<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, 1999
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,
1999 was 38,360,116.
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MERCURY INTERACTIVE CORPORATION
INDEX
Page No.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets -
September 30, 1999 and December 31, 1998 3
Condensed Consolidated Statements of Operations -
Three and nine months ended September 30, 1999
and 1998 4
Condensed Consolidated Statements of Cash Flows -
Nine months ended September 30, 1999 and 1998 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 16
PART II. OTHER INFORMATION
Item 4. Exhibits and Reports on Form 8-K 16
SIGNATURE 17
INDEX TO EXHIBITS 18
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PART I. FINANCIAL INFORMATION
- -----------------------------
Item 1. Financial Statements
MERCURY INTERACTIVE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
(unaudited) (audited)
-------------- -------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 80,950 $ 96,073
Short-term investments 72,031 13,130
Trade accounts receivable 30,743 27,903
Other receivables 7,279 6,012
Prepaid expenses and other current assets 12,652 11,511
------------- ------------
Total current assets 203,655 154,629
Long-term investments 20,058 20,697
Property and equipment, net 34,098 28,250
------------- ------------
$ 257,811 $ 203,576
============= ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 5,316 $ 4,575
Accrued liabilities 25,297 17,792
Income taxes payable 13,742 11,498
Deferred revenue 31,201 24,122
------------- ------------
Total current liabilities 75,556 57,987
------------- ------------
Commitments and contingencies
Stockholders' equity:
Common stock 76 73
Capital in excess of par value 140,637 124,038
Notes receivable from issuance of stock (6,984) (5,130)
Accumulated comprehensive loss (1,000) (775)
Retained earnings 49,526 27,383
------------- ------------
Total stockholders' equity 182,255 145,589
------------- ------------
$ 257,811 $ 203,576
============= ============
</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 Nine months ended
September 30, September 30,
--------------------------- --------------------------
1999 1998 1999 1998
----------- ----------- ----------- ----------
<S> <C> <C> <C> <C>
Revenue:
License $ 33,500 $ 21,550 $ 87,400 $ 56,250
Service 14,000 9,050 40,200 23,750
----------- ----------- ----------- ----------
Total revenue 47,500 30,600 127,600 80,000
----------- ----------- ----------- ----------
Cost of revenue:
License 2,040 1,545 5,546 4,424
Service 4,948 2,959 13,461 7,893
----------- ----------- ----------- ----------
Total cost of revenue 6,988 4,504 19,007 12,317
----------- ----------- ----------- ----------
Gross profit 40,512 26,096 108,593 67,683
----------- ----------- ----------- ----------
Operating expenses:
Research and development, net 5,965 4,098 16,265 10,777
Marketing and selling 21,728 14,146 60,935 38,508
General and administrative 2,901 2,042 7,850 5,790
----------- ----------- ----------- ----------
Total operating expenses 30,594 20,286 85,050 55,075
----------- ----------- ----------- ----------
Income from operations 9,918 5,810 23,543 12,608
Other income, net 1,566 1,214 4,135 2,989
----------- ----------- ----------- ----------
Income before provision for income taxes 11,484 7,024 27,678 15,597
Provision for income taxes 2,297 1,405 5,535 3,119
----------- ----------- ----------- ----------
Net income $ 9,187 $ 5,619 $ 22,143 $ 12,478
=========== =========== =========== ==========
Net income per share (basic) $ 0.24 $ 0.16 $ 0.59 $ 0.36
=========== =========== =========== ==========
Net income per share (diluted) $ 0.22 $ 0.14 $ 0.53 $ 0.32
=========== =========== =========== ==========
Weighted average common shares (basic) 37,961 34,976 37,372 34,510
=========== =========== =========== ==========
Weighted average common shares
and equivalents (diluted) 42,489 39,114 41,748 38,738
=========== =========== =========== ==========
</TABLE>
See accompanying notes to condensed consolidated financial statements
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MERCURY INTERACTIVE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Nine months ended
September 30,
-----------------------------------
1999 1998
------------- ------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 22,143 $ 12,478
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 4,099 3,797
Changes in assets and liabilities:
Trade accounts receivable (2,840) 4,255
Other receivables (1,267) 427
Prepaid expenses and other current assets (1,591) (4,372)
Accounts payable 741 203
Accrued liabilities 7,505 508
Income taxes payable 2,244 1,745
Deferred revenue 7,079 10,394
------------- ------------
Net cash provided by operating activities 38,113 29,435
------------- ------------
Cash flows from investing activities:
Purchases of investments, net (58,262) (13,426)
Acquisition of property and equipment, net (9,497) (11,592)
------------- ------------
Net cash used in investing activities (67,759) (25,018)
------------- ------------
Cash flows from financing activities:
Proceeds from issuance of common stock, net 16,602 8,932
Notes receivable from issuance of stock (1,854) --
------------- ------------
Net cash provided by financing activities 14,748 8,932
------------- ------------
Effect of exchange rate changes on cash (225) (178)
------------- ------------
Net increase (decrease) in cash and cash equivalents (15,123) 13,171
Cash and cash equivalents at beginning of period 96,073 57,211
------------- ------------
Cash and cash equivalents at end of period $ 80,950 $ 70,382
============= ============
</TABLE>
See accompanying notes to condensed consolidated financial statements
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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, 1998, included in the 1998 Form
10-K. The condensed consolidated statements of operations for the three
months and nine months ended September 30, 1999 are not necessarily
indicative of results to be expected for the entire fiscal year ending
December 31, 1999.
2. The effective tax rate for the three months and nine months ended September
30, 1999 differs from statutory tax rates principally because of special
reduced taxation programs sponsored by the government of Israel.
3. The Company obtained no grants for research and development from the Office
of the Chief Scientist in the Israeli Ministry of Industry and Trade in the
three months and nine months ended September 30, 1999, and obtained grants
in the amount of $369,000 and $1.6 million in the three months and nine
months ended September 30, 1998, respectively. These grants were accounted
for using the cost reduction method, under which research and development
expenses were 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 $1.1 million and $2.7 million for the three months and nine
months ended September 30, 1999, respectively, and $715,000 and $1.8
million for the three months and nine months ended September 30, 1998,
respectively. The Company has not applied for, nor does it expect to apply
for, any future Chief Scientist grants.
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 number of common shares outstanding and all dilutive potential
common shares outstanding. For the three months and nine months ended
September 30, 1999 and 1998, dilutive potential common shares outstanding
reflected shares issuable under the Company's stock option plans. The
following table summarizes the Company's earnings per share computations
for the three months ended September 30, 1999 and 1998:
<TABLE>
<CAPTION>
Net Average Earnings
income shares per share
------ ------- ---------
<S> <C> <C> <C>
September 30, 1999:
Basic earnings per share................. $9,187 37,961 $0.24
Dilutive adjustments..................... - 4,528
------ ------
Diluted earnings per share............... $9,187 42,489 $0.22
====== ======
September 30, 1998:
Basic earnings per share................. $5,619 34,976 $0.16
Dilutive adjustments..................... - 4,138
------ ------
Diluted earnings per share............... $5,619 39,114 $0.14
====== ======
</TABLE>
At September 30, 1999, options to purchase 41,000 shares of common stock
with an average price of $64.56 were considered anti-dilutive because the
options' exercise price was greater than the average fair
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market value of the company's common stock for the quarter then ended. At
September 30, 1998, there were no options considered anti-dilutive.
5. The Company reports components of comprehensive income in its annual
consolidated statement of shareholders' equity. Other comprehensive income
consists of net income and foreign currency translation adjustments. The
Company's total comprehensive income (loss) were as follows:
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
--------------------------- ----------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net income $ 9,187 $ 5,619 $ 22,143 $ 12,478
Other comprehensive gain (loss) 158 (239) (225) (178)
----------- ----------- ----------- -----------
Other comprehensive income $ 9,345 $ 5,380 $ 21,918 $ 12,300
=========== =========== =========== ===========
</TABLE>
6. In March 1998, the AICPA issued Statement of Position 98-4, "Deferral of
Effective Date of a provision of SOP 97-2" ("SOP 98-4"). SOP 98-4 defers
for one year the application of certain provisions of Statement of Position
97-2, "Software Revenue Recognition" ("SOP 97-2"). Different informal and
non-authoritative interpretations of certain provisions of SOP 97-2 have
arisen and, as a result, the AICPA issued Statement of Position 98-9,
"Modification of SOP 97-2, Software Revenue Recognition, with Respect to
Certain Transactions" ("SOP 98-9"), in December 1998 which is effective for
periods beginning after March 15, 1999. SOP 98-9 extends the effective
date of SOP 98-4 and provides additional interpretive guidance. The
adoption of SOP 97-2, SOP 98-4 and SOP 98-9 have not had and are not
expected to have a material impact on the Company's results of operations,
financial position or cash flows.
7. In June 1999, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 137, "Accounting for Derivative
Instruments and Hedging Activities--Deferral of the Effective Date of FASB
Statement No. 133--an amendment of FASB Statement No. 133" ("SFAS 137").
SFAS 137 defers for one year the application of Statement of Financial
Accounting Standards No. 133, "Accounting for Derivative Instruments and
Hedging Activities" ("SFAS 133") to all fiscal quarters of fiscal years
beginning after June 15, 2000. SFAS 133 establishes accounting and
reporting standards for derivative instruments and for hedging activities.
The adoption of SFAS 133 AND SFAS 137 have not had and are not expected to
have a material impact on the Company's results of operations, financial
position or cash flows.
8. Statement of Financial Accounting Standards No. 131, "Disclosures about
Segments of an Enterprise and Related Information," requires companies to
report financial and descriptive information about their reportable
operating segments. The Company has three reportable operating segments
including the Americas, Europe, and the Rest of the World, which includes
Israel. These segments are organized, managed and analyzed geographically
and operate in one industry segment: the development and marketing of
automated software testing tools and related services. The Company
evaluates operating segment performance based primarily on net revenues and
certain operating expenses. The Company's products are marketed
internationally through the Company's subsidiaries and through referral
partners, system integrators, distributors and value-added resellers.
Financial information for the Company's operating segments is summarized
below for the three months and nine months ended September 30, 1999 and
1998:
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
------------------------------- ------------------------------
1999 1998 1999 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Net revenue to third parties:
Americas......................................... $ 31,600 $ 20,250 $ 84,800 $ 52,497
Europe........................................... 11,700 8,650 32,800 21,640
Rest of the World................................ 4,200 1,700 10,000 5,863
------------- ------------- ------------ ------------
Consolidated.................................. $ 47,500 $ 30,600 $ 127,600 $ 80,000
============= ============= ============ ============
</TABLE>
7
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<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
------------- -------------
<S> <C> <C>
Identifiable assets:
Americas......................................... $ 178,977 $ 149,464
Europe........................................... 15,604 17,407
Rest of the World................................ 63,230 36,705
------------- -------------
Consolidated.................................. $ 257,811 $ 203,576
============= =============
</TABLE>
The subsidiary located in the United Kingdom accounted for 10% and 11% of
the consolidated net revenue to unaffiliated customers for the three months
and nine months ended September 30, 1999, respectively, and accounted for
10% and 11% of the consolidated net revenue to unaffiliated customers for
the three months and the nine months ended September 30, 1998,
respectively. Operations located in Israel accounted for 22% of the
consolidated identifiable assets at September 30, 1999, and accounted for
17% of the consolidated identifiable assets at December 31, 1998. No other
subsidiary represented 10% or more of the related consolidated amounts for
the periods presented.
9. In October, 1999, the Company announced the signing of a letter of intent
to acquire privately-held Conduct Ltd., a developer of network management
and monitoring solutions based in Israel. The transaction is structured as
a share exchange under which the Company will issue 408,000 shares of
common stock in exchange for all issued and outstanding convertible
preferred and common shares of Conduct Ltd., and assumption of all
outstanding Conduct stock options, warrants and other securities. It is
expected that the acquisition will be accounted for as a pooling of
interests. Closing of the transaction is subject to certain conditions,
including the satisfactory completion of due diligence and execution of a
definitive agreement.
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 $33.5 million during the three months
ended September 30, 1999 from $21.6 million in the three months ended September
30, 1998. License revenue increased 55% to $87.4 million during the nine months
ended September 30, 1999 from $56.3 million during the nine months ended
September 30, 1998. 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 electronic business applications.
Service revenue increased 55% to $14.0 million during the three months
ended September 30, 1999 from $9.1 million in the three months ended September
30, 1998. Service revenue increased 69% to $40.2 million during the nine months
ended September 30, 1999 from $23.8 million during the nine months ended
September 30, 1998. For the three months and nine months ended September 30,
1999, service revenue growth was primarily due to installment based maintenance
contract renewals and an increase in training and consulting revenue. The
Company
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expects that service revenue will continue to increase in absolute dollars as
long as the Company's customer base continues to grow./1/
International revenue represented 33% and 34% of total revenue in the
three months and nine months ended September 30, 1999, respectively. The
absolute dollar growth in international revenue reflected the Company's
continued investment in international operations. 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, decreased to
6% in the three months and nine months ended September 30, 1999, from 7% and 8%
in the three months and nine months ended September 30, 1998, respectively.
License cost of revenue includes cost of production personnel, product packaging
and amortization of capitalized software development costs. The decreased
license cost of revenue as a percentage of revenue in the three months and nine
months ended September 30, 1999 reflected primarily flat absolute dollar
amortization of capitalized software development costs in the three months and
nine months ended September 30, 1999 and 1998.
Service cost of revenue, as a percentage of service revenue was 35% and 33%
in the three months and nine months ended September 30, 1999, respectively,
compared to 33% and 34% in the three months and nine months ended September 30,
1998, respectively. Service cost of revenue consists primarily of costs of
providing customer technical support, training and consulting. Service cost of
revenue as a percentage of service revenue may vary based on the degree of
outsourcing of training and consulting and the profitability of individual
consulting engagements.
Research and development, net
Research and development, net was $6.0 million and $16.3 million, or
13% of total revenue for both the three months and nine months ended September
30, 1999, respectively, compared to $4.1 million and $10.8 million, or 13% of
total revenue for the three months and nine months ended September 30, 1998,
respectively. The increase in absolute dollars in the three months and nine
months ended September 30, 1999 reflected an increase in spending due to growth
in research and development headcount, and increased royalty payments to the
Office of the Chief Scientist in Israel.
The Company obtained no grants for research and development from the Office
of the Chief Scientist in the Israeli Ministry of Industry and Trade in the
three months and nine months ended September 30, 1999, and obtained grants in
the amount of $369,000 and $1.6 million in the three months and nine months
ended September 30, 1998, respectively. These grants were accounted for using
the cost reduction method, under which research and development expenses were
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 $1.1 million
and $2.7 million for the three months and nine months ended September 30, 1999,
respectively, and $715,000 and $1.8 million for the three months and nine months
ended September 30, 1998, respectively. The Company has not applied for, nor
does it expect to apply for, any future Chief Scientist grants.
During the three months and nine months ended September 30, 1999 and 1998,
the Company did not capitalize any software development costs. Amortization
charges included in cost of license revenues were $150,000 and $450,000 for the
three months and nine months ended September 30, 1999 and 1998, respectively. At
September 30, 1999 and December 31, 1998, the Company had a balance in
capitalized software development costs of approximately $135,000 and $585,000,
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
_________________________________
/1/ Forward looking statement
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Company believes that these current research and development expenditures will
be beneficial in the long term development of its business, there can be no
assurance 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 $21.7 million, or 46% of total revenue,
and $60.9 million, or 48% of total revenue, in the three months and nine months
ended September 30, 1999, respectively, compared to $14.1 million, or 46% of
total revenue, and $38.5 million, or 48% of total revenue, in the three months
and nine months ended September 30, 1998, respectively. The absolute dollar
increase in marketing and selling expenses was primarily due to increased
commission expense attributable to the higher revenue level, an increase in
other personnel-related costs reflecting the growth in sales and marketing
headcount, and increased spending on marketing programs. 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 $2.9 million and $7.9 million, or
6% of total revenue, in both the three months and nine months ended September
30, 1999, respectively, from $2.0 million and $5.8 million, or 7% of total
revenue, in both the three months and nine months ended September 30, 1998,
respectively. The increase in absolute dollar spending reflected increased
staffing and related spending necessary to manage and support the Company's
growth.
Other income, net
Other income, net consists primarily of interest income and foreign
exchange gains and losses. The increase in other income, net to $1.6 million and
$4.1 million for the three months and nine months ended September 30, 1999,
respectively, from $1.2 million and $3.0 million for the three months and nine
months ended September 30, 1998, respectively, reflected primarily increased
interest income on higher average cash and investment balances in the three
months and nine months ended September 30, 1999.
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 income 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 $9.2 million and $22.1 million in the
three months and nine months ended September 30, 1999, respectively, compared to
net income of $5.6 million and $12.5 million in the three months and nine months
ended September 30, 1998, 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.
________________________________
/1/ Forward looking statement
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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 conducted an internal review of its 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 contacted vendors of its relevant corporate IT Systems to
determine potential exposure to Year 2000 issues and has obtained written
assurance from such vendors regarding Year 2000 compliance. The Company has
implemented software upgrades for certain systems found not to be Year 2000
compliant. The cost of completing this implementation has not had a material
adverse effect on the Company's results of operations.
At this time, the Company is in the process of determining the state of
compliance of certain third-party suppliers of services such as phone companies,
long distance carriers, financial institutions and utility companies. The
failure of any one of these third-party suppliers to adequately address and
remedy any Year 2000 issues 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 has received confirmation of Year 2000 compliance from
most of these companies, and has relied upon their representations as to their
Year 2000 readiness. The Company has not attempted, nor does it intend to,
independently verify the accuracy of these vendors' representations. There can
be no assurance that these vendors have provided accurate information or that
they are Year 2000 compliant.
Failure of the Company to provide Year 2000 compliant products to its
customers or to receive 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 and financial condition. 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 developed 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 product liability or other 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 on the Company's business, results
of operations and financial condition.
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
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Notes thereto and Management's Discussion and Analysis of Financial Condition
and Results of Operations for the year ended December 31, 1998, contained in the
Company's 1998 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
verbal 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 characterized by rapidly changing
technology, frequent introduction of new products and changes in customer
requirements which can render existing products obsolete or unmarketable. To
maintain its competitive position, the Company must continue to develop and
introduce in a timely and cost-effective manner enhancements to its existing and
new products that keep pace with technological developments and achieve market
acceptance. There can be no assurance that the Company will be able to
successfully identify, develop, manufacture, market or support new products
or enhancements, including the application performance management class of
products, 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 or inhibit
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 Company's current products and products under development are limited
in number and concentrated in the automated software testing and application
performance management markets. These markets have experienced rapid worldwide
growth, and they remain relatively new and not well penetrated. Although the
Company believes that the current trend toward increased use of automated
software testing and application performance management will continue, there
can be no assurance that the automated software testing and application
performance management markets will continue to expand or that the Company's
products will be accepted in any expanded market. /1/ Price reductions or
declines in demand for the Company's software testing and application
performance management products, whether as a result of competition,
technological change or other factors, 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, some of which are
outside of the Company's control. A significant portion of the Company's
operating expenses is relatively fixed, and planned expenditures are based on
sales forecasts. Products are generally shipped as orders are received, and,
consequently, quarterly sales and operating results depend significantly 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 may be impacted by internal budgetary
considerations relating to Year 2000 remediation or Euro conversion efforts. All
of the foregoing may result in unanticipated quarterly earning shortfalls or
losses. Accordingly, the Company believes that quarter-to-quarter comparisons of
its results of operations are not necessarily meaningful and should not be
relied upon as indications of future performance.
The computer software market is intensely 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 financial and technical resources than the
Company, decided to devote substantial resources to entering the software
testing or application performance management markets or if there is an
increase in developing testing or application performance management 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. The Company expects to face
increasing competition in the automated software testing market./1/ 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.
- -----------------------------
/1/ Forward looking statement
12
<PAGE>
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 current system integrators
and value added resellers will continue to offer the Company's products, that
the Company's current system integrators and value added resellers will be able
to effectively sell new products or product applications, 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 products by its system
integrators and value added resellers could have a material adverse effect on
the Company's business, results of operations and financial condition.
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.
As a global concern, the Company faces exposure to adverse movements in
foreign currency exchange rates. Historically, the Company's primary exposure
has been related to non-dollar denominated sales and operating expenses in
Europe and the Pacific Rim. As the Company continues to expand its international
operations, the Company expects to see an increase in exposures related to non-
dollar denominated sales./1/ The Company attempts to limit foreign exchange
exposure through operational strategies and by using forward contracts to offset
the effects of exchange rate changes on intercompany trade balances. These
efforts depend upon estimates of transaction activity in various currencies.
There can be no assurance that the Company will be successful in making these
estimates. To the extent these estimates are overstated or understated during
periods of currency volatility, the Company could experience material currency
gains or losses.
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
growth, the Company is implementing a variety of new or expanded business and
financial systems, procedures and controls, including the improvement of its
accounting, and customer support 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 business,
operating results and financial condition.
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 continued success depends in significant
part on its ability to attract additional qualified employees and to retain the
services of current key employees. In particular, the loss of the services of
one or more of the Company's executive officers could have a material adverse
effect on the Company's business 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 events or
broader market trends
- -----------------------------
/1/ Forward looking statement
13
<PAGE>
that are unrelated to the Company's operating results, including but not limited
to the financial performance of companies in related industries.
As part of its growth strategy, the Company may, from time to time, acquire
or invest in complementary businesses, products or technologies. In October,
1999, the Company announced the signing of a letter of intent to acquire
privately-held Conduct Ltd., a developer of network management and monitoring
solutions based in Israel. The transaction is structured as a share exchange
under which the Company will issue 408,000 shares of common stock in exchange
for all issued and outstanding convertible preferred and common shares of
Conduct Ltd., and assumption of all outstanding Conduct stock options, warrants
and other securities. It is expected that the acquisition will be accounted for
as a pooling of interests. Closing of the transaction is subject to certain
conditions, including the satisfactory completion of due diligence and execution
of a definitive agreement. 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
this or any other acquisition or investment will be realized. 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.
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 holds five patents for elements contained in
certain of its products, and it has filed several other U.S. 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
proprietary 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.
Since its inception, the Company has obtained royalty-bearing grants from
various Israeli government agencies. The Company received and recognized $1.6
million in such grants in 1998; however, it has not applied nor does it
currently anticipate applying for future grants./1/ The Company believes these
grants are no longer needed to subsidize the Company's research and development
projects./1/ 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.
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 product liability or other 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 on the Company's business, results
of operations and financial condition.
- -----------------------------
/1/ Forward looking statement
14
<PAGE>
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 conducted an internal review of its 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 contacted vendors of its relevant corporate IT Systems to
determine potential exposure to Year 2000 issues and has obtained written
assurance from such vendors regarding Year 2000 compliance. The Company has
implemented software upgrades for certain systems found not to be Year 2000
compliant. The cost of completing this implementation has not had a material
adverse effect on the Company's results of operations.
At this time, the Company is in the process of determining the state of
compliance of certain third-party suppliers of services such as phone companies,
long distance carriers, financial institutions and utility companies. The
failure of any one of these third-party suppliers to adequately address and
remedy any Year 2000 issues 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 has received confirmation of Year 2000 compliance from
most of these companies, and has relied upon their representations as to their
Year 2000 readiness. The Company has not attempted, nor does it intend to,
independently verify the accuracy of these vendors' representations. There can
be no assurance that these vendors have provided accurate information or that
they are Year 2000 compliant.
Failure of the Company to provide Year 2000 compliant products to its
customers or to receive 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 and financial condition. 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 developed a contingency plan to respond to any of the foregoing consequences
of internal and external failures to be Year 2000 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, 1999, 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 $173.0 million
at September 30, 1999, from $129.9 million at December 31, 1998. During the nine
months ended September 30, 1999, the Company generated approximately $38.1
million from operations due primarily to profits from operations and an increase
in accrued liabilities and deferred revenue. In addition, during the nine months
ended September 30, 1999, the Company received $14.7 million from the issuance
of common stock under the employee stock option and stock purchase plans.
During the nine months ended September 30, 1999, the Company's primary
investing activities were acquisitions of property and equipment totaling
$9.5 million, net. This included $4.9 million for construction of a new
research and development facility in Israel and expansion of the Company's
Sunnyvale, California headquarters.
15
<PAGE>
Assuming there is no significant change in the Company's business, the
Company believes that its current cash and investment balances and cash flows
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
Interest rate risk. The Company's exposure to market rate risk for changes
in interest rates relates primarily to the Company's investment portfolio. The
Company has not used derivative financial instruments in its investment
portfolio. The Company places its investments with high quality issuers and, by
policy, limits the amount of credit exposure to any one issue or issuer. At
September 30, 1999, $81.0 million (47%) of the Company's cash, cash equivalents
and investment portfolio carried a maturity of less than 90 days, and $153.0
million (88%) carried a maturity of less than one year. All investments mature,
by policy, in less than two years. The Company has the ability and intent to
hold the portfolio to maturity. The effect of a 10% rate decline would not have
a material effect on the portfolio.
Foreign currency risk. The Company transacts business in various foreign
currencies, primarily in Europe the Pacific Rim. Accordingly, the Company is
subject to exposure from movements in foreign currency exchange rates. The
Company's operating expenses in each of these countries are in the local
currencies, which mitigates a significant portion of the exposure related to
local currency revenues.
In addition, the Company uses forward contracts to offset the effects of
exchange rate changes on intercompany trade payables. The Company has not
entered into forward foreign exchange contracts for speculative or trading
purposes. The Company's accounting policies for these contracts are based on the
Company's designation of the contracts as hedging transactions. The criteria the
Company uses for designating a contract as a hedge include the contract's
effectiveness in risk reduction and one-to-one matching of hedging instruments
to underlying transactions. Gains and losses on forward foreign exchange
contracts are recognized in income in the same period as gains and losses on the
underlying transactions. The effect of an immediate 10% change in exchange rates
would not have a material impact on the Company's future operating results or
cash flows.
PART II. OTHER INFORMATION
- --------------------------
Item 4. Exhibits and Reports on Form 8-K
(a) 27.1 - Financial Data Schedule.
(b) No reports on Form 8-K were filed during the three months ended
September 30, 1999.
_________________________________
/1/ Forward looking statement
16
<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 12, 1999 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)
17
<PAGE>
INDEX TO EXHIBITS
- -----------------
<TABLE>
<CAPTION>
Exhibit Sequentially
No. Description Numbered Page
------- ----------- -------------
<S> <C> <C>
27.1 Financial Data Schedule 19
</TABLE>
18
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1999 DEC-31-1999
<PERIOD-START> JUL-01-1999 JAN-01-1999
<PERIOD-END> SEP-30-1999 SEP-30-1999
<CASH> 80,950 80,950
<SECURITIES> 92,089 92,089
<RECEIVABLES> 35,027 35,027
<ALLOWANCES> 4,284 4,284
<INVENTORY> 0 0
<CURRENT-ASSETS> 203,655 203,655
<PP&E> 52,963 52,963
<DEPRECIATION> 18,865 18,865
<TOTAL-ASSETS> 257,811 257,811
<CURRENT-LIABILITIES> 75,556 75,556
<BONDS> 0 0
0 0
0 0
<COMMON> 76 76
<OTHER-SE> 182,179 182,179
<TOTAL-LIABILITY-AND-EQUITY> 257,811 257,811
<SALES> 33,500 87,400
<TOTAL-REVENUES> 47,500 127,600
<CGS> 2,040 5,546
<TOTAL-COSTS> 6,988 19,007
<OTHER-EXPENSES> 30,594 85,050
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 0 0
<INCOME-PRETAX> 11,484 27,678
<INCOME-TAX> 2,297 5,535
<INCOME-CONTINUING> 9,187 22,143
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 9,187 22,143
<EPS-BASIC> .24 .59
<EPS-DILUTED> .22 .53
</TABLE>
