<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED September 30, 1996
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _______ TO _______.
Commission File Number : 0-22350
MERCURY INTERACTIVE CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 77-0224776
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
470 Potrero Avenue, Sunnyvale, California 94086
(Address of principal executive offices)
Registrant's telephone number, including area code: (408) 523-9900
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such a shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES X NO
--- ---
The number of shares of Registrant's Common Stock outstanding as of
October 31, 1996 was 16,018,170.
<PAGE>
MERCURY INTERACTIVE CORPORATION
-------------------------------
INDEX
-----
PART 1. FINANCIAL INFORMATION
Page No.
--------
Item 1. Financial Statements:
Condensed Consolidated Balance Sheet - September 30, 1996
and December 31, 1995 3
Condensed Consolidated Statement of Operations - Three and
Nine months ended September 30, 1996 and 1995 4
Condensed Consolidated Statement of Cash Flows -
Nine months ended September 30, 1996 and 1995 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 7
PART II. OTHER INFORMATION
Item 5. Other Information 14
Item 6. Exhibits and Reports on Form 8-K 14
SIGNATURES 15
INDEX TO EXHIBITS 16
2
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
MERCURY INTERACTIVE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
(in thousands, except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
September 30, December 31,
1996 1995
------------- ------------
<S> <C> <C>
ASSETS
- ------
Current assets:
Cash and cash equivalents $ 43,863 $ 45,850
Short-term investments 29,291 31,996
Trade accounts receivable (net of allowances of $1,004 and $705) 14,417 12,158
Government grant and other receivables 3,204 2,621
Inventories 827 510
Prepaid expenses and other assets 3,309 2,544
-------- --------
Total current assets 94,911 95,679
Long-term investments 4,258 7,819
Property and equipment, net 10,637 8,762
Deposits and other assets 1,418 560
-------- --------
$111,224 $112,820
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Current liabilities:
Accounts payable $ 2,589 $ 1,272
Accrued liabilities 7,864 13,846
Deferred revenue 5,259 5,086
-------- --------
Total current liabilities 15,712 20,204
======== ========
Commitments and contingencies (Notes 5 & 6)
Stockholders' equity:
Common stock, par value $.002 per share, 25,000 shares
authorized; 16,011 and 15,728 shares issued and outstanding 32 31
Capital in excess of par value 99,806 98,309
Cumulative translation adjustment (136) 31
Accumulated deficit (4,190) (5,755)
-------- --------
Total stockholders' equity 95,512 92,616
-------- --------
$111,224 $112,820
======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements
3
<PAGE>
MERCURY INTERACTIVE CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Three months ended Nine months ended
Sept 30, Sept 30,
1996 1995 1996 1995
-------- -------- -------- -------
<S> <C> <C> <C> <C>
Revenue:
License $ 11,400 $ 8,610 $ 29,350 $ 22,563
Service 2,800 1,640 7,950 4,387
-------- -------- -------- --------
Total revenue 14,200 10,250 37,300 26,950
-------- -------- -------- --------
Cost of revenue:
License 1,042 628 2,247 1,798
Service 824 503 2,242 1,272
-------- -------- -------- --------
Total cost of revenue 1,866 1,131 4,489 3,070
-------- -------- -------- --------
Gross profit 12,334 9,119 32,811 23,880
-------- -------- -------- --------
Operating expenses:
Research and development 2,721 1,562 7,573 7,173
Less: grants (160) (530) (1,408) (858)
-------- -------- -------- --------
Research and development, net 2,561 1,032 6,165 6,315
Marketing, selling and general and administrative 8,835 5,681 24,564 16,598
Settlement of litigation --- --- 2,600 ---
-------- -------- -------- --------
Total operating expenses 11,396 6,713 33,329 22,913
Income (loss) from operations 938 2,406 (518) 967
Other income, net 856 651 2,477 1,541
-------- -------- -------- --------
Income before provision for income taxes 1,794 3,057 1,959 2,508
Provision for income taxes 359 611 394 870
-------- -------- -------- --------
Net income $ 1,435 $ 2,446 $ 1,565 $ 1,638
======== ======== ======== ========
Net income per share $ 0.09 $ 0.16 $ 0.09 $ 0.11
======== ======== ======== ========
Weighted average common shares and equivalents 16,614 15,558 16,583 14,433
======== ======== ======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements
4
<PAGE>
MERCURY INTERACTIVE CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
Increase (Decrease) in Cash and Cash Equivalents
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Nine months ended
Sept 30,
1996 1995
------- -------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 1,565 $ 1,638
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 2,262 1,434
Non-cash acquisition and other non-recurring charges --- 1,885
Net changes in assets and liabilities:
Trade accounts receivable (2,259) (521)
Government grant and other receivables (583) (1,181)
Inventories (317) (214)
Prepaid expenses and other assets (1,623) (1,059)
Accounts payable 1,317 (279)
Accrued liabilities (including in 1996 the payment of litigation-related (5,982) 2,419
accruals of $2,000 and acquisition and restructuring accruals of $3,550)
Deferred revenue 173 (651)
------- -------
Net cash provided by (used in) operating activities (5,447) 3,471
------- -------
Cash flows from investing activities:
Investment proceeds (purchases), net 6,266 (8,515)
Acquisition of property and equipment (4,137) (5,451)
------- -------
Net cash provided by (used in) investing activities 2,129 (13,966)
------- -------
Cash flows from financing activities:
Proceeds from issuance of common stock 1,498 55,067
------- -------
Net cash provided by financing activities 1,498 55,067
------- -------
Effect of exchange rate changes on cash (167) 199
------- -------
Net increase (decrease) in cash and cash equivalents (1,987) 44,771
Cash and cash equivalents at beginning of period 45,850 10,465
------- -------
Cash and cash equivalents at end of period $ 43,863 $55,236
------- -------
Cash paid during the period for income taxes: $ --- $ 625
======= =======
</TABLE>
See accompanying notes to condensed consolidated financial statements
5
<PAGE>
MERCURY INTERACTIVE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. The unaudited financial information furnished herein reflects all
adjustments, consisting only of normal recurring adjustments, that in the
opinion of management are necessary to fairly state the Company's
consolidated financial position, the results of its operations, and its
cash flows for the periods presented. This Quarterly Report on Form 10-Q
should be read in conjunction with the Company's audited financial
statements for the year ended December 31, 1995, included in the 1995
Annual Report and Form 10-K. The condensed consolidated statement of
operations for the nine months ended September 30, 1996 is not necessarily
indicative of results to be expected for the entire fiscal year ending
December 31, 1996. Certain items have been reclassified to conform to the
current period presentation.
2. The portfolio of short and long-term investments is carried at cost (which
approximates market) as of the balance sheet date and consists of
investments in high quality financial, government and corporate securities.
In accordance with Statement of Financial Accounting Standards No. 115,
"Accounting for Certain Investments in Debt and Equity Securities", the
Company has categorized its marketable securities as "available-for-sale"
securities. Realized gains or losses are determined based on the specific
identification method and are reflected in income.
3. The effective tax rate for the nine months ended September 30, 1996 differs
from statutory tax rates principally because of special reduced taxation
programs sponsored by the government of Israel.
4. Net income per common share has been computed using the weighted average
number of common and dilutive common equivalent shares outstanding during
the period. Dilutive common equivalent shares consist of common stock
issuable upon exercise of stock options (using the treasury stock method).
5. The Company obtained grants for research and development from the Office of
the Chief Scientist in the Israeli Ministry of Industry and Trade in the
amounts of $160,000 and $1.4 million in the quarter and nine months ended
September 30, 1996, respectively, and $530,000 and $858,000 in the nine
months ended September 30, 1995. These grants are accounted for using the
cost reduction method, under which research and development expenses are
decreased by the amounts of the grants. The Company is not obligated to
repay thes grants: however, it has agreed to pay royalties at rates ranging
from 2% to 5% of product sales resulting from the research, up to the
amount of the grants obtained and for certain grants up to 150% of the
grants obtained. Royalty expenses under these agreements amounted to
approximately $495,000 and $1.0 million for the quarter and nine months
ended September 30, 1996, respectively, and $214,000 and $614,000 for the
quarter and nine months ended September 30, 1995 respectively. As of
September 30, 1996, the Company is committed to pay, if and when earned,
$2.6 million in royalties.
The Company also obtained grants in the amounts of $391,000 in the nine
months ended September 30, 1996 for research and development projects from
the Israel-U.S. Binational Industrial Research and Development Foundation
("BIRD-F"). There were no BIRD-F grants received in the quarter ended
September 30, 1996. The grants are accounted for using the cost reduction
method, under which research and development expenses are decreased by the
amount of the grant obtained. The Company is not obligated to repay these
grants; however, it has agreed to pay BIRD-F royalties at the rate of up to
5% of sales of any product or development resulting from such research, but
not in excess of 150% of the grant. Royalty expense under BIRD-F grants
amounted to less than $5,000 for the quarters and nine months ended
September 30, 1996 and 1995. As of September 30, 1996, the Company is
committed to pay, if and when earned, approximately $1.3 million in
royalties.
During the latter half of the fourth quarter of 1995, representatives from
the Office of the Chief Scientist approached a number of companies in
Israel, including the Company's research and development subsidiary, to
reassess the methods used to classify revenues subject to royalties payable
under grants received. As a result of this review, the Office of the Chief
Scientist believed that certain revenues for the year may have been subject
to a 1% higher royalty rate the originally paid. As a result, during the
fourth quarter of 1995, the Company recorded charges of approximately
$550,000 and $150,000, representing the Company's estimate of royalties
(recorded in marketing, selling and general and administrative expense) and
interest (charged against other income, net), respectively which may have
been assessed by the Office of the Chief Scientist of the government of
Israel, related to revenues for the years 1991-1995. This dispute was
settled during the current quarter, resulting in a net benefit to operating
income of approximately $300,000 representing the reversal of a portion of
the aforementioned royalty charges originally recorded in marketing,
selling and general and administrative expense. As a result of this
resolution, prospective royalty payments will be made on an expanded
product base. Also in the current quarter, in conjunction with the
resolution of this issue, the Company reversed the interest charge of
$150,000.
6. In prior years, The Company received grants from the Government of Israel
through the Fund for the Encouragement of Marketing Activities ("the
Marketing Fund") which were used to offset marketing expenses in the years
received. The grants were received from the government of Israel for
approved programs for marketing activities and were recognized on the cost
reduction basis as a reduction of marketing expenses as such expenses were
incurred. Under the terms of the marketing grants, if and when export sales
from Israel to certain countries exceed a predetermined base of historical
export sales from Israel, a royalty of 3% of the increase in export sales
from Israel must generally be paid, up to the amount of the grants
obtained. Royalty expense under these agreements amounted to approximately
$100,000 and $327,000 for the quarter and nine months ended September 30,
1996, respectively, and $75,000 and $210,000 in the quarter and nine months
ended September 30, 1995, respectively. As of September 30, 1996, the
Company is committed to pay, if and when earned, approximately $643,000 in
royalties.
On February 13, 1995, the Company's UK subsidiary, Mercury Interactive (UK)
Limited, was served with a complaint brought by Mercury Communications
Limited ("Mercury Communications") a subsidiary of Cable and Wireless plc.
The complaint alleged that use by the Company's subsidiary of "Mercury" and
"Mercury Interactive" in the UK infringed upon Mercury Communications' UK
trademark rights. On March 13, 1996, the Company settled this matter.
On August 21, 1995, the Company was served with a complaint filed in the
United States District Court for the Eastern District of Virginia by
Performix, Inc., a software company located in McLean, Virginia. The
complaint alleged that an employee of the Company attempted to copy without
authorization one of the plaintiff's software programs. On March 7, 1996,
the Company settled this matter and recorded a charge of $2.1 million (net
of taxes of $500,000), which reflected settlement costs for all outstanding
litigation as well as related legal fees.
6
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Results of Operations
Revenue
-------
License revenue increased 32% to $11.4 million during the third quarter
of 1996 from $8.6 million in the third quarter of 1995. License revenue
increased 41% to $29.4 million during the nine months ended September 30, 1996
from $20.9 million during the nine months ended September 30, 1995, excluding a
one time payment in April 1995 of $1.7 million from Compuware, in exchange for
the right to OEM the Company's products. The Compuware payment is excluded as it
is not representative of normal ongoing revenue transactions. This contract was
terminated in March 1996, and no further material revenue was recorded under
this contract by the Company since the one time payment in April 1995. The
Company's growth in license revenue is due to continuing growth in license fees
from the WinRunner and LoadRunner products, as well as sales of TestSuite, the
Company's complete automated software quality solution for the enterprise, which
was released in June 1995. License revenue in the third quarter of 1996 also
benefited from the Company's ongoing expansion into alternate distribution
channels, such as referral partners, system integrators and value added
resellers. Revenue generated through alternate channels represented
approximately 42% and 41% of the license fees during the quarter and nine months
ended September 30, 1996, respectively. Revenue generated through alternate
channels represented approximately 30% and 18% of the license fees during the
quarter and nine months ended September 30, 1995, respectively.
Service revenue increased to $2.8 million or 20% of total revenue in the
third quarter of 1996 from $1.6 million or 16% of total revenue in the third
quarter of 1995 and increased to $8.0 million, or 21% of total revenue in the
nine months ended September 30, 1996, from $4.4 million or 16% of total revenue
in the nine months ended September 30, 1995. This increase in service revenue in
1996 compared to 1995 is primarily due to increases in the Company's base of
installed users and the associated increase in maintenance, customer training
and support revenue. The increase is also attributable to the introduction in
June 1995 of the Company's LoadRunner Quickstart training program which
accounted for more than 20% of the increase in service revenue. The Company
expects that service revenues will continue to increase in absolute dollars as
long as the Company's customer base continues to grow.
International revenue in the quarter and the nine months ended September
30, 1996 represented 34% and 37%, respectively, of total revenue. International
revenue was approximately 27% and 28% in the quarter and the nine months ended
September 30, 1995, respectively, excluding the $1.7 million in revenue from
Compuware discussed above. In an effort to improve Europe's contribution to
revenue, the Company restructured European operations in December 1995 and is
currently in the process of rebuilding the operations. During the quarter, the
Company hired sales managers in the U.K. and France and is recruiting other
sales personnel. However, there can be no assurance that the Company will be
able to increase revenue from Europe.
Cost of revenue
---------------
License cost of revenue, as a percentage of license revenue, was 9% and
6% in the third quarter and nine months ended September 30, 1996, respectively,
compared to 7% and 8% in the quarter and nine months ended September 30, 1995.
License cost of revenue consists primarily of employee-related costs including
salaries, travel and depreciation.
Service cost of revenue, as a percentage of service revenue was 29% and
28% in the quarter and nine months ended September 30, 1996, respectively,
compared to 31% and 29% in the quarter and nine months ended September 30, 1995,
respectively. Service cost of revenue consists primarily of costs of customer
technical support, education and consulting.
7
<PAGE>
Research and development
------------------------
Research and development expenditures, before reductions for grants,
increased to $2.7 million or 19% of total revenue in the third quarter of 1996
from $1.6 million or 15% of total revenue in the third quarter of 1995, and
increased to $7.6 million or 20% of total revenue in the nine months ended
September 30, 1996 from $4.6 million or 17% in the nine months ended September
30, 1995, excluding charges totaling approximately $2.6 million related to the
acquisition of Blue Lagoon Software during the second quarter of 1995. Research
and development expenses for the nine months ended September 30, 1995 included
the write-off of in-process research and development, and the write-off of
obsolete technology, each related to the acquisition of Blue Lagoon Software,
which totaled approximately $2.4 million, as well as approximately $200,000 of
incentive compensation payments related to the acquisition. The increase in
research and development expenses was due to an increase in research and
development personnel from 123 employees at September 30, 1995 to 159 employees
at September 30, 1996. The increase in research and development personnel-
related costs, including depreciation of equipment purchased to support the
expanded research and development staff, accounted for approximately $1.0
million of the increase in the third quarter of 1996, and $2.2 million of the
increase in the nine months ended September 30, 1996.
The Company capitalized $495,000 and $1.0 million of software
development costs during the third quarter and nine months ended September 30,
1996, respectively, and $190,000 and $587,000 in the quarter and nine months
ended September 30, 1995, respectively, in accordance with Statement of
Financial Accounting Standards No. 86, "Accounting for the Costs of Computer
Software to be Sold, Leased, or Otherwise Marketed." The Company began
amortizing capitalized costs in the second quarter of 1996. Amortization expense
for the quarter and nine months ended September 30, 1996 was approximately
$120,000 and $180,000, respectively. At September 30, 1996 and December 31,
1995, the Company had a net balance in capitalized software development costs of
approximately $1.4 million and $495,000, respectively.
The Company obtained grants for research and development from the Office
of the Chief Scientist in the Israeli Ministry of Industry and Trade in the
amounts of $160,000 and $1.4 million in the quarter and nine months ended
September 30, 1996, respectively, and $530,000 and $858,000 in the nine months
ended September 30, 1995. These grants are accounted for using the cost
reduction method, under which research and development expenses are decreased by
the amounts of the grants. The Company is not obligated to repay these grants;
however, it has agreed to pay royalties at rates ranging from 2% to 5% of
product sales resulting from the research, up to the amount of the grants
obtained and for certain grants up to 150% of the grants obtained. Royalty
expense under these agreements amounted to approximately $495,000 and $1.0
million for the quarter and nine months ended September 30, 1996, respectively,
and $214,000 and $614,000 for the quarter and nine months ended September 30,
1995 respectively. As of September 30, 1996, the Company is committed to pay, if
and when earned, $2.6 million in royalties.
The Company also obtained grants in the amounts of $391,000 in the nine
months ended September 30, 1996 for research and development projects from the
Israel-U.S. Binational Industrial Research and Development Foundation ("BIRD-
F"). There were no BIRD-F grants received in the quarter ended September 30,
1996. The grants are accounted for using the cost reduction method, under which
research and development expenses are decreased by the amount of the grant
obtained. The Company is not obligated to repay these grants; however, it has
agreed to pay BIRD-F royalties at the rate of up to 5% of sales of any product
or development resulting from such research, but not in excess of 150% of the
grant. Royalty expense under BIRD-F grants amounted to less than $5,000 for the
quarters and nine months ended September 30, 1996 and 1995. As of September 30,
1996, the Company is committed to pay, if and when earned, approximately $1.3
million in royalties.
During the latter half of the fourth quarter of 1995, representatives
from the Office of the Chief Scientist approached a number of companies in
Israel, including the Company's research and development subsidiary, to reassess
the methods used to classify revenues subject to royalties payable under grants
received. As a result of this review, the Office of the Chief Scientist believed
that certain revenues for the year may have been subject to a 1% higher royalty
rate than originally paid. As a result, during the fourth quarter of 1995, the
Company recorded charges of approximately $550,000 and $150,000, representing
the Company's estimate of royalties (recorded in
8
<PAGE>
marketing, selling and general and administrative expense) and interest (charged
against other income, net), respectively, which may have been assessed by the
Office of the Chief Scientist of the government of Israel, related to revenues
for the years 1991-1995. This dispute was settled during the current quarter,
resulting in a net benefit to operating income of approximately $300,000,
representing the reversal of a portion of the aforementioned royalty charges
originally recorded in marketing, selling and general and administrative
expense. As a result of this resolution, prospective royalty payments will be
made on an expanded product base. Also in the current quarter, in conjunction
with the resolution of this issue, the Company reversed the interest charge of
$150,000.
The Company intends to continue making significant expenditures on
research and development to develop new products and expand the platforms and
operating systems on which its products are offered. While the Company believes
that these current research and development expenditures will be beneficial in
the long term development of its business, there can be no assurances that the
development of products will be successful. Research and development
expenditures are incurred substantially in advance of related revenue and in
some cases do not result in the generation of revenue.
Marketing, selling and general and administrative
-------------------------------------------------
Marketing, selling and general and administrative expenses increased to
$8.8 million, or 62% of total revenue, and $24.6 million, or 66% of total
revenue, in the quarter and nine months ended September 30, 1996, respectively,
from $5.7 million, or 55% of total revenue and $16.0 million, or 60% of total
revenue, in the quarter and nine months ended September 30, 1995, respectively,
excluding charges totaling approximately $550,000 related to the acquisition of
Blue Lagoon Software during the second quarter of 1995. During the second
quarter of 1995, the Company recorded non-recurring costs primarily related to
the write-off of approximately $250,000 of fixed assets, as well as special
incentive payments to management and certain other employees totaling
approximately $300,000 in conjunction with integrating the operations and
technology of Blue Lagoon Software into the Company's operations. Approximately
$900,000 and $1.9 million of the increase during the quarter and nine months
ended September 30, 1996, respectively, resulted from increased worldwide sales
and marketing activities including increased advertising and marketing
communications, increased participation in seminars and trade shows and
expansion into alternate distribution channels. The Company has also expanded
its operations into the Far East, which accounted for approximately $270,000 and
$1.0 million of the increase in the quarter and nine months ended September 30,
1996, respectively, compared to the quarter and nine months ended September 30,
1995. In addition, the increase in expenses relates to increases in personnel in
the marketing, sales and administrative departments to 164 employees at
September 30, 1996 from 112 employees at September 30, 1995. Excluding costs
related to expansion into the Far East, personnel-related expenses, including
commissions and travel, resulted in approximately $1.7 million and $4.2 million
of the increase in marketing, selling and general and administrative expense
during the quarter and nine months ended September 30, 1996, respectively,
compared to the quarter and nine months ended September 30, 1995. The Company
expects marketing, selling and general and administrative expenses to increase
in absolute dollars as total revenues increase, but such expenses may vary as a
percentage of revenue.
In prior years, the Company received grants from the Government of
Israel through the Fund for the Encouragement of Marketing Activities ("the
Marketing Fund") which were used to offset marketing expenses in the years
received. The grants were received from the government of Israel for approved
programs for marketing activities and were recognized on the cost reduction
basis as a reduction of marketing expenses as such expenses were incurred. Under
the terms of the marketing grants, if and when export sales from Israel to
certain countries exceed a predetermined base of historical export sales from
Israel, a royalty of 3% of the increase in export sales from Israel must
generally be paid, up to the amount of the grants obtained. Royalty expense
under these agreements amounted to approximately $100,000 and $327,000 for the
quarter and nine months ended September 30, 1996, respectively, and $73,000 and
$210,000 in the quarter and nine months ended September 30, 1995, respectively.
As of September 30, 1996, the Company is committed to pay, if and when earned,
approximately $643,000 in royalties.
9
<PAGE>
Other income, net
-----------------
Other income, net consists primarily of interest income and foreign
exchange gains and losses. In the third quarter and nine months ended September
30 of 1996 and 1995, the Company earned interest income primarily on its
investments in money market accounts and marketable securities, which consist of
investments in high quality financial, government and corporate securities. The
significant increase in other income, net to $856,000 and $2.5 million in the
quarter and nine months ended September 30, 1996, respectively, from $651,000
and $1.5 million in the quarter and nine months ended September 30, 1995,
respectively, resulted primarily from a higher average investment balance during
the 1996 periods due to the investment of the proceeds from the Company's
offering of Common Stock in August 1995. In addition, other income, net included
a $150,000 benefit from the resolution of the dispute with the Chief Scientist
in Israel. This was partially offset by foreign exchange losses of approximately
$110,000.
Provision for income taxes
--------------------------
The Company has accounted for income taxes in accordance with the
provisions of Statement of Financial Accounting Standards No. 109, "Accounting
for Income Taxes". The Company recorded a tax expense of $359,000 and $394,000
in the quarter and nine months ended September 30, 1996, respectively, compared
to $611,000 and $870,000 in the quarter and nine months ended September 30,
1995, respectively.
The Company participates in special programs sponsored by the government
of Israel relating to taxation. Future provisions for taxes will depend upon the
mix of worldwide income and the tax rates in effect for various tax
jurisdictions.
Net income
----------
The Company reported net income of $1.4 million and $1.6 million in the
quarter and nine months ended September 30, 1996, respectively, compared to $2.4
million and $1.6 million in the quarter and nine months ended September 30,
1995, respectively. The results of operations for the quarter ended September
30, 1996 included a benefit from the resolution of the dispute with the Chief
Scientist in Israel. The results of operations for the nine months ended
September 30, 1996 included the first quarter charge for the settlement of
litigation of $2.1 million (net of taxes of $500,000). The results of operations
for the quarter and nine months ended September 30, 1995 were adversely impacted
by the acquisition of Blue Lagoon and other related non-recurring charges. The
Company's operating expenses are based in part on its expectations of future
revenues, and expenses are generally incurred in advance of revenues. The
Company plans to continue to expand and increase its operating expenses to
support anticipated revenue growth. If revenues do not materialize in a quarter
as expected, the Company's results from operations for that quarter are likely
to be materially adversely affected. Net income may be disproportionately
affected by a reduction in revenues because only a small portion of the
Company's expenses varies with its revenues.
Inflation
---------
Inflation has not had a significant impact on the Company's operating
results to date, nor does the Company expect it to have a significant impact
during the year.
Factors that May Affect Future Results
--------------------------------------
The statements in this Item 2 in the last sentence of the second
paragraph under the caption "Revenue", the first sentence of the sixth paragraph
under the caption "Research and Development," the sentence under the caption
"Inflation," the sixth sentence in the paragraph under the caption "Net
income", the last sentence in the fourth paragraph and the second sentence in
the tenth paragraph under this caption "Factors that May Affect Future
Results" and the second paragraph under the caption "Liquidity and Capital
Resources" are forward looking statements. In addition, the Company may from
time to time make oral forward looking statements. The factors set forth under
the captions "Research and
10
<PAGE>
Development," "Net income" and "Liquidity and Capital Resources" as well as the
following, are important risk factors that could cause actual results to differ
materially from those projected in any such forward looking statements.
The market for software products, and in particular, internet-related
products, is generally characterized by rapidly changing technology, frequent
new product introductions and changes in customer requirements, which can render
existing products obsolete or unmarketable. The Company believes that a major
factor in its future success will be its ability to continue to develop and
introduce in a timely and cost-effective manner enhancements to its existing
products and new products that will gain market acceptance. There can be no
assurance that the Company will be able to identify, develop, manufacture,
market or support new products or enhancements successfully, that any new
products or enhancements will gain market acceptance, or that the Company will
be able to respond effectively to technological changes. There can be no
assurance that the Company will not encounter technical or other difficulties
that could delay introduction of new products in the future. If the Company is
unable to introduce new products or enhancements and respond to industry changes
on a timely basis, its business could be materially adversely affected.
The market for automated software testing products is relatively new and
undeveloped. Marketing and sales techniques in the automated software testing
marketplace, as well as the bases for competition, are not well established.
There can be no assurance that a significant market for automated software
testing products will be developed or that the Company's products will be
accepted in any expanded market. Although the Company believes that the current
trend toward increased use of automated software testing will continue, a
majority of software testing is still carried out manually, and there can be no
assurance that the automated software market will enjoy continued growth.
The Company's current products and products under development are
limited in number and concentrated exclusively in the software testing market.
The life cycles of the Company's products are difficult to estimate due in large
measure to the recent emergence of the Company's market as well as the unknown
future effect of product enhancements and competition. Price reductions or
declines in demand for the Company's software testing products, whether as a
result of competition, technological change or otherwise, would have a
materially adverse effect on the Company's results of operations or financial
position.
The Company faces direct competition from a few public and several
privately-held companies in the United States and Europe. The market for
software products in general is highly competitive and the Company faces
competition from established and emerging companies. There could be a materially
adverse effect on the Company's results of operations or financial position if
any of the major software manufacturers, which have significantly greater
resources than the Company, decided to devote substantial resources to entering
the software testing market or if there is an increase in developing testing
utilities internally by the Company's customers or potential customers. A
variety of external and internal factors could materially adversely affect the
Company's ability to compete. These include the relative functionality,
price/performance and reliability of the products offered by the Company and its
competitors, the timing and success of new product development or enhancement
efforts of the Company and its competitors, and the effectiveness of the
marketing efforts of the Company and its competitors. There can be no assurance
that the Company will be able to compete successfully in the future or that
competitive pressures will not materially adversely affect the Company's
business.
The Company may from time to time experience significant fluctuation in
quarterly operating results. Such fluctuations in quarterly operating results
may occur in the future due to many factors, some of which are outside of the
Company's control. Products are generally shipped as orders are received, and,
consequently, quarterly sales and operating results depend primarily on the
volume and timing of orders received during the quarter, which are difficult to
forecast. In particular, the Company has historically received a substantial
portion of its orders at the end of the quarter. If an unanticipated order
shortfall occurs at the end of a quarter, the Company's operating results for
that quarter could be materially adversely affected. A significant portion of
the Company's operating expenses are relatively fixed, and planned expenditures
are based on sales forecasts. All of the foregoing may result in unanticipated
quarterly earning shortfalls or losses. Accordingly, the Company believes that
period-to-period comparisons of its results of operations are not necessarily
meaningful and should not be relied upon as indications of future performance.
11
<PAGE>
Sales to customers located outside the United States have historically
accounted for a significant percentage of revenue and the Company anticipates
that such sales will continue to be a significant percentage of the Company's
total revenue. Accordingly, such factors as currency fluctuations, political and
economic instability and trade restrictions could have a negative impact on the
Company's financial performance. The Company is continuing to strengthen its
European sales organization to enhance that organization's contribution to
revenues. During the current quarter, the Company hired sales managers in the
U.K. and France and is recruiting other sales personnel. However, the success of
these efforts is not assured and depends in part on the Company's ability to
develop and retain successful sales personnel in that region. If European
revenues do not materialize in a quarter as expected, the Company's results from
operations for that quarter are likely to be materially adversely affected. A
significant portion of the Company's operating expenses are relatively fixed,
and planned expenditures are based on sales forecasts. All of the foregoing may
result in unanticipated quarterly earning shortfalls or losses.
Certain of the Company's sales are made in currencies other than the
U.S. Dollar and its financial results are reported in U.S. Dollars. Fluctuations
in the rates of exchange between the U.S. Dollar and other currencies may have a
materially adverse effect on the Company's results of operations and financial
position. To date, the Company has not hedged against currency translation
risks.
As part of its growth strategy, the Company may from time to time
acquire or invest in complementary businesses, products or technologies. For
example, during 1995, the Company acquired Blue Lagoon Software and EBY
Semantica. While there are currently no commitments with respect to any
particular acquisition, Company management frequently evaluates the strategic
opportunity available related to complementary products, technologies or
businesses. The process of integrating an acquired company's business into the
Company's operations may result in unforeseen operating difficulties and
expenditures and may absorb significant management attention that would
otherwise be available for the ongoing development of the Company's business.
Moreover, there can be no assurance that the anticipated benefits of any
acquisition will be realized. Future acquisitions by the Company could result in
potentially dilutive issuances of equity securities, the incurrence of debt and
contingent liabilities and amortization expenses related to goodwill and other
intangible assets, any of which could materially adversely affect the Company's
operating results and financial condition.
Since its inception, the Company has obtained royalty-bearing grants
from various Israeli government agencies. While the Company expects to receive
additional grants in the future, any such grants will likely decline as a
percentage of gross research and development spending and there can be no
assurance that the Company will receive any such grants. Termination or
substantial reduction of such grants or changes in revenue classification could
have a materially adverse effect on the Company. The terms of certain grants
prohibit the manufacture of products developed under these grants outside of
Israel and the transfer of technology developed pursuant to the terms of these
grants to any person, without the prior written consent of the government of
Israel. As a result, if the Company is unable to obtain the consent of the
government of Israel, the Company may not be able to take advantage of strategic
manufacturing and other opportunities outside of Israel.
Since 1993, the Company has experienced significant annual increases in
revenue. This growth has placed and, if it continues, will place a significant
strain on the Company's management, resources and operations. To accommodate its
recent growth, the Company is implementing a variety of new or expanded business
and financial systems, procedures and controls, including the improvement of its
accounting and other internal management systems. There can be no assurance that
the implementation of such systems, procedures and controls can be completed
successfully, or without disruption of the Company's operations. If the
Company's growth continues, the Company may be required to hire and integrate
substantial numbers of new employees. The market has become increasingly
competitive both in the United States and Israel and may require the Company to
pay higher salaries. The Company's failure to manage growth effectively could
have a materially adverse effect on the Company's results of operations or
financial position.
The Company's success depends to a significant extent on the performance
of its senior management and certain key employees. Competition for highly
skilled employees with technical, management and other specialized
12
<PAGE>
training is intense in the computer industry. The Company's failure to attract
additional qualified employees or to retain the services of key personnel could
materially adversely affect the Company's business.
The Company currently relies on a combination of trademark, copyright
and trade secret laws and contractual provisions to protect its proprietary
rights in its products. The Company presently has no registered copyrights. The
Company has filed applications for patents, but there can be no assurance that
any of the Company's patent applications will result in an issued patent or
that, if issued, such patent would be upheld if challenged. There can be no
assurance that the Company's competitors will not independently develop
technologies that are substantially equivalent or superior to the Company's
technology. There can also be no assurance that the measures taken by the
Company to protect its propriety rights will be adequate to prevent
misappropriation for the technology or independent development by others of
similar technology. In addition, the laws of various countries in which the
Company's products may be sold may not protect the Company's products and
intellectual property rights to the same extent as the laws of the United
States. There can be no assurance that third parties will not assert
intellectual property infringement claims against the Company or that any such
claims will not require the Company to enter into royalty or cross-license
arrangements or result in costly litigation.
In selling its products, the Company relies primarily on "shrink wrap"
licenses that are not signed by licensees. The provisions in such licenses
limiting the Company's exposure to potential product liability claims may
therefore be unenforceable under the laws of certain jurisdictions. Although
the Company carries errors and omissions insurance against such claims, there
can be no assurance that such insurance will continue to be available on
acceptable terms, if at all, or that such insurance will provide the Company
with adequate protection against any such claims. Although the Company has not
experienced any product liability claims to date, the sale and support of
products by the Company may entail the risk of such claims. A significant
product liability claim against the Company could have a material adverse effect
upon the Company's business, financial condition and results of operations.
The Company's stock price, like that of other technology companies, is
subject to significant volatility. Past financial performance should not be
considered a reliable indicator of future performance, and investors should not
use historical trends to anticipate results or trends in future periods. If
revenues or earnings in any quarter fail to meet expectations of the investment
community, there could be an immediate and significant impact on the Company's
stock price. In addition, the Company's stock price may be affected by broader
market trends that may be unrelated to the Company's performance.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the recorded amounts of assets and liabilities,
disclosure of those assets and liabilities at the date of the financial
statements and the recorded amounts of expenses during the reporting period. A
change in the facts and circumstances surrounding these estimates could result
in a change to the estimates and impact future operating results.
LIQUIDITY AND CAPITAL RESOURCES
Cash, cash equivalents and investments decreased to $77.4 million at
September 30, 1996 from $85.7 million at December 31, 1995. During the nine
months ended September 30, 1996, the Company paid $7.7 million related to
litigation and costs related to the acquisition of Semantica of which $5.7
million had been accrued at December 31, 1995. In addition, the Company received
$1.5 million from the issuance of Common Stock under employee stock option and
purchase plans. The Company used $3.6 million in cash for purchases of computers
and related equipment. The Company's short-term and long-term investments
consist of investments in high quality financial, government and corporate
securities.
Assuming there is no significant change in the Company's business, the
Company believes that its current cash and investment balances and cash flow
from operations, will be sufficient to fund the Company's cash needs for at
least the next twelve months.
13
<PAGE>
MERCURY INTERACTIVE CORPORATION
PART II. OTHER INFORMATION
Item 5. Other Information
On October 23, 1996, Standish O'Grady resigned from the Company's
Board of Directors.
Item 6. Exhibits and Reports on Form 8-K
(a) 11.1 - Computation of net income per common and common
equivalent share.
27 - Financial Data Schedule.
(b) No reports on Form 8-K were filed during the quarter ended
September 30, 1996.
14
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: November 14, 1996 MERCURY INTERACTIVE CORPORATION
(Registrant)
/s/ SHARLENE ABRAMS
--------------------------------------------
Sharlene Abrams
Vice-President of Finance and Administration,
Chief Financial Officer and Secretary
(Principal Financial and Accounting Officer)
15
<PAGE>
INDEX TO EXHIBITS
Exhibit
No. Description
11.1 Computation of net income per common and common equivalent share
27 Financial Data Schedule
16
<PAGE>
EXHIBIT 11.1
MERCURY INTERACTIVE CORPORATION
COMPUTATION OF NET INCOME PER COMMON
AND COMMON EQUIVALENT SHARE
(Primary and fully diluted)
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
1996 1995 1996 1995
-------- -------- -------- -------
<S> <C> <C> <C> <C>
Weighted average common shares outstanding 15,990 14,372 15,862 13,390
Weighted average common equivalent shares from dilutive
options 624 1,186 721 1,043
-------- -------- -------- -------
Weighted average common shares and equivalents $ 16,614 $ 15,558 $ 16,583 $14,433
======== ======== ======== =======
Net income $ 1,435 $ 2,446 $ 1,565 $ 1,638
======== ======== ======== =======
Net income per share $ 0.09 $ 0.16 $ 0.09 $ 0.11
======== ======== ======== =======
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-START> JUL-01-1996
<PERIOD-END> SEP-30-1996
<CASH> 43,863
<SECURITIES> 29,291
<RECEIVABLES> 15,421
<ALLOWANCES> 1,004
<INVENTORY> 827
<CURRENT-ASSETS> 94,911
<PP&E> 0
<DEPRECIATION> 6,364
<TOTAL-ASSETS> 111,224
<CURRENT-LIABILITIES> 15,712
<BONDS> 0
0
0
<COMMON> 32
<OTHER-SE> 95,480
<TOTAL-LIABILITY-AND-EQUITY> 111,224
<SALES> 14,200
<TOTAL-REVENUES> 14,200
<CGS> 1,042
<TOTAL-COSTS> 1,866
<OTHER-EXPENSES> 11,396
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 1,794
<INCOME-TAX> 359
<INCOME-CONTINUING> 1,435
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,435
<EPS-PRIMARY> 0.09
<EPS-DILUTED> 0.09
</TABLE>
