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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K


þ		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended October 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 .

Commission File Number 0-13351

NOVELL, INC.

(Exact name of registrant as specified in its charter)


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

404 Wyman Street, Suite 500

Waltham, MA 02451

(Address of principal executive offices including zip code)

(781) 464-8000

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:


Title of Each Class		Name of Each Exchange on Which Registered

Common Stock, par value $.10 per share		The NASDAQ Stock Market LLC (NASDAQ Global Select Market)

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes o No þ

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

The aggregate market value of the registrant’s common stock held by non-affiliates as of April 30, 2006 (based on the last reported sales price of the common stock on the NASDAQ Global Select Market on such date) was $2,100,323,354. For purposes of this disclosure, shares of common stock held by persons who hold more than 5% of the outstanding common stock and common stock held by executive officers and directors of the registrant have been excluded because such persons are deemed to be “affiliates” as that term is defined under the rules and regulations promulgated under the Securities Act of 1933. This determination is not necessarily conclusive for other purposes.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act)

Large Accelerated Filer þ Accelerated Filer o Non-Accelerated Filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act) Yes o No þ

As of April 30, 2007 there were 346,742,418 shares of the registrant’s common stock outstanding.

EXPLANATORY NOTE

On May 23, 2007, we announced that we had completed our self-initiated, voluntary review of our historical stock-based compensation practices and determined the related accounting impact. The review was conducted under the direction of the Audit Committee of our Board of Directors, who engaged the law firm of Cahill Gordon & Reindel LLP, with whom we previously had no relationship, as independent outside legal counsel to assist in conducting the review. The scope of the review covered approximately 400 grant actions (on approximately 170 grant dates) from November 1, 1996 through September 12, 2006. Within these pools of grants are more than 58,000 individual grants. In total, the review encompassed awards relating to more than 230 million shares of common stock granted over the ten-year period. As a result of the review, we delayed the filing of our Quarterly Reports on Form 10-Q for the fiscal quarters ended July 31, 2006 and January 31, 2007 and our Annual Report on Form 10-K for the fiscal year ended October 31, 2006. Simultaneous with this filing, we are filing our other delinquent reports.

The Audit Committee, together with its independent outside legal counsel, did not find any evidence of intentional wrongdoing by any former or current Novell employees, officers or directors. We have determined, however, that we utilized incorrect measurement dates for some of the stock-based compensation awards granted during the review period.

In light of the above findings, stock-based compensation expense in a cumulative after-tax amount of approximately $19 million should have been reported in our consolidated financial statements during the period from fiscal 1997 through 2005. We have determined, however, that the amounts of stock-based compensation expense that should have been recognized in each of the applicable historical periods, including the interim periods of fiscal 2005 and 2006, were not material to those periods on either a quantitative or qualitative basis. Therefore, we will not restate our consolidated financial statements for prior periods.

We implemented the guidance applicable to the initial adoption of Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements,” as of November 1, 2005. Accordingly, our financial statements for the 2006 fiscal year, included in this report, reflect cumulative adjustments of approximately $19 million for unrecorded stock-based compensation expense, and related income tax effects, as a decrease to retained earnings as of November 1, 2005, the beginning of our 2006 fiscal year. The adjustment to retained earnings will reduce retained earnings as of the beginning of the 2006 fiscal year from $984 million to $965 million, or a reduction of two percent.

NOVELL, INC.

FORM 10-K

This Annual Report on Form 10-K contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements, other than statements of historical fact, regarding our strategy, future operations, financial position, estimated revenue, projected costs, projected savings, prospects, plans, opportunities and objectives constitute “forward-looking statements.” The words “may,” “will,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “potential,” or “continue” and similar types of expressions identify forward-looking statements, although not all such statements contain these identifying words. These forward-looking statements are based upon information that is currently available to us and/or management’s current expectations, speak only as of the date hereof, and are subject to risks and uncertainties. We expressly disclaim any obligation, except as required by law, or undertaking to update or revise any forward-looking statements contained or incorporated by reference herein to reflect any change or expectations with regard thereto or to reflect any change in events, conditions, or circumstances on which any such forward-looking statement is based, in whole or in part. Our actual results may differ materially from the results discussed in or implied by such forward-looking statements. We are subject to a number of risks, some of which may be similar to those of other companies of similar size in our industry, including pre-tax losses, rapid technological changes, competition, limited number of suppliers, customer concentration, failure to successfully integrate acquisitions, adverse government regulations, failure to manage international activities, and loss of key individuals. Risks that may affect our operating results include, but are not limited to, those discussed in Part I Item 1A, titled “Risk Factors.” Readers should carefully review the risk factors described in this document and in other documents that we file from time to time with the Securities and Exchange Commission.

PART I


Item 1.	*Business*

The Company

Novell develops, implements, and supports proprietary, mixed source and open source software for use in business solutions. With approximately 4,500 employees in over 80 offices worldwide, we provide customers with enterprise infrastructure software and a full range of training and support services. Our products enable customers to solve business challenges by maximizing the effectiveness of their information technology (“IT”) environments.

Incorporated in January 25, 1983, Novell has a 24-year history of innovation and industry leadership, enabling customers to build their own ‘Open Enterprise’ by adding the strength, flexibility and economy of open source software to their existing IT infrastructures. We offer an open source platform along with fully integrated systems management and security and identity solutions. Our specific offerings include identity and access management products, resource management products, SUSE^® Linux Enterprise Server (“SLES”), Open Enterprise Server, NetWare^®, and Collaboration products on several operating systems, including Linux, NetWare, Windows, and Unix. These technologies allow us to help customers manage both our open source platform and the other heterogeneous components of their IT infrastructures.

By delivering these technology solutions to our customers, we help them drive increased performance from their IT infrastructures at a reduced cost and with lower risk. In doing so, we give our customers more time to focus on innovation and growth in their core businesses.

To help ensure customer success, we offer customers extensive technical support and training through our worldwide support network. We also have strong partnerships in place with application providers, hardware and software vendors, and consultants and systems integrators. With our open source platform, enterprise infrastructure software, and global network of partners, we offer full solutions to our customers, regardless of their size or location.


Novell annual report 2006	1

Our software solutions are grouped into three main solution categories: systems, security and identity management, open platform solutions, and workspace solutions. In addition, we offer worldwide IT consulting, training and technical support services. Following are descriptions of these categories.

Systems, Security and Identity Management. Our systems, security, and identity management products include applications that offer broad capabilities for automating the management of IT resources. This group of Novell^® solutions creates and assigns digital identities to IT resources, and protects those resources from unauthorized use. They also manage and track the use of IT assets and report on that usage for auditing, billing and compliance reporting purposes. Among other benefits, customers use these solutions to:


	•	Automate the management of IT assets, including servers, desktops, laptops and hand-held devices, through their entire lifecycle with device location tracking, utilization reporting and routing administrative tasks.

	•	Lower the total cost of ownership of desktops and laptops through automated machine configuration and software patch management across the enterprise.

	•	Reduce the complexity and costs of managing users and their access to systems through instant provisioning of new employees, streamlined authentication and authorization, and centrally managed access policies.

	•	Secure enterprise information from unauthorized use through the instant revocation of access rights, the creation of a consistent enterprise-wide security model, and by gaining full visibility into how information, services and resources are being used.

We believe that businesses recognize the need to manage access to their assets, and the use and optimization of those assets, with systems that are driven by business policies. Novell meets this need by offering systems that help customers define, implement and administer business policies across a single enterprise. Novell’s solutions also accommodate customers’ need for increased business agility. By using our products, customers can extend their business processes and systems across organizational and technical boundaries, integrating with the operational environments of their customers, employees, suppliers and partners. This affords organizations the opportunity to make changes to their business operations without incurring the cost of constantly changing individual software application components, and without impacting their business partners.

These identity-based technologies not only regulate user access to data and applications, but are increasingly becoming the basis for securing and managing other information assets, such as mobile computing and communications devices and data center servers. We believe that identity management technologies are increasingly becoming the preferred means by which businesses will efficiently utilize all their IT assets. We have developed products for this market to help our customers take advantage of these opportunities. These products can be deployed across a number of systems, including Linux, NetWare, Windows, and Unix recognizing the heterogeneous nature of today’s IT infrastructures. Our development strategy has been to produce systems, security and identity management technologies as a set of discrete software components that customers can deploy quickly to meet specific business needs. We believe that this approach is far more appealing to customers than the alternative approach of building large, monolithic applications requiring lengthy implementations without any immediate business benefit.

Open Platform Solutions. Our open platform solutions category includes solutions that offer effective, open and cross-platform approaches to computing, networking and collaboration. Open platform solutions offer operating systems, network services, and workgroup software solutions.

With our open platform solutions, including our Linux-based and other related products, we focus on the substantial growth opportunities presented by enterprise adoption of open source technologies.

The foundation of this category is SUSE Linux Enterprise, our high quality and highly interoperable enterprise computing platform. With its openness, reliability and enterprise-class performance, we refer to SUSE Linux


2	Novell annual report 2006

Enterprise as the Platform for the Open Enterprise. It offers businesses a complete open platform that supports mission-critical applications from the desktop to the data center. Components of this platform include:


	•	SUSE Linux Enterprise Server, which handles a variety of server workloads including edge and infrastructure computing, enterprise database deployment, line-of-business applications, and mission-critical software applications.

	•	SUSE Linux Enterprise Desktop, which offers a general-purpose desktop computing environment with high usability, a broad range of productivity applications including a full office suite, and advanced graphic capabilities.

A major focus of our open platform solutions is to advance and promote open source computing, with particular emphasis on driving increased enterprise adoption of Linux. We believe that a major shift toward the use of open source software is well underway across many industry segments. This trend is fueled by organizations that are more critically assessing the cost effectiveness of their existing IT infrastructures, evaluating viable open source alternatives, and seeking ways to avoid vendor lock-in.

We believe that we are uniquely positioned to drive the transition to greater use of open source software, as well as to benefit from this trend. Widespread adoption of Linux and open source software was initially hindered by weak technical support, a shortcoming that we are particularly well positioned to address. We leverage our financial stability, experience, and global services and support capabilities to help our customers integrate Linux and other open source software into their existing IT environments.

While the flexibility and cost savings of Linux and open source have made it attractive to enterprise customers, we believe they continue to look to proprietary software vendors to provide applications, management and security solutions. With our SUSE Linux Enterprise platform, our customers can now easily take a cross-platform approach, deploying the best of proprietary and open source software offerings for management and security functionality. We believe that many businesses find value in Novell providing them with a path to a more open, flexible and reliable IT environment, without requiring them to dismantle or disrupt any software or systems they presently have running. For example, we offer solutions today that allow customers to collaborate seamlessly across their Windows and Linux environments. We also provide solutions that enable IT managers to control Linux, NetWare and Windows systems simultaneously, consistently and easily.

Workspace solutions. Like our open platform solutions, our workspace solutions category also includes solutions that offer effective, open and cross-platform approaches to computing, networking and collaboration. Workspace solutions offer operating systems, network services, and workgroup software solutions. Our workspace solutions category is comprised of proprietary software products that provide customers with powerful solutions that are designed to operate within existing heterogeneous computing environments as well as to provide tools and strategies to allow easy migration between platforms to better fit customers’ technology plans. Our primary server products within this category are Open Enterprise Sever (OES) and NetWare. OES consists of several enterprise-ready, scalable networking and collaboration services. These include file, print, messaging, scheduling and directory-based management modules that allow customers to manage their global computing environment from a single, central console deployed on either of our major operating systems platforms. Our workspace solutions category also includes our GroupWise^® and collaboration technologies, Novell Cluster Services^tm, and BorderManager^®.

Global services and support. We provide worldwide IT consulting, training and technical support services to address our customers’ needs. Our worldwide IT consulting practice provides the business knowledge and technical expertise our customers need to implement and achieve maximum benefit from our products and solutions. We also offer open source and identity-driven services designed to assist our customers with fast and effective application integration or migration of their existing platforms to Linux.

Through our training services, we offer skills assessments, advanced technical training courses, and customized 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,


Novell annual report 2006	3

including Linux. In support of our strategy to drive increased enterprise adoption of Linux, we offer the Novell Certified Linux Engineer^sm and Novell Certified Linux Professional^sm programs.

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

Recent Developments. In the first quarter of fiscal 2007, we modified our segments to focus on a business unit structure, which will allow us to build upon the progress we have made in strengthening our geographic sales and marketing capabilities and to further increase our market responsiveness. Four of the new business units are based on our product categories, specifically:


	•	open platform solutions;

	•	systems and resource management;

	•	identity and security management; and

	•	workgroup.

The final business unit is general business consulting. We believe that this modification created stronger focus on the customer. Each business unit has targets specific to its business in terms of revenue, profit and growth rates. We also believe that process excellence and process consistency are critical to the success of these units. Therefore, each has the same basic structure and main areas of focus: engineering, product management, and product marketing.

With the sizable growth opportunities we see within specific areas of our previous resource management and identity and security management business unit, we now believe a singular focus on the major growth categories within this unit is appropriate and will enable even greater success. Accordingly, we created two separate business units to focus on each of these areas. First, there is the systems and resource management business unit, which focuses on meeting the growing infrastructure management needs of our customers for desktops, networks and servers. This unit includes the entire ZENworks^® product family. Second is the identity and security management business unit that continues to provide advanced, identity-driven solutions to the enterprise market. This unit includes Sentinel^tm, Identity Manager, Novell Access Manager^tm, Secure Login, Novell eDirectory^tm, and Novell Audit.

To further refine our focus on specific growth opportunities, we created two additional business units: open platform solutions and workgroup. The open platform solutions business unit will focus on the unique growth opportunity around open source technologies. This business unit includes SUSE Linux Enterprise, SUSE Linux Enterprise Server, SUSE Linux Enterprise Desktop, and the other Linux-based solutions in our portfolio. The new workgroup business unit will focus on bringing our new technologies for collaboration to both existing and new customers. This business unit includes Open Enterprise Server, NetWare and NetWare-related products, GroupWise, and BorderManager.

We believe that this new business unit structure will help us to further improve our responsiveness to the needs of our customers and the demands of the marketplace.

Components of our Solutions Categories

The following is a description of the core products and services that made up each of our information solution categories during fiscal 2006. A solution may be offered in the form of licenses, maintenance, stand-alone upgrade protection, or in the case of SUSE Linux Enterprise Server, a subscription. Maintenance includes upgrade protection, on a when-and-if available basis, and technical support. A subscription includes configuration support and updates and upgrades to the technology, on a when-and-if available basis. Maintenance, upgrade protection and subscriptions typically have a one to three year contractual term.


4	Novell annual report 2006

Systems, security, and identity management


	•	Resource management products


	•	ZENworks management products protect the integrity of networks by centralizing, automating, and simplifying every aspect of network management, from distributing vital information across the enterprise to maintaining consistent policies on desktops, servers, and devices on Linux, NetWare, and Windows environments.


	•	Identity and access management products


	•	Identity Manager is a powerful data-sharing and synchronization solution, often referred to as a meta-directory solution, which automatically distributes new and updated information across every designated application and directory on a network. This ensures that trusted customers, partners, and suppliers are accessing consistent information, regardless of the applications and directories to which they have access.

	•	SecureLogin is a directory-integrated authentication solution that delivers reliable, single sign-on access across multi-platform networks, simplifying password management by eliminating the need for users to remember more than one password.

	•	iChain^® is an identity-based security solution that controls access across technical and organizational boundaries to applications, the web, and network resources. iChain separates security from individual applications and web servers, enabling single-point, policy-based management of authentication and access privileges throughout the Internet.

	•	Sentinel automates the monitoring of IT for effectiveness allowing users to detect and resolve threats in real-time. Sentinel also provides documented evidence needed by some users to comply with regulatory and industry compliance requirements.


	•	Other systems, security, and identity management


	•	Novell eDirectory is a full-service, platform-independent directory that significantly simplifies the complexities of managing users and resources in a mixed Linux, NetWare, UNIX, and Windows environment. It is a secure, scalable, directory service that allows organizations to centrally store and manage information across all networks and operating systems and leverage existing IT investments.

Open platform solutions.


	•	Linux platform products


	•	SUSE Linux Enterprise Server is an enterprise-class, open source server operating system for professional deployment in heterogeneous IT environments of all sizes and sectors. This operating system integrates all server services relevant in Linux and constitutes a stable and secure platform for the cost-efficient operation of IT environments.

	•	Linux Desktop is a business desktop product that brings together the Linux operating environment with a complete set of office applications. Among the more significant business applications, it includes OpenOffice (an office productivity suite), Mozilla’s Firefox browser, and Novell Evolution^tm, a collaboration client for Linux.


	•	Other open platform products


	•	SUSE Linux, formerly SUSE Linux Professional, is an open source product that combines a fast, secure operating system with over 1,000 open source applications. It is ideal for new Linux users as well as technical enthusiasts, and it is available for download at OpenSUSE.org or available through the retail channel.


Novell annual report 2006	5

Workspace solutions


	•	Open Enterprise Server (“OES”) is a secure, highly available suite of services that provides proven networking, communication, collaboration and application services in an open, easy-to-deploy environment. OES provides customers the choice of deploying on either NetWare or SUSE Linux Enterprise Server and provides common management tools, identity-based services and support backed by Novell.

	•	NetWare and NetWare-related


	•	NetWare is our proprietary operating system platform that offers secure continuous access to core network resources such as files, printers, directories, e-mail and databases seamlessly across all types of networks, storage platforms and client desktops.

	•	Novell Cluster Services is a scalable, highly available Storage Area Network resource management tool that reduces administrative costs and complexity of delivering uninterrupted access to information and resources.


	•	Collaboration


	•	GroupWise collaboration products offer traditional and mobile users solutions for communication over intranets, extranets and the Internet.


	•	Other workspace


	•	BorderManager is a suite of network services used to connect a network securely to the Internet or any other network, allowing outside access to intranets and user access to the Internet.

	•	Novell iFolder^® is a product that allows users to access, organize, and manage computer files from any computer at any time, while ensuring the information is safe and up-to-date.

Global services and support.


	•	Consulting services: We provide technical expertise to deliver world-class solutions, based on an innovative approach focused on solving our customers’ business problems. We deliver services ranging from discovery workshops to strategy projects to solution implementations, all using a consistent, well-defined methodology. Our consulting approach is based on a strong commitment to open standards, interoperability, and the right blend of technology from Novell and other leading vendors.

	•	Technical Support: We provide phone-based, web-based, and onsite technical support for our proprietary and open source products through our Premium Service^sm program. Premium Service provides customers with the flexibility to select the appropriate level of technical support services, which may include stated response times, around-the-clock support, service account management, and dedicated resources, such as Novell’s most experienced engineers. The Dedicated Support Engineer, Primary Support Engineer, Advantage Support Engineer, and Account Management programs allow customers to build an ongoing support relationship with Novell at an appropriate level for their needs. We have committed a significant amount of technical support resources to the Linux open source platform. We also offer a full array of remote monitoring services and managed services. These services help customers increase system uptime, leveraging our experts to monitor and maintain the technologies our customers have employed.


	•	Technical Support Alliance (“TSANet”): TSANet is an industry organization that enables worldwide seamless collaborative support for multi-vendor support issues. TSANet was originally organized in 1993, with Novell being instrumental in the formation and charter of the organization. Membership today consists of more than one hundred software and hardware companies, including industry leaders such as Dell Inc., EMC Corporation, Hewlett-Packard Company, International Business Machines Corporation, Microsoft Corporation, Novell, Inc., Red Hat Inc., Sun Microsystems, Inc., Symantec Corp., and Unisys Corporation. We are an active member of TSANet worldwide, with representation on both the North American Board of Trustees and the European Board of Directors.


6	Novell annual report 2006


	•	Training Services: We accelerate the adoption and enable the effective use of our products and solutions through the delivery of timely and relevant instructor-led and technology-based training courses, assessments and performance consulting services.

Programs are delivered directly to customers and through our global channel of authorized Novell training partners. Our courses provide customers with a thorough understanding of the implementation, configuration, and administration of our products and solutions. Additionally, we offer performance consulting services that provide clients and partners with an evaluation of their proficiencies and their knowledge gaps. We also deliver Advanced Technical Training at an engineer level to customers and partners on a global basis. Our key certification programs include the following:


	•	Certified Novell Engineer^sm (“CNE^®”) Program: Through the long-standing CNE program, we are strengthening the networking industry’s self-support capability. CNE certificate holders are individuals who have received in-depth training and information and passed a comprehensive test validating their ability to proficiently administer both Novell and other networks.

	•	Certified Linux Professional (“CLP”) Program: The CLP program represents the cornerstone of our commitment to providing training and certification options for our clients and partners who require credentials and validation of competency on our SUSE Linux Enterprise Server platform.

	•	Certified Linux Engineer (“CLE”) Program: The CLE program represents the IT industry’s most advanced Linux engineering certification. Our Practicum testing technology allows us to validate a student or IT professional’s competencies versus the classic IT certification approach of testing book knowledge.

Strategy

We offer customers enterprise infrastructure software in a flexible combination of open source, mixed source and proprietary technologies. We also offer a full range of high-quality services to ensure customer success in their deployments of our solutions. Our strategy is to offer customers a compelling open source computing platform, along with integrated systems, security, and identity solutions, and workspace products. By offering these technologies and services, and showing customers how they can easily manage both our platform and the other heterogeneous components of their IT infrastructures, we will help them drive increased IT effectiveness while lowering cost, complexity and risk. Deployed either directly or through our global network of partners, Novell solutions enable customers to spend more of their time, energy and resources focused on driving their own businesses forward.

Our strategy is to create products that enable our customers to secure, manage, simplify, and integrate their heterogeneous IT environments at low cost, while ensuring the products are easy to implement, deploy and maintain. A key component of our strategy is to ensure that key Novell product functions work on the Linux platform. We pursue our strategy through five key areas as follows:

Product Strategy

Our overall products and services strategy is two-fold. First, we offer products and services that will help to broaden and accelerate enterprise adoption of Linux in general, and SUSE Linux Enterprise in particular. We plan to leverage this broadening base of Linux implementations as a foundation upon which we will sell our enterprise infrastructure software offerings, which is the second part of our strategy.

A key enabling element of this strategy is for us to continue to deliver innovative, open source and open standards-based products that are easy to deploy, simple to operate, and highly reliable and scalable. By doing so, we will empower IT executives to create more robust computing environments at a lower cost of operation.

With regard to Linux adoption, we plan to continue our strong support of the open source development community, and of the many open source organizations and projects to which we presently contribute. We also plan to continue to use our significant engineering and support resources to encourage customers to adopt Linux. One way we can accomplish this is to develop and sell key product functions that operate on the Linux platform.


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To support the second part of our two-fold strategy — driving sales of enterprise infrastructure software — our plan is to continue developing and delivering role-based, policy-driven identity management solutions (based on a set of processes that control access to applications based on a pre-determined set or rules). Our design approach involves creation of sets of open standards-based, discrete software products that are easy for customers to implement and that quickly deliver value — without further dependence on proprietary software. We use our enterprise infrastructure software as a basis for establishing and maintaining long-term strategic relationships with key customers.

Professional Services Strategy

Our professional services strategy is to focus our IT consulting and training expertise on identity-driven solutions and open source software adoption, and to provide a full range of support services for all our proprietary, mixed source and open source products.

Alliances and Partnership Strategy

We partner with industry leaders in the software, hardware, consulting, and system integration industries to bring to market our solution offerings. We believe that a well-managed and supported partnership portfolio is critical to our success in today’s competitive solutions market and helps increase our revenue and customer reach. Our business partner strategy is based on having a single partner program with a goal of providing consistent interactions with Novell focused on technology enablement, certification, joint marketing, and sales initiatives.

To ensure partner efficiency, we have developed a partner ecosystem that combines our knowledge, services and solutions with that of our partners’ to provide customers the ability to adapt to, and profit from, the opportunities open source and identity brings to businesses. We become the foundation for the ecosystem, providing technology, programs, resources, and skills to create solutions and ensure that customers get the functionality and business value required to improve the bottom line results of their businesses.

Our partners include: Microsoft, IBM, HP, Dell, Inc., Intel Corporation, Oracle Corporation, SAP AG, Advanced Micro Devices, Inc., Veritas, Computer Associates International, Inc., EMC, and Adobe Systems, Inc. These partners are all members of the Novell PartnerNet^® Program and gain value through participating in different partner tracks. Solution providers gain access to various marketing programs that help drive sales volumes. Technology partners receive solution developer toolkits and services that ensure successful enablement of their technology with our technology. Our training partners have opportunities to increase their skill levels and provide training services to our customers.

Multi-channel Sales Strategy

We deliver solutions through direct and indirect channels, serving large organizations directly or with systems integration partners, and serving small- and medium-sized organizations through our channel partners. We have reengaged and renewed our business partner and channel relationships, with an emphasis on specialization, giving us a greater presence in the marketplace while lowering our distribution costs. To maximize our reach while ensuring the highest quality of service to our customers, we provide our channel partners complete access to all of our tools, training and methodologies.

Personnel Development Strategy

Our employees are our most significant asset. We work continuously to update their skill sets by providing education and training to improve our productivity. We regularly assess our development progress and focus on key areas as appropriate.

Where appropriate, we also intend to augment our offerings and delivery capabilities through acquisitions. Taken together, we believe the success of these key strategies will provide lasting benefits to our customers and stockholders alike.


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Recent Developments.

We recently entered into a partnership with Microsoft. The overarching purpose of this partnership is to increase the utility, desirability and penetration of Linux by enabling its interoperation with Windows to a mixed environment that is easier to maintain. We believe that this partnership will help us deliver value to customers by giving them greater flexibility and effectiveness in their IT environments. The partnership consists of three related agreements:


	•	A technical collaboration agreement primarily in the areas of virtualization, web services management, directory interoperability, and document format compatibility;

	•	A business collaboration agreement around joint sales and marketing activities; and

	•	A patent cooperation agreement.

We believe that this partnership addresses pressing, industry-wide issues, that it puts customers’ needs first, and that our company will benefit from it financially and strategically.

Acquisitions and Dispositions

We acquire companies or technology when we determine that the related products or technology are strategic or complimentary to our current or future product offerings, as the opportunities arise. For example, during fiscal 2006, we acquired 100% of the outstanding stock of e-Security, Inc., which provides security information, event management and compliance software. e-Security’s products are now part of our identity and access management sub-category. During fiscal 2006, we also acquired the remaining 50% interest in our sales and marketing joint venture in India; we acquired some developed technology, which was integrated into our Workspace solutions products; and we along with four other companies, established Open Invention Network, LLC (“OIN”), a privately held company that has and will acquire patents to promote Linux and open source.

As we determine that parts of our business are no longer strategic to the company as a whole, we will look for alternatives such as divestitures or other capital structures. For example, during fiscal 2006, we sold our shares in Celerant consulting to a group comprised of Celerant management and Caledonia Investments plc and we sold our Japan consulting group to a third party as these operations were no longer strategic to our business.

Segment and Geographic Information

We sell our products, services, and solutions primarily to corporations, government entities, educational institutions, resellers and distributors both domestically and internationally.

We operate and report our financial results in three segments based on geographic area. Prior to May 2006, we had a fourth segment, Celerant consulting, which was divested in May 2006 and is included in discontinued operations (see Note E to our consolidated financial statements). Our performance is evaluated by our Chief Executive Officer and our other chief decision makers based on reviewing revenue and segment operating income (loss) information for each geographic segment.

The geographic segments are:


	•	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 to conform to the new segment presentation.

All segments sell our software and services. These offerings are sold in the United States directly and through original equipment manufacturers, resellers, and distributor channels, and internationally directly and through original equipment manufacturers and distributors who sell to dealers and end users.


Novell annual report 2006	9

Segment disclosures and geographical information for fiscal years 2006, 2005, and 2004 are presented in Part II, Item 8, Note AA of the notes to the consolidated financial statements of this report, which is incorporated by reference into this Part I, Item 1.

Segment Changes

Beginning in the first quarter of fiscal 2007, we will begin operating and reporting our financial results in five new business unit segments based on information solution categories, rather than on geographic area. The new segments will be:


	•	Open Platform Solutions, which will focus on the unique growth opportunities around open source technologies. This business unit includes SUSE Linux Enterprise, SUSE Linux Enterprise Desktop, and other Linux-based solutions.

	•	Systems and Resource Management, which will focus on meeting the growing infrastructure management needs of our customers for desktops, networks and servers. This business unit includes the ZENworks product family.

	•	Identity and Security Management, which will continue to provide advanced, identity-driven solutions to the enterprise market. This business unit includes Sentinel, Identity Manager, Access Manager, Secure Login, eDirectory, and Novell Audit.

	•	Workgroup, which will focus on bringing our new technologies for collaboration to both existing and new customers. This business unit includes Open Enterprise Server, NetWare, GroupWise and BorderManager.

	•	Business consulting, which conducts general consulting activities and is comprised primarily of our Salmon and Swiss consulting units.

We changed our operating and reporting structure to increase integration and teamwork internally, to build stronger business-focused units, and to be better equipped to address customer needs. As our strategy continues to evolve, the way in which management views financial information to best evaluate performance and operating results may also change.

Product Development

We conduct product development activities throughout the world in order to meet the needs of our worldwide customer base. Our commitment to deliver world-class products that manage, simplify, secure, and accelerate business solutions means continued investment in product development. Our major product development sites include Provo, Utah; Waltham and Cambridge, Massachusetts; Nuremberg, Germany; Dublin, Ireland; Bangalore, India; and Prague, Czech Republic.

In addition to technology developed in-house, our products also include technology developed by the open source community. Some of our product development engineers work as a part of open source development teams across the world. This involvement ensures our role in leading technical advances, developing new features and having input over timing of releases, as well as other information related to the development of the Linux kernel and other open source projects.

Product development expenses for the fiscal years 2006, 2005, and 2004 are discussed in Part II, Item 7 of this report, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which is incorporated by reference into this Part I, Item 1.

Sales and Marketing

Our sales and marketing strategy targets customers who are looking for solutions in the following five technology areas: data center, security and identity management, resource management, desktop and workgroup. We sell our business solutions via a multi-channel sales and marketing model, with value added partners such as demand agents, vertical markets resellers, systems integrator distributors, and OEMs who meet our criteria, as well


10	Novell annual report 2006

as selling directly to named enterprise customers. In addition, we conduct sales and marketing activities and provide technical support, training, and field service to our customers from our 21 U.S. and 99 international sales offices.

Distributors. We have established a network of independent distributors who sell our products to resellers, dealers, VARs (value added resellers), and computer retail outlets. As of October 31, 2006, there were 11 U.S. distributors and approximately 112 international distributors.

VARs and Systems Integrators. We also sell directly to VARs and systems integrators who provide solutions across multiple vertical market segments and whose volume of purchases warrants buying directly from us.

OEMs/Independent Hardware Vendors (“IHVs”)/Independent Software Vendors (“ISVs”). We license subsets of products to domestic and international OEMs/IHVs/ISVs for integration with their products and/or solutions. As of October 31, 2006, we had agreements with approximately 150 IHVs and ISVs.

End-User Customers. We have assembled worldwide field resources to work directly with enterprise end users. Additionally, product upgrades and software maintenance are sold directly to end-users. Customers can also purchase products and services under license agreements through partners or resellers in or near their geographic locations.

Marketing Strategy. Our marketing strategy is to clearly articulate Novell’s value proposition in the markets we choose to serve and in doing so attract and retain satisfied customers. To do this, we employ multiple channels of communications to raise awareness, generate demand and provide tools for our multi-channel field sales and services organizations. We examine and select market opportunities that best fit our current product portfolio and solutions strengths. This includes researching geographic and industry markets, determining product lifecycle maturity, and assessing competitive strategies. Our marketing strategy is driven by a key set of metrics that include the measurement of awareness across geographies, specific lead generation metrics and deliverables to support the sales process. Our marketing strategy will be successful if we increase the market’s adoption of our products based on clear market differentiation, improve the win ratio of our sales force by providing quality training and tools, and shorten the sales cycle by providing convincing evidence of our capabilities to prospective customers. Our target marketing audience is the CIO and other senior IT executives responsible for key IT functions across the enterprise.

Marketing Initiatives. Our marketing activities are varied but tightly focused. To more closely align our offerings with customers needs, we have developed a series of strategic campaigns that address these customer needs and align them with our capabilities. Specifically, our campaigns are focused on promoting our enterprise wide “desktop to data center” Linux platform, our Security and Systems Management offerings used to manage mixed IT environments, and our advanced workgroup capabilities for file, print, directory, and advanced collaboration. Our marketing campaigns are based on our positioning of “Software for the Open Enterprise”. We believe this positioning best serves us in increasing our relevance to our customers

International Revenue. In fiscal years 2006, 2005, and 2004, approximately 52%, 55%, and 53%, respectively, of our revenue was generated from customers outside the U.S. No foreign countries accounted for more than 10% of revenue in fiscal year 2006 or 2004. In fiscal 2005, revenue in the United Kingdom accounted for approximately 12% of our total revenue based on revenue classified by location of the end-user customers. For information regarding risk related to foreign operations, see Part I, Item 1A, “Risk Factors,” which information is incorporated by reference into this Part I, Item 1.

Major Customers

No single customer accounted for more than 10% of our revenue in fiscal year 2006, 2005, or 2004.

Manufacturing Suppliers

Our physical products, which consist primarily of discs and manuals, are duplicated by outside vendors. Multiple high-volume manufacturers are available. We do not rely on a single provider for our raw materials, nor have we encountered problems with our existing manufacturing suppliers.


Novell annual report 2006	11

Backlog

Lead times for our products are relatively short. Consequently, we do not believe that backlog is a reliable indicator of future revenue or earnings. Our practice is to ship products promptly upon the receipt of purchase orders from our customers and, therefore, backlog is not significant.

Although we have a significant amount of deferred revenue recorded on our consolidatated balance sheet, included in this report, the majority of this amount relates to maintenance contracts and subscriptions, which is recognized ratably over the related service periods, typically one to three years, and does not pertain to unshipped product.

Competition

The market for identity-driven computing solutions and Linux and platform services solutions is highly competitive and subject to rapid technological change. We expect competition to continue to increase both from existing competitors and new market entrants. We believe that competitive factors common to all of our segments include the following:


	•	our ability to preserve our traditional customer base;

	•	our ability to sell overall solutions comprised of products and services provided by us and our partners;

	•	the timing and market acceptance of new solutions developed by us and our competitors;

	•	brand and product awareness;

	•	the ability of Linux and open source solutions to provide a lower total cost of ownership;

	•	the completeness of our suite of product and solutions offerings to solve customer problems;

	•	our ability to establish and maintain key strategic relationships with distributors, resellers, independent software vendors, and other partners; and

	•	the pricing of our products and services and the pricing strategies of our competitors.

Primary competitors of our identity-driven computing solutions include Microsoft, IBM, Sun, Oracle, HP, Altiris, Inc., LANDesk, Inc., and Computer Associates. Primary competitors for our Linux and platform services solutions include Microsoft and Red Hat. Primary competitors of our global services and support group include IBM, Accenture, HP, Computer Services Corporation (“CSC”) and Capgemini Group.

One pervasive factor facing us and all companies doing business in our industry is the presence — and dominance — of Microsoft. However, in November 2006 Novell and Microsoft entered into a set of broad business and technical collaboration agreements to build, market and support a series of new solutions to make Novell and Microsoft products work better together. The two companies also agreed to provide each other’s customers with patent coverage for their respective products. We will continue to be competitors of Microsoft, but it is our goal that through this set of agreements, Microsoft will serve as an important indirect source of channel sales for Novell’s Linux sales.

Copyright, Licenses, Patents, and Trademarks

We rely on copyright, patent, trade secret, and trademark law, as well as provisions in our license, distribution, and other agreements to protect our intellectual property rights. Our portfolio of patents, copyrights, and trademarks as a whole is material to our business but no individual piece of intellectual property is critical to our business. We have been issued what we consider to be valuable patents and have numerous other patents pending. No assurance can be given that the pending patents will be issued or, if issued, will provide protection for our competitive position. Notwithstanding our efforts to protect our intellectual property through contractual measures, unauthorized parties may still attempt to violate our intellectual property rights.

Our business includes a mix of proprietary offerings and offerings based on open source technologies. With respect to proprietary offerings, we perform the majority of our development efforts internally, but we also acquire


12	Novell annual report 2006

and license technologies from third parties. No one license is critical to our business. Our open source offerings are primarily comprised of open source components developed by independent third parties over whom we exercise no control. The collective licenses to those open source technologies are critical to our business. If we are unable to maintain licenses to these third party open source materials, our distribution of relevant offerings may be delayed until we are able to develop, license, or acquire replacement technologies. Such a delay could have a material adverse impact on our business.

In November 2005, Open Invention Network LLC (“OIN”) was established by us, IBM, Philips, Red Hat and Sony. OIN is a privately held company that has and will acquire patents to promote Linux and open source by offering its patents on a royalty-free basis to any company, institution or individual that agrees not to assert its patents against the Linux operating system or certain Linux-related applications. In addition, OIN, in its discretion, will enforce its patents to the extent it believes such action will serve to further protect and promote Linux and open source. In fiscal 2007, NEC became an investor in OIN, with the same rights, privileges and obligations as the original investors.

The software industry is characterized by frequent litigation regarding patent, copyright and other intellectual property rights and trends suggest that this may increase. From time to time, we have had infringement claims asserted by third parties against us and our products. While there are no known pending or threatened claims against us for which we expect to have an unsatisfactory resolution that would have a material adverse effect on our results of operations and financial condition, there can be no assurance that such claims will not be asserted, or, if asserted, will be resolved in a satisfactory manner. In addition, there can be no assurance that third-parties will not assert other claims against us with respect to any third-party technology. In the event of litigation to determine the validity of any third-party claims, such litigation could result in significant expense to us and divert the efforts of our technical and management personnel, whether or not such litigation is determined in our favor.

In the event of an adverse result in any such litigation, we could be required to expend significant resources to develop non-infringing technology or to obtain licenses to the technology that was the subject of the litigation. There can be no assurance that we would be successful in such development or that any such licenses would be available.

In addition, the laws of certain countries in which our products are or may be developed, manufactured, or sold may not protect our products and intellectual property rights to the same extent as the laws of the U.S.

Seasonality

All segments of our business often experience a higher volume of revenue at the end of each quarter and during the fourth quarter of our fiscal year due to the spending cycles of our customers and the negotiation patterns typical in the software industry.

Corporate Information

Novell was incorporated in Delaware on January 25, 1983. Our headquarters and principal executive offices are located at 404 Wyman Street, Suite 500, Waltham, MA 02451. Our telephone number at that address is (781) 464-8000. We also have offices located in Provo, Utah, telephone number (801) 861-7000. Our website is www.novell.com. We conduct primary product development activities in Provo, Utah; Waltham, Massachusetts; Cambridge, Massachusetts; Dublin, Ireland; Nuremberg, Germany; Bangalore, India, and Prague, Czech Republic. We also contract out some product development activities to third-party developers.

Our Annual Report, Securities and Exchange Commission (“SEC”) filings, earnings announcements, and other financial information are available on our Investor Relations website at http://www.novell.com/ir. We make our annual, quarterly, and current reports, including any amendments to those reports, freely available on our website as soon as reasonably practicable after they are filed with or furnished to the SEC. This and other information that we file with or furnish to the SEC is also freely available on the SEC’s website at www.sec.gov. Mailed copies of these reports can be obtained free of charge through our automated telephone access system at (800) 317-3195 or by emailing Novell’s investor relations department at irmail@novell.com. The information on


Novell annual report 2006	13

our website listed above is not and should not be considered part of this Annual Report on Form 10-K and is intended to be an inactive textual reference only.

Employees

As of April 30, 2007, we had 4,549 employees. The functional distribution of our employees was: sales and marketing — 1,094; product development — 1,373; general and administrative — 635; and service, consulting, training, and operations — 1,447. Of these, 3,630 employees are in locations outside the Americas. None of our employees are represented by a labor union, and we consider our employee relations to be good.

Competition for personnel of the highest caliber is intense in the software and consulting industries. To make a long-term relationship with us rewarding, we endeavor to give our employees challenging work, educational opportunities, competitive wages, sales commission plans, bonuses, and opportunities to participate financially in the success of Novell through stock option and stock purchase plans.


Item 1A.	*Risk Factors*

Matters related to or arising out of our historical stock-based compensation practices, including government actions, litigation matters, NASDAQ listing and downgrades in our credit ratings, could have a material adverse effect on the Company.

Our historical stock-based compensation practices have exposed us to risks associated with the judgments we made historically as well as those made as a result of our review of those practices. Based on the findings of the review of our historical stock-based compensation practices by the Audit Committee, we concluded that we had utilized incorrect measurement dates for some of the stock-based compensation awards granted during the review period, November 1, 1996 through October 31, 2006. As a result, we have recorded in our consolidated financial statements for the fiscal year ended October 31, 2006, which are included in this Annual Report on Form 10-K, a cumulative $19.2 million adjustment for unrecorded stock-based compensation expense, and related income tax effects, as a decrease to retained earnings as of November 1, 2005, the beginning of our 2006 fiscal year, in accordance with the guidance applicable to the initial compliance with Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” and $0.1 million of non-cash expense in the 2006 fiscal year. We determined that the amounts of stock-based compensation expense that should have been recognized in each of the applicable historical periods were not material to those periods on either a quantitative or qualitative basis. Therefore, we did not restate our consolidated financial statements for prior periods. While we believe that we have made appropriate judgments regarding materiality and in determining the correct measurement dates for our stock-based compensation awards , the SEC and the IRS may disagree with our judgments. If the SEC or the IRS disagrees with our judgments, we may have to restate our financial statements, amend prior filings with the SEC, incur additional expenses as a result of different tax decisions, or take other actions not currently contemplated.

As discussed in Part I, Item 3, “Legal Proceedings,” derivative actions were filed against us and our current and former officers and directors after we disclosed the commencement of our Audit Committee’s review of our historical stock-based compensation practices. The disclosure about our historical stock-based compensation practices in this Annual Report on Form 10-K may adversely affect the outcome of that litigation and may result in the filing of additional litigation and in government actions. No assurance can be given regarding the outcomes of litigation or government actions relating to our historical stock-based compensation practices. The resolution of any of such matters may be time consuming and expensive, and may distract management from the conduct of our business. Furthermore, if we are subject to adverse findings in litigation or government actions, we could be required to pay damages or penalties or have other remedies imposed, which could harm our business, financial condition, results of operations and cash flows.

As a result of our Audit Committee’s review of our historical stock-based compensation practices, we were delinquent in filing our Quarterly Reports on Form 10-Q for the fiscal quarters ended July 31, 2006 and January 31, 2007 and our Annual Report on Form 10-K for the fiscal year ended October 31, 2006 with the SEC. Consequently, NASDAQ notified us that we were not in compliance with the filing requirements for continued listing as set forth in


14	Novell annual report 2006

Marketplace Rule 4310(c)(14) and were therefore subject to delisting from the NASDAQ Global Select Market. As a result, we requested and participated in a hearing with NASDAQ to determine our listing status. NASDAQ ultimately permitted our securities to remain listed provided that we file our delinquent periodic reports with the SEC within a specified time frame. On May 25, 2007, we filed our Quarterly Reports on Form 10-Q for the fiscal quarters ended July 31, 2006 and January 31, 2007 and our Annual Report on Form 10-K for the fiscal year ended October 31, 2006 with the SEC. However, if NASDAQ determines that we do not meet the NASDAQ’s listing requirements, our common stock may be delisted from the NASDAQ Global Select Market.

Furthermore, the disclosure about our historical stock-based compensation practices in this Annual Report on Form 10-K and any resulting adverse effects on the Company as described above could cause our credit ratings to be downgraded. A significant downgrade in ratings may increase our cost of borrowing or limit our access to capital.

We may experience difficulties, delays or unexpected costs in completing our cost reduction and sales growth strategic initiatives and may not achieve the anticipated benefits of these initiatives.

We previously announced three strategic initiatives as part of our plan to increase profitability through revenue growth and cost reduction. These initiatives include a major shift in our sales strategy from direct to indirect sales; an investment in overlapping offshore research and development teams to eventually assume functions once handled by more expensive environments; and a move to a shared services model for our financial and administrative functional support in order to reduce costs. We may not realize, in full or in part, the anticipated benefits from one or more of these initiatives, and other events and circumstances, such as difficulties, delays or unexpected costs, may occur which could result in our not realizing all or any of the anticipated benefits. If we are unable to realize these benefits, our ability to continue to fund our planned business activities may be adversely affected. In addition, our plans to invest in these initiatives ahead of future growth means that such costs will be incurred whether or not we realize these benefits. We are also subject to the risk of business disruption in connection with our strategic initiatives, which could have a material adverse effect on our business, financial condition and operating results.

Our shift to a sales strategy more focused on indirect sales may result in decreased or fluctuating revenue.

We have historically relied heavily on our direct sales force in selling our products. Our ability to achieve significant revenue growth in the future will depend in large part on our success in establishing relationships with distributors and OEM partners. We are currently investing, and plan to continue to invest, significant resources to develop distribution relationships. Our distributors also sell, or may potentially sell, products offered by our competitors. There can be no assurance that we will be able to retain or attract a sufficient number of existing or future third party distribution partners or that such partners will recommend, or continue to recommend, our products. The inability to establish or maintain successful relationships with distributors and OEM partners could cause our sales to decline.

In addition, indirect channel sales involve a number of special risks. We lack control over the delivery of our products to end-users. Resellers and distributors may have the ability to terminate their relationship with us on short notice. Our indirect channel partners may not market or support our products effectively or be able to release their products embedded with our products in a timely manner. We may not be able to effectively manage conflicts between our various indirect channel and direct customers, and economic conditions or industry demand may adversely affect indirect channel partners, or indirect channel partners may devote greater resources to marketing and supporting the products of other companies. As a result, revenues derived from indirect channel partners may fluctuate significantly in subsequent periods, which may adversely affect our business, operating results, and financial condition.

Increasing our foreign research and development operations exposes us to risks that are beyond our control and could affect our ability to operate successfully.

In order to enhance the cost-effectiveness of our operations, we plan to increasingly shift portions of our research and development operations to jurisdictions with lower cost structures than that available in the United States. The transition of even a portion of our research and development operations to a foreign country involves a


Novell annual report 2006	15

number of logistical and technical challenges that could result in product development delays and operational interruptions, which could reduce our revenues and adversely affect our business. We may encounter complications associated with the set-up, migration and operation of business systems and equipment in expanded or new facilities. This could result in delays in our research and development efforts and otherwise disrupt our operations. If such delays or disruptions occur, they could damage our reputation and otherwise adversely affect our business and results of operations.

We cannot be certain that any shifts in our operations to offshore jurisdictions will ultimately produce the expected cost savings. We cannot predict the extent of government support, availability of qualified workers, future labor rates, or monetary and economic conditions in any offshore locations where we may operate.

The relocation of labor resources may have a negative impact on our existing employees, which could negatively impact our operations. In addition, we will likely be faced with competition in these offshore markets for qualified personnel, including skilled design and technical personnel, and we expect this competition to increase as companies expand their operations offshore. If the supply of such qualified personnel becomes limited due to increased competition or otherwise, it could increase our costs and employee turnover rates.

Our NetWare revenue stream continues to deteriorate.

We have been selling and upgrading NetWare for many years, sales of which have been declining. Our strategy is to offset these declines by sales of our next generation of NetWare enterprise-ready operating system and services, Open Enterprise Server, or OES, which gives customers the opportunity to choose between a NetWare operating system and a Linux operating system, providing NetWare customers a means to migrate to Linux and open source solutions. However, NetWare and OES combined license and maintenance revenue of our business declined by $49.4 million or 18% in fiscal 2006, excluding the impact of favorable foreign exchange rates. If our strategy is unsuccessful, our NetWare and OES revenue stream will deteriorate faster than the growth of revenue streams from our other products.

If our identity-driven computing solutions and Linux and platform services solutions do not grow at the rate we anticipate, our growth will be negatively impacted.

Our product strategy focuses on two specific areas: identity-driven computing solutions, and Linux and platform services solutions with a specific emphasis on open source platforms. We have focused on these offerings because we believe that identity-driven solutions and open source platforms are two of the fastest growing segments in our industry, and we believe that they represent the best opportunity for us to profitably grow our revenue. Our ability to achieve success with this strategy is dependent on a number of factors including, but not limited to, the following:


	•	the growth of these markets;

	•	our development of key product solutions and upgrades;

	•	the acceptance of our solutions by clients, particularly enterprise companies, large industry partners and major accounts;

	•	enticing customers to upgrade from older versions of our products to newer versions; and

	•	successfully selling technical support and other Novell solutions along with our products.

We may not be able to successfully compete in a challenging market for computer software and consulting services.

The industries we compete in are highly competitive. We expect competition to continue to increase both from existing competitors and new market entrants. Competitors of our identity-driven computing solutions and Linux and platform services solutions include Microsoft, IBM, Sun, HP, Altiris, Oracle, LANDesk, and Computer Associates. Our primary competitor in the North America Linux market is Red Hat. Competitors of our global services and support group include IBM, Accenture, HP, CSC and Capgemini. Many of our competitors have


16	Novell annual report 2006

greater financial, technical and marketing resources than we have. We believe that competitive factors common to all of our segments include:


	•	the pricing of our products and services and the pricing strategies of our competitors;

	•	the timing and market acceptance of new solutions developed by us and our competitors;

	•	brand and product awareness;

	•	the performance, reliability and security of our products;

	•	the ability to preserve our legacy customer base;

	•	our ability to establish and maintain key strategic relationships with distributors, resellers and other partners; and

	•	our ability to attract and retain highly qualified development, consulting and managerial personnel.

If third parties claim that we infringed upon their intellectual property, our ability to use some technologies and products could be limited and we may incur significant costs to resolve these claims.

Litigation regarding intellectual property rights is common in the software industry. We have from time to time received letters or been the subject of claims suggesting that we are infringing upon the intellectual rights of others. In addition, we have faced and expect to continue to face from time to time disputes over rights and obligations concerning intellectual property. The cost and time of defending ourselves can be significant. If an infringement claim is successful, we and our customers may be required to obtain one or more licenses from third parties, and we may be obligated to pay or reimburse our customers for monetary damages. In such instances, we or our customers may not be able to obtain necessary licenses from third parties at a reasonable cost or at all, and may face delays in product shipment while developing or arranging for alternative technologies, which could adversely affect our operating results.

In the event claims for indemnification are brought for intellectual property infringement, we could incur significant expenses, thereby adversely affecting our results of operations.

We indemnify customers against certain claims that our products infringe upon the intellectual property rights of others. Additionally, under our Novell Linux Indemnification Program, we offer indemnification for copyright infringement claims made by third parties against registered Novell customers who obtain SUSE Linux Enterprise Server 8, SUSE Linux Enterprise Server 9, SUSE Linux Enterprise Server 10, SUSE Linux Enterprise Desktop 10, SUSE Linux Retail Solution, Novell Point of Service, Novell Linux Desktop, and SUSE Linux Enterprise Desktop, and who, after January 12, 2004, obtained upgrade protection and a qualifying technical support contract from us or a participating channel partner. Although indemnification programs for proprietary software are common in our industry, indemnification programs that cover open source software are less so. For example, the SCO Group, Inc. has brought claims against two end users of Linux and has threatened to bring claims against other end users of Linux arising out of the facts alleged in SCO’s lawsuit against IBM and in SCO’s public statements. In the event that claims for indemnification are brought for intellectual property infringement, we could incur significant expense reimbursing customers for their legal costs and, in the event those claims are successful, for damages.

Legal actions being taken by SCO could adversely affect our revenue and business plan if these legal actions cause a reduction in demand for our SUSE Linux and Ximian^® products.

SCO filed a legal action in March 2003 against IBM alleging, among other things, that Linux is an unauthorized derivative of UNIX and that portions of UNIX intellectual property that SCO alleges it owns have been included in the Linux operating system without authorization. In addition, SCO has warned that legal liability for the use of Linux may extend to commercial users, has threatened such users with litigation and has sought licensing fees from them, and more recently has filed Linux-related suits against other parties. As discussed below, SCO sued Novell for slander of title relating to disputes about whether Novell or SCO owns the copyrights to UNIX, on which some of SCO’s Linux-related claims depend. It is possible that SCO’s actions may reduce general demand


Novell annual report 2006	17

for Linux and Linux related products and services. In this event, demand for our Linux (or open source) products and services could decrease, which would reduce revenue, and otherwise adversely affect our business since we have made a strategic decision to become active in the Linux market.

A lawsuit filed against us by SCO could result in a substantial judgment against us and adversely affect our revenue and business plan if SCO is successful.

In January 2004, SCO filed suit against us in the Third Judicial District Court of Salt Lake County, State of Utah. We removed the claim to the U.S. District Court, District of Utah. SCO’s original complaint alleged that our public statements and filings regarding the ownership of the copyrights in UNIX and UnixWare have harmed SCO’s business reputation and affected its efforts to protect its ownership interest in UNIX and UnixWare. The District Court dismissed the original complaint, but allowed SCO an opportunity to file an amended complaint, which SCO did in July 2004. As with the original complaint, SCO is again seeking to require us to assign all copyrights that we have registered in UNIX and UnixWare to SCO, to prevent us from representing that we have any ownership interest in the UNIX and UnixWare copyrights, to require us to withdraw all representations we have made regarding our ownership of the UNIX and UnixWare copyrights, and to pay actual, special and punitive damages in an amount to be proven at trial. Our revenue and business plan could be adversely affected if SCO is ultimately successful.

If the Free Software Foundation releases a new version of the GNU General Public License with certain currently proposed terms, our business may suffer harm.

The GNU General Public License, or GPL, is an open source license that governs significant amounts of code used on a royalty-free basis in Linux distributions such as SUSE Linux. The Free Software Foundation, or FSF, owns the copyright to the GPL as well as software licensed under the GPL that is generally considered integral to Linux distributions. In January 2006, the FSF released a draft of a new version of the GPL known as “GPLv3,” which it intends to use for future software releases once it is finalized. The FSF is currently seeking comment on GPLv3, and a final version is expected by July 2007. Once issued, open source developers and IT vendors may elect to provide software under GPLv3, though software made available under earlier GPL versions will remain available under those earlier versions.

On November 2, 2006, we announced a new relationship with Microsoft. Among other things, Microsoft agreed to make covenants with our customers not to assert its patents against them. Microsoft also purchased coupons that it can distribute to customers who can in turn redeem them for subscriptions to SUSE Linux Enterprise Server. The FSF criticized our deal with Microsoft because it only provides patent protections for our customers rather than for all licensees of GPL software, and on March 28, 2007, the FSF released a new draft of GPLv3, known as “Discussion Draft 3,” that includes provisions intended to negate at least part of our Microsoft agreement.

Discussion Draft 3 includes a term intended to require Microsoft to make the same patent covenants that our customers receive to all recipients of the GPLv3 software included in our products. It also includes a license condition intended to preclude companies from entering into patent arrangements such as our agreement with Microsoft by prohibiting any company that has entered into such an arrangement from distributing GPLv3 code. This license condition does not apply to arrangements entered before March 28, 2007, so as currently proposed it would not apply to our agreement with Microsoft; however, the FSF specifically indicated that this “grandfathering” condition is tentative and may be dropped depending on feedback the FSF receives.

If the final version of GPLv3 contains terms or conditions that interfere with our agreement with Microsoft or our ability to distribute GPLv3 code, Microsoft may cease to distribute SUSE Linux coupons in order to avoid the extension of its patent covenants to a broader range of GPLv3 software recipients, we may need to modify our relationship with Microsoft under less advantageous terms than our current agreement, or we may be restricted in our ability to include GPLv3 code in our products, any of which could adversely affect our business and our operating results. In such a case, we would likely explore alternatives to remedy the conflict, but there is no assurance that we would be successful in these efforts.


18	Novell annual report 2006

We have experienced delays in the introduction of new products due to various factors, resulting in lost revenue.

We have in the past experienced delays in the introduction of new products due to a number of factors, including the complexity of software products, the need for extensive testing of software to ensure compatibility of new releases with a wide variety of application software and hardware devices, the need to “debug” products prior to extensive distribution, and with regard to our open-source products, our increasing reliance on the work of third parties not employed by Novell. Our open source offerings depend to a large extent on the efforts of developers not employed by us for the creation and update of open source technologies. For example, Linus Torvalds, the original developer of the Linux kernel, and a small group of engineers, many of whom are not employed by us, are primarily responsible for the development and evolution of the Linux kernel that is a key component of our Open Enterprise Server and SUSE Linux Enterprise offerings. The timing and nature of new releases of the Linux kernel are controlled by these third parties. Delays in developing, completing, or shipping new or enhanced products could result in delayed or reduced revenue for those products and could adversely impact customer acceptance of those offerings.

We benefit from the open source contributions of third-party programmers and corporations, and if they cease to make these contributions, our product strategy could be adversely affected.

Our open source offerings depend to a large extent on the efforts of developers not employed by us for the creation and update of open source technologies. Also, we and many other corporations contribute software into the open source movement. If key members, or a significant percentage, of this group of developers or corporations decides to cease development of the Linux kernel or other open source applications, we would have to either rely on another party (or parties) to develop these technologies, develop them ourselves or adapt our product strategy accordingly. This could increase our development expenses, delay our product releases and upgrades and adversely impact customer acceptance of open source offerings.

We may not be able to attract and retain qualified personnel because of the intense competition for qualified personnel in the computer and consulting industries.

Our ability to maintain our competitive technological position depends, in large part, on our ability to attract and retain highly qualified development, consulting, and managerial personnel. Competition for personnel of the highest caliber is intense in the software and consulting industries. The loss of certain key individuals, or a significant group of key personnel, would adversely affect our performance. The failure to successfully hire suitable replacements in a timely manner could have a material adverse effect on our business.

If our relationships with other IT services organizations become impaired, we could lose business.

We maintain relationships with IT services organizations that recommend, design and implement solutions that include our products for their customers’ businesses. Any of these organizations could decide at any time to not continue to do business with us or to not recommend our products. A change in the willingness of these IT service organizations to do business with us or recommend our products could result in lower revenue.

The success of our acquisitions is dependent on our ability to integrate personnel, operations and technology, and if we are not successful, our revenue will not grow at the rate we anticipate.

Achieving the benefits of acquisitions will depend in part on the successful integration of personnel, operations and technology. The integration of acquisitions will be subject to risks and will require significant expenditure of time and resources. The challenges involved in integrating acquisitions include the following:


	•	obtaining synergies from the companies’ organizations;

	•	obtaining synergies from the companies’ service and product offerings effectively and quickly;

	•	bringing together marketing efforts so that the market receives useful information about the combined companies and their products;


Novell annual report 2006	19


	•	coordinating sales efforts so that customers can do business easily with the combined companies;

	•	integrating product offerings, technology, back office, human resources, accounting and financial systems;

	•	assimilating employees who come from diverse corporate cultural backgrounds into a common business culture revolving around our solutions offerings; and

	•	retaining key officers and employees who possess the necessary skills and experience to quickly and effectively transition and integrate the businesses.

Failure to effectively and timely complete the integration of acquisitions could materially harm the business and operating results of the combined companies. In addition, goodwill related to any acquisitions could become impaired. Furthermore, we may assume significant liabilities in connection with acquisitions we make or become responsible for liabilities of the acquired businesses.

Our financial and operating results vary and may fall below analysts’ estimates, which may cause the price of our common stock to decline.

We currently provide estimates of our revenue and earnings per share for the full year with updates as changes warrant. Our operating results may fluctuate from quarter to quarter due to a variety of factors including, but not limited to:


	•	timing of orders from customers and shipments to customers;

	•	impact of foreign currency exchange rates on the price of our products in international locations;

	•	inability to respond to the decline in revenue through the distribution channel; and

	•	inability to deliver solutions as expected by our customers and systems integration partners.

In addition, we often experience a higher volume of revenue at the end of each quarter and during the fourth quarter of our fiscal year. Because of this, fixed costs that are out of line with revenue levels may not be detected until late in any given quarter and results of operations could be adversely affected.

Due to these factors or other unanticipated events, quarter-to-quarter comparisons of our operating results may not be reliable indicators of our future performance. In addition, from time to time our quarterly financial results may fall below the expectations of the securities and industry analysts who publish reports on our company, or of investors generally. This could cause the market price of our securities to decline, perhaps significantly.

We face increased risks in conducting a global business.

We are a global corporation with subsidiaries, offices and employees around the world and, as such, we face risks in doing business abroad that we do not face domestically. Certain risks inherent in transacting business internationally could negatively impact our operating results, including:


	•	costs and difficulties in staffing and managing international operations;

	•	unexpected changes in regulatory requirements;

	•	tariffs and other trade barriers;

	•	difficulties in enforcing contractual and intellectual property rights;

	•	longer payment cycles;

	•	local political and economic conditions;

	•	potentially adverse tax consequences, including restrictions on repatriating earnings and the threat of “double taxation”; and

	•	fluctuations in currency exchange rates, which can affect demand and increase our costs.


20	Novell annual report 2006

We may not be able to protect our confidential information, and this could adversely affect our business.

We generally enter into contractual relationships with our employees to protect our confidential information. The misappropriation of our trade secrets or other proprietary information could seriously harm our business. In addition, we may not be able to timely detect unauthorized use of our intellectual property and take appropriate steps to enforce our rights. In the event we are unable to enforce these contractual obligations and our intellectual property rights, our business could be adversely affected.

Our consulting services contracts contain pricing risks and, if our estimates prove inaccurate, we could lose money.

Our IT consulting business derives a portion of its revenue from fixed-price, fixed-time contracts. Because of the complex nature of the services provided, it is sometimes difficult to accurately estimate the cost, scope and duration of particular client engagements. If we do not accurately estimate the resources required for a project, do not accurately assess the scope of work associated with a project, do not manage the project properly, or do not satisfy our obligations in a manner consistent with the contract, then our costs to complete the project could increase substantially. We have occasionally had to commit unanticipated additional resources to complete projects, and may have to take similar action in the future. We may not be compensated for these additional costs or the commitment of these additional resources.

Our IT consulting clients may cancel or reduce the scope of their engagements with us on short notice.

If our clients cancel or reduce the scope of an engagement with our IT consulting business, we may be unable to reassign our professionals to new engagements without delay. Personnel and related costs constitute a substantial portion of our operating expenses. Because these expenses are relatively fixed, and because we establish the levels of these expenses well in advance of any particular quarter, cancellations or reductions in the scope of client engagements could result in the under-utilization of our professional services employees, causing significant reductions in operating results for a particular quarter.

Conversion of our Debentures into shares of our common stock will dilute the ownership interests of existing stockholders.

The conversion of some or all of our $600 million aggregate principal amount of senior convertible debentures due 2024, (the “Debentures”, into shares of common stock will dilute the ownership interest of existing common stockholders. Any large volume sales in the public market of the common stock issued upon such conversion could adversely affect prevailing market prices of our common stock. In addition, the existence of the Debentures may encourage short selling by market participants because the conversion of the Debentures could depress the price of our common stock.


Item 1B.	*Unresolved Staff Comments*

None.


Item 2.	*Properties*

In the U.S., we own approximately 887,000 (and occupy approximately 831,000) square feet of office space on 46 acres in Provo, Utah. We use that space for administrative offices and product development center. We also occupy 85,000 square feet of warehouse space in and around Provo for operational support. We lease 105,000 square feet of office space in Waltham, Massachusetts, and occupy 96,000 square feet as our corporate headquarters and principal executive offices. This facility is also used for product development. We lease a 177,000 square-foot office building in Cambridge, Massachusetts, of which we occupy approximately 22,000 square feet for product development activities and sublease approximately 155,000 square feet. We lease a 64,000 square-foot facility in Lebanon, New Hampshire, of which 15,200 square feet is used for product development and 48,800 square feet is subleased. In addition, we lease offices that host sales, support and/or product development activity in Arkansas,


Novell annual report 2006	21

California, Florida, Georgia, Illinois, Michigan, Minnesota, Missouri, New York, Oregon, Texas, Utah, Virginia, and Washington.

Internationally, we own office buildings in the United Kingdom, the Netherlands, South Africa, and Mumbai India. We use these office buildings, which vary in size from 18,000 to 85,000 square feet, for sales, support and administrative offices.

We lease and occupy a shared service center in Dublin Ireland of 20,000 square feet, and product development centers in Nuremberg Germany, Prague Czech Republic and Bangalore India of 64,000 square feet, 7,500 square feet and 80,000 square feet respectively. Novell has recently entered into an agreement to expand its total occupancy in Bangalore India to 158,000 square feet. In addition, each of our subsidiaries in Argentina, Australia, Austria, Belgium, Brazil, Canada, China, Colombia, Denmark, Finland, France, Germany, India, Israel, Italy, Japan, Malaysia, Mexico, Netherlands, New Zealand, Norway, Portugal, Scotland, Singapore, South Africa, Spain, Sweden, Switzerland, Taiwan, and Venezuela, leases a small facility used as sales and support offices. We have leased facilities in Luxembourg, Netherlands, United Kingdom and Thailand which we no longer occupy.

The terms of the above leases vary from month-to-month to up to 18 years. We believe that our existing facilities are adequate to meet our current requirements and we anticipate that suitable additional or substitute space will be available, as necessary, upon reasonable terms.


Item 3.	*Legal Proceedings*

Between September and November of 2006, seven separate purported derivative complaints were filed in Massachusetts state and federal courts against us and many of our current and former officers and directors asserting various claims related to alleged options backdating. Novell is also named as a nominal defendant in these complaints, although the actions are derivative in nature and purportedly asserted on behalf of Novell. These actions arose out of our announcement of a voluntary review of our historical stock-based compensation practices. The complaints essentially allege that since 1999, we have materially understated our compensation expenses and, as a result, overstated actual income. The five actions filed in federal court have been consolidated, and the parties to that action have stipulated that the defendants’ answer or motion to dismiss will be due 45 days after the filing of an amended complaint. The two actions filed in state court have also been consolidated and transferred to the Business Litigation Session of Massachusetts Suffolk County Superior Court, and the parties to that action have stipulated that the defendants’ answer or motion to dismiss will be due 30 days after the filing of an amended complaint. We are in the process of evaluating these claims.

On November 12, 2004, we filed suit against Microsoft in the U.S. District Court, District of Utah. We are seeking treble and other damages under the Clayton Act, based on claims that Microsoft eliminated competition in the office productivity software market during the time that we owned the WordPerfect word-processing application and the Quattro Pro spreadsheet application. Among other claims, we allege that Microsoft withheld certain critical technical information about Windows from us, thereby impairing our ability to develop new versions of WordPerfect and other office productivity applications, and that Microsoft integrated certain technologies into Windows designed to exclude WordPerfect and other Novell applications from relevant markets. In addition, we allege that Microsoft used its monopoly power to prevent original equipment manufacturers from offering WordPerfect and other applications to customers. On June 10, 2005, Microsoft’s motion to dismiss the complaint was granted in part and denied in part. On September 2, 2005, Microsoft sought appellate review of the District Court’s denial of its motion. On January 31, 2006, the Fourth Circuit Court of Appeals granted interlocutory review of Microsoft’s appeal with respect to the question of whether Novell lacked standing to assert the antitrust claims allowed by the District Court. As a result of Microsoft’s appeal, Novell filed a notice of appeal of the District Court’s dismissal of Novell’s other causes of action. Both appeals have been fully briefed and argued before the Circuit Court; however, it is uncertain when a final decision can be expected. While there can be no assurance as to the ultimate disposition of the litigation, we do not believe that its resolution will have a material adverse effect on our financial position, results of operations, or cash flows.

On January 20, 2004, the SCO Group, Inc. (“SCO”) filed suit against us in the Third Judicial District Court of Salt Lake County, State of Utah. We removed the action to the U.S. District Court, District of Utah. SCO’s original


22	Novell annual report 2006

complaint alleged that our public statements and filings regarding the ownership of the copyrights in UNIX and UnixWare have harmed SCO’s business reputation and affected its efforts to protect its ownership interest in UNIX and UnixWare. The District Court dismissed the original complaint, but allowed SCO an opportunity to file an amended complaint, which SCO did on July 9, 2004. On July 29, 2005, Novell filed an answer to the amended complaint setting forth numerous affirmative defenses and counterclaims alleging slander of title and breach of contract, and seeking declaratory actions and actual, special and punitive damages in an amount to be proven at trial. On February 3, 2006, SCO filed a Second Amended Complaint alleging that Novell has violated the non-competition provisions of the agreement under which we sold our Unix business to SCO, that we failed to transfer all of the Unix business, that we infringe SCO’s copyrights, and that we are engaging in unfair competition by attempting to deprive SCO of the value of the Unix technology. SCO seeks to require us to assign all copyrights that we have registered in UNIX and UnixWare to SCO, to prevent us from representing that we have any ownership interest in the UNIX and UnixWare copyrights, to require us to withdraw all representations we have made regarding our ownership of the UNIX and UnixWare copyrights, and to cause us to pay actual, special and punitive damages in an amount to be proven at trial. As a result of SCO’s Second Amended Complaint, SUSE filed a demand for arbitration before the International Court of Arbitration in Zurich, Switzerland, pursuant to a “UnitedLinux Agreement” in which SCO and SUSE were parties. Hearings before the International Court Tribunal are currently set for December 2007. The issues related to SCO’s claimed ownership of the UNIX copyrights and Novell’s rights under the UNIX agreements with SCO are currently scheduled for trial in the U.S. District Court, District of Utah, for September 2007. We believe that we have meritorious defenses to SCO’s claims and meritorious support for our counterclaims. Accordingly, we intend to vigorously pursue our claims while defending against the allegations in SCO’s complaint. Although there can be no assurance as to the ultimate disposition of the suit, we do not believe that the resolution of this litigation will have a material adverse effect on our financial position, results of operations or cash flows.

On July 12, 2002, Amer Jneid and other related plaintiffs filed a complaint in the Superior Court of California, Orange County, alleging claims for breach of contract, fraud in the inducement, misrepresentation, infliction of emotional distress, rescission, slander and other claims against us in connection with our purchase of so-called “DeFrame” technology from the plaintiffs and two affiliated corporations (TriPole Corporation and Novetrix), and employment agreements we entered into with the plaintiffs in connection with the purchase. The complaint sought unspecified damages, including “punitive damages.” The dispute (resulting in these claims) arises out of the plaintiffs’ assertion that we failed to properly account for license distributions which the plaintiffs claim would have entitled them to certain bonus payouts under the purchase and employment agreements. After a lengthy jury trial, the jury returned a verdict in favor of the various plaintiffs on certain contract claims and in favor of us on the remaining claims. The jury verdict found in favor of the plaintiffs and against us in the amount of approximately $19 million. Our equitable defenses are expected to be ruled on by the trial court in late spring 2007. Depending on the outcome of such rulings, a judgment against us may be entered at such time. In the event a final judgment is entered by the trial court, we intend to file various post-trial motions, including a motion for judgment notwithstanding the verdict. If necessary, we intend to pursue an appeal of any resulting judgment.

SilverStream, which we acquired in July 2002, and several of its former officers and directors, as well as the underwriters who handled SilverStream’s two public offerings, were named as defendants in several class action complaints that were filed on behalf of certain former stockholders of SilverStream who purchased shares of SilverStream common stock between August 16, 1999 and December 6, 2000. These complaints are closely related to several hundred other complaints that the same plaintiffs have brought against other issuers and underwriters. These complaints all allege violations of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended. In particular, they allege, among other things, that there was undisclosed compensation received by the underwriters of the public offerings of all of the issuers, including SilverStream. A Consolidated Amended Complaint with 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 seeking monetary damages, statutory compensation and other relief that may be deemed appropriate by the Court. While we believe that SilverStream and its former officers and directors have meritorious defenses to the claims, a tentative settlement has been reached between many of the defendants and the plaintiffs, which contemplates a settlement of the claims, including the ones against SilverStream and its former directors and officers. The settlement agreement, however, has not been finally approved by the Court. While there


Novell annual report 2006	23

PART II


Item 5.	*Market for Registrant’s Common Equity and Related Stockholder Matters, and Issuer Purchases of Equity Securities*

Novell’s common stock trades in the Nasdaq Global Select Market under the symbol “NOVL.” The following chart sets forth the high and low sales prices of our common stock during each quarter of the last two fiscal years:


	First		Second		Third		Fourth
	Quarter		Quarter		Quarter		Quarter

Fiscal 2006
High	$	9.81	$	9.83	$	8.56	$	6.98
Low	$	7.17	$	7.00	$	5.73	$	5.75
Fiscal 2005
High	$	7.70	$	6.23	$	6.69	$	7.77
Low	$	5.49	$	4.94	$	5.68	$	5.80

No dividends have been declared on our common stock. We have no current plans to pay dividends on our common stock, and intend to retain our earnings for use in our business. We had 7,340 stockholders of record at April 30, 2007.

Issuances of Unregistered Common Stock

Not Applicable

Repurchases of Common Stock

On September 22, 2005, our board of directors approved a share repurchase program for up to $200.0 million of our common stock through September 21, 2006. On April 4, 2006, our board of directors approved an amendment to the share repurchase program increasing the limit on repurchase from $200.0 million to $400.0 million and extending the program through April 3, 2007. As of July 31, 2006, we had completed the repurchase program purchasing 51.5 million shares of common stock at an average price of $7.76 per share.


Novell annual report 2006	25


Item 6.	*Selected Financial Data*

The following selected historical consolidated financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited consolidated financial statements and related notes to those statements included in this report. The selected historical consolidated financial data for the periods presented have been derived from our audited consolidated financial statements.


	Fiscal Year Ended
	October 31,			October 31,		October 31,		October 31,			October 31,
	2006(a)			2005(b)		2004		2003			2002
	(In thousands, except per share data)

Statement of operations
Net revenue	$	967,277		$	1,039,223	$	1,003,854	$	966,167		$	1,009,088
Gross profit		647,192			687,157		681,976		618,079			642,533
Income (loss) from operations(c)		(38,685	)		423,958		48,061		(32,938	)		(73,291	)
Income (loss) from continuing operations before taxes		30,856			457,951		57,931		(59,083	)		(96,699	)
Income tax expense		23,231			86,660		11,335		102,882			8,880
Income (loss) from continuing operations		7,625			371,291		46,596		(161,965	)		(105,579	)
Income from discontinued operations, net of taxes		11,928			5,431		10,592		61			2,458
Net income (loss) before accounting change		19,553			376,722		57,188		(161,904	)		(103,121	)
Cumulative effect of accounting change, net of tax(d)		(897	)		—		—		—			(143,702	)
Net income (loss)		18,656			376,722		57,188		(161,904	)		(246,823	)
Net income (loss) from continuing operations, diluted	$	7,406		$	373,183	$	20,319	$	(161,965	)	$	(105,579	)
Net income (loss) available to common stockholders, diluted	$	18,220		$	378,159	$	30,818	$	(161,904	)	$	(246,823	)
Net income (loss) from continuing operations per common share, diluted	$	0.02		$	0.85	$	0.05	$	(0.44	)	$	(0.29	)
Net income (loss) per common share, diluted	$	0.05		$	0.86	$	0.08	$	(0.44	)	$	(0.68	)
Balance sheet
Cash, cash equivalents and short-term investments	$	1,466,287		$	1,654,904	$	1,211,467	$	751,852		$	635,858
Working capital		1,075,580			1,284,901		843,930		406,014			330,232
Total assets		2,449,723			2,761,858		2,293,358		1,569,572			1,667,266
Senior convertible debentures		600,000			600,000		600,000		—			—
Series B Preferred Stock		9,350			9,350		25,000		—			—
Total stockholders’ equity(e)	$	1,104,650		$	1,386,486	$	963,364	$	934,470		$	1,065,542


(a)		In the first quarter of fiscal 2006, we adopted FASB Statement No. 123(R), which required us to record compensation expenses related to stock awards. For fiscal 2006, compensation expense totaled $35.2 million. Prior years were not restated to include such expense.

(b)		In the first quarter of fiscal 2005, we recognized a gain of $447.6 million on a litigation settlement with Microsoft to settle potential anti-trust litigation.


26	Novell annual report 2006


(c)		Income (loss) from operations for all periods presented excludes the results of Celerant, which have been classified as discontinued operations.

(d)		In May 2006, we adopted Financial Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations” (“FIN 47”), which required us to recognize the cumulative effect of initially applying FIN 47 as a change in accounting principle. In fiscal 2002, we adopted Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” resulting in a transitional goodwill impairment loss.

(e)		As discussed in Note C to the consolidated financial statements contained in this report, in accordance with the provisions of SAB 108, we decreased beginning retained earnings at November 1, 2005 by approximately $19.2 million, from $984.1 million to $964.9 million with the offset to additional paid-in capital to record a cumulative after-tax stock-based compensation expense that should have been recognized in the consolidated financial statements during the period 1997 through 2005. Had the stock-based compensation expense been recognized during that period, net income would have been reduced by the following amounts: $2.3 million in fiscal 2002, $2.9 million in fiscal 2003, $0.7 million in fiscal 2004, and $0.2 million in fiscal 2005.


Item 7.	*Management’s Discussion and Analysis of Financial Condition and Results of Operations*

Overview

With respect to the U.S. economy, spending continues to improve in many of the areas of information technology (“IT”) that we target such as security, regulatory compliance and server/function consolidation. We believe that strategic IT security projects put on hold in previous years are now being approved. Overall, increased IT funding is helping to attract new Linux and identity management business, which is still driven by an increased focus on gaining efficiencies and lowering operating costs.

Internationally, the European area of our EMEA segment has experienced sluggish growth. Market spending is still below our expectations with long sales cycles and a clear focus on IT cost savings. Consolidation of platforms and security remain high priority items for our customers.

The economy in Asia Pacific, including Japan, is mixed as some regions continue to struggle with core economic issues while others are growing at or above global rates.

We continue to make progress in several of our key product areas:


	•	Linux and Open Source products remain an important growth business. Revenues from our Linux platform products increased 26% year over year in fiscal 2006. A major fiscal 2006 milestone was the delivery of SUSE Linux Enterprise 10, the platform for the Open Enterprise. SUSE Linux Enterprise 10 offers a complete open source platform for the mission-critical applications that drive customers’ businesses. It includes SUSE Linux Enterprise Server and SUSE Linux Enterprise Desktop, providing an array of enterprise-class computing solutions that we believe is unmatched in the industry.

	•	We continue to grow our positions in the systems, security and identity management market by offering the most comprehensive products that address customer problems in the areas of security, compliance, risk mitigation and systems management. Our unique role-based, policy-driven approach has been well received, and we continue to experience strong invoicing growth in this category and a number of large enterprise deals. In fiscal year 2006, we introduced a number of new product releases including Novell Identity Manager 3, Novell Secure Login 6 and Novell Access Manager 3. Our e-Security Sentinel product acquisition provides a comprehensive compliance solution to integrate people, systems and processes. We expect strong revenue and performance momentum in fiscal 2007 from our new products.

	•	We continued efforts to stabilize the decline of our revenue from our legacy products, such as OES and NetWare and NetWare-related products. Our legacy revenue base is an important source of cash flow and a potential opportunity for us to sell more products and services. With the release of our OES product in March 2005, we have taken steps to help maintain that installed base and address revenue declines of these products. Nevertheless, our combined NetWare and OES business declined by 18% during fiscal 2006 compared to fiscal 2005. We continue to work with our customers to help them migrate from NetWare and other platforms


Novell annual report 2006	27


		of our competitors to OES and SUSE Linux using tools, training and education emphasizing the return on investment of upgrading Linux versus proprietary platforms.

Our strategic focus is to provide enterprise-class infrastructure software and services with a flexible combination of open source and proprietary technologies. By implementing our solutions, customers can reduce costs and complexity while increasing the return on their IT investment. Unlike other infrastructure software providers, we help customers migrate from proprietary solutions to open source technology at a pace that best suits them.

In support of this strategy, we have identified several key initiatives including:


	•	redesigning our sales model;

	•	realigning our research and development processes; and

	•	implementing changes in our administrative and support functions.

Our initiatives and their implementation involve opportunities, risks and challenges. While these initiatives, which we will implement in fiscal 2007, will require substantial investment, we believe they will result in long-term profitability. The following discusses these initiatives in further detail.


	•	We intend to improve our sales model by investing in and aligning it to address our unique markets and opportunities. We are undertaking a major shift from direct to indirect sales coverage and capabilities. Specifically, we are building out a world class infrastructure for web- and tele-sales that will be focused on our renewal activities, thus enabling our direct sales force to focus on new customer acquisition. Additionally, we are investing in new, dedicated sales force training and specialization roles, which we believe will result in improved customer conversations regarding the benefits of our products. Finally, we are increasing our targeted set of global strategic partners with whom we go to market with in our strategic product categories. In November 2006, we announced that one such partner was Microsoft.

	•	We intend to restructure our research and development processes to reduce costs and improve productivity by evaluating the appropriate balance between on and offshore research and development locations. As a result, we are investing in overlapping, offshore research and development teams to eventually assume functions once handled in more expensive environments. Additionally, we believe our investments in an improved product life-cycle management process will help facilitate this activity while assuring our products are addressing the needs of the market.

	•	We plan to implement changes to our administrative and support functions in the near future with the goal of increasing efficiency and reducing costs. We are currently reviewing recommendations made by an external specialty consulting firm that we hired to study our administrative support functions and cost structure as the first step toward implementing this initiative.

Critical Accounting Policies

An accounting policy is deemed to be critical if it requires us to make an accounting estimate based on assumptions about matters that are uncertain at the time an accounting estimate is made, and if different estimates that reasonably could have been used or changes in the accounting estimate that are reasonably likely to occur periodically could materially change the financial statements. We consider accounting policies related to revenue recognition and related reserves, impairment of long-lived assets, valuation of deferred tax assets, loss contingency accruals and share-based payments to be critical accounting policies due to the judgments and estimation processes involved in each.

Revenue Recognition and Related Reserves. Our revenue is derived primarily from the sale of software licenses, software maintenance, upgrade protection, subscriptions of SUSE Linux Enterprise Server (“SLES”), technical support, training, and consulting services. Our customers include: distributors, who sell our products to resellers, dealers, and VARs; OEMs, who integrate our products with their products or solutions; VARs, who provide solutions across multiple vertical market segments which usually includes services; and end users, who may purchase our products and services directly from Novell or from other partners or resellers. Except for our SUSE Linux product, distributors do not order to stock and only order products when they have an end customer order,


28	Novell annual report 2006

which they present to us. With respect to our SUSE Linux product, distributors place orders and the product is then sold through to end customers principally through the retail channel. OEMs report the number of copies duplicated and sold via an activity or royalty report. Software maintenance, upgrade protection, technical support, and subscriptions of SLES typically involve one to three year contract terms. Our standard contracts offer a 90-day right of return.

Revenue is recognized in accordance with Statement of Position (“SOP”) 97-2, “Software Revenue Recognition,” and Staff Accounting Bulletin No. 104, “Revenue Recognition,” and related interpretations. When an arrangement does not require significant production, modification or customization of software or does not contain services considered to be essential to the functionality of the software, revenue is recognized when the following four criteria are met:


	•	Persuasive evidence of an arrangement exists — We require evidence of an agreement with a customer specifying the terms and conditions of the products or services to be delivered typically in the form of a signed contract or statement of work accompanied by a purchase order.

	•	Delivery has occurred — For software licenses, delivery takes place when the customer is given access to the software programs via access to a web site or shipped medium. For services, delivery takes place as the services are provided.

	•	The fee is fixed or determinable — Fees are fixed or determinable if they are not subject to a refund or cancellation and do not have payment terms that exceed our standard payment terms. Typical payment terms are net 30 days.

	•	Collection is probable — We perform a credit review of all customers with significant transactions to determine whether a customer is creditworthy and collection is probable. Prior Novell established credit history, credit reports, financial statements, and bank references are used to assess creditworthiness.

In general, revenue for transactions that do not involve software customization or services considered essential to the functionality of the software is recognized as follows:


	•	Software license fees for our SUSE Linux product are recognized when the product is sold through to an end customer;

	•	Software license fees for sales through OEMs are recognized upon receipt of license activity or royalty reports;

	•	All other software license fees are recognized upon delivery of the software;

	•	Software maintenance, upgrade protection, technical support, and subscriptions of SLES are recognized ratably over the contract term; and

	•	Consulting, training and other similar services are recognized as the services are performed.

If the fee due from the customer is not fixed or determinable, revenue is recognized as payments become due from the customer. If collection is not considered probable, revenue is recognized when the fee is collected. We record provisions against revenue for estimated sales returns and allowances on product and service-related sales in the same period as the related revenue is recorded. We also record a provision to operating expenses for bad debts resulting from customers’ inability to pay for the products or services they have received. These estimates are based on historical sales returns and bad debt expense, analyses of credit memo data, and other known factors, such as bankruptcy. If the historical data we use to calculate these estimates do not accurately reflect future returns or bad debts, adjustments to these reserves may be required that would increase or decrease revenue or net income.

Many of our software arrangements include multiple elements. Such elements typically include any or all of the following: software licenses, rights to additional software products, software maintenance, upgrade protection, technical support, training and consulting services. For multiple-element arrangements that do not involve significant modification or customization of the software and do not involve services that are considered essential to the functionality of the software, we allocate value to each element based on its relative fair value, if sufficient Novell-specific objective evidence of fair value exists for each element of the arrangement. Novell-specific


Novell annual report 2006	29

objective evidence of fair value is determined based on the price charged when each element is sold separately. If sufficient Novell-specific objective evidence exists for all undelivered elements, but does not exist for the delivered element, typically the software, then the residual method is used to allocate value to each element. Under the residual method, each undelivered element is allocated value based on Novell-specific objective evidence of fair value for that element, as described above, and the remainder of the total arrangement fee is allocated to the delivered element, typically the software. If sufficient Novell-specific objective evidence does not exist for all undelivered elements and the arrangement involves rights to unspecified additional software products, all revenue is recognized ratably over the term of the arrangement. If the arrangement does not involve rights to unspecified additional software products, all revenue is initially deferred until typically the only remaining undelivered element is software maintenance or technical support, at which time the entire fee is recognized ratably over the remaining maintenance or support term.

In the case of multiple-element arrangements that involve significant modification or customization of the software or involve services that are considered essential to the functionality of the software, contract accounting is applied. When Novell-specific objective evidence exists for software maintenance or technical support in arrangements requiring contract accounting, the consulting and license fees are combined and revenue is recognized on the percentage of completion basis. The percentage of completion is generally calculated using estimated hours incurred to date relative to the total expected hours for the entire project. The cumulative impact of any revision in estimates to complete or recognition of losses on contracts is reflected in the period in which the changes or losses become known. The maintenance or support fee is unbundled from the other elements and revenue is recognized ratably over the maintenance or support term. When Novell-specific objective evidence does not exist for software maintenance or support, then all revenue is deferred until completion of the consulting services, at which time the entire fee is recognized ratably over the remaining maintenance or support period.

Consulting project contracts are either time-and-materials or fixed-price contracts. Revenue from time-and-materials contracts is recognized as the services are performed. Revenue from fixed-price contracts is recognized based on the proportional performance method, generally using estimated time to complete to measure the completed effort. The cumulative impact of any revision in estimates to complete or recognition of losses on contracts is reflected in the period in which the changes or losses become known. Consulting revenue includes reimbursable expenses charged to our clients.

Long-lived Assets. Our long-lived assets include net fixed assets, goodwill, and other intangible assets. At October 31, 2006, our long-lived assets included $184.1 million of net fixed assets, $424.7 million of goodwill, and $40.4 million of identifiable intangible assets.

We periodically review our property, plant, and equipment and finite-lived intangible assets for impairment in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors that could indicate an impairment include significant underperformance of the asset as compared to historical or projected future operating results, significant changes in the actual or intended use of the asset, or significant negative industry or economic trends. When we determine that the carrying value of an asset may not be recoverable, the related estimated future undiscounted cash flows expected to result from the use and eventual disposition of the asset are compared to the carrying value of the asset. If the sum of the estimated future cash flows is less than the carrying amount, we record an impairment charge based on the difference between the carrying value of the asset and its fair value, which we estimate based on discounted expected future cash flows. In determining whether an asset is impaired, we must make assumptions regarding recoverability of costs, estimated future cash flows from the asset, intended use of the asset and other related factors. If these estimates or their related assumptions change, we may be required to record impairment charges for these assets.

We evaluate the recoverability of goodwill and indefinite-lived intangible assets annually as of August 1, or more frequently if events or changes in circumstances warrant, such as a material adverse change in the business. Goodwill is considered to be impaired when the carrying value of a reporting unit exceeds its estimated fair value. Indefinite-lived intangible assets are considered impaired if their carrying value exceeds their estimated fair value. Fair values are estimated using a discounted cash flow methodology. In assessing the


30	Novell annual report 2006

recoverability of our goodwill and indefinite-lived intangible assets, we must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. This process requires subjective judgment at many points throughout the analysis. Changes in reporting units and changes to the estimates used in the analyses, including estimated future cash flows, could cause one or more of the reporting units or indefinite-lived intangibles to be valued differently in future periods. Future analysis could potentially result in a non-cash goodwill impairment charge of up to $424.7 million, the full amount of our goodwill, depending on the estimated value of the reporting units and the value of the net assets attributable to those reporting units at that time.

During the fourth quarters of fiscal 2006, 2005, and 2004, we completed our annual goodwill impairment reviews and determined that there was no goodwill impairment. These assessments are made at the reporting unit level, and therefore we could be subject to an impairment charge to goodwill if any one of our reporting units does not perform in line with forecasts in the future. In addition, changes in the assumptions used in the analyses could have changed the resulting outcomes. For example, to estimate the fair value of our reporting units at August 1, 2006, we made estimates and judgments about future cash flows based on our fiscal 2007 forecast and current long-range plans used to manage the business. These long-range estimates could change in the future depending on internal changes in our company as well as external factors. Future changes in estimates could possibly result in a non-cash impairment charge that could have a material adverse impact on our results of operations. Beginning in the first quarter of fiscal 2007, we will begin operating and reporting our financial results in four new business unit segments based on information solution categories. We do not anticipate that implementation of the change in segments will result in an impairment of our goodwill, however, future performance of the new segments could result in a non-cash impairment charge.

Developed technology is amortized over three years as a cost of revenue. Patents are amortized over their estimated useful lives, generally ten years, as a cost of revenue. Customer/contractual relationships are amortized over one to three years as a sales expense. Most of our trademarks/trade names have indefinite lives and therefore are not amortized but are reviewed for impairment at least annually. During fiscal 2006, we recorded a $1.2 million impairment charge for certain intangible assets we acquired as a part of the Ximian acquisition. During fiscal 2005, we recorded a $1.5 million impairment charge for certain intangible assets we acquired as a part of the SilverStream and SUSE acquisitions.

Deferred Tax Assets. In accordance with applicable accounting standards, we regularly assess our ability to realize our deferred tax assets. Assessments of the realization of deferred tax assets require that management consider all available evidence, both positive and negative, and make significant judgments about many factors, including the amount and likelihood of future taxable income. Based on all the available evidence, we continue to believe that it is more likely than not that our remaining U.S. net deferred tax assets, and certain foreign deferred tax assets, are not currently realizable. As a result, we continue to provide a full valuation reserve on our U.S. net deferred tax assets and certain foreign deferred tax assets.

Loss Contingency Accruals and Restructurings. We are required to make accruals for certain loss contingencies related to litigation and taxes. We accrue these items in accordance with SFAS No. 5, “Accounting for Contingencies,” which requires us to accrue for losses we believe are probable and can be reasonably estimated, however, the estimation of the amount to accrue requires significant judgment. Litigation accruals require us to make assumptions about the future outcome of each case based on current information. Tax accruals require us to make assumptions based on the results of tax audits, past experience and interpretations of tax law. When our restructurings include leased facilities, in accordance with SFAS 146, “Accounting for Costs Associated with Exit or Disposal Activities,” we are required to make assumptions about future sublease income, which would offset our costs and decrease our accrual. From time to time, we are subjected to tax audits and must make assumptions about the outcome of the audit. If any of the estimates or their related assumptions change in the future, or if actual outcomes are different than our estimates, we may be required to record additional charges or reduce our accruals. During fiscal 2006, we recorded a $24.0 million adjustment to increase accruals related to loss contingencies due to changes in facts and circumstances. During fiscal 2005, we recorded a $1.2 million adjustment to reduce previous restructuring accruals and a $5.3 million adjustment to increase merger liabilities primarily due to changes in estimates we originally made regarding future subleases. In fiscal 2004, we recorded a $4.9 million adjustment to a


Novell annual report 2006	31

previous restructuring accrual due to changes in estimates we originally made regarding future sublease income, a $9.0 million reduction of our litigation accrual due to changes in the estimated outcome of certain ongoing legal cases and $6.0 million reduction to our income tax accrual to reflect current estimated tax exposures.

Share-based Payments. On November 1, 2005, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payment,” which requires us to account for share-based payment transactions using a fair value-based method and recognize the related expense in the results of operations. Prior to our adoption of SFAS No.123(R), as permitted by SFAS No. 123, we accounted for share-based payments to employees using the Accounting Principles Board Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees,” intrinsic value method and, therefore, we generally recognized compensation expense for restricted stock awards and did not recognize compensation cost for employee stock options. SFAS No. 123(R) allows companies to choose one of two transition methods: the modified prospective transition method or the modified retrospective transition method. We chose to use the modified prospective transition methodology, and accordingly, we have not restated the results of prior periods.

Under the fair value recognition provisions of SFAS No. 123(R), share-based compensation cost is estimated at the grant date based on the fair value of the award and is recognized as expense over the requisite service period of the award. The fair value of restricted stock awards is determined by reference to the fair market value of our common stock on the date of grant. Consistent with the valuation method we used for disclosure-only purposes under the provisions of SFAS No. 123, we use the Black-Scholes model to value both service condition and performance condition option awards under SFAS No. 123(R). For awards with market conditions granted subsequent to our adoption of SFAS No. 123(R), we use a lattice valuation model to estimate fair value. For awards with only service conditions and graded-vesting features, we recognize compensation cost on a straight-line basis over the requisite service period. For awards with performance or market conditions granted subsequent to our adoption of SFAS No. 123(R), we recognize compensation cost based on the graded-vesting method.

Determining the appropriate fair value model and related assumptions requires judgment, including estimating stock price volatility, forfeiture rates, and expected terms. The expected volatility rates are estimated based on historical and implied volatilities of our common stock. The expected term represents the average time that options that vest are expected to be outstanding based on the vesting provisions and our historical exercise, cancellation and expiration patterns. We estimate pre-vesting forfeitures when recognizing compensation expense based on historical rates and forward-looking factors. We update these assumptions at least on an annual basis and on an interim basis if significant changes to the assumptions are warranted.

We issue performance-based equity awards, typically to senior executives, which vest upon the achievement of certain financial performance goals, including revenue and income targets. Determining the appropriate amount to expense based on the anticipated achievement of the stated goals requires judgment, including forecasting future financial results. The estimate of expense is revised periodically based on the probability of achieving the required performance targets and adjustments are made as appropriate. The cumulative impact of any revision is reflected in the period of change. If the financial performance goals are not met, the award does not vest, so no compensation cost is recognized and any previously recognized compensation cost is reversed.

In the past, we have issued market condition equity awards, typically granted to senior executives, the vesting of which is accelerated or contingent upon the price of Novell common stock meeting specified pre-established stock price targets. For awards granted prior to our adoption of SFAS No. 123(R), the fair value of each market condition award was estimated as of the grant date using the same option valuation model used for time-based options without regard to the market condition criteria. As a result of our adoption of SFAS No. 123(R), compensation cost is recognized over the estimated requisite service period and is not reversed if the market condition target is not met. If the pre-established stock price targets are achieved, any remaining expense on the date the target is achieved is recognized either immediately or, in situations where there is a remaining minimum time vesting period, ratably over that period.


32	Novell annual report 2006

SAB 108

In September 2006, the SEC staff issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”). SAB 108 was issued in order to eliminate the diversity of practice surrounding how public companies quantify financial statement misstatements. SAB 108 is effective for fiscal years ending after November 15, 2006, but we adopted it early in fiscal 2006.

Traditionally, there have been two widely-recognized methods for quantifying the effects of financial statement misstatements: the “roll-over” method and the “iron curtain” method. The roll-over method focuses primarily on the impact of a misstatement on the income statement, including the reversing effect of prior year misstatements, but its use can lead to the accumulation of misstatements on the balance sheet. The iron-curtain method, on the other hand, focuses primarily on the effect of correcting the period-end balance sheet with less emphasis on the reversing effects of prior year errors on the income statement. Prior to our application of the guidance in SAB 108, we consistently applied the roll-over method when quantifying financial statement misstatements.

In SAB 108, the SEC staff established an approach that requires quantification of financial statement misstatements based on the effects of misstatements on each of the financial statements and the related financial statement disclosures. This model is commonly referred to as a “dual approach” because it requires quantification of errors under both the iron curtain and the roll-over methods.

SAB 108 permits us to initially apply its provisions to errors that are material under the dual method but were not previously material under our previously used method of assessing materiality either by (i) restating prior financial statements as if the “dual approach” had always been applied or (ii) recording the cumulative effect of initially applying the “dual approach” as adjustments to the carrying values of the applicable balance sheet accounts as of November 1, 2005 with an offsetting adjustment recorded to the opening balance of retained earnings. We elected to record the effects of applying SAB 108 using the cumulative effect transition method and adjusted beginning retained earnings for fiscal 2006 in the accompanying consolidated financial statements for misstatements associated with our historical stock-based compensation expense and related income tax effects as described below. We do not consider any of the misstatements to have a material impact on our consolidated financial statements in any of the prior years affected under our previous method for quantifying misstatements, the roll-over method.

Historical Stock-Based Compensation Practices

On May 23, 2007, we announced that we had completed our self-initiated, voluntary review of our historical stock-based compensation practices and determined the related accounting impact.

The review was conducted under the direction of the Audit Committee of our Board of Directors, who engaged the law firm of Cahill Gordon & Reindel LLP, with whom we had no previous relationship, as independent outside legal counsel to assist in conducting the review. The scope of the review covered approximately 400 grant actions (on approximately 170 grant dates) from November 1, 1996 through September 12, 2006. Within these pools of grants are more than 58,000 individual grants. In total, the review encompassed awards relating to more than 230 million shares of common stock granted over the ten-year period.

Administrative Corrections — In the period of fiscal 1997 to 2005, we corrected administrative errors identified subsequent to the original authorization by awarding stock options that we dated with the original authorization date. The administrative errors included incorrect lists of optionees, generally new hires who were inadvertently omitted from the lists of optionees because of the delayed updating of our personnel list, and miscalculations of the number of options to be granted to particular employees on approved lists.


Novell annual report 2006	33

Number of Shares Approved Not Specified — Documented authorization for certain grants, primarily in the period from fiscal 1997 through 2000, lacked specificity for some portion or all of the grant.

Authorization Incomplete or Received Late — For certain grants, primarily in the period from fiscal 1997 through 2004, there is incomplete documentation to determine with certainty when the grants were actually authorized or the authorization was received after the stated grant date.

In light of the above findings, we and our advisors performed an exhaustive process to uncover all information that could be used in making a judgment as to appropriate measurement dates. We used all available information to form conclusions as to the most likely option granting actions that occurred and to form conclusions as to the appropriate measurement dates.

Under APB No. 25, “Accounting for Stock Issued to Employees,” because the exercise prices of the stock options on the new measurement dates were, in some instances, lower than the fair market value of the underlying stock on such dates, we are required to record compensation expense for these differences. As a result, stock-based compensation expense in a cumulative after-tax amount of approximately $19.2 million should have been reported in the consolidated financial statements for the fiscal years ended October 31, 1997 through October 31, 2005. After considering the materiality of the amounts of stock-based compensation and related income tax effects that should have been recognized in each of the applicable historic periods, including the interim periods of fiscal 2005 and 2006, we determined that the errors were not material to any prior period, on either a quantitative or qualitative basis, under our previous method for quantifying misstatements, the roll-over method. Therefore, we will not restate our consolidated financial statements for prior periods. In accordance with the provisions of SAB 108, we decreased beginning retained earnings at November 1, 2005 by approximately $19.2 million, from $984.1 million to $964.9 million, or a reduction of two percent, with the offset to additional paid-in capital in the consolidated balance sheet.

The following table summarizes the effects, net of income taxes, (on a cumulative basis prior to fiscal 2004 and in fiscal 2004 and 2005) resulting from changes in measurement dates and the related application of the guidance applicable to the initial compliance with SAB 108:


	(Amounts in 000s)

Cumulative prior to fiscal 2004	$	18,291
Fiscal 2004		698
Fiscal 2005		201

Total adjustment at November 1, 2005	$	19,190

Acquisitions and Equity Investments

e-Security

On April 19, 2006, we acquired 100% of the outstanding stock of e-Security, Inc., a privately held company headquartered in Vienna, Virginia. e-Security provides security information, event management and compliance software. e-Security’s products are now part of our identity and access management sub-category. The purchase price was approximately $71.7 million in cash, plus transaction costs of $1.1 million. e-Security’s results of operations have been included in our consolidated financial statements beginning on the acquisition date.

Open Invention Network, LLC

In November 2005, Open Invention Network, LLC (“OIN”) was established by us, IBM, Philips, Red Hat and Sony. OIN is a privately held company that has acquired and intends to continue acquiring patents to promote Linux and open source by offering its patents on a royalty-free basis to any company, institution or individual that agrees not to assert its patents against the Linux operating system or certain Linux-related applications. In addition, OIN, in its discretion, will enforce its patents to the extent it believes such action will serve to further protect and promote Linux and open source. Each party contributed capital with a fair value of $20.0 million to OIN. We account for our 20% ownership interest using the equity method of accounting. Our $20.0 million contribution


34	Novell annual report 2006

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 patents had a book value of $14.4 million, including $0.3 million of prepaid acquisition costs. The $1.4 million difference between the fair value and book value of the patents will be amortized to our investment in OIN account and equity income over the remaining estimated useful life of the patents, which is approximately nine years. Our investment in OIN, as of October 31, 2006 of $18.9 million is classified as other assets in the consolidated balance sheet. In fiscal 2007, our ownership interest in OIN decreased to approximately 17% due to the addition of NEC, a new investor in the company.

Onward Novell

In December 2005, we acquired the remaining 50% ownership of our sales and marketing joint venture in India from our joint venture partner for approximately $7.5 million in cash and other consideration. At October 31, 2005, $7.5 million of our cash was held in an escrow account for the acquisition and classified as other assets in the consolidated balance sheet. The cash was paid out of the escrow account during the first quarter of fiscal 2006. At the time of the acquisition, the net book value of the minority interest was $5.3 million. The $2.0 million difference between the net book value of the minority interest and the amount we paid for the remaining 50% ownership was recorded as goodwill.

Tally Systems Corp.

On April 1, 2005, we acquired a 100% interest in Tally Systems Corp., a privately-held company headquartered in Lebanon, New Hampshire. Tally provides automated PC hardware and software recognition products and services used by customers to manage hardware and software assets. These products and services are now part of our ZENworks product line. The purchase price was approximately $17.3 million in cash, plus transaction costs of $0.4 million and excess facility costs of $4.5 million recorded as an acquisition liability. Tally’s results of operations have been included in our statement of operations beginning on the acquisition date.

Immunix, Inc.

On April 27, 2005, we acquired a 100% interest in Immunix, Inc., a privately-held company headquartered in Portland, Oregon, which provides enterprise class, host intrusion prevention solutions for the Linux platform. This acquisition enables us to expand security offerings on the Linux platform. The purchase price was approximately $17.3 million in cash, plus transaction costs of $0.4 million. Immunix’s results of operations have been included in our statement of operations beginning on the acquisition date.

Salmon Ltd.

On July 19, 2004, we purchased all of the outstanding stock of Salmon Ltd, a privately-held information technology services and consulting firm headquartered in Watford, England, for approximately $8.2 million in cash, plus merger and transaction costs of $0.6 million. Salmon’s results of operations have been included in our statement of operations beginning on the acquisition date.

The purchase agreement provides for contingent payments of up to an additional $10.6 million based upon the future revenue and profitability of both Salmon and Novell in the United Kingdom over a period of two years. Approximately $3.2 million of contingent earnouts were recorded to goodwill in fiscal 2005 and approximately $5.7 million in fiscal 2006.

SUSE LINUX AG

On January 12, 2004, we purchased substantially all of the outstanding stock of SUSE LINUX AG, a privately-held company and a leading provider of Linux-based products, for approximately $210.0 million in cash, plus


Novell annual report 2006	35

merger and transaction costs of $9.0 million. SUSE’s results of operations have been included in our statement of operations beginning on the acquisition date.

Divestitures

Celerant

On May 24, 2006, we sold our shares in Celerant consulting to a group comprised of Celerant management and Caledonia Investments plc for $77.0 million in cash. Celerant consulting was acquired by Novell in 2001 as part of the Cambridge Technology Partners purchase acquisition. There are no on-going shareholder or operational relationships between us and Celerant consulting. The sale of Celerant consulting does not impact our IT consulting business.

Celerant consulting is accounted for as a discontinued operation and accordingly, its results of operations and the gain on its sale are reported separately in a single line item in our consolidated statement of operations. The results of discontinued operations for fiscal years 2006, 2005, and 2004 are as follows:


	Fiscal Year Ended
	October 31,		October 31,		October 31,
	2006		2005		2004
	(In thousands)

Celerant net revenue	$	83,341	$	158,472	$	162,063
Celerant income before taxes	$	1,783	$	8,191	$	17,043
Gain on sale of Celerant		11,117		—		—
Income tax expense		972		2,760		6,451

Income from discontinued operations	$	11,928	$	5,431	$	10,592

Japan Consulting Group

On August 10, 2006, we sold our Japan consulting group (“JCG”) to Nihon Unisys, LTD (“Unisys”) for $4.0 million. $2.8 million of the selling price was paid at closing and $1.2 million is contingent upon certain key employees remaining employed by Unysis for a 12-month period after closing. Unisys will pay $200,000 for each key employee that is still employed by Unisys at the end of the retention period up to $1.2 million. We recorded a loss of $8.3 million related to the excess carrying amount of the JCG over its fair value, of which $7.1 million was to write off goodwill.

It is anticipated that the JCG will continue to be a key partner for Novell with respect to subcontracting consulting services. Likewise, the cash flows from the JCG to Novell are also anticipated to increase as Novell plans to be a subcontractor for the JCG. As a result of our expected continuing involvement, the JCG has not been presented as a discontinued operation.

Results of Operations

Revenue

We sell our products, services, and solutions primarily to corporations, government entities, educational institutions, resellers and distributors both domestically and internationally. In the statement of operations, we categorize revenue as software licenses or maintenance, subscriptions, and services. Software license revenue includes new and upgrade license revenue only. Maintenance, subscriptions, and services includes SLES subscriptions, upgrade protection contracts, and all other service revenue.


36	Novell annual report 2006


	Fiscal Year Ended October 31,						2006 vs			2005 vs
	2006		2005		2004		2005			2004
	(In thousands)						(Percentage change)

Software licenses	$	173,678	$	213,803	$	234,037		(19	)%		(9	)%
Maintenance, subscriptions, and services		793,599		825,420		769,817		(4	)%		7	%

Total net revenue	$	967,277	$	1,039,223	$	1,003,854		(7	)%		4	%

Software license revenue decreased in fiscal 2006 compared to fiscal 2005 primarily due to the impact of a large sale in the EMEA region in fiscal 2005, which added $21.5 million to license revenue in fiscal 2005, and a $28.5 million expected decline in license sales of NetWare/OES and other workspace products. These decreases were offset somewhat by a $9.0 million increase in sales of our identity and access management products, which are sold under the licensing model, and from more of our customers purchasing multiple-product, multiple-year subscriptions, which we record as maintenance, subscriptions, and services revenue.

Software licenses revenue decreased in fiscal 2005 compared to fiscal 2004 primarily due to declines in license sales of workspace products such as NetWare/OES and GroupWise. In addition, the decrease was due to more of our customers purchasing under multiple-product, multiple-year subscription contracts, which we classify as maintenance, subscriptions, and services revenue.

Maintenance, subscriptions, and services revenue decreased during fiscal 2006 compared to fiscal 2005 primarily due to a $21.9 million decrease in IT consulting and services revenue that was expected as a result of the restructuring actions taken in the fourth quarter of fiscal 2005 and a $25.7 million decrease NetWare/OES combined maintenance revenue, offset somewhat by increased maintenance revenue from our systems, security and identity management products of $18.8 million and increased subscriptions for our Linux open platform solutions of $9.5 million. The change in the mix of our revenue towards more maintenance and subscription contracts has somewhat increased revenue in the maintenance, subscriptions, and services category compared to the software licenses category during the fiscal 2006.

Maintenance, subscriptions, and services revenue increased during fiscal 2005 compared to fiscal 2004 due primarily to higher IT consulting and services revenue of $28.4 million resulting from the acquisition of Salmon and increased consulting revenue in all geographic regions, and $27.2 million due to higher maintenance revenue. The change in the mix of our revenue towards more maintenance and subscription contracts has also driven the increase in revenue in the maintenance, subscriptions, and services category.

During fiscal 2006, we also analyzed revenue by the following solution categories:


	•	Systems, security, and identity management (formerly Identity-driven computing solutions). Sub-categories include:


	•	Resource management — major products include ZENworks

	•	Identity and access management — major products include Identity Manager, Secure Login, iChain and Sentinel

	•	Other systems, security, and identity management products — major products include eDirectory and web services


	•	Open platform solutions. Sub-categories include:


	•	Linux platform products — major products include SUSE LINUX Enterprise Server and our Linux desktop products

	•	Other open platform products — major products include SUSE LINUX Professional


	•	Workspace solutions. Sub-categories include:


	•	Open Enterprise Server (“OES”)


Novell annual report 2006	37


	•	NetWare and other NetWare-related — major products include NetWare and Cluster Services

	•	Collaboration — major products include GroupWise

	•	Other workspace — major products include BorderManager and Novell iFolder


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

Prior to fiscal 2006, Open platform solutions and Workspace solutions were combined in a category called Linux and platform services solutions. Prior to the third quarter of fiscal 2006, OES was classified in open platform solutions. Beginning in the third quarter of fiscal 2006, OES is categorized in workspace solutions. Prior periods have been recast to conform to the new presentation.


	Fiscal Year Ended October 31,						2006 vs			2005 vs
	2006		2005		2004		2005			2004
	(In thousands)						(Percentage change)

Resource management	$	134,579	$	144,358	$	124,338
Identity and access management		97,721		74,936		61,324
Other systems, security, and identity management products		17,975		21,022		21,353

Systems, security and identity management		250,275		240,316		207,015		4	%		16	%

Linux platform products		45,296		35,836		19,309
Other open platform products		8,146		17,761		14,678

Open platform solutions		53,442		53,597		33,987		—	%		58	%

Open Enterprise Server		181,695		85,331		—
NetWare and other NetWare-related		47,779		193,549		301,441
Collaboration		96,176		99,422		103,556
Other workspace products		23,594		30,842		50,093

Workspace solutions		349,244		409,144		455,090		(15	)%		(10	)%

Total software licenses and maintenance		652,961		703,057		696,092
Global services and support		314,316		336,166		307,762		(6	)%		9	%

Total net revenue	$	967,277	$	1,039,223	$	1,003,854		(7	)%		4	%

Systems, security and identity management increased in fiscal 2006 compared to fiscal 2005 primarily due to strong sales growth in our identity and access management products, which increased by 30% year-over-year. These increases were offset by decreases in our resource management products due primarily to $13.4 million of revenue recognized from a large transaction in EMEA during the fourth quarter of fiscal 2005.

Systems, security and identity management revenue increased in fiscal 2005 compared to fiscal 2004 due primarily to $13.4 million of revenue recognized from a large transaction in EMEA during the fourth quarter of fiscal 2005, which included ZENworks and Identity Manager products. In addition, revenue from sales of Identity Manager products increased by approximately $11.1 million during the same period.

Open platform solutions remained flat in fiscal 2006 compared to fiscal 2005 as the increases in SUSE Linux Enterprise Server and our Linux desktop product sales were offset by declines in the SUSE Linux consumer product.

Open platform solutions revenue increased in fiscal 2005 compared to fiscal 2004 due primarily to an increase of $16.8 million in sales of our SUSE Linux Enterprise Server products.


38	Novell annual report 2006

Workspace solutions decreased in fiscal 2006 compared to fiscal 2005 primarily due to a decrease in our combined NetWare-related/OES revenue and declines in our installed base, offset somewhat by the release of OES in the middle of the second quarter of fiscal 2005. NetWare and NetWare-related revenue combined with OES revenue decreased $49.4 million or 18% in fiscal 2006 compared to fiscal 2005. We expect year over year declines for combined NetWare-related revenue and OES revenue to continue in the same range during fiscal 2007.

Workspace solutions revenue decreased in fiscal 2005 compared to fiscal 2004 primarily due to a decline in combined NetWare/OES revenue of $22.6 million and decreased collaboration revenue of $4.1 million.

Global services and support decreased in fiscal 2006 compared to fiscal 2005 primarily due to expected decreases in IT consulting revenue in the EMEA and Asia Pacific segments as a result of our decision to focus on Novell product-related consulting, thereby eliminating projects that did not focus on our products and reducing revenue from general IT consulting projects.

Global services and support revenue increased in fiscal 2005 compared to fiscal 2004 primarily due to favorable foreign exchange rates, the acquisition of Salmon and increased consulting and services revenue in the Americas.

Further explanation of revenue trends by product follows in the discussion of revenue by geographic segment.

Revenue by reporting segment was as follows:


	Fiscal Year Ended October 31,						2006 vs			2005 vs
	2006		2005		2004		2005			2004
	(In thousands)						(Percentage change)

Americas	$	536,813	$	537,198	$	535,507		—	%		—	%
EMEA		345,597		407,998		378,269		(15	)%		8	%
Asia Pacific		84,867		94,027		90,078		(10	)%		4	%

Total net revenue	$	967,277	$	1,039,223	$	1,003,854		(7	)%		4	%

Revenue by solution category in the Americas was as follows:


	Fiscal Year Ended October 31,						2006 vs			2005 vs
	2006		2005		2004		2005			2004
	(In thousands)						(Percentage change)

Resource management	$	77,785	$	75,412	$	69,300
Identity and access management		55,105		37,742		30,418
Other systems, security, and identity management products		10,806		12,578		11,230

Systems, security and identity management		143,696		125,732		110,948		14	%		13	%

Linux platform products		21,292		16,854		7,026
Other open platform products		4,431		6,213		4,758

Open platform solutions		25,723		23,067		11,784		12	%		96	%

Open Enterprise Server		110,396		46,351		—
NetWare and other NetWare-related		16,944		103,728		162,172
Collaboration		61,349		61,213		64,583
Other workspace products		10,267		12,234		30,481

Workspace solutions		198,956		223,526		257,236		(11	)%		(13	)%

Total software licenses and maintenance		368,375		372,325		379,968
Global services and support		168,438		164,873		155,539		2	%		6	%

Total net revenue	$	536,813	$	537,198	$	535,507		—	%		—	%


Novell annual report 2006	39

Revenue from the Americas decreased slightly in fiscal 2006 compared to fiscal 2005 due primarily to decreased combined NetWare/OES revenue, offset somewhat by increased revenue from identity and access management, Linux platform, and resource management products. We had revenue from OES for the entire year in fiscal 2006 compared to only two and a half quarters in fiscal 2005.

Revenue from the Americas remained flat in fiscal 2005 compared to fiscal 2004. Revenue in fiscal 2004 included $13.5 million of Canopy royalty revenue. Excluding the Canopy revenue in fiscal 2004, revenue was up $15.2 million in fiscal 2005 compared to fiscal 2004, primarily due to increases in consulting and services revenue, Linux platform revenue, resource management revenue, and identity and access management product revenue. These increases were offset somewhat by lower combined NetWare/OES revenue of $12.1 million and lower collaboration revenue. Overall, favorable foreign currency exchange rates increased revenue in the Americas segment by approximately $3.1 million during fiscal 2005.

Revenue by solution category in EMEA was as follows:


	Fiscal Year Ended October 31,						2006 vs			2005 vs
	2006		2005		2004		2005			2004
	(In thousands)						(Percentage change)

Resource management	$	48,279	$	61,153	$	47,308
Identity and access management		33,875		30,109		25,553
Other systems, security, and identity management products		5,850		6,720		7,507

Systems, security and identity management		88,004		97,982		80,368		(10	)%		22	%

Linux platform products		19,642		16,524		9,507
Other open platform products		2,934		11,302		12,053

Open platform solutions		22,576		27,826		21,560		(19	)%		29	%

Open Enterprise Server		60,893		34,294		—
NetWare and other NetWare-related		18,895		68,787		108,802
Collaboration		30,589		33,362		33,284
Other workspace products		5,297		9,442		10,370

Workspace solutions		115,674		145,885		152,456		(21	)%		(4	)%

Total software licenses and maintenance		226,254		271,693		254,384
Global services and support		119,343		136,305		123,885		(12	)%		10	%

Total net revenue	$	345,597	$	407,998	$	378,269		(15	)%		8	%

Revenue from EMEA decreased in fiscal 2006 compared to fiscal 2005, primarily due to a decrease in combined NetWare/OES revenue, IT consulting revenue, and resource management revenue. Consulting revenue decreases were expected and primarily the result of our planned move to focus on Novell product-related consulting. The decreases in other open platform revenue were also expected and were primarily the result of planned reductions of our consumer product, SUSE Linux (formerly SUSE Professional). The decrease in resource management revenue was due primarily to a large transaction in EMEA during the fourth quarter of fiscal 2005, which included ZENworks and Identity Manager products. Overall, foreign currency exchange rates decreased revenue in the EMEA segment by approximately $5.5 million during fiscal 2006.

Revenue from EMEA increased in fiscal 2005 compared to fiscal 2004, primarily due to additional revenue from favorable foreign currency rates of $12.5 million. In addition, after adjusting for foreign currency impacts, revenue increased due to higher resource management revenue, increased IT consulting revenue, primarily from the acquisition of Salmon, and increased Linux platform revenue. These increases were offset somewhat by decreases in combined NetWare/OES revenue of $8.6 million.


40	Novell annual report 2006

Revenue by solution category in Asia Pacific was as follows:


	Fiscal Year Ended October 31,						2006 vs			2005 vs
	2006		2005		2004		2005			2004
	(In thousands)						(Percentage change)

Resource management	$	8,515	$	7,792	$	7,729
Identity and access management		8,741		7,086		5,354
Other systems, security, and identity management products		1,318		1,724		2,615

Systems, security and identity management		18,574		16,602		15,698		12	%		6	%

Linux platform products		4,363		2,459		454
Other open platform products		781		246		189

Open platform solutions		5,144		2,705		643		90	%		321	%

Open Enterprise Server		10,405		4,686		—
NetWare and other NetWare-related		11,940		21,034		30,466
Collaboration		4,239		4,847		5,689
Other workspace products		8,030		9,166		9,244

Workspace solutions		34,614		39,733		45,399		(13	)%		(12	)%

Total software licenses and maintenance		58,332		59,040		61,740
Global services and support		26,535		34,987		28,338		(24	)%		23	%

Total net revenue	$	84,867	$	94,027	$	90,078		(10	)%		4	%

Revenue in the Asia Pacific segment decreased in fiscal 2006 compared to fiscal 2005 primarily due to decreased combined NetWare/OES revenue and a decrease in IT consulting revenue, offset slightly from small increases in revenue from each of the other categories.

Revenue in the Asia Pacific segment increased slightly in fiscal 2005 compared to fiscal 2004. Decreases in combined NetWare/OES, combined, revenue of $4.7 million were offset by increases in consulting and services revenue, higher Linux revenue, and favorable foreign currency exchange rates of $2.0 million.

Deferred revenue

Deferred revenue represents revenue that is expected to be recognized in future periods. The majority of deferred revenue relates to maintenance contracts and subscriptions and is recognized ratably over the related service periods, typically one to three years. The increase in deferred revenue of $21.2 million at October 31, 2006 compared to October 31, 2005 is primarily attributable to increased subscription revenue and improved advanced invoicing. As more of our revenue contracts shift to multiple-product, multiple-year subscription arrangements, we expect that a greater proportion of our revenue will initially be deferred and recognized over the contractual service term as maintenance and subscription revenue.


Novell annual report 2006	41

Gross profit


	Fiscal Year Ended October 31,									2006 vs			2005 vs
	2006			2005			2004			2005			2004
	($ in thousands)									(Percentage change)

Software licenses	$	155,517		$	192,203		$	210,559			(19	)%		(9	)%
As a percent of software license revenue		90	%		90	%		90	%
Maintenance, subscriptions, and services	$	491,675		$	494,954		$	471,417			(1	)%		5	%
As a percent of maintenance, subscriptions and services revenue		62	%		60	%		61	%
Total gross profit	$	647,192		$	687,157		$	681,976			(6	)%		1	%
As a percent of net revenue		67	%		66	%		68	%

Gross profit from software licenses as a percentage of related sales remained flat from fiscal 2004 through fiscal 2006. The decrease in gross profit from software licenses for fiscal 2006 compared to fiscal 2005 is primarily due to decreased sales of software licenses and the related shift in revenue from licenses to subscriptions. The decrease in gross profit from software licenses for fiscal 2005 compared to fiscal 2004 is primarily due to decreased sales volume of software licenses.

The increase in gross profit from maintenance, subscriptions, and services as a percentage of maintenance, subscriptions, and services revenue for fiscal 2006 compared to fiscal 2005 was primarily a result of the consulting headcount reductions that took place in fiscal 2005 and a shift in the mix of revenue to more product-related revenue compared to consulting revenue, which carries higher costs of goods. These improvements were offset somewhat by additional stock-based compensation expense from the adoption of SFAS No. 123(R), which totaled approximately $4.1 million in fiscal 2006.

The increase in gross profit from maintenance, subscriptions, and services for fiscal 2005 compared to fiscal 2004 is primarily due to increased sales volume in the related sales category. The decrease in gross profit from maintenance, subscriptions, and services as a percentage of related revenue for fiscal 2005 compared to fiscal 2004 is primarily due to the impact of the Canopy royalty revenue recognized in fiscal 2004, which did not have any costs associated with it, and a shift in the mix of revenue in this category to lower margin consulting services revenue, increased royalty costs and increased amortization of intangible assets associated with recent acquisitions.


42	Novell annual report 2006

Operating expenses


	Fiscal Year Ended October 31,									2006 vs			2005 vs
	2006			2005			2004			2005			2004
	($ in thousands)									(Percentage change)

Sales and marketing	$	357,116		$	359,991		$	337,624			(1	)%		7	%
as a percent of net revenue		37	%		35	%		34	%
Product development	$	180,380		$	199,971		$	194,607			(10	)%		3	%
as a percent of net revenue		19	%		19	%		20	%
General and administrative	$	128,922		$	92,632		$	80,758			39	%		15	%
as a percent of net revenue		13	%		9	%		8	%
Restructuring expenses	$	4,405		$	57,753		$	22,903			(92	)%		152	%
as a percent of net revenue		—	%		6	%		2	%
Purchased in-process research and development	$	2,110		$	480		$	—			340	%		—	%
as a percent of net revenue		—	%		—	%		—	%
Gains on sale of property, plant & equipment	$	(5,968	)	$	(1,589	)	$	(1,977	)		276	%		(20	)%
as a percent of net revenue		(1	)%		—	%		—	%
Gain on settlement of potential litigation	$	—		$	(447,560	)	$	—			—	%		—	%
as a percent of net revenue		—	%		43	%		—	%
Impairment of intangible assets	$	1,230		$	1,521		$	—			(19	)%		—	%
as a percent of net revenue		—	%		—	%		—	%
Loss on sale of Japan consulting group	$	8,273		$	—		$	—			—	%		—	%
as a percent of net revenue		1	%		—	%		—	%
Executive termination benefits	$	9,409		$	—		$	—			—	%		—	%
as a percent of net revenue		1	%		—	%		—	%
Total operating expenses	$	685,877		$	263,199		$	633,915			161	%		(58	)%
As a percent of net revenue		71	%		25	%		63	%

Sales and marketing expenses remained relatively flat in fiscal 2006 compared to fiscal 2005. Increased expense from the adoption of SFAS No. 123(R), which totaled approximately $11.5 million in fiscal 2006, higher compensation expense, and additional sales expense related to the acquisition of e-Security in the second quarter of fiscal 2006 were offset by savings from the fiscal 2005 headcount reductions and decreased spending on marketing-related activities. Sales and marketing headcount was approximately 78 employees, or 7%, lower at the end of fiscal 2006 compared to the end of fiscal 2005.

Sales and marketing expenses for fiscal 2005, in total and as a percentage of revenue, increased compared to fiscal 2004 due primarily to increased marketing activities in the Americas and Asia Pacific. Sales and marketing expenses were approximately $14.2 million higher in the Americas in fiscal 2005 compared to fiscal 2004, mainly related to planned spending increases. Sales and marketing expenses in Asia Pacific increased primarily due to our investments in China of approximately $2.8 million. In addition sales and marketing increased due to inclusion of SUSE and Salmon for the full year in fiscal 2005. Unfavorable foreign currency exchange rates increased sales and marketing expenses by approximately $7.3 million in fiscal 2005.

Product development expenses in fiscal 2006 decreased compared to fiscal 2005 primarily due to planned savings as a result of the fiscal 2005 headcount reductions, offset somewhat by additional expense from the adoption of SFAS No. 123(R), which totaled approximately $8.2 million in fiscal 2006. Product development headcount was approximately 255 employees, or 16%, lower at the end of fiscal 2006 compared to the end of fiscal 2005.

Product development expenses in fiscal 2005 increased compared to fiscal 2004 due primarily to the acquisitions of Tally and Immunix, which added $2.5 million, and salary increases granted in fiscal 2005, which


Novell annual report 2006	43

added $3.4 million. These increases were offset somewhat by realized savings in fiscal 2005 from prior year headcount reductions.

General and administrative expenses increased in fiscal 2006 compared to fiscal 2005 due primarily to $22.8 million of litigation-related expenses resulting from an adjustment to a loss contingency based on changes in facts and circumstances, partially offset by a settlement we received from one of our insurance companies for past legal expenses, $11.1 million of stock-based compensation expense resulting from the adoption of SFAS No. 123(R), $3.0 million in increased expenses related to an internal project aimed at streamlining administrative and support functions, $1.9 million of additional expenses resulting from our voluntary stock option review, and a reduction in bad debt allowances and other accruals that reduced general and administrative expenses in fiscal 2005. These increases were offset somewhat by headcount reductions and lower facilities expenses. General and administrative headcount was lower by approximately 21 employees, or 3%, at the end of fiscal 2006 compared to the end of fiscal 2005.

General and administrative expenses increased in fiscal 2005 compared to fiscal 2004 primarily due to $10.7 million in one-time adjustments for changes in estimates in the prior year and salary increases granted in fiscal 2005 of approximately $3.0 million, offset somewhat by an adjustment of bad debt allowances and other accruals of $3.6 million during fiscal 2005.

Purchased in-process research and development (“IPR&D”) relates to technology that was not technologically feasible at the date of the acquisition, meaning it had not reached the working model stage, did not contain all of the major functions planned for the product, and was not ready for initial customer testing. IPR&D was valued based on discounting forecasted cash flows that will be generated directly from the related products. The in-process research and development does not have any alternative future use and did not otherwise qualify for capitalization. As a result, the amount was expensed. IPR&D in fiscal 2006 related to the acquisition of e-Security in the second quarter of fiscal 2006. At the acquisition date, e-Security was working on the next two releases of its product called Sentinel, one of which was released in the third calendar quarter of 2006 and the second is expected to be released in the first calendar half of 2007. These releases had not yet achieved technological feasibility at the time of acquisition. Completion of the development of the future upgrades of the Sentinel products is dependent upon our successful integration of the e-Security products with Novell products and services. The in-process research and development does not have any alternative future use and did not otherwise qualify for capitalization. Purchased IPR&D in fiscal 2005 related to technology purchased in the acquisitions of Immunix and Ximian.

During fiscal 2006, we recognized a $6.0 million gain on the sale of our two corporate aviation assets and certain corporate real estate assets. During fiscal 2005, we recognized a $1.6 million gain on the sale of a facility in Lindon, Utah. During fiscal 2004, we recognized a gain of $2.0 million on the sale of one of our facilities.

Gain on settlement of potential litigation in fiscal 2005 related to an agreement with Microsoft to settle potential antitrust litigation related to our NetWare operating system in exchange for $536 million in cash. On November 18, 2004, we received $536 million in cash from Microsoft. The financial terms of the NetWare settlement agreement, net of related legal fees of $88 million, resulted in a pre-tax gain of approximately $447.6 million in the first quarter of fiscal 2005.

The loss on sale of Japan consulting group relates to the excess of the carrying value of the JCG over its fair value at the time we entered into an agreement to sell the JCG.

The executive termination benefits related to the termination of our former Chief Executive Officer and Chief Financial Officer by our Board of Directors during the third quarter of fiscal 2006. They received benefits pursuant to their severance arrangements totaling $9.4 million, of which approximately $2.7 million of the expense related to stock compensation and $6.7 million related to severance and other benefits.

The impairments of $1.2 million related to our Ximian trademark/trade name intangible assets that ceased being utilized in the fourth quarter of fiscal 2006 and no longer had any value. During fiscal 2005, we also determined that $0.7 million of our trademarks and trade names were impaired as they were no longer being utilized and no longer had any value, and we also determined that certain internal use software intangible assets with a net book value of $0.8 million were fully impaired. The fair value of the software was determined based on the fact that


44	Novell annual report 2006

this software, as well as a similar product from a competitor, are now both available for free to the general public and the related technology is not proprietary to either us or the competitor.

Restructuring Expenses

Fiscal 2006

During fiscal 2006, we recorded net restructuring expenses of $4.4 million, $4.2 million of which related to restructuring activity recognized during fiscal 2006 and $0.2 million of which consisted of net adjustments related to previously recorded merger liabilities and restructuring liabilities. The adjustments to the merger liabilities have been recorded in the statement of operations since the changes have occurred outside the relevant purchase price allocation period.

The fiscal 2006 restructuring expenses related to efforts to restructure our business to improve profitability. These efforts are centered around three main initiatives: (1) improving our sales model and sales staff specialization; (2) integrating product development approach; and (3) improving in our administrative and support functions. As all three of these initiatives are in the early stages of being implemented, further restructuring activities are anticipated during fiscal 2007. Specific actions taken during fiscal 2006 included reducing our workforce by 24 employees, in sales, product development, consulting, general and administrative, marketing and technical support, exiting a facility and liquidating two legal entities. Total restructuring expenses by reporting segment were as follows: EMEA $1.7 million, Asia Pacific $1.4 million, Americas $0.8 million, and corporate unallocated operating costs $0.3 million.

The following table summarizes the activity during fiscal 2006 related to this restructuring:


							Other
	Severance and			Excess			Restructuring-
	Benefits			Facilities			Related Costs			Total
	(In thousands)

Original reserve	$	3,420		$	606		$	163		$	4,189
Cash payments		(323	)		(591	)		(35	)		(949	)

Balance at October 31, 2006	$	3,097		$	15		$	128		$	3,240

As of October 31, 2006, the remaining unpaid balances include accrued liabilities related to severance benefits which will be paid out over the remaining severance obligation period, various fees relating to the exited facility, which will be paid out during fiscal 2007, and various fees related to the liquidation of two legal entities, which will be paid out during fiscal 2007.

Fiscal 2005

During fiscal 2005, we recorded net restructuring expenses of $57.7 million, of which $53.6 million related to restructuring activity recognized during fiscal 2005 and $5.3 million related to adjustments to previously recorded merger liabilities to adjust lease accruals, less a net release of $1.2 million related to an adjustment of prior period restructuring liabilities. The adjustments to the merger liabilities have been recorded in the statement of operations since the changes have occurred outside the relevant purchase price allocation period. These restructuring expenses related to our continuing efforts to restructure our business to improve profitability and to focus on Linux and identity-driven computing. Specific actions taken included reducing our workforce by 817 employees, primarily in product development, consulting, sales, and general and administrative, though all areas were impacted. Total restructuring expenses for fiscal 2005 by reporting segment were as follows: EMEA $25.7 million, corporate unallocated operating costs $12.6 million, Americas $14.1 million, and Asia Pacific $5.3 million.


Novell annual report 2006	45

The following table summarizes the activity related to this restructuring:


							Other
	Severance and			Excess			Restructuring-
	Benefits			Facilities			Related Costs			Total
	(In thousands)

Original reserve	$	45,763		$	7,364		$	477		$	53,604
Cash payments		(17,271	)		(913	)		(218	)		(18,402	)

Balance at October 31, 2005		28,492			6,451			259			35,202
Cash payments		(25,438	)		(4,022	)		(202	)		(29,662	)
Non-cash adjustments		(1,721	)		1,437			—			(284	)

Balance at October 31, 2006	$	1,333		$	3,866		$	57		$	5,256

The $1.2 million adjustments of prior period restructuring and merger liabilities are reflected in the appropriate restructurings. As of October 31, 2005, the remaining unpaid balances include accrued liabilities related to severance benefits which will be paid out over the remaining severance obligation period, lease costs for redundant facilities which will be paid over the respective remaining contract terms, and various employee-related severance costs which will be primarily paid over the next twelve months.

Fiscal 2004

During fiscal 2004, we recorded net restructuring expenses of $19.1 million. These restructuring expenses were in response to the evolution of our business strategy to develop a competitive position in the Linux market. This strategy includes plans to support the Linux operating system in addition to the NetWare operating system, by offering our products and services that run on Linux, NetWare and other platforms. The acquisitions of Ximian and SUSE were direct results of the evolution in our business strategy. These changes were made to address market penetration for Linux and NetWare and to address NetWare revenue declines. Specific actions taken include reducing our workforce by 136 employees during fiscal 2004, mainly in consulting, sales and product development in EMEA and the Americas. In addition, we consolidated facilities, resulting in the closure of two sales facilities and the disposal of excess equipment and tenant improvements in the United States. Total restructuring expenses for fiscal 2004 by reporting segment were as follows: Americas $5.7 million, EMEA $9.4 million, Asia Pacific $0.4 million, and non-allocated corporate costs $3.5 million.

The following table summarizes the activity related to this restructuring:


	Severance and			Excess
	Benefits			Facilities			Total
	(In thousands)

Original reserve	$	12,910		$	6,152		$	19,062
Cash payments		(8,252	)		(3,645	)		(11,897	)

Balance at October 31, 2004		4,658			2,507			7,165
Cash payments		(2,716	)		(1,109	)		(3,825	)
Non-cash adjustments		(699	)		59			(640	)

Balance at October 31, 2005		1,243			1,457			2,700

Cash payments		(1,012	)		(1,067	)		(2,079	)
Non-cash adjustments		(231	)		487			256

Balance at October 31, 2006	$	—		$	877		$	877

As of October 31, 2006, the remaining balance of the fiscal 2004 restructuring expenses included accrued liabilities related to lease costs for redundant facilities, which will be paid over the respective remaining contract terms.


46	Novell annual report 2006

During fiscal 2004, we also recorded a $5.9 million restructuring expense to increase prior restructuring liabilities by $1.0 million and prior merger-related liabilities by $4.9 million, and we released approximately $2.1 million of excess restructuring reserves related to prior restructuring events. The increases were the result of changes in estimates used when the original expenses were recorded primarily due to changes in the real estate market in the United Kingdom. The net impact of the fiscal 2004 restructurings and the release of the prior restructuring excess reserves was an expense of $22.9 million in fiscal 2004. These adjustments, which pertain to separate restructuring events, are included in the applicable restructuring accruals.

Other income (expense), net


	Fiscal Year Ended October 31,									2006 vs			2005 vs
	2006			2005			2004			2005			2004
	($ in thousands)									(Percentage change)

Impairment of investments	$	(1,470	)	$	(3,387	)	$	(5,415	)		(57	)%		(37	)%
as a percent of net revenue		—	%		—	%		(1	)%
Investment income	$	61,076		$	46,045		$	23,401			33	%		97	%
as a percent of net revenue		6	%		4	%		2	%
Gain on sale of venture capital funds	$	17,953		$	—		$	—			—	%		—	%
as a percent of net revenue		2	%		—	%		—	%
Interest expense and other expenses, net	$	(8,018	)	$	(8,665	)	$	(8,116	)		(7	)%		7	%
as a percent of net revenue		(1	)%		(1	)%		(1	)%
Total other income (expense), net	$	69,541		$	33,993		$	9,870			105	%		244	%
as a percent of net revenue		7	%		3	%		1	%

To assess impairment on our investments, we analyze forecasted financial performance of the investees and our estimate of the potential for investment recovery based on the financial performance factors. When an impairment is deemed to be “other than temporary” we record an impairment expense.

Investment income from short-term and long-term investments increased in fiscal 2006 compared to fiscal 2005 due to higher interest rates, offset somewhat by lower cash balances.

Investment income from short-term and long-term investments increased in fiscal 2005 compared to fiscal 2004 due primarily to interest earned on the $460.0 million received from the issuance of the Debentures in the third quarter of fiscal 2004, after the related stock buy-back and issuance costs, and the $447.6 million cash received from Microsoft in the first quarter of fiscal 2005 in connection with the favorable settlement of potential anti-trust litigation, after related legal fees. Investment income in fiscal 2005 also included long-term investment realized gains of $2.1 million from the sale of long-term investments.

During the fourth quarter of fiscal 2006, we sold all of our rights, titles, interests and obligations for 22 of our 23 Venture Capital Funds, which were classified as long-term investments in the consolidated balance sheet. As of October 31, 2006, the sale of all but one-half of one fund had closed. We recorded a gain of $17.9 million in fiscal 2006 related to the sale of the funds that closed during the fourth quarter of fiscal 2006. The remaining one-half of the one fund that closed subsequent to fiscal 2006 resulted in an additional gain of $3.6 million, which will be reported as part of Novell’s fiscal 2007 first quarter results.

Interest expense and other, net decreased slightly in fiscal 2006 compared to fiscal 2005 due primarily to lower foreign currency transaction losses.

Interest expense and other expenses, net for fiscal 2005 increased compared to fiscal 2004 due primarily to interest expense of $6.0 million related to the issuance of the Debentures in the third quarter of fiscal 2004. This increase was offset somewhat by lower foreign currency transaction losses and minority interest.


Novell annual report 2006	47

Income tax (benefit) expense on income from continuing operations


	Fiscal Year Ended October 31,									2006 vs			2005 vs
	2006			2005			2004			2005			2004
	($ in thousands)									(Percentage change)

Income tax expense	$	23,231		$	86,660		$	11,335			(73	)%		665	%
As a percent of revenue		2	%		8	%		1	%
Effective tax rate		75	%		19	%		20	%

We are subject to income taxes in numerous jurisdictions and the use of estimates is required in determining our provision for income taxes. In addition to the income taxes provided for continuing operations noted above, we provided income tax expense on income from discontinued operations of $1.0 million, $2.8 million, and $6.5 million in fiscal years 2006, 2005, and 2004, respectively.

Due to the utilization of a significant amount of our net operating loss carryforwards during fiscal 2005, substantially all of the tax benefit received from the use of our remaining net operating loss carryforwards to offset U.S. taxable income in 2006 was credited to additional paid-in capital or goodwill and not to income tax expense. In addition, the windfall tax benefits associated with stock-based compensation is also credited to additional 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 which deductions and net operating loss carryforwards are utilized. Accordingly, during fiscal 2006, a tax benefit relating to stock options of $15.3 million was credited to additional paid-in capital and a benefit of $6.6 million was credited to goodwill.

The effective tax rate for fiscal 2006 differs from the federal statutory rate of 35% primarily due to the effects of the valuation allowance on our deferred tax assets, stock-based compensation plans, non-deductible expenses, differences between book and tax items and foreign taxes. The effective tax rate on income from continuing operations for fiscal 2006 was 75% compared to the effective tax rate of 19% for fiscal 2005. The effective tax rate for fiscal 2006 is higher than the effective tax rate for fiscal 2005 primarily because the fiscal 2005 rate reflected a benefit recorded to income tax expense from the use of a significant amount of our net operating loss carryforwards. The effective tax rate for fiscal 2005 of 19% was lower than the 20% effective tax rate for fiscal 2004 primarily due to the use of U.S. net operating loss carryforwards. We expect our effective tax rate in 2007 to approximate 100% due to forecasted near break even operations, our inability to recognize the tax benefits of our deferred tax assets since the assets are subject to a valuation allowance, and the use of net operating loss carryforwards whose benefits are credited to additional paid-in capital or goodwill.

In accordance with applicable accounting standards, we regularly assess our ability to realize our deferred tax assets. Assessments of the realization of deferred tax assets require that management consider all available evidence, both positive and negative, and make significant judgments about many factors, including the amount and likelihood of future taxable income. Based on all the available evidence, we continue to believe that it is more likely than not that our remaining U.S. net deferred tax assets, and certain foreign deferred tax assets, are not currently realizable. As a result, we continue to provide a full valuation reserve on our U.S. net deferred tax assets and certain foreign deferred tax assets. The valuation allowance on deferred tax assets increased by $74.6 million in fiscal 2006 primarily due to stock based compensation and other originating assets, new acquisitions and changes in our deferred tax liabilities.

As of October 31, 2006, we had unrestricted U.S. net operating loss carryforwards for federal tax purposes of approximately $72.0 million. Substantially all of the benefit of the use of these loss carryforwards will be recorded as a credit to additional paid-in capital. If not utilized, these carryforwards will expire in fiscal years 2023 through 2025. Additionally, we had $222.0 million in net operating loss carryforwards from acquired companies that will expire in years 2019 through 2025. These loss carryforwards from acquired companies can be utilized to offset future taxable income, but are subject to certain annual limitations. The benefit of the use of these loss carryforwards will be recorded to first reduce goodwill relating to the acquisition, second to reduce other non-current intangible assets relating to the acquisition, and third to reduce income tax expense. Our alternative minimum tax net operating losses approximate our regular tax net operating losses disclosed above. In addition, we have approximately $160.7 million of foreign loss carryforwards, of which $5.4 million, $2.2 million, $2.5 million,


48	Novell annual report 2006

and $10.9 million are subject to expiration in years 2007, 2008, 2009, and 2014, respectively. The remaining losses do not expire. We have $141.4 million in capital loss carryforwards, which, if not utilized, will expire in fiscal years 2007 through 2011. We have foreign tax credit carryforwards of $40.8 million that expire between 2009 and 2016, general business credit carryforwards of $90.1 million that expire between 2010 and 2026, and alternative minimum tax credit carryforwards of $10.1 million that do not expire. We also have various state net operating loss and credit carryforwards that expire in accordance with the respective state statutes.

As of October 31, 2006, deferred tax assets of approximately $47.0 million pertain to certain tax credits and net operating loss carryforwards resulting from the exercise of employee stock options. If realized, the tax benefit of these credits and losses will be accounted for as a credit to stockholders’ equity. Additionally, deferred tax assets of $90.0 million relate to acquired entities. These acquired deferred tax assets are subject to limitation under the change of ownership rules of the Internal Revenue Code and have been fully reserved. Approximately $63.7 million of future tax benefit relating to these deferred tax assets will be recorded to first reduce goodwill relating to the acquisition, second to reduce other non-current intangible assets relating to the acquisition, and third to reduce income tax expense.

We have permanently reinvested the earnings of several of our foreign subsidiaries. Accordingly, we have not provided deferred income taxes on the excess of the book basis over the tax outside basis in the stock of these foreign subsidiaries. The estimated unrecognized deferred income tax liability for this difference is $0.7 million.

During fiscal 2006, we received a one-time tax benefit of $4.2 million from the Internal Revenue Service relating to net operating loss carrybacks made possible under the “Job Creation and Worker Assistance Act of 2002.” We also recorded a $2.6 million tax benefit attributable to the favorable resolution of a tax examination at one of our foreign subsidiaries. In 2004, we determined that the amount of reserves related to tax exposures was less than the amount recorded in the financial statements. As a result, we reduced the tax reserves by $5.9 million. We continue to evaluate our tax reserves under SFAS No. 5, “Accounting for Contingencies,” which requires us to accrue for losses we believe are probable and can be reasonably estimated. The amount reflected in the consolidated balance sheet at October 31, 2006 is considered adequate based on our assessment of many factors including results of tax audits, past experience and interpretations of tax law applied to the facts of each matter. It is reasonably possible that our tax reserves could be increased or decreased in the near term based on these factors.

Dividends on Series B Preferred Stock


	Fiscal Year Ended October 31,
	2006			2005			2004
	(In thousands)

Non-cash deemed dividend related to beneficial conversion feature of Preferred Stock	$	—		$	—		$	(25,680	)
Preferred Stock cash dividends	$	(187	)	$	(466	)	$	(416	)

In March 23, 2004, we entered into a definitive agreement with IBM providing for an investment of $50.0 million by IBM in Novell. The primary terms of the investment, which were negotiated in November 2003, entailed the purchase by IBM of 1,000 shares of our Series B Preferred Stock that are convertible into 8 million shares of our common stock at a price of $6.25 per common share. The shares are entitled to a dividend of 2% per annum, payable quarterly in cash.

Because the fair value of our common stock of $9.46 per share on March 23, 2004 was greater than the conversion price of $6.25 per share, we recorded a one-time, non-cash deemed dividend of $25.7 million attributable to the value of the Series B Preferred Stock’s conversion feature. This beneficial conversion feature had no impact on net income, but did reduce earnings attributable to common stockholders and thus reduced basic and diluted earnings per share by approximately $0.07 in fiscal 2004.

On June 17, 2004, 500 shares of Series B Preferred Stock, with a carrying value of $25.0 million, were converted into 4.0 million shares of our common stock. On September 21, 2005, 313 shares of Series B Preferred Stock, with a carrying value of $15.7 million, were converted into 2.5 million shares of our common stock.


Novell annual report 2006	49

Subsequent to the end of fiscal 2006, IBM converted all of the remaining outstanding shares of Series B Preferred Stock into 1.5 million shares of common stock.

Net income (loss) components


	Fiscal Year Ended October 31,
	2006			2005		2004
	(In thousands)

Income from continuing operations	$	7,625		$	371,291	$	46,596
Discontinued operations, net of tax		11,928			5,431		10,592
Cumulative effect of a change in accounting principle		(897	)		—		—
Net income	$	18,656		$	376,722	$	57,188

Expense from the adoption of SFAS No. 123(R) in the first quarter of fiscal 2006 decreased income from continuing operations by approximately $35.0 million during fiscal 2006. Net income was favorably impacted by foreign exchange rate fluctuations in fiscal 2006 by approximately $1.3 million.

Discontinued operations relates to the sale of Celerant consulting, discussed in the Divestitures section, above.

In March 2005, the FASB issued Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations” (“FIN 47”), which responded to diversity in practice of how SFAS No. 143, “Accounting for Asset Retirement Obligations,” was being implemented. Specifically, FIN 47 recognized that, when uncertainty about the timing and/or settlement method existed, some entities were recognizing the fair value of asset retirement obligations (“AROs”) prior to retirement of the asset, while others were recognizing the fair value of the obligation only when it was probable that the asset would be retired on a specific date or when the asset was actually retired. FIN 47 clarified that the uncertainty surrounding the timing and method of settlement when settlement is conditional on a future event occurring should be reflected in the measurement of the liability, not in the recognition of the liability. AROs must be recognized even though uncertainty may exist about the timing or method of settlement and therefore a liability should be recognized when the ARO is incurred. We adopted FIN 47 effective May 1, 2006. FIN 47 requires an entity to recognize the cumulative effect of initially applying FIN 47 as a change in accounting principle. Prior to the issuance of FIN 47, we accounted for AROs when it became probable that the asset would be retired or when the asset was actually retired. Our AROs result from facility operating leases where we are the lessee and the lease agreement contains a reinstatement clause, which generally requires any leasehold improvements we make to the leased property to be removed, at our cost, at the end of the lease.

Forward-looking information

Fiscal 2007 will be a year of significant change for Novell. We will make investments to facilitate changes in our business model while sustaining our revenue momentum in our growth businesses, such as Linux and identity management, and managing revenue declines in our legacy workgroup businesses, such as NetWare/OES and GroupWise.

We expect revenue for fiscal 2007 to be in a range similar to the fiscal 2006 actual amounts, including the effect of the net balancing payments and subscription revenue from the Microsoft partnership (see discussion of the Microsoft partnership in Subsequent Events, following) and the impact of dispositions during the year. We also estimate stock-based compensation expenses in fiscal 2007 to be approximately the same amount as in fiscal 2006. Our annual effective tax rate for fiscal year 2007 is estimated to be 100%.

We are targeting to remove certain expenses throughout fiscal 2007 while investing for improved profitability in fiscal 2008. We plan to invest $20 to $25 million in operating expense to execute our model changes in fiscal 2007. Including the impact of these overlapping expenses, in fiscal 2007 we expect to be break even to slightly profitable on an income from operations basis, before consideration of extraordinary items and stock-based compensation expenses. These overlapping expenses will be eliminated by the end of fiscal 2007. After elimination of these expenses and realization of the run rate savings from these investments, we are targeting a fourth quarter fiscal 2007 exit rate operating margin of 5% to 7%, before stock based compensation expenses. By exit rate


50	Novell annual report 2006

operating margin, we mean at the end of the fourth quarter fiscal 2007, we expect to have an annualized expense run rate level that, when compared to the fiscal 2007 revenue, would result in an operating margin of 5% to 7%.

Liquidity and Capital Resources


	October 31,			October 31,			Percentage
	2006			2005			Change
	($ in thousands)

Cash, cash equivalents, and short-term investments	$	1,466,287		$	1,654,904			(11	)%
Percentage of total assets		60	%		60	%

Cash, cash equivalents, and short-term investments decreased $188.6 million from October 31, 2005 to October 31, 2006 primarily due to the following:


	Fiscal 2006			Fiscal 2005			Fiscal 2004
	(In thousands)

Cash provided by operating activities	$	99,006		$	500,414		$	117,413
Issuance of common stock, net	$	40,131		$	22,108		$	58,162
Repurchase of common stock, 2006 retired, 2004 held in treasury	$	(400,000	)	$	—		$	(125,000	)
Expenditures for property, plant and equipment	$	(26,668	)	$	(30,781	)	$	(26,997	)
Proceeds from sales of property, plant and equipment	$	24,992		$	10,421		$	4,951
Proceeds from the sale of Venture Capital fund investments	$	71,298		$	—		$	—
Proceeds from the payoff of a note receivable	$	9,092		$	—		$	—
Proceeds from the sale of Celerant and the Japan consulting group, net of cash divested	$	39,372		$	—		$	—
Net cash paid for acquisitions	$	(71,550	)	$	(33,829	)	$	(205,620	)
Cash paid for intangible assets	$	(1,159	)	$	(15,500	)	$	—
Cash paid for equity share of OIN	$	(4,225	)	$	—		$	—
Restricted cash for acquisition of India joint venture	$	—		$	(7,500	)	$	—
Issuance of Debentures, net of issuance costs	$	—		$	—		$	585,150
Issuance of Series B Preferred Stock	$	—		$	—		$	50,000

Cash provided by operating activities in fiscal 2005 included the receipt of $447.6 million in cash, net of legal fees, in connection with the November 2004 Microsoft settlement.

As of October 31, 2006, we had cash, cash equivalents and other short-term investments of $330.5 million held in accounts outside the United States. Our short-term investment portfolio is diversified among security types, industry groups, and individual issuers. To achieve potentially higher returns, a portion of our investment portfolio is invested in equity securities and mutual funds, which are subject to market risk. Approximately $6.8 million of our short-term investments are designated to fund deferred compensation payments, which are paid out as requested by the plan participants. Our short-term investment portfolio includes gross unrealized gains and losses of $1.3 million and $4.8 million, respectively, as of October 31, 2006. We monitor our investments and record losses when a decline in the investment’s market value is determined to be other than temporary.

Our $20.0 million, 20% ownership interest in OIN consists 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 patents had a book value of $14.4 million, including $0.3 million of prepaid acquisition costs. Subsequent to year-end, our ownership interest in OIN decreased to approximately 17% due to the addition of a new investor in the company. According to the terms of the OIN LLC agreement, we could be required to make future cash contributions which we would fund with cash from operations and cash on hand.

As of October 31, 2006, we have various operating leases related to our facilities. These leases have minimum annual lease commitments of $27.0 million in fiscal 2007, $23.9 million in fiscal 2008, $16.3 million in fiscal 2009, $10.3 million in fiscal 2010, $8.4 million in fiscal 2011, and $33.1 million thereafter. Furthermore, we have $29.3 million of minimum rentals to be received in the future from subleases.


Novell annual report 2006	51

On July 2, 2004, we issued and sold $600 million aggregate principal amount of our Debentures due 2024. The Debentures pay interest at 0.50% per annum, payable semi-annually on January 15 and July 15 of each year, commencing January 15, 2005. Each $1,000 principal amount of the Debentures is convertible, at the option of the holders, into 86.7905 shares of our common stock prior to July 15, 2024 if (1) the price of our common stock trades above 130% of the conversion price for a specified duration, (2) the trading price of the Debentures is below a certain threshold, subject to specified exceptions, (3) the Debentures have been called for redemption, or (4) specified corporate transactions have occurred. None of the conversion triggers were met as of October 31, 2006. The conversion rate is subject to certain adjustments. The conversion rate initially represents a conversion price of $11.52 per share. Holders of the Debentures may require us to repurchase all or a portion of their Debentures on July 15, 2009, July 15, 2014 and July 15, 2019, or upon the occurrence of certain events, including a change in control. The Debentures can be redeemed by us for cash beginning on or after July 20, 2009.

In connection with the issuance of the Debentures, we incurred $14.9 million of issuance costs, which primarily consisted of investment banker fees and legal and other professional fees. These costs are included in other assets and are being amortized as interest expense using the effective interest method over the term from issuance through the first date that the holders can require repurchase of the Debentures (July 15, 2009). Amortization expense related to the issuance costs was $3.0 million, $3.0 million, and $1.0 million for the fiscal years ended October 31, 2006, 2005, and 2004, respectively. In addition, interest expense was $3.0 million, $3.0 million and $1.0 million for the fiscal years ended October 31, 2006, 2005, and 2004, respectively. We made cash payments of $3.0 million in fiscal 2006 and $3.1 million in fiscal 2005, respectively. No payments of interest were made in fiscal 2004.

Due to the voluntary review of our historical stock-based compensation practices that was announced in August 2006 and not completed until May 2007, we did not file our third quarter fiscal 2006 Form 10-Q in a timely manner. In September 2006, we received a letter from Wells Fargo Bank, N.A., the trustee of our Debentures, which asserted that Novell is in default under the indenture because of the delay in filing its Form 10-Q for the period ended July 31, 2006. The letter stated that the asserted default would not become an “event of default” under the indenture if the company cured the default within 60 days after the date of the notice. We believe that these above-mentioned notices of default were invalid and without merit because the indenture only requires us to provide the trustee copies of SEC reports within 15 days after such filings are actually made. However, in order to avoid the expense and uncertainties of further disputing whether a default under the indenture had occurred, we solicited consents from the holders of the Debentures to proposed amendments to the indenture that would give Novell until Thursday, May 31, 2007 to become current in our SEC reporting obligations and a waiver of rights to pursue remedies available under the indenture with respect to any default caused by our not filing SEC reports timely. On November 9, 2006, we received consents from the holders of the Debentures, and therefore we and the trustee entered into a first supplemental indenture implementing the proposed amendments described in the consent solicitation statements. Under the terms of the consent solicitation and first supplemental indenture, we will pay an additional 7.3% per annum, or $44.0 million, in special interest on the Debentures from November 9, 2006 to, but excluding November 9, 2007. In accordance with EITF 96-19, “Debtor’s Accounting for a Modification or Exchange of Debt Instruments” (“EITF 96-19”), since the change in the terms of the Debentures did not result in substantially different cash flows, this change in terms is accounted for as a modification, and therefore the additional $44.0 million of special interest payments will be expensed over the period from November 9, 2006 through July 15, 2009. During the period of November 9, 2006 through July 15, 2009, the new effective interest rate on this debt, including the $44.0 million, will be 3.2%. The $44.0 million will be paid as special interest payments over three periods; the first payment of $8.1 million occurred in January 2007. The next payment of $22.0 million will occur in July 2007 and the final payment of $13.9 million will occur in January 2008. In addition, we paid approximately $1.5 million in fees to Citigroup for work performed on the consent process.

As of October 31, 2006, we also had $9.4 million of Series B Preferred Stock outstanding. The Series B Preferred Stock is redeemable at our option or by the holder only under certain change in control circumstances. In November 2006, all of the Series B Preferred Stock was converted into 1.5 million common shares.


52	Novell annual report 2006

to the share repurchase program increasing the limit on repurchase from $200.0 million to $400.0 million and extending the program through April 3, 2007. As of July 31, 2006, we had completed the share repurchase program by purchasing 51.5 million shares at an average cost per share of $7.76.

Contractual Obligations as of October 31, 2006


	Payments Due by Period
				Less Than									More Than
				1 Year			1-3 Years			3-5 Years			5 Years
	Total			(2007)			(2008-2009)			(2010-2011)			(Beyond 2011)
	(In millions)

Debentures	$	600.0		$	—		$	—		$	—		$	600.0
Interest on Debentures(a)		97.1			33.1			19.9			6.0			38.1
Purchase commitments(b)		1.4			1.0			0.4			—			—
Operating lease obligations		119.0			27.0			40.2			18.7			33.1
Letters of credit		14.9			14.9			—			—			—

Total	$	832.4		$	76.0		$	60.5		$	24.7		$	671.2

Other contractual obligations:
Dividends on Series B Preferred Stock		(c	)		(c	)		(c	)		(c	)		(c	)


(a)		Interest on the Debentures assumes no conversions.

(b)		Purchase obligations represent future contracted payments under normal take or pay arrangements entered into as a part of the normal course of business that are not recorded as liabilities at October 31, 2006.

(c)		During November 2006, the Series B Preferred Stock was converted into 1.5 million common shares, which eliminated the obligation to pay dividends beyond the conversion date.

Our principal source of liquidity continues to be cash from operations, cash on hand, and short-term investments. At October 31, 2006, our principal unused sources of liquidity consisted of cash and cash equivalents of $675.8 million and short-term investments in the amount of $790.5 million. During fiscal 2006, we generated $99.0 million of cash flow from operations. Our liquidity needs for the next twelve months are principally for financing of interest payments on Debentures, fixed assets, payments under our restructuring plans, product development, and to maintain flexibility in a dynamic and competitive operating environment, including pursuing potential acquisition and investment opportunities. Our liquidity needs beyond the next twelve months include those mentioned previously in addition to the possible redemption of our Debentures.

We anticipate being able to fund our current operations, potential future acquisitions, any further integration, restructuring or additional merger-related costs, and planned capital expenditures for the next twelve months with existing cash and short-term investments together with cash generated from operations and investment income and net cash received as a result of our agreement with Microsoft, discussed below under Subsequent Events. We believe that borrowings under our credit facilities or offerings of equity or debt securities are possible for expenditures beyond the next twelve months, if the need arises, although such offerings may not be available to us on acceptable terms and are dependent on market conditions at such time. Investments will continue in product development and in new and existing areas of technology. Cash may also be used to acquire technology through purchases and strategic acquisitions. We also anticipate having adequate cash in fiscal 2007 for necessary capital expenditures.

Recent Pronouncements

In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109,” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” FIN 48 prescribes a two-step process to determine the amount of tax benefit to be recognized. First, the tax position must be evaluated to determine the likelihood that it will be sustained upon external examination. If the tax


Novell annual report 2006	53

position is deemed “more-likely-than-not” to be sustained, the tax position is then assessed to determine the amount of benefit to recognize in the financial statements. The amount of the benefit that may be recognized is the largest amount that has a greater than 50 percent likelihood of being realized upon ultimate settlement. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods and disclosure relative to uncertain tax positions. FIN 48 is effective for fiscal years beginning after December 15, 2006 (Novell’s fiscal 2008, beginning November 1, 2007). We are currently evaluating the impact of this interpretation on our financial position and results of operations.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” (“SFAS No. 157”). SFAS No. 157 defines fair value and provides enhanced guidance for using fair value to measure assets and liabilities. It also expands the amount of disclosure about the use of fair value to measure assets and liabilities. The standard applies whenever other standards require assets or liabilities to be measured at fair value but does not expand the use of fair value to any new circumstances. SFAS No. 157 is effective beginning the first fiscal year that begins after November 15, 2007 (Novell’s fiscal 2009). We are currently evaluating the impact of SFAS No. 157 on our financial position and results of operations.

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Post retirement Plans, an amendment of SFAS Nos. 87, 88, 106, and 132(R),” (“SFAS No. 158”). This statement requires an employer to recognize in its balance sheet the over-funded or under-funded status of a defined benefit post retirement plan measured as the difference between the fair value of plan assets and the present value of the benefit obligation. The recognition of the net liability or asset will require an offsetting adjustment to accumulated other comprehensive income in shareholders’ equity. SFAS No. 158 does not change how post-retirement benefits are accounted for and reported in the income statement. SFAS No. 158 is effective for fiscal years ending after December 15, 2006 (Novell’s fiscal 2007). We do not expect the adoption of SFAS No. 158 to have a material impact on our comprehensive income and we do not anticipate a material adjustment to our statement of financial position as a result of adopting SFAS No. 158.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” (“SFAS No. 159”). SFAS 159 establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. Previously, accounting rules required different measurement attributes for different assets and liabilities that created artificial volatility in earnings. SFAS No. 159 helps to mitigate this type of accounting-induced volatility by enabling companies to report related assets and liabilities at fair value, which would likely reduce the need for companies to comply with detailed rules for hedge accounting. SFAS No. 159 is effective as of the beginning of an entity’s first fiscal year beginning after November 15, 2007 (Novell’s fiscal 2009), though early adoption is permitted. We are currently evaluating the impact of this pronouncement on our financial position and results of operations.

In March 2007, the Emerging Issues Task Force (“EITF”) reached a consensus on issue number 06-10, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Collateral Assignment Split-Dollar Life Insurance Arrangements,” (“EITF 06-10”). EITF 06-10 provides guidance to help companies determine whether a liability for the postretirement benefit associated with a collateral assignment split-dollar life insurance arrangement should be recorded in accordance with either SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions” (if, in substance, a postretirement benefit plan exists), or Accounting Principles Board Opinion No. 12. (if the arrangement is, in substance, an individual deferred compensation contract). EITF 06-10 also provides guidance on how a company should recognize and measure the asset in a collateral assignment split-dollar life insurance contract. EITF 06-10 is effective for fiscal years beginning after December 15, 2007 (Novell’s fiscal 2008), though early adoption is permitted. We are currently evaluating the impact of this pronouncement on our financial position and results of operations.


54	Novell annual report 2006

Subsequent Events

Sale of Venture Capital Funds

In November 2006, we closed the sale of the remaining one-half of one of our venture capital funds, resulting in a gain in the first quarter of fiscal 2007 of $3.6 million on proceeds of $5.0 million.

Conversion of Redeemable Preferred Stock

In November 2006, IBM converted the remaining 187 outstanding shares of Series B Preferred Stock into 1.5 million shares of our common stock.

Microsoft Agreements

On November 2, 2006, we entered into a Business Collaboration Agreement, a Technical Collaboration Agreement, and a Patent Cooperation Agreement with Microsoft Corporation that together are designed to build, market and support a series of new solutions to make Novell and Microsoft products work better together for customers. Each of the agreements is scheduled to expire January 1, 2012.

Under the Business Collaboration Agreement, we are marketing a combined offering with Microsoft. The combined offering consists of SUSE Linux Enterprise Server (“SLES”) and a subscription for SLES support along with Microsoft Windows Server, Microsoft Virtual Server and Microsoft Viridian, and is offered to customers desiring to deploy Linux and Windows in a virtualized setting. Microsoft made an upfront payment to us of $240 million for SLES subscription “certificates,” which Microsoft may use, resell or otherwise distribute over the term of the agreement, allowing the certificate holder to redeem single or multi-year subscriptions for SLES support from us (entitling the certificate holder to upgrades, updates and technical support). Microsoft will spend $12 million annually for marketing Linux and Windows virtualization scenarios and will also spend $34 million over the term of the agreement for a Microsoft sales force devoted primarily to marketing the combined offering. Microsoft agreed that for three years following the initial date of the agreement it will not enter into an agreement with any other Linux distributor to encourage adoption of non-Novell Linux/Windows Server virtualization through a program substantially similar to the SLES subscription “certificate” distribution program.

The Technical Collaboration Agreement focuses primarily on four areas:


	•	Development of technologies to optimize each of SLES and Windows running as guests in a virtualized setting on the other operating system;

	•	Development of management tools for managing heterogeneous virtualization environments, to enable each party’s management tools to command, control and configure the other party’s operating system in a virtual machine environment;

	•	Development of translators to improve interoperability between Microsoft Office and OpenOffice document formats; and

	•	Collaboration on improving directory and identity interoperability and identity management between Microsoft Active Directory software and Novell eDirectory software.

Under the Technical Collaboration Agreement, Microsoft agreed to provide funding to help accomplish these broad objectives, subject to certain limitations.

Under the Patent Cooperation Agreement, Microsoft agreed to covenant with our customers not to assert its patents against our customers for their use of our products and services for which we receive revenue directly or indirectly, with certain exceptions, while we agreed to covenant with Microsoft’s customers not to assert our patents against Microsoft’s customers for their use of Microsoft products and services for which Microsoft receives revenue directly or indirectly, with certain exceptions. In addition, we and Microsoft each irrevocably released the other party, and its customers, from any liability for patent infringement arising prior to November 2, 2006, with certain exceptions. Both we and Microsoft have payment obligations under the Patent Cooperation Agreement. Microsoft made an up-front net balancing payment to us of $108 million, and we will make ongoing payments to Microsoft


Novell annual report 2006	55

totaling not less than $40 million over the five year term of the agreement based on a percentage of our Open Platform Solutions and Open Enterprise Server revenues.

RedMojo Acquisition

On November 17, 2006, we acquired all of the outstanding shares of RedMojo Inc, a privately held technology company that specialized in cross platform virtualization management software tools. The purchase price was $9.7 million in cash plus merger and transaction costs of $0.2 million.

Sale of Salmon Subsidiary

On March 13, 2007, we sold our shares in Salmon Ltd, (“Salmon”) to Okam Limited, a United Kingdom Limited Holding Company for $4.9 million, plus approximately an additional $3.9 million contingent payment to be received if Salmon meets certain revenue targets. There will be no further shareholder or operational relationship between us and Salmon going forward. Salmon was a component of our EMEA operating segment in fiscal 2006 (Business Consulting segment beginning in fiscal 2007) and Salmon’s sale will not have an impact on our IT consulting business. In our second quarter of fiscal 2007, we recognized a gain on the sale of approximately $0.6 million. During the first quarter of fiscal 2007, in anticipation of the sale, we recorded a loss of $10.8 million related to the excess carrying amount of Salmon over its estimated fair value, of which $10.2 million was to write off goodwill and $0.6 million was to write off intangible assets. We will classify Salmon’s results of operations as a discontinued operation in our consolidated statement of operations beginning in the second quarter of fiscal 2007.


Item 7A.	*Quantitative and Qualitative Disclosures About Market Risk*

We are exposed to financial market risks, including changes in interest rates, foreign currency exchange rates, and market prices of equity securities. To mitigate some of these risks, we utilize currency forward contracts and currency options. We do not use derivative financial instruments for speculative or trading purposes, and no significant derivative financial instruments were outstanding at October 31, 2006.

Interest Rate Risk

The primary objective of our short-term investment activities is to preserve principal while maximizing yields without significantly increasing risk. Our strategy is to invest in widely diversified short-term investments, consisting primarily of investment grade securities, substantially all of which either mature within the next twelve months or have characteristics of short-term investments. A hypothetical 50 basis point increase in interest rates would result in approximately a $4.4 million decrease (less than 1%) in the fair value of our available-for-sale securities.

Market Risk

We also hold available-for-sale equity securities in our short-term investment portfolio. As of October 31, 2006, gross unrealized gains, before tax effect on the short-term public equity securities, totaled $0.5 million. A reduction in prices of 10% of these short-term equity securities would result in approximately a $0.7 million decrease (less than 1%) in the fair value of our short-term investments.

Foreign Currency Risk

We use derivatives to hedge those current net assets and liabilities that, when re-measured or settled according to accounting principles generally accepted in the U.S., impact our consolidated statement of operations. Currency forward contracts are utilized in these hedging programs. All forward contracts entered into by us are components of hedging programs and are entered into for the sole purpose of hedging an existing or anticipated currency exposure, not for speculation or trading purposes. Gains and losses on these currency forward contracts would generally be offset by corresponding gains and losses on the net foreign currency assets and liabilities that they hedge, resulting in negligible net gain or loss overall on the hedged exposures. When hedging balance sheet exposures, all gains and losses on forward contracts are recognized in other income (expense) in the same period as when the gains and


56	Novell annual report 2006

losses on re-measurement of the foreign currency denominated assets and liabilities occur. All gains and losses related to foreign exchange contracts are included in cash flows from operating activities in the consolidated statements of cash flows. Our hedging programs reduce, but do not always entirely eliminate, the impact of foreign currency exchange rate movements. If we did not hedge against foreign currency exchange rate movement, an increase or decrease of 10% in exchange rates would result in an increase or decrease in income before taxes of approximately $5 million. This number represents the exposure related to balance sheet re-measurement only and assumes that all currencies move in the same direction at the same time relative to the U.S. dollar.

We do not currently hedge currency risk related to revenues or expenses denominated in foreign currencies; however, due to a number of factors including net operating margin levels and diversity of currencies, we have not historically experienced large foreign exchange gains or losses related to these revenues and expenses.

All of the potential changes noted above are based on sensitivity analyses performed on our financial position at October 31, 2006. Actual results may differ materially.


Novell annual report 2006	57

NOVELL, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share data)


	Fiscal Year Ended
	October 31,			October 31,			October 31,
	2006			2005			2004

Net revenue:
Software licenses	$	173,678		$	213,803		$	234,037
Maintenance, subscriptions, and services		793,599			825,420			769,817

Total net revenue		967,277			1,039,223			1,003,854

Cost of revenue:
Software licenses		18,161			21,600			23,478
Maintenance, subscriptions, and services		301,924			330,466			298,400

Total cost of revenue		320,085			352,066			321,878

Gross profit		647,192			687,157			681,976

Operating expenses (income):
Sales and marketing		357,116			359,991			337,624
Product development		180,380			199,971			194,607
General and administrative		128,922			92,632			80,758
Restructuring expenses		4,405			57,753			22,903
Purchased in-process research and development		2,110			480			—
Gain on sale of property, plant and equipment		(5,968	)		(1,589	)		(1,977	)
Gain on settlement of potential litigation		—			(447,560	)		—
Impairment of intangible assets		1,230			1,521			—
Loss on sale of Japan consulting group		8,273			—			—
Executive termination benefits		9,409			—			—

Total operating expenses		685,877			263,199			633,915

Income (loss) from operations		(38,685	)		423,958			48,061

Other income (expense):
Investment income		61,076			46,045			23,401
Gain on sale of venture capital funds		17,953			—			—
Impairment of investments		(1,470	)		(3,387	)		(5,415	)
Interest expense and other, net		(8,018	)		(8,665	)		(8,116	)

Other income, net		69,541			33,993			9,870

Income from continuing operations before taxes		30,856			457,951			57,931
Income tax expense		23,231			86,660			11,335

Income from continuing operations		7,625			371,291			46,596
Income from discontinued operations before taxes (including gain on disposal of $11,117 in fiscal 2006)		12,900			8,191			17,043
Income tax expense on discontinued operations		972			2,760			6,451

Income from discontinued operations		11,928			5,431			10,592

Income before cumulative effect of change in accounting principle		19,553			376,722			57,188
Cumulative effect of change in accounting principle		(897	)		—			—

Net income	$	18,656		$	376,722		$	57,188

Basic earnings per share:
Income from continuing operations	$	0.02		$	0.97		$	0.05
Discontinued operations		0.03			0.01			0.03
Cumulative effect of change in accounting principle		—			—			—

Net income per share available to common stockholders	$	0.05		$	0.98		$	0.08

Diluted earnings per share:
Income from continuing operations	$	0.02		$	0.85		$	0.05
Discontinued operations		0.03			0.01			0.03
Cumulative effect of change in accounting principle		—			—			—

Net income per share available to common stockholders	$	0.05		$	0.86		$	0.08

Weighted-average shares outstanding:
Basic		361,174			379,499			381,100
Diluted		365,659			440,585			390,879

See notes to consolidated financial statements.


Novell annual report 2006	59

NOVELL, INC.

CONSOLIDATED BALANCE SHEETS

(Amounts in thousands, except share and per share data)


	October 31,			October 31,
	2006			2005

ASSETS
Current assets:
Cash and cash equivalents	$	675,787		$	811,238
Short-term investments		790,500			843,666
Receivables (net of allowances of $5,574 and $16,638 at October 31, 2006 and 2005, respectively)		233,986			293,627
Prepaid expenses		32,328			30,777
Other current assets		28,524			29,745

Total current assets		1,761,125			2,009,053
Property, plant and equipment, net		184,084			212,377
Long-term investments		2,263			54,340
Goodwill		424,701			395,509
Intangible assets, net		40,404			56,421
Deferred income taxes		4,770			1,384
Other assets		32,376			32,774

Total assets	$	2,449,723		$	2,761,858


LIABILITIES, REDEEMABLE SECURITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	44,419		$	45,445
Accrued compensation		103,710			113,760
Other accrued liabilities		106,837			131,105
Income taxes payable		49,600			56,869
Deferred revenue		380,979			376,973

Total current liabilities		685,545			724,152
Deferred income taxes		4,186			4,537
Long-term deferred revenue		45,992			28,778

Senior convertible debentures		600,000			600,000

Total liabilities		1,335,723			1,357,467

Minority interests		—			8,555

Redeemable securities:
Series B Preferred Stock, $.10 par value, Authorized — 1,000 shares;
Outstanding — 187 shares at October 31, 2006 and 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 — 358,512,471 and 400,993,898 shares at October 31, 2006 and 2005, respectively, Outstanding — 343,362,534 and 385,820,699 shares at October 31, 2006 and 2005, respectively		35,851			40,099
Additional paid-in capital		338,954			483,157
Treasury stock, at cost — 15,149,937 and 15,173,199 shares at October 31, 2006 and 2005, respectively		(124,684	)		(124,875	)
Retained earnings		840,449			984,107
Accumulated other comprehensive income		14,080			7,444
Unearned compensation and other		—			(3,446	)

Total stockholders’ equity		1,104,650			1,386,486

Total liabilities, redeemable securities and stockholders’ equity	$	2,449,723		$	2,761,858

See notes to consolidated financial statements.


60	Novell annual report 2006

NOVELL, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(Amounts in thousands)


																			Accumulated
	Common			Common			Treasury			Treasury			Additional						Other			Unearned
	Stock			Stock			Stock			Stock			Paid-In			Retained			Comprehensive			Compensation
	Shares			Amount			Shares			Amount			Capital			Earnings			Income			and Other			Total

Balance at October 31, 2003		376,460		$	37,646			—		$	—		$	319,016		$	576,759		$	7,068		$	(6,019	)	$	934,470
Stock issued from stock plans		12,757			1,276			1			11			63,101			—			—			(5,452	)		58,936
Stock issued for conversion of Series B Preferred Stock		4,000			400			—			—			24,600			—			—			—			25,000
Shares repurchased		—			—			(15,188	)		(125,000	)		—			—			—			—			(125,000	)
Shares cancelled		(156	)		(16	)		—			—			(1,295	)		—			—			537			(774	)
Amortization of unearned stock compensation		—			—			—			—			—			—			—			4,848			4,848
Beneficial conversion feature		—			—			—			—			25,680			(25,680	)		—			—			—
Dividends on Series B Preferred Stock		—			—			—			—			—			(416	)		—			—			(416	)
Change in unrealized gain on investments		—			—			—			—			—			—			(1,352	)		—			(1,352	)
Cumulative translation adjustment		—			—			—			—			—			—			11,720			—			11,720
Change in minimum pension liability		—			—			—			—			—			—			(1,256	)		—			(1,256	)
Net income		—			—			—			—			—			57,188			—			—			57,188

Comprehensive income		—			—			—			—			—			—			—			—			66,301

Balance at October 31, 2004		393,061			39,306			(15,187	)		(124,989	)		431,102			607,851			16,180			(6,086	)		963,364
Stock issued from stock plans		5,678			567			14			114			26,843			—			—			(1,998	)		25,526
Stock plans income tax benefit		—			—			—			—			13,799			—			—			—			13,799
Stock issued for conversion of Series B Preferred Stock		2,504			250			—			—			15,400			—			—			—			15,650
Shares cancelled		(249	)		(24	)		—			—			(4,043	)		—			—			3,325			(742	)
Amortization of unearned stock compensation		—			—			—			—			—			—			—			1,313			1,313
Dividends on Series B Preferred Stock		—			—			—			—			—			(466	)		—			—			(466	)
Change in unrealized gain on investments		—			—			—			—			56			—			(7,767	)		—			(7,711	)
Cumulative translation adjustment		—			—			—			—			—			—			(1,592	)		—			(1,592	)
Change in minimum pension liability		—			—			—			—			—			—			623			—			623
Net income		—			—			—			—			—			376,722			—			—			376,722

Comprehensive income		—			—			—			—			—			—			—			—			368,042

Balance at October 31, 2005		400,994			40,099			(15,173	)		(124,875	)		483,157			984,107			7,444			(3,446	)		1,386,486
Cumulative effect of adoption of SAB 108		—			—			—			—			19,190			(19,190	)		—			—			—

Revised balance at November 1, 2005		400,994			40,099			(15,173	)		(124,875	)		502,347			964,917			7,444			(3,446	)		1,386,486
Stock issued from stock plans		9,549			955			23			191			40,482			—			—			—			41,628
Stock compensation expense		—			—			—			—			35,265			—			—			—			35,265
Compensation expense related to executive termination benefits		—			—			—			—			2,739			—			—			—			2,739
Cumulative effect of adoption of SFAS No. 123R		—			—			—			—			(3,446	)		—			—			3,446			—
Stock plans income tax benefit		—			—			—			—			15,263			—			—			—			15,263
Shares repurchased and retired		(51,515	)		(5,152	)		—			—			(251,911	)		(142,937	)		—			—			(400,000	)
Shares cancelled		(516	)		(51	)		—			—			(1,804	)		—			—			—			(1,855	)
Dividends on Series B Preferred Stock		—			—			—			—			—			(187	)		—			—			(187	)
Change in unrealized gain on investments		—			—			—			—			19			—			4,053			—			4,072
Cumulative translation adjustment		—			—			—			—			—			—			1,950			—			1,950
Change in minimum pension liability		—			—			—			—			—			—			633			—			633
Net income		—			—			—			—			—			18,656			—			—			18,656

Comprehensive income		—			—			—			—			—			—			—			—			25,311

Balance at October 31, 2006		358,512		$	35,851			(15,150	)	$	(124,684	)	$	338,954		$	840,449		$	14,080		$	—		$	1,104,650

See notes to consolidated financial statements.


Novell annual report 2006	61

NOVELL, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)


	Fiscal Year Ended
	October 31,			October 31,			October 31,
	2006			2005			2004

Cash flows from operating activities
Net income	$	18,656		$	376,722		$	57,188
Adjustments to reconcile net income to net cash provided by operating activities:
Stock-based compensation expense		35,265			1,748			4,940
Tax effects of stock-based compensation plans		15,263			13,799			—
Excess tax benefits from stock-based compensation		(15,263	)		—			—
Depreciation and amortization		46,976			54,513			48,542
Decrease in accounts receivable allowances		(6,888	)		(7,838	)		(4,923	)
Utilization of previously reserved acquired net operating losses		6,585			29,600			—
Purchased in-process research and development		2,110			480			—
Deferred income taxes		(4,317	)		(702	)		870
Net gain on sale of property, plant and equipment		(5,968	)		(1,589	)		(1,639	)
Loss on Japan consulting group		8,273			—			—
Executive termination benefits, non-cash		9,409			—			—
Gain on sale of previously impaired long-term investments		(2,226	)		(2,087	)		(3,360	)
Loss on impaired long-term investments		1,481			3,387			5,415
Impairment of intangible assets		1,230			1,521			—
Gain on sale of Celerant, discontinued operations, before taxes		(11,117	)		—			—
Gain on sale of venture capital funds		(17,953	)		—			—
Cumulative effect of change in accounting principle		897			—			—
Changes in current assets and liabilities, excluding acquisitions and dispositions:
Receivables		33,276			(15,087	)		(20,327	)
Prepaid expenses		(4,102	)		(3,777	)		(1,358	)
Other current assets		(88	)		(777	)		(3,069	)
Accounts payable		(1,235	)		(10,935	)		2,492
Accrued liabilities		(32,731	)		30,290			(10,619	)
Deferred revenue		21,505			31,146			43,261

Net cash provided by operating activities		99,038			500,414			117,413

Cash flows from financing activities
Issuance of common stock, net		40,131			22,108			58,162
Excess tax benefits from stock-based compensation		15,263			—			—
Payment of cash dividends on Series B Preferred Stock		(187	)		(591	)		(292	)
Issuance of Series B Preferred Stock		—			—			50,000
Issuance of senior convertible debentures		—			—			600,000
Payment of issuance costs on senior convertible debentures		—			—			(14,850	)
Repurchases of common stock (2006 retired, 2004 held in treasury)		(400,000	)		—			(125,000	)

Net cash (used in) provided by financing activities		(344,793	)		21,517			568,020

Cash flows from investing activities
Purchases of property, plant and equipment		(26,668	)		(30,781	)		(26,997	)


		Page

	Explanatory Note		ii

PART I
Item 1.	Business		1
Item 1A.	Risk Factors		14
Item 1B.	Unresolved Staff Comments		21
Item 2.	Properties		21
Item 3.	Legal Proceedings		22
Item 4.	Submission of Matters to a Vote of Security Holders		24

PART II
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities		25
Item 6.	Selected Financial Data		26
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		27
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk		56
Item 8.	Financial Statements and Supplementary Data		58
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		124
Item 9A.	Controls and Procedures		124
Item 9B.	Other Information		125

PART III
Item 10.	Directors and Executive Officers of the Registrant		126
Item 11.	Executive Compensation		134
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		140
Item 13.	Certain Relationships and Related Transactions and Director Independence		142
Item 14.	Principal Accountant Fees and Services		142

PART IV
Item 15.	Exhibits and Financial Statement Schedules		144
EXHIBIT 10.28
EXHIBIT 10.29
EXHIBIT 10.30
EXHIBIT 10.31
EXHIBIT 10.32
EXHIBIT 10.33
EXHIBIT 10.34
EXHIBIT 10.35
EXHIBIT 10.36
EXHIBIT 21
EXHIBIT 23.1
EXHIBIT 23.2
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2


Item 4.	*Submission of Matters to a Vote of Security Holders*


Item 8.	*Financial Statements and Supplementary Data*


	Page

Consolidated Statements of Operations		59
Consolidated Balance Sheets		60
Consolidated Statements of Stockholders’ Equity		61
Consolidated Statements of Cash Flows		62
Notes to Consolidated Financial Statements		63
Report of PricewaterhouseCoopers LLP, Independent Registered Public Accounting Firm		121
Report of Ernst & Young LLP, Independent Registered Public Accounting Firm		123
Selected Consolidated Quarterly Financial Data — Unaudited		124