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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 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)
<TABLE>
<S> <C>
Delaware 77-0224776
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
</TABLE>
1325 Borregas Avenue, Sunnyvale, California 94089
(Address of principal executive offices)
Registrant's telephone number, including area code: (408) 822-5200
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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 April
30, 1999 was 37,106,513.
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MERCURY INTERACTIVE CORPORATION
INDEX
<TABLE>
<CAPTION>
Page No.
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<C> <S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets-
March 31, 1999 and December 31, 1998...................... 3
Condensed Consolidated Statements of Operations-
Three months ended March 31, 1999 and 1998................ 4
Condensed Consolidated Statements of Cash Flows-
Three months ended March 31, 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...................................................... 15
PART II. OTHER INFORMATION
Item 4. Exhibits and Reports on Form 8-K........................... 16
SIGNATURE........................................................... 17
INDEX TO EXHIBITS................................................... 18
</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>
March 31, December 31,
1999 1998
----------- ------------
(unaudited) (audited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............................ $ 94,329 $ 96,073
Short-term investments............................... 30,471 13,130
Trade accounts receivable............................ 23,457 27,903
Other receivables.................................... 5,027 6,012
Prepaid expenses and other current assets............ 10,827 10,526
-------- --------
Total current assets............................... 164,111 153,644
Long-term investments.................................. 19,108 20,697
Property and equipment, net............................ 29,017 28,250
Other assets........................................... 435 985
-------- --------
$212,671 $203,576
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable..................................... $ 3,726 $ 4,575
Accrued liabilities.................................. 16,476 17,792
Income taxes payable................................. 10,433 11,498
Deferred revenue..................................... 25,823 24,122
-------- --------
Total current liabilities.......................... 56,458 57,987
-------- --------
Commitments and contingencies
Stockholders' equity:
Common stock......................................... 74 73
Capital in excess of par value....................... 128,721 124,038
Notes receivable from sale of stock.................. (4,533) (5,130)
Accumulated comprehensive income..................... (1,026) (775)
Retained earnings.................................... 32,977 27,383
-------- --------
Total stockholders' equity......................... 156,213 145,589
-------- --------
$212,671 $203,576
======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements
3
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MERCURY INTERACTIVE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Three months
ended March 31,
---------------
1999 1998
------- -------
<S> <C> <C>
Revenue:
License...................................................... $24,600 $15,600
Service...................................................... 13,000 6,600
------- -------
Total revenue.............................................. 37,600 22,200
------- -------
Cost of revenue:
License...................................................... 1,636 1,329
Service...................................................... 4,072 2,334
------- -------
Total cost of revenue...................................... 5,708 3,663
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Gross profit................................................... 31,892 18,537
------- -------
Operating expenses:
Research and development, net................................ 4,820 3,023
Marketing and selling........................................ 18,987 10,983
General and administrative................................... 2,245 1,849
------- -------
Total operating expenses................................... 26,052 15,855
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Income from operations......................................... 5,840 2,682
Other income, net.............................................. 1,152 850
------- -------
Income before provision for income taxes....................... 6,992 3,532
Provision for income taxes..................................... 1,398 706
------- -------
Net income..................................................... $ 5,594 $ 2,826
======= =======
Net income per share (basic)................................... $ 0.15 $ 0.08
======= =======
Net income per share (diluted)................................. $ 0.14 $ 0.07
======= =======
Weighted average common shares (basic)......................... 36,848 33,984
Weighted average common shares and equivalents (diluted)....... 41,265 38,282
</TABLE>
See accompanying notes to condensed consolidated financial statements
4
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MERCURY INTERACTIVE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Three months ended
March 31,
--------------------
1999 1998
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net income.............................................. $ 5,594 $ 2,826
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization........................... 1,273 1,132
Changes in assets and liabilities:
Trade accounts receivable............................. 4,446 3,822
Other receivables..................................... 985 (2,180)
Prepaid expenses and other current assets............. 99 (1,353)
Accounts payable...................................... (849) 1,004
Accrued liabilities................................... (1,316) 1,055
Income taxes payable.................................. (1,065) (1,010)
Deferred revenue...................................... 1,701 2,974
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Net cash provided by operating activities........... 10,868 8,270
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Cash flows from investing activities:
Purchases of investments, net............................ (15,752) (4,952)
Acquisition of property and equipment.................... (1,890) (4,637)
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Net cash used in investing activities............... (17,642) (9,589)
--------- --------
Cash flows from financing activities:
Proceeds from issuance of Common Stock, net.............. 4,684 4,103
Notes receivable from issuance of stock.................. 597 --
--------- --------
Net cash provided by financing activities........... 5,281 4,103
--------- --------
Effect of exchange rate changes on cash................... (251) 140
--------- --------
Net increase (decrease) in cash and cash equivalents...... (1,744) 2,924
Cash and cash equivalents at beginning of period.......... 96,073 57,211
--------- --------
Cash and cash equivalents at end of period................ $ 94,329 $ 60,135
========= ========
</TABLE>
See accompanying notes to condensed consolidated financial statements
5
<PAGE>
MERCURY INTERACTIVE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. The unaudited financial information furnished herein reflects all
adjustments, consisting only of normal recurring adjustments, that in the
opinion of management are necessary to fairly state the Company's
consolidated financial position, the results of its operations, and its cash
flows for the periods presented. This Quarterly Report on Form 10-Q should
be read in conjunction with the Company's audited financial statements for
the year ended December 31, 1998, included in the 1998 Form 10-K. The
condensed consolidated statements of operations for the three months ended
March 31, 1999 is 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 ended March 31, 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
quarter ended March 31,1999, and obtained grants in the amount of $802,000
in the quarter ended March 31, 1998. 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
$771,000 and $525,000 for the quarters ended March 31, 1999 and 1998,
respectively. As of March 31, 1999, the Company is committed to pay, if and
when incurred, approximately $1.6 million in royalties. 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 common shares outstanding and all dilutive potential common shares
outstanding. For the quarters ended March 31, 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 quarters ended March 31, 1998 and
1999:
<TABLE>
<CAPTION>
Net Average Earnings
income shares per share
------ ------- ---------
<S> <C> <C> <C>
March 31, 1998:
Basic earnings per share........................ $2,826 33,984 $0.08
Dilutive adjustments............................ 4,298
------ ------
Diluted earnings per share...................... $2,826 38,282 $0.07
====== ======
March 31, 1999:
Basic earnings per share........................ $5,594 36,848 $0.15
Dilutive adjustments............................ 4,417
------ ------
Diluted earnings per share...................... $5,594 41,265 $0.14
====== ======
</TABLE>
In January 1999, the Company declared a two-for-one stock split in the form
of a stock dividend. One additional share of the Company's common stock had
been issued for each share of common stock held by shareholders of record
as of February 12, 1999. New shares were distributed on March 1, 1999. All
per share data contained herein has been restated to reflect the increased
number of shares outstanding.
At March 31, 1999 and 1998, there were no options considered anti-dilutive.
6
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MERCURY INTERACTIVE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
5. The Company reports components of comprehensive income (loss) in its annual
consolidated statement of shareholders' equity. Other comprehensive income
(loss) consists of net income and foreign currency translation adjustments.
The Company's total comprehensive income (loss) were as follows:
<TABLE>
<CAPTION>
Three months ended
March 31,
--------------------
1999 1998
--------- ---------
<S> <C> <C>
Net income........................................... $ 5,594 $ 2,826
Other comprehensive gain (loss)...................... (251) 140
--------- ---------
Other comprehensive income........................... $ 5,343 $ 2,966
========= =========
</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 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 establishes
accounting and reporting standards for derivative instruments and for
hedging activities and is effective for all fiscal quarters of fiscal years
beginning after June 15, 1999. The Company does not expect the adoption of
SFAS 133 to have a material impact on the Company's results of operations.
7
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This Management's Discussion and Analysis of Financial Condition and Results
of Operations contains descriptions of the Company's expectations regarding
future trends affecting its business. These forward looking statements and
other forward looking statements made elsewhere in this document are made in
reliance upon the safe harbor provision of the Private Securities Litigation
Reform Act of 1995. Please read the section below titled "Factors that may
affect future results" to review conditions which the Company believes could
cause actual results to differ materially from those contemplated by the
forward looking statements. Forward looking statements include, but are not
limited to, those items identified with a footnote symbol./1/ The Company
undertakes no obligation to update the information contained herein.
Results of Operations
Revenue
License revenue increased 58% to $24.6 million in the first quarter of 1999
from $15.6 million in the first quarter of 1998. The Company's growth in
license revenue was primarily attributable to growth in license fees from the
LoadRunner, WinRunner and TestDirector products, particularly for use by
customers to test electronic business applications.
Service revenue increased 97% to $13.0 million in the first quarter of 1999
from $6.6 million in the first quarter of 1998. This increase in service
revenue in the first quarter of 1999 compared to the same period in 1998 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/
International revenue represented 35% of total revenue in the quarters ended
March 31, 1999 and 1998. 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 7%
in the first quarter of 1999 from 9% in the first quarter of 1998. 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 first quarter of 1999
reflected primarily flat absolute dollar amortization of capitalized software
development costs in the first quarter of 1999 and 1998.
Service cost of revenue, as a percentage of service revenue was 31% in the
first quarter of 1999 compared to 35% in the first quarter of 1998. Service
cost of revenue consists primarily of costs of providing customer technical
support, training and consulting. The decrease in service cost of revenue as a
percentage of service revenue in the first quarter of 1999 reflected increased
profitability on maintenance revenue. The cost of maintenance relates primarily
to headcount and related expenses and is therefore relatively fixed on a short-
term basis.
Research and development
For the quarter ended March 31, 1999, research and development, net was $4.8
million, or 13% of total revenue, compared to $3.0 million, or 14% of total
revenue in the first quarter of 1998. The increase in absolute dollars in the
quarter ended March 31, 1999 as compared to the quarter ended March 31, 1998
reflected an increase in spending due to growth in research and development
headcount and increased royalty payments, net of grants received in 1998, to
the office of Chief Scientist in Israel.
- --------
/1/Forward looking statement
8
<PAGE>
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
quarter ended March 31, 1999, and obtained grants in the amount of $802,000 in
the quarter ended March 31, 1998. 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 $771,000 and
$525,000 for the quarters ended March 31, 1999 and 1998, respectively. As of
March 31, 1999, the Company is committed to pay, if and when incurred, $1.6
million in royalties. The Company has not applied nor does it currently
anticipate applying for future grants.
During the quarters ended March 31, 1999 and 1998, the Company did not
capitalize any software development costs. Amortization charges included in
cost of license revenues were $150,000 in each of the quarters ended March 31,
1999 and 1998. At March 31, 1999 and December 31, 1998, the Company had a
balance in capitalized software development costs of approximately $435,000 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 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 development./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 $19.0 million, or 50% of total revenue
in the quarter ended March 31, 1999, compared to $11.0 million, or 49% of total
revenue in the quarter ended March 31, 1998. The increase in marketing and
selling expenses was primarily due to increases in commission expenses
attributable to the higher revenue level and other personnel-related costs
reflecting 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 administration
General and administrative expenses were $2.2 million or 6% of total revenue
in the quarter ended March 31, 1999, compared to $1.8 million or 8% of total
revenue in the quarter ended March 31, 1998. The increase in absolute dollar
spending reflects 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 $1.2 million in the
quarter ended March 31, 1999, from $850,000 in the quarter ended March 31,
1998, reflected primarily increased interest income on higher average cash and
investment balances in the quarter ended March 31, 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.
- --------
/1/Forward looking statement
9
<PAGE>
Net income
The Company reported net income of $5.6 million in the quarter ended March
31, 1999, compared to net income of $2.8 million in the quarter ended March 31,
1998. 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 that quarter are
likely to be materially adversely affected. Net income may be
disproportionately affected by a reduction in revenue because only a small
portion of the Company's expenses varies with its revenue.
Inflation
Inflation has not had a significant impact on the Company's operating
results to date.
Year 2000
The approach of Year 2000 presents significant issues for many computer
systems, since much of the software in use today may not accurately process
data beyond 1999. The Company is in the process of conducting an internal
review of most of its internal corporate headquarters computer systems and
software ("IT Systems") including finance, human resources, intranet
applications, payroll systems and customer support organization systems to
determine their Year 2000 compliance. As part of this process, the Company is
contacting vendors of its relevant corporate IT Systems to determine potential
exposure to Year 2000 issues and will be obtaining written assurance from such
vendors regarding Year 2000 compliance. Although the Company believes that most
of its principal corporate IT Systems are Year 2000 compliant, the Company has
not yet completed its assessment and testing of these systems.
At this time, the Company has not determined the state of compliance of
certain third-party suppliers of services such as phone companies, long
distance carriers, financial institutions and utility companies. The failure of
any one of these third-party suppliers could severely disrupt the Company's
ability to carry on its business as well as disrupt the business of the
Company's customers. The Company is in the process of polling these companies
in order to determine their state of compliance and their contingency plans.
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 is currently developing a contingency plan to respond
to any of the foregoing consequences of internal and external failures to be
Year 2000 compliant.
In selling its products, the Company frequently relies on "shrink wrap"
licenses that are not signed by licensees. The provisions in such licenses
limiting the Company's exposure to potential product liability claims may
therefore be unenforceable under the laws of certain jurisdictions. Further,
the Company's license agreements typically contain a representation that the
software is Year 2000 compliant through its description of specifically how the
Company's products process the Year 2000 calendar dates. While the Company
believes
- --------
/1/Forward looking statement
10
<PAGE>
its products are Year 2000 compliant, the risk of Year 2000 noncompliance
claims may increase as December 31, 1999 approaches and passes. The Company
currently carries errors and omissions insurance against such claims, however,
there can be no assurance that such insurance will continue to be available on
acceptable terms, if at all, or that such insurance will provide the Company
with adequate protection against any such claims. Although the Company has not
experienced any product liability or other Year 2000 claims to date, the sale
and support of products by the Company may entail the risk of such claims. A
significant product liability claim against the Company would have a material
adverse effect upon the Company's business, 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 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 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. 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
identify, develop, manufacture, market or support new products or enhancements
successfully, that any such new products or enhancements will gain market
acceptance, or that the Company will be able to respond effectively to
technological changes. There can be no assurance that the Company will not
encounter technical or other difficulties that could delay or inhibit
introduction of new products in the future, including the recently announced
Application Performance Management class of products. 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 exclusively in the automated software testing market.
This market has experienced rapid worldwide growth, and it remains relatively
new and not well penetrated. 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 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 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 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
- --------
/1/Forward looking statement
11
<PAGE>
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. 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 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. 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.
The Company has derived a substantial portion of its revenues from sales of
its products through alternate distribution channels such as referral partners,
system integrators, and value-added resellers. The Company expects that sales
of its products through its alternate distribution channels will continue to
account for a substantial portion of its revenues for the foreseeable future.
Each of the Company's system integrators and value added resellers can cease
marketing the Company's products with limited notice and with little or no
penalty. There can be no assurance that the Company's system integrators and
value added resellers will continue to offer the Company's products or that the
Company will be able to recruit additional or replacement system integrators
and value added resellers. The loss of one or more of the Company's major
system integrators and value added resellers could have a material adverse
effect on the Company's business, financial condition and results of
operations. The Company's system integrators and value added resellers also
offer competitive products manufactured by third parties. There can be no
assurance that the Company's system integrators and value added resellers will
give priority to the marketing of the Company's products as compared to its
competitors' products. Any reduction or delay in sales of the Company's
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
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
unanticipated material currency gains or losses.
- --------
/1/Forward looking statement
12
<PAGE>
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
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 that are unrelated to the Company's operating results,
including 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 complimentary businesses, products or technologies. While there
are currently no commitments with respect to any particular acquisition or
investment, the Company's management frequently evaluates the strategic
opportunity available related to complimentary businesses, products or
technologies. The process of integrating an acquired company's business into
the Company's operations may result in unforeseen operating difficulties and
expenditures and may absorb significant management attention that would
otherwise be available for the ongoing development of the Company's business.
Moreover, there can be no assurance that the anticipated benefits of any
acquisition or investment will be realized. Future acquisitions or investments
by the Company could result in potentially dilutive issuances of equity
securities, the incurrence of debt and contingent liabilities, amortization
expenses related to goodwill and other intangible assets, any of which could
materially adversely affect the Company's operating results and financial
condition.
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 four 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
13
<PAGE>
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 any such claims. Although
the Company has not experienced any product liability or other Year 2000 claims
to date, the sale and support of products by the Company may entail the risk of
such claims. A significant product liability claim against the Company could
have a material adverse effect upon the Company's business, financial condition
and results of operations.
The approach of Year 2000 presents significant issues for many computer
systems, since much of the software in use today may not accurately process
data beyond 1999. The Company is in the process of conducting an internal
review of most of its internal corporate headquarters computer systems and
software ("IT Systems") including finance, human resources, intranet
applications, payroll systems and customer support organization systems to
determine their Year 2000 compliance. As part of this process, the Company is
contacting vendors of its relevant corporate IT Systems to determine potential
exposure to Year 2000 issues and will be obtaining written assurance from such
vendors regarding Year 2000 compliance. Although the Company believes that most
of its principal corporate IT Systems are Year 2000 compliant, the Company has
not yet completed its assessment and testing of these systems.
At this time, the Company has not determined the state of compliance of
certain third-party suppliers of services such as phone companies, long
distance carriers, financial institutions and utility companies. The failure of
any one of these third-party suppliers could severely disrupt the Company's
ability to carry on its business as well as disrupt the business of the
Company's customers. The Company is in the process of polling these companies
in order to determine their state of compliance and their contingency plans.
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 is currently developing a contingency plan to respond
to any of the foregoing consequences of internal and external failures to be
Year 2000 compliant.
- --------
/1/Forward looking statement
14
<PAGE>
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 March 31, 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 $143.9 million
at March 31, 1999, from $129.9 million at December 31, 1998. During the quarter
ended March 31, 1999, the Company generated approximately $10.9 million from
operations due primarily to profits from operations, collection of trade and
other receivables and an increase in deferred revenue. In addition, during the
quarter ended March 31, 1999, the Company received $4.7 million from the
issuance of Common Stock under the employee stock option and purchase plans.
During the quarter ended March 31, 1999, the Company's primary investing
activities were purchases of property and equipment totaling $1.9 million. This
included $1.1 million for construction of a new research and development
facility in Israel. The Company expects to spend an additional $4.5 million to
complete construction of the Israel facility before relocating its Israel
subsidiary there in the third quarter of 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
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
March 31, 1999, $94.3 million (68%) of the Company's cash, cash equivalents and
investment portfolio carried a maturity of less than 90 days, and $124.8
million (87%) 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 and 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.
- --------
/1/Forward looking statement
15
<PAGE>
MERCURY INTERACTIVE CORPORATION
PART II. OTHER INFORMATION
Item 4. Exhibits and Reports on Form 8-K
(a) Exhibit 27.1--Financial Data Schedule.
(b) No reports on Form 8-K were filed during the quarter ended March 31,
1999.
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: May 13, 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>
Sequentially
Numbered
Exhibit No. Description Page
----------- ----------- ------------
<C> <S> <C>
27.1 Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 94,329
<SECURITIES> 49,579
<RECEIVABLES> 26,843
<ALLOWANCES> 3,386
<INVENTORY> 277
<CURRENT-ASSETS> 164,111
<PP&E> 45,355
<DEPRECIATION> 16,338
<TOTAL-ASSETS> 212,671
<CURRENT-LIABILITIES> 56,458
<BONDS> 0
0
0
<COMMON> 74
<OTHER-SE> 156,139
<TOTAL-LIABILITY-AND-EQUITY> 212,671
<SALES> 24,600
<TOTAL-REVENUES> 37,600
<CGS> 1,636
<TOTAL-COSTS> 5,708
<OTHER-EXPENSES> 26,052
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 6,992
<INCOME-TAX> 1,398
<INCOME-CONTINUING> 5,594
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,594
<EPS-PRIMARY> .15
<EPS-DILUTED> .14
</TABLE>
