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| NOVL > SEC Filings for NOVL > Form 10-K on 23-Dec-2008 | All Recent SEC Filings |
23-Dec-2008
Annual Report
Overview
Through our infrastructure software and ecosystem of business partnerships, we harmoniously integrate mixed IT environments, allowing people and technology to work as one. We deliver an interoperable Linux platform and a portfolio of integrated IT management software that helps customers worldwide reduce cost, complexity and risk. With our 25 years of experience and our vision of interoperability and flexibility, we deliver powerful, next-generation business infrastructures that are designed to enable our customers to stay competitive.
To best align our business with our strategy, we are organized into four business unit segments. Our business unit segments are Open Platform Solutions, Identity and Security Management, Systems and Resource Management, and Workgroup. Below is a revenue update on each of our business unit segments:
• Within our Open Platform Solutions business unit segment, Linux and open source products remain an important growth area. During fiscal 2008, we established and expanded relationships with several strategic partners to increase the reach of both our server and desktop products, such as with Microsoft and SAP. Revenue from our Linux Platform Products increased 38% in fiscal 2008 compared to fiscal 2007. Services revenue also increased 1%, such that total revenue from our Open Platform Solutions business unit segment increased 29% in fiscal 2008 compared to fiscal 2007.
• We continue to expand our position in the Identity and Security Management market by offering products that deliver a complete, integrated solution in the areas of security, compliance, and governance issues. Within this segment, revenue from our Identity and Access Management products increased 15% in fiscal 2008 compared to fiscal 2007. This product revenue increase was offset by services revenue declines of 28%, such that total revenue from our Identity and Security Management business unit segment decreased 5% in fiscal 2008 compared to fiscal 2007.
• Systems and Resource Management products continue to be an important part of our product offering. Our strategy is to provide a complete "desktop to data center" offering, with leadership in virtualization for both Linux and mixed-source environments. Systems and Resource Management product revenue increased 15% in fiscal 2008 compared to fiscal 2007, of which 10% of the increase was from the March 2008 acquisition of PlateSpin. The overall product revenue increase was partially offset by services revenue declines of 18%, such that total revenue from our Systems and Resource Management business unit segment increased 10% in fiscal 2008 compared to fiscal 2007.
• Our Workgroup revenue base is an important source of cash flow and provides us with a potential opportunity to sell additional products and services. We continued efforts to stabilize the decline of revenue from our legacy products, such as OES and NetWare-related products. Our revenue from Workgroup products decreased 2% in fiscal 2008, compared to fiscal 2007. In addition, services revenue was lower by 19%, such that total revenue from our Workgroup business unit segment decreased 4% in fiscal 2008 compared to fiscal 2007. Given the current economic environment these revenue declines may continue into fiscal 2009.
During the second quarter of fiscal 2008, we completed our acquisitions of PlateSpin and SiteScape (See the "Acquisitions" section below for more detail).
Our services offerings are focused on supporting product sales, not generating stand-alone revenue or profits, which is in line with our strategic initiatives. This includes focusing our services business on driving more profitable product revenue while leveraging our services capabilities internally and through third-party partners. Our results for fiscal 2008 showed signs of success in this initiative to shift to a more profitable revenue mix, which is reflected in our higher total gross profit and total gross profit margins for fiscal 2008, compared to fiscal 2007. Though total services revenue was down 20%, total product revenue was up 8%, resulting in a net increase in total net revenue of 3% in fiscal 2008 compared to fiscal 2007. Foreign currency exchange rate fluctuations and the PlateSpin acquisition each favorably impacted revenue by 2% during fiscal 2008, compared to fiscal 2007.
During fiscal 2008, we refined the improvements we have made in our sales, product development, and back office initiatives. In conjunction with these initiatives, we incurred $28.6 million of net restructuring expenses, which was above our previously announced range of $15 million to $25 million (See the "Restructuring Expenses" section below for more detail). While our initiatives and their implementation involve opportunities, risks, and challenges, barring unforeseen circumstances, we believe they position us well in this challenging environment.
Overview (Continued)
Given the current economic environment, we are cautious about our overall outlook for fiscal 2009. IT market growth rates are expected to slow, sales cycles are likely to extend and budgets for select IT investments may be reduced or delayed. But this uncertainty creates opportunities for us. For example, as customers seek to leverage and extend their IT investments, we believe our open and interoperable Linux and data center management solutions address our customer's needs for reducing operating and technology costs within the data center. Additionally, the recent financial turmoil demands stricter requirements for regulation and audit, creating opportunities for certain of our products.
Critical Accounting Policies
An accounting policy is deemed to be critical if it requires us to make an accounting estimate based on assumptions about matters that are uncertain at the time an accounting estimate is made, and if different estimates that reasonably could have been used or changes in the accounting estimate that are reasonably likely to occur periodically could materially change the financial statements. We consider accounting policies related to revenue recognition and related reserves, impairment of long-lived assets, valuation of deferred tax assets, loss contingency accruals and share-based payments to be critical accounting policies due to the judgments and estimation processes involved in each.
Revenue Recognition and Related Reserves
Our revenue is derived primarily from the sale of software licenses, software
maintenance, upgrade protection, subscriptions of SUSE Linux Enterprise Server,
technical support, training, and professional services. Our customers include:
distributors, who sell our products to resellers, dealers, and VARs; OEMs, who
integrate our products with their products or solutions; VARs, who provide
solutions across multiple vertical market segments which usually include
services; and end-users, who may purchase our products and services directly
from us or from other partners or resellers. Except for our SUSE Linux product,
distributors do not order to stock and only order products when they have an end
customer order. With respect to our SUSE Linux product, distributors place
orders and the product is then sold to end customers principally through the
retail channel. OEMs report the number of copies duplicated and sold via an
activity or royalty report. Software maintenance, upgrade protection, technical
support, and subscriptions of SLES typically involve one to three year contract
terms. Our standard practice is to provide customers with a 30-day general right
of return. Such return provision allows for a refund and/or credit of any amount
paid by our customers.
Revenue is recognized in accordance with Statement of Position ("SOP") 97-2, "Software Revenue Recognition" ("SOP 97-2"), and Staff Accounting Bulletin No. 104, "Revenue Recognition," and related interpretations. When an arrangement does not require significant production, modification, or customization of software or does not contain services considered to be essential to the functionality of the software, revenue is recognized when the following four criteria are met:
• Persuasive evidence of an arrangement exists - We require evidence of an agreement with a customer specifying the terms and conditions of the products or services to be delivered typically in the form of a signed contract or statement of work accompanied by a purchase order.
• Delivery has occurred - For software licenses, delivery takes place when the customer is given access to the software programs via access to a website or shipped medium. For services, delivery takes place as the services are provided.
• The fee is fixed or determinable - Fees are fixed or determinable if they are not subject to cancellation or other payment terms that exceed our standard payment terms. Typical payment terms are net 30 days.
• Collection is probable - We perform a credit review of all customers with significant transactions to determine whether a customer is creditworthy and collection is probable. Prior credit history with us, credit reports, financial statements, and bank references are used to assess creditworthiness.
Critical Accounting Policies (Continued)
In general, revenue for transactions that do not involve software customization or services considered essential to the functionality of the software is recognized as follows:
• Software license fees for our SUSE Linux product are recognized when the product is sold to an end customer;
• Software license fees for sales through OEMs are recognized upon receipt of license activity or royalty reports;
• All other software license fees are recognized upon delivery of the software;
• Software maintenance, upgrade protection, technical support, and subscriptions of SLES are recognized ratably over the contract term; and
• Professional services, training and other similar services are recognized as the services are performed.
If the fee due from the customer is not fixed or determinable, revenue is recognized as payments become due from the customer. If collection is not considered probable, revenue is recognized when the fee is collected. We record provisions against revenue for estimated sales returns and allowances on product and service-related sales in the same period as the related revenue is recorded. We also record a provision to operating expenses for bad debts resulting from customers' inability to pay for the products or services they have received. These estimates are based on historical sales returns and bad debt expense, analyses of credit memo data, and other known factors, such as bankruptcy. If the historical data we use to calculate these estimates does not accurately reflect future returns or bad debts, adjustments to these reserves may be required that would increase or decrease revenue or net income.
Many of our software arrangements include multiple elements. Such elements typically include any or all of the following: software licenses, rights to additional software products, software maintenance, upgrade protection, technical support, training and professional services. For multiple-element arrangements that do not involve significant modification or customization of the software and do not involve services that are considered essential to the functionality of the software, we allocate value to each element based on its relative fair value, if sufficient Novell-specific objective evidence of fair value exists for each element of the arrangement. Novell-specific objective evidence of fair value is determined based on the price charged when each element is sold separately. If sufficient Novell-specific objective evidence of fair value exists for all undelivered elements, but does not exist for the delivered element, typically the software, then the residual method is used to allocate value to each element. Under the residual method, each undelivered element is allocated value based on Novell-specific objective evidence of fair value for that element, as described above, and the remainder of the total arrangement fee is allocated to the delivered element, typically the software. If sufficient Novell-specific objective evidence of fair value does not exist for all undelivered elements and the arrangement involves rights to unspecified additional software products, all revenue is recognized ratably over the term of the arrangement. If the arrangement does not involve rights to unspecified additional software products, all revenue is initially deferred until typically the only remaining undelivered element is software maintenance or technical support, at which time the entire fee is recognized ratably over the remaining maintenance or support term.
In the case of multiple-element arrangements that involve significant modification or customization of the software or involve services that are considered essential to the functionality of the software, contract accounting is applied. When Novell-specific objective evidence of fair value exists for software maintenance or technical support in arrangements requiring contract accounting, the professional services and license fees are combined and revenue is recognized on the percentage of completion basis. The percentage of completion is generally calculated using hours incurred to date relative to the total expected hours for the entire project. The cumulative impact of any revision in estimates to complete or recognition of losses on contracts is reflected in the period in which the changes or losses become known. The maintenance or support fee is unbundled from the other elements and revenue is recognized ratably over the maintenance or support term. When Novell-specific objective evidence of fair value does not exist for software maintenance or support, then all revenue is deferred until completion of the professional services, at which time the entire fee is recognized ratably over the remaining maintenance or support period.
For consolidated statements of operations classification purposes only, we allocate the revenue first to those elements for which we have Novell-specific objective evidence of fair value, and any remaining recognized revenue is then allocated to those items for which we lack Novell-specific objective evidence of fair value.
Critical Accounting Policies (Continued)
Professional services contracts are either time-and-materials or fixed-price contracts. Revenue from time-and-materials contracts is recognized as the services are performed. Revenue from fixed-price contracts is recognized based on the proportional performance method, generally using estimated time to complete to measure the completed effort. The cumulative impact of any revision in estimates to complete or recognition of losses on contracts is reflected in the period in which the changes or losses become known. Professional services revenue includes reimbursable expenses charged to our clients.
Microsoft Agreements-Related Revenue. On November 2, 2006, we entered into the Microsoft Agreements. Each of the agreements is scheduled to expire on January 1, 2012.
Under the Business Collaboration Agreement, we are marketing a combined offering with Microsoft. The combined offering consists of SLES and a subscription for SLES support along with Microsoft Windows Server, Microsoft Virtual Server and Microsoft Viridian, and is offered to customers desiring to deploy Linux and Windows in a virtualized setting. Microsoft made an upfront payment to us of $240 million for SLES subscription "certificates," which Microsoft may use, resell or otherwise distribute over the term of the agreement, allowing the certificate holder to redeem single or multi-year subscriptions for SLES support from us (entitling the certificate holder to upgrades, updates and technical support). Microsoft agreed to spend $60 million over the term of the agreement for marketing Linux and Windows virtualization scenarios and also agreed to spend $34 million over the term of the agreement for a Microsoft sales force devoted primarily to marketing the combined offering. Microsoft agreed that for three years following the initial date of the agreement it will not enter into an agreement with any other Linux distributor to encourage adoption of other company's Linux/Windows Server virtualization through a program substantially similar to the SLES subscription "certificate" distribution program.
The Technical Collaboration Agreement focuses primarily on four areas:
• Development of technologies to optimize SLES and Windows, each running as guests in a virtualized setting on the other operating system;
• Development of management tools for managing heterogeneous virtualization environments, to enable each party's management tools to command, control and configure the other party's operating system in a virtual machine environment;
• Development of translators to improve interoperability between Microsoft Office and OpenOffice.org document formats; and
• Collaboration on improving directory and identity interoperability and identity management between Microsoft Active Directory software and Novell eDirectory software.
Under the Technical Collaboration Agreement, Microsoft agreed to provide funding to help accomplish these broad objectives, subject to certain limitations.
Under the Patent Cooperation Agreement, Microsoft agreed to covenant with our customers not to assert its patents against our customers for their use of our products and services for which we receive revenue directly or indirectly, with certain exceptions, while we agreed to covenant with Microsoft's customers not to assert our patents against Microsoft's customers for their use of Microsoft products and services for which Microsoft receives revenue directly or indirectly, with certain exceptions. In addition, we and Microsoft each irrevocably released the other party, and its customers, from any liability for patent infringement arising prior to November 2, 2006, with certain exceptions. Both we and Microsoft have payment obligations under the Patent Cooperation Agreement. Microsoft made an upfront net balancing payment to us of $108 million, and we are making ongoing payments to Microsoft totaling a minimum of $40 million over the five-year term of the agreement based on a percentage of our Open Platform Solutions and Open Enterprise Server revenues.
As the three agreements are interrelated and were negotiated and executed simultaneously, for accounting purposes we considered all of the agreements to constitute one arrangement containing multiple elements. The SLES subscription purchases of $240 million were within the scope of SOP 97-2, and are being accounted for based on vendor specific objective evidence of fair value. We recognize the revenue ratably over the respective subscription terms beginning upon customer activation, or for subscriptions which expire un-activated, if any, we will recognize revenue upon subscription expiration. Objective evidence of the fair value of elements within the
Critical Accounting Policies (Continued)
Patent Cooperation Agreement and Technical Collaboration Agreement did not exist. As such, we combined the $108 million for the Patent Cooperation Agreement payment and amounts we are receiving under the Technical Collaboration Agreement and are recognizing this revenue ratably over the contractual term of the agreements of five years. Our periodic payments to Microsoft will be recorded as a reduction of revenue. The contractual expenditures by Microsoft, including the dedicated sales force of $34 million and the marketing funds of $60 million, do not obligate us to perform, and, therefore, do not have an accounting consequence to us.
Long-lived Assets
Our long-lived assets include net fixed assets, long-term investments, goodwill, and other intangible assets. At October 31, 2008, our long-lived assets included $582.1 million of goodwill, $175.0 million of net property, plant and equipment, $53.3 million of identifiable intangible assets, and $15.0 million of long-term investments.
We periodically review our net property, plant and equipment and finite-lived intangible assets for impairment in accordance with Statement of Financial Accounting Standards ("SFAS") No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors that could indicate impairment include significant underperformance of the asset as compared to historical or projected future operating results, significant changes in the actual or intended use of the asset, or significant negative industry or economic trends. When we determine that the carrying value of an asset may not be recoverable, the related estimated future undiscounted cash flows expected to result from the use and eventual disposition of the asset are compared to the carrying value of the asset. If the sum of the estimated future cash flows is less than the carrying amount, we record an impairment charge based on the difference between the carrying value of the asset and its fair value, which we estimate based on discounted expected future cash flows. In determining whether an asset is impaired, we must make assumptions regarding recoverability of costs, estimated future cash flows from the asset, intended use of the asset and other related factors. If these estimates or their related assumptions change, we may be required to record impairment charges for these assets.
We evaluate the recoverability of goodwill and indefinite-lived intangible assets annually as of August 1, or more frequently if events or changes in circumstances warrant, such as a material adverse change in the business. Goodwill is considered to be impaired when the carrying value of a reporting unit exceeds its estimated fair value. Indefinite-lived intangible assets are considered impaired if their carrying value exceeds their estimated fair value. Fair values are estimated using the combination of a discounted cash flow methodology and a market analysis and averaging the results. In assessing the recoverability of our goodwill and indefinite-lived intangible assets, we must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. This process requires subjective judgment at many points throughout the analysis. Changes in reporting units and changes to the estimates used in the analyses, including estimated future cash flows, could cause one or more of the reporting units or indefinite-lived intangibles to be valued differently in future periods. Future analysis could potentially result in a non-cash goodwill impairment charge of up to $582.1 million, the full amount of our goodwill, depending on the estimated value of the reporting units and the value of the net assets attributable to those reporting units at that time.
During the fourth quarters of fiscal 2008, 2007, and 2006, we completed our annual goodwill impairment reviews and determined that there was no goodwill impairment. These assessments are made at the reporting unit level, which are our four business unit segments, and therefore we could be subject to an impairment charge to goodwill if any one of our reporting units does not perform in line with forecasts in the future. In addition, changes in the assumptions used in the analyses could have changed the resulting outcomes. For example, to estimate the fair value of our reporting units at August 1, 2008, we made estimates and judgments about future cash flows based on our fiscal 2009 forecast and current long-range plans used to manage the business. These long-range estimates could change in the future depending on internal changes as well as external factors. Future changes in estimates could possibly result in a non-cash impairment charge that could have a material adverse impact on our results of operations.
Developed technology is generally amortized over three years as a cost of revenue. Customer relationships are amortized over one to three years as a sales expense. Most of our trademarks/trade names have indefinite lives and therefore are not amortized but are reviewed for impairment at least annually. During fiscal 2008, we recorded a $7.7 million impairment charge for developed technology intangible assets that we acquired but later determined that we would not utilize as initially planned. During fiscal 2007, we recorded a $3.9 million impairment charge for certain intangible assets we acquired as a part of the e-Security acquisition. During fiscal 2006, we recorded a $1.2 million impairment charge for certain intangible assets we acquired as a part of the Ximian acquisition.
Critical Accounting Policies (Continued)
Deferred Tax Assets
In accordance with applicable accounting standards, we regularly assess our ability to realize our deferred tax assets. Assessments of the realization of deferred tax assets require that management consider all available evidence, both positive and negative, and make significant judgments about many factors, including the amount and likelihood of future income. Based on all the available evidence, we continue to believe that it is more likely than not that most of our net deferred tax assets, and certain foreign deferred tax assets, are not currently realizable. In reaching this determination, we evaluated our three year cumulative results, our pre-tax losses for the third and fourth quarters of fiscal 2008, as well as the impacts that current economic conditions may have on our future results. As a result, we continue to provide a valuation reserve on our U.S. net deferred tax assets and certain foreign deferred tax assets. It is reasonably possible that we could reduce a significant portion of our valuation allowance in the near-term.
Valuation of Investments that do not have Active Markets
At October 31, 2008 and October 31, 2007, we held eight ARSs that are classified as long-term investments on our consolidated balance sheets. Contractual maturities for these ARSs are 16 years or greater with an interest rate reset date approximately every 28 days. Until the fourth quarter of fiscal 2007, the carrying value of our ARSs approximated fair value. With the liquidity issues experienced in the global credit and capital markets, our ARSs have experienced multiple failed auctions and the estimated market value of these securities is less than cost.
We estimated the fair value of these ARSs using a discounted cash flow analysis . . .
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