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 July 31, 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 August 31, 1999 there were 333,066,484 shares of the Registrant's Common Stock outstanding. Part I. Financial Information, Item 1. Financial Statements NOVELL, INC. CONSOLIDATED UNAUDITED CONDENSED BALANCE SHEETS July 31, Oct. 31, Dollars in thousands, except per share data 1999 1998 - ------------------------------------------------------------------------------------------------------------------- ASSETS Current assets Cash and short-term investments $ 992,201 $ 1,007,167 Receivables, less allowances ($31,880 - July; $47,921 - October) 233,302 246,577 Inventories 2,945 3,562 Prepaid expenses 48,205 63,165 Deferred and refundable income taxes 75,958 95,343 Other current assets 18,704 19,886 - -------------------------------------------------------------------------------------------------------------------- Total current assets 1,371,315 1,435,700 Property, plant and equipment, net 344,750 346,196 Long-term investments 210,835 114,815 Other assets 36,681 27,401 - -------------------------------------------------------------------------------------------------------------------- Total assets $ 1,963,581 $ 1,924,112 ==================================================================================================================== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities Accounts payable $ 74,636 $ 77,987 Accrued compensation 61,543 52,348 Accrued marketing liabilities 16,708 16,383 Other accrued liabilities 53,226 62,206 Income taxes payable 45,083 64,057 Deferred revenue 149,338 141,714 - -------------------------------------------------------------------------------------------------------------------- Total current liabilities 400,534 414,695 Minority interests 10,108 15,919 Shareholders' equity Common stock, par value $.10 a share Authorized - 600,000,000 shares Issued - 333,995,071 shares-July 337,592,460 shares-October 33,400 33,759 Additional paid-in capital 124,422 200,897 Retained earnings 1,407,274 1,290,337 Unearned stock compensation (7,664) (5,396) Cumulative translation adjustment (2,574) (1,753) Unrealized (loss) on investments (1,919) (24,346) - -------------------------------------------------------------------------------------------------------------------- Total shareholders' equity 1,552,939 1,493,498 - -------------------------------------------------------------------------------------------------------------------- Total liabilities and shareholders' equity $ 1,963,581 $ 1,924,112 ==================================================================================================================== See notes to consolidated unaudited condensed financial statements. NOVELL, INC. CONSOLIDATED UNAUDITED CONDENSED STATEMENTS OF INCOME Fiscal Quarter Ended Nine Months Ended Dollars in thousands, July 31, July 31, July 31, July 31, except per share data 1999 1998 1999 1998 Net sales $ 326,808 $ 272,016 $ 928,266 $ 786,308 Cost of sales 73,514 63,069 213,845 179,434 - ------------------------------------------------------------------------------------------------------------------- Gross profit 253,294 208,947 714,421 606,874 Operating expenses Sales and marketing 108,806 96,986 320,598 302,621 Product development 57,183 57,048 169,271 178,136 General and administrative 24,866 24,827 76,271 76,751 - ------------------------------------------------------------------------------------------------------------------- Total operating expenses 190,855 178,861 566,140 557,508 - ------------------------------------------------------------------------------------------------------------------- Income from operations 62,439 30,086 148,281 49,366 Other income (expense) Investment income 10,260 7,390 30,676 37,245 Other, net (4,211) (592) (16,546) (3,337) - ------------------------------------------------------------------------------------------------------------------- Other income, net 6,049 6,798 14,130 33,908 - ------------------------------------------------------------------------------------------------------------------- Income before taxes 68,488 36,884 162,411 83,274 Income taxes 19,177 10,328 45,476 23,317 - ------------------------------------------------------------------------------------------------------------------- Net income $ 49,311 $ 26,556 $ 116,935 $ 59,957 =================================================================================================================== Weighted average shares outstanding Basic 334,488 353,436 335,735 352,076 Diluted 350,951 362,083 351,196 357,213 =================================================================================================================== Net income per share Basic $ 0.15 $ 0.08 $ 0.35 $ 0.17 Diluted $ 0.14 $ 0.07 $ 0.33 $ 0.17 =================================================================================================================== See notes to consolidated unaudited condensed financial statements. NOVELL, INC. CONSOLIDATED UNAUDITED CONDENSED STATEMENTS OF CASH FLOWS Nine Months Ended July 31, July 31, Dollars in thousands 1999 1998 - ------------------------------------------------------------------------------------------------------------------- Cash flows from operating activities Net income $ 116,935 $ 59,957 Adjustments to reconcile net income to net cash provided by operating activities Depreciation and amortization 47,519 59,353 Stock plans' income tax benefits 46,972 3,408 Decrease in receivables 13,275 (711) Decrease in inventories 617 6,382 Decrease (increase) in prepaid expenses 14,960 (10,483) Decrease in deferred and refundable income taxes 20,711 39,522 Decrease in other current assets 1,182 3,848 (Decrease) increase in current liabilities, net (14,161) 33,518 - ------------------------------------------------------------------------------------------------------------------- Net cash provided from operating activities 248,010 194,794 - ------------------------------------------------------------------------------------------------------------------- Cash flows from financing activities Issuance of common stock, net 79,832 26,349 Repurchase of common stock (203,638) (12,427) - ------------------------------------------------------------------------------------------------------------------- Net cash (used) provided from financing activities (123,806) 13,922 - ------------------------------------------------------------------------------------------------------------------- Cash flows from investing activities Expenditures for property, plant and equipment (50,988) (42,617) Purchases of short-term investments (1,567,172) (1,574,104) Maturities of short-term investments 1,190,733 964,366 Sales of short-term investments 537,878 456,464 Expenditures other long-term investments (96,021) (59,387) Other (14,588) 16,773 ---------------------------------------------------------------------------------------------------------------- Net cash used by investing activities (158) (238,505) - ------------------------------------------------------------------------------------------------------------------- Total increase (decrease) in cash and cash equivalents $ 124,046 $ (29,789) Cash and cash equivalents - beginning of period 177,083 208,543 - ------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents - end of period 301,129 178,754 Short-term investments - end of period 691,072 969,171 - ------------------------------------------------------------------------------------------------------------------- Cash and short-term investments - end of period $ 992,201 $ 1,147,925 =================================================================================================================== 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 Cost at Unrealized Unrealized Market Value at (Dollars in thousands) July 31, 1999 Gains Losses July 31, 1999 ------------------------------------------------------------------------------------------------------------------ Cash and cash equivalents Cash $ 224,346 $ - $ - $ 224,346 Taxable money market fund 39,283 - - 39,283 Municipal securities 37,500 - - 37,500 - ------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents $ 301,129 $ - $ - $ 301,129 - --------------------------------------------------------------------------------------------------------------------- Short-term investments Municipal securities $ 417,668 $ 1,242 $ (196) $ 418,714 Money market preferreds 141,405 - (5) 141,400 Mutual funds 120,612 - (1,828) 118,784 Equity securities 14,510 4,083 (6,419) 12,174 - ------------------------------------------------------------------------------------------------------------------- Short-term investments $ 694,195 $ 5,325 $ (8,448) $ 691,072 - --------------------------------------------------------------------------------------------------------------------- Cash and short-term investments $ 995,324 $ 5,325 $ (8,448) $ 992,201 - ------------------------------------------------------------------------------------------------------------------- Gross Gross Fair Cost at Unrealized Unrealized Market Value at (Dollars in thousands) Oct. 31, 1998 Gains Losses Oct. 31, 1998 - ------------------------------------------------------------------------------------------------------------------- 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 nine months of fiscal 1999 the Company realized gains of $49 million and realized losses of $56 million on the sale of securities compared to realized gains of $11 million and realized losses of $9 million in the first nine months of fiscal 1998. C. Income Taxes The Company's estimated effective tax rate for the first nine months of fiscal 1999 was 28.0%, the same as in the first nine months of fiscal 1998. The Company paid cash amounts for income taxes of $5.5 million and $11 million, in the first nine 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 July 31, 1999 borrowings, letter of credit acceptances or commitments of approximately $1.3 million were outstanding 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 July 31, 1999 standby letters of credit of approximately $400,000 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 July 31, 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 July 31, 1999 was approximately $172 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. All 15 million of the Company's put warrant obligations expired worthless in July 1999. 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. During the first nine months of 1999, the Company exercised all of its call options to purchase 10 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 nine months of fiscal 1999 and fiscal 1998, sales to international customers were approximately $421 million and $333 million, respectively. In the first nine months of fiscal 1999 and fiscal 1998, 71% and 66%, 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 11% of total revenue in the first nine months of 1999 and 13% of total revenue in the first nine 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 Nine Months Ended July 31, July 31, July 31, July 31, Amounts in thousands, except per share data 1999 1998 1999 1998 - ------------------------------------------------------------------------------------------------------------------- Basic net income per share computation Net income $ 49,311 $ 26,556 $ 116,935 $ 59,957 - ------------------------------------------------------------------------------------------------------------------- Weighted average shares outstanding 334,488 353,436 335,735 352,076 - ------------------------------------------------------------------------------------------------------------------- Basic net income per share $ 0.15 $ 0.08 $ 0.35 $ 0.17 =================================================================================================================== Diluted net income per share computation Net income $ 49,311 $ 26,556 $ 116,935 $ 59,957 - ------------------------------------------------------------------------------------------------------------------- Weighted average shares outstanding 334,488 353,436 335,735 352,076 Incremental shares attributable to exercise of outstanding options (treasury stock method) 16,463 8,647 15,461 5,137 - ------------------------------------------------------------------------------------------------------------------- Total 350,951 362,083 351,196 357,213 - ------------------------------------------------------------------------------------------------------------------- Diluted net income per share $ 0.14 $ 0.07 $ 0.33 $ 0.17 =================================================================================================================== 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 nine months ended July 31, 1999 and July 31, 1998 were as follows: Fiscal Quarter Ended Nine Months Ended July 31, July 31, July 31, July 31, Dollars in thousands 1999 1998 1999 1998 - ------------------------------------------------------------------------------------------------------------------ Net income $ 49,311 $ 26,556 $ 116,935 $ 59,957 Unrealized gain/(loss) on investments 1,554 (5,436) 22,427 (9,033) Unearned stock compensation (1,241) 131 (2,268) 1,163 Cumulative translation adjustment (732) (843) (821) (675) - ------------------------------------------------------------------------------------------------------------------- Comprehensive income $ 48,892 $ 20,408 $ 136,273 $ 51,412 ================================================================================================================== 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, consulting, developer, education, and technical support programs are the most extensive in the network computing industry. Results of Operations Net Sales Q3 Q3 YTD YTD 1999 Change 1998 1999 Change 1998 - ------------------------------------------------------------------------------------------------------------------- Net sales (millions) $327 20% $272 $928 18% $786 =================================================================================================================== Novell's products can be categorized into four areas, all within the software industry. They are directory-enabled server platforms; network infrastructure and management applications; service, education and consulting; and pre-directory products. The increase in revenue in the third quarter of 1999 and for the first nine months of fiscal 1999 compared to same periods of 1998, is a result of growth in directory-enabled server platforms; network infrastructure and management applications; and service, education and consulting, slightly offset by decreases in pre-directory products. Revenue from the directory-enabled server platforms category, which includes NetWare 4 and NetWare 5, increased $37 million or 27% in the third quarter of 1999 compared to the third quarter of 1998, and $106 million or 28% in the first nine months of fiscal 1999 compared to the first nine months of 1998. The third quarter and year-to-date increase in revenue is due to strong customer acceptance of NetWare 5, which is Internet Protocol based. The network infrastructure and management applications product category includes NetWare for SAA host connectivity products, BorderManager, NDS integration and high availability service products as well as collaboration and management products including GroupWise, ManageWise, and Z.E.N.works. Revenue from this product category was $75 million in the third quarter of 1999 compared to $56 million in the third quarter of 1998. This 34% increase was driven by an increase in sales of management and collaboration products, including new product revenue from Z.E.N.works, and an increase in network infrastructure products including BorderManager and NDS for NT and Solaris, somewhat offset by a decrease in mobile/remote connectivity products. In the first nine months of fiscal 1999 compared to the first nine months of fiscal 1998, network infrastructure and management applications revenue was up $61 million or 39%. This year-to-date increase was driven by strong sales of each of the management and collaboration products, BorderManager, NetWare SAA and NDS for NT and Solaris. Service, education and consulting, revenue, generated from customer service, educational products and courses, and consulting for network solutions, were $49 million and $34 million in the third quarter of 1999 and 1998, respectively. The increase in the third quarter of 1999 was a result of new directory-related consulting revenue, increased service revenue as a result of increased site licenses, and growth in education. In the first nine months of fiscal 1999 compared to the first nine months of fiscal 1998, service, education, and consulting revenue increased by $38 million or 41% due to the same factors driving the quarter over quarter revenue growth. Pre-directory products revenue consists of NetWare 3, non directory-enabled infrastructure products and UNIX royalties. Revenue in this category decreased to $28 million in the third quarter of 1999 compared to $44 million in the third quarter of 1998. Revenue in for the first nine months of 1999 decreased to $88 million compared to $151 million for the same period of 1998. These decreases were primarily the result of shrinking NetWare 3 and host connectivity revenue and the elimination of Tuxedo revenue, which ended in the fourth quarter of fiscal 1998. Revenue from this category is expected to continue to decline as sales of directory-enabled products continue to increase and newer versions of non-directory products are introduced. International sales represented 45% of total sales in the first nine months of 1999 compared to 42% in the first nine months of 1998. This change is the result of stronger sales growth in the international markets where they saw a 27% increase in revenues compared to a 12% increase in domestic revenues in the first nine months of fiscal 1999 compared to the first nine months of fiscal 1998. Gross Profit Q3 Q3 YTD YTD 1999 Change 1998 1999 Change 1998 - ------------------------------------------------------------------------------------------------------------------- Gross profit (millions) $253 21% $209 $714 18% $607 Percentage of net sales 78% 77% 77% 77% =================================================================================================================== Gross profit as a percentage of sales increased slightly in the third quarter of fiscal 1999 compared to the third quarter of fiscal 1998 due to lower inventory variances and decreased royalties, offset by increased expenses, both as a percentage of net sales and in absolute dollars, associated with the ramping up the Company's consulting business. In the first nine months of fiscal 1999 compared to the first nine months of fiscal 1998, the gross margin percentage remained flat. Improvements in inventory variances and training and education costs were offset by higher service, consulting and royalty costs. Operating Expenses Q3 Q3 YTD YTD 1999 Change 1998 1999 Change 1998 - ------------------------------------------------------------------------------------------------------------------- Sales and marketing (millions) $109 12% $97 $321 6% $303 Percentage of net sales 33% 36% 35% 39% - ------------------------------------------------------------------------------------------------------------------- Product development (millions) $ 57 0% $ 57 $169 -5% $178 Percentage of net sales 18% 21% 18% 23% - ------------------------------------------------------------------------------------------------------------------- General and administrative (millions) $ 25 0% $ 25 $ 76 -1% $ 77 Percentage of net sales 8% 9% 8% 10% - ------------------------------------------------------------------------------------------------------------------- Total operating expenses (millions) $191 7% $179 $566 1% $558 Percentage of net sales 58% 66% 61% 71% =================================================================================================================== Sales and marketing expenses increased by $12 million, in the third quarter of fiscal 1999 compared to the third quarter of fiscal 1998 and by $18 million in the first nine months of fiscal 1999 compared to the first nine months of fiscal 1998. At the same time however, sales and marketing expenses decreased as a percentage of net sales in each period of 1999. 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 remained flat in the third quarter of fiscal 1999 compared to the third quarter of fiscal 1998 and decreased by $9 million, or 5% in the first nine months of fiscal 1999 compared to the first nine months of fiscal 1998. Product development expenses also decreased as a percentage of net sales in both comparative periods due to increased sales levels and a more efficient product development organization focused on delivering new products consistent with the Company's strategy. General and administrative expenses remained flat in the third quarter of fiscal 1999 compared to the third quarter of fiscal 1998 and decreased slightly in the first nine months of fiscal 1999 compared to the same period of fiscal 1998. General and administrative expenses decreased as a percentage of net sales in both comparative periods as well, due to a higher revenue base and an increased focus on controlling costs. YTD YTD 1999 Change 1998 - ------------------------------------------------------------------------------------------------------------------- Employees 5,204 - 4,502 Annualized revenue per employee (000's) $253 7% $226 =================================================================================================================== Other Income, Net Q3 Q3 YTD YTD 1999 Change 1998 1999 Change 1998 - ------------------------------------------------------------------------------------------------------------------- Other income, net (millions) $ 6 -11% $ 7 $ 14 -58% $ 34 Percentage of net sales 2% 3% 2% 4% =================================================================================================================== The primary component of other income, net is investment income, which was $10 million in the third quarter of fiscal 1999 compared to $7 million in the third quarter of fiscal 1998. The increase is the result of higher net realized capital losses on the disposal of certain equity securities in the third quarter of fiscal 1998. In addition to investment income, the Company incurred immaterial losses on foreign currency and wrote off certain long-term investments in the third quarter of 1999. Year-to-date other income, net decreased primarily due to lower investment income and net realized capital losses associated with certain equity securities disposed of in fiscal 1999. Investment income was $31 million compared to $37 million in the first nine months of fiscal 1999 and 1998, respectively, and net realized capital losses were $7 million compared to net realized gains of $2 million in the first nine months of fiscal 1999 and 1998, respectively. Income Taxes Q3 Q3 YTD YTD 1999 Change 1998 1999 Change 1998 - ------------------------------------------------------------------------------------------------------------------- Income taxes (millions) $ 19 86% $ 10 $ 45 96% $ 23 Percentage of net sales 6% 4% 5% 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 Q3 Q3 YTD YTD 1999 Change 1998 1999 Change 1998 - ------------------------------------------------------------------------------------------------------------------- Net income (millions) $ 49 86% $ 27 $117 95% $ 60 Percentage of net sales 15% 10% 13% 8% Net income per share - basic $ .15 $.08 $.35 $.17 Net income per share - diluted $ .14 $.07 $.33 $.17 =================================================================================================================== Liquidity and Capital Resources Q3 Q4 1999 Change 1998 - ------------------------------------------------------------------------------------------------------------------- Cash and short-term investments (millions) $992 -1% $1,007 Percentage of total assets 51% 52% =================================================================================================================== Cash and short-term investments decreased by $15 million at July 31, 1999 from $1 billion at October 31, 1998. During the year, the Company spent $204 million of cash for the repurchase of common stock, $72 million to increase collateral associated with certain long-term investments, $51 million to purchase property, plant and equipment, and $14 million for purchases of other assets in the third quarter of 1999. These cash expenditures were offset by the $248 million provided by operating activities and the $80 million from the issuance of common stock. The Company's investment portfolio includes securities with gross unrealized losses of $3 million as of July 31, 1999. The only remaining security with material unrealized losses is Corel common stock, which was obtained in March 1996 upon the Company's sale of its personal productivity applications product line. It is the Company's intention to continue to dispose of the Corel shares over the coming periods. 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 principal source of liquidity has been from operations. At July 31, 1999, the Company's principal unused sources of liquidity consisted of cash and short-term investments and available borrowing capacity of approximately $14 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 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 $60 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 nine months of 1999, the Company repurchased and retired approximately 13.5 million shares at a cost of approximately $204 million. During fiscal 1998, the Company repurchased and retired approximately 21 million shares at a cost of approximately $245 million. In July 1999, the Board of Directors authorized up to $500 million for the repurchase of additional outstanding shares of the Company's common stock through October 31, 2000. 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 has communicated with its main suppliers of technology products and services regarding the Year 2000 status of such products or services. The Company has identified and tested its main internal systems. Most significant Y2K updates have been installed. In 1999 the Company expects to complete implementation of needed year 2000-related modifications to its information systems. The Company has also assessed its internal non-information technology systems. Most significant Y2K updates have been installed, and the Company expects to complete 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 contingency planning for potential critical 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 None 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 July 31, 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: September 10, 1999 /s/ Dr. Eric Schmidt ----------------------------------- Dr. Eric Schmidt Chairman of the Board and Chief Executive Officer (Principal Executive Officer) Date: September 10, 1999 /s/ Dennis R. Raney ----------------------------------- Dennis R. Raney Chief Financial Officer (Principal Financial Officer) Date: September 10, 1999 /s/ Ron Foster ----------------------------------- Ron Foster Vice President and Corporate Controller (Principal Accounting Officer)