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Novell, Inc. (NASDAQ:NOVL)

F1Q09 (Qtr End 01/31/09) Earnings Call Transcript

February 26, 2009 5:00 pm ET

Executives

Susan White – Director, IR

Dana Russell – SVP and CFO

Ron Hovsepian – President and CEO

Analysts

Abhey Lamba – UBS Securities

Mark Murphy – Piper Jaffray

Michael Turits – Raymond James

John DiFucci – JP Morgan

Katherine Egbert – Jefferies

Brad Whitt – Broadpoint AmTech

Brent Williams – The Benchmark Company

Brian Denyeau – Oppenheimer

Kent Schofield – Citi

Operator

Good afternoon. My name is Donna and I will be your conference operator today. At this time, I would like to welcome everyone to the Novell First Quarter 2009 Financial Earnings Release Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question and answer session. (Operator instructions) Thank you.

I would now like to turn the call over to Susan White. Ms. White, you may begin your conference.

Susan White

Thank you. Good afternoon, everyone, and thanks for joining us. I am Susan White, Director of Investor Relations for Novell, and with me today from our executive offices in Waltham, Massachusetts are Ron Hovsepian, President and Chief Executive Officer; and Dana Russell, our Chief Financial Officer.

We are here this afternoon to discuss Novell's financial results for the first fiscal quarter of 2009. If you don’t yet have our press release, you can access it by visiting our Investor Relations web page at www.novell.com. This call is also being broadcast on our website and will be archived on our website for 12 months.

Before I turn the call over to Dana, I would like to take a moment to say that we will be providing non-GAAP financial measures during today’s call. We believe that these measures enhance an overall understanding of our current financial performance and prospects for the future and enable investors to evaluate our performance in the same way that management does. We’ve included reconciliations of these non-GAAP measures to their most directly comparable GAAP measures in our earnings release. As I mentioned, a copy of that release is on our website.

Finally, please note that during today’s call, we may make forward-looking statements. You should be aware that our actual results could differ materially from those contained in the forward-looking statements, which are based on current management expectations and are subject to a number of risks and uncertainties, including but not limited to factors described in our annual report on Form 10-K filed with the Securities and Exchange Commission on December 23, 2008, and in the press release we issued earlier today.

Any forward-looking information that we provide in this call represents our outlook as of today, February 26, 2009, and we do not undertake any obligation to update our forward-looking statements except as required by the securities laws.

With that, we are ready for our CFO, Dana Russell.

Dana Russell

Good afternoon, everyone.

Novell's first quarter 2009 results were released a short time ago. The company reported net revenues of 215 million. Income from operations was 14 million; non-GAAP income from operations was 34 million. Non-GAAP net income was 24 million or $0.07 per share. Foreign currency exchange rates negatively impact revenue by 3 million and positively impacted operating expenses by 11 million and operating income by 8 million on a year over year basis. Our results this quarter were mixed. Product renewals held steady, but new product and service revenue was below our expectations, largely due to the slowing economy. Revenue was also modestly impacted by FX headwinds. Despite the revenue shortfall, we continued our trend to expand operating margins. Non-GAAP operating margin was 16%, that is up from 11% in the year ago quarter. We remained focused on managing expenses and committed to maintaining double-digit operating margins.

Now I will highlight some of our results by business units. You can see the results on the revenue schedule on page 10 of our press release. Within open platform solutions, Linux platform products revenue in the quarter was 35 million, increasing 24% from the year ago quarter. Linux invoicing was 23 million, down 42%. As we have stated before, our Linux business is dependent on large deals which may result in some fluctuations of our quarterly invoicing. This quarter we did not sign any large deals, many of which have been historically fulfilled by Microsoft certificates. Today we have invoiced 199 million or 83% of our original 240 million agreement.

Moving on to our identity and security management business units, identity access and compliance management revenue was 26 million, down 8%, at the invoicing declined 18% due to lower licensing. Next, systems and resource management revenue was 40 million, up 9%, which includes Managed Objects, which was acquired during the quarter. Total invoicing increased 12%. Excluding the impact of Managed Objects and PlateSpin, revenue declined 10% and invoicing was down 22%. Similar to identity, lower licensing accounted for the declines.

Turning to Workgroup, revenue was 81 million, down 9% and invoicing was down 17%. Within our Workgroup category, the combined OES and NetWare related revenue was 44 million, down 14% from the year ago quarter. Combined OES and NetWare invoicing declined 21%. Softness in the fourth quarter continued into the first quarter and was magnified by the economic situation. Customers are downsizing which translated into lower licensing this quarter.

Services revenue declined 32% to 28 million during the quarter. While we expected a slight decline from the fourth quarter levels, companies have lowered their discretionary spending on services which caused services revenue to decline more than anticipated. We expect services to be at or slightly lower than this run rate for the rest of the year.

Now on to expenses, non-GAAP cost of sales and operating expenses were down compared to a year ago due to the impact of FX and continued focus on expense management which more than offset the increased expenses from our PlateSpin and Managed Objects acquisitions. Seasonally, the first quarter typically has the lowest operating expense level of the year. For the rest of the year, we expect our quarterly expense run rate to be about 10 million higher than Q1 levels.

We incurred 8 million of restructuring charges in the first quarter most of which represented a continuation of our 2008 restructuring activities and we expect to incur 5 million to 7 million of charges in the second quarter. We are still evaluating what additional charges we may incur in the second half of fiscal 2009. Total headcount at the end of the quarter was approximately 3900, down from approximately 4000 in the prior quarter.

Turning to our balance sheet and cash flow, cash and short-term investments were $1 billion in line with the prior quarter. We continue to take a conservative view with respect to our cash strategy in light of the volatile financial markets and economic downturn. Our sizeable cash balance is an important asset as it provides flexibility to pursue acquisitions, which is our first priority as well as to continue to repurchase our debentures which we do in July 2009. We are continuing our maintenance program for share repurchase so the number of share outstanding does not increase due to stock-based compensation. Cash flow from operations for the quarter was 14 million, up from a negative 26 million a year ago. This quarter's cash flow included a $25 million payment from Microsoft for the first tranche of our extended agreement.

Now I'll turn the call over to Ron for an update on our business units.

Ron Hovsepian

Thanks, Dana.

Our results this quarter were mixed. Operating margins expanded while revenue was below our expectations. I am disappointed with our revenue and invoicing which were impacted by the slowing economy. Across IT at large and in most industries in general, product revenues are down as customers focus on capital conservation, expense management, simplification and risk mitigation. These factors have led to smaller or delayed projects and extended sales cycles.

While I expect these trends to continue in the near term, the fundamental markets we serve and the value we bring to those markets still look attractive. I firmly believe our strategic direction is sound and that the operational transformation we executed over the last three years will serve us well during these difficult times and when the economy recovers. In fact, the customer focus on producing cost, complexity and risk is well aligned to our overall value proposition. We simply must focus even harder on getting our message out and helping more clients realize these benefits.

Clearly actively managing our cost structure is also critical in ensuring profitability is maintained during this economic slowdown. Fortunately, the work we did over the last two years improving our processes and structuring our business benefited us this quarter. As a result, we continued our trend of improving non-GAAP operating margins and we remain committed to our long-term goal of sustainable profitability.

At Dana has reviewed the specific financial performance of our business units, I will focus my comments on six near term priorities. Priority one, targeting our resources on growth markets. Linux, identity and security and systems and resource management remained attractive markets, and we intend to participate aggressively in their growth. Our Q1 Linux performance did not meet our expectations as our pipeline coverage and conversion was overly reliant on direct sales and sales cycles lengthened. Going forward, we are focused on building our pipeline with and through partners and we will be aggressive on pricing to gain market share.

The identity and security market remains a very attractive and our pipeline is solid. Our ISM focus is on to lead and opportunity conversion. Our confidence in this market remains high. Finally, the systems and resource management market remains very attractive and we have compelling solutions in this category that appeal to those seeking improved date center agility and better end user productivity. Like Linux, we must execute better with and through our channels to realize our SRM objectives while continuing to build our pipeline.

Priority two, managing our capital. In this market in particular, our strong balance sheet is a source of d differentiation for our customers and partners alike as they seek vendors who will be able to serve their needs long-term. I readily acknowledge there are some different views regarding our capital structure. At this time, however, we continue to believe the best avenue for long-term profitable growth is not through a broad-based share buyback program.

Priority three, controlling our cost structure. As I have previously discussed, the strategic initiatives and the operational transformation we undertook over the last couple of years have significantly contributed to a more efficient and leaner cost s structures resulting in a steady operating margin improvement. We have continued our focus on expenses management this year through reductions in travel and entertainment, facilities, headcount, and numerous variable expenses. We are investigating all opportunities to lower costs.

Priority four, expanding our partner ecosystem. Last year, we began an a accelerated sales model shift from direct to indirect coverage with a particular focus on delivery partners as part of our services realignment in support of our shift to a more profitable revenue mix. We are now focused on targeting, enabling and incenting solution providers and value-added partners to drive new license growth. In support of this emphasis, we recently introduced a dramatically enhanced channel program that increases partner profitability, improves training and education, simplifies doing business with Novell and enables faster time to revenue. These changes give us an industry-leading program to retain and attract new partners.

Priority five, improving sales activity levels. The current economic climate has changed the rules for traditional sales and pipeline management. As a result, we simply did not have enough coverage in Q1. Additionally, we had a few high-profile sales leadership changes in EMEA in Q1 that we have now addressed. With longer cycle times and lower yields, our emphasis going forward is on improving productivity in all of our sales channels and on building more pipeline coverage to improve – to move opportunities predictably through their life cycle. I expect pipeline coverage and yield to improve in the coming quarters.

Priority six, delivering targeted innovation. Novell has a history of product leadership and we believe continuing to invest in our product portfolio in a targeted manner is required to maintain this leadership. Later this quarter we will deliver the next release of our Linux platform SUSE Linux Enterprise 11. We believe SUSE Linux Enterprise 11 will be the next most improbable platform for mission-critical computing for both physical and virtual environments. We further extended our comprehensive identity and security management solutions with our recent deals with Fortefi for privileged user management and active identity for enterprise single sign on. Within systems and resource management, we have completed our acquisition of Managed Objects, which strengthens our data centre solutions and (inaudible) capabilities.

WE also introduced the industry's first comprehensive workload management or workload lifecycle management solution under the PlateSpin brand. Finally, we refreshed the two core products in Workgroup business with the release of OES 2 SP1 and GroupWise 8. Our product lines have never been stronger.

In closing, while we are disappointed by the revenue shortfall, we have exhibited strong cost control and expanded operating margins due to our focus on improving our operational model. We remain committed to targeting non-GAAP operating margins of at least 10% in fiscal 2009. While I do not expect the market to materially improve in the near term, I believe our strong balance sheet, recurring revenues, relevant solutions, expanding partner channels and better execution will allow us to weather the current economic uncertainty and favorably position us for long-term success.

We will now take your questions. Operator, would you please open the line to our listeners?

Question-and-Answer-Session

Operator

(Operator instructions) Your first question comes from the line of Abhey Lamba.

Abhey Lamba – UBS Securities

Can you just elaborate on your pipeline comment, how does the pipeline going into Q2 now look versus your typical Q2? And the coverage ratio, what gives you confidence of increasing coverage ratio in this quarter?

Ron Hovsepian

Yes. When I look at the overall pipeline for the exact same period of time compared to the last year in this quarter, we are slightly ahead of our actual pipeline in a comparative basis. So I actually feel good about the amount in the pipeline and the amount that we have in there, we're running a little earlier on the committed, and we are in a better position this year at this time in terms of committed. Now that being said, I'm not misled by the fact that the last two weeks of our Q1 deteriorated is where we really saw the pipe fall apart and the coverage fall apart. So I do feel better about the quality of the coverage that we have, I feel better about where we are in the committed compared to last year at this particular time, but I'm not naive to the fact that we could have deterioration like we did the last 2 to 3 weeks, because that is really where our quarters derailed. Everything else look pretty much historically similar to those last few weeks and then we really felt it at the last two weeks in January.

Abhey Lamba – UBS Securities

Great. Thanks. And lastly any comments on how sustainable the margins are Q1? Really it is a very impressive performance on the margin. Were there any one-time issues or one-time benefits in the quarter that could reverse as you go through the year or you feel pretty good about the quarter margins?

Dana Russell

Yes. There's a couple of one-time items in there, some expenses that were small. I think we feel good about the expense structure in comparison to the revenues. We’ve certainly positioned ourselves for some turmoil in the market. But you can see from the prepared comments there that we do expect the expense structure to increase, second, third and fourth quarter. There is a number of reasons for that. First of all, we would have expectations that the invoicing will increase and most of our invoicing or a good portion of our invoicing occurs in the second half of the year, it is weighted towards the second half of the year, and that will drive royalty costs for some of the things that we purchase, technology, some of our technology purchases. There will also be some discretionary spending increases as well as the normal things like payroll taxes and travel which are typically low because of the way our first quarter ends. Our travel is at the lowest in the first quarter due to the holiday season and then we have also got the impact of payroll taxes. So for those reasons we are going to see some increase in expense. But I think we remain committed to what we said, double-digit operating margins for the year, and we will continue to carry out like you have seen here in the first quarter.

Abhey Lamba – UBS Securities

Okay. Thank you.

Operator

Your next question comes from Mark Murphy of Piper Jaffray.

Mark Murphy – Piper Jaffray

Yes. Thank you. Regarding the Microsoft Linux coupons, is there any way you could characterize the pricing dynamics in terms of just what you are seeing in terms of renewal prices versus the original prices paid?

Dana Russell

Yes Mark. First of all, most of the – we haven't had any renewals yet in the Microsoft certificate, and so from that standpoint we can't report an activity from a renewable standpoint. What we can say though and talk about is the fact that pricing we are aggressive in pricing. Customers certainly are price sensitive and there is an expectation that the prices that we have got through the use of certificates are not going to be the same when we go out and do renewals. To be able to quantify that would be difficult, but we do expect some erosion in terms of margins.

Mark Murphy – Piper Jaffray

And were you able to have any discussion with Microsoft or kind of gain any insight into why there was that level of variance just in terms of your Microsoft driven Linux bookings in the quarter?

Ron Hovsepian

From my perspective, the variance is a little more on our shoulders. As I shared with you the demand is our responsibility with them. Obviously it is a big go to market program together, but the primary responsibility for demand I still view sits on our shoulders. The real issue was our large deal dependency underneath it is what – is where we misfired from an overall coverage perspective. And from my point of view, I see us taking the right corrective actions, the pipe is shaping up historically to what it was the last 18 months for this quarter. So I think if we can execute on that, it will be an aberration this quarter. If we don't, then there may be something more fundamental. But Mark, I haven't uncovered anything that said this was a – this is a root cause issue at all. Again, the other big dimension here is, where we really rang out loudly that our reliance on the direct sell, that we don't have the partner ecosystem to the level of performance that we needed to be, irrelevant again of Microsoft.

Mark Murphy – Piper Jaffray

And then thank you Ron, the question on your license results versus may be what the original plan was entering the quarter and I guess obviously we don't know what that plan was, but as you think about the variants there driven by the economic climate, you had referenced a timeframe of the last couple of weeks where things changed, is that comprised of a couple or a handful of very large transactions that slipped in the end of the quarter, or is it really – is it a pattern of maybe dozens of transactions of all kinds of sizes that are feeling like they require kind of more decision-making hurdles throughout the quarter?

Dana Russell

Mark, just to kind of track you along her with what happened in the quarter, so when you look at it from an invoicing perspective or a bookings perspective, we tracked along against a historical rate where we were at or ahead of the historical rates until the very last week of the quarter actually from a bookings standpoint. And I think if you look at the weakness in our invoicing, it was across all geographies and across all product lines. There wasn't really anything you could specifically look at and say it was one deal that comprised a shortfall. Now we did have a number of reasonably significant deals that we didn't get closed at the end of the quarter which did slip into the second quarter and a number of those have in fact booked in the second quarter. So we feel good about that. We do believe though that there will also be a tough environment at the end of the second quarter. So we are hopeful that our process has really improved as Ron discussed so that we can deals closed in a timely manner. And if you look at the shortfall, I think a couple of points that I would bring out in terms of the total revenue, it really was just associated with licensing and services revenue. We really did maintain the installed base. In fact, that is actually up a bit year over year. And so if you were to look at Page 10 on the press release schedule and go comparing last year with this year, for the same quarter, the shortfall was completely isolated in the licensing area with the exception of a slight degradation of Workgroup. So I think we feel good about the fact that we did maintain that core business and our expectation is we will continue to do that as we go forward here.

Ron Hovsepian

And I will add Mark is that there wasn't one or two big deals that cost us that quarter. It was spread out as Dana said by geo, et cetera, but also by deal size I think was one of your questions.

Mark Murphy – Piper Jaffray

Okay. And then also just thinking about the margin structure, you are one quarter into the year, you are about 60% ahead of your full operating margin target, and you have done that in a seasonally weak Q1 where your top line was adversely impacted. And I guess with the understanding that you have laid out a few areas where expenses should increase and we don't have visibility into the specific amounts, but some of that sounds as though – for instance royalty costs, it doesn't sound like something that will be huge in amount. I guess I'm just trying to gauge, do you indeed think that margins are going to trend materially lower going through the rest of the year or what are the odds I guess at this point that you have any individual quarter that would not be a double-digit operating margin?

Dana Russell

Well, I think our expectation Mark is that we will maintain double-digit operating margins throughout the year. Now that really does depend on our ability to invoice and our licensing revenue. And so as we look today, looking into the future, which is hard to do in this economic environment, we really believe that we can maintain double-digit operating margins each quarter going forward here to. So, there are significant transactions. If they fell out, then we would have some difficulty, but our expectation is that 10% as we’ve talked about in the past would be the floor and not the ceiling.

Mark Murphy – Piper Jaffray

Okay. And Dana, just one last quick one, is there any insight or could you ballpark what is in your budget for travel this year, just on a percentage basis how much you think that would come down?

Dana Russell

Did you say travel budget for the year, Mark ?

Mark Murphy – Piper Jaffray

Yes, sir.

Ron Hovsepian

I don’t think if we are going to share the percentage. We have already aggressively pursued that for the rest of year and in Q1. It was part of the proactive things we did in Q1. I don't want to get into any of the percentages. I don't think we get into that level of detail. But I will tell you it is something we focused on and we got after in Q1.

Mark Murphy – Piper Jaffray

Okay. Fair enough, thank you.

Operator

Your next question comes from Michael Turits of Raymond James.

Michael Turits – Raymond James

Yes. A couple of questions. First just clarifications, first of all, I want to make sure on the Microsoft coupons, there was 199 invoiced, first q question the clarification, did anything come out of the new tranche, the 25 million?

Dana Russell

No.

Michael Turits – Raymond James

So this is the 4 million. You sort of answered it before but I just wanted to get just more thought on it, it is such a huge drop off from the high teens levels quarter of Microsoft invoicing, again if you drill down on what might have happened there, you said lack of large deals, but was it just really the demand falling off?

Dana Russell

Yes, in terms of color around that, I think much of the use of these certificates has been oriented toward larger transactions. And as Ron talked about before, we have been engaged and responsible for bringing a large portion of these transactions together where these certificates have been used. So we really had, we did have some slippage a couple of transactions that moved out of this order into the second quarter, but the reality is, we just didn't have the movement on large deals in the pipeline for large deals in the first quarter that we have had in previous quarters. As Ron also talked about, we are seeing the pipeline move to more historical levels in the second quarter and so we don't see that the market’s gone away, that there is a deterioration or some other event that’s caused us not to be able to do business. We see that we are going to continue to have a very robust business there, we are going to continue to be aggressive, we are gong to continue to pursue customers and use them as an entry point for our proprietary products and things, but we just didn't – we just didn't close large transactions this quarter.

Michael Turits – Raymond James

And then if I can get another question in there on a different subject, also on – I just want to make sure I understand the expense guidance, you thought that on the OpEx side you would go up from this quarter’s 181 million – correction, that’s (inaudible) from this quarter’s 138 million, up 10 million to up to kind of 148-ish and that would stay flat at 148-ish OpEx for the next few quarters?

Dana Russell

A combination of cost to sales and operating expenses we said. If you look at the expense structure this quarter, that will increase. It is a combination of those two elements, cost to sales and operating expenses would be up approximately $10 million.

Michael Turits – Raymond James

So total expenses up $10 million.

Dana Russell

Total expenses up.

Michael Turits – Raymond James

And then they stay flat at that dollar level throughout the rest of the year.

Dana Russell

Yes. There will be some variation quarter to quarter, but we are just trying to provide something for you to build the models on. And as you looked forward and look at our expense structure, you can think about that as a fairly constant run rate unless we were to announce other activities which would change that run rate.

Michael Turits – Raymond James

And should I think of the gross margins as staying pretty flat at this 80% level?

Dana Russell

Yes, I think you can use that as a pretty good measure.

Michael Turits – Raymond James

Great. Thanks very much.

Operator

Your next question comes from John DiFucci of JP Morgan.

John DiFucci – JP Morgan

Thank you. Ron, to follow-up to Mike’s question, and Dana’s answer, to sort help us on the expense line, on the top line, it sounds like, we understand your reluctance to give a lot of top line guidance given the environment and also given what happened this quarter, but it does sound like you feel a little bit better, it sounds like some deals that slipped are already closed, I mean but you also sound pretty cautious. I mean could this decline year over year for licenses, can that happen again this quarter, is that something we should be looking or anticipating something in that neighborhood? It is not like the environment out there is getting – appears to be getting better and it is not like it looks like it is going to get better any time soon?

Ron Hovsepian

No, that is a very fair question, John. The answer to your question directly is could it go down? Absolutely, that is a possibility from my perspective this quarter. In terms of how we are trying to manage the business, John, is that was my comment on there is got to be a different rigor brought to the sales execution and the pipeline management than the normal yields and sales progressions that we have used in the past. We can't use that same data because we will allow them to feeling good in Q1 as Dana said to the last week half or so when it all blew up and fell off I should say. So I am – you did hear me correctly, I was schizophrenic on that one, I am seeing things better in terms of the pipe for the quarter and compared year-to-year at the same week in time. However, I am apprehensive because I do know it is ugly out there and I want to make sure that we behave appropriately in giving you guidance. So is it a possibility? Yes. Do I expect us to improve our yield and our sales progression as we go through the year and understanding and living in this new economic environment? I expect us to improve that quarter by quarter. Q2, I think as I said in the near term, will be more difficult for us as we go through that, as we improve things, in terms of sales management and pipeline management as a general statement. So you did here we correctly that I felt part of it was building but part of it made me apprehensive still.

John DiFucci – JP Morgan

Okay. So it does sound like anything is possible out there but…

Ron Hovsepian

Yes. I was just trying to give you a range, John, of what I was feeling so that you could think about it. I guess the mission was accomplished, I told you the good part and the bad part, so and you felt both ends of that range is the problem.

John DiFucci – JP Morgan

That is okay. And I don't want to put words in your mouth, Ron, but just so – I mean it could be down the same way it was this quarter, but things feel a little bit better right now, you have signed some deals, they slipped from last quarter to this quarter, the same thing could happen at the end of the quarter but things feel a little better at least…

Ron Hovsepian

Yes. So the only handicap I would make to that is the – I've put a little more emphasis on the operative word little because I believe there still will be some natural fall off again in the quarter as it – as the quarter unfolds. My confidence was obviously shaken given last quarter, so you guys know I am conservative on those things and I want to see it come back to life and show some pattern before I get confidence. So operative word on little improvement in Q2 and I expect progressively better improvement out of us as each quarter goes on into the pipeline.

John DiFucci – JP Morgan

Okay. And if I could have a follow-up for Dana on expenses, Dana, most of your margin expansion for this quarter was due to foreign exchange translation effects, I mean even without that, it looks like you had a little bit of margin expansion, maybe 100 basis points or so, but in your guidance that you are giving and with the anticipation, it sounds like the plan or hope that you actually continuously double-digit margin throughout the year, does that assume continued benefit from foreign exchange on the operating line?

Dana Russell

Well, I think we will see a continued benefit from foreign exchange on the operating line as far as we can see here. However, the double-digit commitment wasn't dependent on the benefit of foreign exchange. So we would have been double digits in the first quarter regardless of foreign exchange and we expect to continue in the future that way.

John DiFucci – JP Morgan

Okay, great. Okay, thanks a lot, guys.

Dana Russell

Thanks John.

Operator

Your next question comes from Katherine Egbert of Jefferies.

Katherine Egbert – Jefferies

How do you define the large Linux deals and just to be clear, I mean are there just less deals available or do you feel like you didn't get to the table as much on these larger deals?

Ron Hovsepian

The definition of larger would be in that 250 range and above, give or take. And then in terms of puzzle, pieces of it, I think it was a variety of things. One of the large deals I'm familiar with closed within two weeks of the quarter getting done that we saw in the pipe. It just got a second and third review is what ended up happening by the executive management team. So I see those kinds of things happening, so what I would break it down Katherine is a couple of causes. One is multiple reviews, two is proper qualification as to where the customer is in the cycle, and three is some lead pipeline development and progressing the solutions, getting the proposals out. We obviously did a little bit of structure change with the sales team at the beginning of the year. We also took out last year over $30 million of sales expense which is head count et cetera. We brought more shift to the partner piece of it which isn't fully enabled or ramped up. The partner channel program I referred you to just now in my prepared remarks, we just rolled that out publicly on February 9 as an example on that particular program. So there were those four categories of where we were would be how I would answer that.

Katherine Egbert – Jefferies

So it sounds like you are pretty satisfied with your ability to get into deals, it’s just been these other reasons?

Ron Hovsepian

In general, yes. Do we ever get enough from a sales perspective? No. But I think we are at more the bigger deals, I am not getting the flow though deals with the partner, and we paid the price by not getting the big deals this quarter and not having any – not having not any – but not having enough partner based business filling us through.

Katherine Egbert – Jefferies

Okay. And then is it fair to say that most of your operating losses come from Linux, the other products I guess identity are a bit more mature. And if I look at Red Hat, when they were kind of at your run rate in terms of Linux sales, they actually were breaking even, can you comment on that?

Dana Russell

Well I think we’ve been fairly clear that we have had heavy investments in the open source area and our cash flow and our profitability is very oriented toward our older products, our Workgroup area. So yes, it is pretty easy to surmise that if we have losses that are coming through those areas of heavy investments, which one of the heavy investment areas for us over the last few years has been the open source area.

Katherine Egbert – Jefferies

Why do you think you're not making money at a point that Red Hat began to make or (inaudible) just the break even life cycle. What do you think the difference is?

Ron Hovsepian

This is Ron, I'll go and then Dana feel free. I think like any of these markets, we probably entered the market in terms of time, in terms of scale, behind Red Hat by a few years. So let me break it down simplistically. We had to go get some of the big anchor references, we did that. We started now to get the large accounts flowing through. The next thing you have to do is get the ecosystem of partners going and ISPs. We are getting the ISPs, we have added, we are probably right around 3000 ISPs now at this point in time. So now it is really building up the rest of the partner ecosystem, and that is where we have been the slowest in my opinion, Katherine, and that is the part of the cause there.

The second dimension that I’d introduce to the conversation is our desire in the marketplace is to make sure that we gain those new customers and we will continue to be aggressive with the Linux tool and product in order to drive more of our other management products and other products that sit above that. So fundamentally we have a different strategy on long-term value of Linux in the marketplace and as part of our portfolio. We see it as an important part but we see the long-term profitability coming from these other categories for our business. So it is a slightly different model, the second dimension that I'm highlighting, and then it is timing and maturity of the channel is the first time dimension.

Katherine Egbert – Jefferies

Okay.

Operator

Your next question comes from the line of Brad Whitt of Broadpoint AmTech.

Brad Whitt – Broadpoint AmTech

Hi guys. Thanks for taking my question. I am just curious as to, Ron, you talked about making this migration from direct to more of an indirect sales model, can you give us an idea of how far you are along in that process, like what percentage of your revenue is indirect versus direct and where do you anticipate that heading towards over a period of time?

Ron Hovsepian

So let me just frame it first. In terms of the migration, there are four dimensions that we're looking at inside the company that we track on our dashboard about what we are doing from an overall transformation perspective, and we are progressing well on those four categories. The categories are the programs themselves, the processes, the actual enablement of the partners as we look at the enablement so, and – I am sorry partner has ripped through the model and – the process, the programs, the enablement, and I am forgetting the fourth category, it just went right out of my brain, but it will come back – systems, excuse me, the IT systems to support that. So when you look at it, we are making good progress on all fronts. The program piece has been rolled out now, that is probably the most important part that faces the partner, and then the recruiting enablement piece is underway, that is in an earlier stage, but well under way. I personally have visited most of the key partners that we are pursuing around the globe candidly, and I try to speak with them and follow up with them as much as I personally can, more so it is to make sure that I understand our progression as a company.

So those pieces are under way and right now I would say we're ramping with the partners is really where we are in that process recruiting, enabling, and then we will move more into the ramp truly ramping from a sales perspective. When I say ramping, it is in the enablement piece of it. And then the process we’re focused on, we have a good view into that. And the IT systems now are following along with that. That is probably in the appropriate sequence because we have to have or processes and programs in place before we invest the money into the IT systems. So that is a macro view of our progress there. I would say that we are still we have made good progress, actually very rapid progress over the last six months in particular, and I feel like we have got a very clear framework on how we will progress.

In terms of the revenue and our objectives and what we want to get done there, I'm not going to get into the numbers because you have a blend of different partner types that play different roles, and as I shared with a number of you last year, we made a shift on partners to pick up our limitation, meaning our consultant services, away from Novell to the partners, and that has been growing extremely well. The real key for us is getting partners to create demand and pull through that demand for us. That is where our focus is and we're not where I want us to be in terms of the business. I'm targeted, I'm ramping them and we will work away through that as part of our progression there. And my expectation is I will share that data like I have in the past with you once I have a pattern of data that is of quality that I can share with you out in the future, very similar to some of the other things that we have done in talking about the company’s progress. So I know it is a long-winded answer but it is a multi-dimensional problem that is under – have very good clear blueprint being executed on and the key focus is around demand.

Brad Whitt – Broadpoint AmTech

Okay. That is helpful, Ron. Also you mentioned that you expect your sales productivity to improve this quarter, are there any specific processes or systems, anything that you put in place or made changes or adjustments on this quarter that gives you confidence that it will happen?

Ron Hovsepian

Yes. Obviously the review process by the sales leadership team has to be different. So I have had an opportunity to personally participate with each of the senior leaders on the sales – from the sales pipeline management perspective and all the executives are very concerned about what happened from a sales perspective and I know I have their commitment to focus on that. And in three simple months in each quarter, it should be about building the pipeline, progressing it through the pipeline, and closing it. And everybody is keenly aware of that and we will keep our focus on that as we go through it. So my simple answer is there is more reviews, more discipline being brought to that approach by all of the sales leadership team including myself and Dana as you look at running the business.

Brad Whitt – Broadpoint AmTech

Okay. And then final question would be, can you gives us a little more color what happened with the sales leadership in EMEA and what steps you have taken to make adjustments there?

Ron Hovsepian

Yes. There was a diversity of events that occurred there, in particular obviously the leader moved over to head up HP Germany, that is Volker Smid that moved over to head up HP Germany as the country manager there. So we lost our leader of Europe. Good news is we have been building our team and a bench and I feel very good that we have got the ability to do two things which is what we did. One is John Dragoon, who heads up our marketing for the corporation as CMO, he is over right now on an interim basis helping that team and managing the team. Javier Colado is the replacement. The reason for the delay in putting him in that role is Javier has been the gentleman driving a lot of the channel work for us, and the good news is all the work that he has done around the design with our internal team, that team is about 50 people plus that laid out as this design, he has driven that through with that team and I feel very good as we finish up the next few pieces over the next month or two that Javier will now shift his efforts to executing the model in EMEA will be the intention. And then John can put his full attention back into the marketing piece of it. But also part of our key to success in this approach with the channels is trying to get our marketing programs and commitments to that. So what you’ll see is a very tight piece of work between John and Javier to tie the company together both in the channel and the marketing dimension that I just highlighted to you. So I feel good that we’ve got the right players here in the company to do what we need to do and we have addressed those. We did turnover at the country level in the UK and France. Both of those, one has been addressed and the other is being addressed in terms of replacements, and we have people running those teams right now. So I feel comparable that this is heading in the right direction and confident we can only improve from that perspective.

Brad Whitt – Broadpoint AmTech

Very good. Thanks for taking my questions.

Operator

The next question comes from Brent Williams of The Benchmark Company.

Brent Williams – The Benchmark Company

Hi. A question for you on you mentioned that you are going to be really sensitive to pricing, you guys have always had a reputation I think for being very pragmatic when it takes sort of being scrappier and more aggressive. What do we expect in terms of tone, is this going to be a major marketing focus, or are you telling us this financially, is this going to be a go to market message that say, hey, we are just going to get it done, we want business? Quantitatively, what kind of – how should I think about the impact of this both in terms of how price sensitive is the customer and what might it do to the financials?

Dana Russell

Yes. I think we have been fairly aggressive with pricing and we have been over the last couple of quarters here sort of sent a message that has been we are willing to do what it takes especially in our open source and within the Linux products. That particular set of products is an avenue to generate more customers and the opportunity for us to sell our other proprietary products on top of them. So from that standpoint, if you look at our model, and our model is really is different than Red Hat’s model, Red Hat’s model is an open source model. Our model is geared towards not only performing well with our open source products but also generating significant profitability and margins with these managed services that we sell on top of that. So that is why we are focused on that, we are going to be very aggressive in the marketplace.

Brent Williams – The Benchmark Company

Okay, just trying to get a sense of what you do incrementally, as I said, because you already have made very pragmatic there with that strategy, what are you doing incrementally from here?

Ron Hovsepian

Well, I'll just add to what Dana said. I think what is going to happen is as the sales cycles get elongated, the customer has more buying power. So they are going to obviously pit everybody against each other as we live in this market during the cycle. So what we have to do is look at them “deal by deal” and understand it – I thought it was important that you understood that we will be aggressive in that particular category to ensure that we continue to gain customers. We added about 3000 customers in the Linux business last year and that gives us the ability to up sell and cross sell other products and technologies that fit our model as we’ve shared with you. So I think you'll see two things. One you will see it at a customer – hand-to-hand combat at the customer level. And then two, I think we can do things in the channel to continue to be very aggressive there. And that way, in communicating to the financial community, try to hold as much as we can on to some level of price consistency, but at the end of the day, I want the customer.

Brent Williams – The Benchmark Company

Great. And then the second question, talking about building out the rest of the channel, you talked about the strong ISP presence is kind of first layer, is this an implication that hardware manufacturers are really key to this strategy going forward, is there – where is the most incremental focus, sort of the next wave ?

Ron Hovsepian

Yes. The incremental focus in terms of the next wave is actually with all those solutions providers and partners. So the way I describe it, I feel think through the funnel, Brent, we went from – we had good relationships and we have very good hardware pervasiveness actually in the marketplace in terms of platforms and all that part. So, that is where we started. And then the next part that we needed to get after that we have done a very good job of over the last 15 months in particular is the ISPs. And the next part is now the VADs and VARs so that we have the pull through, because we have the applications that can solve the customer's problem, and that way we can now package it. The hardware is there for it to run on, so now we're stitching together those pieces so that you can put bundles together to get it out into the market.

Brent Williams – The Benchmark Company

Got It. Okay, thanks so much for taking my questions.

Ron Hovsepian

You are welcome, Brent.

Operator

Your next question comes from Brian Denyeau of Oppenheimer.

Brian Denyeau – Oppenheimer

How are you?

Dana Russell

Hi, Brian.

Ron Hovsepian

Hi, Brian.

Brian Denyeau – Oppenheimer

So if you could just help me understand as you guys look to more of an indirect model and your partners become more and more responsible for helping generate demand and build a pipeline, how comfortable do you feel about this as you get to the end of the quarters that you will have enough granularity to know when things like what happened at the end of the last quarter will pop up again?

Ron Hovsepian

A great question, and part of that partner model that I was describing to you from an overall perspective has two dimensions in it that I think we are building to give us that confidence on how we manage it. The first part is, what we would call partner management and our relationship with the partner and how our partner sales team spends time reviewing the pipeline, building the pipeline, executing on that pipeline with the partner. So there is a level of review that will be critical. The second thing that will be critical for us would be our IT systems from an overall management perspective. So one of the things that we did that will allow the partner to actually register from an overall deal perspective. That is what is going to give us the capability. So just case in point, since we rode this program out from February 9 to February 20, so in 11 days, we have already had 88 partners come through and register, a little over 203 reps as part of that, just to give you a little bit of feel for that. And from my perspective that IT system was critical for us so that at least now I can see the deals, Brian to your point, and we can start to track them through the partner management process with our partners as we go through the cycle. So what I would anticipate, and again I don't have all the quality data ye at this point, but I would anticipate in my future is the dashboard that pops up, that has my partners progression just like it has got my direct progression inside of it as it moves through the life cycle.

Brian Denyeau – Oppenheimer

Okay great. Thanks.

Ron Hovsepian

Welcome.

Operator

Your last question comes from the line of Brent Thill of Citi.

Kent Schofield – Citi

Hi, this is Kent Schofield for Brent Thill. Regarding the 3000 customers that you added in Linux last year, could you talk a little bit about some of the success you have had on the up sell side and then any sort of metrics that you might be able to share? And then also you just touched a little bit on geography side and said that it was pretty tough across-the-board, so I was wondering if you could give us a little bit of granularity North America and EMEA and that sort of thing. Thank you.

Ron Hovsepian

Kent, the – it’s Kent, right, I couldn't quite hear it, I just want to make sure.

Kent Schofield – Citi

Yes, it is Kent. Thank you.

Ron Hovsepian

Okay great. What I would share with you is that’s a key statistic that we look at and right now we have been in the mode of gathering those customers, a natural progression for us that I'm not going to get into the details is around how do we attach to those customers once we get them inside the company as that piece of it. So that is one of the metrics of the leadership team is measured on, we do look at that. And I could only provide anecdotal color to you in terms of I was at a German chemical company for example who started out with us on the Linux side and has now progressed to the identity dimension there and those are the kind of transactions that we are looking for. They don't have any other Novell products or didn't have any, and that is the kind of thing that I'm looking for as we build out the products and services. In the UK, we just landed a grocery chain there and again picking up on the Linux on the PlateSpin product as an example. Those are the kind of things that we are looking for and looking to continue to grow inside the business.

Kent Schofield – Citi

Thank you so much.

Ron Hovsepian

Thanks, Kent.

Operator

There are no further questions.

Ron Hovsepian

Okay, then we will end the call officially and thank you.

Operator

This ends Novell’s first quarter 2009 financial release earnings conference call. You may now disconnect.

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Source: Novell, Inc. F1Q09 (Qtr End 01/31/09) Earnings Call Transcript
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