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(Registrant’s telephone
number, including area code)
Securities registered pursuant to Section 12(b) of the
Act:
Title of Each Class
Name of Each Exchange on Which
Registered
Common Stock, par value
$.10 per share
The NASDAQ Stock Market LLC
(NASDAQ Global Select
Market)
Securities registered pursuant to Section 12(g) of the
Act: None
Indicate by check mark if the registrant is a well-known
seasoned issuer, as defined in Rule 405 of the Securities
Act. Yes o No þ
Indicate by check mark if the registrant is not required to file
reports pursuant to Section 13 or Section 15(d) of the
Act. Yes o No þ
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 o No þ
Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of
Regulation S-K
is not contained herein, and will not be contained, to the best
of registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in
Part III of this
Form 10-K
or any amendment to this
Form 10-K. o
The aggregate market value of the registrant’s common stock
held by non-affiliates as of April 30, 2006 (based on the
last reported sales price of the common stock on the NASDAQ
Global Select Market on such date) was $2,100,323,354. For
purposes of this disclosure, shares of common stock held by
persons who hold more than 5% of the outstanding common stock
and common stock held by executive officers and directors of the
registrant have been excluded because such persons are deemed to
be “affiliates” as that term is defined under the
rules and regulations promulgated under the Securities Act of
1933. This determination is not necessarily conclusive for other
purposes.
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, or non-accelerated
filer. See definition of accelerated filer and large accelerated
filer in
Rule 12b-2
of the Exchange Act)
Large Accelerated
Filer þ Accelerated
Filer o Non-Accelerated
Filer o
Indicate by check mark whether the registrant is a shell company
(as defined in
Rule 12b-2
of the
Act) Yes o No þ
On May 23, 2007, we announced that we had completed our
self-initiated, voluntary review of our historical stock-based
compensation practices and determined the related accounting
impact. The review was conducted under the direction of the
Audit Committee of our Board of Directors, who engaged the law
firm of Cahill Gordon & Reindel LLP, with whom we
previously had no relationship, as independent outside legal
counsel to assist in conducting the review. The scope of the
review covered approximately 400 grant actions (on approximately
170 grant dates) from November 1, 1996 through
September 12, 2006. Within these pools of grants are more
than 58,000 individual grants. In total, the review
encompassed awards relating to more than 230 million shares
of common stock granted over the ten-year period. As a result of
the review, we delayed the filing of our Quarterly Reports on
Form 10-Q
for the fiscal quarters ended July 31, 2006 and
January 31, 2007 and our Annual Report on
Form 10-K
for the fiscal year ended October 31, 2006. Simultaneous
with this filing, we are filing our other delinquent reports.
The Audit Committee, together with its independent outside legal
counsel, did not find any evidence of intentional wrongdoing by
any former or current Novell employees, officers or directors.
We have determined, however, that we utilized incorrect
measurement dates for some of the stock-based compensation
awards granted during the review period.
In light of the above findings, stock-based compensation expense
in a cumulative after-tax amount of approximately
$19 million should have been reported in our consolidated
financial statements during the period from fiscal 1997 through
2005. We have determined, however, that the amounts of
stock-based compensation expense that should have been
recognized in each of the applicable historical periods,
including the interim periods of fiscal 2005 and 2006, were not
material to those periods on either a quantitative or
qualitative basis. Therefore, we will not restate our
consolidated financial statements for prior periods.
We implemented the guidance applicable to the initial adoption
of Staff Accounting Bulletin No. 108,
“Considering the Effects of Prior Year Misstatements when
Quantifying Misstatements in Current Year Financial
Statements,” as of November 1, 2005. Accordingly, our
financial statements for the 2006 fiscal year, included in this
report, reflect cumulative adjustments of approximately
$19 million for unrecorded stock-based compensation
expense, and related income tax effects, as a decrease to
retained earnings as of November 1, 2005, the beginning of
our 2006 fiscal year. The adjustment to retained earnings will
reduce retained earnings as of the beginning of the 2006 fiscal
year from $984 million to $965 million, or a reduction
of two percent.
This Annual Report on
Form 10-K
contains certain forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933, as amended,
and Section 21E of the Securities Exchange Act of 1934, as
amended. All statements, other than statements of historical
fact, regarding our strategy, future operations, financial
position, estimated revenue, projected costs, projected savings,
prospects, plans, opportunities and objectives constitute
“forward-looking statements.” The words
“may,”“will,”“expect,”“plan,”“anticipate,”“believe,”“estimate,”“potential,” or
“continue” and similar types of expressions identify
forward-looking statements, although not all such statements
contain these identifying words. These forward-looking
statements are based upon information that is currently
available to us
and/or
management’s current expectations, speak only as of the
date hereof, and are subject to risks and uncertainties. We
expressly disclaim any obligation, except as required by law, or
undertaking to update or revise any forward-looking statements
contained or incorporated by reference herein to reflect any
change or expectations with regard thereto or to reflect any
change in events, conditions, or circumstances on which any such
forward-looking statement is based, in whole or in part. Our
actual results may differ materially from the results discussed
in or implied by such forward-looking statements. We are subject
to a number of risks, some of which may be similar to those of
other companies of similar size in our industry, including
pre-tax losses, rapid technological changes, competition,
limited number of suppliers, customer concentration, failure to
successfully integrate acquisitions, adverse government
regulations, failure to manage international activities, and
loss of key individuals. Risks that may affect our operating
results include, but are not limited to, those discussed in
Part I Item 1A, titled “Risk Factors.”
Readers should carefully review the risk factors described in
this document and in other documents that we file from time to
time with the Securities and Exchange Commission.
Novell develops, implements, and supports proprietary, mixed
source and open source software for use in business solutions.
With approximately 4,500 employees in over 80 offices worldwide,
we provide customers with enterprise infrastructure software and
a full range of training and support services. Our products
enable customers to solve business challenges by maximizing the
effectiveness of their information technology (“IT”)
environments.
Incorporated in January 25, 1983, Novell has a
24-year
history of innovation and industry leadership, enabling
customers to build their own ‘Open Enterprise’ by
adding the strength, flexibility and economy of open source
software to their existing IT infrastructures. We offer an open
source platform along with fully integrated systems management
and security and identity solutions. Our specific offerings
include identity and access management products, resource
management products,
SUSE®
Linux Enterprise Server (“SLES”), Open Enterprise
Server,
NetWare®,
and Collaboration products on several operating systems,
including Linux, NetWare, Windows, and Unix. These technologies
allow us to help customers manage both our open source platform
and the other heterogeneous components of their IT
infrastructures.
By delivering these technology solutions to our customers, we
help them drive increased performance from their IT
infrastructures at a reduced cost and with lower risk. In doing
so, we give our customers more time to focus on innovation and
growth in their core businesses.
To help ensure customer success, we offer customers extensive
technical support and training through our worldwide support
network. We also have strong partnerships in place with
application providers, hardware and software vendors, and
consultants and systems integrators. With our open source
platform, enterprise infrastructure software, and global network
of partners, we offer full solutions to our customers,
regardless of their size or location.
Our software solutions are grouped into three main solution
categories: systems, security and identity management, open
platform solutions, and workspace solutions. In addition, we
offer worldwide IT consulting, training and technical support
services. Following are descriptions of these categories.
Systems, Security and Identity Management. Our
systems, security, and identity management products include
applications that offer broad capabilities for automating the
management of IT resources. This group of
Novell®
solutions creates and assigns digital identities to IT
resources, and protects those resources from unauthorized use.
They also manage and track the use of IT assets and report on
that usage for auditing, billing and compliance reporting
purposes. Among other benefits, customers use these solutions to:
•
Automate the management of IT assets, including servers,
desktops, laptops and hand-held devices, through their entire
lifecycle with device location tracking, utilization reporting
and routing administrative tasks.
•
Lower the total cost of ownership of desktops and laptops
through automated machine configuration and software patch
management across the enterprise.
•
Reduce the complexity and costs of managing users and their
access to systems through instant provisioning of new employees,
streamlined authentication and authorization, and centrally
managed access policies.
•
Secure enterprise information from unauthorized use through the
instant revocation of access rights, the creation of a
consistent enterprise-wide security model, and by gaining full
visibility into how information, services and resources are
being used.
We believe that businesses recognize the need to manage access
to their assets, and the use and optimization of those assets,
with systems that are driven by business policies. Novell meets
this need by offering systems that help customers define,
implement and administer business policies across a single
enterprise. Novell’s solutions also accommodate
customers’ need for increased business agility. By using
our products, customers can extend their business processes and
systems across organizational and technical boundaries,
integrating with the operational environments of their
customers, employees, suppliers and partners. This affords
organizations the opportunity to make changes to their business
operations without incurring the cost of constantly changing
individual software application components, and without
impacting their business partners.
These identity-based technologies not only regulate user access
to data and applications, but are increasingly becoming the
basis for securing and managing other information assets, such
as mobile computing and communications devices and data center
servers. We believe that identity management technologies are
increasingly becoming the preferred means by which businesses
will efficiently utilize all their IT assets. We have developed
products for this market to help our customers take advantage of
these opportunities. These products can be deployed across a
number of systems, including Linux, NetWare, Windows, and Unix
recognizing the heterogeneous nature of today’s IT
infrastructures. Our development strategy has been to produce
systems, security and identity management technologies as a set
of discrete software components that customers can deploy
quickly to meet specific business needs. We believe that this
approach is far more appealing to customers than the alternative
approach of building large, monolithic applications requiring
lengthy implementations without any immediate business benefit.
Open Platform Solutions. Our open platform
solutions category includes solutions that offer effective, open
and cross-platform approaches to computing, networking and
collaboration. Open platform solutions offer operating systems,
network services, and workgroup software solutions.
With our open platform solutions, including our Linux-based and
other related products, we focus on the substantial growth
opportunities presented by enterprise adoption of open source
technologies.
The foundation of this category is SUSE Linux Enterprise, our
high quality and highly interoperable enterprise computing
platform. With its openness, reliability and enterprise-class
performance, we refer to SUSE Linux
Enterprise as the Platform for the Open Enterprise. It offers
businesses a complete open platform that supports
mission-critical applications from the desktop to the data
center. Components of this platform include:
•
SUSE Linux Enterprise Server, which handles a variety of server
workloads including edge and infrastructure computing,
enterprise database deployment,
line-of-business
applications, and mission-critical software applications.
•
SUSE Linux Enterprise Desktop, which offers a general-purpose
desktop computing environment with high usability, a broad range
of productivity applications including a full office suite, and
advanced graphic capabilities.
A major focus of our open platform solutions is to advance and
promote open source computing, with particular emphasis on
driving increased enterprise adoption of Linux. We believe that
a major shift toward the use of open source software is well
underway across many industry segments. This trend is fueled by
organizations that are more critically assessing the cost
effectiveness of their existing IT infrastructures, evaluating
viable open source alternatives, and seeking ways to avoid
vendor lock-in.
We believe that we are uniquely positioned to drive the
transition to greater use of open source software, as well as to
benefit from this trend. Widespread adoption of Linux and open
source software was initially hindered by weak technical
support, a shortcoming that we are particularly well positioned
to address. We leverage our financial stability, experience, and
global services and support capabilities to help our customers
integrate Linux and other open source software into their
existing IT environments.
While the flexibility and cost savings of Linux and open source
have made it attractive to enterprise customers, we believe they
continue to look to proprietary software vendors to provide
applications, management and security solutions. With our SUSE
Linux Enterprise platform, our customers can now easily take a
cross-platform approach, deploying the best of proprietary and
open source software offerings for management and security
functionality. We believe that many businesses find value in
Novell providing them with a path to a more open, flexible and
reliable IT environment, without requiring them to dismantle or
disrupt any software or systems they presently have running. For
example, we offer solutions today that allow customers to
collaborate seamlessly across their Windows and Linux
environments. We also provide solutions that enable IT managers
to control Linux, NetWare and Windows systems simultaneously,
consistently and easily.
Workspace solutions. Like our open platform
solutions, our workspace solutions category also includes
solutions that offer effective, open and cross-platform
approaches to computing, networking and collaboration. Workspace
solutions offer operating systems, network services, and
workgroup software solutions. Our workspace solutions category
is comprised of proprietary software products that provide
customers with powerful solutions that are designed to operate
within existing heterogeneous computing environments as well as
to provide tools and strategies to allow easy migration between
platforms to better fit customers’ technology plans. Our
primary server products within this category are Open Enterprise
Sever (OES) and NetWare. OES consists of several
enterprise-ready, scalable networking and collaboration
services. These include file, print, messaging, scheduling and
directory-based management modules that allow customers to
manage their global computing environment from a single, central
console deployed on either of our major operating systems
platforms. Our workspace solutions category also includes our
GroupWise®
and collaboration technologies, Novell Cluster
Servicestm,
and
BorderManager®.
Global services and support. We provide
worldwide IT consulting, training and technical support services
to address our customers’ needs. Our worldwide IT
consulting practice provides the business knowledge and
technical expertise our customers need to implement and achieve
maximum benefit from our products and solutions. We also offer
open source and identity-driven services designed to assist our
customers with fast and effective application integration or
migration of their existing platforms to Linux.
Through our training services, we offer skills assessments,
advanced technical training courses, and customized training
directly and through authorized training service partners. We
also offer testing and certification programs to systems
administrators, engineers, salespeople, and instructors on a
wide variety of technologies,
including Linux. In support of our strategy to drive increased
enterprise adoption of Linux, we offer the Novell Certified
Linux
Engineersm
and Novell Certified Linux
Professionalsm
programs.
We provide our customers with a global support structure
covering proprietary and open source technical support. We
deliver our technical support services through a variety of
channels, including
on-site
dedicated resources as well as through telephone, web,
e-mail, and
remote systems management.
Recent Developments. In the first quarter of
fiscal 2007, we modified our segments to focus on a business
unit structure, which will allow us to build upon the progress
we have made in strengthening our geographic sales and marketing
capabilities and to further increase our market responsiveness.
Four of the new business units are based on our product
categories, specifically:
•
open platform solutions;
•
systems and resource management;
•
identity and security management; and
•
workgroup.
The final business unit is general business consulting. We
believe that this modification created stronger focus on the
customer. Each business unit has targets specific to its
business in terms of revenue, profit and growth rates. We also
believe that process excellence and process consistency are
critical to the success of these units. Therefore, each has the
same basic structure and main areas of focus: engineering,
product management, and product marketing.
With the sizable growth opportunities we see within specific
areas of our previous resource management and identity and
security management business unit, we now believe a singular
focus on the major growth categories within this unit is
appropriate and will enable even greater success. Accordingly,
we created two separate business units to focus on each of these
areas. First, there is the systems and resource management
business unit, which focuses on meeting the growing
infrastructure management needs of our customers for desktops,
networks and servers. This unit includes the entire
ZENworks®
product family. Second is the identity and security management
business unit that continues to provide advanced,
identity-driven solutions to the enterprise market. This unit
includes
Sentineltm,
Identity Manager, Novell Access
Managertm,
Secure Login, Novell
eDirectorytm,
and Novell Audit.
To further refine our focus on specific growth opportunities, we
created two additional business units: open platform solutions
and workgroup. The open platform solutions business unit will
focus on the unique growth opportunity around open source
technologies. This business unit includes SUSE Linux Enterprise,
SUSE Linux Enterprise Server, SUSE Linux Enterprise Desktop, and
the other Linux-based solutions in our portfolio. The new
workgroup business unit will focus on bringing our new
technologies for collaboration to both existing and new
customers. This business unit includes Open Enterprise Server,
NetWare and NetWare-related products, GroupWise, and
BorderManager.
We believe that this new business unit structure will help us to
further improve our responsiveness to the needs of our customers
and the demands of the marketplace.
Components
of our Solutions Categories
The following is a description of the core products and services
that made up each of our information solution categories during
fiscal 2006. A solution may be offered in the form of licenses,
maintenance, stand-alone upgrade protection, or in the case of
SUSE Linux Enterprise Server, a subscription. Maintenance
includes upgrade protection, on a
when-and-if
available basis, and technical support. A subscription includes
configuration support and updates and upgrades to the
technology, on a
when-and-if
available basis. Maintenance, upgrade protection and
subscriptions typically have a one to three year contractual
term.
ZENworks management products protect the integrity of networks
by centralizing, automating, and simplifying every aspect of
network management, from distributing vital information across
the enterprise to maintaining consistent policies on desktops,
servers, and devices on Linux, NetWare, and Windows environments.
•
Identity and access management products
•
Identity Manager is a powerful data-sharing and synchronization
solution, often referred to as a
meta-directory
solution, which automatically distributes new and updated
information across every designated application and directory on
a network. This ensures that trusted customers, partners, and
suppliers are accessing consistent information, regardless of
the applications and directories to which they have access.
•
SecureLogin is a directory-integrated authentication solution
that delivers reliable, single sign-on access across
multi-platform networks, simplifying password management by
eliminating the need for users to remember more than one
password.
•
iChain®
is an identity-based security solution that controls access
across technical and organizational boundaries to applications,
the web, and network resources. iChain separates security from
individual applications and web servers, enabling single-point,
policy-based management of authentication and access privileges
throughout the Internet.
•
Sentinel automates the monitoring of IT for effectiveness
allowing users to detect and resolve threats in real-time.
Sentinel also provides documented evidence needed by some users
to comply with regulatory and industry compliance requirements.
•
Other systems, security, and identity management
•
Novell eDirectory is a full-service, platform-independent
directory that significantly simplifies the complexities of
managing users and resources in a mixed Linux, NetWare, UNIX,
and Windows environment. It is a secure, scalable, directory
service that allows organizations to centrally store and manage
information across all networks and operating systems and
leverage existing IT investments.
Open
platform solutions.
•
Linux platform products
•
SUSE Linux Enterprise Server is an enterprise-class, open source
server operating system for professional deployment in
heterogeneous IT environments of all sizes and sectors. This
operating system integrates all server services relevant in
Linux and constitutes a stable and secure platform for the
cost-efficient operation of IT environments.
•
Linux Desktop is a business desktop product that brings together
the Linux operating environment with a complete set of office
applications. Among the more significant business applications,
it includes OpenOffice (an office productivity suite),
Mozilla’s Firefox browser, and Novell
Evolutiontm,
a collaboration client for Linux.
•
Other open platform products
•
SUSE Linux, formerly SUSE Linux Professional, is an open source
product that combines a fast, secure operating system with over
1,000 open source applications. It is ideal for new Linux users
as well as technical enthusiasts, and it is available for
download at OpenSUSE.org or available through the retail channel.
Open Enterprise Server (“OES”) is a secure, highly
available suite of services that provides proven networking,
communication, collaboration and application services in an
open,
easy-to-deploy
environment. OES provides customers the choice of deploying on
either NetWare or SUSE Linux Enterprise Server and provides
common management tools, identity-based services and support
backed by Novell.
•
NetWare and NetWare-related
•
NetWare is our proprietary operating system platform that offers
secure continuous access to core network resources such as
files, printers, directories,
e-mail and
databases seamlessly across all types of networks, storage
platforms and client desktops.
•
Novell Cluster Services is a scalable, highly available Storage
Area Network resource management tool that reduces
administrative costs and complexity of delivering uninterrupted
access to information and resources.
•
Collaboration
•
GroupWise collaboration products offer traditional and mobile
users solutions for communication over intranets, extranets and
the Internet.
•
Other workspace
•
BorderManager is a suite of network services used to connect a
network securely to the Internet or any other network, allowing
outside access to intranets and user access to the Internet.
•
Novell
iFolder®
is a product that allows users to access, organize, and manage
computer files from any computer at any time, while ensuring the
information is safe and
up-to-date.
Global
services and support.
•
Consulting services: We provide technical
expertise to deliver world-class solutions, based on an
innovative approach focused on solving our customers’
business problems. We deliver services ranging from discovery
workshops to strategy projects to solution implementations, all
using a consistent, well-defined methodology. Our consulting
approach is based on a strong commitment to open standards,
interoperability, and the right blend of technology from Novell
and other leading vendors.
•
Technical Support: We provide phone-based,
web-based, and onsite technical support for our proprietary and
open source products through our Premium
Servicesm
program. Premium Service provides customers with the flexibility
to select the appropriate level of technical support services,
which may include stated response times,
around-the-clock
support, service account management, and dedicated resources,
such as Novell’s most experienced engineers. The Dedicated
Support Engineer, Primary Support Engineer, Advantage Support
Engineer, and Account Management programs allow customers
to build an ongoing support relationship with Novell at an
appropriate level for their needs. We have committed a
significant amount of technical support resources to the Linux
open source platform. We also offer a full array of remote
monitoring services and managed services. These services help
customers increase system uptime, leveraging our experts to
monitor and maintain the technologies our customers have
employed.
•
Technical Support Alliance
(“TSANet”): TSANet is an industry
organization that enables worldwide seamless collaborative
support for multi-vendor support issues. TSANet was originally
organized in 1993, with Novell being instrumental in the
formation and charter of the organization. Membership today
consists of more than one hundred software and hardware
companies, including industry leaders such as Dell Inc., EMC
Corporation, Hewlett-Packard Company, International Business
Machines Corporation, Microsoft Corporation, Novell, Inc., Red
Hat Inc., Sun Microsystems, Inc., Symantec Corp., and Unisys
Corporation. We are an active member of TSANet worldwide, with
representation on both the North American Board of Trustees and
the European Board of Directors.
Training Services: We accelerate the adoption
and enable the effective use of our products and solutions
through the delivery of timely and relevant instructor-led and
technology-based training courses, assessments and performance
consulting services.
Programs are delivered directly to customers and through our
global channel of authorized Novell training partners. Our
courses provide customers with a thorough understanding of the
implementation, configuration, and administration of our
products and solutions. Additionally, we offer performance
consulting services that provide clients and partners with an
evaluation of their proficiencies and their knowledge gaps. We
also deliver Advanced Technical Training at an engineer level to
customers and partners on a global basis. Our key certification
programs include the following:
•
Certified Novell
Engineersm(“CNE®”)
Program: Through the long-standing CNE program,
we are strengthening the networking industry’s self-support
capability. CNE certificate holders are individuals who have
received in-depth training and information and passed a
comprehensive test validating their ability to proficiently
administer both Novell and other networks.
•
Certified Linux Professional (“CLP”)
Program: The CLP program represents the
cornerstone of our commitment to providing training and
certification options for our clients and partners who require
credentials and validation of competency on our SUSE Linux
Enterprise Server platform.
•
Certified Linux Engineer (“CLE”)
Program: The CLE program represents the IT
industry’s most advanced Linux engineering certification.
Our Practicum testing technology allows us to validate a student
or IT professional’s competencies versus the classic IT
certification approach of testing book knowledge.
Strategy
We offer customers enterprise infrastructure software in a
flexible combination of open source, mixed source and
proprietary technologies. We also offer a full range of
high-quality services to ensure customer success in their
deployments of our solutions. Our strategy is to offer customers
a compelling open source computing platform, along with
integrated systems, security, and identity solutions, and
workspace products. By offering these technologies and services,
and showing customers how they can easily manage both our
platform and the other heterogeneous components of their IT
infrastructures, we will help them drive increased IT
effectiveness while lowering cost, complexity and risk. Deployed
either directly or through our global network of partners,
Novell solutions enable customers to spend more of their time,
energy and resources focused on driving their own businesses
forward.
Our strategy is to create products that enable our customers to
secure, manage, simplify, and integrate their heterogeneous IT
environments at low cost, while ensuring the products are easy
to implement, deploy and maintain. A key component of our
strategy is to ensure that key Novell product functions work on
the Linux platform. We pursue our strategy through five key
areas as follows:
Product
Strategy
Our overall products and services strategy is two-fold. First,
we offer products and services that will help to broaden and
accelerate enterprise adoption of Linux in general, and SUSE
Linux Enterprise in particular. We plan to leverage this
broadening base of Linux implementations as a foundation upon
which we will sell our enterprise infrastructure software
offerings, which is the second part of our strategy.
A key enabling element of this strategy is for us to continue to
deliver innovative, open source and open standards-based
products that are easy to deploy, simple to operate, and highly
reliable and scalable. By doing so, we will empower IT
executives to create more robust computing environments at a
lower cost of operation.
With regard to Linux adoption, we plan to continue our strong
support of the open source development community, and of the
many open source organizations and projects to which we
presently contribute. We also plan to continue to use our
significant engineering and support resources to encourage
customers to adopt Linux. One way we can accomplish this is to
develop and sell key product functions that operate on the Linux
platform.
To support the second part of our two-fold strategy —
driving sales of enterprise infrastructure software —
our plan is to continue developing and delivering role-based,
policy-driven identity management solutions (based on a set of
processes that control access to applications based on a
pre-determined set or rules). Our design approach involves
creation of sets of open standards-based, discrete software
products that are easy for customers to implement and that
quickly deliver value — without further dependence on
proprietary software. We use our enterprise infrastructure
software as a basis for establishing and maintaining long-term
strategic relationships with key customers.
Professional
Services Strategy
Our professional services strategy is to focus our IT consulting
and training expertise on identity-driven solutions and open
source software adoption, and to provide a full range of support
services for all our proprietary, mixed source and open source
products.
Alliances
and Partnership Strategy
We partner with industry leaders in the software, hardware,
consulting, and system integration industries to bring to market
our solution offerings. We believe that a well-managed and
supported partnership portfolio is critical to our success in
today’s competitive solutions market and helps increase our
revenue and customer reach. Our business partner strategy is
based on having a single partner program with a goal of
providing consistent interactions with Novell focused on
technology enablement, certification, joint marketing, and sales
initiatives.
To ensure partner efficiency, we have developed a partner
ecosystem that combines our knowledge, services and solutions
with that of our partners’ to provide customers the ability
to adapt to, and profit from, the opportunities open source and
identity brings to businesses. We become the foundation for the
ecosystem, providing technology, programs, resources, and skills
to create solutions and ensure that customers get the
functionality and business value required to improve the bottom
line results of their businesses.
Our partners include: Microsoft, IBM, HP, Dell, Inc., Intel
Corporation, Oracle Corporation, SAP AG, Advanced Micro Devices,
Inc., Veritas, Computer Associates International, Inc., EMC, and
Adobe Systems, Inc. These partners are all members of the Novell
PartnerNet®Program and gain value through participating in different
partner tracks. Solution providers gain access to various
marketing programs that help drive sales volumes. Technology
partners receive solution developer toolkits and services that
ensure successful enablement of their technology with our
technology. Our training partners have opportunities to increase
their skill levels and provide training services to our
customers.
Multi-channel
Sales Strategy
We deliver solutions through direct and indirect channels,
serving large organizations directly or with systems integration
partners, and serving small- and medium-sized organizations
through our channel partners. We have reengaged and renewed our
business partner and channel relationships, with an emphasis on
specialization, giving us a greater presence in the marketplace
while lowering our distribution costs. To maximize our reach
while ensuring the highest quality of service to our customers,
we provide our channel partners complete access to all of our
tools, training and methodologies.
Personnel
Development Strategy
Our employees are our most significant asset. We work
continuously to update their skill sets by providing education
and training to improve our productivity. We regularly assess
our development progress and focus on key areas as appropriate.
Where appropriate, we also intend to augment our offerings and
delivery capabilities through acquisitions. Taken together, we
believe the success of these key strategies will provide lasting
benefits to our customers and stockholders alike.
We recently entered into a partnership with Microsoft. The
overarching purpose of this partnership is to increase the
utility, desirability and penetration of Linux by enabling its
interoperation with Windows to a mixed environment that is
easier to maintain. We believe that this partnership will help
us deliver value to customers by giving them greater flexibility
and effectiveness in their IT environments. The partnership
consists of three related agreements:
•
A technical collaboration agreement primarily in the areas of
virtualization, web services management, directory
interoperability, and document format compatibility;
•
A business collaboration agreement around joint sales and
marketing activities; and
•
A patent cooperation agreement.
We believe that this partnership addresses pressing,
industry-wide issues, that it puts customers’ needs first,
and that our company will benefit from it financially and
strategically.
Acquisitions
and Dispositions
We acquire companies or technology when we determine that the
related products or technology are strategic or complimentary to
our current or future product offerings, as the opportunities
arise. For example, during fiscal 2006, we acquired 100% of the
outstanding stock of
e-Security,
Inc., which provides security information, event management and
compliance software.
e-Security’s
products are now part of our identity and access management
sub-category.
During fiscal 2006, we also acquired the remaining 50% interest
in our sales and marketing joint venture in India; we acquired
some developed technology, which was integrated into our
Workspace solutions products; and we along with four other
companies, established Open Invention Network, LLC
(“OIN”), a privately held company that has and will
acquire patents to promote Linux and open source.
As we determine that parts of our business are no longer
strategic to the company as a whole, we will look for
alternatives such as divestitures or other capital structures.
For example, during fiscal 2006, we sold our shares in Celerant
consulting to a group comprised of Celerant management and
Caledonia Investments plc and we sold our Japan consulting group
to a third party as these operations were no longer strategic to
our business.
Segment
and Geographic Information
We sell our products, services, and solutions primarily to
corporations, government entities, educational institutions,
resellers and distributors both domestically and internationally.
We operate and report our financial results in three segments
based on geographic area. Prior to May 2006, we had a fourth
segment, Celerant consulting, which was divested in May 2006 and
is included in discontinued operations (see Note E to our
consolidated financial statements). Our performance is evaluated
by our Chief Executive Officer and our other chief decision
makers based on reviewing revenue and segment operating income
(loss) information for each geographic segment.
The geographic segments are:
•
Americas — includes the United States, Canada and
Latin America
•
EMEA — includes Eastern and Western Europe, Middle
East, and Africa
•
Asia Pacific — includes China, Southeast Asia,
Australia, New Zealand, Japan, and India
Prior to fiscal 2006, Latin America and Japan were separate
operating segments. All segment information has been recast to
conform to the new segment presentation.
All segments sell our software and services. These offerings are
sold in the United States directly and through original
equipment manufacturers, resellers, and distributor channels,
and internationally directly and through original equipment
manufacturers and distributors who sell to dealers and end users.
Segment disclosures and geographical information for fiscal
years 2006, 2005, and 2004 are presented in Part II,
Item 8, Note AA of the notes to the consolidated
financial statements of this report, which is incorporated by
reference into this Part I, Item 1.
Segment
Changes
Beginning in the first quarter of fiscal 2007, we will begin
operating and reporting our financial results in five new
business unit segments based on information solution categories,
rather than on geographic area. The new segments will be:
•
Open Platform Solutions, which will focus on the unique growth
opportunities around open source technologies. This business
unit includes SUSE Linux Enterprise, SUSE Linux Enterprise
Desktop, and other Linux-based solutions.
•
Systems and Resource Management, which will focus on meeting the
growing infrastructure management needs of our customers for
desktops, networks and servers. This business unit includes the
ZENworks product family.
•
Identity and Security Management, which will continue to provide
advanced, identity-driven solutions to the enterprise market.
This business unit includes Sentinel, Identity Manager, Access
Manager, Secure Login, eDirectory, and Novell Audit.
•
Workgroup, which will focus on bringing our new technologies for
collaboration to both existing and new customers. This business
unit includes Open Enterprise Server, NetWare, GroupWise and
BorderManager.
•
Business consulting, which conducts general consulting
activities and is comprised primarily of our Salmon and Swiss
consulting units.
We changed our operating and reporting structure to increase
integration and teamwork internally, to build stronger
business-focused units, and to be better equipped to address
customer needs. As our strategy continues to evolve, the way in
which management views financial information to best evaluate
performance and operating results may also change.
Product
Development
We conduct product development activities throughout the world
in order to meet the needs of our worldwide customer base. Our
commitment to deliver world-class products that manage,
simplify, secure, and accelerate business solutions means
continued investment in product development. Our major product
development sites include Provo, Utah; Waltham and Cambridge,
Massachusetts; Nuremberg, Germany; Dublin, Ireland; Bangalore,
India; and Prague, Czech Republic.
In addition to technology developed in-house, our products also
include technology developed by the open source community. Some
of our product development engineers work as a part of open
source development teams across the world. This involvement
ensures our role in leading technical advances, developing new
features and having input over timing of releases, as well as
other information related to the development of the Linux kernel
and other open source projects.
Product development expenses for the fiscal years 2006, 2005,
and 2004 are discussed in Part II, Item 7 of this
report, “Management’s Discussion and Analysis of
Financial Condition and Results of Operations,” which is
incorporated by reference into this Part I, Item 1.
Sales and
Marketing
Our sales and marketing strategy targets customers who are
looking for solutions in the following five technology areas:
data center, security and identity management, resource
management, desktop and workgroup. We sell our business
solutions via a multi-channel sales and marketing model, with
value added partners such as demand agents, vertical markets
resellers, systems integrator distributors, and OEMs who meet
our criteria, as well
as selling directly to named enterprise customers. In addition,
we conduct sales and marketing activities and provide technical
support, training, and field service to our customers from our
21 U.S. and 99 international sales offices.
Distributors. We have established a network of
independent distributors who sell our products to resellers,
dealers, VARs (value added resellers), and computer retail
outlets. As of October 31, 2006, there were
11 U.S. distributors and approximately 112
international distributors.
VARs and Systems Integrators. We also sell
directly to VARs and systems integrators who provide solutions
across multiple vertical market segments and whose volume of
purchases warrants buying directly from us.
OEMs/Independent Hardware Vendors
(“IHVs”)/Independent Software Vendors
(“ISVs”). We license subsets of
products to domestic and international OEMs/IHVs/ISVs for
integration with their products
and/or
solutions. As of October 31, 2006, we had agreements with
approximately 150 IHVs and ISVs.
End-User Customers. We have assembled
worldwide field resources to work directly with enterprise end
users. Additionally, product upgrades and software maintenance
are sold directly to end-users. Customers can also purchase
products and services under license agreements through partners
or resellers in or near their geographic locations.
Marketing Strategy. Our marketing strategy is
to clearly articulate Novell’s value proposition in the
markets we choose to serve and in doing so attract and retain
satisfied customers. To do this, we employ multiple channels of
communications to raise awareness, generate demand and provide
tools for our multi-channel field sales and services
organizations. We examine and select market opportunities that
best fit our current product portfolio and solutions strengths.
This includes researching geographic and industry markets,
determining product lifecycle maturity, and assessing
competitive strategies. Our marketing strategy is driven by a
key set of metrics that include the measurement of awareness
across geographies, specific lead generation metrics and
deliverables to support the sales process. Our marketing
strategy will be successful if we increase the market’s
adoption of our products based on clear market differentiation,
improve the win ratio of our sales force by providing quality
training and tools, and shorten the sales cycle by providing
convincing evidence of our capabilities to prospective
customers. Our target marketing audience is the CIO and other
senior IT executives responsible for key IT functions across the
enterprise.
Marketing Initiatives. Our marketing
activities are varied but tightly focused. To more closely align
our offerings with customers needs, we have developed a series
of strategic campaigns that address these customer needs and
align them with our capabilities. Specifically, our campaigns
are focused on promoting our enterprise wide “desktop to
data center” Linux platform, our Security and Systems
Management offerings used to manage mixed IT environments, and
our advanced workgroup capabilities for file, print, directory,
and advanced collaboration. Our marketing campaigns are based on
our positioning of “Software for the Open Enterprise”.
We believe this positioning best serves us in increasing our
relevance to our customers
International Revenue. In fiscal years 2006,
2005, and 2004, approximately 52%, 55%, and 53%, respectively,
of our revenue was generated from customers outside the
U.S. No foreign countries accounted for more than 10% of
revenue in fiscal year 2006 or 2004. In fiscal 2005, revenue in
the United Kingdom accounted for approximately 12% of our total
revenue based on revenue classified by location of the end-user
customers. For information regarding risk related to foreign
operations, see Part I, Item 1A, “Risk
Factors,” which information is incorporated by reference
into this Part I, Item 1.
Major
Customers
No single customer accounted for more than 10% of our revenue in
fiscal year 2006, 2005, or 2004.
Manufacturing
Suppliers
Our physical products, which consist primarily of discs and
manuals, are duplicated by outside vendors. Multiple high-volume
manufacturers are available. We do not rely on a single provider
for our raw materials, nor have we encountered problems with our
existing manufacturing suppliers.
Lead times for our products are relatively short. Consequently,
we do not believe that backlog is a reliable indicator of future
revenue or earnings. Our practice is to ship products promptly
upon the receipt of purchase orders from our customers and,
therefore, backlog is not significant.
Although we have a significant amount of deferred revenue
recorded on our consolidatated balance sheet, included in this
report, the majority of this amount relates to maintenance
contracts and subscriptions, which is recognized ratably over
the related service periods, typically one to three years, and
does not pertain to unshipped product.
Competition
The market for identity-driven computing solutions and Linux and
platform services solutions 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
segments include the following:
•
our ability to preserve our traditional customer base;
•
our ability to sell overall solutions comprised of products and
services provided by us and our partners;
•
the timing and market acceptance of new solutions developed by
us and our competitors;
•
brand and product awareness;
•
the ability of Linux and open source solutions to provide a
lower total cost of ownership;
•
the completeness of our suite of product and solutions offerings
to solve customer problems;
•
our ability to establish and maintain key strategic
relationships with distributors, resellers, independent software
vendors, and other partners; and
•
the pricing of our products and services and the pricing
strategies of our competitors.
Primary competitors of our identity-driven computing solutions
include Microsoft, IBM, Sun, Oracle, HP, Altiris, Inc., LANDesk,
Inc., and Computer Associates. Primary competitors for our Linux
and platform services solutions include Microsoft and Red Hat.
Primary competitors of our global services and support group
include IBM, Accenture, HP, Computer Services Corporation
(“CSC”) and Capgemini Group.
One pervasive factor facing us and all companies doing business
in our industry is the presence — and
dominance — of Microsoft. However, in November 2006
Novell and Microsoft entered into a set of broad business and
technical collaboration agreements to build, market and support
a series of new solutions to make Novell and Microsoft products
work better together. The two companies also agreed to provide
each other’s customers with patent coverage for their
respective products. We will continue to be competitors of
Microsoft, but it is our goal that through this set of
agreements, Microsoft will serve as an important indirect source
of channel sales for Novell’s Linux sales.
Copyright,
Licenses, Patents, and Trademarks
We rely on copyright, patent, trade secret, and trademark law,
as well as provisions in our license, distribution, and other
agreements to protect our intellectual property rights. Our
portfolio of patents, copyrights, and trademarks as a whole is
material to our business but no individual piece of intellectual
property is critical to our business. We have been issued what
we consider to be valuable patents and have numerous other
patents pending. No assurance can be given that the pending
patents will be issued or, if issued, will provide protection
for our competitive position. Notwithstanding our efforts to
protect our intellectual property through contractual measures,
unauthorized parties may still attempt to violate our
intellectual property rights.
Our business includes a mix of proprietary offerings and
offerings based on open source technologies. With respect to
proprietary offerings, we perform the majority of our
development efforts internally, but we also acquire
and license technologies from third parties. No one license is
critical to our business. Our open source offerings are
primarily comprised of open source components developed by
independent third parties over whom we exercise no control. The
collective licenses to those open source technologies are
critical to our business. If we are unable to maintain licenses
to these third party open source materials, our distribution of
relevant offerings may be delayed until we are able to develop,
license, or acquire replacement technologies. Such a delay could
have a material adverse impact on our business.
In November 2005, Open Invention Network LLC (“OIN”)
was established by us, IBM, Philips, Red Hat and Sony. OIN is a
privately held company that has and will acquire patents to
promote Linux and open source by offering its patents on a
royalty-free basis to any company, institution or individual
that agrees not to assert its patents against the Linux
operating system or certain Linux-related applications. In
addition, OIN, in its discretion, will enforce its patents to
the extent it believes such action will serve to further protect
and promote Linux and open source. In fiscal 2007, NEC
became an investor in OIN, with the same rights, privileges and
obligations as the original investors.
The software industry is characterized by frequent litigation
regarding patent, copyright and other intellectual property
rights and trends suggest that this may increase. From time to
time, we have had infringement claims asserted by third parties
against us and our products. While there are no known pending or
threatened claims against us for which we expect to have an
unsatisfactory resolution that would have a material adverse
effect on our results of operations and financial condition,
there can be no assurance that such claims will not be asserted,
or, if asserted, will be resolved in a satisfactory manner. In
addition, there can be no assurance that third-parties will not
assert other claims against us with respect to any third-party
technology. In the event of litigation to determine the validity
of any third-party claims, such litigation could result in
significant expense to us and divert the efforts of our
technical and management personnel, whether or not such
litigation is determined in our favor.
In the event of an adverse result in any such litigation, we
could be required to expend significant resources to develop
non-infringing technology or to obtain licenses to the
technology that was the subject of the litigation. There can be
no assurance that we would be successful in such development or
that any such licenses would be available.
In addition, the laws of certain countries in which our products
are or may be developed, manufactured, or sold may not protect
our products and intellectual property rights to the same extent
as the laws of the U.S.
Seasonality
All segments of our business often experience a higher volume of
revenue at the end of each quarter and during the fourth quarter
of our fiscal year due to the spending cycles of our customers
and the negotiation patterns typical in the software industry.
Corporate
Information
Novell was incorporated in Delaware on January 25, 1983.
Our headquarters and principal executive offices are located at
404 Wyman Street, Suite 500, Waltham, MA02451. Our
telephone number at that address is
(781) 464-8000.
We also have offices located in Provo, Utah, telephone number
(801) 861-7000.
Our website is www.novell.com. We conduct primary product
development activities in Provo, Utah; Waltham, Massachusetts;
Cambridge, Massachusetts; Dublin, Ireland; Nuremberg, Germany;
Bangalore, India, and Prague, Czech Republic. We also contract
out some product development activities to third-party
developers.
Our Annual Report, Securities and Exchange Commission
(“SEC”) filings, earnings announcements, and other
financial information are available on our Investor Relations
website at http://www.novell.com/ir. We make our annual,
quarterly, and current reports, including any amendments to
those reports, freely available on our website as soon as
reasonably practicable after they are filed with or furnished to
the SEC. This and other information that we file with or furnish
to the SEC is also freely available on the SEC’s website at
www.sec.gov. Mailed copies of these reports can be obtained free
of charge through our automated telephone access system at
(800) 317-3195
or by emailing Novell’s investor relations department at
irmail@novell.com. The information on
our website listed above is not and should not be considered
part of this Annual Report on
Form 10-K
and is intended to be an inactive textual reference only.
Employees
As of April 30, 2007, we had 4,549 employees. The
functional distribution of our employees was: sales and
marketing — 1,094; product development —
1,373; general and administrative — 635; and service,
consulting, training, and operations — 1,447. Of
these, 3,630 employees are in locations outside the Americas.
None of our employees are represented by a labor union, and we
consider our employee relations to be good.
Competition for personnel of the highest caliber is intense in
the software and consulting industries. To make a long-term
relationship with us rewarding, we endeavor to give our
employees challenging work, educational opportunities,
competitive wages, sales commission plans, bonuses, and
opportunities to participate financially in the success of
Novell through stock option and stock purchase plans.
Item 1A.
Risk
Factors
Matters
related to or arising out of our historical stock-based
compensation practices, including government actions, litigation
matters, NASDAQ listing and downgrades in our credit ratings,
could have a material adverse effect on the Company.
Our historical stock-based compensation practices have exposed
us to risks associated with the judgments we made historically
as well as those made as a result of our review of those
practices. Based on the findings of the review of our historical
stock-based compensation practices by the Audit Committee, we
concluded that we had utilized incorrect measurement dates for
some of the stock-based compensation awards granted during the
review period, November 1, 1996 through October 31,2006. As a result, we have recorded in our consolidated
financial statements for the fiscal year ended October 31,2006, which are included in this Annual Report on
Form 10-K,
a cumulative $19.2 million adjustment for unrecorded
stock-based compensation expense, and related income tax
effects, as a decrease to retained earnings as of
November 1, 2005, the beginning of our 2006 fiscal year, in
accordance with the guidance applicable to the initial
compliance with Staff Accounting Bulletin No. 108,
“Considering the Effects of Prior Year Misstatements when
Quantifying Misstatements in Current Year Financial
Statements” and $0.1 million of non-cash expense in
the 2006 fiscal year. We determined that the amounts of
stock-based compensation expense that should have been
recognized in each of the applicable historical periods were not
material to those periods on either a quantitative or
qualitative basis. Therefore, we did not restate our
consolidated financial statements for prior periods. While we
believe that we have made appropriate judgments regarding
materiality and in determining the correct measurement dates for
our stock-based compensation awards , the SEC and the IRS may
disagree with our judgments. If the SEC or the IRS disagrees
with our judgments, we may have to restate our financial
statements, amend prior filings with the SEC, incur additional
expenses as a result of different tax decisions, or take other
actions not currently contemplated.
As discussed in Part I, Item 3, “Legal
Proceedings,” derivative actions were filed against us and
our current and former officers and directors after we disclosed
the commencement of our Audit Committee’s review of our
historical stock-based compensation practices. The disclosure
about our historical stock-based compensation practices in this
Annual Report on
Form 10-K
may adversely affect the outcome of that litigation and may
result in the filing of additional litigation and in government
actions. No assurance can be given regarding the outcomes of
litigation or government actions relating to our historical
stock-based compensation practices. The resolution of any of
such matters may be time consuming and expensive, and may
distract management from the conduct of our business.
Furthermore, if we are subject to adverse findings in litigation
or government actions, we could be required to pay damages or
penalties or have other remedies imposed, which could harm our
business, financial condition, results of operations and cash
flows.
As a result of our Audit Committee’s review of our
historical stock-based compensation practices, we were
delinquent in filing our Quarterly Reports on
Form 10-Q
for the fiscal quarters ended July 31, 2006 and
January 31, 2007 and our Annual Report on
Form 10-K
for the fiscal year ended October 31, 2006 with the SEC.
Consequently, NASDAQ notified us that we were not in compliance
with the filing requirements for continued listing as set forth
in
Marketplace Rule 4310(c)(14) and were therefore subject to
delisting from the NASDAQ Global Select Market. As a result, we
requested and participated in a hearing with NASDAQ to determine
our listing status. NASDAQ ultimately permitted our securities
to remain listed provided that we file our delinquent periodic
reports with the SEC within a specified time frame. On
May 25, 2007, we filed our Quarterly Reports on
Form 10-Q
for the fiscal quarters ended July 31, 2006 and
January 31, 2007 and our Annual Report on
Form 10-K
for the fiscal year ended October 31, 2006 with the SEC.
However, if NASDAQ determines that we do not meet the
NASDAQ’s listing requirements, our common stock may be
delisted from the NASDAQ Global Select Market.
Furthermore, the disclosure about our historical stock-based
compensation practices in this Annual Report on
Form 10-K
and any resulting adverse effects on the Company as described
above could cause our credit ratings to be downgraded. A
significant downgrade in ratings may increase our cost of
borrowing or limit our access to capital.
We may
experience difficulties, delays or unexpected costs in
completing our cost reduction and sales growth strategic
initiatives and may not achieve the anticipated benefits of
these initiatives.
We previously announced three strategic initiatives as part of
our plan to increase profitability through revenue growth and
cost reduction. These initiatives include a major shift in our
sales strategy from direct to indirect sales; an investment in
overlapping offshore research and development teams to
eventually assume functions once handled by more expensive
environments; and a move to a shared services model for our
financial and administrative functional support in order to
reduce costs. We may not realize, in full or in part, the
anticipated benefits from one or more of these initiatives, and
other events and circumstances, such as difficulties, delays or
unexpected costs, may occur which could result in our not
realizing all or any of the anticipated benefits. If we are
unable to realize these benefits, our ability to continue to
fund our planned business activities may be adversely affected.
In addition, our plans to invest in these initiatives ahead of
future growth means that such costs will be incurred whether or
not we realize these benefits. We are also subject to the risk
of business disruption in connection with our strategic
initiatives, which could have a material adverse effect on our
business, financial condition and operating results.
Our shift
to a sales strategy more focused on indirect sales may result in
decreased or fluctuating revenue.
We have historically relied heavily on our direct sales force in
selling our products. Our ability to achieve significant revenue
growth in the future will depend in large part on our success in
establishing relationships with distributors and OEM partners.
We are currently investing, and plan to continue to invest,
significant resources to develop distribution relationships. Our
distributors also sell, or may potentially sell, products
offered by our competitors. There can be no assurance that we
will be able to retain or attract a sufficient number of
existing or future third party distribution partners or that
such partners will recommend, or continue to recommend, our
products. The inability to establish or maintain successful
relationships with distributors and OEM partners could cause our
sales to decline.
In addition, indirect channel sales involve a number of special
risks. We lack control over the delivery of our products to
end-users. Resellers and distributors may have the ability to
terminate their relationship with us on short notice. Our
indirect channel partners may not market or support our products
effectively or be able to release their products embedded with
our products in a timely manner. We may not be able to
effectively manage conflicts between our various indirect
channel and direct customers, and economic conditions or
industry demand may adversely affect indirect channel partners,
or indirect channel partners may devote greater resources to
marketing and supporting the products of other companies. As a
result, revenues derived from indirect channel partners may
fluctuate significantly in subsequent periods, which may
adversely affect our business, operating results, and financial
condition.
Increasing
our foreign research and development operations exposes us to
risks that are beyond our control and could affect our ability
to operate successfully.
In order to enhance the cost-effectiveness of our operations, we
plan to increasingly shift portions of our research and
development operations to jurisdictions with lower cost
structures than that available in the United States. The
transition of even a portion of our research and development
operations to a foreign country involves a
number of logistical and technical challenges that could result
in product development delays and operational interruptions,
which could reduce our revenues and adversely affect our
business. We may encounter complications associated with the
set-up,
migration and operation of business systems and equipment in
expanded or new facilities. This could result in delays in our
research and development efforts and otherwise disrupt our
operations. If such delays or disruptions occur, they could
damage our reputation and otherwise adversely affect our
business and results of operations.
We cannot be certain that any shifts in our operations to
offshore jurisdictions will ultimately produce the expected cost
savings. We cannot predict the extent of government support,
availability of qualified workers, future labor rates, or
monetary and economic conditions in any offshore locations where
we may operate.
The relocation of labor resources may have a negative impact on
our existing employees, which could negatively impact our
operations. In addition, we will likely be faced with
competition in these offshore markets for qualified personnel,
including skilled design and technical personnel, and we expect
this competition to increase as companies expand their
operations offshore. If the supply of such qualified personnel
becomes limited due to increased competition or otherwise, it
could increase our costs and employee turnover rates.
Our
NetWare revenue stream continues to deteriorate.
We have been selling and upgrading NetWare for many years, sales
of which have been declining. Our strategy is to offset these
declines by sales of our next generation of NetWare
enterprise-ready operating system and services, Open Enterprise
Server, or OES, which gives customers the opportunity to choose
between a NetWare operating system and a Linux operating system,
providing NetWare customers a means to migrate to Linux and open
source solutions. However, NetWare and OES combined license and
maintenance revenue of our business declined by
$49.4 million or 18% in fiscal 2006, excluding the impact
of favorable foreign exchange rates. If our strategy is
unsuccessful, our NetWare and OES revenue stream will
deteriorate faster than the growth of revenue streams from our
other products.
If our
identity-driven computing solutions and Linux and platform
services solutions do not grow at the rate we anticipate, our
growth will be negatively impacted.
Our product strategy focuses on two specific areas:
identity-driven computing solutions, and Linux and platform
services solutions with a specific emphasis on open source
platforms. We have focused on these offerings because we believe
that identity-driven solutions and open source platforms are two
of the fastest growing segments in our industry, and we believe
that they represent the best opportunity for us to profitably
grow our revenue. Our ability to achieve success with this
strategy is dependent on a number of factors including, but not
limited to, the following:
•
the growth of these markets;
•
our development of key product solutions and upgrades;
•
the acceptance of our solutions by clients, particularly
enterprise companies, large industry partners and major accounts;
•
enticing customers to upgrade from older versions of our
products to newer versions; and
•
successfully selling technical support and other Novell
solutions along with our products.
We may
not be able to successfully compete in a challenging market for
computer software and consulting services.
The industries we compete in are highly competitive. We expect
competition to continue to increase both from existing
competitors and new market entrants. Competitors of our
identity-driven computing solutions and Linux and platform
services solutions include Microsoft, IBM, Sun, HP, Altiris,
Oracle, LANDesk, and Computer Associates. Our primary competitor
in the North America Linux market is Red Hat. Competitors of our
global services and support group include IBM, Accenture, HP,
CSC and Capgemini. Many of our competitors have
greater financial, technical and marketing resources than we
have. We believe that competitive factors common to all of our
segments include:
•
the pricing of our products and services and the pricing
strategies of our competitors;
•
the timing and market acceptance of new solutions developed by
us and our competitors;
•
brand and product awareness;
•
the performance, reliability and security of our products;
•
the ability to preserve our legacy customer base;
•
our ability to establish and maintain key strategic
relationships with distributors, resellers and other
partners; and
•
our ability to attract and retain highly qualified development,
consulting and managerial personnel.
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 software industry. We have from time to time received
letters or been the subject of claims suggesting that we are
infringing upon the intellectual rights of others. In addition,
we have faced and expect to continue to face from time to time
disputes over rights and obligations concerning intellectual
property. The cost and time of defending ourselves can be
significant. 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, which could adversely affect our
operating results.
In the
event claims for indemnification are brought for intellectual
property infringement, we could incur significant expenses,
thereby adversely affecting our results of operations.
We indemnify customers against certain claims that our products
infringe upon the intellectual property rights of others.
Additionally, under our Novell Linux Indemnification Program, we
offer indemnification for copyright infringement claims made by
third parties against registered Novell customers who obtain
SUSE Linux Enterprise Server 8, SUSE Linux Enterprise
Server 9, SUSE Linux Enterprise Server 10, SUSE Linux
Enterprise Desktop 10, SUSE Linux Retail Solution, Novell
Point of Service, Novell Linux Desktop, and SUSE Linux
Enterprise Desktop, and who, after January 12, 2004,
obtained upgrade protection and a qualifying technical support
contract from us or a participating channel partner. Although
indemnification programs for proprietary software are common in
our industry, indemnification programs that cover open source
software are less so. For example, the SCO Group, Inc. has
brought claims against two end users of Linux and has threatened
to bring claims against other end users of Linux arising out of
the facts alleged in SCO’s lawsuit against IBM and in
SCO’s public statements. In the event that claims for
indemnification are brought for intellectual property
infringement, we could incur significant expense reimbursing
customers for their legal costs and, in the event those claims
are successful, for damages.
Legal
actions being taken by SCO could adversely affect our revenue
and business plan if these legal actions cause a reduction in
demand for our SUSE Linux and
Ximian®
products.
SCO filed a legal action in March 2003 against IBM alleging,
among other things, that Linux is an unauthorized derivative of
UNIX and that portions of UNIX intellectual property that SCO
alleges it owns have been included in the Linux operating system
without authorization. In addition, SCO has warned that legal
liability for the use of Linux may extend to commercial users,
has threatened such users with litigation and has sought
licensing fees from them, and more recently has filed
Linux-related suits against other parties. As discussed below,
SCO sued Novell for slander of title relating to disputes about
whether Novell or SCO owns the copyrights to UNIX, on which some
of SCO’s Linux-related claims depend. It is possible that
SCO’s actions may reduce general demand
for Linux and Linux related products and services. In this
event, demand for our Linux (or open source) products and
services could decrease, which would reduce revenue, and
otherwise adversely affect our business since we have made a
strategic decision to become active in the Linux market.
A lawsuit
filed against us by SCO could result in a substantial judgment
against us and adversely affect our revenue and business plan if
SCO is successful.
In January 2004, SCO filed suit against us in the Third Judicial
District Court of Salt Lake County, State of Utah. We removed
the claim to the U.S. District Court, District of Utah.
SCO’s original complaint alleged that our public statements
and filings regarding the ownership of the copyrights in UNIX
and UnixWare have harmed SCO’s business reputation and
affected its efforts to protect its ownership interest in UNIX
and UnixWare. The District Court dismissed the original
complaint, but allowed SCO an opportunity to file an amended
complaint, which SCO did in July 2004. As with the original
complaint, SCO is again seeking to require us to assign all
copyrights that we have registered in UNIX and UnixWare to SCO,
to prevent us from representing that we have any ownership
interest in the UNIX and UnixWare copyrights, to require us to
withdraw all representations we have made regarding our
ownership of the UNIX and UnixWare copyrights, and to pay
actual, special and punitive damages in an amount to be proven
at trial. Our revenue and business plan could be adversely
affected if SCO is ultimately successful.
If the
Free Software Foundation releases a new version of the GNU
General Public License with certain currently proposed terms,
our business may suffer harm.
The GNU General Public License, or GPL, is an open source
license that governs significant amounts of code used on a
royalty-free basis in Linux distributions such as SUSE Linux.
The Free Software Foundation, or FSF, owns the copyright to the
GPL as well as software licensed under the GPL that is generally
considered integral to Linux distributions. In January 2006, the
FSF released a draft of a new version of the GPL known as
“GPLv3,” which it intends to use for future software
releases once it is finalized. The FSF is currently seeking
comment on GPLv3, and a final version is expected by July 2007.
Once issued, open source developers and IT vendors may elect to
provide software under GPLv3, though software made available
under earlier GPL versions will remain available under those
earlier versions.
On November 2, 2006, we announced a new relationship with
Microsoft. Among other things, Microsoft agreed to make
covenants with our customers not to assert its patents against
them. Microsoft also purchased coupons that it can distribute to
customers who can in turn redeem them for subscriptions to SUSE
Linux Enterprise Server. The FSF criticized our deal with
Microsoft because it only provides patent protections for our
customers rather than for all licensees of GPL software, and on
March 28, 2007, the FSF released a new draft of GPLv3,
known as “Discussion Draft 3,” that includes
provisions intended to negate at least part of our Microsoft
agreement.
Discussion Draft 3 includes a term intended to require Microsoft
to make the same patent covenants that our customers receive to
all recipients of the GPLv3 software included in our products.
It also includes a license condition intended to preclude
companies from entering into patent arrangements such as our
agreement with Microsoft by prohibiting any company that has
entered into such an arrangement from distributing GPLv3 code.
This license condition does not apply to arrangements entered
before March 28, 2007, so as currently proposed it would
not apply to our agreement with Microsoft; however, the FSF
specifically indicated that this “grandfathering”
condition is tentative and may be dropped depending on feedback
the FSF receives.
If the final version of GPLv3 contains terms or conditions that
interfere with our agreement with Microsoft or our ability to
distribute GPLv3 code, Microsoft may cease to distribute SUSE
Linux coupons in order to avoid the extension of its patent
covenants to a broader range of GPLv3 software recipients, we
may need to modify our relationship with Microsoft under less
advantageous terms than our current agreement, or we may be
restricted in our ability to include GPLv3 code in our products,
any of which could adversely affect our business and our
operating results. In such a case, we would likely explore
alternatives to remedy the conflict, but there is no assurance
that we would be successful in these efforts.
We have
experienced delays in the introduction of new products due to
various factors, resulting in lost revenue.
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, the need
to “debug” products prior to extensive distribution,
and with regard to our open-source products, our increasing
reliance on the work of third parties not employed by Novell.
Our open source offerings depend to a large extent on the
efforts of developers not employed by us for the creation and
update of open source technologies. For example, Linus Torvalds,
the original developer of the Linux kernel, and a small group of
engineers, many of whom are not employed by us, are primarily
responsible for the development and evolution of the Linux
kernel that is a key component of our Open Enterprise Server and
SUSE Linux Enterprise offerings. The timing and nature of new
releases of the Linux kernel are controlled by these third
parties. Delays in developing, completing, or shipping new or
enhanced products could result in delayed or reduced revenue for
those products and could adversely impact customer acceptance of
those offerings.
We
benefit from the open source contributions of third-party
programmers and corporations, and if they cease to make these
contributions, our product strategy could be adversely
affected.
Our open source offerings depend to a large extent on the
efforts of developers not employed by us for the creation and
update of open source technologies. Also, we and many other
corporations contribute software into the open source movement.
If key members, or a significant percentage, of this group of
developers or corporations decides to cease development of the
Linux kernel or other open source applications, we would have to
either rely on another party (or parties) to develop these
technologies, develop them ourselves or adapt our product
strategy accordingly. This could increase our development
expenses, delay our product releases and upgrades and adversely
impact customer acceptance of open source offerings.
We may
not be able to attract and retain qualified personnel because of
the intense competition for qualified personnel in the computer
and consulting industries.
Our ability to maintain our competitive technological position
depends, in large part, on our ability to attract and retain
highly qualified development, consulting, and managerial
personnel. Competition for personnel of the highest caliber is
intense in the software and consulting industries. The loss of
certain key individuals, or a significant group of key
personnel, would adversely affect our performance. The failure
to successfully hire suitable replacements in a timely manner
could have a material adverse effect on our business.
If our
relationships with other IT services organizations become
impaired, we could lose business.
We maintain relationships with IT services organizations that
recommend, design and implement solutions that include our
products for their customers’ businesses. Any of these
organizations could decide at any time to not continue to do
business with us or to not recommend our products. A change in
the willingness of these IT service organizations to do business
with us or recommend our products could result in lower revenue.
The
success of our acquisitions is dependent on our ability to
integrate personnel, operations and technology, and if we are
not successful, our revenue will not grow at the rate we
anticipate.
Achieving the benefits of acquisitions will depend in part on
the successful integration of personnel, operations and
technology. The integration of acquisitions will be subject to
risks and will require significant expenditure of time and
resources. The challenges involved in integrating acquisitions
include the following:
•
obtaining synergies from the companies’ organizations;
•
obtaining synergies from the companies’ service and product
offerings effectively and quickly;
•
bringing together marketing efforts so that the market receives
useful information about the combined companies and their
products;
coordinating sales efforts so that customers can do business
easily with the combined companies;
•
integrating product offerings, technology, back office, human
resources, accounting and financial systems;
•
assimilating employees who come from diverse corporate cultural
backgrounds into a common business culture revolving around our
solutions offerings; and
•
retaining key officers and employees who possess the necessary
skills and experience to quickly and effectively transition and
integrate the businesses.
Failure to effectively and timely complete the integration of
acquisitions could materially harm the business and operating
results of the combined companies. In addition, goodwill related
to any acquisitions could become impaired. Furthermore, we may
assume significant liabilities in connection with acquisitions
we make or become responsible for liabilities of the acquired
businesses.
Our
financial and operating results vary and may fall below
analysts’ estimates, which may cause the price of our
common stock to decline.
We currently provide estimates of our revenue and earnings per
share for the full year with updates as changes warrant. Our
operating results may fluctuate from quarter to quarter due to a
variety of factors including, but not limited to:
•
timing of orders from customers and shipments to customers;
•
impact of foreign currency exchange rates on the price of our
products in international locations;
•
inability to respond to the decline in revenue through the
distribution channel; and
•
inability to deliver solutions as expected by our customers and
systems integration partners.
In addition, we often experience a higher volume of revenue at
the end of each quarter and during the fourth quarter of our
fiscal year. 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.
Due to these factors or other unanticipated events,
quarter-to-quarter
comparisons of our operating results may not be reliable
indicators of our future performance. In addition, from time to
time our quarterly financial results may fall below the
expectations of the securities and industry analysts who publish
reports on our company, or of investors generally. This could
cause the market price of our securities to decline, perhaps
significantly.
We face
increased risks in conducting a global business.
We are a global corporation with subsidiaries, offices and
employees around the world and, as such, we face risks in doing
business abroad that we do not face domestically. Certain risks
inherent in transacting business internationally could
negatively impact our operating results, including:
•
costs and difficulties in staffing and managing international
operations;
•
unexpected changes in regulatory requirements;
•
tariffs and other trade barriers;
•
difficulties in enforcing contractual and intellectual property
rights;
•
longer payment cycles;
•
local political and economic conditions;
•
potentially adverse tax consequences, including restrictions on
repatriating earnings and the threat of “double
taxation”; and
•
fluctuations in currency exchange rates, which can affect demand
and increase our costs.
We may
not be able to protect our confidential information, and this
could adversely affect our business.
We generally enter into contractual relationships with our
employees to protect our confidential information. The
misappropriation of our trade secrets or other proprietary
information could seriously harm our business. 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.
Our
consulting services contracts contain pricing risks and, if our
estimates prove inaccurate, we could lose money.
Our IT consulting business derives a portion of its revenue 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 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.
Our IT
consulting clients may 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
our IT 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, 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 professional services employees,
causing significant reductions in operating results for a
particular quarter.
Conversion
of our Debentures into shares of our common stock will dilute
the ownership interests of existing stockholders.
The conversion of some or all of our $600 million aggregate
principal amount of senior convertible debentures due 2024, (the
“Debentures”, into shares of common stock will dilute
the ownership interest of existing common stockholders. Any
large volume sales in the public market of the common stock
issued upon such conversion could adversely affect prevailing
market prices of our common stock. In addition, the existence of
the Debentures may encourage short selling by market
participants because the conversion of the Debentures could
depress the price of our common stock.
Item 1B.
Unresolved
Staff Comments
None.
Item 2.
Properties
In the U.S., we own approximately 887,000 (and occupy
approximately 831,000) square feet of office space on
46 acres in Provo, Utah. We use that space for
administrative offices and product development center. We also
occupy 85,000 square feet of warehouse space in and around
Provo for operational support. We lease 105,000 square feet
of office space in Waltham, Massachusetts, and occupy
96,000 square feet as our corporate headquarters and
principal executive offices. This facility is also used for
product development. We lease a 177,000 square-foot office
building in Cambridge, Massachusetts, of which we occupy
approximately 22,000 square feet for product development
activities and sublease approximately 155,000 square feet.
We lease a 64,000 square-foot facility in Lebanon, New
Hampshire, of which 15,200 square feet is used for product
development and 48,800 square feet is subleased. In
addition, we lease offices that host sales, support
and/or
product development activity in Arkansas,
California, Florida, Georgia, Illinois, Michigan, Minnesota,
Missouri, New York, Oregon, Texas, Utah, Virginia, and
Washington.
Internationally, we own office buildings in the United Kingdom,
the Netherlands, South Africa, and Mumbai India. We use these
office buildings, which vary in size from 18,000 to
85,000 square feet, for sales, support and administrative
offices.
We lease and occupy a shared service center in Dublin Ireland of
20,000 square feet, and product development centers in
Nuremberg Germany, Prague Czech Republic and Bangalore India of
64,000 square feet, 7,500 square feet and
80,000 square feet respectively. Novell has recently
entered into an agreement to expand its total occupancy in
Bangalore India to 158,000 square feet. In addition, each
of our subsidiaries in Argentina, Australia, Austria, Belgium,
Brazil, Canada, China, Colombia, Denmark, Finland, France,
Germany, India, Israel, Italy, Japan, Malaysia, Mexico,
Netherlands, New Zealand, Norway, Portugal, Scotland, Singapore,
South Africa, Spain, Sweden, Switzerland, Taiwan, and Venezuela,
leases a small facility used as sales and support offices. We
have leased facilities in Luxembourg, Netherlands, United
Kingdom and Thailand which we no longer occupy.
The terms of the above leases vary from
month-to-month
to up to 18 years. We believe that our existing facilities
are adequate to meet our current requirements and we anticipate
that suitable additional or substitute space will be available,
as necessary, upon reasonable terms.
Item 3.
Legal
Proceedings
Between September and November of 2006, seven separate purported
derivative complaints were filed in Massachusetts state and
federal courts against us and many of our current and former
officers and directors asserting various claims related to
alleged options backdating. Novell is also named as a nominal
defendant in these complaints, although the actions are
derivative in nature and purportedly asserted on behalf of
Novell. These actions arose out of our announcement of a
voluntary review of our historical stock-based compensation
practices. The complaints essentially allege that since 1999, we
have materially understated our compensation expenses and, as a
result, overstated actual income. The five actions filed in
federal court have been consolidated, and the parties to that
action have stipulated that the defendants’ answer or
motion to dismiss will be due 45 days after the filing of
an amended complaint. The two actions filed in state court have
also been consolidated and transferred to the Business
Litigation Session of Massachusetts Suffolk County Superior
Court, and the parties to that action have stipulated that the
defendants’ answer or motion to dismiss will be due
30 days after the filing of an amended complaint. We are in
the process of evaluating these claims.
On November 12, 2004, we filed suit against Microsoft in
the U.S. District Court, District of Utah. We are seeking
treble and other damages under the Clayton Act, based on claims
that Microsoft eliminated competition in the office productivity
software market during the time that we owned the WordPerfect
word-processing application and the Quattro Pro spreadsheet
application. Among other claims, we allege that Microsoft
withheld certain critical technical information about Windows
from us, thereby impairing our ability to develop new versions
of WordPerfect and other office productivity applications, and
that Microsoft integrated certain technologies into Windows
designed to exclude WordPerfect and other Novell applications
from relevant markets. In addition, we allege that Microsoft
used its monopoly power to prevent original equipment
manufacturers from offering WordPerfect and other applications
to customers. On June 10, 2005, Microsoft’s motion to
dismiss the complaint was granted in part and denied in part. On
September 2, 2005, Microsoft sought appellate review of the
District Court’s denial of its motion. On January 31,2006, the Fourth Circuit Court of Appeals granted interlocutory
review of Microsoft’s appeal with respect to the question
of whether Novell lacked standing to assert the antitrust claims
allowed by the District Court. As a result of Microsoft’s
appeal, Novell filed a notice of appeal of the District
Court’s dismissal of Novell’s other causes of action.
Both appeals have been fully briefed and argued before the
Circuit Court; however, it is uncertain when a final decision
can be expected. 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.
On January 20, 2004, the SCO Group, Inc. (“SCO”)
filed suit against us in the Third Judicial District Court of
Salt Lake County, State of Utah. We removed the action to the
U.S. District Court, District of Utah. SCO’s original
complaint alleged that our public statements and filings
regarding the ownership of the copyrights in UNIX and UnixWare
have harmed SCO’s business reputation and affected its
efforts to protect its ownership interest in UNIX and UnixWare.
The District Court dismissed the original complaint, but allowed
SCO an opportunity to file an amended complaint, which SCO did
on July 9, 2004. On July 29, 2005, Novell filed an
answer to the amended complaint setting forth numerous
affirmative defenses and counterclaims alleging slander of title
and breach of contract, and seeking declaratory actions and
actual, special and punitive damages in an amount to be proven
at trial. On February 3, 2006, SCO filed a Second Amended
Complaint alleging that Novell has violated the non-competition
provisions of the agreement under which we sold our Unix
business to SCO, that we failed to transfer all of the Unix
business, that we infringe SCO’s copyrights, and that we
are engaging in unfair competition by attempting to deprive SCO
of the value of the Unix technology. SCO seeks to require us to
assign all copyrights that we have registered in UNIX and
UnixWare to SCO, to prevent us from representing that we have
any ownership interest in the UNIX and UnixWare copyrights, to
require us to withdraw all representations we have made
regarding our ownership of the UNIX and UnixWare copyrights, and
to cause us to pay actual, special and punitive damages in an
amount to be proven at trial. As a result of SCO’s Second
Amended Complaint, SUSE filed a demand for arbitration before
the International Court of Arbitration in Zurich, Switzerland,
pursuant to a “UnitedLinux Agreement” in which SCO and
SUSE were parties. Hearings before the International Court
Tribunal are currently set for December 2007. The issues related
to SCO’s claimed ownership of the UNIX copyrights and
Novell’s rights under the UNIX agreements with SCO are
currently scheduled for trial in the U.S. District Court,
District of Utah, for September 2007. We believe that we have
meritorious defenses to SCO’s claims and meritorious
support for our counterclaims. Accordingly, we intend to
vigorously pursue our claims while defending against the
allegations in SCO’s complaint. 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.
On July 12, 2002, Amer Jneid and other related plaintiffs
filed a complaint in the Superior Court of California, Orange
County, alleging claims for breach of contract, fraud in the
inducement, misrepresentation, infliction of emotional distress,
rescission, slander and other claims against us in connection
with our purchase of so-called “DeFrame” technology
from the plaintiffs and two affiliated corporations (TriPole
Corporation and Novetrix), and employment agreements we entered
into with the plaintiffs in connection with the purchase. The
complaint sought unspecified damages, including “punitive
damages.” The dispute (resulting in these claims) arises
out of the plaintiffs’ assertion that we failed to properly
account for license distributions which the plaintiffs claim
would have entitled them to certain bonus payouts under the
purchase and employment agreements. After a lengthy jury trial,
the jury returned a verdict in favor of the various plaintiffs
on certain contract claims and in favor of us on the remaining
claims. The jury verdict found in favor of the plaintiffs and
against us in the amount of approximately $19 million. Our
equitable defenses are expected to be ruled on by the trial
court in late spring 2007. Depending on the outcome of such
rulings, a judgment against us may be entered at such time. In
the event a final judgment is entered by the trial court, we
intend to file various post-trial motions, including a motion
for judgment notwithstanding the verdict. If necessary, we
intend to pursue an appeal of any resulting judgment.
SilverStream, which we acquired in July 2002, 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 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 the issuers,
including SilverStream. A Consolidated Amended Complaint with
respect to all of these companies was filed in the
U.S. District Court, Southern District of New York, on
April 19, 2002. The plaintiffs are seeking monetary
damages, statutory compensation and other relief that may be
deemed appropriate by the Court. While we believe that
SilverStream and its former officers and directors have
meritorious defenses to the claims, a tentative settlement has
been reached between many of the defendants and the plaintiffs,
which contemplates a settlement of the claims, including the
ones against SilverStream and its former directors and officers.
The settlement agreement, however, has not been finally approved
by the Court. 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.
Item 4.
Submission
of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during
the fourth quarter of the fiscal year covered by this report.
Market
for Registrant’s Common Equity and Related Stockholder
Matters, and Issuer Purchases of Equity Securities
Novell’s common stock trades in the Nasdaq Global Select
Market under the symbol “NOVL.” The following chart
sets forth the high and low sales prices of our common stock
during each quarter of the last two fiscal years:
First
Second
Third
Fourth
Quarter
Quarter
Quarter
Quarter
Fiscal 2006
High
$
9.81
$
9.83
$
8.56
$
6.98
Low
$
7.17
$
7.00
$
5.73
$
5.75
Fiscal 2005
High
$
7.70
$
6.23
$
6.69
$
7.77
Low
$
5.49
$
4.94
$
5.68
$
5.80
No dividends have been declared on our common stock. We have no
current plans to pay dividends on our common stock, and intend
to retain our earnings for use in our business. We had 7,340
stockholders of record at April 30, 2007.
Issuances
of Unregistered Common Stock
Not Applicable
Repurchases
of Common Stock
On September 22, 2005, our board of directors approved a
share repurchase program for up to $200.0 million of our
common stock through September 21, 2006. On April 4,2006, our board of directors approved an amendment to the share
repurchase program increasing the limit on repurchase from
$200.0 million to $400.0 million and extending the
program through April 3, 2007. As of July 31, 2006, we
had completed the repurchase program purchasing
51.5 million shares of common stock at an average price of
$7.76 per share.
The following selected historical consolidated financial data
should be read in conjunction with “Management’s
Discussion and Analysis of Financial Condition and Results of
Operations” and our audited consolidated financial
statements and related notes to those statements included in
this report. The selected historical consolidated financial data
for the periods presented have been derived from our audited
consolidated financial statements.
Income (loss) from continuing
operations before taxes
30,856
457,951
57,931
(59,083
)
(96,699
)
Income tax expense
23,231
86,660
11,335
102,882
8,880
Income (loss) from continuing
operations
7,625
371,291
46,596
(161,965
)
(105,579
)
Income from discontinued
operations, net of taxes
11,928
5,431
10,592
61
2,458
Net income (loss) before
accounting change
19,553
376,722
57,188
(161,904
)
(103,121
)
Cumulative effect of accounting
change, net of tax(d)
(897
)
—
—
—
(143,702
)
Net income (loss)
18,656
376,722
57,188
(161,904
)
(246,823
)
Net income (loss) from continuing
operations, diluted
$
7,406
$
373,183
$
20,319
$
(161,965
)
$
(105,579
)
Net income (loss) available to
common stockholders, diluted
$
18,220
$
378,159
$
30,818
$
(161,904
)
$
(246,823
)
Net income (loss) from continuing
operations per common share, diluted
$
0.02
$
0.85
$
0.05
$
(0.44
)
$
(0.29
)
Net income (loss) per common
share, diluted
$
0.05
$
0.86
$
0.08
$
(0.44
)
$
(0.68
)
Balance sheet
Cash, cash equivalents and
short-term investments
$
1,466,287
$
1,654,904
$
1,211,467
$
751,852
$
635,858
Working capital
1,075,580
1,284,901
843,930
406,014
330,232
Total assets
2,449,723
2,761,858
2,293,358
1,569,572
1,667,266
Senior convertible debentures
600,000
600,000
600,000
—
—
Series B Preferred Stock
9,350
9,350
25,000
—
—
Total stockholders’ equity(e)
$
1,104,650
$
1,386,486
$
963,364
$
934,470
$
1,065,542
(a)
In the first quarter of fiscal 2006, we adopted FASB Statement
No. 123(R), which required us to record compensation
expenses related to stock awards. For fiscal 2006, compensation
expense totaled $35.2 million. Prior years were not
restated to include such expense.
(b)
In the first quarter of fiscal 2005, we recognized a gain of
$447.6 million on a litigation settlement with Microsoft to
settle potential anti-trust litigation.
Income (loss) from operations for all periods presented excludes
the results of Celerant, which have been classified as
discontinued operations.
(d)
In May 2006, we adopted Financial Interpretation No. 47,
“Accounting for Conditional Asset Retirement
Obligations” (“FIN 47”), which required us
to recognize the cumulative effect of initially applying
FIN 47 as a change in accounting principle. In fiscal 2002,
we adopted Statement of Financial Accounting Standards
No. 142, “Goodwill and Other Intangible Assets,”
resulting in a transitional goodwill impairment loss.
(e)
As discussed in Note C to the consolidated financial
statements contained in this report, in accordance with the
provisions of SAB 108, we decreased beginning retained
earnings at November 1, 2005 by approximately
$19.2 million, from $984.1 million to
$964.9 million with the offset to additional paid-in
capital to record a cumulative after-tax stock-based
compensation expense that should have been recognized in the
consolidated financial statements during the period 1997 through
2005. Had the stock-based compensation expense been recognized
during that period, net income would have been reduced by the
following amounts: $2.3 million in fiscal 2002,
$2.9 million in fiscal 2003, $0.7 million in fiscal
2004, and $0.2 million in fiscal 2005.
Item 7.
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
Overview
With respect to the U.S. economy, spending continues to
improve in many of the areas of information technology
(“IT”) that we target such as security, regulatory
compliance and server/function consolidation. We believe that
strategic IT security projects put on hold in previous years are
now being approved. Overall, increased IT funding is helping to
attract new Linux and identity management business, which is
still driven by an increased focus on gaining efficiencies and
lowering operating costs.
Internationally, the European area of our EMEA segment has
experienced sluggish growth. Market spending is still below our
expectations with long sales cycles and a clear focus on IT cost
savings. Consolidation of platforms and security remain high
priority items for our customers.
The economy in Asia Pacific, including Japan, is mixed as some
regions continue to struggle with core economic issues while
others are growing at or above global rates.
We continue to make progress in several of our key product areas:
•
Linux and Open Source products remain an important growth
business. Revenues from our Linux platform products increased
26% year over year in fiscal 2006. A major fiscal
2006 milestone was the delivery of SUSE Linux
Enterprise 10, the platform for the Open Enterprise. SUSE
Linux Enterprise 10 offers a complete open source platform for
the mission-critical applications that drive customers’
businesses. It includes SUSE Linux Enterprise Server and SUSE
Linux Enterprise Desktop, providing an array of enterprise-class
computing solutions that we believe is unmatched in the industry.
•
We continue to grow our positions in the systems, security and
identity management market by offering the most comprehensive
products that address customer problems in the areas of
security, compliance, risk mitigation and systems management.
Our unique role-based, policy-driven approach has been well
received, and we continue to experience strong invoicing growth
in this category and a number of large enterprise deals. In
fiscal year 2006, we introduced a number of new product releases
including Novell Identity Manager 3, Novell Secure Login 6
and Novell Access Manager 3. Our
e-Security
Sentinel product acquisition provides a comprehensive compliance
solution to integrate people, systems and processes. We expect
strong revenue and performance momentum in fiscal 2007 from our
new products.
•
We continued efforts to stabilize the decline of our revenue
from our legacy products, such as OES and NetWare and
NetWare-related products. Our legacy revenue base is an
important source of cash flow and a potential opportunity for us
to sell more products and services. With the release of our OES
product in March 2005, we have taken steps to help maintain that
installed base and address revenue declines of these products.
Nevertheless, our combined NetWare and OES business declined by
18% during fiscal 2006 compared to fiscal 2005. We continue to
work with our customers to help them migrate from NetWare and
other platforms
of our competitors to OES and SUSE Linux using tools, training
and education emphasizing the return on investment of upgrading
Linux versus proprietary platforms.
Our strategic focus is to provide enterprise-class
infrastructure software and services with a flexible combination
of open source and proprietary technologies. By implementing our
solutions, customers can reduce costs and complexity while
increasing the return on their IT investment. Unlike other
infrastructure software providers, we help customers migrate
from proprietary solutions to open source technology at a pace
that best suits them.
In support of this strategy, we have identified several key
initiatives including:
•
redesigning our sales model;
•
realigning our research and development processes; and
•
implementing changes in our administrative and support functions.
Our initiatives and their implementation involve opportunities,
risks and challenges. While these initiatives, which we will
implement in fiscal 2007, will require substantial investment,
we believe they will result in long-term profitability. The
following discusses these initiatives in further detail.
•
We intend to improve our sales model by investing in and
aligning it to address our unique markets and opportunities. We
are undertaking a major shift from direct to indirect sales
coverage and capabilities. Specifically, we are building out a
world class infrastructure for web- and tele-sales that will be
focused on our renewal activities, thus enabling our direct
sales force to focus on new customer acquisition. Additionally,
we are investing in new, dedicated sales force training and
specialization roles, which we believe will result in improved
customer conversations regarding the benefits of our products.
Finally, we are increasing our targeted set of global strategic
partners with whom we go to market with in our strategic product
categories. In November 2006, we announced that one such partner
was Microsoft.
•
We intend to restructure our research and development processes
to reduce costs and improve productivity by evaluating the
appropriate balance between on and offshore research and
development locations. As a result, we are investing in
overlapping, offshore research and development teams to
eventually assume functions once handled in more expensive
environments. Additionally, we believe our investments in an
improved product life-cycle management process will help
facilitate this activity while assuring our products are
addressing the needs of the market.
•
We plan to implement changes to our administrative and support
functions in the near future with the goal of increasing
efficiency and reducing costs. We are currently reviewing
recommendations made by an external specialty consulting firm
that we hired to study our administrative support functions and
cost structure as the first step toward implementing this
initiative.
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 uncertain at the time an accounting estimate is
made, and if different estimates that reasonably could have been
used or changes in the accounting estimate that are reasonably
likely to occur periodically could materially change the
financial statements. We consider accounting policies related to
revenue recognition and related reserves, impairment of
long-lived assets, valuation of deferred tax assets, loss
contingency accruals and share-based payments to be critical
accounting policies due to the judgments and estimation
processes involved in each.
Revenue Recognition and Related Reserves. Our
revenue is derived primarily from the sale of software licenses,
software maintenance, upgrade protection, subscriptions of SUSE
Linux Enterprise Server (“SLES”), technical support,
training, and consulting services. Our customers include:
distributors, who sell our products to resellers, dealers, and
VARs; OEMs, who integrate our products with their products or
solutions; VARs, who provide solutions across multiple vertical
market segments which usually includes services; and end users,
who may purchase our products and services directly from Novell
or from other partners or resellers. Except for our SUSE Linux
product, distributors do not order to stock and only order
products when they have an end customer order,
which they present to us. With respect to our SUSE Linux
product, distributors place orders and the product is then sold
through to end customers principally through the retail channel.
OEMs report the number of copies duplicated and sold via an
activity or royalty report. Software maintenance, upgrade
protection, technical support, and subscriptions of SLES
typically involve one to three year contract terms. Our standard
contracts offer a
90-day right
of return.
Revenue is recognized in accordance with Statement of Position
(“SOP”)
97-2,
“Software Revenue Recognition,” and Staff Accounting
Bulletin No. 104, “Revenue Recognition,” and
related interpretations. When an arrangement does not require
significant production, modification or customization of
software or does not contain services considered to be essential
to the functionality of the software, revenue is recognized when
the following four criteria are met:
•
Persuasive evidence of an arrangement exists — We
require evidence of an agreement with a customer specifying the
terms and conditions of the products or services to be delivered
typically in the form of a signed contract or statement of work
accompanied by a purchase order.
•
Delivery has occurred — For software licenses,
delivery takes place when the customer is given access to the
software programs via access to a web site or shipped medium.
For services, delivery takes place as the services are provided.
•
The fee is fixed or determinable — Fees are fixed or
determinable if they are not subject to a refund or cancellation
and do not have payment terms that exceed our standard payment
terms. Typical payment terms are net 30 days.
•
Collection is probable — We perform a credit review of
all customers with significant transactions to determine whether
a customer is creditworthy and collection is probable. Prior
Novell established credit history, credit reports, financial
statements, and bank references are used to assess
creditworthiness.
In general, revenue for transactions that do not involve
software customization or services considered essential to the
functionality of the software is recognized as follows:
•
Software license fees for our SUSE Linux product are recognized
when the product is sold through to an end customer;
•
Software license fees for sales through OEMs are recognized upon
receipt of license activity or royalty reports;
•
All other software license fees are recognized upon delivery of
the software;
•
Software maintenance, upgrade protection, technical support, and
subscriptions of SLES are recognized ratably over the contract
term; and
•
Consulting, training and other similar services are recognized
as the services are performed.
If the fee due from the customer is not fixed or determinable,
revenue is recognized as payments become due from the customer.
If collection is not considered probable, revenue is recognized
when the fee is collected. We record provisions against revenue
for estimated sales returns and allowances on product and
service-related sales in the same period as the related revenue
is recorded. We also record a provision to operating expenses
for bad debts resulting from customers’ inability to pay
for the products or services they have received. These estimates
are based on historical sales returns and bad debt expense,
analyses of credit memo data, and other known factors, such as
bankruptcy. If the historical data we use to calculate these
estimates do not accurately reflect future returns or bad debts,
adjustments to these reserves may be required that would
increase or decrease revenue or net income.
Many of our software arrangements include multiple elements.
Such elements typically include any or all of the following:
software licenses, rights to additional software products,
software maintenance, upgrade protection, technical support,
training and consulting services. For multiple-element
arrangements that do not involve significant modification or
customization of the software and do not involve services that
are considered essential to the functionality of the software,
we allocate value to each element based on its relative fair
value, if sufficient Novell-specific objective evidence of fair
value exists for each element of the arrangement.
Novell-specific
objective evidence of fair value is determined based on the
price charged when each element is sold separately. If
sufficient Novell-specific objective evidence exists for all
undelivered elements, but does not exist for the delivered
element, typically the software, then the residual method is
used to allocate value to each element. Under the residual
method, each undelivered element is allocated value based on
Novell-specific objective evidence of fair value for that
element, as described above, and the remainder of the total
arrangement fee is allocated to the delivered element, typically
the software. If sufficient Novell-specific objective evidence
does not exist for all undelivered elements and the arrangement
involves rights to unspecified additional software products, all
revenue is recognized ratably over the term of the arrangement.
If the arrangement does not involve rights to unspecified
additional software products, all revenue is initially deferred
until typically the only remaining undelivered element is
software maintenance or technical support, at which time the
entire fee is recognized ratably over the remaining maintenance
or support term.
In the case of multiple-element arrangements that involve
significant modification or customization of the software or
involve services that are considered essential to the
functionality of the software, contract accounting is applied.
When Novell-specific objective evidence exists for software
maintenance or technical support in arrangements requiring
contract accounting, the consulting and license fees are
combined and revenue is recognized on the percentage of
completion basis. The percentage of completion is generally
calculated using estimated hours incurred to date relative to
the total expected hours for the entire project. The cumulative
impact of any revision in estimates to complete or recognition
of losses on contracts is reflected in the period in which the
changes or losses become known. The maintenance or support fee
is unbundled from the other elements and revenue is recognized
ratably over the maintenance or support term. When
Novell-specific objective evidence does not exist for software
maintenance or support, then all revenue is deferred until
completion of the consulting services, at which time the entire
fee is recognized ratably over the remaining maintenance or
support period.
Consulting project contracts are either
time-and-materials
or fixed-price contracts. Revenue from
time-and-materials
contracts is recognized as the services are performed. Revenue
from fixed-price contracts is recognized based on the
proportional performance method, generally using estimated time
to complete to measure the completed effort. The cumulative
impact of any revision in estimates to complete or recognition
of losses on contracts is reflected in the period in which the
changes or losses become known. Consulting revenue includes
reimbursable expenses charged to our clients.
Long-lived Assets. Our long-lived assets
include net fixed assets, goodwill, and other intangible assets.
At October 31, 2006, our long-lived assets included
$184.1 million of net fixed assets, $424.7 million of
goodwill, and $40.4 million of identifiable intangible
assets.
We periodically review our property, plant, and equipment and
finite-lived intangible assets for impairment in accordance with
Statement of Financial Accounting Standards (“SFAS”)
No. 144, “Accounting for the Impairment or Disposal of
Long-Lived Assets” whenever events or changes in
circumstances indicate that the carrying value may not be
recoverable. Factors that could indicate an impairment include
significant underperformance of the asset as compared to
historical or projected future operating results, significant
changes in the actual or intended use of the asset, or
significant negative industry or economic trends. When we
determine that the carrying value of an asset may not be
recoverable, the related estimated future undiscounted cash
flows expected to result from the use and eventual disposition
of the asset are compared to the carrying value of the asset. If
the sum of the estimated future cash flows is less than the
carrying amount, we record an impairment charge based on the
difference between the carrying value of the asset and its fair
value, which we estimate based on discounted expected future
cash flows. 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 related
assumptions change, we may be required to record impairment
charges for these assets.
We evaluate the recoverability of goodwill and indefinite-lived
intangible assets annually as of August 1, or more
frequently if events or changes in circumstances warrant, such
as a material adverse change in the business. Goodwill is
considered to be impaired when the carrying value of a reporting
unit exceeds its estimated fair value. Indefinite-lived
intangible assets are considered impaired if their carrying
value exceeds their estimated fair value. Fair values are
estimated using a discounted cash flow methodology. In assessing
the
recoverability of our goodwill and indefinite-lived 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 requires subjective judgment at
many points throughout the analysis. Changes in reporting units
and changes to the estimates used in the analyses, including
estimated future cash flows, could cause one or more of the
reporting units or indefinite-lived intangibles to be valued
differently in future periods. Future analysis could potentially
result in a non-cash goodwill impairment charge of up to
$424.7 million, the full amount of our goodwill, depending
on the estimated value of the reporting units and the value of
the net assets attributable to those reporting units at that
time.
During the fourth quarters of fiscal 2006, 2005, and 2004, we
completed our annual goodwill impairment reviews and determined
that there was no goodwill impairment. These assessments are
made at the reporting unit level, and therefore we could be
subject to an impairment charge to goodwill if any one of our
reporting units does not perform in line with forecasts in the
future. In addition, changes in the assumptions used in the
analyses could have changed the resulting outcomes. For example,
to estimate the fair value of our reporting units at
August 1, 2006, we made estimates and judgments about
future cash flows based on our fiscal 2007 forecast and current
long-range plans used to manage the business. These long-range
estimates could change in the future depending on internal
changes in our company as well as external factors. Future
changes in estimates could possibly result in a non-cash
impairment charge that could have a material adverse impact on
our results of operations. Beginning in the first quarter of
fiscal 2007, we will begin operating and reporting our financial
results in four new business unit segments based on information
solution categories. We do not anticipate that implementation of
the change in segments will result in an impairment of our
goodwill, however, future performance of the new segments could
result in a non-cash impairment charge.
Developed technology is amortized over three years as a cost of
revenue. Patents are amortized over their estimated useful
lives, generally ten years, as a cost of revenue.
Customer/contractual relationships are amortized over one to
three years as a sales expense. Most of our trademarks/trade
names have indefinite lives and therefore are not amortized but
are reviewed for impairment at least annually. During fiscal
2006, we recorded a $1.2 million impairment charge for
certain intangible assets we acquired as a part of the Ximian
acquisition. During fiscal 2005, we recorded a $1.5 million
impairment charge for certain intangible assets we acquired as a
part of the SilverStream and SUSE acquisitions.
Deferred Tax Assets. In accordance with
applicable accounting standards, we regularly assess our ability
to realize our deferred tax assets. Assessments of the
realization of deferred tax assets require that management
consider all available evidence, both positive and negative, and
make significant judgments about many factors, including the
amount and likelihood of future taxable income. Based on all the
available evidence, we continue to believe that it is more
likely than not that our remaining U.S. net deferred tax
assets, and certain foreign deferred tax assets, are not
currently realizable. As a result, we continue to provide a full
valuation reserve on our U.S. net deferred tax assets and
certain foreign deferred tax assets.
Loss Contingency Accruals and
Restructurings. We are required to make accruals
for certain loss contingencies related to litigation and taxes.
We accrue these items in accordance with SFAS No. 5,
“Accounting for Contingencies,” which requires us to
accrue for losses we believe are probable and can be reasonably
estimated, however, the estimation of the amount to accrue
requires significant judgment. Litigation accruals require us to
make assumptions about the future outcome of each case based on
current information. Tax accruals require us to make assumptions
based on the results of tax audits, past experience and
interpretations of tax law. When our restructurings include
leased facilities, in accordance with SFAS 146,
“Accounting for Costs Associated with Exit or Disposal
Activities,” we are required to make assumptions about
future sublease income, which would offset our costs and
decrease our accrual. From time to time, we are subjected to tax
audits and must make assumptions about the outcome of the audit.
If any of the estimates or their related assumptions change in
the future, or if actual outcomes are different than our
estimates, we may be required to record additional charges or
reduce our accruals. During fiscal 2006, we recorded a
$24.0 million adjustment to increase accruals related to
loss contingencies due to changes in facts and circumstances.
During fiscal 2005, we recorded a $1.2 million adjustment
to reduce previous restructuring accruals and a
$5.3 million adjustment to increase merger liabilities
primarily due to changes in estimates we originally made
regarding future subleases. In fiscal 2004, we recorded a
$4.9 million adjustment to a
previous restructuring accrual due to changes in estimates we
originally made regarding future sublease income, a
$9.0 million reduction of our litigation accrual due to
changes in the estimated outcome of certain ongoing legal cases
and $6.0 million reduction to our income tax accrual to
reflect current estimated tax exposures.
Share-based Payments. On November 1,2005, we adopted Statement of Financial Accounting Standards
(“SFAS”) No. 123(R), “Share-Based
Payment,” which requires us to account for share-based
payment transactions using a fair value-based method and
recognize the related expense in the results of operations.
Prior to our adoption of SFAS No.123(R), as permitted by
SFAS No. 123, we accounted for share-based payments to
employees using the Accounting Principles Board Opinion
No. 25 (“APB 25”), “Accounting for
Stock Issued to Employees,” intrinsic value method and,
therefore, we generally recognized compensation expense for
restricted stock awards and did not recognize compensation cost
for employee stock options. SFAS No. 123(R) allows
companies to choose one of two transition methods: the modified
prospective transition method or the modified retrospective
transition method. We chose to use the modified prospective
transition methodology, and accordingly, we have not restated
the results of prior periods.
Under the fair value recognition provisions of
SFAS No. 123(R), share-based compensation cost is
estimated at the grant date based on the fair value of the award
and is recognized as expense over the requisite service period
of the award. The fair value of restricted stock awards is
determined by reference to the fair market value of our common
stock on the date of grant. Consistent with the valuation method
we used for disclosure-only purposes under the provisions of
SFAS No. 123, we use the Black-Scholes model to value
both service condition and performance condition option awards
under SFAS No. 123(R). For awards with market
conditions granted subsequent to our adoption of
SFAS No. 123(R), we use a lattice valuation model to
estimate fair value. For awards with only service conditions and
graded-vesting features, we recognize compensation cost on a
straight-line basis over the requisite service period. For
awards with performance or market conditions granted subsequent
to our adoption of SFAS No. 123(R), we recognize
compensation cost based on the graded-vesting method.
Determining the appropriate fair value model and related
assumptions requires judgment, including estimating stock price
volatility, forfeiture rates, and expected terms. The expected
volatility rates are estimated based on historical and implied
volatilities of our common stock. The expected term represents
the average time that options that vest are expected to be
outstanding based on the vesting provisions and our historical
exercise, cancellation and expiration patterns. We estimate
pre-vesting forfeitures when recognizing compensation expense
based on historical rates and forward-looking factors. We update
these assumptions at least on an annual basis and on an interim
basis if significant changes to the assumptions are warranted.
We issue performance-based equity awards, typically to senior
executives, which vest upon the achievement of certain financial
performance goals, including revenue and income targets.
Determining the appropriate amount to expense based on the
anticipated achievement of the stated goals requires judgment,
including forecasting future financial results. The estimate of
expense is revised periodically based on the probability of
achieving the required performance targets and adjustments are
made as appropriate. The cumulative impact of any revision is
reflected in the period of change. If the financial performance
goals are not met, the award does not vest, so no compensation
cost is recognized and any previously recognized compensation
cost is reversed.
In the past, we have issued market condition equity awards,
typically granted to senior executives, the vesting of which is
accelerated or contingent upon the price of Novell common stock
meeting specified pre-established stock price targets. For
awards granted prior to our adoption of
SFAS No. 123(R), the fair value of each market
condition award was estimated as of the grant date using the
same option valuation model used for time-based options without
regard to the market condition criteria. As a result of our
adoption of SFAS No. 123(R), compensation cost is
recognized over the estimated requisite service period and is
not reversed if the market condition target is not met. If the
pre-established stock price targets are achieved, any remaining
expense on the date the target is achieved is recognized either
immediately or, in situations where there is a remaining minimum
time vesting period, ratably over that period.
In September 2006, the SEC staff issued Staff Accounting
Bulletin No. 108, “Considering the Effects of
Prior Year Misstatements when Quantifying Misstatements in
Current Year Financial Statements”
(“SAB 108”). SAB 108 was issued in order to
eliminate the diversity of practice surrounding how public
companies quantify financial statement misstatements.
SAB 108 is effective for fiscal years ending after
November 15, 2006, but we adopted it early in fiscal 2006.
Traditionally, there have been two widely-recognized methods for
quantifying the effects of financial statement misstatements:
the “roll-over” method and the “iron
curtain” method. The roll-over method focuses primarily on
the impact of a misstatement on the income statement, including
the reversing effect of prior year misstatements, but its use
can lead to the accumulation of misstatements on the balance
sheet. The iron-curtain method, on the other hand, focuses
primarily on the effect of correcting the period-end balance
sheet with less emphasis on the reversing effects of prior year
errors on the income statement. Prior to our application of the
guidance in SAB 108, we consistently applied the roll-over
method when quantifying financial statement misstatements.
In SAB 108, the SEC staff established an approach that
requires quantification of financial statement misstatements
based on the effects of misstatements on each of the financial
statements and the related financial statement disclosures. This
model is commonly referred to as a “dual approach”
because it requires quantification of errors under both the iron
curtain and the roll-over methods.
SAB 108 permits us to initially apply its provisions to
errors that are material under the dual method but were not
previously material under our previously used method of
assessing materiality either by (i) restating prior
financial statements as if the “dual approach” had
always been applied or (ii) recording the cumulative effect
of initially applying the “dual approach” as
adjustments to the carrying values of the applicable balance
sheet accounts as of November 1, 2005 with an offsetting
adjustment recorded to the opening balance of retained earnings.
We elected to record the effects of applying SAB 108 using
the cumulative effect transition method and adjusted beginning
retained earnings for fiscal 2006 in the accompanying
consolidated financial statements for misstatements associated
with our historical stock-based compensation expense and related
income tax effects as described below. We do not consider any of
the misstatements to have a material impact on our consolidated
financial statements in any of the prior years affected under
our previous method for quantifying misstatements, the roll-over
method.
Historical
Stock-Based Compensation Practices
On May 23, 2007, we announced that we had completed our
self-initiated, voluntary review of our historical stock-based
compensation practices and determined the related accounting
impact.
The review was conducted under the direction of the Audit
Committee of our Board of Directors, who engaged the law firm of
Cahill Gordon & Reindel LLP, with whom we had no
previous relationship, as independent outside legal counsel to
assist in conducting the review. The scope of the review covered
approximately 400 grant actions (on approximately 170 grant
dates) from November 1, 1996 through September 12,2006. Within these pools of grants are more than 58,000
individual grants. In total, the review encompassed awards
relating to more than 230 million shares of common stock
granted over the ten-year period.
The Audit Committee, together with its independent outside legal
counsel, did not find any evidence of intentional wrongdoing by
any former or current Novell employees, officers or directors.
We have determined, however, that we utilized incorrect
measurement dates for some of the stock-based compensation
awards granted during the review period. The incorrect
measurement dates can be attributed primarily to the following
reasons:
Administrative Corrections — In the period of
fiscal 1997 to 2005, we corrected administrative errors
identified subsequent to the original authorization by awarding
stock options that we dated with the original authorization
date. The administrative errors included incorrect lists of
optionees, generally new hires who were inadvertently omitted
from the lists of optionees because of the delayed updating of
our personnel list, and miscalculations of the number of options
to be granted to particular employees on approved lists.
Number of Shares Approved Not Specified —
Documented authorization for certain grants, primarily in the
period from fiscal 1997 through 2000, lacked specificity for
some portion or all of the grant.
Authorization Incomplete or Received Late — For
certain grants, primarily in the period from fiscal 1997 through
2004, there is incomplete documentation to determine with
certainty when the grants were actually authorized or the
authorization was received after the stated grant date.
In light of the above findings, we and our advisors performed an
exhaustive process to uncover all information that could be used
in making a judgment as to appropriate measurement dates. We
used all available information to form conclusions as to the
most likely option granting actions that occurred and to form
conclusions as to the appropriate measurement dates.
Under APB No. 25, “Accounting for Stock Issued to
Employees,” because the exercise prices of the stock
options on the new measurement dates were, in some instances,
lower than the fair market value of the underlying stock on such
dates, we are required to record compensation expense for these
differences. As a result, stock-based compensation expense in a
cumulative after-tax amount of approximately $19.2 million
should have been reported in the consolidated financial
statements for the fiscal years ended October 31, 1997
through October 31, 2005. After considering the materiality
of the amounts of stock-based compensation and related income
tax effects that should have been recognized in each of the
applicable historic periods, including the interim periods of
fiscal 2005 and 2006, we determined that the errors were not
material to any prior period, on either a quantitative or
qualitative basis, under our previous method for quantifying
misstatements, the roll-over method. Therefore, we will not
restate our consolidated financial statements for prior periods.
In accordance with the provisions of SAB 108, we decreased
beginning retained earnings at November 1, 2005 by
approximately $19.2 million, from $984.1 million to
$964.9 million, or a reduction of two percent, with the
offset to additional paid-in capital in the consolidated balance
sheet.
The following table summarizes the effects, net of income taxes,
(on a cumulative basis prior to fiscal 2004 and in fiscal 2004
and 2005) resulting from changes in measurement dates and
the related application of the guidance applicable to the
initial compliance with SAB 108:
On April 19, 2006, we acquired 100% of the outstanding
stock of
e-Security,
Inc., a privately held company headquartered in Vienna,
Virginia.
e-Security
provides security information, event management and compliance
software.
e-Security’s
products are now part of our identity and access management
sub-category.
The purchase price was approximately $71.7 million in cash,
plus transaction costs of $1.1 million.
e-Security’s
results of operations have been included in our consolidated
financial statements beginning on the acquisition date.
Open
Invention Network, LLC
In November 2005, Open Invention Network, LLC
(“OIN”) was established by us, IBM, Philips, Red
Hat and Sony. OIN is a privately held company that has acquired
and intends to continue acquiring patents to promote Linux
and open source by offering its patents on a royalty-free basis
to any company, institution or individual that agrees not to
assert its patents against the Linux operating system or certain
Linux-related applications. In addition, OIN, in its discretion,
will enforce its patents to the extent it believes such action
will serve to further protect and promote Linux and open
source. Each party contributed capital with a fair value of
$20.0 million to OIN. We account for our 20% ownership
interest using the equity method of accounting. Our
$20.0 million contribution
consisted of patents with a fair value of $15.8 million,
including $0.3 million of prepaid acquisition costs, and
cash of $4.2 million. At the time of the contribution, the
patents had a book value of $14.4 million, including
$0.3 million of prepaid acquisition costs. The
$1.4 million difference between the fair value and book
value of the patents will be amortized to our investment in OIN
account and equity income over the remaining estimated useful
life of the patents, which is approximately nine years. Our
investment in OIN, as of October 31, 2006 of
$18.9 million is classified as other assets in the
consolidated balance sheet. In fiscal 2007, our ownership
interest in OIN decreased to approximately 17% due to the
addition of NEC, a new investor in the company.
Onward
Novell
In December 2005, we acquired the remaining 50% ownership of our
sales and marketing joint venture in India from our joint
venture partner for approximately $7.5 million in cash and
other consideration. At October 31, 2005, $7.5 million
of our cash was held in an escrow account for the acquisition
and classified as other assets in the consolidated balance
sheet. The cash was paid out of the escrow account during the
first quarter of fiscal 2006. At the time of the acquisition,
the net book value of the minority interest was
$5.3 million. The $2.0 million difference between the
net book value of the minority interest and the amount we paid
for the remaining 50% ownership was recorded as goodwill.
Tally
Systems Corp.
On April 1, 2005, we acquired a 100% interest in Tally
Systems Corp., a privately-held company headquartered in
Lebanon, New Hampshire. Tally provides automated PC hardware and
software recognition products and services used by customers to
manage hardware and software assets. These products and services
are now part of our ZENworks product line. The purchase price
was approximately $17.3 million in cash, plus transaction
costs of $0.4 million and excess facility costs of
$4.5 million recorded as an acquisition liability.
Tally’s results of operations have been included in our
statement of operations beginning on the acquisition date.
Immunix,
Inc.
On April 27, 2005, we acquired a 100% interest in Immunix,
Inc., a privately-held company headquartered in Portland,
Oregon, which provides enterprise class, host intrusion
prevention solutions for the Linux platform. This acquisition
enables us to expand security offerings on the Linux platform.
The purchase price was approximately $17.3 million in cash, plus
transaction costs of $0.4 million. Immunix’s results
of operations have been included in our statement of operations
beginning on the acquisition date.
Salmon
Ltd.
On July 19, 2004, we purchased all of the outstanding stock
of Salmon Ltd, a privately-held information technology services
and consulting firm headquartered in Watford, England, for
approximately $8.2 million in cash, plus merger and
transaction costs of $0.6 million. Salmon’s results of
operations have been included in our statement of operations
beginning on the acquisition date.
The purchase agreement provides for contingent payments of up to
an additional $10.6 million based upon the future revenue
and profitability of both Salmon and Novell in the United
Kingdom over a period of two years. Approximately
$3.2 million of contingent earnouts were recorded to
goodwill in fiscal 2005 and approximately $5.7 million in
fiscal 2006.
On March 13, 2007, we sold our shares in Salmon Ltd,
(“Salmon”) to Okam Limited, a United Kingdom Limited
Holding Company for $4.9 million, plus approximately an
additional $3.9 million contingent payment to be received
if Salmon meets certain revenue targets.
SUSE
LINUX AG
On January 12, 2004, we purchased substantially all of the
outstanding stock of SUSE LINUX AG, a privately-held company and
a leading provider of Linux-based products, for approximately
$210.0 million in cash, plus
merger and transaction costs of $9.0 million. SUSE’s
results of operations have been included in our statement of
operations beginning on the acquisition date.
Divestitures
Celerant
On May 24, 2006, we sold our shares in Celerant consulting
to a group comprised of Celerant management and Caledonia
Investments plc for $77.0 million in cash. Celerant
consulting was acquired by Novell in 2001 as part of the
Cambridge Technology Partners purchase acquisition. There are no
on-going shareholder or operational relationships between us and
Celerant consulting. The sale of Celerant consulting does not
impact our IT consulting business.
Celerant consulting is accounted for as a discontinued operation
and accordingly, its results of operations and the gain on its
sale are reported separately in a single line item in our
consolidated statement of operations. The results of
discontinued operations for fiscal years 2006, 2005, and 2004
are as follows:
On August 10, 2006, we sold our Japan consulting group
(“JCG”) to Nihon Unisys, LTD (“Unisys”) for
$4.0 million. $2.8 million of the selling price was
paid at closing and $1.2 million is contingent upon certain
key employees remaining employed by Unysis for a
12-month
period after closing. Unisys will pay $200,000 for each key
employee that is still employed by Unisys at the end of the
retention period up to $1.2 million. We recorded a loss of
$8.3 million related to the excess carrying amount of the
JCG over its fair value, of which $7.1 million was to write
off goodwill.
It is anticipated that the JCG will continue to be a key partner
for Novell with respect to subcontracting consulting services.
Likewise, the cash flows from the JCG to Novell are also
anticipated to increase as Novell plans to be a subcontractor
for the JCG. As a result of our expected continuing involvement,
the JCG has not been presented as a discontinued operation.
Results
of Operations
Revenue
We sell our products, services, and solutions primarily to
corporations, government entities, educational institutions,
resellers and distributors both domestically and
internationally. In the statement of operations, we categorize
revenue as software licenses or maintenance, subscriptions, and
services. Software license revenue includes new and upgrade
license revenue only. Maintenance, subscriptions, and services
includes SLES subscriptions, upgrade protection contracts, and
all other service revenue.
Software license revenue decreased in fiscal 2006 compared to
fiscal 2005 primarily due to the impact of a large sale in the
EMEA region in fiscal 2005, which added $21.5 million to
license revenue in fiscal 2005, and a $28.5 million
expected decline in license sales of NetWare/OES and other
workspace products. These decreases were offset somewhat by a
$9.0 million increase in sales of our identity and access
management products, which are sold under the licensing model,
and from more of our customers purchasing multiple-product,
multiple-year subscriptions, which we record as maintenance,
subscriptions, and services revenue.
Software licenses revenue decreased in fiscal 2005 compared to
fiscal 2004 primarily due to declines in license sales of
workspace products such as NetWare/OES and GroupWise. In
addition, the decrease was due to more of our customers
purchasing under multiple-product, multiple-year subscription
contracts, which we classify as maintenance, subscriptions, and
services revenue.
Maintenance, subscriptions, and services revenue decreased
during fiscal 2006 compared to fiscal 2005 primarily due to a
$21.9 million decrease in IT consulting and services
revenue that was expected as a result of the restructuring
actions taken in the fourth quarter of fiscal 2005 and a
$25.7 million decrease NetWare/OES combined maintenance
revenue, offset somewhat by increased maintenance revenue from
our systems, security and identity management products of
$18.8 million and increased subscriptions for our Linux
open platform solutions of $9.5 million. The change in the
mix of our revenue towards more maintenance and subscription
contracts has somewhat increased revenue in the maintenance,
subscriptions, and services category compared to the software
licenses category during the fiscal 2006.
Maintenance, subscriptions, and services revenue increased
during fiscal 2005 compared to fiscal 2004 due primarily to
higher IT consulting and services revenue of $28.4 million
resulting from the acquisition of Salmon and increased
consulting revenue in all geographic regions, and
$27.2 million due to higher maintenance revenue. The change
in the mix of our revenue towards more maintenance and
subscription contracts has also driven the increase in revenue
in the maintenance, subscriptions, and services category.
During fiscal 2006, we also analyzed revenue by the following
solution categories:
NetWare and other NetWare-related — major products
include NetWare and Cluster Services
•
Collaboration — major products include GroupWise
•
Other workspace — major products include BorderManager
and Novell iFolder
•
Global services and support — comprehensive IT
consulting, training, and technical support services that apply
business solutions to our customers’ business situations,
providing the business knowledge and technical expertise to help
our customers implement our technology.
Prior to fiscal 2006, Open platform solutions and Workspace
solutions were combined in a category called Linux and platform
services solutions. Prior to the third quarter of fiscal 2006,
OES was classified in open platform solutions. Beginning in the
third quarter of fiscal 2006, OES is categorized in workspace
solutions. Prior periods have been recast to conform to the new
presentation.
Systems, security and identity management increased in fiscal
2006 compared to fiscal 2005 primarily due to strong sales
growth in our identity and access management products, which
increased by 30%
year-over-year.
These increases were offset by decreases in our resource
management products due primarily to $13.4 million of
revenue recognized from a large transaction in EMEA during the
fourth quarter of fiscal 2005.
Systems, security and identity management revenue increased in
fiscal 2005 compared to fiscal 2004 due primarily to
$13.4 million of revenue recognized from a large
transaction in EMEA during the fourth quarter of fiscal 2005,
which included ZENworks and Identity Manager products. In
addition, revenue from sales of Identity Manager products
increased by approximately $11.1 million during the same
period.
Open platform solutions remained flat in fiscal 2006 compared to
fiscal 2005 as the increases in SUSE Linux Enterprise Server and
our Linux desktop product sales were offset by declines in the
SUSE Linux consumer product.
Open platform solutions revenue increased in fiscal 2005
compared to fiscal 2004 due primarily to an increase of
$16.8 million in sales of our SUSE Linux Enterprise Server
products.
Workspace solutions decreased in fiscal 2006 compared to fiscal
2005 primarily due to a decrease in our combined
NetWare-related/OES revenue and declines in our installed base,
offset somewhat by the release of OES in the middle of the
second quarter of fiscal 2005. NetWare and NetWare-related
revenue combined with OES revenue decreased $49.4 million
or 18% in fiscal 2006 compared to fiscal 2005. We expect year
over year declines for combined NetWare-related revenue and OES
revenue to continue in the same range during fiscal 2007.
Workspace solutions revenue decreased in fiscal 2005 compared to
fiscal 2004 primarily due to a decline in combined NetWare/OES
revenue of $22.6 million and decreased collaboration
revenue of $4.1 million.
Global services and support decreased in fiscal 2006 compared to
fiscal 2005 primarily due to expected decreases in IT consulting
revenue in the EMEA and Asia Pacific segments as a result of our
decision to focus on Novell product-related consulting, thereby
eliminating projects that did not focus on our products and
reducing revenue from general IT consulting projects.
Global services and support revenue increased in fiscal 2005
compared to fiscal 2004 primarily due to favorable foreign
exchange rates, the acquisition of Salmon and increased
consulting and services revenue in the Americas.
Further explanation of revenue trends by product follows in the
discussion of revenue by geographic segment.
Revenue from the Americas decreased slightly in fiscal 2006
compared to fiscal 2005 due primarily to decreased combined
NetWare/OES revenue, offset somewhat by increased revenue from
identity and access management, Linux platform, and resource
management products. We had revenue from OES for the entire year
in fiscal 2006 compared to only two and a half quarters in
fiscal 2005.
Revenue from the Americas remained flat in fiscal 2005 compared
to fiscal 2004. Revenue in fiscal 2004 included
$13.5 million of Canopy royalty revenue. Excluding the
Canopy revenue in fiscal 2004, revenue was up $15.2 million
in fiscal 2005 compared to fiscal 2004, primarily due to
increases in consulting and services revenue, Linux platform
revenue, resource management revenue, and identity and access
management product revenue. These increases were offset somewhat
by lower combined NetWare/OES revenue of $12.1 million and
lower collaboration revenue. Overall, favorable foreign currency
exchange rates increased revenue in the Americas segment by
approximately $3.1 million during fiscal 2005.
Revenue by solution category in EMEA was as follows:
Revenue from EMEA decreased in fiscal 2006 compared to fiscal
2005, primarily due to a decrease in combined NetWare/OES
revenue, IT consulting revenue, and resource management revenue.
Consulting revenue decreases were expected and primarily the
result of our planned move to focus on Novell product-related
consulting. The decreases in other open platform revenue were
also expected and were primarily the result of planned
reductions of our consumer product, SUSE Linux (formerly SUSE
Professional). The decrease in resource management revenue was
due primarily to a large transaction in EMEA during the fourth
quarter of fiscal 2005, which included ZENworks and Identity
Manager products. Overall, foreign currency exchange rates
decreased revenue in the EMEA segment by approximately
$5.5 million during fiscal 2006.
Revenue from EMEA increased in fiscal 2005 compared to fiscal
2004, primarily due to additional revenue from favorable foreign
currency rates of $12.5 million. In addition, after
adjusting for foreign currency impacts, revenue increased due to
higher resource management revenue, increased IT consulting
revenue, primarily from the acquisition of Salmon, and increased
Linux platform revenue. These increases were offset somewhat by
decreases in combined NetWare/OES revenue of $8.6 million.
Revenue in the Asia Pacific segment decreased in fiscal 2006
compared to fiscal 2005 primarily due to decreased combined
NetWare/OES revenue and a decrease in IT consulting revenue,
offset slightly from small increases in revenue from each of the
other categories.
Revenue in the Asia Pacific segment increased slightly in fiscal
2005 compared to fiscal 2004. Decreases in combined NetWare/OES,
combined, revenue of $4.7 million were offset by increases
in consulting and services revenue, higher Linux revenue, and
favorable foreign currency exchange rates of $2.0 million.
Deferred
revenue
Deferred revenue represents revenue that is expected to be
recognized in future periods. The majority of deferred revenue
relates to maintenance contracts and subscriptions and is
recognized ratably over the related service periods, typically
one to three years. The increase in deferred revenue of
$21.2 million at October 31, 2006 compared to
October 31, 2005 is primarily attributable to increased
subscription revenue and improved advanced invoicing. As more of
our revenue contracts shift to multiple-product, multiple-year
subscription arrangements, we expect that a greater proportion
of our revenue will initially be deferred and recognized over
the contractual service term as maintenance and subscription
revenue.
As a percent of maintenance,
subscriptions and services revenue
62
%
60
%
61
%
Total gross profit
$
647,192
$
687,157
$
681,976
(6
)%
1
%
As a percent of net
revenue
67
%
66
%
68
%
Gross profit from software licenses as a percentage of related
sales remained flat from fiscal 2004 through fiscal 2006. The
decrease in gross profit from software licenses for fiscal 2006
compared to fiscal 2005 is primarily due to decreased sales of
software licenses and the related shift in revenue from licenses
to subscriptions. The decrease in gross profit from software
licenses for fiscal 2005 compared to fiscal 2004 is primarily
due to decreased sales volume of software licenses.
The increase in gross profit from maintenance, subscriptions,
and services as a percentage of maintenance, subscriptions, and
services revenue for fiscal 2006 compared to fiscal 2005 was
primarily a result of the consulting headcount reductions that
took place in fiscal 2005 and a shift in the mix of revenue to
more product-related revenue compared to consulting revenue,
which carries higher costs of goods. These improvements were
offset somewhat by additional stock-based compensation expense
from the adoption of SFAS No. 123(R), which totaled
approximately $4.1 million in fiscal 2006.
The increase in gross profit from maintenance, subscriptions,
and services for fiscal 2005 compared to fiscal 2004 is
primarily due to increased sales volume in the related sales
category. The decrease in gross profit from maintenance,
subscriptions, and services as a percentage of related revenue
for fiscal 2005 compared to fiscal 2004 is primarily due to the
impact of the Canopy royalty revenue recognized in fiscal 2004,
which did not have any costs associated with it, and a shift in
the mix of revenue in this category to lower margin consulting
services revenue, increased royalty costs and increased
amortization of intangible assets associated with recent
acquisitions.
Sales and marketing expenses remained relatively flat in fiscal
2006 compared to fiscal 2005. Increased expense from the
adoption of SFAS No. 123(R), which totaled
approximately $11.5 million in fiscal 2006, higher
compensation expense, and additional sales expense related to
the acquisition of
e-Security
in the second quarter of fiscal 2006 were offset by savings from
the fiscal 2005 headcount reductions and decreased spending on
marketing-related activities. Sales and marketing headcount was
approximately 78 employees, or 7%, lower at the end of fiscal
2006 compared to the end of fiscal 2005.
Sales and marketing expenses for fiscal 2005, in total and as a
percentage of revenue, increased compared to fiscal 2004 due
primarily to increased marketing activities in the Americas and
Asia Pacific. Sales and marketing expenses were approximately
$14.2 million higher in the Americas in fiscal 2005
compared to fiscal 2004, mainly related to planned spending
increases. Sales and marketing expenses in Asia Pacific
increased primarily due to our investments in China of
approximately $2.8 million. In addition sales and marketing
increased due to inclusion of SUSE and Salmon for the full year
in fiscal 2005. Unfavorable foreign currency exchange rates
increased sales and marketing expenses by approximately
$7.3 million in fiscal 2005.
Product development expenses in fiscal 2006 decreased compared
to fiscal 2005 primarily due to planned savings as a result of
the fiscal 2005 headcount reductions, offset somewhat by
additional expense from the adoption of
SFAS No. 123(R), which totaled approximately
$8.2 million in fiscal 2006. Product development headcount
was approximately 255 employees, or 16%, lower at the end of
fiscal 2006 compared to the end of fiscal 2005.
Product development expenses in fiscal 2005 increased compared
to fiscal 2004 due primarily to the acquisitions of Tally and
Immunix, which added $2.5 million, and salary increases
granted in fiscal 2005, which
added $3.4 million. These increases were offset somewhat by
realized savings in fiscal 2005 from prior year headcount
reductions.
General and administrative expenses increased in fiscal 2006
compared to fiscal 2005 due primarily to $22.8 million of
litigation-related expenses resulting from an adjustment to a
loss contingency based on changes in facts and circumstances,
partially offset by a settlement we received from one of our
insurance companies for past legal expenses, $11.1 million
of stock-based compensation expense resulting from the adoption
of SFAS No. 123(R), $3.0 million in increased
expenses related to an internal project aimed at streamlining
administrative and support functions, $1.9 million of
additional expenses resulting from our voluntary stock option
review, and a reduction in bad debt allowances and other
accruals that reduced general and administrative expenses in
fiscal 2005. These increases were offset somewhat by headcount
reductions and lower facilities expenses. General and
administrative headcount was lower by approximately 21
employees, or 3%, at the end of fiscal 2006 compared to the end
of fiscal 2005.
General and administrative expenses increased in fiscal 2005
compared to fiscal 2004 primarily due to $10.7 million in
one-time adjustments for changes in estimates in the prior year
and salary increases granted in fiscal 2005 of approximately
$3.0 million, offset somewhat by an adjustment of bad debt
allowances and other accruals of $3.6 million during fiscal
2005.
Purchased in-process research and development
(“IPR&D”) relates to technology that was not
technologically feasible at the date of the acquisition, meaning
it had not reached the working model stage, did not contain all
of the major functions planned for the product, and was not
ready for initial customer testing. IPR&D was valued based
on discounting forecasted cash flows that will be generated
directly from the related products. The in-process research and
development does not have any alternative future use and did not
otherwise qualify for capitalization. As a result, the amount
was expensed. IPR&D in fiscal 2006 related to the
acquisition of
e-Security
in the second quarter of fiscal 2006. At the acquisition date,
e-Security
was working on the next two releases of its product called
Sentinel, one of which was released in the third calendar
quarter of 2006 and the second is expected to be released in the
first calendar half of 2007. These releases had not yet achieved
technological feasibility at the time of acquisition. Completion
of the development of the future upgrades of the Sentinel
products is dependent upon our successful integration of the
e-Security
products with Novell products and services. The in-process
research and development does not have any alternative future
use and did not otherwise qualify for capitalization. Purchased
IPR&D in fiscal 2005 related to technology purchased in the
acquisitions of Immunix and Ximian.
During fiscal 2006, we recognized a $6.0 million gain on
the sale of our two corporate aviation assets and certain
corporate real estate assets. During fiscal 2005, we recognized
a $1.6 million gain on the sale of a facility in Lindon,
Utah. During fiscal 2004, we recognized a gain of
$2.0 million on the sale of one of our facilities.
Gain on settlement of potential litigation in fiscal 2005
related to an agreement with Microsoft to settle potential
antitrust litigation related to our NetWare operating system in
exchange for $536 million in cash. On November 18,2004, we received $536 million in cash from Microsoft. The
financial terms of the NetWare settlement agreement, net of
related legal fees of $88 million, resulted in a pre-tax
gain of approximately $447.6 million in the first quarter
of fiscal 2005.
The loss on sale of Japan consulting group relates to the excess
of the carrying value of the JCG over its fair value at the time
we entered into an agreement to sell the JCG.
The executive termination benefits related to the termination of
our former Chief Executive Officer and Chief Financial Officer
by our Board of Directors during the third quarter of fiscal
2006. They received benefits pursuant to their severance
arrangements totaling $9.4 million, of which approximately
$2.7 million of the expense related to stock compensation
and $6.7 million related to severance and other benefits.
The impairments of $1.2 million related to our Ximian
trademark/trade name intangible assets that ceased being
utilized in the fourth quarter of fiscal 2006 and no longer had
any value. During fiscal 2005, we also determined that
$0.7 million of our trademarks and trade names were
impaired as they were no longer being utilized and no longer had
any value, and we also determined that certain internal use
software intangible assets with a net book value of
$0.8 million were fully impaired. The fair value of the
software was determined based on the fact that
this software, as well as a similar product from a competitor,
are now both available for free to the general public and the
related technology is not proprietary to either us or the
competitor.
Restructuring
Expenses
Fiscal
2006
During fiscal 2006, we recorded net restructuring expenses of
$4.4 million, $4.2 million of which related to
restructuring activity recognized during fiscal 2006 and
$0.2 million of which consisted of net adjustments related
to previously recorded merger liabilities and restructuring
liabilities. The adjustments to the merger liabilities have been
recorded in the statement of operations since the changes have
occurred outside the relevant purchase price allocation period.
The fiscal 2006 restructuring expenses related to efforts to
restructure our business to improve profitability. These efforts
are centered around three main initiatives: (1) improving
our sales model and sales staff specialization;
(2) integrating product development approach; and
(3) improving in our administrative and support functions.
As all three of these initiatives are in the early stages of
being implemented, further restructuring activities are
anticipated during fiscal 2007. Specific actions taken during
fiscal 2006 included reducing our workforce by 24 employees, in
sales, product development, consulting, general and
administrative, marketing and technical support, exiting a
facility and liquidating two legal entities. Total restructuring
expenses by reporting segment were as follows: EMEA
$1.7 million, Asia Pacific $1.4 million, Americas
$0.8 million, and corporate unallocated operating costs
$0.3 million.
The following table summarizes the activity during fiscal 2006
related to this restructuring:
As of October 31, 2006, the remaining unpaid balances
include accrued liabilities related to severance benefits which
will be paid out over the remaining severance obligation period,
various fees relating to the exited facility, which will be paid
out during fiscal 2007, and various fees related to the
liquidation of two legal entities, which will be paid out during
fiscal 2007.
Fiscal
2005
During fiscal 2005, we recorded net restructuring expenses of
$57.7 million, of which $53.6 million related to
restructuring activity recognized during fiscal 2005 and
$5.3 million related to adjustments to previously recorded
merger liabilities to adjust lease accruals, less a net release
of $1.2 million related to an adjustment of prior period
restructuring liabilities. The adjustments to the merger
liabilities have been recorded in the statement of operations
since the changes have occurred outside the relevant purchase
price allocation period. These restructuring expenses related to
our continuing efforts to restructure our business to improve
profitability and to focus on Linux and identity-driven
computing. Specific actions taken included reducing our
workforce by 817 employees, primarily in product development,
consulting, sales, and general and administrative, though all
areas were impacted. Total restructuring expenses for fiscal
2005 by reporting segment were as follows: EMEA
$25.7 million, corporate unallocated operating costs
$12.6 million, Americas $14.1 million, and Asia
Pacific $5.3 million.
The $1.2 million adjustments of prior period restructuring
and merger liabilities are reflected in the appropriate
restructurings. As of October 31, 2005, the remaining
unpaid balances include accrued liabilities related to severance
benefits which will be paid out over the remaining severance
obligation period, lease costs for redundant facilities which
will be paid over the respective remaining contract terms, and
various employee-related severance costs which will be primarily
paid over the next twelve months.
Fiscal
2004
During fiscal 2004, we recorded net restructuring expenses of
$19.1 million. These restructuring expenses were in
response to the evolution of our business strategy to develop a
competitive position in the Linux market. This strategy includes
plans to support the Linux operating system in addition to the
NetWare operating system, by offering our products and services
that run on Linux, NetWare and other platforms. The acquisitions
of Ximian and SUSE were direct results of the evolution in our
business strategy. These changes were made to address market
penetration for Linux and NetWare and to address NetWare revenue
declines. Specific actions taken include reducing our workforce
by 136 employees during fiscal 2004, mainly in consulting, sales
and product development in EMEA and the Americas. In addition,
we consolidated facilities, resulting in the closure of two
sales facilities and the disposal of excess equipment and tenant
improvements in the United States. Total restructuring expenses
for fiscal 2004 by reporting segment were as follows: Americas
$5.7 million, EMEA $9.4 million, Asia Pacific
$0.4 million, and non-allocated corporate costs
$3.5 million.
The following table summarizes the activity related to this
restructuring:
As of October 31, 2006, the remaining balance of the fiscal
2004 restructuring expenses included accrued liabilities related
to lease costs for redundant facilities, which will be paid over
the respective remaining contract terms.
During fiscal 2004, we also recorded a $5.9 million
restructuring expense to increase prior restructuring
liabilities by $1.0 million and prior merger-related
liabilities by $4.9 million, and we released approximately
$2.1 million of excess restructuring reserves related to
prior restructuring events. The increases were the result of
changes in estimates used when the original expenses were
recorded primarily due to changes in the real estate market in
the United Kingdom. The net impact of the fiscal 2004
restructurings and the release of the prior restructuring excess
reserves was an expense of $22.9 million in fiscal 2004.
These adjustments, which pertain to separate restructuring
events, are included in the applicable restructuring accruals.
To assess impairment on our investments, we analyze forecasted
financial performance of the investees and our estimate of the
potential for investment recovery based on the financial
performance factors. When an impairment is deemed to be
“other than temporary” we record an impairment expense.
Investment income from short-term and long-term investments
increased in fiscal 2006 compared to fiscal 2005 due to higher
interest rates, offset somewhat by lower cash balances.
Investment income from short-term and long-term investments
increased in fiscal 2005 compared to fiscal 2004 due primarily
to interest earned on the $460.0 million received from the
issuance of the Debentures in the third quarter of fiscal 2004,
after the related stock buy-back and issuance costs, and the
$447.6 million cash received from Microsoft in the first
quarter of fiscal 2005 in connection with the favorable
settlement of potential anti-trust litigation, after related
legal fees. Investment income in fiscal 2005 also included
long-term investment realized gains of $2.1 million from
the sale of long-term investments.
During the fourth quarter of fiscal 2006, we sold all of our
rights, titles, interests and obligations for 22 of our 23
Venture Capital Funds, which were classified as long-term
investments in the consolidated balance sheet. As of
October 31, 2006, the sale of all but one-half of one fund
had closed. We recorded a gain of $17.9 million in fiscal
2006 related to the sale of the funds that closed during the
fourth quarter of fiscal 2006. The remaining one-half of the one
fund that closed subsequent to fiscal 2006 resulted in an
additional gain of $3.6 million, which will be reported as
part of Novell’s fiscal 2007 first quarter results.
Interest expense and other, net decreased slightly in fiscal
2006 compared to fiscal 2005 due primarily to lower foreign
currency transaction losses.
Interest expense and other expenses, net for fiscal 2005
increased compared to fiscal 2004 due primarily to interest
expense of $6.0 million related to the issuance of the
Debentures in the third quarter of fiscal 2004. This increase
was offset somewhat by lower foreign currency transaction losses
and minority interest.
We are subject to income taxes in numerous jurisdictions and the
use of estimates is required in determining our provision for
income taxes. In addition to the income taxes provided for
continuing operations noted above, we provided income tax
expense on income from discontinued operations of
$1.0 million, $2.8 million, and $6.5 million in
fiscal years 2006, 2005, and 2004, respectively.
Due to the utilization of a significant amount of our net
operating loss carryforwards during fiscal 2005, substantially
all of the tax benefit received from the use of our remaining
net operating loss carryforwards to offset U.S. taxable
income in 2006 was credited to additional paid-in capital or
goodwill and not to income tax expense. In addition, the
windfall tax benefits associated with stock-based compensation
is also credited to additional paid-in capital. In connection
with our adoption of SFAS No. 123(R), we elected to
follow the tax ordering laws to determine the sequence in which
deductions and net operating loss carryforwards are utilized.
Accordingly, during fiscal 2006, a tax benefit relating to stock
options of $15.3 million was credited to additional paid-in
capital and a benefit of $6.6 million was credited to
goodwill.
The effective tax rate for fiscal 2006 differs from the federal
statutory rate of 35% primarily due to the effects of the
valuation allowance on our deferred tax assets, stock-based
compensation plans, non-deductible expenses, differences between
book and tax items and foreign taxes. The effective tax rate on
income from continuing operations for fiscal 2006 was 75%
compared to the effective tax rate of 19% for fiscal 2005. The
effective tax rate for fiscal 2006 is higher than the effective
tax rate for fiscal 2005 primarily because the fiscal 2005 rate
reflected a benefit recorded to income tax expense from the use
of a significant amount of our net operating loss carryforwards.
The effective tax rate for fiscal 2005 of 19% was lower than the
20% effective tax rate for fiscal 2004 primarily due to the use
of U.S. net operating loss carryforwards. We expect our
effective tax rate in 2007 to approximate 100% due to forecasted
near break even operations, our inability to recognize the tax
benefits of our deferred tax assets since the assets are subject
to a valuation allowance, and the use of net operating loss
carryforwards whose benefits are credited to additional paid-in
capital or goodwill.
In accordance with applicable accounting standards, we regularly
assess our ability to realize our deferred tax assets.
Assessments of the realization of deferred tax assets require
that management consider all available evidence, both positive
and negative, and make significant judgments about many factors,
including the amount and likelihood of future taxable income.
Based on all the available evidence, we continue to believe that
it is more likely than not that our remaining U.S. net
deferred tax assets, and certain foreign deferred tax assets,
are not currently realizable. As a result, we continue to
provide a full valuation reserve on our U.S. net deferred
tax assets and certain foreign deferred tax assets. The
valuation allowance on deferred tax assets increased by
$74.6 million in fiscal 2006 primarily due to stock based
compensation and other originating assets, new acquisitions and
changes in our deferred tax liabilities.
As of October 31, 2006, we had unrestricted U.S. net
operating loss carryforwards for federal tax purposes of
approximately $72.0 million. Substantially all of the
benefit of the use of these loss carryforwards will be recorded
as a credit to additional paid-in capital. If not utilized,
these carryforwards will expire in fiscal years 2023 through
2025. Additionally, we had $222.0 million in net operating
loss carryforwards from acquired companies that will expire in
years 2019 through 2025. These loss carryforwards from acquired
companies can be utilized to offset future taxable income, but
are subject to certain annual limitations. The benefit of the
use of these loss carryforwards will be recorded to first reduce
goodwill relating to the acquisition, second to reduce other
non-current intangible assets relating to the acquisition, and
third to reduce income tax expense. Our alternative minimum tax
net operating losses approximate our regular tax net operating
losses disclosed above. In addition, we have approximately
$160.7 million of foreign loss carryforwards, of which
$5.4 million, $2.2 million, $2.5 million,
and $10.9 million are subject to expiration in years 2007,
2008, 2009, and 2014, respectively. The remaining losses do not
expire. We have $141.4 million in capital loss
carryforwards, which, if not utilized, will expire in fiscal
years 2007 through 2011. We have foreign tax credit
carryforwards of $40.8 million that expire between 2009 and
2016, general business credit carryforwards of
$90.1 million that expire between 2010 and 2026, and
alternative minimum tax credit carryforwards of
$10.1 million that do not expire. We also have various
state net operating loss and credit carryforwards that expire in
accordance with the respective state statutes.
As of October 31, 2006, deferred tax assets of
approximately $47.0 million pertain to certain tax credits
and net operating loss carryforwards resulting from the exercise
of employee stock options. If realized, the tax benefit of these
credits and losses will be accounted for as a credit to
stockholders’ equity. Additionally, deferred tax assets of
$90.0 million relate to acquired entities. These acquired
deferred tax assets are subject to limitation under the change
of ownership rules of the Internal Revenue Code and have been
fully reserved. Approximately $63.7 million of future tax
benefit relating to these deferred tax assets will be recorded
to first reduce goodwill relating to the acquisition, second to
reduce other non-current intangible assets relating to the
acquisition, and third to reduce income tax expense.
We have permanently reinvested the earnings of several of our
foreign subsidiaries. Accordingly, we have not provided deferred
income taxes on the excess of the book basis over the tax
outside basis in the stock of these foreign subsidiaries. The
estimated unrecognized deferred income tax liability for this
difference is $0.7 million.
During fiscal 2006, we received a one-time tax benefit of
$4.2 million from the Internal Revenue Service relating to
net operating loss carrybacks made possible under the “Job
Creation and Worker Assistance Act of 2002.” We also
recorded a $2.6 million tax benefit attributable to the
favorable resolution of a tax examination at one of our foreign
subsidiaries. In 2004, we determined that the amount of reserves
related to tax exposures was less than the amount recorded in
the financial statements. As a result, we reduced the tax
reserves by $5.9 million. We continue to evaluate our tax
reserves under SFAS No. 5, “Accounting for
Contingencies,” which requires us to accrue for losses we
believe are probable and can be reasonably estimated. The amount
reflected in the consolidated balance sheet at October 31,2006 is considered adequate based on our assessment of many
factors including results of tax audits, past experience and
interpretations of tax law applied to the facts of each matter.
It is reasonably possible that our tax reserves could be
increased or decreased in the near term based on these factors.
Non-cash deemed dividend related
to beneficial conversion feature of Preferred Stock
$
—
$
—
$
(25,680
)
Preferred Stock cash dividends
$
(187
)
$
(466
)
$
(416
)
In March 23, 2004, we entered into a definitive agreement
with IBM providing for an investment of $50.0 million by
IBM in Novell. The primary terms of the investment, which were
negotiated in November 2003, entailed the purchase by IBM of
1,000 shares of our Series B Preferred Stock that are
convertible into 8 million shares of our common stock at a
price of $6.25 per common share. The shares are entitled to
a dividend of 2% per annum, payable quarterly in cash.
Because the fair value of our common stock of $9.46 per
share on March 23, 2004 was greater than the conversion
price of $6.25 per share, we recorded a one-time, non-cash
deemed dividend of $25.7 million attributable to the value
of the Series B Preferred Stock’s conversion feature.
This beneficial conversion feature had no impact on net income,
but did reduce earnings attributable to common stockholders and
thus reduced basic and diluted earnings per share by
approximately $0.07 in fiscal 2004.
On June 17, 2004, 500 shares of Series B
Preferred Stock, with a carrying value of $25.0 million,
were converted into 4.0 million shares of our common stock.
On September 21, 2005, 313 shares of Series B
Preferred Stock, with a carrying value of $15.7 million,
were converted into 2.5 million shares of our common stock.
Subsequent to the end of fiscal 2006, IBM converted all of the
remaining outstanding shares of Series B Preferred Stock
into 1.5 million shares of common stock.
Cumulative effect of a change in
accounting principle
(897
)
—
—
Net income
$
18,656
$
376,722
$
57,188
Expense from the adoption of SFAS No. 123(R) in the
first quarter of fiscal 2006 decreased income from continuing
operations by approximately $35.0 million during fiscal
2006. Net income was favorably impacted by foreign exchange rate
fluctuations in fiscal 2006 by approximately $1.3 million.
Discontinued operations relates to the sale of Celerant
consulting, discussed in the Divestitures section, above.
In March 2005, the FASB issued Interpretation No. 47,
“Accounting for Conditional Asset Retirement
Obligations” (“FIN 47”), which responded to
diversity in practice of how SFAS No. 143,
“Accounting for Asset Retirement Obligations,” was
being implemented. Specifically, FIN 47 recognized that,
when uncertainty about the timing
and/or
settlement method existed, some entities were recognizing the
fair value of asset retirement obligations (“AROs”)
prior to retirement of the asset, while others were recognizing
the fair value of the obligation only when it was probable that
the asset would be retired on a specific date or when the asset
was actually retired. FIN 47 clarified that the uncertainty
surrounding the timing and method of settlement when settlement
is conditional on a future event occurring should be reflected
in the measurement of the liability, not in the recognition of
the liability. AROs must be recognized even though uncertainty
may exist about the timing or method of settlement and therefore
a liability should be recognized when the ARO is incurred. We
adopted FIN 47 effective May 1, 2006. FIN 47
requires an entity to recognize the cumulative effect of
initially applying FIN 47 as a change in accounting
principle. Prior to the issuance of FIN 47, we accounted
for AROs when it became probable that the asset would be retired
or when the asset was actually retired. Our AROs result from
facility operating leases where we are the lessee and the lease
agreement contains a reinstatement clause, which generally
requires any leasehold improvements we make to the leased
property to be removed, at our cost, at the end of the lease.
Forward-looking
information
Fiscal 2007 will be a year of significant change for Novell. We
will make investments to facilitate changes in our business
model while sustaining our revenue momentum in our growth
businesses, such as Linux and identity management, and managing
revenue declines in our legacy workgroup businesses, such as
NetWare/OES and GroupWise.
We expect revenue for fiscal 2007 to be in a range similar to
the fiscal 2006 actual amounts, including the effect of the net
balancing payments and subscription revenue from the Microsoft
partnership (see discussion of the Microsoft partnership in
Subsequent Events, following) and the impact of dispositions
during the year. We also estimate stock-based compensation
expenses in fiscal 2007 to be approximately the same amount as
in fiscal 2006. Our annual effective tax rate for fiscal year
2007 is estimated to be 100%.
We are targeting to remove certain expenses throughout fiscal
2007 while investing for improved profitability in fiscal 2008.
We plan to invest $20 to $25 million in operating expense
to execute our model changes in fiscal 2007. Including the
impact of these overlapping expenses, in fiscal 2007 we expect
to be break even to slightly profitable on an income from
operations basis, before consideration of extraordinary items
and stock-based compensation expenses. These overlapping
expenses will be eliminated by the end of fiscal 2007. After
elimination of these expenses and realization of the run rate
savings from these investments, we are targeting a fourth
quarter fiscal 2007 exit rate operating margin of 5% to 7%,
before stock based compensation expenses. By exit rate
operating margin, we mean at the end of the fourth quarter
fiscal 2007, we expect to have an annualized expense run rate
level that, when compared to the fiscal 2007 revenue, would
result in an operating margin of 5% to 7%.
Liquidity
and Capital Resources
October 31,
October 31,
Percentage
2006
2005
Change
($ in thousands)
Cash, cash equivalents, and
short-term investments
$
1,466,287
$
1,654,904
(11
)%
Percentage of total
assets
60
%
60
%
Cash, cash equivalents, and short-term investments decreased
$188.6 million from October 31, 2005 to
October 31, 2006 primarily due to the following:
Fiscal 2006
Fiscal 2005
Fiscal 2004
(In thousands)
Cash provided by operating
activities
$
99,006
$
500,414
$
117,413
Issuance of common stock, net
$
40,131
$
22,108
$
58,162
Repurchase of common stock, 2006
retired, 2004 held in treasury
$
(400,000
)
$
—
$
(125,000
)
Expenditures for property, plant
and equipment
$
(26,668
)
$
(30,781
)
$
(26,997
)
Proceeds from sales of property,
plant and equipment
$
24,992
$
10,421
$
4,951
Proceeds from the sale of Venture
Capital fund investments
$
71,298
$
—
$
—
Proceeds from the payoff of a note
receivable
$
9,092
$
—
$
—
Proceeds from the sale of Celerant
and the Japan consulting group, net of cash divested
$
39,372
$
—
$
—
Net cash paid for acquisitions
$
(71,550
)
$
(33,829
)
$
(205,620
)
Cash paid for intangible assets
$
(1,159
)
$
(15,500
)
$
—
Cash paid for equity share of OIN
$
(4,225
)
$
—
$
—
Restricted cash for acquisition of
India joint venture
$
—
$
(7,500
)
$
—
Issuance of Debentures, net of
issuance costs
$
—
$
—
$
585,150
Issuance of Series B
Preferred Stock
$
—
$
—
$
50,000
Cash provided by operating activities in fiscal 2005 included
the receipt of $447.6 million in cash, net of legal fees,
in connection with the November 2004 Microsoft settlement.
As of October 31, 2006, we had cash, cash equivalents and
other short-term investments of $330.5 million held in
accounts outside the United States. 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 are subject to market risk.
Approximately $6.8 million of our short-term investments
are designated to fund deferred compensation payments, which are
paid out as requested by the plan participants. Our short-term
investment portfolio includes gross unrealized gains and losses
of $1.3 million and $4.8 million, respectively, as of
October 31, 2006. We monitor our investments and record
losses when a decline in the investment’s market value is
determined to be other than temporary.
Our $20.0 million, 20% ownership interest in OIN consists
of patents with a fair value of $15.8 million, including
$0.3 million of prepaid acquisition costs, and cash of
$4.2 million. At the time of the contribution, the patents
had a book value of $14.4 million, including
$0.3 million of prepaid acquisition costs. Subsequent to
year-end, our ownership interest in OIN decreased to
approximately 17% due to the addition of a new investor in the
company. According to the terms of the OIN LLC agreement, we
could be required to make future cash contributions which we
would fund with cash from operations and cash on hand.
As of October 31, 2006, we have various operating leases
related to our facilities. These leases have minimum annual
lease commitments of $27.0 million in fiscal 2007,
$23.9 million in fiscal 2008, $16.3 million in fiscal
2009, $10.3 million in fiscal 2010, $8.4 million in
fiscal 2011, and $33.1 million thereafter. Furthermore, we
have $29.3 million of minimum rentals to be received in the
future from subleases.
On July 2, 2004, we issued and sold $600 million
aggregate principal amount of our Debentures due 2024. The
Debentures pay interest at 0.50% per annum, payable
semi-annually on January 15 and July 15 of each year, commencing
January 15, 2005. Each $1,000 principal amount of the
Debentures is convertible, at the option of the holders, into
86.7905 shares of our common stock prior to July 15,2024 if (1) the price of our common stock trades above 130%
of the conversion price for a specified duration, (2) the
trading price of the Debentures is below a certain threshold,
subject to specified exceptions, (3) the Debentures have
been called for redemption, or (4) specified corporate
transactions have occurred. None of the conversion triggers were
met as of October 31, 2006. The conversion rate is subject
to certain adjustments. The conversion rate initially represents
a conversion price of $11.52 per share. Holders of the
Debentures may require us to repurchase all or a portion of
their Debentures on July 15, 2009, July 15, 2014 and
July 15, 2019, or upon the occurrence of certain events,
including a change in control. The Debentures can be redeemed by
us for cash beginning on or after July 20, 2009.
In connection with the issuance of the Debentures, we incurred
$14.9 million of issuance costs, which primarily consisted
of investment banker fees and legal and other professional fees.
These costs are included in other assets and are being amortized
as interest expense using the effective interest method over the
term from issuance through the first date that the holders can
require repurchase of the Debentures (July 15, 2009).
Amortization expense related to the issuance costs was
$3.0 million, $3.0 million, and $1.0 million for
the fiscal years ended October 31, 2006, 2005, and 2004,
respectively. In addition, interest expense was
$3.0 million, $3.0 million and $1.0 million for
the fiscal years ended October 31, 2006, 2005, and 2004,
respectively. We made cash payments of $3.0 million in
fiscal 2006 and $3.1 million in fiscal 2005, respectively.
No payments of interest were made in fiscal 2004.
Due to the voluntary review of our historical stock-based
compensation practices that was announced in August 2006 and not
completed until May 2007, we did not file our third quarter
fiscal 2006
Form 10-Q
in a timely manner. In September 2006, we received a letter from
Wells Fargo Bank, N.A., the trustee of our Debentures, which
asserted that Novell is in default under the indenture because
of the delay in filing its
Form 10-Q
for the period ended July 31, 2006. The letter stated that
the asserted default would not become an “event of
default” under the indenture if the company cured the
default within 60 days after the date of the notice. We
believe that these above-mentioned notices of default were
invalid and without merit because the indenture only requires us
to provide the trustee copies of SEC reports within 15 days
after such filings are actually made. However, in order to avoid
the expense and uncertainties of further disputing whether a
default under the indenture had occurred, we solicited consents
from the holders of the Debentures to proposed amendments to the
indenture that would give Novell until Thursday, May 31,2007 to become current in our SEC reporting obligations and a
waiver of rights to pursue remedies available under the
indenture with respect to any default caused by our not filing
SEC reports timely. On November 9, 2006, we received
consents from the holders of the Debentures, and therefore we
and the trustee entered into a first supplemental indenture
implementing the proposed amendments described in the consent
solicitation statements. Under the terms of the consent
solicitation and first supplemental indenture, we will pay an
additional 7.3% per annum, or $44.0 million, in
special interest on the Debentures from November 9, 2006
to, but excluding November 9, 2007. In accordance with
EITF 96-19,
“Debtor’s Accounting for a Modification or Exchange of
Debt Instruments”
(“EITF 96-19”),
since the change in the terms of the Debentures did not result
in substantially different cash flows, this change in terms is
accounted for as a modification, and therefore the additional
$44.0 million of special interest payments will be expensed
over the period from November 9, 2006 through July 15,2009. During the period of November 9, 2006 through
July 15, 2009, the new effective interest rate on this
debt, including the $44.0 million, will be 3.2%. The
$44.0 million will be paid as special interest payments
over three periods; the first payment of $8.1 million
occurred in January 2007. The next payment of $22.0 million
will occur in July 2007 and the final payment of
$13.9 million will occur in January 2008. In addition, we
paid approximately $1.5 million in fees to Citigroup for
work performed on the consent process.
As of October 31, 2006, we also had $9.4 million of
Series B Preferred Stock outstanding. The Series B
Preferred Stock is redeemable at our option or by the holder
only under certain change in control circumstances. In November
2006, all of the Series B Preferred Stock was converted
into 1.5 million common shares.
On September 22, 2005, our board of directors approved a
share repurchase program for up to $200.0 million of our
common stock through September 21, 2006. On April 4,2006, our board of directors approved an amendment
to the share repurchase program increasing the limit on
repurchase from $200.0 million to $400.0 million and
extending the program through April 3, 2007. As of
July 31, 2006, we had completed the share repurchase
program by purchasing 51.5 million shares at an average
cost per share of $7.76.
Interest on the Debentures assumes no conversions.
(b)
Purchase obligations represent future contracted payments under
normal take or pay arrangements entered into as a part of the
normal course of business that are not recorded as liabilities
at October 31, 2006.
(c)
During November 2006, the Series B Preferred Stock was
converted into 1.5 million common shares, which eliminated
the obligation to pay dividends beyond the conversion date.
Our principal source of liquidity continues to be cash from
operations, cash on hand, and short-term investments. At
October 31, 2006, our principal unused sources of liquidity
consisted of cash and cash equivalents of $675.8 million
and short-term investments in the amount of $790.5 million.
During fiscal 2006, we generated $99.0 million of cash flow
from operations. Our liquidity needs for the next twelve months
are principally for financing of interest payments on
Debentures, fixed assets, payments under our restructuring
plans, product development, and to maintain flexibility in a
dynamic and competitive operating environment, including
pursuing potential acquisition and investment opportunities. Our
liquidity needs beyond the next twelve months include those
mentioned previously in addition to the possible redemption of
our Debentures.
We anticipate being able to fund our current operations,
potential future acquisitions, any further integration,
restructuring or additional merger-related costs, and planned
capital expenditures for the next twelve months with existing
cash and short-term investments together with cash generated
from operations and investment income and net cash received as a
result of our agreement with Microsoft, discussed below under
Subsequent Events. We believe that borrowings under our credit
facilities or offerings of equity or debt securities are
possible for expenditures beyond the next twelve months, if the
need arises, although such offerings may not be available to us
on acceptable terms and are dependent on market conditions at
such time. 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. We also anticipate having adequate cash in fiscal
2007 for necessary capital expenditures.
Recent
Pronouncements
In June 2006, the FASB issued Interpretation No. 48,
“Accounting for Uncertainty in Income Taxes, an
Interpretation of FASB Statement No. 109,”
(“FIN 48”). FIN 48 clarifies the accounting
for uncertainty in income taxes recognized in an
enterprise’s financial statements in accordance with
SFAS No. 109, “Accounting for Income Taxes.”
FIN 48 prescribes a two-step process to determine the
amount of tax benefit to be recognized. First, the tax position
must be evaluated to determine the likelihood that it will be
sustained upon external examination. If the tax
position is deemed “more-likely-than-not” to be
sustained, the tax position is then assessed to determine the
amount of benefit to recognize in the financial statements. The
amount of the benefit that may be recognized is the largest
amount that has a greater than 50 percent likelihood of
being realized upon ultimate settlement. FIN 48 also
provides guidance on derecognition, classification, interest and
penalties, accounting in interim periods and disclosure relative
to uncertain tax positions. FIN 48 is effective for fiscal
years beginning after December 15, 2006 (Novell’s
fiscal 2008, beginning November 1, 2007). We are currently
evaluating the impact of this interpretation on our financial
position and results of operations.
In September 2006, the FASB issued SFAS No. 157,
“Fair Value Measurements,”
(“SFAS No. 157”). SFAS No. 157
defines fair value and provides enhanced guidance for using fair
value to measure assets and liabilities. It also expands the
amount of disclosure about the use of fair value to measure
assets and liabilities. The standard applies whenever other
standards require assets or liabilities to be measured at fair
value but does not expand the use of fair value to any new
circumstances. SFAS No. 157 is effective beginning the
first fiscal year that begins after November 15, 2007
(Novell’s fiscal 2009). We are currently evaluating the
impact of SFAS No. 157 on our financial position and
results of operations.
In September 2006, the FASB issued SFAS No. 158,
“Employers’ Accounting for Defined Benefit Pension and
Other Post retirement Plans, an amendment of SFAS Nos. 87,
88, 106, and 132(R),” (“SFAS No. 158”).
This statement requires an employer to recognize in its balance
sheet the over-funded or under-funded status of a defined
benefit post retirement plan measured as the difference between
the fair value of plan assets and the present value of the
benefit obligation. The recognition of the net liability or
asset will require an offsetting adjustment to accumulated other
comprehensive income in shareholders’ equity.
SFAS No. 158 does not change how post-retirement
benefits are accounted for and reported in the income statement.
SFAS No. 158 is effective for fiscal years ending
after December 15, 2006 (Novell’s fiscal 2007). We do
not expect the adoption of SFAS No. 158 to have a
material impact on our comprehensive income and we do not
anticipate a material adjustment to our statement of financial
position as a result of adopting SFAS No. 158.
In February 2007, the FASB issued SFAS No. 159,
“The Fair Value Option for Financial Assets and Financial
Liabilities,” (“SFAS No. 159”).
SFAS 159 establishes presentation and disclosure
requirements designed to facilitate comparisons between
companies that choose different measurement attributes for
similar types of assets and liabilities. Previously, accounting
rules required different measurement attributes for different
assets and liabilities that created artificial volatility in
earnings. SFAS No. 159 helps to mitigate this type of
accounting-induced volatility by enabling companies to report
related assets and liabilities at fair value, which would likely
reduce the need for companies to comply with detailed rules for
hedge accounting. SFAS No. 159 is effective as of the
beginning of an entity’s first fiscal year beginning after
November 15, 2007 (Novell’s fiscal 2009), though early
adoption is permitted. We are currently evaluating the impact of
this pronouncement on our financial position and results of
operations.
In March 2007, the Emerging Issues Task Force (“EITF”)
reached a consensus on issue number
06-10,
“Accounting for Deferred Compensation and Postretirement
Benefit Aspects of Collateral Assignment Split-Dollar Life
Insurance Arrangements,” (“EITF
06-10”).
EITF 06-10
provides guidance to help companies determine whether a
liability for the postretirement benefit associated with a
collateral assignment split-dollar life insurance arrangement
should be recorded in accordance with either
SFAS No. 106, “Employers’ Accounting for
Postretirement Benefits Other Than Pensions” (if, in
substance, a postretirement benefit plan exists), or Accounting
Principles Board Opinion No. 12. (if the arrangement is, in
substance, an individual deferred compensation contract). EITF
06-10 also
provides guidance on how a company should recognize and measure
the asset in a collateral assignment split-dollar life insurance
contract. EITF
06-10 is
effective for fiscal years beginning after December 15,2007 (Novell’s fiscal 2008), though early adoption is
permitted. We are currently evaluating the impact of this
pronouncement on our financial position and results of
operations.
In November 2006, we closed the sale of the remaining one-half
of one of our venture capital funds, resulting in a gain in the
first quarter of fiscal 2007 of $3.6 million on proceeds of
$5.0 million.
Conversion
of Redeemable Preferred Stock
In November 2006, IBM converted the remaining 187 outstanding
shares of Series B Preferred Stock into 1.5 million
shares of our common stock.
Microsoft
Agreements
On November 2, 2006, we entered into a Business
Collaboration Agreement, a Technical Collaboration Agreement,
and a Patent Cooperation Agreement with Microsoft Corporation
that together are designed to build, market and support a series
of new solutions to make Novell and Microsoft products work
better together for customers. Each of the agreements is
scheduled to expire January 1, 2012.
Under the Business Collaboration Agreement, we are marketing a
combined offering with Microsoft. The combined offering consists
of SUSE Linux Enterprise Server (“SLES”) and a
subscription for SLES support along with Microsoft Windows
Server, Microsoft Virtual Server and Microsoft Viridian, and is
offered to customers desiring to deploy Linux and Windows in a
virtualized setting. Microsoft made an upfront payment to us of
$240 million for SLES subscription
“certificates,” which Microsoft may use, resell or
otherwise distribute over the term of the agreement, allowing
the certificate holder to redeem single or multi-year
subscriptions for SLES support from us (entitling the
certificate holder to upgrades, updates and technical support).
Microsoft will spend $12 million annually for marketing
Linux and Windows virtualization scenarios and will also spend
$34 million over the term of the agreement for a Microsoft
sales force devoted primarily to marketing the combined
offering. Microsoft agreed that for three years following the
initial date of the agreement it will not enter into an
agreement with any other Linux distributor to encourage adoption
of non-Novell Linux/Windows Server virtualization through a
program substantially similar to the SLES subscription
“certificate” distribution program.
The Technical Collaboration Agreement focuses primarily on four
areas:
•
Development of technologies to optimize each of SLES and Windows
running as guests in a virtualized setting on the other
operating system;
•
Development of management tools for managing heterogeneous
virtualization environments, to enable each party’s
management tools to command, control and configure the other
party’s operating system in a virtual machine environment;
•
Development of translators to improve interoperability between
Microsoft Office and OpenOffice document formats; and
•
Collaboration on improving directory and identity
interoperability and identity management between Microsoft
Active Directory software and Novell eDirectory software.
Under the Technical Collaboration Agreement, Microsoft agreed to
provide funding to help accomplish these broad objectives,
subject to certain limitations.
Under the Patent Cooperation Agreement, Microsoft agreed to
covenant with our customers not to assert its patents against
our customers for their use of our products and services for
which we receive revenue directly or indirectly, with certain
exceptions, while we agreed to covenant with Microsoft’s
customers not to assert our patents against Microsoft’s
customers for their use of Microsoft products and services for
which Microsoft receives revenue directly or indirectly, with
certain exceptions. In addition, we and Microsoft each
irrevocably released the other party, and its customers, from
any liability for patent infringement arising prior to
November 2, 2006, with certain exceptions. Both we and
Microsoft have payment obligations under the Patent Cooperation
Agreement. Microsoft made an up-front net balancing payment to
us of $108 million, and we will make ongoing payments to
Microsoft
totaling not less than $40 million over the five year term
of the agreement based on a percentage of our Open Platform
Solutions and Open Enterprise Server revenues.
RedMojo
Acquisition
On November 17, 2006, we acquired all of the outstanding
shares of RedMojo Inc, a privately held technology company that
specialized in cross platform virtualization management software
tools. The purchase price was $9.7 million in cash plus
merger and transaction costs of $0.2 million.
Sale of
Salmon Subsidiary
On March 13, 2007, we sold our shares in Salmon Ltd,
(“Salmon”) to Okam Limited, a United Kingdom Limited
Holding Company for $4.9 million, plus approximately an
additional $3.9 million contingent payment to be received
if Salmon meets certain revenue targets. There will be no
further shareholder or operational relationship between us and
Salmon going forward. Salmon was a component of our EMEA
operating segment in fiscal 2006 (Business Consulting segment
beginning in fiscal 2007) and Salmon’s sale will not
have an impact on our IT consulting business. In our second
quarter of fiscal 2007, we recognized a gain on the sale of
approximately $0.6 million. During the first quarter of
fiscal 2007, in anticipation of the sale, we recorded a loss of
$10.8 million related to the excess carrying amount of
Salmon over its estimated fair value, of which
$10.2 million was to write off goodwill and
$0.6 million was to write off intangible assets. We will
classify Salmon’s results of operations as a discontinued
operation in our consolidated statement of operations beginning
in the second quarter of fiscal 2007.
Item 7A.
Quantitative
and Qualitative Disclosures About Market Risk
We are exposed to financial market risks, including changes in
interest rates, foreign currency exchange rates, and 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 October 31, 2006.
Interest
Rate Risk
The primary objective of our short-term investment activities is
to preserve principal while maximizing yields without
significantly increasing risk. Our strategy 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
approximately a $4.4 million decrease (less than 1%) 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
October 31, 2006, gross unrealized gains, before tax effect
on the short-term public equity securities, totaled
$0.5 million. A reduction in prices of 10% of these
short-term equity securities would result in approximately a
$0.7 million decrease (less than 1%) in the fair value of
our short-term investments.
Foreign
Currency Risk
We use derivatives to hedge those current net assets and
liabilities that, when re-measured or settled according to
accounting principles generally accepted in the U.S., impact our
consolidated statement of operations. Currency forward contracts
are utilized in these hedging programs. All forward contracts
entered into by us 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 gains and losses on
the net 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
(expense) in the same period as when the gains and
losses on re-measurement 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 consolidated statements 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 $5 million. This number represents the
exposure related to balance sheet re-measurement only and
assumes that all currencies move in the same direction at the
same time relative to the U.S. dollar.
We do not currently hedge currency risk related to revenues or
expenses denominated in foreign currencies; however, due to a
number of factors including net operating margin levels and
diversity of currencies, we have not historically experienced
large foreign exchange gains or losses related to these revenues
and expenses.
All of the potential changes noted above are based on
sensitivity analyses performed on our financial position at
October 31, 2006. Actual results may differ materially.
Series A preferred stock,
$.10 par value, Authorized — 499,000 shares;
no shares issued
—
—
Common stock, par value
$.10 per share, Authorized —
600,000,000 shares; Issued — 358,512,471 and
400,993,898 shares at October 31, 2006 and 2005,
respectively, Outstanding — 343,362,534 and
385,820,699 shares at October 31, 2006 and 2005,
respectively
35,851
40,099
Additional paid-in capital
338,954
483,157
Treasury stock, at
cost — 15,149,937 and 15,173,199 shares at
October 31, 2006 and 2005, respectively
(124,684
)
(124,875
)
Retained earnings
840,449
984,107
Accumulated other comprehensive
income
14,080
7,444
Unearned compensation and other
—
(3,446
)
Total stockholders’ equity
1,104,650
1,386,486
Total liabilities, redeemable
securities and stockholders’ equity
Novell develops, implements, and supports proprietary, mixed
source and open source software for use in business solutions.
With approximately 4,500 employees in over 80 offices worldwide,
we provide customers with enterprise infrastructure software and
a full range of training and support services. Our products
enable customers to solve business challenges by maximizing the
effectiveness of their information technology (IT) environments.
With a
24-year
history of innovation and industry leadership, Novell enables
customers to build their own “Open Enterprise” by
adding the strength, flexibility and economy of open source
software to their existing IT infrastructures. We offer an
open source platform along with fully integrated systems
management and security and identity solutions. Our specific
offerings include identity and access management products,
resource management products, SUSE Linux Enterprise Sever
(“SLES”), Open Enterprise Server, NetWare, and
Collaboration products on several operating systems, including
Linux, NetWare, Windows, and Unix. These technologies allow us
to help customers manage both our open source platform and the
other heterogeneous components of their IT infrastructures.
By delivering these technology solutions to our customers, we
help them drive increased performance from their IT
infrastructures at a reduced cost and with lower risk. In doing
so, we give our customers more time to focus on innovation and
growth in their core businesses.
To help ensure customer success, we offer customers extensive
technical support and training through our worldwide support
network. We also have strong partnerships in place with
application providers, hardware and software vendors, and
consultants and systems integrators. With our open source
platform, enterprise infrastructure software, and global network
of partners, we offer full solutions to our customers,
regardless of their size or location.
Our software solutions are grouped into three main solution
categories: systems, security and identity management; open
platform solutions; and workspace solutions. In addition, we
offer worldwide IT consulting, training and technical support
services. Following are descriptions of these categories.
Systems, Security and Identity Management. Our
systems, security, and identity management products include
applications that offer broad capabilities for automating the
management of IT resources. This group of Novell solutions
creates and assigns digital identities to IT resources, and
protects those resources from unauthorized use. They also manage
and track the use of IT assets and report on that usage for
auditing, billing and compliance reporting purposes. Among other
benefits, customers use these solutions to:
•
Automate the management of IT assets, including servers,
desktops, laptops and hand-held devices, through their entire
lifecycle with device location tracking, utilization reporting
and routing administrative tasks.
•
Lower the total cost of ownership of desktops and laptops
through automated machine configuration and software patch
management across the enterprise.
•
Reduce the complexity and costs of managing users and their
access to systems through instant provisioning of new employees,
streamlined authentication and authorization, and centrally
managed access policies.
•
Secure enterprise information from unauthorized use through the
instant revocation of access rights, the creation of a
consistent enterprise-wide security model, and by gaining full
visibility into how information, services and resources are
being used.
We believe that businesses recognize the need to manage access
to their assets, and the use and optimization of those assets,
with systems that are driven by business policies. Novell meets
this need by offering systems that help customers define,
implement and administer business policies across a single
enterprise. Novell’s solutions also accommodate
customers’ need for increased business agility. By using
our products, customers can extend their business processes and
systems across organizational and technical boundaries,
integrating with the operational
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
environments of their customers, employees, suppliers and
partners. This affords organizations the opportunity to make
changes to their business operations without incurring the cost
of constantly changing individual software application
components, and without impacting their business partners.
These identity-based technologies not only regulate user access
to data and applications, but are increasingly becoming the
basis for securing and managing other information assets, such
as mobile computing and communications devices and data center
servers. We believe that identity management technologies are
increasingly becoming the preferred means by which businesses
will efficiently utilize all their IT assets. We have developed
products for this market to help our customers take advantage of
these opportunities. These products can be deployed across a
number of systems, including Linux, NetWare, Windows, and Unix
recognizing the heterogeneous nature of today’s IT
infrastructures. Our development strategy has been to produce
systems, security and identity management technologies as a set
of discrete software components that customers can deploy
quickly to meet specific business needs. We believe that this
approach is far more appealing to customers than the alternative
approach of building large, monolithic applications requiring
lengthy implementations without any immediate business benefit.
Open Platform Solutions. Both our open
platform solutions and workspace solutions categories include
solutions that offer effective, open and cross-platform
approaches to computing, networking and collaboration. Both
categories offer operating systems, network services, and
workgroup software solutions.
With our open platform solutions, including our Linux-based and
other related products, we focus on the substantial growth
opportunities presented by enterprise adoption of open source
technologies.
The foundation of this category is SUSE Linux Enterprise, our
high quality and highly interoperable enterprise computing
platform. With its openness, reliability and enterprise-class
performance, we refer to SUSE Linux Enterprise as the Platform
for the Open Enterprise. It offers businesses a complete open
platform that supports mission-critical applications from the
desktop to the data center. Components of this platform include:
•
SUSE Linux Enterprise Server, which handles a variety of server
workloads including edge and infrastructure computing,
enterprise database deployment,
line-of-business
applications, and mission-critical software applications.
•
SUSE Linux Enterprise Desktop, which offers a general-purpose
desktop computing environment with high usability, a broad range
of productivity applications including a full office suite, and
advanced graphic capabilities.
A major focus of our open platform solutions is to advance and
promote open source computing, with particular emphasis on
driving increased enterprise adoption of Linux. We believe that
a major shift toward the use of open source software is well
underway across many industry segments. This trend is fueled by
organizations that are more critically assessing the cost
effectiveness of their existing IT infrastructures, evaluating
viable open source alternatives, and seeking ways to avoid
vendor lock-in.
We believe that we are uniquely positioned to drive the
transition to greater use of open source software, as well as to
benefit from this trend. Widespread adoption of Linux and open
source software was initially hindered by weak technical
support, a shortcoming that we are particularly well positioned
to address. We leverage our financial stability, experience, and
global services and support capabilities to help our customers
integrate Linux and other open source software into their
existing IT environments.
While the flexibility and cost savings of Linux and open source
have made it attractive to enterprise customers, we believe they
continue to look to proprietary software vendors to provide
applications, management and security solutions. With our SUSE
Linux Enterprise platform, our customers can now easily take a
cross-platform approach, deploying the best of proprietary and
open source software offerings for management and security
functionality. We believe that many businesses find value in
Novell providing them with a path to a more open, flexible and
reliable
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
IT environment, without requiring them to dismantle or
disrupt any software or systems they presently have running. For
example, we offer solutions today that allow customers to
collaborate seamlessly across their Windows and Linux
environments. We also provide solutions that enable IT managers
to control Linux, NetWare and Windows systems simultaneously,
consistently and easily.
Workspace solutions. Our workspace solutions
category is comprised of proprietary software products that
provide customers with powerful solutions that are designed to
operate within existing heterogeneous computing environments as
well as to provide tools and strategies to allow easy migration
between platforms to better fit customers’ technology
plans. Our primary server products within this category are Open
Enterprise Sever (OES) and NetWare. OES consists of several
enterprise-ready, scalable networking and collaboration
services. These include file, print, messaging, scheduling and
directory-based management modules that allow customers to
manage their global computing environment from a single, central
console deployed on either of our major operating systems
platforms. Our workspace solutions category also includes our
GroupWise and collaboration technologies, Cluster Services, and
BorderManager.
Global services and support. We provide
worldwide IT consulting, training and technical support services
to address our customers’ needs. Our worldwide IT
consulting practice provides the business knowledge and
technical expertise our customers need to implement and achieve
maximum benefit from our products and solutions. We also offer
open source and identity-driven services designed to assist our
customers with fast and effective application integration or
migration of their existing platforms to Linux.
Through our training services, we offer skills assessments,
advanced technical training courses, and customized training
directly and through authorized training service partners. We
also offer testing and certification programs to systems
administrators, engineers, salespeople, and instructors on a
wide variety of technologies, including Linux. In support of our
strategy to drive increased enterprise adoption of Linux, we
offer the Novell Certified Linux Engineer and Novell Certified
Linux Professional programs.
We provide our customers with a global support structure
covering proprietary and open source technical support. We
deliver our technical support services through a variety of
channels, including
on-site
dedicated resources as well as through telephone, web,
e-mail, and
remote systems management.
We are subject to a number of risks similar to those of other
companies of similar size in our industry, including rapid
technological changes, competition, limited number of suppliers,
customer concentration, integration of acquisitions, government
regulations, management of international activities and
dependence on key individuals.
B.
Summary
of Significant Accounting Policies
The accompanying consolidated financial statements reflect the
application of significant accounting policies as described in
this note and elsewhere in the accompanying consolidated
financial statements.
Principles
of Consolidation
The accompanying consolidated financial statements include the
accounts of Novell, Inc., its wholly-owned and majority-owned
subsidiaries and majority-owned joint ventures. All material
inter-company accounts and transactions have been eliminated in
consolidation.
Management’s
Estimates and Uncertainties
The preparation of financial statements in conformity with
accounting principles generally accepted in the
U.S. requires management to make estimates and assumptions
that affect the amounts reported and related disclosure of
contingent assets and liabilities in the financial statements
and accompanying notes. Actual results could differ materially
from those estimates.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
Reclassifications
In May 2006, we sold our Celerant consulting group. The results
of operations for Celerant have been classified as discontinued
operations for all periods presented (see Note E). Certain
other amounts reported in prior years also have been
reclassified from what was previously reported to conform to the
current year’s presentation. These reclassifications did
not have any impact on net income and net income per share
available to common stockholders.
Foreign
Currency Translation
The functional currency of all of our international
subsidiaries, except for our Irish subsidiaries and a German
holding company, is the local currency. These subsidiaries
generate and expend cash primarily in their respective local
currencies. The 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. Translation adjustments are recorded in accumulated other
comprehensive income. With respect to our Irish subsidiaries and
German holding company, the functional currency is the
U.S. dollar for which translation gains and losses are
included in other income and expense. All transaction gains and
losses are reported in other income (expense). Foreign exchange
resulted in losses of $0.7 million, $3.4 million and
$5.0 million during fiscal 2006, 2005 and 2004,
respectively.
Cash,
Cash Equivalents and Short-Term Investments
We consider all investments with an initial term to maturity of
three months or less at the date of purchase to be cash
equivalents. Short-term investments are diversified, primarily
consisting of investment grade securities that either mature
within the next 12 months or have other characteristics of
short-term investments, such as auction dates within at least
six months of the prior auction date or being available to be
used for current operations even if some maturities may extend
beyond one year. All auction rate securities are classified as
short-term investments.
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 value. The unrealized gains and losses
related to these securities are included in accumulated other
comprehensive income (see Note Y). Fair values are based on
quoted market prices where available. If quoted market prices
are not available, we use third-party pricing services to assist
in determining fair value. In many instances, these services
examine the pricing of similar instruments to estimate fair
value. When securities are sold, their cost is determined based
on the
first-in
first-out method. The realized gains and losses related to these
securities are included in investment income in the consolidated
statements of operations.
Concentrations
of Credit Risk
Financial instruments that subject us to credit risk primarily
consist of cash equivalents, short-term investments, accounts
receivable, notes receivable, and amounts due under subleases.
Our credit risk is managed by investing cash and cash
equivalents primarily in high-quality money market instruments
and securities of the U.S. government and its agencies.
Accounts receivable include amounts owed by geographically
dispersed end users, distributors, resellers, and original
equipment manufacturer (“OEM”) customers. No
collateral is required. Accounts receivable are not sold or
factored. At October 31, 2006, there were no receivables
greater than 10% of our total receivables outstanding with any
one customer. At October 31, 2005, we had outstanding
receivables from one customer, which accounted for 13% of our
outstanding receivables. This receivable balance was collected
in full in the first quarter of fiscal 2006. We generally have
not experienced any material losses related to receivables from
individual customers or groups of customers. Due to these
factors, no significant additional credit risk, beyond amounts
provided for, is believed by management to be inherent in
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
our accounts receivable. Our subleases are with many different
parties and thus no concentration of credit risk exists at
October 31, 2006.
During the years ended October 31, 2006, 2005 and 2004,
there were no customers who accounted for more than 10% of total
net revenue.
Equity
Investments
We account for our equity investment where we hold more than
20 percent of the outstanding shares of the investee’s
stock or where we have the ability to significantly influence
the operations or financial decisions of the investee under the
equity method of accounting in accordance with Accounting
Principles Board Opinion No. 18, “The Equity Method of
Accounting for Investments in Common Stock.” We initially
record the investment at cost and adjust the carrying amount
each period to recognize our share of the earnings or losses of
the investee based on our percentage of ownership. We review our
equity investments periodically for indicators of impairment.
Property,
Plant and Equipment
Property, plant and equipment are carried at cost less
accumulated depreciation and amortization. Depreciation and
amortization is computed on the straight-line method over the
estimated useful lives of the assets, or lease term, if shorter.
Such lives are as follows:
Asset Classification
Useful Lives
Buildings
30 years
Furniture and equipment
2 – 7 years
Leasehold improvements and other
3 – 10 years
We review our property, plant and equipment annually for
indicators of impairment in accordance with Statement of
Financial Accounting Standards (“SFAS”) No. 144,
“Accounting for the Impairment or Disposal of Long-Lived
Assets,” whenever events or changes in circumstances
indicate that the carrying value may not be recoverable. Factors
that could indicate an impairment include significant
underperformance of the asset as compared to historical or
projected future operating results, significant changes in the
actual or intended use of the asset, or significant negative
industry or economic trends. When we determine that the carrying
value of an asset may not be recoverable, the related estimated
future undiscounted cash flows expected to result from the use
and eventual disposition of the asset are compared to the
carrying value of the asset. If the sum of the estimated future
cash flows is less than the carrying amount, we record an
impairment charge based on the difference between the carrying
value of the asset and its fair value, which we estimate based
on discounted expected future cash flows. For fiscal years 2006,
2005, and 2004, we have not identified or recorded any
impairment of our property, plant and equipment.
Goodwill
and Intangible Assets
We review our goodwill annually for indicators of impairment in
accordance with SFAS No. 142, “Goodwill and Other
Intangible Assets.” We evaluate the recoverability of
goodwill and indefinite-lived intangible assets annually as of
August 1, or more frequently if events or changes in
circumstances warrant, such as a material adverse change in the
business. Goodwill is considered to be impaired when the
carrying value of a reporting unit exceeds its estimated fair
value. Fair values are estimated using a discounted cash flow
methodology.
In accordance with SFAS No. 142, we do not amortize
goodwill or intangibles with indefinite lives resulting from
acquisitions. We review these assets periodically for potential
impairment issues. Separable intangible assets that are not
deemed to have an indefinite life are amortized over their
estimated useful lives.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
We review our finite-lived intangibles assets for indicators of
impairment in accordance with SFAS No. 144 whenever
events or changes in circumstances indicate that the carrying
value may not be recoverable. When we determine that the
carrying value of an asset may not be recoverable, the related
estimated future undiscounted cash flows expected to result from
the use and eventual disposition of the asset are compared to
the carrying value of the asset. If the sum of the estimated
future cash flows is less than the carrying amount, we record an
impairment charge based on the difference between the carrying
value of the asset and its fair value, which we estimate based
on discounted expected future cash flows.
Disclosure
of Fair Value of Financial Instruments
Our financial instruments mainly consist of cash and cash
equivalents, short-term investments, accounts receivable, notes
receivable, accounts payable, accrued expenses, Series B
Preferred Stock, and the Debentures. The carrying amounts of our
cash equivalents and short-term investments, accounts
receivable, accounts payable and accrued expenses approximate
fair value due to the short-term nature of these instruments. We
periodically review the realizability of each short-term and
long-term investment when impairment indicators exist with
respect to the investment. If an
other-than-temporary
impairment of the value of the investments is deemed to exist,
the carrying value of the investment is written down to its
estimated fair value. We consider an impairment to be
other-than-temporary
when market evidence or issuer-specific knowledge does not
reflect long-term growth to support current carrying values. The
carrying amounts for the Series B Preferred Stock and
Debentures approximate fair value. As of October 31, 2006
and 2005, we did not hold any publicly-traded long-term equity
securities. Our Debentures have interest rates that approximate
current market rates; therefore, the carrying value approximates
fair value.
Revenue
Recognition and Related Reserves.
Our revenue is derived primarily from the sale of software
licenses, software maintenance, upgrade protection,
subscriptions of SUSE Linux Enterprise Server
(“SLES”), technical support, training, and consulting
services. Our customers include: distributors, who sell our
products to resellers, dealers, and VARs; OEMs, who integrate
our products with their products or solutions; VARs, who provide
solutions across multiple vertical market segments which usually
include services; and end users, who may purchase our products
and services directly from Novell or from other partners or
resellers. Except for our SUSE Linux product, distributors do
not order to stock and only order products when they have an end
customer order, which they present to us. With respect to our
SUSE Linux product, distributors place orders and the product is
then sold through to end customers principally through the
retail channel. OEMs report the number of copies duplicated and
sold via an activity or royalty report. Software maintenance,
upgrade protection, technical support, and subscriptions of SLES
typically involve one to three year contract terms. Our standard
contracts offer a
90-day right
of return.
Revenue is recognized in accordance with Statement of Position
(“SOP”)
97-2,
“Software Revenue Recognition,” and Staff Accounting
Bulletin No. 104, “Revenue Recognition,” and
related interpretations. When an arrangement does not require
significant production, modification or customization of
software or does not contain services considered to be essential
to the functionality of the software, revenue is recognized when
the following four criteria are met:
•
Persuasive evidence of an arrangement exists — We
require evidence of an agreement with a customer specifying the
terms and conditions of the products or services to be delivered
typically in the form of a signed contract or statement of work
accompanied by a purchase order.
•
Delivery has occurred — For software licenses,
delivery takes place when the customer is given access to the
software programs via access to a web site or shipped medium.
For services, delivery takes place as the services are provided.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
•
The fee is fixed or determinable — Fees are fixed or
determinable if they are not subject to a refund or cancellation
and do not have payment terms that exceed our standard payment
terms. Typical payment terms are net 30 days.
•
Collection is probable — We perform a credit review of
all customers with significant transactions to determine whether
a customer is creditworthy and collection is probable. Prior
Novell established credit history, credit reports, financial
statements, and bank references are used to assess
creditworthiness.
In general, revenue for transactions that do not involve
software customization or services considered essential to the
functionality of the software is recognized as follows:
•
Software license fees for our SUSE Linux product are recognized
when the product is sold through to an end customer;
•
Software license fees for sales through OEMs are recognized upon
receipt of license activity or royalty reports;
•
All other software license fees are recognized upon delivery of
the software;
•
Software maintenance, upgrade protection, technical support, and
subscriptions of SLES are recognized ratably over the contract
term; and
•
Consulting, training and other similar services are recognized
as the services are performed.
If the fee due from the customer is not fixed or determinable,
revenue is recognized as payments become due from the customer.
If collection is not considered probable, revenue is recognized
when the fee is collected. We record provisions against revenue
for estimated sales returns and allowances on product and
service-related sales in the same period as the related revenue
is recorded. We also record a provision to operating expenses
for bad debts resulting from customers’ inability to pay
for the products or services they have received. These estimates
are based on historical sales returns and bad debt expense,
analyses of credit memo data, and other known factors, such as
bankruptcy. If the historical data we use to calculate these
estimates do not accurately reflect future returns or bad debts,
adjustments to these reserves may be required that would
increase or decrease revenue or net income.
Many of our software arrangements include multiple elements.
Such elements typically include any or all of the following:
software licenses, rights to additional software products,
software maintenance, upgrade protection, technical support
services, training and consulting services. For multiple-element
arrangements that do not involve significant modification or
customization of the software and do not involve services that
are considered essential to the functionality of the software,
we allocate value to each element based on its relative fair
value, if sufficient Novell-specific objective evidence of fair
value exists for each element of the arrangement.
Novell-specific objective evidence of fair value is determined
based on the price charged when each element is sold separately.
If sufficient Novell-specific objective evidence exists for all
undelivered elements, but does not exist for the delivered
element, typically the software, then the residual method is
used to allocate value to each element. Under the residual
method, each undelivered element is allocated value based on
Novell-specific objective evidence of fair value for that
element, as described above, and the remainder of the total
arrangement fee is allocated to the delivered element, typically
the software. If sufficient Novell-specific objective evidence
does not exist for all undelivered elements and the arrangement
involves rights to unspecified additional software products, all
revenue is recognized ratably over the term of the arrangement.
If the arrangement does not involve rights to unspecified
additional software products, all revenue is initially deferred
until typically the only remaining undelivered element is
software maintenance or
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
technical support, at which time the entire fee is recognized
ratably over the remaining maintenance or support term.
In the case of multiple-element arrangements that involve
significant modification or customization of the software or
involve services that are considered essential to the
functionality of the software, contract accounting is applied.
When Novell-specific objective evidence exists for software
maintenance or technical support in arrangements requiring
contract accounting, the consulting and license fees are
combined and revenue is recognized on the percentage of
completion basis. The percentage of completion is generally
calculated using estimated hours incurred to date relative to
the total expected hours for the entire project. The cumulative
impact of any revision in estimates to complete or recognition
of losses on contracts is reflected in the period in which the
changes or losses become known. The maintenance or support fee
is unbundled from the other elements and revenue is recognized
ratably over the maintenance or support term. When
Novell-specific objective evidence does not exist for software
maintenance or support, then all revenue is deferred until
completion of the consulting services, at which time the entire
fee is recognized ratably over the remaining maintenance or
support period.
Consulting project contracts are either
time-and-materials
or fixed-price contracts. Revenue from
time-and-materials
contracts is recognized as the services are performed. Revenue
from fixed-price contracts is recognized based on the
proportional performance method, generally using estimated time
to complete to measure the completed effort. The cumulative
impact of any revision in estimates to complete or recognition
of losses on contracts is reflected in the period in which the
changes or losses become known. Consulting revenue includes
reimbursable expenses charged to our clients.
Cost of
Revenue
Cost of revenue includes the amortization of intangible assets
related to products or services sold, royalty costs and cost
associated with personnel providing consulting services.
Expenses
Product development costs are expensed as incurred. Due to the
use of the working model approach under SFAS No. 86,
“Accounting for the Costs of Computer Software to Be Sold,
Leased, or Otherwise Marketed,” costs incurred subsequent
to the establishment of technological feasibility but prior to
the general release of the product, have not been significant
and therefore have not been capitalized.
Advertising costs are expensed as incurred. Advertising expenses
totaled $3.6 million, $6.0 million, and
$10.6 million, in fiscal years 2006, 2005, and 2004,
respectively.
Share-based
Payments
On November 1, 2005, we adopted Statement of Financial
Accounting Standards (“SFAS”) No. 123(R),
“Share-Based Payment,” which requires us to account
for share-based payment transactions using a fair value-based
method and recognize the related expense in the results of
operations. Prior to our adoption of SFAS No. 123(R),
as permitted by SFAS No. 123, we accounted for
share-based payments to employees using the Accounting
Principles Board Opinion No. 25 (“APB 25”),
“Accounting for Stock Issued to Employees,” intrinsic
value method and, therefore, we generally recognized
compensation expense for restricted stock awards and did not
recognize compensation cost for employee stock options.
SFAS No. 123(R) allows companies to choose one of two
transition methods: the modified prospective transition method
or the modified retrospective transition method. We chose to use
the modified prospective transition methodology, and
accordingly, we have not restated the results of prior periods.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
Under the fair value recognition provisions of
SFAS No. 123(R), share-based compensation cost is
estimated at the grant date based on the fair value of the award
and is recognized as expense over the requisite service period
of the award. The fair value of restricted stock awards is
determined by reference to the fair market value of our common
stock on the date of grant. Consistent with the valuation method
we used for disclosure-only purposes under the provisions of
SFAS No. 123, we use the Black-Scholes model to value
service condition and performance condition option awards under
SFAS No. 123(R). For awards with market conditions
granted subsequent to our adoption of SFAS No. 123(R),
we use a lattice valuation model to estimate fair value. For
awards with only service conditions and graded-vesting features,
we recognize compensation cost on a straight-line basis over the
requisite service period. For awards with performance or market
conditions granted subsequent to our adoption of
SFAS No. 123(R), we recognize compensation cost based
on the graded-vesting method.
Determining the appropriate fair value model and related
assumptions requires judgment, including estimating stock price
volatility, forfeiture rates, and expected terms. The expected
volatility rates are estimated based on historical and implied
volatilities of our common stock. The expected term represents
the average time that options that vest are expected to be
outstanding based on the vesting provisions and our historical
exercise, cancellation and expiration patterns. We estimate
pre-vesting forfeitures when recognizing compensation expense
based on historical rates and forward-looking factors. We update
these assumptions at least on an annual basis and on an interim
basis if significant changes to the assumptions are warranted.
We issue performance-based equity awards, typically to certain
senior executives, which vest upon the achievement of certain
financial performance goals, including revenue and income
targets. Determining the appropriate amount to expense based on
the anticipated achievement of the stated goals requires
judgment, including forecasting future financial results. The
estimate of expense is revised periodically based on the
probability of achieving the required performance targets and
adjustments are made as appropriate. The cumulative impact of
any revision is reflected in the period of change. If the
financial performance goals are not met, the award does not
vest, so no compensation cost is recognized and any previously
recognized compensation cost is reversed.
In the past, we have issued market condition equity awards,
typically granted to certain senior executives, the vesting of
which is accelerated or contingent upon the price of Novell
common stock meeting specified pre-established stock price
targets. For awards granted prior to our adoption of
SFAS No. 123(R), the fair value of each market
condition award was estimated as of the grant date using the
same option valuation model used for time-based options without
regard to the market condition criteria. As a result of our
adoption of SFAS No. 123(R), compensation cost is
recognized over the estimated requisite service period and is
not reversed if the market condition target is not met. If the
pre-established stock price targets are achieved, any remaining
expense on the date the target is achieved is recognized either
immediately or, in situations where there is a remaining minimum
time vesting period, ratably over that period.
Net
Income (Loss) Per Share
Basic and diluted net income per share available to common
stockholders is presented in conformity with
SFAS No. 128, “Earnings per Share,” and the
related interpretation in EITF Issue
No. 03-06,
“Participating Securities and the Two —
Class Method under FASB Statement No. 128.” Basic
net income per share available to common stockholders is
computed by dividing net income available to common stockholders
by the actual weighted-average number of common shares
outstanding during the period. Net income available to common
stockholders reflects net income (loss) after deducting
accumulated preferred stock dividends and earnings allocated to
participating preferred stockholders. Diluted net income
available to common stockholders is based on the basic
calculation but also excludes the minority interest share of net
income on a diluted basis and assumes the conversion of the
Series B Preferred Stock and Debentures using the “if
converted” method, if dilutive, and includes the dilutive
effect of potential common shares under the treasury stock
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
method. Potential common shares include stock options, unvested
restricted stock and, in certain circumstances, convertible
securities such as the Debentures and Series B Preferred
Stock.
In November 2004, the EITF reached a final conclusion on Issue
04-8,
“Accounting Issues Related to Certain Features of
Contingently Convertible Debt and the Effect on Diluted Earnings
per Share.” This issue addresses when the dilutive effect
of contingently convertible debt with a market price trigger
should be included in diluted earnings per share calculations.
The EITF’s conclusion is that the market price trigger
should be ignored and that these securities should be treated as
convertible securities and included in diluted earnings per
share regardless of whether the conversion contingencies have
been met. Because our Debentures are contingently convertible
debt with a market price trigger, we were required to comply
with EITF Issue
04-8
beginning in the first quarter of fiscal 2005. All earnings per
share amounts presented have been revised to conform to the
requirements of EITF Issue No.
04-8.
Derivative
Instruments
A large portion of our revenue, expense, and capital purchasing
activities are transacted in U.S. dollars. However, we
enter into transactions in other currencies, primarily the Euro,
the British Pound Sterling, 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 inter-company 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 do not currently hedge currency
risks related to revenue or expenses denominated in foreign
currencies.
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 year-end, the fair
value of the derivatives as of October 31, 2006 and 2005 is
insignificant. Gains and losses recognized during the year 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.
Recent
Pronouncements
In June 2006, the FASB issued Interpretation No. 48,
“Accounting for Uncertainty in Income Taxes, an
Interpretation of FASB Statement No. 109,”
(“FIN 48”). FIN 48 clarifies the accounting
for uncertainty in income taxes recognized in an
enterprise’s financial statements in accordance with
SFAS No. 109, “Accounting for Income Taxes.”
FIN 48 prescribes a two-step process to determine the
amount of tax benefit to be recognized. First, the tax position
must be evaluated to determine the likelihood that it will be
sustained upon external examination. If the tax position is
deemed “more-likely-than-not” to be sustained, the tax
position is then assessed to determine the amount of benefit to
recognize in the financial statements. The amount of the benefit
that may be recognized is the largest amount that has a greater
than 50 percent likelihood of being realized upon ultimate
settlement. FIN 48 also provides guidance on derecognition,
classification, interest and penalties, accounting in interim
periods and disclosure relative to uncertain tax positions.
FIN 48 is effective for fiscal years beginning after
December 15, 2006 (Novell’s fiscal 2008, beginning
November 1, 2007). We are currently evaluating the impact
of this interpretation on our financial position and results of
operations.
In September 2006, the FASB issued SFAS No. 157,
“Fair Value Measurements,”
(“SFAS No. 157”). SFAS No. 157
defines fair value and provides enhanced guidance for using fair
value to measure assets and liabilities. It also expands the
amount of disclosure about the use of fair value to measure
assets and liabilities. The standard applies whenever other
standards require assets or liabilities to be measured at fair
value but does not expand the use of fair value to any new
circumstances. SFAS No. 157 is effective beginning
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
the first fiscal year that begins after November 15, 2007
(Novell’s fiscal 2009). We are currently evaluating the
impact of SFAS No. 157 on our financial position and
results of operations.
In September 2006, the FASB issued SFAS No. 158,
“Employers’ Accounting for Defined Benefit Pension and
Other Post retirement Plans, an amendment of SFAS Nos. 87, 88,
106, and 132(R),” (“SFAS No. 158”).
This statement requires an employer to recognize in its balance
sheet the over funded or under funded status of a defined
benefit post retirement plan measured as the difference between
the fair value of plan assets and the present value of the
benefit obligation. The recognition of the net liability or
asset will require an offsetting adjustment to accumulated other
comprehensive income in shareholders’ equity.
SFAS No. 158 does not change how post retirement
benefits are accounted for and reported in the income statement.
SFAS No. 158 is effective for fiscal years ending
after December 15, 2006 (Novell’s fiscal 2007). We do
not expect the adoption of SFAS No. 158 to have a
material impact on our comprehensive income and we do not
anticipate a material adjustment to our statement of financial
position as a result of adopting SFAS No. 158.
In February 2007, the FASB issued SFAS No. 159,
“The Fair Value Option for Financial Assets and Financial
Liabilities,” (“SFAS No. 159”).
SFAS 159 establishes presentation and disclosure
requirements designed to facilitate comparisons between
companies that choose different measurement attributes for
similar types of assets and liabilities. Previously, accounting
rules required different measurement attributes for different
assets and liabilities that created artificial volatility in
earnings. SFAS No. 159 helps to mitigate this type of
accounting-induced volatility by enabling companies to report
related assets and liabilities at fair value, which would likely
reduce the need for companies to comply with detailed rules for
hedge accounting. SFAS No. 159 is effective as of the
beginning of an entity’s first fiscal year beginning after
November 15, 2007 (Novell’s fiscal 2009), though early
adoption is permitted. We are currently evaluating the impact of
this pronouncement on our financial position and results of
operations.
In March 2007, the Emerging Issues Task Force (“EITF”)
reached a consensus on issue number
06-10,
“Accounting for Deferred Compensation and Postretirement
Benefit Aspects of Collateral Assignment Split-Dollar Life
Insurance Arrangements,” (“EITF
06-10”).
EITF 06-10
provides guidance to help companies determine whether a
liability for the postretirement benefit associated with a
collateral assignment split-dollar life insurance arrangement
should be recorded in accordance with either
SFAS No. 106, “Employers’ Accounting for
Postretirement Benefits Other Than Pensions” (if, in
substance, a postretirement benefit plan exists), or Accounting
Principles Board Opinion No. 12. (if the arrangement is, in
substance, an individual deferred compensation contract). EITF
06-10 also
provides guidance on how a company should recognize and measure
the asset in a collateral assignment split-dollar life insurance
contract. EITF
06-10 is
effective for fiscal years beginning after December 15,2007 (Novell’s fiscal 2008), though early adoption is
permitted. We are currently evaluating the impact of this
pronouncement on our financial position and results of
operations.
C.
Staff
Accounting Bulletin No. 108
In September 2006, the SEC staff issued Staff Accounting
Bulletin No. 108, “Considering the Effects of
Prior Year Misstatements when Quantifying Misstatements in
Current Year Financial Statements”
(“SAB 108”). SAB 108 was issued in order to
eliminate the diversity of practice surrounding how public
companies quantify financial statement misstatements.
SAB 108 is effective for fiscal years ending after
November 15, 2006, but we adopted it early in fiscal 2006.
Traditionally, there have been two widely-recognized methods for
quantifying the effects of financial statement misstatements:
the “roll-over” method and the “iron
curtain” method. The roll-over method focuses primarily on
the impact of a misstatement on the income statement, including
the reversing effect of prior year misstatements, but its use
can lead to the accumulation of misstatements on the balance
sheet. The iron-curtain method, on the other hand, focuses
primarily on the effect of correcting the period-end balance
sheet with less emphasis on the reversing effects of prior year
errors on the income statement. Prior to our application of the
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
guidance in SAB 108, we consistently applied the roll-over
method when quantifying financial statement misstatements.
In SAB 108, the SEC staff established an approach that
requires quantification of financial statement misstatements
based on the effects of misstatements on each of the financial
statements and the related financial statement disclosures. This
model is commonly referred to as a “dual approach”
because it requires quantification of errors under both the iron
curtain and the roll-over methods.
SAB 108 permits us to initially apply its provisions to
errors that are material under the dual method but were not
previously material under our previously used method of
assessing materiality either by (i) restating prior
financial statements as if the “dual approach” had
always been applied or (ii) recording the cumulative effect
of initially applying the “dual approach” as
adjustments to the carrying values of the applicable balance
sheet accounts as of November 1, 2005 with an offsetting
adjustment recorded to the opening balance of retained earnings.
We elected to record the effects of applying SAB 108 using
the cumulative effect transition method and adjusted beginning
retained earnings for fiscal 2006 in the accompanying
consolidated financial statements for misstatements associated
with our historical stock-based compensation expense and related
income tax effects as described below. We do not consider any of
the misstatements to have a material impact on our consolidated
financial statements in any of the prior years affected under
our previous method for quantifying misstatements, the roll-over
method.
Historical
Stock-Based Compensation Practices
On May 23, 2007, we announced that we had completed our
self-initiated, voluntary review of our historical stock-based
compensation practices and determined the related accounting
impact.
The review was conducted under the direction of the Audit
Committee of our Board of Directors, who engaged the law firm of
Cahill Gordon & Reindel LLP, with whom we had no
previous relationship, as independent outside legal counsel to
assist in conducting the review. The scope of the review covered
approximately 400 grant actions (on approximately 170 grant
dates) from November 1, 1996 through September 12,2006. Within these pools of grants are more than 58,000
individual grants. In total, the review encompassed awards
relating to more than 230 million shares of common stock
granted over the ten-year period.
The Audit Committee, together with its independent outside legal
counsel, did not find any evidence of intentional wrongdoing by
any former or current Novell employees, officers or directors.
We have determined, however, that we utilized incorrect
measurement dates for some of the stock-based compensation
awards granted during the review period. The incorrect
measurement dates can be attributed primarily to the following
reasons:
Administrative Corrections — In the period of
fiscal 1997 to 2005, we corrected administrative errors
identified subsequent to the original authorization by awarding
stock options that we dated with the original authorization
date. The administrative errors included incorrect lists of
optionees, generally new hires who were inadvertently omitted
from the lists of optionees because of the delayed updating of
our personnel list, and miscalculations of the number of options
to be granted to particular employees on approved lists.
Number of Shares Approved Not Specified —
Documented authorization for certain grants, primarily in the
period from fiscal 1997 through 2000, lacked specificity for
some portion or all of the grant.
Authorization Incomplete or Received Late — For
certain grants, primarily in the period from fiscal 1997 through
2004, there is incomplete documentation to determine with
certainty when the grants were actually authorized or the
authorization was received after the stated grant date.
In light of the above findings, we and our advisors performed an
exhaustive process to uncover all information that could be used
in making a judgment as to appropriate measurement dates. We
used all available information to
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
form conclusions as to the most likely option granting actions
that occurred and to form conclusions as to the appropriate
measurement dates.
Under APB No. 25, “Accounting for Stock Issued to
Employees,” because the exercise prices of the stock
options on the new measurement dates were, in some instances,
lower than the fair market value of the underlying stock on such
dates, we are required to record compensation expense for these
differences. As a result, stock-based compensation expense in a
cumulative after-tax amount of approximately $19.2 million
should have been reported in the consolidated financial
statements for the fiscal years ended October 31, 1997
through October 31, 2005. After considering the materiality
of the amounts of stock-based compensation and related income
tax effects that should have been recognized in each of the
applicable historic periods, including the interim periods of
fiscal 2005 and 2006, we determined that the errors were not
material to any prior period, on either a quantitative or
qualitative basis, under our previous method for quantifying
misstatements, the roll-over method. Therefore, we will not
restate our consolidated financial statements for prior periods.
In accordance with the provisions of SAB 108, we decreased
beginning retained earnings at November 1, 2005 by
approximately $19.2 million, from $984.1 million to
$964.9 million, or a reduction of two percent, with the
offset to additional paid-in capital in the consolidated balance
sheet.
The following table summarizes the effects, net of income taxes,
(on a cumulative basis prior to fiscal 2004 and in fiscal 2004
and 2005) resulting from changes in measurement dates and
the related application of the guidance applicable to the
initial compliance with SAB 108:
On April 19, 2006, we acquired 100% of the outstanding
stock of
e-Security,
Inc., a privately-held company headquartered in Vienna,
Virginia.
e-Security
provides security information, event management and compliance
software.
e-Security’s
products are now part of our identity and access management
sub-category.
The purchase price was approximately $71.7 million in cash,
plus transaction costs of $1.1 million.
e-Security’s
results of operations were included in our consolidated
financial statements beginning on the acquisition date.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
We estimated the fair values of the intangible assets as further
described below. Developed technology, customer relationships,
and trademarks/trade names are being amortized over their
estimated useful lives. Goodwill is not amortized but is
periodically evaluated for impairment.
The net tangible liabilities of
e-Security
consisted mainly of accounts payable and other liabilities
reduced by cash and cash equivalents, accounts receivable, and
fixed assets.
In-process research and development valued in the amount of
$2.1 million pertains to technology that was not
technologically feasible at the date of the acquisition, meaning
it had not reached the working model stage, did not contain all
of the major functions planned for the product, and was not
ready for initial customer testing. At the acquisition date,
e-Security
was working on the next two releases of its product called
Sentinel, one of which was released in the third calendar
quarter of 2006 and the second is to be released in the first
calendar half of 2007. These releases had not yet achieved
technological feasibility at the time of acquisition. The
in-process research and development was valued based on
discounting estimated future cash flows from the related
products. Completion of the development of the future upgrades
of the Sentinel products is dependent upon our successful
integration of the
e-Security
products with Novell products and services. The in-process
research and development does not have any alternative future
use and did not otherwise qualify for capitalization. As a
result, this amount was expensed upon acquisition.
Developed technology relates to
e-Security
products that were commercially available and could be combined
with Novell products and services. Discounted expected future
cash flows attributable to the products were used to determine
the value of developed technology. This resulted in a valuation
of approximately $6.9 million related to developed
technology that had reached technological feasibility.
The valuation of customer relationships in the amount of
$3.6 million, which relates primarily to customers under
maintenance agreements, was determined based on discounted
expected future cash flows to be received as a result of the
agreements and assumptions about their renewal rates.
Goodwill from the acquisition resulted from our belief that the
Sentinel products developed by
e-Security
are a valuable addition to our identity and access management
offerings. We believe they will help us remain competitive in
the security and compliance markets and increase our identity
and access management revenue. The goodwill from the
e-Security
acquisition was allocated among our geographic operating
segments (see Note AA).
If the
e-Security
acquisition had occurred on November 1, 2004, the unaudited
pro forma results of operations for the fiscal years 2006 and
2005 would have been:
Fiscal Year Ended
2006
2005
(Amounts in thousands)
Net revenue
$
971,773
$
1,050,387
Net income available to common
stockholders — diluted
$
13,261
$
372,201
Net income per share available to
common stockholders — diluted
$
0.04
$
0.84
Open
Invention Network LLC
In November 2005, Open Invention Network LLC (“OIN”)
was established by us, IBM, Philips, Red Hat and Sony. OIN is a
privately held company that has and intends to continue acquire
patents to promote Linux and open source by offering its
patents on a royalty-free basis to any company, institution or
individual that agrees not to assert its patents against the
Linux operating system or certain Linux-related applications. In
addition, OIN, in its discretion, will enforce its patents to
the extent it believes such action will serve to further protect
and promote Linux and open source. Each party contributed
capital with a fair value of $20.0 million to OIN. We
account for our 20% ownership interest using the equity method
of accounting. Our $20.0 million contribution consisted of
patents with a fair value of $15.8 million, including
$0.3 million of prepaid acquisition costs, and cash of
$4.2 million. At the
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
time of the contribution, the patents had a book value of
$14.4 million, including $0.3 million of prepaid
acquisition costs. The $1.4 million difference between the
fair value and book value of the patents is being amortized to
our investment in OIN account and equity income over the
remaining estimated useful life of the patents, which is
approximately nine years. Our investment in OIN as of
October 31, 2006 of $18.9 million is classified as
other assets in the consolidated balance sheets. In November
2006, our ownership interest in OIN decreased to approximately
17% due to the addition of NEC, a new investor in the company.
Onward
Novell
In December 2005, we acquired the remaining 50% ownership of our
sales and marketing joint venture in India from our joint
venture partner for approximately $7.5 million in cash and
other consideration. At October 31, 2005, $7.5 million
of our cash was held in an escrow account for the acquisition
and classified as other assets in the consolidated balance
sheet. The cash was paid out of the escrow account during the
first quarter of fiscal 2006. At the time of the acquisition,
the net book value of the minority interest was
$5.3 million. The $2.0 million difference between the
net book value of the minority interest and the amount we paid
for the remaining 50% ownership was recorded as goodwill.
Tally
Systems Corp.
On April 1, 2005, we acquired a 100% interest in Tally
Systems Corp., a privately-held company headquartered in
Lebanon, New Hampshire. Tally provides automated PC hardware and
software recognition products and services used by customers to
manage hardware and software assets. This acquisition enables us
to enhance our current ZENworks product offerings. The purchase
price was approximately $17.3 million in cash, plus
transaction costs of $0.4 million and excess facility costs
of $4.5 million recorded as an acquisition liability. In
addition, as a part of the acquisition, we set up a bonus pool
of $0.5 million for Tally employees who satisfy certain
criteria. This bonus pool was not accrued as a component of the
purchase price and any bonus payments out of this pool are
expensed as they are earned.
Tally’s results of operations were included in the
consolidated financial statements beginning on the acquisition
date.
The purchase price was allocated as follows:
Estimated
Estimated
Fair Value
Useful Life
(In thousands)
Fair value of net tangible assets
acquired
$
587
N/A
Identifiable intangible assets:
Developed technology
3,200
4 years
Contractual relationships
1,700
3 years
Customer relationships
280
3 years
Internal use software
90
3 years
Goodwill
16,308
Indefinite
Total net assets acquired
$
22,165
The purchase price was allocated to the tangible and
identifiable intangible assets and the excess of the total
purchase price over the amounts assigned was recorded as
goodwill. We estimated the fair values of the intangible assets
as further described below. Developed technology, contractual
relationships, customer relationships and internal use software
are being amortized over their estimated useful lives. Goodwill
is not amortized but is periodically evaluated for impairment.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
Net tangible assets of Tally consisted mainly of cash and cash
equivalents, accounts receivable and fixed assets reduced by
accounts payable, deferred revenue and other liabilities.
Developed technology relates to Tally’s products that are
commercially available and can be combined with Novell products
and services as well as proprietary technology that could be
used in future product releases. To determine the value of
developed technology, the expected future cash flows
attributable to the products was discounted to take into account
risk associated with these assets. This resulted in a valuation
of approximately $3.2 million related to developed
technology, which had reached technological feasibility.
The valuation of contractual relationships in the amount of
$1.7 million, which relates to a contract with an original
equipment manufacturer reseller in Europe, was determined based
on estimated discounted future cash flow to be received as a
result of the relationship.
Goodwill from the acquisition resulted from our belief that the
asset management products developed by Tally are a valuable
addition to our ZENworks product line and will help us remain
competitive in the hardware and software management products
market. The goodwill from the Tally acquisition was allocated
among our geographic operating segments (see Note AA).
Immunix,
Inc.
On April 27, 2005, we acquired a 100% interest in Immunix,
Inc., a privately-held company headquartered in Portland,
Oregon, which provides enterprise class, host intrusion
prevention solutions for the Linux platform. This acquisition
enables us to expand security offerings on the Linux platform.
The purchase price was approximately $17.3 million in cash,
plus transaction costs of $0.4 million. In addition, as a
part of the acquisition, we set up a bonus pool of
$0.4 million for Immunix employees who satisfy certain
criteria. This bonus pool was not accrued as a component of the
purchase price and any bonus payments out of this pool are
expensed as they are earned.
Immunix’s results of operations were included in the
consolidated financial statements beginning on the acquisition
date.
The purchase price was allocated as follows:
Estimated
Estimated
Fair Value
Useful Life
(In thousands)
Fair value of net tangible
liabilities assumed
$
(112
)
N/A
In-process research and development
480
N/A
Identifiable intangible assets:
Developed technology
2,400
3 years
Trademarks/trade names
120
3 years
Customer relationships
80
1 year
Internal use software
10
3 years
Goodwill
14,676
Indefinite
Total net assets acquired
$
17,654
The purchase price was allocated to the tangible and
identifiable intangible assets and the excess of the total
purchase price over the amounts assigned was recorded as
goodwill. We estimated the fair values of the intangible assets
as further described below. Developed technology,
trademark/trade names, customer relationships and internal use
software are being amortized over their estimated useful lives.
Goodwill is not amortized but is periodically evaluated for
impairment.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
Net tangible liabilities of Immunix consisted mainly of accounts
payable and other liabilities reduced by cash and cash
equivalents, accounts receivable, and fixed assets.
In-process research and development in the amount of
$0.5 million pertains to technology that was not
technologically feasible at the date of the acquisition, meaning
it had not reached the working model stage, did not contain all
of the major functions planned for the product, and was not
ready for initial customer testing. At the acquisition date,
Immunix was working on the next release of its product called
AppArmortm,
which was released in September 2005. This future release had
not yet achieved technological feasibility. The in-process
research and development was valued based on discounting
estimated future cash flows from the related products.
Completion of the development of the future upgrades of these
products is dependent upon our delivery of our Linux
applications products and our successful integration of the
Immunix products. The in-process research and development does
not have any alternative future use and did not otherwise
qualify for capitalization. As a result, the entire amount was
expensed upon acquisition.
Developed technology relates to Immunix products that are
commercially available and can be combined with Novell products
and services. Discounted expected future cash flows attributable
to the products were used to determine the value of developed
technology. This resulted in a valuation of approximately
$2.4 million related to developed technology which had
reached technological feasibility.
Goodwill from the acquisition resulted from our belief that the
Linux platform security products developed by Immunix are a
valuable addition to our Linux offerings and will help us remain
competitive in the Linux market and increase our Linux revenue.
The goodwill from the Immunix acquisition was allocated among
our geographic operating segments (see Note AA).
If the Tally and Immunix acquisitions had occurred on
November 1, 2003, the unaudited pro forma results of
operations for fiscal 2005 and 2004 would have been:
Net income available to common
stockholders — diluted
$
376,049
$
28,268
Net income per share available to
common stockholders — diluted
$
0.86
$
0.07
Salmon
Ltd.
On July 19, 2004, we purchased all of the outstanding stock
of Salmon Ltd., a privately-held information technology services
and consulting firm headquartered in Watford, England, for
approximately $8.2 million in cash, plus merger and
transaction costs of $0.6 million. In addition, we recorded
a deferred income tax liability of $1.2 million resulting
from the book and tax basis differences due to the
non-deductibility of identified intangible assets recorded in
connection with this acquisition.
The acquisition of Salmon enables us to expand our range of IT
consulting services in the United Kingdom. Salmon’s results
of operations have been included in the consolidated financial
statements beginning on the acquisition date.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
The purchase price was allocated as follows:
Estimated
Acquisition Cost
Asset Life
(In thousands)
Fair value of net tangible assets
acquired
$
3,007
N/A
Identifiable intangible assets:
Customer relationships
3,417
3 years
Non-compete agreement
422
3 years
Goodwill
6,146
Indefinite
Total acquisition cost
$
12,992
The purchase price has been allocated to the tangible and
identifiable intangible assets and the excess of the total
purchase price over the amounts assigned has been recorded as
goodwill. We estimated the fair values of the intangible assets
as further described below. Customer relationships and the
non-compete agreement are being amortized over their estimated
useful lives. Goodwill is not amortized but is periodically
evaluated for impairment.
The purchase agreement provides for contingent payments of up to
an additional $10.6 million based upon the future revenue
and profitability of both Salmon and Novell in the United
Kingdom over a period of two years. Approximately
$3.2 million of contingent payments were earned and
recorded to goodwill in fiscal 2005 and approximately
$5.7 million in fiscal 2006.
Net tangible assets of Salmon consisted mainly of cash and cash
equivalents, accounts receivable, fixed assets, accounts
payable, and other liabilities.
Goodwill from the acquisition resulted from our belief that the
consulting methodologies and expertise Salmon had developed are
valuable to our services business. We also believed it was more
beneficial to acquire such knowledge rather than to develop it
in-house. The goodwill from the Salmon acquisition was allocated
100% to our EMEA segment.
The valuation of customer relationships in the amount of
$3.4 million was determined by comparing estimated future
cash flow with and without the relationships in place.
The non-compete agreement in the amount of $0.4 million
relates to an agreement Salmon has with a key individual. The
valuation of the agreement was determined by estimating the
present value of future cash flows with and without the
non-compete agreement in place.
If the Salmon acquisition had occurred on November 1, 2003,
the unaudited pro forma results of operations for fiscal 2004
would have been:
Net income per share attributable
to common stockholders — basic
$
0.08
Net income per share attributable
to common stockholders — diluted
$
0.07
SUSE
LINUX AG
On January 12, 2004, we purchased substantially all of the
outstanding stock of SUSE LINUX AG (“SUSE”), a
privately-held company and a leading provider of Linux-based
products, for approximately $210.0 million in cash,
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
plus merger and transaction costs of $9.0 million. In
addition, we recorded a deferred income tax liability of
$3.0 million resulting from the book and tax basis
differences due to the non-deductibility of identified
intangible assets recorded in connection with this acquisition.
The deferred income tax liability was originally valued at
$17.3 million; however, during the fourth quarter of fiscal
2004, we completed a reorganization of certain subsidiaries of
SUSE LINUX AG in accordance with German merger law that resulted
in a reduction of the deferred tax liability and goodwill of
approximately $14.3 million.
The acquisition of SUSE enables us to offer a wide range of
enterprise solutions on the Linux platform, from the desktop to
the server to the mainframe. SUSE’s results of operations
have been incorporated into ours beginning on the acquisition
date.
The purchase price was allocated as follows:
Estimated
Acquisition Cost
Asset Life
(In thousands)
Fair value of net tangible assets
acquired
$
1,599
N/A
Identifiable intangible assets:
Customer relationships
13,385
3 years
Internal use software
5,864
3 years
Trademarks/trade names
24,221
Indefinite
Goodwill
176,963
Indefinite
Total acquisition costs
$
222,032
The purchase price has been allocated to the tangible and
identifiable intangible assets and the excess of the total
purchase price over the amounts assigned has been recorded as
goodwill. We estimated the fair values of the intangible assets.
Customer relationships and internal use software are being
amortized over their estimated useful lives. Trademarks, trade
names and goodwill are not amortized but are periodically
evaluated for impairment.
Net tangible assets of SUSE consisted mainly of cash and cash
equivalents, accounts receivable, fixed assets, accounts
payable, and other liabilities.
Goodwill from the acquisition resulted from our belief that the
technology SUSE had developed is valuable to our solutions
offerings. We also believed it was more beneficial to acquire
such knowledge rather than to develop it in-house. The goodwill
from the SUSE acquisition has been allocated to our geographic
segments based on anticipated future revenue to be derived from
this transaction.
Customer relationships in the amount of $13.4 million, net
of tax, related to the following types of contracts:
•
product maintenance services;
•
business support services;
•
partner memberships;
•
alliances; and
•
customer backlog.
The valuation of product maintenance services, business support
services, and partner memberships were determined by comparing
the estimated future cash flows generated from annual renewals
of each contract, versus such cash flows without the renewals of
such contracts. The valuation of alliances was determined using
the replacement cost approach. The valuation of customer backlog
was determined based on forecasted cash flows from firm orders
that had been placed that SUSE is expected to service. During
fiscal 2005, we determined that the
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
intangible assets related to customer backlog were impaired and
therefore we wrote off $0.1 million related to this
intangible asset.
Internal use software in the amount of $5.9 million relates
to proprietary know-how that is technologically feasible at the
acquisition date. These included three operational software
applications that SUSE used to package, test, and configure the
open source software for distribution to customers. The
valuation of the internal use software was determined using the
replacement cost approach, whereby estimates of the value are
based upon the estimated cost to recreate the software. During
fiscal 2005, we determined that some of the internal use
software applications we acquired from SUSE had become impaired,
and therefore we wrote off $1.0 million related to those
intangible assets.
The value of trademarks and trade names was determined based on
assigning a royalty rate to the revenue streams that were
expected from the products using the SUSE trade names. The
royalty rate was determined based on trade name recognition,
marketing support, and contribution of the trade name’s
value relative to the revenue drivers. The pre-tax royalty rate
of two percent was applied to the product revenue and discounted
to a present value, resulting in a valuation of approximately
$24.2 million.
If the SUSE acquisition had occurred on November 1, 2003,
the unaudited pro forma results of operations for fiscal 2004
would have been:
Net income per share attributable
to common stockholders — basic and diluted
$
0.08
E.
Divestitures
Celerant
On May 24, 2006, we sold our shares in Celerant consulting
to a group comprised of Celerant management and Caledonia
Investments plc for $77.0 million in cash. Celerant
consulting was acquired by Novell in 2001 as part of the
Cambridge Technology Partners acquisition. There are no ongoing
shareholder or operational relationships between us and Celerant
consulting. The sale of Celerant consulting does not impact our
IT consulting business.
Celerant consulting is accounted for as a discontinued
operation, and accordingly, its results of operations and the
gain on the sale of Celerant consulting are reported separately
in a single line item in our consolidated statement of
operations. The results of discontinued operations for fiscal
2006, 2005, and 2004 are as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
The gain on the sale of Celerant was calculated as follows:
(In thousands)
Sales price
$
77,014
Costs to sell
(3,248
)
73,766
Net book value of Celerant:
Cash
37,344
Accounts receivable, net
35,185
Other current assets
2,418
Goodwill
24,452
Other long-term assets
1,978
Current liabilities
(26,878
)
Minority interest
(2,993
)
Foreign exchange and other
(8,857
)
62,649
Gain on sale of Celerant before
income taxes
$
11,117
Japan
Consulting Group
On August 10, 2006, we sold our Japan consulting group
(“JCG”) to Nihon Unisys, LTD (“Unisys”) for
$4.0 million. $2.8 million of the selling price was
paid at closing and $1.2 million is contingent upon certain
key employees remaining employed by Unisys for the 12 month
period after closing. Unisys will pay $200,000 for each key
employee that is still employed by Unisys at the end of the
retention period up to $1.2 million. We recorded a loss in
our Asia Pacific segment of $8.3 million related to the
excess carrying amount of the JCG over its fair value. The loss
on the sale of the JCG was calculated as follows:
(In thousands)
Fair value of JCG (non-contingent
selling price)
$
2,800
Costs to sell
(393
)
2,407
Net book value of JCG:
Current assets
2,935
Goodwill
7,106
Current liabilities
(619
)
Foreign exchange and other
1,258
10,680
Loss on sale of JCG before income
taxes
$
8,273
It is anticipated that the JCG will continue to be a key partner
for Novell with respect to subcontracting consulting services.
Likewise, the cash flows from the JCG to Novell are also
anticipated to increase as Novell plans to be a subcontractor
for the JCG. As a result of our expected continuing involvement,
the JCG has not been presented as a discontinued operation.
At October 31, 2006, approximately $6.8 million of our
equity securities are designated for deferred compensation
payments, which are paid out as requested by the participants of
the plan.
At October 31, 2006, contractual maturities of our
short-term investments were:
Cost
Fair Market Value
(In thousands)
Less than one year
$
199,846
$
198,310
Due in one to two years
230,696
228,279
Due in two to three years
103,315
103,114
Due in more than three years
168,832
168,908
No contractual maturity
91,378
91,889
Total short-term investments
$
794,067
$
790,500
We had net unrealized losses related to short term investments
of $3.6 million and $7.6 million at October 31,2006 and 2005, respectively. We realized gains on the sales of
securities of $0.7 million, $0.8 million, and
$2.0 million, in fiscal years 2006, 2005, and 2004,
respectively, while realizing losses on sales of securities of
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
$2.1 million, $1.6 million, and $0.6 million,
during those same periods, respectively. At October 31,2006, $324.6 million of the investments with gross
unrealized losses of $3.7 million (out of the total gross
unrealized losses of $4.8 million) had been in a continuous
unrealized loss position for more than 12 months and
$187.9 million of the investments with gross unrealized
losses of $1.1 million had been in a continuous unrealized
loss position for less than 12 months. The unrealized
losses on our investments were caused primarily by interest rate
increases and not the credit quality of the issuers. The
unrealized losses generally represent only 1% of the cost basis
of the related investments and are not considered to be severe.
We have the ability and intent to hold these investments until a
recovery of fair value, which may be at maturity. We therefore
do not consider these investments to be
other-than-temporarily
impaired at October 31, 2006.
G.
Notes Receivable
In October 2004, we completed the sale of three buildings we
owned in Orem, Utah for $12.8 million, including a
$10 million note receivable. The note is collateralized by
the buildings and land as well as a personal guarantee and
letters of credit. As of October 31, 2006, the note
receivable had been paid off in full.
H.
Long-Term
Investments
The primary components of long-term investments were investments
made through the Novell Venture account or directly by us for
strategic direct investments in private long-term equity
securities, generally investments in venture capital funds that
are managed largely by external venture capitalists. 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.
During the fourth quarter of fiscal 2006, we sold all of our
rights, titles, interests and obligations for 22 of our 23
Venture Capital Funds, which were classified in long-term
investments in the consolidated balance sheet for total proceeds
of $71.3 million. As of October 31, 2006, the sale of
all but one-half of one fund had closed. We recorded a gain of
$17.9 million in fiscal 2006 related to the sale of the
funds that closed during the fourth quarter of fiscal 2006. The
remaining one-half of the fund that closed subsequent to fiscal
2006 resulted in an additional gain of $3.6 million on
proceeds of $5.0 million, which will be reported as part of
Novell’s fiscal 2007 first quarter results. In addition,
during fiscal 2006, we recognized a gain on the sale of other
long-term investments of $2.2 million. During fiscal 2005
and 2004, we recognized a gain of $2.1 million and
$3.3 million, respectively, on the sale of long-term
investments.
We routinely review our investments in private securities and
venture funds for impairment. To assess impairment, we analyze
historical and forecasted financial performance of the
investees, the volatility inherent in the external market for
these investments, and our estimate of the potential for
investment recovery based on all these factors. During fiscal
years 2006, 2005, and 2004, we recognized impairment losses on
long-term investments totaling $1.5 million,
$3.4 million, and $5.4 million, respectively.
During fiscal 2006, we sold corporate aviation assets and
certain corporate real estate assets with a net book value of
$19.0 million for $25.0 million, net of commissions,
resulting in a gain of $6.0 million.
Depreciation and amortization expense related to property, plant
and equipment totaled $31.2 million, $35.3 million,
and $40.0 million, in fiscal years 2006, 2005, and 2004,
respectively.
During fiscal 2005, we sold our facility in Lindon, Utah, which
had a net book value of $8.8 million, for
$10.4 million. In October 2004, we completed the sale of
three buildings we owned in Orem, Utah for $12.8 million,
including $10.0 million we financed though a secured note
receivable. This transaction resulted in a loss of approximately
$0.3 million.
J.
Goodwill
and Intangible Assets
Goodwill
The following is a summary of goodwill ultimately resulting from
the indicated acquisitions:
Goodwill is allocated to our reporting segments. In fiscal 2006,
we changed our reporting segments to Americas, EMEA, Asia
Pacific, and Celerant consulting (see Note AA). Previously,
Latin America was separate from North America, and Japan was
separate from Asia Pacific. Goodwill from our acquisition of
Cambridge
The adjustment of $7.1 million related to loss on sale of
the JCG included its proportional share of goodwill from our
SUSE acquisition of $4.9 million, our
e-Security
acquisition of $1.2 million and $1.0 million related
to various other acquisitions. Adjustments to goodwill during
fiscal 2006 decreased goodwill by $2.2 million and were
comprised of $6.6 million of tax-related adjustments, and a
$1.5 million reduction related to facility merger liability
releases where the costs to exit certain facilities were less
than originally estimated at the time of merger, offset somewhat
by a $5.7 million increase to Salmon goodwill primarily for
purchase price adjustments for a second and final contingent
earn-out payment that was earned during the third quarter of
fiscal 2006 and $0.3 million increase for foreign currency
adjustments. The $6.6 million tax adjustments were
attributable to SilverStream, Celerant consulting (acquired
through the acquisition of Cambridge Technology Partners),
Ximian, Tally, and Immunix, and related to the reversal of
deferred tax asset valuation allowances attributable to acquired
net operating loss carryforwards that were utilized by income
generated in the first nine months of fiscal 2006. Goodwill was
reduced for this adjustment because a portion of it related to
the valuation allowances on acquired net operating losses that
were established during the allocation of the purchase price for
each of these acquisitions.
On August 1, 2006, 2005 and 2004, we performed our annual
goodwill impairment test under SFAS No. 142. To
estimate the fair value of our reporting units, management made
estimates and judgments about future cash flows based on
assumptions that are consistent with both short-term and
long-range plans used to manage the business. We also considered
factors such as our market capitalization in assessing the fair
value of the reporting units. Based on the results of our
analyses, we determined that no goodwill impairment existed in
any of our reporting units for any year. This process requires
subjective judgment at many points throughout the analysis.
Changes in reporting units, and changes to the estimates used in
the analyses, including estimated future cash flows, could cause
one or more of the reporting units or indefinite-lived
intangibles to be valued differently in future periods. It is at
least reasonably possible that future analysis could result in a
non-cash goodwill impairment charge and the amount could be
material. Beginning in the first quarter of fiscal 2007, we will
begin operating and reporting our financial results in four new
business unit segments based on information solution categories.
We do not anticipate that implementation of the change in
segments will result in an impairment of our goodwill, however,
future performance of the new segments could result in a
non-cash impairment charge.
During fiscal 2006, we purchased developed technology for
$1.2 million, which was integrated into our Workspace
Solutions products, and we recorded $0.4 million for
trademarks, $3.6 million for customer relationships, and
$6.9 million for developed technology related to the
acquisition of
e-Security.
During fiscal 2006, we also contributed our patent portfolio
towards our 20% ownership interest in OIN. At the time of the
contribution, these patents, which we acquired for
$15.5 million, had a net book value of $14.1 million.
Developed technology at October 31, 2006 related primarily
to the Identity and Access Management product line as a result
of our acquisition of
e-Security,
the ZENworks product offerings from the acquisition of Tally and
Linux products from the acquisitions of Immunix. Trademarks and
trade names at October 31, 2006 related primarily to the
SUSE and
e-Security
individual product names, which we continue to use.
Customer/contractual relationships at October 31, 2006
related primarily to the customers we acquired as a part of our
acquisitions of
e-Security,
Tally, and Salmon. Internal use software at October 31,2006 related to certain build tools we acquired through our
acquisition of SUSE and
e-Security.
Non-compete agreement related to certain agreements that were
assumed through our acquisition of Salmon.
We analyze our intangible assets periodically for indicators of
impairment. During fiscal 2006, we determined that
$1.2 million of our trademarks and trade names were
impaired as they were no longer being utilized and no longer had
any value. These trademarks and trade names were written off and
the related charge recorded as a component of operating expense
in the consolidated statement of operations. Of the
$1.2 million impairment amount, $0.6 million related
to the Americas, $0.5 million related to EMEA, and
$0.1 million related to Asia Pacific.
During fiscal 2005, we also determined that $0.7 million of
our trademarks and trade names were impaired as they were no
longer being utilized and no longer had any value. These
trademarks and trade names were written off and the related
charge recorded as a component of operating expense in the
consolidated statement of operations. Of the $0.7 million
impairment amount, $0.3 million related to the Americas,
$0.3 million related to EMEA, with the remaining
$0.1 million relating to Asia Pacific. During fiscal 2005,
we also determined that internal use software intangible assets
with a net book value of $0.8 million were fully impaired.
The fair value was determined based on the fact that this
software, as well as a similar product from a competitor, is now
both available for free to the general public and the related
technology is not proprietary to either us or the competitor.
This internal use software intangible asset was written off and
the related charge recorded as a component of product
development in the operating expenses section of the
consolidated statement of operations. Of the $0.8 million
impairment amount, $0.4 million related to the Americas,
$0.3 million related to EMEA, with the remaining
$0.1 million relating to Asia
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
Pacific. In addition, during fiscal 2005, we determined that
$0.4 million of our intangible assets, primarily internal
use software, were no longer being utilized. Therefore, the
intangible assets were written off in fiscal 2005. No indicators
of impairment to our intangible assets were noted during fiscal
2004.
Amortization expense on intangible assets was
$12.8 million, $14.0 million, and $9.5 million in
fiscal 2006, 2005, and 2004, respectively. Amortization of
intangible assets is estimated to be approximately
$8.4 million in fiscal 2007, $5.6 million in fiscal
2008, $2.2 million in fiscal 2009, and zero in fiscal 2010.
K.
Income
Taxes
We account for income taxes in accordance with
SFAS No. 109, “Accounting for Income Taxes.”
SFAS No. 109 requires that we record deferred tax
assets and liabilities based upon the future tax consequence of
differences between the book and tax basis of assets and
liabilities, and other tax attributes. SFAS No. 109
also requires that we assess the ability to realize deferred tax
assets based upon a “more likely than not” standard
and provide a valuation allowance for any tax assets not deemed
realizable under this standard.
The components of income tax expense attributable to continuing
operations consist of the following:
In accordance with applicable accounting standards, we regularly
assess our ability to realize our deferred tax assets.
Assessments of the realization of deferred tax assets require
that management consider all available evidence, both positive
and negative, and make significant judgments about many factors,
including the amount and likelihood of future taxable income.
Based on all the available evidence, we continue to believe that
it is more likely than not that our remaining U.S. net
deferred tax assets, and certain foreign deferred tax assets,
are not currently realizable. As a result, we continue to
provide a full valuation reserve on our U.S. net deferred
tax assets and certain foreign deferred tax assets. The
valuation allowance on deferred tax assets increased by
$74.6 million in fiscal 2006 primarily due to stock based
compensation, new acquisitions and changes in our deferred tax
liabilities.
Due to the utilization of a significant amount of our net
operating loss carryforwards during fiscal 2005, substantially
all of the tax benefit received from the use of our remaining
net operating loss carryforwards offset U.S. taxable income
in 2006 was credited to additional paid-in capital or goodwill
and not to income tax expense. In addition, the windfall tax
benefits associated with stock-based compensation is also
credited to additional paid-in capital. In connection with our
adoption of SFAS No. 123(R), we elected to follow the
tax ordering laws to determine the sequence in which deductions
and net operating loss carryforwards are utilized. Accordingly,
during fiscal 2006, a tax benefit relating to stock options of
$15.3 million was credited to additional paid-in capital
and a benefit of $6.6 million was credited to goodwill.
As of October 31, 2006, we had unrestricted U.S. net
operating loss carryforwards for federal tax purposes of
approximately $72.0 million. Substantially all of the
benefit of the use of these loss carryforwards will be recorded
as a credit to additional paid-in capital. If not utilized,
these carryforwards will expire in fiscal years 2023 through
2025. Additionally, we had $222.0 million in net operating
loss carryforwards from acquired companies that will
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
expire in years 2019 through 2025. These loss carryforwards from
acquired companies can be utilized to offset future taxable
income, but are subject to certain annual limitations. The
benefit of the use of these loss carryforwards will be recorded
to first reduce goodwill relating to the acquisition, second to
reduce other non-current intangible assets relating to the
acquisition, and third to reduce income tax expense. Our
alternative minimum tax net operating losses approximate our
regular tax net operating losses disclosed above. In addition,
we have approximately $160.7 million of foreign loss
carryforwards, of which $5.4 million, $2.2 million,
$2.5 million, and $10.9 million are subject to
expiration in years 2007, 2008, 2009, and 2014, respectively.
The remaining losses do not expire. We have $141.4 million
in capital loss carryforwards, which, if not utilized, will
expire in fiscal years 2007 through 2011. We have foreign tax
credit carryforwards of $40.8 million that expire between
2009 and 2016, general business credit carryforwards of
$90.1 million that expire between 2010 and 2026, and
alternative minimum tax credit carryforwards of
$10.1 million that do not expire. We also have various
state net operating loss and credit carryforwards that expire in
accordance with the respective state statutes.
As of October 31, 2006, deferred tax assets of
approximately $47.0 million pertain to certain tax credits
and net operating loss carryforwards resulting from the exercise
of employee stock options. If realized, the tax benefit of these
credits and losses will be accounted for as a credit to
stockholders’ equity. Additionally, deferred tax assets of
$90.0 million relate to acquired entities. These acquired
deferred tax assets are subject to limitation under the change
of ownership rules of the Internal Revenue Code and have been
fully reserved. Approximately $63.7 million of future tax
benefit relating to these deferred tax assets will be recorded
to first reduce goodwill relating to the acquisition, second to
reduce other non-current intangible assets relating to the
acquisition, and third to reduce income tax expense.
We have permanently reinvested the earnings of several of our
foreign subsidiaries. Accordingly, we have not provided deferred
income taxes on the excess of the book basis over the tax
outside basis in the stock of these foreign subsidiaries. The
estimated unrecognized deferred income tax liability for this
difference is $0.7 million.
During fiscal 2006, we received a one-time tax benefit of
$4.2 million from the Internal Revenue Service relating to
net operating loss carrybacks made possible under the “Job
Creation and Worker Assistance Act of 2002.” We also
recorded a $2.6 million tax benefit attributable to the
favorable resolution of a tax examination at one of our foreign
subsidiaries. In 2004, we determined that the amount of reserves
related to tax exposures was less than the amount recorded in
the financial statements. As a result, we reduced the tax
reserves by $5.9 million. We continue to evaluate our tax
reserves under SFAS No. 5, “Accounting for
Contingencies,” which requires us to accrue for losses we
believe are probable and can be reasonably estimated. The amount
reflected in the consolidated balance sheet at October 31,2006 is considered adequate based on our assessment of many
factors including results of tax audits, past experience and
interpretations of tax law applied to the facts of each matter.
It is reasonably possible that our tax reserves could be
increased or decreased in the near term based on these factors.
During fiscal 2006, we recorded net restructuring expenses of
$4.4 million, of which $4.2 million related to
restructuring activity recognized during fiscal 2006 and
$0.2 million of which consisted of net adjustments related
to previously recorded merger liabilities and prior
restructuring liabilities. The adjustments to the merger
liabilities have been recorded in the statement of operations
since the changes have occurred outside the relevant purchase
price allocation period.
The fiscal 2006 restructuring expenses relate to efforts to
restructure our business to improve profitability. These efforts
are centered around three main initiatives: (1) improving
our sales model and sales staff specialization;
(2) integrated product development approach; and
(3) improvements in our administrative and support
functions. As all three of these initiatives are in the early
stages of being implemented, further restructurings are
anticipated during fiscal 2007. Specific actions taken during
the fiscal 2006 included reducing our workforce by 24 employees,
in sales, product development, consulting, general and
administrative, marketing and technical support, exiting a
facility and liquidating two legal entities. Total restructuring
expenses by reporting segment were as follows: EMEA
$1.7 million, Asia Pacific $1.4 million, Americas
$0.8 million, and corporate unallocated operating costs
$0.3 million.
The following table summarizes the activity during fiscal 2006
related to this restructuring:
As of October 31, 2006, the remaining unpaid balances
include accrued liabilities related to severance benefits which
will be paid out over the remaining severance obligation period,
various fees relating to the exited facility, which will be paid
out during fiscal 2007, and various fees related to the
liquidation of two legal entities, which will be paid out during
fiscal 2007.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
Fiscal
2005
During fiscal 2005, we recorded net restructuring expenses of
$57.7 million, of which $53.6 million related to
restructuring activity recognized during fiscal 2005 and
$5.3 million related to adjustments to previously recorded
merger liabilities to adjust lease accruals, less a net release
of $1.2 million related to an adjustment of prior period
restructuring liabilities. The adjustments to the merger
liabilities have been recorded in the statement of operations
since the changes have occurred outside the relevant purchase
price allocation period. These restructuring expenses related to
our continuing efforts to restructure our business to improve
profitability and to focus on Linux and identity-driven
computing. Specific actions taken included reducing our
workforce by 817 employees, primarily in product development,
consulting, sales, and general and administrative, though all
areas were impacted. Total restructuring expenses for fiscal
2005 by reporting segment were as follows: EMEA
$25.7 million, corporate unallocated operating costs
$12.6 million, Americas $14.1 million, and Asia
Pacific $5.3 million.
The following table summarizes the activity related to this
restructuring:
The $1.2 million adjustments of prior period restructuring
and merger liabilities are reflected in the appropriate
restructuring tables below. As of October 31, 2006, the
remaining unpaid balances include accrued liabilities related to
severance benefits which will be paid out over the remaining
severance obligation period, lease costs for redundant
facilities which will be paid over the respective remaining
contract terms, and various employee-related severance costs
which will be primarily paid over the next twelve months.
Fiscal
2004
During fiscal 2004, we recorded net restructuring expenses of
$19.1 million. These restructuring expenses were in
response to the evolution of our business strategy to develop a
competitive position in the Linux market. This strategy includes
plans to support the Linux operating system in addition to the
NetWare operating system, by offering our products and services
that run on Linux, NetWare and other platforms. The acquisitions
of Ximian and SUSE were direct results of the evolution in our
business strategy. These changes were made to address market
penetration for Linux and NetWare and to address NetWare revenue
declines. Specific actions taken include reducing our workforce
by 136 employees during fiscal 2004, mainly in consulting, sales
and product development in EMEA and the Americas. In addition,
we consolidated facilities, resulting in the closure of two
sales facilities and the disposal of excess equipment and tenant
improvements in the United States. Total restructuring expenses
for fiscal 2004 by reporting segment were as follows: the
Americas $5.7 million, EMEA $9.4 million, Asia Pacific
$0.4 million, and non-allocated corporate costs
$3.5 million.
As of October 31, 2006, the remaining balance of the fiscal
2004 restructuring expenses included accrued liabilities related
to lease costs for redundant facilities, which will be paid over
the respective remaining contract terms.
During fiscal 2004, we also recorded a $5.9 million
restructuring expense to increase prior restructuring
liabilities by $1.0 million and prior merger-related
liabilities by $4.9 million, and we released approximately
$2.1 million of excess restructuring reserves related to
prior restructuring events. The increases were the result of
changes in estimates used when the original expenses were
recorded primarily due to changes in the real estate market in
the United Kingdom. The net impact of the fiscal 2004
restructurings and the release of the prior restructuring excess
reserves was an expense of $22.9 million in fiscal 2004.
These adjustments, which pertain to separate restructuring
events, are included in the applicable tables that follow.
Fiscal
2003
During the third quarter of fiscal 2003, we recorded a pre-tax
restructuring expense 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-driven computing areas of our business and our
revised strategy. This strategy includes plans to support Linux
in addition to NetWare, by offering our 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. Total restructuring expenses by reporting segment
were as follows: the Americas $19.4 million, EMEA
$6.0 million, Asia Pacific $2.4 million.
During the fourth quarter of fiscal 2003, we accrued an
additional $10 million related to the completion of
restructuring activities that were part of the previous
quarter’s plan of restructuring. The additional accrual
relates mainly to the severance of approximately 100 employees
and the closing of excess facilities. Such activities occurred
mostly in the Americas reporting segment.
As of October 31, 2006, the remaining balance of the fiscal
2003 restructuring expense included accrued liabilities related
to redundant facilities and other fixed contracts, which will be
paid over the respective remaining contract terms.
During the third quarter of fiscal 2003, we also released
approximately $2.0 million related to excess restructuring
reserves related to the second quarter fiscal 2002 restructuring
event. The net impact of the third quarter fiscal 2003
restructuring and the release of the excess fiscal 2002
restructuring reserves was an expense of $26.0 million.
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
$8.0 million. The original liability was based on estimated
sublease rates and timing, which were affected by the decline in
the real estate market. This additional amount, which pertains
to three separate restructuring events, is included in the
applicable tables that follow.
Fiscal
2002
During the second quarter of fiscal 2002, we recorded a pre-tax
restructuring expense of $20.4 million. The expense was a
result of our continued move toward becoming a business
solutions provider, addressing changes in the market due to
technology changes, and becoming more customer-focused. Specific
actions taken included: reducing our workforce worldwide by
approximately 50 employees (less than 1%) across all functional
areas, consolidating facilities, closing offices in unprofitable
locations, and disposing of excess property and equipment.
As of October 31, 2006, the remaining balance of the second
quarter 2002 restructuring expense included redundant
facilities, which will be paid over the respective remaining
contract terms.
During the second quarter of fiscal 2002, we also released
approximately $1.3 million of excess accruals related to
the fiscal 2000 restructuring, which reduced the restructuring
costs reflected on the statement of operations for fiscal 2002.
These excess accruals relate to facilities and legal costs that
were not required.
Fourth
quarter of fiscal 2001
During the fourth quarter of fiscal 2001, we recorded
$50.7 million of pre-tax, restructuring expenses resulting
from changes in general market conditions, changing customer
demands, and the evolution of our business strategy, all of
which required us to restructure our operations. This business
strategy focused on business solutions designed to secure and
power the networked world across leading operating systems. 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 the overall cost structure
given then current revenue levels and our strategic 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 fits 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 and
control our business.
We have a $25.0 million bank line of credit available for
letter of credit purposes. At October 31, 2006, there were
standby letters of credit of $14.9 million outstanding
under this line, all of which are collateralized by cash. The
bank line expires on April 1, 2008.
The bank line is subject to the terms of a credit agreement
containing financial covenants and restrictions, none of which
are expected to affect our operations. Under the terms of the
credit agreement, we are required to provide a copy of our
quarterly reports filed with the SEC not later than 45 days
after and as of the end of each quarter. Due to
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
the voluntary review of our historical stock-based compensation
practices that was announced in August 2006 and not completed
until May 2007, we did not file our third quarter fiscal 2006
Form 10-Q,
fiscal 2006
Form 10-K,
and first quarter fiscal 2007
Form 10-Q
in a timely manner. On September 19, 2006, we reached an
agreement with Wells Fargo Bank, which extended the deadline for
providing a copy of all outstanding SEC filings until
November 30, 2006. This extension for providing a copy of
all outstanding SEC filings was further extended to
June 30, 2007.
In addition, at October 31, 2006, we had outstanding
letters of credit of an insignificant amount at other banks.
O.
Asset
Retirement Obligations
In March 2005, the Financial Accounting Standards Board
(“FASB”) issued Interpretation No. 47,
“Accounting for Conditional Asset Retirement
Obligations” (“FIN 47”), which responded to
a diversity in practice of how SFAS No. 143,
“Accounting for Asset Retirement Obligations,” was
being implemented. Specifically, FIN 47 recognized that,
when uncertainty about the timing
and/or
settlement method existed, some entities were recognizing the
fair value of asset retirement obligations (“AROs”)
prior to retirement of the asset, while others were recognizing
the fair value of the obligation only when it was probable that
the asset would be retired on a specific date or when the asset
was actually retired. FIN 47 clarified that the uncertainty
surrounding the timing and method of settlement when settlement
is conditional on a future event occurring should be reflected
in the measurement of the liability, not in the recognition of
the liability. AROs are must be recognized even though
uncertainty may exist about the timing or method of settlement
and therefore a liability should be recognized when the ARO is
incurred. We adopted FIN 47 on May 1, 2006.
FIN 47 requires an entity to recognize the cumulative
effect of initially applying FIN 47 as a change in
accounting principle.
Prior to the issuance of FIN 47, we accounted for AROs when
it became probable that the asset would be retired or when the
asset was actually retired. Our AROs result from facility
operating leases where we are the lessee and the lease agreement
contains a reinstatement clause, which generally requires any
leasehold improvements we make to the leased property be
removed, at our cost, at the end of the lease.
Upon adoption, we recorded an increase to leasehold improvements
within our fixed assets of $0.9 million, an increase to
accrued liabilities of $1.8 million and an expense recorded
as a cumulative effect of implementing this accounting change of
$0.9 million. The liability for AROs recorded as of
October 31, 2006 approximates the liability that would have
been recorded as of October 31, 2005.
P.
Senior
Convertible Debentures
On July 2, 2004, we issued and sold $600 million
aggregate principal amount of senior convertible debentures
(“Debentures”) due 2024. The Debentures pay interest
at 0.50% per annum, payable semi-annually on January 15 and
July 15 of each year, commencing January 15, 2005. Each
$1,000 principal amount of Debentures is convertible, at the
option of the holders, into approximately 86.79 shares of
our common stock prior to July 15, 2024 if (1) the
price of our common stock trades above 130% of the conversion
price for a specified duration, (2) the trading price of
the Debentures is below a certain threshold, subject to
specified exceptions, (3) the Debentures have been called
for redemption, or (4) specified corporate transactions
have occurred. None of the conversion triggers have been met as
of October 31, 2006. The conversion rate is subject to
certain adjustments. The conversion rate initially represents a
conversion price of $11.52 per share. Holders of the
Debentures may require us to repurchase all or a portion of
their Debentures on July 15, 2009, July 15, 2014 and
July 15, 2019, or upon the occurrence of certain events
including a change in control. We may redeem the Debentures for
cash beginning on or after July 20, 2009.
The Debentures were sold to an “accredited investor”
within the meaning of Rule 501 under the Securities Act of
1933, as amended (the “Securities Act”), in reliance
upon the private placement exemption afforded by
Section 4(2) of the Securities Act. The initial investor
offered and resold the Debentures to “qualified
institutional
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
buyers” under Rule 144A of the Securities Act. In
connection with the issuance of the Debentures, we agreed to
file a shelf registration statement with the SEC for the resale
of the Debentures and the common stock issuable upon conversion
of the Debentures and use our reasonable best efforts to cause
it to become effective, within an
agreed-upon
period. We also agreed to periodically update the shelf
registration and to keep it effective until the earlier of the
date the Debentures or the common stock issuable upon conversion
of the Debentures is eligible to be sold to the public pursuant
to Rule 144(k) of the Securities Act or the date on which
there are no outstanding registrable securities. We filed the
shelf registration statement and it became effective within the
initial required period. As of October 31, 2006, the common
stock issuable upon the conversion of the Debentures was
eligible for sale to the public under Rule 144(k).
Accordingly, we are no longer obligated to maintain the shelf
registration statement. We have evaluated the terms of the call
feature, redemption feature, and the conversion feature under
applicable accounting literature, including SFAS No. 133,
“Accounting for Derivative Instruments and Hedging
Activities,” and EITF
00-19,
“Accounting for Derivative Financial Instruments Indexed
to, and Potentially Settled in, a Company’s Own
Stock,” and concluded that none of these features should be
separately accounted for as derivatives.
In connection with the issuance of the Debentures, we incurred
$14.9 million of issuance costs, which primarily consisted
of investment banker fees and legal and other professional fees.
These costs are classified within Other Assets and are being
amortized as interest expense using the effective interest
method over the term from issuance through the first date that
the holders can require repurchase of the Debentures, which is
July 15, 2009. Amortization expense related to the issuance
costs was $3.0 million, and interest expense on the
Debentures was $3.0 million for the fiscal year ended
October 31, 2006 and 2005. We made cash payments for
interest of $3.0 million and $3.1 million in fiscal
2006 and 2005, respectively.
Due to the voluntary review of our historical stock-based
compensation practices that was announced in August 2006 and not
completed until May 2007, we did not file our third quarter
fiscal 2006
Form 10-Q
in a timely manner. In September 2006, we received a letter from
Wells Fargo Bank, N.A., the trustee of our Debentures, which
asserted that Novell is in default under the indenture because
of the delay in filing its
Form 10-Q
for the period ended July 31, 2006. The letter stated that
the asserted default would not become an “event of
default” under the indenture if the company cured the
default within 60 days after the date of the notice. We
believe that these above-mentioned notices of default were
invalid and without merit because the indenture only requires us
to provide the trustee copies of SEC reports within 15 days
after such filings are actually made. However, in order to avoid
the expense and uncertainties of further disputing whether a
default under the indenture had occurred, we solicited consents
from the holders of the Debentures to proposed amendments to the
indenture that would give Novell until Thursday, May 31,2007 to become current in our SEC reporting obligations and a
waiver of rights to pursue remedies available under the
indenture with respect to any default caused by our not timely
filing SEC reports. On November 9, 2006, we received
consents from the holders of the Debentures, and therefore we
and the trustee entered into a first supplemental indenture
implementing the proposed amendments described in the consent
solicitation statements. Under the terms of the consent
solicitation and first supplemental indenture, we will pay an
additional 7.3% per annum, or $44.0 million, in
special interest on the Debentures from November 9, 2006
to, but excluding November 9, 2007. In accordance with
EITF 96-19,
“Debtor’s Accounting for a Modification or Exchange of
Debt Instruments”
(“EITF 96-19”),
since the change in the terms of the Debentures did not result
in substantially different cash flows, this change in terms is
accounted for as a modification, and therefore the additional
$44.0 million of special interest payments will be expensed
over the period from November 9, 2006 through July 15,2009. During the period of November 9, 2006 through
July 15, 2009, the new effective interest rate on this
debt, including the $44.0 million, will be 3.2%. The
$44.0 million will be paid as special interest payments
over three periods; the first payment of $8.1 million
occurred in January 2007. The next payment of $22.0 million
will occur in July 2007 and the final payment of
$13.9 million will occur in January 2008. In addition, we
paid approximately $1.5 million in fees to Citigroup for
work performed on the consent process.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
Q.
Guarantees
We have provided guarantees to a foreign taxing authority in the
amount of $3.3 million related to foreign tax audits. It is
expected that the term of the foreign tax audit guarantees will
continue until the conclusion of the audits. In addition, we
have provided a guarantee to a customer for the performance of
one of our foreign subsidiaries on a maintenance contract in the
amount of $0.4 million and a guarantee to a vendor of our
foreign subsidiaries to guarantee lease payments in the amount
of $0.2 million. At October 31, 2006, we had
$2.6 million accrued for these guarantees. We have also
provided other guarantees of insignificant amounts for various
purposes.
Like most software vendors, we are party to a variety of
agreements, primarily with customers, resellers, distributors,
and independent hardware and software vendors (generally,
“customers”), pursuant to which we may be obligated to
indemnify the customer against third party allegations of
intellectual property infringement resulting from the
customer’s use of our offerings or distribution of our
software, either of which may include proprietary
and/or open
source materials. In such circumstances, the customer must
satisfy specified conditions to qualify for indemnification. Our
obligations under these agreements may be limited in terms of
time and/or
amount, and in some instances we may have recourse against third
parties.
It is not possible to predict the maximum potential amount of
future payments under these guarantees and indemnifications or
similar agreements due to the conditional nature of our
obligations and the unique facts and circumstances involved in
each particular agreement. To date, we have not been required to
make any payment guarantees and indemnifications. We do not
record a liability for potential litigation claims related to
indemnification agreements with our customers unless and until
we conclude the likelihood of a material obligation is probable
and estimable.
R.
Commitments
and Contingencies
As of October 31, 2006, we have various operating leases
related to our facilities. These leases have minimum annual
lease commitments of $27.0 million in fiscal 2007,
$23.9 million in fiscal 2008, $16.3 million in fiscal
2009, $10.3 million in fiscal 2010, $8.4 million in
fiscal 2011, and $33.1 million thereafter. Furthermore, we
have $29.3 million of minimum rentals to be received in the
future from subleases.
Rent expense, net of sublease rental income, for operating and
month-to-month
leases was $18.5 million, $23.3 million, and
$21.5 million, in fiscal 2006, 2005, and 2004, respectively.
S.
Legal
Proceedings
Between September and November of 2006, seven separate purported
derivative complaints were filed in Massachusetts state and
federal courts against us and many of our current and former
officers and directors asserting various claims related to
alleged options backdating. Novell is also named as a nominal
defendant in these complaints, although the actions are
derivative in nature and purportedly asserted on behalf of
Novell. These actions arose out of our announcement of a
voluntary review of our historical stock-based compensation
practices. The complaints essentially allege that since 1999, we
have materially understated our compensation expenses and, as a
result, overstated actual income. The five actions filed in
federal court have been consolidated, and the parties to that
action have stipulated that the defendants’ answer or
motion to dismiss will be due 45 days after the filing of
an amended complaint. The two actions filed in state court have
also been consolidated and transferred to the Business
Litigation Session of Massachusetts Suffolk County Superior
Court, and the parties to that action have stipulated that the
defendants’ answer or motion to dismiss will be due
30 days after the filing of an amended complaint. We are in
the process of evaluating these claims.
On November 12, 2004, we filed suit against Microsoft in
the U.S. District Court, District of Utah. We are seeking
treble and other damages under the Clayton Act, based on claims
that Microsoft eliminated competition in the office productivity
software market during the time that we owned the WordPerfect
word-processing application
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
and the Quattro Pro spreadsheet application. Among other claims,
we allege that Microsoft withheld certain critical technical
information about Windows from us, thereby impairing our ability
to develop new versions of WordPerfect and other office
productivity applications, and that Microsoft integrated certain
technologies into Windows designed to exclude WordPerfect and
other Novell applications from relevant markets. In addition, we
allege that Microsoft used its monopoly power to prevent
original equipment manufacturers from offering WordPerfect and
other applications to customers. On June 10, 2005,
Microsoft’s motion to dismiss the complaint was granted in
part and denied in part. On September 2, 2005, Microsoft
sought appellate review of the District Court’s denial of
its motion. On January 31, 2006, the Fourth Circuit Court
of Appeals granted interlocutory review of Microsoft’s
appeal with respect to the question of whether Novell lacked
standing to assert the antitrust claims allowed by the District
Court. As a result of Microsoft’s appeal, Novell filed a
notice of appeal of the District Court’s dismissal of
Novell’s other causes of action. Both appeals have been
fully briefed and argued before the Circuit Court; however, it
is uncertain when a final decision can be expected. 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.
On January 20, 2004, the SCO Group, Inc. (“SCO”)
filed suit against us in the Third Judicial District Court of
Salt Lake County, State of Utah. We removed the action to the
U.S. District Court, District of Utah. SCO’s original
complaint alleged that our public statements and filings
regarding the ownership of the copyrights in UNIX and UnixWare
have harmed SCO’s business reputation and affected its
efforts to protect its ownership interest in UNIX and UnixWare.
The District Court dismissed the original complaint, but allowed
SCO an opportunity to file an amended complaint, which SCO did
on July 9, 2004. On July 29, 2005, Novell filed an
answer to the amended complaint setting forth numerous
affirmative defenses and counterclaims alleging slander of title
and breach of contract, and seeking declaratory actions and
actual, special and punitive damages in an amount to be proven
at trial. On February 3, 2006, SCO filed a Second Amended
Complaint alleging that Novell has violated the non-competition
provisions of the agreement under which we sold our Unix
business to SCO, that we failed to transfer all of the Unix
business, that we infringe SCO’s copyrights, and that we
are engaging in unfair competition by attempting to deprive SCO
of the value of the Unix technology. SCO seeks to require us to
assign all copyrights that we have registered in UNIX and
UnixWare to SCO, to prevent us from representing that we have
any ownership interest in the UNIX and UnixWare copyrights, to
require us to withdraw all representations we have made
regarding our ownership of the UNIX and UnixWare copyrights, and
to cause us to pay actual, special and punitive damages in an
amount to be proven at trial. As a result of SCO’s Second
Amended Complaint, SUSE filed a demand for arbitration before
the International Court of Arbitration in Zurich, Switzerland,
pursuant to a “UnitedLinux Agreement” in which SCO and
SUSE were parties. Hearings before the International Court
Tribunal are currently set for December 2007. The issues related
to SCO’s claimed ownership of the UNIX copyrights and
Novell’s rights under the UNIX agreements with SCO are
currently scheduled for trial in the U.S. District Court,
District of Utah, for September 2007. We believe that we have
meritorious defenses to SCO’s claims and meritorious
support for our counterclaims. Accordingly, we intend to
vigorously pursue our claims while defending against the
allegations in SCO’s complaint. 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.
On July 12, 2002, Amer Jneid and other related plaintiffs
filed a complaint in the Superior Court of California, Orange
County, alleging claims for breach of contract, fraud in the
inducement, misrepresentation, infliction of emotional distress,
rescission, slander and other claims against us in connection
with our purchase of so-called “DeFrame” technology
from the plaintiffs and two affiliated corporations (TriPole
Corporation and Novetrix), and employment agreements we entered
into with the plaintiffs in connection with the purchase. The
complaint sought unspecified damages, including “punitive
damages.” The dispute (resulting in these claims) arises
out of the plaintiffs’ assertion that we failed to properly
account for license distributions which the plaintiffs claim
would have entitled them to certain bonus payouts under the
purchase and employment agreements. After a lengthy jury trial,
the jury returned a verdict in favor of the various plaintiffs
on certain contract claims and in favor of us on the
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
remaining claims. The jury verdict found in favor of the
plaintiffs and against us in the amount of approximately
$19 million. Our equitable defenses are expected to be
ruled on by the trial court in late spring 2007. Depending on
the outcome of such rulings, a judgment against us may be
entered at such time. In the event a final judgment is entered
by the trial court, we intend to file various post-trial
motions, including a motion for judgment notwithstanding the
verdict. If necessary, we intend to pursue an appeal of any
resulting judgment.
SilverStream, which we acquired in July 2002, 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 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 the issuers,
including SilverStream. A Consolidated Amended Complaint with
respect to all of these companies was filed in the
U.S. District Court, Southern District of New York, on
April 19, 2002. The plaintiffs are seeking monetary
damages, statutory compensation and other relief that may be
deemed appropriate by the Court. While we believe that
SilverStream and its former officers and directors have
meritorious defenses to the claims, a tentative settlement has
been reached between many of the defendants and the plaintiffs,
which contemplates a settlement of the claims, including the
ones against SilverStream and its former directors and officers.
The settlement agreement, however, has not been finally approved
by the Court. 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.
During fiscal 2006, we recorded a $24.0 million adjustment
to reflect changes in facts and circumstances surrounding our
outstanding contingencies, and a gain of $1.2 million
related to a settlement we received from one of our insurance
companies for past legal expenses that were covered under our
insurance policies.
We account for legal reserves under SFAS No. 5, which
requires us to accrue for losses we believe are probable and can
be reasonably estimated. We evaluate the adequacy of our legal
reserves based on our assessment of many factors, including our
interpretations of the law and our assumptions about the future
outcome of each case based on current information. It is
reasonably possible that our legal reserves could be increased
or decreased in the near term based on our assessment of these
factors. We are currently party to various legal proceedings and
claims involving former employees, either asserted or
unasserted, which arise in the ordinary course of business.
While the outcome of these matters cannot be predicted with
certainty, we do not believe that the outcome of any of these
claims or any of the above mentioned legal matters will have a
material adverse effect on our consolidated financial position,
results of operations or cash flows.
T.
Redeemable
Preferred Stock
On March 23, 2004, we entered into a definitive agreement
with IBM in connection with IBM’s previously announced
$50 million investment in Novell. The primary terms of the
investment were negotiated in November 2003 and involved the
purchase by IBM of 1,000 shares of our Series B
redeemable preferred stock (“Series B Preferred
Stock”) that are convertible into 8 million shares of
our common stock at a conversion price of $6.25 per common
share. The Series B Preferred Stock is entitled to a
dividend of 2% per annum, payable quarterly in cash.
Dividends on the Series B Preferred Stock during fiscal
2006, 2005, and 2004 amounted to $0.2 million,
$0.5 million, and $0.4 million, respectively. Dividend
payments made during fiscal 2006, 2005, and 2004 were
$0.2 million, $0.6 million, and $0.3 million,
respectively.
Because the fair value of our common stock of $9.46 per
share on March 23, 2004 was greater than the conversion
price of $6.25 per share of Series B Preferred Stock,
we recorded a one-time, non-cash deemed dividend
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
of $25.7 million pursuant to EITF Issue
No. 98-5,
“Accounting for Convertible Securities with Beneficial
Conversion Features or Contingently Adjustable Conversion
Ratios.”
The Series B Preferred Stock is convertible at any time at
the option of the holder and has a liquidation value equal to
$50,000 per share. Each share of Series B Preferred
Stock issued and outstanding is entitled to the number of votes
equal to the number of shares of common stock into which it is
convertible. The Series B Preferred Stock is senior to the
common stock with respect to dividends and liquidation
preferences. The Series B Preferred Stock is redeemable at
our option, and by the holder only under certain change in
control circumstances. Because the redemption is not certain to
occur, the Series B Preferred Stock is not required to be
classified as a liability, but rather is classified in the
mezzanine section of the balance sheet and is stated at
redemption value.
On June 17, 2004, 500 shares of Series B
Preferred Stock, with a carrying value of $25.0 million,
were converted into 4.0 million shares of our common stock.
On September 21, 2005, 313 shares of Series B
Preferred Stock, with a carrying value of $15.7 million,
were converted into 2.5 million shares of our common stock.
Subsequent to the end of fiscal 2006, IBM converted the
remaining outstanding shares of Series B Preferred Stock
into 1.5 million shares of our common stock.
In December 1988, the Board of Directors adopted a Preferred
Share Rights Agreement. This plan was most recently amended in
September 1999 and expired on November 21, 2006. The plan
provided for a dividend of rights, which could not be exercised
until certain events occurred, to purchase shares of our
Series A Preferred Stock. Each common stockholder of record
had one right for each share of common stock owned. This plan
was adopted to ensure that all of our stockholders receive fair
value for their common stock in the event a third party proposes
to acquire us and to guard against coercive tactics to gain
control of us without offering fair value to our stockholders.
In connection with the plan, we had 499,000 authorized shares of
Series A Preferred Stock with a par value of $0.10 per
share, none of which were issued or outstanding at
October 31, 2006 or October 31, 2005.
Stock
Repurchase
On September 22, 2005, our board of directors approved a
share repurchase program for up to $200.0 million of our
common stock through September 21, 2006. On April 4,2006, our board of directors approved an amendment to the share
repurchase program increasing the limit on repurchase from
$200.0 million to $400.0 million and extending the
program through April 3, 2007. As of July 31, 2006, we
had completed the repurchase program purchasing
51.5 million shares of common stock at an average price of
$7.76 per share.
Stock
Option Plans
We currently have five broad-based stock option plans with
options available for grant to employees and consultants, and
one stock option plan with options available for grant to
members of the Board of Directors. We typically grant
nonstatutory options at fair market value on the date of grant.
In addition, we also grant restricted stock purchase rights and
restricted units. Our current practice is to grant options to
mid- and upper-management at time of hire. We also maintain an
on-going annual grant program under which certain employees are
eligible for consideration for performance and retention grants.
These plans are discussed in more detail below.
The 2000
Stock Plan and the 1991 Stock Plan
The 2000 Stock Plan (the “2000 Plan”), with an
aggregate of 16 million shares of common stock reserved for
issuance, provides for the grant of incentive stock options,
nonstatutory stock options, restricted stock purchase rights and
common stock equivalents (“CSE’s”) and was
approved by stockholders in April 2000. Shares of
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
common stock may also be issued under the 2000 Plan to satisfy
our obligations under our Stock Based Deferred Compensation
Plan. As of October 31, 2006, a total of
6,048,122 shares of common stock remained available for
issuance pursuant to the 2000 Plan. The 1991 Stock Plan (the
“1991 Plan”), with an aggregate of
80,277,765 shares of common stock reserved for issuance,
provides for the grant of nonqualified stock options, restricted
stock purchase rights, restricted units, stock appreciation
rights and long-term performance awards and was most recently
approved by the stockholders in March 1994. As of
October 31, 2006, a total of 14,508,574 shares of
common stock remained available for issuance pursuant to the
1991 Plan. Under both plans, options are granted at the fair
market value of our common stock at the date of grant (defined
in the plans as the closing price on the day prior to the grant
date), generally vest over 48 months (although options have
been granted that vest over 24 or 36 months), are
exercisable upon vesting and expire either four, eight or ten
years from the date of grant. Under both plans, restricted stock
purchase rights have been granted providing for the sale of our
common stock to certain employees at a purchase price of
$0.10 per share. Shares of restricted common stock are
subject to repurchase by us at the original purchase price until
such time as they have vested. Grants of restricted stock
generally vest over a three- or four-year period. There were
553,054 shares of outstanding restricted common stock that
remained unvested and subject to repurchase at October 31,2006. Under the 1991 Plan, restricted units may be granted to
employees. These units vest annually over three years or at the
end of three years from their date of grant, have an exercise
price of either $0 or $0.10 and are payable in common stock.
Under the 2000 Plan, CSE’s may be issued to non-employee
members of our Board of Directors, who elect to have all or a
portion of their board retainer deferred through the purchase of
CSE’s. The purchase price for CSE’s is equal to the
fair market value of our common stock on the date of purchase
(defined in the plan as the closing price on the day prior to
the grant date). Participating board members who defer
compensation into the award of CSE’s specify the future
date such common stock equivalents will be converted into shares
of our common stock.
The 2000
Nonqualified Stock Option Plan
The 2000 Nonqualified Stock Option Plan (the “2000 NQ
Plan”), with an aggregate of 28 million shares of
common stock reserved for issuance, provides for the grant of
nonstatutory stock options. As of October 31, 2006, a total
of 12,106,204 shares of common stock remained available for
issuance pursuant to the 2000 NQ Plan. Under the 2000 NQ Plan,
nonstatutory options are granted at the fair market value of our
common stock at the date of grant (defined in the plan as the
closing price on the day prior to the grant date), generally
vest over 48 months (although options have been granted
that vest over 24 months), are exercisable upon vesting and
expire either four, eight or ten years from the date of grant.
The
Novell/SilverStream 1997 Stock Option Plan
The Novell/SilverStream 1997 Stock Option Plan (the
“SilverStream 1997 Plan”), with an aggregate of
12,530,883 shares of common stock reserved for issuance,
after taking into account the retirement of
8,090,788 shares in January 2004 in connection with
Novell’s 2003 stock option exchange program, provides for
the grant of incentive stock options and nonstatutory stock
options, was most recently approved by stockholders of
SilverStream in May of 2002, and was assumed by us in July 2002
in connection with our acquisition of SilverStream. As of
October 31, 2006, a total of 2,234,883 shares of
common stock remained available for issuance pursuant to the
SilverStream 1997 Plan. Under the SilverStream 1997 Plan,
options are granted at the fair market value of our common stock
at the date of grant (defined in the plan as the closing price
on the day prior to the grant date). Options that had been
granted prior to our acquisition of SilverStream were granted at
the fair market value of SilverStream’s common stock at the
date of grant and were converted to options to acquire our
common stock based on the terms of the acquisition. Options
generally vest over 48 months (although options had been
granted before our acquisition of SilverStream that vest over 42
or 60 months), are exercisable upon vesting, and expire
eight or ten years from date of grant.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
The
Novell/SilverStream 2001 Stock Option Plan
The Novell/SilverStream 2001 Stock Option Plan (the
“SilverStream 2001 Plan”), with an aggregate of
2,426,494 shares of common stock reserved for issuance,
provides for the grant of nonstatutory stock options. We assumed
the SilverStream 2001 Plan in July 2002 in connection with the
acquisition of SilverStream. As of October 31, 2006, a
total of 722,316 shares of common stock remain available
for issuance pursuant to the SilverStream 2001 Plan. Under the
SilverStream 2001 Plan, options are granted at the fair market
value of our common stock at the date of grant. Options that had
been granted prior to our acquisition of SilverStream were
granted at the fair market value of SilverStream’s common
stock at the date of grant and were converted to options to
acquire our common stock based on the terms of the acquisition.
Options generally vest over 48 months (although options had
been granted before our acquisition of SilverStream that vest
over 42 months), are exercisable upon vesting and expire
eight or ten years from date of grant.
The Stock
Option Plan for Non-Employee Directors
The Stock Option Plan for Non-Employee Directors (the
“Director Plan”), with an aggregate of
1,500,000 shares of common stock reserved for issuance,
provides for two types of non-discretionary stock option grants
to non-employee members of our Board of Directors: an initial
grant of 30,000 options at the time a director is first elected
or appointed to the Board, with options vesting over four years
and exercisable upon vesting; and an annual grant of 15,000
options upon reelection to the Board, with options vesting over
two years and exercisable upon vesting. Under the Director Plan,
options are granted at the fair market value of our common stock
at the date of grant (defined in the plans as the closing price
on the day prior to the grant date). The Director Plan was
approved by the stockholders in April 1996. As of
October 31, 2006, a total of 349,500 shares of common
stock remained available for issuance pursuant to the Director
Plan. Options expire ten years from the date of grant.
Additional
Stock Option Plans
Miscellaneous plans assumed due to acquisitions (including two
additional SilverStream plans not mentioned above that were also
assumed in connection with the SilverStream acquisition) have
terminated, and no further options may be granted under these
plans. Options previously granted under these plans that have
not yet expired or otherwise become unexercisable continue to be
administered under such plans, and any portions that expire or
become unexercisable for any reason shall be cancelled and be
unavailable for future issuance.
A summary of the status of our stock award plans as of
October 31, 2006, 2005 and 2004 is presented below.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
Employee
Stock Purchase Plan
In May 2003, the stockholders approved a 10.0 million share
increase to the Company’s 1989 Employee Stock Purchase Plan
(the “Purchase Plan”). As amended, we are now
authorized to issue up to 34.0 million shares of our common
stock to our employees who work at least 20 hours a week
and more than five months a year. In May 2003, the Purchase Plan
was further amended to limit the number of shares that can be
purchased by employees during any fiscal year to
3.0 million shares. Under the terms of the Purchase Plan,
there are two six-month offer periods per year, and employees
can choose to have up to 10% of their salary withheld to
purchase our common stock. The employee stock purchase plan was
suspended in April 2005 and then amended in September 2005 to
provide that the purchase price of the common stock is 95% of
the fair market value of Novell’s common stock on the
purchase date. The amended plan began in January 2006.
Under the Purchase Plan, we issued 0.1 million shares to
employees in fiscal 2006, 1.2 million shares to employees
in fiscal 2005 and 2.2 million shares to employees in
fiscal 2004. This plan has approximately 4.9 million shares
available for future issuance.
Shares Reserved
for Future Issuance
As of October 31, 2006, there were 78,626,888 shares
of common stock reserved for stock option exercises,
4,893,273 shares of common stock reserved for issuances
under the stock purchase plan, 1,496,000 shares reserved
for the conversion of Series B Preferred Stock, and
52,074,300 shares reserved for the conversion of the
Debentures.
V.
Stock-Based
Compensation
As discussed in Note B, we adopted
SFAS No. 123(R) on November 1, 2005. Prior to
fiscal 2006, we accounted for stock-based compensation under
APB 25. The adoption of SFAS No. 123(R) had a
significant impact on our results of operations. Our
consolidated statement of operations for fiscal 2006, 2005, and
2004 includes the following amounts of stock-based compensation
expense in the respective captions:
Total unrecognized stock-based compensation expense expected to
be recognized over an estimated weighted-average amortization
period of 2.6 years was $69.4 million at
October 31, 2006.
SFAS No. 123(R) also requires the benefits of tax
deductions in excess of recognized compensation cost to be
reported as a financing cash flow, rather than as an operating
cash flow as required under APB 25 and related
interpretations. This requirement reduced our net operating cash
flows and increased our net financing cash flows by
$15.3 million during fiscal 2006. Our deferred compensation
cost at October 31, 2005 of $3.4 million, which was
accounted for under APB 25, was reclassified into
additional paid-in capital as required under
SFAS No. 123(R).
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
The cumulative effect related to outstanding restricted stock
awards as of October 31, 2005, which are not expected to
vest based on an estimate of forfeitures, was not material.
As a result of adopting SFAS No. 123R on
November 1, 2005, our income from continuing operations
before income taxes and net income for the fiscal year ended
October 31, 2006 are lower by $25.4 million and our
basic and diluted earnings per share from continuing operations
are lower by $0.07 than if we had continued to account for the
share-based compensation under APB No. 25.
Stock
Plans
All stock-based compensation awards are issued under one of the
six stock award plans discussed in Note U. When granting
stock options, we grant nonstatutory options at fair market
value on the date of grant (defined in the plans as the closing
price on the day prior to the grant date). We also grant
restricted stock and restricted stock units.
Time-Based
Stock Awards
Our weighted-average assumptions used in the Black-Scholes
valuation model for equity awards with time-based vesting
provisions granted during the fiscal 2006 are shown below:
The expected volatility rate was estimated based on equal
weighting of the historical volatility of Novell common stock
over a four year period and the implied volatilities of Novell
common stock. The expected term was estimated based on our
historical experience of exercise, cancellation, and expiration
patterns. The risk-free interest rates are based on four year
U.S. Treasury STRIPS.
The pre-vesting forfeiture rate used for the fiscal year ended
October 31, 2006 was 10%, which was based on historical
rates and forward-looking factors. As required under
SFAS No. 123(R), we will adjust the estimated
forfeiture rate to our actual experience.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
A summary of the time-based stock awards, which includes stock
options and restricted stock units, as of October 31, 2006,
and changes during the fiscal year then ended, is as follows:
The weighted-average grant-date fair value of time-based stock
awards granted during fiscal 2006 was $5.97. The total intrinsic
value of stock options exercised during fiscal 2006 was
$40.2 million. As of October 31, 2006, there was
$59.3 million of unrecognized compensation cost related to
time-based stock awards. That cost is expected to be recognized
over a weighted-average period of 2.5 years.
A summary of time-based unvested restricted stock as of
October 31, 2006, and changes during the year then ended,
is as follows:
As of October 31, 2006, there was $2.0 million of
unrecognized compensation cost related to unvested restricted
stock. That cost is expected to be recognized over a
weighted-average period of 2.5 years. The total fair value
of time-based restricted stock that vested during fiscal 2006
was $5.3 million.
Performance-Based
and Market-Condition Awards
We have issued performance-based equity awards to certain senior
executives. These awards have the potential to vest over one to
four years upon the achievement of certain Novell-specific
financial performance goals, specifically related to the
achievement of budgeted revenue and operating income targets in
each fiscal year. The performance-based options were granted at
an exercise price equal to the fair market value of Novell
common stock on the date the option was legally granted and have
a contractual life ranging from two to eight years.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
We have issued market-condition equity awards to certain senior
executives the vesting of which is accelerated or contingent
upon the price of Novell common stock meeting certain
pre-established stock price targets. Certain of these awards
will vest on the sixth anniversary of the grant date if the
market-condition was not previously achieved. The
market-condition options are generally granted at an exercise
price equal to the fair market value of Novell common stock on
the date of the grant and have a contractual life of eight
years. No market-condition awards were granted during the twelve
months ended October 31, 2006.
The fair value of each performance-based and market-condition
option was estimated on the grant date using the Black-Scholes
option valuation model without consideration of the performance
measures or market conditions. The inputs for expected
volatility, expected term, expected dividends, and risk-free
interest rate used in estimating the fair value of
performance-based awards in fiscal 2006, are the same as those
noted above under time-based stock awards.
A summary of the performance-based and market-condition awards
as of October 31, 2006, and changes during the fiscal year
then ended, is as follows:
The weighted-average grant-date fair value of options granted
during fiscal 2006 was $2.78. As of October 31, 2006, there
was $1.6 million of unrecognized compensation cost related
to performance-based and market-condition awards. That cost is
expected to be recognized over a weighted-average period of
3 years.
A status of the unvested, performance-based and market-condition
restricted stock as October 31, 2006, and changes during
the fiscal year then ended, is as follows:
As of October 31, 2006, there was $0.8 million of
unrecognized compensation cost related to unvested,
performance-based and market-condition restricted stock. That
cost is expected to be recognized ratably over a one
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
to four year period. No performance-based restricted stock
vested during fiscal 2006. The total fair value of
market-condition restricted stock that vested during fiscal 2006
was $227,500.
As of October 31, 2006, there were 427,029 stock awards
that have been legally granted and remain outstanding but have
not yet been valued because all of the conditions necessary to
establish the grant date for SFAS No. 123(R)purposes
have not yet occurred. The grant date of these stock awards will
not occur until budgets are approved by our Board of Directors
for the respective years specified in the performance targets.
Celerant
Stock Awards
All rights and obligations regarding Celerant stock awards were
assumed by their acquirer. Novell does not have any obligations
for Celerant stock awards.
Fiscal
2005 and 2004 Stock Award Information
For fiscal 2005 and 2004, had we accounted for all employee
stock-based compensation based on the fair value method as
prescribed by SFAS No. 123, our net income and net
income (loss) per share would have been the following pro forma
amounts:
Less: total stock-based
compensation expense determined under fair value-based method
for all awards, net of related tax effects
(50,420
)
(51,436
)
Add: total stock-based
compensation expense recorded in the statement of operations
2,653
4,940
Pro forma
$
328,955
$
10,692
Net income (loss) per common share:
As reported basic
$
0.98
$
0.08
Pro forma basic
$
0.86
$
(0.04
)
As reported diluted
$
0.86
$
0.08
Pro forma diluted
$
0.75
$
(0.04
)
For the purpose of the above table, the fair value of each
option grant is estimated as of the date of grant using the
Black-Scholes option-pricing model with the following
weighted-average assumptions used for grants in fiscal 2005 and
2004: a risk-free interest rate of approximately 3.8% for fiscal
2005 and 2.8% for fiscal 2004; a dividend yield of 0.0% for both
years; a weighted-average expected life of 4.4 years for
fiscal 2005 and 3.75 years for fiscal 2004; and a
volatility factor of the expected market price of our common
stock of 0.55 for fiscal 2005 and 0.77 for fiscal 2004. The
weighted-average fair value of options granted in fiscal 2005
and 2004 was $3.17 and $5.63, respectively.
Employee
Stock Purchase Plan
Subsequent to the issuance of SFAS No. 123(R), we
amended and re-introduced our Employee Stock Purchase Plan
(“ESPP”). The amended ESPP eliminated the “look
back” feature of the plan and reduced the purchase discount
to 5% off of the end of offering period stock price. As a result
of these amendments, our ESPP is considered
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
non-compensatory under SFAS No. 123(R)and,
accordingly, no compensation expense has been recorded for
issuances under the ESPP. During fiscal 2006, we issued
0.1 million shares of common stock under the ESPP.
W.
Employee
Savings and Retirement Plans
We adopted a 401(k) savings and retirement plan in December
1986. The plan covers all Novell U.S. employees who are
21 years of age or older who are scheduled to complete
1,000 hours of service during any consecutive
12-month
period. Our 401(k) retirement and savings plan allows us to
contribute an amount equal to 100% of each employee’s
contribution up to the higher of 4% of the employee’s
compensation or the maximum contribution allowed by tax laws.
Company matching contributions on our 401(k) savings and
retirement plan and other retirement plans were
$20.6 million, $23.1 million, and $20.6 million,
in fiscal years 2006, 2005, and 2004, respectively.
One of our German subsidiaries sponsors a defined benefit
pension plan covering approximately 142 current employees and
approximately 159 former employees or retirees as of
October 31, 2006. The plan was closed to new members as of
November 2004. Actuarial gains or losses are being amortized
over a 22.0 year period, and the amortization charges are
included within the overall net periodic pension costs, which
are charged to the income statement. Other plan information is
as follows:
Estimated benefit payments for fiscal years 2007, 2008, 2009,
2010, 2011, and thereafter are $14,661, $21,797, $21,797,
$21,797, $26,413, and $525,190, respectively. At
October 31, 2006, we had assets valued at $9.9 million
designated to fund the German pension obligation.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
We also have other retirement plans in certain foreign countries
in which we employ personnel. Each plan is consistent with local
laws and business practices.
X.
Net
Income (Loss) Per Share Attributable to Common
Stockholders
The following table reconciles the numerators and denominators
of the earnings per share calculation for the fiscal years ended
October 31, 2006, 2005, and 2004:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
Incremental shares attributable to the assumed conversion of the
Debentures have been excluded from the calculation of diluted
earnings per share in fiscal 2006 and 2004 as their effect would
have been anti-dilutive.
Incremental shares attributable to the assumed conversion of
Series B Preferred Stock have been excluded from the
calculation of diluted earnings per share in fiscal years 2006,
2005 and 2004 as their effect would have been anti-dilutive.
Incremental shares attributable to options with exercise prices
that were at or greater than the average market price (“out
of the money”) at October 31, 2006, 2005, and 2004
were also excluded from the calculation of diluted earnings per
share as their effect would have been antidilutive. At
October 31, 2006, 2005, and 2004, there were 21,521,748,
22,725,998, and 18,539,606 out of the money options,
respectively, that had been excluded.
Y.
Comprehensive
Income
Our accumulated other comprehensive income (loss) is comprised
of the following:
Total change in gross unrealized
loss on investments during the year
$
3,558
$
(8,550
)
$
(4,251
)
Adjustment for net realized gains
on investments included in net income (loss)
495
783
2,899
Net unrealized loss on investments
4,053
(7,767
)
(1,352
)
Minimum pension liability
633
623
(1,256
)
Cumulative translation adjustments
1,950
(1,592
)
11,720
Other comprehensive income (loss)
$
6,636
$
(8,736
)
$
9,112
The components of accumulated other comprehensive income were
not tax affected due to the fact that the related deferred tax
assets were fully reserved at October 31, 2006, 2005, and
2004, respectively.
Z.
Related
Party Transactions
During fiscal years 2006, 2005, and 2004, we received consulting
services from J.D. Robinson Incorporated. Mr. Robinson, a
director of Novell, is Chairman and Chief Executive Officer and
the sole shareholder of J.D. Robinson Incorporated. The
agreement provides for payments of $0.2 million per year
for these services. In each of fiscal years 2006, 2005, and
2004, services in the amount of $0.2 million were provided
by J.D. Robinson.
AA. Segment
Information
We operate and report our financial results in three segments
based on geographic area. Prior to the end of the third quarter
of fiscal 2006, we had a fourth segment, Celerant consulting,
which was divested in May 2006 and is
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
included in discontinued operations (see Note E). Our
performance is evaluated by our Chief Executive Officer and our
other chief decision makers based on reviewing revenue and
segment operating income (loss) information for each segment.
The geographic segments are:
•
Americas — includes the United States, Canada and
Latin America
•
EMEA — includes Eastern and Western Europe, Middle
East, and Africa
•
Asia Pacific — includes China, Southeast Asia,
Australia, New Zealand, Japan, and India
Prior to fiscal 2006, Latin America and Japan were separate
operating segments. All segment information has been recast to
conform to the new segment presentation.
All segments sell our software and services. These offerings are
sold in the United States directly and through original
equipment manufacturers, resellers, and distributor channels,
and internationally directly and through original equipment
manufacturers and distributors who sell to dealers and end
users. Operating results by segment are as follows:
Common unallocated operating (costs) income includes corporate
services common to all geographic segments such as corporate
sales and marketing, product development, corporate general and
administrative costs, corporate infrastructure costs, and
litigation settlement income or expense. In addition, common
unallocated operating (costs) income in fiscal 2005 also
includes a $447.6 million net gain on settlement of
potential litigation with Microsoft. Stock-based compensation
expenses have not been allocated for management reporting
purposes
In addition to reviewing geographic segment results, our Chief
Executive Officer and chief decision makers review net revenue
by solution category. These solution categories are:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
•
Open platform solutions.
Sub-categories
include:
•
Linux platform products — major products include SUSE
Linux Enterprise Server and our Linux desktop products
•
Other open platform products — major products include
SUSE Linux Professional
•
Workspace solutions.
Sub-categories
include:
•
Open Enterprise Server (OES)
•
NetWare and other NetWare-related — major products
include NetWare and Cluster Services
•
Collaboration — major products include GroupWise
•
Other workspace — major products include BorderManager
and Novell iFolder
•
Global services and support — comprehensive worldwide
IT consulting, training, and technical support services that
apply business solutions to our customers’ business
situations, providing the business knowledge and technical
expertise to help our customers implement our technology.
Prior to fiscal 2006, Open platform solutions and Workspace
solutions were combined in a category called Linux and platform
services solutions. Prior to the third quarter of fiscal 2006,
OES was classified in open platform solutions. Beginning in the
third quarter of fiscal 2006, OES is categorized in workspace
solutions. Prior periods have been recast to conform to the new
presentation. Net revenue by solution category is as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
Beginning in the first quarter of fiscal 2007, we began
operating and reporting our financial results in four new
business unit segments based on information solution categories
and a general business consulting business unit. The four new
business unit segments are:
•
Systems and resource management
•
Identity and security management
•
Open platform solutions
•
Workgroup
We changed our operating and reporting structure to increase
integration and teamwork internally, to build stronger
business-focused units, and to be better equipped to address
customer needs. As our strategy continues to evolve, the way in
which management views financial information to best evaluate
performance and operating results may also change. Beginning in
the first quarter of fiscal 2007, the segments will be reported
as above and prior periods will be recast to conform with the
new reporting structure.
Geographic
Information
Revenue outside the United States is comprised of revenue to
customers in Europe, Africa, the Middle East, Canada, South
America, Australia, and Asia Pacific. Other than revenue from
Ireland, international revenue was not material individually in
any other international location. Inter-company revenue between
geographic areas is accounted for at prices representative of
unaffiliated party transactions.
“U.S. operations” include shipments to customers
in the U.S., licensing to OEMs, and exports of finished goods
directly to international customers, primarily in Canada, South
America, and Asia. “Irish operations” include
shipments from Ireland of product to customers throughout
Europe, the Middle East, and Africa, and licensing to OEMs. The
Irish operation acts as the sales principal and thus records the
revenue on shipments it makes. The Irish operation uses our
other European, Middle Eastern, and African subsidiaries as
commissionaires and commission agents to assist in the sales of
software and in turn pays them a commission. This inter-company
commission is included in the eliminations. “Other
international operations” primarily includes revenue from
consulting and service contracts.
In fiscal years 2006, 2005, and 2004, sales to international
customers were $501.5 million, $568.6 million, and
$529.3 million, respectively. In fiscal 2006, 2005, and
2004, revenue in the EMEA segment accounted for 69%, 72%, and
71%, of our total international revenue, respectively. No one
foreign country accounted for more than 10% of total revenue in
fiscal 2006 and fiscal 2004. In fiscal 2005, revenue from the
United Kingdom accounted for approximately 12% of our total
revenue. There were no customers who accounted for more than 10%
of revenue in any period.
AB. Executive
Termination Benefits
During fiscal 2006, our former Chief Executive Officer and Chief
Financial Officer were terminated by our Board of Directors.
They received benefits pursuant to their respective severance
agreements totaling $9.4 million, of which approximately
$2.7 million related to stock compensation and
$6.7 million related to severance and other benefits.
AC. Subsequent
Events
Sale of
Venture Capital Funds
In November 2006, we closed the sale of the remaining one-half
of one of our venture capital funds, resulting in a gain in the
first quarter of fiscal 2006 of $3.6 million on proceeds of
$5.0 million.
Conversion
of Redeemable Preferred Stock
In November 2006, IBM converted the remaining 187 outstanding
shares of Series B Preferred Stock into 1.5 million
shares of our common stock.
Microsoft
Agreements
On November 2, 2006, we entered into a Business
Collaboration Agreement, a Technical Collaboration Agreement,
and a Patent Cooperation Agreement with Microsoft Corporation
that together are designed to build, market and support a series
of new solutions to make Novell and Microsoft products work
better together for customers. Each of the agreements is
scheduled to expire January 1, 2012.
Under the Business Collaboration Agreement, we are marketing a
combined offering with Microsoft. The combined offering consists
of SUSE Linux Enterprise Server (“SLES”) and a
subscription for SLES support along with Microsoft Windows
Server, Microsoft Virtual Server and Microsoft Viridian, and is
offered to customers desiring to deploy Linux and Windows in a
virtualized setting. Microsoft made an upfront payment to us of
$240 million for SLES subscription
“certificates,” which Microsoft may use, resell or
otherwise distribute over the term of the agreement, allowing
the certificate holder to redeem single or multi-year
subscriptions for SLES support from us (entitling the
certificate holder to upgrades, updates and technical support).
Microsoft will spend $12 million annually for marketing
Linux and Windows virtualization scenarios and will also spend
$34 million over the term of the agreement for a Microsoft
sales force devoted primarily to marketing the combined
offering.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —
(Continued)
Microsoft agreed that for three years following the initial date
of the agreement it will not enter into an agreement with any
other Linux distributor to encourage adoption of non-Novell
Linux/Windows Server virtualization through a program
substantially similar to the SLES subscription
“certificate” distribution program.
The Technical Collaboration Agreement focuses primarily on four
areas:
•
Development of technologies to optimize each of SLES and Windows
running as guests in a virtualized setting on the other
operating system;
•
Development of management tools for managing heterogeneous
virtualization environments, to enable each party’s
management tools to command, control and configure the other
party’s operating system in a virtual machine environment;
•
Development of translators to improve interoperability between
Microsoft Office and OpenOffice document formats; and
•
Collaboration on improving directory and identity
interoperability and identity management between Microsoft
Active Directory software and Novell eDirectory software.
Under the Technical Collaboration Agreement, Microsoft agreed to
provide funding to help accomplish these broad objectives,
subject to certain limitations.
Under the Patent Cooperation Agreement, Microsoft agreed to
covenant with our customers not to assert its patents against
our customers for their use of our products and services for
which we receive revenue directly or indirectly, with certain
exceptions, while we agreed to covenant with Microsoft’s
customers not to assert our patents against Microsoft’s
customers for their use of Microsoft products and services for
which Microsoft receives revenue directly or indirectly, with
certain exceptions. In addition, we and Microsoft each
irrevocably released the other party, and its customers, from
any liability for patent infringement arising prior to
November 2, 2006, with certain exceptions. Both we and
Microsoft have payment obligations under the Patent Cooperation
Agreement. Microsoft made an up-front net balancing payment to
us of $108 million, and we will make ongoing payments to
Microsoft totaling not less than $40 million over the five
year term of the agreement based on a percentage of our Open
Platform Solutions and Open Enterprise Server revenues.
RedMojo
Acquisition
On November 17, 2006, we acquired all of the outstanding
shares of RedMojo Inc, a privately-held technology company that
specialized in cross platform virtualization management software
tools. The purchase price was $9.7 million in cash plus
merger and transaction costs of $0.2 million.
Sale of
Salmon Subsidiary
On March 13, 2007, we sold our shares in Salmon Ltd,
(“Salmon”) to Okam Limited, a United Kingdom Limited
Holding Company for $4.9 million, plus approximately an
additional $3.9 million contingent payment to be received
if Salmon meets certain revenue targets. There will be no
further shareholder or operational relationship between us and
Salmon going forward. Salmon was a component of our EMEA
operating segment in fiscal 2006 (Business Consulting segment
beginning in fiscal 2007) and Salmon’s sale will not
have an impact on our IT consulting business. In our second
quarter of fiscal 2007, we recognized a gain on the sale of
approximately $0.6 million. During the first quarter of
fiscal 2007, in anticipation of the sale, we recorded a loss of
$10.8 million related to the excess carrying amount of
Salmon over its estimated fair value, of which
$10.2 million was to write off goodwill and
$0.6 million was to write off intangible assets. We will
classify Salmon’s results of operations as a discontinued
operation in our consolidated statement of operations beginning
in the second quarter of fiscal 2007.
To the Board of Directors and Stockholders of Novell, Inc.:
We have completed integrated audits of Novell, Inc.’s 2006
and 2005 consolidated financial statements and of its internal
control over financial reporting as of October 31, 2006 in
accordance with the standards of the Public Company Accounting
Oversight Board (United States). Our opinions, based on our
audits, are presented below.
Consolidated
financial statements and financial statement schedule
In our opinion, the consolidated financial statements listed in
the index appearing under Item 15(a)(1) present fairly, in
all material respects, the financial position of Novell, Inc.
and its subsidiaries at October 31, 2006 and 2005, and the
results of their operations and their cash flows for the years
then ended in conformity with accounting principles generally
accepted in the United States of America. In addition, in our
opinion, the financial statement schedule as of and for the
years ended October 31, 2006 and 2005 listed in the index
appearing under Item 15(a)(2) presents fairly, in all
material respects, the information set forth therein when read
in conjunction with the related consolidated financial
statements. These financial statements and the financial
statement schedule are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these
financial statements and the financial statement schedule based
on our audits. We conducted our audits of these statements in
accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material
misstatement. An audit of financial statements includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by
management, and evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable
basis for our opinion.
As discussed in Notes B and O to the consolidated financial
statements, the Company changed the manner in which it accounts
for share-based payments and conditional asset retirement
obligations, respectively, in fiscal 2006.
Internal
control over financial reporting
Also, in our opinion, management’s assessment, included in
Management’s Annual Report on Internal Control over
Financial Reporting appearing under Item 9A, that the
Company maintained effective internal control over financial
reporting as of October 31, 2006 based on criteria
established in Internal Control — Integrated
Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO), is fairly
stated, in all material respects, based on those criteria.
Furthermore, in our opinion, the Company maintained, in all
material respects, effective internal control over financial
reporting as of October 31, 2006, based on criteria
established in Internal Control — Integrated
Framework issued by the COSO. The Company’s management
is responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness
of internal control over financial reporting. Our responsibility
is to express opinions on management’s assessment and on
the effectiveness of the Company’s internal control over
financial reporting based on our audit. We conducted our audit
of internal control over financial reporting in accordance with
the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was
maintained in all material respects. An audit of internal
control over financial reporting includes obtaining an
understanding of internal control over financial reporting,
evaluating management’s assessment, testing and evaluating
the design and operating effectiveness of internal control, and
performing such other procedures as we consider necessary in the
circumstances. We believe that our audit provides a reasonable
basis for our opinions.
A company’s internal control over financial reporting is a
process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with
generally accepted accounting principles. A company’s
internal control over financial reporting includes those
policies and procedures that (i) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the
company; (ii) provide reasonable
assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally
accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance
with authorizations of management and directors of the company;
and (iii) provide reasonable assurance regarding prevention
or timely detection of unauthorized acquisition, use, or
disposition of the company’s assets that could have a
material effect on the financial statements. Because of its
inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of
any evaluation of effectiveness to future periods are subject to
the risk that controls may become inadequate because of changes
in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.
The Board of Directors and Stockholders — Novell, Inc.
We have audited the accompanying consolidated statements of
operations, stockholders’ equity, and cash flows
(“financial statements”) of Novell, Inc. and
subsidiaries (the Company) for the year ended October 31,2004. Our audit also included the financial statement schedule
listed in the Index at Item 15(a)(2) for the year ended
October 31, 2004. These financial statements and schedule
are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these financial
statements and schedule based on our audit.
We conducted our audit in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are
free of material misstatement. We were not engaged to perform an
audit of the Company’s internal control over financial
reporting. Our audit included consideration of internal control
over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not
for the purpose of expressing an opinion on the effectiveness of
the Company’s internal control over financial reporting.
Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, accounting principles used and
significant estimates made by management and evaluating the
overall financial statement presentation.
In our opinion, the financial statements referred to above
present fairly, in all material respects, the consolidated
results of operations and cash flows of Novell, Inc. and
subsidiaries for the year ended October 31, 2004, in
conformity with U.S. generally accepted accounting
principles. Also, in our opinion, the related financial
statement schedule, when considered in relation to the basic
financial statements taken as a whole, presents fairly, in all
material respects, the information set forth therein for the
year ended October 31, 2004.
Income (loss) from continuing
operations before taxes
452,071
(1,308
)
7,429
(241
)
457,951
Income (loss) from continuing
operations
393,326
(16,928
)
560
(5,667
)
371,291
Net income (loss)
395,161
(15,627
)
2,140
(4,952
)
376,722
Income (loss) from continuing
operations per share, basic
$
1.03
$
(0.05
)
$
0.00
$
(0.02
)
$
0.97
Income (loss) from continuing
operations per share, diluted
$
0.90
$
(0.05
)
$
0.00
$
(0.02
)
$
0.85
Net income (loss) per common
share, basic
$
1.04
$
(0.04
)
$
0.01
$
(0.01
)
$
0.98
Net income (loss) per common
share, diluted
$
0.90
$
(0.04
)
$
0.00
$
(0.01
)
$
0.86
Item 9.
Changes
in and Disagreements with Accountants on Accounting and
Financial Disclosure
None
Item 9A.
Controls
and Procedures
Effectiveness
of Disclosure Controls and
Procedures.
Our management, with the participation of our Chief Executive
Officer and Chief Financial Officer, evaluated the effectiveness
of our disclosure controls and procedures as of the end of the
period covered by this report. Based on that evaluation, our
Chief Executive Officer and Chief Financial Officer concluded
that our disclosure controls and procedures as of the end of the
period covered by this report were effective such that the
information required to be disclosed by us in reports filed
under the Securities Exchange Act of 1934 is (i) recorded,
processed, summarized and reported within the time periods
specified in the SEC’s rules and forms and
(ii) accumulated and communicated to our management,
including our Chief Executive Officer and Chief Financial
Officer, as appropriate to allow
timely decisions regarding disclosure. A controls system cannot
provide absolute assurance, however, 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.
Management’s
Annual Report on Internal Control over Financial
Reporting.
Our management is responsible for establishing and maintaining
adequate internal control over financial reporting. Internal
control over financial reporting is defined in
Rules 13a-15(f)
and
15d-15(f) of
the Exchange Act as a process designed by, or under the
supervision of, our Chief Executive Officer and Chief Financial
Officer and effected by our board of directors, management and
other personnel, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with
generally accepted accounting principles and includes those
policies and procedures that:
•
pertain to the maintenance of records that in reasonable detail
accurately and fairly reflect transactions and dispositions of
our assets;
•
provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in
accordance with generally accepted accounting principles, and
that our receipts and expenditures are being made only in
accordance with authorizations of our management and
directors; and
•
provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use or disposition of our
assets that could have a material effect on the financial
statements.
Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements.
Projections of any evaluation of effectiveness to future periods
are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
Our management assessed the effectiveness of our internal
control over financial reporting as of October 31, 2006
using the criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) in Internal
Control-Integrated Framework. Based on this assessment using
those criteria, our management concluded that, as of
October 31, 2006, our internal control over financial
reporting was effective. Our management’s assessment of the
effectiveness of our internal control over financial reporting
as of October 31, 2006 has been audited by
PricewaterhouseCoopers LLP, an independent registered public
accounting firm, as stated in their report which appears under
Item 8.
Changes
in Internal Control Over Financial
Reporting.
No change in our internal control over financial reporting
occurred during our fourth fiscal quarter that has materially
affected, or is reasonably likely to materially affect, our
internal control over financial reporting. As a result of our
self-initiated, voluntary review of our historical stock-based
compensation practices and the related potential accounting
impact for the period from November 1, 1996 through
October 31, 2006 as described in more detail in Note C
of our consolidated financial statements contained in this
report, we have implemented improvements to our processes for
granting stock-based compensation and plan to implement
additional improvements.
The principal occupation and business experience during the past
five years of, and certain other information with respect to,
each of our eleven directors is set forth below. There are no
family relationships among the members of our Board of
Directors, or between any of the executive officers and any
members of our Board of Directors.
Albert Aiello
Director since 2003
Mr. Aiello, age 64, is Managing Director of Albert
Aiello & Associates, a strategic technology management
consulting company he founded in February 2003. Prior to that,
Mr. Aiello served as Global Chief Information Officer of
Lend Lease Corporation, a financial and construction management
company, from January 1998 to December 2002, and as a member of
its board of directors from May 1998 to December 2002.
Mr. Aiello was the Chief Information Officer for Fidelity
Investments, a financial management company, from April 1990 to
December 1997. Mr. Aiello was also Chairman of the Board of
the Software Productivity Consortium from December 1999 to
December 2000. Mr. Aiello has also served as a member of
the board of directors of CoolSavings, Inc.
Fred Corrado
Director since 2002
Mr. Corrado, age 67, served as Vice Chairman of the
Board of Directors and Chief Financial Officer of The Great
Atlantic & Pacific Tea Company, Inc., a food retailer,
from October 1992 until February 2002. Mr. Corrado is also
a director of the New Jersey Performing Arts Center, a
non-profit organization.
Richard L. Crandall
Director since 2003
Mr. Crandall, age 63, is a founding Managing Director
of Arbor Partners, a high technology venture capital firm, a
position he has held since November 1997. Mr. Crandall also
serves as the chairman of the Enterprise Software Roundtable, an
organization of the senior corporate leadership of the 35
largest software companies, which he founded in July 1994.
Mr. Crandall served as the Chairman of Giga Information
Systems, a research and consulting firm, from July 2002 until
February 2003, and was a board member and special advisor of
Giga from its founding in April 1996 until February 2003. Prior
to that, Mr. Crandall was a founder of Comshare, Inc., a
decision support software company, and served as its Chief
Executive Officer from April 1970 until April 1994 and its
Chairman from April 1994 until April 1997. Mr. Crandall is
also a director of Diebold, Inc., and the
Dreman/Claymore
Dividend & Income Fund, a management investment
company.
Ronald W. Hovsepian
Director since 2006
Ronald W. Hovsepian, age 46, has served as one of our
directors and as our President and Chief Executive Officer since
June 2006. Mr. Hovsepian served as our President and Chief
Operating Officer from October 2005 to June 2006. From May 2005
to November 2005, Mr. Hovsepian served as Executive Vice
President and President, Worldwide Field Operations.
Mr. Hovsepian joined us in June 2003 as President, Novell
North America. Before coming to Novell, Mr. Hovsepian was a
Managing Director with Bear Stearns Asset Management, a
technology venture capital fund, from February to December 2002.
From March 2000 to February 2002, Mr. Hovsepian served as
Managing Director for Internet Capital Group, a venture capital
firm. Prior to that, Mr. Hovsepian served in a number of
executive positions with International Business Machines
Corporation over an approximate
17-year
period. Mr. Hovsepian is also chairman of the board of
directors of Ann Taylor Corporation.
Patrick S. Jones, age 62, has been a private investor since
March 2001. Mr. Jones was the Senior Vice President and
Chief Financial Officer of Gemplus International S.A., a
provider of solutions empowered by smart cards from 1998 to 2001
and Vice President Finance, Corporate Controller for Intel from
1992 to 1998. Prior to that, he served as Chief Financial
Officer of LSI Logic. Mr. Jones is also a director of
Genesys S.A. and Lattice Semiconductor Corporation.
Claudine B. Malone
Director since 2003
Ms. Malone, age 71, has been the President and Chief
Executive Officer of Financial and Management Consulting Inc., a
consulting firm, since 1984. Ms. Malone served as a
visiting professor at the Colgate-Darden Business School of the
University of Virginia from 1984 to 1987, an adjunct professor
of the School of Business Administration at Georgetown
University from 1982 to 1984, and an assistant and associate
professor at the Harvard Graduate School of Business
Administration from 1972 to 1981. Ms. Malone also serves on
the boards of Hasbro, Inc. and Aviva Life Insurance Company.
Richard L. Nolan
Director since 1998
Mr. Nolan, age 67, is the William Barclay Harding
Professor of Management of Technology, emeritus, Harvard
Business School, an institution of higher education, a
professorship he was awarded in September 1991. Mr. Nolan
has also been the Philip M. Condit Professor of Business
Administration at the University of Washington since September
2003. Mr. Nolan served as Chairman and Chief Executive
Officer of Nolan, Norton and Company, an information technology
management consulting company, from 1977 until the company was
acquired by KPMG LLP in 1987. Mr. Nolan then served as
Chairman of Nolan, Norton and Company and Partner of KPMG from
1987 to 1991.
Thomas G. Plaskett
Director since 2002
Mr. Plaskett, age 63, has served as Chairman of Fox
Run Capital Associates, a private merchant banking and
consulting firm focusing on advisory and consulting services for
emerging companies, from October 1991 to the present.
Additionally, Mr. Plaskett served as the Chairman of Probex
Corporation, an energy technology company, from November 1999
until December 2000 and as its President and CEO from November
1999 to August 2000. Mr. Plaskett served as Vice Chairman
of Legend Airlines, Inc., an airline, from June 1997 until
February 2001 and as its Executive Vice President from September
1999 to February 2001. Mr. Plaskett also served as the
Chairman of Greyhound Lines, Inc., a transportation company,
from March 1995 until March 1999. Mr. Plaskett is also a
director of Alcon, Inc. and RadioShack Corporation and is
chairman of the board of directors of Platinum Research
Organization, Inc.
John W. Poduska, Sr., Sc.D.
Director since 2001
Dr. Poduska, age 69, was the Chairman of Advanced
Visual Systems, Inc., a provider of visualization software, from
January 1992 to December 2001. From December 1989 until December
1991, Dr. Poduska was President and Chief Executive Officer
of Stardent Computer, Inc., a computer manufacturer. From
December 1985 until December 1989, Dr. Poduska was founder,
Chairman and Chief Executive Officer of Stellar Computer, Inc.,
a computer manufacturer and the predecessor of Stardent
Computer, Inc. Prior to founding Stellar Computer, Inc.,
Dr. Poduska founded Apollo Computer Inc. and Prime Computer
Inc. Dr. Poduska is also a director of Anadarko Petroleum
Corporation and Safeguard Scientifics, Inc.
Mr. Robinson, age 71, is co-founder and General
Partner of RRE Ventures and Chairman of RRE Investors, LLC,
private information technology venture investment firms, and has
held those positions since 1994. He has also been President of
J.D. Robinson Inc., a strategic advisory firm, since 1993.
Mr. Robinson previously served as Chairman and Chief
Executive Officer of American Express Company, a financial
services company, from 1977 to 1993. Mr. Robinson is
non-executive chairman of Bristol-Myers Squibb Company, and a
director of The
Coca-Cola
Company and First Data Corporation.
Kathy Brittain White
Director since 2003
Ms. White, age 57, has served as President and Founder
of Rural Sourcing, Inc., an organization aimed at developing
information technology employment in rural communities, since
January 2004. Ms. White also serves as President of the
Horizon Institute of Technology, a foundation supporting
technology outreach initiatives in the Arkansas delta, since
founding it in 2002. Ms. White served as Executive Vice
President and Chief Information Officer for Cardinal Health,
Inc., a provider of medical products and services, from February
1999 until March 2003. Prior to that, Ms. White served
as Senior Vice President and Chief Information Officer with
Allegiance Healthcare, Inc., a provider of medical products and
services, from 1996 until its acquisition by Cardinal in
February 1999. Ms. White was also an associate professor at
the University of North Carolina, Greensboro for ten years.
Ms. White is a director of Mattel, Inc.
Set forth below (as of May 25, 2007) are the names,
ages, and titles of the persons currently serving as our
executive officers.
Name
Age
Position
Ronald W. Hovsepian
46
President and Chief Executive
Officer
Dr. Jeffrey Jaffe
52
Executive Vice President and Chief
Technology Officer
Tom Francese
57
Executive Vice President,
Worldwide Sales
Alan J. Friedman
59
Senior Vice President, People
Joseph A. LaSala, Jr
52
Senior Vice President, General
Counsel and Secretary
Colleen O’Keefe
51
Senior Vice President of Services
John Dragoon
47
Senior Vice President and Chief
Marketing Officer
Dana C. Russell
45
Senior Vice President and Chief
Financial Officer
Ronald W. Hovsepian
Ronald W. Hovsepian has served as one of our directors and as
our President and Chief Executive Officer since June 2006.
Mr. Hovsepian served as our President and Chief Operating
Officer from October 2005 to June 2006. From May 2005 to
November 2005, Mr. Hovsepian served as Executive Vice
President and President, Worldwide Field Operations.
Mr. Hovsepian joined us in June 2003 as President, Novell
North America. Before coming to Novell, Mr. Hovsepian was a
Managing Director with Bear Stearns Asset Management, a
technology venture capital fund, from February to December 2002.
From March 2000 to February 2002, Mr. Hovsepian served as
Managing Director for Internet Capital Group, a venture capital
firm. Prior to that, Mr. Hovsepian served in a number of
executive positions with International Business Machines
Corporation over an approximate
17-year
period. Mr. Hovsepian is also chairman of the board of
directors of Ann Taylor Corporation.
Dr. Jeffrey Jaffe, Novell’s Executive Vice President
and Chief Technology Officer, joined Novell in November 2005.
From October 2001 to October 2005 Dr. Jaffe served as
President of Bell Labs Research and Advanced Technologies. Prior
to that, Dr. Jaffe held a variety of technical and
management positions with IBM, most recently serving as general
manager of IBM’s SecureWay business unit, where he was
responsible for IBM’s security, directory, and networking
software business.
Tom Francese
Tom Francese has served as Novell’s Executive Vice
President, Worldwide Sales since October 2006 and as President,
Novell EMEA since joining Novell in October 2005. Prior to
joining Novell, Mr. Francese held numerous executive sales
positions with IBM over a
30-year
period, except for February 2000 to June 2000 during which he
served as a Managing Director of Deutsche Bank with
responsibilities in information technology.
Alan J. Friedman
Alan J. Friedman became Senior Vice President, People in July
2001 in connection with Novell’s acquisition of Cambridge
Technology Partners (“Cambridge”). Mr. Friedman
served as Cambridge’s Senior Vice President of Human
Resources, Enterprises Learning and Knowledge Management from
January 2000 to July 2001, and had joined Cambridge in December
1999 as Vice President of Learning and Knowledge Management.
Prior to joining Cambridge, Mr. Friedman was Senior Vice
President of Human Resources for Arthur D. Little, Inc., a
consulting firm, from June 1993 to December 1999.
Joseph A. LaSala, Jr.
Joseph A. LaSala, Jr. became Senior Vice President, General
Counsel and Secretary of Novell in July 2001 in connection with
Novell’s acquisition of Cambridge. From March 2000 to July
2001, Mr. LaSala served as Senior Vice President, General
Counsel and Secretary of Cambridge. Prior to joining Cambridge,
Mr. LaSala served as Vice President, General Counsel and
Secretary of UPR from January 1996 to March 2000.
Mr. LaSala is a member of the board of directors of Buckeye
GP LLC, the general partner of Buckeye Partners, L.P.
Colleen O’Keefe
Colleen O’Keefe joined Novell in December 2006 as
Novell’s Senior Vice President of Services to oversee
Novell’s global technical support group, which provides
onsite and remote support services, outsourced IT management
services and global training services to customers. Prior to
joining Novell, from September 2002 to November 2006,
Ms. O’Keefe held several positions at NCR Corporation,
including Vice President and General Manager, Payment Solutions
Division, vice president of Global Managed Services for
NCR’s Worldwide Customer Services division and vice
president of Global Customer Care. From September 1999 to March
2002, she served as senior vice president, Customer Services, at
Global Crossing. In addition, Ms. O’Keefe served in a
number of positions in the telecommunications industry,
including 18 years at Southern New England Telephone and
two years at AT&T.
John Dragoon
John Dragoon has served as Novell’s Senior Vice President
and Chief Marketing Officer since March 2006. Mr. Dragoon
joined Novell in October 2003 as Vice President, Worldwide Field
Marketing. Prior to joining Novell, from April 2002 to September
2003 Mr. Dragoon was the senior vice president of marketing
and product management at Art Technology Group, a provider of
Internet commerce, service, and marketing solutions and from
April 2001 to March 2003 served as vice president, operations,
of Internet Capital Group, a venture capital firm. Prior to his
tenure at Internet Capital Group, Mr. Dragoon served in a
number of sales and marketing positions at IBM from 1984 to 2000.
Dana C. Russell
Dana C. Russell has served as Novell’s Senior Vice
President and Chief Financial Officer since February 2007. Prior
to that, Mr. Russell served as Novell’s Vice President
and interim Chief Financial Officer from June 2006 to February
2007, and as Vice President of Finance from March 2000 to June
2006. He served as the Corporate
Controller from June 2003 to June 2006, and was also the
Treasurer from December 2005 to June 2006. Mr. Russell
joined Novell in 1994. Prior to joining Novell, Mr. Russell
worked at Price Waterhouse in Salt Lake City. He is a CPA
licensed in the State of Utah.
About the
Board of Directors and its Committees
Board
of Directors
We are managed under the direction of the Board of Directors,
whose purpose is to maximize long-term economic value for our
stockholders by responsibly addressing not only their concerns,
but also those of our customers, employees, business partners,
the communities and governments where we have operations and do
business, and the public at large. In fulfilling its duties, the
Board of Directors and its committees oversee corporate
governance, oversee and advise management in developing our
financial and business goals, evaluate management’s
performance in pursuing and achieving those goals, and oversee
our public disclosures and the disclosure processes. Our
Statement on Corporate Governance sets forth the duties and
responsibilities of the Board of Directors, criteria for the
constitution of, membership on, and the procedures for and
required meetings of the Board of Directors and other corporate
governance matters. This Statement is available on our website
at http://www.novell.com/company/ir/cg/through the
Corporate Governance page.
Independence
There are eleven directors on our Board of Directors. The Board
of Directors has determined that eight of its eleven directors
are “independent” as defined by the listing standards
of The Nasdaq Stock Market currently in effect and approved by
the SEC and all applicable rules and regulations of the SEC.
These eight directors are: Albert Aiello, Fred Corrado, Patrick
Jones, Richard L. Nolan, Claudine B. Malone, Thomas G. Plaskett,
John W. Poduska, Sr. and Kathy Brittain White. The
Board of Directors has also determined that the foregoing eight
directors, except Richard L. Crandall, also meet the
“outside director” standard for purposes of
Rule 162(m) of the Internal Revenue Code of 1986, as
amended. All members of the Audit, Compensation and Corporate
Governance Committees satisfy the “independence” or
“outside directorship” standards applicable to members
of each such committee.
The following provides an overview of the membership and
responsibilities of all of the committees of the Board of
Directors.
Audit
Committee
Fred Corrado, Chairperson
• Oversee accounting and
financial reporting processes and audits of the financial
statements
Albert Aiello
— review
judgments and decisions affecting financial statements
Richard L. Crandall
— review all
financial data to be released
Patrick S. Jones
• Monitor compliance
with applicable laws and regulations and review significant
cases of misconduct
Claudine B. Malone
• Oversee internal
control over financial reporting
• Oversee disclosure
controls and procedures
• Oversee implementation
of the Code of Business Ethics
• Oversee our
initiatives in connection with Section 404 of the
Sarbanes-Oxley Act of 2002 to (i) establish and maintain an
adequate internal control structure and procedures for financial
reporting and (ii) assess the effectiveness of such
internal control structure and procedures.
• Oversee our investment
policies, controls, and procedures, and portfolio performance
• Oversee internal audit
function
• Oversee independent
auditors
— appoint
and approve compensation
— pre-approve
permitted services
— evaluate
performance
— monitor
independence
In addition to the above functions, the Audit Committee has
adopted procedures for its receipt, retention, and treatment of
concerns and complaints regarding accounting, internal controls,
or auditing matters. The Audit Committee has established an
online reporting tool located at
www.novell.com/ethics/index.jsp, accessible through the
Corporate Governance page, for the submission of such concerns
by stockholders, employees and members of the public. All
submissions may be made completely anonymously. The Audit
Committee encourages, but does not require, that anyone making a
submission supply his or her contact information to facilitate
follow-up,
clarification and assistance with investigation of the concern
or complaint. We do not permit retaliation or discrimination of
any kind against employees for any complaints submitted in good
faith.
The Board of Directors has adopted a written charter for the
Audit Committee. A current copy of the Audit Committee Charter
is available on our website at
http://www.novell.com/company/ir/cg/through the
Corporate Governance page.
Financial
Expertise
The Board of Directors has determined that four of the members
of the Audit Committee, Mr. Corrado, Mr. Crandall,
Mr. Jones and Ms. Malone, possess the attributes to be
considered financially sophisticated for purposes of the listing
standards of The Nasdaq Stock Market and have the background to
be considered “audit committee financial experts” as
defined by the rules and regulations of the SEC.
The Board of Directors believes that information technology is
critical in how corporations run their businesses and that
boards of directors need to take an active role in understanding
and overseeing the technological initiatives of their
corporations in order to effectively oversee risk management,
monitor internal controls, and promote effective communication
among employees. The charter of the Technology Committee is
available on our website at
http://www.novell.com/company/ir/cg/through the Corporate
Governance page.
Option
Grant Committee
Ronald W. Hovsepian
• Make discretionary
grants of stock options, restricted stock and restricted stock
units to non-executive employees eligible to participate in our
employee equity plans.
Meetings
of the Board of Directors and Board Committees
During fiscal 2006, the Board of Directors held eleven meetings,
the Audit Committee held fourteen meetings, the Compensation
Committee held five meetings, the Corporate Governance Committee
held four meetings, the Technology Committee held four meetings,
and the Option Grant Committee acted entirely by written
consent. During the last fiscal year, each current director
attended at least 75% of the meetings of the Board of Directors
and the committees on which he or she then served.
Our policy on director attendance at annual meetings calls for
directors to be invited but not required to attend our annual
meetings of stockholders. In 2006, one director attended the
annual meeting.
Bylaw
Amendments regarding Director Nomination Process
On April 10, 2007, our Board of Directors approved
amendments to Article II, Section 2.11 and
Article III, Section 3.13 of the Bylaws revising the
deadlines for submission of stockholder proposals for company
stockholder meetings. Prior to the recent amendments, our Bylaws
required a stockholder to deliver notice of intention to make
director nominations or propose other business for consideration
in a stockholders’ meeting no later than 90 days prior
to the first anniversary of the date of the first mailing to
stockholders of the prior year’s proxy statement. The
revised Bylaws provide that, in the event that no annual meeting
was held in the prior year or if the date of the annual meeting
is more than thirty (30) days before or more than thirty
(30) days after the anniversary date of the prior
year’s annual meeting, notice must be received by our
corporate secretary not earlier than 120 days prior to the
annual meeting and not later than either (i) 90 days
prior to the date of the annual meeting or (ii) ten days
following the first public announcement of the meeting date,
whichever comes last.
We have adopted two codes of ethics, each designed to encourage
our employees, executives and directors to act with the highest
integrity.
Code of Business Ethics. We review and
update our Code of Business Ethics annually (the
“Code”). The purpose of the Code is to convey the
basic principles of business conduct expected of all our
executives and employees, including our Chief Executive Officer,
Chief Financial Officer and Principal Accounting Officer,
Controller, and other senior financial personnel performing
similar functions. We require each of these persons to review
the Code at least once a year and to submit a report to the our
Ethics Officer (i) stating that he or she has read and
understands the Code, (ii) reporting any conflicts of
interest he or she may have, (iii) agreeing to comply with
all of our policies, and (iv) reporting any suspected
violations of the Code or our policies referenced in the Code by
him or her or other employees. In support of the Code, we have
provided our employees with numerous avenues for the reporting
of ethics violations or other similar concerns, including the
required employee reports and an anonymous telephone hotline.
The Audit Committee monitors the implementation and enforcement
of the Code. The Code meets the definition of “code of
ethics” under the rules and regulations of the SEC and is
posted on our website at http://www.novell.com/company/ir/cg/through the Corporate Governance page.
Non-Employee Director Code of
Ethics. The Board of Directors has
established the Non-Employee Director Code of Ethics (the
“Director Code”). The Director Code sensitizes
directors on areas of ethical risk relating to their specialized
roles, provides guidance to help directors recognize and deal
with ethical issues, provides mechanisms for directors to report
unethical conduct, and fosters among directors a culture of
honesty and accountability. Each director is required to review
the Director Code at least once a year and to submit a report
(i) stating that he or she has read and understands the
Director Code, (ii) reporting any conflicts of interest he
or she may have, (iii) agreeing to comply with the Director
Code, and (iv) reporting any suspected violations of the
Director Code. A copy of the Director Code may be found at
www.novell.com/company/ir/cg/through the Corporate
Governance page.
Section 16(a)
Beneficial Ownership Reporting Company
Section 16(a) of the Securities Exchange Act of 1934
requires our directors, executive officers and any persons who
beneficially own more than 10% of our common stock to send
reports of their ownership of shares of common stock and changes
in ownership to us and the SEC. Based on our records and
information that we received during this fiscal year, we believe
that during fiscal 2006 all of such reporting persons complied
with all Section 16(a) reporting requirements applicable to
them, except that Mr. Messman, a former director and chief
executive officer, reported one Form 4 transaction late.
Item 11.
Executive
Compensation
Summary
Compensation Table
The table below shows, for the last three fiscal years,
compensation paid to our current Chief Executive Officer, our
former Chief Executive Officer and the four other most highly
compensated executive officers during fiscal 2006 (based on
salary and bonus) serving at fiscal year end. We refer to all of
these officers as the “Named Executive Officers.”
Compensation deferred at the election of the executive, pursuant
to the our Retirement and Savings Plan, the Deferred
Compensation Plan, and the Stock-Based Deferred Compensation
Plan, is included in the year earned.
(2)
Cash bonuses for services rendered in fiscal 2006, 2005 and 2004
have been listed in the fiscal year earned, although most
bonuses were paid after the end of the applicable fiscal year.
Pursuant to Mr. Hovsepian’s
employment arrangement, 50% of his bonus for the first year of
employment was guaranteed, and $250,000 of the bonus listed for
2004 was paid in satisfaction of that guarantee in June 2004.
(3)
No Named Executive Officer received perquisites in an amount
greater than the lesser of (i) $50,000 or (ii) 10% of
such Named Executive Officer’s total salary plus bonus,
except for Mr. Messman in 2005 and 2004, Dr. Jaffe in
2006, and Mr. Francese in 2006. Amounts listed for
Mr. Messman in 2006 and for Mr. LaSala represent
reimbursement for the payment of taxes.
Amounts for Mr. Messman in fiscal 2005 and fiscal 2004
include personal use of our corporate aircraft that was valued
at $137,711 (valued at the incremental cost to the corporation)
and $54,615 (valued using Standard Industry Fare Level
(“SIFL”) rates from the U.S. Department of
Transportation), respectively.
The amount for Dr. Jaffe represents $75,000 in relocation
expenses and $45,346 in reimbursement for the payment of taxes.
The amount for Mr. Francese includes (i) a cash
payment of $193,590 intended to compensate for a portion of
housing, car, cost of living, continuation of his residence in
Texas, and the storage of household goods, (ii) $56,410 in
rent paid by Novell on behalf of Mr. Francese,
(iii) $50,219 for travel for Mr. Francese and his
family and storage of household goods, and (iv) $18,162 in
reimbursement for the payment of taxes.
(4)
The dollar value of restricted common stock awards is calculated
by multiplying the closing market price of our common stock on
the date of grant, less the purchase price, by the number of
shares awarded. Holders of such restricted common stock awards
have the right to vote the shares and to receive cash dividends,
if any. Any stock dividends that may be received will have the
same vesting restrictions as the shares. The award to
Ms. Heystee was an award of restricted common stock units
(“RSU’s”). RSU’s are automatically converted
to common stock upon vesting. Until conversion, the holders of
RSU’s do not have any right to vote any underlying shares
of common stock or to receive dividends.
As of October 31, 2006, when the closing price of our
common stock was $6.00, Mr. Hovsepian had 321,750 unvested
shares with a fair market value of $1,898,325, Dr. Jaffe
had 107,830 unvested shares with a fair market value of
$636,197, Mr. Francese had 58,334 unvested shares with a
fair market value of $344,171, Mr. LaSala had 20,070
unvested shares with a fair market value of $118,413, and
Ms. Heystee had 44,405 unvested RSU’s that represented
a fair market value of $261,990.
One-half of the restricted stock grant in fiscal 2006 of
150,000 shares to Mr. Messman, 59,250 shares to
Mr. Hovsepian, 7,830 shares to Dr. Jaffe, and
20,070 shares to Mr. LaSala will vest over four years
on each annual grant date anniversary and one-half will vest
based on the achievement of various operating profit targets. An
additional restricted stock grant in fiscal 2006 of
100,000 shares to Dr. Jaffe will vest one-third on
each of the first three annual anniversaries of the grant date.
One half of the restricted stock grant in fiscal 2006 of 34,405
RSU’s to Ms. Heystee will vest over four years on each
annual grant date anniversary and one half will vest based upon
the achievement of various operating revenue targets. One half
of the restricted stock grant in fiscal 2005 of
300,000 shares to Mr. Hovsepian will vest based on the
achievement of various operating profit targets, and the other
half will vest ratably on each of the first four annual
anniversaries of the grant date. The restricted stock grant in
fiscal 2005 of 100,000 shares to Mr. Francese will
vest as follows: 50,000 shares will vest ratably on each of
the first three annual anniversaries of the grant date,
25,000 shares will vest on the day that the average
reported closing price of our common stock over the previous 30
consecutive trading days has been greater than or equal to
$8.20, and 25,000 shares will vest on the day that the
average reported closing price of our common stock over the
previous 30 consecutive trading days has been greater than or
equal to $9.42.
(5)
The stated amounts are our matching contributions to our 401(k)
Retirement and Savings Plan, Deferred Compensation Plan, and
Stock-Based Deferred Compensation Plan, except as follows:
In September 2006, we adopted an amendment to our Flexible Time
Off (“FTO”) program (vacation and sick days) to reduce
the number of hours that may be carried over from year to year
by immediately cashing out all accruals over 120 hours to
bring accrued FTO for all employees to 120 hours and
establishing additional caps on the number of hours that may be
carried over in future years. The following persons received the
following one-time payments pursuant to the amendment to the FTO
program: Mr. Messman — $114,265;
Mr. Hovsepian — $35,439; and
Mr. LaSala — $23,212.
Upon his termination in June 2006, Mr. Messman received a
one-time payment of $114,265 to cash out his accrued but unused
FTO.
The following amounts reflect the dollar value of benefits
related to life insurance: Mr. Messman — $6,000,
$5,500 and $5,060 in fiscal years 2006, 2005 and 2004,
respectively; and Mr. LaSala — $1,780, $1,680 and
$1,580 in fiscal years 2006, 2005 and 2004, respectively.
Messrs. Messman and LaSala have collaterally assigned these
life insurance policies to us to secure the repayment to us of
up to the entire amount of the premiums paid by us pursuant to
these policies. These payments are in respect of split-dollar
insurance arrangements that were entered into prior to the
adoption of the Sarbanes-Oxley Act of 2002, and no new
arrangements have been entered into since the adoption of the
Act.
The amount of $5,571,243 in 2006 was a severance benefit paid to
Mr. Messman pursuant to his severance agreement.
(6)
Mr. Messman served as Chief Executive Officer until June
2006. Dr. Jaffe joined us as an executive officer in
November 2005. Mr. Francese joined us as an executive
officer in October 2005. Ms. Heystee became an executive
officer in July 2005.
Stock
Option Grants in Fiscal Year 2006
This table shows stock option grants during fiscal 2006 to the
Named Executive Officers. We have not granted any stock
appreciation rights to the Named Executive Officers.
Individual Grants
Number of
% of Total
Securities
Options
Potential Realizable Value at
Underlying
Granted to
Assumed Annual Rates of
Options
Employees
Exercise
Stock Price Appreciation for Option Term(3)
Granted
in Fiscal
Price
Expiration
5%
10%
Name
(#)(1)
Year(2)
($/Sh)
Date
($)
($)
Jack L. Messman
600,000
(4)(5)
7.07
%
$
8.71
12/21/2006
(5)
$
—
$
—
Ronald W. Hovsepian
237,005
(4)
2.79
%
$
8.71
12/12/2013
$
985,618
$
2,360,726
Dr. Jeffrey M. Jaffe
300,000
(6)
3.53
%
$
7.93
11/28/2013
$
1,135,867
$
2,720,598
31,325
(4)
0.37
%
$
8.71
12/12/2013
$
130,269
$
312,018
Thomas Francese
—
—
%
—
—
—
—
Joseph A. LaSala, Jr.
80,275
(4)
0.95
%
$
8.71
12/12/2013
$
333,835
$
799,592
Susan Heystee
137,615
(4)
1.62
%
$
8.71
12/12/2013
$
572,291
$
1,370,736
(1)
All options shown in the table have exercise prices equal to the
fair market value of our common stock on the date of grant and
have the terms indicated. In the event of a change in control,
as defined in our stock plans, except as otherwise determined by
the Board of Directors prior to the occurrence of such change in
control, all options shall become fully exercisable and vested
and shall be terminated in exchange for a net cash payment. In
the event of a merger involving us or the sale of substantially
all of our assets that does not constitute a change in control,
the acquiring company shall assume the unvested options. The
Board of Directors can accelerate unvested options if the
acquiring company does not assume the options. Each of the
persons listed in the table has a severance agreement with us
that may vary the treatment of these options in the event of a
change in control. The plans provide for various methods of
exercise. We currently allow for cash, cashier’s check or
cashless exercise.
(2)
Options to purchase a total of approximately
8,487,998 shares were granted to employees in fiscal 2006.
(3)
Potential realizable value assumes the price of our common stock
will appreciate at the annual rates shown. These rates are
compounded annually from the date of grant until the end of the
term of the option. The potential realizable value is calculated
as:
• the potential stock price per share at the end of
the term based on the 5% and 10% assumed appreciation rates,
• less the exercise price per share,
• times the number of shares subject to the option.
These numbers are calculated based on the requirements of the
SEC and do not reflect our estimate of future common stock price
growth. Actual gains, if any, on stock option exercises and
common stock holdings are dependent on, among other things, the
timing of such exercise and the future performance of our common
stock. There is no assurance that the rates of appreciation
assumed in this table can be achieved or that the amounts
reflected will be received by the individuals.
(4)
Half of the shares subject to this option become vested and
exercisable based on timing requirements, with 25% of this half
of the option becoming exercisable on the first annual
anniversary of the date of grant, and an additional 2.0833% of
this half of the option becoming vested and exercisable on each
succeeding monthly anniversary of the date of grant, so that
this half of the option will be fully vested on the fourth
annual anniversary of the date of grant. The other half of the
shares subject to this option will vest based on the achievement
of various operating revenue targets.
(5)
Pursuant to our severance agreement with Mr. Messman,
112,500 of the shares subject to this option became immediately
vested and exercisable upon the termination of his employment on
June 21, 2006 and subsequently expired unexercised six
months after termination on December 21, 2006. The
remaining 487,500 shares subject to this option expired
upon the termination of Mr. Messman’s employment on
June 21, 2006.
(6)
One-third of the shares subject to this option become vested and
exercisable based on timing requirements with 25% of this
one-third of the options becoming exercisable on the first
annual anniversary of the date of grant, with an additional
2.0833% of such portion becoming vested and exercisable on each
succeeding monthly anniversary of the date of grant, so that
this one-third of the option will be fully vested on the fourth
annual anniversary of the date of grant. Another one-third of
the shares subject to this option will vest based on the
achievement of various operating revenue targets. The final
one-third of the shares subject to this option will vest based
on the achievement of various operating profit targets.
Aggregated
Option Exercises in Last Fiscal Year and Fiscal Year-End Option
Values
This table shows information regarding shares acquired and value
realized upon exercise of stock options by the Named Executive
Officers during fiscal 2006 and the number and value of options
held at the end of fiscal 2006 by the Named Executive Officers.
The primary goal of our director compensation program is to
support the achievement of our performance objectives and to
attract and retain highly qualified directors. Compensation of
our non-employee directors is as follows:
•
the annual retainer for the Chairman of the Board of Directors
is $125,000;
•
the annual retainer for all other members of the Board of
Directors is $50,000;
•
the annual retainer for service as chairperson of the Audit
Committee is $20,000;
•
the annual retainer for service as chairperson of all other
committees of the Board of Directors is $10,000;
•
fees for attendance at meetings of the Board of Directors are
$1,500;
•
fees for attendance at committee meetings of the Board of
Directors are $1,500; and
•
stock option grants as described below.
Our non-employee directors are reimbursed for their expenses
incurred in attending meetings of the Board of Directors and its
Committees.
Non-employee directors may elect to have all or a portion of
their annual board retainer deferred through the purchase of
common stock equivalents (“CSE’s”) and designate
what date in the future such CSE’s will be paid out in
shares of our common stock.
Subject to the vesting provisions described below, the annual
board retainer payable to any non-employee director who elects
to defer all or a portion of his annual board retainer shall be
increased by an amount (such amount to be referred to as the
“Match”) of up to 25% of such portion of the annual
board retainer that is deferred through the purchase of
CSE’s, provided that the Match shall be used solely to
purchase additional CSE’s. The exact percentage of the
Match shall be determined by the Compensation Committee. For the
upcoming year, the Compensation Committee has determined that
the Match will be 25%. The CSE’s purchased with Match funds
shall be credited to a separate bookkeeping account from the
CSE’s purchased with the annual board retainer. In the
event that any non-employee director ceases to serve as a member
of our Board of Directors prior to the third anniversary of such
director’s purchase of any CSE’s with any given Match,
all CSE’s purchased with each such Match shall be forfeited
and such director shall no longer have any rights with respect
to such Match or such CSE’s.
Upon the initial appointment of each non-employee director to
the Board of Directors, such director will be granted options to
purchase an aggregate of 50,000 shares of common stock,
vesting 25% annually over four years. In addition, each
incumbent non-employee director will receive an annual grant of
an option to purchase an aggregate of 25,000 shares of
common stock, vesting 50% annually over two years. Options will
be granted either automatically pursuant to our Stock Option
Plan for Non-Employee Directors (the “Director Plan”)
or by the Compensation Committee pursuant to our 2000 Stock
Plan. All options are non-statutory options, have an exercise
price equal to the fair market value of our common stock on the
date of grant and have a term of eight or ten years. Upon a
change in control, options granted under the Director Plan
become exercisable in full by a non-employee director if within
one year of such change in control the non-employee director
ceases for any reason to be a member of the Board of Directors.
Under the 2000 Stock Plan, in the event of a change in control,
the outstanding options may be assumed or substituted for by the
successor corporation. If the successor corporation refuses to
assume or substitute for the outstanding options, the options
will fully vest and become fully exercisable. Upon retirement
from the Board of Directors after the age 73, options
granted under the Director Plan become fully vested. Upon
retirement from the Board of Directors after the age of 65, the
vesting of options granted under the 2000 Stock Plan is
accelerated by one year. Upon resignation from the Board of
Directors for any reason, directors have six months in which to
exercise their vested options.
In May 2006, all non-employee directors were each granted
options to purchase 25,000 shares of common stock with an
exercise price of $8.22 per share per the annual grant to
incumbent directors.
Novell had a Directors’ Charitable Award Program (the
“Charitable Program”) for which all members of the
Board of Directors were eligible, subject to vesting
requirements. The Board of Directors terminated the Charitable
Program with respect to all persons joining our Board of
Directors after January 7, 2003, but has kept the program
in place with respect to those persons who were directors on or
prior to January 7, 2003. The Charitable Program is funded
by life insurance policies purchased by us, which provide for a
$1,000,000 death benefit to participating directors. Upon the
death of a participating director, we will donate the proceeds
of the $1,000,000 death benefit (paid in ten equal annual
installments) to non-profit organizations recommended by the
director. Individual directors derive no financial benefit from
the Charitable Program since all available insurance proceeds
and tax deductions accrue solely to us. The aggregate cost to us
of the life insurance premiums paid during fiscal 2006 to fund
the Charitable Program was $276,602.
Employment
Contracts, Termination of Employment and
Change-in-Control
Arrangements
Ms. Heystee and Messrs. Hovsepian, Francese, Jaffe and
LaSala are all party to employment arrangements with us that
currently provide for annual base salaries of $400,000,
$825,000, $500,000, $450,000, and $355,000, respectively.
Ms. Heystee and Messrs. Hovsepian, Francese, Jaffe and
LaSala are all eligible to participate in our Fiscal 2007 Annual
Bonus Program for Executives that provides for the payment of
bonuses if personal and corporate performance goals are met with
annual target bonus of 50%, 125%, 125%, 100%, and 75% of base
salary, respectively. They are all entitled to receive employee
benefits made available to other employees and officers and
their eligible dependents, such as health-care insurance,
long-term disability insurance, short-term disability insurance,
term life insurance coverage, accidental death and dismemberment
coverage, and business travel accident insurance.
Pursuant to his offer letter and a related letter of
understanding with us, Mr. Francese is also entitled to
receive 100,000 shares of restricted common stock for
$.10 per share, half of which vest over three years and
half of which vest when certain performance goals are satisfied.
Additionally, each year Mr. Francese is working in EMEA for
Novell, he will receive (i) an annual cash allowance of
$250,000 which is intended to compensate him for a portion of
his expenses associated with housing, car, cost of living,
continued maintenance of a residence in Texas, and the storage
of his household goods, and (ii) reimbursement of up to
$24,000 per year for the cost of family travel back to the
United States. In the event Mr. Francese relocates to the
United States for Novell, Novell will reimburse him up to
$50,000 for the costs associated with such relocation.
Pursuant to his offer letter, Dr. Jaffe is also entitled to
receive 100,000 shares of restricted common stock for
$.10 per share, which vest over three years. Dr. Jaffe
also received a lump sum after-tax cash payment equal to $75,000
to compensate him for relocating to Waltham, Massachusetts, with
the entire before-tax cash value repayable if Novell terminates
his employment for cause or he resigns within one year. Finally,
Dr. Jaffe receives $20,000 per year for tax
preparation and other expenses.
Each of Ms. Heystee and Messrs. Hovsepian, Francese,
Jaffe and LaSala are, and Mr. Messman was, a party to a
severance agreement with us. Generally, in the event of
involuntary termination of an executive’s employment
without a change in control, the agreements provide the
following benefits paid by Novell: (i) payment of a
multiple of the executive’s base salary; (ii) a
prorated bonus for the year of termination; (iii) twelve
months of continued health and dental coverage;
(iv) accelerated vesting of that portion of the
executive’s outstanding stock options, if any, that would
have vested within the one year period following the date of
executive’s termination; (v) accelerated vesting of
the portion of the executive’s outstanding restricted
common stock, if any, that would have vested within the one year
period from the date of executive’s termination; and
(vi) reimbursement for outplacement benefits that are
actually provided, not to exceed 20% of the executive’s
base salary. The multiples referred to in (i) above for the
Named Executive Officers are as follows:
Mr. Messman — two times; and Ms. Heystee and
Messrs. Hovsepian, Francese, Jaffe and LaSala —
one and one half times. Additionally, Mr. Messman was
eligible to receive an amount equal to two times his target
bonus.
The severance agreements also provide that in the event of an
involuntary termination in connection with a change in control,
the executive will receive the following benefits paid by us:
(i) payment of a multiple of the executive’s base
salary and target bonus; (ii) a prorated bonus for the year
of termination; (iii) a certain number of months of
continued health and dental coverage; (iv) a lump sum cash
payment of what we would have paid as
matching contributions under our 401(k) plan for a certain
number of months after the executive’s termination date;
(v) a lump sum cash payment of what we would have paid as
premiums under the executive’s split-dollar life insurance
policy, if any, for a certain number of months after the
executive’s termination date; (vi) payment of certain
legal fees; (vii) outstanding restricted common stock, if
any, and other equity rights, if any, will become fully vested;
(viii) outstanding stock options, if any, will become fully
vested; (ix) a lump sum payment equal to 20% of the
executive’s base salary which may be used to cover the
costs of outplacement assistance; and (x) if the payments
provided to the executive exceed the amount that triggers the
excise tax under section 4999 of the Tax Code by more than
10%, the payments will be
grossed-up.
The multiples and total number of months for health and dental
insurance coverage, 401(k) plan matching contributions and life
insurance premiums for each Named Executive Officer are as
follows:
Mr. Messman — three times and 36 months; and
Ms. Heystee and Messrs. Hovsepian, Francese, Jaffe and
LaSala — two times and 24 months. Additionally,
all of the severance agreements contain non-competition and
non-solicitation provisions.
Prior to the termination of his employment in June 2006,
Mr. Messman was a party to an employment agreement with us
that provided for an annual base salary of $950,000, an annual
target bonus of 143% of his base salary, employee benefits made
available to our employees and officers and their eligible
dependents, such as health-care insurance, long-term disability
insurance, short-term disability insurance, term life insurance
coverage, accidental death and dismemberment coverage, and
business travel accident insurance for the benefit of
Mr. Messman. Upon the termination of his employment,
Mr. Messman received severance benefits pursuant to the
provisions of the severance agreement described above relating
to involuntary termination without a change in control.
Item 12.
Security
Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
Equity
Compensation Plan Information
The following table provides information regarding the aggregate
number of shares of our common stock to be issued under all of
our stock option and equity-based plans upon exercise of
outstanding options, warrants and other rights and their
weighted-average exercise price as of October 31, 2006.
Material features of the 2000 Nonqualified Stock Option Plan and
the Novell/SilverStream 2001 Stock Option Plan, which plans were
not approved by stockholders, are described in Note U to
the Consolidated Financial Statements filed as part of our
Annual Report on
Form 10-K
for the year ended October 31, 2006.
Number of
Securities to
be Issued Upon
Number of Securities
Exercise
Remaining Available for
of Outstanding
Weighted-Average
Future Issuance Under
Options,
Exercise Price of
Equity Compensation Plans
Warrants and
Outstanding Options,
(Excluding Securities
Plan Category
Rights (a)
Warrants and Rights (b)
Reflected in Column (a))(c)
Equity compensation plans approved
by security holders
31,898,842
$
5.78
23,141,079
Equity compensation plans not
approved by security holders
SHARE
OWNERSHIP BY PRINCIPAL STOCKHOLDERS, DIRECTORS AND
MANAGEMENT
This table shows, as of April 30, 2007, how many shares of
our common stock are beneficially owned by stockholders who have
reported or are known by us to have beneficial ownership of more
than five percent of our common stock, our directors, our named
executive officers and our executive officers as a group. There
were 346,742,418 shares of common stock outstanding on
April 30, 2007.
All current directors and
executive officers as a group (19 persons)
574,598
(8)
4,313,733
481,321
5,369,652
1.55
%
*
less than 1%
(1)
The persons named in the table have sole voting and investment
power with respect to all shares shown as beneficially owned by
them except as may be otherwise indicated in a footnote. With
respect to directors and executive officers, these tables
include vested restricted stock holdings and exclude shares that
may be acquired through stock option exercises and unvested
restricted common stock holdings.
(2)
Includes shares that can be acquired through stock options that
are exercisable through June 29, 2007.
(3)
These shares can be voted, but are subject to a vesting
schedule, forfeiture risk and other restrictions.
Pursuant to a Schedule 13G/A filed on February 12,2007, Capital Research and Management Company disclosed that it
had sole power to vote and dispose of all shares. Capital
Research and Management Company subsequently disclosed in a
Form 13F filed for the period ended March 31, 2007
that it held 29,056,800 shares of common stock.
(5)
Pursuant to a Schedule 13G/A filed on January 10,2007, Columbia Wanger Asset Management, L.P. disclosed that it
had sole power to vote and dispose of 23,924,600 shares and
shared power to vote and dispose of 500,000 shares.
(6)
Pursuant to a Schedule 13G/A filed on February 6,2007, OppenheimerFunds, Inc. disclosed that it had shared power
to vote and dispose of all shares.
(7)
Pursuant to a Schedule 13G filed on April 13, 2007,
Ziff Asset Management, L.P. disclosed that it and its affiliates
named in that Schedule had shared power to vote and dispose of
all shares. Affiliates named included Ziff Asset Management,
L.P.; PBK Holdings, Inc.; Philip B. Korsant; and ZBI Equities,
L.L.C., all of which have a principal business address of 283
Greenwich Avenue, Greenwich, CT06830.
(8)
Includes shares owned as of April 30, 2007 as well as
shares to be issued in connection with the filing of this Annual
Report on
Form 10-K
under restricted stock units that vested during March 2007.
Item 13.
Certain
Relationships and Related Transactions
During fiscal 2006, we received consulting services from J.D.
Robinson Inc. The consulting agreement between us and J.D.
Robinson Inc. with respect to the provision of those services
provides for us to make payments of $200,000 per year to J.D.
Robinson Inc. for these services. Mr. Robinson, a member of
our Board of Directors, is President and the sole stockholder of
J.D. Robinson Inc.
Item 14.
Principal
Accountant Fees and Services
PricewaterhouseCoopers LLP (“PwC”) served as our
independent registered public accounting firm and audited our
consolidated financial statements for fiscal years 2005 and
2006, and performed audit-related services and consultation in
connection with various accounting and financial reporting
matters. Additionally, PwC performed certain non-audit services
that are permitted under the Sarbanes-Oxley Act and related
rules of the SEC for Novell during fiscal years 2005 and 2006.
Fees
Billed to Novell by PwC During Fiscal Years 2005 and
2006
Audit
Fees
The aggregate fees billed by PwC for the fiscal year ended
October 31, 2005 for services rendered for the audit of
Novell’s annual financial statements included in
Novell’s
Form 10-K
and review of the interim financial statements included in
Novell’s
Forms 10-Q,
including services related thereto, were $3,819,000.
The aggregate fees billed by PwC for the fiscal year ended
October 31, 2006 for services rendered for the audit of
Novell’s annual financial statements included in
Novell’s
Form 10-K
and review of the interim financial statements included in
Novell’s
Forms 10-Q,
including services related thereto, were $3,985,000.
Audit-Related
Fees
The aggregate fees billed by PwC for the fiscal year ended
October 31, 2005 for assurance and related services that
are reasonably related to the performance of the audit or review
of Novell’s financial statements and are not reported as
“Audit Fees,” including an audit of a foreign
retirement fund, were $1,000.
The aggregate fees billed by PwC for the fiscal year ended
October 31, 2006 for assurance and related services that
are reasonably related to the performance of the audit or review
of Novell’s financial statements and are not reported as
“Audit Fees,” including an audit of a license fee,
were $2,000.
The aggregate fees billed by PwC for the fiscal year ended
October 31, 2005 for services rendered for tax compliance,
tax advice and tax planning, which included tax return
preparation in various foreign jurisdictions, consultation
regarding various tax issues, support provided to management in
connection with income and other tax audits, and tax services
for expatriate employees, were $198,178.
The aggregate fees billed by PwC for the fiscal year ended
October 31, 2006 for services rendered for tax compliance,
tax advice and tax planning, which included tax return
preparation in various foreign jurisdictions, consultation
regarding various tax issues, support provided to management in
connection with income and other tax audits, services relating
to transfer pricing analysis, and tax services for expatriate
employees, were $26,344.
All
Other Fees
The aggregate fees billed by PwC for the fiscal year ended
October 31, 2005 for products and services other than those
described above, including license fees for product research,
were $1,500.
There were no fees billed by PwC for the fiscal year ended
October 31, 2006 for products and services other than those
described above.
Pre-approval
Policies and Procedures
All audit and non-audit services to be performed by
Novell’s independent registered public accounting firm must
be approved in advance by the Audit Committee. As permitted by
the SEC’s rules, the Audit Committee has authorized each of
its members to pre-approve audit, audit-related, tax and
non-audit services, provided that such approved service is
reported to the full Audit Committee at its next meeting.
As early as practicable in each fiscal year, the independent
auditor provides to the Audit Committee a schedule of the audit
and other services that the independent auditor expects to
provide or may provide during the fiscal year. The schedule will
be specific as to the nature of the proposed services, the
proposed fees, and other details that the Audit Committee may
request. The Audit Committee will by resolution authorize or
decline the proposed services. Upon approval, this schedule will
serve as the budget for fees by specific activity or service for
the next twelve months.
A schedule of additional services proposed to be provided by the
independent auditor, or proposed revisions to services already
approved, along with associated proposed fees, may be presented
to the Audit Committee for their consideration and approval at
any time. The schedule will be specific as to the nature of the
proposed service, the proposed fee, and other details that the
Audit Committee may request. The Audit Committee will by
resolution authorize or decline authorization for each proposed
new service.
Applicable SEC rules and regulations permit waiver of the
pre-approval requirements for services other than audit, review
or attest services if certain conditions are met. Out of the
services characterized above as “Audit-Related,”“Tax,” and “All Other,” none were billed
pursuant to these provisions in fiscal years 2005 or 2006
without pre-approval.
Report of PricewaterhouseCoopers LLP, Independent Registered
Public Accounting Firm.
Report of Ernst & Young LLP, Independent Registered
Public Accounting Firm.
(2.)
Financial Statement Schedules:
The following consolidated financial statement schedule is
included on page 147 of this
Form 10-K:
Schedule II — Valuation and Qualifying Accounts
Schedules other than that listed above are omitted because they
are not required, not applicable or because the required
information is shown in the consolidated financial statements or
notes thereto.
(3.)
Exhibits:
A list of the exhibits required to be filed as part of this
report is set forth in the Exhibit Index on page 148
of this
Form 10-K,
which immediately precedes such exhibits, and is incorporated
herein by reference.
Pursuant to the requirements of Section 13 or 15(d) 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.
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons
on behalf of the Registrant and in the capacities and on the
dates indicated.
Name
Title
Date
/s/ Ronald
W. Hovsepian
(Ronald
W. Hovsepian)
President and Chief Executive
Officer (Principal Executive Officer)
Amendment No. 1 to Agreement
and Plan of Reorganization, dated as of May 24, 2001, by
and among Novell, Inc., Ceres Neptune Acquisition Corp. and
Cambridge Technology Partners (Massachusetts), Inc. (1)
(Annex A)
2
.2
Agreement and Plan of Merger,
dated as of June 9, 2002 by and among Novell, Inc.,
Delaware Planet, Inc. and Silver Stream Software, Inc. (2)
(Exhibit 2.1)
Form of certificate representing
the shares of Novell common stock. (5) (Exhibit 4.3)
4
.3
Preferred Shares Rights Agreement,
dated as of December 7, 1988, as amended and restated
effective September 20, 1999, by and between Novell, Inc.
and Chase Mellon Shareholder Services, L.L.C. (6)
(Exhibit 1)
Registration Rights Agreement
dated July 2, 2004 between the Registrant and Citigroup
Global Markets Inc., for itself and on behalf of certain
purchasers. (7) (Exhibit 10.1)
10
.2*
Novell, Inc. 1989 Employee Stock
Purchase Plan. (9) (Exhibit 4.1)
10
.3*
Novell, Inc. 1991 Stock Plan. (10)
(Exhibit 4.1)
10
.4*
Novell, Inc. 2000 Stock Plan. (11)
(Exhibit 4.2)
10
.5*
Novell, Inc. 2000 Stock Option
Plan. (11) (Exhibit 4.1)
10
.6*
UNIX System Laboratories, Inc.
Stock Option Plan. (12) (Exhibit 4.3)
10
.7*
Novell, Inc. Stock Option Plan for
Non-Employee Directors. (13) (Exhibit 4.1)
Incorporated by reference to the Exhibit identified in
parentheses, filed as an exhibit to the Registrant’s
Registration Statement on Form
S-1, filed
November 30, 1984, and amendments thereto (File
No. 2-
94613).
Portions of this exhibit have been omitted and filed separately
with the Securities and Exchange Commission pursuant to a
request for confidential treatment.
150
Novell
annual report 2006
Dates Referenced Herein and Documents Incorporated by Reference