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Netscape misfires on enterprise

Netscape takes Wall Street by surprise in announcing that its fourth-quarter revenues and profits will fall far short of expectations.

Netscape Communications (NSCP) took Wall Street by surprise today in announcing that its fourth-quarter revenues and profits will fall far short of expectations.

The biggest surprise came in the news that Netscape's enterprise software sales See related story: Netscape expects to report loss also would be lower than expected. This was the market, after all, that Netscape had touted as the focus of its new business strategy, which would relegate the browser sales that established the company as a leader on the Internet to a back-seat role given that software giant Microsoft (MSFT) had started moving in.

"I think they underestimated Microsoft and IBM (IBM), and probably realized it in the fourth quarter of 1996, but have tried to hold it together as long as they could with their Web-based ad sales," said Bruce Smith, an analyst with Merrill Lynch. "I don't think we have seen an end to this problem."

Smith added that Netscape's performance over the last several quarters has disappointed the marketplace in terms of sales of both enterprise and browser products. Meanwhile, he said, Web-based advertising revenues have helped boost the company, allowing it to meet Wall Street's quarterly expectations.

Investors apparently also have concerns about when the transition to the enterprise strategy will fully kick in. The transition was revved up a year ago, but has yet to fire on all cylinders.

One analyst described today's news as a "hiccup" in a generally sound Netscape strategy.

"I'm not so surprised they're having these growing pains," said Allen Bonde, director of advisory services at Boston's Extraprise Group. "Their revenue is still up and robust. Absolutely, there's a future for them as an enterprise company."

Bonde pointed to Netscape's recent acquisitions of Kiva Software and Actra, makers of high-end application servers and e-commerce tools, as excellent positioning moves for what he sees as the coming boom in online transactions between companies and consumers.

A reseller and electronic distributor of Netscape products agreed with Bonde's appraisal, but chided Netscape for not minding the pitfalls of Wall Street.

"As an investor, I'd be greatly disappointed, but [within the software industry] people see that they've come a long way in a short time and they're now shifting to the enterprise market with a lot more in-depth technology," said Peter Jackson, CEO of Intraware. "They needed to translate that sooner, and that was the only thing they failed on."

Jackson, whose company also distributes the products of enterprise competitor NetDynamics, was guarded in his praise of Netscape's purchase of Kiva, noting that "Kiva-type" servers and tools are in high demand.

Shares of Netscape fell by nearly 21 percent on today's news, hitting a new 52-week low and closing at 18-9/16--down 4-13/16 over Friday. The stock was on a downward descent for most of last year, falling from its 52-week high of 59-1/4 last January.

The company's enterprise contracts, which include products and services, are expected to reach $91 million in the fourth quarter, up substantially from year-ago figures of $54 million but down from $95 million during the previous quarter, said Quincy Smith, a Netscape spokesman.

"That was a real surprise, given that their third quarter was strong," said Jamie Kiggen, an analyst with Cowen & Co. "I thought they would have had an improved quarter sequentially, but they didn't."

Professional services for the enterprise market, an area into which Netscape has thrown resources during the past year--including beefing up staff in this department by over 60 percent--is expected to generate flat revenues over the previous quarter, Kiggen said.

"That was also a surprise, given how much they have invested in that area," he said. "I think, however, [enterprise] will start growing because of the number of people devoted to that effort."

Web-based advertising sales and trademark fees from content partners and providers are expected to contribute $22 million to Netscape's fourth-quarter revenues, compared with $9 million a year ago. However, those revenues declined from $27 million during the previous quarter, Smith said, declining to comment on analysts' characterizations of the company's current business prospects.

Kiggen added that he thought this quarter's performance was more of an aberration than a trend. He noted, however, that it is difficult to determine at this point whether and when Netscape's revenue growth will return to its earlier levels.

Netscape said it expects to post a fourth-quarter loss of between $85 million and $89 million, and a 9 percent to 13 percent rise in revenues, to between $125 million and $130 million. Although the company posted a sizable net loss in the June quarter due to an acquisition charge, the fourth quarter will mark the first time the company has posted an operating loss since it went public in 1995.

The company had cited pricing pressure from Microsoft and IBM's Lotus as pulling down its enterprise-related sales.

Kiggen pointed out that large deals in the enterprise space are negotiated on an individual basis, ruling out a scenario in which Microsoft or IBM had come in with a list price that undercut Netscape. Nevertheless, he said, "These are big companies that use any given number of measures to win business, including...price."

Although demand for Netscape's products remains strong, Kiggen said the problem the company is facing stem from an inability to close deals. He said that some of the deals the company had in the pipeline at the close of the fourth quarter may now slide over into the first quarter, while others may be lost altogether to competitors.

Meanwhile, sales to standalone clients dropped against year-ago levels. Wall Street expected as much, since Netscape has been focusing more on the enterprise market of late. Standalone client sales, which comprise sales of just the browser, are expected to account for $17 million during the fourth quarter, down from $52 million a year ago and $27 million during the previous quarter, said Smith of Merrill Lynch.

Smith said he consistently advocated Netscape keeping its focus on the browser business rather than entering the highly competitive enterprise market and taking on Microsoft and IBM, which have significantly more resources and more partner relationships.

"What has been the most important thing for Netscape is Navigator, and that will show them the way," Smith said. "The key to everything is the browser and browser market share. All their success depends on browser market share and having a desktop presence."

During a conference call with analysts, Smith said Jim Barksdale, Netscape chief executive, strongly indicated that the company would make its browser available for free during the next few weeks, a move that would follow in the footpath of Microsoft's efforts in the browser space.

Although Smith applauds that strategy, he estimates it will cut out more than 20 percent of the company's revenues. A shift toward free browsers would not only affect the revenues generated from the company's standalone products, he said, but also would affect bundled products that may get repriced downward.

Netscape plans to release its fourth-quarter results on January 27 after the markets close.