Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

This Management's Discussion and Analysis of Financial Condition and Results of Operations and other parts of this Quarterly Report on Form 10-Q contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements, other than statements of historical fact, regarding our strategy, future operations, financial position, estimated revenue, projected costs, projected savings, prospects, plans, opportunities, beliefs, and objectives constitute "forward-looking statements." The words "may," "will," "expect," "plan," "anticipate," "believe," "estimate," "potential," or "continue" and similar types of expressions identify such statements, although not all forward-looking statements contain these identifying words. These statements are based upon information that is currently available to us and/or management's current expectations, speak only as of the date hereof, and are subject to risks and uncertainties. We expressly disclaim any obligation, except as required by federal securities laws, or undertaking to update or revise any forward-looking statements contained herein to reflect any change of expectations with regard thereto or to reflect any change in events, conditions, or circumstances on which any such forward-looking statement is based, in whole or in part. Our actual results may differ materially from the results discussed in or implied by such forward-looking statements. We are subject to a number of risks, some of which may be similar to those of other companies of similar size in our industry, including the impact of the current economic environment, pre-tax losses, rapid technological changes, competition, limited number of suppliers, customer concentration, failure to successfully integrate acquisitions, adverse government regulations and changes to laws to which we are subject, failure to manage international activities, inability to control indirect sales activities, dependence on relationships with significant strategic partners, and loss of key individuals. Risks that may affect our operating results include, but are not limited to, those discussed in the "Risk Factors" section in our Annual Report on Form 10-K for fiscal 2008 filed with the Securities and Exchange Commission ("SEC") on December 23, 2008. Readers should carefully review the risk factors described in the Annual Report on Form 10-K for fiscal 2008.

Overview

We develop, sell and install enterprise-quality software that is positioned in the operating systems and infrastructure software layers of the information technology ("IT") industry. We develop and deliver Linux operating system software for the full range of computers from desktops to servers. In addition, we provide a portfolio of integrated IT management software for systems, identity and security management for both Linux and mixed-platform environments. Our 26 years of experience serving the full range of enterprise sizes, combined with the quality and flexibility of our open-platform software technology, offers customers an IT infrastructure that is responsive to the cost pressures and the expanding IT initiatives that are characteristic of today's business environment.

In addition to our technology offerings, within each of our business unit segments we offer a worldwide network of service personnel to help our customers and third-party partners effectively utilize our software. We also have strategic partnerships with application providers, hardware and software vendors, and consultants and systems integrators. In this way we can offer a broad solution to our customers.

We are organized into four business unit segments, which are Open Platform Solutions, Identity and Security Management, Systems and Resource Management, and Workgroup.

In the third quarter and first nine months of fiscal 2009, total revenue decreased 12% and 9%, compared to the respective prior year periods, similar to many companies in the software industry. Foreign currency exchange rate fluctuations unfavorably impacted revenue by 3% and 2% in the third quarter and first nine months of fiscal 2009, compared to the respective prior year periods. The lower total revenue for the third quarter and first nine months of fiscal 2009 reflected lower services revenue of 30% and 32%, respectively, and lower product revenue of 9% and 5%, respectively, compared to the prior year periods. The lower services revenue is due in part to our strategic initiative of focusing our services business on driving more profitable product revenue while leveraging our services capabilities internally and through third-party partners. The lower product revenue for both the third quarter and first nine months of fiscal 2009, compared to the prior year periods, was primarily a result of lower software licenses revenue, which declined across all segments, except for the Open Platform Solutions business unit segment, for which software licenses revenue is immaterial. The lower software licenses revenue reflected the impact of the slowing economy, which affected our industry more severely in fiscal 2009 than in fiscal 2008. In general, despite challenges posed by the current economic climate, maintenance and subscriptions revenue remained relatively steady due primarily to consistent renewal rates.

Overview (Continued)

Below is a brief summary of the revenue results for each of our four business unit segments:

• Within our Open Platform Solutions business unit segment, total revenue increased 14% and 15% for the third quarter and first nine months of fiscal 2009, compared to the respective prior year periods, reflecting strong growth in our Linux Platform Products category.

• Within our Identity and Security Management business unit segment, total revenue decreased 24% and 20% for the third quarter and first nine months of fiscal 2009, compared to the respective prior year periods, reflecting lower software licenses and services revenues.

• Within our Systems and Resource Management business unit segment, total revenue decreased 14% and 5% for the third quarter and first nine months of fiscal 2009, compared to the respective prior year periods, reflecting lower software licenses and services revenues. In the first nine months of fiscal 2009, revenue from the PlateSpin and Managed Objects acquisitions was $15.4 million compared to PlateSpin revenue of $9.3 million in the prior year period.

• Within our Workgroup business unit segment, total revenue decreased 15% for both the third quarter and first nine months of fiscal 2009, compared to the respective prior year periods, reflecting lower software licenses and services revenues.

In the third quarter and first nine months of fiscal 2009, total services revenue decreased 30% and 32%, compared to the respective prior year periods. Our services offerings are focused on supporting product sales, not generating stand-alone revenue or profits, which is in line with our strategic initiative of focusing our services business on driving more profitable product revenue while leveraging our services capabilities internally and through third-party partners. Our prior strategy positioned our services offerings less as an enabler of software sales, and more as an independent and unrelated direct revenue initiative. We shifted our services strategy and positioning in fiscal 2008, with an intended gradual implementation. As a result of this, we have seen a general decline in our services revenue in the third quarter and first nine months of fiscal 2009 compared to the respective prior year periods. Services revenues were also impacted by the weak economy as customers reduced their discretionary spending.

Because much of the revenue we invoice is deferred and recognized over time, we consider invoicing, or bookings, to be a key indicator of current sales performance and future revenue performance. Overall invoicing was lower in all of our business unit segments, for both the third quarter and first nine months of fiscal 2009, compared to the respective prior year periods, largely as a result of the weak economy, as customers focused on capital conservation and expense management. These factors have led to projects being delayed or reduced in scope, and have resulted in extended sales cycles for our customers. While we expect these trends to continue in the near term, the fundamental markets that we serve and the value we bring to those markets remain attractive. We believe that the current customer focus on reducing cost, complexity and risk is aligned with our overall value proposition. Additionally, the recent financial turmoil demands stricter requirements for regulation and audit, creating the potential for expanded opportunities for certain of our products.

The increase in gross profit percentage of revenue during the third quarter and first nine months of fiscal 2009 compared to the prior year periods reflected the benefits of our cost reduction initiatives, including prior restructuring actions, and the benefits of realigning our services business to be more efficient and product focused, resulting in a shift to higher-margin product revenue. Total gross profit was lower for the third quarter and first nine months of fiscal 2009, compared to the prior year periods, primarily due to the 12% and 9% decreases in total net revenue, respectively.

Despite the decreasing revenue, our operating margins continue to improve, reflecting the positive impacts of recent restructuring and other cost cutting initiatives. For the third quarter and first nine months of fiscal 2009, we reported operating margins of 10% and 8%, respectively, which compares to 0% and 2% for the third quarter and first nine months of fiscal 2008, respectively.

During the third quarter of fiscal 2009, we recorded net restructuring expenses of $1.2 million, under our current restructuring plan, which we began implementing in the third quarter of fiscal 2009 in response to current economic conditions. During the first nine months of fiscal 2009, we recorded net restructuring expenses of $16.5 million.

Results of Operations

Reclassifications

Certain amounts reported in prior periods have been reclassified from what was previously reported to conform to the current year's presentation. These reclassifications did not have any impact on net income (loss).

Revenue

We sell our software and services primarily to corporations, government entities, educational institutions, independent hardware and software vendors, resellers, and distributors, both domestically and internationally. In our consolidated statements of operations, we categorize revenue as software licenses, maintenance and subscriptions, and services. Software licenses revenue includes sales of proprietary licenses and certain royalties. Maintenance and subscriptions revenue includes product maintenance agreements, Linux subscriptions and upgrade protection contracts. Services revenue includes professional services, technical support, and training.

                                       Three months ended                               Nine months ended
                                   July 31,          July 31,                      July 31,          July 31,
(Dollars in thousands)               2009              2008           Change         2009              2008           Change
Software licenses                $      27,020     $      53,003       (49)%     $      85,537     $     137,621       (38)%
Maintenance and subscriptions          163,699           155,898         5%            480,843           456,837         5%
Services                                25,365            36,284       (30)%            80,170           117,319       (32)%

Total net revenue                $     216,084     $     245,185       (12)%     $     646,550     $     711,777        (9)%

Our overall revenue decline of 12% and 9% for the third quarter and first nine months of fiscal 2009, respectively, was similar to that experienced by many companies in the software industry.

Revenue in our software licenses category decreased during the third quarter and first nine months of fiscal 2009 compared to the prior year periods as software licenses revenue declined across all segments except for the Open Platform Solutions business unit segment, for which software licenses revenue is immaterial. The lower software licenses revenue reflected the impact of the slowing economy, which affected our industry more severely in fiscal 2009 than in fiscal 2008. For the first nine months of fiscal 2009, this decrease was partially offset by additional software licenses revenue in the first year after acquiring PlateSpin, which we acquired on March 26, 2008, and from Managed Objects, which we acquired on November 13, 2008, which accounted for $6.5 million of incremental software licenses revenue.

Revenue from maintenance and subscriptions increased in the third quarter and first nine months of fiscal 2009 compared to the prior year periods primarily due to increased revenue from Linux Platform Products, which increased $7.0 million, or 22%, in the third quarter of fiscal 2009, and $21.1 million, or 24%, in the first nine months of fiscal 2009, compared to the respective prior year periods. Revenue from maintenance and subscriptions also benefited from our acquisitions. During the third quarter of fiscal 2009, our acquisition of Managed Objects contributed $1.6 million of incremental maintenance and subscriptions revenue. For the first nine months of fiscal 2009, incremental maintenance and subscriptions revenue in the first year after acquiring PlateSpin and from Managed Objects accounted for new revenue of $5.9 million. In general, despite challenges posed by the current economic climate, maintenance and subscriptions revenue continued at relatively steady rates due primarily to consistent renewal rates.

While our services offerings are focused increasingly on supporting product sales, not generating stand-alone revenue or profits, the decline in services revenue in the third quarter and first nine months of fiscal 2009 compared to the prior year periods was greater than anticipated as customers reduced their discretionary spending in response to current economic conditions.

Foreign currency exchange rate fluctuations, as measured by using prior period foreign currency exchange rates on non-U.S. dollar denominated revenue, negatively impacted total net revenue by $6.1 million, or 3%, and $15.2 million, or 2%, during the third quarter and first nine months of fiscal 2009, respectively.

Results of Operations (Continued)

Net revenue in the Open Platform Solutions segment was as follows:



                                      Three months ended                              Nine months ended
                                   July 31,         July 31,                     July 31,          July 31,
(Dollars in thousands)               2009             2008          Change         2009              2008           Change
Software licenses                $         73     $          -        -%       $         104     $         164      (37)%
Maintenance and subscriptions          39,868           33,558       19%             115,764            96,113       20%
Services                                4,307            5,326      (19)%             13,954            16,922      (18)%

Total net revenue                $     44,248     $     38,884       14%       $     129,822     $     113,199       15%

Revenue from our Open Platform Solutions segment increased in the third quarter of fiscal 2009 compared to the prior year period primarily due to Linux Platform Products, which increased by $7.0 million, or 22%. Invoicing for Linux Platform Products in the third quarter of fiscal 2009 decreased 24% compared to the prior year period, in part due to declining server shipments and increased virtualization. In addition, because our Linux business is dependent on large deals, we experience fluctuations in our quarterly invoicing. The invoicing change from the prior year period is primarily the result of a decrease in the number of large deals that closed in the third quarter of fiscal 2009, reflecting the impact of the weak economy.

Revenue from our Open Platform Solutions segment increased in the first nine months of fiscal 2009 compared to the prior year period primarily due to Linux Platform Products, which increased by $21.1 million, or 24%. Invoicing for Linux Platform Products in the first nine months of fiscal 2009 decreased 22% compared to the prior year period. The invoicing decrease in the first nine months of 2009 primarily reflects fluctuations in our quarterly invoicing. The invoicing change from the prior year period is the result of a decrease in the number of large deals that closed in the first nine months of fiscal 2009, reflecting the impact of the weak economy.

Net revenue in the Identity and Security Management segment was as follows:

                                      Three months ended                              Nine months ended
                                   July 31,         July 31,                     July 31,          July 31,
(Dollars in thousands)               2009             2008          Change         2009              2008           Change
Software licenses                $      7,929     $     16,567      (52)%      $      23,087     $      40,581      (43)%
Maintenance and subscriptions          22,336           20,311       10%              65,790            59,339       11%
Services                                8,102           13,482      (40)%             26,322            43,769      (40)%

Total net revenue                $     38,367     $     50,360      (24)%      $     115,199     $     143,689      (20)%

Revenue from our Identity and Security Management segment decreased in the third quarter of fiscal 2009 compared to the prior year period, primarily from lower software licenses revenue as well as lower services revenue, reflecting the impact of the weak economy. Identity, Access and Compliance Management product revenue decreased $5.3 million, or 16%, in the third quarter of fiscal 2009 compared to the prior year period, due in part to invoicing declines of 4% in the third quarter of fiscal 2009 compared to the prior year period. Longer sales cycles and decreased contract duration also negatively impacted revenue.

Revenue from our Identity and Security Management segment decreased in the first nine months of fiscal 2009 compared to the prior year period, primarily due to the weak economy. Identity, Access and Compliance Management product revenue decreased $7.2 million, or 8%, compared to the first nine months of fiscal 2008, due in part to invoicing declines of 8% in the first nine months of fiscal 2009 compared to the prior year period. Longer sales cycles and decreased contract duration also negatively impacted revenue.

Net revenue in the Systems and Resource Management segment was as follows:

                                      Three months ended                              Nine months ended
                                   July 31,         July 31,                     July 31,          July 31,
(Dollars in thousands)               2009             2008          Change         2009              2008           Change
Software licenses                $      7,527     $     15,439      (51)%      $      25,183     $      34,476      (27)%
Maintenance and subscriptions          32,469           31,671        3%              95,151            90,573        5%
Services                                5,584            5,972       (6)%             16,003            18,141      (12)%

Total net revenue                $     45,580     $     53,082      (14)%      $     136,337     $     143,190       (5)%

Revenue from our Systems and Resource Management segment decreased in the third quarter of fiscal 2009 compared to the prior year period, primarily from lower software licenses revenue from our ZENworks® and PlateSpin® products. This decrease was

Results of Operations (Continued)

partially offset by $1.7 million of incremental revenue from our Managed Objects acquisition. Invoicing for Systems and Resource Management products decreased 16% in the third quarter of fiscal 2009 compared to the prior year period, reflecting the impact of the weak economy. These revenue declines were also impacted by longer sales cycles and decreased contract duration.

Revenue from our Systems and Resource Management segment decreased in the first nine months of fiscal 2009 compared to the prior year period, primarily from lower software licenses revenue from our ZENworks products. This decrease was partially offset by additional revenue in the first year after acquiring PlateSpin and from Managed Objects which resulted in incremental revenue of $12.4 million. Invoicing for Systems and Resource Management products decreased 8% in the first nine months of fiscal 2009 compared to the prior year period, reflecting the impact of the weak economy. These revenue declines were also impacted by longer sales cycles and decreased contract duration.

Net revenue in the Workgroup segment was as follows:

                                        Three months ended                              Nine months ended
                                    July 31,         July 31,                      July 31,          July 31,
(Dollars in thousands)                2009             2008           Change         2009              2008           Change
Software licenses                 $     11,491     $      20,997      (45)%      $      37,163     $      62,400      (40)%
Maintenance and subscriptions           69,026            70,358       (2)%            204,138           210,812       (3)%
Services                                 7,372            11,504      (36)%             23,891            38,487      (38)%

Total net revenue                 $     87,889     $     102,859      (15)%      $     265,192     $     311,699      (15)%

Revenue from our Workgroup segment decreased in the third quarter of fiscal 2009 compared to the prior year period primarily from lower combined OES and NetWare-related product revenue of $6.2 million, lower services revenue of $4.1 million and lower Collaboration product revenue of $2.4 million. Invoicing for the combined OES and NetWare-related products decreased 13% in the third quarter of fiscal 2009 compared to the prior year period. Product invoicing for the Workgroup segment decreased 14% in the third quarter of fiscal 2009 compared to the prior year period. These declines were attributable to the weak economy and the lifecycle stage of our products in the Workgroup segment, and further reflect longer sales cycles and decreased contract duration.

Revenue from our Workgroup segment decreased in the first nine months of fiscal 2009 compared to the prior year period primarily from lower combined OES and NetWare-related product revenue of $19.9 million, lower services revenue of $14.6 million and lower Collaboration product revenue of $8.8 million. Invoicing for the combined OES and NetWare-related products decreased 20% in the first nine months of fiscal 2009 compared to the prior year period. Product invoicing for the Workgroup segment decreased 18% in the first nine months of fiscal 2009 compared to the prior year period. These declines were attributable to the weak economy and the lifecycle stage of our products in the Workgroup segment, and further reflect longer sales cycles and decreased contract duration.

Deferred Revenue

We had total deferred revenue of $674.3 million as of July 31, 2009 compared to $725.6 million and $730.1 million at July 31, 2008 and October 31, 2008, respectively. Deferred revenue represents revenue that is expected to be recognized in future periods primarily under maintenance contracts and subscriptions that are recognized ratably over the related contract periods, typically one to three years. Deferred revenue related to our agreements with Microsoft is recognized ratably over various related service periods, which can extend up to five years. The decrease in total deferred revenue of $55.8 million compared to October 31, 2008 is primarily attributable to the recognition of deferred revenue related to our agreement with Microsoft to purchase SLES certificates (See the subsection entitled, "Microsoft Agreements-Related Revenue" of Note B, "Summary of Significant Accounting Policies" in our fiscal 2008 Annual Report on Form 10-K for more details on the 2006 Microsoft agreement).

Results of Operations (Continued)

Gross Profit



                                               Three months ended                            Nine months ended
                                            July 31,         July 31,                    July 31,         July 31,
(Dollars in thousands)                        2009             2008           Change       2009             2008           Change
Software licenses                          $   24,250       $   47,691        (49)%     $   77,861       $  125,182        (38)%
percentage of related revenue                      90 %             90 %                        91 %             91 %
Maintenance and subscriptions              $  150,027       $  142,597          5%      $  441,927       $  420,588          5%
percentage of related revenue                      92 %             91 %                        92 %             92 %
Services                                   $   (5,176 )     $   (4,691 )      (10)%     $  (12,400 )     $  (11,989 )       (3)%
percentage of related revenue                     (20 )%           (13 )%                      (15 )%           (10 )%
Total gross profit                         $  169,101       $  185,597         (9)%     $  507,388       $  533,781         (5)%
percentage of revenue                              78 %             76 %                        78 %             75 %
. . .