), and favorable Euro exchange rates. These increases were
partially offset by decreased demand for IT consulting services (decrease of 3%
and 7%, respectively), which is largely the result of weak sales in the United
States as a result of the poor economy.
Beginning November 1, 2002, we reorganized our operations and began reporting
our financial results in four new segments; three are based on geographic area
and the fourth is Celerant management consulting. The geographic segments
include:
o Americas - includes the United States, Canada, and Latin America
o EMEA - includes Eastern and Western Europe, Middle East, and Africa
o Asia Pacific -includes China, Japan, Southeast Asia, Australia, New Zealand,
and India
Company performance is evaluated by our Chief Executive Officer and senior
executive officers, our chief decision makers, based on reviewing revenue and
segment operating income (loss) for the geographic segments listed above and the
Celerant management consulting segment. Separate financial information is not
evaluated by business segment in regards to asset allocation.
Three months ended July 31, Nine months ended July 31,
--------------------------- --------------------------
2003 2002 Change 2003 2002 Change
---- ---- ------ ---- ---- ------
(Dollars in thousands)
Americas $ 135,635 $ 151,255 (10)% $ 396,979 $ 448,707 (12)%
EMEA 87,400 79,383 10% 257,800 233,492 10%
Asia Pacific 23,235 20,094 11% 62,000 59,062 5%
Celerant 36,539 31,541 16% 101,968 92,723 10%
---------- ----------- ---------- -----------
Total net revenue $ 282,809 $ 282,273 --% $ 818,747 $ 833,984 (2)%
========== =========== ========== ===========
Revenue in the Americas decreased during the third quarter and first nine months
of fiscal 2003 compared to the same periods of fiscal 2002 due to decreased
software and consulting revenue reflecting poor market conditions in the United
States and Latin America, declining Netware revenue and lower IT consulting
demand and billing rates. In addition, revenue in the Americas was negatively
affected during the first nine months of fiscal 2003 by a temporary distraction
to our selling efforts in the United States while we transferred certain of our
customer accounts from our sales force to our channel partners and restructured
the sales organization. Revenue increased in EMEA during the third quarter and
first nine months of fiscal 2003 due to favorable foreign exchange rates and
recovering European market conditions, which resulted in greater demand for our
products and services. The increase in revenue in Asia Pacific during the third
quarter of fiscal 2003 was primarily due to strong sales in Japan and Australia.
For the first nine months of fiscal 2003, Asia Pacific sales increased primarily
due to strong sales in Australia and India, offset somewhat by lower sales in
Japan due to a weak economy during the first half of fiscal 2003. Celerant
worldwide revenue increased in the third quarter and first nine months of fiscal
2003 due primarily to improved revenue growth in Europe, which resulted in
greater demand for Celerant's consulting services, revenue recognized on a
number of large completed contracts, and favorable foreign exchange rates.
Revenue outside the U.S. represented 54% of total revenue in the third quarter
of fiscal 2003 compared to 49% in the third quarter of fiscal 2002. Revenue
outside the U.S. for the first nine months of fiscal 2003 was 54% compared to
48% in the first nine months of fiscal 2002.
In addition to reviewing geographic and Celerant management consulting segment
results, our chief decision makers review net revenue by solution category:
These solutions categories are:
o Identity management and secure web services - solutions that help customers
with their identity management and security issues. Products include
Secure-Login/Single SignOn, DirXML, iChain, exteNd, and BorderManager. This
category is branded as Nsure and exteNd.
o Cross platform services - solutions that offer an effective and open
approach to networking and collaboration services, including file, print,
messaging, scheduling, workspace, etc. while using a cross-platform
approach. Products include NetWare, GroupWise, ZEN, and Novell iFolder.
This category is branded as Nterprise.
o Worldwide services - comprehensive worldwide consulting, education, and
support services that apply Net business solutions to our customers'
business situations, providing the business knowledge and technical
expertise to help our customers implement our identity management, secure
web services, and cross platform services. This category is branded as
Ngage.
o Celerant management consulting - provides operational strategy and
implementation consulting services, which result in quantifiable value, to
a wide range of customers across various sectors, worldwide.
Three months ended July 31, Nine months ended July 31,
--------------------------- --------------------------
2003 2002 Change 2003 2002 Change
---- ---- ------ ---- ---- ------
(Dollars in thousands)
Identity management and secure
web services $ 26,318 $ 19,576 34% $ 72,132 $ 53,055 36%
Cross platform services 144,376 153,208 (6)% 422,242 450,264 (6)%
Worldwide services 75,576 77,949 (3)% 222,406 237,943 (7)%
Celerant management consulting
36,539 31,541 16% 101,969 92,723 10%
---------- ----------- ---------- -----------
Total net revenue $ 282,809 $ 282,274 --% $ 818,749 $ 833,985 (2)%
========== =========== ========== ===========
Identity management and secure web services revenue increased in the third
quarter and first nine months of fiscal 2003 compared to the same periods of
fiscal 2002 due to the addition of the SilverStream secure web services products
in July 2002, which added $4.4 million and $9.6 million, respectively, and
increased demand for our Secure Login/Single SignOn and DirXML products as the
secure identity market continues to grow. Cross platform services declined in
the third quarter and first nine months of fiscal 2003 compared to the same
periods in fiscal 2002 primarily due to the decline in demand for our NetWare
products (decrease of 12% for both periods), offset slightly by increased demand
for our Groupwise and ZEN products. Worldwide services revenue declined in the
third quarter and first nine months of fiscal 2003 compared to the same periods
in fiscal 2002 primarily due to the weakened demand for our IT consulting
services in the U.S. and lower billing rates as a result of the weak economic
environment.
At July 31, 2003, we had $295.8 million of deferred revenue, representing
revenue that is expected to be recognized in future periods. The majority of
this deferred revenue relates to maintenance contracts, which are recognized
ratably over the maintenance period. We have either received payment or recorded
a receivable for the deferred revenue, and have determined collectability to be
reasonably certain. Direct costs incurred to fulfill these maintenance
obligations are relatively small and are recognized as work is performed.
Forward-looking revenue trends
Due to the uncertainty in the U.S. and global economies, heightened political
conflicts throughout the world, and continued volatility in the information
technology marketplace, we are unable to predict when the information technology
or consulting markets will recover, in the U.S. or globally. We anticipate some
continued declines in our NetWare revenue. However, with the enhancements added
to our future releases of NetWare, which will include network services running
on both the NetWare kernel and the Linux kernel, and our recent acquisition of
Ximian we have begun to deliver on our Linux strategy. We believe this will help
to slow the NetWare revenue decline by retaining existing customers and
attracting new customers by providing them with a migration path to Linux,
should they choose to pursue those alternatives. We also believe that the
identity management and secure web services markets will continue to grow as
they mature, which may improve revenue from our offerings in these areas.
As previously disclosed, we have decided not to provide specific revenue
forecast information for the remainder of fiscal 2003 or future periods.
Gross profit
Three months ended July 31, Nine months ended July 31,
--------------------------- --------------------------
2003 2002 Change 2003 2002 Change
---- ---- ------ ---- ---- ------
(Dollars thousands)
Gross profit $ 175,332 $ 172,451 2% $ 504,935 $ 493,766 2%
Percentage of revenue 62% 61% 62% 59%
Gross profit in total and as a percentage of sales increased in the third
quarter and first nine months of fiscal 2003 compared to the same periods of
fiscal 2002 primarily due to improved consulting margins resulting from
headcount reductions in fiscal 2002 and 2003 and improved performance in our
Celerant management consulting segment. Gross margins on new software licenses
were 92% and 91% in the third quarter and first nine months of fiscal 2003,
respectively, compared to 90% and 90% for the same periods of fiscal 2002. Gross
margins on maintenance and services were 52% and 49% in the third quarter and
first nine months of fiscal 2003, respectively, compared to 52% and 48% for the
same periods of fiscal 2002. We are continuing to address ways to improve our
gross margin percentage in future periods, such as improving utilization,
increasing IT consulting billing rates, and reducing expenses. However, due to
the uncertainty in the U.S. and global economies, heightened political conflicts
throughout the world, and continued volatility in the information technology
marketplace, we are unable to predict when we will see significant improvements
in our gross margin percentages. As previously disclosed, we have decided not to
provide specific forecasted earnings information for the remainder of fiscal
2003 or future periods.
Operating expenses
Three months ended July 31, Nine months ended July 31,
--------------------------- --------------------------
2003 2002 Change 2003 2002 Change
---- ---- ------ ---- ---- ------
(Dollars in thousands)
Sales and marketing $ 92,470 $ 87,487 6% $292,512 $ 255,108 15%
Percentage of revenue 33% 31% 36% 31%
Product development $ 48,178 $ 44,130 9% $ 139,454 $ 129,528 8%
Percentage of revenue 17% 16% 17% 16%
General and administrative $ 28,379 $ 29,566 (4)% $ 86,663 $ 90,946 (5)%
Percentage of revenue 10% 11% 11% 11%
Restructuring $ 26,350 $ -- --% $ 35,025 $ 19,100 83%
Percentage of revenue 9% --% 4% 4%
In-process R&D $ -- $ 3,000 (100)% $ -- $ 3,000 (100)%
Percentage of revenue --% 1% --% --%
Total operating expenses $ 195,377 $ 164,183 19% $ 553,654 $ 497,682 11%
Percentage of revenue 69% 58% 68% 60%
Operating expenses, in total and as a percentage of revenue, increased in the
third quarter and first nine months of fiscal 2003 compared to the same periods
in fiscal 2002 primarily due to a third quarter fiscal 2003 restructuring
charge, additional operating expenses related to the SilverStream acquisition in
the third quarter of fiscal 2002, increased sales and marketing headcount, and
increased marketing costs for our new advertising campaign that was rolled out
during the first quarter. These expenses were offset somewhat by lower salary
expenses as a result of lower bonus accruals and lower headcount due to the
restructuring and other headcount reductions in fiscals 2003 and 2002.
Sales and marketing expense, in total and as a percentage of revenue, increased
in the third quarter and first nine months of fiscal 2003 compared to the same
periods in fiscal 2002 primarily as a result of increased marketing costs
associated with our advertising campaign and increased sales headcount,
primarily from the addition of SilverStream during fiscal 2003, prior to
reductions related to the third quarter restructuring. We have spent
approximately $27 million during the first three quarters of fiscal 2003 on our
new advertising campaign and anticipate spending approximately $6 million during
the remainder of fiscal 2003 in an effort to attract new customers and increase
revenue. At the end of the third quarter of fiscal 2003, sales and marketing
headcount decreased by 88 employees compared to the third quarter of fiscal
2002. Sales and marketing expenses can fluctuate as a percentage of revenue in
any given period due to product promotions, advertising, and other discretionary
expenses.
Product development expenses, in total and as a percentage of revenue, increased
in the third quarter and first nine months of fiscal 2003 compared to the same
periods of fiscal 2002 due primarily to the addition of SilverStream in July of
fiscal 2002. The increase in cost for the additional headcount in the first and
second quarters of fiscal 2003 was offset slightly by savings related to lower
bonus accruals in fiscal 2003 and a favorable settlement received in the first
quarter of fiscal 2003 related to development obligations dating back to
agreements signed in the 1990s. Product development headcount decreased by 81
employees compared to the third quarter of fiscal 2002, which includes the
reductions related to the third quarter restructuring net of additional
employees to support our Linux initiatives. We anticipate that our product
development expenses will remain relatively flat or decrease slightly in
remaining quarters of fiscal 2003 compared to the second quarter of fiscal 2003
amounts as we continue our cost cutting efforts.
General and administrative expenses in the third quarter and first nine months
of fiscal 2003 decreased from the same periods of fiscal 2002 primarily due to
lower bad debt expense and lower operating costs related to decreased headcount
and integration costs. General and administrative headcount decreased by 61
employees at the end of the third quarter of fiscal 2003 after the reductions
related to the restructuring compared to the same period of fiscal 2002. As a
percentage of revenue, general and administrative costs remained relatively flat
during the first nine months of fiscal 2003 compared to the same periods in
fiscal 2002 partially as a result of lower revenue in fiscal 2003. We anticipate
that our general and administrative expenses will remain relatively flat or
decrease slightly during the remainder of fiscal 2003 as we continue our cost
cutting efforts.
Restructuring
Third quarter of fiscal 2003
During the third quarter of fiscal 2003, we recorded a pre-tax restructuring
charge of approximately $27.8 million resulting from the restructuring of our
operations in response to changes in general market conditions, changing
customer demands, and the evolution of our business strategy relative to the
identity management and secure web services areas of our business and our
revised strategy. This strategy includes plans to support the Linux kernel in
addition to the NetWare kernel, by offering Novell products and services that
run on both Netware and Linux platforms. These changes in strategy and company
structure were made to address the current revenue declines. Specific actions
taken included reducing our workforce worldwide by approximately 600 employees
(approximately 10%) across all functions and geographies, with a majority coming
from product development, sales, and general and administrative functions,
primarily in the United States. In addition, we consolidated facilities, and
disposed of excess equipment. By reporting segment, the Americas accounted for
$19.4 million, EMEA accounted for $6.0 million, and Asia Pacific accounted for
$2.4 million.
We anticipate the actions to produce annual savings of approximately $75 million
in operating expense relating to headcount and an additional $25 million in
annualized savings from lower non-salary-related operating expenses.
The following table summarizes the activity during the third quarter of 2003
related this restructuring.
Balance at
Original Cash Non-cash July 31,
Charge Payments Adjustments 2003
--------- --------- ----------- ---------
In thousands
Severance and benefits $ 20,287 $ (11,671) $ -- $ 8,616
Excess facilities and property and equipment 5,778 -- 218 5,996
Other restructuring-related costs 1,729 (67) (261) 1,401
-------- ---------- --------- --------
$ 27,794 $ (11,738) $ (43) $ 16,013
======== ========== ========= ========
As of July 31, 2003, the remaining balance of the third quarter of fiscal 2003
restructuring charge included accrued liabilities related to severance and
benefits, which will be paid out over the remaining severance obligation period,
not to exceed two years, lease costs for redundant facilities, which will be
paid over the respective remaining contract terms, and various severed employee
related costs, which will be paid over the next four quarters.
During the third quarter of fiscal 2003, we also released approximately $1.4
million related to excess restructuring reserves related to the second quarter
fiscal 2002 restructuring event. This release is reflected in the second quarter
fiscal 2002 table below. The net impact of the third quarter fiscal 2003
restructuring and the release of the excess fiscal 2002 reserves was a charge of
$26.4 million.
..
Second quarter of fiscal 2003
During the second quarter of fiscal 2003, we determined that the amount we had
originally accrued for facility-related costs in previous restructurings was too
low and accrued an additional $8.7 million. The original liability was based on
estimated sublease rates and timing, which have been affected by the decline in
the real estate market. This additional amount, which pertains to three separate
restructuring events, is included in the following tables.
Second quarter of fiscal 2002
During the second quarter of fiscal 2002, we recorded a pre-tax restructuring
charge of approximately $20 million resulting from our continued migration
towards becoming a solutions provider and as a result of changing business
needs. Specific actions taken included reducing our workforce worldwide by
approximately 50 employees (less than 1%), consolidating facilities, closing
offices in unprofitable locations, and disposing of excess property and
equipment.
As noted above, during the second quarter of fiscal 2003, we determined that the
amount we had originally accrued for facility-related costs was too low and
accrued an additional $7.7 million. The original liability for lease costs was
based on estimated sublease rates and timing, which have been affected by the
decline in the real estate market. Additionally, during the third quarter of
fiscal 2003 we released approximately $1.4 million of excess restructuring
reserves related to excess severance costs
The following table summarizes the activity during fiscal 2003 related to the
second quarter of fiscal 2002 restructuring.
Balance at Balance at
Original October 31, Cash July 31,
Charge 2002 Payments Adjustments 2003
------ ---------- ---------- ----------- --------
In thousands
Severance and benefits $ 14,748 $ 4,258 $ (2,851) $ (100) $ 1,307
Excess facilities and property and equipment 5,146 4,221 (2,445) 6,391 8,167
Other restructuring-related costs 492 300 -- -- 300
-------- -------- -------- -------- --------
$ 20,386 $ 8,779 $ (5,296) $ 6,291 $ 9,774
======== ======== ========= ======== ========
As of July 31, 2003, the remaining balance of the second quarter of fiscal 2002
restructuring charge included accrued liabilities related to severance and
benefits, which will be paid out over the remaining severance obligation period,
and lease costs for redundant facilities and other fixed contracts, which will
be paid over the respective remaining contract terms.
Fourth quarter of fiscal 2001
During the fourth quarter of fiscal 2001, we recorded $51 million of pre-tax
restructuring charges resulting from the restructuring of our operations in
light of changes in general market conditions, changing customer demands, and
the evolution of our business strategy. The execution of this strategy included
refining our consulting initiatives, refocusing research and development
efforts, defining sales and marketing efforts to be more customer and solutions
oriented, and adjusting our overall cost structure given current revenue levels
and our direction.
Specific actions included reducing our workforce worldwide by approximately
1,100 employees (approximately 16%), consolidating excess facilities and
disposing of excess property and equipment, terminating a management consulting
contract that no longer fit with our strategic focus, and abandoning and writing
off technologies that no longer fit within our new strategy. We also realigned
our remaining resources to better manage our business. As noted above, during
the second quarter of fiscal 2003, we determined that the amount we had
originally accrued for facility-related costs was too low and accrued an
additional $0.3 million. The original liability was based on estimated sublease
rates and timing, which have been affected by the decline in the real estate
market.
The following table summarizes the costs and activities during fiscal 2003
related to the fourth quarter of 2001 restructuring.
Balance at Balance at
Original October 31, Cash July 31,
Charge 2002 Payments Adjustments 2003
------ ----------- ---------- ------------ --------
In thousands
Severance and benefits $ 32,793 $ 1,117 $ (907) $ -- $ 210
Excess facilities and property and equipment 10,896 4,651 (2,051) 262 2,862
Other restructuring-related costs 6,973 624 (439) -- 185
-------- -------- ---------- -------- -------
$ 50,662 $ 6,392 $ (3,397) $ 262 $ 3,256
======== ======== ========== ======== ========
As of July 31, 2003, the remaining balance of the fourth quarter fiscal 2001
restructuring charge included accrued liabilities largely related to severance
and benefits, which will be paid out during fiscal 2003, and lease costs for
excess facilities, which will be paid over the respective remaining lease terms.
Third quarter of fiscal 2001
During the third quarter of fiscal 2001, we recorded a pre-tax restructuring
charge of approximately $30 million as a result of our July 2001 acquisition of
Cambridge Technology Partners and changes in our business to move towards a Net
business solutions strategy. Specific actions included reducing our workforce
worldwide by approximately 280 employees across all functional areas
(approximately 5% before the addition of Cambridge), consolidating facilities
and disposing of excess property and equipment, abandoning and writing off
technologies that no longer fit within our new strategy, and discontinuing
unprofitable product lines. As noted above, during the second quarter of fiscal
2003, we determined that the amount we had originally accrued for
facility-related costs was too low and accrued an additional $0.7 million. The
original liability was based on estimated sublease rates and timing, which have
been affected by the decline in the real estate market.
The following table summarizes the activity during fiscal 2003 related to the
third quarter of fiscal 2001 restructuring costs.
Balance at Balance at
Original October 31, Cash July 31,
Charge 2002 Payments Adjustments 2003
--------- ---------- --------- ----------- ----------
In thousands
Severance and benefits $ 15,978 $ -- $ -- $ -- $ --
Excess facilities and property and equipment 10,740 3,889 (1,778) 678 2,789
Other restructuring-related costs 3,675 137 (137) -- --
-------- -------- --------- -------- ---------
$ 30,393 $ 4,026 $ (1,915) $ 678 $ 2,789
======== ======== ========= ======== =========
As of July 31, 2003, the remaining balance of the third quarter of fiscal 2001
restructuring charge included accrued liabilities related to lease costs for
excess facilities, which will be paid over the respective remaining lease terms.
As a result of the fiscal 2002 and the two fiscal 2001 restructurings, we
reduced our expenses by approximately $50 million on a quarterly basis, before
any increased strategic expenditures and the impact of the SilverStream
acquisition. We could incur additional restructuring charges in the future as we
continue to develop our Net solutions strategy using both Netware and Linux
platforms and react to market conditions by reducing costs.
In-process research and development
The purchased in-process research and development charge in the third quarter of
fiscal 2002 resulted from the acquisition of SilverStream and pertains mainly to
research and development work for the next version of the current SilverStream
products.
Employees
July 31, July 31,
2003 2002 Change
(Dollars in thousands)
Employees at end of quarter (full time equivalents) 5,943 6,582 (10)%
Revenue per average employee for three months ended $ 186 $ 182
Headcount in the third quarter of fiscal 2003 decreased compared to the same
period in fiscal 2002 due the second quarter fiscal 2002 and third quarter
fiscal 2003 restructurings, which were previously discussed. We continue to
monitor headcount to ensure our resources are aligned with expected business
levels and our business strategy.
Other income (expense), net
Three months ended July 31, Nine months ended July 31,
--------------------------- --------------------------
2003 2002 Change 2003 2002 Change
---- ---- ------ ---- ---- ------
(Dollars in thousands)
Other income (expense), net $ (3,717) $ 7,230 (151)% $ (22,381) $ (698) (3,106)%
Percentage of revenue (1)% 3% (3)% --%
The primary components of other income (expense), net in the third quarter and
first nine months of fiscal 2003, were a gain on the sale of our facility in San
Jose, California of $24.9 million, offset by a charge for impaired intangible
assets of $24.3 million. In addition, other income (expense), net in the third
quarter of fiscal 2003 included a net investment loss of $5.0 million, which was
comprised of impairment losses on long-term investments totaling $8.0 million
offset by realized net gains and interest income on short-term securities of
$3.0 million. Other income (expense), net during the third quarter of fiscal
2002 included net investment income of $5.3 million. There were no investment
impairment losses during the third quarter of fiscal 2002.
Other income (expense), net during the first nine months of fiscal 2003 included
impairment losses on long-term investments totaling $32.6 million, realized net
gains on the sale of short-term securities of $1.3 million, and interest income
of $8.6 million, in addition to the gain on sale of our facility and impaired
intangible asset charge, discussed previously. During the first nine months of
fiscal 2002, other income (expense), net included investment income of $20.5
million and a $9 million gain on the sale of a building in the first quarter of
fiscal 2002, offset by investment impairment losses of $29.8 million.
Income tax expense (benefit)
Three months ended July 31, Nine months ended July 31,
--------------------------- --------------------------
2003 2002 Change 2003 2002 Change
---- ---- ------ ---- ---- ------
(Dollars in thousands)
Income tax (benefit) expense $ (11,362) $ 5,549 (305)% $ (18,200) $ 6,835 (366)%
Percentage of revenue (4)% 2% (2)% 1%
Effective tax (benefit)
expense rate (48)% 36% (26)% 148%
Our actual effective tax benefit rate for the third quarter of fiscal 2003 was
48% compared to the effective tax expense rate of 36% for the same period in
2002. Our actual effective tax benefit rate for the first nine months of fiscal
2003 was 26% compared to the effective tax rate of 148% for the same period in
2002. The rate differs because of differences in the amount of non-deductible
investment impairments taken in each period and non-taxable capital gains
realized in the third quarter of 2003.
Net income (loss) and net income (loss) per share
Three months ended July 31, Nine months ended July 31,
(Dollars in thousands, 2003 2002 Change 2003 2002 Change
---- ---- ------ ---- ---- ------
except per share)
Net income (loss ) $ (12,400) $ 9,949 (225)% $ (52,900) $ (155,151) 66%
Percentage of revenue (4)% 4% (7)% (19)%
Net income (loss) per share:
Basic and diluted $ (0.03) $ 0.03 (222)% $ (0.14) $ (0.43) 67%
The year-to-date fiscal 2002 net loss and net loss per share includes a $143.7
million cumulative effect of an accounting change, which resulted from our
adoption of SFAS No. 142. Through our initial SFAS No. 142 analysis, we
determined that a portion of our goodwill related to the acquisition of
Cambridge Technology Partners in July 2001 had become impaired. Before the
cumulative effect of the accounting change, net loss per share was $0.03 for the
first nine months of fiscal 2002. The net loss per share during the third
quarter and first nine months of fiscal 2003 was primarily due to the charge for
long-term investment impairments, charges for impaired intangibles, higher sales
and marketing expenses to roll out our new advertising campaign, and
restructuring expenses, offset somewhat by the gain on the sale of a facility,
as discussed previously. In addition, the net loss per share for the first nine
months of fiscal 2003 included additional expenses related to the adjustments of
previous restructuring and merger expenses incurred in the second quarter of
fiscal 2003. At this time, we have decided not to provide specific forecasted
earnings information for the remainder of fiscal 2003.
Liquidity and capital resources
July 31, October 31,
2003 2002 Change
----------- ----------- ------
(Dollars in thousands)
Cash, cash equivalents, and short-term investments $ 738,777 $ 635,858 16%
Percentage of total assets 46% 38%
Cash, cash equivlaents and short-term investments totaled $738.8 million at July
31, 2003 compared to $635.9 million at October 31, 2002. The increase in cash
can be attributed to cash received from the sale of our facility in San Jose,
California of $125 million, cash provided by operations of $2 million, cash
proceeds from stock issuances under employee stock option or equity plans of
$7.8 million and the impact of foreign exchange fluctuations. These increases
were offset somewhat by expenditures for fixed assets of $30.6 million, cash
paid to acquire Volera minority interest shares from Accenture of $1.1 million,
and net cash paid for long-term investments of $11.3 million.
Our short-term investment portfolio is diversified among security types,
industry groups, and individual issuers. To achieve potentially higher returns,
a portion of our investment portfolio is invested in equity securities and
mutual funds, which incur market risk. We mark our short-term investments to
market each month. Our short-term investment portfolio includes gross unrealized
gains of $1.7 million and gross unrealized losses of $0.1 million as of July 31,
2003. We monitor our investments and record losses when a decline in the
investment's market value is determined to be other than temporary.
We have also invested excess cash in long-term investments through the Novell
Venture account, CTC I, and direct investments in equity securities of
privately-held companies. Investments made through the Novell Venture account
and CTC I generally are in privately-held companies, including small
capitalization stocks in the high technology industry sector, and
expansion-stage privately-held companies. Within the Novell Venture account
there are also investments in venture capital funds that are managed largely by
external venture capitalists. CTC I is managed internally. The value of the
investments made through the Novell Venture account and CTC I is dependent on
the performance, successful acquisition, and/or initial public offering of the
investees. As of July 31, 2003, we had commitments to contribute an additional
$57.8 million to the externally managed venture capital funds over the next
three to four years, as requested by the fund managers, and commitments to the
CTC I fund to contribute up to an additional $300,000 over the next three to
four years. We intend to fund these investments with cash from operations and
cash income from short-term investments, and sales of short-term investments on
hand.
As of July 31, 2003, we had cash and other short-term investments of $442
million in accounts outside the U.S. Repatriation of any portion of this amount
would be subject to U.S. federal income taxes. We have provided for the tax
liability on these amounts for financial statement purposes except for $15
million of earnings, which is permanently invested outside the U.S.
Repatriation, however, could result in a loss of certain tax attributes of up to
$38.5 million and result in additional U.S. federal income tax payments of such
amounts in future years.
During the first quarter of fiscal 2002, we sold our subsidiary in the Czech
Republic. As a part of this transaction, we provided a guarantee to the landlord
of our building there whereby we agreed to pay any and all monies due under the
lease, including legal fees if the new lessee defaults on the lease. During the
first nine months of fiscal 2003, we paid approximately $0.1 million against
this guarantee and have accrued a liability for an additional $0.4 million that
we could be required to pay, excluding legal fees, if the new lessee continues
in default.
As an element of our standard contract terms, we include an indemnification
clause in our agreements with our customers that indemnifies the licensee
against certain liability and damages arising from intellectual property
infringement claims arising from their use or distribution of our software.
These terms are common in the high technology industry. We do not record a
liability for potential litigation claims related to indemnification agreements
with our customers. We do not believe the likelihood of a material obligation is
probable.
On August 4, 2003, we acquired Ximian, Inc., a privately-held company and
leading provider of desktop and server solutions that enable enterprise Linux
adoption, for approximately $40 million. The acquisition of Ximian expands
Novell's ability to support Linux solutions, providing Novell with Linux
desktop, groupware and management technologies. The acquisition also brings
leaders in the open source community and a strong core of Linux developers to
Novell.
Our principal source of liquidity continues to be from operations, on-hand cash,
and income from short-term investments. At July 31, 2003, our principal unused
sources of liquidity consisted of cash on hand in the amount of $450.7 million,
short-term investments in the amount of $288.1 million, and available borrowing
capacity of under our $15 million line of credit. Our liquidity needs are
principally for financing of accounts receivable, acquisition of fixed assets
and strategic investments, product development, and flexibility in a dynamic and
competitive operating environment.
During the first nine months of fiscal 2003, we generated $2 million of cash
from operations. Through our third quarter fiscal 2003 restructuring, we will
reduce our cost structure over the remainder of fiscal 2003 and anticipate
positive net cash flows from operating and investing activities for the
remainder of fiscal 2003. We anticipate being able to fund our current
operations, any future acquisitions, any further integration, restructuring or
any merger-related costs, and planned capital expenditures for the foreseeable
future with existing cash on hand and short-term investments together with cash
generated from operations, and investment income. We believe that additional
borrowings under our credit facilities or offerings of equity or debt securities
are possible if the need arises, although such offerings may not be available to
us on acceptable terms. Investments will continue in product development and in
new and existing areas of technology. Cash may also be used to acquire
technology through purchases and strategic acquisitions. Capital expenditures in
fiscal 2003 are anticipated to be approximately $40 million, but could be
reduced if our growth is less than presently anticipated.
During the fourth quarter of fiscal 2001, the Board of Directors extended our
stock repurchase program through June 30, 2003 and authorized the use of up to
$500 million for the repurchase of additional outstanding shares of our common
stock. This program was not extended beyond June 30, 2003.
New Accounting Pronouncement
Financial Accounting Standards Board Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"), was issued in January 2003. FIN 46
requires that if an entity is the primary beneficiary of a variable interest
entity, the assets, liabilities and results of operations of the variable
interest entity should be included in the consolidated financial statements of
the entity. The provisions of FIN 46 are effective immediately for all
arrangements entered into after January 31, 2003. We have not invested in any
variable interest entities after January 31, 2003. For those arrangements
entered into prior to January 31, 2003, the provisions of FIN 46 are required to
be adopted at the beginning of the first interim or annual period beginning
after June 15, 2003. We are reviewing our arrangements with variable interest
entities entered into prior to January 31, 2003. We do not believe that our
arrangements with these entities will require consolidation of their financial
information in our financial statements.
Factors Affecting Future Results of Operations
Our future results of operations involve a number of risks and uncertainties
that could cause actual results to differ materially from expected and historic
results. A number of these risks and uncertainties are discussed in the
following paragraphs.
The Current Economic Climate and Outlook in the Technology Consulting,
Operational Consulting, and Information Technology Services Sector Is Weak,
Causing Our Business to Suffer
The weakened global economic climate, particularly in the technology sector, has
had an adverse effect on our stock price and ability to sell products and
services. Future economic projections for this sector do not anticipate a quick
recovery. A continuation of the weakened global economy could have further
negative effects on our stock price and ability to sell products and services in
the future.
Our Financial and Operating Results May Vary, Negatively Affecting our Ability
to Detect Trends
We often experience a higher volume of revenue at the end of each quarter and
during our fourth quarter. Because of this, fixed costs that are out of line
with revenue levels may not be detected until late in any given quarter and
results of operations could be adversely affected.
Operating results have been, and may also continue to be, affected by other
factors including, but not limited to:
o timing of orders from customers and shipments to customers;
o product mix, including a shift from higher margin to lower margin
products or services;
o impact of foreign currency exchange rates on the price of our products
in international locations;
o our responses to revenue declines experienced by our distribution
partners;
o our ability to realize projected benefits from our restructurings and
our corporate strategies; and
o our ability to deliver solutions as expected by our customers and
systems integration partners.
We May Not Be Able to Successfully Compete in a Challenging Market for Computer
Software, Operational Consulting, and IT Consulting Services
The market for networking applications and solutions as well as IT consulting is
highly competitive and subject to rapid technological change. We expect
competition to continue to increase both from existing competitors and new
market entrants. We believe that competitive factors common to all of our
solution categories include: the breadth of our offerings; the pricing of our
products and services; and the timing and market acceptance of new solutions
developed by us and our competitors.
Software licenses and maintenance
In addition to the factors listed above, key competitive factors related to our
software licenses and maintenance include brand and product awareness; the
performance, reliability and security of our products; the ability to preserve
our legacy customer base; the completeness of our suite of product and solutions
offerings; our ability to establish and maintain key strategic relationships
with distributors, resellers and other partners; and the pricing strategies of
our competitors. Our key competitors related to software licenses and
maintenance revenue include Microsoft, IBM, BEA Systems, Sun Microsystems,
Altiris, Netegrity, Computer Associates and Critical Path.
Worldwide IT Services
The key competitive factors faced by us related to IT consulting are attracting
and retaining the highest quality consultants and the depth and breadth of our
skills and expertise. The market for IT consulting services is highly
competitive due to the existence of several large IT consulting firms
specializing in the information systems area such as IBM, Accenture, EDS and
Microsoft. Many of these companies have greater financial, technical and
marketing resources and greater name recognition in the IT consulting area,
which could inhibit our ability to grow our IT consulting business.
Additionally, the worldwide marketplace for IT consulting services is highly
fragmented. We often encounter different groups of competitors in different
regions of the world. Many of these local competitors may have niche
consultancies carved out in a local market against whom it may be difficult to
win business.
Celerant Management Consulting
Because of the extremely specialized nature of the implementation consulting
services provided by Celerant, the main competitive factor faced by Celerant is
not so much presented by rival consulting firms, but rather lies with
prospective clients themselves. The primary decision often faced by Celerant's
prospective clients is a weighing of the costs of a Celerant engagement against
the measurable results and financial benefits to be realized during and after
the engagement. Therefore, a key factor lies in convincing clients of Celerant's
ability to deliver those results and benefits. An additional consideration
potential clients factor into their decisions is a judgment as to whether they
can successfully perform the work that they require themselves, or whether they
need the assistance of a third party such as Celerant.
General
We do not have the product breadth and market power of Microsoft. Microsoft's
ability to ship networking products with features and functionality that compete
with ours, together with its greater ability to offer incentives to customers to
purchase certain products in order to obtain favorable sales terms or necessary
compatibility or information with respect to other products, may significantly
inhibit our ability to grow our business. Microsoft has significant financial
resources, which could allow it to aggressively price its products and services
for long periods of time to the potential detriment of competitors. We believe,
and the courts have agreed, that Microsoft exploits its desktop operating
monopoly in anticompetitive ways designed to maintain that monopoly and, in our
view, to extend its market power to quash competitive alternatives to Microsoft
products. For example, in the past, Microsoft has employed tactics that limit or
block effective and efficient interoperability with our products. We will
ensure, to the best of our ability, that our products will interoperate with
those of Microsoft as they enhance new operating systems and applications.
We May Not be Able To Attract and Retain Qualified Employees Because of the
Intense Competition for Qualified Employees in the Computer and Consulting
Industries
Our ability to maintain our competitive technological position will depend, in
large part, on our ability to attract and retain highly qualified development,
consulting, and managerial employees. Even in light of the current economic
downturn, competition for employees of the highest caliber is intense in the
software and consulting industries. The loss of a significant number of key
employees would adversely affect our performance. The failure to successfully
attract, hire, retain and promote qualified employees as we need them could have
a material adverse effect on our business.
If We Are Not Successful in Developing a Strong Business with our Nsure and
exteNd Products and Services, Our Long-Term Growth Will Be Negatively
Impacted
The success of our net directory services products that comprise our Nsure and
exteNd secure web services and identity management solutions sets is important
to our strategy. The acquisition of SilverStream helped further our development
of secure Web services products and enhanced our identity management product
offerings. Our ability to achieve success with our Nsure and exteNd products and
services is dependent on a number of factors including, but not limited to, the
following: growth of the Web-based applications industry; acceptance of the
Nsure and exteNd solution sets by clients; further development of key Nsure and
exteNd product solutions and upgrades; and acceptance of those products by large
industry partners and major accounts. If we are unable to grow the Nsure and
exteNd products and services to become a major component of our business, our
long-term growth will be negatively impacted.
If We Are Unable to Unify Our Diverse Cultures, the Benefits of Our Solutions
Strategy May Not Be Fully Realized
We have a talented, energetic, and exciting group of employees. As a result of
our acquisitions over the last couple of years, a number of these employees come
from diverse geographic and corporate cultural backgrounds. We are in the
process of a cultural initiative to bring our whole company together towards a
new common culture that revolves around our solutions offerings. If we are not
successful in forging a new, vibrant culture with unified goals and a common
vision that is solutions-based, employee energies may be diverted or diluted and
we may not achieve the full benefits of our solutions strategy.
Our Existing Product Revenue May Deteriorate More Rapidly Than Any Increase in
Sales of Our New Products
We have several existing products, which we have been selling and upgrading for
many years. Sales of these existing products, particularly NetWare, are
declining at a faster rate than we are able to increase sales of new products or
technologies. If we are unsuccessful in increasing sales of new products or
technologies, particularly in our exteNd solution set and Net Directory Services
product line, our long-term growth will be negatively impacted.
If We Do Not Generate New Customers, Our Ability to Grow Our Business Will Be
Negatively Impacted
A significant percentage of our revenue is generated from existing customers. In
order to achieve our growth objectives, we must accelerate the rate at which we
generate new business. We are in the middle of several sales and marketing
initiatives in order to accomplish this goal. If those initiatives are not
successful, our ability to cultivate new customers may be adversely affected.
We Have Experienced Delays in the Introduction and Acceptance of New Products
Due to Various Factors
As is common in the computer software industry, we have in the past experienced
delays in the introduction of new products due to a number of factors, including
the complexity of software products, the need for extensive testing of software
to ensure compatibility of new releases with a wide variety of application
software and hardware devices, and the need to "debug" products prior to
extensive distribution. Significant delays in developing, completing, or
shipping new or enhanced products would adversely affect our business.
Moreover, we may experience delays in market acceptance of new releases of our
products as we engage in marketing and education of the user base regarding the
advantages of and system requirements for new products and as customers evaluate
the advantages and disadvantages of upgrading. We have encountered these issues
on each major new release of our products, and expect that we will encounter
such issues in the future. Our ability to achieve desired levels of revenue
growth depends at least in part on the successful completion, introduction and
sale of new versions of our products. There can be no assurance that we will be
able to respond effectively to technological changes or new product
announcements by others, or that our research and development efforts will be
successful. Should we experience material delays or revenue shortfalls with
respect to new product releases, our revenue and net income could be adversely
affected.
If Third Parties Claim that We Infringed Upon Their Intellectual Property, Our
Ability to Use Some Technologies and Products Could Be Limited and We May Incur
Significant Costs to Resolve These Claims
Litigation regarding intellectual property rights is common in the Internet and
software industries. We have in the past received letters or been the subject of
claims suggesting that we are infringing upon the intellectual rights of others.
For example, in May 2002 a suit was filed by France Telecom SA and U.S. Philips
Corporation against us alleging that Novell's NetWare client software infringes
upon a patent allegedly co-owned by them and seeking unspecified damages and an
injunction. In addition, we have faced and expect to continue to face from time
to time disputes over rights and obligations concerning intellectual property.
We expect third-party infringement claims involving Internet technologies and
software products and services to increase because it has become more common for
companies to work with attorneys on a contingency basis to bring these kinds of
claims. While we have no reason to think we would not have strong defenses to
such claims, the cost and time of defending ourselves can be significant. In
addition, we have agreed, and may agree in the future, to indemnify customers
against claims that our products infringe upon the intellectual property rights
of others. We could incur substantial costs in defending ourselves and our
customers against infringement claims. If an infringement claim is successful,
we and our customers may be required to obtain one or more licenses from third
parties, and we may be obligated to pay or reimburse our customers for monetary
damages. In such instances, we or our customers may not be able to obtain
necessary licenses from third parties at a reasonable cost or at all, and may
face delays in product shipment while developing or arranging for alternative
technologies.
We May Not Be Able to Protect Our Confidential Information, Which May Adversely
Affect Our Business
We generally enter into contractual relationships with our employees to protect
our confidential information. In the event that our trade secrets or other
proprietary information are misappropriated, our business could be seriously
harmed. In addition, we may not be able to timely detect unauthorized use of our
intellectual property and take appropriate steps to enforce our rights. In the
event we are unable to enforce these contractual obligations and our
intellectual property rights, our business could be adversely affected.
We Face Increased Risks in Conducting a Global Business, Which May Damage
Business Results
We are a multi-national corporation with offices and subsidiaries around the
world and, as such, we face risks in doing business abroad that we do not face
domestically. Certain aspects inherent in transacting business internationally
could negatively impact our operating results, including:
o costs and difficulties in staffing and managing international operations;
o unexpected changes in regulatory requirements;
o tariffs and other trade barriers;
o difficulties in enforcing contractual and intellectual property rights;
o longer payment cycles;
o local political and economic conditions;
o potentially adverse tax consequences, including restrictions on
repatriating earnings and the threat of "double taxation"; and
o fluctuations in currency exchange rates, which can affect demand and
increase Novell's costs.
Some of Our Short-term, Long-term, and Venture Capital Fund Investments Have
Become Impaired and Additional Investments Could Become Impaired
Our investment portfolio includes short-term investments in publicly traded
equity securities, long-term equity investments in privately-held companies,
small capitalization stocks in the high-technology industry sector, and funds
managed by venture capitalists. Many of these investments might become
other-than-temporarily impaired. During the first nine months of fiscal 2003, we
recorded an impairment charge of $32.6 million related to some of the
investments in our portfolio in cases where their market value had experienced
an other-than-temporary decline. As of July 31, 2003, we had net unrealized
gains, after taxes, on investments totaling approximately $1.4 million; however,
there can be no assurances that these gains will be realized and that losses
will not occur. If the companies and funds in which we have invested suffer poor
financial performance, or if the privately-held companies in which we have
invested are not successfully acquired or do not experience initial public
offerings, the value of our investments will decrease.
Our Existing Relationships With Other Information Technology Services
Organizations May Be Impaired and We Could Lose Business
We maintain relationships with IT services organizations that recommend, design
and implement solutions for their customers' eBusiness that include Novell Net
services products. At the same time, our service offerings compete with those of
these same organizations. Although many companies in high technology industries
co-exist in a similar state of competition, any of these organizations could
decide at any time to not continue to do business with us or to recommend our
products. A change in the willingness of these IT service organizations to do
business with us could adversely affect our business.
Our Business May Be Negatively Affected if We Do Not Continue to Adapt to Rapid
Technological Change, Evolving Business Practices and Changing Consumer
Requirements
The software industry and IT consulting market is characterized by rapidly
changing technology, evolving business practices and changing client needs.
Accordingly, our future success will depend in part on our ability to continue
to adapt and meet these challenges. Among the most important challenges we face
is the need to continue to:
o effectively identify and use leading technologies;
o enhance strategic and technical expertise;
o influence and respond to emerging industry standards and other
technology changes and to orient management teams to capitalize on
these changes;
o recruit and retain qualified project personnel;
o enhance current services;
o develop new services that meet changing customer needs; and
o effectively advertise and market Net business solutions.
Our Consulting Services Contracts Contain Pricing Risks and, If Our Estimates
Prove Inaccurate, We Could Incur Additional Costs or Not Realize Anticipated
Revenue
Revenue from our Celerant consulting business and about half of the revenue from
our IT consulting group within our worldwide services is derived from
fixed-price, fixed-time contracts. Because of the complex nature of the services
provided, it is sometimes difficult to accurately estimate the cost, scope, and
duration of particular client engagements. If we do not accurately estimate the
resources required for a project, do not accurately assess the scope of work
associated with a project, do not manage the project properly, or do not satisfy
our obligations in a manner consistent with the contract, then our costs to
complete the project could increase substantially. We have occasionally had to
commit unanticipated additional resources to complete projects, and we may have
to take similar action in the future. We may not be compensated for these
additional costs or the commitment of these additional resources. Additionally,
our Celerant management consulting business derives a meaningful portion of our
revenues from projects priced on a contingency basis. If results are not met, or
if a dispute arises, potentially large revenues may not be realized.
Our IT Consulting and Celerant Consulting Clients Can Cancel or Reduce the Scope
of Their Engagements With Us on Short Notice
If our clients cancel or reduce the scope of an engagement with the IT
consulting group within our worldwide services business or the Celerant
management consulting business, we may be unable to reassign our professionals
to new engagements without delay. Personnel and related costs constitute a
substantial portion of our operating expenses. Because these expenses are
relatively fixed in the short term, and because we establish the levels of these
expenses well in advance of any particular quarter, cancellations or reductions
in the scope of client engagements could result in the under-utilization of our
consultants, causing significant reductions in operating results for a
particular quarter.
Actions Taken By the SCO Group Could Impact the Acceptance of the Linux
Operating System, Negatively Affecting Novell's Linux Initiatives
Novell recently announced some important Linux initiatives. These include an
upcoming NetWare version based on the Linux kernel, as well as collaboration and
resource management solutions for Linux. The SCO Group ("SCO") has recently
written a "Letter to Linux Customers" that states that Linux infringes on SCO's
Unix intellectual property and other rights, and that SCO intends to
aggressively protect and enforce those rights. SCO's actions have the potential
to disrupt business relations that might otherwise form at a critical time
around Linux technologies, and could potentially deprive Novell of important
economic opportunities. It is possible that SCO's actions, if carried forward,
could lead to the loss of sales and jobs, delayed projects, canceled financing,
and a balkanized Linux community, any of which could hurt Novell's Linux
initiatives.
Our Stock Price Will Fluctuate
Our future earnings and stock price could be subject to significant volatility,
particularly on a quarterly basis. Due to analysts' expectations of continued
growth, any shortfall in anticipated earnings can be expected to have an
immediate and significant adverse effect on the trading price of our common
stock in any given period. Revenue fluctuations may also contribute to the
volatility of the trading price of our common stock in any given period.
In addition, the market prices for securities of software companies have been,
and continue to be, very volatile. The market price of our common stock, in
particular, has been subject to wide fluctuations in the past. As a result of
the foregoing factors and other factors that may arise in the future, the market
price of our common stock may be subject to significant fluctuations within a
short period of time. These fluctuations may be due to factors specific to us,
to changes in analysts' earnings estimates, or to factors affecting the computer
industry or the securities markets in general.
Item 7A. Qualitative and Quantitative Disclosures About Market Risk
We are exposed to financial market risks, including changes in interest rates,
foreign currency exchange rates, and the market prices of equity securities. To
mitigate some of these risks, we utilize currency forward contracts and currency
options. We do not use derivative financial instruments for speculative or
trading purposes, and no significant derivative financial instruments were
outstanding at July 31, 2003.
Interest Rate Risk
The primary objective of our short-term investment activities is to preserve
principal while maximizing yields without significantly increasing risk. The
strategy we use to achieve this objective is to invest in widely diversified
short-term investments, consisting primarily of investment grade securities,
substantially all of which either mature within the next twelve months or have
characteristics of short-term investments. A hypothetical 50 basis point
increase in interest rates would result in an approximately $1.2 million
decrease (less than 0.5% of total investments) in the fair value of our
available-for-sale securities.
Market Risk
We also hold available-for-sale equity securities in our short-term investment
portfolio. As of July 31, 2003, gross unrealized gains, before tax effect, on
the short-term public equity securities totaled $0.2 million. A reduction in
prices of 10% of these short-term equity securities would result in
approximately a $0.5 million decrease (less than 0.1% of total investments) in
the fair value of our short-term investments.
In addition, we invest in equity securities of privately-held companies, which
are included in our long-term portfolio of investments, primarily for the
promotion of business and strategic objectives. These investments are generally
in small capitalization stocks in the high technology industry sector or venture
capital funds. Because of the nature of these investments, we are exposed to
risks that the value of these equity securities will change. We typically do not
attempt to reduce or eliminate our market exposure on these securities. A 10%
adverse change in equity prices of equity securities of privately-held companies
would result in an approximately $5 million decrease in the fair value of our
available-for-sale long-term securities.
Foreign Currency Risk
We use derivatives to hedge those net assets and liabilities that, when
translated or remeasured according to accounting principles generally accepted
in the U.S., impact our condensed consolidated statement of operations. Currency
forward contracts are utilized in these hedging programs. All forward contracts
that we enter into are components of hedging programs and are entered into for
the sole purpose of hedging an existing or anticipated currency exposure, not
for speculation or trading purposes. Gains and losses on these currency forward
contracts would generally be offset by corresponding losses and gains on the
foreign currency assets and liabilities that they hedge, resulting in negligible
net gain or loss overall on the hedged exposures. When hedging balance sheet
exposures, all gains and losses on forward contracts are recognized in other
income and expense in the same period as when the gains and losses on
translation or remeasurement of the foreign currency denominated assets and
liabilities occur. All gains and losses related to foreign exchange contracts
are included in cash flows from operating activities in the condensed
consolidated statement of cash flows. Our hedging programs reduce, but do not
always entirely eliminate, the impact of foreign currency exchange rate
movements. If we did not hedge against foreign currency exchange rate movement,
an increase or decrease of 10% in exchange rates would result in an increase or
decrease in income before taxes of approximately $1 million. This number
represents the exposure related to balance sheet remeasurement and intercompany
translation only and assumes that all currencies move in the same direction at
the same time relative to the U.S. dollar.
All of the potential changes noted above are based on sensitivity analyses
performed on our financial position at July 31, 2003. Actual results may differ
materially.
Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
The Company's management, with the participation of the Company's Chief
Executive Officer and Chief Financial Officer, evaluated the effectiveness the
Company's disclosure controls and procedures as of the end of the period covered
by this report. Based on that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that the Company's disclosure controls and
procedures as of the end of the period covered by this report were designed and
functioning effectively to provide reasonable assurance that the information
required to be disclosed by the Company in reports filed under the Securities
Exchange Act of 1934 is recorded, processed, summarized and reported within the
time periods specified in the SEC's rules and forms. The Company believes that a
controls system, no matter how well designed and operated, cannot provide
absolute assurance that the objectives of the controls system are met, and no
evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, within a company have been detected.
(b) Change in Internal Control over Financial Reporting
No change in the Company's internal control over financial reporting occurred
during the Company's most recent fiscal quarter that has materially affected, or
is reasonably likely to materially affect, the Company's internal control over
financial reporting.
Part II. Other Information
Except as listed below, all information required by items in Part II is omitted
because the items are inapplicable or the answer is negative.
Item 1. Legal Proceedings.
The information required by this item is incorporated herein by reference to
Note J of our financial statements contained in Part I, Item 1 of this Form
10-Q.
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Exhibit
Number Description
31.1 Certification pursuant to 18 U.S.C. Section 1350 Sarbanes-Oxley
Act of 2002
31.2 Certification pursuant to 18 U.S.C. Section 1350 Sarbanes-Oxley
Act of 2002
99.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
99.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K.
Form 8-K dated May 5, 2003, reporting under Item 5.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Novell, Inc.
(Registrant)
Date: September 12, 2003 /s/ Joseph S. Tibbetts, Jr.
-------------------------------
Joseph S. Tibbetts, Jr.
Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)