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Novell Delivers a Different Kind of Earnings Surprise

Novell surprised investors and analysts Wednesday when it indefinitely postponed the release of its fourth-quarter and full-year financial results while it continues to answer new questions from the Securities and Exchange Commission.

Citing what it called an "abundance of caution," the Waltham, Mass.-based company sent out a press release Wednesday morning detailing its decision to delay the release of its financial reports while it exchanges letters back and forth with the SEC regarding financial reports it filed for the second quarter of this year and all of 2006.

Analysts were expecting the software company to return a profit of 4 cents a share, on a non-GAAP basis, on sales of $242 million in the quarter. Last quarter, it earned 5 cents a share on sales of $243 million.

"This is not an SEC investigation," Bruce Lowry, a Novell spokesman, said in an interview with InternetNews.com. "This was a voluntary decision on our part to not go forward [with the scheduled earnings report]. We're waiting for the SEC to reply to the last set of fairly narrow questions that we replied to in November. We're being very conservative in our approach."

Novell's most recent dialogue with the SEC began when it received a letter dated August 7 requesting additional information regarding its 10-K filing for fiscal 2006 and its 10-Q filing for the second quarter of this year.

Novell responded with a letter of its own on September 20, only to receive a follow-up letter from the SEC on October 18 seeking more specific information. On November 7, Novell said it responded to this second inquiry, which it said was limited to "certain accounting matters," and is still waiting to hear back from the SEC.

Lowry said the company decided to hold off the announcement of its intention to delay its fourth-quarter and full-year results in the expectation that the SEC would respond in time to resolve the issue and let Novell deliver its results as scheduled Wednesday afternoon.

However, Novell's decision to wait until the 11th hour before pulling the plug on the earnings release didn't strike one analyst as a particularly conservative tactic.

"Waiting until the last minute was not the most efficient thing to do," Abhey Lamba, an analyst at UBS, said in an interview with InternetNews.com. "They should have had a Plan B they could have gone ahead with when they didn't hear back from the SEC. It would have been more comforting. Lacking any other information, it does leave some unanswered questions."

Lamba said he and the other dozen or so analysts covering the stock learned of Novell's unorthodox move early Wednesday morning during a conference call with Novell officials.

"It's unusual," he said. "I think there was a hardware company that did something like this once in the past. But it definitely wasn't expected and it's not typical."

And while Novell's Lowry said the company wanted "to wait and make sure we're absolutely aligned with the SEC," the decision to err on the side of caution and nix the earnings report this time around marks a change in strategy considering the company still went ahead and released its third-quarter results on August 29 as scheduled—more than three weeks after the company received the first letter from the SEC.

"At the time [late August], we did release our third-quarter results after receiving one comment letter from the SEC," Lowry said. "We didn't announce that we'd received the first letter because it's a fairly standard process. It's an exchange of letters. It's not unusual."

Lowry said he couldn't comment on the specific information requested of Novell by the SEC in either letter, but did say the company in May concluded a year-long voluntary review of its stock-option accounting practices and found "no evidence of any wrongdoing."

The backdating of employee stock options and then failing to disclose the practice in SEC-mandated financial reports has resulted in either internal or federal investigations of more than 200 companies in the past five years. Former Brocade Communications CEO Gregory Reyes in August was convicted on 10 felony counts including securities fraud, conspiracy and filing false financial statements.

"I can't categorically say that there's no relationship between the accounting options and these letters with the SEC because I really don't know what's in those letters," Lowry said. "But I can tell you that, as far as I know, the options thing is something that's basically in the past and was taken care of and resolved in May."

Novell said it plans to file its 10-K for the fiscal year that concluded October 31 on or before the December 31 deadline.

UBS' Lamba, who initiated coverage of Novell shares in October with a "neutral" rating before upgrading it to a "buy" recommendation on November 12, said it's too early to make any sweeping conclusions about the significance, or lack thereof, of the SEC inquiries.

"We need more information to figure out if it will have an impact on our valuation," he said. "It seems like it could be benign but it could be a larger issue. We just can't say."