Novell F3Q06 (Qtr End 7/31/06) Earnings Call Transcript (NOVL)

Aug.29.06 | About: Novell, Inc. (NOVL)

Novell, Inc. (NASDAQ:NOVL)

F3Q06 Earnings Conference Call

August 29, 2006, 5:00 pm ET

Executives

Ronald Hovsepian - President & COO

Dana Russell - Interim Chief Financial Officer

William Smith - Vice President Investor Relations

Analysts

Katherine Egbert - Jefferies

Mark Murphy - First Albany Capital

Brent Thill - Citigroup Global Markets

Kirk Materne - Banc of America Securities

Brendan Barnicle - Pacific Crest Securities

Jason Maynard - Credit Suisse First Boston

Terry Tillman - SunTrust Robinson Humphrey

Operator

Good afternoon. I would like to welcome everyone to the Novell Q3 2006 Financial Results Conference Call. I would now like to the turn the conference call over to Novell, Investor Relations. Thank you, you may begin.

William Smith - Vice President Investor Relations

Good afternoon everyone and thanks for joining us. I’m Bill Smith, Vice President for Investor Relations for Novell, and with me today from our executive offices in Waltham, Massachusetts are Ron Hovsepian, President and COO and Dana Russell, Interim Chief Financial Officer.

We are here this afternoon to discuss Novell’s preliminary financial results for Q3 2006. There is a live webcast of this call taking place on the Investor Relations page of our website at www.novell.com. That call is being recorded and will be accessible on the website through September 6th. A telephone replay of this call will also be available two hours after the conclusion of this call at phone number 800-642-1687, and will run through September 6th. You should note that the results we are announcing today are preliminary financial results for Q3 ended July 31st 2006. These financial results are preliminary because Novell during this quarter began a self-initiated voluntary review at the company’s historical stock based compensation practices and related potential accounting impact.

The financial results today do not take into account any adjustments that may be required in connection with the completion of the stock based compensation review and should be considered preliminary until Novell files its Form 10-Q for Q3 fiscal quarter ended July 31st 2006. This review may result in the need to record non-cash stock compensation charges and related tax effects. Novell does not know whether any such compensation charges would affect the preliminary financial results for its Q3 2006 or would be deemed to be material and require the company to restate previously issued financial statements. It is possible that as a result of the ongoing stock based compensation review Novell may not file its quarterly report on Form 10-Q for the quarter ended July 31st 2006 on a timely basis.

I should also note that during this call we will be making statements that are not historical in nature and they may be characterized as forward looking statements. You should be aware that Novell’s actual results could differ materially from those contained in the forward looking statements which are based on current expectations of Novell management and are subject to a number of risks and uncertainty including factors described in Novell’s annual report on Form 10-K filed with the Securities and Exchange Commission on January 10th 2006. Novell disclaims any intention or obligation to update any forward-looking statements as a result of developments occurring after the date of this call. I’ll now turn the call over to Dana.

Dana Russell - Interim Chief Financial Officer

Thanks Bill, good afternoon everyone. Before I highlight Novell’s preliminary Q3 financial results, I would like to note that all of Celerant’s financial results have been excluded from Novell’s continuing operations for income statement purposes and are recorded as income from discontinued operations in all periods presented. Accordingly you will see on page six, of 13 in the press release schedule that the preliminary consolidated statements of operations report income and EPS for continuing operations and total net income. That being said, the company reported $241 million for Q3. The GAAP loss available to common stockholders for continuing operations for this quarter was $3 million or $0.01 per diluted common share. GAAP net income available to common stockholders in total was $12 million resulting in total net income per diluted common share of $0.03. Non-GAAP adjusted income available to common stockholders from continuing operations for the quarter was $20 million or $0.05 per diluted common share.

I want to note that this includes a positive $0.02 impact from the tax provision. Excluding the positive tax impact, non-GAAP earnings per share would have been $0.03, which is consistent with our guidance. The non-GAAP earnings per share excludes stock-based compensation, severance related expenses, a loss on the disposition of our CTP Japan Consulting Group, a gain on sale of property, plant, and equipment and related adjustments for income taxes as well as debt interest expense and the allocation of earnings to preferred stockholders. The $241 million of total revenue this quarter represents a 4% decrease from the same quarter a year ago. This is due to planned declines in IT consulting in connection with our Q4 fiscal 2005 restructuring as well as largely anticipated declines in our legacy network business. There was no need for year-over-year impact from foreign currency on either revenue or net income.

Now turning to page 11 of 13 in the press release schedules titled Unaudited Trended Solutions and Segment Revenue, I’ll briefly review revenue by solution category. Our System Security and Identity Management revenue category generated $64 million in the quarter up 14% from the prior year. Within that category we recorded revenue of $34 million in the Resource Management business that was up 2% from the year-ago quarter. Gains in our ZEN Patch Management and ZEN Asset Management products drove growth in this category and we expect that any near-term future revenue growth in this category would also be a result of these point products sales.

Our Identity and Access Management business generated $26 million in revenue, which was an increase of 46% from the same period a year ago. The strong growth in this category was the result of continued contributions by our Identity Manager and iChain products. I will note that this was the first full quarter of eSecurity revenue contributions; it did not have a material revenue impact on this category. Nonetheless, we are excited about the potential that this product brings to this category in the future. All products in this category saw growth rates in excess of 40%. We doubled license sales and invoicing in the period was up over 77% from the year-ago period. This category has been strong over the past several quarters and we see no reasons why such above market growth rates shouldn’t continue in the near term.

Continuing on with revenue, our second solution category is open platform solutions. You will note that we moved Open Enterprise Server from this category to the Work Space category, we believe this classification gives investors a better sense to the business dynamics associated with this product because OES while a Linux based product is more closely aligned with the transition from our network product. So open platform solutions generated revenue of $15 million this quarter compared to $14 million in the year ago quarter. Linux platform products revenue increased 30% over the prior year to $12 million with growth across virtually every product including 30% growth in SUSE Linux Enterprise Server and as a leading indicator of momentum, invoicing grew 34% over the year ago period ahead of market growth rates.

We are building up a strong base of deferred revenue in this category that will contribute to higher recognized revenues in the future. The third revenue associated with open platform solutions at the end of the quarter was $40 million up $6 million from the prior quarter and up $17 million year-over-year. Sales of our Linux desktop were a contributing factor to success in this category. In addition to experiencing strong growth rates in revenue the desktop has been a major selling point in competitive situations and in terms of overall customer interest in purchasing Linux Solutions from Novell. Other open platform products revenue decrease 26% on a year-over-year basis. This was largely a result of our decision to change the focus of our SUSE professional product, recently renamed Open SUSE, from a consumer retail product to a community addition which is now available free of charge for download off our website. Our third revenue category, Work Space solutions, generated revenue of $84 million in the quarter including the revenue from Open Enterprise Server. The combination of Open Enterprise Server and Network related products generated revenue of $55 million, which was down 19% on a year-over-year basis.

Year-over-year invoicing declined 15% for our combined Netware and OES products and that leads us to believe to we should expect Q4 year-over-year declines at or above the rate of decline we saw in Q3, which is based on our current forecasted revenue trends and some difficult year-over-year comparisons. Within our collaboration category we reported revenue of $25 million, up 8% over the prior year. While approximately 25% of this increase was attributable to one large deal, we also saw a general uplift from a major upgrade shift to the market in the last quarter. Shifting to global services revenue component of IT and software solutions, at $78 million this quarter, global services accounted for 32% of total revenue and was down 8% on a year-over-year basis. The IT consulting component of this category contributed $38 million in revenue and was down 18% year over year. This decline was planned given our focus on consulting engagements around Novell products, thereby reducing revenue from general IT projects and the specific reduction of IT consulting resources during the second half of 2005. As a side note I should mention that we disposed of our Japan CTP consulting group, which was focused on non-Novell product consulting engagements. Japan CTP consulting contributed approximately $1 million to $2 million in quarterly revenues and was marginally profitable. Again the disposition of this business reflects our increased focus on activities of real Novell products. Now looking at the more significant regions in which we do business.

The America’s region reported revenue of $137 million for the quarter, which was up 1% on a year over year basis. Profitability was up slightly year over year as the specific measures we took during the previous quarters to manage cost within this region had an impact. We will continue to focus on maintaining margins while we grow top line performance. The EMEA region reported $84 million in revenue for the quarter; they have 10% on a year-over-year basis. As we mentioned in Q2, much of this was due to planned reductions in our consulting business. I want to note that EMEA’s invoicing was strong in the quarter growing 6% year-over-year suggesting that EMEA is having better success penetrating the newer technology markets and accounts versus the older products in markets characterized by a recognized revenue trends. Profitability declined slightly due to reduction of recognized revenue from NetWare Legacy products but we are very encouraged with the increased invoicing and deferred revenue from our newer strategic products, which will contribute to recognized revenue and profitability in future quarters.

Now turning to operating expenses, I would like to point out once again that these values do not reflect the impact of Celerant. They strictly relate to Novell’s continuing operations. Total operating expenses excluding stock based compensation and other one-time items were $155 million in Q3 down 2% from the year ago period and 1% from Q2. So the marketing expenses were flat compared to Q2 at $86 million or 36% of revenue. While sales expenses increased world wide as a result of higher compensation expense and sales expense acquired with eSecurity we did successfully mitigate some of the impact by containing marketing expenses during the quarter per our plan.

Product development expenses decreased approximately 3% from Q2 totaling $45 or 19% of revenue in Q3 due to the prior restructuring activities and usual seasonality in this expense category. Total headcount at the end of the quarter was approximately 4700. We are very aware of the cost structure for this Company particularly the significant current investments in Linux and Identity and the resulting impact on incomes. We also understand the need to improve profitability as we continue to make these investments and take advantage of our momentum in key strategic areas of our business. The GAAP and non-GAAP income tax benefit from continued operations in the quarter was $2 million. The current GAAP and non-GAAP income tax benefit is a result of two primary factors. First, the company had $6 million in tax benefit in the quarter from tax refunds and federal tax return true ups. Second, the company’s annual projected income tax provision decreased during the quarter and as a result the company recorded a tax benefit in the quarter to bring the year to date income tax provision in line with revised annual projections.

Now I shifting to the balance sheet, there is a few items to note. Cash in short-term investments of $1.3 billion were down 19% from the prior year due primarily to stock repurchases as well as the purchase of eSecurity in Q2. Offset by positive cash flow from operations over the past 12 months, the sale of both corporate jets, a net cash from the sale of Celerant. Cash flows from operations for Q3 was a positive $33 million, up $17 million over the prior year due primarily to a reduction in overall cost.

Net receivables decrease $19 million from the same period a year a go due primarily to the sale of Celerant. DSO, sales outstanding was 88, up eleven days compared to the year ago period due to a higher level of late quarter invoicing in the current quarter compared to the same period a year ago and our accounts receivable aging remains consistent with prior periods. Goodwill increased $32 million from the year ago period due largely to the eSecurity acquisition offset by the sale of Celerant. Deferred revenue at $391 million was up 7% year over year, which reflects our continued shift to more of the subscription and maintenance business. This shift to a subscription and maintenance business is also starting to show itself through a more consistent quarter over quarter recognized revenue trend versus the traditional Q4 increases from the immediate recognition of year end license sales.

Now turning to guidance. For the fourth fiscal quarter ended October 31st 2006, we expect revenue to be in the range of $246 million to $256 million. Non-GAAP earnings per share excluding the impact of stock-based compensation expense is expected to be $0.04 per share. Now the revenue guidance anticipates several factors. First as we mentioned, a continued decline in combined NetWare and OES at or above the rates experienced in Q3 on a year over year comparison. Second, lower consulting revenues associated with the focus on Novell products and increasing revenues in Linux and Identity. And finally, forecasted revenue trends and difficult year over comparisons as we previously mentioned. The guidance also includes the impact of accelerating some incremental spending into Q4 as we look for ways to invest in the business with the goal of increasing efficiencies over the long-term. Specifically, some of this spending would relate to increasing the efficiency and effectiveness of our after market and our R&D processes.

The impact of stock-based compensation expense is expected to be approximately $0.03 per share for Q4 of fiscal 2006, which would result in reported GAAP results of $0.01. The non-GAAP EPS guidance assumes shares outstanding to be $398 million at $0.04 per share. This includes the diluted effect of the 52 million potential shares related to the conversion of our outstanding debentures. We are also assuming a non-GAAP effective tax rate between 40% to 45%, which excludes the impact of stock-related compensation.

On a summary note Novell in making progress in its key strategic areas. We are spending money to grow our Linux and Identity businesses and we are seeing results. We saw gains in both recognize revenue and the invoicing for our Linux and Identity businesses beyond the market growth rates. These gains give us confidence to believe that we are on the right track for the health of the business. While current overall profitability may not be at levels we find acceptable given these current trends and the business environment we see an improve profitability over the long-term. And with that I’ll turn the call over to Ron.

Ronald W. Hovsepian - President and CEO

Thanks Dana, and welcome everyone. I’m pleased that Novell delivered on its financial guidance around revenue and non-GAAP EPS again. It’s important for us to set realistic financial goals and to achieve or surpass them with consistency, which we have now done with success since giving financial guidance a few quarters ago. We are still driving to achieve our previously stated goal of reaching 12% to 15% operating margins as we exit fiscal year 2008. In Q3 as has been the case for the last several quarters we saw outstanding growth in our strategic businesses of Linux and Identity and we continue to experience some well understood and expected challenges in our work group business. In general, we are executing our plan.

In my new role as CEO I’ve spent the last 60 days talking to hundreds of customers, partners, employees, investors, and the media. There is a positive and yet challenging tone to all the conversations and it has further energized me to aggressively execute and take advantage of our opportunities. Throughout these conversations I see a focused, dedicated, and experienced management team, a hardworking, smart, and enthusiastic employee base, and a portfolio of leading-edge products and a set of loyal customers. I will declare that we will simplify Novell’s business, focus our energies and activities and execute with passion. With this as our charge, I am confident that we will get Novell on the right track to grow and improve profitability over the long-term. We will win in our chosen markets. Regarding the voluntary stock-based compensation review, we said all we can say on that topic at this point, but I do want to reinforce that this is a no way a reflection on the quality of our business or the future growth prospects. We will be reporting to you on the progress of this work as appropriate. In the meantime it’s full speed ahead with building our business and executing on our strategy.

So let’s a get a little deeper into the main business drivers this quarter. In our Linux business, as Dana had pointed out we had a very good quarter in this category, generating the best year-over-year results that we’ve ever had in the main products in this category, excluding the planned declines of SUSE Linux Professional products. Our EMEA region executed particularly well in Q3 and is generating positive momentum for future quarters. We attribute the success of this category in the quarter to a mix of factors, including the introduction of channel rebates to drive volume, changes to our sales incentives, and the introduction of Code 10, our reference to the launch of SUSE Linux Enterprise 10 platform. The release of the next version of our flagship Linux platform product, SUSE Linux Enterprise 10 was the highlight in this business quarter. The SUSE Linux Enterprise 10 is the next generation platform for the open enterprise and we believe it’s the best engineered, more secure, and most interoperable Linux platform in the industry. It include SUSE Linux Enterprise Server and SUSE Linux Enterprise Desktop providing a secure and reliable foundation for enterprise computing from the desktop to the data center, a lineup of enterprise-class solutions matched by no other Linux center.

Market and community interest has been very strong in this new product set. Since SUSE Linux Enterprise 10 was launched on July 17 more than 160,000 copies of SUSE Linux Enterprise Server had been downloaded. More than 194,000 copies of SUSE Linux Enterprise Desktop have been downloaded, and Novell’s Linux homepage has received more than 1.5 million page views. Large enterprise adoption of Linux solutions continues to be strong as customers like Office Depot, United Airlines, Ritz Camera, Banca Popolare di Milano, all bought extended Linux solutions from Novell in the past quarter. From the partner perspective, gross SUSE Linux ISV certifications were still strong in this quarter. Total software application certified on SUSE Linux were 993 this quarter, an increase of almost 15% from the year-ago totals. Noticeably we had over 400 supportive partner products to support the launch of SUSE Linux Enterprise 10.

We talked to you last quarter about some issues we needed to address, specifically our renewals process and performance in our Linux business. I am pleased to report progress in that area. While we still encounter relatively lower than expected overall renewals in our Linux business, the release of SUSE Linux Enterprise 10 includes features that will make it easier for us to increase our renewal rates. First, we had implemented a new registration process with SUSE Linux Enterprise 10 that allows us to capture information about our customers and how they are using our software. We know which software they have installed and how often they are updating their software. Having this data allows us to enable our sales people and our channel with automated processes to follow up on the renewals. This will allow us to fully implement online renewals engine for all customers to renew via the rep. We have showcased our renewals engine through the newly launched Novell Customer Center. Novell Customer Center combines innovative tools to bring together all of Novell’s customer information to provide customers with a coherent picture of contracts, licenses, subscriptions and product entailments. As a result customers are better able to manage their subscriptions, ensure licensing compliance, simplify patch acquisition and update processes, and ultimately reduce systems management cost.

Novell customer center is fully enabled for managing the following products, SUSE Linux professional which is 10.1, which is now openSUSE, SUSE Linux Enterprise Desktop 10 and SUSE Linux Enterprise Server 10. As a sign of its early success we’ve already had more than 32,000 individual registrations of SUSE Linux Enterprise Server and SUSE Linux Enterprise Desktop in the customer center and over 540,000 page views of the center on novell.com. Ultimately we’ve laid the groundwork for enabling online renewals for all of our customers and all of our products, not just the SUSE Linux’s products. By time the online renewals engine into the Novell customer center by combining product service support options for customer contacts and the Novell Customer Center simplifies administration making it faster, easier and more cost effective for companies to do business with Novell.

Back to and into Identity business, we are pleased this business continues to be a steady and outstanding performer. On the Identity management side this business continues to exhibit growth rates well ahead of market growth rates. The Identity market continues to see strong growth in relevance with our customers. This is primarily driven by the need for regulatory compliance, SarbOx, HIPAA and Basel II, etc, and corporate and IT governance. With customers’ needs for security, identity and systems management converging this creates a unique opportunity for Novell and we are one of the very few who can handle this, vendors that can deliver comprehensive and compliance solutions in the market. In addition, Novell has been active in providing thought leadership in this market. With the acquisition of eSecurity last quarter, we’ve spurred enterprises to rethink their approach to building a real time comprehensive compliance solution by adding security event management through the Identity and systems management. Additionally, we’ve leveraged our expertise in the open source community to advance key identity management technologies in open source. Specifically, we’ve launched and have assumed a leadership position in the Bandit project.

The Bandit project is building a system of loosely coupled components providing consistent identity services. It is a community that organizes and standardizes Identity related technologies in an open way, promoting both interoperability and collaboration. These components expressed in an open standard protocol and specifications will be leveraged to further enhance Novell’s identity offerings. Even with our strong identity management performance we are still not operating up to our potential in this category. Next quarter, we expect better performance from our Asia-Pacific region and the newly acquired eSecurity business. Despite a slower than expected start from eSecurity, we are still excited about the potential that this new business holds for us. The pipeline is building and we expect this product line to significantly improve performance over the next few quarters. In our systems and resource management business, we saw satisfactory performance.

New point products and partner products, such as ZENworks Asset Management, and ZENworks Patch Management helped successfully grow this category. We recently added another point product to our price list in the end point security space, for which our customers have been asking. We believe that systems management has enormous potential to differentiate Novell over the long-term. Managing our customers’ identities, systems, and other resources are a strategic IT need for customers and we will be increasing our investments appropriately in this area. The near term outlook for our Identity category remains encouraging. Our pipeline and invoicing look strong and our steady flow of new products and aggressive sales and marketing campaigns should sustain over the near term this already strong performance.

In our Workgroup Solutions category while OES continues to make inroads with our customer base, we were disappointed by the revenue performance of the combined category of NetWare and OES. Many of the known competitive issues still affect us in this quarter. We expect to see similar year over year declines with the combined NetWare and OES category for at least the next few quarters.

Turning to the corporate. Turning to some of the corporate initiatives for a moment we’ve made additional progress in the quarter in our mission to simplify and focus the business. Following on the heels of the announced sale of Celerant, our management consultant subsidiary, we reached an agreement after the quarter ended to sell our business consultant group in Japan to a division of Unisys. This group was not focused on Novell products. The ongoing financial impact will be immaterial, but the sale is indicative of the management’s desire to eliminate businesses and other efforts that do not align with our strategic goals around promoting Linux and Identity. Our efforts to simplify Novell’s business and refocus the business on our strategic priorities will be ongoing.

In conclusion, with the business experiencing increased stability, we are focused operational efficiencies, improving and sustainable profitability are at the top of my list of priorities. We are not yet operating at the profit margins we would like to. With our target of 12% to 15% operating margin at the end of 2008, we clearly have a lot of ground to cover. The leadership team is at work reviewing the projects to help us in that effort and others. Having only been in the post for two months I'm not yet in a position to begin to review with you the specific outcomes of these projects. For now let me highlight the major categories of the initiatives we will be working on.

First, strategic selection, this work includes market selection including our geographic and industry and solution segmentation. Second area, rights to market, this work includes reengineering of our go to market capabilities including the appropriate use of the right channel economics for proper market coverage and the increased investment in our channel and alliance partners. We are working with a leading outside consultant firm which specializes in rights to market optimization. The only focus will be in improving the eco system for our growth businesses of our Linux and Identity while improving the efficiency of our sales process. Third area, product management, this initiative is focused on ensuring that Novell knows as a technology innovator and thought leader, transforms itself into being a market and a customer driven company. Accordingly, this work will focus on both process and productivity improvements, the results of which will be products both our customers developed and sourced in the most efficient and cost-effective manner possible. Fourth, our back office improvements, we are bench marking our finance, HR and IT and procurement functions to assure that we are competitive from both a process and an expense perspective; this work was recently kicked off.

I expect to discuss more about our plans for Novell’s future at our next earnings call, the Q4 ‘06 call, as we close out the fiscal year and set objectives for the new one. At that time I expect to discuss some more focused Novell strategy and the milestones for success including select indicators like operating expenses including selected leading indicators, business indicators and operating expense initiatives. Operator, we are now ready for questions, please open up the queue.

Question-and-Answer-Session

Operator

[Operator Instructions]. Your first question comes from Mark Murphy from First Albany.

Mark Murphy - First Albany Capital

Thank you Ron, I have a question on the maintenance revenue. It looks like -- the numbers right, it looks like that is now down to year-over-year two quarters in a row and that’s in the period of time where you’ve made some acquisitions. Is there any color you can provide us on maybe the renewal rates? Is there any new pressure that you’re seeing on the maintenance pricing or is it possible that there is any kind of temporary side effect on the maintenance line subsequent to the Celerant spin off or perhaps any other kind of affect there -- and then could you give us may be a handicap what revenue line might look like the next few quarters?

Dana Russell

Hi, Mark this is Dana, let me give you a little color on that. If you look at that what you are saying is maintenance and services and it did decline. So the major decline there is actually consulting which we’ve talked about, which was planned. We also talked about from the clients in our network, my network OES business and that makes up the rest of that decline. On the positive side though I think what you will see if you go through the press release schedules is you’ve got growth in our key areas both on licensing and maintenance. So on a go-forward basis I think based on the guidance if you look at that you will be able to model out some of the projections around network and OES, which is a key factor in that particular category.

Mark Murphy - First Albany Capital

Dana, just to clarify that, if you’re to strip out the services part of that and just look at the pure maintenance number, we are coming up with about roughly 117.5 and than comparing that to 121.6 in the year ago, is that a fair way to be looking at the pure maintenance number?

Dana Russell

Mark, I think the thing to do is actually look at it, if you were to take your press release schedules on page 12, you will be able to go through each of those categories and look at that on a year-over-year basis for each particular area, and that will give you a good indication in terms of where we stand. And then I think you can take your NetWare and OES and not let out for future look in terms of what those balances may be.

Mark Murphy - First Albany Capital

Okay, thank you and just as a final question. Did I hear it correctly, did you say that we should expect to see a similar NetWare and OES decline for the -- are you saying for Q4 or is that more of a general comment referencing the next few quarters?

Dana Russell

Next few quarters. Yeah, I think there is a couple of things there, Mark, what I specifically talking to was next quarter from the standpoint of a couple of things. One, there is -- if you look at it on a year-over-year basis we had a very good quarter for that particular category in 2005. We also had in there a very large one-time deal which accounted for about $20 million of total revenue and particular to the combined NetWare OES line item was about $2.7 million. So I think we are experiencing declines overall to Ron’s point that comments were specific to Q4.

Mark Murphy - First Albany Capital

Okay, thank you very much.

Operator

Your next question comes from Terry Tillman of SunTrust Robinson Humphrey, you proceed with your question.

Terry Tillman - SunTrust Robinson Humphrey

Thanks guys, Ron, I had a few questions, first on the Linux front. So if I look at this $11.6 million revenue line, which I know is maintenance primarily around the subscription, that’s up from $10.3 million, can you help us delineate in terms of how the SLED’s business did in the quarter versus maybe the desktop business?

Dana Russell

Well, yeah this is Dana again. We can give you a little delineation of estimate standpoint that the SLED’s business was very strong and I think it was comparable in terms of the overall growth in that category, both on an invoicing and the recognize revenue basis.

Terry Tillman - SunTrust Robinson Humphrey

Okay I guess, Ron, can you talk a little bit about you know, you have been focused and trying to more strongly engage with the large hardware vendors, were you adding a process and was any of these increase in year-over-year growth attributable to that or is that still more benefits to occur in the future?

Ronald W. Hovsepian

The answer is yes to actually both we are making progress with our strategic partners. Some of the problematic pieces that I announced around the channel rebates was a key piece of it as well as some of the problematic team selling that we’re doing with a couple of the key hardware partners and that has been well received by them, in particular one has put a specific program in place to help focus all of us to work with them more closely. In terms of the long term I think it’s still out in the future, the growth of what we can’t see through the channel piece of that with those partners and we are working very closely with them to see how we can put the proper programs there, that’s also referenced in our rights to market improvement, is really focusing more of our market development dollars and alliance team around those pieces to really extract the most valuable possible and leveraging their ego systems and that’s really what's most important from my perspective.

Terry Tillman - SunTrust Robinson Humphrey

Okay, and then just a final question related to the topic in NetWare and OES. I know in the past when OES was first contemplated and was first introduced, the idea was this would be a very important channel business and I thought there was going to be some enticement -- I’ve heard about enticements to help the channel partners really drive OES sales. What’s going on and why isn’t that working out as well, because that combined category was now down 19% versus 16% in the prior quarter? So what’s going on with that and how can you rectify it?

Ronald W. Hovsepian

From my point of view, there is two things going on here. One is we are actually getting good transition of our customers signing the contracts, migrating from the NetWare to OES, that’s where you saw the OES overall growth come from. Where we are seeing the erosion as the NetWare piece of the equation there, and what’s happening as we put the programs and the incentives in place with the solution providers, as we mentioned in past calls, we are getting hit by the competition very hard there with very large incentives for our channel partners to migrate them off of either NetWare or OES, from an overall perspective. So we are still continuing the feel that pressure, and Dana if you want to add any more color to that.

Dana Russell]

That’s really the answer.

Terry Tillman - SunTrust Robinson Humphrey

Okay, thanks guys.

Operator

Your next question comes from Brendan Barnicle of Pacific Crest Securities. Please proceed with your question.

Brendan Barnicle - Pacific Crest Securities

Thanks, Ron, I had a couple of general questions to answer is, one is migration trends, there has been some industry data that suggests that there has been some -- in the street data that suggests that there has been some deceleration in Unix to Linux migration, do you see any of that at all?

Ronald W. Hovsepian

At this point no, as Dana has shared with you -- we showed both the revenue number and he gave you the invoicing number, which is a good leading indicator for that and that was 34%. So we did see that as a future indicator. What I’ve seen and heard from the teams out on the street has been continued opportunity in the market place and I haven’t seen any slow down. I think we should get is the -- customers are going to pause potentially around the transition from the edge servers to making a enterprise decision and that’s really what we focused our strategy on, was when the customer makes a decision from moving from edge based computing on Linux to the broader ways of your business applications or the data center. Those are the areas that we focused in on to really grow our revenue stream and that’s where we are still seeing a lot of interest and lot of activity and a lot of positive momentum. I hadn’t seen anything slow down that arena, but I do think as customers digest the edge servers, there will be little bumps as they move up to the application environment. The analogue would be looking at what happened inside the Unix market place, and went through a similar phenomenon as we go through that. I also think we are going to open up and make sure we emphasizes our first to market around some of the virtualization and the Data Center capabilities that we did build into the Coe 10 base. So I am hopeful that that will continue the momentum as well.

Brendan Barnicle - Pacific Crest Securities

And, I wanted to follow up on that virtualization piece to how are you guys pricing virtualization as that per server, is it per instance of the OS?

Ronald W. Hovsepian

It’s a per server pricing at this point, which we think is also advantageous for the customers, as they look at how pricing is in the market.

Brendan Barnicle - Pacific Crest Securities

Great, then lastly, Larry Ellison has made comments about potentially getting into the Linux distribution business, do you think there is any likelihood of that and do you see them potentially maybe supporting any of the other Linux distributions or anything like that? Thank you.

Dana Russell

You know -- what Larry is going to do, what I can show with you is right now they support 16 different operating systems inside of Oracle, so if someone who looks from the outside in, they support, I think its 16 or 17 operating systems and if they were to add another one you know, that would be their choice, other than that -- yeah that’s why I don’t where else it would lead.

Brendan Barnicle - Pacific Crest Securities

Great, thanks a lot.

Operator

Your next question comes from Brent Thill of Citigroup, please proceed with your question.

Brent Thill - Citigroup Global Markets

Good afternoon, just a question on Q4 even if you strip out the $20 million deal from last year and strip out Celerant, the numbers are still I think coming in roughly down 4% to 8% organically, is that a fair deal with the organic business when you strip out those two factors for Q4?

Dana Russell

Yeah though we have -- so we had it the one large deal, but we also have taken measures to reduce, consciously reduce consulting that we talked about you know, in previous calls and then also in this call. And so that does play into the overall year-over-year decline.

Brent Thill - Citigroup Global Markets

Okay, as you are pushing that to your third party partners?

Dana Russell

Yes.

Brent Thill - Citigroup Global Markets

Okay and, Ron, maybe if you can just comment relative to the 1.3 in the balance sheet -- $1.3 billion, your view versus acquisitions going forward now. Is it more focused on the co-axis you have today or also looking at for acquisitions?

Ronald W. Hovsepian

As we’ve indicated in past conversations we will look to make the right acquisitions on a regular basis with our board we reevaluate the use of the capital along all lines as to what’s best to do for our shareholders and for the long-term sustainability of the business and we will continue to do that. I will indicate that we have said we are going to be acquisitive and I believe that is still on our future.

Brent Thill - Citigroup Global Markets

Thanks.

Ronald W. Hovsepian

Yeah.

Operator

The next question comes from Kirk Materne of Banc of America, please proceed with your question.

Kirk Materne - Banc of America Securities

Yeah, thanks very much. Ron, maybe just give your comments on NetWare, how do you view managing that business going forward from profitability standpoint, I guess at what point in time you have to make some adjustments on that and how fast can you make those given you know, the pace of decline right now obviously that’s becoming less and less profitable as we go forward each and each quarter, so I guess what’s your view I guess I know you are only 60 days into this, but your view on how quickly you need to adjust some of those cost given what’s going on in that part of the business?

Ronald W. Hovsepian

Yeah thank you. I will look at and this is a general business statement and it also then applies specifically to NetWare. We will look at the EBITDA ratios very closely at both from a development perspective, a sales perspective, and the back office perspective to make sure that as different parts of the business fluctuate and in this case in your NetWare example, making sure that we put those expenses and balance with where the performance of those businesses are, as well as where there may be in their life cycles would be the other dimension. So the answer to your question very simple; is yes we will look at those pieces very closely and look to balance them accordingly to the different businesses as we look at the company.

Kirk Materne - Banc of America Securities

You know, I mean to sort of pin you in to a time frame but is that obviously it seems you had your eye on for a while now I guess, how quickly can you make changes there you know, is it a year period, is it within a year, I’m just trying to get the sense of how long it takes you guys to sort of go about identify what can be changed and then I guess attack that?

Ronald W. Hovsepian

We do understand that needs to be done inside of that; there is a thoughtfulness that has to go through any of those processes. I’m very focused right now in getting the next release out which is in the June time frame, which allows us to do a number of things, so inside of that would then afford us to then take a moment of pause and understand what the next evolution of that product set that would be or not be.

Kirk Materne - Banc of America Securities

Okay thanks, let me just -- one further question on NetWare. Things like the maintenance portion of that’s going down faster than licensed which would seem somewhat incongruent. I guess, what’s going on, I guess around the maintenance in -- I guess we received licenses tail off -- about kind of pays as well?

Dana Russell

Kirk, this is Dana, we’ve obviously looked a lot of that number and the various aspects of it and I think across the board what we have seen is, we have seen two things. One there is pricing pressure, which is impacting us, but also there are just customers that have moved away from NetWare and so that’s impacted the maintenance number.

Kirk Materne - Banc of America Securities

Okay thanks very much.

Operator

The next question comes from Jason Maynard of Credit Suisse, please proceed with your question.

Jason Maynard - Credit Suisse First Boston

Hey, good afternoon guys. Ron, you talked a little bit about some of the initiatives and plans around, I guess streamlining, go to market and efficiency and effectiveness and the same time you’re still talking about the 12% to 15% operating margin targets. How should we think about operating margins maybe in more of an interim period over the next year?

Ronald W. Hovsepian

Great question, as I indicated in my comments I would like to give you more of that color and more of that milestones that go along with our Jason, in the next Earnings Call, so that we can be as -- give you our best judgment once we have integrated all those pieces together as to what the sensitivities would be, of each one of those areas.

Jason Maynard - Credit Suisse First Boston

Okay, are there any sort of gaining factors right now that we should be thinking about in terms of areas of maybe more pronounced cost reduction, things that sort of stand out to you and then you talked about sort of 18 -- I think initiatives of the company is contemplating.

Ronald W. Hovsepian

Yeah, those 18 fall into those four major buckets that I just walked you through, the strategic completeness of the rights to market, the product management as well as what we can do in the back office. So there are funnel into those groups Jason. I think in terms of what’s gaining and how we are looking at it very closely and integrating it is, you just have to look at -- take product management as an example as you run a leverage the most efficient market that could balance your overall costing for that environment. You’ve got to make sure that you time that with your product releases. So you get the light skills. If you talk about what we need to do in telemarketing as an example, at telesales, they are -- we are gaited by, how fast we put together the proper bid for doing that type of work in the integrated manner that we have laid out. So those would be examples of things that are gaining. I don’t see anything that has an extensive tail on it, in terms of time. I think some things will take a little longer for us to ferret through and a more complex, but if there is nothing what I see on the horizon that makes me back down from that 12% to 15% at all in terms of the timing, Jason.

Jason Maynard - Credit Suisse First Boston

You mentioned acquisitions and you’ve been consistent talking about that as a strategic path. If you were to going to plan an acquisition, would you consider perhaps taking a bigger cut to may be some of the revenue producing, but albeit lower margin areas of your current business. If you were to marry that with maybe an acquisition of a little bit more size and scale?

Ronald W. Hovsepian

In that strategic direction area that selection of segments and markets obviously were generating some different scenarios that we’re going to work through and those do have scenarios where we increase in certain markets and decrease in others as you would expect, none that I’ll comment on any detail at this point.

Jason Maynard - Credit Suisse First Boston

Okay that’s fair, thanks for your time.

Ronald W. Hovsepian

Yeah.

William Smith

Thanks, Jason.

Operator

Your last question comes from Katherine Egbert of Jefferies, please proceed with your question.

Katherine Egbert - Jefferies

Hi thank you, I’m going to follow up a little bit on the last set of questions. Can you tell us which of your products right now are profitable?

Ronald W. Hovsepian

We see that information here in terms of our understanding of what’s going on with about the product that is not information that we have shared to this point and I can’t comment on it anything past that.

Katherine Egbert - Jefferies

Okay, thanks a lot and then maybe more broadly to get to a 12 to 15% operating margin, do you think it’s primarily a function of cost cutting from here or revenue growth?

Dana Russell - Interim Chief Financial Officer

Right now I think it’s a balancing act of both as you look at the market, we’re looking at all the sensitivities of how you get the business optimized there and we’ve got growth market so as you have seen now obviously the sensitivity changes depending upon how fast the revenue growth ones go up or some of those one that are declining if they accelerate. So and I think buried inside Kirk’s question was, okay Ron are you paying attention of that, you are in the management team and are you going to adjust accordingly, and the answer to that is yes, Katherine.

Katherine Egbert - Jefferies

Okay, thanks for your time.

Ronald W. Hovsepian

Yeah and I thank you. Operator?

Operator

Yes sir, that’s the final question.

Ronald W. Hovsepian

Okay.

Operator

This does concludes the conference, you may disconnect at this time.

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