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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 8-K
CURRENT REPORT
[X] PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
DATE OF REPORT (DATE OF EARLIEST EVENT REPORTED): January 19, 2000
__________________
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, CA 94089
(Address of principal executive offices)
(408) 822-5200
(Registrant's telephone number, including area code)
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TABLE OF CONTENTS
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Page
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8-K
Item 5. ........................................... 3
Item 7. ........................................... 3
Table 1 ........................................... 5
Table 2 ........................................... 6
Sup Balance Sheet ........................................... 18
Sup Income Statement ........................................... 19
Table 3 ........................................... 20
Cash Flow Statement ........................................... 21
Table 4 ........................................... 23
Table 5 ........................................... 25
Table 6 ........................................... 27
Table 7 ........................................... 28
Table 8 ........................................... 29
Table 9 ........................................... 30
Table 10 ........................................... 30
Table 11 ........................................... 31
Table 12 ........................................... 31
Table 13 ........................................... 32
Table 14 ........................................... 32
Table 15 ........................................... 32
Table 16 ........................................... 32
Table 17 ........................................... 33
Table 18 ........................................... 34
Table 19 ........................................... 35
Sup Balance Sheet 2 ........................................... 37
Sup Income Statement 2 ........................................... 38
Sup Cash Flow Statement 2 ........................................... 39
Table 20 ........................................... 40
Table 21 ........................................... 41
Table 22 ........................................... 42
Table 23 ........................................... 42
EX-23.1
EX-23.1. ........................................... 43
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2
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Item 5. OTHER EVENTS
This Current Report on Form 8-K is to file the Supplemental Consolidated
Financial Statements, Selected Supplemental Consolidated Financial Data,
Management's Discussion and Analysis of Financial Condition and Results of
Operations, and Supplemental Consolidated Financial Statements with respect to
the acquisition of Conduct Ltd. ("Conduct") by Mercury Interactive Corporation
("the Company"), which acquisition was closed on November 30, 1999. Pursuant
to a share exchange agreement dated November 24, 1999, the Company acquired all
of the outstanding capital shares and assumed all of the outstanding stock
options of Conduct in exchange for approximately 408,000 shares of the Company's
stock. The acquisition is being accounted for as a pooling of interests
transaction. Accordingly, the financial statements and other financial data
reflect the Company's financial position and results of operations as if Conduct
was a wholly owned subsidiary of the Company since inception.
Item 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS
(a) Exhibits.
23.1 Consent of Independent Accountants
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the Registrant has duly caused this report to be signed on its behalf
by the undersigned hereunto duly authorized.
Mercury Interactive Corporation
Date: January 19, 2000
By /s/ Sharlene Abrams
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Sharlene Abrams, Vice President of Finance and
Administration, Chief Financial Officer and
Secretary
(Principal Accounting and Financial Officer)
3
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SUPPLEMENTAL CONSOLIDATED FINANCIAL INFORMATION
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SUPPLEMENTAL CONSOLIDATED FINANCIAL INFORMATION OF MERCURY INTERACTIVE
<S> <C>
Selected Supplemental Consolidated Financial Data 5
Management's Discussion and Analysis of Financial Condition and Results of Operations 6
Report of Independent Accountants 17
Supplemental Consolidated Balance Sheets at December 31, 1998 and 1997 18
Supplemental Consolidated Statements of Operations for the three years ended December 31, 1998, 1997 and 1996 19
Supplemental Consolidated Statements of Stockholders' Equity for the three years ended December 31, 1998, 1997 and 1996 20
Supplemental Consolidated Statements of Cash Flows for the three years ended December 31, 1998, 1997 and 1996 21
Notes to Supplemental Consolidated Financial Statements 22
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4
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Selected Supplemental Consolidated Financial Data/2/
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<CAPTION>
Year ended December 31,
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1998 1997 1996 1995 1994
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(in thousands, except per share amounts)
Statements of Operations Data:
Revenue:
License.......................................... $ 84,450 $56,683 $43,270 $32,765 $20,270
Service.......................................... 36,550 20,017 11,280 6,685 3,180
----------- --------- --------- ---------- ---------
Total revenue................................. 121,000 76,700 54,550 39,450 23,450
----------- --------- --------- ---------- ---------
Cost of revenue:
License.......................................... 6,291 4,351 3,419 2,626 1,594
Service.......................................... 11,757 6,225 3,240 1,887 872
----------- --------- --------- ---------- ---------
Total cost of revenue......................... 18,048 10,576 6,659 4,513 2,466
----------- --------- --------- ---------- ---------
Gross profit....................................... 102,952 66,124 47,891 34,937 20,984
----------- --------- --------- ---------- ---------
Operating expenses:
Research and development, net.................... 16,907 11,333 9,670 6,523 4,285
Write off of in-process research and development
and related expenses........................... -- 5,500 -- 7,700 --
Marketing and selling............................ 57,243 37,073 29,426 21,361 9,576
General and administrative....................... 8,466 6,642 4,178 3,911 2,531
Settlement of litigation......................... -- -- 2,600 2,000 --
----------- --------- --------- ---------- ---------
Total operating expenses...................... 82,616 60,548 45,874 41,495 16,392
----------- --------- --------- ---------- ---------
Income (loss) from operations...................... 20,336 5,576 2,017 (6,558) 4,592
Other income, net.................................. 4,640 3,083 3,375 2,277 1,348
----------- --------- --------- ---------- ---------
Income (loss) before provision for income taxes.... 24,976 8,659 5,392 (4,281) 5,940
Provision for income taxes......................... 5,451 2,927 1,157 970 891
----------- --------- --------- ---------- ---------
Net income (loss).................................. $ 19,525 $ 5,732 $ 4,235 $(5,251) $ 5,049
=========== ========= ========= ========== =========
Net income (loss) per share (basic)................ $ 0.55 $ 0.18 $ 0.13 $ (0.19) $ 0.20
=========== ========= ========= ========== =========
Net income (loss) per share (diluted).............. $ 0.50 $ 0.17 $ 0.13 $ (0.19) $ 0.19
=========== ========= ========= ========== =========
Weighted average common shares (basic)............. 35,327 32,747 31,817 27,894 25,220
=========== ========= ========= ========== =========
Weighted average common shares and equivalents
(diluted).......................................... 39,409 34,229 33,127 27,894 26,674
=========== ========= ========= ========== =========
</TABLE>
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<CAPTION>
December 31,
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1998 1997 1996 1995 1994
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Balance Sheet Data:
Working capital.................................... $ 96,267 $ 87,733 $ 78,046 $ 75,475 $33,722
Total assets....................................... 204,686 143,663 117,625 112,820 49,594
Stockholders' equity............................... 146,408 112,120 99,048 92,616 39,167
</TABLE>
/2/ All historical information has been restated to reflect the acquisition of
Conduct Ltd. on November 30, 1999 which was accounted for as a pooling of
interests.
The above share and per share amounts do not reflect the effect of the two-for-
one stock split announced on January 13, 2000.
5
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Management's Discussion and Analysis of Financial Condition and Results of
Operations
Results of Operations
All historical financial information and analysis have been restated to
reflect the acquisition of Conduct Ltd. on November 30, 1999, which was
accounted for as a pooling of interests (see Notes 1 and 8 to the Supplemental
Consolidated Financial Statements).
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.
The following table sets forth, as a percentage of revenue, certain
consolidated statements of operations data for the periods indicated (after
giving effect to rounding). These operating results are not necessarily
indicative of the results for any future period.
<TABLE>
<CAPTION>
Year ended December 31,
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1998 1997 1996
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Revenue:
License.................................................. 70% 74% 79%
Service.................................................. 30 26 21
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Total revenue...................................... 100 100 100
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Cost of revenue:
License.................................................. 5 6 6
Service.................................................. 10 8 6
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Total cost of revenue.............................. 15 14 12
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Gross profit................................................... 85 86 88
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Operating expenses:
Research and development, net............................ 14 15 18
Write off of in-process research and development
and related expenses................................. -- 7 --
Marketing and selling.................................... 47 48 54
General and administrative............................... 7 9 7
Settlement of litigation................................. -- -- 5
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Total operating expenses........................... 68 79 84
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Income from operations......................................... 17 7 4
Other income, net.............................................. 4 4 6
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Income before provision for income taxes....................... 21 11 10
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Provision for income taxes..................................... 5 4 2
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Net income .................................................... 16% 7% 8%
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6
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Revenue
License revenue increased to $84.5 million in 1998 from $56.7 million in
1997 and $43.3 million in 1996. The Company's growth in license revenue is
attributable primarily to growth in license fees from the WinRunner, LoadRunner
and TestDirector products, particularly for use by customers to test electronic
business, enterprise resource planning, and Year 2000 remediation applications.
License revenue also benefited from increased productivity from the Company's
alternate distribution channels, such as referral partners, systems integrators
and value added resellers. For the year ended December 31, 1998, the indirect
sales channel accounted for approximately 50% of total revenue compared to 47%
and 43% for the year ended December 31, 1997 and 1996, respectively.
Service revenue increased to $36.6 million or 30% of total revenue in 1998
from $20.0 million or 26% of total revenue in 1997 and $11.3 million or 21% of
total revenue in 1996. The increase in service revenue in 1998 compared to 1997
and 1996 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%, 36% and 33% of total revenue in
1998, 1997 and 1996, respectively. The absolute dollar growth in international
revenue reflected the Company's continued investment in international
operations. The decrease in international revenue as a percentage of revenue
from 1997 to 1998 was due primarily to higher relative growth in domestic
revenue during 1998. The Company expects international revenue to continue to
increase in absolute dollars; however, achievement of these results cannot be
assured./1/
Cost of revenue
License cost of revenue, as a percentage of license revenue, was 7% in 1998
and 8% in 1997 and 1996. License cost of revenue includes cost of production
personnel, product packaging and amortization of capitalized software
development costs. The decrease in license cost of revenue as a percentage of
revenue in 1998 reflected primarily flat absolute dollar amortization of
capitalized software development costs over the three years.
Service cost of revenue, as a percentage of service revenue, increased to
32% in 1998 from 31% in 1997 and 29% in 1996. Service cost of revenue consists
primarily of costs of providing customer technical support, training and
consulting. The increase in service cost of revenue in 1998 reflected an
increase in outsourced training and consulting.
Research and development, net
For the year ended December 31, 1998, research and development, net was
$16.9 million, or 14% of total revenue, an increase from $11.3 million, or 15%
of total revenue in 1997, and $9.7 million, or 18% of total revenue in 1996.
The increase in absolute dollars in 1998 as compared to 1997 reflected an
increase in spending of $3.3 million due to growth in research and development
headcount from 137 to 181, and increased royalty payments to the Office of the
Chief Scientist in Israel, net of grants received, of $712,000. Also, in 1997,
the Company capitalized software development costs of $500,000 compared to zero
in 1998.
In September of 1997, the Company acquired certain technologies from Dixon
Software Technology, which was integrated into its next generation of load-
testing products. As a result of this purchase in the third quarter of 1997,
the Company recorded a one-time charge for write off of in-process research and
development and related expenses of $5.5 million.
Research and development expense for each of the three years ended December
31, 1998, 1997 and 1996 was net of research grants received by the Company from
the government of Israel, and included royalty expense for obligations to the
government of Israel for sales of products developed under government-funded
research. The Company obtained grants from the Office of the Chief Scientist in
the Israeli Ministry of Industry and Trade ("the Chief Scientist") in the
amounts of $1.6 million, $2.1 million and $1.8 million in 1998, 1997 and 1996,
respectively. In 1996, the Company also received a grant in the amount of
$391,000 from the Israel-U.S. Binational Industrial Research and Development
Foundation ("BIRD-F"). 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,
________________________________
/1/Forward looking statement
7
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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 $2.7 million, $1.6 million and $1.1 million for the years ended
December 31, 1998, 1997 and 1996, respectively. As of December 31, 1998, the
Company was committed to pay, if and when earned, $2.8 million in additional
royalties for Chief Scientist grants and $700,000 for the BIRD-F grants. The
Company has not applied for, nor does it anticipate applying for, any future
Chief Scientist or BIRD-F grants.
During 1998, the Company did not capitalize any software development costs.
The Company capitalized $500,000 and $1.3 million during the years ended
December 31, 1997 and 1996, respectively, in accordance with Statement of
Financial Accounting Standards No. 86, "Accounting for the Costs of Computer
Software to be Sold, Leased, or Otherwise Marketed." Amortization charges
included in cost of license revenues were $600,000 in both 1998 and 1997 and
$300,000 in 1996. In conjunction with the technology acquisition in 1997, the
Company wrote off approximately $250,000 of capitalized development costs as
obsolete. At December 31, 1998 and 1997 the Company had a net balance of
capitalized software development costs of $585,000 and $1.2 million,
respectively.
The Company intends to continue making significant expenditures on research
and development to develop new products and expand the platforms and operating
systems on which its products are offered./1/ While the Company believes that
these current research and development expenditures will be beneficial in the
long term development of its business, there can be no 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 $57.2 million in 1998, compared to
$37.1 million in 1997 and $29.4 million in 1996. The increase in expenses in
1998 as compared to 1997 was primarily due to an increase in personnel related
costs of $8.7 million reflecting growth in sales headcount from 159 to 238, an
increase in sales commissions of $5.6 million attributable to higher revenue, an
increase in facilities and related costs of $2.0 million and an increase in
spending on marketing programs of $1.7 million. The increase in expenses in
1997 as compared to 1996 was primarily due to an increase in personnel related
costs of $3.7 million, and an increase in sales commissions of $3.4 million.
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 expense increased to $8.5 million, or 7% of
total revenue in 1998, from $6.6 million, or 9% of total revenue in 1997 and
$4.2 million, or 8% of total revenue in 1996. The increase in absolute dollars
in 1998 reflected primarily increased personnel and information systems costs.
Other income, net
Other income, net consists primarily of interest income and foreign
exchange gains and losses. The increase in other income, net to $4.6 million in
1998 from $3.1 million in 1997 reflected increased interest income on higher
average cash and investment balances. The decrease in other income, net in 1997
from $3.4 million in 1996 was due primarily to foreign exchange losses. (See
Note 2 to Notes to Consolidated Financial Statements)
Provision for income taxes
The Company participates in special programs sponsored by the government of
Israel relating to taxation, contributing to significantly lower income tax
expense than expected based on the U.S. federal income tax rate. Future
provisions for taxes will depend upon the mix of worldwide income and the tax
rates in effect for various tax jurisdictions.
In the 1997 and 1998 tax provisions, the Company has not fully recognized
the tax benefit associated with the write off of in-process technology and
related expenses because realization of the future tax benefit is uncertain.
- --------------
/1/ Forward looking statement
8
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Net income
The Company reported net income of $19.5 million in 1998, compared to net
income of $5.7 million in 1997 and $4.2 million in 1996. In 1997, the results of
operations were impacted by the acquisition of certain technologies which
resulted in a one-time charge for write off of in-process research and
development and related expenses of $5.5 million. 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 revenues do not materialize in a quarter as expected, the
Company's results from operations for that quarter are likely to be materially
adversely affected. Net income may be disproportionately affected by a reduction
in 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.
Risk Factors
In addition to the Supplemental Consolidated Financial Statements, Selected
Supplemental Consolidated Financial Data, Management's Discussion and Analysis
of Financial Condition and Results of Operations and Supplemental Interim
Financial Statements included in this Current Report on Form 8-K filed on
January 19, 2000, the following risk factors should be considered carefully in
evaluating Mercury and its business. This Current Report on Form 8-K contains
forward-looking statements within the "safe harbor" provisions of the Private
Securities Litigation Reform Act of 1995 with respect to Mercury's financial
conditions, results of operations and businesses. Words such as "anticipates,"
"expects," "intends," "plans," "believes," "seeks," "estimates" and similar
expressions indicate forward-looking statements. In addition, Mercury has
identified certain forward looking statements below and elsewhere in this
Current Report on Form 8-K with a footnote symbol/1/. These forward-looking
statements are not guarantees of future performance and are subject to risks and
uncertainties that could cause actual results to differ materially from the
results contemplated by the forward-looking statements.
Mercury's business will suffer if it does not successfully respond rapidly
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to technological changes. 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, Mercury must continue to develop and
introduce in a timely and cost-effective manner enhancements to our existing and
new products that keep pace with technological developments and achieve market
acceptance. We cannot assure you that:
. Mercury will be able to successfully identify, develop, manufacture,
market or support new products or enhancements, including the
application performance management class of products;
. any such new products or enhancements will gain market acceptance;
. Mercury will be able to respond effectively to technological changes;
or
. Mercury will not encounter technical or other difficulties that could
delay or inhibit introduction of new products in the future.
If Mercury is unable to introduce new products or enhancements and respond
to industry changes on a timely basis, our business could be materially
adversely affected.
Mercury is dependent on a limited number of products concentrated in
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relatively new markets. Mercury's current products and products under
- ----------------------
development are limited in number and concentrated in the automated software
_____________________________________
/1/Forward looking statement
9
<PAGE>
testing and application performance management markets. These markets have
experienced rapid worldwide growth, and they remain relatively new and not well
penetrated. Although Mercury believes that the current trend toward increased
use of automated software testing and application performance management will
continue, we cannot assure you that the automated software testing and
application performance management markets will continue to expand or that
Mercury's products will be accepted in any expanded market./1/ Price reductions
or declines in demand for Mercury's software testing or application performance
management products, whether as a result of competition, technological change or
other factors, would have a material adverse effect on Mercury's results of
operations or financial position.
Operating results may fluctuate significantly and may be difficult to predict.
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Mercury may experience significant fluctuations in future quarterly operating
results. A number of factors, many of which are outside of our control, are
likely to cause fluctuations in operating results, including, but not limited
to:
. the demand for our products;
. our success in developing new products;
. delays in introduction of new products or product enhancements by
Mercury;
. the size and timing of individual orders;
. software bugs or other product quality problems;
. competition and pricing;
. customer order deferrals in anticipation of new products or product
enhancements;
. reduction in demand for automated software testing products;
. changes in operating expenses;
. mix of products sold; and
. general United States or international economic conditions.
In addition, Mercury's operating results are subject to a number of
additional factors which could cause a revenue shortfall in any given quarter:
. a significant portion of Mercury'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;
. Mercury has historically received a substantial portion of its orders
at the end of a quarter, up to the last few days of a quarter; and
. product orders are affected by the buying patterns of customers.
If an unanticipated order shortfall occurs at the end of a quarter,
Mercury's operating results for the quarter could be materially adversely
affected. Mercury believes that period-to-period comparisons of its results of
operations are not necessarily meaningful and should not be relied upon as
indications of future performance.
The computer software market is intensely competitive and Mercury continues
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to face direct competition mainly from well established, publicly-held
- ----------------------------------------------------------------------
companies. There could be a material adverse effect on Mercury's results of
- ---------
operations or financial position if any of the major software manufacturers,
which have significantly greater financial and technical resources than Mercury,
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
Mercury's customers or potential customers. A variety of external and internal
factors could materially adversely affect Mercury's ability to compete:
. the relative functionality, price, performance and reliability of the
products offered by Mercury and its competitors;
. the timing and success of new product development or enhancement
efforts of Mercury and its competitors; and
__________________________________
/1/ Forward looking statement
10
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. the effectiveness of the marketing and sales efforts of Mercury and
its competitors.
Mercury expects to face increasing competition in the automated software
testing and application performance management markets./1/ We cannot assure you
that Mercury will be able to compete successfully in the future or that
competitive pressures will not materially adversely affect Mercury's business.
Mercury is substantially dependent on its alternate distribution channels.
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Mercury 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. Mercury 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.
Mercury's dependence on such partners is subject to a number of risks:
. Each of Mercury's system integrators and value added resellers can
cease marketing Mercury's products with limited notice and with little
or no penalty;
. Mercury's current system integrators and value added resellers may not
be able to effectively sell our new products or product applications;
. Mercury may not be able to recruit additional or replacement system
integrators and value added resellers if we lose any of our current
partners;
. Mercury's system integrators and value added resellers also offer
competitive products manufactured by third parties; or
. Mercury's system integrators and value added resellers may not give
priority to the marketing of Mercury's products as compared to our
competitors' products.
The loss of one or more of our major system integrators and value added
resellers or any reduction or delay in sales of Mercury products by our system
integrators and value added resellers could have a material adverse effect on
our business, results of operations and financial condition.
Mercury is dependent on its international operations for a substantial
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portion of its revenues. Sales to customers located outside the United States
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have historically accounted for a significant percentage of revenue and Mercury
anticipates that such sales will continue to be a significant percentage of
Mercury's total revenue./1/ Mercury's international activities expose it to
additional risks. As Mercury continues to expand internationally, it is
increasingly subject to risks of doing business internationally, including:
. unexpected changes in regulatory requirements and tariffs;
. export restrictions;
. political and economic instability;
. difficulties in staffing and managing foreign operations;
. reduced protection for intellectual property rights in some countries;
. longer payment cycles;
. problems in collecting accounts receivable;
. potentially adverse tax consequences;
. seasonal reductions in business activity during the summer months in
Europe and certain other parts of the world;
. fluctuations in currency exchange rates may make Mercury products more
expensive to international customers; and
. future international activity may result in foreign currency
denominated sales, causing gains and losses on the conversion to U.S.
dollars of accounts receivable and accounts payable arising from
international operations.
Any of these risks could harm our international operations. For example,
some European countries already have laws and regulations related to
technologies used on the Internet that are more strict than those currently in
force in the United States. Any or all of these factors could cause our
business and prospects to suffer.
Mercury's financial results may be negatively impacted by foreign currency
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fluctuations. Since certain of Mercury's sales are made in currencies other
- ------------
than the U.S. Dollar and its financial results are reported in U.S.
- --------------------------
/1/ Forward looking statement
11
<PAGE>
Dollars, fluctuations in the rates of exchange between the U.S. Dollar and other
currencies may have a material adverse effect on Mercury's results of
operations, including:
. an increase in the value of a particular currency relative to the U.S.
Dollar will increase the U.S. Dollar reporting value for transactions
in such currency;
. a decrease in the value of such currency relative to the U.S. Dollar
will decrease the U.S. Dollar reporting value for transactions in such
currency; and
. Mercury incurs expenses in Pacific Rim and European currencies,
primarily for employee salaries and marketing and sales expenses, as a
result, an increase in the value of Pacific Rim and European
currencies in comparison to the U.S. Dollar could increase sales and
marketing costs.
As Mercury continues to expand its international operations, Mercury
expects to see an increase in exposures related to non-dollar denominated
sales./1/ Mercury 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. We cannot assure you
that Mercury will be successful in making these estimates. To the extent these
estimates are overstated or understated during periods of currency volatility,
Mercury could experience material currency gains or losses.
Mercury must effectively manage growth. Since 1991, Mercury has
--------------------------------------
experienced significant annual increases in revenue. This growth has placed
and, if it continues, will place a significant strain on Mercury's management,
resources and operations. To accommodate its growth, Mercury is implementing a
variety of new or expanded business and financial systems, procedures and
controls, including the improvement of our accounting, and customer support
systems. We cannot assure you that the implementation of such systems,
procedures and controls can be completed successfully, or without disruption of
Mercury's operations. If Mercury's growth continues, we 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 Mercury to pay higher salaries. Mercury's failure to manage growth
effectively could have a material adverse effect on Mercury's business,
operating results and financial condition.
Mercury's success depends to a significant extent on the performance of its
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senior management and certain key employees. Competition for highly skilled
- -------------------------------------------
employees, including sales, technical and management personnel, is intense in
the computer software industry. Mercury'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 Mercury's executive officers could have a material
adverse effect on Mercury's business and results of operations.
Mercury stock will likely be subject to substantial price and volume
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fluctuations due to a number of factors, some of which are beyond Mercury's
- ---------------------------------------------------------------------------
control. The trading price of Mercury's common stock has been and is likely to
- -------
continue to be highly volatile. Mercury's stock price has increased
substantially in the last two years. Mercury's stock price is subject to wide
fluctuations in response to a variety of factors including:
. quarterly variations in operating results;
. announcements of technological innovations;
. announcements of new software or services by Mercury or its
competitors;
. changes in financial estimates by securities analysts; or
. other events beyond our control.
In addition, the stock market has experienced significant price and volume
fluctuations that have particularly affected the trading prices of equity
securities of many high technology companies. These fluctuations have often
been unrelated or disproportionate to the operating performance of these
companies. Any negative change in the public's perception of software or
Internet software companies could depress Mercury's stock price regardless of
its operating results.
- -----------------------------
/1/ Forward looking statement
12
<PAGE>
Recently, when the market price of a stock has been volatile, holders of
that stock have often instituted securities class action litigation against the
company that issued the stock. If any of Mercury's shareholders brought such a
lawsuit against Mercury, it could incur substantial costs defending the lawsuit.
The lawsuit could also divert the time and attention of Mercury's management.
Acquisitions Mercury has made and may make in the future could disrupt its
--------------------------------------------------------------------------
business or not be successful and harm its financial condition. Mercury has in
- --------------------------------------------------------------
the past, and intends in the future, to acquire or make investments in other
complementary companies, products and technologies. Mercury recently acquired
Conduct Ltd. In the event of any future acquisitions or investments, Mercury
could:
. issue stock that would dilute the ownership of its then existing
shareholders;
. incur debt;
. assume liabilities;
. incur amortization expense related to goodwill and other intangible
assets; or
. incur large and immediate write-offs.
These acquisitions and investments also involve numerous risks, including:
. problems integrating the operations, technologies or products
purchased with those Mercury already has;
. unanticipated costs and liabilities;
. diversion of management's attention from Mercury's core business;
. adverse effects on existing business relationships with suppliers and
customers;
. risks associated with entering markets in which Mercury has no or
limited prior experience; and
. potential loss of key employees, particularly those of the acquired
organizations.
Mercury's failure to adequately protect its proprietary rights may harm its
---------------------------------------------------------------------------
competitive position. Mercury relies on a combination of patents, copyrights,
- --------------------
trademark, service mark and trade secret laws and contractual restrictions to
establish and protect proprietary rights in its products and services. However,
Mercury will not be able to protect its intellectual property if it is unable to
enforce its rights or if it does not detect unauthorized use of its intellectual
property.
Mercury holds five patents for elements contained in certain of its
products, and we have filed several other U.S. patent applications on various
elements of its products. There can be no assurance that Mercury's patent
applications will result in issued patents or that, if issued, the patents would
be upheld if challenged.
Mercury has applied for trademarks and service marks on certain terms and
symbols that it believes are important for its business. Mercury also has one
registered copyright. In addition, it generally enters into confidentiality or
license agreements with its employees and consultants and with its customers and
corporations with whom Mercury has strategic relationships, and Mercury attempts
to maintain control over access to and distribution of its software
documentation and other proprietary information. However, the steps Mercury has
taken to protect its technology or intellectual property may be inadequate.
Mercury's competitors may independently develop technologies that are
substantially equivalent or superior to Mercury's. Moreover, in other countries
where Mercury does business, there may not be effective legal protection of
patents and other proprietary rights that Mercury believes are important to
Mercury's business.
Mercury's commercial success will also depend in part on not infringing the
proprietary rights of others and not breaching technology licenses that cover
technology used in its products. It is uncertain whether any third party
patents will require Mercury to develop alternative technology or to alter its
products or processes, obtain licenses or cease activities that infringe on
third party's intellectual property rights. If any such licenses are required,
they may be very costly or Mercury may not be able to obtain such licenses at
all. Mercury's failure to obtain a license to any technology that it may require
to commercialize its products and services could cause its business and
prospects to suffer.
In addition, litigation may be necessary in the future to enforce our
intellectual property rights, to protect our trade secrets, to determine the
validity and scope of the proprietary rights of others or to defend against
claims of
13
<PAGE>
infringement or invalidity. Litigation like this, whether successful or
unsuccessful, could result in substantial costs and diversions of our management
resources, either of which could harm our business.
Mercury's products may contain product errors which could subject Mercury
-------------------------------------------------------------------------
to product liability claims. Mercury's products may contain undetected errors or
- ---------------------------
failures when first introduced or as new versions are released, which can result
in loss of or delay in market acceptance and could adversely impact future
operating results. In selling its products, Mercury frequently relies on "shrink
wrap" licenses that are not signed by licensees, the provisions in such licenses
limiting Mercury's exposure to potential product liability claims may therefore
be unenforceable under the laws of certain jurisdictions. Mercury currently
carries errors and omissions insurance against such claims, however, we cannot
assure you that such insurance will continue to be available on acceptable
terms, if at all, or that such insurance will provide Mercury with adequate
protection against product liability or other claims. In the event of a products
liability claim, Mercury may be found liable and required to pay damages which
could materially affect Mercury's financial condition.
Operations in Israel may be affected by volatile economic, political and
------------------------------------------------------------------------
military conditions. Mercury's research and development operations are primarily
- -------------------
located in Israel and may be affected by economic, political and military
conditions in that country. In addition to the risk factors affecting
international sales and operations generally, Mercury's business is also
dependent on trading relationships between Israel and other countries.
Accordingly, Mercury's operations could be adversely affected if major
hostilities involving Israel should occur or if trade between Israel and its
current trading partners were interrupted or curtailed. This risk is heightened
due to the restrictions on Mercury's ability to manufacture or transfer outside
of Israel any technology developed under research and development grants from
the government of Israel as described in the risk factor below. Additionally,
Mercury participates in special Israeli government programs that provide
significant tax advantages. The loss of or any material decrease in these tax
benefits would have a material adverse effect on Mercury.
Mercury is subject to restrictions imposed by grants from the government of
---------------------------------------------------------------------------
Israel. Since its inception, Mercury has obtained royalty-bearing grants from
- ------
various Israeli government agencies. Mercury 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/ Mercury believes these
grants are no longer needed to subsidize Mercury'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 Mercury is unable
to obtain the consent of the government of Israel, Mercury may not be able to
take advantage of strategic manufacturing and other opportunities outside of
Israel.
Anti-takeover effects of certain charter provisions, unissued preferred
-----------------------------------------------------------------------
stock and Delaware law. Mercury's Board of Directors has the authority to issue
- ----------------------
up to 5,000,000 shares of Preferred stock and to determine the price, rights,
preferences and privileges of those shares without any further vote or action by
the stockholders. The rights of the holders of common stock will be subject to,
and may be adversely affected by, the rights of the holders of any Preferred
Stock that may be issued in the future. The issuance of Preferred Stock, while
providing desirable flexibility in connection with possible acquisitions and
other corporate purposes, could have the effect of making it more difficult for
a third party to acquire a majority of the outstanding voting stock of Mercury.
Mercury has no present plans to issue shares of Preferred Stock. In addition,
Mercury is subject to the anti-takeover provisions of Section 203 of the
Delaware General Corporation Law. In general, the statute prohibits a publicly-
held Delaware corporation from engaging in a "business combination" with an
"interested stockholder" for a period of three years after the date of the
transaction in which the person became an interested stockholder, unless the
business combination is approved in a prescribed manner. For purposes of Section
203, a "business combination" includes a merger, asset sale or other transaction
resulting in a financial benefit to the interested stockholder, and an
"interested stockholder" is a person who, together with affiliates and
associates, owns (or within three years prior, did own) 15% or more of the
corporation's voting stock. Furthermore, certain provisions of Mercury's
Certificate of Incorporation may have the effect of delaying or preventing
changes in control or management of Mercury, which could adversely affect the
market price of Mercury's common stock.
- ---------------------------
/1/ Forward looking statement
14
<PAGE>
Year 2000 computer complications could disrupt our operations and harm our
--------------------------------------------------------------------------
business. Some computers, software, and other equipment include programming
- --------
code in which calendar year data is abbreviated to only two digits. As a result
of this design decision, some of these systems could fail to operate or fail to
produce correct results if "00" is interpreted to mean 1900, rather than 2000.
These problems are commonly referred to as the "Year 2000 Problem."
The Year 2000 Problem could affect computers, software, and other equipment
used, operated or maintained by us. We have not experienced any significant
problems on January 1, 2000 or since then and believe that our computer systems
are Year 2000 compliant.
Mercury believes that it has substantially identified and resolved all
potential Year 2000 Problems with any of the software products that we develop
and market. However, Mercury also believes that it is not possible to determine
with complete certainty that all Year 2000 Problems affecting its software
products have been identified or corrected due to the complexity of these
products and the fact that these products interact with other third-party vendor
products and operate on computer systems which are not under Mercury's control.
Since January 1, 2000, to its knowledge, Mercury had no interruptions with
third-party software and no complaints from any customers. Mercury has
developed a contingency plan to respond to any of the foregoing consequences of
internal and external failures to be Year 2000 compliant. Mercury does not
believe that the Year 2000 Problem will have a material adverse effect on its
business or results of operations.
Liquidity and Capital Resources
At December 31, 1998, the Company's principle source of liquidity consisted
of $130.7 million of cash and investments as compared to $92.4 million and $80.0
million at December 31, 1997 and 1996, respectively. The December 31, 1998
balance included $88.3 million of short-term and $20.7 million of long-term
investments in high quality government and corporate securities.
During 1998, the Company generated $39.5 million cash from operating
activities, compared to cash generated from operating activities of $17.2
million in 1997 and cash used for operating activities of $1.8 million in 1996.
The increase in 1998 compared to 1997 was due primarily to an increase in net
income, an increase in deferred revenue, and increases in accrued liabilities
and income taxes payable. The increase in 1997 compared to 1996 was primarily
due to an increase in net income, excluding the write off of in-process research
and development and related expenses and an increase in deferred revenue,
partially offset by an increase in trade accounts receivable.
The Company's primary investing activities were net purchases of
investments in 1998 of $1.3 million compared to net proceeds from investments in
1997 and 1996 of $512,000 and $4.1 million, respectively. The Company also
purchased property and equipment, which totaled $15.0 million, $11.9 million and
$4.7 million in 1998, 1997 and 1996, respectively. The Company spent $1.5
million and $7.3 million in 1998 and 1997, respectively, for purchase and
renovation of its headquarters building in Sunnyvale, California. The Company
spent $5.7 million and $1.8 million in 1998 and 1997, respectively, on
construction of a new research and development facility in Israel. The Company
expects to spend an additional $4.0 million to complete this construction and
will relocate its Israel subsidiary to the new facility in the third quarter of
1999.
The Company's primary financing activity consisted of issuances of common
stock under the Employee Stock Option and Stock Purchase Plans. Proceeds from
issuance of stock under the Employee Stock Option and Purchase Plans amounted to
$14.4 million, $7.7 million and $2.3 million in 1998, 1997 and 1996,
respectively.
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
$4.7 least the next twelve months./1/
- -----------------------------
/1/ Forward looking statement
15
<PAGE>
New Accounting Pronouncements
In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued a Statement of Position 98-1, "Accounting for the Cost of
Computer Software Developed or Obtained for Internal Use" (SOP 98-1). SOP 98-1
is effective for the financial statements for years beginning after December 15,
1998. SOP 98-1 provides guidance over accounting for computer software
developed or obtained for internal use including the requirement to capitalize
specified costs and amortization of such costs. The company adopted the
provisions of SOP 98-1 in its fiscal year ending December 31, 1999 Adoption did
not have a material effect on the Company's financial statements.
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 did not
have a material impact on the Company's results of operations, financial
position or cash flows.
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 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
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.
16
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
Mercury Interactive Corporation
In our opinion, the consolidated balance sheet and the related consolidated
statements of operations and of shareholder's equity and of cash flows (which
statements are not presented separately herein) present fairly, in all material
respects, the financial position of Mercury Interactive Corporation and its
subsidiaries at December 31, 1998 and 1997, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1998, in conformity with accounting principles generally accepted in the
United States. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with auditing standards generally accepted in the
United States which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
As described in Note 8, on November 30, 1999 Mercury Interactive
Corporation merged with Conduct Ltd. in a transaction accounted for as a
pooling of interests. The accompanying supplemental consolidated financial
statements give retroactive effect to the merger of Mercury Interactive
Corporation with Conduct Ltd. Generally accepted accounting principles
proscribe giving effect to a consummated business combination accounted for by
the pooling of interests method in financial statements that do not include the
date of consummation. These financial statements do not extend through the date
of consummation; however, they will become the historical consolidated financial
statements of Mercury Interactive Corporation and subsidiaries after financial
statements covering the date of consummation of the business combination are
issued.
In our opinion, based on our audits the accompanying supplemental
consolidated balance sheets and the related supplemental consolidated statements
of operations and of shareholders' equity and of cash flows present fairly, in
all material respects, the financial position of Mercury Interactive Corporation
and its subsidiaries at December 31, 1998 and December 31, 1997, and the results
of their operations and their cash flows for each of the three years ended
December 31,1998, in conformity with accounting principles generally accepted in
the United States. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with auditing standards generally accepted in the
United States which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining on a test basis evidence supporting
the amounts and disclosure in the financial statements, assessing the accounting
principles used and significant estimates made by management, and evaluating the
overall financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
San Jose, California
January 28, 1999, except as to the pooling of interests with
Conduct Ltd. which is as of January 19, 2000
17
<PAGE>
MERCURY INTERACTIVE CORPORATION
SUPPLEMENTAL CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
December 31,
------------------------------
1998 1997
---------- ----------
<S> <C> <C>
ASSETS
- ------
Current assets:
Cash and cash equivalents................................................... $ 96,836 $ 57,291
Short-term investments...................................................... 13,130 31,357
Trade accounts receivable (net of allowance for
doubtful accounts and sales returns of $3,623 and $1,878)............ 27,903 23,782
Government grants and other receivables..................................... 6,012 3,606
Prepaid expenses and other current assets................................... 10,664 3,240
---------- ----------
Total current assets..................................................... 154,545 119,276
Long-term investments......................................................... 20,697 3,771
Property and equipment, net................................................... 28,423 19,431
Other assets.................................................................. 1,021 1,185
---------- ----------
$ 204,686 $ 143,663
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Current liabilities:
Accounts payable............................................................ $ 4,622 $ 4,188
Accrued liabilities......................................................... 18,036 13,267
Income taxes payable........................................................ 11,498 3,121
Deferred revenue............................................................ 24,122 10,967
---------- ----------
Total current liabilities................................................ 58,278 31,543
---------- ----------
Commitments and contingencies (Note 5)
Stockholders' equity :
Common Stock, par value $.002 per share, 120,000 shares authorized;
36,995 and 33,477 shares issued and outstanding........................... 74 67
Capital in excess of par value.............................................. 128,502 108,265
Notes receivable from issuance of stock................................... (5,130) --
Accumulated comprehensive loss.............................................. (775) (424)
Retained earnings........................................................... 23,737 4,212
---------- ----------
Total stockholders' equity............................................... 146,408 112,120
---------- ----------
$ 204,686 $ 143,663
========== ==========
</TABLE>
The accompanying notes are an integral part of these supplemental consolidated
financial statements.
18
<PAGE>
MERCURY INTERACTIVE CORPORATION
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
Year ended December 31,
----------------------------------------------
1998 1997 1996
------------- ----------- ------------
<S> <C> <C> <C>
Revenue:
License................................................... $ 84,450 $ 56,683 $ 43,270
Service................................................... 36,550 20,017 11,280
---------- ---------- -----------
Total revenue....................................... 121,000 76,700 54,550
---------- ---------- -----------
Cost of revenue:
License................................................... 6,291 4,351 3,419
Service................................................... 11,757 6,225 3,240
---------- ---------- -----------
Total cost of revenue............................... 18,048 10,576 6,659
---------- ---------- -----------
Gross profit.................................................... 102,952 66,124 47,891
---------- ---------- -----------
Operating expenses:
Research and development, net............................. 16,907 11,333 9,670
Write off of in-process research and development
and related expenses................................ -- 5,500 --
Marketing and selling..................................... 57,243 37,073 29,426
General and administrative................................ 8,466 6,642 4,178
Settlement of litigation.................................. -- -- 2,600
---------- ---------- -----------
Total operating expenses............................ 82,616 60,548 45,874
---------- ---------- -----------
Income from operations.......................................... 20,336 5,576 2,017
Other income, net............................................... 4,640 3,083 3,375
---------- ---------- -----------
Income before provision for income taxes........................ 24,976 8,659 5,392
Provision for income taxes...................................... 5,451 2,927 1,157
---------- ---------- -----------
Net income...................................................... $ 19,525 $ 5,732 $ 4,235
========== ========== ===========
Net income per share (basic).................................... $ 0.55 $ 0.18 $ 0.13
========== ========== ===========
Net income per share (diluted).................................. $ 0.50 $ 0.17 $ 0.13
========== ========== ===========
Weighted average common shares (basic).......................... 35,327 32,747 31,817
========== ========== ===========
Weighted average common shares and equivalents (diluted)........ 39,409 34,229 33,127
========== ========== ===========
</TABLE>
The accompanying notes are an integral part of these supplemental consolidated
financial statements.
19
<PAGE>
MERCURY INTERACTIVE CORPORATION
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands)
<TABLE>
<CAPTION>
Accumulated other
----------------------------------------------------
Notes Retained
Capital in Receivable Earnings/ Comprehensive
Common Stock Excess of From issuance of Accumulated Income Stockholders'
----------------
Shares Amount Par value stock deficit (loss) Equity
------ ------ --------- ------------ ----------- ------------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31,
1995...................... 31,456 $ 63 $ 98,277 -- $ (5,755) $ 31 $ 92,616
Net income................. -- -- -- -- 4,235 -- 4,235
Currency translation
adjustments............... -- -- -- -- -- (130) (130)
------ ------ --------- ------------ ----------- ------------- ------------
Other comprehensive income.
Stock issued under stock
option and employee stock
purchase plans............ 656 1 1,926 -- -- -- 1,927
Pooling of interest
acquisition............... 1 400 -- 400
------ ------ --------- ------------ ----------- ------------- ------------
Balance at December 31,
1996...................... 32,113 64 100,603 -- (1,520) (99) 99,048
Net income................. -- -- -- -- 5,732 -- 5,732
Currency translation
adjustments............... -- -- -- -- -- (325) (325)
------ ------ --------- ------------ ----------- ------------- ------------
Other comprehensive income.
Stock issued under stock
option and employee stock
purchase plans............ 1,364 3 7,563 -- -- -- 7,566
Pooling of interest
acquisition............... 99 -- -- -- 99
------ ------ --------- ------------ ----------- ------------- ------------
Balance at December 31,
1997...................... 33,477 67 108,265 -- 4,212 (424) 112,120
Net income................. -- -- -- -- 19,525 -- 19,525
Currency translation
adjustments............... -- -- -- -- -- (351) (351)
------ ------ --------- ------------ ----------- ------------- ------------
Other comprehensive income.
Stock issued under stock
option and employee stock
purchase plans............ 3,150 6 16,272 $ (5,130) -- -- 11,148
Pooling of interest
acquisition............... 368 1 3,965 -- 3,966
------ ------ --------- ------------ ----------- ------------- ------------
Balance at December 31,
1998...................... 36,995 $ 74 $ 128,502 $ (5,130) $ 23,737 $ (775) $ 146,408
======= ====== ========= ============ =========== ============= ============
<CAPTION>
Comprehensive
Income
(loss)
-------------
<S> <C>
Balance at December 31,
1995......................
Net income................. $ 4,235
Currency translation
adjustments............... (130)
--------------
Other comprehensive income. 4,105
==============
Stock issued under stock
option and employee stock
purchase plans............
Pooling of interest
acquisition
Balance at December 31,
1996......................
Net income................. 5,732
Currency translation
adjustments............... (325)
--------------
Other comprehensive income. 5,407
==============
Balance at December 31,
1997......................
Net income................. 19,525
Currency translation
adjustments............... $ (351)
---------------
Other comprehensive income. $ 19,174
===============
</TABLE>
The accompanying notes are an integral part of these supplemental consolidated
financial statements.
20
<PAGE>
MERCURY INTERACTIVE CORPORATION
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------------------------
1998 1997 1996
-------- -------- ----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income....................................................................... $ 19,525 $ 5,732 $ 4,235
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Depreciation and amortization............................................... 4,223 3,775 3,274
Deferred income taxes....................................................... (1,840) 270 674
Changes in assets and liabilities:
Trade accounts receivable.............................................. (4,006) (7,240) (6,534)
Government grant and other receivables................................. (4,034) (730) (564)
Prepaid expenses and other current assets.............................. (1,443) 858 (1,128)
Other assets........................................................... (436) -- --
Accounts payable....................................................... 803 1,923 611
Accrued liabilities.................................................... 5,320 5,141 (5,218)
Income taxes payable................................................... 8,373 2,485 237
Deferred revenue....................................................... 13,030 4,936 2,594
-------- -------- ----------
Net cash provided by (used in) operating activities............... 39,515 17,150 (1,819)
-------- -------- ----------
Cash flows from investing activities:
Maturity of investments.......................................................... 35,128 35,640 39,789
Purchases of investments......................................................... (33,826) (35,128) (35,640)
Acquisition of property and equipment............................................ (15,040) (11,927) (4,652)
Capitalization of software development costs..................................... -- (500) (1,340)
-------- -------- ----------
Net cash used in investing activities....................................... (13,738) (11,915) (1,843)
-------- -------- ----------
Cash flows from financing activities:
Proceeds from issuance of common stock, net...................................... 19,483 7,664 2,327
Notes receivable from issuance of stock.......................................... (5,130) -- --
-------- -------- ----------
Net cash provided by financing activities................................... 14,353 7,664 2,327
-------- -------- ----------
Effect of exchange rate changes on cash............................................... (585) (28) (95)
-------- -------- ----------
Net increase (decrease) in cash....................................................... 39,545 12,871 (1,430)
Cash and cash equivalents at beginning of period...................................... 57,291 44,420 45,850
-------- -------- ----------
Cash and cash equivalents at end of period............................................ $ 96,836 $ 57,291 $ 44,420
======== ======== ==========
Supplemental Disclosure:
Cash paid during the period for income taxes.......................................... $ 1,365 $ 2,083 $ 1,182
</TABLE>
The accompanying notes are an integral part of these supplemental consolidated
financial statements.
21
<PAGE>
MERCURY INTERACTIVE CORPORATION
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1-THE COMPANY AND ITS SIGNIFICANT ACCOUNTING POLICIES
Mercury Interactive Corporation (the "Company"), incorporated in Delaware
in July 1989, develops, markets and supports a family of automated client/server
and Web-based system tools for testing business-critical enterprise
applications. The Company operates in one industry segment. See Note 7 for
geographic reporting. No customer accounted for more than 10% of the Company's
revenue in 1998, 1997 or 1996.
Supplemental Consolidated Financial Statements
The Company acquired Conduct Ltd. on November 30, 1999, which was
accounted for as a pooling of interests. The supplemental consolidated financial
statements for each of the three years ended December 31, 1998, 1997 and 1996
and the accompanying notes reflect the Company's financial position and results
of operations as if the acquired entity was a wholly owned subsidiary of the
Company since inception (see Note 8).
Basis of presentation
The Company has a wholly owned research and development subsidiary
incorporated in Israel and sales subsidiaries in Canada, Europe and the Pacific
Rim for marketing, distribution and support of products. The consolidated
financial statements include the accounts of the Company and its wholly owned
subsidiaries. All significant intercompany accounts and transactions have been
eliminated.
Share and per share amounts do not reflect the effect of the two-for-one
stock split announced on January 13, 2000.
Foreign currency translation
The functional currency of the Company's subsidiary in Israel is the U.S.
dollar. Assets and liabilities in Israel are translated at year-end exchange
rates, except for property and equipment, which is translated at historical
rates. Revenues and expenses are translated at average exchange rates in effect
during the year, except for costs related to those balance sheet items, which
are translated at historical rates. Foreign currency translation gains and
losses, which have not been material to date for this subsidiary, are included
in the supplemental consolidated statement of operations.
The functional currencies of all other subsidiaries are the local
currencies. Accordingly, all assets and liabilities of these subsidiaries are
translated at the current exchange rate at the end of the period and revenues
and costs at average exchange rates in effect during the period. The gains and
losses from translation of these subsidiaries' financial statements are recorded
directly into a separate component of stockholders' equity. Net gains and losses
resulting from foreign exchange transactions were not significant during any of
the periods presented.
Cash and cash equivalents
The Company considers all highly liquid debt instruments purchased with a
maturity of three months or less at the date of purchase to be cash equivalents.
Short-term and long-term investments
The Company considers all investments with maturities of less than one year
as of December 31, 1998 to be short-term investments and all investments with
maturities greater than one year to be long-term investments. In
22
<PAGE>
MERCURY INTERACTIVE CORPORATION
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
accordance with Statement of Financial Accounting Standards No. 115, "Accounting
for Certain Investments in Debt and Equity Securities," the Company has
categorized its marketable securities as "held to maturity" securities.
The investments, which all have contractual maturities of less than two years,
are carried at cost plus accrued interest. Realized gains or losses are
determined based on the specific identification method and are reflected in
other income.
The portfolio of short and long-term investments (including cash and cash
equivalents) consisted of the following:
December 31,
------------
Investment Type 1998 1997
--------------- ---- ----
Cash and interest bearing demand deposits $ 21,655 $ 13,167
Municipal securities 50,936 63,449
Corporate debt securities 38,022 7,856
Money Market preferred stock 18,450 7,947
U.S. treasury and agency securities 1,600 --
--------- --------
Total $ 130,663 $ 92,419
========= ========
Revenue recognition
The Company's product revenues are derived from product licensing fees, and
the Company's service revenues are derived from maintenance support services,
training and consulting. Revenue from product licensing fees is recognized upon
shipment and resolution of any material vendor obligations. Products shipped,
for which material vendor obligations exist, are recorded as deferred revenue.
Service revenue from customer maintenance fees for ongoing customer support and
product updates is recognized ratably over the period of the contract. Payments
for maintenance fees are generally made in advance, are nonrefundable and are
classified as deferred revenue. Revenues for training and consulting services
are recognized as the services are provided.
Inventories
Inventories are stated at the lower of standard cost, which approximates
actual cost, using the first-in, first-out method, or market.
Property and equipment
Property and equipment are stated at cost. Depreciation and amortization
are provided using the straight-line method over the estimated economic lives of
assets, which are three to ten years for office furniture and equipment, three
to five years for computers and related equipment, four to ten years for
leasehold improvements, or the term of the lease, whichever is shorter, and
thirty years for the building.
Research and development
In accordance with Statement of Financial Accounting Standards No. 86,
"Accounting for Costs of Computer Software to be Sold, Leased or Otherwise
Marketed," all costs incurred to establish the technological feasibility of a
computer product to be sold, leased or otherwise marketed are expensed as
research and development costs. Costs incurred subsequent to the establishment
of technological feasibility, and prior to the general release of the product to
the public are capitalized. Amortization of capitalized software development
costs is provided on a product-by-product basis using the straight-line method
over the estimated economic life of the products of two years.
In 1998, the Company did not capitalize any software development costs. The
Company capitalized $500,000 and $1.3 million of software development costs
during the years ended December 31, 1997 and 1996, respectively. Amortization
charges included in cost of license revenues were $600,000 in 1998 and 1997, and
$300,000 in 1996. In conjunction with the technology acquisition in 1997 the
Company wrote-off approximately $250,000 of capitalized
23
<PAGE>
MERCURY INTERACTIVE CORPORATION
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
development costs as obsolete in the year ended December 31, 1997. At December
31, 1998 and 1997 the Company had a net balance of capitalized software
development costs of $585,000 and $1.2 million, respectively.
Research and development expense for each of the three years ended December
31, 1998, 1997 and 1996 is net of research grants received by the Company from
the government of Israel, and includes royalty expense for obligations to the
government of Israel for sales of products developed under government-funded
research. The Company obtained grants from the Office of the Chief Scientist in
the Israeli Ministry of Industry and Trade ("the Chief Scientist") in the
amounts of $1.6 million, $2.1 million and $1.8 million in 1998, 1997 and 1996,
respectively. In 1996, the Company also received a grant in the amount of
$391,000 from the Israel-U.S. Binational Industrial Research and Development
Foundation ("BIRD-F"). 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 $2.7 million, $1.6
million and $1.1 million for the years ended December 31, 1998, 1997 and 1996,
respectively. As of December 31, 1998, the Company is committed to pay, if and
when earned, $2.8 million in additional royalties for Chief Scientist grants and
$700,000 for the BIRD-F grants. The Company has not applied for, nor does it
expect to apply for, any future Chief Scientist or BIRD-F grants.
Stock-based compensation
The Company accounts for stock-based compensation using the intrinsic value
method presented in Accounting Principles Board Opinion (APB) No. 25, "
Accounting for Stock Issued to Employees" and related interpretations. The
Company's policy is to grant options with an exercise price equal to the quoted
market price of the Company' stock on the grant date. Accordingly, no
compensation cost has been recognized in the Company's statements of operations.
The Company provides additional pro forma disclosure as required under Statement
of Financial Accounting Standard No. 123 ("SFAS 123"), " Accounting for Stock-
based Compensation." See Note 3.
Concentration of risks
Financial instruments, which potentially subject the Company to
concentrations of credit risk, consist principally of cash equivalents,
investments and accounts receivable. The Company invests primarily in money
market accounts and marketable securities and places its investments with high
quality financial, government or corporate institutions. The Company's accounts
receivables are derived from sales to customers located primarily in the U.S.,
Canada, Europe, Pacific Rim and Israel. The Company performs ongoing credit
evaluations of its customers and to date has not experienced any material
losses.
24
<PAGE>
MERCURY INTERACTIVE CORPORATION
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Net income per share
Earnings per share are calculated in accordance with the provisions of
Statement of Accounting Standards No. 128, "Earnings per Share," ("SFAS 128").
SFAS 128 requires the Company to report both basic earnings per share, which
is the weighted-average number of common shares outstanding, and diluted
earnings per share, which includes the weighted-average common shares
outstanding and all dilutive potential common shares outstanding. All periods
presented herein have been restated to reflect the adoption of SFAS 128. For
the years ended December 31, 1998, 1997 and 1996, dilutive potential common
shares outstanding reflects primarily shares issuable under the Company's
stock option plans. Share and per share amounts do not reflect the effect of
the two-for-one stock split announced on January 13, 2000. The following table
summarizes the Company's earnings per share computations for the years ended
December 31, 1996, 1997 and 1998:
Average Earnings per
Net income shares share
------------ ------- ------------
December 31, 1996:
Basic earnings per share $ 4,235 31,817 $ 0.13
Dilutive adjustments -- 1,310
----------- ------- -----
Diluted earnings per share $ 4,235 33,127 0.13
----------- -------
December 31, 1997:
Basic earnings per share $ 5,732 32,747 $ 0.18
Dilutive adjustments -- 1,482
----------- -------
Diluted earnings per share $ 5,732 34,229 0.17
----------- -------
December 31, 1998:
Basic earnings per share $ 19,525 35,327 $ 0.55
Dilutive adjustments -- 4,082
----------- -------
Diluted earnings per share $ 19,525 39,409 0.50
----------- -------
At December 31, 1998, 1997,and 1996, options to purchase a total of 140,000
shares of common stock with an average exercise price of $19.24, 470,546 shares
of common stock with an average exercise price of $9.65, and 502,942 shares of
common stock with an average exercise price of $9.03, respectively, are
considered anti-dilutive because the options' exercise price was greater than
the average fair market value of the Company's common stock for the years then
ended.
Management Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Reclassifications
Certain previously reported amounts have been reclassified to conform to
the 1998 consolidated financial statement presentation.
25
<PAGE>
MERCURY INTERACTIVE CORPORATION
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Comprehensive Income
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income." This Statement
requires that all items recognized under accounting standards as components of
comprehensive earnings be reported in an annual financial statement that is
displayed with the same prominence as other annual financial statements. The
Company's comprehensive income has been included in the Consolidated Statement
of Stockholders' Equity for all periods.
Segment Reporting
Effective January 1998, the Company adopted Statement of Financial
Accounting Standard No. 131, "Disclosures about Segments of an Enterprise and
Related Information." This statement establishes standards for the manner in
which public companies report information about operating segments in annual and
interim financial statements. The Company has included information related to
geographic segments. See Note 7.
New Accounting Pronouncements
In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued a Statement of Position 98-1, "Accounting for the Cost of
Computer Software Developed or Obtained for Internal Use"(SOP 98-1). SOP 98-1 is
effective for the financial statements for years beginning after December 15,
1998. SOP 98-1 provides guidance over accounting for computer software developed
or obtained for internal use including the requirement to capitalize specified
costs and amortization of such costs. The company adopted the provisions of SOP
98-1 in its fiscal year ending December 31, 1999. Adoption did not have a
material effect on the Company's financial statements.
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 a material impact on the Company's results of operations,
financial position or cash flows.
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 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
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.
26
<PAGE>
MERCURY INTERACTIVE CORPORATION
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 2--FINANCIAL STATEMENT COMPONENTS
<TABLE>
<CAPTION>
December 31,
---------------------------
1998 1997
--------- ---------
(in thousands)
<S> <C> <C>
Government grants and other receivables:
Government grants receivables..................................... $ 400 $ 977
Employee receivables.............................................. 1,014 277
Income tax receivable............................................. 2,618 1,484
Other receivables................................................. 1,980 868
--------- ---------
$ 6,012 $ 3,606
========= =========
Prepaid expenses and other current assets:
Prepaid compensation.............................................. $ 5,717 $ 1,427
Deferred income tax............................................... 1,840 --
Other............................................................. 3,107 1,813
--------- ---------
$ 10,664 $ 3,240
========= =========
Property and equipment:
Land.............................................................. $ 4,807 $ 5,128
Buildings......................................................... 13,504 6,712
Computers and equipment........................................... 18,039 13,855
Office furniture and equipment.................................... 4,481 2,206
Leasehold improvements............................................ 2,934 2,185
--------- ---------
43,765 30,086
Less: accumulated depreciation and amortization................... (15,342) (10,655)
--------- ---------
$ 28,423 $ 19,431
========= =========
Accrued liabilities:
Payroll and accrued commissions (including payroll taxes)......... $ 8,759 $ 4,822
Vacation and severance............................................ 3,457 2,542
Acquisition of technologies and related costs..................... -- 2,316
Royalties......................................................... 2,177 1,357
Other............................................................. 3,643 2,230
--------- ---------
$ 18,036 $ 13,267
========= =========
</TABLE>
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------
1998 1997 1996
---- ---- ----
(in thousands)
<S> <C> <C> <C>
Other income, net:
Interest income............................................. $ 4,741 $ 3,521 $ 3,162
Foreign exchange gains (losses) and other................... (101) (438) 213
-------- ------- -------
$ 4,640 $ 3,083 $ 3,375
======== ======= =======
</TABLE>
27
<PAGE>
MERCURY INTERACTIVE CORPORATION
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 3--COMMON STOCK
In August 1989, the Company adopted a stock option plan (the "Plan").
Options granted under the Plan are for periods not to exceed ten years. For
holders of 10% or more of the total combined voting power of all classes of the
Company's stock, options may not be granted at less than 110% of the fair value
of the Common Stock at the date of grant and the option term may not exceed 5
years. Incentive stock option grants under the Plan must be at exercise prices
no less than 100% of the fair market value and non-statutory stock option grants
under the Plan must be at exercise prices no less than 85% of the fair market
value of the stock on the date of grant. Options are immediately exercisable but
all shares purchased upon exercise of options are subject to repurchase by the
Company until vested. Options generally vest over a period of four years. In
August 1998, the stockholders reserved additional 600,000 shares of Common Stock
for issuance upon exercise of stock options to be granted under this plan.
In August 1998, the stockholders adopted the 1999 Stock Option Plan (the
"1999 Plan") to replace the Amended and Restated 1989 Stock Option plan,
effective on the expiration of the term of such plan in August 1999. The Company
reserved 450,000 shares of Common Stock for issuance upon exercise of stock
options to be granted under this plan. The provisions of the supplemental plan
regarding option term, grant price, exercise price, and resting period are
identical to those of the Plan except that all options granted under the 1999
Plan must be at exercise prices no less than 100% of the fair market value.
In May 1996, the Company adopted a stock option plan solely for grants to
employees of the Company and its subsidiaries located outside the United States
(the "Supplemental Plan"). The Company reserved 1,000,000 shares of Common Stock
for issuance upon exercise of stock options to be granted under this plan. The
provisions of the Supplemental Plan regarding option term, grant price, exercise
price, and vesting period is identical to those of the Plan.
The following table presents the combined activity of the Plan and the
Supplemental Plan for the years ended December 31, 1996, 1997 and 1998 (shares
in thousands):
<TABLE>
<CAPTION>
Options outstanding
------------------------------
Options Weighted
available Number of average
For grant Shares exercise price
------------ ---------- ---------------
<S> <C> <C> <C>
Balance outstanding at December 31, 1995......... 320 4,008 $ 5.35
Additional shares authorized..................... 2,418 -- --
Options granted.................................. (3,756) 3,756 6.04
Options canceled................................. 1,046 (1,046) 7.23
Options exercised................................ -- (468) 3.67
------------ ------------
Balance outstanding at December 31, 1996......... 28 6,250 5.64
Additional shares authorized..................... 1,496 -- --
Options granted.................................. (2,134) 2,134 5.93
Options canceled................................. 626 (626) 5.99
Options exercised................................ -- (1,062) 4.81
------------ ------------
Balance outstanding at December 31, 1997......... 16 6,696 5.84
Additional shares authorized..................... 2,233 -- --
Options granted.................................. (2,660) 2,660 12.97
Options canceled................................. 465 (465) 8.82
Options exercised................................ -- (3,040) 5.44
------------- ------------
Balance outstanding at December 31, 1998......... 54 5,851 $ 8.98
------------ ------------
</TABLE>
28
<PAGE>
MERCURY INTERACTIVE CORPORATION
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In May of 1996, the Board of Directors authorized the Company to offer all
employees with outstanding options at exercise price in excess of $8.00 per
share the opportunity to exchange such options for new options. Each new option
was issued under the same terms as the surrendered options. As a result, options
covering 542,166 shares ranging in price from $8.38 to $9.50 were canceled and
options for an equal number of shares were granted at the exercise price of
$6.38.
The following table presents weighted average price and remaining
contractual life information about significant option groups outstanding under
the Plan and the Supplemental Plan at December 31, 1998 (shares in thousands):
<TABLE>
<CAPTION>
Options outstanding Options exercisable
--------------------------------------------------------- --------------------------------
Weighted average Number
Range of Number Remaining Weighted average Exercisable Weighted average
exercise prices Outstanding Contractual life Exercise price at 12/31/98 exercise price
- --------------- (yr.)
----------- ----------------- ---------------- ----------- -----------------
<S> <C> <C> <C> <C> <C>
$ 0.15 - 6.13.................... 1,440 5.86 $ 4.89 528 $ 4.95
$ 6.19 - 7.63.................... 1,673 7.23 6.62 718 6.49
$ 7.88 - 12.63.................... 2,404 9.09 12.06 156 9.67
$ 16.19 - 19.82.................... 334 9.29 16.67 10 16.97
---------- ---------
5,851 7.77 $ 8.99 1,412 $ 6.34
---------- ---------
</TABLE>
In October 1998, the Company issued notes receivable of $5.1 million to
officers and key employees of the Company in connection with the purchase of
common stock. The notes bear interest at 5%, are secured by the shares
purchased, and require quarterly interest payments. The full amount of the notes
and the final interest payment are due no later than December 31, 2000.
Directors' Stock Option Plan
On August 3, 1994, the Board of Directors of the Company adopted the 1994
Directors' Stock Option Plan (the "Directors' Plan"). The Company reserved
1,000,000 shares of Common Stock for issuance upon exercise of stock options to
be granted during the ten year term of the Directors' Plan. Only outside
directors may be granted options under the Directors' Plan. The Plan provided
for an initial option grant of 25,000 shares to outside directors of the Company
as of August 3, 1994 or upon initial election to the Board of Directors after
August 3, 1994. In addition, the plan provided for automatic annual grants of
5,000 shares upon re-election of the individual to the Board of Directors. In
August 1998, the stockholders agreed to amend the Directors' plan to increase
the number of shares granted to 50,000 shares as an initial grant to new non-
employee directors, 10,000 shares as the annual grant to continuing non-employee
directors of the Corporation, and to provide for a one-time grant of 25,000
shares to the non-employee directors of the Corporation who were serving as
directors of the Corporation as of August 14,1998. The option term shall be ten
years, and options shall be exercisable while such person remains a director.
The exercise price shall be 100% of fair market value on the date of grant. The
initial option grants vest 20% annually for each director on the date of each
Annual Meeting of Stockholders of the Company after the date of grant of such
option. The annual option grants shall vest in full on the fifth anniversary
following each individual's re-election to the Board of Directors.
29
<PAGE>
MERCURY INTERACTIVE CORPORATION
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following table presents the activity for the Directors' Plan for the
years ended December 31, 1996, 1997 and 1998 (shares in thousands):
<TABLE>
<CAPTION>
Options outstanding
-----------------------------------
Options Number of Weighted
available shares average price
for grant
----------- ------------- --------------
<S> <C> <C> <C>
Balance outstanding at December 31, 1995..... 760 220 $ 5.66
Options granted.............................. (90) 90 7.38
Options canceled............................. 90 (90) 6.14
Options exercised............................ -- (40) 4.57
----------- -----------
Balance outstanding at December 31, 1996..... 760 180 6.52
Options granted.............................. (30) 30 6.13
Options canceled............................. -- -- --
Options exercised............................ -- (20) 4.57
----------- -----------
Balance outstanding at December 31, 1997..... 730 190 6.66
Options granted.............................. (180) 180 19.40
Options canceled............................. -- -- --
Options exercised............................ -- (80) 7.62
----------- -----------
Balance outstanding at December 31, 1998..... 550 290 $ 14.28
=========== ===========
</TABLE>
The following table presents weighted average price and remaining
contractual life information about significant option groups outstanding under
the Director's Plan at December 31, 1998 (shares in thousands):
<TABLE>
<CAPTION>
Options outstanding Options exercisable
----------------------------------------------------- ---------------------------------
Weighted average Number
Range of Number Remaining Weighted average exercisable Weighted average
exercise prices Outstanding contractual life Exercise price at 12/31/98 Exercise price
- -------------- (yr.)
------------ ------------------ --------------- ------------- ----------------
<S> <C> <C> <C> <C> <C>
$ 4.57 - $ 6.75...................... 80 7.20 $ 5.97 -- --
$ 7.88 - $10.57...................... 40 6.83 9.22 -- --
$17.32 - $19.82...................... 170 9.50 18.57 20 $19.82
--------- -------
290 8.54 $14.28 20 $19.82
--------- -------
</TABLE>
Employee Stock Purchase Plans
In October 1993, the Board of Directors and stockholders adopted the
Employee Stock Purchase Plan (the "1993 ESPP") and reserved 1,000,000 shares for
issuance. Under the plan, employees were granted the right to purchase shares of
Common Stock at a price per share that was the lesser of: (i) 85% of the fair
market value of the shares at the participant's entry date into the two-year
offering period, or (ii) the fair market value at the end of each six-month
segment within such offering period. The 1993 ESPP was terminated in February
1998. In August 1998, the stockholders adopted the 1998 Employee Stock Purchase
Plan (the "1998 ESPP") to replace the 1993 ESPP and the reservation of 650,000
shares for issuance thereunder. Under the 1998 ESPP, employees are granted the
right to purchase shares of common stock at a price per share that is the lesser
of 85% of the fair market value of the shares at the participant's entry date
into the six month offering period, or 85% of the fair market value of the
shares at the end of the six month offering period. During 1998, 1997 and 1996,
approximately 42,000, 280,000 and 188,000 shares, respectively, were purchased
under the Company's Employee Stock Purchase Plans.
30
<PAGE>
MERCURY INTERACTIVE CORPORATION
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Pro Forma Disclosure
The Company has adopted the disclosure provisions only of SFAS No. 123 and
will continue to account for its stock option plans in accordance with the
provisions of APB 25. Accordingly, no compensation cost has been recognized for
the stock option plans of the ESPP.
Pursuant to the requirements of SFAS 123, the following are pro forma net
income (loss) and net income (loss) per share for 1998, 1997 and 1996, as if the
compensation costs for the option plans and the ESPP had been determined based
on the fair value at the grant date for grants in 1998, 1997 and 1996,
consistent with the provisions of SFAS 123:
<TABLE>
<CAPTION>
1998 1997 1996
---------- --------- ---------
<S> <C> <C> <C>
Pro forma net income (loss) (in thousands)............................ 7,882 $ (379) $ (828)
Pro forma net income (loss) per share (basic) ........................ 0.22 (0.01) (0.03)
Pro forma net income (loss) per share (diluted)....................... 0.20 (0.01) (0.03)
</TABLE>
The fair value of options and shares issued pursuant to the option plans
and the ESPP at the grant date were estimated using the Black-Scholes model with
the following weighted average assumptions:
<TABLE>
<CAPTION>
Option plans ESPP
------------------ -------------------
1998 1997 1996 1998 1997 1996
----- ----- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Expected life (years).................................. 4.00 5.00 4.45 0.50 0.50 0.50
Risk-free interest rate................................ 5.22% 6.10% 6.20% 4.90% 5.36% 5.13%
Volatility............................................. 83% 86% 94% 83% 86% 94%
Dividend yield......................................... None None None None None None
</TABLE>
The weighted fair value per share of options granted under the Plan and
Supplemental Plan during the years ended December 31, 1998, 1997 and 1996 were
$8.26, $4.24 and $4.09, respectively. The weighted fair value per share of
options granted under the Directors' Plan during the years ended December 31,
1998, 1997 and 1996 were $12.25, $4.36, and $5.68, respectively.
31
<PAGE>
MERCURY INTERACTIVE CORPORATION
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 4--INCOME TAXES
Income (loss) before income taxes consists of the following (in thousands):
<TABLE>
<CAPTION>
Year ended December 31,
-------------------------------------------
1998 1997 1996
---------- --------- ----------
<S> <C> <C> <C>
Domestic......................................................... $ 6,239 $ (284) $ (1,053)
Foreign.......................................................... 18,737 8,943 6,445
---------- --------- ----------
$ 24,976 $ 8,659 $ 5,392
========== ========= ==========
</TABLE>
The provision for income taxes is comprised of the following (in thousands):
<TABLE>
<CAPTION>
Year ended December 31,
-------------------------------------
1998 1997 1996
--------- ---------- ---------
<S> <C> <C> <C>
Current:
Federal............................................ $ 5,322 $1,222 $ (110)
State.............................................. 350 355 65
Foreign............................................ 1,619 1,080 528
--------- ---------- ---------
Total Current................................... 7,291 2,657 483
--------- ---------- ---------
Deferred:
Federal............................................ (1,756) 193 597
State.............................................. (84) 77 77
--------- ---------- ---------
Total Deferred.................................. (1,840) 270 674
--------- ---------- ---------
Total tax expense.................................... $ 5,451 $2,927 $1,157
========= ========== =========
</TABLE>
Deferred tax assets consist of the following (in thousands):
<TABLE>
<CAPTION>
December 31,
------------
1998 1997
--------- ----------
<S> <C> <C>
Tax credits.......................................... $ 253 $ 860
Accruals and reserves................................ 1,821 972
Other................................................ (234) 357
--------- ----------
1,840 2,189
Valuation allowance.................................. -- (2,189)
--------- ----------
$1,840 $ --
--------- ----------
</TABLE>
Management believes it is more likely than not that future operations will
generate sufficient taxable income to realize the December 31, 1998 deferred tax
assets.
The provision for income taxes differs from the amount obtained by applying
the statutory federal income tax rate to income before taxes as follows (in
thousands):
<TABLE>
<CAPTION>
December 31,
-----------
1998 1997 1996
--------- -------- --------
<S> <C> <C> <C>
Statutory federal tax................................ $ 8,492 $ 2,944 $ 1,887
State tax, net of federal benefit.................... 350 549 58
Foreign rate differentials from U.S. statutory rate.. (5,288) (2,739) (2,194)
Non-deductible expenses.............................. -- 51 68
Non-utilized net operating 2,826 2,722 1,883
losses..............................................
Tax-exempt interest.................................. (409) (756) (779)
Other................................................ (520) 156 234
--------- ---------- ---------
$ 5,451 $ 2,927 $ 1,157
========= ========== =========
</TABLE>
32
<PAGE>
MERCURY INTERACTIVE CORPORATION
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Income taxes are not provided for the undistributed earnings of the
Company's foreign subsidiaries because it is management's intention to reinvest
such earnings in its foreign operations.
The Company's Israeli facilities have been granted the status of an
"Approved Enterprise" under the Israeli law for the Encouragement of Capital
Investments, 1959, as amended. An Approved Enterprise is eligible for
significant tax rate reductions for several years following the first year in
which the Company has Israeli taxable income (after consideration of tax losses
carried forward). The Company realized tax savings of approximately $5.2
million, $4.2 million, and $2.2 million in 1998, 1997 and 1996, respectively, as
a result of this tax holiday. Because the Israeli Company currently has four
overlapping Approved Enterprise plans, the tax holidays and rate reductions
which the Company will be able to realize in future years are expected to extend
until 2007.
NOTE 5--COMMITMENTS AND CONTINGENCIES
Royalty Commitments
Research and development expense for each of the three years ended December
31, 1998, 1997 and 1996 is net of research grants received by the Company from
the government of Israel, and includes royalty expense for obligations to the
government of Israel for sales of products developed under government-funded
research. The Company obtained grants from the Office of the Chief Scientist in
the Israeli Ministry of Industry and Trade ("the Chief Scientist") in the
amounts of $1.6 million, $2.1 million and $1.8 million in 1998, 1997 and 1996,
respectively. In 1996, the Company also received a grant in the amount of
$391,000 from the Israel-U.S. Binational Industrial Research and Development
Foundation ("BIRD-F"). 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 $2.7 million, $1.6
million and $1.1 million for the years ended December 31, 1998, 1997 and 1996,
respectively. As of December 31, 1998, the Company is committed to pay, if and
when earned, $2.8 million in additional royalties for Chief Scientist grants and
$700,000 for the BIRD-F grants.
Lease commitments
The Company leases facilities for sales offices in the U.S. and foreign
locations under non-cancelable operating leases that expire from 1999 through
2003. Certain of these leases contain renewal options. The Company also leases
certain equipment and vehicles under various leases with lease terms ranging
from month-to-month up to one year. Future minimum payments under the
facilities and equipment leases with non-cancelable terms in excess of one year
are as follows as of December 31, 1998 (in thousands):
1999..................... $1,575
2000..................... 1,147
2001..................... 383
2002..................... 191
2003..................... 83
------
Total..................... $3,379
======
Total rent expense under operating leases amounted to $2.0 million, $1.6
million, and $1.1 million for the years ended December 31, 1998, 1997 and 1996,
respectively.
33
<PAGE>
MERCURY INTERACTIVE CORPORATION
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 6--RELATED PARTIES
At December 31, 1998, the Company held seven notes receivable with balances
totaling $5.1 million from officers and key employees of the Company. These
notes arose from transactions occurring on October 5, 1998 whereby the Company
loaned the key employees money to purchase an aggregate of 886,428 shares of the
Company's common stock at the then fair market value. These notes, which bear
interest at the rate of 5% per annum, mature on December 31, 2000. Interest on
the notes is due quarterly, with the principal amount and final interest payment
being payable in full no later than the maturity date. If the officer or key
employee's employment is terminated prior to January 1, 2001, the unpaid portion
of the note would become payable in full. These notes are collateralized by the
shares purchased. The receivable is shown on the balance sheets as a reduction
in equity.
NOTE 7--GEOGRAPHIC REPORTING
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------
(in thousands)
-------------
1998 1997 1996
------ ------- -------
<S> <C> <C> <C>
Net revenue to third parties:
North America......................... $ 78,797 $ 49,354 $ 36,364
Europe................................ 33,140 21,223 12,003
Israel and Rest of the World.......... 9,063 6,123 6,183
-------- -------- --------
Consolidated....................... $121,000 $ 76,700 $ 54,550
======== ======== ========
Identifiable assets:
North America......................... $161,751 $111,561 $ 94,748
Europe................................ 14,388 11,656 6,960
Israel and Rest of the World.......... 28,547 20,446 15,917
-------- -------- --------
Consolidated....................... $204,686 $143,663 $117,625
======== ======== ========
</TABLE>
The subsidiary located in the United Kingdom accounted for 11% of the 1998
consolidated revenue to unaffiliated customers. Operations located in Israel
accounted 19% of the December 31, 1998 consolidated identifiable assets. In 1997
and 1996, no subsidiary represented 10 percent or more of the related
consolidated amounts.
NOTE 8--ACQUISITIONS
On September 30, 1997, the Company acquired certain in-process technologies
from Dixon Software Technology, an unrelated company, for $4.5 million and
related acquisition costs of $1.0 million. As a result of this purchase, the
Company recorded a one-time charge of $5.5 million during the year ended
December 31, 1997.
On November 30, 1999, the Company acquired Conduct Ltd. Under terms of the
agreement, 408,000 shares of the Company's common stock were issued 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. The transaction was accounted for as a pooling of
interests in the year 1999; therefore, all prior periods presented have been
restated.
34
<PAGE>
MERCURY INTERACTIVE CORPORATION
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Since its inception, Conduct Ltd. has not recorded any revenues. The net
income for the separate companies and the combined amounts presented in the
consolidated financial statements follow (in thousands).
Year ended December 31,
-----------------------
(in thousands)
-------------
1998 1997 1996
------ ------ ------
Net Income (loss):
Mercury Interactive Corporation........... $21,805 $ 6,707 $4,626
Conduct Ltd............................... (2,280) (975) (391)
-------- ------- ------
$19,525 $ 5,732 $4,235
======== ======= ======
NOTE 9--LEGAL MATTERS
During 1995, the Company was engaged in the defense of a lawsuit, which
alleged that an employee of the Company attempted to copy a software program
without authorization. The matter was settled on March 7, 1996 and, as a
result, the Company recorded a charge of $2.6 million during the quarter ending
March 31, 1996 reflecting settlement costs and related legal fees.
NOTE 10--SUBSEQUENT EVENTS
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 has
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.
35
<PAGE>
SUPPLEMENTAL INTERIM FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Supplementary Consolidated Balance Sheets as of September 30, 1999 and December 31, 1998....................... 37
Supplementary Consolidated Statements of Operations for the nine months ended September 30, 1999 and 1998...... 38
Supplementary Consolidated Statements of Cash Flows for the nine months ended September 30, 1999 and 1998...... 39
Notes to Supplementary Consolidated Financial Statements....................................................... 40
</TABLE>
36
<PAGE>
MERCURY INTERACTIVE CORPORATION
SUPPLEMENTAL 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 $ 81,048 $ 96,836
Short-term investments 72,031 13,130
Trade accounts receivable 30,796 27,903
Other receivables 7,279 6,012
Prepaid expenses and other current assets 12,687 10,664
----------- -----------
Total current assets 203,841 154,545
Long-term deposit 21 --
Long-term investments 20,058 20,697
Property and equipment, net 34,251 28,423
Other assets -- 1,021
----------- -----------
$ 258,171 $ 204,686
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Current liabilities:
Accounts payable $ 5,486 $ 4,622
Accrued liabilities 25,771 18,036
Income taxes payable 13,742 11,498
Short-term loan 502 --
Deferred revenue 31,430 24,122
----------- -----------
Total current liabilities 76,931 58,278
----------- -----------
Commitments and contingencies
Stockholders' equity:
Common stock 77 74
Capital in excess of par value 145,602 128,502
Notes receivable from issuance of stock (6,984) (5,130)
Accumulated comprehensive loss (1,000) (775)
Retained earnings 43,545 23,737
----------- ------------
Total stockholders' equity 181,240 146,408
----------- ------------
$ 258,171 $ 204,686
=========== ============
</TABLE>
See accompanying notes to supplemental consolidated financial statements
37
<PAGE>
MERCURY INTERACTIVE CORPORATION
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Nine months ended
September 30,
------------------------------
1999 1998
------------ -------------
<S> <C> <C>
Revenue:
License $ 87,400 $ 56,250
Service 40,200 23,750
------------ -------------
Total revenue 127,600 80,000
------------ -------------
Cost of revenue:
License 5,546 4,424
Service 13,461 7,893
------------ -------------
Total cost of revenue 19,007 12,317
------------ -------------
Gross profit 108,593 67,683
------------ -------------
Operating expenses:
Research and development, net 17,656 11,633
Marketing and selling 61,486 39,158
General and administrative 8,209 6,026
------------ -------------
Total operating expenses 87,351 56,817
------------ -------------
Income from operations 21,242 10,866
Other income, net 4,101 3,030
------------ -------------
Income before provision for income taxes 25,343 13,896
Provision for income taxes 5,535 3,119
------------ -------------
Net income $ 19,808 $ 10,777
============ =============
Net income per share (basic) $ 0.52 $ 0.31
============ =============
Net income per share (diluted) $ 0.47 $ 0.28
============ =============
Weighted average common shares (basic) 37,771 34,879
============ =============
Weighted average common shares
and equivalents (diluted) 42,172 39,116
============ =============
</TABLE>
See accompanying notes to supplemental consolidated financial statements
38
<PAGE>
MERCURY INTERACTIVE CORPORATION
SUPPLEMENTAL 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 $ 19,808 $ 10,777
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 4,195 3,854
Changes in assets and liabilities:
Trade accounts receivable (2,893) 4,204
Other receivables (1,267) 427
Prepaid expenses and other current assets (1,472) (4,406)
Accounts payable 864 68
Accrued liabilities 8,237 320
Income taxes payable 2,244 1,745
Deferred revenue 7,308 10,394
------------- ------------
Net cash provided by operating activities 37,024 27,383
------------- ------------
Cash flows from investing activities:
Purchases of investments, net (58,262) (13,426)
Acquisition of property and equipment, net (9,573) (11,710)
------------- ------------
Net cash used in investing activities (67,835) (25,136)
------------- ------------
Cash flows from financing activities:
Proceeds from issuance of common stock, net 17,102 12,305
Notes receivable from issuance of stock (1,854) --
------------- ------------
Net cash provided by financing activities 15,248 12,305
------------- ------------
Effect of exchange rate changes on cash (225) (178)
Net increase (decrease) in cash and cash equivalents (15,788) 14,374
Cash and cash equivalents at beginning of period 96,836 57,291
------------- ------------
Cash and cash equivalents at end of period $ 81,048 $ 71,665
============= ============
</TABLE>
See accompanying notes to supplemental consolidated financial statements
39
<PAGE>
MERCURY INTERACTIVE CORPORATION
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS
1. The accompanying unaudited supplemental consolidated financial statements
include Mercury Interactive Corporation and its subsidiaries (collectively,
the "Company").
These supplemental consolidated financial statements have been prepared
pursuant to the rules and regulations of the Securities and Exchange
Commission ("SEC") and, in the opinion of management, reflect all normal
recurring adjustments necessary to present fairly the financial position,
results of operations and cash flows for the periods presented in
conformity with generally accepted accounting principles. All significant
intercompany accounts and transactions have been eliminated.
These supplemental consolidated financial statements have been prepared to
give retroactive effect to the acquisition of Conduct Ltd. in November
1999.
These supplemental consolidated financial statements do not reflect the
effect of the two-for-one stock split announced on January 13, 2000.
2. The effective tax rate for the 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
nine months ended September 30, 1999, and obtained grants in the amount of
$1.6 million in the nine months ended September 30, 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 $2.8 million for the nine months ended
September 30, 1999, respectively, and $1.8 million for the nine months
ended September 30, 1998. 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 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 nine
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.... $19,808 37,771 $0.52
Dilutive adjustments........ - 4,401
------- ------
Diluted earnings per share.. $19,808 42,172 $0.47
======= ======
September 30, 1998:
Basic earnings per share.... $10,777 34,879 $0.31
Dilutive adjustments........ - 4,237
------- ------
Diluted earnings per share.. $10,777 39,116 $0.28
======= ======
</TABLE>
40
<PAGE>
MERCURY INTERACTIVE CORPORATION
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
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 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>
Nine months ended
September 30,
----------------------------
1999 1998
----------- -----------
<S> <C> <C>
Net income $ 19,808 $ 10,777
Other comprehensive gain (loss) (225) (178)
----------- ------------
Other comprehensive income $ 19,583 $ 10,599
=========== ===========
</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 nine
41
<PAGE>
MERCURY INTERACTIVE CORPORATION
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
months ended September 30, 1999 and 1998:
<TABLE>
<CAPTION>
Nine months ended
September 30,
-----------------------
1999 1998
----------- ---------
<S> <C> <C>
Net revenue to third parties:
Americas.......................................................... $ 84,800 $ 52,497
Europe............................................................ 32,800 21,640
Rest of the World................................................. 10,000 5,863
---------- ------------
Consolidated................................................... $ 127,600 $ 80,000
========== ===========
September 30, December 31,
1999 1998
----------- -----------
Identifiable assets:
Americas..........................................................
Europe............................................................ $ 178,977 $ 161,751
Rest of the World................................................. 15,604 14,388
Consolidated................................................... 63,590 28,547
----------- ----------
$ 258,171 $ 204,686
=========== ==========
</TABLE>
The subsidiary located in the United Kingdom accounted for 11% of the
consolidated net revenue to unaffiliated customers for the nine months
ended September 30, 1999 and 1998. Operations located in Israel accounted
for 22% of the consolidated identifiable assets at September 30, 1999, and
accounted for 18% 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. On November 30, 1999, the Company acquired Conduct Ltd. Under terms of the
agreement, 408,000 shares of the Company's common stock were issued 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. The transaction was accounted for
as a pooling of interests in the year 1999; therefore, all prior periods
presented have been restated.
Since its inception, Conduct Ltd. has not recorded any revenues. The net
income for the separate companies and the combined amounts presented in the
supplemental consolidated financial statements follow (in thousands).
<TABLE>
<CAPTION>
Nine months ended
September 30,
----------------------------
1999 1998
----------- -----------
<S> <C> <C>
Net income (loss):
Mercury Interactive Corporation............................ $ 22,143 $ 12,478
Conduct Ltd. .............................................. (2,335) (1,701)
---------- -----------
Consolidated............................................ $ 19,808 $ 10,777
========== ===========
</TABLE>
42
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statements on Form S-8 (Nos. 33-71018, 33-74728, 33-95178, 333-09913, 333-27951,
333-62125,333-81401 and 333-94837) of Mercury Interactive Corporation of our
report dated January 28, 1999, except as to the pooling of interests with
Conduct Ltd which is as of January 19, 2000, relating to the supplemental
consolidated financial statements for the three years ended December 31, 1998
which appear in this Form 8-K.
PricewaterhouseCoopers LLP
San Jose, California
January 19, 2000
