Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  
TRANSCRIPT SPONSOR
Wall Street Breakfast

Novell, Inc. (NASDAQ:NOVL)

F3Q07 Earnings Call

August 29, 2007 5:00 pm ET

Executives

Ron Hovsepian - President, CEO

Dana Russell - CFO

Susan White - IR

Analysts

Mark Murphy - First Albany Capital

Katherine Egbert - Jefferies

Brent Thill - Citigroup

Brent Williams - Benchmark

Aaron Schwartz – JP Morgan

Jim Gilman - Cross Research

Brian Kraft - Credit Suisse

Terry Tillman - SunTrust Robinson Humphrey

Denny Fish - JMP Securities

Presentation

Operator Welcome to the Novell third quarter 2007 financial earnings release conference call. (Operator Instructions) Ms. White, you may begin your conference.

Susan White

Good afternoon, everyone and thanks for joining us. I'm Susan White, Director of Investor Relations for Novell. 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 third fiscal quarter 2007. If you don't yet have our third quarter 2007 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 available on our website and for telephone playback through September 14th, 2007. The domestic toll free replay number is 800-642-1687. The international replay number is 1-706-645-9291. Replay listeners must enter conference ID number 10920968.

Before I turn the call over to Dana, I would like to take a moment to say that we will provide 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 the 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 May 25th, 2007. Any forward-looking information that we provide in this call represents our outlook as of today, August 29 2007 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. For the quarter, the company reported net revenues of $243 million. Loss from continuing operations was $3 million. Non-GAAP net income was $16 million or $0.05 per share. Non-GAAP income excludes stock-based compensation, restructuring expenses, voluntary stock option review expenses and other one-time items.

Foreign currency exchange rates favorably impacted revenue by $4 million and negatively impacted operating loss by $1 million in the quarter on a year-over-year basis. On a year-to-date basis, foreign exchange rates favorably impacted revenue by $10 million and negatively impacted operating loss by $5 million.

Overall, our results were good this quarter. We had another strong quarter in our Linux platform products and workgroup declines were less than expected. We continue to work hard to control expenses and improve profitability.

I will highlight some of our quarterly results by business unit. I'll refer to the business unit schedule on page 10 and the revenue schedule on page 11 of our press release. Let's begin by turning to page 11. Within open platform solutions, Linux platform products revenue was $21 million, increasing 77%. Year-to-date, Linux platform products revenue was $55 million, that's up 71%. Linux platform products invoicing was $38 million, up 95% and year-to-date invoicing was $163 million, up 243%.

Now turning to page 10 of our press release, gross margin for OPS was 67%, up from 55% in the year ago quarter. The improvement was driven by product revenue growth. Product development expenses were 42% of OPS revenue, down significantly from 60% a year ago due to increased leverage in the model.

Turning back to our revenue schedule on page 11 within our identity and security management business unit, identity and access management revenue was $27 million, up 2%. Year-to-date, identity and access management revenue was $74 million, flat compared to the same period a year ago. Year-over-year, invoicing for identity and access management increased 3% and year-to-date invoicing was up 10% in line with market growth rates.

As seen on page 10 of our press release, gross margin for ISM was 45%, and that's up from 43% a year ago. The increase was due to improved profitability of our consulting engagements. Product development expenses were 30% of revenue, up from 27% in 3Q06, due to overlapping expenses from our product development initiatives.

Turning back to page 11 of our press release, our systems and resource management revenue was $35 million, and that was up 4%. Year-to-date revenue was $99 million, that's down 1%, and invoicing in 3Q07 was up 3% and on a year-to-date basis, invoicing was up 1%.

Total workgroup revenue of $83 million was down 2% in the quarter and year-to-date revenue of $247 million was down 6%. Excluding the impact from Microsoft, workgroup revenue was down 7% in the quarter and down 11% year-to-date. Year-over-year invoicing declined 9% for workgroup, year-to-date invoicing was down 10%. Within our workgroup category, the combined OES and NetWare-related revenue was $50 million, down 8%. Year-to-date, OES and NetWare-related revenue was $150 million, down 13%. Combined OES and NetWare invoicing declined 11% in the quarter and year-to-date invoicing was down 13%.

On a non-GAAP basis, operating margin was up over 5%, and that's up from 3% a year ago. For the quarter, cost of sales and operating expenses were $231 million, relatively unchanged from a year ago. Gross margin increased to 71%, up from 68% due to increased improvement consulting margin. Sales and marketing expenses were lower due to continued expense control. Product development expenses were higher, mainly as a result of transformational activities in our data center automation initiatives. G&A expenses were higher due to increased legal costs.

Total operating expenses include $6 million of overlapping expenses for the quarter and $15 million year-to-date. We expect to incur total overlapping expenses of $20 million to $25 million for the year, which will all be removed by the end of the fourth quarter. We've incurred $6 million of restructuring charges this quarter and a total of $22 million under our current restructuring plan. We expect to incur total charges of $35 million to $45 million by the end of fiscal 2007.

On the balance sheet, there's a few items to note. Cash and short-term investments of $1.8 billion were unchanged from the prior quarter. We did have positive cash flow from operations of $26 million. Net receivables decreased $35 million from the same period a year ago, primarily due to improved management. Days sales outstanding was 74 days, down from 88 days a year ago. Total headcount at the end of the quarter was approximately 4,600.

With that, I'll turn the call over to Ron.

Ronald Hovsepian

Thanks, Dana. Today I will provide an overview of each business unit and an update of our strategic initiatives and close with the progress report on our key milestones. We have completed three quarters of the year and we are well-positioned to achieve most of our financial and strategic objectives for fiscal 2007. As we have undergone transformational changes this year, some areas have excelled while other areas need improvement. This is not surprising, given the magnitude of the change we are undertaking. Overall, I am pleased with our progress.

Let me begin with the business unit updates, starting with open platform solutions. Within our OPS business unit, Linux platform products had another strong quarter. On a year-over-year basis, recognize revenue for Linux platform products grew 77% and invoicing increased 95%, well in excess of market growth rates.

Our relationship with Microsoft continues to deliver strong results. Year-to-date and less than one year into our partnership, we have invoiced $105 million or 44% of our five-year, $240 million agreement. Earlier this summer, the final version of the GNU general public license version 3 was released. We fully intend to support this license and more importantly, it grandfathers the Novell-Microsoft agreement from the provision designed to prevent similar arrangements. GPL3 does not inhibit us from delivering SUSE Linux enterprise to customers whether direct from Novell or from the Microsoft program. SUSE Linux Enterprise is poised to expand it footprint in the desktop market. Earlier this month, we announced a partnership with Lenovo in which they will begin offering preloaded SUSE Linux enterprise desktop, or SLED, on Lenovo ThinkPad notebooks starting in the fourth quarter of this year. Dell, also announced they will offer preloaded SLED on PCs for the China market. This is an important milestone for Linux. It is the first time an enterprise desktop distribution has been selected by a tier 1independent hardware vendor.

On the customer side, we had an important win with the electronics corporation Tamil Nadu in India which is rolling out SUSE Linux Enterprise across 30 ,000 desktops and almost 2,000 servers. While the Linux desktop market is still in it infancy, we are making important strides.

There was also an important legal development for Linux. In 2004, SCO filed suit against us claiming among other things that it was the rightful owner of Unix copyrights and that Unix was improperly in Linux. Earlier this month, the federal district court in Utah ruled that Novell is the owner of Unix copyrights, thereby cutting the core out of SCO’s case and eliminating its threat to the Linux community based on allegations of Unix copyright infringement. This is a great development for Linux and the open source community. Customers and developers can deploy and develop on Linux with increased confidence that SCO’s copyright infringement allegations have been put to rest. Of course, the lawsuit is not over and SCO may appeal but this is an important milestone in our effort to clear away obstacles to Linux deployment.

Now let's turn to our identity and security management. Within this business unit, identity and security products posted invoicing growth of 3%. I am disappointed with these results. The problem is most pronounced in the Americas and is due to the lack of sales execution. The sales cycle has become more complex and competitive in the Americas, and we have not shown proper discipline in managing the sales cycle. To correct the problem, we are improving the management of the sales process, increasing specialization of the sales force, and expanding our channel partnerships.

In our systems and resource management business unit, we have been investing in two major products which were released earlier this month. The first product is our newest Zen Works configuration management offering, which has been architected to be cross platform and is well-suited for both Windows-centric and mixed environments. The market has been anticipating this release and it has been well-received by both the analyst community and customers in our beta program. We also announced the general availability of our data center automation offering Zen Works Orchestrater, which is developing a solid pipeline. These offerings hold the potential to become a new source of growth in the future.

Turning to our workgroup business unit. Workgroup performed better than expected this quarter, with invoicing declining 9% year over year due to the strength of our bundled offering Novell Open Workgroup Suite. While I am pleased with these results, I continue to caution that it is too early to conclude that this performance is a trend.

Moving on to our strategic initiatives. We have three major initiatives underway to help us reach our financial goals in fiscal 2007. I am pleased with the progress of each initiative, and I am confident we will achieve our target non-GAAP exit rate operating margin of 5% to 7% in fiscal 2007.

Here's a brief update on each initiative. Initiative 1, sales model. In our sales model initiative, we are shifting some of our resources towards indirect model as well as improving the efficiency of our sales force through specialization. Phase 1 of our teleweb initiative is progressing according to plan, enabling most of our renewal business to run on a teleweb model in fiscal 2008.

Initiative 2, our R&D processes. In our R&D initiative, we are improving the cost and productivity balance between on and offshore R&D locations. We exceeded our third quarter goals to hire 50% of our total headcount for the year and we have now hired 85% of our total fiscal year goal.

Initiative 3, back office. Our back office initiative is focused on creating a shared service model which will provide a standard and centralized and automated platform for many of our back office functions. The transition of many of our back office processes is on track.

Finally, I want to discuss our progress on our six key milestones for fiscal year 2007. The first milestone was to deliver revenue that is flat or near flat on a year-over-year basis. Year-to-date, revenue was flat compared to last year. Revenues continue to be more heavily weighted towards our Linux business than expected. We expect to achieve our top line revenue target.

Milestone 2, increased growth of recognized and invoiced Linux revenue from fiscal 2006 levels. Our Linux business has exceeded our expectations. Year-to-date, invoicing is about 250% of full year 2006 levels and recognize revenue is over 120% of the full year 2006 revenue. Last quarter, we achieved this milestone for invoicing and I'm confident we will reach this goal for recognized revenue for the full year.

Milestone 3, sustained growth of 30% for our recognized and invoiced identity revenues. This milestone will not be achieved. Year-to-date, revenue is flat compared to the same period a year ago while invoicing is up 10% in line with market growth rates.

Milestone 4, expand global strategic partner relationships. Last quarter, we achieved this milestone with the addition of SAP, Cap Gemini, and the Dell Lighthouse program. This quarter we expanded our partnerships with Lenovo and Dell to provide preloaded SLED on PCs and notebooks.

Milestone 5, improve operational efficiencies and milestone 6, achieve a non-GAAP exit rate operating margin of 5% to 7%. For the entire quarter, we achieved an operating margin of over 5% on a non-GAAP basis. Our cost control programs continue to track according to plan. Therefore, this leaves us well-positioned to reach our target rate margin of 5% to 7% in fiscal 2007.

In closing, I am pleased with the success in our Linux business, which continues to grow significantly faster than the market. I am also excited about our new Zen Works offerings which have the potential to become important growth drivers in the future. I am disappointed with the performance of our identity business, but we understand the issues and we are working hard to fix them. I am pleased with the workgroup results this quarter, but it is too early to conclude this is a trend. We are making significant progress on our strategic initiatives, and I am confident we will achieve our exit rate operating margin target this fiscal year.

I will now turn the call back over to Dana for financial guidance.

Dana Russell

I want to reiterate the revenue guidance we gave earlier of $925 million to $955 million for fiscal 2007. Year-to-date we've achieved non-GAAP operating income of $19 million compared to our guidance of breakeven to $10 million for all of fiscal 2007. Based on these results, we're confident we'll exceed our non-GAAP operating income guidance for fiscal 2007. This quarter, we achieved an operating margin of over 5% on a non-GAAP basis and we are confident we will achieve an exit rate operating margin of 5% to 7% in fiscal 2007.

With that, I'll stop and open it up for questions.

Question-and-Answer Session

Operator (Operator Instructions) Your first question comes from Mark Murphy – First Albany.

Mark Murphy – First Albany

A quick question on the NetWare maintenance revenue stream. Have you passed through a cost of living increase there to the customer base or has the maintenance rate changed in any way? Dana Russell Mark, we did have a cost increase or a price increase that had been passed through. I am not exactly sure what kind of an impact that has on the overall revenue stream, but it does have some impact, which has been positive.

Mark Murphy – First Albany

Is that likely to be an annually recurring event?

Dana Russell

No decision on that.

Mark Murphy – First Albany

A question for Ron. Can you talk a little bit about Citrix and ZENSource? How does that acquisition affect the marketplace, and what effect, if any, would that have on Novell’s approach to virtualization?

Ronald Hovsepian

Let me start with the last part of your question. In terms of ZEN and ZENSource, for those of you who don’t know ZEN, it runs an open source project that is the virtualization manager and ZENSource is the company that produces some products to go along with that. From our point of view, the ZEN product and the virtualization management is an open source project and therefore, we do not anticipate any inhibitors to the direction that we're heading with ZEN inside the SUSE Linux distribution.

In terms of broader implications in terms of where Citrix is going with the product, that I'm not familiar with as to what they would do. In terms of where we're focused, we're continuing our focus on our strategy around virtualization management through our ZENworks Orchestrater and our ZENworks virtual machine manager, of which ZEN, the virtual machine manager is just one of several virtual machine managers that we would run on. So (a) it's an open source project, I don't see any changes in the market at this point and (b) in terms of where Citrix will take it in the long run, I'm not sure what their plans are.

Mark Murphy - First Albany

Are there any cautious signals in the pipeline at all related to some of the recent macroeconomic concerns? For example, do you see anything different in your financial services vertical than you have in the recent past?

Ron Hovsepian

Yes, they've had a lot of volume of transactions lately. That was a little humor there. In terms of buying patterns, is that what you're digging at? In terms of where they're going from a buy perspective?

Mark Murphy - First Albany

That's correct, Ron. That's all I'm looking for is whether you see anyone pulling in the horns a little on spending based upon what you see reflected in the pipeline just based upon the volatility in the markets and the concerns about the credit crunch.

Ron Hovsepian

I think two things. One is that given the range of products that we have that gives us a level of diversification that's good. In those markets that we do choose to serve, like Linux and our identity markets as well as our systems and resource manager market, those continue to be markets where there's good interest from the customer. I haven't seen any major signs of slowdown in terms of the pipe or the pipe being elongated. I do hear all the noise around it, but in these particular markets that we participate in, I haven't seen a direct corollary at this point based on the last quarter.

Operator Your next question comes from the line of Katharine Egbert - Jefferies.

Katherine Egbert - Jefferies

I have a couple quick questions on the revenue. So OES was down about 8% year on year and then the Linux invoices were up nicely quarter on quarter. How sustainable do you think each of those is? Also, the lighter than expected drop in the Workgroup invoices. How sustainable is all of this?

Dana Russell

Katharine, the first part of that question, I didn't catch. Could you just repeat that for me? I got the second half but if you'd do that first half, I'd appreciate it.

Katherine Egbert - Jefferies

What I'm asking is, the positive trends in OES, Linux, and Workgroup, basically. How sustainable are those trends, do you think?

Dana Russell

Well, I think in terms of the Workgroup as a total product family there, we've said that we continue to want to exhibit some caution. We just really are early in terms of being able to know whether or not we have a trend here. We're certainly viewing that with some caution and we hope, we're hopeful but we're cautiously optimistic. As far as Linux goes, I think we've had a fairly strong pattern here over the last three quarters where we've seen not only a robust market, but some opportunities for us and we continue to be bullish about our ability to compete in that marketplace.

Katherine Egbert - Jefferies

What about OES?

Dana Russell

OES I'm lumping that together in the Workgroup family in terms of combining that with NetWare. So NetWare and OES, I'm putting that in the same group.

Ron Hovsepian

The only thing I would add to what Dana said about OES and NetWare being lumped together, we're pleased with the results but we remain cautious because we've seen irregularities in that pattern over the last two or three years. The one thing that I would point out though is we're just shipping in the not too distant future, the Gold Master on OES2. So I'm still reserved in my thoughts here until I see that product generally available in the market for a little while and really see the hard core adoption of it before I'll come off of the cautious approach that we're taking to it right now.

Katherine Egbert - Jefferies

How much did Microsoft influence your Linux numbers?

Ron Hovsepian

From my perspective right now, the lines have really become blurred as to how much of it is influenced. I would say the good news is that we've got a nice halo effect and a good working relationship between the two and overall we're driving good working relationships in two major geographies. Still ramping up Asia Pacific from my point of view but the two big geographies seem to be clicking well. What's difficult, Katherine, as we said in the prior calls is that as we bring deals in, sometimes they end up going through the Microsoft body and sometimes they go through ours and that's why we're not really breaking that out anymore.

Katherine Egbert - Jefferies

What about the 12% to 16% operating margin guidance for next year? Do you think that's still attainable?

Dana Russell

If you look at the results so far this year, I think it's fair to say that we're ahead of schedule on our exit rate targets. We've operated over 5% for the full quarter versus the exit rate that we said on the last day of the year, which would be 5% to 7%. We've got over $19 million in operating income so far this year versus a full-year plan of basically breakeven.

That being said, the exit rate discussions have been a little bit confusing so we've had a lot of questions about that. Conceptually, we believe that our operational efficiencies and the improvements that we've previously stated are still achievable for '08. But as we move forward, what we'd like to do is talk about next year's goals and milestones and state them in a manner that's a full-year operating income versus an exit rate. And so we believe that this will continue to provide the insight into the transition, but it'll be a more concrete and measurable way to track the results going forward. We're developing that full-year operating income plan right now and so we'll discuss that with you on the next call.

Operator Your next question comes from Brent Thill - Citigroup.

Brent Thill - Citigroup

If you could just address how you think virtualization is going to impact the overall software pricing mechanism, I think there's been maybe some overblown concerns that the pricing environment is going to have to change. I am just curious in terms of your view as it relates to that.

Ron Hovsepian

Brent, you broke up a little bit. I believe you were saying is virtualization causing consolidation of servers and therefore is that affecting your market?

Brent Thill - Citigroup

Sorry, Ron. More as it relates to the pricing and how you go to market and the actual pricing matrix.

Ron Hovsepian

Yes, where we have a little different model than Red Hat is that we've focused on a number of ELA agreements and what we want to get done inside those ELA agreements. We haven't been as prone to the vagaries of tying it to just the server, even though we have a server offering, we do focus on that desktop to data center story from us. So we have a broader array of ways of solving some of the customers' problems inside of there in terms of how we go to market and pricing it. That's been a nice advantage for us over the last few quarters, candidly, and last year in particular.

So we're not seeing that as we run into that as much of an issue. Customers are more having conversations about what do I need to do from a Linux deployment perspective? But in terms of how to think about modeling it, at this point I don't see anything in our business model that would be different than what you've seen from us in the last three quarters in terms of Linux pricing, if that helps.

Brent Thill - Citigroup

Absolutely. And just as it relates to the macro environment, it sounds like you didn't see any deterioration in the financial services vertical and just curious in terms of how you think about the second half of this year. Do you expect a more pronounced flush this year than maybe you've seen historically or how do you feel the set up for the second half of this year?

Ron Hovsepian

I'm sorry, “a more pronounced” and I lost that one in there, Brent.

Brent Thill - Citigroup

It seems like the overall health of the software industry in the first half has been pretty good and we haven't seen that for a number of years. Do you expect this health to stay stable or do you think the overall environment's going to continue to accelerate like we've seen it historically as seasonality has helped out the overall industry?

Ron Hovsepian

Yes, I can comment more from our perspective. From my point of view right now as I look at the second half of the year at the macro level, I do not see any big slowdowns to report on our side of it in the markets that we're serving right now. That doesn't mean at the macro level there'll be some elongation of sales cycles, et cetera, for some other people but right now in our markets, I'm just not seeing it. There's a good level of interest.

We've got some plumbing work we need to continue to work on around some of our sales executions, some other pieces like we experienced in identity, but I'm not seeing the macro impact now. We'll stay tuned and keep you posted on that through the fourth quarter here with us, but at this point, I don't see it just yet.

Operator Your next question comes from Brent Williams - Benchmark.

Brent Williams - Benchmark

The pro forma sales and marketing expenses as a percentage of revenue was the lowest percentage it'd been maybe in the last year-and-a-half, the lowest absolute dollars in like three-and-a-half years. So first off, it's pretty impressive. How'd you get there?

Secondly, how much does this resemble what we should expect going forward? I mean was this major headcount in the sales and marketing organization? Did you sell the corporate 747 or how did this go?

Ron Hovsepian

I'm sorry, what was the last one? Did we sell the corporate what?

Brent Williams - Benchmark

The corporate 747.

Ron Hovsepian

Yes, we sold that, definitely. That took sales expense right back down and we took back all the golf clubs. We're actually very pleased to see the expenses be focused on by all aspects of the business, candidly. Our sales team has been very focused and very aggressive on working through a number of the sales items. Again, we're still going to have some seasonality on some program spend and other things that will move up and down within the quarter, but in general the body, the framework is moving in the right direction in terms of our sales expense for the company. So I do feel good there.

We don't have any corporate jets. We got rid of those early on in my tenure here, which was about $4.7 million of operating expenses, but who's paying attention, right?

Dana Russell

One comment, Brent, is we did have a low quarter in marketing spend this quarter so I do expect these expenses to tick up a little bit in the fourth quarter and overall progress has been very good. We've got these transitional activities that Ron's talk about in the past in terms of changing the way that we go to market, sell our Teleweb initiatives, those kinds of things are helping to drive the lower sales and marketing spend. But we still do have some overlapping spend in the fourth quarter and we'll probably have a little bit of an uptake on marketing as well.

Brent Williams - Benchmark

Next, looking at the Linux business can you give us some sense on the largest deal sizes that you took in during the quarter as you recall, I guess it was Q1, there were a couple of really large deals. What does that look like in Q3 here?

Dana Russell

I think we can talk a little bit about that. We know that we had some large deals that we've called out and talked about in the previous quarters. This quarter was no exception. There were a couple of large deals. I guess in terms of stating size, we wouldn't state that. There is some dependencies on large deals and we've had some fluctuation from quarter to quarter as a result of that. We'll expect to see that as we go forward. So it's not a change so far.

Brent Williams - Benchmark

Lastly, on the SCO group suit, congratulations on the victory there. Obviously that's huge for you and the open source community as a whole. There’s a trial still going on, on a bunch of remaining issues. Are your legal expenses going to spike up as you prep for trial and I guess as you go through it in Q4 here?

Dana Russell

Yes, I think we're still planning on a run rate with legal expenses as they have been. Now, we're hopeful that those expenses will come down in the future, but at this point, we're still planning on giving guidance that general G&A expenses will remain high.

Ron Hovsepian

Yes, the formal trial actually begins September 14 or 17, I believe is the exact date. What we had was a summary judgment from that federal district court in Utah, which gave us the clarity around the ownership of Unix copyrights. But the case begins, I believe the 14 or the 17. I apologize, I forget the exact date.

Dana Russell

The summary judgment, that's a very good milestone, that's an important indicator, a very important indicator but there's still things out there that could happen. SCO could still appeal so it isn't a final decision and so we're remaining geared up to defend ourselves in the open source community with all the might that we have.

Operator Your next question comes from Aaron Schwartz – JP Morgan.

Aaron Schwartz - JP Morgan

Just wanted to touch on the strength in the license revenue. There were a number of moving parts within that. I'm just wondering if you could talk about the productivity of the sales force with regards to the changes you made in the sales model earlier this year?

Ron Hovsepian

In terms of overall productivity, it's a little complex as you're pointing out appropriately, Aaron because of the amount of selling and the Linux piece of it blending with some of our other businesses like our identity business which is more license-based. It is complex to carve through it. But what I would point you towards is I do think the overall expense structure direction is the better indicator right now of overall productivity of where we're heading with the business with the top line revenue growth from a overall percentage.

As Dana said, we'll have some programmatic and overlap expense hit us a little on the fourth quarter that will spike that. But in general, we feel good that we're heading in the right direction with the sales expense in the productivity. Candidly, I'm very pleased with the expense work but longer-term, I want revenue growth in all categories, not just in a few categories. That, as you know is all part of the transition we're going through.

Dana Russell

Aaron, just to follow up to that, we've had quite a bit of discussions that we know that we need to improve sales efficiency, especially as a metrics when you're comparing the licensing revenue and I am caveating that by including also the Linux revenue because all of that shows up in maintenance as you know. We know you have a long ways to go. We talk about this being a longer-term plan; that this will continue on through 2008 where we'll continue to refine the sales organization and the efforts that we have around those transformational activities. But we feel like we're making good progress.

Aaron Schwartz - JP Morgan

I know it's still early, but on the SLED’s release, now that that's anniversaried, can you talk about the renewal rates there even if it's qualitatively?

Ron Hovsepian

I'm probably best suited to speak on it qualitatively because the anniversary's just come up in July. So we're real early and there's no trend data to speak to at this point really. But the good news is we've got our Teleweb team gearing up for a solid execution going into '08. So I feel more comfortable we'll be able to improve our overall productivity for renewals at this point.

Additionally, we took some other steps with some outsourcing partners and others to collect more of our overall renewal, not just SLED’s but our overall renewal rates for the company, as well. this has been a real big focus area by the sales force to get after that particular piece of it. Still a little more construction to do, but feel good that the pieces are lining up to get the proper execution as we go into the '08 year.

Aaron Schwartz - JP Morgan

The last question I have is just on the ability for you to unwind the overlapping expenses. It sounds like you have a little more confidence on this call relative to the past call. Specifically, I just wanted to ask about the back office initiatives. I know that seemed like it was a little behind plan in the first half. It seems like you made up some ground there in Q3, is that correct?

Ron Hovsepian

I'll let Dana go in a sec, I think we were a little behind in Q1 on the R&D one, and that's the one where we made up some ground. On the back office, I feel we've been pretty much tracking that one accordingly. I'm just trying to think if there's anything else we said, Aaron. I apologize, I don't remember everything from that last call. If we gave you any misdirection there, I apologize.

I think in terms of the back office it itself, we feel good that's on track that that will contribute to the overall exit rates that we talked about for this fiscal year and position us well into next year.

Operator Your next question comes from James Gilman - Cross Research.

James Gilman - Cross Research

First, just a little bit on the Microsoft partnership. I think it was this week or either last that the Free Software Foundation claimed that Microsoft’s statement that it is not a party to the GPL version 3 whereas the Free Software Foundation says they are and implied they might take legal action. How do you think just that discussion there impacts the agreement with you and Microsoft?

Ron Hovsepian

From our point of view, two things. One, in terms of what the Free Software Foundation is doing with Microsoft, you're going to have to get either one of them to comment on their halves of it. From our point of view in terms of what we are executing and what we are able to execute with SUSE, we do not anticipate any problems and we're able to go into all of our customers and have a good, clean conversation about Linux and SUSE Linux, specifically. Depending on what program or approach the customer takes either with Microsoft or standalone for us directly we do not anticipate any problems in our ability to deliver Linux to the customer.

James Gilman - Cross Research

Going into your initiatives with the sales and marketing, you mentioned several times the Teleweb, how does that impact your relationship with the partners? Does that affect their revenue stream?

Ron Hovsepian

No, the Teleweb is primarily focused in '08 on really dealing with our renewals and our overall renewal process. In terms of the partners themselves, over time that should be a support function as we work with our partners as we funnel leads and we become more proactive. So there are two parts, the selling and the renewal. Right now we focused primarily on the renewal. Over time, that function will obviously support our direct sales force where appropriate, and some cases it's not, by the way. And then in other areas, they will be the direct sales force where they are calling on customers over the phone and using the web. Therefore, our partner design has to account for that as we think about how we handle and manage our partner relationships. But at this point, I do not anticipate that causing any conflict.

James Gilman - Cross Research

Following up on several other questions earlier in reference to the sales and marketing expense being lower than it has in the past, is it possible that the restructuring and such in the initiatives that you have in place has impacted the sales force, which might have impacted your ability to expand on your identity management?

Ron Hovsepian

Without a doubt when you take the amount of change on that we took on just in the sales force alone, let alone across the entire company, there are always going to be a certain risk and certain things that fall out of place and don't flow perfectly to plan. I do believe one of the areas that may have slipped here -- not may have, did slip -- is our identity business from a overall sales perspective. I do think it is one of the things that I would put down as part of the collateral damage and the changes as we deal with that with those set of changes.

Just back to getting the focus and the things we want to get done inside the business, and it's got our focus and our attention. We have to balance that against all of the other things we're doing. But I think it's fair to say that at times things will slip. Given the magnitude of driving a brand new renewal business into this company on a Teleweb structure, enforcing the specialization that we want, and redesigning the partner pieces of the business, that's a lot of moving parts. While I'm disappointed, I want to make sure that we are genuine with ourselves and intellectually honest with ourselves that stuff will break. I want you guys to know that. We didn't know if everything would go perfectly to plan and this is one of the things didn't go as we hoped it did.

James Gilman - Cross Research

I appreciate your color on that. In reference to Linux invoicing, linearity in the quarter or a break out from a month-to-month basis?

Ron Hovsepian

We don't break out any month-by-month data on any of our products. I probably wouldn't comment on that one.

James Gilman - Cross Research

The win in India, can you provide some color there on how it impacts invoicing?

Ron Hovsepian

The impact on invoicing?

James Gilman - Cross Research

How it impacted deal size?

Ron Hovsepian

I'm not going to give all the details in terms of the numbers, but in terms of the deal size, it was a real nice deal with Tamil Nadu out of India. It's 30,000 SLED desktops with just under 2,000 servers associated with that. So it was a very nice fulfillment of our desktop to data center. Another good example of where we're able to go into a customer and have an enterprise discussion versus an EDGE server discussion.

James Gilman - Cross Research

Did Microsoft have any impact on that?

Ron Hovsepian

That was a Novell-led deal.

James Gilman - Cross Research

Lastly, IBM came out supporting SOLARIS on the hardware. How do you think that impacts the overall Linux market going forward?

Ron Hovsepian

What I understand about the announcement, it was supporting on the mainframe so it is an old Unix and it gives IBM an opportunity to consolidate onto a Z series platform. The good news is we've had great support from IBM and we're their market share leader on the Z Series that run Linux. We've got the lion share of that particular market, over 80%. So from my point of view, I think it's actually a good thing. It gives us an opportunity to consolidate and move those footprints from SOLARIS over to Linux at the right time when the customer's ready for it.

Operator Your next question comes from the line of Brian Kraft - Credit Suisse.

Brian Kraft - Credit Suisse

I want to go back to the sales channel changes you made on identity and security. Can you talk about how long we should think about or at least model for the disruption to continue and any changes you made to the leadership there in that group?

Ron Hovsepian

In terms of how to model that, I think the difficulty there is we haven't broke out any deeper forward information on that particular area. I really can't comment on it. What I can say is it's getting a high level of focus from all of us inside the business and it's going to take a little time to rebuild as you know, those are longer sales cycles and complex sales cycles that we're dealing with. So building that team up and finishing the specialization process through the end of this year, I think is going to be critical for what we need to get done. But other than that, I really can't give you anymore color on top of that one, I apologize.

Brian Kraft - Credit Suisse

You said $105 million Linux SUSE invoice with Microsoft? Is that right?

Ron Hovsepian

It's $105 million of invoicing that has occurred of the $240 million through the quarter. That's about 44% of the contract of the $240 million five-year contract.

Brian Kraft - Credit Suisse

That compares to the $91 million at tend of last quarter, right?

Ron Hovsepian

Yes, that does.

Operator Your next question comes from Terry Tillman – SunTrust Robinson Humphrey.

Terry Tillman - SunTrust Robinson Humphrey

First question, Ron, for you is when I look at the combined NetWare and OES business, I appreciate that you want to remain reserved in terms of calling a trend here. But the 8% decline in that combined segment, that's one of the lowest rates of decline I can remember. So what I'm trying to figure out is you talk about these product bundles potentially some price increases. Is there also the potential here that maybe you're just simply hitting a natural trough in that business?

Ron Hovsepian

Of course that's one scenario that we'd all hope for, candidly, but at this point, I'm not at all near calling that out because what I shared with you earlier. We still have to get OES 2 out into the customers' hands and make sure that that's adopted correctly. I am very pleased with the bundle. We've had nice uptick inside of that bundled offering in the market, which has helped us a lot. As you said, the price and other traditional things, all of that has contributed to two good quarters of performance in that business from a relative comparison basis. But I just want to be really careful with this one because I think we've all been probably bitten from it before. I'm going to just remain very analytical on this particular one versus falling pray to one particular quarter's performance.

Terry Tillman - SunTrust Robinson Humphrey

The final question, just relates to OES 2 coming out, several new key ZENworks products, one including the data center automation product. These products are coming out. Historically, though, there has been a trend where these segments whenever new releases come out, they tend to stub their toe in terms of the revenues. Can you give us any comfort that maybe with these new releases there will be less disruption in the past with some of your prior new product releases?

Ron Hovsepian

I think what you're referring to is in some of the traditional products and NetWare being one of them, there was always a preference because these are critical applications for customers is to take their time towards implementation.

What we've tried to do differently this time is a couple things. One is we've had a more extensive data program as we've looked at what we're doing inside the company with the customers on this particular product. We're trying to knock down that ahead of time to get the quality to the comfort zone for the customers, but again, because this played such a critical role for customers, there's a high sensitivity around that.

In terms of the ZENworks product, what's an entire re-architected brand new product that's crossed platform. That particular one, I'm more enthusiastic about our hitting that and getting it into the market and getting it out the door for ourselves as well as the ZENworks Orchestrater. Those particular products to me are ready to go and at the customer, and we've been doing the same kind of testing that I referred to in terms of the beta process.

You may or may not remember on that particular one. We identified that we had approximately 60 customers in the beta early release early support program last quarter and about five partners. So, again, we're trying to be a little more staged in our implementation on these things to give the level of quality and confidence to the market.

Operator Your final question comes from Denny Fish - JMP Securities.

Denny Fish - JMP Securities

Thank you.

Just quick question on use of cash since it hasn't been asked yet. Any new thought to potential stock buyback?

Secondly, you made a small acquisition during the quarter, XENSource, what do you expect in terms of revenue contribution and is that the type of acquisitions we should expect going forward or is there the potential for maybe something a little bit bigger?

Ron Hovsepian

In terms of the use of cash, obviously that's something that we regularly look at. XENSource is a good example. As I shared with you before that that would be what I would qualify as a tuck-in type or a gap-filling technology. It's a great end point security technology. We will continue to look at acquisitions that fill our strategic desires as well as some short-term tactical ones, and ones of larger scale to your question. When we do that, we always look at the holistic body and we include in our analysis the appropriate look at buybacks, as well as part of that. But we feel given the amount of change in everything that's going on in the markets that we want to maintain a strong buying position for ourselves in the market.

Denny Fish - JMP Securities

So is it safe to assume then not to expect a buyback over the near term?

Ron Hovsepian

As I said, we're going to look at the options on a regular basis, but the preference you heard from me is to focus in on how we get this company positioned to grow.

Operator At this time, there are no further questions.

Ron Hovsepian

Great. Thank you, everyone.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Novell F3Q07 (Qtr End 7/31/07) Earnings Call Transcript
This Transcript
All Transcripts