SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-Q [X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Fiscal Quarter Ended April 30, 1999 or [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from _______ to _______ Commission File Number: 0-13351 NOVELL, INC. (Exact name of registrant as specified in its charter) Delaware 87-0393339 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 122 East 1700 South 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 May 28, 1999 there were 334,998,746 shares of the registrant's common stock outstanding. Part I. Financial Information, Item 1. Financial Statements NOVELL, INC. CONSOLIDATED UNAUDITED CONDENSED BALANCE SHEETS Apr. 30, Oct. 31, Dollars in thousands, except per share data 1999 1998 - ------------------------------------------------------------------------------ ASSETS Current assets Cash and short-term investments $ 974,440 $ 1,007,167 Receivables, less allowances ($44,215 - April; $47,921 - October) 209,282 246,577 Inventories 3,108 3,562 Prepaid expenses 56,397 63,165 Deferred and refundable income taxes 88,480 95,343 Other current assets 18,489 19,886 - ------------------------------------------------------------------------------ Total current assets 1,350,196 1,435,700 Property, plant and equipment, net 344,261 346,196 Long-term investments 200,302 114,815 Other assets 24,334 27,401 - ------------------------------------------------------------------------------ Total assets $ 1,919,093 $ 1,924,112 ============================================================================== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities Accounts payable $ 61,920 $ 77,987 Accrued compensation 56,044 52,348 Accrued marketing liabilities 19,243 16,383 Other accrued liabilities 65,968 62,206 Income taxes payable 61,647 64,057 Deferred revenue 132,854 141,714 - ------------------------------------------------------------------------------ Total current liabilities 397,676 414,695 Minority interests 10,573 15,919 Shareholders' equity Common stock, par value $.10 a share Authorized - 600,000,000 shares Issued - 334,558,416 shares-April 337,592,460 shares-October 33,456 33,759 Additional paid-in capital 131,165 200,897 Retained earnings 1,357,961 1,290,337 Unearned stock compensation (6,423) (5,396) Cumulative translation adjustment (1,842) (1,753) Unrealized (loss) on investments (3,473) (24,346) - ------------------------------------------------------------------------------ Total shareholders' equity 1,510,844 1,493,498 - ------------------------------------------------------------------------------ Total liabilities and shareholders' equity $ 1,919,093 $ 1,924,112 ============================================================================== See notes to consolidated unaudited condensed financial statements. NOVELL, INC. CONSOLIDATED UNAUDITED CONDENSED STATEMENTS OF INCOME Fiscal Quarter Ended Six Months Ended Amounts in thousands, Apr. 30, Apr. 30, Apr. 30, Apr. 30, except per share data 1999 1998 1999 1998 - ------------------------------------------------------------------------------ Net sales $315,652 $262,250 $ 601,458 $ 514,292 Cost of sales 76,211 59,278 140,331 116,365 - ------------------------------------------------------------------------------ Gross profit 239,441 202,972 461,127 397,927 Operating expenses Sales and marketing 106,455 101,424 211,792 205,635 Product development 58,083 60,850 112,088 121,088 General and administrative 25,411 26,350 51,405 51,924 - ------------------------------------------------------------------------------ Total operating expenses 189,949 188,624 375,285 378,647 - ------------------------------------------------------------------------------ Income from operations 49,492 14,348 85,842 19,280 Other income (expense) Investment income 10,653 15,456 20,416 29,855 Other, net (6,358) (2,989) (12,335) (2,745) - ------------------------------------------------------------------------------ Other income, net 4,295 12,467 8,081 27,110 - ------------------------------------------------------------------------------ Income before taxes 53,787 26,815 93,923 46,390 Income taxes 15,061 7,508 26,299 12,989 - ------------------------------------------------------------------------------ Net income $ 38,726 $ 19,307 $ 67,624 $ 33,401 ============================================================================== Weighted average shares outstanding Basic 335,276 351,762 336,359 351,396 Diluted 351,116 356,586 351,319 354,779 ============================================================================== Net income per share Basic $ 0.12 $ 0.05 $ 0.20 $ 0.10 Diluted $ 0.11 $ 0.05 $ 0 .19 $ 0.09 ============================================================================== See notes to consolidated unaudited condensed financial statements. NOVELL, INC. CONSOLIDATED UNAUDITED CONDENSED STATEMENTS OF CASH FLOWS Six Months Ended ---------------------------- Apr. 30, Apr 30, Dollars in thousands 1999 1998 - ------------------------------------------------------------------------------ Cash flows from operating activities Net income $ 67,624 $ 33,401 Adjustments to reconcile net income to net cash provided (used) by operating activities Depreciation and amortization 32,585 40,227 Stock plans income tax benefits 25,356 1,150 Decrease in receivables 37,295 11,987 Decrease in inventories 454 4,340 Decrease (increase) in prepaid expenses 6,768 (4,467) Decrease in deferred and refundable income taxes 6,858 17,860 Decrease in other current assets 1,397 2,243 (Decrease) in current liabilities, net (17,019) (37,453) - ------------------------------------------------------------------------------ Net cash provided from operating activities 161,318 69,288 - ------------------------------------------------------------------------------ Cash flows from financing activities Issuance of common stock, net 50,804 13,923 Repurchase of common stock (146,195) - - ------------------------------------------------------------------------------ Net cash (used) provided from financing activities (95,391) 13,923 - ------------------------------------------------------------------------------ Cash flows from investing activities Expenditures for property, plant and equipment (31,677) (17,231) Purchases of short-term investments (1,270,979) (1,037,871) Maturities of short-term investments 969,270 552,398 Sales of short-term investments 363,271 379,014 Other (87,850) (11,221) - ------------------------------------------------------------------------------ Net cash (used) by investing activities (57,965) (134,911) - ------------------------------------------------------------------------------ Total increase (decrease) in cash and cash equivalents $ 7,962 $ (51,700) Cash and cash equivalents - beginning of period 177,083 208,543 - ------------------------------------------------------------------------------ Cash and cash equivalents - end of period 185,045 156,843 Short-term investments - end of period 789,395 927,792 - ------------------------------------------------------------------------------ Cash and short-term investments - end of period $ 974,440 $ 1,084,635 ============================================================================== 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. Actual results could differ 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 1998 Annual Report to Shareholders. These statements do include all normal recurring adjustments which 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 income, have been made to the prior years amounts in order to conform to the current year's presentation. B. Cash and Short-term Investments All marketable debt and equity securities are included in cash and short-term investments and are considered available-for-sale and carried at fair market value, with the unrealized gains and losses, net of tax, included in shareholders equity. Fair market values are based on quoted market prices at end of period, where available; if quoted market prices are not available, then fair market values are based on quoted market prices of comparable instruments. Municipal securities included in short-term investments have contractual maturities from 1-5 years. Money market preferreds have contractual maturities of less than 180 days. No other short-term investments have contractual maturities. The cost of securities sold is based on the specific identification method. Such securities are anticipated to be used for current operations and are therefore classified as current assets, even though some maturities may extend beyond one year. 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 Apr. 30, Gains Losses Apr. 30, (Dollars in thousands) 1999 1999 - ------------------------------------------------------------------------------ Cash and cash equivalents Cash $ 146,929 $ - $ - $ 146,929 Taxable money market fund 31,116 - - 31,116 Municipal securities 7,000 - - 7,000 - ------------------------------------------------------------------------------ Cash and cash equivalents $ 185,045 $ - $ - $ 185,045 - ------------------------------------------------------------------------------ Short-term investments Municipal securities $ 431,433 $ 6,435 $ (2) $ 437,866 Money market preferreds 177,900 - - 177,900 Mutual funds 120,098 - (43) 120,055 Equity securities 65,619 23,271 (35,316) 53,574 - ------------------------------------------------------------------------------ Short-term investments $ 795,050 $ 29,706 $ (35,361) $ 789,395 - ------------------------------------------------------------------------------ Cash and short-term investments $ 980,095 $ 29,706 $ (35,361) $ 974,440 - ------------------------------------------------------------------------------ Gross Gross Fair Market Cost at Unrealized Unrealized Value at Oct. 31, Gains Losses Oct. 31, (Dollars in thousands) 1998 1999 - ------------------------------------------------------------------------------ Cash and cash equivalents Cash $ 98,444 $ - $ - $ 98,444 Repurchase agreements 8,092 - - 8,092 Money market fund 55,957 - - 55,957 Municipal securities 14,590 - - 14,590 - ------------------------------------------------------------------------------ Cash and cash equivalents $ 177,083 $ - $ - $ 177,083 - ------------------------------------------------------------------------------ Short-term investments Municipal securities $ 448,195 $ 8,027 $ - $ 456,222 Money market mutual funds 95,631 - - 95,631 Money market preferreds 181,719 - (19) 181,700 Mutual funds 15,340 - - 15,340 Equity securities 128,837 30,159 (77,805) 81,191 - ------------------------------------------------------------------------------ Short-term investments $ 869,722 $ 38,186 $ (77,824) $ 830,084 Cash and short-term investments $1,046,805 $ 38,186 $ (77,824) $1,007,167 - ------------------------------------------------------------------------------ During the first six months of fiscal 1999 the Company had realized gains of $25 million on the sale of securities compared to realized gains of $5 million in the first six months of fiscal 1998, while realizing losses on sales of securities of $29 million in the first six months of fiscal 1999 and $2 million in the first six months of fiscal 1998. C. Income Taxes The Company's estimated effective tax rate for the first six months of fiscal 1999 was 28.0%, the same as in the first six months of fiscal 1998. The Company paid cash amounts for income taxes of $4 million and $10 million, in the first six months of fiscal 1999 and 1998, respectively. D. Commitments and Contingencies The Company currently has a $10 million unsecured revolving bank line of credit, with interest at the prime rate. The line can be used for either letter of credit or working capital purposes. The line is subject to the terms of a loan agreement containing financial covenants and restrictions, none of which are expected to significantly affect the Company's operations. At April 30, 1999 there were no borrowings, letter of credit acceptances or commitments under such line. The Company has an additional $5 million line of credit with another bank which is not subject to a loan agreement. At April 30, 1999 standby letters of credit of approximately $3 million were outstanding under this line of credit. In fiscal 1997, the Company entered into agreements to lease buildings being constructed on land owned by the Company in San Jose, California and in Provo, Utah. The lessor has committed to fund up to $272 million for construction of the buildings. The leases are for a period of seven years and can be renewed for two additional five year periods, subject to the approval of the lender and the Company, at the sole discretion of each party. Rent obligations commenced during the second quarter of fiscal 1999 for San Jose and will commence upon the Company's occupation of the Provo building in fiscal 2000. Annual rent under each agreement is determined by taking the portion of the committed amount actually utilized and associated capitalized interest accrued during the construction period and multiplying this amount by the secured interest rate. If the Company does not purchase the buildings, or arrange for the sale of the buildings, at the end of the lease, the Company will guarantee the lessor no more than 85% of the residual value of the buildings. The guaranteed residual value at April 30, 1999, was approximately $218 million. In addition, the agreement calls for the Company to maintain a specific level of restricted cash to serve as collateral for the leases and maintain compliance with certain financial covenants. The value of restricted cash held as collateral at April 30, 1999 was approximately $164 million, and is included in long-term investments. In 1993, a suit was filed due to a failed contract against a company that Novell subsequently acquired. The plaintiff obtained a jury verdict against the acquired company in 1996. In May 1999, the Company settled this legal matter. The resolution of this legal matter did not have a material adverse effect on the Company's financial position, results of operations, or cash flows. In February 1998, a suit was filed against Novell and certain of its officers and directors, alleging violation of federal securities laws. 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. The case is in its preliminary stages. Novell believes that the case is without merit, and intends to vigorously defend against the allegations. While there can be no assurance as to the ultimate disposition of the case, 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 the claims will not have a material adverse effect on its financial position, results of operations, or cash flows. E. Put Warrants In connection with the Company's stock repurchase program, the Company sold put warrants on 15 million shares of its common stock during the third quarter of fiscal 1998, giving a third party the right to sell shares of Novell common stock to the Company at contractually specified prices. The put warrants are exercisable only at maturity, expire at various dates through July 1999, and can only be settled in shares. Additionally, during the third quarter of fiscal 1998, the Company purchased call options on 10 million shares of its common stock, giving the Company the right to purchase shares of Novell common stock at contractually specified prices. The call options are exercisable only at maturity and expire at various dates through July 1999. The premiums received from the sale of the put warrants offset in full the cost of the call options. In the first six months of fiscal 1999, 9 million of the Company's put warrant obligations expired worthless and the Company exercised 6 million call options to purchase 6 million shares of Novell common stock in connection with the Company's stock repurchase program. F. International Sales The Company operates in one business segment and markets internationally both directly to end users and through distributors who sell to dealers and end users. For the first six months of fiscal 1999 and fiscal 1998, sales to international customers were approximately $277 million and $223 million, respectively. In the first six months of fiscal 1999 and fiscal 1998, 72% and 67%, respectively, of international sales were to European countries. No one foreign country accounted for 10% or more of total sales in either period. Except for one multi-national distributor, which accounted for 12% of total revenue in the first six months of 1999 and 13% of total revenue in the first six months of fiscal 1998, no customer accounted for more than 10% of total revenue in any period. G. Net Income Per Share Fiscal Quarter Ended Six Months Ended -------------------- --------------------- Apr. 30, Apr. 30, Apr. 30, Apr. 30, Amounts in thousands, 1999 1998 1999 1998 except per share data - ----------------------------------------------------------------------------- Basic net income per share computation Net income $ 38,726 $ 19,307 $ 67,624 $ 33,401 - ------------------------------------------------------------------------------ Weighted average shares outstanding 335,276 351,762 336,359 351,396 - ------------------------------------------------------------------------------ Basic net income per share $ .12 $ .05 $ 0.20 $ 0.10 ============================================================================== Diluted net income per share computation Net income $ 38,726 $ 19,307 $ 67,624 $ 33,401 - ------------------------------------------------------------------------------ Weighted average shares outstanding 335,276 351,762 336,359 351,396 Incremental shares attributable to exercise of outstanding options (treasury stock method) 15,839 4,824 14,960 3,383 - ------------------------------------------------------------------------------ Total 351,116 356,586 351,319 354,779 - ------------------------------------------------------------------------------ Diluted net income per share $ 0.11 $ 0.05 $ 0.19 $ 0.09 ============================================================================== H. Comprehensive Income In the first quarter of 1999, the Company adopted Statement of Financial Accounting Standards No. 130 (SFAS 130), Reporting Comprehensive Income. SFAS 130 establishes new rules for the reporting and displaying of comprehensive income. SFAS 130 requires unrealized gains or losses on the Company's available-for-sale securities, unearned stock compensation and cumulative translation adjustments, which prior to adoption were only reported separately in shareholders equity, to be included in comprehensive income. The components of comprehensive income, net of tax, for the three months and six months ended April 30, 1999 and April 30, 1998 were as follows: Fiscal Quarter Ended Six Months Ended --------------------- ------------------- Apr. 30, Apr. 30, Apr. 30, Apr. 30, Dollars in thousands 1999 1998 1999 1998 - ------------------------------------------------------------------------------ Net income $ 38,726 $ 19,307 $ 67,624 $ 33,401 Unrealized gain/(loss) on investments (6,459) 6,815 20,873 (3,597) Unearned stock compensation (728) 194 (1,027) 1,032 Cumulative translation adjustment 35 54 (89) 168 - ------------------------------------------------------------------------------ Comprehensive income $ 31,574 $ 26,370 $ 87,381 $ 31,004 ============================================================================== Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Introduction Novell is the world's leading provider of directory-enabled networking software. Novell solutions give businesses total control of their private networks and the Internet, simplifying the management of user access and identity. Novell's worldwide channel, developer, education, and technical support programs are the most extensive in the network computing industry. Results of Operations Net Sales Q2 Q2 YTD YTD 1999 Change 1998 1999 Change 1998 - ------------------------------------------------------------------------------ Net sales (millions) $316 21% $262 $601 17% $514 ============================================================================== Novell's products can be categorized into three areas, all within the software industry. They are server platforms; network infrastructure and applications; and service, training, consulting and other. While revenue increased from the second quarter of 1998 to the second quarter of 1999, and from the first six months of fiscal 1998 to the first six months of fiscal 1999, analysis of the individual product categories characterizes the changes that have occurred. The server platforms product category includes directory-enabled NetWare (NetWare 4 and NetWare 5) and NetWare 3. Server platforms revenue increased by $38 million or 26% in the second quarter of 1999 compared to the second quarter of 1998. Directory-enabled NetWare increased $49 million or 41% following strong acceptance of NetWare 5, while NetWare 3 revenue decreased $11 million or 36% from the second quarter of fiscal 1998 compared to the second quarter of fiscal 1999. In the first six months of fiscal 1999 compared to the first six months of fiscal 1998, server platforms revenue was up $56 million or 19%. Directory-enabled NetWare increased $69 million or 28%, while NetWare 3 revenue slid $13 million or 25% during the six month comparative periods. The network infrastructure and applications product category includes NetWare for SAA host connectivity products, BorderManager, NDS integration and high availability service products. Collaboration and management products such as GroupWise, ManageWise, and Z.E.N.works are also included in this product category. The product category had revenue of $75 million in the second quarter of 1999 compared to $72 million in the second quarter of 1998. This 4% increase was driven by new product revenue from Z.E.N.works, as well as strong growth in BorderManager and NDS for NT and Solaris. These increases were somewhat offset by a decrease in host connectivity products and in Tuxedo royalties, which ended in the fourth quarter of fiscal 1998. In the first six months of fiscal 1999 compared to the first six months of fiscal 1998, network infrastructure and applications revenue was up $10 million or 7%. This 7% increase was driven by the same factors driving the quarter over quarter revenue growth. Service, training, consulting, and other includes revenue from customer service, training products and courses, consulting for network solutions, UNIX royalties, and other. These revenues were $53 million and $41 million in the second quarter of 1999 and 1998, respectively. The increase was a result of new consulting revenue, as well as growth in service and training revenue. UNIX royalties were flat and represented only 2% of total revenue in the second quarter of 1999 compared to 3% in the second quarter of 1998. In the first six months of fiscal 1999 compared to the first six months of fiscal 1998, service, training, consulting and other revenue increased by $21 million or 27% due to the same factors driving the quarter over quarter revenue growth. International sales represented 46% of total sales in the first six months of 1999 compared to 43% in the first six months of 1998. This change is a result of a 11% increase in domestic revenues compared to a 24% increase in international revenues in the first six months of fiscal 1999 compared to the first six months of fiscal 1998. Gross Profit Q2 Q2 YTD YTD 1999 Change 1998 1999 Change 1998 - ----------------------------------------------------------------------------- Gross profit (millions) $239 18% $203 $461 16% $398 Percentage of net sales 76% 77% 77% 77% ============================================================================== The gross margin percentage decreased slightly in the second quarter of fiscal 1999 compared to the second quarter of fiscal 1998 due to higher royalty costs and an increase in expenses associated with ramping up the Company's consulting business, both as a percentage of net sales and in absolute dollars. In the first six months of fiscal 1999 compared to the first six months of fiscal 1998, the gross margin percentage remained flat. Higher service, consulting and royalty costs were offset by lower material, inventory and training and education costs. Operating Expenses Q2 Q2 YTD YTD 1999 Change 1998 1999 Change 1998 - ----------------------------------------------------------------------------- Sales and marketing (millions) $106 5% $101 $212 3% $206 Percentage of net sales 34% 39% 35% 40% - ------------------------------------------------------------------------------ Product development (millions) $ 58 -5% $ 61 $112 -7% $121 Percentage of net sales 18% 23% 19% 24% - ------------------------------------------------------------------------------ General and administrative (millions) $ 25 -4% $ 26 $ 51 -2% $ 52 Percentage of net sales 8% 10% 8% 10% - ------------------------------------------------------------------------------ Total operating expenses (millions) $190 1% $189 $375 -1% $379 Percentage of net sales 60% 72% 62% 74% ============================================================================== Sales and marketing expenses increased by $5 million and $6 million, respectively, in the second quarter of fiscal 1999 compared to the second quarter of fiscal 1998 and in the first six months of fiscal 1999 compared to the first six months of fiscal 1998, but decreased as a percentage of net sales. Lower international selling expenses were partially offset by higher marketing expenses in both comparative periods. Sales and marketing expenses fluctuate as a percentage of net sales in any given period due to product promotions, advertising or other discretionary expenses. Product development expenses decreased by $3 million in the second quarter of fiscal 1999 compared to the second quarter of fiscal 1998 and by $9 million, or 7% in the first six months of fiscal 1999 compared to the first six months of fiscal 1998. Product development expenses decreased as a percentage of net sales, in both comparative periods, due to a more efficient product development organization focused on delivering new products consistent with its strategy. General and administrative expenses decreased slightly by $1 million in both the second quarter of fiscal 1999 compared to the second quarter of fiscal 1998 and in the six months of fiscal 1999 compared to the first six months of fiscal 1999. General and administrative expenses also decreased as a percentage of net sales, in both comparative periods, due to a higher revenue base. YTD YTD 1999 Change 1998 - ------------------------------------------------------------------------------ Employees 4,591 - 4,570 Annualized revenue per employee (000's) $253 15% $220 ============================================================================== Other Income, Net Q2 Q2 YTD YTD 1999 Change 1998 1999 Change 1998 - ------------------------------------------------------------------------------ Other income, net (millions) $ 4 -67% $ 12 $ 8 -70% $ 27 Percentage of net sales 1% 5% 1% 5% ============================================================================== The primary component of other income, net is investment income, which was $11 million in the second quarter of fiscal 1999 compared to $15 million in the second quarter of fiscal 1998. The decrease in the second quarter of 1999 compared to the second quarter in 1998 is the result of net realized capital losses as the Company disposed of certain equity securities. In the second quarter of 1999, in addition to investment income, the Company had immaterial losses on foreign currency, the accrual for certain legal matters and the write-off of certain long-term investments. In the first six months of fiscal 1999, net investment income was $20 million compared to $30 million in the first six months of fiscal 1998. The decrease in the period was also the result of net realized capital losses associated with certain equity securities. Income Taxes Q2 Q2 YTD YTD 1999 Change 1998 1999 Change 1998 - ------------------------------------------------------------------------------ Income taxes (millions) $ 15 88% $ 8 $ 26 100% $ 13 Percentage of net sales 5% 3% 4% 3% Effective tax rate 28% 28% 28% 28% ============================================================================== The effective tax rate for fiscal 1999 is estimated to be 28%, the same as fiscal 1998. Net Income and Net Income Per Share Q2 Q2 YTD YTD 1999 Change 1998 1999 Change 1998 - ------------------------------------------------------------------------------ Net income (millions) $ 39 105% $ 19 $ 68 106% $ 33 Percentage of net sales 12% 7% 11% 6% Net income per share - basic $.12 $.05 $.20 $.10 Net income per share - diluted $.11 $.05 $.19 $.09 ============================================================================== Liquidity and Capital Resources Q2 Q4 1999 Change 1998 - ------------------------------------------------------------------------------ Cash and short-term investments (millions) $974 -3% $1,007 Percentage of total assets 51% 52% ============================================================================== Cash and short-term investments decreased to $974 million at April 30, 1999 from $1,007 million at October 31, 1998. The major reason for this decrease was the $146 million of cash used for repurchase of common stock, the $32 million used for expenditures on property, plant and equipment, the $66 million used to increase collateral associated with certain long-term investments, partially offset by the $161 million provided by operating activities and the $50 million from the issuance of common stock. The investment portfolio is diversified among security types, industry groups, and individual issuers. To achieve potentially higher returns, a limited portion of the Company's investment portfolio is invested in mutual funds, which incur market risk. The Company believes that the market risk has been limited by diversification and by use of a funds management timing service which switches funds out of mutual funds and into money market funds when preset signals occur. The Company's investment portfolio includes securities with gross unrealized losses of $6 million as of April 30, 1999. Certain securities with material unrealized losses are Corel common stock, which was obtained in March 1996 upon the Company's sale of its personal productivity applications product line and SCO common stock, which was obtained in December 1995 upon the sale of the Company's UnixWare product line. It is the Company's intention to continue to dispose of such shares over the coming periods. The Company's principal source of liquidity has been from operations. At April 30, 1999, the Company's principal unused sources of liquidity consisted of cash and short-term investments and available borrowing capacity of approximately $15 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 six months of fiscal 1999, the Company has continued to generate cash from operations. The Company anticipates being able to fund its current operations and capital expenditures planned for the foreseeable future with existing cash and short-term investments together with internally generated funds. The Company believes that borrowings under the Company's credit facilities or public offerings of equity or debt securities are available if the need arises. 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 1999 are anticipated to be approximately $45 million, but could be reduced if the growth of the Company is less than presently anticipated. In June 1998, the Company announced its intent to repurchase and retire up to 10 percent, or approximately 35 million shares, of Novell common stock over the next twelve months. During the first six months of 1999, the Company repurchased and retired approximately 10 million shares at a cost of approximately $146 million. During fiscal 1998, the Company repurchased and retired approximately 21 million shares at a cost of approximately $245 million. Future Results The Company'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 are the following: business conditions and the general economy; competitive factors, such as rival operating systems, acceptance of new products and price pressures; availability of third-party compatible products at reasonable 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; market fluctuations of investment securities; and litigation. In the past, many information technology products were designed with two digit year codes that did not recognize century and millennium fields. As a result, these hardware and software products may not function or may give incorrect results beginning in the year 2000. The year 2000 issue is faced by substantially every company in the computer industry, as well as every company which relies on computer systems. The Company has created a company-wide Year 2000 team to identify and resolve Year 2000 issues associated either with the Company's internal systems or the products and services sold by the company. As part of this effort, the Company is communicating with its main suppliers of technology products and services regarding the Year 2000 status of such products or services. The Company has identified and is testing its main internal systems and expects to complete testing by mid 1999. In 1999 the Company expects to complete implementation of any needed year 2000-related modifications to its information systems. The Company is also currently assessing its internal non-information technology systems, and expects to complete testing and any needed modifications to these systems in 1999. The Company's total cost relating to these activities has not been and is not expected to be material to the Company's financial position, results of operations, or cash flows. The Company believes that necessary modifications will be made on a timely basis. However, there can be no assurance that there will not be a delay in, or increased costs associated with, the implementation of such modifications, or that the Company's suppliers will adequately prepare for the year 2000 issue. It is possible that any such delays, increased costs, or supplier failures could have a material adverse impact on the Company's operations and financial results, by, for example, impacting the Company's ability to deliver products or services to its customers. The Company has begun contingency planning and finalized in mid-1999 its main assessment of and contingency planning for potential operational or performance problems related to year 2000-related issues with its information systems. The Company's year 2000 effort has included testing products currently or recently on the Company's price list for year 2000 issues. Generally, for products that were identified as needing updates to address year 2000 issues, the Company has prepared or is preparing updates, or has removed the product from its price list. Some of the Company's customers are using product versions that the Company will not support for year 2000 issues; the Company is encouraging these customers to migrate to current product versions that are year 2000 ready. For third party products which the Company distributes with its products, the Company has sought information from the product manufacturers regarding the products year 2000 readiness status. Customers who use the third-party products are directed to the product manufacturer for detailed year 2000 status information. On its year 2000 web site at www.novell.com/year2000/, the Company provides information regarding which of its products are year 2000 ready and other general information related to the Company's year 2000 efforts. The Company's total costs relating to these activities has not been and is not expected to be material to the Company's financial position or results of operations. The Company believes its current products, with any applicable updates, are well-prepared for year 2000 date issues, and the Company plans to support these products for date issues that may arise related to the year 2000. However, there can be no guarantee that one or more current Company products do not contain year 2000 date issues that may result in material costs to the Company. Because it is in the business of selling software products, the Company's risk of being subjected to lawsuits relating to year 2000 issues with its software products is likely to be greater than that of companies in other industries. Because computer systems may involve different hardware, firmware and software components from different manufacturers, it may be difficult to determine which component in a computer system may cause a year 2000 issue. As a result, the Company may be subjected to year 2000-related lawsuits independent of whether its products and services are year 2000 ready. The outcomes of any such lawsuits and the impact on the Company cannot be determined at this time. Novell believes that it has the product offerings, facilities, personnel, and competitive and financial resources for continued business success, but future revenues, costs, margins, product mix, and profits are all influenced by a number of factors, such as those discussed above, as well as risks described in detail in the Company's fiscal 1998 report on Form 10-K. 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 D 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 The Company held its Annual Meeting of Shareholders on April 12, 1999 for the following purposes: 1. To elect nine directors. 2. To ratify the selection of Ernst & Young LLP as independent auditors for Novell, Inc. 3. To consider a shareholder proposal regarding the Company s shareholder rights plan. The following tables set forth the outcome of the matters voted upon at the meeting and the number of votes cast for, against or withheld. Votes Votes Proposal 1 For Withheld - ------------------------------------------------------------------------------ Election of Directors Eric E. Schmidt 298,089,204 1,466,931 John A. Young 298,034,410 1,521,725 Elaine R. Bond 297,891,695 1,664,440 Hans-Werner Hector 298,066,275 1,489,860 Reed E. Hundt 298,060,103 1,496,032 William N. Joy 298,128,243 1,427,892 Jack L. Messman 297,853,404 1,702,731 Richard L. Nolan 296,835,870 2,720,265 Larry W. Sonsini 297,918,041 1,638,094 - ------------------------------------------------------------------------------ Votes Votes Votes Proposal 2 For Against Abstained - ------------------------------------------------------------------------------ Ratify the selection of Ernst & Young LLP as Independent Auditors 298,140,476 627,160 788,339 - ------------------------------------------------------------------------------ Votes Votes Votes Broker Proposal 3 For Against Abstained Non-Vote - ------------------------------------------------------------------------------ Consider a shareholder proposal regarding the Company's shareholder rights plan. 127,255,971 89,074,751 8,834,507 74,390,906 - ------------------------------------------------------------------------------ Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits Exhibit Number Description - ------- ___________ 27* Financial Data Schedule (b) Reports on Form 8-K. No reports on Form 8-K were filed by the Registrant during the quarter ended April 30, 1999. - -------------------------- *Filed herewith. SIGNATURES Pursuant to the requirements of the Securities and 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: June 11, 1999 /s/ Dr. Eric Schmidt ------------------------ Dr. Eric Schmidt Chairman of the Board and Chief Executive Officer (Principal Executive Officer) Date: June 11, 1999 /s/ Dennis R. Raney -------------------------- Dennis R. Raney Chief Financial Officer (Principal Financial Officer) Date: June 11, 1999 /s/ Ron Foster -------------------------- Ron Foster Vice President and Corporate Controller (Principal Accounting Officer)