ITEM 1. BUSINESS.
OVERVIEW
Netscape Communications Corporation ("Netscape" or the "Company") is a leading provider of open software for linking people and information over intranets and the Internet. Netscape develops, markets and supports a broad suite of enterprise server and client software, development tools and commercial applications to create a single shared communications platform for network-based solutions. Netscape software is based on industry standard protocols and therefore can be deployed across a variety of computer operating systems, platforms and databases and can be interconnected with traditional client/ server applications. Using Netscape solutions, organizations can extend their internal information systems and applications to geographically dispersed facilities as well as to third party partners and customers. In addition, Netscape's products allow individuals and organizations to access information and to execute transactions across the Internet such as the buying and selling of information, software, and other merchandise.
Netscape released its first product, Navigator 1.0, in December 1994, which offered an easy to use graphical user interface for browsing the World Wide Web (the "Web"). Since that time, the Company has become increasingly focused on offering user and network services for use in intranet applications, including features with email and graphics. The Company currently offers a broad suite of software products and tools, targeted primarily at corporate intranets, for use in a variety of information sharing, network management and commerce-enabling applications.
To reach a diverse and worldwide customer base, Netscape delivers its suite of products and services through multiple distribution channels. The Company offers its products via a direct sales force, telesales, and the Internet as well as through resellers such as original equipment manufacturers ("OEMs"), value-added resellers (together with systems integrators referred to herein as "VARs") and software retailers (collectively, "Resellers"). To accelerate the market acceptance of the Company's products, Netscape has entered into reseller agreements with leading telecommunications and technology companies with complementary resources. These companies include, among others, Apple Computer, Inc. ("Apple"), Compaq Computer Corporation ("Compaq"), Digital Equipment Corporation ("Digital"), Hewlett-Packard Company ("Hewlett-Packard"), International Business Machines Corporation ("IBM"), Informix
Software, Inc. ("Informix"), Novell, Inc. ("Novell"), Olivetti SPA ("Olivetti"), Siemens AG ("Siemens"), Silicon Graphics, Inc. ("Silicon Graphics"), Sybase, Inc. ("Sybase") and Sun Microsystems, Inc. ("Sun").
Netscape was incorporated in Delaware in April 1994, and in April 1996 acquired InSoft, Inc., which was incorporated in September 1991. Netscape's home page can be located on the Web at http:// home.netscape.com. The Company's principal executive office is located at 501 East Middlefield Road, Mountain View, California 94043, and its telephone number at this location is (415) 254-1900. Netscape's common stock is listed on the Nasdaq National Market under the symbol "NSCP." Except as otherwise noted herein, all references to "Netscape" or the "Company" shall mean Netscape Communications Corporation and its subsidiaries.
RECENT DEVELOPMENTS
BOARD OF DIRECTORS
In January 1997, Eric A. Benhamou, Chairman, President and Chief Executive Officer of 3Com Corporation, was appointed to the Company's Board of Directors and will serve as a Class I director.
NEW PRODUCTS
In October 1996, the Company introduced Netscape SuiteSpot 3.0 and Netscape Communicator, are expected to be commercially available in the second quarter of 1997. See "Planned Products and Releases." In addition, to provide further support for its developer and customer community, the Company announced Netscape SuiteTools, a comprehensive family of tools for developing and managing intranet applications, interactive content and Web sites with Netscape's Open Network Environment ("Netscape ONE").
BUSINESS COMBINATIONS AND JOINT VENTURES
In March 1997, the Company entered into an agreement to enter into a joint venture with Novell subject to required governmental approvals, to deliver a broad range of intranet solutions on current and future Novell platforms. In addition, the Company entered into other business combinations and joint ventures in 1996. See "Business Combinations and Joint Ventures."
PLANNED PRODUCTS AND RELEASES
In October 1996, the Company announced a matched server/client solution focused on the intranet market as an upgrade and extension of its server and client products. Netscape SuiteSpot 3.0, an upgrade to Netscape SuiteSpot 2.0 that is planned to be commercially available in the second quarter of 1997, is designed to be an integrated suite of server software that offers advanced messaging and groupware functionality, provides an open foundation for the creation of network-based applications and enables flexible content management. Netscape Communicator, an upgrade to Netscape Navigator that is planned to be commercially available in the second quarter of 1997, is designed to be a componentized suite of client software for open HTML-based email, groupware, authoring, calendaring and Web browsing. Together, the Netscape SuiteSpot 3.0 and Netscape Communicator solution are designed to offer a matched feature approach enabling organizations to use email, groupware and other enterprise applications across an open network.
Netscape SuiteSpot 3.0 and Netscape Communicator, 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. Therefore, particular attention should be paid to "Factors Affecting the Company's Business, Operating Results and Financial Condition--Product Introductions and Transitions."
NETSCAPE SUITESPOT 3.0.
The Company's next-generation server software suite will be comprised of ten server and tool products for building corporate intranets. Together with the announced Netscape Communicator client, Netscape SuiteSpot 3.0 is expected to provide enterprise customers with an integrated solution for building and maintaining Web sites, open email, publishing and groupware solutions on intranets. In addition, Netscape SuiteSpot 3.0 is designed to support the Netscape ONE framework that allows developers to build cross-platform, network-based applications. Netscape SuiteSpot 3.0 is planned to be commercially available in the second quarter of 1997. Below is a description of each server and tool that collectively comprise Netscape SuiteSpot 3.0.
NETSCAPE ENTERPRISE SERVER 3.0. This enterprise server is designed to be the platform that will enable users to share, locate and publish information. Among the features the Company plans to include are the ability to manage documents in a variety of formats, including Microsoft Office and Adobe PDF, full-text search capability, agent technology, custom views, access controls and document control with versioning. Netscape Enterprise Server 3.0, an upgrade of Netscape's currently shipping Enterprise Server 2.0 is currently available in public beta version and is planned to be commercially released as a standalone product in the second quarter of 1997.
NETSCAPE MESSAGING SERVER 3.0. This server is designed to expand its native support of Internet standards and is designed to extend beyond a traditional client/server messaging architecture through interoperability with native Internet and proprietary LAN-based mail systems. Among the features the Company plans to include are LDAP directory services support, offline and mobile user support, tools for migration from proprietary messaging solutions and IMAP4 and POP3 support. Netscape Messaging Server 3.0, an upgrade to Netscape Mail Server 2.0, is currently available in public beta version and is planned to be commercially released as a standalone product in the second quarter of 1997.
NETSCAPE COLLABRA SERVER 3.0. This open discussion server is designed to allow group-to-group collaboration and knowledge-sharing among teams both inside and outside an organization. Among the features the Company plans to include are support for full-text search across all discussion forums, enhanced encryption, single point administration and advanced replication capabilities. Netscape Collabra Server 3.0, an upgrade to Netscape Collabra Server 2.1, is currently available in public beta version and is planned to be commercially released as a standalone product in the second quarter of 1997.
NETSCAPE CALENDAR SERVER 1.0. This server is designed to be the open standards-based server for calendaring and scheduling across the enterprise. Among the features the Company plans to include are access controls to protect data and enterprise scalability. Netscape Calendar Server 1.0 is currently commercially available.
NETSCAPE MEDIA SERVER 1.0. This server is designed to be the audio broadcasting and publishing extension to the Netscape Enterprise Server. Among the features the Company plans to include are the ability to deliver audio across a TCP/IP network, integration of audio with text and graphics and support for industry-standard protocols and file formats including RTSP. Netscape Media Server 1.0 is currently commercially available.
NETSCAPE CATALOG SERVER 1.0. This is the automated search and discovery server for creating, managing and maintaining an online catalog of files residing on enterprise intranets and the Internet. This server features an automated catalog that is easy to manage and customize with the ability to catalog in multiple file formats. Netscape Catalog Server 1.0 is currently commercially available.
NETSCAPE DIRECTORY SERVER 1.0. This is the server for managing "white pages" information such as names, email addresses, phone numbers and certificates. Its features include universal access to directory information through LDAP, support for distributed searches, replication capabilities and safeguarding of
directory information using both access control lists and SSL. Netscape Directory Server 1.0 is currently commercially available.
NETSCAPE CERTIFICATE SERVER 1.0. This server enables organizations to issue, sign and manage public-key certificates. Its features include single user login, SSL support and software signing using the industry-standard RSA digital signature algorithm. Netscape Certificate Server 1.0 is currently commercially available.
NETSCAPE PROXY SERVER 2.5. This server is designed to replicate and filter access to content on an intranet or the Internet. Among the features the Company plans to include are access and control points for encrypted traffic, automatic proxy configuration and replication on demand and on command. Netscape Proxy Server 2.5, an upgrade to Netscape Proxy Server 2.0, is currently available in public beta version and is planned to be commercially released as a standalone product in the second quarter of 1997.
NETSCAPELIVEWIRE/NETSCAPE LIVEWIRE PRO. These are visual tools suites designed for managing Web sites and creating online applications. Features include the ability to create and import Web page content with a site downloader, a JavaScript compiler and interoperability with Oracle, Informix, Sybase and ODBC databases. Both Netscape LiveWire 1.01 and LiveWire Pro 1.01 are currently commercially available.
NETSCAPE COMMUNICATOR
The Company's next generation client product, Netscape Communicator, will aggregate a set of features for the user to share and access information on intranets or the Internet. Additionally, the Company announced the Netscape Communicator Professional Edition, which is expected to include calendaring and centralized management capabilities. The Netscape Communicator and Netscape Communicator Professional Edition are currently available in public beta version and are planned to be commercially released in the second quarter of 1997. Below is a description of each component that collectively comprise the Netscape Communicator.
NETSCAPE NAVIGATOR 4.0. This component is designed to enable access to information and network applications on intranets and the Internet using the intuitive Netscape Navigator interface. Among the features the Company plans to include are an improved user interface, JavaScript style sheets, layers, improved Java performance and platform support, multiple user profiles and embedded object support. The Netscape Navigator 4.0 component is designed to offer a point-and-click graphical user interface that enables users to navigate the Internet's vast array of network resources. Netscape Navigator 4.0 is planned to be an extension of the browser functionality in Netscape Navigator 3.0.
NETSCAPE MESSENGER. This component is designed to enable corporate email built on open standards. Among the features to be included are integration with Netscape Composer to create HTML mail with embedded objects and images, S/MIME encrypted and digitally signed messages, LDAP Internet-wide directory technology, additional support for IMAP4, POP3 and SMTP/MIME, message filters, an integrated spelling checker, hierarchical folders and search capabilities. Netscape Messenger will be an extension of the mail functionality in Netscape Navigator 3.0.
NETSCAPE COLLABRA. This component is designed to enable enterprise discussion groups based on Internet standards. Among the features the Company plans to include are NNTP support for threaded discussion groups, HTML content, forum names for discussions, access controls for private discussions, searching across all forums and offline reading and posting.
NETSCAPE COMPOSER. This component is designed to be an HTML editor for Web pages, email and discussion groups. Among the features the Company plans to include are one-button publishing, formatting which includes fonts and styles, drag-and-drop images, an extensible editor plug-in API and FTP and
HTTP publishing support. Netscape Composer is designed to be an extension of the authoring functionality in Netscape Navigator Gold.
NETSCAPE CONFERENCE. This component is designed to enable live connection of people and information with Internet telephones, shared whiteboards and file transfer. Among the features the Company plans to include are audio conferencing, voicemail, collaborative browsing, full-duplex echo and silence suppression, H.323 support and integration with Netscape Messenger address book. Netscape Conference is designed to be an extension of the Netscape CoolTalk plug-in for Netscape Navigator 3.0.
NETSCAPE CALENDAR. This component is designed to enable enterprise calendaring and scheduling. Among the features the Company plans to include are local and remote server searching, schedule delegation, offline support and drag-and-drop events. Netscape Calendar will be bundled exclusively with the Netscape Communicator Professional Edition.
NETSCAPE AUTOADMIN. This component is designed to enable centralized management to install, deploy and configure the Netscape Communicator. Among the features the Company plans to include are automatic download and installation of new Netscape Communicator plug-ins and components and the capability to restrict the downloading of such components to those authorized. Netscape AutoAdmin will be bundled exclusively with the Netscape Communicator Professional Edition.
THE FOREGOING SECTION CONTAINS FORWARDING-LOOKING STATEMENTS THAT HAVE BEEN MADE PURSUANT TO THE PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995, REGARDING THE COMPANY'S PLANNED PRODUCTS AND ENHANCEMENTS, INCLUDING FORWARD-LOOKING STATEMENTS REGARDING PLANNED FEATURES AND PLANNED RELEASE DATES. WORDS SUCH AS "ANTICIPATES," "EXPECTS," "INTENDS," "PLANS," "DESIGNS," "BELIEVES," "SEEKS," "ESTIMATES," VARIATIONS OF SUCH WORDS AND SIMILAR EXPRESSIONS ARE INTENDED TO IDENTIFY SUCH FORWARD-LOOKING STATEMENTS. ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED BY THE FORWARD-LOOKING STATEMENTS IN THE FOREGOING SECTION, PARTICULARLY THOSE WITH RESPECT TO PLANNED RELEASE DATES AND PLANNED FEATURES. THE RESULTS ANTICIPATED BY SUCH FORWARD-LOOKING STATEMENTS ARE SUBJECT TO NUMEROUS DIFFERENT RISKS AND UNCERTAINTIES AS SET FORTH IN "FACTORS AFFECTING THE COMPANY'S BUSINESS, OPERATING RESULTS AND FINANCIAL CONDITION," SPECIFICALLY THE FACTORS ENTITLED "PRODUCT INTRODUCTIONS AND TRANSITIONS" AND "NEW PRODUCT DEVELOPMENT AND TECHNOLOGICAL CHANGE." FOR EXAMPLE, THE COMPANY'S ABILITY TO RELEASE SUCH PLANNED PRODUCTS AND ENHANCEMENTS WITH THEIR PLANNED FEATURES IN A TIMELY AND COST-EFFECTIVE MANNER, OR AT ALL, COULD BE MATERIALLY ADVERSELY AFFECTED BY ANY TECHNICAL OR OTHER PROBLEMS IN, OR DIFFICULTIES WITH, SUCH PLANNED PRODUCTS OR ENHANCEMENTS, THIRD PARTY PRODUCTS OR TECHNOLOGIES WHICH RENDER THE COMPANY'S PLANNED PRODUCTS AND ENHANCEMENTS OBSOLETE, THE UNAVAILABILITY OF REQUIRED THIRD PARTY TECHNOLOGY LICENSES ON COMMERCIALLY REASONABLE TERMS, THE LOSS OF KEY RESEARCH AND DEVELOPMENT PERSONNEL, THE INABILITY OR FAILURE TO RECRUIT AND RETAIN ADDITIONAL QUALIFIED RESEARCH AND DEVELOPMENT PERSONNEL, OR THE ADOPTION OF COMPETING STANDARDS.
RECENT PRICING AND SUPPORT ANNOUNCEMENTS
In conjunction with the announcement of the Company's matched server and client solution, the Company announced a new pricing program that reflects the enterprise scalability of the Company's products. The Company's new pricing program will make its Netscape SuiteSpot 3.0 and Netscape Communicator products available on a per seat basis. In addition, the Netscape Messaging, Netscape Collabra, Netscape Directory and Netscape Calendar servers will be available as standalone products with a certain number of client access licenses ("CALs"). As customers increase the number of users to prescribed levels, additional incremental license charges will apply, subject to volume and other discounts. This pricing model is noted in the table below.
NETSCAPE ENTERPRISE LICENSE FEES ----------------------------------------------
* Price includes software, CALs, support, and 1 year subscription. Minimum user-level is 500.
** Reflects most recent pricing announcement in February 1997.
In February 1997, the Company announced revised pricing and support initiatives for the enterprise market. In particular, the Company announced its five-tiered support program to deliver a level of support that matches the needs of various sized organizations. In addition, the Company increased the per user charge for Netscape Communicator and Netscape SuiteSpot 3.0 from $99 to $104, and the Company raised the overall price of Netscape SuiteSpot 3.0 from $3,995 to $4,995 and enterprise server standalone from $995 to $1,295. These pricing charges will be effective April 1, 1997.
The Company's server and client product lines account for the vast majority of the Company's total revenues. The Company has in the past changed, and may in the future change, the pricing of its products. The pricing changes announced in February 1997 and October 1996 and any future pricing changes could materially adversely affect sales of the Company's products and consequently materially adversely affect the Company's business, operating results and financial condition.
PRODUCTS
The Company is a leading provider of open software for linking people and information over intranets and the Internet. Netscape develops, markets and supports a broad suite of enterprise server and client software, development tools and commercial applications to create a single shared communications platform for network-based solutions. Netscape software is based on industry standard protocols and therefore can be deployed across a variety of computer operating systems, platforms and databases and can be interconnected with traditional client/server applications. Using Netscape solutions, organizations can extend their internal information systems and applications to geographically dispersed facilities as well as to third party partners and customers. In addition, Netscape's products allow individuals and organizations to access information and to execute transactions across the Internet such as the buying and selling of information, software, and other merchandise.
In addition to the products discussed above under "Planned Products and Releases," Netscape's product line currently includes the following products:
NETSCAPE NAVIGATOR CLIENT SOFTWARE
Netscape Navigator features a point-and-click graphical user interface that enables users to navigate the Internet's vast array of networked resources as well as to exchange information and participate in commerce on the Internet. Netscape Navigator brings Web exploring, email, newsgroups, chat and FTP together in an integrated package designed to be easy to use and learn. In addition, Netscape Navigator provides a platform for live online applications, supporting Live Objects and other interactive multimedia content such as Java applets, frames and Netscape online plug-ins. The Company currently offers three versions of its Netscape Navigator client software and a product bundle of add-on features that work in conjunction with Netscape Navigator.
The Netscape Navigator product line is as follows:
NETSCAPE NAVIGATOR LAN EDITION. Netscape Navigator LAN Edition is intended for users who already have TCP/IP connections to the Internet or intranets. It incorporates all of the features of Netscape Navigator and is available for Microsoft Windows, Apple Macintosh and various Unix platforms. It is compatible with standard TCP/IP implementations on these platforms.
NETSCAPE NAVIGATOR PERSONAL EDITION. Netscape Navigator Personal Edition is intended for companies and individuals without direct TCP/IP connections who want dial-up access to the Internet. It includes a TCP/IP stack, an implementation of the Point to Point Protocol and a dialer. Components are installed and configured through installation programs designed for ease of use. Netscape Navigator Personal Edition features automatic access to a choice of Internet service providers.
NETSCAPE NAVIGATOR GOLD. Netscape Navigator Gold includes the standard features of Netscape Navigator and adds a WYSIWYG editor that allows a user to create and publish live, online Web pages in one integrated program. Netscape Navigator Gold is designed to make building a Web page as easy as using a word processor.
NETSCAPE POWER PACK. Netscape Power Pack is a suite of add-on applications that extends the capabilities of Netscape Navigator in the Windows environment. Netscape Power Pack combines Netscape SmartMarks, Netscape Chat and multimedia add-on applications from such vendors as Adobe, Apple and Progressive Networks. Netscape SmartMarks provides advanced bookmark and Web monitoring services for users of Netscape Navigator. Netscape Chat is an interaction tool that integrates with Netscape Navigator to support real-time communications.
Licenses of Netscape Navigator and related client products accounted for 57.1% of the Company's total revenues in the year ended December 31, 1996.
NETSCAPE SERVER SOFTWARE
Netscape server products combine encryption features, intuitive graphical administration, high performance and adherence to standards to enable communications and electronic commerce over the Internet and intranets. These products can either be used independently for implementing and operating Web server sites, email or newsgroups, or they can be integrated to provide a seamless, high performance TCP/IP-based communication solution, as well as provide a platform to create next-generation, live, online applications.
Netscape markets its servers individually and collectively through the Netscape SuiteSpot server bundle. Netscape SuiteSpot is a flexible suite of up to five integrated servers which enables business workgroups to communicate and collaborate utilizing open Internet standards, thereby providing the basis for a client/server workgroup environment.
NETSCAPE FASTTRACK SERVER. The Netscape FastTrack Server is an easy to use, entry level Web server that enables non-programmers to create and manage a Web site. It is designed to be a complete solution for creating and managing Web sites on the Internet and intranets. The Netscape FastTrack Server is an open platform for publishing traditional Internet documents as well as developing and deploying live network-centric and media-rich applications. The Netscape FastTrack Server enables end-users to install an Internet site. The installation wizard automatically detects system configuration information to assist the user in optimizing server performance. The server also includes an editor for HTML documents, forms and applications, and supports one-button publishing. The Netscape FastTrack Server also offers encryption features to restrict access to server resources (such as applications, documents and administrative tools), as well as to encrypt the information that flows between the server and client. Flexible access control allows users to select which resources to protect. While the Netscape FastTrack Server is the only server not shipping in Netscape SuiteSpot, it is designed to be easily upgradeable to the Netscape Enterprise Server.
NETSCAPE SUITESPOT 2.0
Netscape SuiteSpot 2.0 includes Netscape LiveWire Pro for creating live online applications and Web sites plus the choice of any five of the following servers:
NETSCAPE ENTERPRISE SERVER. This server is a high-performance Web server for creating, managing and intelligently distributing information throughout an enterprise or across the Internet. It is an open platform for developing and serving live, online applications using next-generation development tools based on the Java and JavaScript programming languages. It includes full-text and database search capabilities, enterprise-wide management and control features, and tools for creating and maintaining data.
The Netscape Enterprise Server provides advanced capabilities for content creation and management, including WYSIWYG editing, full text search and revision control. It extends the development platform to include open, server-side applications using Java and JavaScript applications. The Netscape Enterprise Server also provides encryption and network management capabilities including SSL and advanced access control with remote, cross-platform administration, SNMP and reporting. The Netscape Enterprise Server also delivers second generation performance enhancements including multi-processor support.
NETSCAPE MESSAGING SERVER. This server is server software that enables the transport of email and messages within an intranet and over the Internet. The Netscape Mail Server complies with HTML and other standard document formats and is designed to make installation and integration easy for the user.
NETSCAPE CALENDAR SERVER. This server is designed to be an open standards-based server for calendaring and scheduling across the enterprise. Among the features included are access controls to protect data and enterprise scalability.
NETSCAPE MEDIA SERVER. This server is designed to be the audio broadcasting and publishing extension to the Netscape Enterprise Server. Among the features included are the ability to deliver audio across a TCP/IP network, integration of audio with text and graphics and support for industry-standard protocols and file formats including RTSP.
NETSCAPE PROXY SERVER. This server is server software designed to improve the performance and security of communications across a TCP/IP network. Performance is improved because the server stores frequently-accessed pages locally. Security is enhanced because the server provides encrypted communications through a firewall onto the Internet.
NETSCAPE CATALOG SERVER. This server is a new class of server software that automatically builds and maintains a common directory of resources, cataloging and indexing information so users can locate and access it quickly, regardless of where the information is stored on intranets. It can also be configured to catalog selected resources on the Web. The server is designed to be efficient, automated, open, customizable and cross-platform, enabling companies to deploy it network-wide across different brands of operating systems and Web servers.
NETSCAPE DIRECTORY SERVER. This server manages "white pages" information such as names, email addresses, phone numbers and certificates. Its features include universal access to directory information through LDAP, support for distributed searches, replication capabilities and safeguarding of directory information using both access control lists and SSL.
NETSCAPE CERTIFICATE SERVER. This server enables organizations to issue, sign and manage public-key certificates. Its features include single user login, SSL support and software signing using the industry-standard RSA digital signature algorithm.
COMMERCIAL APPLICATIONS
Netscape commercial applications are designed to enable organizations to conduct electronic commerce on the Internet. These applications are intended to address different business needs, including the presentation of multimedia formats, support for large numbers of merchants and products, the need for
real time data management, support for special communities of interest and the automation of high volumes of online transactions. The commercial applications are designed to provide the capability to manage large-scale commercial sites on the Internet.
Certain commercial applications are designed to enable credit authorization and transaction settlement. Credit card authorization occurs online by checking records to ensure no abnormal activity has occurred and that the transaction does not exceed the authorized credit limit. A merchant bank performs transaction settlement by transferring funds from the customer's account to the merchant's account.
The Company's commercial applications product line is currently comprised of the following products:
NETSCAPE MERCHANT SYSTEM. Netscape Merchant System allows users to create and manage virtual storefronts. By storing product information in a relational database, it provides the flexibility to add and delete products, change prices and import new graphics. Furthermore, display pages are automatically updated, which simplifies the task of managing products.
With Netscape Merchant System, shoppers may browse or make multi-level queries and view automatically generated pages displaying items that meet their stated criteria. An electronic shopping basket allows shoppers to hold items and allows purchases of any one or many products at a time of a customer's choosing, even if the basket contains items from several merchants in the mall. At the point of sale, Netscape Merchant System automatically forwards the shopping basket and payment information to credit card authorization and processing partners.
NETSCAPE PUBLISHING SYSTEM. Netscape Publishing System is designed for users who want to create subscription-based online publications. This software is not only for news services, but for anyone publishing large amounts of information, such as banks communicating daily news information and services, car manufacturers publishing specifications on new vehicles, industry analysts issuing reports on new market developments and departments within an enterprise.
Netscape Publishing System manages critical data for a publisher, such as content, files, pricing information, access authorization, user demographic information and advertising response rates. It is designed to display context-sensitive advertising to subscribers based upon specified criteria, including available demographic information, entry path and time. Netscape Publishing System archives past issues, links related stories and creates HTML pages on the fly in response to user queries by concept or keyword.
NETSCAPE COMMERCE PLATFORM. The Netscape Commerce Platform is comprised of two major components the Netscape SuiteSpot line of software and the Netscape Commerce Extensions (such as Netscape LivePayment) that allow developers and businesses to create a customized commerce environment. The Netscape Commerce Platform provides a server/client system that scales seamlessly between workgroups, across an intranet as well as the Internet.
Licenses of the Company's server and commercial applications software accounted for 27.0% of the Company's total revenues in the year ended December 31, 1996.
DEVELOPMENT TOOLS
Netscape's development tools are designed to allow developers to efficiently create and manage live online applications that combine rich multimedia content with application logic and database connectivity. These applications can take advantage of many multimedia datatypes, such as Adobe Acrobat files, Macromedia Director movies, Progressive Networks' RealAudio real-time audio, Apple QuickTime and QuickTime VR movies, and VRML and SGML documents. They also incorporate application logic consisting of Java applets and Netscape JavaScripts, and connections to enterprise-class SQL databases. The resulting live online applications operate on a variety of processors and operating systems together with Netscape client and server software.
NETSCAPE LIVEWIRE. Netscape LiveWire is a visual application development tool designed for creating live online applications and managing Web sites. LiveWire includes Netscape Navigator Gold, LiveWire Site Manager, LiveWire Server Extension Engine and LiveWire Server Front Panel.
NETSCAPE LIVEWIRE PRO. Netscape LiveWire Pro includes all of the components and features included in Netscape LiveWire with the addition of a run-time version of the Informix Online relational database and database connectivity, with extensions to the Netscape Server Language to support reading from and writing to SQL databases from Informix, Oracle, Sybase and Microsoft.
NETSCAPE ONE
In July 1996, Netscape announced the creation of its Netscape ONE, which provides a framework for developers to build cross-platform, network-based applications. Netscape ONE is intended to promote a standards-based approach to managing distributed objects on the network and to serve as an alternative to platform-specific application development. Netscape ONE incorporates technologies such as Java Script 1.1, HTTP and HTML, among others, and, in combination with CORBA, permits developers to write distributed applications and integrate information systems running on a broad range of operating systems.
NETSCAPE APPFOUNDRY
In September 1996, Netscape announced the AppFoundry Program to demonstrate applications developed using the Netscape ONE framework. These applications can be deployed and customized by an enterprise, and demonstrate the speed at which applications can be built using an open Internet-standard platform. Applications include programs for internal purchasing, travel and expense reporting, job posting and applicant processing and sales trend analysis. The combination of Netscape ONE and AppFoundry create an environment where the enterprise customer can enable communication and share information and applications within its own departments as well as with its third party partners and customers through a single common intranet infrastructure.
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 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.
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 predominantly 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, results of operations and financial condition.
SECURITY RISKS
The Company has included in its products security protocols which operate in conjunction with encryption and authentication technology licensed from RSA Data Security Inc. ("RSA"). Despite the existence of these technologies, the Company's products have been found to be vulnerable to break-ins and similar disruptive problems caused by Internet users. In the last two years, there have been several instances in which weaknesses or vulnerabilities in the Company's security implementation were discovered. In each instance in which a vulnerability or weakness was discovered and verified in the Company's security implementation, the Company attempted to address the vulnerability or weakness by making the various design changes in its security and reviewing those changes both internally and with a broad set of outside industry experts. The design changes appear to have resolved known security vulnerabilities and weaknesses in the Company's products.
In addition, the Company's products incorporate technology from other software companies which could be vulnerable to security flaws. For example, in March 1996 certain security flaws were discovered in the Java programming language; in particular, one security flaw was discovered which could have jeopardized the security of information stored in the computer of Netscape Navigator users. Sun, the licensor of Java, has corrected this particular security flaw and has distributed the software fix to the Company. However, there can be no assurance that the Company's products will not be susceptible to other security flaws, whether in the Company's products or technologies, in Java or in other technology incorporated into the Company's products.
Despite the Company's attempts to address the vulnerabilities and weaknesses in its security implementation, the Company's products and licensed technology incorporated in such products may continue to be vulnerable to break-ins and similar disruptive problems caused by Internet users. Further, as is generally known, weaknesses in the environment in which Netscape products are used may compromise the security of confidential electronic information exchanges across the Internet. This includes, but is not limited to, the security of the physical network, security of the physical machines used for the information transfer and the security of the operating system on top of which the Netscape products are running. Any such flaws in the Internet or the end-user environment, or weaknesses or vulnerabilities in the Company's products or licensed technology incorporated in such products, would jeopardize the security of confidential information sent over the Internet using Netscape software, such as credit card numbers and email, and might enable others to dismantle the special security techniques meant to protect such transactions.
Any further computer break-ins or other disruptions could jeopardize the security of information stored in and transmitted through the computer systems of end-users of the Company's products, which may result in significant liability to the Company and may also deter potential customers. Moreover, the security and privacy concerns of existing and potential customers, as well as concerns related to computer viruses, may inhibit the growth of the Internet and intranet market generally, and the Company's customer base and revenues in particular. The Company attempts to limit its liability to its customers, including liability arising from failure of the security implementation contained in the Company's products, through contractual provisions. However, there can be no assurance that such limitations will be effective. The Company currently does not have product liability insurance to protect against risks associated with forced break-ins or disruptions. There can be no assurance that additional security vulnerabilities and weaknesses will not be discovered in the Company's products or licensed technology incorporated in such products or that weaknesses in the end-user environments will not limit the use of the Internet as a commercial medium. Any additional security related problems in the Company's products or licensed technology incorporated in such products may require significant expenditures of capital and resources by the Company to alleviate such problems, may result in lawsuits against the Company, may result in loss of customers and may cause interruptions, delays or cessations of product shipments to the Company's customers. Any such expenditures, lawsuits, loss of customers, interruptions, cessations or delays would likely have a material adverse effect on the Company's business, operating results and financial condition.
SERVICES
SUPPORT PROGRAMS
The Company has made a commitment to provide timely, high quality technical support to meet the diverse needs of its customers and partners and to facilitate the adoption and use of its products. The Company offers several support products:
NETSCAPE HELP DESK SUPPORT. The Company offers an annual support program intended for organizations that need to internally support a large-scale deployment of Netscape Navigator software and for authorized VARs and systems integrators providing direct support to their customers. This program offers a full spectrum of support, including access to technical experts, support and training materials, support tools, call histories, maintenance releases and software updates.
NETSCAPE CONSULTATION SUPPORT. For individuals and for small groups using Netscape Navigator software, the Company offers support through a toll-free telephone number on a time and materials payment basis. This service provides online technical support and bug fixes or software releases as required. Netscape Consultation Support is particularly economical for self-supporting departments that consolidate questions through a department system administrator.
NETSCAPE SERVER ANNUAL SUPPORT. The Company offers an annual support program targeted at system administrators who have licensed Netscape servers. The program features are similar to those in Netscape Help Desk Support but are oriented toward the Netscape server software.
NETSCAPE PREMIUM SUPPORT. The Company offers medium to large-sized organizations and strategic partners 24-hour support, partner specific training and consulting, online access to support information, and early access to new software releases.
CONSULTING
The Company offers consulting services for particularly complex application design, integration and installation. Consulting services are provided at negotiated rates and typically include on-site support during the installation process by Company engineers.
TRAINING
Netscape offers hands-on training courses and materials to resellers and end-users covering installation, configuration and troubleshooting. In addition, courses and materials cover security and encryption, user support, data loading and content creation, HTML user interface design, HTML template scripting and integration with the database.
ADVERTISING SPACE
For its most frequently visited Web pages, Netscape has created a program which enables advertisers to display their logo or message on a hyperlinked button with access to their Web site. The Company charges a monthly fee for the advertising spots, which varies depending on the specific page location and the number of visits to the page.
MARKETING AND DISTRIBUTION
MARKETING
The Company uses a variety of marketing programs designed to stimulate demand for its products and services. In addition, the Company has developed co-marketing programs with channel partners designed to take advantage of their complementary marketing capabilities. The key elements of the Company's marketing strategy include:
MARKETING ON THE INTERNET. Netscape Navigator is designed to automatically access the Netscape home page on the Company's Web server each time it starts up. The home page provides frequently updated help for new users, news about the Company, directories to interesting sites on the Internet, a variety of product and technical support information and access to the Company's electronic store where goods and services can be purchased. The Company makes its products available for evaluation and purchase through its home page. Certain customer information is collected electronically through an automated registration process, creating the basis for ongoing marketing of upgrades, new products, add-on products and merchandise. The Company is additionally involved in various forms of electronic advertising and electronic promotions on the Internet.
TARGET MARKETING. The Company focuses direct marketing efforts on decision makers in medium and large-sized enterprises, new electronic merchants and companies now publishing on the Web. The
Company addresses these customers through a referral program for Netscape Navigator users, outbound telemarketing, direct response advertising, trade shows and seminar programs. The goal of these efforts is to identify potential buyers of the Company's products, create awareness of the Company's product offerings and generate leads for follow-on sales.
MARKETING TO PC USERS. Client products are marketed widely to PC users in both the business and home PC market segments. Retail distribution through national resellers, reseller agreements with Internet service providers, and bundling arrangements with PC hardware and software OEMs are being used to make the Company's client products available to a large number of potential customers. In order to stimulate demand for its products, the Company also advertises in PC industry publications and engages in sales promotions with distribution partners.
DISTRIBUTION
The Company has designed its distribution strategy to address the particular requirements of its diverse institutional and individual target customers. The Company's direct distribution efforts consist of a direct sales force and telesales as well as marketing directly via the Netscape home page on the Internet. The Company's products are distributed indirectly through OEMs, VARs and software retailers.
DIRECT SALES. The Company's direct sales force targets primarily medium to large-sized organizations, including telecommunications companies, manufacturers, retailers, publishers and financial service companies. The Company believes that these organizations are most likely to become the electronic merchants and information publishers for commerce on the Internet. In addition, these organizations have a substantial installed base of intranets and have been widely deploying Web servers for internal enterprise applications. In certain instances, the Company's direct sales force works with complementary hardware OEMs, VARs and systems integrators to deliver complete solutions for major customers.
TELESALES. The Company's telesales organization, based in Mountain View, California, receives customer orders as well as proactively contacts potential customers.
INTERNET SALES. The Company offers its products and services electronically via the Internet through an implementation of the Company's Merchant System commercial application. Internet sales and distribution is particularly well suited to address the large base of Internet users.
OEMS. The Company has established OEM relationships to leverage its sales efforts. For example, the Company has OEM reseller agreements with Apple, Compaq, Digital, Hewlett-Packard, IBM, Informix, Novell, Olivetti, Siemens, Silicon Graphics, Sun and Sybase to bundle Netscape's server or client software with certain of their product offerings.
VARS. VARs and systems integrators customize, configure and install the Company's software products with complementary hardware, software and services. In combining these products and services, these Resellers are able to deliver more complete Netscape-based solutions to address specific customer needs. The Company may also help these VARs design customized applications to meet the unique requirements of these customers.
RETAIL DISTRIBUTION. The Company currently distributes its Netscape Navigator Personal Edition, Netscape Navigator Gold and Power Pack retail products through a network of retail distributors in North America.
The Company sells its products directly to end-users and via the Internet. In addition, the Company offers its products indirectly through OEMs, VARs and software retailers. The Company is currently pursuing a strategy which is intended to increase sales through OEMs, VARs and system integrators as a percentage of total revenues, especially in international markets. The Company expects that any material increase in sales through Resellers as a percentage of total revenues, especially any increase in the
percentage of sales through OEMs, VARs and system integrators, will adversely affect the Company's average selling prices and gross margins due to the lower unit prices that are typically charged when selling through indirect channels. In recent quarters, sales through indirect channels have increased as a percentage of total revenues, which has adversely impacted average selling prices; however, gross margins to date have not decreased due to the large percentage of sales through OEMs, which have lower associated costs of revenues than other Resellers due to the absence of packaging costs. Other potential adverse consequences of the Company's focus on increasing sales through Resellers are the diversion of management resources and attention from direct sales, which could adversely affect direct sales revenue and sales of Netscape SuiteSpot 3.0 and Netscape Communicator (a large percentage of which are expected to be made through direct sales due to the nature of the sale), and greater revenue fluctuation due to a greater percentage of retail revenue, which tends to fluctuate with product releases and may be subject to seasonality. Moreover, there can be no assurance that the Company will be able to continue to attract and retain Resellers that will be able to market the Company's products effectively, particularly Resellers of intranet software for the enterprise, such as Netscape SuiteSpot 3.0 and Netscape Communicator, and will be qualified to provide timely and cost-effective customer support and service. There also can be no assurance that the Company will be able to manage conflicts among its Resellers. In addition, the Company's agreements with Resellers typically do not restrict Resellers from distributing competing products, and in many cases may be terminated by either party without cause. Further, in some cases the Company has granted exclusive distribution rights that are limited by territory and in duration. Consequently, the Company may be adversely affected should any Reseller fail to adequately penetrate its market segment. The inability to recruit, manage, educate or retain important Resellers, particularly Resellers of intranet software for the enterprise, or their inability to penetrate their respective market segments, could materially adversely affect the Company's business, operating results or financial condition. See "Product Introductions and Transitions" and "Factors Affecting the Company's Business, Operating Results and Financial Condition--Evolving Distribution Channels."
In addition to expanding its direct sales channels, the Company will continue to distribute its products electronically through the Internet. Distributing the Company's products through the Internet makes the Company's software more susceptible than other software to unauthorized copying and use. The Company has historically allowed and currently intends to continue to allow potential customers to electronically download its client and server software for a free evaluation period. There can be no assurance that, upon expiration of the evaluation period, the Company will be able to collect payment from users that retain a copy of the Company's software. In addition, by distributing its products for free evaluation over the Internet, the Company may have reduced the future demand for its products. If, as a result of changing legal interpretations of liability for unauthorized use of the Company's software or otherwise, users were to become less sensitive to avoiding copyright infringement, the Company's business, operating results and financial condition would be materially adversely affected.
INTERNATIONAL
International revenues (sales outside of North America) accounted for approximately 17.2% and 29.3% of total revenues for the years ended December 31, 1995 and 1996, respectively, and were immaterial in the year ended December 31, 1994.
The Company believes it is important to have a strong international presence and intends to conduct business in markets outside the United States through a combination of subsidiaries and distributors. The Company intends to primarily address this market through the use of Resellers.
A key component of the Company's strategy is its continued expansion into international markets. To date, the Company has only limited experience in developing localized versions of its products and marketing and distributing its products internationally, and the Company is currently incurring, and expects to continue to incur, significant costs in developing, marketing and distributing localized versions. If the international revenues are not adequate to offset the expense of establishing and maintaining foreign
operations and the costs of localizing the Company's products, the Company's business, operating results or financial condition could be materially adversely affected. There can be no assurance that the Company will be able to successfully market, sell and deliver its products in foreign markets. In addition to the uncertainty as to the Company's ability to continue to generate revenues from its foreign operations and expand its international presence, there are certain risks inherent in doing business on an international level, such as unexpected changes in regulatory requirements, export and import restrictions, export and import controls relating to encryption technology, tariffs and other trade barriers, difficulties in staffing and managing foreign operations, longer payment cycles, problems in collecting accounts receivable, political instability, fluctuations in currency exchange rates, software piracy, seasonal reductions in business activity during the summer months in Europe and certain other parts of the world and potentially adverse tax consequences, which could adversely impact the success of the Company's international operations. There can be no assurance that one or more of such factors will not have a material adverse effect on the Company's future international operations and, consequently, on the Company's business, operating results and financial condition. See "Government Regulation."
RESEARCH AND DEVELOPMENT
The Company's current development efforts are focused on new products, product enhancements and adapting existing products to new operating systems. See "Planned Products and Releases." There can be no assurance, however, that such products, product enhancements or product adaptations will be made commercially available as planned or otherwise on a timely and cost-effective basis, or that if introduced, these products will achieve market acceptance.
The Company believes that its software development team represents a significant competitive advantage for the Company. The team includes key members of the engineering teams which developed the original Mosaic Web client at NCSA, the original Web server software at CERN and NCSA, and the original Lightweight Directory Access Protocol (LDAP) standard at the University of Michigan, as well as leading software security specialists. The Company's ability to attract and retain highly qualified employees will continue to be the principal determinant of its success in maintaining technological leadership. Netscape has a policy of using equity-based compensation programs to reward and motivate significant contributors among its employees.
Research and development expenses were $4.1 million, $26.8 million and $83.0 million in the years ended December 31, 1994, 1995 and 1996, respectively. To date, principally all software development costs have been expensed as incurred. The Company believes that significant investments in research and development are required to remain competitive. As a consequence, the Company intends to continue to increase the absolute amount of its research and development expenditures in the future.
NEW PRODUCT DEVELOPMENT AND TECHNOLOGICAL CHANGE
Substantially all of the Company's revenues have been derived, and substantially all of the Company's future revenues are expected to be derived, from the license of its software and sale of associated services. Accordingly, broad acceptance of the Company's software products and services by customers is critical to the Company's future success. However, the markets for the Company's products are characterized by rapidly changing technology, evolving industry standards and frequent new product introductions; therefore, the Company's future success will depend on its ability to design, develop, test and support new software products and enhancements that meet changing customer needs and respond to technological developments and emerging industry standards on a timely and cost-effective basis. There can be no assurance that the Company will successfully identify new product opportunities and develop and bring new products, such as Netscape SuiteSpot 3.0 and Netscape Communicator, to market in a timely and cost-effective manner, or that products or technologies developed by others will not render the Company's products or technologies obsolete or noncompetitive. While the Company has addressed the need to develop new products and enhancements primarily through its internal development efforts, the Company
has also addressed this need through acquisitions and the license of third party technology. Acquisitions involve numerous risks, including difficulties in the assimilation of the operations, technologies and products of the acquired companies, the diversion of management's attention from other business concerns, risks of entering markets in which the Company has no or limited direct prior experience and where competitors in such markets have stronger market positions, and the potential loss of key employees of the acquired company. Licensing of third party technology also involves numerous risks, including product liability claims based on licensed technology, liability for licensed technology which infringes the proprietary rights of others, the potential inability of third party licensors to indemnify the Company for intellectual property infringement claims, the risk that the scope of third party licensor indemnification is not as broad as the indemnification the Company provides to its customers, and the unavailability of similar technology on commercially reasonable terms in the event that the third party technology is unavailable. See "Proprietary Rights" and "Factors Affecting the Company's Business, Operating Results and Financial Condition--Uncertain Protection of Intellectual Property; Unisys Patent Enforcement; Risks Associated with Licensed Third Party Technology." The failure of the Company's new product development efforts could have a material adverse effect on the Company's business, financial condition or results of operations. The Company's current products are designed around certain standards, including, for example, security standards, and current and future sales of the Company's products will be dependent, in part, on widespread adoption of such standards by enterprises, consumers, developers and other software providers. Widespread adoption of a standard not supported by Netscape could have a material adverse effect on the Company's business, operating results or financial condition. In addition, there can be no assurance that the Company will not experience difficulties that could delay or prevent the successful development, introduction and marketing of new products and enhancements, such as Netscape SuiteSpot 3.0 and Netscape Communicator, or that its new products and enhancements, including Netscape SuiteSpot 3.0 and Netscape Communicator, will adequately meet the requirements of the marketplace and achieve market acceptance. Further, because the Company has only recently commenced shipment of many of its products, there can be no assurance that, despite testing by the Company and by current and potential customers, errors will not be found in the Company's products, or, if discovered, successfully corrected in a timely and cost-effective manner. If the Company is unable to develop on a timely and cost- effective basis new software products, enhancements to existing products or error corrections, or if such new products or enhancements do not achieve market acceptance, the Company's business, operating results and financial condition will be materially adversely affected. See "Planned Products and Releases," "Products," "Product Introductions and Transitions," and "Research and Development."
COMPETITION
The market for software and services for intranets and the Internet is relatively new, intensely competitive, rapidly evolving 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 has bundled 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 that 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.
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 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 "Product Introductions and Transitions."
GOVERNMENT REGULATION
The Company is not currently subject to direct government regulation, other than pursuant to securities laws and the regulations thereunder applicable to all publicly owned companies and laws and regulations applicable to businesses generally, and there are currently few laws or regulations directly applicable to access to or commerce on the Internet. However, due to the increasing popularity and use of the Internet, it is likely that a number of laws and regulations may be adopted at the local, state, national or international levels with respect to the Internet, covering issues such as user privacy and expression, pricing of products and services, taxation, advertising, intellectual property rights, information security or the convergence of traditional communication services with Internet communications. For example, the Telecommunications Reform Act of 1996 (the constitutionality of which is currently under challenge) was recently enacted and imposes criminal penalties (via the Communications Decency Act or "CDA") on anyone who distributes obscene, lascivious or indecent communications over the Internet. Moreover, the adoption of any such laws or regulations may decrease the growth of the Internet, which could in turn decrease the demand for the Company's products or increase the Company's cost of doing business or in some other manner have a material adverse effect on the Company's business, operating results or financial condition. In addition, the applicability to the Internet of existing laws governing issues such as property ownership, copyrights and other intellectual property issues, taxation, libel and personal privacy is uncertain. The vast majority of such laws were adopted prior to the advent of the Internet and related technologies and, as a result, do not contemplate or address the unique issues of the Internet and related technologies. Changes to such laws intended to address these issues, including some recently proposed changes, could create uncertainty in the marketplace which could reduce demand for the Company's products, could increase the Company's cost of doing business as a result of costs of litigation or increased product development costs, or could in some other manner have a material adverse effect on the Company's business, operating results or financial condition.
Because the encryption technology contained in the Company's products is deemed to be a "munition," such products are subject to U.S. export controls pertaining to munitions. There can be no assurance that such export controls, either in their current form or as may be subsequently revised, will not limit the Company's ability to distribute certain encrypted products outside of the United States or electronically. While Netscape takes precautions against unlawful exportation, such exportation may occur from time to time. In addition, federal or state legislation or regulation may further limit levels of encryption or authentication technology, and foreign governments could enact import laws or regulations that may restrict the type of encryption software that is permitted for distribution in their countries. Moreover, as a consequence of such export controls, Netscape must develop and market both domestic and international versions of its products that contain encryption software, with the version for the U.S. market having a stronger level of encryption than the version for export to international markets. Along with the additional costs associated with the duplication of effort and expense in research, development, manufacturing and distribution of different versions of products, the Company may lose sales from customers who wish to have the same level of encryption security throughout their organization. The Company may also encounter difficulties competing with non-U.S. producers of strong encryption products, which producers have the ability to both import their products into the United Stated and sell products overseas. Finally, due to the weaker level of encryption contained in the Company's products shipped internationally, the Company may not acquire the installed international base necessary to make the functionality of its products part of an international standard.
Additionally, some countries have enacted import laws requiring the alteration of the Company's products in order for the government of such countries to maintain a level of control over the content of products entering such countries. In addition to the costs incurred by the Company in complying with varying international regulations, alteration of the Company's products may cause such products to perform at a level below their intended level and thereby subject the Company to potential liability and other adverse consequences. Any such export restrictions, import restrictions, new legislation or regulation or unlawful exportation could have a material adverse impact on the Company's business, operating results or financial condition. See "Marketing and Distribution--International."
PROPRIETARY RIGHTS
The Company's success and ability to compete is dependent in part upon its internally developed technology. While the Company relies on patents, trademark, trade secret and copyright law to protect its technology, the Company believes that factors such as the technological and creative skills of its personnel, new product developments, frequent product enhancements, name recognition and reliable product maintenance are more essential to establishing and maintaining a technology leadership position. There can be no assurance that others will not develop technologies that are similar or superior to the Company's technology. The Company generally enters into confidentiality or license agreements with its employees, consultants and vendors, and generally controls access to and distribution of its software, documentation and other proprietary information. Despite these precautions, it may be possible for a third party to copy or otherwise obtain and use the Company's products or technology without authorization, or to develop similar technology independently. In addition, effective patents, copyright and trade secret protection may be unavailable or limited in certain foreign countries. To license its products, the Company relies in part on "shrink wrap" licenses that are not signed by the end-user and, therefore, may be unenforceable under the laws of certain jurisdictions. Despite the Company's efforts to protect its proprietary rights, unauthorized parties may attempt to copy aspects of the Company's products or to obtain and use information that the Company regards as proprietary. Policing unauthorized use of the Company's products is difficult. There can be no assurance that the steps taken by the Company will prevent misappropriation of its technology or that such agreements will be enforceable. In addition, litigation may be necessary in the future to enforce the Company's intellectual property rights, to protect the Company's trade secrets, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or
invalidity. Such litigation could result in substantial costs and diversion of resources and could have a material adverse effect on the Company's business, operating results or financial condition.
Unisys Corporation ("Unisys") has announced its intention to require the payment of royalties for the use of compression technology associated with the Graphics Interchange Format ("GIF"). Unisys asserts that this popular file format is based on compression technology patented by Unisys. The Company's products have the ability to decompress files, including files stored in GIF. The Company and, to the Company's knowledge, other licensees, have received notice of Unisys' intention to enforce or license such patent. The Company could incur additional costs and liability should its products be found to be within the scope of the Unisys patent, including costs and liability from claims for indemnification resulting from infringement. The assertion of these patent rights by Unisys, if successful, could prevent the Company's products from enabling users to view files compressed in GIF. The Company does not believe its products infringe the Unisys patent; however, there can be no assurance that the Company's products are not within the scope of the Unisys patent or that the Company's business, operating results and financial condition will not be materially adversely affected if the Company's products are found to be within the scope of the Unisys patent.
From time to time the Company has, in addition to the notice from Unisys, received, and may receive in the future, notice of claims of infringement of other parties' proprietary rights. Although the Company does not believe that its products infringe the proprietary rights of any third parties, there can be no assurance that infringement or invalidity claims (or claims for indemnification resulting from infringement claims) will not be asserted or prosecuted against the Company or that any such assertions or prosecutions will not materially adversely affect the Company's business, financial condition or results of operations. Irrespective of the validity or the successful assertion of such claims, the Company would incur significant costs and diversion of resources with respect to the defense thereof which could have a material adverse effect on the Company's business, financial condition or results of operations. In addition, the assertion of such infringement claims could result in injunctions preventing Netscape from distributing certain products, which could have a material adverse effect on the Company's business, financial condition or results of operations. If any claims or actions are asserted against the Company, the Company may seek to obtain a license under a third party's intellectual property rights. There can be no assurance, however, that under such circumstances, a license would be available on reasonable terms or at all.
The Company also relies on certain other technology which it licenses from third parties, including software which is integrated with internally developed software and used in the Company's products to perform key functions. There can be no assurance that these third party technology licenses will continue to be available to the Company on commercially reasonable terms. The loss of or inability to maintain any of these technology licenses could result in delays or reductions in product shipments until equivalent technology could be identified, licensed and integrated. Any such delays or reductions in product shipments could materially adversely affect the Company's business, operating results or financial condition. Moreover, although the Company is generally indemnified by the third parties against claims that the third parties' technology infringes the proprietary rights of others, such indemnification is not always available for all types of intellectual property rights (for example, patents may be excluded) and in some cases the geographical scope of such indemnification is limited. The result is that the indemnity that the Company receives against such claims is often less broad than the indemnity that the Company provides to its customers. Even in cases in which the indemnity that the Company receives from a third party licensor is as broad as the indemnity that the Company provides to its customers, often the third party licensors from whom the Company would be receiving indemnity are not well-capitalized and may not be able to indemnify the Company in the event that such third party technology infringes the proprietary rights of others. Accordingly, the Company could have substantial exposure in the event that technology licensed from a third party infringes another party's proprietary rights. The Company currently does not have any liability insurance to protect against the risk that licensed third party technology infringes the proprietary rights of others. There can be no assurance that infringement or invalidity claims arising from the
incorporation of third party technology, and claims for indemnification from the Company's customers resulting from such infringement claims will not be asserted or prosecuted against the Company or that any such assertions or prosecutions will not materially adversely affect the Company's business, financial condition or results of operations. Irrespective of the validity or successful assertion of such claims, the Company would incur significant costs and the diversion of resources with respect to the defense thereof, in addition to potential product redevelopment costs and delays, all of which could have a material adverse effect on the Company's business, financial condition or results of operations.
BUSINESS COMBINATIONS AND JOINT VENTURES
In April 1996, the Company entered into a business combination with InSoft, Inc. ("InSoft"), a privately-held company that provides network-based communications and collaborative multimedia software for the enterprise. Netscape purchased all of the outstanding capital stock and assumed all of the outstanding stock options of InSoft. The business combination was accounted for as a pooling of interests. In May 1996, the Company entered into a business combination with Paper Software, Inc. ("Paper Software"), a privately-held company that provides distributed three-dimensional graphics and is the maker of WebFX Virtual Reality Markup Language ("VRML") software. Netscape purchased all of the outstanding capital stock of Paper Software. The business combination was accounted for as a pooling of interests. In May 1996, the Company entered into a business combination with Netcode Corporation ("Netcode"), a privately-held company that created a Java-based object toolkit and visual interface builder for developing Java applications. Netscape purchased all of the outstanding capital stock and assumed all of the outstanding options of Netcode. The business combination was accounted for as a pooling of interests.
In April 1996, the Company entered into a joint venture with GE Information Services ("GEIS") to form Actra Business Systems L.L.C. that intends to develop and market software for Internet-based business-to-business electronic commerce. In August 1996, the Company entered into a joint venture called Navio Communications, Inc. ("Navio"), an independent Internet software company in which Netscape has an equity position. Navio plans to deliver core, scalable 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 will continue to consider business combinations, investments or strategic alliances that it believes can complement its overall business strategy. See "Factors Affecting the Company's Business, Operating Results and Financial Condition--Risks of Acquisitions and Investments."
EMPLOYEES
As of February 28, 1997, the Company had approximately 1,811 employees. The Company's future success depends in significant part upon the continued service of its key technical and senior management personnel and its continuing ability to attract and retain highly qualified technical and managerial personnel, especially software developers. Competition for highly qualified personnel is intense, and there can be no assurance that the Company will be able to retain its key managerial and technical employees or that it will be able to attract and retain additional highly qualified technical and managerial personnel in the future. None of the Company's employees is represented by a labor union. The Company has not experienced any work stoppages and considers its relations with its employees to be good.
The rapid execution necessary for the Company to fully exploit the market window for its products and services requires an effective planning and management process. The Company's rapid growth has placed, and its planned growth is expected to continue to place, a significant strain on the Company's managerial, operational and financial resources. As of February 28, 1997, the Company had grown to approximately 1,811 employees from approximately 203 employees on December 31, 1994. In addition, the Company has completed four acquisitions since November 1995; assimilating the operations and personnel
of such acquired companies has also placed a significant strain on the Company's managerial, operational and financial resources. To manage its growth, the Company must continue to implement and improve its operational and financial systems and to expand, train and manage its employee base. Further, the Company is required and will continue to be required to manage multiple relationships among various customers, suppliers, resellers, licensors, strategic partners and other third parties. Although the Company believes that it has made adequate allowances for the costs and risks associated with this expansion, there can be no assurance that the Company's systems, procedures or controls will be adequate to support the Company's current or future operations or that Company management will be able to effectively manage this expansion and still achieve the rapid execution necessary to fully exploit the market window for the Company's products and services in a timely and cost-effective manner. The Company's future operating results will also depend on its ability to manage its expanding product line, expand its sales and marketing organizations, implement and manage new distribution channels to penetrate different and broader markets, including the market for intranet software for the enterprise, and expand its support organization commensurate with the increasing base of its installed products. If the Company is unable to manage growth effectively or unable to achieve the rapid execution necessary to fully exploit the market window for the Company's products and services in a timely and cost-effective manner, the Company's business, operating results and financial condition will be materially adversely affected. See "Factors Affecting the Company's Business, Operating Results and Financial Condition--Management of Growth" and "-- Dependence on Key Personnel."
FACTORS AFFECTING THE COMPANY'S BUSINESS, OPERATING RESULTS AND FINANCIAL CONDITION
IN ADDITION TO OTHER INFORMATION IN THIS ANNUAL REPORT ON FORM 10-K AND IN THE DOCUMENTS INCORPORATED BY REFERENCE HEREIN, THE FOLLOWING RISK FACTORS SHOULD BE CAREFULLY CONSIDERED IN EVALUATING THE COMPANY AND ITS BUSINESS BECAUSE SUCH FACTORS CURRENTLY HAVE A SIGNIFICANT IMPACT OR MAY HAVE A SIGNIFICANT IMPACT IN THE COMPANY'S BUSINESS, OPERATING RESULTS OR FINANCIAL CONDITION. THE SECTION ENTITLED "BUSINESS--PLANNED PRODUCTS AND RELEASES" IN THIS FORM 10-K CONTAINS FORWARD-LOOKING STATEMENTS THAT HAVE BEEN MADE PURSUANT TO THE PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE PROJECTED IN THE FORWARD-LOOKING STATEMENTS AS A RESULT OF THE FOLLOWING RISK FACTORS SET FORTH BELOW AND ELSEWHERE IN THIS FORM 10-K, SPECIFICALLY THE RISK FACTORS ENTITLED "PRODUCT INTRODUCTIONS AND TRANSITIONS" AND "NEW PRODUCT DEVELOPMENT AND TECHNOLOGICAL CHANGE."
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 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.
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, results of operations and financial condition.
POTENTIAL FLUCTUATIONS IN QUARTERLY RESULTS
As a result of the Company's relatively limited operating history and recent "pooling of interests" acquisitions, the Company does not have relevant historical financial data for a significant number of periods on which to base planned operating expenses. Accordingly, the Company's expense levels, which are to a large extent fixed, are based in part on its expectations as to future revenues. In addition, the Company typically operates with minimal backlog, therefore, quarterly sales and operating results generally depend on the volume and timing of and ability to fulfill orders received within the quarter, which are difficult to forecast. The Company typically recognizes a substantial portion of its revenues in the last month of each quarter. Accordingly, the Company may be unable to adjust spending in a timely manner to compensate for any unexpected revenue shortfall. As a result, 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. Moreover, the Company (i) plans to continue to increase its operating expenses to fund greater levels of research and development, increase its sales and marketing operations, develop new distribution channels, improve its operational and financial systems and broaden its customer support capabilities and (ii) may continue to incur significant merger-related charges and other increases in operating expenses associated with recently completed and any future acquisitions. To the extent that such expenses precede or are not subsequently followed by increased revenues, the Company's business, operating results and financial condition will be materially adversely affected.
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, the timing of large sales (particularly to enterprise customers), more complex products with higher 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 particular, as the Company becomes increasingly focused on larger sales of intranet and messaging solutions to enterprise customers the Company believes that quarterly operating results may fluctuate due to the timing of revenue from such large sales. 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 pricing changes announced in February 1997 and October 1996) or enter into business combinations (such as the Collabra, InSoft, Netcode and Paper business combinations) that could have a material adverse effect on the Company's business, results of operations 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 upon 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.
COMPETITION
The market for software and services for intranets and the Internet is relatively new, intensely competitive, rapidly evolving 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 has bundled 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.
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 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 "--Product Introductions and Transitions."
NEED TO MANAGE EVOLVING MARKET AND PRODUCTS
The Company's software business initially was characterized by relatively short sales cycles, relatively small initial sales orders, relatively simple uses for its software, short product development cycles and low aggregate royalty payments to third parties for embedded technology. However, the Company has evolved and expanded its product lines, and, as the Company has increased its focus on sales to enterprise
customers, the Company's business has been, and, will continue to be, characterized by longer sales cycles, larger initial sales orders, more complex use of its software, longer product development cycles and higher aggregate royalty payments to third parties for embedded technology. For example, the Company's server product line has evolved from software products which merely enabled publication of HTML-based documents to SuiteSpot, an integrated suite of server products that address an array of complex information technology issues such as email, groupware, calendaring, security for internal information and online commerce, as well as information publication. Further, the Company now offers complex commercial application software to accompany its server and client software. Organizations which initially purchased Internet and intranet products for trial use are now building complex intranets. The Company expects that sales of its software will be increasingly made to enterprises, especially once Netscape SuiteSpot 3.0 and Netscape Communicator are commercially available, and that due to higher price points and more complex uses, these sales will require approval at the highest levels of the customer's organization. These sales are likely to be more difficult, expensive and time-consuming for the Company, and will require greater training of the Company's sales personnel and reseller partners. Further, these sales generally involve a significant commitment of capital by prospective customers, with the attendant delays frequently associated with large capital expenditures and lengthy acceptance procedures. For these and other reasons, the sales cycle associated with the license of the Company's software products has lengthened, may continue to lengthen and is subject to a number of significant risks over which the Company has little or no control. The Company has relatively limited experience with these types of sales, and there can be no assurance that the Company will be able to successfully manage this evolution in its business, and the failure to successfully manage this evolution in its business could have a material adverse effect on the Company's business, operating results and financial condition. "--Product Introductions and Transitions."
NEW PRODUCT DEVELOPMENT AND TECHNOLOGICAL CHANGE
Substantially all of the Company's revenues have been derived, and substantially all of the Company's future revenues are expected to be derived, from the license of its software and sale of associated services. Accordingly, broad acceptance of the Company's software products and services by customers is critical to the Company's future success. However, the markets for the Company's products are characterized by rapidly changing technology, evolving industry standards and frequent new product introductions; therefore, the Company's future success will depend on its ability to design, develop, test and support new software products and enhancements on a timely and cost-effective basis that meet changing customer needs and respond to technological developments and emerging industry standards. There can be no assurance that the Company will successfully identify new product opportunities and develop and bring new products, such as Netscape SuiteSpot 3.0 and Netscape Communicator, to market in a timely and cost-effective manner, or that products or technologies developed by others will not render the Company's products or technologies obsolete or noncompetitive. While the Company has addressed the need to develop new products and enhancements primarily through its internal development efforts, the Company has also addressed this need through acquisitions and the license of third party technology. Acquisitions involve numerous risks, including difficulties in the assimilation of the operations, technologies and products of the acquired companies, the diversion of management's attention from other business concerns, risks of entering markets in which the Company has no or limited direct prior experience and where competitors in such markets have stronger market positions, and the potential loss of key employees of the acquired company. Licensing of third party technology also involves numerous risks, including product liability claims based on licensed technology, liability for licensed technology which infringes the proprietary rights of others, the potential inability of third party licensors to indemnify the Company for intellectual property infringement claims, the risk that the scope of third party licensor indemnification is not as broad as the indemnification the Company provides to its customers, and the unavailability of similar technology on commercially reasonable terms in the event that the third party technology is unavailable. See "--Uncertain Protection of Intellectual Property; Unisys Patent Enforcement; Risks
Associated with Licensed Third Party Technology." The failure of the Company's new product development efforts, especially with respect to Netscape SuiteSpot 3.0 or Netscape Communicator, could have a material adverse effect on the Company's business, financial condition or results of operations. The Company's current products are designed around certain standards, including, for example, security standards, and current and future sales of the Company's products will be dependent, in part, on widespread adoption of such standards by enterprises, consumers, developers and other software providers. Widespread adoption of a standard not supported by Netscape could have a material adverse effect on the Company's business, operating results or financial condition. In addition, there can be no assurance that the Company will not experience difficulties that could delay or prevent the successful development, introduction and marketing of new products and enhancements, such as Netscape SuiteSpot 3.0 and Netscape Communicator, or that its new products and enhancements, including Netscape SuiteSpot 3.0 and Netscape Communicator, will adequately meet the requirements of the marketplace and achieve market acceptance. Further, because the Company has only recently commenced shipment of many of its products, there can be no assurance that, despite testing by the Company and by current and potential customers, errors will not be found in the Company's products, or, if discovered, successfully corrected in a timely and cost-effective manner. If the Company is unable to develop on a timely and cost-effective basis new software products, enhancements to existing products or error corrections, or if such new products or enhancements do not achieve market acceptance, the Company's business, operating results and financial condition will be materially adversely affected. See "Planned Products and Releases, "Products," "Product Introductions and Transitions," and "Research and Development."
DEVELOPING MARKET; NEW ENTRANTS; UNCERTAIN ACCEPTANCE OF THE COMPANY'S PRODUCTS; PRICE EROSION; UNCERTAIN ADOPTION OF INTERNET AND INTRANETS AS A MEDIUM OF COMMERCE AND COMMUNICATIONS
The market for the Company's software and services, especially for its intranet products and services such as Netscape SuiteSpot 3.0 and Netscape Communicator, is relatively new, is rapidly evolving and is characterized by an increasing number of market entrants who have introduced or developed products and services for communication and commerce over the Internet and intranets. As is typical in the case of a new and rapidly evolving industry, demand and market acceptance for recently introduced products and services are subject to a high level of uncertainty. The industry is relatively young and has a limited number of proven products. Moreover, critical issues concerning the use of intranets and of the Internet (including security, reliability, cost, ease of deployment and administration and quality of service) remain unresolved and may impact the growth of intranet and Internet use. While the Company believes that its software products offer significant advantages for commerce, collaboration and communication over the Internet and intranets, there can be no assurance that commerce, collaboration and communication over the Internet or intranets will become widespread, or that the Company's products for commerce, collaboration and communication over the Internet or intranets will become widely adopted for these purposes.
In particular, the Company's client software competes with free client software distributed by online service providers, Internet access providers and others. In addition, computer operating systems companies, notably Microsoft, bundle client software with their operating systems at little or no additional cost to users, which may cause the price of the Company's client products to decline. The Company announced significant price reductions in its server product line during the quarter ended December 31, 1995 and announced further price reductions in its server product line in March 1996. See "--Competition." Moreover, continued market acceptance of the Company's server and commercial applications software products is substantially dependent upon the adoption of the Internet and intranets for commerce, collaboration and communications. The adoption of the Internet or intranets for commerce, collaboration and communications, particularly by those individuals and enterprises which have historically relied upon alternative means of commerce, collaboration and communication, generally requires the acceptance of a new way of conducting business and exchanging, collaborating information. In particular, enterprises that have already invested substantial resources in other means of conducting commerce collaboration and exchanging information may be particularly reluctant or slow to adopt a new strategy that may make some
or all of their existing information systems technology, software and systems obsolete. In addition, there can be no assurance that individual PC users in business or at home will adopt or, if adopted, continue to use the Internet or intranets for online commerce, collaboration or communication.
Because the market for the Company's products and services, especially its intranet products and services such as Netscape SuiteSpot 3.0 and Netscape Communicator, is relatively new and evolving, it is difficult to predict the future growth rate, if any, and size of this market. There can be no assurance that the market for the Company's products and services will continue to develop, that the Company's new products or services, especially its intranet products and services such as Netscape SuiteSpot 3.0 and Netscape Communicator, will be adopted or that existing products and services will continue to be adopted, or that the Internet or intranets will be widely adopted for commerce, collaboration and communication. If the market for the Company's products fails to continue to develop, develops more slowly than expected or becomes saturated with competitors, or if the Company's new products and services, especially its intranet products and services such as Netscape SuiteSpot 3.0 and Netscape Communicator, do not achieve market acceptance, the Company's business, operating results and financial condition will be materially adversely affected.
MANAGEMENT OF GROWTH
The rapid execution necessary for the Company to fully exploit the market window for its products and services requires an effective planning and management process. The Company's rapid growth has placed, and its planned growth is expected to continue to place, a significant strain on the Company's managerial, operational and financial resources. As of February 28, 1997, the Company had grown to approximately 1,811 employees from approximately 203 employees on December 31, 1994. In addition, the Company has completed four acquisitions since November 1995; assimilating the operations and personnel of such acquired companies has also placed a significant strain on the Company's managerial, operational and financial resources. To manage its growth, the Company must continue to implement and improve its operational and financial systems and to expand, train and manage its employee base. Further, the Company is required and will continue to be required to manage multiple relationships among various customers, suppliers, resellers, licensors, strategic partners and other third parties. Although the Company believes that it has made adequate allowances for the costs and risks associated with this expansion, there can be no assurance that the Company's systems, procedures or controls will be adequate to support the Company's current or future operations or that Company management will be able to effectively manage this expansion and still achieve the rapid execution necessary to fully exploit the market window for the Company's products and services in a timely and cost-effective manner. The Company's future operating results will also depend on its ability to manage its expanding product line, expand its sales and marketing organizations, implement and manage new distribution channels to penetrate different and broader markets, including the market for intranet software for the enterprise, and expand its support organization commensurate with the increasing base of its installed products. If the Company is unable to manage growth effectively or unable to achieve the rapid execution necessary to fully exploit the market window for the Company's products and services in a timely and cost-effective manner, the Company's business, operating results and financial condition will be materially adversely affected. See "Employees."
RISKS OF ACQUISITIONS AND INVESTMENTS
In 1996, the Company completed business combinations with InSoft, Paper Software and Netcode and incurred an aggregate of $6.1 million in acquisition and related costs. In addition, in 1996, the Company formed two joint ventures and made several equity investments in companies with complementary technology. In March 1997, the Company entered into an agreement to enter into a joint venture with Novell, subject to required governmental approvals, to deliver a broad range of intranet solutions on current and future Novell platforms. As part of its overall strategy, the Company plans to enter into further
business combinations and make significant investments in complementary companies, products or technologies and to enter into joint ventures and strategic alliances with other companies. Any such transactions would be accompanied by the risks commonly encountered in such transactions. In particular, business combinations with high technology companies include such risks as the difficulty of assimilating the operations and personnel of the combined companies, the potential disruption of the Company's ongoing business, the inability to retain key technical and managerial personnel, the inability of management to maximize the financial and strategic position of the Company through the successful integration of acquired businesses, additional expenses associated with amortization of acquired intangible assets, the maintenance of uniform standards, controls, procedures and policies and the impairment of relationships with employees and customers as a result of any integration of new personnel. There can be no assurance that the Company would be successful in overcoming these risks or any other problems encountered in connection with such business combinations, investments or joint ventures or that such transactions will not materially adversely affect the Company's business, financial condition or results of operations.
LIMITED OPERATING HISTORY; ACCUMULATED DEFICIT
The Company was incorporated in April 1994, and, although the Company has acquired a number of companies which were incorporated prior to that time, the Company only commenced shipment of its products for intranets and the Internet in December 1994. Accordingly, the Company has a relatively limited operating history upon which an evaluation of the Company and its prospects can be based. The Company's prospects must be considered in light of the risks, expenses and difficulties frequently encountered by companies in their earlier stages of development, particularly companies in new and rapidly evolving markets. To address these risks, the Company must, among other things, respond to competitive developments, continue to attract, retain and motivate qualified persons, expand its management processes and capabilities and continue to upgrade its technologies and successfully commercialize products and services incorporating such technologies. There can be no assurance that the Company will be successful in addressing such risks. As of December 31, 1996, the Company had an accumulated deficit of $2.2 million. Although the Company has experienced revenue growth in recent periods, historical growth rates will not be sustained and are not indicative of future operating results. There can be no assurance that the Company will sustain profitability.
EVOLVING DISTRIBUTION CHANNELS
The Company sells its products directly to end-users and via the Internet. In addition, the Company offers its products indirectly through OEMs, VARs and software retailers. The Company is currently pursuing a strategy which is intended to increase sales through OEMs, VARs and system integrators as a percentage of total revenues, especially in international markets. The Company expects that any material increase in sales through Resellers as a percentage of total revenues, especially any increase in the percentage of sales through OEMs, VARs and system integrators, will adversely affect the Company's average selling prices and gross margins due to the lower unit prices that are typically charged when selling through indirect channels. In recent quarters, sales through indirect channels have increased as a percentage of total revenues, which has adversely impacted average selling prices; however, gross margins to date have not decreased due to the large percentage of sales through OEMs, which have lower associated costs of revenues than other Resellers due to the absence of packaging costs. Other potential adverse consequences of the Company's focus on increasing sales through Resellers are the diversion of management resources and attention from direct sales, which could adversely affect direct sales revenue and sales of Netscape SuiteSpot 3.0 and Netscape Communicator (a large percentage of which are expected to be made through direct sales due to the nature of the sale), and greater revenue fluctuation due to a greater percentage of retail revenue, which tends to fluctuate with product releases and may be subject to seasonality. Moreover, there can be no assurance that the Company will be able to continue to attract and retain Resellers that will be able to market the Company's products effectively, particularly
Resellers of intranet software for the enterprise, such as Netscape SuiteSpot 3.0 and Netscape Communicator, and will be qualified to provide timely and cost-effective customer support and service. There also can be no assurance that the Company will be able to manage conflicts among its Resellers. In addition, the Company's agreements with Resellers typically do not restrict Resellers from distributing competing products, and in many cases may be terminated by either party without cause. Further, in some cases the Company has granted exclusive distribution rights that are limited by territory and in duration. Consequently, the Company may be adversely affected should any Reseller fail to adequately penetrate its market segment. The inability to recruit, manage, educate or retain important Resellers, particularly Resellers of intranet software for the enterprise, such as Netscape SuiteSpot 3.0 and Netscape Communicator, or their inability to penetrate their respective market segments, could materially adversely affect the Company's business, operating results or financial condition. See "Marketing and Distribution."
In addition to expanding its direct sales channels, the Company will continue to distribute its products electronically through the Internet. Distributing the Company's products through the Internet makes the Company's software more susceptible than other software to unauthorized copying and use. The Company has historically allowed and currently intends to continue to allow potential customers to electronically download its client and server software for a free evaluation period. There can be no assurance that, upon expiration of the evaluation period, the Company will be able to collect payment from users that retain a copy of the Company's software. In addition, by distributing its products for free evaluation over the Internet, the Company may have reduced the future demand for its products. If, as a result of changing legal interpretations of liability for unauthorized use of the Company's software or otherwise, users were to become less sensitive to avoiding copyright infringement, the Company's business, operating results and financial condition would be materially adversely affected.
SECURITY RISKS AND SYSTEM DISRUPTIONS; LACK OF PRODUCT LIABILITY INSURANCE FOR PRODUCTS INCORPORATING SECURITY FEATURES
The Company has included in its products security protocols which operate in conjunction with encryption and authentication technology licensed from RSA Data Security Inc. ("RSA"). Despite the existence of these technologies, the Company's products have been found to be vulnerable to break-ins and similar disruptive problems caused by Internet users. In the last two years, there have been several instances in which weaknesses or vulnerabilities in the Company's security implementation were discovered. In each instance in which a vulnerability or weakness was discovered and verified in the Company's security implementation, the Company attempted to address the vulnerability or weakness by making the various design changes in its security and reviewing those changes both internally and with a broad set of outside industry experts. The design changes appear to have resolved known security vulnerabilities and weaknesses in the Company's products.
In addition, the Company's products incorporate technology from other software companies which could be vulnerable to security flaws. For example, in March 1996 certain security flaws were discovered in the Java programming language; in particular, one security flaw was discovered which could have jeopardized the security of information stored in the computer of Netscape Navigator users. Sun, the licensor of Java, has corrected this particular security flaw and has distributed the software fix to the Company. However, there can be no assurance that the Company's products will not be susceptible to other security flaws, whether in the Company's products or technologies, in Java or in other technology incorporated into the Company's products.
Despite the Company's attempts to address the vulnerabilities and weaknesses in its security implementation, the Company's products and licensed technology incorporated in such products may continue to be vulnerable to break-ins and similar disruptive problems caused by Internet users. Further, as is generally known, weaknesses in the environment in which Netscape products are used may compromise the security of confidential electronic information exchanges across the Internet. This includes, but is not limited to, the security of the physical network, security of the physical machines used for the information
transfer and the security of the operating system on top of which the Netscape products are running. Any such flaws in the Internet or the end-user environment, or weaknesses or vulnerabilities in the Company's products or licensed technology incorporated in such products, would jeopardize the security of confidential information sent over the Internet using Netscape software, such as credit card numbers and email, and might enable others to dismantle the special security techniques meant to protect such transactions.
Any further computer break-ins or other disruptions could jeopardize the security of information stored in and transmitted through the computer systems of end-users of the Company's products, which may result in significant liability to the Company and may also deter potential customers. Moreover, the security and privacy concerns of existing and potential customers, as well as concerns related to computer viruses, may inhibit the growth of the Internet and intranet market generally, and the Company's customer base and revenues in particular. The Company attempts to limit its liability to its customers, including liability arising from failure of the security implementation contained in the Company's products, through contractual provisions. However, there can be no assurance that such limitations will be effective. The Company currently does not have product liability insurance to protect against risks associated with forced break-ins or disruptions. There can be no assurance that additional security vulnerabilities and weaknesses will not be discovered in the Company's products or licensed technology incorporated in such products or that weaknesses in the end-user environments will not limit the use of the Internet as a commercial medium. Any additional security related problems in the Company's products or licensed technology incorporated in such products may require significant expenditures of capital and resources by the Company to alleviate such problems, may result in lawsuits against the Company, may result in loss of customers and may cause interruptions, delays or cessations of product shipments to the Company's customers. Any such expenditures, lawsuits, loss of customers, interruptions, cessations or delays would likely have a material adverse effect on the Company's business, operating results and financial condition.
GOVERNMENT REGULATION AND LEGAL UNCERTAINTIES
The Company is not currently subject to direct government regulation, other than pursuant to securities laws and the regulations thereunder applicable to all publicly owned companies and laws and regulations applicable to businesses generally, and there are currently few laws or regulations directly applicable to access to or commerce on the Internet. However, due to the increasing popularity and use of the Internet, it is likely that a number of laws and regulations may be adopted at the local, state, national or international levels with respect to the Internet, covering issues such as user privacy and expression, pricing of products and services, taxation, advertising, intellectual property rights, information security or the convergence of traditional communication services with Internet communications. For example, the Telecommunications Reform Act of 1996 (the constitutionality of which is currently under challenge) was recently enacted and imposes criminal penalties (via the Communications Decency Act or "CDA") on anyone who distributes obscene, lascivious or indecent communications over the Internet. Moreover, the adoption of any such laws or regulations may decrease the growth of the Internet, which could in turn decrease the demand for the Company's products or increase the Company's cost of doing business or in some other manner have a material adverse effect on the Company's business, operating results or financial condition. In addition, the applicability to the Internet of existing laws governing issues such as property ownership, copyrights and other intellectual property issues, taxation, libel and personal privacy is uncertain. The vast majority of such laws were adopted prior to the advent of the Internet and related technologies and, as a result, do not contemplate or address the unique issues of the Internet and related technologies. Changes to such laws intended to address these issues, including some recently proposed changes, could create uncertainty in the marketplace which could reduce demand for the Company's products, could increase the Company's cost of doing business as a result of costs of litigation or increased product development costs, or could in some other manner have a material adverse effect on the Company's business, operating results or financial condition.
Because the encryption technology contained in the Company's products is deemed to be a "munition," such products are subject to U.S. export controls pertaining to munitions. There can be no assurance
that such export controls, either in their current form or as may be subsequently revised, will not limit the Company's ability to distribute certain encrypted products outside of the United States or electronically. While Netscape takes precautions against unlawful exportation, such exportation may occur from time to time. In addition, federal or state legislation or regulation may further limit levels of encryption or authentication technology, and foreign governments could enact import laws or regulations that may restrict the type of encryption software that is permitted for distribution in their countries. Moreover, as a consequence of such export controls, Netscape must develop and market both domestic and international versions of its products that contain encryption software, with the version for the U.S. market having a stronger level of encryption than the version for export to international markets. Along with the additional costs associated with the duplication of effort and expense in research, development, manufacturing and distribution of different versions of products, the Company may lose sales from customers who wish to have the same level of encryption security throughout their organization. The Company may also encounter difficulties competing overseas with competitors that are subject to less restrictive controls. Finally, due to the weaker level of encryption contained in the Company's products shipped internationally, the Company may not acquire the installed international base necessary to make the functionality of its products part of an international standard.
Additionally, some countries have enacted import laws requiring the alteration of the Company's products in order for the government of such countries to maintain a level of control over the content of products entering such countries. In addition to the costs incurred by the Company in complying with varying international regulations, alteration of the Company's products may cause such products to perform at a level below their intended level and thereby subject the Company to potential liability and other adverse consequences. Any such export restrictions, import restrictions, new legislation or regulation or unlawful exportation could have a material adverse impact on the Company's business, operating results or financial condition. See "Marketing and Distribution--International."
UNCERTAIN PROTECTION OF INTELLECTUAL PROPERTY; UNISYS PATENT ENFORCEMENT; RISKS ASSOCIATED WITH LICENSED THIRD PARTY TECHNOLOGY
The Company's success and ability to compete is dependent in part upon its internally developed technology. While the Company relies on patents, trademark, trade secret and copyright law to protect its technology, the Company believes that factors such as the technological and creative skills of its personnel, new product developments, frequent product enhancements, name recognition and reliable product maintenance are more essential to establishing and maintaining a technology leadership position. There can be no assurance that others will not develop technologies that are similar or superior to the Company's technology. The Company generally enters into confidentiality or license agreements with its employees, consultants and vendors, and generally controls access to and distribution of its software, documentation and other proprietary information. Despite these precautions, it may be possible for a third party to copy or otherwise obtain and use the Company's products or technology without authorization, or to develop similar technology independently. In addition, effective patents, copyright and trade secret protection may be unavailable or limited in certain foreign countries. To license its products, the Company relies in part on "shrink wrap" licenses that are not signed by the end-user and, therefore, may be unenforceable under the laws of certain jurisdictions. Despite the Company's efforts to protect its proprietary rights, unauthorized parties may attempt to copy aspects of the Company's products or to obtain and use information that the Company regards as proprietary. Policing unauthorized use of the Company's products is difficult. There can be no assurance that the steps taken by the Company will prevent misappropriation of its technology or that such agreements will be enforceable. In addition, litigation may be necessary in the future to enforce the Company's intellectual property rights, to protect the Company's trade secrets, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. Such litigation could result in substantial costs and diversion of resources and could have a material adverse effect on the Company's business, operating results or financial condition.
Unisys Corporation ("Unisys") has announced its intention to require the payment of royalties for the use of compression technology associated with the Graphics Interchange Format ("GIF"). Unisys asserts that this popular file format is based on compression technology patented by Unisys. The Company's products have the ability to decompress files, including files stored in GIF. The Company and, to the Company's knowledge, other licensees, have received notice of Unisys' intention to enforce or license such patent. The Company could incur additional costs and liability should its products be found to be within the scope of the Unisys patent, including costs and liability from claims for indemnification resulting from infringement. The assertion of these patent rights by Unisys, if successful, could prevent the Company's products from enabling users to view files compressed in GIF. The Company does not believe its products infringe the Unisys patent; however, there can be no assurance that the Company's products are not within the scope of the Unisys patent or that the Company's business, operating results and financial condition will not be materially adversely affected if the Company's products are found to be within the scope of the Unisys patent.
From time to time the Company has, in addition to the notice from Unisys, received, and may receive in the future, notice of claims of infringement of other parties' proprietary rights. Although the Company does not believe that its products infringe the proprietary rights of any third parties, there can be no assurance that infringement or invalidity claims (or claims for indemnification resulting from infringement claims) will not be asserted or prosecuted against the Company or that any such assertions or prosecutions will not materially adversely affect the Company's business, financial condition or results of operations. Irrespective of the validity or the successful assertion of such claims, the Company would incur significant costs and diversion of resources with respect to the defense thereof which could have a material adverse effect on the Company's business, financial condition or results of operations. In addition, the assertion of such infringement claims could result in injunctions preventing Netscape from distributing certain products, which could have a material adverse effect on the Company's business, financial condition or results of operations. If any claims or actions are asserted against the Company, the Company may seek to obtain a license under a third party's intellectual property rights. There can be no assurance, however, that under such circumstances, a license would be available on reasonable terms or at all.
The Company also relies on certain other technology which it licenses from third parties, including software which is integrated with internally developed software and used in the Company's products to perform key functions. There can be no assurance that these third party technology licenses will continue to be available to the Company on commercially reasonable terms. The loss of or inability to maintain any of these technology licenses could result in delays or reductions in product shipments until equivalent technology could be identified, licensed and integrated. Any such delays or reductions in product shipments could materially adversely affect the Company's business, operating results or financial condition. Moreover, although the Company is generally indemnified by the third parties against claims that the third parties' technology infringes the proprietary rights of others, such indemnification is not always available for all types of intellectual property rights (for example, patents may be excluded) and in some cases the geographical scope of such indemnification is limited. The result is that the indemnity that the Company receives against such claims is often less broad than the indemnity that the Company provides to its customers. Even in cases in which the indemnity that the Company receives from a third party licensor is as broad as the indemnity that the Company provides to its customers, often the third party licensors from whom the Company would be receiving indemnity are not well-capitalized and may not be able to indemnify the Company in the event that such third party technology infringes the proprietary rights of others. Accordingly, the Company could have substantial exposure in the event that technology licensed from a third party infringes another party's proprietary rights. The Company currently does not have any liability insurance to protect against the risk that licensed third party technology infringes the proprietary rights of others. There can be no assurance that infringement or invalidity claims arising from the incorporation of third party technology, and claims for indemnification from the Company's customers resulting from such infringement claims will not be asserted or prosecuted against the Company or that any such assertions or prosecutions will not materially adversely affect the Company's business, financial
condition or results of operations. Irrespective of the validity or successful assertion of such claims, the Company would incur significant costs and the diversion of resources with respect to the defense thereof, in addition to potential product redevelopment costs and delays, all of which could have a material adverse effect on the Company's business, financial condition or results of operations. See "Proprietary Rights."
DEPENDENCE ON KEY PERSONNEL
The Company's performance is substantially dependent on the performance of its executive officers and key employees, some of whom have worked together for only a short period of time. Given the Company's relatively early stage of development, the Company is dependent on its ability to retain and motivate highly qualified personnel, especially its management and highly skilled development teams. The Company does not have "key person" life insurance policies on any of its employees. The loss of the services of any of its executive officers or other key employees could have a material adverse effect on the business, operating results or financial condition of the Company.
The Company's future success also depends on its continuing ability to identify, hire, train and retain other highly qualified technical and managerial personnel, especially software developers. Competition for such personnel is intense, and there can be no assurance that the Company will be able to attract, assimilate or retain other highly qualified technical and managerial personnel in the future. The inability to attract and retain the necessary technical and managerial personnel could have a material adverse effect on the Company's business, operating results or financial condition. See "Employees."
RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS AND EXPANSION
International revenues (sales outside of North America) were approximately 17.2% and 29.3% of total revenues for the years ended December 31, 1995 and 1996, respectively. A key component of the Company's strategy is its continued expansion into international markets. To date, the Company has only limited experience in developing localized versions of its products and marketing and distributing its products internationally, and the Company is currently incurring, and expects to continue to incur, significant costs in developing, marketing and distributing localized versions. If the international revenues are not adequate to offset the expense of establishing and maintaining foreign operations and the costs of localizing the Company's products, the Company's business, operating results or financial condition could be materially adversely affected. There can be no assurance that the Company will be able to successfully market, sell and deliver its products in foreign markets. In addition to the uncertainty as to the Company's ability to continue to generate revenues from its foreign operations and expand its international presence, there are certain risks inherent in doing business on an international level, such as unexpected changes in regulatory requirements, export and import restrictions, export and import controls relating to encryption technology, tariffs and other trade barriers, difficulties in staffing and managing foreign operations, longer payment cycles, problems in collecting accounts receivable, political instability, fluctuations in currency exchange rates, software piracy, seasonal reductions in business activity during the summer months in Europe and certain other parts of the world and potentially adverse tax consequences, which could adversely impact the success of the Company's international operations. There can be no assurance that one or more of such factors will not have a material adverse effect on the Company's future international operations and, consequently, on the Company's business, operating results and financial condition. See "Marketing and Distribution--International."
DEPENDENCE ON THE INTERNET
Although some sales of the Company's products will depend upon growth of intranets, sales of the Company's products will continue to depend in large part upon a robust industry and infrastructure for providing Internet access and carrying Internet traffic. The Internet may not prove to be a viable commercial marketplace because of inadequate development of the necessary infrastructure (e.g., reliable network backbone), untimely development of complementary products (e.g., high speed modems), delays
in the development or adoption of new standards and protocols required to handle increased levels of Internet activity, or due to increased government regulation. In addition, to the extent that the Internet continues to experience significant growth in the number of users and the level of use, there can be no assurance that the Internet infrastructure will continue to be able to support the demands placed on it by such potential growth. Because global commerce and online exchange of information on the Internet and other similar open wide area networks are new and evolving, it is difficult to predict with any assurance whether the Internet will prove to be a viable commercial marketplace. If the necessary infrastructure or complementary products are not developed, or if the Internet does not become a viable commercial marketplace, the Company's business, operating results and financial condition will be materially adversely affected.
ITEM 2.
ITEM 2. PROPERTIES.
The Company leases and occupies various facilities in Mountain View, California, which provide for approximately 500,000 square feet of office space and contain the Company's principal executive, administrative, engineering, sales, marketing, customer support and research and development functions. Such leases expire at various dates ranging from 1999 through 2006. The Company has executed leases for an additional 800,000 square feet in Mountain View and Sunnyvale, California beginning in 1997 and 1998 and expiring at various times through 2013 for general corporate use. The Company believes that its existing facilities and facilities subject to lease will be adequate until 1999 and that sufficient additional space will be available as needed thereafter. The Company also has short-term operating leases for sales offices in North America, Europe, Asia and Australia.
In addition, the Company maintains secure computers which contain confidential information of the Company and its customers. The Company's operations are dependent in part upon its ability to protect its internal network infrastructure against damage from physical break-ins, natural disasters, operational disruptions and other events. Physical break-ins could result in the theft or loss of confidential or critical business information of the Company or its customers. Any such break-in or damage or failure that causes interruptions in the Company's operations could materially adversely affect the Company's business, operating results or financial condition.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
The Company is subject to various legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business. While the outcome of these claims cannot be predicted with certainty, management does not believe that the outcome of any of these legal matters will have a material adverse effect on the Company's business, operating results or financial condition.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of security holders during the fourth quarter of 1996.
EXECUTIVE OFFICERS OF THE COMPANY
The executive officers of the Company and their ages as of March 17, 1997 are as follows:
The Company's executive officers are appointed by, and serve at the discretion of, the Board of Directors. Each executive officer is a full time employee of the Company. There is no family relationship between any executive officer or director of the Company.
Dr. Clark co-founded the Company in April 1994 and serves as its Chairman of the Board. From inception of the Company to January 1995, Dr. Clark served as the President and Chief Executive Officer of the Company. From 1981 to 1994, Dr. Clark was Chairman of the Board of Directors of Silicon Graphics, a computer systems company he founded in 1981. Dr. Clark also served as Chief Technical Officer of Silicon Graphics from 1981 to 1987. Prior to founding Silicon Graphics, Dr. Clark was an associate professor at Stanford University. Dr. Clark holds a Ph.D. from the University of Utah and an M.S. and a B.S. from the University of New Orleans.
Mr. Barksdale joined the Company in January 1995 as President and Chief Executive Officer. He has served as a director of the Company since October 1994. From January 1992 to January 1995, Mr. Barksdale served as President and Chief Operating Officer, and, as of September 1994, Chief Executive Officer, of AT&T Wireless Services (formerly, McCaw Cellular Communications, Inc. (collectively, "McCaw")), a cellular telecommunications company. From April 1983 to January 1992, Mr. Barksdale served as Executive Vice President and Chief Operating Officer of Federal Express Corporation ("Federal Express"), an express package delivery company. From 1979 to 1983, Mr. Barksdale served as Chief Information Officer of Federal Express. Mr. Barksdale also held various management positions, including Chief Information Officer, with Cook Industries Inc., during the mid-1970s and was employed by IBM from 1965 to 1972. He holds a B.A. from the University of Mississippi. Mr. Barksdale serves as a director of 3Com Corporation, Harrah's Entertainment, Inc., Robert Mondavi Corp. and @Home Corporation.
Mr. Andreessen co-founded the Company in April 1994. He currently serves as Senior Vice President, Technology and has been a director of the Company since September 1994. He received a B.S. from the University of Illinois in December 1993, where he co-authored the original NCSA Mosaic Web browser.
Ms. Bergin joined the Company in November 1995 as Vice President and Corporate Controller and was elected to Vice President, Finance and Corporate Controller in January 1997. From November 1991 to November 1995, Ms. Bergin served as Vice President, Finance and Corporate Controller of Frame Technology Corporation, a document publishing software firm. Prior to that time, she served as Corporate Controller of Boole & Babbage, Inc., a mainframe performance software company for five years. Ms. Bergin holds a B.A. from Santa Clara University.
Mr. Currie joined the Company as Vice President and Chief Financial Officer in April 1995 and was elected to Senior Vice President in January 1996. From April 1989 to March 1995, Mr. Currie held various management positions at McCaw, including Executive Vice President and Chief Financial Officer, and as of February 1993, Executive Vice President of Corporate Development. From 1982 to 1989, he held various positions at Morgan Stanley & Co. Incorporated. Mr. Currie holds an M.B.A. from Stanford University and a B.A. from Williams College.
Mr. Geisel joined the Company in March 1996 as Senior Vice President, Information Systems and Chief Information Officer. From June 1994 to March 1996, Mr. Geisel served as Executive Vice President, Global Solutions Delivery for Xerox Corporation, an office equipment company. From May 1993 to June 1994, Mr. Geisel was a consultant. From September 1992 to June 1993, Mr. Geisel served as President and Chief Executive Officer of White Pine Software, Inc., a desktop connectivity software company. From February 1987 to September 1992, Mr. Geisel was President and Chief Executive Officer of IIS Inc., a software, systems and information services firm he founded in 1987. Mr. Geisel holds an M.S.E. and a B.S.E. from Arizona State University.
Mr. Hahn joined the Company in November 1995 as Vice President, Enterprise Technology, in connection with the Company's acquisition of Collabra Software, Inc., a collaborative computing software company, where Mr. Hahn served as President and Chief Executive Officer from February 1993 to November 1995. Mr. Hahn was elected to Senior Vice President in January 1996 and in October 1996 was elected Senior Vice President and General Manager of the Server Product Division. From September 1992 to February 1993, Mr. Hahn was employed by Merrill, Pickard, Anderson & Eyre, a venture capital firm. From June 1990 to August 1992, he served as Vice President, General Manager of the cc:Mail Division of Lotus Development Corporation, now a subsidiary of IBM. Prior to that time, he served as Vice President and General Manager, Server Products Division at Convergent Technologies/Unysis Corporation. Mr. Hahn holds a B.S. from the Worcester Polytechnic Institute.
Mr. Homer joined the Company in October 1994 as Vice President, Marketing and was elected to Senior Vice President in January 1996. From April 1994 to October 1994, Mr. Homer was a consultant. From August 1993 to April 1994, Mr. Homer served as Vice President, Engineering at EO Corporation, a handheld computer manufacturer, and from July 1991 to July 1993, Mr. Homer was Vice President, Marketing of GO Corporation, a pen-based software company. He had previously been Director of Product Marketing of Apple, where he held various technical and marketing positions from 1982 through 1991. Mr. Homer holds a B.S. from the University of California, Berkeley.
Ms. Katz joined the Company in May 1995 as Vice President, General Counsel and Secretary and was elected to Senior Vice President in January 1996. From March 1993 until joining the Company, Ms. Katz served as Senior Vice President and General Counsel of McCaw. In addition, from March 1992 until joining the Company, Ms. Katz served as Senior Vice President and General Counsel of LIN Broadcasting Corporation, a subsidiary of McCaw. Prior to March 1992, Ms. Katz was in private legal practice, most recently as a partner in the law firm of Heller, Ehrman, White & McAuliffe. Ms. Katz is a Fellow of the Discovery Institute and serves as a member of the Board of Directors of the Software Publishers
Association. Ms. Katz holds a J.D. from the University of Washington School of Law, a Ph.D. from Columbia University, an M.A. from New York University and a B.A. from Stanford University.
Ms. Malefyt joined the Company in December 1994 as Vice President, Human Resources and was elected to Senior Vice President in January 1996. From May 1988 to December 1994, Ms. Malefyt served as a Director, Human Resources at Silicon Graphics. Prior to that time, she served as Vice President, Human Resources at ISI. Ms. Malefyt holds an M.S. from Antioch University and a B.A. from Harding University.
Mr. Rulon-Miller joined the Company in October 1994 as Vice President, Sales and Field Operations and was elected to Senior Vice President in January 1996. From December 1992 to October 1994, Mr. Rulon-Miller was President and Chief Executive Officer of Software Alliance Corp., a software company and a subsidiary of Teknekron Communications Systems Inc. From October 1986 to December 1992, he served as Vice President, Sales, of North American Operations of NeXT Software, Inc., a software company. Mr. Rulon-Miller has previously held management positions at Tandem Computers, Inc., American Express Company and IBM. Mr. Rulon-Miller holds a B.A. from Princeton University.
Dr. Schell joined the Company in October 1994 as Vice President, Engineering and was elected to Senior Vice President in January 1996. In October 1996, Dr. Schell was elected to the position of Senior Vice President and General Manager of the Client Product Division. From January 1993 to October 1994, Dr. Schell was employed by Symantec Corporation, a software company, most recently as Vice President/ General Manager of the Central Point Division (formerly Central Point Software, Inc.). From March 1989 to December 1992, he served as Vice President, Languages and dBase at Borland International, a database software company. Prior to that time, Dr. Schell held various management positions at Sun and Intel Corporation. Dr. Schell holds a Ph.D., an M.S. and a B.A. from the University of Illinois.
Mr. Sha joined the Company in August 1994 as Vice President and General Manager, Integrated Applications and was elected to Senior Vice President in January 1996. From June 1990 to August 1994, Mr. Sha served as Vice President, Unix Division at Oracle, a database software company. From June 1986 to June 1990, he served as Vice President/General Manager, Advanced Systems Division at Wyse Technology, Inc. Mr. Sha holds an M.S.E.E. from the University of California, Berkeley, an M.B.A. from Santa Clara University and a B.S.E.E. from National Taiwan University.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company made its initial public offering on August 8, 1995 at a price of $14.00 per share (as adjusted to reflect a two-for-one stock split effective January 1996). The Company's common stock is listed on the Nasdaq National Market under the symbol "NSCP." The following table sets forth the high and low sale prices per share of the Company's common stock for the periods indicated, as adjusted to reflect the two-for-one stock split.
As of March 17, 1997, there were 2,468 holders of record of the Company's common stock. Because many of the Company's shares of common stock are held by brokers and other institutions on behalf of stockholders, the Company is unable to estimate the total number of stockholders represented by these record holders. The Company has never declared or paid any cash dividends on its common stock. Since the Company currently intends to retain all future earnings to finance future growth, it does not anticipate paying any cash dividends in the foreseeable future.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
The information required by this item is incorporated by reference to the section entitled "Selected Consolidated Financial Data" in the Company's 1996 Annual Report to Stockholders.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The information required by this item is incorporated by reference to the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company's 1996 Annual Report to Stockholders.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The information required by this item is incorporated by reference to the Consolidated Financial Statements, and the related notes thereto, Report of Independent Auditors and the Supplementary Quarterly Consolidated Financial Data in the Company's 1996 Annual Report to Stockholders.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
Not applicable.
With the exception of the information specifically incorporated by reference from the 1996 Annual Report to Stockholders in Parts II and IV of this Form 10-K, the Company's 1996 Annual Report to Stockholders is not to be deemed filed as part of this Form 10-K.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY.
The information required by this item concerning the Company's directors is incorporated by reference to the information set forth in the sections entitled "Proposal One--Election of Directors" and "Compliance with Section 16(a) of the Exchange Act" in the Company's Proxy Statement for the 1997 Annual Meeting of Stockholders to be filed with the Commission within 120 days after the end of the Company's fiscal year ended December 31, 1996, except that the information required by this item concerning the executive officers of the Company is incorporated by reference to the information set forth in the section entitled "Executive Officers of the Company" at the end of Part I of this Annual Report on Form 10-K.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this item regarding executive compensation is incorporated by reference to the information set forth in the sections entitled "Proposal One--Election of Directors--Director Compensation" and "Executive Officer Compensation" in the Company's Proxy Statement for the 1997 Annual Meeting of Stockholders to be filed with the Commission within 120 days after the end of the Company's fiscal year ended December 31, 1996.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this item regarding security ownership of certain beneficial owners and management is incorporated by reference to the information set forth in the section entitled "Share Ownership by Principal Stockholders and Management" in the Company's Proxy Statement for the 1997 Annual Meeting of Stockholders to be filed with the Commission within 120 days after the end of the Company's fiscal year ended December 31, 1996.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this item regarding certain relationships and related transactions is incorporated by reference to the information set forth in the section entitled "Certain Transactions with Management" in the Company's Proxy Statement for the 1997 Annual Meeting of Stockholders to be filed with the Commission within 120 days after the end of the Company's fiscal year ended December 31, 1996.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) The following documents are filed as part of this Form 10-K:
1. FINANCIAL STATEMENTS. The following consolidated financial statements, and the related notes thereto, of the Company and the Report of Independent Auditors are incorporated by reference to the Company's 1996 Annual Report to Stockholders.
Report of Ernst & Young LLP, Independent Auditors
Consolidated Balance Sheets as of December 31, 1996 and 1995
Consolidated Statements of Operations for each of the three years in the period ended December 31, 1996
Consolidated Statements of Stockholders' Equity for each of the three years in the period ended December 31, 1996
Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 1996
Notes to Consolidated Financial Statements
2. FINANCIAL STATEMENT SCHEDULES. The following financial statement schedule of the Company for each of the years ended December 31, 1996, 1995 and 1994 is filed as part of this Form 10-K and should be read in conjunction with the Consolidated Financial Statements, and related notes thereto, of the Company.
Schedules other than those listed above have been omitted since they are either not required, not applicable, or the information is otherwise included.
3. EXHIBITS: The exhibits listed on the accompanying index to exhibits immediately following the financial statement schedule are filed as part of, or incorporated by reference into, this Form 10-K.
(b) REPORTS ON FORM 8-K. No Current Report on Form 8-K was filed by the Company in the fourth quarter ended December 31, 1996.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized on this 28th day of March 1997.
NETSCAPE COMMUNICATIONS CORPORATION
By: /s/ PETER L.S. CURRIE ----------------------------------------- Peter L.S. Currie, SENIOR VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
Pursuant to the requirements of the Securities Exchange Act of 1934, this Form 10-K has been signed below by the following persons on March 28, 1997 on behalf of the Registrant and in the capacities and indicated:
SIGNATURE TITLE - ------------------------------ ------------------------------
President and Chief Executive /s/ JAMES L. BARKSDALE Officer and Director - ------------------------------ (principal executive James L. Barksdale officer)
Senior Vice President and /s/ PETER L.S. CURRIE Chief Financial Officer - ------------------------------ (principal financial Peter L.S. Currie officer)
Vice President, Finance and /s/ NOREEN G. BERGIN Corporate Controller - ------------------------------ (principal accounting Noreen G. Bergin officer)
/s/ JAMES H. CLARK - ------------------------------ Chairman of the Board James H. Clark
/s/ MARC L. ANDREESSEN - ------------------------------ Director Marc L. Andreessen
/s/ ERIC A. BENHAMOU - ------------------------------ Director Eric A. Benhamou
/s/ L. JOHN DOERR - ------------------------------ Director L. John Doerr
/s/ JOHN E. WARNOCK - ------------------------------ Director John E. Warnock
NETSCAPE COMMUNICATIONS CORPORATION SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 (IN THOUSANDS)
S-1
INDEX TO EXHIBITS
- ------------------------
+ Confidential treatment has been previously granted for certain portions of these exhibits.
* Indicates management compensatory plan, contract or arrangement.