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EX-32.1 - 18 U.S.C. SECTION 1350 CERTIFICATION. - NOVELL INCdex321.htm
EX-32.2 - 18 U.S.C. SECTION 1350 CERTIFICATION. - NOVELL INCdex322.htm
EX-10.8 - LETTER AGREEMENT WITH MR. PLASKETT. - NOVELL INCdex108.htm
EX-31.1 - RULE 13A-14(A) CERTIFICATION. - NOVELL INCdex311.htm
EX-10.7 - NON-EMPLOYEE DIRECTOR REMUNERATION AND EXPENSE REIMBURSEMENT SUMMARY. - NOVELL INCdex107.htm
EX-10.5 - FORM OF 2010 RESTRICTED STOCK UNIT AGREEMENT. - NOVELL INCdex105.htm
EX-10.9 - LETTER AGREEMENT WITH MS. WHITE. - NOVELL INCdex109.htm
EX-10.4 - FORM OF RESTRICTED STOCK UNIT AGREEMENT (FOR DIRECTORS). - NOVELL INCdex104.htm
EX-31.2 - RULE 13A-14(A) CERTIFICATION. - NOVELL INCdex312.htm
EX-10.2 - FORM OF RESTRICTED STOCK AGREEMENT. - NOVELL INCdex102.htm
EX-10.1 - FORM OF RESTRICTED STOCK UNIT AGREEMENT. - NOVELL INCdex101.htm
EX-10.6 - ONE-TIME INCREMENTAL RETAINER TO CHAIRMAN. - NOVELL INCdex106.htm
EX-10.3 - FORM OF NONQUALIFIED STOCK OPTION GRANT AGREEMENT (FOR DIRECTORS). - NOVELL INCdex103.htm
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

 

(Mark One)

 

þ

Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

    

For the Quarterly Period Ended April 30, 2010

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 incorporation or organization)   (I.R.S. Employer Identification No.)

404 Wyman Street, Waltham, MA 02451

(Address of principal executive offices and zip code)

(781) 464-8000

(Registrant’s telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

 

 

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 þ No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  þ

  

Accelerated file

 

¨

Non-accelerated filer    ¨ (Do not check if smaller reporting company)

  

Smaller reporting company

 

¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No þ

As of May 28, 2010, there were 349,868,167 shares of the registrant’s common stock outstanding.

 

 

 


Table of Contents

NOVELL, INC.

TABLE OF CONTENTS

 

Part I — Financial Information:

   3

Item 1: Financial Statements

   3

Consolidated Balance Sheets at April 30, 2010 (unaudited) and October 31, 2009

   3

Consolidated Statements of Operations for the three and six months ended April  30, 2010 and 2009 (unaudited)

   4

Consolidated Statements of Cash Flows for the six months ended April  30, 2010 and 2009 (unaudited)

   6

Notes to Unaudited Consolidated Financial Statements

   7

Item  2: Management’s Discussion and Analysis of Financial Condition and Results of Operations

   23

Item 3: Quantitative and Qualitative Disclosures about Market Risk

   33

Item 4: Controls and Procedures

   33

Part II — Other Information:

   34

Item 1: Legal Proceedings

   34

Item 1A: Risk Factors

   34

Item 2: Unregistered Sales of Equity Securities and Use of Proceeds

   44

Item 6: Exhibits

   44

 

2


Table of Contents

Part I. – Financial Information

Item 1. Financial Statements

NOVELL, INC.

FINANCIAL STATEMENTS

CONSOLIDATED BALANCE SHEETS

(Amounts in thousands, except share and per share data)

 

     April 30,
2010
    October 31,
2009
 
     (unaudited)        
ASSETS   

Current assets:

    

Cash and cash equivalents

   $ 581,425      $ 591,656   

Short-term investments

     398,161        391,809   

Restricted cash

     53,052        53,033   

Receivables (net of allowances of $3,524 and $4,085 at April 30, 2010 and October 31, 2009, respectively)

     131,864        177,898   

Prepaid expenses

     20,300        17,708   

Current deferred tax assets

     4,624        5,521   

Other current assets

     22,648        26,747   
                

Total current assets

         1,212,074            1,264,372   

Property, plant and equipment, net

     163,420        170,459   

Long-term investments

            10,303   

Goodwill

     353,734        356,033   

Intangible assets, net

     32,488        36,621   

Deferred income taxes

     19,009        26,717   

Other assets

     34,033        38,403   
                

Total assets

   $ 1,814,758      $ 1,902,908   
                
LIABILITIES AND STOCKHOLDERS’ EQUITY   

Current liabilities:

    

Accounts payable

   $ 31,682      $ 37,628   

Accrued compensation

     58,628        87,928   

Other accrued liabilities

     79,308        97,154   

Income taxes payable

     1,059          

Deferred revenue

     441,866        495,245   
                

Total current liabilities

     612,543        717,955   

Deferred income taxes

     8,314        8,403   

Long-term deferred revenue

     173,170        193,526   

Other long-term liabilities

     46,943        48,502   
                

Total liabilities

     840,970        968,386   
                

Stockholders’ equity:

    

Common stock, par value $0.10 per share, Authorized — 600,000,000 shares;

    

Issued — 364,950,122 and 362,175,921 shares at April 30, 2010 and October 31, 2009, respectively;

    

Outstanding — 349,846,963 and 347,072,762 shares at April 30, 2010 and October 31, 2009, respectively

     36,495        36,218   

Additional paid-in capital

     459,072        441,798   

Treasury stock, at cost — 15,103,159 shares at April 30, 2010 and October 31, 2009

     (124,299     (124,299

Retained earnings

     599,924        559,823   

Accumulated other comprehensive income

     2,596        20,982   
                

Total stockholders’ equity

     973,788        934,522   
                

Total liabilities and stockholders’ equity

   $ 1,814,758      $ 1,902,908   
                

See notes to consolidated financial statements.

 

3


Table of Contents

NOVELL, INC.

FINANCIAL STATEMENTS

CONSOLIDATED STATEMENTS OF OPERATIONS

(Amounts in thousands, except per share data)

 

     Three months ended  
     April 30,
2010
    April 30,
2009
 
     (unaudited)  

Net revenue:

    

Software licenses

   $ 27,691      $ 30,250   

Maintenance and subscriptions

     153,855        158,329   

Services

     22,468        27,016   
                

Total net revenue

         204,014            215,595   
                

Cost of revenue:

    

Software licenses

     1,925        1,856   

Maintenance and subscriptions

     20,825        21,958   

Services

     18,562        21,468   
                

Total cost of revenue

     41,312        45,282   
                

Gross profit

     162,702        170,313   
                

Operating expenses:

    

Sales and marketing

     74,853        75,697   

Product development

     39,368        44,552   

General and administrative

     28,578        25,032   

Restructuring expenses

            7,224   

Loss on sale of subsidiaries

            184   
                

Total operating expenses

     142,799        152,689   
                

Income from operations

     19,903        17,624   
                

Other income (expense):

    

Investment income

     3,262        5,390   

Gain on sale of previously impaired investments, net

     1,967          

Impairment of long-term investments

            (1,419

Interest expense and other, net

     (43     (3,767
                

Total other income, net

     5,186        204   
                

Income from continuing operations before taxes

     25,089        17,828   

Income tax expense

     5,177        2,777   
                

Income from continuing operations

     19,912        15,051   

Income from discontinued operations

            566   
                

Net income

   $ 19,912      $ 15,617   
                

Basic earnings per share:

    

Income from continuing operations

   $ 0.06      $ 0.04   
                

Net income per share

   $ 0.06      $ 0.05   
                

Diluted earnings per share:

    

Income from continuing operations

   $ 0.06      $ 0.04   
                

Net income per share

   $ 0.06      $ 0.05   
                

Weighted-average shares outstanding — basic

     349,204        344,881   

Weighted-average shares outstanding — diluted

     352,008        345,839   

See notes to consolidated financial statements.

 

4


Table of Contents

NOVELL, INC.

FINANCIAL STATEMENTS

CONSOLIDATED STATEMENTS OF OPERATIONS

(Amounts in thousands, except per share data)

 

     Six months ended  
     April 30,
2010
    April 30,
2009
 
     (unaudited)  

Net revenue:

    

Software licenses

   $ 48,884      $ 58,517   

Maintenance and subscriptions

     312,806        317,144   

Services

     44,690        54,805   
                

Total net revenue

     406,380        430,466   
                

Cost of revenue:

    

Software licenses

     3,613        3,892   

Maintenance and subscriptions

     43,397        44,660   

Services

     38,020        43,627   
                

Total cost of revenue

     85,030        92,179   
                

Gross profit

     321,350        338,287   
                

Operating expenses:

    

Sales and marketing

     143,769        152,591   

Product development

     79,070        89,944   

General and administrative

     54,405        49,227   

Restructuring expenses

     2,774        15,273   

Gain on sale of subsidiaries

            (16
                

Total operating expenses

         280,018            307,019   
                

Income from operations

     41,332        31,268   
                

Other income (expense):

    

Investment income

     6,530        12,566   

Gain on sale of previously impaired investments, net

     7,195          

Impairment of long-term investments

            (3,096

Interest expense and other, net

     (1,873     (6,902
                

Total other income, net

     11,852        2,568   
                

Income from continuing operations before taxes

     53,184        33,836   

Income tax expense

     13,083        9,144   
                

Income from continuing operations

     40,101        24,692   

Income from discontinued operations

            1,602   
                

Net income

   $ 40,101      $ 26,294   
                

Basic earnings per share:

    

Income from continuing operations

   $ 0.12      $ 0.07   
                

Net income per share

   $ 0.12      $ 0.08   
                

Diluted earnings per share:

    

Income from continuing operations

   $ 0.11      $ 0.07   
                

Net income per share

   $ 0.11      $ 0.08   
                

Weighted-average shares outstanding — basic

     348,447        344,429   

Weighted-average shares outstanding — diluted

     350,136        345,543   

See notes to consolidated financial statements.

 

5


Table of Contents

NOVELL, INC.

FINANCIAL STATEMENTS

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts in thousands)

 

     Six months ended  
     April 30,
2010
    April 30,
2009
 
     (unaudited)  

Cash flows from operating activities

    

Net income

   $ 40,101      $ 26,294   

Adjustments to reconcile net income to net cash used in operating activities:

    

Stock-based compensation expense

     14,742        13,722   

Depreciation and amortization

     14,655        21,473   

Change in accounts receivable allowances

     (571     336   

Income from discontinued operations

            (1,602

Gain on sale of subsidiaries

            (16

Impairment of long-term investments

            3,096   

Gain on sale of previously impaired investments

     (8,009       

Loss on sale of previously impaired investments

     814          

Gain on debenture repurchases

            (68

Changes in assets and liabilities, excluding acquisitions and dispositions:

    

Receivables

     46,872        63,214   

Prepaid expenses

     (3,451     2,575   

Other current assets

     3,413        7,377   

Deferred income taxes

     7,406        9,303   

Accounts payable

     71        (11,552

Accrued liabilities

     (43,260     (73,501

Deferred revenue

     (74,981     (73,748
                

Net cash used in operating activities

     (2,198     (13,097
                

Cash flows from investing activities

    

Purchases of property, plant and equipment

     (13,432     (6,582

Purchases of short-term investments

     (131,552     (147,849

Maturities of short-term investments

     27,981        25,507   

Sales of short-term investments

     100,688        132,762   

Proceeds from sales of and distributions from long-term investments

     8,629        1,736   

Net cash paid for acquisitions

            (48,472

Cash proceeds from sale of discontinued operations

     471        1,036   

Change in restricted cash

     (19     (260

Other

     527        1,473   
                

Net cash used in investing activities

     (6,707     (40,649
                

Cash flows from financing activities

    

Issuances of common stock

     5,536        1,152   

Debenture repurchases

            (3,869

Debt repayment

            (378

Excess tax benefits from stock-based compensation

     1        (2,788
                

Net cash provided by (used in) financing activities

     5,537        (5,883
                

Effect of exchange rate changes on cash

     (6,863     (457
                

Decrease in cash and cash equivalents

     (10,231     (60,086

Cash and cash equivalents — beginning of period

          591,656             680,034   
                

Cash and cash equivalents — end of period

   $ 581,425      $ 619,948   
                

See notes to consolidated financial statements.

 

6


Table of Contents

NOVELL, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

A. Quarterly Financial Statements

The interim consolidated financial statements as of April 30, 2010 and for the three and six months ended April 30, 2010 and 2009 were prepared by us pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) for interim financial reporting. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ materially from those estimates. The accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q but do not include all of the information and notes required by accounting principles generally accepted in the United States and should, therefore, be read in conjunction with our Annual Report on Form 10-K for the fiscal year ended October 31, 2009. The accompanying financial statements are unaudited and include all normal recurring adjustments that we believe are necessary for a fair statement of our financial condition and results of operations as of and for the interim periods presented. The interim operating results are not necessarily indicative of the results for a full year.

Reclassifications

As more fully described in Note M, “Segment Information,” during the first quarter of fiscal 2010, we reorganized our business unit segment structure and management resulting in a change to our reportable business unit segments. In connection with this reorganization, we evaluated our internal cost structure to ensure the resulting business unit segment gross profit and operating income were reflective of our business unit segment management structure. As a result of this evaluation, we determined the allocation and assignment of costs between maintenance and subscriptions and services within cost of revenue should be adjusted to be reflective of the new business unit segment management structure for the second quarter and first six months of fiscal 2010 and 2009. For the second quarter and first six months of fiscal 2009, in our consolidated statements of operations, $9.1 million and $18.4 million of costs, respectively, were moved from the services cost of revenue line item to the maintenance and subscriptions cost of revenue line item. This change impacted only the components of cost of revenue and had no impact on revenue, total cost of revenue or total gross profit.

Certain other amounts reported in prior periods have been reclassified from what was previously reported to conform to the current year’s presentation. These reclassifications did not have any impact on the statements of operations.

B. Cash, Cash Equivalents, and Short-Term Investments

The following is a summary of our short-term available-for-sale investments at April 30, 2010 and October 31, 2009:

 

(In thousands)

   Cost at
April 30,
2010
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
    Fair Market
Value at
April 30,
2010

Short-term investments:

          

U.S. government and agency securities

   $ 180,963    $ 2,211    $ (32   $ 183,142

Corporate notes and bonds

     181,676      3,485      (20     185,141

Asset-backed securities

     21,573      240      (27     21,786

Equity securities

     8,331                       (239     8,092
                            

Total short-term investments

   $         392,543    $         5,936    $ (318   $         398,161
                            

(In thousands)

   Cost at
October 31,
2009
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
    Fair Market
Value at
October 31,
2009

Short-term investments:

          

U.S. government and agency securities

   $ 183,062    $ 2,633    $      $ 185,695

Corporate notes and bonds

     169,685      4,269      (12     173,942

Asset-backed securities

     24,828      439             25,267

Equity securities

     7,923           (1,018     6,905
                            

Total short-term investments

   $ 385,498    $ 7,341    $ (1,030   $ 391,809
                            

 

7


Table of Contents

NOVELL, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

B. Cash, Cash Equivalents, and Short-Term Investments (Continued)

 

As of April 30, 2010, $8.1 million market value of our equity securities are designated for deferred compensation payments, which are paid out as requested by participants of the plan upon termination.

As of April 30, 2010, contractual maturities of our short-term investments were:

 

(In thousands)

   Cost    Fair
Value

Less than one year

   $ 69,522    $ 70,312

Due in one to two years

     144,061      146,505

Due in two to three years

     121,385      122,927

Due in more than three years

     49,244      50,325

No contractual maturity

     8,331      8,092
             

Total short-term investments

   $             392,543    $             398,161
             

We had net unrealized gains related to short-term investments of $5.6 million and $6.3 million at April 30, 2010 and October 31, 2009, respectively.

Realized gains and losses related to our short-term investments were as follows:

 

     Three months ended    Six months ended

(In thousands)

   April 30,
2010
   April 30,
2009
   April 30,
2010
   April 30,
2009

Realized gains

   $             3,228    $             1,039    $             3,609    $             2,081

Realized losses

   $ 47    $ 264    $ 108    $ 1,277

With the exception of our short-term auction-rate securities (“ARSs”), the realized gains and losses on our short-term investments are included in the “Investment income” line item in the consolidated statements of operations.

During the second quarter of fiscal 2010, ARSs classified as short-term investments, with a book value of $1.8 million, were sold for $4.2 million, resulting in a gain of $2.4 million. This gain is a component of the line item “Gain on sale of previously impaired investments, net” in our consolidated statements of operations. We reversed $2.4 million in unrealized gains associated with these securities that were recorded in the “Accumulated other comprehensive income” line item in our consolidated balance sheets in prior periods.

We did not record any impairment losses on short-term investments during the second quarters or first six months of fiscal 2010 and 2009, as we considered the unrealized losses to be temporary. With respect to our debt securities that are in an unrealized loss position, we expect to recover the entire cost basis of these securities before we sell them, therefore they are not considered to be other-than-temporarily impaired. We do not consider our equity securities that are in an unrealized loss position to be impaired as we have the ability and intent to hold these investments until a recovery of fair value.

During the first six months of fiscal 2010 and 2009, the U.S. dollar value of our foreign-denominated cash and cash equivalent holdings decreased by a net $6.9 million and $0.5 million, respectively. The decrease in fiscal 2010 resulted from the strengthening of the U.S. dollar against certain foreign currencies, primarily the Euro. As foreign currency exchange rates continue to fluctuate, especially the Euro, we may see further changes in the U.S. dollar value of our foreign-denominated cash and cash equivalent holdings.

C. Long-Term Investments

As of April 30, 2010, we do not have any investments classified as long-term. At October 31, 2009, $10.3 million of our ARSs were classified as long-term investments in our consolidated balance sheets, and were our only long-term investments. At April 30, 2010, we no longer hold any ARSs.

 

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NOVELL, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

C. Long-Term Investments (Continued)

 

During the first quarter of fiscal 2010, ARSs with an estimated fair value of $4.2 million were reclassified from long-term investments to short-term investments in our consolidated balance sheet. These securities were sold during the second quarter of fiscal 2010 (See Note B “Cash, Cash Equivalents, and Short-Term Investments”).

During the second quarter of fiscal 2010, ARSs classified as long-term investments, with a book value of $1.7 million, were sold for $0.9 million, resulting in a loss on sale of $0.8 million. This loss is a component of the line item “Gain on sale of previously impaired investments, net” in our consolidated statements of operations. We reversed $0.3 million in unrealized gains associated with these securities that were recorded in the “Accumulated other comprehensive income” line item in our consolidated balance sheets in prior periods.

During the first six months of fiscal 2010, ARSs classified as long-term investments, with a book value of $3.8 million, were sold for $8.0 million, resulting in a net gain on sale of $4.2 million. This net gain is a component of the line item “Gain on sale of previously impaired investments, net” in our consolidated statements of operations. We reversed $3.0 million in unrealized gains associated with these securities that were recorded in the “Accumulated other comprehensive income” line item in our consolidated balance sheets in prior periods.

During the second quarter and first six months of fiscal 2010, we also recognized a gain of $0.4 million and $0.6 million, respectively, related to the sales of direct investments that we had previously fully impaired. These gains are shown as a component of the line item “Gain on sale of previously impaired investments, net” in our consolidated statements of operations.

D. Fair Value Measurements

The following table summarizes the composition and fair value hierarchy of our financial assets as of April 30, 2010. Our level 1 financial instruments are valued using quoted prices in active markets for identical instruments. We did not have any level 2 or level 3 financial instruments at April 30, 2010.

 

(In thousands)

   Fair Value of
Level 1 Financial
Instruments as of
April 30, 2010

Short-term investments:

  

U.S. government and agency securities

   $ 183,142

Corporate notes and bonds

     185,141

Asset-backed securities

     21,786

Equity securities

     8,092
      

Total

   $             398,161
      

 

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Table of Contents

NOVELL, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

D. Fair Value Measurements (Continued)

 

The following table summarizes the composition and fair value hierarchy of our financial assets as of October 31, 2009. We did not have any level 2 financial instruments at October 31, 2009. Our ARSs were our only level 3 financial assets at October 31, 2009 and were valued using unobservable inputs that were supported by little or no market activity and that were significant to the fair value of the investments.

 

          Fair Value Measurements Using

(In thousands)

   Total as of
October 31, 2009
   Quoted Prices in
Active Markets

for Identical
Assets
(Level 1)
   Significant
Unobservable
Inputs

(Level 3)

Short-term investments:

        

U.S. government and agency securities

   $ 185,695    $ 185,695    $

Corporate notes and bonds

     173,942      173,942     

Asset-backed securities

     25,267      25,267     

Equity securities

     6,905      6,905     
                    

Total short-term investments

     391,809      391,809     

Long-term investments

     10,303           10,303
                    

Total

   $             402,112    $             391,809    $             10,303
                    

The following table summarizes the change in composition and fair value hierarchy of our level 3 financial assets, which were comprised entirely of our ARSs, for the second quarters of fiscal 2010 and 2009:

 

     Fair Value Measurements Using  Significant
Unobservable Inputs (Level 3)
for the three months ended
 

(In thousands)

   April 30, 2010     April 30, 2009  

Beginning balance

   $                   6,232      $                   9,617   

Total gains or (losses):

    

Impairment included in earnings

            (1,419

Book value of assets sold

     (3,521       

Removed from accumulated other comprehensive income

     (2,711     (231
                

Ending balance

   $      $ 7,967   
                

The following table summarizes the change in composition and fair value hierarchy of our level 3 financial assets, which were comprised entirely of our ARSs, for the first six months of fiscal 2010 and 2009:

 

     Fair Value Measurements Using Significant
Unobservable Inputs (Level 3)
for the six months ended
 

(In thousands)

   April 30, 2010     April 30, 2009  

Beginning balance

   $                 10,303      $                 11,063   

Total gains or (losses):

    

Impairment included in earnings

            (3,096

Book value of assets sold

     (5,597       

Removed from accumulated other comprehensive income

     (4,706       
                

Ending balance

   $      $ 7,967   
                

See Note B, “Cash, Cash Equivalents, and Short-Term Investments” for more information on the sale of the $1.8 million book value of ARSs classified as short-term investments that occurred in the second quarter of fiscal 2010. See Note C, “Long-Term Investments” for more information on the sales of the $1.7 million and $3.8 million book value of ARSs classified as long-term investments that occurred during the second quarter and first six months of fiscal 2010, respectively.

 

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NOVELL, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

E. Derivative Instruments and Hedging Activities

The net notional amount of foreign currency exchange contracts hedging foreign currency transactions was $11.3 million and $27.0 million at April 30, 2010 and October 31, 2009, respectively. The fair value of these contracts was immaterial at both April 30, 2010 and October 31, 2009.

During the second quarters of fiscal 2010 and 2009, we recognized gains of $0.8 million and $2.4 million, respectively, on our foreign currency exchange contracts. During the first six months of fiscal 2010 and fiscal 2009, we recognized a gain of $0.6 million and a loss of $1.9 million, respectively, on our foreign currency exchange contracts. These gains and losses are shown as a component of the line item “Interest expense and other, net” in our consolidated statements of operations.

F. Goodwill and Intangible Assets

Goodwill

During the first quarter of fiscal 2010, our former Open Platform Solutions, Identity and Security Management and Systems and Resource Management business unit segments were consolidated to form the new Security, Management and Operating Platforms business unit segment (“SMOP”) (See Note M, “Segment Information,” for more information on our business unit segment structural and management reorganization). The three components of SMOP will continue to be considered reporting units for goodwill impairment testing purposes. As there were no changes to the reporting units, no interim goodwill impairment tests were required. Our former Workgroup business unit segment was renamed Collaboration Solutions (“CS”).

Goodwill allocated to our business unit segments as of April 30, 2010 is as follows:

 

(In thousands)

   SMOP     CS     Total  

Balance as of October 31, 2009:

      

Goodwill

   $ 477,048      $ 149,029      $ 626,077   

Accumulated impairment

     (270,044            (270,044
                        

Net goodwill

     207,004        149,029        356,033   

Activity during the six months ended April 30, 2010:

      

Release of merger liability

     (1,782     (1,413     (3,195

Impact of foreign currency exchange translation

     896               896   

Balance as of April 30, 2010:

      

Goodwill

     476,162        147,616        623,778   

Accumulated impairment

     (270,044            (270,044
                        

Net goodwill

   $     206,118      $     147,616      $     353,734   
                        

During the second quarter of fiscal 2010, we assigned to a subtenant a facility lease related to our April 2005 acquisition of Tally Systems Corp. At the time of the acquisition, this lease had a nine-year term and therefore a merger liability was established as part of the acquisition purchase price allocation. Because the cost of exiting this lease was less than the estimated merger liability, we released this excess, reducing the cost of the acquired company. This adjustment to the purchase price resulted in a $3.2 million reduction to total goodwill, comprised of goodwill reductions in our SMOP and CS business unit segments of $1.8 million and $1.4 million, respectively.

Also, a $0.9 million increase in goodwill during the first six months of fiscal 2010 was due to the impact of foreign currency exchange translation related to the portion of our goodwill that is denominated in Canadian dollars.

 

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NOVELL, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

F. Goodwill and Intangible Assets (Continued)

 

Intangible Assets

The following is a summary of intangible assets:

 

     April 30, 2010    October 31, 2009     

(In thousands)

   Gross
Amount
   Accumulated
Amortization
    Net Book
Value
   Gross
Amount
   Accumulated
Amortization
    Net Book
Value
   Asset
Lives

Developed technology

   $ 30,765    $ (25,319   $ 5,446    $ 30,765    $ (22,546   $ 8,219   

3 or 4 years

Trademarks/trade names

     25,511      (1,015     24,496      25,511      (865     24,646   

3 years or
Indefinite

Customer relationships

     15,701          (13,155     2,546      15,701      (11,945     3,756   

3 years

                                              

Total intangible assets

   $     71,977    $ (39,489   $     32,488    $     71,977    $     (35,356   $     36,621   
                                              

Amortization of intangible assets for the second quarters of fiscal 2010 and 2009 was $2.0 million and $4.3 million, respectively. Amortization of intangible assets for the first six months of fiscal 2010 and 2009 was $4.1 million and $8.6 million, respectively. Amortization of existing intangibles is estimated to be approximately $3.8 million for the remainder of fiscal 2010, $4.0 million in fiscal 2011, and $0.5 million in fiscal 2012, with nothing thereafter.

We evaluate the recoverability of goodwill and indefinite-lived intangible assets annually as of August 1. In addition, we evaluate the recoverability of our goodwill and all our intangible assets if events or changes in circumstances warrant, such as a material adverse change in the business.

G. Income Taxes

We are subject to income taxes in numerous jurisdictions and the use of estimates is required in determining our provision for income taxes. For the second quarter and first six months of fiscal 2010, we provided $5.2 million and $13.1 million for income tax expense, respectively. Income tax expense was recorded based on the estimated annual effective tax rate for the year applied to “ordinary” income (pre-tax income excluding unusual or infrequently occurring discrete items).

Income Tax Expense

The effective tax rate for the second quarter of fiscal 2010 was 21%, compared to an effective tax rate of 16% for the prior year period primarily due to a benefit from discrete tax items in the prior year period and a shift in jurisdictional earnings. The effective tax rate for the first six months of fiscal 2010 was 25%, compared to an effective tax rate of 27% for the prior year period primarily due to a shift in jurisdictional earnings.

The effective tax rates for the second quarter and first six months of fiscal 2010 differ from the federal statutory rate of 35% primarily due to the effects of stock-based compensation, differences between the book and tax treatment of certain income items on which a valuation allowance has been recorded, and the jurisdictional mix of earnings.

Valuation Allowance

We continue to believe, based on all available evidence, that it is more likely than not that most of our net deferred tax assets will not be realized. As a result, we have provided a valuation allowance on our U.S. and selected international net deferred tax assets. In reaching this determination, we evaluated our three-year cumulative results, pre-tax losses in recent quarters, as well as the impacts that economic conditions may have on our future results. As deferred tax assets or liabilities increase or decrease in the future, or if a portion or all of the valuation allowance is no longer deemed to be necessary, the adjustments to the valuation allowance will increase or decrease future income tax provisions or additional paid-in capital. It is reasonably possible that we could reduce a significant portion of our valuation allowance in the near-term. The amount of this potential reduction is not reasonably determinable at this time.

 

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NOVELL, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

G. Income Taxes (Continued)

 

Income Tax Reserves

As of April 30, 2010, we had unrecognized tax benefits totaling $36.2 million, excluding interest, of which $25.0 million would favorably impact the effective tax rate if recognized. As of October 31, 2009, we had unrecognized tax benefits totaling $37.3 million, excluding interest. The $1.1 million decrease in unrecognized tax benefits relates primarily to benefits recognized as a result of the lapse of statutes of limitations.

During the second quarter of fiscal 2010, we accrued $0.3 million in interest related to unrecognized tax benefits. During the first six months of fiscal 2010, we accrued $0.5 million in interest related to unrecognized tax benefits. We had $9.8 million and $9.3 million accrued for the payment of interest related to unrecognized tax benefits as of April 30, 2010 and October 31, 2009, respectively.

As of April 30, 2010, we have recorded a $34.8 million liability for unrecognized tax benefits and related interest in the line item “Other long-term liabilities” in our consolidated balance sheet.

As of April 30, 2010, we believe it is reasonably possible that $23.5 million of unrecognized tax benefits and accrued interest will decrease within the next 12 months as the result of statutes of limitations expiring in various jurisdictions. We believe that this favorable decrease in unrecognized tax benefits may significantly impact the effective tax rate.

We conduct business globally. As a result, we file income tax returns and are subject to examination by taxing authorities in various jurisdictions throughout the world. In the U.S. we are currently in appeals with the Internal Revenue Service regarding two issues related to its examination of tax years 2005 and 2006. We do not anticipate that the settlement of the two outstanding issues will have a material impact on our financial position or results of operations. In addition, we are at various stages in examinations in some state and foreign jurisdictions. With few exceptions, we are no longer subject to U.S. federal, state and local income tax examinations for years prior to fiscal 2002 or non-U.S. income tax examinations for years prior to fiscal 2005.

H. Restructuring and Merger Liabilities

Restructuring Liabilities

During the first quarter of fiscal 2010, we recorded net restructuring expenses of $2.8 million. This was comprised of $2.9 million primarily for termination benefits for five employees as part of our business unit segment structural and management reorganization, partially offset by $0.1 million in reductions to accruals for changes in estimates related to prior period restructuring activities. During the second quarter of fiscal 2010, there were no restructuring expenses.

 

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NOVELL, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

H. Restructuring and Merger Liabilities (Continued)

 

Our restructuring activities in prior periods are disclosed in detail in our Annual Report on Form 10-K for fiscal 2009. The following table summarizes the restructuring reserve balance as of April 30, 2010 and activity during the first six months of fiscal 2010:

 

     Restructuring Action Taken In:  

(In thousands)

   Fiscal 2010     Fiscal 2009     Fiscal 2008     Prior to
Fiscal 2008
    Total  

Balance as of October 31, 2009:

          

Workforce reductions

   $      $ 6,606      $ 622      $      $ 7,228   

Excess facilities, property and equipment

            3,450        835        1,330        5,615   
                                        

Total restructuring reserve balance

            10,056        1,457                1,330                12,843   
                                        

Original charge/adjustments:

          

Workforce reductions

     2,876        (84     104               2,896   

Excess facilities, property and equipment

            (163     63        (22     (122
                                        

Total original charge/adjustments

     2,876        (247     167        (22     2,774   
                                        

Payments:

          

Workforce reductions

     (428     (6,097     (173            (6,698

Excess facilities, property and equipment

            (927     (358     (638     (1,923
                                        

Total payments

     (428     (7,024     (531     (638     (8,621
                                        

Balance as of April 30, 2010:

          

Workforce reductions

     2,448        425        553               3,426   

Excess facilities, property and equipment

                    2,360        540        670        3,570   
                                        

Total restructuring reserve balance

   $         2,448      $ 2,785      $         1,093      $ 670      $ 6,996   
                                        

The net adjustments decreasing the restructuring reserves during the first six months of fiscal 2010 by $0.1 million resulted from changes in prior fiscal year estimates for various severance-related benefits and facility reserves. These adjustments are reflected in the table above for the respective fiscal year.

As of April 30, 2010, the remaining unpaid restructuring balances include accrued liabilities related to severance and other benefits, the majority of which we expect to be paid by February 2011, and lease costs for redundant facilities, which we expect to be paid over the respective remaining contract terms, the longest of which extends to 2018. These liabilities are partially reduced by sublease income for several of the redundant facilities.

Merger Liabilities

The following table summarizes the merger liabilities balance as of April 30, 2010, and activity associated with our acquisitions, including transaction costs, during the first six months of fiscal 2010:

 

(In thousands)

   Balance at
October 31, 2009
   Payments/
Adjustments
    Balance at
April 30, 2010

Facilities related

   $ 9,971    $ (4,008   $ 5,963

Other

     127      (127    
                     

Total merger liabilities

   $             10,098    $             (4,135   $             5,963
                     

During the second quarter of fiscal 2010, we assigned a facility lease to a subtenant, and as a result released $3.2 million of merger liabilities (See Note F, “Goodwill and Intangible Assets”).

As of April 30, 2010, the remaining unpaid merger liabilities balance relates to lease costs for redundant facilities, which we expect to be paid over the respective remaining contract terms, the longest of which extends to 2025.

 

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NOVELL, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

I. Legal Proceedings

SilverStream, which we acquired in July 2002, and several of its former officers and directors, as well as the underwriters who handled SilverStream’s two public offerings, were named as defendants in several class action complaints that were filed on behalf of certain former stockholders of SilverStream who purchased shares of SilverStream common stock between August 16, 1999 and December 6, 2000. These complaints are closely related to several hundred other complaints that the same plaintiffs have brought against other issuers and underwriters. These complaints all allege violations of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended. In particular, they allege, among other things, that there was undisclosed compensation received by the underwriters of the public offerings of all of the issuers, including SilverStream. A Consolidated Amended Complaint with respect to all of these complaints was filed in the U.S. District Court, Southern District of New York, on April 19, 2002. While we believe that SilverStream and its former officers and directors have meritorious defenses to the claims, various parties participated in settlement discussions and reached a proposed settlement agreement. After notice to the plaintiff class, the settlement agreement received final approval from the Court on September 10, 2009. Certain parties have filed Notices of Appeal from the Court’s decision. We believe it is probable that any settlement payment will be covered by our insurance carrier. Thus, we do not believe that resolution of this litigation will have a material adverse effect on our financial position, results of operations or cash flows.

On July 12, 2002, Amer Jneid and other related plaintiffs filed a complaint in the Superior Court of California, Orange County, alleging claims for breach of contract, fraud in the inducement, misrepresentation, infliction of emotional distress, rescission, slander and other claims against us in connection with our purchase of so-called “DeFrame” technology from the plaintiffs and two affiliated corporations (TriPole Corporation and Novetrix), and employment agreements that we entered into with the plaintiffs in connection with the purchase. The complaint sought unspecified damages, including punitive damages. The dispute (resulting in these claims) arises out of the plaintiffs’ assertion that we failed to properly account for license distributions which the plaintiffs claim would have entitled them to certain bonus payouts under the purchase and employment agreements. After a lengthy jury trial, the jury returned a verdict in favor of the various plaintiffs on certain contract claims and in favor of us on various remaining claims. We then pursued an appeal of the judgment and the related orders to the California Court of Appeals. We accrued $27.0 million in prior fiscal periods for this matter. As part of the appeal process and during the first quarter of fiscal 2008, we posted a $51.5 million bond in conjunction with our appeal of this judgment. On December 17, 2009, the California Court of Appeals reversed the judgment against us and remanded the case for a new trial. The Court of Appeals also awarded attorneys’ fees and costs to the plaintiffs and such amount will be determined by the trial court. In May 2010, $35.3 million of the bond amount was returned to us and we anticipate that the remaining amount of the bond will be released by the trial court. We are evaluating all of our options with respect to settling this case or taking the matter back to trial. While there can be no assurance as to the ultimate disposition of the litigation, we do not believe that its resolution will have a material adverse effect on our financial position or results of operations.

On January 20, 2004, the SCO Group, Inc. (“SCO”) filed suit against us in the Third Judicial District Court of Salt Lake County, State of Utah. Upon our motion, the action was removed to the U.S. District Court, District of Utah. SCO’s original complaint alleged that our public statements and filings regarding the ownership of the copyrights in UNIX and UnixWare harmed SCO’s business reputation and affected its efforts to protect its ownership interest in UNIX and UnixWare. Our answer set forth numerous affirmative defenses and counterclaims alleging slander of title and breach of contract, and seeking declaratory actions and actual, special and punitive damages in an amount to be proven at trial. On February 3, 2006, SCO filed a Second Amended Complaint alleging that we had violated supposed non-competition provisions of the agreement under which we sold certain UNIX-related assets to SCO, that we infringed SCO’s copyrights, and that we are engaging in unfair competition by attempting to deprive SCO of the value of the UNIX technology. SCO sought to require us to assign all copyrights that we have registered in UNIX and UnixWare to SCO, to prevent us from representing that we have any ownership interest in the UNIX and UnixWare copyrights, to require us to withdraw all representations we have made regarding our ownership of the UNIX and UnixWare copyrights, and to cause us to pay actual, special and punitive damages in an amount to be proven at trial. As a result of SCO’s Second Amended Complaint, our wholly-owned subsidiary, SUSE Linux AG (“SUSE”), filed a demand for arbitration before the International Court of Arbitration in Zurich, Switzerland, pursuant to a “UnitedLinux Agreement” in which SCO and SUSE were parties. On August 10, 2007, the U.S. District Court Judge issued a Memorandum Decision and Order that granted us summary judgment against SCO on significant issues in the litigation. The District Court determined that we own the UNIX copyrights and dismissed certain of SCO’s claims against us. On September 14, 2007, SCO filed a petition for relief under Chapter 11 of the U.S. Bankruptcy Code. On July 16, 2008, the U.S. District Court issued Findings of Fact and Conclusions of Law wherein the Court determined that SCO did not have authority to enter into the 2003 Sun Microsystems, Inc. agreement and owed us $2.5 million plus prejudgment interest. The Court further concluded that SCO’s licenses to Microsoft and other “SCOsource licensees” included an “incidental” license to Unix SVRX code and therefore we were not entitled to any proceeds from such licenses. On November 20, 2008, the U.S. District Court entered Final Judgment dismissing SCO’s remaining claims against us and awarded us $3.5 million. On November 25, 2008, SCO filed a Notice of Appeal from that decision to the Tenth Circuit Court of Appeals. On August 24, 2009, a three Judge Panel from the Tenth Circuit Court of Appeals issued an

 

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NOVELL, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

I. Legal Proceedings (Continued)

 

opinion that reversed in part and affirmed in part the District Court’s decision. The Circuit Court affirmed the award to us of $3.5 million but remanded the remainder of the case back to the District Court for trial on the issue of whether the UNIX copyrights had been or should be transferred to SCO. On August 25, 2009, the U.S. Bankruptcy Court entered an Order appointing an independent Chapter 11 Trustee to manage the SCO bankruptcy estate. On March 30, 2010, the U.S. District Court jury returned a verdict in our favor and determined that under the asset purchase agreement as amended, we retained the UNIX and UnixWare copyrights. The District Court has yet to rule on certain remaining claims by SCO, including whether SCO is entitled to an immediate transfer of certain UNIX copyrights. While there can be no assurance as to the ultimate disposition of the litigation, we do not believe that its resolution will have a material adverse effect on our financial position, results of operations or cash flows.

On November 12, 2004, we filed suit against Microsoft in the U.S. District Court, District of Utah. We are seeking treble and other damages under the Clayton Act, based on claims that Microsoft eliminated competition in the office productivity software market during the time that we owned the WordPerfect word-processing application and the Quattro Pro spreadsheet application. Among other claims, we allege that Microsoft withheld certain critical technical information about the Windows operating system (“Windows”) from us, thereby impairing our ability to develop new versions of WordPerfect and other office productivity applications, and that Microsoft integrated certain technologies into Windows designed to exclude WordPerfect and other applications owned by us from relevant markets. In addition, we allege that Microsoft used its monopoly power to prevent original equipment manufacturers from offering WordPerfect and other applications to customers. On June 10, 2005, Microsoft’s motion to dismiss the complaint was granted in part and denied in part. On October 15, 2007, the U.S. Fourth Circuit Court of Appeals affirmed the District Court’s ruling. On March 18, 2008, the United States Supreme Court rejected Microsoft’s Petition for a Writ of Certiorari seeking to appeal the Fourth Circuit’s Decision. As a result of these rulings, we elected to proceed with the remaining claims against Microsoft. On March 29, 2010, the Federal District Court ruled that our underlying claims against Microsoft had been assigned to Caldera, Inc., in connection with the transfer of the DR DOS business by us in approximately 1996. Accordingly, the court dismissed our complaint against Microsoft. We have filed a notice of appeal to the U.S. Fourth Circuit Court of Appeals and intend to seek review of the District Court’s decision dismissing the complaint.

On June 15, 2009, our Board of Directors received a letter from four stockholders who had previously filed lawsuits against us for alleged options backdating, demanding that the Board of Directors investigate certain issues relating to our historical stock option grant practices, as well as our Audit Committee’s findings concerning those practices announced in our May 23, 2007 press release. The Board of Directors constituted a Special Litigation Committee to investigate the allegations in the demand letter. On August 28, 2009, these stockholders filed a complaint in the Massachusetts Middlesex County Superior Court against many of our current and former officers and directors asserting various claims related to alleged option backdating. We were also named as a nominal defendant in this complaint, although the action is derivative in nature and purportedly asserted on our behalf. On May 17, 2010, the Board responded to the demand letter, notifying the plaintiffs’ counsel that the demanded lawsuit would not serve the best interests of the Company and further demanding that the plaintiffs dismiss the derivative complaints previously filed. While there can be no assurance as to the ultimate disposition of this stockholder complaint, we do not believe that its resolution will have a material adverse effect on our financial position, results of operations or cash flows.

In November 2007, we were served with a complaint by IP Innovations (a patent litigation company), alleging that the distribution of Linux-based products by both Red Hat, Inc. (a co-defendant in the case) and us violates certain U.S. Patents. In prior periods, we accrued $1.3 million for this matter. On April 30, 2010, a U.S. District Court jury returned a verdict in our favor ruling that we did not infringe the patents in suit and, in addition, concluding that the patents were invalid on multiple grounds. As a result of this ruling, we released our accrual related to this matter during the second quarter of fiscal 2010. Although the plaintiffs have filed post-trial motions seeking to set aside the jury verdict, we do not believe that the resolution of this matter will have a material adverse effect on our financial position, results of operations or cash flows.

We are aware of two purported class action lawsuits, captioned Waldon v. Hovsepian and Fitzgerald v. Hovsepian, filed on or about March 5, 2010 in Massachusetts Superior Court, Middlesex County. The complaints name our Board of Directors as defendants, and allege breaches of fiduciary duties in connection with the unsolicited, conditional proposal from Elliott Associates, L.P. (“Elliott”) to acquire us for $5.75 per share in cash. The complaints do not define a putative class period. The plaintiffs seek to enjoin further alleged breaches of fiduciary duty and costs and attorneys’ fees. While there can be no assurance as to the ultimate disposition of these two lawsuits, we do not believe that the resolution of these claims will have a material adverse effect, individually or in the aggregate, on our financial position, results of operations or cash flows.

 

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NOVELL, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

I. Legal Proceedings (Continued)

 

In addition to the matters discussed above, we are currently party to various legal proceedings and claims involving former employees, either asserted or unasserted, which arise in the ordinary course of business. While the outcome of these matters cannot be predicted with certainty, we do not believe that the outcome of any of these claims will have a material adverse effect, individually or in the aggregate, on our consolidated financial position, results of operations or cash flows.

We accrue for losses that we believe are probable and can be reasonably estimated. We evaluate the adequacy of our legal reserves based on our assessment of many factors, including our interpretations of the law and our assumptions about the future outcome of each case based on current information. It is reasonably possible that our legal reserves could be increased or decreased in the near term based on our assessment of these factors.

J. Income Per Share From Continuing Operations

The following tables reconcile the numerators and denominators of the income per share from continuing operations calculation for the second quarters and first six months of fiscal 2010 and 2009:

 

     Three months ended

(In thousands, except per share data)

   April 30,
2010
   April 30,
2009

Basic income per share from continuing operations computation:

     

Income from continuing operations

   $ 19,912    $ 15,051
             

Weighted-average common shares outstanding, excluding unvested restricted stock

             349,204              344,881
             

Basic income per share from continuing operations

   $ 0.06    $ 0.04
             

Diluted income per share from continuing operations computation:

     

Income from continuing operations

   $ 19,912    $ 15,051
             

Weighted-average common shares outstanding, excluding unvested restricted stock

     349,204      344,881

Incremental shares attributable to the assumed exercise of outstanding options, unvested restricted stock, and other stock plans

     2,804      958
             

Total adjusted weighted-average common shares

     352,008      345,839
             

Diluted income per share from continuing operations

   $ 0.06    $ 0.04
             

Incremental shares attributable to options with exercise prices that were at or greater than the average market price for the respective period (“out-of-the-money”) were excluded from the calculation of diluted income per share for the second quarters of fiscal 2010 and 2009 as their effect would have been anti-dilutive. Out-of-the-money options for the second quarters of fiscal 2010 and 2009 totaled 16.3 million shares and 24.1 million shares, respectively.

 

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NOVELL, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

J. Income Per Share From Continuing Operations (Continued)

 

     Six months ended

(In thousands, except per share data)

   April 30,
2010
   April 30,
2009

Basic income per share from continuing operations computation:

     

Income from continuing operations

   $ 40,101    $ 24,692
             

Weighted-average common shares outstanding, excluding unvested restricted stock

             348,447              344,429
             

Basic income per share from continuing operations

   $ 0.12    $ 0.07
             

Diluted income per share from continuing operations computation:

     

Income from continuing operations

   $ 40,101    $ 24,692
             

Weighted-average common shares outstanding, excluding unvested restricted stock

     348,447      344,429

Incremental shares attributable to the assumed exercise of outstanding options,
unvested restricted stock, and other stock plans

     1,689      1,114
             

Total adjusted weighted-average common shares

     350,136      345,543
             

Diluted income per share from continuing operations

   $ 0.11    $ 0.07
             

Incremental shares attributable to options with exercise prices that were at or greater than the average market price for the respective period (“out-of-the-money”) were excluded from the calculation of diluted income per share for the first six months of fiscal 2010 and 2009 as their effect would have been anti-dilutive. Out-of-the-money options for the first six months of fiscal 2010 and 2009 totaled 20.2 million shares and 23.3 million shares, respectively.

K. Comprehensive Income

The components of comprehensive income are as follows:

 

     Three months ended    Six months ended  

(In thousands)

   April 30,
2010
    April 30,
2009
   April 30,
2010
    April 30,
2009
 

Net income

   $             19,912      $             15,617    $             40,101      $             26,294   

Change in net unrealized gain on investments

     (962     1,130      (37     7,425   

Adjustment for previously recorded unrealized gains
related to sale of ARSs
(1)

     (2,711          (5,363       

Change in cumulative translation adjustments

     (7,187     2,011      (12,500     (5,383

Change in unrecognized pension costs

     (269     110      (486     180   
                               

Comprehensive income

   $ 8,783      $ 18,868    $ 21,715      $ 28,516   
                               

(1) We reversed the unrealized gains associated with the sale of our ARSs that were recorded in the prior period in the “Accumulated other comprehensive income” line item in our consolidated balance sheet. These reversals are part of the $2.0 million and $7.2 million gain in the “Gain on sale of previously impaired investments, net” line item in our consolidated statements of operations for the second quarter and first six months of fiscal 2010, respectively.

 

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NOVELL, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

K. Comprehensive Income (Continued)

 

Our accumulated other comprehensive income is comprised of the following:

 

(In thousands)

   April 30,
2010
    October  31,
2009

Net unrealized gain on investments

   $             5,618      $             11,018

Unrecognized pension actuarial gain and transition obligation, net

     3,912        4,398

Cumulative translation adjustment

     (6,934     5,566
              

Total accumulated other comprehensive income

   $ 2,596      $ 20,982
              

L. Stock-Based Compensation

Equity-Based Awards

We made stock option and restricted stock unit grants for the following number of shares during the first six months of fiscal 2010 and 2009:

 

     Six months ended

(In thousands of shares)

   April 30,
2010
   April 30,
2009

Stock options:

     

Performance-based

      1,882

Time-based

   5,110    2,118
         

Total stock options

               5,110                4,000
         

Restricted stock units:

     

Market-based

   1,230   

Performance-based

      827

Time-based

   3,075    1,716
         

Total restricted stock units

   4,305    2,543
         

Stock Options

Performance-based: During the first six months of fiscal 2009, we granted stock options to executives that will vest based on the achievement of certain revenue targets set in each applicable fiscal year beginning in the year of grant. If the targets are not met, the stock options will expire unvested.

Time-based: During the first six months of fiscal 2010 and 2009, we granted time-based stock options to executive and non-executive employees. The weighted-average grant-date fair value of time-based stock options granted during the first six months of fiscal 2010 was $1.70. Vesting of the options occurs over four years in accordance with the following schedule: either 1) 25% of the grant vests on the first anniversary of the grant date and the remaining 75% of the grant vests monthly thereafter; or 2) 25% of the grant vests on each grant date anniversary. The options expire eight years after the grant date.

Restricted Stock Units

Market-based: During the first quarter of fiscal 2010, we granted restricted stock units to executives that will vest based on the achievement of certain stock price targets. The stock-based compensation cost and derived service periods for these restricted stock units were estimated using the Monte Carlo simulation method utilizing a volatility of 46.4% and a risk-free rate of 2.9%. The weighted-average fair value of these awards is $3.25 and the derived service periods range from approximately one year to approximately two and one-third years. During the second quarter of fiscal 2010, one-third of the market award vested due to the achievement of the target applicable to that portion of the award. This resulted in the recognition of $1.4 million in stock-based compensation during the first six months of fiscal 2010 related to that portion of the award. If the remaining targets are not met, the restricted stock units will expire on the seventh anniversary of the grant date and will not convert into shares of common stock.

 

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NOVELL, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

L. Stock-Based Compensation (Continued)

 

Performance-based: During the first six months of fiscal 2009, we granted restricted stock units to executives that will vest based on the achievement of certain profit targets set in each applicable fiscal year beginning in the year of grant. If the targets are not met, the restricted stock units will expire and will not convert into shares of common stock.

Time-based: During the first six months of fiscal 2010, we granted time-based restricted stock units to non-executive employees primarily as part of our annual grant program. The weighted-average grant-date fair value of time-based restricted stock units granted during the first six months of fiscal 2010 was $4.60. During the first six months of fiscal 2009, we granted time-based restricted stock units to executive and non-executive employees. Units vest proportionally on each grant date anniversary over either three or four years.

Stock-Based Compensation Expense

Our consolidated statements of operations include the following amounts of stock-based compensation expense in the respective captions:

 

     Three months ended    Six months ended

(In thousands)

   April 30,
2010
   April 30,
2009
   April 30,
2010
   April 30,
2009

Cost of revenue

   $ 772    $ 671    $ 1,331    $ 1,583
                           

Sales and marketing

     2,349      1,550      4,189      4,113

Product development

     2,075      2,289      4,139      4,794

General and administrative

     3,096      1,181      5,083      3,232
                           

Operating expenses

     7,520      5,020      13,411      12,139
                           

Total stock-based compensation expense

   $             8,292    $             5,691    $             14,742    $             13,722
                           

Total unrecognized stock-based compensation expense expected to be recognized over an estimated weighted-average amortization period of 2.1 years was $43.0 million at April 30, 2010.

M. Segment Information

In December 2009, we announced our business unit segment structural and management reorganization to better align our business with our strategic objective of becoming an industry leader in the emerging Intelligent Workload Management market, while continuing to develop collaboration solutions. As part of this reorganization, we consolidated our reportable business unit segments from four to two. Our former Open Platform Solutions, Identity and Security Management and Systems and Resource Management business unit segments were consolidated to form the new Security, Management and Operating Platforms business unit segment (“SMOP”). Our former Workgroup business unit segment was renamed Collaboration Solutions (“CS”) to promote and highlight our recent areas of innovation.

Our performance is evaluated by our chief executive officer and our other chief decision makers based on reviewing revenue and operating income information for each business unit segment. Our software and services are sold both directly by our business unit segments and indirectly through original equipment manufacturers, resellers, and distributors who sell to end users.

 

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NOVELL, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

M. Segment Information (Continued)

 

Operating results by business unit segment are as follows:

 

     Three months ended  
     April 30, 2010     April 30, 2009  

(In thousands)

   Net revenue    Gross
profit
    Operating
income  (loss)
    Net revenue    Gross
profit
    Operating
income  (loss)
 

SMOP

   $ 125,546    $ 97,924      $ (5,870   $ 128,312    $ 99,837      $ (5,707

CS

     78,468      66,914        36,344        87,283      73,882        40,727   

Common unallocated operating costs

          (2,136     (10,571          (3,406     (17,396
                                              

Total per statements of operations

   $     204,014    $     162,702      $     19,903      $     215,595    $     170,313      $     17,624   
                                              
     Six months ended  
     April 30, 2010     April 30, 2009  

(In thousands)

   Net revenue    Gross
profit
    Operating
income (loss)
    Net revenue    Gross
profit
    Operating
income (loss)
 

SMOP

   $ 250,200    $ 192,750      $ (9,795   $ 253,163    $ 196,265      $ (14,112

CS

     156,180      132,385        73,020        177,303      149,093        82,959   

Common unallocated operating costs

          (3,785     (21,893          (7,071     (37,579
                                              

Total per statements of operations

   $ 406,380    $ 321,350      $ 41,332      $ 430,466    $ 338,287      $ 31,268   
                                              

Segment operating income (loss) is comprised of business unit segment gross profit, less operating expenses attributable to each business unit segment. Beginning in fiscal 2010, operating expenses, including sales and marketing, product development, and general and administrative expenses, have been allocated to the business unit segments. All prior period amounts have been reclassified to conform to the current year’s presentation. Common unallocated operating costs include items such as stock-based compensation, acquisition-related intangible asset amortization, restructuring, certain litigation related activity and other unusual items that are not considered part of our ongoing, ordinary business.

Geographic Information

The table below shows our net revenue from the U.S. and from international locations:

 

     Three months ended    Six months ended

(In thousands)

   April 30,
2010
   April 30,
2009
   April 30,
2010
   April 30,
2009

Net revenue:

           

U.S.

   $ 97,693    $ 108,144    $ 195,675    $ 213,251

International

     106,321      107,451      210,705      217,215
                           

Total net revenue

   $         204,014    $         215,595    $         406,380    $         430,466
                           

During the second quarters and first six months of fiscal 2010 and 2009, revenue in Germany accounted for 10% of our net revenue. No other country outside of the U.S. accounted for 10% or more of our net revenue for the second quarters or first six months of fiscal 2010 or 2009. No single customer accounted for 10% or more of our total revenue for any period presented.

For the second quarters of fiscal 2010 and 2009, 68% and 70%, respectively, of our revenue outside the U.S. was in the Europe, Middle East and Africa region. For the first six months of fiscal 2010 and 2009, 69% and 70%, respectively, of our revenue outside the U.S. was in the Europe, Middle East and Africa region.

N. Share Repurchase Program

During fiscal 2008, our Board of Directors authorized the repurchase of up to $100 million of our outstanding common stock. There is no fixed termination date for the repurchase program. There were no repurchases under the program during the second quarters or first six months of fiscal 2010 or 2009. As of April 30, 2010, $33.2 million remains available to be used for repurchasing common stock under the current Board authorization.

 

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NOVELL, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

O. Recent Pronouncements

In June 2009, the Financial Accounting Standards Board (“FASB”) issued new guidance to replace the quantitative-based risks and rewards calculation for initially determining which enterprise, if any, has a controlling financial interest in, and will be required to consolidate, a variable interest entity. A variable interest entity is defined as an entity that will need additional funding to operate. Companies are now required to follow a more qualitative approach, focused on identifying which enterprise has the power to direct the activities of the variable interest entity that most significantly impacts the variable interest entity’s economic performance. Companies are also required to perform ongoing assessments of which enterprise, if any, will have to consolidate the variable interest entity. Additional disclosures are also required. This guidance is effective for fiscal years beginning after November 15, 2009 (our fiscal 2011). Currently, the impact of this pronouncement on our financial position and results of operations is anticipated to be immaterial.

In January 2010, the FASB issued updated guidance to improve disclosures regarding fair value measurements. This update requires entities to 1) disclose separately the amounts of significant transfers in and out of level 1 and level 2 fair value measurements and describe the reasons for the transfers and 2) present separately (i.e. on a gross basis rather than as a net amount), information about purchases, sales, issuances, and settlements in the roll forward of changes in level 3 fair value measurements. The update requires fair value disclosures by class of assets and liabilities rather than by major category or line item in the statement of financial position. Disclosures regarding the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements for assets and liabilities in both level 2 and level 3 are also required. For all portions of the update except the gross presentation of activity in the level 3 roll forward, this standard is effective for interim and annual reporting periods beginning after December 15, 2009 (the second quarter of our fiscal 2010, which is when we implemented this standard). For the gross presentation of activity in the level 3 roll forward, this guidance is effective for fiscal years beginning after December 15, 2010 (our fiscal 2012). As this guidance is only disclosure-related, and we currently do not have any level 3 fair value measurements, it is presently anticipated that this guidance will not have an impact on our financial position and results of operations.

In January 2009, the SEC issued its final rules requiring public companies to provide their financial statements and financial statement schedules to the SEC and on their corporate websites in interactive data format using eXtensible Business Reporting Language (“XBRL”). XBRL is a standardized, machine-readable language designed to enhance the electronic communication of business information and should make business information more accessible. These rules will not change the SEC’s existing requirement to provide financial statements in the traditional format. Under these rules, we will be required to file our financial statements for the third quarter of fiscal 2010 using XBRL, in addition to our traditional filing format.

P. Recent Company Developments

On March 2, 2010, we announced the receipt of an unsolicited, conditional proposal from Elliott to acquire us for $5.75 per share in cash. On March 20, 2010, we announced that our Board of Directors concluded, after careful consideration, including a review of the proposal with our independent financial and legal advisors, that the Elliott proposal was inadequate and that it undervalued our franchise and growth prospects. We also announced that our Board authorized a thorough review of various alternatives to enhance stockholder value that include, but are not limited to, a return of capital to stockholders through a stock repurchase or cash dividend, strategic partnerships and alliances, joint ventures, a recapitalization and a sale of the company.

 

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NOVELL, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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 and other parts of this Quarterly Report on Form 10-Q contain certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements, other than statements of historical fact, regarding our strategy; future operations; financial position and results; liquidity; future opportunities; growth of business unit segments; the macroeconomic environment; market evolution and opportunities; company trends; market outlook; customer priorities; timing of realization of projections; functionality, characteristics, quality and performance capabilities of our products and technology; results achievable and benefits attainable through deployment of our products and provision of services; expanded opportunities for our products; release of funds in the Amer Jneid legal matter; funding of liquidity needs; foreign currency exchange rate fluctuations and impact on the value of our foreign-denominated cash and cash equivalent holdings; reduction of our valuation allowance on net deferred tax assets; decrease of unrecognized tax benefits and accrued interest; opportunities; beliefs; and objectives constitute “forward-looking statements.” The words “may,” “will,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “potential,” or “continue” and similar types of expressions identify such statements, although not all forward-looking statements contain these identifying words. These statements are based upon information that is currently available to us and/or management’s current expectations, speak only as of the date hereof, and are subject to risks and uncertainties. We expressly disclaim any obligation, except as required by federal securities laws, or undertaking to update or revise any forward-looking statements contained herein to reflect any change of expectations with regard thereto or to reflect any change in events, conditions, or circumstances on which any such forward-looking statement is based, in whole or in part. Our actual results may differ materially from the results discussed in or implied by such forward-looking statements. We are subject to a number of risks, including, among others, risks relating to: uncertainty introduced by the review of various alternatives to enhance stockholder value authorized by our Board; indirect sales, growth rates of our business units, renewal of SUSE® Linux Enterprise Server (“SLES™”) subscriptions with customers who have received certificates from Microsoft, decline rates of Open Enterprise Server (“OES”) and NetWare® revenue, development of products and services, the Intelligent Workload Management market, software vulnerabilities, delays in product releases, reliance on open source software, adequacy of renewal rates, uncertain economic conditions, competition, rapid technological changes, failure to expand brand awareness, adequacy of technical support, pricing pressures, system failures, integration of acquisitions, industry consolidation, challenges resulting from a global business, foreign research and development operations, loss of key employees, intellectual property infringement, litigation matters, unpredictable financial results, impairments, the timing of revenue recognition, our investments, and effective use of our cash. Risks that may affect our operating results include, but are not limited to, those discussed in the “Risk Factors” section in Part II Item 1A, titled “Risk Factors”. Readers should carefully review the risk factors described in this document and in other documents that we file from time to time with the Securities and Exchange Commission.

Overview

In December 2009, we announced our business unit segment structural and management reorganization to better align our business with our strategic objective of becoming an industry leader in the emerging Intelligent Workload Management market, while continuing to develop collaboration solutions. As part of this reorganization, we consolidated our reportable business unit segments from four to two. Our former Open Platform Solutions, Identity and Security Management and Systems and Resource Management business unit segments were consolidated to form the new Security, Management and Operating Platforms business unit segment (“SMOP”). Our former Workgroup business unit segment was renamed Collaboration Solutions (“CS”) to promote and highlight our recent areas of innovation.

On March 2, 2010, we announced the receipt of an unsolicited, conditional proposal from Elliott Associates, L.P. (“Elliott”) to acquire us for $5.75 per share in cash. On March 20, 2010, we announced that our Board of Directors concluded, after careful consideration, including a review of the proposal with our independent financial and legal advisors, that the Elliott proposal was inadequate and that it undervalued our franchise and growth prospects. We also announced that our Board authorized a thorough review of various alternatives to enhance stockholder value that include, but are not limited to, a return of capital to stockholders through a stock repurchase or cash dividend, strategic partnerships and alliances, joint ventures, a recapitalization and a sale of the company. We believe that the uncertainty associated with recent company developments has negatively impacted revenue during the second quarter of fiscal 2010, particularly in our Identity and Security Management business.

 

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NOVELL, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – (Continued)

Overview (Continued)

 

In the second quarter of fiscal 2010, total revenue decreased 5% compared to the prior year period. Product and services revenues were lower by 4% and 17%, respectively, in the second quarter of fiscal 2010 compared to the prior year period. We believe that the lower product revenue primarily resulted from the uncertainty associated with recent company developments as well as weakness in our legacy products. The lower services revenue was due primarily to lower discretionary spending availability from our consulting services customers and lower renewals on technical support contracts. Foreign currency exchange rate fluctuations, as measured using the prior year period foreign currency exchange rates on non-U.S. dollar denominated revenue and expenses, favorably impacted revenue by $2.0 million, or 1%, in the second quarter of fiscal 2010, compared to the prior year period.

In the first six months of fiscal 2010, total revenue decreased 6% compared to the prior year period. Product and services revenues were lower by 4% and 18%, respectively, in the first six months of fiscal 2010 compared to the prior year period. We believe that the lower product revenue primarily resulted from the uncertainty associated with recent company developments as well as weakness in our legacy products. The lower services revenue was due primarily to lower discretionary spending availability from our consulting services customers and lower renewals on technical support contracts. Foreign currency exchange rate fluctuations, as measured using the prior year period foreign currency exchange rates on non-U.S. dollar denominated revenue and expenses, favorably impacted revenue by $2.9 million, or 1%, in the first six months of fiscal 2010, compared to the prior year period.

Below is a brief summary of the revenue results for our two business unit segments:

 

 

 

Total revenue from SMOP for the second quarter of fiscal 2010 decreased $2.8 million, or 2%, compared to the prior year period. Total revenue from SMOP for the first six months of fiscal 2010 decreased $3.0 million, or 1%, compared to the prior year period.

 

 

 

Total revenue from CS for the second quarter of fiscal 2010 decreased $8.8 million, or 10%, compared to the prior year period. Total revenue from CS for the first six months of fiscal 2010 decreased $21.1 million, or 12%, compared to the prior year period.

Because much of the revenue we invoice is deferred and recognized over time, we consider invoicing, or bookings, to be a key indicator of current sales performance and future revenue performance. Total invoicing was lower for the second quarter of fiscal 2010 compared to the prior year period due primarily to lower SMOP and CS product invoicing.

Total invoicing was flat for the first six months of fiscal 2010 compared to the prior year period largely as a result of higher SMOP product invoicing that was offset by lower CS product invoicing and lower services invoicing. We believe that the current customer focus on reducing cost, complexity and risk is aligned with our overall value proposition.

Total gross profit was 80% and 79% for the second quarter and first six months of fiscal 2010, respectively, compared to 79% for both of the prior year periods.

Despite lower revenue, our operating margins continue to improve, reflecting the positive impacts of recent restructuring and other cost-cutting initiatives. For the second quarter of fiscal 2010, we reported operating margins of 10%, which compares to 8% for the prior year period. Foreign currency exchange rate fluctuations, as measured using the prior year period foreign currency exchange rates on non-U.S. dollar denominated revenue and expenses, unfavorably impacted income from operations by $3.6 million, or 15%, in the second quarter of fiscal 2010 compared to the prior year period.

For the first six months of fiscal 2010, we reported operating margins of 10%, which compares to 7% for the prior year period. The first six months of fiscal 2010 included a $4.6 million change in accounting estimate related to fiscal 2009 sales compensation expense that increased profitability in the period. Foreign currency exchange rate fluctuations, as measured using the prior year period foreign currency exchange rates on non-U.S. dollar denominated revenue and expenses, unfavorably impacted income from operations by $9.4 million, or 19%, in the first six months of fiscal 2010 compared to the prior year period.

In the first quarter of fiscal 2010, we recorded net restructuring expenses of $2.8 million related primarily to termination benefits for certain executive employees as part of our business unit segment structural and management reorganization discussed above. We did not record any restructuring charges in the second quarter of fiscal 2010.

 

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NOVELL, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – (Continued)

 

Critical Accounting Policies

An accounting policy is deemed to be critical if it requires us to make an accounting estimate based on assumptions about matters that are uncertain at the time an accounting estimate is made, and if different estimates that reasonably could have been used or changes in the accounting estimate that are reasonably likely to occur periodically could materially change the financial statements. We consider accounting policies related to revenue recognition and related reserves, impairment of long-term assets, valuation of deferred tax assets, loss contingency accruals and share-based payments to be critical accounting policies due to the judgments and estimation processes involved in each. For a more detailed explanation of the judgments included in these areas, refer to our Annual Report on Form 10-K for fiscal 2009.

Results of Operations

Reclassifications

As more fully described in Note M, “Segment Information,” during the first quarter of fiscal 2010, we reorganized our business unit segment structure and management resulting in a change to our reportable business unit segments. In connection with this reorganization, we evaluated our internal cost structure to ensure the resulting business unit segment gross profit and operating income were reflective of our business unit segment management structure. As a result of this evaluation, we determined the allocation and assignment of costs between maintenance and subscriptions and services within cost of revenue should be adjusted to be reflective of the new business unit segment management structure for the second quarter and first six months of fiscal 2010 and 2009. For the second quarter and first six months of fiscal 2009, in our consolidated statements of operations, $9.1 million and $18.4 million of costs, respectively, were moved from the services cost of revenue line item to the maintenance and subscriptions cost of revenue line item. This change impacted only the components of cost of revenue and had no impact on revenue, total cost of revenue or total gross profit.

Certain other amounts reported in prior periods have been reclassified from what was previously reported to conform to the current year’s presentation. These reclassifications did not have any impact on the statements of operations.

Revenue

We sell our software and services primarily to businesses, government entities, educational institutions, independent hardware and software vendors, resellers, and distributors both domestically and internationally. In our consolidated statements of operations, we categorize revenue as software licenses, maintenance and subscriptions, and services. Software licenses revenue includes sales of proprietary licenses and certain royalties. Maintenance and subscriptions revenue includes product maintenance agreements and Linux subscriptions. Services revenue includes professional services, stand-alone technical support, and training.

Total net revenue was as follows:

 

             Three months ended                          Six months ended              

(Dollars in thousands)

   April 30,
2010
   April 30,
2009
     Change      April 30,
2010
   April 30,
2009
     Change  

Software licenses

   $ 27,691    $ 30,250    (8)%     $ 48,884    $ 58,517    (16)% 

Maintenance and subscriptions

     153,855      158,329    (3)%       312,806      317,144    (1)% 

Services

     22,468      27,016    (17)%       44,690      54,805    (18)% 
                                 

Total net revenue

   $ 204,014    $ 215,595    (5)%     $ 406,380    $ 430,466    (6)% 
                                 

Revenue in our software licenses category decreased during the second quarter and first six months of fiscal 2010 compared to the prior year periods as software licenses revenue declined across both business unit segments. The lower software licenses revenue reflected the continued weakness in our legacy products.

Revenue from maintenance and subscriptions decreased in the second quarter and first six months of fiscal 2010 compared to the prior year periods. Maintenance and subscriptions revenue from SMOP was relatively flat in the second quarter of fiscal 2010 compared to the prior year period, and increased $4.8 million, or 3%, in the first six months of fiscal 2010, compared to the prior year period. Maintenance and subscriptions revenue from CS declined $4.7 million, or 7%, in the second quarter of fiscal 2010, and $9.2 million, or 7%, in the first six months of fiscal 2010, compared to the prior year periods.

 

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NOVELL, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – (Continued)

Results of Operations (Continued)

 

The lower services revenue in the second quarter and first six months of fiscal 2010 compared to the prior year periods is due primarily to lower discretionary spending availability from our consulting services customers and lower renewals on technical support contracts.

Foreign currency exchange rate fluctuations, as measured using prior period foreign currency exchange rates on non-U.S. dollar denominated revenue, favorably impacted total net revenue by $2.0 million, or 1%, and $2.9 million, or 1%, during the second quarter and first six months of fiscal 2010, respectively.

Net revenue in SMOP was as follows:

 

             Three months ended                          Six months ended              

(Dollars in thousands)

   April 30,
2010
   April 30,
2009
     Change      April 30,
2010
   April 30,
2009
     Change  

Software licenses

   $ 17,388    $ 17,742    (2)%     $ 30,848    $ 32,845    (6)% 

Maintenance and subscriptions

     91,666      91,486    —%       186,871      182,032    3% 

Services

     16,492      19,084    (14)%       32,481      38,286    (15)% 
                                 

Total net revenue

   $ 125,546    $ 128,312    (2)%     $ 250,200    $ 253,163    (1)% 
                                 

Revenue from SMOP decreased in the second quarter of fiscal 2010 compared to the prior year period. Revenue associated with our Linux Platform Products decreased by $1.5 million, or 4%, and SMOP services revenue declined $2.6 million, or 14%, compared to the prior year period. These revenue decreases were offset by higher revenue from Identity, Access and Compliance Management products, which increased by $2.5 million, or 9%, compared to the prior year period. Revenue from Systems and Resource Management products was relatively flat compared to the prior year period. Overall, product invoicing for SMOP decreased 3% compared to the prior year period, due primarily to a decrease in invoicing for our Identity, Access and Compliance Management products, partially offset by stronger invoicing for our Systems and Resource Management products. Identity, Access and Compliance Management invoicing decreased due in part to a reduction in contract length compared to the prior year period reflecting, we believe, the uncertainty associated with recent company developments.

Renewals of Microsoft SLES certificates began in early fiscal 2010, and as anticipated, the renewals have been invoiced at much lower amounts than under the original agreement. The lower invoicing associated with the Microsoft SLES certificates was partially offset by significant growth in our non-Microsoft invoicing of Linux Platform Products. (See the subsection entitled, “Microsoft Agreements–Related Revenue” of Note B, “Summary of Significant Accounting Policies” in our fiscal 2009 Annual Report on Form 10-K for more details on the Microsoft SLES certificates and related agreements.)

Revenue from SMOP decreased in the first six months of fiscal 2010 compared to the prior year period. Revenue associated with our Systems and Resource Management products decreased by $2.0 million, or 2%, and SMOP services revenue declined $5.8 million, or 15%, compared to the prior year period. These revenue decreases were offset by higher revenue from Identity, Access and Compliance Management products, which increased by $5.9 million, or 11%, and Linux Platform Products, which increased by $0.7 million, or 1%, compared to the prior year period. Overall, product invoicing for SMOP increased 10% compared to the prior year period, due primarily to stronger invoicing for our Linux Platform Products and Identity, Access and Compliance Management products, partially offset by a decline in invoicing for our Systems and Resource Management products. The higher invoicing for our Linux Platform Products resulted from significant growth in our non-Microsoft invoicing, partially offset by lower invoicing associated with the Microsoft SLES certificates. Identity, Access and Compliance Management revenue and invoicing increased due in part to several large deals in the first quarter of fiscal 2010. However, we believe this positive momentum was negatively impacted in the second quarter of fiscal 2010, by the uncertainty associated with recent company developments. The revenue and invoicing declines for Systems and Resource Management products were primarily due to challenges gaining traction in this market segment.

 

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NOVELL, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – (Continued)

Results of Operations (Continued)

 

Net revenue in CS was as follows:

 

             Three months ended                          Six months ended              

(Dollars in thousands)

       April 30,    
2010
       April 30,    
2009
     Change          April 30,    
2010
       April 30,    
2009
     Change  

Software licenses

   $ 10,303    $ 12,508    (18)%     $ 18,036    $ 25,672    (30)% 

Maintenance and subscriptions

     62,189      66,843    (7)%       125,935      135,112    (7)% 

Services

     5,976      7,932    (25)%       12,209      16,519    (26)% 
                                 

Total net revenue

   $ 78,468    $ 87,283    (10)%     $ 156,180    $ 177,303    (12)% 
                                 

Revenue from CS decreased in the second quarter of fiscal 2010 compared to the prior year period primarily from lower combined OES and NetWare-related product revenue of $2.9 million, or 6%, lower Collaboration product revenue of $2.2 million, or 9%, and lower services revenue of $2.0 million, or 25%. Overall, product invoicing for CS decreased 8% in the second quarter of fiscal 2010 compared to the prior year period. Invoicing for Collaboration products and combined OES and NetWare-related products decreased 12% and 2%, respectively, in the second quarter of fiscal 2010 compared to the prior year period. These declines were primarily due to the mature lifecycle stage of our CS products.

Revenue from CS decreased in the first six months of fiscal 2010 compared to the prior year period primarily from lower Collaboration product revenue of $5.6 million, or 11%, lower combined OES and NetWare-related product revenue of $5.4 million, or 6%, and lower services revenue of $4.3 million, or 26%. Overall, product invoicing for CS decreased 12% in the first six months of fiscal 2010 compared to the prior year period. Invoicing for Collaboration products and combined OES and NetWare-related products decreased 9% and 5%, respectively, in the first six months of fiscal 2010 compared to the prior year period. These declines were primarily due to the mature lifecycle stage of our CS products.

Deferred Revenue

We had total deferred revenue of $615.0 million as of April 30, 2010 compared to $659.4 million and $688.8 million at April 30, 2009 and October 31, 2009, respectively. Deferred revenue represents revenue that is expected to be recognized in future periods primarily under maintenance contracts and subscriptions that are recognized ratably over the related contract periods, typically one to three years. Deferred revenue related to our agreements with Microsoft is recognized ratably over various related service periods, which can extend up to five years. The decrease in total deferred revenue of $73.8 million compared to October 31, 2009 is primarily attributable to seasonably lower invoicing in the first six months of the fiscal year and from the recognition of deferred revenue related to our agreement with Microsoft to purchase SLES certificates.

Gross Profit

 

             Three months ended                           Six months ended               

(Dollars in thousands)

       April 30,    
2010
        April 30,    
2009
      Change          April 30,    
2010
        April 30,    
2009
      Change  

Software licenses

   $ 25,766      $ 28,394      (9)%     $ 45,271      $ 54,625      (17)% 

percentage of related revenue

     93     94        93     93  

Maintenance and subscriptions

   $ 133,030      $ 136,371      (2)%     $ 269,409      $ 272,484      (1)% 

percentage of related revenue

     86     86        86     86  

Services

   $ 3,906      $ 5,548      (30)%     $ 6,670      $ 11,178      (40)% 

percentage of related revenue

     17     21        15     20  

Total gross profit

   $ 162,702      $ 170,313      (4)%     $ 321,350      $ 338,287      (5)% 

percentage of revenue

     80     79        79     79  

Software licenses, maintenance and subscriptions, and services gross profit all decreased in the second quarter and first six months of fiscal 2010 compared to the respective prior year periods primarily from lower revenue. Services gross margins decreased as a percentage of sales as we entered into several low margin service engagements that drove product sales during the second quarter and first six months of fiscal 2010. Our services offerings are focused on supporting product sales, not generating stand-alone revenue or profits, in line with our strategic initiatives.

 

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NOVELL, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – (Continued)

Results of Operations (Continued)

 

Total gross profit was lower for the second quarter of fiscal 2010 compared to the prior year period primarily due to the 5% decrease in total net revenue. Foreign currency exchange rate fluctuations, as measured using the prior year period foreign currency exchange rates on non-U.S. dollar denominated revenue and expenses, positively impacted gross profit $0.9 million in the second quarter of fiscal 2010 compared to the prior year period.

Total gross profit was lower for the first six months of fiscal 2010 compared to the prior year period primarily due to the 6% decrease in total net revenue. Foreign currency exchange rate fluctuations, as measured using the prior year period foreign currency exchange rates on non-U.S. dollar denominated revenue and expenses, positively impacted gross profit $0.3 million in the first six months of fiscal 2010 compared to the prior year period.

Gross profit by business unit segment was as follows:

 

             Three months ended                           Six months ended               

(Dollars in thousands)

       April 30,    
2010
        April 30,    
2009
      Change          April 30,    
2010
        April 30,    
2009
      Change  

SMOP

   $ 97,924      $ 99,837      (2)%     $ 192,750      $ 196,265      (2)% 

percentage of related revenue

     78     78        77     78  

CS

   $ 66,914      $ 73,882      (9)%     $ 132,385      $ 149,093      (11)% 

percentage of related revenue

     85     85        85     84  

Common unallocated operating costs

   $ (2,136   $ (3,406   37%     $ (3,785   $ (7,071   46% 

Total gross profit

   $ 162,702      $ 170,313      (4)%     $ 321,350      $ 338,287      (5)% 

percentage of revenue

     80     79        79     79  

Gross profit was lower in both SMOP and CS for the second quarter and first six months of fiscal 2010 compared to the prior year periods primarily due to lower revenues. Gross profit as a percentage of revenue was essentially flat for both business unit segments for the second quarter and first six months of fiscal 2010 compared to the respective prior year periods.

Operating Expenses

 

             Three months ended                           Six months ended               

(Dollars in thousands)

       April 30,    
2010
        April 30,    
2009
      Change          April 30,    
2010
        April 30,    
2009
      Change  

Sales and marketing

   $ 74,853      $ 75,697      (1)%     $ 143,769      $ 152,591      (6)% 

percentage of revenue

     37     35        35     35  

Product development

   $ 39,368      $ 44,552      (12)%     $ 79,070      $ 89,944      (12)% 

percentage of revenue

     19     21        19     21  

General and administrative

   $ 28,578      $ 25,032      14%     $ 54,405      $ 49,227      11% 

percentage of revenue

     14     12        13     11  

Restructuring expenses

   $      $ 7,224      —%     $ 2,774      $ 15,273      (82)% 

percentage of revenue

         3        1     4  

Loss (gain) on sale of subsidiaries

   $      $ 184      —%     $      $ (16   —% 

percentage of revenue

                     

Total operating expenses

   $ 142,799      $ 152,689      (6)%     $ 280,018      $ 307,019      (9)% 

percentage of revenue

     70     71        69     71  

Sales and marketing expenses decreased slightly in the second quarter of fiscal 2010 compared to the prior year period primarily from the benefits of our prior cost reduction initiatives, including our prior restructuring actions, partially offset by unfavorable foreign currency exchange rate fluctuations of $2.7 million. Sales and marketing headcount was lower by 20 employees, or 2%, at the end of the second quarter of fiscal 2010 compared to the prior year period.

Sales and marketing expenses decreased in the first six months of fiscal 2010 compared to the prior year period primarily from a $4.6 million change in accounting estimate related to fiscal 2009 sales compensation expense that reduced expenses in the first quarter of fiscal 2010 and the cost reduction initiatives described above, partially offset by unfavorable foreign currency exchange rate fluctuations of $5.8 million.

 

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NOVELL, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – (Continued)

Results of Operations (Continued)

 

Product development expenses in the second quarter of fiscal 2010 decreased compared to the prior year period primarily from cost reduction initiatives, including our prior restructuring actions, partially offset by unfavorable foreign currency exchange rate fluctuations of $1.0 million. Product development headcount decreased by 130 employees, or 10%, at the end of the second quarter of fiscal 2010 compared to the prior year period.

Product development expenses in the first six months of fiscal 2010 decreased compared to the prior year period primarily from cost reduction initiatives, including our prior restructuring actions, partially offset by unfavorable foreign currency exchange rate fluctuations of $2.1 million.

General and administrative expenses increased in the second quarter of fiscal 2010 compared to the prior year period primarily from higher legal and outside consulting service costs as well as unfavorable foreign currency exchange rate fluctuations of $0.8 million, partially offset by cost reduction initiatives, including our prior restructuring actions. General and administrative headcount was lower by 160 employees, or 28%, at the end of the second quarter of fiscal 2010 compared to the prior year period, reflecting the outsourcing of the majority of our IT support functions to Affiliated Computer Services, Inc. in the third quarter of fiscal 2009. This decrease in headcount-related expenses was offset by an increase in outside service costs as a result of the IT outsourcing.

General and administrative expenses increased in the first six months of fiscal 2010 compared to the prior year period primarily from higher legal and outside consulting service costs as well as unfavorable foreign currency exchange rate fluctuations of $1.8 million, partially offset by cost reduction initiatives, including our prior restructuring actions.

During the first quarter of fiscal 2010, we recorded net restructuring expenses of $2.8 million. This was comprised of $2.9 million primarily for termination benefits for certain executive employees as part of our business unit segment structural and management reorganization, partially offset by $0.1 million in reductions to accruals for changes in estimates related to prior period restructuring activities. During the second quarter of fiscal 2010, there were no restructuring expenses.

Foreign currency exchange rate fluctuations during the second quarter of fiscal 2010, compared to the prior year period, as measured using the prior year period foreign currency exchange rates on non-U.S. dollar denominated revenue and expenses, favorably impacted revenue by $2.0 million, unfavorably impacted operating expenses by $5.6 million and unfavorably impacted income from operations by $3.6 million. Foreign currency exchange rate fluctuations during the first six months of fiscal 2010, compared to the prior year period, favorably impacted revenue by $2.9 million, unfavorably impacted operating expenses by $12.3 million and unfavorably impacted income from operations by $9.4 million. Since a large portion of our recognized revenue is deferred revenue that was recorded at different foreign currency exchange rates, the impact to revenue of changes in foreign currency exchange rates is recognized over time, whereas the impact to expenses is more immediate, as expenses are recognized at the current foreign currency exchange rate in effect at the time the expense is incurred.

Other Income (Expense)

 

             Three months ended                           Six months ended               

(Dollars in thousands)

       April 30,    
2010
        April 30,    
2009
      Change          April 30,    
2010
        April 30,    
2009
      Change  

Investment income

   $ 3,262      $ 5,390      (39)%     $ 6,530      $ 12,566      (48)% 

percentage of revenue

     2     3        2     3  

Gain on sale of previously impaired investments, net

   $ 1,967      $      —%     $ 7,195      $      —% 

percentage of revenue

     1            2      

Impairment of long-term investments

   $      $ (1,419   —%     $      $ (3,096   —% 

percentage of revenue

         (1 )%             (1 )%   

Interest expense and other, net

   $ (43   $ (3,767   99%     $ (1,873   $ (6,902   73% 

percentage of revenue

         (2 )%             (2 )%   

Total other income, net

   $ 5,186      $ 204      —%     $ 11,852      $ 2,568      362% 

percentage of revenue

     3            3     1  

Investment income includes income from short-term and long-term investments. Investment income for the second quarter and first six months of fiscal 2010 decreased compared to the prior year periods due primarily to lower interest rates and to a decrease in cash,

 

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NOVELL, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – (Continued)

Results of Operations (Continued)

 

cash equivalents and short-term investments resulting primarily from cash expended for repurchasing the remainder of our 0.5% senior convertible debentures due 2024 (“Debentures”) in fiscal 2009.

During the second quarter of fiscal 2010, auction-rate securities (“ARSs”) classified as short-term investments, with a book value of $1.8 million, were sold for $4.2 million, resulting in a gain of $2.4 million. During the second quarter of fiscal 2010, we sold our remaining ARS that was classified as long-term, with a book value of $1.7 million for $0.9 million, resulting in a loss on sale of $0.8 million. The net gain recognized during the second quarter of fiscal 2010 from the sale of our remaining short-term and long-term ARSs was $1.6 million. During the second quarter of fiscal 2010, we also recognized a gain of $0.4 million related to the sale of a direct investment that was previously fully impaired.

During the first six months of fiscal 2010, we sold our remaining ARSs with a book value of $5.6 million for $12.2 million, resulting in a gain of $6.6 million. During the first six months of fiscal 2010, we also recognized a gain of $0.6 million related to the sales of direct investments that were previously fully impaired.

During the second quarter and first six months of fiscal 2009, we recorded other-than-temporary impairment charges of $1.4 million and $3.1 million, respectively, related to our ARSs.

Interest expense and other, net for the second quarter and first six months of fiscal 2010 decreased compared to the respective prior year periods due primarily to the Debenture repurchase in fiscal 2009, which resulted in lower interest expense. In the first six months of fiscal 2010, interest expense and other, net was comprised primarily of losses associated with our equity investment in Open Invention Network, LLC (“OIN”).

Income Tax Expense

 

             Three months ended                           Six months ended               

(Dollars in thousands)

       April 30,    
2010
        April 30,    
2009
      Change          April 30,    
2010
        April 30,    
2009
      Change  

Income tax expense

   $ 5,177      $ 2,777      86%     $ 13,083      $ 9,144      43% 

Effective tax rate

     21     16        25     27  

The effective tax rate for the second quarter of fiscal 2010 was 21%, compared to an effective tax rate of 16% for the prior year period primarily due to a benefit from discrete tax items in the prior year period and a shift in jurisdictional earnings. The effective tax rate for the first six months of fiscal 2010 was 25%, compared to an effective tax rate of 27% for the prior year period primarily due to a shift in jurisdictional earnings.

The effective tax rates for the second quarter and first six months of fiscal 2010 differ from the federal statutory rate of 35% primarily due to the effects of stock-based compensation, differences between the book and tax treatment of certain income items on which a valuation allowance has been recorded, and the jurisdictional mix of earnings.

Net Income Components

 

                 Three months  ended                            Six months  ended            

(In thousands)

       April 30,    
2010
       April 30,    
2009
       April 30,    
2010
       April 30,    
2009

Income from continuing operations

   $ 19,912    $ 15,051    $ 40,101    $ 24,692

Income from discontinued operations

          566           1,602
                           

Net income

   $ 19,912    $ 15,617    $ 40,101    $ 26,294
                           

Discontinued operations for the second quarter and first six months of fiscal 2009 relates to the gains from the sale in March 2007 of our Salmon Ltd. subsidiary as they met certain cumulative revenue targets. No further gains are anticipated from this sale.

 

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NOVELL, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – (Continued)

 

Liquidity and Capital Resources

The balance in cash, cash equivalents, and short-term investments and the balance as a percent of total assets are as follows:

 

(Dollars in thousands)

       April 30,    
2010
        October 31,    
2009
      Change  

Cash, cash equivalents, and short-term investments

   $ 979,586      $ 983,465      —% 

Percent of total assets

     54     52  

An overview of the significant cash flow activities for the first six months of fiscal 2010 and 2009 is as follows:

 

                 Six months  ended              

(In thousands)

   April 30,
2010
    April 30,
2009
 

Net cash used in operating activities

   $ (2,198   $ (13,097

Purchases of property, plant and equipment

     (13,432     (6,582

Proceeds from sales of and distributions from long-term investments

     8,629        1,736   

Net cash paid for acquisitions

            (48,472

Cash used in operating activities during the first six months of fiscal 2010 was $2.2 million. Cash used in operating activities during the first six months of fiscal 2009 was $13.1 million and included the receipt of $25.0 million from Microsoft for the first payment under the August 2008 agreement to purchase additional SLES certificates.

As of April 30, 2010, we had cash, cash equivalents, and short-term investments of $445.7 million held in accounts outside the United States, which would largely be subject to taxation if repatriated. Our short-term investment portfolio is diversified among security types, industry groups, and individual issuers. As of April 30, 2010, our short-term investment portfolio includes gross unrealized gains and losses of $5.9 million and $0.3 million, respectively.

During the first six months of fiscal 2010 and 2009, the U.S. dollar value of our foreign-denominated cash and cash equivalent holdings decreased by a net $6.9 million and $0.5 million, respectively. The decrease in fiscal 2010 resulted from the strengthening of the U.S. dollar against certain foreign currencies, primarily the Euro. As foreign currency exchange rates continue to fluctuate, especially the Euro, we may see further changes in the U.S. dollar value of our foreign-denominated cash and cash equivalent holdings.

Purchases of property, plant and equipment increased in the first six months of fiscal 2010 compared to the prior year period primarily as a result of our SAP customer relationship management software implementation, which was completed in the second quarter of fiscal 2010. This software implementation is for internal use only.

During the first six months of fiscal 2010, we sold our remaining ARSs with a book value of $5.6 million for $12.2 million, resulting in a gain of $6.6 million. During the first six months of fiscal 2010, we also recognized a gain of $0.6 million related to the sales of direct investments that were previously fully impaired. These gains are shown as a component of the line item “Gain on sale of previously impaired investments, net” in our consolidated statements of operations.

In relation to the appeal we filed in the Amer Jneid legal matter, we were required by the court to post a $51.5 million bond during fiscal 2008 (See Note I, “Legal Proceedings”). The amount of the bond was determined by statutory regulations and has no connection to the amount we believe may ultimately be paid in this matter. The bond is held in an interest-bearing account in our name, but is restricted and classified as such in our consolidated balance sheets. As of April 30, 2010, our restricted cash balance was $53.1 million. In May 2010, $35.3 million of the bond amount was returned to us and we anticipate that the remaining amount of the bond will be released by the trial court.

According to the terms of the agreement under which we have a $20.0 million or 17% interest in OIN, we could be required to make future cash contributions, which we would fund with cash from operating activities and cash on hand.

During fiscal 2008, our Board of Directors authorized the repurchase of up to $100 million of our outstanding common stock. There is no fixed termination date for the repurchase program. There were no repurchases under the program during the second quarters or first six months of fiscal 2010 or 2009. As of April 30, 2010, $33.2 million remains available to be used for repurchasing common stock under the current Board authorization.

 

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NOVELL, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – (Continued)

Liquidity and Capital Resources (Continued)

 

There have been no significant changes to our contractual obligations as disclosed in our fiscal 2009 Annual Report on Form 10-K.

Our principal sources of liquidity continue to be from operating activities, cash on hand, and short-term investments. Our liquidity needs for the next twelve months and beyond are principally for the financing of fixed assets, repurchases of common stock under our share repurchase plan, payments under prior restructuring plans, product development investments, and maintaining flexibility in a dynamic and competitive operating environment.

Barring unforeseen circumstances, we anticipate being able to fund these liquidity needs for the next twelve months with existing cash, cash equivalents, and short-term investments together with cash generated from operating activities and investment income.

Off-Balance Sheet Arrangements

At April 30, 2010, we had no off-balance sheet arrangements as defined by applicable SEC rules.

Recent Pronouncements

In June 2009, the Financial Accounting Standards Board (“FASB”) issued new guidance to replace the quantitative-based risks and rewards calculation for initially determining which enterprise, if any, has a controlling financial interest in, and will be required to consolidate, a variable interest entity. A variable interest entity is defined as an entity that will need additional funding to operate. Companies are now required to follow a more qualitative approach, focused on identifying which enterprise has the power to direct the activities of the variable interest entity that most significantly impacts the variable interest entity’s economic performance. Companies are also required to perform ongoing assessments of which enterprise, if any, will have to consolidate the variable interest entity. Additional disclosures are also required. This guidance is effective for fiscal years beginning after November 15, 2009 (our fiscal 2011). Currently, the impact of this pronouncement on our financial position and results of operations is anticipated to be immaterial.

In January 2010, the FASB issued updated guidance to improve disclosures regarding fair value measurements. This update requires entities to 1) disclose separately the amounts of significant transfers in and out of level 1 and level 2 fair value measurements and describe the reasons for the transfers and 2) present separately (i.e. on a gross basis rather than as a net amount), information about purchases, sales, issuances, and settlements in the roll forward of changes in level 3 fair value measurements. The update requires fair value disclosures by class of assets and liabilities rather than by major category or line item in the statement of financial position. Disclosures regarding the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements for assets and liabilities in both level 2 and level 3 are also required. For all portions of the update except the gross presentation of activity in the level 3 roll forward, this standard is effective for interim and annual reporting periods beginning after December 15, 2009 (the second quarter of our fiscal 2010, which is when we implemented this standard). For the gross presentation of activity in the level 3 roll forward, this guidance is effective for fiscal years beginning after December 15, 2010 (our fiscal 2012). As this guidance is only disclosure-related, and we currently do not have any level 3 fair value measurements, it is presently anticipated that this guidance will not have an impact on our financial position and results of operations.

In January 2009, the SEC issued its final rules requiring public companies to provide their financial statements and financial statement schedules to the SEC and on their corporate websites in interactive data format using eXtensible Business Reporting Language (“XBRL”). XBRL is a standardized, machine-readable language designed to enhance the electronic communication of business information and should make business information more accessible. These rules will not change the SEC’s existing requirement to provide financial statements in the traditional format. Under these rules, we will be required to file our financial statements for the third quarter of fiscal 2010 using XBRL, in addition to our traditional filing format.

 

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NOVELL, INC.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Foreign currency exchange rate fluctuations, as measured using prior period foreign currency exchange rates on non-U.S. dollar denominated revenue, favorably impacted revenue by $2.0 million, unfavorably impacted operating expenses by $5.6 million and unfavorably impacted income from operations by $3.6 million during the second quarter of fiscal 2010. Foreign currency exchange rate fluctuations favorably impacted revenue by $2.9 million, unfavorably impacted operating expenses by $12.3 million and unfavorably impacted income from operations by $9.4 million during the first six months of fiscal 2010.

During the first six months of fiscal 2010 and 2009, the U.S. dollar value of our foreign-denominated cash and cash equivalent holdings decreased by a net $6.9 million and $0.5 million, respectively. The decrease in fiscal 2010 resulted from the strengthening of the U.S. dollar against certain foreign currencies, primarily the Euro. As foreign currency exchange rates continue to fluctuate, especially the Euro, we may see further changes in the U.S. dollar value of our foreign-denominated cash and cash equivalent holdings.

Since a large portion of our recognized revenue is deferred revenue that was recorded at different foreign currency exchange rates, the impact to revenue of changes in foreign currency exchange rates is recognized over time, whereas the impact to expenses is more immediate, as expenses are recognized at the current foreign currency exchange rate in effect at the time the expense is incurred.

Apart from the above, there have been no significant changes in our interest rate risk and market risk exposures and procedures or in our foreign currency hedging procedures during the second quarter or first six months of fiscal 2010 as compared to the respective risk exposures and procedures disclosed in Management’s Discussion and Analysis of Financial Condition and Results of Operations, set forth in Part II Item 7A, in our Annual Report on Form 10-K for the fiscal year ended October 31, 2009.

Item 4. Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures, as of the end of the period covered by this report, (i) were appropriately designed to provide reasonable assurance of achieving their objectives and (ii) were effective and provided reasonable assurance that the information required to be disclosed by us in reports filed under the Securities Exchange Act of 1934, as amended, is (a) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (b) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

(b) Change in Internal Control over Financial Reporting

No change in our internal control over financial reporting occurred during our second quarter of fiscal 2010 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II — OTHER INFORMATION

Part II. — Other Information

Except as listed below, other items in Part II are omitted because the items are inapplicable or require no response.

Item 1. Legal Proceedings

The information required by this item is incorporated herein by reference from Note I of our financial statements contained in Part I, Item 1 of this Form 10-Q.

Item 1A. Risk Factors

Our Board of Directors has authorized a thorough review of various alternatives to enhance stockholder value. As a result of the uncertainty associated with these recent company developments, our business may be negatively impacted.

On March 2, 2010, we announced the receipt of an unsolicited, conditional proposal from Elliott Associates, L.P. (“Elliott”) to acquire us for $5.75 per share in cash. On March 20, 2010, we announced that our Board of Directors concluded, after careful consideration, including a review of the proposal with our independent financial and legal advisors, that the Elliott proposal was inadequate and that it undervalued our franchise and growth prospects. We also announced that our Board authorized a thorough review of various alternatives to enhance stockholder value that include, but are not limited to, a return of capital to stockholders through a stock repurchase or cash dividend, strategic partnerships and alliances, joint ventures, a recapitalization and a sale of the company.

There can be no assurances as to the outcome of the review undertaken by our Board. In the event that the Board determines to engage in a particular course of action, the result and success of that course of action cannot be assured and could negatively affect our stock price. Our stock price may also fluctuate as a result of actual or speculated developments with respect to the review process. The review process may become a distraction for our management and employees and may require the expenditure of significant time and financial resources. The resulting uncertainty may adversely affect our ability to hire new talent, retain key employees, and grow and enhance our business. We believe that the uncertainty associated with these recent company developments negatively affected operating results in the second quarter of fiscal 2010 and may continue to adversely affect operating results. These consequences, alone or in combination, may harm our business and have a material adverse effect on our financial condition and the results of our operations.

We may not be able to attract and retain new customers through indirect sales, which may result in decreased or fluctuating revenue. In addition, our reliance on an indirect sales channel for the distribution of our products could adversely affect the sales of our products.

Our ability to attract and retain new customers and achieve significant revenue growth in the future will depend in large part on our ability to continue to establish and maintain strategic distribution and other collaborative relationships with industry-leading hardware manufacturers, distributors, software vendors and enterprise solutions providers such as Microsoft, SAP, ACS, Dell, HP, IBM, Cap Gemini, Atos Origin, Accenture, Verizon Business and other third parties that are willing to recommend, design and implement solutions that include our products. These relationships create the potential to distribute our products to a much larger customer base than we would otherwise be able to reach through our direct sales and marketing efforts. We are currently investing, and plan to continue to invest, significant resources to maintain and further develop these distribution relationships.

The reliance and the distribution of our products through indirect channel partners presents a number of special risks, including but not limited to:

 

 

 

our ability to retain or attract a sufficient number of existing or future distribution partners;

 

 

our lack of control over the delivery of our products to end-users;

 

 

the ability of resellers and distributors to terminate their relationships with us on short notice;

 

 

the failure of our indirect channel partners to recommend, or continue to recommend, or support our products effectively or to release their products in which our products are embedded in a timely manner;

 

 

our inability to effectively manage conflicts between our indirect channel partners and the end-users of our products;

 

 

the impact of economic conditions or industry demand on our indirect channel partners; and

 

 

the failure of indirect channel partners to devote sufficient resources to marketing and supporting our products.

 

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RISK FACTORS (Continued)

 

Our inability to establish or maintain successful relationships with distribution partners could have a material adverse effect on our business, financial condition, and operating results. In addition, revenues derived from indirect channel partners may fluctuate significantly, which could have a material adverse effect on our business, financial condition, and operating results.

If our Security, Management and Operating Platforms business unit segment does not grow at the rate we anticipate, or if the growth rate declines, our financial results, including cash flow, will be negatively impacted.

Our near-term growth strategy focuses on our Security, Management and Operating Platforms business unit segment, which serves the Intelligent Workload Management (“IWM”) market. We have focused on this business because we believe that it represents the best current opportunity for us to profitably grow our revenue. Our ability to achieve success with this strategy is dependent on a number of factors including, but not limited to, the following:

 

 

 

the growth of this market;

 

 

our development of key products and upgrades;

 

 

delivery of product milestones in a timely manner;

 

 

the acceptance of our products particularly by enterprise companies, large industry partners and major accounts;

 

 

the decisions by customers to upgrade from older versions of our products to newer versions; and

 

 

the attractiveness of our products to current and future distribution partners.

If this business unit segment does not grow at the rates we anticipate or declines, our business, financial condition, and operating results could be adversely affected.

Our inability to renew SLES subscriptions with those customers who have received SLES certificates from Microsoft, or renewals of such subscriptions at deeply discounted rates, or failure to maintain our channel partnership with Microsoft at historical levels, could adversely affect our future sales and profitability.

The Microsoft Agreements have been a significant contributor to our product revenue and the increase in our gross and operating margins over the past few years. Most of the Microsoft SLES certificate sales have been three-year arrangements that began to expire in the first quarter of fiscal 2010. Accordingly, the ongoing financial benefit of the Microsoft Agreements will depend on our ability to renew SLES subscriptions with those customers who received SLES certificates from Microsoft and the pricing we are able to obtain in connection with such renewals. If we are unable to renew the SLES subscriptions as they expire, or if renewed subscriptions are at a lower price than Microsoft paid us for the SLES certificates, our financial results could be adversely affected. In addition, if Microsoft does not acquire additional SLES certificates, ceases to distribute SLES certificates, diminishes its marketing efforts in relation to SLES certificates, or significantly discounts SLES certificates upon distribution, our financial results could be adversely affected. There can be no assurance that Microsoft will continue to operate as a distribution partner for us after our agreement with Microsoft expires or terminates, or that the channel partnership will be maintained at historical levels.

Microsoft also provides funding for development to enable interoperability between our respective platforms. There can be no assurance that Microsoft will continue to fund development efforts after our agreement with Microsoft expires or terminates. If funding were reduced or terminated, the rate of interoperability development could be affected, which could adversely affect SLES revenues and our financial results.

Our OES and NetWare-related revenue stream may decline at accelerated rates which would adversely affect our business, operating results and cash flow.

Sales of our OES and NetWare-related products have been declining for many years and declines at accelerated rates could offset or out-pace any growth in sales of our other products. We terminated general support of our NetWare products beginning in March 2010. While customers are eligible to receive extended support for NetWare, some NetWare customers may migrate to a competing platform which would negatively impact our revenue. Our strategy is to stabilize these sales declines to the extent practicable with new product releases and other efforts; however, combined OES and NetWare-related product revenue declined by $5.4 million, or 6%, in the first six months of fiscal 2010, compared to the prior year period. If our strategy is unsuccessful, our combined OES and NetWare-related revenue stream may decline more rapidly than any growth of other revenue streams from our other products, which could have a material adverse effect on our business, financial condition, and operating results.

 

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RISK FACTORS (Continued)

 

If we are unable to develop new and enhanced products and services that achieve widespread market acceptance, or if we are unable to continually improve the performance, features, and reliability of our existing products and services or adapt our business model to keep pace with industry trends, our business and operating results would be adversely affected.

Our success depends on our ability to respond to the rapidly changing needs of our customers by developing or introducing new products, product upgrades, and services on a timely basis. We have in the past incurred, and will continue to incur, significant research and development expenses as we strive to remain competitive. New product development and introduction involves a significant commitment of time and resources and is subject to a number of risks and challenges including:

 

 

 

managing the length of the development cycle for new products and product enhancements, which has frequently been longer than we originally estimated;

 

 

adapting to emerging and evolving industry standards and to technological developments by our competitors and customers;

 

 

entering into new or unproven markets with which we have limited experience;

 

 

shifting our skill set to new strategic areas;

 

 

managing new product and service strategies;

 

 

incorporating acquired products and technologies; and

 

 

developing or expanding efficient sales channels.

If we are not successful in managing these risks and challenges, or if our new products, product upgrades, and services are not technologically competitive or do not achieve market acceptance, our business and operating results would be adversely affected.

The success of our Intelligent Workload Management strategy is contingent upon the realization and development of the IWM market.

Our IWM strategy is intended to enable computing resources to be managed and optimized in a policy-driven, secure, and compliant manner across physical, virtual, and cloud environments. Although we have encountered interest in IWM-oriented products, the IWM market is nascent and developing. It is difficult to accurately predict the scale of the IWM market, the timing of development of the IWM market, and our ability to penetrate the IWM market. While we anticipate differentiable solutions that will be attractive to many customers within the IWM market, we are investing at an early stage and success in the IWM market, if achieved, would require time and resources. It is uncertain whether or when the IWM market will realize its potential, as well as the extent and timing of our impact within the IWM market. We also expect other enterprise software vendors to enter the IWM market with solutions that will directly compete with our offerings. Our ability to capture market share will depend on the relative timing of product offerings; capabilities, design and functionality of our products relative to products of our competitors; and strategic fit of our products within the IWM market.

Our software may have vulnerabilities, defects and errors, which may lead to a loss of revenue or product liability claims.

Software products are internally complex and occasionally contain defects or errors, especially when first introduced or when new versions or enhancements are released. Despite extensive testing, we may not detect defects or errors in our new products, platforms or product enhancements until after we have commenced commercial shipments. If defects or errors, including security flaws or incompatibilities, are discovered in our existing or acquired products, platforms or product enhancements, then potential customers may delay or forego purchases; our reputation in the marketplace may be damaged; we may incur additional service and warranty costs; and we may have to divert additional development resources to correct the defects or errors. If any or all of the foregoing occur, we may lose revenues or incur higher operating expenses and lose market share, any of which could severely harm our financial condition and operating results.

 

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RISK FACTORS (Continued)

 

We have experienced, and may continue to experience, delays in the introduction of new products due to various factors, which result in lost revenue.

In the past, we have experienced delays in the introduction of new products due to a number of factors including: the complexity of software products, the need for extensive testing of software to ensure compatibility of new releases with a wide variety of application software and hardware devices, the need to ensure quality of products prior to extensive distribution, and with regard to our open source products, our continuing reliance on the work of third parties not employed by us. Our open source offerings depend to a large extent on the efforts of developers not employed by us for the creation and modification of open source technologies. For example, Linus Torvalds, the original developer of the Linux kernel, and a small group of engineers, many of whom are not employed by us, are primarily responsible for the development and evolution of the Linux kernel that is a key component of our OES and SUSE Linux Enterprise offerings. The timing and nature of new releases of the Linux kernel are controlled by these third parties. Delays in developing, completing, or shipping new or enhanced products could continue to result in delayed or reduced revenue for those products and could adversely impact customer acceptance of those offerings.

Our inability to rely on software licensed from third parties, including open source contributions of third-party programmers and corporations, would adversely affect our business and operating results.

We use various types of software licensed from unaffiliated third parties. Our open source offerings, for example, are primarily comprised of open source components developed by independent third parties over whom we exercise no control. The collective licenses to third-party technologies are critical to our business. If we are unable to maintain licenses to third-party materials, our distribution of relevant offerings may be delayed until we are able to develop, license, or acquire replacement technologies. Such a delay could have a material adverse impact on our business.

If key developers or a significant percentage of developers or corporations decide to cease development of the Linux kernel or other open source software, or if we are unable to maintain licenses to proprietary software or such software is no longer available to us on commercially reasonable terms, we would have to either rely on another party (or parties) to develop these technologies, develop them ourselves, or adapt our product strategy accordingly. This could increase our development expenses, delay our product releases and upgrades, and adversely impact customer acceptance of our relevant offerings.

In addition, we may be unable to predict the future course of open source technology development, which could impact the market appeal of our products as well as our reputation.

Because of the characteristics of open source software, there are few technology barriers to entry in the open source market by new competitors and it may be relatively easy for new competitors with greater resources than we have to enter our markets and compete with us.

One of the characteristics of open source software is that any open source licensee can modify the existing software or develop new software that competes with existing open source software. Such competition can develop without the degree of overhead and lead time required by traditional proprietary software companies. It is possible for new competitors with greater resources than ours to develop their own open source solutions, potentially reducing the demand for, and putting price pressure on, our solutions. In addition, some competitors make their open source software available for free download and use, or may position their open source software as a loss leader. We cannot guarantee that we will be able to compete successfully against current and future competitors or that competitive pressure and/or the availability of open source software will not result in price reductions, reduced operating margins and loss of market share, any one of which could seriously harm our business.

If our customers do not renew their maintenance and subscription agreements with us, our operating results may be adversely impacted.

Our customers may elect not to renew their maintenance and subscriptions for our service after expiration of their agreements. In addition, our customers may opt for a lower priced service option. Our customers’ renewal rates may decline or fluctuate as a result of a number of factors, including their level of satisfaction with our services and their ability to continue their operations and spending levels. Renewal rates may also decline as a result of elections by customers to use our products on an unsupported basis. If we experience a decline in the renewal rates for our customers or they opt for a lower priced service option or fewer subscriptions, our operating results may be adversely impacted.

 

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RISK FACTORS (Continued)

 

Uncertain economic conditions and reductions in IT spending could adversely affect our business, financial condition, and operating results.

In the past, unfavorable or uncertain economic conditions have resulted in reduced global IT spending rates that have adversely affected the markets in which we do business. While the economy has shown signs of improvement, there has been renewed concern about the strength and sustainability of a recovery, particularly given recent events in Europe, which has been impacted by the risk of sovereign debt defaults in certain European Union countries. Accordingly, current and/or future weakness in the United States economy and/or in the economies of the other geographic regions in which we operate could have a negative impact on our revenues and operating results. For example, in fiscal 2009, as a result of company trends and economic uncertainty, management reduced its long-range revenue growth plans, resulting in the impairment of $270.0 million of goodwill related to our Systems and Resource Management reporting unit. While we are unable to accurately predict changes in general economic conditions and how the current global financial and market conditions will affect global IT spending rates, we believe that there is always the potential for a slowdown in global IT spending. This could result in reductions in sales of our products, longer sales cycles, slower adoption of new technologies, and increased price competition. Any of these events would likely harm our business, financial condition, and operating results.

We may not be able to successfully compete in a challenging market for infrastructure software services.

The industries in which we compete are highly competitive, and customer requirements evolve rapidly. We expect competition to continue to increase both from existing competitors and from new market entrants. Our competitors of the Security, Management and Operating Platforms business unit segment include, but are not limited to, Microsoft, IBM, Oracle, Sun, HP, Symantec, BMC Software, Inc., VMware, Inc., Computer Associates, Arcsight, Citrix, and Red Hat. Our primary competitors for the Collaboration Solutions business unit segment include, but are not limited to, Microsoft, IBM, and Google. Many of our competitors have greater financial, technical and marketing resources than we have. We believe that competitive factors common to both of our segments include:

 

 

 

the pricing of products and services as well as pricing strategies;

 

 

the availability of open source or free-ware alternatives;

 

 

the timing and market acceptance of new products;

 

 

brand and product awareness;

 

 

the performance, reliability and security of products;

 

 

the ability to preserve an existing customer base;

 

 

the impact of current macroeconomic conditions;

 

 

the ability to establish and maintain key strategic relationships with distributors, resellers, and other partners; and

 

 

the ability to attract and retain highly qualified development, services, and managerial personnel.

Our inability to maintain a strong brand could impact our future success.

We believe that the future success of our business depends on our ability to maintain and enhance our brand, and expand brand awareness into emerging strategic markets. If we fail to promote and maintain our brand, we may not be able to expand our customer base or attract talented employees, and our business, financial condition, and operating results could be materially and adversely affected.

Our inability to meet customer demand for technical support services could adversely affect our customer relationships.

We offer technical support services with many of our products. There may be situations where we are unable to respond adequately to accommodate short-term increases in customer demand for support services. We also may be unable to modify the format of our support services to compete with changes in support services provided by our competitors. Any failure to maintain adequate customer support could cause customer dissatisfaction, result in reduced sales of products and reductions in the renewals of software maintenance and support agreements, and, accordingly, have a material adverse affect on our business, financial condition, and operating results.

 

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RISK FACTORS (Continued)

 

Our professional services clients may cancel or reduce the scope of their engagements with us on short notice.

If our clients cancel or reduce the scope of a professional services engagement, we may be unable to reassign our professionals to new engagements without delay. Because these expenses are relatively fixed, and because we establish the levels of these expenses well in advance of any particular quarter, cancellations or reductions in the scope of client engagements could result in the under-utilization of our professional services employees, leading to reduced profitability.

We are vulnerable to system failures, which could harm our reputation and business.

Although we have outsourced much of our internal IT services, we are still vulnerable to system failures. We rely on our technology infrastructure and outsourcing partner, among other functions, to sell our products and services, support our partners, fulfill orders and bill, collect and make payments. Our systems are vulnerable to damage or interruption from natural disasters, power loss, telecommunication failures, terrorist attacks, computer intrusions and viruses, computer denial-of-service attacks and other events. A significant number of our systems are not redundant, and our disaster recovery planning is not sufficient to address every eventuality. Our systems are also subject to break-ins, sabotage and intentional acts of vandalism by internal employees, contractors and third-parties. Despite any precautions we may take, such problems could result in, among other consequences, interruptions in our services, which could harm our reputation, business and financial condition. We do not carry business interruption insurance sufficient to protect us from all losses that may result from interruptions in our services as a result of system failures or to cover all contingencies.

The success of our acquisitions is dependent on our ability to integrate personnel, operations, and technology, and if we are not successful, our financial and operating results may be adversely affected.

Achieving the benefits of acquisitions depends on the successful integration of personnel, operations and technology. The integration of acquisitions is subject to risks and requires significant expenditure of time and resources. During fiscal 2009, we made two acquisitions. The most recent acquisition was completed in February 2009. The challenges involved in integrating acquisitions include the following:

 

 

 

obtaining synergies from the companies’ organizations and service and product offerings effectively and quickly;

 

 

bringing together marketing efforts so that the market receives useful information about the combined companies and their products;

 

 

coordinating sales efforts so that customers can do business easily with the combined companies;

 

 

integrating product offerings, technology, back office, human resources, and accounting and financial systems;

 

 

assimilating employees with diverse corporate cultural backgrounds into a common business culture revolving around our corporate strategy; and

 

 

retaining key officers and employees who possess the necessary skills and experience to quickly and effectively transition and integrate the businesses.

Failure to effectively and timely complete the integration of acquisitions could materially harm the business and operating results of the combined companies. Furthermore, we may assume significant liabilities in connection with acquisitions and/or incur substantial accounting charges for restructuring and related expenses, the write-off of purchased in-process research and development, impairment of goodwill and intangible assets, and stock-based compensation expense. Using our cash for acquisitions may prevent us from pursuing other business opportunities. For example, during fiscal 2009 it was determined that $270.0 million of our goodwill, and $5.7 million of PlateSpin’s and $3.4 million of Managed Objects’ developed technology and customer relationship intangible assets were impaired.

The consolidation of our industry may adversely affect our acquisition program.

We believe that the software industry will continue to undergo considerable consolidation and changes during the next several years. This consolidation could increase the competition we face to acquire businesses and increase the prices we must pay for the businesses that we acquire. In response to this consolidation, we consider from time to time additional strategies to enhance stockholder value. In considering various strategies, we evaluate the consequences, including, among other things, the implications to our liquidity and capital structure, tax effects and accounting consequences, any of which could have a material adverse impact on our financial condition.

 

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RISK FACTORS (Continued)

 

The risks associated with conducting a global business could adversely affect our results.

We are a global corporation with subsidiaries, offices and employees around the world and, as such, we face certain risks in doing business abroad that we do not face domestically. Risks inherent in transacting business internationally could negatively impact our operating results, including:

 

 

 

costs and difficulties in staffing and managing international operations;

 

 

unexpected changes in regulatory requirements;

 

 

tariffs and other trade barriers;

 

 

difficulties in enforcing contractual and intellectual property rights;

 

 

longer payment cycles;

 

 

local political and economic conditions;

 

 

potentially adverse tax consequences, including restrictions on repatriating earnings and the threat of “double taxation”; and

 

 

fluctuations in foreign currency exchange rates, which can affect demand, increase our costs and affect our net income.

Increasing our foreign research and development operations exposes us to risks that are beyond our control and could affect our ability to operate successfully.

In order to enhance the cost-effectiveness of our operations, we have shifted portions of our research and development operations to jurisdictions outside of the United States. The transition of even a portion of our research and development operations to a foreign country involves a number of logistical and technical challenges that could result in product development delays and operational interruptions, which could reduce our revenues and adversely affect our business. We may encounter complications associated with the set-up, migration and operation of business systems and equipment in expanded or new facilities. This could result in delays in our research and development efforts and otherwise disrupt our operations. If such delays or disruptions occur, they could damage our reputation and otherwise adversely affect our business, financial condition, and operating results.

We cannot be certain that any shifts in our operations to offshore jurisdictions will ultimately produce sustained cost savings. We cannot predict the extent of government support, availability of qualified workers, future labor rates, or monetary and economic conditions in any offshore location where we may operate.

The relocation of labor resources may have a negative impact on our existing employees, which could negatively impact our operations. In addition, we will likely be faced with competition in these offshore markets for qualified personnel, including skilled design and technical personnel, and we expect this competition to increase as other companies expand their operations offshore. If the supply of qualified personnel becomes limited due to increased competition or otherwise, it could increase our costs and employee turnover rates.

We may not be able to attract and retain qualified personnel because of the intense competition for qualified personnel in the software industry. Furthermore, the loss of certain key individuals could adversely affect our performance and could have a material adverse affect on our business, financial condition, and operating results.

Our ability to maintain and enhance our competitive technological position depends, in large part, on our ability to attract and retain highly qualified development, services, and managerial personnel. Furthermore, our future success depends on the services and effectiveness of a number of key officers and employees, including our CEO. Competition for personnel of the highest caliber is intense in the software industry. The loss of the technical knowledge and industry expertise of certain key individuals could seriously impede our success. Moreover, the loss of these individuals, particularly to a competitor, some of which may be in a position to offer greater compensation, and any resulting loss of customers or market confidence could reduce our market share, diminish our brand and adversely affect our business. The uncertainty associated with our Board’s review of various alternatives to enhance stockholder value may enhance attrition and impact our ability to attract qualified replacement candidates. If we do not succeed in retaining and motivating our key employees, and attracting new key personnel, our business, its financial performance and our stock price may decline.

 

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RISK FACTORS (Continued)

 

If third parties claim that we infringed their intellectual property, our ability to use some technologies and products could be limited and we may incur significant costs to resolve these claims.

Litigation regarding intellectual property rights is common in the software industry. We have from time to time received letters or been the subject of claims suggesting that we are infringing the intellectual property rights of others. In addition, we have faced and expect to continue to face from time to time disputes over rights and obligations concerning intellectual property, including with respect to third party proprietary and open source components. The cost and time of defending ourselves can be significant. If an infringement claim is successful, we and our customers may be required to obtain one or more licenses from third parties, and we may be obligated to pay or reimburse our customers for monetary damages. In such instances, we or our customers may not be able to obtain necessary licenses from third parties at a reasonable cost or at all, and may face delays in product shipment while developing or arranging for alternative technologies, which could adversely affect our operating results.

In the event claims for indemnification are brought for intellectual property infringement, we could incur significant expenses, thereby adversely affecting our operating results.

We indemnify customers against certain claims that our products, including open source components thereof, infringe the intellectual property rights of others. Although indemnification programs for proprietary software are common in our industry, indemnification programs that cover open source software are less so. In the event that we are required to indemnify our customers against claims for intellectual property infringement, we could incur significant expense reimbursing customers for their legal costs and, in the event those claims are successful, for damages.

Legal actions taken by claimants alleging intellectual property infringement could adversely affect our revenue and business plan if these legal actions cause a reduction in demand for our SUSE Linux and Ximian® products.

In January 2004, The SCO Group, Inc. (“SCO”) filed suit against us in Utah State Court and the case was later removed to the U.S. District Court in Utah (See Part I, Item 1, Note I, “Legal Proceedings,” in the consolidated financial statements). SCO’s complaint asserted ownership of UNIX copyrights and further alleged that our public statements and filings regarding the ownership of the copyrights in UNIX have harmed SCO’s business reputation and affected its efforts to protect its ownership interest in UNIX and UnixWare. In August 2007, the U.S. District Court granted us summary judgment against SCO, concluding that we retained ownership of the UNIX copyrights, and dismissed SCO’s claims against us. In August 2009, the Tenth Circuit Court of Appeals issued an opinion that reversed in part and affirmed in part the Trial Court’s decision. In March 2010, we received a favorable jury verdict concluding that we had not transferred the UNIX copyrights and, therefore, defeated SCO’s damage claims against us. Although the jury verdict is a significant win for us, SCO’s remaining claims, including whether SCO is entitled to an immediate transfer of certain UNIX copyrights, must still be determined by the U.S. District Court. If SCO is able to succeed on such remaining claims, our future revenue and business plans associated with our SUSE Linux and Ximian products could be adversely affected.

We may not be able to protect our confidential information, and this could adversely affect our business.

We generally enter into contractual relationships with our employees and third parties to protect our confidential information. The misappropriation of our trade secrets or other proprietary information could harm our business. In addition, we may not be able to timely detect unauthorized use of our intellectual property and take appropriate steps to enforce our rights. In the event we are unable to enforce these contractual obligations and our intellectual property rights, our business could be adversely affected.

Litigation matters related to or arising out of our historical stock-based compensation practices could have a material adverse effect on our business, financial condition, operating results and cash flows.

As discussed in Part I, Item 1, Note I, “Legal Proceedings,” of this report, derivative actions were filed against us and our current and former officers and directors relating to our historical stock-based compensation practices. In addition, two separate lawsuits have been filed against our current Board of Directors in connection with the Elliott proposal. No assurance can be given regarding the outcome of these litigation matters or any possible government actions relating to our historical stock-based compensation practices. The resolution of such matters may be time consuming and expensive, and may distract management from the conduct of our business. Furthermore, if we are subject to adverse findings in litigation actions, we could be required to pay damages or penalties or have other remedies imposed, which could harm our business, financial condition, operating results and cash flows.

 

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RISK FACTORS (Continued)

 

Failure to maintain effective internal controls over financial reporting could have a material adverse effect on our business, operating results and stock price.

We must continue to document and test our internal controls over financial reporting in order to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 (“Section 404”), which requires an annual management assessment of the effectiveness of our internal controls over financial reporting and a report by our independent registered public accounting firm addressing this assessment. During the course of our documentation and testing we may identify deficiencies that we may not be able to remediate in time to meet the deadlines imposed by Section 404 for continuing compliance with the requirements of Section 404. If we fail to maintain the adequacy of our internal controls, as such standards are modified, supplemented or amended from time to time, we and/or our independent registered public accounting firm may not be able to conclude at each fiscal year-end that we have effective internal controls over financial reporting in accordance with Section 404. In addition, we may incur increased costs in order to address the requirements of Section 404. The extent and timing of incurrence of any such costs is difficult to predict. Moreover, effective internal controls, particularly those related to revenue recognition, are necessary for us to produce reliable financial reports and are important to helping prevent financial fraud. If, in any year, we and/or our independent registered public accounting firm cannot attest that we have effective internal controls over financial reporting in accordance with Section 404, our business and operating results could be harmed and result in a negative market reaction.

Our financial and operating results may fluctuate from quarter to quarter, which may cause the price of our common stock to decline.

Our financial and operating results may fluctuate from quarter to quarter due to a variety of factors including, but not limited to:

 

 

 

the timing of orders from customers and shipments to customers;

 

 

the decisions of our current and future customers not to renew their subscription agreements with us;

 

 

the impact of foreign currency exchange rates on the price of our products in international locations;

 

 

the inability to respond to the decline in revenue through the distribution channel; and

 

 

the inability to deliver products that are satisfactory to our customers and distribution partners.

In addition, we often experience a higher volume of revenue at the end of each quarter. Because of this, fixed costs that are not appropriate for prevailing revenue levels may not be detected until late in any given quarter and operating results could be adversely affected. Due to these factors or other unanticipated events, our financial and operating results in any one quarter may not be a reliable indicator of our future performance.

During fiscal 2009 we recorded goodwill impairment charges of $270.0 million. If our goodwill or intangible assets become further impaired, we may be required to record a significant charge to earnings.

Under generally accepted accounting principles, we review our intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. Goodwill is tested for impairment at least annually. In determining whether an asset is impaired, we must make assumptions regarding recoverability of costs, estimated future cash flows from the asset, intended use of the asset and other related factors. Fair values are estimated using the combination of a discounted cash flow methodology and a market analysis and weighting the results. Factors that may be considered a change in circumstances, indicating that the carrying value of our goodwill or amortizable intangible assets may not be recoverable, include a decline in stock price and market capitalization, reduced future cash flow estimates, and slower growth rates in our industry. We may be required to record a significant charge in our financial statements during the period in which any impairment of our goodwill or amortizable intangible assets is determined, negatively impacting our operating results. For more information on our goodwill impairment charge of $270.0 million recorded in fiscal 2009, see Part II, Item 8, Note K, “Goodwill and Intangible Assets” in the consolidated financial statements of our Annual Report on Form 10-K for the fiscal year ended October 31, 2009.

Changes to the estimates used in the analysis, including estimated future cash flows, could cause either of our business unit segments or our indefinite-lived intangibles to be valued differently in future periods. It is at least reasonably possible that future analyses could result in additional material non-cash goodwill impairment charges.

 

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NOVELL, INC.

RISK FACTORS (Continued)

 

Because we recognize revenue from maintenance and subscriptions over the term of the agreements, downturns or upturns in sales may not be immediately reflected in our operating results.

We recognize maintenance and subscription revenue from customers ratably over the term of their agreements, which are generally one to three years. As a result, much of the revenue we report in each quarter is deferred revenue from maintenance and subscription agreements entered into during previous quarters. Consequently, a decline in maintenance and/or subscriptions sales in any one quarter will not necessarily be fully reflected in the revenue in that quarter and will negatively affect our revenue in future quarters. In addition, we may be unable to adjust our cost structure to reflect this reduced revenue. Accordingly, the effect of significant downturns in sales and market acceptance of our products may not be fully reflected in our operating results until future periods. Our maintenance and subscription model also makes it difficult for us to rapidly increase our revenue through additional sales in any period, as revenue from new customers must be recognized over the term of the applicable agreement.

If we do not make effective use of our substantial cash resources, our financial results could suffer and the value of our common stock could decline.

Our ability to increase stockholder value is dependent, in part, on the effective use of our cash balance. We may use these funds to continue to operate our business, finance strategic acquisitions, execute corporate transactions, or repurchase shares of our common stock. We cannot ensure that any of these measures will be executed, or that such measures will improve our financial results or increase stockholder value.

We may experience risks in our investments due to changes in the market, which could adversely affect the value or liquidity of our investments.

At April 30, 2010, we had $979.6 million in cash, cash equivalents and short-term investments. We maintain a portfolio of cash equivalents and short-term and long-term investments in a variety of securities that may include commercial paper, certificates of deposit, money market funds and government debt securities. These available-for-sale investments are subject to interest rate risk, credit risk, general market risk, and currency risk and may decline in value.

Our investments are subject to general credit, liquidity, market, currency and interest rate risks. As a result, we may experience reductions in value or loss of liquidity of our investments. In addition, should any investment cease paying or reduce the amount of interest paid to us, our interest income would suffer. These market risks associated with our investment portfolio could have a material adverse effect on our business, financial condition, and operating results.

We have real estate lease commitments for unoccupied space and restoration obligations, and if we are unable to sublet this space on acceptable terms our operating results and financial condition could be adversely affected.

We are party to real estate leases worldwide for a total of approximately 634,000 square feet. At October 31, 2009, we actively utilized approximately 95% of this space, or 602,000 square feet. We own 995,000 square feet of office space. At October 31, 2009, approximately 19%, or 213,000 square feet of our owned space is currently unoccupied. Approximately 17% or 165,000 square feet of the owned space is sublet to a third party.

Our stock price may be volatile in the future, and the stock price may decline.

The market price of our common stock has experienced significant fluctuations in the past and may continue to fluctuate in the future. The market price of our common stock may be affected by a number of factors, including:

 

 

 

announcements of quarterly operating results and revenue and earnings forecasts by us that fail to meet or be consistent with our earlier projections or the expectations of our investors or securities analysts;

 

 

announcements by either our competitors or our customers that fail to meet or be consistent with their earlier projections or the expectations of our investors or securities analysts;

 

 

rumors, announcements, or press articles regarding our, or our competitors’ operations, management, organization, financial condition, or financial statements;

 

 

changes in revenue and earnings estimates by us, our investors, or securities analysts;

 

 

accounting charges, including charges relating to the impairment of goodwill, intangible assets or other assets;

 

 

announcements of planned acquisitions or dispositions by us or by our competitors;

 

 

announcements of new or planned products by us, our competitors, or our customers;

 

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NOVELL, INC.

RISK FACTORS (Continued)

 

 

 

gain or loss of a significant customer or partner;

 

 

the inception of, or material developments in relation to, litigation initiated by us or brought against us;

 

 

inquiries by the SEC, NASDAQ, law enforcement, or other regulatory bodies;

 

 

acts of terrorism, the threat of war, and other crises or emergency situations;

 

 

economic slowdowns or the perception of an oncoming economic slowdown in any of the major markets in which we operate; and

 

 

uncertainty associated with our Board’s review of various alternatives to enhance stockholder value.

The stock market in general, and the market prices of stocks of technology companies in particular, have experienced extreme price volatility that has adversely affected, and may continue to adversely affect, the market price of our common stock.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

The following table presents information regarding purchases of shares of our common stock pursuant to our share repurchase program and for our stock-based compensation plans during the second quarter of fiscal 2010.

 

(In thousands, except per share amounts)

 

                                                     Period

   Total number
of shares
purchased
   Average price
paid per
share
   Total number of
shares purchased
as part of publicly
announced plans
or programs
   Maximum
dollar value of
shares that
may yet be
purchased

under the plans
or programs

February 1, 2010 through February 28, 2010

   10    $ 4.75       $ 33,180

March 1, 2010 through March 31, 2010

   136      5.82         33,180

April 1, 2010 through April 30, 2010

   13      5.85         33,180
               

Total

               159    $ 5.75                —      33,180
               

The total number of shares purchased was for shares surrendered to us to satisfy tax withholding obligations in connection with our equity plans.

During fiscal 2008, our Board of Directors authorized the repurchase of up to $100 million of our outstanding common stock. There is no fixed termination date for the repurchase program. There were no repurchases under the program during the second quarters or first six months of fiscal 2010 or 2009. As of April 30, 2010, $33.2 million remains available to be used for repurchasing common stock under the current Board authorization.

Item 6. Exhibits

The list of exhibits set forth on the Exhibit Index filed as a part of this Quarterly Report on Form 10-Q is incorporated herein by reference.

 

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NOVELL, INC.

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:   June 8, 2010

   

By:

 

/s/ DANA C. RUSSELL                                        

     

Dana C. Russell

     

Senior Vice President and Chief Financial Officer

     

(Principal Financial Officer and Principal Accounting Officer)

 

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NOVELL, INC.

EXHIBIT INDEX

The following exhibits are filed as part of this Quarterly Report on Form 10-Q:

 

Exhibit

Number

  

Description

  10.1*

  

Form of Restricted Stock Unit Agreement.

  10.2*

  

Form of Restricted Stock Agreement.

  10.3*

  

Form of Nonqualified Stock Option Grant Agreement (for Directors).

  10.4*

  

Form of Restricted Stock Unit Agreement (for Directors).

  10.5*

  

Form of 2010 Restricted Stock Unit Agreement.

  10.6*

  

One-time incremental retainer to Chairman.

  10.7*

  

Non-Employee Director Remuneration and Expense Reimbursement Summary.

  10.8*

  

Letter agreement with Mr. Plaskett to amend (1) a Restricted Stock Unit Agreement dated
April 7, 2009, (2) a Nonqualified Stock Option Agreement dated April 7, 2009, and (3) a Stock
Option Agreement Outside Directors Grant dated June 3, 2008.

  10.9*

  

Letter agreement with Ms. White to amend (1) a Restricted Stock Unit Agreement dated
April 7, 2009, (2) a Nonqualified Stock Option Agreement dated April 7, 2009, and (3) a Stock
Option Agreement Outside Directors Grant dated June 3, 2008.

  31.1  

  

Rule 13a-14(a) Certification.

  31.2  

  

Rule 13a-14(a) Certification.

  32.1  

  

18 U.S.C. Section 1350 Certification.

  32.2  

  

18 U.S.C. Section 1350 Certification.

 

 

* Indicates management contracts or compensatory plans.

 

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