Novell (NYSE: NOVL) executives said this week that it's seven-year-old Linux business has finally broken even -- making good on promises made a year ago.
But it hasn't been an easy trek to begin making money off of Linux, and one factor may weigh against Novell's Linux business going forward: The waning revenue from its landmark 2006 agreement with Microsoft to begin reselling Linux support subscriptions.
This week, Novell reported its first-quarter fiscal 2010 earnings for the quarter ending on Jan. 31. Net revenues came in at $202 million, a decline from the $215 million reported for the first quarter of 2009.
On the net income side, things are a bit brighter. Novell reported GAAP net income of $20 million, or $0.06 per share, an increase over the $11 million or $0.03 per share it reported for the first quarter of 2009.
When it comes to Novell's Linux business, CFO Dana Russell reported that Linux platform product revenue increased by 6 percent on a year-over-year basis to $37 million.
Novell entered the Linux business in 2003 with the $210 million acquisition of SUSE Linux. In May 2009, Russell revealed that the company's Linux business was not profitable, but pledged at the time that it would hit breakeven in the next 12 to 18 months.
As it turned out, Russell had good news for investors ahead of schedule.
"We made a commitment that Linux would be breakeven at the end of this year," he said. "Even though we don't report Linux separately, this business was breakeven, which is a significant milestone."
Three years ago, Novell entered into a Linux reselling agreement with Microsoft for Linux support subscriptions. The first of the three-year subscriptions are now ending, and Novell this week provided some color on how much those Microsoft Linux subscriptions actually bring in and at what rate they are now being renewed.
The key takeaway: Novell's new breakeven Linux performance is due mostly to strength in areas other than the Microsoft deal.
In fact, income from the Microsoft agreement is waning dramatically. As part of the two companies' agreement, Microsoft purchased $250 million of SUSE Linux support certificates that were resold to joint Microsoft/Novell customers. Now Microsoft and Novell are renewing those certificates, but they aren't fetching the prices that they once did.
"Renewal of Linux distributions associated with Microsoft certificates began during the quarter, and as expected, we realized much lower invoicing than the original agreement," Russell said. "Lower invoicing associated with Microsoft certificates was offset by significant growth in our non-Microsoft invoicing."
The decline stems from the fact that Novell sold its Linux support certificates to Microsoft at a discount and as companies come to renew, additional discounts are being provided, Russell said.
"On the original certificates, we were paid from Microsoft at ... 45 percent of list price, so a 45 percent discount," he said. "And in most of these certificates, especially in the early part of this program, we went out to very large, strategic customers at fairly significant discounts."
Among those big customers that signed on early to the Microsoft-Novell deal is Walmart, the world's largest retailer and certainly a company that's no stranger to discounting. Overall, Novell and Microsoft said that they had over 400 joint customers by the end of 2009.
"And so as we look at the renewals, the expectation is that we could see -- especially for very large, strategic customers -- the pricing now has changed dramatically, and what we are seeing is something more akin to 80 percent to 90 percent discount," Russell said. "And so, if you do the math on that, that would give you ... a very good indication on what we expect as we go forward here with the program and the financial impact associated with it."