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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED MARCH 31, 1997
OR
[ ] 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: 0-26310
NETSCAPE COMMUNICATIONS CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 94-3200270
(State or other jurisdiction of (I.R.S. Employer
incorporation or Identification
organization) No.)
501 EAST MIDDLEFIELD ROAD, MOUNTAIN VIEW, CALIFORNIA 94043
(Address of principal executive offices) (zip code)
Registrant's telephone number, including area code: (415) 254-1900
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 [x] No [ ]
The number of shares outstanding of the registrant's Common Stock as of May 5,
1997 was 88,252,277.
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INDEX
NETSCAPE COMMUNICATIONS CORPORATION
PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Page
----
<S> <C>
Item 1. Financial Statements (Unaudited)
(a) Condensed Consolidated Balance Sheets as of March 31, 1997 and December 31, 1996 . . . . . . . 3
(b) Condensed Consolidated Statements of Income for the Three Months Ended March 31, 1997
and 1996 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
(c) Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31,
1997 and 1996. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
(d) Notes to Condensed Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations . . . . . . . 8
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
</TABLE>
2
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NETSCAPE COMMUNICATIONS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
ASSETS
MARCH 31, 1997 DECEMBER 31, 1996
-------------- -----------------
(Unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents. . . . . . . . . . . . . . . . . . . . . . . . . $103,289 $87,530
Short-term investments . . . . . . . . . . . . . . . . . . . . . . . . . . 114,682 113,034
Accounts receivable, net . . . . . . . . . . . . . . . . . . . . . . . . . 117,727 110,627
Deferred tax assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . 21,956 20,347
Other current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . 16,012 16,892
------------------------------------
Total current assets. . . . . . . . . . . . . . . . . . . . . . . . . 373,666 348,430
Property and equipment, net . . . . . . . . . . . . . . . . . . . . . . . . . 103,039 86,567
Long-term investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80,881 90,504
Other assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13,235 11,949
------------------------------------
$570,821 $537,450
------------------------------------
------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $33,085 $27,634
Accrued compensation and related liabilities . . . . . . . . . . . . . . . 15,435 17,162
Other accrued liabilities. . . . . . . . . . . . . . . . . . . . . . . . . 14,353 12,781
Income taxes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,829 7,731
Deferred revenues. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93,214 80,294
Current portion of long-term obligations and installment notes payable . . 893 714
------------------------------------
Total current liabilities . . . . . . . . . . . . . . . . . . . . . . 166,809 146,316
Long-term obligations and installment notes payable . . . . . . . . . . . . . 70 484
Stockholders' equity:
Preferred stock, common stock and additional paid-in capital . . . . . . . 403,346 399,022
Deferred compensation. . . . . . . . . . . . . . . . . . . . . . . . . . . (5,514) (6,128)
Retained earnings (accumulated deficit). . . . . . . . . . . . . . . . . . 5,717 (2,227)
Other. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 393 (17)
------------------------------------
Total stockholders' equity . . . . . . . . . . . . . . . . . . . . . . . 403,942 390,650
------------------------------------
$570,821 $537,450
------------------------------------
------------------------------------
</TABLE>
See accompanying notes.
3
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NETSCAPE COMMUNICATIONS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
QUARTERS ENDED MARCH 31,
-----------------------
1997 1996
---- ----
(Unaudited)
Revenues:
Product revenues . . . . . . . . . . . . . . . . $89,769 $49,051
Service revenues . . . . . . . . . . . . . . . . 30,472 7,070
----------------------
Total revenues . . . . . . . . . . . . . . . . 120,241 56,121
Cost of revenues:
Cost of product revenues . . . . . . . . . . . . 9,751 6,811
Cost of service revenues . . . . . . . . . . . . 6,067 1,683
----------------------
Total cost of revenues . . . . . . . . . . . . 15,818 8,494
----------------------
Gross profit. . . . . . . . . . . . . . . . . . . . 104,423 47,627
Operating expenses:
Research and development . . . . . . . . . . . . 28,975 14,126
Sales and marketing. . . . . . . . . . . . . . . 54,042 25,805
General and administrative . . . . . . . . . . . 9,691 5,206
----------------------
Total operating expenses . . . . . . . . . . . 92,708 45,137
----------------------
Operating income. . . . . . . . . . . . . . . . . . 11,715 2,490
Interest income, net . . . . . . . . . . . . . . 2,395 2,431
Equity in net losses of joint ventures . . . . . (1,501) --
----------------------
Interest and other income, net . . . . . . . . 894 2,431
----------------------
Income before income taxes. . . . . . . . . . . . . 12,609 4,921
Provision for income taxes. . . . . . . . . . . . . 4,665 1,332
----------------------
Net income. . . . . . . . . . . . . . . . . . . . . $7,944 $3,589
----------------------
----------------------
Net income per share. . . . . . . . . . . . . . . . $0.09 $0.04
----------------------
----------------------
Shares used in computing net income per share . . . 90,785 85,003
----------------------
----------------------
See accompanying notes.
4
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NETSCAPE COMMUNICATIONS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
QUARTERS ENDED MARCH 31,
------------------------
1997 1996
---- ----
(Unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $7,944 $3,589
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,573 2,306
Amortization of deferred compensation. . . . . . . . . . . . . . . . . . . . . . . . . . . 614 614
Deferred income taxes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,609) _
Changes in assets and liabilities:
Accounts receivable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (7,100) (22,424)
Other current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 880 (3,932)
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,451 12,644
Accrued compensation and related liabilities . . . . . . . . . . . . . . . . . . . . . . . (1,727) 2,462
Other accrued liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,572 676
Income taxes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,098 1,065
Deferred revenues. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,920 24,313
------------------
Net cash provided by operating activities . . . . . . . . . . . . . . . . . . . . . . . . . . 28,616 21,313
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (24,045) (14,341)
Increase in other assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,286) 731
Purchases of investments available-for-sale . . . . . . . . . . . . . . . . . . . . . . . . . (41,059) (168,839)
Maturities of investments available-for-sale. . . . . . . . . . . . . . . . . . . . . . . . . 34,016 137,608
Sales of investments available-for-sale . . . . . . . . . . . . . . . . . . . . . . . . . . . 14,993 26,126
------------------
Net cash used in investing activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . (17,381) (18,715)
CASH FLOWS FROM FINANCING ACTIVITIES
Payments on installment notes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . (235) (141)
Proceeds from issuance of common stock, net . . . . . . . . . . . . . . . . . . . . . . . . . 4,324 1,363
------------------
Net cash provided by financing activities . . . . . . . . . . . . . . . . . . . . . . . . . . 4,089 1,222
Effect of foreign exchange rate changes on cash and cash equivalents. . . . . . . . . . . . . 435 --
------------------
Net increase in cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . 15,759 3,820
Cash and cash equivalents at beginning of period. . . . . . . . . . . . . . . . . . . . . . . 87,530 55,276
------------------
Cash and cash equivalents at end of period. . . . . . . . . . . . . . . . . . . . . . . . . . $103,289 $59,096
------------------
------------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Income taxes paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $4,176 $19
</TABLE>
See accompanying notes.
5
<PAGE>
NETSCAPE COMMUNICATIONS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements reflect
all adjustments consisting of normal recurring adjustments which, in the opinion
of management, are necessary for a fair presentation of the results for the
periods shown. The results of operations for such periods do not necessarily
indicate the results expected for the full fiscal year or for any future period.
The accompanying financial statements should be read in conjunction with the
audited consolidated financial statements of Netscape Communications Corporation
("Netscape" or the "Company") for the year ended December 31, 1996 and the notes
thereto incorporated by reference into the Company's Annual Report on Form 10-K
for the year ended December 31, 1996.
PER SHARE AMOUNTS
Net income per share is computed using the weighted average number of common and
dilutive common equivalent shares outstanding during the period. Common
equivalent shares consist of the shares issuable upon the exercise of stock
options (using the treasury stock method).
In February 1997, the Financial Accounting Standards Board issued Statement
No. 128, Earnings per Share, which is required to be adopted on December 31,
1997. At that time, the Company will be required to change the method currently
used to compute earnings per share and to restate all prior periods. Under the
new requirements for calculating primary earnings per share, the dilutive effect
of stock options will be excluded. The impact of Statement 128 on the
calculation of primary and fully diluted earnings per share for the first
quarter ended March 31, 1997 and March 31, 1996 is not material.
REVENUE RECOGNITION
The Company's product revenues are derived from product licensing fees, while
service revenues are derived from fees for support, training, consulting, and
Web advertising and content. Product revenues, net of allowances for future
returns, are generally recognized when a license agreement is in effect, the
product has been shipped, the license fee is fixed or determinable, no
significant vendor obligations remain, and collectibility is reasonably
assured. Product revenues from OEMs are generally recognized upon delivery
of product masters provided that the license fees are fixed and
collectibility is not dependent upon resale to the end users. Otherwise,
these product revenues are recognized upon notification of delivery to the
end user. Product and service revenues from customer subscription and
technical support contracts are recognized ratably over the term of the
contract period, which is typically 12 months. Payments for subscription and
support fees are generally made in advance and are nonrefundable. Service
revenues from training and consulting are recognized when the services are
performed. Service revenues from the sale of Web advertising and content are
recognized in the period in which the content is displayed on a Web page of
the Company. Costs related to insignificant obligations, primarily telephone
support, are accrued upon shipment and included in cost of revenues.
CASH, CASH EQUIVALENTS, SHORT- AND LONG-TERM INVESTMENTS
Cash and cash equivalents consist of cash on deposit with banks and money
market instruments with original maturities of 90 days or less. Short- and
long-term investments consist of debt securities with original maturities
primarily between 90 days and five years. The debt securities are all
classified as available-for-sale. Long-term investments additionally include
equity holdings in both public and private high-technology companies, which
have been classified as available-for-sale. Unrestricted public equity
securities with a readily determinable fair value, and debt securities, are
stated at fair value, which is determined based upon the quoted market prices
of the securities. Other equity securities are stated at cost.
JOINT VENTURES
6
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In April 1996, the Company formed a joint venture with GE Information Services
to form Actra Business Systems L.L.C. ("Actra") to develop and market software
for Internet-based business-to-business electronic commerce. The Company
acquired for cash a 50% joint venture interest in the outstanding common stock
of Actra.
In July 1996, the Company formed a joint venture called Navio
Communications, Inc. ("Navio"), an independent Internet software company, to
deliver core, scaleable technology for the Netscape Navigator for a wide-variety
of consumer and non-PC products such as televisions, telephones, set-top boxes,
game players, and the new breed of network computers and information appliances.
The Company acquired for cash and the contribution of certain technology
licenses a 50% joint venture interest in the outstanding voting capital stock of
Navio.
The Company reports its share of earnings and losses of the joint
ventures under the equity method of accounting. In the quarter ended March
31, 1997, the Company entered into a preliminary agreement to form an
additional joint venture with Novell, Inc. The joint ventures are in the
development stage and will incur escalating losses in the near term. The
balance of investments in joint ventures at March 31, 1997 was immaterial.
SUBSEQUENT EVENTS
On April 30, 1997, the Company announced the signing of definitive agreements to
acquire DigitalStyle Corporation ("DigitalStyle"), a Web graphics tools vendor,
and Portola Communications, Inc. ("Portola"), a company with expertise in high
performance messaging systems. Under the terms of the agreements, the Company
will purchase all of the outstanding capital stock and will assume all of the
outstanding stock options of DigitalStyle and Portola, both privately held
companies, for an aggregate of approximately 2.1 million shares of the Company's
common stock, subject to adjustment. Both acquisitions will be accounted for as
purchase transactions. The Company anticipates that a substantial portion of
the purchase price for each acquisition will be written off as in-process
research and development in the quarter in which the transactions close. The
transactions are currently anticipated to close in the second or third quarter
of this year and are subject to customary conditions of closing, including
regulatory and other approvals.
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THIS MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS CONTAINS FORWARD-LOOKING STATEMENTS THAT HAVE BEEN MADE
PURSUANT TO THE PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995. SUCH FORWARD LOOKING STATEMENTS ARE BASED ON CURRENT EXPECTATIONS,
ESTIMATES AND PROJECTIONS ABOUT NETSCAPE'S INDUSTRY, MANAGEMENT'S BELIEFS,
AND CERTAIN ASSUMPTIONS MADE BY NETSCAPE'S MANAGEMENT. WORDS SUCH AS
"ANTICIPATES," "EXPECTS," "INTENDS," "PLANS," "BELIEVES," "SEEKS,"
"ESTIMATES," VARIATIONS OF SUCH WORDS AND SIMILAR EXPRESSIONS ARE INTENDED TO
IDENTIFY SUCH FORWARD-LOOKING STATEMENTS. THESE STATEMENTS ARE NOT GUARANTEES
OF FUTURE PERFORMANCE AND ARE SUBJECT TO CERTAIN RISKS, UNCERTAINTIES AND
ASSUMPTIONS THAT ARE DIFFICULT TO PREDICT; THEREFORE, ACTUAL RESULTS MAY
DIFFER MATERIALLY FROM THOSE EXPRESSED OR FORECASTED IN ANY SUCH
FORWARD-LOOKING STATEMENTS. SUCH RISKS AND UNCERTAINTIES INCLUDE THOSE SET
FORTH IN THE ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1996
UNDER "FACTORS AFFECTING THE COMPANY'S BUSINESS, OPERATING RESULTS AND
FINANCIAL CONDITION" ON PAGES 27 THROUGH 42 THEREOF. PARTICULAR ATTENTION
SHOULD BE PAID TO THE CAUTIONARY LANGUAGE IN THE SECTIONS ENTITLED "PLANNED
PRODUCTS AND RELEASES," "FACTORS AFFECTING THE COMPANY'S BUSINESS, OPERATING
RESULTS AND FINANCIAL CONDITION --PRODUCT INTRODUCTIONS AND TRANSITIONS" AND
"-- COMPETITION." UNLESS REQUIRED BY LAW, THE COMPANY UNDERTAKES NO
OBLIGATION TO UPDATE PUBLICLY ANY FORWARD-LOOKING STATEMENTS, WHETHER AS A
RESULT OF NEW INFORMATION, FUTURE EVENTS OR OTHERWISE. HOWEVER, READERS
SHOULD CAREFULLY REVIEW THE RISK FACTORS SET FORTH IN OTHER REPORTS OR
DOCUMENTS THE COMPANY FILES FROM TIME TO TIME WITH THE SECURITIES AND
EXCHANGE COMMISSION, PARTICULARLY THE QUARTERLY REPORTS ON FORM 10-Q AND ANY
CURRENT REPORTS ON FORM 8-K.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The Company's operating performance each quarter is subject to various
risks and uncertainties as discussed in the Company's Form 10-K and the 1996
Annual Report to Stockholders (the "Annual Report"). The following discussion
should be read in conjunction with the section entitled "Factors Affecting the
Company's Business, Operating Results and Financial Condition" in the Form 10-K,
and the section entitled "Management's Discussion and Analysis of Financial
Condition and Results of Operations" in the Annual Report.
OVERVIEW
Netscape Communications Corporation ("Netscape" or the "Company") is a leading
provider of open software for linking people and information over private
enterprise networks ("intranets") based on transmission control
protocol/Internet protocol ("TCP/IP") and the Internet. The Company was
incorporated in April 1994 and completed business combinations with Collabra
Software, Inc. ("Collabra") in November 1995 and InSoft, Inc. ("InSoft") in
April 1996. InSoft was incorporated in September 1991, and Collabra was
incorporated in February 1993. The business combinations were treated as
poolings of interest for accounting purposes, and accordingly, the historical
financial statements for the Company have been restated as if the transactions
occurred at the beginning of the earliest period presented. The Company
additionally completed business combinations with Netcode Corporation
("Netcode") and Paper Software, Inc. ("Paper") in April 1996 and May 1996,
respectively, in transactions accounted for as poolings of interest. Operating
results since January 1, 1996, have been restated to reflect the operating
results of Netcode and Paper.
CERTAIN FACTORS AFFECTING OPERATING RESULTS
RECENT EVENTS
On April 30, 1997, the Company announced the signing of definitive agreements to
acquire DigitalStyle Corporation ("DigitalStyle"), a Web graphics tools vendor,
and Portola Communications, Inc. ("Portola"), a company with expertise in high
performance messaging systems. Under the terms of the agreements, the Company
will purchase all of the outstanding capital stock and will assume all of the
outstanding stock options of DigitalStyle and Portola, both privately held
companies, for an aggregate of approximately 2.1 million shares of the Company's
common stock, subject to adjustment. Both acquisitions will be accounted for as
purchase transactions. The Company anticipates that a substantial portion of
the purchase price for each acquisition will be written off as in-process
research and development in the quarter in which the transactions close. The
transactions are currently anticipated to close in the second or third quarter
of this year and are subject to customary conditions of closing, including
regulatory and other approvals.
There can be no assurance that Netscape will complete the proposed mergers
or that the Company will not incur additional charges in subsequent quarters to
reflect costs associated with the mergers or that management will be successful
in its efforts to integrate the operations of the acquired companies. Although
the Company believes the
8
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proposed acquisitions described above are in the best interest of the Company
and its stockholders, there are significant risks associated with these
transactions, including but not limited to: (i) difficulties in integration
of the companies, (ii) difficulties in maintaining revenue levels during
product transitions, (iii) difficulties or delays in achieving product and
technology integration benefits, and (iv) increased competition from other
software companies. Further, the proposed acquisitions described above all
relate to companies that are in their early stages of development. As a
result, the Company believes that the increases in costs of revenue and in
operating expenses (due in part to amortization of goodwill and other
intangible assets and charges associated with in-process research and
development) associated with the development and integration of these new
technologies will, in the near term, greatly exceed any associated increases
in revenues, which will have an adverse impact on operating results.
In the quarter ended March 31, 1997 the Company entered into a
preliminary agreement to form a joint venture with Novell, Inc. ("Novell").
Regulatory approval was granted in May 1997. See "--Results of
Operations--Revenues--Product Revenues." The Company expects to make further
acquisitions and investments and to enter into further joint ventures and
strategic alliances, some of which may be material, when it believes such
transactions will complement its overall business strategy. However, such
transactions, and in particular the acquisitions of high-technology
companies, are inherently risky and there can be no assurance that the
proposed acquisitions or any such future transactions or joint ventures will
be successful and will not adversely affect the Company's business, operating
results, or financial condition.
RISKS RELATED TO PRODUCT INTRODUCTIONS AND TRANSITIONS
The markets for the Company's products are characterized by rapidly changing
technology, evolving industry standards and frequent new product introductions.
In October 1996, the Company introduced Netscape SuiteSpot 3.0 and Netscape
Communicator. Although some individual components of Netscape SuiteSpot 3.0 are
currently available, Netscape SuiteSpot 3.0 and Netscape Communicator are not
expected to be commercially available until the second quarter of 1997. These
new products, unlike current Netscape products, are designed primarily for
email, groupware and other enterprise applications across an open network, and
represent a significant product transition for the Company. There are several
risks inherent in such a product transition:
POSSIBLE DEFERRAL OF PURCHASES; POSSIBLE DELAY IN COMMERCIAL AVAILABILITY;
POSSIBLE PRODUCT DEFECTS. In the near term, the Company's revenues may be
materially adversely affected as prospective customers defer purchases of the
Company's current products in anticipation of the commercial release of the new
products. Furthermore, the Company has in the past experienced delays in the
commercial availability of new products, and there can be no assurance that
Netscape SuiteSpot 3.0 and Netscape Communicator will be commercially available
in the second quarter of 1997, particularly since the software in these products
is more complex than the Company's previous products, needs extensive testing to
ensure compatibility with a variety of other software programs, and needs
debugging prior to commercial release. Delays in the commencement of commercial
shipment of Netscape SuiteSpot 3.0 or Netscape Communicator may result in
customer dissatisfaction and delay or loss of revenues. In addition, software
products as complex as those offered by the Company frequently contain errors or
bugs, especially when first made commercially available. Although the Company
conducts extensive product testing, the Company has in the past released
products that contain such defects. Therefore, there can be no assurance that,
despite testing by the Company and by current and potential customers, errors or
bugs will not be discovered after the new products are installed and used by
customers, which could result in delay or loss of revenue, delay in market
acceptance, diversion of development resources, damage to the Company's
reputation, or increased service and warranty costs, any of which could have a
material adverse effect upon the Company's business, operating results or
financial condition.
NO ASSURANCE OF MARKET ACCEPTANCE. Even if Netscape SuiteSpot 3.0 and Netscape
Communicator are commercially available in the second quarter of 1997, there can
be no assurance that these products will achieve market acceptance and become
widely adopted. The market for intranet software has only recently begun to
develop, is rapidly evolving and is characterized by an increasing number of
market entrants who have introduced or developed products and services for
communication and collaboration over enterprise networks. As is typical in the
case of a new and rapidly evolving market, demand and market acceptance for
recently introduced products and services are subject to a high level of
uncertainty. The industry is young and has few proven products. Moreover,
Netscape does not have the name recognition in the enterprise software market
that most of its competitors have and has limited experience, relative to its
competitors, in selling to this market. Market acceptance of Netscape SuiteSpot
3.0 and Netscape Communicator could also be limited by how the Company prices
these products.
9
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NEED TO EXECUTE NEW AND DIFFICULT TYPE OF SALE. In order for Netscape SuiteSpot
3.0 and Netscape Communicator to achieve market acceptance, the Company will
need to successfully execute a different type of sale than it has historically
executed and adjust to longer sales cycles. Sales of Netscape SuiteSpot 3.0 and
Netscape Communicator are expected to be made predominately to companies,
institutions and government entities. These types of customers generally commit
significant resources to an evaluation of enterprise software and require the
vendor to expend substantial time, effort and money educating them about the
value of the vendor's solution. As a result, sales to these types of customers
generally require an extensive sales effort throughout the organization, and
often require final approval by an executive officer or senior level employee.
The Company will likely experience delays following initial contact with a
prospective customer and expend substantial funds and management effort in
connection with these sales. The Company has very little experience with these
types of sales, and there can be no assurance that the Company will be able to
successfully execute such sales. In order to successfully accomplish these new,
difficult and lengthy sales, the Company will be required to expand its direct
sales force, extensively train its sales personnel, invest greater resources in
the sales effort and educate the indirect channels. There can be no assurance
that the Company will be able to accomplish any of the foregoing on a timely and
cost-effective basis, and failure to do so could have a material adverse effect
on the Company's business, operating results and financial condition. The
Company will need to add trained, technical personnel to help it implement the
Netscape SuiteSpot 3.0 and Netscape Communicator solutions for its enterprise
customers. Personnel with the sufficient level of expertise and experience for
these positions are in great demand, and there can be no assurance that the
Company will be able to hire and retain a sufficient number of qualified
personnel for these purposes, and failure to do so could have a material adverse
effect on the Company's business, operating results and financial condition.
FLUCTUATIONS IN OPERATING RESULTS FROM ENTERPRISE SOFTWARE SALES. Revenue from
sales of Netscape SuiteSpot 3.0 and Netscape Communicator are expected to
fluctuate substantially from quarter to quarter as a result of the timing of
significant orders. Moreover, because, as discussed above, the procurement
process of the Company's customers may take a significant amount of time from
initial contact to order placement and may involve competing capital budget
considerations, sales of the Company's new enterprise software products will be
difficult to predict. If single, large sales of enterprise software products
become a larger percentage of revenue, as the Company anticipates may happen,
the loss or deferral of one or more significant sales could have a material
adverse impact on quarterly results of operations, particularly if there are
significant sales and marketing expenses associated with the deferred sale.
While the Company attempts to pursue multiple enterprise software sales
opportunities at any given time, there can be no assurance that the Company will
not experience fluctuations in revenue.
The Company's revenues are also likely to fluctuate due to factors which
impact the organizations that are likely to be prospective customers of the
Company's enterprise software products. Expenditures by these organizations tend
to vary in cycles that reflect overall economic conditions and budgeting and
buying patterns of these organizations. The Company's business would be
adversely affected by a decline in the economic prospects of its customers or
the economy generally, which could alter current or prospective customers'
capital spending priorities or budget cycles or extend the Company's sales cycle
with respect to certain customers. In addition, many large organizations defer
capital expenditures beyond the first quarter, meaning that the Company may
realize lower revenue from enterprise software sales in the first quarter than
in later quarters of the year. For these reasons, among others, there can be no
assurance that the Company will be able to maintain profitability on a
quarter-to-quarter basis.
COMPETITION; MANAGEMENT OF GROWTH. With the introduction of Netscape
SuiteSpot 3.0 and Netscape Communicator, the Company will face new
competition from providers of enterprise software, most of whom have longer
operating histories, larger installed customer bases, existing relationships
with prospective enterprise customers and significantly greater financial,
technical, marketing, public relations and distribution resources than the
Company. The Company's future success will depend to a large degree upon its
ability to address the increasingly sophisticated needs of its customers in
the face of such intense competition, and there can be no assurance that the
Company will be able to compete successfully in this market, particularly
given the advantages many of its competitors have. See "--Competition." In
addition, expansion of the Company's product line will require more
management attention. This may place a significant strain on the Company's
management and operations. The Company's inability to effectively compete or
manage its expanding product line would have a material adverse effect on the
Company's business, operating results and financial condition.
COMPETITION
The market for software and services for intranets and the Internet is
relatively new, intensely competitive, rapidly evolving
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<PAGE>
and subject to rapid technological change. The Company expects competition to
persist, intensify and increase in the future. Many of the Company's current and
potential competitors have longer operating histories, larger installed customer
bases and significantly greater financial, technical, marketing, public
relations and distribution resources than the Company. Such competition could
materially adversely affect the Company's business, operating results or
financial condition. The Company's current and potential competitors can be
divided into several groups: Microsoft, Web server software and service vendors,
browser software vendors, and other operating system vendors.
In particular the market for intranet software is rapidly evolving and
increasingly competitive. The Company's intranet solution of SuiteSpot server
software and Netscape Navigator client software has recently been upgraded to
include more robust email features. The Company's intranet solution currently
competes with Lotus Notes and Microsoft Exchange, both of which offer electronic
mail and groupware capability. In addition, Oracle has announced its intention
to compete in this market through its InterOffice products. Lotus (a subsidiary
of IBM), Microsoft and Oracle all have significantly greater financial,
technical, marketing and public relations resources, larger installed customer
bases, greater distribution capability and significantly greater name
recognition and experience in selling to enterprises than the Company.
MICROSOFT. Microsoft is devoting a significant portion of its substantial
resources to developing, marketing and distributing Internet and intranet
software and services in an attempt to gain market share. Microsoft bundles
its own browser with its Windows 95 operating system, allows it to be downloaded
for free over the Internet and offers it as a free product to distributors and
end-users, including distributors and end-users of the Company's products.
Microsoft recently introduced a new version of this browser that has similar
features and functionality to the browser features of Netscape Navigator 3.0,
and this new version has reduced Netscape Navigator's market share. Microsoft
has also announced that future versions of its Microsoft Office Applications
suite will offer enhanced Internet and intranet capability that may be dependent
upon certain functionality of Microsoft's browser. Further, in August 1996,
Microsoft shipped Version 2.0 of its Internet Information Server ("IIS") that is
bundled with Microsoft's Windows NT Advanced Server operating system at no
additional cost, and in December 1996, Microsoft shipped Version 3.0 of its IIS
which can be downloaded from the Internet at no additional cost. The release of
such products may cause further price pressure on Netscape's server products and
may reduce Netscape's market share. Microsoft has also been adding Internet and
intranet capability to its range of server software offered on the Windows NT
operating system. Microsoft is bundling a Web authoring tool for free with its
NT Server and recently introduced a server that will compete with Netscape Proxy
Server. Further, Microsoft is expected to soon begin offering products in the
commercial applications software area, particularly products competitive to
Netscape Merchant System. In June 1996, Microsoft announced server products for
Internet service providers ("ISPs") and content providers to set up Web servers
and related services. In the intranet software market, Microsoft has recently
begun offering Microsoft Exchange, an email and groupware product that operates
in conjunction with Microsoft's Back Office and browser products. Microsoft also
recently announced its Outlook product, which is intended to be an email client
for intranets and the Internet.
Microsoft's significant focus and product development activity in the
market for Internet and intranet products and services and the penetration of
Microsoft's software into its installed base of PC users has significantly
increased the competitive pressures on the Company. Such pressures have placed
significant price pressure on the Company and in the future may result in price
reductions in Netscape's products and may also materially reduce Netscape's
market share. If this were to occur, sales of Netscape's products in particular,
and Netscape's business, operating results and financial condition in general,
could be materially adversely affected.
The Company believes that Microsoft has attempted to create competitive
advantages for its browser and server products by bundling these products with
its operating systems, often at no additional cost. Moreover, Microsoft has
announced its intention to bundle its browser and server products in a more
tightly integrated fashion with its underlying operating systems. If Microsoft's
browser and server products are more tightly integrated with Microsoft's
operating systems, the ability of Microsoft's competitors, including Netscape,
to obtain effective access to Microsoft's operating systems could be impeded,
particularly if such competitors do not obtain the application programming
interfaces or other technical information necessary to access Microsoft's
operating systems in a timely fashion. Microsoft may also use other means of
attempting to restrict access to its operating systems. For example, Microsoft
may assert licensing or other restrictions which could restrict the access of
competitors to its operating systems. In particular, Microsoft has asserted that
its Windows NT Workstation operating system is not meant to be used as a server
operating system for a Web site. If Microsoft is successful in restricting
access to its operating systems, sales of Netscape's products in particular, and
Netscape's business, operating results and financial condition in general, could
be materially adversely affected.
11
<PAGE>
The Company also believes that Microsoft has used, and will continue to
use, its dominant position in desktop software to secure preferential
distribution and bundling contracts with third parties such as ISPs, online
service providers and VARs, including third parties with whom the Company has
relationships. In addition, the Company believes that Microsoft may be using
co-marketing funds and other inducements to have Web sites developed exclusively
for Internet Explorer or using technology that may only be accessed by Internet
Explorer. Further, the Company believes that Microsoft may promote technologies
and standards with which Netscape's products are not compatible. For example,
Microsoft is promoting its proprietary ActiveX technology as an alternative to
the Java programming language for Internet application software, while also
developing Java-based tools that may be optimized for use with Microsoft
products. Although Netscape has announced that it will provide native support
for ActiveX on the Windows 95 platform in Netscape Communicator, if Microsoft is
successful in promoting widespread adoption of its ActiveX technology as an
alternative to Java or promoting the widespread adoption of proprietary
extensions of Java, Netscape's business, operating results and financial
condition could be materially adversely affected. Similarly, Microsoft is
promoting its proprietary Distributed Common Object Model ("DCOM") technology as
an alternative to the CORBA and IIOP standards for a cross-platform,
network-based environment. The Company has endorsed the CORBA and IIOP standards
in its products, and if Microsoft is successful in promoting widespread adoption
of its DCOM technology, the Company's business, operating results and financial
condition could be materially adversely affected.
Microsoft has a longer operating history, a much larger installed base and
number of employees and dramatically greater financial, technical, marketing and
public relations resources, access to distribution channels and name recognition
than the Company, all of which are a significant competitive advantage. For
example, Microsoft is currently offering certain of its Internet and intranet
products for free or for no additional charge when bundled with another product
and may eventually offer all of its Internet and intranet products for free or
for no additional charge when bundled with another product. In addition to
offering its browser and server products for free, Microsoft is also offering
special incentives, such as free access to Web sites that would otherwise
require a subscription fee, to users of its browser product. In addition,
Microsoft is investing significantly in localizing its Internet and intranet
software in non-English languages, which may be a competitive threat as Netscape
attempts to expand its international business. As a result of all of the
foregoing, there can be no assurance that Netscape's business, operating results
and financial condition will not be materially adversely affected.
OTHER COMPETITION. In addition to Microsoft, several companies are currently
offering Web server software products that compete directly with the Company's
Web server products. Organizations offering competing Web server products for
the Internet include the Apache (which has the largest measured share of Web
servers on the Internet as of July 1996), Microsoft and the NCSA. Unlike
Netscape, which charges for its Web server products for the Internet, the Web
servers from Apache, Microsoft and NCSA are offered for free. Companies offering
competing Web server products for intranets include Microsoft, IBM, Oracle and
Novell, among others. Some of these companies are enhancing the functionality of
their existing products through their Web server product offerings. In addition
to Microsoft's bundling of IIS with its Windows NT Advanced Server, Lotus, a
subsidiary of IBM, has developed a Web server based on its popular Notes group
software program. Oracle's Web server product works with its large installed
base of database software. Companies that offer Web server and client products
that are or can be bundled with operating systems or databases are particularly
formidable competition in the market for intranet software. The Company also
expects competition from companies that offer products competitive with the
Company's commercial application products by enabling Web site creation and
maintenance and a framework for online commerce. These companies include Open
Market, Inc., BroadVision, Inc., Connect, Inc. and Edify Corporation. In the
future, software companies which have server products in other product
categories may choose to enhance the functionality of existing products or
develop new products which are competitive with the Company's Web server and
commercial applications products.
In addition to Microsoft, several companies are currently offering a
client-based Web browser that competes directly with the Company's Netscape
Navigator product line. NCSA distributes its product, NCSA Mosaic, for free for
noncommercial use.
The Company believes that other operating system vendors may become
competitors. Although IBM and Apple have each announced an intention to
incorporate Netscape Navigator client software into their operating systems, IBM
and Apple are each currently offering competing browsers and may continue to do
so. In addition, IBM and Apple may also incorporate some Web server
functionality into their operating systems which would compete with the
Company's Web server and commercial applications products. The Company also
expects Unix operating systems vendors, such as Sun, Hewlett-Packard, IBM,
Digital, Santa Cruz and Silicon Graphics, to incorporate Web client and server
software into their
12
<PAGE>
operating systems. If these companies incorporate Web client or server
functionality into their software products and such technology is not licensed
from Netscape or is licensed from Netscape at significantly reduced prices, the
Company's business, operating results and financial condition could be
materially adversely affected.
Additional competition could come from client/server applications and tools
vendors, multimedia companies, document management companies, networking
software companies, network management companies and educational software
companies. Further, the Company's current products are designed around certain
standards, and industry acceptance of competing standards could decrease the
demand for the Company's products.
Competitive factors in the market for Internet and intranet software and
services include core technology, breadth of product features, product quality,
marketing and distribution resources, pricing, and customer service and support.
Except as set forth above, the Company believes it presently competes favorably
with respect to each of these factors. However, the market and competition are
still new and rapidly emerging, especially the intranet software market, and
there can be no assurance that the Company will be able to compete successfully
against current or future competitors, nor can there be any assurance that this
competition will not result in price reductions of the Company's products or
loss of market share or will not in some other manner materially adversely
affect the Company's business, operating results and financial condition. See
"-- Risks Related to Product Introductions and Transitions."
POTENTIAL FLUCTUATIONS IN QUARTERLY OPERATING RESULTS
Although Netscape has achieved earnings per share growth in previous quarters,
the Company's expenses are relatively fixed in the near term, and unexpected
variances in planned revenues, which are difficult to forecast, can result in
variations in operating margins and earnings. The Company typically operates
with minimal backlog; therefore, quarterly sales and operating results generally
depend on the volume and timing of orders received within the quarter, which are
difficult to forecast, as well as on its ability to fulfill such orders.
Moreover, the Company typically recognizes a substantial portion of its revenues
in the last month of each quarter. Accordingly, the Company will likely be
unable to adjust spending in a timely manner to compensate for any unexpected
revenue shortfall. Any significant shortfall of demand for the Company's
products and services in relation to the Company's expectations would have an
immediate material adverse impact on the Company's business, operating results,
and financial condition. Further, as the Company becomes increasingly focused on
sales to enterprise customers, the Company expects that a limited number of
large sales may account for a significant portion of revenue in some quarters,
resulting in fluctuations in revenue in future periods and adversely impacting
operating results in periods of lower than expected revenue.
The Company believes that significant ongoing investment in all areas of
the business will continue to be critical to the success of Netscape.
Specifically, the Company plans to continue increasing its operating expenses to
fund greater levels of research and development, expand the sales and marketing
infrastructure domestically and internationally, improve core management
information systems, and broaden customer support capabilities. The Company also
continues to seek acquisitions, strategic investments, and joint ventures that
complement the Company's overall business strategy. As a result of these
factors, the Company directs a significant percentage of its revenues towards
operating expenses and towards non-operating expenses associated with equity
interests in joint ventures and strategic investments. These planned increases
in operating and non-operating expenses will adversely impact operating results
in the near future, particularly after adjusting for the impact of any
merger-related charges, amounts of purchased in-process research and
development, and any amortization of goodwill and other intangible assets from
acquisitions accounted for by the purchase method of accounting, and such
planned increases may materially adversely affect the Company's business,
operating results, and financial condition, especially to the extent that they
precede associated revenues by a quarter or are not followed by increased
revenues. In particular, the Company anticipates that a substantial portion of
the purchase price of each of DigitalStyle and Portola will be written off as
in-process research and development in the quarter in which the transactions
close (currently expected to be in the second or third quarter of this year).
As a result, historical growth rates for revenue and net income are not expected
to be sustained.
The Company expects to experience significant fluctuations in future
quarterly operating results that may be caused by many factors, including demand
for the Company's products, introduction or enhancement of products by the
Company and its competitors, market acceptance of new products (especially
Netscape Communicator, which is currently in public beta release, and Netscape
SuiteSpot 3.0, of which some components are currently shipping and others are in
public beta release), the timing of large sales (particularly to enterprise
customers), more complex products with higher
13
<PAGE>
prices and longer sales cycles, price changes by the Company or its competitors,
the mix of distribution channels through which products are sold, the mix of
products and services sold, the mix of international and North American
revenues, costs of litigation, and general economic conditions. In addition, as
a strategic response to changes in the competitive environment, the Company may
from time to time make certain pricing or marketing decisions (such as the
change in client and server pricing effective as of December 15, 1996) or enter
into business combinations (such as the Collabra, InSoft, Netcode, and Paper
business combinations and the pending business combinations with DigitalStyle
and Portola) that could have a material adverse effect on the Company's
business, operating results, or financial condition. As a result, the
Company believes that period-to-period comparisons of its results of operations
are not necessarily meaningful and should not be relied on as any indication of
future performance. Because of all of the foregoing factors, it is likely that
in some future quarters the Company's operating results will be below the
expectations of public market analysts and investors. In such event, the price
of the Company's common stock would likely be materially adversely affected.
RESULTS OF OPERATIONS
The following table sets forth operating results, in absolute dollars and as a
percentage of total revenues, for the quarters ended March 31, 1997, December
31, 1996, and March 31, 1996.
<TABLE>
<CAPTION>
QUARTERS ENDED
-------------------------------------------------------
MARCH 31, 1997 DECEMBER 31, 1996 MARCH 31, 1996
-------------- ----------------- --------------
(In thousands, except per share data)
(Unaudited)
<S> <C> <C> <C> <C> <C> <C>
Total revenues . . . . . . . . . . . . . . . . . . . . . . $120,241 100.0% $115,052 100.0% $56,121 100.0%
Cost of revenues . . . . . . . . . . . . . . . . . . . . . 15,818 13.2 14,749 12.8 8,494 15.1
-----------------------------------------------------------
Gross profit . . . . . . . . . . . . . . . . . . . . . . . 104,423 86.8 100,303 87.2 47,627 84.9
Operating expenses:
Research and development. . . . . . . . . . . . . . . . . 28,975 24.1 26,832 23.3 14,126 25.2
Sales and marketing . . . . . . . . . . . . . . . . . . . 54,042 44.9 51,410 44.7 25,805 45.9
General and administrative. . . . . . . . . . . . . . . . 9,691 8.1 11,074 9.6 5,206 9.3
Property rights agreement and related charges . . . . . . - - 250 0.2 - -
-----------------------------------------------------------
Total operating expenses. . . . . . . . . . . . . . . . 92,708 77.1 89,566 77.8 45,137 80.4
Operating income . . . . . . . . . . . . . . . . . . . . . 11,715 9.7 10,737 9.4 2,490 4.5
Interest income, net. . . . . . . . . . . . . . . . . . . 2,395 2.0 2,179 1.9 2,431 4.3
Equity in net losses of joint ventures. . . . . . . . . . (1,501) (1.2) (926) (0.8) - -
-----------------------------------------------------------
Other income, net . . . . . . . . . . . . . . . . . . . 894 0.8 1,253 1.1 2,431 4.3
-----------------------------------------------------------
Income before income taxes . . . . . . . . . . . . . . . . 12,609 10.5 11,990 10.5 4,921 8.8
Provision for income taxes . . . . . . . . . . . . . . . . 4,665 3.9 3,234 2.9 1,332 2.4
-----------------------------------------------------------
Net income . . . . . . . . . . . . . . . . . . . . . . . . $7,944 6.6% $8,756 7.6% $3,589 6.4%
-----------------------------------------------------------
-----------------------------------------------------------
Net income per share . . . . . . . . . . . . . . . . . . . $0.09 $0.10 $0.04
---------- --------- ---------
---------- --------- ---------
</TABLE>
REVENUES
The Company derives its revenues from license fees for its software products and
fees for services, which are generally charged separately from software
licenses. Product revenues consist of product licensing fees, and service
revenues consist of fees for maintenance and support services, training,
consulting, and Web advertising and content.
<TABLE>
<CAPTION>
QUARTERS ENDED
-------------------------------------------------------
MARCH 31, 1997 DECEMBER 31, 1996 MARCH 31, 1996
-------------- ----------------- --------------
(In thousands)
(Unaudited)
<S> <C> <C> <C> <C> <C> <C>
Client . . . . . . . . . . . . . . . . . . . . . . . . . . $43,148 35.9% $58,539 50.9% $34,987 62.3%
Server, commercial applications and other. . . . . . . . . 46,621 38.8 37,456 32.5 14,064 25.1
-----------------------------------------------------------
Total product revenues. . . . . . . . . . . . . . . . . 89,769 74.7 95,995 83.4 49,051 87.4
Services . . . . . . . . . . . . . . . . . . . . . . . . . 30,472 25.3 19,057 16.6 7,070 12.6
-----------------------------------------------------------
Total revenues. . . . . . . . . . . . . . . . . . . . . $120,241 100.0% $115,052 100.0% $56,121 100.0%
-----------------------------------------------------------
-----------------------------------------------------------
</TABLE>
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<PAGE>
TOTAL REVENUES. Total revenues for the quarters ended March 31, 1997
and 1996 were $120.2 million and $56.1 million, respectively, representing a
114.3% increase. The Company experienced absolute dollar growth in both
major product groups and in service revenues in the quarter ended March 31,
1997 as compared to the quarter ended March 31, 1996. In general, the
Company has experienced revenue growth in all product lines offered by the
Company as a result of higher volumes of software license and server-related
product sales, as opposed to higher prices. In particular, server,
commercial applications, and other revenues increased 231.5% from the first
quarter of 1996 to the first quarter of 1997 as a result of an expanded core
server product line and general growth in the market for intranet-related
software products in the corporate environment. Service revenues experienced
growth in absolute dollars and as a percentage of total revenues between
each period primarily due to increased fees from the sale of Web advertising
and content, and, to a lesser extent, sales of consulting services and
increased technical support services provided to a larger installed base of
customers. A significant portion of revenue in the first quarter of 1997, as
in prior quarters, was attributable to several large licensing transactions.
In general, the Company's revenue stream is comprised of transactions which
have increased significantly in average size over the past several quarters.
Such large licensing transactions, including licenses to OEM and enterprise
customers, are expected to continue to account for a significant portion of
revenue in future quarters. The loss or deferral of, or failure to
consummate, one or more such large licensing transactions could have a
material adverse impact on results of operations in future quarters.
Total revenues for the quarters ended March 31, 1997 and December 31,
1996 were $120.2 million and 115.1 million, respectively, representing a 4.5%
increase. The Company experienced absolute dollar and percentage growth in
the server, commercial applications and other product group and in service
revenues, but the client product group decreased in both absolute dollars and
as a percentage of revenues from the fourth quarter of 1996 to the first
quarter of 1997. Although the Company experienced absolute dollar and
percentage growth quarter to quarter, the growth in revenues of 4.5% reflects
a lower revenue growth rate than the Company has experienced in recent
quarters. The Company believes that this lower growth rate was due to longer
sales cycles associated with the Company's efforts to sell significantly more
complex products and solutions to corporate enterprise users, training
requirements for both customers and Netscape personnel and distribution
partners associated with the more complex products and solutions, customers
delaying purchases in anticipation of Netscape Communicator and Netscape
Suitespot 3.0, and increased competition.
PRODUCT REVENUES. Product revenues for the quarters ended March 31, 1997,
December 31, 1996, and March 31, 1996 were $89.8 million, $96.0 million and
$49.1 million, respectively, representing an 83.0% increase year to year and
a 6.5% decrease from the fourth quarter of 1996 to the first quarter of 1997.
The growth year to year was primarily a result of the Company expanding its
product line from five server products and two client products at the end of
the first quarter of 1996 to nine server products and three client products
by the end of the first quarter of 1997, as well as increased unit shipments
of products shipping in 1996.
While client product revenues experienced absolute dollar growth in the
first quarter of 1997 compared to the first quarter of 1996, client product
revenues decreased in absolute dollars and as a percentage of total revenues
in the first quarter of 1997 as compared to the fourth quarter of 1996. The
Company believes that this was a result of (i) larger average transaction
sizes for client product sales, which increased the units sold but resulted
in lower average selling prices ("ASP's") due to volume discounts, (ii) the
announcement in October 1996 of the forthcoming Netscape Communicator
product, which may have led to some corporate and reseller customers delaying
purchases in anticipation of the new product, and (iii) the seasonally lower
demand for the Company's products experienced in the first quarter,
particularly in the retail channel. The Company expects to commercially
release Netscape Communicator in the second quarter of 1997.
Licenses of the Company's server, commercial applications and other
software revenues accounted for $46.6 million, or 38.8% of the Company's
total revenues, in the quarter ended March 31, 1997 as compared to $37.5
million, or 32.5% of total revenues, in the quarter ended December 31, 1996,
and $14.1 million, or 25.1% of total revenues in the quarter ended March 31,
1996. The growth in server and commercial applications revenues between
periods was primarily accounted for by an increase in the unit volume of core
server products, as opposed to commercial applications products. In addition,
the quarter ended March 31, 1997 was the first full quarter the Company's
Client Access Licensing pricing program (described below) was in place which,
the Company believes, has increased server product revenues. Overall, the
Company believes that this growth reflected the increased market demand for
intranet server products such as the Netscape Enterprise Server and, in
particular, the Netscape SuiteSpot bundle, which allows customers to choose
server components from the complete Netscape server product line.
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<PAGE>
The Company expects that the percentage of product revenues attributable to
its server, commercial applications, and other software products as compared to
its client product line will fluctuate in future periods depending on the timing
of new product introductions, consumer buying patterns, pricing actions taken by
the Company, competition, and other factors. In general, it is the Company's
strategy to achieve a greater percentage of revenues from its server product
family in future periods, although there can be no assurance that the Company
will be successful at achieving this goal. In conjunction with the October 1996
announcement of the Company's planned Netscape SuiteSpot 3.0 and Netscape
Communicator products, the Company announced a new pricing program that makes
Netscape client and server products available on a combined per seat basis. In
addition, certain server products were priced depending on the number of client
computers that would access the server ("client access licenses"). In both of
these cases, as customers increase the number of users to prescribed levels,
additional incremental license charges will apply but are subject to volume and
other discounts. Because the Company's server and client product lines account
for the vast majority of the Company's total revenues, any change in pricing
could have a material adverse effect on sales of the Company's products and,
consequently, could have a materially adverse effect on the Company's business,
operating results, or financial condition.
During the quarter ended March 31, 1997, the Company entered into a
significant license agreement with Novell to sell the Netscape SuiteSpot
family of server software on the Novell IntranetWare networking platform. The
agreement provides for substantial revenues to be paid to the Company during
the quarter and over a period of several years. Separately, the Company
agreed to invest $10 million for a minority equity interest in a joint
venture with Novell subject to governmental approvals. Upon formation of the
joint venture, the license agreement will be assigned by Novell to the joint
venture. If the joint venture is not formed, the Company will not make any
such investment and the license remains in effect with Novell as the licensee.
SERVICE REVENUES. Service revenues for the quarters ended March 31, 1997,
December 31,1996, and March 31,1996 were $30.5 million, $19.1 million, and
$7.1 million, respectively. Service revenues experienced growth in absolute
dollars and as a percentage of total revenues between each period primarily
due to increased fees from the sale of Web advertising and content, and, to a
lesser extent, sales of consulting services and increased technical support
services provided to a larger installed base of customers. The Company
believes that service revenues may fluctuate as a percentage of total
revenues in future periods depending on the timing of the sale of Web
advertising and content, growth in the installed base of technical support
contracts, and the continued expansion of the Company's professional services
consulting organization.
CHANNEL MIX. The Company distributes substantially all of its products
through a combination of direct (including field sales, Internet-based sales,
and telesales) and indirect (including original equipment manufacturers or OEMs,
systems integrators, value-added resellers or VARS, and software retailers)
channels.
The Company experienced absolute dollar growth across all channels for
the quarter ended March 31, 1997 compared to the quarter ended March 31,
1996, except the retail channel. The Company believes that the decline in
retail channel revenues was primarily due to reduced demand associated with
the anticipated release of the Netscape Communicator. OEM and VAR channel
revenues combined increased in the quarter ended March 31, 1997 compared to
the quarter ended March 31, 1996. The growth in these channels was due to
increased revenues attributable to an increased number of OEMs and VARs as
well as increased sales from those OEMs and VARs that partnered with the
Company prior to the first quarter of 1996.
The Company experienced absolute dollar growth across all distribution
channels except the retail channel in the quarter ended March 31, 1997
compared to the quarter ended December 31, 1996. The Company believes that
the decline in retail revenues was primarily due to the anticipated release
of the Netscape Communicator, as well as seasonally lower demand in the first
calendar quarter associated with consumer buying patterns.
In general, it is the Company's strategy to increase indirect channel
revenues as a percentage of total revenues in future periods, although there can
be no assurance that the Company will be successful at accomplishing this goal.
Specifically, the Company believes that indirect channels will account for a
greater percentage of total revenues as OEM and VAR channels become more
established and are further leveraged by the Company, and as the absolute number
of OEM and VAR partners increases. In the near term, however, the distribution
of revenues among channels will fluctuate depending on the timing of new product
releases, the Company's ability to expand, leverage, and educate OEMs and VARs,
the timing of larger enterprise sales in strategic accounts through the
Company's direct sales force, and, to a lesser extent, customer buying patterns,
which typically impact revenues in the retail channel.
GEOGRAPHIC MIX. International revenues (sales outside of North America)
historically have been comprised of product revenues and, in particular,
client product revenues. For the quarters ended March 31, 1997, December 31,
1996, and March 31, 1996 international revenues were 25.9%, 29.7%, and 26.9%
of total revenues, respectively. International revenues experienced absolute
dollar growth in the quarter ended March 31, 1997 compared to the quarter
ended March 31, 1996 due to increased sales and marketing efforts in Europe
and the Pacific Rim, as well as increased demand for Internet- and
Intranet-related products, particularly client software, in international
markets. The decline, in both absolute dollars and as a percentage of total
revenues, from the quarter ended December 31, 1996 to the quarter ended March
31, 1997 was primarily due to the decline in client product revenues, as
discussed above, slower growth in international demand for server products as
compared to North America, and increased service revenues, which are
primarily North
16
<PAGE>
American based. The Company is continuing to make significant investments in
international markets through the deployment of sales personnel in several
countries in Europe, Latin America, and the Pacific Rim, as well as through
partnering with OEMs and VARs throughout the world. Management believes that
international revenues may account for a greater percentage of total revenues
in future periods, although this percentage may fluctuate in the near term as
a result of localized product release timing, competition, the general demand
for Internet- and intranet-related products in international markets, and the
timing of large product and service transactions.
The Company invoices the customers of its international subsidiaries in
both U.S. dollars and the local currencies of its subsidiaries. The Company has
not engaged in foreign currency hedging activities, and a portion of its
international revenues is currently subject to currency exchange fluctuation
risk. The Company anticipates that international revenues may increase as a
percentage of total revenues in the future, and, as a result, foreign currency
exposure may increase.
GROSS MARGIN
COST OF PRODUCT REVENUES. Cost of product revenues for all periods presented
consisted primarily of the cost of product materials, royalties paid for
licensed technology, and amounts paid to third-party vendors for sales
administration, and order fulfillment. Cost of product revenues for the
quarters ended March 31, 1997, December 31, 1996, and March 31, 1996 were
10.9%, 9.9%, and 13.9%, of related product revenues, respectively. The
decrease in cost of product revenues in the first quarter of 1997 compared to
the same quarter a year ago was due primarily to lower retail revenues as a
percentage of total revenues in the first quarter of 1997, as retail revenues
typically have higher material and fulfillment costs. Additionally, cost of
products decreased due to larger average transaction sizes which typically
carry lower material and fulfillment costs. Cost of product revenues
increased as a percentage of related product revenue in the first quarter of
1997 compared to the immediately prior quarter primarily due to an increase
in the amount of royalties paid for licensed technology and amounts paid to
third party vendors.
COST OF SERVICE REVENUES. Cost of service revenues for all periods
presented consisted primarily of outside consulting services and
personnel-related costs incurred in providing customer support, consulting
services, and fees paid to third parties related to the sale of advertising.
Cost of service revenues for the quarters ended March 31, 1997, December
31,1996, and March 31, 1996 were 19.9%, 27.4%, and 23.8% of related service
revenues, respectively. The decreases as a percentage of revenue in the quarter
ended March 31, 1997 from the quarters ended December 31, 1996 and March 31,
1996 was primarily due to the increase in Web advertising and content sales,
which typically have higher margins than other service revenues. The Company
believes that the gross margin earned on service revenues in the future may
be adversely impacted by the composition of such revenues and increased costs
incurred in achieving such revenues.
Gross margins on total revenues may be impacted by the mix of distribution
channels used by the Company, the mix of products or services sold, the mix of
product revenues versus service revenues, the mix of international versus North
American revenues, and the prices charged for products. The Company typically
realizes higher gross margins on direct sales than on sales through VAR and
software retail channels, higher gross margins on North American sales than
international sales, and higher gross margins on product revenues than on
service revenues. In addition, the Company earns lower gross margins on
shrink-wrap product licenses than on right-to-copy licenses such as those
entered into with OEM partners. During the quarter ended March 31, 1997, overall
average sales prices continued to be adversely impacted, and may continue to be
adversely impacted in the future, by increased sales through OEM and VAR
channels and by an increase in the number of large sales to enterprises, which
are typically subject to volume discounts. The effect on the margins of this
decline in overall selling prices was partially mitigated by the decline in
retail sales as a percentage of total revenue (which typically have lower gross
margins associated with packaging costs) in the first quarter of 1997 compared
to the immediate prior quarter, as well as to the first quarter of 1996. In
addition, gross margins may be adversely impacted by increased international
revenues as a percentage of total revenues and increased service revenues as a
percentage of total revenues. In addition, the Company expects that the total
gross margin will fluctuate in future periods due to increased costs associated
with licensed technology included in both client and server products and product
warranty costs, which include 90-day free telephone support for Netscape
Navigator products.
OPERATING EXPENSES
The increase in the Company's total operating expenses in absolute dollars in
the quarter ended March 31, 1997 compared to the quarter ended December 31,
1996, and the quarter ended March 31, 1996 reflects the Company's rapid growth
and expansion in all operating areas. The Company believes that continued
expansion of operations is essential to achieving
17
<PAGE>
and maintaining a strong competitive position. In particular, the Company
anticipates headcount growth in most functional areas in future quarters,
increased investment in sales and marketing programs, expenditures related to
acquisitions and investments and substantial charges associated with
in-process research and development. Additionally, the Company anticipates
continued increases in its infrastructure-related expenses, such as costs for
facilities, telecommunications, and management information systems.
The Company recorded deferred compensation of $11.1 million for the
difference between the grant price and the deemed fair value of the Company's
common stock for stock options granted in the first six months of 1995.
Operating expenses include $614,000 of non-cash charges associated with the
amortization of such deferred compensation in each of the quarters ended March
31, 1997, December 31, 1996 and March 31, 1996. The remaining deferred
compensation will be amortized to operating expense over the related 50-month
vesting period of the shares and will therefore continue to have an adverse
impact on the Company's operating results. Specifically, the Company will
record additional operating expenses of $614,000 for the quarter ended June 30,
1997 and in QUARTERLY periods thereafter associated with deferred compensation
amortization.
RESEARCH AND DEVELOPMENT. Research and development expenses consisted
primarily of salaries and consulting fees to support product development.
Research and development expenses were $29.0 million, $26.8 million and $14.1
million for the quarters ended March 31, 1997, December 31, 1996 and March 31,
1996, respectively, or 24.1% , 23.3% and 25.2% of total revenues, respectively.
The absolute dollar increases in each of the periods were primarily attributable
to increased staffing and external consultant costs. The capitalizable portion
of the software development costs have been immaterial and, to date, have been
expensed as incurred. Management believes that research and development
activities are a critical area for investment in the Company and, as a result,
intends to increase the level of research and development expenses in future
periods, which may cause increases in such expenses as a percentage of total
revenues in future periods.
SALES AND MARKETING. Sales and marketing expenses consist primarily of
compensation, consulting fees, travel, and advertising. Sales and marketing
expenses were $54.0 million, $51.4 million and $25.8 million for the quarters
ended March 31, 1997, December 31, 1996, and March 31, 1996, respectively, or
44.9%, 44.7%, and 45.9% of total revenues, respectively. The absolute dollar
increases in each of the quarters were generally due to increased staffing,
marketing programs, costs associated with opening new sales offices, sales
commissions on increased revenues, and continued investment in Europe and the
Pacific Rim. The Company intends to increase the level of sales and marketing
expenses in future periods, which may cause increases in such expenses as a
percentage of total revenues in future periods.
GENERAL AND ADMINISTRATIVE. General and administrative expenses consist
primarily of salaries, fees for professional services, and accounts
receivable allowances. General and administrative expenses for the quarters
ended March 31, 1997, December 31, 1996, and March 31, 1996 were $9.7 million
, $ 11.1 million, and $5.2 million, or 8.1%, 9.6%, and 9.3% of total
revenues, respectively. The absolute dollar increases from the quarter ended
March 31, 1996 were primarily attributable to increased staffing, increased
fees for professional services, and higher accounts receivable allowances to
support higher revenue levels. The decrease in absolute dollars and as a
percentage of total revenues in the first quarter of 1997 compared to the
immediate prior quarter was due to increased accounts receivable allowances
made in the fourth quarter of 1996. The Company intends to increase the
level of general and administrative expenses in future periods, which may
cause increases in such expenses as a percentage of total revenues in future
periods.
NET INTEREST INCOME
Net interest income was flat at $2.4 million for the quarters ended March
31, 1997 and 1996, respectively, although investment balances increased, due
primarily to lower market interest rates on average cash and investment
balances. Net interest income rose slightly in the quarter ended March 31, 1997
compared to the quarter ended December 31, 1996, consistent with the increase in
the cash, cash equivalent, and investment balances. Pretax interest income in
future periods may fluctuate as a result of fluctuations in average cash
balances maintained by the Company and changes to market interest rates for
investments.
EQUITY IN NET LOSSES OF JOINT VENTURES
Equity in net losses of joint ventures, which began to be incurred in the second
quarter of 1996, were $1.5 million and $926,000 for the quarters ended March 31,
1997 and December 31, 1996, respectively. They reflect the Company's share of
the net losses of the Company's joint ventures under the equity method of
accounting. The Company may provide
18
<PAGE>
additional contributions to these joint ventures in the future. Each of the
joint ventures are in the development stage and will incur escalating losses in
the near term as the joint ventures grow and increase operating expenses to fund
their growth.
INCOME TAXES
The Company recorded an income tax provision equal to 37% of pretax income in
the first quarter of 1997. This rate approximates the net effective statutory
federal and state rates adjusted for tax exempt interest income and tax credits.
The Company anticipates its 1997 effective tax rate to be approximately
37%, excluding the effect of the acquisitions of DigitalStyle and Portola
announced in April 1997; however, the rate could change based upon a change in
the estimated amount or geographic mix of the Company's earnings, the amount of
permanent reinvestment offshore of a portion of the Company's 1997 earnings,
changes in U.S. tax law such as reinstatement of the research tax credit, or the
effect of future acquisitions, including the acquisitions of DigitalStyle and
Portola.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 1997, the Company's principal source of liquidity was $218.0
million in cash, cash equivalents, and short-term investments, representing a
$17.4 million increase from the December 31, 1996 balance of $200.6 million.
During the same period, long-term investments decreased by $9.6 million from
$90.5 million at December 31, 1996, to $80.9 million at March 31, 1997. The
Company's cash and short-term investments are managed to be available for
strategic investment opportunities or other potential cash needs in the future.
The Company has no material debt.
For the quarters ended March 31, 1997 and 1996, cash provided by operating
activities of $28.6 million and $21.3 million, respectively, was primarily
attributable to increases in net income, deferred revenues, and accounts
payable, partially offset by the growth in accounts receivable. Cash used in
investing activities of $17.4 million and $18.7 million for the quarters ended
March 31, 1997 and 1996, respectively, related primarily to capital expenditures
of $24.0 million and $14.3 million, respectively. The capital expenditures
primarily consisted of purchases of computer hardware and software as well as
leasehold improvements and furniture and fixtures related to additional leased
facilities. The Company estimates that capital expenditures will increase in
future quarters. Cash flows from financing activities of $4.1 million and $1.2
million in the quarters ended March 31, 1997 and March 31, 1996, respectively,
were primarily attributable to proceeds from the issuance of common stock under
the Company's stock option plans.
Deferred revenues primarily consist of the unrecognized portion of product
and service revenues received pursuant to subscription and support contracts,
respectively, and the unrecognized portion of nonrefundable, prepaid license
royalties received pursuant to reseller agreements. Deferred revenues increased
from $80.3 million at December 31, 1996, to $93.2 million at March 31, 1997, due
to an increase in the number of reseller agreements, the amount of prepayments
received pursuant to reseller agreements and, to a lesser extent, an increase in
the number of training, consulting, and subscription and support contracts.
The Company's principal commitments as of March 31, 1997 consisted of
payments under operating leases for monthly rent and operating lease agreements
that include commitments by the Company to complete the build-out of certain
tenant improvements.
Management believes existing cash and investments together with cash flows
expected to be generated from operations will be sufficient to meet the
Company's operating requirements for at least the next 12 months.
19
<PAGE>
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
Exhibit 11.1 Statements of Computation of Earnings Per Share.
Exhibit 27.1 Financial Data Schedule.
(b) Reports on Form 8-K:
None.
ITEMS 1, 2, 3, 4 and 5 are not applicable and have been omitted.
20
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
following authorized representatives.
NETSCAPE COMMUNICATIONS CORPORATION
Date: May 15, 1997 By: /s/ PETER L.S. CURRIE
------------------- ----------------------
Peter L.S. Currie,
Senior Vice President and
Chief Financial Officer
(PRINCIPAL FINANCIAL OFFICER)
Date: May 15, 1997 By: /s/ NOREEN G. BERGIN
------------------- --------------------
Noreen G. Bergin
Vice President, Finance and Corporate Controller
(PRINCIPAL ACCOUNTING OFFICER)
21
<PAGE>
EXHIBIT 11.1
NETSCAPE COMMUNICATIONS CORPORATION
STATEMENTS OF COMPUTATION OF EARNINGS PER SHARE
(In thousands, except per share data)
<TABLE>
<CAPTION>
QUARTERS ENDED MARCH 31,
------------------------
1997 1996
---- ----
(Unaudited)
<S> <C> <C>
Primary AND FULLY DILUTED:
Weighted average common stock outstanding. . . . . . . . . . . . . . . . . . . . 88,138 83,550
Net effect of dilutive stock options based on the treasury stock method. . . . . 2,647 1,453
------------------
Total weighted average common and common equivalent shares
outstanding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90,785 85,003
------------------
------------------
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $7,944 $3,589
------------------
------------------
Net income per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $0.09 $0.04
------------------
------------------
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM NETSCAPE
COMMUNICATIONS CORPORATION'S QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER
ENDED MARCH 31, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> MAR-31-1997
<CASH> 103,289
<SECURITIES> 114,682
<RECEIVABLES> 117,727
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 373,666
<PP&E> 129,049
<DEPRECIATION> 26,010
<TOTAL-ASSETS> 570,821
<CURRENT-LIABILITIES> 166,809
<BONDS> 0
0
0
<COMMON> 9
<OTHER-SE> 403,933
<TOTAL-LIABILITY-AND-EQUITY> 570,821
<SALES> 89,769
<TOTAL-REVENUES> 120,241
<CGS> 9,751
<TOTAL-COSTS> 15,818
<OTHER-EXPENSES> 92,708
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 12,609
<INCOME-TAX> 4,665
<INCOME-CONTINUING> 7,944
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 7,944
<EPS-PRIMARY> 0.09
<EPS-DILUTED> 0.09
</TABLE>
