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Executives

Susan Walker White - Director, Investor Relations

Dana C. Russell - Chief Financial Officer, Senior Vice President

Ronald W. Hovsepian - President, Chief Executive Officer, Director

Analysts

Aaron Schwartz - J.P. Morgan

Abhey Lamba - UBS

Katherine Egbert - Jefferies & Company

James Gilman - Cross Research

Matt Cross - Pacific Crest Securities

Novell, Inc. (NOVL) F2Q08 Earnings Call May 29, 2008 5:00 PM ET

Operator

Good afternoon. At this time, I would like to welcome everyone to the Novell second quarter 2008 financial earnings release conference call. (Operator Instructions) I would now like to turn the call over to Ms. Susan White, Director of Investor Relations. Miss White, you may begin your conference.

Susan Walker White

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

We are here this afternoon to discuss Novell's financial results for the second fiscal quarter of 2008. If you don’t yet have our press release, you can access it by visiting our investor relations webpage 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 June 13, 2008. The domestic toll-free replay number is 800-642-1687, and the international replay number is 1-706-645-9291. Replay listeners must enter conference ID number 45769805.

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

Finally, please note that during today’s call, we may make forward-looking statements. You should be aware that our actual results could differ materially from those contained in the forward-looking statements, which are based on current management expectations and are subject to a number of risks and uncertainties, including but not limited to factors described in our annual report on Form 10-K, filed with the Securities and Exchange Commission on December 21, 2007, and in the press release we issued earlier today.

Any forward-looking information that we provide in this call represents our outlook as of today, May 29, 2008, 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 C. Russell

Good afternoon, everyone. Novell's second fiscal quarter 2008 financial results were released a short time ago. The company reported net revenues of $236 million, income from operations was $2 million, non-GAAP income from operations was $16 million, non-GAAP net income was $21 million, or $0.06 per share.

Foreign currency exchange rates positively impacted revenue by $8 million and negatively impacted operating expenses by $9 million, with the net effect on operating income of negative $1 million on a year-over-year basis. We were pleased with the overall performance this quarter. Product revenue grew 7% and license revenue increased 6% on a year-over-year basis.

Invoicing was very strong, with total product invoicing up 20%, which included growth in every product category and total invoicing was up 10% from the prior year. Invoicing included an up-tick in our multiple year contracts, demonstrating customers’ long-term commitment to Novell.

We are seeing good traction in our services realignment, which is focusing our services business to drive higher margin product revenue, while transferring lower margin service revenue to our partners.

Non-GAAP operating margin of 7% increased from 4% a year ago as we continue to focus on profitability while growing revenues.

Now I’ll highlight some of our quarterly results by business unit. You can see the results on the revenue schedule on page 10 of our press release. Within open platform solutions, Linux platform products revenue was $29 million, increasing 31% from the year-ago quarter. Linux invoicing was $38 million, up 23% year over year. Within our identity and security management business unit, identity and access management had a strong quarter. Revenue was $27 million, up 13% from the year-ago quarter. Invoicing increased 31% on a year-over-year basis, exceeding market growth rates.

Resource -- systems and resource management revenue was $41 million, up 15% from the year-ago quarter and invoicing was up 27%. This includes revenue from PlateSpin that was acquired late in the quarter. We don’t plan to report PlateSpin separately going forward; however, PlateSpin contributed revenue and invoicing of approximately $3 million respectively. Excluding the impact of PlateSpin, revenue was up 7% and invoicing increased 17% year over year, which was a strong quarter for these products.

Workgroup revenue of $92 million was down 1% from the year-ago quarter but invoicing increased 6% year over year. Within our Workgroup category, the combined OES and Netware related revenue was $54 million, down 2% from the year-ago quarter. Combined OES and Netware invoicing was up 5% year over year.

Now on to our expenses for the quarter. Although operating expenses were impacted by FX and acquisitions, they remain flat with the prior year on a non-GAAP basis. Gross margins and operating margins improved year over year due to a more profitable revenue mix and leverage in the model. We will continue to work on improving our expense structure through the rest of the year to make sure we meet our operating margin targets.

Turning to our balance sheet and cash flow, cash and short-term investments declined to $1.4 billion from $1.8 billion year over year, mostly due to the PlateSpin acquisition and the repurchase of a portion of our outstanding debentures. To date we have used $135 million of cash for the repurchase of our debentures.

On May 13, 2008, we announced a share repurchase program of up to $100 million of the company’s common stock. To date, we have not repurchased any shares under this program.

Cash flow from operations was negative $18 million compared to negative $29 million a year ago. Historically, we have seen negative cash flow in the second fiscal quarter.

We incurred $2 million of new restructuring charges this quarter, in line with plan, and total headcount at the end of the quarter was approximately 4,200, up from 4,000 last quarter, primarily due to the acquisitions of PlateSpin and SiteScape.

Now I’ll turn the call over to Ron for an update on our business units, as well as a progress report on our strategic initiatives and milestones. Ron.

Ronald W. Hovsepian

Thanks, Dana. Our business continues to gain momentum and is tracking according to plan. Our commitment to interoperability and the strength of our offerings continue to be positive catalysts for the development of new customers and our partner ecosystem.

During today’s call, I will review each of our business units and provide you an update on our strategic initiatives and milestones. Let me begin with our business unit review.

Starting with Open Platform Solutions, we had some very exciting partner developments. First, we deepened our relationship with SAP. Last year, SAP selected SUSE Linux Enterprise Server as a preferred Linux provider. In March of this year, SAP announced that it exclusively selected SUSE Linux Enterprise Server as the only Linux distribution to run SAP’s all-in-one solution, which is targeted for small and medium-sized companies. The SME market is a critical market for both SAP and Novell. We are also working with SAP to optimize additional SAP applications on SUSE Linux Enterprise.

This announcement is a big win for Novell, our customers, and partners. We benefit from increased distribution. Our customers benefit through reduced complexity of application deployments, more integrated and optimized operating platforms, and lower costs.

Our partners benefit from a new revenue opportunity by participating in SAP’s partner referral program. Our SAP partnership also positively impacts our other businesses.

Second, our partnership with Microsoft continues to expand. During the third quarter, we announced an incremental investment in the China market to focus on converting unsupported Linux users to SUSE Linux Enterprise. We also expanded our technical collaboration agreement to simplify and standardize the management infrastructure needed for efficient Windows Linux management.

To date, we have invoiced $157 million, or 65% of the original five-year, $240 million agreement.

Third, turning to our desktop market, HP, the largest PC manufacturer, announced it will preload SUSE Linux Enterprise desktop on its 2133 Mini-Note PC, which is designed for the education market. HP joins Dell and Lenovo in shipping PCs preloaded with SUSE Linux Enterprise.

On to the identity and security management, our efforts to develop our identity partners are beginning to pay off. During the quarter, we announced several new partnerships, including ATOS Origin, SAP, and HP.

With ATOS Origin, we are adding systems integrator expertise focused in the European market. With SAP, we announced an integrated governance risk management and compliance solution utilizing Novell's identity solutions portfolio. And with HP, we announced an exclusive agreement to migrate HP’s identity customers to Novell's identity product portfolio. Under the agreement, HP will resell Novell identity products.

Now turning to our systems and resource management, we’ve completed the acquisition of PlateSpin, which is now part of our systems and resource management business unit. We now have the only unified workloads management solution for both physical and virtual environments. PlateSpin has created substantial opportunities to expand our ecosystem, which we are actively pursuing. The integration is tracking on plan.

Next, our Workgroup business unit had better-than-expected results. We are encouraged by the direction of these results, which again were partly due to the success of our bundled product, Novell Open Workgroup Suite.

Within Workgroup, collaboration had another strong quarter with year-over-year growth in both revenue and invoicing. During the quarter, we acquired SiteScape, a leading provider of team workspace and real-time collaboration technology. This integration is tracking on plan.

Now turning to our strategic initiatives, this year we have four initiatives focused around our sales model, R&D processes, back office optimization, and services business realignment. Our first three initiatives were started last year and are tracking on plan. During the quarter, we increased our global R&D footprint with the expansion of our India development center.

Our fourth initiative is also tracking on plan. We continue to see the successful transfer of services revenue to our partners, with good traction in recruiting and enabling partners. This quarter, we signed several new services partners, many of which are in the identity market.

In order to track our progress on our initiatives, we had five milestones for fiscal 2008. These are: number one, achieve revenue of 940 to 970. Based on our revenue of $467 million through the first half of this year, this goal remains well within target.

Goal two: grow product revenue at or better than market growth rates for Linux, identity and access management, and systems management. Not only did we meet or exceed market growth rates for revenue, we realized strength in invoicing, which bodes well for the continuation of these trends.

Three, achieve Workgroup product revenue of at least $285 million to $300 million. Workgroup has over-performed in the first half of 2008. We feel this over-achievement is a good indication that Workgroup is showing signs of stabilization that we’ve been working towards.

Four, expand relationships with one to two more global strategic partners. During the quarter, we deepened our relationships with SAP and HP. With SAP, we are working to enable SAP’s enterprise applications to work with numerous Novell Linux and management technologies. With HP, we agreed to migrate HP’s identity customers to Novell's identity portfolio, providing us with new potential customers.

With these two announcements, we’ve achieved this milestone for the year and we are continuing our focus on global strategic partners focus, because we believe it provides great leverage for the company and value to our customers.

Our fifth goal, achieve non-GAAP operating income margin of 7% to 9%. Based on our non-GAAP operating margin of 9% for the first half of the year, we are well-positioned to achieve this goal.

Overall, product revenue was up 7% year over year, driven by our three growth businesses, Linux, Identity, and Systems Management. We saw strong invoicing growth across all businesses. Our business remains on track, our strategic initiatives are on plan, and I am confident we will achieve our full-year milestones.

Now I will open it up for questions. Operator, please open the queue for our listeners.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Aaron Schwartz with J.P. Morgan.

Aaron Schwartz - J.P. Morgan

A question on the Workgroup segment; given the revenue out-performance in the first half, and I guess, Ron, your comments about some signs of stabilization there, can you talk about how that could impact your profitability for this year and next year as well? I know that Workgroup probably has some of the higher operating margins out of all your business segments.

Ronald W. Hovsepian

Yeah, Aaron, as we look at it, as I had indicated, the stabilization, that stabilization we’ve all been striving towards appears to be occurring and with that, that gives us a lot of confidence as we look at the second half and as we look into next year for our performance on the bottom line in terms of the overall profitability for the company. So at this point, we are sticking to our guidance but we do feel good and we can see some upside as we look at the overall cadence of that business as we’ve strengthened it and where we see it heading to, but at this point we are just going to hold to that guidance.

Aaron Schwartz - J.P. Morgan

Okay, and then shifting gears to the open division, can you talk about some of the productivity of channel partners contributing to your invoicing there? I know that’s been an effort for you outside of Microsoft, just recruiting additional partners in there and sort of time frame to maybe expect that to gain some leverage?

Ronald W. Hovsepian

The partner, as you look at the partner revenue, you have to look at both -- at several dimensions of it because they play different roles there. But the net affect that I would highlight and what we are tracking, and we track multiple pieces here, but what I’m really focused on is the recruitment of the new partners by each one of the business units and I feel very good about that recruitment process. I feel good as to where we are in enablement, which is really the next step, and then the final step is them driving demand and getting the implementation fees that they look for, and any other fees from us in the relationship.

We are working our way through that funnel, if you think of it in those three steps, and I feel good about where we are in the recruitment. We are getting more enabled and then the overall demand assistance that we are looking for from them is still coming up the curve from my perspective. And you’ll see other -- you know, that’s on a small and a large scale, meaning an SAP and a small regional player.

I think I’m also looking at what we see with SAP as we ramp up with them through the second half of the year on this all-in-one bundle I think will have a good impact as I look into Q4 and into 2009.

Aaron Schwartz - J.P. Morgan

Okay, and last question, probably for Dana, I know you are not providing too many metrics on PlateSpin, but can you help us out with just the OpEx contribution? It seems like it was on the books for maybe a month but just in terms of how we are looking at the model for next quarter?

Dana C. Russell

Yeah, Aaron, we can talk about that. We mentioned that on the revenue line, we saw $3 million of revenue. It was slightly dilutive. I think we were about $3.5 million, $4 million of expense, so that was the current quarter impact.

Aaron Schwartz - J.P. Morgan

Okay. Congratulations and thanks for taking my questions.

Operator

Your next question comes from the line of Abhey Lamba with UBS.

Abhey Lamba - UBS

Thanks. Just following up on the last question about the Netware business, can you comment on the traction for OES 2 and when do you think it can start growing on a year-over-year basis?

Ronald W. Hovsepian

In terms of overall traction inside of OES 2, we know that the customers were looking for a specific service pack release from us, so we want to make sure that we get that into the market. What we are seeing, as the invoicing had indicated, a real good trend inside of that business, in terms of the core Netware, and I’m just looking over at Dana to confirm the invoicing percentage.

Dana C. Russell

Yeah, we were actually up 5% on a year-over-year basis, combined Netware and OES.

Ronald W. Hovsepian

So we feel it’s heading in the right direction. In terms of the adoption into the customer environment, as I’ve shared with you in prior calls, that’s really what I’m tracking too and until I see that next version get out there and get adopted, that’s where I’ll feel good.

What I will tell you is betas have gone extremely well. We feel good about that. Those are all the leading indicators that we look at and the feedback from the customers has been very positive. There’s just one or two features that we are looking for in this next service pack release.

Abhey Lamba - UBS

And when is that due?

Ronald W. Hovsepian

You know, I should have been flipping ahead because I knew you were going to ask that -- it’s due out this summer. That’s what I thought, summer, this summer.

Abhey Lamba - UBS

And lastly, Dana, any update on the exit rate operating margin for this year? Are you still focused on 12 to 15? And how should we think about next year’s margin in light of your year-end target?

Dana C. Russell

No, I think that’s still the plan. We are still very focused on meeting those exit rate targets that we had previously announced, so no changes there. And we feel very good that we can continue the profitability trends, continuing to increase and expand margins into 2009.

Abhey Lamba - UBS

Thank you.

Operator

Your next question comes from the line of Katherine Egbert with Jefferies.

Katherine Egbert - Jefferies & Company

Good afternoon. Dana, can you tell us, of the $3 million that PlateSpin added, how much of that was license revenue?

Dana C. Russell

License revenue was the majority of that, Katherine, so I don’t know the exact number but I think it was like $2.5 million of it was --

Ronald W. Hovsepian

It would be the majority.

Dana C. Russell

Yeah.

Katherine Egbert - Jefferies & Company

Okay. And then Ron, you talked about partners in a number of your products -- is there any chance for partnering PlateSpin?

Ronald W. Hovsepian

Oh, yes, there’s been a lot of activity in that arena, at both small and large customers, small and large partners, excuse me, Katherine. That has been very good and very active. I personally have had a chance to meet with a couple of potential partners, as well as current partners, and I feel good about our opportunity with that partner portfolio and growing it, in particular with some of the larger partners that may want to package or bundle things with us.

Katherine Egbert - Jefferies & Company

Okay, and then you mentioned that there’s more leverage in the operating expense line. Can you tell us where you might see more leverage, kind of which categories you expect?

Dana C. Russell

Yeah, as Ron talked about the strategic initiatives, we’ve talked about several categories of expenses that we are focused on. Obviously the sales and marketing has been a focus and we continue to see opportunities there to be, to optimize the model. We are also addressing back office expenses, and then you can see from this quarter, we had a fairly significant drop-off in the services revenue, professional services and we are also impacting expenses and optimizing expenses in that area as well.

Katherine Egbert - Jefferies & Company

Okay, and then last one, what about -- you know, you’ve guided to revenue and improving margins for the rest of the year. What about cash flow? Do you think you can be positive for the year or can you be positive like in the next two quarters, you think?

Dana C. Russell

Oh, yeah. We’ll definitely be positive. We will be quite positive in the second half of the year and I don’t know that we’ve given out exact numbers around that but we’ll have -- we’ll be positive for the full year and we’ll certainly be positive in the third and fourth quarter.

Katherine Egbert - Jefferies & Company

Okay, that helps. Thanks a lot. Good job.

Operator

(Operator Instructions) Your next question comes from the line of James Gilman with Cross Research.

James Gilman - Cross Research

Good afternoon, Ron and Dana. I have several questions. First, in reference to the HP announcement, you mentioned migrating the customers. What kind of timeframe are we looking, or do you expect here on the migration? And what kind of percentage of those that you’ll be able to migrate?

Ronald W. Hovsepian

We haven’t given any public percentages but the timeframe is the day after we sign the agreement and realistically, these are going to be customer-driven, depending upon the complexity and where they are in their implementations and what the migration plans would look like from the customer’s perspective. So I think it will vary over the next 12 to 24 months as the customer goes through that migration. But we are going to have a very active and focused program over the next six to 12 months to get them signed up.

James Gilman - Cross Research

Do you think you’ll be able to in the future periods to provide a little bit more color around that, to quantify that opportunity?

Ronald W. Hovsepian

I don’t see us doing that because I’m really focused on the broader growth of the identity business at this point, so I don’t see that breakout. We don’t breakout other arrangements, reseller type arrangements, with the exception right now of just Microsoft, and that’s just to give you some good guidance in the spirit of being open. But that one, I don’t anticipate doing that.

James Gilman - Cross Research

Okay. In reference to the stabilization of the Workgroup, I’d like to drill down a little bit there. Can you maybe give us -- attribute some causes that are, you know, why that has stabilized? Is it the type of customer base? Is it -- you know, even though we see it on the revenue line, is it FX impact? I mean, can you give us some color there?

Dana C. Russell

James, I think we’ve probably actually talked about this a little bit before with you, but last year we saw group-wise with overall growth somewhere around 6% I think on an invoice or a bookings basis, and we’ve continued to see some strength there, which into 2008 has sort of continued on.

This was a quarter where we were particularly pleased with OES and Netware increasing on a bookings basis and even though Workgroup overall had been stabilizing over the last couple of quarters, this was the first quarter that we’ve actually seen bookings increases for that particular product category, for Netware and OES. I think there’s a number of factors there -- number one, it’s focus from the company, so we are very focused on that. We are doing the things that you’d think normal blocking and tackling, compliance type activities, making sure we are getting out, working on the renewal process, the tele-sales activities that we’ve implemented over this last year or so definitely having a positive impact there.

So I think it’s a combination of things which is attributed to some of the success in that particular area.

James Gilman - Cross Research

Okay. Moving on to the interest income, given the environment, you had a relatively strong number there. You have a lower cash balance. You probably shifted out some things. How should we look at the interest income line in future periods?

Dana C. Russell

Yeah, you are going to see that come down. I think there’s some tailing effect of lower interest rates which hadn’t impacted the overall number, which will as we go forward here. Most of the cash was in the -- still in the coffers during much of the quarter, so it wasn’t impacted in -- you know, we didn’t impact earnings as a result of that cash going out. It went out later in the quarter, so I think you can look at it -- I’d take that balance, the current cash balances and think about interest rates somewhere more in that 3% range, and calculate interest income based on that.

James Gilman - Cross Research

All right, and last question here is just from a macro standpoint in the U.S., some inflationary pressures and such from fuel and things. Do you think that -- what kind of impact will that have on Novell's business do you think, positive or negative?

Ronald W. Hovsepian

From an overall economic perspective, you know, we do remain cautious as we look at the rest of 2008. As I said, you heard Dana walk through some real positive overall invoicing numbers and growth in all of our market, in our market segments that we are trying to grow and stabilization in our base business, so overall we feel good. The one thing that is making us just step back is the overall economic environment. None of us can predict that and therefore we are being reserved in our approach. That’s why we think there might be upside but we are not ready to go out and commit that at this point because of that economic overhang.

So I don’t have a deeper opinion than what I’ve shared with you in past calls. I like where our segments are. I like -- meaning the growth segments. Our installed base is in some insular spots, which is good for us, so when I look at both our growth businesses, they tend to be either catalysts for expense savings or compliance or risk-based. Customers need to do those types of things. And then on the core business, we are into places that our long, loyal customers and are less subject to broader changes in their infrastructures. So those things bode well for us, in my opinion.

James Gilman - Cross Research

Thank you for taking my questions.

Operator

Your next question comes from the line of Matt [Cross] with Pacific Crest Securities.

Matt Cross - Pacific Crest Securities

Good afternoon, guys. You mentioned additional desktop progress for Linux, and how much of this is due to Red Hat exiting the desktop market versus increased demand that you’ve seen?

Ronald W. Hovsepian

I wouldn’t attribute any of it to them exiting the market because technically, they would have had to put a product out there to enter the market, which they never got done. And I don’t say that to be a complete smart-ass on that one, but it’s -- they weren’t really in the market completely, Matt. There was obviously the overture all the time to be in the market. So this relationship with HP, we’ve been working for a while and all of our focus has been out in the customers. As I said to you all along, this is going to be a long, slow climb in that marketplace but it’s something we think the customers, as they look at managing Linux, both at the desktop through the server side, the customer wants that one Linux learning experience so that they can manage whatever footprint, you know, kiosks and other pieces, so that they have one efficiency in terms of learning a particular code base. And that’s really -- our position really hasn’t changed there, so we’ll stay focused on the enterprises and the larger plays versus any consumer or anything like that. We’re not going to go chase that market.

Matt Cross - Pacific Crest Securities

And with the pay-down of some of your debentures and acquisition of PlateSpin, should we expect more of the same for future cash outlays?

Dana C. Russell

I think we’ll be opportunistic on the debentures, so I would have to make -- it would have to make financial sense for us. Those debentures have a feature where they could be put to us in July of 2009, so from that standpoint, there could be a significant outlay of cash there.

Matt Cross - Pacific Crest Securities

Great, and then just finally, what kind of factor has virtualization been in people’s decisions to purchase SUSE Linux Enterprise Server?

Ronald W. Hovsepian

It’s actually been a good factor from our perspective. We delivered the virtualization capability in SUSE Linux in the summer of 2006, and when we did that, that gave us a nice leadership position so Matt, the way we’ve been looking at it is how do we go harvest roughly 2.5 million SUSE enabled virtualization footprints that we have out in the marketplace. And part of our learning from companies like BMW or Sumitomo Electric who have used our virtualization is we were missing some of the tools which led us into conversations with a PlateSpin and some other things that we need to do to make it easier for them to take advantage of virtualization.

So all in all, I know this is a question of is the consolidation of virtualization going to affect the overall operating system market. I think it’s the right question to keep asking us. I think because we are in a growth mode, I haven’t seen anything that shows me that it’s going to slow down at all.

I think for us for the next year or two, it’s really how fast does the customer migrate their UNIX to Linux still. That’s really the majority of the footprint that’s moving over at this particular point in time, more than it is virtualization. Where it may come in to impact is if a customer has used the hardware virtualization that would sit in a UNIX environment, taking advantage of a risk chipset that they all use. That might be where you get some slowdown there, but if we are moving them from that UNIX world to our Linux world, it won’t matter in that particular scenario.

Does that help bring some light to that, or --

Matt Cross - Pacific Crest Securities

Yeah, definitely. Thank you very much. That’s it for me.

Operator

We have no further questions at this time.

Ronald W. Hovsepian

Great, Operator, then I’ll conclude our call and thank everybody -- do I need to -- no? Okay, I’ll thank everybody for joining us and talk to you all soon.

Operator

Ladies and gentlemen, this concludes today’s Novell second quarter 2008 financial earnings release conference call. You may now disconnect.

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