Table of Contents

Dr. Eric Scmidt

Promises Kept
Growth in Novell's
Next Generation Net
Services Software

Fiscal 1999 was a year of accelerating growth in Novell's business led by widespread acceptance of Novell® Directory Services® (NDS®) and a new NetWare services platform with Internet protocol support. It was a year of building market momentum around Net services software products, important industry partnerships, and our initial steps to extend the value of Novell's directory technology into the Internet. We took NDS to Solaris* to make it available on the leading Internet servers, and also to Windows NT*, as well as NetWare. We began to deliver the first network management services intended to make Novell the leading supplier of Net services software to secure and manage how business is done over the Internet.

In the context of our overall industry, the unbelievable growth of the Internet, the opening-up of bandwidth for easy access, the availability of limitless storage-will fundamentally change the way we use and rely on networks over the next five years. For Novell, these forces create a tremendous opportunity to build the next generation of Net services that ride on top of this global network infrastructure. We anticipate a future where Novell software is a seamless, interoperable part of Net transactions between users of networks in business, government, education and in life across the Net.

Taken as a whole, this growth translates to a very large market for Net services software as the barriers between traditional business networks and the Internet come down to create one Net. Novell is already the market leader in management software for traditional networks. With what we have accomplished over the last two years, we have positioned the company to grow as the leading Net services software provider in a one-Net digital economy.


In 1999 Novell accomplished what it set out to do. We met important business objectives that management set for the company.

> We achieved our objective to move to a new growth phase in Novell's business around our traditional business model, established customer base, and the accelerated delivery of new products. The market embraced our moving NetWare, the most scalable network services platform on the planet, to IP. More than a dozen new Net services products were launched that expand the value of directory-based solutions. New offerings included Novell Single Sign-On, NDS for NT, NDS for Solaris, NetWare Cluster Services™, NetWare Enterprise Print services; and the extraordinarily fast Novell Internet Caching System™ software, the first Novell software for hardware OEMs to use to create appliance products that deploy network services.

> We delivered the latest version of NDS that scales to Internet requirements of billions of objects that represent people and resources such as data, files, computers, even other directories, in NDS. Right after fiscal year-end we launched NDS eDirectory™ to serve both .coms and traditional businesses that need to recognize users from the Internet and securely manage their access to information and services. CNN Interactive was one of the first adopters. Competing on the Web is all about the quality experience for Web users. Novell software enhances Web ease-of-use, performance and security.

> We are committed to enhance the value of Net services from partners as well as from Novell. America Online and AltaVista are both using NDS to carry instant messaging services into corporate networks. Novell is working with Red Hat and others to take NDS eDirectory to the Linux* operating system, to developers that use Linux, and to the various categories of network service providers, from traditional Internet Service Providers, to newer Application Service Providers. Sun has embraced NDS on Solaris servers with the objective of reinforcing its presence in Internet sites. And Lucent has new applications that use NDS to implement policy-based management of Net resources-from switches to IP addresses.

> A major priority was to expand consulting support for deployment of Net services, directory solutions and new e-business solutions. We increased the Novell Consulting services team from a staff of 128 at the start of the year to over 300 at year-end. In September, Novell announced a $100 million investment in Whittman-Hart, the leading middle-market IT consulting firm in the U.S. The firm is training 600 of its consultants to design and help deploy directory-based e-commerce solutions that address the needs of mid-sized businesses. These steps are only the beginning. In 2000, we expect to expand our partnerships with other leading consulting and systems integrator organizations around the world.

> Finally, better alignment of our marketing organization with Novell's sales and business objectives was required. By year-end we had consolidated Novell product marketing and product management into a single organization aligned with a new corporate marketing team. Experienced new leadership is in place and charged to deliver a clear, compelling, consistent marketing message around the value of Net services software and Novell's role in the digital economy.


Our strategy and business objectives for the long-term are balanced against a disciplined approach to achieving operational objectives quarter-by-quarter. In 1999 this translated to improved financial performance. Total revenue increased to $1.27 billion, up 17 percent from fiscal 1998, compared to 8 percent revenue growth in fiscal 1998. Income from operations of $223 million was 18 percent of revenue, up from 9 percent of revenue a year ago, and up each consecutive quarter through the year. After-tax net income of $191 million reached 15 percent of revenue, up 87 percent from the year earlier.

Revenue growth by product category captures the basic premise of Novell's business: customer deployments of Novell's market-leading directory platform, and the move to Net services based on directory, drive demand for all categories of Novell's software and services. Directory-enabled NetWare server software grew 24 percent to $659 million. Revenue from software for infrastructure, management and collaboration services increased 39 percent to $315 million, fueled by growth from ZENworks™ for Workstations, BorderManager™, GroupWise® and NDS for NT and Solaris. Service, education, and consulting revenue grew 40 percent to $181 million with growth across each component. When declining revenue from pre-directory products is set aside, total directory-related revenue increased 30 percent to account for 91 percent of total Novell revenue.

A key financial objective for fiscal 1999 was to increase income from operations to 20 percent of revenue by year-end. We achieved this goal with sharp focus on operating expense discipline. Operating margins rose each consecutive quarter, finishing at 22 percent of revenue in the fourth quarter.

In addition to the investment we made in Whittman-Hart, we made a half dozen pre-IPO Internet investments in companies that complement Novell's Net services strategy, or that are poised to benefit from the growth of networks, including: Edgix, EnCommerce, Oblix and Red Hat. We also invested directly in Novell, spending $403 million to purchase and retire 23 million shares of common stock in fiscal 1999.


Novell is building these services to deploy within the remarkable arena that the Internet has become. Our vision has been validated.

We've entered 2000 on a solid business footing. Globally, Novell is helping its customers create digital enterprises. We believe we can build Novell's business franchise around Net services software that is valued for securely managing how business is done on the Net, how governments respond to their constituents on the Net, how education is offered on the Net, and how individuals use the Net.

Our model is to provide flexible Net services software that enhances customer networks and supports the mix of resources that are typical in their organizations: from varied client workstations that typically run Microsoft operating systems, to IBM mainframes, to servers from Compaq, other Intel OEMs, and Sun, to applications from PeopleSoft, Lotus and Oracle, to switches and routers from Cisco, Lucent and Nortel. We contribute to, and benefit from, the efforts of these and other important vendors whose products come together on the Net and use NDS as a platform for better management, or to deploy their own services. With directory software as the underpinning, Net services enhance the manageability and value of applications and devices, and personalize the experience of every user accessing the rich resources of the Net.

The next generation of Net services software products will change the Internet from a collection of destinations, to a way for individuals to get things done, invoke services, exchange information, do business and be recognized as members of communities. These products will tame the explosive demands of e-business and help Novell profit from the limitless opportunities of a digital economy.

Dr. Eric Schmidt

Dr. Eric E. Schmidt Chairman and Chief Executive Officer
December 22, 1999

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