Novell F1Q06 (Qtr Ending Jan 31, 2006) Earnings Conference Call Transcript (NOVL)

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 |  About: Novell, Inc. (NOVL)
by: SA Transcripts

Novell Q1 2006 Results Conference Call Transcript (NASDAQ:NOVL)

March 2, 2006

Executives:

Jack Messman, Chairman & CEO

Ronald Hovsepian, President & COO

Joseph Tibbetts, Senior Vice President, CFO

William Smith, Vice President Investor Relations

Analysts:

Brent Phil, Prudential

Chris Russ, Wachovia

Brendan Barnicle, Pacific Crest Securities

Terry Tillman, SunTrust Robinson Humphrey

Jason Mader, Credit Suisse

Mark Murphy, First Albany

Steve Ashley, Robert W. Baird

Bill Smith, VP Investor Relations

Good afternoon everyone, thanks for joining us. I’m Bill Smith, Vice President of Investor Relations for Novell and with me today from our executive offices in Waltham, MA are Jack Messman, Chairman and CEO, Ron Hovsepian, President and COO and Joe Tibbetts, Senior Vice President and CFO. We’re here this afternoon to discuss Novell’s financial results for the first fiscal quarter 2006. I would like to note that there’s 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 March 16th. A telephone replay of this call will also be available 15 minutes after the conclusion of this call at 800-642-1687, and will run through March 16th. During the call we will also be making references to the financial schedules attached to today’s press release, so I encourage you to keep those at hand. I should also note that during this call, we will be making statements that are not historical in nature and that maybe 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 uncertainties including factors described in Novell’s annual report on Form 10K filed with the Securities and Exchange Commission on January 10, 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 will now turn the call over to Joe.

Joseph Tibbetts, Senior Vice President, CFO

Good afternoon everyone. Novell’s first fiscal quarter 2006 financial results were released a short time ago and in summary, for the quarter, the company reported net revenues of $274 million and GAAP diluted net income available to common stockholders of $2 million. GAAP income per diluted share was 0¢ or break even. On a non-GAAP basis, adjusted diluted net income available to common stockholders for the quarter was $18 million or 4¢ per diluted common share. This excludes favorable restructuring adjustments of $1 million, the impact of stock based compensation expense which we commenced this quarter for the first time, totaling $14 million and adjustments for income taxes. As required, we adopted the new announcement, accounting pronouncement for stock based compensation FAS 123R this quarter on a prospected basis. Our GAAP results for the first quarter of fiscal 2006 therefore, include net stock compensation expense under the new standard. In our non-GAAP results we have included all stock based compensation expense to give you a clearer picture of our underlying performance.

A reconciliation of GAPP and non-GAAP financial information is provided in the press released schedules and I’ll give more detail on our financial performance in my remarks shortly and with that, I ll turn the call over to you, Jack.

Jack Messman, Chairman & CEO

Thanks Joe. And, welcome everybody. As Joe just summarized, we had a good quarter. Novell’s first quarter is seasonally weaker due to the holidays from Thanksgiving to New Years, which impact our product sales and consulting services. Many of the trends we’ve experienced in our business over the past several quarters continued into this quarter. The core business performed well, our non-core business Selerant Consulting has not performed expectations and as you may remember, we are pursuing strategic alternatives for this business. Overall, revenue and non-GAAP net income for the quarter exceed our expectations in previously provided financial guidance. Our performance in the cost area reflects the favorable impact of our Q4 ’05 restructuring effort.

In our Linux business, our momentum continues to grow. Our Linux platform revenues increased 22% over the first quarter of ’05. We made significant progress in key Linux efforts such as the data center, desktop, and in our sales channels, and Ron Hovsepian can provide more color on this during the Q&A period. The data center continues to be a key focus for our Linux business and we took several steps in this quarter to maintain and enhance our leadership position in this category. From Enterprise class computing workloads in the data center Novell SUSE Linux Enterprise server 9 or / 9 now supports virtual irons, data center virtualization and management platform and with the virtual iron software deployed on top of SUSE Linux Enterprise Server, customers can allocate computing resources as needed to applications allowing business requirements to drive data center technology instead of the other way around.

Virtual Iron complements other virtualization solutions we support including ZEN wear, and XEN ZEN. In fact, Novell was the first to ship ZEN virtualization as part of SUSE Linux 9.3 and we plan to include the new ZEN 3 hypervisor as part of our next generation Enterprise Linux product line. For virtualization, customers can pick the solution they want and be confident that it works with SUSE Linux Enterprise server. Security is an important issue. In the data center Linux market, Novell has donated the core components of its Novell AP Armor framework to provide a foundation for our new open source project dedicated to advancing Linux applications security. With AP Armor technology now freely available under open source licenses, the community has excellent configuration and monitoring tools to address security issues. AP Armor is much easier to use and implement than the SE Linux security technology in the kernel today.

We recently demonstrated the next release of our desktop product, Novell Linux Desktop 10, should be available by this summer. Our customers and partners are excited about this groundbreaking desktop implementation of Linux. In addition to an enhanced open source graphic sub-system, termed, XGL, the forthcoming desktop Linux distribution also features numerous business applications, such as software for translating visual basic macros and Microsoft Excel into their open office macro equipment installed basic. Both hardware and software vendors have expressed strong support for this new XGL graphic subsystem, while open source community members agree these enhancements clearly and positively impact the state of the art of Linux desktop graphical capabilities.

While our Novell Linux desktop revenues are growing, they are relatively small at this time. Our new version of the desktop to be announced formally next week at CIBIT in Europe address many desktop needs. We’re confident that the usability and visual enhancements to the Linux desktop will fuel more growth in this market and break down some of the barriers to mainstream Linux adoption in the desktop. We are addressing the interest in developing countries in Linux. We continuing to enjoy the leading market share in China, as reported earlier this week.

Turning to our Linux go to market progress, we’ve said before that we’re focused on the Enterprise market for our Linux Solutions. But we certainly need to improve our presence in the indirect channel. On the Enterprise Linux side of our business, we continue to make excellent progress. So much so that we virtually have no Linux competition in one major Enterprise vertical market today that is the retail sector. In a closely watched ranking of technology suppliers for the retail sector by RIS News Leader Board 2005, Novell debuted as the sole Linux distributor. We scored particularly well on the quality of support and service, ease of installation and administration and maintenance. As a result, retailers can look to Novell with confidence to leverage open source and retail environment and we’ve had a number of wins in that sector.

Our efforts to increase our volume business through the indirect channel also made good progress this quarter. We have concentrated on enlisting the help of significant channel partners to help sell our Linux Solutions. In the quarter we signed agreements with Synex, one of the top five global distributors of Linux Solutions, Software Spectrum, a major distributor of Linux Solutins, effectively displacing our competitor from this relationship and AdNet a major IBM distribution partner. To help our partners sell Novell Linux Solutions, we continue to increase the number of applications running on our Linux platform. With regard to Linux only, the number of our partners hardware and software solutions that are ready and certified increased to 2,157, up 86% from the end of Q1 ’05

With regard to partners software solutions, the number of these solutions that are ready or certified on Linux is 916, up 57% from the end Q1 ’05. In addition to enlisting the help of partners, we must also make our Linux Solutions more easily consumed by the small and medium size business channel. As more small and medium size businesses bring Linux into their organization, they are looking for an easy to deploy, easy to maintain solution at a reasonable price. In Q1 06, Novell introduced a Linux based bundle targeted at the mid market served by our channel. This bundle includes SLES 9 plus technical support and training all in a single boxed product. This bundled solution was built in response to customer and partner demand for a Linux based product that is both easy, easier to build and to sell. And with this product, Novell offers a highly competitive package, a more highly competitive package than that of our competitor, with more rests of support offerings and full self-study training on Linux, which is not offered by any other Linux distributor.

Our system security and identity management business, which consists of resource management, identity management and access management performed well. In our identity based resource management business, we are encouraged by the strong growth in this category up 11% versus first quarter ’05. The focus for this business line is on executing with the recently released ZEN work 7 suite.

Also, we are in discussions with larger partners to help sell Linux management tools. Novell is absolutely committed to succeeding in this market. A robust set of management tools that manage from the desktop to the server are critical to Novell’s long-term strategy as a strategic provider of infrastructure software to the enterprise. It is clear that customers want to reduce complexity and cost through better resource management.

Analysts continue to rate the resource management market segment as one of the fastest growing in the software industry, and we expect to see continued growth despite aggressive competitive pressures in this space. Novell’s identity and access management business continued to exhibit growth above the market growth rate as predicted by the analysts with a number of significant enterprise customer wins in this space. Revenues were up 43% versus first quarter ’05. Identity remains a fast growth business for Novell. We have a 17% market share, second to IBM according to the Radicoty analysts organization. We had another very good quarter in this category due to Novell’s technical strengths, and ability to communicate a clear value proposition to the customer. We are consistently named to the short list in identity management requests for proposals, where similar competitive bid situations and in certain cases, are being invited to advise customers on a request for proposal creation, which is clearly an ideal situation for winning business. Customers are seeing the many positive press reports regarding our identity management solution and its awards from peers and reviewers prior to engaging with us. We’re starting to see a trend in identity management new business deal sizes which have increased to over $500,000. However, the competitive landscape is forcing prospects to do more specific proof of concepts in order to win the business thereby keeping the sale cycle long in the specific solution area. Our strength in this category is lead by our anchor product, Identity Manager and we continue to innovate and be recognized for this innovation within this category and let me give you a few examples: Our past efforts in this category were recently recognized, a Novell Identity Manager 2 was chosen as best identity manager in Infaworlds 2006 technology of the year awards. Infraworld remarked that powerful graphic work flow and design tools and intuitive user interface and a solid directory foundation gave Novell Identity Manager 2 an edge over strong competitors. This quarter we announced the worldwide availability of the next generation version of Identity Manager, Novell Identity Manager 3.

And anecdotally. I can say that interest was ver strong with significant enhanced use, ease of use, Novell Identity Manager 3 delivers advanced visual modeling, workflow and self-service capabilities, giving companies flexible yet powerful new tools for meeting their security and compliance needs. Consequently, customers will be better positioned to simplify and control user access, to protect sensitive data, to reduce their administrative costs and to comply with corporate and regulatory mandates. In addition to managing identities, Novell is focused on the important category of audit and compliance within the larger identity management category.

Given enterprise focus on Sarbanes Oxley and other compliance activities, Novell’s excellence in identity and access management makes this area a very good fit for Novell. To that end, we recently debuted the Novell Audit 2 product. A setr of new tools for customers to monitor and audit user access and other network events across the enterprise. And this fills a critical requirement in complying with regulations such as Sarbanes Oxley HIPPA and BOZLE 2. Coupled with Novell Identity Manager 3, Novell Audit 2, customers have an unmatched solution to ensure security and validate compliance initiatives while streamlining what can be a time intensive, expensive process. We believe that audit and compliance tools will play a major or significant role in Novell’s identity management solution in the future and therefore, we’re increasing our efforts in this market.

And finally, Q1 ’06 was a strong quarter for our identity management product with most aspects of the business growing on a year to year basis. Access management products continue to show strong growth as well, and we are very proud of our leadership in this fast growing market. Our strong growth in this category validates the strategic reassessment of our business which we implemented last quarter. There’s a lot of internal synergy between our products as well. Novell Linux business continues to open doors for identity and access management product sales. On the other hand, Linux is increasingly the platform of choice for deployment of our identity and access management offerings. Likewise, Novell’s ZENworks Linux management is the only resource management product for Linux desktops on the market.

Let’s now turn to the key issue of performance of OES and the NetWare related product lines. Our combined NetWare and OES business declined by 11% over the prior year’s first quarter. As you know, we are focused on slowing the decline of our combined NetWare and OES sales. While we have been more successful slowing the sales decline in previous quarters, we believe the combination of OES products and an aggressive marketing program have slowed the historical declines in this product set and have good prospects for continuing to do so in the future. We’ve increased our efforts to communicate the open source nature of our OES product to help slow this decline. And our Linux business continues to give our installed base a migration path forward. Before we dive into the financial specifics of the business in Q1, let me turn to the state of spending in the IT markets in which we operate. In the Americas, IT spending is increasing in key areas that map well to our strategy such as security, regulatory compliance and server function consolidation, including management. The drivers around Sarbanes Oxley, security web services and identity federation are still in growth mode and provide excellent business opportunity for Novell. Customers are increasingly taking a positive attitude to IT investment. And more companies are looking at value creation in the IT investments rather than just cost cutting. But cost cutting remains the leading driver. Strategic IT security projects that were put on hold in previous years are now being approved to move forward. Overall, the loosening of budgets is helping to attract new Linux and identity management business which is driven by an increased focus on gaining efficiencies and lowering expenses. Spending in state governments is extremely tight since most states are experiencing reduced IT budgets. The delay in the approval of the US federal government budget for FY ’06 caused a delay in several appropriation bills, thereby impacting the government’s ability to approve and process new orders. In our media geography the spending outlook does not appear to show signs of improvement from 2005 levels. Pressure on IT departments to support business goals more efficiently coupled with an ongoing focus on securing and automating the IT infrastructure will cause companies to further squeeze IT budgets. In the IT services area, downward price pressure is likely to continue in 2006. The UNIX market continues to offer the most Linux revenue potential both for Edge and Commodity replacements as well as data center and enterprise wide deployments.

Two wrap up my piece of this call, I’m please with the progress in the business this quarter. Our success this quarter is reflective of the strategic investments we have made in the business over the last several years. We’re focused on delivering against established goals, as evidenced by not only meeting but exceeding our financial guidance provided not you the last quarter. And with that, I’ll turn ito over to Joe for more financial detail on the quarter.

Joseph Tibbetts

Thank you Jack. So from a relative standpoint, our $274 million of total revenue this quarter represented a decrease of $16 million or 5% from the same quarter a year ago. Selerant accounted for the majority of this decrease with $9 million of it followed by changes in foreign currency exchange rates, which unfavorably impacted revenue by $7 million; but actually favorably impacted net income by $1 million year over year. Overall I’m pleased with the top line performance this quarter. In addition to beating our expectations for the quarter, we absorbed the planned decline in our core consulting revenue which came about as a result of our move to focus more on Novell product related consulting. Our new business product revenues grew and more than offset continued declines in our legacy product revenue.

As many of you have already noted on page 10-12 of the earnings press release materials, this quarter, we implemented some changes through our revenue reporting categories. Specifically, we introduced three new revenue groupings designed to provide more visibility to the business. And we further broke those groupings down to highlight components with different growth rates. So the new major groupings are: Systems Security and Identity Management, which is comprised of our identity and resource management products, Open Platform Solutions, which includes OES, SLESS, Novell Linux Desktop and other open source products and then finally, Work Space Solutions which includes NetWare, Collaboration and Border Manager products. So for your reference, the products that are included in each of these grouping are lined in more detail on the last page of the press release.

By diving into the revenue by solution category with that in mind, you know, basically we want to refer to page 10 of the press release as I go through it. Systems Security and Identity Management which is our first revenue category, generated revenue of $63 million in the quarter which was up 20% from the prior year. And then within that category, we recorded revenue of $33 million in the resource management category, up 11% from the year ago quarter. Year over year, our ZENworks patch management product more than doubled revenues and our new ZEN Asset Management product acquired as part of the Tally acquisition at the end of the second fiscal quarter of last year also contributed to $1 million. In general, we continued our steady progress in the resource management category with nice growth.

Our Identity and Access Management business generated $26 million in revenue, which was an increase of 43% from the same period a year ago. The identity business continues to exhibit growth well beyond the market growth rate predicted by industry analysts. Strong growth in our Identity Manager product was accompanied by significant market interest in the recently released Identity Manager 3. Access Management products also exhibited strong growth for the second straight quarter with revenue gains of 70% year over year. In the Open Platform Solutions category, we generated revenue of $56 million this quarter, with the bulk of the year over year increase coming from Open Enterprise Server, OES. OES generated revenue of $43 million in this quarter, and for comparative purposes, you will recall that OES shipped in the second quarter of fiscal ’05 so we had no OES revenue to compare to in the year ago period. Linux Platform products, our second sub category here increased 22% over the prior year to $10 million and we had strong gains in SUSE Linux server as well as Novell desktop and our point of sales solutions.

While invoicing was strong in the quarter, we must continue to work to improve our subscription renewal efforts which have been hampered by less effective renewal processes in previous versions of SLOSS. We anticipate the next version of SLOSS due out this summer as Jack talked about, will drive increased revenue, I’m sorry, renewal rates among our customer base as we introduce new technology and making it easier for customers to continue their subscriptions to SLOSS.

Our third revenue category, Workspace Solutions, generated revenues of $47 million in the quarter. Revenue from our NetWare and other related category was $18 million and again, you should note that under our new revenue groupings, this category no longer includes the positive offsetting effects of OES. This revenue decline was expected given the continued decline in stand alone NetWare product sales which we are working to offset via the continuing ramp up of our OES product.

On the bottom of page 10 of the press release we included a summary which combines OES and NetWare related revenue. And this combination declined 7% on a year over year basis which is in line with last year’s decline in this combined category. In collaboration, the sub category in this group experienced 3% decline from the prior year’s revenue to $24 for the quarter. We continue to see increased customer interest in running GroupWise on OES and SLASS and as you know we remain committed to the GroupWise platform.

In global services looking at that component of IT software and solutions, this again, remind you it combines our IT consulting customer support service training revenue. At $76 million this quarter, global services accounted for 28% of total revenue and was down 6% on a year over year basis. IT consulting contributed $37 million in revenue as was down 13% year over year. I mentioned previously that we’re focusing this business on engagements around Novell products and reducing revenue from general IT products. Consulting profitability decreased 3 percentage points compared to the prior year resulting in a contribution margin of 30% this quarter. This was due to a lower average billing rate versus the prior year which including sub contractors was $113 per hour down from $118 the prior year. Technical services and training remain 52% of global services was $39 million in the quarter, up 2% year over year.

Our Selerant management consulting unit had another difficult quarter as I alluded to earlier, in Q1 Selerant revenue was $32 million that was down 27% from the year ago period and as you know, we continue to pursue strategic alternatives for our Selerant subsidiary.

Looking at the revenue in the more significant regions in which we do business, in the Americas, we reported revenue of $134 million for the quarter which was up 4% on a year over year basis; this region continues to make incremental progress in its results and show improved profitability. However, we’re still making changes to the sales organization as part of our on going improvements both in our direct and partner channel efforts which dampened performance in the quarter. The EMEA region generated $89 million in revenue for the quarter, down 7% on a year over year basis. EMEA saw progress in slowing the decline of NetWare due to channel improvements but lower growth rates in both Linux and Identity Management, due in part of disruption in the consulting organization from our new 2006 sales program.

In addition, foreign exchange had a $4 million unfavorable impact on EMEA year over year. While revenue increased, we managed the business to actually a more profitable level in EMEA increasing revenue per head as well as our overall operational efficiency. Operational improvement continue in this region as well and we anticipate filling some key positions in the near future. Overall gross margin was 63% on the quarter, up 2% points from the year ago quarter. Our Q4 restructuring effort reduced expenses in technical support and consulting services. This effort resulted in a higher mix of products versus services sold in the quarter and lowered the overall cost of revenue structure which, I’m sorry, both of which helped drive the improved gross margin.

Moving to operating expenses, you should note that these amounts overall operating expenses in these amounts include the impact of the stock based compensation expense which was $14 million for the whole quarter. We have certain equity awards that vest upon Novell’s stock price trading at specified levels and during the first quarter a significant portion of the awards with these provisions vested due to the increase in Novell price. So as a result, we are required to accelerate the un expensed fair value of those particular awards. And our overall expense for the quarter is higher than what we would expect as our normal run rate. I’ll have more to say about that in a few minutes.

Our schedule of stock based compensation expense by major expense category can be found on page 5 of the press release. Total on going operating expenses including stock based compensation expense were $174 million in Q1, up 2% from the year ago period and down 6% from last quarter. Compared to Q4 we had a 6% decrease in sales and marketing expenses, to $94 million or 34% of revenue. This sequential decrease was due to headcount reduction which was part of the Q4 restructuring plan as well as decreased quarter 1 commissions offset by increased stock based compensation.

In the product development area cost decreased approximately 18% in Q4, totaling $44 million, 15% of revenue. This was attributable to headcount reductions as part of the restructuring plan and it was offset by the increasing stock based compensation. G&A expense was up 13% from Q4 at $36 million or 13% of revenue due primarily to the impact of the stock compensation expense, offset by reduced bonus expense in Q1, headcount reductions and reduced facilities expense. On a year over year basis, we saw an increase in G&A expenses as a result of the increased stock based compensation charges.

Year over year expense declines in sales, marketing and product development mainly due to reductions as a result of the Q4 restructuring plan and again, you know that impact was offset by or partially offset by the increased stock based compensation. The declines in spending are more significant when compared to the exit run rate spending in Q4 ’05 and excluded the increased stock based compensation, total annualized spending decreases from Q4 exit run rate are still in line with our original plan of approximately $110 million.

As part of the restructuring in Q4, we reduced our headcount by approximately 585 people, which was in line with our previous estimates from last quarter. Our total headcount at the end of the quarter after the impact of the restructuring was approximately 5,200. The GAAP income tax provision for the quarter was $11 million, compared to a non-GAAP provision of $10 million. So if you look at the effective tax rates there, you have an 87% tax rate, effective tax rate for GAAP and a 37% for non-GAAP. The non-GAAP numbers exclude the impact to the stock related compensation which was a big impact on our book income but not an immediate deduction for taxable income. So that’s the reason for a significant swing in our tax provision effective rate. The resulting impact was that the tax provision was much higher on taxable income than book income because of these longer term timing differences.

On the EPS calculation regarding our EPS calculation, the share counts are included in the press release schedules but I always have to remind you that the number differs from period to period and from GAAP to non-GAAP depending on what level the earning are and whether they are sufficient to make the impact of including the additional shares related to the assumed conversion of our debentures or preferred stock, dilutive or undilutive. On the balance sheet, a few items to note there, cash and short term investments ended at $1.7 billion up 2% from the prior year due to a positive cash flow from operations and financing activities. Cash flow from operations for Q1 was a positive $25 million, that compares to $4 million in the prior year if you exclude the effects of the Microsoft settlement in the prior year.

Net receivables decreased $16 million from the same period a year ago due to a decrease in past due receivables primarily in EMEA, DSO or Days Sales Outstanding was 59, flat compared to a year ago and aging actually improved compared to last year. Deferred revenue at $367 million was up 7% year over year, the increase reflects improved advanced invoicing as well as Novell’s continued shift to products and services bundled and/or provided over an extended period, a format which requires ratable revenue recognition, typical of a subscription and maintenance business. Deferred revenue associated with Linux and other open platform products and this is excluding OES in this case, at the end of the quarter, it was $32 million, up $2 million from the prior quarter and up $16 million year over year due to strong invoicing in the quarter in that category. Socklers equity increased $33 million from the prior quarter, the increase is higher than usual and sort of beyond normal changes from option exercises in net income and the reason for that is the new stock based compensation accounting; the credit of which goes to Socklers Equity. So that will continue that kind of change will continue going forward.

I think that the remainder of the balance sheet’s largely self-explanatory; I do want to address our share repurchase program. With regard to Novell, we go to our previously announced common stock repurchase plan we remain committed to the plan but as of yet, we have not been able to repurchase any of our common stock due to self-imposed trading blackout. And as you know, the kind of blackout that we’re talking about here are necessary during any situation that involves material non public information that we have that our investors don’t have. On guidance basis, for the quarter, for the second fiscal quarter ended April we expect revenues to be in the range of $272 million to $282 million, earnings per share excluding the impact of stock based compensation expense is expected to be in the range of 2¢ to 3¢ per share and while that may seem a penny or so low, given our you know Q1 performance, keep in mind that Q2 will have higher expenses than in Q1 due to brain share and other seasonal effects, particularly around compensation affects that have seasonal impact this time of year. The impact of the stock based compensation expense is expected to be approximately 2¢ per share for the second quarter of fiscal 2006 which would result in a reported EPS of somewhere between break even and a penny.

This EPS guidance assumes shares outstanding used for EPS purposes to be 454 million shares at 3¢ per share, which includes a diluttive effect of the 52 million potential shares related to the conversion of our outstanding debentures. At (inaudible) of 2¢ or less per share than the guidance assumed shares outstanding used for EPS purposes to be the lower number of 402 million. We’re assuming a GAAP effective tax rate for Q2 between 65% and 70% and that’s again being triggered by the lower book than taxable income negotiated with the expensing of stock related compensation. Now while that seems particularly high, for those of you who have followed this tax rate, because we have fully reserved deferred tax assets, the interplay of the stock related compensation and that fact are what triggers a very high tax rate on a book basis.

So to wrap things up, we’re very pleased with the overall results from the quarter, and we’re pleased we were able to exceed our guidance targets despite an increasingly competitive marketplace. The key drivers of our business continue their steady growth and we expect to generate continued momentum moving into the second quarter. So with that, we’ll be ready to take your questions, among Jack, Ron and myself. Operator, we’re all set for questions.

Question-and-Answer Session

Operator

Your first question is from the line of Brent Phil with Prudential.

Brent Phil

Thanks and good afternoon. Could you just help us balance going forward the trade off between license revenue and service revenue? Should we continue to see a shift towards service. I think there’s been one quarter in the past years where we’ve seen positive license growth, how are you viewing this trade off going forward?

Joseph Tibbetts

Hi, Brent how are you? I think that over time our product revenue will continue to grow relative to services because I think at least with respect to services of consulting and training and support. Services including subscription and that sort of thing and maintenance we hope will continue to grow. We’re looking for new product license revenue to continue to grow relative to the overall revenue.

Brent Phil

And the 272-282 for Q2 is there a range of how we should think about modeling license?

Joseph Tibbetts

We’re not really giving any further granularity unfortunately in the 272-282 but I wouldn’t expect any dramatically different you know from quarter to quarter, dramatically different ratio unless you know we had some specific transactions that would jump into that.

Brent Phil

And as a quick follow up. If you could just give us a sense of progress that you’ve made on the OEM side with hardware vendors particularly Dell, HP and IBM? Anything that’s changed over the last few months, that’ll be great.

Ronald Hovsepian

Hi, this is Ron, Brent, how are you doing?

Brent Phil

Good Ron, thanks.

Ronald Hovespian

We have made progress, while we don’t share the detailed numbers on these calls, I will tell you it was significant double digit growth occurred with the OEMs this past quarter so we felt good about that part of the progress therer.

Brent Phil

Thanks.

Operator

The next question is from the line of Chris Russ from Wachovia.

Chris Russ

Hi, good afternoon. Question, the platform revenue which includes OES, NetWare and SUSE Linux, you know last quarter it did pretty well, right? It was up 2.7% year over year in the quarter, and for the year I think fiscal ’05 down about 9%, this quarter down 11% year over year. What are you thinking of in terms of fiscal year ’06 where platform revenue could end up? Could it be similar to last year, meaning like down 9% or is the target to bring it down to sort of the mid single digits in terms of the year over year decline?

Joseph Tibbett

Chris, I think you’re talking about the combination of Open Enterprise Server and NetWare?

Chris Russ

Yeah the whole thing.

Joseph Tibbetts

So the 11% as you point out was pretty consistent with I think overall in’05 we were down about 10%, so we’re still in the same ballpark. You know, our hope is you know those numbers will continue to hold or get better, but you know that number has bounced around a little bit over several years of transition. We’re pleased with the adoption of Open Enterprise Server as we’ve moved along here and we think that’s the right trend overall and what it says is, we’re succeeding and holding our customers in place to a large degree and we’re hoping that we can do a little better than that. We can’t give you any specific guidance of you know hey we think we’re going to hit 5% or 15% but you know I think we’re kind of in the ballpark now that we’ve been for awhile and you know you have to model it as you see it.

Chris Russ

Okay. And a general question regarding market share and competition with Red Hat, you know they’re claiming to have 80% of the paid Linux market. Do you think that market share is flatish or growing or declining? Do you think you’re gaining share relative to Red Hat, based on these last quarter results with what you’re seeing for SUSE Linux and for OEF?

Ronald Hovsepian

Yes. This is Ron. In terms of overall market share data as you know, stuff comes out each quarter from IDC and it does vary. In the segment that we’re really focusing on, the Enterprise pieces of it, as well as the Enterprise/Data Center as we refer to it, as well as some of the emerging markets, we actually feel good about what we’re doing and for example in Asia and Latin America, granted on a small basis that we’ve seen significant growth in those markets. Where it’s been, where they’ve had a good head start on us, has been in the North American market and in Europe and that’s one where it’s more hand to hand combat. I do feel good about that as I had outlined earlier on last quarter’s call, excuse me. You know, there’s kind of a life cycle that we have to deal with here, connecting the ISVs to the Enterprise reference to the Channel, those pieces are all getting in place in those markets and my hope is that starts to kick in over the next few quarters as we look at this business and continue to push on it.

Chris Russ

Okay. Thanks very much.

Operator

Your next question is from the line of Brendan Barnicle with Pacific Crest Securities.

Brendan Barnicle

Great, thanks. I wanted to just follow up on the within the platform solutions it looks like the only segment that was down was the open other products, and I saw some of the SUSE products. What’s attributing to that year over year decline? Is there a shift of what’s in that product category?

Joseph Tibbett

Yeah, it’s largely in SUSE Linux Professional, which is a product that because we opened source, we’ve decided the open SUSE project we consciously realized that in doing so we were doing the right thing overall but it would hurt that professional product and that’s what’s in that other category largely.

Brendan Barnicle

Okay, thanks for the clarification. And with the virtualization, it sounds like you guys are going to put a couple of different virtualization projects in there rather than just ZEN, what’s the decision about doing multiple choices rather than just going with the single one that made, appeared to be sort of most predominant one right now?

Ronald Hovespian

Yeah, this is Ron. So in answer to your question, we are absolutely supporting ZEN. We will be the first one to ship ZEN in the SUSE, in our SUSE offering, so I want to be careful there. We absolutely are in big, in a very large way supporting ZEN as a standard. What your question is, kind of there’s a letter above that, that our manager is on top of virtualization, and that’s where it is right now at this point in the market’s maturity we’re supporting a lot of customer choice and as Jack had highlighted in his comments, there are several different companies there. So, real strong, dedicated support to ZEN, XEN ZEN and a customer driven approach right now on the managers that sit above that.

Brendan Barnicle

And do you think that by offering more that’s what customers are asking for, as opposed to having you guys make the decision and pick the best one in there?

Ronald Hovespian

I’m sorry, could you just repeat the question one more time.

Brendan Barnicle

Sure. You’re hearing back from the customer’s that they’d rather have a choice of all of those rather than just having you select which ever one you think would work best for them?

Ronald Hovespian

Yeah. The answer is right now because the market’s so young, there’s a number of players that have gotten themselves positioned there with different pieces of virtualization, meaning some focus more on memory, some focus more on logic, some processors, some focus more on disk sub systems, depending on the heritage of those virtualization tools and what the customer’s unique issues are, they may chose to head in that direction with a particular vendor. This is a young market, virtualization, right now. Second part of it is, the good news is the way we’ve layed out SUSE it allows all these different players and approaches to sit on top of our platform which I think is a little compliment to the engineering team.

Brendan Barnicle

Great, thank you.

Operator

Your next question is from the line of Terry Tillman with SunTrust Robinson Humphrey.

Terry Tillman

Hi guys. First question for Joe, it’s financial related. Can you talk a little bit more about the subscription renewal effort and maybe you weren’t as pleased, the invoicing is strong but maybe there could be improvements in the subscription side and the renewals? Can you walk through, iif these are system changes or the next release how it’s going to enable better renewal efforts?

Joseph Tibbetts

Yeah Terry. It’s kind of both. From the product technical side, we need to make it easier for the customer to recognize they need to renew and go ahead and do a renewal. We haven’t done that sufficiently yet. Our Code 10 product or SUSE 10 product will allow that. Internally, just in terms of processes and getting a handle on making sure that customers are renewing, we can do better. So, it’s really a process standard and a technology thing.

Terry Tillman

Okay. And then in terms of Selerant, I mean you may not be able to give specific item by item guidance, but the kind of decline we saw last quarter, I mean could something similar to that be in the cards for the second quarter?

Joseph Tibbetts

You know, I can’t give you that granular guidance, obviously we would hope not and we’d hope to do better. And you know in terms of the process that we’re on, we really can’t say anything about where that stands until something happens so, I really can’t give you any news there, but we’re obviously working with Selerant to help improve their performance. They’re focused on the right things and we’ll hope for additional better performance this quarter and you know we’re certainly making every effort to have that.

Terry Tillman

Okay, and then the last question for Ron. It relates to the ZENworks. I know you had a recent new product release of version 7. Could you maybe help us you know you’re having success out of the Legacy NetWare installed base or any kind of improved points there, and then second, related to that, do you feel like you have everything you need now? You added inventory through Tally, now you’ve got Onex Management, are there still some pieces missing that within ZENworks? Thank you.

Joseph Tibbetts

In terms of the ZENworks piece of it, as we had reported that was up 11% from last year, so it was good progress that we continue to make on that piece of it. We still need to deliver the re-architecture piece of it, so we don’t have “everything.” But we have most of the things we need to do. The team has enough that it can sell what we have right now and it would open up more markets with that re-architecture to be very candid. The opportunity is still here for us to sell more and I’d like to see us continue these types of growth rates on the sales. But it will be hard as we get into some of the issues around the edge.

Operator

Your next question is from the line of Jason Mader with Credit Suisse.

Jason Mader

Hey good afternoon guys. Just one question on the guidance. Normally April is a seasonally better quarter for spending. Could you maybe just talk about sort of what your macro assumptions that are underlying the guidance is?

Joseph Tibbetts

Sure, we do have some seasonal spending that start with Brain Share, which involves a fair amount of expense in it’s own right and a lot of travel and time put in by employees from all around the world, it’s a huge event as you know. Second is, we’ve got kind of an interesting occurrence in our compensation expense because our Q2 starts in February and ends in April and that’s a really down time for vacations. People don’t typically relative to the quarter that we were just in, take nearly as much vacation and in the quirks of accounting, you know you basically record the expense for vacation when people are working and then you take a buy on it when they’re on vacation. So that means that during this quarter, more heads are working and that’s good news but it also means that our expense structure is going to be opposite. It’s really those two things, plus payroll taxes you know because of the quirks of payroll taxes being front loaded in a calendar year we’ve had only one month of the new calendar year in our last quarter and we’ll have three full expense rate for us in calendar year of Q2. So, when you add all that up, there’s a significant expense structure we’ve got to absorb.

Jason Mader

Okay, but from a revenue perspective, the April quarter is typically a little better seasonally than tthe Q1 January quarter. I’m trying to understand the load under your guidance should be flat sequentially, just what are your underlying assumptions that would actually tie you to see a normal seasonal improvement?

Joseph Tibbetts

I think we’re looking at the combination of all of our business including Selerant. We’re looking at you know the fact that we’ve taken some aspects of our business down intentionally in terms of some of the consulting revenue. I think we’re trying to give you the best range that we have in our minds as to where we can come out and that points us to the range that we’ve given you there with sort of a $10 million bracket on it.

Jason Mader

Okay. Maybe a question for Ron here on OES and where that was down, we color them together as 11%, help me understand why OES isn’t influencing perhaps greater NetWare renewals, convincing more folks to move from NetWare to OES because I would have assumed with the product release that you know the decline would start to turn around or at least be in single digits or low single digits versus another down 9%, 10%, 11%? What’s not happening there that ought to be happening?

Ronald Hovsepian

There’s probably three things Jason that I’d highlight very quickly to you. Item one is the customers break into two buckets, the first bucket is ones that are very loyal to NetWare and have not made the decision to go to Linux, so the organization has to go through the sales process of choosing to go through to Linux and once they make that decision, then they make the move to OES, so there’s a two step sales process we have to go through, one is convincing the organization of Linux as a platform and then the second one is to then sell the OES products. So that elongates some of the pie. Second bucket that I would point to is, what I’ve learned over the past two years from the Americas in detail, is that there is a certain lumpiness to some of those renewals. We can shift around on us and as I learned in my first year that some of those will move in an out of different quarters and I’ll all of a sudden feel really good because I’m down in the single digits, then boom it pops up to 10-11 again. And I don’t have that statistically mapped out where I’ve got it to a perfect science to be candid, but there is a level of lumpiness that we just manage through quarter by quarter. The third piece of it is inside of OES itself, most customers have a propensity to wait for a service pack release 1, and there’s always that behavior in a lot of customers buying pattern for software. So those three factors go into what goes into that number.

Jason Mader

Did you, I think you mentioned on the call you were looking at maybe more marketing around OES? Did I hear that correctly?

Ronald Hovsepian

I would say this, concentrated marketing campaigns to our core install base of customers. So specifically when you look at NetWare and OES and GroupWise, those two in particular, those are a certain set of customers that drive the large proportion of that revenue and we put plans internally to migrate those customers to our latest releases to make sure we’ve got them all up to speed for a variety of reasons. A) to protect the base and, B) obviously to manage our business more efficiently.

Jason Mader

Okay. And my last question, would just concern customers are very interested in combining open source GA to their Linux distribution. There’s obviously been some press reports about JBOX potentially being acquired. If JBOX was hypothetically acquired, where do you guys thinking about in terms of filling that gap given that so many customers look for these two products to be sold together to be included together in their deployment. How do you fill the hole that potentially could occur?

Ronald Hovespian

The good news is we feel really good about it from two levels; and the JBOX example specifically. One is the contractual relationship we have with JBOX, puts us in a really long term relationship with them to support the customers who want to buy it as part of a full distribution and we would expect that not only in the spirit of open sources with whoever, if something were to be an event, we would expect that to continue under the terms and conditions of our contract with them. So we feel very strongly there and then as you know, this is a game of choice in the overall marketplace. But from a JBOX perspective, we’ve chosen that, we feel good about it. We feel good about the relationship and it’s just one of the pieces that we do packet into our distribution and we feel good about it.

Operator

The next question is from the line of Mark Murphy with First Albany.

Mark Murphy

Thank you.. Joe, just because of the revenue category reclassification, can you help us to understand which set of numbers we should be using here? Just to try to compare you Linux related revenues on a sequential and year over year basis?

Joseph Tibbetts

Well you know, clearly the Linux platform products sub category is the one consistently has been there and is the one we’re you know, includes SLESS and is down in growth pattern. The other open platform products you know as you see is declining. It includes professional, it includes some amount of non recurring engineering that we don’t put emphasis on. And then you know the OES growth obviously is going to continue to occur as we get netware based to convert over and once that’s completely converted over then that number won’t continue to grow iin anywhere near the pace that it’s growing right now.

Mark Murphy

Hey Joe, just to clarify then. The number we’d be looking at here is the $10.4 million number versus the $8.5 million a year ago and $35.8 million for FY’05?

Joseph Tibbetts

Yes.

Mark Murphy

Then, as a follow up, can you provided that NetWare and OES revenue the year over year change is, that was down 11%, is that a local currency or is that as reported?

Joseph Tibbetts

As reported.

Mark Murphy

The local currency would be what

Joseph Tibbetts

When you say local currency I think what you mean is consistent currency.

Mark Murphy

Correct.

Joseph Tibbetts

I’m not exactly sure, so we know that. I’m not exactly sure what that percentage was this quarter. I suspect given that the currency rate hit us pretty hard, there’s probably a pretty significant difference there due to that maybe a couple of percent.

Mark Murphy

Okay. And Joe, just a last question. The guidance is calling for in the second quarter kind of similar year over year decline in total revenue and I’m curious beyond that are you building the expense plans for the business around a stabilizing revenue base in the back half, or is it assuming some amount of growth or an on-going decline? Just as we try to model out the expense line?

Joseph Tibbetts

Yeah, we I mean we haven’t given full year revenue growth so I’ve got to be careful that I don’t tread on those waters, but you know I think clearly we’re trying to grow our business here and we’re balancing the part of the business that is shrinking and balancing it quite well with the pieces of our business that are growing, that we’ve put our efforts into. So, you know as those two things offset, we’re not seeing dramatic growth in revenue, but clearly as we go forward, you know that’s, we’re absolutely trying to grow revenue as well as at the same time which is always a balance as you know, increase our profitability.

Mark Murphy

Okay. Thank you.

Operator

Your next question is from the line of Steve Ashley with Robert W. Baird.

Steve Ashley

Hi guys. NHS obviously great deal in the previous fourth quarter. You booked $20 million and recognized $10 million. Were you able to recognize any additional revenue in this current period?

Joseph Tibbetts

Yes, I think there was a small piece of revenue recognized from NHS this quarter. Actually ironically, I think if you compared that particular customer year on year, you’d see a decline because in the prior year, we had some NHS revenue that was on a stand alone basis in the quarter, but a piece of that revenue would have been recorded this quarter and probably for some quarters to come.

Steve Ashley

Does that sound like less that $1 million?

Joseph Tibbetts

I really can’t say, Steve. But I wouldn’t say it materially moved the quarter around.

Steve Ashley

And any kind of guidance you could give us on maybe the number of new customers you were able to get in the Celeste Business?

Joseph Tibbetts

We haven’t started reporting any of those numbers formally to the market. We do track new customer growth. We set targets for size of customers as well, meaning we want to know how many new $100,000 customers do we have and how many million dollar customers do we have, in terms of driving overall growth in terms of the customer base. What I can do is give you some highlights of some of the key players that we did drive good invoice with. Those would be things like Syak, the New York Stock Exchange, all the trading terminals have a little SUSE logo popping up on them. The Telecom Company of Brazil, Telmar, Loews has selected us and you know South African Department of Homeland Affairs, so we’re doing well making the penetration on the strategy we set. We do track it internally something we don’t share publicly yet.

Steve Ashley

Just a follow up question was actually asked on the first question. You said you were having some nice traction with the Linux, with the hardware vendors. Do you know what percentage of your Linux business might have been come from indirect channel partners this period?

Joseph Tibbetts

Yes I do know what those percentages are precisely we do not share them so I apologize on that, but we do know the mix both of bi partner as well as OEM, so by distribution channel and OEM hardware partner. What I did share with you is that we saw good double digit growth uptick and then what I also shared with you and Jack had mentioned it, we’re continuing to sign those vendors and the part to remember here is you’ve got to have the big guys so we’ve got those. You’ve got to have the key customers and then you also have to have the distribution channels. And you have to make all those flow, so there some lag times as you sign up each piece of the equation there.

Steve Ashley

(Inaudible)

Joseph Tibbetts

It would be a little bit higher because if you translate the 2¢ of stock compensation expense that I’m guiding to for next quarter, that’s down from this quarter. We won’t have that one shot deal that I spent a little time with on the call. So our total $14 million this quarter will be less next quarter and so therefore, the difference between the two effective rates will probably be down.

Steve Ashley

Thanks.

Operator

Ladies and gentlemen, we have reached the end of the allotted time period for questions and answers. This concludes today’s conference call. You may now disconnect.

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