Novell Inc. Q3
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Novell Inc. Q3
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(FOOL CONFERENCE CALL SYNOPSIS)* By Debora Tidwell (MF Debit)
Novell Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: NOVL)") else Response.Write("(NASDAQ: NOVL)") end if %> UNION CITY, Ca., August 29, 1996/FOOLWIRE/ --- Novell Inc. released Q3 1996 results last Thursday, August 22nd, after the market closed. (Note: Because of the changes in channel inventories Novell made last quarter, sequential comparisons in this report are made to Q1 numbers, not Q2. This was how Novell chose to do it in the conference call.)
Novell's Q3 revenue was $365 million, just short of the run rate they anticipated in their last conference call. This compares to $377 million in revenue from continuing lines of business in Q1 1996. Net income was $59 million or 16% of revenue, the same net profit percentage they achieved in 1995. Earnings were $0.17 per share, as expected, a $114 million improvement over their reported Q2 results.
To put these results in perspective, net income as a percentage of revenue was in the top 1/3 of 1995 results ahead of, for example, 3Com, Hewlett-Packard, Oracle, Computer Associates, Silicon Graphics, Sun Microsystems, and Bay Networks.
Novell has bounced back. They have returned to profitability in revenue near Q1 1996 levels, less the contribution of sold or discontinued businesses. During Q3 Novell held the course charted earlier this year. They continued to execute changes and deliver products and programs that will increase Novell's market strength. By the end of 1996, all of Novell's efforts will engage to extend their LAN leadership into the Internet/intranet markets.
There were four factors that impacted revenue -- product mix, geography, license revenue, and channel inventory. With regard to product mix, NetWare 4 unit sales were up 17% versus Q1. However, NetWare 4 product mix shifted significantly to upgrades and this shift resulted in a higher proportion of lower average selling price products, accounting for why NetWare 4 revenue is only up slightly in the face of significant revenue growth.
As far as geographic factors, revenue from Europe, the Middle East, and Africa was weaker than anticipated -- off $20 million from Q1. A decline compared to Q1 is normal due to the seasonal market weakness in these areas during the Summer months, but the decline was larger than they expected. Decreased sales of the NetWare 3 product line were a large factor here. In addition, they did not have the benefit of revenue growth from Japan. Revenue from Japan was $29 million, even with Q1 1996. They believe that localized solutions and products aimed at small businesses scheduled for release in Q4 and early 1997 will make a significant difference in their geography-based performance.
The third factor worth mentioning is continued growth in license revenue. Growth in license programs which drove their decision to reduce channel inventory last quarter continued very strong in Q3. Revenue from corporate, channel, and OEM license programs increased 26% year-over-year and accounted for 36% of revenue. In this case, a comparison to Q2 does make sense and so, sequentially from Q2, this business grew by 16%. Major accounts that adopted or upgraded to NetWare 4 in Q3 include Citicorp, Coca-Cola, Wal-Mart, JP Morgan, Raytheon, Jenny Craig International, The German Ministry of Education, and the State of North Carolina. In addition to NetWare 4 revenue growth, the growth in license programs reflect increasing adoption of Novell's Network Services. They are seeing strong demand for ManageWise and GroupWise in both license and box revenue sales.
The fourth revenue factor is channel inventory. In Q3 they did resume shipments to their distribution channels and held channel inventory dollars constant at Q2-end levels. In fact, they did receive $5 million in orders that they chose not to recognize as revenue because they would have caused Novell to exceed their channel inventory targets. They are committed to maintain the inventory levels they achieved in Q2 as they move ahead.
When they compare their overall Q3 license plus channel results to Q1, all product categories were approximately equal with the exception of NetWare 3, which was down approximately $14 million and GroupWise which was up approximately $4 million. Although revenue must increase as they move ahead, they are pleased with their recovery and pleased with their expense levels. The continued strong cost controls position Novell for increased earnings growth.
They believe that product revenue will grow in Q4 as they refresh their product line across the board following betas that have been very favorably received by customers and reviewers alike. As they enter their strongest seasonal selling period, they will back their product launches with substantial new marketing and advertising programs.
At the May 29th analyst meeting they discussed the changes they are making to revitalize Novell's growth. This growth centers around software services required for full-service intranets. The product launches this Fall form the basis of this effort. On August 17th, the company briefed the trade press on their market direction, product and launch plans. While similar in content to their May 29th meeting, they demonstrated progress they've made since then. IntraNetWare was announced as the first full-service platform for intranets and access to the Internet. The clear path for 55 million NetWare users to upgrade their NetWare networks to full service intranets. It ships this quarter. Green River, the NetWare 4.11 operating system, was demonstrated with important new speed, security and system recovery enhancements. It also ships this quarter. GroupWise 5 was shown, their first implementation of a true intranet service that runs across all major servers and clients including Web browsers and clients. It ships this quarter. ManageWise 2.1 was shown managing not only NetWare and UNIX servers, but also Microsoft NT servers in a range of clients. It began shipping this month. The Novell Directory Services was demonstrated working with Web publishing solutions. It was also shown running on Microsoft NT server operating systems. The Web capabilities are here today. They will, as they earlier announced, ship NDS on Microsoft NT during the first half of 1997.
When they take a step back and look at the market over the past several years and how they think it will evolve, they see some significant changes taking place in the client/server world -- a movement toward what they've talked about as the client/network world in the past. In the client/server world, the operating system was king. In today's environment and going forward software that provides network services is king. For Novell's market presence, products and technology, they believe they are well positioned to lead this network software segment. In the past pre-Internet and client/server days, Novell defined the NOS and brought the operating system and with it brought the network services including file, print, security, directory, management, and messaging. That was a client/server strategy and was the "intranet" of its day. But, it was vendor-driven and was based on proprietary solutions whether those solutions came from Novell, Microsoft, or IBM.
Today the industry is moving to a network services model based on open standards and Internet technology. Browsers become the universal client. Customers and users, not vendors, now drive the solution by choosing open network services that best meet their needs. To be successful in this environment, Novell is rapidly becoming an intranet company. With IntraNetWare, they have created what they think is the premier intranet platform for this network services model. At the same time, they are unbundling the services of the network operating system. They will sell them in any combination whether supporting individual users and servers, private intranets, or the public data networks of their telecom partners. They will continue to advance and leverage their traditonal network operating system business, but the growth potential will be limited as all server operating systems become increasingly commoditized.
Their future growth will come from a burgeoning market for network services software. They will sell it as they traditionally have. They will also derive revenue from pay-for-use, annual user royalties from public data networks that deploy their software. They believe that revenue from cross-platform network services and software will surpass their traditional operating system business a couple of years from now. They anticipate that it will grow from a little more than $200 million year-to-date to over $1 billion in annual revenue before the year 2000.
Between now and the end of October, Novell will spend $20 million in worldwide advertising to support the launch of their new products and intranet solutions. This is the largest new product media budget in the company's history and will support advertising in leading publications including Fortune, Forbes, Newsweek, Wired, and Sports Illustrated. They will also fund banner advertising and commercials in more than 25 online media such as America Online, Netscape, CNN Interactive, and Hotwired. Their objective here is to reach beyond Novell's traditional technical decision-maker audience to target the full range of today's network purchasers -- CEOs, COOs, CIOs, and other executives who are increasingly involved in purchase decisions for network software and services. Their messages will be simple and two-fold -- 1) Novell connects and manages all network resources regardless of platform; and 2) the easiest way to implement an intranet is by extending your existing Novell network. These campaigns will significantly increase awareness of Novell as a major intranet player and they will build on these efforts with continuous advertising through fiscal 1997.
Over the past three quarters, Novell has addressed hard business issues and executed as planned. They have tightened their financial model to enhance earnings potential. They have brought revenue and profit back up to near-Q1 levels less the discontinued or sold business lines. They have dramatically reduced and established discipline in the management of channel inventory. They have accelerated product development to keep pace with the new industry dynamics. They have laid the groundwork for intensified marketing initiatives. They have extended their network operating system into a comprehensive platform for the rapidly expanding intranet and Internet market. They have demonstrated that Novell can expand its business as the leading provider of cross-platform network services. They are now in a great position to help transform the Internet and intranets into global networks.
PRODUCT LINE REVENUES
Today their business model consists of three major revenue components. First, their core server operating environment -- NetWare 3 and NetWare 4; second, their Network Services consisting of GroupWise, ManageWise, Host, Mobile, Remote and TCP-IP connectivity and other network services; and third, revenue from education, service, and their ongoing UNIX royalties.
Revenue in Q3 was $365 million and earnings were $59 million or $0.17 per share on 352 million shares outstanding. This compares with $538 million in Q3 1995 which did include $89 million of sold or discontinued product lines, and compares with $438 million in Q1 1996 which included $61 million from sold or discontinued product lines.
The revenue differences between each of these three periods is almost completely composed of decreases in NetWare 3 and those revenue reductions from sold or discontinued product lines. Comparing total continuing product revenue in those three periods, they recorded $449 million of revenue in Q3 a year ago, $377 million in Q1 1996, and $365 million in Q3 1996. Comparing year-over-year, there was an $84 million decline in revenue, of which $80 million is accounted for by declines in NetWare 3. The NetWare 3 revenue in each of those three periods -- $165 million in Q3 1995, $99 million in Q1 1996, and $85 million in Q3 1996.
NetWare 4 revenue in those 3 periods was $130 million in Q3 1995, $131 million in Q1 1996, and $131 million in Q3 1996. In Q3 1996, distribution units were up 17% from Q1, but due to the lower average selling price from the strong upgrade growth, total revenue dollars in this area (NetWare 4) were flat Q1 to Q3.
They have other miscellaneous NetWare including Nest and Tuxedo and other royalties of $5 million in Q3 1995, $4 million in Q1 1996, and $7 million in Q3 1996.
In the Network Services area they had revenues of $87 million in Q3 1995, $88 million in Q1 1996, and $85 million in Q3 1996. But, in this Network Services category, GroupWise and ManageWise collectively were up 33% year-over-year while Host and TCP-IP connectivity were down 33%. They have cross-licensed their SAA or host connectivity with IBM which accounts for that decline and are actively moving the TCP-IP connectivity into the core NetWare, and it is included as a primary protocol in NetWare 4.11 and IntraNetWare.
Their Education, Service, and UNIX royalty revenue for the three periods was $61 million in Q3 last year, $54 million in Q1 1996, and $57 million in Q3 this year.
Their discontinued operations in the same three periods were $89 million in Q3 last year, $61 million in Q1 1996, and of course zero in Q3 1996.
Also within revenue categories the corporate channel and OEM licensing revenue continued to grow, accounting for 36% of their total corporate revenue in Q3. That is up 26% from the year ago quarter, up 41% from Q1 this year, and up 16% sequentially compared to Q2. Within this category of licensed revenue, revenue from the major account licenses was up 49% year-over-year, 41% over Q1 1996, and 15% sequentially, driven both by upgrades and new adoptions of server operating systems as well as by demand for the network services in their installed base as add-on products are being purchased in their enterprise NetWare environment.
On a geographic basis, US revenue totalled $189 million or 52% of revenue. Revenue outside the US totalled $176 million and included $104 million from Europe/Middle East/Africa, $55 million from Asia/Pacific, and $17 million from Canada and the Americas. Revenue from these ongoing products in the US was up by approximately 12% from Q1 of 1996, which was offset by an approximately 20% decline in the EMEA market and a flat compare for the Asia/Pacifc markets including Japan, and those comparisons are Q1 to Q3.
INDIVIDUAL LINE ITEMS OF THE INCOME STATEMENT
Turning to the expense portion of the income statement, cost of goods sold decreased 2% to 21% of revenue and that is from a 23% of revenue in Q3 1995 and is due primarily to changes in product mix and the reduction of service expenses associated with sold and discontinued product lines. Cost of goods sold percent decreased approximately 1% from Q1, again due primarily to lower service expenses. This means that their gross profit percent was 77% in Q3 1995, 78% in Q1 1996, and 79% in Q3 1996.
Sales and marketing expenses for Q3 were $125 million or 34% of revenue which was down $24 million or 16% from Q3 last year which was at 28% of that revenue. These expenses were approximately flat in terms of dollars compared to Q1 and Q2, but are expected to increase in Q4 as Novell aggressively launches their many new products.
Product development expenditures continued to be significant at 17% of revenue or $60 million. This compares with 17% of revenue and $90 million in Q3 1995. These expenses are down in absolute dollars from $79 million in Q1 and $70 million in Q2.
Selling and administrative expenses declined in absolute dollars to $34 million from $39 million in Q3 1995 and $39 million in Q1 1996 and from $35 million in Q2 1996.
Overall, their expense base is now stabilized and they would expect to grow it from these levels based on product cycles and revenue growth, targeting increased operating profit percentage-wise in 1997.
Overall income from operations in the quarter was $70 million or 19% of revenue which compares to $134 million or 25% of revenue in the year earlier quarter and 19% of revenue in Q1. Other income and expense, primarily investment income totalled $15 million this quarter compared to $19 million in Q3 1995 and $15 million in Q1. That gave them a pre-tax profit of $85 million or 23% of revenue for the current quarter. Income taxes were $26 million based on a currently expected full year effective tax rate of 31%. This is down from the 33.5% estimated during the first two quarters, although it only had a $2 million total impact on the current quarter's taxes. Net income was $59 million or 16% of revenue compared with $102 million or 19% of revenue a year ago.
KEY FACTORS ON THE BALANCE SHEET
Cash and short term investments ended the quarter at $1 billion, down slightly from the $1.2 billion at the end of Q2 and $1.3 billion at their prior year end. During the quarter, Novell repurchased an additional 10 million shares of outstanding common stock for $139 million which brings them on a year-to-date basis to a total repurchase of 33 million shares since October 1995 for a total of $444 million.
Accounts receivable decreased by $117 million from the end of Q1 as they resumed shipments to distributors in Q3. Overall their balance sheet has strengthened compared to fiscal year end with both improved current ratios and quick ratios and overall they are very pleased with the actions they took over the last three quarters which resulted in the expected return to profitability
LOOKING AHEAD TO Q4
Their outlook for Q4 is for sequential revenue growth with flat to slighty higher earnings based on the following: Continued product demand during their exciting new releases of NetWare, GroupWise, ManageWise, and IntraNetWare during Q4; continued strength of their worldwide licensing program; the introduction of platform independent network services; and with expense growth matching some of that revenue growth from the aggressive channel and end user marketing programs associated with the new product introductions.
PRODUCT PLANS AND GROWTH OPPORTUNITIES
NetWare 4.11 (code named Green River) is now in the final phase of beta testing and will be introduced at Networld+Interop in September assuming there are no unexpected problems that surface in the final weeks of beta, their shipments will begin in October. They have listened very carefully to their customers' changing needs and the response from customers, industry analysts, and media reviews has been overwhelmingly positive about 4.11. Lee Doyle of IDC was quoted on the front page of the June 24th issue of Computerworld as saying that "Green River offers users much more network capability than the upcoming NT 4.0 release. It will make it a no-brainer for most NetWare 2x and 3x shops who are users to go ahead and upgrade to NetWare 4."
Netware 4.11 widens the network gap between NetWare and Windows NT. Novell achieves even greater performance levels with built-in symmetrical multiprocessing support (SMP) to run enterprise-wide intranet applications. The performance is also enhanced with auto recovery features to ensure server availability. Directory improvements include new graphical network administration tools and improved migration and installation tools to make new installs easy and accelerate the pace of NetWare 4 upgrades within their installed base. Novell achieved a milestone with security. NetWare is now compliant with the Federal Government's C2 level of security for data transmission across networks. They emphasized "across networks" in that statement because NT is only C2 compliant if it is in a standalone machine, not on a network.
IntraNetWare was announced on August 13th at a press briefing. It answers the question of how NetWare evolves to become a full-service intranet platform. IntraNetWare is a complete server operating environment that includes all the features and distributed services included in NetWare 4.11. In other words, Green River is in that product. Secondly, the Web server, Netscape browser and authoring tools are integrated with Novell's directory services for intranet management and security. That's part of IntraNetWare. Third, they've provided full support for the Internet's TCP-IP communications protocol. They have also provided support for the Internet's file transfer protocol (FTP) and UNIX print services. They have integrated multi-protocol routing to build wide-area intranets and both user and group-level security tied to Novell Directory Services.
Both IntraNetWare and NetWare 4.11 are intended to accelerate adoption of Novell's Directory Services as the basis for business networks becoming manageable secure intranets through competitive wins and upgrades from their installed base of NetWare 2 and 3 users. IntraNetWare is targeted to ship one week after NetWare 4.11. Pricing for both products is going to be announced at the Networld+Interop show in Atlanta.
An additional server/operating environment product is ahead of schedule for early 1997 release. This is Novell's solution for the small office network market. As they've said before, they intend to aggressively market new small network solutions that leverage a specially engineered version of Green River with best-of-breed 3rd party products and services. From the user's perspective, their small business solution will be pre-configured, easy to install, and competitively priced. It will significantly lower the cost of integration, a benefit that end users are willing to pay for. The solution has received very positive feedback from their partners and resellers and looks to be a very exciting product. Their objective with this product is to help counter NetWare 3 declines and get back into the middle of the rapidly growing small network market.
In addition to the server/operating environment products, they are on target for early Fall delivery of important new services products. GroupWise 5 adds document management and imaging capabilities and an expanded email environment for communication and collaboration over intranets and the Internet. GroupWise 5 works with GroupWise Web Access for access to its universal mailbox from any Web browser on any type of client. It provides calendaring, scheduling, and other vital groupware functions over the Internet and intranet connections and is cross-platform. It will run across all major server and client platforms. Scaling from 5 to hundreds of thousands of users, GroupWise is 3rd in market share. Their objective is to aggressively expand that market share with an absolute blowout launch in September. No other product offers this integrated mail, calendaring, scheduling, and document management -- Notes doesn't and Exchange doesn't.
ManageWise 2.1 has begun shipping this month and is already the leading end-to-end PC network managment system. 2.1 enables customers to manage mixed networks of NetWare and Windows NT servers from a single console in addition to integrating with leading SNMP products from HP, IBM, Sun, and others. SNMP is the Internet standard protocol for network management. ManagWise 2.1 also gains management support for Windows '95 and OS/2 Warp clients, supplementing their Windows and Macintosh support to-date.
Their objective for NDS (Network Data Services) is to provide the directory foundation for the corporate intranet. A single directory is required for intranets. It reduces one of the largest costs associated with network management and will eliminate one of the major barriers to information access -- that there is too much informatio and it is not well organized. Because different applications and networking products use different directories, the average Fortune 1000 company today has between 13 and 16 directories in their system. NDS is designed to be the directory of directories, finding and managing the names, email addresses, Web site addresses, passwords, and network resources including servers, applications, printers and other peripherals. This year they are enhancing NDS to fully interoperate with Internet standards and protocols including emerging lightweight directory access protocol or LDAP and TCP-IP. They have an opportunity to make NDS a directory for intranets and Internet accessible from any Web browser. In July they shocked Microsoft by demonstrating NDS running on NT. The product plan they shared in late May calls for Novell to begin selling NDS as a software service to run on NT during the first half of 1997. Of course it is already shipping on SCO's version of UNIX and is in beta on HP-UX.
Finally, regarding their NetWare Connect Service initiative to establish distributed Novell services including NDS as the infrastructure for public data networks through telco partners, NetWare Connect Service is now available from the world's 2 largest telecommunications carriers. In July NetWare Connect Service license to AT&T became AT&T Worldnet Intranet Connect Services. The Worldnet is AT&T's principal Internet access service for businesses and consumers and now NCS is part of that family of services. Also in July, Nippon Telephone and Telegraph announced the availability of NTT Connect Services. By the end of 1996, NTT expects to interconnect with AT&T Worldnet Intranet Connect Services, taking NCS closer to Novell's original objective of a global dial tone for intranets. They continue to work with Telstra in Australia and other carriers to extend their service worldwide. In total, the carriers working with NCS today account for more than 85% of the reach of the world telephone systems.
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ * A Fool conference call synopsis represents an effort to highlight the salient points of a conference call and should not be taken as an authoritative accounting or transcription of the entire event. Note: Statements made by a company other than historical information may constitute forward-looking statements for which the company can claim protection under the Safe Harbor Act. Please consult the company's filings with the SEC for information on risk factors which might cause actual results to differ materially from the information contained in these forward-looking statements.
(c) Copyright 1996, The Motley Fool. All rights reserved. This material is for personal use only. Republication and redissemination, including posting to news groups, is expressly prohibited without the prior written consent of The Motley Fool.
* A Fool conference call synopsis represents an effort to highlight the salient points of a conference call and should not be taken as an authoritative accounting or transcription of the entire event. Note: Statements made by a company other than historical information may constitute forward-looking statements for which the company can claim protection under the Safe Harbor Act. Please consult the company's filings with the SEC for information on risk factors which might cause actual results to differ materially from the information contained in these forward-looking statements. |
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Copyright 1996, The Motley Fool |