<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
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.)
1325 Borregas Avenue, Sunnyvale, California 94089
(Address of principal executive offices)
Registrant's telephone number, including area code: (408) 822-5200
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, 1998 was 17,658,085.
<PAGE>
MERCURY INTERACTIVE CORPORATION
INDEX
PART 1. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Page No.
--------
<S> <C>
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets -
September 30, 1998 and December 31, 1997 3
Condensed Consolidated Statements of Operations -
Three and nine months ended September 30, 1998 and 1997 4
Condensed Consolidated Statements of Cash Flows -
Nine months ended September 30, 1998 and 1997 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 8
Item 3. Quantitative and Qualitative Disclosures About Market Risk 15
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Stockholders 16
Item 5. Other Information 17
Item 6. Exhibits and Reports on Form 8-K 17
SIGNATURE 18
INDEX TO EXHIBITS 19
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
- -----------------------------
ITEM 1. FINANCIAL STATEMENTS
MERCURY INTERACTIVE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
(unaudited) (audited)
------------- ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 70,382 $ 57,211
Short-term investments 48,554 31,357
Trade accounts receivable 19,527 23,782
Government grants and other receivables 3,179 3,606
Inventories 214 252
Other current assets 7,364 2,954
------- -------
Total current assets 149,220 119,162
Long-term investments --- 3,771
Property and equipment, net 27,537 19,292
Other assets 735 1,185
------- -------
$ 177,492 $ 143,410
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 4,248 $ 4,045
Accrued liabilities 17,664 15,411
Deferred revenue 21,361 10,967
------- -------
Total current liabilities 43,273 30,423
------- -------
Commitments and contingencies
Stockholders' equity:
Common stock 35 33
Capital in excess of par value 116,730 107,800
Cumulative translation adjustment (602) (424)
Retained earnings 18,056 5,578
------- -------
Total stockholders' equity 134,219 112,987
------- -------
$ 177,492 $ 143,410
======= =======
</TABLE>
See accompanying notes to condensed consolidated financial statements
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3
<PAGE>
MERCURY INTERACTIVE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Three months ended Nine months ended
Sept 30, Sept 30,
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenue:
License $ 21,550 $ 14,300 $ 56,250 $ 37,883
Service 9,050 5,300 23,750 14,617
------- ------ ------- -------
Total revenue 30,600 19,600 80,000 52,500
------- ------ ------- -------
Cost of revenue:
License 1,545 1,073 4,266 2,969
Service 2,959 1,520 8,051 4,346
------- ------ ------- -------
Total cost of revenue 4,504 2,593 12,317 7,315
------- ------ ------- -------
Gross profit 26,096 17,007 67,683 45,185
------- ------ ------- -------
Operating expenses:
Research and development, net 4,098 2,970 10,777 8,454
Write off of in-process research and
development and related expenses --- 5,500 --- 5,500
Marketing and selling 14,146 9,154 38,508 25,502
General and administrative 2,042 1,786 5,790 4,779
------- ------ ------- -------
Total operating expenses 20,286 19,410 55,075 44,235
------- ------ ------- -------
Income (loss) from operations 5,810 (2,403) 12,608 950
Other income, net 1,214 816 2,989 2,371
------- ------ ------- -------
Income (loss) before provision for income taxes 7,024 (1,587) 15,597 3,321
Provision for income taxes 1,405 683 3,119 1,664
------- ------ ------- -------
Net income (loss) $ 5,619 $ (2,270) $ 12,478 $ 1,657
======= ====== ======= =======
Net income (loss) per share (basic) $ 0.32 $ (0.14) $ 0.72 $ 0.10
======= ====== ======= =======
Net income (loss) per share (diluted) $ 0.29 $ (0.14) $ 0.64 $ 0.10
======= ====== ======= =======
Weighted average common shares (basic) 17,488 16,433 17,255 16,279
======= ====== ======= =======
Weighted average common shares
and equivalents (diluted) 19,557 16,433 19,369 17,138
======= ====== ======= =======
</TABLE>
See accompanying notes to condensed consolidated financial statements
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4
<PAGE>
MERCURY INTERACTIVE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Nine months ended
Sept 30,
1998 1997
---- ----
<S> <C> <C>
Net cash provided by operating activities $ 29,435 $ 12,974
Cash flows from investing activities:
Investment proceeds, net (13,426) 122
Acquisition of property and equipment (11,592) (10,075)
Capitalization of software development costs - (400)
------- -------
Net cash used in investing activities (25,018) (10,353)
------- -------
Cash flows from financing activities:
Proceeds from issuance of common stock 8,932 4,041
------- -------
Net cash provided by financing activities 8,932 4,041
------- -------
Effect of exchange rate changes on cash (178) (347)
------- -------
Net increase in cash and cash equivalents 13,171 6,315
Cash and cash equivalents at beginning of period 57,211 44,337
------- -------
Cash and cash equivalents at end of period $ 70,382 $ 50,652
======= =======
</TABLE>
See accompanying notes to condensed consolidated financial statements
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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, 1997, included in the 1997 Form
10-K. The condensed consolidated statement of operations for the nine
months ended September 30, 1998 is not necessarily indicative of results to
be expected for the entire fiscal year ending December 31, 1998.
2. The effective tax rate for the nine months ended September 30, 1998 differs
from statutory tax rates principally because of special reduced taxation
programs sponsored by the government of Israel.
3. 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 $369,000 and $1.6 million in the quarter and the nine months
ended September 30, 1998, respectively, and $1.1 million in the nine months
ended September 30, 1997. 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 $715,000 and $1.8 million for the quarter and the nine months
ended September 30, 1998, respectively, and $307,000 and $1.2 million for
the quarter and the nine months ended September 30, 1997, respectively. As
of September 30, 1998, the Company is committed to pay, if and when
incurred, approximately $3.6 million in royalties.
4. Earnings per share are calculated in accordance with the provisions of
Statement of Financial Accounting Standards No. 128, "Earnings per Share,"
(SFAS 128). SFAS 128 requires the Company to report both basic earnings
per share, which is the weighted-average number of common shares
outstanding, and diluted earnings per share, which includes the weighted-
average common shares outstanding and all dilutive potential common shares
outstanding. For the quarters ended September 30, 1998 and 1997, dilutive
potential common shares outstanding reflects shares issuable under the
Company's stock option plans. The following table summarizes the Company's
earnings per share computations for the quarters and the nine months ended
September 30, 1997 and 1998:
<TABLE>
<CAPTION>
Three months ended Nine months ended
Sept 30, Sept 30,
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net income (loss) for basic and diluted
earnings per share $ 5,619 $ (2,270) $ 12,478 $ 1,657
======= ======= ======= =======
Weighted average shares 17,488 16,433 17,255 16,279
Effect of dilutive securities 2,069 - 2,114 859
------- ------- ------- -------
Adjusted weighted average shares 19,557 16,433 19,369 17,138
------- ------- ------- -------
Net income (loss) per share (basic) $ 0.32 $ (0.14) $ 0.72 $ 0.10
======= ======= ======= =======
Net income (loss) per share (diluted) $ 0.29 $ (0.14) $ 0.64 $ 0.10
======= ======= ======= =======
</TABLE>
At September 30, 1998, there were no options considered anti-dilutive. At
September 30, 1997, options to purchase a total of 106,677 shares of common
stock with an average exercise price of $19.00 were considered anti-
dilutive because the options' exercise price was greater than the average
fair market value of the Company's common stock for the quarter then ended.
6
<PAGE>
5. Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income." This
Statement requires that all items recognized under accounting standards as
components of comprehensive earnings be reported in an annual financial
statement that is displayed with the same prominence as other annual
financial statements. This Statement also requires that an entity classify
items of other comprehensive earnings by their nature in an annual
financial statement. Net exchange gains or losses resulting from the
translation of assets and liabilities of foreign subsidiaries, except those
in highly inflationary economies, are accumulated in a separate section of
stockholders' equity titled, "Cumulative translation adjustment." Also
included are the effects of exchange rate changes on the intercompany
transactions of a long-term investment nature. An analysis of this account
follows:
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Opening balance $(363) $(375) $(424) $ (99)
Translation adjustments (239) (71) (178) (347)
----- ----- ----- -----
Ending balance $(602) $(446) $(602) $(446)
===== ===== ===== =====
</TABLE>
6. In June 1998, the Financial Accounting Standards Board issued SFAS 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS 133
establishes accounting and reporting standards for derivative instruments
and for hedging activities and is effective for all fiscal quarters of
fiscal years beginning after June 15, 1999. The Company does not expect the
adoption of SFAS 133 to have a material impact on the Company's results of
operations.
7
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Management's Discussion and Analysis of Financial Condition and
Results of Operations contains descriptions of the Company's expectations
regarding future trends affecting its business. These forward looking statements
and other forward looking statements made elsewhere in this document are made in
reliance upon the safe harbor provision of the Private Securities Litigation
Reform Act of 1995. Please read the section below titled "Factors that may
affect future results" to review conditions which the Company believes could
cause actual results to differ materially from those contemplated by the forward
looking statements. Forward-looking statements include, but are not limited to,
those items identified with a footnote symbol /1/. The Company undertakes no
obligation to update the information contained herein.
RESULTS OF OPERATIONS
REVENUE
License revenue increased 51% to $21.6 million during the third quarter of
1998 from $14.3 million in the third quarter of 1997. License revenue increased
48% to $56.3 million during the nine months ended September 30, 1998 from $37.9
million during the nine months ended September 30, 1997. The Company's growth
in license revenue reflected growth in license fees from the LoadRunner,
WinRunner and Test Director products, particularly for use by customers to test
Year 2000 remediation applications and electronic business and enterprise
resource planning application deployments. License revenue in the third quarter
of 1998 also benefited in absolute dollars from increased productivity from the
Company's alternate distribution channels, such as referral partners, system
integrators and value added resellers.
Service revenue increased to $9.1 million or 30% of total revenue in the
third quarter of 1998 from $5.3 million or 27% of total revenue in the third
quarter of 1997 and increased to $23.8 million, or 30% of total revenue in the
nine months ended September 30, 1998, from $14.6 million, or 28% of total
revenue in the nine months ended September 30, 1997. This increase of service
revenue in 1998 compared to 1997 was primarily due to the renewal of maintenance
contracts and an increase in training and consulting revenue. The Company
expects that service revenue will continue to increase in absolute dollars as
long as the Company's customer base continues to grow./1/
North American revenue in the quarter and the nine months ended September
30, 1998 represented 66% and 63%, respectively, of total revenue. International
revenue in the quarter and the nine months ended September 30, 1998 represented
34% and 37%, respectively, of total revenue. The Company expects international
revenue to continue to increase in absolute dollars, however, achievement of
these results cannot be assured./1/
COST OF REVENUE
License cost of revenue, as a percentage of license revenue, was 7% and 8%
in the quarter and the nine months ended September 30, 1998, respectively,
compared to 8% in both the quarter and the nine months ended September 30, 1997.
License cost of revenue includes cost of production personnel, product packaging
and amortization of capitalized software development costs.
Service cost of revenue, as a percentage of service revenue was 33% and 34%
in the quarter and the nine months ended September 30, 1998, respectively,
compared to 29% and 30% in the quarter and the nine months ended September 30,
1997, respectively. Service cost of revenue consists primarily of costs of
providing customer technical support, training and consulting. The increased
service cost of revenue in the quarter and the nine months ended September 30,
1998 reflected increased outsourcing of training and consulting.
________________________________
/1/ Forward looking statement
8
<PAGE>
RESEARCH AND DEVELOPMENT
Research and development, net was $4.1 million and $10.8 million, or 13% of
total revenue for the quarter and the nine months ended September 30, 1998,
respectively, compared to $3.0 million and $8.5 million, or 15% and 16% of total
revenue for the quarter and the nine months ended September 30, 1997,
respectively. The increase in spending in absolute dollars reflected increased
personnel costs from headcount growth and increased research and development
consulting costs.
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 $369,000 and $1.6 million in the quarter and the nine months ended September
30, 1998, respectively, and $1.1 million in the nine months ended September 30,
1997. 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 $715,000 and $1.8 million for the quarter
and the nine months ended September 30, 1998, respectively, and $307,000 and
$1.2 million for the quarter and the nine months ended September 30, 1997,
respectively. As of September 30, 1998, the Company is committed to pay, if and
when incurred, approximately $3.6 million in royalties.
During the quarter and the nine months ended September 30, 1998, the
Company did not capitalize any software development costs. The Company
capitalized $100,000 and $400,000 in the quarter and the nine months ended
September 30, 1997, 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." Amortization charges included in cost
of license revenues were $150,000 and $450,000 for the quarter and the nine
months ended September 30, 1998 and 1997, respectively. At September 30, 1998
and December 31, 1997, the Company had a balance in capitalized software
development costs of approximately $735,000 and $1.2 million, respectively.
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./1/ 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 or will not be rendered obsolete by
future technology acquisitions or developments./1/ 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 AND SELLING
Marketing and selling expenses were $14.1 million, or 46% of total revenue,
and $38.5 million, or 48% of total revenue, in the quarter and the nine months
ended September 30, 1998, respectively, compared to $9.2 million, or 47% of
total revenue, and $25.5 million, or 49% of total revenue, in the quarter and
the nine months ended September 30, 1997, respectively. The increase in
absolute dollars in marketing and selling expense was primarily due to an
increase in commission expense attributable to the higher revenue level and
other personnel-related costs reflecting the growth in sales headcount. The
Company expects marketing and selling expenses to increase in absolute dollars
as total revenue increases, but such expenses may vary as a percentage of
revenue./1/
GENERAL AND ADMINISTRATIVE
General and administrative expenses were $2.0 million and $5.8 million, or
7% of total revenue, in both the quarter and the nine months ended September 30,
1998, respectively, compared to $1.8 million and $4.8 million, or 9% of total
revenue, in both the quarter and the nine months ended September 30, 1997,
respectively. The increase in absolute dollars reflected increased personnel
and information systems costs.
________________________________
/1/ Forward looking statement
9
<PAGE>
OTHER INCOME, NET
Other income, net consists primarily of interest income and foreign
exchange gains and losses. The increase in other income, net to $1.2 million
and $3.0 million for the quarter and the nine months ended September 30, 1998,
respectively, from $816,000 and $2.4 million for the quarter and the nine months
ended September 30, 1997, respectively, reflected increased interest income on
higher average cash and investment balances in the quarter and the nine months
ended September 30, 1998.
PROVISION FOR INCOME TAXES
The Company participates in special programs sponsored by the government of
Israel relating to taxation, contributing to significant lower income tax
expense than expected based on the U.S. federal income tax rate. 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 $5.6 million and $12.5 million in the
quarter and the nine months ended September 30, 1998, respectively, compared to
net loss of $2.3 million and net income of $1.7 million in the quarter and the
nine months ended September 30, 1997, respectively. 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./1/ If revenue does not materialize in a quarter as expected,
the Company's results from operations for the quarter are likely to be
materially adversely affected. Net income may be disproportionately affected by
a reduction in revenue because only a small portion of the Company's expenses
varies with its revenue.
INFLATION
Inflation has not had a significant impact on the Company's operating
results to date.
YEAR 2000
The approach of Year 2000 presents significant issues for many computer
systems, since much of the software in use today may not accurately process data
beyond 1999. The Company is in the process of conducting an internal review of
most of its internal corporate headquarters computer systems and software ("IT
Systems") including finance, human resources, Intranet applications, payroll
systems and customer support organization systems to determine their Year 2000
compliance. As part of this process, the Company is contacting vendors of its
relevant internal corporate headquarters IT Systems to determine potential
exposure to Year 2000 issues and will be obtaining written assurance from such
vendors regarding Year 2000 compliance. Although the Company believes that
most of its principal internal corporate headquarters IT Systems are Year 2000
compliant, the Company has not yet made an assessment of the status of other
property and equipment not directly associated with information systems.
At this time, the Company has not determined the state of compliance of
certain third-party suppliers of services such as phone companies, long distance
carriers, financial institutions and electric companies. The failure of any one
of these third-party suppliers could severely disrupt the Company's ability to
carry on its business as well as disrupt the business of the Company's
customers. The Company is beginning the process of polling these companies in
order to determine contingency plans.
________________________________
/1/ Forward looking statement
10
<PAGE>
Failure of the Company to provide Year 2000 compliant business solutions to
its customers or to receive such business solutions from its suppliers could
result in liability to the Company or otherwise have a material adverse effect
on the Company's business, results of operations, financial condition and
prospects. Furthermore, the Company believes that the purchasing patterns of
customers and potential customers may be affected by Year 2000 issues as
companies expend significant resources to correct or patch their current
software systems for Year 2000 compliance. These expenditures may result in
reduced funds available to purchase products and services such as those offered
by the Company, which could result in a material adverse effect on the Company's
business, results of operations and financial condition. The Company could be
affected through disruptions in the operation of the enterprises with which the
Company interacts or from general widespread problems or an economic crisis
resulting from noncompliant Year 2000 systems. Despite the Company's efforts to
address the Year 2000 effect on its internal systems and business operations,
such effect could result in a material disruption of its business or have a
material adverse effect on the Company's business, financial condition or
results of operations. The Company has just begun the process of developing a
contingency plan to respond to any of the foregoing consequences of internal and
external failures to be Year 2000 compliant.
In selling its products, the Company frequently relies 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. Further,
the Company's license agreements typically contain a representation that the
software is Year 2000 compliant through its description of specifically how the
Company's products process the Year 2000 calendar dates. While the Company
believes its products are Year 2000 compliant, the risk of Year 2000
noncompliance claims may increase as December 31, 1999 approaches and passes.
The Company currently carries errors and omissions insurance against such
claims, however, 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 or other Year 2000 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 would
have a material adverse effect upon the Company's business, financial condition
and results of operations.
FACTORS THAT MAY AFFECT FUTURE RESULTS
The Company operates in a dynamic and rapidly changing environment that
involves numerous risks and uncertainties. The following section lists some,
but not all, of those risks and uncertainties which may have a material adverse
effect on the Company's business, financial condition or results of operations.
This section should be read in conjunction with the unaudited Condensed
Consolidated Financial Statements and Notes thereto included in Part I - Item 1
of this Quarterly Report on Form 10-Q and the audited Consolidated Financial
Statements and Notes thereto and Management's Discussion and Analysis of
Financial Condition and Results of Operations for the year ended December 31,
1997, contained in the Company's 1997 Form 10-K. The Company has identified
certain forward-looking statements in the Management's Discussion and Analysis
of Financial Condition and Results of Operations with a footnote symbol /1/.
The Company may also make oral forward looking statements from time to time.
Actual results may differ materially from those projected in any such forward
looking statements due to a number of factors, including those set forth below
and elsewhere in this Form 10-Q.
The market for software 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 such 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.
11
<PAGE>
The market for automated software testing products is relatively new and
not well penetrated. 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 the market for automated software
testing products will continue to expand 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, there
can be no assurance that the automated software testing market will enjoy
continued growth./1/
The Company's current products and products under development are limited
in number and concentrated exclusively in the automated 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 material
adverse effect on the Company's results of operations or financial position.
The Company may from time to time experience significant fluctuation in
quarterly operating results due to a variety of factors. 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 a quarter, up to the
last few days of a quarter. If an unanticipated order shortfall occurs at the
end of a quarter, the Company's operating results for the quarter could be
materially adversely affected. In addition, product orders are affected by the
buying patterns of customers. The buying trends of customers are further
impacted by internal budgetary considerations relating to Year 2000 remediation
or Euro conversion efforts. 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.
The market for software products, in general, is highly competitive. The
Company continues to face direct competition mainly from well established,
publicly-held companies. There could be a material 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 and sales 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 has derived a substantial portion of its revenues from sales of
its products through alternate distribution channels such as referral partners,
system integrators, and value-added resellers. The Company expects that sales
of its products through its alternate distribution channels will continue to
account for a substantial portion of its revenues for the foreseeable future.
Each of the Company's system integrators and value added resellers can cease
marketing the Company's products with limited notice and with little or no
penalty. There can be no assurance that the Company's system integrators and
value added resellers will continue to offer the Company's products or that the
Company will be able to recruit additional or replacement system integrators and
value added resellers. The loss of one or more of the Company's major system
integrators and value added resellers could have a material adverse effect on
the Company's business, financial condition and results of operations. The
Company's system integrators and value added resellers also offer competitive
products manufactured by third parties. There can be no assurance that the
Company's system integrators and value added resellers will give priority to the
marketing of the Company's products as compared to its competitors' products.
Any reduction or delay in sales of the Company's
________________________________
/1/ Forward looking statement
12
<PAGE>
products by its system integrators and value added resellers could have a
material adverse effect on the Company's business, financial condition and
results of operations.
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./1/ Accordingly, such factors as currency fluctuations, political
and economic instability and trade restrictions could have a negative impact on
the Company's financial performance.
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
material adverse effect on the Company's results of operations and financial
position. The Company attempts to limit these exposures through operational
strategies and, on a limited basis, by using foreign currency forward contracts
to offset the effects of exchange rate changes on intercompany trade payables.
The Company's stock price, has been and will continue to be, 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 impacted by broader
market trends that are unrelated to the Company's operating results.
As part of its growth strategy, the Company may, from time to time, acquire
or invest in complementary businesses, products or technologies. While there
are currently no commitments with respect to any particular acquisition or
investment, the Company's management frequently evaluates the strategic
opportunity available related to complimentary businesses, products or
technologies. 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 or investment will be realized. Future acquisitions or investments
by the Company could result in potentially dilutive issuances of equity
securities, the incurrence of debt and contingent liabilities, 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. There can be no assurances that the
Company will be awarded such grants in the future or that if such grants are
made available in the future, that the Company will choose to accept them.
Termination or substantial reduction of such grants or changes in revenue
classification could have a material 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 1991, 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 has been 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 will be required to
hire and integrate substantial numbers of new employees. The market has become
increasingly competitive both in the United States and internationally and may
require the Company to pay higher salaries. The Company's failure to manage
growth effectively could have a material adverse effect on the Company's results
of operations or financial position.
________________________________
/1/ Forward looking statement
13
<PAGE>
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, including sales, technical and management personnel, 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 holds three patents for elements contained in certain of its products,
and it has filed several other U.S. and foreign patent applications on various
elements of its products. 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 of 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 frequently relies 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. Further,
the Company's license agreements typically contain a representation that the
software is Year 2000 compliant through its description of specifically how the
Company's products process the Year 2000 calendar dates. While the Company
believes its products are Year 2000 compliant, the risk of Year 2000
noncompliance claims may increase as December 31, 1999 approaches and passes.
The Company currently carries errors and omissions insurance against such
claims, however, 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 or other Year 2000 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 approach of Year 2000 presents significant issues for many computer
systems, since much of the software in use today may not accurately process data
beyond 1999. The Company is in the process of conducting an internal review of
most of its internal corporate headquarters computer systems and software ("IT
Systems") including finance, human resources, Intranet applications, payroll
systems and customer support organization systems to determine their Year 2000
compliance. As part of this process, the Company is contacting vendors of its
relevant internal corporate headquarters IT Systems to determine potential
exposure to Year 2000 issues and will be obtaining written assurance from such
vendors regarding Year 2000 compliance. Although the Company believes that
most of its principal internal corporate headquarters IT Systems are Year 2000
compliant, the Company has not yet made an assessment of the status of other
property and equipment not directly associated with information systems.
At this time, the Company has not determined the state of compliance of
certain third-party suppliers of services such as phone companies, long distance
carriers, financial institutions and electric companies. The failure of any one
of these third-party suppliers could severely disrupt the Company's ability to
carry on its business as well as disrupt the business of the Company's
customers. The Company is beginning the process of polling these companies in
order to determine contingency plans.
Failure of the Company to provide Year 2000 compliant business solutions to
its customers or to receive such business solutions from its suppliers could
result in liability to the Company or otherwise have a material adverse effect
on the Company's business, results of operations, financial condition and
prospects. Furthermore, the Company believes that the purchasing patterns of
customers and potential customers may be affected by Year 2000 issues as
companies expend significant resources to correct or patch their current
software systems for Year 2000
14
<PAGE>
compliance. These expenditures may result in reduced funds available to purchase
products and services such as those offered by the Company, which could result
in a material adverse effect on the Company's business, results of operations
and financial condition. The Company could be affected through disruptions in
the operation of the enterprises with which the Company interacts or from
general widespread problems or an economic crisis resulting from noncompliant
Year 2000 systems. Despite the Company's efforts to address the Year 2000 effect
on its internal systems and business operations, such effect could result in a
material disruption of its business or have a material adverse effect on the
Company's business, financial condition or results of operations. The Company
has just begun the process of developing a contingency plan to respond to any
of the foregoing consequences of internal and external failures to be Year 2000
and leap year compliant.
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
At September 30, 1998, the Company's short-term investments consisted of
investments in high-quality financial, government and corporate securities.
Cash, cash equivalents and investments increased to $118.9 million at September
30, 1998, from $92.3 million at December 31, 1997. During the nine months ended
September 30, 1998, the Company generated approximately $29.4 million from
operations due primarily to profits from operations, collection of trade
receivables and an increase in deferred revenue. In addition, during the nine
months ended September 30, 1998, the Company received $8.9 million from the
issuance of Common Stock under the employee stock option and stock purchase
plans.
During the nine months ended September 30, 1998, the Company's primary
investing activities were purchases of property and equipment totaling $11.6
million. This included $1.1 million for construction of a new research and
development facility in Israel. The Company expects to spend an additional $2.6
million to complete construction of this facility before relocating its Israel
subsidiary there in 1999.
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./1/
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company has an investment portfolio of fixed income securities that are
classified as "held to maturity" securities. These securities, like all fixed
income instruments, are subject to interest rate risk and will decline in value
if market interest rates increase. The Company attempts to limit this exposure
by investing primarily in short-term securities and holding securities to
maturity.
________________________________
/1/ Forward looking statement
15
<PAGE>
MERCURY INTERACTIVE CORPORATION
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS
(a) The Special Meeting of the Stockholders (the "Meeting") of Mercury
Interactive Corporation was held at the Company's offices at 1325 Borregas
Avenue, Sunnyvale, California 94089 on August 14, 1998 at 10:00 a.m.
(b) The following proposals were considered at the Meeting with their results
according to the respective vote of the stockholders:
PROPOSAL 1 - To ratify and approve the adoption of the 1998 Employee Stock
Purchase Plan to replace the 1993 Employee Stock Purchase Plan and the
reservation of 325,000 shares for issuance thereunder.
For 15,639,470
Against 140,517
Abstain 19,926
PROPOSAL 2 - To ratify and approve the reservation of an additional 300,000
shares of Common Stock for issuance under the Amended and Restated 1989
Stock Option Plan.
For 9,317,570
Against 6,462,942
Abstain 19,401
PROPOSAL 3 - To ratify and approve the adoption of the 1999 Stock Option
Plan to replace the Amended and Restated 1989 Stock Option Plan, effective
on the expiration of the term of such plan in August 1999, and the
reservation of 225,000 shares for the issuance thereunder.
For 9,669,122
Against 6,108,065
Abstain 22,726
PROPOSAL 4 - To ratify and approve the amendment of the 1994 Directors'
Stock Option Plan to increase the number of shares granted as an initial
grant to new non-employee directors and an annual grant to continuing non-
employee directors of the Corporation, and to provide for a one-time grant
to the non-employee directors of the Corporation who are serving as
directors of the Corporation as of the date of this Special Meeting of
Stockholders.
For 11,604,592
Against 4,169,849
Abstain 25,472
16
<PAGE>
ITEM 5. OTHER INFORMATION
Stockholder proposals related to the Company's 1999 Annual Meeting of
Stockholders, but submitted outside the processes of Rule 14a-8 under the
Securities Exchange Act of 1934, must be received by the company prior to March
6, 1999 in order to withhold authority of management proxies to use their
discretionary voting authority with respect to any such proposal.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) 3.1 - Certificate of Amendment of the Restated Certificate of
Incorporation
(b) 27.1 - Financial Data Schedule.
(c) No reports on Form 8-K were filed during the quarter ended September 30,
1998.
17
<PAGE>
SIGNATURE
- ---------
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 13, 1998 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)
18
<PAGE>
INDEX TO EXHIBITS
-----------------
Exhibit Description
No.
3.1 Certificate of Amendment of the Restated Certificate of
Incorporation
27.1 Financial Data Schedule
19
<PAGE>
EXHIBIT 3.1
CERTIFICATE OF AMENDMENT
OF
RESTATED CERTIFICATE OF INCORPORATION
Mercury Interactive Corporation, a corporation organized and existing under and
by virtue of the General Corporation Law of the State of Delaware,
DOES HEREBY CERTIFY:
FIRST: That at a meeting of the Board of Directors of Mercury Interactive
Corporation, resolutions were duly adopted setting forth a proposed amendment of
the Certificate of Incorporation of said corporation, declaring said amendment
to be advisable and calling a meeting of the stockholders of said corporation
for consideration thereof. The resolution setting forth the proposed amendment
is as follows:
RESOLVED: that the Restated Certificate of Incorporation of this
corporation by amended by changing the first paragraph of the Article thereof
numbered III so that, as amended said first paragraph of said Article shall be
and read as follows:
"This corporation is authorized to issue two classes of stock to be
designated, respectively, "Common Stock" and "Preferred Stock". The total
number of shares which the corporation is authorized to issue is Sixty-five
Million (65,000,000) shares. Sixty Million (60,000,000) shares shall be Common
Stock and Five Million (5,000,000) shares shall be Preferred Stock, each with a
par value of $.002 per share."
SECOND: That thereafter, pursuant to resolution of its Board of Directors,
a meeting of the stockholders of said corporation was duly called and held,
upon notice in accordance with Section 222 of the General Corporation Law of the
state of Delaware at which meeting the necessary number of share as required by
statue were voted in favor of the amendment.
THIRD: That said amendment was duly adopted in accordance with the
provisions of Section 242 of the General Corporation Law of the State of
Delaware.
IN WITNESS WHEREOF, Mercury Interactive Corporation has caused this
certificate to be signed by Amnon Landan, its Chief Executive Officer, and
Sharlene Abrams, its Secretary, this 20/th/ day of May, 1998.
By: /s/ Amnon Landan
-----------------------------
Chief Executive Officer
Attest: /s/ Sharlene Abrams
---------------------
Secretary
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<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JUL-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 70,382
<SECURITIES> 48,554
<RECEIVABLES> 22,213
<ALLOWANCES> 2,686
<INVENTORY> 214
<CURRENT-ASSETS> 149,220
<PP&E> 41,494
<DEPRECIATION> (13,957)
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0
0
<COMMON> 35
<OTHER-SE> 134,184
<TOTAL-LIABILITY-AND-EQUITY> 177,492
<SALES> 30,600
<TOTAL-REVENUES> 30,600
<CGS> 4,504
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