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At Novell, Too Soon to Celebrate

Christmas came early for Novell (NOVL) this year. The British government's National Health Service has awarded the software company a $40 million contract. The biggest deal Novell has closed in recent history, it helped the outfit push past analyst expectations of $300 million in fourth-quarter sales, which instead totaled $320 million. It was the highest revenue quarter for Novell in years, crowed Chief Executive Jack Messman on the company's conference call.

Profits, however, were another story. Novell lost $5 million thanks to restructuring costs, vs. a profit of $15 million a year ago.

Yet the deal and relatively strong quarter gave the embattled CEO some much-needed good news. After the company's lackluster third-quarter results, Messman came under criticism from investors and analysts for lacking a technical vision, hoarding cash, and investing too heavily in its legacy businesses.

FANCY FOOTWORK. Now facing a potential proxy fight next spring to unseat him and the board, Messman has spent much of the last two months proving he's listening to critics, and that Novell is on the path to recovery (see BW, 10/31/05, "Cold Realities for Novell").

Messman has promoted well-regarded head of sales Ron Hovsepian to chief operating officer and president, and hired Jeffrey Jaffe as chief technology officer -- a post that had been vacated by Alan Nugent last spring. Nugent was one of several executives credited with the company's Linux strategy, and analysts complained that he and others left a void when it came to Novell's technical vision.

The CEO also announced a $200 million share buyback, his intention to sell off Novell's declining Celerant consulting division, and a 10% cut in the workforce -- a move that will save the company $110 million next year. That's some fancy footwork for the former railroad executive, who also has been criticized for moving too slow.

LINUX LIFT. Some investors have responded positively to the moves: Novell's stock hit a new 52-week high of $8.17 on Nov. 18, though it has since fallen, closing at $7.67 just before the earnings release. But Messman will need more than one good quarter, especially since the deal with Britain's National Health Service, while for the entire range of Novell products, clearly skewed some of the fourth-quarter numbers.

Consider the impact on the outfit's NetWare operating system, which has been declining by double digits for years. The deal actually helped push NetWare revenues up 3% for the quarter, limiting the revenue decline for the year to just 9%. Even though only half of the $40 million deal was recorded as revenue in the fourth quarter, Novell executives were careful to say that the trend will not continue.

Still, Linux and identity management are both trending up for Novell. Linux revenue was $61 million, up 30% over the previous quarter and a whopping year-over-year increase of 418%. The bulk of Linux revenue came from Novell's Open Enterprise Server, a new product that runs on both a NetWare and a Linux kernel. It's a bridge product that allows companies now on NetWare to upgrade to Linux at the flip of a switch -- when they're ready.

SLOW REVIVAL. The result of nearly two years of engineering work, the Open Enterprise Server is at the core of Novell's strategy to give NetWare customers a reason to stay with the company, rather than switch to Microsoft (MSFT). If you include that product in overall Linux server shipments, Novell starts to rival revenues of Linux vendor Red Hat (RHAT), which made nearly $200 million last year. Red Hat will report its third-quarter results on Dec. 21.

Despite the strong showing, Novell says it expects first-quarter 2006 revenues to fall between $260 million and $270 million, lower than the $288 million Wall Street is projecting. Messman told analysts that revenue will be lower because it's a seasonally slower period and the company is de-emphasizing some older product lines.

The first quarter will mark the two-year anniversary of Novell getting Linux religion -- the time line Messman originally gave for how long it would take to revive the company. Poised before that deadline, his rhetoric has softened. "While we have come to the end of the two-year period, we still have much to do," he told investors and analysts, promising to continually search for ways to boost the top line and trim the bottom line.


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