It's going to get a lot worse for Novell Inc. (Nasdaq: NOVL) before it gets better. Novell's second quarter profit warning may only be the beginning of the company's problems.
After the closing bell Tuesday, the company, which makes network operating software, said it would report second quarter earnings of 8 cents a share, half of what Wall Street was expecting. The company will miss First Call Corp. consensus estimates by 8 cents a share, and that sum includes a $35 million royalty payment from Caldera Systems (Nasdaq: CALD). The payment is related to an antitrust settlement between Caldera and Microsoft.
Novell: Its own fault?
Without the Caldera crutch, Novell would have missed estimates by a whopping 16 cents a share. "We'd have been very close to break even," CFO Dennis Raney said during a Tuesday afternoon conference call.
Analysts responded with stunned silence -- never a good response on a conference call. Sales will be in the $300 million range, down from the first quarter and a year ago.
Despite a passing reference to sales problems related to Linux and Windows 2000, Novell shoulders most of the blame for its problems.
Management said Novell had weak sales because of "the introduction of Windows 2000 and growing market interest in the Linux operating system." But don't put much stock into that statement -- it's not like Red Hat (Nasdaq: RHAT), Corel (Nasdaq: RHAT) and Microsoft are ganging up on Novell. Raney, who mispronounced Linux on the analyst conference call, wasn't convincing.
The company had problems in the sales channel because of "management and organizational issues."
The management issues are clear -- Novell couldn't stay focused. In February, Novell morphed again, as CEO Eric Schmidt became chief visionary. The company also has suffered from a serious brain drain in the sales department. The problems began to appear in Novell's first quarter, which was disappointing.
Raney said second quarter quotas weren't met, and problems with channel partners were only aggravated by Novell's sales turnover. As a result, Novell lost $10 million a week in sales for the last five weeks of the quarter.
The organizational issues could also be huge. The company said it has missed out as its channel partners have moved to application service provider (ASP) models. The company has only begun making ASP investments. Meanwhile, Novell hasn't done squat to boost demand. The company said it will move aggressively to broaden market awareness.
When will all these problems get fixed? Not until fiscal 2001.
And that's a bit late. While Novell is trying to fix itself, Windows 2000 sales will begin to kick in. On its latest conference call, Microsoft said Windows 2000 sales should pick up in June after the company finishes up more applications. Linux is also getting traction.
Although Novell has arguably the best network operating system available, no one cares. The company blew its chance. Novell had a three-year lead on Windows 2000 courtesy of Microsoft's habitual delays. But no one heard about it until recently. Novell needed to do a lot more talking to boost demand. Now demand is weak, and it's not clear how Novell will regain its past glory.
It may be too late.
Effect on Microsoft trial
On the surface, Novell's problems shouldn't affect Microsoft's antitrust trial. But they do.
Novell was one of Microsoft's key competitors for server software, and Bill Gates needs all the competition he can get. Gates' argument is that Microsoft has a lot of competition. The government argues that Microsoft has squashed key competitors with cushy package deals.
In addition, the Justice Department is trying to limit Microsoft's encroachment on the network operating system market with Windows 2000. Novell is stumbling before Windows 2000 even gets going, and could bolster the government's case.
Novell's problems are mostly its own doing, but just the perception that Microsoft whacked another competitor could go a long way -- especially when the government is trying to cook up remedies against Microsoft.