-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, B5NeFEcGoLkWTsRcs3Eq4ZHy0xJDafUYH6GPnosMr1yEvb+GDMU9zEVvmfV/8Tpo GRBAWlUkxMPfJ4wfqLsxJg== 0001012870-99-000972.txt : 19990403 0001012870-99-000972.hdr.sgml : 19990403 ACCESSION NUMBER: 0001012870-99-000972 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MERCURY INTERACTIVE CORPORATION CENTRAL INDEX KEY: 0000867058 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 770224776 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-22350 FILM NUMBER: 99583750 BUSINESS ADDRESS: STREET 1: 470 POTRERO AVE CITY: SUNNYVALE STATE: CA ZIP: 94086 BUSINESS PHONE: 4085239900 MAIL ADDRESS: STREET 1: 470 POTRERO AVE CITY: SUNNYVALE STATE: CA ZIP: 94086 10-K 1 FORM 10-K - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 ---------------- FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934. for the fiscal year ended December 31, 1998 [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934. Commission File Number: 0-22350 ---------------- MERCURY INTERACTIVE CORPORATION (Exact name of registrant as specified in its charter) Delaware 77-0337705 (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) ---------------- Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.002 par value 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 [_] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [_] The aggregate market value of the voting stock held by non-affiliates of the Registrant was approximately $923,955,141 as of February 26, 1999, based upon the closing sale price reported for that date on the NASDAQ National Market. Shares of Common Stock held by each officer and director and by each person who owns 5% or more of the outstanding Common Stock have been excluded because such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily conclusive for other purposes. The number of shares of Registrant's Common Stock outstanding as of February 26, 1999 was 36,865,650. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Proxy Statement for Registrant's 1999 Annual Meeting of Stockholders to be held May 26, 1999 are incorporated by reference in Part III of this Form 10-K Report. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- TABLE OF CONTENTS
Page ---- PART I Item 1. Business...................................................... 3 General....................................................... 3 Products...................................................... 4 Research and Development...................................... 6 Marketing, Sales and Support.................................. 6 Competition................................................... 8 Manufacturing................................................. 8 Patents, Trademarks and Licenses.............................. 8 Personnel..................................................... 9 Operations in Israel.......................................... 10 Item 2. Properties.................................................... 10 Item 3. Legal Proceedings............................................. 11 Item 4. Submission of Matters to a Vote of Security Holders........... 11 PART II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters.......................................... 12 Item 6. Selected Consolidated Financial Data.......................... 13 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.................................... 13 Item 7a. Quantitative and Qualitative Disclosures about Market Risk.... 23 Item 8. Financial Statements and Supplementary Data................... 23 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure..................................... 23 PART III Item 10. Directors and Executive Officers of the Registrant............ 24 Item 11. Executive Compensation........................................ 24 Item 12. Security Ownership of Certain Beneficial Owners and Management................................................... 24 Item 13. Certain Relationships and Related Transactions................ 24 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8- K ........................................................... 25
2 PART I Item 1. Business General Mercury Interactive Corporation and its subsidiaries (hereafter, collectively, "Mercury Interactive" or the "Company") develops, markets and supports a comprehensive suite of automated software testing solutions. The Company's products automate testing of complex software applications throughout the enterprise by helping to ensure that software works as required by anticipating problems and identifying issues. This helps companies build better applications, from e-business/Internet transaction systems to enterprise resource planning and other client/server applications. The Company's products also help companies test and refine software to meet two of today's most pressing information system issues: the Year 2000 problem and the adoption of a single European currency. Mercury Interactive's automated tools address the full range of enterprise software testing challenges facing corporate IS departments, systems integrators and consultants. The Company's products provide: (1) Functional testing: solutions that help ensure enterprise applications and their interfaces work as planned. (2) Load testing: software tools that test and stress enterprise applications under real world conditions to predict systems behavior and performance and to identify and isolate problems. (3) Test process management: integrated tools that organize and manage the testing process to determine application readiness. Mercury Interactive's solutions enhance and accelerate the application deployment process because they are designed to support business and functional needs as well as IS needs. The Company's products can be applied by non-technical users who are helping determine IS priorities and requirements. The products are also highly integrated, so they work together in combination to test applications across the enterprise. Most of the Company's automated testing products are available in specialized versions: for example, customized products for SAP R/3 applications, or Year 2000-specific solutions designed for legacy mainframe applications. The Company has established relationships with several major software industry leaders to ensure that its testing solutions reflect both their unique products and the unique needs of their customers. Mercury Interactive is committed to continuing research and development in order to achieve its strategy of offering advanced and innovative testing solutions for evolving business needs. Mercury Interactive is also committed to strong strategic alliances, both technology alliances with other industry- leading companies and with channel partners, such as the major systems integrators. The Company's products have been selected for the testing needs of many of the world's largest and most innovative business organizations. Alcatel, Allstate Insurance, American Airlines, America Online, Citibank, E*Trade, Eli Lilly, Federal Express, Hewlett Packard, Internet Shopping Network, Nabisco, Siemens, The Gap, and many others rely on Mercury Interactive's solutions to ensure the performance and reliability of their critical business systems. 3 Products The Company's current testing products are presented in the table below, and described immediately following.
Product Name Product Description Status Typical List Price Range* ----------------- -------------------------- ------------------------ ------------------------- XRunner Automated application Release 1.0-1991 $60,000 for five users testing for UNIX, X- Release 4.0-July 1996 Window WinRunner Automated application Release 1.0-June 1993 $2,850-$5,000 per user testing for Windows, Release 4.0-March 1996 Windows NT, Windows 95 Release 5.0-July 1998 LoadRunner Automated multi-user Release 1.0-November $40,000-$50,000 for 1993 testing for UNIX, RTE, Release 4.5-May 1997 package simulating 50 Windows, Windows NT and Release 5.0-July 1998 users Windows 95 TestDirector Automated test Release 1.0-November $8,995 for server management 1994 plus 5 system for QA workgroups Release 4.0-June 1997 users, additional users Release 5.0-July 1998 for $495 each WebTest World Wide Web application Product family released $195-$995 per copy testing March 1996 Astra SiteManager Visual Web site Release 1.0-October 1996 $495 per copy management tool Astra SiteTest Web site stress testing Release 1.0-December $9,500 per copy 1996 Release 2.0-December 1997 Astra QuickTest World Wide Web Release 1.0-May 1998 $4,000 per copy functional testing
- -------- *Prices vary within the ranges shown according to system configuration and country where purchased. XRunner The Company's XRunner(R) is an automated GUI regression tool which tests X- Window applications running under UNIX. XRunner makes test development easier by incorporating simplified test script management, point-and-click selection and interactive debugging. These features boost new testers' productivity while providing a complete testing solution for evolving business needs. XRunner features the RapidTest Script Wizard which automatically learns an application and generates tests for unattended regresssion testing. XRunner was released in 1991. WinRunner The Company's WinRunner(R) tests enterprise applications on Windows 3.1, Windows 95, and Windows NT platforms. WinRunner simplifies test automation by providing powerful, productive and cost effective test solutions. WinRunner utilizes Mercury Interactive's point-and-click Visual Testing to help users quickly create test and verification scenarios. WinRunner provides support for leading development environments such as SAP, PeopleSoft, Baan, Oracle NCA, Microsoft Visual Basic and PowerBuilder. WinRunner 2000 is specifically designed to test applications for compliance with Year 2000 requirements. WinRunner was made generally available in 1993. 4 LoadRunner The Company's LoadRunner(R) is an integrated client/server and Web load testing tool. It provides a scalable load testing solution for managing the risk of enterprise systems. LoadRunner uses a minimum of hardware resources to provide consistent, repeatable and measurable load to exercise the system just like real users would. LoadRunner automates both client and server load testing from a single point of control while helping developers get an accurate view of system behavior and performance throughout the application development lifecycle. LoadRunner is available for Windows, Window 95, Windows NT, UNIX and Remote Terminal Emulation (RTE). LoadRunner was made generally available in 1993. TestDirector The Company's TestDirector(R) is a workgroup test management software which directs the quality assurance process for software development. TestDirector helps developers and testers to be more productive by walking them through a full regression test cycle from planning and design, automated test creation, manual and automatic test execution, defect tracking and application quality analysis. TestDirector was released in 1994. WebTest The Company's WebTest(R) is designed specifically for testing World Wide Web applications. The technology helps information systems' organizations improve the quality and reliability of Web-based systems by allowing developers to measure response time to a browser request, to determine the maximum number of hits the server can support, and to validate the systems' ability to function correctly under varying conditions. WebTest extends Mercury Interactive's GUI testing tools, WinRunner and XRunner, allowing them to interact with Web pages, browsers, HTML links and images. WebTest, together with LoadRunner, tests Web site performance and capacity by emulating Web user HTTP or secure sockets layer (SSL) encrypted traffic between the browser and server. WebTest was released in 1996. Astra SiteManager The Company's Astra SiteManager(TM) is a comprehensive visual Web site management tool that is designed to meet the challenges faced by Webmasters and business managers of rapidly growing Web sites with changing content and shape. Astra SiteManager scans an entire Web site highlighting functional areas with color-coded links and URLs--to create a complete visual map of a Web site. It pinpoints broken links or access problems, compares maps as a site changes, identifies key usage patterns for improving Web site effectiveness and validates dynamically generated pages. Astra SiteManager was released in 1996. Astra SiteTest The Company's Astra SiteTest(TM) is a stress testing tool for Web-based systems-Internet and intranet-that provides consistent, repeatable and measurable load to exercise the systems as real users would. Astra SiteTest helps Webmasters get an accurate view of system behavior and performance throughout the application development lifecycle. Astra SiteTest was released in 1996. Astra QuickTest The Company's Astra QuickTest(TM) is an icon-based functional testing tool for e-business. By replacing traditional scripts with icons, it records and represents user actions visually to simplify and accelerate testing. Astra QuickTest is designed specifically for deploying reliable e-business applications. Astra QuickTest(TM) was released in 1998. 5 Research and Development Since its inception, the Company has made substantial investments in research and product development. The Company believes that its success will depend in large part on its ability to maintain and enhance its current product line, develop new products, maintain technological competitiveness and meet an expanding range of customer requirements, each of which is essential to maintaining the Company's current leadership position in its market. The technologies that drive the Company's products are aimed at providing a consistent and comprehensive solution to software quality issues throughout the software development organization. By enabling reliable automation of testing, these technologies enable the Company's products to provide substantial productivity improvement. The Company believes that it was the first to comprehensively address client/server software quality by combining key enabling technologies such as output synchronization, GUI-based application testing, multi-platform portability, text recognition and multi-user testing. Mercury Interactive's products are designed to be used throughout the development, maintenance and porting processes and are available on a variety of computing platforms and operating environments. In addition to the teams developing software testing products, the Company maintains an advanced research group that is responsible for exploring new directions and applications of core technologies, migrating new technologies into the existing product lines and maintaining research relationships outside the Company both within industry and academia. The research and development group also maintains relationships with third party software vendors and with all major hardware vendors on whose platforms the Company's products operate. Key development engineers are rotated to assignments in customer support positions in the Company's major markets for periods ranging from three months to two years. This improves feedback from current customers and strengthens ties between the Customer Support Organization and the research and development group. The Company's primary research and development group is located near Tel Aviv, Israel. Performing research and development in Israel offers a number of strategic advantages. Israeli engineers typically hold advanced degrees in computer-related disciplines. Operation in Israel has allowed the Company to enjoy tax incentives and research subsidies from the government of Israel. Geographic proximity to Europe, a strategic market for the Company, offers another key advantage. As of December 31, 1998 the Company's research and development group consisted of 166 employees. During 1998, 1997 and 1996 net research and development costs were $15.7 million, $10.9 million and $9.4 million, respectively. The Company anticipates that it will continue to commit substantial resources to research and development in the future. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Marketing, Sales and Support Direct Sales The Company markets its products primarily through its direct sales and service organization, which focuses on major accounts. The Company employs technically proficient salespeople and highly skilled field application engineers capable of serving the sophisticated needs of prospective customers' engineering and management staffs. As of December 31, 1998, the Company's sales force consisted of 238 employees. The Company has 18 sales and support centers throughout the United States. Internationally, the Company's subsidiaries operate eleven sales and support offices located in Canada, Brazil, the United Kingdom, France, Germany, Belgium, Sweden, Japan, Australia, Singapore and Israel. The Company also markets its products through distributors in Europe and Pacific Rim countries. 6 International sales represented 35%, 36%, and 33% of the Company's total revenues in 1998, 1997, and 1996, respectively. The Company expects that in future periods, international sales will continue to account for a significant portion of the Company's total revenue. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Alternate Channels The Company has established an indirect sales channel of value added resellers and major system integrators, including Andersen Consulting, Deloitte & Touche, EDS, Ernst & Young, Keane and KPMG. 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 years ended December 31, 1997 and 1996, respectively. The Company has derived a substantial portion of its revenue from sales of its products through alternate distribution channels such as referral partners, system integrators, and value-added resellers. The Company expects that sales of its products through its alternate distribution channels will continue to account for a substantial portion of its revenues for the foreseeable future. Each of the Company's system integrators and value added resellers can cease marketing the Company's products with limited notice and with little or no penalty. There can be no assurance that the Company's system integrators and value added resellers will continue to offer the Company's products or that the Company will be able to recruit additional or replacement system integrators and value added resellers. The loss of one or more of the Company's major system integrators and value added resellers could have a material adverse effect on the Company's business, financial condition and results of operations. The Company's system integrators and value added resellers also offer competitive products manufactured by third parties. There can be no assurance that the Company's system integrators and value added resellers will give priority to the marketing of the Company's products as compared to its competitors' products. Any reduction or delay in sales of the Company's products by its system integrators and value added resellers could have a material adverse effect on the Company's business, financial condition and results of operations. Customer Support The Company believes that strong customer support is crucial to both the initial marketing of its products and maintenance of customer satisfaction, which in turn enhances the Company's reputation and generates repeat orders. In addition, the Company believes that the customer interaction and feedback involved in its ongoing support functions provide the Company with information on market trends and customer requirements that is critical to future product development efforts. Pre-sales support is provided by sales personnel and post-sales support is provided by the Company's Customer Support Organization ("CSO") pursuant to training and consulting engagements and renewable annual maintenance contracts. As of December 31, 1998, the Company's CSO consisted of 104 employees. The maintenance contracts provide for technical and emergency support as well as software upgrades, on an if and when available basis. When the Company's local sales and support offices are unable to solve a problem, the Company's engineers and product developers in Israel work with the support personnel. By taking advantage of time differences, the Company can provide support around the clock, ensuring prompt resolution of problems. Pricing The Company licenses its software to customers under non-exclusive license agreements that restrict use of the products to internal purposes at a specified site. The Company typically licenses software products to either allow up to a set number of users to access the software on a network at any one time, using any workstation attached to that network, or to allow use of the software on designated computers or workstations. The Company's products are priced to encourage customers to purchase multiple products and licenses because the cost to the Company of supporting a one-user configuration is almost as high as a multiple-user configuration. License fees are dependent on the product licensed, the number of users of the product licensed and the country in which such licenses are sold, as international prices tend to be higher than United States prices. 7 Sales to the Company's indirect sales channel partners which are intended for resale to end users are made at varying discounts off of the Company's list prices, generally based on the sales volume of the indirect sales channel partner. In addition, the Company sells annual maintenance contracts which include on-site customer support and upgrades for approximately 15% of the license purchase price. Training and consulting revenues are generated on a time and expense basis at industry-competitive rates. Backlog The time between order and delivery of the Company's products is generally quite short. The number of orders, as well as the size of individual orders, can vary substantially from month to month. Because of the short period between order receipt and shipment of products, the Company typically does not have a significant backlog of unfilled orders and believes that backlog is not significant to an understanding of its business nor representative of potential revenue for any future period. Competition While the Company believes it is the leading provider of automated client/server, E-business and Enterprise Resource Planning ("ERP", such as packaged applications offered by SAP and Oracle) testing tools, several other companies compete in the automated client/server testing market and several potential customers develop testing utilities internally. The market for automated client/server, E-business and ERP testing tools is relatively young and competing solutions for the problem of software testing productivity are evolving rapidly. The market for software products, in general, is highly competitive. The Company continues to face direct competition from well established, publicly- held companies. There could be a material adverse effect on the Company's results of operations or financial position if any of the major software manufacturers, which have significantly greater financial and technical resources than the Company, decided to devote substantial resources to entering the software testing market or if there is an increase in developing testing utilities internally by the Company's customers or potential customers. A variety of external and internal factors could materially adversely affect the Company's ability to compete. These include the relative functionality, price, performance and reliability of the products offered by the Company and its competitors, the timing and success of new product development or enhancement efforts of the Company and its competitors, and the effectiveness of the marketing and sales efforts of the Company and its competitors. There can be no assurance that the Company will be able to compete successfully in the future or that competitive pressure will not materially adversely affect the Company's business. Manufacturing The Company's products are principally composed of user manuals and storage media, such as diskettes tapes, and/or CD-ROM, which are produced by the Company in its facility in Israel. Often, the Company's products require multiple user manuals and magnetic media. The Company believes that there is an adequate supply of and source for the raw materials for its products and that there are multiple sources available for storage media duplication and manual printing. The Company performs final quality control tests on its products. Although the Company believes that its quality control activities effectively accomplish the Company's product quality goals, there can be no assurance that the Company's quality control efforts will always be completely successful. Undetected material programming errors, product tampering, and exposure to a computer virus in the product development, duplication, assembly or distribution process, whether performed by the Company, its contractors, distributors, or resellers, could have a material adverse effect on shipments of new and existing products. Assembly and packaging of final products are performed both by the Company and by domestic and overseas subcontractors of the Company. Patents, Trademarks and Licenses The Company currently relies upon a combination of trademark, copyright, and trade secret laws and contractual provisions to protect proprietary rights in its products. The source code for the Company's products is protected both as a trade secret and as an unpublished copyrighted work. Despite these precautions, it may be 8 possible for a third party to copy or otherwise obtain and use the Company's products or technology without authorization. In addition, the laws of various countries in which the Company's products may be sold may not protect the Company's products and intellectual property rights to the same extent as the laws of the United States. Because the software industry is characterized by rapid technological change, the Company believes that factors such as the technological and creative skills of its personnel, new product developments, frequent product enhancements, name recognition and reliable product maintenance are more important to establishing and maintaining a technology leadership position than the various legal protections of its technology. The Company presently has one registered copyright. The Company holds four patents for elements contained in certain of its products, and it has filed several other U.S. and foreign patent applications on various elements of its products. There can be no assurance that any of the Company's patent applications will result in an issued patent or that, if issued, such patent would be upheld if challenged. There can be no assurance that the Company's competitors will not independently develop technologies that are substantially equivalent or superior to the Company's technology. There can also be no assurance that the measures taken by the Company to protect its proprietary rights will be adequate to prevent misappropriation of the technology or independent development by others of similar technology. Although the Company believes that its products and other proprietary rights do not infringe upon the proprietary rights of third parties there can be no assurance that third parties will not assert intellectual property infringement claims against the Company in the future or that any such claims will not require the Company to enter into royalty or cross-license arrangements or result in costly litigation. Personnel As of December 31, 1998, the Company had a total of 621 employees, of which 263 were based in the United States and 358 were based internationally. Of the total, 391 were engaged in marketing, sales and related customer support services, 166 were in research and development, and 64 were in general and administrative functions. The Company's success depends in significant part upon the performance of its senior management and certain key employees. Competition for highly skilled employees, including sales, technical and management personnel, is intense in the computer industry. There can be no assurance that the Company will retain its key managerial and technical employees. The Company's failure to attract, assimilate or retain highly qualified sales, technical and managerial personnel could materially adversely affect the Company's business. None of the Company's employees are represented by a labor union. The Company has never experienced any work stoppages. The executive officers of the Company as of March 1, 1999 are as follows:
Name Age Position ---- --- -------- Aryeh Finegold.......... 52 Chairman of the Board of Directors Amnon Landan............ 40 President, Chief Executive Officer and Director Kenneth R. Klein........ 39 President, North American Operations Sharlene Abrams......... 41 Vice President of Finance and Administration, Chief Financial Officer and Secretary Moshe Egert............. 34 Vice President of European Operations
Mr. Aryeh Finegold, a founder of the Company, has served as Chairman of the Board of Directors since the Company's incorporation in July 1989, served as Chief Executive Officer from July 1989 until January 1997 and served as President from July 1989 until October 1995. Previously, Mr. Finegold was President, Chief Executive Officer and Chairman of the Board of Directors of Ready Systems, Inc. He also co-founded Daisy Systems, Inc., serving as its President and Chief Executive Officer. Previously, Mr. Finegold was a product line architect in the microprocessor division at Intel Corporation. 9 Mr. Amnon Landan has served as President and Chief Executive Officer of the Company since February 1997, and has been a director of the Company since February 1996. From October 1995 to January 1997 he served as President, and from March 1995 to September 1995 he served as President of North American Operations. He served as Chief Operating Officer from August 1993 until March 1995. From December 1992 to August 1993, he served as the Company's Vice President of Operations and from June 1991 to December 1992, he served as Vice President of Research and Development. From November 1989 to June 1991, he served in several technical positions with the Company. Mr. Kenneth R. Klein has served as President, North American Operations since July 1998. From April 1995 to July 1998 he served as Vice President of North American Sales. From May 1992 to March 1995, he served as the Company's Western Area Sales Manager. From March 1990 to May 1992, Mr. Klein served as Regional Sales Manager for Interactive Development Environments, a CASE tool company. Ms. Sharlene Abrams has served as Vice President of Finance and Administration and Chief Financial Officer of the Company since November 1993. She has served as Secretary of the Company since February 1996. From 1988 until joining the Company, Ms. Abrams was employed at Price Waterhouse LLP most recently as a senior manager. Prior to 1988, Ms. Abrams held various finance and accounting positions in other public companies and in public accounting. She is a Certified Public Accountant. Mr. Moshe Egert has served as Vice President of European Operations since July 1996. From February 1994 to June 1996, he served as Director of European Marketing. From October 1990 through January 1994, he served in several management and technical positions with the Company. Operations in Israel The Company's research and development operations are primarily located in Israel and may be affected by economic, political and military conditions in that country. The Company's business is also dependent on trading relationships between Israel and other countries. Accordingly, the Company'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. The Company benefits from various policies of the government of Israel, including reduced taxation and special subsidy programs, designed to stimulate economic activity, particularly the high technology industry in that country. The Company's operations also benefit from the availability of highly skilled and relatively low cost scientific and technical personnel in Israel. As a condition of its receipt of funds for various research and development projects conducted under programs sponsored by the government of Israel, the Company has agreed that products resulting from these projects may not be manufactured, nor may the technology developed in the projects be transferred, outside of Israel without government consent. Item 2. Properties The Company is headquartered in Sunnyvale, California in a 55,000 square foot building which the Company owns. The Company's research and development activities are conducted by the Company's subsidiary in Israel, where that subsidiary leases approximately 24,000 square feet under a lease that expires in December 2000. In addition, in 1995, the Company purchased land in Israel where construction of a new research and development facility is currently underway. Relocation of the Israel subsidiary to this new facility is expected to occur in the third quarter of 1999. The Company's field sales and support operations occupy leased facilities in 17 locations in the United States, one location in Canada, one location in Brazil, five locations in Europe, one location in Israel, and three locations in the Pacific Rim. The Company believes that its existing facilities are adequate for its current needs and that additional space will be available as needed. 10 Item 3. Legal Proceedings There are presently pending no legal proceedings, other than routine litigation incidental to the Company's business, to which the Company is a party or to which any of its properties is subject. Item 4. Submission of Matters to a Vote of Security Holders No matters were submitted during the fourth quarter of 1998 to a vote of the holders of Mercury Interactive Corporation's Common Stock through the solicitation of proxies or otherwise. 11 PART II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters Market for Common Stock Mercury Interactive Corporation Common Stock is traded on the NASDAQ National Market tier of The NASDAQ Stock Market under the symbol MERQ. The following table lists the high and low sales price since January 1, 1997:
High Low ------ ------ 1998: First quarter ended March 31.................................. $19.13 $12.19 Second quarter ended June 30.................................. $22.32 $15.63 Third quarter ended September 30.............................. $22.88 $15.75 Fourth quarter ended December 31.............................. $31.63 $10.57 1997: First quarter ended March 31.................................. $ 7.38 $ 4.88 Second quarter ended June 30.................................. $ 8.88 $ 5.16 Third quarter ended September 30.............................. $11.94 $ 7.13 Fourth quarter ended December 31.............................. $13.38 $ 9.75
The above prices per share, as well as those set forth elsewhere in this Form 10-K, are adjusted to reflect the 2:1 stock split (effected as a stock dividend) distributed to stockholders in late February 1999. The Company's stock price, has been and will continue to be, subject to significant volatility. Past financial performance should not be considered a reliable indicator of future performance, and investors should not use historical trends to anticipate results or trends in future periods. If revenues or earnings in any quarter fail to meet expectations of the investment community, there could be an immediate and significant impact on the Company's stock price. In addition, the Company's stock price may be impacted by broader market trends that are unrelated to the Company's operating results. Holders of Record On February 26, 1999, there were approximately 7,700 holders of record of Mercury Interactive Corporation Common Stock. Dividends The Company paid no cash dividends during fiscal 1998. The Company intends to retain earnings for use in its business and does not anticipate paying any cash dividends in the foreseeable future. 12 Item 6. Selected Consolidated Financial Data
Year ended December 31, -------------------------------------------- 1998 1997 1996 1995 1994 -------- -------- -------- -------- ------- (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... 15,747 10,933 9,396 6,523 4,285 Write off of in-process research and development and related expenses....................... -- 5,500 -- 7,700 -- Marketing and selling........... 56,476 36,804 29,360 21,361 9,576 General and administrative...... 8,052 6,362 4,113 3,911 2,531 Settlement of litigation........ -- -- 2,600 2,000 -- -------- -------- -------- -------- ------- Total operating expenses...... 80,275 59,599 45,469 41,495 16,392 -------- -------- -------- -------- ------- Income (loss) from operations..... 22,677 6,525 2,422 (6,558) 4,592 Other income, net................. 4,579 3,109 3,361 2,277 1,348 -------- -------- -------- -------- ------- Income (loss) before provision for income taxes..................... 27,256 9,634 5,783 (4,281) 5,940 Provision for income taxes........ 5,451 2,927 1,157 970 891 Net income (loss)................. $ 21,805 $ 6,707 $ 4,626 $ (5,251) $ 5,049 ======== ======== ======== ======== ======= Net income (loss) per share (basic).......................... $ 0.62 $ 0.20 $ 0.15 $ (0.19) $ 0.20 ======== ======== ======== ======== ======= Net income (loss) per share (diluted)........................ $ 0.56 $ 0.20 $ 0.14 $ (0.19) $ 0.19 ======== ======== ======== ======== ======= Weighted average common shares (basic).......................... 34,958 32,746 31,816 27,894 25,220 ======== ======== ======== ======== ======= Weighted average common shares (diluted)........................ 39,030 34,208 33,126 27,894 26,674 ======== ======== ======== ======== ======= December 31, -------------------------------------------- 1998 1997 1996 1995 1994 -------- -------- -------- -------- ------- Balance Sheet Data: Working capital................. $ 95,657 $ 88,739 $ 78,082 $ 75,475 $33,722 Total assets.................... 203,576 143,410 117,489 112,820 49,594 Stockholders' equity............ 145,589 112,987 99,039 92,616 39,167
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Results of Operations This Management's Discussion and Analysis of Financial Condition and Results of Operations contains descriptions of the Company's expectations regarding future trends affecting its business. These forward looking statements and other forward looking statements made elsewhere in this document are made in reliance upon the safe harbor provision of the Private Securities Litigation Reform Act of 1995. Please read the section below titled "Factors that may affect future results" to review conditions which the Company believes could cause actual 13 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.
Year ended December 31, --------------------------- 1998 1997 1996 ------- ------- ------- Revenue: License........................................... 70% 74% 79% Service........................................... 30 26 21 ------- ------- ------- Total Revenue................................... 100 100 100 ------- ------- ------- Cost of revenue: License........................................... 5 6 6 Service........................................... 10 8 6 ------- ------- ------- Total cost of revenue............................... 15 14 12 ------- ------- ------- Gross profit........................................ 85 86 88 ------- ------- ------- Operating expenses: Research and development, net..................... 13 14 17 Write off of in-process research and development and related expenses............................. -- 7 -- Marketing and selling............................. 47 48 54 General and administrative........................ 6 8 7 Settlement of litigation.......................... -- -- 5 ------- ------- ------- Total operating expenses........................ 66 77 83 ------- ------- ------- Income from operations.............................. 19 9 5 Other income, net................................... 4 4 6 ------- ------- ------- Income before provision for income taxes............ 23 13 11 ------- ------- ------- Provision for income taxes.......................... 5 4 2 ------- ------- ------- Net income ......................................... 18% 9% 9% ------- ------- -------
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 years 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/ - -------- /1/ Forward looking statement 14 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 revenues 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 decreased 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 increased service cost of revenue in 1998 reflected increased outsourcing of training and consulting. Research and development For the year ended December 31, 1998, research and development, net was $15.7 million, or 13% of total revenue, an increase from $10.9 million, or 14% of total revenue in 1997, and $9.4 million, or 17% of total revenue in 1996. The increase in absolute dollars in 1998 as compared to 1997 reflected an increase in spending of $2.8 million due to growth in research and development headcount from 130 to 166, 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, $2.0 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 was committed to pay, if and when earned, $2.7 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 - -------- /1/ Forward looking statement 15 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 $56.5 million in 1998, compared to $36.8 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 $8.1 million, or 6% of total revenue in 1998, from $6.4 million, or 8% of total revenue in 1997 and $4.1 million, or 7% 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. Net income The Company reported net income of $21.8 million in 1998, compared to net income of $6.7 million in 1997 and $4.6 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 costs 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 - -------- /1/ Forward looking statement 16 quarter as expected, the Company's results from operations for that quarter are likely to be materially adversely affected. Net income may be disproportionately affected by a reduction in revenue because only a small portion of the Company's expenses varies with its revenue. Inflation Inflation has not had a significant impact on the Company's operating results to date. Year 2000 The approach of Year 2000 presents significant issues for many computer systems, since much of the software in use today may not accurately process data beyond 1999. The Company is in the process of conducting an internal review of most of its internal corporate headquarters computer systems and software ("IT Systems") including finance, human resources, intranet applications, payroll systems and customer support organization systems to determine their Year 2000 compliance. As part of this process, the Company is contacting vendors of its relevant corporate IT Systems to determine potential exposure to Year 2000 issues and will be obtaining written assurance from such vendors regarding Year 2000 compliance. Although the Company believes that most of its principal corporate IT Systems are Year 2000 compliant, the Company has not yet completed its assessment and testing of these systems. At this time, the Company has not determined the state of compliance of certain third-party suppliers of services such as phone companies, long distance carriers, financial institutions and electric companies. The failure of any one of these third-party suppliers could severely disrupt the Company's ability to carry on its business as well as disrupt the business of the Company's customers. The Company is in the process of polling these companies in order to determine their state of compliance and their contingency plans. Failure of the Company to provide Year 2000 compliant business solutions to its customers or to receive such business solutions from its suppliers could result in liability to the Company or otherwise have a material adverse effect on the Company's business, results of operations, financial condition and prospects. Furthermore, the Company believes that the purchasing patterns of customers and potential customers may be affected by Year 2000 issues as companies expend significant resources to correct or patch their current software systems for Year 2000 compliance. These expenditures may result in reduced funds available to purchase products and services such as those offered by the Company, which could result in a material adverse effect on the Company's business, results of operations and financial condition. The Company could be affected through disruptions in the operation of the enterprises with which the Company interacts or from general widespread problems or an economic crisis resulting from noncompliant Year 2000 systems. Despite the Company's efforts to address the Year 2000 effect on its internal systems and business operations, such effect could result in a material disruption of its business or have a material adverse effect on the Company's business, financial condition or results of operations. The Company has just begun the process of developing a contingency plan to respond to any of the foregoing consequences of internal and external failures to be Year 2000 compliant. In selling its products, the Company frequently relies on "shrink wrap" licenses that are not signed by licensees. The provisions in such licenses limiting the Company's exposure to potential product liability claims may therefore be unenforceable under the laws of certain jurisdictions. Further, the Company's license agreements typically contain a representation that the software is Year 2000 compliant through its description of specifically how the Company's products process the Year 2000 calendar dates. While the Company believes its products are Year 2000 compliant, the risk of Year 2000 noncompliance claims may increase as December 31, 1999 approaches and passes. The Company currently carries errors and omissions insurance against such claims, however, there can be no assurance that such insurance will continue to be available on acceptable terms, if at all, or that such insurance will provide the Company with adequate protection against any such claims. Although the Company has not experienced any product liability or other Year 2000 claims to date, the sale and support of products by the Company may entail the risk of such claims. A significant product liability claim against the Company would have a material adverse effect upon the Company's business, financial condition and results of operations. 17 Factors that May Affect Future Results The Company operates in a dynamic and rapidly changing environment that involves numerous risks and uncertainties. The following section lists some, but not all, of those risks and uncertainties which may have a material adverse effect on the Company's business, financial condition or results of operations. This section should be read in conjunction with the audited Consolidated Financial Statements and Notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations included in this Annual Report on Form 10-K. The Company has identified certain forward looking statements in the Management's Discussion and Analysis of Financial Condition and Results of Operations with a footnote symbol/1/. The Company may also make oral forward looking statements from time to time. Actual results may differ materially from those projected in any such forward looking statements due to a number of factors, including those set forth below and elsewhere in this Form 10-K. The market for software products is generally characterized by rapidly changing technology, frequent new product introductions and changes in customer requirements which can render existing products obsolete or unmarketable. To maintain its competitive position, the Company must continue to develop and introduce in a timely and cost-effective manner enhancements to its existing and new products that keep pace with technological developments and achieve market acceptance. There can be no assurance that the Company will be able to identify, develop, manufacture, market or support new products or enhancements successfully, that any such new products or enhancements will gain market acceptance, or that the Company will be able to respond effectively to technological changes. There can be no assurance that the Company will not encounter technical or other difficulties that could delay introduction of new products in the future. If the Company is unable to introduce new products or enhancements and respond to industry changes on a timely basis, its business could be materially adversely affected. The Company's current products and products under development are limited in number and concentrated exclusively in the automated software testing market. This market has experienced rapid worldwide growth, and it remains relatively new and not well penetrated. Although the Company believes that the current trend toward increased use of automated software testing will continue, there can be no assurance that the automated software testing market will continue to expand or that the Company's products will be accepted in any expanded market./1/ Price reductions or declines in demand for the Company's software testing products, whether as a result of competition, technological change or other factors, would have a material adverse effect on the Company's results of operations or financial position. The Company may from time to time experience significant fluctuation in quarterly operating results due to a variety of factors, some of which are outside of the Company's control. A significant portion of the Company's operating expenses are relatively fixed, and planned expenditures are based on sales forecasts. Products are generally shipped as orders are received, and, consequently, quarterly sales and operating results depend primarily on the volume and timing of orders received during the quarter, which are difficult to forecast. In particular, the Company has historically received a substantial portion of its orders at the end of a quarter, up to the last few days of a quarter. If an unanticipated order shortfall occurs at the end of a quarter, the Company's operating results for the quarter could be materially adversely affected. In addition, product orders are affected by the buying patterns of customers. The buying trends of customers are further impacted by internal budgetary considerations relating to Year 2000 remediation or Euro conversion efforts. All of the foregoing may result in unanticipated quarterly earning shortfalls or losses. Accordingly, the Company believes that 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. The Company continues to face direct competition mainly from well established, publicly- held companies. There could be a material adverse effect on the Company's results of operations or financial position if any of the major software manufacturers, which have - -------- /1/ Forward looking statement 18 significantly greater financial and technical resources than the Company, decided to devote substantial resources to entering the software testing market or if there is an increase in developing testing utilities internally by the Company's customers or potential customers. A variety of external and internal factors could materially adversely affect the Company's ability to compete. These include the relative functionality, price, performance and reliability of the products offered by the Company and its competitors, the timing and success of new product development or enhancement efforts of the Company and its competitors, and the effectiveness of the marketing and sales efforts of the Company and its competitors. The Company expects to face increasing competition in the automated software testing market./1/ There can be no assurance that the Company will be able to compete successfully in the future or that competitive pressures will not materially adversely affect the Company's business. The Company has derived a substantial portion of its revenues from sales of its products through alternate distribution channels such as referral partners, system integrators, and value-added resellers. The Company expects that sales of its products through its alternate distribution channels will continue to account for a substantial portion of its revenues for the foreseeable future. Each of the Company's system integrators and value added resellers can cease marketing the Company's products with limited notice and with little or no penalty. There can be no assurance that the Company's system integrators and value added resellers will continue to offer the Company's products or that the Company will be able to recruit additional or replacement system integrators and value added resellers. The loss of one or more of the Company's major system integrators and value added resellers could have a material adverse effect on the Company's business, financial condition and results of operations. The Company's system integrators and value added resellers also offer competitive products manufactured by third parties. There can be no assurance that the Company's system integrators and value added resellers will give priority to the marketing of the Company's products as compared to its competitors' products. Any reduction or delay in sales of the Company's products by its system integrators and value added resellers could have a material adverse effect on the Company's business, financial condition and results of operations. Sales to customers located outside the United States have historically accounted for a significant percentage of revenue and the Company anticipates that such sales will continue to be a significant percentage of the Company's total revenue./1/ Accordingly, such factors as currency fluctuations, political and economic instability and trade restrictions could have a negative impact on the Company's financial performance. As a global concern, the Company faces exposure to adverse movements in foreign currency exchange rates. Historically, the Company's primary exposure related to non-dollar denominated sales and operating expenses in Europe and Australia. As the Company expands its operations in Europe and the Pacific Rim, the Company expects to see an increase in exposures related to non-dollar denominated sales./1/ The Company attempts to limit foreign exchange exposure by operational strategies and, on a limited basis, by using forward contracts to offset the effects of exchange rate changes on intercompany trade balances. These efforts depend upon estimates of transaction activities in various currencies. There can be no assurance that the company will be successful in making these estimates. To the extent these estimates are overstated or understated during periods of currency volatility, the Company could experience unanticipated material currency gains or losses. The Company's stock price, has been and will continue to be, subject to significant volatility. Past financial performance should not be considered a reliable indicator of future performance, and investors should not use historical trends to anticipate results or trends in future periods. If revenues or earnings in any quarter fail to meet expectations of the investment community, there could be an immediate and significant impact on the Company's stock price. In addition, the Company's stock price may be impacted by events or broader market trends that are unrelated to the Company's operating results. As part of its growth strategy, the Company may, from time to time, acquire or invest in complimentary businesses, products or technologies. While there are currently no commitments with respect to any particular - -------- /1/ Forward looking statement 19 acquisition or investment, the Company's management frequently evaluates the strategic opportunity available related to complimentary businesses, products or technologies. The process of integrating an acquired company's business into the Company's operations may result in unforeseen operating difficulties and expenditures and may absorb significant management attention that would otherwise be available for the ongoing development of the Company's business. Moreover, there can be no assurance that the anticipated benefits of any acquisition or investment will be realized. Future acquisitions or investments by the Company could result in potentially dilutive issuances of equity securities, the incurrence of debt and contingent liabilities, amortization expenses related to goodwill and other intangible assets, any of which could materially adversely affect the Company's operating results and financial condition. Since its inception, the Company has obtained royalty-bearing grants from various Israeli government agencies. The Company received and recognized $1.6 million in such grants during 1998; however, it has not applied nor does it currently anticipate applying for future grants./1/ The Company believes these grants are no longer needed to subsidize the Company's research and development projects./1/ The terms of certain grants prohibit the manufacture of products developed under these grants outside of Israel and the transfer of technology developed pursuant to the terms of these grants to any person, without the prior written consent of the government of Israel. As a result, if the Company is unable to obtain the consent of the government of Israel, the Company may not be able to take advantage of strategic manufacturing and other opportunities outside of Israel. Since 1991, the Company has experienced significant annual increases in revenue. This growth has placed and, if it continues, will place a significant strain on the Company's management, resources and operations. To accommodate its recent growth, the Company has been implementing a variety of new or expanded business and financial systems, procedures and controls, including the improvement of its accounting and other internal management systems. There can be no assurance that the implementation of such systems, procedures and controls can be completed successfully, or without disruption of the Company's operations. If the Company's growth continues, the Company will be required to hire and integrate substantial numbers of new employees. The market has become increasingly competitive both in the United States and internationally and may require the Company to pay higher salaries. The Company's failure to manage growth effectively could have a material adverse effect on the Company's business, operating results and financial condition. The Company's success depends to a significant extent on the performance of its senior management and certain key employees. Competition for highly skilled employees, including sales, technical and management personnel, is intense in the computer industry. The Company's continued success depends in significant part on its ability to attract additional qualified employees and to retain the services of current key employees. In particular, the loss of the services of one or more of the Company's executive officers could have a material adverse effect on the Company's business and results of operations. The Company currently relies on a combination of trademark, copyright and trade secret laws and contractual provisions to protect its proprietary rights in its products. The Company presently has one registered copyright. The Company holds four patents for elements contained in certain of its products, and it has filed several other U.S. and foreign patent applications on various elements of its products. There can be no assurance that any of the Company's patent applications will result in an issued patent or that, if issued, such patent would be upheld if challenged. There can be no assurance that the Company's competitors will not independently develop technologies that are substantially equivalent or superior to the Company's technology. There can also be no assurance that the measures taken by the Company to protect its propriety rights will be adequate to prevent misappropriation of the technology or independent development by others of similar technology. In addition, the laws of various countries in which the Company's products may be sold may not protect the Company's products and intellectual property rights to the same extent as the laws of the United States. There can be no assurance that third parties will not assert intellectual property infringement claims against the Company or that any such claims will not require the Company to enter into royalty or cross-license arrangements or result in costly litigation. - -------- /1/ Forward looking statement 20 In selling its products, the Company frequently relies on "shrink wrap" licenses that are not signed by licensees. The provisions in such licenses limiting the Company's exposure to potential product liability claims may therefore be unenforceable under the laws of certain jurisdictions. Further, the Company's license agreements typically contain a representation that the software is Year 2000 compliant through its description of specifically how the Company's products process the Year 2000 calendar dates. While the Company believes its products are Year 2000 compliant, the risk of Year 2000 noncompliance claims may increase as December 31, 1999 approaches and passes. The Company currently carries errors and omissions insurance against such claims, however, there can be no assurance that such insurance will continue to be available on acceptable terms, if at all, or that such insurance will provide the Company with adequate protection against any such claims. Although the Company has not experienced any product liability or other Year 2000 claims to date, the sale and support of products by the Company may entail the risk of such claims. A significant product liability claim against the Company could have a material adverse effect upon the Company's business, financial condition and results of operations. The approach of Year 2000 presents significant issues for many computer systems, since much of the software in use today may not accurately process data beyond 1999. The Company is in the process of conducting an internal review of most of its internal corporate headquarters computer systems and software ("IT Systems") including finance, human resources, Intranet applications, payroll systems and customer support organization systems to determine their Year 2000 compliance. As part of this process, the Company is contacting vendors of its relevant corporate IT Systems to determine potential exposure to Year 2000 issues and will be obtaining written assurance from such vendors regarding Year 2000 compliance. Although the Company believes that most of its principal corporate IT Systems are Year 2000 compliant, the Company has not yet completed its assessment and testing of these systems. At this time, the Company has not determined the state of compliance of certain third-party suppliers of services such as phone companies, long distance carriers, financial institutions and electric companies. The failure of any one of these third-party suppliers could severely disrupt the Company's ability to carry on its business as well as disrupt the business of the Company's customers. The Company is in the process of polling these companies in order to determine their state of compliance and their contingency plans. Failure of the Company to provide Year 2000 compliant business solutions to its customers or to receive such business solutions from its suppliers could result in liability to the Company or otherwise have a material adverse effect on the Company's business, results of operations, financial condition and prospects. Furthermore, the Company believes that the purchasing patterns of customers and potential customers may be affected by Year 2000 issues as companies expend significant resources to correct or patch their current software systems for Year 2000 compliance. These expenditures may result in reduced funds available to purchase products and services such as those offered by the Company, which could result in a material adverse effect on the Company's business, results of operations and financial condition. The Company could be affected through disruptions in the operation of the enterprises with which the Company interacts or from general widespread problems or an economic crisis resulting from noncompliant Year 2000 systems. Despite the Company's efforts to address the Year 2000 effect on its internal systems and business operations, such effect could result in a material disruption of its business or have a material adverse effect on the Company's business, financial condition or results of operations. The Company has begun the process of developing a contingency plan to respond to any of the foregoing consequences of internal and external failures to be Year 2000 compliant. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the recorded amounts of assets and liabilities, disclosure of those assets and liabilities at the date of the financial statements and the recorded amounts of expenses during the reporting period. A change in the facts and circumstances surrounding these estimates could result in a change to the estimates and impact future operating results. Liquidity and Capital Resources At December 31, 1998, the Company's principle source of liquidity consisted of $129.9 million of cash and investments as compared to $92.3 million and $80.0 million at December 31, 1997 and 1996, respectively. 21 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 $41.9 million cash from operating activities, compared to cash generated from operating activities of $17.1 million in 1997 and cash used for operating activities of $1.6 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 an increase in deferred revenue, partially offset by an increase in 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 $14.9 million, $11.8 million and $4.6 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 $11.1 million, $7.6 million and $1.9 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 least the next twelve months./1/ 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 will adopt the provisions of SOP 98-1 in its fiscal year ending December 31, 1999, and does not expect such adoption to 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 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. In June 1998, the Financial Accounting Standards Board issued SFAS 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS 133 establishes accounting and reporting standards for derivative instruments and for hedging activities and is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. The Company does not expect the adoption of SFAS 133 to have a material impact on the Company's results of operations. - -------- /1/ Forward looking statement 22 Item 7a. Quantitative and Qualitative Disclosures about Market Risk Interest rate risk. The Company's exposure to market rate risk for changes in interest rates relates primarily to the Company's investment portfolio. The Company has not used derivative financial instruments in its investment portfolio. The Company places its investments with high quality issuers and, by policy, limits the amount of credit exposure to any one issue or issuer. At December 31, 1998, $96.1 million (74%) of the Company's cash, cash equivalents and investment portfolio carried a maturity of less than 90 days, and $109.2 million (84%) carried a maturity of less than one year. All investments mature, by policy, in less than two years. The Company has the ability and intent to hold the portfolio to maturity. The effect of a 10% rate decline would not have a material effect on the portfolio. Information about the Company's investment portfolio is set forth in Footnote 1 of Item 14(a)(1) of this Form 10-K and is incorporated herein by reference. Foreign currency risk. The Company transacts business in various foreign currencies, primarily in Europe and the Pacific Rim. Accordingly, the Company is subject to exposure from movements in foreign currency exchange rates. The Company's operating expenses in each of these countries are in the local currencies, which mitigates a significant portion of the exposure related to local currency revenues. In addition, the Company uses forward contracts to offset the effects of exchange rate changes on intercompany trade payables. The Company has not entered into forward foreign exchange contracts for speculative or trading purposes. The Company's accounting policies for these contracts are based on the Company's designation of the contracts as hedging transactions. The criteria the Company uses for designating a contract as a hedge include the contract's effectiveness in risk reduction and one-to-one matching of hedging instruments to underlying transactions. Gains and losses on forward foreign exchange contracts are recognized in income in the same period as gains and losses on the underlying transactions. The effect of an immediate 10% change in exchange rates would not have a material impact on the Company's future operating results or cash flows. At December 31, 1998, the Company had no outstanding forward foreign exchange contracts. Item 8. Financial Statements and Supplementary Data Financial statements required pursuant to this Item are presented beginning on page F-1 of this report. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure During the twenty-four month period preceding December 31, 1998, the Company neither changed accountants nor had disagreements with its accountants on any matter of accounting principles or practices, financial statement disclosure or auditing scope and procedures. 23 PART III Certain information required by Part III is omitted from this Annual Report on Form 10-K because the Company will file a definitive proxy statement within 120 days after the end of its fiscal year pursuant to Regulation 14A (the "Proxy Statement") for its Annual Meeting of Stockholders, currently scheduled for May 26, 1999, and the information included in the Proxy Statement is incorporated herein by reference. Item 10. Directors and Executive Officers of the Registrant The information concerning the Company's officers required by this Item is incorporated by reference to the section of Part I of this Annual Report on Form 10-K entitled "Item 1. Business--Personnel." The information concerning the Company's directors required by this Item is incorporated by reference to the information under the heading "Election of Directors--Nominees" in the Company's Proxy Statement. Item 11. Executive Compensation The information required by this Item is incorporated by reference to the Company's Proxy Statement under the heading "Executive Compensation." Item 12. Security Ownership of Certain Beneficial Owners and Management The information required by this Item is incorporated by reference to the Company's Proxy Statement under the heading "Security Ownership of Certain Beneficial Owners and Management." Item 13. Certain Relationships and Related Transactions The information required by this Item is incorporated by reference to the Company's Proxy Statement under the heading "Certain Transactions." 24 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (a) The following documents are filed as a part of this report: 1. Financial Statements. The following financial statements of Mercury Interactive Corporation are filed as a part of this report:
Page ---- Report of Independent Accountants..................................... F- 1 Consolidated Balance Sheets at December 31, 1998 and 1997............. F- 2 Consolidated Statements of Operations for the years ended December 31 1998, 1997 and 1996.................................................. F- 3 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1998, 1997 and 1996..................................... F- 4 Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996.................................................. F- 5 Notes to Consolidated Financial Statements............................ F- 6
2. Schedules The following financial statement schedule is filed as part of this Form 10- K: Schedule II--Valuation and Qualifying Accounts for the Three Years Ended December 31, 1998 Financial statement schedules not listed above have been omitted because they are not applicable or the required information is shown in the financial statements or notes thereto. 3. Exhibits
Description ----------- 3.1(1) Certificate of Incorporation of Registrant, as amended and restated to date. 3.2(10) Certificate of Amendment of the Restated Certificate of Incorporation 3.3(1) By-laws of Registrant, as amended to date. 10.1(11),(2) 1989 Stock Option Plan and forms of Incentive Stock Option Agreement and Nonstatutory Stock Option Agreement. 10.2(1) Form of Directors' and Officers' Indemnification Agreement. 10.3(1) Registration and Information Rights Agreement made as of March 13, 1992. 10.4(1) Lease Agreement dated August 30, 1990 between the Registrant and Reuven Down covering the property at 4 Hayotzrim Street, Or Yehudah, a suburb of Tel Aviv, Israel (translated from original Hebrew). 10.5(1) Consulting Agreement by and between the Registrant and Aryeh Finegold, dated March 1, 1992. 10.6(1) Agreement by and between Mercury Interactive (Israel) Limited, a wholly-owned subsidiary of the Registrant ("Mercury Israel"), and the Office of the Chief Scientist in the Ministry of Industry and Trade dated February 11, 1991 (translation from original Hebrew). 10.7(1) Agreement by and between Mercury Israel and the Office of the Chief Scientist in the Ministry of Industry and Trade dated February 10, 1992 (translation from original Hebrew). 10.8(1) Agreement by and between Mercury Israel and the Office of the Chief Scientist in the Ministry of Industry and Trade dated December 13, 1992 (translation from original Hebrew).
25
Description ----------- 10.9(11),(2) Form of 1998 Employee Stock Purchase Plan and form of Agreements. 10.10(1) 401(k) Plan. 10.11(1) Microsoft Solutions Channel Alliance Agreement dated March 5, 1993 between Registrant and Microsoft Corporation. 10.12(2),(4) 1994 Directors' Stock Option Plan and form of Agreements. 10.13(3) Agreement by and between Mercury Israel and the Office of the Chief Scientist in the Ministry of Industry and Trade dated May 5, 1993 (translation from original Hebrew). 10.14(3) Agreement by and between Mercury Israel and the Office of the Chief Scientist in the Ministry of Industry and Trade dated June 21, 1993 (translation from original Hebrew). 10.15(3) Agreement by and between Mercury Israel and the Fund for the Encouragement of Marketing Abroad in the Ministry of Industry and Trade dated February 15, 1993 (translation from original Hebrew). 10.16(5) Agreement by and between Mercury Israel and the Office of the Chief Scientist in the Ministry of Industry and Trade dated November 13, 1994 (translation from original Hebrew). 10.17(5) Agreement by and between Mercury Israel and the Office of the Chief Scientist in the Ministry of Industry and Trade dated November 13, 1994 (translation from original Hebrew). 10.18(6) Agreement by and between Mercury Israel and the Fund for the Encouragement of Marketing Abroad in the Ministry of Industry and Trade dated January 1, 1996 (translation from original Hebrew). 10.19(6) Agreement by and between Mercury Israel and the Office of the Chief Scientist in the Ministry of Industry and Trade dated September 30, 1995 (translation from original Hebrew). 10.20(6) Agreement by and between Mercury Israel and the Office of the Chief Scientist in the Ministry of Industry and Trade dated September 30, 1995 (translation from original Hebrew). 10.21(7) Preferred Share Purchase Rights Agreement. 10.22(8) 1996 Supplemental Stock Plan. 10.23(9) Purchase Agreement between Mercury Interactive Corporation and Dixon Software Technology dated September 30, 1997. 10.24(9) Purchase and Sale Agreement and Joint Escrow Instructions by and between Mercury Interactive Corporation and M. C. Securities, LLC dated July 1, 1997. 10.25(11),(2) 1999 Stock Option Plan 10.26 Form of Change of Control Agreements entered into by the Company with the Chairman, the Chief Executive Officer, the Chief Financial Officer and the President of North American Operations. 21.1 Subsidiaries of Registrant. 23.1 Consent of Independent Accountants. 24.1 Power of Attorney (see page 26). 27.1 Financial Data Schedule
- -------- (1) Exhibits 3.1, 3.3, 10.2, 10.3, 10.4, 10.5, 10.6, 10.7, 10.8, 10.10, and 10.11 are incorporated by reference to Exhibits 3.3, 3.4, 10.2, 10.3, 10.5, 10.7, 10.8, 10.9, 10.10, 10.12, and 10.14 respectively, filed in response to Item 16(a), "Exhibits," of the Registrant's Registration Statement on Form S-1, as amended (File No. 33-68554), which was declared effective on October 29, 1993. 26 (2) Designates management contract or compensatory plan arrangements required to be filed as an exhibit of this Annual Report on Form 10-K. (3) Exhibits 10.13, 10.14, and 10.15 are incorporated by reference to Exhibits 10.1, 10.2 and 10.3, respectively, filed with the Form 10-Q for the three month period ended March 31, 1994. (4) Exhibit 10.12 is incorporated by reference to Exhibit 10.1 filed with the Form 10-Q for the three month period ended September 30, 1994. (5) Exhibits 10.16 and 10.17 are incorporated by reference to Exhibits 10.19 and 10.20, respectively, filed with the Form 10-K for the year ended December 31, 1994. (6) Exhibits 10.18, 10.19, and 10.20 are incorporated by reference to Exhibits 10.21, 10.22, and 10.23, respectively, filed with the Form 10-K for the year ended December 31, 1995. (7) Exhibit 10.21 is incorporated by reference to the Exhibit 1 to the Company's Form 8-A, filed with the Securities and Exchange Commission on July 9, 1996. (8) Exhibit 10.22 is incorporated by reference to Exhibit 4.2 to the Company's Registration Statement on Form S-8, No. 333-09913, filed with the Securities and Exchange Commission on August 9, 1996. (9) Exhibits 10.23 and 10.24 are incorporated by reference to Exhibits 10.1 and 10.2, respectively, filed with the Form 10-Q for the three month period ended September 30, 1997. (10) Exhibit 3.2 is incorporated by reference to Exhibit 3.1 filed with the Form 10-Q for the three month period ended September 30, 1998. (11) Exhibits 10.1, 10.9, and 10.25 are incorporated by reference to Exhibits 4.1, 4.3, and 4.2, respectively, filed with the Company's Registration Statement on Form S-8, No. 333-62125, filed with the Securities and Exchange Commission on August 24, 1998. (b)Reports on Form 8-K No report on Form 8-K was filed during the fourth quarter of the year ended December 31, 1998. 27 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant, Mercury Interactive Corporation, a corporation organized and existing under the laws of the State of Delaware, has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. Mercury Interactive Corporation By /s/ Sharlene Abrams __________________________________ Sharlene Abrams, Vice President of Finance and Administration, Chief Financial Officer and Secretary Dated: March 30, 1999 KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints jointly and severally, Amnon Landan and/or Sharlene Abrams and each one of them, his or her attorneys-in-fact, each with the power of substitution, for him or her in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his or her substitute or substitutes, may do or cause to be done by virtue hereof.
Signature Title Date --------- ----- ---- /s/ Aryeh Finegold Chairman of the Board of March 30, 1999 ________________________________________ Directors Aryeh Finegold /s/ Amnon Landan President, Chief Executive March 30, 1999 ________________________________________ Officer and Director Amnon Landan (Principal Executive Officer) /s/ Sharlene Abrams Vice President of Finance March 30, 1999 ________________________________________ and Administration, Chief Sharlene Abrams Financial Officer (Principal Financial and Accounting Officer) and Secretary /s/ Igal Kohavi Director March 30, 1999 ________________________________________ Igal Kohavi /s/ Yair Shamir Director March 30, 1999 ________________________________________ Yair Shamir /s/ Giora Yaron Director March 30, 1999 ________________________________________ Giora Yaron
28 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of Mercury Interactive Corporation In our opinion, the consolidated financial statements listed in the index appearing under Item 14(a) (1) and (2) present fairly, in all material respects, the financial position of Mercury Interactive Corporation and its subsidiaries (the "Company") 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 generally accepted accounting principles. 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 generally accepted auditing standards 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. PRICEWATERHOUSECOOPERS LLP San Jose, California January 28, 1999 F-1 MERCURY INTERACTIVE CORPORATION CONSOLIDATED BALANCE SHEETS (in thousands, except per share amounts)
December 31, ------------------ 1998 1997 -------- -------- ASSETS Current assets: Cash and cash equivalents................................ $ 96,073 $ 57,211 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 Inventories.............................................. 271 252 Prepaid expenses and other current assets................ 10,255 2,954 -------- -------- Total current assets................................... 153,644 119,162 Long-term investments...................................... 20,697 3,771 Property and equipment, net................................ 28,250 19,292 Other assets............................................... 985 1,185 -------- -------- $203,576 $143,410 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable......................................... $ 4,575 $ 4,045 Accrued liabilities...................................... 17,792 12,290 Income taxes payable..................................... 11,498 3,121 Deferred revenue......................................... 24,122 10,967 -------- -------- Total current liabilities.............................. 57,987 30,423 -------- -------- Commitments and contingencies (Note 5) Stockholders' equity: Common Stock, par value $.002 per share, 120,000 shares authorized; 36,626 and 33,476 shares issued and outstanding............................................. 73 67 Capital in excess of par value........................... 124,038 107,766 Notes receivable from sale of stock...................... (5,130) -- Accumulated comprehensive income......................... (775) (424) Retained earnings........................................ 27,383 5,578 -------- -------- Total stockholders' equity............................. 145,589 112,987 -------- -------- $203,576 $143,410 ======== ========
The accompanying notes are an integral part of these consolidated financial statements. F-2 MERCURY INTERACTIVE CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share amounts)
Year ended December 31, ------------------------ 1998 1997 1996 -------- ------- ------- 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....................... 15,747 10,933 9,396 Write off of in-process research and development and related expenses................................... -- 5,500 -- Marketing and selling............................... 56,476 36,804 29,360 General and administrative.......................... 8,052 6,362 4,113 Settlement of litigation............................ -- -- 2,600 -------- ------- ------- Total operating expenses.......................... 80,275 59,599 45,469 -------- ------- ------- Income from operations................................ 22,677 6,525 2,422 Other income, net..................................... 4,579 3,109 3,361 -------- ------- ------- Income before provision for income taxes.............. 27,256 9,634 5,783 Provision for income taxes............................ 5,451 2,927 1,157 -------- ------- ------- Net income............................................ $ 21,805 $ 6,707 $ 4,626 ======== ======= ======= Net income per share (basic).......................... $ 0.62 $ 0.20 $ 0.15 ======== ======= ======= Net income per share (diluted)........................ $ 0.56 $ 0.20 $ 0.14 ======== ======= ======= Weighted average common shares (basic)................ 34,958 32,746 31,816 ======== ======= ======= Weighted average common shares (diluted).............. 39,030 34,208 33,126 ======== ======= =======
The accompanying notes are an integral part of these consolidated financial statements. F-3 MERCURY INTERACTIVE CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (in thousands)
Common stock Accumulated other ------------- --------------------------------------- Notes Retained Capital in receivable earnings/ Comprehensive Comprehensive excess of from sale Accumulated income Stockholders' income Shares Amount par value of stock deficit (loss) equity (loss) ------ ------ ---------- ---------- ----------- ------------- ------------- ------------- Balance at December 31, 1995................... 31,456 $ 63 $ 98,277 $ -- $(5,755) $ 31 $ 92,616 Net income.............. -- -- -- -- 4,626 -- 4,626 $ 4,626 Currency translation adjustment............. -- -- -- -- -- (130) (130) (130) ------ ---- -------- ------- ------- ----- -------- ------- Other comprehensive income................. 4,496 ------- Stock issued under stock option and employee stock purchase plans... 656 1 1,926 -- -- -- 1,927 ------ ---- -------- ------- ------- ----- -------- Balance at December 31, 1996................... 32,112 64 100,203 -- (1,129) (99) 99,039 Net income.............. -- -- -- -- 6,707 -- 6,707 6,707 Currency translation adjustment............. -- -- -- -- -- (325) (325) (325) ------ ---- -------- ------- ------- ----- -------- ------- Other comprehensive income................. 6,382 ------- Stock issued under stock option and employee stock purchase plans... 1,364 3 7,563 -- -- -- 7,566 ------ ---- -------- ------- ------- ----- -------- ------- Balance at December 31, 1997................... 33,476 67 107,766 -- 5,578 (424) 112,897 Net income.............. -- -- -- -- 21,805 -- 21,805 21,805 Currency translation adjustment............. -- -- -- -- -- (351) (351) (351) ------ ---- -------- ------- ------- ----- -------- ------- Other comprehensive income................. $21,454 ------- Stock issued under stock option and employee stock purchase plans... 3,150 6 16,272 $(5,130) -- -- 11,148 ------ ---- -------- ------- ------- ----- -------- Balance at December 31, 1998................... 36,626 $ 73 $124,038 $(5,130) $27,803 $(775) $145,589 ====== ==== ======== ======= ======= ===== ========
The accompanying notes are an integral part of these consolidated financial statements. F-4 MERCURY INTERACTIVE CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
Year ended December 31, --------------------------- 1998 1997 1996 -------- -------- ------- Cash flows from operating activities: Net income...................................... $ 21,805 $ 6,707 $ 4,626 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization................. 4,141 3,741 3,263 Deferred income taxes......................... (1,840) 270 674 Changes in assets and liabilities: Trade accounts receivable................... (3,902) (7,214) (6,527) Government grant and other receivables...... (4,034) (730) (564) Inventories................................. 8 345 (44) Prepaid expenses and other current assets... (1,451) 513 (1,084) Other assets................................ (400) -- -- Accounts payable............................ 899 1,800 591 Accrued liabilities......................... 5,303 4,271 (5,324) Income taxes payable........................ 8,373 2,485 237 Deferred revenue............................ 13,030 4,936 2,594 -------- -------- ------- Net cash provided by (used in) operating activities............................... 41,932 17,124 (1,558) -------- -------- ------- 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........... (14,924) (11,799) (4,596) Capitalization of software development costs.... -- (500) (1,340) -------- -------- ------- Net cash used in investing activities..... (13,622) (11,787) (1,787) -------- -------- ------- Cash flows from financing activities: Proceeds from issuance of Common Stock, net..... 16,267 7,565 1,927 Notes receivable from issuance of stock......... (5,130) -- -- -------- -------- ------- Net cash provided by financing activities............................... 11,137 7,565 1,927 -------- -------- ------- Effect of exchange rate changes on cash........... (585) (28) (95) -------- -------- ------- Net increase (decrease) in cash................... 38,862 12,874 (1,513) Cash and cash equivalents at beginning of period.. 57,211 44,337 45,850 -------- -------- ------- Cash and cash equivalents at end of period........ $ 96,073 $ 57,211 $44,337 ======== ======== ======= Supplemental Disclosure: Cash paid during the period for income taxes...... $ 1,365 $ 2,083 $ 1,182
The accompanying notes are an integral part of these consolidated financial statements. F-5 MERCURY INTERACTIVE CORPORATION NOTES TO 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. 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. 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 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 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. F-6 MERCURY INTERACTIVE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 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................ $ 20,892 $13,087 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.................................................. $129,900 $92,339 ======== =======
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 development costs as obsolete in the year ended December 31, 1997. At December 31, F-7 MERCURY INTERACTIVE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 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, $2.0 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, $2.7 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. F-8 MERCURY INTERACTIVE CORPORATION NOTES TO 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 shares issuable under the Company's stock option plans. The following table summarizes the Company's earnings per share computations for the years ended December 31, 1996, 1997 and 1998:
Average Earnings Net income shares per share ---------- ------- --------- December 31, 1996: Basic earnings per share...................... $ 4,626 31,816 $0.15 Dilutive adjustments.......................... -- 1,310 ------- ------ Diluted earnings per share.................... $ 4,626 33,126 0.14 ------- ------ December 31, 1997: Basic earnings per share...................... $ 6,707 32,746 $0.20 Dilutive adjustments.......................... -- 1,462 ------- ------ Diluted earnings per share.................... $ 6,707 34,208 0.20 ------- ------ December 31, 1998: Basic earnings per share...................... $21,805 34,958 $0.62 Dilutive adjustments.......................... -- 4,072 ------- ------ Diluted earnings per share.................... $21,805 39,030 0.56 ======= ======
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. 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. F-9 MERCURY INTERACTIVE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 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 geographical 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 will adopt the provisions of SOP 98-1 in its fiscal year ending December 31, 1999, and does not expect such adoption to 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 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. In June 1998, the Financial Accounting Standards Board issued SFAS 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS 133 establishes accounting and reporting standards for derivative instruments and for hedging activities and is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. The Company does not expect the adoption of SFAS 133 to have a material impact on the Company's results of operations. F-10 MERCURY INTERACTIVE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) NOTE 2--FINANCIAL STATEMENT COMPONENTS
December 31, ------------------ 1998 1997 -------- -------- (in thousands) Government grant and other receivables: Government grant 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................................................ 2,698 1,527 -------- -------- $ 10,255 $ 2,954 ======== ======== Property and equipment: Land................................................. $ 4,807 $ 5,128 Buildings............................................ 13,504 6,712 Computers and equipment.............................. 17,819 13,722 Office furniture and equipment....................... 4,433 2,186 Leasehold improvements............................... 2,902 2,154 -------- -------- 43,465 29,902 Less: accumulated depreciation and amortization...... (15,215) (10,610) -------- -------- $ 28,250 $ 19,292 ======== ======== Accrued liabilities: Payroll and accrued commissions (including payroll taxes).............................................. $ 8,759 $ 4,822 Vacation and severance............................... 3,422 2,517 Acquisition of technologies and related costs........ -- 2,316 Royalties............................................ 2,177 1,357 Other................................................ 3,434 1,278 -------- -------- $ 17,792 $ 12,290 ======== ========
Year ended December 31, ---------------------- 1998 1997 1996 ------ ------ ------ (in thousands) Other income, net: Interest income.................................... $4,680 $3,547 $3,148 Foreign exchange gains (losses) and other.......... (101) (438) 213 ------ ------ ------ $4,579 $3,109 $3,361 ====== ====== ======
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 F-11 MERCURY INTERACTIVE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 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):
Options outstanding ---------------- Weighted Options Number average available of exercise for grant shares price --------- ------ -------- 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.................... 2,214 -- -- Options granted................................. (2,632) 2,632 13.04 Options canceled................................ 456 (456) 8.86 Options exercised............................... -- (3,040) 5.44 ------ ------ Balance outstanding at December 31, 1998.......... 54 5,832 $8.99 ====== ======
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. F-12 MERCURY INTERACTIVE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 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):
Options outstanding Options exercisable -------------------------------- -------------------- Weighted average Weighted Weighted Range of remaining average Number average exercise Number contractual exercise exercisable exercise prices outstanding life (yr.) price at 12/31/98 price -------- ----------- ----------- -------- ----------- -------- $ 0.15-- 6.13........... 1,440 5.86 $ 4.89 528 $ 4.95 $ 6.19-- 7.63........... 1,654 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 ----- ----- 5,832 7.77 $ 8.99 1,412 $ 6.34 ===== =====
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. F-13 MERCURY INTERACTIVE CORPORATION NOTES TO 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):
Options outstanding --------------- Options Number Weighted available of average for grant shares price --------- ------ -------- 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 ==== ===
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):
Options outstanding Options exercisable -------------------------------- -------------------- Weighted average Weighted Weighted Range of remaining average Number average exercise Number contractual exercise exercisable exercise prices outstanding life (yr.) price at 12/31/98 price -------- ----------- ----------- -------- ----------- -------- $ 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 === ===
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. F-14 MERCURY INTERACTIVE CORPORATION NOTES TO 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:
1998 1997 1996 ------- ---- ----- Pro forma net income (loss) (in thousands).............. $10,162 $596 $(437) Pro forma net income (loss) per share (basic)........... 0.29 0.02 (0.02) Pro forma net income (loss) per share (diluted)......... 0.26 0.02 (0.02)
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:
Option plans ESPP ---------------- ---------------- 1998 1997 1996 1998 1997 1996 ---- ---- ---- ---- ---- ---- 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
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. NOTE 4--INCOME TAXES Income (loss) before income taxes consists of the following (in thousands):
Year ended December 31, --------------------- 1998 1997 1996 ------- ------ ------ Domestic.............................................. $ 6,939 $ 16 $ (933) Foreign............................................... 20,317 9,618 6,716 ------- ------ ------ $27,256 $9,634 $5,783 ======= ====== ======
F-15 MERCURY INTERACTIVE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The provision for income taxes is comprised of the following (in thousands):
Year ended December 31, ---------------------- 1998 1997 1996 ------- ------ ------ 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 ======= ====== ======
Deferred tax assets consist of the following (in thousands):
December 31, --------------- 1998 1997 ------ ------- Tax credits................................................. $ 253 $ 860 Accruals and reserves....................................... 1,821 972 Other....................................................... (234) 357 ------ ------- 1,840 2,189 Valuation allowance......................................... -- (2,189) ------ ------- $1,840 $ -- ====== =======
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):
December 31, ------------------------- 1998 1997 1996 ------- ------- ------- Statutory federal tax........................... $ 9,267 $ 3,276 $ 2,024 State tax, net of federal benefit............... 350 549 58 Foreign rate differentials from U.S. statutory rate........................................... (5,208) (2,739) (2,194) Non-deductible expenses......................... -- 51 68 Non-utilized net operating losses............... 2,051 2,390 1,746 Tax-exempt interest............................. (409) (756) (779) Other........................................... (520) 156 234 ------- ------- ------- $ 5,451 $ 2,927 $ 1,157 ======= ======= =======
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. F-16 MERCURY INTERACTIVE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 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, $2.0 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, $2.7 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.................................. $1,519 2000.................................. 1,114 2001.................................. 379 2002.................................. 191 2003.................................. 83 ------ Total............................... $3,286 ======
Total rent expense under operating leases amounted to $1.9 million, $1.5 million, and $1.0 million for the years ended December 31, 1998, 1997 and 1996, respectively. F-17 MERCURY INTERACTIVE CORPORATION NOTES TO 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 443,214 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
Year ended December 31, -------------------------- 1998 1997 1996 -------- -------- -------- (in thousands) 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................... 27,437 20,193 15,781 -------- -------- -------- Consolidated................................. $203,576 $143,410 $117,489 ======== ======== ========
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. F-18 MERCURY INTERACTIVE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 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. 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. F-19 MERCURY INTERACTIVE CORPORATION UNAUDITED QUARTERLY FINANCIAL DATA
Quarter ended --------------------------------------------------------------------------- Dec. 31, Sept. 30, June 30, March 31, Dec. 31, Sept. 30, June 30, March 31, 1998 1998 1998 1998 1997 1997 1997 1997 -------- --------- -------- --------- -------- --------- -------- --------- (in thousands, except per share amounts) Revenue: License................ $28,200 $21,550 $19,100 $15,600 $18,800 $14,300 $12,300 $11,283 Service................ 12,800 9,050 8,100 6.600 5,400 5,300 5,200 4,117 ------- ------- ------- ------- ------- ------- ------- ------- Total revenue.......... 41,000 30,600 27,200 22,200 24,200 19,600 17,500 15,400 ------- ------- ------- ------- ------- ------- ------- ------- Cost of revenue: License................ 1,867 1,545 1,550 1,329 1,382 1,073 992 904 Service................ 3,864 2,959 2,600 2,334 1,879 1,520 1,612 1,214 ------- ------- ------- ------- ------- ------- ------- ------- Total cost of revenue.. 5,731 4,504 4,150 3,663 3,261 2,593 2,604 2,118 ------- ------- ------- ------- ------- ------- ------- ------- Gross profit............ 35,269 26,096 23,050 18,537 20,939 17,007 14,896 13,282 ------- ------- ------- ------- ------- ------- ------- ------- Operating expenses: Research and development, net...... 4,970 4,098 3,656 3,023 2,479 2,970 2,928 2,556 Write off of in-process research and development and related expenses...... -- -- -- -- -- 5,500 -- -- Marketing and selling.. 17,968 14,146 13,379 10,983 11,302 9,154 8,574 7,774 General and administrative........ 2,262 2,042 1,899 1,849 1,583 1,786 1,563 1,430 ------- ------- ------- ------- ------- ------- ------- ------- Total operating expenses.............. 25,200 20,286 18,934 15,855 15,364 19,410 13,065 11,760 ------- ------- ------- ------- ------- ------- ------- ------- Income (loss) from operations............. 10,069 5,810 4,116 2,682 5,575 (2,403) 1,831 1,522 Other income, net....... 1,590 1,214 925 850 738 816 846 709 ------- ------- ------- ------- ------- ------- ------- ------- Income (loss) before provision for income taxes.................. 11,659 7,024 5,041 3,532 6,313 (1,587) 2,677 2,231 Provision for income taxes.................. 2,332 1,405 1,008 706 1,263 683 535 446 ------- ------- ------- ------- ------- ------- ------- ------- Net income (loss)....... $ 9,327 $ 5,619 $ 4,033 $ 2,826 $ 5,050 $(2,270) $ 2,142 $ 1,785 ======= ======= ======= ======= ======= ======= ======= ======= Net income (loss) per share (basic).......... $ 0.26 $ 0.16 $ 0.12 $ 0.08 $ 0.15 $ (0.07) $ 0.07 $ 0.06 ======= ======= ======= ======= ======= ======= ======= ======= Net income (loss) per share (diluted)........ $ 0.23 $ 0.14 $ 0.10 $ 0.07 $ 0.14 $ (0.07) $ 0.06 $ 0.05 ======= ======= ======= ======= ======= ======= ======= ======= Weighted average common shares (basic)......... 36,306 34,976 34,570 33,984 33,306 32,866 32,534 32,274 ======= ======= ======= ======= ======= ======= ======= ======= Weighted average common shares (diluted)....... 39,902 39,114 38,820 38,282 36,678 32,866 34,002 33,288 ======= ======= ======= ======= ======= ======= ======= =======
F-20 SCHEDULE II MERCURY INTERACTIVE CORPORATION VALUATION AND QUALIFYING ACCOUNTS For the Three Years Ended December 31, 1998 (In thousands)
Additions Balance at charged to Deductions Balance at beginning costs and bad debts end of Description of period expenses charged off period ----------- ---------- ---------- ----------- ---------- Reserve for sales returns and doubtful accounts receivable: December 31, 1998.............. $1,878 $2,943 $1,198 $3,623 December 31, 1997.............. $1,136 $1,927 $1,185 $1,878 December 31, 1996.............. $ 705 $2,831 $2,400 $1,136
EX-10.26 2 CHANGE OF CONTROL AGREEMENT Exhibit 10.26 February 26, 1998 ________________ Re: Change of Control Agreement Dear __________: As we have discussed, Mercury Interactive Corporation (the "Company") has agreed to extend certain benefits to you in the event your employment with the Company is terminated within eighteen months of a "Change of Control" of the Company. This letter sets out the terms of our agreement (the "Letter"). Capitalized terms are defined on Exhibit A, attached. 1. Severance Benefits. If you or the Company terminate your employment at ------------------ any time within the Change of Control Period, then you will be entitled to receive severance benefits as follows: (a) Voluntary Resignation; Termination for Cause. If you terminate your employment by reason of voluntary resignation (and not by Involuntary Termination) or if you are terminated for Cause, then you will not be entitled to receive severance or other benefits. (b) Involuntary Termination. If your employment is terminated or you terminate your employment as a result of Involuntary Termination, you will be entitled to receive the following benefits: (i) severance pay, based upon your base compensation as of the date your employment ceases, in an amount equal to one year of base compensation. Any amount payable shall be paid at the regular base compensation rate during the Severance Period, according to normal Company payroll practices and commencing with the month immediately after the month in which your employment so ceases; (ii) coverage under the Company's health, life, dental and other insurance programs for the Severance Period; and (iii) accelerated vesting of all stock options held by you, including those granted after this Letter. (c) Disability; Death. If the Company terminates your employment as a result of your Disability (as defined below) or such employment is terminated by your death, then such termination shall be treated as if it were an Involuntary Termination, and the severance and other benefits shall be provided, in accordance with subsection (b) above. 2. Successors. Any successor to the Company (whether direct or indirect and ---------- whether by purchase, lease, merger, consolidation, liquidation or otherwise) to all or substantially all of the Company's business and/or assets shall assume the obligations under this Letter and agree expressly to perform the obligations under this Letter in the same manner and to the same extent as the Company would be required to perform such obligations in the absence of a succession. For all purposes under this Letter, the term "Company" shall include any successor to the Company's business and/or assets which executes and delivers the assumption agreement described in this Section 3 or which becomes bound by the terms of this Letter by operation of law. 3. Law Governing; Arbitration. This Letter shall be governed by and -------------------------- construed in accordance with the laws of the State of California. Any dispute or controversy arising under or in connection with this Letter shall be settled exclusively in arbitration conducted in Sunnyvale, California, in accordance with the rules of the American Arbitration Association then in effect. Judgment may be entered on the arbitrator's award in any court having jurisdiction. Punitive damages shall not be awarded. In any arbitration proceeding, the party determined to be the prevailing party shall be entitled to receive, in addition to any other award, its attorneys' fees and expenses of the proceeding. 4. Employment and Income Taxes. All payments made pursuant to this Letter --------------------------- will be subject to withholding of employment taxes. By your signature below, you indicate that you agree to the terms set out in this Letter. Very truly yours, MERCURY INTERACTIVE CORPORATION By:___________________________________ Title:________________________________ ACKNOWLEDGED AND AGREED: ____________________________________ Date:_______________________________ EXHIBIT A Definition of Terms. The following terms referred to in this Letter shall have - ------------------- the following meanings: "Cause" means (i) any act of personal dishonesty taken by you in connection with ----- your responsibilities as an employee and intended to result in substantial personal enrichment; (ii) your being convicted of a felony; or (iii) a willful act by you which constitutes gross misconduct and which is injurious to the Company. "Change of Control" means the occurrence of any of the following events: ----------------- (a) Any "person" (as such term is used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended), excluding existing beneficial owners as of the date of this Letter, is or becomes the "beneficial owner" (as defined in Section 13d-3 of said Act), directly or indirectly, of securities of the Company representing 50% or more of the total voting power represented by the Company's then outstanding voting securities, excluding conversion of any convertible securities issued as of the date of this Letter; (b) The composition of the Board of Directors changes during any period of 36 months such that individuals who at the beginning of the period were members of the Board of Directors (the "Continuing Directors") cease for any reason to constitute at least a majority thereof; unless at least 66-2/3% of the Continuing Directors has either (i) approved the election of the new Directors, (ii) if the election of the new Directors is voted on by shareholders, recommended that the shareholders vote for approval, or (iii) otherwise determined that such change in composition does not constitute a Change of Control, even if the Continuing Directors do not constitute a quorum of the whole Board (it being understood that this requirement shall not be capable of satisfaction unless there is at least one Continuing Director); (c) The shareholders of the Company approve a merger or consolidation of the Company with any other corporation, other than a merger or consolidation which would result in the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity) at least 50% of the total voting power represented by the voting securities of the Company or such surviving entity outstanding immediately after such merger or consolidation, or the shareholders of the Company approve a plan of complete liquidation of the Company or an agreement for the sale or disposition by the Company of all or substantially all of the Company's assets; (d) Any other provision of this subsection notwithstanding, the term Change of Control shall not include either of the following events undertaken at the election of the Company: (i) Any transaction, the sole purpose of which is to change the state of the Company's incorporation; or (ii) A transaction, the result of which is to sell all or substantially all of the assets of the Company to another corporation (the "surviving corporation") provided that the surviving corporation is owned directly or indirectly by the shareholders of the Company immediately following such transaction in substantially the same proportions as their ownership of the Company's common stock immediately preceding such transaction. "Change of Control Period" means the period beginning with the date that a ------------------------ Change of Control has occurred (as determined by the Board of Directors of the Company) and ending eighteen months later. "Disability" means that you suffer from a physical or mental disability to an ---------- extent that renders it impracticable for you to continue performing your duties hereunder. You shall be deemed to be so disabled if (i) a physician selected by the Company (and the Company will use its best efforts to coordinate such determination by the physician with the Company's long term disability insurance carrier) advises the Company that your physical or mental condition will render you unable to perform your duties for a period exceeding three consecutive months, or (ii) due to a physical or mental condition, you have not substantially performed your duties hereunder for a period of three consecutive months. "Involuntary Termination" means (i) without your consent, your assignment to ----------------------- any duties or the significant reduction of your duties, either of which is inconsistent with your position or title with the Company and responsibilities in effect immediately prior to such assignment, or your removal from such position and responsibility, or a reduction in your title; (ii) a greater than 10% reduction by the Company in your base compensation as in effect immediately prior to such reduction; provided, however, that such reduction shall not apply if substantially all executive officers of the Company agree to a similar reduction in base compensation; or (iii) any purported termination of you by the Company (other than a voluntary termination initiated by the Executive) which is not effected for Disability or for Cause. "Severance Period" means the twelve month period following your termination of ---------------- employment. EX-21.1 3 SUBSIDIARIES OF REGISTRANT EXHIBIT 21.1 SUBSIDIARIES OF REGISTRANT Mercury Interactive (Israel) Limited, incorporated under the laws of Israel Mercury Interactive (UK) LTD., incorporated under the laws of the United Kingdom Mercury Interactive France SARL, incorporated under the laws of France Mercury Interactive GmbH, incorporated under the laws of Germany Mercury Interactive (Europe) BV, incorporated under the laws of The Netherlands Mercury Interactive (Canada) Inc., incorporated under the laws of Canada Mercury Interactive Japan K.K., incorporated under the laws of Japan Mercury Interactive (Australia) Pty ltd., incorporated under laws of Australia Mercury Interactive (Singapore) LTD., incorporated under the laws of Singapore Mercury Interactive (Belgium)--Benelux Branch, registered under the laws of Belgium Mercury Interactive Brasil Limitada, incorporated under the laws of Brazil Mercury Interactive NORDIC AB, incorporated under the laws of Norway EX-23.1 4 CONSENT OF PRICEWATERHOUSECOOPERS LLP 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, and 333-62125) of Mercury Interactive Corporation of our report dated January 28, 1999 appearing on page F-1 of this Form 10-K. PRICEWATERHOUSECOOPERS LLP San Jose, California March 30, 1999 EX-27 5 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10K AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 20,892,000 109,008,000 31,526,000 3,623,000 271,000 153,644,000 43,465,000 (15,215,000) 203,576,000 57,987,000 0 0 0 73,000 145,516,000 203,576,000 0 121,000,000 18,048,000 18,048,000 80,275,000 0 0 27,256,000 5,451,000 21,805,000 0 0 0 21,805,000 0.62 0.56
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