** **

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**Form10-Q**

 

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| **(Mark  One)** |
|-----------------|
| **ý**      | **Quarterly  Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934** |
|            |   |
|            | **For  the Quarterly Period Ended January 31, 2006** |
|            |   |
| **or**          |
|            |   |
| **o**           | **Transition  Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934** |
|            |   |
| ** **      | **For  the transition period from               to** |

 

**CommissionFile Number: 0-13351**

 

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**NOVELL,INC.**

**(Exact name of registrant as specified in its charter)**

 

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| **Delaware**                    | **87-0393339**      |
|---------------------------------|---------------------|
| (State or other jurisdiction of | (I.R.S. Employer    |
| incorporation or organization)  | Identification No.) |

** **

**404Wyman Street**

**Waltham,MA 02451**

(Address of principal executive offices andzip code)

 

**(781)464-8000**

(Registrant’s telephone number, including areacode)

 

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Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the Registrant was required to file such reports) and (2) has been subjectto such filing requirements for the past 90days.    Yes  ý    No  o

 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer andlarge accelerated filer” in Rule 12b-2 of the Exchange Act  (Check one)

| Large accelerated filer    ý | Accelerated  filer o | Non-accelerated  filer o |
|---------------------------------------------|---------------------------|-------------------------------|

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of theAct)    Yes  o    No  ý

 

As of February 28, 2006 there were 389,440,303 sharesof the registrant’s common stock outstanding.

 

 

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**NOVELL,INC.**

**TABLEOF CONTENTS**

 
| ** **                                                                                               | **Page** |
|----------------------------------------------------------------------------------------------------------|----------|
| Part I — Financial Information:                                                                     | 3        |
|                                                                                                     |     |
| Item 1 :  Financial Statements                                                                           | 3        |
|                                                                                                     |     |
| Consolidated  Balance Sheets at January 31, 2006 (unaudited) and October 31, 2005                        | 3        |
|                                                                                                     |     |
| Consolidated  Statements of Operations for the three months ended January 31, 2006 and 2005  (unaudited) | 4        |
|                                                                                                     |     |
| Consolidated  Statements of Cash Flows for the three months ended January 31, 2006 and 2005  (unaudited) | 5        |
|                                                                                                     |     |
| Notes to Unaudited Consolidated Financial Statements                                                     | 6        |
|                                                                                                     |     |
| Item 2: Management’s Discussion and Analysis of Financial  Condition and Results of Operations      | 21       |
|                                                                                                     |     |
| Item 3: Quantitative  and Qualitative Disclosures About Market Risk                                      | 34       |
|                                                                                                     |     |
| Item  4: Controls and Procedures                                                                         | 35       |
|                                                                                                     |     |
| Part  II — Other Information:                                                                       | 35       |
|                                                                                                     |     |
| Item  1: Legal Proceedings                                                                               | 35       |
|                                                                                                     |     |
| Item 6:  Exhibits                                                                                        | 35       |

 

2

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**Part I.Financial Information**

**Item 1.Financial Statements**

 

**NOVELL,INC.**

**CONSOLIDATEDBALANCE SHEETS**

(amounts inthousands, except share and per share data)

 
| ** **                                                                                                                                                                                                                                      | ** ** | **January 31,  2006** | ** ** | **October 31,  2005** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                      | ** ** | **(unaudited)**       | ** ** | ** **            | ** ** |
| ASSETS                                                                                                                                                                                                                                          | ** ** | ** **            |       |                  |       |
| Current assets:                                                                                                                                                                                                                                 |       |                  |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                                                                       |       | $                     | 845,128    |                  | $          | 811,238 |   |
| Short-term investments                                                                                                                                                                                                                          |       | 840,462               |       | 843,666               |       |
| Receivables (net of allowances of $13,665 and $16,638 at January 31,  2006 and October 31, 2005, respectively)                                                                                                                                  |       | 185,251               |       | 293,627               |       |
| Prepaid expenses                                                                                                                                                                                                                                |       | 34,423                |       | 30,777                |       |
| Other current assets                                                                                                                                                                                                                            |       | 26,305                |       | 29,745                |       |
| Total current assets                                                                                                                                                                                                                            |       | 1,931,569             |       | 2,009,053             |       |
| Property, plant and equipment, net                                                                                                                                                                                                              |       | 209,624               |       | 212,377               |       |
| Long-term investments                                                                                                                                                                                                                           |       | 54,221                |       | 54,340                |       |
| Goodwill                                                                                                                                                                                                                                        |       | 396,676               |       | 395,509               |       |
| Intangible assets, net                                                                                                                                                                                                                          |       | 39,499                |       | 56,421                |       |
| Deferred income taxes                                                                                                                                                                                                                           |       | 679                   |       | 1,384                 |       |
| Other assets                                                                                                                                                                                                                                    |       | 42,797                |       | 32,774                |       |
| Total assets                                                                                                                                                                                                                                    |       | $                     | 2,675,065  |                  | $          | 2,761,858 |   |
|                                                                                                                                                                                                                                            |       |                  |       |                  |       |
| LIABILITIES, REDEEMABLE  SECURITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                                               |       |                  |       |                  |       |
| Current liabilities:                                                                                                                                                                                                                            |       |                  |       |                  |       |
| Accounts payable                                                                                                                                                                                                                                |       | $                     | 43,602     |                  | $          | 45,445 |   |
| Accrued compensation                                                                                                                                                                                                                            |       | 86,512                |       | 113,760               |       |
| Other accrued liabilities                                                                                                                                                                                                                       |       | 82,985                |       | 131,105               |       |
| Income taxes payable                                                                                                                                                                                                                            |       | 58,817                |       | 56,869                |       |
| Deferred revenue                                                                                                                                                                                                                                |       | 367,451               |       | 405,751               |       |
| Total current liabilities                                                                                                                                                                                                                       |       | 639,367               |       | 752,930               |       |
| Deferred income taxes                                                                                                                                                                                                                           |       | 4,369                 |       | 4,537                 |       |
| Senior convertible debentures                                                                                                                                                                                                                   |       | 600,000               |       | 600,000               |       |
| Total liabilities                                                                                                                                                                                                                               |       | 1,243,736             |       | 1,357,467             |       |
| Minority interests                                                                                                                                                                                                                              |       | 2,805                 |       | 8,555                 |       |
|                                                                                                                                                                                                                                            |       |                  |       |                  |       |
| Redeemable securities:                                                                                                                                                                                                                          |       |                  |       |                  |       |
| Series B preferred stock, $.10 par value, Authorized — 1,000 shares;  Issued —1,000 shares; Outstanding — 187 shares at January 31, 2006 and  October 31, 2005 (at redemption value)                                             |       | 9,350                 |       | 9,350                 |       |
| Stockholders’ equity:                                                                                                                                                                                                                      |       |                  |       |                  |       |
| Series A preferred stock, $.10 par value, Authorized — 499,000  shares; no shares issued                                                                                                                                                   |       | —                |       | —                |       |
| Common stock, par value $.10 per share, Authorized — 600,000,000  shares; Issued — 404,051,530 and 400,993,898 shares; Outstanding —  388,880,156 and 385,820,699 shares at January 31, 2006 and October 31, 2005,  respectively |       | 40,405                |       | 40,099                |       |
| Additional paid-in capital                                                                                                                                                                                                                      |       | 508,243               |       | 483,157               |       |
| Treasury stock, at cost — 15,171,374 and 15,173,199 shares at January  31, 2006 and October 31, 2005, respectively                                                                                                                         |       | (124,860              | )          | (124,875              | )          |
| Retained earnings                                                                                                                                                                                                                               |       | 985,925               |       | 984,107               |       |
| Accumulated other comprehensive income                                                                                                                                                                                                          |       | 9,461                 |       | 7,444                 |       |
| Unearned stock compensation                                                                                                                                                                                                                     |       | —                |       | (3,446                | )          |
| Total stockholders’ equity                                                                                                                                                                                                                 |       | 1,419,174             |       | 1,386,486             |       |
| Total liabilities, redeemable securities, and stockholders’ equity                                                                                                                                                                         |       | $                     | 2,675,065  |                  | $          | 2,761,858 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

3

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**NOVELL,INC.**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

(amounts inthousands, except per share data)

 
| ** **                                                            | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                            | ** ** | **January 31,  2006**  | ** ** | **January 31,  2005** | ** ** |
| ** **                                                            | ** ** | **(unaudited)**        | ** ** | ** ** | ** ** |
| Net revenue:                                                          |       |                   |       |   |   |
| Software licenses                                                     |       | $                      | 42,102     |   | $ | 44,296 |   |
| Maintenance and services                                              |       | 232,306                |       | 245,832 |   |
| Total net revenue                                                     |       | 274,408                |       | 290,128 |   |
|                                                                  |       |                   |       |   |   |
| Cost of revenue:                                                      |       |                   |       |   |   |
| Software licenses                                                     |       | 4,297                  |       | 4,632 |   |
| Maintenance and services                                              |       | 96,965                 |       | 107,419 |   |
| Total cost of revenue                                                 |       | 101,262                |       | 112,051 |   |
| Gross profit                                                          |       | 173,146                |       | 178,077 |   |
|                                                                  |       |                   |       |   |   |
| Operating expense  (income):                                          |       |                   |       |   |   |
| Sales and marketing                                                   |       | 94,153                 |       | 95,244 |   |
| Product development                                                   |       | 44,117                 |       | 47,758 |   |
| General and administrative                                            |       | 35,454                 |       | 28,240 |   |
| Restructuring expenses                                                |       | (1,064                 | )          | 6,419 |   |
| Gain on sale of property, plant and equipment                         |       | —                 |       | (1,589 | ) |
| Gain on settlement of potential litigation                            |       | —                 |       | (447,560 | ) |
| Total operating expense (income)                                      |       | 172,660                |       | (271,488 | ) |
| Income from operations                                                |       | 486                    |       | 449,565 |   |
|                                                                  |       |                   |       |   |   |
| Other income (expense):                                               |       |                   |       |   |   |
| Investment income                                                     |       | 14,979                 |       | 9,453 |   |
| Impairment of investments                                             |       | (387                   | )          | (1,013 | ) |
| Interest expense and other, net                                       |       | (1,890                 | )          | (3,405 | ) |
| Total other income, net                                               |       | 12,702                 |       | 5,035 |   |
| Income before income taxes                                            |       | 13,188                 |       | 454,600 |   |
| Income tax expense                                                    |       | 11,323                 |       | 59,439 |   |
| Net income                                                            |       | $                      | 1,865      |   | $ | 395,161 |   |
| Net income available to  common stockholders — basic             |       | $                      | 1,811      |   | $ | 390,891 |   |
| Net income available to  common stockholders — diluted           |       | $                      | 1,811      |   | $ | 392,384 |   |
|                                                                  |       |                   |       |   |   |
| Weighted-average shares  outstanding — basic                     |       | 385,787                |       | 377,257 |   |
| Weighted-average shares  outstanding — diluted                   |       | 394,534                |       | 435,467 |   |
|                                                                  |       |                   |       |   |   |
| Net income per share  available to common stockholders — basic   |       | $                      | 0.00       |   | $ | 1.04 |   |
| Net income per share  available to common stockholders — diluted |       | $                      | 0.00       |   | $ | 0.90 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

4

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**NOVELL,INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

(amounts inthousands)

 
| ** **                                                                         | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                         | ** ** | **January 31,  2006**  | ** ** | **January 31,  2005** | ** ** |
| ** **                                                                         | ** ** | **(unaudited)**        | ** ** | ** ** | ** ** |
| **Cash flows from operating  activities**                                          |       |                   |       |   |   |
| Net income                                                                         |       | $                      | 1,865      |   | $ | 395,161 |   |
| Adjustments to reconcile net income to net cash provided by operating  activities: |       |                   |       |   |   |
| Stock-based compensation expense                                                   |       | 13,695                 |       | 459 |   |
| Tax effects of stock-based compensation plans                                      |       | 4,039                  |       | 4,260 |   |
| Excess tax benefits from stock-based compensation                                  |       | (4,039                 | )          | — |   |
| Depreciation and amortization                                                      |       | 11,511                 |       | 12,436 |   |
| Decrease in accounts receivable allowances                                         |       | (2,973                 | )          | (5,219 | ) |
| Utilization of previously reserved acquired net operating losses                   |       | 544                    |       | 29,000 |   |
| Gain on sale of property, plant and equipment                                      |       | —                 |       | (1,589 | ) |
| Impairment of long-term investments, net of gains                                  |       | 387                    |       | 1,013 |   |
| Changes in current assets and liabilities, excluding the effect of  acquisitions:  |       |                   |       |   |   |
| Receivables                                                                        |       | 111,349                |       | 73,322 |   |
| Prepaid expenses                                                                   |       | (3,921                 | )          | (5,451 | ) |
| Other current assets                                                               |       | 4,718                  |       | (1,001 | ) |
| Deferred income taxes                                                              |       | 537                    |       | 785 |   |
| Accounts payable                                                                   |       | (1,843                 | )          | (10,053 | ) |
| Accrued liabilities                                                                |       | (72,446                | )          | (10,394 | ) |
| Deferred revenue                                                                   |       | (38,300                | )          | (31,082 | ) |
| Net cash provided by operating activities                                          |       | 25,123                 |       | 451,647 |   |
| **Cash flows from financing  activities**                                          |       |                   |       |   |   |
| Issuance of common stock, net                                                      |       | 9,876                  |       | 4,467 |   |
| Excess tax benefits from stock-based compensation                                  |       | 4,039                  |       | — |   |
| Payment of cash dividends on Series B preferred stock                              |       | —                 |       | (250 | ) |
| Net cash provided by financing activities                                          |       | 13,915                 |       | 4,217 |   |
| **Cash flows from investing  activities**                                          |       |                   |       |   |   |
| Purchases of property, plant and equipment                                         |       | (7,603                 | )          | (5,649 | ) |
| Proceeds from the sale of property, plant and equipment                            |       | —                 |       | 10,421 |   |
| Purchases of short-term investments                                                |       | (228,981               | )          | (425,423 | ) |
| Maturities of short-term investments                                               |       | 24,083                 |       | 127,567 |   |
| Sales of short-term investments                                                    |       | 209,372                |       | 186,150 |   |
| Cash paid for equity investment in Open Invention Network, LLC                     |       | (4,225                 | )          | — |   |
| Purchase of intangible assets                                                      |       | —                 |       | (15,500 | ) |
| Purchases of long-term investments                                                 |       | (2,462                 | )          | (3,574 | ) |
| Proceeds from the sales of and distributions from long-term  investments           |       | 2,206                  |       | 1,327 |   |
| Other                                                                              |       | 2,462                  |       | 6,257 |   |
| Net cash used in investing activities                                              |       | (5,148                 | )          | (118,424 | ) |
| Total increase in cash and  cash equivalents                                       |       | 33,890                 |       | 337,440 |   |
| Cash and cash equivalents  — beginning of period                              |       | 811,238                |       | 434,404 |   |
| Cash and cash equivalents —  end of period                                    |       | $                      | 845,128    |   | $ | 771,844 |   |
|                                                                               |       |                   |       |   |   |
| **Supplemental disclosure of  non-cash activities:**                               | ** ** | ** **             | ** ** | ** ** | ** ** |
| Contribution of patents to  Open Invention Network, LLC                            |       | $                      | 14,383     |   | $ | — |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

5

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**NOVELL,INC.**

**NOTES TO UNAUDITED CONSOLIDATEDFINANCIAL STATEMENTS**

**January31, 2006**

 

**A.Quarterly Financial Statements**

 

The interim consolidatedfinancial statements as of January 31, 2006 and for the three months endedJanuary 31, 2006 and 2005 were prepared by Novell, Inc. (“Novell”) pursuant tothe rules and regulations of the Securities and Exchange Commission (“SEC”) forinterim financial reporting. The preparation of financial statements inconformity with accounting principles generally accepted in the United Statesrequires management to make estimates and assumptions that affect the amountsreported in the financial statements and accompanying notes. Actual resultscould differ materially from those estimates. The accompanying unauditedconsolidated financial statements have been prepared in accordance with theinstructions to Form 10-Q but do not include all of the information and notesrequired by accounting principles generally accepted in the United States andshould, therefore, be read in conjunction with our fiscal 2005 Annual Report onForm 10-K. The accompanying financial statements are unaudited and include allnormal recurring adjustments that we believe are necessary for a fair statementof the financial condition and results of operations of Novell as of and forthe interim periods presented. The interim operating results are notnecessarily indicative of the results for a full year.

 

*Reclassifications*

 

Certain amounts reportedin prior years have been reclassified from what was previously reported toconform to the current year’s presentation. These reclassifications did nothave any impact on net income and net income per share available to commonstockholders.

 

**B.  Significant Accounting Policies**

 

OnNovember 1, 2005, we adopted Statement of Financial Accounting Standards (“SFAS”)No. 123(R), “Share-Based Payment,” whichrequires us to account for share-based payment transactions using a fairvalue-based method and recognize the related expense in the results ofoperations.  Prior to our adoption ofSFAS No. 123(R), as permitted by SFAS No. 123, we accounted forshare-based payments to employees using the Accounting Principles BoardOpinion  No. 25 (“APB 25”), “Accountingfor Stock Issued to Employees,” intrinsic value method and, therefore wegenerally recognized compensation expense for restricted stock awards and didnot recognize compensation cost for employee stock options.  SFASNo. 123(R) allows companies to choose one of two transition methods: themodified prospective transition method or the modified retrospective transitionmethod. We chose to use the modified prospective transition methodology andaccordingly, we have not restated the results of prior periods.

 

Under the fair valuerecognition provisions of SFAS No. 123(R), stock-based compensation cost isestimated at the grant date based on the fair value of the award and isrecognized as expense over the requisite service period of the award.  The fair value of restricted stock awards isdetermined by reference to the fair market value of our common stock on thedate of grant.  Consistent with thevaluation method we used for disclosure-only purposes under the provisions ofSFAS No. 123, we use the Black-Scholes model to value service condition andperformance condition option awards under SFAS No. 123(R).  For awards with market conditions grantedsubsequent to our adoption of SFAS No. 123(R), we use a lattice valuation modelto estimate fair value. For awards with only service conditions andgraded-vesting features, we recognize compensation cost on a straight-linebasis over the requisite service period. For awards with performance or market conditions granted subsequent toour adoption of SFAS No. 123(R), we recognize compensation cost based on thegraded-vesting method.

 

Determining the appropriatefair value model and related assumptions requires judgment, includingestimating stock price volatility, forfeiture rates, and expected terms.  The expected volatility rates are estimatedbased on historical and implied volatilities of our common stock.  The expected term represents the average timethat options that vest are expected to be outstanding based on the vestingprovisions and our historical exercise, cancellation and expiration patterns.  We estimate pre-vesting forfeitures whenrecognizing compensation expense based on historical rates and forward-lookingfactors. We will update these assumptions at least on an annual basis and on aninterim basis if significant changes to the assumptions are warranted.

 

We issue performance-basedequity awards, typically to certain senior executives, whose vesting iscontingent upon meeting certain financial performance goals, including revenueand income targets.    Determining theappropriate amount to expense based on achievement of the stated goals requiresjudgment, including forecasting future financial results.  The estimate of expense is revisedperiodically based on the probability of achieving the required performancetargets and adjustments are made as appropriate.  The cumulative impact of any revision isreflected in the period of change.  Ifthe 

 

6

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financial performance goals are not met, no compensation cost isrecognized and any previously recognized compensation cost is reversed.

 

We issued market conditionequity awards, typically granted to certain senior executives, whose vesting isaccelerated or contingent upon the price of Novell common stock meeting certainpre-established stock price targets.  Forawards granted prior to our adoption of SFAS No. 123(R), the fair value of eachmarket condition award was estimated as of the grant date using the same optionvaluation model used for time-based options without regard to the marketcondition criteria.  As a result of our adoptionof SFAS No. 123(R), compensation cost is recognized over the estimatedrequisite service period and is not reversed if the market condition target isnot met.   If the pre-established stockprice targets are achieved, any remaining expense on the date the target isachieved is recognized either immediately, or in situations where there is aremaining minimum time vesting period, ratably over that period.

 

**C.Acquisitions and Equity Investments**

 

*OpenInvention Network, LLC*

 

InNovember 2005, Open Invention Network LLC (“OIN”) was established by us, IBM,Philips, Red Hat and Sony.  OIN is aprivately held company that has and will acquire patents to promote Linux andopen source by offering its patents on a royalty-free basis to any company,institution or individual that agrees not to assert its patents against theLinux operating system or certain Linux-related applications.  In addition, OIN, in its discretion, willenforce its patents to the extent it believes such action will serve to furtherprotect and promote Linux and open source. Each party contributed capital with a fair value of $20.0 million toOIN.  We account for our 20% ownershipinterest using the equity method of accounting. Our $20.0 million contribution consisted of patents with a fair value of$15.8 million, including $0.3 million of prepaid acquisition costs, and cash of$4.2 million.  At the time of thecontribution, the patents had a book value of $14.4 million, including $0.3million of prepaid acquisition costs. The $1.4 million difference between the fair value and book value of thepatents will be amortized to our investment in OIN account and equity incomeover the remaining estimated useful life of the patents, which is approximatelynine years.  Our investment in OIN of $18.7million is classified as other assets in the consolidated balance sheet.

 

*Onward India*

 

In December 2005, weacquired the remaining 50% ownership of our sales and marketing joint venturein India from our joint venture partner for approximately $7.5 million in cashand other consideration. At October 31, 2005, $7.5 million of our cash was heldin an escrow account for the acquisition and classified as other assets in theconsolidated balance sheet. The cash was paid out of the escrow account duringthe first quarter of fiscal 2006.  At thetime of the acquisition, the net book value of the minority interest was $5.3million.  The $2.0 million differencebetween the net book value of the minority interest and the amount we paid forthe remaining 50% ownership was recorded as goodwill.

 

**D. Cash,Cash Equivalents, and Short-Term Investments**

 

We consider all investmentswith an initial term to maturity of three months or less at the date ofpurchase to be cash equivalents. Short-term investments are diversified,primarily consisting of investment grade securities that either mature withinthe next 12 months or have other characteristics of short-term investments,such as auction dates within at least six months of the prior auction date orbeing available to be used for current operations even if some maturities mayextend beyond one year. All auction rate securities are classified asshort-term investments.

 

All marketable debt andequity securities that are included in cash, cash equivalents, and short-term investmentsare considered available-for-sale and are carried at fair value. The unrealizedgains and losses related to these securities are included in accumulated othercomprehensive income. Other than temporary declines in fair value are recordedin the consolidated statements of operations. Fair values are based on quoted market prices where available. If quotedmarket prices are not available, we use third-party pricing services to assistin determining fair value. In many instances, these services examine thepricing of similar instruments to estimate fair value.

 

At January 31, 2006,approximately $6.7 million of our equity securities were designated fordeferred compensation payments, which are paid out as requested by theparticipants of the plan.

 

7

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At January 31, 2006,contractual maturities of our short-term investments were:

 
| **(In thousands)**            | ** ** | **Cost**   | ** ** | **Fair Market Value** | ** ** |
|-------------------------------|------------|------------|------------|-----------------------|------------|
| ** **                    | ** ** | ** ** | ** ** | ** **            | ** ** |
| Less than one year            |       | $          | 221,947    |                  | $          | 221,932 |   |
| Due in one to two years       |       | 148,232    |       | 147,443               |       |
| Due in two to three years     |       | 276,542    |       | 272,939               |       |
| Due in more than three  years |       | 194,128    |       | 191,446               |       |
| No contractual maturity       |       | 5,963      |       | 6,702                 |       |
| Total short-term investments  |       | $          | 846,812    |                  | $          | 840,462 |   |

 

When securities are sold,their cost is determined based on the first-in first-out method. The realizedgains and losses related to these securities are included in investment incomein the consolidated statements of operations. Realized gains and losses on short-term investments were as follows:

 

| ** **         | ** ** | **Three months ended** | ** ** |
|--------------------|------------|----------------------------------|------------|
| **(In thousands)** | ** ** | **January 31,  2006**       | ** ** | **January 31,  2005** | ** ** |
| Realized gains     |       | $                                | 126        |   | $ | 286 |   |
| Realized losses    |       | 1,222                            |       | 297 |   |
|                    |            |                                  |            |  |  |  |  |

 

We had net unrealized lossesrelated to short-term investments of $6.3 million at January 31, 2006 comparedto net unrealized losses of $7.6 million at October 31, 2005.  Our short-term investment portfolio includesgross unrealized gains and losses of $0.8 million and $7.1 million,respectively, as of January 31, 2006.  Wedid not record any impairment losses on short-term investments during the firstquarters of fiscal 2006 or fiscal 2005.

 

**E.Property, Plant and Equipment**

 

At January 31, 2006, we hadcorporate aviation assets with a net book value of approximately $18.8 millionclassified as held for sale. We anticipate selling these assets during fiscal2006 for at least net book value.

 

**F.  Long-Term Investments**

 

At January 31, 2006,long-term investments primarily consisted of investments made in venturecapital partnerships. Long-term investments, for which we do not have theability to exercise significant influence, are accounted for initially at costand written down to fair value when indicators of impairment are deemed to beother than temporary.

 

We routinely review ourlong-term investments for impairment. To assess impairment, we analyzeforecasted financial performance of the investees and our estimate of thepotential for investment recovery based on the financial performance factors.During the first quarters of fiscal 2006 and 2005, we recognized impairmentlosses on long-term investments totaling $0.4 million and $1.0 million,respectively.

 

**G.Goodwill and Intangible Assets**

 

*Goodwill*

 

The following is asummary of goodwill as of the dates shown resulting from the indicatedacquisitions:

 
| **(In thousands)**             | ** ** | **January 31,  2006** | ** ** | **October 31,  2005** | ** ** |
|--------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                     | ** ** | ** **            | ** ** | ** **            | ** ** |
| SUSE                           |       | $                     | 176,963    |                  | $          | 176,963 |   |
| SilverStream                   |       | 112,392               |       | 112,622               |       |
| Ximian                         |       | 33,814                |       | 33,852                |       |
| Cambridge Technology  Partners |       | 25,677                |       | 25,903                |       |
| Tally                          |       | 16,283                |       | 16,308                |       |
| Immunix                        |       | 14,651                |       | 14,676                |       |
| Salmon                         |       | 5,847                 |       | 6,146                 |       |
| Onward India                   |       | 2,010                 |       | —                |       |
| Other technology companies     |       | 9,039                 |       | 9,039                 |       |
| Total goodwill                 |       | $                     | 396,676    |                  | $          | 395,509 |   |

 

8

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Goodwill is allocated to our reporting segments.  In fiscal 2006, we changed our reportingsegments to Americas, EMEA, Asia Pacific, and Celerant consulting (see NoteS).  Previously, Latin America wasseparate from North America, and Japan was separate from Asia Pacific.

 

Goodwill by reporting segment is as follows:

 

| **(In thousands)**              | ** ** | **Americas** | ** ** | **EMEA** | ** ** | **Asia****Pacific** | ** ** | **Celerant****Consulting** | ** ** | **Total** | ** ** |
|---------------------------------|------------|--------------|------------|----------|------------|---------------------|------------|----------------------------|------------|-----------|------------|
| Balance as of October 31,  2005 |       | $            | 191,498    |     | $          | 150,487             |       | $                          | 27,621     |      | $          | 25,903 |   | $ | 395,509 |   |
| Onward India                    |       | —       |       | —   |       | 2,010               |       | —                     |       | 2,010     |       |
| Adjustments                     |       | (163         | )          | (437     | )          | (17                 | )          | (226                       | )          | (843      | )          |
| Balance as of January 31,  2006 |       | $            | 191,335    |     | $          | 150,050             |       | $                          | 29,614     |      | $          | 25,677 |   | $ | 396,676 |   |

 

Adjustments to goodwillduring the first quarter of fiscal 2006 included an adjustment of approximately$0.5 million, attributable to SilverStream, Celerant consulting (acquiredthrough the acquisition of Cambridge Technology Partners), Ximian, Salmon,Tally, and Immunix, related to the reversal of deferred tax asset valuationallowances attributable to acquired net operating loss carryforwards that wereutilized by income generated in the first quarter of fiscal 2006. Goodwill wasreduced for this adjustment because a portion of it related to the valuationallowances on acquired net operating losses that were established during theallocation of the purchase price for each of these acquisitions. The remaining$0.3 million primarily related to foreign exchange adjustments.

 

*IntangibleAssets*

 

The following is a summaryof intangible assets:

 
| ** **                 | ** ** | **January 31, 2006** | ** ** | **October 31, 2005**          | ** ** | ** **          | ** ** |
|----------------------------|------------|----------------------|------------|-------------------------------|------------|---------------------|------------|
| **(In thousands)**         | ** ** | **Gross  Amount**    | ** ** | **Accumulated  Amortization** | ** ** | **Net Book  Value** | ** ** | **Gross  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net Book  Value** | ** ** | **Asset Lives** | ** ** |
| ** **                 | ** ** | ** **           | ** ** | ** **                    | ** ** | ** **          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Trademarks and trade names |       | $                    | 25,571     |                          | $          | (30                 | )          | $ | 25,541 |   | $ | 25,571 |   | $ | (20 | ) | $ | 25,551 |   | 3  years or Indefinite |   |
| Patents                    |       | —               |       | —                        |       | —              |       | 15,500 |   | (1,392 | ) | 14,108 |   | 10  years |   |
| Customer/contractual       |       |                 |       |                          |       |                |       |   |   |   |   |   |   |   |   |
| relationships              |       | 19,362               |       | (12,038                       | )          | 7,324               |       | 19,362 |   | (10,454 | ) | 8,908 |   | 1-3  years |   |
| Developed technology       |       | 22,850               |       | (17,599                       | )          | 5,251               |       | 22,850 |   | (16,718 | ) | 6,132 |   | 3-4  years |   |
| Internal use software      |       | 5,193                |       | (4,005                        | )          | 1,188               |       | 5,193 |   | (3,700 | ) | 1,493 |   | 3  years |   |
| Non-compete agreement      |       | 422                  |       | (227                          | )          | 195                 |       | 422 |   | (193 | ) | 229 |   | 3  years |   |
| Total intangible assets    |       | $                    | 73,398     |                          | $          | (33,899             | )          | $ | 39,499 |   | $ | 88,898 |   | $ | (32,477 | ) | $ | 56,421 |   |   |   |
|                            |            |                      |            |                               |            |                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

During the first quarterof fiscal 2006, we contributed our patent portfolio towards our 20% ownershipinterest in OIN.  At the time of thecontribution, these patents, which we acquired for $15.5 million, had a netbook value of $14.1 million.

 

Amortization ofintangible assets for the first quarters of fiscal 2006 and 2005 was $2.8million and $3.0 million, respectively. Amortization of intangibles isestimated to be approximately $7.9 million for the remainder of fiscal 2006,$4.3 million in fiscal 2007, $1.5 million in fiscal 2008, and $0.3 million infiscal 2009.

 

**H.Income Taxes**

 

We are subject to incometaxes in numerous jurisdictions and the use of estimates is required indetermining our provision for income taxes. For the first quarter of fiscal 2006, we provided income taxes of $11.3million based on the estimated annual effective tax rate for the year appliedto ‘ordinary’ income (pre-tax income excluding unusual or infrequentlyoccurring discrete items).  Due to theutilization of a significant amount of our net operating loss carryforwardsduring fiscal 2005, substantially all of the future benefit received from ourremaining net operating loss carryforwards used to offset U.S. taxable incomewill be credited to additional paid-in capital or goodwill and not income taxexpense.  In addition, the windfall taxbenefits associated with stock-based compensation will be credited toadditional paid-in capital. In connection with our adoption of SFAS No. 123(R),we elected to follow the tax ordering laws to determine the sequence in whichdeductions and net operating loss carryforwards are utilized.  Accordingly, during the 

 

9

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first quarter offiscal 2006, a $4.0 million tax benefit relating to stock options was creditedto additional paid-in capital and a $0.5 million benefit was credited togoodwill.

 

The effective tax ratediffers from the federal statutory rate of 35% primarily due to the effects ofstock-based compensation plans, differences between book and tax items andforeign taxes.  The effective tax ratefor the first quarter of fiscal 2006 was 85.9% compared to the effective taxrate of 13.1% for the same period in 2005. The effective rate for the first quarter of fiscal 2006 differs from thefirst quarter of fiscal 2005 due to the use of net operating losses in thefirst quarter of fiscal 2005, which offset income tax expense associatedprimarily with the income generated from a settlement we reached with Microsoftin the first quarter of fiscal 2005.  The effective tax rate for fiscal 2006 will be higher than the rate forfiscal 2005 primarily because the fiscal 2005 rate reflected a benefit recordedto income tax expense from the use of a significant amount of our net operatingloss carryforwards.

 

In accordance withdeterminations made pursuant to the applicable accounting standards, wecontinue to believe that it is more likely than not that our remaining U.S. netdeferred tax assets will not be realized based on the weight of all availableevidence. As a result, we have provided a full valuation reserve on our U.S.net deferred tax assets. As deferred tax assets or liabilities increase ordecrease in the future, or if a portion or all of the valuation allowance is nolonger deemed to be necessary, the adjustments to the valuation allowance willincrease or decrease future income tax provisions, goodwill or additionalpaid-in capital.

 

Wepaid cash for income taxes of $4.5 million in the first quarter of fiscal 2006and $3.4 million during the same period of fiscal 2005. We continue to evaluateour tax reserves under SFAS No. 5, “Accounting for Contingencies,” whichrequires us to accrue for losses we believe are probable and can be reasonablyestimated.  The amount reflected in theconsolidated balance sheet at January 31, 2006 is considered adequate based onour assessment of many factors including, results of tax audits, pastexperience and interpretations of tax law applied to the facts of each matter.It is reasonably possible that our tax reserves could be increased or decreasedin the near term based on these factors.

 

 **I. Line of Credit**

 

We have a $25.0 million bankline of credit available for letter of credit purposes. At January 31, 2006,there were standby letters of credit of $17.6 million outstanding under thisline, all of which are collateralized by cash. The bank line of credit expireson April 1, 2006. The bank line of credit is subject to the terms of a creditagreement containing financial covenants and restrictions, none of which areexpected to affect our operations. We are in compliance with all financialcovenants relating to this line of credit as of January 31, 2006. In addition,at January 31, 2006, we had outstanding letters of credit of an insignificantamount at other banks.

 

10

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**J.Restructuring and Merger Liabilities**

 

*RestructuringLiabilities*

 

Our restructuringactivities in previous periods are disclosed in detail in our Annual Report onForm 10-K for the fiscal year 2005. The following table summarizes therestructuring reserve balance and activity during the first quarter of fiscal2006:

 
| **(In  thousands)**                        | ** ** | **Fiscal  2005****Restructurings** | ** ** | **Fiscal  2004  Restructurings** | ** ** | **Fiscal  2003****Restructuring** | ** ** | **Fiscal  2002****Restructuring** | ** ** | **Fiscal  2001****Restructurings** | ** ** | **Total** | ** ** |
|--------------------------------------------|------------|------------------------------------|------------|----------------------------------|------------|-----------------------------------|------------|-----------------------------------|------------|------------------------------------|------------|-----------|------------|
| **Balance at October 31, 2005:**           |       |                               |       |                             |       |                              |       |                              |       |                               |       |      |       |
| Workforce  reductions                      |       | $                                  | 28,492     |                             | $          | 1,243                             |       | $                                 | —     |                               | $          | —    |       | $ | — |   | $ | 29,735 |   |
| Excess  facilities, property and equipment |       | 6,451                              |       | 1,457                            |       | 3,121                             |       | 3,660                             |       | 327                                |       | 15,016    |       |
| Other restructuring-related  costs         |       | 259                                |       | —                           |       | 10                                |       | 37                                |       | 274                                |       | 580       |       |
| Total  restructuring reserve balance       |       | 35,202                             |       | 2,700                            |       | 3,131                             |       | 3,697                             |       | 601                                |       | 45,331    |       |
| **Adjustments:**                           |       |                               |       |                             |       |                              |       |                              |       |                               |       |      |       |
| Workforce  reductions                      |       | (707                               | )          | —                           |       | —                            |       | —                            |       | —                             |       | (707      | )          |
| Excess  facilities, property and equipment |       | (61                                | )          | —                           |       | —                            |       | —                            |       | —                             |       | (61       | )          |
| Other  restructuring-related costs         |       | —                             |       | —                           |       | —                            |       | (37                               | )          | (259                               | )          | (296      | )          |
| Total adjustments                          |       | (768                               | )          | —                           |       | —                            |       | (37                               | )          | (259                               | )          | (1,064    | )          |
| **Payments:**                              |       |                               |       |                             |       |                              |       |                              |       |                               |       |      |       |
| Workforce  reductions                      |       | (21,137                            | )          | (84                              | )          | —                            |       | —                            |       | —                             |       | (21,221   | )          |
| Excess  facilities, property and equipment |       | (2,592                             | )          | (681                             | )          | (255                              | )          | (421                              | )          | (281                               | )          | (4,230    | )          |
| Other  restructuring-related costs         |       | (186                               | )          | —                           |       | (9                                | )          | —                            |       | (15                                | )          | (210      | )          |
| Total payments                             |       | (23,915                            | )          | (765                             | )          | (264                              | )          | (421                              | )          | (296                               | )          | (25,661   | )          |
| **Balance  at January 31, 2006:**          |       |                               |       |                             |       |                              |       |                              |       |                               |       |      |       |
| Workforce  reductions                      |       | 6,648                              |       | 1,159                            |       | —                            |       | —                            |       | —                             |       | 7,807     |       |
| Excess  facilities, property and equipment |       | 3,798                              |       | 776                              |       | 2,866                             |       | 3,239                             |       | 46                                 |       | 10,725    |       |
| Other  restructuring-related costs         |       | 73                                 |       | —                           |       | 1                                 |       | —                            |       | —                             |       | 74        |       |
| Total  restructuring reserve balance       |       | $                                  | 10,519     |                             | $          | 1,935                             |       | $                                 | 2,867      |                               | $          | 3,239     |       | $ | 46 |   | $ | 18,606 |   |

 

Adjustments to reduce therestructuring reserves during the first quarter of fiscal 2006 of $1.1 millionrelated to changes in estimates, of which $0.4 million was related to AsiaPacific, $0.3 million was related to the Americas, $0.3 million was related toEMEA, and $0.1 million was related to Celerant consulting.

 

*MergerLiabilities*

 

The following tablesummarizes the merger liabilities balance and activity during the first quarterof fiscal 2006:

 

| **(In thousands)**       | ** ** | **Balance at****October 31,  2005** | ** ** | **Payments/****adjustments** | ** ** | **Balance at****January 31,  2006** | ** ** |
|--------------------------|------------|-----------------------------------------------|------------|------------------------------|------------|-----------------------------------------------|------------|
| Facilities related       |       | $                                             | 17,606     |                         | $          | (797                                          | )          | $ | 16,809 |   |
| Employee related         |       | 169                                           |       | (105                         | )          | 64                                            |       |
| Other                    |       | 76                                            |       | 1                            |       | 77                                            |       |
| Total merger liabilities |       | $                                             | 17,851     |                         | $          | (901                                          | )          | $ | 16,950 |   |

 

As of January 31, 2006,the remaining unpaid balances include accrued liabilities related to severancebenefits which will be paid out over the remaining severance obligation period,lease costs for redundant facilities which will be paid over the respectiveremaining contract terms, and various employee-related severance costs whichwill be primarily paid over the next twelve months.

 

11

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**K.Senior Convertible Debentures**

 

On July 2, 2004, weissued and sold $600.0 million aggregate principal amount of our seniorconvertible debentures (“Debentures”) due 2024. The Debentures pay interest at0.50% per annum, payable semi-annually on January 15 and July 15 of each yearuntil maturity, commencing January 15, 2005. During the first three months offiscal 2006, we incurred interest expense of $0.8 million related to theDebentures and made cash payments for interest of $1.5 million.

 

In connection with theissuance of the Debentures, we incurred $14.9 million of issuance costs, whichprimarily consisted of investment banker, legal and other professional fees.These costs are classified within Other Assets and are being amortized asinterest expense using the effective interest method over the term fromissuance through the date that the holders can first require repurchase of theDebentures (July 15, 2009). Amortization expense related to the issuance costswas $0.7 million for both the first quarter of fiscal 2006 and fiscal 2005,respectively.

 

**L.Guarantees**

 

We have provided a guaranteeto a foreign taxing authority in the amount of $2.4 million related to aforeign tax audit. It is expected that the term of the foreign tax auditguarantee will continue until the conclusion of the audit. In addition, we haveprovided a guarantee to a customer for the performance of one of our foreignsubsidiaries on a maintenance contract in the amount of $0.4 million, and a$0.2 million guarantee to a vendor of our foreign subsidiaries to guaranteelease payments. At January 31, 2006, we had $2.4 million accrued for theseguarantees. We have also provided other guarantees of insignificant amounts forvarious purposes.

 

Like most software vendors,we are party to a variety of agreements, primarily with customers, resellers,distributors, and independent hardware and software vendors (generally, “customers”),pursuant to which we may be obligated to indemnify the customer against thirdparty allegations of intellectual property infringement resulting from the customer’suse of our offerings or distribution of our software, either of which mayinclude proprietary and/or open source materials. In such circumstances, thecustomer must satisfy specified conditions to qualify for indemnification. Ourobligations under these agreements may be limited in terms of time and/oramount, and in some instances we may have recourse against third parties.

 

It is not possible topredict the maximum potential amount of future payments under these guaranteesand indemnifications, or similar agreements, due to the conditional nature ofour obligations and the unique facts and circumstances involved in eachparticular agreement. To date, we have not been required to make any paymentguarantees and indemnifications. We do not record a liability for potentiallitigation claims related to indemnification agreements with our customersunless and until we conclude the likelihood of a material obligation isprobable and estimable.

 

**M.Commitments and Contingencies**

 

As of January 31, 2006,we had a carrying value of $52.7 million related to long-term investments invarious venture capital funds and had commitments to contribute an additional$19.2 million to these funds at times and amounts as requested by the fundmanagers.

 

**N. LegalProceedings**

 

On November 12, 2004, wefiled suit against Microsoft in the U.S. District Court, District of Utah. Weare seeking treble damages under the Clayton Act, plus interest, in an amountto be determined at trial based on claims that Microsoft eliminated competitionin the office productivity software market during the time that we owned theWordPerfect word-processing application and the Quattro Pro spreadsheetapplication. Among other claims, we allege that Microsoft withheld certaincritical technical information about Windows from us, thereby impairing ourability to develop new versions of WordPerfect and other office productivityapplications, and that Microsoft integrated certain technologies into Windowsdesigned to exclude WordPerfect and other Novell applications from relevantmarkets. In addition, we allege that Microsoft used its monopoly power toprevent OEMs from offering WordPerfect and other applications to customers. OnJune 10, 2005, Microsoft’s motion to dismiss the complaint was granted in partand denied in part. The Fourth Circuit Court recently granted interlocutoryreview of Microsoft’s appeal, which claims that Novell lacked standing toassert the causes of action not dismissed by the District Court.  In addition, Novell has sought the FourthCircuit’s review of the District Court’s dismissal of Novell’s other causes ofaction.  While there can be no assuranceas to the ultimate disposition of the litigation, we do not believe that itsresolution will have a material adverse effect on our financial position,results of operations, or cash flows.

 

On January 20, 2004, the SCOGroup, Inc. (“SCO”) filed suit against us in the Third Judicial District Courtof Salt 

 

12

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Lake County, State of Utah. We removed the claim to the U.S. DistrictCourt, District of Utah. SCO’s original complaint alleged that our publicstatements and filings regarding the ownership of the copyrights in UNIX andUnixWare have harmed SCO’s business reputation and affected its efforts toprotect its ownership interest in UNIX and UnixWare. The District Courtdismissed the original complaint, but allowed SCO an opportunity to file anamended complaint, which SCO did on July 9, 2004. On June 27, 2005, our motionto dismiss SCO’s amended complaint was denied. On July 29, 2005, we filed ananswer to the complaint setting forth numerous affirmative defenses andcounterclaims alleging slander of title and breach of contract, and seekingdeclaratory actions and actual, special and punitive damages in an amount to beproven at trial. On December 30, 2005, SCO filed an amended complaint allegingthat Novell has violated the non-competition provisions of the agreement underwhich we sold our Unix business to SCO, that we failed to transfer all of theUnix business, that we infringe SCO’s copyrights, and that we are engaging inunfair competition by attempting to deprive SCO of the value of the Unixtechnology.  In both SCO’s original andamended complaints, SCO seeks to require us to assign all copyrights that wehave registered in UNIX and UnixWare to SCO, to prevent us from representingthat we have any ownership interest in the UNIX and UnixWare copyrights, torequire us to withdraw all representations we have made regarding our ownershipof the UNIX and UnixWare copyrights, and to cause us to pay actual, special andpunitive damages in an amount to be proven at trial.  We believe that we have meritorious defensesto SCO’s claims and meritorious support for our counterclaims. Accordingly, weintend to vigorously pursue our claims while defending against the allegationsin SCO’s complaint. Although there can be no assurance as to the ultimatedisposition of the suit, we do not believe that the resolution of thislitigation will have a material adverse effect on our financial position,results of operations or cash flows.

 

SilverStream, which weacquired in July 2002, and several of its former officers and directors, aswell as the underwriters who handled SilverStream’s two public offerings, werenamed as defendants in several class action complaints that were filed onbehalf of certain former stockholders of SilverStream who purchased shares ofSilverStream common stock between August 16, 1999 and December 6, 2000. Thesecomplaints are closely related to several hundred other complaints that thesame plaintiffs have brought against other issuers and underwriters. Thesecomplaints all allege violations of the Securities Act of 1933, as amended (the“Securities Act”) and the Securities Exchange Act of 1934, as amended (the “ExchangeAct”). In particular, they allege, among other things, that there wasundisclosed compensation received by the underwriters of the public offeringsof all of the issuers, including SilverStream. A Consolidated Amended Complaintwith respect to all of these companies was filed in the U.S. District Court,Southern District of New York, on April 19, 2002. The plaintiffs are seekingmonetary damages, statutory compensation and other relief that may be deemedappropriate by the Court. While we believe that SilverStream and its formerofficers and directors have meritorious defenses to the claims, a tentativesettlement has been reached between many of the defendants and the plaintiffs,which contemplates a settlement of the claims, including the ones againstSilverStream and its former directors and officers. The settlement agreement,however, has not been finally approved by the Court. While there can be noassurance as to the ultimate disposition of the litigation, we do not believethat its resolution will have a material adverse effect on our financialposition, results of operations or cash flows.

 

We account for legalreserves under SFAS No. 5, “Accounting for Contingencies,” which requires us toaccrue for losses we believe are probable and can be reasonably estimated. Weevaluate the adequacy of our legal reserves based on our assessment of manyfactors, including our interpretations of the law and our assumptions about thefuture outcome of each case based on current information.  It is reasonably possible that our legalreserves could be increased or decreased in the near term based on ourassessment of these factors. We are currently party to various legalproceedings and claims including former employees, either asserted orunasserted, which arise in the ordinary course of business. While the outcomeof these matters cannot be predicted with certainty, we do not believe that theoutcome of any of these claims or any of the above mentioned legal matters willhave a material adverse effect on our consolidated financial position, resultsof operations or cash flows.

 

**O.Redeemable Preferred Stock**

 

Holders of our Series BPreferred Stock are entitled to dividends of 2% of the redemption value perannum, payable quarterly in cash. Dividends on the Series B Preferred Stockduring the first quarter of fiscal 2006 amounted to $47,000. There were no cashpayments made for dividends during the first quarter of fiscal 2006.

 

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**P. NetIncome Per Share Available to Common Stockholders**

 

The following tablereconciles the numerators and denominators of the net income per sharecalculation for the first quarters of fiscal 2006 and 2005:

 
| ** **                                                                                                                        | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|
| **(In thousands, except per share  data)**                                                                                        | ** ** | **January 31,  2006**  | ** ** | **January 31,  2005** | ** ** |
| ** **                                                                                                                        | ** ** | ** **             | ** ** | ** ** | ** ** |
| **Basic net income per share  computation:**                                                                                      |       |                   |       |   |   |
| Net income                                                                                                                        |       | $                      | 1,865      |   | $ | 395,161 |   |
| Dividends on Series B Preferred Stock                                                                                             |       | (47                    | )          | (125 | ) |
| Allocation of earnings to holders of Series B Preferred Stock                                                                     |       | (7                     | )          | (4,145 | ) |
| Net income attributable to common stockholders                                                                                    |       | $                      | 1,811      |   | $ | 390,891 |   |
| Weighted-average common shares outstanding, excluding unvested  restricted stock                                                  |       | 385,787                |       | 377,257 |   |
| Basic net income per share attributable to common stockholders                                                                    |       | $                      | 0.00       |   | $ | 1.04 |   |
| **Diluted net income per share  computation:**                                                                                    |       |                   |       |   |   |
| Net income                                                                                                                        |       | $                      | 1,865      |   | $ | 395,161 |   |
| Dividends on Series B Preferred Stock                                                                                             |       | (47                    | )          | (125 | ) |
| Allocation of earnings to the holders of Series B Preferred Stock                                                                 |       | (7                     | )          | (4,145 | ) |
| Interest expense on the Debentures                                                                                                |       | —                 |       | 750 |   |
| Amortization of debt issuance costs                                                                                               |       | —                 |       | 743 |   |
| Diluted net income attributable to common stockholders                                                                            |       | $                      | 1,811      |   | $ | 392,384 |   |
| Weighted-average common shares outstanding                                                                                        |       | 385,787                |       | 377,257 |   |
| Incremental shares attributable to the assumed exercise of  outstanding options, unvested restricted stock, and other stock plans |       | 8,747                  |       | 6,136 |   |
| Incremental shares attributable to the assumed conversion of the  Debentures                                                      |       | —                 |       | 52,074 |   |
| Total adjusted weighted-average common shares                                                                                     |       | 394,534                |       | 435,467 |   |
| Diluted net income per share attributable to common stockholders                                                                  |       | $                      | 0.00       |   | $ | 0.90 |   |

 

The 1.5 million shares ofcommon stock attributable to the assumed conversion of outstanding Series BPreferred Stock and the incremental shares attributable to the 52.0 millionshares attributable to the assumed conversion of outstanding Debentures werenot included in the calculation of diluted net income per share in the firstquarter of fiscal 2006 as their effects were antidilutive. Incremental sharesattributable to options with exercise prices that were at or greater than theaverage market price (“out of the money”) at January 31, 2006 were also notincluded in the calculation of diluted net income per share as their effectwould have been antidilutive. Out of the money options for the first quartersof fiscal 2006 and 2005 totaled 21,459,300 and 23,239,119, respectively.

 

**Q.Comprehensive Income**

 

The components ofcomprehensive income are as follows:

 

| ** **                                    | ** ** | **Three Months Ended**     | ** ** |
|-----------------------------------------------|------------|----------------------------|------------|
| **(In thousands)**                            | ** ** | **January 31,  2006** | ** ** | **January 31,  2005** | ** ** |
| ** **                                    | ** ** | ** **                 | ** ** | ** ** | ** ** |
| Net income                                    |       | $                          | 1,865      |   | $ | 395,161 |   |
| Change in net unrealized  loss on investments |       | 1,270                      |       | (2,211 | ) |
| Change in pension  liability                  |       | 106                        |       | (35 | ) |
| Change in cumulative  translation adjustments |       | 641                        |       | 6,856 |   |
| Comprehensive income                          |       | $                          | 3,882      |   | $ | 399,771 |   |

 

Our accumulated othercomprehensive income (loss) is comprised of the following:

 
| ** **                                   | ** ** | **January 31,  2006** | ** ** | **October 31,  2005** | ** ** |
|----------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                   | ** ** | **(In thousands)**    | ** ** |
| Net unrealized loss on  investments          |       | $                     | (6,350     | )                     | $          | (7,620 | ) |
| Minimum pension liability                    |       | (527                  | )          | (633                  | )          |
| Cumulative translation  adjustment           |       | 16,338                |       | 15,697                |       |
| Total accumulated other comprehensive income |       | $                     | 9,461      |                  | $          | 7,444 |   |

 

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**R.Stock-Based Compensation**

 

The adoption of SFAS No.123(R) had a significant impact on our results of operations.   Our consolidated statement of operations forthe three months ended January 31, 2006 includes the following stock-basedcompensation expense:

 

| **(In thousands)**         | ** ** | **Three months ended  January 31, 2006** | ** ** |
|----------------------------|------------|---------------------------------------------------------|------------|
| Cost of revenue            |       | $                                                       | 1,062      |   |
| Sales and marketing        |       | 3,532                                                   |       |
| Product development        |       | 2,637                                                   |       |
| General and administrative |       | 6,464                                                   |       |
| Operating income           |       | 13,695                                                  |       |
| Tax benefit                |       | —                                                  |       |
| Net income                 |       | $                                                       | 13,695     |   |

 

Unrecognized stock-basedcompensation expense expected to be recognized over an estimatedweighted-average amortization period of 1.93 years was $53.4 million at January31, 2006.

 

SFAS No. 123(R) alsorequires the benefits of tax deductions in excess of recognized compensationcost to be reported as a financing cash flow, rather than as an operating cashflow as required under APB 25 and related interpretations. This requirementreduced our net operating cash flows and increased our net financing cash flowsby $4.0 million.  Our deferredcompensation cost at October 31, 2005 of $3.4 million, which was accounted forunder APB 25, was reclassified into additional paid-in capital.  The cumulative effect related to outstandingrestricted stock awards as of October 31, 2005, which are not expected to vestbased on an estimate of forfeitures, was not material.

 

*Stock Plans*

 

We currently have five stockaward plans that allow us to grant stock options, restricted stock, restrictedunits and other equity based awards to employees and consultants, and one stockoption plan that allows us to grant stock options to members of the Board ofDirectors. All stock-based compensation awards are issued under one of thesesix stock award plans.  When grantingstock options, we typically grant nonstatutory options at fair market value onthe date of grant. We also grant restricted stock and restricted stockunits.   These plans are discussed inmore detail in our fiscal 2005 Form 10-K, Note R.

 

*Time-Based Stock Awards*

 

Our weighted-averageassumptions used in the Black-Scholes valuation model for equity awards withtime-based vesting provisions granted during the three months ended January 31,2006 are shown below:

 

| **(In thousands)**      | ** ** | **Three months ended  January 31, 2006** | ** **  |
|-------------------------|------------|---------------------------------------------------------|-------------|
| Expected volatility     |       | 50                                                      | %           |
| Expected dividends      |       | 0                                                       | %           |
| Expected term           |       | 4                                                       |  years |
| Risk-free interest rate |       | 4.3  - 4.5                                              | %           |

 

The expected volatility ratewas estimated based on equal weighting of the historical volatility of Novellcommon stock over a four year period and the implied volatilities of Novellcommon stock.  The expected term wasestimated based on our historical experience of exercise, cancellation, andexpiration patterns.  The risk-freeinterest rates are based on four year U.S. Treasury STRIPS.

 

The pre-vesting forfeiturerate used for the three months ended January 31, 2006 was 10%, which was basedon historical rates and forward-looking factors.  As required under SFAS No. 123(R), we willadjust the estimated forfeiture rate to our actual experience.

 

15

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A summary of the time-basedstock awards as of January 31, 2006, and changes during the three months thenended, is as follows:

 

| ** **                       | ** ** | **Shares  (000s)** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Weighted-  Average  Remaining  Contractual  Term  (years)** | ** ** | **Aggregate  Intrinsic  Value  (000s)** | ** ** |
|----------------------------------|------------|--------------------|------------|-----------------------------------------|------------|---------------------------------------------------------------|------------|-----------------------------------------|------------|
| **Stock Awards**                 |       |               |       |                                    |       |                                                          |       |                                    |       |
| Outstanding at November 1,  2005 |       | 47,042             |       | $                                       | 6.68       |                                                          |       |                                    |       |   |
| Granted                          |       | 1,265              |       | 8.34                                    |       |                                                          |       |                                    |       |
| Exercised                        |       | (2,589             | )          | 4.14                                    |       |                                                          |       |                                    |       |
| Forfeited or expired             |       | (2,000             | )          | 8.76                                    |       |                                                          |       |                                    |       |
| Outstanding at January 31,  2006 |       | 43,718             |       | $                                       | 6.79       |                                                          | 5.13       |                                    | $          | 135,205 |   |
| Exercisable at January 31,  2006 |       | 29,589             |       | $                                       | 6.89       |                                                          | 4.33       |                                    | $          | 89,410 |   |

 

The weighted-averagegrant-date fair value of stock options granted during the first three monthsended January 31, 2006 was $3.90.  Thetotal intrinsic value of stock options exercised during the three months endedJanuary 31, 2006 was $11.2 million.

 

A summary of time-basedunvested restricted stock as of January 31, 2006, and changes during the threemonths then ended, is as follows:

 

| ** **                    | ** ** | **Shares  (000s)** | ** ** | **Weighted-  Average  Fair  Value** | ** ** |
|-------------------------------|------------|--------------------|------------|-------------------------------------|------------|
| **Unvested Restricted Stock** |       |               |       |                                |       |
| Unvested at November 1,  2005 |       | 984                |       | $                                   | 4.85       |   |
| Granted                       |       | 275                |       | 8.33                                |       |
| Vested                        |       | —             |       | —                              |       |
| Forfeited                     |       | (5                 | )          | 3.64                                |       |
| Unvested at January 31,  2006 |       | 1,254              |       | $                                   | 5.62       |   |

 

As of January 31, 2006,there was $4.4 million of unrecognized compensation cost related to unvestedrestricted stock.  That cost is expectedto be recognized over a weighted-average period of 1.7 years.  No time-based restricted stock vested duringthe three months ended January 31, 2006.

 

*Performance-Based and Market-Condition Awards*

 

We have issuedperformance-based equity awards to certain senior executives.  These awards have the potential to vest overone to four years upon meeting certain Novell-specific financial performancegoals, specifically related to the achievement of budgeted revenue andoperating income targets in each fiscal year. The performance-based options were granted at an exercise price equal tothe fair market value of Novell common stock on the date the option was legallygranted and have a contractual life ranging from two to eight years.

 

We have issuedmarket-condition equity awards to certain senior executives whose vesting isaccelerated or contingent upon the price of Novell common stock meeting certainpre-established stock price targets.  Certainof these awards will vest on the sixth anniversary of the grant date if themarket-condition was not previously achieved. The market-condition options are generally granted at an exercise priceequal to the fair market value of Novell common stock on the date of the grantand have a contractual life of eight years.  No market-condition awards were granted during the three months endedJanuary 31, 2006.

 

The fair value of eachperformance-based and market-condition option was estimated on the grant dateusing the Black-Scholes option valuation model without consideration of theperformance measures or market conditions. The inputs for expected volatility, expected term, expected dividends,and risk-free interest rate used in estimating the fair value ofperformance-based awards in the three months ended January 31, 2006, are thesame as those noted above under time-based options.

 

16

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A summary of theperformance-based and market-condition awards as of January 31, 2006, andchanges during the three months then ended, is as follows:

 

| ** **                       | ** ** | **Shares  (000s)** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Weighted-  Average  Remaining  Contractual  Term  (years)** | ** ** | **Aggregate  Intrinsic  Value  (000s)** | ** ** |
|----------------------------------|------------|--------------------|------------|-----------------------------------------|------------|---------------------------------------------------------------|------------|-----------------------------------------|------------|
| **Stock Awards**                 |       |               |       |                                    |       |                                                          |       |                                    |       |
| Outstanding at November 1,  2005 |       | 2,413              |       | $                                       | 7.49       |                                                          |       |                                    |       |   |
| Granted                          |       | 535                |       | 8.36                                    |       |                                                          |       |                                    |       |
| Exercised                        |       | (31                | )          | 6.35                                    |       |                                                          |       |                                    |       |
| Forfeited or expired             |       | (81                | )          | 8.60                                    |       |                                                          |       |                                    |       |
| Outstanding at January 31,  2006 |       | 2,836              |       | $                                       | 7.64       |                                                          | 7.1        |                                    | $          | 4,142 |   |
| Exercisable at January 31,  2006 |       | 1,349              |       | $                                       | 6.53       |                                                          | 6.9        |                                    | $          | 4,230 |   |

 

The weighted-averagegrant-date fair value of options granted during the first three months endedJanuary 31, 2006 was $4.49. No performance-based stock options were exercisedin the three months ended January 31, 2006.

 

A status of the unvested,performance-based and market-condition restricted stock as January 31, 2006,and changes during the three months then ended, is as follows:

 

| ** **                    | ** ** | **Shares  (000s)** | ** ** | **Weighted-  Average  Fair Value** | ** ** |
|-------------------------------|------------|--------------------|------------|------------------------------------|------------|
| **Unvested Restricted Stock** |       |               |       |                               |       |
| Unvested at November 1,  2005 |       | 125                |       | $                                  | 7.42       |   |
| Granted                       |       | 87                 |       | 9.22                               |       |
| Vested                        |       | (25                | )          | 7.35                               |       |
| Forfeited                     |       | —             |       | —                             |       |
| Unvested at January 31,  2006 |       | 187                |       | $                                  | 8.27       |   |

 

As of January 31, 2006,there was $1.8 million of unrecognized compensation cost related to unvested,performance-based and market-condition restricted stock.  That cost is expected to be recognizedratably over a one to four year period. No performance-based restricted stock vested during the three monthsended January 31, 2006.  The total fairvalue of market-condition restricted stock that vested during the three monthsended January 31, 2006 was $184,000.

 

As of January 31, 2006,there were 773,000 stock awards that had been legally granted but not yetvalued because all of the conditions necessary to establish the grant date forSFAS No. 123(R) purposes have not yet occurred. The grant date of these stock awards will not occur until budgets areapproved by our Board of Directors for the respective years specified in theperformance targets.

 

*Celerant Stock Awards*

 

Duringthe first three months of fiscal 2006, Celerant did not grant any newstock-based compensation awards.  Uponadoption of SFAS No. 123(R), we applied a forfeiture rate of 16% to theCelerant option expense, which was based on historical rates.    As of January 31, 2006, there were 2.4million time-based options for Celerant Stock outstanding, of which 1.8million  were exercisable, and 1.7million performance based options for Celerant Stock outstanding, of which 0.2million were exercisable.

 

17

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*First Quarter Fiscal 2005*

 

For the three months endedJanuary 31, 2005, had we accounted for all employee stock-based compensationbased on the fair value method as prescribed by SFAS No. 123, our net income andnet income per share would have been the following pro forma amounts:

 

| **(in thousands, except per share data)**                                                                                         | ** ** | **Three months********ended****January 31, 2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------|------------|
|                                                                                                                              |       |                                                        |       |
| Net income, as reported                                                                                                           |       | $                                                           | 395,161    |   |
| Less: total stock-based compensation expense determined under fair  value-based method for all awards, net of related tax effects |       | (12,410                                                     | )          |
| Add: total stock-based compensation expense recorded in the statement  of operations under APB 25                                 |       | 459                                                         |       |
| Pro forma net income                                                                                                              |       | $                                                           | 383,210    |   |
| Net income per share available to common stockholders:                                                                            |       |                                                        |       |
| As reported basic                                                                                                                 |       | $                                                           | 1.04       |   |
| Pro forma basic                                                                                                                   |       | $                                                           | 1.00       |   |
| As reported diluted                                                                                                               |       | $                                                           | 0.90       |   |
| Pro forma diluted                                                                                                                 |       | $                                                           | 0.88       |   |

 

For the purpose of the abovetable, the fair value of each option grant was estimated as of the date ofgrant using the Black-Scholes option pricing model with the followingweighted-average assumptions used for grants in the first quarter of fiscal2005: a risk-free interest rate of approximately 3.7%; a dividend yield of 0%;a weighted-average expected life of 5.5 years; and a volatility rate of 73%.The expected volatility was estimated using the historical volatility over aperiod of five years.  Theweighted-average fair value of options granted in the first quarter of fiscal2005 was $4.18.

 

*Employee Stock Purchase Plan*

 

Subsequent to the issuanceof SFAS No. 123(R), we amended and re-introduced our Employee Stock PurchasePlan (“ESPP”).  The amended ESPPeliminated the “look back” feature of the plan and reduced the purchasediscount to 5% off of the end of offering period stock price.  As a result of these amendments, our ESPP isconsidered non-compensatory under SFAS No. 123(R), and accordingly, nocompensation expense has been recorded for grants under the ESPP.

 

**S.Segment Information**

 

We operate and report ourfinancial results in four operating segments: three are based on geographicareas and the fourth is Celerant consulting. Our performance is evaluated by our Chief Executive Officer and ourother chief decision makers based on reviewing revenue and segment operatingincome (loss) information for each segment.

 

The geographic segmentsare:

 

•                  Americas — includes the United States, Canada and Latin America

 

•                  EMEA — includes Eastern and Western Europe, Middle East, and Africa

 

•                  Asia Pacific — includes China, Southeast Asia, Australia, New Zealand,Japan, and India

 

Prior to fiscal 2006,Latin America and Japan were separate operating segments.  All segment information has been recast toconform to the new segment presentation.

 

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All geographic segmentssell our software and services. These offerings are sold in the United Statesdirectly and through original equipment manufacturers, resellers, anddistributor channels, and internationally directly and through originalequipment manufacturers and distributors who sell to dealers and end users.Operating results by segment are as follows:

 
| ** **                                   | ** ** | **Three Months Ended** | ** ** |
|----------------------------------------------|------------|------------------------|------------|
| ** **                                   | ** ** | **January 31, 2006**   | ** ** | **January 31, 2005** | ** ** |
| **(in thousands)**                           | ** ** | **Net revenue**   | ** ** | **Operating****income (loss)** | ** ** | **Net revenue** | ** ** | **Operating****income (loss)** | ** ** |
| Americas                                     |       | $                      | 133,777    |   | $ | 69,900 |   | $ | 128,982 |   | $ | 66,876 |   |
| EMEA                                         |       | 88,836                 |       | 30,218 |   | 95,551 |   | 21,196 |   |
| Asia Pacific                                 |       | 19,681                 |       | 2,321 |   | 21,546 |   | 4,864 |   |
| Common unallocated  operating (costs) income |       | —                 |       | (87,670 | ) | — |   | 353,983 |   |
| Stock-based compensation  expenses           |       | —                 |       | (13,502 | ) | — |   | (459 | ) |
| Total geographic segments                    |       | 242,294                |       | 1,267 |   | 246,079 |   | 446,460 |   |
| Celerant consulting                          |       | 32,114                 |       | (588 | ) | 44,049 |   | 3,105 |   |
| Stock-based compensation  expenses           |       | —                 |       | (193 | ) | — |   | — |   |
| Total Celerant consulting                    |       | 32,114                 |       | (781 | ) | 44,049 |   | 3,105 |   |
| Total per statements of operations           |       | $                      | 274,408    |   | $ | 486 |   | $ | 290,128 |   | $ | 449,565 |   |

 

Common unallocatedoperating (costs) income include corporate services common to all geographicsegments such as corporate sales and marketing, product development, corporategeneral and administrative costs, corporate infrastructure costs, andlitigation settlement income or expense.  For management reporting purposes, Celerant consulting does not receivean allocation for these corporate services.  In addition, common unallocated operating income(costs) in the first three months of fiscal 2005 also includes a $447.6 millionnet gain on settlement of potential litigation with Microsoft. Stock-basedcompensation expenses have not been allocated for management reporting purposes

 

In addition to reviewinggeographic and Celerant consulting segment results, our Chief Executive Officerand chief decision makers review net revenue by solution category. Thesesolution categories are:

 

•                  Systems, security, and identity management (formerly Identity-drivencomputing solutions) — major products include Identity Manager, ZENworks,eDirectory, web services, Secure Login, and iChain.

 

•                  Open platform solutions — major products include Open EnterpriseServer, SUSE LINUX Enterprise Server, SUSE LINUX Professional, and Novell LinuxDesktop.

 

•                  Workspace solutions — major products include NetWare, GroupWise, SmallBusiness Suite, Cluster Services, Novell iFolder and BorderManager.

 

•                  Global services and support — comprehensive worldwide IT consulting,training, and technical support services that apply business solutions to ourcustomers’ business situations, providing the business knowledge and technicalexpertise to help our customers implement our technology.

 

•                  Celerant consulting — operational strategy and implementationconsulting services offered to a wide range of customers across varioussectors, worldwide.

 

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Prior to fiscal 2006,Open platform solutions and Workspace solutions were combined in a categorycalled Linux and platform services solutions. Prior periods have been recast to conform to the new presentation.  Net revenue by solution category and Celerantconsulting are as follows:

 

| ** **                                                | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------------|------------|------------------------|------------|
| **(in thousands)**                                        | ** ** | **January 31,  2006**  | ** ** | **January 31,  2005** | ** ** |
| Resource management                                       |       | $                      | 33,158     |   | $ | 29,968 |   |
| Identity and access management                            |       | 25,548                 |       | 17,855 |   |
| Other systems, security, and identity management products |       | 4,298                  |       | 4,835 |   |
| Systems, security, and  identity management               |       | 63,004                 |       | 52,658 |   |
| Open Enterprise Server                                    |       | 43,112                 |       | — |   |
| Linux platform products                                   |       | 10,382                 |       | 8,491 |   |
| Other open platform products                              |       | 2,745                  |       | 5,541 |   |
| Open platform solutions                                   |       | 56,239                 |       | 14,032 |   |
| NetWare and other NetWare-related                         |       | 18,256                 |       | 68,746 |   |
| Collaboration                                             |       | 23,676                 |       | 24,340 |   |
| Other workspace products                                  |       | 5,411                  |       | 5,907 |   |
| Workspace solutions                                       |       | 47,343                 |       | 98,993 |   |
| Total software licenses and maintenance                   |       | 166,586                |       | 165,683 |   |
| Global services and  support                              |       | 75,708                 |       | 80,396 |   |
| Total IT software and solutions                           |       | 242,294                |       | 246,079 |   |
| Celerant consulting                                       |       | 32,114                 |       | 44,049 |   |
| Total net revenue                                         |       | $                      | 274,408    |   | $ | 290,128 |   |

 

For the first quarters offiscal 2006 and 2005, revenues in the United States were $123.0 million and$122.3 million, respectively.  Revenuesfrom customers outside the United States were $151.4 million and $167.8 millionin the first quarters of fiscal 2006 and 2005, respectively.  For the first quarters of fiscal 2006 and2005, 75% and 77%, respectively, of our revenues outside the United States werein EMEA. During the first quarter of fiscal 2006, sales to customers in theUnited Kingdom accounted for 10% of our net revenue. During thefirst quarter of fiscal 2005, sales to customers in Germany accounted for 11%of our net revenue and sales to customers in the United Kingdom accounted for10% of our net revenue. Nosingle customer accounted for more than 10% of our total revenue for any periodpresented.

 

**T.Derivative Instruments**

 

A large portion of ourrevenue, expense, and capital purchasing activities is transacted in U.S.dollars. We do not currently hedge currency risks related to revenue orexpenses denominated in foreign currencies. However, we hedge currency risks ofsome assets and liabilities denominated in foreign currencies to protectagainst reductions in value caused by changes in foreign exchange rates. Wehave established balance sheet and intercompany hedging programs that useone-month foreign currency forward contracts, primarily on the Euro, JapaneseYen, and certain other European, Latin American, and Asian currencies.

 

We enter into theseone-month hedging contracts two business days before the end of each month andsettle them at the end of the following month. Due to the short period of timebetween entering into the forward contracts and the quarter-end, the fair valueof the derivatives as of January 31, 2006 is insignificant. Gains and lossesrecognized during a quarter on these foreign currency contracts are recorded asother income or expense and generally offset corresponding gains and losses onthe underlying hedged assets and liabilities, resulting in negligible effect toour financial statements.

 

**U.  Share Repurchase Program**

 

On September 22, 2005, ourboard of directors approved a share repurchase program for up to $200.0 millionof our common stock through September 21, 2006. As of January 31, 2006, noshares of common stock had been repurchased under this program.

 

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**Item 2.Management’s Discussion and Analysis of Financial Condition and Results ofOperations**

 

*ThisManagement’s Discussion and Analysis of Financial Condition and Results ofOperations (“MD&A”) and other parts of this Form 10-Q containforward-looking statements within the meaning of Section 27A of the SecuritiesAct of 1933, as amended, and Section 21E of the Securities Act of 1934, asamended. All statements, other than statements of historical fact, regardingour strategy, future operations, financial position, estimated revenue,projected costs, projected savings, prospects, plans, opportunities, andobjectives constitute “forward-looking statements.” The words “may,” “will,” “expects,”“plans,” “anticipates,” “believe,” “estimates,” “potential,” or “continue” andsimilar types of expressions identify such statements, although not allforward-looking statements contain these identifying words. These statementsare based upon information that is currently available to us and/or management’sexpectations, speak only as of the date hereof, and are subject to risks anduncertainties. We expressly disclaim any obligation, except as required by law,or undertaking to update or revise forward-looking statements contained hereinto reflect any change or expectations with regard thereto or to reflect anychange in events, conditions, or circumstances on which any suchforward-looking statement is based, in whole or in part. Our actual results maydiffer materially from the results discussed in or implied by such forward-lookingstatements. We are subject to a number of risks, some of which may be similarto those of other companies of similar size in our industry, including pre-taxlosses, rapid technological changes, competition, limited number of suppliers,customer concentration, failure to successfully integrate acquisitions, adversegovernment regulations, failure to manage international activities, and loss ofkey individuals. Risks that may affect our operating results include, but arenot limited to, those discussed in the “Risk Factors” section of our AnnualReport on Form 10-K filed with the Securities and Exchange Commission onJanuary 10, 2006.*

 

**Introduction**

 

Novell designs, develops,maintains, implements, and supports proprietary and open source software foruse in business solutions. With approximately 5,200 employees globally, we helpour worldwide customers manage, simplify, secure and integrate their technologyenvironments by leveraging best-of-breed, open source and open standards-basedsoftware. With over 20 years of experience, our employees, partners and supportcenters around the world help customers gain control over their informationtechnology (“IT”) operating environment while reducing the cost, complexity,and vulnerabilities of those environments. We provide security and identitymanagement, resource management, desktop, workgroup, and data center solutionson several operating systems, including Linux, NetWare(R), Windows, and Unix.All of our solutions are supported by our global services and support,including consulting, training and technical support services.

 

We deliver this value to ourcustomers by developing, maintaining and delivering information solutions inthe following categories:

 

*Systems,security, and identity management ( formerly called Identity-driven computingsolutions).*  Our systems,security, and identity management products include applications that offer abroad set of capabilities that manage resources, assets, and people through theassignment of digital identities, including the following:

 

•             resource managementcapabilities for both desktop and server environments;

 

•             provisioning andde-provisioning capabilities; and

 

•             secure authentication andauthorization services.

 

We believe that customershave recognized the need to manage the access, utilization and optimization ofassets through information systems that can help them understand, implement andadminister business policies, not only within organizations, but also betweenorganizations and their customers and trading partners. Our software solutionsenable organizations to balance growing user demands for services andinformation with demands for increased security and agility. By using ourproducts, customers can integrate business processes and systems, extendingthem within and across enterprise boundaries to interact with customers,employees, suppliers and partners. This affords organizations the opportunityto make changes to their business operations without incurring the cost ofconstantly changing individual software application components.

 

These identity-basedtechnologies not only regulate user access to data and applications, but areincreasingly becoming the basis for securing and managing other informationassets, including devices such as mobile phones and the components that make uptoday’s modern data centers. We believe that identity management willincreasingly become the preferred means by which businesses will efficientlyutilize all IT assets, and we have developed products for this market to helpour customers take advantage of these opportunities. These products can bedeployed across a number of 

 

 

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systems, including Linux,Unix, NetWare, and Windows, recognizing the heterogeneous nature of today’s ITdepartments. Our development strategy has been to develop systems, security andidentity management technologies as a set of discrete software services thatcan be deployed as needed, as opposed to the use of a single monolithic applicationthat can take years to implement and deploy without any immediate businessbenefit.

 

*Openplatform solutions and workspace solutions.*  Both our open platform solutions andworkspace solutions categories include solutions that offer effective and open approachesto networking and collaboration services, including file, print, messaging,scheduling, and workspace while using a cross-platform approach.  Both consist of operating systems, networkservices, and workgroup computing software solutions. We offer two majoroperating system platforms, SUSE(R) Linux Enterprise Server and NetWare.

 

Our open platform solutionscategory is comprised of our offerings based on Linux and other relatedproducts. These solutions provide the foundation for value added network andworkspace computing solutions deployed on both servers and desktops. OpenEnterprise Server (“OES”) consists of enterprise-ready, scalable networking andcollaboration services — including file, print, messaging, scheduling anddirectory-based management modules that allow customers to manage theircomputing environment from a single, central console deployed on either of ourmajor operating systems platforms.

 

A major focus of our openplatform solutions is to embrace and promote open source computing. Open sourceis a term used to describe software source code that generally allows free use,modification, and distribution of source code, subject to certain conditions.Open source software is generally built by a community of developers, many of whomare unaffiliated with each other. Corporations also fund open source projectsor contribute code into open source to further assist the development efforts.We believe that a major shift toward the use of open source software isunderway as companies are more critically evaluating the cost effectiveness oftheir information technology investments, seeing value in having access to thesource code, and are looking for ways to avoid vendor lock-in.

 

We believe that we areuniquely positioned to drive the transition to greater use of open sourcesoftware, as well as to benefit from this trend. Widespread adoption of Linuxand open source software was initially hindered by weak technical support, ashortcoming that we are particularly well positioned to address. We leverageour financial stability, experience, and global services and supportcapabilities to help our customers integrate Linux and other open sourcesoftware into their existing IT environments. While the flexibility and costsavings of Linux and open source have made it attractive to enterprisecustomers, we believe they continue to look to proprietary software vendors toprovide applications, management and security. With our SUSE Linux EnterpriseServer open source platform and our other Linux and platform servicessolutions, our customers can deploy the best of proprietary and open sourcesoftware that many businesses find more attractive. As an example, ourGroupWise product allows customers to collaborate seamlessly across theirWindows and Linux environments. We also provide solutions allowing IT managersto centrally control Linux, NetWare and Windows systems in a consistent andstraightforward way.

 

Our workspace solutionscategory is comprised of proprietary software products that provide customerswith powerful solutions that are designed to operate within existingheterogeneous computing environments as well as to provide tools and strategiesto allow easy migration between platforms to fit better with our customers’technology plans.  Our primary serverproduct in this solution category is NetWare. Our workspace solutions category also includes our GroupWise andcollaboration technologies, Small Business Suite, Cluster Services, andBorderManager.

 

*Globalservices and support.*  Weprovide worldwide IT consulting, training and technical support services toaddress our customers’ needs. Our worldwide IT consulting practice provides thebusiness knowledge and technical expertise to help our customers implement andachieve maximum benefit from our products and solutions. We also offer opensource and identity-driven services that are focused on aiding our clients inrapidly integrating applications or migrating existing platforms to Linux.

 

Through our trainingservices, we offer skills assessments, advanced technical training courses, andcustomized training directly and through authorized training service partners.We also offer testing and certification programs to systems administrators,engineers, salespeople, and instructors on a wide variety of technologies,including Linux. Over a decade ago, we introduced the concept of softwareengineer certifications. Building on this program, we introduced our NovellCertified Linux Engineer and Novell Certified Linux Professional programs toaccelerate the adoption of Linux and open source in the enterprise.

 

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We provide our customerswith a global support structure covering proprietary and open source technicalsupport. We deliver our technical support services through a variety ofchannels, including on-site dedicated resources as well as through telephone,web, e-mail, and remote systems management.

 

*Celerantconsulting.*  Celerant, amajority-owned subsidiary of Novell, provides value-based, operational strategyand implementation consulting services to a wide variety of customers mainly inEurope and the United States. Celerant specializes in improving the valuederived from existing business processes by accelerating time to value andeliminating non-value creating activities. As discussed in our Fiscal 2005 Form 10-K, we are exploring strategicalternatives for Celerant.

 

**Overview**

 

With respect to the U.S.economy, spending continues to improve in many of the areas of informationtechnology (“IT”) that we target such as security, regulatory compliance andserver/function consolidation. We believe that strategic IT security projectsput on hold in previous years are now being approved. Overall, increased ITfunding is helping to attract new Linux and identity management business, whichis driven by an increased focus on gaining efficiencies and loweringexpenses.   Sales cycles of our productsand services are still relatively long, with customers frequently requiring aproduct pilot before a larger purchase will occur.

 

Internationally, in our EMEAsegment, the European economy is flat, and market spending is still belowexpectations with long sales cycles and a clear focus on IT cost savings.Consolidation of platforms and security remain high priority items for ourcustomers, and initiatives on auditing in the health and public sector areincreasing on a small enterprise and local government scale. Our EMEA segmentremains a focus for our management and we expect to face continued financialchallenges in that region. The economy in Asia Pacific, including Japan, ismixed as some regions continue to struggle with core economic issues and othersare growing at or above global rates.

 

We continued to makeprogress on our key initiatives this quarter.

 

•     One of our most important initiatives is toincrease revenue from our Linux and Open Source product offerings.  Revenues from our Linux platform productsincreased 22% during the first quarter of fiscal 2006 over the same period inthe prior year. We recently demonstrated the next release of Novell LinuxDesktop.  In support of the open sourcemovement, during the first quarter of fiscal 2006 we donated the corecomponents of our AppArmor framework to provide a foundation for a new opensource project dedicated to advancing Linux application security.  In November 2005, Open Invention Network LLC(“OIN”) was established by us, IBM, Philips, Red Hat and Sony to acquirepatents and promote and protect Linux and open source.

 

•     We continued to grow our positions in theresource management and identity market by offering the most comprehensiveproducts that address customer problems in the areas of security, compliance,risk mitigation and systems management. Our unique role-based, policy-drivenapproach has been well received, and we continue to experience strong deferredrevenue growth in this category, with large enterprise deals driving licensegrowth.  We expect strong revenue andperformance momentum in these areas throughout the remainder of fiscal2006.  We released Novell IdentityManager 3.0 in the first quarter of fiscal 2006, with advanced capabilities forflexible, powerful tools to help customers to meet their security andcompliance needs.

 

•     We continued efforts to stabilize thedecline of our revenue from traditional products, such as NetWare. Ourtraditional revenue base is an important source of cash flow and a potentialopportunity for us to sell more products and services. With the release of ourOES product in March 2005, we have taken steps to help maintain that installedbase and address revenue declines of these products. However, our combinedNetWare and OES business declined by 11% during the first quarter of fiscal2006 compared to the same period in the prior year.  We continue to work with our customers tohelp them migrate from NetWare and other platforms of our competitors to OESusing tools, training and education emphasizing the return on investment ofupgrading to Linux versus proprietary platforms.

 

•     As we have discussed in the past, we havere-architected our go to market plans, selecting key geographies in which todeploy our resources and clearly defining our partner and channel strategy. Inaddition, we have restructured our sales incentive plans to motivate our directsales and channel partners to focus on key product areas globally. Now we arefocused on executing on those plans.

 

23

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In addition to our strategicinitiatives, we made a number of operational improvements in our businessduring the first quarter of fiscal 2006:

 

•     In the fourth quarter of fiscal 2005, weundertook a significant restructuring action as part of our ongoing transitionto Linux and identity management to concentrate our resources on key growthopportunities in the Linux, open source, resource management, and identitymarkets in order to better align our costs with our revenue opportunities andour overall business strategy. To achieve greater operational efficiencies inour business, we are also focused on eliminating non-core assets.

 

•     In connection with our restructuring, westreamlined our field operations, segmenting our markets into what we considerto be primary markets — large, established markets where we have a significantcustomer presence and the ability to deliver the range of our products directlyto the customer — and emerging markets, where we will look more to partners inour go to market and delivery. We believe this reorganization will also help usto leverage our direct sales force more effectively.

 

•     The restructuring involved the eliminationor cutback of certain product and service offerings. We expect that theannualized run rate cost savings to be realized as a result of thisrestructuring will be approximately $110 million, prior to considering theimpact of SFAS No. 123(R). Some of these cuts are expected to negatively impactrevenue in fiscal year 2006. This negative impact is in addition to continuedexpected declines in our traditional business revenue, which was also a significantfactor in our restructuring decision.

 

**Resultsof Operations**

 

*CriticalAccounting Policies*

 

OnNovember 1, 2005, we adopted SFAS No. 123(R), “Share-Based Payment,” which requires us to account forshare-based payment transactions using a fair value-based method and recognizethe related expense in the results of operations.  Prior to our adoption of SFAS No. 123(R), aspermitted by SFAS No. 123, we accounted for share-based payments to employeesusing the APB No. 25, “Accounting for Stock Issued to Employees,” intrinsicvalue method and, therefore we generally recognized compensation expense forrestricted stock awards and did not recognize compensation cost for employeestock options.  SFAS No. 123(R) allows companies tochoose one of two transition methods: the modified prospective transitionmethod or the modified retrospective transition method. We chose to use themodified prospective transition methodology and, accordingly, we have notrestated the results of prior periods.

 

Under the fair value recognitionprovisions of SFAS No. 123(R), stock-based compensation cost is estimated atthe grant date based on the fair value of the award and is recognized asexpense over the requisite service period of the award.  The fair value of restricted stock awards isdetermined by reference to the fair market value of our common stock on thedate of grant.  Consistent with thevaluation method we used for disclosure-only purposes under the provisions ofSFAS No. 123, we use the Black-Scholes model to value service condition andperformance condition option awards under SFAS No. 123(R).  For awards with market conditions grantedsubsequent to our adoption of SFAS No. 123(R), we use a lattice valuation modelto estimate fair value. For awards with only service conditions andgraded-vesting features, we recognize compensation cost on a straight-linebasis over the requisite service period. For awards with performance or market conditions granted subsequent toour adoption of SFAS No. 123(R), we recognize compensation cost based on thegraded-vesting method.

 

Determining the appropriatefair value model and related assumptions requires judgment, includingestimating stock price volatility, forfeiture rates, and expected terms.  The expected volatility rates are estimatedbased on historical and implied volatilities of our common stock.  The expected term represents the average timethat options that vest are expected to be outstanding based on the vestingprovisions and our historical exercise, cancellation and expirationpatterns.  We estimate pre-vestingforfeitures when recognizing compensation expense based on historical rates andforward-looking factors. We will update these assumptions at least on an annualbasis and on an interim basis if significant changes to the assumptions arewarranted.

 

We issue performance-basedequity awards, typically to certain senior executives, whose vesting iscontingent upon meeting certain financial performance goals, including revenueand income targets.    Determining theappropriate amount to expense based on achievement of the stated goals requiresjudgment, including forecasting future financial results.  The estimated expense is revised periodicallybased on the probability of achieving the required performance targets andadjustments are made as appropriate.  Thecumulative impact of any revision is reflected in the period of change.  If the 

 

24

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financial performance goals are not met, no compensation cost isrecognized and any previously recognized compensation cost is reversed.

 

                We issued market condition equity awards, typicallygranted to certain senior executives, whose vesting is accelerated orcontingent upon the price of Novell common stock meeting certainpre-established stock price targets.  Forawards granted prior to our adoption of SFAS No. 123(R), the fair value of eachmarket condition award was estimated as of the grant date using the same optionvaluation model used for time-based options without regard to the marketcondition criteria.  As a result of ouradoption of SFAS No. 123(R), compensation cost is recognized over the estimatedrequisite service period and is not reversed if the market condition target isnot met.   If the pre-established stockprice targets are achieved, any remaining expense on the date the target isachieved is recognized either immediately, or in situations where there is aremaining minimum time vesting period, ratably over that period.

 

*Acquisitionsand Equity Investments*

 

*OpenInvention Network*

 

InNovember 2005, OIN was established by us, IBM, Philips, Red Hat and Sony.  OIN is a privately held company that has andwill acquire patents to promote Linux and open source by offering its patentson a royalty-free basis to any company, institution or individual that agreesnot to assert its patents against the Linux operating system or certainLinux-related applications.  In addition,OIN, in its discretion, will enforce its patents to the extent it believes suchaction will serve to further protect and promote Linux and open source.  Each party contributed capital with a fairvalue of $20.0 million to OIN.  Weaccount for our 20% ownership interest using the equity method ofaccounting.  Our $20.0 millioncontribution consisted of patents with a fair value of $15.8 million, including$0.3 million of prepaid acquisition costs, and cash of $4.2 million.  At the time of the contribution, the patentshad a book value of $14.4 million, including $0.3 million of prepaidacquisition costs.  The $1.4 milliondifference between the fair value and book value of the patents will beamortized to our investment in OIN account and equity income over the remainingestimated useful life of the patents, which is approximately nine years. Ourinvestment in OIN of $18.7 million is classified as other assets in theconsolidated balance sheet.

 

*OnwardIndia*

 

In December 2005, weacquired the remaining 50% ownership of our sales and marketing joint venturein India from our joint venture partner for approximately $7.5 million in cashand other consideration. At October 31, 2005, $7.5 million of our cash was heldin an escrow account for the acquisition and classified as other assets in theconsolidated balance sheet. The cash was paid out of the escrow account duringthe first quarter of fiscal 2006.    Atthe time of the acquisition, the net book value of the minority interest was$5.3 million.  The $2.0 milliondifference between the net book value of the minority interest and the amountwe paid for the remaining 50% ownership was recorded as goodwill.

 

*Revenue*

 

We sell our products,services, and solutions primarily to corporations, government entities,educational institutions, resellers and distributors both domestically andinternationally. In the consolidated statements of operations, we categorizerevenue as software licenses or maintenance and services. Software licensesrevenue includes sales of proprietary licenses, upgrade licenses and certainroyalties. Maintenance and services revenue includes all other revenue,including Linux subscriptions and upgrade protection contracts.

 

| ** **                 | ** ** | **Three Months Ended**     | ** ** | ** **                 | ** ** |
|----------------------------|------------|----------------------------|------------|----------------------------|------------|
| **(dollars in thousands)** | ** ** | **January 31,  2006** | ** ** | **January 31,  2005** | ** ** | **Change** | ** ** |
| Software licenses          |       | $                          | 42,102     |                       | $          | 44,296 |   | (5 | )% |
| Maintenance and services   |       | 232,306                    |       | 245,832                    |       | (6 | )% |
|                       |       |                       |       |                       |       |   |   |
| Total net revenue          |       | $                          | 274,408    |                       | $          | 290,128 |   | (5 | )% |

 

Software licenses revenuedecreased in the first quarter of fiscal 2006 compared to the same period offiscal 2005 primarily due to more of our customers purchasing under multipleproduct, multiple year subscriptions, which we record as maintenance andservices revenue, as well as declines in our installed base mainly due toNetWare.

 

The decrease inmaintenance and services revenue during the first quarter of fiscal 2006compared to the same period of fiscal 2005 is primarily due to an $11.9 milliondecrease in Celerant revenue and a decrease in IT consulting and 

 

25

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services revenue of $4.7 million that was planned as aresult of the restructuring plan we established in the fourth quarter of fiscal2005.  These decreases were offsetsomewhat by increased maintenance revenue.  The change in the mix of our revenue towards more maintenance andsubscription contracts has also driven an increase in revenue in themaintenance and services category compared to the software licenses category.

 

Overall, foreign currencyexchange rates decreased revenue in the first quarter of fiscal 2006 byapproximately $6.7 million, compared to the same period in fiscal 2005 due to astronger U.S. dollar.

 

We also analyze revenue bysolution categories. These solution categories are:

 

•                  Systems, security, and identity management (formerly Identity-drivencomputing solutions) — major products include Identity Manager, ZENworks,eDirectory, web services, Secure Login, and iChain.

 

•                  Open platform solutions — major products include Open EnterpriseServer, SUSE LINUX Enterprise Server, SUSE LINUX Professional, and Novell LinuxDesktop.

 

•                  Workspace solutions — major products include NetWare, GroupWise, SmallBusiness Suite, Cluster Services, Novell iFolder and BorderManager.

 

•                   Global services and support— comprehensive IT consulting, training, and technical support services thatapply business solutions to our customers’ business situations, providing thebusiness knowledge and technical expertise to help our customers implement ourtechnology.

 

•                  Celerant consulting — operational strategy and implementationconsulting services offered to a wide range of customers across varioussectors, worldwide.

 

Prior to fiscal 2006,Open platform solutions and Workspace solutions were combined in a categorycalled Linux and platform services solutions.

 

| ** **                                                | ** ** | **Three Months Ended**     | ** ** | ** **                 | ** ** |
|-----------------------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| **(dollars in thousands)**                                | ** ** | **January 31,  2006** | ** ** | **January 31,  2005** | ** ** | **Change** | ** ** |
| Resource management                                       |       | $                          | 33,158     |                       | $          | 29,968 |   |   |   |
| Identity and access management                            |       | 25,548                     |       | 17,855                     |       |   |   |
| Other systems, security, and identity management products |       | 4,298                      |       | 4,835                      |       |   |   |
| Systems, security and identity management                 |       | 63,004                     |       | 52,658                     |       | 20 | % |
| Open Enterprise Server                                    |       | 43,112                     |       | —                     |       |   |   |
| Linux platform products                                   |       | 10,382                     |       | 8,491                      |       |   |   |
| Other open platform products                              |       | 2,745                      |       | 5,541                      |       |   |   |
| Open platform solutions                                   |       | 56,239                     |       | 14,032                     |       | 301 | % |
| NetWare and other NetWare-related                         |       | 18,256                     |       | 68,746                     |       |   |   |
| Collaboration                                             |       | 23,676                     |       | 24,340                     |       |   |   |
| Other workspace products                                  |       | 5,411                      |       | 5,907                      |       |   |   |
| Workspace solutions                                       |       | 47,343                     |       | 98,993                     |       | (52 | )% |
| Global services and support                               |       | 75,708                     |       | 80,396                     |       | (6 | )% |
| Celerant consulting                                       |       | 32,114                     |       | 44,049                     |       | (27 | )% |
|                                                      |       |                       |       |                       |       |   |   |
| Total net revenue                                         |       | $                          | 274,408    |                       | $          | 290,128 |   | (5 | )% |

 

Systems,security and identity management increased in the first quarter of fiscal 2006compared to the same quarter of fiscal 2005 primarily due to strong growth inour identity and access management products, which increased $7.7 million, andincreases in our resource management revenue of $3.2 million.

 

Openplatform solutions increased in the first quarter of fiscal 2006 compared tothe same quarter of fiscal 2005, primarily as a result of the release of OES inthe second quarter of fiscal 2005, which accounted for $43.1 million of revenuein the first quarter of fiscal 2006 and a $1.9 million increase in Linuxplatform product revenue.  Theseincreases were offset by a decrease in other open platform product revenue of $2.8million, primarily due to planned reductions of our consumer product, SUSELinux (formerly SUSE Professional).

 

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Workspacesolutions decreased in the first quarter of fiscal 2006 compared to the same periodof fiscal 2005 primarily due to a $50.5 million decrease in our NetWare-relatedrevenue resulting from customers migrating to our OES product and declines inour installed base.  NetWare and OESrevenue combined decreased $6.5 million or 11%. Increased revenue from our other products offset the decline inNetWare-related revenue.

 

Globalservices and support decreased primarily due to decreases in IT consulting revenue, which decreased inthe EMEA segment by approximately $4.3 million and approximately $2.4 millionin the Asia Pacific segment as a result of our move to focus on Novellproduct-related consulting.  Thesedecreases were offset somewhat by an increase in consulting of $1.3 million inthe Americas.  Celerant revenue decreasedprimarily due to poor performance in the U.S. and Europe as well as the effectof foreign exchange rates.

 

We further analyzerevenue by solution categories within each geographic segment.

 

**Netrevenue by reporting segment was as follows:**

 

| ** **                 | ** ** | **Three Months Ended**     | ** ** | ** **                 | ** ** |
|----------------------------|------------|----------------------------|------------|----------------------------|------------|
| **(dollars in thousands)** | ** ** | **January 31,  2006** | ** ** | **January 31,  2005** | ** ** | **Change** | ** ** |
| Americas                   |       | $                          | 133,777    |                       | $          | 128,982 |   | 4 | % |
| EMEA                       |       | 88,836                     |       | 95,551                     |       | (7 | )% |
| Asia Pacific               |       | 19,681                     |       | 21,546                     |       | (9 | )% |
| Celerant consulting        |       | 32,114                     |       | 44,049                     |       | (27 | )% |
|                       |       |                       |       |                       |       |   |   |
| Total net revenue          |       | $                          | 274,408    |                       | $          | 290,128 |   | (5 | )% |

 

**Netrevenue by solution category in the Americas segment was as follows:**

 

| ** **                                                      | ** ** | **Three Months Ended**     | ** ** | ** **                 | ** ** |
|-----------------------------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| **(dollars in thousands)**                                      | ** ** | **January 31,  2006** | ** ** | **January 31,  2005** | ** ** | **Change** | ** ** |
| Resource management                                             |       | $                          | 18,344     |                       | $          | 16,931 |   |   |   |
| Identity and access management                                  |       | 15,912                     |       | 9,371                      |       |   |   |
| Other systems, security, and identity management  products |       | 2,185                      |       | 2,695                      |       |   |   |
| Systems, security and identity management                       |       | 36,441                     |       | 28,997                     |       | 26 | % |
| Open Enterprise Server                                          |       | 25,853                     |       | —                     |       |   |   |
| Linux platform products                                         |       | 4,866                      |       | 4,056                      |       |   |   |
| Other open platform products                                    |       | 1,644                      |       | 1,329                      |       |   |   |
| Open platform solutions                                         |       | 32,363                     |       | 5,385                      |       | 501 | % |
| NetWare and other NetWare-related                               |       | 7,303                      |       | 37,600                     |       |   |   |
| Collaboration                                                   |       | 14,228                     |       | 15,115                     |       |   |   |
| Other workspace products                                        |       | 2,823                      |       | 2,685                      |       |   |   |
| Workspace solutions                                             |       | 24,354                     |       | 55,400                     |       | (56 | )% |
| Global services and support                                     |       | 40,619                     |       | 39,200                     |       | 4 | % |
|                                                            |       |                       |       |                       |       |   |   |
| Total net revenue                                               |       | $                          | 133,777    |                       | $          | 128,982 |   | 4 | % |

 

Revenue from the Americasincreased in the first quarter of fiscal 2006 compared to the same quarter infiscal 2005 due primarily to increased identity and access management revenueof $6.5 million and new revenue from OES of $25.9 million, offset by a $30.3million decrease in NetWare-related revenue.

 

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**Netrevenue by solution category in the EMEA segment was as follows:**

** **

| ** **                                                | ** ** | **Three Months Ended**     | ** ** | ** **                 | ** ** |
|-----------------------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| **(dollars in thousands)**                                | ** ** | **January 31,  2006** | ** ** | **January 31,  2005** | ** ** | **Change** | ** ** |
| Resource management                                       |       | $                          | 13,024     |                       | $          | 11,360 |   |   |   |
| Identity and access management                            |       | 6,979                      |       | 6,578                      |       |   |   |
| Other systems, security, and identity management products |       | 1,680                      |       | 1,475                      |       |   |   |
| Systems, security and identity management                 |       | 21,683                     |       | 19,413                     |       | 12 | % |
| Open Enterprise Server                                    |       | 14,888                     |       | —                     |       |   |   |
| Linux platform products                                   |       | 4,549                      |       | 4,013                      |       |   |   |
| Other open platform products                              |       | 708                        |       | 4,154                      |       |   |   |
| Open platform solutions                                   |       | 20,145                     |       | 8,167                      |       | 147 | % |
| NetWare and other NetWare-related                         |       | 7,886                      |       | 24,664                     |       |   |   |
| Collaboration                                             |       | 8,451                      |       | 8,070                      |       |   |   |
| Other workspace products                                  |       | 1,558                      |       | 2,266                      |       |   |   |
| Workspace solutions                                       |       | 17,895                     |       | 35,000                     |       | (49 | )% |
| Global services and support                               |       | 29,113                     |       | 32,971                     |       | (12 | )% |
|                                                      |       |                       |       |                       |       |   |   |
| Total net revenue                                         |       | $                          | 88,836     |                       | $          | 95,551 |   | (7 | )% |

 

Revenue from EMEAdecreased in the first quarter of fiscal 2006 compared to the same quarter offiscal 2005, primarily due to a $16.8 million decrease in NetWare-relatedrevenue, a $3.4 million decrease in other open platform product revenue, primarily due to planned reductions of ourconsumer product, SUSE Linux, and a $4.3 million decrease in ITconsulting revenue.  These decreases wereoffset by increased resource management revenue of $1.7 million and new revenuefrom OES of $14.9 million.  Overall,foreign currency exchange rates decreased revenue in the EMEA segment byapproximately $3.9 million during the first quarter of fiscal 2006.

 

**Netrevenue by solution category in the Asia Pacific segment was as follows:**

** **

| ** **                                                | ** ** | **Three Months Ended**     | ** ** | ** **                 | ** ** |
|-----------------------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| **(dollars in thousands)**                                | ** ** | **January 31,  2006** | ** ** | **January 31,  2005** | ** ** | **Change** | ** ** |
| Resource management                                       |       | $                          | 1,791      |                       | $          | 1,677 |   |   |   |
| Identity and access management                            |       | 2,656                      |       | 1,905                      |       |   |   |
| Other systems, security, and identity management products |       | 433                        |       | 665                        |       |   |   |
| Systems, security and identity management                 |       | 4,880                      |       | 4,247                      |       | 15 | % |
| Open Enterprise Server                                    |       | 2,371                      |       | —                     |       |   |   |
| Linux platform products                                   |       | 966                        |       | 422                        |       |   |   |
| Other open platform products                              |       | 394                        |       | 59                         |       |   |   |
| Open platform solutions                                   |       | 3,731                      |       | 481                        |       | 676 | % |
| NetWare and other NetWare-related                         |       | 3,067                      |       | 6,483                      |       |   |   |
| Collaboration                                             |       | 997                        |       | 1,155                      |       |   |   |
| Other workspace products                                  |       | 1,030                      |       | 955                        |       |   |   |
| Workspace solutions                                       |       | 5,094                      |       | 8,593                      |       | (41 | )% |
| Global services and  support                              |       | 5,976                      |       | 8,225                      |       | (27 | )% |
|                                                      |       |                       |       |                       |       |   |   |
| Total net revenue                                         |       | $                          | 19,681     |                       | $          | 21,546 |   | (9 | )% |

 

The overall decrease inAsia Pacific segment revenue for the first quarter of fiscal 2006 compared tothe same quarter of fiscal 2005 is primarily due to a $2.4 million decrease inIT consulting revenue and a $3.4 million decrease in NetWare-related revenue,offset somewhat by approximately $2.4 million of new revenue from OES.

 

*Forward-lookingrevenue trends*

 

As discussed in our fiscal2005 Form 10-K, we expect our newer product offerings of open source, identityand resource management to grow during fiscal 2006. However, it is still tooearly to predict the longer-term impact of OES on our traditional revenue,principally NetWare and GroupWise, which are still significant components ofour overall revenue. In addition, the restructuring actions we took in fiscal2005 involved the elimination or cutback of certain product and serviceofferings, resulting in the elimination or reduction of certain lower marginrevenue. We also expect the 

 

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restructuring to have somerevenue reduction shorter-term.  We arestill exploring strategic alternatives for Celerant, which could affect revenuein fiscal 2006.

 

We expect revenue in thesecond fiscal quarter of 2006 to be in the range of $272 to $282 million.

 

*Deferredrevenue*

 

Deferred revenue representsrevenue that is expected to be recognized in future periods. The majority ofdeferred revenue relates to maintenance contracts and subscriptions and isrecognized ratably over the related service periods, typically one to threeyears. The decrease in deferred revenue at January 31, 2006 compared to October31, 2005 of $38.3 million is primarily attributable to seasonably lowerinvoicing during our first fiscal quarter of fiscal 2006.  As more of our revenue contracts shift tomultiple product, multiple year subscription arrangements, we expect that agreater proportion of our revenue will initially be deferred and recognizedover the contractual service term as maintenance and subscription revenue.

 

*Grossprofit*

 

| ** **                            | ** ** | **Three Months Ended**     | ** ** | ** **                 | ** ** |
|---------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| **(dollars in thousands)**            | ** ** | **January 31,  2006** | ** ** | **January 31,  2005** | ** ** | **Change** | ** ** |
| Software licenses gross profit        |       | $                          | 37,805     |                       | $          | 39,664 |   | (5 | )% |
| *percentage of related revenue*       | * *   | *90*                       | *%*        | *90*                       | %          |   |   |
| Maintenance and services gross profit |       | $                          | 135,341    |                       | $          | 138,413 |   | (2 | )% |
| *percentage of related revenue*       | * *   | *58*                       | *%*        | *56*                       | %          |   |   |
| Total gross profit                    |       | $                          | 173,146    |                       | $          | 178,077 |   | (3 | )% |
| *percentage of revenue*               | * *   | *63*                       | *%*        | *61*                       | %          |   |   |

 

The decrease in grossprofit from software licenses for the first quarter of fiscal 2005 compared tothe same quarter of fiscal 2005 is primarily due to decreased sales of softwarelicenses.

 

The decrease in grossprofit from maintenance and services for the first quarter of fiscal 2006compared to the same quarter of fiscal 2005 was primarily the result ofadditional expense from the adoption of SFAS No. 123(R) in the first quarter offiscal 2006 of approximately $1.1 million, and lower maintenance and servicesrevenue.  The increase in gross profitfrom maintenance and services as a percentage of related revenue for the firstquarter of fiscal 2006 was primarily a result of the headcount reductions thattook place in fiscal 2005.

 

*Operatingexpenses*

 

| ** **                                    | ** ** | **Three Months Ended**     | ** ** | ** **                 | ** ** |
|-----------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| **(dollars in thousands)**                    | ** ** | **January 31,  2006** | ** ** | **January 31,  2005** | ** ** | **Change** | ** ** |
| Sales and marketing                           |       | $                          | 94,153     |                       | $          | 95,244 |   | (1 | )% |
| *percentage of revenue*                       | * *   | *34*                       | *%*        | *33*                       | %          |   |   |
| Product development                           |       | $                          | 44,117     |                       | $          | 47,758 |   | (8 | )% |
| *percentage of revenue*                       | * *   | *16*                       | *%*        | *16*                       | %          |   |   |
| General and administrative                    |       | $                          | 35,454     |                       | $          | 28,240 |   | 26 | % |
| *percentage of revenue*                       | * *   | *13*                       | *%*        | *10*                       | %          |   |   |
| Restructuring expenses                        |       | $                          | (1,064     | )                          | $          | 6,419 |   | (117 | )% |
| *percentage of revenue*                       | * *   | *—*                   | *%*        | *2*                        | %          |   |   |
| Gain on sale of property, plant and equipment |       | $                          | —     |                       | $          | (1,589 | ) | — | % |
| *percentage of revenue*                       | * *   | *—*                   | *%*        | *(1%*                      | )          |   |   |
| Gain on settlement of potential litigation    |       | $                          | —     |                       | $          | (447,560 | ) | — | % |
| *percentage of revenue*                       | * *   | *—*                   | *%*        | *(154%*                    | )          |   |   |
| Total operating expenses (income)             |       | $                          | 172,660    |                       | $          | (271,488 | ) | 164 | % |
| *percentage of revenue*                       | * *   | *63*                       | *%*        | *(94%*                     | )          |   |   |

 

Sales and marketingexpenses decreased in the first quarter of fiscal 2006 compared to the samequarter of fiscal 2005 due primarily to planned reductions as a result of thefiscal 2005 headcount reductions, offset somewhat by additional expense fromthe adoption of SFAS No. 123(R) in the first quarter of fiscal 2006 ofapproximately $3.5 million.  

 

29

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Sales and marketing headcount was approximately 151 or12% lower in the first quarter of fiscal 2006 compared to the same period offiscal 2005.

 

 Product development expenses in the firstquarter of fiscal 2006 decreased compared to the same quarter of fiscal 2005due primarily to planned reductions as a result of the fiscal 2005 headcountreductions, offset somewhat by additional expense from the adoption of SFAS No.123(R) in the first quarter of fiscal 2006 of approximately $2.6 million.  Product development headcount wasapproximately 199 or 13% lower in the first quarter of fiscal 2006 compared tothe same period of fiscal 2005.

 

General andadministrative expenses increased in the first quarter of fiscal 2006 comparedto the same quarter of fiscal 2005 due primarily to additional expense ofapproximately $6.5 million resulting from the adoption of SFAS No. 123(R) inthe first quarter of fiscal 2006, offset by reduced bonus expenses, headcountreductions and lower facilities expenses. General and administrative headcount was approximately 61 or 9% lower inthe first quarter of fiscal 2006 compared to the same period of fiscal 2005.

 

 

During the first quarterof fiscal 2006, we recorded adjustments to the restructuring reserves of $1.1million related to changes in estimates, of which $0.4 million was related toAsia Pacific, $0.3 million was related to the Americas, $0.3 million wasrelated to EMEA, and $0.1 million was related to Celerant.

 

During the first quarterof fiscal 2005, we recognized a gain of $1.6 million on the sale of ourfacility in Lindon, Utah and a gain on a settlement of $447.6 million, net oflegal expenses of approximately $88.4 million, with Microsoft concerningpotential anti-trust litigation related to our NetWare operating system.

 

*Otherincome (expense)*

 

| ** **                      | ** ** | **Three Months Ended**     | ** ** | ** **                 | ** ** |
|---------------------------------|------------|----------------------------|------------|----------------------------|------------|
| **(dollars in thousands)**      | ** ** | **January 31,  2006** | ** ** | **January 31,  2005** | ** ** | **Change** | ** ** |
| Investment income               |       | $                          | 14,979     |                       | $          | 9,453 |   | 58 | % |
| *percentage of revenue*         | * *   | *5*                        | *%*        | *3*                        | %          |   |   |
| Impairment of investments       |       | $                          | (387       | )                          | $          | (1,013 | ) | 62 | % |
| *percentage of revenue*         | * *   | *—*                   | *%*        | *—*                   | %          |   |   |
| Interest expense and other, net |       | $                          | (1,890     | )                          | $          | (3,405 | ) | 44 | % |
| *percentage of revenue*         | * *   | *(1%*                      | *)*        | *(1%*                      | )          |   |   |
| Total other income, net         |       | $                          | 12,702     |                       | $          | 5,035 |   | 152 | % |
| *percentage of revenue*         | * *   | *5*                        | *%*        | *2*                        | %          |   |   |

 

Novell’s long-terminvestments consist primarily of investments in venture capital partnerships.Investment income includes income from short-term and long-term investments.Investment income for the first quarter of fiscal 2006 increased compared tothe same periods in fiscal 2005 due to interest earned on the $447.6 millioncash received from the settlement we reached with Microsoft.

 

To assess impairment, weanalyze forecasted financial performance of the investees and our estimate ofthe potential for investment recovery based on the financial performancefactors.

 

Interest expense andother, net for the first quarter of fiscal 2006 decreased compared to the samequarter of fiscal 2005 primarily due to lower foreign currency transactionlosses*.*

 

*Incometax expense*

 

| ** **                 | ** ** | **Three Months Ended** | ** ** | ** **                 | ** ** |
|----------------------------|------------|----------------------------------|------------|----------------------------|------------|
| **(dollars in thousands)** | ** ** | **January 31,  2006**       | ** ** | **January 31,  2005** | ** ** | **Change** | ** ** |
| Income tax expense         |       | $                                | 11,323     |                       | $          | 59,439 |   | (81 | )% |
| *percentage of revenue*    | * *   | *4*                              | *%*        | *20*                       | %          |   |   |
| Effective tax rate         |       | 86                               | %          | 13                         | %          |   |   |
|                            |            |                                  |            |                            |            |  |  |  |  |

 

We are subject to incometaxes in numerous jurisdictions and the use of estimates is required indetermining our provision for income taxes. For the first quarter of fiscal 2006, we provided income taxes of $11.3million based on the 

 

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estimated annual effective tax rate for the yearapplied to ‘ordinary’ income (pre-tax income excluding unusual or infrequentlyoccurring discrete items).  Due to theutilization of a significant amount of our net operating loss carryforwardsduring fiscal 2005, substantially all of the future benefit received from ourremaining net operating loss carryforwards used to offset U.S. taxable incomewill be credited to additional paid-in capital or goodwill and not income taxexpense.  In addition, the windfall taxbenefits associated with stock-based compensation will be credited toadditional paid-in capital. In connection with our adoption of SFAS No. 123(R),we elected to follow the tax ordering laws to determine the sequence in whichdeductions and net operating loss carryforwards are utilized.  Accordingly, during the first quarter offiscal 2006, a $4.0 million tax benefit relating to stock options was creditedto additional paid-in capital and a $0.5 million benefit was credited togoodwill.

 

The effective tax ratediffers from the federal statutory rate of 35% primarily due to the effects ofstock-based compensation plans, differences between book and tax items andforeign taxes.  The effective tax ratefor the first quarter of fiscal 2006 was 85.9% compared to the effective taxrate of 13.1% for the same period in 2005. The effective rate for the first quarter of fiscal 2006 differs from thefirst quarter of fiscal 2005 due to the use of net operating losses in thefirst quarter of fiscal 2005, which offset income tax expense associatedprimarily with the income generated from a settlement we reached with Microsoftin the first quarter of fiscal 2005.  The effective tax rate for fiscal 2006 will be higher than the rate forfiscal 2005 primarily because the fiscal 2005 rate reflected a benefit recordedto income tax expense from the use of a significant amount of our net operatingloss carryforwards.

 

In accordance withdeterminations made pursuant to the applicable accounting standards, wecontinue to believe that it is more likely than not that our remaining U.S. netdeferred tax assets will not be realized based on the weight of all availableevidence. As a result, we have provided a full valuation reserve on our U.S.net deferred tax assets. As deferred tax assets or liabilities increase ordecrease in the future, or if a portion or all of the valuation allowance is nolonger deemed to be necessary, the adjustments to the valuation allowance willincrease or decrease future income tax provisions, goodwill or additionalpaid-in capital.

 

Wecontinue to evaluate our tax reserves under SFAS No. 5, “Accounting forContingencies,” which requires us to accrue for losses we believe are probableand can be reasonably estimated.   Theamount reflected in the consolidated balance sheet at January 31, 2006 isconsidered adequate based on our assessment of many factors including, resultsof tax audits, past experience and interpretations of tax law applied to thefacts of each matter. It is reasonably possible that our tax reserves could beincreased or decreased in the near term based on these factors.

 

 *Net income available tocommon stockholders*

 

| ** **                                                 | ** ** | **Three Months Ended** | ** ** | ** **                 | ** ** |
|------------------------------------------------------------|------------|----------------------------------|------------|----------------------------|------------|
| **(dollars in thousands)**                                 | ** ** | **January 31,  2006**       | ** ** | **January 31,  2005** | ** ** | **Change** | ** ** |
| Net income                                                 |       | $                                | 1,865      |                       | $          | 395,161 |   | (100% | ) |
| Net income available to common stockholders — basic   |       | $                                | 1,811      |                       | $          | 390,891 |   | (100% | ) |
| Net income available to common stockholders — diluted |       | $                                | 1,811      |                       | $          | 392,384 |   | (100% | ) |

 

Additional expense fromthe adoption of SFAS No. 123(R) in the first quarters of fiscal 2006 decreasednet income by approximately $13.7 million. Net income was favorably impacted in the first quarter of fiscal 2006 byapproximately $1.1 million due to foreign exchange rate fluctuations.

 

Net income available tocommon stockholders — basic for the first quarter of fiscal 2006 and fiscal2005 differs from net income due to the deduction of Series B Preferred Stockdividends and earnings allocated to the holders of Series B Preferred Stock,which are required to be deducted from net income to arrive at net incomeavailable to common stockholders — basic.

 

Net income available tocommon stockholders — diluted for the first quarter of fiscal 2005 differs fromnet income available to common stockholders — basic for the same quarter offiscal 2005 due to the interest expense and amortization of issuance costsattributable to the Debentures that are added back to net income. In computingthe diluted net income per share for the first quarter of fiscal 2005, it isassumed the Debentures are converted into common stock at the beginning of theperiod, and we would therefore not incur interest expense or amortization costsrelated to the Debentures.

 

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**Liquidityand Capital Resources**

 
| **(dollars in thousands)**                        | ** ** | **January 31, 2006** | ** ** | **October 31, 2005** | ** ** | **Change** | ** ** |
|---------------------------------------------------|------------|----------------------|------------|--------------------------------|------------|------------|------------|
| Cash, cash equivalents and short-term investments |       | $1,685,590           |       | $1,654,904                     |       | 2          | %          |
| *Percent of total assets*                         | * *   | *63*                 | *%*        | *60*                           | %          |       |       |

 

An overview of thesignificant cash flow activities for the three months ended January 31, 2006and January 31, 2005 is as follows:

 
| ** **                                                                        | ** ** | **Three Months Ended**         | ** ** |
|-----------------------------------------------------------------------------------|------------|--------------------------------|------------|
| **(in thousands)**                                                                | ** ** | **January 31, 2006** | ** ** | **January 31, 2005** | ** ** |
| Cash provided by operating activities, including potential litigation  settlement |       | $                              | 25,123     |   | $ | 451,647 |   |
| Issuance of common stock, net                                                     |       | 9,876                          |       | 4,467 |   |
| Purchases of property, plant and equipment                                        |       | (7,603                         | )          | (5,649 | ) |
| Proceeds from the sale of property, plant and equipment                           |       | —                         |       | 10,421 |   |
| Purchase of intangible assets                                                     |       | —                         |       | (15,500 | ) |
| Cash paid for equity investment in OIN                                            |       | (4,225                         | )          | — |   |
| Other investing activities                                                        |       | 2,462                          |       | 6,257 |   |
|                                                                                   |            |                                |            |  |  |  |  |

 

Cash provided byoperating activities in the first three months of fiscal 2005 included thereceipt of $536 million in cash, $447.6 million in cash net of legal fees, inconnection with the Microsoft settlement (included in cash provided byoperating activities).

 

As of January 31, 2006,we had cash, cash equivalents and other short-term investments of approximately$350.2 million held in accounts outside the United States. Our short-terminvestment portfolio is diversified among security types, industry groups, andindividual issuers, and consists primarily of investment grade securities. Toachieve potentially higher returns, a portion of our investment portfolio isinvested in equity securities and mutual funds, both of which are subject tomarket risk. Approximately $6.7 million of our short-term investments aredesignated for deferred compensation payments, which are paid out as requestedby the plan participants. Our short-term investment portfolio includes grossunrealized gains and losses of $0.8 million and $7.1 million, respectively, asof January 31, 2006. We monitor our investments and record losses when adecline in the investment’s market value is determined to be other thantemporary.

 

Our $25.0 million bank lineof credit, which is used for letter of credit purposes, expires on April 1,2006. We are currently in the process of renewing the line of credit for anadditional one-year term.   At January31, 2006, we had corporate aviation assets with a net book value ofapproximately $18.8 million classified as held for sale. We anticipate sellingthese assets during fiscal 2006 for at least book value.

 

We invested excess cash inlong-term investments through the Novell Venture account and directly in equitysecurities in privately-held companies. Investments made through the NovellVenture account are generally in funds managed by venture capitalists for thepromotion of our business and strategic objectives. As of January 31, 2006, wehad a carrying value of $52.7 million related to investments in various venturecapital funds and had commitments to contribute an additional $19.2 million tothese funds, of which we estimate approximately $13.6 million could becontributed during the remainder of fiscal 2006, approximately $4.9 million infiscal 2007, and approximately $0.7 million thereafter as requested by the fundmanagers. We intend to fund these investments with cash from operations andcash on hand.

 

Our $20.0 million, 20%ownership interest in OIN consisted of patents with a fair value of $15.8million, including $0.3 million of prepaid acquisition costs, and cash of $4.2million.  At the time of thecontribution, the patents had a book value of $14.4 million, including $0.3million of prepaid acquisition costs. According to the terms of the LLC agreement, we could be required tomake future cash contributions which, if required, we would fund with cash fromoperations and cash on hand.

 

As of January 31, 2006, wehave various operating leases related to our facilities. These leases haveminimum annual lease commitments of $23.3 million for the remainder of fiscal2006, $25.7 million in fiscal 2007, $22.7 million in fiscal 2008, $14.8 millionin fiscal 2009, $9.2 million in fiscal 2010, and $36.5 million thereafter.Furthermore, we have $23.3 million of minimum rentals to be received in thefuture from subleases.

 

On July 2, 2004, weissued and sold $600.0 million aggregate principal amount of our Debentures due2024. The Debentures pay interest at 0.50% per annum, payable semi-annually onJanuary 15 and July 15 of each year until maturity, commencing January 15, 2005.We paid $1.5 million in interest during the first three months of fiscal 2006.

 

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As of January 31, 2006,we also have 187 shares of Series B Preferred Stock outstanding with a carryingvalue of $9.4 million. The Series B Preferred Stock is redeemable at our optionand by the holder under certain change in control circumstances.

 

On September 22, 2005, ourboard of directors approved a share repurchase program for up to $200.0 millionof our common stock through September 21, 2006. As of January 31, 2006, no shares of common stock had been repurchasedunder this program.

 

There have been nosignificant changes to our contractual obligations as disclosed in our fiscal2005 Form 10-K.

 

Our principal sources ofliquidity continue to be from operations, cash on hand, and short-terminvestments. At January 31, 2006, our principal unused sources of liquidityconsisted of cash and cash equivalents of $845.1 million and short-terminvestments in the amount of $840.5 million. During the first three months offiscal 2006, we generated $25.1 million of cash flow from operations. Ourspecific liquidity needs for the next twelve months are principally forfinancing of fixed assets, commitments to our venture capital funds and productdevelopment.  Our general liquidity needsrelate to our need to maintain flexibility in a dynamic and competitiveoperating environment, including the ability to pursue potential acquisitionand investment opportunities. We expect our liquidity needs beyond the nexttwelve months would include those mentioned previously as well as to thepossible redemption of our Debentures, which the holders can first require usto repurchase on July 15, 2009.

 

We anticipate generatingpositive cash flows from operations in addition to investment income in fiscal2006 sufficient to fund operations. We anticipate being able to fund ourcurrent operations, future potential acquisitions, any further integration,restructuring or additional merger-related costs, and planned capitalexpenditures for the next twelve months with existing cash and short-terminvestments together with cash generated from operations and investment income.We believe that borrowings under our credit facilities or offerings of equity ordebt securities are possible for expenditures beyond the next twelve months, ifthe need arises, although such offerings may not be available to us onacceptable terms and would be dependent on market conditions at such time.Investments will continue in product development and in new and existing areasof technology. Cash may also be used to acquire technology through purchasesand strategic acquisitions.

 

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**Item 3. Quantitative and QualitativeDisclosures About Market Risk**

 

We are exposed tofinancial market risks, including changes in interest rates, foreign currencyexchange rates, and market prices of equity securities. To mitigate some of ourforeign currency exchange risks, we utilize currency forward contracts andcurrency options. We do not use derivative financial instruments forspeculative or trading purposes, and no significant derivative financialinstruments were outstanding at January 31, 2006.

 

*InterestRate Risk*

 

The primary objective ofour short-term investment activities is to preserve principal while maximizingyields without significantly increasing risk. Our strategy is to invest inwidely diversified short-term investments, consisting primarily of investmentgrade securities, substantially all of which either mature within the nexttwelve months or have characteristics of short-term investments. A hypothetical50 basis point increase in interest rates would result in an approximately $5.0million decrease (less than 0.5%) in the fair value of our available-for-salesecurities.

 

*MarketRisk*

 

We also holdavailable-for-sale equity securities in our short-term investment portfolio. Asof January 31, 2006, gross unrealized gains, before tax effect on theshort-term public equity securities totaled $0.7 million. A reduction in pricesof 10% of these short-term equity securities would result in an approximately$0.7 million decrease (less than 0.5%) in the fair value of our short-terminvestments.

 

In addition, we invest inequity securities issued by privately-held companies that are included in ourlong-term portfolio of investments, primarily for the promotion of business andstrategic objectives. These investments are generally in thinly capitalizedcompanies in the high-technology industry sector or venture capital funds.Because of the nature of these investments, we are exposed to equity pricerisks. We typically do not attempt to reduce or eliminate our market exposureon these securities. A 10% adverse change in equity prices of long-term equitysecurities would result in an approximate $5.4 million decrease in the fairvalue of our long-term securities.

 

*ForeignCurrency Risk*

 

We use derivatives tohedge those net assets and liabilities that, when re-measured or settledaccording to accounting principles generally accepted in the United States,impact our consolidated statement of operations. Currency forward contracts areutilized in these hedging programs. All forward contracts entered into by usare components of hedging programs and are entered into for the sole purpose ofhedging an existing or anticipated currency exposure, not for speculation ortrading purposes. Gains and losses on these currency forward contracts wouldgenerally be offset by corresponding gains and losses on the net foreigncurrency assets and liabilities that they hedge, resulting in negligible netgain or loss overall on the hedged exposures. When hedging balance sheetexposures, all gains and losses on forward contracts are recognized in otherincome (expense) in the same period as when the gains and losses onre-measurement of the foreign currency denominated assets and liabilitiesoccur. All gains and losses related to foreign exchange contracts are includedin cash flows from operating activities in the consolidated statements of cashflows. Our hedging programs reduce, but do not always entirely eliminate, theimpact of foreign currency exchange rate movements. If we do not hedge againstforeign currency exchange rate movement, an increase or decrease of 10% inexchange rates would result in an increase or decrease in income before taxesof approximately $4.3 million. This number represents the exposure related tobalance sheet re-measurement only and assumes that all currencies move in thesame direction at the same time relative to the U.S. dollar.

 

All of the potentialchanges noted above are based on sensitivity analyses performed on ourfinancial position at January 31, 2006. Actual results may differ materially.

 

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**Item 4.Controls and Procedures**

 

(a)                   Evaluation of Disclosure Controls andProcedures

 

Novell’s management, withthe participation of the Chief Executive Officer and Chief Financial Officer,evaluated the effectiveness of Novell’s disclosure controls and procedures asof the end of the period covered by this report. Based on that evaluation, theChief Executive Officer and Chief Financial Officer concluded that Novell’sdisclosure controls and procedures as of the end of the period covered by thisreport were designed and functioning effectively to provide reasonableassurance that the information required to be disclosed by Novell in reportsfiled under the Securities Exchange Act of 1934, as amended, is (i) recorded,processed, summarized and reported within the time periods specified in theSecurities and Exchange Commission’s rules and forms and (ii) accumulated andcommunicated to Novell’s management, including the Chief Executive Officer andChief Financial Officer, or persons performing similar functions, asappropriate to allow timely decisions regarding disclosure.

 

(b)                  Change in Internal Control over FinancialReporting

 

No change in Novell’sinternal control over financial reporting occurred during the first quarter offiscal 2006 that has materially affected, or is reasonably likely to materiallyaffect, internal control over financial reporting.

 

**Part II. Other Information**

 

Except as listed below,other items in Part II are omitted because the items are inapplicable orrequire no response.

 

**Item 1. Legal Proceedings**

 

The information requiredby this item is incorporated herein by reference to Note M of our financialstatements contained in Part I, Item 1 of this Form 10-Q.

 

**Item 6. Exhibits**

 

(a)                   Exhibits

 
| **Exhibit  Number** | ** ** | **Description**                                    |
|---------------------|------------|----------------------------------------------------|
| 12.1                |       | Computation  of Ratio of Earnings to Fixed Charges |
|                |       |                                               |
| 31.1                |       | Rule  13a-14(a) Certification                      |
|                |       |                                               |
| 31.2                |       | Rule  13a-14(a) Certification                      |
|                |       |                                               |
| 32.1                |       | 18  U.S.C. Section 1350 Certification              |
|                |       |                                               |
| 32.2                |       | 18  U.S.C. Section 1350 Certification              |

 

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.

 
|                  | Novell, Inc. (Registrant) |
|-----------------------|---------------------------|
|                  |                      |   |
|                  |                      |   |
| Date:  March 10, 2006 | By:                       | /s/ JOSEPH S. TIBBETTS, JR. |
|                  |                      | Joseph S. Tibbetts, Jr.Chief Financial  Officer(Principal  Financial Officer and Principal Accounting Officer) |

 

 

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