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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2000
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _______ TO _______.
Commission File Number: 0-22350
MERCURY INTERACTIVE CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 77-0224776
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1325 Borregas Avenue, Sunnyvale, California 94089
(Address of principal executive offices)
Registrant's telephone number, including area code: (408) 822-5200
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such a shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES x NO
The number of shares of Registrant's Common Stock outstanding as of April 30,
2000 was 79,542,879.
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MERCURY INTERACTIVE CORPORATION
INDEX
Page No.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets -
March 31, 2000 and December 31, 1999 3
Condensed Consolidated Statements of Operations -
Three months ended March 31, 2000 and 1999 4
Condensed Consolidated Statements of Cash Flows -
Three months ended March 31, 2000 and 1999 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 8
Item 3. Quantitative and Qualitative Disclosures About Market Risk 17
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds 17
Item 4. Exhibits and Reports on Form 8-K 17
SIGNATURE 18
INDEX TO EXHIBITS 19
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PART I. FINANCIAL INFORMATION
- -----------------------------
Item 1. Financial Statements
MERCURY INTERACTIVE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
March 31, December31,
2000 1999
(unaudited) (audited)
----------- -----------
ASSETS
Current assets:
Cash and cash equivalents $ 118,022 $113,346
Short-term investments 66,353 57,981
Trade accounts receivable, net 38,008 40,399
Other receivables 5,182 6,325
Prepaid expenses and other assets 17,116 16,702
--------- --------
Total current assets 244,681 234,753
Long-term investments 36,490 15,555
Property and equipment, net 49,484 46,910
--------- --------
$ 330,655 $297,218
========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 8,336 $ 8,469
Accrued liabilities 30,882 33,433
Income taxes payable 22,060 19,945
Deferred revenue 51,003 35,840
--------- --------
Total current liabilities 112,281 97,687
--------- --------
Stockholders' equity:
Common stock 159 156
Capital in excess of par value 163,863 148,826
Notes receivable from issuance of stock (11,018) (5,090)
Accumulated other comprehensive loss (1,302) (1,242)
Retained earnings 66,672 56,881
--------- --------
Total stockholders' equity 218,374 199,531
--------- --------
$ 330,655 $297,218
========= ========
See accompanying notes to condensed consolidated financial statements
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MERCURY INTERACTIVE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
Three months ended
March 31,
-------------------------
2000 1999
---------- ----------
Revenue:
License $ 42,000 $ 24,600
Service 18,400 13,000
---------- ----------
Total revenue 60,400 37,600
---------- ----------
Cost of revenue:
License 2,195 1,636
Service 6,179 4,072
---------- ----------
Total cost of revenue 8,374 5,708
---------- ----------
Gross profit 52,026 31,892
---------- ----------
Operating expenses:
Research and development, net 7,100 5,236
Marketing and selling 32,058 19,131
General and administrative 3,237 2,330
---------- ----------
Total operating expenses 42,395 26,697
---------- ----------
Income from operations 9,631 5,195
Other income, net 2,608 1,153
---------- ----------
Income before provision for income taxes 12,239 6,348
Provision for income taxes 2,448 1,398
---------- ----------
Net income $ 9,791 $ 4,950
========== ==========
Net income per share (basic) $ 0.12 $ 0.07
========== ==========
Net income per share (diluted) $ 0.11 $ 0.06
========== ==========
Weighted average common shares (basic) 78,943 74,434
========== ==========
Weighted average common shares
and equivalents (diluted) 91,208 83,310
========== ==========
See accompanying notes to condensed consolidated financial statements
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MERCURY INTERACTIVE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Three months ended
March 31,
----------------------------
2000 1999
--------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 9,791 $ 4,950
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 1,607 1,427
Changes in assets and liabilities:
Trade accounts receivable, net 2,391 4,446
Other receivables 1,143 985
Prepaid expenses and other assets (414) 1,225
Accounts payable (133) (638)
Accrued liabilities (2,551) (1,795)
Income taxes payable 2,115 (832)
Deferred revenue 15,163 1,701
--------- --------
Net cash provided by operating activities 29,112 11,469
--------- --------
Cash flows from investing activities:
Purchases of investments, net (29,307) (15,752)
Acquisition of property and equipment, net (4,181) (3,020)
--------- --------
Net cash used in investing activities (33,488) (18,772)
--------- --------
Cash flows from financing activities:
Issuance of common stock, net of related notes
receivable 9,112 5,306
--------- --------
Net cash provided by financing activities 9,112 5,306
--------- --------
Effect of exchange rate changes on cash (60) (250)
--------- --------
Net increase (decrease) in cash and cash equivalents 4,676 (2,247)
Cash and cash equivalents at beginning of period 113,346 96,836
--------- --------
Cash and cash equivalents at end of period $ 118,022 $ 94,589
========= ========
</TABLE>
See accompanying notes to condensed consolidated financial statements
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MERCURY INTERACTIVE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. The unaudited financial information furnished herein reflects all
adjustments, consisting only of normal recurring adjustments, that in
the opinion of management are necessary to fairly state the Company's
consolidated financial position, the results of its operations, and its
cash flows for the periods presented. This Quarterly Report on Form
10-Q should be read in conjunction with the Company's audited financial
statements for the year ended December 31, 1999, included in the 1999
Form 10-K. The condensed consolidated statements of operations for the
three months ended March 31, 2000 are not necessarily indicative of
results to be expected for the entire fiscal year ended December 31,
2000.
2. The effective tax rate for the three months ended March 31, 2000
differs from statutory tax rates principally because of special reduced
taxation programs sponsored by the government of Israel.
3. 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 reporting of both basic
earnings per share, which is the weighted-average number of common
shares outstanding, and diluted earnings per share, which includes the
weighted-average common shares outstanding and all dilutive potential
common shares outstanding. For the three months ended March 31, 2000
and 1999, dilutive potential common shares outstanding reflects shares
issuable under the Company's stock option plans. The following table
summarizes the Company's earnings per share computations for the three
months ended March 31, 1999 and 2000 (in thousands, except per share
amounts):
<TABLE>
<CAPTION>
Net Average Earnings
income shares per share
--------- --------- ---------
<S> <C> <C> <C>
March 31, 1999:
Basic earnings per share............................. $ 4,950 74,434 $ 0.07
Dilutive adjustments................................. - 8,876
--------- ---------
Diluted earnings per share........................... $ 4,950 83,310 $ 0.06
========= =========
March 31, 2000:
Basic earnings per share............................ $ 9,791 78,943 $ 0.12
Dilutive adjustments................................ - 12,265
--------- ---------
Diluted earnings per share.......................... $ 9,791 91,208 $ 0.11
========= =========
</TABLE>
At March 31, 2000 and 1999, there were no options considered anti-
dilutive.
4. The Company reports components of comprehensive income in its annual
consolidated statements of shareholders' equity. Comprehensive income
consists of net income and foreign currency translation adjustments.
The Company's total comprehensive income was as follows:
Three months ended
March 31,
----------------------
2000 1999
--------- ---------
Net income $ 9,791 $ 4,950
Other comprehensive loss (60) (250)
--------- ---------
Comprehensive income $ 9,731 $ 4,700
========= =========
5. 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, marketing, and sale
of automated software testing tools and integrated performance
management solutions. The Company evaluates operating segment
performance based primarily on net revenues and certain operating
expenses. The Company's products are
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marketed internationally through the Company's subsidiaries and through
referral partners, system integrators, distributors and value-added
resellers. Financial information for the Company's operating segments
is summarized below for the three months ended March 31, 2000 and 1999:
Three months ended
March 31,
-------------------------
2000 1999
---------- -----------
Net revenue to third parties:
Americas.............................. $ 41,200 $ 24,400
Europe................................ 13,900 10,400
Rest of the World..................... 5,300 2,800
---------- -----------
Consolidated..................... $ 60,400 $ 37,600
========== ===========
March 31, December 31,
2000 1999
---------- -----------
Identifiable assets:
Americas.............................. $ 217,243 $ 200,854
Europe................................ 24,416 25,389
Rest of the World..................... 88,996 70,975
---------- -----------
Consolidated..................... $ 330,655 $ 297,218
========== ===========
The subsidiary located in the United Kingdom accounted for 7% and 12%
of the consolidated net revenue to unaffiliated customers for the three
months ended March 31, 2000 and March 31, 1999, respectively.
Operations located in Israel accounted for 25% and 22% of the
consolidated identifiable assets at March 31, 2000 and December 31,
1999, respectively. No other subsidiary represented 10% or more of the
related consolidated amounts for the periods presented.
6. The Company has issued notes receivable totaling $11.0 million, net of
repayments, to its officers and key employees in connection with the
purchase of common stock. The notes bear interest at a market rate and
are secured by the shares purchased. The notes and related interest are
due in varying installments through January of 2004.
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
hedging activities. The adoption of SFAS 133 and SFAS 137 is not
expected to have a material effect on the Company's results of
operations, financial position or cash flows.
8. In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial
Statements," ("SAB 101") which provides guidance on the recognition,
presentation, and disclosure of revenue in financial statements filed
with the SEC. SAB 101 outlines the basic criteria that must be met to
recognize revenue and provides guidance for disclosures related to
revenue recognition policies. The adoption of SAB 101 has not had and
is not expected to have a material effect on the Company's results of
operations, financial position or cash flows.
9. In March 2000, the Financial Accounting Standards Board issued
Interpretation No. 44, "Accounting for Certain Transactions Involving
Stock Compensation - an interpretation of APB Opinion No. 25" ("FIN
44"). This Interpretation clarifies the application of Accounting
Practice Board Opinion No. 25, "Accounting for Stock Issued to
Employees" regarding (a) the definition of employee for purposes of
applying Opinion No. 25, (b) the criteria for determining whether a
plan qualifies as a noncompensatory plan, (c) the accounting
consequence of various modifications to the terms of a previously fixed
stock option or award, and (d) the accounting for an exchange of stock
compensation awards in a business combination. This Interpretation is
effective July 1, 2000, but certain conclusions in this Interpretation
cover specific events that occur after either December 15, 1998, or
January 12, 2000. To the extent that FIN 44 covers events occurring
during the period after December 15, 1998, or January 12, 2000, but
before the effective date of July 1, 2000, the effects of applying this
Interpretation are recognized on a prospective basis from July 1, 2000.
The adoption of FIN 44 is not expected to have a material effect on the
Company's results of operations, financial position or cash flows.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This Quarterly Report on Form 10-Q contains forward-looking statements
within the meaning of Section 21E of the Securities Exchange Act of 1934 and
Section 27A of the Securities Act of 1933. In some cases, forward-looking
statements are identified by words such as "believes," "anticipates," "expects,"
"intends," "plans," "will," "may" and similar expressions. In addition, any
statements that refer to our plans, expectations, strategies or other
characterizations of future events or circumstances are forward-looking
statements. Our actual results could differ materially from those discussed in,
or implied by, these forward-looking statements. Factors that could cause actual
results or conditions to differ from those anticipated by these and other
forward-looking statements include those more fully described in "Risk Factors."
Our business may have changed since the date hereof, and we undertake no
obligation to update the forward-looking statements in this Quarterly Report on
Form 10-Q.
Results of Operations
Revenue
License revenue increased 71% to $42.0 million for the three months
ended March 31, 2000 from $24.6 million for the three months ended March 31,
1999. Our growth in license revenue is attributable primarily to growth in
license fees from LoadRunner and TestDirector products, and initial revenues
from our new application performance management products.
Service revenue increased 42% to $18.4 million for the three months
ended March 31, 2000 from $13.0 million for the three months ended March 31,
1999. The increase in our service revenue was primarily due to the renewal of
maintenance contracts. We expect that service revenue will continue to increase
in absolute dollars as long as our customer base continues to grow.
Cost of revenue
License cost of revenue, as a percentage of license revenue, decreased
to 5% for the three months ended March 31, 2000 from 7% for the three months
ended March 31, 1999. License cost of revenue includes cost of production
personnel and product packaging. The decreased license cost of revenue as a
percentage of license revenue for the three months ended March 31, 2000 was
primarily due to faster growth in revenue than costs. License cost of revenue is
primarily related to headcount and is relatively fixed on a short-term basis.
Service cost of revenue, as a percentage of service revenue, was 34%
for the three months ended March 31, 2000 compared to 31% for the three months
ended March 31, 1999. Service cost of revenue consists primarily of costs of
providing customer technical support, training and consulting, and costs of
investments in our hosted e-service business infrastructure. Service cost of
revenue as a percentage of service revenue may vary based on the degree of
outsourcing of training and consulting and the profitability of individual
consulting engagements. Investments in hosted e-service business infrastructure
may cause service cost of revenue, as a percentage of service revenue, to
increase or remain flat throughout fiscal 2000 and early fiscal 2001.
Research and development, net
For the three months ended March 31, 2000, research and development,
net was $7.1 million, or 12% of total revenue, compared to $5.2 million, or 14%
of total revenue for the three months ended March 31, 1999. The increase in
absolute dollars in the three months ended March 31, 2000 reflected an increase
in spending due to growth in research and development headcount.
Research and development expense in 1999 includes royalty expense for
obligations to the government of Israel for sales of products developed under
government-funded research grants. We are not obligated to repay any such
grants; however, we have 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. We did not
have royalty expense under these agreements in the three months ended March 31,
2000. Royalty expense amounted to approximately $771,000 for the three months
ended March 31, 1999. As of March 31, 2000, we had no
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outstanding royalty obligations. We have not applied for, nor do we anticipate
applying for, any additional grants from the government of Israel.
Marketing and selling
Marketing and selling expenses were $32.1 million, or 53% of total
revenue for the three months ended March 31, 2000, compared to $19.1 million, or
51% of total revenue for the three months ended March 31, 1999. The absolute
dollar increase in marketing and selling expenses was primarily due to increased
commission expense attributable to the higher revenue level, an increase in
personnel-related costs reflecting the growth in sales and marketing headcount,
and increased spending on marketing programs. We expect marketing and selling
expenses to increase in absolute dollars as total revenue increases, but these
expenses may vary as a percentage of revenue.
General and administrative
General and administrative expenses were $3.2 million, or 5% of total
revenue for the three months ended March 31, 2000, compared to $2.3 million or
6% of total revenue for the three months ended March 31, 1999. The increase in
absolute dollar spending reflected increased staffing and related spending
necessary to manage and support our growth.
Other income, net
Other income, net consists primarily of interest income and foreign
exchange gains and losses. The increase in other income, net to $2.6 million for
the three months ended March 31, 2000, from $1.2 million for the three months
ended March 31, 1999, reflected increased interest income on higher average cash
and investment balances and higher interest rates for the three months ended
March 31, 2000.
Provision for income taxes
We have structured our operations in a manner designed to maximize
income in Israel where tax rate incentives have been extended to encourage
foreign investments. The tax holidays and rate reductions which we will be able
to realize under programs currently in effect expire at various dates through
2007. Future provisions for taxes will depend upon the mix of worldwide income
and the tax rates in effect for various tax jurisdictions. See "--Risk
Factors--We are subject to the risk of increased taxes."
Net income
We reported net income of $9.8 million for the three months ended March
31, 2000, compared to net income of $5.0 million for the three months ended
March 31, 1999.
Liquidity and Capital Resources
At March 31, 2000, our short-term and long-term investments consisted
of investments in high-quality financial, government and corporate securities.
Cash, cash equivalents and investments increased to $220.9 million at March 31,
2000, from $186.9 million at December 31, 1999. During the three months ended
March 31, 2000, we generated approximately $29.1 million from operations due
primarily to profits from operations and an increase in deferred revenue.
Our primary investing activities were net purchases of investments for
the three months ended March 31, 2000 of $29.3 million compared to $15.8 million
for the three months ended March 31,1999. We also purchased property and
equipment in the amount of $4.2 million during the three months ended March 31,
2000. This included $1.2 million for construction of an existing as well as a
second research and development facility in Israel. We expect to spend an
additional
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$12.0 to $13.0 million to complete the construction of the second Israel
facility. We also plan to spend $3.5 million to complete the renovation of our
second headquarters building in Sunnyvale, California.
Our primary financing activity consisted of issuances of common stock
under our employee stock option and stock purchase plans. During the three
months ended March 31, 2000, we received $9.1 million from the issuance of
common stock, net of notes receivable issued and collected from issuance of
common stock.
Assuming there is no significant change in our business, we believe
that our current cash and investment balances and cash flow from operations will
be sufficient to fund our cash needs for at least the next twelve months. We
also expect to satisfy our financing requirements through the incurrence of debt
from time to time. As of March 31, 2000, we did not have any debt outstanding.
We currently plan to issue up to $500,000,000 in principal amount of convertible
subordinated notes. If we complete this transaction, our leverage will increase
significantly. We may not succeed in completing this transaction.
Risk Factors
In addition to the other information included in this Quarterly Report
on Form 10-Q, the following risk factors should be considered carefully in
evaluating us and our business.
Our future success depends on our ability to respond to rapid market
and technological changes by introducing new products and to continually improve
the performance, features and reliability of our existing products and respond
to competitive offerings. Our business will suffer if we do not successfully
respond to rapid technological changes. The market for our software products is
characterized by:
. rapidly changing technology;
. frequent introduction of new products and enhancements to existing
products by our competitors;
. increasing complexity and interdependence of Internet related
applications;
. changes in industry standards and practices; and
. changes in customer requirements and demands.
To maintain our competitive position, we must continue to enhance our
existing software testing and application performance management products and to
develop new products and services, functionality and technology that address the
increasingly sophisticated and varied needs of our prospective customers. The
development of new products and services, and enhancement of existing products
and services, entail significant technical and business risks and require
substantial lead-time and significant investments in product development. If we
fail to anticipate new technology developments, customer requirements or
industry standards, or if we are unable to develop new products and services
that adequately address these new developments, requirements and standards in a
timely manner, our products may become obsolete, our ability to compete may be
impaired and our revenues could decline.
We expect our quarterly revenues and operating results to fluctuate,
which may cause the price of our stock and any outstanding notes to decline. Our
revenues and operating results have varied in the past and are likely to vary
significantly from quarter to quarter in the future. These fluctuations are due
to a number of factors, many of which are outside of our control, including:
. fluctuations in demand for and sales of our products and services;
. our success in developing and introducing new products and the timing
of new product introductions;
. our ability to introduce enhancements to our existing products in a
timely manner;
. the introduction of new or enhanced products by our competitors and
changes in the pricing policies of these competitors;
. the discretionary nature of our customers' purchase and budget cycles;
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. the amount and timing of operating costs and capital expenditures
relating to the expansion of our business;
. deferrals by our customers of orders in anticipation of new products or
product enhancements; and
. the mix of our domestic and international sales, together with
fluctuations in foreign currency exchange rates.
In addition, the timing of our license revenues is difficult to predict
because our sales cycles are typically short and can vary substantially from
product to product and customer to customer. We base our operating expenses on
our expectations regarding future revenue levels. As a result, if total revenues
for a particular quarter are below our expectations, we could not
proportionately reduce operating expenses for that quarter.
We have experienced seasonality in our revenues and earnings, with the
fourth quarter of the year typically having the highest revenue and earnings for
the year and higher revenue and earnings than the first quarter of the following
year. We believe that this seasonality results primarily from the budgeting
cycles of our customers and from the structure of our sales commission program.
We believe this seasonality may or may not continue in the future.
Due to these and other factors, we believe that period-to-period
comparisons of our results of operations are not necessarily meaningful and
should not be relied upon as indications of future performance. If our operating
results are below the expectations of investors or securities analysts, the
price of our common stock, and therefore any outstanding notes, could decline.
We expect to face increasing competition in the future, which could
cause reduced sales levels and result in price reductions, reduced gross margins
or loss of market share. The market for our testing and application performance
management products and services is extremely competitive, dynamic and subject
to frequent technological changes. There are few substantial barriers to entry
in our market. In addition, the rapid growth and use of Internet for e-business
is a recent and emerging phenomenon. The Internet lowers the barriers to entry
for other companies to compete with us in the testing and application
performance management markets. As a result of the increased competition, our
success will depend, in large part, on our ability to identify and respond to
the needs of potential customers, and to new technological and market
opportunities, before our competitors identify and respond to these needs and
opportunities. We may fail to respond quickly enough to these needs and
opportunities.
In the market for solutions for testing of applications, our principal
competitors include Compuware, Radview, Rational Software, RSW (a division of
Teradyne) and Segue Software. In the new and rapidly changing market for
application performance management solutions, our competitors include providers
of hosted services such as Keynote Systems and Service Metrics (a division of
Exodus Communications), and emerging application service providers ("ASPs") such
as Freshwater Software. In addition, we face potential competition in this
market from existing providers of testing solutions such as Segue. Finally, in
both the market for testing solutions and the market for application performance
management solutions, we face potential competition from established providers
of systems and network management software such as BMC Software and Computer
Associates.
The software industry is increasingly experiencing consolidation, and
this could increase the resources available to our competitors and the scope of
their product offerings. Our competitors and potential competitors may undertake
more extensive marketing campaigns, adopt more aggressive pricing policies or
make more attractive offers to distribution partners and to employees.
If we fail to maintain our existing distribution channels and develop
additional channels in the future, our revenues will decline. We derive a
substantial portion of our revenues from sales of our products through
distribution channels such as system integrators and value-added resellers. We
expect that sales of our products through these channels will continue to
account for a substantial portion of our revenues for the foreseeable future. We
have also entered into private labeling arrangements with ASPs and an enterprise
software company who incorporate our products and services into their offerings.
We may not experience increased revenues from these new channels, which could
harm our business.
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The loss of one or more of our system integrators, value-added
resellers or ASPs, or any reduction or delay in their sales of our products and
services could result in reductions in our revenue in future periods. In
addition, our ability to increase our revenue in the future depends on our
ability to expand our indirect distribution channels.
Our dependence on indirect distribution channels presents a number of risks,
including:
. many of our system integrators, value-added resellers and partner ASPs
can cease marketing our products and services with limited or no notice
and with little or no penalty;
. our existing system integrators, value-added resellers and ASPs may not
be able to effectively sell any new products and services that we may
introduce;
. we may not be able to replace existing or recruit additional system
integrators, value-added resellers and ASPs if we lose any of our
existing ones;
. our system integrators, value-added resellers and ASPs also offer
competitive products and services from third parties;
. we may face conflicts between the activities of our indirect channels
and our direct sales and marketing activities; and
. our system integrators, value-added resellers and ASPs may not give
priority to the marketing of our products and services as compared to
our competitors' products.
In March 1999, we entered into an agreement with Tivoli Systems, a
subsidiary of IBM, for the joint development and marketing of a family of
products for enterprise application performance management, incorporating
elements of our technology, which would be marketed and sold only by Tivoli.
Under this agreement, we agreed that until October 2002, we would not license
this technology to any other party for purposes of developing a product similar
to any developed under this agreement. In addition, we agreed that until October
2002, we would not enter into technology relationships to create similar
products with specified competitors of Tivoli as long as Tivoli continues to
agree to pay annual minimum royalties. These restrictions may limit our ability
to enter into new private labelling relationships. In addition, Tivoli may not
succeed in developing and selling these new products.
We depend on strategic relationships and business alliances for
continued growth of our business. Our development, marketing and distribution
strategies rely increasingly on our ability to form strategic relationships with
software and other technology companies. These business relationships often
consist of cooperative marketing programs, joint customer seminars, lead
referrals and cooperation in product development. Many of these relationships
are not contractual and depend on the continued voluntary cooperation of each
party with us. Divergence in strategy or change in focus by, or competitive
product offerings by, any of these companies may interfere with our ability to
develop, market, sell or support our products, which in turn could harm our
business. Further, if these companies enter into strategic alliances with other
companies or are acquired, they could reduce their support of our products. Our
existing relationships may be jeopardized if we enter into alliances with
competitors of our strategic partners. In addition, one or more of these
companies may use the information they gain from their relationship with us to
develop or market competing products.
If we are unable to manage our growth, our business may be harmed.
Since 1991, we have experienced significant annual increases in revenue,
employees and number of product and service offerings. This growth has placed
and, if it continues, will place a significant strain on our management and our
financial, operational, marketing and sales systems. If we cannot manage our
growth effectively, our business, competitive position, operating results and
financial condition could suffer. Although we are implementing a variety of new
or expanded business and financial systems, procedures and controls, including
the improvement of our sales and customer support systems, the implementation of
these systems, procedures and controls may not be completed successfully, or may
disrupt our operations. Any failure by us to properly manage these transitions
could impair our ability to attract and service customers and could cause us to
incur higher operating costs and experience delays in the execution of our
business plan.
The success of our business depends on the efforts and abilities of our
senior key personnel. We depend on the continued services and performance of our
senior management and other key personnel. We do not have long
12
<PAGE>
term employment agreements with any of our key personnel. The loss of any of our
executive officers or other key employees could hurt our business.
If we cannot hire qualified personnel, our ability to manage our
business, develop new products and increase our revenues will suffer. We believe
that our ability to attract and retain qualified personnel at all levels in our
organization is essential to the successful management of our growth. In
particular, our ability to achieve revenue growth in the future will depend in
large part on our success in expanding our direct sales force and in maintaining
a high level of technical consulting, training and customer support. There is
substantial competition for experienced personnel in the software and technology
industry. If we are unable to retain our existing key personnel or attract and
retain additional qualified individuals, we may from time to time experience
inadequate levels of staffing to perform services for our customers. As a
result, our growth could be limited due to our lack of capacity to develop and
market our products to our customers.
We depend on our international operations for a substantial portion of
our revenues. Sales to customers located outside the United States have
historically accounted for a significant percentage of our revenue and we
anticipate that such sales will continue to be a significant percentage of our
revenue. As a percentage of our total revenues, sales to customers outside the
United States were approximately 32% and 35% for the three months ended March
31, 2000 and 1999, respectively. In addition, we have substantial research and
development operations in Israel. We face risks associated with our
international operations, including:
. changes in taxes and regulatory requirements;
. difficulties in staffing and managing foreign operations;
. reduced protection for intellectual property rights in some countries;
. the need to localize products for sale in international markets;
. longer payment cycles to collect accounts receivable in some countries;
. seasonal reductions in business activity in other parts of the world in
which we operate;
. political and economic instability; and
. economic downturns in international markets.
Any of these risks could harm our international operations and cause
lower international sales. 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 to be harmed.
Because our research and development operations are primarily located
in Israel, we may be affected by volatile economic, political and military
conditions in that country and by restrictions imposed by that country on the
transfer of technology. Our operations depend on the availability of
highly-skilled and relatively low-cost scientific and technical personnel in
Israel. Our business also depends on trading relationships between Israel and
other countries. In addition to the risks associated with international sales
and operations generally, our 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.
These risks are compounded due to the restrictions on our ability to
manufacture or transfer outside of Israel any technology developed under
research and development grants from the government of Israel, without the prior
written consent of the government of Israel. If we are unable to obtain the
consent of the government of Israel, we may not be able to take advantage of
strategic manufacturing and other opportunities outside of Israel. We have, in
the past, obtained royalty-bearing grants from various Israeli government
agencies. In addition, we participate in special Israeli government programs
that provide significant tax advantages. The loss of or any material decrease in
these tax benefits could negatively affect our financial results.
13
<PAGE>
We are subject to the risk of increased taxes. We have structured our
operations in a manner designed to maximize income in Israel where tax rate
incentives have been extended to encourage foreign investment. Our taxes could
increase if these tax rate incentives are not renewed upon expiration or tax
rates applicable to us are increased. Tax authorities could challenge the manner
in which profits are allocated among us and our subsidiaries, and we may not
prevail in any such challenge. If the profits recognized by our subsidiaries in
jurisdictions where taxes are lower became subject to income taxes in other
jurisdictions, our worldwide effective tax rate would increase.
Our financial results may be negatively impacted by foreign currency
fluctuations. Our foreign operations are generally transacted through our
international sales subsidiaries. As a result, these sales and related expenses
are denominated in currencies other than the U.S. Dollar. Because our financial
results are reported in U.S. Dollars, our results of operations may be harmed by
fluctuations in the rates of exchange between the U.S. Dollar and other
currencies, including:
. a decrease in the value of Pacific Rim or European currencies relative
to the U.S. Dollar, which would decrease our reported U.S. Dollar
revenue, as we generate revenues in these local currencies and report
the related revenues in U.S. Dollars; and
. an increase in the value of Pacific Rim, European or Israeli currencies
relative to the U.S. Dollar, which would increase our sales and
marketing costs in these countries and would increase research and
development costs in Israel.
We attempt 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. This requires us to estimate the volume
of transactions in various currencies. We may not be successful in making these
estimates. If these estimates are overstated or understated during periods of
currency volatility, we could experience material currency gains or losses.
Our ability to successfully implement our business strategy depends on
the continued growth of the Internet. In order for our business to be
successful, the Internet must continue to grow as a medium for conducting
business. However, as the Internet continues to experience significant growth in
the number of users and the complexity of Web-based applications, the Internet
infrastructure may not be able to support the demands placed on it or the
performance or reliability of the Internet might be adversely affected. Security
and privacy concerns may also slow the growth of the Internet. Because our
revenues ultimately depend upon the Internet generally, our business may suffer
as a result of limited or reduced growth.
Our recent acquisition and any future acquisitions may be difficult to
integrate, disrupt our business, dilute stockholder value or divert the
attention of our management. We have acquired, and in the future we may acquire
or make investments in other companies with similar products and technologies.
For example, in November 1999, we completed our acquisition of Conduct Ltd. In
the event of any future acquisitions or investments, we could:
. issue stock that would dilute the ownership of our then-existing
stockholders;
. incur debt;
. assume liabilities;
. incur amortization expense related to goodwill and other intangible
assets; or
. incur large write-offs.
If we fail to achieve the financial and strategic benefits of past and
future acquisitions, our operating results will suffer. Acquisitions and
investments involve numerous other risks, including:
. difficulties integrating the acquired operations, technologies or
products with ours ;
. failure to achieve targeted synergies;
. unanticipated costs and liabilities;
14
<PAGE>
. diversion of management's attention from our core business;
. adverse effects on our existing business relationships with suppliers
and customers or those of the acquired organization;
. difficulties entering markets in which we have no or limited prior
experience; and
. potential loss of key employees, particularly those of the acquired
organizations.
The price of our common stock may fluctuate significantly, which may
result in losses for investors and possible lawsuits. The market price for our
common stock has been and may continue to be volatile. For example, during the
52-week period ended April 28, 2000, the closing prices of our common stock as
reported on the Nasdaq National Market ranged from a high of $132.13 to a low of
$12.94. We expect our stock price to be subject to fluctuations as a result of a
variety of factors, including factors beyond our control. These factors include:
. actual or anticipated variations in our quarterly operating results;
. announcements of technological innovations or new products or services
by us or our competitors;
. announcements relating to strategic relationships or acquisitions;
. changes in financial estimates or other statements by securities
analysts;
. changes in general economic conditions;
. conditions or trends affecting the software industry and the Internet;
and
. changes in the economic performance and/or market valuations of other
software and high-technology companies.
Because of this volatility, we may fail to meet the expectations of our
stockholders or of securities analysts at some time in the future, and our stock
price could decline as a result.
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 our stock price regardless of our operating results.
If we fail to adequately protect our proprietary rights and
intellectual property, we may lose a valuable asset, experience reduced revenues
and incur costly litigation to protect our rights. We rely on a combination of
patents, copyrights, trademarks, service marks and trade secret laws and
contractual restrictions to establish and protect our proprietary rights in our
products and services. We will not be able to protect our intellectual property
if we are unable to enforce our rights or if we do not detect unauthorized use
of our intellectual property. Despite our precautions, it may be possible for
unauthorized third parties to copy our products and use information that we
regard as proprietary to create products that compete with ours. Some license
provisions protecting against unauthorized use, copying, transfer and disclosure
of our licensed programs may be unenforceable under the laws of certain
jurisdictions and foreign countries. Further, the laws of some countries do not
protect proprietary rights to the same extent as the laws of the United States.
To the extent that we increase our international activities, our exposure to
unauthorized copying and use of our products and proprietary information will
increase.
In many cases, we enter into confidentiality or license agreements with
our employees and consultants and with the customers and corporations with whom
we have strategic relationships and business alliances. No assurance can be
given that these agreements will be effective in controlling access to and
distribution of our products and proprietary information. Further, these
agreements do not prevent our competitors from independently developing
technologies that are substantially equivalent or superior to our products.
15
<PAGE>
Litigation may be necessary in the future to enforce our intellectual
property rights and to protect our trade secrets. Litigation like this, whether
successful or unsuccessful, could result in substantial costs and diversions of
our management resources, either of which could seriously harm our business.
Third parties could assert that our products and services infringe
their intellectual property rights, which could expose us to litigation that,
with or without merit, could be costly to defend. We may from time to time be
subject to claims of infringement of other parties' proprietary rights. We could
incur substantial costs in defending ourselves and our customers against these
claims. Parties making these claims may be able to obtain injunctive or other
equitable relief that could effectively block our ability to sell our products
in the United States and internationally and could result in an award of
substantial damages against us. In the event of a claim of infringement, we may
be required to obtain licenses from third parties, develop alternative
technology or to alter our products or processes or cease activities that
infringe the intellectual property rights of third parties. If we are required
to obtain licenses, we cannot be sure that we will be able to do so at a
commercially reasonable cost, or at all. Defense of any lawsuit or failure to
obtain required licenses could delay shipment of our products and increase our
costs. In addition, any such lawsuit could result in our incurring significant
costs or the diversion of the attention of our management.
Defects in our products may subject us to product liability claims and
make it more difficult for us to achieve market acceptance for these products,
which could harm our operating results. Our products may contain errors or
"bugs" that may be detected at any point in the life of the product. Any future
product defects discovered after shipment of our products could result in loss
of revenues and a delay in the market acceptance of these products that could
adversely impact our future operating results.
In selling our products, we frequently rely on "shrink wrap" or "click
wrap" licenses that are not signed by licensees. Under the laws of various
jurisdictions, the provisions in these licenses limiting our exposure to
potential product liability claims may be unenforceable. We currently carry
errors and omissions insurance against such claims, however, we cannot provide
assurance that this insurance will continue to be available on commercially
reasonable terms, or at all, or that this insurance will provide us with
adequate protection against product liability and other claims. In the event of
a products liability claim, we may be found liable and required to pay damages
which would seriously harm our business.
We have adopted anti-takeover defenses that could delay or prevent an
acquisition of our company, including an acquisition that would be beneficial to
our stockholders. Our 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 our outstanding voting stock. We have no
present plans to issue shares of preferred stock. Furthermore, certain
provisions of our Certificate of Incorporation and of Delaware law may have the
effect of delaying or preventing changes in our control or management, which
could adversely affect the market price of our common stock.
Leverage and debt service obligations may adversely affect our cash
flow. Upon completion of the currently proposed offering of up to $500,000,000
principal amount of convertible subordinated notes, we will have a substantial
amount of outstanding indebtedness, primarily the notes. There is the
possibility that we may be unable to generate cash sufficient to pay the
principal of, interest on and other amounts due in respect of our indebtedness
when due. Our leverage could have significant negative consequences, including:
. increasing our vulnerability to general adverse economic and industry
conditions;
. requiring the dedication of a substantial portion of our expected cash
flow from operations to service our indebtedness, thereby reducing the
amount of our expected cash flow available for other purposes,
including capital expenditures; and
. limiting our flexibility in planning for, or reacting to, changes in
our business and the industry in which we compete.
16
<PAGE>
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Interest rate risk. Our exposure to market rate risk for changes in
interest rates is limited to our investment portfolio. Derivative financial
instruments are not a part of our investment policy. We place our investments
with high quality issuers and, by policy, limit the amount of credit exposure to
any one issuer or issue. In addition, we have classified all of our investments
as "held to maturity." This classification does not expose the consolidated
statements of income or balance sheet to fluctuation in interest rates. At March
31, 2000, $118.0 million, or 53%, of our cash, cash equivalents and investment
portfolio carried a maturity of less than 90 days, and $184.4 million, or 83%,
carried a maturity of less than one year. All investments mature, by policy, in
less than two years. The effect of a 10% rate decline would not be material on
the portfolio.
Foreign currency risk. A portion of our business is conducted in
currencies other than the U.S. Dollar. Our operating expenses in each of these
countries are in the local currencies, which mitigates a significant portion of
the exposure related to local currency revenues.
We have entered into forward foreign exchange contracts to hedge
amounts denominated in foreign currencies, due from certain subsidiaries, mainly
Europe and the Pacific Rim, against fluctuations in exchange rates. We have not
entered into forward foreign exchange contracts for speculative or trading
purposes. Our accounting policies for these contracts are based on our
designation of the contracts as hedging transactions. The criteria we use for
designating a contract as a hedge considers the contract's effectiveness in
reducing risk by matching hedging instruments to underlying transactions. Gains
and losses on forward foreign exchange contracts are recognized in income in the
same period as gains and losses on the underlying transactions. The effect of an
immediate 10% change in exchange rates would not have a material impact on our
operating results or cash flows.
PART II. OTHER INFORMATION
- --------------------------
Item 2. Changes in Securities and Use of Proceeds
(c) Recent Sales Of Unregistered Securities.
1. On November 30, 1999 and in connection with the acquisition of all
of the outstanding capital stock of Conduct Ltd., Mercury issued 387,892 shares
of common stock to the former shareholders of Conduct Ltd.
The foregoing transaction was made in reliance on Section 4(2) of the
Securities Act, or Regulation D promulgated thereunder, or Rule 701 promulgated
under Section 3(b) of the Securities Act, as transactions by an issuer not
involving a public offering or transactions pursuant to compensatory benefit
plans and contracts relating to compensation as provided under Rule 701.
Item 4. Exhibits and Reports on Form 8-K
(a) 27.1 - Financial Data Schedule.
(b) Reports on Form 8-K
On January 19, 2000, we filed a Current Report on Form 8-K relating to
the acquisition of Conduct Ltd., which was closed on November 30, 1999.
17
<PAGE>
SIGNATURE
- ---------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MERCURY INTERACTIVE CORPORATION
(Registrant)
Dated: May 15, 2000 By: /s/ Sharlene Abrams
-------------------------------------------
Sharlene Abrams,
Chief Financial Officer, Vice President of
Finance and Administration
18
<PAGE>
INDEX TO EXHIBITS
- -----------------
Exhibit Sequentially
No. Description Numbered Page
------- ----------- -------------
27.1 Financial Data Schedule 20
19
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-2000
<PERIOD-START> JAN-01-2000
<PERIOD-END> MAR-31-2000
<CASH> 118,022
<SECURITIES> 102,843
<RECEIVABLES> 44,136
<ALLOWANCES> 6,128
<INVENTORY> 0
<CURRENT-ASSETS> 244,681
<PP&E> 71,701
<DEPRECIATION> 22,217
<TOTAL-ASSETS> 330,655
<CURRENT-LIABILITIES> 112,281
<BONDS> 0
0
0
<COMMON> 159
<OTHER-SE> 218,215
<TOTAL-LIABILITY-AND-EQUITY> 330,655
<SALES> 42,000
<TOTAL-REVENUES> 60,400
<CGS> 2,145
<TOTAL-COSTS> 8,374
<OTHER-EXPENSES> 42,395
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 12,239
<INCOME-TAX> 2,448
<INCOME-CONTINUING> 9,791
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 9,791
<EPS-BASIC> .12
<EPS-DILUTED> .11
</TABLE>
