Will Novell find its niche?

Business 101: Anyone can cut expenses, but it takes vision to grow revenues.

That's the predicament facing Novell (NOVL). The network software company, which last year suffered a $78.3 million loss and declining market share in its core business of server operating systems, has passed first part of the test by cutting expenses. Last quarter, Novell eked out its first operating profit since a major restructuring last year that resulted in a 17 percent staff reduction and consolidation of a number of facilities.

But whether Novell eventually can double its revenues to return to the $2 billion level it once reached in the mid-1990s remains to be seen. That will surely be a pressing topic of discussion on the convention floor as the company opens its annual BrainShare conference in Salt Lake City this week.

"Twenty percent growth is not happening this year, based on their core products," said Mary McCathery, an analyst with Alex. Brown. "To get growth above 20 percent, they'll have to make some acquisitions."

It was only a year ago this month that the company named a chief executive, one who was recognized for his technology know-how but lacked a track record of running a company, let alone a troubled one. CEO Eric Schmidt, the former chief technology officer at Sun Microsystems, has won praise from Wall Street for cutting costs, but many analysts and investors remain skeptical of the 42-year-old executive's ability to drive new product revenues and turn the company around.

Novell faces competitors such as Microsoft in its core server operating systems business and is going head to head with Lotus Development and Netscape Communications in the groupware arena, a key part of Novell's network services business and revenues.

These worthy competitors, along with excess inventory sitting in the company's channel, have contributed to a steep drop in Novell's year-to-year revenue since fiscal 1995. Such factors, in addition to declining market share in Novell's primary business, precipitated the climate that Schmidt walked into when he joined the company.

Although they note that Novell has since gained control of its expenses, most analysts expect the company to fall short once again on revenue growth for the second quarter ending next month. For the second quarter a year ago, Novell reported quarterly revenues of $273.1 million, and a number of analysts expect the company to end its 1998 fiscal year in October at around $1 billion--flat from its performance of a year ago.

The decline is expected despite the company's efforts to roll out myriad new products during its first quarter, including BorderManager FastCache, NetWare Directory Services (NDS) for Windows NT, Netscape server products, and Year 2000 solutions for its core NetWare servers and for ManageWise. This lineup of products, atypical for Novell in the number of products being released simultaneously, is part of the company's network services business, which accounts for nearly one-fourth of its total revenues.

Novell executives declined to discuss their outlook for the company's future revenue growth, other than to point to previous statements that it expects weakness in the Asia-Pacific region, which plagued Novell's last quarter, to stabilize. They also cited Schmidt's previous comments that Novell's new products will drive growth.

NetWare 5 is one of the products that Novell is heavily banking on this year. It will be the first version of the software to offer native support for Java, which some see as a possible driver of application development for Novell. The product is slated for shipment this summer and will be the latest edition to Novell's NetWare server operating software business, which accounts for 61 percent of its total revenues.

Although the server operating systems market is growing overall, Novell's slice of the pie is declining in unit shipments and percentage, losing ground to Windows NT.

But there is some cause for optimism on the revenue side of the equation. Two large distributors for Novell, MicroAge and Inacom, as well as reseller Powerscourt, have said that they expect their share of Novell-related revenues to rise.

MicroAge said it expects Novell-related sales to be down slightly from a year ago but to increase over the previous quarter, said Cammie McClellan, MicroAge category strategy networking operating systems manager.

Inacom, a smaller distributor, is more bullish. It expects its Novell sales to finish up 35 percent from a year ago in the current quarter and to rise 20 percent sequentially, product manager Adam Shomaker said.

"When NetWare 5 comes out, I think we'll be up 40 percent from a year ago for all of our Novell business," Shomaker said, adding that about a third of Inacom's business comes from Novell licensing fees and the remainder from its boxed products.

"="" revenue"="">

Bill Towey, president of reseller Powerscourt, said that demand for NDS for NT has been hot but that BorderManager FastCache, which is sold separately from BorderManager, has been selling at a rate of one FastCache to every ten BorderManagers.

NDS for NT serves as a Windows NT database for user, network equipment, computer systems, applications, files, and other network resource information. BorderManager FastCache, on the other hand, is a solution that has limited appeal, due to its use as a "back end" infrastructure product that is mainly used by Internet service providers, Towey said. BorderManager, however, is used by end users and, therefore, carries a larger market.

One distributor, DistribuPro, expects to see its revenue from Novell products fall 50 percent from the previous quarter. Rebecca Florio, a sales manager for DistribuPro, attributes the drop to Novell's more stringent product return policy for resellers, which took effect last month. As a result, DistribuPro is ordering fewer products from Novell because it doesn't want to be stuck with excess inventory that it may not be able to return.

Novell instituted the policy as a way to keep inventory moving through the distribution channel after it took severe measures to reduce the backlog that had built up from previous quarters, said Peter Troop, Novell's director of investor relations.

Analysts offered up two other strategies that could jump-start Novell's revenues: One is to embark on acquisitions and the other calls for a shift away from server operating system software--the company's core product.

Charles Phillips, an analyst with Morgan Stanley Dean Witter, said Novell needs to shift to offering application server operating systems, rather than server operating systems that primarily dish up files from the network.

"For the last couple of years, it's been the same story," Phillips said. "People are looking for application servers, but Novell is still selling file servers."

Although Novell has tried to offer customers both features with NetWare, it has not received strong support from application developers, such as Netscape, until recently. In the first quarter, Novell began shipping Netscape server products for NetWare servers.

But Phillips said the company needs to reposition itself with a broad array of Internet and network services, given that its move into application servers has not fared well.

"It's too early for them to have a real impact on revenues and to offset the sales declines with NetWare 3 and 4," Phillips said of the new products. "None of these products are blockbusters that will turn Novell around by themselves. What Novell needs is a family of products to build their business over time."

Sanjiv Hingorani, an analyst with Furman Selz, also had his doubts that Novell's new products will drive revenue growth.

"The new products are way overdue," he said. "[Novell] may have missed the market because things like NetWare 5 and NDS for NT were needed long before now."