UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark one)
[X] Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the Quarterly Period Ended July 31, 2002
or
[ ] Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the transition period from
-------
to
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Commission File Number: 0-13351
NOVELL, INC.
(Exact name of registrant as specified in its charter)
Delaware 87-0393339
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1800 South Novell Place
Provo, Utah 84606
(Address of principal executive offices and zip code)
(801) 861-7000
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO __
As of August 31, 2002, there were 364,412,913 shares of the Registrant's Common
Stock outstanding.
Part I. Financial Information
Item 1. Financial Statements
NOVELL, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
July 31, 2002 October 31, 2001
------------- ----------------
Amounts in thousands, except share and per share data (Unaudited)
Assets
Current assets:
Cash and short-term investments $ 607,310 $ 705,243
Receivables (less allowances of $39,822 - July 31, 2002
and $47,249 - October 31, 2001) 204,811 227,044
Inventories 231 947
Prepaid expenses 26,901 29,808
Deferred income taxes 22,098 34,595
Other current assets 22,710 29,729
---------------- ---------------
Total current assets 884,061 1,027,366
Property, plant and equipment, net 459,687 496,620
Goodwill 167,310 187,795
Intangible assets 38,857 4,221
Long-term investments 94,657 114,971
Other assets 73,223 73,033
---------------- ---------------
Total assets $ 1,717,795 $ 1,904,006
================ ===============
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 59,063 $ 77,571
Accrued compensation 87,922 87,382
Accrued marketing liabilities 12,183 13,672
Other accrued liabilities 127,778 150,842
Income taxes payable 26,245 38,175
Deferred revenue 239,929 243,261
---------------- ---------------
Total current liabilities 553,120 610,903
Minority interests 19,170 22,436
Stockholders' equity:
Common stock, par value $.10 per share:
authorized - 600,000,000 shares:
Issued --364,344,161 shares-July 31, 2002,
362,341,403 shares-October 31, 2001 36,434 36,234
Preferred stock, par value $.10 per share:
authorized - 500,000 shares, issued - 0 shares -- --
Additional paid in capital 291,594 256,332
Retained earnings 830,335 985,486
Accumulated other comprehensive income (loss) (3,389) 2,455
Other (9,469) (9,840)
----------------- ----------------
Total stockholders' equity 1,145,505 1,270,667
---------------- ---------------
Total liabilities and stockholders' equity $ 1,717,795 $ 1,904,006
================ ===============
See notes to consolidated unaudited condensed financial statements.
NOVELL, INC.
CONSOLIDATED UNAUDITED CONDENSED STATEMENTS OF OPERATIONS
Three Months Ended
----------------------------------------------
July 31, 2002 July 31, 2001
Amounts in thousands, except per share data
Net sales $ 282,273 $ 249,084
Cost of sales 109,822 76,176
--------------- ---------------
Gross profit 172,451 172,908
Operating expenses:
Sales and marketing 90,125 100,013
Product development 41,492 47,976
General and administrative 29,566 28,101
Restructuring -- 30,392
Purchased in-process research and development 3,000 --
--------------- ---------------
Total operating expenses 164,183 206,482
Income (loss) from operations 8,268 (33,574)
Other income, net
Investment income 5,268 8,636
Other, net 1,962 1,870
--------------- ---------------
Other income, net 7,230 10,506
Income (loss) before taxes 15,498 (23,068)
Income tax expense (benefit) 5,549 (3,794)
--------------- ----------------
Net income (loss) $ 9,949 $ (19,274)
=============== ================
Net income (loss) per share:
Basic $ 0.03 $ (0.06)
============== ===============
Diluted $ 0.03 $ (0.06)
============== ===============
Weighted average shares outstanding:
Basic 364,211 328,683
Diluted 364,247 328,683
See notes to consolidated unaudited condensed financial statements.
NOVELL, INC.
CONSOLIDATED UNAUDITED CONDENSED STATEMENTS OF OPERATIONS
Nine Months Ended
----------------------------------------------
July 31, 2002 July 31, 2001
Amounts in thousands, except per share data
Net sales $ 833,985 $ 734,874
Cost of sales 340,219 210,255
--------------- ---------------
Gross profit 493,766 524,619
Operating expenses:
Sales and marketing 261,660 338,335
Product development 122,976 147,388
General and administrative 90,946 77,347
Restructuring 19,100 30,392
Purchase in-process research and development 3,000 --
--------------- ---------------
Total operating expenses 497,682 593,462
Loss from operations (3,916) (68,843)
Other income (loss), net
Investment income (loss) (9,323) (104,710)
Other, net 8,625 856
--------------- ---------------
Other income (loss), net (698) (103,854)
Loss before taxes (4,614) (172,697)
Income tax expense (benefit) 6,835 (5,386)
--------------- ----------------
Net loss before cumulative effect of change in accounting
principle (11,449) (167,311)
Cumulative effect of change in accounting principle (143,702) (11,048)
---------------- ----------------
Net loss $ (155,151) $ (178,359)
================ ================
Net loss per share - basic and diluted:
Before cumulative effect of change in accounting principle $ (0.03) $ (0.52)
Cumulative effect of change in accounting principle (0.40) (0.03)
--------------- ---------------
$ (0.43) $ (0.55)
=============== ===============
Weighted average shares outstanding - basic and diluted: 363,131 322,913
See notes to consolidated unaudited condensed financial statements.
NOVELL, INC.
CONSOLIDATED UNAUDITED CONDENSED STATEMENTS OF CASH FLOWS
Nine Months Ended
Dollars in thousands July 31, 2002 July 31, 2001
------------- -------------
Cash flows from operating activities
Net loss $ (155,151) $ (178,359)
Adjustments to reconcile net loss to net cash provided by operating
activities
Gain on sale of fixed assets (8,762) --
Depreciation and amortization 49,175 66,995
Loss on impaired goodwill 143,702 --
Loss on impaired investments and fixed assets 29,839 152,806
Non-cash restructuring charges 16,426 19,185
Purchased in-process research and development 3,000 --
Decrease in receivables 29,346 43,392
Decrease in inventories 716 1,554
Decrease (increase) in prepaid expenses 4,756 (5,085)
Decrease (increase) in deferred income taxes 963 (8,339)
Decrease in other current assets 7,656 9,013
Decrease in accounts payable (21,564) (23,905)
Decrease in current liabilities, net (78,168) (26,172)
(Decrease) increase in deferred revenue (3,332) 10,494
-------------- -------------
Net cash provided by operating activities 18,602 61,579
Cash flows from financing activities
Issuance of common stock, net 6,861 5,528
Repurchase of common stock -- (64,954)
------------- --------------
Net cash provided by (used in) financing activities 6,861 (59,426)
Cash flows from investing activities
Expenditures for property, plant and equipment (18,676) (25,044)
Proceeds from the sale of property, plant and equipment 16,050 --
Purchases of short-term investments (1,191,184) (642,197)
Maturities of short-term investments 907,134 546,823
Sales of short-term investments 425,534 103,413
Proceeds from Volera minority shareholders -- 25,975
Cash acquired from acquisitions - SilverStream in 2002, Cambridge in
2001 108,286 72,358
Cash paid for acquisition of SilverStream (210,847) --
Expenditures for long-term investments (7,882) (36,523)
Other (2,955) (14,006)
-------------- --------------
Net cash provided by investing activities 25,460 30,799
Total increase in cash and cash equivalents 50,923 32,952
Cash and cash equivalents - beginning of period 337,927 289,537
------------- -------------
Cash and cash equivalents - end of period 388,850 322,489
Short-term investments - end of period 218,460 364,454
------------- -------------
Cash and short-term investments - end of period $ 607,310 $ 686,943
============= =============
See notes to consolidated unaudited condensed financial statements.
NOVELL, INC.
NOTES TO CONSOLIDATED UNAUDITED CONDENSED FINANCIAL STATEMENTS
A. Quarterly Financial Statements
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements
and accompanying notes. As discussed under the subheading "Critical
Accounting Policies" in Part I, Item 2, "Management's Discussion and
Analysis of Financial Condition and Results of Operations," actual results
could differ materially from those estimates. The accompanying consolidated
unaudited condensed financial statements have been prepared in accordance
with the instructions to Form 10-Q but do not include all of the
information and footnotes required by generally accepted accounting
principles and should, therefore, be read in conjunction with the Company's
fiscal 2001 Annual Report on Form 10-K. These financial statements do
include all normal recurring adjustments that the Company believes
necessary for a fair presentation of the statements. The interim operating
results are not necessarily indicative of the results for a full year.
Certain reclassifications, none of which affected net loss, have been made
to the prior years' amounts in order to conform to the current year's
presentation.
B. Acquisitions
Pursuant to the terms of an Agreement and Plan of Merger, dated as of June
9, 2002 by and among Novell, Delaware Planet, Inc., a wholly owned
subsidiary of Novell, and SilverStream Software, Inc., a Delaware
corporation ("SilverStream"), Delaware Planet commenced a cash tender offer
on June 18, 2002 to acquire all of the outstanding shares of SilverStream
common stock at a price of $9.00 per share. On July 17, 2002, Delaware
Planet announced the completion of its cash tender offer, pursuant to which
it purchased almost all outstanding shares of SilverStream common stock at
a price of $9.00 per share. On July 19, 2002, Novell completed its
acquisition of SilverStream by merging Delaware Planet into SilverStream.
As a result of the merger, each share of SilverStream common stock that was
not tendered in the tender offer now represents the right to receive $9.00
in cash, without interest.
SilverStream provides software products and services that enable
organizations to more effectively conduct business using the Web.
SilverStream's products and services leverage the power of standards such
as Java and XML to unify relevant information and services while enabling
businesses to leverage prior technology investments. They also help
customers rapidly deliver Web-based applications that are scalable,
reliable and secure. The Company acquired SilverStream to further its
development of Web services products and services and to enhance its
current Web services and product offerings.
At the closing date of the merger, there were 23,427,448 shares of
SilverStream outstanding resulting in a total cash acquisition price of
$210.8 million. Direct transaction costs are estimated to be $4.0 million
and SilverStream stock options assumed, both vested and unvested, totaled
$28.6 million.
With respect to stock options assumed as a part of the merger, all
SilverStream options, vested and unvested, were exchanged for Novell
options with the same terms and vesting characteristics. The fair value of
these options was included in the acquisition purchase price. The portion
of the intrinsic value of unvested options that will be earned over the
remaining vesting period of those options has been deducted from the fair
value of the unvested options. This deferred compensation will be amortized
over the remaining vesting period of approximately two years, in accordance
with Financial Accounting Standards Board Interpretation Number 44 ("FIN
44"). In total, options to purchase 4.9 million shares of SilverStream
common stock were converted into options to purchase 15.0 million shares of
Novell stock using a conversion ratio of 3.0518.
The fair value of the options was determined using the Black-Scholes model
using the following assumptions:
o Fair market value of the underlying shares was based on the average
closing price of Novell's common stock on June 10, 2002 and the three
days prior and subsequent to that date.
o Expected life of 2-5 years
o Expected volatility of 80%
o Risk free interest rate of 5%
o Expected dividend rate of 0%
The value of the acquisition was preliminarily allocated as follows:
Estimated
(in thousands) Acquisition Cost Asset Life (in years)
---------------- ---------------------
Adjusted net tangible assets acquired $ 97,833 N/A
Deferred compensation 4,826 2 years
Intangible assets
Purchased in-process research and development 3,000 expensed in the third quarter of fiscal
2002
Developed technology 19,800 3 years
Trademarks / trade names 2,200 indefinite life
Goodwill 115,771 N/A
-----------
$ 243,430
The allocation will be adjusted over the next twelve months as integration
plans are finalized, as allowed by Statement of Financial Accounting
Standards ("SFAS") No. 141, "Business Combinations," issued by the
Financial Accounting Standards Board ("FASB") in June 2001. There are no
other outstanding contingencies that could affect the allocation.
Goodwill from the acquisition resulted from the Company's belief that the
technology SilverStream had developed is valuable to its Web services
strategy. The Company also believes it was more beneficial to acquire such
technology rather than develop it in-house. The goodwill from the
SilverStream acquisition has been allocated to the Company's product
segment because the eXtendTM product suite will be included with the Net
Directory Services group of products. In accordance with SFAS No. 142,
"Goodwill and Other Intangible Assets," also issued by the FASB in June
2001, the Company will not amortize the goodwill or intangibles with
indefinite lives associated with this acquisition. The Company will review
these assets periodically for potential impairment issues. Goodwill is not
deductible for tax purposes.
Net tangible assets of SilverStream consisted mainly of cash and cash
equivalents, accounts receivable, fixed assets, accounts payable, and other
liabilities.
The value of deferred compensation of approximately $4.8 million represents
the intrinsic value of the unvested options assumed by Novell and was
determined under the guidance of FIN 44.
The $3.0 million of in-process research and development pertains to
acquired research and development on the eXtend line of products that are
not currently technologically feasible, meaning they have not reached the
working model stage and do not contain all of the major functions planned
for the product nor are they ready for initial customer testing. The
estimated amount of the in-process research and development charge
represents a preliminary estimate and represents technology related to
replacement and enhancement to be included in the next versions of the
SilverStream's eXtend product line. Shortly before the acquisition,
SilverStream released its latest version of each of its products in the
eXtend line: Application Server, Composer, Workbench, and Director.
Therefore, there was minimal research and development in process.
In-process research and development was valued based on discounting
forecasted cash flows directly from the related products. Completion of
development on the future upgrades of these products is dependant upon the
Company delivering on its web services strategy and successfully
integrating SilverStream. The in-process research and development does not
have any alternative future use and did not otherwise qualify for
capitalization.
To determine the value of the developed technology, the expected future
cash flow attributable to the existing product technology, the family of
eXtend products, which are currently shipping and can be combined with
Novell products or services, was discounted taking into account risk
associated with these assets relative to the in-process research and
development. The analysis resulted in a valuation of approximately $19.8
million for developed technology, which has reached technological
feasibility.
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 eXtend 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 rates of
0.5 percent to the product revenues were then discounted to a present
value, resulting in a valuation of approximately $2.2 million.
The Company's statement of operations includes SilverStream results for the
period July 20, 2002 through July 31, 2002. The unaudited pro forma
consolidated statement of operations data for the nine months ended July
31, 2002 and 2001 set forth below gives effect to the acquisition of
SilverStream as if it had occurred on November 1, 2000. The unaudited pro
forma results for these periods include an adjustment to reflect
amortization of intangibles recorded in conjunction with the acquisition
and the adoption of FAS 142 at the beginning of each of these periods.
Nine months Nine months
ended July 31, 2002 ended July 31, 2001
Amounts in thousands, except per share data
Revenue $ 861,841 $ 791,957
Net income (loss) before accounting change (95,584) (176,811)
Net income (loss) (239,286) (190,859)
Earnings (loss) per share - Basic and Diluted $ (0.66) $ (0.59)
C. Cash and Short-term Investments
The Company considers all highly liquid debt instruments purchased with a
term to maturity of three months or less to be cash equivalents. Short-term
investments are widely diversified, consisting primarily of investment
grade securities that either mature within the next 12 months or have other
characteristics of short-term investments such as the following. Fixed
income securities are included in short-term investments and have
contractual maturities ranging from zero to seven years. Securities that
are anticipated to be used for current operations are classified as
short-term investments, even though some maturities may extend beyond one
year. Money market preferreds, included in short-term investments, have
contractual maturities of less than 180 days. No other short-term
investments have contractual maturities. All marketable debt and equity
securities that are included in cash and short-term investments are
considered available-for-sale and are carried at fair market value. The
unrealized gains and losses related to these securities are included in
Other Comprehensive Income (Loss), net of tax, after any applicable tax
valuation allowances. Fair market values are based on quoted market prices
where available; if quoted market prices are not available, the fair market
values are based on quoted market prices of similar instruments of
companies that are comparable in size, product offerings, and market
sector. When securities are sold, their cost is determined based on the
specific identification method. As of July 31, 2002, the Company had $3.3
million of cash restricted in support of outstanding letters of credit.
The following is a summary of cash and short-term investments, all of which
are considered available-for-sale.
Gross Gross Fair Market
Cost at Unrealized Unrealized Value at
(Amounts in thousands) July 31, 2002 Gains Losses July 31, 2002
------------- ----- ------ -------------
Cash and cash equivalents:
Cash $ 159,940 $ -- $ -- $ 159,940
U.S. government and agency securities 42,821 -- -- 42,821
Corporate debt 50,795 -- -- 50,795
Money market funds 135,294 -- -- 135,294
----------- ---------- ---------- -----------
Total cash and cash equivalents 388,850 -- -- 388,850
Short-term investments:
U.S. government and agency securities 62,105 519 -- 62,624
Corporate debt 148,125 2,322 (272) 150,175
Money market preferreds -- -- -- --
Equity securities 8,835 313 (3,487) 5,661
----------- ---------- ----------- ------------
Total short-term investments 219,065 3,154 (3,759) 218,460
Total cash and short-term investments $ 607,915 $ 3,154 $ (3,759) $ 607,310
=========== ========== =========== ============
Gross Gross Fair Market
Cost at Unrealized Unrealized Value at
(Amounts in thousands) October 31, Gains Losses October 31,
------------ ----- ------ -----------
2001 2001
---- ----
Cash and cash equivalents:
Cash $ 156,088 $ -- $ -- $ 156,088
Corporate debt 3,995 -- -- 3,995
Money market funds 177,844 -- -- 177,844
---------- ------- --------- ----------
Total cash and cash equivalents 337,927 -- -- 337,927
Short-term investments:
State and local government debt 151,459 5,074 -- 156,533
Corporate debt 138,679 2,255 (9) 140,925
Money market preferreds 17,034 -- (34) 17,000
Mutual funds 41,014 -- -- 41,014
Equity securities 12,336 538 (1,030) 11,844
---------- ------- --------- ---------
Total short-term investments 360,522 7,867 (1,073) 367,316
Total cash and short-term investments $ 698,449 $ 7,867 $ (1,073) $ 705,243
- ========== ======== ========== =========
During the first nine months of fiscal 2002, the Company realized gains of
$7.4 million and realized losses of $1.0 million on the sale of short-term
securities. During the first nine months of fiscal 2001, the Company
realized gains of $10.7 million and realized losses of $0.8 million from
the sale of short-term securities.
The Company did not record any impairment losses on short-term investments
during the first nine months of fiscal 2002. During the first nine months
of fiscal 2001 the Company recorded $16.5 million of impairment losses
related to short-term investments whose decline in market value was
determined to be other than temporary. The Company reviews all of its
investments for impairment and recognizes impairment losses as appropriate.
D. Long-term Investments
The primary components of long-term investments are investments made
through the Novell Venture account, Cambridge Technology Capital Fund I
L.P. ("CTC I"), and direct strategic long-term equity investments.
Long-term investments are initially recorded at cost and are written down
when they become impaired.
Investments made through the Novell Venture account generally are in
private companies, primarily small capitalization stocks in the
high-technology industry sector, and funds managed by venture capitalists.
Investments made through CTC I generally are in expansion-stage, private
companies providing products and services within the technology industry.
The value of the investments made through the Novell Venture account and
CTC I is dependent on the performance, successful acquisition, and/or
initial public offering of the investees.
The Company routinely reviews its investments in private securities and
venture funds for impairment. The Company analyzes each investment based on
factors such as the investee's financial statements, the business
environment in which the investee operates, as well as information obtained
from the investee regarding its operations. During the first nine months of
fiscal 2002 and 2001, the Company recognized impairment losses on long-term
investments totaling $29.8 million and $133.2 million, respectively.
E. Goodwill and Intangible Assets
The following is a summary of goodwill:
July 31, 2002 October 31, 2001
------------- ----------------
(Amounts in thousands)
IT consulting related goodwill $ -- $ 138,211
Celerant related goodwill 42,500 42,500
Product related goodwill 124,810 7,084
------------ ------------
Total goodwill $ 167,310 $ 187,795
============ ============
Total goodwill at July 31, 2002 included goodwill $115.8 million from the
SilverStream acquisition, which is included in the product segment.
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets." SFAS No. 142 supersedes APB Opinion No. 17, "Intangible Assets,"
and states that goodwill and other intangible assets with indefinite lives
are no longer amortized but are reviewed for impairment annually, or more
frequently if impairment indicators arise. Separable intangible assets that
are not deemed to have an indefinite life will continue to be amortized
over their useful lives. The provisions under SFAS No. 142 relating to the
discontinuance of amortization of goodwill and indefinite lived intangible
assets are effective for assets acquired after June 30, 2001, and for
assets acquired prior to June 30, 2001, upon adoption of the statement.
Novell elected to adopt this statement beginning in the first quarter of
fiscal 2002, and discontinued amortization of goodwill acquired prior to
July 1, 2001. The Company will review goodwill and intangibles for
impairment on a periodic basis. The following table shows what net income
would have been had the provision been applied at the beginning of fiscal
2001:
Quarter ended Quarter ended Year-to-date Year-to-date
(Amounts in thousands) July 31, 2002 July 31, 2001 July 31, 2002 July 31, 2001
------------- ------------- ------------- -------------
Income (loss) before extraordinary item
As reported $ 9,949 $ (19,274) $ (11,449) $ (167,311)
Pro forma $ (18,308) $ (165,349)
Net income (loss)
As reported $ 9,949 $ (19,274) $ (155,151) $ (178,359)
Pro forma $ (18,308) $ (176,397)
Basic and diluted income (loss) per share
As reported $ 0.03 $ (0.06) $ (0.43) $ (0.55)
Pro forma $ (0.06) $ (0.55)
SFAS No. 142 also requires companies to perform an impairment test within
six months of adopting the statement. Steps required in the impairment test
include: Step 1 - identifying reporting units, assigning assets and
liabilities to the reporting units, assigning goodwill to reporting units,
and determining if the fair value of each reporting unit is less than its
carrying amount. If the fair value is below carrying value, Step 2 -
determining the impairment amount - is performed. The Company completed
this test during the second quarter of fiscal 2002. Through Step 1, the
Company reviewed its three operating segments to identify its four
reporting units; Product, Volera, Inc., Information Technology (IT)
Consulting, and Management Consulting. The Company's consulting segment was
broken down into two reporting units, IT Consulting and Management
Consulting, because they are managed and reported separately within the
Company and the they do not share the same customer base or offer similar
services Based on the present value of expected future cash flows and
analysis of qualitative factors, the Company determined that the IT
Consulting unit had a fair value that was less than its carrying amount.
Step 2 was then performed for this unit to determine the impairment amount,
resulting in a transitional goodwill impairment loss of $143.7 million as
of November 1, 2001, which was recorded as the cumulative effect of an
accounting change in the Company's Consolidated Statements of Operations.
The decline in fair value of the IT consulting unit was primarily due to a
softening in the consulting and technology markets as well as the global
economy causing a sharp decline in IT consulting revenue and profitability.
The changes in the carrying amount of goodwill for the nine months ended
July 31, 2002 are as follows:
Management
(Amounts in thousands) Product Volera IT Consulting Consulting Total
------- ------ ------------- ---------- -----
Balance as of November 1, 2001 $ 7,084 $ -- $ 143,702 $ 42,500 $ 193,286
Acquisitions during the year 117,726 -- -- -- 117,726
Impairment of goodwill -- -- (143,702) -- (143,702)
---------- --------- ----------- ------------ ----------
Balance as of July 31, 2002 $ 124,810 $ -- $ -- $ 42,500 $ 167,310
========== ========= -========= ============ ==========
The following is a summary of intangible assets:
(Amounts in thousands) July 31, 2002 October 31, 2001
------------- ----------------
Developed technology $ 35,275 $ 4,221
Trade names 3,582 --
------------ ------------
Total intangible assets $ 38,857 $ 4,221
============ ============
Developed technology relates primarily to technology acquired as a part of
the acquisition of SilverStream's eXtend product line of shipping products.
Also included are several other small product-related acquisitions.
Developed technology is amortized over three years. Trade names relate to
the SilverStream individual product names, which Novell continues to use.
This asset has an indefinite life and therefore is not amortized but will
be reviewed for impairment at least annually. Financial Accounting
Standards No. 109 ("FAS 109"), "Accounting for Income Taxes," requires that
a deferred tax liability be established for identifiable intangible assets.
FAS 109 also prohibits the recognition of a deferred tax liability for
non-deductible goodwill.
F. Income Taxes
The Company's estimated effective tax rate for the first nine months of
fiscal 2002 is 30% on income before the write-off of purchased in-process
research and development, investment impairment, and the effect of the
cumulative change in accounting principle. The rate differs from the
effective tax rate of 21% for fiscal 2001 primarily as a result of changes
in the forecasted income before taxes for fiscal 2002. There is no tax
benefit for the investment impairment because corporations can only use
capital losses to offset capital gains. The Company cannot be assured at
this time that it can generate sufficient capital gains during the
five-year carry-over period to recognize the tax benefit of this capital
loss. Accordingly, a valuation allowance has been established for the
investment impairments taken in the second quarter of fiscal 2002. There is
no tax benefit for the change in accounting method since goodwill is not
deductible for tax purposes in this situation. The write-off of purchased
in-process research and development is not deductible for tax purposes.
The Company paid cash amounts for income taxes of $14.7 million in the
first nine months of fiscal 2002 and $9.2 million during the same period of
fiscal 2001.
G. Line of Credit
The Company currently has a $10 million unsecured revolving bank line of
credit. The line of credit expires on March 1, 2003. The line can be used
for either letter of credit or working capital purposes and is subject to
the terms of a credit agreement containing financial covenants and
restrictions, none of which are expected to significantly affect the
Company's operations. At July 31, 2002, there were standby letters of
credit of $6.6 million outstanding under this agreement. The Company has an
additional $3.4 million in outstanding letters of credit at other banks
collateralized by $3.3 million cash.
H. Restructuring
During the second quarter of fiscal 2002, the Company recorded a pre-tax
restructuring charge of approximately $20.4 million. The charge was a
result of the Company's continued move towards its business strategy of
becoming a solutions provider, addressing changes in the market due to
technology changes, and becoming more customer focused. Specific actions
taken included reducing the Company's workforce worldwide by approximately
50 employees (less than 1%), consolidating facilities, closing offices in
unprofitable locations, and disposing of excess property and equipment. The
following table summarizes the activity during fiscal 2002 related to the
second quarter fiscal 2002 restructuring.
Total Cash Non-Cash Balance at
Restructuring Charge Payments Charges July 31, 2002
-------------------- -------- -------- -------------
(Amounts in thousands)
Severance and benefits $ 14,748 $ (7,743) $ (1,318) $ 5,687
Excess facilities and property and
equipment 5,146 (556) -- 4,590
Other restructuring-related costs 492 (3) (150) 339
------------ ------------ ------------ ------------
$ 20,386 $ (8,302) $ (1,468) $ 10,616
============ =========== ============ ============
As of July 31, 2002, the remaining balance of the second quarter 2002
restructuring charge included accrued liabilities related to severance and
benefits, which will be paid out over the next four quarters, and redundant
facilities and other fixed contracts, which will be paid over the
respective remaining contract terms.
At the end of the fourth quarter of fiscal 2001, the Company recorded $50.7
million of pre-tax, restructuring charges resulting from changes in general
market conditions, changing customer demands, and the Company's evolution
of its business strategy, all of which required the Company to restructure
its operations. This business strategy focuses on Net business solutions
along with Net services software designed to secure and power the networked
world across leading operating systems. The execution of this strategy
included refining the Company's 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 current revenue levels and the Company's direction.
Specific actions included reducing the Company's workforce worldwide by
approximately 1,100 employees (approximately 16%), consolidating excess
facilities and disposing of excess property and equipment, terminating a
management consulting contract that no longer fit with the Company's
strategic focus, and abandoning and writing off technologies that no longer
fit within the Company's new strategy. The Company also realigned its
remaining resources to better manage and control its business.
The following table summarizes the costs and activities during the first
nine months of fiscal 2002, related to the fourth quarter 2001
restructuring.
Non-Cash
Balance at Cash Charges / Balance
October 31, 2001 Payments Adjustments July 31, 2002
---------------- -------- ----------- -------------
(Amounts in thousands)
Severance and benefits $ 32,793 $ (26,646) $ (4,000) $ 2,147
Excess facilities and property and
equipment 10,896 (5,271) 1,970 7,595
Other restructuring-related costs 911 (226) -- 685
------------ ------------ ----------- ------------
$ 44,600 $ (32,143) $ (2,030) $ 10,427
============ =========== =========== ============
As of July 31, 2002, the remaining balance of the fourth quarter 2001
restructuring charge included accrued liabilities largely related to
severance and benefits, which will be paid out during fiscal 2002, and
redundant facilities costs, which will be paid over the respective
remaining lease terms.
During the third quarter of fiscal 2001, the Company recorded a
restructuring charge of approximately $30.4 million, pre-tax, as a result
of the Company's acquisition of Cambridge Technology Partners ("Cambridge")
and changes in the Company's business to move towards a Net business
solutions strategy.
Specific actions included reducing the Company's workforce worldwide by
approximately 280 employees (approximately 5% before the addition of
Cambridge) across all functional areas, consolidating facilities and
disposing of excess property and equipment, abandoning and writing off
technologies that no longer fit within the integrated Company's new
strategy, and discontinuing unprofitable product lines. The following table
summarizes the activity during the first nine months of 2002, related to
the third quarter 2001 restructuring costs.
Balance at Cash Non-Cash Balance at
October 31, 2001 Payments Charges July 31, 2002
---------------- -------- ------- -------------
(Amounts in thousands)
Severance and benefits $ 3,377 $ (2,128) $ -- $ 1,249
Abandoned technology 211 (211) -- --
Excess facilities and property and
equipment 9,736 (5,191) -- 4,545
Exit unprofitable product lines 486 (486) -- --
Other restructuring-related costs 527 (340) -- 187
------------ ---------- ---------- ------------
$ 14,337 $ (8,356) $ -- $ 5,981
============ =========== =========== ============
As of July 31, 2002, the remaining balance of the third quarter 2001
restructuring charge included accrued liabilities largely related to
severance benefits and excess facilities costs, which will be paid over the
respective remaining lease terms.
During the second quarter of fiscal 2002, the Company also released
approximately $1.3 million of excess accruals related to a fiscal 2000
restructuring, which reduced the restructuring costs reflected on the
statement of operations for the nine months ended July 31, 2002. These
excess accruals relate to facilities and legal costs that were not
required.
I. Commitments and Contingencies
On December 21, 2001, Novell formed a venture capital fund, Novell
Technology Capital Fund I, L.P. (the "Fund"), and related entities that
include Novell Technology GPLP I, L.P. ("GPLP"), the general partner of the
Fund. Subsequent to the end of the third quarter of fiscal 2002, due to the
difficulty of raising funds in the current market conditions, Novell
decided not to go forward with this initiative and is in the process of
dissolving the Fund. Novell had committed to an aggregate investment of $15
million in the Fund and in GPLP, from which it will be released. Mr.
Messman, a director of Novell and Novell's Chief Executive Officer and
President, had committed to an investment in the Fund as a limited partner.
Mr. Linsalata, Novell's Senior Vice President, Venture Investments, had
committed to an investment in the Fund as a limited partner, and to a
limited partnership investment in GPLP. Additionally, Mr. Linsalata would
have been entitled to a portion of the amounts allocable to GPLP by the
Fund. No amounts have been distributed by the Fund or GPLP. The financial
and operating results of the Fund, GPLP and other related entities have
been consolidated in Novell's financial statements for the third quarter of
fiscal 2002.
The Board of Directors also established the Novell Venture account within
Novell's investment portfolio for the purpose of making investments in
private companies, mainly small capitalization stocks in the
high-technology industry sector, and in funds managed by venture
capitalists for the promotion of the Company's business and strategic
objectives. As of July 31, 2002, the Company had investments of $35.7
million in private companies and $56.5 million in externally managed
venture capital funds, and had commitments to the externally managed
venture capital funds to contribute an additional $77.5 million over the
next two to five years, as requested by the fund managers. Novell, through
its acquisition of Cambridge, also owns both limited and general
partnership interests in the Cambridge Technology Capital Fund I ("CTC I")
entitling it to approximately 24% of CTC I's income and expenses. As of
July 31, 2002, the Company had an investment balance of $1.4 million in CTC
I and had commitments to contribute an additional $300,000 through 2007.
In May 2002, France Telecom SA and U.S. Philips Corporation, alleged
co-owners of a U.S. patent, filed suit in the U.S. District Court, District
of Delaware, against Novell. The plaintiffs allege that Novell's NetWare
client software infringes the patent. In the suit, the plaintiffs seek
unspecified monetary damages and an injunction prohibiting infringement of
the patent. Novell intends to vigorously defend itself. This litigation is
in its early stages. Although there can be no assurance as to the ultimate
disposition of the suit, Novell does not believe that the resolution of
this litigation will have a material adverse effect on its financial
position, results of operations, or cash flows.
SilverStream and several of its former officers and directors, as well as
the underwriters who handled SilverStream's public offerings, are named as
defendants in several class action complaints that have been filed on
behalf of certain of former stockholders of SilverStream who purchased
securities between August 16, 1999 and December 6, 2000. These complaints
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 SilverStream's initial and secondary public offerings. The
plaintiffs are seeking monetary damages, statutory compensation and other
relief that may be deemed appropriate by the court. The plaintiffs have
brought similar actions against a large number of other issuers and
underwriters, making similar allegations. A Consolidated Amended
Complaint was filed, in the U.S. District Court, Southern District of New
York, on April 19, 2002. All issuers, including SilverStream, filed a
Motion to Dismiss on July 15, 2002. Novell believes that SilverStream
and the individual defendants have meritorious defenses to the claims made
in the complaints and intends to contest the lawsuits vigorously.
In February 1998, a suit was filed in the U.S. District Court, District of
Utah, against Novell and certain of its officers and directors, alleging
violation of federal securities laws by concealing the true nature of
Novell's financial condition and seeking unspecified damages. The lawsuit
was brought as a purported class action on behalf of purchasers of Novell
common stock from November 1, 1996 through April 22, 1997. After a first
dismissal and a subsequent amendment to the complaint, the Federal District
Judge dismissed the amended complaint with prejudice for failure to state a
claim. The plaintiffs have filed a Notice of Appeal to the Tenth Circuit
Court of Appeals and Novell intends to vigorously defend to uphold the
Federal District Court's ruling. While there can be no assurance as to the
ultimate disposition of the lawsuit, Novell does not believe that the
resolution of this litigation will have a material adverse effect on its
financial position, results of operations, or cash flows
In January 1995, Lantec, Inc. filed suit against Novell in the U.S.
District Court, the District of Utah, for alleged anti-trust violations
arising from Novell's acquisition of the GroupWise technology. The
plaintiffs were seeking to demonstrate damages of $300 million. On April
19, 2001, the judge ruled in favor of Novell and dismissed the entire
complaint. The plaintiff filed a Notice of Appeal to the Tenth Circuit
Court of Appeals and Novell intends to vigorously defend to uphold the
Federal District Court's ruling. While there can be no assurance as to the
ultimate disposition of the lawsuit, Novell does not believe that the
resolution of this litigation will have a material adverse effect on its
financial position, results of operations, or cash flows.
The Company is a party to a number of legal claims arising in the ordinary
course of business. The Company believes the ultimate resolution of these
claims will not have a material adverse effect on its financial position,
results of operations, or cash flows.
J. Segment Information
The Company is organized and operates as three business segments: product,
consulting, and Volera, Inc. The Company's products and services are sold
throughout the world. The Company's offerings within the product segment
are sold domestically via direct, OEM, reseller, and distributor channels,
and internationally are sold directly and through distributors who sell to
dealers and end users. The following is a description of each of the three
segments:
o Product - includes Net Management Services products (Directory-Enabled
OS, Management and Collaboration products, and UNIX royalties), Net
Directory Services and other directory products, and product-related
customer service, support, and education. Products in this segment are
packaged under the names NetWare, ZEN, GroupWare, eDirectory, DirXML,
iChain, Single Sign On, eXtend (SilverStream product suite).
o Consulting - includes Novell and Cambridge IT services consulting and
Celerant management consulting. o Volera, Inc. - Novell's majority-owned
subsidiary, which provides Content Distribution Network software.
Beginning November 1, 2001, the performance of the Company is evaluated by
the Chief Executive Officer and the Worldwide Management Committee, the
Company's chief decision makers, based on the review of revenue, segment
gross margin, and segment income (loss) from operations for each of the
segments above. Performance is also evaluated based on revenue results by
geographic region. Separate financial information is not evaluated by
business segment in regards to asset allocation. Except for net sales,
operating results by segment are not available for the third quarter and
year-to-date fiscal 2001. Prior to the acquisition of Cambridge, the
Company operated in one segment and did not maintain operating results for
the current segments. Operating results, other than net sales, were
available on a total company basis only. As the Company continues to
consolidate its operations, it will evaluate how it should most
appropriately manage its business and may make changes to its operating
segments accordingly.
Operating Results by Segment
Quarter ended July 31, 2002 Product Consulting Volera Total Novell
------- ---------- ------ ------------
(Amounts in thousands)
Net sales $ 206,153 $ 74,155 $ 1,965 $ 282,273
Direct consulting cost of sales 58,315 58,315
----------
Consulting contribution margin 15,840
Other cost of sales 39,530 11,002 975 51,507
---------- ---------- ---------- ----------
Gross profit 166,623 4,838 990 172,451
Segment operating expenses 130,157 24,843 6,183 161,183
----------- ---------- ---------- ----------
Segment income (loss) from operations $ 36,466 $ (20,005) $ (5,193) 11,268
========== =========== ===========
Unallocated operating expenses 3,000
----------
Income from operations $ 8,268
==========
Quarter ended July 31, 2001 Product Consulting Volera Total Novell
------- ---------- ------ ------------
(Amounts in thousands)
Net sales $ 209,750 $ 37,109 $ 2,225 $ 249,084
Year-to-date July 31, 2002 Product Consulting Volera Total Novell
------- ---------- ------ ------------
(Amounts in thousands)
Net sales $ 602,519 $ 225,968 $ 5,498 $ 833,985
Direct consulting cost of sales 186,413 186,413
----------
Consulting contribution margin 39,555
Other cost of sales 115,086 35,956 2,764 153,806
---------- ---------- ---------- ----------
Gross profit (loss) 487,433 3,599 2,734 493,766
Segment operating expenses 377,575 75,426 19,925 472,926
----------- ---------- ---------- ----------
Segment income (loss) from operations $ 109,858 $ (71,827) $ (17,191) 20,840
========== =========== ===========
Unallocated operating expenses 24,756
----------
Loss from operations $ (3,916)
===========
Product Consulting Volera Total Novell
Year-to-date July 31, 2001
(Amounts in thousands)
Net sales $ 664,067 $ 64,874 $ 5,933 $ 734,874
Direct consulting cost of sales includes salaries, benefits, and project
related travel expenses for consultants (reimbursable and
non-reimbursable), fees paid to subcontractors for work performed on
projects, and other expenses incurred specifically for consulting projects.
Other cost of sales for consulting includes consulting costs not directly
attributable to a project, including allocations for facilities and
information systems and technology. Segment operating expenses include
direct segment costs along with management's allocation of certain common
sales, marketing, and general and administrative costs to each business
unit. Unallocated operating expenses include purchased in-process research
and development, restructuring, and integration expenses.
Prior to fiscal 2002, the Company operated in one segment. The Company's
decision makers evaluated the Company based on total Company results.
Revenue was evaluated based on geographic location and product category.
Other than net sales, separate financial information was not available by
product category and geographic location. The following table shows third
quarter and year-to-date fiscal 2002 and 2001 revenue under the previous
segment categories.
Revenue by product category Three Months Ended Nine Months Ended
--------------------------- ------------------------------------------------------------------
(Amounts in thousands) July 31, 2002 July 31, 2001 July 31, 2002 July 31, 2001
------------- ------------- ------------- -------------
Net management services $ 158,226 $ 170,226 $ 463,774 $ 537,977
Net directory services 12,995 4,854 35,004 20,469
Net content services 1,965 2,225 5,498 5,933
Consulting, support services and education 109,087 71,779 329,709 170,495
---------- ---------- ----------- ----------
Total net sales $ 282,273 $ 249,084 $ 833,985 $ 734,874
========== ========== ========== ==========
Sales outside the U.S. are comprised of sales to international customers in
Europe, the Middle East, Africa, Canada, South America, and the Asia
Pacific region. International sales in any single international location
were not material to the Company as a whole.
For the first nine months of fiscal 2002 and fiscal 2001, sales to
international customers were approximately $400.2 million and $322.6
million, respectively. In the first nine months of fiscal 2002 and fiscal
2001, 73% and 67%, respectively, of international sales were to European
countries. No one foreign country accounted for 10% or more of total net
sales in either period.
There were no customers accounting for more than 10% of total revenue
during the first nine months of fiscal 2002 or fiscal 2001.
K. Net Income (Loss) Per Share
Three Months Ended Nine Months Ended
------------------------------------------------------------------
(Amounts in thousands, except per share data) July 31, 2002 July 31, 2001 July 31, 2002 July 31, 2001
------------- ------------- ------------- -------------
Basic net income per share computation
Net income (loss) $ 9,949 $ (19,274) $ (155,151) $ (178,359)
----------- ------------ ------------ ------------
Weighted average shares outstanding 364,211 328,683 363,131 322,913
----------- ----------- ----------- -----------
Basic net income (loss) per share $ 0.03 $ (0.06) $ (0.43) $ (0.55)
========== =========== =========== ===========
Diluted net income per share computation
Net income (loss) $ 9,949 $ (19,274) $ (155,151) $ (178,359)
----------- ------------ ------------ ------------
Weighted average shares outstanding 364,211 328,683 363,131 322,913
Incremental shares attributable to exercise of
outstanding options (treasury stock method) 36 -- -- --
----------- ----------- ----------- ----------
Total 364,247 328,683 363,131 322,913
----------- ----------- ----------- ----------
Diluted net income (loss) per share $ 0.03 $ (0.06) $ (0.43) $ (0.55)
========== =========== ============ ===========
L. Comprehensive Income (Loss)
The components of comprehensive income (loss), net of tax, for the
three-month and year-to-date periods ended July 31, 2002 and 2001, were as
follows:
Three Months Ended Nine Months Ended
----------------------------------------------------------------------
(Amounts in thousands) July 31, 2002 July 31, 2001 July 31, 2002 July 31, 2001
------------- ------------- ------------- -------------
Net income (loss) $ 9,949 $ (19,274) $ (155,151) $ (178,359)
Change in net unrealized gain/loss on
investments (672) (4,630) (4,687) 71,225
Change in cumulative translation adjustment (843) 197 (1,157) 722
----------- ----------- ----------- -----------
Comprehensive loss $ 8,434 $ (23,707) $ (160,995) $ (106,412)
========== ============ =========== ============
The components of accumulated other comprehensive income, net of related
tax, at July 31, 2002 and October 31, 2001, are as follows:
July 31, 2002 October 31, 2001
(Amounts in thousands)
Net unrealized gain on investment: $ 345 $ 5,032
Cumulative translation adjustment (3,734) (2,577)
------------ ------------
Accumulated other comprehensive income (loss) $ (3,389) $ 2,455
============ ===========
M. Derivative Instruments
A large portion of Novell's sales, expense and capital purchasing
activities are transacted in U.S. dollars. However, Novell does enter into
transactions in other currencies, primarily European, Japanese yen and
certain other Latin American and Asian currencies. To protect against
reductions in value caused by changes in foreign exchange rates, Novell has
established balance sheet hedging programs. The Company hedges currency
risks of some assets and liabilities denominated in foreign currencies
through the use of one-month forward contracts. Due to the short period of
time between entering into the forward contracts and the quarter end, the
fair value of the derivatives as of July 31, 2002 is insignificant and,
accordingly, did not have a material impact on our financial position or
results of operations. The Company does not currently hedge currency risks
related to revenue or expenses denominated in foreign currencies.
N. Recent Accounting Pronouncements
In August 2001, the FASB issued Statement of Financial Accounting
Standards ("SFAS") No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets." SFAS No. 144 addresses financial accounting and
reporting for the impairment of long-lived assets and for long-lived assets
to be disposed. The provisions of SFAS No. 144 are effective for fiscal
year 2002 and will be applied prospectively. The Company adopted SFAS No.
144 during fiscal 2002 and it did not have a material impact on the
Company's consolidated financial position and results of operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." The Statement requires that a
liability for a cost associated with an exit or disposal activity be
recognized when the liability is incurred. This statement eliminates the
definition and requirements for recognition of exit costs in the Emerging
Issues Task Force ("EITF") Issues 94-3, which defined the requirements for
recognition of a liability at the date an entity commits to a restructuring
plan. This statement also established the fair value is the objective for
initial measurement of the liability. The provisions of the Statement are
effective for exit or disposal activities that are initiated after December
31, 2002, with early application encouraged. The Company will adopt this
statement in the fourth quarter of fiscal 2002.
At the beginning of the second quarter of fiscal 2002, the Company adopted
FASB Emerging Issues Task Force No. 01-14, "Income Statement
Characterization of Reimbursements Received for `Out-of-Pocket' Expenses
Incurred" ("EITF 01-14"). EITF 01-14 requires companies to account for
reimbursements received for incurred out-of-pocket expenses as revenue and
the related expenses as cost of sales. EITF 01-14 also requires companies
to reclassify prior period financial statements to conform to current year
presentation for comparative purposes. Previously these expenses were not
included in the statement of operations. The adoption of EITF 01-14 did not
have an impact on net earnings in any reported period. The Company restated
the third quarter of fiscal 2001 through the first quarter of fiscal 2002
increasing revenue and cost of goods sold between $2.5 million and $8.2
million in each quarter depending on the amount of reimbursable revenue
incurred.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This Management's Discussion and Analysis of Financial Condition and Results of
Operations ("MD&A") and other parts of this Form 10-Q contain forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995 that involve risks and uncertainties. In some cases, such forward-looking
statements may be identified by the use of terminology such as "may," "will,"
"expects," "plans," "anticipates," "estimates," "potential," or "continue" or
the negative thereof or other comparable terminology. Such forward-looking
statements include statements regarding, among other things, our revenue
expectations, future business strategies, market conditions and opportunities,
and liquidity. All forward-looking statements are based on management's
expectations and information available to the Company on the date hereof, and
the Company assumes no obligation to update any such forward-looking statements.
The Company's actual results may differ materially from management's
expectations and the results discussed in such forward-looking statements as a
result of a number of factors, which include, but are not limited to, those set
forth below in the section titled "Risk Factors Affecting Future Results of
Operations."
Introduction
Novell, Inc., ("Novell" or the "Company") provides Net business solutions and
Net services software designed to secure and power the networked world. Novell
and its services division, Cambridge Technology Partners ("Cambridge"), help
organizations solve complex business challenges, simplify their systems and
processes, and capture new opportunities. Novell provides worldwide channel,
consulting, education, and developer programs to support its offerings.
Critical Accounting Policies
The Company considers certain accounting policies related to revenue recognition
and impairment of long-lived assets and valuation of deferred tax assets to be
critical policies due to the estimation processes involved in each.
Revenue recognition. The Company's IT consulting services business derives a
portion of its revenue from fixed-price, fixed-time contracts, which require the
accurate estimation of the cost, scope and duration of each engagement. Revenue
and the related costs for these projects are recognized based on percentage of
completion, using time-to-completion to measure the percent complete with
revisions to estimates reflected in the period in which changes become known. If
the Company does not accurately estimate the resources required or the scope of
work to be performed, or does not manage its projects properly within the
planned periods of time or satisfy its obligations under the contracts, future
consulting margins may be significantly and negatively affected or losses on
existing contracts may need to be recognized. Any such resulting reductions in
margins or contract losses could be material to the Company's results of
operations.
The Company recognizes revenue from product sales, including license fees, when
persuasive evidence of an agreement exists, delivery of the product has
occurred, and the fee is fixed or determinable and collection is probable. If
the total fee due from the customer is not fixed or determinable at the sale
date, revenue is recognized as payments become due from the customer. If
collection is not considered probable, revenue is recognized when the fee is
collected. Revenue from services, including maintenance contracts and
consulting, is recognized as services are performed, a signed contract exists,
the fee is fixed or determinable, and collection of the resulting receivable is
reasonably assured. The Company records a provision against revenue for
estimated sales returns and allowances on product and service related sales in
the same period as the related revenues are recorded. These estimates are based
on historical sales returns, analysis of credit memo data and other known
factors. If the historical data the Company uses to calculate these estimates
does not properly reflect future returns, revenue could be overstated.
Impairment of long-lived assets and valuation of deferred tax assets. The
Company's long-lived assets include fixed assets, long-term investments,
goodwill and other intangible assets. At July 31, 2002, the Company had $ 459.7
million of fixed assets, $94.7 million of long-term investments, $167.3 million
of goodwill, $38.9 million of intangible assets, and $81.9 million of net
deferred tax assets, current and non-current, accounting for approximately 44%
of the Company's total assets.
The Company periodically reviews its fixed assets for impairment in accordance
with FAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets."
In determining whether a fixed asset is impaired, the Company 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 in the future, the Company may be
required to record impairment charges for these assets not previously recorded.
The fair value of the long-term investments is dependant on the performance of
the companies or venture funds in which the Company has invested, as well as
volatility inherent in the external markets for these investments. In assessing
potential impairment for these investments, the Company will consider these
factors as well as the forecasted financial performance of its investees. If
these forecasts are not met, the Company may have to record additional
impairment charges not previously recognized. During the nine months ended July
31, 2002, the Company recognized $29.8 million of impairment losses related to
its long-term investments.
In assessing the recoverability of the Company's goodwill and other intangibles,
the Company must make assumptions regarding estimated future cash flows and
other factors to determine the fair value of the respective assets. If these
estimates or their related assumptions change in the future, the Company may be
required to record impairment charges for these assets not previously recorded.
On November 1, 2001, the Company adopted Statement of Financial Accounting
Standards No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets," and was,
therefore, required to analyze its goodwill and other intangibles with
indefinite lives for impairment issues during the first six months of fiscal
2002, and then on a periodic basis thereafter. The Company's first goodwill
impairment analysis under SFAS 142 was completed during the second quarter of
fiscal 2002 and resulted in an impairment charge of $143.7 million related to
goodwill in its IT Consulting group.
The carrying value of the Company's net deferred tax assets assumes that the
Company will be able to generate sufficient future taxable income in certain tax
jurisdictions, based on estimates and assumptions. If these estimates and
related assumptions change in the future, the Company may be required to record
additional valuation allowances against its deferred tax assets resulting in
additional income tax expense in the Company's consolidated statement of
operations. Management evaluates the realizability of the deferred tax assets
and assesses the need for additional valuation allowances on a quarterly basis.
Acquisitions
Pursuant to the terms of an Agreement and Plan of Merger, dated as of June 9,
2002 by and among Novell, Delaware Planet, Inc., a wholly owned subsidiary of
Novell, and SilverStream Software, Inc., a Delaware corporation
("SilverStream"), Delaware Planet commenced a cash tender offer on June 18, 2002
to acquire all of the outstanding shares of SilverStream common stock at a price
of $9.00 per share. On July 17, 2002, Delaware Planet announced the completion
of its cash tender offer, pursuant to which it purchased almost all outstanding
shares of SilverStream common stock at a price of $9.00 per share. On July 19,
2002, Novell completed its acquisition of SilverStream by merging Delaware
Planet into SilverStream. As a result of the merger, each share of SilverStream
common stock that was not tendered in the tender offer now represents the right
to receive $9.00 in cash, without interest.
SilverStream provides software products and services that enable organizations
to more effectively conduct business using the Web. SilverStream's products and
services leverage the power of standards such as Java and XML to unify relevant
information and services while enabling businesses to leverage prior technology
investments. They also help customers rapidly deliver Web-based applications
that are scalable, reliable and secure. The Company acquired SilverStream to
further its development of Web services products and services and to enhance its
current Web services and product offerings.
At the closing date of the merger, there were 23,427,448 shares of SilverStream
outstanding resulting in a total cash acquisition price of $210.8 million.
Direct transaction costs are estimated to be $4.0 million and SilverStream stock
options assumed, both vested and unvested, totaled $28.6 million.
With respect to stock options assumed as a part of the merger, all SilverStream
options, vested and unvested, were exchanged for Novell options with the same
terms and vesting characteristics. The fair value of these options was included
in the acquisition purchase price. The portion of the intrinsic value of
unvested options that will be earned over the remaining vesting period of those
options has been deducted from the fair value of the unvested options. This
deferred compensation will be amortized over the remaining vesting period of
approximately two years, in accordance with Financial Accounting Standards Board
Interpretation Number 44 ("FIN 44"). In total, options to purchase 4.9 million
shares of SilverStream common stock were converted into options to purchase 15.0
million shares of Novell stock using a conversion ratio of 3.0518. The fair
value of the options was determined using the Black-Scholes model using the
following assumptions:
o Fair market value of the underlying shares was based on the average
closing price of Novell's common stock on June 10, 2002 and the three
days prior and subsequent to that date.
o Expected life of 2-5 years
o Expected volatility of 80%
o Risk free interest rate of 5%
o Expected dividend rate of 0%
The value of the acquisition was preliminarily allocated as follows:
Estimated
(in thousands) Acquisition Cost Asset Life (in years)
---------------- ---------------------
Adjusted net tangible assets acquired $ 97,833 N/A
Deferred compensation 4,826 2 years
Intangible assets
Purchased in-process research and development 3,000 expensed in the third quarter fiscal 2002
Developed technology 19,800 3 years
Trademarks / trade names 2,200 indefinite life
Goodwill 115,771 N/A
-----------
$ 243,430
The allocation will be adjusted over the next twelve months as integration plans
are finalized, as allowed by Statement of Financial Accounting Standards
("SFAS") No. 141, "Business Combinations" issued by the Financial Accounting
Standards Board ("FASB") in June 2001. There are no other outstanding
contingencies that could affect the allocation.
Goodwill from the acquisition resulted from the Company's belief that the
technology SilverStream had developed is valuable to its Web services strategy.
The Company also believes it was more beneficial to acquire such technology
rather than develop it in-house. The goodwill from the SilverStream acquisition
has been allocated to the Company's product segment because the eXtend product
suite will be included with the Net Directory Services group of products. In
accordance with SFAS No. 142, "Goodwill and Other Intangible Assets," also
issued by the FASB in June 2001, the Company will not amortize the goodwill or
intangibles with indefinite lives associated with this acquisition. The Company
will review these assets periodically for potential impairment issues. Goodwill
is not deductible for tax purposes.
Net tangible assets of SilverStream consisted mainly of cash and cash
equivalents, accounts receivable, fixed assets, accounts payable, and other
liabilities.
The value of the deferred compensation of approximately $4.8 million represents
the intrinsic value of the unvested options assumed by Novell and was determined
under the guidance of FIN 44.
The $3.0 million of in-process research and development pertains to acquired
research and development on the eXtend line of products that are not currently
technologically feasible, meaning they have not reached the working model stage
and do not contain all of the major functions planned for the product nor are
they ready for initial customer testing. The estimated amount of the in-process
research and development charge represents a preliminary estimate and represents
technology related to replacement and enhancement to be included in the next
versions of the SilverStream's eXtend product line. Shortly before the
acquisition, SilverStream released its latest version of each of its products in
the eXtend line, Application Server, Composer, Workbench, and Director.
Therefore, there was minimal research and development in process. Completion of
development on the future upgrades of these products is dependant upon the
Company delivering on its web services strategy and successfully integrating
SilverStream. . The in-process research and development does not have any
alternative future use and did not otherwise qualify for capitalization.
To determine the value of the developed technology, the expected future cash
flow attributable to the existing product technology, the family of eXtend
products, which are currently shipping and can be combined with Novell products
or services, was discounted, taking into account risks associated with these
assets relative to the in-process research and development. The analysis
resulted in a valuation of approximately $19.8 million for developed technology,
which has reached technological feasibility.
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 eXtend 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 rates of 0.5 percent to the
product revenues were then discounted to a present value, resulting in a
valuation of approximately $2.2 million.
The Company's statement of operations includes SilverStream results for the
period July 20, 2002 through July 31, 2002.
Results of Operations
Net Sales
Quarter ended July 31, Year-to-date July 31,
---------------------- ---------------------
2002 2001 Change 2002 2001 Change
---- ---- ------ ---- ---- ------
Net sales (thousands) $ 282,273 $ 249,084 13.3% $ 833,985 $ 734,874 13.5%
Beginning in fiscal 2002, Novell's operations are organized by operating segment
o product, consulting, and Volera, Inc. o Product - includes Net Management
Services products (Directory-Enabled OS, Management and Collaboration
products, and UNIX royalties), Net Directory Services and other directory
products, and product-related customer service, support, and education.
Products in this segment are packaged under the names NetWare, ZEN,
GroupWare, eDirectory, DirXML, iChain, Single Sign On, eXtend
(SilverStream product suite).
o Consulting - includes Novell and Cambridge IT services consulting and
Celerant management consulting.
o Volera, Inc. - Novell's majority-owned
subsidiary, which provides Content Distribution Network software.
Product sales decreased $3.6 million or 2% in the third quarter of fiscal 2002
and $61.5 million or 9% year-to-date 2002 compared to the same periods of fiscal
2001. Within the product segment, sales from Net Management Services products
decreased $12.0 million or 7% in the third quarter of fiscal 2002 and $74.2
million or 14% year-to-date 2002 compared to the same periods of fiscal 2001.
These decreases were primarily due to decreased sales of NetWare, which
decreased 14% in the quarter and 17% year-to-date, and lower Unix royalty
revenue from expiring royalty contracts, which decreased 11% for the quarter and
13% year-to-date. Also, year-to-date sales from Net Management Services were
affected by decreased sales of Management and Collaboration products. Sales from
Net Directory Services products increased $8.1 million or 168% in the third
quarter of fiscal 2002 and $14.5 million or 71% year-to-date 2002 compared to
the same periods of fiscal 2001 primarily due to increased sales from DirXML and
Single Sign On, which have both grown over 300% year over year, and the addition
of SilverStream revenue for the period July 20, 2002 through July 31, 2002.
Product related service, education, and support remained relatively flat during
the third quarter of fiscal 2002 and decreased $1.9 million year-to-date 2002
compared to the same periods of fiscal 2001. The Company believes product sales
for the fourth quarter of fiscal 2002 will increase approximately $10 million
above third quarter fiscal 2002 levels, with approximately $8 million coming
from the addition of eXtend product sales and the balance resulting from
seasonality.
Consulting sales were $37.0 million or 99.8% higher in the third quarter of
fiscal 2002 and $161.1 million or 248% higher year-to-date 2002 compared to the
same periods of fiscal 2001, due to the acquisition of Cambridge at the end of
the third quarter of fiscal 2001. Cambridge operations were included in the
Company's operating results for only 21 days in fiscal 2001 compared to the
entire quarter in fiscal 2002. Consulting sales decreased $1.2 million in the
third quarter of fiscal 2002 compared to the second quarter of fiscal 2002, as
sales from both the IT services and Celerant consulting units decreased
approximately $0.6 million quarter over quarter. This decrease was primarily due
to a weakened services market and decreased demand for the Company's systems
integration and Net solutions. The Company expects to see a leveling off of the
decrease in the demand for consulting sales over the next few quarters as the
economy stabilizes and companies increase investments in technology solutions.
At the beginning of the second quarter of fiscal 2002, the Company adopted FASB
Emerging Issues Task Force No. 01-14, "Income Statement Characterization of
Reimbursements Received for `Out-of-Pocket' Expenses Incurred," ("EITF 01-14").
EITF 01-14 requires companies to account for reimbursements received for
incurred out-of-pocket expenses as revenue and the related expenses as cost of
sales. Previously they were not included in the statement of operations.
Reimbursable expense revenue is now included in consulting revenue in all
periods presented. The Company restated the third quarter of fiscal 2001 through
the first quarter of fiscal 2002 increasing revenue and cost of goods sold
between $2.5 million and $8.2 million in each quarter, depending on the amount
of reimbursable revenue incurred.
Net sales from Volera, Inc. were relatively flat in the third quarter of fiscal
2002 and year-to-date 2002 compared to the same periods of fiscal 2001 and are
expected to remain relatively flat for the remainder of fiscal 2002. Volera's
performance has not met the growth expectations of the Company and thus the
Company is re-evaluating its strategy for Volera.
International sales represented 49% of total net sales in the third quarter of
fiscal 2002 and 48% year-to-date 2002 compared to 43% in the third quarter of
fiscal 2001 and 44% for the first nine months of fiscal 2001. During the third
quarter of fiscal 2002, international sales increased 28% while domestic sales
increased 2% compared to the same period of fiscal 2001. Year-to-date,
international sales increased 24% and domestic sales increased 5% compared to
the same period of fiscal 2001. Internationally, sales increases during the
quarter were due to the addition of Cambridge, favorable foreign exchange rates,
which accounted for approximately $4.8 million, and recovering European market
conditions. The increase in domestic sales during the third quarter and first
nine months of fiscal 2002 was largely due to the addition of Cambridge revenue
beginning July 10, 2001, the end of the third quarter of fiscal 2001.
Total net sales increased 3% in the third quarter of fiscal 2002 compared to the
second quarter of fiscal 2002. Product sales were up 5%, consulting sales were
down 2% and Volera sales were up 41% in the third quarter of fiscal 2002
compared to the second quarter of fiscal 2002. International sales benefited
approximately $4.8 million from favorable exchange rates. The Company expects
total net sales for the fourth quarter of fiscal 2002 to increase approximately
$10 million compared to third quarter 2002 levels, with approximately $8 million
coming from the addition of SilverStream and the balance due to seasonality.
Although NetWare sales improved in the third quarter of fiscal 2002 compared to
the second quarter of fiscal 2002, the Company is working to address the
long-term growth potential of the NetWare product line. In addition, the Company
is also addressing declining sales in the consulting segment in an effort to
improve results in future periods. The Company completed its integration of
Cambridge during the first half of fiscal 2002. It has reorganized its sales
force to provide better coverage and resources for its customers and partners,
focusing on solving business issues with Novell solutions and services. In
addition, the Company is integrating the SilverStream products into its
offerings and integrating SilverStream's operations as deemed appropriate. The
Company anticipates that it will take several quarters to fully realize the
benefits from these actions.
At July 31, 2002, the Company had $239.9 million of deferred revenue on its
Balance Sheet representing revenue that will be recognized in future periods.
The majority of this deferred revenue relates to one-year maintenance contracts,
which are recognized ratably over a 12-month period. The Company has either
received payment or recorded a receivable for the deferred revenue, and believes
the risk of collectability is low. Direct costs to be incurred to fu1fill these
maintenance obligations are relatively small and are recognized as work is
performed.
Gross Profit
Quarter ended July 31, Year-to-date July 31,
---------------------- ---------------------
2002 2001 Change 2002 2001 Change
---- ---- ------ ---- ---- ------
Gross profit (thousands) $ 172,451 $172,908 (0.3)% $ 493,766 $ 524,619 (5.9)%
Percentage of net sales 61.1% 69.4% 59.2% 71.4%
Gross profit as a percentage of net sales decreased in the third quarter and
year-to-date 2002 compared to the same periods of fiscal 2001, primarily due to
the effects of a higher mix of lower-margin consulting business along with
decreased product sales levels. The mix between product sales and consulting
sales has shifted due to the acquisition of Cambridge, causing product sales to
become a smaller percentage of total sales. During the third quarter and
year-to-date fiscal 2002, gross margin for the consulting segment was $4.8
million or 7% and $3.6 million or 2%, respectively. The low consulting margins
are primarily due to decreased consulting sales, reduced prices, and increased
costs related to excess consultants who were not fully utilized on consulting
engagements. The Company does not expect overall gross profit margins to reach
fiscal 2001 levels in the future due to the increase in the consulting business
as a percentage of total sales. However, the Company believes the current gross
profit margin of 61% can be improved and is currently addressing ways to improve
its gross margin in future periods, such as improved utilization and increased
consulting billing rates.
As described above, the Company adopted EITF 01-14, which requires companies to
account for reimbursements received for out-of-pocket expenses incurred as
revenue and the related expenses as cost of sales. This change did not have a
significant effect on gross margin.
Operating Expenses
Quarter ended July 31, Year-to-date July 31,
(Amounts in thousands) 2002 2001 Change 2002 2001 Change
---- ---- ------ ---- ---- ------
Sales and marketing $ 90,125 $ 100,013 (9.9)% $ 261,660 $ 338,335 (22.7)%
Percentage of net sales 31.9% 40.2% 31.4% 46.0%
Product development 41,492 47,976 (13.5)% 122,976 147,388 (16.6)%
Percentage of net sales 14.7% 19.3% 14.7% 20.1%
General and
administrative 29,566 28,101 5.2% 90,946 77,347 17.6%
Percentage of net sales 10.5% 11.3% 10.9% 10.5%
Restructuring -- 30,392 -- 19,100 30,392 (37.2)%
Percentage of net sales -- 12.2% 2.3% 4.1%
Purchased in-process R&D
3,000 -- -- 3,000 -- --
Percentage of net sales 1.1% -- 0.4% --
Total operating expenses
$ 164,183 $ 206,482 (20.5)% 497,682 593,462 (16.1)%
Percentage of net sales 58.2% 82.9% 59.7% 80.8%
Sales and marketing expenses decreased $9.9 million and $76.7 million in the
third quarter and year-to-date of fiscal 2002, respectively, compared to the
same periods of fiscal 2001. These declines are primarily due to decreased
spending on marketing campaigns and lower headcount due to the restructurings in
the third and fourth quarters of fiscal 2001 and second quarter of fiscal 2002.
Sales and marketing headcount decreased by 241 year-over-year, excluding the
addition of 151 SilverStream employees who became Novell employees on July 20,
2002. In addition, sales and marketing expenses fluctuate in any given period
due to the timing of product promotions, advertising or other discretionary
expenses.
Product development expenses decreased $6.5 million in the third quarter of
fiscal 2002 and $24.4 million year-to-date 2002 compared to the same periods in
fiscal 2001. These declines are due primarily to decreased headcount as a result
of the restructurings that took place in the third and fourth quarters of fiscal
2001 and second quarter of fiscal 2002. Product development headcount decreased
by 75 year-over-year, excluding the addition of 121 SilverStream employees who
became Novell employees on July 20, 2002. Product development expense as a
percentage of sales decreased due to the addition of Cambridge consulting sales,
which does not have any associated product development costs.
General and administrative expenses increased $1.5 million during the third
quarter of fiscal 2002 and $13.6 million year-to-date 2002 compared to the same
periods of fiscal 2001. The increase in general and administrative expense
dollars in the third quarter of fiscal 2002 was primarily due to the impact of a
full quarter of Cambridge general and administrative costs, net of integration
or restructuring reductions, compared to only 21 days of these expenses in the
third quarter of fiscal 2001. In addition, the Company incurred higher costs
related to the addition of SilverStream at the end of the third quarter of
fiscal 2002, and higher costs for outside advisors, offset somewhat by lower bad
debt write-offs related to uncollectible accounts receivable. General and
administrative costs decreased as a percentage of sales in the third quarter of
fiscal 2002 compared to the same period of fiscal 2001 primarily due to
increased sales in the third quarter of fiscal 2002. The year-to-date general
and administrative expense increases, both dollars and as a percentage of sales,
were primarily due to the addition of Cambridge general and administrative costs
and integration costs related to the acquisition of Cambridge, offset somewhat
by headcount reductions resulting from the restructurings that took place in the
third and fourth quarters of fiscal 2001.
The purchased in-process research and development charge in the third quarter of
fiscal 2002 resulted from the acquisition of SilverStream and pertains mainly to
research and development work for the next version of the current SilverStream
products.
Restructuring
During the second quarter of fiscal 2002, the Company recorded a pre-tax
restructuring charge of approximately $20.4 million. The charge was a result of
the Company's continued move towards its business strategy of becoming a
solutions provider, addressing changes in the market due to technology changes,
and becoming more customer-focused. Specific actions taken included reducing the
Company's workforce worldwide by approximately 50 employees (less than 1%),
consolidating facilities, closing offices in unprofitable locations, and
disposing of excess property and equipment. The following table summarizes the
activity during fiscal 2002 related to the second quarter fiscal 2002
restructuring.
Total Cash Non-Cash Balance at
Restructuring Charge Payments Charges July 31, 2002
-------------------- -------- -------- -------------
(Amounts in thousands)
Severance and benefits $ 14,748 $ (7,743) $ (1,318) $ 5,687
Excess facilities and property and
equipment 5,146 (556) -- 4,590
Other restructuring-related costs 492 (3) (150) 339
------------ ------------ ------------ ------------
$ 20,386 $ (8,302) $ (1,468) $ 10,616
============ =========== ============ ============
As of July 31, 2002, the remaining balance of the second quarter 2002
restructuring charge included accrued liabilities related to severance and
benefits, which will be paid out over the next four quarters and redundant
facilities and other fixed contracts, which will be paid over the respective
remaining contract terms.
At the end of the fourth quarter of fiscal 2001, the Company recorded $50.7
million of pre-tax, restructuring charges resulting from changes in general
market conditions, changing customer demands, and the Company's evolution of its
business strategy, all of which required the Company to restructure its
operations. This business strategy focuses on Net business solutions along with
Net services software designed to secure and power the networked world across
leading operating systems. The execution of this strategy included refining the
Company's 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 current revenue levels and the
Company's direction.
Specific actions included reducing the Company's 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 the Company's strategic
focus, and abandoning and writing off technologies that no longer fit within the
Company's new strategy. The Company also realigned its remaining resources to
better manage and control its business. The following table summarizes the costs
and activities during the first nine months of fiscal 2002, related to the
fourth quarter 2001 restructuring.
Non-Cash
Balance at Cash Charges / Balance at
October 31, 2001 Payments Adjustments July 31, 2002
---------------- -------- ----------- -------------
(Amounts in thousands)
Severance and benefits $ 32,793 $ (26,646) $ (4,000) $ 2,147
Excess facilities and property and
equipment 10,896 (5,271) 1,970 7,595
Other restructuring-related costs 911 (226) -- 685
------------ ------------ ----------- ------------
$ 44,600 $ (32,143) $ (2,030) $ 10,427
============ =========== =========== ============
As of July 31, 2002, the remaining balance of the fourth quarter 2001
restructuring charge included accrued liabilities largely related to severance
and benefits, which will be paid out during fiscal 2002, and redundant
facilities costs, which will be paid over the respective remaining lease terms.
During the third quarter of fiscal 2001, the Company recorded a restructuring
charge of approximately $30.4 million, pre-tax, as a result of the Company's
acquisition of Cambridge Technology Partners ("Cambridge") and changes in the
Company's business to move towards a Net business solutions strategy.
Specific actions included reducing the Company's workforce worldwide by
approximately 280 employees (approximately 5% before the addition of Cambridge)
across all functional areas, consolidating facilities and disposing of excess
property and equipment, abandoning and writing off technologies that no longer
fit within the integrated Company's new strategy, and discontinuing unprofitable
product lines. The following table summarizes the activity during the first nine
months of 2002, related to the third quarter 2001 restructuring costs.
Balance at Cash Non-Cash Balance at
October 31, 2001 Payments Charges July 31, 2002
---------------- -------- ------- -------------
(Amounts in thousands)
Severance and benefits $ 3,377 $ (2,128) $ -- $ 1,249
Abandoned technology 211 (211) -- --
Excess facilities and property and
equipment 9,736 (5,191) -- 4,545
Exit unprofitable product lines 486 (486) -- --
Other restructuring-related costs 527 (340) -- 187
------------ ---------- ---------- ------------
$ 14,337 $ (8,356) $ -- $ 5,981
============ =========== =========== ============
As of July 31, 2002, the remaining balance of the third quarter 2001
restructuring charge included accrued liabilities largely related to severance
benefits and excess facilities costs, which will be paid over the respective
remaining lease terms.
As a result of the fiscal 2002 and two 2001 restructurings, the Company
estimates that its operating expenses will be reduced by approximately $180
million annually compared to fourth quarter fiscal 2001 operating expense
levels, before increased strategic expenditures. Year-to-date 2002, the Company
had recognized approximately $125 million in savings due to the restructurings
over the fourth quarter 2001 expense levels.
During the second quarter of fiscal 2002, the Company also released
approximately $1.3 million of excess accruals related to a fiscal 2000
restructuring, which reduced the restructuring costs reflected on the statement
of operations for the nine months ended July 31, 2002. These excess accruals
relate to facilities and legal costs that were not required.
The Company could incur additional restructuring charges in the future as it
continues to develop its Net solutions strategy and react to market conditions.
Employee Headcount
Employees at end of period July 31, 2002 July 31, 2001 Change
- -------------------------- ------------- ------------- ------
Cost of Goods 2,589 3,277 (21.0)%
Sales & marketing 1,491 1,584 (5.9)
Product development 1,378 1,312 5.0
===
General & administrative 880 1,114 (21.0)
--- ------
Total headcount 6,338 7,287 (13.0)
Annualized sales per average
employee $ 182 $ 163 11.7%
Headcount decreased from the third quarter of 2001, primarily due the
elimination of duplicate functions related to the acquisition of Cambridge, and
headcount reductions resulting from the restructurings that occurred during the
third and fourth quarters of fiscal 2001 and second quarter of fiscal 2002,
offset somewhat by the addition of 455 SilverStream employees.
Other Income (Loss), Net
Quarter ended July 31, Year-to-date July 31,
(Amounts in thousands) 2002 2001 Change 2002 2001 Change
---- ---- ------ ---- ---- ------
Other income (loss), net $ 7,230 $ 10,506 (31.2)% $ (698) $ (103,854) 99.3%
Percentage of net sales 2.6% 4.2% (0.1)% (14.1)%
The primary component of other income is related to investment income or losses.
During the third quarter of fiscal 2002, investment income was $5.3 million
compared to investment income of $13.6 million offset by investment impairment
losses of $5.0 million during the third quarter of fiscal 2001. Year-to-date
fiscal 2002, investment income of $20.5 million was offset by investment
impairment losses of $29.8 million compared to investment income of $42.3
million offset by $149.7 million of investment impairment losses in the same
period of fiscal 2001. Investment impairment losses relate to certain
investments in the Company's portfolio, whose declines in market values were
determined to be other than temporary. Also included in other income during
year-to-date fiscal 2002 was an $8.8 million gain on the sale of a building.
Income Taxes Expense (Benefit)
Quarter ended July 31, Year-to-date July 31,
---------------------- ---------------------
2002 2001 Change 2002 2001 Change
---- ---- ------ ---- ---- ------
Income tax expense (benefit) (thousands) $5,549 $ (3,794) 246.3% $ 6,835 $(5,386) 226.9%
Percentage of net sales 2.0% (1.5)% 0.8% (0.7)%
Effective tax expense (benefit) rate 35.8% (16.4)% 148.1% (3.1)%
Effective tax expense (benefit) rate on
income before change in accounting
method, purchased in-process R&D, and
asset impairment 30.0% (21.0)% 30.0% (21.0)%
The Company's effective tax rate, before the write-off of purchased in-process
research and development, investment impairment charges, and the accounting
change, for the third quarter and the full year of fiscal 2002 is estimated to
be 30%, compared to 21% in fiscal 2001. The third quarter and fiscal year 2002
rates differ from the effective tax rate for fiscal 2001 primarily as a result
of changes in the forecasted income before taxes for fiscal 2002. There is no
tax benefit for the investment impairment because corporations can only use
capital losses to offset capital gains. The Company cannot be assured at this
time that it can generate sufficient capital gains during the five-year
carry-over period to recognize the tax benefit of this capital loss.
Accordingly, a valuation allowance has been established. There is no tax benefit
for the change in accounting method since goodwill is not deductible for tax
purposes in this situation. The write-off of purchased in-process research and
development is not deductible for tax purposes.
Net Loss and Net Loss Per Share
(dollars in thousands, except Quarter ended July 31, Year-to-date July 31,
---------------------- ---------------------
per share data) 2002 2001 Change 2002 2001 Change
---- ---- ------ ---- ---- ------
Income (loss) before accounting change
$ 9,949 $ (19,274) 151.6% $ (11,449) $(167,311) 93.2%
Percentage of net sales 3.5% (7.7)% (1.4)% (22.8)%
Net income (loss) $ 9,949 $ (19,274) 151.6% $(155,151) $(178,359) 13.0%
Percentage of net sales 3.5% (7.7)% (18.6)% (24.3)%
Income (loss) per share, before
accounting change - basic and diluted $ 0.03 $(0.06) $ (0.03) $ (0.52)
Net income (loss) per share - basic and
diluted $ 0.03 $(0.06) $ (0.43) $ (0.55)
Change in Accounting Principle
Effective November 1, 2001 the Company adopted SFAS No. 142." SFAS No. 142
requires, among other things, the discontinuance of amortization related to
goodwill and indefinite lived intangible assets. These assets will then be
subject to an impairment test at least annually. In addition, the statement
includes provisions requiring companies to identify reporting units upon
adoption, for the purpose of assessing potential future impairments and to
perform an initial impairment analysis within the first six months after
adoption. The Company completed its goodwill impairment analysis during the
second quarter of fiscal 2002 and recognized a transitional goodwill impairment
loss of $143.7 million as of November 1, 2001, which was recorded as the
cumulative effect of a change in accounting principle in the Company's
consolidated Statements of Operations. Any further impairment losses recorded in
the future could have a material adverse impact on our financial conditions and
results of operations.
Liquidity and Capital Resources
July 31, 2002 October 31, 2001 Change
Cash and short-term investments (000s) $607,310 $705,243 (13.9)%
Percentage of total assets 35.4% 37.0%
During the nine months ended July 31, 2002, cash and short-term investments
decreased by $97.9 million to $607.3 million at July 31, 2002, down from $705.2
million at October 31, 2001, primarily due to the acquisition of SilverStream.
The Company paid approximately $210.8 million cash to SilverStream shareholders
for the acquisition and acquired approximately $108.3 million cash from
SilverStream, resulting in a net cash outflow of approximately $102.5 million.
In addition, cash decreased by $18.7 million for purchases of property, plant
and equipment, and $18.3 million in net purchases of investments and other
long-term investing activities. These decreases in cash were offset somewhat by
$18.6 million cash provided by operating activities, $16.1 million cash received
from the sale of a building, and $6.9 million from the net issuance of common
stock. Included in the cash provided by operating activities amount were
payments made during the first nine months of fiscal 2002 related to fiscal 2001
and 2002 merger and restructuring actions. Restructuring and merger related
expenses will continue to be paid out during the next several quarters,
including those related to the acquisition of SilverStream.
The Company's short-term investment portfolio is diversified among security
types, industry groups, and individual issuers. To achieve potentially higher
returns, a portion of the Company's investment portfolio is invested in equity
securities and mutual funds, which incur market risk. The Company's short-term
investment portfolio includes gross unrealized gains of $3.2 million and gross
unrealized losses of $3.8 million as of July 31, 2002. The Company monitors its
investments and records losses when a decline in the investment's market value
is determined to be other than temporary.
The Company also invests excess cash in long-term investments through the Novell
Venture account, Cambridge Technology Capital Fund I L.P. ("CTC I"), and
strategic long-term equity investments. Investments made through the Novell
Venture account, CTC I, generally are in expansion-stage private companies,
primarily small capitalization stocks, in the high-technology industry sector.
The Novell Venture account funds are managed largely by external venture
capitalists. CTC I is managed internally. The value of the investments made
through the Novell Venture account and CTC I is dependent on the performance,
successful acquisition, and/or initial public offering of the investees. The
Company monitors its investments and records losses when a decline in the
investment's market value is determined to be other than temporary. The Company
analyzes each investment based on factors such as the investee's financial
statements, the business environment in which the investee operates, as well as
information obtained from the investee regarding its operations.
As of July 31, 2002, Novell had cash and other short-term investments of $366
million held in accounts outside the United States. Repatriation of any portion
of this amount would be subject to U.S. federal income taxes. The Company has
provided for the tax liability on these amounts for financial statement
purposes. Repatriation, however, could result in a loss of certain tax
attributes of up to $30 million and result in additional federal income tax
payments of such amounts in future years.
The Company's principal source of liquidity has been from operations and
investment income. In addition, at July 31, 2002, the Company's principal unused
sources of liquidity consisted of cash and short-term investments and available
borrowing capacity of approximately $3.4 million under its credit facilities.
The Company's liquidity needs are principally for the Company's financing of
accounts receivable, capital assets, strategic investments, product development
and flexibility in a dynamic and competitive operating environment.
During the first nine months of fiscal 2002, the Company generated $18.6 million
of cash flow from operations, and anticipates generating positive cash flows
from operations in addition to investment income in the fourth quarter of fiscal
2002 sufficient to fund operations. The Company anticipates being able to fund
its current operations, future acquisitions, integration, restructuring and
merger-related costs, and planned capital expenditures for the foreseeable
future with existing cash and short-term investments together with cash
generated from operations and investment income. The Company believes that
borrowings under the Company's credit facilities or offerings of equity or debt
securities are possible if the need arises, although such offerings may not be
available to the Company on acceptable terms, given current market conditions.
Investments will continue in product development and in new and existing areas
of technology. Cash may also be used to acquire technology through purchases and
strategic acquisitions. Capital expenditures in fiscal 2002 are anticipated to
be approximately $25 million, but could be reduced if the growth of the Company
is less than presently anticipated. The Company has commitments to invest up to
an additional $77.5 million in externally managed venture capital funds over the
next two to five years, which it intends to fund with cash from operations and
cash and short-term investments on hand.
During the fourth quarter of 2001, the Board of Directors extended the Company's
stock repurchase program through June 30, 2003 and authorized the use of up to
$500 million for the repurchase of additional outstanding shares of the
Company's common stock. As of July 31, 2002, $89 million of the authorized
amount had been spent to repurchase 14 million shares under this plan at an
average price of $6.23 per share. There were no shares repurchased during the
first nine months of fiscal 2002.
Recent Pronouncements
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." SFAS 144 addresses financial accounting and
reporting for the impairment of long-lived assets and for long-lived assets to
be disposed of. The provisions of SFAS 144 will be effective for fiscal year
2002 and will be applied prospectively. The Company adopted SFAS 144 during
fiscal 2002 and adoption 144 did not have a material impact on the Company's
consolidated financial position and results of operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." The Statement requires that a liability for a
cost associated with an exit or disposal activity be recognized when the
liability is incurred. This statement eliminates the definition and requirements
for recognition of exit costs in the Emerging Issues Task Force ("EITF") Issues
94-3, which defined the requirements for recognition of a liability at the date
an entity commits to a restructuring plan. This statement also established the
fair value is the objective for initial measurement of the liability. The
provisions of the Statement are effective for exit or disposal activities that
are initiated after December 31, 2002, with early application encouraged. The
Company will adopt this statement in the fourth quarter of fiscal 2002.
Risk Factors Affecting Future Results of Operations
Novell's future results of operations involve a number of risks and
uncertainties. Among the factors that could cause actual results to differ
materially from historical results or from Novell's expectations are the
following: Novell's ability to successfully blend its products and services and
continuing to transition to a solutions based Net services software company;
Novell's ability to take a competitive position in the Web services industry;
business conditions and the general economy; competitive factors, such as rival
operating systems, directories and applications; acceptance of new products and
services and price pressures; availability of third-party compatible products at
below market prices; risk of nonpayment of accounts or notes receivable; risks
associated with foreign operations; risk of product line or inventory
obsolescence due to shifts in technologies or market demand; timing of software
product introductions; further declines in the demand for information technology
consulting services; risk of consulting clients terminating or reducing the
scope of engagements; fluctuations in the value of investment securities; and
litigation.
Other factors may also adversely affect Novell's financial results and stock
price, including but not limited to:
o competition for qualified employees;
o competition from other product and service companies;
o delays in the introduction of new products and services;
o success of new products, technologies or services;
o stock market fluctuations unrelated to Company performance;
o failure to properly estimate costs of fixed fee engagements;
o failure to properly manage consulting engagements within fixed-fees
agreed to by customers; and
o inability to fully utilize consultants on client engagements.
The Current Economic Climate and Outlook in the Technology and Information
Technology Services Sector Is Very Weak
The weakened economic climate, particularly in the technology sector, has had an
adverse impact on demand for software, has had an adverse effect on Novell's
stock price and operations. Future economic projections for this sector do not
anticipate a quick recovery. A continuation of the weakened economy could have
further negative effects on Novell's stock price and operations in the future.
Our Financial Results May Vary
As is typical within the software industry, Novell often experiences a higher
volume of sales at the end of each quarter and during Novell's fourth quarter.
Because of this, fixed costs that are out of line with sales levels may not be
detected until late in any given quarter and results of operations could be
adversely affected.
Operating results have been, and may in the future be affected, by other factors
including, but not limited to:
o timing of orders from customers and shipments to customers;
o product mix, including a shift from higher margin to lower margin
products or services;
o delays or problems with our fulfillment agents;
o impact of foreign currency exchange rates on the price of our products
in international locations;
o inability to respond to the decline in sales through our distribution
channel;
o inability to derive benefits from our restructurings and new corporate
strategy; and
o inability to deliver solutions as expected by our consulting customers;
.
We Compete in a Challenging Market
Novell's solutions offerings compete in a highly challenging market. One
pervasive factor underlying all of Novell's business endeavors is the presence
of Microsoft in all sectors of the software business, and Microsoft's dominance
in many of those sectors.
In a finding upheld by the Circuit Court for the District of Columbia, the
United States District Court found that Microsoft violated Section 2 of the
Sherman Act by unlawfully acting to maintain its monopoly over desktop operating
systems. Novell believes that Microsoft is exploiting its desktop operating
monopoly in a way that is designed to extend its market power into the market
for server operating systems, and to claim control of network and web services
such as authentication, using many of the same anti-competitive practices found
by the United States District Court to be in violation of the nation's antitrust
laws. Novell is concerned that the Second Revised Proposed Final Judgment of the
litigation between the Department of Justice and Microsoft will not benefit
competition or consumers in a meaningful way and, if approved, could result in
continued harm to Novell.
Additionally, Novell does not have the product breadth and market power of
Microsoft. Microsoft's ability to ship networking products with features and
functionality that compete with Novell's, together with its ability to offer
incentives to customers to purchase certain products in order to obtain
favorable sales terms or necessary compatibility or information with respect to
other products, may significantly inhibit Novell's ability to grow its business.
Microsoft has significant financial resources, which could allow it to
aggressively price its products and services for long periods of time to the
potential detriment of competitors. Microsoft in the past has also employed
tactics that limit or block effective and efficient interoperability with
Novell's products. Microsoft frequently bundles software features, which compete
directly with stand-alone products from Novell, into its operating system for
free. As Microsoft creates new operating systems and applications, there can be
no assurance that Novell will be able to ensure its products will be compatible
with those of Microsoft.
Although these market conditions and the judgments reached in litigation
concerning Microsoft may affect overall Novell performance, Novell believes its
strong product offering and "One Net" business strategy will be competitive in
the marketplace. Additionally, if the more meaningful relief being sought by the
nine litigating states is imposed on Microsoft, there could be a restoration of
competition in the marketplace that would benefit Novell.
Novell's solutions offerings also face competition from several large consulting
firms specializing in the information systems area such as Hewlett-Packard
Company, IBM, Accenture, Cap Gemini and the three remaining consulting arms of
the "Big Four" accounting firms. Many of these companies have greater financial,
technical and marketing resources and greater name recognition in the solutions
area, which could inhibit Novell's ability to grow its consulting business.
Additionally, Novell may face competition from other industry companies, which
could introduce competitive products and/or services. If any of these competing
products or services achieves market acceptance, Novell's business and results
of operations could be materially adversely affected. Novell believes that
additional factors that affect success in the marketplace include technical
innovation to meet dynamic market needs, marketing strength, system performance,
customer service and support, reliability, ease of use, security, and price
compared to performance. Novell seeks to address all of these factors with its
marketing and product development. However, these factors are also addressed by
competitors, including Microsoft, in ways that may cause Novell's chances of
success to be diminished.
We Face Intense Competition for Qualified Personnel and Executives in the
Computer and Consulting Industries
The ability of Novell to maintain its competitive technological position will
depend, in large part, on its ability to attract and retain highly qualified
development, consulting, and managerial personnel. We compete for such personnel
in the software and consulting industries. The loss of a significant group of
key personnel would adversely affect Novell's performance. The failure to
successfully promote and hire suitable replacements in a timely manner could
have a material adverse effect on Novell's business.
Novell's Business May be Adversely Impacted by Acquisitions Which May Affect its
Ability to Manage and Maintain its Business.
Since Novell's inception, it has acquired a number of businesses, including
Cambridge Technology Partners in July 2001 and SilverStream Software, Inc. in
July 2002. In the future, Novell may undertake additional acquisitions of
businesses that complement its existing operations. Past or future acquisitions
by Novell could involve a number of risks, including:
o the possibility that one or more such acquisitions may not close due to
closing conditions in the acquisition agreements, the inability to
obtain regulatory approval, or the inability to meet conditions imposed
for government or court approvals for the transaction;
o the diversion of the attention of management and other key personnel;
o the inability to effectively integrate an acquired business into
Novell's culture,
o failure to combine product and service delivery methodology and other
standards, controls, procedures and policies;
o the inability to retain the management, key personnel and other
employees of an acquired business;
o the inability to retain the customers of an acquired business;
o the possibility that Novell's reputation will be affected by customer
satisfaction problems of an acquired business;
o potential known or unknown liabilities associated with an acquired
business, including but not limited to regulatory, environmental
and tax liabilities;
o the write down of acquired identifiable intangibles, which may
adversely affect Novell's reported results of operations; and
o litigation which has or which may arise in the future in connection
with such acquisitions.
We Have Experienced Delays in the Introduction and Acceptance of New Products
and Solutions Due to Various Factors
As is common in the computer software industry, Novell has in the past
experienced delays in the introduction of new products due to a number of
factors, including the complexity of software products, the need for extensive
testing of software to ensure compatibility of new releases with a wide variety
of application software and hardware devices, and the need to "debug" products
prior to extensive distribution. Novell could, in the future, experience the
same difficulties in introducing new solutions. Significant delays in
developing, completing or shipping new or enhanced products and solutions would
adversely affect Novell.
Moreover, Novell may experience delays in market acceptance of new releases of
its products and solutions as Novell engages in marketing and education of the
user base regarding the advantages and system requirements for new products and
solutions, and as customers evaluate the advantages and disadvantages of
upgrading. Additionally, Novell has invested considerable time and resources in
web services and it is unclear how the web services market will mature, if at
all. Novell has encountered these issues on each major new release of its
products and services, and expects that it will encounter such issues in the
future. Novell's ability to achieve desired levels of sales growth depends at
least in part on the successful completion, introduction and sale of new
versions of its products and sales of its solutions. There can be no assurance
that Novell will be able to respond effectively to technological changes or new
product announcements by others, or that Novell's research and development
efforts will be successful. Should Novell experience material delays or sales
shortfalls with respect to new product or solutions releases, Novell's sales and
net income could be adversely affected.
If Third Parties Claim that We Infringed Upon Their Intellectual Property, Our
Ability to Use Some Technologies and Products Could Be Limited and We May Incur
Significant Costs to Resolve these Claims
Litigation regarding intellectual property rights is common in the Internet and
software industries. Novell expects third-party infringement claims involving
Internet technologies and software products and services to increase. If an
infringement claim is filed against Novell, it may be prevented from using some
technologies and may incur significant costs to resolve the claim.
Novell has in the past received letters suggesting that it is infringing upon
the intellectual rights of others, and it may from time to time encounter
disputes over rights and obligations concerning intellectual property. Novell's
products and services may be found to infringe on the intellectual property
rights of third parties.
In addition, Novell has agreed, and may agree in the future, to indemnify
customers against claims that its products infringe upon the intellectual
property rights of others. Novell could incur substantial costs in defending
itself and its customers against infringement claims. In the event of a claim of
infringement, Novell and its customers may be required to obtain one or more
licenses from third parties. In such instances, Novell or its customers may not
be able to obtain necessary licenses from third parties at a reasonable cost or
at all.
We May Not Be Able to Protect Our Confidential Information, Which May Adversely
Affect Our Business
Novell generally enters into contractual relationships with its employees that
protect its confidential information. In the event that Novell's trade secrets
or other proprietary information are misappropriated, Novell's business could be
seriously harmed. In addition, Novell may not be able to timely detect
unauthorized use of its intellectual property and take appropriate steps to
enforce its rights. In the event Novell is unable to enforce these contractual
obligations, its business could be adversely affected.
We May Not Be Successful at Introducing New Technologies
Novell is committed to its strategy of achieving widespread acceptance and
adoption of Novell's Net Services and e-solutions products, Net Directory
Services ("NDS"), and the products and applications that take advantage of
directory services. Novell is also seeking to take a competitive position in the
Web services industry. Novell's ability to achieve success with its Net
Services, NDS and Web services solutions is dependent on a number of factors
including, but not limited to, the following: development of key Net Services,
directory and Web services products and upgrades, the acceptance of those
products by large industry partners, the marketing of those products through
appropriate channels of distribution, and the acceptance of those products in
major accounts. Novell has only had limited success in introducing new
technologies and there can be no assurance of success with Net Directory
Services, Net Services or Web services solutions.
Our Existing Product Sales May Deteriorate More Rapidly Than Sales of Our New
Products Increase
Novell has several existing products, which it has been selling and upgrading
for many years. Technology shifts or competition could occur causing sales of
these products to decline at a faster rate than Novell is able to increase sales
of new products or technologies. Sales from Net Management Services decreased
during the first nine months of fiscal 2002 by 13.8%, resulting in overall
declines in net product sales by 1.7% in the first nine months of fiscal 2002
compared to the same period of fiscal 2001.
Catastrophic Events Could Harm Our Ability To Conduct Business
Like many multinational corporations, Novell faces business risks as a result of
threats posed by major disasters, especially earthquakes and floods, power
outages, telecommunication failures, application or hardware failures and
terrorist acts. In addition, due to relocation, restructuring and consolidation,
Novell does not have a satisfactory level of redundancy in its IT facilities.
Novell is evaluating its exposure to these risks and taking protective measures,
including improving its disaster recovery capabilities and improving its IT
backup capacity. The occurrence of any of these events would threaten Novell's
ability to continue operations, to provide essential products and services and
to recover operating costs.
We Face Increased Risks in Conducting a Global Business, Which May Damage
Business Results
Novell is a multi-national corporation with offices and subsidiaries around the
world and, as such, it faces risks in doing business abroad that it does not
face domestically. Certain aspects inherent in transacting business
internationally could negatively impact the operating results of Novell,
including:
o costs and difficulties in staffing and managing international
operations;
o unexpected changes in regulatory requirements;
o tariffs and other trade barriers;
o difficulties in enforcing contractual and intellectual property rights;
o longer payment cycles;
o local political, social and economic conditions;
o potentially adverse tax consequences, including restrictions on
repatriating earnings and the threat of "double taxation"; and
o fluctuations in currency exchange rates.
Some of Our Short-term, Long-term, and Venture Capital Fund Investments Have
Become Impaired. Additional Investments Could Become Impaired
Novell's investment portfolio includes investments in public and private equity
securities, small capitalization stocks in the high-technology industry sector,
and funds managed by venture capitalists. Many of these investments have lost a
significant portion of their value at least on a short-term basis, and possibly
on a permanent basis. Additional investments may also lose value. During the
first nine months of fiscal 2002, Novell recorded an impairment charge of $29.8
million related to some of the long-term investments in its portfolio whose
market value had experienced an other-than-temporary decline. As of July 31,
2002, Novell had net unrealized gains on short-term investments of approximately
$0.3 million, net of taxes. However, there can be no assurances that these gains
will be realized and that losses will not occur.
Our Existing Relationships With Other Information Technology Services
Organizations May Be Impaired
Novell relies on existing relationships with information technology services
organizations that recommend, design and implement solutions for their customers
that include Novell Net services products. A change in the willingness of these
information technology service organizations to do business with Novell could
undercut Novell's efforts to continue to transition to a solutions-based Net
services software company.
Our Business May Be Negatively Affected if We Do Not Continue to Adapt to Rapid
Technological Change, Evolving Business Practices and Changing Consumer
Requirements
The software industry and Internet professional services market is characterized
by rapidly changing technology, evolving business practices and changing client
needs. Accordingly, Novell's future success will depend in part on its ability
to continue to adapt and meet these challenges. Among the most important
challenges facing Novell are the need to continue to:
o effectively identify and use leading technologies;
o develop strategic and technical expertise;
o influence and respond to emerging industry standards and other
technology changes and to orient management teams to capitalize on
these changes;
o recruit and retain qualified project personnel;
o enhance current services;
o develop new services that meet changing customer needs; and
o effectively advertise and market services.
Our Services Contracts Contain Pricing Risks
Novell's Cambridge IT services business derives a significant portion of its
sales 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 Novell does not
accurately estimate the resources required for a project, does not accurately
assess the scope of work associated with a project, does not manage the project
properly, or does not satisfy its obligations in a manner consistent with the
contract, then Novell's costs to complete the project could increase
substantially. Novell has occasionally had to commit unanticipated additional
resources to complete projects, and it may have to take similar action in the
future. Novell may not be compensated for these additional costs or the
commitment of these additional resources.
Our Cambridge IT Services Clients Can Cancel or Reduce the Scope of Their
Engagements With Us on Short Notice
If Novell's clients cancel or reduce the scope of an engagement with the
Cambridge IT services business, Novell may be unable to reassign its
professionals to new engagements without delay. Personnel and related costs
constitute a substantial portion of Novell's operating expenses. Because these
expenses are relatively fixed, and because Novell establishes 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 Novell's professional services employees, causing
significant reductions in operating results for a particular quarter.
Our Stock Price Will Fluctuate
Novell's future financial results and stock price could be subject to
significant volatility, particularly on a quarterly basis. Any shortfall in
earnings can be expected to have an immediate and significant adverse effect on
the trading price of Novell's Common Stock in any given period. Sales
fluctuations may also contribute to the volatility of the trading price of
Novell Common Stock in any given period.
In addition, the market prices for securities of software companies have been
very volatile both recently and historically. The market price of Novell Common
Stock, in particular, has been subject to wide fluctuations in the past. As a
result of the foregoing factors and other factors that may arise in the future,
the market price of Novell's Common Stock may be subject to significant
fluctuations within a short period of time. These fluctuations may be due to
factors specific to Novell, to changes in analysts' earnings estimates, or to
factors affecting the computer industry or the securities markets in general.
Item 3. Qualitative and Quantitative Disclosures About Market Risk
Novell is exposed to financial market risks, including changes in interest
rates, foreign currency exchange rates and marketable equity security prices. To
mitigate some of these risks, Novell utilizes currency forward contracts and
currency options. Novell does not use derivative financial instruments for
speculative or trading purposes, and no derivative financial instruments were
outstanding at July 31, 2002.
Interest Rate Risk
The primary objective of Novell's investment activities is to preserve principal
while maximizing yields without significantly increasing risk. This is
accomplished by investing in widely diversified short-term investments,
consisting primarily of investment grade securities, substantially all of which
either mature within the next 12 months or have characteristics of short-term
investments. A hypothetical 50 basis point increase in interest rates would
result in an approximate $0.8 million decrease (less than 0.5%) in the fair
value of Novell's available-for-sale securities.
Market Risk
Novell also holds available-for-sale equity securities in its short-term
investment portfolio. As of July 31, 2002, gross unrealized losses, before tax
effect, on short-term public equity securities totaled $3.5 million. A 10%
adverse change in prices of these short-term equity securities would result in
an approximate $0.6 million decrease in the fair value of Novell's short-term
investments.
In addition, Novell invests in equity securities, included in its long-term
portfolio of investments, for the promotion of business and strategic
objectives. These investments are generally in small capitalization stocks in
the high-technology industry sector, both public and private, through direct
investment or through investments in venture capital funds. Because of the
nature of these investments, Novell is exposed to equity price risks. Novell
typically does not attempt to reduce or eliminate its market exposure on these
securities. A 10% adverse change in equity prices of long-term equity securities
would result in an approximately $9.0 million decrease in the fair value of
Novell's available-for-sale long-term securities.
Foreign Currency Risk
Novell uses derivatives to hedge those net assets and liabilities that, when
remeasured according to accounting principles generally accepted in the United
States of America, impact the condensed consolidated statement of operations.
Currency forward contracts are utilized in these hedging programs. All forward
contracts entered into by the Company are components of hedging programs and are
entered into for the sole purpose of hedging an existing or anticipated currency
exposure, not for speculation or trading purposes. Gains and losses on these
currency forward contracts would generally be offset by corresponding losses and
gains on the net foreign currency assets and liabilities that they hedge,
resulting in negligible net gain or loss overall on hedged exposures. The
Company hedges balance sheet exposures only, with all gains and losses on
forward contracts recognized in other income and expense in the same period as
the gains and losses on remeasurement of the foreign currency denominated assets
and liabilities occur. All gains and losses related to foreign exchange
contracts are included in cash flows from operating activities in the condensed
consolidated statement of cash flows. The Company's hedging programs reduce, but
do not eliminate, the impact of foreign currency exchange rate movements. If
Company did not hedge against foreign currency exchange rate movement of foreign
currency denominated assets, liabilities, and investments, an increase or
decrease of 10% in exchange rates would result in an increase or decrease in
income before taxes of approximately $7.7 million. This number represents the
exposure related to balance sheet remeasurements only and assumes that all
currencies move in the same direction at the same time relative to the US
dollar.
All of the potential changes noted above are based on sensitivity analyses
performed on Novell's financial position at July 31, 2002. Actual results may
differ materially.
Item 4. Controls and Procedures
There were no significant changes in the Company's internal controls or in other
factors that could significantly affect those controls subsequent to the date of
their evaluation, including any corrective actions with regard to significant
deficiencies and material weaknesses.
Part II. Other Information
Except as listed below, all information required by items in Part II is omitted
because the items are inapplicable or the answer is negative.
Item 1. Legal Proceedings.
The information required by this item is incorporated herein by reference to
Footnote I of the Company's financial statements contained in Part I, Item 1 of
this Form 10-Q.
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Exhibit
Number Description
10.1 Key Employment Agreement dated as of July 19, 2002 between Novell,
Inc. and David Litwack10.1, incorporated by reference to
Exhibit (d)(4) to the Schedule TO filed by the Registrant with the SEC
on June 18, 2002.
..
10.2 Novell, Inc./SilverStream Software, Inc. 1997 Stock Incentive Plan,
incorporated by reference to Exhibit 4.2 of the Registrant's
Registration Statement on Form S-8, filed August 6, 2002 (File No.
333-97713).
10.3 Novell, Inc./SilverStream Software, Inc. 2001 Stock Incentive Plan,
incorporated by reference to Exhibit 4.3 of the Registrant's
Registration Statement on Form S-8, filed August 6, 2002 (File No.
333-97713).
10.4 Novell, Inc./SilverStream Software, Inc./eObject, Inc. 2000 Stock Plan,
incorporated by reference to Exhibit 4.4 of the Registrant's
Registration Statement on Form S-8, filed August 6, 2002 (File No.
333-97713).
10.5 Novell, Inc./SilverStream Software, Inc./Bondi Software, Inc. Employee
Stock Option Plan , incorporated by reference to Exhibit 4.5 of the
Registrant's Registration Statement on Form S-8, filed August 6, 2002
(File No. 333-97713).
(b) Reports on Form 8-K.
Notice of Novell's scheduled report of second quarter results and related
conference call to be held on May 23, 2002, as filed May 6, 2002 under
Item 5.
Agreement and Plan of Merger dated as of June 9, 2002 by and among Novell,
Delaware Planet Inc., a Delaware corporation and a wholly-owned subsidiary
of Novell and SilverStream Software, Inc., a Delaware corporation, as filed
June 10, 2002 under Item 5.
Announcement of the closing of the tender offer by Novell, Inc. for the
shares of SilverStream on July 19, 2002, as filed on July 17, 2002 under
Item 2.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Novell, Inc.
(Registrant)
Date: September 16, 2002 /s/ Ronald C. Foster
----------------------------
Ronald C. Foster
Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)
CERTIFICATIONS
I, Jack L. Messman, certify that:
1. I have reviewed this quarterly report on Form 10-Q of
Novell, Inc;
2. Based on my knowledge, this quarterly report does not
contain any untrue statement of a material fact or omit to
state a material fact necessary to make the statements made,
in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report,
fairly present in all material respects the financial
condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this
quarterly report;
Date: September 16, 2002
/s/ Jack L. Messman
---------------------
Jack. L. Messman
President and Chief Executive Officer
---------------------------------------
[Title]
I, Ronald C. Foster, certify that:
1. I have reviewed this quarterly report on Form 10-Q of
Novell, Inc;
2. Based on my knowledge, this quarterly report does not
contain any untrue statement of a material fact or omit to
state a material fact necessary to make the statements made,
in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report,
fairly present in all material respects the financial
condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this
quarterly report;
Date: September 16, 2002
/s/ Ronald C. Foster
Ronald C. Foster
Chief Financial Officer
-----------------------
[Title]