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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 JUNE 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 July 31,
1998 was 17,409,263.
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MERCURY INTERACTIVE CORPORATION
-------------------------------
INDEX
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PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Page No.
--------
<S> <C> <C>
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets -
June 30, 1998 and December 31, 1997 3
Condensed Consolidated Statements of Operations -
Three and six months ended June 30, 1998 and 1997 4
Condensed Consolidated Statements of Cash Flows -
Six months ended June 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 14
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Stockholders 15
Item 6. Exhibits and Reports on Form 8-K 15
SIGNATURE 16
INDEX TO EXHIBITS 17
</TABLE>
2
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PART I. FINANCIAL INFORMATION
- -----------------------------
ITEM 1. FINANCIAL STATEMENTS
MERCURY INTERACTIVE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
June 30, December 31,
1998 1997
(unaudited) (audited)
----------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 71,476 $ 57,211
Short-term investments 36,318 31,357
Trade accounts receivable 18,981 23,782
Government grants and other receivables 3,970 3,606
Inventories 205 252
Other current assets 6,179 2,954
-------- --------
Total current assets 137,129 119,162
Long-term investments 1,498 3,771
Property and equipment, net 25,620 19,292
Other assets 885 1,185
-------- ---------
$ 165,132 $ 143,410
======== =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 5,221 $ 4,045
Accrued liabilities 15,786 15,411
Deferred revenue 18,365 10,967
-------- --------
Total current liabilities 39,372 30,423
-------- --------
Commitments and contingencies
Stockholders' equity:
Common stock 35 33
Capital in excess of par value 113,651 107,800
Cumulative translation adjustment (363) (424)
Retained earnings 12,437 5,578
-------- --------
Total stockholders' equity 125,760 112,987
-------- --------
$ 165,132 $ 143,410
======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements
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MERCURY INTERACTIVE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenue:
License $ 19,100 $ 12,300 $ 34,700 $ 23,583
Service 8,100 5,200 14,700 9,317
-------- ------- ------- --------
Total revenue 27,200 17,500 49,400 32,900
-------- ------- ------- --------
Cost of revenue:
License 1,550 992 2,879 1,896
Service 2,600 1,612 4,934 2,826
-------- ------- ------- --------
Total cost of revenue 4,150 2,604 7,813 4,722
-------- ------- ------- --------
Gross profit 23,050 14,896 41,587 28,178
-------- ------- ------- --------
Operating expenses:
Research and development, net 3,656 2,928 6,679 5,484
Marketing and selling 13,379 8,574 24,362 16,348
General and administrative 1,899 1,563 3,748 2,993
-------- ------- ------- --------
Total operating expenses 18,934 13,065 34,789 24,825
-------- ------- ------- --------
Income from operations 4,116 1,831 6,798 3,353
Other income, net 925 846 1,775 1,555
-------- ------- ------- --------
Income before provision for income taxes 5,041 2,677 8,573 4,908
Provision for income taxes 1,008 535 1,714 981
-------- ------- ------- --------
Net income $ 4,033 $ 2,142 $ 6,859 $ 3,927
======== ======= ======= ========
Net income per share (basic) $ 0.23 $ 0.13 $ 0.40 $ 0.24
======== ======= ======= ========
Net Income per share (diluted) $ 0.21 $ 0.13 $ 0.36 $ 0.23
======== ======= ======= ========
Weighted average common shares (basic) 17,285 16,267 17,138 16,202
======== ======= ======= ======
Weighted average common shares
and equivalents (diluted) 19,410 17,001 19,275 16,823
======== ======= ======= ======
</TABLE>
See accompanying notes to condensed consolidated financial statements
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4
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MERCURY INTERACTIVE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Six months ended
June 30,
1998 1997
-------- --------
<S> <C> <C>
Net cash provided by operating activities $ 19,443 $ 8,856
Cash flows from investing activities:
Investment purchases, net (2,688) (8,095)
Acquisition of property and equipment (8,404) (2,610)
Capitalization of software development costs - (300)
------- -------
Net cash used in investing activities (11,092) (11,005)
------- -------
Cash flows from financing activities:
Proceeds from issuance of common stock 5,853 1,849
------- -------
Net cash provided by financing activities 5,853 1,849
------- -------
Effect of exchange rate changes on cash 61 (276)
------- -------
Net increase (decrease) in cash and cash equivalents 14,265 (576)
Cash and cash equivalents at beginning of period 57,211 44,337
------- -------
Cash and cash equivalents at end of period $ 71,476 $ 43,761
======= =======
</TABLE>
See accompanying notes to condensed consolidated financial statements
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5
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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 six
months ended June 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 six months ended June 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 $410,000 and $1.2 million in the quarter and the six months
ended June 30, 1998, respectively, and $379,000 and $1.1 million in the
quarter and the six months ended June 30, 1997, respectively. 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 $586,000 and $1.1 million for the
quarter and the six months ended June 30, 1998, respectively, and $453,000
and $867,000 for the quarter and the six months ended June 30, 1997,
respectively. As of June 30, 1998, the Company is committed to pay, if and
when incurred, approximately $5.0 million in royalties.
4. Earnings per share are calculated in accordance with the provisions of
Statement of 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 June 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 ended June 30, 1997 and 1998:
<TABLE>
<CAPTION>
Net Average Earnings
income shares per share
-------- -------- ---------
<S> <C> <C> <C>
June 30, 1997:
Basic earnings per share.... $ 2,142 16,267 $ 0.13
Dilutive adjustments........ - 734
-------- -------
Diluted earnings per share.. $ 2,142 17,001 $ 0.13
======== =======
June 30, 1998:
Basic earnings per share.... $ 4,033 17,285 $ 0.23
Dilutive adjustments........ - 2,125
-------- -------
Diluted earnings per share.. $ 4,033 19,410 $ 0.21
======== =======
</TABLE>
At June 30, 1998 there were no options considered anti-dilutive. At June
30, 1997, options to purchase a total of 181,836 shares of common stock
with an average exercise price of $18.16 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.
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
6
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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 Six months ended
June 30, June 30,
1998 1997 1998 1997
-------- -------- -------- -------
<S> <C> <C> <C> <C>
Opening balance $ (284) $ (361) $ (424) $ (99)
Translation adjustments (79) (14) 61 (276)
------- ------- ------- -------
Ending balance $ (363) $ (375) $ (363) $ (375)
======= ======= ======= =======
</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
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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 55% to $19.1 million during the second
quarter of 1998 from $12.3 million in the second quarter of 1997. License
revenue increased 47% to $34.7 million during the six months ended June 30, 1998
from $23.6 million during the six months ended June 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 second
quarter of 1998 also benefited from increased productivity from the Company's
alternate distribution channels, such as referral partners, system integrators
and value added resellers.
Service revenue increased to $8.1 million or 30% of total revenue in
the second quarter of 1998 from $5.2 million or 30% of total revenue in the
second quarter of 1997 and increased to $14.7 million, or 30% of total revenue
in the six months ended June 30, 1998, from $9.3 million, or 28% of total
revenue in the six months ended June 30, 1997. This increase of service revenue
in absolute dollars 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 both the quarter and the six months ended
June 30, 1998 represented 65% of total revenue. International revenue in both
the quarter and the six months ended June 30, 1998 represented 35% 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 8% in
both the quarter and the six months ended June 30, 1998, unchanged from the
quarter and the six months ended June 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 32%
and 34% in the quarter and the six months ended June 30, 1998, respectively,
compared to 31% and 30% in the quarter and the six months ended June 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 six months ended June 30, 1998 reflected
increased outsourcing of training and consulting.
- ---------------------------------
/1/ Forward looking statement
8
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RESEARCH AND DEVELOPMENT
Research and development, net was $3.7 million and $6.7 million, or
13% and 14% of total revenue for the quarter and the six months ended June 30,
1998, respectively, compared to $2.9 million and $5.5 million, or 17% of total
revenue for both the quarter and the six months ended June 30, 1997,
respectively. The increase in spending in absolute dollars reflected increased
personnel costs from headcount growth.
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 $410,000 and $1.2 million in the quarter and the six months ended
June 30, 1998, respectively, and $379,000 and $1.1 million in the quarter and
the six months ended June 30, 1997, respectively. 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 $586,000 and
$1.1 million for the quarter and the six months ended June 30, 1998,
respectively, and $453,000 and $867,000 for the quarter and the six months ended
June 30, 1997, respectively. As of June 30, 1998, the Company is committed to
pay, if and when incurred, approximately $5.0 million in royalties.
During the quarter and the six months ended June 30, 1998, the Company
did not capitalize any software development costs. The Company capitalized
$150,000 and $300,000 in the quarter and the six months ended June 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 $300,000 for the quarter and the six months ended June 30,
1998 and 1997, respectively. At June 30, 1998 and December 31, 1997, the
Company had a balance in capitalized software development costs of approximately
$885,000 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 $13.4 million and $24.4 million,
or 49% of total revenue, in both the quarter and the six months ended June 30,
1998, respectively, from $8.6 million, or 49% of total revenue, and $16.3
million, or 50% of total revenue, in the quarter and the six months ended June
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 $1.9 million, or 7% of total
revenue, and $3.7 million, or 8% of total revenue, in the quarter and the six
months ended June 30, 1998, respectively, from $1.6 million, and $3.0 million,
or 9% of total revenue, in both the quarter and the six months ended June 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 $925,000 and
$1.8 million for the quarter and the six months ended June 30, 1998,
respectively, from $846,000 and $1.6 million for the quarter and the six months
ended June 30, 1997, respectively, reflected increased interest income on higher
average cash and investment balances in the quarter and the six months ended
June 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 $4.0 million and $6.9 million in
the quarter and the six months ended June 30, 1998, respectively, compared to
net income of $2.1 million and $3.9 million in the quarter and the six months
ended June 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 has recently implemented new information systems and
accordingly does not anticipate any internal Year 2000 issues from its own
information systems, databases or programs./1/ However, the Company could be
adversely impacted by Year 2000 issues faced by major distributors, suppliers,
customers, vendors and financial service organizations with which the Company
interacts. The Company is currently taking steps to address the impact, if any,
of the Year 2000 issue on the operations of the Company. There can be no
assurances that the Company will be able to detect all potential failures of the
Company's and/or third parties' computer systems. A significant failure of the
Company's or a third party's computer system could have a material adverse
effect on the Company's business, financial condition and result of operations.
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.
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
- ---------------------------------
/1/ Forward looking statement
10
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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 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
- -------------------------------
/1/ Forward looking statement
11
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marketing of the Company's products as compared to its competitors' products.
Any reduction or delay in sales of the Company's 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 generally has not hedged currency
exposures.
As part of its growth strategy, the Company may, from time to time,
acquire or invest in complementary businesses, products or technologies. For
example, in the third quarter of 1997, the Company purchased certain
technologies which the Company has integrated into the recently announced
version 5.0 of the Company's products. 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.
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.
- ---------------------------------
/1/ Forward looking statement
12
<PAGE>
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 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.
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 has recently implemented new information systems and
accordingly does not anticipate any internal Year 2000 issues from its own
information systems, databases or programs./1/ However, the Company could be
adversely impacted by Year 2000 issues faced by major distributors, suppliers,
customers, vendors and financial service organizations with which the Company
interacts. The Company is currently taking steps to address the impact, if any,
of the Year 2000 issue on the operations of the Company. There can be no
assurances that the Company will be able to detect all potential failures of the
Company's and/or third parties' computer systems. A significant failure of the
Company's or a third party's computer system could have a material adverse
effect on the Company's business, financial condition and result of operations.
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.
- -----------------------------------
/1/ Forward looking statement
13
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 1998, the Company's short-term and long-term investments
consisted of investments in high-quality financial, government and corporate
securities. Cash, cash equivalents and investments increased to $109.3 million
at June 30, 1998, from $92.3 million at December 31, 1997. During the six
months ended June 30, 1998, the Company generated approximately $19.4 million
from operations due primarily to profits from operations, collection of trade
receivables and an increase in deferred revenue. In addition, during the six
months ended June 30, 1998, the Company received $5.9 million from the issuance
of Common Stock under the employee stock option and purchase plans.
During the six months ended June 30, 1998, the Company's primary
investing activities were purchases of property and equipment totaling $8.4
million. This included $2.1 million for construction of a new research and
development facility in Israel. The Company expects to spend an additional $6.2
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
14
<PAGE>
MERCURY INTERACTIVE CORPORATION
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS
(a) The 1998 Annual Meeting of the Stockholders of Mercury Interactive
Corporation was held at the Company's offices at 1325 Borregas Avenue,
Sunnyvale, California 94089 on May 10, 1998 at 10:00 a.m.
(b) At the Annual Meeting, the following five persons were elected to the
Company's Board of Directors, constituting all members of the Board of
Directors.
<TABLE>
<CAPTION>
Nominee For Withheld
------- --- --------
<S> <C> <C>
Aryeh Finegold 15,203,967 154,882
Amnon Landan 15,203,717 155,132
Igal Kohavi 15,202,562 156,287
Yair Shamir 15,203,267 155,582
Giora Yaron 15,202,932 155,917
</TABLE>
(c) The following additional proposals were considered at the Annual
Meeting with their results according to the respective vote of the
stockholders:
PROPOSAL 2 - Ratification and approval to increase the authorized
number of shares of Common Stock of the Company to 60,000,000.
<TABLE>
<CAPTION>
For Against Abstentions Broker Non-Votes
--- -------- ----------- ----------------
<S> <C> <C> <C>
10,164,624 5,177,584 16,641 0
</TABLE>
PROPOSAL 3 - The adoption and amendments to various employee stock
option plans, not approved.
<TABLE>
<CAPTION>
For Against Abstentions Broker Non-Votes
--- -------- ----------- ----------------
<S> <C> <C> <C>
5,287,613 6,777,792 26,700 0
</TABLE>
PROPOSAL 4 - Ratification and approval of the appointment of Price
Waterhouse LLP as independent accountants of the Company for the year
ending December 31, 1998.
<TABLE>
<CAPTION>
For Against Abstentions Broker Non-Votes
--- -------- ----------- ----------------
<S> <C> <C> <C>
15,339,649 7,140 12,060 0
</TABLE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) 27.1 - Financial Data Schedule.
(b) No reports on Form 8-K were filed during the quarter ended June 30,
1998.
15
<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: August 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)
16
<PAGE>
INDEX TO EXHIBITS
- -----------------
Exhibit Description Sequentially
No. Numbered Page
27.1 Financial Data Schedule 18
17
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> APR-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 71,476
<SECURITIES> 37,816
<RECEIVABLES> 21,110
<ALLOWANCES> 2,129
<INVENTORY> 205
<CURRENT-ASSETS> 137,129
<PP&E> 38,306
<DEPRECIATION> (12,686)
<TOTAL-ASSETS> 165,132
<CURRENT-LIABILITIES> 39,372
<BONDS> 0
0
0
<COMMON> 35
<OTHER-SE> 125,725
<TOTAL-LIABILITY-AND-EQUITY> 165,132
<SALES> 27,200
<TOTAL-REVENUES> 27,200
<CGS> 4,150
<TOTAL-COSTS> 4,150
<OTHER-EXPENSES> 18,934
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 5,041
<INCOME-TAX> 1,008
<INCOME-CONTINUING> 4,033
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4,033
<EPS-PRIMARY> 0.23
<EPS-DILUTED> 0.21
</TABLE>
